-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ls5pAdXMCqdB+P3D5jJdTYhlQFeSG3AentvZzLmSs2qyVrq5ztwB5CJfDCbIRKvP +/v0FUJkD0/0zMbUOcBaqQ== 0000950144-97-003573.txt : 19970401 0000950144-97-003573.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950144-97-003573 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 24 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MEDAPHIS CORP CENTRAL INDEX KEY: 0000878556 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MANAGEMENT SERVICES [8741] IRS NUMBER: 581651222 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-19480 FILM NUMBER: 97571229 BUSINESS ADDRESS: STREET 1: 2700 CUMBERLAND PKWY STE 300 CITY: ATLANTA STATE: GA ZIP: 30339 BUSINESS PHONE: 7703193300 MAIL ADDRESS: STREET 1: 2700 CUMBERLAND PKWY STREET 2: STE 300 CITY: ATLANTA STATE: GA ZIP: 30339 10-K405 1 MEDAPHIS CORPORATION FORM 10-K405 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 --------------------- FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996). FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 000-19480 MEDAPHIS CORPORATION (Exact Name of Registrant as Specified in Its Charter) DELAWARE 58-1651222 (State or Other Jurisdiction (I.R.S. Employer of 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) Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- --------------------- NONE NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01 PAR VALUE (Title of Class) 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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the Registrant as of March 21, 1997 was approximately $787,082,573 calculated using the closing price on such date of $10.875. The number of shares outstanding of the Registrant's common stock (the "Common Stock") as of March 24, 1997 was 72,412,624. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Annual Meeting of Stockholders to be held on May 8, 1997 are incorporated herein by reference in Part III. ================================================================================ 2 MEDAPHIS CORPORATION FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 TABLE OF CONTENTS
PAGE OF FORM 10-K --------- PART I ITEM 1. BUSINESS........................................... 1 ITEM 2. PROPERTIES......................................... 9 ITEM 3. LEGAL PROCEEDINGS.................................. 9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................ 12 EXECUTIVE OFFICERS OF THE REGISTRANT............... 12 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........................ 13 ITEM 6. SELECTED FINANCIAL DATA............................ 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................ 16 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........ 25 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE................ 25 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................................ 25 ITEM 11. EXECUTIVE COMPENSATION............................ 26 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................... 26 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.... 26 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K............................... 26
THIS FORM 10-K 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, AS AMENDED (THE "1933 ACT"), AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED BY THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. 15 U.S.C.A SECTIONS 77Z-2 AND 78U-5 (SUPP. 1996). THOSE STATEMENTS INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF MEDAPHIS CORPORATION AND MEMBERS OF ITS MANAGEMENT TEAM, AS WELL AS THE ASSUMPTIONS ON WHICH SUCH STATEMENTS ARE BASED. PROSPECTIVE INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS CURRENTLY KNOWN TO MANAGEMENT THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN FORWARD-LOOKING STATEMENTS ARE SET FORTH IN THE SAFE HARBOR COMPLIANCE STATEMENT FOR FORWARD-LOOKING STATEMENTS INCLUDED AS EXHIBIT 99.6 TO THIS FORM 10-K, AND ARE HEREBY INCORPORATED 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. 3 PART I ITEM 1. BUSINESS OVERVIEW OF COMPANY Medaphis Corporation, a corporation organized in 1985 under the laws of the State of Delaware ("Medaphis" or the "Company"), provides business management services and information products primarily to healthcare providers. Medaphis' healthcare services are designed to assist its clients with the business management functions associated with the delivery of healthcare services, thereby permitting physicians and hospitals to focus on providing quality medical services to their patients. Medaphis' healthcare information systems include patient-centered clinical information management systems and enterprise-wide patient and employee scheduling systems. These systems are designed to improve efficiency and quality of care within hospitals and emerging integrated healthcare delivery systems. Medaphis currently provides business management systems and services to approximately 20,000 physicians and over 2,500 hospitals in all 50 states, subrogation and recovery services to healthcare plans covering in excess of 31 million people throughout the United States and systems integration and work flow engineering systems and services in the United States and abroad. RECENT DEVELOPMENTS 1997 Business Plan In February 1997 Medaphis announced the implementation during the 1997 fiscal year of a business plan focused on Medaphis' core business and comprised of the five following components: (1) exiting non-core businesses, such as the proposed sale of Healthcare Recoveries, Inc. ("HRI") that is discussed below; (2) achieving improved predictability of results through enhanced management accountability and controls; (3) reducing costs and increasing efficiencies; (4) emphasizing customer service; and (5) implementing cross-selling initiatives. Amended and Restated Credit Agreement Effective February 4, 1997, Medaphis and its senior lenders entered into the Second Amended and Restated Credit Agreement (the "Second Amended Facility"). The lenders' commitments have been increased from $250 million to $285 million and extended through June 30, 1998. Borrowings under the Second Amended Facility are secured by substantially all of the Company's assets and guaranteed by substantially all of the Company's subsidiaries. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources. The Second Amended Facility provides for contractual amortization of the $285 million loan commitments by a scheduled reduction to $200 million on July 31, 1997 (which may be deferred to September 30, 1997 by the required lenders) and to $150 million on January 31, 1998. As of March 29, 1997, the Company had approximately $251 million outstanding under the Second Amended Facility. The Company and its lenders have always contemplated that the contractual amortization of loan commitments under the Second Amended Facility would be accomplished through asset divestitures since operating cash flow was never intended to be utilized for this purpose and would be insufficient to meet these obligations. Accordingly, at the time that the Second Amended Facility was consummated and announced in February 1997, the Company adopted and announced its 1997 business plan which, among other objectives, includes the divestiture of non-core businesses to meet the Company's contractual obligations under the Second Amended Facility and otherwise. The Company remains confident that it will be able to meet its amortization obligations under the Second Amended Facility through the continued execution of the Company's 1997 business plan and related asset divestiture program. See Item 1. Recent Developments -- Planned Divestitures and Assessments of Non-Core Businesses. The Second Amended Facility provides for adjustment of the interest rates, fees, charges and other compensation to be paid to the lenders by the Company, including the vesting of certain warrant arrangements 4 for 1% of the Common Stock of the Company on each of January 1, 1998 and April 1, 1998, modification of the financial reporting requirement to the lenders, restrictions on new acquisitions and certain litigation settlement payments, establishment of a maximum permitted capital expenditures covenant for the fiscal quarters ending on or after March 31, 1997 and additional financial covenants for fiscal quarters ending on and after June 30, 1997. Abandonment of Reengineering Program In an effort to improve the productivity and cost efficiency of its operations, in late 1994 Medaphis undertook a comprehensive reengineering program. During fiscal 1996, Medaphis assessed the reengineering program to determine whether the objectives of the program were being achieved. Based upon this assessment, the Company abandoned the reengineering program and incurred a charge of $88.2 million in the fourth quarter of fiscal 1996 with respect to such abandonment. See Note 13 of Notes to Consolidated Financial Statements and Supplementary Data included in Item 8. Financial Statements and Supplementary Data. As a result of the assessment it was concluded that it was not cost effective to continue the development and deployment of the software and technology upon which the reengineering program was based and that the reengineering software and technology had no alternative useful application in the Company's operations. In lieu of further developing and deploying the reengineering software and technology, the Company intends to further refine, enhance and develop certain of the Company's existing software and billing systems and to migrate the Company's billing and accounts receivable management systems to the Company's most proven software systems and technology, so as to reduce the number of systems and technologies that must be maintained and supported. Planned Divestitures and Assessments of Non-Core Businesses As part of the Company's strategy to focus on the healthcare provider market and to meet its contractual loan obligations under the Second Amended Facility, the Company's 1997 business plan includes the planned divestiture of HRI and the assessment of alternatives for the BSG Group (BSG Corporation ("BSG"), Rapid System Solutions, Inc. ("Rapid Systems") and Sage Communications, Inc. ("Sage")). The Company remains confident that the amortization obligations under the Second Amended Facility will be timely met through the divestiture of HRI. Consistent with these objectives, in January 1997, the Company engaged Bear, Stearns & Co., Inc. to act as its exclusive financial advisor in connection with the divestiture of HRI. The Company has recently filed a registration statement relating to an initial public offering of 100% of the outstanding capital stock of HRI and, concurrently, is in the market actively soliciting interest from prospective financial and strategic buyers for this business unit. The Company remains confident that these steps will result in the divestiture of HRI within the appropriate time frame and believes that the net proceeds of such divestiture will be more than adequate to meet all amortization obligations required to be paid during 1997 under the Second Amended Facility. The alternatives with respect to the BSG Group include, but are not limited to, seeking a buyer, a spin-off transaction or other capital raising alternatives. DESCRIPTION OF BUSINESS BY INDUSTRY SEGMENT The following description of the Company's business by industry segment should be read in conjunction with Note 16 of Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data. Services Medaphis is a leading provider of business management services to the healthcare industry in the United States. The Company's business management services enable healthcare providers to outsource to Medaphis business management functions associated with the delivery of healthcare, thereby allowing physicians and hospitals to focus on delivering quality medical services to their patients. The services provided by the Company include both revenue and cost management services. Revenue management services encompass billing and accounts receivable management services consisting of medical coding, automated patient billing, claims submission, capitation analysis, past due and delinquent accounts receivable collection and contract 2 5 negotiations with payors, including managed care organizations and other services associated with the revenue cycle of a healthcare provider. Cost management services include comprehensive practice management services consisting of front office administration, benefit plan design and administration, cash flow forecasting and budgeting, general consulting services and other services associated with the management of the costs of running a practice for a healthcare provider. In addition, through HRI the Company provides subrogation and related recovery services primarily to healthcare payors to assist them in recovering the related benefits provided to insureds who are injured in accidents or under other circumstances where a third party is ultimately responsible for paying such benefits. Medaphis plans to divest HRI. The Company provides business management services to approximately 20,000 physicians and 2,500 hospitals in all 50 states and subrogation and recovery services to healthcare plans covering in excess of 31 million people throughout the United States. Accounts receivable and practice management services are normally provided to customers under contractual arrangements which range from month-to-month to longer durations, renew automatically at the end of the initial term and can be canceled by either party with between 90 and 180 days prior written notification. Fees payable to the Company for its accounts receivable management services are generally based on a percentage of cash collected by the Company for its clients. Fees are negotiated based on the breadth and types of services provided, expected collectibility of the client's accounts receivable portfolio and the cost of providing such services. The Company strives to retain its customers to provide a recurring base of revenue. No single client of the Company in this industry segment accounted for 10% or more of the Company's consolidated revenue in 1996. The Company's business management services to hospitals include not only billing and accounts receivable management services, but also specialized accounts receivable management services that generally involve more intensive accounts receivable services, including automated collection procedures. The Company's specialized accounts receivable management services for hospitals are usually provided with respect to a specific portfolio or specific type of accounts receivable. The management services business in the healthcare industry is highly competitive. The Company competes with national and regional physician and hospital reimbursement organizations and certain physician groups and hospitals which provide their own business management services. Competition among these organizations is based upon the relationship with the client or prospective client, the efficiency and effectiveness of converting medical and hospital services to cash, the ability to provide proactive practice management services and, to the extent that service offerings are comparable, upon price. Healthcare Information Technology ("HIT") The Company's HIT group is a leading provider of information management systems to the healthcare industry. Medaphis' products address both the business and clinical management needs of healthcare providers. The Company's products generally function in either a stand-alone provider setting or across the healthcare enterprise. Business management products include those designed to effectively utilize and share staff by automated staff scheduling, to improve operating room utilization and inventory management via automated scheduling and inventory systems, to improve staff productivity by reducing or eliminating repetitive or redundant tasks and to implement best practices via automated expert-systems technologies. Medaphis' clinical management products can be used to check for redundant or duplicative procedures, to provide information access to assist the provider in clinical decision making, to automate manual care protocols and to allow real-time shared access to a patient's clinical information. Medaphis' products also provide a variety of interfaces to third-party products and services which complement the Company's products and further assist providers with their business and clinical information management needs. Medaphis provides its healthcare information technology products to over 1,800 hospitals and approximately 4,000 physicians, primarily in the United States. The Company provides products to its customers via contractual relationships that vary depending on the type of products or services being purchased, such as software licenses, hardware purchases, implementation services and continuing customer support and software maintenance activities. Timing of amounts paid to the Company vary by the type of product provided, but generally include an up front amount followed by payments tied to completion of implementation events. 3 6 Customer support and software maintenance fees generally renew automatically. The Company strives to retain its customers to provide a recurring base of revenue. No single client of the Company in this industry segment accounted for 10% or more of the Company's consolidated revenue during 1996. The healthcare information technology business is highly competitive. The Company competes primarily with national companies, many of which have longer operating histories and greater financial resources than those of the Company. These competitors exist in both the "best of breed" niche marketplace and in the enterprise-wide market for broad sets of application products. Competition among these companies is based on product quality, ease of use and ease of integration of new products with other existing and planned applications. BSG Group In February 1997, Medaphis announced that it was assessing alternatives for its BSG Group, including a sale, spin-off or other alternative, such as a partial sale or a joint venture. The BSG Group provides information technology and change management services to organizations seeking to transform their operations through the strategic use of client/server and other advanced technologies. The BSG Group focuses on customers in industries where technology-enabled change and reengineering can have a significant competitive impact. The BSG Group seeks to establish long-term alliances with its customers, enabling them to increase revenue, raise productivity and improve product quality. The BSG Group offers a wide range of services that enable customers to utilize effectively advanced information technologies, including those that incorporate client/server architectures. Its information technology services include consulting, change management, technology migration, application development, systems integration, package installation, training and ongoing systems management. Through long-term alliances with its customers, the BSG Group helps them to increase revenue, to raise productivity and to improve product quality. Besides working closely with its customers' information technology professionals and users, the Company establishes relationships with its customers' senior management who increasingly view technology as critical to overall business strategy. No single client of the Company in this industry segment accounted for 10% or more of the Company's consolidated revenue in 1996. During the third quarter of 1996, Medaphis consolidated the business operations of its wholly owned subsidiary, Imonics Corporation ("Imonics"), into BSG. Imonics operated a software development and support and systems integration outsourcing business acquired by Medaphis in December 1994. In 1996, Imonics' business operations were discontinued and the responsibility for completing Imonics' unfinished software engineering projects was transferred to the BSG Group. The client/server information technology and change management industry is highly fragmented and characterized by low barriers to entry, rapid change and intense competition. The markets in which the BSG Group competes include companies specializing in information technology and systems integration consulting services, application development companies, software development and systems integration units of major computer equipment manufacturers, information systems facilities management and outsourcing organizations, major accounting firms and information systems groups of large general management consulting firms. Many of the BSG Group's competitors have longer operating histories and substantially greater financial, technical and marketing resources, and generate greater systems technology consulting and systems integration revenue, than does the BSG Group. The introduction of lower priced competition or significant price reductions by current or potential competitors, or such competitors' ability to respond more quickly than the BSG Group to new or emerging technologies or changes in customer requirements, could have an adverse effect on the BSG Group's business. Many of the BSG Group's current and potential customers periodically evaluate whether to staff system implementation and deployment projects with their in-house information systems staff instead of an outside services company. 4 7 RESULTS BY INDUSTRY SEGMENT Information relating to the Company's industry segments, including revenue, operating profit or loss and identifiable assets attributable to each segment for each of the fiscal years 1994 through 1996 is presented in Note 16 of Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. HEALTHCARE INDUSTRY Because a substantial portion of its revenue is derived from organizations involved in the U.S. healthcare system, the Company's business is impacted by trends in the healthcare industry. As healthcare expenditures have grown as a percentage of the U.S. gross national product, public and private healthcare cost containment measures have applied pressure to the margins of healthcare providers. Historically, some healthcare payors have willingly paid the prices established by providers while other healthcare payors, notably government programs and managed care companies, have paid far less than established prices and, in many cases, less than the average cost of providing the services. Consequently, prices charged to healthcare payors willing to pay established prices have increased in order to recover the cost of services purchased by the government and others but not paid by them (i.e., "cost shifting"). In addition, the increasing complexity in the reimbursement system and the assumption of greater payment responsibility by individuals have caused healthcare providers to experience increased receivables and bad debt levels and higher business office costs. Healthcare providers historically have addressed these pressures on profitability by increasing their prices, by relying on demographic changes to support increases in the volume and intensity of medical procedures, and by cost shifting; nonetheless, management believes that the revenue growth rate experienced by the Company's clients continues to be adversely affected by increased utilization of managed care providers and other industry factors impacting healthcare providers in the United States. At the same time, the process of submitting healthcare claims for reimbursement to third-party payors in accordance with applicable industry and regulatory standards continues to grow in complexity and to become more costly. Management believes that these trends have placed pressure on the rate of revenue growth and profit margins of the Company's physician and hospital accounts receivable and practice management operations. Due to these revenue and margin pressures, Medaphis Physician Services Corporation ("MPSC"), the Company's largest subsidiary providing accounts receivable and practice management services to physicians, did not significantly contribute to the Company's operating profit for 1996, nor is it expected to significantly contribute until further progress is made in, among other things, ongoing initiatives designed to reduce redundant costs, improve efficiencies and enhance operational effectiveness in MPSC's operations. The United States healthcare industry continues to experience significant change as federal and state governments, as well as private industry, work to bring more efficiency and effectiveness to the healthcare system. Medaphis continues to evaluate governmental and industry reform initiatives in an effort to position itself to take advantage of the opportunities created thereby. RESEARCH AND DEVELOPMENT Information regarding research and development (which consists primarily of software development costs) is included in Note 1 of Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data. REGULATION Under Medicare law, physicians and hospitals are only permitted to assign Medicare claims to a billing and collection service in certain limited circumstances. The Medicare statutes that restrict the assignment of Medicare claims are supplemented by Medicare regulations and provisions in the Medicare Carrier's Manual (the "Manual"). The Medicare regulations and the Manual provide that a billing service that prepares and sends bills for the provider or physician and does not receive and negotiate the checks made payable to the 5 8 provider or physician does not violate the restrictions on assignment of Medicare claims. Management believes that its practices do not violate the restrictions on assignment of Medicare claims, but rather the Company operates in a manner consistent with these provisions because it bills only in the name of the medical provider, checks and payments for Medicare services are made payable to the medical provider and the Company lacks any power, authority or ability to negotiate checks made payable to the medical provider. Medaphis' medical billing and collection activities are also governed by numerous federal and state civil and criminal laws. In general, these laws provide for various fines, penalties, multiple damages, assessments and sanctions for violations, including possible exclusion from Medicare, Medicaid and certain other federal and state healthcare programs. See Item 3. Legal Proceedings. Submission of claims for services or procedures that are not provided as claimed may lead to civil monetary penalties, criminal fines, imprisonment and/or exclusion from participation in Medicare, Medicaid and other federally funded healthcare programs. Specifically, the Federal False Claims Act allows a private person to bring suit alleging false or fraudulent Medicare or Medicaid claims or other violations of the statute and for such person to share in any amounts paid to the government in damages and civil penalties. Successful plaintiffs can receive up to 25-30% of the total recovery from the defendant. Such qui tam actions or "whistle-blower lawsuits" have increased significantly in recent years and have increased the risk that a company engaged in the healthcare industry, such as Medaphis and many of its customers, may become the subject of a federal or state investigation or may ultimately be required to defend a false claims action, may be subjected to government investigation and possible criminal fines, may be sued by private payors and may be excluded from Medicare, Medicaid and/or other federally funded healthcare programs as a result of such an action. The government on its own may also institute a Civil False Claims Act case, either in conjunction with a criminal prosecution or as a stand alone civil case. Whether instituted by a qui tam plaintiff or by the government, the government can recover triple its damages together with civil penalties of $5,000 -- $10,000 per false claim. Under applicable case law, a party successfully sued under the Federal False Claims Act may be jointly and severally liable for damages and penalties. Some state laws also provide for false claims actions, including actions initiated by a qui tam plaintiff. There can be no assurance that Medaphis will not be the subject of false claims or qui tam proceedings relating to its billing and collection activities or that Medaphis will not be the subject of further government scrutiny or investigations relating to its billing and accounts receivable management services operations. See Item 3. Legal Proceedings. Any such proceeding or investigation could have a material adverse effect upon the Company. Credit collection practices and activities are regulated by both federal and state law. The Federal Fair Debt Collection Practices Act (the "Federal Fair Debt Act") sets forth various provisions designed to eliminate abusive, deceptive and unfair debt collection practices by debt collectors. The Federal Fair Debt Act also provides for, among other things, a civil right of action against any debt collector who fails to comply with the provisions thereof. Various states have also promulgated laws and regulations that govern credit collection practices. In general, these laws and regulations prohibit certain fraudulent and oppressive credit collection practices and also may impose license or registration requirements upon collection agencies. In addition, state credit collection laws and regulations generally provide for criminal fines, civil penalties and injunctions for failure to comply with such laws and regulations. Although most of the Company's billing and accounts receivable management services the Company provides to its clients are not considered debt collection services, the Company may be subjected to regulation as a "debt collector" under the Federal Fair Debt Act and as a "collection agency" under certain state collection agency laws and regulations. Management believes that the Company operates in accordance with the Federal Fair Debt Act and complies in all material respects with the applicable collection agency laws and regulations governing collection practices in the states in which it conducts its business or is exempt from such laws and regulations. The ownership and operation of hospitals is subject to comprehensive regulation by federal and state governments which may adversely affect hospital reimbursement. Hospitals are paid a predetermined amount for operating expenses relating to each Medicare patient admission based on the patient's diagnosis. Additional changes in the reimbursement provisions of the Medicare and Medicaid programs may continue to reduce the rate of increase of federal expenditures for hospital inpatient costs and charges. Such changes could 6 9 have an adverse effect on the operations of hospitals in general, and consequently reduce the amount of the Company's revenue related to its hospital clients. GOVERNMENTAL BUDGETARY CONSTRAINTS AND HEALTHCARE REFORM The federal government in recent years has placed increased scrutiny on the billing and collection practices of healthcare providers and related entities. This scrutiny has been directed at, among other things, fraudulent billing practices. The Department of Health and Human Services in recent years has increased the resources of its Office of the Inspector General ("OIG") specifically to pursue both false claims and fraud and abuse violations under the Medicare program. This heightened examination has resulted in a number of high profile investigations, lawsuits and settlements. In 1996, Congress enacted the Health Insurance Portability and Accounting Act of 1996, Pub. L. No. 104-191, 1996 U.S.C.C.A.N. (110 Stat. 1936) (the "Health Insurance Act"), which includes an expansion of certain fraud and abuse provisions, such as expanding the application of Medicare and Medicaid fraud penalties to other federal healthcare programs, and creating additional criminal offenses relating to "healthcare benefit programs," which are defined to include both public and private payor programs. The Health Insurance Act also provides for forfeitures and asset freezing orders in connection with such healthcare offenses. Civil monetary penalties and program exclusion authority available to the OIG also have been expanded. The Health Insurance Act contains provisions for instituting greater coordination of federal, state and local enforcement agency resources and actions through the OIG. There also have been several recent healthcare reform proposals which have included an expansion of the anti-kickback laws to include referrals of any patients regardless of payor source. In the 1995 and 1996 sessions of the United States Congress, the focus of healthcare legislation was on budgetary and related funding mechanism issues. A number of reports, including the 1995 Annual Report of the Board of Trustees of the Federal Hospital Insurance Program, projected that the Medicare "trust fund" is likely to become insolvent by the year 2002 if the current growth rate of approximately 10% per annum in Medicare expenditures continues. Similarly, federal and state expenditures under the Medicaid program are projected to increase significantly during the same seven-year period. In response to these projected expenditure increases, and as part of an effort to balance the federal budget, both the Congress and the Clinton Administration have made proposals to reduce the rate of increase in projected Medicare and Medicaid expenditures and to change funding mechanisms and other aspects of both programs. In late 1995, Congress passed legislation that would substantially reduce projected expenditure increases and would make significant changes in the Medicare and the Medicaid programs. The Clinton Administration has proposed alternate measures to reduce, to a lesser extent, projected increases in Medicare and Medicaid expenditures. Neither proposal became law prior to Congress' 1996 adjournment. Medaphis anticipates that both the Clinton Administration and the Republican majorities in Congress will introduce legislation in 1997 designed to reduce projected increases in Medicare and Medicaid expenditures and to make other changes in the Medicare and Medicaid programs. Medaphis anticipates that such proposed legislation would, if adopted, change aspects of the present methods of paying physicians under such programs and provide incentives for Medicare and Medicaid beneficiaries to enroll in health maintenance organizations and other managed care plans. Medaphis cannot predict the effect of any such legislation, if adopted, on its operations. A number of states in which Medaphis has operations either have adopted or are considering the adoption of healthcare reform proposals at the state level. Medaphis cannot predict the effect of proposed state healthcare reform laws on its operations. Additionally, certain reforms are occurring in the healthcare market which may continue regardless of whether comprehensive federal or state healthcare reform legislation is adopted and implemented. These market reforms include certain employer initiatives such as creating purchasing cooperatives and contracting for healthcare services for employees through managed care companies (including health maintenance organizations), and certain provider initiatives such as risk-sharing among healthcare providers and managed care companies through capitated contracts and integration among hospitals and physicians into comprehensive delivery systems. Consolidation of management and billing services by integrated delivery systems may result in a decrease in demand for Medaphis' billing and collection services for particular physician practices, but this decrease may be offset by an increase in demand for 7 10 Medaphis' consulting and comprehensive business management services (including billing and collection services) for the new provider systems. EMPLOYEES The Company currently employs approximately 9,375 full-time and part-time employees. The Company has no labor union contracts and believes relations with its employees are satisfactory. ACQUISITIONS In fiscal 1996, Medaphis completed four acquisitions that were accounted for as purchases and four acquisitions that were accounted for as poolings-of-interests. The four purchase acquisitions are as follows: On February 12, 1996, the Company acquired substantially all of the assets and assumed certain of the related liabilities of Medical Management Computer Services, Inc. ("MMCS"). MMCS provides billing and accounts receivable management services primarily to emergency room physicians. On February 20, 1996, the Company acquired substantially all of the assets and assumed certain of the related liabilities of CBT Financial Services, Inc. ("CBT"). CBT provides collection and billing services primarily to hospitals. On April 16, 1996, the Company acquired the outstanding capital stock of The Medico Group, Ltd. ("MEDICO"). MEDICO provides billing and accounts receivable management services primarily to anesthesiologists. On October 8, 1996, the Company acquired the assets and assumed substantially all of the liabilities of Sage. Sage provides systems integration services and data warehousing decision support applications, primarily to the telecommunications industry. For each of the foregoing acquisitions, the purchase price was allocated to the assets acquired and the liabilities assumed based on their estimated fair value as of the date of acquisition. The Company acquired the following businesses in fiscal 1996 which were recorded using the pooling-of-interests method of accounting: On February 29, 1996, the Company exchanged 92,991 shares of its Common Stock for all of the outstanding shares of common stock of Intelligent Visual Computing, Inc. ("IVC"). IVC provides systems integration and work flow engineering systems and services to clients in healthcare and other industries. On April 3, 1996, the Company exchanged approximately 1.1 million shares of its Common Stock for all of the outstanding shares of common stock of Rapid Systems. Rapid Systems is a client server/systems integration company whose core competencies include network design, integration and management, database design and development, graphical user interface application design, development and implementation, and strategic systems engineering and computer security. During 1995, Rapid Systems had revenue of $14.7 million. On May 6, 1996, the Company exchanged approximately 7.5 million shares of its Common Stock for all of the outstanding shares of common stock of BSG. In addition, the Company assumed BSG stock options representing approximately 2.3 million additional shares of the Company's Common Stock. BSG provides information technology and change management services to organizations seeking to transform their operations through the strategic use of client/server and other advanced technologies. During 1995, BSG had revenue of $69.7 million. On June 29, 1996, the Company exchanged approximately 6.2 million shares of its Common Stock for all of the outstanding shares of common stock of Health Data Sciences Corporation ("HDS"). In addition, the Company assumed HDS stock options representing approximately 433,000 additional shares of the Company's Common Stock. HDS is a developer and supplier of advanced healthcare information systems which address a healthcare enterprise's clinical information needs through the integrated 8 11 monitoring, scheduling, documentation and control of patient care. During 1995, HDS had revenue of $12.2 million. Because these acquisitions have been recorded using the pooling-of-interests method of accounting, no adjustments have been made to the historical carrying amounts of assets acquired and liabilities assumed. The consolidated financial statements included in this Report have been restated to include the financial position and operating results of Rapid Systems, BSG and HDS for all periods prior to the acquisitions. No restatement has been made for the financial position and operating results of IVC prior to the beginning of the fiscal year of its acquisition due to its immateriality. In August 1996 Medaphis announced that it did not anticipate any significant acquisitions in the near term. ITEM 2. PROPERTIES The Company's principal executive offices are leased and are located in Atlanta, Georgia. The lease expires in February 2000. SERVICES MPSC's principal office is leased and is located in Atlanta, Georgia. The lease expires in February 2000. In addition to its principal office, MPSC, through its various operating subsidiaries, occupies approximately 25 information processing centers ("IPCs") and local business offices throughout the United States. Three of the facilities are owned and are unencumbered. The remainder of the facilities are leased with expiration dates ranging from March 1997 to December 2008. Medaphis Services Corporation's principal office is leased and is located in Norcross, Georgia. The lease expires in May 2002. HIT The HIT group's principal office is leased and is located in Atlanta, Georgia. The lease expires in February 2000. In addition to its principal office, HIT, through its various operating subsidiaries, occupies approximately 25 offices in the United States, Australia, Canada and Europe. All facilities are leased and such leases expire on dates ranging from March 1997 to April 2004. BSG GROUP The BSG Group's principal offices are located in Austin and Houston, Texas. The leases expire in the year 2000. In addition to its principal offices, the BSG Group, through its various operating subsidiaries, occupies approximately 25 offices in the United States. All facilities are leased and such leases expire on dates ranging from April 1998 to April 2005. ITEM 3. LEGAL PROCEEDINGS The United States Attorney's Office for the Central District of California is conducting an investigation (the "Federal Investigation") of Medaphis' billing and collection practices in its offices located in Calabasas and Cypress, California (the "Designated Offices"). Medaphis first became aware of the Federal Investigation when it received search warrants and grand jury subpoenas on June 13, 1995. Although the precise scope of the Federal Investigation is not known to the Company at this time, Medaphis believes that the U.S. Attorney's Office is investigating allegations of billing fraud and that the inquiry is focused upon Medaphis' billing and collection practices in the Designated Offices. Numerous federal and state civil and criminal laws govern medical billing and collection activities. In general, these laws provide for various fines, penalties, multiple damages, assessments and sanctions for violations, including possible exclusion from Medicare, Medicaid and certain other federal and state healthcare programs. Although the Designated Offices represent less than 2% of Medaphis' annual revenue, there can be no assurance that the Federal Investigation will be resolved promptly, that additional subpoenas or search warrants will not be received by Medaphis or that the Federal Investigation will not have a material adverse effect upon the Company. The Company recorded 9 12 charges of $12 million in the third quarter of 1995 and $2 million in the fourth quarter of 1996 solely for the administrative fees, costs and expenses it anticipates incurring in connection with the Federal Investigation and the putative class action lawsuits described below which were filed following the Company's announcement of the Federal Investigation. The charges are intended to cover only the anticipated expenses of the Federal Investigation and the related lawsuits and do not include any provision for fines, penalties, damages, assessments, judgments or sanctions that may arise out of such matters. Following the announcement of the Federal Investigation, Medaphis, various of its current and former officers and directors and the lead underwriters associated with Medaphis' public offering of Common Stock in April 1995 were named as defendants in putative shareholder class action lawsuits filed in the United States District Court for the Northern District of Georgia. In general, these lawsuits allege violations of the federal securities laws in connection with Medaphis' public statements and filings under the federal securities acts, including the registration statement filed in connection with Medaphis' public offering of Common Stock in April 1995. On October 13, 1995, the named plaintiffs in these lawsuits filed a consolidated class action complaint (the "Consolidated Complaint"). On January 3, 1996, the court denied defendant's motion to dismiss the Consolidated Complaint. On April 11, 1996, certain of the named plaintiffs to the Consolidated Complaint voluntarily dismissed with prejudice all of their claims. As a result of these dismissals, the Consolidated Complaint no longer contains any claims based on the 1933 Act and the Company's underwriters and outside directors are no longer named as defendants. On June 26, 1996, the court denied the plaintiffs' motion to certify a plaintiffs' class. The plaintiffs and the defendants have reached an agreement in principle to settle this action on a class-wide basis for $4.75 million, subject to court approval and other customary conditions (the "1995 Class Action Settlement"). The 1995 Class Action Settlement would also include the related putative class action lawsuit currently pending in the Superior Court of Cobb County, Georgia, described more fully below. The Company expects to receive approximately $3.7 million from insurance to fund a portion of the 1995 Class Action Settlement and accrued approximately $1.2 million in the quarter ending December 31, 1996 to fund the anticipated balance of the 1995 Class Action Settlement and to pay certain fees incident thereto. On November 5, 1996, Medaphis, Randolph G. Brown, Michael R. Cote and James S. Douglass were named as defendants in a putative shareholder class action lawsuit filed in Superior Court of Cobb County, State of Georgia. This lawsuit alleges violations of Georgia securities laws based on the same public statements and filings generally described above. The lawsuit is brought on behalf of a putative class of purchasers of Medaphis Common Stock during the period from March 29, 1995 through June 15, 1995. The plaintiffs seek compensatory damages and costs. As noted above, it is currently contemplated that this action will be settled as part of the 1995 Class Action Settlement. The Company and its clients from time to time have received, and the Company anticipates that they will receive in the future, official inquiries (including subpoenas, search warrants, as well as informal requests) concerning particular billing and collection practices related to certain subsidiaries of the Company and its many clients. In March 1997, the Company was informed by the Civil Division of the Department of Justice that it is investigating allegations concerning the Company's Gottlieb's Financial Services, Inc. ("GFS") subsidiary. No subpoenas or other process have been issued to the Company or to GFS in connection with the investigation. There can be no assurance that this matter will be resolved promptly, that subpoenas will not be received by Medaphis or that the investigation will not have a material adverse effect upon Medaphis. Following the Company's August 14, 1996 announcement regarding earnings expectations and certain charges, Medaphis and certain of its current and former officers, one of whom was also a director, were named as defendants in nineteen putative shareholder class action lawsuits filed in the United States District Court for the Northern District of Georgia. On November 22, 1996, the plaintiffs in these lawsuits filed a Consolidated Amended Class Action Complaint (the "1996 Consolidated Complaint"). In general, the 1996 Consolidated Complaint alleges violations of the federal securities laws in connection with Medaphis' filings under the federal securities acts and public disclosures. The 1996 Consolidated Complaint is brought on behalf of a class of all persons who purchased or otherwise acquired Medaphis Common Stock between January 6, 1996 and October 21, 1996. The 1996 Consolidated Complaint also asserts claims on behalf of a sub-class of all persons who acquired Medaphis Common Stock pursuant to the merger between Medaphis and HDS. On 10 13 December 30, 1996, the defendants filed a motion to dismiss most of the 1996 Consolidated Complaint. On February 3, 1997, the plaintiffs filed a Consolidated Second Amended Complaint. On February 14, 1997, the defendants moved to dismiss the Consolidated Second Amended Complaint in its entirety. On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit Sharing Plan filed a shareholder derivative lawsuit in the United States District Court for the Northern District of Georgia alleging that certain of Medaphis' current and former directors breached their fiduciary duties, were grossly negligent, and breached various contractual obligations to Medaphis by allegedly failing to implement and maintain an adequate system of internal accounting controls, allowing Medaphis to commit securities law violations and damaging Medaphis' reputation. The plaintiff seeks compensatory damages and costs. On January 28, 1997, Medaphis and certain individual defendants filed a motion to dismiss the complaint. On February 11, 1997, the plaintiff filed an amended complaint adding as defendants additional current and former directors and officers of Medaphis. Medaphis has not yet responded to the amended complaint. On November 7, 1996, Health Systems International, Inc. filed suit in the Superior Court for the State of California, County of Los Angeles against Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed Medaphis directors, officers and employees. Generally, this lawsuit alleges that the defendants violated federal and California securities laws and common law by, among other things more fully described in the complaint, making material misstatements and omissions in public and private disclosures in connection with the acquisition of HDS. The plaintiff seeks rescissory, compensatory and punitive damages, rescission, injunctive relief and costs. On January 10, 1997, the defendants filed a demurrer to the complaint. The demurrer was denied on February 5, 1997. On March 18, 1997, the court denied the plaintiff's motion for a preliminary injunction. As a result of the Company's restatement of its fiscal 1995 financial statements, the Company may not be able to sustain a defense to strict liability on certain claims under the 1933 Act, but the Company believes that it has substantial defenses to the alleged damages relating to the 1933 Act claims. A putative class action complaint was filed by Ernest Hecht and Stephen D. Strandberg against Steven G. Papermaster, Robert E. Pickering, Jr., David S. Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division, Essex County, State of New Jersey. The alleged class consists of persons and entities whose options to purchase BSG common stock were converted to Medaphis stock options in connection with Medaphis' acquisition of BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary duties of candor, loyalty and fair dealing and negligence against the BSG defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud and deceit against the Medaphis defendants (Medaphis and Brown). On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two entities they control made a demand for indemnification under an indemnification agreement executed by Medaphis in connection with its acquisition of BSG in May 1996. On the date of the demand, Mr. Papermaster was an executive officer and a director of Medaphis. Mr. Papermaster resigned such positions on March 21, 1997, although he remains a director and executive officer of BSG. The indemnification demand claims damages of $35 million (the maximum damages payable by Medaphis under the indemnification agreement) for the alleged breach by the Company of its representations and warranties made in the merger agreement between Medaphis and BSG. The Company believes it has meritorious defenses to the indemnification claim. The Company also has received other written demands from various stockholders, including stockholders of recently acquired companies. To date, these other stockholders have not filed lawsuits. On January 8, 1997, the Securities and Exchange Commission (the "Commission") notified the Company that it is conducting a non-public investigation into, among other things, certain trading and other issues related to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's loss for the quarter ending September 30, 1996 and its restated consolidated financial statements for the three months and year ended December 31, 1995 and its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996. The Company intends to cooperate fully with the Commission in its investigation. Although the Company believes that it has meritorious defenses to the claims of liability or for damages in the actions against, and written demands placed upon, the Company, there can be no assurance that 11 14 additional lawsuits will not be filed against the Company, that the lawsuits, the written demands and the pending governmental investigations will not have a disruptive effect upon the operations of the business, that the written demands, the defense of the lawsuits and the pending investigations will not consume the time and attention of the senior management of the Company and that the resolution of the lawsuits, the written demands and the pending governmental investigations will not have a material adverse effect upon the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to security holders for a vote during the fourth quarter of 1996. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information regarding the executive officers of the Company as of March 31, 1997:
YEAR FIRST NAME AGE POSITION ELECTED OFFICER - ---- --- -------- --------------- David E. McDowell................ 54 Chairman and Chief Executive 1996 Officer and Director Carl James Schaper............... 45 Executive Vice President and 1997 President of Medaphis Healthcare Information Technology Company William R. Spalding.............. 38 Executive Vice President -- 1996 Strategic Planning Jerome H. Baglien................ 47 Senior Vice President and 1997 Chief Financial Officer Daniel S. Connors, Jr............ 54 Senior Vice President -- 1996 Personnel & Administration Harvey Herscovitch............... 59 Senior Vice 1997 President -- Strategy & Organization
Each of the above executive officers was elected by the Board of Directors to hold office until the next annual election of officers and until his successor is elected and qualified or until his earlier resignation or removal. DAVID E. MCDOWELL joined Medaphis in October 1996 as Chairman and Chief Executive Officer. Mr. McDowell was appointed to the Medaphis Board of Directors in May 1996. From 1992 to 1996, Mr. McDowell was President, Chief Operating Officer and a director of McKesson Corporation. McKesson Corporation is the world's largest distributor of pharmaceutical and healthcare products through McKesson Drug Company in the United States and Medis Health and Pharmaceutical Services, Inc. in Canada. CARL JAMES SCHAPER joined Medaphis in March 1997 as President of Medaphis Healthcare Information Technology Company and Executive Vice President of Medaphis. From 1994 to 1997, Mr. Schaper held numerous positions with Dun & Bradstreet Software, including President, Chief Executive Officer, Chief Operating Officer, Executive Vice President, and Senior Vice President, Field Operations and Marketing. From 1989 to 1994, Mr. Schaper held several positions with Banyan Systems, Inc., including Senior Vice President, Worldwide Sales and Marketing, Vice President, North America Field Operations and Regional Vice President. WILLIAM R. SPALDING joined Medaphis in January 1996 as Senior Vice President -- Administration, General Counsel and Secretary and was promoted to the position of Executive Vice President -- Strategic Planning in February of 1997. Prior to joining the Company, Mr. Spalding served as a partner in the law firm 12 15 of King & Spalding, where he specialized in mergers and acquisitions and securities transactions. Mr. Spalding joined King & Spalding in 1985. JEROME H. BAGLIEN joined Medaphis in February 1997 as Senior Vice President and Chief Financial Officer. From 1993 to 1996 Mr. Baglien was employed by Keebler Company where he served as Chief Financial Officer. From 1988 to 1993, Mr. Baglien served as Vice President, Finance and Administration with Lamb Weston, Inc., a wholly owned subsidiary of ConAgra. From 1983 to 1988, Mr. Baglien was employed by Tree Top, Inc. as Chief Financial Officer and Controller. DANIEL S. CONNORS, JR. joined Medaphis in November 1996 as Senior Vice President -- Personnel and Administration. During 1996, Mr. Connors served as Vice President, Strategic Implementation with D.F. Blumberg & Associates, Inc. From 1993 to 1996, Mr. Connors served as President and Chief Operating Officer of Technology Service Solutions, an IBM/Eastman Kodak joint venture company. From 1965 to 1993, Mr. Connors was employed by IBM Corporation where he held several executive positions and ultimately served as Vice President, Point of Sales Services. HARVEY HERSCOVITCH joined Medaphis in February 1997 and serves as Senior Vice President -- Strategy & Organization. From 1993 to December 1996, Mr. Herscovitch served as an independent consultant in the pharmaceutical benefits management and wholesale pharmaceutical distribution industries. Prior to 1993, Mr. Herscovitch was employed by IBM Corporation in a variety of executive positions dealing with the services side of the business. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded in the Nasdaq National Market under the symbol MEDA. The prices in the table below represent the high and low sales price for the Common Stock as reported in the National Market System for the periods presented. Such prices are based on inter-dealer bid and asked prices without markup, markdown, commissions or adjustments and may not represent actual transactions.
YEAR ENDED DECEMBER 31, 1995 HIGH LOW ---------------------------- ------- ------- First Quarter............................................. $32.750 $22.000 Second Quarter............................................ 34.250 20.500 Third Quarter............................................. 30.375 20.250 Fourth Quarter............................................ 38.500 26.000
YEAR ENDED DECEMBER 31, 1996 HIGH LOW ---------------------------- ------- ------- First Quarter............................................. $53.250 $34.000 Second Quarter............................................ 50.250 34.625 Third Quarter............................................. 42.500 11.250 Fourth Quarter............................................ 18.500 8.250
The last reported sales price of the Common Stock as reported on the Nasdaq National Market on March 24, 1997 was $10.5625 per share. As of March 24, 1997 the Company's Common Stock was held of record by 822 stockholders. Medaphis has never paid cash dividends on its Common Stock and does not anticipate paying cash dividends in the foreseeable future, but intends instead to retain any future earnings for reinvestment in its business. The Second Amended Facility contains restrictions on the Company's ability to declare or pay cash dividends on its Common Stock. 13 16 RECENT SALES OF UNREGISTERED SECURITIES Conversion of Medaphis Convertible Subordinated Debentures Effective January 1, 1996, all holders of the Company's 6.5% convertible subordinated debentures exercised their rights to convert the debentures into an aggregate 4,526,786 shares of Medaphis Common Stock at $14.00 per share, or at an aggregate conversion price of $63,375,004. The Company relied on Section 4(2) of the 1933 Act as its exemption from the registration requirements of the 1933 Act. Warrants Issued in Connection with the Second Amended Facility On February 4, 1997, the Company entered into the Second Amended Facility. As an inducement for the lenders named therein to enter into the Second Amended Facility, the Company offered and issued to such lenders warrants to purchase the Company's Common Stock. The warrants contain a vesting arrangement whereby 1% of the Company's Common Stock vests in favor of the lenders on each of January 1, 1998 and April 1, 1998. The Company relied on Section 4(2) of the 1933 Act as its exemption from the registration requirements of the 1933 Act. Intelligent Visual Computing, Inc. On February 29, 1996, the Company acquired IVC by merger (the "IVC Merger"). As the merger consideration for the IVC Merger, Medaphis offered and issued to the former IVC shareholders an aggregate 92,991 shares of Medaphis Common Stock for all of the outstanding common stock, par value $.01 per share, of IVC. The Company relied on Section 4(2) of the 1933 Act as its exemption from the registration requirements of the 1933 Act. Issuance to Certain Employees of Health Data Sciences Corporation On January 21, 1997, the Company offered, and on February 4, 1997 issued, an aggregate 31,449 shares of restricted Medaphis Common Stock to certain key employees of HDS, a wholly owned subsidiary, for $.01 per share, or an aggregate offering and sales price of $314.49. The Company relied on Section 4(2) of the 1933 Act as its exemption from the registration requirements of the 1933 Act. ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected consolidated financial information for Medaphis for and as of each of the five fiscal years in the period ended December 31, 1996. The selected consolidated financial information of Medaphis for each of the four fiscal years in the period ended December 31, 1996 and as of December 31, 1996, 1995, 1994 and 1993 has been derived from the audited consolidated financial statements of Medaphis which give retroactive effect to the mergers with Automation Atwork Companies ("Atwork"), HRI, Medical Management Sciences, Inc. ("MMS"), Rapid Systems, BSG and HDS, all of which have been accounted for as poolings-of-interests. The selected consolidated financial data of Medaphis for the fiscal year ended December 31, 1992 and as of December 31, 1992 has been derived from the unaudited consolidated financial statements of Medaphis, which give retroactive effect to the mergers with Atwork, HRI, MMS, Rapid Systems, BSG and HDS. Management believes that the unaudited consolidated financial statements referred to above include all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair presentation of the financial position and results of operations for such periods. The loan commitments under the Company's Second Amended Facility will reduce to $200 million and $150 million as of July 31, 1997, and January 31, 1998, respectively, and will expire on June 30, 1998. In developing its 1997 business plan, the Company did not expect to generate sufficient cash flow from operations to meet the required debt reduction and, therefore, management of the Company has adopted plans to dispose of HRI and is seeking alternatives for the BSG Group which it believes will generate sufficient net proceeds to meet the required debt reductions. The Company has retained investment banking counsel to advise it on the divestiture of HRI as well as to assist in the evaluation of alternatives for the BSG Group. There can be no assurance that the Company will 14 17 be successful in its efforts divest HRI and/or the BSG Group. If the Company is unable to generate sufficient net proceeds through the divestiture of HRI and/or the BSG Group or obtain alternative debt financing by July 31, 1997, unless extended by the lenders until September 30, 1997, the Company's borrowings under the Second Amended Facility will become immediately due and payable. As a result, there are doubts that the Company will continue as a going concern, and therefore, the Company may be unable to realize its assets and discharge its liabilities in the normal course of business. The consolidated financial statements of the Company do not include any adjustments relating to the recoverability and classification of recorded asset amounts or to amounts and classification of liabilities that may be necessary should the Company be unable to continue as a going concern.
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 1996 1995 1994 1993 1992 --------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA Revenue.................................. $ 608,313 $559,877 $398,934 $279,326 $175,424 Salaries and wages....................... 398,573 325,868 227,109 164,474 106,296 Other operating expenses................. 163,677 140,296 95,195 71,363 51,241 Depreciation............................. 28,276 14,487 9,430 7,285 4,775 Amortization............................. 20,016 18,048 10,691 7,878 4,043 Interest expense, net.................... 11,585 10,062 5,926 6,573 965 Restructuring and other charges.......... 179,768 54,950 1,905 -- -- Income (loss) before extraordinary item and cumulative effect of accounting change................................ (124,621) (5,621) 32,523 14,704 5,534 Net income (loss)........................ (124,621) (5,621) 32,523 14,704 9,010(1) Pro forma net income (loss)(2)........... (123,642) (8,504) 30,706 13,524 9,629 Weighted average shares outstanding...... 71,225 56,591 60,245 51,109 48,843 PER SHARE DATA(2) Pro forma income (loss) before extraordinary item and cumulative effect of accounting change........... $ (1.74) $ (.15) $ 0.51 $ 0.26 $ 0.13 Pro forma net income loss................ $ (1.74) $ (.15) $ 0.51 $ 0.26 $ 0.21
AS OF DECEMBER 31, ------------------------------------------------------ 1996 1995 1994 1993 1992 --------- -------- -------- -------- -------- (IN THOUSANDS) BALANCE SHEET DATA Working capital.......................... $ 75,633 $ 95,230 $ 89,262 $ 71,278 $ 36,570 Intangible assets........................ 389,033 455,611 376,827 183,190 116,383 Total assets............................. 815,624 795,606 627,151 367,281 228,305 Long-term debt........................... 215,752 150,565 148,261 9,803 16,059 Convertible subordinated debentures...... -- 63,375 63,375 63,375 60,000 Stockholders' equity..................... 392,290 421,306 257,097 189,850 87,876
- --------------- (1) Reflects the extraordinary loss of $2.1 million relating to the prepayment of certain indebtedness net of income tax benefit and the cumulative benefit for the change in accounting for income taxes arising from the adoption of Statement of Financial Accounting Standards No. 109 of $5.6 million. (2) In 1995 and 1996, Company acquired Atwork, Consort, MMS, IVC, Rapid Systems and BSG in merger transactions accounted for as poolings-of-interests. Prior to the mergers, Atwork, Consort, MMS, IVC, Rapid Systems and a company acquired by BSG prior to the Company's merger with BSG had elected "S" corporation status for income tax purposes. As a result of the mergers (or, in the case of the company acquired by BSG, its acquisition by BSG), such entities terminated their "S" corporation elections. Pro forma net income (loss) and pro forma net income (loss) per common share are presented in the consolidated statements of operations as if each of these entities had been a "C" corporation during the periods presented. 15 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In fiscal 1996 Medaphis: (1) acquired eight companies in four transactions accounted for as purchases and in four transactions accounted for as poolings-of-interests; (2) recorded a charge of $138.6 million in the fourth quarter related to the abandonment of its reengineering program begun in late 1994, the shutdown of Imonics and other matters; (3) incurred a significant net loss due primarily to the reengineering abandonment and other restructuring charges and operating losses in both its BSG Group and Services segments; (4) was sued under the federal securities laws for allegedly misleading disclosures about earnings and other matters, which lawsuits have not been resolved and are costly for Medaphis to defend; and (5) used cash in excess of cash provided by operations to fund working capital of $7.9 million and incurred capital expenditures of $51.1 million, with the result that by December 31, 1996, the Company had borrowed $242.7 million of the $250 million available under its bank credit facilities. In response to these events, in February 1997 Medaphis entered into the Second Amended Facility which provides $35 million of additional debt capacity, but also requires significant reductions in the lenders' commitments to $200 million in July 1997 (which may be extended by the lenders to September 30, 1997) and to $150 million in January 1998. In order to generate funds necessary to make the required payments under the Second Amended Facility in July 1997 and January 1998, the Company announced its plan to sell or spin-off its wholly owned operating subsidiary, HRI, by filing a registration statement with the Commission relating to an initial public offering of 100% of the common stock of HRI. Because HRI is not considered a segment of the Company, the Company will not record the financial position, results of operations and cash flows of HRI as discontinued operations. Medaphis also is assessing alternatives for its BSG Group. The alternatives include, but are not limited to, seeking a buyer, a spin-off transaction or other capital raising alternatives. In February 1997, Medaphis announced the implementation during the 1997 fiscal year of a business plan focused on Medaphis' core business and comprised of the five following components: (1) exiting non-core businesses, such as the planned sale of HRI that is discussed below; (2) achieving improved predictability of results through enhanced management accountability and controls; (3) reducing costs and increasing efficiencies; (4) emphasizing customer service; and (5) implementing cross-selling initiatives. Medaphis' business is impacted by trends in the U.S. healthcare industry. As healthcare expenditures have grown as a percentage of the U.S. gross national product, public and private healthcare cost containment measures have applied pressure to the margins of healthcare providers. Historically, some healthcare payors have willingly paid the prices established by providers while other healthcare payors, notably the government and managed care companies, have paid far less than established prices (in many cases less than the average cost of providing the services). As a consequence, prices charged to healthcare payors willing to pay established prices have increased in order to recover the cost of services purchased by the government and others but not paid by them (i.e., "cost shifting"). The increasing complexity in the reimbursement system and the assumption of greater payment responsibility by individuals have caused healthcare providers to experience increased receivables and bad debt levels and higher business office costs. Healthcare providers historically have addressed these pressures on profitability by increasing their prices, by relying on demographic changes to support increases in the volume and intensity of medical procedures, and by cost shifting. Notwithstanding providers' responses to revenue pressures, management believes that the revenue growth rate experienced by the Company's clients continues to be adversely affected by increased managed care and other industry factors impacting healthcare providers in the United States. At the same time, the process of submitting healthcare claims for reimbursement to third-party payors in accordance with applicable industry and regulatory standards continues to grow in complexity and to become more costly. Management believes that these trends have placed pressure on the rate of revenue growth and profit margins of the Company's physician accounts receivable and practice management operations. Due to these revenue and margin pressures, MPSC, the Company's largest subsidiary providing accounts receivable and practice management services to physicians, did not significantly contribute to the Company's operating profit for 1996 and this trend is not expected to improve until further progress is made with, among other things, ongoing initiatives designed to reduce redundant costs, improve efficiencies and enhance operational effectiveness in MPSC's operations. 16 19 RESULTS OF OPERATIONS The following table shows certain items reflected in the Company's statements of operations as a percentage of revenue:
YEAR ENDED DECEMBER 31, ------------------------ 1996 1995 1994 ------ ------ ------ Revenue..................................................... 100.0% 100.0% 100.0% Salaries and wages.......................................... 65.5 58.2 56.9 Other operating expenses.................................... 26.9 25.1 23.9 Depreciation................................................ 4.6 2.6 2.3 Amortization................................................ 3.3 3.2 2.7 Interest expense, net....................................... 1.9 1.8 1.5 Restructuring and other charges............................. 29.6 9.8 0.5 ----- ----- ----- Income (loss) before income taxes........................... (31.8) (0.7) 12.2 Income tax expense (benefit)................................ (11.3) 0.3 4.0 ----- ----- ----- Net income (loss)........................................... (20.5) (1.0) 8.2 Pro forma adjustments 0.2 (0.5) (0.5) ----- ----- ----- Pro forma net income (loss)................................. (20.3)% (1.5)% 7.7% ===== ===== =====
REVENUE Revenue classified by the Company's different operating segments is as follows:
1996 1995 1994 -------- -------- -------- (IN THOUSANDS) Revenue: Services......................................... $415,328 $402,467 $291,536 BSG Group........................................ 113,988 98,615 57,732 HIT.............................................. 81,646 60,521 50,387 Corporate and eliminations....................... (2,649) (1,726) (721) -------- -------- -------- $608,313 $559,877 $398,934 ======== ======== ========
Services' operations in fiscal 1996 experienced minimal net business growth as new sales were largely offset by client losses. Services' revenue in 1996 increased 3.2% from 1995 as compared with an increase of 38.1% in 1995 from 1994. The slowdown in revenue growth is attributable to the above-mentioned revenue pressures on the physician accounts receivable and practice management operations. The growth in 1995 was primarily attributable to acquisitions. These client losses are partly due to the reengineering and consolidation effort undertaken by MPSC. During the consolidation effort, management's focus was redirected to consolidation and away from client service. Services' 1995 revenue growth resulted from acquisitions and an increase in the number of business management services clients. The BSG Group's 1996 revenues increased 15.6% from 1995 which had increased 70.8% from 1994. The increases in the BSG Group's revenue reflect the demand for the BSG Group's service offerings as migration to client/server architectures continued to accelerate. This demand for the BSG Group's services were negatively affected in 1996 by a decrease in the revenues generated by Imonics. HIT's revenue increased 34.9% in 1996 as compared with the same period in 1995. This increase is primarily the result of an increase in the number of healthcare information system licenses sold by HDS. Included in HIT's revenue for the 1996 fiscal year is approximately $14.5 million of onetime fees associated with these licenses. HIT's revenue for 1995 increased 20.1% from 1994. This growth was due to an increase in the sales of Atwork's scheduling products which was offset by HDS not selling as many healthcare information system licenses in fiscal year 1995 as compared to fiscal year 1994. 17 20 SALARIES AND WAGES Salaries and wages represented 65.5% of revenue in 1996 as compared with 58.2% and 56.9% in 1995 and 1994, respectively. The increase in salaries and wages as a percentage of revenue for 1996, as compared with 1995, is due to a slowdown in the growth of the Company's revenue and an increase in the employment levels (both employees and independent contractors) across the Company. The increase in 1995 resulted from a decrease in the revenue recognized at HDS offset by the changes in compensation to the former owners of Atwork. OTHER OPERATING EXPENSES Other operating expenses increased to 26.9% of revenue in 1996 from 25.1% in 1995 which had increased from 23.9% in 1994. The increase in other operating expenses as a percentage of revenue for 1996, as compared with 1995, is due to a slowdown in the growth of the Company's revenue. The increase in 1995 was a result of the decrease in the 1995 revenue at HDS primarily associated with the timing of new sales. Other operating expenses are primarily comprised of postage, facility and equipment rental, telecommunications, travel, office supplies, legal, accounting and other outside professional services. DEPRECIATION Depreciation expense was $28.3 million in 1996, $14.5 million in 1995 and $9.4 million in 1994. These increases reflect the Company's investment in property and equipment, including approximately $42 million of new computer and other data processing equipment purchased in connection with the Company's reengineering program, to support growth in its business, including acquisitions. The Company wrote down the value of the equipment purchased in connection with the Company's reengineering program to its net realizable value during the fourth quarter of 1996 and recorded a charge of approximately $16 million. The Company expects depreciation expense to increase by approximately $6.5 million in 1997 from the 1996 expense amount. AMORTIZATION Amortization of intangible assets, which are primarily associated with the Company's acquisitions and software products, was $20.0 million in 1996, $18.0 million in 1995 and $10.7 million in 1994. The increases are primarily due to increased amortization of goodwill and client lists resulting from acquisitions. INTEREST Net interest expense was $11.6 million in 1996, $10.1 million in 1995 and $5.9 million in 1994. The increases in 1996 and 1995 are primarily due to increased borrowings under the Company's expanded credit facility to finance acquisitions and the Company's investment in its reengineering and consolidation project. Management anticipates that future interest expense will change as a result of increases in interest rates and borrowings under the Second Amended Facility. 18 21 RESTRUCTURING AND OTHER CHARGES Components of restructuring and other charges are as follows:
1996 1995 1994 -------- ------- ------ (IN THOUSANDS) Restructuring charges....................................... $ 14,076 $15,000 $ -- Software abandonment........................................ 86,088 1,800 -- Property and equipment impairment........................... 35,592 5,000 -- Intangible asset impairment................................. 13,048 -- 1,905 Legal costs................................................. 12,800 12,000 -- Pooling charges............................................. 8,953 11,700 -- Severance costs............................................. 3,913 5,000 -- Other....................................................... 5,298 4,450 -- -------- ------- ------ $179,768 $54,950 $1,905 ======== ======= ======
Restructuring Charges. In 1995, Management approved a restructuring plan relating to the consolidation of the Company's data processing function in MPSC. The Company recorded a reserve for the exit costs associated with the restructuring plan of approximately $15.0 million. During 1996, the Company revised its original plan of consolidating into ten regional IPCs and reduced these reserves by approximately $1.8 million. The Company has adopted a plan to downsize certain of the existing IPCs and the costs associated with exiting these facilities will be charged against the restructuring reserves established in 1995. The Company also incurred approximately $5.2 million of costs which were related to MPSC's reengineering and consolidation project which had not previously been accrued. Also during 1996, the Company restructured its client/server system integration businesses and consolidated Rapid Systems into BSG and adopted a plan to shut down Imonics. In connection with this restructuring, the Company recorded charges of approximately $3.0 million for the costs associated with the termination of certain leases, approximately $6.5 million for severance costs for all notified employees of Imonics and approximately $1.2 million for other exit activities. Software Abandonment. In June 1996, the Company began a comprehensive assessment of the reengineering program for the Company's Services division which was begun in 1994. The comprehensive review was completed and management concluded that it was not cost effective to continue the development and deployment of the software and technology upon which the reengineering program was based and that the reengineering software and technology had no alternative useful application in the Company's operations. In connection with abandonment of its reengineering program and the shutdown of Imonics, the Company abandoned certain software development projects and recorded charges for the write-off of approximately $86.1 million of capitalized software development costs related to these projects. In connection with The Halley Exchange, Inc. acquisition in 1995, the Company recorded a $1.8 million charge related to the cost of purchased research and development activities related to acquired technology for which technological feasibility had not yet been established and which had no alternative future uses. Property and Equipment Impairment. In connection with the abandonment of the reengineering project and the shutdown of Imonics in 1996 and the restructuring of MPSC in 1995, the Company assessed the recoverability of certain of its long lived assets and recorded impairment losses of approximately $35.6 million and $5.0 million in 1996 and 1995, respectively. Intangible Asset Impairment. In 1996, the Company adopted a plan to shut down Imonics and recorded a charge of approximately $13 million for the write-off of the unamortized goodwill associated with the purchase of Imonics. In 1994, a charge of approximately $1.9 million, associated with the write-off of a non-compete agreement, was recorded by one of the Company's subsidiaries prior to that subsidiary's merger with the Company because the non-compete agreement was deemed to have no value. 19 22 Legal Costs. In 1996, the Company recorded a charge of $5.0 million for the administrative fees, costs and expenses it anticipates incurring in connection with various putative class action lawsuits which have been filed since August 14, 1996 against the Company and certain of its former officers, one of whom was also a director. The Company also accrued $4.6 million for the legal costs and other fees the Company has or plans to incur in connection with the turnaround effort undertaken by the new management team and various other legal matters. The Company recorded charges of $2.0 million and $12.0 million in 1996 and 1995, respectively, for the administrative fees, costs and expenses it anticipates incurring in connection with the Federal Investigation and various putative class action lawsuits which are based on the Federal Investigation. In 1996, the Company reached an agreement in principle to settle the class action lawsuits which are based on the Federal Investigation for $4.75 million. Also in 1996, the Company has recorded a $1.2 million charge for its portion of this settlement (the Company expects the remainder of the settlement to be funded by insurance). Pooling Charges. In connection with the following mergers, the Company incurred transaction fees, costs and expenses. In accordance with the requirements of pooling-of-interests accounting, these costs have been reflected in the operating results for 1996 and 1995.
1996 1995 ------ ------- (IN THOUSANDS) Atwork...................................................... $ (430) $ 6,000 HRI......................................................... (778) 2,000 Consort Technologies, Inc................................... (529) 1,200 MMS......................................................... (845) 2,500 IVC......................................................... 169 -- Rapid Systems............................................... 584 -- BSG......................................................... 6,094 -- HDS......................................................... 4,688 -- ------ ------- $8,953 $11,700 ====== =======
Severance Costs. In 1995, management of MPSC formalized an involuntary severance benefit plan. The Company recorded charges of approximately $0.9 and $5.0 million in 1996 and 1995, respectively, in accordance with Statement of Financial Accounting Standards No. 112 to reflect the expense for employees' rights to involuntary severance benefits that have accumulated to date. Also, in 1996 the Company recorded a charge of $3.0 million for severance costs associated with former executive management. Other Costs. During 1996, the Company canceled an initiative to develop an on-line practice management system. The Company recorded a charge of approximately $2.0 million relating to the deferred costs associated with this project. The Company also accrued $1.3 million for certain liabilities associated with the Company's billing and accounts receivable management services operations. In addition, the Company also recorded a charge of approximately $2.0 million for miscellaneous asset write-offs. Prior to the Company's merger with MMS, MMS terminated a merger agreement with an unrelated third party. In connection with the termination of this agreement, MMS agreed to pay costs associated with the planned merger and potential initial public offering of the combined entity. Such costs amounted to approximately $3.7 million and were recorded as a charge in 1995. In addition, in 1995 the Company recorded a charge of $750,000 for certain amounts paid to the former owners of an acquired company. During the fourth quarter of 1996, the Company recorded charges of $138.6 million related to the abandonment of the reengineering program, the shut down of Imonics and other charges as discussed above. INCOME (LOSS) BEFORE INCOME TAXES The Company's income (loss) before income taxes was (31.8)% of revenues in 1996 as compared with (0.7)% in 1995 and 12.2% in 1994. The reasons for the losses before income taxes in 1996 and 1995 are the 20 23 above mentioned revenue pressure MPSC is experiencing and the restructuring and other charges taken by the Company. Excluding restructuring and other charges from all years presented, income before income taxes as a percentage of revenue would have been (2.2)%, 9.1% and 12.7%, respectively for 1996, 1995 and 1994. INCOME TAXES Effective income tax rates for the periods presented vary from statutory rates primarily as a result of nondeductible expenses associated with merger transactions consummated by the Company in 1996 and previous years. Pro forma adjustments for income taxes have been provided for companies which elected to be treated as "S" Corporations under the Internal Revenue Code of 1986, as amended, prior to merging with the Company. ACQUISITIONS In fiscal 1996, Medaphis completed four acquisitions that were accounted for as purchases and four acquisitions that were accounted for as poolings-of-interests. The four purchase acquisitions are as follows: On February 12, 1996, the Company acquired substantially all of the assets and assumed certain of the related liabilities of MMCS. MMCS provides billing and accounts receivable management services primarily to emergency room physicians. On February 20, 1996, the Company acquired substantially all of the assets and assumed certain of the related liabilities of CBT. CBT provides collection and billing services primarily to hospitals. On April 16, 1996, the Company acquired the outstanding capital stock of MEDICO. MEDICO provides billing and accounts receivable management services primarily to anesthesiologists. On October 8, 1996, the Company acquired the assets and assumed substantially all of the liabilities of Sage. Sage provides systems integration services and data warehousing decision support applications, primarily to the telecommunications industry. For each of the foregoing acquisitions, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair value as of the date of acquisition. The Company acquired the following businesses in fiscal 1996 which were recorded using the pooling-of-interests method of accounting: On February 29, 1996, the Company exchanged approximately 92,991 shares of its Common Stock for all of the outstanding shares of common stock of IVC. IVC provides systems integration and work flow engineering systems and services to clients in the healthcare and other industries. On April 3, 1996, the Company exchanged approximately 1.1 million shares of its Common Stock for all of the outstanding shares of common stock of Rapid Systems. Rapid Systems is a client server/systems integration company whose core competencies include network design, integration and management, database design and development, graphical user interface application design, development and implementation and strategic systems engineering and computer security. During 1995, Rapid Systems had revenue of $14.7 million. On May 6, 1996, the Company exchanged approximately 7.5 million shares of its Common Stock for all of the outstanding shares of common stock of BSG. In addition, the Company assumed BSG stock options representing approximately 2.3 million additional shares of the Company's Common Stock. BSG provides information technology and change management services to organizations seeking to transform their operations through the strategic use of client/server and other advanced technologies. During 1995, BSG had revenue of $69.7 million. On June 29, 1996, the Company exchanged approximately 6.2 million shares of its Common Stock for all of the outstanding shares of common stock of HDS. In addition, the Company assumed HDS stock options representing approximately 433,000 additional shares of the Company's Common Stock. HDS is a developer and supplier of advanced healthcare information systems which address a healthcare 21 24 enterprise's clinical information needs through the integrated monitoring, scheduling, documentation and control of patient care. During 1995, HDS had revenue of $12.2 million. Because these acquisitions have been recorded using the pooling-of-interests method of accounting, no adjustments have been made to the historical carrying amounts of assets acquired and liabilities assumed. The consolidated financial statements included in this report have been restated to include the financial position and operating results of Rapid Systems, BSG and HDS for all periods prior to the acquisitions. No restatement has been made for the financial position and operating results of IVC prior to the beginning of the fiscal year of its acquisition due to its immateriality. In August 1996, Medaphis announced that it did not anticipate any significant acquisitions in the near term. LIQUIDITY AND CAPITAL RESOURCES The Company had working capital of $75.6 million at December 31, 1996, and had unrestricted cash and cash equivalents of $7.6 million. The Company used $7.9 million in cash for operating activities in the year ended December 31, 1996. The decrease in the Company's operating cash flows resulted from the increased levels of working capital committed to the Company's technology systems operations, expenditures related to restructuring and other charges and the ongoing revenue and margin pressures at MPSC. At December 31, 1996, the Company had $242.7 million of borrowings outstanding under the $250 million revolving credit agreement (the "Senior Credit Facility"). Borrowings under the Senior Credit Facility bore interest at interest rates ranging from 6.78% to 6.90%. On February 4, 1997, the Company entered into the Second Amended Facility. This agreement replaced the Senior Credit Facility and increased the revolving line of credit to $285 million. The Second Amended Facility expires on June 30, 1998 and may be extended or otherwise amended pursuant to the agreement. Borrowings under the Second Amended Facility are secured by substantially all of the Company's assets and are guaranteed by substantially all of the Company's subsidiaries. The Second Amended Facility effectively refinanced the loans outstanding under the Senior Credit Facility and can be used to finance working capital and other general corporate needs with restrictions on new acquisitions, certain litigation settlement payments and capital expenditures for the fiscal quarter ending March 31, 1997. The Second Amended Facility provides for "base rate" loans which bear interest equal to prime plus 1% as long as certain financial covenants are met. The loan commitments under the Second Amended Facility will reduce to $200 million and $150 million on July 31, 1997 (unless extended by the lenders to September 30, 1997) and January 31, 1998, respectively. In late 1996 and in 1997, the Company has taken actions to reduce capital expenditures and to monitor uses of cash. The Company believes that it will be able to fund its operating cash requirements through operating cash flows and limited borrowings under the Second Amended Facility through July 31, 1997, when the Company will be required to reduce the outstanding amount of borrowings under the Second Amended Facility to a maximum of $200 million. In developing its 1997 business plan, the Company did not expect to generate sufficient cash flow from operations to meet the required debt reduction and, therefore, management has adopted plans to divest HRI and is seeking alternatives for the BSG Group which it believes will generate sufficient net proceeds to meet the July 31, 1997 reduction in the loan commitments required by the Second Amended Facility. The Company has retained investment banking counsel to advise it on the divestiture of HRI as well as to assist in the evaluation of alternatives for the BSG Group. On March 14, 1997, the Company filed a registration statement with the Commission relating to the planned initial public offering of 100% of the common stock of HRI. This initial public offering is subject to review by the Commission and the marketability of HRI. There can be no assurance that the Company will be successful in its efforts to sell HRI and/or the BSG Group. If the Company is unable to generate sufficient net proceeds through the sale of HRI and/or the BSG Group or obtain alternative debt financing by July 31, 1997, unless extended by the lenders until September 30, 1997, the Company's lender can cause the borrowing under the Second Amended Facility to become immediately due and payable. 22 25 As part of the consideration paid to the six-bank syndicate for the Second Amended Facility, the Company issued the lenders warrants with vesting arrangements for 1% of the Common Stock of the Company on each of January 1, 1998 and April 1, 1998. These warrants terminate if the Company has no outstanding borrowings on the line of credit on December 31, 1997. The Company has not allocated any value to these warrants because management believes the Company will generate sufficient cash flows from asset sales to repay all the borrowings under the Second Amended Facility by December 31, 1997. In December 1995, the Company gave notice of its intent to redeem its 6.5% convertible subordinated debentures due January 1, 2000. The debentures were convertible into shares of the Company's Common Stock at a conversion price of $14.00 per share. All of the debenture holders exercised their conversion rights effective January 1, 1996, and as a result, approximately 4.5 million shares of Common Stock were issued in the conversion. OTHER MATTERS The United States Attorney's Office for the Central District of California is conducting an investigation (the "Federal Investigation") of Medaphis' billing and collection practices in its offices located in Calabasas and Cypress, California (the "Designated Offices"). Medaphis first became aware of the Federal Investigation when it received search warrants and grand jury subpoenas on June 13, 1995. Although the precise scope of the Federal Investigation is not known to the Company at this time, Medaphis believes that the U.S. Attorney's Office is investigating allegations of billing fraud and that the inquiry is focused upon Medaphis' billing and collection practices in the Designated Offices. Numerous federal and state civil and criminal laws govern medical billing and collection activities. In general, these laws provide for various fines, penalties, multiple damages, assessments and sanctions for violations, including possible exclusion from Medicare, Medicaid and certain other federal and state healthcare programs. Although the Designated Offices represent less than 2% of Medaphis' annual revenue, there can be no assurance that the Federal Investigation will be resolved promptly, that additional subpoenas or search warrants will not be received by Medaphis or that the Federal Investigation will not have a material adverse effect upon the Company. The Company recorded charges of $12 million in the third quarter of 1995 and $2 million in the fourth quarter of 1996, solely for the administrative fees, costs and expenses it anticipates incurring in connection with the Federal Investigation and the putative class action lawsuits described below which were filed following the Company's announcement of the Federal Investigation. The charges are intended to cover only the anticipated expenses of the Federal Investigation and the related lawsuits and do not include any provision for fines, penalties, damages, assessments, judgments or sanctions that may arise out of such matters. Following the announcement of the Federal Investigation, Medaphis, various of its current and former officers and directors and the lead underwriters associated with Medaphis' public offering of Common Stock in April 1995 were named as defendants in putative shareholder class action lawsuits filed in the United States District Court for the Northern District of Georgia. In general, these lawsuits allege violations of the federal securities laws in connection with Medaphis' public statements and filings under the federal securities acts, including the registration statement filed in connection with Medaphis' public offering of Common Stock in April 1995. On October 13, 1995, the named plaintiffs in these lawsuits filed a consolidated class action complaint (the "Consolidated Complaint"). On January 3, 1996, the court denied defendant's motion to dismiss the Consolidated Complaint. On April 11, 1996, certain of the named plaintiffs to the Consolidated Complaint voluntarily dismissed with prejudice all of their claims. As a result of these dismissals, the Consolidated Complaint no longer contains any claims based on the 1933 Act, and the Company's underwriters and outside directors are no longer named as defendants. On June 26, 1996, the court denied the plaintiffs' motion to certify a plaintiffs' class. The plaintiffs and the defendants have reached an agreement in principle to settle this action on a class-wide basis for $4.75 million, subject to court approval and other customary conditions (the "1995 Class Action Settlement"). The 1995 Class Action Settlement would also include the related putative class action lawsuit currently pending in the Superior Court of Cobb County, Georgia, described more fully below. The Company expects to receive approximately $3.7 million from insurance to fund a portion of the 1995 Class Action Settlement and accrued approximately $1.2 million in the 23 26 quarter ending December 31, 1996 to fund the anticipated balance of the 1995 Class Action Settlement and to pay certain fees incident thereto. On November 5, 1996, Medaphis, Randolph G. Brown, Michael R. Cote and James S. Douglass were named as defendants in a putative shareholder class action lawsuit filed in Superior Court of Cobb County, State of Georgia. This lawsuit alleges violations of Georgia securities laws based on the same public statements and filings generally described above. The lawsuit is brought on behalf of a putative class of purchasers of Medaphis Common Stock during the period from March 29, 1995 through June 15, 1995. The plaintiffs seek compensatory damages and costs. As noted above, it is currently contemplated that this action will be settled as part of the 1995 Class Action Settlement. The Company and its clients from time to time have received, and the Company anticipates that they will receive in the future, official inquiries (including subpoenas, search warrants, as well as internal requests) concerning particular billing and collection practices related to certain subsidiaries of the Company and its many clients. In March 1997, the Company was informed by the Civil Division of the Department of Justice that it is investigating allegations concerning GFS. No subpoenas or other process have been issued to the Company or to GFS in connection with this investigation. Following the Company's August 14, 1996 announcement regarding earnings expectations and certain charges, Medaphis and certain of its current and former officers, one of whom was also a director, were named as defendants in nineteen putative shareholder class action lawsuits filed in the United States District Court for the Northern District of Georgia. On November 22, 1996, the plaintiffs in these lawsuits filed a Consolidated Amended Class Action Complaint (the "1996 Consolidated Complaint"). In general, the 1996 Consolidated Complaint alleges violations of the federal securities laws in connection with Medaphis' filings under the federal securities acts and public disclosures. The 1996 Consolidated Complaint is brought on behalf of a class of all persons who purchased or otherwise acquired Medaphis Common Stock between January 6, 1996 and October 21, 1996. The 1996 Consolidated Complaint also asserts claims on behalf of a sub-class of all persons who acquired Medaphis Common Stock pursuant to the merger between Medaphis and HDS. On December 30, 1996, the defendants filed a motion to dismiss most of the 1996 Consolidated Complaint. On February 3, 1997, the plaintiffs filed a Consolidated Second Amended Complaint. On February 14, 1997, the defendants moved to dismiss the Consolidated Second Amended Complaint in its entirety. On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit Sharing Plan filed a shareholder derivative lawsuit in the United States District Court for the Northern District of Georgia alleging that certain of Medaphis' current and former directors breached their fiduciary duties, were grossly negligent, and breached various contractual obligations to Medaphis by allegedly failing to implement and maintain an adequate system of internal accounting controls, allowing Medaphis to commit securities law violations, and damaging Medaphis' reputation. The plaintiff seeks compensatory damages and costs. On January 28, 1997, Medaphis and certain individual defendants filed a motion to dismiss the complaint. On February 11, 1997, the plaintiff filed an amended complaint adding as defendants additional current and former directors and officers of Medaphis. Medaphis has not yet responded to the amended complaint. On November 7, 1996, Health Systems International, Inc. filed suit in the Superior Court for the State of California, County of Los Angeles against Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed Medaphis directors, officers and employees. Generally, this lawsuit alleges that the defendants violated federal and California securities laws and common law by, among other things more fully described in the complaint, making material misstatements and omissions in public and private disclosures in connection with the acquisition of HDS. The plaintiff seeks rescissory, compensatory and punitive damages, rescission, injunctive relief and costs. On January 10, 1997, the defendants filed a demurrer to the complaint. The demurrer was denied on February 5, 1997. On March 18, 1997, the court denied the plaintiff's motion for a preliminary injunction. As a result of the Company's restatement of its fiscal 1995 financial statements, the Company may not be able to sustain a defense to strict liability on certain claims under the 1933 Act, but the Company believes that it has substantial defenses to the alleged damages relating to the 1933 Act claims. A putative class action complaint was filed by Ernest Hecht and Stephen D. Strandberg against Steven G. Papermaster, Robert E. Pickering, Jr., David S. Lundeen, Norman Smith, Raymond J. Noorda, 24 27 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 common stock were converted to Medaphis stock options in connection with Medaphis' acquisition of BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary duties of candor, loyalty and fair dealing and negligence against the BSG defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud and deceit against the Medaphis defendants (Medaphis and Brown). On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two entities they control made a demand for indemnification under an indemnification agreement executed by Medaphis in connection with its acquisition of BSG in May 1996. On the date of the demand, Mr. Papermaster was an executive officer and a director of Medaphis. Mr. Papermaster resigned such positions on March 21, 1997, although he remains a director and executive officer of BSG. The indemnification demand claims damages of $35 million (the maximum damages payable by Medaphis under the indemnification agreement) for the alleged breach by the Company of its representations and warranties made in the merger agreement between Medaphis and BSG. The Company believes it has meritorious defenses to the indemnification claim. The Company also has received other written demands from various stockholders, including stockholders of recently acquired companies. To date, these other stockholders have not filed lawsuits. On January 8, 1997, the Commission notified the Company that it is conducting a nonpublic investigation into, among other things, certain trading and other issues related to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's loss for the quarter ending September 30, 1996 and its restated consolidated financial statements for the three months and year ended December 31, 1995 and its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996. The Company intends to cooperate fully with the Commission in its investigation. Although the Company believes that it has meritorious defenses to the claims of liability or for damages in the actions against, and written demands placed upon, the Company, there can be no assurance that additional lawsuits will not be filed against the Company, that the lawsuits, the written demands and the pending governmental investigations will not have a disruptive effect upon the operations of the business, that the written demands, the defense of the lawsuits and the pending investigations will not consume the time and attention of the senior management of the Company and that the resolution of the lawsuits, the written demands and the pending governmental investigations will not have a material adverse effect upon the Company. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's Consolidated Financial Statements appear beginning at page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item with respect to directors and executive officers of the Registrant, except certain information regarding executive officers which is contained in Part I of this Report pursuant to General Instruction G of this Form 10-K, is included in the sections entitled "Management of the Company" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" of the Proxy Statement for the Annual Meeting of Stockholders to be held May 8, 1997 and is incorporated herein by reference. 25 28 ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is included in the sections entitled "Certain Information Regarding Executive Officers," "Compensation Committee Report on Executive Compensation," "Compensation Committee Interlocks and Insider Participation" and "Stock Price Performance Graph" of the Proxy Statement for the Annual Meeting of Stockholders to be held May 8, 1997 and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is included in the sections entitled "Management Common Stock Ownership" and "Principal Stockholders" of the Proxy Statement for the Annual Meeting of Stockholders to be held on May 8, 1997 and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is included in the section entitled "Certain Transactions" of the Proxy Statement for the Annual Meeting of Stockholders to be held May 8, 1997 and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)1. Financial Statements Independent Auditors' Report; Consolidated Statements of Operations -- years ended December 31, 1996, 1995 and 1994; Consolidated Balance Sheets -- as of December 31, 1996 and 1995; Consolidated Statements of Cash Flows -- years ended December 31, 1996, 1995 and 1994; Consolidated Statements of Stockholders' Equity -- years ended December 31, 1996, 1995 and 1994; and Notes to Consolidated Financial Statements. 2. Financial Statement Schedules Included in Part IV of the report: Schedule II -- Valuation and Qualifying Accounts -- years ended December 31, 1996, 1995 and 1994. Schedules, other than Schedule II, are omitted because of the absence of the conditions under which they are required. 3. Exhibits The following list of exhibits includes both exhibits submitted with this Form 10-K as filed with the Commission and those incorporated by reference to other filings:
EXHIBIT NO. DOCUMENT - ------- -------- 2.1 -- Amended and Restated Merger Agreement, dated July 28, 1995, among Registrant, RaySub, Inc. and Healthcare Recoveries, Inc. (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed on September 12, 1995). 2.2 -- Merger Agreement, dated December 29, 1995, among Registrant, CarSub, Inc. and Medical Management Sciences, Inc. (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed on January 19, 1996).
26 29
EXHIBIT NO. DOCUMENT - ------- -------- 2.3 -- Merger Agreement, dated as of March 12, 1996, by and among Registrant, Rapid Systems Solutions, Inc. and RipSub, Inc. (incorporated by reference to Exhibit 2.19 to Annual Report on Form 10-K for the fiscal year ended December 31, 1995, File No. 000-19480 (the "1995 Form 10-K")). 2.4 -- Merger Agreement, dated as of March 15, 1996, by and among Registrant, BSGSub, Inc. and BSG Corporation (incorporated by reference to Exhibit 2.1 to Registration Statement on Form S-4, File No. 33-2506). 3.1 -- Amended and Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.1 to 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 Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1993). 3.3 -- Certificate of Amendment of Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.3 to Registration Statement on Form 8-A/A, filed on March 28, 1995). 3.4 -- Certificate of Amendment of Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 4.4 to Registration Statement on Form S-8, Registration No. 333- 03213). 3.5 -- Amended and Restated By-Laws of Registrant (incorporated by reference to Exhibit 3.2 to Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 000-19480 (the "1992 Form 10-K")). 4.1 -- Indenture by and between Registrant and Trust Company Bank, as Trustee, dated December 30, 1992 (incorporated by reference to Exhibit 4 to Current Report on Form 8-K filed on January 11, 1993). 4.2 -- Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the 1995 Form 10-K). 4.3 -- Form of Option Agreement relating to Registrant's Stock Option Plan (incorporated by reference to Exhibit 4.2 to Registration Statement on Form S-1, File No. 33-42216). 4.4 -- Form of Option Agreement relating to Registrant's Executive Performance Plan (incorporated by reference to Exhibit 4.3 to Registration Statement on Form S-1, File No. 33-42216). 4.5 -- Form of Option Agreement relating to Registrant's Stock Option Plan for Employees of Acquired Companies (incorporated by reference to Exhibit 4.4 to Registration Statement on Form S-3, File No. 33-71552). 4.6 -- Form of Option Agreement relating to Registrant's Restricted Stock Plan (incorporated by reference to Exhibit 4.5 to the 1995 Form 10-K). 4.7 -- Form of Option Agreement relating to Registrant's Non-Employee Director Stock Option Plan (incorporated by reference to Exhibit 4.6 to the 1995 Form 10-K). 4.8 -- Registration Rights Agreement, dated as of March 17, 1995, by and among Registrant, David Michael Warner and John P. Holton (incorporated by reference to Exhibit 4.10 to Annual Report on Form 10-K for the year ended December 31, 1994, File No. 000-19480 (the "1994 Form 10-K")). 4.9 -- Form of Common Stock Purchase Warrant issued to Fredrica Morf and Ursula Nelson (incorporated by reference to Exhibit 4.19 to the 1994 Form 10-K).
27 30
EXHIBIT NO. DOCUMENT - ------- -------- 4.10 -- Form of Warrant issued to one or more lenders pursuant to Registrant's Second Amended and Restated Credit Agreement, dated as of February 4, 1997 (incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed on February 18, 1997). 4.11 -- Form of Registration Rights Agreement among Registrant, Bryan Dieter and The Decision Support Group, Inc. (incorporated by reference to Exhibit 4.26 to the 1994 Form 10-K). 4.12 -- Form of Registration Rights Agreement among Registrant, Mahmoud R. Ghavi, Barry G. Wahlig, William L. McCready, and Kimberly D. Elkins (incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed on December 5, 1995). 4.13 -- Form of Registration Rights Agreement among Registrant, William J. DeZonia, Lori T. Caudill, Carol T. Shumaker, Alyson T. Stinson, James F. Thacker, James F. Thacker Retained Annuity Trust and Paulanne H. Thacker Retained Annuity Trust (incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed on January 19, 1996). 4.14 -- Form of Registration Rights Agreement among Registrant, Raymond J. Noorda and Steven G. Papermaster (incorporated by reference to Exhibit 4.17 to Registration Statement on Form S-4, file No. 33-2506). 4.15 -- Form of Registration Rights Agreement among Registrant, Michael Clark, Andrei Mitran, and Steven Theidke (incorporated by reference to Exhibit 4.18 to Registration Statement on Form S-4, File No. 33-2506). 4.16 -- Notice of Redemption for 6.5% Convertible Subordinated Debentures Due 2000 (incorporated by reference to Exhibit 4.21 to the 1995 Form 10-K). 4.17 -- Form of Option Agreement relating to Registrant's Non-Qualified Stock Option Plan for Non-Executive Employees. 10.1 -- Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 28.1 to Registration Statement on Form S-8, File No. 33-46847). 10.2 -- First Amendment to Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 28.1 to Registration Statement on Form S-8, File No. 33-64952). 10.3 -- Second Amendment to Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.5 to the 1992 Form 10-K). 10.4 -- Third Amendment to Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10 to Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1993). 10.5 -- Fourth Amendment to Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1993). 10.6 -- Fifth Amendment to the Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan (incorporated by reference to Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (the "1993 Form 10-K")). 10.7 -- Sixth Amendment to Medaphis Corporation Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10 to Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1994).
28 31
EXHIBIT NO. DOCUMENT - ------- -------- 10.8 -- Seventh Amendment to Medaphis Corporation Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 99 to Registration Statement on Form S-8, File No. 33-95742). 10.9 -- Eighth Amendment to Medaphis Corporation Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 99.1 to Registration Statement on Form S-8, File No. 333-07203). 10.10 -- Ninth Amendment to Medaphis Corporation Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 99.2 to Registration Statement on Form S-8, File No. 333-07203). 10.11 -- Tenth Amendment to Medaphis Corporation Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 99.3 to Registration Statement on Form S-8, File No. 333-7203). 10.12 -- Eleventh Amendment to Medaphis Corporation Amended and Restated Non-Qualified Stock Option Plan. 10.13 -- Medaphis Corporation Senior Executive Performance Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 28.2 to Registration Statement on Form S-8, File No. 33-46847). 10.14 -- First Amendment to Medaphis Corporation Senior Executive Performance Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1993). 10.15 -- Medaphis Corporation Non-Qualified Stock Option Plan for Employees of Acquired Companies (incorporated by reference to Exhibit 99.1 to Registration Statement on Form S-8, File No. 33-67752). 10.16 -- First Amendment to Medaphis Corporation Non-Qualified Stock Option Plan for Employees of Acquired Companies (incorporated by reference to Exhibit 99 to Registration Statement on Form S-8, File No. 33-71556). 10.17 -- Second Amendment to Medaphis Corporation Non-Qualified Stock Option Plan for Employees of Acquired Companies (incorporated by reference to Exhibit 99 to Registration Statement on Form S-8, File No. 33-88442). 10.18 -- Third Amendment to Medaphis Corporation Non-Qualified Stock Option Plan for Employees of Acquired Companies (incorporated by reference to Exhibit 10.14 to the 1995 Form 10-K). 10.19 -- Fourth Amendment to Medaphis Corporation Non-Qualified Stock Option Plan for Employees of Acquired Companies (incorporated by reference to Exhibit 99.2 to Registration Statement on Form S-8, File No. 333-3213). 10.20 -- Fifth Amendment to Medaphis Corporation Non-Qualified Stock Option Plan for Employees of Acquired Companies (incorporated by reference to Exhibit 99.1 to Registration Statement on Form S-8, File No. 333-07627). 10.21 -- Sixth Amendment to Medaphis Corporation Non-Qualified Stock Option Plan for Employees of Acquired Companies. 10.22 -- Medaphis Corporation Non-Employee Director Stock Option Plan, dated as of August 12, 1994 (incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.23 -- Medaphis Corporation Non-Qualified Stock Option Plan for Non-Executive Employees. 10.24 -- First Amendment to Medaphis Corporation Non-Qualified Stock Option Plan for Non-Executive Employees.
