<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q/A
<TABLE>
<S> <S>
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
</TABLE>
Commission file number 000-19480
MEDAPHIS CORPORATION
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 58-1651222
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2700 CUMBERLAND PARKWAY, SUITE 300 30339
ATLANTA, GEORGIA (Zip code)
(Address of principal executive offices)
</TABLE>
(770) 444-5300
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares of stock outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
CLASS OUTSTANDING AT APRIL 30, 1997
----- -----------------------------
<C> <C>
Common Stock
$0.01 PAR VALUE 72,429,480 SHARES
Non-voting Common Stock
$0.01 PAR VALUE 0 SHARES
</TABLE>
================================================================================
<PAGE> 2
MEDAPHIS CORPORATION
FORM 10-Q/A
MARCH 31, 1997
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Part I: Financial Information
Consolidated Statements of Operations for the three months
ended March 31, 1997 and 1996.......................... 3
Consolidated Balance Sheets as of March 31, 1997 and
December 31, 1996...................................... 4
Consolidated Statements of Cash Flows for the three months
ended March 31, 1997 and 1996.......................... 5
Notes to Consolidated Financial Statements................ 6
Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 18
Part II: Other Information
Legal Proceedings......................................... 24
Other Information......................................... 26
Exhibits and Reports on Form 8-K.......................... 27
Index to Exhibits......................................... 30
</TABLE>
---------------------
THIS FORM 10-Q/A AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY
MEDAPHIS CORPORATION OR ITS REPRESENTATIVES CONTAIN STATEMENTS WHICH MAY
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE SECURITIES ACT
OF 1933 AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995. 15 U.S.C.A. SECTIONS 77Z-2 AND 78U-5
(SUPP. 1996). THOSE STATEMENTS INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF
OR CURRENT EXPECTATIONS OF MEDAPHIS CORPORATION AND MEMBERS OF ITS MANAGEMENT
TEAM AS WELL AS THE ASSUMPTIONS ON WHICH SUCH STATEMENTS ARE BASED. PROSPECTIVE
INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH
FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS CURRENTLY KNOWN TO MANAGEMENT THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN FORWARD-LOOKING
STATEMENTS ARE SET FORTH IN THE SAFE HARBOR COMPLIANCE STATEMENT FOR
FORWARD-LOOKING STATEMENTS INCLUDED AS EXHIBIT 99.1 TO THIS FORM 10-Q/A, AND ARE
HEREBY INCORPORATED HEREIN BY REFERENCE. THE COMPANY UNDERTAKES NO OBLIGATION TO
UPDATE OR REVISE FORWARD-LOOKING STATEMENTS TO REFLECT CHANGED ASSUMPTIONS, THE
OCCURRENCE OF UNANTICIPATED EVENTS OR CHANGES TO FUTURE OPERATING RESULTS OVER
TIME.
2
<PAGE> 3
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------------
1997 1996
-------------- --------------
(AS RESTATED, (AS RESTATED,
SEE NOTE 8) SEE NOTE 8)
<S> <C> <C>
Revenue..................................................... $147,546 $162,249
Salaries and wages.......................................... 93,578 91,730
Other operating expenses.................................... 40,242 39,335
Depreciation................................................ 6,985 5,940
Amortization................................................ 6,114 6,533
Interest expense, net....................................... 6,115 2,105
Restructuring and other charges............................. -- 306
-------- --------
Total expenses.................................... 153,034 145,949
Income (loss) before income taxes........................... (5,488) 16,300
Income tax (benefit) expense................................ (2,424) 7,230
-------- --------
Net income (loss)................................. (3,064) 9,070
Pro forma income tax adjustments............................ -- 354
-------- --------
Pro forma net income (loss)....................... $ (3,064) $ 9,424
======== ========
Pro forma net income (loss) per common share................ $ (0.04) $ 0.12
======== ========
Weighted average shares outstanding......................... 72,235 75,704
======== ========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE DATA)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
-------------- --------------
(UNAUDITED)
(AS RESTATED, (AS RESTATED,
SEE NOTE 8) SEE NOTE 8)
<S> <C> <C>
ASSETS
Current Assets:
Cash...................................................... $ 10,174 $ 7,631
Restricted cash........................................... 19,952 19,568
Accounts receivable, billed............................... 101,728 99,823
Accounts receivable, unbilled............................. 75,017 79,911
Deferred tax asset........................................ 36,177 36,177
Other..................................................... 13,809 12,129
-------- ---------
Total current assets.............................. 256,857 255,239
Property and equipment...................................... 92,798 97,850
Deferred tax asset.......................................... 45,473 43,044
Intangible assets........................................... 531,852 539,151
Other....................................................... 3,698 1,570
-------- ---------
$930,678 $ 936,854
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 14,698 $ 11,765
Accrued compensation...................................... 34,086 30,332
Accrued expenses.......................................... 90,710 100,675
Current portion of long-term debt......................... 106,955 55,975
-------- ---------
Total current liabilities......................... 246,449 198,747
Long-term debt.............................................. 162,720 215,752
Other obligations........................................... 12,331 13,830
-------- ---------
Total liabilities................................. 421,500 428,329
-------- ---------
Stockholders' Equity:
Common stock, voting, $0.01 par value, 200,000 authorized
in 1997 and 1996; issued and outstanding 72,417 in 1997
and 71,705 in 1996..................................... 724 717
Common stock, non voting, $0.01 par value, 600 authorized
in 1997 and 1996; none issued.......................... -- --
Paid-in capital........................................... 670,336 666,673
Accumulated deficit....................................... (161,882) (158,696)
-------- ---------
509,178 508,694
Less treasury stock, at cost -- 16 shares in 1996......... -- (169)
-------- ---------
Total stockholders' equity........................ 509,178 508,525
-------- ---------
$930,678 $ 936,854
======== =========
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------------
1997 1996
------------- -------------
(AS RESTATED, (AS RESTATED,
SEE NOTE 8) SEE NOTE 8)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $ (3,064) $ 9,070
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Depreciation and amortization.......................... 13,099 12,473
(Gain) loss on sale of property and equipment.......... (102) 210
Deferred income taxes.................................. (2,429) 7,230
Changes in assets and liabilities, excluding effects of
acquisitions:
Increase in accounts receivable, billed.............. (1,905) (16,195)
Decrease (increase) in accounts receivable,
unbilled............................................ 4,893 (7,115)
Increase (decrease) in accounts payable.............. 2,933 (8,634)
Increase in accrued compensation..................... 3,754 9,016
Decrease in accrued expenses......................... (10,260) (9,629)
Other, net........................................... (1,042) (598)
-------- --------
Net cash provided by (used for) operating
activities...................................... 5,877 (4,172)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash acquired........................ (769) (5,722)
Purchases of property and equipment....................... (3,400) (19,467)
Proceeds from sale of property and equipment.............. 3,644 13
Software development costs................................ (1,398) (13,419)
-------- --------
Net cash used for investing activities............ (1,923) (38,595)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock.................... 3,618 7,660
Proceeds from borrowings.................................. 10,000 43,566
Principal payments of long-term debt...................... (12,020) (13,782)
Other..................................................... (3,009) 3,819
-------- --------
Net cash (used for) provided by financing
activities...................................... (1,411) 41,263
-------- --------
CASH:
Net change................................................ 2,543 (1,504)
Balance at beginning of period............................ 7,631 18,979
-------- --------
Balance at end of period.................................. $ 10,174 $ 17,475
======== ========
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest............................................... $ 4,615 $ 3,551
Income taxes........................................... 612 629
Non-cash investing and financing activities:
Liabilities assumed in acquisitions.................... -- 2,027
Additions to capital lease obligations................. -- 9,190
Common stock issued upon conversion of subordinated
debentures............................................ -- 63,375
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Medaphis Corporation ("Medaphis" or the "Company") are presented in accordance
with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X. For further
information, the reader of this Form 10-Q/A may wish to refer to the audited
consolidated financial statements of the Company for the fiscal years ended
December 31, 1996 and 1997 included in the Company's Annual Report on Form 10-K
filed February 2, 1998 ("10-K").
The unaudited condensed financial information has been prepared in
accordance with the Company's customary accounting policies and practices. In
the opinion of management, all adjustments, consisting of normal recurring
adjustments considered necessary for a fair presentation of results for the
interim period, have been included.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. Actual results could differ from those estimates.
As in the past, the Company's consolidated financial statements have been
prepared on a going concern basis which contemplates the realization of assets
and the settlement of liabilities and commitments in the normal course of
business. On March 31, 1997, the Company's independent auditors noted in a
modifying fourth paragraph to their unqualified independent report on the
Company's financial statements included in the 10-K that, because the Company's
plans to divest of certain assets to generate funds to meet scheduled 1997
amortization requirements did not then include binding contracts to dispose of
these assets, and because no other contractual arrangements were in place to
refinance or raise additional funds to otherwise satisfy such required debt
reduction, substantial doubt was raised about the Company's ability to continue
as a going concern. As discussed in Note 7, the Company's cash flow from
operations will not be sufficient to satisfy required reductions in the
Company's outstanding borrowings; however, as discussed in the next paragraph,
the Company has adopted plans to divest certain assets which management believes
will generate the necessary cash flows to satisfy these required debt
reductions. The Company's consolidated financial statements do not include any
adjustments relating to the recoverability and classification of liabilities
that may be necessary should the Company, contrary to plans and expectations, be
unable to continue as a going concern.
As previously discussed in the Company's 10-K, the Company and its lenders
have always contemplated that the contractual amortization of loan commitments
under the Second Amended and Restated Loan Facility (the "Second Amended
Facility") would be accomplished through asset divestitures since operating cash
flow was never intended to be utilized for this purpose and would be
insufficient to meet these obligations. Also as previously announced and
pursuant to the Company's 1997 business plan, the Company is pursuing the sale
of Healthcare Recoveries, Inc. ("HRI") and the assessment of alternatives for
its client/server integration businesses (the "BSG Group"). On April 22, 1997,
the Company announced that its two-pronged divestiture strategy for HRI, either
through a private sale or an initial public offering (in which it is being
advised by Bear, Stearns & Co. Inc.) continued to be on track. The Company also
reported that one or more private sale preliminary indications of interest for
the purchase of HRI have been received that are in excess of the funds required
to satisfy 1997 amortization obligations under the Second Amended Facility. The
Company has also filed the HRI registration statement with the SEC which is
completing its review process. The preliminary prospectus (subject to
completion) was distributed by the Company during the week of April 28, 1997.
The Company remains confident that it will be able to meet its amortization
obligations under the Second Amended Facility through the continued execution of
the Company's 1997 business plan and related asset divestiture program.
6
<PAGE> 7
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 2 -- LEGAL MATTERS
The United States Attorney's Office for the Central District of California
is conducting an investigation (the "Federal Investigation") of Medaphis'
billing and collection practices in its offices located in Calabasas and
Cypress, California (the "Designated Offices"). Medaphis first became aware of
the Federal Investigation when it received search warrants and grand jury
subpoenas on June 13, 1995. Although the precise scope of the Federal
Investigation is not known to the Company at this time, Medaphis believes that
the U.S. Attorney's Office is investigating allegations of billing fraud and
that the inquiry is focused upon Medaphis' billing and collection practices in
the Designated Offices. Numerous federal and state civil and criminal laws
govern medical billing and collection activities. In general, these laws provide
for various fines, penalties, multiple damages, assessments and sanctions for
violations, including possible exclusion from Medicare, Medicaid and certain
other federal and state healthcare programs. Although the Designated Offices
represent less than 2% of Medaphis' annual revenue, there can be no assurance
that the Federal Investigation will be resolved promptly, that additional
subpoenas or search warrants will not be received by Medaphis or that the
Federal Investigation will not have a material adverse effect upon the Company.
The Company recorded charges of $12 million in the third quarter of 1995 and $2
million in the fourth quarter of 1996, solely for the administrative fees, costs
and expenses it anticipates incurring in connection with the Federal
Investigation and the putative class action lawsuits described below which were
filed following the Company's announcement of the Federal Investigation. The
charges are intended to cover only the anticipated expenses of the Federal
Investigation and the related lawsuits and do not include any provision for
fines, penalties, damages, assessments, judgments or sanctions that may arise
out of such matters.
Following the announcement of the Federal Investigation, Medaphis, various
of its current and former officers and directors and the lead underwriters
associated with Medaphis' public offering of common stock in April 1995 were
named as defendants in putative shareholder class action lawsuits filed in the
United States District Court for the Northern District of Georgia. In general,
these lawsuits allege violations of the federal securities laws in connection
with Medaphis' public statements and filings under the federal securities acts,
including the registration statement filed in connection with Medaphis' public
offering of common stock in April 1995. On October 13, 1995, the named
plaintiffs in these lawsuits filed a consolidated class action complaint (the
"Consolidated Complaint"). On January 3, 1996, the court denied defendants'
motion to dismiss the Consolidated Complaint. On April 11, 1996, certain of the
named plaintiffs to the Consolidated Complaint voluntarily dismissed with
prejudice all of their claims. As a result of these dismissals, the Consolidated
Complaint no longer contains any claims based on the Securities Act of 1933, as
amended, and the Company's underwriters and outside directors are no longer
named as defendants. On June 26, 1996, the court denied the plaintiffs' motion
to certify a plaintiffs' class. The plaintiffs and the defendants have reached
an agreement in principle to settle this action on a class-wide basis for $4.75
million, subject to court approval and other customary conditions (the "1995
Class Action Settlement"). The 1995 Class Action Settlement would also include
the related putative class action lawsuit currently pending in the Superior
Court of Cobb County, Georgia, described more fully below. The Company expects
to receive approximately $3.7 million from insurance to fund a portion of the
1995 Class Action Settlement and accrued approximately $1.2 million in the
quarter ending December 31, 1996 to fund the anticipated balance of the 1995
Class Action Settlement and to pay certain fees incident thereto.
On November 5, 1996, Medaphis, Randolph G. Brown, Michael R. Cote and James
S. Douglass were named as defendants in a putative shareholder class action
lawsuit filed in Superior Court of Cobb County, State of Georgia. This lawsuit
alleges violations of Georgia securities laws based on the same public
statements and filings generally described above. The lawsuit is brought on
behalf of a putative class of purchasers of Medaphis common stock during the
period from March 29, 1995 through June 15, 1995. The plaintiffs seek
compensatory damages and costs. As noted above, it is currently contemplated
that this action will be settled as part of the 1995 Class Action Settlement.
