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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ----- TO -----
COMMISSION FILE NUMBER 000-19480
MEDAPHIS CORPORATION
(Exact name of Registrant as specified in its charter)
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)
(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.
CLASS OUTSTANDING AT OCTOBER 31, 1996
- --------------------------------------------- ---------------------------------------------
COMMON STOCK 71,696,802 SHARES
$0.01 PAR VALUE
NON-VOTING COMMON STOCK 0 SHARES
$0.01 PAR VALUE
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2
MEDAPHIS CORPORATION
FORM 10-Q
SEPTEMBER 30, 1996
PAGE
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PART I: FINANCIAL INFORMATION
Consolidated Statements of Operations for the three and nine months ended September
30, 1996 and 1995................................................................ 2
Consolidated Balance Sheets as of September 30, 1996 and December 31, 1995 (As
restated, see Note 8)............................................................ 3
Consolidated Statements of Cash Flows for the nine months ended September 30, 1996
and 1995......................................................................... 4
Notes to Consolidated Financial Statements.......................................... 5
Management's Discussion and Analysis of Financial Condition and Results of
Operations....................................................................... 15
PART II: OTHER INFORMATION
Legal Proceedings................................................................... 24
Other Information................................................................... 24
Exhibits and Reports on Form 8-K.................................................... 25
Index to Exhibits................................................................... 27
This Form 10-Q contains statements which may constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Those statements include statements regarding the intent, belief or current
expectations of Medaphis Corporation and members of its management team.
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 included as
Exhibit 99 to this Form 10-Q, 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.
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PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1996 1995 1996 1995
-------- -------- -------- --------
Revenue............................................. $126,731 $140,752 $465,551 $415,131
-------- -------- -------- --------
Salaries and wages.................................. 109,615 82,625 292,843 238,112
Other operating expenses............................ 39,016 36,673 117,169 104,756
Depreciation........................................ 6,221 3,548 16,496 10,663
Amortization........................................ 4,937 4,606 14,672 13,368
Interest expense, net............................... 3,284 2,318 8,019 8,487
Restructuring and other charges..................... 24,275 14,000 41,600 45,750
-------- -------- -------- --------
Total expenses............................ 187,348 143,770 490,799 421,136
-------- -------- -------- --------
Loss before income taxes............................ (60,617) (3,018) (25,248) (6,005)
Income taxes........................................ (23,622) 70 (4,315) (2,500)
-------- -------- -------- --------
Net loss............................................ (36,995) (3,088) (20,933) (3,505)
Pro forma adjustments, principally income taxes..... 625 365 979 (3,849)
-------- -------- -------- --------
Pro forma net loss.................................. $(36,370) $ (2,723) $(19,954) $ (7,354)
======== ======== ======== ========
Pro forma net loss per common share................. $ (0.51) $ (0.05) $ (0.28) $ (0.13)
======== ======== ======== ========
Weighted average shares outstanding................. 71,665 57,696 71,123 55,962
======== ======== ======== ========
See notes to consolidated financial statements.
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4
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE DATA)
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- -------------
(UNAUDITED) (AS RESTATED,
SEE NOTE 8)
ASSETS
Current Assets:
Cash............................................................... $ 7,016 $ 19,270
Restricted cash.................................................... 12,989 15,340
Accounts receivable, billed........................................ 98,232 84,256
Accounts receivable, unbilled...................................... 101,271 89,429
Other.............................................................. 14,835 14,870
-------- --------
Total current assets....................................... 234,343 223,165
Property and equipment............................................... 131,809 97,895
Intangible assets.................................................... 481,690 455,611
Other................................................................ 18,197 18,935
-------- --------
Total assets............................................... $ 866,039 $ 795,606
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable................................................... $ 9,387 $ 23,220
Accrued compensation............................................... 32,269 24,505
Accrued expenses................................................... 77,650 69,529
Current portion of long-term debt.................................. 9,541 10,681
-------- --------
Total current liabilities.................................. 128,847 127,935
Long-term debt and capital lease obligations......................... 245,120 150,565
Convertible subordinated debentures.................................. -- 63,375
Other obligations.................................................... 14,546 18,926
Deferred income taxes................................................ 4,013 13,499
-------- --------
Total liabilities.......................................... 392,526 374,300
-------- --------
Stockholders' Equity:
Preferred stock.................................................... -- 382
Common stock, voting, $.01 par value, 200,000 authorized; issued
and outstanding 71,663 in 1996 and 58,917 in 1995............... 717 589
Common stock, nonvoting, $.01 par value, 600 authorized; none
issued.......................................................... -- --
Paid-in capital.................................................... 496,644 426,387
Accumulated deficit................................................ (23,283) (6,052)
-------- --------
474,078 421,306
Less 15 shares of common stock in treasury, at cost................ 565 --
-------- --------
Total stockholders' equity................................. 473,513 421,306
-------- --------
$ 866,039 $ 795,606
======== ========
See notes to consolidated financial statements.
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5
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1996 1995
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................................... $(20,933) $ (3,505)
Adjustments to reconcile net loss to net cash (used for) provided
by operating activities:
Depreciation and amortization................................... 31,168 24,031
Impairment loss on property and equipment....................... 10,361 5,030
Deferred income taxes........................................... (4,315) (3,016)
Changes in assets and liabilities, excluding effects of
acquisitions:
Decrease (increase) in restricted cash........................ 1,030 (675)
Increase in accounts receivable, billed....................... (11,630) (25,546)
Increase in accounts receivable, unbilled..................... (15,807) (62)
Decrease in accounts payable.................................. (13,177) (1,431)
Increase in accrued compensation.............................. 7,037 2,967
Increase in accrued expenses.................................. 4,212 23,231
Other, net.................................................... 4,597 (3,682)
-------- --------
Net cash (used for) provided by operating activities....... (7,457) 17,342
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash acquired................................. (13,569) (55,804)
Purchases of property and equipment................................ (44,851) (34,704)
Software development costs......................................... (33,937) (21,754)
-------- --------
Net cash used for investing activities..................... (92,357) (112,262)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock............................. 6,852 142,897
Proceeds from borrowings........................................... 110,615 65,145
Principal payments of long-term debt............................... (33,429) (106,701)
Other.............................................................. 3,813 (5,664)
-------- --------
Net cash provided by financing activities.................. 87,851 95,677
-------- --------
CASH:
Net change......................................................... (11,963) 757
Balance at beginning of period (see Note 3)........................ 18,979 17,651
-------- --------
Balance at end of period................................... $ 7,016 $ 18,408
======== ========
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest........................................................ $ 10,921 $ 9,857
Income taxes.................................................... 6,797 2,078
Non-cash investing and financing activities:
Liabilities assumed in purchase acquisitions.................... 2,737 5,756
Additions to capital lease obligations.......................... 14,043 3,575
Common stock issued for acquisitions............................ -- 459
Common stock issued upon conversion of subordinated
debentures..................................................... 63,375 --
See notes to consolidated financial statements.
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited 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 may wish to refer to the audited
supplemental consolidated financial statements of the Company for the year ended
December 31, 1995 (as restated) included in the Company's Current Report on Form
8-K/A filed November 14, 1996. See Note 8 for a discussion of the restatement of
the Company's consolidated financial statements for the three months and year
ended December 31, 1995 and as of March 31, 1996 and June 30, 1996.
