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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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
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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.
SHARES OUTSTANDING
TITLE OF CLASS AT NOVEMBER 6, 1998
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Common Stock $0.01 Par Value................................ 78,731,387 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 SEPTEMBER 30, 1998
PAGE
----
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements..............................
Consolidated Balance Sheets as of September 30, 1998
and December 31, 1997.................................
Consolidated Statements of Operations for the three and
nine months ended September 30, 1998 and 1997.........
Consolidated Statements of Cash Flows for the nine
months ended September 30, 1998 and 1997..............
Notes to Consolidated Financial Statements.............
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations....................
Part II: OTHER INFORMATION
Item 1: Legal Proceedings.................................
Item 6: Exhibits and Reports on Form 8-K..................
Index to Exhibits.........................................
---------------------
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. FIFTEEN 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)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
ASSETS
Current Assets:
Cash...................................................... $ 10,768 $ 15,341
Restricted cash........................................... 221 2,218
Accounts receivable, billed............................... 74,806 84,506
Accounts receivable, unbilled............................. 53,565 63,553
Other..................................................... 8,315 11,716
--------- --------
Total current assets.............................. 147,675 177,334
Property and equipment...................................... 58,360 59,694
Deferred income taxes....................................... -- 60,857
Intangible assets........................................... 49,851 462,510
Net assets of discontinued operation........................ 91,249 90,865
Other....................................................... 11,106 9,951
--------- --------
$ 358,241 $861,211
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 8,671 $ 9,941
Accrued compensation...................................... 29,075 31,869
Accrued expenses.......................................... 42,751 50,681
Accrued litigation settlement............................. 12,500 --
Current portion of long-term debt......................... 1,977 11,432
Deferred income taxes..................................... 2,392 2,392
--------- --------
Total current liabilities......................... 97,366 106,315
Long-term debt.............................................. 222,068 189,259
Accrued litigation settlements.............................. 28,875 52,500
Other obligations........................................... 3,983 11,356
--------- --------
Total liabilities................................. 352,292 359,430
--------- --------
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 78,679 in 1998
and 73,204 in 1997..................................... 787 732
Common stock, non voting, $0.01 par value, 600 authorized
in 1998 and 1997; none issued.......................... -- --
Paid-in capital........................................... 739,630 678,998
Accumulated deficit....................................... (734,468) (177,949)
--------- --------
Total stockholders' equity........................ 5,949 501,781
--------- --------
$ 358,241 $861,211
========= ========
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1998 1997 1998 1997
--------- -------- --------- ---------
Revenue............................................ $ 101,309 $111,209 $ 328,410 $ 368,401
--------- -------- --------- ---------
Salaries and wages................................. 77,294 80,369 222,365 237,799
Other operating expenses........................... 42,100 41,747 105,563 115,807
Depreciation....................................... 6,291 6,625 19,867 19,335
Amortization....................................... 5,245 5,297 16,471 16,493
Interest expense, net.............................. 6,196 7,241 18,410 19,411
Intangible asset impairment........................ 390,641 -- 390,641 --
Litigation settlements............................. 19,500 52,500 41,375 52,500
Restructuring and other charges.................... 3,784 13,837 5,780 16,661
--------- -------- --------- ---------
Total expenses........................... 551,051 207,616 820,472 478,006
--------- -------- --------- ---------
Loss before income taxes........................... (449,742) (96,407) (492,062) (109,605)
Income tax expense (benefit)....................... 67,619 (14,721) 62,595 (19,766)
--------- -------- --------- ---------
Loss from continuing operations.................... (517,361) (81,686) (554,657) (89,839)
Income from discontinued operation, net of tax..... 1,356 477 3,687 4,306
Extraordinary items, net of tax.................... -- -- (5,557) 76,391
--------- -------- --------- ---------
Net loss................................. $(516,005) $(81,209) $(556,527) $ (9,142)
========= ======== ========= =========
Basic and diluted net income (loss) per common
share:
Loss from continuing operations.................... $ (6.58) $ (1.12) $ (7.26) $ (1.24)
Income from discontinued operation, net of tax..... 0.02 0.01 0.05 0.06
Extraordinary items, net of tax.................... -- -- (0.07) 1.05
--------- -------- --------- ---------
Net loss........................................... $ (6.56) $ (1.11) $ (7.28) $ (0.13)
========= ======== ========= =========
Weighted average shares outstanding................ 78,655 72,942 76,442 72,542
========= ======== ========= =========
See notes to consolidated financial statements.
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MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS
ENDED
SEPTEMBER 30,
---------------------
1998 1997
--------- ---------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................... $(556,527) $ (9,142)
Less: income from discontinued operation.................... 3,687 4,306
--------- ---------
(560,214) (13,448)
Adjustments to reconcile net loss, excluding the
discontinued operation, to net cash used for operating
activities:
Depreciation and amortization............................. 36,338 35,828
Gain on sale of HRI, net of tax........................... -- (76,391)
Impairment losses on long-lived assets.................... 390,641 8,661
Early extinguishment of debt.............................. 9,231 --
Deferred income taxes..................................... 60,857 (15,905)
Changes in assets and liabilities, excluding effects of
acquisitions:
Restricted cash........................................... 2,500 799
Accounts receivable, billed............................... 9,700 (3,343)
Accounts receivable, unbilled............................. 9,988 8,704
Accounts payable.......................................... (1,270) 5,580
Accrued compensation...................................... (2,794) 8,612
Accrued expenses.......................................... (9,408) (15,414)
Accrued litigation settlements............................ 41,375 52,500
Other, net................................................ 6,647 (3,334)
--------- ---------
Net cash used for operating activities............. (6,409) (7,151)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment......................... (19,331) (9,700)
Software development costs.................................. (3,217) (4,121)
Proceeds from sale of HRI, net.............................. -- 126,375
Other....................................................... 2,164 (1,439)
--------- ---------
Net cash (used for) provided by investing
activities........................................ (20,384) 111,115
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from employee stock purchase plan.................. 1,446 1,286
Proceeds from the exercise of employee stock options........ 5,683 5,522
Proceeds from borrowings.................................... 339,467 98,992
Principal payments of long-term debt........................ (315,248) (203,329)
Deferred financing costs.................................... (12,432) (3,008)
--------- ---------
Net cash provided by (used for) financing
activities........................................ 18,916 (100,537)
--------- ---------
CASH:
Net change.................................................. (7,877) 3,427
Net cash provided by (used for) discontinued operation...... 3,304 (4,783)
Balance at beginning of period.............................. 15,341 5,403
--------- ---------
Balance at end of period.................................... $ 10,768 $ 4,047
========= =========
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest.................................................. $ 13,926 $ 12,503
Income taxes.............................................. 1,482 10,347
Non-cash investing and financing activities:
Additions to capital lease obligations.................... 42 --
Issuance of stock warrants................................ -- 4,969
Issuance of Common Stock upon funding of litigation
settlement.............................................. 52,500 --
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 (as amended by Form 10-K/A filed June 22, 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.
As discussed more thoroughly in Note 2, the Hospital Services segment has
been presented as a discontinued operation for all periods presented.
NOTE 2 -- DISCONTINUED OPERATION
On October 15, 1998, the Company entered into a definitive agreement to
sell its Hospital Services segment, which provides business management services
and bad debt collections to approximately 1,200 hospital clients, to NCO Group,
Inc. for up to $117.5 million. In accordance with the agreement, $107.5 million
is payable at closing and an additional purchase price adjustment of up to $10.0
million is payable subject to the achievement of various operational targets in
1999. The sale is subject to regulatory approval, but is expected to be
consummated by December 15, 1998.
Pursuant to Accounting Principles Board ("APB") Opinion No. 30, "Reporting
the Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," the consolidated financial statements of the Company have been
presented to reflect the Hospital Services segment as a discontinued operation.
The net operating results of the segment have been reported in the Consolidated
Statements of Operations as "Income from discontinued operation"; the net assets
have been reported in the Consolidated Balance Sheets as "Net assets of
discontinued operation"; and the net cash flows have been reported in the
Consolidated Statements of Cash Flows as "Net cash provided by (used for)
discontinued operation".
Summarized financial information for the discontinued operation is as
follows:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------- -----------------
1998 1997 1998 1997
------- ------- ------- -------
(IN THOUSANDS)
Revenue................................................... $29,124 $23,840 $81,081 $72,410
Income from discontinued operation, net of tax of $943,
$331, $2,562 and $2,993................................. 1,356 477 3,687 4,306
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(IN THOUSANDS)
Current assets.............................................. $ 36,982 $ 35,102
Total assets................................................ 105,573 103,681
Current liabilities......................................... 14,154 12,624
Total liabilities........................................... 14,324 12,816
Net assets of discontinued operation........................ 91,249 90,865
NOTE 3 -- INTANGIBLE ASSET IMPAIRMENT
At September 30, 1998, the Company recorded an intangible asset impairment
charge of $390.6 million to adjust the intangible assets of the Physician
Services segment to their fair value. As previously disclosed, management
continually monitors its results of operations and other developments within the
industry to adjust its cash flow forecast, as necessary, to determine if an
adjustment is necessary to the carrying value of the Company's intangible
assets.