7
<PAGE> 8
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
The Company and its clients from time to time have received, and the
Company anticipates that they will receive in the future, official inquiries
(including subpoenas, search warrants, as well as informal requests) concerning
particular billing and collection practices related to certain subsidiaries of
the Company and its many clients. In March 1997, the Company was informed by the
Civil Division of the Department of Justice that it is investigating allegations
concerning the Company's Gottlieb's Financial Services, Inc. ("GFS") subsidiary.
The Company has received a request from the Department of Justice for records,
and may receive additional requests. The Company intends to cooperate in
producing records. There can be no assurance that this matter will be resolved
promptly or that the investigation will not have a material adverse effect upon
Medaphis.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its current and former
officers, one of whom was also a director, were named as defendants in nineteen
putative shareholder class action lawsuits filed in the United States District
Court for the Northern District of Georgia. On November 22, 1996, the plaintiffs
in these lawsuits filed a Consolidated Amended Class Action Complaint (the "1996
Consolidated Complaint"). In general, the 1996 Consolidated Complaint alleges
violations of the federal securities laws in connection with Medaphis' filings
under the federal securities acts and public disclosures. The 1996 Consolidated
Complaint is brought on behalf of a class of all persons who purchased or
otherwise acquired Medaphis common stock between January 6, 1996 and October 21,
1996. The 1996 Consolidated Complaint also asserts claims on behalf of a
sub-class of all persons who acquired Medaphis common stock pursuant to the
merger between Medaphis and Health Data Sciences Corporation ("HDS"). On
December 30, 1996, the defendants filed a motion to dismiss most of the 1996
Consolidated Complaint. On February 3, 1997, the plaintiffs filed a Consolidated
Second Amended Complaint. On February 14, 1997, the defendants moved to dismiss
the Consolidated Second Amended Complaint in its entirety.
On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit
Sharing Plan filed a shareholder derivative lawsuit in the United States
District Court for the Northern District of Georgia alleging that certain of
Medaphis' current and former directors breached their fiduciary duties, were
grossly negligent, and breached various contractual obligations to Medaphis by
allegedly failing to implement and maintain an adequate system of internal
accounting controls, allowing Medaphis to commit securities law violations and
damaging Medaphis' reputation. The plaintiff seeks compensatory damages and
costs. On January 28, 1997, Medaphis and certain individual defendants filed a
motion to dismiss the complaint. On February 11, 1997, the plaintiff filed an
amended complaint adding as defendants additional current and former directors
and officers of Medaphis. On April 23, 1997, Medaphis and certain of the
defendants filed a motion to dismiss the amended complaint.
On November 7, 1996, Health Systems International, Inc. filed suit in the
Superior Court for the State of California, County of Los Angeles against
Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed
Medaphis directors, officers and employees. Generally, this lawsuit alleges that
the defendants violated federal and California securities laws and common law
by, among other things more fully described in the complaint, making material
misstatements and omissions in public and private disclosures in connection with
the acquisition of HDS. Plaintiff seeks rescissory, compensatory and punitive
damages, rescission, injunctive relief and costs. On January 10, 1997, the
defendants filed a demurrer to the complaint. The demurrer was denied on
February 5, 1997. On March 18, 1997, the court denied the plaintiff's motion for
a preliminary injunction. As a result of the Company's restatement of its fiscal
1995 financial statements, the Company may not be able to sustain a defense to
strict liability on certain claims under the 1933 Act, but the Company believes
that it has substantial defenses to the alleged damages relating to the 1933 Act
claims.
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberg against Steven G. Papermaster, Robert E. Pickering, Jr., David S.
Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and
Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division,
8
<PAGE> 9
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Essex County, State of New Jersey. The alleged class consists of persons and
entities whose options to purchase BSG Corporation ("BSG") common stock were
converted to Medaphis stock options in connection with Medaphis' acquisition of
BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary
duties of candor, loyalty and fair dealing and negligence against the BSG
defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud
and deceit against the Medaphis defendants (Medaphis and Brown). On April 18,
1997, the Medaphis defendants and BSG defendants filed motions to dismiss the
complaint.
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control made a demand for indemnification under an indemnification
agreement executed by Medaphis in connection with its acquisition of BSG in May
1996. On the date of the demand, Mr. Papermaster was an executive officer and a
director of Medaphis. Mr. Papermaster resigned such positions on March 21, 1997,
although he remains an executive officer of BSG. The indemnification demand
claims damages of $35 million (the maximum damages payable by Medaphis under the
indemnification agreement) for the alleged breach by the Company of its
representations and warranties made in the merger agreement between Medaphis and
BSG.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity
Trust, and the Paulanne H. Thacker Retained Annuity Trust filed a complaint
against the Company and Randolph G. Brown in the United States District Court
for the Southern District of New York arising out of Medaphis' acquisition of
Medical Management Sciences, Inc. ("MMS") in December of 1995. The complaint is
brought on behalf of all former shareholders of MMS who exchanged their MMS
holdings for unregistered shares of Medaphis common stock. In general, the
complaint alleges both common law fraud and violations of the federal securities
laws in connection with the merger. In addition, the complaint alleges breaches
of contract relating to the merger agreement and a registration rights
agreement, as well as tortious interference with economic advantage. The
plaintiffs seek rescission of the merger agreement and the return of all MMS
shares, as well as damages in excess of $100 million. Additionally, plaintiffs
seek to void various noncompete covenants and contract provisions between
Medaphis and plaintiffs.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") notified the Company that it is conducting a non-public
investigation into, among other things, certain trading and other issues related
to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's
loss for the quarter ending September 30, 1996 and its restated consolidated
financial statements for the three months and year ended December 31, 1995 and
its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996.
The Company intends to cooperate fully with the Commission in its investigation.
Although the Company believes that it has meritorious defenses to the
claims of liability or for damages in the actions against, and written demands
placed upon the Company, there can be no assurance that additional lawsuits will
not be filed against the Company, that the lawsuits, the written demands and the
pending governmental investigations will not have a disruptive effect upon the
operations of the business, that the written demands, the defense of the
lawsuits and the pending investigations will not consume the time and attention
of the senior management of the Company or that the resolution of the lawsuits,
the written demands and the pending governmental investigations will not have a
material adverse effect upon the Company.
9
<PAGE> 10
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 3 -- ACQUISITIONS AND OTHER MATTERS
In 1996, the Company acquired Intelligent Visual Computing Inc. ("IVC"),
Rapid Systems Solutions, Inc. ("Rapid Systems"), BSG and HDS in acquisitions
accounted for as poolings-of-interests. A reconciliation of revenue, pro forma
net income and pro forma net income per common share of the Company, as
originally reported (which includes IVC), with the Company after restating for
the mergers with Rapid Systems, BSG and HDS, including the pro forma provision
for "S" corporation income taxes, is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1996
------------------
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
(AS RESTATED,
SEE NOTE 8)
<S> <C>
Revenue:
Medaphis, as originally reported.......................... $136,582
Restatement adjustments................................... (2,878)
--------
Medaphis, as restated..................................... 133,704
Rapid Systems............................................. 5,248
BSG, as restated.......................................... 19,539
HDS....................................................... 3,758
--------
Combined.................................................. $162,249
========
Pro forma net income (loss):
Medaphis, as originally reported.......................... $ 13,198
Restatement adjustments................................... (6,155)
--------
Medaphis, as restated..................................... 7,043
Rapid Systems............................................. (852)
BSG, as restated.......................................... 2,497
HDS....................................................... 382
Pro forma provision for Rapid Systems..................... 354
--------
Combined.................................................. $ 9,424
========
Pro forma net income per common share:
Medaphis, as originally reported.......................... $ 0.23
========
Medaphis, as restated..................................... $ 0.12
========
Combined.................................................. $ 0.12
========
</TABLE>
In February 1996, the Company, through its wholly owned indirect
subsidiary, Imonics GMBH, entered into a joint venture (the "Joint Venture").
The Joint Venture was formed in order to provide customer-service related work
flow applications throughout Europe. Each partner holds a 50% interest in the
Joint Venture. During the quarter ended March 31, 1996, the Joint Venture signed
an agreement with a German telecommunications entity to provide systems
integration and work flow engineering systems and services over a multi-year
contract. Included in revenue in the accompanying Consolidated Statement of
Operations, for the quarter ended March 31, 1996, is approximately $12.5 million
relating to the Company's share of net earnings of the Joint Venture.
10
<PAGE> 11
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 4 -- RESTRUCTURING AND OTHER CHARGES
Components of restructuring and other charges are as follows:
<TABLE>
<CAPTION>
MARCH 31,
1996
--------------
(AS RESTATED,
SEE NOTE 8)
(IN THOUSANDS)
<S> <C>
Restructuring charges....................................... $ 2,099
Pooling charges............................................. (1,793)
-------
$ 306
=======
</TABLE>
Restructuring Charges. During the first quarter of 1996, the Company
incurred approximately $2.1 million of costs which were related to the Company's
reengineering and consolidation project which had not previously been accrued.
Pooling Charges. In connection with the IVC merger, the Company incurred
estimated transaction fees, costs and expenses of $200,000. In addition,
management revised its estimate of certain transaction fees, costs and expenses
associated with the mergers recorded using the pooling-of-interests method of
accounting consummated in 1995 and reversed estimated charges which had been
reflected in the Company's operating results in the periods the mergers were
consummated.
<TABLE>
<CAPTION>
MARCH 31,
1996
--------------
(AS RESTATED,
SEE NOTE 8)
(IN THOUSANDS)
<S> <C>
IVC......................................................... $ 200
Automation Atwork Companies................................. (408)
Healthcare Recoveries, Inc. ("HRI")......................... (765)
Consort Technologies, Inc................................... (526)
Other....................................................... (294)
-------
$(1,793)
=======
</TABLE>
A description of the type and amount of exit costs incurred in the quarter
ended March 31, 1997 are as follows:
<TABLE>
<CAPTION>
RESERVE INCURRED RESERVE
BALANCE THROUGH BALANCE
12/31/96 3/31/97 3/31/97
-------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Lease termination costs..................................... $ 7,514 $(1,188) $6,326
Severance................................................... 2,748 (799) 1,949
Other....................................................... 1,222 (816) 406
------- ------- ------
$11,484 $(2,803) $8,681
======= ======= ======
</TABLE>
NOTE 5 -- INCOME TAXES
In 1996, Medaphis acquired IVC, Rapid Systems and BSG in merger
transactions which were accounted for as poolings-of-interests. Prior to such
mergers, IVC, Rapid Systems and a company acquired by BSG prior to the BSG
merger had elected "S" corporation status for income tax purposes. As a result
of such mergers (or, in the case of the company acquired by BSG, its acquisition
by BSG), such entities terminated their "S"
11
<PAGE> 12
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
corporation elections. Pro forma net income and pro forma net income per common
share are presented as if the entities had been "C" corporations during the
three months ended March 31, 1996.
NOTE 6 -- LINES OF BUSINESS
Medaphis has five reportable segments: Physician Services, Hospital
Services, HRI, HIT, and the BSG Group. Physician Services is the largest
provider of business management solutions and claims processing to physicians in
the United States. Hospital Services is the largest provider of business
management services to hospitals in the United States. HRI provides subrogation
and related recovery services primarily to healthcare payors. HIT provides
application software and systems integration services to both hospitals and
physicians. The BSG Group provides full-service systems integration, information
technology consulting and tailored software development to more than 100 clients
in a variety of markets, including healthcare.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies included in the Form 10-K.
Medaphis evaluates each segments' performance based on operating profit or loss.
The Company also accounts for intersegment sales as if the sales were to third
parties.
Information concerning the operations in these reportable segments is as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------------
1997 1996
--------------- ---------------
(IN THOUSANDS) (IN THOUSANDS)
(AS RESTATED, (AS RESTATED,
SEE NOTE 8) SEE NOTE 8)
<S> <C> <C>
Revenue:
Physician Services........................................ $ 71,760 $ 76,247
Hospital Services......................................... 23,756 22,281
HRI....................................................... 8,916 6,676
HIT....................................................... 19,690 16,212
BSG Group................................................. 23,810 41,263
Corporate and Eliminations................................ (386) (430)
-------- --------
$147,546 $162,249
======== ========
</TABLE>
12
<PAGE> 13
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------------
1997 1996
--------------- ---------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C>
Operating profit (loss)(1):
Physician Services........................................ $ 1,241 $ (268)
Hospital Services......................................... 2,483 4,674
HRI....................................................... 2,253 1,388
HIT....................................................... 2,818 3,597
BSG Group................................................. 274 14,241
Corporate and Eliminations................................ (8,442) (4,921)
-------- --------
$ 627 $ 18,711
======== ========
Interest expense, net....................................... $ 6,115 $ 2,105
-------- --------
Restructuring and other charges:
Physician Services........................................ $ -- $ 1,805
Hospital Services......................................... -- --
HRI....................................................... -- (765)
HIT....................................................... -- (934)
BSG Group................................................. -- 200
Corporate................................................. -- --
-------- --------
-- 306
-------- --------
Income (loss) before income taxes........................... $ (5,488) $ 16,300
======== ========
Depreciation and amortization:
Physician Services........................................ $ 8,494 $ 7,515
Hospital Services......................................... 1,278 1,200
HRI....................................................... 245 195
HIT....................................................... 1,710 1,486
BSG Group................................................. 1,045 1,744
Corporate................................................. 327 333
-------- --------
$ 13,099 $ 12,473
======== ========
Capital expenditures:
Physician Services........................................ $ 1,272 12,787
Hospital Services......................................... 786 1,482
HRI....................................................... 51 305
HIT....................................................... 665 966
BSG Group................................................. 609 3,337
Corporate................................................. 17 590
-------- --------
$ 3,400 $ 19,467
======== ========
</TABLE>
13
<PAGE> 14
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
<TABLE>
<CAPTION>
AS OF
----------------------------------
MARCH 31, DECEMBER 31,
1997 1996
--------------- ---------------
(IN THOUSANDS) (IN THOUSANDS)
(AS RESTATED (AS RESTATED
SEE NOTE 8) SEE NOTE 8)
<S> <C> <C>
Identifiable assets:
Physician Services........................................ $600,765 $610,150
Hospital Services......................................... 100,288 97,626
HRI....................................................... 24,947 23,863
HIT....................................................... 66,450 67,961
BSG Group................................................. 44,334 51,972
Corporate................................................. 93,894 85,282
-------- --------
$930,678 $936,854
======== ========
</TABLE>
- ---------------
(1) Excludes restructuring and other charges, litigation settlement and interest
expense.