29 32
EXHIBIT NO. DOCUMENT - ------- -------- 10.25 -- Restricted Stock Plan of the Registrant, dated as of August 12, 1994 (incorporated by reference to Exhibit 10.2 to Registration Statement on Form S-4, File No. 33-88910). 10.26 -- Form of Medaphis Corporation Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.19 to the 1995 Form 10-K). 10.27 -- First Amendment to Medaphis Corporation Employee Stock Purchase Plan. 10.28 -- Retirement Savings Trust (incorporated by reference to Exhibit 10.10 to Registration Statement on Form S-1, File No. 33-42216). 10.29 -- Amended and Restated Medaphis Employees' Retirement Savings Plan. 10.30 -- First Amendment to the Amended and Restated Medaphis Employees' Retirement Savings Plan. 10.31 -- Form of Second Amendment to the Amended and Restated Medaphis Employees' Retirement Savings Plan. 10.32 -- Loan Agreement, dated October 1, 1983, between Medical Management Consultants, Inc. and Development Authority of Cobb County (incorporated by reference to Exhibit 10.16 to Registration Statement on Form S-1, File No. 33-42216). 10.33 -- Second Amended and Restated Credit Agreement, dated as of February 4, 1997, among the Registrant, the lenders listed therein and the Agent (incorporated by reference to Exhibit 99.2 to Current Report on Form 8-K filed on February 18, 1997). 10.34 -- Certificate of Merger of CompMed, Inc. with and into Medaphis Physician Services Corporation dated as of December 31, 1993 (incorporated by reference to Exhibit 10.30 to the 1993 Form 10-K). 10.35 -- Employment Agreement, dated December 14, 1992, between MedCorp Holding, Inc. and Dennis A. Pryor (incorporated by reference to Exhibit 10.26 to the 1992 Form 10-K). 10.36 -- Amendment No. 1 to the Employment Agreement between Dennis A. Pryor and Medaphis Physician Services Corporation (formerly MedCorp Holding, Inc., which changed its name to CompMed, Inc. and subsequently merged into Medaphis Physician Services Corporation (incorporated by reference to Exhibit 10.37 to the 1994 Form 10-K)). 10.37 -- Lease Agreement, dated August 1, 1989, between Financial Enterprises III (a general partnership consisting of Martin L. Brill and Dennis A. Pryor) and Medical Management Sciences South, Inc. 10.38 -- Agreement for Management Services by and among Registrant, INTEGRATEC Med-Services, Inc. and Medaphis Hospital Services Corporation, dated as of January 13, 1993 (incorporated by reference to Exhibit 10.37 to the 1993 Form 10-K). 10.39 -- Employment Agreement by and between Registrant and Randolph G. Brown, dated March 24, 1995 (incorporated by reference to Exhibit 10.46 to the 1994 Form 10-K). 10.40 -- Master Equipment Lease, dated January 25, 1994, by and between Trust Company Bank and Registrant (incorporated by reference to Exhibit 10.63 to the 1994 Form 10-K). 10.41 -- Lease and Development and Participation Agreement, dated April 21, 1995 (incorporated by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.42 -- Master Equipment Lease Agreement Intended for Security with NationsBank Leasing Corporation, dated May 31, 1995 (incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1995).
30 33
EXHIBIT NO. DOCUMENT - ------- -------- 10.43 -- Equipment Lease, dated September 29, 1995, by and between NationsBank Leasing Corporation of North Carolina and Registrant (incorporated by reference to Exhibit 10.70 to the 1995 Form 10-K). 10.44 -- Equipment Lease, dated October 31, 1995 by and between NationsBank Leasing Corporation of North Carolina and Registrant (incorporated by reference to Exhibit 10.71 to the 1995 Form 10-K). 10.45 -- Equipment Lease, dated January 31, by and between NationsBank Leasing Corporation of North Carolina and Registrant (incorporated by reference to Exhibit 10.72 to the 1995 Form 10-K). 10.46 -- Equipment Lease, dated February 29, 1996, by and between NationsBank Leasing Corporation of North Carolina and Registrant (incorporated by reference to Exhibit 10.73 to the 1995 Form 10-K). 10.47 -- Tivoli Systems, Inc. End User Software License Agreement, dated June 30, 1995 (incorporated by reference to exhibit 10.3 to Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.48 -- Medaphis Corporation Re-engineering, Consolidation and Business Improvement Cash Incentive Plan, dated February 21, 1996 (incorporated by reference to Exhibit 10.1 to Registration Statement on Form S-4, File no. 33-2506). 10.49 -- Employment Agreement by and between Registrant and David E. McDowell, dated November 19, 1996. 10.50 -- Employment Agreement by and between Registrant and Daniel S. Connors, Jr., dated February 25, 1997. 10.51 -- Employment Agreement by and between Registrant and Carl James Schaper, dated February 25, 1997. 10.52 -- Employment Agreement by and between Registrant and Jerome H. Baglien, dated January 3, 1997. 11 -- Statement re: Computation of Per Share Earnings. 21 -- Subsidiaries of Registrant. 23.1 -- Consent of Deloitte & Touche LLP. 27 -- Financial Data Schedule (for SEC use only). 99.1 -- Consolidated Class Action Complaint filed in the United States District Court for the Northern District of Georgia, Atlanta Division (incorporated by reference to Exhibit 99.1 to the 1995 Form 10-K). 99.2 -- Consolidated Class Action Complaint filed in the United States District Court, Northern District of Georgia, Atlanta Division. 99.3 -- Complaint filed in Los Angeles County Superior Court. 99.4 -- Class Action Complaint filed in Superior Court of New Jersey, Law Division, Essex County. 99.5 -- Verified Derivative Complaint filed in the United States District Court, Northern District of Georgia, Atlanta Division. 99.6 -- Safe Harbor Compliance Statement for Forward-Looking Statements.
- --------------- * The exhibits which are referenced in the above documents are hereby incorporated by reference. Such exhibits have been omitted for purposes of this filing but will be furnished supplementary to the Commission upon request. 31 34 (b) Reports on Form 8-K One report on Form 8-K/A was filed during the quarter ended December 31, 1996:
FINANCIAL ITEM REPORTED STATEMENTS FILED DATE OF REPORT ------------- ---------------- ----------------- Restatement of Medaphis Corporation's Supplemental Consolidated Financial Statements to effect for the merger with HDS........................... Yes(1) November 14, 1996
- --------------- (1) Supplemental Consolidated Financial Statements of the Company (audited) for the years ended December 31, 1995 (as restated), 1994 and 1993 were filed. 32 35 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Medaphis Corporation (Registrant) By: /s/ JEROME H. BAGLIEN ------------------------------------ Jerome H. Baglien Senior Vice President and Chief Financial Officer (Principal Accounting Officer) Date: March 31, 1997 33 36 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ DAVID E. MCDOWELL Chairman, Chief Executive March 31, 1997 - ----------------------------------------------------- Officer and Director David E. McDowell /s/ JEROME H. BAGLIEN Senior Vice President and Chief March 31, 1997 - ----------------------------------------------------- Financial Officer (Principal Jerome H. Baglien Accounting Officer) /s/ ROBERT C. BELLAS, JR. Director March 31, 1997 - ----------------------------------------------------- Robert C. Bellas, Jr. /s/ DAVID R. HOLBROOKE, M.D. Director March 31, 1997 - ----------------------------------------------------- David R. Holbrooke, M.D. /s/ JOHN C. POPE Director March 31, 1997 - ----------------------------------------------------- John C. Pope /s/ DENNIS A. PRYOR Director March 31, 1997 - ----------------------------------------------------- Dennis A. Pryor
34 37 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Medaphis Corporation: We have audited the accompanying consolidated balance sheets of Medaphis Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedule listed in the Index at Item 14. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Medaphis Corporation and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 6 to the consolidated financial statements, the Company's credit facility requires significant reductions in the Company's borrowings by July 31, 1997, which may be extended by the lenders to September 30, 1997. The Company does not expect to generate sufficient cash flow from operations to meet this required loan reduction. While the Company plans to divest of certain assets to generate funds to meet this requirement, the Company does not have binding contracts to dispose of these assets or to refinance or raise additional funds to otherwise satisfy such required debt reduction. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to this matter also are described in Note 6. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. DELOITTE & TOUCHE LLP March 31, 1997 Atlanta, Georgia F-1 38 CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------------- 1996 1995 1994 ----------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenue..................................................... $ 608,313 $559,877 $398,934 --------- -------- -------- Salaries and wages.......................................... 398,573 325,868 227,109 Other operating expenses.................................... 163,677 140,296 95,195 Depreciation................................................ 28,276 14,487 9,430 Amortization................................................ 20,016 18,048 10,691 Interest expense, net....................................... 11,585 10,062 5,926 Restructuring and other charges............................. 179,768 54,950 1,905 --------- -------- -------- Total expenses.................................... 801,895 563,711 350,256 --------- -------- -------- Income (loss) before income taxes........................... (193,582) (3,834) 48,678 Income tax expense (benefit)................................ (68,961) 1,787 16,155 --------- -------- -------- Net income (loss)........................................... (124,621) (5,621) 32,523 ========= ======== ======== Pro forma adjustments, principally income taxes............. 979 (2,883) (1,817) --------- -------- -------- Pro forma net income (loss)................................. $(123,642) $ (8,504) $ 30,706 ========= ======== ======== Pro forma net income (loss) per common share................ $ (1.74) $ (0.15) $ 0.51 ========= ======== ======== Weighted average shares outstanding......................... 71,225 56,591 60,245 ========= ======== ========
See notes to consolidated financial statements. F-2 39 CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ------------------- 1996 1995 -------- -------- (IN THOUSANDS, EXCEPT PAR VALUE DATA) ASSETS Current Assets: Cash and cash equivalents................................. $ 7,631 $ 19,270 Restricted cash........................................... 19,568 15,340 Accounts receivable, billed (net of allowance for doubtful accounts of $13,260 and $6,225)........................ 99,823 84,256 Accounts receivable, unbilled............................. 94,057 89,429 Deferred income taxes..................................... 36,177 -- Other..................................................... 12,129 14,870 -------- -------- Total current assets.............................. 269,385 223,165 Property and equipment...................................... 97,850 97,895 Deferred income taxes....................................... 42,379 -- Intangible assets........................................... 389,033 455,611 Other....................................................... 16,977 18,935 -------- -------- $815,624 $795,606 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable.......................................... $ 11,765 $ 23,220 Accrued compensation...................................... 30,332 24,505 Accrued expenses.......................................... 95,680 69,529 Current portion of long-term debt......................... 55,975 10,681 -------- -------- Total current liabilities......................... 193,752 127,935 Long-term debt.............................................. 215,752 150,565 Other obligations........................................... 13,830 18,926 Deferred income taxes....................................... -- 13,499 Convertible subordinated debentures......................... -- 63,375 -------- -------- Total liabilities................................. 423,334 374,300 -------- -------- Stockholders' Equity: Preferred stock........................................... -- 382 Common stock, voting, $.01 par value, 200,000 authorized in 1996 and 100,000 in 1995; issued and outstanding 71,705 in 1996 and 58,917 in 1995...................... 717 589 Paid-in capital........................................... 522,491 426,387 Accumulated deficit....................................... (130,749) (6,052) -------- -------- 392,459 421,306 Less treasury stock, at cost -- 16 shares in 1996......... 169 -- -------- -------- Total stockholders' equity........................ 392,290 421,306 -------- -------- $815,624 $795,606 ======== ========
See notes to consolidated financial statements. F-3 40 CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 --------- -------- -------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss)........................................... $(124,621) $ (5,621) $ 32,523 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization............................. 48,292 32,535 20,121 Impairment loss on assets................................. 135,195 5,035 -- Deferred income taxes..................................... (71,939) 1,312 15,239 Other non-cash charges.................................... -- 417 1,208 Changes in assets and liabilities, excluding effects of acquisitions: Increase in restricted cash............................ (6,152) (3,253) (1,963) Increase in accounts receivable, billed................ (11,316) (21,549) (8,038) Increase in accounts receivable, unbilled.............. (8,593) (9,714) (24,279) Increase (decrease) in accounts payable................ (10,297) 4,738 5,341 Increase (decrease) in accrued compensation............ 5,277 (396) 5,704 Increase (decrease) in accrued expenses................ 26,870 25,725 (3,844) Other, net............................................. 9,421 (5,841) 2,197 --------- -------- -------- Net cash provided by (used in) operating activities...................................... (7,863) 23,388 44,209 --------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Acquisitions, net of cash acquired.......................... (18,200) (76,077) (153,385) Purchases of property and equipment......................... (51,135) (50,986) (13,063) Software development costs.................................. (37,946) (35,611) (9,519) Other....................................................... -- 650 (1,969) --------- -------- -------- Net cash used for investing activities............ (107,281) (162,024) (177,936) --------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of common stock...................... 11,475 151,825 4,933 Proceeds from borrowings.................................... 129,155 140,780 122,100 Payments of long-term debt.................................. (36,511) (138,244) (6,108) Dividends to shareholders of acquired companies............. (6) (6,751) (8,528) Repurchase of stock and warrants............................ (5,591) -- -- Other....................................................... 5,274 (7,355) (675) --------- -------- -------- Net cash provided by financing activities......... 103,796 140,255 111,722 --------- -------- -------- CASH AND CASH EQUIVALENTS Net change.................................................. (11,348) 1,619 (22,005) Balance at beginning of year (see Note 2)................... 18,979 17,651 39,656 --------- -------- -------- Balance at end of year...................................... $ 7,631 $ 19,270 $ 17,651 ========= ======== ========
See notes to consolidated financial statements. F-4 41 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
RETAINED COMMON PREFERRED EARNINGS TREASURY TOTAL COMMON STOCK PREFERRED STOCK PAID-IN (ACCUMULATED STOCK STOCKHOLDERS' SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT) AMOUNT EQUITY ------ ------ --------- --------- -------- ------------- -------- ------------- (IN THOUSANDS) BALANCE AT DECEMBER 31, 1993...... 47,151 $471 19,452 $ 222 $207,218 $ (18,061) $ -- $ 189,850 Changes in HRI's stockholders' equity in the six months ended June 30, 1994 (see Note 2)...... (9) -- -- -- (76) (554) -- (630) Issuance of common stock.......... 19 -- -- -- 14 -- -- 14 Issuance of common stock in acquisitions.................... 2,108 21 -- -- 38,775 -- -- 38,796 Exercise of stock options......... 734 8 -- -- 2,162 -- -- 2,170 Issuance and conversion of preferred stock at acquired companies....................... -- -- 2,739 3 3,465 -- -- 3,468 Pre-merger dividends to former owners.......................... -- -- -- -- -- (8,378) -- (8,378) Net income........................ -- -- -- -- -- 32,523 -- 32,523 Other............................. (13) -- -- -- (24) (692) -- (716) ------ ---- ------- ----- -------- --------- ------- --------- BALANCE AT DECEMBER 31, 1994...... 49,990 500 22,191 225 251,534 4,838 -- 257,097 Issuance of common stock.......... 4,239 42 -- -- 121,580 -- -- 121,622 Issuance of common stock in acquisitions.................... 20 -- -- -- 459 -- -- 459 Exercise of stock options (including tax benefit of $7,901)......................... 557 6 -- -- 12,516 -- -- 12,522 Issuance and conversion of preferred stock at acquired companies....................... 3,344 33 (2,737) 157 37,398 -- -- 37,588 Pre-merger dividends to former owners.......................... -- -- -- -- -- (4,517) -- (4,517) Net loss.......................... -- -- -- -- -- (5,621) -- (5,621) Other............................. 767 8 -- -- 2,900 (752) -- 2,156 ------ ---- ------- ----- -------- --------- ------- --------- BALANCE AT DECEMBER 31, 1995...... 58,917 589 19,454 382 426,387 (6,052) -- 421,306 Changes in HDS's stockholders' equity in the three months ended March 31, 1996 (see Note 2)..... -- -- -- -- -- (382) -- (382) Issuance of common stock in acquisitions.................... 93 1 -- -- 3,823 249 -- 4,073 Exercise of stock options (including tax benefit of $21,012)........................ 1,593 16 -- -- 32,471 -- -- 32,487 Repurchase of stock and warrants........................ (16) -- -- -- (5,422) -- (169) (5,591) Conversion of preferred stock at acquired companies.............. 6,528 65 (19,454) (382) 317 -- -- -- Conversion of subordinated debentures...................... 4,527 45 -- -- 62,305 -- -- 62,350 Net loss.......................... -- -- -- -- (124,621) -- (124,621) Other............................. 63 1 -- -- 2,610 57 -- 2,668 ------ ---- ------- ----- -------- --------- ------- --------- BALANCE AT DECEMBER 31, 1996...... 71,705 $717 -- $ -- $522,491 $(130,749) $ (169) $ 392,290 ====== ==== ======= ===== ======== ========= ======= =========
See notes to consolidated financial statements. F-5 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION. The consolidated financial statements include the accounts of Medaphis Corporation and its subsidiaries ("Medaphis" or the "Company"), including the retroactive effect of all mergers which have been accounted for under the pooling-of-interests method of accounting. The Company's consolidated financial statements, have been prepared on a going concern basis which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business and consequently do not include any adjustments relating to the recoverability and classification of liabilities that may be necessary should the Company be unable to continue as a going concern. As discussed in Note 6, the Company's cash flow from operations will not be sufficient to satisfy required reductions in the Company's outstanding borrowings; however, the Company has adopted plans to divest of certain assets which management believes will generate the necessary cash flows to satisfy these required debt reductions. CONSOLIDATION. All significant intercompany transactions have been eliminated. Certain amounts in the prior years' consolidated financial statements have been reclassified to conform to the current year presentation. NATURE OF OPERATIONS. Medaphis provides business management services and systems primarily to the healthcare industry throughout the United States. The Company historically has not experienced any significant losses related to individual customers, class of customers or groups of customers in any geographical area. USE OF ESTIMATES. 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 and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. REVENUE RECOGNITION. Fees for the Company's business management services are primarily based on a percentage of net collections on clients' patient accounts, and revenue is recognized as such business management services are performed. Accounts receivable, billed, principally represents amounts invoiced to clients. Accounts receivable, unbilled, represents amounts recognized for services rendered but not yet invoiced and is based on the Company's estimate of the fees that will be invoiced when collections on patient accounts are received. Revenue from software licenses is generally recognized upon shipment of the products and when no significant contractual obligations remain outstanding. When the Company receives payment prior to shipment or fulfillment of significant vendor obligations, such payments are recorded as deferred revenue and are recognized as revenue upon shipment or fulfillment of significant vendor obligations. The license agreements typically provide for partial payments subsequent to shipment; such terms result in an unbilled receivable at the date the revenue is recognized. Costs related to insignificant vendor obligations are accrued upon recognition of the license revenue. Software maintenance revenue is deferred and recognized ratably over the term of the maintenance agreement, which is typically one year. Revenues from systems integration contracts are recorded based on the terms of the underlying contracts, which are primarily time and material or fixed price contracts. Revenue from time and material type contracts is recognized as services are rendered and costs are incurred based on contractual rates. Revenue from fixed price contracts is recorded using the percentage of completion method. Expected losses are charged to operations in the period such losses are determined. Revenue for which customers have not yet been invoiced is reflected as accounts receivable, unbilled in the accompanying consolidated balance sheets. CASH AND CASH EQUIVALENTS. Cash and cash equivalents include all highly liquid investments with an initial maturity of no more than three months. F-6 43 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) RESTRICTED CASH. Restricted cash represents amounts collected on behalf of certain clients, a portion of which is held in trust until remitted to such clients. PROPERTY AND EQUIPMENT. Property and equipment, including equipment under capital leases, is stated at cost. Depreciation is computed using the straight line method over the estimated useful lives of the assets, generally four to ten years for furniture and fixtures, three to seven years for equipment, and 20 years for buildings. INTANGIBLE ASSETS. Intangible assets are composed principally of goodwill, clients lists and software development costs. Goodwill and Clients Lists. Goodwill represents the excess of the cost of the businesses acquired over the fair value of net identifiable assets at the date of the acquisition and is amortized using the straight line method, generally over 40 years. Clients lists are amortized using the straight line method over their estimated useful lives, generally seven to 20 years. The Company continually monitors events and changes in circumstances that could indicate carrying amounts of intangible assets may not be recoverable. When events or changes in circumstances are present that indicate the carrying amount of intangible assets may not be recoverable, the Company assesses the recoverability of intangible assets by determining whether the carrying value of such intangible assets will be recovered through undiscounted expected future cash flows after related interest charges. Should the Company determine that the carrying values of specific intangible assets are not recoverable, the Company would record a charge to reduce the carrying value of such assets to their fair values. During 1996, the Company adopted a plan to shut down its wholly-owned operating subsidiary, Imonics Corporation ("Imonics"), and recorded a charge of approximately $13.0 million for the write-off of the unamortized goodwill associated with the purchase of Imonics. In 1994, a charge of approximately $1.9 million associated with the write-off of a non-compete agreement was recorded by one of the Company's subsidiaries prior to that subsidiary's merger with the Company because the non-compete agreement was deemed to have no value. No impairment losses were recorded by the Company in 1995. Software Development Costs. Intangible assets include software development costs incurred in the development or the enhancement of software utilized in providing the Company's business management systems and services. Software development costs are capitalized upon the establishment of technological feasibility for each product or process and capitalization ceases when the product or process is available for general release to customers or is put into service. Capitalized software development costs were approximately $37.9 million and $36.3 million in 1996 and 1995, respectively. In 1996, the Company abandoned its reengineering program and adopted a plan to shut down Imonics and, as a result of these actions, Medaphis wrote off approximately $85.9 million of capitalized software costs which had no future value to the Company. The Company recorded research and development expenses of approximately $3.2 million, $2.8 million and $4.6 million in 1996, 1995 and 1994, respectively. Software development costs are amortized using the straight line method over the estimated economic lives of the assets, which are generally three to five years. Amortization expense related to the Company's capitalized software costs totaled $6.6 million, $5.1 million and $2.9 million in 1996, 1995 and 1994, respectively. STOCK-BASED COMPENSATION PLANS. The Company accounts for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). Effective in 1996, the Company implemented the disclosure requirements of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-based Compensation" ("SFAS No. 123"). SFAS No. 123 requires that companies which elect to not account for stock-based compensation as prescribed by that statement shall disclose the pro forma effects on earnings (loss) and earnings (loss) per share as if SFAS No. 123 had been adopted. Additionally, certain other disclosures are required with respect to stock compensation and the assumptions used to determine the pro forma effects of SFAS No. 123. F-7 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) LEGAL COSTS. The Company records charges for the administrative fees, costs and expenses it anticipates incurring in conjunction with its legal matters when management can reasonably estimate these costs. INCOME TAXES. Deferred income taxes are recognized for the tax consequences of "temporary differences" between financial statement carrying amounts and the tax bases of existing assets and liabilities. The measurement of deferred tax assets and liabilities is predominantly determined by reference to the tax laws and changes to such laws. Management includes the consideration of future events to assess the likelihood that tax benefits will be realized in the future. PRO FORMA PROVISION FOR INCOME TAXES. In 1995 and 1996, the Company acquired the Automation Atwork Companies ("Atwork"), Medical Management Sciences, Inc. ("MMS"), Rapid Systems Solutions, Inc. ("Rapid Systems") and BSG Corporation ("BSG") in merger transactions accounted for as poolings-of- interests. Prior to the mergers, Atwork, MMS, Rapid Systems and a company acquired by BSG prior to the merger between BSG and the Company (the "BSG Merger") had elected "S" corporation status for income tax purposes. As a result of the mergers (or, in the case of the company acquired by BSG, its acquisition by BSG), such entities terminated their "S" corporation elections. Pro forma provision (benefit) for income taxes, taken together with reported income tax expense (benefit), presents the combined pro forma tax expense (benefit) of such entities as if they had been "C" corporations during the periods presented. PRO FORMA NET INCOME (LOSS) PER COMMON SHARE. Pro forma net income (loss) per common share is based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period. Common stock equivalents include the dilutive effect of the assumed exercise of certain outstanding stock options and conversion of convertible preferred stock. Fully diluted pro forma net income per common share is not presented as it is not materially different from primary pro forma net income (loss) per common share or it is antidilutive. The Company's convertible subordinated debentures were not considered common stock equivalents at issuance and are included in the computation of fully diluted pro forma net income (loss) per common share. F-8 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 2. BUSINESS COMBINATIONS AND DIVESTITURES From January 1, 1994 through December 31, 1996, the Company acquired either substantially all of the assets or all of the outstanding capital stock of each of the following businesses which were accounted for using the purchase method of accounting:
COMPANY ACQUIRED CONSIDERATION ACQUISITION DATE - ---------------- ------------- ---------------- (IN THOUSANDS) Sage Communication, Inc. ("Sage")....................... * October 1996 The Medico Group, Ltd................................... * April 1996 Medical Management Computer Sciences, Inc............... * February 1996 CBT Financial Services, Inc............................. * February 1996 The Receivables Management Division of MedQuist, Inc.... $ 17,300 December 1995 The Halley Exchange, Inc. ("Halley").................... * December 1995 Billing and Professional Services, Inc.................. * October 1995 Medical Office Consultants, Inc......................... * May 1995 Computers Diversified, Inc.............................. 15,500 April 1995 Medical Management, Inc................................. 8,000 March 1995 The Decision Support Group, Inc......................... * January 1995 Imonics Corporation..................................... 32,200 December 1994 John Rex, Inc. ("Anescor").............................. 6,000 December 1994 AdvaCare, Inc........................................... 101,600 November 1994 Marmac Management, Inc.................................. * September 1994 Central Billing Services, Inc........................... 19,700 September 1994 Omni Medical Systems, Inc............................... * August 1994 Physician Billing, Inc.................................. 13,000 July 1994 Medical Management Resources, Inc....................... 11,000 July 1994 Consolidated Medical Services, Inc...................... * June 1994 Northwest Creditors Service, Inc........................ 6,600 June 1994 Managed Practice Division of Datamedic Corporation...... 5,000 April 1994
- --------------- * Consideration not material. Each of the foregoing acquisitions has been recorded using the purchase method of accounting and, accordingly, the purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair value as of the date of acquisition. The allocation of the purchase price of certain of the 1996 acquisitions is preliminary and will be adjusted when the necessary information is available. The operating results of the acquired businesses are included in the Company's consolidated statements of operations from the respective dates of acquisition. The pro forma impact of the foregoing acquisitions not presented due to the immaterial effect these acquisitions have on the Company's results of operations for 1996 and 1995. F-9 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In addition to the foregoing acquisitions, the Company acquired eight businesses in 1996 and 1995 which were accounted for using the pooling-of-interests method of accounting. Following is a list of the businesses acquired and the shares exchanged:
SHARES ACQUISITION COMPANY ACQUIRED EXCHANGED DATE - ---------------- --------- ---------------- Health Data Sciences Corporation ("HDS").................... 6,215,000 June 1996 BSG......................................................... 7,539,000 May 1996 Rapid Systems............................................... 1,135,000 April 1996 Intelligent Visual Computing, Inc. ("IVC").................. * February 1996 MMS......................................................... 4,000,000 December 1995 Consort Technologies, Inc. ("Consort")...................... 825,000 November 1995 Healthcare Recoveries, Inc. ("HRI")......................... 3,265,000 August 1995 Atwork...................................................... 8,000,000 March 1995
- --------------- * Consideration not material Since these acquisitions have been recorded using the pooling-of-interests method of accounting, no adjustment has been made to the historical carrying amounts of assets acquired and liabilities assumed. The accompanying consolidated financial statements have been restated to include the financial position and operating results of Atwork, HRI, MMS, Rapid Systems, BSG and HDS for all periods prior to the mergers. No restatement has been made for the financial position and operating results of Consort and IVC prior to the beginning of the fiscal year of their acquisitions due to their immateriality. Prior to its merger with the Company, HRI reported on a fiscal period ending June 30. HRI's financial position and operating results as of and for the period ended June 30, 1994 were combined with the Company's financial position and operating results as of and for the year ended December 31, 1993. HRI's financial position and operating results for 1995 and 1994, which were restated to a calendar year basis, were combined with the Company's financial position and operating results as of and for the years ended December 31, 1995 and 1994. Accordingly, HRI's operating results for the six months ended June 30, 1994 were duplicated in each of the years ended December 31, 1994 and 1993. HRI's revenues and net income for that six-month period were $7,822,000 and $755,000, respectively. Consolidated retained earnings has been reduced by $554,000 which represents HRI's net income applicable to common stockholders for the six months ended June 30, 1994 in order to eliminate the duplication of income applicable to common stockholders for that period in the retained earnings balance. Prior to its merger with the Company, HDS reported on a fiscal period ending March 31. HDS's financial position and operating results as of and for the years ended March 31, 1996, 1995 and 1994 were combined with the Company's financial position and operating results as of and for the years ended December 31, 1995, 1994 and 1993, respectively. Accordingly, HDS's operating results for the three months ended March 31, 1996 were duplicated in each of the years ended December 31, 1996 and 1995. HDS's revenues and net income for that three-month period were $3,758,000 and $382,000, respectively. The beginning cash and cash equivalents balance in the accompanying 1996 consolidated statement of cash flows does not equal the December 31, 1995 cash and cash equivalents balance as a result of the combination, in the 1995 consolidated balance sheet, of HDS's financial position as of March 31, 1996 with the financial position of the Company as of December 31, 1995. F-10 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A reconciliation of revenue, pro forma net income (loss) and pro forma net income (loss) per common share of the Company, as previously reported, Rapid Systems, BSG, HDS and combined, including the pro forma provision for Rapid Systems and BSG income taxes, is as follows:
1995 1994 --------- ---------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenue: Medaphis, as previously reported......................... $463,321 $319,138 Rapid Systems............................................ 14,722 8,558 BSG...................................................... 69,663 49,174 HDS...................................................... 12,171 22,064 -------- -------- Combined......................................... $559,877 $398,934 ======== ======== Pro forma net income (loss): Medaphis, as previously reported......................... $ (4,680) $ 22,935 Rapid Systems............................................ 972 773 BSG...................................................... (1,045) 1,329 HDS...................................................... (3,173) 6,037 Pro forma provision for Rapid Systems and BSG income taxes................................................. (578) (368) -------- -------- Combined......................................... $ (8,504) $ 30,706 ======== ======== Pro forma net income (loss) per common share: Medaphis, as previously reported......................... $ (0.09) $ 0.50 ======== ======== Combined................................................. $ (0.15) $ 0.51 ======== ========
A summary of revenue and pro forma net income for each of the three pooling-of-interests transactions consummated after the first quarter of 1996 for interim year-to-date periods preceding the dates of consummation are as follows (in thousands):
INTERIM PERIOD PRO FORMA PRECEDING NET INCOME COMPANY ACQUIRED CONSUMMATION REVENUE (LOSS) - ---------------- -------------- ------- ----------------- Rapid Systems................................ March 31, 1996 $ 5,248 $ (498) BSG.......................................... March 31, 1996 19,539 2,497 HDS.......................................... March 31, 1996 3,758 382
On March 14, 1997, the Company filed a registration statement with the Securities and Exchange Commission (the "Commission") relating to the planned initial public offering of 100% of the common stock of HRI. This initial public offering is subject to review by the Commission and the marketability of HRI. The proceeds from this offering will be used to repay borrowings under the Second Amended and Restated Agreement (the "Second Amended Facility") (see Note 6 where discussed). Because HRI is not a reportable segment for financial reporting purposes, the Company has not reported the financial position, results of operations and cash flows of HRI as discontinued operations. Medaphis also is assessing alternatives for its BSG Group (BSG, Rapid Systems and Sage). The alternatives include, but are not limited to, seeking a buyer, a spin-off transaction or other capital raising alternatives. F-11 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 3. PROPERTY AND EQUIPMENT Property and equipment consists of the following:
1996 1995 ------- -------- (IN THOUSANDS) Land........................................................ $ 2,873 $ 2,873 Buildings................................................... 8,105 9,839 Furniture and fixtures...................................... 23,276 19,485 Equipment................................................... 120,731 100,866 Other....................................................... 9,766 6,055 ------- -------- 164,751 139,118 Less accumulated depreciation............................... 66,901 41,223 ------- -------- $97,850 $ 97,895 ======= ========
4. INTANGIBLE ASSETS Intangible assets consists of the following:
1996 1995 -------- -------- (IN THOUSANDS) Goodwill.................................................... $355,074 $361,096 Client lists................................................ 57,203 51,862 Software development costs.................................. 34,982 82,219 Other....................................................... 1,000 2,159 -------- -------- 448,259 497,336 Less accumulated amortization............................... 59,226 41,725 -------- -------- $389,033 $455,611 ======== ========
5. ACCRUED EXPENSES Accrued expenses consists of the following:
1996 1995 ------- ------- (IN THOUSANDS) Accrued costs of businesses acquired........................ $ 9,904 $13,582 Funds due clients........................................... 19,207 12,757 Deferred revenue............................................ 13,858 11,590 Accrued legal costs......................................... 15,173 8,264 Accrued restructuring and severance costs................... 18,080 7,801 Interest.................................................... 985 2,917 Other....................................................... 18,473 12,618 ------- ------- $95,680 $69,529 ======= =======
F-12 49 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 6. LONG-TERM DEBT Long-term debt consists of the following:
1996 1995 -------- -------- (IN THOUSANDS) Borrowings under Senior Credit Facility..................... $242,730 $128,000 Capital lease obligations, weighted average effective interest rates of 7.4% and 8.4%........................... 27,810 23,670 Other....................................................... 1,187 9,576 -------- -------- 271,727 161,246 Less current portion........................................ 55,975 10,681 -------- -------- $215,752 $150,565 ======== ========
At December 31, 1996, the Company had a $250 million revolving credit agreement ("the Senior Credit Facility") which was composed of a $240 million revolving credit line and a $10 million cash management line with a six-bank syndicate to finance future acquisitions, working capital and other general corporate needs. The Company had the option of making "LIBOR" based loans or "base rate" loans under the Senior Credit Facility. LIBOR based loans bore interest at LIBOR for the then current interest period plus amounts varying from 1.25% to 1.75% based on the Company's financial performance. Base rate loans bore interest equal to prime. At December 31, 1996, the Company had LIBOR based loans outstanding at interest rates ranging from 6.78% to 6.90%. The Senior Credit Facility contained, among other things, financial covenants which required the Company to maintain certain financial ratios. The Company was in compliance with all covenants as of December 31, 1996. On February 4, 1997, the Company entered into the Second Amended Facility. This agreement replaced the Senior Credit Facility and increased the revolving line of credit to $285 million. The Second Amended Facility is composed of a $275 million revolving line of credit and a $10 million cash management swing loan line with lenders from a six-bank syndicate. The Second Amended Facility effectively refinanced the loans outstanding under the Senior Credit Facility and can be used to finance working capital and other general corporate needs. The Second Amended Facility provides for "base rate" loans which bear interest equal to prime plus 1% as long as certain financial covenants are met. The loan commitments under the Second Amended Facility will reduce to $200 million and $150 million on July 31, 1997 (unless extended by the lenders until September 30, 1997) and January 31, 1998, respectively. The Company does not and did not expect to generate sufficient cash flow from operations to satisfy the required reductions in debt. Management of the Company has adopted plans to divest HRI and is seeking alternatives for the BSG Group, which management believes will generate sufficient net proceeds to meet the reduction in the loan commitments required by the Second Amended Facility. The Company has retained an investment banking firm to advise it on the divestiture of HRI as well as to assist in the evaluation of alternatives for the BSG Group. While management is confident the Company will be able to meet its debt service obligations, there can be no assurance that the Company will be successful in its efforts to divest HRI or the BSG Group. If the Company is unable to dispose of HRI or the BSG Group or through other means generate sufficient net proceeds to satisfy the required reductions in the loan commitments, the Company's lenders can cause the borrowings under the Second Amended Facility to become immediately due and payable. The Second Amended Facility also contains restrictions on the Company's ability to declare or pay cash dividends on its common stock. As part of the consideration paid to the six-bank syndicate for the Second Amended Facility, the Company issued the lenders warrants with vesting for 1% of the common stock of the Company on each of January 1, 1998 and April 1, 1998. The warrants terminate if the Company has no outstanding borrowings on the line of credit on December 31, 1997. The Company has not allocated any value to these warrants because management believes the Company will realize sufficient net proceeds from the divestiture of HRI and the potential alternatives for the BSG Group or the refinancing of any remaining borrowings under the Second F-13 50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Amended Facility to enable the Company to repay all borrowings under the Second Amended Facility by December 31, 1997. The Second Amended Facility expires on June 30, 1998 but may be extended, or otherwise amended, pursuant to agreement between the Company and the lenders under the Second Amended Facility. Borrowings under the Second Amended Facility are secured by substantially all of the Company's assets and are guaranteed by substantially all of the Company's subsidiaries. In April 1995, the Company used the net proceeds of its fourth public offering to repay indebtedness of approximately $121 million then outstanding under the Senior Credit Facility. The Company's capital leases consist principally of leases for equipment. As of December 31, 1996 and 1995, the net book value of equipment subject to capital leases totaled $26.6 million and $20.3 million, respectively. The carrying amounts of long-term debt and capital lease obligations reflected in the consolidated balance sheets approximate fair value of such instruments due to the variable rate nature of the long-term debt and the fixed rates on the capital lease obligations which approximate market rates. The aggregate maturities of long-term debt and capital lease obligations are as follows (in thousands): 1997........................................................ $ 55,975 1998........................................................ 211,403 1999........................................................ 3,306 2000........................................................ 74 2001........................................................ 69 Thereafter.................................................. 900 -------- $271,727 ========
7. CONVERTIBLE SUBORDINATED DEBENTURES The Company issued $63.4 million of 6.5% convertible subordinated debentures to finance the acquisition of CompMed, Inc. The debentures were due on January 1, 2000. The debenture holders had the right to convert the debentures into shares of the Company's common stock at a conversion price of $14.00 per share. In 1995, the Company gave notice of its intent to redeem the debentures on January 1, 1996. Such notice triggered the conversion right of the debenture holders through the date of the redemption. All of the debenture holders exercised their conversion right effective January 1, 1996 and, as a result, approximately 4.5 million shares were issued in the conversion in 1996. The fair value of these convertible subordinated debentures was approximately $170 million based on the market price of Medaphis common stock into which the debentures were converted on January 1, 1996. Pro forma net loss per common share for 1995, assuming the debentures had been converted on January 1, 1995, and assuming the repayment of indebtedness outstanding under the Senior Credit Facility associated with the Company's April 1995 public offering had occurred on January 1, 1995 (see Note 6) would have been $(0.07) per share. 8. LEASE COMMITMENTS The Company leases office space and equipment under noncancelable operating leases which expire at various dates through 2008. Rent expense was $25.6 million, $22.4 million and $13.3 million for the years ended December 31, 1996, 1995 and 1994, respectively. F-14 51 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Future minimum lease payments under noncancelable operating leases are as follows (in thousands): 1997........................................................ $ 26,019 1998........................................................ 24,087 1999........................................................ 21,497 2000........................................................ 10,367 2001........................................................ 6,566 Thereafter.................................................. 15,336 -------- $103,872 ========
9. INCOME TAXES Income tax expense (benefit) is comprised of the following:
1996 1995 1994 -------- ------- -------- (IN THOUSANDS) Current: Federal........................................... $ 634 $ 66 $ 264 State............................................. 2,533 1,795 439 Deferred: Federal........................................... (63,137) 413 13,977 State............................................. (8,948) (928) 1,988 Foreign........................................... 146 -- -- Valuation allowance................................. (189) 441 (513) -------- ------- -------- Income tax expense (benefit)........................ (68,961) 1,787 16,155 Pro forma adjustments for income taxes.............. (979) 3,389 1,817 -------- ------- -------- $(69,940) $ 5,176 $ 17,972 ======== ======= ========
In 1995 and 1996, the Company acquired Atwork, Consort, MMS, IVC, Rapid Systems and BSG in merger transactions accounted for as poolings-of-interests. Prior to the mergers, Atwork, Consort, MMS, IVC, Rapid Systems and a company acquired by BSG prior to the BSG Merger had elected "S" corporation status for income tax purposes. As a result of the mergers (or, in the case of the company acquired by BSG, its acquisition by BSG), such entities terminated their "S" corporation elections. Pro forma net income (loss) and pro forma net income (loss) per common share are presented in the consolidated statements of operations as if each of these entities had been a "C" corporation during the periods presented. A reconciliation between the amount determined by applying the federal statutory rate to income before income taxes and income tax expense is as follows:
1996 1995 1994 -------- ------- -------- (IN THOUSANDS) Income tax expense at federal statutory rate........ $(67,753) $(1,342) $ 17,037 State taxes, net of federal benefit................. (7,074) 361 2,475 Nondeductible goodwill amortization................. 1,491 1,298 380 Nondeductible deal costs of business combinations... 3,314 5,623 -- Other items not deductible for tax purposes......... 1,051 371 272 Research and development tax credits................ -- -- (596) Valuation allowance................................. (189) 441 (513) Foreign............................................. 146 -- -- Other............................................... (926) (1,576) (1,083) -------- ------- -------- $(69,940) $ 5,176 $ 17,972 ======== ======= ========
F-15 52 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In 1995, the effects of changes in the Company's assessment of the tax consequences of certain matters comprise substantially all of "other" in the above rate reconciliation. Deferred taxes are recorded based upon differences between the financial statement and tax bases of assets and liabilities and available tax credit carryforwards. The components of deferred taxes as of December 31, 1996 and 1995 are as follows:
1996 1995 -------- -------- (IN THOUSANDS) Net operating loss carryforwards............................ $122,424 $ 58,888 Research and development credits............................ -- 1,078 Valuation allowance......................................... (18,334) (18,310) Accounts receivable......................................... (40,125) (31,841) Depreciation and amortization............................... (15,318) (37,674) Accrued expenses............................................ 34,268 21,166 Other deferred tax liabilities.............................. (4,359) (6,806) -------- -------- $ 78,556 $(13,499) ======== ========
The valuation allowance relates primarily to the uncertainty of the realizability of net operating loss carryforwards assumed in certain business combinations. The change in the valuation allowance during 1996 relates primarily to the finalization of the purchase price allocation of an entity acquired in 1995. As of December 31, 1996, the Company had federal net operating loss carryforwards for income tax purposes of approximately $315 million which expire at various dates between 1997 and 2011. The Internal Revenue Code of 1986, as amended, may impose substantial limitations on the use of net operating loss carryforwards upon the occurrence of an "ownership change." The Company has experienced three ownership changes which have established maximum annual limitations on income against which net operating losses incurred prior to the ownership changes may be offset. However, because the limitation operates in a cumulative manner and in previous years the Company did not utilize net operating losses ("NOLs"), the Company has approximately $250 million in cumulative unutilized NOLs available in 1997. In future years, currently unavailable NOLs will become available to offset income prior to the date of their expiration. Management expects to utilize a significant portion of the currently available NOLs with the anticipated taxable gain from the divestiture of HRI. As of December 31, 1996, the Company has recorded a deferred tax asset of $78.6 million reflecting primarily the benefit of $122.4 million in loss carryforwards. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward period are reduced. 10. CAPITAL STOCK On May 1, 1996, the stockholders of the Company approved an amendment to the Company's Amended and Restated Certificate of Incorporation, thereby increasing the number of authorized shares of the Company's voting common stock from 100 million to 200 million shares. On May 3, 1995, the Company's Board of Directors declared a two-for-one stock split of the outstanding shares of common stock. The stock split was effected in the form of a stock dividend payable on May 31, 1995 to stockholders of record as of May 24, 1995. The effect of the stock split has been retroactively applied to all periods presented in the accompanying consolidated financial statements. On April 12, 1995, the Company completed a fourth public offering of its common stock in which 4,244,000 shares were sold at $31.75 per share. The Company sold 4,000,000 shares of its common stock and 244,000 shares of common stock were sold on behalf of certain of the Company's stockholders. The net proceeds to the Company were approximately $121 million. Prior to the BSG Merger, BSG had two classes of preferred stock outstanding. Dividends were noncumulative and payable at 8% per year at the discretion of BSG's Board of Directors. The preferred shares F-16 53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) were convertible, at the option of the holder on a one-to-one basis into common shares of BSG, and the preferred shareholders had the right to vote on an as converted basis. In connection with the BSG Merger on May 6, 1996, all preferred shares were converted into common shares of BSG which were subsequently exchanged for common shares of the Company. Prior to the Company's merger with HDS, HDS had three classes of preferred stock outstanding. The preferred stock carried no guaranteed dividend features and had no mandatory redemption features. The preferred shares were convertible, at the option of the holder on a one-to-one basis into common shares of HDS. In connection with HDS's merger with the Company on June 29, 1996, all preferred shares were converted into common shares of HDS which were subsequently exchanged for common shares of the Company. 11. COMMON STOCK OPTIONS AND STOCK AWARDS The Company has several stock option plans including a Non-Qualified Stock Option Plan, a Non-Qualified Stock Option Plan for Employees of Acquired Companies, a Non-Qualified Stock Option Plan for Non-executive Employees and several stock option plans assumed as a result of the BSG Merger (collectively the "Stock Option Plans"). Granted options expire 10 to 11 years after the date of grant and generally vest over a three-to-five-year period. In connection with the BSG Merger, the Company offered to issue options under the Company's Non-Qualified Stock Option Plan for Employees of Acquired Companies in exchange for options outstanding under the BSG option plans. In 1994, the Company adopted a Non-Employee Director Stock Option Plan ("Director Plan") for non-employees who serve on the Company's Board of Directors. The plan was approved by the Company's stockholders at the annual stockholders' meeting in 1995. The Director Plan provides for an initial grant of 10,000 options at a strike price corresponding to the date on which the non-employee director is elected or appointed to the Board of Directors. Additionally, each non-employee director receives an annual grant of 2,000 options at each subsequent annual meeting in which the non-employee director is a member of the Board of Directors. All options granted under the Director Plan vest over a five-year period and expire 11 years from the date of grant. The Company has a Senior Executive Non-Qualified Stock Option Plan which permits certain of the Company's former executive officers to purchase up to an aggregate of 550,746 shares of the Company's common stock at $2 per share. All options available for grant under this plan have been granted, expire January 16, 2001 and are currently exercisable. As of December 31, 1996, 347,960 options issued under this plan have been exercised (117,960 during 1996 and zero during 1995). F-17 54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Activity related to the Stock Option Plans is summarized as follows:
1996 1995 1994 ------------------------- ------------------------- ------------------------- SHARES WEIGHTED-AVERAGE SHARES WEIGHTED-AVERAGE SHARES WEIGHTED-AVERAGE (000) EXERCISE PRICE (000) EXERCISE PRICE (000) EXERCISE PRICE ------ ---------------- ------ ---------------- ------ ---------------- Options outstanding as of January 1.................. 9,559 $12.27 6,447 $ 8.38 5,680 $ 6.46 Granted...................... 7,021 11.56 4,109 17.75 1,730 12.95 Canceled..................... (3,947) 22.17 (440) 7.79 (378) 8.70 Exercised.................... (1,536) 7.95 (557) 11.24 (585) 3.02 ------ ------- ----- ------- ----- ------- Options outstanding as of December 31................ 11,097 $ 8.91 9,559 $12.27 6,447 $ 8.38 ====== ======= ===== ======= ===== ======= Options exercisable as of December 31................ 3,022 2,620 1,927 ====== ===== ===== Weighted-average fair value of options granted during the year................... $ 4.18 $2.87 ====== =====
The following table summarizes information about stock options outstanding at December 31, 1996:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------------- --------------------------------- NUMBER WEIGHTED- NUMBER OUTSTANDING AT AVERAGE EXERCISABLE AT DECEMBER 31, REMAINING WEIGHTED- DECEMBER 31, 1996 CONTRACTUAL AVERAGE 1996 WEIGHTED-AVERAGE RANGE OF EXERCISE PRICES (000) LIFE EXERCISE PRICE (000) EXERCISE PRICE - ------------------------ -------------- ----------- -------------- -------------- ---------------- $0.08 to $7.75................... 2,655 7.42 $ 3.32 1,499 $ 3.13 $8.25 to $8.50................... 3,795 10.88 8.50 6 8.33 $8.70 to $13.50.................. 3,534 8.27 9.83 1,110 9.69 $13.56 to $21.06................. 627 7.97 14.18 259 14.30 $21.75 to $52.01................. 486 9.76 29.08 148 25.25 ------ ----- ------ ----- ------- $0.08 to $52.01.................. 11,097 9.00 $ 8.91 3,022 $ 7.55 ====== ===== ====== ===== =======
On October 25, 1996, the Company changed the exercise price of approximately 2.0 million of its then outstanding stock options which had an exercise price of $15 or greater. These options have a new exercise price of $9.875. No other terms of these options were changed. In 1994, the disinterested members of the Company's Board of Directors approved the Medaphis Corporation Restricted Stock Plan (the "Restricted Plan") for executive officers. The plan was approved by the Company's stockholders at the annual stockholders' meeting in 1995. The Restricted Plan authorized the award of 249,000 shares of $0.01 par value common stock to certain executive officers who have since resigned from the Company. The restricted stock vests ratably over a four-year period from the date of award. Vesting may be accelerated if certain performance goals are achieved. One of these performance goals was achieved based on 1995 results of operations, and accordingly, 50% of the awards made under the Restricted Plan have vested. In 1996, the disinterested members of the Company's Board of Directors approved the Medaphis Corporation Reengineering, Consolidation and Business Improvement Cash Incentive Plan ("Reengineering Incentive Plan") and the Company granted 155,749 units pursuant to the provisions of the plan to certain key employees of the Company. The Reengineering Incentive Plan provides for the payment of cash bonuses to participants if certain performance goals related to the Company's reengineering and consolidation project are achieved and certain general business improvement milestones are satisfied. Awards under the plan are based on units awarded to each participant. If the performance goals specified in the Reengineering Incentive Plan F-18 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) are achieved and the awards vest, the value of each unit will equal the average price of the Company's common stock during the ten trading days immediately preceding such vesting date. At the point it becomes probable that the performance goals and milestones will be met, the Company will begin to accrue for the full amount of these bonuses. All awards made under the Reengineering Incentive Plan, to the extent they remain unvested, terminate on December 31, 1997. Because of the Company's decision to abandon the reengineering program, certain of the performance goals and milestones will not be met prior to December 31, 1997, therefore all grants pursuant to the Reengineering Incentive Plan will terminate unvested. The Company accounts for its stock-based compensation plans under APB No. 25. As a result, the Company has not recognized compensation expense for stock options granted with an exercise price equal to the quoted market price of the Company's common stock on the date of grant and which vest based solely on continuation of employment by the recipient of the option award. The Company adopted SFAS No. 123 for disclosure purposes in 1996. For SFAS No. 123 purposes, the fair value of each option grant and stock based award has been estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
1996 1995 ----- ----- Expected life (years)....................................... 4.16 3.84 Risk-free interest rate..................................... 5.06% 6.18% Dividend rate............................................... 0.00% 0.00% Expected volatility......................................... 48.83% 18.81%
Had compensation cost been determined consistent with SFAS No. 123, utilizing the assumptions detailed above, the Company's pro forma net loss and pro forma loss per share would have increased to the following pro forma amounts:
1996 1995 --------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Pro forma net loss: As reported -- pro forma for income taxes................. $(123,642) $(8,504) Pro forma -- for SFAS No. 123............................. $(126,659) $(9,538) Pro forma net loss per share: As reported -- pro forma for income taxes................. $ (1.74) $ (0.15) Pro forma -- for SFAS No. 123............................. $ (1.78) $ (0.17)
Because the method of accounting under SFAS No. 123 has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that expected in future years. 12. EMPLOYEE BENEFIT PLANS The Company has various defined contribution plans whereby employees meeting certain eligibility requirements can make specified contributions to the plans, a percentage of which are matched by the Company. The Company's contribution expense was $3.5 million, $3.3 million and $1.9 million for the years ended December 31, 1996, 1995 and 1994, respectively. The Company maintains a noncontributory money purchase pension plan which covers substantially all employees who are retained by the Company primarily to service specific physician clients. Contributions are determined annually by the Company not to exceed the maximum amount deductible for federal income tax purposes. The Company's contribution to the plan was $1.2 million in 1996, $1.0 million in 1995 and $0.7 million in 1994. F-19 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 13. RESTRUCTURING AND OTHER CHARGES Components of restructuring and other charges are as follows:
1996 1995 1994 -------- ------- ------ (IN THOUSANDS) Restructuring charges....................................... $ 14,076 $15,000 $ -- Software abandonment........................................ 86,088 1,800 -- Property and equipment impairment........................... 35,592 5,000 -- Intangible asset impairment................................. 13,048 -- 1,905 Legal costs................................................. 12,800 12,000 -- Pooling charges............................................. 8,953 11,700 -- Severance costs............................................. 3,913 5,000 -- Other....................................................... 5,298 4,450 -- -------- ------- ------ $179,768 $54,950 $1,905 ======== ======= ======
Restructuring Charges. In 1995, Management approved a restructuring plan relating to the consolidation of the Company's data processing function in its wholly owned operating subsidiary, Medaphis Physician Services Corporation ("MPSC"). The Company recorded a reserve for the exit costs associated with the restructuring plan of approximately $15.0 million. During 1996, the Company revised its original plan of consolidating into ten regional information processing centers ("IPCs") and reduced these reserves by approximately $1.8 million. The Company has adopted a plan to downsize certain of the existing IPCs and the costs associated with exiting these facilities will be charged against the restructuring reserves established in 1995. The Company also incurred approximately $5.2 million of costs which were related to MPSC's reengineering and consolidation project which had not previously been accrued. Also during 1996, the Company restructured its client/server system integration businesses and consolidated Rapid Systems into BSG and adopted a plan to shut down Imonics. In connection with this restructuring, the Company recorded charges of approximately $3.0 million for the costs associated with the termination of certain leases, approximately $6.5 million for severance costs for all notified employees of Imonics and approximately $1.2 million for other exit activities. Software Abandonment. In June 1996, the Company began a comprehensive assessment of the reengineering program for the Company's Services division which was begun in 1994. The comprehensive review was completed and management came to the conclusion that it was not cost effective to continue the development and deployment of the software and technology upon which the reengineering program was based and that the reengineering software and technology had no alternative useful application in the Company's operations. In connection with abandonment of its reengineering program and the shutdown of Imonics, the Company abandoned certain software development projects and recorded charges for the write-off of approximately $86.1 million of capitalized software development costs related to these projects. In connection with the Halley acquisition in 1995, the Company recorded a $1.8 million charge related to the cost of purchased research and development activities related to acquired technology for which technological feasibility had not yet been established and which had no alternative future uses. Property and Equipment Impairment. In connection with the abandonment of the reengineering project and the shutdown of Imonics in 1996 and the restructuring of MPSC in 1995, the Company assessed the recoverability of certain of its long lived assets and recorded impairment losses of approximately $35.6 million and $5.0 million in 1996 and 1995, respectively. Intangible Asset Impairment. In 1996, the Company adopted a plan to shut down Imonics and recorded a charge of approximately $13 million for the write-off of the unamortized goodwill associated with the purchase of Imonics. In 1994, a charge of approximately $1.9 million, associated with the write-off of a non- F-20 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) compete agreement, was recorded by one of the Company's subsidiaries prior to that subsidiary's merger with the Company because the non-compete agreement was deemed to have no value. Legal Costs. In 1996, the Company recorded a charge of $5.0 million for the administrative fees, costs and expenses it anticipates incurring in connection with various putative class action lawsuits which have been filed since August 14, 1996 against the Company and certain of its former officers, one of whom was also a director. The Company also accrued $4.6 million for the legal costs and other fees the Company has or plans to incur in connection with the turnaround effort undertaken by the new management team and various other legal matters. The Company recorded charges of $2.0 million and $12.0 million in 1996 and 1995, respectively, for the administrative fees, costs and expenses it anticipates incurring in connection with the Federal Investigation (as defined in Note 14) and various putative class action lawsuits which are based on the Federal Investigation. In 1996, the Company reached an agreement in principle to settle the class action lawsuits which are based on the Federal Investigation for $4.75 million. Also in 1996, the Company has recorded a $1.2 million charge for its portion of this settlement (the Company expects the remainder of the settlement to be funded by insurance) (See Note 14 for more detail on the Federal investigation and the settlement of the lawsuits). Pooling Charges. In connection with the following mergers, the Company incurred transaction fees, costs and expenses. In accordance with the requirements of pooling-of-interests accounting, these costs have been reflected in the operating results for 1996 and 1995.
1996 1995 ------ ------- (IN THOUSANDS) Atwork...................................................... $ (430) $ 6,000 HRI......................................................... (778) 2,000 Consort..................................................... (529) 1,200 MMS......................................................... (845) 2,500 IVC......................................................... 169 -- Rapid Systems............................................... 584 -- BSG......................................................... 6,094 -- HDS......................................................... 4,688 -- ------ ------- $8,953 $11,700 ====== =======
Severance Costs. In 1995, management of MPSC formalized an involuntary severance benefit plan. The Company recorded charges of approximately $0.9 and $5.0 million in 1996 and 1995, respectively, in accordance with Statement of Financial Accounting Standards No. 112 to reflect the expense for employees' rights to involuntary severance benefits that have accumulated to date. Also, in 1996 the Company recorded a charge of $3.0 million for severance costs associated with former executive management. Other Costs. During 1996, the Company canceled an initiative to develop an on-line practice management system. The Company recorded a charge of approximately $2.0 million relating to the deferred costs associated with this project. The Company also accrued $1.3 million for certain liabilities associated with the Company's billing and accounts receivable management services operations. In addition, the Company also recorded a charge of approximately $2.0 million for miscellaneous asset write-offs. Prior to the Company's merger with MMS, MMS terminated a merger agreement with an unrelated third party. In connection with the termination of this agreement, MMS agreed to pay costs associated with the planned merger and potential initial public offering of the combined entity. Such costs amounted to approximately $3.7 million and were recorded as a charge in 1995. In addition, in 1995 the Company recorded a charge of $750,000 for certain amounts paid to the former owners of an acquired company. During the fourth quarter of 1996, the Company recorded charges of $138.6 million related to the abandonment of the reengineering program, the shut down of Imonics and other charges as discussed above. F-21 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A description of the type and amount of restructuring costs recorded at the commitment date and subsequently incurred for both the restructuring of Imonics and MPSC are as follows:
1995 COSTS RESERVE COSTS RESERVE INITIAL APPLIED BALANCE APPLIED BALANCE RESERVE AGAINST DECEMBER 31, RESERVE AGAINST DECEMBER 31, CHARGE RESERVE 1995 ADJUSTMENTS RESERVES 1996 ------- ------- ------------ ----------- -------- ------------ Lease termination costs......... $ 6,726 $ (736) $ 5,990 $ 5,017 $ (3,493) $ 7,514 Incremental costs associated with discontinued client contracts..................... 5,488 (797) 4,691 (2,690) (2,001) -- Severance....................... -- -- -- 6,541 (3,793) 2,748 Other........................... 2,823 (1,035) 1,788 5,208 (5,774) 1,222 ------- ------- ------- ------- -------- ------- $15,037 $(2,568) $12,469 $14,076 $(15,061) $11,484 ======= ======= ======= ======= ======== =======
14. CERTAIN LEGAL MATTERS The United States Attorney's Office for the Central District of California is conducting an investigation (the "Federal Investigation") of Medaphis' billing and collection practices in its offices located in Calabasas and Cypress, California (the "Designated Offices"). Medaphis first became aware of the Federal Investigation when it received search warrants and grand jury subpoenas on June 13, 1995. Although the precise scope of the Federal Investigation is not known to the Company at this time, Medaphis believes that the U.S. Attorney's Office is investigating allegations of billing fraud and that the inquiry is focused upon Medaphis' billing and collection practices in the Designated Offices. Numerous federal and state civil and criminal laws govern medical billing and collection activities. In general, these laws provide for various fines, penalties, multiple damages, assessments and sanctions for violations, including possible exclusion from Medicare, Medicaid and certain other federal and state healthcare programs. Although the Designated Offices represent less than 2% of Medaphis' annual revenue, there can be no assurance that the Federal Investigation will be resolved promptly, that additional subpoenas or search warrants will not be received by Medaphis or that the Federal Investigation will not have a material adverse effect upon the Company. The Company recorded charges of $12 million in the third quarter of 1995 and $2 million in the fourth quarter of 1996 solely for the administrative fees, costs and expenses it anticipates incurring in connection with the Federal Investigation and the putative class action lawsuits described below which were filed following the Company's announcement of the Federal Investigation. The charges are intended to cover only the anticipated expenses of the Federal Investigation and the related lawsuits and do not include any provision for fines, penalties, damages, assessments, judgments or sanctions that may arise out of such matters. Following the announcement of the Federal Investigation, Medaphis, various of its current and former officers and directors and the lead underwriters associated with Medaphis' public offering of Common Stock in April 1995 were named as defendants in putative shareholder class action lawsuits filed in the United States District Court for the Northern District of Georgia. In general, these lawsuits allege violations of the federal securities laws in connection with Medaphis' public statements and filings under the federal securities acts, including the registration statement filed in connection with Medaphis' public offering of Common Stock in April 1995. On October 13, 1995, the named plaintiffs in these lawsuits filed a consolidated class action complaint (the "Consolidated Complaint"). On January 3, 1996, the court denied defendant's motion to dismiss the Consolidated Complaint. On April 11, 1996, certain of the named plaintiffs to the Consolidated Complaint voluntarily dismissed with prejudice all of their claims. As a result of these dismissals, the Consolidated Complaint no longer contains any claims based on the 1933 Act and the Company's underwriters and outside directors are no longer named as defendants. On June 26, 1996, the court denied the plaintiffs' motion to certify a plaintiffs' class. The plaintiffs and the defendants have reached an agreement in principle to settle this action on a class-wide basis for $4.75 million, subject to court approval and other customary conditions (the "1995 Class Action Settlement"). The 1995 Class Action Settlement would also include the related putative class action lawsuit currently pending in the Superior Court of Cobb County, F-22 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Georgia, described more fully below. The Company expects to receive approximately $3.7 million from insurance to fund a portion of the 1995 Class Action Settlement and accrued approximately $1.2 million in the quarter ending December 31, 1996 to fund the anticipated balance of the 1995 Class Action Settlement and to pay certain fees incident thereto. On November 5, 1996, Medaphis, Randolph G. Brown, Michael R. Cote and James S. Douglass were named as defendants in a putative shareholder class action lawsuit filed in Superior Court of Cobb County, State of Georgia. This lawsuit alleges violations of Georgia securities laws based on the same public statements and filings generally described above. The lawsuit is brought on behalf of a putative class of purchasers of Medaphis Common Stock during the period from March 29, 1995 through June 15, 1995. The plaintiffs seek compensatory damages and costs. As noted above, it is currently contemplated that this action will be settled as part of the 1995 Class Action Settlement. The Company and its clients from time to time have received, and the Company anticipates that they will receive in the future, official inquiries (including subpoenas, search warrants, as well as informal requests) concerning particular billing and collection practices related to certain subsidiaries of the Company and its many clients. In March 1997, the Company was informed by the Civil Division of the Department of Justice that it is investigating allegations concerning the Company's Gottlieb's Financial Services, Inc. ("GFS") subsidiary. No subpoenas or other process have been issued to the Company or to GFS in connection with the investigation. There can be no assurance that this matter will be resolved promptly, that subpoenas will not be received by Medaphis or that the investigation will not have a material adverse effect upon Medaphis. Following the Company's August 14, 1996 announcement regarding earnings expectations and certain charges, Medaphis and certain of its current and former officers, one of whom was also a director, were named as defendants in nineteen putative shareholder class action lawsuits filed in the United States District Court for the Northern District of Georgia. On November 22, 1996, the plaintiffs in these lawsuits filed a Consolidated Amended Class Action Complaint (the "1996 Consolidated Complaint"). In general, the 1996 Consolidated Complaint alleges violations of the federal securities laws in connection with Medaphis' filings under the federal securities acts and public disclosures. The 1996 Consolidated Complaint is brought on behalf of a class of all persons who purchased or otherwise acquired Medaphis Common Stock between January 6, 1996 and October 21, 1996. The 1996 Consolidated Complaint also asserts claims on behalf of a sub-class of all persons who acquired Medaphis Common Stock pursuant to the merger between Medaphis and HDS. On December 30, 1996, the defendants filed a motion to dismiss most of the 1996 Consolidated Complaint. On February 3, 1997, the plaintiffs filed a Consolidated Second Amended Complaint. On February 14, 1997, the defendants moved to dismiss the Consolidated Second Amended Complaint in its entirety. On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit Sharing Plan filed a shareholder derivative lawsuit in the United States District Court for the Northern District of Georgia alleging that certain of Medaphis' current and former directors breached their fiduciary duties, were grossly negligent, and breached various contractual obligations to Medaphis by allegedly failing to implement and maintain an adequate system of internal accounting controls, allowing Medaphis to commit securities law violations and damaging Medaphis' reputation. The plaintiff seeks compensatory damages and costs. On January 28, 1997, Medaphis and certain individual defendants filed a motion to dismiss the complaint. On February 11, 1997, the plaintiff filed an amended complaint adding as defendants additional current and former directors and officers of Medaphis. Medaphis has not yet responded to the amended complaint. On November 7, 1996, Health Systems International, Inc. filed suit in the Superior Court for the State of California, County of Los Angeles against Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed Medaphis directors, officers and employees. Generally, this lawsuit alleges that the defendants violated federal and California securities laws and common law by, among other things more fully described in the complaint, making material misstatements and omissions in public and private disclosures in connection with the acquisition of HDS. The plaintiff seeks rescissory, compensatory and punitive damages, rescission, injunctive relief and costs. On January 10, 1997, the defendants filed a demurrer to the complaint. The F-23 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) demurrer was denied on February 5, 1997. On March 18, 1997, the court denied the plaintiff's motion for a preliminary injunction. As a result of the Company's restatement of its fiscal 1995 financial statements, the Company may not be able to sustain a defense to strict liability on certain claims under the 1933 Act, but the Company believes that it has substantial defenses to the alleged damages relating to the 1933 Act claims. A putative class action complaint was filed by Ernest Hecht and Stephen D. Strandberg against Steven G. Papermaster, Robert E. Pickering, Jr., David S. Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division, Essex County, State of New Jersey. The alleged class consists of persons and entities whose options to purchase BSG common stock were converted to Medaphis stock options in connection with Medaphis' acquisition of BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary duties of candor, loyalty and fair dealing and negligence against the BSG defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud and deceit against the Medaphis defendants (Medaphis and Brown). On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two entities they control made a demand for indemnification under an indemnification agreement executed by Medaphis in connection with its acquisition of BSG in May 1996. On the date of the demand, Mr. Papermaster was an executive officer and a director of Medaphis. Mr. Papermaster resigned such positions on March 21, 1997, although he remains a director and executive officer of BSG. The indemnification demand claims damages of $35 million (the maximum damages payable by Medaphis under the indemnification agreement) for the alleged breach by the Company of its representations and warranties made in the merger agreement between Medaphis and BSG. The Company believes it has meritorious defenses to the indemnification claim. The Company also has received other written demands from various stockholders, including stockholders of recently acquired companies. To date, these other stockholders have not filed lawsuits. On January 8, 1997, the Securities and Exchange Commission (the "Commission") notified the Company that it is conducting a non-public investigation into, among other things, certain trading and other issues related to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's loss for the quarter ending September 30, 1996 and its restated consolidated financial statements for the three months and year ended December 31, 1995 and its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996. The Company intends to cooperate fully with the Commission in its investigation. Although the Company believes that it has meritorious defenses to the claims of liability or for damages in the actions against, and written demands placed upon, the Company, there can be no assurance that additional lawsuits will not be filed against the Company, that the lawsuits, the written demands and the pending governmental investigations will not have a disruptive effect upon the operations of the business, that the written demands, the defense of the lawsuits and the pending investigations will not consume the time and attention of the senior management of the Company and that the resolution of the lawsuits, the written demands and the pending governmental investigations will not have a material adverse effect upon the Company. F-24 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 15. CASH FLOW INFORMATION Supplemental disclosures of cash flow information and non-cash investing and financing activities were as follows:
1996 1995 1994 ------- ------- -------- (IN THOUSANDS) Non-cash investing and financing activities: Liabilities assumed in acquisitions................ $ 3,436 $11,454 $108,781 Additions to capital lease obligations............. 15,705 17,646 5,356 Common stock issued in conjunction with acquisitions.................................... -- 459 38,796 Cash paid for: Interest (net of amounts capitalized of $4,092, $2,359 and $0 for 1996, 1995 and 1994, respectively)................................... 14,762 11,129 6,796 Income taxes....................................... 7,314 3,155 517
16. LINES OF BUSINESS The Company operates in three major lines of business: Services (providing healthcare business management services to physicians, hospitals and payors), BSG Group (client/server information technology services) and HIT (healthcare information technology and hardware sales). Operating profit is total revenue less operating expenses. Corporate items include interest income and expense and other general corporate expenses. Corporate assets consist primarily of cash and cash equivalents, deferred income taxes, deferred financing costs, fixed assets, and miscellaneous prepaids and receivables. Information concerning operations in these lines of business is as follows:
1996 1995 1994 --------- -------- -------- Revenue: Services............................................ $ 415,328 $402,467 $291,536 BSG Group........................................... 113,988 98,615 57,732 HIT................................................. 81,646 60,521 50,387 Corporate and eliminations.......................... (2,649) (1,726) (721) --------- -------- -------- $ 608,313 $559,877 $398,934 ========= ======== ======== Operating profit (loss) (1): Services............................................ $ 14,454 $ 52,136 $ 47,979 BSG Group........................................... (14,982) 5,249 1,885 HIT................................................. 25,649 15,024 13,342 Corporate and eliminations.......................... (27,350) (11,231) (6,697) --------- -------- -------- $ (2,229) $ 61,178 $ 56,509 ========= ======== ======== Interest expense, net................................. $ 11,585 $ 10,062 $ 5,926 Restructuring and other charges: Services............................................ $ 97,692 $ 47,000 $ 1,905 BSG Group........................................... 60,882 -- -- HIT................................................. 3,957 7,950 -- Corporate........................................... 17,237 -- -- --------- -------- -------- 179,768 54,950 1,905 --------- -------- -------- Income (loss) before income taxes..................... $(193,582) $ (3,834) $ 48,678 ========= ======== ========
F-25 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1996 1995 1994 --------- -------- -------- Identifiable Assets: Services............................................ $ 594,738 $628,522 $521,102 BSG Group........................................... 51,972 70,807 48,282 HIT................................................. 84,298 86,029 55,142 Corporate........................................... 84,616 10,248 2,625 --------- -------- -------- $ 815,624 $795,606 $627,151 ========= ======== ======== Depreciation and amortization: Services............................................ $ 32,498 $ 22,015 $ 14,606 BSG Group........................................... 7,980 5,842 1,974 HIT................................................. 6,135 4,153 3,356 Corporate........................................... 1,679 525 185 --------- -------- -------- $ 48,292 $ 32,535 $ 20,121 ========= ======== ======== Capital expenditures: Services............................................ $ 31,432 $ 34,648 $ 9,799 BSG Group........................................... 13,376 12,927 2,271 HIT................................................. 3,204 1,847 267 Corporate........................................... 3,123 1,564 726 --------- -------- -------- $ 51,135 $ 50,986 $ 13,063 ========= ======== ========
- --------------- (1) Excludes restructuring and other charges and interest expense. 17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
QUARTER ENDED ------------------------------------------------ MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- -------- ------------ ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 (AS PREVIOUSLY REPORTED) Revenue........................................... $163,627 $175,193 $126,731 $ 142,937 Pro forma net income (loss)....................... 13,079 3,337 (36,370) (103,688) Pro forma net income (loss) per common share...... $ 0.17 $ 0.04 $ (0.51) $ (1.45) Weighted average shares outstanding............. 75,704 75,006 71,665 71,695 1996 (AS RESTATED) Revenue........................................... $162,249 $169,719 $132,874 $ 143,471 Pro forma net income (loss)....................... 11,013 (3,097) (31,502) (100,056) Pro forma net income (loss) per common share...... $ 0.15 $ (0.04) $ (0.44) $ (1.40) Weighted average shares outstanding............. 75,704 71,167 71,665 71,695 1995 Revenue........................................... $133,093 $141,286 $140,752 $ 144,746 Pro forma net income (loss)....................... (11,857) 7,226 (2,723) (1,150) Pro forma net income (loss) per common share...... $ (0.23) $ 0.10 $ (0.05) $ (0.02) Weighted average shares outstanding............. 50,932 69,053 57,696 58,068
As a result of a review initiated by senior management and the Audit Committee of the Board of Directors (the "Audit Committee") in March 1997 prior to completion of the audit process for the Company's 1996 fiscal year, information was developed that certain revenues and expenses may have been recorded incorrectly between certain quarters during 1996. At the conclusion of the review, the Company determined that there were certain accounting errors and irregularities and that its interim financial statements for each fiscal quarter of 1996 required restatement as set forth herein. These errors and irregularities F-26 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) consisted primarily of the following: (1) incorrect quarterly recording of revenues and the related costs and expenses for certain contracts; (2) incorrect quarterly recording of certain liabilities for employee bonuses and related expenses; (3) certain costs and expenses of certain acquired companies, which were later determined not to be properly recordable, were recognized by those companies in periods prior to their acquisitions, resulting in an overstatement of the Company's earnings subsequent to those acquisitions; and (4) incorrect depreciation of certain assets related to the Company's comprehensive reengineering and consolidation project. The Company has determined that all appropriate adjustments have been made to its interim financial statements and that its consolidated financial statements, taken as a whole, present fairly in all material respects the Company's financial position, results of operations and cash flows for its fiscal year ended December 31, 1996 in conformity with generally accepted accounting principles. All adjustments were for inter-period transactions and had no effect on the Company's 1996 annual proforma net loss as previously reported and as set forth herein. F-27 64 MEDAPHIS CORPORATION SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
ADDITIONS ----------------------- CHARGED BALANCE AT CHARGED TO TO BALANCE AT BEGINNING COSTS AND OTHER END DESCRIPTION OF YEAR EXPENSES ACCOUNTS DEDUCTIONS OF YEAR - ----------- ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS) YEAR ENDED DECEMBER 31, 1996 Allowance for doubtful accounts..... $6,225 $16,657 $ -- $(9,622)(2) $13,260 YEAR ENDED DECEMBER 31, 1995 Allowance for doubtful accounts..... $3,205 $ 6,718 $1,278(1) $(4,976)(2) $ 6,225 YEAR ENDED DECEMBER 31, 1994 Allowance for doubtful accounts..... $2,193 $ 4,089 $ 338(1) $(3,415)(2) $ 3,205
- --------------- (1) Represents the allowance recorded in conjunction with acquired companies. (2) Represents write-off of uncollectible accounts receivable. F-28 EX-4.17 2 NON-QUALIFIED STOCK OPTION PLAN 1 Exhibit 4.17 MEDAPHIS CORPORATION NON-QUALIFIED STOCK OPTION PLAN FOR NON-EXECUTIVE EMPLOYEES STOCK OPTION (NONTRANSFERABLE) STOCK OPTION AGREEMENT Medaphis Corporation, a Delaware corporation, pursuant to action of the Committee and in accordance with the Medaphis Corporation Non-Qualified Stock Option Plan for Non-Executive Employees ("Plan"), hereby grants a Stock Option ("Option") to ____________________ ("Eligible Employee") to purchase from Medaphis Corporation __________ shares of Stock, at an Option Price of $__________ per share, which Option is subject to all of the terms and conditions set forth in this Option Agreement and in the Plan. This Option is granted effective as of ____________________ ("Option Grant Date"). MEDAPHIS CORPORATION By:_________________________ TERMS AND CONDITIONS Section 1. Plan. This Option shall not be treated as an "incentive stock option" as defined in Section 422 of the Code. This Option is subject to all the terms and conditions set forth in the Plan and this Option Agreement, and all of the terms defined in the Plan shall have the same meaning in this Option Agreement when such terms start with a capital letter. A copy of the Plan will be made available to Eligible Employee upon written request to the corporate Secretary of the Company. Section 2. Vesting. (a) Except as provided in Section 14 of the Plan or in Section 2(b) or Section 2(c), Eligible Employee's vested percentage for purposes of Section 3 shall be as follows: (1) zero, if Eligible Employee's employment by the Company or a subsidiary of the Company terminates before the first anniversary of the Option Grant Date; 2 (2) thirty three and 1/3 percent (33-1/3%) if Eligible Employee remains an employee of the Company or a subsidiary on the first anniversary of the Option Grant Date; (3) sixty six and 2/3 percent (66-2/3%) if Eligible Employee remains an employee of the Company or a subsidiary on the second anniversary of the Option Grant Date; and (4) one hundred percent (100%) if Eligible Employee remains an employee of the Company or a subsidiary on the third anniversary of the Option Grant Date. (b) Eligible Employee's vested percentage shall be 100% no later than the first day after the Option Grant Date which follows a 20 consecutive trading day period in which the average Fair Market Value of a share of Stock has been at least $25 a share if Eligible Employee remains an employee of the Company or a subsidiary on such day. (c) (1) If Eligible Employee's employment with the Company or any subsidiary of the Company terminates for any reason other than death or disability (within the meaning of Section 22(e)(3) of the Code) before this Option is fully vested, any portion of this Option which is not vested on the date of such termination of Eligible Employee's employment shall be automatically forfeited as of his employer termination date. (2) In the event of termination of Eligible Employee's employment with the Company or any subsidiary of the Company for any reason other than death or disability (within the meaning of Section 22(e)(3) of the Code), after any portion of this Option is vested as set forth in this Section 2, this Option shall be exercisable to the extent vested in accordance with the limitations set forth in Section 4. (3) In the event of termination of employment as a result of the death or disability (within the meaning of Section 22(e)(3) of the Code) of Eligible Employee, this Option shall be and become 100% exercisable without regard to the vesting schedule set forth in this Section 2 and the personal representative of Eligible Employee's estate shall be entitled to exercise this Option subject to the limitations set forth in Section 4. 2 3 Section 3. Date Exercisable. This Option shall be exercisable (to the extent vested under Section 2) on any normal business day of the Company that comes before the date this Option expires under Section 4. The maximum number of shares of Stock that may be purchased by exercise of this Option on any such day shall equal the excess, if any, of (a) the product of the vested percentage of this Option under Section 2 on such date and the total number of shares of Stock subject to this Option on the Option Grant Date, as adjusted in accordance with Section 13 of the Plan, over (b) the number of shares of Stock which have previously been purchased by exercise of this Option, as adjusted in a manner consistent with Section 13 of the Plan. Section 4. Life of Option. The Option shall expire when exercised in full; provided, however, the Option also shall expire immediately and automatically on the earlier of (a) the date which is the eleventh anniversary of the Option Grant Date, (b) the end of the three (3) month period which begins on the date Eligible Employee's employment by the Company or any subsidiary of the Company terminates for any reason other than as a result of the death or disability (within the meaning of Section 22(e)(3) of the Code) of Eligible Employee or as a result of a Change of Control event described in Section 14.1 of the Plan, (c) the end of the six (6)month period which begins on the date Eligible Employee's employment by the Company or any subsidiary of the Company terminates for reasons of death or disability (within the meaning of Section 22(e)(3) of the Code) of Eligible Employee, (d) upon the consummation of a Change of Control event described in Section 14.1(1), (2) or (3) of the Plan, or (e) the end of the three (3) month period which begins on the date an Eligible Employee's employment by the Company or any subsidiary of the Company terminates as a result of a Change of Control event described in Section 14.1(4) or (5) of the Plan. Section 5. Method of Exercise of Option. Eligible Employee may (subject to Section 2, Section 3, Section 4, Section 11, Section 12 and Section 13) exercise this Option in whole or in part (before the date this Option expires) for a whole number of shares of Stock on any normal business day of the Company by (a) delivering the Option Agreement to the Company at its principal place of business together with written notice of the exercise of this Option and (b) simultaneously paying to the company the Option Price. Section 6. Delivery. The Company's delivery of Stock pursuant to the exercise of this Option (as described in Section 5) shall discharge the Company of all of its duties and responsibilities with respect to this Option. Section 7. Adjustment. The Committee shall have the right to make such adjustments to this Option as described under Section 13 of the Plan. Section 8. Nontransferable. This Option shall be transferable by Eligible Employee only by will or by the laws of descent and distribution at Eligible Employee's death, and this Option shall be exercisable during Eligible Employee's lifetime only by Eligible 3 4 Employee or, if Eligible Employee is determined under applicable law to be incompetent to act on his or her on behalf, by the person authorized under such applicable law to act on Eligible Employee's behalf. Section 9. Employment and Termination. Neither the Plan, this Option nor any related material shall give Eligible Employee the right to continue in employment by the Company or a subsidiary or shall adversely affect the right of the Company or a subsidiary to terminate Eligible Employee's employment with or without cause at any time. Section 10. Stockholder Status. Eligible Employee shall have no rights as a stockholder with respect to any shares of Stock under this Option until such shares have been duly issued and delivered to Eligible Employee, and no adjustment shall be made for dividends of any kind or description whatsoever or for distributions of other rights of any kind or description whatsoever respecting such Stock except as expressly set forth in the Plan. Section 11. Other Laws. The Company shall have the right to refuse to issue or transfer any Stock under this Option if the Company acting in its absolute discretion determines that the issuance or transfer of such Stock might violate any applicable law or regulation, and any payment tendered in such event to exercise this Option shall be promptly refunded to Eligible Employee. Section 12. Securities Registration. Eligible Employee may be requested by the Company to hold any shares of Stock received upon the exercise of this Option for personal investment and not for purposes of resale or distribution to the public and Eligible Employee shall, if so requested by the Company, deliver a certified statement to that effect to the Company as a condition to the issuance of such Stock to Eligible Employee. Section 13. Other Conditions. Eligible Employee shall (as a condition to the exercise of this Option) enter into any agreement or make any representations required by the Company related to the Stock to be acquired pursuant to the exercise of this Option, including any agreement which restricts the transfer of Stock acquired pursuant to the exercise of this Option and provides for the repurchase of such Stock by the Company under certain circumstances. Section 14. Tax Withholding. The Company shall have the right to withhold or retain from any payment to Eligible Employee (whether or not such payment is made pursuant to this Option) or take such other action as is permissible under the Plan which the Company deems necessary or appropriate to satisfy any income or other tax withholding requirements as a result of the grant or exercise of this Option. 4 5 Section 15. Governing Law. The Plan and this Option shall be governed by the laws of the State of Delaware. Section 16. Modification, Amendment, and Cancellation. The Company shall have the right unilaterally to modify, amend, or cancel this Option in accordance with Section 15 of the Plan. Section 17. Binding Effect. This Option shall be binding upon the Company and Eligible Employee and their respective heirs, executors, administrators and successors. 5 EX-10.12 3 11TH AMEND TO NON-QUALIFIED STOCK OPTION PLAN 1 EXHIBIT 10.12 ELEVENTH AMENDMENT TO AMENDED AND RESTATED MEDAPHIS CORPORATION NON-QUALIFIED STOCK OPTION PLAN THIS AMENDMENT is effective as of August 8, 1996, and is made by MEDAPHIS CORPORATION, a corporation organized and doing business under the laws of the State of Delaware (the "Company"). W I T N E S S E T H: WHEREAS, the Company has previously adopted the Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan (the "Plan"); WHEREAS, the First Amendment to the Plan, which increased the number of shares available for grant, became effective on January 30, 1992; WHEREAS, the Second Amendment to the Plan, which formally allowed the Committee authorized to administer the Plan, upon the exercise of an option by an optionee, to withhold amounts necessary to satisfy state and federal tax withholding requirements applicable to such exercise, became effective on August 5, 1992; WHEREAS, the Third Amendment to the Plan, which increased the number of shares available for grant thereunder and provided that future options be granted at a price not less than fair market value as of the date of grant, became effective on April 29, 1993; WHEREAS, the Fourth Amendment to the Plan, which effected certain changes to the Plan designed to preserve the Company's ability to account for certain transactions under the "pooling of interests" accounting method, became effective on July 22, 1993; WHEREAS, the Fifth Amendment to the Plan, which permitted the options granted pursuant to the Plan to be transferable by the optionee only by will or the laws of descent and distribution or pursuant to a qualified domestic relations order, became effective on December 15, 1993; WHEREAS, the Sixth Amendment to the Plan, which increased the number of shares available for grant, became effective on April 27, 1994; WHEREAS, the Seventh Amendment to the Plan, which increased the number of shares available for grant, became effective on April 27, 1995; WHEREAS, the Eighth Amendment to the Plan, which increased the number of shares available for grant and limited the maximum number of options available for grant to any one individual, became effective on May 1, 1996; 2 WHEREAS, the Ninth Amendment to the Plan, which formally allowed the Committee authorized to administer the Plan to amend the Plan without the approval of the stockholders of the Company if such amendment would not alter the rights of any participant under the Plan who is subject to Rule 16b-3 of the Securities and Exchange Act of 1934, as amended, and further, formally allowed the Committee authorized to administer the Plan to adjust the time periods set forth in Section 5(f) of the Plan, became effective as of August 24, 1995; WHEREAS, the Tenth Amendment to the Plan, which formally provided that the Plan would be administered by the Compensation Committee of the Company, to consist of "disinterested persons" as defined in Rule 16b-3 of the Securities Exchange Act of 1934, as amended, and "outside directors" as provided for in Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"), and the regulations promulgated thereunder, became effective as of May 1, 1996; and WHEREAS, the Compensation Committee of the Company has authorized an amendment to the Plan to clarify that absent specific action of the Compensation Committee of the Company, options cease vesting immediately upon a participant's termination of employment (other than as a result of death or disability within the meaning of Code Section 22(e)(3) in which case the vesting of such options accelerates), and to allow the Compensation Committee of the Company to permit a participant under the Plan not subject to Rule 16b-3 of the Securities Exchange Act of 1934, as amended, nevertheless to continue vesting in any of such participant's stock options granted pursuant to the Plan subsequent to termination of employment. NOW, THEREFORE, BE IT RESOLVED, that Section 5(f) of the Plan is hereby amended by deleting Section 5(f) of the Plan in its entirety, and replacing it with the following: "(f) provide that if the optionee ceases to be an employee of the Company or any parent or subsidiary corporation of the Company (other than as a result of a Change of Control event or death or disability within the meaning of Code Section 22(e)(3)), before the option is fully vested, any portion of the option which is not fully vested on the date of such termination of employment shall be automatically forfeited as of such employment termination date, and the vested portion of the option which is unexercised shall expire, terminate and become unexercisable upon the expiration of three (3) months from the date on which the optionee ceases to be an employee of the Company or of any parent or subsidiary corporation of the Company; provided, however, that the Compensation Committee, in its sole and absolute discretion, may permit an optionee who is not subject to Rule 16b-3 of the Securities Exchange Act of 1934, as amended, to continue vesting in all or any portion of such option subsequent to termination of employment with the Company or any parent or subsidiary corporation of the Company; and (g) provide that if the optionee ceases to be an employee of the Company or any parent or subsidiary corporation of the Company by reason of death or disability (within the meaning of Code Section 22(e)(3)), as determined in the sole and absolute judgment of the Company, before the option is fully vested, the option or any portion thereof which is unexercised shall immediately be and become fully exercisable without regard to the vesting schedule set forth herein and shall expire, terminate and become unexercisable after the expiration of six (6) - 2 - 3 months from the date the optionee ceases to be employed by the Company or any parent or subsidiary corporation of the Company." Except as specifically amended by this Eleventh Amendment, the Plan shall remain in full force and effect as prior to this Eleventh Amendment. IN WITNESS WHEREOF, the Company has caused this Eleventh Amendment to be executed on the day and year first above written. MEDAPHIS CORPORATION By: /s/ Michael R. Cote ------------------------------------ Michael R. Cote Senior Vice President, Finance and Chief Financial Officer ATTEST: By: /s/ William R. Spalding ------------------------------------- William R. Spalding Senior Vice President, Administration and General Counsel [Corporate Seal] - 3 - EX-10.21 4 6TH AMEND TO NON-QUALIFIED STOCK OPTION PLAN 1 EXHIBIT 10.21 SIXTH AMENDMENT TO MEDAPHIS CORPORATION NON-QUALIFIED STOCK OPTION PLAN FOR EMPLOYEES OF ACQUIRED COMPANIES THIS SIXTH AMENDMENT is made the 7th day of January, 1997 by MEDAPHIS CORPORATION, a corporation organized and doing business under the laws of the State of Delaware (the "Company"). W I T N E S S E T H WHEREAS, the Company has previously adopted the Medaphis Corporation Non-Qualified Stock Option Plan for Employees of Acquired Companies (the "Plan"); and WHEREAS, the Board of Directors of the Company has approved an increase in the number of shares reserved for issuance pursuant to the Plan to 6,515,000 shares from 5,015,000 shares. NOW, THEREFORE, Section 3 of the Plan is hereby amended by deleting Section 3 of the Plan in its entirety and replacing it with the following: "Section 3 SHARES RESERVED UNDER THE PLAN There shall be 6,515,000 shares of Stock reserved for issuance under this Plan, and such shares of Stock shall be reserved to the extent that the Company deems appropriate from authorized but unissued shares of Stock and from shares of Stock which have been repurchased by the Company. Furthermore, any shares of Stock subject to an Option that remain unissued after the cancellation or expiration of such Option thereafter shall again become available for use under this Plan." FURTHER, except as specifically amended by this Sixth Amendment, the Plan shall remain in full force and effect as prior to this Sixth Amendment. 2 IN WITNESS WHEREOF, the Company has caused this Sixth Amendment to be executed on the day and year first above written. MEDAPHIS CORPORATION By: /s/ Michael R. Cote ----------------------------------------- Title: Senior Vice President - Finance, Chief Financial Officer and Assistant Secretary ATTEST: By: /s/ William R. Spalding --------------------------------- Title: Senior Vice President, General Counsel and Secretary [CORPORATE SEAL] -2- EX-10.23 5 NON-QUALIFIED STOCK OPTION PLAN/NON-EXEC EMPLOYEE 1 EXHIBIT 10.23 MEDAPHIS CORPORATION NON-QUALIFIED STOCK OPTION PLAN FOR NON-EXECUTIVE EMPLOYEES 2 TABLE OF CONTENTS