During the third quarter of 1998, management of the Company believed there
were events and changes in circumstances that warranted a re-assessment as to
whether the carrying amount of the intangible assets for the Physician Services
segment was still recoverable. These events included: (i) a continual increase
in the segment's operating losses due primarily to client losses; (ii)
significant litigation charges within the Physician Services segment; and (iii)
absence of revenue growth within the Physician Services segment. Therefore, in
accordance with applicable accounting rules, management prepared a 40 year
undiscounted cash flow analysis to determine if these intangible assets were
still recoverable. Management prepared the analysis with assumptions that
reflected its current outlook on the business. In all instances, management
believes the assumptions inherent in the analysis were reasonable and
supportable. The following key assumptions were used in management's
undiscounted cash flow analysis: (i) revenue was forecasted to decline over the
next five years and then remain flat; (ii) EBITDA margin was forecasted to
continue to decrease in 1999, increase slightly over the following four years
and then stabilize at a moderate margin over the remaining life of the asset;
and (iii) capital spending would be maintained in the range of 3% of revenue.
Since the undiscounted cash flow model showed an impairment of the Company's
long-lived assets, the Company used a discounted cash flow model to measure the
fair value of these long-lived assets which was consistent with the Company's
policy. The fair value calculation determined that the fair value of the
long-lived assets was approximately $63 million. The Company wrote-off the value
of its longest lived assets first, which resulted in the write-off of all of the
Physician Services segment's goodwill and a portion of the value of its client
lists. As a result of this impairment charge, the Company reduced the estimated
useful life of its remaining intangible assets for the Physician Services
segment to 10 years.
NOTE 4 -- 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
conducted an investigation of the billing and collection practices in two
offices of the Company's wholly owned subsidiary, Medaphis Physician Services
Corporation ("MPSC"), which offices are located in Calabasas and Cypress,
California (the "Designated Offices") (the "California Investigation"). Medaphis
first became aware of the California Investigation on June 13, 1995 when search
warrants were executed on the Designated Offices and it and MPSC received grand
jury subpoenas. Medaphis received an additional grand jury subpoena on August
22,
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MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
1997, with which it complied. The subpoena required, 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 appropriate state or states may elect to intervene fully or partially in
qui tam litigation and proceed with the action.
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) (the
"Complaint"). 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 disclosures 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.
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' termination of Relator II, including a count under the state and
federal whistleblower protection statutes.
The Company recorded charges of $12 million in the third quarter of 1995
solely for legal and administrative fees, costs and expenses it anticipates
incurring in connection with the California Investigation and the putative class
action lawsuits which were filed in 1995 following the Company's announcement of
the California Investigation. Since the third quarter of 1995, the Company has
periodically adjusted this reserve, as necessary, including a $0.3 million
increase in the second quarter of 1998. Such adjustments to the reserve have
aggregated to a net reduction of $0.5 million. The reserve currently covers only
the anticipated expenses of the California Investigation and the related
lawsuits and does not include any provision for fines, penalties, damages,
assessments, judgments or sanctions that may arise out of such matters.
During the third quarter of 1998, the Company reached an agreement to
settle with the United States, the State of California and the Relators on all
claims related to the California Investigation and underlying qui tam
litigation. Such settlements provide for the payment by the Company of $3.6
million in the aggregate, the dismissal of all pending proceedings against the
Company and the release of various other claims arising out of the California
Investigation. As a part of these settlements, CompMed, Inc., a company acquired
by the Company in 1992, pled guilty to a single criminal count.
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, which primarily impacts certain managed care
plans, 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
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9
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
overpayments by carriers and beneficiaries, 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.
The Company learned in March 1997 that the United States Department of
Justice and the United States Attorney in Grand Rapids, Michigan were
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 requested that
GFS voluntarily produce records, and GFS complied with that request. The Company
recorded charges of $2 million and $1 million in the second and third quarters
of 1997, respectively, and $0.7 million and $0.1 million in the second and third
quarters of 1998, 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 has determined it is in its best interest to settle such
claims. The Company has reached an agreement in principle with the United States
to settle the matters related to the GFS Investigation on an ability to pay
basis. The settlement, which is subject to definitive documentation, requires
the Company to pay to the United States and the various states a total of $15
million, of which $8 million will be paid within 10 days of the execution of a
definitive Settlement Agreement among the parties, with the balance of $7
million being paid in eight equal quarterly installments over 1999 and 2000. The
deferred portion of the settlement payment will bear interest at the one year
Treasury Bill rate. The Settlement Agreement will provide for the dismissal with
prejudice of claims against the Company and the release by the United States of
civil and administrative claims arising out of the emergency room billing of
government programs services provided by GFS from 1993 through the date of the
Settlement Agreement.
The Company recorded a litigation settlement charge of $19.5 million in the
quarter ended September 30, 1998 in connection with the settlement of the
California Investigation and the agreement in principle with respect to the GFS
Investigation.
In connection with the settlement of the California and GFS Investigations,
the Company entered into a Corporate Integrity Agreement with the Office of the
Inspector General of the Department of Health and Human Services. This
Agreement, which has a term of sixty-five months, provides that the government
will not seek to exclude the Company from participation in governmental health
care programs based on the conduct alleged in the California and GFS
Investigations and requires the Company to continue its existing compliance
program, augmented by an annual third party review and additional reporting
requirements.
In addition, the Company decided in April 1998 to transition GFS from a
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."
7
10
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
The Company and its clients from time to time have received, and the
Company anticipates that they will receive in the future, official inquiries
(including subpoenas, search warrants, as well as informal requests) concerning
particular billing and collection practices related to certain subsidiaries of
the Company and its many clients.
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 "Derivative Suit"). The plaintiff sought
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 was denied without prejudice. The
parties entered into a Stipulation and Settlement Agreement dated June 26, 1998
(the "Derivative Stipulation") to settle the Derivative Suit. The Derivative
Stipulation provides for the enactment of procedures for governance of the Audit
Committee of the Board of Directors and for such attorney's fees and expenses as
may be awarded by the court in an amount not to exceed $250,000 (to be paid by
the Company's directors' and officers' liability insurance carrier). On
September 29, 1998, the court granted final approval to the settlement and
ordered all claims dismissed.
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 Health Data
Sciences ("HDS"). Plaintiff seeks rescissory, compensatory and punitive damages
in excess of $100 million, rescission, injunctive relief and costs. On January
10, 1997, the defendants filed a demurrer to the complaint. On February 5, 1997,
the Court overruled defendants' demurrer. On March 18, 1997, the court denied
the plaintiff's motion for a preliminary injunction. On July 16, 1997, plaintiff
filed an amended complaint adding several new parties, including current and
former directors and former and current officers of Medaphis. All of the newly
added defendants have responded to the amended complaint. As a result of the
Company's 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. The Company is unable to
estimate a possible range of loss.
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. 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 independent accountants and BSG.
On or about October 29, 1997, all
8
11
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
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. On May 15, 1998, the Judge
signed an order to that effect. The plaintiffs have appealed from this order,
and that appeal is pending. The Company is unable to estimate a possible range
of loss.
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control (collectively, the "BSG Principals") 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 March 31, 1999. 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. In June 1998, the Company and
the BSG Principals reached an agreement in principle to settle the claims made
on behalf of the former BSG shareholders in exchange for approximately 3.2
million shares of Medaphis Common Stock, subject to negotiation and definitive
documentation of other terms and conditions of the settlement. The Company
recorded a litigation settlement charge of $21.3 million in the quarter ended
June 30, 1998 in connection with this agreement in principle. The charge
reflects 3.2 million shares of Medaphis Common Stock valued at the fair value
per share on the date on which the material terms of the agreement in principle
was reached. The Company classified the entire $21.3 million liability
associated with the proposed settlement as noncurrent since such obligation will
be settled with Common Stock rather than current assets and the exact timing of
the payments of claims pursuant to such settlement is not determinable.
