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EXHIBIT 99.3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Medaphis is a leading provider of business management systems and services
to the healthcare industry. Medaphis' systems and 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. The Company also
provides subrogation and related recovery services primarily to healthcare
payors, scheduling and information management systems to hospitals and emerging
integrated healthcare delivery systems and systems integration and work flow
engineering systems and services. The Company's scheduling and information
systems are designed to improve efficiency by automating certain scheduling and
related management functions within a healthcare facility and its systems
integration and work flow engineering systems and services are designed to
increase flexibility, improve end-user access to information and increase
decision making through the strategic use and development of client/server,
imaging and other advanced technologies. The Company currently provides business
management systems and services to approximately 19,100 physicians and over
2,000 hospitals in all 50 states, subrogation and recovery services to
healthcare plans covering in excess of 23 million people throughout the United
States and systems integration and work flow engineering systems and services in
the United States and abroad.
Medaphis' business is impacted by trends in the U.S. healthcare industry.
As healthcare expenditures have grown as a percentage the of U.S. gross national
product, public and private healthcare cost containment measures have applied
pressure to the margins of healthcare providers. Historically, some payors have
willingly paid the prices established by providers while other 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 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"). 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. 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 foregoing,
management of the Company 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 become more costly.
Management of the Company believes that the decline in revenue growth
experienced by the Company's clients, the increasing complexity and costs
associated with providing billing and accounts receivable management services to
healthcare providers and the Company's on-going re-engineering and consolidation
project have placed pressure on the rate of revenue growth and margins in the
Company's physician and hospital billing operations which are the subject of
such re-engineering and consolidation project. Due to these revenue and margin
pressures, Medaphis Physician Services Corporation did not significantly
contribute to the Company's operating profit for the second half of 1995 and
this trend is not expected to improve until further progress is made in the
Company's re-engineering and consolidation project. To date, the Company has
been able to offset such revenue and margin pressures through expanded growth in
its information management and systems integration services operations. To
address the revenue and margin pressures in its billing and accounts receivable
management services operations going forward, the Company has commenced a
comprehensive re-engineering and consolidation project which is intended to
reduce the Company's operating costs, increase the consistency and quality of
services and enhance operating margins. The Company continually monitors events
and changes in circumstances that could indicate carrying amounts of intangible
assets, including those associated with the operations of MPSC, may not be
recoverable. It is reasonably possible that based on the results of the
Company's re-engineering and consolidation plan, the
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Company's estimates of undiscounted expected future cash flows after related
interest charges used to assess recoverability of the carrying value of
intangible assets, may be significantly reduced.
The U.S. healthcare industry continues to experience tremendous change as
both federal and state governments, as well as private industry, work to bring
more efficiency and effectiveness to the healthcare system. Medaphis continues
to evaluate governmental and industry reform initiatives in an effort to
position itself to take advantage of the opportunities created thereby.
RESULTS OF OPERATIONS
The following table shows the percentage of certain items reflected in the
Company's statements of income to revenue.
YEAR ENDED DECEMBER 31,
-------------------------
1995 1994 1993
----- ----- -----
Revenue............................................................. 100.0% 100.0% 100.0%
Salaries and wages.................................................. 57.4 56.9 58.9
Other operating expenses............................................ 24.6 23.9 25.5
Depreciation........................................................ 2.6 2.3 2.6
Amortization........................................................ 3.1 2.7 2.8
Interest expense, net............................................... 1.8 1.5 2.4
Restructuring and other charges..................................... 9.7 0.5 0.0
----- ----- -----
Income before income taxes.......................................... 0.8 12.2 7.8
Income taxes........................................................ 0.9 4.0 2.5
----- ----- -----
Net income (loss)................................................... (0.1) 8.2 5.3
Pro forma adjustments............................................... (0.5) (0.5) (0.5)
----- ----- -----
Pro forma net income (loss)......................................... (0.6)% 7.7% 4.8%
===== ===== =====
REVENUE
Revenue increased 41.5% to $564.3 million in 1995 as compared with $398.9
million in 1994 and increased 42.8% in 1994, as compared with 1993. Revenue
growth results from (i) acquisitions; (ii) increases in the number of business
management services clients; and (iii) increases in sales to information
management and systems integration clients. The Company has consummated 25
business combinations during the period from January 1, 1993 through December
31, 1995.
