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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-KSB
 (Mark One)þ
    
    ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934
 For the Fiscal Year Ended December 31, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934
 For the Transition Period from  to 001-14665
COMMISSION FILE NUMBER CLAIMSNET.COM INC. (Exact name of small business issuer in its charter) Delaware
    
    75-2649230(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)14860 Montfort Dr., Suite 250Dallas, Texas
    
    75254(Address of principal
    
    (Zip Code)executive offices)
 Registrants telephone number, including area code: 972-458-1701 Securities registered pursuant to Section 12(b) of the Exchange Act: None Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, $.001 par value 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
þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
(229.405 of this chapter) is not contained in this report, and no disclosure will 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-KSB or any amendment to this Form 10-KSB o Registrants revenues for the year ended December 31, 2004: $1,046,000. The aggregate market value of the Common Stock of the registrants held by non-affiliates of the
registrant, based on the average of bid and ask price of $0.20 on the OTC Bulletin Board stock
market on January 28, 2005, was $5,125,236. Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date. Common Stock, $.001 par value, 25,626,180 shares outstanding as of
March 16, 2005. DOCUMENTS INCORPORATED BY REFERENCE      None. Transitional Small Business
Format (check one): Yes o No þ    1




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TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIESITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONITEM 7. FINANCIAL STATEMENTSITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREITEM 8A. CONTROLS AND PROCEDURESITEM 8B. OTHER INFORMATIONPART IIIITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACTITEM 10. EXECUTIVE COMPENSATIONITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERSITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 13. EXHIBITSITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESSIGNATURESForm of Warrant Issued to Thomas MichaelForm of Warrant Issued to Gary J. AustinForm of Warrant Issued to Laura M. BrayForm of Warrant Issued to Don CrosbieNote with National Financial CorporationNote with R.L. Armstrong Limited PartnershipNote with Elmira United CorporationNote with Douglas R. UrquahartNote with Newman Family TrustNote with Elmira United CorporationRegistration Rights AgreementCertification of Don CrosbieCertification of Laura M. BrayCertification Pursuant to Section 906 of Don CrosbieCertification Pursuant to Section 906 of Laura M. Bray    Table of Contents  
 PART I THIS REPORT CONTAINS FORWARD-LOOKING INFORMATION THAT INVOLVES RISKS AND UNCERTAINTIES. OUR ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED BY THE FORWARD-LOOKING INFORMATION. FACTORS
THAT MAY CAUSE SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED ELSEWHERE IN THIS
REPORT INCLUDING OUR ABILITY TO SECURE ADDITIONAL FUNDING, SUCCESSFULLY IMPLEMENT OUR REVISED
BUSINESS STRATEGY, DEVELOP AND MAINTAIN STRATEGIC PARTNERSHIPS OR ALLIANCES, INCREASE OUR CUSTOMER
BASE, FURTHER DEVELOP OUR TECHNOLOGY AND TRANSACTION PROCESSING SYSTEM, RESPOND TO COMPETITIVE
DEVELOPMENTS, OR COMPLY WITH GOVERNMENT REGULATIONS. ANY FORWARD-LOOKING STATEMENT THAT WE MAKE IS
INTENDED TO SPEAK ONLY AS OF THE DATE ON WHICH WE MADE THE STATEMENT. WE WILL NOT UPDATE ANY
FORWARD-LOOKING STATEMENT TO REFLECT EVENTS OR CIRCUMSTANCES THAT OCCUR AFTER THE DATE ON WHICH THE
STATEMENT IS MADE. THESE RISKS AND UNCERTAINTIES, AMONG OTHERS, MAY CAUSE OUR ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THOSE DESCRIBED IN FORWARD-LOOKING STATEMENTS MADE IN THIS REPORT OR
PRESENTED ELSEWHERE BY MANAGEMENT FROM TIME TO TIME. 
 ITEM 1. BUSINESS Claimsnet.com inc. is a Delaware corporation originally formed in April 1996. We are an electronic
commerce company engaged in healthcare transaction processing for the medical and dental industries
by means of the Internet. Our proprietary software, which was developed over the last eight years,
enables the efficient communication of data between healthcare payers and their provider networks
and trading partners (claims clearinghouses, third party administrators, preferred provider
organizations, health maintenance organizations, claim re-pricing organizations, independent
physician associations, and managed service organizations), for the purpose of conducting
administrative transactions required to effect financial reimbursement for healthcare services.
Our system improves both the ease of data exchange as well as the quality of the data being
exchanged, allowing the users to realize an increase in electronic transaction and cost
improvements from better data. We accomplish this by allowing healthcare providers, Electronic
Data Interchange (EDI) vendors, and trading partners to download healthcare claims interactively on
the Internet and electronically transmit the claims to us for pre-processing. Our software
provides real-time editing of the claims data for compliance with the format and content
requirements of payers and converts the claims to satisfy payers specific processing requirements.
We then electronically transmit pre-processed claims directly or indirectly to medical and dental
payers. In addition, our software provides for secure encryption of all claims data transmitted in
compliance with the regulations of the United States Centers for Medicare and Medicaid Services
(formerly HCFA). We formerly focused our business primarily toward healthcare providers, both from a marketing
perspective and from a system functionality perspective. During 2002, we shifted our business
strategy to focus on the payer market and their trading partners. We effected this transition by
selling our provider-focused client base to a clearinghouse partner and we simultaneously entered
into an agreement to provide the acquirer with a limited license to our proprietary software. The
license allows the providers to continue to use our proprietary system and also provides a
recurring revenue stream to us. We provide support services to the acquirer. We believe that the following are significant advantages of our electronic transaction
pre-processing services:  
    the ability to easily configure the system to meet the specific needs of our clients, both in the format and content of
data being exchanged;
    the ability to accept input from a variety of sources (direct output from a providers practice management system, EDI
files from clearinghouses and trading partners, and data conversion from scanned paper forms), pre-process the data,
improve the data or reject the transaction according to client-specific business rules, and deliver the data in a
consistent and client-defined format;
    the ability to create multiple custom Web site formats to be promoted by partners and sponsors without modification of
the server-based processing systems;
    the ability of healthcare providers utilizing their Web sites to interactively process claims on the Internet and
receive real time edits prior to claim submission; and
    the minimal software and processing power required for providers to utilize our proprietary software. We believe that the services offered by our competitors are generally based on legacy mainframe
technology, proprietary networks, and proprietary file formats, which limit the ability of those
competitors to offer interactive Internet-based processing services on an economical basis. 2