The unaudited 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. Results of operations of interim periods are not necessarily
indicative of operating results for the year.
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.
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 a charge of $12 million in the third quarter of 1995 solely
for the administrative fees, costs and expenses it anticipates incurring in
connection with the Federal Investigation and the putative class action lawsuits
which are based on the Federal Investigation. The charge is intended to cover
only the anticipated administrative expenses of the Federal Investigation and
the related lawsuits and does 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 then-current 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, 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
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. Additionally, on November 5, 1996, Medaphis, Randolph
G. Brown, former Chairman, Chief Executive Officer and President and a former
director of Medaphis, Michael R. Cote, Senior Vice President -- Finance, Chief
Financial Officer and Assistant Secretary of Medaphis, and James S. Douglass,
former Vice President, Corporate Controller and Chief Accounting Officer of
Medaphis, 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 federal and 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 stock during the period
March 29, 1995 through June 15, 1995. Plaintiffs seek compensatory damages and
costs. The Company believes that it has meritorious defenses to this action.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis, and one or more of Randolph G.
Brown, Michael R. Cote and James S. Douglass were named as defendants in
nineteen putative shareholder class action lawsuits filed in the United States
District Court for the Northern District of Georgia, Atlanta Division.
Generally, these lawsuits allege violations of the federal securities laws in
connection with Medaphis' filings under the federal securities acts and public
disclosures concerning various subjects, including Medaphis' reengineering
project, management and operations of certain Medaphis subsidiaries, and
Medaphis' reported and projected revenues and earnings. The lawsuits are each
brought on behalf of putative classes of persons who acquired Medaphis common
stock, including persons who acquired stock either in the public market or in
connection with three of Medaphis' recent business acquisitions. Eighteen of the
actions have been consolidated, and the Company anticipates that the nineteenth
also will be consolidated. Plaintiffs seek rescissory and compensatory damages
and costs. The Company believes that it has meritorious defenses to this action.
On November 1, 1996, Medaphis, Randolph G. Brown, Robert C. Bellas, a
director of Medaphis, David R. Holbrooke, a director of Medaphis, and Richard H.
Stowe, a former director of Medaphis, were named as defendants in a shareholder
derivative action filed in the United States District Court for the Northern
District of Georgia, Atlanta Division. Generally, the lawsuit alleges that the
defendants breached their fiduciary duties, were grossly negligent and breached
various contractual obligations to the Company 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.
Plaintiffs seek compensatory damages and costs.
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 Health Data Sciences Corporation. Plaintiff seeks rescissory,
compensatory and punitive damages, injunctive relief and costs. The Company
believes that it has meritorious defenses to this action.
The Company also has received written demands from various stockholders,
including stockholders of recently acquired companies. To date, these
stockholders have not filed lawsuits.
Although the Company believes that it has meritorious defenses to 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 and the written demands will not have a disruptive effect upon the
operations of the business, that the written demands and the defense of the
lawsuits will not consume the time and
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
attention of the senior management of the Company or that the lawsuits will not
have a material adverse effect upon the Company.
NOTE 3. RECENT ACQUISITIONS
From January 1, 1995 through September 30, 1996, the Company acquired
either substantially all of the assets or all of the outstanding capital stock
of each of the following businesses which were recorded using the purchase
method of accounting:
ACQUISITION
COMPANY ACQUIRED CONSIDERATION DATE
---------------------------------------------------- --------------- ----------------
(IN THOUSANDS)
The Medico Group, Ltd............................... * April 1996
Medical Management Computer Services, Inc........... * February 1996
CBT Financial Services, Inc......................... * February 1996
The Receivables Management Division of MedQuist,
Inc............................................... $17,300 December 1995
The Halley Exchange, Inc............................ * December 1995
Billing and Professional Services, Inc.............. * October 1995
Medical Office Consultants, Inc..................... * May 1995
Computers Diversified, Inc.......................... 15,500 April 1995
Medical Management, Inc............................. 8,000 March 1995
The Decision Support Group, Inc..................... * January 1995
- ---------------
* Consideration not material.
Each of the foregoing acquisitions has been 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 value
as of the date of acquisition. The allocation of the purchase price of certain
of these acquisitions is preliminary and will be adjusted when the necessary
information is available. The operating results of the acquired businesses are
included in the Company's consolidated statements of operations from the
respective dates of acquisition.
In addition to the foregoing acquisitions, the Company acquired the
following businesses in 1996 and 1995 which were recorded using the
pooling-of-interests method of accounting:
SHARES ACQUISITION
COMPANY ACQUIRED EXCHANGED DATE
-------------------------------------------------------- --------- ----------------
Health Data Sciences Corporation ("HDS")................ 6,215,000 June 1996
BSG Corporation ("BSG")................................. 7,539,000 May 1996
Rapid Systems Solutions, Inc. ("Rapid Systems")......... 1,135,000 April 1996
Intelligent Visual Computing, Inc. ("IVC").............. * February 1996
Medical Management Sciences, Inc. ("MMS")............... 4,000,000 December 1995
Consort Technologies, Inc. ("Consort").................. 825,000 November 1995
Healthcare Recoveries, Inc. ("HRI")..................... 3,265,000 August 1995
Automation Atwork ("Atwork")............................ 8,000,000 March 1995
- ---------------
* Consideration not material.
Since these acquisitions have been recorded using the pooling-of-interests
method of accounting, no adjustments have been made to the historical carrying
amounts of assets acquired and liabilities assumed. The accompanying
consolidated financial statements have been restated to include the financial
position and operating results of Atwork, HRI, MMS, Rapid Systems, BSG and HDS
for all periods prior to the mergers. No restatement has been made for the
financial position and operating results of Consort and IVC prior to the
beginning of the fiscal year of their acquisitions due to their immateriality.
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of revenue, pro forma net income (loss) and pro forma net
income (loss) per common share of the Company, as previously reported (which
includes Atwork) with the Company after restating for all material acquisitions
accounted for under the pooling-of-interests method of accounting, including the
pro forma provision for "S" corporation income taxes, is as follows (in
thousands, except per share data):
THREE MONTHS
ENDED NINE MONTHS
SEPTEMBER ENDED
30, SEPTEMBER 30,
1995 1995
------------ -------------
Revenue:
Medaphis, as previously reported.......................... $112,344 $ 327,866
Consort................................................... 1,024 2,804
MMS....................................................... 4,421 14,625
Rapid Systems............................................. 4,009 10,102
BSG....................................................... 17,255 51,319
HDS....................................................... 1,699 8,415
-------- --------
Combined.................................................. $140,752 $ 415,131
======== ========
Pro forma net income (loss):
Medaphis, as previously reported.......................... $ 1,072 $ (2,601)
Consort................................................... 222 751
MMS....................................................... (1,665) 355
Rapid Systems............................................. 431 724
BSG....................................................... (2,381) (2,151)
HDS....................................................... (767) (3,555)
Pro forma provision for "S" corporation income taxes...... 365 (877)
-------- --------
Combined.................................................. $ (2,723) $ (7,354)
======== ========
Pro forma net income (loss) per common share:
Medaphis, as previously reported.......................... $ 0.02 $ (0.06)
======== ========
Combined.................................................. $ (0.05) $ (0.13)
======== ========
Prior to its merger with the Company, HDS reported on a fiscal period
ending March 31. HDS's financial position and operating results as of and for
the fiscal year ended March 31, 1996 was combined with the Company's financial
position and operating results as of and for the year ended December 31, 1995.