NOTE 7 -- LONG-TERM DEBT
On February 4, 1997, the Company entered into the Second Amended and
Restated Credit Agreement (the "Second Amended Facility"). This agreement
replaced the Company's previous senior credit facility and increased the
revolving line of credit to $285 million. The Second Amended Facility is
composed of a $275 million revolving line of credit and a $10 million cash
management swing loan line with lenders from a six-bank syndicate. The Second
Amended Facility effectively refinanced the loans outstanding under the previous
senior credit facility and can be used to finance working capital and other
general corporate needs. The Second Amended Facility provides for "base rate"
loans which bear interest equal to prime plus 1% as long as certain financial
covenants are met. The loan commitments under the Second Amended Facility will
reduce to $200 million and $150 million on July 31, 1997 (unless extended by the
lenders until September 30, 1997) and January 31, 1998, respectively. The
Company does not and did not expect to generate sufficient cash flow from
operations to satisfy the required reductions in debt. Management of the Company
has adopted plans to divest HRI and is seeking alternatives for the BSG Group,
which management believes will generate sufficient net proceeds to meet the
reduction in the loan commitments required by the Second Amended Facility. The
Company has retained an investment banking firm to advise it on the divestiture
of HRI as well as to assist in the evaluation of alternatives for the BSG Group.
While management is confident the Company will be able to meet its debt service
obligations, there can be no assurance that the Company will be successful in
its efforts to divest HRI or the BSG Group. If the Company is unable to dispose
of HRI or the BSG Group or through other means generate sufficient net proceeds
to satisfy the required reductions in the loan commitments, the Company's
lenders can cause the borrowings under the Second Amended Facility to become
immediately due and payable. The Second Amended Facility also contains
restrictions on the Company's ability to declare or pay cash dividends on its
common stock.
As part of the consideration paid to the six-bank syndicate for the Second
Amended Facility, the Company issued the lenders warrants with vesting for 1% of
the common stock of the Company on each of January 1, 1998 and April 1, 1998.
The warrants terminate if the Company has no outstanding borrowings on the line
of credit on December 31, 1997. The Company has not allocated any value to these
warrants because management believes the Company will realize sufficient net
proceeds from the divestiture of HRI and the potential alternatives for the BSG
Group or the refinancing of any remaining borrowings under the Second Amended
Facility to enable the Company to repay all borrowings under the Second Amended
Facility by December 31, 1997.
14
<PAGE> 15
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 8 -- RESTATEMENT OF THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTERLY
PERIOD ENDED MARCH 31, 1996 AND 1997
As a result of a review initiated by senior management and the Audit
Committee of the Board of Directors (the "Audit Committee") in March 1997 prior
to completion of the audit process for the Company's 1996 fiscal year,
information was developed that certain revenues and expenses may have been
recorded incorrectly between certain quarters during 1996. At the conclusion of
the review, the Company determined that there were certain accounting errors and
irregularities and that its interim financial statements for each fiscal quarter
of 1996 required restatement. These errors and irregularities consisted
primarily of the following: (1) incorrect quarterly recording of revenues and
the related costs and expenses for certain contracts; (2) incorrect quarterly
recording of certain liabilities for employee bonuses and related expenses; (3)
certain costs and expenses of certain acquired companies, which were later
determined not to be properly recordable, were recognized by those companies in
periods prior to their acquisitions, resulting in an overstatement of the
Company's earnings subsequent to those acquisitions; and (4) incorrect
depreciation of certain assets related to the Company's comprehensive
reengineering and consolidation project.
During the third quarter of 1997, in connection with a refinancing effort
of the Company's then credit agreement, management evaluated certain revenue
practices at Health Data Sciences Corporation ("HDS"), a wholly-owned subsidiary
of the Company which was acquired by the Company in a merger transaction in June
1996 that was accounted for as a pooling of interests. These practices related
principally to revenue recognized in fiscal years 1994, 1995 and 1996. As
disclosed by the Company in its Form 10-Q for its fiscal quarter ending
September 30, 1997, management determined that certain revenue of HDS was
improperly recognized and, accordingly, determined to restate its financial
statements for its 1994, 1995 and 1996 fiscal years and the first two fiscal
quarters of its 1997 fiscal year. The effect of such restatements on the
Company's net income (loss) for the years ended December 31, 1994, 1995 and 1996
was ($5.8) million, $(1.1) million and $(7.3) million, respectively. The
cumulative reduction in assets caused by such restatement was $20.5 million.
As a result of the HDS related restatements, Deloitte & Touche, the
predecessor accountant withdrew its audit opinion dated March 31, 1997 in
respect of the Company's 1994, 1995 and 1996 fiscal years. Consequently, the
Company engaged Price Waterhouse to re-audit the Company's 1995 and 1996 fiscal
years and audit the Company's nine-month period ending September 30, 1997.
Subsequent to the restatement related to HDS and in connection with the
reaudit of the Company's fiscal years ended December 31, 1995 and 1996 and the
audit of the Company's nine months ended September 30, 1997 by Price Waterhouse,
the Board of Directors of the Company determined, upon recommendation of the
Audit Committee of the Board, to restate the results of such periods to account
for the December 1995 acquisition of Medical Management Sciences, Inc. ("MMS")
on a purchase accounting basis. The MMS transaction had been accounted for as a
pooling of interests.
The Company has determined that all appropriate adjustments have been made
to its interim financial statements and that its consolidated financial
statements, taken as a whole, present fairly in all material respects the
Company's financial position, results of operations and cash flows for its
fiscal quarter ended March 31, 1996 and 1997 in conformity with generally
accepted accounting principles.
15
<PAGE> 16
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1996
------------------------------------
AS AS
ORIGINALLY PREVIOUSLY AS
REPORTED RESTATED RESTATED
----------- ---------- ---------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Revenue..................................................... $163,627 $162,249 $162,249
Salaries and wages.......................................... 90,565 91,730 91,730
Other Operating expenses.................................... 39,354 39,335 39,335
Depreciation................................................ 4,951 5,940 5,940
Amortization................................................ 4,909 5,109 6,533
Income before income taxes.................................. 21,593 18,088 16,300
Net income.................................................. 12,725 10,659 9,070
Pro forma net income........................................ 13,079 11,013 9,424
Pro forma net income per common share....................... $ 0.17 $ 0.15 $ 0.12
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1997
---------------------
AS
ORIGINALLY AS
REPORTED RESTATED
---------- --------
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
<S> <C> <C>
Revenue..................................................... $147,546 $147,546
Salaries and wages.......................................... 93,578 93,578
Other operating expenses.................................... 40,242 40,242
Depreciation................................................ 6,985 6,985
Amortization................................................ 4,690 6,114
Income (loss) before income taxes........................... (4,064) (5,488)
Pro forma net income (loss)................................. (1,839) (3,064)
Pro forma net income per common share....................... $ (0.03) $ (0.04)
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
1996
---------------------
AS
ORIGINALLY AS
REPORTED RESTATED
---------- --------
(IN THOUSANDS)
<S> <C> <C>
Current Assets.............................................. $269,385 $255,239
Total Assets................................................ 815,624 936,854
Current Liabilities......................................... 193,752 198,747
Total Liabilities........................................... 423,334 428,329
Total Stockholders' Equity.................................. 392,290 508,525
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31, 1997
---------------------
AS
ORIGINALLY AS
REPORTED RESTATED
---------- --------
(IN THOUSANDS)
<S> <C> <C>
Current Assets.............................................. $271,003 $256,857
Total Assets................................................ 810,673 930,678
Current Liabilities......................................... 241,454 246,449
Total Liabilities........................................... 416,505 421,500
Total Stockholders' Equity.................................. 394,168 509,178
</TABLE>
16
<PAGE> 17
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 9 -- NEW ACCOUNTING PRONOUNCEMENT
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No.
128"). SFAS No. 128 provides for new accounting principles used in the
calculation of earnings per share ("EPS") and shall be effective for financial
statements for both interim and annual periods ending after December 15, 1997.
This new pronouncement would not materially effect the EPS calculation for the
three month periods ended March 31, 1997 and 1996.
17
<PAGE> 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Medaphis Corporation, a corporation organized in 1985 under the laws of the
State of Delaware ("Medaphis" or the "Company"), provides business management
services and information products primarily to healthcare providers. Medaphis'
healthcare services are designed to assist its clients with the business
management functions associated with the delivery of healthcare services,
thereby permitting physicians and hospitals to focus on providing quality
medical services to their patients. Medaphis' healthcare information systems
include patient-centered clinical information management systems and
enterprise-wide patient and employee scheduling systems. These systems are
designed to improve efficiency and quality of care within hospitals and emerging
integrated healthcare delivery systems. Medaphis currently provides business
management systems and services to approximately 20,500 physicians and over
2,600 hospitals in all 50 states, subrogation and recovery services to
healthcare plans covering in excess of 32 million people throughout the United
States and systems integration and services in the United States and abroad.
In February 1997, Medaphis announced the implementation during the 1997
fiscal year of a business plan focused on Medaphis' core business and comprised
of the following five components: (1) exiting non-core businesses, such as the
planned sale of Healthcare Recoveries, Inc. ("HRI") that is discussed below; (2)
achieving improved predictability of results through enhanced management
accountability and controls; (3) reducing costs and increasing efficiencies; (4)
emphasizing customer service; and (5) implementing cross-selling initiatives.
Medaphis' business is impacted by trends in the U.S. healthcare industry.
As healthcare expenditures have grown as a percentage of the U.S. gross national
product, public and private healthcare cost containment measures have applied
pressure to the margins of healthcare providers. Historically, some healthcare
payors have willingly paid the prices established by providers while other
healthcare payors, notably the government and managed care companies, have paid
far less than established prices (in many cases less than the average cost of
providing the services). As a consequence, prices charged to healthcare payors
willing to pay established prices have increased in order to recover the cost of
services purchased by the government and others but not paid by them (i.e.,
"cost shifting"). The increasing complexity in the reimbursement system and
assumption of greater payment responsibility by individuals have caused
healthcare providers to experience increased receivables and bad debt levels and
higher business office costs. Healthcare providers historically have addressed
these pressures on profitability by increasing their prices, by relying on
demographic changes to support increases in the volume and intensity of medical
procedures, and by cost shifting. Notwithstanding providers' responses to
revenue pressures, management believes that the revenue growth rate experienced
by the Company's clients continues to be adversely affected by increased managed
care and other industry factors impacting healthcare providers in the United
States. At the same time, the process of submitting healthcare claims for
reimbursement to third-party payors in accordance with applicable industry and
regulatory standards continues to grow in complexity and to become more costly.
Management believes that these trends have placed pressure on the rate of
the revenue growth and profit margins of the Company's physician accounts
receivable and practice management operations. Due to these revenue and margin
pressures, Medaphis Physicians Services Corporation ("MPSC"), the Company's
largest subsidiary providing accounts receivable and practice management
services to physicians, did not significantly contribute to the Company's
operating profit for 1996 and this trend is not expected to improve until
further progress is made with, among other things, ongoing initiatives designed
to reduce redundant costs, improve efficiencies and enhance operational
effectiveness in MPSC's operations.
18
<PAGE> 19
RESULTS OF OPERATIONS
The following table shows the percentage of certain items reflected in the
Company's statements of operations to revenue.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------------
1997 1996
-------------- --------------
(AS RESTATED (AS RESTATED
SEE NOTE 8) SEE NOTE 8)
<S> <C> <C>
Revenue..................................................... 100.0% 100.0%
Salaries and wages.......................................... 63.4 56.5
Other operating expenses.................................... 27.3 24.2
Depreciation................................................ 4.7 3.7
Amortization................................................ 4.1 4.0
Interest expense, net....................................... 4.1 1.3
Restructuring and other charges............................. 0.0 0.2
----- -----
Income (loss) before income taxes........................... (3.6) 10.1
Income taxes................................................ (1.6) 4.5
----- -----
Net income (loss)........................................... (2.0) 5.6
Pro forma adjustments....................................... -- 0.2
----- -----
Pro forma net income (loss)................................. (2.0)% 5.8%
===== =====
</TABLE>
Revenue. Revenue classified by the Company's different operating segments
is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------------
1997 1996
-------------- --------------
(IN THOUSANDS)
(AS RESTATED (AS RESTATED
SEE NOTE 8) SEE NOTE 8)
<S> <C> <C>
Revenue:
Physician Services................................... $ 71,760 $ 76,247
Hospital Services.................................... 23,756 22,281
HRI.................................................. 8,916 6,676
HIT.................................................. 19,690 16,212
BSG Group............................................ 23,810 41,263
Corporate and Eliminations........................... (386) (430)
-------- --------
$147,546 $162,249
======== ========
</TABLE>
As part of the 1997 operating plan, management's primary emphasis is on
improving the services provided to its existing clients and not on growing its
revenue base.
The slight decrease in Physician Services' revenue in the first quarter of
1997 from the same period of 1996 is attributable to the above-mentioned revenue
pressure on the physician accounts receivable and practice management operations
and the emphasis of improving customer service.
The 42.3% decrease in the BSG Group's revenue is primarily a result of the
Company's decision to shut down its wholly-owned operating subsidiary, Imonics
Corporation ("Imonics"). Imonics generated approximately $16.5 million during
the three month period ended March 31, 1996.
HIT's revenue increased 21.5% during the three months ended March 31, 1997
as compared with the same period for the prior year. This increase is primarily
a result of an increase in the number of healthcare information system licenses
sold by Healthcare Data Sciences Corporation.
Salaries and Wages. Salaries and wages increased to 63.4% of revenue in
the first quarter of 1997 from 56.5% in the first quarter of 1996. The increase
in salaries and wages, as a percentage of revenue, is due to a
19
<PAGE> 20
slowdown in the growth of the Company's revenue. The Company has not reduced its
employment levels to coincide with the decrease in revenue because the 1997
operating plan has placed a renewed emphasis on client service.