Page ---- SECTION 1. PURPOSE.............................................................................1 SECTION 2. DEFINITIONS.........................................................................1 2.1. Board......................................................................1 2.2. Code.......................................................................1 2.3. Committee..................................................................1 2.4. Company....................................................................1 2.5. Eligible Employee..........................................................1 2.6. Exchange Act...............................................................2 2.7. Fair Market Value..........................................................2 2.8. 1933 Act...................................................................2 2.9. Option.....................................................................2 2.10. Option Agreement...........................................................2 2.11. Option Price...............................................................3 2.12. Plan.......................................................................3 2.13. Stock......................................................................3 SECTION 3. SHARES RESERVED UNDER THE PLAN......................................................3 SECTION 4. EFFECTIVE DATE......................................................................3 SECTION 5. ADMINISTRATION......................................................................3 SECTION 6. ELIGIBILITY.........................................................................4 SECTION 7. GRANT OF OPTIONS....................................................................4 SECTION 8. OPTION PRICE........................................................................5 SECTION 9. EXERCISE PERIOD.....................................................................5 SECTION 10. NONTRANSFERABILITY..................................................................6 SECTION 11. SECURITIES REGISTRATION.............................................................6 SECTION 12. LIFE OF PLAN........................................................................7 SECTION 13. ADJUSTMENT..........................................................................8
i 3 SECTION 14. CHANGE OF CONTROL AND CERTAIN OTHER EVENTS..........................................8 14.1. Change of Control Events...................................................8 14.2. The Company................................................................9 14.3. Operating Subsidiary.......................................................9 14.4. Notice.....................................................................9 14.5. Disposition of Stock Following Change of Control of Company................9 14.6. Disposition of Stock Following Change of Control of Subsidiary............10 14.7. Fractional Shares.........................................................11 SECTION 15. AMENDMENT OR TERMINATION...........................................................11 SECTION 16. MISCELLANEOUS......................................................................11 16.1. No Stockholder Rights.....................................................11 16.2. No Contract of Employment.................................................11 16.3. Other Conditions..........................................................12 16.4. Withholding...............................................................12 16.5. Construction..............................................................12 16.6. No "Incentive Stock Option" Treatment.....................................12 16.7. Not Rule 16b-3 Plan.......................................................12 16.8. References................................................................12
ii 4 MEDAPHIS CORPORATION NON-QUALIFIED STOCK OPTION PLAN FOR NON-EXECUTIVE EMPLOYEES SECTION 1. PURPOSE The purpose of this Plan is to provide options to purchase stock to Eligible Employees in order for such Eligible Employees to acquire or increase their proprietary interest in the Company, and for such Eligible Employees to share in the success of the Company and to encourage them to remain in the employ of the Company. SECTION 2. DEFINITIONS Each capitalized term set forth in this Section 2 shall have the meaning set forth opposite such capitalized term for purposes of this Plan and, for purposes of such definitions, the singular shall include the plural and the plural shall include the singular. 2.1. Board -- means the Board of Directors of the Company. 2.2. Code --means the Internal Revenue Code of 1986, as amended. 2.3. Committee -- means the committee appointed by the Board to administer this Plan and at all times shall consist of two or more members of the Board. 2.4. Company -- means Medaphis Corporation, a Delaware corporation, and any successor to such corporation. 2.5. Eligible Employee --means any person who is an employee of the Company or any of its subsidiaries and who is (in the judgment of the Committee) neither subject to the 5 provisions of Section 16 of the Exchange Act nor an executive level employee on the date an Option is granted to such individual under this Plan. 2.6. Exchange Act -- means the Securities Exchange Act of 1934, as amended. 2.7. Fair Market Value -- means for any date (i) the closing price for such date for a share of Stock as reported by The Wall Street Journal under the New York Stock Exchange Composite Transactions quotation system (or under any successor quotation system) or, (ii) if the Stock is not traded on the New York Stock Exchange, as reported for such date by The Wall Street Journal under the NASDAQ National Market System quotation system or under the quotation system under which such closing price is reported or, (iii) if The Wall Street Journal does not report such closing price, such closing price as reported for such date by a newspaper or trade journal selected by the Committee or, (iv) if no such closing price is available for such date, such closing price as so reported or so quoted in accordance with Section 2.7(i), (ii) or (iii) for the immediately preceding business day, or, (v) if no newspaper or trade journal reports such closing price or if no such price quotation is available, the price that the Committee acting in good faith determines through any reasonable valuation method that a share of Stock might change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts. 2.8. 1933 Act -- means the Securities Act of 1933, as amended. 2.9. Option -- means an option granted under this Plan to purchase Stock. 2.10. Option Agreement -- means the written agreement that sets forth the terms of an Option granted to an Eligible Employee under this Plan. 2 6 2.11. Option Price -- means the price that shall be paid to purchase one share of Stock upon the exercise of an Option granted under this Plan. 2.12. Plan -- means this Medaphis Corporation Non-qualified Stock Option Plan for Non-Executive Employees, as amended from time to time. 2.13. Stock -- means the common stock of the Company, par value $.01 per share. SECTION 3. SHARES RESERVED UNDER THE PLAN There shall be 925,000 shares of Stock reserved for issuance under this Plan, and such shares of Stock shall be reserved to the extent that the Company deems appropriate from authorized but unissued shares of Stock and from shares of Stock which have been repurchased by the Company. Furthermore, any shares of Stock subject to an Option that remain unissued after the cancellation or expiration of such Option thereafter shall again become available for use under this Plan. SECTION 4. EFFECTIVE DATE The effective date of this Plan shall be November 19, 1996. SECTION 5. ADMINISTRATION This Plan shall be administered by the Committee. The Board may from time to time remove members from, or add members to, the Committee. Vacancies on the Committee shall be filled by the Board and the Board shall designate the Chairman of the Committee. The Committee shall hold meetings at such times and places as it may determine. The Committee 3 7 acting in its absolute discretion shall exercise such powers and take such action as expressly called for under this Plan and, further, the Committee shall have the power to interpret this Plan and to take such other action (except to the extent the right to take such action is expressly and exclusively reserved for the Board) in the administration and operation of this Plan as the Committee deems equitable under the circumstances, which action shall be binding on the Company, on each affected Eligible Employee and on each other person directly or indirectly affected by such action. No member of the Board or the Committee shall be liable for any action or determination made in good faith with respect to this Plan or any Option granted under this Plan. SECTION 6. ELIGIBILITY Only Eligible Employees shall be eligible for the grant of Options under this Plan. SECTION 7. GRANT OF OPTIONS The Committee, acting in its absolute discretion, shall have the right to grant Options to Eligible Employees under this Plan. Each grant of an Option shall be evidenced by an Option Agreement, and each Option Agreement shall incorporate such terms and conditions as the Committee, acting in its absolute discretion, deems consistent with the terms of this Plan; provided that (unless the Committee decides otherwise with respect to any Option grant or Option grants) each Option Agreement shall provide that if the Eligible Employee ceases to be an employee of the Company or of any parent or subsidiary of the Company (other than as a result of a transaction contemplated by Section 14) before the Option is fully vested, any portion of the 4 8 Option which is not fully vested on the date of such termination of employment shall be automatically forfeited as of such employment termination date, and the vested portion of the Option which is unexercised shall expire, terminate and become unexercisable no later than the earlier to occur of: (i) the expiration of three (3) months from the date on which the Eligible Employee ceases to be an employee of the Company or of any parent or subsidiary of the Company for any reason other than death or disability (within the meaning of Code Section 22(e)(3)), or (ii) the expiration of six (6) months from the date the Eligible Employee ceases to be employed by the Company or any parent or subsidiary of the Company for reasons of death or disability (within the meaning of Code Section 22(e)(3)). SECTION 8. OPTION PRICE The Option Price for each share of Stock subject to an Option may (in the absolute discretion of the Committee) be more or less than or equal to the Fair Market Value of a share of Stock on the date such Option is granted; provided, however, that in no event shall the Option Price be less than adequate consideration as determined by the Committee. SECTION 9. EXERCISE PERIOD Each Option granted under this Plan shall be exercisable in whole or in part at such time or times as set forth in the related Option Agreement, but no Option Agreement shall make an Option exercisable after the earlier of (a) the date such option is exercised in full or forfeited, or 5 9 (b) the date which is the eleventh anniversary of the date such Option is granted. SECTION 10. NONTRANSFERABILITY No Option granted under this Plan shall be transferable by an Eligible Employee other than by will or by the laws of descent and distribution at his or her death, and an Option shall be exercisable during an Eligible Employee's lifetime only by the Eligible Employee or, if the Eligible Employee is determine under applicable law to be incompetent to act on his or her own behalf, by the person authorized under such applicable law to act on the Eligible Employee's behalf. The Company shall treat any person to whom an Option is transferred by will or by the laws of descent and distribution the same as an Eligible Employee for purposes of exercising such Option. SECTION 11. SECURITIES REGISTRATION Each Option Agreement shall provide that, upon the receipt of shares of Stock as a result of the exercise of an Option, the Eligible Employee shall, if so requested by the Company, hold such shares of Stock for investment and not with a view to resale or distribution to the public and, if so requested by the Company, shall deliver to the Company a written statement satisfactory to the Company to that effect. Each Option Agreement also shall provide that, if so requested by the Company, the Eligible Employee shall make a written representation to the Company that he or she will not sell or offer to sell any of such Stock unless a registration statement shall be in effect with respect to such stock under the 1933 Act and any applicable state 6 10 securities law or unless he or she shall have furnished to the Company an opinion, in form and substance satisfactory to the Company, of legal counsel acceptable to the Company, that such registration is not required. Certificates representing the Stock transferred upon the exercise of an Option granted under this Plan may at the discretion of the Company bear a legend to the effect that such Stock has not been registered under the 1933 Act or any applicable state securities law and that such Stock may not be sold or offered for sale in the absence of an effective registration statement as to such Stock under the 1933 Act and any applicable state securities law or an opinion, in form and substance satisfactory to the Company, of legal counsel acceptable to the Company, that such registration is not required. SECTION 12. LIFE OF PLAN No Option shall be granted under this Plan on or after the earlier of (a) the tenth anniversary of the effective date of this Plan (as determined under Section 4), in which event this Plan thereafter shall continue in effect until all outstanding Options have been exercised in full or no longer are exercisable, or (b) the date on which all of the Stock reserved under Section 3 has (as a result of the exercise of Options granted under this Plan) been issued or no longer is available for use under this Plan, in which event this Plan also shall terminate on such date. 7 11 SECTION 13. ADJUSTMENT The number of shares of Stock reserved under Section 3, the number of shares of Stock subject to Options granted under this Plan and the Option Price of such Options shall be adjusted by the Committee in a equitable manner to reflect any change in the capitalization of the Company, including, but not limited to, such changes as stock dividends or stock splits, a subdivision or combination of the Stock, a reclassification of the Stock, a merger or consolidation of the Company or any like changes in the Stock or in the value of a share of Stock. If any adjustment under this Section 13 would create a fractional share of Stock or a right to acquire a fractional share of Stock, such fractional share shall be disregarded and the number of shares of Stock reserved under this Plan and the number subject to any Options granted under this Plan shall be the next lower number of shares of Stock, rounding all fractions downward. Any adjustment made under this Section 13 by the Committee shall be conclusive and binding on affected persons. SECTION 14. CHANGE OF CONTROL AND CERTAIN OTHER EVENTS 14.1. Change of Control Events. The following events shall constitute "Change of Control" events for purposes of this Plan: (1) The adoption of a plan of merger or consolidation of the Company with any other corporation as a result of which the holders of the outstanding voting stock of the Company as a group would receive less than fifty percent (50%) of the voting stock of the surviving or resulting corporation; (2) The adoption of a plan of liquidation or the approval of the dissolution of the Company; (3) The sale or transfer of substantially all of the assets of the Company; (4) The sale or transfer of substantially all of the assets or stock of an 8 12 operating subsidiary of the Company, other than as security for obligations of the Company; or (5) The sale or transfer of substantially all of the assets of an operating division of the Company or its subsidiaries, other than as security for obligations of the Company. 14.2. The Company. In the event of a Change of Control event described in Section 14.1(1), (2) or (3), the unexercised portion of all outstanding Options under this Plan will become fully vested and immediately exercisable and will remain exercisable until the occurrence of such Change of Control event, after which time all outstanding Options will immediately terminate as to any portion thereof not exercised. 14.3. Operating Subsidiary. In the event of a Change of Control event described in Section 14.1(4) or (5) which results in the Eligible Employees employed by the affected operating subsidiary or division being terminated from their current employment with the Company, then the unexercised portion of all outstanding Options under this Plan held by those affected Eligible Employees will become fully vested and immediately exercisable. Such Options will remain exercisable until the earlier of (1) the expiration of the respective terms of such Options, or (2) six (6) months following such termination of employment. 14.4. Notice. Subject to compliance with applicable federal and state securities laws, the Committee will undertake to provide applicable Eligible Employees with reasonable notice of any Change of Control event described in Section 14.1 prior to the occurrence of such Change of Control event. 14.5. Disposition of Stock Following Change of Control of Company. In the event of a Change of Control event described in Section 14.1(1), (2) or (3), each Eligible Employee electing to exercise any outstanding Option will have the right in connection with the closing of such 9 13 Change of Control event either to (1) sell to the Company or the surviving or resulting corporation, the shares of Stock which the Eligible Employee received upon exercise of such Option at a cash price per share equivalent of the Fair Market Value of the Stock as of the date of such Change of Control event, or (2) receive the number and class of shares of stock or other securities or any other property to which the terms of the agreement of merger, consolidation, or other reorganization would entitle the Eligible Employee to receive as the holder of record of the number of shares of Stock which the Eligible Employee received upon exercise of such Option; provided, however, that in the event a Change of Control event contemplated by this Section 14.5 involves a merger to be accounted for under the "pooling of interest" accounting method, then the Committee shall have the authority hereunder to modify the rights of an Eligible Employee under this Section 14.5 to the extent necessary in order to preserve the "pooling of interest" accounting treatment for such merger. 14.6. Disposition of Stock Following Change of Control of Subsidiary. In the event of a Change of Control event described in Section 14.1(4) or (5), each affected Eligible Employee electing to exercise any outstanding Option will have the right to sell to the Company the shares of Stock which the Eligible Employee received upon exercise of such Option at a price per share equivalent to the Fair Market Value of the Stock subject to such Option, such payment to be made in the form of cash or notes or any combination of cash and notes, as determined by the Committee. The Committee will make reasonable efforts to assure that an Eligible Employee electing to sell shares of Stock pursuant to this Section 14.6 receives cash consideration in the amount at least sufficient to offset the aggregate Option Price paid to the Company by the Eligible Employee in connection with the exercising of such Option. 10 14 14.7. Fractional Shares. No Change of Control event contemplated by this Section 14 shall create a right to acquire a fractional share of Stock, and any such fractional share shall be forfeited by the Eligible Employee. SECTION 15. AMENDMENT OR TERMINATION This Plan maybe amended by the Committee from time to time to the extent that the Committee deems necessary or appropriate. The Committee also may suspend the granting of Options under this Plan at any time and may terminate this Plan at any time; provided; however, the Committee shall not have the right unilaterally to modify, amend or cancel any Option granted before such modification, amendment or cancellation unless the Eligible Employee consents in writing to such modification, amendment or cancellation. SECTION 16. MISCELLANEOUS 16.1. No Stockholder Rights. No Eligible Employee shall have any rights as a stockholder of the Company as a result of the grant of an Option to him or to her under this Plan or his or her exercise of such Option pending the actual delivery of Stock subject to such Option to such Eligible Employee. 16.2. No Contract of Employment. The grant of an Option to an Eligible Employee under this Plan shall not constitute a contract of employment and shall not confer on an Eligible Employee any rights upon his or her termination of employment in addition to those rights, if any, expressly set forth in the Option Agreement which evidences his or her Option. 11 15 16.3. Other Conditions. Each Option Agreement may require that an Eligible Employee (as a condition to the exercise of an Option) enter into any agreement or make such representations requested by the Company, including any agreement which restricts the transfer of Stock acquired pursuant to the exercise of such Option and provides for the repurchase of such Stock by the Company under certain circumstances. 16.4. Withholding. The exercise of any Option granted under this Plan shall constitute an Eligible Employee's full and complete consent to whatever action the Committee deems necessary to satisfy the federal and state tax withholding requirements, if any, which the Committee acting in its discretion deems applicable to such exercise. 16.5. Construction. This Plan shall be construed under the laws of the State of Delaware. 16.6. No "Incentive Stock Option" Treatment. No Option granted under this Plan shall be treated as an "incentive stock option" within the meaning of Section 422 of the Code. 16.7. Not Rule 16b-3 Plan. This Plan is not intended to satisfy and will not satisfy the conditions set forth in Rule 16b-3 under Section 16 of the Exchange Act. 16.8. References. Any reference in this Plan to a section (ss.) shall be to a section (ss.) of this Plan unless otherwise specified in such reference. 12 16 IN WITNESS WHEREOF, the Company has caused its duly authorized officer to execute this Plan as of this 19th day of November, 1997 to evidence its adoption of this Plan. MEDAPHIS CORPORATION By: /s/ William R. Spalding ------------------------------------- 13 EX-10.24 6 1ST AMEND TO NON-QUALIFIED STOCK OPTION PLAN 1 EXHIBIT 10.24 FIRST AMENDMENT TO MEDAPHIS CORPORATION NON-QUALIFIED STOCK OPTION PLAN FOR NON-EXECUTIVE EMPLOYEES THIS FIRST AMENDMENT (the "First Amendment") is made this 21 day of January, 1997, by MEDAPHIS CORPORATION, a Delaware corporation (the "Company"). W I T N E S S E T H WHEREAS, the Company has previously adopted the Medaphis Corporation Non-Qualified Stock Option Plan for Non-Executive Employees (the "Plan"); and WHEREAS, the Board of Directors of the Company has approved an increase in the number of shares reserved for issuance pursuant to the Plan to 1,025,000 from 925,000 shares (the "First Amendment"). NOW, THEREFORE, Section 3 of the Plan is hereby amended by deleting Section 3 of the Plan in its entirety and replacing it with the following: "Section 3 SHARES RESERVED UNDER THE PLAN There shall be 1,025,000 shares of Stock reserved for issuance under this Plan, and such shares of Stock shall be reserved to the extent that the Company deems appropriate from authorized but unissued shares of Stock and from shares of Stock which have been repurchased by the Company. Furthermore, any shares of Stock subject to an Option that remain unissued after the cancellation or expiration of such Option thereafter shall again become available for use under this Plan." FURTHER, except as specifically amended by this First Amendment, the Plan shall remain in full force and effect as prior to this First Amendment. 2 IN WITNESS WHEREOF, the Company has caused this First Amendment to be executed on the day and year first above written. MEDAPHIS CORPORATION By: /s/ William R. Spalding -------------------------------- Name: William Spalding ------------------------------ Title: EVP ----------------------------- ATTEST: By: /s/ Peggy Sherman --------------------------------- Name: Peggy Sherman ------------------------------- Title: VP, AGC ------------------------------ -2- EX-10.27 7 1ST AMEND TO EMPLOYEE STOCK PURCHASE PLAN 1 EXHIBIT 10.27 FIRST AMENDMENT TO THE MEDAPHIS CORPORATION EMPLOYEE STOCK PURCHASE PLAN THIS FIRST AMENDMENT (the "Amendment") is effective as of the _____ day of December, 1996, and is made by MEDAPHIS CORPORATION, a corporation organized and doing business under the laws of the State of Delaware (the "Company"). W I T N E S S E T H: WHEREAS, the Compensation Committee of the Board of Directors of the Company (the "Committee") has approved an amendment to the Medaphis Corporation Employee Stock Purchase Plan (the "Plan"). NOW, THEREFORE, the Plan is hereby amended, effective as of the date first written above, by deleting Sections 2(g), 2(h) and 2(k) in their entirety and replacing such sections with the following: "(g) "Enrollment Period" means the period commencing on each January 1 and ending on the next succeeding December 31. (h) "Entry Date" means January 1st and July 1st of each calendar year. (k) "Purchase Period" means each six-month period ending June 30 and December 31 during an Enrollment Period." FURTHER, Section 3(b) of the Plan is hereby deleted in its entirety. FURTHER, Section 3(c) of the Plan shall hereafter be referred to as Section 3(b). FURTHER, Section 5(b) of the Plan is hereby amended by deleting Section 5(b) of the Plan in its entirety and replacing the following in lieu thereof: "(b) The Company shall pay the cash balance of a Participant's Contribution Account to the Participant as soon as administratively feasible following (i) the date of processing of the withdrawal request or (ii) the date a person otherwise ceases to be a Participant pursuant to Paragraph 3(b), clauses (1) and (2), as applicable (the events described in this subparagraph being referred to collectively as a "Termination Event")." FURTHER, except as specifically amended by this Amendment, the Plan shall remain in full force and effect as prior to this Amendment. 2 IN WITNESS WHEREOF, the Company has caused this Amendment to be executed as of the date first above written. MEDAPHIS CORPORATION By: /s/ William R. Spalding ------------------------------------- Title: ---------------------------------- ATTEST: /s/ Peggy Sherman - ---------------------------------- Title: Assistant Secretary ---------------------------- [CORPORATE SEAL] -2- EX-10.29 8 AMENDED & RESTATED EMPLOYEE RETIREMENT SVNGS PLAN 1 EXHIBIT 10.29 THE MEDAPHIS EMPLOYEES' RETIREMENT SAVINGS PLAN THIS INDENTURE made on the ____ day of ______________, 1995, by MEDAPHIS CORPORATION, a corporation duly organized and existing under the laws of the State of Delaware hereinafter called the "Primary Sponsor"); W I T N E S S E T H: WHEREAS, the Primary Sponsor established by indenture dated June 30, 1991, the Medaphis Corporation Employees' Retirement Savings Plan which was last amended and restated by indenture dated December 22, 1993 (the "Plan"); and WHEREAS, the Primary Sponsor wishes to amend and restate the Plan to provide participants an opportunity to invest matching contributions in common stock of the Primary Sponsor and to make certain other changes in the provisions of the Plan; and WHEREAS, the Board of Directors of the Primary Sponsor has approved and authorized the amendment and restatement of the Plan; and WHEREAS, the Plan is intended to be a profit sharing plan within the meaning of Treasury Regulations Section 1.401-1(b)(1)(ii) and also contains a cash or deferred arrangement as described in Section 401(k) of the Internal Revenue Code of 1986; and NOW, THEREFORE, the Primary Sponsor does hereby amend and restate the Plan, in its entirety, generally effective July 1, 1995, to read as follows: 2 THE MEDAPHIS EMPLOYEES' RETIREMENT SAVINGS PLAN
SECTION 1 DEFINITIONS ........................................... -1- SECTION 2 ELIGIBILITY ........................................... -13- SECTION 3 CONTRIBUTIONS ......................................... -14- SECTION 4 ALLOCATIONS ........................................... -16- SECTION 5 INDIVIDUAL FUNDS AND INVESTMENTS OF TRUST ASSETS ...... -17- SECTION 6 PLAN LOANS ............................................ -18- SECTION 7 WITHDRAWALS DURING EMPLOYMENT ......................... -20- SECTION 8 DEATH BENEFITS ........................................ -22- SECTION 9 PAYMENT OF BENEFITS ON RETIREMENT OR DEATH ............ -23- SECTION 10 PAYMENT OF BENEFITS ON TERMINATION OF EMPLOYMENT ...... -26- SECTION 11 ADMINISTRATION OF THE PLAN ............................ -28- SECTION 12 CLAIM REVIEW PROCEDURE ................................ -30- SECTION 13 LIMITATION OF ASSIGNMENT, PAYMENTS TO LEGALLY INCOMPETENT DISTRIBUTEE AND UNCLAIMED PAYMENTS ........ -31- SECTION 14 PROHIBITION AGAINST DIVERSION ......................... -32- SECTION 15 LIMITATION OF RIGHTS .................................. -33- SECTION 16 AMENDMENT TO OR TERMINATION OF THE PLAN AND THE TRUST ................................................. -33- SECTION 17 ADOPTION OF PLAN BY AFFILIATES ........................ -34- SECTION 18 QUALIFICATION AND RETURN OF CONTRIBUTIONS ............. -35- SECTION 19 INCORPORATION OF SPECIAL LIMITATIONS .................. -35- APPENDIX A SPECIAL NONDISCRIMINATION RULES ....................... A-1 APPENDIX B LIMITATION ON ALLOCATIONS ............................. B-1 APPENDIX C TOP-HEAVY PROVISIONS .................................. C-1 APPENDIX D SPECIAL RULES ......................................... D-1
3 SECTION 1 DEFINITIONS Wherever used herein, the masculine pronoun shall be deemed to include the feminine, and the singular to include the plural, unless the context clearly indicates otherwise and the following words and phrases shall, when used herein, have the meanings set forth below: 1.1 "Account" means the account established and maintained by the Plan Administrator to reflect the interest of a Member in the Fund. In addition to any other accounts as the Plan Administrator may establish and maintain, the Plan Administrator shall establish and maintain separate accounts (each of which shall be adjusted pursuant to the Plan to reflect income, gains, losses and other credits or charges attributable thereto) for each Member to be designated as follows: (a) "Employee Deferral Account" which shall reflect a Member's interest in contributions made by a Plan Sponsor under Plan Sections 3.1 and 3.4. (b) "Matching Account" which shall reflect a Member's interest in matching contributions made by a Plan Sponsor under Plan Section 3.2. (c) "Company Account" which shall reflect a Member's interest in contributions made by a Plan Sponsor under Plan Section 3.3. (d) "Voluntary Contribution Account" which shall reflect a Member's interest in Voluntary Contributions made by a Member to the Fund pursuant to Plan Section 3.5. (e) "Rollover Account" which shall reflect a Member's interest in Rollover Amounts. In addition, the Plan Administrator shall allocate the interest of a Member in any funds transferred to the Plan in a trust-to-trust transfer (other than Rollover Amounts) or pursuant to the merger of another tax-qualified retirement plan with the Plan among the Member's Accounts as the Plan Administrator determines best reflects the interest of the Member. 1.2 "Accrued Benefit" means the balance of a Member's Account. 1.3 "Affiliate" means (a) any corporation which is a member of the same controlled group of corporations (within the meaning of Code Section 414(b)) as is a Plan Sponsor, (b) any other trade or business (whether or not incorporated) under common control (within the meaning of Code Section 414(c)) with a Plan Sponsor, (c) any other corporation, partnership or other organization which is a member of an affiliated service group (within the meaning of Code Section 414(m)) with a Plan Sponsor, and (d) any other entity required to be aggregated with a Plan Sponsor pursuant to regulations under Code Section 414(o). 1.4 "Anniversary Date" means the first day of each Plan Year. 4 1.5 "Annual Compensation" means the amount paid to an Employee by a Plan Sponsor (and Affiliates for purposes of Appendix B hereto) during a Plan Year as compensation that would be subject to income tax withholding under Code Section 3401(a), (but without regard to any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed, such as the exception for agricultural labor in Code Section 3401(a)(2)), to the extent not in excess of $150,000 (for the Plan Year beginning in 1994), which amount shall be adjusted for changes in the cost of living as provided in regulations issued by the Secretary of the Treasury. Notwithstanding the above, Annual Compensation shall be determined as follows: (a) in determining the amount of contributions under Plan Section 3 and allocations under Plan Section 4 made by or on behalf of an Employee and for purposes of applying the provisions of Appendix A hereto for such Plan Years as the Secretary of the Treasury may allow, Annual Compensation shall only include amounts received for the portion of the Plan Year during which the Employee was a Member and shall exclude income from sources outside the United States whether or not excludable under Code Section 911; (b) in determining the amount of contributions under Plan Section 3 and allocations under Plan Section 4 made by or on behalf of an Employee, Annual Compensation shall not include reimbursements or other expense allowances, taxable fringe benefits, amounts realized from the exercise of non-qualified stock options or when restricted stock (or property) held by an employee either becomes freely transferable or is no longer subject to a substantial risk of forfeiture, moving expense allowances, deferred compensation (except as provided in Subsection (d) below), and welfare benefits. Further, only for purposes of Plan Sections 3.1, 3.2, and 3.3, Annual Compensation shall not include any short-term disability pay and, for the period beginning April 1, 1994 and ending September 30, 1994 only, any "on call" income; (c) for purposes of applying the $150,000 limit, as adjusted, with respect to Plan Sections 3 and 4 and Appendix A, the rules contained in Subsection (b) of the Plan Section containing the definition of the term "Highly Compensated Employee" shall apply, except that in applying such rules, the term "family" shall include only the spouse of the Member and any lineal descendants of the Member who have not attained age 19 before the close of the Plan Year; and (d) for all purposes under the Plan except Appendix B hereto, Annual Compensation shall include any amount contributed by a Plan Sponsor on behalf of an Employee pursuant to a salary reduction agreement which is not includable in the gross income of the Employee under Section 125, 402(e)(3), or 402(h) of the Code. -2- 5 (e) in determining the amount of contributions under Plan Sections 3.1 and 3.2 made by or on behalf of an Employee, Annual Compensation shall include amounts accrued with respect to services performed in the Plan Year and, but for the Employee's election to defer such amounts (under this Plan or any other plan of deferred compensation maintained by the Primary Sponsor or an Affiliate), would have been received by the Employee in the Plan Year. 1.6 "Beneficiary" means the person or trust that a Member designated most recently in writing to the Plan Administrator; provided, however, that if the Member has failed to make a designation, no person designated is alive, no trust has been established, or no successor Beneficiary has been designated who is alive, the term "Beneficiary" means (a) the Member's spouse or (b) if no spouse is alive, the Member's surviving children, or (c) if no children are alive, the Member's parent or parents, or (d) if no parent is alive, the legal representative of the deceased Member's estate. Notwithstanding the preceding sentence, the spouse of a married Member shall be his Beneficiary unless that spouse has consented in writing to the designation by the Member of some other person or trust and the spouse's consent acknowledges the effect of the designation and is witnessed by a notary public or a Plan representative. A Member may change his designation at any time. However, a Member may not change his designation without further consent of his spouse under the terms of the preceding sentence unless the spouse's consent permits designation of another person or trust without further spousal consent and acknowledges that the spouse has the right to limit consent to a specific beneficiary and that the spouse voluntarily relinquishes this right. Notwithstanding the above, the spouse's consent shall not be required if the Member establishes to the satisfaction of the Plan Administrator that the spouse cannot be located, if the Member has a court order indicating that he is legally separated or has been abandoned (within the meaning of local law) unless a "qualified domestic relations order" (as defined in Code Section 414(p)) provides otherwise, or if there are other circumstances as the Secretary of the Treasury prescribes. If the spouse is legally incompetent to give consent, consent by the spouse's legal guardian shall be deemed to be consent by the spouse. 1.7 "Board of Directors" means the Board of Directors of the Primary Sponsor. 1.8 "Break in Service" means the failure of an Employee to perform an Hour of Service during the twelve consecutive month period commencing on a Severance Date. 1.9 "Code" means the Internal Revenue Code of 1986, as amended. 1.10 "Company Stock" means a share or shares of any class of stock issued by the Primary Sponsor (or any of its Affiliates) which constitutes employer securities within the meaning of Code Section 4978(e)(5). 1.11 "Company Stock Fund" means an Individual Fund that is primarily invested in Company Stock. 1.12 "CompMed Employee" means an individual who was an Employee of CompMed, Inc. immediately before January 1, 1994. -3- 6 1.13 "CompMed Plan" means the CompMed, Inc. 401(k) Savings Plan. 1.14 "Deferral Amount" means a contribution of a Plan Sponsor on behalf of a Member pursuant to Plan Section 3.1. 1.15 "Direct Rollover" means a payment by the Plan to the Eligible Retirement Plan specified by the Distributee." 1.16 "Disability" means a disability of a Member within the meaning of Code Section 72(m)(7), to the extent that the Member is, or would be, entitled to disability retirement benefits under the federal Social Security Act or to the extent that the Member is entitled to recover benefits under any long term disability plan or policy maintained by the Plan Sponsor. The determination of whether or not a Disability exists shall be determined by the Plan Administrator and shall be substantiated by competent medical evidence. 1.17 "Distributee" means an Employee or former Employee. In addition, the Employee's or former Employee's surviving spouse and the Employee's or former Employee's spouse or former spouse who is the alternate payee under a qualified domestic relations order, as defined in Code Section 414(p), are Distributees with regard to the interest of the spouse or former spouse." 1.18 "Early Retirement Age" means age 55. 1.19 "Effective Date" means July 1, 1995. 1.20 "Elective Deferrals" means, with respect to any taxable year of the Member, the sum of: (a) any Deferral Amounts; (b) any contributions made by or on behalf of a Member under any other qualified cash or deferred arrangement as defined in Code Section 401(k), whether or not maintained by a Plan Sponsor, to the extent such contributions are not or would not, but for Code Section 402(g)(1) be included in the Member's gross income for the taxable year; and (c) any other contributions made by or on behalf of a Member pursuant to Code Section 402(g)(3). 1.21 "Eligibility Service" means the completion by an Employee of a twelve-consecutive-month period beginning on the date on which the Employee first performs or performed an Hour of Service upon his employment or reemployment or any anniversary thereof, without reaching a Severance Date; provided, however: -4- 7 (a) if an Employee quits, retires or is discharged and then performs an Hour of Service within twelve months of his Severance Date, then such period of severance shall be taken into account in calculating Eligibility Service; (b) if an Employee quits, is discharged, or retires during an absence from service of twelve months or less for any reason other than quit, discharge or attainment of a Retirement Date and the Employee then performs an Hour of Service within twelve months of the date the Employee was first absent from service, then such period of absence shall be taken into account in calculating Eligibility Service; (c) in the case of an Employee who remains absent from service beyond the first anniversary of the commencement of a period of absence (1) by reason of the pregnancy of the Employee, (2) by reason of the birth of a child of the Employee, (3) by reason of the placement of a child with the Employee in connection with the adoption of the child by the Employee, or (4) for purposes of caring for such child for a period immediately following its birth or placement, the period between the first and second anniversaries of such period of absence shall not be counted as Eligibility Service. Eligibility Service shall not include, in the case of a rehired Employee who did not have any vested right at his Severance Date and then incurs five consecutive Breaks in Service, all periods which would otherwise constitute Eligibility Service before the first of the five consecutive Breaks in Service commenced. 1.22 "Eligible Employee" means any Employee of a Plan Sponsor other than an Employee who is (a) covered by a collective bargaining agreement between a union and a Plan Sponsor, provided that retirement benefits were the subject of good faith bargaining, unless the collective bargaining agreement provides for participation in the Plan, (b) a leased employee within the meaning of Code Section 414(n)(2), (c) considered a "leased employee" within the meaning of Code Section 414(n)(2) with respect to a client of a Plan Sponsor and is an active participant in the tax-qualified retirement plan of the client during any part of the Plan Year, (d) a participant in another tax-qualified retirement plan maintained by the Plan Sponsor or Affiliate thereof and who is eligible to receive benefits under such plan during any part of the Plan Year if he otherwise satisfies the requirement to either perform a requisite number of Hours of Service or be employed as of a particular date, or (e) deemed to be an Employee of a Plan Sponsor pursuant to regulations under Code Section 414(o). 1.23 "Eligible Retirement Plan" means an individual retirement account described in Code Section 408(a), an individual retirement annuity described in Code Section 408(b), an annuity plan described in Code Section 403(a) or a qualified trust described in Code Section 401(a) that accepts the Distributee's Eligible Rollover Distribution. However, in the case of an Eligible Rollover Distribution to the surviving spouse, an Eligible Retirement Plan is an individual retirement account or individual retirement annuity. 1.24 "Eligible Rollover Distribution" means any distribution of all or any portion of the balance to the credit of the Distributee, except that an Eligible Rollover Distribution does not include: any distribution that is one of a series of substantially equal periodic payments (not -5- 8 less frequently than annually) made for the life (or life expectancy) of the Distributee or the joint lives (or joint life expectancies) of the Distributee and the Distributee's designated Beneficiary, or for a specified period of ten years or more; any distribution to the extent such distribution is required under Code Section 401(a)(9); and the portion of any distribution that is not includible in gross income (determined without regard to the exclusion for net unrealized appreciation with respect to employer securities). 1.25 "Employee" means any person who is employed by a Plan Sponsor or an Affiliate for purposes of the Federal Insurance Contributions Act, who is a leased employee within the meaning of Code Section 414(n)(2) with respect to a Plan Sponsor, or who is deemed to be an employee of a Plan Sponsor pursuant to regulations under Code Section 414(o). 1.26 "Employment Date" means that date on which an Employee first performs an Hour of Service with a Plan Sponsor or, in the alternative, on which an Employee again performs an Hour of Service following any period of severance which is not required to be taken into account in determining the Employee's period of Service. 1.27 "Entry Date" means the first day of January, April, July, and October. Effective October 1, 1995, "Entry Date" means the first day of each calendar month. 1.28 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 1.29 "Fiduciary" means each Named Fiduciary and any other person who exercises or has any discretionary authority or control regarding management or administration of the Plan, any other person who renders investment advice for a fee or has any authority or responsibility to do so with respect to any assets of the Plan or any other person who exercises, or has any authority or control respecting management or disposition of assets of the Plan. 1.30 "Fund" means the amount at any given time of cash and other property held by the Trustee pursuant to the Plan. 1.31 "Gottlieb Plan" means the GFS 401(K) Savings Plan. 1.32 "Highly Compensated Employee" means an Employee who is described in Subsection (a), unless the Plan Sponsor makes an election pursuant to Subsection (b). (a) (1) The Employee during the Plan Year immediately preceding the Plan Year in question: (A) was at any time an owner of more than five percent (5%) of the outstanding stock of a Plan Sponsor or Affiliate or more than five percent (5%) of the total combined voting power of all stock of a Plan Sponsor or Affiliate; or -6- 9 (B) received Annual Compensation in excess of $100,000 (for the Plan Year beginning in 1995) which amount shall be adjusted for changes in the cost of living as provided in regulations issued by the Secretary of the Treasury; or (C) received Annual Compensation in excess of $66,000 (for the Plan Year beginning in 1995) which amount shall be adjusted for changes in the cost of living as provided in regulations issued by the Secretary of the Treasury, and who was in the group consisting of the most highly compensated twenty percent (20%) of the Employees; or (D) was at any time an officer of the Plan Sponsor or of any Affiliate whose Annual Compensation was greater than fifty percent (50%) of the amount in effect under Code Section 415(b)(1)(A) for the calendar year in which the Plan Year ends, where the term "officer" means an administrative executive in regular and continual service to the Plan Sponsor or Affiliate; provided, however, that in no event shall the number of officers exceed the lesser of Clause (i) or (ii) of this Subparagraph (D), where: (i) equals fifty (50) Employees; and (ii) equals the greater of (I) three (3) Employees or (II) ten percent (10%) of the number of Employees during the Plan Year, with any non- integer being increased to the next integer. If for any year no officer of the Plan Sponsor meets the requirements of this Subparagraph (D), the highest paid officer of the Plan Sponsor for the Plan Year shall be considered an officer for purposes of this Subparagraph (D). (2) The Employee during the Plan Year in question (A) is described in Subsection (a)(1)(A), or (B) is both (i) described in Subsection (a)(1)(B), (a)(1)(C), or (a)(1)(D), and (ii) one of the 100 Employees who received the most Annual Compensation during that Plan Year. The Plan Administrator may make an election to substitute $66,000 (as adjusted) for $100,000 (as adjusted) in Paragraph (2) of this Subparagraph (B) of Subsection (a)(1) provided that at all times during the Plan Year the Plan Sponsor and its Affiliates maintain significant business activities and have Employees in at least two significantly separate geographic areas and satisfy such other conditions as the Secretary of the Treasury prescribes. For purposes of Subparagraphs (C) and (D) of this Subsection (a)(1), the following shall be excluded when determining the number of Employees in the -7- 10 most highly compensated twenty percent (20%) of the Employees and the number of officers: (i) Employees who have not completed six (6) months of service, (ii) Employees who normally work less than 17 1/2 hours per week, (iii) Employees who normally work during not more than six (6) months during any Plan Year, (iv) Employees who have not attained age 21, (v) Employees who are included in a unit of employees covered by an agreement which the Secretary of Labor finds to be a collective bargaining agreement between employee representatives and the Plan Sponsor or its Affiliates, provided 90% or more of the Employees are covered under collective bargaining agreements and the Plan only covers Employees who are not covered under the collective bargaining agreements. (b) Notwithstanding the provisions of Subsection (a), the Primary Sponsor may elect to determine each Highly Compensated Employee to be each Employee who during the Plan Year in question is described in Subsection (a), pursuant to the provisions of Treas. Reg. Section 1.414(q)-1T, Q&A-14(b). (c) For purposes of this Section, if any Employee is a member of the family of a five percent (5%) owner as defined in Subsection (a)(1) of this Section or of a Highly Compensated Employee whose Annual Compensation is such that he is among the ten (10) Highly Compensated Employees receiving the greatest amount of Annual Compensation during the Plan Year, then (1) the Employee shall not be considered a separate Employee, and (2) any Annual Compensation paid to the Employee, and any applicable contribution or benefit on behalf of the Employee, shall be treated as if it were paid to, or on behalf of, the five percent (5%) owner or the Employee who is among the ten (10) Highly Compensated Employees receiving the greatest amount of Annual Compensation during the Plan Year. For purposes of this Subsection (c), the term "family" means with respect to any Employee, the Employee's spouse and lineal descendants or ascendants and the spouses of lineal descendants or ascendants. (d) For purposes of this Section, a former Employee shall be treated as a Highly Compensated Employee if (1) the former Employee was a Highly Compensated Employee at the time the former Employee separated from service with the Plan Sponsor or Affiliate or (2) the former Employee was a Highly Compensated Employee at any time after the former Employee attained age 55. -8- 11 (e) For purposes of this Section, Employees who are nonresident aliens and who receive no earned income from the Plan Sponsor or an Affiliate from sources within the United States shall not be treated as Employees. (f) For purposes of this Section, Annual Compensation shall be determined without regard to the $150,000 limitation, as adjusted. 1.33 "Hour of Service" means: (a) Each hour for which an Employee is paid, or entitled to payment, for the performance of duties for a Plan Sponsor or any Affiliate during the applicable computation period, and such hours shall be credited to the computation period in which the duties are performed; (b) Each hour for which an Employee is paid, or entitled to payment, by a Plan Sponsor or any Affiliate on account of a period of time during which no duties are performed (irrespective of whether the employment relationship has terminated) due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence; (c) Each hour for which back pay, irrespective of mitigation of damages, is either awarded or agreed to by a Plan Sponsor or any Affiliate, and such hours shall be credited to the computation period or periods to which the award or agreement for back pay pertains rather than to the computation period in which the award, agreement or payment is made; provided, that the crediting of Hours of Service for back pay awarded or agreed to with respect to periods described in Subsection (b) of this Section shall be subject to the limitations set forth in Subsection (e); (d) Solely for purposes of determining whether a Break in Service has occurred, each hour during any period that the Employee is absent from work (1) by reason of the pregnancy of the Employee, (2) by reason of the birth of a child of the Employee, (3) by reason of the placement of a child with the Employee in connection with the adoption of the child by the Employee, or (4) for purposes of caring for such child for a period immediately following its birth or placement. The hours described in this Subsection (d) shall be credited (A) only in the computation period in which the absence from work begins, if the Employee would be prevented from incurring a Break in Service in that year solely because of that credit, or (B), in any other case, in the next following computation period; and (e) The Plan Administrator shall credit Hours of Service in accordance with the provisions of Section 2530.200b-2(b) and (c) of the -9- 12 U.S. Department of Labor Regulations or such other federal regulations as may from time to time be applicable and determine Hours of Service from the employment records of a Plan Sponsor or in any other manner consistent with regulations promulgated by the Secretary of Labor, and shall construe any ambiguities in favor of crediting Employees with Hours of Service. Notwithstanding any other provision of this Section, in no event shall an Employee be credited with more than 501 Hours of Service during any single continuous period during which he performs no duties for the Plan Sponsor or Affiliate. (f) In the event that a Plan Sponsor or an Affiliate acquires substantially all of the assets of another corporation or entity or a controlling interest of the stock of another corporation or merges with another corporation or entity and is the surviving entity, then service of an Employee who was employed by the prior corporation or entity and who is employed by the Plan Sponsor or an Affiliate at the time of the acquisition or merger shall be counted in the manner provided, with the consent of the Primary Sponsor, in resolutions adopted by the Plan Sponsor authorizing the counting of such service. (g) Notwithstanding the foregoing, for purposes of determining whether a Break in Service occurs and whether an Employee satisfies his Eligibility Period of Service, Hours of Service shall be calculated on an equivalency based on earnings, as permitted by Section 2530.200b-3(a) and (f) of the U.S. Department of Labor Regulations, as follows: (1) The Employee shall be credited with hours equal to the Employee's total earnings for the performance of duties during the applicable computation period divided by the Employee's lowest hourly rate of compensation during that computation period. (2) 870 hours credited under Subsection (1) above shall be treated as the equivalent of 1,000 Hours of Service. 435 hours credited under Subsection (1) above shall be treated as the equivalent of 500 Hours of Service. 1.34 "Individual Funds" means two or more individual subfunds of the Fund (other than the Loan Fund) as may be established by the Plan Administrator from time to time for the investment of the Fund. 1.35 "Investment Committee" means a committee which may be established to direct the Trustee with respect to investments of the Fund. 1.36 "Investment Manager" means a Fiduciary, other than the Trustee, the Plan Administrator, or a Plan Sponsor, who may be appointed by the Primary Sponsor: -10- 13 (a) who has the power to manage, acquire, or dispose of any assets of the Fund or a portion thereof; and (b) who (1) is registered as an investment adviser under the Investment Advisers Act of 1940; (2) is a bank as defined in that Act; or (3) is an insurance company qualified to perform services described in Subsection (a) above under the laws of more than one state; and (c) who has acknowledged in writing that he is a Fiduciary with respect to the Plan. 1.37 "Loan Fund" means the separate subfund of the Fund for the investment of a Member's Account in a note made by the Member evidencing a loan to the Member from the Fund. 1.38 "Member" means any Employee or former Employee who has become a participant in the Plan for so long as his vested Accrued Benefit has not been fully distributed pursuant to the Plan. 1.39 "MMNE Plan" means the Medical Management of New England, Inc. 401(k) Salary Savings Retirement Plan. 1.40 "Named Fiduciary" means only the following: (a) The Plan Administrator; (b) The Trustee; (c) The Board of Directors; (d) The Investment Committee; and (e) The Investment Manager. 1.41 "Normal Retirement Age" means age 65. 1.42 "Plan Administrator" means the organization or person designated to administer the Plan. 1.43 "Plan Sponsor" means individually the Primary Sponsor and any Affiliate or other entity which has adopted the Plan and Trust. 1.44 "Plan Year" means the calendar year. -11- 14 1.45 "Qualified Member" means any Member who (i) is not a Highly Compensated Employee, (ii) was a participant in the CompMed, Inc. Profit Sharing Plan and Trust as of December 31, 1993 and (iii) is a remote-site non-exempt Employee. 1.46 "Records Center Plan" means the Records Center, Inc. Profit Sharing Retirement Plan. 1.47 "Retirement Date" means the date on which the Member retires on or after attaining Normal Retirement Age or becoming subject to a Disability. 1.48 "Rollover Amount" means any amount transferred to the Fund by a Member, which amount qualifies as an Eligible Rollover Distribution under Code Section 402(c)(4), 403(a)(4), or 408(d)(3)(A)(ii) and any regulations issued thereunder. 1.49 "Service" means a period commencing on an Employee's Employment Date and ending on his Severance Date thereafter. The following rules shall apply: (a) Notwithstanding the foregoing, if an Employee performs one Hour of Service within twelve (12) months of (a) a Severance Date described in Subsection (a) of Plan Section 1.50, or (b) the date the Employee was first absent from service for any other reason, any period of severance which would otherwise occur shall be ignored and be required to be taken into account in computing the Employee's period of Service. (b) The period between the first anniversary and second anniversary of an absence from service for the reasons specified in Plan Section 1.50(b)(2) shall be neither a period of severance or a period of Service. (c) In the event that a Plan Sponsor or an Affiliate acquires a substantial part of the assets of another corporation, or merges with another corporation and is the surviving entity, then the Service performed for such prior corporation or entity by an Employee who becomes employed by the Plan Sponsor or an Affiliate as a result of the acquisition or merger shall be credited as service in the manner provided, with the consent of the Primary Sponsor, in resolutions adopted by the Plan Sponsor. 1.50 "Severance Date" means the earlier of: (a) the date on which an Employee quits, is discharged, retires or dies; or (b) (1) the first anniversary of the first date of a period in which an Employee remains absent from service (with or without pay) with the Plan Sponsor for any other reason, such as vacation, layoff, or leave of absence; or (2) in the case of an Employee who remains absent from service beyond the first anniversary of the first day of absence by reason of the Employee's pregnancy, the birth of the Employee's child, the placement of a child in the Employee's home or adoption by the Employee, or the caring for the child for the period immediately following its birth or adoption, the second anniversary of the first day of absence from service. -12- 15 1.51 "Termination Completion Date" means the last day of the fifth consecutive Break in Service computation period, determined under the Plan Section which defines Break in Service, in which a Member completes a Break in Service. 1.52 "Trust" means the trust established under an agreement between the Primary Sponsor and the Trustee to hold the Fund or any successor agreement. 1.53 "Trustee" means the trustee under the Trust. 1.54 "Valuation Date" means the last day of March, June, September, and December or any other date which the Plan Administrator declares to be a Valuation Date; provided, however, that the Plan Administrator may in its sole discretion provide for more frequent Valuation Dates with respect to the Individual Funds. 1.55 "Voluntary Contribution" means a non-deductible contribution to the Fund made by the Member. 1.56 "Years of Service" means, with respect to each Employee, the number of years and fractions of a year of Service credited to that Employee. The following rules shall apply: (a) In the case of an Employee who incurs a Break in Service, Years of Service completed prior to the Break in Service shall not be considered in calculating the Employee's nonforfeitable percentage of his Accrued Benefit under Plan Section 10.3 until the Employee has completed a one-year period of Service after such Break in Service. (b) In the case of an Employee who completes five consecutive Breaks in Service, all Years of Service in Plan Years after his Termination Completion Date shall be disregarded in determining the vested portion of his Accrued Benefit derived from Plan Sponsor contributions which accrued before his Termination Completion Date. (c) In the case of an Employee who incurs a Break in Service and at that time does not have any vested right in Plan Sponsor contributions, any Years of Service completed by him prior to such Break in Service shall be disregarded for purposes of determining the vested percentage of his right to such contributions if the consecutive period of severance equals or exceeds his prior Years of Service, whether or not consecutive, completed before such Break in Service. SECTION 2 ELIGIBILITY 2.1 Each individual who was a member of the Plan as of the date immediately preceding the Effective Date shall become a Member of the Plan as of the Effective Date. 2.2 Each Eligible Employee shall become a Member as of the Entry Date coinciding with or next following the date he completes his Eligibility Service. -13- 16 2.3 Each former Member who is reemployed by a Plan Sponsor shall become a Member as of the date of his reemployment as an Eligible Employee. 2.4 Each former Employee who completes his Eligibility Service but terminates employment with a Plan Sponsor before becoming a Member shall become a Member as of the latest of the date he (a) is reemployed, (b) would have become a Member if he had not terminated employment, or (c) becomes an Eligible Employee. 2.5 Solely for the purpose of contributing a Rollover Amount to the Plan, an Eligible Employee who has not yet become a Member pursuant to any other provision of this Section 2 shall become a Member as of the date on which the Rollover Amount is contributed to the Plan. 2.6 Notwithstanding anything contained in this Section 2 to the contrary, in the event that an individual becomes an Eligible Employee of a Plan Sponsor by reason of an acquisition by the Plan Sponsor of a controlling interest in or a substantial part of all the assets of the individual's prior employer with a Plan Sponsor, if the Eligible Employee was covered under a plan of the prior employer meeting the requirements of Code Section 401(a), such Eligible Employee shall become a Member as of the date of his employment with the Plan Sponsor as an Eligible Employee. SECTION 3 CONTRIBUTIONS 3.1 (a) The Plan Sponsor shall make a contribution to the Fund on behalf of each Eligible Employee who is a Member and who has elected to defer a portion of Regular Compensation otherwise payable to him for the Plan Year and to have such portion contributed to the Fund. The election must be made before the Annual Compensation is payable and may only be made pursuant to an agreement between the Member and the Plan Sponsor which shall be in such form and subject to such rules and limitations as the Plan Administrator may prescribe and shall specify the percentage of Annual Compensation that the Member desires to defer and to have contributed to the Fund. Once a Member has made an election for a Plan Year, the Member may revoke his election at any time, effective as of the beginning of the payroll period immediately following the date timely notice is received by the Plan Administrator; provided, however, the election to revoke may be effective at a later date as specified by the Member, but in no event later than seven (7) months after the election is received by the Plan Administrator. A Member may modify his election by notifying the Plan Administrator in the manner and pursuant to rules established by the Plan Administrator. The contribution made by a Plan Sponsor on behalf of an Eligible Employee who is a Member under this Section 3.1 shall be in an amount equal to the amount specified in the Member's deferral election, but not greater than sixteen percent (16%) of the Member's Annual Compensation. Notwithstanding the foregoing, the Plan Administrator may reduce the amount that certain Highly Compensated Employees may elect to defer in their deferral elections to a uniform percentage less than sixteen percent (16%) of Annual Compensation, in the event the Plan Administrator deems such reduction necessary for the Plan to comply with one or more of the following limitations: (a) -14- 17 Section 3.1(b) (relating to the annual limit on salary deferrals set forth in Code Section 402(g)), (b) Section 3.1(a) and Section 4 of Appendix A (relating to the non-discrimination testing limitations under Code Sections 401(k)(3) or 401(m)), and (c) Appendix B (relating to the limit on "annual additions," within the meaning of Code Section 415). (b) Elective Deferrals shall in no event exceed $9,240 (for 1995) in any one taxable year of the Member, which amount shall be adjusted for changes in the cost of living as provided by the Secretary of the Treasury. In the event the amount of Elective Deferrals exceeds $9,240 (for 1995) as adjusted, in any one taxable year then, (1) not later than the immediately following March 1, the Member may designate to the Plan the portion of the Member's Deferral Amount which consists of excess Elective Deferrals, and (2) not later than the immediately following April 15, the Plan may distribute the amount designated to it under Paragraph (1) above, as adjusted to reflect income, gain, or loss attributable to it through the date of the distribution, and reduced by any "Excess Deferral Amounts," as defined in Appendix A hereto, previously distributed or recharacterized with respect to the Member for the Plan Year beginning with or within that taxable year. The payment of the excess Elective Deferrals, as adjusted and reduced, from the Plan shall be made to the Member without regard to any other provision in the Plan. In the event that a Member's Elective Deferrals exceed $9,240, as adjusted, in any one taxable year under the Plan and other plans of the Plan Sponsor and its Affiliates, the Member shall be deemed to have designated for distribution under the Plan the amount of excess Elective Deferrals, as adjusted and reduced, by taking into account only Elective Deferral amounts under the Plan and other plans of the Plan Sponsor and its Affiliates. 3.2 The Plan Sponsor proposes to make contributions to the Fund with respect to each Plan Year on behalf of each Member in an amount equal to fifty percent (50%) of the amount deferred by the Member pursuant to Plan Section 3.1, not in excess of six percent (6%) of the Member's Annual Compensation. The Board of Directors may, at its discretion, increase the percentage contribution under this Section 3.2 for all members, or for any specified unit, division, subdivision, or location, or for any Members who participated in a specified prior plan that was merged into the Plan. 3.3 Effective upon resolution by the Board of Directors, a Plan Sponsor proposes to make contributions to the Fund with respect to each Plan Year in an amount determined by the Plan Sponsor. 3.4 The Plan Sponsor proposes to make Qualified Nonelective Contributions to the Fund with respect to the Plan Year ending December 31, 1994 in an amount determined by the Plan Sponsor. 3.5 Effective upon implementation by the Plan Administrator and subject to such rules and limitations as the Plan Administrator may from time to time prescribe, each Eligible Employee who is a Member may contribute as a Voluntary Contribution to the Fund an amount of his Annual Compensation, which when added to the amount deferred by the Member pursuant -15- 18 to Plan Section 3.1 shall not exceed sixteen percent (16%) of the Member's Annual Compensation. Voluntary Contributions shall be made to the Fund through regular payroll deductions or in such other manner as shall be agreed upon by each Member and the Plan Administrator. Once implemented, the Plan Administrator may, at any time, suspend the making of any further Voluntary Contributions. 3.6 Forfeitures under Plan Section 3.2 shall be used to reduce Plan Sponsor contributions and not to increase benefits. 3.7 Any Eligible Employee who is a Member may, with the consent of the Plan Administrator and subject to such rules and conditions as the Plan Administrator may prescribe, transfer a Rollover Amount to the Fund; provided, however, that the Plan Administrator shall not administer this provision in a manner which is discriminatory in favor of Highly Compensated Employees. 3.8 Contributions may be made only in cash or other property which is acceptable to the Trustee. In no event will the sum of contributions under Plan Sections 3.1, 3.2 and 3.3 exceed the deductible limits under Code Section 404. SECTION 4 ALLOCATIONS 4.1 (a) As soon as reasonably practicable following the date of withholding by the Plan Sponsor, if applicable, and receipt by the Trustee, Plan Sponsor contributions made on behalf of each Member under Plan Sections 3.1 and 3.2 (including forfeitures during the Plan Year used to reduce such contributions), and Voluntary Contributions and Rollover Amounts contributed by the Member, shall be allocated to the Employee Deferral Account, Matching Account, Voluntary Contribution Account and Rollover Account, respectively, of the Member on behalf of whom the contributions were made. (b) As of the last day of each Plan Year, Plan Sponsor contributions made under Plan Section 3.3 and forfeitures from Company Accounts shall be allocated to the Company Account of each Eligible Employee who is a Member who is employed by a Plan Sponsor on the last day of the Plan Year, or whose death or Retirement Date occurred during the Plan Year, in the proportion that the Member's Annual Compensation bears to the Annual Compensation of all Members entitled to an allocation under this Subsection (b) and Subsection (c) hereof. (c) As of the last day of each Plan Year, if necessary to satisfy with respect to the Plan Year, the minimum coverage requirements prescribed in Code Section 410(b) or the minimum participation requirements under Code Section 401(a)(26) and regulations issued thereunder, Plan Sponsor contributions made under Plan Section 3.3 shall be allocated to the Company Account of Eligible Employees who are Members and who are not Highly Compensated Employees, beginning with the individual receiving the least Annual Compensation for the Plan Year who completed more than 500 Hours of Service during that Plan Year, but who terminated employment before the last day of the Plan -16- 19 Year, in the proportion set forth in Subsection (b), determined without regard to the last day of the Plan Year rule in that Subsection in the case of Plan Sponsor contributions under Plan Section 3.3. (d) As of December 31, 1994, Plan Sponsor contributions made under Plan Section 3.4 shall be allocated to the Employee Deferral Account of each Qualified Member in the proportion that the Qualified Member's Annual Compensation bears to the Annual Compensation of all Qualified Members entitled to an allocation under this Subsection (d). 4.2 Except as otherwise provided in the Plan and the Trust, as of each Valuation Date, the Trustee shall determine the net income or net loss of the Fund and shall allocate such amounts to the Accounts of Members as hereinafter set forth. (a) The net income or net loss of the Individual Funds shall be allocated as of each Valuation Date to the Account of each Member in the proportion that the value of the Account invested in the Individual Fund or Loan Fund as of the preceding Valuation Date, increased by one-half of the total contributions allocated to that Member's Account since the preceding Valuation Date and reduced by the full amount of any withdrawals from that Member's Account since that Valuation Date, bears to the total value of all Accounts invested in the Individual Fund or Loan Fund, respectively, as of the preceding Valuation Date. (b) Notwithstanding the foregoing, in the event Valuation Dates are changed to a daily basis, the net income or net loss of the Individual Funds shall be allocated as of each Valuation Date to each Account in the proportion that the value of the Account invested in that Individual Fund as of that Valuation Date bears to the value of all Accounts invested in that Individual Fund as of that Valuation Date. SECTION 5 INDIVIDUAL FUNDS AND INVESTMENTS OF TRUST ASSETS 5.1 Until such time as the Plan Administrator may direct otherwise, each Member may direct the Plan Administrator to invest contributions to his Account in two or more Individual Funds as the Member shall designate by providing notice to the Plan Administrator according to the procedures established by the Plan Administrator for that purpose. Notwithstanding the foregoing, Members shall not be able to direct the investment of any Account other than their Matching Accounts into the Company Stock Fund subject to such rules as the Plan Administrator shall develop, including the Primary Sponsor's "stock trading policy." (a) All investment directions shall be in multiples of 1% of contributions being made at any time. A Member can change the investment of contributions to his Account once each calendar quarter. Effective October 1, 1995, a Member can change the investment of contributions to his Account once each month. A new investment direction shall be effective as of the first Entry Date after timely election is received by the Plan Administrator, provided that the election is made according to the procedures established -17- 20 by the Plan Administrator. Notwithstanding the foregoing, a new investment election may be effective at a later date as specified by the Member, but in no event later than seven (7) months after the election is received by the Plan Administrator. (b) An investment direction, once given, shall be deemed to be a continuing direction until changed as otherwise provided herein. If no direction is effective for the date a contribution is to be made, all contributions which are to be made for such date shall be invested in such Individual Fund as the Plan Administrator, the Investment Manager, the Investment Committee, or the Trustee, as applicable, may determine. To the extent permissible by law, no Fiduciary shall be liable for any loss, which results from a Member's exercise or failure to exercise his investment election. 5.2 A Member may elect, once each calendar quarter, by notice to the Plan Administrator according to the procedures established by the Plan Administrator for such purpose, to transfer, in multiples of 1%, his Account between Individual Funds provided that such election is made by the deadline established by the Plan Administrator for such transfers. Effective October 1, 1995, a Member may elect to transfer the investment of his Account once each month, subject to the foregoing procedures. An election under this Section 5.2 shall be effective as of the first Entry Date after timely election is received by the Plan Administrator, provided that the election is made according to the procedures established by the Plan Administrator. Notwithstanding the foregoing, an election under this Section 5.2 may be effective at a later date as specified by the Member, but in no event later than seven (7) months after the election is received by the Plan Administrator. 5.3 A Member who makes an election pursuant to Plan Section 5.1 or Plan Section 5.2 may apply the new investment direction to his current Account, all future contributions, or both his current Account and all future contributions. 5.4 A Loan Fund shall be established by the Trustee on behalf of each Member for whom a loan is made pursuant to Plan Section 6. The Loan Fund shall be credited with the amount of any loan made by the Plan to the Member and shall be debited with all principal and interest repayments of any such loans. Under rules established by the Plan Administrator, a Member's interest in the Individual Funds shall be debited by the amount credited to the Member's Loan Fund. All principal and interest repayments debited to the Loan Fund shall be invested as contributions to the Member's Account pursuant to Plan Section 5.1. Each Loan Fund shall be invested in a note or notes made by the Member evidencing the promised repayment of monies loaned to the Member from the Fund. SECTION 6 PLAN LOANS 6.1 All loans under the Plan will be subject to the requirements of this Section and such other rules as the Plan Administrator may from time to time prescribe, including without limitation any rules restricting the purpose for which loans will be approved (the "Loan Procedures"). The Loan Procedures shall be set forth in a separate written document, which shall form a part of the Plan and is incorporated herein by reference. -18- 21 6.2 Subject to the provisions of the Plan and the Trust, each Member who is an Employee shall have the right, subject to prior approval by the Plan Administrator, to borrow from the Fund. In addition, each "party in interest," as defined in ERISA Section 3(14), who is (a) a Member but no longer an Employee, (b) the Beneficiary of a deceased Member, or (c) an alternate payee of a Member pursuant to the provisions of a "qualified domestic relations order," as defined in Code Section 414(p), shall also have the right, subject to prior approval by the Plan Administrator, to borrow from the Fund; provided, however, that loans to such parties in interest may not discriminate in favor of Highly Compensated Employees. 6.3 In order to apply for a loan, a borrower must complete and submit an application to the Plan Administrator in such form and subject to such rules as the Plan Administrator may prescribe for this purpose. 6.4 Loans shall be available to all eligible borrowers on a reasonably equivalent basis which shall take into account the borrower's credit worthiness, ability to repay, and ability to provide adequate security. Loans shall not be made available to Highly Compensated Employees, officers or shareholders of a Plan Sponsor in an amount greater than the amount made available to other borrowers. This provision shall be deemed to be satisfied if all borrowers have the right to borrow the same percentage of their interest in the Member's vested Accrued Benefit, notwithstanding that the dollar amount of such loans may differ as a result of differing values of Members' vested Accrued Benefit. 6.5 Each loan shall bear a "reasonable rate of interest" and provide that the loan be amortized in substantially level payments, made no less frequently than quarterly, over a specified period of time. A "reasonable rate of interest" shall be that rate that provides the Plan with a return commensurate with the interest rates charged by persons in the business of lending money for loans which would be made under similar circumstances. 6.6 Each loan shall be adequately secured, with the security for the outstanding balance of all loans to the borrower to consist of one-half (1/2) of the borrower's interest in the Member's vested Accrued Benefit, or such other security as the Plan Administrator deems acceptable. 6.7 Each loan, when added to the outstanding balance of all other loans to the borrower from all retirement plans of the Plan Sponsor and its Affiliates which are qualified under Section 401 of the Code, shall not exceed the lesser of: (a) $50,000, reduced by the excess, if any, of (1) the highest outstanding balance of loans made to the borrower from all retirement plans qualified under Code Section 401 of the Plan Sponsor and its Affiliates during the one (1) year period immediately preceding the day prior to the date on which such loan was made, over -19- 22 (2) the outstanding balance of loans made to the borrower from all retirement plans qualified under Code Section 401 of the Plan Sponsor and its Affiliates on the date on which such loan was made, or (b) one-half (1/2) of the value of the borrower's interest in the vested Accrued Benefit attributable to the Member's Account. For purposes of this Section, the value of the vested Accrued Benefit attributable to a Member's Account shall be established as of the latest preceding Valuation Date, or any later date on which an available valuation was made, and shall be adjusted for any distributions or contributions made through the date of the origination of the loan. 6.8 The entire unpaid principal sum and accrued interest shall, at the option of the Plan Administrator, become due and payable if (a) a borrower fails to make any loan payment when due, (b) a borrower ceases to be a "party in interest", as defined in ERISA Section 3(14), (c) the vested Accrued Benefit held as security under the Plan for the borrower will, as a result of an impending distribution or withdrawal, be reduced to an amount less than the amount of all unpaid principal and accrued interest then outstanding under the loan, or (d) a borrower makes any untrue representations or warranties in connection with the obtaining of the loan. In that event, the Plan Administrator may take such steps as it deems necessary to preserve the assets of the Plan, including, but not limited to, the following: (1) direct the Trustee to deduct the unpaid principal sum, accrued interest, and any other applicable charge under the note evidencing the loan from any benefits that may become payable out of the Plan to the borrower, (2) direct the Plan Sponsor to deduct and transfer to the Trustee the unpaid principal balance, accrued interest, and any other applicable charge under the note evidencing the loan from any amounts owed by the Plan Sponsor to the borrower, or (3) liquidate the security given by the borrower, other than amounts attributable to a Member's Employee Deferral Account, and deduct from the proceeds the unpaid principal balance, accrued interest, and any other applicable charge under the note evidencing the loan. If any part of the indebtedness under the note evidencing the loan is collected by law or through an attorney, the borrower shall be liable for attorneys' fees in an amount equal to ten percent of the amount then due and all costs of collection. 6.9 Each loan shall be made only in accordance with regulations and rulings of the Internal Revenue Service or the Department of Labor. The Plan Administrator shall be authorized to administer the loan program of this Section and shall act in his sole discretion to ascertain whether the requirements of such regulations and rulings and this Section have been met. 6.10 Loans will be made last from amounts invested in the Company Stock Fund. -20- 23 SECTION 7 WITHDRAWALS DURING EMPLOYMENT 7.1 A Member who has attained age 59 1/2 may withdraw all or any portion of the balance in his Employee Deferral Account, his Rollover Account, and the vested portion of his Matching Account. A Member who makes a withdrawal under this Plan Section 7.1 will not be eligible to receive contributions pursuant to Plan Section 3.2 or any contributions on behalf of the Member to his Employee Deferral Account with respect to the three month period following the date of the withdrawal. Any withdrawal under this Plan Section 7.1 shall be made last from amounts invested in the Company Stock Fund. 7.2 A withdrawal pursuant to this Section 7.2 is designated a "Hardship Withdrawal" and is subject to the following rules: The Trustee shall, upon the direction of the Plan Administrator, distribute all or a portion of a Member's Rollover Account and Employee Deferral Account consisting of Deferral Amounts (but not earnings thereon) prior to the time such account is otherwise distributable in accordance with the other provisions of the Plan; provided, however, that any such distribution shall be made only if the Member is an Employee and demonstrates that he is suffering from "hardship" as determined herein. For purposes of this Section, a distribution will be deemed to be an account of hardship if the distribution is on account of: (a) medical expenses described in Section 213(d) of the Code incurred by the Member, his spouse, or any dependents of the Member (as defined in Section 152 of the Code) or necessary for these persons to obtain medical care described in Section 213(d) of the Code; (b) costs directly related to the purchase (excluding mortgage payments) of a principal residence for the Member; (c) payment of tuition, related educational fees, and room and board expenses for the next 12 months of post-secondary education for the Member, his spouse, children, or dependents; (d) the need to prevent the eviction of the Member from his principal residence or foreclosure on the mortgage of the Member's principal residence; or (e) any other contingency determined by the Internal Revenue Service to constitute an "immediate and heavy financial need" within the meaning of Regulations Section 1.401(k)-1(d). 7.3 In addition to the requirements set forth in Plan Section 7.2, any distribution pursuant to Plan Section 7.2 shall not be in excess of the amount necessary to satisfy the need determined under Section 7.2 and shall also be subject to the requirements of Subsection (a) or (b) of this Section. -21- 24 (a) (1) the Member shall first obtain all distributions, other than hardship distributions, and all nontaxable loans currently available under all plans maintained by the Plan Sponsor; (2) the Plan Sponsor shall not permit Elective Deferrals or after-tax employee contributions to be made to the Plan or any other plan maintained by the Plan Sponsor, for a period of twelve (12) months after the Member receives the distribution pursuant to this Section; and (3) the Plan Sponsor shall not permit Elective Deferrals to be made to the Plan or any other plan maintained by the Plan Sponsor for the Member's taxable year immediately following the taxable year of the hardship distribution in excess of the limit under Plan Section 3.1(b) for the taxable year, less the amount of the Elective Deferrals made to the Plan or any other plan maintained by the Plan Sponsor for the taxable year in which the distribution under this Section occurs. (b) The Plan Administrator determines that it can rely on the Member's written representation, unless the Plan Administrator has actual knowledge to the contrary, that the need determined under Plan Section 7.2 cannot reasonably be relieved -- (1) through reimbursement or compensation by insurance or otherwise, (2) by reasonable liquidation of the assets of the Member, his spouse and minor children, to the extent that the liquidation would not itself cause an immediate and heavy financial need and to the extent that the assets of the spouse and minor children are reasonably available to the Member, (3) by cessation of Elective Deferrals, or (4) by other distributions or nontaxable (at the time of the distribution) loans from plans maintained by the Plan Sponsor or any other employer, or by borrowing from commercial sources on reasonable commercial terms. Such distribution shall be made only in accordance with such rules, policies, procedures, restrictions, and conditions as the Plan Administrator may from time to time adopt. Any determination of the existence of hardship and the amount to be distributed on account thereof shall be made by the Plan Administrator (or such other person as may be required to make such decisions) in accordance with the foregoing rules as applied in a uniform and nondiscriminatory manner, provided that, unless the Member requests otherwise, any such withdrawal shall include the amount necessary to pay any federal, state or local income taxes and penalties reasonably anticipated to result from such withdrawal. A distribution under this Section shall be made in a lump sum to the Member, and shall be subject to the Eligible Rollover Distribution requirements of Section 9.5. -22- 25 SECTION 8 DEATH BENEFITS 8.1 Upon the death of a Member who is an Employee at the time of his death, his Beneficiary shall be entitled to the full value of his Accrued Benefit. 8.2 Upon the death of a Member who is not an Employee at the time of his death, prior to the distribution of his vested Accrued Benefit, his Beneficiary shall be entitled to his vested Accrued Benefit. 8.3 If, subsequent to the death of a Member, the Member's Beneficiary dies while entitled to receive benefits under the Plan, the successor Beneficiary, if any, or the Beneficiary listed under Subsection (a), (b) or (c) of the Plan Section containing the definition of the term "Beneficiary" shall generally be entitled to receive benefits under the Plan. However, if the deceased Beneficiary was the Member's spouse at the time of the Member's death, or if no successor Beneficiary shall have been designated by the Member and be alive and no Beneficiary listed under Subsection (a), (b) or (c) of the Plan Section containing the definition of the term "Beneficiary" shall be alive, the Member's unpaid vested Accrued Benefit shall be paid to the personal representative of the deceased Beneficiary's estate. 8.4 Any benefit payable under this Section 8 shall be paid in accordance with and subject to the provisions of Plan Section 9 or Section 10, whichever is applicable, after receipt by the Trustee from the Plan Administrator of due notice of the death of the Member. SECTION 9 PAYMENT OF BENEFITS ON RETIREMENT OR DEATH 9.1 The Accrued Benefit of a Member who has attained a Retirement Date or has attained Normal Retirement Age or died while an Employee shall be fully vested and nonforfeitable. As of a Member's Retirement Date or death while an Employee, he or his Beneficiary shall be entitled to his Accrued Benefit to be paid in accordance with this Section 9. A Member may elect to delay distribution until he reaches age 70 1/2. The Accrued Benefit of a Member which is to be paid under this Section 9 shall be determined as of the Valuation Date coinciding with or next following the Member's Retirement Date or death, or, if the Member elects to delay distribution until age 70 1/2, as of the Valuation Date coinciding with or next following the date the Member reaches age 70 1/2. Such amount shall be decreased by the amount necessary to satisfy the unpaid principal, accrued interest and penalties on any loan made to the Member from the Plan (which loan shall be deemed to be satisfied as a result of such reduction) and adjusted for a pro rata share of any income, gains, and losses attributable thereto through the Valuation Date coinciding with or immediately preceding the date the Accrued Benefit is paid. Payment shall be made as soon as administratively feasible after the Valuation Date. If the amount of the payment required to commence on a date cannot be ascertained by that date, payment shall commence retroactively to that date and shall commence no later than sixty (60) days after the earliest date on which the amount of payment can be ascertained. -23- 26 9.2 Payment to a Member shall be in the form of one lump sum payment in cash, unless the Accrued Benefit of the Member exceeds $3,500, in which event the Member or the Beneficiary by written instrument delivered to the Plan Administrator may elect to have his or her Account distributed in one of the forms of distribution listed below, as chosen by the Member or Beneficiary: (a) one lump sum payment in cash; (c) a combination of one lump sum payment in cash for a portion of his Account designated by the Member and annual, semiannual, quarterly, or monthly installments in cash for the remaining portion of the Member's Account; or (d) annual, semiannual, quarterly or monthly installments in cash. If the Member elects annual, semiannual, quarterly, or monthly installments for some or all of his Account, such distributions shall be made over a period specified by the Member not exceeding the life expectancy of the Member or the joint life expectancies of the Member and his Beneficiary. 9.3 Notwithstanding any provision of the Plan to the contrary, (a) if a Member's vested Accrued Benefit exceeds $3,500, it shall not be distributed before the Member's Normal Retirement Age or death without the consent of the Member; and (b) the payments to be made to a Member, shall satisfy the incidental death benefit requirements under Code Section 401(a)(9)(G) and the regulations thereunder. 9.4 Notwithstanding any other provisions of the Plan, (a) Prior to the death of a Member, all retirement payments hereunder shall -- (1) be distributed to the Member not later than the required beginning date (as defined below) or, (2) be distributed, commencing not later than the required beginning date (as defined below)-- (A) in accordance with regulations prescribed by the Secretary of the Treasury, over the life of the Member or over the lives of the Member and his designated individual Beneficiary, if any, or (B) in accordance with regulations prescribed by the Secretary of the Treasury, over a period not extending beyond the life expectancy of the Member or the joint life and last survivor expectancy of the Member and his designated individual Beneficiary, if any. -24- 27 (b) (1) If -- (A) the distribution of a Member's retirement payments have begun in accordance with Subsection (a)(2) of this Section, and (B) the Member dies before his entire vested Accrued Benefit has been distributed to him, then the remaining portion of his vested Accrued Benefit shall be distributed at least as rapidly as under the method of distribution being used under Subsection (a)(2) of this Section as of the date of his death. (2) If a Member dies before the commencement of retirement payments hereunder, the entire interest of the Member shall be distributed within five (5) years after his death. (3) If -- (A) any portion of a Member's vested Accrued Benefit is payable to or for the benefit of the Member's designated individual Beneficiary, if any, (B) that portion is to be distributed, in accordance with regulations prescribed by the Secretary of the Treasury, over the life of the designated individual Beneficiary or over a period not extending beyond the life expectancy of the designated individual Beneficiary, and (C) the distributions begin not later than one (1) year after the date of the Member's death or such later date as the Secretary of the Treasury may by regulations prescribe, then, for purposes of Paragraph (2) of this Subsection (b), the portion referred to in Subparagraph (A) of this Paragraph (3) shall be treated as distributed on the date on which the distributions to the designated individual Beneficiary begin. (4) If the designated individual Beneficiary referred to in Paragraph (3)(A) of this Subsection (b) is the surviving spouse of the Member, then -- (A) the date on which the distributions are required to begin under Paragraph (3)(C) of this Subsection (b) shall not be earlier than the date on which the Member would have attained age 70 1/2, and (B) if the surviving spouse dies before the distributions to such spouse begin, this Subsection (b) shall be applied as if the surviving spouse were the Member. -25- 28 (c) For purposes of this Section, the term "required beginning date" means April 1 of the calendar year following the calendar year in which the Member attains age 70 1/2. Notwithstanding the foregoing, in the case of a Member who is not described in Section 1(b)(3) of Appendix C hereto and who has attained age 70 1/2 before January 1, 1988, the term "required beginning date" means April 1 of the calendar year following the calendar year in which the Member retires or otherwise terminates employment. 9.5 Notwithstanding any provisions of the Plan to the contrary that would otherwise limit a Distributee's election under this Section 9, a Distributee may elect, at the time and in the manner prescribed by the Administrator, to have any portion of an Eligible Rollover Distribution paid directly to an Eligible Retirement Plan specified by the Distributee in a direct rollover. If the Eligible Rollover Distribution is one to which Code Sections 401(a)(11) and 417 do not apply, such Eligible Rollover Distribution may commence less than 30 days after the notice required under section 1.411(a)-11(c) of the Income Tax Regulations is give, provided that: (1) The Plan Administrator clearly informs the Distributee that the Distributee has a right to a period of at least 30 days after receiving the notice to consider the decisions of whether or not to elect a distribution (and, if applicable, a particular distribution option), and (2) the Distributee, after receiving the notice, affirmatively elects a distribution. SECTION 10 PAYMENT OF BENEFITS ON TERMINATION OF EMPLOYMENT 10.1 Transfer of a Member from one Plan Sponsor to another Plan Sponsor or to an Affiliate shall not be deemed for any purpose under the Plan to be a termination of employment of the Member. 10.2 In the event of the termination of employment of a Member for reasons other than death or attainment of a Retirement Date, the Member's Accrued Benefit shall be determined as of the Valuation Date coinciding with or immediately preceding the Member's termination of employment, increased by any amounts allocated to the Account of the Member since that Valuation Date, decreased by any distributions made since that Valuation Date from the Mem- ber's Account, decreased by the amount necessary to satisfy, as of the Member's termination of employment, the unpaid principal, accrued interest and penalties on any loan made to the Member from the Plan (which loan shall be deemed to be satisfied as a result of such reduction) and adjusted for a pro rata share of any income, gains, and losses attributable thereto through the Valuation Date coinciding with or immediately preceding the date the Accrued Benefit is paid. 10.3 That portion of a Member's Accrued Benefit in which he is vested shall be: (a) his Employee Deferral Account, Voluntary Contribution Account, and Rollover Account, which shall be fully vested and nonforfeitable at all times; and -26- 29 (b) that portion of the value of his Matching Account and Company Account computed according to the following vesting schedule taking into account any Years of Service subsequent to such Valuation Date until the date of his termination of employment:
Full Years of Percentage Service Vested ------- ------ Less than 2 0% 2 50% 3 100%