HDS's financial position and operating results for 1996, which have been
restated to a calendar year basis, have been combined with the Company's
financial position and operating results for 1996. Accordingly, HDS's operating
results for the three months ended March 31, 1996, were duplicated in the year
ended December 31, 1995 and the nine months ended September 30, 1996. HDS's
revenue and net income for the three month period ended March 31, 1996 were
$3,758,000 and $382,000, respectively. The beginning cash balance in the
accompanying statement of cash flows for the nine month period ended September
30, 1996 does not equal the December 31, 1995 cash balance as a result of the
combination of HDS's financial position as of March 31, 1996 with the financial
position of the Company as of December 31, 1995.
The following unaudited pro forma financial information presents the
results of operations of the Company for the nine months ended September 30,
1996 and 1995 as if all the material acquisitions noted above had occurred on
January 1, 1995. The pro forma information presented below does not purport to
be indicative of the results that would have been obtained if the operations had
actually been combined for the
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
periods presented and is not necessarily indicative of operating results to be
expected in future periods (in thousands, except per share data):
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1996 1995
-------- --------
Revenue........................................................ $465,551 $433,306
Pro forma net loss............................................. (19,954) (4,647)
Pro forma net loss per common share............................ $ (0.28) $ (0.08)
In October 1996, the Company acquired the outstanding capital stock of Sage
Communications Corporation ("Sage"). Sage provides systems integration services
and data warehousing decision support applications, primarily to the
telecommunications industry. This transaction will be accounted for as a
purchase. The pro forma effect of Sage on the consolidated results of operations
of Medaphis for 1996 and 1995 is not significant.
NOTE 4. FINANCING TRANSACTIONS
In 1995, the Company gave notice of its intent to redeem its 6 1/2%
convertible subordinated debentures due January 1, 2000. The debentures were
convertible into shares of the Company's common stock at a conversion price of
$14.00 per share. All of the debenture holders exercised their conversion right
effective January 1, 1996, and as a result, approximately 4.5 million shares of
common stock were issued in the conversion.
The Company has amended its $250 million Senior Credit Facility to extend
the expiration date to March 17, 1998.
NOTE 5. RESTRUCTURING AND OTHER CHARGES
Components of restructuring and other charges include restructuring
charges, property and equipment impairment, pooling charges, software
abandonment, severance costs and legal and other costs. A description of each
component is as follows:
Restructuring Charges. During the third quarter of 1996, the Company
finalized its plan to restructure its client/server information technology
businesses and began to consolidate Imonics Corporation ("Imonics") and Rapid
Systems into BSG. In conjunction with this restructuring plan, the Company
recorded charges of approximately $1.3 million for the costs associated with the
termination of certain leases and $3.9 million ($1.2 million of this amount was
recorded in the second quarter of 1996) for severance costs for employees of
Imonics who have been notified of their termination. The Company also reviewed
the adequacy of existing reserves related to the Company's restructuring plan at
its operating subsidiary, Medaphis Physician Services Corporation ("MPSC"), and
reduced these reserves by approximately $2.1 million in the third quarter of
1996. During the nine months ended September 30, 1996, the Company also incurred
approximately $5.2 million of costs which were related to the Company's
reengineering project which had not previously been accrued because they did not
meet the definition of an exit activity as established by the appropriate
authoritative accounting literature.
In 1995, management approved a restructuring plan relating to the
consolidation of the Company's data processing function in MPSC. The Company
recorded a reserve for the exit costs associated with the restructuring plan of
approximately $15.0 million. During the third quarter of 1996, the Company
revised its original plan of consolidating into ten regional information
processing centers ("IPCs"). The Company has adopted a plan to downsize certain
of the existing IPCs and the costs associated with exiting these facilities will
be charged against the restructuring reserves established in 1995. The Company
has commenced a comprehensive assessment of the reengineering program designed
to ensure that the individual projects which
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
make up the program are properly aligned with the overall goals and objectives
of the program. Although management remains committed to completing such
assessment in due course, there can be no assurance that the work associated
with such assessment will be completed prior to December 31, 1996.
Property and Equipment Impairment. In connection with the restructuring of
Imonics and MPSC, the Company assessed the recoverability of its long lived
assets and recorded impairment losses of approximately $6.4 million and $5.0
million during the third quarter of 1996 and first quarter of 1995,
respectively.
Pooling Charges. In connection with the IVC, Rapid Systems, BSG and HDS
pooling-of-interests transactions consummated in 1996, the Company recorded
transaction fees, costs and expenses of approximately $12.9 million. Management
finalized the estimated transaction fees, costs and expenses associated with all
the pooling-of-interests transactions consummated in 1996 and 1995 and reversed
$1.2 million and $3.6 million of these charges during the three and nine months
ended September 30, 1996, respectively. As a result of the 1995
pooling-of-interests transactions with HRI (August) and Atwork (January) the
Company incurred transaction fees, costs and expenses of approximately $2.0
million and $6.0 million, respectively.
Software Abandonment. In connection with the consolidation of Imonics into
BSG, and the adoption by Imonics of the BSG business model, the Company
abandoned certain software development projects and recorded a charge in the
third quarter of 1996 for the write-off of approximately $6.9 million of
capitalized software development costs related to these projects.
Severance Costs. In 1995, MPSC formalized an involuntary severance benefit
plan. The Company has recorded charges of approximately $2.0 million and $5.0
million for the three months ended September 30, 1996 and nine months ended
September 30, 1995, respectively, to accrue the estimated involuntary severance
benefits which had accumulated.
Legal and Other Costs The Company has recorded a charge of $5.0 million in
the third quarter of 1996 for the administrative fees, costs and expenses it
anticipates incurring in connection with various putative class action lawsuits
which have been filed against the Company and certain of its current and former
officers, one of whom was also a director, since August 14, 1996. The Company
also recorded a charge of $12.0 million in the third quarter of 1995 for the
administrative fees, costs and expenses it anticipated incurring in connection
with the Federal Investigation and various putative class action lawsuits which
are based on the Federal Investigation.
During the three month period ended September 30, 1996, the Company
canceled an initiative to develop an on-line practice management system. The
Company recorded a $2.0 million charge relating to the deferred costs associated
with this project. The Company also accrued $1.3 million for certain liabilities
associated with the Company's billing and accounts receivable management
services operations.
10
12
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following chart reflects the additions, adjustments and costs applied
against the restructuring reserve for the nine months ended September 30, 1996:
RESERVE COSTS RESERVE
BALANCE ADDITION APPLIED BALANCE
DECEMBER 31, TO RESERVE AGAINST SEPTEMBER 30,
1995 RESERVE ADJUSTMENTS(1) RESERVE 1996
------------ -------- -------------- ------------- -------------
Lease terminations.......... $ 5,990 $1,320 $ 2,008 $(2,201) $ 7,117
Incremental costs associated
with discontinued client
contracts................. 4,691 -- (2,690) (2,001) --
Severance................... -- 3,902 -- (2,176) 1,726
Other....................... 1,788 208 (1,369) (627) --
------- ------ ------- ------- -------
$ 12,469 $5,430 $ (2,051) $(7,005) $ 8,843
======= ====== ======= ======= =======
- ---------------
(1) Adjustments reflect the reallocation and reduction of reserves.