The Company's selling activities generated new business management services
client relationships with estimated annualized revenue of approximately $54.5
million and $42.9 million in 1995 and 1994, respectively. An increasing
proportion of the Company's revenue growth has resulted from revenues
attributable to information management and systems integration services which
contributed $55.0 million and $37.0 million in revenue growth in 1995 and 1994,
respectively, primarily from sales to new clients.
SALARIES AND WAGES
Salaries and wages represented 57.4% of revenue in 1995 as compared with
56.9% and 58.9% in 1994 and 1993, respectively. The increase in 1995 resulted
from a decrease in the revenue recognized at HDS offset by the changes in
compensation to the former owners of Atwork. The decreases in 1994 resulted
primarily from changes in compensation to the former owners of MMS.
OTHER OPERATING EXPENSES
Other operating expenses increased to 24.6% of revenue in 1995 from 23.9%
in 1994 which had decreased from 25.5% in 1993. The increase in 1995 was a
result of the decrease in the 1995 revenue at HDS primarily associated with the
timing of new sales. The decrease in 1994 from the 1993 level resulted primarily
from the benefits of economies of scale realized as a result of the overall
growth in the Company's business and
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continued growth in the Company's information management and systems integration
services, which historically incur less operating expenses as a percentage of
revenue. Other operating expenses are primarily comprised of postage, facility
and equipment rental, telecommunications, travel, outside consulting services
and office supplies.
DEPRECIATION
Depreciation expense was $14.5 million in 1995, $9.4 million in 1994 and
$7.3 million in 1993. These increases reflect the Company's investment in
property and equipment to support growth in its business, including
acquisitions.
In 1994, the Company began a comprehensive re-engineering and consolidation
project. As part of this project, management anticipates consolidating the
processing function currently being performed in approximately 300 local
business offices into approximately 10 regional processing centers. In addition,
new computer equipment and proprietary software will be installed in the
Company's transaction processing operations. The project did not result in
significant increases in depreciation expense and amortization expense in 1995.
Management anticipates increases in depreciation expense in 1996 and thereafter
in anticipation of the scheduled completion of the project during 1997.
AMORTIZATION
Amortization of intangible assets, which are primarily associated with the
Company's acquisitions, was $17.4 million in 1995, $10.7 million in 1994 and
$7.9 million in 1993. The increases are primarily due to increased amortization
of goodwill and client lists resulting from acquisitions. Management estimates
that intangible assets acquired in connection with 1995 acquisitions accounted
for under the purchase method of accounting will increase amortization expense
by approximately $1.3 million in 1996. As noted above, Management anticipates
that amortization expense in 1996 and thereafter will increase upon the
completion of its re-engineering and consolidation project. The Company intends
to amortize the software developed in connection with this project over its
estimated useful life of seven years.
INTEREST
Net interest expense was $10.1 million in 1995, $5.9 million in 1994 and
$6.6 million in 1993. The increase in 1995 is primarily due to increased
borrowings under the Senior Credit Facility to finance acquisitions and the
Company's investment in its re-engineering and consolidation project. Management
anticipates interest expense will be impacted by interest rate fluctuations,
increased borrowings under the Senior Credit Facility to finance future
acquisitions and continued investment in the Company's re-engineering and
consolidation project.
RESTRUCTURING AND OTHER CHARGES
During 1994, the Company began a comprehensive re-engineering and
consolidation project in order to enhance its ability to provide more effective
and efficient business management services to its physician and hospital
clients. This project is designed to further enhance the Company's long-term
operating efficiency and client service capability. The Company will consolidate
its billing and accounts receivable processing function, which is currently
operated out of approximately 300 local business offices, into approximately ten
regional processing centers. It is currently anticipated that the project will
be substantially completed during 1997. As a result of this project, the Company
recorded restructuring and other charges of approximately $25 million during
1995, consisting primarily of exit costs ($15.0 million), involuntary severance
benefits ($5.0 million) and impairment losses associated with the disposition of
property and equipment ($5.0 million).
In connection with the Atwork, HRI, Consort and MMS mergers, the Company
incurred transaction fees, costs and expenses of approximately $6.0 million,
$2.0 million, $1.2 million and $2.5 million, respectively. In accordance with
the requirements of pooling of interests accounting, the costs associated with
these mergers have been reflected in the operating results of the Company for
1995.
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The Company recorded a charge of $12 million in 1995, for the
administrative fees, costs and expenses it anticipates incurring in connection
with the Federal Investigation (see Other Matters) and various putative class
action lawsuits which have been filed against the Company, certain of its
officers and directors and its lead underwriters from its April 1995 public
offering.