Other Operating Expenses. Other operating expenses increased to 27.3% of
revenue in the first quarter of 1997 compared to 24.2% in the first quarter of
1996. The increase in other operating expenses as a percentage of revenue for
1997, as compared with 1996, is due to the previously mentioned slowdown in the
growth of the Company's revenue. Other operating expenses are primarily
comprised of postage, facility and equipment rental, telecommunications, travel,
outside consulting and legal services and office supplies.
Depreciation. Depreciation expense was $7.0 million in the first quarter
of 1997 as compared with $5.9 million in the first quarter of 1996. This
increase reflects the Company's investment in property and equipment to support
its business.
Amortization. Amortization of intangible assets, which are primarily
associated with the Company's acquisitions and internally developed software,
was $6.1 million in the first quarter of 1997 as compared with $6.5 million in
the first quarter of 1996. The decrease is primarily due to the write-off of
Imonics' purchased goodwill.
Interest. Net interest expense was $6.1 million in the first quarter of
1997 as compared with $2.1 million in the first quarter of 1996. The increase is
primarily due to increased borrowing under the Company's Second Amended
Facility. Management anticipates that future interest expense will be impacted
by interest rate fluctuations and changes in the amount of borrowings under the
Second Amended and Restated Credit Agreement (the "Second Amended Facility").
Restructuring and Other Charges. Components of restructuring and other
charges are as follows:
<TABLE>
<CAPTION>
MARCH 31,
1996
---------------
(IN THOUSANDS)
(AS RESTATED)
SEE NOTE 8
<S> <C>
Restructuring charges.................................. $ 2,099
Pooling charges........................................ (1,793)
-------
$ 306
=======
</TABLE>
Restructuring Charges. During the first quarter of 1996, the Company
incurred approximately $2.1 million of costs which were related to the Company's
reengineering and consolidation project which had not previously been accrued.
Pooling Charges. In connection with the Intelligent Visual Computing, Inc.
("IVC") merger, the Company incurred estimated transaction fees, costs and
expenses of $200,000. In addition, management revised its estimate of certain
transaction fees, costs and expenses associated with the mergers recorded using
the pooling-of-interests method of accounting consummated in 1995 and reversed
estimated charges which had been reflected in the Company's operating results in
the periods the mergers were consummated.
<TABLE>
<CAPTION>
1996
--------------
(IN THOUSANDS)
(AS RESTATED)
SEE NOTE 8
<S> <C>
IVC......................................................... $ 200
Automation Atwork Companies................................. (408)
HRI......................................................... (765)
Consort Technologies, Inc................................... (526)
Other....................................................... (294)
-------
$(1,793)
=======
</TABLE>
20
<PAGE> 21
Income (Loss) Before Income Taxes. The Company's loss before income taxes
was (3.6)% of revenue in the first quarter of 1997 as compared with income of
10.1% of revenue in the first quarter of 1996. The decrease is primarily the
result of the aforementioned revenue decreases.
Income Taxes. Effective income tax rates for the periods presented vary
from statutory rates primarily as a result of nondeductible goodwill associated
with merger transactions consummated by the Company in previous years. Pro forma
adjustments for income taxes have been provided for companies accounted for
under the pooling-of-interest method of accounting which elected to be treated
as "S" corporations under the Internal Revenue Code of 1986, as amended, prior
to merging with the Company.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $10.4 million at March 31, 1997,
including $10.2 million of cash.
The Company's operating activities generated cash of $5.9 million during
the three months ended March 31, 1997 as compared with the use of cash of $4.2
million during the three months ended March 31, 1996. The increase in the
Company's operating cash flows resulted primarily from the collection of
outstanding receivables and management's cash control initiatives.
On February 4, 1997, the Company entered into the Second Amended Facility
which replaced the Company's previous revolving credit agreement and increased
the revolving line of credit from $250 million to $285 million. At March 31,
1997, the Company had $244 million in borrowings outstanding under the Second
Amended Facility which bore interest at 9.5%. The Second Amended Facility
expires on June 30, 1998 and may be extended or otherwise amended pursuant to
the agreement. Borrowings under the Second Amended Facility are secured by
substantially all of the Company's assets and are guaranteed by substantially
all of the Company's subsidiaries. The Second Amended Facility effectively
refinanced the loans outstanding under the Company's previous senior credit
facility and can be used to finance working capital and other general corporate
needs with restrictions on new acquisitions, certain litigation settlement
payments and capital expenditures for the fiscal quarter ending March 31, 1996.
The Second Amended Facility provides for "base rate" loans which bear interest
equal to prime plus 1% as long as certain financial covenants are met. The loan
commitments under the Second Amended Facility will reduce to $200 million and
$150 million on July 31, 1996 (unless extended by the lenders to September 30,
1997) and January 31, 1998, respectively. In late 1996 and in 1997, the Company
has taken actions to reduce capital expenditures and to monitor uses of cash.
The Company believes that it will be able to fund its operating cash
requirements through operating cash flows and borrowings under the Second
Amended Facility through July 31, 1997, when the Company will be required to
reduce the outstanding amount of borrowings under the Second Amended Facility to
a maximum of $200 million. In developing its 1997 business plan, the Company did
not expect to generate sufficient cash flow from operations to meet the required
debt reduction and, therefore, management has adopted plans to divest HRI and is
seeking alternatives for the BSG Group, which it believes will generate
sufficient net proceeds to meet the July 31, 1997 reduction in the loan
commitments required by the Second Amended Facility. The Company has retained
investment banking counsel to advise it on the divestiture of HRI as well as to
assist in the evaluation of alternatives for the BSG Group. On March 14, 1997,
the Company filed a registration statement with the Commission relating to the
planned initial public offering of 100% of the common stock of HRI. This initial
public offering is subject to review by the Commission and the marketability of
HRI. There can be no assurance that the Company will be successful in its
efforts to sell HRI and/or the BSG Group. If the Company is unable to generate
sufficient net proceeds through the sale of HRI and/or the BSG Group or obtain
alternative debt financing by July 31, 1997 (unless extended by the lenders
until September 30, 1997), the Company's lenders can cause the borrowing under
the Second Amended Facility to become immediately due and payable.
As part of the consideration paid to the six-bank syndicate for the Second
Amended Facility, the Company issued the lenders warrants with vesting
arrangements for 1% of the Common Stock of the Company on each of January 1,
1998 and April 1, 1998. These warrants terminate if the Company has no
outstanding borrowings on the line of credit on December 31, 1997. The Company
has not allocated any value to these warrants because management believes the
Company will generate sufficient cash flows from asset
21
<PAGE> 22
sales or the refinancing of any remaining borrowings under the Second Amended
Facility to repay all the borrowings under the Second Amended Facility by
December 31, 1997.
OTHER MATTERS
As a result of a review initiated by senior management and the Audit
Committee of the Board of Directors (the "Audit Committee") in March 1997 prior
to completion of the audit process for the Company's 1996 fiscal year,
information was developed that certain revenues and expenses may have been
recorded incorrectly between certain quarters during 1996. At the conclusion of
the review, the Company determined that there were certain accounting errors and
irregularities and that its interim financial statements for each fiscal quarter
of 1996 required restatement. These errors and irregularities consisted
primarily of the following: (1) incorrect quarterly recording of revenues and
the related costs and expenses for certain contracts; (2) incorrect quarterly
recording of certain liabilities for employee bonuses and related expenses; (3)
certain costs and expenses of certain acquired companies, which were later
determined not to be properly recordable, were recognized by those companies in
periods prior to their acquisitions, resulting in an overstatement of the
Company's earnings subsequent to those acquisitions; and (4) incorrect
depreciation of certain assets related to the Company's comprehensive
reengineering and consolidation project.
During the third quarter of 1997, in connection with a refinancing effort
of the Company's then credit agreement, management evaluated certain revenue
practices at Health Data Sciences Corporation ("HDS"), a wholly-owned subsidiary
of the Company which was acquired by the Company in a merger transaction in June
1996 that was accounted for as a pooling of interests. These practices related
principally to revenue recognized in fiscal years 1994, 1995 and 1996. As
disclosed by the Company in its Form 10-Q for its fiscal quarter ending
September 30, 1997, management determined that certain revenue of HDS was
improperly recognized and, accordingly, determined to restate its financial
statements for its 1994, 1995 and 1996 fiscal years and the first two fiscal
quarters of its 1997 fiscal year. The effect of such restatements on the
Company's net income (loss) for the years ended December 31, 1994, 1995 and 1996
was ($5.8) million, $(1.1) million and $(7.3) million, respectively. The
cumulative reduction in assets caused by such restatement was $20.5 million.
As a result of the HDS related restatements, Deloitte & Touche, the
predecessor accountant withdrew its audit opinion dated March 31, 1997 in
respect of the Company's 1994, 1995 and 1996 fiscal years. Consequently, the
Company engaged Price Waterhouse to re-audit the Company's 1995 and 1996 fiscal
years and audit the Company's nine-month period ending September 30, 1997.
Subsequent to the restatement related to HDS and in connection with the
reaudit of the Company's fiscal years ended December 31, 1995 and 1996 and the
audit of the Company's nine months ended September 30, 1997 by Price Waterhouse,
the Board of Directors of the Company determined, upon recommendation of the
Audit Committee of the Board, to restate the results of such periods to account
for the December 1995 acquisition of Medical Management Sciences, Inc. ("MMS")
on a purchase accounting basis. The MMS transaction had been accounted for as a
pooling of interests.
The Company has determined that all appropriate adjustments have been made
to its interim financial statements and that its consolidated financial
statements, taken as a whole, present fairly in all material respects the
Company's financial position, results of operations and cash flows for its
fiscal quarter ended March 31, 1996 and 1997 in conformity with generally
accepted accounting principles.
22
<PAGE> 23
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1996
-------------------------------------------
AS ORIGINALLY AS PREVIOUSLY
REPORTED RESTATED AS RESTATED
------------- ------------- -----------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Revenue.................................................... $163,627 $162,249 $162,249
Salaries and wages......................................... 90,565 91,730 91,730
Other Operating expenses................................... 39,354 39,335 39,335
Depreciation............................................... 4,951 5,940 5,940
Amortization............................................... 4,909 5,109 6,533
Income before income taxes................................. 21,593 18,088 16,300
Net income................................................. 12,725 10,659 9,070
Pro forma net income....................................... 13,079 11,013 9,424
Pro forma net income per common share...................... $ 0.17 $ 0.15 $ 0.12
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1997
---------------------
AS
ORIGINALLY AS
REPORTED RESTATED
---------- --------
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
<S> <C> <C>
Revenue..................................................... $147,546 $147,546
Salaries and wages.......................................... 93,578 93,578
Other operating expenses.................................... 40,242 40,242
Depreciation................................................ 6,985 6,985
Amortization................................................ 4,690 6,114
Income (loss) before income taxes........................... (4,064) (5,488)
Pro Forma net income (loss)................................. (1,839) (3,064)
Pro Forma net income per common share....................... $ (0.03) $ (0.04)
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
1996
---------------------
AS
ORIGINALLY AS
REPORTED RESTATED
---------- --------
(IN THOUSANDS)
<S> <C> <C>
Current Assets.............................................. $269,385 $255,239
Total Assets................................................ 815,624 936,854
Current Liabilities......................................... 193,752 198,747
Total Liabilities........................................... 423,334 428,329
Total Stockholders' Equity.................................. 392,290 508,525
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31, 1997
---------------------
AS
ORIGINALLY AS
REPORTED RESTATED
---------- --------
(IN THOUSANDS)
<S> <C> <C>
Current Assets.............................................. $271,003 $256,857
Total Assets................................................ 810,673 930,678
Current Liabilities......................................... 241,454 246,449
Total Liabilities........................................... 416,505 421,500
Total Stockholders' Equity.................................. 394,168 509,178
</TABLE>
23
<PAGE> 24
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The United States Attorney's Office for the Central District of California
is conducting an investigation (the "Federal Investigation") of Medaphis'
billing and collection practices in its offices located in Calabasas and
Cypress, California (the "Designated Offices"). Medaphis first became aware of
the Federal Investigation when it received search warrants and grand jury
subpoenas on June 13, 1995. Although the precise scope of the Federal
Investigation is not known to the Company at this time, Medaphis believes that
the U.S. Attorney's Office is investigating allegations of billing fraud and
that the inquiry is focused upon Medaphis' billing and collection practices in
the Designated Offices. Numerous federal and state civil and criminal laws
govern medical billing and collection activities. In general, these laws provide
for various fines, penalties, multiple damages, assessments and sanctions for
violations, including possible exclusion from Medicare, Medicaid and certain
other federal and state healthcare programs. Although the Designated Offices
represent less than 2% of Medaphis' annual revenue, there can be no assurance
that the Federal Investigation will be resolved promptly, that additional
subpoenas or search warrants will not be received by Medaphis or that the
Federal Investigation will not have a material adverse effect upon the Company.
The Company recorded charges of $12 million in the third quarter of 1995 and $2
million in the fourth quarter of 1996, solely for the administrative fees, costs
and expenses it anticipates incurring in connection with the Federal
Investigation and the putative class action lawsuits described below which were
filed following the Company's announcement of the Federal Investigation. The
charges are intended to cover only the anticipated expenses of the Federal
Investigation and the related lawsuits and do not include any provision for
fines, penalties, damages, assessments, judgments or sanctions that may arise
out of such matters.
Following the announcement of the Federal Investigation, Medaphis, various
of its current and former officers and directors and the lead underwriters
associated with Medaphis' public offering of common stock in April 1995 were
named as defendants in putative shareholder class action lawsuits filed in the
United States District Court for the Northern District of Georgia. In general,
these lawsuits allege violations of the federal securities laws in connection
with Medaphis' public statements and filings under the federal securities acts,
including the registration statement filed in connection with Medaphis' public
offering of common stock in April 1995. On October 13, 1995, the named
plaintiffs in these lawsuits filed a consolidated class action complaint (the
"Consolidated Complaint"). On January 3, 1996, the court denied defendants'
motion to dismiss the Consolidated Complaint. On April 11, 1996, certain of the
named plaintiffs to the Consolidated Complaint voluntarily dismissed with
prejudice all of their claims. As a result of these dismissals, the Consolidated
Complaint no longer contains any claims based on the Securities Act of 1933, as
amended, and the Company's underwriters and outside directors are no longer
named as defendants. On June 26, 1996, the court denied the plaintiffs' motion
to certify a plaintiffs' class. The plaintiffs and the defendants have reached
an agreement in principle to settle this action on a class-wide basis for $4.75
million, subject to court approval and other customary conditions (the "1995
Class Action Settlement"). The 1995 Class Action Settlement would also include
the related putative class action lawsuit currently pending in the Superior
Court of Cobb County, Georgia, described more fully below. The Company expects
to receive approximately $3.7 million from insurance to fund a portion of the
1995 Class Action Settlement and accrued approximately $1.2 million in the
quarter ending December 31, 1996 to fund the anticipated balance of the 1995
Class Action Settlement and to pay certain fees incident thereto.
