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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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 MARCH 31, 1998
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 MAY 1, 1998
----- --------------------------
Common Stock
$0.01 par value 78,251,728 shares
Non-voting Common Stock
$0.01 par value 0 shares
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MEDAPHIS CORPORATION
FORM 10-Q
FOR THE FISCAL QUARTER ENDED MARCH 31, 1998
PAGE
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Part I: Financial Information............................... 1
Consolidated Balance Sheets as of March 31, 1998 and
December 31, 1997...................................... 1
Consolidated Statements of Operations for the three months
ended March 31, 1998 and 1997.......................... 2
Consolidated Statements of Cash Flows for the three months
ended March 31, 1998 and 1997.......................... 3
Notes to Consolidated Financial Statements................ 4
Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 14
Part II: Other Information.................................. 19
Legal Proceedings......................................... 19
Other Matters............................................. 24
Exhibits and Reports on Form 8-K.......................... 25
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THIS FORM 10-Q AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY
MEDAPHIS CORPORATION OR ITS REPRESENTATIVES CONTAIN STATEMENTS WHICH MAY
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE SECURITIES ACT
OF 1933 AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995. 15 U.S.C.A. SECTIONS 77Z-2 AND 78U-5
(SUPP. 1996). THOSE STATEMENTS INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF
OR CURRENT EXPECTATIONS OF MEDAPHIS CORPORATION AND MEMBERS OF ITS MANAGEMENT
TEAM AS WELL AS THE ASSUMPTIONS ON WHICH SUCH STATEMENTS ARE BASED. PROSPECTIVE
INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH
FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS CURRENTLY KNOWN TO MANAGEMENT THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN FORWARD-LOOKING
STATEMENTS ARE SET FORTH IN THE SAFE HARBOR COMPLIANCE STATEMENT FOR
FORWARD-LOOKING STATEMENTS INCLUDED AS EXHIBIT 99.1 TO THIS FORM 10-Q, 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 BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT PAR VALUE DATA)
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 7,125 $ 17,794
Restricted cash........................................... 8,467 5,576
Accounts receivable, billed............................... 104,662 100,813
Accounts receivable, unbilled............................. 73,821 75,888
Other..................................................... 13,334 12,365
--------- ---------
Total current assets.............................. 207,409 212,436
Property and equipment...................................... 80,346 72,763
Deferred income taxes....................................... 67,936 60,857
Intangible assets........................................... 511,019 515,939
Other....................................................... 13,599 12,032
--------- ---------
$ 880,309 $ 874,027
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 10,119 $ 12,256
Accrued compensation...................................... 31,807 36,506
Accrued expenses.......................................... 53,571 56,295
Current portion of long-term debt......................... 10,834 11,490
Deferred income taxes..................................... 2,392 2,392
--------- ---------
Total current liabilities......................... 108,723 118,939
Long-term debt.............................................. 213,073 189,451
Accrued litigation settlement............................... 52,500 52,500
Other obligations........................................... 11,255 11,356
--------- ---------
Total liabilities................................. 385,551 372,246
--------- ---------
Stockholders' Equity:
Preferred stock, no par value, 20,000 authorized in 1998
and 1997; none issued.................................. -- --
Common stock, voting, $0.01 par value, 200,000 authorized
in 1998 and 1997; issued and outstanding 74,002 in 1998
and 73,204 in 1997..................................... 740 732
Common stock, non-voting, $0.01 par value, 600 authorized
in 1998 and 1997; none issued.......................... -- --
Paid-in capital........................................... 682,674 678,998
Accumulated deficit....................................... (188,656) (177,949)
--------- ---------
Total stockholders' equity........................ 494,758 501,781
--------- ---------
$ 880,309 $ 874,027
========= =========
See notes to consolidated financial statements.
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MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
-------------------
1998 1997
-------- --------
Revenue..................................................... $140,340 $147,546
-------- --------
Salaries and wages.......................................... 88,198 93,578
Other operating expenses.................................... 39,339 40,242
Depreciation................................................ 8,304 6,985
Amortization................................................ 6,118 6,114
Interest expense, net....................................... 6,375 6,115
Restructuring and other charges............................. 561 --
-------- --------
Total expenses.................................... 148,895 153,034
-------- --------
Loss before income taxes and extraordinary item............. (8,555) (5,488)
Income tax benefit.......................................... (3,405) (2,424)
-------- --------
Loss before extraordinary item.............................. (5,150) (3,064)
Extraordinary item: early extinguishment of debt, net of
tax....................................................... (5,557) --
-------- --------
Net loss.......................................... $(10,707) $ (3,064)
======== ========
Basic net loss per common share:
Loss before extraordinary item............................ $ (0.07) $ (0.04)
Extraordinary item: early extinguishment of debt, net of
tax.................................................... (0.08) --
-------- --------
Net loss.......................................... $ (0.15) $ (0.04)
======== ========
Weighted average shares outstanding......................... 73,479 72,235
======== ========
See notes to consolidated financial statements.
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MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
-------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(10,707) $(3,064)
Adjustments to reconcile net loss to net cash (used for)
provided by operating activities:
Depreciation and amortization.......................... 14,422 13,099
Early extinguishment of debt........................... 9,231 --
Gain on sale of property and equipment................. -- (102)
Deferred income taxes.................................. (7,079) (2,429)
Changes in assets and liabilities, excluding effects of
acquisitions:
Accounts receivable, billed.......................... (3,849) (1,905)
Accounts receivable, unbilled........................ 2,067 4,893
Accounts payable..................................... (2,137) 2,933
Accrued compensation................................. (4,676) 3,754
Accrued expenses..................................... (5,455) (10,260)
Other, net........................................... (350) (1,042)
-------- -------
Net cash (used for) provided by operating
activities....................................... (8,533) 5,877
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (15,638) (3,400)
Proceeds from sale of property and equipment.............. -- 3,644
Software development costs................................ (1,304) (1,398)
Other..................................................... (418) (769)
-------- -------
Net cash used for investing activities............ (17,360) (1,923)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock.................... 756 194
Proceeds from the exercise of employee stock options...... 2,907 3,424
Proceeds from borrowings.................................. 242,000 10,000
Principal payments of long-term debt...................... (219,076) (12,020)
Deferred financing costs.................................. (11,363) (3,009)
-------- -------
Net cash provided by (used for) financing
activities....................................... 15,224 (1,411)
-------- -------
CASH:
Net change................................................ (10,669) 2,543
Balance at beginning of period............................ 17,794 7,631
-------- -------
Balance at end of period.................................. $ 7,125 $10,174
======== =======
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest............................................... $ 3,853 $ 4,615
Income taxes........................................... 616 612
Non-cash investing and financing activities:
Additions to capital lease obligations................. 42 --
See notes to consolidated financial statements
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Medaphis Corporation ("Medaphis" or the "Company") are presented in accordance
with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X. For further
information, the reader of this Form 10-Q may wish to refer to the audited
consolidated financial statements of the Company for the fiscal year ended
December 31, 1997 included in the Company's Annual Report on Form 10-K filed
February 2, 1998.
The unaudited condensed financial information has been prepared in
accordance with the Company's customary accounting policies and practices. In
the opinion of management, all adjustments, consisting of normal recurring
adjustments considered necessary for a fair presentation of results for the
interim period, have been included.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. Actual results could differ from those estimates.
NOTE 2 -- LEGAL MATTERS
Numerous federal and state civil and criminal laws govern medical billing
and collection activities. In general, these laws provide for various fines,
penalties, multiple damages, assessments and sanctions for violations, including
possible exclusion from Medicare, Medicaid and certain other federal and state
healthcare programs.
The United States Attorney's Office for the Central District of California
is conducting an investigation of the billing and collection practices in two
offices of the Company's wholly owned subsidiary, MPSC, which offices are
located in Calabasas and Cypress, California (the "Designated Offices") (the
"California Investigation"). Medaphis first became aware of the California
Investigation on June 13, 1995 when search warrants were executed on the
Designated Offices and it and MPSC received grand jury subpoenas. Medaphis
received an additional grand jury subpoena on August 22, 1997, with which it is
complying. The subpoena requires, among other things, records of any audit or
investigative reports relating to the billing of payors globally for
radiological services during the period January 1, 1991 to date and any refunds
owed to or issued to payors with respect to such global billing reports in the
Company's various offices, including the Designated Offices.
Investigations such as the California Investigation can be initiated
following the commencement of qui tam litigation which is commenced under
applicable state and federal statutes and is maintained under court seal without
disclosure to the defendant. Under the applicable statutes, the United States
and the State of California may elect to intervene fully or partially in qui tam
litigation, and proceed with the action. The United States typically will
provide a defendant with the opportunity to enter into settlement negotiations
prior to the intervention of the United States in the matter. An application by
the United States to partially lift the seal in qui tam litigation in order to
make disclosure of the complaint available to the defendant often precedes such
settlement discussions.
On February 6, 1998, on application of the United States, the United States
District Court for the Central District of California issued an order partially
lifting the seal on the qui tam suit entitled United States of America and State
of California, ex rel. Relator I and Relator II v. Compmed Corporation, Medaphis
Corporation, Does 1 to 200, Inclusive. Civil Action No. 94-8158 LGB (kx). On
February 11, 1998, the United States provided Medaphis with a copy of the
Complaint, Substitution of Attorney, and Order which prohibited the Company from
making any use of the Complaint, including any public disclosure, other than for
the purposes of settlement negotiations, without further order of the Court. On
February 12, 1998, upon the joint application of Medaphis and the United States,
the Court issued an order modifying its February 6, 1998 order to allow Medaphis
to make public disclosures concerning the Complaint and its contents to the
extent that
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Medaphis determined such disclosures were required by applicable securities
laws, provided that such disclosure did not reveal the Relators' identities.