NOTE 6. INCOME TAXES
In 1995 and 1996, Medaphis acquired Atwork, MMS, Rapid Systems and BSG in
merger transactions which were accounted for as poolings-of-interests. Prior to
such mergers, Atwork, MMS, Rapid Systems and a company acquired by BSG prior to
the BSG merger had elected "S" corporation status under the Internal Revenue
Code for income tax purposes. As a result of such mergers (or, in the case of
the company acquired by BSG, its acquisition by BSG), the "S" corporation
elections of such companies terminated. Pro forma net loss and pro forma net
loss per common share are presented as if the entities had been "C" corporations
during the three and nine months ended September 30, 1996 and 1995. The effect
of the tax status change associated with the acquisition of Rapid Systems is
reflected in income taxes in the three and nine months ended September 30, 1996
with an offsetting benefit recorded within pro forma adjustments.
NOTE 7. LINES OF BUSINESS
The Company operates in three major lines of business: Services (providing
healthcare transaction processing services to physicians, hospitals and payors),
BSG Group (client/server information technology services), and HIT (healthcare
information technology and hardware sales). Total revenue includes only sales to
unaffiliated customers as reported in the Company's consolidated statements of
operations. Operating profit represents total revenue less operating expenses
excluding restructuring and other charges. Corporate items include general
corporate expenses. Corporate assets consist primarily of cash, deferred
financing costs, fixed assets, miscellaneous prepaids and receivables and real
estate purchased in acquisitions. Information concerning operations in these
lines of business is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1996 1995 1996 1995
-------- -------- -------- --------
(IN THOUSANDS)
Revenue:
Services.................................... $102,832 $101,735 $321,020 $305,080
BSG Group................................... 11,637 28,479 90,880 74,476
HIT......................................... 13,070 11,084 55,726 36,862
Corporate and eliminations.................. (808) (546) (2,075) (1,287)
-------- -------- -------- --------
$126,731 $140,752 $465,551 $415,131
======== ======== ======== ========
11
13
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1996 1995 1996 1995
-------- -------- -------- --------
(IN THOUSANDS)
Operating profit (loss):
Services.................................... $ 2,985 $ 9,179 $ 36,454 $ 40,975
BSG Group................................... (30,762) 3,893 (20,592) 6,987
HIT......................................... 1,475 2,729 23,598 7,473
Corporate................................... (6,756) (2,501) (15,089) (7,203)
-------- -------- -------- --------
$(33,058) $ 13,300 $ 24,371 $ 48,232
======== ======== ======== ========
Interest expense, net......................... 3,284 2,318 8,019 8,487
-------- -------- -------- --------
Restructuring and other charges:
Services.................................... 4,352 14,000 7,908 39,000
BSG Group................................... 15,280 -- 24,733 --
HIT......................................... (357) -- 3,959 6,750
Corporate................................... 5,000 -- 5,000 --
-------- -------- -------- --------
24,275 14,000 41,600 45,750
-------- -------- -------- --------
Loss before income taxes...................... $(60,617) $ (3,018) $(25,248) $ (6,005)
======== ======== ======== ========
Depreciation and amortization:
Services.................................... $ 7,069 $ 5,356 $ 20,237 $ 16,156
BSG Group................................... 2,656 1,690 6,782 4,833
HIT......................................... 1,200 1,008 3,562 2,751
Corporate................................... 233 100 587 291
-------- -------- -------- --------
$ 11,158 $ 8,154 $ 31,168 $ 24,031
======== ======== ======== ========
Capital expenditures:
Services.................................... $ 4,689 $ 11,239 $ 24,566 $ 22,483
BSG Group................................... 4,628 4,466 16,566 10,238
HIT......................................... 642 269 2,134 1,130
Corporate................................... 322 298 1,585 853
-------- -------- -------- --------
$ 10,281 $ 16,272 $ 44,851 $ 34,704
======== ======== ======== ========
AS OF SEPTEMBER 30,
-------------------
1996 1995
-------- --------
Identifiable assets:
Services.................................... $678,870 $578,711
BSG Group................................... 96,728 65,524
HIT......................................... 76,727 69,661
Corporate................................... 13,714 8,849
-------- --------
$866,039 $722,745
======== ========
In March 1996, a European joint venture formed by Imonics (the "Joint
Venture") entered into a software licensing and a software engineering contract.
Included in the BSG Group's revenue during the three and nine months ended
September 30, 1996 is a charge against revenue of approximately $9.3 million and
revenue of approximately $4.5 million, respectively, relating to the Company's
share of net earnings of the Joint Venture. Also included in the BSG Group's
revenue for the three and nine months ended September 30,
12
14
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1996 are charges of $7.5 million for the expected renegotiation of various
contracts and adjustments to bad debt reserves.
The BSG Group also accrued $6.0 million of salaries and wages for the
expected costs needed to complete two of Imonics' software engineering projects.
NOTE 8. RESTATEMENT OF 1995 CONSOLIDATED FINANCIAL STATEMENTS AND 1996 BALANCE
SHEETS
The Company has restated its financial statements for the three months and
year ended December 31, 1995. The restatement results primarily from a software
licensing agreement entered into by Imonics in December 1995 for which the
Company recognized associated license fee revenue in 1995. Subsequent to the
issuance of the Company's 1995 consolidated financial statements, management
discovered unauthorized correspondence made by an Imonics employee which created
a contingency for the license fee payable under this agreement. Such contingency
precluded recognition of license fee revenue in 1995 associated with this
agreement. The Company currently is in the process of amending certain filings
made pursuant to the Securities Exchange Act of 1934, as amended, which contain
financial information affected by the restatement. The Company is also required
to restate its balance sheets as of March 31, 1996 and its balance sheet as of
June 30, 1996 contained in the March 31, 1996 and June 30, 1996 Forms 10-Q,
respectively, for the effect of the 1995 restatement adjustments. The previously
recognized license fee revenue and certain other adjustments previously
considered immaterial are included as part of the adjustments to the Company's
previously reported results of operations and financial position. The
significant effects of the restatement are as follows:
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
For the Three Months Ended December 31, 1995:
Revenue................................................. $ 149,172 $ 144,746
Income before income taxes.............................. 10,711 2,171
Net income (loss)....................................... 3,008 (2,116)
Pro forma net income (loss)............................. 3,974 (1,150)
Pro forma net income (loss) per common share............ 0.06 (0.02)
For the Year Ended December 31, 1995:
Revenue................................................. 564,303 559,877
Income (loss) before income taxes....................... 4,706 (3,834)
Net loss................................................ (497) (5,621)
Pro forma net loss...................................... (3,380) (8,504)
Pro forma net loss per common share..................... (0.06) (0.15)
As of December 31, 1995:
Total current assets.................................... 228,357 223,165
Total assets............................................ 801,869 795,606
Total current liabilities............................... 125,658 127,935
Total liabilities....................................... 375,439 374,300
Total stockholders' equity.............................. 426,430 421,306
As of March 31, 1996:
Total current assets.................................... 199,934 194,742
Total assets............................................ 779,966 773,703
Total current liabilities............................... 98,321 100,598
Total liabilities....................................... 324,786 323,647
Total stockholders' equity.............................. 455,180 450,056
13
15
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
As of June 30, 1996:
Total current assets.................................... 271,452 266,260
Total assets............................................ 909,964 903,701
Total current liabilities............................... 107,106 109,383
Total liabilities....................................... 391,136 389,997
Total stockholders' equity.............................. $ 518,828 $ 513,704
14
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Medaphis Corporation ("Medaphis" or the "Company") provides transaction
processing and client/ server information technology systems and services for
clients in multiple vertical markets, initially concentrated in healthcare.