On November 5, 1996, Medaphis, Randolph G. Brown, Michael R. Cote and James
S. Douglass were named as defendants in a putative shareholder class action
lawsuit filed in Superior Court of Cobb County, State of Georgia. This lawsuit
alleges violations of Georgia securities laws based on the same public
statements and filings generally described above. The lawsuit is brought on
behalf of a putative class of purchasers of Medaphis common stock during the
period from March 29, 1995 through June 15, 1995. The plaintiffs seek
compensatory damages and costs. As noted above, it is currently contemplated
that this action will be settled as part of the 1995 Class Action Settlement.
The Company and its clients from time to time have received, and the
Company anticipates that they will receive in the future, official inquiries
(including subpoenas, search warrants, as well as informal requests)
24
<PAGE> 25
concerning particular billing and collection practices related to certain
subsidiaries of the Company and its many clients. In March 1997, the Company was
informed by the Civil Division of the Department of Justice that it is
investigating allegations concerning the Company's Gottlieb's Financial
Services, Inc. ("GFS") subsidiary. The Company has received a request from the
Department of Justice for records, and may receive additional requests. The
Company intends to cooperate in producing records. There can be no assurance
that this matter will be resolved promptly or that the investigation will not
have a material adverse effect upon Medaphis.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its current and former
officers, one of whom was also a director, were named as defendants in nineteen
putative shareholder class action lawsuits filed in the United States District
Court for the Northern District of Georgia. On November 22, 1996, the plaintiffs
in these lawsuits filed a Consolidated Amended Class Action Complaint (the "1996
Consolidated Complaint"). In general, the 1996 Consolidated Complaint alleges
violations of the federal securities laws in connection with Medaphis' filings
under the federal securities acts and public disclosures. The 1996 Consolidated
Complaint is brought on behalf of a class of all persons who purchased or
otherwise acquired Medaphis common stock between January 6, 1996 and October 21,
1996. The 1996 Consolidated Complaint also asserts claims on behalf of a
sub-class of all persons who acquired Medaphis common stock pursuant to the
merger between Medaphis and Health Data Sciences Corporation ("HDS"). On
December 30, 1996, the defendants filed a motion to dismiss most of the 1996
Consolidated Complaint. On February 3, 1997, the plaintiffs filed a Consolidated
Second Amended Complaint. On February 14, 1997, the defendants moved to dismiss
the Consolidated Second Amended Complaint in its entirety.
On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit
Sharing Plan filed a shareholder derivative lawsuit in the United States
District Court for the Northern District of Georgia alleging that certain of
Medaphis' current and former directors breached their fiduciary duties, were
grossly negligent, and breached various contractual obligations to Medaphis by
allegedly failing to implement and maintain an adequate system of internal
accounting controls, allowing Medaphis to commit securities law violations and
damaging Medaphis' reputation. The plaintiff seeks compensatory damages and
costs. On January 28, 1997, Medaphis and certain individual defendants filed a
motion to dismiss the complaint. On February 11, 1997, the plaintiff filed an
amended complaint adding as defendants additional current and former directors
and officers of Medaphis. On April 23, 1997, Medaphis and certain of the
defendants filed a motion to dismiss the amended complaint.
On November 7, 1996, Health Systems International, Inc. filed suit in the
Superior Court for the State of California, County of Los Angeles against
Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed
Medaphis directors, officers and employees. Generally, this lawsuit alleges that
the defendants violated federal and California securities laws and common law
by, among other things more fully described in the complaint, making material
misstatements and omissions in public and private disclosures in connection with
the acquisition of HDS. Plaintiff seeks rescissory, compensatory and punitive
damages, rescission, injunctive relief and costs. On January 10, 1997, the
defendants filed a demurrer to the complaint. The demurrer was denied on
February 5, 1997. On March 18, 1997, the court denied the plaintiff's motion for
a preliminary injunction. As a result of the Company's restatement of its fiscal
1995 financial statements, the Company may not be able to sustain a defense to
strict liability on certain claims under the 1933 Act, but the Company believes
that it has substantial defenses to the alleged damages relating to the 1933 Act
claims.
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberg against Steven G. Papermaster, Robert E. Pickering, Jr., David S.
Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and
Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division,
Essex County, State of New Jersey. The alleged class consists of persons and
entities whose options to purchase BSG Corporation ("BSG") common stock were
converted to Medaphis stock options in connection with Medaphis' acquisition of
BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary
duties of candor, loyalty and fair dealing and negligence against the BSG
defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud
and deceit against the Medaphis defendants (Medaphis and
25
<PAGE> 26
Brown). On April 18, 1997, the Medaphis defendants and BSG defendants filed
motions to dismiss the complaint.
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control made a demand for indemnification under an indemnification
agreement executed by Medaphis in connection with its acquisition of BSG in May
1996. On the date of the demand, Mr. Papermaster was an executive officer and a
director of Medaphis. Mr. Papermaster resigned such positions on March 21, 1997,
although he remains an executive officer of BSG. The indemnification demand
claims damages of $35 million (the maximum damages payable by Medaphis under the
indemnification agreement) for the alleged breach by the Company of its
representations and warranties made in the merger agreement between Medaphis and
BSG.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity
Trust, and the Paulanne H. Thacker Retained Annuity Trust filed a complaint
against the Company and Randolph G. Brown in the United States District Court
for the Southern District of New York arising out of Medaphis' acquisition of
Medical Management Sciences, Inc. ("MMS") in December of 1995. The complaint is
brought on behalf of all former shareholders of MMS who exchanged their MMS
holdings for unregistered shares of Medaphis common stock. In general, the
complaint alleges both common law fraud and violations of the federal securities
laws in connection with the merger. In addition, the complaint alleges breaches
of contract relating to the merger agreement and a registration rights
agreement, as well as tortious interference with economic advantage. The
plaintiffs seek rescission of the merger agreement and the return of all MMS
shares, as well as damages in excess of $100 million. Additionally, plaintiffs
seek to void various noncompete covenants and contract provisions between
Medaphis and plaintiffs.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") has notified the Company that it is conducting a non-public
investigation into, among other things, certain trading and other issues related
to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's
loss for the quarter ending September 30, 1996 and its restated consolidated
financial statements for the three months and year ended December 31, 1995 and
its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996.
The Company intends to cooperate fully with the Commission in its investigation.
Although the Company believes that it has meritorious defenses to the
claims of liability or for damages in the actions against, and written demands
placed upon the Company, there can be no assurance that additional lawsuits will
not be filed against the Company, that the lawsuits, the written demands and the
pending governmental investigations will not have a disruptive effect upon the
operations of the business, that the written demands, the defense of the
lawsuits and the pending investigations will not consume the time and attention
of the senior management of the Company or that the resolution of the lawsuits,
the written demands and the pending governmental investigations will not have a
material adverse effect upon the Company.
ITEM 5. OTHER INFORMATION
On April 25, 1997, the Compensation Committee of the Board of Directors of
the Company approved an adjustment of the exercise price for certain outstanding
employee stock options which have an exercise price of $5.50 and above. No
adjustments were made to any options held by directors or former employees of
the Company. The revised exercise price of $5.375 was established by reference
to the closing price of the Company's common stock on April 25, 1997. In
approving the adjustment, the Compensation Committee relied upon the views of
its outside advisors with respect to the legal, accounting and compensation
issues associated with the action and took into consideration, among other
things, the following factors: (i) the Company had historically paid salaries
which were at or below market levels and had made up for lower salaries through
stock option grants to employees; (ii) the Company historically had used stock
options as its principal long-term incentive program; (iii) the highly skilled
employees of the Company possessed marketable skills; and (iv) senior management
of the Company believed that there was potential for increased attrition among
its key employees and that adjustment of the exercise price of the outstanding
options would significantly help to mitigate such risk.
26
<PAGE> 27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
3.1 -- Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.1 of
Registrant's Registration Statement on Form S-1, File No.
33-42216)
3.2 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3 of
Registrant's Quarterly Report on Form 10-Q for the Quarterly
Period Ended March 31, 1993)
3.3 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.3 to the
Registrant's Registration Statement on Form 8-A/A, filed on
May 22, 1996)
3.4 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 4.4 to the Registration Statement on Form S-8, File
No. 333-03213)
3.5 -- Amended and Restated By-Laws of Registrant (incorporated by
reference to Exhibit 3.2 of Registrant's 1992 Form 10-K,
File No. 000-19480)
4.1 -- Form of Warrant issued to one or more lenders pursuant to
Registrant's Second Amended and Restated Credit Agreement,
dated as of February 4, 1997 (incorporated by reference to
Exhibit 4.1 to Current Report on Form 8-K filed on February
18, 1997)
10.1 -- Sixth Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Employees of Acquired Companies
(incorporated by reference to Exhibit 10.21 of the Annual
Report on Form 10-K for the year ended December 31, 1996,
File No. 000-19480)
10.2 -- First Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Non-Executive Employees (incorporated by
reference to Exhibit 10.24 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.3 -- Employment Agreement by and between Registrant and Daniel S.
Connors, Jr., dated February 25, 1997 (incorporated by
reference to Exhibit 10.50 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.4 -- Employment Agreement by and between Registrant and Carl
James Schaper, dated February 25, 1997 (incorporated by
reference to Exhibit 10.51 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.5 -- Employment Agreement by and between Registrant and Jerome H.
Baglien, dated January 3, 1997 (incorporated by reference to
Exhibit 10.52 of the Annual Report on Form 10-K for the year
ended December 31, 1996, File No. 000-19480)
10.6 -- Second Amended and Restated Credit Agreement, dated as of
February 4, 1997, among the Registrant, the lenders listed
therein and the Agent (incorporated by reference to Exhibit
99.2 to Current Report on Form 8-K filed on February 18,
1997)
10.7 -- Form of Second Amendment to the Amended and Restated
Medaphis Employees' Retirement Savings Plan (incorporated by
reference to Exhibit 10.31 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
11 -- Statement regarding Computation of Earnings Per Share
27 -- Financial Data Schedule (for SEC use only)
99.1 -- Safe Harbor Compliance Statement for Forward-Looking
Statements
</TABLE>
27
<PAGE> 28
(B) REPORTS ON FORM 8-K
The following reports on Form 8-K have been filed by the Company during the
quarter ended March 31, 1997:
<TABLE>
<CAPTION>
FINANCIAL
STATEMENTS
ITEM REPORTED FILED DATE OF REPORT FILE DATE
- ------------- ---------- ----------------- -----------------
<S> <C> <C> <C>
7th Modification of bank agreement.... No December 31, 1996 January 3, 1997
1996 Year end press release, second
amended and restated credit
agreement........................... Yes(1) December 31, 1996 February 18, 1997
</TABLE>
- ---------------
(1) Consolidated statement of operations for the three months and year ended
December 31, 1996, condensed consolidated balance sheets as of December 31,
1996 and 1995 and supplemented consolidated segment data for the quarterly
periods ended March 31, June 30, September 30 and December 31, 1996 and
1995.
28
<PAGE> 29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEDAPHIS CORPORATION
By: /s/ ALLEN W. RITCHIE
-----------------------------------
Allen W. Ritchie
Senior Vice President
and Chief Financial
Officer
Date: February 2, 1998
By: /s/ MARK P. COLONNESE
-----------------------------------
Mark P. Colonnese
Vice President and
Corporate Controller
(Principal Accounting
Officer)
29
<PAGE> 30
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION OF EXHIBITS PAGE
- ------- ----------------------- ------------
<C> <C> <S> <C>
3.1 -- Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.1 of
Registrant's Registration Statement on Form S-1, File No.
33-42216)
3.2 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3 of
Registrant's Quarterly Report on Form 10-Q for the Quarterly
Period Ended March 31, 1993)
3.3 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.3 to the
Registrant's Registration Statement on Form 8-A/A, filed on
May 22, 1996)
3.4 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 4.4 to the Registration Statement on Form S-8, File
No. 333-03213)
3.5 -- Amended and Restated By-Laws of Registrant (incorporated by
reference to Exhibit 3.2 of Registrant's 1992 Form 10-K,
File No. 000-19480)
4.1 -- Form of Warrant issued to one or more lenders pursuant to
Registrant's Second Amended and Restated Credit Agreement,
dated as of February 4, 1997 (incorporated by reference to
Exhibit 4.1 to Current Report on Form 8-K filed on February
18, 1997)
10.1 -- Sixth Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Employees of Acquired Companies
(incorporated by reference to Exhibit 10.21 of the Annual
Report on Form 10-K for the year ended December 31, 1996,
File No. 000-19480)
10.2 -- First Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Non-Executive Employees (incorporated by
reference to Exhibit 10.24 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.3 -- Employment Agreement by and between Registrant and Daniel S.
Connors, Jr., dated February 25, 1997 (incorporated by
reference to Exhibit 10.50 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.4 -- Employment Agreement by and between Registrant and Carl
James Schaper, dated February 25, 1997 (incorporated by
reference to Exhibit 10.51 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.5 -- Employment Agreement by and between Registrant and Jerome H.