On November 9, 1998, the parties entered into a letter of intent with
respect to the settlement of the BSG Principals' claims. The terms of the letter
of intent, which vary from the previously announced agreement in principle,
provide for the payment by the Company to the BSG Principals of 4.5 million
shares of the Company's Common Stock and $2.5 million in cash, to be funded by
the Company's officers and directors' and officers' liability insurance. The
settlement is subject to the consent and approval of the Company's insurer and
its funding of the cash portion of the settlement. Based on the price of the
Company's Common Stock on the date of the letter of intent, the settlement would
result in a charge of approximately $17.7 million, $2.5 million of which would
be funded by insurance. Since the Company had previously estimated this
liability at $21.3 million, the Company will reduce this liability in the fourth
quarter of 1998 by $3.6 million.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity Trust
and the Paulanne H. Thacker Retained Annuity Trust filed a complaint against the
Company and Randolph G. Brown in the United States District Court for the
Southern District of New York arising out of Medaphis' acquisition of Medical
Management Sciences, Inc. ("MMS") in December of 1995. The complaint was 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 alleged
common law fraud and violations of the federal securities laws in connection
with the merger. In addition, the complaint alleged breaches of contract
relating to the merger agreement and a registration rights agreement, as well as
tortious interference with economic advantage and declaratory judgement.
Defendants filed a motion to dismiss the complaint. On September 29, 1998, the
Court granted Defendants' motion to dismiss with respect to all securities law,
fraud and tort claims. Plaintiffs' claims for breach of contract and declaratory
judgement remain outstanding. Plaintiffs have sought leave to file a
supplemental amended complaint asserting solely the contract and declaratory
judgment claims, and seeking rescission of the merger agreement and return of
all MMS shares, damages in excess of $100 million, and voiding of various
non-compete covenants and contract provisions between Medaphis and plaintiffs.
The
9
12
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Company expects that discovery, which had been stayed pending resolution of the
motion to dismiss, will commence in the near term. The Company is unable to
estimate a possible range of loss.
On August 12, 1997, George D. Stickle 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 asserted 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 asserted 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 sought rescission, unspecified rescissory and
compensatory damages, and interest, fees and other costs. The parties entered
into a Stipulation and Agreement of Settlement dated June 26, 1998 (the "Stickle
Stipulation") to settle the Stickle putative class action suit on a class wide
basis for $137,500 in cash (to be paid by the Company's directors' and officers'
liability insurance carrier) and 61,553 shares of Medaphis Common Stock. The
Company recorded a litigation settlement charge of approximately $0.4 million in
the quarter ended June 30, 1998 in connection with this agreement. On June 26,
1998, the court entered an order substituting Peter Gladkin as lead plaintiff in
lieu of George Stickle, granted preliminary approval of the settlement and
conditionally certified the class for settlement purposes only. On September 29,
1998, the court granted final approval to the settlement and ordered all claims
dismissed.
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. A number of the former
stockholders of Rapid Systems Solutions, Inc. ("RSSI"), a company acquired by
the Company in 1996, opted out of the settlement of the 1996 Class Action
against the Company and made claims against the Company, alleging securities
fraud and other potential causes of action in connection with the acquisition.
The Company has settled with each of such former RSSI stockholders for a total
of $444,000 in cash, in the aggregate, to be funded by the Company's directors'
and officers' liability insurer and the forgiveness of certain indebtedness. The
Company recorded a litigation settlement charge of $1.2 million in the quarter
ended September 30, 1998 in connection with this settlement.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") notified the Company that it was conducting a formal, non-public
investigation into, among other things, certain trading and other issues related
to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's
loss for the quarter ended September 30, 1996 and its restated consolidated
financial statements for the three months and year ended December 31, 1995 and
its restated unaudited balance sheets as of March 31, 1996, and June 30, 1996.
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 has cooperated with the Commission
in its investigation and will continue to do so.
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 certain of the pending claims, the Company has not
accrued any amounts for any damages, settlements, penalties or awards with
respect to such unsettled claims, except as otherwise disclosed.
10
13
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 5 -- RESTRUCTURING AND OTHER CHARGES
Components of restructuring and other charges are as follows:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------- ----------------
1998 1997 1998 1997
------ ------- ------ -------
(IN THOUSANDS)
Restructuring costs................................. $ -- $ 5,465 $ 325 $ 5,465
Property and equipment impairment................... -- 6,959 -- 6,959
Legal costs......................................... 1,814 600 2,504 2,600
Pooling charges..................................... -- (46) -- (46)
Severance costs..................................... 511 859 1,436 1,683
Other............................................... 1,459 -- 1,515 --
------ ------- ------ -------
$3,784 $13,837 $5,780 $16,661
====== ======= ====== =======
Restructuring Costs. In June 1998, the Company recorded approximately $0.3
million of restructuring costs for the consolidation of several corporate and
operating division departments to eliminate redundant activities. These costs
relate to severance costs for approximately 20 employees who had been notified
of their termination and related benefits.
In August 1997, the Company adopted a plan to combine the operations of its
technology companies into Per-Se Technologies (the "Per-Se Restructuring"). In
connection with the Per-Se Restructuring, the Company recorded charges of $2.7
million for the costs associated with the termination of certain leases and $1.1
million for severance costs related to employees who had been notified of their
termination by September 30, 1997. In addition, the Company reevaluated the
adequacy of the reserves established for the MPSC office consolidations and
recorded a charge of $1.7 million.
The description of the type and amount of restructuring costs recorded and
applied against each reserve in the nine months ended September 30, 1998 is as
follows:
RESERVE COSTS RESERVE
BALANCE APPLIED BALANCE
DECEMBER 31, RESERVE AGAINST SEPTEMBER 30,
1997 ADJUSTMENT RESERVE 1998
------------ ---------- ------- -------------
(IN THOUSANDS)
Lease termination costs................... $8,015 $ -- $(2,005) $6,010
Severance................................. 1,357 325 (1,437) 245
------ ---- ------- ------
$9,372 $325 $(3,442) $6,255
====== ==== ======= ======
Property and Equipment Impairment. During the quarter ended September 30,
1997, the Company assessed the recoverability of certain of its property and
equipment and recorded a charge for impairment losses of $7.0 million.
Legal Costs. In the three and nine months ended September 30, 1998, the
Company recorded charges of $0.1 million and $0.8 million, respectively, for the
legal and administrative fees, costs and expenses associated with various legal
matters described in Note 4. In the three and nine months ended September 30,
1997, the Company recorded charges of $0.6 million and $2.6 million,
respectively, for the legal and administrative fees, costs and expenses
associated with the same legal matters.
In addition, the Company settled various legal matters for $1.7 million in
the third quarter of 1998.
Severance Costs. The Company recorded charges of $0.5 million and $1.4
million in the three and nine months ended September 30, 1998, respectively, for
severance costs associated with former executive
11
14
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
management. The Company had recorded $0.9 million and $1.7 million in the three
and nine months ended September 30, 1997, respectively, for severance costs
associated with former executive management.
NOTE 6 -- INCOME TAXES
INCOME TAXES. Based on recent events and the current operating forecast,
the Company reassessed the recoverability of its deferred tax asset at September
30, 1998. Based on its analysis, the Company determined a full valuation
allowance of $67.6 million against the deferred tax asset was required. If,
during the future periods, management believes the Company will generate
sufficient taxable income to realize the deferred tax asset, then the Company
will adjust this valuation reserve accordingly.
NOTE 7 -- 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 is
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
inconsequential 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 3.0%. Base rate loans bear interest at prime
plus 1.75%. 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.
Availability under the Credit Facility is determined by the Company's Borrowing
Base (as defined). Amounts outstanding under the Credit Facility will be due on
February 20, 2001. At September 30, 1998, the Company had $47 million in
borrowings outstanding under the Credit Facility at interest rates ranging from
8.0% 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.
12
15
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
On October 15, 1998, the Company entered into a definitive agreement with
NCO Group, Inc. for the sale of the Company's Hospital Services segment for up
to $117.5 million in cash. The Company expects the sale to be consummated prior
to December 15, 1998, but there can be no assurance that the sale will be
consummated. If consummated, a portion of the net proceeds of the sale will be
used to pay off the Credit Facility in full. Under the Indenture governing the
Notes, the balance of the net sale proceeds must be reinvested in the Company's
business within 360 days after the sale. To the extent that proceeds are not so
reinvested, the Company is required to offer to repurchase Notes at par with
such proceeds.
On October 16, 1998, the Company entered into a letter agreement with the
requisite lenders under the Credit Facility which, among other things,
contained: (i) a waiver concerning the GFS Investigation and the California
Investigation including the acknowledgment that neither investigation settlement
is expected to have a material adverse effect; (ii) a waiver concerning the
Company's compliance with the financial covenants for the fiscal quarter ended
September 30, 1998 provided that the Hospital Services segment is sold on or
before December 15, 1998; and (iii) a consent to the sale of the Hospital
Services segment provided that the net disposition proceeds are used immediately
upon closing of the sale to pay in full the obligations outstanding under the
Credit Facility. The letter agreement also contained the First Amendment to the
Credit Facility which, among other things, changed the margin on Base Rate and
LIBOR loans to 1.75% and 3.0% per annum, respectively. The letter agreement is
included as Exhibit 10.5 to this Quarterly Report on Form 10-Q.