According to the Complaint, filed December 20, 1995 by the Relators and
which contains allegations raised by them, the action is to recover damages and
civil penalties on behalf of the United States and the State of California
arising out of alleged false claims presented by the defendants on behalf of
their clients for payment under various state and federal insurance programs. No
charges or claims by the government have been made. The Complaint includes
causes of action under the Federal False Claims Act, 31 U.S.C. sec 3729 et seq.,
and the California False Claims Act, Cal. Gov't Code sec. 12650 et seq. The
Complaint also includes causes of action relating to Medaphis's termination of
Relator II, including a count under the state and federal whistleblower
protection statutes. The Complaint alleges overpayments of approximately
$20,500,000 together with treble damages and additional penalties based on
statutory civil penalties. The Complaint alleges that at least 50,000 separate
false claims were filed under federal programs and at least 8,000 separate false
claims were filed under state programs. The Complaint also alleges unspecified
compensatory, general and punitive damages on behalf of Relator II on his or her
employment claims. The allegations in the Complaint are limited to the office of
CompMed (acquired by Medaphis) in Culver City, California. Medaphis believes
that this Complaint relates to and concerns the California Investigation.
Medaphis is engaged in discussions with the United States and California, and
intends to pursue settlement discussions with the United States, the State of
California, and the Relators. The Company has agreed with the government to toll
applicable statutes of limitations through September 30, 1998, and anticipates
executing an agreement to that effect.
Although the Company continues to believe that the principal focus of the
California Investigation remains on the billing and collection practices in the
Designated Offices, there can be no assurance that the California Investigation
will not expand to other offices, that the California Investigation or the qui
tam suit will be resolved promptly, that additional subpoenas or search warrants
will not be received by Medaphis or MPSC or that the California Investigation or
the qui tam suit will not have a material adverse effect on the Company. The
Company recorded charges of $12 million in the third quarter of 1995, $2 million
in the fourth quarter of 1996 and a credit of $2.8 million in the third quarter
of 1997, solely for legal and administrative fees, costs and expenses it
anticipates incurring in connection with the California Investigation and the
putative class action lawsuits described below which were filed in 1995
following the Company's announcement of the California Investigation. The
charges are intended to cover only the anticipated expenses of the California
Investigation and the related lawsuits and do not include any provision for
fines, penalties, damages, assessments, judgments or sanctions that may arise
out of such matters.
In September 1996, MPSC became aware of apparently inadvertent computer
software errors affecting some of its electronic billing to carriers in the
State of California. The error relates to global billing (i.e., billing for the
professional and technical components of a service) for certain radiological
services under circumstances where the radiologist is only entitled to bill for
the professional component of such services. The Company believes such
inadvertent errors may have caused overpayments on certain claims submitted on
behalf of clients in the State of California. The full extent of overpayments by
carriers and beneficiaries, which impacts only certain managed care plans,
cannot be determined by the Company, but as notifications to the affected
clients and carriers occur, and refunds or offsets are sought, the Company may
be required to return to clients its portion of fees previously collected, and
may receive claims for alleged damages as a result of the error. The Company is
unable to estimate the possible range of loss, if any.
Following the announcement of the investigation by the United States
Attorney's Office for the Central District of California, Medaphis, various of
its current and former officers and directors and the lead underwriters
associated with Medaphis' public offering of Common Stock in April 1995, were
named as defendants in putative shareholder class action lawsuits filed in the
United States District Court for the Northern District of Georgia. In general,
these lawsuits alleged violations of the federal securities laws in connection
with Medaphis' public statements and filings under the federal securities acts,
including the
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
registration statement filed in connection with Medaphis' public offering of
Common Stock in April 1995. On October 13, 1995, the named plaintiffs in these
lawsuits filed a consolidated class action complaint (the "Consolidated
Complaint"). On January 3, 1996, the court denied defendants' motion to dismiss
the Consolidated Complaint, which argued that the Consolidated Complaint failed
to state a claim upon which relief may be granted. On April 11, 1996, certain of
the named plaintiffs to the Consolidated Complaint voluntarily dismissed with
prejudice all of their claims. As a result of these dismissals, the Consolidated
Complaint no longer contained any claims based on the Securities Act and the
Company's underwriters and outside directors were no longer named as defendants.
On June 26, 1996, the court denied plaintiffs' motion to certify plaintiffs'
class. On May 19, 1997, the plaintiffs and the defendants entered into a
stipulation and settlement agreement, pursuant to which the parties agreed to
settle this action on a class-wide basis for $4.75 million, subject to court
approval (the "1995 Class Action Settlement"). The 1995 Class Action Settlement
included the related putative class action lawsuit filed in the Superior Court
of Cobb County, Georgia, described more fully below. On October 28, 1997 the
court certified a class for settlement purposes, approved the settlement and
entered final judgment dismissing the action with prejudice. One of Medaphis'
directors' and officers' liability insurance carriers has paid $3.7 million of
the 1995 Class Action Settlement directly for the benefit of the plaintiffs. The
Company accrued approximately $1.2 million in the quarter ended December 31,
1996 for the anticipated balance of the 1995 Class Action Settlement and to pay
certain fees incident thereto. On November 6, 1997, the Company paid the
remaining $1.05 million balance of the settlement.
The Company learned in March 1997 that the United States Department of
Justice and the United States Attorney in Grand Rapids, Michigan are
investigating allegations concerning the Company's wholly owned subsidiary,
Gottlieb's Financial Services, Inc. ("GFS") (the "GFS Investigation"). Beginning
in February, 1998, the Office of the Inspector General of Health and Human
Services has requested information from GFS following an audit of a GFS client.
GFS has complied with those requests. In 1993, Medaphis acquired GFS, an
emergency room physician billing company located in Jacksonville, Florida, which
had developed a computerized coding system. In 1994, Medaphis acquired and
merged into GFS another emergency room physician billing company, Physician
Billing, Inc., located in Grand Rapids, Michigan. For each of the years ended
December 31, 1996 and 1997, GFS represented approximately 7% of Medaphis'
revenue. During those years, GFS processed approximately 5.6 million and 6.25
million claims, respectively, approximately 2 million and 2.3 million of which,
respectively, were made to government programs. The government has requested
that GFS voluntarily produce records, and GFS has complied with that request.
Although the precise scope and subject matter of the GFS Investigation are not
known to the Company, Medaphis believes that the GFS Investigation, which is
being participated in by federal law enforcement agencies having both civil and
criminal authority, involves GFS's billing procedures and the computerized
coding system used in Jacksonville and Grand Rapids to process claims and may
lead to claims of errors in billing. There can be no assurance that the GFS
Investigation will be resolved promptly or that the GFS Investigation will not
have a material adverse effect upon Medaphis. No charges or claims by the
government have been made. Currently, the Company has recorded charges of $2
million and $1 million in the second and third quarters of 1997, respectively,
solely for legal and administrative fees, costs and expenses in connection with
the GFS Investigation, which charges do not include any provision for fines,
penalties, damages, assessments, judgments or sanctions that may arise out of
this matter. The Company is in discussions with the United States and intends to
pursue settlement discussions with the United States.
In addition, the Company decided in April 1998 to transition from the
computerized coding system to manual coding. There can be no assurances that the
Company will not be subject to customer complaints, claims and contract
terminations as a result of the coding system transition or modifications
previously made to the system.
The Company and its clients from time to time have received, and the
Company anticipates that they will receive in the future, official inquiries
(including subpoenas, search warrants, as well as informal requests)
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
concerning particular billing and collection practices related to certain
subsidiaries of the Company and its many clients.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its then current and
former officers, one of whom was also a director, were named as defendants in
nineteen putative shareholder class action lawsuits filed in the United States
District Court for the Northern District of Georgia. On November 22, 1996, the
plaintiffs in these lawsuits filed a Consolidated Amended Class Action
Complaint. On February 3, 1997, the plaintiffs filed a Consolidated Second
Amended Complaint (the "Consolidated Second Amended Complaint"). In general, the
Consolidated Second Amended Complaint alleged violations of the federal
securities laws in connection with Medaphis' filings under the federal
securities acts and public disclosures. The Consolidated Second Amended
Complaint was brought on behalf of a class of persons who purchased or otherwise
acquired Medaphis Common Stock between February 6, 1996 and October 21, 1996.
The Consolidated Second Amended Complaint also asserted claims on behalf of a
sub-class of all persons who acquired Medaphis Common Stock pursuant to the
merger between Medaphis and HDS. The Consolidated Second Amended Complaint
sought compensatory and rescissory damages, as well as fees, interest and other
costs. On February 14, 1997, the defendants moved to dismiss the Consolidated
Second Amended Complaint in its entirety. On May 27, 1997, the court denied
defendants' motion to dismiss.
The parties entered into a Stipulation and Agreement of Settlement dated
December 15, 1997 (the "Stipulation") to settle the 1996 putative shareholder
class action litigation which is the subject of the Consolidated Second Amended
Complaint on a class-wide basis for $20 million in cash (to be paid by the
Company's directors' and officers' liability insurance carriers), 3,955,556
shares of Medaphis Common Stock, and warrants to purchase 5,309,523 shares of
Medaphis Common Stock at $12 per share for a five-year period. The Stipulation
also includes, among other things: (i) a complete release of claims against the
Company, the individual defendants and certain related persons and entities; and
(ii) certain anti-dilution rights in favor of plaintiffs with respect to certain
future issuances of shares of Medaphis Common Stock or warrants or rights to
acquire Medaphis Common Stock to settle existing civil litigation and claims
pending or asserted against the Company, subject to a 5.0 million share basket
below which there will be no dilution adjustments. The Stipulation also contains
other conditions including, but not limited to, consent and approval of the
Company's insurance carriers and the insurance carriers' payment of the cash
portion of the settlement, and the final approval of the settlement by the
court. On December 15, 1997, the court granted preliminary approval to the
settlement and conditionally certified the classes for settlement purposes only.
The Company's insurance carriers consented to the settlement and funded the $20
million cash portion. On March 25, 1998, the Court granted final approval of the
settlement and entered final judgment dismissing the action.