Medaphis' healthcare transaction 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's healthcare
transaction processing services also includes the provision of subrogation and
related recovery services primarily to healthcare payors. 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 the quality of care within
hospitals and emerging integrated healthcare delivery systems. The Company's
client/server information technology services are designed to effect fundamental
business process transformation and innovation through the rapid, high impact
development, delivery, deployment and maintenance of client/server technology
and the careful, deliberate transfer of the processes and related technology to
its clients.
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 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 some 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 believes that the revenue recognized 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 believes that the
decline in revenue 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
reengineering project have placed pressure on the rate of revenue growth and
margins in the Company's physician operations which are the subject of such
reengineering project. Due to these revenue and margin pressures, Medaphis
Physician Services Corporation ("MPSC") has not significantly contributed to the
Company's operating profit since the second half of 1995.
During the second half of 1995 and the first half of 1996, the Company was
able to offset the margin and revenue pressures experienced at MPSC through
expanded growth in its client/server information technology services and
information management operations. Much of this growth came from the signing of
new systems integration and healthcare information systems contracts which have
included significant initial license fees as well as through strategic
acquisitions. Given the size and complexity of the large-scale systems
integration and healthcare information system contracts entered into by the
Company and the license fees associated therewith, management believes that the
results of operations for the Company's BSG Group (client/server information
technology services) and healthcare information technology division ("HIT") may
be subject to significant quarterly fluctuations based upon the timing of
receipt of such contracts. However, management also anticipates that the
episodic nature of the Company's existing systems integration operations should
be partially offset over time by the results of operations of BSG Corporation
("BSG") and Rapid Systems Solutions, Inc. ("Rapid Systems"), which historically
have had a larger number of smaller systems integration projects which have not
included significant initial license fees, and the adoption by Imonics
Corporation ("Imonics") of the BSG business model.
15
17
The Company initiated a reengineering program focused upon its billing and
accounts receivable management operations in early 1995. The reengineering
program involves office consolidation, workflow, process and operational
improvements and new technology development. The overall goals of the
reengineering program are to increase the operating efficiency and enhance the
quality and productivity of the Company's billing and accounts receivable
management services operations. To date, the Company has spent approximately
$62.0 million on the development of software applications and technology and
approximately $42.0 million on hardware and equipment for the reengineering
program. The Company has encountered difficulties with the program. These
difficulties have included, among others, delays in achieving the targeted
consolidation of offices, delays in the development and implementation of
software applications and technology which achieve efficiencies and enhance
productivity in a scaled operating environment and delays in the implementation
of improved operational processes. As a result, management has commenced a
comprehensive assessment of the reengineering program designed to ensure that
the individual projects making up the program are properly aligned with overall
goals and objectives of the program. It is anticipated that this assessment will
include review of the total number, size and geographic location of the
Company's information processing centers ("IPCs") and a comprehensive assessment
of the various software development and technology projects forming a part of
the program. Although management remains committed to completing such assessment
in due course, there can be no assurance that the work associated with such
assessment will be completed prior to December 31, 1996. While this assessment
is underway, management has significantly reduced the level of expenditures on
the reengineering program. As part of this assessment, the Company has adopted a
plan to downsize certain of its existing IPCs and to charge the exit costs
incurred in connection with such downsizing in future periods against the
restructuring reserve established by the Company in the first quarter of 1995.
In terms of the on-going assessment of the software development and technology
projects, management anticipates that such assessment may result in
reaffirmation and continuation of certain projects, revisions to certain
projects to better align such projects with the overall goals of the program
and/or abandonment of certain projects. To the extent a software development or
technology project is abandoned in the future, the Company would incur a charge
relating to the abandonment and disposition of such project. To the extent the
Company incurs such a charge, there can be no assurance that such charge will
not be material.
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 Consolidated Statements of Operations to revenue.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1996 1995 1996 1995
----- ----- ----- -----
Revenue........................................... 100.0% 100.0% 100.0% 100.0%
Salaries and wages................................ 86.5 58.7 62.9 57.4
Other operating expenses.......................... 30.8 26.1 25.2 25.2
Depreciation...................................... 4.9 2.5 3.5 2.6
Amortization...................................... 3.9 3.3 3.2 3.2
Interest expense, net............................. 2.6 1.6 1.7 2.0
Restructuring and other charges................... 19.1 9.9 8.9 11.0
----- ----- ----- -----
Loss before income taxes.......................... (47.8) (2.1) (5.4) (1.4)
Income taxes...................................... (18.6) -- (0.9) (0.6)
----- ----- ----- -----
Net loss.......................................... (29.2) (2.1) (4.5) (0.8)
Pro forma adjustments............................. 0.5 0.2 0.2 (0.9)
----- ----- ----- -----
Pro forma net loss................................ (28.7)% (1.9)% (4.3)% (1.7)%
===== ===== ===== =====
16
18
Revenue. Revenue classified by the Company's different operating segments
is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1996 1995 1996 1995
-------- -------- -------- --------
Services.................................... $102,832 $101,735 $321,020 $305,080
BSG Group................................... 11,637 28,479 90,880 74,476
HIT......................................... 13,070 11,084 55,726 36,862
Corporate and eliminations.................. (808) (546) (2,075) (1,287)
-------- -------- -------- --------
$126,731 $140,752 $465,551 $415,131
======== ======== ======== ========
Revenue for the three month period ended September 30, 1996 declined 10% to
$126.7 million as compared with $140.8 million in the same period in 1995.
Revenue for the three month period ended September 30, 1996 includes charges of
$16.8 million related primarily to the renegotiation of a systems integration
contract entered into by a European joint venture formed by Imonics (the "Joint
Venture"). Excluding these charges, revenue increased 2% to $143.5 million in
the third quarter of 1996 as compared with $140.8 million in the third quarter
of 1995. Revenue increased 12% to $465.6 million in the nine month period ended
September 30, 1996 as compared with $415.1 million in the same period in 1995.
Year to date revenue growth in 1996 as compared with 1995 results from: (i)
acquisitions; (ii) increases in sales to information management and systems
integration clients; and (iii) net increases in the number of business
management services clients. The Company has consummated 18 business
combinations during the period from January 1, 1995 through September 30, 1996.
Services' revenue in the third quarter of 1996 was flat as compared with
the same period of 1995. This is largely attributable to slower than expected
new business sales. Services operations experienced minimal net business growth
as new sales were largely offset by client losses. A substantial portion of
Services' revenue is recurring in nature.