NOTE 8 -- NEW ACCOUNTING PRONOUNCEMENTS
In October 1997, the American Institute of Certified Public Accountants
(the "AICPA") issued Statements 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. The Company had historically recorded the revenue associated with
software licenses upon shipment 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 its ULTICARE(R) software license sales
only from upon delivery to a percentage-of-completion method over the life of
the installation period. As of September 30, 1998, the Company had not sold any
ULTICARE licenses that required installation; therefore, the adoption of SOP
97-2 has had no material impact on the Company's operating results for the nine
months ended September 30, 1998. SOP 97-2 will not materially impact the pattern
of revenue recognition for all of the Company's other software sales.
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income ("SFAS 130"). The Company's
net loss, as presented in the Consolidated Statements of Operations,
approximates the Company's other comprehensive income amount, as defined, for
all periods presented.
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 SOP
98-1 will have a material impact on the Company's results of operations.
In June 1998, the AICPA issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS 133 establishes guidance on the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities and is effective for
financial statements for all fiscal quarters of fiscal years beginning after
June \15, 1999. The Company does not believe that SFAS 133 will have a material
impact on the Company's results of operations.
13
16
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 9 -- SEGMENT REPORTING
Medaphis provides its services and products through the Physician Services
segment, Per-Se Technologies ("Per-Se") and Impact Innovations ("Impact"). The
Physician Services segment provides business management services and claims
processing to physicians including the collection of clinical data, data input,
medical coding, billing, cash collections and accounts receivable management.
Per-Se provides application software and system integration services to
healthcare markets. Impact provides full-service systems integration,
information technology consulting and tailored software development to
service-oriented markets such as energy, communications and financial services.
Healthcare Recoveries, Inc. ("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 its operating profit
or loss. The Company also accounts for inter-segment sales as if the sales were
to third parties.
14
17
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
The Company's reportable segments are strategic business units that offer
different products and services. The Per-Se segment includes the results of the
newly formed Electronic Commerce group, for all periods presented. Some parts of
this group had previously been included in the Physician and Hospital Services
segments. Information concerning the operations in these reportable segments is
as follows:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- ---------------------
1998 1997 1998 1997
--------- -------- --------- ---------
(IN THOUSANDS)
Revenue:
Physician Services....................... $ 62,534 $ 59,419 $ 202,235 $ 205,791
Per-Se................................... 19,447 24,479 64,454 69,002
Impact................................... 19,375 27,346 62,078 78,993
HRI...................................... -- -- -- 14,720
Eliminations............................. (47) (35) (357) (105)
--------- -------- --------- ---------
$ 101,309 $111,209 $ 328,410 $ 368,401
========= ======== ========= =========
Operating profit(1):
Physician Services....................... $ (9,856) $(11,920) $ (5,391) $ (5,578)
Per-Se................................... (9,152) 1,520 (6,217) 12,423
Impact................................... (2,174) (3,879) (404) (4,370)
HRI...................................... -- -- -- 3,685
Corporate................................ (8,439) (8,550) (23,844) (27,193)
--------- -------- --------- ---------
$ (29,621) $(22,829) $ (35,856) $ (21,033)
========= ======== ========= =========
Interest expense, net...................... $ 6,196 $ 7,241 $ 18,410 $ 19,411
========= ======== ========= =========
Restructuring and other charges (including
intangible asset impairment and
litigation settlements):
Physician Services....................... $ 410,458 $ 4,894 $ 410,458 $ 6,894
Per-Se................................... (50) 3,253 112 3,253
Impact................................... 2,014 2,430 2,403 2,430
HRI...................................... -- -- -- --
Corporate................................ 1,503 55,760 24,823 56,584
--------- -------- --------- ---------
$ 413,925 $ 66,337 $ 437,796 $ 69,161
========= ======== ========= =========
Loss before income taxes................... $(449,742) $(96,407) $(492,062) $(109,605)
========= ======== ========= =========
Depreciation and amortization:
Physician Services....................... $ 7,355 $ 8,546 $ 23,500 $ 25,851
Per-Se................................... 2,325 1,756 6,921 4,920
Impact................................... 888 1,118 3,175 3,292
HRI...................................... -- -- -- 401
Corporate................................ 968 502 2,742 1,364
--------- -------- --------- ---------
$ 11,536 $ 11,922 $ 36,338 $ 35,828
========= ======== ========= =========
Capital expenditures:
Physician Services....................... $ 763 $ 2,093 $ 12,822 $ 3,863
Per-Se................................... 593 720 3,382 2,129
Impact................................... 335 949 963 2,045
HRI...................................... -- -- -- 108
15
18
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- ---------------------
1998 1997 1998 1997
--------- -------- --------- ---------
(IN THOUSANDS)
Corporate................................ 422 1,011 2,164 1,555
--------- -------- --------- ---------
$ 2,113 $ 4,773 $ 19,331 $ 9,700
========= ======== ========= =========
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(IN THOUSANDS)
Identifiable Assets:
Physician Services........................................ $142,863 $563,884
Per-Se.................................................... 64,343 75,964
Impact.................................................... 25,566 31,359
Corporate(2).............................................. 125,469 190,004
-------- --------
$358,241 $861,211
======== ========
- - ---------------
(1) Excludes restructuring and other charges, litigation settlements, intangible
asset impairment and interest expense.
(2) Includes net assets of $91,249 and $90,865 related to the discontinued
operation.
16
19
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 approximately 20,000 physicians and 1,500 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 Physician Services segment, Per-Se Technologies ("Per-Se")
and Impact Innovations ("Impact").
The Physician Services segment provides a range of business management
services to physicians, 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 in improving cash flows and reducing administrative costs and
burdens. Per-Se provides application software and a broad range of information
technology and consulting services to healthcare providers. Impact provides
system integration services to 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 presents certain items reflected in the Company's
consolidated statements of operations as a percentage of revenue:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- ---------------
1998 1997 1998 1997
------ ----- ------ -----
Revenue........................................... 100.0% 100.0% 100.0% 100.0%
Salaries and wages................................ 76.3 72.3 67.7 64.5
Other operating expenses.......................... 41.6 37.5 32.1 31.4
Depreciation...................................... 6.2 6.0 6.0 5.2
Amortization...................................... 5.2 4.8 5.0 4.5
Interest expense, net............................. 6.1 6.5 5.6 5.3
Intangible asset impairment....................... 385.6 0.0 118.9 0.0
Litigation settlements............................ 19.2 47.2 12.6 14.3
Restructuring and other charges................... 3.7 12.4 1.8 4.5
------ ----- ------ -----
Loss before income taxes.......................... (443.9) (86.7) (149.7) (29.7)
Income tax expense (benefit)...................... 66.7 (13.2) 19.1 (5.4)
------ ----- ------ -----
Loss from continuing operations................... (510.6) (73.5) (168.8) (24.3)
Income from discontinued operation, net of tax.... 1.3 0.4 1.1 1.2
Extraordinary items, net of tax................... 0.0 0.0 (1.7) 20.7
------ ----- ------ -----
Net loss.......................................... (509.3)% (73.1)% (169.4)% (2.4)%
====== ===== ====== =====
17
20
Three months ended September 30, 1998 compared to three months ended September
30, 1997
REVENUE. Revenue classified by the Company's different operating segments
is as follows:
THREE MONTHS
ENDED
SEPTEMBER 30,
---------------------------------
1998 1997
--------------- ---------------
(IN THOUSANDS)
Physician Services....................................... $ 62,534 $ 59,419
Per-Se................................................... 19,447 24,479
Impact................................................... 19,375 27,346
Eliminations............................................. (47) (35)
-------- --------
$101,309 $111,209
======== ========
Physician Services' revenue increased by 5.2% for the three month period
ended September 30, 1998 as compared with the three month period ended September
30, 1997. The Company performed a detailed review to update the assumptions and
methodology underlying the calculation of accounts receivable, unbilled in the
third quarter of 1997. Excluding the adjustment to revenue of $10.7 million in
the third quarter of 1997, as a result of the review, Physician Services'
revenue would have decreased by 10.8% for the three month period ended September
30, 1998 as compared with the three month period ended September 30, 1997. The
decrease is attributable to the operating problems at Gottlieb's Financial
Services, Inc. ("GFS") related to the change to a manual coding process and an
increase in client losses within the entire Physician Services segment which
exceeded management's expectations. In addition, the Physician Services segment
continues to be affected by the revenue pressures on the physician accounts
receivable operations resulting from an increase in managed care. As further
discussed below, management believes the client losses and revenue pressures
will continue in the near future.
Per-Se's revenue decreased by 20.6% during the three months ended September
30, 1998 as compared with the same period for the prior year. The decrease is
primarily a result of a slowdown in software license fees in the patient
scheduling product line. Management believes this decline is due to certain
technical problems with a release within the patient scheduling product line.
The Company believes these problems have been corrected and Per-Se is in the
process of rebuilding its relationship with its clients which will allow Per-Se
to expand its reference base for new sales. The decrease in revenue is also a
result of Per-Se not selling any Patient1 software licenses in this period as
compared to $4.2 million in the same period last year.