The Company recorded a $52.5 million charge in the quarter ended September
30, 1997 in connection with the Stipulation. This charge is comprised of the
following: (i) $30.2 million representing the original 3,355,556 shares of
common stock valued at the fair value of a common share on the date that the
material terms of the agreement were reached or approximately $9 per share and
(ii) $22.3 million representing the fair value of the warrants on the date the
material terms of the agreement were reached, valued using the Black-Scholes
option pricing model with the following assumptions: expected life -- 5 years,
risk free interest rate -- 6%, dividend rate -- 0% and expected volatility
factor -- 60%. No accounting recognition was required for the additional 600,000
shares to be issued pursuant to the agreement as these shares represent the
maximum number of contingent shares that were issuable based on certain stock
price contingencies during the ten day period prior to October 11, 1997. As a
result of the actual decline in the Company's stock price during such period,
the Stipulation required that the maximum number of contingent shares be
awarded; however, no additional accounting charge is required in connection with
the award of such contingent shares. Although the exact timing of the issuance
of the 3,955,556 shares is not known, the Company does not expect such shares to
be issued before the second quarter of 1998. Additionally, no accounting
recognition has been afforded the cash portion of the Stipulation as this amount
is the responsibility of the insurance carriers. Such amount has
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10
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
been paid directly to an escrow account for the benefit of the plaintiffs by the
insurance carriers. The Company has classified the entire $52.5 million
liability associated with the settlement as noncurrent as such obligation will
be settled with equity (common stock and warrants) rather than current assets as
the exact timing of such settlement is not determinable.
On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit
Sharing Plan filed a shareholder derivative lawsuit in the United States
District Court for the Northern District of Georgia alleging that certain of
Medaphis' current and former directors breached their fiduciary duties, were
grossly negligent, and breached various contractual obligations to Medaphis by
allegedly failing to implement and maintain an adequate system of internal
accounting controls, allowing Medaphis to commit securities law violations and
damaging Medaphis' reputation. The plaintiff seeks unspecified compensatory
damages and costs on behalf of the Company. On January 28, 1997, Medaphis and
certain individual defendants filed a motion to dismiss the complaint. On
February 11, 1997, the plaintiff filed an amended complaint adding as
defendants, additional current and former directors and officers of Medaphis. On
April 23, 1997, Medaphis and all other defendants filed a motion to dismiss the
amended complaint, which motion is still pending. The Company is unable to
estimate a possible range of loss.
On November 7, 1996, Health Systems International, Inc. filed suit in the
Superior Court for the State of California, County of Los Angeles against
Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed
Medaphis directors, officers and employees. Generally, this lawsuit alleges that
the defendants violated federal and California securities laws and common law
by, among other things, making material misstatements and omissions in public
and private disclosures in connection with the acquisition of HDS. Plaintiff
seeks rescissory, compensatory and punitive damages in excess of $100 million,
rescission, injunctive relief and costs. The Company is unable to estimate a
possible range of loss. On January 10, 1997, the defendants filed a demurrer to
the complaint. On February 5, 1997 the Court overruled defendants' demurrer. On
March 18, 1997, the court denied the plaintiff's motion for a preliminary
injunction. On July 16, 1997, plaintiff filed an amended complaint adding
several new parties, including current and former directors and former and
current officers of Medaphis. All of the newly added defendants have responded
to the amended complaint. As a result of the Company's restatement of its fiscal
1995 financial statements, the Company may not be able to sustain a defense to
strict liability on certain claims under the Securities Act, but the Company
believes that it has substantial defenses to the alleged damages relating to
such Securities Act claims.
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberger against Steven G. Papermaster, Robert E. Pickering, Jr., David S.
Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and
Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division,
Essex County, State of New Jersey. The alleged class consists of persons and
entities whose options to purchase BSG Corporation ("BSG") common stock were
converted to Medaphis stock options in connection with Medaphis' acquisition of
BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary
duties of candor, loyalty and fair dealing and negligence against the BSG
defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud
and deceit against the Medaphis defendants (Medaphis and Brown). Plaintiffs seek
unspecified compensatory and punitive damages, as well as fees, interest and
other costs. The Company is unable to estimate a possible range of loss. On
April 18, 1997, the Medaphis defendants and BSG defendants filed motions to
dismiss the complaint. On or about July 3, 1997, in lieu of responding to these
motions, the plaintiffs filed an amended complaint, adding new claims under the
Securities Act and common law and new parties, including former officers of
Medaphis, Medaphis' former outside auditors and BSG. On or about October 29,
1997 all defendants filed motions to dismiss the amended complaint. On May 12,
1998, the court ruled in favor of defendants on the motions, dismissing all of
plaintiffs' claims with prejudice and without leave to amend. The Company
expects that the judge will sign an order to that effect, at which time
statutory appeal periods will begin to run.
8
11
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control made a demand for indemnification under an indemnification
agreement executed by Medaphis in connection with its acquisition of BSG in May
1996. The indemnification demand claims damages of $35 million (the maximum
damages payable by Medaphis under the indemnification agreement) for the alleged
breach by Medaphis of its representations and warranties made in the merger
agreement between Medaphis and BSG. On December 31, 1996, Medaphis entered into
a standstill and tolling agreement with Mr. Noorda, Mr. Papermaster and other
former BSG shareholders, which, as extended, runs through June 30, 1998. The
standstill and tolling agreement extends any applicable statute of limitations
for claims by the former BSG shareholders and provides that neither party will
file suit against the other prior to the expiration of the agreement.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity Trust
and the Paulanne H. Thacker Retained Annuity Trust filed a complaint against the
Company and Randolph G. Brown in the United States District Court for the
Southern District of New York arising out of Medaphis' acquisition of MMS in
December of 1995. The complaint is brought on behalf of all former shareholders
of MMS who exchanged their MMS holdings for unregistered shares of Medaphis
Common Stock. In general, the complaint alleges both common law fraud and
violations of the federal securities laws in connection with the merger. In
addition, the complaint alleges breaches of contract relating to the merger
agreement and a registration rights agreement, as well as tortious interference
with economic advantage. The plaintiffs seek rescission of the merger agreement
and the return of all MMS shares, as well as damages in excess of $100 million.
The Company is unable to estimate a possible range of loss. Additionally,
plaintiffs seek to void various non-compete covenants and contract provisions
between Medaphis and plaintiffs. Defendants have filed a motion to dismiss the
complaint. Discovery has been stayed pending resolution of the motion to
dismiss.
On August 12, 1997, George D. Stickel filed a putative class action
complaint against Medaphis, Randolph W. Brown, Michael R. Cote and James S.
Douglass in the United States District Court for the Northern District of
Georgia. The complaint asserts claims under the Exchange Act on behalf of all
persons who purchased or otherwise acquired Medaphis Common Stock between
February 6, 1996 and October 21, 1996. The complaint also asserts claims under
the Securities Act on behalf of a subclass consisting of all persons and
entities who, in connection with the merger of the Company and HDS, acquired
options to purchase shares of Medaphis Common Stock between February 6, 1996 and
October 21, 1996. The complaint seeks rescission, unspecified rescissory and
compensatory damages, and interest, fees and other costs. The Company is unable
to estimate a possible range of loss.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies. To date,
these other stockholders have not filed lawsuits.
On January 8, 1997, the Commission notified the Company that it was
conducting a formal, non-public investigation into, among other things, certain
trading and other issues related to Medaphis' August 14, 1996 and October 22,
1996 announcements of the Company's loss for the quarter ending September 30,
1996 and its restated consolidated financial statements for the three months and
year ending December 31, 1995 and its restated unaudited balance sheets as of
March 31, 1996, and June 30, 1996. In addition, the Company believes that the
Commission is investigating the Company's restatement of its interim financial
statements for each quarter of 1996 and the November 19, 1997 and December 23,
1997 restatements of the Company's financial statements. The Company intends to
cooperate fully with the Commission in its investigation.
9
12
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Although the Company believes that it has meritorious defenses to the
claims of liability or for damages in the actions against and written demands
placed upon the Company, there can be no assurance that additional lawsuits will
not be filed against the Company. Further, there can be no assurance that the
lawsuits, the written demands and the pending governmental investigations will
not have a disruptive effect upon the operations of the business, that the
written demands, the defense of the lawsuits and the pending investigations will
not consume the time and attention of the senior management of the Company, or
that the resolution of the lawsuits, the written demands and the pending
governmental investigations will not have a material adverse effect upon the
Company, including, without limitation, the Company's results of operations,
financial position and cash flow. Because the Company is unable to estimate a
range of loss with respect to any of the pending claims, the Company has not
accrued any amounts for any contingent liability with respect to such claims.
NOTE 3 -- RESTRUCTURING AND OTHER CHARGES
In the first quarter of 1998, the Company recorded a charge of $0.6 million
for the severance costs associated with a former executive.
The description of the type and the amount of exit costs applied against
each reserve in the quarter ended March 31, 1998 are as follows:
RESERVE RESERVE
BALANCE COSTS APPLIED BALANCE
12/31/97 AGAINST RESERVE 3/31/98
-------- --------------- --------
(IN THOUSANDS)
Lease termination costs.............................. $8,015 $ (804) $7,211
Severance............................................ 1,357 (801) 556
------ ------- ------
$9,372 $(1,605) $7,767
====== ======= ======
NOTE 4 -- LONG-TERM DEBT
On February 20, 1998, the Company sold $175 million of senior notes (the
"Notes"). The Notes bear interest at the rate of 9 1/2% per annum, payable
semi-annually on February 15 and August 15 of each year, commencing on August
15, 1998. The Notes will mature on February 15, 2005. The Notes will be
redeemable at the option of the Company, in whole or in part, at any time on or
after February 15, 2002, at a declining premium to par until 2004 and at par
thereafter, plus accrued and unpaid interest. In addition, at any time on or
prior to February 15, 2001, the Company may redeem up to 35% of the original
principal amount of the Notes at a redemption price equal to 109.5% of the
principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, to the redemption date, with the net cash proceeds of one or
more equity offerings; provided that at least $100 million aggregate principal
amount of the Notes remain outstanding immediately following any such
redemption.