The decline in the BSG Group's revenue during the third quarter of 1996
compared with 1995 reflects the $16.8 million charge related primarily to the
renegotiation of a systems integration contract entered into by the Joint
Venture. Excluding these charges, the revenue recorded in the third quarter of
1996 would have been approximately the same as the third quarter of 1995. The
BSG Group's third quarter 1996 revenues were affected by, among other things,
the efforts of the BSG Group's management team to reorganize Imonics.
HIT's revenue increased 18% in the third quarter of 1996 compared with the
same period in 1995. This increase is primarily the result of an increase in
recurring systems maintenance revenue. Included in HIT's revenue for the nine
months ended September 30, 1996 is approximately $14.5 million of one-time fees
associated with the licensing of Health Data Sciences Corporation's ("HDS")
healthcare information system.
Salaries and Wages. Salaries and wages for the three and nine month
periods ended September 30, 1996 increased to 86.5% of revenue in the third
quarter of 1996 from 58.7% in the third quarter of 1995 and increased to 62.9%
of revenue in the nine month period ended September 30, 1996 from 57.4% in the
same period in 1995. This increase was compounded by the $16.8 million charge
against revenue and a $6.0 million charge to salaries and wages expense for the
costs needed to complete two of Imonics' software engineering projects.
Excluding these charges, salaries and wages increased to 72.2% and 59.5% of
revenue for the three and nine month periods ended September 30, 1996. Such
increases are due in part to increased employment levels across the Company and
an increase in the use of independent contractors by Imonics to perform systems
integration services for its clients. Generally, the use of independent
contractors to perform such tasks is more costly than staffing such work with
employees.
During the third quarter of 1996, management undertook various profit
improvement initiatives, including the reorganization of Imonics. Such actions
resulted in a reduction in the Company's work force of approximately 430
employees and outside consultants who were working on various projects during
the third quarter with annualized salary and wage costs and estimated forecasted
annualized outside consultant fees approximating $30 million, some of which had
been capitalized in prior periods.
17
19
Other Operating Expenses. Other operating expenses increased to 30.8% of
revenue in the third quarter of 1996 from 26.1% in the third quarter of 1995 and
remained at 25.2% of revenue in the nine month period ended September 30, 1996
as compared with the same period in 1995. Excluding the impact of the charges
against revenue recorded in the third quarter of 1996, other operating expenses
were 27.2% of revenue for the three month period ended September 30, 1996. Other
operating expenses are primarily comprised of postage, facility and equipment
rental, telecommunications, travel, office supplies, legal, accounting and other
outside professional services. On a year to date basis in 1996 as compared with
1995, the Company experienced improved operating leverage of such costs
resulting from increased revenues in 1996 as compared with 1995.
Depreciation. Depreciation expense was $6.2 million in the third quarter
of 1996 as compared with $3.5 million in the third quarter of 1995 and $16.5
million in the nine month period ended September 30, 1996 as compared with $10.7
million in the same period of 1995. This increase reflects the Company's
investment in property and equipment to support growth in its business,
including acquisitions.
In connection with the Company's reengineering project, management
currently anticipates that depreciation expense will increase by approximately
$2.5 million per quarter from current levels beginning in the fourth quarter of
1996 and continuing through 2000. This increase relates to the new computer and
other equipment acquired for the reengineering project.
Amortization. Amortization of intangible assets, which are primarily
associated with the Company's acquisitions and internally developed software,
was $4.9 million in the third quarter of 1996 as compared with $4.6 million in
the third quarter of 1995 and $14.7 million in the nine month period ended
September 30, 1996 as compared with $13.4 million in the same period in 1995.
The increase is primarily due to increased amortization of the Company's
capitalized software. To date, the Company has capitalized approximately $62.0
million in software development costs primarily incurred in connection with the
reengineering project. The Company has not amortized any portion of these costs.
Management currently anticipates that amortization expense in 1997 and
thereafter will increase in future periods as a result of the reengineering
project. The Company intends to amortize the software applications developed in
connection with this project over their estimated useful lives of five to seven
years.
Interest. Net interest expense was $3.3 million in the third quarter of
1996 as compared with $2.3 million in the same period of 1995. This increase
resulted from increased borrowings under the Senior Credit Facility to finance
acquisitions and funding of the Company's reengineering project. Net interest
expense decreased to $8.0 million in the nine month period ended September 30,
1996 as compared with $8.5 million in the same period in 1995. The decrease is
primarily due to the conversion of the Company's subordinated debentures into
common stock on January 1, 1996. Management anticipates that future interest
expense will increase as a result of changes in interest rates, increased
borrowings under the Senior Credit Facility and continued investment in the
Company's reengineering project.
Restructuring and Other Charges. Components of restructuring and other
charges include restructuring charges, property and equipment impairment,
pooling charges, software abandonment, severance costs and legal and other
costs. A description of each component is as follows:
Restructuring Charges. During the third quarter of 1996, the
Company finalized its plan to restructure its client/server
information technology businesses and began to consolidate Imonics and
Rapid Systems into BSG. In conjunction with this restructuring plan,
the Company recorded charges of approximately $1.3 million for the
costs associated with the termination of certain leases and $3.9
million ($1.2 million of this amount was recorded in the second
quarter of 1996) for severance costs for employees of Imonics who have
been notified of their termination. The Company also reviewed the
adequacy of existing reserves related to the Company's restructuring
plan at MPSC, and reduced these reserves by approximately $2.1 million
in the third quarter of 1996. During the nine months ended September
30, 1996, the Company also incurred approximately $5.2 million of
costs which were related to the Company's reengineering project which
had not previously been accrued because they did not meet the
definition of an exit activity as established by the appropriate
authoritative accounting literature.
18
20
In 1995, management approved a restructuring plan relating to the
consolidation of the Company's data processing function in MPSC. The
Company recorded a reserve for the exit costs associated with the
restructuring plan of approximately $15.0 million. During the third
quarter of 1996, the Company revised its original plan of
consolidating into ten regional IPCs. The Company has adopted a plan
to downsize certain of the existing IPCs and the costs associated with
exiting these facilities will be charged against the restructuring
reserves established in 1995. The Company has commenced a
comprehensive assessment of the reengineering program designed to
ensure that the individual projects which make up the program are
properly aligned with the overall goals and objectives of the program.
Although management remains committed to completing such assessment in
due course, there can be no assurance that the work associated with
such assessment will be completed prior to December 31, 1996.
Property and Equipment Impairment. In connection with the
restructuring of Imonics and MPSC, the Company assessed the
recoverability of its long lived assets and recorded impairment losses
of approximately $6.4 million and $5.0 million during the third
quarter of 1996 and first quarter of 1995, respectively.
Pooling Charges. In connection with the Intelligent Visual
Computing, Inc. ("IVC"), Rapid Systems, BSG and HDS
pooling-of-interests transactions consummated in 1996, the Company
recorded transaction fees, costs and expenses of approximately $12.9
million. Management finalized the estimated transaction fees, costs
and expenses associated with all the pooling-of-interests transactions
consummated in 1995 and 1996 and reversed $1.2 million and $3.6
million of these charges during the three and nine months ended
September 30, 1996, respectively. As a result of the 1995
pooling-of-interests transactions with Healthcare Recoveries, Inc.
(August) and Automation Atwork (January) the Company incurred
transaction fees, costs and expenses of approximately $2.0 million and
$6.0 million, respectively.