The 29.1% decrease in Impact's revenue for the quarter ended September 30,
1998 as compared to the same period in 1997 is primarily a result of the
Company's decision late in 1997 to downsize this segment which created less
billable hours in 1998. This segment was downsized in 1997 principally to obtain
efficiencies, but also to reduce unproductive billable staff since growth in the
business had not occurred as quickly as planned.
OPERATING PROFIT (LOSS). Operating profit (loss), which excludes
restructuring and other charges, litigation settlements, intangible asset
impairment and interest expense, classified by the Company's different operating
segments is as follows:
THREE MONTHS
ENDED
SEPTEMBER 30,
---------------------------------
1998 1997
--------------- ---------------
(IN THOUSANDS)
Physician Services....................................... $ (9,856) $(11,920)
Per-Se................................................... (9,152) 1,520
Impact................................................... (2,174) (3,879)
Corporate................................................ (8,439) (8,550)
-------- --------
$(29,621) $(22,829)
======== ========
18
21
The operating loss for Physician Services in the third quarter of 1998 was
$9.9 million as compared to only $1.2 million in the third quarter of 1997,
excluding the previously mentioned adjustment to accounts receivable, unbilled.
This increase in the operating loss for the Physician Services division is
directly attributable to the revenue declines resulting from various operational
issues at GFS and client losses throughout the segment. Additionally, the
operating loss for the three months ended September 30, 1998 was impacted by a
$4.0 million increase in the allowance for doubtful accounts receivable. On July
19, 1998, FPA Medical Management and certain affiliates ("FPA") filed for
protection under Chapter 11 of the United States Bankruptcy Code. GFS is a
principal vendor to FPA. On August 18, 1998, the Bankruptcy Court entered an
Order authorizing FPA to assume certain vendor contracts, including GFS's
contract. The Company has been paid all pre-petition receivables an is
continuing to provide services to FPA under the contract. There can be no
assurance that FPA will continue to perform its obligations or that FPA will not
seek to liquidate under Chapter 7 of the Bankruptcy Code. The failure of FPA to
perform its obligations could have material adverse effect on GFS.
The operations of Per-Se have been impacted by the previously mentioned
decline in software license sales, increased investments in new product
development and reserve adjustments. During the third quarter of 1998, Per-Se
increased its reserves for bad debts by $7.3 million related to various
receivables and for a significant client which sought bankruptcy protection
during the quarter. In the third quarter of 1997, Per-Se recorded charges of
$4.7 million to adjust accounts receivable, unbilled for unanticipated
collection issues on certain contracts. On Jule 21, 1998 Allegheny Health,
Education and Research Foundation and ceratin affiliate (the "Debtor") filed for
protection under Chapter 11 on the United States Bankruptcy Code. Two of the
Company's affiliates have contracts with the Debtor and are among the Debtor's
twenty largest unsecured creditors. To date, the Debtor has not rejected the
Company's contracts. However, the Company expects that the Debtor will reject
the contracts and that the Company will have to seek to recover pre-peition
amounts outstanding as a general unsecured creditor. There can be no assurance
that the Company will realize any of these outstanding amounts. The Company has
reserved all pre-petition accounts receivable amounts.
The decrease in Impact's operating loss for the quarter ended September 30,
1998 as compared to the same period in 1997 is primarily a result of the
Company's decision late in 1997 to downsize this segment which created
management efficiencies and reduced the number of unproductive billable staff.
The Company's corporate overhead costs have decreased slightly over the
prior year. Management is committed to continually monitor its overhead costs to
create efficient processes and reduce costs where possible. Currently,
management is in the process of reducing costs in the payroll processing area
where management has made the decision to outsource its payroll processing
function. Depreciation expense will increase approximately $1.5 million over the
next two quarters as the Company fully depreciates the remaining cost of the
current payroll processing system over its shortened remaining useful life.
However, after the new processing system is in place, the Company expects an
overall reduction in its payroll processing costs.
INTEREST. Net interest expense was $6.2 million in the third quarter of
1998 as compared with $7.2 million in the third quarter of 1997. The $7.2
million of interest expense in the third quarter of 1997 includes $2.3 million
of expense associated with warrants issued in connection with the Company's debt
facility during that period. The Company entered into a new debt facility on
December 23, 1997, therefore, these warrants never became exercisable. Excluding
these warrants, net interest expense would have increased by $1.3 million due to
higher debt outstanding.
INTANGIBLE ASSET IMPAIRMENT. At September 30, 1998, the Company recorded
an intangible asset impairment charge of $390.6 million to adjust the intangible
assets of the Physician Services segment to their fair value. As previously
disclosed, management continually monitors its results of operations and other
developments within the industry to adjust its cash flow forecast, as necessary,
to determine if an adjustment is necessary to the carrying value of the
Company's intangible assets.
During the third quarter of 1998, management of the Company believed there
were events and changes in circumstances that warranted a re-assessment as to
whether the carrying amount of the intangible assets for the Physician Services
segment was still recoverable. These events included: (i) a continual increase
in the segment's operating losses due primarily to client losses; (ii)
significant litigation charges within the Physician
19
22
Services segment; and (iii) absence of revenue growth within the Physician
Services segment. Therefore, in accordance with applicable accounting rules,
management prepared a 40 year undiscounted cash flow analysis to determine if
these intangible assets were still recoverable. Management prepared the analysis
with assumptions that reflected its current outlook on the business. In all
instances, management believes the assumptions inherent in the analysis were
reasonable and supportable. The following key assumptions were used in
management's undiscounted cash flow analysis: (i) revenue was forecasted to
decline over the next five years and then remain flat; (ii) EBITDA margin was
forecasted to continue to decrease in 1999, increase slightly over the following
four years and then stabilize at a moderate margin over the remaining life of
the asset; and (iii) capital spending would be maintained in the range of 3% of
revenue. Since the undiscounted cash flow model showed an impairment of the
Company's long-lived assets, the Company used a discounted cash flow model to
measure the fair value of these long-lived assets which was consistent with the
Company's policy. The fair value calculation determined that the fair value of
the long-lived assets was approximately $63 million. The Company wrote-off the
value of its longest lived assets first, which resulted in the write-off of all
of the Physician Services segment's goodwill and a portion of the value of its
client lists. As a result of this impairment charge, the Company reduced the
estimated useful life of its remaining intangible assets for the Physician
Services segment to 10 years.
LITIGATION SETTLEMENTS. During the third quarter of 1998, the Company
successfully negotiated agreements to resolve the investigations of the
Company's billing and collection practices in California and a settlement in
principle of allegations involving billing and collection practices at GFS.
Medaphis will pay approximately $12.5 million before year end and an additional
$7.0 million in two equal payments of $3.5 million in 1999 and 2000. Settlement
has been reached with all parties in connection with the California
Investigation and is subject to final approval by the State of California and
court approval. An agreement in principle based on the Company's ability to pay,
subject to definitive documentation and final approval by the United States, has
been reached in connection with the GFS Investigation.
In the prior year's comparable quarter, the Company had recorded a
litigation settlement charge of $52.5 million for the settlement of a class
action legal matter brought against the Company in 1996.
RESTRUCTURING AND OTHER CHARGES. The Company did not record any
restructuring costs during the third quarter of 1998 as compared to $5.5 million
of restructuring costs recorded during the third quarter of 1997. These costs in
1997 were primarily for the Company's August 1997 plan to consolidate its
technology companies (the "Per-Se Restructuring"). As of September 30, 1998,
management has decided not to continue with the Per-Se Restructuring and
management is currently assessing the strategic alternatives for Impact.
The Company incurred other charges of approximately $3.8 million and $8.4
million in the three-month period ended September 30, 1998 and 1997,
respectively. The 1998 amounts included: (i) $1.8 million of legal costs
primarily associated with the settlement of certain legal matters; (ii) $0.5
million for severance costs associated with former executive management; and
(iii) $1.5 million for the loss recorded on the sale of the data warehousing
software group of Impact. The 1997 charges were comprised of the following
amounts: (i) $7.0 million in non-cash property and equipment impairment charges
associated with the Per-Se Restructuring and the Company's assessment of the
recoverability of certain of its long-lived assets; (ii) $0.6 million for legal
costs associated with various legal matters (see Note 4 of the Notes to
Consolidated Financial Statements); and (iii) $0.8 million associated with
severance costs associated with former executive management.
INCOME TAXES. Based on recent events and the current operating forecast,
the Company reassessed the recoverability of its deferred tax asset at September
30, 1998. Based on its analysis, the Company determined a full valuation
allowance of $67.6 million against the deferred tax asset was required. If,
during the future periods, management believes the Company will generate
sufficient taxable income to realize the deferred tax asset, then the Company
will adjust this valuation reserve accordingly.