10.4 The Member shall be entitled to payment in the form specified in Plan Section 9.2. Payment shall be made as soon as administratively feasible after the Valuation Date coinciding with or immediately following the Member's termination of employment; provided, however, if the Member's vested Accrued Benefit exceeds $3,500 it will not be distributed before the Member's Normal Retirement Age or death without the Member's consent. A Member may, however, elect to have payment of his Accrued Benefit delayed until he attains age 70 1/2. Unless a Member elects to delay commencement of payment of his Accrued Benefit, in no event shall payment be made later than sixty (60) days after the end of the Plan Year in which the Normal Retirement Age of the Member occurs. Payment shall be subject to the minimum distribution requirements set forth in Plan Section 9. Any distribution under this Section shall be subject to the Eligible Rollover Distribution requirements of Section 9.5. 10.5 (a) If any portion of a Member's vested Accrued Benefit derived from Plan Sponsor contributions is paid prior to his Termination Completion Date, a portion of his Accrued Benefit equal to his total non-vested Accrued Benefit derived from Plan Sponsor contributions multiplied by a fraction, the numerator of which is the amount of the distribution attributable to Plan Sponsor contributions and the denominator of which is the total vested Accrued Benefit attributable to Plan Sponsor contributions, shall be immediately forfeited. The amount forfeited shall not exceed the Members non-vested Accrued Benefit. Upon the termination of employment of a Member who is not vested in any part of his Accrued Benefit, the Member shall be deemed to have received a distribution and his Accrued Benefit shall be immediately forfeited. (b) If the Member is reemployed by a Plan Sponsor or an Affiliate prior to his Termination Completion Date and (a) if the Member's Accrued Benefit was partially vested and the Member repays to the Fund no later than the earlier of his Termination Completion Date or the fifth anniversary of the Member's reemployment all of that portion of his vested Accrued Benefit which was paid to him or (b) if the Member's Accrued Benefit was not vested upon his termination of employment, then any portion of his Accrued Benefit which was forfeited shall be restored effective on the Valuation Date coinciding with or next following the repayment or the Member's reemployment, respectively. The restoration on any Valuation Date of the forfeited portion of the Accrued Benefit of a Member pursuant to the preceding sentence shall be made first from forfeitures available for allocation on that Valuation Date, to the extent available, and -27- 30 secondly from additional employer contributions. Only after restorations have been made shall the remaining net income be available for allocation under Plan Section 4. (c) If a Member who is partially vested in his Accrued Benefit does not receive, prior to his Termination Completion Date, a distribution of any portion of his vested Accrued Benefit, then no forfeiture of that Member's non-vested portion of his Accrued Benefit shall occur until that Member's Termination Completion Date. 10.6 In the event that a Plan amendment directly or indirectly changes the vesting schedule, the vesting percentage for each Member in his Accrued Benefit accumulated to the date when the amendment is adopted shall not be reduced as a result of the amendment. In addition, any Member with at least three (3) Years of Service may irrevocably elect to remain under the pre-amendment vesting schedule with respect to all of his benefits accrued both before and after the amendment. SECTION 11 ADMINISTRATION OF THE PLAN 11.1 Trust Agreement. The Primary Sponsor shall establish a Trust with the Trustee designated by the Board of Directors for the management of the Fund, which Trust shall form a part of the Plan and is incorporated herein by reference. 11.2 Operation of the Plan Administrator. The Primary Sponsor shall appoint a Plan Administrator. If an organization is appointed to serve as the Plan Administrator, then the Plan Administrator may designate in writing a person who may act on behalf of the Plan Administrator. The Primary Sponsor shall have the right to remove the Plan Administrator at any time by notice in writing. The Plan Administrator may resign at any time by written notice of resignation to the Trustee and the Primary Sponsor. Upon removal or resignation, or in the event of the dissolution of the Plan Administrator, the Primary Sponsor shall appoint a successor. 11.3 Fiduciary Responsibility. (a) The Plan Administrator, as a Named Fiduciary, may allocate its fiduciary responsibilities among Fiduciaries other than the Trustee, designated in writing by the Plan Administrator and may designate in writing other persons (other than the Trustee) to carry out its fiduciary responsibilities under the Plan. The Plan Administrator may at any time and from time to time remove any such person designated to carry out its fiduciary responsibilities under the Plan by notice in writing to such person. (b) The Plan Administrator and each other Fiduciary may employ persons to perform services and to render advice with regard to any of the Fiduciary's responsibilities under the Plan. Charges for all such services performed and advice rendered may be directly paid by each Plan Sponsor but until paid shall constitute a charge against the Fund. -28- 31 (c) Each Plan Sponsor shall indemnify and hold harmless each person constituting the Plan Administrator or the Investment Committee, if any, from and against any and all claims, losses, costs, expenses (including, without limitation, attorney's fees and court costs), damages, actions or causes of action arising from, on account of or in connection with the performance by such person of his duties in such capacity, other than such of the foregoing arising from, on account of or in connection with the willful neglect or willful misconduct of such person so acting. 11.4 Duties of the Plan Administrator. (a) The Plan Administrator shall advise the Trustee with respect to all payments under the terms of the Plan and shall direct the Trustee in writing to make such payments from the Fund; provided, however, in no event shall the Trustee be required to make such payments if the Trustee has actual knowledge that such payments are contrary to the terms of the Plan and the Trust. (b) The Plan Administrator shall from time to time establish rules, not contrary to the provisions of the Plan and the Trust, for the administration of the Plan and the transaction of its business. All elections and designations under the Plan by a Participant or Beneficiary shall be made on forms prescribed by the Plan Administrator. The Plan Administrator shall have discretionary authority to construe the terms of the Plan and shall determine all questions arising in the administration, interpretation and application of the Plan, including, but not limited to, those concerning eligibility for benefits and it shall not act so as to discriminate in favor of any person. All determinations of the Plan Administrator shall be conclusive and binding on all Employees, Members, Beneficiaries and Fiduciaries, subject to the provisions of the Plan and the Trust and subject to applicable law. (c) The Plan Administrator shall furnish Members and Beneficiaries with all disclosures now or hereafter required by ERISA or the Code. The Plan Administrator shall file, as required, the various reports and disclosures concerning the Plan and its operations as required by ERISA and by the Code, and shall be solely responsible for establishing and maintaining all records of the Plan and the Trust. (d) The statement of specific duties for a Plan Administrator in this Section is not in derogation of any other duties which a Plan Administrator has under the provisions of the Plan or the Trust or under applicable law. 11.5 Investment Manager. The Primary Sponsor may, by action in writing certified by notice to the Trustee, appoint an Investment Manager. Any Investment Manager may be removed in the same manner in which appointed, and in the event of any removal, the Investment Manager shall, as soon as possible, but in no event more than thirty (30) days after notice of removal, turn over all assets managed by it to the Trustee or to any successor Investment Manager appointed, and shall make a full accounting to the Primary Sponsor with respect to all assets managed by it since its appointment as an Investment Manager. -29- 32 11.6 Investment Committee. The Primary Sponsor may, by action in writing certified by notice to the Trustee, appoint an Investment Committee. The Primary Sponsor shall have the right to remove any person on the Investment Committee at any time by notice in writing to such person. A person on the Investment Committee may resign at any time by written notice of resignation to the Primary Sponsor. Upon such removal or resignation, or in the event of the death of a person on the Investment Committee, the Primary Sponsor may appoint a successor. Until a successor has been appointed, the remaining persons on the Investment Committee may continue to act as the Investment Committee. 11.7 Action by the Primary Sponsor or a Plan Sponsor. Any action to be taken by the Primary Sponsor or a Plan Sponsor shall be taken by resolution or written direction duly adopted by its board of directors or appropriate governing body, as the case may be; provided, however, that by such resolution or written direction, the board of directors or appropriate governing body, as the case may be, may delegate to any officer or other appropriate person of a Plan Sponsor the authority to take any such actions as may be specified in such resolution or written direction, other than the power to amend, modify or terminate the Plan or the Trust or to determine the basis of any Plan Sponsor contributions. SECTION 12 CLAIM REVIEW PROCEDURE 12.1 If a Member or Beneficiary is denied a claim for benefits under a Plan, the Plan Administrator shall provide to the claimant written notice of the denial within 90 days after the Plan Administrator receives the claim, unless special circumstances require an extension of time for processing the claim. If such an extension of time for processing is required, written notice of the extension shall be furnished to the claimant prior to the termination of the initial 90-day period. In no event shall the extension exceed a period of 90 days from the end of such initial period. The extension notice shall indicate the special circumstances requiring an extension of time and the date by which the Plan Administrator expects to render the final decision. 12.2 If the claimant is denied a claim for benefits, the Plan Administrator shall provide, within the time frame set forth in Plan Section 12.1, written notice of the denial which shall set forth: (a) the specific reasons for the denial; (b) specific references to the pertinent provisions of the Plan on which the denial is based; (c) a description of any additional material or information necessary for the claimant to perfect the claim and an explanation of why the material or information is necessary; and (d) an explanation of the Plan's claim review procedure. -30- 33 12.3 After receiving written notice of the denial of a claim, a claimant or his representative may: (a) request a full and fair review of the denial by written application to the Plan Administrator; (b) review pertinent documents; and (c) submit issues and comments in writing to the Plan Administrator. 12.4 If the claimant wishes a review of the decision denying his claim to benefits under the Plan, he must submit the written application to the Plan Administrator within sixty (60) days after receiving written notice of the denial. 12.5 Upon receiving the written application for review, the Plan Administrator may schedule a hearing for purposes of reviewing the claimant's claim, which hearing shall take place not more than thirty (30) days from the date on which the Plan Administrator received the written application for review. 12.6 At least ten (10) days prior to the scheduled hearing, the claimant and his representative designated in writing by him, if any, shall receive written notice of the date, time, and place of the scheduled hearing. The claimant or his representative may request that the hearing be rescheduled for his convenience on another reasonable date or at another reasonable time or place. 12.7 All claimants requesting a review of the decision denying their claim for benefits may employ counsel for purposes of the hearing. 12.8 No later than sixty (60) days following the receipt of the written application for review, the Plan Administrator shall submit its decision on the review in writing to the claimant involved and to his representative, if any; provided, however, a decision on the written application for review may be extended, in the event special circumstances such as the need to hold a hearing require an extension of time, to a day no later than one hundred twenty (120) days after the date of receipt of the written application for review. The decision shall include specific reasons for the decision and specific references to the pertinent provisions of the Plan on which the decision is based. SECTION 13 LIMITATION OF ASSIGNMENT, PAYMENTS TO LEGALLY INCOMPETENT DISTRIBUTEE AND UNCLAIMED PAYMENTS 13.1 No benefit which shall be payable under the Plan to any person shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or charge, and any attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge the same shall be void; and no such benefit shall in any manner be liable for, or subject to, the debts, contracts, liabilities, engagements or torts of any person, nor shall it be subject to -31- 34 attachment or legal process for, or against, such person, and the same shall not be recognized under the Plan, except to such extent as may be required by law. Notwithstanding the above, this Section shall not apply to a "qualified domestic relations order" (as defined in Code Section 414(p)), and benefits may be paid pursuant to the provisions of such an order. The Plan Administrator shall develop procedures (in accordance with applicable federal regulations) to determine whether a domestic relations order is qualified, and, if so, the method and the procedures for complying therewith. 13.2 If any person who shall be entitled to any benefit under the Plan shall become bankrupt or shall attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge such benefit under the Plan, then the payment of any such benefit in the event a Member or Beneficiary is entitled to payment shall, in the discretion of the Plan Administrator, cease and terminate and in that event the Trustee shall hold or apply the same for the benefit of such person, his spouse, children, other dependents or any of them in such manner and in such proportion as the Plan Administrator shall determine. 13.3 Whenever any benefit which shall be payable under the Plan is to be paid to or for the benefit of any person who is then a minor or determined to be incompetent by qualified medical advice, the Plan Administrator need not require the appointment of a guardian or custodian, but shall be authorized to cause the same to be paid over to the person having custody of such minor or incompetent, or to cause the same to be paid to such minor or incompetent without the intervention of a guardian or custodian, or to cause the same to be paid to a legal guardian or custodian of such minor or incompetent if one has been appointed or to cause the same to be used for the benefit of such minor or incompetent. 13.4 If the Plan Administrator cannot ascertain the whereabouts of any Member to whom a payment is due under the Plan, the Plan administrator may direct that the payment and all remaining payments otherwise due to the Member be cancelled on the records of the Plan and the amount thereof applied as a forfeiture in accordance with Plan Section 3.6, except that, in the event the Member later notifies the Plan Administrator of his whereabouts and requests the payments due to him under the Plan, the Plan Sponsor shall contribute to the Plan an amount equal to the payment to be paid to him as soon as administratively feasible. SECTION 14 PROHIBITION AGAINST DIVERSION At no time shall any part of the Fund be used for or diverted to purposes other than the exclusive benefit of the Members or their Beneficiaries, subject, however, to the payment of all taxes and administrative expenses and subject to the provisions of the Plan with respect to returns of contributions. -32- 35 SECTION 15 LIMITATION OF RIGHTS Membership in the Plan shall not give any Employee any right or claim except to the extent that such right is specifically fixed under the terms of the Plan. The adoption of the Plan and the Trust by any Plan Sponsor shall not be construed to give any Employee a right to be continued in the employ of a Plan Sponsor or as interfering with the right of a Plan Sponsor to terminate the employment of any Employee at any time. SECTION 16 AMENDMENT TO OR TERMINATION OF THE PLAN AND THE TRUST 16.1 The Primary Sponsor reserves the right at any time to modify or amend or terminate the Plan or the Trust in whole or in part by notice thereof in writing delivered to the Trustee; provided, however, that the Primary Sponsor shall have no power to modify or amend the Plan in such manner as would cause or permit any portion of the funds held under a Plan to be used for, or diverted to, purposes other than for the exclusive benefit of Members or their Beneficiaries, or as would cause or permit any portion of a fund held under the Plan to become the property of a Plan Sponsor; and provided further, that the duties or liabilities of the Trustee shall not be increased without its written consent; and provided further, that the Plan Administrator may amend the Loan Procedures from time to time without the need for further consent of the Primary Sponsor. No such modifications or amendments shall have the effect of retroactively changing or depriving Members or Beneficiaries of rights already accrued under the Plan. No Plan Sponsor other than the Primary Sponsor shall have the right to so modify, amend or terminate the Plan or the Trust. Notwithstanding the foregoing, each Plan Sponsor may terminate its own participation in the Plan and Trust pursuant to the Plan. 16.2 Each Plan Sponsor other than the Primary Sponsor shall have the right to terminate its participation in the Plan and Trust by resolution of its board of directors or other appropriate governing body and notice in writing to the Primary Sponsor and the Trustee unless such termination would result in the disqualification of the Plan or the Trust or would adversely affect the exempt status of the Plan or the Trust as to any other Plan Sponsor. If contributions by or on behalf of a Plan Sponsor are completely terminated, the Plan and Trust shall be deemed terminated as to such Plan Sponsor. Any termination by a Plan Sponsor, shall not be a termination as to any other Plan Sponsor. 16.3 (a) If the Plan is terminated by the Primary Sponsor or if contributions to the Trust should be permanently discontinued, it shall terminate as to all Plan Sponsors and the Fund shall be used, subject to the payment of expenses and taxes, for the benefit of Members and Beneficiaries, and for no other purposes, and the Account of each affected Member shall be fully vested and nonforfeitable, notwithstanding the provisions of the Section of the Plan which sets forth the vesting schedule. -33- 36 (b) In the event of the partial termination of the Plan, each affected Member's Account shall be fully vested and nonforfeitable, notwithstanding the provisions of the Section of the Plan which sets forth the vesting schedule. 16.4 In the event of the termination of the Plan or the Trust with respect to a Plan Sponsor, the Accounts of the Members with respect to the Plan as adopted by such Plan Sponsor shall be held subject to the instructions of the Plan Administrator; provided that the Trustee shall not be required to make any distribution until it receives a copy of an Internal Revenue Service determination letter to the effect that the termination does not affect the qualified status of the Plan or the exempt status of the Trust or, in the event that such letter is applied for and is not issued, until the Trustee is reasonably satisfied that adequate provision has been made for the payment of all taxes which may be due and owing by the Trust. 16.5 In the case of any merger or consolidation of the Plan with, or any transfer of the assets or liabilities of the Plan to, any other plan qualified under Code Section 401, the terms of the merger, consolidation or transfer shall be such that each Member would receive (in the event of termination of the Plan or its successor immediately thereafter) a benefit which is no less than the benefit which the Member would have received in the event of termination of the Plan immediately before the merger, consolidation or transfer. 16.6 Notwithstanding any other provision of the Plan, an amendment to the Plan -- (a) which eliminates or reduces an early retirement benefit, if any, or which eliminates or reduces a retirement-type subsidy (as defined in regulations issued by the Department of the Treasury), if any, or (b) which eliminates an optional form of benefit shall not be effective with respect to benefits attributable to service before the amendment is adopted. In the case of a retirement-type subsidy described in Subsection (a) above, this Section shall be applicable only to a Member who satisfies, either before or after the amendment, the pre-amendment conditions for the subsidy. SECTION 17 ADOPTION OF PLAN BY AFFILIATES Any corporation or other business entity related to the Primary Sponsor by function or operation and any Affiliate, if the corporation, business entity or Affiliate is authorized to do so by written direction adopted by the Board of Directors, may adopt the Plan and the related Trust by action of the board of directors or other appropriate governing body of such corporation, business entity or Affiliate. Any adoption shall be evidenced by certified copies of the resolutions of the foregoing board of directors or governing body indicating the adoption and by the execution of the Trust by the adopting corporation, or business entity or Affiliate. The resolution shall state and define the effective date of the adoption of the Plan by the Plan Sponsor and, for the purpose of Code Section 415, the "limitation year" as to such Plan Sponsor. Notwithstanding the foregoing, however, if the Plan and Trust as adopted by an Affiliate -34- 37 or other corporation or business entity under the foregoing provisions shall fail to receive the initial approval of the Internal Revenue Service as a qualified Plan and Trust under Code Sections 401(a) and 501(a), any contributions by the Affiliate or other corporation or business entity after payment of all expenses will be returned to such Plan Sponsor free of any trust, and the Plan and Trust shall terminate, as to the adopting Affiliate or other corporation or business entity. SECTION 18 QUALIFICATION AND RETURN OF CONTRIBUTIONS 18.1 If the Plan and the related Trust fail to receive the initial approval of the Internal Revenue Service as a qualified plan and trust within one (1) year after the date of denial of qualification (a) the contribution of a Plan Sponsor after payment of all expenses will be returned to a Plan Sponsor free of the Plan and Trust, (b) contributions made by a Member shall be returned to the Member who made the contributions, and (c) the Plan and Trust shall thereupon terminate. 18.2 If and to the extent permitted by the Code and other applicable laws and regulations thereunder, upon a Plan Sponsor's request, a contribution which was made by reason of a mistake of fact or upon the deductibility of the contribution under Code Section 404, shall be returned to a Plan Sponsor within one (1) year after the payment of the contribution, or the disallowance of the deduction (to the extent disallowed), whichever is applicable. In the event of a contribution which was made by reason of a mistake of fact or which was conditioned upon the deductibility of the contribution, the amount to be returned to the Plan Sponsor shall be the excess of the contribution above the amount that would have been contributed had the mistake of fact or the mistake in determining the deduction not occurred, less any net loss attributable to the excess. Any net income attributable to the excess shall not be returned to the Plan Sponsor. No return of any portion of the excess shall be made to the Plan Sponsor if the return would cause the balance in a Member's Account to be less than the balance would have been had the mistaken contribution not been made. SECTION 19 INCORPORATION OF SPECIAL LIMITATIONS Appendices A, B, C, and D to the Plan, attached hereto, are incorporated by reference and the provisions of the same shall apply notwithstanding anything to the contrary contained herein. -35- 38 IN WITNESS WHEREOF, the Primary Sponsor has caused this indenture to be executed as of the date first above written. MEDAPHIS CORPORATION By: /s/ Michael R. Cote -------------------- Title: ----------------- ATTEST: /s/ Peggy Sherman - -------------------------- Title: -------------------- [CORPORATE SEAL] -36- 39 APPENDIX A SPECIAL NONDISCRIMINATION RULES SECTION 1 As used in this Appendix, the following words shall have the following meanings: (a) "Eligible Member" means a Member who is an Employee during any particular Plan Year. (b) "Highly Compensated Eligible Member" means any Eligible Member who is a Highly Compensated Employee. (c) "Matching Contribution" means any contribution made by a Plan Sponsor to a Matching Account and any other contribution made to a plan by a Plan Sponsor or an Affiliate on behalf of an Employee on account of a contribution made by an Employee or on account of an Elective Deferral. (d) "Qualified Matching Contributions" means Matching Contributions which are immediately nonforfeitable when made, and which would be nonforfeitable, regardless of the age or service of the Employee or whether the Employee is employed on a certain date, and which may not be distributed, except upon one of the events described under Section 401(k)(2)(B) of the Code and the regulations thereunder. (e) "Qualified Nonelective Contributions" means contributions of the Plan Sponsor or an Affiliate, other than Matching Contributions or Elective Deferrals, which are nonforfeitable when made, and which would be nonforfeitable regardless of the age or service of the Employee or whether the Employee is employed on a certain date, and which may not be distributed, except upon one of the events described under Code Section 401(k)(2)(B) and the regulations thereunder. SECTION 2 In addition to any other limitations set forth in the Plan, for each Plan Year one of the following tests must be satisfied: (a) the actual deferral percentage for the Highly Compensated Eligible Members must not be more than the actual deferral percentage of all other Eligible Members multiplied by 1.25; or (b) the excess of the actual deferral percentage for the Highly Compensated Eligible Members over that of all other Eligible Members must not be more than two (2) percentage points, and the actual deferral percentage for the Highly Compensated Eligible A-1 40 Members must not be more than the actual deferral percentage of all other Eligible Members multiplied by two (2). The "actual deferral percentage" for the Highly Compensated Eligible Members and all other Eligible Members for a Plan Year is the average in each group of the ratios, calculated separately for each Employee, of the Deferral Amounts contributed by the Plan Sponsor on behalf of an Employee for the Plan Year to the Annual Compensation of the Employee in the Plan Year. In addition, for purposes of calculating the "actual deferral percentage" as described above, Deferral Amounts of Employees who are not Highly Compensated Employees which are prohibited by Code Section 401(a)(30) shall not be taken into consideration. Except to the extent limited by Treasury Regulation section 1.401(k)-1(b)(5) and any other applicable regulations promulgated by the Secretary of the Treasury, all or part of the Qualified Matching Contributions and Qualified Nonelective Contributions made pursuant to the Plan may be treated as Deferral Amounts for purposes of determining the "actual deferral percentage." SECTION 3 If the Deferral Amounts contributed on behalf of any Highly Compensated Eligible Member exceeds the amount permitted under the "actual deferral percentage" test described in Section 2 of this Appendix A for any given Plan Year, then before the end of the Plan Year following the Plan Year for which the Excess Deferral Amount was contributed, (a) the amount of the Excess Deferral Amount for the Plan Year, as adjusted to reflect income, gain, or loss attributable to it through the date the Excess Deferral Amount is distributed to the Member and reduced by any excess Elective Deferrals as determined pursuant to Plan Section 3.1 previously distributed to the Member for the Member's taxable year ending with or within the Plan Year, may be distributed to the Highly Compensated Eligible Member. The income allocable to such Excess Deferral Amount shall be determined in a similar manner as described in Section 4.2 of the Plan. The Excess Deferral Amount to be distributed shall be reduced by Deferral Amounts previously distributed for the taxable year ending in the same Plan Year, and shall also be reduced by Deferral Amounts previously distributed for the Plan Year beginning in such taxable year. For all other purposes under the Plan other than this Appendix A recharacterized amounts shall continue to be treated as Deferral Amounts. In the event the multiple use of limitations contained in Sections 2(b) and 5(b) of this Appendix, pursuant to Treasury Regulations section 1.401(m)-2 as promulgated by the Secretary of the Treasury, requires a corrective distribution, such distribution shall be made pursuant to this Section 3, and not Section 6 of Appendix A. For purposes of this Section 3, "Excess Deferral Amount" means, with respect to a Plan Year, the excess of: (a) the aggregate amount of Deferral Amounts contributed by a Plan Sponsor on behalf of Highly Compensated Eligible Members for the Plan Year, over (b) the maximum amount of Deferral Amounts permitted under Section 2 of this Appendix A for the Plan Year, which shall be determined by reducing the Deferral A-2 41 Amounts contributed on behalf of Highly Compensated Eligible Members in order of the actual deferral percentages beginning with the highest of such percentages. Distribution of the Excess Deferral Amounts for any Plan Year shall be made to the Highly Compensated Eligible Members on the basis of the respective portions of the Excess Deferral Amount attributable to each Highly Compensated Eligible Member. As to any Highly Compensated Employee who is subject to the family aggregation rules of subsection (b) of the Plan Section containing the definition of the term "Highly Compensated Employee," any distribution of such Highly Compensated Employee's allocable portion of the Excess Deferral Amount for a Plan Year shall be allocated among the family members of such Highly Compensated Employee who are combined to determine the actual deferral percentage in proportion to the Deferral Amounts taken into account under this Section 3. SECTION 4 The Plan Administrator shall have the responsibility of monitoring the Plan's compliance with the limitations of this Appendix A and shall have the power to take all steps it deems necessary or appropriate to ensure compliance, including, without limitation, restricting the amount which Highly Compensated Eligible Members can elect to have contributed pursuant to Plan Section 3.1. Any actions taken by the Plan Administrator pursuant to this Section 4 shall be pursuant to non-discriminatory procedures consistently applied. SECTION 5 In addition to any other limitations set forth in the Plan, Matching Contributions under the Plan and the amount of nondeductible employee contributions under the Plan, for each Plan Year must satisfy one of the following tests: (a) The contribution percentage for Highly Compensated Eligible Members must not exceed 125% of the contribution percentage for all other Eligible Members; or (b) The contribution percentage for Highly Compensated Eligible Members must not exceed the lesser of (1) 200% of the contribution percentage for all other Eligible Members, and (2) the contribution percentage for all other Eligible Members plus two (2) percentage points. Notwithstanding the foregoing, for purposes of this Section 5, the terms Highly Compensated Eligible Member and Eligible Member shall not include any Member who is not eligible to receive a Matching Contribution under the provisions of the Plan, other than as a result of the Member failing to contribute to the Plan or failing to have an Elective Deferral contributed to the Plan on the Member's behalf. Notwithstanding the foregoing, if Qualified Matching Contributions are taken into account for purposes of applying the test contained in Section 2 of this Appendix A, they shall not be taken into account under this Section 5. In applying the above tests, the Plan Administrator shall comply with any regulations promulgated by the Secretary of the Treasury which prevent or restrict the use of the test contained in Section 2(b) A-3 42 of this Appendix A and the test contained in Section 5(b) of this Appendix A. The "contribution percentage" for Highly Compensated Eligible Members and for all other Eligible Members for a Plan Year shall be the average of the ratios, calculated separately for each Member, of (A) to (B), where (A) is the amount of Matching Contributions under the Plan (excluding Qualified Matching Contributions which are used to apply the test set forth in Section 2 of this Appendix A or Matching Contributions which are used to satisfy the minimum required contributions to the Accounts of Eligible Members who are not Key Employees pursuant to Section 1 of Appendix C to the Plan) and nondeductible employee contributions made under the Plan for the Eligible Member for the Plan Year, and where (B) is the Annual Compensation of the Eligible Member for the Plan Year. Except to the extent limited by Treasury Regulation Section 1.401(m)-1(b)(5) and any other applicable regulations promulgated by the Secretary of the Treasury, a Plan Sponsor may elect to treat Deferral Amounts and Qualified Nonelective Contributions as Matching Contributions for purpose of determining the "contribution percentage," provided the Deferral Amounts, excluding those treated as Matching Contributions, satisfy the test set forth in Section 2 of Appendix A. SECTION 6 If the Matching Contributions and nondeductible employee contributions and, if taken into account under Section 5 of this Appendix A, the Deferral Amounts made by or on behalf of Highly Compensated Eligible Members exceed the amount permitted under the "contribution percentage test" for any given Plan Year, then, before the close of the Plan Year following the Plan Year for which the excess aggregate contributions were made, the amount of the excess aggregate contributions attributable to the Plan for the Plan Year, as adjusted to reflect any income, gain or loss attributable to such contributions through the date the excess aggregate contributions are distributed or forfeited, shall be distributed or, if the excess aggregate contributions are forfeitable, forfeited. The income allocable to such contributions shall be determined in a similar manner as described in Section 4.2 of the Plan. As to any Highly Compensated Employee, any distribution or forfeiture of his allocable portion of the excess aggregate contributions for a Plan Year shall first be attributed to any nondeductible employee contributions made by the Member during the Plan Year for which no corresponding Plan Sponsor contribution is made and then to any remaining nondeductible employee contributions made by the Member during the Plan Year and any Matching Contributions thereon. As between the Plan and any other plan or plans maintained by the Plan Sponsor in which excess aggregate contributions for a Plan Year are held, each such plan shall distribute or forfeit a pro-rata share of each class of contribution based on the respective amounts of a class of contribution made to each plan during the Plan Year. The payment of the excess aggregate contributions shall be made without regard to any other provision in the Plan. In the event the multiple use of limitations contained in Sections 2(b) and 5(b) of this Appendix, pursuant to Treasury Regulation section 1.401(m)-2 as promulgated by the Secretary of the Treasury, requires a corrective distribution, such distribution shall be made pursuant to Section 3 of Appendix A, and not this Section 6. For purposes of this Section 6, with respect to any Plan Year, "excess aggregate contributions" means the excess of: A-4 43 (a) the aggregate amount of the Matching Contributions and nondeductible employee contributions and, if taken into account under Section 5 of this Appendix A, the Deferral Amounts actually made on behalf of Highly Compensated Eligible Members for the Plan Year, over (b) the maximum amount of the contributions permitted under the limitations of Section 5 of this Appendix A, determined by reducing contributions made on behalf of Highly Compensated Eligible Members in order of their contribution percentages beginning with the highest of such percentages. Distribution or forfeiture of nondeductible employee contributions or Matching Contributions in the amount of the excess aggregate contributions for any Plan Year shall be made with respect to Highly Compensated Employees on the basis of the respective portions of the excess aggregate contributions attributable to each Highly Compensated Employee. Forfeitures of excess aggregate contributions may not be allocated to Members whose contributions are reduced under this Section 6. As to any Highly Compensated Employee who is subject to the family aggregation rules of subsection (b) of the Plan Section containing the definition of the term "Highly Compensated Employee," any distribution or forfeiture of such Highly Compensated Employee's allocable portion of the excess aggregate contributions for a Plan Year shall be allocated among the family members of such Highly Compensated Employee which are combined to determine the contribution percentage in proportion to the contributions taken into account under this Section 6. The determination of the amount of excess aggregate contributions under this Section 6 shall be made after (1) first determining the excess Elective Deferrals under Section 3.1(b) of the Plan, and (2) then determining the Excess Deferral Amounts under Section 3 of this Appendix A. SECTION 7 Except to the extent limited by rules promulgated by the Secretary of the Treasury, if a Highly Compensated Eligible Member is a participant in any other plan of the Plan Sponsor or any Affiliate which includes Matching Contributions, deferrals under a cash or deferred arrangement pursuant to Code Section 401(k), or nondeductible employee contributions, any contributions made by or on behalf of the Member to the other plan shall be allocated with the same class of contributions under the Plan for purposes of determining the "actual deferral percentage" and "contribution percentage" under the Plan; provided, however, contributions that are made under an "employee stock ownership plan" (within the meaning of Code Section 4975(e)(7)) shall not be combined with contributions under any plan which is not an employee stock ownership plan (within the meaning of Code Section 4975(e)(7)). Except to the extent limited by rules promulgated by the Secretary of the Treasury, if the Plan and any other plans which include Matching Contributions, deferrals under a cash or deferred arrangement pursuant to Code Section 401(k), or nondeductible employee contributions are considered as one plan for purposes of Code Section 401(a)(4) and 410(b)(1), any contributions under the other plans shall be allocated with the same class of contributions under the Plan for A-5 44 purposes of determining the "contribution percentage" and "actual deferral percentage" under the Plan; provided, however, contributions that are made under an "employee stock ownership plan" (within the meaning of Code Section 4975(e)(7)) shall not be combined with contributions under any plan which is not an employee stock ownership plan (within the meaning of Code Section 4975(e)(7)). A-6 45 APPENDIX B LIMITATION ON ALLOCATIONS SECTION 1 The "annual addition" for any Member for any one limitation year may not exceed the lesser of: (a) $30,000 (or, if greater, one-quarter of the dollar limitation in effect under Code Section 415(b)(1)(A)), adjusted for changes in the cost of living as provided in regulations issued by the Secretary of the Treasury); or (b) 25% of the Member's Annual Compensation. SECTION 2 For the purposes of this Appendix B, the term "annual addition" for any Member means for any limitation year, the sum of certain Plan Sponsor and Member contributions, forfeitures, and other amounts as determined in Code Section 415(c)(2) in effect for that limitation year. SECTION 3 In the event that a Plan Sponsor maintains a defined benefit plan under which a Member also participates, the sum of the defined benefit plan fraction and the defined contribution plan fraction for any limitation year for any Member may not exceed 1.0. (a) The defined benefit plan fraction for any limitation year is a fraction: (1) the numerator of which is the projected annual benefit of the Member under the defined benefit plan (determined as of the close of such year); and (2) the denominator of which is the lesser of (A) the product of 1.25, multiplied by the maximum annual benefit allowable under Code Section 415(b)(1)(A), or (B) the product of (i) 1.4, multiplied by (ii) the maximum amount which may be taken into account under Section 415(b)(1)(B) of the Code with respect to the Member under the defined benefit plan for the limitation year (determined as of the close of the limitation year). B-1 46 (b) The defined contribution plan fraction for any limitation year is a fraction: (1) the numerator of which is the sum of a Member's annual additions as of the close of the year; and (2) the denominator of which is the sum of the lesser of the following amounts determined for the year and for all prior limitation years during which the Member was employed by a Plan Sponsor: (A) the product of 1.25, multiplied by the dollar limitation in effect under Code Section 415(c)(1)(A) for the limitation year (determined without regard to Section 415(c)(6) of the Code); or (B) the product of (i) 1.4, multiplied by (ii) the amount which may be taken into account under Code Section 415(c)(1)(B) (or Code Section 415(c)(7), if applicable) with respect to the Member for the limitation year. SECTION 4 For purposes of this Appendix B, the term "limitation year" shall mean a Plan Year unless a Plan Sponsor elects, by adoption of a written resolution, to use any other twelve-month period adopted in accordance with regulations issued by the Secretary of the Treasury. For purposes of applying the limitations set forth in this Appendix B, the term "Plan Sponsor" shall mean a Plan Sponsor and any other corporations which are members of the same controlled group of corporations (as described in Section 414(b) of the Code, as modified by Code Section 415(h)) as is a Plan Sponsor, any other trades or businesses (whether or not incorporated) under common control (as described in Code Section 414(c), as modified by Code Section 415(h)) with a Plan Sponsor, any other corporations, partnerships, or other organizations which are members of an affiliated service group (as described in Section 414(m) of the Code) with a Plan Sponsor, and any other entity required to be aggregated with a Plan Sponsor pursuant to regulations under Code Section 414(o). SECTION 5 For purposes of applying the limitations of this Appendix B, all defined contribution plans maintained or deemed to be maintained by a Plan Sponsor shall be treated as one defined contribution plan, and all defined benefit plans now or previously maintained or deemed to be maintained by a Plan Sponsor shall be treated as one defined benefit plan. In the event any of the actions to be taken pursuant to Section 6 of this Appendix or pursuant to any language of similar import in another defined contribution plan are required to be taken as a result of the annual additions of a Member exceeding the limitations set forth in Section 1 of this Appendix B-2 47 because of the Member's participation in more than one defined contribution plan, the actions shall be taken first with regard to this Plan. SECTION 6 In the event that as a result of either the allocation of forfeitures to the Account of a Member or a reasonable error in estimating the Member's Annual Compensation, the annual addition allocated to the Account of a Member exceeds the limitations set forth in Section 1 of this Appendix B or in the event that the aggregate contributions made on behalf of a Member under both a defined benefit plan and a defined contribution plan, subject to the reduction of allocations in other defined contribution plans required by Section 5 of this Appendix B, cause the aggregate limitation fraction set forth in Section 3 of this Appendix B to be exceeded, the Plan Administrator shall, in writing, direct the Trustee to take such of the following actions as the Plan Administrator shall deem appropriate, specifying in each case the amount or amounts of contributions involved: (a) A Member's annual addition shall be reduced by distributing to the Member Voluntary Contributions made by the Member which cause the annual addition to exceed such limitations; (b) If further reduction is necessary, contributions made by the Plan Sponsor on behalf of the Member pursuant to Plan Section 3.1 with respect to which no contribution is made under Plan Section 3.2 shall be reduced in the amount of the remaining excess and distributed to the Member; (c) If further reduction is necessary, contributions made by the Plan Sponsor on behalf of the Member pursuant to Plan Section 3.1 and contributions of the Plan Sponsor thereon pursuant to Plan Section 3.2 shall be reduced in the amount of the remaining excess. The amount of the reduction under Plan Section 3.1 shall be distributed to the Member. The amount of the reduction under Plan Section 3.2 shall be reallocated to the Matching Accounts of Members who are not affected by the limitation in the same proportion as the contribution of the Plan Sponsor for the year is allocated under Plan Section 4.1 to the Accounts of such Members; (d) If further reduction is necessary, contributions made by the Plan Sponsor on behalf of the Member pursuant to Plan Section 3.3 shall be reduced in the amount of the remaining excess. The amount of the reduction shall be reallocated to the Accounts of Members who are not affected by the limitations in the same proportion as the contribution of the Plan Sponsor for the year is allocated under Plan Section 4.1 to the Accounts of such Members; and (e) If further reduction is necessary, contributions made by the Plan Sponsor on behalf of the Member pursuant to Plan Section 3.4 shall be reduced in the amount of the remaining excess. The amount of the reduction shall be reallocated to the Accounts of Members who are not affected by the limitations in the same proportion as the B-3 48 contribution of the Plan Sponsor for the year is allocated under Plan Section 4.1 to the Accounts of such Members; and (f) If further reduction is necessary, forfeitures allocated to the Member's Account shall be reduced by the amount of the remaining excess. The amount of the reduction shall be reallocated to the Company Accounts of Members who are not affected by the limitations in the same proportions as the contributions of the Plan Sponsor for the year are allocated to the Company Accounts of such Members; (g) If the contribution of the Plan Sponsor and forfeitures would cause the annual addition to exceed the limitations set forth herein with respect to all Members under the Plan, the portion of such contribution in excess of the limitations shall be segregated in a suspense account. While the suspense account is maintained, (1) no Plan Sponsor contributions under the Plan shall be made which would be precluded by this Appendix B, (2) income, gains and loses of the Fund shall not be allocated to such suspense account and (3) amounts in the suspense account shall be allocated in the same manner as Plan Sponsor contributions and forfeitures under the Plan as of each Valuation Date on which Plan Sponsor contributions may be allocated until the suspense account is exhausted. In the event of the termination of the Plan, the amounts in the suspense account shall be returned to the Plan Sponsor to the extent that such amounts may not then be allocated to the Members' Accounts. B-4 49 APPENDIX C TOP-HEAVY PROVISIONS SECTION 1 As used in this Appendix, the following words shall have the following meanings: (a) "Determination Date" means, with respect to any Plan Year, the last day of the preceding Plan Year, or, in the case of the first Plan Year, means the last day of the first Plan Year. (b) "Key Employee" means an Employee or former Employee (including a Beneficiary of a Key Employee or former Key Employee) who at any time during the Plan Year containing the Determination Date or any of the four (4) preceding Plan Years is: (1) An officer described in the Subsection of the Plan Section containing the definition of the term "Highly Compensated Employee"; (2) One of the ten (10) Employees owning both (A) more than one-half percent (1/2%) of the outstanding stock of the Plan Sponsor or an Affiliate, more than one-half percent (1/2%) of the total combined voting power of all stock of the Plan Sponsor or an Affiliate, or more than one-half percent (1/2%) of the capital or profits interest in the Plan Sponsor or an Affiliate, and (B) the largest percentage ownership interests in the Plan Sponsor or any of its Affiliates, and whose Annual Compensation is equal to or greater than the amount in effect under Section 1(a) of Appendix B to the Plan for the calendar year in which the Determination Date falls; or (3) An owner of more than five percent (5%) of the outstanding stock of the Plan Sponsor or an Affiliate or more than five percent (5%) of the total combined voting power of all stock of the Plan Sponsor or an Affiliate; or (4) An owner of more than one percent (1%) of the outstanding stock of the Plan Sponsor or an Affiliate or more than one percent (1%) of the total combined voting power of all stock of the Plan Sponsor or an Affiliate, and who in such Plan Year had Annual Compensation from the Plan Sponsor and all of its Affiliates of more than $150,000. Employees other than Key Employees are sometimes referred to in this Appendix as "non-key employees." C-1 50 (c) "Required Aggregation Group" means: (1) each plan of the Plan Sponsor and its Affiliates which qualifies under Code Section 401(a) in which a Key Employee is a participant, and (2) each other plan of the Plan Sponsor and its Affiliates which qualifies under Code Section 401 (a) and which enables any plan described in Subsection (a) of this Section to meet the requirements of Section 401(a)(4) or 410 of the Code. (d) (1) "Top-Heavy" means: (A) if the Plan is not included in a Required Aggregation Group, the Plan's condition in a Plan Year for which, as of the Determination Date: (i) the present value of the cumulative Accrued Benefits under the Plan for all Key Employees exceeds 60 percent of the present value of the cumulative Accrued Benefits under the Plan for all Members; and (ii) the Plan, when included in every potential combination, if any, with any or all of: (I) any Required Aggregation Group, and (II) any plan of the Plan Sponsor which is not part of any Required Aggregation Group and which qualifies under Code Section 401 (a) is part of a Top-Heavy Group (as defined in Paragraph (2) of this Subsection); and (B) if the Plan is included in a Required Aggregation Group, the Plan's condition in a Plan Year for which, as of the Determination Date: (i) the Required Aggregation Group is a Top-Heavy Group (as defined in Paragraph (2) of this Subsection); and (ii) the Required Aggregation Group, when included in every potential combination, if any, with any or all of the plans of the Plan Sponsor and its Affiliates which are not part of the C-2 51 Required Aggregation Group and which qualify under Code Section 401(a), is part of a Top-Heavy Group (as defined in Paragraph (2) of this Subsection). (C) For purposes of Subparagraphs (A)(ii) and (B)(ii) of this Paragraph (1), any combination of plans must satisfy the requirements of Sections 401(a)(4) and 410 of the Code. (2) A group shall be deemed to be a Top-Heavy Group if: (A) the sum, as of the Determination Date, of the present value of the cumulative accrued benefits for all Key Employees under all plans included in such group exceeds (B) 60 percent of a similar sum determined for all participants in such plans. (3) (A) For purposes of this Section, the present value of the accrued benefit for any participant in a defined contribution plan as of any Determination Date or last day of a plan year shall be the sum of: (i) as to any defined contribution plan other than a simplified employee pension, the account balance as of the most recent valuation date occurring within the plan year ending on the Determination Date or last day of a plan year, and (ii) as to any simplified employee pension, the aggregate employer contributions, and (iii) an adjustment for contributions due as of the Determination Date or last day of a plan year. In the case of a plan that is not subject to the minimum funding requirements of Code Section 412, the adjustment in Clause (iii) of this Subparagraph (A) shall be the amount of any contributions actually made after the valuation date but on or before the Determination Date or last day of the plan year to the extent not included under Clause (i) or (ii) of this Subparagraph (A); provided, however, that in the first plan year of the plan, the adjustment in Clause (iii) of this Subparagraph (A) shall also reflect the amount of any contributions made thereafter that are allocated as of a date in such first plan year. In the case of a plan that is subject to the minimum funding requirements, the account balance in Clause (i) and the aggregate contributions in Clause (ii) of this Subparagraph (A) C-3 52 shall include contributions that would be allocated as of a date not later than the Determination Date or last day of a plan year, even though those amounts are not yet required to be contributed, and the adjustment in Clause (iii) of this Subparagraph (A) shall be the amount of any contribution actually made (or due to be made) after the valuation date but before the expiration of the extended payment period in Code Section 412(c)(10) to the extent not included under Clause (i) or (ii) of this Subparagraph (A). (B) For purposes of this Subsection, the present value of the accrued benefit for any participant in a defined benefit plan as of any Determination Date or last day of a plan year must be determined as of the most recent valuation date which is within a 12-month period ending on the Determination Date or last day of a plan year as if such participant terminated as of such valuation date; provided, however, that in the first plan year of a plan, the present value of the accrued benefit for a current participant must be determined either (i) as if the participant terminated service as of the Determination Date or last day of a plan year or (ii) as if the participant terminated service as of such valuation date, but taking into account the estimated accrued benefit as of the Determination Date or last day of a plan year. For purposes of this Subparagraph (B), the valuation date must be the same valuation date used for computing plan costs for minimum funding, regardless of whether a valuation is performed that year. The actuarial assumptions utilized in calculating the present value of the accrued benefit for any participant in a defined benefit plan for purposes of this Subparagraph (B) shall be established by the Plan Administrator after consultation with the actuary for the plan, and shall be reasonable in the aggregate and shall comport with the requirements set forth by the Internal Revenue Service in Q&A T-26 and T-27 of Regulation Section 1.416-1. (C) For purposes of determining the present value of the cumulative accrued benefit under a plan for any participant in accordance with this Subsection, the present value shall be increased by the aggregate distributions made with respect to the participant (including distributions paid on account of death to the extent they do not exceed the present value of the cumulative accrued benefit existing immediately prior to death) under each plan being considered, and under any terminated plan which if it had not been terminated would have been in a Required Aggregation Group with the Plan, during the 5-year period ending on the Determination Date or last day of the plan year that falls within the calendar year in which the Determination Date falls. C-4 53 (D) For purposes of this Paragraph (3), participant contributions which are deductible as "qualified retirement contributions" within the meaning of Code Section 219 or any successor, as adjusted to reflect income, gains, losses, and other credits or charges attributable thereto, shall not be considered to be part of the accrued benefits under any plan. (E) For purposes of this Paragraph (3), if any employee is not a Key Employee with respect to any plan for any plan year, but such employee was a Key Employee with respect to such plan for any prior plan year, any accrued benefit for such employee shall not be taken into account. (F) For purposes of this Paragraph (3), if any employee has not performed any service for any Plan Sponsor or Affiliate maintaining the plan during the five-year period ending on the Determination Date, any accrued benefit for that employee shall not be taken into account. (G) (i) In the case of an "unrelated rollover" (as defined below) between plans which qualify under Code Section 401(a), (a) the plan providing the distribution shall count the distribution as a distribution under Subparagraph (C) of this Paragraph (3), and (b) the plan accepting the distribution shall not consider the distribution part of the accrued benefit under this Section; and (ii) in the case of a "related rollover" (as defined below) between plans which qualify under Code Section 401(a), (a) the plan providing the distribution shall not count the distribution as a distribution under Subparagraph (C) of this Paragraph (3), and (b) the plan accepting the distribution shall consider the distribution part of the accrued benefit under this Section. For purposes of this Subparagraph (G), an "unrelated rollover" is a rollover as defined in Code Section 402(c)(4) or 408(d)(3) or a plan-to-plan transfer which is both initiated by the participant and made from a plan maintained by one employer to a plan maintained by another employer where the employers are not Affiliates. For purposes of this Subparagraph (G), a "related rollover" is a rollover as defined in Code Section 402(c)(4) or 408(d)(3) or a plan-to-plan transfer which is either not initiated by the participant or made to a plan maintained by the employer or an Affiliate. C-5 54 SECTION 2 (a) Notwithstanding anything contained in the Plan to the contrary, except as otherwise provided in Subsection (b) of this Section, in any Plan Year during which the Plan is Top-Heavy, allocations of Plan Sponsor contributions and forfeitures for the Plan Year for the Account of each Member who is not a Key Employee and who has not separated from service with the Plan Sponsor prior to the end of the Plan Year shall not be less than 3 percent of the Member's Annual Compensation. For purposes of this Subsection, an allocation to a Member's Account resulting from any Plan Sponsor contribution attributable to a salary reduction or similar arrangement shall not be taken into account. (b) (1) The percentage referred to in Subsection (a) of this Section for any Plan Year shall not exceed the percentage at which allocations are made or required to be made under the Plan for the Plan Year for the Key Employee for whom the percentage is highest for the Plan Year. For purposes of this Paragraph, an allocation to the Account of a Key Employee resulting from any Plan Sponsor contribution attributable to a salary reduction or similar agreement shall be taken into account. (2) For purposes of this Subsection (b), all defined contribution plans which are members of a Required Aggregation Group shall be treated as part of the Plan. (3) This Subsection (b) shall not apply to any plan which is a member of a Required Aggregation Group if the plan enables a defined benefit plan which is a member of the Required Aggregation Group to meet the requirements of Code Section 401(a)(4) or 410. (4) If the Plan Sponsor maintains a defined benefit plan which is qualified under Code Section 401(a) and which would be Top-Heavy within the meaning of the Plan for its plan year ending within or coincident with the Plan Year, no allocation shall be made pursuant to Subsection (a) of this Section on behalf of any Member who participates in the defined benefit plan and acquires a year of service within the meaning of paragraphs (4), (5) and (6) of Code Section 411(a) under the defined benefit plan for the plan year, if the defined benefit plan provides generally that the accrued benefit of the member when expressed as an annual retirement benefit shall not, when expressed as a percentage of the Member's compensation, be less than the lesser of (A) 2 percent multiplied by the number of such years of service in plan years during which such plan was Top-Heavy, or (B) 20 percent. C-6 55 SECTION 3 In any limitation year (as defined in Section 4 of Appendix B to the Plan) which contains any portion of a Plan Year in which the Plan is Top-Heavy, the number "1.0" shall be substituted for the number "1.25" in Section 3 of Appendix B to the Plan. C-7 56 APPENDIX D SPECIAL RULES SECTION 1 SPECIAL RULES FOR GOTTLIEB EMPLOYEES (a) Any Member who was a participant in the Gottlieb Plan immediately before January 1, 1994 shall have the same number of Years of Service under the Plan as he had under the Gottlieb Plan. In addition, for the Plan Year beginning January 1, 1994, any such Member shall be given credit for the greater of the period of Service he would have received under the terms of the Gottlieb Plan or the period of Service he would receive as a participant in the Plan. For the Plan Year beginning January 1, 1995, and for all subsequent years, the Years of Service for any such Member will be credited in accordance with the terms of the Plan. (b) For any Member who was a participant in the Gottlieb Plan immediately before January 1, 1994, "Normal Retirement Age" means age 59 1/2. SECTION 2 SPECIAL RULES FOR COMPMED EMPLOYEES (a) Any Member who was a participant in the CompMed Plan immediately before January 1, 1994 shall have the same number of Years of Service under the Plan as he had under the CompMed Plan. In addition, for the Plan Year beginning January 1, 1994, any such Member shall be given credit for the greater of the period of Service he would have received under the terms of the CompMed Plan or the period of Service he would receive as a participant in the Plan. For the Plan Year beginning January 1, 1995, and for all subsequent years, the Years of Service for any such Member will be credited in accordance with the terms of the Plan. (b) For any CompMed Employee, "Eligibility Service" shall be as defined in the CompMed Plan. SECTION 3 SPECIAL RULES FOR MMNE EMPLOYEES (a) Any Member who was a participant in the MMNE Plan immediately before January 1, 1994 shall have the same number of Years of Service under the Plan as he had under the MMNE Plan. In addition, for the Plan Year beginning January 1, 1994, any such Member shall be given credit for the greater of the period of Service he would have received under the terms of the MMNE Plan or the period of Service he would receive as a participant in the Plan. For the Plan Year beginning January 1, 1995, and for all subsequent years, the Years of Service for any such Member will be credited in accordance with the terms of the Plan. D-1 57 (b) Any Member who was a participant in the MMNE Plan immediately before January 1, 1994 shall be 25% vested after the completion of one Year of Service. (c) For any Member who was a participant in the MMNE Plan immediately before January 1, 1994 and who completes 2 Years of Service, such Member may request a withdrawal of any vested amounts from his Matching Account by submitting such request to the Plan Administrator according to normal administrative procedures. Upon receipt of such request, the Plan Administrator will provide for such distribution at a reasonable time and in a reasonable manner. D-2 EX-10.30 9 1ST AMEND TO EMPLOYEE RETIREMENT SAVINGS PLAN 1 EXHIBIT 10.30 FIRST AMENDMENT TO THE MEDAPHIS EMPLOYEES' RETIREMENT SAVINGS PLAN THIS AMENDMENT, made as of the 31st day of July, 1996, by MEDAPHIS CORPORATION, a corporation duly organized and existing under the laws of the State of Delaware (hereinafter called the "Primary Sponsor"). W I T N E S S E T H WHEREAS, the Primary Sponsor adopted the Medaphis Employees' Retirement Savings Plan (the "Plan") by indenture dated June 30, 1991; and WHEREAS, the Plan was last amended and restated by indenture effective July 1, 1995; and WHEREAS, the Primary Sponsor desires to amend the Plan to preserve certain "protected benefits" of members of plans of acquired companies which are merged into the Plan and to extend certain of those benefits to participants generally. NOW, THEREFORE, the Primary Sponsor does hereby amend the Plan, effective July 31, 1996, as follows: 1. Section 1.1 of the Plan shall be amended by adding the following definition thereto: ""Prior Company Account"--which shall reflect a Member's interest in contributions (other than Elective Deferrals) that are made by a Member's prior employer and which are 100% vested." 2. Section 6 of the Plan shall be amended by adding the following Section 6.11 thereto: "Prior to making any loan to a Member pursuant to this Section, the consent of the requesting Member's spouse as to the use of the Member's Account as security for any requested loan and the offset against the Member's Account in the event of a default on any requested loan must be obtained in accordance with the notice and consent requirements of Code Sections 417 and 411(a)(11) and the Regulations promulgated thereunder." 3. Section 7.1 of the Plan shall be amended by replacing the first sentence of Section 7.1 with the following: "A Member who has attained age 59 1/2 may withdraw, in a lump sum in cash, all or any portion of the balance of his Employee Deferral Account, his Rollover Account, his Prior Company Account, and the vested portion of his Matching Account." 2 4. Section 7.2 of the Plan shall be amended by replacing the first sentence of Section 7.2 with the following: "A withdrawal pursuant to this Section 7.2 is designated a "Hardship Withdrawal" and is subject to the following rules: The Trustee shall, upon the direction of the Plan Administrator, distribute, in a lump sum in cash, all or a portion of a Member's Rollover Account, Employee Deferral Account consisting of Deferral Amounts (but not earnings thereon) and Prior Company Account prior to the time such account is otherwise distributable in accordance with the other provisions of the Plan; provided, however, that any such distribution shall be made only if the Member is an Employee and demonstrates that he is suffering from "hardship" as determined herein." 5. Section 7 of the Plan shall be amended by adding the following Section 7.4 thereto: "Prior to making any distribution pursuant to this Section, the spouse of any Member requesting a distribution from his Account must consent to the making of such distribution to the Member in accordance with all notice and consent requirements of Code Sections 417 and 411(a)(11) and the Regulations promulgated thereunder." 6. Section 9.2 of the Plan shall be amended by replacing Section 9.2 with the following: "Payment to a Member shall be in the form of one lump sum payment in cash unless the Accrued Benefit of the Member exceeds $3,500, in which event the Member or the Beneficiary by written instrument delivered to the Plan Administrator may elect to have his or her Account distributed in one of the forms of distribution listed below, as chosen by the Member or Beneficiary: (a) one lump sum payment in cash; (b) a combination of one lump sum payment in cash for a portion of his Account designated by the Member in annual, semiannual, quarterly, or monthly installments in cash for the remaining portion of the Member's Account; (c) annual, semiannual, quarterly or monthly installments in cash (If the Member elects annual, semiannual, quarterly, or monthly installments for some or all of his Account, such distributions shall be made over a period specified by the Member not exceeding the life expectancy of the Member or the joint life expectancies of the Member and his Beneficiary); -2- 3 (d) a single life annuity (If the Member elects to receive his benefits in the form of a single life annuity and is married on the date of his death or the date distributions are to commence, if applicable, the benefit shall automatically be payable pursuant to Subsection (e) of this Section unless the Member makes an election pursuant to Section 9.2A not to receive the applicable annuity under Subsection (e) during the applicable election period); (e) an immediate annuity for the life of the Member with a survivor annuity for the life of his or her spouse which is fifty percent (50%) of the annuity payable during the joint lives of the Member and his spouse (hereinafter referred to as a "Qualified Joint and Survivor Annuity") (If the Member's Accrued Benefit is payable in the form of a life annuity, and the Member dies before he begins to receive payments from the Fund, the Member's spouse shall receive an immediate annuity for her life (hereinafter referred to as a "Qualified Preretirement Survivor Annuity"). Notwithstanding the foregoing, the surviving spouse of a Member who is entitled to receive a Qualified Preretirement Survivor Annuity may elect a lump sum payment prior to the date the annuity is purchased or distributions begin); (f) a single life annuity with certain periods of five, ten or fifteen years as selected by the Member (If the Member elects to receive his benefits in the form provided in this Subsection and is married on the date of his death or the date distributions are to commence, if applicable, the benefit shall automatically be payable pursuant to Subsection (e) of this Section unless the Member makes an election pursuant to Section 9.2A not to receive the applicable annuity under Subsection (e) during the applicable election period); and (g) a single life annuity with installment refund and survival percentages for the contingent annuitant designated by the Member of 50% or 100% (If the Member elects to receive his benefits in the form provided in this Subsection and is married on the date of his death or the date distributions are to commence, if applicable, the benefit shall automatically be payable pursuant to Subsection (e) of this Section unless the Member makes an election pursuant to Section 9.2A not to receive the applicable annuity under Subsection (e) during the applicable election period). If an annuity is to be paid from the Plan, such annuity may be purchased with the Member's Account from an insurance company designated by the Plan Administrator or its designee in writing to the insurance company and may be distributed to the Member or his Beneficiary in full satisfaction of the benefits to which the Member or his Beneficiary is entitled under the Plan. The amount of the annuity shall be the actuarial equivalent of the Member's Account (reduced by any commissions or other costs charged by the insurance company) based on factors used by the insurance company from which the annuity is purchased." -3- 4 7. The Plan shall be amended by adding the following Section 9.2A: "(a) The Plan Administrator shall furnish to the Member a written explanation of: (1) the terms and conditions of the Qualified Joint and Survivor Annuity and the Qualified Preretirement Survivor Annuity; (2) the Member's right to make, and the effect of, an election not to receive the Qualified Joint and Survivor Annuity or the Qualified Preretirement Survivor Annuity; (3) the rights of the Member's spouse as described below; and (4) the right to make and the effect of an election pursuant to this Paragraph. In the case of a Qualified Joint and Survivor Annuity, the written explanation shall be provided to the Member within ninety (90) days prior to the first date on which he is entitled to commencement of payments from the Fund. In the case of Qualified Preretirement Survivor Annuity, the written explanation shall be provided to the Member in whichever of the following periods ends last: (A) the period beginning with the first day of the Plan Year in which the Member attains age 32 and ending with the close of the Plan Year preceding the Plan Year in which the Member attains age 35; (B) the period beginning one year before and ending one year after the Employee first becomes a Member; (C) the period beginning one year before and ending one year after the provisions of this Subsection apply to the Member; or (D) a reasonable period of time after separation from service in the case of a Member who separates from service before attaining age 35. The Member may elect, during the applicable election period not to receive the Qualified Joint and Survivor Annuity or Qualified Preretirement Survivor Annuity by execution and delivery to the Committee of a form provided for that purpose by the Committee. The term "applicable election period" shall mean, with respect to a Qualified Joint and Survivor Annuity, the 90-day period ending on the first date on which the Member is entitled to commencement of payment from the Fund and with respect to a Qualified -4- 5 Preretirement Survivor Annuity, the period which begins on the first day of the Plan Year in which the Employee becomes a Member and ends on his death. In the case of a married Member no election shall be effective unless: (I) the spouse of the Member consents in writing to the election and the consent acknowledges the effect of the election (including, if applicable, the identity of any Beneficiary other than the Member's spouse and the alternate form of payment) and is witnessed by a notary public, or (II) it is established to the satisfaction of the Committee that the consent required pursuant to Subclause (I) of this Paragraph may not be obtained because there is no spouse, the spouse cannot be located, the Member has a court order indicating that he is legally separated or has been abandoned (within the meaning of local law) unless a qualified domestic relations order provides otherwise, or of any other circumstances as permitted by regulations promulgated by the Department of the Treasury. If the spouse is legally incompetent to give consent, consent by the spouse's legal guardian shall be deemed to be consent by the spouse. (b) Any consent by a spouse (or establishment that the consent of a spouse may not be obtained) shall be effective only with respect to that spouse. If an election is made, the Member's vested Accrued Benefit shall be paid in the alternate form of payment set forth in Plan Section 9.2 chosen by the Member by written instrument delivered to the Committee. Any waiver of a Qualified Preretirement Survivor Annuity made prior to the first day of the Plan Year in which the Member attains age 35 shall become invalid as of the first day of the Plan Year in which the Member attains age 35 and a Qualified Preretirement Survivor Annuity shall be provided, unless a new waiver is obtained. The Member may revoke any election not to receive payment in the form of a Qualified Joint and Survivor Annuity or Qualified Preretirement Survivor Annuity at any time prior to commencement of payments from the Fund, and may make a new election at any time prior to the commencement of payments from the Fund." 8. Section 9.3(a) of the Plan shall be amended by replacing Section 9.3 (a) with the following: "(a) if a Member's vested Accrued Benefit exceeds $3,500, it shall not be distributed before the Member's Normal Retirement Age or death without the consent of the Member, and if the Member is married and elects a form of payment other than a Qualified Joint and Survivor annuity, with the consent of his spouse (of if the Member is deceased, his surviving spouse)." -5- 6 9. Section 10.3(a) of the Plan shall be amended by replacing Section 10.3(a) with the following: "(a) his Employee Deferral Account, Voluntary Contribution Account, his Rollover Account, and Prior Company Account, which shall be fully vested and nonforfeitable at all times; and" * * * * * Except as specifically amended hereby, the Plan shall remain in full force and effect as prior to this Amendment. IN WITNESS WHEREOF, the Primary Sponsor has executed this First Amendment as of the date and the year first above written. MEDAPHIS CORPORATION By: ------------------- Title: ------------------- ATTEST: By: --------------------------- Title: ------------------------ -6- EX-10.31 10 2ND AMEND TO EMPLOYEE RETIREMENT SAVINGS PLAN 1 EXHIBIT 10.31 FORM OF AMENDMENT TO THE MEDAPHIS EMPLOYEES' RETIREMENT SAVINGS PLAN THIS AMENDMENT is made on the _____ day of _____________, 1997, by MEDAPHIS CORPORATION, a corporation duly organized and existing under the laws of the State of Delaware (hereinafter called the "Primary Sponsor"); WHEREAS, the Primary Sponsor established by indenture dated June 30, 1991, the Medaphis Corporation Employees' Retirement Savings Plan which was last amended and restated by indenture effective as of July 1, 1995 (the "Plan"); and WHEREAS, the Primary Sponsor applied for a favorable determination letter from the Internal Revenue Service with respect to the July 1, 1995 restatement of the Plan; and WHEREAS, by letter dated November 21, 1996, the Internal Revenue Service conditioned its favorable determination as to the tax-qualified status of the Plan upon the Primary Sponsor's adopting of the provisions contained in this Amendment. NOW, THEREFORE, the Primary Sponsor does hereby amend the Plan as follows: 1. Section 4.1 of the Plan shall be deleted in its entirety and replaced with the following: "4.1 (a) As soon as reasonably practicable following the date of withholding by the Plan Sponsor, if applicable, and receipt by the Trustee, Plan Sponsor contributions made on behalf of each Member under Plan Sections 3.1 and 3.2 (including forfeitures during the Plan Year used to reduce such contributions), and Voluntary Contributions and Rollover Amounts contributed by the Member, shall be allocated to the Employee Deferral Account, Matching Account, Voluntary Contribution Account and Rollover Account, respectively, of the Member on behalf of whom the contributions were made. (b) As of the last day of each Plan Year, Plan Sponsor contributions made under Plan Section 3.3 and forfeitures from Company Accounts shall be allocated to the Company Account of each Eligible Employee who is a Member who is employed by a Plan Sponsor on the last day of the Plan Year, or whose death or Retirement Date occurred during the Plan Year, in the proportion that the Member's Annual Compensation bears to the Annual Compensation of all Members entitled to an allocation under this Subsection (b). (c) As of December 31, 1994, Plan Sponsor contributions made under Plan Section 3.4 shall be allocated to the Employee Deferral Account of each Qualified Member in the proportion that the Qualified Member's Annual Compensation bears to the Annual Compensation of all Qualified Members entitled to an allocation under this Subsection (c)." 2 IN WITNESS WHEREOF, the Primary Sponsor has caused this amendment to be executed as of the date first above written. MEDAPHIS CORPORATION By: ----------------------------------- Title: ------------------------------- ATTEST: - -------------------------------- Title: -------------------------- [CORPORATE SEAL] - 2 - EX-10.37 11 LEASE AGREEMENT 1 EXHIBIT 10.37 LEASE AGREEMENT THIS LEASE, made this 1st day of August, 1989 by and between Financial Enterprises, III, hereinafter called "Landlord" and Medical Management Sciences South, Inc. hereinafter called "Tenant". W I T N E S S E T H 1. PREMISES. Landlord does hereby lease to Tenant and Tenant hereby leases from Landlord the office building located at 1030 East 4th Street, Suite A; Chattanooga, Tennessee hereinafter called the "Premises". 2. TERM. This Lease shall be for a term of one (1) year beginning on August 1, 1989 and ending on July 31, 1990, both dates inclusive, unless sooner terminated as herein provided. The lease will automatically renew for one (1) year periods unless sixty (60) day notice is given by either party. 3. RENT. The Tenant shall pay to the Landlord the annual rent of Fifty-Two Thousand Three Hundred Eighty Dollars ($52,380) in legal tender, in equal monthly installments of Four Thousand Three Hundred Sixty-Five Dollars ($4,365) in advance, on the first day of each month throughout the term of the Lease. The rent shall be payable at the office of the Landlord or at such other place as the Landlord may designate in writing. 2 4. PAST DUE RENTS. Tenant hereby recognizes and acknowledges that if rental payments are not received when due Landlord will suffer damages and additional expense thereby and Tenant therefore agrees that a late charge equal to five percent (5%) of the basis monthly rental (including additional rent as hereinafter provided) may be assessed by Landlord as additional rental if Tenant shall fail to pay any rent by the 10th of each month. 5. ASSIGNMENT AND SUBLETTING. Tenant covenants it will not assign this Lease or sublet the Premises without the prior written consent of Landlord. 6. QUIET ENJOYMENT. Landlord agrees that upon compliance with the terms and conditions of this Lease, Tenant shall and may peaceably and quietly have, hold and enjoy the premises for the term of this Lease and any renewal of said term. 7. USE AND CONDITION. Tenant shall use the premises only for business or professional office purposes. Tenant knows the conditions of the Premises and Tenant has confirmed to its satisfaction that the Premises can be lawfully used for purposes of Tenant's business. The Premises shall not be used during the term or an extension or renewal term for any purpose other than those specified herein. -2- 3 8. CARE OF PREMISES. Tenant shall commit no waste and shall take good care of the Premises and fixtures, and shall, at Tenant's sole cost and to the satisfaction of Landlord, repair all damage or injury to the Premises, fixtures and Building resulting from carelessness, omission, neglect or other cause of Tenant, its servants, employees, agents, visitors, or licensees. Should Tenant fail to perform such repairs or replacements, Landlord may do so, after ten (10) days notice and the cost of such repairs or replacements shall become collectible as additional rent hereunder and shall be paid by Tenant within ten (10) days after presentation of a statement therefor. Upon the expiration of this Lease, Tenant shall return all keys and shall surrender the Premises in clean and good condition, reasonable use and wear excepted. 9. TAXES. Landlord shall pay all taxes, and assessments upon the leased property during the term of the Lease. 10. INSURANCE. The Tenant shall at all times during the term of this Lease, at its own cost and expense, provide adequate insurance coverage on the premises. 11. UTILITIES. The Tenant shall be required to furnish all utilities. -3- 4 12. REPAIRS. Landlord shall (to the extent of Landlord's installations therein) keep the Premises in good working order and condition and shall make all repairs and replacements not occasioned by the negligence of Tenant, its agents, contractors, employees or invites. Should Landlord be prevented by Tenant from making repairs, or replacements during regular hours, Tenant shall bear any increased expense. Tenant shall repair and maintain all of the Tenant's installations in the premises. Landlord shall not be liable to Tenant as a result of damage or loss to Tenant's property, including without limitation, Tenant's fixtures, furniture and/or equipment, resulting from water damage or leakage from any pipe within the Building or leakage through the exterior wall, windows or the roof of the Building; whether or not such damage shall be caused by or contributed to as a result of Landlord's negligence or omission. 13. PERSONAL PROPERTY. All personal property and equipment of every kind and description which may at any time be in the Premises shall be at Tenant's risk, or at the risk of those claiming under Tenant. 14. DEFAULT. In the event of the occurrence of any of the following conditions: (1) The rent (or additional rent) is not paid when due; (2) The Premises are vacated even though Tenant continues to pay the stipulated monthly rent; -4- 5 (3) Any petition or other action if filed by or against Tenant under any section or chapter of the Federal Bankruptcy Act; (4) Tenant shall become insolvent or transfer property in fraud of creditors; (5) Tenant shall make an assignment for the benefit of creditors; (6) A receiver or trustee is appointed for any of Tenant's assets and such appointment is not vacated within thirty (30) days; or (7) Tenant fails to comply with any provision or covenant of this Lease (other than the payment of rent) or any of the Rules and Regulations now or hereafter established by Landlord and fails to correct or cure the same within fifteen (15) days after Notice thereof, or, in the event such defect cannot reasonably be cured within the said fifteen (15) day period, then if Tenant shall fail to commence to cure said defect within the aforesaid fifteen (15) day period and thereafter diligently pursue the same to completion; then in any of such events Landlord shall have all remedies provided at law all in equity, including the right to (i) terminate the Lease by written notice to Tenant (in which event Tenant shall immediately surrender the Premises to Landlord) and retain all deposits, security for rent or other monies received from Tenant on account of damages, (ii) enter the Premises and remove Tenant and Tenant's property therefrom with or without force and without being liable to Tenant in any manner whatsoever for any damages, and attempt to relet the Premises for Tenant's account on such terms as Landlord alone shall determine or (iii) to continue this Lease and sue for Tenant's performance hereunder (including payment of rent and additional rent as they become due). In every event Landlord shall also be entitled to recover from Tenant all costs of collection, including attorney's fee at the agreed rate of fifteen (15%) of all sums due to the Landlord. The proceeds of any reletting -5- 6 during the term of this Lease shall be applied first to all expenses occasioned by such reletting (including, without limitation, attorney's fees and leasing commissions and such alterations and redecorating of the Premises as the Landlord's sole judgment may be desirable) and secondly to the rent and additional rent due hereunder, Tenant shall be liable for any deficiency (including costs of collection and attorney's fees) but not entitled to any surplus so arising. The above stated remedies of Landlord shall be deemed to be in addition to, and not in lieu of, any other rights and remedies provided Landlord either at law or in equity each of which shall remain cumulatively available to the Landlord. No delay in enforcing the provisions of this Lease shall be deemed to constitute a waiver of such default by Landlord, and the pursuit by Landlord of one or more remedies shall not be deemed to constitute an election against other remedies. All remedies provided in this Lease, at law or in equity shall be cumulatively available to the Landlord. If the Premises are relet following Tenant's default Landlord shall not be liable for the good faith failure to collect any such rent. IN WITNESS WHEREOF, Landlords and Tenant have respectively signed and sealed this Lease. LANDLORD FINANCIAL ENTERPRISES, III By: S/ ---------------------- -6- 7 TENANT MEDICAL MANAGEMENT SCIENCES SOUTH, INC. By: S/ ---------------------- -7- EX-10.49 12 EMPLOYMENT AGREEMENT (MCDOWELL) 1 EXHIBIT 10.49 EMPLOYMENT AGREEMENT This Employment Agreement (the "Agreement") is made and entered into as of the 19th day of November, 1996, by and between Medaphis Corporation, a Delaware corporation (the "Company"), and David E. McDowell (the "Employee"). STATEMENT OF BACKGROUND INFORMATION The Company renders to hospitals, physicians, and/or other healthcare organizations and providers: (a) billing services, accounts receivable management services, collection services, electronic claims services, financial management services, and practice and facilities management services; (b) eligibility verification and certification for Medicaid, Medicare and other healthcare assistance programs; (c) filing and other medical claims securitization services: (d) medical coverage information services: and (e) medical and insurance claims monitoring and tracking services (collectively the "Processing Business"). The Company also provides subrogation and related recovery services for healthcare payors, including health maintenance organizations, indemnity insurers. Blue Cross and Blue Shield organizations, third-party administrators, self-funded employee health welfare benefit plans, and provider hospital organizations (the "Subrogation Business"). The Company also: (a) develops, markets and licenses to hospitals, integrated healthcare delivery systems, and other healthcare providers and other end users (collectively "Providers"), (i) strategic, operational and financial information systems and services and decision support tools for healthcare providers, (ii) software systems which provide claims and reimbursement services and electronic claims processing, and (iii) software applications which assist Providers with automated scheduling and resource management (the items discussed in Sections (a)(i), (a)(ii) and (a)(iii) of this paragraph are referred to as "Systems"), which Systems include, but are not limited to, nurse scheduling and management information systems, operating room patient scheduling and surgery information systems, enterprise wide patient scheduling and resource management systems, enterprise-wide employee scheduling and management information systems and related software interfaces to other information systems: and (b) provides to Providers installation and support services related to the Company's Systems (the "Systems Business"). The Company also renders professional services with respect to the development of computer software, algorithms, designs, documentation, and related materials, and the development, design, deployment, and operation of local and wide area computer networks, all in conjunction with the sale, design, deployment, operation and maintenance of custom computer 2 processing systems for improvement of operational efficiency or functionality, through the use of image storage and processing, work flow technology, optical character recognition or other related technologies (the "System Integration Business") (the Processing Business, the Subrogation Business, the Systems Business, the Systems Integration Business and any other distinct business segment in which the Company engages during Employee's employment are collectively referred to as the "Business"). The Compensation Committee (the "Committee") of the Board of Directors of the Company (the "Board") has determined to create certain long-term retention incentives to reward Employee for successful performance with the Company. The Committee has determined that it would be in the best interest of Medaphis and its stockholders if Employee were employed by Medaphis for a term of five years. Employee acknowledges the Company's ownership of its goodwill, and the necessity of the restrictive covenants contained in this Agreement to protect the Company's interest in such material asset. STATEMENT OF AGREEMENT In consideration of the mutual covenants, promises and conditions set forth in this Agreement, the parties agree as follows: 1. Employment. The Company employs Employee and Employee accepts such employment upon the terms and conditions set forth in this Agreement. For purposes of Sections 6, 7 and 8 of this Agreement, "employment" shall mean any period of time during which the Company is paying the Employee salary under Section 5(b) of this Agreement, whether or not the Employee is currently performing services for the Company at the time of such payment. For all other purposes under this Agreement, "employment" shall have its customary meaning. 2. Duties of Employee. Employee agrees to perform and discharge the usual duties of a Chairman of the Board of Directors and Chief Executive Officer of a similarly sized organization, including, without limitation, those presently set forth in the Bylaws of the Company, and such other duties as may be reasonably assigned by the Board, and to comply with all of the Company's policies, standards and regulations. Employee's title shall be Chairman of the Board of Directors and Chief Executive Officer, and Employee shall report to the Board. All of Employee's time, attention and energies which are devoted to business endeavors will be devoted to the Business, and Employee will not, during the term of this Agreement, be engaged (whether or not during normal business hours) in any other business or professional activity, whether or not such activity is pursued for gain, profit or other pecuniary advantage, without the prior written consent of the Board, which consent will not be unreasonably withheld. This Section will not be construed to prevent Employee from: (a) investing personal assets in - 2 - 3 businesses which do not compete with the Company in such form or manner that will not require any services on the part of Employee in the operation or the affairs of the companies in which such investments are made and in which Employee's participation is solely that of an investor; (b) purchasing securities in any corporation whose securities are listed on a national securities exchange or regularly traded in the over-the-counter market, provided that Employee at no time owns, directly or indirectly, in excess of one percent of the outstanding stock of any class of any such corporation engaged in a business competitive with that of the Company; or (c) participating in conferences, preparing and publishing papers or books or teaching, participating on the board of directors of other companies ("Other Boards") or providing limited advisory services, so long as these activities are not contrary to the Company's interests, and, with regard to participation on Other Boards or the provision of limited advisory services, so long as the Board approves Employee's participation on any such Other Boards or approves the provision of such limited advisory services, which approval will not be unreasonably withheld. 3. Term. The term of this Agreement will be for a period of five years commencing on November 19, 1996 and expiring on the fifth anniversary of that date, subject to earlier termination as provided for in Section 4. 4. Termination and Suspension. (a) By the Company. Notwithstanding anything contained in Section 3 to the contrary, the Company has the right to terminate this Agreement and all of its obligations under this Agreement immediately if the Board takes action to terminate after any of the following events occurs: (i) Employee materially breaches any of the terms or conditions set forth in this Agreement and fails to cure such breach within ten (10) days after Employee's receipt from the Company written notice of such breach, which notice describes in reasonable detail the Company's belief that Employee is in breach hereof (notwithstanding the foregoing, no cure period shall be applicable to breaches by Employee of Sections 6, 7 or 8 of this Agreement); (ii) Employee commits any act in bad faith materially detrimental to the business or reputation of the Company; (iii) Employee engages in illegal activities or is convicted of any crime involving fraud, deceit or moral turpitude; or (iv) Employee dies or becomes mentally or physically incapacitated or disabled so as to be materially unable to perform Employee's duties under this Agreement. Without limiting the generality of the foregoing. Employee's inability to adequately perform services under this Agreement for a period of ninety (90) consecutive days will be conclusive evidence of such mental or physical - 3 - 4 incapacity or disability, unless such inability to adequately perform services under this Agreement is pursuant to a mental or physical incapacity or disability covered by the Family Medical Leave Act, in which case such ninety-day period shall be extended to a one hundred fifty-day period. (b) By Employee or by the Company other than for Cause. If Employee terminates this Agreement pursuant to any of clauses (i) - (v) below or if the Company terminates this Agreement other than pursuant to Section 4(a) hereof, the Company obligations hereunder to pay Employee the annual salary under Section 5(b), to provide for the continued vesting of stock option awards under Section 5(c) hereof and to provide for health insurance benefits to Employee under Section 5(d) hereof shall continue in accordance with the terms hereof through November 19, 2001: (i) the Company materially breaches any of the terms or conditions set forth in this Agreement and fails to cure its breach within ten (1O) days after its receipt from Employee of written notice of such breach, which notice describes in reasonable detail Employee's belief that the Company is in breach hereof; (ii) without Employee's express written consent, the Company assigns to Employee duties, or significantly reduces Employee's assigned duties, in a manner inconsistent with Employee's position with the Company; (iii) without Employee's express written consent, the Company requires Employee's relocation outside of the metropolitan Atlanta, Georgia area. (iv) the Company fails to obtain the assumption of this Agreement by any successors to the Company; or (v) a Change in Control Event (as defined herein) occurs, and Employee's employment is terminated by Employee or the Company, for whatever reason, within one hundred twenty (120) calendar days thereafter. Upon a Change in Control Event, the applicable provisions of Section 4(e) shall apply. For purposes of this Agreement a "Change in Control Event" shall mean the occurrence of any of the following: (1) the adoption of a plan of merger or consolidation of the Company with any other corporation as a result of which the holders of the outstanding voting stock of the Company as a group would receive less than 50% of the voting stock of the surviving or resulting corporation; (2) the adoption of a plan of liquidation or the approval of the dissolution of the Company; - 4 - 5 (3) the sale or transfer of substantially all of the assets of the Company; (4) the following individuals cease for any reason to constitute a majority of the number of directors then serving: individuals who, on the date hereof, constitute the Board and any new director (other than a director whose initial assumption of office is in connection with an actual or threatened election contest, including but not limited to a consent solicitation, relating to the election of directors of the Company) whose appointment or election by the Board or nomination for election by the Company's stockholders was approved or recommended by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors on the date hereof or whose appointment, election or nomination for election was previously so approved or recommended; or (5) any individual, entity, group (within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, and the rules promulgated thereunder), or other person acquires in a single transaction or a series of transactions more than 30% of the outstanding shares of the Company's common stock. (c) Suspension By the Company. If Employee is indicted for any felony, the Company may immediately suspend Employee without compensation. If the indictment is dropped, or if Employee is acquitted (the dropping of an indictment and an acquittal each referred to as an "Acquittal Event"), the Company shall, within ten (10) days after it receives written notice of any Acquittal Event, remit to Employee all amounts otherwise payable pursuant to this Agreement but withheld during the suspension period, together with interest from each due date paid at the then-current prime rate plus two percentage points, as reported in The Wall Street Journal. Upon any such Acquittal Event, the Company's payment obligations to Employee under this Agreement shall resume and shall continue throughout the remainder of the term of this Agreement, subject to the terms and conditions of this Agreement, but the Company shall have the option whether to ask Employee actually to return to work and to publicly associate with the Company. At the Company's request in this circumstance, Employee will refrain from working at or for the Company (notwithstanding his continuing compensation under this Agreement) and will refrain from representing to any person or entity that he is associated with the Company. (d) No Duty to Mitigate. If Employee terminates his employment under and in accordance with this Agreement or if the Company wrongfully terminates Employee's employment under this Agreement. Employee shall not be required to mitigate the amount of any payment contemplated by this Agreement (whether seeking new employment or in any other manner). - 5 - 6 (e) Gross-Up. Upon a Change in Control Event and a termination of this Agreement by Employee pursuant to Section 4(b)(v), the Company will pay to Employee (in lieu of an obligation to make further payments to Employee under or on account of Section 5(b) and to provide benefits to Employee under or on account of Section 5(d)) the salary that would have been payable to Employee under this Agreement from the date of termination until November 18, 2001. The amounts payable to Employee under the previous sentence of this Section 4(e) shall be paid by the Company in periodic payments or in a lump sum, at the option of Employee. If any payment or other benefit (a "Termination Payment") received or to be received by Employee in connection with a Change in Control Event (whether or not this Agreement is terminated) or Employee's termination of employment (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, with any person whose actions result in a Change in Control Event or with any person affiliated with the Company or such person) is or will be subject to the tax (the "Excise Tax") imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), the Company shall pay to Employee, a Gross-Up Payment (as defined) to the extent provided by the second paragraph of this Section 4(e). A Gross-Up Payment (as defined) shall be payable pursuant to this Section 4(e) on and subject to the following terms and conditions: (1) At the time the applicable Termination Payment is made, an additional amount (the "Gross-Up Payment") shall be paid by the Company such that the net amount retained by Employee, after deduction of any Excise Tax on such Termination Payment and any federal, state and local income tax, employment tax and Excise Tax on the Gross-Up Payment, shall be equal to the amount or value of such Termination Payment. For purposes of determining whether any such Termination Payment will be subject to the Excise Tax, all Termination Payments shall be treated as "parachute payments" within the meaning of Section 280G(b)(2) of the Code, and all "excess parachute payments" within the meaning of Section 80G(b)(1) of the Code shall be treated as being subject to the Excise Tax,unless in the opinion of tax counsel reasonably acceptable to Employee and selected by the accounting firm which, immediately prior to the Change in Control Event, was the Company's independent auditors, such payments (in whole or in part) do not constitute "parachute payments" within the meaning of Section 28OG of the Code or represent reasonable compensation for services actually rendered in excess of the "base amount" allocable to such reasonable compensation. The full amount of the Gross-Up Payment shall be treated as being subject to the Excise Tax. The value of any non-cash benefits or any deferred payment or benefit shall be determined in accordance with the principles of Sections 28OG(d)(3) and (4) of the Code. (2) For purposes of determining the amount of any Gross-Up Payment, Employee shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the applicable Termination Payment or Gross-Up Payment is made, and shall be deemed to pay state and local income taxes at the highest marginal - 6 - 7 rates of taxation in the state and locality of his residence on the date the applicable Termination Payment or Gross-Up Payment is made, net of the maximum reduction in federal income taxes that could be obtained from deduction of such state and local taxes. (3) If the Excise Tax or income tax payable with respect to a Gross-Up Payment as finally determined exceeds the amount taken into account or paid to Employee at the time the applicable Termination Payment or Gross-Up Payment is made (including by reason of any payment the existence or amount of which cannot be determined at the time of the applicable Gross-Up Payment), the Company shall make an additional Gross-Up Payment in respect of such excess (plus any interest payable by Employee with respect to such excess) at the time that the amount of such excess is finally determined. 5. Compensation and Benefits. (a) Signing Incentive. As a material inducement to Employee to enter into this Agreement (including, without limitation, the covenants set forth in Sections 6, 7 and 8 of this Agreement), the Company will pay Employee, within five (5) days after Employee's execution of this Agreement, Five Hundred Thousand Dollars. (b) Annual Salary. For all services rendered by Employee under this Agreement, the Company will pay Employee a base salary of a minimum of Three Hundred Thousand Dollars per annum in equal bi-weekly installments. Such annual salary may be increased by the Committee. (c) Stock Option Awards. Employee shall be entitled to receive under the Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan (1) options to purchase 600,000 shares of the Company's common stock for an exercise price equal to the closing price of the Company's Common Stock on the Nasdaq National Market on November 19, 1996, which options shall have an effective grant date of November 19, 1996 and shall vest ratably over five years, and (2) performance options to purchase 210,000 shares of the Company's Common Stock for an exercise price equal to the closing price of the Company's Common Stock on the Nasdaq National Market on November 19, 1996, which performance options shall have an effective grant date of November 19, 1996 and shall vest ratably as follows: (i) 1/3 based on 100% appreciation in the market price of the Company's Common Stock above the closing price of the Company's Common Stock on the Nasdaq National Market on November 19, 1996, (ii) 1/3 based on 200% appreciation in the market price of the Company's Common Stock above the closing price of the Company's Common Stock on the Nasdaq National Market on November 19, 1996, and (iii) 1/3 based on 300% appreciation in the market price of the Company's Common Stock above the closing price of the Company's Common Stock on the Nasdaq National Market on November 19, 1996. In any event, the 210,000 performance stock options will vest on November 19, 2001 and all stock options contemplated by this Section 5(c) shall vest upon a Change in Control Event. In addition to any other rights provided Employee under the Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan or in the stock options agreement evidencing the - 7 - EX-10.50 13 EMPLOYMENT AGREEMENT (CONNORS) 1 EXHIBIT 10.50 EMPLOYMENT AGREEMENT This Employment Agreement (the "Agreement") is made and entered into this 25th day of February, 1997, by and between MEDAPHIS CORPORATION, a Delaware corporation (the "Company"), and Daniel S. Connors, Jr., a resident of the State of Pennsylvania (the "Employee"). Statement of Background Information The Company renders to hospitals, physicians, and/or other healthcare organizations and providers: (a) billing services, accounts receivable management services, collection services, electronic claims services, financial management services, and practice and facilities management services: (b) eligibility verification and certification for Medicaid, Medicare and other healthcare assistance programs; (c) filing and other medical claims securitization services; (d) medical coverage information services; and (e) medical and insurance claims monitoring and tracking services (collectively the "Processing Business"). The company also provides subrogation and related recovery services for healthcare payors, including health maintenance organizations, indemnity insurers, Blue Cross and Blue Shield organizations, third-party administrators, self-funded employee health welfare benefit plans, and provider hospital organizations (the "Subrogation Business"). The Company also: (a) develops, markets and licenses to hospitals, integrated healthcare delivery systems, and other healthcare providers and other end users (collectively "Providers"), (i) strategic, operational and financial information systems and services and decision support tools for healthcare providers, (ii) software systems which provide claims and reimbursement services and electronic claims processing, and (iii) software applications which assist Providers with automated scheduling and resource management (the items discussed in Sections (a)(i), (a)(ii) and (a)(iii) of this paragraph are referred to as "Systems"), which Systems include, but are not limited to, nurse scheduling and management information systems, operating room patient scheduling and surgery information systems, enterprise wide patient scheduling and resource management systems, enterprise-wide employee scheduling and management information systems and related software interfaces to other information systems; and (b) provides to Providers installation and support services related to the Company's Systems (the "Systems Business"). The Company also renders professional services with respect to the development of computer software, algorithms, design, documentation, and related materials, and the development, design, deployment, and operation of local and wide area computer networks, all in conjunction with the sale, design, deployment, operation and maintenance of custom computer processing systems for improvement of operational efficiency or functionality through the use of image storage and processing, work flow technology, optical character recognition or other related technologies (the -1- 2 "System Integration Business") (the Processing Business, the Subrogation Business, the Systems Business, the Systems Integration Business and any other distinct business segment in which the Company engages during Employee's employment are collectively referred to as the "Business"). In consideration of the mutual covenants, promises and conditions set forth in this Agreement, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Employment. The Company hereby employs Employee and Employee hereby accepts such employment upon the terms and conditions set forth in this Agreement. For purposes of Sections 7 and 8 of this Agreement, "employment" shall mean any period of time during which the Company is paying the Employee salary, wages, or any other amounts, whether or not the Employee is currently performing services for the Company at the time of such payment. Notwithstanding anything in this Agreement to the contrary, in the event the Company is paying the Employee salary, wages, benefits, severance or any other sums of money after termination of Employee's employment with the Company, and Employee obtains any other employment for consideration in any capacity, then such payments will (i) cease immediately if Employee's employment with the Company was terminated as a result of the occurrence of any events described in Section 4(a)(i) through 4(a)(iv) hereof ("terminated for cause"), or (ii) be reduced by an amount equal to the value of consideration received in connection with or as a result of such other employment if Employee was terminated other than as a result of the occurrence of any events described in Section 4(a)(i) through 4(a)(iv) hereof ("terminated without cause"). 2. Duties of Employee. Employee's initial title will be Senior Vice President, Personnel and Administration, and Employee initially will report directly to the Chief Executive Officer and/or President of the Company. Employee initially will be responsible for managing and directing the Company's Corporate Services and Corporate Information Management Groups and agrees to perform and discharge such other duties as may be assigned to Employee from time to time by the Company to the reasonable satisfaction of the Company. Employee also agrees to comply with all of the Company's policies, standards and regulations and to follow the instructions and directives of Employee's superiors within the Company, as promulgated by the officers of the Company. Employee will devote Employee's full professional and business-related time, skills and best efforts to such duties and will not, during the term of this Agreement, be engaged (whether or not during normal business hours) in any other business or professional activity, whether or not such activity is pursued for gain, profit or other pecuniary advantage, without the prior written consent of the President of the Company, which consent will not be unreasonably withheld. This Section will not be construed to prevent Employee from (a) investing personal assets in businesses which do not compete with the Company in such form or manner that will not require any services on the part of Employee in the operation or the affairs of the companies in which such investments -2- 3 are made and in which Employee's participation is solely that of an investor; (b) purchasing securities in any corporation whose securities are listed on a national securities exchange or regularly traded in the over-the-counter market, provided that Employee at no time owns, directly or indirectly, in excess of one percent (1%) of the outstanding stock of any class of any such corporation engaged in a business competitive with that of the Company; or (c) participating in conferences, preparing and publishing papers or books or teaching, so long as the President of the Company approves such participation, preparation and publication or teaching prior to Employee's engaging therein. 3. Term. The term of this Agreement will be for a two year period of time, commencing as of November 20, 1996 and expiring on November 20, 1998, subject to earlier termination as provided for in Section 4 of this Agreement. 4. Termination. (a) Termination by Company for Cause. Notwithstanding anything contained in Section 3 to the contrary, the Company may terminate this Agreement and all of its obligations hereunder immediately if any of the following events occur: (i) Employee materially breaches any of the terms or conditions set forth in this Agreement and fails to cure such breach within ten (10) days after Employee's receipt from the Company of written notice of such breach (notwithstanding the foregoing, no cure period shall be applicable to breaches by Employee of Sections 6, 7 or 8 of this Agreement); (ii) Employee commits any other act materially detrimental to the business or reputation of the Company; (iii) Employee engages in dishonest or illegal activities or commits or is convicted of any crime involving fraud, deceit or moral turpitude; or (iv) Employee dies or becomes mentally or physically incapacitated or disabled so as to be unable to perform Employee's duties under this Agreement. Without limiting the generality of the foregoing, Employee's inability adequately to perform services under this Agreement for a period of sixty (60) consecutive days will be conclusive evidence of such mental or physical incapacity or disability, unless such inability adequately to perform services under this Agreement is pursuant to a mental or physical incapacity or disability covered by the Family Medical Leave Act, in which case such sixty (60)-day period shall be extended to a one hundred and twenty (120)-day period. -3- 4 (b) Termination by Company Without Cause. Notwithstanding anything contained in Section 3 to the contrary, the Company may terminate Employee's employment pursuant to this Agreement without cause upon at least thirty (30) days' prior written notice to Employee. Subject to the provisions of clause (ii) of Section 1 hereof, in the event Employee's employment with the Company is terminated by the Company without cause, the Company shall remain subject to its obligations hereunder as if Employee remained employed hereunder for the balance of the term hereof, as provided in Section 3 above. 5. Compensation and Benefits. a) Annual Salary. During the term of this Agreement and for all services rendered by Employee under this Agreement, the Company will pay Employee a base salary of One Hundred Fifty Thousand Dollars ($150,000.00) per annum in equal bi-weekly installments. Such annual salary will be subject to adjustments by any increases given in the normal course of business. b) Incentive Compensation. Beginning on January 1, 1997 and lasting through the remaining term of the Agreement, Employee shall be entitled to incentive compensation payments in accordance with the Incentive Compensation Plan for Medaphis Corporation and its Subsidiary Corporations (the "Incentive Compensation Plan"). In the event the Company achieves the parameters set forth in the Plan, such incentive compensation payments will be limited in the aggregate to 40% of Employee's base salary. c) Stock Options. As soon as reasonably practicable after the signing of this Agreement, and subject to the approval of the Compensation Committee of the Board of Directors of Medaphis Corporation, the Company will cause Medaphis to issue to Employee, effective as of the date approved by the Compensation Committee of the Board of Directors of Medaphis Corporation, options to purchase Fifty Thousand (50,000) shares of Medaphis Common Stock pursuant to the terms and conditions of the Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan ("Stock Option Plan"), as amended. Such options will vest at the rate of thirty-three percent (33%) per year for a three-year period beginning on the starting date of this Agreement, subject to the terms and conditions of the Stock Option Plan. The grant of options referenced in this Section is the same grant of options which was previously communicated to Employee via letter from David McDowell on Tuesday, November 26, 1996, and does not represent an additional grant of options to Employee. Employee shall be considered for additional grants of options to purchase shares of Medaphis common stock in a manner which is consistent with other senior officers of the Company. However, nothing in this Agreement shall give rise to a contractual right to Employee to receive grants of additional stock options of Medaphis. Further, Medaphis has -4- 5 no obligation to Employee to create parity with any other Medaphis executives with respect to any options granted to such other executives. d) Other Benefits. Employee will be entitled to such fringe benefits as may be provided from time-to-time by the Company to its employees, including, but not limited to, group health insurance, life and disability insurance, vacations and any other fringe benefits now or hereafter provided by the Company to its employees, if and when Employee meets the eligibility requirements for any such benefit. The Company reserves the right to change or discontinue any employee benefit plans or programs now being offered to its employees; provided, however, that all benefits provided for employees of the same position and status as Employee will be provided to Employee on an equal basis. e) Business Expenses. Employee will be reimbursed for all reasonable expenses incurred in the discharge of Employee's duties under this Agreement pursuant to the Company's standard reimbursement policies. f) Withholding. The Company will deduct and withhold from the payments made to Employee under this Agreement, state and federal income taxes, FICA and other amounts normally withheld from compensation due employees. g) Relocation Expenses. Provided Employee supplies the Company with adequate documentation, Employee will be compensated for the following expenses associated with Employee's relocation from Pennsylvania to Atlanta, Georgia : i. Employee will be reimbursed for all reasonable and customary costs incurred by Employee in connection with the sale of Employee's existing residence in the State of Pennsylvania; ii. Employee will be reimbursed for all reasonable and customary costs incurred by Employee in connection with the acquisition of Employee's new residence in the State of Georgia; iii. Employee will receive a temporary housing allowance of $2,000.00 per month, not to exceed three months, to allow Employee to locate an acceptable residence; and iv. Employee will be reimbursed for all reasonable and customary moving costs incurred by Employee in connection with his relocation from the State of Pennsylvania to the State of Georgia. -5- 6 h) Tax Gross-Up Payment. Employee will receive a payment from the Company (the "Tax Gross-Up Payment") in an amount equal to the federal and state income taxes payable by Employee as a result of the amounts reimbursed to Employee under Section 5(g) of this Agreement and the Tax Gross-Up Payment, after taking into consideration any income tax deductions available to Employee with respect to any such expenses so reimbursed. Such Tax Gross-Up Payments shall be paid to Employee at such time or times as Employee shall provide the Company with sufficient documentation to calculate the same. i) Attorney's Fees. Employee will be reimbursed for reasonable attorney's fees, not to exceed Three Thousand Dollars ($3,000.00), in connection with the review of this Agreement by Employee's legal counsel. j) House Loan. The Company agrees to loan Employee Seventy-Five Thousand Dollars ($75,000.00) for the purpose of securing his Georgia residence. Employee agrees to secure this loan with a second mortgage on Employee's residence. The parties agree that this loan will be forgiven on a pro-rata basis over a five year period (forgiven at a rate of $15,000.00 per year), so that in the event Employee remains employed with the Company following the end of five years from the effective date of this Agreement, he will not be required to repay this loan. In the event Employee is terminated from the Company for any reason, that portion of the loan which has not yet been forgiven will be immediately due and owing to the Company. k) Departure of David E. McDowell. In the event David E. McDowell, for whatever reason, leaves his position as the Chairman and Chief Executive Officer of Medaphis Corporation, Employee will be provided sixty (60) days within which to decide whether Employee desires to remain employed by the Company. In the event Employee elects to continue his employment with the Company following such a departure from the Company by David E. McDowell, this Agreement will remain in effect according to all of its terms. In the event Employee elects to resign following the departure from the Company of David E. McDowell, Employee will be entitled to have the remaining portion of this Agreement paid out according to its terms. 6. Non-Disclosure of Proprietary Information. Employee recognizes and acknowledges that the Trade Secrets (as defined below) and Confidential Information (as defined below) of the Company and its affiliates and all physical embodiments thereof (as they may exist from time-to-time, collectively, the "Proprietary Information") are valuable, special and unique assets of the Company's and its affiliates' businesses. Employee further acknowledges that access to such Proprietary Information is essential to the performance of Employee's duties under this Agreement. Therefore, in order to obtain access to such Proprietary Information, Employee agrees that Employee shall hold in confidence all Proprietary Information and will not reproduce, use, distribute, disclose, publish or otherwise disseminate any Proprietary -6- 7 Information, in whole or in part, and will take no action causing, or fail to take any action necessary to prevent causing, any Proprietary Information to lose its character as Proprietary Information, nor will Employee make use of any such information for Employee's own purposes or for the benefit of any person, firm, corporation, association or other entity (except the Company) under any circumstances. For purposes of this Agreement, the term "Trade Secrets" means information, including, but not limited to, any technical or nontechnical data, formula, pattern, compilation, program, device, method, technique, drawing, process, financial data, financial plan, product plan, list of actual or potential customers or suppliers, or other information similar to any of the foregoing, which derives economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can derive economic value from its disclosure or use. For purposes of this Agreement, the term "Trade Secrets" does not include information that Employee can show by competent proof (i) was known to Employee and reduced to writing prior to disclosure by the Company (but only if Employee promptly notifies the Company of Employee's prior knowledge); (ii) was generally known to the public at the time the Company disclosed the information to Employee; (iii) became generally known to the public after disclosure by the Company through no act or omission of Employee; or (iv) was disclosed to Employee by a third party having a bona fide right both to possess the information and to disclose the information to Employee. The term "Confidential Information" means any data or information of the Company, other than trade secrets, which is valuable to the Company and not generally known to competitors of the Company. The provisions of this Section 6 will apply to Trade Secrets for so long as such information remains a trade secret and to Confidential Information during Employee's employment with the Company and for a period of two (2) years following any termination of Employee's employment with the Company for whatever reason. 