In connection with the Halley acquisition, the Company recorded a $1.8
million charge during 1995 related to the cost of purchased research and
development activities related to acquired technology for which technological
feasibility had not yet been established and which had no alternative future
uses.
Prior to the Company's merger with MMS, MMS terminated a merger agreement
with an unrelated third party. In connection with the termination of this
agreement, MMS agreed to pay costs associated with the terminated merger and
potential initial public offering of the combined entity. Such costs amounted to
approximately $3.7 million and were recorded as a charge in 1995.
INCOME BEFORE INCOME TAXES
The Company's income before income taxes was 0.8% of revenues in 1995 as
compared with 12.2% in 1994 and 7.8% in 1993. The primary reasons for the
decrease in 1995 were the restructuring and other charges recorded in 1995
associated with (i) the Company's re-engineering and consolidation project; (ii)
four pooling-of-interests transactions consummated in 1995; (iii) the Federal
Investigation; and (iv) purchased research and development activities. The
increase in 1994 as compared with 1993 was attributable to operating leverage
and changes in compensation paid to the former owners of Atwork, interest
expense as a percentage of revenue and the Company's information management and
systems integration operations reflecting the higher margin nature of these
operations when compared with the Company's existing billing and accounts
receivable management services operations. Excluding restructuring and other
charges from all years presented, income before income taxes as a percentage of
revenue would have been 10.6%, 12.7% and 7.8%, respectively for 1995, 1994 and
1993.
INCOME TAXES
The Company's historical effective income tax rates were 110.6%, 33.2% and
32.4% for 1995, 1994 and 1993, respectively. The increase in the effective tax
rate for 1995 was primarily attributable to non-deductible merger costs incurred
in connection with pooling-of-interest transactions consummated in 1995. On a
pro forma basis, assuming Atwork and MMS were "C" corporations for all periods
presented, the Company's pro forma effective tax rates were 182.6%, 36.9% and
37.8%, respectively, for 1995, 1994 and 1993. The increase in the Company's pro
forma effective tax rate in 1995 resulted primarily from the previously noted
non-deductible merger costs.
PRO FORMA NET INCOME (LOSS)
The Company's pro forma net loss was $3.4 million in 1995 as compared with
pro forma net income of $30.7 million and $13.5 million, respectively, in 1994
and 1993. As a percentage of revenue, pro forma net income (loss) was (0.6)% in
1995 as compared with 7.7% and 4.8% in 1994 and 1993, respectively. The decrease
in 1995 was primarily attributable to the restructuring and other charges
previously discussed. The increase in 1994 as compared with 1993 resulted
primarily from economies of scale realized in other operating expenses, changes
in compensation paid to the former owners of Atwork as compared to revenue and
lower interest expense as a percentage of revenue.
PRO FORMA NET INCOME (LOSS) PER COMMON SHARE
The weighted average shares outstanding were 56,591,000 in 1995, 60,245,000
in 1994 and 51,109,000 in 1993. The decrease in 1995 was primarily caused by the
exclusion of common stock equivalents in 1995 during which the Company
experienced a pro forma net loss offset by the public offering of 4.0 million
shares in April 1995. The increase in 1994 as compared with 1993 was primarily
the result of the public offering of approximately 6.4 million shares in
December 1993. Pro forma net income (loss) per common share was $(0.06) in 1995
as compared with $0.51 and $0.26 in 1994 and 1993, respectively.
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COMPLETED ACQUISITIONS
On January 23, 1995, the Company acquired substantially all of the assets
and assumed certain of the related liabilities of Decision Support Group, a
healthcare decisions support company located in Burlington, Vermont. Decision
Support Group is involved primarily in the development of healthcare decision
support systems.
On March 6, 1995, the Company acquired the outstanding capital stock of
Medical Management, Inc. ("MMI") for $8.0 million in cash. MMI provides billing
and accounts receivable management services to anesthesiologists.
On April 28, 1995, the Company acquired the outstanding capital stock of
Medical Billing Service ("MBS") and purchased certain assets and assumed the
related liabilities of Computers Diversified, Inc. ("CDI") for approximately
$15.5 million in cash. MBS and CDI provide integrated claims data processing
systems and services to physicians, hospitals and clinics, and had revenue of
approximately $12.1 million in 1994.