Payment of principal, of premium, if any, and interest on the Notes will be
fully and unconditionally guaranteed, on a senior unsecured basis, jointly and
severally by all of the Company's present and future domestic restricted
subsidiaries (the "Subsidiary Guarantors"). The financial statements of the
Subsidiary Guarantors have not been presented as all subsidiaries, except for
certain insignificant foreign subsidiaries, have provided guarantees and the
parent company does not have any significant operations or assets, separate from
its investment in subsidiaries. Any non-guarantor subsidiaries are insignificant
individually and in the aggregate to the consolidated financial statements.
The Company also entered into a new $100 million credit facility (the
"Credit Facility") on February 20, 1998. The Company has the option of making
"LIBOR" based loans or "base rate" loans under the Credit Facility. LIBOR based
loans bear interest at LIBOR plus amounts ranging from 1.0% to 2.75% based on
the
10
13
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Company's leverage ratio, as defined in the Credit Facility. Base rate loans
bear interest at prime plus amounts ranging from 0.0% to 1.75% based on the
Company's leverage ratio, as defined. In addition the Company pays a quarterly
commitment fee on the unused portion of the Credit Facility ranging from 0.25%
to 0.75% per annum based on the Company's leverage ratio. The Credit Facility
contains financial and other restrictive covenants, including without limitation
those restricting the incurrence of additional indebtedness, the creation of
liens, the payment of dividends, sales of assets, capital expenditures, and
prepayment of the Notes and those requiring maintenance of minimum net worth,
minimum EBITDA (as defined), minimum interest coverage and maximum leverage.
Amounts outstanding under the Credit Facility will be due on February 20, 2001.
At March 31, 1998, the Company had $36 million in borrowings outstanding under
the Credit Facility at interest rates ranging from 8.1% to 8.2%.
The Company used the proceeds from the offering of the Notes, together with
the initial borrowing under the Credit Facility and available cash, to repay the
$210 million borrowings under the then-current loan facility plus accrued
interest. As a result of this early extinguishment of debt, the Company recorded
an extraordinary charge of $5.6 million, net of tax of $3.6 million, to
write-off the unamortized costs associated with the previous debt facility.
NOTE 5 -- NEW ACCOUNTING PRONOUNCEMENTS
In October 1997, the American Institute of Certified Public Accountants
(the "AICPA") issued Statement of Position ("SOP") 97-2, Software Revenue
Recognition ("SOP 97-2"). SOP 97-2 is effective for transactions entered into in
the first quarter of 1998. In March 1998, the AICPA issued SOP 98-4, Deferral of
the Effective Date of a Provision of SOP 97-2, "Software Revenue Recognition,"
("SOP 98-4"). SOP 98-4 defers for one year the application of certain passages
in SOP 97-2. Prior to SOP 97-2, the Company had generally recorded the revenue
associated with its various software products upon delivery of the product and
when no significant contractual obligations remained outstanding. The adoption
of SOP 97-2 changes the way the Company records revenue for one of its software
products, ULTICARE(R), from upon delivery to a percentage-of-completion method
over the life of the installation period. The adoption of SOP 97-2 had no impact
on the Company's operating results for the three months ended March 31, 1998, as
the Company did not enter into any new software licenses for ULTICARE in the
first quarter. SOP 97-2 will not materially impact the pattern of revenue
recognition for all of the Company's other software products.
In March 1998, the AICPA issued SOP 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use ("SOP 98-1"). SOP 98-1
provides guidance on the accounting for the costs of computer software developed
or obtained for internal use and is effective for financial statements for
fiscal years beginning after December 15, 1998. The Company does not believe
that SOP 98-1 will have a material impact on the Company's results of
operations.
NOTE 6 -- SEGMENT REPORTING
Medaphis provides its services and products through its Healthcare Services
Group and Per-Se Technologies. The Healthcare Services Group provides business
management services to physicians and hospitals, including the collection of
clinical data, data input, medical coding, billing, cash collections and
accounts receivable management. The Healthcare Services Group consists of two
reportable segments based on the clients they serve: (i) Physician Services,
which is a leading provider of business management solutions and claims
processing to physicians in the United States; and (ii) Hospital Services, which
is a leading provider of business management services to hospitals in the United
States. Per-Se Technologies ("Per-Se") provides application software and a broad
range of information technology and consulting services to healthcare and other
service-oriented markets. Per-Se is organized into two reportable segments based
on their different service offerings: (i) Per-Se Software Products, which
provides application software and system integration services; and (ii) Per-Se
Consulting Services, which provides full-service systems integration,
11
14
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
information technology consulting and tailored software development. HRI
provided subrogation and related recovery services primarily to healthcare
payors. HRI was sold on May 28, 1997.
Medaphis evaluates each segment's performance based on operating profit or
loss. The Company also accounts for intersegment sales as if the sales were to
third parties.
The Company's reportable segments are strategic business units that offer
different products and services. Information concerning the operations in these
reportable segments is as follows:
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
-------- --------
(IN THOUSANDS)
Revenue:
Physician Services........................................ $ 70,099 $ 71,760
Hospital Services......................................... 25,271 23,756
Per-Se Software Products.................................. 23,712 19,690
Per-Se Consulting Services................................ 21,706 23,810
HRI....................................................... -- 8,916
Eliminations.............................................. (448) (386)
-------- --------
$140,340 $147,546
======== ========
Operating profit(loss)(1):
Physician Services........................................ $ 1,564 $ 1,241
Hospital Services......................................... 1,773 2,483
Per-Se Software Products.................................. 2,593 2,818
Per-Se Consulting Services................................ 555 274
HRI....................................................... -- 2,253
Corporate................................................. (8,104) (8,442)
-------- --------
$ (1,619) $ 627
======== ========
Interest expense, net....................................... $ 6,375 $ 6,115
-------- --------
Restructuring and other charges:
Physician Services........................................ $ -- $ --
Hospital Services......................................... -- --
Per-Se Software Products.................................. -- --
Per-Se Consulting Services................................ -- --
HRI....................................................... -- --
Corporate................................................. 561 --
-------- --------
$ 561 $ --
-------- --------
Loss before income taxes.................................... $ (8,555) $ (5,488)
======== ========
Depreciation and amortization:
Physician Services........................................ $ 8,404 $ 8,494
Hospital Services......................................... 1,799 1,278
Per-Se Software Products.................................. 2,162 1,710
Per-Se Consulting Services................................ 1,211 1,045
HRI....................................................... -- 245
Corporate................................................. 846 327
-------- --------
$ 14,422 $ 13,099
======== ========
12
15
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
-------- --------
(IN THOUSANDS)
Capital expenditures:
Physician Services........................................ $ 11,934 $ 1,272
Hospital Services......................................... 1,470 786
Per-Se Software Products.................................. 1,198 665
Per-Se Consulting Services................................ 221 609
HRI....................................................... -- 51
Corporate................................................. 815 17
-------- --------
$ 15,638 $ 3,400
======== ========
AS OF
------------------------
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
(IN THOUSANDS)
Identifiable Assets:
Physician Services........................................ $569,787 $563,825
Hospital Services......................................... 108,758 106,479
Per-Se Software Products.................................. 68,689 72,505
Per-Se Consulting Services................................ 32,200 30,489
HRI....................................................... -- --
Corporate................................................. 100,875 100,729
-------- --------
$880,309 $874,027
======== ========
- ---------------
(1) Excludes restructuring and other charges and interest expense.
13
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Medaphis Corporation, a corporation organized in 1985 under the laws of the
State of Delaware ("Medaphis" or the "Company") is a leader in delivering
healthcare information and business management services, together with enabling
technologies in selected industries. Medaphis believes it is well-positioned to
capitalize on the healthcare industry trends toward consolidation, managed care
and cost containment through a broad range of services and products that enable
customers to provide quality patient care efficiently and cost effectively.
Servicing over 20,000 physicians and 2,700 hospitals, predominantly in North
America, the Company's large client base and national presence further support
the Company's competitive position. Medaphis provides its services and products
through its Healthcare Services Group and through Per-Se Technologies, its
Information Technology Group.
The Healthcare Services Group provides a range of business management
services to physicians and hospitals, including clinical data collection, data
input, medical coding, billing, cash collections and accounts receivable
management. These services are designed to assist customers with the business
management functions associated with the delivery of healthcare services,
allowing physicians and hospital staffs to focus on providing quality patient
care. These services also assist physicians and hospitals in improving cash
flows and reducing administrative costs and burdens. Per-Se Technologies
provides application software and a broad range of information technology and
consulting services to healthcare and other service-oriented markets such as
energy, communications and financial services.
Medaphis markets its services and products primarily to integrated
healthcare delivery networks, hospitals, physician practices, long-term care
facilities, home health providers and managed care providers.
RESULTS OF OPERATIONS
The following table shows the amount and the percentage of revenue for
items reflected in the Company's Statements of Operations.
THREE MONTHS ENDED
MARCH 31,
------------------------------------
1998 1997
---------------- ----------------
(DOLLARS IN THOUSANDS)
Revenue.................................................. $140,340 100.0% $147,546 100.0%
Salaries and wages....................................... 88,198 62.9 93,578 63.4
Other operating expenses................................. 39,339 28.0 40,242 27.3
Depreciation............................................. 8,304 5.9 6,985 4.7
Amortization............................................. 6,118 4.4 6,114 4.1
Interest expense, net.................................... 6,375 4.5 6,115 4.1
Restructuring and other charges.......................... 561 0.4 -- --
-------- ----- -------- -----
Loss before income taxes and extraordinary item.......... (8,555) (6.1) (5,488) (3.6)
Income tax benefit....................................... (3,405) (2.4) (2,424) (1.6)
-------- ----- -------- -----
Loss before extraordinary item........................... (5,150) (3.7) (3,064) (2.0)
Extraordinary item: early extinguishment of debt, net of
tax.................................................... (5,557) (3.9) -- --
-------- ----- -------- -----
Net loss....................................... $(10,707) (7.6)% $ (3,064) (2.0)%
======== ===== ======== =====
14
17
Revenue. Revenue classified by the Company's different reportable segments
is as follows:
THREE MONTHS ENDED
MARCH 31,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
Physician Services........................................ $ 70,099 $ 71,760
Hospital Services......................................... 25,271 23,756
Per-Se Software Products.................................. 23,712 19,690
Per-Se Consulting Services................................ 21,706 23,810
HRI....................................................... -- 8,916
Eliminations.............................................. (448) (386)
-------- --------
$140,340 $147,546
======== ========
The 2% decrease in Physician Services' revenue in the first quarter of 1998
from the same period of 1997 is attributable to system and process changes in
the first quarter of 1998 which delayed the Company's ability to record certain
revenue. Management believes these changes were one-time events that will not be
recurring. During the quarter, management at Physician Services continued its
emphasis on customer service and not revenue growth.