7.A. Non-Competition Covenant. During Employee's employment by the Company and for a period of two (2) years following any termination of Employee's employment for whatever reason, Employee will not, directly or indirectly, on Employee's own behalf or in the service of or on behalf of any other individual or entity, compete with the Company within the Geographical Area (as hereinafter defined). The term "compete" means to engage in, have any equity or profit interest in, make any loan to or for the benefit of, or render any services of any kind to, directly or indirectly, on Employee's own behalf or in the service of or on behalf of any other individual or entity, either as a proprietor, employee, agent, independent contractor, consultant, director, officer, partner or stockholder (other than a stockholder of a corporation listed on a national securities exchange or whose stock is regularly traded in the over-the-counter market, provided that Employee at no time owns, directly or indirectly, in excess of one percent (1%) of the outstanding stock of any class of any such corporation) any business which provides Business services. For purposes of this Agreement, the term -7- 8 "Geographical Area" means the territory located within a seventy-five (75) mile radius of each facility for which Employee has management responsibility during Employee's employment with the Company. B. Non-Solicitation of Clients Covenant. Employee agrees that during Employee's employment by the Company and for a period of two (2) years following the termination of Employee's employment for whatever reason, Employee will not, directly or indirectly, on Employee's own behalf or in the service of or on behalf of any other individual or entity, divert, solicit or attempt to solicit any individual or entity (i) who is a client of the Company at any time during the six (6)-month period prior to Employee's termination of employment with the Company ("Client"), or was actively sought by the Company as a prospective client, and (ii) with whom Employee had material contact while employed by the Company to provide Business services to such Clients or prospects. C. Construction. The parties hereto agree that any judicial authority construing all or any portion of this Section 7 or Section 8 below may, if it chooses, sever any portion of the Geographical Area, client base, prospective relationship or prospect list or any prohibited business activity from the coverage of such Section and to apply the provisions of such Section to the remaining portion of the Geographical Area, the client base or the prospective relationship or prospect list, or the remaining business activities not so severed by such judicial authority. In addition, it is the intent of the parties that the judicial authority may, if it chooses, replace each such severed provision with a provision as similar in terms to such severed provision as may be possible and be legal, valid and enforceable. It is the intent of the parties that Sections 7 and 8 be enforced to the maximum extent permitted by law. In the event that any provision of either such Section is determined not to be specifically enforceable, the Company shall nevertheless be entitled to bring an action to seek to recover monetary damages as a result of the breach of such provision by Employee. 8. Non-Solicitation of Employees Covenant. Employee further agrees and represents that during Employee's employment by the Company and for a period of two (2) years following any termination of Employee's employment for whatever reason, Employee will not, directly or indirectly, on Employee's own behalf or in the service of, or on behalf of any other individual or entity, divert, solicit or hire away, or attempt to divert, solicit or hire away, to or for any individual or entity which is engaged in providing Business services, any person employed by the Company for whom Employee had supervisory responsibility or with whom Employee had material contact while employed by the Company, whether or not such employee is a full-time employee or temporary employee of the Company, whether or not such employee is employed pursuant to written agreement and whether or not such employee is employed for a determined period or at-will. -8- 9 9. Existing Restrictive Covenants. Employee represents and warrants that Employee's employment with the Company does not and will not breach any agreement which Employee has with any former employer to keep in confidence confidential information or not to compete with any such former employer. Employee will not disclose to the Company or use on its behalf any confidential information of any other party required to be kept confidential by Employee. 10. Return of Proprietary Information. Employee acknowledges that as a result of Employee's employment with the Company, Employee may come into the possession and control of Proprietary Information, such as proprietary documents, drawings, specifications, manuals, notes, computer programs, or other proprietary material. Employee acknowledges, warrants and agrees that Employee will return to the Company all such items and any copies or excerpts thereof, and any other properties, files or documents obtained as a result of Employee's employment with the Company, immediately upon the termination of Employee's employment with the Company. 11. Proprietary Rights. During the course of Employee's employment with the Company, Employee may make, develop or conceive of useful processes, machines, compositions of matter, computer software, algorithms, works of authorship expressing such algorithm, or any other discovery, idea, concept, document or improvement which relates to or is useful to the Company's Business (the "Inventions"), whether or not subject to copyright or patent protection, and which may or may not be considered Proprietary Information. Employee acknowledges that all such Inventions will be "works made for hire" under United States copyright law and will remain the sole and exclusive property of the Company. Employee also hereby assigns and agrees to assign to the Company, in perpetuity, all right, title and interest Employee may have in and to such Inventions, including without limitation, all copyrights, and the right to apply for any form of patent, utility model, industrial design or similar proprietary right recognized by any state, country or jurisdiction. Employee further agrees, at the Company's request and expense, to do all things and sign all documents or instruments necessary, in the opinion of the Company, to eliminate any ambiguity as to the ownership of, and rights of the Company to, such Inventions, including filing copyright and patent registrations and defending and enforcing in litigation or otherwise all such rights. Employee will not be obligated to assign to the Company any Invention made by Employee while in the Company's employ which does not relate to any business or activity in which the Company is or may reasonably be expected to become engaged, except that Employee is so obligated if the same relates to or is based on Proprietary Information to which Employee will have had access during and by virtue of Employee's employment or which arises out of work assigned to Employee by the Company. Employee will not be obligated to assign any Invention which may be wholly conceived by Employee after Employee leaves -9- 10 the employ of the Company, except that Employee is so obligated if such Invention involves the utilization of Proprietary Information obtained while in the employ of the Company. Employee is not obligated to assign any Invention which relates to or would be useful in any business or activities in which the Company is engaged if such Invention was conceived and reduced to practice by Employee prior to Employee's employment with the Company, provided that all such Inventions are listed at the time of employment on the attached Exhibit A. 12. Remedies. Employee agrees and acknowledges that the violation of any of the covenants or agreements contained in Sections 6, 7, 8, 9, 10 and 11 of this Agreement would cause irreparable injury to the Company, that the remedy at law for any such violation or threatened violation thereof would be inadequate, and that the Company will be entitled, in addition to any other remedy, to temporary and permanent injunctive or other equitable relief without the necessity of proving actual damages or posting a bond. 13. Notices. Any notice or communication under this Agreement will be in writing and sent by registered or certified mail addressed to the respective parties as follows: If to the Company: If to Employee: 2700 Cumberland Parkway Daniel S. Connors, Jr. Suite 300 2700 Cumberland Parkway Atlanta, GA 30339 Suite 300 Attn: General Counsel Atlanta, GA 30339 14. Severability. Subject to the application of Section 7(C) to the interpretation of Sections 7 and 8, in case one or more of the provisions contained in this Agreement is for any reason held to be invalid, illegal or unenforceable in any respect, the parties agree that it is their intent that the same will not affect any other provision in this Agreement, and this Agreement will be construed as if such invalid or illegal or unenforceable provision had never been contained herein. It is the intent of the parties that this Agreement be enforced to the maximum extent permitted by law. 15. Entire Agreement. This Agreement embodies the entire agreement of the parties relating to the subject matter of this Agreement and supersedes all prior agreements, oral or written, regarding the subject matter hereof. No amendment or modification of this Agreement will be valid or binding upon the parties unless made in writing and signed by the parties. 16. Binding Effect. This Agreement will be binding upon the parties and their respective heirs, representatives, successors, transferees and permitted assigns. -10- 11 17. Assignment. This Agreement is one for personal services and will not be assigned by Employee. The Company may assign this Agreement to its parent company or to any of its subsidiaries or affiliated companies; provided that the parent or any subsidiary or affiliate fulfills the obligations of the Company under this Agreement. 18. Governing Law. This Agreement is entered into and will be interpreted and enforced pursuant to the laws of the State of Georgia. The parties hereto hereby agree that the appropriate forum and venue for any disputes between any of the parties hereto arising out of this Agreement shall be any federal court in the state where the Company has its principal place of business and each of the parties hereto hereby submits to the personal jurisdiction of any such court. The foregoing shall not limit the rights of any party to obtain execution of judgment in any other jurisdiction. The parties further agree, to the extent permitted by law, that a final and unappealable judgment against either of them in any action or proceeding contemplated above shall be conclusive and may be enforced in any other jurisdiction within or outside the United States by suit on the judgment, a certified exemplified copy of which shall be conclusive evidence of the fact and amount of such judgment. 19. Surviving Terms. Sections 6, 7, 8, 9, 10, 11 and 12 of this Agreement shall survive termination of this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. COMPANY: EMPLOYEE: MEDAPHIS CORPORATION By: /s/ David McDowell /s/ Daniel S. Connors, Jr. --------------------------------- ----------------------------------- Daniel S. Connors, Jr. Title: CEO ------------------------------ -11- 12 EXHIBIT A INVENTIONS Employee represents that there are no Inventions. DSC, Jr. ----------------- Employee Initials -12- EX-10.51 14 EMPLOYMENT AGREEMENT (SCHAPER) 1 EXHIBIT 10.51 EMPLOYMENT AGREEMENT This Employment Agreement (the "Agreement") is made and entered into this 25th day of February, 1997, by and between MEDAPHIS CORPORATION, a Delaware corporation (the "Company"), and Carl James Schaper, a resident of the State of Georgia (the "Employee"). Statement of Background Information The Company: (a) develops, markets and licenses to hospitals, integrated healthcare delivery systems, and other healthcare providers and other end users (collectively "Providers"), (i) strategic, operational and financial information systems and services and decision support tools for healthcare providers, (ii) software systems which provide claims and reimbursement services and electronic claims processing, and (iii) software applications which assist Providers with automated scheduling and resource management (the items discussed in Sections (a)(i), (a)(ii) and (a)(iii) of this paragraph are referred to as "Systems"), which Systems include, but are not limited to, nurse scheduling and management information systems, operating room patient scheduling and surgery information systems, enterprise wide patient scheduling and resource management systems, enterprise-wide employee scheduling and management information systems and related software interfaces to other information systems; and (b) provides to Providers installation and support services related to the Company's Systems (the "Business"). In consideration of the mutual covenants, promises and conditions set forth in this Agreement, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Employment. The Company hereby employs Employee and Employee hereby accepts such employment upon the terms and conditions set forth in this Agreement. Notwithstanding anything in this Agreement to the contrary, in the event the Company is paying Employee salary, wages, benefits, severance or any other sums of money after termination of Employee's employment with the Company, and Employee obtains any other employment for consideration in any capacity, then such payments will cease immediately if Employee's employment with the Company was terminated as a result of the occurrence of any events described in Section 4(a)(i) through 4(a)(iii) hereof ("terminated for cause"). 2. Duties of Employee. Employee's title will be Executive Vice President of Medaphis Corporation and President of Medaphis Healthcare Information Technology Company and Employee will report directly to the Chief Executive Officer of the Company. Employee agrees to perform and discharge such other duties as may be assigned to Employee from time to time by the Company to the reasonable satisfaction of the Company, and such duties will be consistent with those duties regularly and customarily assigned by the Company to the position of Executive Vice President of Medaphis Corporation and President of Medaphis -1- 2 Healthcare Information Technology Company. Employee also agrees to comply with all of the Company's policies, standards and regulations and to follow the instructions and directives of Employee's superiors within the Company, as promulgated by the officers of the Company. Employee will devote Employee's full professional and business-related time, skills and best efforts to such duties and will not, during the term of this Agreement, be engaged (whether or not during normal business hours) in any other business or professional activity, whether or not such activity is pursued for gain, profit or other pecuniary advantage, without the prior written consent of the Chief Executive Officer of the Company, which consent will not be unreasonably withheld. This Section will not be construed to prevent Employee from (a) investing personal assets in businesses which do not compete with the Company in such form or manner that will not require any services on the part of Employee in the operation or the affairs of the companies in which such investments are made and in which Employee's participation is solely that of an investor; (b) purchasing securities in any corporation whose securities are listed on a national securities exchange or regularly traded in the over-the-counter market, provided that Employee at no time owns, directly or indirectly, in excess of one percent (1%) of the outstanding stock of any class of any such corporation engaged in a business competitive with that of the Company; or (c) participating in conferences, preparing and publishing papers or books or teaching, so long as the Chief Executive Officer of the Company approves such participation, preparation and publication or teaching prior to Employee's engaging therein. 3. Term. The term of this Agreement will be for a three (3) year period of time, commencing as of February 25, 1997 and expiring on February 25, 2000, subject to earlier termination as provided for in Section 4 of this Agreement. Both parties to this Agreement agree that they will provide ninety (90) days' notice to the other side as to whether they intend to negotiate to extend the term of this Agreement at the end of the initial three year term of this Agreement. 4. Termination. (a) Termination by Company for Cause. Notwithstanding anything contained in Section 3 to the contrary, the Company may terminate this Agreement and all of its obligations hereunder immediately if any of the following events occur: (i) Employee materially breaches any of the terms or conditions set forth in this Agreement and fails to cure such breach within ten (10) days after Employee's receipt from the Company of written notice of such breach (notwithstanding the foregoing, no cure period shall be applicable to breaches by Employee of Sections 6, 7 or 8 of this Agreement); (ii) Employee engages in dishonest or illegal activities or commits or is convicted of any crime involving fraud, deceit or moral turpitude; or -2- 3 (iii) Employee dies or becomes mentally or physically incapacitated or disabled so as to be unable to perform Employee's duties under this Agreement. Without limiting the generality of the foregoing, Employee's inability adequately to perform services under this Agreement for a period of sixty (60) consecutive days will be conclusive evidence of such mental or physical incapacity or disability, unless such inability adequately to perform services under this Agreement is pursuant to a mental or physical incapacity or disability covered by the Family Medical Leave Act, in which case such sixty (60)-day period shall be extended to a one hundred and twenty (120)-day period. (b) Termination by Company Without Cause. Notwithstanding anything contained in Section 3 to the contrary, the Company may terminate Employee's employment pursuant to this Agreement without cause upon at least thirty (30) days' prior written notice to Employee. Subject to the provisions of clause (ii) of Section 1 hereof, in the event Employee's employment with the Company is terminated by the Company without cause, the Company shall remain subject to its obligations hereunder as if Employee remained employed hereunder for the balance of the term hereof, as provided in Section 3 above. (c) Change in Control. In the event there is a change in control of Medaphis Corporation, Employee will be provided thirty (30) days in which to decide whether Employee desires to remain employed by the Company under the terms of this Agreement. In the event Employee elects to continue his employment with the Company following such a change in control, this Agreement will remain in effect according to all of its terms. In the event Employee decides to resign from the Company following such a change in control, Employee will be entitled to receive a severance payment equal to the greater of (1) one year of salary continuation at Employee's then current base salary, or (2) those payments due and owing to Employee under the remaining term of this Agreement. For purposes of this Agreement, a "change in control" of Medaphis Corporation shall be deemed to occur upon any of the following: (i) a consolidation or merger of Medaphis Corporation with or into any other corporation, or any other entity or person, other than a wholly-owned subsidiary of Medaphis Corporation, excluding any transaction in which stockholders of Medaphis Corporation prior to the transaction will maintain voting control or own at least 50% of the resulting entity after the transaction; (ii) any corporate reorganization, including an exchange offer, in which Medaphis Corporation shall not be the continuing or surviving entity resulting from such reorganization, excluding any transaction in which stockholders of the Medaphis -3- 4 Corporation prior to the transaction will maintain voting control or own at least 50% of the resulting entity after the transaction; or (iii) the sale of a substantial portion of Medaphis Corporation's assets, which shall be deemed to occur on the date that any one person, or more than one person acting as a group, acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) assets from Medaphis Corporation that (a) have a total fair market value equal to more than 50% of the total fair market value of all the assets of Medaphis Corporation, immediately prior to such acquisition or acquisitions, or (b) have a total fair market value equal to more than 75% of the total fair market value of all the assets of Medaphis Healthcare Information Technology Company immediately prior to such acquisition or acquisitions, or (c) represents a majority of the common stock of any (1) subsidiary of Medaphis Corporation, the revenues of which, in the most recent fiscal year, represent more than 75% of the consolidated gross revenues of Medaphis Corporation and its subsidiaries. Notwithstanding the foregoing, a transfer of assets or common stock in a subsidiary by Medaphis Corporation will not be treated as a sale of a substantial portion of Medaphis Corporation's assets if the assets are transferred to an entity, 50% or more of the total value or voting power of which is owned, directly or indirectly, by Medaphis Corporation. 5. Compensation and Benefits. a) Annual Salary. During the term of this Agreement and for all services rendered by Employee under this Agreement, the Company will pay Employee a base salary of Two Hundred Fifty Thousand Dollars ($250,000.00) per annum in equal bi-weekly installments. Such annual salary will be subject to adjustments by any increases given in the normal course of business. b) Incentive Compensation. Employee shall be eligible to participate in the 1997 Medaphis Corporation and its Subsidiary Corporations Incentive Compensation Plan at a participation category of 80% of Employee's base salary, payable at the discretion of the Board of Directors of the Company. At the end of the initial year of the Agreement, Employee shall be eligible to receive an additional payment of One Hundred Thousand Dollars ($100,000.00). c) Stock Options. As soon as reasonably practicable after the signing of this Agreement, the Company will cause Medaphis to issue to Employee, effective as of February 25, 1997, options to purchase Two Hundred and Fifty Thousand (250,000) shares of Medaphis Common Stock pursuant to the terms and conditions of the Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan ("Stock Option Plan"), as amended. Such options will vest at the rate of thirty-three and one-third percent (33.33%) per year for a -4- 5 three-year period beginning on the starting date of this Agreement, subject to the terms and conditions of the Stock Option Plan. Employee shall be considered for additional grants of options to purchase shares of the Company's common stock in a manner which is consistent with other senior officers of the Company. However, nothing in this Agreement shall give rise to a contractual right to Employee to receive grants of additional stock options of the Company. Further, the Company has no obligation to Employee to create parity with any other Company executives with respect to any options granted to such other executives. d) Other Benefits. Employee will be entitled to such fringe benefits as may be provided from time-to-time by the Company to its employees, including, but not limited to, group health insurance, life and disability insurance, vacations and any other fringe benefits now or hereafter provided by the Company to its employees, if and when Employee meets the eligibility requirements for any such benefit. The Company reserves the right to change or discontinue any employee benefit plans or programs now being offered to its employees; provided, however, that all benefits provided for employees of the same position and status as Employee will be provided to Employee on an equal basis. e) Business Expenses. Employee will be reimbursed for all reasonable expenses incurred in the discharge of Employee's duties under this Agreement pursuant to the Company's standard reimbursement policies. f) Withholding. The Company will deduct and withhold from the payments made to Employee under this Agreement, state and federal income taxes, FICA and other amounts normally withheld from compensation due employees. g) Signing Bonus. Upon execution of this Agreement, the Company will pay Employee a signing bonus in the amount of One Hundred Thousand Dollars ($100,000.00). h) Attorney's Fees. Employee will be reimbursed for reasonable attorney's fees, not to exceed Three Thousand Dollars ($3,000.00), in connection with the review of this Agreement by Employee's legal counsel. 6. Non-Disclosure of Proprietary Information. Employee recognizes and acknowledges that the Trade Secrets (as defined below) and Confidential Information (as defined below) of the Company and its affiliates and all physical embodiments thereof (as they may exist from time-to-time, collectively, the "Proprietary Information") are valuable, special and unique assets of the Company's and its affiliates' businesses. Employee further acknowledges that access to such Proprietary Information is essential to the performance of Employee's duties under this Agreement. Therefore, in order to obtain access to such Proprietary Information, Employee agrees that, except with respect to those duties assigned to him by the Company, Employee shall hold in confidence all Proprietary Information and will not reproduce, use, distribute, disclose, publish or otherwise disseminate any Proprietary Information, in whole -5- 6 or in part, and will take no action causing, or fail to take any action necessary to prevent causing, any Proprietary Information to lose its character as Proprietary Information, nor will Employee make use of any such information for Employee's own purposes or for the benefit of any person, firm, corporation, association or other entity (except the Company) under any circumstances. For purposes of this Agreement, the term "Trade Secrets" means information, including, but not limited to, any technical or nontechnical data, formula, pattern, compilation, program, device, method, technique, drawing, process, financial data, financial plan, product plan, list of actual or potential customers or suppliers, or other information similar to any of the foregoing, which derives economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can derive economic value from its disclosure or use. For purposes of this Agreement, the term "Trade Secrets" does not include information that Employee can show by competent proof (i) was known to Employee and reduced to writing prior to disclosure by the Company (but only if Employee promptly notifies the Company of Employee's prior knowledge); (ii) was generally known to the public at the time the Company disclosed the information to Employee; (iii) became generally known to the public after disclosure by the Company through no act or omission of Employee; or (iv) was disclosed to Employee by a third party having a bona fide right both to possess the information and to disclose the information to Employee. The term "Confidential Information" means any data or information of the Company, other than trade secrets, which is valuable to the Company and not generally known to competitors of the Company. The provisions of this Section 6 will apply to Trade Secrets for so long as such information remains a trade secret and to Confidential Information during Employee's employment with the Company and for a period of two (2) years following any termination of Employee's employment with the Company for whatever reason. 7.A. Non-Competition Covenant. During Employee's employment by the Company and for a period of two (2) years following any termination of Employee's employment for whatever reason, Employee will not, directly or indirectly, on Employee's own behalf or in the service of or on behalf of any other individual or entity, compete with the Company within the Geographical Area (as hereinafter defined). The term "compete" means to engage in, have any equity or profit interest in, make any loan to or for the benefit of, or render any services of any kind to, directly or indirectly, on Employee's own behalf or in the service of or on behalf of any other individual or entity, either as a proprietor, employee, agent, independent contractor, consultant, director, officer, partner or stockholder (other than a stockholder of a corporation listed on a national securities exchange or whose stock is regularly traded in the over-the-counter market, provided that Employee at no time owns, directly or indirectly, in excess of one percent (1%) of the outstanding stock of any class of any such corporation) any business which provides Business products or services. For purposes of this Agreement, the term "Geographical Area" means the territory located within a seventy-five (75) mile -6- 7 radius of each facility for which Employee has management responsibility during Employee's employment with the Company. B. Non-Solicitation of Clients Covenant. Employee agrees that during Employee's employment by the Company and for a period of two (2) years following the termination of Employee's employment for whatever reason, Employee will not, directly or indirectly, on Employee's own behalf or in the service of or on behalf of any other individual or entity, divert, solicit or attempt to solicit any individual or entity (i) who is a client of the Company at any time during the six (6)-month period prior to Employee's termination of employment with the Company ("Client"), or was actively sought by the Company as a prospective client, and (ii) with whom Employee had material contact while employed by the Company to provide Business services or products to such Clients or prospects. C. Construction. The parties hereto agree that any judicial authority construing all or any portion of this Section 7 or Section 8 below may, if it chooses, sever any portion of the Geographical Area, client base, prospective relationship or prospect list or any prohibited business activity from the coverage of such Section and to apply the provisions of such Section to the remaining portion of the Geographical Area, the client base or the prospective relationship or prospect list, or the remaining business activities not so severed by such judicial authority. In addition, it is the intent of the parties that the judicial authority may, if it chooses, replace each such severed provision with a provision as similar in terms to such severed provision as may be possible and be legal, valid and enforceable. It is the intent of the parties that Sections 7 and 8 be enforced to the maximum extent permitted by law. In the event that any provision of either such Section is determined not to be specifically enforceable, the Company shall nevertheless be entitled to bring an action to seek to recover monetary damages as a result of the breach of such provision by Employee. 8. Non-Solicitation of Employees Covenant. Employee further agrees and represents that during Employee's employment by the Company and for a period of two (2) years following any termination of Employee's employment for whatever reason, Employee will not, directly or indirectly, on Employee's own behalf or in the service of, or on behalf of any other individual or entity, divert, solicit or hire away, or attempt to divert, solicit or hire away, to or for any individual or entity which is engaged in providing Business services or products, any person employed by the Company for whom Employee had supervisory responsibility or with whom Employee had material contact while employed by the Company, whether or not such employee is a full-time employee or temporary employee of the Company, whether or not such employee is employed pursuant to written agreement and whether or not such employee is employed for a determined period or at-will. 9. Existing Restrictive Covenants. Employee represents and warrants that Employee's employment with the Company does not and will not breach any agreement which Employee has with any former employer to keep in confidence confidential information or not to -7- 8 compete with any such former employer. Employee will not disclose to the Company or use on its behalf any confidential information of any other party required to be kept confidential by Employee. 10. Return of Proprietary Information. Employee acknowledges that as a result of Employee's employment with the Company, Employee may come into the possession and control of Proprietary Information, such as proprietary documents, drawings, specifications, manuals, notes, computer programs, or other proprietary material. Employee acknowledges, warrants and agrees that Employee will return to the Company all such items and any copies or excerpts thereof, and any other properties, files or documents obtained as a result of Employee's employment with the Company, immediately upon the termination of Employee's employment with the Company. 11. Proprietary Rights. During the course of Employee's employment with the Company, Employee may make, develop or conceive of useful processes, machines, compositions of matter, computer software, algorithms, works of authorship expressing such algorithm, or any other discovery, idea, concept, document or improvement which relates to or is useful to the Company's Business (the "Inventions"), whether or not subject to copyright or patent protection, and which may or may not be considered Proprietary Information. Employee acknowledges that all such Inventions will be "works made for hire" under United States copyright law and will remain the sole and exclusive property of the Company. Employee also hereby assigns and agrees to assign to the Company, in perpetuity, all right, title and interest Employee may have in and to such Inventions, including without limitation, all copyrights, and the right to apply for any form of patent, utility model, industrial design or similar proprietary right recognized by any state, country or jurisdiction. Employee further agrees, at the Company's request and expense, to do all things and sign all documents or instruments necessary, in the opinion of the Company, to eliminate any ambiguity as to the ownership of, and rights of the Company to, such Inventions, including filing copyright and patent registrations and defending and enforcing in litigation or otherwise all such rights. Employee will not be obligated to assign to the Company any Invention made by Employee while in the Company's employ which does not relate to any business or activity in which the Company is or may reasonably be expected to become engaged, except that Employee is so obligated if the same relates to or is based on Proprietary Information to which Employee will have had access during and by virtue of Employee's employment or which arises out of work assigned to Employee by the Company. Employee will not be obligated to assign any Invention which may be wholly conceived by Employee after Employee leaves the employ of the Company, except that Employee is so obligated if such Invention involves the utilization of Proprietary Information obtained while in the employ of the Company. Employee is not obligated to assign any Invention which relates to or would be useful in any -8- 9 business or activities in which the Company is engaged if such Invention was conceived and reduced to practice by Employee prior to Employee's employment with the Company. 12. Remedies. Employee agrees and acknowledges that the violation of any of the covenants or agreements contained in Sections 6, 7, 8, 9, 10 and 11 of this Agreement would cause irreparable injury to the Company, that the remedy at law for any such violation or threatened violation thereof would be inadequate, and that the Company will be entitled, in addition to any other remedy, to temporary and permanent injunctive or other equitable relief without the necessity of proving actual damages or posting a bond. 13. Notices. Any notice or communication under this Agreement will be in writing and sent by registered or certified mail addressed to the respective parties as follows: If to the Company: If to Employee: 2700 Cumberland Parkway Carl James Schaper Suite 300 2700 Cumberland Parkway Atlanta, GA 30339 Suite 300 Attn: General Counsel Atlanta, GA 30339 14. Severability. Subject to the application of Section 7(C) to the interpretation of Sections 7 and 8, in case one or more of the provisions contained in this Agreement is for any reason held to be invalid, illegal or unenforceable in any respect, the parties agree that it is their intent that the same will not affect any other provision in this Agreement, and this Agreement will be construed as if such invalid or illegal or unenforceable provision had never been contained herein. It is the intent of the parties that this Agreement be enforced to the maximum extent permitted by law. 15. Entire Agreement. This Agreement embodies the entire agreement of the parties relating to the subject matter of this Agreement and supersedes all prior agreements, oral or written, regarding the subject matter hereof. No amendment or modification of this Agreement will be valid or binding upon the parties unless made in writing and signed by the parties. 16. Binding Effect. This Agreement will be binding upon the parties and their respective heirs, representatives, successors, transferees and permitted assigns. 17. Assignment. This Agreement is one for personal services and will not be assigned by Employee. The Company may assign this Agreement to its parent company or to any of its subsidiaries or affiliated companies; provided that the parent or any subsidiary or affiliate fulfills the obligations of the Company under this Agreement. -9- 10 18. Governing Law. This Agreement is entered into and will be interpreted and enforced pursuant to the laws of the State of Georgia. The parties hereto hereby agree that the appropriate forum and venue for any disputes between any of the parties hereto arising out of this Agreement shall be any federal court in the state where the Company has its principal place of business and each of the parties hereto hereby submits to the personal jurisdiction of any such court. The foregoing shall not limit the rights of any party to obtain execution of judgment in any other jurisdiction. The parties further agree, to the extent permitted by law, that a final and unappealable judgment against either of them in any action or proceeding contemplated above shall be conclusive and may be enforced in any other jurisdiction within or outside the United States by suit on the judgment, a certified exemplified copy of which shall be conclusive evidence of the fact and amount of such judgment. 19. Indemnification. Employee shall be entitled to the indemnification and exculpation offered through and set forth in the Company's Charter and By-laws. 20. Surviving Terms. Sections 6, 7, 8, 9, 10, 11 and 12 of this Agreement shall survive termination of this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. COMPANY: EMPLOYEE: MEDAPHIS CORPORATION By: /s/ Daniel S. Connors /s/ Carl James Schaper -------------------------------- ----------------------------------- Carl James Schaper Title: SVP Personnel & Admin ------------------------------ -10- 11 EXHIBIT A INVENTIONS Employee represents that there are no Inventions. CJS ----------------- Employee Initials -11- EX-10.52 15 EMPLOYMENT AGREEMENT (BAGLIEN) 1 EXHIBIT 10.52 EMPLOYMENT AGREEMENT This Employment Agreement (the "Agreement") is made and entered into this 3rd day of January, 1997, by and between MEDAPHIS CORPORATION, a Delaware corporation (the "Company" or "Medaphis"), and Jerome H. Baglien, a resident of the State of Illinois (the "Employee"). Statement of Background Information The Company renders to hospitals, physicians, and/or other healthcare organizations and providers: (a) billing services, accounts receivable management services, collection services, electronic claims services, financial management services, and practice and facilities management services: (b) eligibility verification and certification for Medicaid, Medicare and other healthcare assistance programs; (c) filing and other medical claims securitization services; (d) medical coverage information services; and (e) medical and insurance claims monitoring and tracking services (collectively the "Processing Business"). The company also provides subrogation and related recovery services for healthcare payors, including health maintenance organizations, indemnity insurers, Blue Cross and Blue Shield organizations, third-party administrators, self-funded employee health welfare benefit plans, and provider hospital organizations (the "Subrogation Business"). The Company also: (a) develops, markets and licenses to hospitals, integrated healthcare delivery systems, and other healthcare providers and other end users (collectively "Providers"), (i) strategic, operational and financial information systems and services and decision support tools for healthcare providers, (ii) software systems which provide claims and reimbursement services and electronic claims processing, and (iii) software applications which assist Providers with automated scheduling and resource management (the items discussed in Sections (a)(i), (a)(ii) and (a)(iii) of this paragraph are referred to as "Systems"), which Systems include, but are not limited to, nurse scheduling and management information systems, operating room patient scheduling and surgery information systems, enterprise wide patient scheduling and resource management systems, enterprise-wide employee scheduling and management information systems and related software interfaces to other information systems; and (b) provides to Providers installation and support services related to the Company's Systems (the "Systems Business"). The Company also renders professional services with respect to the development of computer software, algorithms, design, documentation, and related materials, and the development, design, deployment, and operation of local and wide area computer networks, all in conjunction with the sale, design, deployment, operation and maintenance of custom computer processing systems for improvement of operational efficiency or functionality through the use of image storage and processing, work flow technology, optical character recognition or other related technologies (the "System Integration Business") (the Processing Business, the Subrogation Business, the Systems -1- 2 Business, the Systems Integration Business and any other distinct business segment in which the Company engages during Employee's employment are collectively referred to as the "Business"). In consideration of the mutual covenants, promises and conditions set forth in this Agreement, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Employment. The Company hereby employs Employee and Employee hereby accepts such employment upon the terms and conditions set forth in this Agreement. For purposes of Sections 7 and 8 of this Agreement, "employment" shall mean any period of time during which the Company is paying the Employee salary, wages, or any other amounts, whether or not the Employee is currently performing services for the Company at the time of such payment. Notwithstanding anything in this Agreement to the contrary, in the event the Company is paying the Employee salary, wages, benefits, severance or any other sums of money after termination of Employee's employment with the Company, and Employee obtains any other employment for consideration in any capacity, then such payments will cease immediately if Employee's employment with the Company was terminated as a result of the occurrence of any events described in Section 4(b)(i) ("terminated for cause"). 2. Duties of Employee. Employee's title will be Senior Vice President and Chief Financial Officer and Employee will report directly to the Chief Executive Officer and/or President of the Company. Employee agrees to perform and discharge such other duties, which are not inconsistent with such position, as may be assigned to Employee from time to time by the Company to the reasonable satisfaction of the Company for the normal professional performance of this position. Employee also agrees to comply with all of the Company's policies, standards and regulations and to follow the instructions and directives of Employee's superiors within the Company, as promulgated by the officers of the Company. Employee will devote Employee's full professional and business-related time, skills and best efforts to such duties and will not, during the term of this Agreement, be engaged (whether or not during normal business hours) in any other business or professional activity, whether or not such activity is pursued for gain, profit or other pecuniary advantage, without the prior written consent of the Chief Executive Officer or President of the Company, which consent will not be unreasonably withheld. This Section will not be construed to prevent Employee from (a) investing personal assets in businesses which do not compete with the Company in such form or manner that will not require any services on the part of Employee in the operation or the affairs of the companies in which such investments are made and in which Employee's participation is solely that of an investor; (b) purchasing securities in any corporation whose securities are listed on a national securities exchange or regularly traded in the over-the-counter market, provided that Employee at no time owns, directly or indirectly, in excess of one percent (1%) of the outstanding stock of any class of any such corporation engaged in a business competitive with that of the Company; or (c) participating in conferences, preparing and publishing papers or books or teaching, so long as the Chief Executive Officer or President of the Company approves such participation, preparation and publication or teaching prior to Employee's engaging therein. -2- 3 3. Term. The term of this Agreement will be for a three year period of time, commencing as of February 7, 1997 and expiring on February 7, 2000, subject to earlier termination as provided for in Section 4 of this Agreement. 4. Termination. (a) Termination upon Death or Disability. If Employee dies during the Term, this Agreement shall terminate as of Employee's death to the extent described below in this Section 4. If Employee by virtue of "disability" (as determined below) is unable to perform substantially all of the Employee's duties hereunder, the Company shall, to the extent permitted by law, have the right to terminate the employment of Employee upon notice in writing to Employee. Upon death or other termination of employment by virtue of such disability, (i) Employee (or Employees estate or beneficiaries in the case of the death of Employee) shall be entitled to receive any Annual Salary and Benefit Plan benefits theretofore earned or accrued under this Agreement, and reimbursement under Section 5 for expenses incurred, prior to the date of termination, and (ii) this Agreement shall otherwise terminate upon such death or other termination of employment and there shall be no further rights with respect to Employee hereunder; provided that no provision of this Agreement shall limit any of Employee's rights (or the rights of Employee's estate or beneficiaries) otherwise set forth under any insurance, pension or other benefit programs of the Company for which Employee shall be eligible at the time of such death or disability. For purposes of this Section 4, Employee shall be deemed to have incurred a "disability" if, because of injury or sickness, Employee cannot for a period of one hundred and twenty (120) days in a consecutive 365-day period, perform substantially all of the essential duties of Employee's regular occupation, unless, such inability to adequately perform services under this Agreement is pursuant to a mental or physical incapacity or disability covered by the Family Medical Leave Act, in which case such one hundred and twenty (120) day period shall be extended to a one hundred and eighty (180) day period. (b) Termination for Cause; Termination by Employee without Good Reason (i) for purposes of this Agreement, "Cause" shall be deemed to exist if Employee (i) commits (a) a felony, (b) a crime of fraud, moral turpitude, dishonesty, breach of trust or unethical business conduct or (c) any crime or misdemeanor involving the Company, (ii) acts, or fails to act, to the detriment of the Company where such action or inaction constitutes material misconduct, intentional or gross neglect, fraud, misappropriation or embezzlement, (iii) breaches this Agreement in any material respect, and fails to cure such breach within ten (10) days after Employee's receipt of written -3- 4 notice of such breach (notwithstanding the foregoing, no cure period shall be applicable to breaches by Employee of Section 6, 7 or 8 of this Agreement). (ii) For purposes of this Agreement, "Good Reason" shall be deemed to exist if, without Employee's express written consent, (i) the Company materially breaches this Agreement, (ii) Employee is assigned duties materially inconsistent with Section 2, or (iii) Employee's duties and responsibilities are substantially reduced without Cause. Employee shall not be deemed to have terminated employment for Good Reason unless (i) Employee gives the Company notice of termination of Employee's employment not later than thirty days after the occurrence of the event or condition constituting Good Reason; provided that a continuing event or condition first occurs or arises; and (ii) such notice specifies an effective date for the termination which is at least thirty days after the date of the notice. Notwithstanding the foregoing, (i) if there exists (without regard to this clause (i) an event or condition that constitutes Good Reason, the Company shall have ten days from the date such notice is given to cure such event or condition and, if the Company does so, such event or condition shall not constitute Good Reason hereunder, and (ii) Good Reason shall not be deemed to exist at any time which Employee could be terminated for Cause. (iii) The Company may terminate Employee's employment hereunder for Cause. If the Company terminates Employee's employment for Cause or Employee resigns or otherwise terminates Employee's employment with the Company without Good Reason, (i) Employee shall have no right to receive any compensation or benefit hereunder on and after the date of Employee's termination other than Annual Salary and Benefit Plan benefits theretofore earned and accrued under this Agreement, and reimbursement under Section 5 for expenses theretofore incurred and paid, and (ii) this Agreement shall otherwise terminate upon such termination of employment and Employee shall have no further rights hereunder. (c) Termination Without Cause, Termination for Good Reason The Company may terminate Employee's employment at any time for any reason, and Employee may terminate Employee's employment for Good Reason. If the Company terminates Employee's employment and such termination is not pursuant to Section 4(a) or 4(b), or Employee terminates Employee's employment for Good Reason, (i) Employee will receive the Annual Salary and the coverage under the Welfare Plans (provided payments under such Welfare Plans to Employee would not result in disqualification by the Company or its participants under such plans) that Employee would have received and payable at the same times and dates as would have been applicable in the absence of such termination, (ii) Employee shall be entitled to receive reimbursement under Section 5 for expenses incurred prior to the -4- 5 date of termination, (iii) Employee shall be entitled to receive any Annual Salary and Benefit Plan benefits, theretofore earned to accrued under this Agreement, and (iv) no payments or benefits provided under this Section shall be reduced by any amount Employee may earn or receive from employment with another employer or from any other source. 5. Compensation and Benefits. a) Annual Salary. During the term of this Agreement and for all services rendered by Employee under this Agreement, the Company will pay Employee a base salary of Two Hundred Fifty Thousand Dollars ($250,000.00) per annum in equal bi-weekly installments. Such annual salary will be subject to adjustments by any increases given in the normal course of business. b) Incentive Compensation. During the term of the Agreement, Employee shall have a target bonus equal to 80% of Employee's base salary, payable upon the achievement of certain objectives set by the Board of Directors or the President of the Company. For the first year of the Agreement, if such objectives are not met, all or a portion of such bonus still may be paid at the sole discretion of the Board of Directors of the Company. c) Stock Options. As soon as reasonably practicable after the signing of this Agreement, and subject to the approval of the Compensation Committee of the Board of Directors of Medaphis Corporation, the Company will cause Medaphis to issue to Employee, effective as of the date approved by the Compensation Committee of the Board of Directors of Medaphis Corporation, options to purchase Two Hundred and Fifty Thousand (250,000) shares of Medaphis Common Stock pursuant to the terms and conditions of the Amended and Restated Medaphis Corporation Non-Qualified Stock Option Plan ("Stock Option Plan"), as amended. Such options will vest at the rate of thirty-three and one-third percent (33.33%) per year for a three-year period beginning on the starting date of this Agreement, subject to the terms and conditions of the Stock Option Plan. Such options shall vest in full immediately upon the occurrence of certain change in control events outlined in the Stock Option Plan. Employee shall be considered for additional grants of options to purchase shares of Medaphis common stock in a manner which is consistent with other senior officers of the Company. However, nothing in this Agreement shall give rise to a contractual right to Employee to receive grants of additional stock options of Medaphis. Further, Medaphis has no obligation to Employee to create parity with any other Medaphis executives with respect to any options granted to such other executives. d) Other Benefits. Employee will be entitled to such fringe benefits as may be provided from time-to-time by the Company to its employees, including, but not limited to, group health insurance, life and disability insurance, vacations and any other fringe benefits now or hereafter provided by the Company to its employees, if and when Employee meets the eligibility requirements for any such benefit. The Company reserves the right to change or discontinue any employee benefit plans or programs now being offered to its employees; -5- 6 provided, however, that all benefits provided for employees of the same position and status as Employee will be provided to Employee on an equal basis. e) Business Expenses. Employee will be reimbursed for all reasonable expenses incurred in the discharge of Employee's duties under this Agreement pursuant to the Company's standard reimbursement policies. f) Withholding. The Company will deduct and withhold from the payments made to Employee under this Agreement, state and federal income taxes, FICA and other amounts normally withheld from compensation due employees. g) Relocation Expenses. The Company will engage a relocation firm chosen by the Company to determine the fair market value of Employee's primary residence and to be responsible for the ultimate sale of such residence, all pursuant to the terms of a "home guaranty support" package to be agreed upon between the Company and the relocation firm and attached hereto. Such terms will provide that Employee will be able to borrow from the relocation firm an amount equal to the difference between Employee's equity ownership in such residence and the fair market value of such residence as determined by the relocation firm, and the outstanding balance of any such loan shall be payable from the proceeds of the sale of the residence. Furthermore, provided Employee supplies the Company with adequate documentation, Employee will be compensated for the following expenses associated with Employee's relocation to Atlanta, Georgia : i. Employee will be reimbursed for all reasonable and customary costs incurred by Employee in connection with the sale of Employee's existing residence; ii. Employee will be reimbursed for all reasonable and customary costs incurred by Employee in connection with the acquisition of Employee's new residence in the State of Georgia; iii. Employee will receive a temporary housing allowance of $3,000.00 per month, not to exceed four months, to allow Employee to locate an acceptable residence; and iv. Employee will be reimbursed for all reasonable and customary moving costs incurred by Employee in connection with his relocation to the State of Georgia. v. Employee will be reimbursed a temporary commuting allowance of up to $1,000 per month, not to exceed four months, for travel during the initial start-up period for travel to and from the employee's existing home. h) Tax Gross-Up Payment. Employee will receive a payment from the Company (the "Tax Gross-Up Payment") in an amount equal to the federal and state income taxes payable by -6- 7 Employee as a result of the amounts reimbursed to Employee under Section 5(g) of this Agreement and the Tax Gross-Up Payment, after taking into consideration any income tax deductions available to Employee with respect to any such expenses so reimbursed. Such Tax Gross-Up Payments shall be paid to Employee at such time or times as Employee shall provide the Company with sufficient documentation to calculate the same. i) Attorney's Fees. Employee will be reimbursed for reasonable attorney's fees, not to exceed Three Thousand Dollars ($3,000.00), in connection with the review of this Agreement by Employee's legal counsel. j) Golf Club Membership. The Company will pay for Employee's membership initiation fee to join the golf club of Employee's choice up to an amount not to exceed Thirty-Five Thousand Dollars ($35,000.00). 6. Non-Disclosure of Proprietary Information. Employee recognizes and acknowledges that the Trade Secrets (as defined below) and Confidential Information (as defined below) of the Company and its affiliates and all physical embodiments thereof (as they may exist from time-to-time, collectively, the "Proprietary Information") are valuable, special and unique assets of the Company's and its affiliates' businesses. Employee further acknowledges that access to such Proprietary Information is essential to the performance of Employee's duties under this Agreement. Therefore, in order to obtain access to such Proprietary Information, Employee agrees that Employee shall hold in confidence all Proprietary Information and will not reproduce, use, distribute, disclose, publish or otherwise disseminate any Proprietary Information, in whole or in part, and will take no action causing, or fail to take any action necessary to prevent causing, any Proprietary Information to lose its character as Proprietary Information, nor will Employee make use of any such information for Employee's own purposes or for the benefit of any person, firm, corporation, association or other entity (except the Company) under any circumstances. For purposes of this Agreement, the term "Trade Secrets" means information, including, but not limited to, any technical or nontechnical data, formula, pattern, compilation, program, device, method, technique, drawing, process, financial data, financial plan, product plan, list of actual or potential customers or suppliers, or other information similar to any of the foregoing, which derives economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can derive economic value from its disclosure or use. For purposes of this Agreement, the term "Trade Secrets" does not include information that Employee can show by competent proof (i) was known to Employee and reduced to writing prior to disclosure by the Company (but only if Employee promptly notifies the Company of Employee's prior knowledge); (ii) was generally known to the public at the time the Company disclosed the information to Employee; (iii) became generally known to the public after disclosure by the Company through no act or omission of Employee; or (iv) was disclosed to Employee by a third party having a bona fide right both to possess the information and to disclose the information to Employee. The term "Confidential Information" means any data or information of the -7- 8 Company, other than trade secrets, which is valuable to the Company and not generally known to competitors of the Company. The provisions of this Section 6 will apply to Trade Secrets for so long as such information remains a trade secret and to Confidential Information during Employee's employment with the Company and for a period of two (2) years following any termination of Employee's employment with the Company for whatever reason. 7.A. Non-Competition Covenant. During Employee's employment by the Company and for a period of two (2) years following any termination of Employee's employment for whatever reason, Employee will not, directly or indirectly, on Employee's own behalf or in the service of or on behalf of any other individual or entity, compete with the Company within the Geographical Area (as hereinafter defined). The term "compete" means to engage in, have any equity or profit interest in, make any loan to or for the benefit of, or render any services of any kind to, directly or indirectly, on Employee's own behalf or in the service of or on behalf of any other individual or entity, either as a proprietor, employee, agent, independent contractor, consultant, director, officer, partner or stockholder (other than a stockholder of a corporation listed on a national securities exchange or whose stock is regularly traded in the over-the-counter market, provided that Employee at no time owns, directly or indirectly, in excess of one percent (1%) of the outstanding stock of any class of any such corporation) any business which provides Business products or services. For purposes of this Agreement, the term "Geographical Area" means the territory located within a seventy-five (75) mile radius of each facility for which Employee has management responsibility during Employee's employment with the Company. B. Non-Solicitation of Clients Covenant. Employee agrees that during Employee's employment by the Company and for a period of two (2) years following the termination of Employee's employment for whatever reason, Employee will not, directly or indirectly, on Employee's own behalf or in the service of or on behalf of any other individual or entity, divert, solicit or attempt to solicit any individual or entity (i) who is a client of the Company at any time during the six (6)-month period prior to Employee's termination of employment with the Company ("Client"), or was actively sought by the Company as a prospective client, and (ii) with whom Employee had material contact while employed by the Company to provide Business services or products to such Clients or prospects. C. Construction. The parties hereto agree that any judicial authority construing all or any portion of this Section 7 or Section 8 below may, if it chooses, sever any portion of the Geographical Area, client base, prospective relationship or prospect list or any prohibited business activity from the coverage of such Section and to apply the provisions of such Section to the remaining portion of the Geographical Area, the client base or the prospective relationship or prospect list, or the remaining business activities not so severed by such judicial authority. In addition, it is the intent of the parties that the judicial authority may, if it chooses, replace each such severed provision with a provision as similar in terms to such severed provision as may be possible and be legal, valid and enforceable. It is the intent of the parties that Sections 7 and 8 be enforced to the maximum extent permitted by law. In the -8- 9 event that any provision of either such Section is determined not to be specifically enforceable, the Company shall nevertheless be entitled to bring an action to seek to recover monetary damages as a result of the breach of such provision by Employee. 8. Non-Solicitation of Employees Covenant. Employee further agrees and represents that during Employee's employment by the Company and for a period of two (2) years following any termination of Employee's employment for whatever reason, Employee will not, directly or indirectly, on Employee's own behalf or in the service of, or on behalf of any other individual or entity, divert, solicit or hire away, or attempt to divert, solicit or hire away, to or for any individual or entity which is engaged in providing Business services or products, any person employed by the Company for whom Employee had supervisory responsibility or with whom Employee had material contact while employed by the Company, whether or not such employee is a full-time employee or temporary employee of the Company, whether or not such employee is employed pursuant to written agreement and whether or not such employee is employed for a determined period or at-will. 9. Existing Restrictive Covenants. Employee represents and warrants that Employee's employment with the Company does not and will not breach any agreement which Employee has with any former employer to keep in confidence confidential information or not to compete with any such former employer. Employee will not disclose to the Company or use on its behalf any confidential information of any other party required to be kept confidential by Employee. 10. Return of Proprietary Information. Employee acknowledges that as a result of Employee's employment with the Company, Employee may come into the possession and control of Proprietary Information, such as proprietary documents, drawings, specifications, manuals, notes, computer programs, or other proprietary material. Employee acknowledges, warrants and agrees that Employee will return to the Company all such items and any copies or excerpts thereof, and any other properties, files or documents obtained as a result of Employee's employment with the Company, immediately upon the termination of Employee's employment with the Company. 11. Proprietary Rights. During the course of Employee's employment with the Company, Employee may make, develop or conceive of useful processes, machines, compositions of matter, computer software, algorithms, works of authorship expressing such algorithm, or any other discovery, idea, concept, document or improvement which relates to or is useful to the Company's Business (the "Inventions"), whether or not subject to copyright or patent protection, and which may or may not be considered Proprietary Information. Employee acknowledges that all such Inventions will be "works made for hire" under United States copyright law and will remain the sole and exclusive property of the Company. Employee also hereby assigns and agrees to assign to the Company, in perpetuity, all right, title and interest Employee may have in and to such Inventions, including without limitation, all copyrights, and the right to apply for any form of patent, utility model, industrial design or similar proprietary right recognized by any state, country or jurisdiction. Employee further -9- 10 agrees, at the Company's request and expense, to do all things and sign all documents or instruments necessary, in the opinion of the Company, to eliminate any ambiguity as to the ownership of, and rights of the Company to, such Inventions, including filing copyright and patent registrations and defending and enforcing in litigation or otherwise all such rights. Employee will not be obligated to assign to the Company any Invention made by Employee while in the Company's employ which does not relate to any business or activity in which the Company is or may reasonably be expected to become engaged, except that Employee is so obligated if the same relates to or is based on Proprietary Information to which Employee will have had access during and by virtue of Employee's employment or which arises out of work assigned to Employee by the Company. Employee will not be obligated to assign any Invention which may be wholly conceived by Employee after Employee leaves the employ of the Company, except that Employee is so obligated if such Invention involves the utilization of Proprietary Information obtained while in the employ of the Company. Employee is not obligated to assign any Invention which relates to or would be useful in any business or activities in which the Company is engaged if such Invention was conceived and reduced to practice by Employee prior to Employee's employment with the Company, provided that all such Inventions are listed at the time of employment on the attached Exhibit A. 12. Remedies. Employee agrees and acknowledges that the violation of any of the covenants or agreements contained in Sections 6, 7, 8, 9, 10 and 11 of this Agreement would cause irreparable injury to the Company, that the remedy at law for any such violation or threatened violation thereof would be inadequate, and that the Company will be entitled, in addition to any other remedy, to temporary and permanent injunctive or other equitable relief without the necessity of proving actual damages or posting a bond. The Company agrees and acknowledges that the violation of Employee's rights with respect to the Invention set forth on Exhibit A would cause irreparable injury to Employee, that the remedy at law for any such violation or threaten violation thereof would be inadequate, and that Employee will be entitled, in addition to any other remedy, to temporary and permanent injunctive or other equitable relief without the necessity of proving actual damages or posting a bond. 13. Notices. Any notice or communication under this Agreement will be in writing and sent by registered or certified mail addressed to the respective parties as follows: If to the Company: If to Employee: 2700 Cumberland Parkway Jerome H. Baglien. Suite 300 6239 Pinetree Drive Atlanta, GA 30339 Long Grove, Illinois 60047 Attn: General Counsel 14. Contract Review. Medaphis will reexamine the senior management employment contract methodology with respect to the terms and conditions relating to the potential renewal and -10- 11 extension of this agreement following completion of the term set forth herein. It is anticipated that this review will be completed during the initial 18 months of this Agreement. 15. Severability. Subject to the application of Section 7(C) to the interpretation of Sections 7 and 8, in case one or more of the provisions contained in this Agreement is for any reason held to be invalid, illegal or unenforceable in any respect, the parties agree that it is their intent that the same will not affect any other provision in this Agreement, and this Agreement will be construed as if such invalid or illegal or unenforceable provision had never been contained herein. It is the intent of the parties that this Agreement be enforced to the maximum extent permitted by law. 16. Entire Agreement. This Agreement embodies the entire agreement of the parties relating to the subject matter of this Agreement and supersedes all prior agreements, oral or written, regarding the subject matter hereof. No amendment or modification of this Agreement will be valid or binding upon the parties unless made in writing and signed by the parties. 17. Binding Effect. This Agreement will be binding upon the parties and their respective heirs, representatives, successors, transferees and permitted assigns. 18. Assignment. This Agreement is one for personal services and will not be assigned by Employee. The Company may assign this Agreement to its parent company or to any of its subsidiaries or affiliated companies; provided that the parent or any subsidiary or affiliate fulfills the obligations of the Company under this Agreement. 19. Governing Law. This Agreement is entered into and will be interpreted and enforced pursuant to the laws of the State of Georgia. The parties hereto hereby agree that the appropriate forum and venue for any disputes between any of the parties hereto arising out of this Agreement shall be any federal court in the state where the Company has its principal place of business and each of the parties hereto hereby submits to the personal jurisdiction of any such court. The foregoing shall not limit the rights of any party to obtain execution of judgment in any other jurisdiction. The parties further agree, to the extent permitted by law, that a final and unappealable judgment against either of them in any action or proceeding contemplated above shall be conclusive and may be enforced in any other jurisdiction within or outside the United States by suit on the judgment, a certified exemplified copy of which shall be conclusive evidence of the fact and amount of such judgment. 20. Surviving Terms. Sections 6, 7, 8, 9, 10, 11 and 12 of this Agreement shall survive termination of this Agreement. -11- 12 IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. COMPANY: EMPLOYEE: MEDAPHIS CORPORATION By: /s/ Daniel S. Connors /s/ Jerome H. Baglien ----------------------------------- ----------------------------------- Jerome H. Baglien Title: SVP Personnel & Administration -------------------------------- -12- 13 EXHIBIT A INVENTIONS Declared Inventions: The SOFTCARE software and database tools, medical instrument interface tools (both radio frequency and direct electronic interfaces), and physicians research and diagnostic database tools. JHB -------------------- Employee Initials -13- EX-11 16 STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE 1 EXHIBIT 11 MEDAPHIS CORPORATION COMPUTATION OF PRIMARY AND FULLY PRO FORMA EARNINGS PER SHARE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
DESCRIPTION 1996 1995 1994 - ----------- --------- -------- ------- (IN THOUSANDS EXCEPT PER SHARE DATA) PRIMARY Weighted average shares outstanding during the period....... 71,225 56,591 50,128 Shares issuable upon assumed exercise of stock options, less amounts assumed repurchased under the treasury stock method.................................................... -- -- 3,700 Preferred Stock............................................. -- -- 6,417 --------- -------- ------- Total weighted average common stock and common stock equivalents outstanding during the period................. 71,225 56,591 60,245 ========= ======== ======= Pro forma net income (loss)................................. $(123,642) $ (8,504) $30,706 ========= ======== ======= Pro forma net income (loss) per common share................ $ (1.74) $ (0.15) $ 0.51 ========= ======== ======= FULLY Weighted average shares outstanding during the period....... 71,225 56,591 50,128 Shares issuable upon assumed exercise of stock options, less amounts assumed repurchased under the treasury stock method.................................................... -- -- 4,255 Preferred Stock............................................. -- -- 6,417 Convertible Debentures...................................... -- -- 4,527 --------- -------- ------- Total weighted average common stock and common stock equivalents outstanding during the period................. 71,225 56,591 65,327 ========= ======== ======= Pro forma net income (loss)................................. $(123,642) $ (8,504) $30,706 ========= ======== ======= Interest adjustment......................................... -- -- 2,614 --------- -------- ------- $(123,642) $ (8,504) $33,320 --------- -------- ------- Pro forma net income (loss) per common share................ $ (1.74) $ (0.15) $ 0.51 ========= ======== =======
2 EX-21 17 SUBSIDIARIES OF REGISTRANT 1 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT Medaphis Corporation owns 100% of the capital stock of each of the following corporations: (i) Healthcare Recoveries, Inc., a Delaware corporation; (ii) Medaphis Physician Services Corporation, a Georgia corporation; (iii) Gottlieb's Financial Services, Inc., a Georgia corporation; (iv) Medical Management Sciences, Inc., a Maryland corporation; (v) Medaphis Services Corporation, a Georgia corporation; (vi) Medaphis Services Holding Corporation, a Georgia corporation; (vii) Medaphis Healthcare Information Technology Company, a Georgia corporation; (viii) Automation Atwork, a California corporation; (ix) Consort Technologies, Inc., a Georgia corporation; (x) Health Data Sciences Corporation, a Delaware corporation; (xi) Imonics Corporation, a Georgia corporation; (xii) Rapid Systems Solutions, Inc., a Maryland corporation; and (xiii) BSG Corporation, a Delaware corporation. Medaphis Physician Services Corporation owns 100% of the capital stock of Medaphis Information Processing Corporation, a Georgia corporation. Medaphis Services Corporation owns 100% of the capital stock of each of the following corporations: (i) ARTRAC Corporation, a Georgia corporation; (ii) AssetCare, Inc., a Georgia corporation; (iii) National Healthcare Technologies, Inc., an Indiana corporation; and 2 (iv) Central Healthcare Services, Inc., a Georgia corporation. ARTRAC Corporation owns 100% of the capital stock of ARTRAC Healthcare Resources, Inc., a Georgia corporation. AssetCare, Inc. owns 100% of Amerikids, a California corporation. Central Healthcare Services, Inc. owns 100% of the capital stock of Shure Communications and Technologies, Inc., a Texas corporation. Health Data Sciences Corporation owns 100% of the capital stock of Health Data Sciences, Limited, a foreign subsidiary formed in Canada. Imonics Corporation owns 100% of the capital stock of Imonics GmbH and 50% of the capital stock of Bertelsmann Imonics GmbH & Co. KG, both of which are foreign subsidiaries formed in Germany. BSG Corporation owns 100% of the capital stock of BSG Alliance/IT, Inc., a Delaware corporation and BSG Capital, Inc., a Delaware corporation. BSG Alliance/IT, Inc. owns 100% of the capital stock of SageComm International Limited, a foreign subsidiary formed in the U.K. BSG Capital, Inc. owns 51% of the capital stock of alliance/IT L.L.C., a Delaware Limited Liability Company. -2- EX-23.1 18 CONSENT OF DELOITTE & TOUCHE LLP 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the Registration Statement No. 333-1800 of Medaphis Corporation on Form S-4 and to the incorporation by reference in Registration Statements Nos. 33-46847, 33-64952, 33-67752, 33-71556, 33-88442, 33-88444, 33-90876, 33-90874, 33-95742, 33-95746, 33-95748, 333-03213, 333-07201, 333-07203 and 333-07627 of Medaphis Corporation on Form S-8 of our report dated March 31, 1997 (which expresses an unqualified opinion and includes an explanatory paragraph relating to a going concern uncertainty), appearing in the Annual Report on Form 10-K of Medaphis Corporation for the year ended December 31, 1996. DELOITTE & TOUCHE LLP Atlanta, Georgia March 31, 1997 EX-27 19 FINANCIAL DATA SCHEDULE (FOR SEC USE ONLY)
5 1,000 U.S. DOLLARS YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1 7,631 0 193,880 13,260 0 269,385 97,850 0 815,624 193,752 0 0 0 717 391,573 815,624 608,313 608,313 0 0 790,310 0 11,585 (193,582) (68,961) (124,621) 0 0 0 (124,621) (1.74) (1.74)
EX-99.2 20 CONSOLIDATED CLASS ACTION COMPLAINT (GEORGIA) 1 EXHIBIT 99.2 UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF GEORGIA ATLANTA DIVISION - ---------------------------------------------- : CIVIL ACTION NO. IN RE 1996 MEDAPHIS CORPORATION : 1:96-CV-2088-FMH SECURITIES LITIGATION : : PLAINTIFFS DEMAND A JURY TRIAL - ---------------------------------------------- ----------------- CONSOLIDATED SECOND AMENDED CLASS ACTION COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS --------------------------------------------- Pursuant to pretrial Order No. 2 entered by the court on October 23, 1996, plaintiffs, on behalf of themselves and all others similarly situated, by their attorneys, allege the following upon information and belief (except for those allegations which pertain to plaintiffs and their attorneys, which allegations are based on personal knowledge). Plaintiffs' information and belief is based, inter alia, on the investigation made by and through plaintiffs' attorneys, which investigation included, without limitation, a review and analysis of various public filings made by and articles concerning Medaphis Corporation and related entities, press releases, reports of securities analysts, press reports, and other investigatory efforts. NATURE OF THE ACTION 1. This is a class action brought against Medaphis Corporation ("Medaphis" or the "Company"), and certain of its officers and directors, on behalf of a plaintiff class (the "Class") consisting of all persons who purchased or otherwise acquired Medaphis common stock between February 6, 1996 and October 21, 1996, inclusive (the "Class Period"), and who 2 sustained damages thereby. On behalf of themselves and the members of the Class, plaintiffs seek to recover damages caused by defendants' violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act"). Certain plaintiffs also assert claims under the Securities Act of 1933 (the "Securities Act") on behalf of a sub-class (the "Sub-Class") consisting of persons and entities who, in connection with the HDS Merger (described below), acquired Medaphis stock during the Class Period pursuant to a registration statement and prospectus issued by the Company. 2. Medaphis sells outsourced business management services to doctors and hospitals, primarily for the management of billing and accounts receivable. For several years, Medaphis has been pursuing a strategy of aggressive growth through acquisitions, reportedly having acquired more than 40 companies that provide business management services and systems primarily to physicians and hospitals. For the most part, Medaphis used its common stock as currency in connection with this acquisition strategy. 3. In order for Medaphis to be able to continue to grow by making acquisitions through exchanges of its stock, it was imperative that the company's stock be maintained at high prices. Defendants maintained and increased the price of Medaphis stock by presenting continued growth in the Company's reported revenues and earnings, as well as positive developments in Medaphis' business operations and strategies. 4. One of the ways in which defendants touted the Company's business and prospects was to boast of the historical and anticipated future success of Imonics, Inc. ("Imonics"), which was acquired by the Company in December of 1994. Imonics specialized in systems integration and client service computing; that is, Imonics helped companies to - 2 - 3 coordinate different types of computer systems to work together and to connect numerous (and sometimes different) desktop computers to a single "server" technology. Defendants publicly represented that Imonics was a major contributor of profits and revenues to Medaphis' overall results. Medaphis also placed Imonics in charge of the "re-engineering" of Medaphis' core physician billing business, known as Medaphis Physicians Services Corporation ("MPSC"), in which it provided critical software integration services that would supposedly make MPSC more efficient. According to defendants, Imonics provided Medaphis with an "immense competitive advantage." These and other positive statements of similar import concerning Imonics and the MPSC re-engineering project permeated defendants' public statements during the Class Period. At the time these representations were made, however, and as the investment community was unaware until the end of the Class Period, Imonics was experiencing severe operational problems including, among other things, excessive staffing and payroll, inadequate cost controls and significant cost overruns, and poor operating performance and shoddy execution on critical projects. Unbeknownst to the investing public, these problems were so severe that they negated Imonics' ability to perform as positively portrayed by defendants. 5. Yet another way in which defendants ensured that Medaphis remained a darling of the investment community was to boast of the acquisitions made by the Company over the years, and the successful and synergistic integration of the acquired companies into Medaphis' overall business operations, especially the Imonics operations. However, defendants knew, but concealed from the public until the close of the Class Period, that at the time these statements were being made by defendants, the integration of many of the newly acquired - 3 - 4 subsidiaries with the operations of Imonics was failing, and doomed to ultimate failure in view of the dilapidated operating condition of Imonics. 6. Defendants also realized that, in order to maintain Medaphis' stock price, it was important that the Company meet earnings estimates being made by and for it by securities analysts. Therefore, on February 6, 1996 (the beginning of the Class Period), the Company reported record operating results for the fourth quarter and year ended December 1995, results which were precisely in line with analysts' expectations. It was not until the close of the Class Period, in October of 1996, that the investment community was stunned to learn, by the Company's own admission, that these results were materially false and misleading as a result of defendants' employment of improper and deceptive accounting practices. 7. Having artificially propped up reported earnings for the fourth quarter and year ended December 31, 1995, defendants were under enormous pressure to continue the trend of reporting increased earnings for the first quarter of 1996. The opportunity to do so arose in February 1996, when Medaphis, through Imonics, entered into a joint venture (the "Joint Venture") with a subsidiary of the German conglomerate Bertelsmann AG ("Bertelsmann"), to develop systems integration projects for customers in Europe. In turn, the Joint Venture then signed a multi-year systems integration contract (the "Systems Integration Contract") to provide services to a major telecommunications company. 8. Immediately upon entering into the Systems Integration Contract, Medaphis recognized $12.5 million of earnings before income taxes and approximately $7.6 million in net earnings -- earnings which represented a majority of total reported net income for its first quarter ended March 31, 1996, and which enabled the Company on April 23, 1996 to - 4 - 5 report record revenues and earnings for the quarter. Predictably, in reaction to these results, Medaphis common stock soared to a near-record high of $48.50 per share. However, the investment community was not aware until the end of the Class Period that the first quarter results (like those reported only two months earlier) were materially false and misleading, and that the recognition of $12.5 million as net income from the Joint Venture at the time of the contract's signing violated Generally Accepted Accounting Principles as well as the Company's own stated policy relating to the recognition of revenue. The earnings had been recognized albeit artificially -- for the purpose of prolonging the illusion of growth and success. 9. The facade that defendants had created began to crumble on August 14, 1996, when -- contrary to the expectations theretofore fostered by the Company -- Medaphis surprised the investment community by reporting that it would suffer a substantial loss for the quarter ended September 30, 1996. This reversal was attributable to the need to take write-offs in the total amount of $35 to $40 million which resulted, among other factors, from: the Company's falsification of its reported earnings by over $9 million for the first quarter of 1996; and a $15 million write-off arising from the need to reorganize Imonics due to the significant operational problems that were known internally but concealed throughout the Class Period. 10. The Company also disclosed on August 14, 1996 that, contrary to its previous representations that the Company's technology division (which included Imonics) was "offsetting" margin and other pressures being experienced by MPSC, Imonics was suffering from severe operational problems such that it was not and could not offset pressures adversely affecting MPSC. In addition to Imonics' problems, the Company revealed for the first time that yet another highly touted subsidiary, Automation Atwork ("Atwork"), was experiencing weak - 5 - 6 sales and serious problems with one of its new product lines, and that such problems had existed since late 1995. 11. The Company further surprised the market on August 14, 1996 by announcing that, as a result of Imonics' severe operational difficulties and problems associated with the merger of Imonics with other newly acquired companies, Medaphis could no longer pursue a "growth through acquisitions" strategy, which had previously been touted by defendants as the key to the Company's success and the engine of future earnings growth. This acknowledgment stood in contrast to defendants' numerous earlier statements, which portrayed Imonics as the Company's great revenue and profit engine and boasted that the various mergers involving Imonics were progressing seamlessly. It was also revealed on August 14, 1996 that the operational problems at Imonics were so significant that Imonics was completely unable to perform its existing obligations under the Joint Venture and that (unbeknownst to the investing public), well before the end of the Class Period, the problems were so severe that Bertelsmann, Imonics' partner in the Joint Venture, insisted that Medaphis either renegotiate the terms of the Systems Integration Contract or abandon the agreement altogether. 12. Predictably, the day after these negative announcements, the market price of Medaphis common stock plummeted by $21.375 per share, or 60%, on extraordinarily high volume of almost 43 million shares, representing approximately 60% of all such shares then outstanding, to close at $14.25 per share on August 15, 1996. 13. Yet, as surprising as it was, the company's August 14, 1996 release was itself false and misleading and was only the tip of the iceberg. After the surprising August 14, 1996 announcement, defendants represented to analysts and investors that the Company had - 6 - 7 identified all of the problems affecting Medaphis and "concluded that all of the potential problems have been reserved against." 14. In light of these assurances, the market was shocked on October 22, 1996, when the Company issued a press release announcing for the first time that its previously reported revenues and earnings for the fourth quarter and full year of 1995 were false and had to be restated. The October 22, 1996 announcement also revealed: that the company had written-off additional previously concealed amounts totalling in the millions of dollars relating to a reorganization of Imonics; and that the entire senior management of Imonics had been fired. As a result of these stunning developments, Medaphis would suffer nearly double the loss announced only two months earlier for the third quarter 1996, and was forced to reduce earnings projections for 1997. 15. The October 22, 1996 press release explained that the restatements of earnings for the fourth quarter and full year of 1995 were the result of improperly recorded revenues booked in connection with a major license agreement executed in December 1995, and other unspecified transactions. In summary, in its zeal to report growing revenues and profits, the Company fraudulently recognized earnings and revenues from one or more license agreements during 1995 on the basis that the agreements were unconditional, while secretly sending the customers involved side letters relieving the customer of obligations under the agreement. The revelation that the previously reported earnings were false reduced -- with the stroke of a pen -- reported fourth quarter 1995 operating results from net income of approximately $4 million to a loss of $1.1 million for the quarter (a shocking 120% reversal). In - 7 - 8 a similar vein, the previously reported loss of $3.4 million for full year 1995 more than doubled to a restated loss of approximately $8.5 million. 16. Not surprisingly, the October 22 announcements devastated the market price of Medaphis stock, this time erasing an additional $450 million in market value as the stock plunged in a single day by $6.375 (or 38%) from $16.75 to $10.375 per share, which represented a 52-week low. Prior to the August and October 1996 disclosures, Medaphis common stock traded at prices in the range of $32.75 to $53.25 per share. 17. In addition to pummeling the price of the Company's stock, the surprise announcements issued at the end of the Class Period shattered the credibility of Medaphis with the investment community. Indeed, in commenting upon these startling disclosures, securities analysts issued blistering criticisms of the defendants' credibility. One firm, Deutsche Morgan Grenfell/CJL, complained in an October 23, 1996 report that [t]here were clearly more negative issues at hand within the Company than were delineated in the August pre-announcement," and that "we don' t believe management has been as forthcoming as we would like with operational issues." (emphasis added). Another firm, Donaldson, Lufkin & Jenrette, complained that Medaphis "management had suggested that MPSC had turned the corner in the second quarter" and, as a result, now "have no credibility with investors." Cowen & Co. termed these developments a "complete shocker" in view of the Company's contrary representations during the Class Period. 18. Plaintiffs and the other members of the Class and the Sub-Class, who purchased or otherwise acquired Medaphis stock at artificially inflated prices, have suffered substantial damages by reason of defendants' wrongful conduct. - 8 - 9 JURISDICTION AND VENUE 19. The claims asserted herein arise pursuant to Sections 10(b) and 20(a) of the Exchange Act, as amended, 15 U.S.C. Sections 78j(b) and 78t(a), and Rule l0b-5 promulgated thereunder by the Securities and Exchange Commission ("SEC"), 17 C.F.R. Section 240.10b-5; and Sections 11, 12(a) (2) and 15 of the Securities Act, 15 U.S.C. Sections 77k, 771(a) (2), and 77o. 20. This Court has jurisdiction over the subject matter of this action pursuant to Section 22 of the Securities Act, 15 U.S.C. Section 77v; Section 27 of the Exchange Act, 15 U.S.C. ss.78aa; and 28 U.S.C. Sections 1331 and 1337, as amended. 21. Venue is proper in this District under Section 22 of the Securities Act and Section 27 of the Exchange Act, 15 U.S.C. Section 78aa. Many of the acts and transactions giving rise to the violations of law complained of herein, including the preparation and dissemination to the investing public of false and misleading information, occurred in this District. Further, defendant Medaphis has its principal place of business in this District. 22. In connection with the acts, conduct and other wrongs complained of herein, the defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, including the United States mails and interstate telephone communications, and the facilities of the national securities exchanges. ORGANIZATION OF THE COMPLAINT 23. Counts I and II of this Complaint are brought on behalf of the Class, identified in paragraph 31 hereof, pursuant to Sections 10(b) and 20(a) of the Exchange Act. - 9 - 10 24. Counts III, IV and V of this Complaint are brought on behalf of the Sub- Class, identified in paragraph 31 hereof, and are based only on the false and misleading statements made in the Registration Statement and Prospectus issued in connection with Medaphis' merger with Health Data Sciences Corporation (the "HDS Merger"). These claims are brought pursuant to Sections 11, 12 (a) (2) and 15 of the Securities Act. THE PARTIES PLAINTIFFS 25. The following representative plaintiffs appointed by the Court as Lead Plaintiffs purchased or otherwise acquired Medaphis stock during the Class Period as identified in their certifications previously filed with the Court, and were damaged thereby: Carley Capital Group ("Carley"); Catherine Baker knoll, State Treasurer of the Commonwealth of Pennsylvania, as custodian of the Pennsylvania School Employees Retirement System Pension Fund; Vicki Mann; Leonard C. Mead, Jr.; Dennis McDowell; PBHG Growth Fund; Raymond E. and Deborah J. Smith, Trustees of the Smith Trust; Deborah Ann Smith; and Management Group, L.P. ("WME"). In connection with their purchases of Medaphis Stock, the Lead Plaintiffs suffered losses in excess of $35 million. 26. Additional persons who have filed complaints and/or signed certifications in connection with this consolidated action, but who were not named as lead plaintiffs are as follows: Samuel 8. Cinnamon; Robert Dawes; Efim Derevayanny; Deborah M. Dowd; Kenneth W. Gross; Carol Ann Hayes; James V. Hayes; Carol Ann Hayes and Vincent Brogna, Trustees of the VRB Irrevocable Trust dated April 1, 1970; Susan Heslip; Murray Lazar; Werner Levy; - 10 - 11 Frederick R. Adler; Nicholas G. Metcalf; Michel Neiman by Loic Lamoureux, attorney-in-fact; Joanne M. Noumi; Arthur Rosen; Abraham L. Slomovics; Sarah K. Steiner; Eric Stewart; Ezriel Tauber; Hal Wickey; Angela Witt; Joseph F. Anzlovar; Hamilton Lee Durning; Lisa Shepley; Carole Shepley; and William Yates. These persons purchased or otherwise acquired Medaphis stock during the Class Period as identified in certifications previously filed with the Court and were damaged thereby. 27. While the persons identified in paragraph 26 above were not appointed lead plaintiffs by the Court, they remain ready and willing to serve as class representatives and lead plaintiffs if necessary. DEFENDANTS 28. Defendant Medaphis is a corporation organized and existing under the laws of the State of Delaware. Medaphis maintains its principal executive offices at 2700 Cumberland Parkway, Suite 300, Atlanta, Georgia. Medaphis common stock is and was, at all relevant times, actively traded on the NASDAQ National Market System, under the symbol "MEDA," and was registered pursuant to Section 12 of the Exchange Act. As of August 12, 1996, there were reportedly more than 71 million shares of Medaphis common stock outstanding. Pursuant to the requirements of the Exchange Act and the regulations promulgated thereunder by the SEC, Medaphis files annual, quarterly and other reports with the SEC. 29. (a) Defendant Randolph G. Brown ("Brown") was, at all relevant times until his resignation on October 31, 1996, the President, Chief Executive Officer and a Director of Medaphis. Defendant Brown also served as a member of the Executive Committee of - 11 - 12 Medaphis' Board of Directors, which possesses the power and authority of the Board in the management of the business and affairs of the Company. (b) Defendant Michael R. Cote ("Cote") is and was, at all relevant times, Senior Vice President-Finance and Chief Financial Officer of the Company. Press releases issued by defendants during the Class Period consistently identified Cote as the contact person at the Company for purposes of communications with the investment community. (c) Defendant James S. Douglass ("Douglass") is and was, at all relevant times, Vice President, Corporate Controller, and Chief Accounting Officer of the Company. (d) The individual defendants identified in the foregoing subparagraphs are sometimes referred to herein collectively as the "Individual Defendants." 30. The Individual Defendants, because of their directorial, officer and/or stockholder positions with the Company, controlled and/or possessed the power and authority to control the contents of its quarterly and annual reports and filings, press releases and presentations to securities analysts and, thereby, the investing public. Each Individual Defendant attended management and/or board meetings and was provided with copies of the Company's reports and press releases alleged herein to be misleading, before or shortly after their issuance, and each had the ability and opportunity to prevent their issuance or cause them to be corrected. CLASS ACTION ALLEGATIONS 31. All plaintiffs bring this class action pursuant to Fed. R. Civ. P. 23(a) and (b)(3) on behalf of a Class consisting of all persons who purchased or otherwise acquired - 12 - 13 Medaphis common stock between February 6, 1996 and October 21, 1996, inclusive, and who were damaged thereby. Lead Plaintiffs Carley and WME assert Counts III, IV and V herein on behalf of a Sub-Class consisting of all persons who acquired Medaphis common stock pursuant to the HDS Merger, described below. Excluded from the Class and Sub-Class are the defendants; members of the immediate families of the Individual Defendants; any entity in which any defendant or excluded person has or had a controlling interest; the officers and directors of Medaphis; and the legal affiliates, representatives, heirs, controlling persons, successors, and predecessors in interest or assigns of any such excluded party. 32. The members of the Class and Sub-Class are so numerous and geographically dispersed that joinder of all members is impracticable. While the exact number of Class and Sub-Class members is unknown at this time and can only be determined by appropriate discovery, plaintiffs believe that there are thousands of members of the Class and Sub-Class located throughout the United States. As of August 12, 1996, there were 71,848,856 shares of Medaphis common stock outstanding. The shares outstanding include approximately 6.2 million shares of Medaphis common stock that were issued by the Company to hundreds of HDS shareholders in connection with the HDS merger. Throughout the Class Period, Medaphis shares were actively traded on the NASDAQ National Market System. Many millions of shares of Medaphis common stock were traded during the Class Period. Record owners and other members of the Class and Sub-Class may be identified from records maintained by the Company and/or its transfer agent and may be notified of the pendency of this action by mail and publication, using forms of notice similar to those customarily used in securities class actions. - 13 - 14 33. Plaintiffs' claims are typical of the claims of the members of the Class and the Sub-Class, because all members of the Class and Sub-Class acquired Medaphis stock at artificially inflated prices and were damaged as a result of the defendants' violations of the federal securities laws complained of herein. 34. Plaintiffs will fairly and adequately protect the interests of the Class and the Sub-Class and have retained counsel who are experienced and competent in class and securities litigation. Plaintiffs have no interest that is contrary to or in conflict with those of the members of the Class or the SubClass. 35. A class action is superior to all other available methods for the fair and efficient adjudication of this controversy, since joinder of all members of the Class and SubClass is impracticable. Furthermore, as the damages suffered by individual members of the Class and Sub-Class may be relatively small, the expense and burden of individual litigation make it virtually impossible for the members of the Class and Sub-Class individually to seek redress for the wrongs done to them. There will be no difficulty in the management of this action as a class action. 36. Questions of law and fact common to the members of the Class and Sub- Class predominate over any questions that may affect only individual members because defendants have acted on grounds generally applicable to the entire Class and Sub-Class. Among the common questions of law and fact are: (a) Whether defendants violated the federal securities laws as alleged herein; - 14 - 15 (b) Whether the Company's publicly disseminated releases and statements omitted and/or misrepresented material facts, and whether defendants breached any duty to convey material facts or to correct material facts previously disseminated; (c) Whether defendants participated in and pursued the common course of conduct complained of herein; (d) Whether defendants acted willfully or recklessly in omitting and/or misrepresenting material facts; (e) Whether the market prices of Medaphis stock during the Class Period were artificially inflated due to the material nondisclosures and/or misrepresentations complained of herein; and (f) Whether the members of the Class and SubClass have sustained damages and, if so, what is the appropriate measure of damages. APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD ON THE MARKET DOCTRINE 37. Members of the Class rely upon the presumption of reliance afforded by the "fraud-on-the-market" doctrine. At all relevant times, the market for Medaphis common stock was an efficient market. Medaphis stock met the requirements for listing and was listed and actively traded on the NASDAQ National Market system, a highly efficient and automated market. Medaphis was also registered pursuant to Section 12 of the Exchange Act (15 U.S.C. Section 78e) and filed periodic public reports with the SEC and the NASD. Further, Medaphis regularly communicated with public investors by means of established market communication - 15 - 16 mechanisms, including through regular disseminations of press releases on the national circuits of major newswire services and through other wide ranging public disclosures such as communications with financial press, Dow Jones and other similar reporting services. Additionally, Medaphis stock was followed by securities analysts employed by major brokerage firms who wrote reports which were distributed to the sales force and customers of their respective brokerage firms and which were publicly available and entered the public marketplace. Among the various securities firms that regularly followed Medaphis during the Class Period were Alex. Brown & Sons, Inc.; Bear, Stearns & Co.; Cowen & Company; Dean Witter Reynolds; Donaldson Lufkin & Jenrette; Hambrecht & Quist; J.C. Bradford; Jefferies & Company; Mason Cabot; Montgomery Securities; Needham & Co.; Oppenheimer & Co.; Prudential Securities; Salomon Brothers; Smith Barney; and UBS Securities. 38. As a result, the market for Medaphis stock promptly digested current information regarding the Company from all publicly-available sources and reflected such information in the price of the stock. Moreover, Medaphis' stock price responded quickly and decisively to adverse Company news identified in this Complaint, further evidencing the efficiency of the market for Medaphis stock. Under these circumstances, all persons who purchased or acquired Medaphis stock during the Class Period suffered similar injury through their purchase or acquisition of such securities at artificially inflated prices, and a presumption of reliance applies. FACTUAL BACKGROUND 1. MEDAPHIS' BUSINESS OPERATIONS AND METEORIC GROWTH THROUGH ACQUISITIONS - 16 - 17 39. Medaphis has consistently described itself as a leading provider of business management systems and services to the healthcare industry. The Company's original and core business consists of billing, collection, and other outsourced financial services designed to assist its physician clients with the business management functions associated with providing medical services. Medaphis also provides subrogation and related recovery services primarily to healthcare payers, scheduling information management systems to hospitals and emerging integrated healthcare delivery stems, and systems integration and work flow engineering systems and services. 40. Medaphis reportedly provides business management systems and services to over 19,000 physicians and over 2,000 hospitals across the United States, subrogation and recovery services to healthcare plans covering in excess of 23 million people nationwide, and systems integration and work flow engineering systems and services in the United States and abroad. The Company's operations are organized into two principal operating units: Medaphis Services Corporation, which includes all doctor and hospital transaction processing companies, including MPSC; and Medaphis Systems Corporation, which includes all of Medaphis' technology companies, including its systems integration businesses (such as Imonics) and its healthcare information businesses (such as Atwork). 41. Over the past several years, a key component of Medaphis' stated business strategy involved growth through acquisitions of other businesses, using its stock as currency. Indeed, Medaphis built its reputation in the investment community by representing itself as a fast-growing company with an aggressive acquisition program and a successful history of integrating those acquisitions smoothly into its overall business operations. such representations - 17 - 18 - -- which, as will be shown herein, were demonstrably false and misleading -- convinced the investment community that the Company's strategy was successful and poised Medaphis for future earnings growth. Indeed: Analysts liked the flawless way Medaphis assimilated these firms [it acquired], which formed the core of the company's 40-plus acquisitions over eight years. As revenue grew fivefold, Medaphis gained Wall Street stardom. The Atlanta Journal and Constitution, September 8, 1996. 42. The Company's rising stock price financed Medaphis' growth strategy. Because Medaphis paid for most of its acquisitions with stock, the higher the price of the stock, the fewer shares the Company had to exchange to acquire target businesses. 43. Prior to and during the Class Period, defendants left no doubt that Imonics -- a company acquired by Medaphis in late 1994 -- was one of the keys to the Company's success which would enable the Company to continue its strategy of growth through acquisitions. Medaphis consistently represented that the Imonics acquisition allowed it to diversify its operations from primarily billing and accounts receivable management and enabled the Company to offer integration services to various health care providers and other businesses. Imonics was also put in charge of re-engineering the physician billing business of Medaphis, which falls under MPSC, the Company's largest operating unit, which reportedly accounts for approximately 60% of the Company's total services revenues. Indeed, with the acquisition of Imonics, Medaphis began a much-publicized project to re-engineer the paper and labor intensive business of MPSC in order to significantly reduce personnel-related costs, upgrade the Company's systems to the - 18 - 19 level of other service industries, and provide for economies of scale. Defendants have referred to this project as the "Re-Engineering Project". 44. The Re-Engineering Project was designed to allow for the consolidation of the processing operations of MPSC that had previously been conducted in over 300 local physician backoffice operations into fewer than 10 large regional data processing centers. The Re-Engineering Project involved designing and installing software through Imonics to automate the Company's billing process and reduce the quantity of paper processed. FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD 1. DEFENDANT MOTIVATION AND METHODOLOGIES 45. The defendants were aware that in order for Medaphis to preserve its status as a Wall Street "star," it would have to continue its aggressive acquisition of high-profit technology companies to generate revenues sufficient to maintain its growth and cover the high costs of its Re-Engineering Project. Moreover, to continue its acquisition strategy, Medaphis would have to use its stock as currency. To this end, beginning at the end of 1995, defendants set out to increase the price of Medaphis stock and thereby ensure that the Company's acquisition pipeline remained robust by issuing a series of materially false and misleading public statements. 46. The materially false and misleading public statements issued by defendants related in large part to reported financial results and financial statements that did not comply with Generally Accepted Accounting Principles ("GAAP"). GAAP encompasses the rules, conventions and practices recognized and employed by the accounting profession for the preparation of financial statements. Statements of Financial Accounting Standards are - 19 - 20 promulgated by the profession's Financial Accounting Standards Board, and are considered the highest authority of GAAP. SEC Regulation S-X (17 C.F.R. Section 210. 4-01(a) (1)) provides that financial statements filed with the SEC which are not prepared in compliance with GAAP are presumed to be misleading and inaccurate. 47. Defendants' false and misleading statements also related to narrative misrepresentations concerning: Medaphis' business operations and the Re-Engineering Project; Medaphis' earnings growth; the operating performance, condition and prospects of Imonics; and Medaphis' acquisition and integration of several companies into the operations of Imonics. 48. Defendants issued these statements directly, through press releases, SEC filings, and annual and quarterly reports to shareholders. Defendants also provided guidance to securities analysts and used them as conduits to provide false and misleading information to the investment community. 