Software Abandonment. In connection with the consolidation of
Imonics into BSG, and the adoption by Imonics of the BSG business
model, the Company abandoned certain software development projects and
recorded a charge in the third quarter of 1996 for the write-off of
approximately $6.9 million of capitalized software development costs
related to these projects.
Severance Costs. In 1995, MPSC formalized an involuntary
severance benefit plan. The Company has recorded charges of
approximately $2.0 million and $5.0 million for the three months ended
September 30, 1996 and nine months ended September 30, 1995,
respectively, to accrue the estimated involuntary severance benefits
which had accumulated.
Legal and Other Costs The Company has recorded a charge of $5.0
million in the third quarter of 1996 for the administrative fees,
costs and expenses it anticipates incurring in connection with various
putative class action lawsuits which have been filed against the
Company and certain of its current and former officers, one of whom
was also a director, since August 14, 1996. The Company also recorded
a charge of $12.0 million in the third quarter of 1995 for the
administrative fees, costs and expenses it anticipated incurring in
connection with the investigation by the United States Attorney's
Office for the Central District of California of Medaphis' billing and
collection practices in its offices located in Calabasas and Cypress,
California (the "Federal Investigation") and various putative class
action lawsuits which are based on the Federal Investigation.
During the three month period ended September 30, 1996, the
Company canceled an initiative to develop an on-line practice
management system. The Company recorded a $2.0 million charge relating
to the deferred costs associated with this project. The Company also
accrued $1.3 million for certain liabilities associated with the
Company's billing and accounts receivable management services
operations.
Loss Before Income Taxes. The Company's loss before income taxes was 47.8%
of revenue in the third quarter of 1996 as compared with 2.1% of revenue in the
third quarter of 1995. The loss before income taxes was 5.4% of revenue for the
nine month period ended September 30, 1996 as compared with 1.4% of revenue
19
21
in the same period in 1995. The 1996 periods include restructuring and other
charges approximating $24.3 million and $41.6 million for the three and nine
months ended September 30, 1996, respectively. The 1996 periods also include
charges of $16.8 million to revenue and $6.0 million to salaries and wages
associated with the reorganization of Imonics. Excluding the effects of
restructuring and other charges and charges associated with the reorganization
of Imonics, income (loss) before income taxes was $(13.5) million and $11.0
million for the three months ended September 30, 1996 and 1995, respectively,
and $39.2 million and $39.7 million for the nine months ended September 30, 1996
and 1995, respectively.
Income Taxes. Effective income tax rates for the periods presented vary
from statutory rates primarily as a result of nondeductible expenses associated
with merger transactions consummated by the Company in 1996 and previous years.
Pro forma adjustments for income taxes have been provided for companies which
elected to be treated as "S" Corporations under the Internal Revenue Code prior
to merging with the Company.
RECENT ACQUISITIONS
On February 12, 1996, the Company acquired substantially all of the assets
and assumed certain of the related liabilities of Medical Management Computer
Services, Inc. ("MMCS"). MMCS provides billing and accounts receivable
management services primarily to emergency room physicians.
On February 20, 1996, the Company acquired substantially all of the assets
and assumed certain of the related liabilities of CBT Financial Services, Inc.
("CBT"). CBT provides collection and billing services primarily to hospitals.
On April 16, 1996, the Company acquired the outstanding capital stock of
The Medico Group, Ltd. ("MEDICO"). MEDICO provides billing and accounts
receivable management services primarily to anesthesiologists.
On October 8, 1996, the Company acquired the outstanding capital stock of
Sage Communications Corporation ("Sage"). Sage provides systems integration
services and data warehousing decision support applications, primarily to the
telecommunications industry.
Each of the foregoing acquisitions was or will be recorded using the
purchase method of accounting and, accordingly, the purchase price has been or
will be allocated to the assets acquired and liabilities assumed based on their
estimated fair market value at the date of the acquisitions.
On February 29, 1996, the Company exchanged shares of its common stock for
all of the outstanding shares of common stock of IVC. IVC provides systems
integration and work flow engineering systems and services to clients in the
healthcare and other industries. This transaction has been accounted for using
the pooling-of-interests method of accounting.
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. 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. 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
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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 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 clinical information needs through the integrated monitoring,
scheduling, documentation and control of patient care. 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 $105.5 million at September 30, 1996,
including $7.0 million of cash.
The Company used $7.5 million in cash for operating activities in the nine
months ended September 30, 1996. The decrease in the Company's operating cash
flows resulted from the increased levels of working capital committed to the
Company's technology systems operations, expenditures related to restructuring,
merger and other charges, and the ongoing revenue and margin pressures at MPSC.
Management expects the continued use of cash to fund restructuring and merger
costs, growth of the Company's technology systems operations and to support
operations of MPSC until further progress is made in the Company's reengineering
project and the improvement of MPSC's overall operations. Management expects to
fund such cash requirements through cash flows from operations and, to the
extent necessary, through amounts available for borrowing under the Senior
Credit Facility.
At September 30, 1996, approximately $224 million of borrowings were
outstanding under the Company's $250 million Senior Credit Facility. Amounts
available for borrowing under the Senior Credit Facility may be used for
expansion of the Company's business and general corporate purposes. The Company
has amended its Senior Credit Facility to extend its expiration date to March
17, 1998. Management is currently exploring alternatives designed to increase
the resources available to the Company to meet its anticipated liquidity and
capital resource needs. These alternatives include, among others, discussions
with its senior lenders to increase the size of its Senior Credit Facility and
modify the covenants contained therein, expanded use of lease lines to finance
equipment purchases and reductions in planned expenditures.
In December 1995, the Company gave notice of its intent to redeem its
6 1/2% convertible subordinated debentures due January 1, 2000. The debentures
were convertible into shares of the Company's common stock at a conversion price
of $14.00 per share. All of the debenture holders exercised their conversion
rights effective January 1, 1996, and as a result, approximately 4.5 million
shares of common stock were issued in the conversion.
The Company has commenced a comprehensive reengineering project. As part of
this project, the Company initially anticipated consolidating MPSC's processing
functions currently being performed in approximately 300 local business offices
into approximately ten or less regional processing centers. The Company has
commenced a comprehensive assessment of the reengineering program designed to
ensure that the individual projects making up the program are properly aligned
with the overall goals and objectives of the program. It is anticipated that
this assessment will include review of the total number, size and geographic
location of the Company's IPCs and a comprehensive assessment of the various
software development and technology projects forming a part of the program.
Although management remains committed to completing such assessment in due
course, there can be no assurance that the work associated with such assessment
will be completed prior to December 31, 1996. While this assessment is underway,
management has significantly reduced the level of expenditures on the
reengineering program. As part of this assessment, the Company has adopted a
plan to downsize certain of the existing IPCs and to charge the exit costs
incurred in future periods in connection with such downsizing against the
restructuring reserve established by the Company in the first quarter of 1995.
In terms of the on-going assessment of the software development and technology
projects,
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management anticipates that such assessment may result in reaffirmation and
continuation of certain projects, revisions to certain projects to better align
such projects with the overall goals of the program and/or abandonment of
certain projects. To the extent a software development or technology project is
abandoned in the future, the Company would incur a charge relating to the
abandonment and disposition of such project. To the extent the Company incurs
such a charge, there can be no assurance that such charge will not be material.