The 6% increase in Hospital Services' revenue for the three months ended
March 31, 1998, as compared to the same period of the prior year, reflects
volume growth.
Per-Se Software Products' revenue increased 20% during the three months
ended March 31, 1998 as compared with the same period for the prior year. This
increase is primarily a result of an increase in the amount of revenue
associated with the Company's ULTICARE(R) software product.
The 9% decrease in the Per-Se Consulting Services' revenue is primarily a
result of the Company's late 1997 decision to downsize this segment, which
created less billable hours in the first quarter of 1998 as compared to the
first quarter of 1997.
Medaphis divested HRI in May 1997 through an initial public offering of
100% of its stock.
Salaries and Wages. Salaries and wages decreased to 62.9% of revenue in
the first quarter of 1998 from 63.4% in the first quarter of 1997. The decrease
in salaries and wages, as a percentage of revenue, is a direct result of the
Company's restructuring and cost containment initiatives implemented during the
third and fourth quarters of 1997.
Other Operating Expenses. Other operating expenses increased to 28.0% of
revenue in the first quarter of 1998 compared to 27.3% in the first quarter of
1997. The increase in other operating expenses as a percentage of revenue for
1998, as compared with 1997, is primarily due to third party commission costs
and increased marketing costs associated with the Per-Se Software Products
segment. Other operating expenses are primarily comprised of postage, facility
and equipment rental, telecommunications, travel, outside consulting and legal
services and office supplies.
Depreciation. Depreciation expense was $8.3 million in the first quarter
of 1998 as compared with $7.0 million in the first quarter of 1997. This
increase reflects the Company's investment in property and equipment to support
its business.
Amortization. Amortization of intangible assets, which are primarily
associated with the Company's acquisitions and internally developed software,
was $6.1 million in both the first quarters of 1998 and 1997.
Interest. Net interest expense was $6.4 million in the first quarter of
1998 as compared with $6.1 million in the first quarter of 1997. The increase is
primarily due to the increased borrowing rate associated with the $210 million
loan facility entered into in December 1997 (the "Bridge Notes"), which was
outstanding for approximately two months in 1998.
15
18
Restructuring and Other Charges. In the first quarter of 1998, the Company
recorded a charge of $0.6 million for the severance costs associated with a
former executive.
Income Taxes. Effective income tax rates for the periods presented vary
from statutory rates primarily as a result of nondeductible goodwill associated
with merger transactions consummated by the Company in previous years.
As of March 31, 1998, the Company had recorded a net deferred tax asset of
$67.9 million primarily reflecting a tax benefit of $104.3 million for net
operating loss carryforwards ("NOLs") offset by a valuation allowance of $26.5
million. The valuation allowance primarily reflects the Company's assessment of
the uncertainty associated with the realizability of NOLs assumed in certain
business combinations; a full valuation allowance has been provided on such
amounts. With respect to the deferred tax assets for which a valuation allowance
has not been provided, realizability of such amount is dependent on the Company
generating sufficient taxable income prior to the expiration of such NOLs.
Currently, the Company's NOLs are scheduled to expire in varying amounts from
1998 through 2011; however, no material amounts are scheduled to expire prior to
2008. Although realization is not assured, based on the Company's current
analyses and estimates, management believes it is more likely than not that the
Company will generate sufficient taxable income to fully realize the deferred
tax asset prior to the expiration of the carryforward period. In addition, if
future taxable income is not sufficient to fully utilize the deferred tax asset,
other tax planning strategies are available to the Company, which makes it more
likely than not that the Company will be able to utilize the deferred tax asset.
Extraordinary Item. The Company used the proceeds from the February 1998
issuance of the Notes (as defined) and the Credit Facility (as defined) to pay
off the Company's Bridge Notes. The Company recorded a charge of $5.6 million,
net of tax of $3.6 million, to write-off the unamortized costs associated with
the Bridge Notes.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $98.7 million at March 31, 1998,
including $7.1 million of cash.
The Company's operating activities used $8.5 million of cash during the
three months ended March 31, 1998 as compared with the generation of cash of
$5.9 million during the three months ended March 31, 1997. The decrease in the
Company's operating cash flows resulted primarily from the timing of payment and
reduction of current liabilities.
Purchases of property and equipment were $15.6 million in the first quarter
of 1998 compared to $3.4 million in the prior year comparable quarter. The
increase reflects the purchase for approximately $10 million of certain real
property that the Company was leasing.
On February 20, 1998, the Company sold $175 million of senior notes (the
"Notes"). The Notes bear interest at the rate of 9 1/2% per annum, payable
semi-annually on February 15 and August 15 of each year, commencing on August
15, 1998. The Notes will mature on February 15, 2005. The Notes will be
redeemable at the option of the Company, in whole or in part, at any time on or
after February 15, 2002, at a declining premium to par until 2004 and at par
thereafter, plus accrued and unpaid interest. In addition, at any time on or
prior to February 15, 2001, the Company may redeem up to 35% of the original
principal amount of the Notes at a redemption price equal to 109.5% of the
principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, to the redemption date, with the net cash proceeds of one or
more equity offerings; provided that at least $100 million aggregate principal
amount of the Notes remain outstanding immediately following any such
redemption.
Payment of principal, of premium, if any, and interest on the Notes will be
fully and unconditionally guaranteed, on a senior unsecured basis, jointly and
severally by all of the Company's present and future domestic restricted
subsidiaries (the "Subsidiary Guarantors"). The financial statements of the
Subsidiary Guarantors have not been presented as all subsidiaries, except for
certain insignificant foreign subsidiaries, have provided guarantees and the
parent company does not have any significant operations or assets, separate from
its investment in subsidiaries. Any non-guarantor subsidiaries are insignificant
individually and in the aggregate to the consolidated financial statements.
16
19
The Company also entered into a new $100 million credit facility (the
"Credit Facility") on February 20, 1998. The Company has the option of making
"LIBOR" based loans or "base rate" loans under the Credit Facility. LIBOR based
loans bear interest at LIBOR plus amounts ranging from 1.0% to 2.75% based on
the Company's leverage ratio, as defined in the Credit Facility. Base rate loans
bear interest at prime plus amounts ranging from 0.0% to 1.75% based on the
Company's leverage ratio, as defined. In addition the Company pays a quarterly
commitment fee on the unused portion of the Credit Facility ranging from 0.25%
to 0.75% per annum based on the Company's leverage ratio. The Credit Facility
contains financial and other restrictive covenants, including without limitation
those restricting the incurrence of additional indebtedness, the creation of
liens, the payment of dividends, sales of assets, capital expenditures, and
prepayment of the Notes, those requiring maintenance of minimum net worth,
minimum EBITDA (as defined) and minimum interest coverage and limiting leverage.
Amounts outstanding under the Credit Facility will be due on February 20, 2001.
At March 31, 1998, the Company had $36 million in borrowings outstanding under
the Credit Facility at interest rates ranging from 8.1% to 8.2%.
As disclosed in Part II, Item 5 -- Other Information, the Company recently
decided to transition from the computerized coding system used by GFS for
emergency room physician billing to manual coding. The Company does not expect
to incur any material extraordinary charges as a result of the transition from
the computerized coding system. However, there can be no assurance that any
third party claims or lost business relating to transition from, or
modifications previously made to, the GFS coding system will not have a material
adverse effect on the Company, including, without limitation, on the Company's
revenue, results of operations, financial condition or cash flow.
The Company believes that its cash flow, together with available borrowings
under the Credit Facility, will be sufficient to permit the Company to meet its
operating expenses and to service its debt requirements as they become due for
the foreseeable future, however, there can be no assurance that such results
will be achieved. The Company is a party to legal actions and government
investigations as described in Part II, Item 1 -- Legal Proceedings. There can
be no assurance that these actions or investigations will not have a disruptive
effect upon the operations of the business or that the resolution of these
actions and investigations will not have a material adverse effect on the
Company's liquidity or financial position. If the Company is unable to service
its indebtedness, it will be required to adopt alternative strategies, which may
include actions such as reducing or delaying capital expenditures, selling
assets, restructuring or refinancing its indebtedness or seeking additional
equity capital. There can be no assurance that any of these strategies could be
effected on satisfactory terms.
The degree to which the Company is leveraged could have the following
consequences: (i) the Company's ability to obtain additional financing in the
future for working capital, capital expenditures, acquisitions or other general
corporate purposes may be impaired; and (ii) a substantial portion of the
Company's cash flow from operations may be dedicated to the payment of principal
and interest on its indebtedness, thereby reducing the funds available to the
Company for its operations. In addition, the Credit Facility and the Indenture
contain financial and other restrictive covenants, including without limitation
those restricting the incurrence of additional indebtedness, the creation of
liens, the payment of dividends, sales of assets, capital expenditures, and
prepayments of indebtedness and, with respect to the Credit Facility only, those
requiring maintenance of minimum net worth, minimum EBITDA and minimum interest
coverage and limiting leverage.