49. In writing their reports, several of which are referred to herein at paragraphs 52, 53, 54, 85, 89, 106 and 107, securities analysts relied in substantial part upon information provided to them privately by the Company. Indeed, it was the Company's practice to have key members of its management team, including defendants Brown and Cote, communicate with securities analysts on a regular basis to discuss the Company's business, operations, performance and prospects. Defendants knew that by disseminating information to the investment community, investors would rely and act upon such information and that such information would have an effect on the market price of the Company's stock. 2. FEBRUARY 6, 1996 PRESS RELEASE ANNOUNCING FOURTH QUARTER AND YEAR-END 1995 RESULTS AND RELATED ANALYSTS REPORTS - 20 - 21 50. On February 6, 1996, the start of the Class Period, defendants issued a press release announcing the Company's results for the fourth quarter and year ended December 31, 1995. The Company reported fourth quarter earnings of $11.4 million or $0.22 per share before one-time merger and other charges. These results, which were in line with analysts' estimates, represented a more than 50% increase over reported earnings of $0.14 per share in the fourth quarter of 1994. For the full year of 1995, Medaphis reported operating earnings of $41.9 million or $0.82 per share before charges, representing an increase of approximately 80% over reported operating earnings for the full year of 1994. The Company also reported in the February 6, 1996 release that operating revenues grew 29% in the fourth quarter, to $122.5 million, also in line with analysts' projections. Revenue for the year ended December 31, 1995 was reportedly $467.8 million, up 47% from $319.1 million in the same period in 1994. 51. In this press release, defendant Brown noted that the Re-Engineering Project was progressing well and achieving "significant milestones," and that the Company's technology division (which includes Imonics and Atwork) "continued to grow rapidly and show positive operating results outperforming our expectations in the second half of 1995" and was "effectively offsetting the margin pressure and results" being experienced by MPSC. 52. Securities analysts following Medaphis, while taking note of the margin pressures at MPSC, recommended the purchase of Medaphis stock based on defendants' representations and other information provided by the Company. For example, on February 7, 1996, one day after the quarterly and annual operating results were issued, Donaldson, Lufkin & Jenrette issued a research report which stated: - 21 - 22 Medaphis reported Q4 and year end 1995 results from continuing operations of $0.22 and $0.82, respectively.... Based on the results... it is becoming clear that the higher-growth technology businesses (such as Imonics, Atwork and Consort) are more than offsetting the margin pressures at MPSC. As MEDA essentially hit our EPS projections, we remain comfortable with our $1.07 EPS estimate for this year and a range of $1.40 -1.50 for 1997. 53. In a similar vein, a research report issued by Hambrecht & Quist on February 7, 1996, again prepared on the basis of information provided by the Company and/or its senior management, stated: Management indicates that, in addition to the technology units, several of the recent acquisitions are experiencing growth that is well-above the corporate average. Overall, the Company's internal growth has largely been moderated by a lack of growth in the MPSC unit. Looking forward, this unit should see better growth as the re-engineering effort winds down. MPSC's growth, when combined with the other units, should accelerate Medaphis' internal growth rate.... The company continues to progress on the reengineering front.... To reiterate, while Medaphis' re-engineering is modestly depressing margins in the near-term, we believe the long term efficiencies gained will more than offset any pricing pressure in the core billing and receivables market and fuel significant EBITDA margin expansion in 1997. 54. Likewise, a report issued by the firm of Morgan Stanley on February 6, 1996, on the basis of information provided by the Company and/or its senior management, stated in relevant part: MEDA's overall fundamentals continue to be buoyed by its strong technology divisions. We estimate that the companies Atwork, Imonics, and recently acquired Consort divisions will be the driving force to margins. We estimate that these divisions are on the order of 1-2 times more profitable than MEDA's core A/R, billing business. As evidence of MEDA's conviction here, it has significantly added to staff at the Imonics subsidiary, increasing headcount from 80 to 300 in 1995. - 22 - 23 55. The February 6, 1996 press release announcing operating results for the fourth quarter and full year, 1995, and the information provided by defendants to the market through the analysts' reports referred to in paragraphs 50-54 were materially false and misleading in at least the following respects: (a) The financial results incorporated and discussed therein were false and had been achieved only through the use of improper accounting practices in violation of GAAP. As was ultimately disclosed at the close of the Class Period, the operating results reported for this period were improperly and materially overstated by at least $5 million as a result of the reporting of revenues and profits under software license agreements entered into by Imonics, which is permissible under GAAP only where customers are unconditionally obligated to perform under the agreements. In fact, unbeknownst to the public, in order to create the illusion that more customers had signed such license agreements than was actually the case, the Company had aggressively enlisted one or more major customers, but then provided them with secret side letters, enabling the customer(s) to avoid paying all of the fees payable under the agreements. This was improper under GAAP, in the following respects: Accounting Research Bulletin ("ARB") 13, Chapter 1, section A: Profit is deemed to be realized when a sale in the ordinary course of business is effected, unless the circumstances are such that the collection of the sale price is not reasonably assured. (Emphasis added). Financial Accounting Standards Board ("FASB") Statement of Concepts ("CON"), paragraph 83 (a): Revenues and gains are generally not recognized until realized or realizable. Revenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash. Revenues and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. (Emphasis added). - 23 - 24 FASB Statement of Standards No. 5, paragraph 27: Contingencies that might result in gains usually are not reflected in the accounts since to do so might be to recognize revenue prior to its realization. FASB Statement of Standards No. 48 ("FAS48"), paragraph 6: If an enterprise sells its product but gives the buyer the right to return the product, revenue from the sales transaction shall be recognized at time of sale only if all of the following conditions are met: (I) The seller's price to the buyer is substantially fixed or determinable at the date of sale; (2) The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (3) The buyer's obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) The buyer acquiring the product for resale has economic substance apart from that provided by the seller; (5) The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and the amount of future returns can be reasonably estimated. Where resolution of a significant contingency is part of a license agreement, then "a sale in the ordinary course of business" has not been "effected." (ARB 43). Additionally, if the contingency is not resolved, then "related assets received or held are [not] readily convertible to known amounts of cash or claims to cash." (FASB CON 5). Further, if the non-satisfaction of the contingency results in the "return" of the product or the absence of any obligation of the buyer to pay for the license fee, then the buyer is not "obligated to pay the seller" and revenue may not permissibly be recognized under the license agreement. (FAS48). As detailed in paragraphs 125-129, the falsification of reported revenue in the fourth quarter of 1995 ultimately required the Company, at the end of the Class Period, to restate the results to reduce reported net income by $5.1 million, resulting in a net loss of $1.1 million rather than the previously reported net income of $4 million for the quarter, and a net loss of $8.5 million for 1995, over double the previously reported net loss of $3.4 million for the year. - 24 - 25 (b) In addition, the representations that the technology division (consisting primarily of Imonics and Atwork) was "effectively offsetting" the margin pressures and results at MPSC were materially false and misleading when made because the technology division was not able to offset revenue, growth and margin pressures affecting MPSC because: (i) Imonics was experiencing severe operational problems including, among other things, excessive staffing, inadequate cost controls, and poor operating performance so severe that they negated Imonics' ability to perform as represented; and (ii) Atwork's sales pipeline had been in decline since September of 1995, and there were significant operating flaws, or "bugs," in certain of the Atwork division's software products introduced at year end 1995. 3. PUBLIC STATEMENTS RELATING TO THE RAPID SYSTEMS AND BSG MERGERS 56. Having disseminated its materially false and misleading press release of February 6, which included false financial results showing increasing net income rather than the true losses the Company was actually suffering, Medaphis implemented its scheme to use its stock (the price of which was artificially inflated as a result of defendants' misstatements) as currency for additional acquisitions. 57. Thus, on February 29, 1996, defendants caused Medaphis to file with the SEC a Form 5-4 Registration Statement (the "February 1996 Registration Statement"), which was signed by defendants Brown, Cote and Douglass. Defendants filed the February 1996 Registration Statement in order to issue 2 million shares of Medaphis common stock which the Company reported "may be offered by Medaphis from time to time in connection with acquisitions of other businesses or properties." - 25 - 26 58. On March 13, 1996, the defendants issued a press release announcing that Medaphis had signed a definitive agreement to acquire all of the outstanding capital stock of Rapid Systems Solutions, Inc. ("Rapid Systems") (a closely-held, Columbia, Maryland based computer systems integration company) in exchange for 1,135,000 shares of Medaphis common stock, worth approximately $43 million (the "Rapid Systems Merger"). Defendant Brown stated that Rapid Systems was acquired specifically because it complemented "the work Imonics is doing on the Medaphis re-engineering project." 59. Two days later, on March 15, 1996, defendants issued a press release announcing yet another acquisition, this time reporting that Medaphis had executed a definitive agreement to acquire all of the outstanding capital stock of BSG Corporation ("BSG") for approximately $350 million in stock, including 7.5 million shares of Medaphis common stock and assumption by Medaphis of BSG stock options and stock rights representing an additional 2.66 million shares of Medaphis common stock (the "BSG Merger"). This transaction represented the largest acquisition yet for Medaphis. According to the March 15 announcement, the Company's "existing systems integration and information technology (IT) services companies -- including Imonics Corporation and Rapid Systems Solutions Inc. -- will come under the BSG umbrella, thereby creating the industry's largest IT services company focused purely on client/server technology and applications." 60. Significantly, defendant Brown, in emphasizing the importance of the BSG Merger, assured investors that BSG had the necessary infrastructure to manage successfully the integration of both Imonics and Rapid Systems to create successfully the largest client/server technology services company in the country: - 26 - 27 The merger with BSG is a major milestone in increasing our technology capabilities. Working with Imonics and Rapid Systems Solutions, BSG will lead our systems integration efforts and we believe will accelerate transformation of the way transaction processing is performed in the healthcare industry. . . . We are excited about our newly acquired capabilities in client/server consulting and systems integration. Imonics and Rapid Systems Solutions combined with BSG have created. we believe. the largest pure client/server technology services company in the country. (Emphasis added). 61. A March 18, 1996 Wall Street Journal article reported in connection with the planned BSG Merger that: [t]he company said it decided to make a bigger push into systems integration following the successful 1994 acquisition of Imonics, which has seen its profit double since the purchase and its employees increase, according to Michael Cote, Medaphis' chief financial officer. 62. As a result of the foregoing positive announcements, on March 20, 1996, Medaphis shares hit a 52-week high of $53.25, a 40% increase over the stock's March 12, 1996 close of $37.50. 63. The statements concerning the synergies and efficiencies of the Rapid Systems and BSG Mergers, and the Company's integration of the operations of Rapid Systems and BSG into its overall business identified in paragraphs 57-61 above were materially false and misleading. Among other reasons, because of the severe operational problems at Imonics summarized at paragraphs 55(b) and 69 hereof, there was no reasonable basis for the representations concerning the synergies offered by the merger of Imonics and Rapid Systems with BSG's operations. Defendant Cote's representations concerning the supposed profitability of Imonics were false and misleading for the same reason, as well as for the added reason that, as - 27 - 28 set forth in greater detail at paragraph 55(a) above, Medaphis' publicly reported profits were materially false and misleading as a result of improper revenue recognition practices relating specifically to improprieties at Imonics. 64. On April 3, 1996, in connection with the BSG Merger, Medaphis filed with the SEC a Registration Statement on Form 5-4 (The "BSG Registration Statement") and a Proxy Statement/Prospectus (the "BSG Prospectus"). The BSG Registration Statement was signed by defendants Brown, Cote and Douglass. 65. The BSG Prospectus, which was included as part of the BSG Registration Statement filed with the SEC, incorporated by reference Medaphis' Annual Report on Form 10-K for the fiscal year ended December 31, 1995, including the audited financial statements incorporated by reference therein, (discussed at paragraphs 70-80 herein), and incorporated the false and misleading statements of the Company's year-end and fourth quarter 1995 results as reported in the February 6, 1996 press release referred to at paragraph 50 above. These documents represent that the financial results presented therein "include all adjustments ... that are necessary for a fair presentation of the financial position and results of operations for such periods." 66. In addition, the BSG Prospectus repeated defendants' misleading statements regarding the successful consolidation of Imonics, BSG and Rapid Systems, stating that the merger "will position Medaphis as the leading client/server systems integration and workflow engineering company in the United States." The BSG Prospectus also falsely stated that: - 28 - 29 Finally, management believes that BSG, Rapid Systems and Imonics complement each other and that the combination of these three organizations within Medaphis should produce synergies. . . . Imonics possesses extremely talented object oriented programming expertise, an existing library of object codes and proprietary pricing methodologies. Management of Medaphis believes that each of the foregoing attributes of BSG, Rapid Systems and Imonics are complimentary [sic] in nature and together position Medaphis to take advantage of systems integration and workflow engineering projects within and outside the healthcare industry. 67. The BSG Prospectus also provided the following highly positive description of the Re-Engineering Project: In order to increase efficiency and position Medaphis to take advantage of the opportunities being created by ongoing changes in the healthcare industry, Medaphis has commenced a re-engineering project which will involve, among other things, the consolidation of the billing and accounts receivable processing function of its billing and accounts receivable management business, which is currently operated out of approximately 300 local business offices around the country, into approximately 10 remote processing centers. In addition to the consolidation of processing operations, the re-engineering project will involve the establishment of advanced client/server computing at the local sales and service offices and at remote processing centers. This computing infrastructure will be designed to significantly reduce paper handling and greatly increase the speed of record recovery while permitting communication over a wide-area network and across geographic markets and linking together all of Medaphis' operating divisions . . 68. The BSG Prospectus continued: Medaphis believes the re-engineering project will provide its customers and employees with the full information processing and communications power of an advanced distributed computing system. The re-engineering project is designed to enable Medaphis to continue to grow and achieve economies of scale in several areas, including training, client service, patient and payor relations, transaction processing operations and electronic data interchange capabilities. The project is expected to be substantial Iv completed during 1997. Although the re-engineering project will involve - 29 - 30 consolidation of the processing functions of its billing and accounts receivable management services. Medaphis intends to continue to maintain and place increased emphasis on the sales and customer service functions of this business on a local basis. (Emphasis added). 69. (a) The representations contained in the BSG Registration Statement and Prospectus, which incorporated Medaphis' operating results for the fourth quarter and full year 1995 by reference, as well as the May 7, 1996 press release, were materially false and misleading in the manner and for the reasons specified in paragraph 55(a) above. (b) In addition, defendants' representations regarding the progress, positive results, and expected completion date of the Re-Engineering Project were materially false and misleading and lacked a reasonable basis when made in that they misrepresented and/or failed to disclose that: (i) progress on the Re-Engineering Project was being impeded by, among other things, the serious management, operational, and other problems being experienced by Imonics, set forth above, and the Company's inability to successfully integrate and coordinate the acquisitions of BSG and Rapid Systems; (ii) the software designed to automate the billing process at MPSC was not appropriate for large volume processing, thus requiring further software development and causing a deferral of the office consolidation element of the Re- Engineering Project; and (iii) in light of these problems, the Re-Engineering Project was not likely to be completed until 1997, if not 1998, contrary to defendants' representations. (c) Further, defendants' statements regarding the synergies to be derived from the BSG and Rapid Systems mergers, and the ability of Medaphis and Imonics to successfully integrate and coordinate these acquisitions, were materially false and misleading in - 30 - 31 that they misrepresented and/or failed to disclose: (i) the adverse facts regarding Imonics, identified above at paragraph 55(b); and (ii) that the integration of Imonics' operations with 8SG and Rapid Systems was not proceeding well in view of Imonics dilapidated condition, and could not be accomplished without a complete reorganization of Imonics. (d) Moreover, defendants' representation that the Company would "continue to maintain and place increased emphasis on the sales and customer service functions" of the Company's MPSC division was false and misleading. As defendants knew or recklessly disregarded, the Company's focus on the Re-Engineering Project at MPSC was done at the expense of customer service and customer retention, which was leading to significant revenue declines and reductions in profitability for Medaphis. (e) In addition, the increasing staff levels at Imonics, cited by analysts as a positive growth factor based on defendants' representations, was, in reality, excessive, as evidenced by the October 22, 1996 disclosure that the Company had terminated 430 employees, including the entire Imonics senior management team. 4. REPRESENTATIONS CONTAINED IN THE 1995 10-K AND ANNUAL REPORT 70. On or about April 1, 1996, Medaphis filed with the SEC its Form 10-K for the fiscal year ended December 31, 1995 (the "1995 l0-K"). The 1995 10-K was signed by, among others, defendants Brown, Cote and Douglass. 71. The 1995 10-K incorporated, at page 19, the same reported financial results for the fourth quarter and full year of 1995 as were announced on February 6, 1996 as set forth in paragraph 50 herein. The 1995 10-K also incorporated by reference the financial - 31 - 32 presentations set forth in the Company's 1995 Annual Report, which is discussed in greater detail in paragraphs 75-80 hereof. The 1995 10-K further stated, in relevant part, that such financial presentations therein "include all adjustments ... that are necessary for a fair presentation of the financial position and results of operations for such periods." 72. The 1995 10-K boasted of the "core competencies in the systems integration and work flow engineering fields," and went on to state that although MPSC was experiencing some "revenue and margins pressures", these pressures were being "offset" by growth in Medaphis' information management and systems integration services business (for which Imonics was responsible), and that the Re-Engineering Project was easing such pressures. 73. The 1995 l0-K also contained a description of the Re-Engineering Project virtually identical to that set forth in the BSG Prospectus quoted at paragraphs 65-67 above. 74. With respect to the Company's revenue recognition policy, the 1995 10-K stated: REVENUE RECOGNITION. . . . Revenue from software licenses is generally recognized upon shipment of the products and when no significant contractual obligations remain outstanding. When the Company receives payment prior to shipment or fulfillment of significant vendor obligations, such payments are recorded as deferred revenue and are recognized as revenue upon shipment or fulfillment of significant vendor obligations. The license agreements typically provide for partial payments subsequent to shipment; such terms result in an unbilled receivable at the date the revenue is recognized. Costs related to insignificant vendor obligations are accrued upon recognition of the license revenue. Software maintenance revenue is deferred and recognized ratably over the term of the maintenance agreement, which is typically one year. - 32 - 33 Revenues from systems integration contracts are recorded on the percentage of completion method of accounting. (Emphasis added). 75. At or about the time that it filed the 1995 10-K, the Company also issued its 1995 Annual Report. Like the 1995 l0-K, the 1995 Annual Report incorporated the same reported financial results for the fourth quarter and full year of 1995 as were announced on February 6, 1996. The 1995 Annual Report represented that the financial statements set forth therein: present fairly, in all material respects, the financial position of Medaphis Corporation and subsidiaries at December 31, 1995 and 1994 and the results of their operations and cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. 76. In the 1995 Annual Report, the defendants again touted the benefits and "positive results" of the Re-Engineering Project, and set forth a description thereof virtually identical to that set forth in the BSG Prospectus (see paragraphs 65-67 herein), and in the 1995 l0-K (see paragraphs 70-74 herein). The 1995 Annual Report also represented that: The positive results of this progressive effort are already in evidence. Today, Medaphis is a leading provider of information management systems and systems integration and work flow engineering systems and services to the healthcare industry and other industries. 77. The 1995 Annual Report also emphasized the positive contributions that Imonics had made to the Company's business, stating that, because of Imonics, the Company had gained an "immense competitive advantage" and had "re-engineered its future." Defendants assured investors that Imonics would allow the Company to recognize efficiencies that "will dramatically change the way business is done." The following excerpt appeared in the 1995 Annual Report: IMONICS: A LEADER IN BUSINESS PROCESS - 33 - 34 RE-ENGINEERING AND SYSTEMS INTEGRATION. With the 1994 acquisition of Imonics. Medaphis re-engineered its future. A leader in business process re-engineering and systems integration, Imonics will enable Medaphis to create internal efficiencies, while being able to offer the same cost-effective solutions to others throughout the healthcare industry, and in other industries. For Medaphis, or for any other customer service or business operation that processes large volumes of paper, fax and phone calls, Imonics' software solutions provide an immense competitive advantage. The first signs of these increased efficiencies are already in evidence in our Pittsburgh office. And as they are applied to an even greater extent in the coming months, our belief is that they will dramatically change the way business is done throughout our transaction processing operations and, hopefully, our entire industry. (Emphasis added.) 78. The Annual Report also stated that the progress of the Re-Engineering project "has been nothing short of remarkable," and that [t]he impact on customer service is immeasurable." 79. The 1995 Annual Report also praised the Company's 1995 acquisition of Atwork, which was described as "the leading provider of information systems that schedule the activities of patients and employees in healthcare." The 1995 Annual Report offered a highly upbeat assessment of Atwork: Atwork solves complex scheduling problems in healthcare management, and they have historically enjoyed a high level of client satisfaction. Atwork markets four leading products to healthcare providers. The first, ANSOS, automates nurse staffing and scheduling, and, as the market leader, is the most widely used system of its kind. The second, ORSOS, used for operating room scheduling and inventory management, is the market leader as well. The third product, One-Call, is used for enterprise-wide patient scheduling. And finally, One-Staff is used to schedule and manage all employees throughout the healthcare enterprise. - 34 - 35 80. The letter to stockholders, included in the 1995 Annual Report and signed by defendant Brown, stated, among other things, that: Medaphis has embarked on an aggressive technology initiative to increase its own internal efficiencies, as well as those of its clients. The positive results of this progressive effort are already in evidence. Today, Medaphis is a leading provider of information management systems and systems integration and work flow engineering systems and services to the healthcare industry and other industries. *** In the course of solving our own technology problems, we have discovered a major business opportunity -- the lack of next generation distributed processing platforms and user-oriented applications to solve business and information processing needs of industry in general, particularly healthcare. 81. The representations contained in the 1995 10-K and Annual Report and the documents incorporated therein by reference, incorporating Medaphis' operating results for the fourth quarter and full year of 1995, and Medaphis' revenue recognition policies, were materially false and misleading in the manner and for the reasons set forth in paragraph 55(a) above. The representations concerning the finances and operations of Imonics, the progress of the Re-Engineering Project at MPSC, and the ability of Medaphis and Imonics to successfully integrate and coordinate the acquisitions of BSG and Atwork were materially false and misleading for failing to disclose the adverse material facts concerning Imonics and Atwork specified at paragraphs 55(b) and 69 above. 5. REPRESENTATIONS CONCERNING THE BERTELSMANN JOINT VENTURE AND MEDAPHIS' RESULT. FOR THE FIRST QUARTER OF 1996 ENDED MARCH 30. 1996 - 35 - 36 82. In February 1996, Medaphis, through Imonics, entered into a Joint Venture with a subsidiary of Bertelsmann, a German corporation. According to the Company, the Joint Venture was formed to pursue custom software development and systems integration projects for customer service systems in Europe, primarily in Germany, over a multi-year period, with each partner holding a 50% interest in the Joint Venture. The Joint Venture partnership agreement was signed on March 13, 1996, eighteen days before the close of the Company's fiscal 1996 first quarter. 83. On or about March 31, 1996, the last day of the first quarter of fiscal 1996, the Joint Venture concluded an agreement with a German telecommunications entity to provide systems integration and work flow engineering systems and services (the "Systems Integration Contact"). Immediately upon entering into the Systems Integration Contract on March 31, 1996, the Company recognized $12.5 million of Joint Venture net earnings, thereby dramatically improving reported revenues and net earnings for the first quarter of 1996. 84. On April 23, 1996, Medaphis issued a press release to announce its first quarter results, which included the $12.5 million in net earnings recognized in connection with the Systems Integration Contract the Company rushed to enter into at the close of first quarter. The Company reported that revenues had increased by 24.1% over results for the first quarter of 1995, from $110.1 million to $136.6 million, and that reported net income had increased from a reported loss of over $8.2 million for the quarter ended March 31, 1995, to a reported Profit of $13.2 million for the first quarter of 1996. Commenting on these reported results, defendant Brown noted that Medaphis was "pleased with the first quarter," adding: - 36 - 37 The performance of our client/server IT services business was excellent and included formation of a joint-venture with a subsidiary of Bertelsmann A.G. in Germany. The joint venture signed a large contract with a telecommunications company during the quarter. 85. The market recognized the Joint Venture and the new Systems Integration Contract as an important step for Medaphis, adding significantly to the Company's value to an investor. In an April 30, 1996 Smith Barney report, for example, which was prepared based on information provided by defendants, the Joint Venture was specifically cited as an example of one of the areas in which Medaphis had "displayed strong growth": Imonics announced a joint venture with Bertelsmann, AG to provide systems integration services overseas. Bertelsmann's BMG Music Club has been a client of Imonics for several years. In the same announcement, the JV disclosed a major, multi-year contract with a foreign telecommunications company. Although Imonics is performing most of the work on [Medaphis'] re-engineering, its headcount has grown to over 400 to also staff the growth in its outside business. 86. On May 14, 1996, defendants caused Medaphis to file its first quarter Form 10-Q with the SEC (the "First Quarter 10-Q"), which was signed by defendants Cote and Douglass, in which it incorporated and provided additional details concerning first quarter 1996 financial results for the quarter previously announced on April 23, 1996 (see paragraph 84 herein). 87. The First Quarter 10-Q represented that the financial information contained therein was "prepared in accordance with the Company's customary accounting policies and practices." - 37 - 38 88. In addition, the First Quarter 10-Q expressly incorporated the representations contained in the 1995 10-K, including the representation that "[r]evenues from systems integration contracts are recorded on the percentage of completion method of accounting," and also contained management's representation that the financial statements included therein reflect "all adjustments . . . necessary for a fair presentation of the results of operations of the interim period." 89. At or about the time defendants publicly announced Medaphis' first quarter 1996 operating results and filed the First Quarter 10-Q, several bullish reports were issued by securities analysts based on information provided by the Company: (a) "Over the next several quarters, we expect the re-engineering program in its core Medaphis Physician Services Corporation to begin to have an impact while the growth in its technology businesses continues continues [Sic] to accelerate." (May 16, 1996 report by Donaldson, Lufkin & Jenrette Securities Corporation); (b) "Near-term, we have confidence in our quarterly estimates as well as our $1.05 - $1. 10 estimate for the full year." (May 16, 1996 report by Donaldson, Lufkin & Jenrette Securities Corporation); and (c) "Based on our conversation with management yesterday, our comfort level on near-term earnings prospects have increased. While management did not endorse a specific estimate, it appears as though there have been some fundamental positive changes.... While there remains consolidation challenges, we believe that these are the early signs that the large software development project is beginning to pay off...." (June 4, 1996 report by Donaldson, Lufkin & Jenrette Securities Corporation). 90. The representations contained in Medaphis' announcements concerning the Bertelsmann Joint Venture and the Company's financial results for the quarter ended March 31, 1996, as set forth in paragraphs 82-88 herein, were materially false and misleading in that the - 38 - 39 financial results set forth therein were falsified and had been achieved only through the use of improper accounting practices which violated GAAP. Indeed, the reported net income for this period of $13.2 million was improperly and materially overstated by virtue of the recognition of $12.5 million in profits from the Systems Integration Contract immediately upon the execution of the contract in violation of relevant accounting principles, including GAAP. Defendants knew or recklessly disregarded, at the time the contract was entered into, that: (i) Imonics was experiencing serious problems, including over-staffing, poor management, inadequate cost controls and poor operational performance (as detailed in paragraphs 55(b) and 69 hereof); and (ii) that, as is also detailed at paragraphs 55(b) and 69 hereof, Imonics was unable to perform its obligations under the Systems Integration Contract and the Joint Venture. Under such circumstances, the recognition of $12.5 million in Joint Venture net earnings was improper. ARB 43 provides that "profit is deemed to be realized when a sale in the ordinary course of business is effected, unless the circumstances are such that the collection of the sale price is not reasonably assured." Additionally, the Company could not in good faith consider the Systems Integration Contract to result in "actual or expected cash flow that ha[s] accrued or will eventuate as a result of the entity's ongoing major or central operations," if, at the time the contract was entered into, defendants were aware that there was no basis for the belief that Imonics could fulfill its obligations under the Contract as proscribed by paragraph 78 of FASB CON 6. Finally, recognition of the revenues from the contract under such circumstances was improper under FASB CON 5, paragraph 83, which provides: Revenues are not recognized until earned. An entity's revenue earning activity involves delivering or producing goods, rendering services, or activities that constitute its major or central operations, - 39 - 40 and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. Accordingly, in recognizing $12.5 million in Joint Venture net earnings in March of 1996, the Company violated these provisions of GAAP. 91. Second, defendants improperly recognized $12.5 million in Joint Venture net earnings in the first quarter because if these revenues could have been properly recognized at all, they should have been recognized ratably over the period the services were performed under the Systems Integration Contract in accordance with the percentage-of-completion method of accounting. As noted above, FASB CON 5, paragraph 83, provides that "revenues are not "earned," and therefore should not be recognized, until an "entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues." (Emphasis added). 92. In addition, the First Quarter 10-Q, having incorporated by reference the 1995 10-K (and derivatively the 1995 Annual Report), was materially false and misleading for the same reasons, specified in paragraph 81 herein, as the 1995 10-K and Annual Report were false and misleading. In addition, the First Quarter 10-Q expressly incorporated the additional representation contained in the 1995 10-K that "[r]evenue from systems integration contracts are recorded on the percentage-of-completion method of accounting." (Emphasis added). Thus, in recognizing first quarter revenues from the System Integration Contract, defendants violated the Company's own disclosed revenue recognition policy, rendering this specific statement false. 6. ADDITIONAL PUBLIC STATEMENTS RELATING TO IMONICS AND THE HDS MERGER - 40 - 41 93. In April 1996, Medaphis officials attended a Robinson-Humphrey Co. conference at which they touted the success at Imonics, declaring that it was "going like gangbusters." 94. Seeking to continue its practice of acquiring companies utilizing overvalued Medaphis stock, on or about May 24, 1996, Medaphis announced its intention to acquire Health Data Sciences Corporation ("HDS") in exchange for 6,125,000 Medaphis common shares and assumption or issuance by Medaphis of stock options representing an additional 556,000 shares. Based on the May 24, 1996 closing price of Medaphis stock of $40.938, the HDS Merger was valued at approximately $273.5 million. 95. HDS was a developer and supplier of health care information systems to institutions, payers, health care networks, and providers. HDS' main product offering was a line generally known as ULTICARE (R), an integrated information system which allows doctors and hospitals in large health care systems to enter and access immediately clinical information on patients. The ULTICARE system can also schedule medical procedures, such as surgery. 96. According to an article published in the Atlanta Journal and Constitution on May 25, 1996, defendant Brown stated that, with the planned acquisition of HDS, "I think we now have the pieces we need .... This is where we've been aiming with our business." 97. A definitive Merger Agreement was executed by Medaphis and HDS on May 23, 1996 (the "HDS Merger"). Under the terms of the HDS Merger, stockholders of HDS were entitled to receive .7912 of a share of Medaphis common stock for each share of HDS common stock and HDS preferred stock. In connection therewith, the defendants were specifically motivated to keep the price of Medaphis stock artificially high in order to complete - 41 - 42 the acquisition of HDS. Indeed, the Merger Agreement explicitly provided that, if the average closing price of Medaphis stock for a period of time dropped below $37 per share, HDS could unilaterally terminate the deal. Thus, defendants knew that it was imperative that the company continue to tout its many "successes" while concealing the true facts about Medaphis' business. 98. On May 31, 1996, in connection with the HDS Merger, Medaphis filed an Amendment No. 1 to its Form 5-4 Registration Statement with the SEC (the "HDS Registration Statement"). The Registration statement included a Proxy statement/Prospectus, also dated May 31, 1996, which was issued in connection with a special meeting of HDS stockholders to be held on June 29, 1996 (the "HDS Prospectus"). The HDS Registration Statement was signed by defendants Brown, Cote and Douglass. 99. The HDS Prospectus included, inter alia, a detailed description of the background of the HDS Merger, the reasons for the HDS Merger, and the terms of the Merger. The HDS Prospectus also included an upbeat description of Medaphis' Re-engineering Project which was substantially similar to the statements contained in the BSG Prospectus, the 1995 l0- K and the 1995 Annual Report. The defendants again represented in the HDS Prospectus that "[t]he [Re-Engineering] project is expected to be substantially completed during 1997." 100. As they had in the BSG Prospectus, the defendants also continued to tout the benefits of the BSG and Rapid Systems mergers in the HDS Prospectus, stating that: Management believes that the acquisition of workflow engineering operations, will position Medaphis as the leading client/server systems integration and workflow engineering companies in the United States. - 42 - 43 101. The HDS Registration Statement and Prospectus explicitly incorporated by reference Medaphis' 1995 Annual Report, filed on April 1, 1996, and its First Quarter 10-Q, filed on May 15, 1996, relevant excerpts of which are set forth at length at paragraphs 70-80, 87- 88, and 92, respectively. As such, the HDS Registration Statement and Prospectus was materially false and misleading for the same reasons the 1995 Annual Report and First Quarter 10-Q were misleading, as specified in paragraphs 81 and 90-93, respectively. 102. The additional representations in the HDS Prospectus, set forth in paragraphs 99-100, concerning the finances and operations of Imonics, the progress of the Re- Engineering Project at MPSC, and the ability of Medaphis and Imonics to successfully integrate the Company's various acquisitions were materially false and misleading for failing to disclose the adverse material facts concerning Imonics specified at paragraphs 55(b) and 69 hereof. 103. Had the full truth about Medaphis been disclosed at the time, the company never would have been able to complete the HDS Merger. Based on recent trading prices of Medaphis stock (approximately $8.50 per share), the acquisition of HDS, which cost the Company just over 6 million shares, would have cost nearly five times that amount, or 28 million shares. Based on recent trading prices, defendants' fraudulent conduct enabled the Company to purchase HDS -- a company valued at $230 - $260 million in the HDS Merger -- for stock now worth just $53 million, costing HDS shareholders hundreds of millions of dollars in losses. 7. PUBLIC STATEMENTS RELATING TO SECOND QUARTER 1996 RESULTS 104. On July 23, 1996, defendants issued a press release announcing Medaphis' financial results for the second quarter of 1996, ending on June 30, 1996. The Company reported - 43 - 44 that revenue for the three months ended June 30, 1996 was $175.2 million, up 24% from the $141.3 million in the year-earlier period, and that, excluding merger and other one-time costs, net income was $18.7 million, up 159%, with earnings per share of $0.25, up 150%. For the six months ended June 30, 1996, Medaphis reported a 255% increase in revenues over the six months ended June 30, 1995, from $274.4 million to $338.8 million, and a 500% increase in net income and earnings per share, from a loss of $4.6 million or $.08 per share in 1995 to net income of $16.4 million or $.22 per share in 1996. 105. Defendant Brown continued to assure the investment community that Medaphis' technology companies were "generat[ing] strong results," and he explained that much of these "strong results" were attributable to the recent acquisitions of HDS, Rapid Systems and BSG: We are pleased with the second quarter and underlying results of our technology and services businesses. The technology companies continue to generate strong results, especially our latest additions: Health Data Sciences Corporation ("HDS"), BSG Corporation and Rapid systems Solutions, Inc. I am thrilled with the recent addition of HDS to our technology capabilities and am excited about the opportunities that it affords us to offer patient- centered information technology in the healthcare industry. Medaphis Physician Services Corporation continued to adversely affect results of the Services Division in the second quarter; however its operating results improved slightly over the first Quarter of 1996. We continue to assess and evaluate the technology and processes necessary to ensure our long-term success and remain cautiously optimistic that the re-engineering project and related management initiatives are positioning the Company for important improvements in operating results. (Emphasis added). 106. The defendants' representations concerning the second quarter of 1996 had their intended effect on the investment community. On July 24, 1996, Bear Stearns issued a - 44 - 45 research report based on information provided by the Company which stated, in relevant part, that: Importantly, management is confident that the top line and cost pressures in the physician billing business (which we estimate to be 25% -30% of total revenue) may have bottomed. These pressures are expected to continue to moderate over the third and fourth quarters of 1996 allowing for a stabilization of this business segment. DURING 1997, we expect to see the benefits of the re- engineering which we believe will pave the way for earnings acceleration." In a similar vein, a Cowen & Co. report dated July 23, 1996, based on information provided by the Company, stated: Technology Strategy A Winner - Virtually all of the revenue growth was derived from terrific performances in the technology companies (+82% at $70MM). Strongest performers include Consort Technologies (radiology information systems), Atwork (medical software), BSG, RSSI and Imonics (client/server systems integration)." Likewise, on July 24, 1996, Donaldson Lufkin & Jenrette issued a research report based on information provided by the Company which stated: EPS for the next two quarters should be $0.28 and $0.30, respectively. Management indicated comfort with street estimates for the third and fourth quarter of this Year. This is in sharp contrast to previous statements about the last few quarters when management consistently hedged about its near-term operating results. (Emphasis Added). 107. The representations contained in the July 23, 1996 press release, which incorporated and reflected Medaphis' operating results for the first quarter of 1996 (see paragraph 84 herein), were materially false and misleading for the reasons set forth in paragraph 90 herein. The representations concerning the finances and operations of Imonics, the progress of the Re- -45- 46 engineering Project at MPSC, and the ability of Medaphis and Imonics to successfully integrate the Company' s various acquisitions were materially false and misleading for failing to disclose the adverse material facts concerning Imonics specified at paragraphs 55(b) and 69 hereof. Moreover, defendants' forecasts of $0.28 and $0.30 per share for the third and fourth quarters of 1996, respectively, were contradicted by the adverse facts set forth above in 55 and P. 69, and were issued by defendants, through analysts' reports endorsed and adopted by the Company, without any reasonable basis. THE TRUTH BEGINS TO EMERGE 1. THE AUGUST 14, 1996 DISCLOSURES 108. On August 14, 1996, after the close of trading, Medaphis finally began to disclose the severe problems which it had been experiencing with Imonics, as well as the difficulties being encountered with MPSC, Atwork, the BSG Merger and the Re-engineering Project during the Class Period. On that day, it issued a press release announcing that it expected to report a in the range of $0.28 to $0.33 per share in the third quarter of 1996, which would include substantial charges in the range of $35 to $40 million. It also announced that it expected earnings per share in the range of only $0.75 to $0.90 for fiscal 1997, compared with analyst expectations of earnings per share of $0.27 for the third quarter and $1.42 for fiscal 1997. The press release stated: The Company's near-term earnings will be impacted by continued weakness in Medaphis Physician Services Corp.'s business and the reorganization of Imonics. Medaphis' near-term outlook also has been affected by slower than expected sales of some of the Company's enterprise-wide scheduling products [sold by Atwork]. The third quarter earnings estimate includes charges in the range of $35 to $40 million relating primarily to the reorganization of - 46 - 47 Imonics and the re-engineering and consolidation program at MPSC. 109. A substantial portion of the Company's difficulties, and the resulting third quarter charges, were reported to have arisen from the need to reorganize its Imonics subsidiary and the Company's problems with the Systems Integration Contract, so positively reported by Medaphis during the Class Period. Explaining the situation, Medaphis reported: Management has commenced the process of reorganizing the Imonics systems integration business. This reorganization resulted from a review by BSG of Imonics' overall operations and an assessment of recent difficulties encountered by Imonics with a large systems integration agreement entered into by its European joint venture. The reorganization of Imonics will include efforts to more closely align Imonics' business practices with those of BSG. The BSG model is structured to manage client/server information technology projects with experienced project management. It is currently anticipated that Imonics' European joint venture will continue with its system integration project on terms and conditions mutually satisfactory to the parties, but that the agreement relating to the project will be restructured. 110. Medaphis further disclosed that approximately $9 million of charges would be made in the third quarter to account for the restructuring of the Systems Integration Contract entered into by the Joint Venture, with another $15 million in charges relating to the reorganization of Imonics. 111. In addition, the Company revealed that, contrary to its July 23, 1996 representations, its MPSC unit was continuing to experience poor results, due in part to delays in the Re-Engineering Project. The Company disclosed that as a result of these problems, it would - 47 - 48 take a restructuring charge of approximately $11 million, and "up to $5 million of other costs." The Company stated: The Company expects to incur charges in the third quarter in the range of $35 to $40 million. These charges are expected to consist of approximately $9 million relating to the restructuring of a large systems integration agreement entered into by Imonics' European joint venture, approximately $15 million relating to reorganization of Imonics, approximately $11 relating to additional restructuring costs associated with MPSC's re-engineering and consolidation program and up to $5 million of other costs. 112. Defendant Brown was quoted as stating: We are extremely disappointed with these developments. The problems that we have identified at MPSC and Imonics are being addressed by a new operating management team which possesses the process and technology expertise and experience we need to execute our plan. 113. Moreover, in sharp contrast to defendants' previous statements that Medaphis would continue to grow through acquisitions -- the key to its success -- the company announced that it had abandoned its acquisition strategy: "We're focused on re-engineering MPSC's business for future growth, and not on expanding the business through acquisitions in the near term," defendant Douglass stated. 114. As reported in Bloomberg News on August 15, 1996, Bertelsmann officials had called Medaphis in late July to complain about the computer integration project which Imonics was working on with the Joint Venture. In particular, Bertelsmann offered two choices to Medaphis: quit or renegotiate the contract. According to Cowen & Co. analyst Charles Trafton, the news of problems with Imonics came as "a complete shocker" and "Imonics was not delivering." - 48 - 49 115. On the same day it announced its anticipated losses for the third quarter, Medaphis filed its Form 10-Q for the fiscal 1996 second quarter (the "Second Quarter 10-Q"). In it, the Company disclosed for the first time that the Joint Venture had begun discussions with its European Partner, Bertelsmann, and the related customer on July 25. 1996 regarding difficulties that had been encountered with certain aspects of the Systems Integration Contract. As a result of these difficulties, which were not disclosed until August 14, 1996, Medaphis reported that it had been forced to negotiate "the restructuring of the operating relationships and economics underlying the Contract," adding: Although a restructured arrangement among the parties is subject to the negotiation and execution of definitive agreements, the Company anticipates that the contract will be amended and a restructured arrangement will be executed that will position the Joint Venture to move forward with the project and to pursue other opportunities and projects on terms and conditions that are mutually beneficial to the parties. The Company anticipates recording a loss related to the restructured arrangement of approximately $9 million during the third quarter of 1996. 116. With respect to the Imonics' restructuring, the Company disclosed in the Second Quarter l0-Q that, contrary to previous statements to the effect that the Company had the necessary infrastructure to create tremendous business opportunities, the Company would need to take a charge of $15 million to reorganize Imonics because of over-staffing, inadequate internal cost controls and poor operating performance. The Second Quarter l0-Q stated: Many changes have and will continue to occur at Imonics Corporation ("Imonics") including: headcount reductions, increased focus on project management, increased cost controls and implementation of the BSG business model. In addition to the expected $9 million loss related to the restructured arrangement noted above, the Company anticipates recording losses in the third - 49 - 50 quarter of 1996 related primarily to the reorganization of Imonics of approximately $15 million. 117. The market reacted sharply and dramatically to Medaphis' August 14 announcement, with its share price plunging the following day, decreasing the value of the Company by $1.6 billion. The stock price closed at $14-1/4 per share, after dropping by $21-3/8, or approximately 60 percent. More than 42 million shares of Medaphis stock changed hands during the day, making it the most active U.S. issue on NASDAQ that day and representing the sixth-highest single trading day in NASDAQ history, excluding penny stocks. 2. THE OCTOBER 22, 1996 DISCLOSURES 118. Despite the startling disclosures of August 14, 1996, and the resulting drop in the Price of Medaphis stock, defendants had not yet disclosed the full extent of the company's problems known to or recklessly disregarded by defendants at the time. Instead, defendants continued to mislead investors about the current and future business Prospects of Medaphis and represented that all of the Company's problems had been identified and adequately reserved against. 119. For example, after a meeting with Medaphis senior management on August 21, 1996, an analyst with Bear, Stearns & Co. ("Bear Stearns") reported that: [a]fter uncovering the problems at Imonics and MPSC, management undertook a rigorous examination of all business units in order to assess [the] possibility [of additional charges and a further reduction in earnings expectations] and concluded that all of the potential problems have been reserved against. (Emphasis added). 120. Based largely on this positive meeting with Medaphis management, Bear Stearns forecast third quarter earnings per share of $0.02 excluding charges of $35 - $40 million, - 50 - 51 and continued to give Medaphis stock an "Attractive" rating. Other analysts issued similar cautiously optimistic reports following the August 21, 1996 meeting, and, based on guidance from Medaphis management, projected earnings per share of approximately $0.02 for the third quarter, excluding charges, or a loss of about $0.27 per share including charges. 121. On October 22, 1996, Medaphis shocked the market for the second time in as many months, issuing a press release announcing third quarter results that were far worse than analysts' diminished expectations and the Company's previous projections. The Company also reduced its earnings projections for 1997 even further, announced even larger charges associated with the reorganization of Imonics, and revealed that due to improper revenue recognition practices in the Imonics division. the Company would have to restate its financial results for the fourth quarter and year ended December 31. 1995. 122. In contrast to its August 16, 1996 forecast of losses in the range of $.28 - $.33 per share, including charges, Medaphis reported a loss of $.51 per share, or $36.4 million for the 1996 third quarter. These results compared to a net loss per share of $0.05 in the year-ago quarter. The Company reported that revenue fell 10% in the third quarter, to $126.7 million, from $140.8 million a year ago. 123. In addition, the Company disclosed that rather than taking charges of between $35 - $40 million, Medaphis reported total charges of approximately $50 million in the third quarter, relating primarily to the reorganization of Imonics and the write-off of revenue from the Systems Integration Contract. The October 22, 1996 press release stated: The results for the three months ended September 30, 1996 include a charge against revenue of $16.8 million relating primarily to the reorganization of Imonics, including the renegotiation of a large - 51 - 52 systems integration contract entered into by Imonics' European joint venture in March 1996. In addition, approximately $8.5 million was included in salaries and wages relating to employees and contractors, who are no longer providing services to the Company, costs to complete certain Imonics contracts and certain other nonrecurring items. In addition, a $24.3 million restructuring charge was recorded during the quarter relating to the reorganization of Imonics. The charge consists of approximately $10.7 million relating to the write down of Imonics' assets, $3.7 million of severance costs primarily for former Imonics' employees, $3.2 million in exit costs for lease terminations and $6.7 million of legal and other costs. 124. While Medaphis had stated in August that it expected 1997 earnings per share to fall between $0.75 and $0.90, defendant Brown lowered that range to just $0.60 to $0.75 in connection with the October 22 press release. At the same time, however, defendant Brown hinted that 1997 earnings are likely to come in even lower still, stating: "I believe there are risks inherent in the business which could cause us to fall short of that goal." 125. In yet another stunning disclosure, the Company announced in the press release that it would restate 1995 results to reflect an actual loss for the year ended December 31. 1995 of 58.5 million. compared with a previously reported loss of $3.4 million. For the 1995 fourth quarter, the Company said it expected to post a loss of $1.1 million. compared with a previously reported profit of $4 million. 126. Medaphis stated that the 1995 restatements were the result of improper revenue recognition practices in the Company's Imonics division, including the improper recognition of $5.1 million in earnings in the fourth quarter of 1995. According to the Company, the Imonics unit had booked revenue on a license agreement it had executed in December 1995 despite the existence of "unauthorized correspondence" which improperly "created a - 52 - 53 contingency" under the license agreement. The revenue recognized on this contract, "together with previously deemed immaterial amounts," reduced net income for the quarter and year ended December 31, 1995 by $5.1 million. As disclosed in the press release: The Company also announced that it intends to restate its financial results for the year and three months ended December 31, 1995. This restatement relates primarily to a license agreement entered into by Imonics in December 1995 and unauthorized correspondence discovered in connection with the Imonics reorganization which created a contingency upon license fees payable under the agreement. The license fee revenue payable under the agreement and recognized by the Company during the fourth quarter of 1995, together with previously deemed immaterial amounts, are expected to result in an aggregate reduction to net income for the quarter and year ended December 31, 1995 of $5.1 million. After appropriate adjustments for such items, it is currently anticipated that the Company's restated results for the year ended December 31, 1995 will be a net loss of $8.5 million as compared with a previously reported net loss of $3.4 million. In addition, it is anticipated that restated results for the quarter ended December 31, 1995 will reflect a net loss of $1.1 million, as compared with previously reported net income of $4.0 million. 127. Continuing the stream of devastating disclosures that day, Medaphis reported in the press release that during the third quarter it had laid off 430 employees, including the entire senior management team at Imonics. This was in stark contrast to defendants' prior statements portraying the growth in the number of Imonics employees as a positive factor. The Company also announced it was attempting to negotiate its credit line from $250 million to $300 million. 128. In a lengthy statement accompanying the October 22 press release, defendant Brown admitted that BSG had been preoccupied with the restructuring of Imonics, and - 53 - 54 that the Company's strategic acquisition program had "ended," and that "[w]e have no ongoing plans to make acquisitions at this time." 129. The adverse disclosures of October 22, 1996 drove the Company's stock down $6.375 or 38%, to close at just $10.375 per share, a 52-week low for the stock. The drop in the market capitalization of the Company was approximately $450 million. The trading volume of Medaphis stock on October 22 was more than 13 million shares, making it the most actively traded stock in the United States that day. DURING the Class Period, Medaphis shares, artificially inflated by defendants' wrongful conduct, had closed as high as $52 1/2 per share (on March 20, 1996). 130. On October 31, 1996, Medaphis announced that it had named David E. McDowell the Company's new Chairman and Chief Executive, replacing defendant Brown. According to the Company, defendant Brown had resigned for "personal" reasons. SUMMARY OF FALSE AND MISLEADING NATURE OF DEFENDANTS' STATEMENTS DURING THE CLASS PERIOD 131. All of defendants' representations set forth above, as well as other substantially similar representations, made during the Class Period, were materially false and misleading and misrepresented and/or failed to disclose material adverse information, including that: (a) The revenues and earnings of Medaphis were materially and improperly overstated during the Class Period due to defendants' utilization of improper accounting methods, including by means of "side letters" in the fourth quarter and year ended - 54 - 55 December 31, 1995 and in connection with the recognition of $12.5 million in Joint Venture net earnings under the Systems Integration Contract in the first quarter ended March 31, 1996; (b) The Company's revenues, net income, and earnings per share for the year and three months ended December 31, 1995 were materially inflated and overstated by $5.1 million as a result of improper revenue recognition practices in the Company's Imonics division which were violative of GAAP and other accounting rules and regulations, as set forth above; (c) The Imonics division, which was responsible for re-engineering the Company's physician billing business, was over-staffed and poorly managed, thereby adversely affecting any purported success of the Re-Engineering Project, and the Imonics division would have to be substantially reorganized, which would result in a substantial charge in the many millions of dollars; (d) The Imonics division would not be able to actively seek new license revenue opportunities, which had been expected to yield approximately $50 million in revenue in 1997, until after the division can be reorganized (through a full integration with BSG), and its serious internal deficiencies are corrected. Since software license revenue has a high operating margin, much of the impact of this reduced revenue will fall directly to the pretax line; (e) With regard to the Re-Engineering Project, the software designed to automate the billing process at MPSC was not appropriate for large volume processing thus requiring further software development and causing a deferral of the office consolidation element of the Re-Engineering Project. Thus, the Company would not achieve the expected increase in profitability which would have resulted from such consolidation; - 55 - 56 (f) Medaphis' physician billing business, MPSC, was performing poorly and the Re-Engineering Project was suffering from multiple problems; (g) Due to the severe problems being experienced by the Company's MPSC subsidiary and the Re-Engineering Project, there was no reasonable basis for the defendants' statements made in connection with the report of second quarter 1996 results that MPSC was "improv[ing]" and that the Re-Engineering Project was "positioning the Company for important improvements in operating results"; (h) With respect to the Joint Venture's Systems Integration Contract (executed in the first quarter of 1996 and touted in the Company's First Quarter l0-Q), Medaphis improperly recognized, in violation of GAAP, millions of dollars in revenue because: (1) the Contract was subject to significant contingencies and ongoing obligations, thus making revenue recognition improper; and (2) the revenue should have been recognized, if at all, ratably over the life of the Contract, based on the percentage-of-completion method of accounting, rather than up front upon signing the Contract. This improper recognition of revenue caused revenue, net income and earnings per share to be materially overstated in the Company's financial statements for the quarters ended March 3l, 1996 and June 30, 1996 in violation of GAAP. Moreover, as a result of Medaphis' failure to meet milestone deadlines, Medaphis has been forced to reverse at least $9 million in recognized revenues to reserve for the reduction in Contract terms during the third quarter of 1996; (i) Further, with respect to the Systems Integration Contract, Imonics had failed to meet milestone deadlines in implementation of the Contract due to, inter alia, weak project management, a poor infrastructure at Imonics, and a failure to provide adequate staffing - 56 - 57 with the skills necessary to perform the project. As a result, the German customer had chosen to renegotiate the contract on terms substantially less favorable to the Company; (j) Contrary to defendants' representations that the Re-Engineering Project would be substantially completed by fiscal year 1997, such that the Company would begin to experience operating leverage, i.e., enhanced margins in the services division, by the beginning of 1997, defendants knew or recklessly disregarded but failed to disclose that the Re- Engineering Project was suffering from numerous problems and thus was not likely to be completed until late 1997, if not 1998, at which time any benefits therefrom would only begin to be realized; (k) The Atwork division's sales pipeline had been in decline since September 1995, and significant bugs in the Atwork division's Windows-based scheduling software introduced at year-end 1995 were not corrected until May 1996. As a result, Atwork's sales were at least 9 months behind Company forecasts; (l) Because of the extensive problems at Imonics, BSG would have to focus all of its attention on reorganizing Imonics and integrating Imonics and Rapid Systems, and would be unable to pursue any significant revenue opportunities of its own, thereby negatively impacting results for at least the remainder of 1996; and (m) Contrary to defendants' representations, Imonics, Atwork, and the Company's other technology businesses were not in fact able to offset revenue, growth, and margin pressures adversely affecting MPSC; (n) Contrary to defendants' statements regarding the synergies to be derived from the BSG and Rapid Systems Mergers, the integration of Imonics' operations with - 57 - 58 BSG and Rapid Systems was not proceeding well, could not be accomplished without a complete reorganization of Imonics, and would require Medaphis to take substantial charges against earnings in the third quarter of 1996; (o) The Company's focus on the Re-Engineering Project at MPSC was done only at the expense of customer service and customer retention, which was leading to significant revenue declines and reductions in profitability for Medaphis; (p) The increasing staff levels at Imonics, cited by analysts as a positive growth factor based on defendants' representations, was, in reality, excessive, as evidenced by the October 23, 1996 disclosure that the Company had terminated 430 employees, including the entire Imonics senior management team; and (q) Defendants' forecasts of $0.28 and $0.30 per share for the third and fourth quarters of 1996, respectively, were contradicted by the adverse facts set forth above and were issued by defendants, through analysts' reports endorsed and adopted by the Company, without any reasonable basis. COUNT I ON BEHALF OF ALL PLAINTIFFS, THE CLASS AND THE SUB-CLASS FOR VIOLATIONS OF SECTION 10(B) OF THE EXCHANGE ACT AND RULE L0B-5 PROMULGATED THEREUNDER AGAINST ALL DEFENDANTS 132. Plaintiffs incorporate by reference and reallege all paragraphs previously alleged herein and assert these claims against all defendants. 133. During the Class Period, defendants, individually and in concert, engaged in a plan, scheme and course of conduct, pursuant to which they knowingly and/or recklessly - 58 - 59 engaged in acts, transactions, practices, and courses of business which operated as a fraud upon plaintiff and other members of the Class and the Sub-Class, and made various untrue statements of material fact and omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, to plaintiffs and other Class and Sub-Class members as set forth above. The purpose and effect of said scheme was to induce plaintiffs and the members of the Class and Sub-Class to purchase and/or acquire the Company's common stock at artificially inflated prices. 134. By reason of the foregoing, defendants knowingly or recklessly violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder in that they (a) employed devices, schemes and artifices to defraud; (b) made untrue statements of material fact and/or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; and (c) engaged in acts, practices, [and] course of business which operated as a fraud and deceit upon plaintiffs and other members of the Class and the Sub-Class in an effort to maintain an artificially high market price for the Company's securities. 135. Each defendant is sued as a primary participant in the wrongful and illegal conduct charged herein. The Individual Defendants are sued as controlling persons as alleged below. 136. In addition to the duties of full disclosure imposed on defendants as a result of their making, or participation in the making of, affirmative statements and reports to the investing public, defendants had a duty to promptly disseminate truthful information that would be material to investors in compliance with the integrated disclosure provisions of the SEC as - 59 - 60 embodied in SEC Regulation S-X (17 C.F.R. Section 210.01 et seq.) and S-K (17 C.F.R. Section 22910 et seq.) and other SEC regulations, including accurate and truthful information with respect to the Company's business, operations, financial condition and performance so that the market prices of the Company's publicly traded securities would be based on truthful, complete and accurate information. As a seller of Medaphis stock during the Class Period, while in possession of material non-public information, defendant Medaphis had a duty to disclose such information or to abstain from trading in such stock. 137. Defendants, individually and in concert, directly and indirectly, by the use of means and instrumentalities of interstate commerce and the mails, engaged and participated in a continuous course of conduct to conceal adverse material information about the business, management, financial condition, performance, operations, and prospects of the Company, as specified herein. Defendants employed devices, schemes and artifices to defraud, while in possession of material adverse non-public information, and engaged in acts, practices, and a course of conduct as alleged herein in an effort to assure investors of the Company's value and performance and continued substantial growth, which included the making of, or the participation in the making of, untrue statements of material facts and omitting to state material facts necessary in order to make the statements made about the Company and its business, operations and future prospects, in light of the circumstances under which they were made, not misleading, as set forth more particularly herein, and engaged in transactions, practices and a course of business which operated as a fraud and deceit upon the purchasers of Medaphis stock during the Class Period. - 60 - 61 138. Each of the Individual Defendants' primary liability and controlling person liability arises from the following facts, among others: (i) each of the Individual Defendants was a high-level executive and/or director at the Company during the Class Period and was a member of the Company's senior management team; (ii) each of the Individual Defendants, by virtue of his responsibilities and activities as a senior executive officer and/or director of the Company, was privy to and participated in the creation, development and reporting of the Company's internal budgets, plans, projections and/or reports; (iii) the Individual Defendants enjoyed significant personal contact and familiarity with each other and were advised of and had access to other members of the Company's management team, internal reports, and other data and information about the Company's financial condition and performance at all relevant times; and (iv) the Individual Defendants were aware of the Company's dissemination of information to the investing public which they knew or recklessly disregarded was materially false and misleading. 139. Defendants had actual knowledge of the misrepresentations and omissions of material facts set forth herein, or acted with reckless disregard for the truth in that they failed to ascertain and to disclose such facts, even though such facts were available to them. Defendants' material misrepresentations and/or omissions were made knowingly or recklessly and for the purpose and effect of concealing the truth with respect to the Company's operations, business, management, performance and prospects from the investing public and supporting the artificially inflated price of its stock. As demonstrated by their misrepresentation of the Company's condition and performance throughout the Class Period, if they did not have actual knowledge of the misrepresentations and omissions alleged, defendants were reckless in failing to obtain such knowledge by deliberately refraining from taking those steps necessary to discover - 61 - 62 whether their statements were false or misleading. The Individual Defendants -- by virtue of their receipt of information reflecting the true facts regarding the Company, and/or their control over or association with the Company that made them privy to confidential proprietary information concerning the Company -- participated in and knew of (or recklessly disregarded) the fraudulent scheme alleged herein. The undisclosed problems alleged in this Complaint were sustained, material and of a nature that evidences that they were in existence during the Class Period and were therefore known to or within the purview of all defendants at all relevant times. 140. As a result of the dissemination of the material misleading information and failure to disclose material facts, as set forth above, the market price of Medaphis common stock was artificially inflated during the Class Period. In ignorance of the fact that the market price of Medaphis stock was artificially inflated, plaintiffs and other members of the Class and Sub-Class relied, to their damage, directly on the misstatements or on the integrity of the market both as to price and as to whether to purchase or acquire these securities. Plaintiffs and the other members of the Class and Sub-Class would not have purchased or otherwise acquired Medaphis stock at the market prices they paid or acquired such securities, or at all, if they had been aware that the market prices had been artificially and falsely inflated by the defendants' false and misleading statements and concealments. At the time of the acquisition of Medaphis common stock by plaintiffs and the other members of the Class and the Sub-Class, the fair market value of said common stock was substantially less than the prices at which plaintiffs acquired such stock. As a direct and proximate result of the defendants' wrongful conduct, plaintiffs and other members of the Class and the Sub-Class have suffered substantial damages in connection with their acquisitions of Medaphis stock. - 62 - 63 141. The statutory safe harbor provided for forward-looking statements under certain circumstances does not apply to any of the allegedly false statements pleaded in this Complaint. To the extent there were any forward-looking statements, there were no meaningful cautionary statements identifying important and material factors that could cause actual results to differ materially from those in the purportedly forward-looking statements. Alternatively, to the extent that the statutory safe harbor does apply to any forward-looking statements pleaded herein, the defendants are liable for those false forward-looking statements because at the time each of those forward-looking statements was made, the particular speaker knew the forward-looking statement was false, and the forward-looking statement was authorized and/or approved by an executive officer of Medaphis who knew that the statement was false when made. COUNT II ON BEHALF OF ALL PLAINTIFFS, THE CLASS AND THE SUB-CLASS FOR VIOLATIONS OF SECTION 20(A) OF THE EXCHANGE ACT AGAINST THE INDIVIDUAL DEFENDANTS 142. Plaintiffs repeat and reallege the allegations set forth above as if set forth fully herein. This claim is asserted against the Individual Defendants. 143. At all relevant times, the Individual Defendants acted as controlling persons of the Company within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of, among other things, the Individual Defendants' high-level positions, and defendants' participation in and/or awareness of the Company's operations and business and/or intimate knowledge of the Company's operations and business, the Individual Defendants had the power to influence and control and did influence and control, directly or indirectly, the various - 63 - 64 statements and documents complained of herein. The Individual Defendants were provided with or had unlimited access to copies of the Company's reports, press releases, public filings and other statements complained of herein prior to and/or shortly after these statements were issued and had the ability to prevent the issuance of the statements or to cause the statements to be corrected. 144. In addition, the Individual Defendants had direct involvement in the operations of the Company, and, therefore, are presumed to have had the power to control or influence the regular transactions giving rise to the securities violations alleged herein and exercised the same. 145. As set forth above, defendant Medaphis violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. By virtue of their controlling positions, the Individual Defendants also are liable for such primary violations pursuant to Section 20(a) of the Exchange Act. As a direct and proximate result of defendants' wrongful conduct, plaintiffs and other members of the Class and Sub-Class suffered damages in connection with their acquisitions of the Company's stock during the Class Period. COUNT III ON BEHALF OF THE SUB-CLASS FOR VIOLATIONS OF SECTION 11 OF THE SECURITIES ACT AGAINST ALL DEFENDANTS - 64 - 65 146. Plaintiffs Carley Capital Group and WME Management Group, L.P. (the "Sub-Class Plaintiffs") incorporate by reference and reallege the allegations set forth above as if set forth fully herein. 147. This Count is brought for violations of Section 11 of the Securities Act, 15 U.S.C. Section 77k, on behalf of the Sub-Class as defined herein against Medaphis and the Individual Defendants. 148. The HDS Registration Statement, which contained the HDS Prospectus, (hereinafter referred to as the "Registration Statement" and the "Prospectus"), and the documents incorporated therein by reference, as set forth in paragraphs 64-65 and 98-100 hereof, were inaccurate and misleading, contained untrue statements of material facts, omitted to state other facts necessary to make the statements made not misleading, and concealed and failed adequately to disclose material facts, all as set forth in paragraphs 69 and 101-102 above. 149. Medaphis is the registrant for the shares sold to the Sub-Class Plaintiffs and other members of the Sub-Class. Medaphis issued, caused to be issued and participated in the issuance of materially false and misleading written statements to the investing public which were contained in the Registration Statement, which misrepresented or failed to disclose, inter alia, the facts set forth above. 150. Each of Defendants Brown, Cote and Douglass, either personally or through an attorney-in-fact, signed the Registration Statement and was a director and/or senior executive of Medaphis at the time of the HDS Merger referred to hereinabove. 151. The defendants named herein were responsible for the contents and dissemination of the Registration Statement and the Prospectus. None of the defendants named - 65 - 66 herein made a reasonable investigation or possessed reasonable grounds for believing that the statements contained in the Registration Statement and Prospectus were true and did not omit any material facts and were not materially misleading, all for the reasons set forth in paragraphs 69, 101-102 and 147 above. 152. Defendants had actual knowledge of the misrepresentations and omissions of material facts set forth herein, or acted with reckless disregard for the truth in that they failed to ascertain and to disclose such facts, even though such facts were available to them. Defendants' material misrepresentations and/or omissions were made knowingly or recklessly and for the purpose and effect of concealing the truth with respect to the Company's operations, business, management, performance and prospects from the investing public and supporting the artificially inflated price of its stock. 153. The Sub-Class Plaintiffs acquired shares of Medaphis stock issued pursuant to, or traceable to, the Registration Statement. 154. The Sub-Class Plaintiffs and the other members of the Sub-Class have sustained damages. The value of the Company's shares has declined substantially subsequent to and due to defendants' violations. 155. At the times they purchased the Company's shares, the Sub-Class Plaintiffs and other members of the Sub-Class were without knowledge of the facts concerning the wrongful conduct alleged herein and could not have reasonably discovered those facts. Less than one year has elapsed from the time that the Sub-Class Plaintiffs discovered or reasonably could have discovered the facts upon which this Complaint is based to the time of filing this - 66 - 67 Complaint. Less than three years has elapsed from the time that the securities upon which this claim is brought were bona fide offered to the public to the time of filing this Complaint. 156. The Sub-Class Plaintiffs are entitled to recover from defendants damages measured by the difference between their exchange price for Medaphis securities and the actual value of such securities. COUNT IV ON BEHALF OF THE SUB-CLASS FOR VIOLATIONS OF SECTION 12(A) (2) OF THE SECURITIES ACT AGAINST ALL DEFENDANTS 157. The Sub-Class Plaintiffs incorporate by reference and reallege the allegations set forth above as if set forth fully herein. 158. This Claim is brought by the Sub-Class Plaintiffs pursuant to Section 12(a) (2) of the Securities Act, 15 U.S.C. Section 771(a) (2), on behalf of the Sub-Class against Medaphis and the Individual Defendants. 159. The statements referred to above at paragraphs 64-65 and 98-100 were each made in a "prospectus" as that term is defined in Section 2(a) (10) of the Securities Act, contained untrue statements of material facts, omitted to state other facts necessary to make the statements made not misleading, and concealed and failed to disclose material facts on the grounds and for the reasons set forth in paragraphs 69 and 101-102 herein. The actions of the defendants named in this Count solicited the sale of shares of Medaphis common stock in - 67 - 68 connection with the HDS Merger for their personal financial gain. Those actions included participating in the preparation of the materially false and misleading Prospectus and other materials used in the sale of Medaphis common stock. 160. The defendants owed to the purchasers of the Company's shares, including the Sub-Class Plaintiffs and other members of the Sub-Class, the duty to make a reasonable and diligent investigation of the statements contained in the Prospectus and other offering materials to ensure that such statements were true and that there was no omission to state a material fact required to be stated in order to make the statements contained therein not materially misleading. 161. Defendants had actual knowledge of the misrepresentations and omissions of material facts set forth herein, or acted with reckless disregard for the truth in that they failed to ascertain and to disclose such facts, even though such facts were available to them. Defendants' material misrepresentations and/or omissions were made knowingly or recklessly and for the purpose and effect of concealing the truth with respect to the Company's operations, business management, performance and prospects from the investing public and supporting the artificially inflated price of its stock. 162. The Sub-Class Plaintiffs and other members of the Sub-Class purchased or otherwise acquired the Company's common stock pursuant to and traceable to the Prospectus. The Sub-Class Plaintiffs did not know, or in the exercise of reasonable diligence could not have known, of the untruths and omissions contained in or made in connection with the Prospectus. 163. The Sub-Class Plaintiffs and other members of the Sub-Class have sustained injury and suffered damages. - 68 - 69 164. By reason of the conduct alleged herein, the defendants named in this Count violated Section 12 (a) (2) of the Securities Act. Accordingly, the Sub-Class Plaintiffs and the other members of the Sub-Class who hold the Company's shares have the right to rescind and recover the consideration paid for the Company's shares and hereby elect to rescind and tender their shares of the Company to the defendants sued herein. Sub-Class members who have sold their shares of Medaphis are entitled to rescissory damages. 165. Less than three years have elapsed from the time that the securities upon which this Count is brought were sold to the public to the time of the filing of this action. Less than one year has elapsed from the time when the Sub-Class Plaintiffs discovered or reasonably could have discovered the facts upon which this Count is based to the time of the filing of this action. COUNT V ON BEHALF OF THE SUB-CLASS FOR VIOLATIONS OF SECTION 15 OF THE SECURITIES ACT AGAINST THE INDIVIDUAL DEFENDANTS 166. The Sub-Class Plaintiffs incorporate by reference and reallege the allegations set forth above as if set forth fully herein. 167. The Individual Defendants acted as controlling persons of the Company within the meaning of Section 15 of the Securities Act. By reason of their senior management positions, stock ownership and directorships as alleged above, these defendants had the power to - 69 - 70 influence and exercised the same to cause Medaphis to engage in the acts and conduct complained of in Count III herein. 168. Defendants had actual knowledge of the misrepresentations and omissions of material facts set forth herein, or acted with reckless disregard for the truth in that they failed to ascertain and to disclose such facts, even though such facts were available to them. Defendants' material misrepresentations and/or omissions were made knowingly or recklessly and for the purpose and effect of concealing the truth with respect to the Company's operations, business management, performance and prospects from the investing public and supporting the artificially inflated price of its stock. 169. By reason of such conduct, the Individual Defendants are liable pursuant to Section 15 of the Securities Act, 15 U.S.C. Section 77o. As a direct and proximate result of the conduct of the Individual Defendants alleged in Count III herein, the Sub-Class Plaintiffs and the other members of the Sub-Class suffered damages in connection with their acquisitions of the Company's securities pursuant to the HDS Merger. WHEREFORE, plaintiffs, on behalf of themselves and on behalf of the Class and Sub-Class, pray for judgment as follows: (a) Declaring this action to be a class action pursuant to Rules 23(a) and 23(b) (3) of the Federal Rules of Civil Procedure on behalf of the Class and the Sub-Class as defined herein; (b) Awarding plaintiffs and the members of the Class and/or Sub-Class rescissory or compensatory damages in an amount which may be proven at trial, together with interest thereon; - 70 - 71 (c) Awarding the Sub-Class Plaintiffs and members of the Sub-Class rescission and damages in accordance with Section 12 (a) (2) of the Securities Act on Counts IV and V; (d) Awarding plaintiffs and the members of the Class and Sub-Class pre-judgment and post-judgment interest, as well as their reasonable attorneys' and experts' witness fees and other costs; and (e) Awarding such other and further relief as this Court may deem just and proper, including any extraordinary equitable and/or injunctive relief as permitted by law or equity to attach, impound or otherwise restrict the defendants' assets to assure plaintiffs have an effective remedy. DEMAND FOR JURY TRIAL Plaintiffs, on their own behalf and on behalf of the Class and Sub-Class, hereby demand a trial by jury on all Counts hereof. Dated: February 3, 1997 APPEL, CHITWOOD & HARLEY BY: /s/ -------------------------------- Martin Chitwood Georgia Bar No. 124950 Christi C. Mobley Georgia Bar No. 107869 1400 Resurgens Plaza 945 East Paces Ferry Rd. Atlanta, GA 30326 (404) 266-1650 - 71 - 72 - and - BARRACK RODOS AND BACINE BY: /s/ -------------------------------- Leonard Barrack Gerald J. Rodos Sheldon L. Albert Anthony J. Bolognese 3300 Two Commerce Square 2001 Market Street Philadelphia, PA 19103 (215) 963-0600 - and - BERGER & MONTAGUE, P.C. BY: /s/ -------------------------------- Sherrie R. Savett Genna D. Kidd 1622 Locust Street Philadelphia, PA 19103 (215) 875-3000 CO-LEAD COUNSEL FOR PLAINTIFFS CARR, TABB & POPE BY: /s/ -------------------------------- W. Pitts Carr Georgia Bar No. 112100 Render C. Freeman Georgia Bar No. 275910 1355 Peachtree Street, N.E. Suite 2000 Atlanta, GA 30309 (404) 876-7790 LIAISON COUNSEL FOR PLAINTIFFS - 72 - 73 ABBEY GARDY & SQUITIERI Jill Abrams 212 East 39th Street New York, NY 10016 (212) 889-3700 ALPERT BARKER & CALCUTT Jonathan Alpert Patrick Calcutt 100 South Ashley Drive Suite 2000 Tampa, FL 33602 (813) 223-4131 BERMAN, DEVALERIO & PEASE Glen DeValerio One Liberty Square Boston, Massachusetts 02109 (617) 542-8300 BERNSTEIN, LIEBHARD & LIFSHITZ Mel E. Lifshitz 274 Madison Avenue New York, NY 10016 (212) 779-1414 BERNSTEIN, LITOWITZ, BERGER & GROSSMAN Vincent R. Cappucci Steven B. Singer Kevin M. McGee 1285 Avenue of the Americas New York, New York 10019 (212) 554-1400 FINKELSTEIN, THOMPSON & LOUGHRAN Burton Finkelstein Doug Thompson 1055 Jefferson Street, N.W. Suite 601 Washington, DC 20007 - 73 - 74 GOODKIND LABATON RUDOFF & SUCHAROW, L.L.P. Jonathan M. Plasse Barbara J. Hart 100 Park Avenue New York, New York 10017 (212) 907-0700 HOFFMAN & EDELSON Marc H. Edelson Jerry Hoffman Suite 280, Jenkintown Plaza 101 Greenwood Avenue Jenkintown, PA 19046 (215) 886-4111 JAROSLAWICZ & JAROSLAWICZ David Jaroslawicz 150 William Street 19th Floor New York, New York 10038 (212) 227-2780 KAPLAN, KILSHEIMER & FOX, L.L.P. Robert N. Kaplan Richard J. Kilsheimer Ariana J. Tadler 685 Third Avenue New York, New York 10017 (212) 554-1444 LAW OFFICE OF MILES TEPPER Miles M. Tepper 7 Becker Farm Road Roseland, NJ 07068 (201) 740-1881 MAGER, LIEBENBERG & WHITE Roberta Liebenberg 10th Floor, 2 Penn Center 15th & JFK Boulevard Philadelphia, PA 19102 - 74 - 75 (215) 569-6921 MANN & WOOLRIDGE Theo Davis Mann 28 Jackson Street Newnan, GA 30263 (770) 253-2222 MILBERG WEISS BERSHAD HYNES & LERACH LLP David J. Bershad Richard H. Weiss Janine L. Pollack One Pennsylvania Plaza New York, New York 10119 (212) 594-5300 POMERANTZ, HAUDEK, BLOCK & GROSSMAN Stanley B. Grossman D. Brian Hufford 100 Park Avenue New York, New York 10017 (212) 818-0477 RACKEMANN, SAWYER & BREWSTER, P.C. Alan B. Rubenstein One Financial Center Boston, MA 02111 (617) 542-2300 SCHATZ & NOBEL, P.C. Jeffrey S. Nobel 216 Main Street Hartford, Ct. 06106 (860) 493-6292 LOCKRIDGE GRINDAL NAUEN & HOLSTEIN, PLLP Richard Lockridge W. Joseph Bruckner Suite 2200 100 Washington Ave., South - 75 - 76 Minneapolis, MN 58401 (612) 339-6900 SCHIFFRIN & CRAIG, LTD. Andrew L. Barroway Three Bala Plaza East Suite 400 Bala Cynwyd, PA 19004 SPECTOR & ROSEMAN, P.C. Robert M. Roseman Jeffrey L. Kodroff Mark J. Dorval 2000 Market Street 12th Floor Philadelphia, PA 19103 (215) 864-2424 WECHSLER HARWOOD HALEBIAN & FEFFER, LLP Jeff Haber 805 Third Avenue New York, NY 10022 (212) 935-7400 WEISS & YOURMAN Joseph H. Weiss Mark D. Smilow 319 Fifth Avenue New York, New York 10016 (212) 682-2010 WOLF HALDENSTEIN ADLER FREEMAN & HERZ, L.L.P. Fred Taylor Isquith Neil L. Zola 270 Madison Avenue New York, New York 10016 (212) 545-4653 COUNSEL FOR PLAINTIFFS - 76 - 77 IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF GEORGIA ATLANTA DIVISION - -----------------------------------------X IN RE 1996 MEDAPHIS CORPORATION : CIVIL ACTION NO. SECURITIES LITIGATION : 1: 96-CV 2088-FMH - -----------------------------------------X CERTIFICATE OF SERVICE This is to certify that I have this day served a true and correct copy of the within and foregoing "CONSOLIDATED SECOND AMENDED CLASS ACTION COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS" upon counsel for defendants by facsimile and hand delivery this 3rd day of February, 1997 at the following address: M. Robert Thornton, Esq. King & Spalding 191 Peachtree Street, N.E. Suite 4200 Atlanta, Georgia 30303 /s/ -------------------------------- Martin D. Chitwood Georgia Bar No. 124950 Christi C. Mobley Georgia Bar No. 107869 APPEL, CHITWOOD & HARLEY 1400 Resurgens Plaza 945 East Paces Ferry Road Atlanta, Georgia 30326 (404) 266-1650 - 77 - EX-99.3 21 COMPLAINT (LOS ANGELES, CA) 1 EXHIBIT 99.3 FRIED, FRANK, HARRIS, SHRIVER & JACOBSON STEPHEN D. ALEXANDER (SBN #141099) DAVID R. BOYKO (SBN #178116) 725 South Figueroa Street, Suite 3890 Los Angeles, CA 90017 (213) 689-5800 Attorneys for Plaintiffs HEALTH SYSTEMS INTERNATIONAL, INC. SUPERIOR COURT FOR THE STATE OF CALIFORNIA FOR THE COUNTY OF LOS ANGELES HEALTH SYSTEMS ) Case No. BC160414 INTERNATIONAL, INC., a ) Delaware corporation ) COMPLAINT FOR VIOLATION OF ) SECTIONS 11,12(2), and 15 OF Plaintiff, ) SECURITIES ACT OF 1933, ) CALIFORNIA CORPORATIONS ) CODE SECTIONS 25401 v. ) and 25402, FRAUD, INTENTIONAL AND ) NEGLIGENT MISREPRESENTATION, MEDAPHIS CORPORATION., a ) AND INTENTIONAL INTERFERENCE Delaware corporation; RANDOLPH G. ) WITH PROSPECTIVE ECONOMIC BROWN, an individual; and DOES 1- ) ADVANTAGE 50, inclusive, ) ) Defendants, ) - ---------------------------------------- Plaintiff HEALTH SYSTEMS INTERNATIONAL, INC. (hereinafter "HSI") for its complaint against MEDAPHIS CORPORATION (hereinafter "Medaphis"), RANDOLPH G. BROWN (hereinafter "Mr. Brown"), and DOES 1-50 inclusive, alleges as follows: 2 SUMMARY OF ALLEGATIONS 1. The claims and allegations herein arise from the acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. Medaphis accomplished this transaction by offering 0.7912 shares of its own common stock in exchange for each share of common and preferred stock of HDS. The primary purpose of this acquisition was purportedly to enhance Medaphis position in the market for advanced healthcare information systems through HDS' integrated information management system, ULTICARE(R), and to provide Medaphis with additional opportunities to cross-sell its systems and services to the HDS customer base. 2. Plaintiff HSI is informed and believes, and on the basis of such information and belief alleges, that the CEO of Medaphis, Mr. Randolph Brown, and his aligned insiders instead planned and accomplished the acquisition of HDS before the close of the second quarter of Medaphis' 1996 fiscal year to artificially inflate Medaphis' own sagging earnings and thereby sustain the inflated market value of its own stock. By utilizing the pooling of interests accounting method for the transaction, Medaphis was able to increase its reported earnings for the second quarter of its 1996 fiscal year, meet the composite estimate of market analysts who follow Medaphis stock, and thereby maintain an artificially high market price for its stock. 3. In furtherance of this scheme, Mr. Brown and his Medaphis allies required the acquisition to be consummated before reporting their third quarter results and admitting undisclosed, adverse financial results. To induce HSI, a major shareholder of HDS, to accept Medaphis' share exchange offer, Medaphis and Mr. Brown made false and misleading statements that Medaphis' core businesses were not experiencing any problems, that research 2 3 development costs, rather than sagging revenue from operations, would temporarily drag down earnings, and deliberately failed to disclose that Medaphis would shortly reveal a write-off of up to $40,000,000 in reorganization costs and would lower its earnings estimate for the following year, which would more than halve the value the of shares to be received by HDS shareholders. These false and misleading statements were contained in oral communications with HSI, as well as in the prospectus provided by Medaphis to all HDS shareholders in connection with the share exchange offer. Further, despite knowing of HSI's discussions and intent to form a strategic alliance of its own with HDS, these defendants wrongfully interfered with that prospective business relationship by proposing to acquire HDS using Medaphis stock whose market price was artificially inflated by these false and misleading statements which disguised Medaphis' poor business performance and sagging fortunes. When Medaphis revealed this information, a scant two months after HDS shareholders had voted to accept Medaphis' shares in exchange for their HDS holdings, Medaphis stock plummeted from a closing price of $39.74 on the last trading day before HDS' shareholders voted on the acquisition, to a closing price of $14.25 on August 15, 1996 after revealing its true financial condition, and to a low of $11.375 on September 12, 1996 after the information was fully disseminated to, and taken into account by, the market. On October 21, Medaphis revealed its actual financial results for the third quarter of 1996 and announced a loss of $36.4 million. Its stock price immediately plunged another 38%, reaching a low of $8.37 after the information had been fully disseminated to the market. 4. The reality of Medaphis, concealed by artful accounting practices, restatements, write-offs, and other churning created by its acquisition of the prior and future earnings of new businesses, has been one of stagnation in its shrinking core businesses and failure to meet the 3 4 substantial technological challenges of its new businesses. The aftermath of Medaphis' acquisition of HDS apparently resulted from the failed efforts of the defendants herein to maintain a facade of earnings growth momentum. As Medaphis has revealed its reality, layer by layer, the market prices for its shares have plummeted to reflect those revelations. It is now clear that HSI and other shareholders of HDS were systematically deceived by the defendants. 5. The actions of Medaphis, Mr. Brown, and other Medaphis insiders and agents were accomplished by the use of fraud and false and misleading statements to induce HDS shareholders to accept Medaphis' share exchange offer. HDS shareholders accepted Medaphis' offer of stock only to find themselves defrauded of over half the value received in violation of the Securities Act of 1933, the California Corporations Code, and common law principles of fraud. PARTIES 6. HSI is, and at all relevant times hereinafter mentioned was, a corporation duly organized and existing under the laws of the State of Delaware, with a principal place of business in Woodland Hills, California. HSI provides managed health care services in California and other states through its principal operating subsidiaries, including Health Net, the second largest provider of health maintenance organization ("HMO") services in California. HSI owned stock representing approximately sixteen percent of HDS. 7. Medaphis is, and at all relevant times hereinafter mentioned was, a corporation duly organized and existing under the laws of the State of Delaware, with its principal place of business in Atlanta, Georgia. Medaphis provides business management services and systems to the healthcare industry, including scheduling, information systems, subrogation and related recovery services, systems integration, and integrated healthcare delivery systems. Medaphis is qualified 4 5 and does business in California. Medaphis stock is publicly traded on the Nasdaq Stock Market under the symbol "MEDA." 8. HDS was, until the effective date of its acquisition by Medaphis, a corporation organized and existing under the laws of the State of Delaware with its principal place of business in San Bernardino, California. HDS is a developer and supplier of healthcare information systems for integrated patient care by integrated healthcare enterprises, HMOs, municipal healthcare systems; and elder care organizations. HDS stock was not publicly traded prior to the acquisition by Medaphis. HSI owned 1,234,544 shares (or 77%) of HDS Series F preferred stock, representing over sixteen percent of the total outstanding equity of HDS. 9. Mr. Brown is an individual who resides in the State of Georgia. During all times stated herein, Mr. Brown served as Chairman, Chief Executive Officer, and President of Medaphis. Mr. Brown resigned as Chairman and Chief Executive Officer of Medaphis on October 3l, 1996. 10. The true names and capacities of the defendants named herein as DOES 1 through 50, inclusive, are unknown to HSI and, therefore, HSI sues them by such fictitious names. Once HSI has ascertained the true names and capacities of said defendants, HSI will amend this complaint accordingly. 11. HSI is informed and believes and based thereon alleges that the defendants designated herein by the fictitious names DOES 1 through 50, inclusive, are, and at all relevant times hereinafter mentioned were, insiders of Medaphis, including without limitation, officers, directors, employees, agents, servants, and representatives, subsidiaries, affiliates, or co-conspirators of Medaphis, and in that capacity are liable to HSI for the claims alleged herein. 5 6 JURISDICTION AND VENUE 12. This court has jurisdiction over this matter, and venue is proper pursuant to 17 U.S.C. 77v, Cal. Code Civ. Proc. Section Section 395,395.5 and Los Angeles County Superior Court Rule 2.0 in that: Medaphis does business in California, including Los Angeles County; Medaphis, as well as DOES 1 through 50 engaged in substantial, systematic, and continuous activities in California in order to effectuate the acquisition of HDS; and HSI's principal place of business in Woodland Hills is in the County of Los Angeles. The amount in controversy among the parties exceeds the jurisdictional minimum of this Court. GENERAL ALLEGATIONS A. Medaphis and HDS 13. Medaphis provides business management services and systems to the healthcare industry, as well as subrogation and recovery services (which assist in recovery of benefits) to healthcare payors. In addition, Medaphis also provides information management systems and systems integration services to various entities in the healthcare industry. 14. HDS develops and supplies healthcare information systems to a wide range of entities in the healthcare industry, primarily through its integrated information system known as ULTICARE(R). HDS also has extensive experience in most areas of patient care automation. HDS is one of the top ten vendors of patient care systems in the United States, an industry which is forecast to become a $20 billion dollar industry by the year 2000. 15. HSI was not only an investor in HDS, but also a key business partner. In 1995, HSI entered into a $4 million dollar, non-exclusive, seven year license for use of HDS' ULTICARE(R) products covering an unlimited numbers of non-hospital patients and available to 6 7 all HSI affiliates. HSI and HDS also agreed to jointly develop a call center as part of an overall patient care system. HSI is to provide clinical and technical assistance to HDS in developing this center and to contribute $1 million dollars to its development as well. Both companies would share equally in any earnings generated from sales to third parties. HSI also pays substantial amounts to HDS for on-going consulting and system support services. For additional consideration, the term of this license was later modified and extended to twenty years. 16. HSI considers the ULTICARE(R) system to be a superior product line and essential to its own efforts to develop and implement its "Fourth Generation Medical Management" initiative. That initiative requires an advanced information management system which can simultaneously house clinical data from all providers within a large geographic region, serve as the primary contact system between health plan members and the healthcare system, provide clinical practice management tools to improve the quality of care and reduce costs for physicians, and automate clinical protocols to optimize patient workup and treatment. Successful implementation of this initiative, and therefore continued viability of the ULTICARE(R) system is critical to HSI's ability to manage costs and to compete and prosper in the competitive health care services industry. B. B. Medaphis' Acquisition of HDS 17. In early May, 1996, Medaphis management initiated discussions with HDS regarding a potential acquisition of the company. Medaphis proposed to structure the transaction as a share exchange, in which it offered Medaphis common stock in exchange for the common and preferred stock of HDS shareholders. Medaphis further proposed that the transaction be structured so that it would receive pooling of interests accounting treatment. 7 8 18. The HDS Board of Directors met in San Bernardino, California to consider Medaphis' proposal. Based on the information before the Board, and in particular Medaphis' representations concerning its business and prospects, the Directors voted in favor of the acquisition and to recommend that HDS' shareholders also vote in favor of the transaction. On June 29, 1996, in Riverside, California, HDS held a special meeting of its stockholders to consider the proposed transaction. The HDS stockholders, including HSI, voted to accept Medaphis' offer of a share exchange. 19. HSI relied on the statements and representations Medaphis included in a prospectus relating to its share exchange offer and to the issuance of new shares of Medaphis common stock to be exchanged for HDS common and preferred stock. That prospectus, dated May 31,1996, included and/or incorporated the following material statements and representations: (a) In 1994, Medaphis purchased Imonics Corporation, a leader in business process re-engineering and systems integration services, to help transition Medaphis from simply the "leading provider of transaction processing services for doctors and hospitals... [to, by the end of 1996,] an equally important healthcare information systems company and as one of the leading advanced client/server systems integrators in the world." (from the Medaphis 1995 Annual Report, incorporated by reference); (b) Imonics' expertise in technology systems was explained as a critical element of Medaphis' technology improvement and future business prospects because it had been" a leader in business process re-engineering and systems integration. For years, Imonics has been providing hardware and software solutions to business operations which process large volume of paper. Now, Imonics is applying these same efficiencies within Medaphis 8 9 through systems integration and work flow engineering services." (from the Medaphis 1995 Annual Report, incorporated by reference); (c) In February 1996, a wholly owned German subsidiary of Imonics entered into a joint venture with a subsidiary of Bertelsmann AG, and shortly thereafter booked $12.5 million dollars in revenue to account for a multi-year contract with a German telecommunications firm for systems integration and work flow engineering systems and services (from the Medaphis 10-Q Report dated March 31, 1996, incorporated by reference); (d) Medaphis had approved in early 1995 a restructuring plan to consolidate the data processing functions of its core business, Medaphis Physician Services Corp., by 1997 and had recorded a $15 million reserve for costs associated with that plan; (e) Medaphis' only expected accounting charges in the near-term were approximately $7,500,000 in the second quarter of 1996 for expenses associated with share exchange acquisitions consummated during that period and $4,800,000 for expenses relating to the HDS acquisition when consummated; (f) An important component of Medaphis' business strategy was growth through acquisitions and that it had successfully integrated several recent acquisitions ("Increasingly, Medaphis is looking to companies that can expand Medaphis' technology business and help contribute to the technological advantages Medaphis is now able to offer in healthcare and other industries. Since 1988, Medaphis has acquired nearly 40 businesses providing business management systems and services to physicians and hospitals for total consideration of approximately $900 million." (from the Medaphis 1995 9 10 Annual Report, incorporated by reference)); (g) Medaphis has been successful in its strategy of offsetting margin pressure in its core business operations with growth in its technology operations; and (h) Medaphis touted itself as possessing the exemplary management skills necessary to establish, maintain, and expand its leadership in the healthcare industry ("I believe we have the right people in the right slots, where their talents, skills, interests and creativity were most needed, in assignments that should prove extraordinarily fulfilling for them and rewarding for our stockholders." "In 1995, Medaphis futher strengthened its market leading position in providing business management services to physicians..." "As the healthcare industry's leading provider of business management systems and services, Medaphis is able to help its clients more efficiently and effectively manage their business offices," (from the Medaphis 1995 Annual Report, incorporated by reference)). 