Effective income tax rates for the prior period presented vary from
statutory rates primarily as a result of nondeductible goodwill associated with
merger transactions consummated by the Company in previous years.
20
23
DISCONTINUED OPERATION. On October 15, 1998, the Company entered into a
definitive agreement to sell its Hospital Services segment, which provides
business management services and bad debt collections to approximately 1,200
hospital clients, to NCO Group, Inc. for up to $117.5 million. In accordance
with the agreement, $107.5 million is payable at closing and an additional
purchase price adjustment of up to $10.0 million is payable subject to the
achievement of various operational targets in 1999. The sale is subject to
regulatory approval, but is expected to be consummated by December 15, 1998.
Pursuant to Accounting Principles Board ("APB") Opinion No. 30, "Reporting
the Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," the consolidated financial statements of the Company have been
presented to reflect the Hospital Services segment as discontinued operations.
The net operating results of the segment have been reported in the Consolidated
Statements of Operations as "Income from discontinued operation"; the net assets
have been reported in the Consolidated Balance Sheets as "Net assets of
discontinued operation"; and the net cash flows have been reported in the
Consolidated Statements of Cash Flows as "Net cash provided by (used for)
discontinued operation".
Summarized financial information for the discontinued operation for the
three months ended September 30, 1998 and 1997 is as follows:
THREE MONTHS
ENDED
SEPTEMBER 30,
-----------------
1998 1997
------- -------
(IN THOUSANDS)
Revenue..................................................... $29,124 $23,840
Income from discontinued operation, net of tax of $943 and
$331...................................................... 1,356 477
Nine months ended September 30, 1998 compared to nine months ended September
30, 1997
REVENUE. Revenue classified by the Company's different operating segments
is as follows:
NINE MONTHS
ENDED
SEPTEMBER 30,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
Physician Services.......................................... $202,235 $205,791
Per-Se...................................................... 64,454 69,002
Impact...................................................... 62,078 78,993
HRI......................................................... -- 14,720
Eliminations................................................ (357) (105)
-------- --------
$328,410 $368,401
======== ========
Excluding the previously discussed revenue adjustment for accounts
receivable, unbilled, Physician Services' revenue decreased 6.6% for the
nine-month period ended September 30, 1998 as compared with the nine-month
period ended September 30, 1997. The previously discussed operating issues at
GFS and client losses contributed to the decline in revenue.
Per-Se's revenue decreased 6.6% during the nine months ended September 30,
1998 as compared with the same period for the prior year. The decrease is
primarily a result of the previously discussed issues with Per-Se's patient
scheduling product and a decrease in the sales of the Patient1 product in 1998.
Per-Se has grown its pipeline for Patient1 and currently is one of two finalists
on several proposals.
In addition to growing its customer base for its existing software
products, management of Per-Se is expecting to grow future revenue through its
newly formed Electronic Commerce group ("E-Commerce"). The Company is
transforming this business from internal cost centers within the Physician and
Hospital Services segments to a revenue producing operating unit within Per-Se.
Management anticipates this business will grow next year with positive operating
and cash flow margins.
21
24
The 21.4% decrease in the Impact's revenue is primarily a result of the
Company's decision in late 1997 to downsize this segment which created less
billable hours in the nine months ended September 30, 1998 as compared to the
same period in 1997. This segment was downsized in 1997 principally to obtain
management efficiencies, but also to reduce unproductive billable staff since
growth in the business had not occurred as quickly as had been planned.
Medaphis divested Healthcare Recoveries, Inc. ("HRI") in May 1997 through
an initial public offering of 100% of its stock.
OPERATING PROFIT (LOSS). Operating profit (loss) classified by the
Company's different operating segments is as follows:
NINE MONTHS
ENDED
SEPTEMBER 30,
-----------------------------
1998 1997
------------- -------------
(IN THOUSANDS)
Physician Services.......................................... $ (5,391) $ (5,578)
Per-Se...................................................... (6,217) 12,423
Impact...................................................... (404) (4,370)
HRI......................................................... -- 3,685
Corporate................................................... (23,844) (27,193)
-------- --------
$(35,856) $(21,033)
======== ========
The operating loss for Physician Services for the nine months ended
September 30, 1998 was $5.4 million compared to a $5.1 million operating profit
for the nine months ended September 30, 1997, excluding the previously mentioned
adjustment to the accounts receivable unbilled account. This increase in the
operating loss for the Physician Services division is directly attributable to
revenue declines resulting from various operational issues at GFS and client
losses throughout the segment as well as increases in the reserve for bad debts.
The operating profit for Per-Se for the nine months ended September 30,
1998 has been impacted negatively by the previously mentioned decline in
software license sales, increased investments in new product development,
increases in general and administrative costs and reserve adjustments.
The decrease in Impact's operating loss for the nine-month period ended
September 30, 1998 as compared to the same period in 1997 is primarily a result
of the Company's decision late in 1997 to downsize this segment which created
management efficiencies and reduced the number of unproductive billable staff.
The Company's corporate overhead costs have decreased by 12.3% for the nine
months ended September 30, 1998 as compared to the nine months ended September
30, 1997. This reduction is primarily the result of less professional services
fees and a reduction of headcount resulting from process improvement
initiatives. Management is committed to continually monitor its overhead costs
to create efficient processes and reduce costs where possible.
INTEREST. Net interest expense decreased by approximately $1 million for
the nine-month period ended September 30, 1998 as compared to the nine-month
period ended September 30, 1997. See management's discussion in "Three months
ended September 30, 1998 compared to three months ended September 30, 1997."
INTANGIBLE ASSET IMPAIRMENT. See management's discussion in "Three months
ended September 30, 1998 compared to three months ended September 30, 1997."
LITIGATION SETTLEMENTS. In addition to the previously mentioned $19.5
million settlements of the federal investigations during the third quarter of
1998, the Company has agreed, in principle, to the material terms to settle
three outstanding legal matters which aggregated $21.9 million in the second
quarter of 1998. The Company has agreed, in principle, to settle these matters
primarily with Common Stock. In the comparable prior year's period, the Company
recorded a litigation settlement charge of $52.5 million for the settlement of
22
25
a class action legal matter brought against the Company in 1996. See Note 4 of
the Notes to Consolidated Financial Statements where the 1998 settlements in
principle are discussed in detail.
RESTRUCTURING AND OTHER CHARGES. The Company recorded restructuring costs
of $0.3 million in the nine months ended September 30, 1998 for the severance
costs associated with the downsizing of several corporate departments as
compared to $5.5 million of restructuring costs recorded in the nine-month
period ended September 30, 1997. These costs in 1997 were primarily for the
Per-Se Restructuring. As of September 30, 1998, management has decided not to
continue with the Per-Se Restructuring and management is currently assessing the
strategic alternatives for Impact.
As of September 30, 1998, the Company had accrued, but had not yet paid,
expenses of approximately $6.3 million, in connection with the various
restructurings undertaken over the past few years. Such amounts consist
primarily of estimated lease termination costs which will be paid in varying
amounts through 2005.
The Company incurred other charges of approximately $5.5 million and $11.2
million in the nine-month period ended September 30, 1998 and 1997,
respectively. The 1998 amounts included: (i) $2.5 million of legal costs
consisting of an increase to the Company's legal reserves for the legal and
administrative fees, costs and expenses associated with various legal matters
(see Note 4 of the Notes to Consolidated Financial Statements) as well as the
settlement of certain pending matters; (ii) $1.5 million for severance costs
associated with former executive management; and (iii) $1.5 million for the loss
recorded on the sale of the data warehousing software group of impact. The 1997
charges were comprised of the following amounts: (i) $7.0 million in non-cash
property and equipment impairment charges associated with the Per-Se
Restructuring and the Company's assessment of the recoverability of certain of
its long-lived assets; (ii) $2.6 million for legal costs associated with various
legal matters (see Note 4 of the Notes to Consolidated Financial Statements);
and (iii) $1.6 million associated with severance costs associated with former
executive management.
INCOME TAXES. See management's discussion in "Three months ended September
30, 1998 compared to three months ended September 30, 1997."
DISCONTINUED OPERATION. See management's discussion in "Three months ended
September 30, 1998 compared to three months ended September 30, 1997."
Summarized financial information for the discontinued operation for the
nine months ended September 30, 1998 and 1997 is as follows:
NINE MONTHS
ENDED
SEPTEMBER 30,
-----------------
1998 1997
------- -------
(IN THOUSANDS)
Revenue..................................................... $81,081 $72,410
Income from discontinued operation, net of tax of $2,562 and
$2,993.................................................... 3,687 4,306
EXTRAORDINARY ITEM. The Company used the proceeds from the February 1998
issuance of $175 million of senior notes and the Credit Facility, as defined
below, to redeem the notes evidencing the Company's previous debt facility. 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 previous debt facility.