OTHER MATTERS
It is possible that the Company's currently installed computer systems,
software products or other business systems, or those of the Company's
customers, vendors or resellers, working either alone or in conjunction with
other software or systems, will not accept input of, store, manipulate and
output dates for the years 1999, 2000 or thereafter without error or
interruption (commonly known as the "Year 2000" problem). The Company has
conducted a review of its business systems, including its computer systems, and
is querying its customers, vendors and resellers as to their progress in
identifying and addressing problems that their computer systems may face in
correctly interrelating and processing date information as the year 2000
approaches and is reached. Through its review, the Company has identified a
number of older legacy systems
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that will be abandoned in favor of a limited number of more efficient processing
systems, rather than make all the systems Year 2000 compliant. GFS's
computerized coding system is one of the legacy systems from which the Company
has determined to transition. The Company believes that it is on target to have
completed these system migration efforts with respect to its Physician Services
and Hospital Services businesses in the first quarter of 1999. Per-Se
Technologies products are scheduled to be Year 2000 compliant with releases due
out in the third quarter of 1998. The estimated cost of the Company's Year 2000
compliance efforts is $10 million to $15 million over 1998 and 1999, the
majority of which represents redirection of internal resources. However, there
can be no assurance that the Company will identify all such Year 2000 problems
in its computer systems or those of its customers, vendors or resellers in
advance of their occurrence or that the Company will be able to successfully
remedy any problems that are discovered. The expenses of the Company's efforts
to identify and address such problems, or the expenses or liabilities to which
the Company may become subject as a result of such problems, could have a
material adverse effect on the Company's business, financial condition and
results of operations. The revenue stream and financial stability of existing
customers may be adversely impacted by Year 2000 problems, which could cause
fluctuations in the Company's revenue. In addition, failure of the Company to
identify and remedy Year 2000 problems could put the Company at a competitive
disadvantage relative to companies that have corrected such problems.
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PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Other Matters."
The United States Attorney's Office for the Central District of California
is conducting an investigation of the billing and collection practices in two
offices of the Company's wholly owned subsidiary, MPSC, which offices are
located in Calabasas and Cypress, California (the "Designated Offices") (the
"California Investigation"). Medaphis first became aware of the California
Investigation on June 13, 1995 when search warrants were executed on the
Designated Offices and it and MPSC received grand jury subpoenas. Medaphis
received an additional grand jury subpoena on August 22, 1997, with which it is
complying. The subpoena requires, among other things, records of any audit or
investigative reports relating to the billing of payors globally for
radiological services during the period January 1, 1991 to date and any refunds
owed to or issued to payors with respect to such global billing reports in the
Company's various offices, including the Designated Offices.
Investigations such as the California Investigation can be initiated
following the commencement of qui tam litigation which is commenced under
applicable state and federal statutes and is maintained under court seal without
disclosure to the defendant. Under the applicable statutes, the United States
and the State of California may elect to intervene fully or partially in qui tam
litigation, and proceed with the action. The United States typically will
provide a defendant with the opportunity to enter into settlement negotiations
prior to the intervention of the United States in the matter. An application by
the United States to partially lift the seal in qui tam litigation in order to
make disclosure of the complaint available to the defendant often precedes such
settlement discussions.
On February 6, 1998, on application of the United States, the United States
District Court for the Central District of California issued an order partially
lifting the seal on the qui tam suit entitled United States of America and State
of California, ex rel. Relator I and Relator II v. Compmed Corporation, Medaphis
Corporation, Does 1 to 200, Inclusive. Civil Action No. 94-8158 LGB (kx). On
February 11, 1998, the United States provided Medaphis with a copy of the
Complaint, Substitution of Attorney, and Order which prohibited the Company from
making any use of the Complaint, including any public disclosure, other than for
the purposes of settlement negotiations, without further order of the Court. On
February 12, 1998, upon the joint application of Medaphis and the United States,
the Court issued an order modifying its February 6, 1998 order to allow Medaphis
to make public disclosures concerning the Complaint and its contents to the
extent that Medaphis determined such disclosures were required by applicable
securities laws, provided that such disclosure did not reveal the Relators'
identities.
According to the Complaint, filed December 20, 1995 by the Relators and
which contains allegations raised by them, the action is to recover damages and
civil penalties on behalf of the United States and the State of California
arising out of alleged false claims presented by the defendants on behalf of
their clients for payment under various state and federal insurance programs. No
charges or claims by the government have been made. The Complaint includes
causes of action under the Federal False Claims Act, 31 U.S.C. sec 3729 et seq.,
and the California False Claims Act, Cal. Gov't Code sec. 12650 et seq. The
Complaint also includes causes of action relating to Medaphis's termination of
Relator II, including a count under the state and federal whistleblower
protection statutes. The Complaint alleges overpayments of approximately
$20,500,000 together with treble damages and additional penalties based on
statutory civil penalties. The Complaint alleges that at least 50,000 separate
false claims were filed under federal programs and at least 8,000 separate false
claims were filed under state programs. The Complaint also alleges unspecified
compensatory, general and punitive damages on behalf of Relator II on his or her
employment claims. The allegations in the Complaint are limited to the office of
CompMed (acquired by Medaphis) in Culver City, California. Medaphis believes
that
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this Complaint relates to and concerns the California Investigation. Medaphis is
engaged in discussions with the United States and California, and intends to
pursue settlement discussions with the United States, the State of California,
and the Relators. The Company has agreed with the government to toll applicable
statutes of limitations through September 30, 1998, and anticipates executing an
agreement to that effect.
Although the Company continues to believe that the principal focus of the
California Investigation remains on the billing and collection practices in the
Designated Offices, there can be no assurance that the California Investigation
will not expand to other offices, that the California Investigation or the qui
tam suit will be resolved promptly, that additional subpoenas or search warrants
will not be received by Medaphis or MPSC or that the California Investigation or
the qui tam suit will not have a material adverse effect on the Company. The
Company recorded charges of $12 million in the third quarter of 1995, $2 million
in the fourth quarter of 1996 and a credit of $2.8 million in the third quarter
of 1997, solely for legal and administrative fees, costs and expenses it
anticipates incurring in connection with the California Investigation and the
putative class action lawsuits described below which were filed in 1995
following the Company's announcement of the California Investigation. The
charges are intended to cover only the anticipated expenses of the California
Investigation and the related lawsuits and do not include any provision for
fines, penalties, damages, assessments, judgments or sanctions that may arise
out of such matters.
In September 1996, MPSC became aware of apparently inadvertent computer
software errors affecting some of its electronic billing to carriers in the
State of California. The error relates to global billing (i.e., billing for the
professional and technical components of a service) for certain radiological
services under circumstances where the radiologist is only entitled to bill for
the professional component of such services. The Company believes such
inadvertent errors may have caused overpayments on certain claims submitted on
behalf of clients in the State of California. The full extent of overpayments by
carriers and beneficiaries, which impacts only certain managed care plans,
cannot be determined by the Company, but as notifications to the affected
clients and carriers occur, and refunds or offsets are sought, the Company may
be required to return to clients its portion of fees previously collected, and
may receive claims for alleged damages as a result of the error. The Company is
unable to estimate the possible range of loss, if any.
Following the announcement of the investigation by the United States
Attorney's Office for the Central District of California, Medaphis, various of
its current and former officers and directors and the lead underwriters
associated with Medaphis' public offering of Common Stock in April 1995, were
named as defendants in putative shareholder class action lawsuits filed in the
United States District Court for the Northern District of Georgia. In general,
these lawsuits alleged violations of the federal securities laws in connection
with Medaphis' public statements and filings under the federal securities acts,
including the registration statement filed in connection with Medaphis' public
offering of Common Stock in April 1995. On October 13, 1995, the named
plaintiffs in these lawsuits filed a consolidated class action complaint (the
"Consolidated Complaint"). On January 3, 1996, the court denied defendants'
motion to dismiss the Consolidated Complaint, which argued that the Consolidated
Complaint failed to state a claim upon which relief may be granted. On April 11,
1996, certain of the named plaintiffs to the Consolidated Complaint voluntarily
dismissed with prejudice all of their claims. As a result of these dismissals,
the Consolidated Complaint no longer contained any claims based on the
Securities Act and the Company's underwriters and outside directors were no
longer named as defendants. On June 26, 1996, the court denied plaintiffs'
motion to certify plaintiffs' class. On May 19, 1997, the plaintiffs and the
defendants entered into a stipulation and settlement agreement, pursuant to
which the parties agreed to settle this action on a class-wide basis for $4.75
million, subject to court approval (the "1995 Class Action Settlement"). The
1995 Class Action Settlement included the related putative class action lawsuit
filed in the Superior Court of Cobb County, Georgia, described more fully below.
On October 28, 1997 the court certified a class for settlement purposes,
approved the settlement and entered final judgment dismissing the action with
prejudice. One of Medaphis' directors' and officers' liability insurance
carriers has paid $3.7 million of the 1995 Class Action Settlement directly for
the benefit of the plaintiffs. The Company accrued approximately $1.2 million in
the quarter ended December 31, 1996 for the anticipated balance of the 1995
Class Action Settlement and to pay certain fees incident thereto. On November 6,
1997, the Company paid the remaining $1.05 million balance of the settlement.
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The Company learned in March 1997 that the United States Department of
Justice and the United States Attorney in Grand Rapids, Michigan are
investigating allegations concerning the Company's wholly owned subsidiary,
Gottlieb's Financial Services, Inc. ("GFS") (the "GFS Investigation"). Beginning
in February, 1998, the Office of the Inspector General of Health and Human
Services has requested information from GFS following an audit of a GFS client.
GFS has complied with those requests. In 1993, Medaphis acquired GFS, an
emergency room physician billing company located in Jacksonville, Florida, which
had developed a computerized coding system. In 1994, Medaphis acquired and
merged into GFS another emergency room physician billing company, Physician
Billing, Inc., located in Grand Rapids, Michigan. For each of the years ended
December 31, 1996 and 1997, GFS represented approximately 7% of Medaphis'
revenue. During those years, GFS processed approximately 5.6 million and 6.25
million claims, respectively, approximately 2 million and 2.3 million of which,
respectively, were made to government programs. The government has requested
that GFS voluntarily produce records, and GFS has complied with that request.