20. In addition, HSI relied on the representations and warranties that Medaphis made in its Merger Agreement with HDS, dated May 23, 1996. The Agreement was incorporated, as Annex A, into the Medaphis prospectus relating to its share exchange offer and to the issuance of new shares of Medaphis common stock to be exchanged for HDS common and preferred stock. The Agreement included the following material statements and representations: (a) Since December 3l, 1995, there was not a change in the results of operations, liabilities, financial condition, or business of Medaphis that, as a whole, would have a material adverse effect on the company; (b) Since that same date, there were not any developments, events, or conditions which had, or were likely to have, a material adverse effect on Medaphis; 10 11 (C) since that same date, there were neither write downs nor material liability or obligation or contingency or reserve increases suffered other than in the ordinary course of business; and (d) Medaphis made no untrue statement of material fact or omitted to state a material fact which would be necessary to make its statements not misleading. 21. Mr. Brown and DOES 1 through 25, because of their positions of control and authority as officers and/or directors of Medaphis were able to, and did, control the contents of several quarterly and annual financial reports, SEC filings, presentations to security analysts following Medaphis, and the representations made to HSI. Each had the ability to review and correct or prevent the issuance of the SEC filings alleged herein to be false or misleading. Because of their membership on the Board of Directors and/or executive or managerial positions with Medaphis, each of the referenced defendants had access to the adverse, non-public information about Medaphis' business, finances, products, markets, and present and future business prospects via their access to internal corporate documents, conversations with corporate employees and officers, attendance at Medaphis' management and Board of Directors meetings and committees thereof, as well as via reports and other information provided to them in connection with this conduct. As a result, each of these defendants was responsible for the accuracy of the public reports and representations detailed herein. 22. In addition to defendants' direct responsibility for the contents of those representations, defendants also provided similarly deceptive and unreasonable statements of Medaphis' business and financial condition to the security analysts following Medaphis so that the resulting optimistic reports on the Medaphis would maintain and/or boost the market price of its 11 12 stock. Those reports, some of which were reviewed by HSI prior to the acquisition included the following statements: (a) "Over the next several quarters, we expect the re-engineering program in its core Medaphis Physician Services Corporation to begin to have an impact while the growth in its technology businesses continues [sic] to accelerate." (May 16, 1996 report by Donaldson, Lufkin & Jenrette Securities Corporation); (b) "Near-term, we have confidence in our quarterly estimates as well as our $1.05 - $1.10 estimate for the full year." (May 16, 1996 report by Donaldson, Lufkin & Jenrette Securities Corporation); (C) "Based on our conversation with management yesterday, our comfort level on near-term earnings prospects have increased. While management did not endorse a specific estimate, it appears as though there have been some fundamental positive changes... While there remains consolidation challenges, we believe that these are the early signs that the 'large software development project is beginning to pay off..." (June 4, 1996 report by Donaldson, Lufkin & Jenrette Securities Corporation); (d) "MEDAPHIS HAS ONE OF THE BEST MANAGEMENT TEAMS in the health-care information sector, in our opinion ... IN EARLY MAY 1996, MEDAPHIS CLOSED ON THE ACQUISITION OF BSG... We believe that BSG would have gone public and accepted public funds rather than Medaphis stock if its due diligence turned up any meaningful concerns about Medaphis' future." (June 4, 1996 report by Dean Witter Reynolds Inc.); and (e) "First, a 'research report' from the Center for Financial Research and 12 13 Analysis has been circulating questioning Medaphis' accounting practices, fundamentals and acquisition strategy. We disagree with virtually all of the points made... It appears as though BSG, Rapid Systems and Imonics, are all on or above budget while its core business continues to work through the reengineering process... [Medaphis] is likely to grow [earnings per share] in 1997 by about 30 - 40%." (June 27, 1996 report by Donaldson, Lufkin & Jenrette Securities Corp.) C. Medaphis' Oral Representations to HSI 23. In May 1996, Mr. Brown, in his capacity as President and CEO of Medaphis, met with several officers of HSI, among them Dr. Malik Hasan (HSI's Chairman, President and Chief Executive Officer), to persuade them to accept Medaphis' offer of its shares in exchange for their HDS holdings. During that meeting, Mr. Brown made certain representations to HSI, including those set forth below. HSI is informed and believes, and on that basis alleges, that these representations were false or misleading when made and that Mr. Brown was aware of their false or misleading nature. Such representations included: (a) Medaphis was a very successful company which had shown substantial growth in earnings, that it would continue to grow, and that it was planning to grow very substantially in the near future as the result of its on-going program of acquisitions; (b) it had recently acquired, and successfully integrated the operations of, several key healthcare technology companies, including Imonics, a leader in the systems engineering field which would be critical to Medaphis' future plans; (C) the financial markets had respected, and prices for Medaphis stock had relected, that demonstrated growth capability, as well as confidence in the Medaphis management 13 14 team; (d) by combining with HDS, Medaphis' earnings would continue to grow and stock price would continue to rise; and (e) as a shareholder in Medaphis, HSI would benefit from this continued growth. 24. In response to Dr. Hasan's questions regarding Medaphis' haste to close the transaction, Mr. Brown stated that Medaphis had to close the HDS transaction before the end of the second quarter because the company had experienced some cost overruns on a development project which would adversely affect earnings in that quarter, and he wanted to use HDS' earnings (which had not yet been declared) as an offset. Further, Mr. Brown assured HSI that revenue and earnings from operations were on-track, and that Medaphis' core business, Medaphis Physicians' Service Co., was operating on a sound basis and in a satisfactory manner, with the exception of the development cost overruns associated with a new imaging system for its fully automated, paperless payment program. Mr. Brown assured HSI that the development problems had been solved, that the program was "on-track," and that Medaphis' earnings in the second quarter would be affected by the cost overrun which he wanted to offset with HDS' earnings and therefore the transaction had to be closed prior to the end of that quarter. 25. During these same meetings, Mr. Brown, and the proxy and prospectus provided to HSI by Medaphis, failed to disclose the following material facts which Mr. Brown and Medaphis had an obligation to disclose in order to make their representations about Medaphis not false or misleading: (a) Medaphis was experiencing major problems with the systems integration 14 15 contract in Europe for which it had just booked $12.5 million dollars in revenue and would have to restructure the operation; (b) Medaphis' core business, Medaphis Physician's Service Corp., was no longer profitable, and the restructuring of that business would require far more time than the company had publicly disclosed and additional writeoffs considerably in excess of the $25 million already disclosed as a reserve; (C) Imonics, previously exclaimed as the shining star of the new, technology-oriented Medaphis, was racked by poor and inexperienced management and inability to control costs, and it would have to undergo a major management restructuring accompanied by material writeoffs; (d) Medaphis' overall conversion to a more "high tech" company, the hope for the future which Medaphis' management held out to investors, was proceeding neither as smoothly nor as successfully as the company had advertised, and the difficulties of integrating the various recent acquisitions would seriously cripple any near-term success of this purported "strategy;" (e) Medaphis' management was forecasting a horrific third-quarter of thirty to forty million dollars, or twenty-eight to thirty-three cents loss per share (in sharp contrast to financial analysts' consensus estimate of twenty-seven cents per share) due to these reorganization and restructuring charges; and (f) Medaphis' core businesses were doing poorly and the company was able to maintain the illusion of profitability and its then-current stock price by acquiring other, profitable companies whose earnings would boost its own. 15 16 26. In reasonable reliance on Defendants' oral statements and the written representations contained in Medaphis' proxy/prospectus, HSI voted to accept Medaphis' offer to exchange its preferred shares of HDS for shares of Medaphis. Pursuant to that exchange offer, HSI exchanged 1,234,544 shares of Series F Preferred Stock of HDS for 976,771 shares of common stock of Medaphis, valued at approximately $41 million dollars on the acquisition's effective date of July 1, 1996. 27. When deciding to accept Medaphis' offer of a share exchange, HSI was unaware that Medaphis' representations were false and misleading and did not know of the material facts which Mr. Brown and Medaphis had failed to disclose. As a result, HSI voted to approve the merger and exchange its shares of HDS Series F Preferred Stock for Medaphis common stock. D. Medaphis Reveals Its True Business Condition 28. Following the close of the stock market on August 14,1996, Medaphis publicly announced what HSI alleges on information and belief that it had privately known: (a) it expected to incur an approximately $9,000,000 charge in the next fiscal quarter to restructure the operating relationships and economics of the European joint venture it had booked $12.5 millions dollars in revenue for less than six months earlier; (b) its core business, Medaphis Physician's Service Corp., continued to experience grave weakness, had encountered delays in the restructuring process that had begun a year earlier, and would have to incur another $11,000,000 in restructuring charges over and above the $25,000,000 taken in 1995; (c) because of the management weaknesses and inefficiencies in its once glittering subsidiary Imonics (which was itself carrying out the re-engineering of Medaphis' 16 17 core business), Medaphis was restructuring that company, including layoffs and implementation of a new business model and expected to incur an approximately $15,000,000 charge for reorganizing Imonics; and (d) Medaphis would no longer maintain its growth and profitability by acquiring other companies, and therefore significantly revised its 1997 earnings forecast from the analysts' consensus estimate of $1.42 per share to a range of $0.75 to $0.90 per share. 29. In fact, even these forecasts did not reveal the true state of Medaphis' business operations and finances. On October 22, 1996, Medaphis publicly revealed that the third quarter write-offs actually taken were even larger than forecast on August 14. It had taken a $24.3 million write-off for Imonics' restructuring (compared to the previously announced $15 million) and $16.8 million relating primarily to the renegotiation of Imonics' European contract (compared to the previously announced $9 million). It further revealed that, due to improprieties at Imonics, it had restated its financial results for the year and the quarter ended December 31, 1995 to reflect a $5.1 million reduction in net income and therefore a net loss of $8.5 million for that year and $1.1 million for that quarter. In addition, it now forecast only $0.60 to $0.75 earnings per share for 1997. Capping off this debacle of mismanagement, Mr. Brown resigned as Chairman and Chief Executive Officer of Medaphis on October 31,1996, shortly after the full dissemination of this information reduced the market price of Medaphis shares to a meager $8.37. 30. HSI alleges, on information and belief, that this information was known to Medaphis, Mr. Brown, and DOES 1 through 50 while they were negotiating the acquisition of HDS, after execution of the Merger Agreement with HDS, and at the time the Medaphis prospectus became effective and thereafter. Each of these defendants had a statutory and common- 17 18 law obligation to reveal this information in order to make their prior representations (as described herein) neither false nor misleading. 31. Through its ownership of a separate class of equity securities, HSI's consent was required for the transaction. Had HSI known of the true facts concerning the problems with Medaphis' business operations, as well as the apparent deficiencies of the management of Medaphis and its subsidiaries, it would have rejected the offer to exchange its HDS shares for those of Medaphis by exercising its voting power to block the transaction, and it would not have signed the affiliate letter agreeing not to sell the Medaphis stock it would receive from the transaction until after Medaphis had filed financial statements containing post-merger financial information, and would have sought to acquire HDS itself. HSI would have so acted, not only as a major investor in HDS whose holdings were likely to suffer from Medaphis' acquisition, but also as a major healthcare business with a vital interest in HDS' continued development and success of its ULTICARE(R) line of products. FIRST CAUSE OF ACTION (Violation of Section 11 of the Securities Act of 1933) (By HSI Against Medaphis and DOES 1-50) 32. HSI realleges and incorporates by this reference the allegations contained in paragraphs 1 through 3l, supra as if fully set forth herein. 33. HSI purchased Medaphis common stock by means of a registration statement which, when effective, contained untrue statements of fact and material omissions regarding the poor financial health of its core business operations, the pending restructuring of its European joint venture, and the large pending restructuring and reorganization charges. Medaphis, as well as 18 19 DOES 1 through 50 who, by virtue of their position and/or relationship to Medaphis, had knowledge of such untrue statements of fact and material omissions and access to adverse, non-public information which should have been disclosed. 34. The conduct described above is prohibited under the Securities Act of 1933, codified at 17 U.S.C. Section 77k. 35. HSI has been damaged by Medaphis' untrue statements of fact and material omissions in an amount not yet determined, but which is in excess of $38 million. SECOND CAUSE OF ACTION (Violation of the Section 12(2) of the Securities Act of 1933) (By HSI Against Medaphis and DOES 1-50) 36. HSI realleges and incorporates by this reference the allegations contained in paragraphs 1 through 35, supra, as if fully set forth herein. 37. Medaphis and DOES 1 through 50 offered and sold Medaphis common stock by means of interstate commerce, including but not limited to, interstate mail and telephone services, by means of a prospectus as well as oral communications at the June 1996 HDS shareholders meeting and in a May 1996 meeting with Dr. Hasan and HSI, which included untrue statements of fact and/or material omissions regarding the flagging health of Medaphis' core business, of its pending restructuring charges, and of problems with its European joint venture. The true material facts were not known to HSI when it voted to accept the Medaphis common stock in exchange for its HDS holdings, and, had HSI known the material facts not disclosed to it, HSI would not have voted to accept Medaphis' offer of a share exchange. 19 20 38. The conduct described above is prohibited under the Securities Act of 1933, codified at 17 U.S.C. Section 771(2). 39. HSI has been damaged by Medaphis' false statements of material facts and material omissions in an amount not yet determined, but which is in excess of $38 million. THIRD CAUSE OF ACTION (Violation of Section 15 of the Securities Act of 1933) (By HSI Against Mr. Brown and DOES 1-50) 40. HSI realleges and incorporates by this reference the allegations contained in paragraphs 1 through 39, supra, as if fully set forth herein. 41. The defendants herein acted as controlling persons of Medaphis within the meaning of Section I5 of the Securities Act of 1933. By reason of their position as senior officers, directors, and/or agents of Medaphis, these defendants had the power and authority to cause Medaphis to engage in the wrongful conduct complained of herein. Some or all of these defendants also indicated their power and authority over Medaphis by signing the Registration Statement (Form S-4) complained of herein. 42.1 By reason of such wrongful conduct, defendants are jointly and severally liable, pursuant to Section 15 of the Securities Act of 1933 (codified at 17 U.S.C. Section 77o), for Medaphis' violations of Section 11 and 12(2) of the same Act as described above. As a direct and proximate result of this wrongful conduct, HSI suffered damages in connection with its purchase of Medaphis' common stock pursuant to the share exchange with HDS shareholders. 20 21 FOURTH CAUSE OF ACTION (Violation of Cal. Corp. Code Section 25401) (By HSI Against Medaphis) 43. HSI realleges and incorporates by this reference the allegations contained in paragraphs 1 through 42, supra, as if fully set forth herein. 44. Medaphis offered and sold its securities in this state by means of oral and written communications which included untrue statements of material fact and/or were misleading, under the circumstances in which they were made, because they omitted a material fact. Medaphis possessed knowledge that it core operations were suffering financially, that its European joint venture would have to be restructured, that it would have to take large restructuring and reorganization charges, and did not disclose these material facts to HSI. Instead Medaphis omitted these facts from its written and oral representations, thereby leaving them false and misleading in light of the circumstances in which they were made. 45. The conduct described above is prohibited under California Corporations Code Section 25401, and HSI is granted a right of action against such conduct by Section 25501 of that Code. 46. Had HSI known of the true facts concerning the problems with Medaphis' business operations, as well as the apparent deficiencies of the management of Medaphis and its subsidiaries, it would have rejected the offer to exchange its HDS shares for those of Medaphis by exercising its voting power to block the transaction, and it would not have signed the affiliate letter agreeing not to sell the Medaphis stock it would receive from the transaction until after Medaphis had filed financial statements containing post-merger financial information, and would have pursued its own 21 22 plans to acquire HDS. HSI has been damaged by its detrimental reliance on Medaphis' representations and by Medaphis' material omissions in an amount not yet determined, but which is in excess of $38 million. FIFTH CAUSE OF ACTION (Violation of Cal. Corp. Code Section 25402) (By HSI Against Mr. Brown and DOES 1-50) 47. HSI realleges and incorporates by this reference the allegations contained in paragraphs 1 through 46, supra, as if fully set forth herein. 48. Mr. Brown and DOES 1-50, by virtue of their position and/or relationship to Medaphis possessed material information about Medaphis' business operations, plans, and finances which they knew would significantly affect the market price and which had not, to their knowledge, generally been available to the public. Mr. Brown and DOES 1-50 offered and sold Medaphis securities in this state despite knowing such information regarding the restructuring and reorganization charges that the company would have to reveal, the continued weakness and unprofitability of Medaphis' core businesses, and the large disparity between earnings estimates made by outside analysts and what the company was itself projecting. 49. The conduct described above is prohibited under California Corporations Code Section 25402, and HSI is granted a right of action against such conduct by Section 25502 of that Code. 50. Had HSI known of the true facts concerning the problems with Medaphis' business operations, as well as the apparent deficiencies of the management of Medaphis and its subsidiaries, 22 23 it would have rejected the offer to exchange its HDS shares for those of Medaphis by exercising its voting power to block the transaction, and it would not have signed the affiliate letter agreeing not to sell the Medaphis stock it would receive from the transaction until after Medaphis had filed financial statements containing post-merger financial information, and would have pursued its own plans to acquire HDS. HSI has been damaged by its detrimental reliance on Medaphis' representations and by Medaphis' material omissions in an amount not yet determined, but which is in excess of $38 million. SIXTH CAUSE OF ACTION (Fraud and Intentional Misrepresentation) (By HSI Against Medaphis, Mr. Brown, and DOES 1 through 50) 51. HSI realleges and incorporates by this reference the allegations contained in paragraphs 1 through 31, supra as if fully set forth herein. 52. On information and belief, HSI alleges that each of the representations described above was false or misleading when made by Defendants (as described above), was known to be false or misleading when made, and was made with intent to mislead and deceive HSI. The representations were made with the intent to induce HSI's reliance and to accept the offer to purchase Medaphis stock in exchange for its shares of HDS Common and Series F preferred stock. 53. Each of the Defendants had a duty to disclose this information on the grounds that the information was material to the acquisition transaction and that the Merger Agreement and the prospectus required the disclosure of all material facts. Defendants' failure to disclose these material facts to HSI, therefore, constitutes fraud and/or negligent misrepresentation. Had HSI known of the true facts concerning the problems with Medaphis' business operations, as well as the apparent 23 24 deficiencies of the management of Medaphis and its subsidiaries, it would have rejected the offer to exchange its HDS shares for those of Medaphis by exercising its voting power to block the transaction, and it would not have signed the affiliate letter agreeing not to sell the Medaphis stock it would receive from the transaction until after Medaphis had filed financial statements containing post-merger financial information, and would have pursued its own plans to acquire HDS. 54. HSI has been damaged by its detrimental reliance on Defendants' representations and by Defendants' material omissions in an amount not yet determined, but which is in excess of $38 million. SEVENTH CAUSE OF ACTION (Fraud and Negligent Misrepresentation) (By HSI Against Medaphis, Mr. Brown, and DOES 1 to 50) 55. HSI realleges and incorporates by this reference the allegations contained in paragraphs 1 through 31, supra, as if fully set forth herein. 56. On information and belief, HSI alleges that each of the representations described above was false or misleading when made by Defendants (as described above), was made without a reasonable basis for believing it to be true, and was made with intent to mislead and deceive HSI. The representations were made with the intent to induce HSI's reliance and to accept the offer to purchase Medaphis stock in exchange for its shares of HDS Common and Series F preferred stock. 57. Each of the Defendants had a duty to disclose this information on the grounds that the information was material to the acquisition transaction and that the Merger Agreement and the prospectus required the disclosure of all material facts. Defendants' failure to disclose these material facts to HSI, therefore, constitutes fraud and/or negligent misrepresentation. Had HSI known of 24 25 the true facts concerning the problems with Medaphis' business operations, as well as the apparent deficiencies of the management of Medaphis and its subsidiaries, it would have rejected the offer to exchange its HDS shares for those of Medaphis by exercising its voting power to block the transaction, and it would not have signed the affiliate letter agreeing not to sell the Medaphis stock it would receive from the transaction until after Medaphis had filed financial statements containing post-merger financial information, and would have pursued its own plans to acquire HDS. 58. HSI has been damaged by its detrimental reliance on Defendants' representations and by Defendants' material omissions in an amount not yet determined, but which is in excess of $38 million. EIGHTH CAUSE OF ACTION (Intentional Interference with Prospective Economic Advantage) (By HSI Against Medaphis and Mr. Brown) 59. HSI realleges and incorporates by this reference the allegations contained in paragraphs 1 through 31, supra, as if fully set forth herein. 60. When Medaphis submitted its unsolicited acquisition proposal to HDS, HSI had already discussed a strategic merger with HDS which was well-received by its management and directors. HSI disclosed this intent to Medaphis and Mr. Brown during the meetings referred to herein. Such a merger represented an economically profitable business opportunity for HSI which would give HSI a leading position in the expanding field of healthcare information services and bring in-house the technology which HSI envisioned as a key to its future success. 61. Medaphis and Mr. Brown wrongfully and intentionally interfered with this prospective business relationship by proposing to acquire HDS through a transaction financed by 25 26 Medaphis stock, rather than cash, with a market value in excess of $250 million which had been artificially inflated by Medaphis' failure to disclose the true facts concerning its financial health as alleged above. The value of this consideration, far in excess of what HSI had proposed, was made possible only through the fraudulent misrepresentations of Medaphis and Mr. Brown as detailed herein. Had the true value of Medaphis' shares been known, as reflected by the market price after its August 14 disclosures, the relationship between HSI and HDS would not have been disrupted, and HSI would have pursued its merger proposal with HDS. 62. Defendants' wrongful conduct has actually and proximately caused HSI to suffer damages in an amount not yet determined, but which is no less than $50 million. 26 27 PRAYER FOR RELIEF WHEREFORE, HSI prays for relief as follows: On the SECOND AND FOURTH CAUSES OF ACTION: 1. For rescission of its purchase of Medaphis common stock received in exchange for its common and preferred stock of HDS; 2. That Medaphis be ordered to hold HDS as a separate business entity and to preserve its existing management, officers, and budget and not to take further steps to effectuate the merger during the pendency of this suit; On the FIRST, THIRD, FIFTH, SIXTH, SEVENTH, AND EIGHTH CAUSES OF ACTION: 1. For general damages against Medaphis, Mr. Brown, and DOES 1 through 50 according to proof; 2. For punitive damages against Medaphis, Mr. Brown, and DOES 1 through 50 in the amount of 100,000,000; On ALL CAUSES OF ACTION: 1. For the costs of suit, attorneys' fees, and pre- and post-judgment interest incurred herein; and 27 28 2. For all other such relief as the Court may deem just and proper. Dated: November, 7 1996. FRIED, FRANK, HARRIS, SHRIVER & JACOBSON STEPHEN D. ALEXANDER DAVID R. BOYKO By:/s/ --------------------------------- Stephen D. Alexander Attorneys for Plaintiff HEALTH SYSTEMS INTERNATIONAL, INC. 28 EX-99.4 22 CLASS ACTION COMPLAINT (NEW JERSEY) 1 EXHIBIT 99.4 WILENTZ, GOLDMAN & SPITZER A professional Corporation Nicholas w. McClear, Esq. (2288) 90 Woodbridge Center Drive P.O. Box 10 Woodbridge, New Jersey 07095-0958 (908) 636-8000 Attorneys for Plaintiffs, Ernest Hecht and Stephen D. Strandberg, on behalf of themselves and all others similarly situated. SUPERIOR COURT OF NEW JERSEY LAW DIVISION ESSEX COUNTY DOCKET NO. L-12691-96 - -------------------------------------x : ERNEST HECHT and STEPHEN D. : STRANDBERG, on behalf of : themselves and all others : similarly situated, : : Plaintiffs, : Civil Action : v. : COMPLAINT - CLASS ACTION : STEVEN G. PAPERMASTER; ROBERT : E. PICKERING, JR.; DAVID S. : LUNDEEN; NORMAN SMITH; RAYMOND : J. NOORDA; GREGORY A. GROSH; : MEDAPHIS CORPORATION, a Delaware : corporation; and RANDOLPH G. BROWN : : DEMAND FOR JURY TRIAL : Defendants. : - -------------------------------------x Individual and representative plaintiffs, Ernest Hecht and Stephen D. Strandberg, on behalf of themselves and all others similarly situated, complain against defendants Steven G. Papermaster ("PAPERMASTER"), Robert E. Pickering, Jr. ("PICKERING"), David S. Lundeen ("LUNDEEN"), Norman Smith ("SMITH"), Raymond J. Noorda ("NOORDA"), and Gregory A. Grosh ("GROSH") (hereinafter 2 from time to time collectively called the "BSG DEFENDANTS"); and Medaphis Corporation ("MEDAPHIS") and Randolph G. Brown ("BROWN") (hereinafter from time to time collectively called the "MEDAPHIS DEFENDANTS") as follows, upon information and belief (except for those allegations which pertain to plaintiffs and their attorneys, which allegations are based upon personal knowledge) based, inter alia, on the investigation made by plaintiffs' attorneys, which investigation included, without limitation, a review of various public filings and articles about BSG Corporation ("BSG") and defendant Medaphis: NATURE OF THE ACTION 1. This is a class action on behalf of a class comprising all persons or entities whose options to purchase shares of BSG common stock ("BSG Options") were converted in connection with the merger between defendant Medaphis and BSG on or about May 6, 1996 ("Merger") into options to purchase shares of the common stock ("Shares") of defendant Medaphis ("Medaphis Options") and who suffered damages as a result thereof. 2. On behalf of themselves and the class, plaintiffs seek, inter alia, to recover: (A) damages to the class and plaintiffs caused by (I) the BSG Defendants' violation of their fiduciary duties and the duty to perform due diligence as directors, officers, and controlling shareholders of BSG in adequately investigating, negotiating and consummating the Merger Agreement (as hereinafter defined), the Merger and related transactions with due regard to the rights of plaintiff and the other members of the class and (ii) the Medaphis Defendants' fraud; and (B) punitive damages. BSG CORPORATION 3. Before the Merger, BSG was a privately-held Delaware corporation with its principal place of business in Austin, Texas. 2 3 4. It was founded by defendant Papermaster in 1987. It described itself as one of the largest pure client/server and advanced technology systems integrators serving Fortune 1000 customers. It was engaged in the business of providing information technology and change management services to organizations seeking to transform their operations through the strategic use of client/server and other advanced technologies. 5. BSG had grown substantially since its founding, exceeding a 50% growth rate every year. In 1993, its revenues were about $26 million. In 1994, its revenues grew to over $46 million. In 1995, BSG's revenues increased to about $69.7 million. In 1995, Fortune magazine denominated BSG as one of its "25 Cool Companies," and Inc. magazine listed it as one of the 1995 Inc. 500 Companies. 6. BSG employed over 650 persons at 11 locations across the United States. 7. Immediately before the Merger, its largest shareholder was NFT Ventures, Inc. ("NFT"), a Utah corporation. NFT's president and one of its two directors is defendant Noorda. Its sole shareholder is the Raymond J. Noorda Family Trust ("Noorda Trust") of which defendant Noorda is one of the two trustees. 8. Immediately before the Merger, another large shareholder was NP Ventures LTD ("NP"), a Texas limited partnership. Its general partner was Powershift Partners, Ltd., whose general partner, in turn, was defendant Papermaster. THE UNDERLYING MERGER THE MERGER AGREEMENT 9. Defendant Medaphis; BSGSUB, Inc., its wholly-owned subsidiary; and BSG entered into a definitive agreement dated as of March 15, 1996 for the Merger ("Merger Agreement"), 3 4 whereby, in part, defendant Medaphis agreed to acquire, through the merger of BSGSUB, Inc., into and with BSG, all of BSG's outstanding capital stock for about 7.5 million Shares and further to assume BSG Options and stock rights, representing an additional approximately 2.7 million Shares. 10. The Merger was subject to, inter alia, BSG shareholder approval. The holders of BSG Options, however, had no right to vote to approve the Merger. 11. BSG's Board of Directors, including the BSG Defendants, approved the execution, delivery and performance of the Merger Agreement, as well as the Merger itself and all other contemplated transactions. The Merger Agreement committed BSG's Board of Directors to recommending to BSG's shareholders approval of the Merger Agreement and the contemplated transactions. 12. Before approval of the Merger Agreement, the BSG Defendants undertook a financial investigation of Medaphis. 13. Before approval of the Merger Agreement, the BSG Defendants negotiated its terms with representatives of defendant Medaphis. 14. In anticipation and before the execution of the Merger Agreement, defendant Papermaster executed a certain Stockholders Agreement and delivered it to Medaphis. 15. In anticipation and before the execution of the Merger Agreement, defendant Papermaster used his ability to direct the affairs of NP to cause NP to execute the Stockholders Agreement and deliver it to Medaphis. 16. In anticipation and before the execution of the Merger Agreement, defendant Noorda used his ability to direct the affairs of NFT to cause NFT to execute the Stockholders Agreement and deliver it to Medaphis. 4 5 17. The Merger Agreement provided, in part, that: (A) Defendant Medaphis would assume all of BSG's rights and obligations with respect to the BSG Options. (B) In connection with the Merger, the BSG Stock Options Plans would be amended to provide that the BSG Options will evidence the right to purchase Shares. (C) The nature of the options would change from Incentive Stock Options "ISO's") to Non-Qualified Stock Options. (D) Each holder of BSG Options would have to complete, execute and return an Option Assumption Agreement, along with the original BSG option agreements; otherwise the BSG Options would continue to govern. (E) Each BSG Option Holder completing and returning the Option Assumption Agreement would receive a Medaphis Option for the number of Shares equal to the product of the number of shares covered by the BSG Option multiplied by a conversion ratio based, generally speaking, on (I) the number of Shares and the number of BSG shares of common stock being exchanged through the Merger and (ii) the closing price of the Shares on NASDAQ the trading date before the date of the Agreement ("Conversion Ratio"). (F) The exercise price of a Medaphis Option would be calculated by dividing the per share exercise price of a BSG Option by the Conversion Ratio. 18. In addition to the above provisions, the Merger Agreement contained a number of provisions that benefitted only all or some of the BSG Defendants. 19. The Merger Agreement further provided, in part, that: 5 6 (A) Defendant Medaphis would, for five years, nominate to its Board of Directors a designee of defendants Papermaster and Noorda. (B) After the Merger, defendant Papermaster would remain a director of BSG. (C) After the Merger, defendant Papermaster would remain BSG's Chairman of the Board and Chief Executive Officer. (D) After the Merger, defendant Lundeen would remain an Executive Vice President and Chief Financial Officer of BSG. (E) After the Merger, defendant Pickering would be an Executive Vice President of BSG. (F) After the Merger, Employment Agreements would be executed with the BSG Defendants (except Noorda). (G) After the Merger, BSG would be the parent/umbrella organization for all of Medaphis's process re-engineering and systems integration companies and capabilities. Therefore, by virtue of their guaranteed positions and employment, the BSG Defendants would be in charge of these expanded operations. 20. In addition to these specific provisions, the BSG Defendants had substantial personal inducement to approve the Merger Agreement, the Merger, and related transactions. They would reap most of the financial gain from the consummation of the Merger. The BSG Defendants, directly or indirectly, held and controlled enough BSG shares to approve the Merger Agreement, the Merger and related transactions. 21. On the other hand, the Merger Agreement had a substantial adverse impact on the interests of the holders of BSG Options: 6 7 (A) Transformation of the options from ISO's to Non-Qualified Stock Options created negative tax consequences for the holders of BSG Options. The BSG Options, being ISO's, would have been taxed at lower capital gains rates and only when the holder sold the shares acquired through exercise of the options. In contrast, the Medaphis Options, being Non-Qualified Stock Options, would be taxed as ordinary income and on two occasions: first, when an option was exercised, and, second, when the shares acquired through exercise of the options were sold. In effect, the conversion of the nature of the options reduced their value by about 40%. (B) As a practical matter, holders of the BSG Options were compelled to have their BSG Options converted into Medaphis Options. After the Merger, BSG Options would be worthless. 22. In announcing the execution of the Merger Agreement, BSG and defendant Papermaster represented to the holders of BSG Options: [T]his change [from ISO's to Non-Qualified Stock Options] was a key component in the overall transaction which, among other benefits ENABLED US TO OBTAIN AN EXTREMELY ATTRACTIVE PRICE FOR YOUR BSG SHARES . . . . (Emphasis supplied). 23. In the same announcement, BSG and defendant Papermaster informed the holders of BSG Options: THE SENIOR EXECUTIVES OF BSG AND I PLAN TO CONVERT OUR STOCK OPTIONS INTO NON-QUALIFIED MEDAPHIS STOCK OPTIONS. I BELIEVE THAT THIS IS NOT ONLY IN THE BEST INTEREST OF BSG AND OUR EMPLOYEES, but inherently is in the best interest of Medaphis and its shareholders. (Emphasis supplied). 7 8 THE MERGER 24. On May 6, 1996, the Merger was accomplished through the exchange of about 7.5 million Shares for all BSG capital stock, along with an additional approximately 2.3 million Shares for the assumption of BSG Options. BSG, Inc., was merged into and with BSG, with BSG surviving the Merger as a wholly-owned subsidiary of defendant Medaphis. 25. Each share of BSG common was exchanged into about .23 of a Share, the Conversion Ratio being calculated after all shares of BSG's two classes of preferred stock had been converted into common stock. 26. Further, in connection with the Merger, defendant Medaphis entered into a Registration Rights Agreement with NFT and with NP whereby NFT and NP are entitled to certain demand and incidental registration rights with respect to its Shares received in the Merger. 27. Defendant Medaphis issued a press release dated May 7, 1996, announcing the Merger. The press release quoted defendant Brown as follows: Over the past few years, BSG has focused on building the infrastructure necessary to not only manage its growth, but also to manage the over 1,000 client/server-based technical staff who are now a part of the BSG group as a result of this Merger. Imonics, Rapid Systems Solutions and BSG create, we believe, the largest specialty client/server IT services company in the industry. This merger creates wonderful business opportunities for BSG and Medaphis and we are delighted about future prospects. (Emphasis added). 8 9 PARTIES PLAINTIFFS 28. Plaintiff Ernest Hecht is a citizen of the State of New Jersey, residing in Millburn, New Jersey, who, when the Merger occurred, held BSG Options covering 22,383 BSG shares. In connection with the Merger, his BSG Options were converted into Medaphis Options covering 5,148 Shares, and he has been damaged as a result of defendants' misconduct as described herein. On or about June 6, 1996, Mr. Hecht exercised some of his Medaphis Options to acquire 1,000 Shares; on or about August 23, 1996, he exercised some of his Medaphis Options to acquire another 500 Shares. Mr. Hecht now holds Medaphis Options covering 3,648 Shares. 29. Plaintiff Stephen D. Strandberg is a citizen of the State of New Jersey, residing in Maplewood, New Jersey, who, when the Merger occurred, held BSG Options covering 38,713 BSG shares. In connection with the Merger, his BSG Options were converted into Medaphis Options covering 8,904 Shares, and he as been damaged as a result of defendants' misconduct as described herein. DEFENDANTS THE BSG DEFENDANTS 30. Defendant Papermaster, before the Merger, was BSG's Chairman, President and Chief Executive Officer. He remained BSG's Chairman and Chief Executive Officer after the Merger. 31. Defendant Pickering who, at all relevant times before the Merger, was an Executive Vice President of BSG. 32. Defendant Lundeen, since August 22, 1995, was BSG's Chief Financial Officer and an Executive Vice President. He retained these positions with BSG after the Merger. 9 10 33. Defendant Smith was an Executive Vice President of BSG. 34. Defendant Noorda, since April 18, 1995, was a director of BSG. By reason of his positions as the president and one of two directors of NFT and one of the two trustees of the Noorda Trust, he had the power to direct the voting of NFT's BSG shares, including approval of the Merger. NFT owned about 19,287,848 BSG shares of common stock (after conversion, as required by the Merger Agreement, of preferred stock into common) immediately before the Merger. These shares represented about 58.84% of BSG's outstanding capital stock on a fully diluted basis. 35. Defendant Grosh was an executive of BSG and was appointed as one of the individuals to investigate Medaphis, the Merger Agreement, the Merger and related transactions. THE MEDAPHIS DEFENDANTS 36. Defendant Medaphis is a Delaware corporation with its principal place of business in the State of Georgia. It is a provider of out-sourced billing, accounts receivable and business management systems and services to the health care industry. There are more than 7l million Shares outstanding. Both before and after the Merger, the Shares were actively traded on the NASDAQ National Market System ("NASDAQ"). 37. Defendant Brown is a citizen of the State of Georgia. At all relevant times until on or about October 31, 1996, he had been the president, chief executive officer and a director of defendant Medaphis. He joined Medaphis in July 1987 as Executive Vice president and Chief Financial Officer and was named President, Chief Executive Officer and Director in April 1988, and Chairman in January 1991. Defendant Brown received $1,508,396.00 in total cash compensation in 1995, including a $1 million dollar signing bonus as part of a five year employment contract entered into in March 1995. Also in 1995, defendant Brown received options to purchase 200,000 Shares at an 10 11 exercise price of $22.8150 per share. As of March 12, 1996, defendant Brown beneficially owned 500,750 Shares. 38. By reason of his stock ownership, management positions membership on the Board of Directors of Medaphis, and the ability to make public statements in the name of Medaphis, defendant Brown controlled defendant Medaphis and had the power and influence to cause it to engage in the unlawful conduct complained of herein. Defendant Brown had access to the adverse non-public information about the operations, results and financial condition of Medaphis, as particularized herein, via access to internal corporate documents, communications with corporate officers and employees attendance at management and board of director meetings and committees thereof, and other means. CLASS ACTION ALLEGATIONS 39. Pursuant to Rules 23(a) and 23(b) (3) of the Federal Rules of Civil procedure, plaintiffs bring this action as a class action on behalf of a class (i) comprising all persons or entities whose BSG Options were converted into Medaphis Options in connection with the Merger and who suffered damages as a result thereof, but (ii) excluding the defendants; members of the immediate family of the individual defendants; any entity in which any defendant has or had a controlling interest; and the legal affiliates, representatives, heirs, controlling persons, successors and predecessors-in-interest or assigns of any such excluded party (the "Class"). 40. The members of the Class are so numerous that joinder of all members is impractical, but the exact number of the members of the Class can only be determined by discovery. 41. There are questions of law and fact common to the members of the Class. All members of the Class are owed the same duties by defendants; therefore, the questions of law and 11 12 fact as to the liability of each defendant are common to the Class. Among the common questions to the Class are: (A) Did the BSG Defendants perform due diligence in their investigation, negotiation and consummation of the Merger Agreement, Merger, and related transactions? (B) Did the BSG Defendants faithfully discharge their fiduciary duty and duty of care in their investigation, negotiation and consummation of the Merger Agreement, the Merger and related transactions? (C) Did the BSG Defendants faithfully discharge their duties of loyalty, candor, and fair dealing in their investigation, negotiation and consummation of the Merger Agreement, the Merger and related transactions? (D) Were the BSG Defendants negligent in their investigation, negotiation and consummation of the Merger Agreement the Merger and related transactions? (E) Did the Medaphis Defendants provide the BSG Defendants with materially false or misleading information in connection with the Merger Agreement, the Merger and related transactions? (F) Did the Medaphis Defendants' publicly disseminated releases and statements before the Merger contain materially false or misleading information? (G) Did the Medaphis defendants act wilfully or recklessly in omitting and/or misrepresenting material facts? (H) Were the market prices for the Shares artificially inflated by the material nondisclosures and/or misrepresentations? (I) Have the members of the Class sustained damages? 12 13 (J) If so, what is the appropriate measure of damages? 42. The questions affecting individual members of the Class pertain primarily to the amount of damages, and, therefore, the common questions of law and fact predominate over any questions affecting individual members in that defendants have acted on grounds generally applicable to the entire Class. 43. Plaintiffs' claims are typical of the claims of all other members of the Class because plaintiffs and the other members of the Class sustained damages arising out of defendants' misconduct. 44. Plaintiffs will fairly and adequately protect the interest of the Class and have retained counsel who are experienced and competent in class actions. Plaintiffs have no interest that is contrary to or in conflict with those of the other members of the Class that they seek to represent. 45. There is no litigation already commenced by any other member of the Class concerning the issues raised in this Complaint. 46. The size of the claims of some members of the Class may be relatively small in comparison to the expense and burden of seeking legal redress individually for the wrongs defendants committed against them, and absent Class members have no substantial interest in individually controlling the prosecution of individual actions. 47. Without a class action, defendants will continue to retain the proceeds of their wrongful conduct. 48. No difficulties are likely to be encountered in the management of this action as a Class action. 13 14 49. A class action will cause an orderly and expeditious administration of claims; will foster economies of time, effort and expense; and will insure uniformity of decisions. 50. It is desirable to litigate in one forum the claims of the Class. 51. For these reasons, a class action is superior to all other available methods for the fair and efficient adjudication of this controversy. APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD-ON-THE-MARKET DOCTRINE 52. At all relevant times, the market for the Shares was an efficient market for the following reasons, among others: (A) The Shares were listed and actively traded on NASDAQ, a highly efficient and automated market. (B) As a regulated issuer, defendant Medaphis filed periodic public reports with the SEC. (C) Defendant Medaphis regularly communicated with public investors via established market communication mechanisms, including through regular disseminations of press releases on the national circuits of major newswire services and through other wide-ranging public disclosures, such as communications with the financial press, Dow Jones and other similar reporting services. (D) Defendant Medaphis was followed by securities analysts employed by brokerage firms who wrote reports which were distributed to the sales force and certain customers of their respective brokerage firms. Each of these reports was publicly available and entered the public marketplace. 14 15 53. As a result, the market for the Shares promptly digested current information regarding Medaphis from all publicly available sources and reflected such information in the price of the Shares. FACTUAL ALLEGATIONS THE BSG DEFENDANTS' FINANCIAL INVESTIGATION AND NEGOTIATIONS 54. During their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, the BSG Defendants obtained from the Medaphis Defendants access to already publicly available information, consisting of: (i) Medaphis's Annual Report on Form 10-K for the year ending December 31, 1994 (including all exhibits and items incorporated by reference); (ii) its Quarterly Reports on Form 10-Q for the 3 quarters ending March 31, June 30 and September 30, 1995 (along with all exhibits and incorporated items); (iii) the proxy statement for its April 27, 1995 annual shareholders' meeting; and (iv) its Current Reports on Form 8-K filed with the SEC since September 30, 1995. 55. During their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, the BSG Defendants obtained from the Medaphis Defendants access to: (i) Medaphis's audited consolidated balance sheets as of December 31, 1993 and 1994 and statements of operations, changes in stockholders' equity and cash flows for the fiscal year then ended, along with the notes thereto; and (ii) its unaudited consolidated balance sheet as of September 30, 1995. 56. During their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, the BSG Defendants, their accountants, counsel and other authorized representatives had full access to, inter alia, all of Medaphis's contracts, commitments, books, records and other information, and the right to obtain 15 16 all financial, technical and operating data, as well as other information pertaining to Medaphis's business. 57. During their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, the BSG Defendants received from the Medaphis Defendants certain material information about the finances and operations of Medaphis, including, inter alia: (A) Medaphis' financial condition during, inter alia, the fiscal year 1995, the fourth quarter 1995 and the first quarter 1996. (B) The operations and revenues of a joint venture in which Imonics GMBH, a wholly-owned subsidiary of Medaphis, held a 50% interest ("Joint Venture"). (C) The results at Medaphis' largest operating subsidiary, Medaphis physician Services Corporation ("MPSC"), were "improv[ing]" and Medaphis' re-engineering project. (D) The operations of Rapid Systems Solutions, Inc., a Medaphis wholly-owned subsidiary ("Rapid"); Imonics; and all other of Medaphis's process re-engineering and systems integration companies and capabilities and ability to integrate their operations under BSG after the Merger. FINANCIAL RESULTS 58. During their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, the BSG Defendants received from the Medaphis Defendants and investigated information about Medaphis's finances and results of operations for the fiscal year 1995, the fourth quarter 1995 and the first quarter 1996. 16 17 59. As eventually set forth in a press release and its Form 10-K filed on April I, 1996, defendant Medaphis recorded for the year ending December 31, 1995, a net loss of $1.1 million, and for the quarter ending December 31, 1995, net income of $4.0 million. 60. As eventually set forth in a press release dated April 23, 1996, and its Form 10-Q filed with the SEC on May 14, 1996, defendant Medaphis recorded for the first quarter 1996 net income of about $13.2 million. 61. The fourth quarter 1995 results contained $4.0 million in revenue from an Imonics license agreement. 62. Defendant Medaphis included in its Consolidated Statement of Income for the first quarter 1996 about $12.5 million relating to its purported share of net earnings from the Joint Venture. 63. In its April 23, 1996 press release, defendant Medaphis reported that it was "pleased with the first quarter": revenues had increased by 24.l% over the same quarter in the prior year, from $110.1 million to $136.6 million, and that, excluding certain restructuring and merger costs, net income had increased by 55% to $13.2 million and earnings per share had increased by 35% to $0.23 per share. 64. The first quarter Form 10-Q, which provided to the public additional details concerning its financial results, stated: Revenue. Revenue increased 24.1% to $136.6 million in the first quarter of 1996 as compared with $110.1 million in the first quarter of 1995. Revenue growth results from: (i) acquisitions; (ii) increases in the number of business management services to clients; and (iii) increases in sales to information management and systems integration clients. The Company has consummated 14 business combinations during the period from January 1, 1995, through March 31, 1996. 17 18 Revenue of the Company's services division was $106.1 million and $98.1 million, respectively, for the quarters ended March 31, 1996 and 1995. A substantial portion of the revenue in the Company's services division is recurring, representing approximately 70% of consolidated revenue. Revenue of the Company's technology systems division was $30.9 million and $12.3 million, respectively, for the quarters ended March 31, 1996 and 1995. The Company's overall internal revenue growth during the quarter ended March 31, 1996 was approximately 19.5% THE JOINT VENTURE'S OPERATIONS AND REVENUES 65. During their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, the BSG Defendants received from the Medaphis Defendants information about the Joint Venture's operations and finances. 66. In February, 1996, immediately before the execution of the Merger Agreement, Medaphis, through Imonics, had entered into the Joint Venture. The Joint Venture was formed to pursue custom software development and systems integration projects for customer service systems in Europe. 67. The Joint Venture reportedly signed a large software licensing and software engineering contract with a German telecommunications entity to provide systems integration and work flow engineering systems and services over a multi-year period. 68. Subsequently, defendant Medaphis provided similar, but less detailed information about the Joint Venture to the public. In Defendant Medaphis' April 23, 1996 announcement of first quarter 1996 results, defendant Brown noted: The performance of our client/server IT services business was excellent and included formation of a joint-venture with a subsidiary of Bertelsmann A.G. in Germany. The joint venture signed a large contract with a telecommunications company during the quarter. 18 19 (Emphasis supplied) 69. The first quarter 10-Q also reported the formation of the Joint Venture and disclosed inclusion of $12.5 million net earnings from the Joint Venture. 70. In April 1996, officials of defendant Medaphis attended a Robinson-Humphrey Co. conference at which they touted the successes at Imonics, declaring that it was "going like gangbusters". 71. The market responded favorably to the information about the Joint Venture. In an April 30, 1996 company report on Medaphis by Smith Barney, for example, the Joint Venture was specifically cited as an example of one of the areas in which Medaphis had "displayed strong growth." MPSC AND THE RE-ENGINEERING PROJECT 72. During their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, the BSG Defendants received from the Medaphis Defendants and investigated information about the operations and results at MPSC and the Re-engineering Project. 73. Purportedly to improve its operations and operating results, productivity and cost efficiency, in late 1994 Defendant Medaphis undertook a comprehensive re-engineering initiative (the "Re-Engineering Project") of its physician accounts receivable and practice management operations at MPSC. The Re-Engineering project involves, among other things, the consolidation of the processing operations in over 300 offices into fewer than 10 large regional processing centers. The Project also involves implementation of advanced client/server computing in its processing operations and at local sales and services offices. Before the Merger, application development, work flow 19 20 engineering and implementation of these advanced technologies was performed by Imonics, a subsidiary of defendant Medaphis acquired in 1994. 74. As eventually represented in its Form 10-K for the 1995 fiscal year, Defendant Medaphis represented to the BSG Defendants that the Re-Engineering Project "is expected to be substantially completed during 1997." INTEGRATION OF OTHER SUBSIDIARIES AND OPERATIONS 75. During their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, the BSG Defendants received from the Medaphis Defendants information about and investigated the operations of Medaphis' process re-engineering and systems integration companies and capabilities and the capability and costs of integrating under BSG. 76. Exhibit 5.15 to the Merger Agreement, provided, in pertinent part, that: BSG will be the parent/umbrella organization for all of Medaphis's process re-engineering and systems integration companies and capabilities (collectively, the "Relevant Businesses") . Imonics, BSG Alliance/IT and other Relevant Business will become subsidiaries or divisions of BSG and will form part of the "BSG (Business Systems) Group." 77. On March 15, 1995, the date of the Merger Agreement, the Medaphis Defendants issued a press release announcing the Merger Agreement that stated: The merger with BSG is a major milestone in increasing our technology capabilities. Working with Imonics and Rapid Systems Solutions, BSG will lead our systems integration efforts and we believe will accelerate transformation of the way transaction processing is performed in the healthcare industry. Over the past few years, BSG has focused on building the infrastructure necessary to not only manage its growth, but also to 20 21 manage the over 1,900 client/server-based technical staff who are now a part of Medaphis. We are excited about our newly acquired capabilities in client/server consulting and systems integration. Imonics and Rapid Systems Solutions combined with BSG have created, we believe, the largest pure client/server technology services company in the country. (Emphasis supplied). THE MATERIAL INACCURACIES IN THE MEDAPHIS DEFENDANTS' INFORMATION 78. The Medaphis Defendants had misused accounting policy to inappropriately record about $4 million in revenues from Imonics in the fourth quarter of 1995, thereby inflating the financials of Medaphis and the price of the Shares. 79. The Medaphis Defendants had misused accounting policy to inappropriately record over $12 million in revenues from its Joint Venture in the first quarter of 1996, thereby inflating the financials of Medaphis and the price of the Shares. 80. As The Wall Street Journal reported on August 16, 1996: Robert Olstein, the manager of the Olstein Financial Alert fund, a mutual fund based in Purchase, N.Y., said he had recently sold the stock short because of concerns about the company's accounting, including rises in capitalized software costs and in what are called "unbilled revenues". Such revenues reflect work done on contracts for which customers have not yet been charged. Apparently it was the profits resulting from some of those revenues that were wiped out in the write-off that provoked yesterday's plunge. (Emphasis supplied). 81. According to Medaphis' Form 8-K, which it filed on July 9, 1996 to report on its acquisition of HDS, its revenue recognition policy is as follows: Revenues from systems integration contracts are recorded based on the terms of the underlying contracts which are primarily time and material or fixed price contracts. Revenue from time and material type 21 22 contracts is recognized as services are rendered and costs are incurred based on contractual rates. Revenue from fixed price contracts is recorded using the percentage of completion method. Expected losses are charged to operations in the period such losses are determined. Revenue for which customers have not yet been invoiced is reflected as accounts receivable. unbilled in the accompanying consolidated balance sheets. (Emphasis added) 82. The BSG Defendants, in their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, should have verified the validity of the Imonics licensing agreement and the Joint Venture's contract; the ability of Imonics to complete them satisfactorily; and the propriety of Medaphis's accounting practices and inclusion of revenues from the license agreement and the Joint Venture contract in its financial results. 83. Moreover, the Medaphis Defendants failed to disclose the extent of the problems being experienced by the Company's MPSC subsidiary and the Re-Engineering Project, and there was no reasonable basis for the defendants' information that MPSC was improving and that the Reengineering Project was positioning the Company for important improvements in operating results. 84. MPSC had not been able, in fact, to consolidate offices, improve business procedures or develop technology as fast as planned. 85. The BSG Defendants, in their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, should likewise have discovered the extent of the problems being experienced by the Company's MPSC subsidiary and the Re-engineering Project, and further have verified the validity of the basis 22 23 for the defendants' information that MPSC was improving and that the Re-engineering Project was positioning the Company for important improvements in operating results. 86. The Medaphis Defendants also acted knowingly or recklessly by touting the capability and costs of BSG merger to Medaphis without also disclosing the substantial financial adverse impact that would result from the need to integrate Rapid's Imonic's operations with BSG. 87. The BSG Defendants, in their financial investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger, and the related transactions, should have verified the capability and costs of integrating Medaphis's process re-engineering and systems integration companies and capabilities under BSG. MEDAPHIS' TRUE FINANCIAL CONDITION EXPOSED 88. Only three months after the Merger, Medaphis' true financial condition and operating difficulties began to be exposed in two bombshell announcements. 89. The first bombshell was on August 14, 1996. After the close of trading, defendant Medaphis issued a press release disclosing its severe problems with Imonics and with MPSC and the Re-engineering Project. Defendant Medaphis announced that it expected to report a large loss, in the range of $0.28 to $0.33 per share, in the third quarter of 1996, which would include charges in the range of $35 to $40 million. 90. A substantial portion of Medaphis' difficulties were reported to have arisen from the need to reorganize Imonics and its problems with the Joint Venture's contract, so positively reported by defendant Medaphis previously. Explaining the situation, defendant Medaphis reported: Management has commenced the process of reorganizing the Imonics systems integration business. This reorganization resulted from a review by BSG of 23 24 Imonics' overall operations and an assessment of recent difficulties encountered by Imonics with a large systems integration agreement entered into by its European joint venture. The reorganization of Imonics will include efforts to more closely align Imonics' business practices with those of BSG. The BSG model is structured to manage client/server information technology projects with experienced project management. It is currently anticipated that Imonics' European joint venture will continue with its system integration project on terms and conditions mutually satisfactory to the parties, but that the agreement relating to the project will be restructured. 91. Defendant Medaphis further disclosed that about $9 million of charges would be made in the third quarter to write off revenues from the Joint IVenture, caused by the restructuring of the systems integration agreement entered into by the Joint Venture. Another $15 million in charges related to the reorganization of Imonics. 92. In addition, defendant Medaphis revealed that MPSC was continuing to experience poor results, due in part to delays in the Re-Engineering Project. It further disclosed that, as a result of these problems, Medaphis would take a restructuring charge of approximately $11 million. 24 25 93. The second bombshell came on October 22, 1996, when defendant Medaphis further revealed the extent of its problems with Imonics and the joint venture and admitted that its prior financial statements were materially inaccurate. It announced that its net loss per share for the third quarter was actually greater than anticipated on August 14: $0.51, compared to a predicted $0.28 to $0.33. 94. Again, a substantial portion of the loss was attributable to its severe problems with Imonics, again resulting in large charges: (A) There was a charge against revenues of $16.8 million, relating primarily to Imonics' reorganization, including reorganization of the Joint Venture's contract. (B) About $8.5 million was included in salaries and wages relating to employees and contractors who were no longer providing services to Imonics. (C) In addition, a $24.3 million restricting charge was recorded, consisting of about $10,7 million relating to a write-down of Imonics' assets; $3.7 million of severance costs, primarily for former Imonics employees; $3.2 million in exist costs for lease terminations; and $6.7 million of legal and other costs. 95. Defendant Medaphis further admitted the need to restate its financial results for the year and the three months ended December 31, 1995. It was reported that the restatement related to the 1995 Imonics license agreement. License fee revenue payable under this agreement had been recognized during the fourth quarter of 1995. Medaphis anticipated that net income for the quarter and year ended December 3l, 1995 of $5.1 million, resulting in a net loss for 1995 of $8.5 million, compared with the previously reported net loss of $3.4 million; and a net loss for the quarter of $1.1 million, instead of the previously reported net income of $4.0 million. 25 26 96. Medaphis further reported that during the third quarter 1996, it terminated 430 employees, including Imonics' entire former senior management team. The firing of Imonics' senior management team had first been announced on August 26, 1996. THE SHARES CRASH 97. The market has reacted sharply and dramatically to the two waves of revelations. 98. On the day following the August 14 disclosures, the price of the Shares plummeted 60%. The Shares closed at $14-1/4, after dropping by $21-3/8. Some 43 million Shares changed hands during the day, making it the most active U.S. issue and representing the sixth-highest single trading day in NASDAQ history, excluding penny stocks. 99. Similarly, after the second disclosure on October 22, 1996, the Shares, which had fluctuated in the $12 to $18 range, plunged almost another 38% and has traded as low as $8.25. On November 6, 1996, the Shares closed at $8.56 and 1/4. 100. These facts, as alleged herein, provide a strong inference that: (A) The BSG Defendants failed to perform due diligence and exercise reasonable care in the investigation, negotiation and consummation of the Merger Agreement, Merger and related transactions. Had they performed due diligence and exercised the requisite care, they would have discovered the inappropriate accounting policies, operational difficulties, and adverse financial information ultimately admitted by the Medaphis Defendants. (B) The BSG Defendants approved the Merger Agreement and the Merger because of substantial personal inducements given to them, and thus violated their duties of loyalty and candor. 26 27 (C) The BSG Defendants used the extensive financial and operational information obtained about Medaphis during the investigation and negotiation of the Merger Agreement, Merger and related transactions to engage in post-Merger speculation in the Shares, in breach of their duties of loyalty and candor. (D) The Medaphis Defendants made materially false and misleading statements to the BSG Defendants and the investing public knowing that said statements issued or disseminated in the name of the Company were materially false and misleading; knew or recklessly disregarded that such statements would be issued or disseminated to the BSG Defendants and the investing public; and knowingly and substantially participated or acquiesced in the issuance or dissemination of such statements. COUNT I AGAINST ALL THE BSG DEFENDANTS FOR FAILURE TO PERFORM DUE DILIGENCE 101. Plaintiffs adopt by reference paragraphs 1 through 100 hereof. 102. Each BSG Defendant owed a fiduciary duty to the plaintiffs and the other members of the Class because of his or her position as a director, officer and/or controlling shareholder of BSG to perform due diligence in their investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger and related transactions. 103. The BSG Defendants failed to perform due diligence in their investigation of Medaphis and their investigation and negotiation of the Merger Agreement, the Merger and related transactions. 104. Had the BSG Defendants performed due diligence, they would have uncovered the Medaphis Defendants' misrepresentations and the truth about Medaphis' financial condition. 27 28 105. Had the BSG Defendants performed due diligence, they would not have approved the Merger Agreement, the Merger and related transactions on the terms and conditions agreed to and/or would have negotiated better terms for the conversion of BSG Options into Medaphis Options. 106. The above-described acts and omissions by the BSG Defendants constitute breaches of their fiduciary duty and duty to perform due diligence owed to plaintiffs and all other members of the Class. 107. Plaintiffs and all other members of the Class have suffered substantial damages caused by the BSG Defendants. COUNT II AGAINST ALL THE BSG DEFENDANTS FOR BREACH OF FIDUCIARY DUTY AND DUTY OF CARE 108. Plaintiffs adopt by reference paragraphs 1 through 100 hereof. 109. Each BSG Defendant owed a fiduciary duty and duty of care to the plaintiffs and the other members of the Class because of his or her position as a director, officer and/or controlling shareholder of BSG to adequately investigate Medaphis and investigate and negotiate the Merger Agreement, the Merger and related transactions. 110. The BSG Defendants failed to exercise the degree of care owed to the Class to adequately investigate Medaphis and investigate and negotiate the Merger Agreement, the Merger and related transactions. 111. Had the BSG Defendants exercised the degree of care owed to the Class, they would have uncovered the Medaphis Defendants' misrepresentations and the truth about Medaphis' financial condition. 28 29 112. Had the BSG Defendants exercised the required degree of care, they would not have approved the Merger Agreement, the Merger and related transactions on the terms and conditions agreed to and/or would have negotiated better terms for the conversion of BSG Options into Medaphis Options. 113. The above-described acts and omissions by the BSG Defendants constitute breaches of their fiduciary duties to plaintiffs and all other members of the Class. 114. Plaintiffs and all other members of the Class have suffered substantial damages caused by the BSG Defendants. COUNT III AGAINST ALL THE BSG DEFENDANTS FOR BREACH OF DUTIES OF CANDOR, LOYALTY AND FAIR DEALING 115. Plaintiffs adopt by reference paragraphs I through 100 hereof. 116. Each BSG Defendant owed fiduciary duties of candor, loyalty and fair dealing to the plaintiffs and the other members of the Class because of his or her position as a director, officer and/or controlling shareholder of BSG to adequately investigate Medaphis and investigate and negotiate the Merger Agreement, the Merger and related transactions. 117. The BSG Defendants approved the Merger Agreement, the Merger and related transactions because their terms were favorable to the BSG Defendants. 118. The above-described acts and omissions by the BSG Defendants constitute breaches of their fiduciary duties of candor, loyalty and fair dealing to plaintiffs and all other members of the Class. 29 30 119. Plaintiffs and all other members of the Class have suffered substantial damages caused by the BSG Defendants. COUNT IV AGAINST ALL THE BSG DEFENDANTS FOR NEGLIGENCE 120. Plaintiffs adopt by reference paragraphs 1 through 100 hereof. 121. The BSG Defendants negligently investigated Medaphis and investigated and negotiated the Merger Agreement, the Merger and related transactions. 122. Had the BSG Defendants exercised the degree of care owed to the Class, they would have uncovered the Medaphis Defendants' misrepresentations and the truth about Medaphis' financial condition. 123. Had the BSG Defendants exercised the required degree of care, they would not have approved the Merger Agreement, the Merger and related transactions on the terms and conditions agreed to and/or would have negotiated better terms for the conversion of BSG Options into Medaphis Options. 124. The above-described acts and omissions by the BSG Defendants constitute breaches of their fiduciary duties to plaintiffs and all other members of the Class. 125. Plaintiffs and all other members of the Class have suffered substantial damages caused by the BSG Defendants. 30 31 COUNT V AGAINST ALL THE MEDAPHIS DEFENDANTS FOR FRAUD AND DECEIT 126. Plaintiffs adopt by reference paragraphs 1 through 100 hereof. 127. For several years, under the leadership of defendant Brown, defendant Medaphis had grown substantially through a strategy of aggressive growth primarily by acquisitions such as the Merger. Since 1988, defendant Medaphis acquired over 40 companies, including more than 20 acquired in the past two years. The growth was financed through a rising price in its Shares. Because defendant Medaphis paid for most of its acquisitions through exchange of stock, as it did for BSG, the higher the price of the Shares, the fewer Shares it had to pay to make acquisitions. 128. The Medaphis Defendants knew that in order for Medaphis to be able to continue to grow through acquisitions, most often using the Shares as currency, it was imperative that the Shares trade at high prices. The Medaphis Defendants further realized that they must present their overall business in an extraordinary favorable light to maintain and increase the price of the Shares. 129. Specifically with regard to the Merger, the Medaphis Defendants had a substantial incentive to keep the price of the Shares artificially high in order to give up fewer shares in the Merger as well as increase the exercise price of the Medaphis Options, thus lowering their value. 130. Further, defendant Brown had a substantial personal incentive to inflate the price of the Shares in order, among other things, to: (i) protect and enhance his executive position and the consequent substantial compensation and prestige; and (ii) enhance the value of his substantial personal holdings of Medaphis securities and options to acquire such securities. 131. The Medaphis Defendants, individually and in concert, engaged in a plan, scheme and course of conduct, pursuant to which they knowingly and/or recklessly engaged in acts, transactions, 31 32 practices, and courses of business which operated as a fraud and deceit, and made various untrue statement of material fact and omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, as described herein. The purpose and effect of the scheme was to artificially inflate the price of the Shares. 132. The Medaphis Defendants, directly and indirectly, engaged and participated in, and aided and abetted a common plan, scheme and continuing course of conduct to conceal or fail to disclose material information about the business, management, earnings, and finances of Medaphis as described herein. The Medaphis Defendants employed devices, schemes and artifices to defraud and engaged in acts, practices and a course of conduct as herein alleged in an effort to fraudulently reduce the amount of and exercise price of Medaphis Options, which included the making of untrue statements of material facts, omitting to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and engaging in transactions, practices and courses of business which operated as a fraud or deceit. 133. The false and misleading statements and omissions therefrom, were done with the intent to deceive or defraud or to aid and abet the deception and defraud, or were made with such recklessness or indifference to truth as to constitute intent to deceive and fraud. 134. The acts, practices and common course of conduct by said defendants operated as a fraud and deceit upon (a) the market in the Shares; and (b) plaintiffs and the other members of the Class. 135. The Medaphis Defendants had a duty to promptly disseminate accurate and truthful information with respect to Medaphis' operations, results and financial condition, or to cause and 32 33 direct that such information be disseminated, and to promptly correct any previously disseminated information that was misleading. 136. As a result of the Medaphis Defendants' fraud and deceit, the market price of the Shares was artificially inflated at the time of both the Merger Agreement and the Merger, causing injury to plaintiffs and other members of the class. WHEREFORE, individual and representative plaintiffs, Ernest Hecht and Stephen D. Strandberg, on behalf of themselves and the other members of the Class, respectfully request that this Court: (A) Determine that this lawsuit may be maintained as a class action pursuant to Rules 23(a) and 23(b) (3) of the Federal Rules of Civil Procedure on behalf of the Class defined herein; (B) Award compensatory damages against the defendants, jointly and severally, in favor of the plaintiffs and the other members of the Class in an amount to be determined by the Court as fair and just for the misconduct of defendants; (C) Award the plaintiffs and the other members of the Class punitive damages; (D) Awarding such further relief as this Court may deem just and equitable, including any equitable or injunctive relief as permitted by the law or equity to attach, to impound or otherwise restrict the defendants' assets to assure plaintiffs have an effective remedy; (E) Awarding plaintiffs and the other members of the Class pre-judgment and post-judgment interest, as well as their reasonable attorneys' fees and expert witnesses' fee' other costs. 33 34 WILENTZ, GOLDMAN & SPITZER A Professional Corporation By:/s/ ------------------------------------- NICHOLAS W. McCLEAR Attorneys for Plaintiffs Ernest Hecht and Stephen D. Strandberg, individually and on behalf of all others similarly situated DATED: November 8, 1996 OF COUNSEL: FREUNDLICH & REISEN 159 Millburn Avenue Millburn, New Jersey 07041 (201) 376-1090 LAWRENCE E. FELDMAN, ESQ. Lawrence E. Feldman & Associates Manor Professional Building 7837 Old York Road Elkins Park, PA 19028 (215) 635-4704 34 35 DEMAND FOR TRIAL FOR JURY Individual and representative plaintiffs, Ernest Hecht and Stephen D. Strandberg, individually and on behalf of all others similarly situated, demand trial by jury on all issues. WILENTZ, GOLDMAN & SPITZER A Professional Corporation By: /s/ ----------------------------- NICHOLAS W. McCLEAR Attorneys for Plaintiffs Ernest Hecht and Stephen D. Strandberg, individually and on behalf of all others similarly situated DATED: 35 36 DESIGNATION OF TRIAL COUNSEL Trial counsel on behalf of Ernest Hecht and Stephen D. Strandberg, individually and on behalf of all others similarly situated shall be Nicholas W. McClear, Esq. WILENTZ, GOLDMAN & SPITZER A Professional Corporation By: /s/ ---------------------------- NICHOLAS W. McCLEAR Attorneys for Plaintiffs Ernest Hecht and Stephen D. Strandberg, individually and on behalf of all others similarly situated DATED: November 8, 1996 36 37 CERTIFICATION PURSUANT TO RULE 4:5-1 We hereby certify that the matter in controversy is not, to our knowledge, the subject of any other pending action or arbitration proceeding, and that no other action or arbitration proceeding is contemplated by the plaintiffs at this time. We are not aware of any other parties who should be joined in this action at this time. By: /S/ ---------------------------- NICHOLAS W. McCLEAR DATED: November 8, 1996 37 EX-99.5 23 VERIFIED DERIVATIVE COMPLAINT (GEORGIA) 1 EXHIBIT 99.5 UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF GEORGIA ATLANTA DIVISION - ------------------------------------------ ) THOMAS W. BROWN, ADMINISTRATOR, ) NO. 1 96-CV 2904 THOMAS W. BROWN PROFIT SHARING ) PLAN, Derivatively on Behalf of ) FIRST AMENDED VERIFIED MEDAPHIS CORPORATION, ) DERIVATIVE COMPLAINT ) Plaintiff, ) PLAINTIFF DEMANDS A vs. ) RANDOLPH G. BROWN, ROBERT C. BELLAS, ) TRIAL BY JURY JR., DAVID R. HOLBROOKE, RICHARD H. ) STOWE, JOHN A. DOWNER, DAVID E. ) McDOWELL, DENNIS A. PRYOR, STEVEN G. ) PAPERMASTER, MICHAEL L. DOUGLAS, ) MICHAEL R. COTE and JAMES S. ) DOUGLASS, ) ) Defendants, ) and ) ) MEDAPHIS CORPORATION, ) ) Nominal Defendant. ) - ------------------------------------------) Plaintiff, through his attorneys, for his First Amended Derivative Complaint ("Complaint") alleges, as of November 1, 1996, the date of the original filing of Plaintiff's derivative complaint, upon information and belief, except as to the allegations contained in paragraph 2, which are alleged upon personal knowledge, as follows: 2 INTRODUCTION 1. This is a shareholders' derivative action brought on behalf of Medaphis Corporation (hereinafter "Medaphis" or "the Company"), a Delaware corporation whose headquarters and principal place of business are in Atlanta, Georgia. Medaphis' shares are publicly traded on the NASDAQ market, with at least hundreds of record shareholders and many thousands of beneficial shareholders. In this action, plaintiff, on behalf of Medaphis, alleges that defendants have damaged Medaphis by deliberately, in bad faith or recklessly (I) engaging in violations of federal securities laws, (ii) implementing a sham system of internal controls completely inadequate to ensure timely and proper accounting and reserves to account for receivables, (iii) engaging in fraud and securities fraud, and (iv) by damaging the Company's reputation. As alleged herein, defendants' actions and omissions were deliberate, undertaken in bad faith, fraudulent, and constituted breaches of their fiduciary duties of loyalty and due care. The acts and omissions alleged herein occurred during the period from February 29, 1996 through October 22, 1996 (the "Relevant Period"). Defendants were motivated by the desire to wrongfully obtain the resources Medaphis needed to succeed in its existing commitments, which it could not meet, at a nominal cost, and thereby secure their continued lucrative employments as officers and directors of Medaphis and its subsidiaries. Defendants knew that if Medaphis' true financial and operational condition became known, Medaphis would be unable to continue to grow using its stock as currency for acquisitions, to gain expertise and manpower to perform under existing Medaphis contracts which Medaphis lacked the resources to perform, as set forth below. Defendants knew that if the truth about Medaphis became public, Medaphis would be forced to restructure and eliminate or divest itself of subsidiaries of which certain defendants are -2- 3 officers and founders, and otherwise renegotiate the Company's major contracts and credit resources, to the personal detriment of defendants. THE PARTIES 2. Plaintiff Thomas W. Brown, Administrator, Thomas W. Brown Profit Sharing Plan, resides in Carnegie, Pennsylvania. Plaintiff purchased 1,260 shares of Medaphis common stock on June 21, 1995 and has been a shareholder of the Company continuously since that date. 3. Nominal Defendant Medaphis is a provider of outsourced billing, accounts receivable and business management systems and services to the health care industry. As of August 12, 1996, there were more than 71 million shares of Medaphis common stock outstanding. During the Relevant Period, the Company's common stock was actively traded on the NASDAQ National Market System. 4. Defendant Randolph G. Brown ("Brown") was at all times relevant the President, Chief Executive Officer and a Director of Medaphis. He joined the Company in July 1987 as Executive Vice President and Chief Financial Officer and was named President, Chief Executive Officer and Director in April 1988, and Chairman in January 1991. Defendant Brown received $1,508,396 in total cash compensation in 1995, which included a $1 million signing bonus received as part of a five-year employment agreement he entered into in March 1995. Also in 1995, defendant Brown received options to purchase 200,000 shares of Medaphis common stock at an exercise price of $22.8150 per share. As of March 12, 1996, defendant Brown beneficially owned a total of 500,750 shares of the Company's common stock. Brown executed the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission -3- 4 ("SEC") on April 1, 1996. Brown was still a director of the Company on November 1, 1996, when this derivative action was first filed. 5. Defendant Robert C. Bellas, Jr. ("Bellas") has been a director of Medaphis since 1987, and is a member of the Audit and Compensation Committees of the Board of Directors. Bellas serves as Chairman of the Compensation Committee. Bellas signed the Company's Annual Report on Form 10-K filed with the SEC on April 1, 1996. As of April 3, 1996, Bellas beneficially owned 8,115 shares of the Company's common stock, including shares issuable upon the exercise of stock options. Bellas signed Medaphis' registration statement on Form S-3 filed with the SEC on July 12, 1996. 6. Defendant David R. Holbrooke ("Holbrooke") has been a director of Medaphis since 1994, and is a member of the Audit Committee of the Board of Directors. Holbrooke signed the Company' s Annual Report on Form 10-K filed with the SEC on April 1, 1996. As of April 3, 1996, Holbrooke beneficially owned 33,900 shares of the Company's common stock, including shares issuable upon the exercise of stock options. Holbrooke signed Medaphis' registration statement on Form S-3 filed with the SEC on July 12, 1996. 7. Defendant Richard H. Stowe ("Stowe") was a director of Medaphis from 1988 until approximately May 16, 1996, and was a member of the Audit and Compensation Committees of the Board of Directors. Stowe chaired the Company's Audit Committee. Stowe signed the Company's Annual Report on Form 10-K filed with the SEC on April 1, 1996. As of April 3, 1996, Stowe beneficially owned 13,762 shares of the Company's common stock, including shares issuable upon the exercise of stock options. -4- 5 8. Defendant John A. Downer ("Downer") was a director of Medaphis from 1989 until approximately May 16, 1996. Downer signed the Company's Annual Report on Form 10-K filed with the SEC on April 1, 1996. 9. Defendant David E. McDowell ("McDowell") has since approximately May 16, 1996, served as a director of Medaphis. Since approximately October 31, 1996, McDowell has served as Chairman and Chief Executive Officer of Medaphis, assuming these positions following Brown's resignation of these positions. McDowell signed Medaphis' registration statement on Form S-3 filed with the SEC on July 12, 1996. 10. Defendant Dennis A. Pryor ("Pryor") has since 1992 served as a director of Medaphis. Pryor served as Chairman of Medaphis subsidiary CompMed, acquired by merger in 1992. Pryor signed Medaphis' registration statement on Form S-3 filed with the SEC on July 12, 1996. 11. Defendant Steven G. Papermaster ("Papermaster") has, since approximately May 16, 1996, served as a director of Medaphis. Papermaster is Chairman and CEO of Medaphis subsidiary BSG Corp., acquired by merger on May 6, 1996. Papermaster signed Medaphis' registration statement on Form S-3 filed with the SEC on July 12, 1996. 12. Defendant Michael L. Douglas ("Douglas") from approximately June 26, 1996 to approximately February 5, 1997, served as a director, Vice Chairman and Chief Operating Officer of Medaphis. Although represented by Medaphis to be a director at the time, Douglas did not sign the registration statement on Form S-3 filed with the SEC on July 12, 1996. 13. Defendant Michael R. Cote ("Cote") is and was, at all relevant times, Senior Vice President-Finance and Chief Financial Officer of the Company. Press releases issued by -5- 6 defendants during the Relevant Period consistently identified Cote as the contact person at the Company for purposes of communications with the investment community. Cote signed all periodic reports and registration statements filed with the SEC during the Relevant Period. 14. Defendant James S. Douglass ("Douglass") is and was, at all relevant times, Vice President, Corporate Controller, and Chief Accounting Officer of the Company. 15. Brown, Bellas, Holbrooke, Stowe, Downer, McDowell, Pryor, Papermaster and Douglas, are collectively hereinafter sometimes referred to as the "Director Defendants". 16. Brown, Bellas, Holbrooke, Stowe, Downer, McDowell, Pryor, Papermaster, Douglas, Cote and Douglass are collectively hereinafter sometimes referred to as the "Individual Defendants". JURISDICTION AND VENUE 17. This court has subject matter jurisdiction over this action pursuant to 28 U.S.C. ss.ss. 1332(a) (1) and 1367(a). Venue is proper pursuant to 28 U.S.C. ss. 1391(a)(2) because a substantial part of the events or omissions giving rise to the claims set forth herein occurred in this judicial district. SUBSTANTIVE ALLEGATIONS MEDAPHIS' BUSINESS OPERATIONS AND METEORIC GROWTH THROUGH ACQUISITIONS 18. Medaphis has consistently described itself as a leading provider of business management systems and services to the healthcare industry. The Company's original and core business consists of billing, collection, and other outsourced financial services designed to assist its physician clients with the business management functions associated with providing medical -6- 7 services. Medaphis also provides subrogation and related recovery services primarily to healthcare payers, scheduling and information management systems to hospitals and emerging integrated healthcare delivery systems, and systems integration and work flow engineering systems and services. 19. Medaphis reportedly provides business management systems and services to over 19,000 physicians and over 2,000 hospitals across the United States, subrogation and services to healthcare plans covering in excess of 23 million people nationwide, and systems integration and work flow engineering systems and services in the United States and abroad. The Company's operations are organized into two principal operating units: Medaphis Services Corporation, which includes all doctor and hospital transaction processing companies, including MPSC; and Medaphis Systems Corporation, which includes all of Medaphis' technology companies, including its systems integration businesses (such as Imonics) and its healthcare information businesses (such as Atwork) . 20. Over the past several years, a key component of Medaphis' stated business strategy involved growth through acquisitions of other businesses, using its stock as currency. Indeed, Medaphis built its reputation in the investment community by representing itself as a fast-growing company with an aggressive acquisition program and a successful history of integrating those acquisitions smoothly into its overall business operations. Such representations - which, as will be shown herein, were demonstrably false and misleading - convinced the investment community that the Company's strategy was successful and poised Medaphis for future earnings growth. For example: -7- 8 Analysts liked the flawless way Medaphis assimilated these firms [it acquired], which formed the core of the company's 40-plus acquisitions over eight years. As revenue grew fivefold, Medaphis gained Wall Street stardom. The Atlanta Journal and Constitution, September 8, 1996. 21. The Company's rising stock price financed Medaphis' growth strategy. Because Medaphis paid for most of its acquisitions with stock, the higher the price of the stock, the fewer shares the Company had to issue to acquire target businesses. 22. Prior to and during the Relevant Period, defendants left no doubt that Imonics -- a company acquired by Medaphis in late 1994 -- was one of the keys to the Company's success, and enabled the Company to continue its strategy of growth through acquisitions. Medaphis consistently represented that the Imonics acquisition allowed it to diversify its operations from primarily billing and accounts receivable management and enabled the Company to offer integration services to various health care providers and other businesses. Imonics was also put in charge of re-engineering the physician billing business of Medaphis, which falls under MPSC, the Company's largest operating unit, which reportedly accounts for approximately 60% of the Company's total services revenues. 23. With the acquisition of Imonics, Medaphis began a much-publicized project to re- engineer the paper and labor intensive business of MPSC in order to significantly reduce personnel-related costs, upgrade the Company's systems to the level of other service industries, and provide for economies of scale. Defendants have referred to this project as the "Re-Engineering Project". 24. The Re-Engineering Project was designed to allow for the consolidation of the processing operations of MPSC that had previously been conducted in over 300 local physician -8- 9 backoffice operations into fewer than 10 large regional data processing centers. The Re-Engineering Project involved designing and installing software through Imonics to automate the Company's billing process and reduce the quantity of paper processed. FALSE AND MISLEADING STATEMENTS DURING THE RELEVANT PERIOD 1. DEFENDANTS' MOTIVATION AND METHODOLOGIES 25. The defendants were aware that in order for Medaphis to preserve its status as a Wall Street "star," it would have to continue aggressively acquiring high-profit technology companies to generate revenues sufficient to maintain its growth and cover the high costs of its Re-Engineering Project. Moreover, to continue its acquisition strategy, Medaphis would have to use it stock as currency. To this end, beginning at the end of 1995, defendants set out to increase the price of Medaphis stock and thereby ensure that the Company's acquisition pipeline remained robust by issuing a series of materially false and misleading public statements. Specifically, defendants knew that, but for Medaphis continuing its acquisition strategy, Medaphis would be unable to meet its obligations under existing contracts, and would be forced to eliminate, divest or otherwise restructure its operations to the detriment of defendants' positions with Medaphis and the Medaphis subsidiaries of which defendants were founders and employees. 26. The materially false and misleading public statements issued by defendants related in large part to reported financial results and financial statements that did not comply with Generally Accepted Accounting Principles ("GAAP"). GAAP encompasses the rules, conventions and practices recognized and employed by the accounting profession for the preparation financial statements. Statements of Financial Accounting Standards are promulgated by the profession's -9- 10 Financial Accounting Standards Board, and are considered the highest authority of GAAP. SEC Regulation S-X (17 C.F.R. ss.210.4-01(a)(1)) provides that financial statements filed with the SEC which are not prepared in compliance with GAAP are presumed to be misleading and inaccurate. 27. Defendants' false and misleading statements also related to narrative misrepresentations concerning: Medaphis' business operations and the Re-Engineering Project; Medaphis' earnings growth; the operating performance, condition and prospects of Imonics; and Medaphis' acquisition and integration of several companies into the operations of Imonics. 28. Defendants issued these statements directly, through press releases, SEC filings, and annual and quarterly reports to shareholders. Defendants also provided guidance to securities analysts and used them as conduits to provide false and misleading information to the investment community. 29. In writing their reports, several of which are referred to herein at paragraphs 32, 33, 34, 63, 67, and 86-88 securities analysts relied in substantial part upon information provided to them privately by the Company. Indeed, it was the Company' s practice to have key members of its management team, including defendants Brown and Cote, communicate with securities analysts on a regular basis to discuss the Company's business, operations, performance and prospects. Defendants knew that by disseminating information to the investment community, investors would rely and act upon such information and that such information would have in effect on the market price of the Company's Stock. -10- 11 2. FEBRUARY 6, 1996 PRESS RELEASE ANNOUNCING FOURTH QUARTER AND YEAR-END 1995 RESULTS AND RELATED ANALYSTS REPORTS 30. On February 6, 1996, defendants issued a press release announcing the Company's results for the fourth quarter and year ended December 31, 1995. The Company reported fourth quarter earnings of $11.4 million or $0.22 per share before one-time merger and other charges. These results, which were in line with analysts' estimates, represented a more than 50% increase over reported earnings of $0.14 per share in the fourth quarter of 1994. For the full year of 1995, Medaphis reported operating earnings of $41.9 million or $0.82 per share before charges, representing an increase of approximately 80% over reported operating earnings for the full year of 1994. The Company also reported in the February 6, 1996 release that operating revenues grew 29% in the fourth quarter, to $122.5 million, also in line with analysts' projections. Revenue for the year ended December 31, 1995 was reportedly $467.8 million, up 47% from $319.1 million in the same period in 1994. 31. In this press release, defendant Brown noted that the Re-Engineering Project was progressing well and had achieved "significant milestones", and that the Company's technology division (which includes Imonics and Atwork) "continued to grow rapidly and show positive operating results outperforming our expectations in the second half of 1995" and was "effectively offsetting the margin pressure and results" being experienced by MPSC. 32. Securities analysts following Medaphis, while taking note of the margin pressures at MPSC, recommended the purchase of Medaphis stock based on defendants' representations and other information provided by the Company. For example, on February 7, 1996, one day -11- 12 after the quarterly and annual operating results were issued, Donaldson, Lufkin & Jenrette issued a research report which stated: Medaphis reported Q4 and year end 1995 results from continuing operations of $0.22 and $0.82, respectively.... Based on the results... it is becoming clear that the higher-growth technology businesses (such as Imonics, Atwork and Consort) are more than offsetting the margin pressures at MPSC. As MEDA essentially hit our EPS projections, we remain comfortable with our $1.07 EPS estimate for this year and a range of $1.40 - 1.50 for 1997. 33. In a similar vein, a research report issued by Hambrecht & Quist on February 7, 1996, again prepared on the basis of information provided by the Company and/or its senior management stated: Management indicates that, in addition to the technology units, several of the recent acquisitions are experiencing growth that is well-above the corporate average. Overall, the company 's internal growth has largely been moderated by a lack of growth in the MPSC unit. Looking forward, this unit should see better growth as the re-engineering effort winds down. MPSC's growth, when combined with the other units, should accelerate Medaphis' internal growth rate.... The company continues to progress on the re-engineering front.... To reiterate, while Medaphis' re-engineering is modestly depressing margins in the near-term, we believe the long term efficiencies gained will more than offset any pricing pressure in the core billing and receivables market and fuel significant EBITDA margin expansion in 1997. 34. Likewise, a report issued by the firm of Morgan Stanley on February 6, 1996, on the basis of information provided by the Company and/or its senior management, stated in relevant part: MEDA's overall fundamentals continue to be buoyed by its strong technology divisions. We estimate that the companies Atwork, Imonics, and recently acquired Consort divisions will be the driving force to margins. We estimate that these divisions are on the order of 1-2 times more profitable than MEDA's core A/R, billing business. As evidence of MEDA's conviction here, it has significantly added to staff at the Imonics subsidiary, increasing headcount from 80 to 300 in 1995. -12- 13 The February 6, 1996 press release announcing operating results for the fourth quarter and full year, 1995, and the information provided by defendants to the market through the analysts' reports referred to in paragraphs 30-34 were materially false and misleading in at least the following respects: (a) The financial results incorporated and discussed therein were false and had been achieved only through the use of improper accounting practices in violation of GAAP. As was ultimately disclosed at the close of the Relevant Period, the operating results reported for this period were improperly and materially overstated by at least $5 million as a result of the reporting of revenues and profits under software license agreements entered into by Imonics, which is permissible under GAAP only where customers are unconditionally obligated to perform under the agreements. In fact, unknown to the general public, in order to create the illusion that more customers had signed such license agreements than was actually the case, the Company had aggressively enlisted one or more major customers but then provided them with secret side letters, enabling the customer(s) to avoid paying all of the fees payable under the agreements. This was improper under GAAP, in the following respects: Accounting Research Bulletin ("ARB") 43, Chapter 1, Section A: Profit is deemed to be realized when a sale in the ordinary course of business is effected, unless the circumstances are such that the collection of the sale price is not reasonably assured. (Emphasis added.) Financial Accounting Standards Board ("FASB") Statement of Concepts ("CON"), paragraph 83 (a): Revenues and gains are generally not recognized until realized or realizable. Revenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash. Revenues and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. (Emphasis added). -13- 14 FASB Statement of Standards No. 5, paragraph 27: Contingencies that might result in gains usually are not reflected in the accounts since to do so might be to recognize revenue prior to its realization. FASB Statement of Standards No. 48 ("FAS48"), paragraph 6: If an enterprise sells its product but gives the buyer the right to return the product, revenue from the sales transaction shall be recognized at time of sale only if all of the following conditions are met: (1) The seller's price to the buyer is substantially fixed or determinable at the date of sale; (2) The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (3) The buyer's obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) The buyer acquiring the product for resale has economic substance apart from that provided by the seller; (5) The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and the amount of future returns can be reasonably estimated. Where resolution of a significant contingency is part of a license agreement, then "a sale in the ordinary course of business" has not been "effected." (ARB 43). Additionally, if the contingency is not resolved, then "related assets received or held are [not] readily convertible to known amounts of cash or claims to cash." (FASB CON 5). Further, if the non-satisfaction of the contingency results in the "return" of the product or the absence of any obligation of the buyer to pay for the license fee, then the buyer is not "obligated to pay the seller" and revenue may not permissibly be recognized under the license agreement. (FAS48). As detailed in paragraphs 107- 108, the falsification of reported revenue in the fourth quarter of 1995 ultimately required the Company, at the end of the Relevant Period, to restate the results to reduce reported net income by $5.1 million, resulting in a net loss of $1.1 million rather than the previously reported net income of $4 million for the quarter, and a net loss of $8.5 million for 1995, over double the previously reported net loss of $3.4 million for the year. (b) In addition, the representations that the technology division (consisting primarily of Imonics and Atwork) was "effectively offsetting" the margin pressures and results at -14- 15 MPSC were materially false and misleading when made in that the technology division was not able to offset revenue, growth and margin pressures affecting MPSC because: (i) Imonics was experiencing severe operational problems including, among other things, excessive staffing, inadequate cost controls, and poor operating performance so severe that they negated Imonics' ability to perform as represented; and (ii) Atwork's sales pipeline had been in decline since September of 1995 and there were significant operating flaws, or "bugs," in certain of the Atwork division's software products introduced at year end 1995. 3. PUBLIC STATEMENTS RELATING TO THE RAPID SYSTEMS AND BSG MERGERS 35. Having disseminated its materially false and misleading press release of February 6, 1996, which included false financial results showing increasing net income rather than true losses the Company was actually suffering, Medaphis implemented its scheme to use its stock (the price of which was artificially inflated as a result of defendants' misstatements) as currency for additional acquisitions. 36. Thus, on February 29, 1996, defendants caused Medaphis to file with the SEC a Form S-4 Registration Statement (the "February 1996 Registration Statement"), which was signed by defendants Brown, Bellas, Holbrooke, Pryor, Stowe, Downer, Cote and Douglass. Defendants filed the February, 1996 Registration Statement in order to issue 2 million shares of Medaphis common stock which the Company reported "may be offered by Medaphis from time to time in connection with acquisitions of other businesses or properties." 37. On March 13, 1996, the defendants issued a press release announcing that Medaphis had signed a definitive agreement to acquire all of the outstanding capital stock of -15- 16 Rapid Systems Solutions, Inc. ("Rapid Systems") (a closely-held, Columbia, Maryland based computer systems integration company) in exchange for 1,135,000 shares of Medaphis common stock, worth approximately $43 million (the "Rapid Systems Merger"). Defendant Brown stated that Rapid Systems was acquired specifically because it complemented "the work Imonics is doing on the Medaphis re-engineering project." 38. Two days later, on March 15, 1996, defendants issued a press release announcing yet another acquisition, this time reporting that Medaphis had executed a definitive agreement to acquire all of the outstanding capital stock of BSG Corporation ("BSG") for approximately $350 million in stock, including 7.5 million shares of Medaphis common stock, and assumption by Medaphis of BSG stock options and stock rights representing an additional 2.66 million shares of Medaphis common stock (the "BSG Merger"). This transaction represented the largest acquisition yet for Medaphis. According to the March 15 announcement, the Company's "existing systems integration and information technology (IT) services companies - including Imonics Corporation and Rapid Systems Solutions, Inc. - will come under the BSG umbrella, thereby creating the industry's largest IT services company focused purely on client/server technology and applications. 39. Significantly, defendant Brown, in emphasizing the importance of the BSG Merger, assured investors that BSG had the necessary infrastructure to manage successfully the integration of both Imonics and Rapid Systems to create successfully the largest client/server technology services company in the country: The merger with BSG is a major milestone in increasing our technology capabilities. Working with Imonics and Rapid Systems Solutions, BSG will lead our systems -16- 17 integration efforts and we believe will accelerate transformation of the way transaction processing in performed in the healthcare industry. We are excited about our newly acquired capabilities in client/server consulting and systems integration. Imonics and Rapid Systems Solutions combined with BSG have created, we believe, the largest pure client/server technology services company in the country. (Emphasis added.) 40. A March 18, 1996 Wall Street Journal article reported in connection with the planned BSG Merger that: [t]he company said it decided to make a bigger push into systems integration following the successful 1994 acquisition of Imonics, which has seen its profit double since the purchase and its employees increase, according to Michael Cote, Medaphis' chief financial officer. 41. As a result of the foregoing positive announcements, on March 20, 1996, Medaphis shares hit a 52-week high of $53.25, a 40% increase over the stock's March 12, 1996 close of $37.50. 42. The statements concerning the synergies and efficiencies of the Rapid Systems and BSG Mergers, and the Company's integration of the operations of Rapid Systems and BSG into its overall business identified in paragraphs 36-40 above were materially false and misleading. Among other reasons, because of the severe operational problems at Imonics summarized at paragraphs 34(b) and 47 hereof, there was no reasonable basis for the representations concerning the synergies offered by the merger of Imonics and Rapid Systems with BSG's operations. Defendant Cote's representations concerning the supposed profitability of Imonics were false and misleading for the same reason, as well as for the added reason that, as set forth in greater detail at paragraph 34(a) above, Medaphis' publicly reported profits were materially false and misleading as a result of improper revenue recognition practices relating specifically to improprieties at Imonics. -17- 18 43. On April 3, 1996, in connection with the BSG Merger, Medaphis filed with the SEC a Registration Statement on Form S-4 (The "BSG Registration Statement") and a Proxy Statement/Prospectus (the "BSG Prospectus"). The BSG Registration Statement was signed by defendants Brown, Bellas, Holbrooke, Pryor, Stowe, Downer, Cote and Douglass. 44. The BSG Prospectus, which was included as part of the BSG Registration Statement filed with the SEC, incorporated by reference Medaphis' Annual Report on Form 10-K for the fiscal year ended December 31, 1995, including the audited financial statements incorporated by reference therein, (discussed at paragraphs 47-57 herein), and incorporated the false and misleading statements of the Company's year-end and fourth quarter 1995 results as reported in the February 6, 1996 press release referred to at paragraph 30 above. These documents represent that the financial results presented therein "include all adjustments . . . that are necessary for a fair presentation of the financial position and results of operations for such periods." 