Baglien, dated January 3, 1997 (incorporated by reference to
Exhibit 10.52 of the Annual Report on Form 10-K for the year
ended December 31, 1996, File No. 000-19480)
10.6 -- Second Amended and Restated Credit Agreement, dated as of
February 4, 1997, among the Registrant, the lenders listed
therein and the Agent (incorporated by reference to Exhibit
99.2 to Current Report on Form 8-K filed on February 18,
1997)
10.7 -- Form of Second Amendment to the Amended and Restated
Medaphis Employees' Retirement Savings Plan (incorporated by
reference to Exhibit 10.31 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
</TABLE>
30
<PAGE> 31
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION OF EXHIBITS PAGE
- ------- ----------------------- ------------
<C> <C> <S> <C>
11 -- Statement regarding Computation of Earnings Per Share
27 -- Financial Data Schedule (for SEC use only)
99.1 -- Safe Harbor Compliance Statement for Forward-Looking
Statements
</TABLE>
31
<PAGE> 1
EXHIBIT 11
MEDAPHIS CORPORATION
COMPUTATION OF PRIMARY AND FULLY DILUTED PRO FORMA EARNINGS PER SHARE
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------
DESCRIPTION 1997 1996
- ----------- ------------ ------------
(AS RESTATED (AS RESTATED
SEE NOTE 8) SEE NOTE 8)
<S> <C> <C>
Weighted average shares outstanding during the period....... 72,235 70,434
Shares issuable upon assumed exercise of stock options, less
amounts assumed repurchased under the treasury stock
method.................................................... -- 5,270
------- -------
Total weighted average common stock and common stock
equivalents outstanding during the period................. 72,235 75,704
======= =======
Pro forma net income (loss)................................. $(3,064) $ 9,424
======= =======
Pro forma net income (loss) per common share................ $ (0.04) $ 0.12
======= =======
</TABLE>
32
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF MEDAPHIS CORPORATION FOR THE THREE MONTHS ENDED MARCH
31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<EXCHANGE-RATE> 1
<CASH> 10,174
<SECURITIES> 0
<RECEIVABLES> 176,745
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 256,857
<PP&E> 92,798
<DEPRECIATION> 0
<TOTAL-ASSETS> 930,678
<CURRENT-LIABILITIES> 246,449
<BONDS> 0
0
0
<COMMON> 724
<OTHER-SE> 509,178
<TOTAL-LIABILITY-AND-EQUITY> 930,678
<SALES> 0
<TOTAL-REVENUES> 147,546
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 146,919
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,115
<INCOME-PRETAX> (5,488)
<INCOME-TAX> (2,424)
<INCOME-CONTINUING> (3,064)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,064)
<EPS-PRIMARY> (0.04)
<EPS-DILUTED> (0.04)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF MEDAPHIS CORPORATION FOR THE THREE MONTHS ENDED MARCH
31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<RESTATED>
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-31-1996
<PERIOD-END> MAR-31-1996
<EXCHANGE-RATE> 1
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 0
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 0
<SALES> 0
<TOTAL-REVENUES> 162,249
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 143,844
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,105
<INCOME-PRETAX> 16,300
<INCOME-TAX> 7,230
<INCOME-CONTINUING> 9,070
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,424
<EPS-PRIMARY> 0.12
<EPS-DILUTED> 0.12
</TABLE>
<PAGE> 1
EXHIBIT 99.1
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
SAFE HARBOR COMPLIANCE STATEMENT
FOR FORWARD-LOOKING STATEMENTS
In passing the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"), 15 U.S.C.A. Sections 77z-2 and 78u-5 (Supp. 1996), Congress
encouraged public companies to make "forward-looking statements" by creating a
safe harbor to protect companies from securities law liability in connection
with forward-looking statements. Medaphis Corporation ("Medaphis" or the
"Company") intends to qualify both its written and oral forward-looking
statements for protection under the Reform Act and any other similar safe harbor
provisions.
"Forward-looking statements" are defined by the Reform Act. Generally,
forward-looking statements include expressed expectations of future events and
the assumptions on which the expressed expectations are based. All
forward-looking statements are inherently uncertain as they are based on various
expectations and assumptions concerning future events and they are subject to
numerous known and unknown risks and uncertainties which could cause actual
events or results to differ materially from those projected. Due to those
uncertainties and risks, the investment community is urged not to place undue
reliance on written or oral forward-looking statements of Medaphis. The Company
undertakes no obligation to update or revise this Safe Harbor Compliance
Statement for Forward-Looking Statements (the "Safe Harbor Statement") to
reflect future developments. In addition, Medaphis undertakes no obligation to
update or revise forward-looking statements to reflect changed assumptions, the
occurrence of unanticipated events or changes to future operating results over
time.
Medaphis provides the following risk factor disclosure in connection with
its continuing effort to qualify its written and oral forward-looking statements
for the safe harbor protection of the Reform Act and any other similar safe
harbor provisions. Important factors currently known to management that could
cause actual results to differ materially from those in forward-looking
statements include the disclosures contained in the Annual Report on Form 10-K
to which this statement is appended as an exhibit and also include the
following:
SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE DEBT
The Company has substantial indebtedness and, as a result, significant debt
service obligations. The Company's ability to make payments on its debt
obligations will depend on its future operating performance, which will be
affected by prevailing economic conditions and financial, business and other
factors, certain of which are beyond the Company's control. If the Company is
unable to service its indebtedness, it will be required to adopt alternative
strategies, which may include actions such as reducing or delaying capital
expenditures, selling assets, restructuring or refinancing its indebtedness or
seeking additional equity capital. There can be no assurance that any of these
strategies could be effected on satisfactory terms.
The degree to which the Company is leveraged could have important
consequences, including: (i) the Company's ability to obtain additional
financing in the future for working capital, capital expenditures, acquisitions
or other general corporate purposes may be impaired; (ii) a substantial portion
of the Company's cash flow from operations may be dedicated to the payment of
principal and interest on its indebtedness, thereby reducing the funds available
to the Company for its operations; (iii) the Company's existing indebtedness
contains, and future financings are expected to contain, financial and other
restrictive covenants, including without limitation those restricting the
incurrence of additional indebtedness, the creation of liens, the payment of
dividends, sales of assets, capital expenditures, prepayment and those requiring
maintenance of minimum net worth, minimum EBITDA, minimum interest coverage and
maximum leverage requirements; (iv) certain of the Company's borrowings are and
will continue to be at variable rates of interest which expose the Company to
the risk of increases in interest rates; and (v) the Company may be more
leveraged than certain of its competitors, which may place the Company at a
relative competitive disadvantage and make the Company more vulnerable to
changes in its industry and changing economic conditions. As a result of the
<PAGE> 2
Company's level of indebtedness, its financial capacity to respond to market
conditions, extraordinary capital needs and other factors may be limited.
LITIGATION AND GOVERNMENT INVESTIGATIONS
Numerous federal and state civil and criminal laws govern medical billing
and collection activities. In general, these laws provide for various fines,
penalties, multiple damages, assessments and sanctions for violations, including
possible exclusion from Medicare, Medicaid and certain other federal and state
healthcare programs.
The United States Attorney's Office for the Central District of California
is conducting an investigation of the billing and collection practices in two
offices of the Company's wholly owned subsidiary, Medaphis Physician Services
Corporation ("MPSC"), which offices are located in Calabasas and Cypress,
California (the "Designated Offices") (the "California Investigation"). Medaphis
first became aware of the California Investigation on June 13, 1995 when search
warrants were executed on the Designated Offices and it and MPSC received grand
jury subpoenas. Medaphis received an additional grand jury subpoena on August
22, 1997, with which it is complying. The subpoena requires, among other things,
records of any audit or investigative reports relating to the billing of payors
globally for radiological services during the period January 1, 1991 to date and
any refunds owed to or issued to payors with respect to such global billing
reports in the Company's various offices, including the Designated Offices.
Although the precise scope of the California Investigation is not known to the
Company at this time, Medaphis believes that the U.S. Attorney's Office is
investigating allegations of billing fraud and that the inquiry is focused upon
billing and collection practices in the Designated Offices. No charges or claims
by the government have been made. Although the Company continues to believe that
the principal focus of the California Investigation remains on the billing and
collection practices in the Designated Offices, there can be no assurance that
the California Investigation will not expand to other offices, that the
California Investigation will be resolved promptly, that additional subpoenas or
search warrants will not be received by Medaphis or MPSC or that the California
Investigation will not have a material adverse effect on the Company. The
Company recorded charges of $12 million in the third quarter of 1995, $2 million
in the fourth quarter of 1996 and a credit of $2.8 million in the third quarter
of 1997, solely for legal and administrative fees, costs and expenses it
anticipates incurring in connection with the California Investigation and the
putative class action lawsuits described below which were filed in 1995
following the Company's announcement of the California Investigation. The
charges are intended to cover only the anticipated expenses of the California
Investigation and the related lawsuits and do not include any provision for
fines, penalties, damages, assessments, judgments or sanctions that may arise
out of such matters.
MPSC has become aware of apparently inadvertent computer software errors
affecting some of its electronic billing to carriers in the State of California.
The error relates to global billing (i.e., billing for the professional and
technical components of a service) for certain radiological services under
circumstances where the radiologist is only entitled to bill for the
professional component of such services. The Company believes such inadvertent
errors may have caused overpayments on certain claims submitted on behalf of
clients in the State of California. The full extent of overpayments by carriers
and beneficiaries has not been determined, but as notifications to the affected
clients and carriers occur, and refunds or offsets are sought, the Company may
be required to return to clients its portion of fees previously collected, and
may receive claims for alleged damages as a result of the error.
Following the announcement of the investigation by the United States
Attorney's Office for the Central District of California, Medaphis, various of
its current and former officers and directors and the lead underwriters
associated with Medaphis' public offering of Common Stock in April 1995, were
named as defendants in putative shareholder class action lawsuits filed in the
United States District Court for the Northern District of Georgia. In general,
these lawsuits alleged violations of the federal securities laws in connection
with Medaphis' public statements and filings under the federal securities acts,
including the registration statement filed in connection with Medaphis' public
offering of Common Stock in April 1995. On October 13, 1995, the named
plaintiffs in these lawsuits filed a consolidated class action complaint (the
"Consolidated Complaint"). On January 3, 1996, the court denied defendants'
motion to dismiss the Consolidated Complaint, which argued that the Consolidated
Complaint failed to state a claim upon which
2
<PAGE> 3
relief may be granted. On April 11, 1996, certain of the named plaintiffs to the
Consolidated Complaint voluntarily dismissed with prejudice all of their claims.
As a result of these dismissals, the Consolidated Complaint no longer contained
any claims based on the Securities Act of 1933, as amended (the "1933 Act"), and
the Company's underwriters and outside directors were no longer named as
defendants. On June 26, 1996, the court denied plaintiffs' motion to certify
plaintiffs' class. The plaintiffs and the defendants agreed to settle this
action on a class-wide basis for $4.75 million, subject to court approval (the
"1995 Class Action Settlement"). The 1995 Class Action Settlement included the
related putative class action lawsuit currently pending in the Superior Court of
Cobb County, Georgia, described more fully below. On October 29, 1997 the court
certified a class for settlement purposes, approved the settlement and entered
final judgment dismissing the action with prejudice. One of Medaphis' directors
and officers' liability insurance carriers has paid $3.7 million of the 1995
Class Action Settlement. The Company accrued approximately $1.2 million in the
quarter ended December 31, 1996 for the anticipated balance of the 1995 Class
Action Settlement and to pay certain fees incident thereto. On November 6, 1997,
the Company paid the remaining $1.05 million balance of the settlement.
On November 5, 1996, Medaphis, Randolph G. Brown, a former officer and
director, and Michael R. Cote and James S. Douglass, former officers, were named
as defendants in a putative shareholder class action lawsuit filed in Superior
Court of Cobb County, State of Georgia. This lawsuit was brought on behalf of a
putative class of purchasers of Medaphis Common Stock during the period from
March 29, 1995 through June 15, 1995. Plaintiffs sought compensatory damages and
costs. Pursuant to the 1995 Class Action Settlement, the claims in this state
action were settled and were dismissed without prejudice.
The Company learned in March 1997 that the government is investigating
allegations concerning the Company's wholly owned subsidiary, Gottlieb's
Financial Services, Inc. ("GFS") (the "GFS Investigation"). In 1993, Medaphis
acquired GFS, an emergency room physician billing company located in
Jacksonville, Florida, which had developed a computerized coding system. In
1994, Medaphis acquired and merged into GFS another emergency room physician
billing company, Physician Billing, Inc., located in Grand Rapids, Michigan. For
the year ended December 31, 1996, GFS represented approximately 7% of Medaphis'
revenue. During that year, GFS processed approximately 5.6 million claims,
approximately 2 million of which were made to government programs. The
government has requested that GFS voluntarily produce records, and GFS is
complying with that request. Although the precise scope and subject matter of
the GFS Investigation are not known to the Company, Medaphis believes that the
GFS Investigation, which is being participated in by federal law enforcement
agencies having both civil and criminal authority, involves GFS's billing
procedures and the computerized coding system used in Jacksonville and Grand
Rapids to process claims and may lead to claims of errors in billing. There can
be no assurance that the GFS Investigation will be resolved promptly or that the
GFS Investigation will not have a material adverse effect upon Medaphis. No
charges or claims by the government have been made. Currently, the Company has
recorded charges of $2 million and $1 million in the second and third quarters
of 1997, respectively, solely for legal and administrative fees, costs and
expenses in connection with the GFS Investigation, which charges do not include
any provision for fines, penalties, damages, assessments, judgments or sanctions
that may arise out of this matter.
The Company and its clients from time to time have received, and the
Company anticipates that they will receive in the future, official inquiries
(including subpoenas, search warrants, as well as informal requests) concerning
particular billing and collection practices related to certain subsidiaries of
the Company and its many clients.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its then current and
former officers, one of whom was also a director, were named as defendants in
nineteen putative shareholder class action lawsuits filed in the United States
District Court for the Northern District of Georgia. On November 22, 1996, the
plaintiffs in these lawsuits filed a Consolidated Amended Class Action
Complaint. On February 3, 1997, the plaintiffs filed a Consolidated Second
Amended Complaint (the "Consolidated Second Amended Complaint"). In general, the
Consolidated Second Amended Complaint alleges violations of the federal
securities laws in connection with Medaphis' filings under the federal
securities acts and public disclosures. The Consolidated Second Amended
Complaint is brought on behalf of a class of persons who purchased or otherwise
acquired Medaphis Common
3
<PAGE> 4
Stock between February 6, 1996 and October 21, 1996. The Consolidated Second
Amended Complaint also asserts claims on behalf of a sub-class of all persons
who acquired Medaphis Common Stock pursuant to the merger between Medaphis and
Health Data Sciences Corporation ("HDS"). The Consolidated Second Amended
Complaint seeks compensatory and rescissory damages, as well as fees, interest
and other costs. On February 14, 1997, the defendants moved to dismiss the
Consolidated Second Amended Complaint in its entirety. On May 27, 1997, the
court denied defendants' motion to dismiss. As a result of the Company's
restatement of its fiscal 1995 financial statements, the Company may not be able
to sustain a defense to strict liability on certain claims under the 1933 Act,
but the Company believes that it has substantial defenses to the alleged damages
relating to such 1933 Act claims.