Although the precise scope and subject matter of the GFS Investigation are not
known to the Company, Medaphis believes that the GFS Investigation, which is
being participated in by federal law enforcement agencies having both civil and
criminal authority, involves GFS's billing procedures and the computerized
coding system used in Jacksonville and Grand Rapids to process claims and may
lead to claims of errors in billing. There can be no assurance that the GFS
Investigation will be resolved promptly or that the GFS Investigation will not
have a material adverse effect upon Medaphis. No charges or claims by the
government have been made. Currently, the Company has recorded charges of $2
million and $1 million in the second and third quarters of 1997, respectively,
solely for legal and administrative fees, costs and expenses in connection with
the GFS Investigation, which charges do not include any provision for fines,
penalties, damages, assessments, judgments or sanctions that may arise out of
this matter. The Company is in discussions with the United States and intends to
pursue settlement discussions with the United States.
In addition, the Company decided in April 1998 to transition from the
computerized coding system to manual coding. There can be no assurances that the
Company will not be subject to customer complaints, claims and contract
terminations as a result of the coding system transition or modifications
previously made to the system. See "Management's Discussion and Analysis of
Results of Operations -- Liquidity and Capital Resources."
The Company and its clients from time to time have received, and the
Company anticipates that they will receive in the future, official inquiries
(including subpoenas, search warrants, as well as informal requests) concerning
particular billing and collection practices related to certain subsidiaries of
the Company and its many clients.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its then current and
former officers, one of whom was also a director, were named as defendants in
nineteen putative shareholder class action lawsuits filed in the United States
District Court for the Northern District of Georgia. On November 22, 1996, the
plaintiffs in these lawsuits filed a Consolidated Amended Class Action
Complaint. On February 3, 1997, the plaintiffs filed a Consolidated Second
Amended Complaint (the "Consolidated Second Amended Complaint"). In general, the
Consolidated Second Amended Complaint alleged violations of the federal
securities laws in connection with Medaphis' filings under the federal
securities acts and public disclosures. The Consolidated Second Amended
Complaint was brought on behalf of a class of persons who purchased or otherwise
acquired Medaphis Common Stock between February 6, 1996 and October 21, 1996.
The Consolidated Second Amended Complaint also asserted claims on behalf of a
sub-class of all persons who acquired Medaphis Common Stock pursuant to the
merger between Medaphis and HDS. The Consolidated Second Amended Complaint
sought compensatory and rescissory damages, as well as fees, interest and other
costs. On February 14, 1997, the defendants moved to dismiss the Consolidated
Second Amended Complaint in its entirety. On May 27, 1997, the court denied
defendants' motion to dismiss. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Other Matters."
The parties entered into a Stipulation and Agreement of Settlement dated
December 15, 1997 (the "Stipulation") to settle the 1996 putative shareholder
class action litigation which is the subject of the Consolidated Second Amended
Complaint on a class-wide basis for $20 million in cash (to be paid by the
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Company's directors' and officers' liability insurance carriers), 3,955,556
shares of Medaphis Common Stock, and warrants to purchase 5,309,523 shares of
Medaphis Common Stock at $12 per share for a five-year period. The Stipulation
also includes, among other things: (i) a complete release of claims against the
Company, the individual defendants and certain related persons and entities; and
(ii) certain anti-dilution rights in favor of plaintiffs with respect to certain
future issuances of shares of Medaphis Common Stock or warrants or rights to
acquire Medaphis Common Stock to settle existing civil litigation and claims
pending or asserted against the Company, subject to a 5.0 million share basket
below which there will be no dilution adjustments. The Stipulation also contains
other conditions including, but not limited to, consent and approval of the
Company's insurance carriers and the insurance carriers' payment of the cash
portion of the settlement, and the final approval of the settlement by the
court. On December 15, 1997, the court granted preliminary approval to the
settlement and conditionally certified the classes for settlement purposes only.
The Company's insurance carriers consented to the settlement and funded the $20
million cash portion. On March 25, 1998, the Court granted final approval of the
settlement and entered final judgment dismissing the action.
The Company recorded a $52.5 million charge in the quarter ended September
30, 1997 in connection with the Stipulation. This charge is comprised of the
following: (i) $30.2 million representing the original 3,355,556 shares of
common stock valued at the fair value of a common share on the date that the
material terms of the agreement were reached or approximately $9 per share and
(ii) $22.3 million representing the fair value of the warrants on the date the
material terms of the agreement were reached, valued using the Black-Scholes
option pricing model with the following assumptions: expected life -- 5 years,
risk free interest rate -- 6%, dividend rate -- 0% and expected volatility
factor -- 60%. No accounting recognition was required for the additional 600,000
shares to be issued pursuant to the agreement as these shares represent the
maximum number of contingent shares that were issuable based on certain stock
price contingencies during the ten day period prior to October 11, 1997. As a
result of the actual decline in the Company's stock price during such period,
the Stipulation required that the maximum number of contingent shares be
awarded; however, no additional accounting charge is required in connection with
the award of such contingent shares. Although the exact timing of the issuance
of the 3,955,556 shares is not known, the Company does not expect such shares to
be issued before the second quarter of 1998. Additionally, no accounting
recognition has been afforded the cash portion of the Stipulation as this amount
is the responsibility of the insurance carriers. Such amount has been paid
directly to an escrow account for the benefit of the plaintiffs by the insurance
carriers. The Company has classified the entire $52.5 million liability
associated with the settlement as noncurrent as such obligation will be settled
with equity (common stock and warrants) rather than current assets as the exact
timing of such settlement is not determinable.
On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit
Sharing Plan filed a shareholder derivative lawsuit in the United States
District Court for the Northern District of Georgia alleging that certain of
Medaphis' current and former directors breached their fiduciary duties, were
grossly negligent, and breached various contractual obligations to Medaphis by
allegedly failing to implement and maintain an adequate system of internal
accounting controls, allowing Medaphis to commit securities law violations and
damaging Medaphis' reputation. The plaintiff seeks unspecified compensatory
damages and costs on behalf of the Company. On January 28, 1997, Medaphis and
certain individual defendants filed a motion to dismiss the complaint. On
February 11, 1997, the plaintiff filed an amended complaint adding as
defendants, additional current and former directors and officers of Medaphis. On
April 23, 1997, Medaphis and all other defendants filed a motion to dismiss the
amended complaint, which motion is still pending. The Company is unable to
estimate a possible range of loss.
On November 7, 1996, Health Systems International, Inc. filed suit in the
Superior Court for the State of California, County of Los Angeles against
Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed
Medaphis directors, officers and employees. Generally, this lawsuit alleges that
the defendants violated federal and California securities laws and common law
by, among other things, making material misstatements and omissions in public
and private disclosures in connection with the acquisition of HDS. Plaintiff
seeks rescissory, compensatory and punitive damages in excess of $100 million,
rescission, injunctive relief and costs. The Company is unable to estimate a
possible range of loss. On January 10, 1997, the
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defendants filed a demurrer to the complaint. On February 5, 1997 the Court
overruled defendants' demurrer. On March 18, 1997, the court denied the
plaintiff's motion for a preliminary injunction. On July 16, 1997, plaintiff
filed an amended complaint adding several new parties, including current and
former directors and former and current officers of Medaphis. All of the newly
added defendants have responded to the amended complaint. As a result of the
Company's restatement of its fiscal 1995 financial statements, the Company may
not be able to sustain a defense to strict liability on certain claims under the
Securities Act, but the Company believes that it has substantial defenses to the
alleged damages relating to such Securities Act claims.
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberger against Steven G. Papermaster, Robert E. Pickering, Jr., David S.
Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and
Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division,
Essex County, State of New Jersey. The alleged class consists of persons and
entities whose options to purchase BSG Corporation ("BSG") common stock were
converted to Medaphis stock options in connection with Medaphis' acquisition of
BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary
duties of candor, loyalty and fair dealing and negligence against the BSG
defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud
and deceit against the Medaphis defendants (Medaphis and Brown). Plaintiffs seek
unspecified compensatory and punitive damages, as well as fees, interest and
other costs. The Company is unable to estimate a possible range of loss. On
April 18, 1997, the Medaphis defendants and BSG defendants filed motions to
dismiss the complaint. On or about July 3, 1997, in lieu of responding to these
motions, the plaintiffs filed an amended complaint, adding new claims under the
Securities Act and common law and new parties, including former officers of
Medaphis, Medaphis' former outside auditors and BSG. On or about October 29,
1997 all defendants filed motions to dismiss the amended complaint. On May 12,
1998, the court ruled in favor of defendants on the motions, dismissing all of
plaintiffs' claims with prejudice and without leave to amend. The Company
expects that the judge will sign an order to that effect, at which time
statutory appeal periods will begin to run.
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control made a demand for indemnification under an indemnification
agreement executed by Medaphis in connection with its acquisition of BSG in May
1996. The indemnification demand claims damages of $35 million (the maximum
damages payable by Medaphis under the indemnification agreement) for the alleged
breach by Medaphis of its representations and warranties made in the merger
agreement between Medaphis and BSG. On December 31, 1996, Medaphis entered into
a standstill and tolling agreement with Mr. Noorda, Mr. Papermaster and other
former BSG shareholders, which, as extended, runs through June 30, 1998. The
standstill and tolling agreement extends any applicable statute of limitations
for claims by the former BSG shareholders and provides that neither party will
file suit against the other prior to the expiration of the agreement.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity Trust
and the Paulanne H. Thacker Retained Annuity Trust filed a complaint against the
Company and Randolph G. Brown in the United States District Court for the
Southern District of New York arising out of Medaphis' acquisition of MMS in
December of 1995. The complaint is brought on behalf of all former shareholders
of MMS who exchanged their MMS holdings for unregistered shares of Medaphis
Common Stock. In general, the complaint alleges both common law fraud and
violations of the federal securities laws in connection with the merger. In
addition, the complaint alleges breaches of contract relating to the merger
agreement and a registration rights agreement, as well as tortious interference
with economic advantage. The plaintiffs seek rescission of the merger agreement
and the return of all MMS shares, as well as damages in excess of $100 million.
The Company is unable to estimate a possible range of loss. Additionally,
plaintiffs seek to void various non-compete covenants and contract provisions
between Medaphis and plaintiffs. Defendants have filed a motion to dismiss the
complaint. Discovery has been stayed pending resolution of the motion to
dismiss.
On August 12, 1997, George D. Stickel filed a putative class action
complaint against Medaphis, Randolph W. Brown, Michael R. Cote and James S.