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 the three months ended September 30, 1996, the Company capitalized
approximately $7.5 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 the Company's capital expenditures have related either to
acquisitions of healthcare business management service companies and technology
companies, the reengineering project discussed above 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.
OTHER MATTERS
The Company has restated its financial statements for the three months and
year ended December 31, 1995. The restatement results primarily from a software
licensing agreement entered into by Imonics in December 1995 for which the
Company recognized associated license fee revenue in 1995. Subsequent to the
issuance of the Company's 1995 consolidated financial statements, management
discovered unauthorized correspondence made by an Imonics employee which created
a contingency for the license fee payable under this agreement. Such contingency
precluded recognition of license fee revenue in 1995 associated with this
agreement. The Company currently is in the process of amending certain filings
made pursuant to the Securities Exchange Act of 1934, as amended, which contain
financial information affected by the restatement. The Company is also required
to restate its balance sheets as of March 31, 1996 and June 30, 1996 contained
in the March 31, 1996 and June 30, 1996 Forms 10-Q, respectively, for the effect
of the 1995 restatement adjustments. The previously recognized license fee
revenue and certain other adjustments previously considered immaterial are
included as part of the adjustments to the Company's previously reported results
of operations and financial position. The significant effects of the restatement
are as follows:
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
For the Three Months Ended December 31, 1995:
Revenue................................................. $ 149,172 $ 144,746
Income before income taxes.............................. 10,711 2,171
Net income (loss)....................................... 3,008 (2,116)
Pro forma net income (loss)............................. 3,974 (1,150)
Pro forma net income (loss) per common share............ 0.06 (0.02)
For the Year Ended December 31, 1995:
Revenue................................................. 564,303 559,877
Income (loss) before income taxes....................... 4,706 (3,834)
Net loss................................................ (497) (5,621)
Pro forma net loss...................................... (3,380) (8,504)
Pro forma net loss per common share..................... (0.06) (0.15)
As of December 31, 1995:
Total current assets.................................... 228,357 223,165
Total assets............................................ 801,869 795,606
Total current liabilities............................... 125,658 127,935
Total liabilities....................................... 375,439 374,300
Total stockholders' equity.............................. 426,430 421,306
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AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
As of March 31, 1996:
Total current assets.................................... 199,934 194,742
Total assets............................................ 779,966 773,703
Total current liabilities............................... 98,321 100,598
Total liabilities....................................... 324,786 323,647
Total stockholders' equity.............................. 455,180 450,056
As of June 30, 1996:
Total current assets.................................... 271,452 266,260
Total assets............................................ 909,964 903,701
Total current liabilities............................... 107,106 109,383
Total liabilities....................................... 391,136 389,997
Total stockholders' equity.............................. $ 518,828 $ 513,704
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PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis, and one or more of Randolph G.
Brown, former Chairman, Chief Executive Officer and President and a former
director of Medaphis, Michael R. Cote, Senior Vice President -- Finance, Chief
Financial Officer and Assistant Secretary of Medaphis, and James S. Douglass,
former Vice President, Corporate Controller and Chief Accounting Officer of
Medaphis were named as defendants in nineteen putative shareholder class action
lawsuits filed in the United States District Court for the Northern District of
Georgia, Atlanta Division. Generally, these lawsuits allege violations of the
federal securities laws in connection with Medaphis' filings under the federal
securities acts and public disclosures concerning various subjects, including
Medaphis' re-engineering project, management and operations of certain Medaphis
subsidiaries, and Medaphis' reported and projected revenues and earnings. The
lawsuits are each brought on behalf of putative classes of persons who acquired
Medaphis common stock, including persons who acquired stock either in the public
market or in connection with three of Medaphis' recent business acquisitions.
Eighteen of the actions have been consolidated, and the Company anticipates that
the nineteenth also will be consolidated. Plaintiffs seek rescissory and
compensatory damages and costs.
On November 1, 1996, Medaphis, Randolph G. Brown, Robert C. Bellas, a
director of Medaphis, David R. Holbrooke, a director of Medaphis, and Richard H.
Stowe, a former director of Medaphis, were named as defendants in a shareholder
derivative action filed in the United States District Court for the Northern
District of Georgia, Atlanta Division. Generally, the lawsuit alleges that the
defendants breached their fiduciary duties, were grossly negligent, and breached
various contractual obligations to the Company 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.
Plaintiffs seek compensatory damages and costs.
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 Health Data Sciences Corporation. Plaintiff seeks rescissory,
compensatory and punitive damages, injunctive relief and costs.
Although the Company believes it has meritorious defenses to the actions
against the Company, there can be no assurance that additional lawsuits will not
be filed against the Company, that the lawsuits will not have a disruptive
effect upon the business, that the defense of the lawsuits will not consume the
time and attention of the senior management of the Company or that the lawsuits
will not have a material adverse effect upon the Company.
ITEM 5. OTHER INFORMATION
On October 24, 1996, 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 $15 and
above. No adjustment was made to any options held by executive officers or
directors of the Company. The revised exercise price of $9.875 was established
by reference to the closing price of the Company's common stock on October 25,
1996. 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 which made them
highly mobile; and (iv) senior management of the Company believed that
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there was potential for increased attrition among its key employees and that
adjustment of the exercise price of outstanding options would significantly help
to mitigate such risk.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
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 Amended and Restated 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 Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.3 of 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
the Registrant (incorporated by reference to Exhibit 4.4 of the Registrant's
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).
10.1 -- Fifth Modification of Amended and Restated Credit Agreement among the Registrant
and the Lenders named therein, dated October 10, 1996.
10.2 -- Sixth Modification of Amended and Restated Credit Agreement among the Registrant
and the Lenders named therein, dated October 31, 1996.
10.3 -- Employment Agreement by and between Registrant and Michael L. Douglas, dated as
of June 24, 1996.
10.4 -- Restricted Stock Agreement by and between Registrant and Michael L. Douglas,
dated as of June 26, 1996.
11 -- Statement regarding Computation of Earnings Per Share.
27 -- Financial Data Schedule (for SEC use only).
99 -- Safe Harbor Compliance Statement for Forward-Looking Statements.
(b) REPORTS ON FORM 8-K
The following reports on Form 8-K have been filed by the Company during the
quarter ended September 30, 1996:
FINANCIAL
STATEMENTS
ITEM REPORTED FILED DATE OF REPORT FILE DATE
---------------------------------------------- ---------- -------------- -------------
Acquisition of HDS............................ Yes(1) June 29, 1996 July 3, 1996
Consolidated Supplemental Financial Statements
to give effect for the acquisition of HDS... Yes(2) June 29, 1996 July 9, 1996
- ---------------
(1) Pro Forma Combined Financial Statements of the Company for the years ended
December 31, 1995, 1994, and 1993 (unaudited) were filed.
(2) Supplemental Consolidated Financial Data of the Company (audited) for the
years ended December 31, 1995, 1994 and 1993 were filed.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 1996 MEDAPHIS CORPORATION
-----------------------------------------------
(Registrant)
Date: November 14, 1996 /s/ David E. McDowell
-----------------------------------------------
David E. McDowell
Chairman and Chief Executive Officer
Date: November 14, 1996 /s/ Michael R. Cote
-----------------------------------------------
Michael R. Cote
Senior Vice President -- Finance, Chief
Financial Officer and Assistant Secretary
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