On May 28, 1997, Medaphis sold HRI through an initial public offering of
100% of its stock, which generated net proceeds to the Company of approximately
$117 million. The Company recorded an extraordinary gain on the sale of HRI of
$76.4 million, net of tax of $46.2 million, in the second quarter of 1997.
Medaphis had acquired HRI on August 28, 1995 through a business combination
accounted for as a pooling-of-interests.
23
26
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $50.3 million at September 30, 1998,
including $10.8 million of cash.
The Company's operating activities used $6.4 million of cash during the
nine months ended September 30, 1998 as compared with $7.2 a use of million
during the nine months ended September 30, 1997. The increase in the Company's
operating cash flows resulted primarily from aggressive collection of the
Company's accounts receivable.
Purchases of property and equipment were $19.3 million in the first nine
months of 1998 compared to $9.7 million in the prior year comparable period. The
increase reflects the purchase for approximately $9 million of certain real
property that the Company previously leased.
On February 20, 1998, the Company sold $175 million of 9 1/2% Senior Notes
due 2005 (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 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 is
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 operation 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 3.0%. Base rate loans bear interest at prime
plus 1.75%. In addition the Company pays a quarterly commitment fee on the
unused portion on 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) and minimum interest coverage and limiting leverage. Availability under
the Credit Facility is determined by the Company's Borrowing Base (as defined).
Amounts outstanding under the Credit Facility will be due on February 20, 2001.
At September 30, 1998, the Company had $47 million in borrowing outstanding
under the Credit Facility at interest ranging from 8.0% to 8.2%.
On October 16, 1998, the Company entered into a letter agreement with the
requisite lenders under the Credit Facility which, among other things,
contained: (i) a waiver concerning the GFS Investigation and the California
Investigation including the acknowledgment that neither investigation settlement
is expected to have a material adverse effect; (ii) a waiver concerning the
Company's compliance with the financial covenants for the fiscal quarter ended
September 30, 1998 provided that the Hospital Services segment is sold on or
before December 15, 1998; and (iii) a consent to the sale of the Hospital
Services segment provided that the net disposition proceeds are used immediately
upon closing of the sale to pay in full the obligations outstanding under the
Credit Facility. The letter agreement also contained the First Amendment to the
Credit Facility which, among other things changed the margin on Base Rate and
LIBOR loans to 1.75% and 3.0% per annum, respectively.
24
27
The Company entered into a definitive agreement to sell its Hospital
Services segment to the NCO Group, Inc. on October 15, 1998. Under the terms of
the agreement, the Company will receive up to $117.5 million for the sale,
$107.5 million payable at Closing and an additional purchase price adjustment of
up to $10.0 million subject to the achievement of various operational targets in
1999. The transaction is subject to regulatory approval and is expected to be
consummated by December 15, 1998.
The Company will use the proceeds from the sale of its Hospital Services
segment to pay down its existing obligations under the Credit Facility. The
Company believes that the excess cash obtained from the sale of the Hospital
Services segment and anticipated cash flow from operations will be sufficient to
permit the Company to meet its operating expenses, make necessary capital
investments in operations and service its debt requirements for the foreseeable
future, however, there can be no assurance that such results will be achieved.
There can be no assurance that the sale of the Hospital Service segment
will be consummated. If such sale is not consummated prior to December 15, 1998,
the Company will not have sufficient liquidity without obtaining an additional
waiver from the requisite lenders under the Credit Facility or alternate sources
of liquidity. There can be no assurance that any required waiver or alternate
source of liquidity. There can be no assurance that any required waiver or
alternate source of liquidity will be available to the Company or can be
obtained on terms and conditions satisfactory to the Company.
The Company decided to transition from a 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. 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 is a party to legal actions 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 will not have a material
adverse effect on the Company's liquidity or financial position or that
appropriate amendments to the Credit Facility would not be required. 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, restricting 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 purpose 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
for the Notes 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 prepayments of indebtedness.
YEAR 2000
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 that will be abandoned in favor of a limited
number of more efficient processing systems, rather than make all the systems
Year 2000 compatible. GFS's computerized coding system is one of the legacy
systems from
25
28
which the Company has transitioned. The Company believes that it is on target to
complete substantially all of these system migration efforts with respect to its
Physician Services business in the first half of 1999. The detail planning and
inventory for the majority of the Company's legacy systems that are being
modified for Year 2000 compatibility has been completed and such systems are in
remediation. In the third quarter of 1998, Per-Se Technologies released Year
2000 compatible versions for its scheduling products. Customers, vendors and
resellers have been identified and requests for information distributed
regarding the Year 2000 readiness of such parties. Responses are expected
through the first quarter of 1999. The Company will develop contingency plans
during the fourth quarter of 1998 through the second quarter of 1999 in response
to assessments of the Year 2000 readiness of customers, vendors and resellers.
The estimated cost of the Company's Year 2000 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.
The United States Attorney's Office for the Central District of California
conducted an investigation of the billing and collection practices in two
offices of the Company's wholly owned subsidiary, Medaphis Physician Services
Corporation ("MPSC"), which offices are located in Calabasas and Cypress,
California (the "Designated Offices") (the "California Investigation"). Medaphis
first became aware of the California Investigation on June 13, 1995 when search
warrants were executed on the Designated Offices and it and MPSC received grand
jury subpoenas. Medaphis received an additional grand jury subpoena on August
22, 1997, with which it complied. The subpoena required, 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 appropriate state or states may elect to intervene fully or partially in
qui tam litigation and proceed with the action.
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) (the
"Complaint"). 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 disclosures 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.
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' termination of Relator II, including a count under the state and
federal whistleblower protection statutes.
The Company recorded charges of $12 million in the third quarter of 1995
solely for legal and administrative fees, costs and expenses it anticipates
incurring in connection with the California Investigation and certain putative
class action lawsuits which were filed in 1995 following the Company's
announcement of the California Investigation. Since the third quarter of 1995,
the Company has periodically adjusted this reserve, as necessary, including a
$0.3 million increase in the second quarter of 1998. Such adjustments to the
reserve have aggregated to a net reduction of $0.5 million. The reserve
currently covers only the anticipated expenses of the California Investigation
and the related lawsuits and does not include any provision for fines,
penalties, damages, assessments, judgments or sanctions that may arise out of
such matters.
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During the third quarter of 1998, the Company reached an agreement to
settle with the United States, the State of California and the Relators on all
claims related to the California Investigation and underlying qui tam
litigation. Such settlements provide for the payment by the Company of $3.6
million in the aggregate, the dismissal of all pending proceedings against the
Company and the release of various other claims arising out of the California
Investigation. As a part of these settlements, CompMed, Inc., a company acquired
by the Company in 1992, pled guilty to a single criminal count.
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 which primarily impacts certain managed care
plans, 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, 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.
The Company learned in March 1997 that the United States Department of
Justice and the United States Attorney in Grand Rapids, Michigan were
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 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 requested that GFS voluntarily
produce records, and GFS complied with that request. The Company recorded
charges of $2 million and $1 million in the second and third quarters of 1997,
respectively, and $0.7 million in the second quarter of 1998 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 has determined it is in its best interest to settle such
claims. The Company has reached an agreement in principle with the United States
to settle the matters related to the GFS Investigation on an ability to pay
basis. The settlement, which is subject to definitive documentation, requires
the Company to pay to the United States and the various states a total of $15
million, of which $8 million will be paid within 10 days of the execution of a
definitive Settlement Agreement among the parties, with the balance of $7
million being paid in eight equal quarterly installments over 1999 and 2000. The
deferred portion of the settlement payment will bear interest at the one year
Treasury Bill rate. The Settlement Agreement will provide for the dismissal with
prejudice of claims against the Company and the release by the United States of
civil and administrative claims arising out of the emergency room billing of
government programs services provided by GFS from 1993 through the date of the
Settlement Agreement.
The Company recorded a litigation settlement charge of $19.5 million in the
quarter ended September 30, 1998 in connection with the settlement of the
California Investigation and the agreement in principle with respect to the GFS
Investigation.
In connection with the settlement of the California and GFS Investigations,
the Company entered into a Corporate Integrity Agreement with the Office of the
Inspector General of the Department of Health and Human Services. This
Agreement, which has a term of sixty-five months, provides that the government
will not seek to exclude the Company from participation in governmental health
care programs based on the
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31
conduct alleged in the California and GFS Investigations and requires the
Company to continue its existing compliance program, augmented by an annual
third party review and additional reporting requirements.
In addition, the Company decided in April 1998 to transition GFS from a
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.
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 "Derivative Suit"). The plaintiff sought
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 was denied without prejudice. The
parties entered into a Stipulation and Settlement Agreement dated June 26, 1998
(the "Derivative Stipulation") to settle the Derivative Suit. The Derivative
Stipulation provides for the enactment of procedures for governance of the Audit
Committee of the Board of Directors and for such attorney's fees and expenses as
may be awarded by the court in an amount not to exceed $250,000 (to be paid by
the Company's directors' and officers' liability insurance carrier). On
September 29, 1998, the court granted final approval to the settlement and
ordered all claims dismissed.