45. In addition, the BSG Prospectus repeated defendants' misleading statements regarding the successful consolidation of Imonics, BSG and Rapid Systems, stating that the merger "will position Medaphis as the leading client/server systems integration and workflow engineering company in the United States." The BSG Prospectus also falsely stated that: Finally, management believes that BSG, Rapid Systems and Imonics complement each other and that the combination of these three organizations within Medaphis should produce synergies.... Imonics possesses extremely talented object oriented programming expertise, an existing library of object codes and proprietary pricing methodologies. Management of Medaphis believes that each of the foregoing attributes of BSG, Rapid Systems and Imonics are complimentary [sic] in nature and together position Medaphis to take advantage of systems integration and workflow engineering projects within and outside the healthcare industry. -18- 19 46. The BSG Prospectus also provided the following highly positive description of the Re-Engineering Project: In order to increase efficiency and position Medaphis to take advantage of the opportunities being created by ongoing changes in the healthcare industry, Medaphis has commenced a re-engineering project which will involve, among other things, the consolidation of the billing and accounts receivable processing function of its billing and accounts receivable management business, which is currently operated out of approximately 300 local business offices around the country, into approximately 10 remote processing centers. In addition to the consolidation of processing operations, the re-engineering project will involve the establishment of advanced client/server computing at the local sales and service offices and at remote processing centers. This computing infrastructure will be designed to significantly reduce paper handling and greatly increase the speed of record recovery while permitting communication over a wide-area network and across geographic markets and linking together all of Medaphis' operating divisions . . . 47. The BSG Prospectus continued: Medaphis believes the re-engineering project will provide its customers and employees with the full information processing and communications power of an advanced distributed computing system. The re-engineering project is designed to enable Medaphis to continue to grow and achieve economies of scale in several areas, including training, client service, patient and payer relations, transaction processing operations and electronic data interchange capabilities. The project is expected to be substantially completed during 1997. Although the re-engineering project will involve consolidation of the processing functions of its billing and accounts receivable management services, Medaphis intends to continue to maintain and place increased emphasis on the sales and customer service functions of this business on a local basis. (Emphasis added) (a) The representations contained in the BSG Registration Statement and Prospectus, which incorporated Medaphis' operating results for the fourth quarter and full year 1995 by reference, as well as the May 7, 1996 press release, were materially false and misleading in the manner and for the reasons specified in paragraph 34(a) above. (b) In addition, defendants' representations regarding the progress, positive results, and expected completion date of the Re- Engineering Project were materially false and -19- 20 misleading and lacked a reasonable basis when made, in that they misrepresented and/or failed to disclose that: (I) progress of the Re-Engineering Project was being impeded by, among other things, the serious management, operational, and other problems being experienced by Imonics, set forth above, and the Company's inability to successfully integrate and coordinate the acquisitions of BSG and Rapid Systems; (ii) the software designed to automate the billing process at MPSC was not appropriate for large volume processing, thus requiring further software development and causing a deferral of the office consolidation element of the Re-Engineering Project; and (iii) in light of these problems, the Re-Engineering Project was not likely to be completed until late 1997, if not 1998, contrary to defendants' representations. (c) Further, defendants' statements regarding the synergies to be derived from the BSG and Rapid Systems mergers, and the ability of Medaphis and Imonics to successfully integrate and coordinate these acquisitions, were materially false and misleading in that they misrepresented and/or failed to disclose: (I) the adverse facts regarding Imonics, identified above at paragraph 34(b); and (ii) that the integration of Imonics' operations with BSG and Rapid Systems was not proceeding well in view of Imonics distressed condition, and could not be accomplished without a complete reorganization of Imonics. (d) Moreover, defendants' representation that the Company would "continue to maintain and place increased emphasis on the sales and customer service functions" of the Company s MPSC division was false and misleading. As defendants knew or recklessly disregarded: the Company's focus on the Re-Engineering Project at MPSC was done at the expense of customer service and customer retention, which was leading to significant revenue declines and reductions in profitability for Medaphis. -20- 21 (e) In addition, the increasing staff levels at Imonics, cited by analysts as a positive growth factor based on defendants' representations, were, in reality, excessive, as evidenced by the October 22, 1996 disclosure that the Company had terminated 430 employees, including the entire Imonics senior management team. 4. REPRESENTATIONS CONTAINED IN THE 1995 10-K AND ANNUAL REPORT 48. On or about April 1, 1996, Medaphis filed with the SEC its Form 10-K for the fiscal year ended December 31, 1995 (the "1995 10-K"). The 1995 10-K was signed by defendants Brown, Bellas, Holbrooke, Pryor, Stowe, Downer, Cote and Douglass. 49. The 1995 10-K incorporated, at page 19, the same reported financial results for the fourth quarter and full year of 1995 as were announced on February 6, 1996 as set forth in paragraph 30 herein. The 1995 10-K also incorporated by reference the financial presentations set forth in the Company's 1995 Annual Report, which is discussed in greater detail in paragraphs 53- 59 hereof. The 1995 10-K further stated, in relevant part, that such financial presentations therein "include all adjustments that are necessary for a fair presentation of the financial position and results of operations for such periods." 50. The 1995 10-K boasted of the "core competencies in the systems integration and work flow engineering fields," and went on to state that although MPSC was experiencing some "revenue and margins pressures", these pressures were being "offset" by growth in Medaphis' information management and systems integration services business (for which Imonics was responsible), and that the Re-Engineering Project was easing such pressures. -21- 22 51. The 1995 l0-K also contained a description of the Re- Engineering Project virtually identical to that set forth in the BSG Prospectus quoted at paragraphs 44-46 above. 52. With respect to the Company's revenue recognition policy, the 1995 10-K stated: REVENUE RECOGNITION. . . . Revenue from software licenses is generally recognized upon shipment of the products and when no significant contractual obligations remain outstanding. When the Company receives payment prior to shipment or fulfillment of significant vendor obligations, such payments are recorded as deferred revenue and are recognized as revenue upon shipment or fulfillment of significant vendor obligations. The license agreements typically provide for partial payments subsequent to shipment; such terms result in an unbilled receivable at the date the revenue is recognized. Costs related to insignificant vendor obligations are accrued upon recognition of the license revenue. Software maintenance revenue is deferred and recognized ratably over the term of the maintenance agreement, which is typically one year. Revenues from systems integration contracts are recorded on the percentage of completion method of accounting. (Emphasis added). 53. At or about the time that it filed the 1995 l0-K, the Company also issued its 1995 Annual Report. Like the 1995 10-K, the 1995 Annual Report incorporated the same reported financial results for the fourth quarter and full year of 1995 as were announced on February 6, 1996. The 1995 Annual Report represented that the financial statements set forth therein: present fairly, in all material respects, the financial position of Medaphis Corporation and subsidiaries at December 31, 1995 and 1994 and the results of their operations and cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. 54. In the 1995 Annual Report, the defendants again touted the benefits and "positive results" of the Re-Engineering Project, and set forth a description thereof virtually identical to that set forth in the BSG Prospectus (see paragraphs 44-46 herein), and in the 1995 10-K (see paragraphs 48-52 herein). The 1995 Annual Report also represented that: -22- 23 The positive results of this progressive effort are already in evidence. Today, Medaphis is a leading provider of information management systems and systems integration and work flow engineering systems and services to the healthcare industry and other industries. 55. The 1995 Annual Report also emphasized the positive contributions that Imonics had made to the Company's business, stating that, because of Imonics, the Company had gained an "immense competitive advantage" and had "re-engineered its future." Defendants assured investors that Imonics would allow the Company to recognize efficiencies that "will dramatically change the way business done." The following excerpt appeared in the 1995 Annual Report: IMONICS: A LEADER IN BUSINESS PROCESS RE- ENGINEERING AND SYSTEMS INTEGRATION. With the 1994 acquisition of Imonics, Medaphis re-engineered its future. A leader in business process re-engineering and systems integration, Imonics will enable Medaphis to create internal efficiencies while being able to offer the same cost -effective solutions to others throughout the healthcare industry, and in other industries. For Medaphis, or for any other customer service or business operation that processes large volumes of paper, fax and phone calls, Imonics' software solutions provide an immense competitive advantage. The first signs of these increased efficiencies are already in evidence in our Pittsburgh office. And as they are applied to an even greater extent in the coming months, our belief is that they will dramatically change the way business is done throughout our transaction processing operations and, hopefully, our entire industry. (Emphasis added.) 56. The Annual Report also stated that the progress of the Re- Engineering project "has been nothing short of remarkable," and that "[t]he impact on customer service is immeasurable." 57. The 1995 Annual Report also praised the Company's 1995 acquisition of Atwork, which was described as "the leading provider of information systems that schedule the activities of patients and employees in healthcare." The 1995 Annual Report offered a highly upbeat assessment of Atwork: -23- 24 Atwork solves complex scheduling problems in healthcare management, and they have historically enjoyed a high level of client satisfaction. Atwork markets four leading products to healthcare providers. The first, ANSOS, automates nurse staffing and scheduling, and, as the market leader, is the most widely used system of its kind. The second, ORSOS used for operating room scheduling and inventory management, is the market leader as well. The third product, One-Call, is used for enterprise-wide patient scheduling. And finally, One-Staff is used to schedule and manage all employees throughout the healthcare enterprise. 58. The letter to stockholders, included in the 1995 Annual Report and signed by defendant Brown, stated, among other things, that: Medaphis has embarked on an aggressive technology initiative to increase its own internal efficiencies, as well as those of its clients. The positive results of this progressive effort are already in evidence. Today, Medaphis is a leading provider of information management systems and systems integration and work flow engineering systems and services to the healthcare industry and other industries. *** In the course of solving our own technology problems, we have discovered a major business opportunity -the lack of next generation distributed processing platforms and user-oriented applications to solve business and information processing needs of industry in general, particularly healthcare. 59. The representations contained in the 1995 10-K and Annual Report and the documents incorporated therein by reference, incorporating Medaphis' operating results for the fourth quarter and full year of 1995, and Medaphis' revenue recognition policies, were materially false and misleading in the manner and for the reasons set forth in paragraph 34(a) above. The representations concerning the finances and operations of Imonics, the progress of the Re-Engineering Project at MPSC, and the ability of Medaphis and Imonics to successfully integrate and coordinate the acquisitions of BSG and Atwork were materially false and misleading for failing to disclose the adverse material facts concerning Imonics and Atwork specified at -24- 25 paragraphs 34(b) and 68 above. The false and misleading representations in the 1995 10-K were incorporated by reference into the July 12, 1995 Registration Statement on Form S-3 signed by Defendants Brown, Cote, Douglass, Bellas, McDowell, Holbrooke, Pryor and Papermaster. 5. REPRESENTATIONS CONCERNING THE BERTELSMANN JOINT VENTURE AND MEDAPHIS' RESULTS FOR THE FIRST QUARTER OF 1996 ENDED MARCH 30, 1996 60. In February 1996, Medaphis, through Imonics, entered into a Joint Venture with a subsidiary of Bertelsmann AG, a German corporation. According to the Company, the Joint Venture was formed to pursue custom software development and systems integration projects for customer service systems in Europe, primarily in Germany, over a multi-year period, with each partner holding a 50% interest in the Joint Venture. The Joint partnership agreement was signed on March 13, 1996, eighteen days before the close of the Company's fiscal 1996 first quarter. 61. On or about March 31, 1996, the last day of the first quarter of fiscal 1996, the Joint Venture concluded an agreement with a German telecommunications entity to provide systems integration and work flow engineering systems and services (the "Systems Integration Contact"). Immediately upon entering into the Systems Integration Contract on March 31, 1996, the Company recognized $12.5 million of Joint venture net earnings, thereby dramatically improving reported revenues and net earnings for the first quarter of 1996. 62. On April 23, 1996, Medaphis issued a press release to announce its first quarter results, which included the premature and decidedly optimistic report of $12.5 million in net earnings recognized in connection with the Systems Integration Contract into which the Company had rushed at the close of first quarter. The Company reported that revenues had increased by 24.l% over results for the first quarter of 1995, from $110.1 million to $136.6 million, and that -25- 26 reported net income had increased from a reported loss of over $8.2 million for the quarter ended March 31, 1995, to a reported profit of $13.2 million for the first quarter of 1996. Commenting on these reported results, defendant Brown noted that Medaphis was "pleased with the first quarter," adding: The "performance of our client/server IT services business was excellent and included formation of a joint-venture with a subsidiary of Bertelsmann A.G. in Germany. The joint venture signed a large contract with a telecommunications company during the quarter. 63. The market recognized the Joint Venture and the new Systems Integration Contract as an important step for Medaphis, adding significantly to the Company's value to an investor. In an April 30, 1996 Smith Barney report, for example, which was prepared based on information provided by defendants, the Joint Venture was specifically cited as an example of one of the areas in which Medaphis had "displayed strong growth": Imonics announced a joint venture with Bertelsmann, AG to provide systems integration services overseas. Bertelsmann's BMG Music Club has been a client of Imonics for several years. In the same announcement, the JV disclosed a major, multi-year contract with a foreign telecommunications company. Although Imonics is performing most of the work on [Medaphis'] re-engineering, its headcount has grown to over 400 to also staff the growth in its outside business. 64. On May 14, 1996, defendants caused Medaphis to file its first quarter Form 10-Q with the SEC (the "First Quarter 10-Q"), which was signed by defendants Cote and Douglass, in which it incorporated and provided additional details concerning first quarter 1996 financial results for the quarter previously announced on April 23, 1996 (see paragraph 62 herein). 65. The First Quarter 10-Q represented that the financial information contained therein was "prepared in accordance with the Company's customary accounting policies and practices." -26- 27 66. In addition, the First Quarter 10-Q expressly incorporated the representations contained in the 1995 10-K, including the representation that "[r]evenues from systems integration contracts are recorded on the percentage of completion method of accounting," and also contained management's representation that the financial statements included therein reflect "all adjustments . . . necessary for a fair presentation of the results of operations of the interim period." 67. At or about the time defendants Publicly announced Medaphis' first quarter 1996 operating results and filed the First Quarter l0-Q, several bullish reports were issued by securities analysts based on information provided by the Company: (a) "Over the next several quarters, we expect the re-engineering program in its core Medaphis Physician Services Corporation to begin to have an impact while the growth in its technology businesses continues [sic] to accelerate." (May 16, 1996 report by Donaldson, Lufkin & Jenrette Securities Corporation); (b) "Near-term, we have confidence in our quarterly estimates as well as our $1.05 - $1.10 estimate for the full year." (May 16, 1996 report by Donaldson, Lufkin & Jenrette Securities Corporation); and (c) "Based on our conversation with management yesterday, our comfort level on near-term earnings prospects have increased. While management did not endorse a specific estimate, it appears as though there have been some fundamental positive changes. While there remains consolidation challenges, we believe that these are the early signs that the large software development project is beginning to pay off. (June 4, 1996 report by Donaldson, Lufkin & Jenrette Securities Corporation). 68. The representations contained in Medaphis' announcements concerning the Bertelsmann Joint Venture and the Company s financial results for the quarter ended March 31, 1996, as set forth in paragraphs 60-68 herein, were materially false and misleading in that the financial results set forth therein were falsified and had been achieved only through the use of improper accounting practices which violated GAAP. -27- 28 69. The reported net income for this period of $13.2 million was improperly and materially overstated by virtue of the recognition of $12.5 million in profits from the Systems Integration Contract immediately upon the execution of the contract in violation of relevant accounting principles, including GAAP. Defendants knew or recklessly disregarded, at the time the contract was entered into, that; (I) Imonics was experiencing serious problems, including over-staffing poor management, inadequate cost controls and poor operational performance (as detailed in paragraphs 34(b) and 47 hereof); and (ii) that, as is also detailed at paragraphs 34(b) and 47 hereof, Imonics was unable to perform its obligations under the Systems Integration Contract and the Joint Venture. Under such circumstances, the recognition of $12.5 million in Joint Venture net earnings was improper. ARB 43 provides that "profit is deemed to be realized when a sale in the ordinary course of business is effected, unless the circumstances are such that the collection of the sale price is not reasonably assured." Additionally, the Company could not in good faith consider the Systems Integration Contract to result in "actual or expected cash flow ... that ha[s] accrued or will eventuate as a result of the entity's ongoing mayor Or central operations," if, at the time the contract was entered into, defendants were aware that there was no basis for the belief that Imonics could fulfill its obligations under the Contract as proscribed by paragraph 78 of FASB CON 6. 70. Recognition of the revenues from the contract under such circumstances was improper under FASB CON 5, paragraph 83, which provides: Revenues are not recognized until earned. An entity's revenue earning activity involves delivering or producing goods, rendering services, or activities that constitute its major or central operations, and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. -28- 29 Accordingly, in recognizing $12.5 million in Joint Venture net earnings in March of 1996, the Company violated these provisions of GAAP. 71. Second, defendants improperly recognized $12.5 million in Joint Venture net earnings in the first quarter because if these revenues could have been properly recognized at all, they should have been recognized ratably over the period the services were performed under the Systems Integration Contract in accordance with the percentage-of-completion method of accounting. As noted above, FASB CON 5, paragraph 83, provides that "revenues are not earned," and therefore should not be recognized, until an "entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues." (Emphasis added). 72. In addition, the First Quarter 10-Q, having incorporated by reference the 1995 10-K (and derivatively the 1995 Annual Report), was materially false and misleading for the same reasons, specified in paragraph 82 herein, as the 1995 10-K and Annual Report were false and misleading. The First Quarter 10-Q expressly incorporated the additional representation contained in the 1995 10-K that "[r]evenue from systems integration contracts are recorded on the percentage-of-completion method of accounting." (Emphasis added). Thus, in recognizing first quarter revenues from the Systems Integration Contract, defendants violated the Company s own disclosed revenue recognition policy, rendering this specific statement false. 6. ADDITIONAL PUBLIC STATEMENTS RELATING TO IMONICS AND THE HDS MERGER 73. In April 1996, Medaphis officials attended a Robinson-Humphrey Co. conference at which they touted the successes at Imonics, declaring that it was "going like gangbusters." -29- 30 74. Seeking to continue its practice of acquiring companies utilizing overvalued Medaphis stock, on or about May 24, 1996, Medaphis announced its intention to acquire Health Data Sciences Corporation ("HDS") in exchange for 6,125,000 Medaphis common shares and assumption or issuance by Medaphis of stock options representing an additional 556,000 shares. Based on May 24, 1996 closing price of Medaphis stock of $40.938, the HDS Merger was valued at approximately $273.5 million. 75. HDS was a developer and supplier of health care information systems to institutions, payers, health care networks, and providers. HDS' main product offering was a line generally known as ULTICARE(R), an integrated information system which allows doctors and hospitals in large health care systems to enter, and access immediately thereafter, clinical information on patients. The ULTICARE system can also schedule medical procedures, such as surgery. 76. According to an article published in the Atlanta Journal and Constitution on May 25, 1996, defendant Brown stated that, with the planned acquisition of HDS, "I think we now have the pieces we need... This is where we've been aiming with our business." 77. A definitive Merger Agreement was executed by Medaphis and HDS on May 23, 1996 (the "HDS Merger"). Under the terms of the HDS Merger, stockholders of HDS were entitled to receive .7912 of a share of Medaphis common stock for each share of HDS common stock and HDS preferred stock. In connection therewith, the defendants were specifically motivated to keep the price of Medaphis stock artificially high in order to complete the acquisition of HDS. This was because the Merger Agreement expressly provided that HDS could unilaterally terminate the deal if the average closing price of Medaphis stock dropped below $37 per share for -30- 31 a period of time. Thus, defendants knew that it was imperative that the Company continue to tout its many "successes" while concealing the true facts about Medaphis' business. 78. On May 31, 1996, in connection with the HDS Merger, Medaphis filed an Amendment No. 1 to its Form S-4 Registration Statement with the SEC (the "HDS Registration Statement"). The Registration Statement included a Proxy Statement/Prospectus, also dated May 31, 1996, which was issued in connection with a special meeting of HDS stockholders to be held on June 29, 1996 (the "HDS Prospectus"). The HDS Registration Statement was signed by defendants Brown, Bellas, Holbrooke, Pryor, McDowell, Papermaster, Cote and Douglass. 79. The HDS Prospectus included, inter alia, a detailed description of the background of the HDS Merger, the reasons for the HDS Merger, and the terms of the Merger. The HDS Prospectus also included an upbeat description of Medaphis' Re-Engineering Project which was substantially similar to the statements contained in the BSG Prospectus, the 1995 10-K and the 1995 Annual Report. The defendants again represented in the HDS Prospectus that "[t]he [Re-Engineering] project is expected to be substantially completed during 1997." 80. As they had in the BSG Prospectus, the defendants also continued to tout the benefits of the BSG and Rapid Systems mergers in the HDS Prospectus, stating that: Management believes that the acquisition of BSG, when combined with Rapid Systems and Medaphis' existing systems integration and workflow engineering operations, will position Medaphis as the leading client/server systems integration and workflow engineering companies in the United States. 81. The HDS Registration Statement and Prospectus expressly incorporated by reference Medaphis' 1995 Annual Report, filed on April 1, 1996, and its First Quarter l0-Q, filed on May 15, 1996, relevant excerpts of which are set forth at length herein above. As such, the -31- 32 HDS Registration Statement and Prospectus was materially false and misleading for the same reasons the 1995 Annual Report and First Quarter 10-K were misleading, as specified above. 82. The additional representations in the HDS Prospectus, set forth in paragraphs 79- 80, concerning the finances and operations of Imonics, the progress of the Re-Engineering Project at MPSC, and the ability of Medaphis and Imonics to successfully integrate the Company's various acquisitions were materially false and misleading for failing to disclose the adverse material facts concerning Imonics specified at paragraphs 34(b) and 47 hereof. 83. Had the full truth about Medaphis been disclosed at the time, the Company never would have been able to complete the HDS Merger. Based on recent trading prices of Medaphis stock (as low as $8.50 per share), the acquisition of HDS, which cost the Company just over 6 million shares, would have cost nearly five times that amount, or 28 million shares. Based recent trading prices, defendants' fraudulent conduct enabled the Company to purchase HDS -- a company valued at $230 - $260 million in the HDS Merger for stock now worth just $53 million, costing HDS shareholders hundreds of millions of dollars in losses. Consequently, Defendants have exposed the Company to at least $177 million securities fraud liability in connection with this transaction alone. 7. PUBLIC STATEMENTS RELATING TO SECOND QUARTER 1996 RESULTS 84. On July 23, 1996, defendants issued a press release announcing Medaphis' financial results for the second quarter of 1996, ending on June 30, 1996. The Company reported that revenue for the three months ended June 30, 1996 was $175.2 million, up 24% from the $141.3 million in the year-earlier period, and that, excluding merger and other one-time costs, net income was $18.7 million, up 159%, with earnings per share of $0.25, up 150%. For the six months -32- 33 ended June 30, 1996, Medaphis reported a 23% increase in revenues over the six months ended June 30, 1995, from $274.4 million to $338.8 million, and an increase in net income and earnings per share, from a loss of $4.6 million or $.08 per share in 1995 to net income of $16.4 million or $.22 per share in 1996. 85. Defendant Brown continued to assure the investment community that Medaphis' technology companies were "generat[ing] strong results," and he explained that much of these "strong results" were attributable to the recent acquisitions of HDS, Rapid Systems and BSG: We are pleased with the second quarter and underlying results of our technology and services businesses. The technology companies continue to generate strong results, especially our latest additions: Health Data Sciences Corporation ("HDS"), BEG Corporation and Rapid Systems Solutions, Inc. I am thrilled with the recent addition of HDS to our technology capabilities and am excited about the opportunities that it affords us to offer patient-centered information technology in the healthcare industry. Medaphis Physician Services Corporation continued to adversely affect results of the Services Division in the second quarter; however its operating results improved slightly over the first Quarter of 1996. We continue to assess and evaluate the technology and processes necessary to ensure our long-term success and remain cautiously optimistic that the re- engineering project and related management initiatives are positioning the Company for important improvements in operating results. (Emphasis added). 86. The defendants' representations concerning the second quarter of 1996 had their intended effect on the investment community. On July 24, 1996, Bear Stearns issued a research report based on information provided by the Company which stated, in relevant part, that: Importantly, management is confident that the top line and cost pressures in the physician billing business (which we estimate to be 25% - 30% of total revenue) may have bottomed. These pressures are expected to continue to moderate over the third and fourth quarters of 1996 allowing for a stabilization of this business segment. During 1997, we expect to see the benefits of the re-engineering which we believe will pave the way for earnings acceleration." 87. In a similar vein, a Cowen & Co. report dated July 23, 1996, based on information provided by the Company, stated: -33- 34 Technology Strategy A Winner - Virtually all of the revenue growth was derived from terrific performances in the technology companies (+82% at $70MM). Strongest performers include Consort Technologies (radiology information systems), Atwork (medical software), BEG, RSSI and Imonics (client/server systems integration)." 88. Similarly, on July 24, 1996, Donaldson Lufkin & Jenrette issued a research report based on information provided by the Company which stated: EPS for the next two quarters should be $0.28 and $0.30, respectively. Management indicated comfort with street estimates for the third and fourth Quarter of this year. This is in sharp contrast to previous statements about the last few quarters when management consistently hedged about its near-term operating results. 89. The representations contained in the July 23, 1996 press release, which incorporated and reflected Medaphis' operating results for the first quarter of 1996 (see paragraph 84 herein), were materially false and misleading for the reasons set forth in paragraph 68-69 herein. The representations concerning the finances and operations of Imonics, the progress of the Re-Engineering Project at MPSC, and the ability of Medaphis and Imonics to successfully integrate the Company's various acquisitions were materially false and misleading for failing to disclose the adverse material facts concerning Imonics specified at paragraphs 34(b) and 47 hereof. Moreover, defendants' forecasts of $0.28 and $0.30 per share for the third and fourth quarters of 1996, respectively, were contradicted by the adverse facts set forth above in 34(b) and 47 and were issued by defendants, through analysts' reports endorsed and adopted by the Company, without any reasonable basis. THE TRUTH BEGINS TO EMERGE 1. THE AUGUST 14, 1996 DISCLOSURES 90. On August 14, 1996, after the close of trading, Medaphis finally began to disclose the severe problems which it had been experiencing with Imonics, as well as the difficulties being -34- 35 encountered with MPSC, Atwork, the BSG Merger and the Re-Engineering Project during the Class Period. On that day, it issued a press release announcing that it expected to report a loss in the range of $0.28 to $0.33 per share in the third quarter of 1996, which would include substantial charges in the range of $35 to $40 million. It also announced that it expected earnings per share in the range of only $0.75 to $0.90 for fiscal 1997, compared with analysts' expectations of earnings per share of $0.27 for the third quarter and $1.42 for fiscal 1997. The press release stated: The Company's near-term earnings will be impacted by continued weakness in Medaphis Physician Services Corp.'s business and the reorganization of Imonics. Medaphis' near-term outlook also has been affected by slower than expected sales of some of the Company's enterprise-wide scheduling products. The third quarter earnings estimate includes charges in the range of $35 to $40 million relating primarily to the reorganization of Imonics and the re-engineering and consolidation program at MPSC. 91. A substantial portion of the Company's difficulties, and the resulting third quarter charges, were reported to have arisen from the need to reorganize its Imonics subsidiary and the Company's problems with the Systems Integration Contract, so positively reported by Medaphis during the Relevant Period. Explaining the situation, Medaphis reported: Management has commenced the process of reorganizing the Imonics systems integration business. This reorganization resulted from a review by BSG of Imonics' overall operations and an assessment of recent difficulties encountered by Imonics with a large systems integration agreement entered into by its European joint venture. The reorganization of Imonics will include efforts to more closely align Imonics' business practices with those of BSG. The BSG model is structured to manage client/server information technology projects with experienced project management. It is currently anticipated that Imonics' European joint venture will continue with its system integration project on terms and conditions mutually satisfactory to the parties, but that the agreement relating to the project will be restructured. -35- 36 92. Medaphis further disclosed that approximately $9 million of charges would be made in the third quarter to account for the restructuring of the Systems Integration Contract entered into by the Joint Venture with another $15 million in charges relating to the reorganization of Imonics. 93. The Company revealed that, contrary to its July 23, 1996 representations, its MPSC unit was continuing to experience poor results, due in part to delays in the Re-Engineering Project. The Company disclosed that as a result of these problems, it would take a restructuring charge of approximately $11 million, and "up to $5 million of other costs." The Company stated: The Company expects to incur charges in the third quarter in the range of $35 to $40 million. These charges are expected to consist of approximately $9 million relating to the restructuring of a large systems integration agreement entered into by Imonics' European joint venture, approximately $15 million relating to reorganization of Imonics, approximately $11 million relating to additional restructuring costs associated with MPSC's re-engineering and consolidation program and up to $5 million of other costs. 94. Defendant Brown was quoted as stating: We are extremely disappointed with these developments. The problems that we have identified at MPSC and Imonics are being addressed by a new operating management team which possesses the process and technology expertise and experience we need to execute our plan. 95. Moreover, in sharp contrast to defendants' previous statements that Medaphis would continue to grow through acquisitions -- the key to its success -- the Company announced that it had abandoned its acquisition strategy: "We're focused on re-engineering MPSC's business for future growth, and not on expanding the business through acquisitions in the near term," defendant Douglass stated. 96. As reported in Bloomberg News on August 15, 1996, Bertelsmann officials had called Medaphis in late July to, complain about the computer integration project which Imonics -36- 37 was working on with the Joint Venture. In particular, Bertelsmann offered two choices to Medaphis: quit or renegotiate the contract. According to Cowen & Co. analyst Charles Trafton, the news of problems with Imonics came as "a complete shocker" and "Imonics was not delivering." 97. On the same day it announced its anticipated losses for the third quarter, Medaphis filed its Form 10-Q for the fiscal 1996 second quarter (the "Second Quarter 10-Q"). In it, the Company disclosed for the first time that the Joint Venture had begun discussions with its European Partner, Bertelsmann, and the related customer on July 25, 1996 regarding difficulties that had been encountered with certain aspects of the Systems Integration Contract. As a result of these difficulties, which were not disclosed until August 14, 1996, Medaphis reported that it had been forced to negotiate "the restructuring of the operating relationships and economics underlying the Contract," adding: Although a restructured arrangement among the parties is subject to the negotiation and execution of definitive agreements, the Company anticipates that the contract will be amended and a restructured arrangement will be executed that will position the Joint Venture to move forward with the project and to pursue other opportunities and projects on terms and conditions that are mutually beneficial to the parties. The Company anticipates recording a loss related to the restructured arrangement or approximately $9 million during the third quarter of 1996. 98. With respect to the Imonics' restructuring, the Company disclosed in the Second Quarter 10-Q that, contrary to previous statements to the effect that the Company had the necessary infrastructure to create tremendous business opportunities, the Company would need to take a charge of $15 million to reorganize Imonics because of over-staffing, inadequate internal cost controls and poor operating performance. The Second Quarter 10-Q stated: -37- 38 Many changes have and will continue to occur at Imonics Corporation ("Imonics") including: headcount reductions, increased focus on project management, increased cost controls and implementation of the BSG business model. In addition to the expected $9 million loss related to the restructured arrangement noted above, the Company anticipates recording losses in the third quarter of 1996 related primarily to the reorganization of Imonics of approximately $15 million. 99. The market reacted sharply and dramatically to Medaphis' August 14 announcement, with its share price plunging the following day, decreasing the value of the Company by $1.6 billion. The stock price closed at $14-1/4 per share, after dropping by $21-3/8, or approximately 60 percent. More than 42 million shares of Medaphis stock changed hands during the day, making it the most active U.S. issue on NASDAQ that day and representing the sixth-highest single trading day in NASDAQ history, excluding penny stocks. 2. THE OCTOBER 22, 1996 DISCLOSURES 100. Despite the startling disclosures of August 14, 1996, and the resulting drop in the price of Medaphis stock, defendants had not yet disclosed the full extent of the Company' s problems known to, or recklessly disregarded by, defendants at the time. Instead, defendants continued to mislead investors about the current and future business prospects of Medaphis and represented that all of the Company's problems had been identified and adequately reserved against. 101. For example, after a meeting with Medaphis senior management on August 21, 1996, an analyst with Bear, Stearns Co. ("Bear Stearns") reported that: [a]fter uncovering the problems at Imonics and MPSC, management undertook a rigorous examination of all business units in order to assess [the] possibility [of additional charges and a further reduction in earnings expectations] and concluded that all of the potential problems have been reserved against. (Emphasis added). -38- 39 102. Based largely on this positive meeting with Medaphis management, Bear Stearns forecast third quarter earnings per share of $0.02 excluding charges of $35 - $40 million, and continued to give Medaphis stock an "Attractive" rating. Other analysts issued similar cautiously optimistic reports following the August 21, 1996 meeting, and, based on guidance from Medaphis management, projected earnings per share of approximately $0.02 for the third quarter, excluding charges, or a loss of about $0.27 per share including charges. 103. On October 22, 1996, Medaphis shocked the market for the second time in as many months, issuing a press release announcing third quarter results that were far worse than analysts' diminished expectations and the Company's previous projections. The Company also reduced its earnings projections for 1997 even further, announced even larger charges associated with the reorganization of Imonics, and revealed that due to improper revenue recognition practices in the Imonics division, the Company would have to restate its financial results for the fourth Quarter and year ended December 31, 1995. 104. In contrast to its August 16, 1996 forecast of losses in the range of $.28 - $.33 per share, including charges; Medaphis reported a loss of $.5l per share, or $36.4 million for the 1996 third quarter. These results compared to a net loss per share of $0.05 in the year-ago quarter. The Company reported that revenue fell 10% in the third quarter, to $126.7 million, from $140.8 million the prior year. 105. The Company disclosed that rather than taking charges of between $35 - $40 million, Medaphis reported total charges of approximately $50 million in the third quarter, relating primarily to the reorganization of Imonics the write-off of revenues from the Systems Integration Contract. The October 22, 1996 press release stated: -39- 40 The results for the three months ended September 30, 1996 include a charge against revenue of $16.8 million relating primarily to the reorganization of Imonics, including the renegotiation of a large systems integration contract entered into by Imonics' European joint venture in March 1996. In addition, approximately $8.5 million was included in salaries and wages relating to employees and contractors, who are no longer providing services to the Company, costs to complete certain Imonics contracts and certain other nonrecurring items. In addition, a $24.3 million restructuring charge was recorded during the quarter relating to the reorganization of Imonics. The charge consists of approximately $10.7 million relating to the write down of Imonics' assets, $3.7 million of severance costs primarily for former Imonics employees, $3.2 million in exit costs for lease terminations and $6.7 million of legal and other costs. 106. While Medaphis had stated in August that it expected 1997 earnings per share to fall between $0.75 and $0.90, defendant Brown lowered that range to just $0.60 to $0.75 in connection with the October 22, 1996 press release. At the same time, however, defendant Brown hinted that 1997 earnings were likely to come in even lower still, stating: "I believe there are risks inherent in the business which could cause us to fall short of that goal." 107. In yet another stunning disclosure, the Company announced in the press release that it would restate 1995 results to reflect an actual loss for the year ended December 31, 1995 $8.5 million, compared with a previously reported loss of $3.4 million. For the 1995 fourth quarter, the Company said it expected to post a loss of $1.1 million, compared with a previously reported profit of $4 million. 108. Medaphis stated that the 1995 restatements were the result of improper revenue recognition practices in the Company's Imonics division, including the improper recognition of $5.1 million in earnings in the fourth quarter of 1995. According to the Company, the Imonics unit had booked revenue on a license agreement it had executed in December 1995 despite the existence of "unauthorized correspondence" which improperly "created a contingency" under the license agreement. The revenue recognized on this contract, "together with previously deemed -40- 41 immaterial amounts," reduced net income for the quarter and year ended December 31, 1995 by $5.1 million. As disclosed in the press release: The Company also announced that it intends to restate its financial results for the year and three months ended December 31, 1995. This restatement relates primarily to a license agreement entered into by Imonics in December 1995 and unauthorized correspondence discovered in connection with the Imonics reorganization which created a contingency upon license fees payable under the agreement. The license fee revenue payable under the agreement and recognized by the Company during the fourth quarter of 1995, together with previously deemed immaterial amounts, are expected to result in an aggregate reduction to net income for the quarter and year ended December 31, 1995 of $5.1 million. After appropriate adjustments for such items, it is currently anticipated that the Company's restated results for year ended December 31, 1995 will be a net loss of $8.5 million as compared with previously reported net loss of $3.4 million. In addition, it is anticipated that restated results for the quarter ended December 31, 1995 will reflect a net loss of $1.1 million, as compared with previously reported net income of $4.0 million. 109. Continuing the stream of devastating disclosures that day, Medaphis reported in the press release that during the third quarter it had laid off 430 employees, including the entire senior management team at Imonics. This was in stark contrast to defendants' prior statements portraying the growth in the number of Imonics employees as a positive factor. The Company also announced attempting to renegotiate its credit line from $250 million to $300 million. 110. In a lengthy statement accompanying the October 22, 1996 press release, defendant Brown admitted that BSG had been "preoccupied with the restructuring of Imonics, that the Company's strategic acquisition program had "ended," and that "[w]e have no ongoing plans to make acquisitions at this time." 111. The adverse disclosures of October 22, 1996 drove the Company's stock down $6.375 or 38%, to close at just $10.375 per share, a 52-week low for the stock. The drop in the market capitalization of the Company was approximately $450 million. The trading volume of Medaphis stock on October 22, 1996 was more than 13 million shares, making it the most actively -41- 42 traded stock in the United States that day. During the Relevant Period, Medaphis shares, artificially inflated by defendants' wrongful conduct, had closed as high as $52 1/2 per share (on March conduct, had closed as high as $52 1/2 per share (on March 20, 1996). 112. On October 31, 1996, Medaphis announced that it had named David E. McDowell the Company's new Chairman and Chief Executive, replacing defendant Brown. According to the Company, defendant Brown had resigned for "personal" reasons. However, Brown had not resigned his board of directors position when Plaintiff's initial complaint herein was filed November 1, 1996. DEFENDANTS' CONDUCT HAS DAMAGED MEDAPHIS 113. Each of the defendants, by reason of their management positions, membership on Medaphis' Board of Directors or membership on the Audit Committee, were, during the time they held such positions, "controlling persons" of Medaphis within the meaning of ss. 20 of the Securities and Exchange Act of 1934. Said defendants had the power and influence, and exercised the same, to cause Medaphis to engage in the illegal practices complained of herein. 114. Said defendants participated in the decisions to release the false and misleading press releases and SEC filings complained of herein, and/or were aware of, or recklessly disregarded, the misstatements contained therein and omissions therefrom and were aware of their materially misleading nature. Because of their Board Membership, Audit Committee membership and/or executive and managerial positions with Medaphis, each of the defendants had access to the adverse non-public information about Medaphis' financial performance and condition, as particularized herein. Each of the defendants knew that those adverse facts rendered misleading the positive statements made by and about Medaphis in the press releases and SEC filings. -42- 43 115. Said defendants, because of their positions of control and authority as officers and/or directors of the Company and/or as members of the Audit Committee, were able to and did control the contents of the SEC filings and press releases pertaining to the Company. Each of said defendants was provided with copies of Medaphis' public statements and SEC filings alleged herein to be misleading prior to or shortly after their issuance and had the ability and opportunity to prevent their issuance or cause them to be promptly corrected. 116. Each of the defendants engaged in a course of conduct which was designed to and did (I) deceive the investing public regarding Medaphis' financial reporting and business prospects; (ii) artificially inflate the market price of Medaphis' securities; (iii) enable Medaphis to make acquisitions paid for with Medaphis stock based on the inflated value of that stock; (iv) cause members of the public to purchase or otherwise acquire Medaphis securities at inflated prices, including, without limitation, shareholders of HDS, BSG and other companies acquired for Medaphis stock; and (v) make the stock and options of some of the defendants more valuable. Defendants undertook this scheme to prolong the appearance of good fortune at Medaphis in a desperate gamble to gain the resources and expertise necessary to attempt to meet Medaphis' contractual commitments, and to avoid the otherwise inevitable consequences including eliminating, divesting or reorganizing Medaphis and certain of its subsidiaries in which defendants held managerial positions and which certain defendants had founded. In furtherance of this course of conduct, defendants took the actions as set forth herein. 117. Defendants engaged in a conspiracy and common course of conduct, commencing at least by February 29, 1996, the purpose and effect of which was, inter alia, to cause Medaphis to deceptively present the Company's financial reporting, financial performance and business -43- 44 prospects. Defendants did this so that they could inflate the price of the Company's stock in order to: (I) protect and enhance their executive positions and the substantial compensation and prestige they obtained thereby; (ii) enhance the value of their Medaphis stock holdings and their options to buy Medaphis stock; and (iii) conceal their previous fraudulent conduct. 118. As set forth above, Defendants accomplished their conspiracy and common course of conduct through the issuance of the interrelated and interdependent deceptive and misleading press releases to the public, as well as by filing the false and misleading SEC filings, all of which misrepresented Medaphis' financial condition, financial performance and business prospects, thereby creating a deceptive and misleading impression of continued growth and future profitability. 119. Each of the defendants aided and abetted and rendered substantial assistance in the wrongs complained of herein. In taking the actions to substantially assist the commission of the fraud complained of, each defendant acted with knowledge of the primary wrongdoing, substantially assisted the accomplishment of that fraud, and was aware of his overall contribution to and furtherance of the fraud. 120. Defendants either knew or recklessly disregarded the fact that the illegal acts and practices and misleading statements and omissions described herein would adversely affect the integrity of the market for Medaphis securities and would artificially inflate the prices of those securities. Defendants, by acting as herein described, knowingly and/or recklessly exposed Medaphis to liability under the federal securities laws for violations thereof. 121. As a result of the dissemination of the false and misleading statements described herein, the market price of Medaphis stock was artificially inflated. That has resulted in the -44- 45 Company being subjected to at least 18 class action lawsuits brought on behalf of purchasers of Medaphis securities during the time the Company was disseminating the above quoted false information ("the Class Actions"). 122. Medaphis has been damaged by its exposure to multi-million dollar damages claims by the members of the classes in the Class Actions, as well as to the substantial legal expenses to be incurred in connection with the Class Actions. In addition, the Company's reputation in the securities markets has been severely damaged, thereby hampering the Company's ability to secure future business partners and financing. 123. In particular, Medaphis announced on October 22, 1996, that it was curtailing a program of expansion which had enabled the Company to acquire 46 targets in eight years. 124. Medaphis' reputation, and specifically its ability to retain its significant joint venture partners on favorable terms was damaged: On August 14, 1996, Medaphis announced that it would be forced to renegotiate its major Joint Venture agreement in Europe. DERIVATIVE ACTION ALLEGATIONS 125. Plaintiff brings this action, pursuant to Rule 23.1, Federal Rules of Civil Procedure, on behalf of Medaphis to enforce claims of Medaphis against defendants which may properly be asserted by Medaphis and which Medaphis has failed to enforce. 126. The wrongs complained of herein began following plaintiff's purchase of stock of Medaphis in June, 1995, and were not consummated until October 22, 1996. Hence, plaintiff has standing to bring this derivative action on behalf of Medaphis to recover damages for all of the conduct described in this complaint. DEMAND IS EXCUSED FOR FUTILITY -45- 46 127. Demand on Medaphis to bring this action has not been made and is not necessary because such demand would be futile. Medaphis is controlled by its Board of Directors, and, as described herein, each of the Directors, were involved in and approved the transactions and misstatements complained of herein, knew or should have known that Medaphis did not have an adequate system of internal controls in place to account for "accounts receivable, unbilled", and/or were responsible for the unlawful and improper conduct of Medaphis which has damaged the company, and hence are named as defendants herein. The Director Defendants were not in a position to exercise independent business judgment with respect to the claims alleged herein due to their individual and collective approval of, participation in and responsibility for this unlawful and wrongful conduct. Hence, the Director Defendants were not disinterested and could not have exercised independent business judgment on the issue of whether Medaphis should prosecute this action. Under the factual circumstances described herein, the directors of Medaphis were more interested in protecting themselves than they were in protecting one company by prosecuting this action. Therefore demand on Medaphis and its Board of Directors was futile and is excused. In particular: (a) Demand on defendants Brown, Pryor, and Papermaster would have been futile, and is therefore excused, because they were actively involved in the day-to-day management of Medaphis and its major subsidiaries, including BSG which directly managed Imonics, and were directly responsible for the acts and omissions, including the false statements and omissions, complained of herein. Brown in particular made many of the false statements alleged herein; -46- 47 (b) Demand on defendants Holbrooke, Bellas and McDowell would have been futile, and is therefore excused, because Holbrooke, Bellas and McDowell served on the Audit Committee of the Board of Directors, and were charged with "meeting with the Company's auditors at least annually to review the Company's financial statements and internal accounting controls. The Audit Committee is also responsible for submitting recommendations to the Board regarding the Company's internal accounting controls. Medaphis 1996 Proxy Statement at 3. (i) Medaphis is required to have an Audit Committee by the NASDAQ National Market System listing of Medaphis' securities. National Association of Securities Dealers, Inc. Bylaws, Schedule D, Part III, P. 6, ss. (d) provides that "[e]ach Nasdaq National Market issuer shall establish and maintain an Audit Committee, a majority of the members of which shall be independent directors." (ii) Among other things, as members of the Audit Committee, McDowell, Holbrooke and Bellas had the duty to: - - Recommend the firm to be employed as the corporation's external auditor and review the proposed discharge of such firm. - - Review the external auditor's compensation, the proposed terms of its engagement and its independence. - - Review the appointment and replacement of the senior internal auditing executive. - - Serve as the channel of communication between the external auditor and the board and between the senior internal auditing executive and the board. - - Review the results of each external audit of the corporation, the report of the audit, any related management letter, management's responses to recommendations made by the -47- 48 external audit in connection with the audit and reports of the internal auditing department, that are material to the corporation as a whole and management's responses to those reports. - - Review the corporation's annual financial statements; any certification, report, opinion or review rendered by the external auditor in connection with those financial statements; and any significant disputes between management and the external auditor that arose in connection with the preparation of those financial statements. - - Consider, in consultation with the external auditor and the senior internal auditing executive, the adequacy of the corporation's internal controls. - - Consider major changes and other major questions of choice respecting the appropriate auditing and accounting principles and practices to be used in preparation of the corporation's financial statements when presented by the external auditor, principal senior executive or otherwise. (iii) The Audit Committee should properly have been the keystone of Medaphis' corporate finance governance. Instead, Holbrooke, Bellas and McDowell perpetrated a sham, and utterly failed to ensure that Medaphis' Audit Committee was an informed, vigilant and effective overseer of the Company's financial reporting process and its internal control system. (iv) Despite claiming to have met four times during the 1996 fiscal year, Holbrooke, Bellas and McDowell through utter and complete abdication of their duties to Medaphis, failed to implement and maintain an adequate system of internal controls to account for receivables. Holbrooke, Bellas and McDowell either knew or should have known that Medaphis lacked an adequate system of internal controls. Their service on the Audit Committee was a -48- 49 sham, in that they took no action whatsoever to assure that such a system of internal controls was in place. The absence of such controls directly contributed to the false financial statements and violations of GAAP alleged herein, and was the proximate cause of Medaphis' disastrous restatement and consequent exposure to massive liability for violation of the federal securities laws; (c) Medaphis was controlled by its Board of Directors, and, as described herein, all the members of the Board of Directors of Medaphis were involved in and approved the false or misleading SEC filings complained of herein. Furthermore, Defendant Brown is responsible in damages for the unlawful and improper conduct of Medaphis which has damaged the Company. None of the Director Defendants serving on November 1, 1996, was in position to exercise independent business judgment with respect to the claims alleged herein due to their individual and collective approval of, participation in and responsibility for Medaphis' unlawful and wrongful conduct, which has damaged and will continue to damage Medaphis severely. Hence, the Director Defendants serving on November 1, 1996, were and are not disinterested and could not have exercised independent business judgment on the issue of whether Medaphis should prosecute this action. Under the factual circumstances described herein, the Director Defendants serving on November 1, 1996, were more interested in protecting themselves than they were in protecting the Company by prosecuting this action. Therefore, demand on Medaphis and its Board of Directors would have been futile and is excused; (d) Further, demand would have been futile and, in turn, legally excused, because the Director Defendants serving on November 1, 1996, had and have irreconcilable conflicts of interest because of their responsibility for and control of the related class action -49- 50 securities litigation arising out of their acts of wrongdoing alleged herein, which are themselves also a basis for liability herein. Although the class action complaint herein, which alleges that Medaphis and other defendants violated federal securities laws, only explicitly names Defendant Brown, the statute of limitations has not, and will not run until August for the remaining directors not yet named in the class action. These directors signed the false or misleading SEC filings herein complained of and each is exposed to liability for violation of the securities laws. Such a conflict renders each of the Medaphis directors incapable of disinterestedly deciding to prosecute this action. Each of said directors signed the SEC false or misleading SEC filings listed after their name: Brown: February 29, 1996 Registration Statement on Form S-4 (registration of stock to acquire Rapid Systems); April 3, 1996, Registration Statement on Form S-4 (the BSG Prospectus); April 1, 1996, Annual Report on Form l0-K For The Year Ended December 31, 1995; July 12, 1995 Registration Statement on Form S-3; Bellas: February 29, 1996 Registration Statement on Form S-4 (registration of stock to acquire Rapid Systems); April 3, 1996, Registration Statement on Form S-4 (the BSG Prospectus); April 1, 1996, Annual Report on Form 10-K For The Year Ended December 31, 1995; July 12, 1995 Registration Statement on Form S-3; Holbrooke: February 29, 1996 Registration Statement on Form S-4 (registration of stock to acquire Rapid Systems); April 3, 1996, Registration Statement on Form S-4 (the BSG Prospectus); April 1, 1996, Annual Report on Form 10-K For The Year Ended December 31, 1995; July 12, 1995 Registration Statement on Form S-3; -50- 51 Pryor: February 29, 1996 Registration Statement on Form S-4 (registration of stock to acquire Rapid Systems); April 3, 1996, Registration Statement on Form S-4 (the BSG Prospectus); April 1, 1996, Annual Report on Form l0-K For The Year Ended December 31, 1995; July 12, 1995 Registration Statement on Form S-3; McDowell: July 12, 1995 Registration Statement on Form S-3; Papermaster: July 12, 1995 Registration Statement on Form S-3; Douglas: None. (e) Medaphis has agreed to indemnify its directors and officers against liability for acts and omissions occurring in the performance of their duties as directors and maintains insurance policies to cover the costs of such indemnification. Under the terms of those insurance policies, however, claims against directors which are brought by the Company or other directors are excluded from coverage. Therefore, Medaphis' Board of Directors, or any committee thereof, was effectively disabled from complying with any demand that would cause the Company to bring suit against the Defendants because to do so would result in the loss of insurance coverage; (f) In order to bring this action for bad faith breaches of fiduciary duty, the members of Medaphis' Board of Directors would have had to sue themselves and/or their fellow directors and allies in the top ranks of the corporation. They, therefore, would not initiate litigation nor be able to prosecute any such action. 128. Each and every member of the Board of Directors was incapable of exercising independent business judgment in connection with a shareholder demand in this case. Brown was still on the board November 1, 1996, when this action was first filed. He is an insider and primary actor in the underlying securities fraud, having made many of the untrue statements to the press. -51- 52 He signed all of the periodic reports and registration statements complained of herein. Bellas, Holbrooke and McDowell, in addition to deliberately making a sham of the Audit Committee also signed some or all of the registration statements complained of herein and are primarily liable under the federal securities laws. Papermaster and Pryor, in addition to signing some or all of the registration statements herein, also were insiders in direct control of major Medaphis subsidiaries, with intimate working knowledge of the day to day affairs of Medaphis. Papermaster, in particular, was charged with supervising and ameliorating Imonics. Medaphis acquired BSG, of which Papermaster was CEO, to integrate the operations of Imonics and Rapid Systems. BSG allegedly possessed large processing volume software expertise which Imonics in fact lacked, and which it needed to meet its commitments under the Bertelsmann contracts, and on the MPSC Re- Engineering Project. In essence, Papermaster was hired to straighten out the mess at Imonics. He knew from his first day on the job that Imonics lacked the capacity to perform under the Bertelsmann contract and on the MPSC Re-Engineering Project. Finally, Douglas, the 'mystery director', was never elected by the shareholders, who came and went before any shareholder ever had the opportunity to vote for him, constituted the unauthorized seventh member of the board in violation of the Company's By-Laws. Douglas failed to execute the Company's registration statements, despite being required to do so by SEC regulations. Each member of this group lacked the independence required to evaluate a shareholder demand, for all the reasons set forth above. 129. No demand has been made on the shareholders of Medaphis to cause Medaphis to bring this action against defendants on behalf of the Company because such an effort would be futile. The shareholders of Medaphis do not have the power to collectively act on behalf of the -52- 53 company. All any shareholder or group of shareholders can do is, as plaintiff does here, bring a derivative action, on behalf of Medaphis, pursuant to Rule 23.1 of the Federal Rules of Civil Procedure. 130. Plaintiff will fairly and adequately protect the interests of Medaphis and its shareholders in enforcing the rights of Medaphis against the Defendants. Plaintiff's attorneys are experienced in this type of litigation and will prosecute this action diligently on behalf of Medaphis to enforce the rights of the company against the Defendants. Plaintiff has no interest adverse to Medaphis. COUNT I BAD FAITH BREACH OF FIDUCIARY DUTY AGAINST ALL DEFENDANTS 131. Plaintiff incorporates by reference the allegations set forth in paragraphs 1 through 130 above. 132. Each of the Defendants, as directors and/or officers of Medaphis, owed fiduciary duties to the company. 133. By engaging in conduct described above, and by their actions or omissions causing or permitting Medaphis to engage in unlawful conduct described above, each of Defendants deliberately and in bad faith breached his fiduciary duties to the company. Defendants' violation of their fiduciary duties to Medaphis was willful and knowing and made in bad faith. 134. Medaphis has been damaged by Defendants' breach of their fiduciary duties. COUNT II VIOLATION OF LAW -53- 54 135. Plaintiff incorporates by reference the allegations set forth in Paragraphs 1 through 130 above. 136. Defendants deliberately violated the federal securities laws and have damaged Medaphis thereby. 137. Each of the defendants owes a fiduciary duty of care to Medaphis. 138. Each of the defendants has breached his fiduciary duty of care to Medaphis by violating the federal securities laws, as set forth above. COUNT III GROSS NEGLIGENCE AGAINST ALL DEFENDANTS 139. Plaintiff incorporates by reference the allegations set forth in Paragraphs 1 through 130 above. 140. Each of the Defendants, as directors and/or officers of Medaphis, owed to Medaphis a duty to act with reasonable care. 141. Each of the Defendants, by their conduct and omissions described herein, breached his duty to act with reasonable care. 142. The breach by Defendants of their duty to act with reasonable care was grossly negligent and reckless. 143. Medaphis has been damaged by the gross negligence and reckless disregard by defendants of their duties. COUNT IV BREACH OF CONTRACT AGAINST THE ALL DEFENDANTS -54- 55 144. Plaintiff repeats, realleges and incorporates the allegations set forth in Paragraphs 1 to 130 above. 145. In consideration of the substantial compensation and professional enhancement and prestige which each of the Defendants received, as directors and/or officers of Medaphis, each of those defendants contracted with Medaphis to act in the best interests of Medaphis and to cause Medaphis to operate lawfully and properly. Specifically, Brown, Pryor, McDowell, Papermaster, Douglas, Cote and Douglass all had written employment contracts with Medaphis, which they breached by their actions, as set forth herein. Each of the Director Defendants also had an express agreement to serve as a director of the corporation in exchange for compensation, which each Director Defendant breached by their actions herein. 146. By their actions and omissions set forth herein, those defendants breached their contractual obligations and commitments to Medaphis by not acting in the best interests of Medaphis and by causing or permitting Medaphis to act in unlawful and improper ways. 147. Medaphis has been damaged by Defendants' breaches of their contracts with Medaphis. PRAYERS FOR RELIEF WHEREFORE, Plaintiff, on behalf of Medaphis, demands judgment against defendants, and each of them jointly and severally, as follows: A. Determining that this suit is a proper derivative action and certifying plaintiff as appropriate representative of Medaphis for said action pursuant to Rule 23.1 of the Federal Rules of Civil Procedure; -55- 56 B. Declaring that each of the defendants breached his fiduciary duty to Medaphis in bad faith, and breached his contract with Medaphis as alleged herein; C. Declaring that each of the Director Defendants breached his duty of care to Medaphis and that this conduct constituted gross negligence; D. Determining and awarding Medaphis the damages sustained by it as a result of the violations set forth in each count of this complaint from each of the defendants named in each count, jointly and severally, with interest thereon; F. Awarding plaintiff the costs and disbursements of this action, including reasonable fees and costs to plaintiff's attorneys, accountants, and experts; G. Granting such other further relief as the Court may deem just and proper. JURY DEMAND Plaintiff demands a trial by jury. (Signatures appear on the following page.) -56- 57 Dated: February ll, 1997 Respectfully submitted, /s/ ----------------------------------- ROBERT C. SCHUBERT, ESQ. /s/ ----------------------------------- JUDEN JUSTICE REED, ESQ. SCHUBERT & REED LLP Two Embarcadero Center, Suite 1050 San Francisco, CA 94111 Telephone: 415-788-4220 Telecopier: 415-788-0161 /s/ ----------------------------------- ALFRED G. YATES, JR., ESQ. ALFRED G. YATES, JR. & ASSOCIATES 519 Allegheny Building 429 Forbes Avenue Pittsburgh, Pennsylvania 15219 Telephone: 412-391-5164 Telecopier: 412-471-1033 BIRD, BALLARD & STILL /s/ ----------------------------------- WILLIAM Q. BIRD, ESQ. 14 Seventeenth Street, Suite 5 Atlanta, GA 30309 Telephone: 404-873-4696 Telecopier: 404-872-3745 ATTORNEYS FOR DERIVATIVE PLAINTIFF -57- 58 VERIFICATION I, Thomas W. Brown, hereby declare: 1. I am the administrator for the Thomas W. Brown Profit Sharing Plan, plaintiff in the captioned matter. 2. I have read the foregoing First Amended Verified Derivative Complaint and know its contents. I am informed and believe and on that ground allege that the matters stated therein are true and correct Executed this ____ day of February, 1997 in Pittsburgh, Pennsylvania. I declare under penalty of perjury that the foregoing is true and correct. /s/ ----------------------------------- Thomas W. Brown 59 UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF GEORGIA ATLANTA DIVISION - ------------------------------------------ ) THOMAS W. BROWN, ADMINISTRATOR, ) NO. 1 96-CV 2904 THOMAS W. BROWN PROFIT SHARING ) PLAN, Derivatively on Behalf of ) MEDAPHIS CORPORATION, ) ) Plaintiff, ) vs. ) RANDOLPH G. BROWN, ROBERT C. BELLAS, ) JR., DAVID R. HOLBROOKE, RICHARD H. ) STOWE, JOHN A. DOWNER, DAVID E. ) McDOWELL, DENNIS A. PRYOR, STEVEN G. ) PAPERMASTER, MICHAEL L. DOUGLAS, ) MICHAEL R. COTE and JAMES S. ) DOUGLASS, ) ) Defendants, ) and ) ) MEDAPHIS CORPORATION, ) ) Nominal Defendant. ) - ------------------------------------------) CERTIFICATE OF SERVICE THIS IS TO CERTIFY that I have this day served a copy of the within and foregoing First Amended Verified Derivative Complaint upon all parties in this action by depositing same in the United States mail, in a properly addressed envelope with adequate postage thereon, to the following: 60 M. Robert Thornton, Esq. Robert A. Ambler, Jr., Esq. Leisa L. Bernardin, Esq. King & Spalding 191 Peachtree Street Atlanta, GA 30303-1763 Henry P. Wasserstein, Esq. Skadden, Arps, Slate, Meagher & Floam 919 Third Avenue New York, NY 10022 J. Marbury Rainer, Esq. Parker, Hudson, Rainer & Dobbs 1500 Marquis Two Tower 285 Peachtree Center Ave. Atlanta, GA 30303 Jack J. Dalton, Esq. John M. Bowler, Esq. Troutman Sanders NationsBank Plaza, Suite 5200 600 Peachtree Street, NE Atlanta, GA 30308-2216 This _______ day of February, 1997. /s/ ------------------------------------- William Q. Bird Georgia State Bar No. 057900 BIRD, BALLARD & STILL 14 Seventeenth Street, Suite 5 Post Office Box 7009 Atlanta, Georgia 30357 404/873-4696 -2- EX-99.6 24 SAFE HARBOR COMPLIANCE STATEMENT 1 EXHIBIT 99.6 PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR COMPLIANCE STATEMENT FOR FORWARD-LOOKING STATEMENTS In passing the Private Securities Litigation Reform Act of 1995 (the "Reform Act"), 15 U.S.C.A. Sections 77z-2 and 78u-5 (Supp. 1996), Congress encouraged public companies to make "forward-looking statements" by creating a safe harbor to protect companies from securities law liability in connection with forward-looking statements. Medaphis Corporation ("Medaphis" or the "Company") intends to qualify both its written and oral forward-looking statements for protection under the Reform Act and any other similar safe harbor provisions. "Forward-looking statements" are defined by the Reform Act. Generally, forward-looking statements include expressed expectations of future events and the assumptions on which the expressed expectations are based. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected. Due to those uncertainties and risks, the investment community is urged not to place undue reliance on written or oral forward-looking statements of Medaphis. The Company undertakes no obligation to update or revise this Safe Harbor Compliance Statement for Forward-Looking Statements (the "Safe Harbor Statement") to reflect future developments. In addition, Medaphis undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. Medaphis provides the following risk factor disclosure in connection with its continuing effort to qualify its written and oral forward-looking statements for the safe harbor protection of the Reform Act and any other similar safe harbor provisions. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements include the following: FUTURE OPERATING RESULTS. While Medaphis has in the past expanded its operations through acquisitions and internal growth, the 1997 business plan of the Company does not provide for further acquisitions and, in any event, any such acquisitions would require the unanimous consent of the Company's existing lenders. While the Company has and continues to implement management initiatives designed to enhance and improve its business and operations, there can be no assurance that Medaphis will be able to achieve or sustain profitability or revenue growth on an annual or quarterly basis in the future, that fluctuations in quarter-to-quarter or year-to-year operating results will not occur or that any such quarter-to-quarter or year-to-year fluctuations will not be material. Future operating results of Medaphis will be dependent upon, among other things, (i) successful integration of certain recently acquired businesses, (ii) successfully exiting non-core businesses, (iii) improvement in operations of the Company's physician billing business, (iv) successful implementation of various management initiatives designed to reduce costs and increase efficiencies within the Company's core business and (v) successful growth in sales of the Company's business management services and information products. The Company has recently consummated a number of significant acquisitions, many of which the Company is in the process of integrating into its operations. In addition, the Company recently announced its intention to focus on its core business of delivering business management services and information products to healthcare providers and to divest non-strategic businesses, including Healthcare Recoveries, Inc. ("HRI"). The Company also recently announced that it was assessing alternatives for BSG Corporation ("BSG"), including, but not limited to, seeking a buyer, a spin-off transaction or other capital-raising alternatives. There can be no assurance that the Company will be able to successfully integrate any of the recently acquired companies, that Medaphis will be able to continue to operate recently acquired companies in a profitable manner or that any of the recently acquired companies will not have a material adverse effect upon Medaphis' 2 results of operations, particularly while such acquisitions are being integrated into the Company. Similarly, there can be no assurance that the Company will be able to successfully exit non-core businesses in a timely fashion or at all, that the Company will be able to divest HRI on favorable terms, that the Company will be able to find a buyer or develop suitable alternatives for BSG or that any such divestiture and/or assessment will not have a material adverse effect upon the results of operations of the Company. Additionally, there can be no assurance that any such divestiture or assessment will not have an adverse effect upon the results of operations of HRI or BSG or the reputation and standing of each of these businesses in their respective markets or their ability to attract and retain key employees. During the six months ended December 31, 1996, the Company undertook to reorganize its Imonics operating unit, integrate the Imonics operations into BSG and to discontinue the custom software development business previously pursued by the Imonics unit. This process involved, among other things, recording large restructuring and other charges during the relevant period, significant downsizing of Imonics' employee workforce, renegotiation of Imonics' significant client contracts and other restructuring, reorganization and exit activities. There can be no assurance that such restructuring and reorganization activities will not have an adverse effect upon the reputation and standing of Medaphis, BSG and/or Rapid Systems Solutions, Inc. in the information management and client/server information technology marketplaces or that such matters will not have an adverse effect upon the results of operations of Medaphis in future periods or adversely effect BSG's ability to attract and retain key employees. The Company's expansion strategy in the past has involved both acquisitions and internal growth. The Company recently announced that it intends to focus on its core business of delivering business management services and information products to healthcare providers and to divest non-strategic businesses. Moreover, the Company does not currently anticipate pursuing any significant acquisitions. There can be no assurance that such shift in focus will not have an adverse effect upon the Company's revenue and operations. The Company is experiencing margin pressure in the billing and accounts receivable management services operations of Medaphis Physician Services Corporation, a wholly owned subsidiary of the Company ("MPSC"). MPSC has not significantly contributed to the Company's overall results of operations for the past eighteen months. Management does not expect this trend to improve significantly until further progress is made with, among other things, ongoing initiatives designed to reduce redundant costs, improve efficiencies and enhance operational effectiveness in MPSC's operations. One of the major components of the Company's 1997 operating plan is to reduce costs and increase efficiencies in the core business. During 1996 and going forward, the Company has and will continue to implement various initiatives within the Company's Services Division (which includes MPSC) designed to reduce costs and improve operational efficiency. These initiatives have included, among other things, downsizing of management ranks and improvements in operational processes through the implementation of best practices. Although the preliminary indications from such management initiatives have been positive, there can be no assurance that the Company will be able to successfully implement such initiatives throughout MPSC's operations, that such management initiatives ultimately will be successful, that MPSC's margins will improve or that MPSC will contribute meaningfully to the Company's overall results of operations in future periods. The Company's future operations are dependent upon, among other things, continued growth in sales of its healthcare information technology ("HIT") products, including, but not limited to, sales of its clinical information management system in both domestic and international markets. The markets for these products are characterized by rapidly changing technology, evolving industry standards and frequent new products and product enhancements. The Company's success in its HIT business will depend upon its continued ability (i) to enhance its existing products, (ii) to effect conversions of existing products into foreign languages, (iii) to introduce new products on a timely and cost effective basis to meet evolving customer requirements, (iv) to achieve market acceptance for new product offerings and (v) to respond to emerging industry standards and other technological changes. During the six months ended December 31, 1996, the Company experienced slower than expected sales of certain of its enterprise-wide and departmental scheduling products. There can be no assurance that sales of such scheduling products will improve, that Medaphis will be able to effectively enhance existing products, create new products or respond to technological changes or new industry 2 3 standards. Moreover, there can be no assurance that competitors of Medaphis will not develop competitive products, or that any such competitive products will not have an adverse effect upon Medaphis' operating results. The Company recently announced its operating plan for 1997. As noted above, the operating plan involves refocusing the Company on its core business of providing business management services and information products to healthcare providers. The major components of the plan include (i) exiting non-core businesses, (ii) achieving improved predictability of business results through enhanced management accountability and controls, (iii) reducing costs and increasing efficiencies in the core business, (iv) achieving excellence in customer service, and (v) implementing cross-selling initiatives. Although management believes that the 1997 operating plan reflects the key action items which will contribute to Medaphis' efforts to improve and enhance the operations of the Company, there can be no assurance that the operating plan will result in meaningful improvements to the Company's operating results in future periods or that the plan will ultimately be successful. ABANDONED REENGINEERING PROGRAM; EXISTING SYSTEMS AND TECHNOLOGY. The Company recently announced that it had abandoned its reengineering program. This decision was reached at the conclusion of a comprehensive assessment of the program begun during 1996. The conclusions of the assessment were that it was not cost effective to continue the development and deployment of the software and technology upon which the reengineering program was based and that the reengineering software and technology had no alternative useful application in the Company's operations. In lieu of further developing and deploying the reengineering software and technology, the Company intends to further refine, enhance and develop certain of the Company's existing software and billing systems and to migrate over time the Company's billing and accounts receivable management services operations to the Company's most proven software systems and technology, so as to reduce the number of systems and technology that must be maintained and supported. Moreover, management intends to continue to implement "best practices" and other established process improvements in its operations going forward. There can be no assurance that the Company will be able to successfully refine, enhance and develop its software and billing systems going forward, that the costs associated with maintaining, enhancing and developing such software and systems will not increase significantly in future periods, that the Company will be able to successfully migrate the Company's billing and accounts receivable management services operations to the Company's most proven software systems and technology or that the Company's existing software and technology will not become obsolete as a result of ongoing technological developments in the marketplace. CASH FLOW FROM OPERATIONS; SENIOR CREDIT FACILITY. During the year ended December 31, 1996, the Company used approximately $8 million in cash for operating activities. At December 31, 1996, approximately $242.7 million in borrowings were outstanding under the Company's Senior Credit Facility. The Senior Credit Facility was amended and restated on February 4, 1997 (the "Amended Facility") to, among other things, increase the loan commitments from $250 million to $285 million and extend the maturity through June 30, 1998. The Amended Facility is secured by substantially all of the Company's assets and is guaranteed by substantially all of the Company's subsidiaries. The loan commitments under the Amended Facility will reduce to $200 million on July 31, 1997 (unless extended to September 30, 1997) and $150 million on January 31, 1998. Certain of the other material terms of the Amended Facility include adjustment of the interest rates, fees and charges and other compensation to be paid to the lenders by the Company, including the vesting of certain warrant arrangements for 1% of the common stock of the Company on each of January 1, 1998 and April 1, 1998; modification of the financial reporting requirement to the lenders; restrictions on new acquisitions and certain litigation settlement payments; and establishment of a maximum permitted capital expenditures covenant for the fiscal quarter ending March 31, 1997 and additional financial covenants for fiscal quarters ending on and after June 30, 1997. This summary of certain terms of the Amended Facility and the warrants are subject to the terms of the agreements which have been incorporated by reference as exhibits to this Annual Report on Form 10-K. While management presently anticipates that the liquidity provided in the Amended Facility (together with anticipated results from operations based on the 1997 business plan) will be sufficient to fund the 3 4 Company's anticipated operating and capital expenditure requirements during 1997, there can be no assurance that there will not be material deviations in actual operations from the 1997 business plan which would make it necessary for the Company to seek either further modifications to the Amended Facility or other sources of liquidity. Similarly, while the Company presently anticipates that the timing and proceeds from the previously announced non-core business divestiture program will be sufficient to meet the Company's principal amortization and other obligations under the Amended Facility, there can be no assurance that the timing or amount of the proceeds to be generated from business divestitures for debt service purposes will not require further modifications of the Amended Facility, some of which modifications would require the consent of all of the lenders thereto. Finally, while the Amended Facility incorporates an extension of maturity through June 30, 1998, the Company will be required to renegotiate the Amended Facility prior to maturity and complete its non-core business divestiture program in order to provide adequate liquidity for the Company's 1998 business plan. There can be no assurance that the Company's lenders will agree to further modifications of the Amended Facility or that the Company will complete the non-core business divestiture program as required. The Company may also be required to consider other alternative financing arrangements and/or equity transactions, which could prove costly and/or involve further dilution to the Company's stockholders. There can be no assurance that any such alternative financing arrangements and/or equity transactions will be available to the Company on acceptable terms or at all. PENDING FEDERAL INVESTIGATION; PUTATIVE CLASS ACTION LAWSUITS. The United States Attorney's Office for the Central District of California is conducting an investigation (the "Federal Investigation") of Medaphis' billing and collection practices in its offices located in Calabasas and Cypress, California (the "Designated Offices"). Medaphis first became aware of the Federal Investigation when it received search warrants and grand jury subpoenas on June 13, 1995. Although the precise scope of the Federal Investigation is not known to the Company at this time, Medaphis believes that the U.S. Attorney's Office is investigating allegations of billing fraud and that the inquiry is focused upon Medaphis' billing and collection practices in the Designated Offices. Numerous federal and state civil and criminal laws govern medical billing and collection activities. In general, these laws provide for various fines, penalties, multiple damages, assessments and sanctions for violations, including possible exclusion from Medicare, Medicaid and certain other federal and state healthcare programs. Although the Designated Offices represent less than 2% of Medaphis' annual revenue, there can be no assurance that the Federal Investigation will be resolved promptly, that additional subpoenas or search warrants will not be received by Medaphis or that the Federal Investigation will not have a material adverse effect upon the Company. The Company recorded charges of $12 million in the third quarter of 1995 and $2 million in the fourth quarter of 1996, solely for the administrative fees, costs and expenses it anticipates incurring in connection with the Federal Investigation and the putative class action lawsuits described below which were filed following the Company's announcement of the Federal Investigation. The charges are intended to cover only the anticipated expenses of the Federal Investigation and the related lawsuits and do not include any provision for fines, penalties, damages, assessments, judgments or sanctions that may arise out of such matters. Following the announcement of the Federal Investigation, Medaphis, various of its current and former officers and directors and the lead underwriters associated with Medaphis' public offering of common stock in April 1995 were named as defendants in putative shareholder class action lawsuits filed in the United States District Court for the Northern District of Georgia. In general, these lawsuits allege violations of the federal securities laws in connection with Medaphis' public statements and filings under the federal securities acts, including the registration statement filed in connection with Medaphis' public offering of common stock in April 1995. On October 13, 1995, the named plaintiffs in these lawsuits filed a consolidated class action complaint (the "Consolidated Complaint"). On January 3, 1996, the court denied defendants' motion to dismiss the Consolidated Complaint. On April 11, 1996, certain of the named plaintiffs to the Consolidated Complaint voluntarily dismissed with prejudice all of their claims. As a result of these dismissals, the Consolidated Complaint no longer contains any claims based on the Securities Act of 1933, as amended, and the Company's underwriters and outside directors are no longer named as defendants. On June 26, 1996, the court denied the plaintiffs' motion to certify a plaintiffs' class. The plaintiffs and the defendants have reached an agreement in principle to settle this action on a class-wide basis for $4.75 million, subject to court approval and other customary conditions (the "1995 Class Action Settlement"). The 1995 Class Action Settlement 4 5 would also include the related putative class action lawsuit currently pending in the Superior Court of Cobb County, Georgia, described more fully below. The Company expects to receive approximately $3.7 million from insurance to fund a portion of the 1995 Class Action Settlement and accrued approximately $1.2 million in the quarter ending December 31, 1996 to fund the anticipated balance of the 1995 Class Action Settlement and to pay certain fees incident thereto. On November 5, 1996, Medaphis, Randolph G. Brown, Michael R. Cote and James S. Douglass were named as defendants in a putative shareholder class action lawsuit filed in Superior Court of Cobb County, State of Georgia. This lawsuit alleges violations of Georgia securities laws based on the same public statements and filings generally described above. The lawsuit is brought on behalf of a putative class of purchasers of Medaphis common stock during the period from March 29, 1995 through June 15, 1995. The plaintiffs seek compensatory damages and costs. As noted above, it is currently contemplated that this action will be settled as part of the 1995 Class Action Settlement. The Company and its clients from time to time have received, and the Company anticipates that they will receive in the future, official inquiries (including subpoenas, search warrants, as well as informal requests) concerning particular billing and collection practices related to certain subsidiaries of the Company and its many clients. In March 1997, the Company was informed by the Civil Division of the Department of Justice that it is investigating allegations concerning the Company's Gottlieb's Financial Services, Inc. ("GFS") subsidiary. No subpoenas or other process have been issued to the Company or to GFS in connection with the investigation. There can be no assurance that this matter will be resolved promptly, that subpoenas will not be received by Medaphis or that the investigation will not have a material adverse effect upon Medaphis. Following the Company's August 14, 1996 announcement regarding earnings expectations and certain charges, Medaphis and certain of its current and former officers, one of whom was also a director, were named as defendants in nineteen putative shareholder class action lawsuits filed in the United States District Court for the Northern District of Georgia. On November 22, 1996, the plaintiffs in these lawsuits filed a Consolidated Amended Class Action Complaint (the "1996 Consolidated Complaint"). In general, the 1996 Consolidated Complaint alleges violations of the federal securities laws in connection with Medaphis' filings under the federal securities acts and public disclosures. The 1996 Consolidated Complaint is brought on behalf of a class of all persons who purchased or otherwise acquired Medaphis common stock between January 6, 1996 and October 21, 1996. The 1996 Consolidated Complaint also asserts claims on behalf of a sub-class of all persons who acquired Medaphis common stock pursuant to the merger between Medaphis and Health Data Sciences Corporation ("HDS"). On December 30, 1996, the defendants filed a motion to dismiss most of the 1996 Consolidated Complaint. On February 3, 1997, the plaintiffs filed a Consolidated Second Amended Complaint. On February 14, 1997, the defendants moved to dismiss the Consolidated Second Amended Complaint in its entirety. On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit Sharing Plan filed a shareholder derivative lawsuit in the United States District Court for the Northern District of Georgia alleging that certain of Medaphis' current and former directors breached their fiduciary duties, were grossly negligent, and breached various contractual obligations to Medaphis by allegedly failing to implement and maintain an adequate system of internal accounting controls, allowing Medaphis to commit securities law violations and damaging Medaphis' reputation. The plaintiff seeks compensatory damages and costs. On January 28, 1997, Medaphis and certain individual defendants filed a motion to dismiss the complaint. On February 11, 1997, the plaintiff filed an amended complaint adding as defendants additional current and former directors and officers of Medaphis. Medaphis has not yet responded to the amended complaint. On November 7, 1996, Health Systems International, Inc. filed suit in the Superior Court for the State of California, County of Los Angeles against Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed Medaphis directors, officers and employees. Generally, this lawsuit alleges that the defendants violated federal and California securities laws and common law by, among other things more fully described in the complaint, making material misstatements and omissions in public and private disclosures in connection with the acquisition of HDS. Plaintiff seeks rescissory, compensatory and punitive damages, rescission, injunctive relief and costs. On January 10, 1997, the defendants filed a demurrer to the complaint. The 5 6 demurrer was denied on February 5, 1997. On March 18, 1997, the court denied the plaintiff's motion for a preliminary injunction. As a result of the Company's restatement of its fiscal 1995 financial statements, the Company may not be able to sustain a defense to strict liability on certain claims under the 1933 Act, but the Company believes that it has substantial defenses to the alleged damages relating to the 1933 Act Claims. A putative class action complaint was filed by Ernest Hecht and Stephen D. Strandberg against Steven G. Papermaster, Robert E. Pickering, Jr., David S. Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division, Essex County, State of New Jersey. The alleged class consists of persons and entities whose options to purchase BSG common stock were converted to Medaphis stock options in connection with Medaphis' acquisition of BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary duties of candor, loyalty and fair dealing and negligence against the BSG defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud and deceit against the Medaphis defendants (Medaphis and Brown). On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two entities they control made a demand for indemnification under an indemnification agreement executed by Medaphis in connection with its acquisition of BSG in May 1996. On the date of the demand, Mr. Papermaster was an executive officer and a director of Medaphis. Mr. Papermaster resigned such positions on March 21, 1997, although he remains a director and executive officer of BSG. The indemnification demand claims damages of $35 million (the maximum damages payable by Medaphis under the indemnification agreement) for the alleged breach by the Company of its representations and warranties made in the merger agreement between Medaphis and BSG. The Company believes it has meritorious defenses to the indemnification claim. The Company also has received written demands from various stockholders, including stockholders of recently acquired companies. To date, these stockholders have not filed lawsuits. On January 8, 1997, the Securities and Exchange Commission (the "Commission") has notified the Company that it is conducting a non-public investigation into, among other things, certain trading and other issues related to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's loss for the quarter ending September 30, 1996 and its restated consolidated financial statements for the three months and year ended December 31, 1995 and its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996. The Company intends to cooperate fully with the Commission in its investigation. Although the Company believes that it has meritorious defenses to the claims of liability or for damages in the actions against, and written demands placed upon, the Company, there can be no assurance that additional lawsuits will not be filed against the Company, that the lawsuits, the written demands and the pending governmental investigations will not have a disruptive effect upon the operations of the business, that the written demands, the defense of the lawsuits and the pending investigations will not consume the time and attention of the senior management of the Company, that the resolution of the lawsuits, the written demands and the pending governmental investigations will not have a material adverse effect upon the Company. HEALTHCARE FRAUD INITIATIVES; HEALTHCARE REFORM MEASURES The federal government in recent years has placed increased scrutiny on the billing and collection practices of healthcare providers and related entities. This scrutiny has been directed at, among other things, fraudulent billing practices. The Department of Health and Human Services in recent years has increased the resources of its Office of the Inspector General ("OIG") specifically to pursue both false claims and fraud and abuse violations of the Medicare program. This heightened examination has resulted in a number of high profile investigations, lawsuits and settlements. In 1996, Congress enacted the Health Insurance Portability and Accounting Act of 1996, Pub. L. No. 104-191, 1996 U.S.C.C.A.N. (110 Stat. 1936) (the "Health Insurance Act"), which includes an expansion of certain fraud and abuse provisions, such as expanding the application of Medicare and Medicaid fraud penalties to other federal healthcare programs, and creating additional criminal offenses relating to "healthcare benefit programs," which are defined to include both public and private payor programs. The Health Insurance Act also provides for forfeitures and asset freezing orders in connection with such healthcare 6 7 offenses. Civil monetary penalties and program exclusion authority available to the OIG also have been expanded. The Health Insurance Act contains provisions for instituting greater coordination of federal, state and local enforcement agency resources and actions through the OIG. There also have been several recent healthcare reform proposals which have included an expansion of the anti-kickback laws to include referrals of any patients regardless of payor source. In addition to the provisions of the Health Insurance Act, submission of claims for services or procedures that are not provided as claimed may lead to civil monetary penalties, criminal fines, imprisonment and/or exclusion from participation in Medicare, Medicaid and other federally funded healthcare programs. Specifically, the Federal False Claims Act allows a private person to bring suit alleging false or fraudulent Medicare or Medicaid claims or other violations of the statute and for such person to share in any amounts paid to the government in damages and civil penalties. Successful plaintiffs can receive up to 25-30% of the total recovery from the defendant. Such qui tam actions or "whistleblower lawsuits' have increased significantly in recent years and have increased the risk that a company engaged in the healthcare industry such as Medaphis and many of its customers may become the subject of a federal or state investigation or may ultimately be required to defend a false claims action, may be subjected to government investigation and possible criminal fines, may be sued by private payors, and may be excluded from Medicare, Medicaid and/or other federally funded healthcare programs as a result of such an action. The government on its own may also institute a Civil False Claims Act case, either in conjunction with a criminal prosecution or as a stand alone civil case. Whether instituted by a qui tam plaintiff or by the government, the government can recover triple its damages together with civil penalties of $5,000-$10,000 per false claim. Under applicable case law, a party successfully sued under the False Claims Act may be jointly and severally liable for the damages and penalties. Some state laws also provide for false claims actions, including actions initiated by a qui tam plaintiff. There can be no assurance that Medaphis will not be the subject of false claims or qui tam proceedings relating to its billing and collection activities or that Medaphis will not be the subject of further government scrutiny or investigations relating to its billing and accounts receivable management services operations. See "Pending Federal Investigation; Putative Class Action Lawsuits." Any such proceeding or investigation could have a material adverse effect upon the Company. In the 1995 and 1996 sessions of the United States Congress, the focus of healthcare legislation was on budgetary and related funding mechanism issues. A number of reports, including the 1995 Annual Report of the Board of Trustees of the Federal Hospital Insurance Program (Medicare), have projected that the Medicare "trust fund" is likely to become insolvent by the year 2002 if the current growth rate of approximately 10% per annum in Medicare expenditures continue. Similarly, federal and state expenditures under the Medicaid program are projected to increase significantly during the same seven-year period. In response to these projected expenditure increases, and as part of an effort to balance the federal budget, both the Congress and the Clinton Administration have made proposals to reduce the rate of increase in projected Medicare and Medicaid expenditures and to change funding mechanisms and other aspects of both programs. In late 1995, Congress passed legislation that would substantially reduce projected expenditure increases substantially and would make significant changes in the Medicare and the Medicaid programs. The Clinton Administration has proposed alternate measures to reduce, to a lesser extent, projected increases in Medicare and Medicaid expenditures. Neither proposal became law prior to Congress' 1996 adjournment. Medaphis anticipates that both the Clinton Administration and the Republican majorities in Congress will introduce legislation in 1997 designed to reduce projected increases in Medicare and Medicaid expenditures and to make other changes in the Medicare and Medicaid programs. Medaphis anticipates that such proposed legislation would, if adopted, change aspects of the present methods of paying physicians under such programs and provide incentives for Medicare and Medicaid beneficiaries to enroll in health maintenance organizations and other managed care plans. Medaphis cannot predict the effect of any such legislation, if adopted, on its operations. A number of states in which Medaphis has operations either have adopted or are considering the adoption of healthcare reform proposals at the state level. Medaphis cannot predict the effect of proposed state healthcare reform laws on its operations. Additionally, certain reforms are occurring in the healthcare market which may continue regardless of whether comprehensive federal or state healthcare reform legislation is 7 8 adopted and implemented. These market reforms include certain employer initiatives such as creating purchasing cooperatives and contracting for healthcare services for employees through managed care companies (including health maintenance organizations), and certain provider initiatives such as risk-sharing among healthcare providers and managed care companies through capitated contracts and integration among hospitals and physicians into comprehensive delivery systems. Consolidation of management and billing services by integrated delivery systems may result in a decrease in demand for Medaphis' billing and collection services for particular physician practices, but this decrease may be offset by an increase in demand for Medaphis' consulting and comprehensive business management services (including billing and collection services) for the new provider systems. CLIENT/SERVER INFORMATION TECHNOLOGY PROJECTS. Medaphis' client/server information technology business involves, among other things, projects designed to reengineer significant client operations through the strategic use of imaging, client/server and other advanced technologies. Failure to meet expectations with respect to a major project could damage the Company's reputation and standing in the client/server information technology marketplace, affect its ability to attract new client/server information technology business, result in the payment of damages to the client and jeopardize the Company's ability to collect for services already performed on the project. VOLATILITY OF STOCK PRICE. Medaphis believes factors such as announcements with respect to the Federal Investigation, the Company's liquidity and financial resources, divestiture of businesses, the ongoing governmental investigation, putative class action lawsuits, other lawsuits or demands, healthcare reform measures and quarter-to-quarter and year-to-year variations in financial results could cause the market price of Medaphis common stock to fluctuate substantially. Any adverse announcement with respect to such matters or any shortfall in revenue or earnings from levels expected by securities analysts could have an immediate and material adverse effect on the trading price of Medaphis common stock in any given period. As a result, the market for Medaphis common stock may experience material adverse price and volume fluctuations and an investment in the Company's common stock is not suitable for any investor who is unwilling to assume the risk associated with any such price and volume fluctuations. COMPETITION. Medaphis faces intense competition in each of the areas in which it does business. In providing business management systems and services to physicians and hospitals, Medaphis competes with certain national information management systems and transaction processing organizations, certain regional companies which provide such systems or services and certain physician groups and hospitals which provide their own business management services. In providing subrogation and recovery services, Medaphis competes primarily with the internal recovery operations of potential customers and with certain regional subrogation recovery vendors. In terms of providing client/server information technology services, Medaphis competes with national, regional and local companies specializing in information technology and systems integration consulting services, national and regional application development companies and the software development and systems integration units of national computer equipment manufacturers, large information systems facilities management and outsourcing organizations, national "Big Six" accounting firms and the information systems groups of large general management consulting firms. Certain of Medaphis' competitors have longer operating histories and greater financial, technical and marketing resources than Medaphis. There can be no assurance that competition from current or potential competitors will not have a material adverse effect upon Medaphis. This Safe Harbor Statement supersedes the Safe Harbor Statement filed as Exhibit 99.5 to the Company's Current Report on Form 8-K filed on February 18, 1997. 8 -----END PRIVACY-ENHANCED MESSAGE-----