On May 19, 1995, the Company acquired the outstanding capital stock of
Medical Office Consultants, Inc. ("MOC"). MOC provides billing and accounts
receivable management services primarily to urologists.
On October 23, 1995, the Company acquired the outstanding capital stock of
Billing and Professional Services, Inc. ("BAPS"). BAPS provides billing and
accounts receivable management services to pathologists.
On December 20, 1995, the Company acquired the outstanding capital stock of
the Halley Exchange, Inc. ("Halley"). Halley is an electronic medical claims
clearing house.
On December 31, 1995, the Company acquired the Receivables Management
Division and related consulting services of MedQuist, Inc. ("RMD") for
approximately $17.3 million in cash. RMD provides bad debt collection and
patient entitlement services to healthcare providers.
Each of the foregoing acquisitions was recorded using the purchase method
of accounting and, accordingly, the purchase price has been allocated to the
assets acquired and liabilities assumed based on their estimated fair market
value at the date of the acquisitions. The allocations are preliminary and will
be adjusted when the necessary information is available.
On March 17, 1995, the Company acquired Atwork by exchanging eight million
shares of common stock for all of the outstanding common stock of Atwork. Atwork
provides scheduling and management systems and services to hospitals and
emerging integrated healthcare delivery systems and had revenues of
approximately $28.3 million in 1994. This transaction has been accounted for
using the pooling-of-interests method of accounting and, accordingly, the
financial statements of the Company have been restated to reflect the operations
of Atwork.
On August 28, 1995, the Company exchanged approximately 3.3 million shares
of its common stock for all of the outstanding shares of common stock of
Healthcare Recoveries, Inc. ("HRI"). HRI is a leading provider of subrogation
and related recovery services primarily for healthcare payors. Its clients
include health maintenance organizations, indemnity insurers, Blue Cross and
Blue Shield organizations, third party administrators, self-funded employee
health welfare benefit plans, and a multi-specialty physicians group. This
transaction has been accounted for as a pooling-of-interests and, accordingly,
the financial statements of the Company have been restated to include the
operations of HRI.
On November 22, 1995, the Company exchanged approximately 825,000 shares of
its common stock for all of the capital stock of Consort. Consort provides
comprehensive radiology information and scheduling systems for hospitals and
imaging centers. This transaction has been accounted for as a
pooling-of-interests. However, due to the immateriality of Consort's operations,
no restatement of historical financial statements has been made.
On December 29, 1995 the Company acquired MMS by exchanging four million
shares of common stock for all of the outstanding common stock of MMS. MMS
provides business management services to
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approximately 1,700 radiologists and radiation oncologists. In addition, MMS
owns Managed Imaging, Inc., a management services organization specializing in
network formation, administration, marketing, contracting, management and
information services to physicians and physician networks in connection with
managed care and alternative reimbursement systems. This transaction has been
accounted for as a pooling-of-interests and, accordingly, the financial
statements of the Company have been restated to include the operations of MMS.
On April 3, 1996, the Company exchanged approximately 1.1 million shares of
its common stock for all of the outstanding shares of common stock of Rapid
Systems Solutions, Inc. ("Rapid Systems"). Rapid Systems is a client
server/systems integration company whose core competencies include: network
design, integration and management; database design and development; graphical
user interface application design, development and implementation; and strategic
systems engineering and computer security. During 1995, Rapid Systems had
revenue of $14.7 million. This transaction has been accounted for using the
pooling-of-interests method of accounting and, accordingly, the financial
statements of the Company have been restated to reflect the operations of Rapid
Systems.
On May 6, 1996, the Company exchanged approximately 7.5 million shares of
its common stock for all of the outstanding shares of common stock of BSG
Corporation ("BSG"). In addition, the Company assumed BSG stock options
representing approximately 2.3 million additional shares of the Company's common
stock. BSG provides information technology and change management services to
organizations seeking to transform their operations through the strategic use of
client/server and other advanced technologies. During 1995, BSG had revenue of
$69.7 million. This transaction has been accounted for using the
pooling-of-interests method of accounting and, accordingly, the financial
statements of the Company have been restated to reflect the operations of BSG.