The parties entered into a Stipulation and Agreement of Settlement dated
December 15, 1997 (the "Stipulation") to settle the 1996 putative shareholder
class action litigation which is the subject of the Consolidated Second Amended
Complaint on a class-wide basis for $20 million in cash (to be paid by the
Company's directors' and officers' liability insurance carriers), 3,955,556
shares of Medaphis Common Stock, and warrants to purchase 5,309,523 shares of
Medaphis Common Stock at $12 per share for a five-year period which were valued
at $22.3 million using an option pricing model. The Stipulation also includes,
among other things: (i) a complete release of claims against the Company, the
individual defendants and certain related persons and entities; and (ii) certain
anti-dilution rights in favor of plaintiffs with respect to certain future
issuances of shares of Medaphis Common Stock or warrants or rights to acquire
Medaphis Common Stock to settle existing civil litigation and claims pending or
asserted against the Company, subject to a 5.0 million share basket below which
there will be no dilution adjustments. The Stipulation also contains other
conditions including, but not limited to, consent and approval of the Company's
insurance carriers and the insurance carriers' payment of the cash portion of
the settlement, and the final approval of the settlement by the court. On
December 15, 1997, the court granted preliminary approval to the settlement and
conditionally certified the classes for settlement purposes only. The Company
recorded a $52.5 million charge in the quarter ended September 30, 1997 for this
settlement. Such amount has been reflected as a non-current liability as the
Company does not anticipate satisfying the obligation with current assets.
On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit
Sharing Plan filed a shareholder derivative lawsuit in the United States
District Court for the Northern District of Georgia alleging that certain of
Medaphis' current and former directors breached their fiduciary duties, were
grossly negligent, and breached various contractual obligations to Medaphis by
allegedly failing to implement and maintain an adequate system of internal
accounting controls, allowing Medaphis to commit securities law violations and
damaging Medaphis' reputation. The plaintiff seeks compensatory damages and
costs on behalf of the Company. On January 28, 1997, Medaphis and certain
individual defendants filed a motion to dismiss the complaint. On February 11,
1997, the plaintiff filed an amended complaint adding as defendants, additional
current and former directors and officers of Medaphis. On April 23, 1997,
Medaphis and all other defendants filed a motion to dismiss the amended
complaint.
On November 7, 1996, Health Systems International, Inc. filed suit in the
Superior Court for the State of California, County of Los Angeles against
Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed
Medaphis directors, officers and employees. Generally, this lawsuit alleges that
the defendants violated federal and California securities laws and common law
by, among other things, making material misstatements and omissions in public
and private disclosures in connection with the acquisition of HDS. Plaintiff
seeks rescissory, compensatory and punitive damages, rescission, injunctive
relief and costs. On January 10, 1997, the defendants filed a demurrer to the
complaint. On February 5, 1997 the Court overruled defendants demurrer. On March
18, 1997, the court denied the plaintiff's motion for a preliminary injunction.
On July 16, 1997, plaintiff filed an amended complaint adding several new
parties, including current and former directors and former and current officers
of Medaphis. All of the newly added defendants have responded to the amended
complaint. As a result of the Company's restatements of its fiscal 1995
financial statements, the Company may not be able to sustain a defense to strict
liability on certain claims under the 1933 Act, but the Company believes that it
has substantial defenses to the alleged damages relating to such 1933 Act
claims.
4
<PAGE> 5
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberger against Steven G. Papermaster, Robert E. Pickering, Jr., David S.
Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and
Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division,
Essex County, State of New Jersey. The alleged class consists of persons and
entities whose options to purchase BSG Corporation ("BSG") common stock were
converted to Medaphis stock options in connection with Medaphis' acquisition of
BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary
duties of candor, loyalty and fair dealing and negligence against the BSG
defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud
and deceit against the Medaphis defendants (Medaphis and Brown). Plaintiffs seek
compensatory and punitive damages, as well as fees, interest and other costs. On
April 18, 1997, the Medaphis defendants and BSG defendants filed motions to
dismiss the complaint. On or about July 3, 1997, in lieu of responding to these
motions, the plaintiffs filed an amended complaint, adding new claims under the
1933 Act and common law and new parties, including former officers of Medaphis,
Medaphis' former outside auditors and BSG. On or about October 29, 1997 all
defendants filed motions to dismiss the amended complaint.
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control made a demand for indemnification under an indemnification
agreement executed by Medaphis in connection with its acquisition of BSG in May
1996. The indemnification demand claims damages of $35 million (the maximum
damages payable by Medaphis under the indemnification agreement) for the alleged
breach by Medaphis of its representations and warranties made in the merger
agreement between Medaphis and BSG. On December 31, 1996, Medaphis entered into
a standstill and tolling agreement with Mr. Noorda, Mr. Papermaster and other
former BSG shareholders, which, as extended, runs through September 30, 1998.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity Trust
and the Paulanne H. Thacker Retained Annuity Trust filed a complaint against the
Company and Randolph G. Brown in the United States District Court for the
Southern District of New York arising out of Medaphis' acquisition of Medical
Management Sciences, Inc. ("MMS") in December of 1995. The complaint is brought
on behalf of all former shareholders of MMS who exchanged their MMS holdings for
unregistered shares of Medaphis Common Stock. In general, the complaint alleges
both common law fraud and violations of the federal securities laws in
connection with the merger. In addition, the complaint alleges breaches of
contract relating to the merger agreement and a registration rights agreement,
as well as tortious interference with economic advantage. The plaintiffs seek
rescission of the merger agreement and the return of all MMS shares, as well as
damages in excess of $100 million. Additionally, plaintiffs seek to void various
non-compete covenants and contract provisions between Medaphis and plaintiffs.
Defendants have filed a motion to dismiss the complaint. Discovery has been
stayed pending resolution of the motion to dismiss.
On August 12, 1997, George W. Stickel filed a putative class action
complaint against Medaphis, Randolph W. Brown, Michael R. Cote and James S.
Douglass in the United States District Court for the Northern District of
Georgia. The complaint asserts claims under the Securities Exchange Act of 1934
on behalf of all persons who purchased or otherwise acquired Medaphis Common
Stock between February 6, 1996 and October 21, 1996. The complaint also asserts
claims under the 1933 Act on behalf of a sub-class consisting of all persons and
entities who, in connection with the merger of the Company and HDS, acquired
options to purchase shares of Medaphis Common Stock between February 6, 1996 and
October 21, 1996. The complaint seeks rescission, rescissory and compensatory
damages, and interest, fees and other costs. Defendants have not yet responded
to the complaint.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies. To date,
these other stockholders have not filed lawsuits. The Company has entered into
standstill and tolling agreements with these and certain other stockholders of
recently acquired companies.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") notified the Company that it was conducting a formal, non-public
investigation into, among other things, certain trading and other issues related
to Medaphis' August 14, 1996 and October 22, 1996 announcements of the
5
<PAGE> 6
Company's loss for the quarter ending September 30, 1996 and its restated
consolidated financial statements for the three months and year ending December
31, 1995 and its restated unaudited balance sheets as of March 31, 1996, and
June 30, 1996. In addition, the Company believes that the Commission is
investigating the Company's restatement of its interim financial statements for
each quarter of 1996. The Company intends to cooperate fully with the Commission
in its investigation.
Although the Company believes that it has meritorious defenses to the
claims of liability or for damages in the actions against and written demands
placed upon the Company, there can be no assurance that additional lawsuits will
not be filed against the Company. Further, there can be no assurance that the
lawsuits, the written demands and the pending governmental investigations will
not have a disruptive effect upon the operations of the business, that the
written demands, the defense of the lawsuits and the pending investigations will
not consume the time and attention of the senior management of the Company, or
that the resolution of the lawsuits, the written demands and the pending
governmental investigations will not have a material adverse effect upon the
Company.
DEPENDENCE ON TURNAROUND; FUTURE OPERATING RESULTS; MANAGEMENT
The Company suffered several setbacks in recent years, including (i)
government investigations into: (a) the billing and collection practices in two
offices of Medaphis Physicians Services Corporation ("MPSC") (the "California
Investigation"), and (b) the billing procedures and computerized coding system
used in Gottlieb's Financial Services, Inc. ("GFS") to process claims, which may
lead to claims of errors in billing (the "GFS Investigation"); (ii) the failure
of prior managements' acquisition strategy to integrate companies acquired;
(iii) several restatements of various financial statements of the Company,
including restatements of the Company's fiscal 1994, 1995, 1996 and interim 1997
financial statements; (iv) the discontinuance of the operations of one of the
businesses acquired; (v) the abandonment of an extensive reengineering program
that failed to realize the improvement in customer service and reduction of
costs that were expected; (vi) a steep drop in the price of its common stock;
and (vii) the filing of various lawsuits and claims made against the Company,
including multiple putative shareholder class action lawsuits alleging
violations of the federal securities laws. Consequently, the Company has been
operating in what is commonly described as a "turnaround" situation. In addition
to the risks generally associated with any entity in a turnaround situation, the
Company faces certain challenges more specific to its operations, including: (i)
integrating several recent acquisitions into its ongoing operations; (ii)
shifting its strategic focus from acquiring compatible businesses to running its
existing businesses efficiently and profitably; (iii) successfully completing
the combination of the operations of BSG Corporation ("BSG") and Healthcare
Information Technologies ("HIT") under the Per-Se name, following the
reorganization of its Imonics Corporation ("Imonics"), BSG and BSG Government
Solutions, Inc. (formerly Rapid Systems Solutions, Inc.) ("BSG Government")
subsidiaries and the shutdown of Imonics; (iv) managing existing customers'
perceptions of the Company's continued viability and refocusing on the high
levels of customer service required to develop new customers and retain existing
customers; (v) combating employee turnover, particularly in light of declines in
the market value of the Company's common stock (the value of which often plays a
role in compensation of employees); (vi) reducing costs and increasing
efficiencies; and (vii) reevaluating the efficiency of its operations following
the Company's 1996 abandonment of its reengineering initiative to develop a
unified billing and information hardware and software system across all of its
operating platforms, the costs of which were subsequently determined to outweigh
the benefits.
There can be no assurance that the Company will successfully meet these or
other operating challenges or that the Company's operating plans ultimately will
be successful. Any failure with respect to the foregoing could have a material
adverse effect on the Company.
The Company's success in general, and the successful implementation of its
operating plans in particular, is dependent upon, among other things, the
continued contributions of the Company's senior management. There can be no
assurance that the Company's management will be successful and the loss of
services of those members could have a material adverse effect on the Company's
businesses.
6
<PAGE> 7
RESTATEMENT OF FINANCIAL STATEMENTS; ACCOUNTING ISSUES
In October 1996, the Company restated its financial results for the year
and three months ended December 31, 1995. This restatement related primarily to
a side letter relating to a license agreement entered into by Imonics in
December 1995, which created a contingency upon license fees payable under the
agreement. The contingency occurred, entitling the purchaser to a refund and
cancellation of the contract. The license fee revenue payable under the
agreement and recognized by the Company during the fourth quarter of 1995,
together with previously deemed immaterial amounts, resulted in an aggregate
reduction to net income for the quarter and year ended December 31, 1995 of $5.1
million.
As a result of a review initiated by senior management and the Audit
Committee of the Board of Directors in March 1997 prior to completion of the
audit process for the Company's 1996 fiscal year, information was developed
indicating that certain revenues and expenses may have been recorded incorrectly
between certain quarters during 1996. In addition, Deloitte & Touche LLP
("Deloitte & Touche") provided to senior management of the Company a letter
relating to the Company's internal control structure resulting from Deloitte &
Touche's audit of the Company's financial statements for the year ended December
31, 1996. This letter reflected Deloitte & Touche's view that inadequate
internal controls over the preparation of interim financial information for each
fiscal quarter of 1996 constituted a material weakness in internal controls
which resulted in certain errors and irregularities in the financial information
for such quarters. The Company previously disclosed in its Form 10-K for its
fiscal year ended December 31, 1996 that such errors and irregularities in its
financial information had occurred for each fiscal quarter of 1996. In
connection with the issuance of Deloitte & Touche's audit report dated March 31,
1997 on the Company's financial statements for the year ended December 31, 1996,
the Company recorded all adjustments to its interim financial statements deemed
appropriate for such errors and irregularities and consequently restated such
interim financial statements. All adjustments were for interim period
transactions and had no effect on the Company's 1996 annual pro forma net loss.
The reports of Deloitte & Touche on the Company's financial statements for
the fiscal year ended December 31, 1996, dated March 31, 1997, included an
unqualified opinion with an explanatory paragraph that stated Deloitte &
Touche's conclusion that uncertainty then existed regarding the ability of the
Company to continue as a going concern due to a mandatory commitment reduction
in the Company's Existing Credit Facility that was required by July 31, 1997.
However, the Company satisfied such commitment reduction on May 28, 1997 by
applying the proceeds of the sale of HRI.
On June 30, 1997, following a competitive review and request for proposal
process in which Deloitte & Touche, the Company's then-present auditors, and a
number of other nationally recognized accounting firms participated, the Company
notified Deloitte & Touche that it had been dismissed as the Company's principal
accountants and that the Company intended to engage new principal accountants.
This action was recommended by the Audit Committee of the Company's Board of
Directors, and the Board approved such change on June 27, 1997. On July 9, 1997,
the Company engaged Price Waterhouse LLP ("Price Waterhouse") as the Company's
new principal accountants.
During the third quarter of 1997, in connection with a refinancing effort
of the Company's then credit agreement, management evaluated certain revenue
practices at Health Data Sciences Corporation ("HDS"), a wholly-owned subsidiary
of the Company which was acquired by the Company in a merger transaction in June
1996 that was accounted for as a pooling of interests. These practices related
principally to revenue recognized in fiscal years 1994, 1995 and 1996. As
disclosed by the Company in its Form 10-Q for its fiscal quarter ending
September 30, 1997, management determined that certain revenue of HDS was
improperly recognized and, accordingly, determined to restate its financial
statements for its 1994, 1995 and 1996 fiscal years and the first two fiscal
quarters of its 1997 fiscal year. The effect of such restatements on the
Company's net income (loss) for the years ended December 31, 1994, 1995 and 1996
was ($5.8) million, $(1.1) million and $(7.3) million, respectively. The
cumulative reduction in assets caused by such restatement was $20.5 million.