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 Health Data
Sciences Corporation ("HDS"). Plaintiff seeks rescissory, compensatory and
punitive damages in excess of $100 million, rescission, injunctive relief and
costs. On January 10, 1997, the defendants filed a demurrer to the complaint. On
February 5, 1997, the Court overruled defendants' demurrer. On March 18, 1997,
the court denied the plaintiff's motion for a preliminary injunction. On July
16, 1997, plaintiff filed an amended complaint adding several new parties,
including current and former directors and former and current officers of
Medaphis. All of the newly added defendants have responded to the amended
complaint. As a result of the Company's 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. The Company is unable to estimate a possible range of loss.
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
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32
Brown). Plaintiffs seek unspecified compensatory and punitive damages, as well
as fees, interest and other costs. On April 18, 1997, the Medaphis defendants
and BSG defendants filed motions to dismiss the complaint. On or about July 3,
1997, in lieu of responding to these motions, the plaintiffs filed an amended
complaint, adding new claims under the Securities Act and common law and new
parties, including former officers of Medaphis, Medaphis' former independent
accountants 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. On May 15, 1998, the Judge signed an order to that
effect. The plaintiffs have appealed from this order, and that appeal is
pending. The Company is unable to estimate a possible range of loss.
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control (collectively, the "BSG Principals") 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 March 31, 1999. 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. In June 1998, the Company and
the BSG Principals reached an agreement in principle to settle the claims made
on behalf of the former BSG shareholders in exchange for approximately 3.2
million shares of Medaphis Common Stock, subject to negotiation and definitive
documentation of other terms and conditions of the settlement. The Company
recorded a litigation settlement charge of $21.3 million in the quarter ended
June 30, 1998 in connection with this agreement in principle. The charge
reflects 3.2 million shares of Medaphis Common Stock valued at the fair value
per share on the date on which the material terms of the agreement in principle
was reached. The Company classified the entire $21.3 million liability
associated with the proposed settlement as noncurrent since such obligation will
be settled with Common Stock rather than current assets and the exact timing of
the payments of claims pursuant to such settlement is not determinable.
On November 9, 1998, the parties entered into a letter of intent with
respect to the settlement of the BSG Principals' claims. The terms of the letter
of intent, which vary from the previously announced agreement in principle,
provide for the payment by the Company to the BSG Principals of 4.5 million
shares of the Company's voting common stock and $2.5 million in cash, to be
funded by the Company's officers and directors liability insurance. The
settlement is subject to the consent and approval of the Company's insurer and
its funding of the cash portion of the settlement. Based on the price of the
Company's common stock on the date of the letter of intent, the settlement would
result in a charge of approximately $17.7 million, $2.5 million of which would
be funded by insurance. Since the Company had previously estimated this
liability at $21.3 million, the Company will reduce this liability in the fourth
quarter of 1998 by $3.6 million.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity Trust
and the Paulanne H. Thacker Retained Annuity Trust filed a complaint against the
Company and Randolph G. Brown in the United States District Court for the
Southern District of New York arising out of Medaphis' acquisition of Medical
Management Sciences, Inc. ("MMS") in December of 1995. The complaint was 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 alleged
common law fraud and violations of the federal securities laws in connection
with the merger. In addition, the complaint alleged breaches of contract
relating to the merger agreement and a registration rights agreement, as well as
tortious interference with economic advantage and declaratory judgement.
Defendants filed a motion to dismiss the complaint. On September 29, 1998, the
Court granted Defendants' motion to dismiss with respect to all securities law,
fraud and tort claims. Plaintiffs' claims for breach of contract and declaratory
judgement remain outstanding. Plaintiffs have sought leave to file a
supplemental amended complaint asserting solely the contract and declaratory
judgment claims, and seeking rescission of the merger agreement and return of
all MMS shares, damages in excess of $100 million, and
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33
voiding of various non-compete covenants and contract provisions between
Medaphis and plaintiffs. The Company expects that discovery, which had been
stayed pending resolution of the motion to dismiss, will commence in the near
term. The Company is unable to estimate a possible range of loss.
On August 12, 1997, George D. Stickle 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 asserted 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 asserted 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 sought rescission, unspecified rescissory and
compensatory damages, and interest, fees and other costs. The parties entered
into a Stipulation and Agreement of Settlement dated June 26, 1998 (the "Stickle
Stipulation") to settle the Stickle putative class action suit on a class wide
basis for $137,500 in cash (to be paid by the Company's directors' and officers'
liability insurance carrier) and 61,553 shares of Medaphis Common Stock. The
Company recorded a litigation settlement charge of approximately $0.4 million in
the quarter ended June 30, 1998 in connection with this agreement. On June 26,
1998, the court entered an order substituting Peter Gladkin as lead plaintiff in
lieu of George Stickle, granted preliminary approval of the settlement and
conditionally certified the class for settlement purposes only. On September 29,
1998, the court granted final approval to the settlement and ordered all claims
dismissed.
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. A number of the former
stockholders of Rapid Systems Solutions, Inc. ("RSSI"), a company acquired by
the Company in 1996, opted out of the settlement of the 1996 Class Action
against the Company and made claims against the Company, alleging securities
fraud and other potential causes of action in connection with the acquisition.
The Company has settled with each of such former RSSI stockholders for a total
of $444,000 in cash, in the aggregate, to be funded by the Company's directors'
and officers' liability insurer, and the forgiveness of certain indebtedness.
The Company recorded a litigation settlement charge of $1.2 million in the
quarter ended September 30, 1998 in connection with this settlement.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") notified the Company that it was conducting a formal, non-public
investigation into, among other things, certain trading and other issues related
to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's
loss for the quarter ended September 30, 1996 and its restated consolidated
financial statements for the three months and year ended December 31, 1995 and
its restated unaudited balance sheets as of March 31, 1996, and June 30, 1996.
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 has cooperated with the Commission
in its investigation and will continue to do so.
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 certain of the pending claims, the Company has not
accrued any amounts for any damages, settlements, penalties or awards with
respect to such unsettled claims, except as otherwise disclosed.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) Exhibits
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- - ------- -----------------------
2.1 -- Stock Purchase Agreement dated as of October 15, 1998,
between Registrant and NCO Group, Inc.
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, as amended
4.1 -- Credit Agreement dated February 13, 1998, among Registrant,
as Borrower, various financial institutions from time to
time parties thereto, as the Lenders, DLJ Capital 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 Registrants' Registration
Statement on Form S-4, File No. 333-47409)
10.1 -- Employment Agreement dated July 27, 1998, between Registrant
and Wayne A. Tanner
10.2 -- Impact Innovations Key Employee Incentive Plan
10.3 -- Medaphis Corporation Long Term Incentive Plan
10.4 -- Corporate Integrity Agreement between the Office of the
Inspector General of the Department of Health and Human
Services and Registrant
10.5 -- Waiver and First Amendment to Credit Agreement, dated
October 16, 1998, among Registrant, as Borrower, DLJ Capital
Funding, Inc., as Syndication Agent, Wachovia Bank, N.A., as
Administrative Agent, and various financial institutions, as
Lenders.
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
32
35
(B) Reports on Form 8-K
The Company has filed the following report on Form 8-K during the quarter
ended September 30, 1998:
FINANCIAL
STATEMENTS
ITEM REPORTED FILED DATE OF REPORT FILING DATE
- - ------------- ---------- -------------- --------------
Announcement of certain executive officer
appointments and promotions................. No July 29, 1998 August 3, 1998
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEDAPHIS CORPORATION
(Registrant)
By: /s/ JAMES W. FITZGIBBONS
------------------------------------
James W. FitzGibbons
Vice President and Controller
(Principal Accounting Officer)
Date: November 16, 1998
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- - ------- -----------------------
2.1 -- Stock Purchase Agreement dated as of October 15, 1998,
between Registrant and NCO Group, Inc.
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, as amended
4.1 -- Credit Agreement dated February 13, 1998, among Registrant,
as 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 Registrants's Registration
Statement on Form S-4, File No. 333-47409)
10.1 -- Employment Agreement dated July 27, 1998, between Registrant
and Wayne A. Tanner
10.2 -- Impact Innovations Key Employee Incentive Plan
10.3 -- Medaphis Corporation Long Term Incentive Plan
10.4 -- Corporate Integrity Agreement between the Office of the
Inspector General of the Department of Health and Human
Services and Registrant
10.5 -- Waiver and First Amendment to Credit Agreement, dated
October 16, 1998, among Registrant,as Borrower, DLJ Capital
Funding, Inc., as Syndication Agent, Wachovia Bank, N.A., as
Administrative Agent, and various financial institutions, as
Lenders.
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
35