Douglass in the United States District Court for the Northern District of
Georgia. The complaint asserts claims under the Exchange Act on behalf of all
persons
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who purchased or otherwise acquired Medaphis Common Stock between February 6,
1996 and October 21, 1996. The complaint also asserts claims under the
Securities Act on behalf of a subclass consisting of all persons and entities
who, in connection with the merger of the Company and HDS, acquired options to
purchase shares of Medaphis Common Stock between February 6, 1996 and October
21, 1996. The complaint seeks rescission, unspecified rescissory and
compensatory damages, and interest, fees and other costs. The Company is unable
to estimate a possible range of loss.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies. To date,
these other stockholders have not filed lawsuits.
On January 8, 1997, the Commission notified the Company that it was
conducting a formal, non-public investigation into, among other things, certain
trading and other issues related to Medaphis' August 14, 1996 and October 22,
1996 announcements of the Company's loss for the quarter ending September 30,
1996 and its restated consolidated financial statements for the three months and
year ending December 31, 1995 and its restated unaudited balance sheets as of
March 31, 1996, and June 30, 1996. In addition, the Company believes that the
Commission is investigating the Company's restatement of its interim financial
statements for each quarter of 1996 and the November 19, 1997 and December 23,
1997 restatements of the Company's financial statements. The Company intends to
cooperate fully with the Commission in its investigation.
Although the Company believes that it has meritorious defenses to the
claims of liability or for damages in the actions against and written demands
placed upon the Company, there can be no assurance that additional lawsuits will
not be filed against the Company. Further, there can be no assurance that the
lawsuits, the written demands and the pending governmental investigations will
not have a disruptive effect upon the operations of the business, that the
written demands, the defense of the lawsuits and the pending investigations will
not consume the time and attention of the senior management of the Company, or
that the resolution of the lawsuits, the written demands and the pending
governmental investigations will not have a material adverse effect upon the
Company, including, without limitation, the Company's results of operations,
financial position and cash flow. Because the Company is unable to estimate a
range of loss with respect to any of the pending claims, the Company has not
accrued any amounts for any contingent liability with respect to such claims.
ITEM 5. OTHER MATTERS
In 1993, the Company acquired GFS, an emergency room physician billing
company, which had developed a computerized coding system. In 1994, the Company
acquired and merged into GFS another emergency room physician billing company,
Physician Billing, Inc., located in Grand Rapids, Michigan, which was then
migrated to the GFS coding system.
The GFS coding system was developed in-house at GFS in the 1980s using the
COBOL computer language. The program and its source code were not extensively
documented. In addition, the program was originally written to conform with
then-existing government billing regulations, which have since been changed. At
the time of these changes, and thereafter, the Company undertook some revisions
to the coding system. In March 1997, Medaphis learned that GFS was the target of
a government investigation. Although the precise scope and subject matter of the
government investigation are not known to the Company, Medaphis believes that
the investigation -- which is being participated in by several agencies having
administrative, civil and/or criminal authority -- involves GFS billing
procedures and the coding system used in both Grand Rapids and Jacksonville. See
Note 2 of Notes to Consolidated Financial Statements. Promptly after the Company
became aware of the GFS Investigation, the Company expanded its compliance
efforts with respect to the GFS coding system and undertook a substantial
process review using both internal resources and outside consultants.
The Company decided in April 1998 to transition GFS from the computerized
coding system to manual coding. The decision to terminate use of the coding
system was based on several factors. These included the high cost of continuing
management, compliance and quality assurance oversight and the failure to meet
the Company's current efficiency and productivity targets. In addition, the
system will not comply with anticipated
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revisions to government billing regulations, and is not "Year 2000"compliant.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Other Matters." During the transition period, which should be
completed by the fall of 1998, GFS will continue to utilize the coding system in
conjunction with an increasing volume of manual coding and the Company will
continue to support GFS with its compliance and quality assurance programs in
support of both the coding system and manual coding.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
3.1 -- Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.1 to
Registrant's Registration Statement on Form S-1, File No.
33-42216)
3.2 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3 to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1993)
3.3 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.3 to
Registrant's Registration Statement on Form 8-A/A, filed on
May 22, 1996)
3.4 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 4.4 to 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 3.6 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997)
4.1 -- Credit Agreement dated February 13, 1998, among Registrant,
as the Borrower, various financial institutions from time to
time parties thereto, as the Lenders, DLJ Capital Funding,
Inc., as the Syndication Agent for the Lenders, and Wachovia
Bank, N.A., as the Administrative Agent for the Lenders
(including form of note) (incorporated by reference to
Exhibit 10.1 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.2 -- Subsidiary Guaranty dated February 20, 1998, among the
domestic subsidiaries of Registrant and Wachovia Bank, N.A.,
as Administrative Agent (incorporated by reference to
Exhibit 10.2 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.3 -- Indenture dated as of February 20, 1998, among Registrant,
as Issuer, the Subsidiary Guarantors named in the Indenture
and State Street Bank and Trust Company, as Trustee
(including form of note) (incorporated by reference to
Exhibit 10.3 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.4 -- Registration Rights Agreement dated as of February 20, 1998,
among Registrant, the Subsidiary Guarantors, and Donaldson
Lufkin & Jenrette Securities Corporation (incorporated by
reference to Exhibit 4.15 to Registrant's Registration
Statement on Form S-4, File No. 333-47409)
10.1 -- Fifth Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Non-Executive Employees (incorporated by
reference to Exhibit 10.28 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997)
10.2 -- Third Amendment to Medaphis Corporation Employee Stock
Purchase Plan (incorporated by reference to Exhibit 10.33 to
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997)
10.3 -- Fourth Amendment to the Amended and Restated Medaphis
Employees' Retirement Savings Plan (incorporated by
reference to Exhibit 10.39 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997)
25
28
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
10.4 -- Employment Agreement dated January 25, 1998 between
Registrant and Allen W. Ritchie (incorporated by reference
to Exhibit 10.69 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997)
10.5 -- Employment Agreement dated January 27, 1998 between
Registrant and Kevin P. Castle
11 -- Statement regarding Computation of Earnings Per Share
27 -- Financial Data Schedule (for SEC use only)
99.1 -- Safe Harbor Compliance Statement for Forward-Looking
Statements
(B) Reports on Form 8-K
The Company has filed the following reports on Form 8-K during the quarter
ended March 31, 1998:
FINANCIAL
STATEMENTS
ITEM REPORTED FILED DATE OF REPORT FILE DATE
- ------------- ---------- -------------- ---------
Establishment of $210 million term loan
to refinance existing bank facility;
restatement of Registrant's financial
statements to reflect treatment of
acquisition of Medical Management
Sciences, Inc. as a purchase rather
than a pooling of interests; release of
unqualified audit opinion of Price
Waterhouse............................. Yes(1) December 23, 1997 January 8, 1998
Underwritten commitment for $100 million
revolving credit facility and
announcement of certain management
changes................................ No January 26, 1998 January 28, 1998
Partial unsealing of QuiTam complaint
filed against Registrant on December
20, 1995............................... No February 11, 1998 February 13, 1998
Announcement of planned closing of
financing package...................... No February 17, 1998 February 18, 1998
Announcement of closing of $275 million
financing package...................... No February 13, 1998 March 2, 1998
- ---------------
(1) Audited consolidated financial statements for the nine months ended
September 30, 1997 and the two years ended December 31, 1996.
26
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEDAPHIS CORPORATION
(Registrant)
Date: May 14, 1998
By: /s/ DAVID E. MCDOWELL
------------------------------------
David E. McDowell
Chairman and Chief Executive Officer
By: /s/ MARK P. COLONNESE
------------------------------------
Mark P. Colonnese
Senior Vice President and
Chief Financial Officer
(Principal Accounting Officer)
27
30
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
3.1 -- Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.1 to
Registrant's Registration Statement on Form S-1, File No.
33-42216)
3.2 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3 to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1993)
3.3 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.3 to
Registrant's Registration Statement on Form 8-A/A, filed on
May 22, 1996)
3.4 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 4.4 to 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 3.6 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997)
4.1 -- Credit Agreement dated February 13, 1998, among Registrant,
as the Borrower, various financial institutions from time to
time parties thereto, as the Lenders, DLJ Capital Funding,
Inc., as the Syndication Agent for the Lenders, and Wachovia
Bank, N.A., as the Administrative Agent for the Lenders
(including form of note) (incorporated by reference to
Exhibit 10.1 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.2 -- Subsidiary Guaranty dated February 20, 1998, among the
domestic subsidiaries of Registrant and Wachovia Bank, N.A.,
as Administrative Agent (incorporated by reference to
Exhibit 10.2 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.3 -- Indenture dated as of February 20, 1998, among Registrant,
as Issuer, the Subsidiary Guarantors named in the Indenture
and State Street Bank and Trust Company, as Trustee
(including form of note) (incorporated by reference to
Exhibit 10.3 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.4 -- Registration Rights Agreement dated as of February 20, 1998,
among Registrant, the Subsidiary Guarantors, and Donaldson
Lufkin & Jenrette Securities Corporation (incorporated by
reference to Exhibit 4.15 to Registrant's Registration
Statement on Form S-4, File No. 333-47409)
10.1 -- Fifth Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Non-Executive Employees (incorporated by
reference to Exhibit 10.28 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997)
10.2 -- Third Amendment to Medaphis Corporation Employee Stock
Purchase Plan (incorporated by reference to Exhibit 10.33 to
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997)
10.3 -- Fourth Amendment to the Amended and Restated Medaphis
Employees' Retirement Savings Plan (incorporated by
reference to Exhibit 10.39 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997)
10.4 -- Employment Agreement dated January 25, 1998 between
Registrant and Allen W. Ritchie (incorporated by reference
to Exhibit 10.69 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997)
10.5 -- Employment Agreement dated January 27, 1998 between
Registrant and Kevin P. Castle
11 -- Statement regarding Computation of Earnings Per Share
27 -- Financial Data Schedule (for SEC use only)
99.1 -- Safe Harbor Compliance Statement for Forward-Looking
Statements