As a result of the HDS-related restatements, Deloitte & Touche withdrew its
audit opinion dated March 31, 1997 in respect of the Company's 1994, 1995 and
1996 fiscal years. Consequently, the Company
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engaged Price Waterhouse to re-audit the Company's 1995 and 1996 fiscal years
and audit the Company's nine-month period ending September 30, 1997. The Company
determined to further restate the results of such periods to account for the
December 1995 acquisition by the Company of Medical Management Sciences, Inc.
("MMS") on a purchase accounting basis. Such acquisition had previously been
accounted for as a pooling of interests.
Financial statements for the Company's 1995, 1996 and 1997 fiscal years
reflecting the HDS and MMS related restatements are being filed by the Company
as an exhibit to the Annual Report on Form 10-K to which this exhibit is
appended. Such financial statements were audited by Price Waterhouse and
accompanied by their audit opinion which was unqualified and was not subject to
any modifying paragraphs.
While the Company restated its 1994 financial statements, it has not
reaudited such financial statements. Consequently, the Company may not be in
full compliance with the reporting requirements of applicable securities laws.
There can be no assurances that any such failure to be in compliance will not
have a material adverse consequence for the Company.
In addition, the Company received a subpoena from the Securities and
Exchange Commission (the "Commission") in connection with an on-going Commission
investigation on January 2, 1998. The subpoena seeks information in connection
with the November 19 and December 23, 1997 restatements and certain charges
taken by the Company in the third quarter of 1997. There can be no assurances
that the results of such inquiry will not have a material adverse effect on the
Company or that further restatements of the Company's financial statements will
not be required.
There can be no assurance that there will not be additional adjustments to
or reserves taken in the Company's financial statements in respect of the
pending or future lawsuits and government investigations.
EVOLVING INDUSTRY STANDARDS; RAPID TECHNOLOGICAL CHANGES
The markets for Medaphis' software products and services are characterized
by rapidly changing technology, evolving industry standards and frequent new
product introductions. Medaphis' success in its business will depend in part
upon its continued ability to enhance its existing products and services, to
introduce new products and services quickly and cost-effectively to meet
evolving customer needs, to achieve market acceptance for new product and
service offerings and to respond to emerging industry standards and other
technological changes. There can be no assurance that Medaphis will be able to
respond effectively to technological changes or new industry standards.
Moreover, there can be no assurance that competitors of Medaphis will not
develop competitive products, or that any such competitive products will not
have an adverse effect upon Medaphis' operating results.
The Company intends further to refine, enhance and develop certain of the
Company's existing software and billing systems and to change all of the
Company's billing and accounts receivable management services operations over to
the Company's most proven software systems and technology to reduce the number
of systems and technologies that must be maintained and supported. Moreover,
management intends to continue to implement "best practices" and other
established process improvements in its operations going forward. There can be
no assurance that the Company will be successful in refining, enhancing and
developing its software and billing systems going forward, that the costs
associated with refining, enhancing and developing such software and systems
will not increase significantly in future periods, that the Company will be able
successfully to migrate the Company's billing and accounts receivable management
services operations to the Company's most proven software systems and technology
or that the Company's existing software and technology will not become obsolete
as a result of ongoing technological developments in the marketplace.
CLIENT/SERVER INFORMATION TECHNOLOGY PRODUCTS
Medaphis' client/server information technology business involves, among
other things, projects designed to reengineer significant customer operations
through the strategic use of imaging, client/server and other advanced
technologies. Failure to meet expectations with respect to a major project could
damage the Company's reputation and standing in the client/server information
technology marketplace, affect its ability
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to attract new client/server information technology business, result in the
payment of damages to the customer, jeopardize the Company's ability to collect
for services already performed on the project and otherwise adversely affect its
results of operations.
POTENTIAL "YEAR 2000" PROBLEMS
It is possible that the Company's currently installed computer systems,
software products or other business systems, or those of the Company's
customers, vendors or resellers, working either alone or in conjunction with
other software or systems, will not accept input of, store, manipulate and
output dates for the years 1999, 2000 or thereafter without error or
interruption (commonly known as the "Year 2000" problem). The Company has
conducted a review of its business systems, including its computer systems, and
is querying its customers, vendors and resellers as to their progress in
identifying and addressing problems that their computer systems may face in
correctly interrelating and processing date information as the year 2000
approaches and is reached. However, there can be no assurance that the Company
will identify all such Year 2000 problems in its computer systems or those of
its customers, vendors or resellers in advance of their occurrence or that the
Company will be able to successfully remedy any problems that are discovered.
The expenses of the Company's efforts to identify and address such problems, or
the expenses or liabilities to which the Company may become subject as a result
of such problems, could have a material adverse effect on the Company's
business, financial condition and results of operations. The revenue stream and
financial stability of existing customers may be adversely impacted by Year 2000
problems, which could cause fluctuations in the Company's revenues. In addition,
failure of the Company to identify and remedy Year 2000 problems could put the
Company at a competitive disadvantage relative to companies that have corrected
such problems.
COMPETITION; INDUSTRY AND MARKET CHANGES
The business of providing management services and information technology to
physicians and hospitals is highly competitive. Medaphis competes with certain
national and regional physician and hospital reimbursement organizations and
collection businesses (including local independent operating companies), certain
national information and data processing organizations and certain physician
groups and hospitals that provide their own business management services.
Potential industry and market changes that could adversely affect the billing
and collection aspects of Medaphis' business include (i) a significant increase
in managed care providers relative to conventional fee-for-service providers,
potentially resulting in substantial changes in the medical reimbursement
process, or the Company's failure to respond to such changes and (ii) new
alliances between healthcare providers and third-party payors in which
healthcare providers are employed by such third-party payors. The business of
providing application software, information technology and consulting services
is also highly competitive and Medaphis faces competition from certain national
and regional companies in connection with its technology operations. Certain of
Medaphis' competitors have longer operating histories and greater financial,
technical and marketing resources than Medaphis. There can be no assurance that
competition from current or future competitors will not have a material adverse
effect upon Medaphis.
The Company's business is affected by, among other things, trends in the
U.S. healthcare industry. As healthcare expenditures have grown as a percentage
of the U.S. Gross National Product, public and private healthcare cost
containment measures have applied pressure to the margins of healthcare
providers. Historically, some healthcare payors have paid the prices established
by providers while other healthcare payors, notably government agencies and
managed care companies, have paid less than established prices (in many cases
less than the average cost of providing the services). As a consequence, prices
charged to healthcare payors willing to pay established prices have increased in
order to recover the cost of services purchased by government agencies and
others but not paid for by them (i.e., "cost shifting"). The increasing
complexity in the reimbursement system and assumption of greater payment
responsibility by individuals have caused healthcare providers to experience
increased accounts receivable and bad debt levels and higher business office
costs. Healthcare providers historically have addressed these pressures on
profitability by increasing their prices, by relying on demographic changes to
support increases in the volume and intensity of medical procedures and by cost
shifting. Notwithstanding the providers' responses to these pressures,
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management believes that the revenue growth rate experienced by the Company's
clients continues to be adversely affected by increased managed care and other
industry factors affecting healthcare providers in the United States. At the
same time, the process of submitting healthcare claims for reimbursement to
third party payors in accordance with applicable industry and regulatory
standards continues to grow in complexity and to become more costly. Management
believes that these trends have adversely affected and could continue to
adversely affect the revenues and profit margins of the Company's operations.
GOVERNMENTAL INVESTIGATORY RESOURCES AND HEALTHCARE REFORM
The federal government in recent years has placed increased scrutiny on the
billing and collection practices of healthcare providers and related entities,
and particularly on possibly fraudulent billing practices. This heightened
scrutiny has resulted in a number of high profile civil and criminal
investigations, lawsuits and settlements.
In 1996, Congress enacted the Health Insurance Portability and Accounting
Act of 1996, Pub. L. No. 104-191, 1996 U.S.C.C.A.N. (110 Stat. 1936) (codified
in scattered sections of the United States Code, including 18, 26, 29 and 42
U.S.C.), which includes an expansion of provisions relating to fraud and abuse,
creates additional criminal offenses relating to healthcare benefit programs,
provides for forfeitures and asset-freezing orders in connection with such
healthcare offenses and contains provisions for instituting greater coordination
of federal, state and local enforcement agency resources and actions.
In recent years, the focus of healthcare legislation has been on budgetary
and related funding mechanism issues. Both the Congress and the Clinton
Administration have made proposals to reduce the rate of increase in projected
Medicare and Medicaid expenditures and to change funding mechanisms and other
aspects of both programs. In late 1995, Congress passed legislation that would
substantially reduce projected expenditure increases and would make significant
changes in the Medicare and Medicaid programs. The Clinton Administration has
proposed alternate measures to reduce, to a lesser extent, projected increases
in Medicare and Medicaid expenditures. Neither proposal has become law and
Medaphis anticipates that both the Clinton Administration and the Republican
majorities in Congress will introduce legislation in 1998 designed to reduce
projected increases in Medicare and Medicaid expenditures and to make other
changes in the Medicare and Medicaid programs. Medaphis anticipates that such
proposed legislation would, if adopted, change aspects of the present methods of
paying physicians under such programs and provide incentives for Medicare and
Medicaid beneficiaries to enroll in health maintenance organizations and other
managed care plans. Medaphis cannot predict the effect of any such legislation,
if adopted, on its operations.
A number of states in which Medaphis has operations either have adopted or
are considering the adoption of healthcare reform proposals at the state level.
Medaphis cannot predict the effect of proposed state healthcare reform laws on
its operations. Additionally, certain reforms are occurring in the healthcare
market, including certain employer initiatives such as creating purchasing
cooperatives and contracting for healthcare services for employees through
managed care companies (including health maintenance organizations), and certain
provider initiatives such as risk-sharing among healthcare providers and managed
care companies through capitated contracts and integration among hospitals and
physicians into comprehensive delivery systems. Consolidation of management and
billing services through integrated delivery systems may result in a decrease in
demand for Medaphis billing and collection services for particular physician
practices.
EXISTING GOVERNMENT REGULATION
Existing government regulation can adversely affect Medaphis' business
through, among other things, its potential to reduce the amount of reimbursement
received by Medaphis' clients for healthcare services. Medaphis' medical billing
and collection activities are also governed by numerous federal and state civil
and criminal laws. In general, these laws provide for various fines, penalties,
multiple damages, assessments and sanctions for violations, including possible
exclusion from Medicare, Medicaid and certain other federal and state healthcare
programs.
Submission of claims for services or procedures that are not provided as
claimed, or which otherwise violate the regulations, may lead to civil monetary
penalties, criminal fines, imprisonment and/or exclusion
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from participation in Medicare, Medicaid and other federally funded healthcare
programs. Specifically, the Federal False Claims Act allows a private person to
bring suit alleging false or fraudulent Medicare or Medicaid claims or other
violations of the statute and for such person to share in any amounts paid to
the government in damages and civil penalties. Successful plaintiffs can receive
up to 25-30% of the total recovery from the defendant. Such qui tam actions or
"whistle-blower" lawsuits have increased significantly in recent years and have
increased the risk that a company engaged in the healthcare industry, such as
Medaphis and many of its customers, may become the subject of a federal or state
investigation, may ultimately be required to defend a false claims action, may
be subjected to government investigation and possible criminal fines, may be
sued by private payors and may be excluded from Medicare, Medicaid and/or other
federally funded healthcare programs as a result of such an action. Some state
laws also provide for false claims actions, including actions initiated by a qui
tam plaintiff. Medaphis is currently the subject of several federal
investigations, and there can be no assurance that Medaphis will not be the
subject of false claims or qui tam proceedings relating to its billing and
collection activities or that Medaphis will not be the subject of further
government scrutiny or investigations relating to its billing and accounts
receivable management services operations. Any such proceeding or investigation
could have a material adverse effect upon the Company.
Credit collection practices and activities are regulated by both federal
and state law. The Federal Fair Debt Collection Practices Act (the "Federal Fair
Debt Act") sets forth various provisions designed to eliminate abusive,
deceptive and unfair debt collection practices by debt collectors. Various
states have also promulgated laws and regulations that govern credit collection
practices. AssetCare, Inc. a subsidiary of the Company, is registered as a debt
collector in 26 states; however, there can be no assurance that the Company and
its subsidiaries (other than AssetCare), will not be subjected to regulation as
a "debt collector" under the Federal Fair Debt Act or as a "collection agency"
under certain state collection agency laws and regulations. In the event that
the Company or a subsidiary of the Company other than AssetCare is subjected to
such regulation, its impact on the Company cannot be predicted.
The ownership and operation of hospitals is subject to comprehensive
regulation by federal and state governments which may adversely affect hospital
reimbursement. Such regulation could have an adverse effect on the operations of
hospitals in general, and consequently reduce the amount of the Company's
revenue related to its hospital clients.
There can be no assurance that current or future government regulations or
healthcare reform measures will not have a material adverse effect upon
Medaphis' business.
NASD ACTIONS. There can be no assurances that the NASD will not suspend
trading in the Company's common stock or de-list the Company's Common Stock as a
result of either the restatements described in this Form 10-K or the withdrawal
by Deloitte & Touche LLP of its opinions in respect of the financial statements
for the Company's 1994, 1995 and 1996 fiscal years.
VOLATILITY OF STOCK PRICE. Medaphis believes factors such as announcements
with respect to the investigation of the billing practices of certain offices of
MPSC by the United States Attorney's Office for the Central District of
California, the Company's liquidity and financial resources, divestiture of
businesses, the ongoing governmental investigations, putative class action
lawsuits, other lawsuits or demands, healthcare reform measures and
quarter-to-quarter and year-to-year variations in financial results could cause
the market price of Medaphis Common Stock to fluctuate substantially. Any
adverse announcement with respect to such matters or any shortfall in revenue or
earnings from levels expected by securities analysts could have an immediate and
material adverse effect on the trading price of Medaphis Common Stock in any
given period. As a result, the market for Medaphis Common Stock may experience
material adverse price and volume fluctuations and an investment in the
Company's Common Stock is not suitable for any investor who is unwilling to
assume the risk associated with any such price and volume fluctuations.
This Safe Harbor Statement supersedes the Safe Harbor Statements filed as
Exhibit 99.1 to the Company's Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 1997 and as Exhibit 99.6 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.
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