On June 29, 1996, the Company exchanged approximately 6.2 million shares of
its common stock for all of the outstanding shares of common stock of Health
Data Sciences Corporation ("HDS"). In addition, the Company assumed HDS stock
options representing approximately 433,000 additional shares of the Company's
common stock. HDS is a developer and supplier of advanced healthcare information
systems which address a healthcare enterprise's information needs through the
integrated monitoring, scheduling, documentation and control of patient care
activities. During 1995, HDS had revenue of $12.2 million. This transaction has
been accounted for using the pooling-of-interests method of accounting and,
accordingly, the financial statements of the Company have been restated to
reflect the operations of HDS.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $102.7 million at December 31, 1995,
including $19.3 million of cash and cash equivalents.
Management believes additional working capital is not required to meet its
current liquidity needs before acquisitions, internal growth of the business and
investments in the Company's re-engineering and consolidation project. The
Company produced $23.5 million of operating cash flow ($45.1 million before
restructuring and other charges) in 1995. If current operating levels are
maintained, management believes that the Company should produce cash flow from
operations adequate to meet its liquidity requirements before acquisitions,
internal growth of the business and investments in the Company's re-engineering
and consolidation project. Any excess will be available to help fund the working
capital requirements of internal growth and the Company's re-engineering and
consolidation project.
At December 31, 1995, $128 million of borrowings were outstanding under the
$250 million Senior Credit Facility. Borrowings under the Senior Credit Facility
bear interest at rates ranging from 7.1% to 7.2% and are due in March 1997, and
can be extended under certain circumstances with the approval of the banks.
Amounts available for borrowing under the Senior Credit Facility may be used for
future acquisitions, expansion of the Company's business, and general corporate
purposes.
The Company estimates that each one million dollars of internal revenue
growth requires no more than $500,000 of additional capital. The increase in
this estimate from prior periods reflects the evolution of the Company's
business and operations. If the current rate of internal growth continues at
historical operating margins, the Company estimates that its cash flow from
operations will be adequate to meet its capital
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requirements for internal growth. Internal growth may also be funded by the
Company's Senior Credit Facility. Management estimates that, at historical
operating margins, any borrowings that are incurred for internal growth purposes
can be repaid within two years by operating cash flow. Management also believes
the Senior Credit Facility will be sufficient to meet any seasonal cash
requirements.
During 1994, the Company began a comprehensive re-engineering and
consolidation project. As part of this project, the Company anticipates
consolidating the processing function currently being performed in approximately
300 local business offices into approximately ten regional processing centers.
The Company purchased computer equipment related to this project for
approximately $23.5 million in 1995, the majority of which was obtained through
a capital lease arrangement, and anticipates purchasing approximately $16
million of additional computer equipment in 1996 and 1997. The Company also
incurred software development costs of approximately $29 million in 1995 related
to this project and anticipates incurring an additional $17 million in 1996.
Additionally, the Company anticipates incurring lease buyout and termination
payments, involuntary severance benefits and other cash expenditures of
approximately $12 to $17 million during 1996 and 1997 relating to this project.
The remaining costs related to the project are expected to be financed through
the Company's Senior Credit Facility, future operating cash flows and capital
lease financing. During 1995, the Company capitalized approximately $36.5
million of software development costs associated with the development or
enhancement of software to be used in the processing function of the Company's
business management services or otherwise sold externally by the Company.
Substantially all of the Company's capital expenditures have related either
to acquisitions of healthcare business management service companies and
technology companies or to the expansion, improvement, or maintenance of
existing facilities. The Company has financed its growth through cash flows from
operations, the issuance of debt and equity securities and borrowings.
Management believes anticipated cash flow from operations and borrowing capacity
under the Senior Credit Facility will provide adequate capital resources to
support the Company's anticipated long-term financing needs.
OTHER 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 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
the Federal Investigation will be resolved promptly, that additional subpoenas
or warrants will not be received by Medaphis or that the Federal Investigation
will not have a material adverse effect upon Medaphis. The Company recorded a
charge of $12 million in 1995 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. The charge is intended
to cover only the anticipated administrative expenses of the Federal
Investigation and the lawsuits and does not include any provision for fines,
penalties, damages, assessments, judgements or sanctions that may arise out of
such matters.
Following the announcement of the Federal Investigation, Medaphis, various
of its 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 Federal District
Court for the Northern District of Georgia. In general, these lawsuits allege
violations of the federal securities laws in connection with Medaphis' 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
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January 3, 1996, the court denied defendants' motion to dismiss the Consolidated
Complaint which argued that the Complaint failed to state a claim upon which
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 contains
any claims based on the Securities Act of 1933, 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 Company
believes that it has meritorious defenses to this action and intends to assert
them vigorously.