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We generate recurring revenue primarily from implementation fees, development fees, license fees,
support fees and transaction-based fees. We use the services of certain partners and vendors to
assist with the conversion of scanned paper forms, the printing of paper forms from electronic
data, and the delivery of certain electronic transactions. ELECTRONIC CLAIMS PROCESSING MARKET Healthcare claims are traditionally processed by clearinghouses using a similar operating structure
to that which exists in the credit card industry. A merchant that accepts a credit card for payment
does not send payment requests directly to the bank that issued the card, but sends the payment
request to a clearinghouse. The payment request is processed and transmitted to the appropriate
bank. Healthcare claim clearinghouses accept, sort, process, edit, and then forward the claims to
the appropriate payers, either electronically or on paper. Many of the major healthcare
clearinghouses operate in a mainframe computer environment. Furthermore, traditional clearinghouses
process claims in off-line batches and return edit results to the submitters in a subsequent batch
transmission. This operating configuration is both expensive and time consuming due to the source
code changes required to continuously process claims correctly to meet payer requirements. In
contrast, our healthcare transaction processing software system on the Internet is designed to
operate in a real-time, open client-server configuration. This operating alternative offers the
provider and payer a method of communicating directly in a rapid, accurate, and cost-effective
manner. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) includes a section on
administrative simplification requiring improved efficiency in health care delivery by
standardizing electronic data interchange, and protection of confidentiality and security of health
data through setting and enforcing standards. More specifically, HIPAA calls for (a)
standardization of electronic patient health, administrative and financial data, (b) unique health
identifiers for individuals, employers, health plans and health care providers, and (c) security
standards protecting the confidentiality and integrity of individually identifiable health
information. All healthcare organizations are affected, including health care providers, health
plans, employers, public health authorities, life insurers, clearinghouses, billing agencies,
information systems vendors, service organizations, and universities. HIPAA calls for severe civil
and criminal penalties for noncompliance. The provisions relating to standards for electronic
transactions, including health claims and equivalent managed care encounter information, became
effective in October 2003 for clearinghouse and large payer organizations with implementation by
all entities no later than October 2004. The provisions relating to standards for privacy were
implemented in April 2003 for large organizations and April 2004 for small organizations. The
provisions relating to security must be implemented by April 2005 for large organizations and April
2006 for small organizations. The provisions relating to national provider identifiers must be
implemented by May 2007 for large organizations and May 2008 for small organizations. We believe that the convergence of HIPAA mandates and the proliferation of internet technology will
cause sweeping changes in the health care claims processing market. At a minimum, it will cause
all payers to implement secure electronic transaction processing capabilities for a full menu of
administrative transactions. We expect the universal availability of data exchange between
healthcare organizations to generate growth in the healthcare EDI industry. If the industry
evolves toward direct payer submission of claims or real-time adjudication of claims, we believe
our software will be able to offer efficient access to payers and healthcare providers in a
HIPAA-compliant format. BUSINESS STRATEGY Our business strategy is as follows:  
    to utilize our state of the art technology to help large healthcare organizations achieve more efficient and less
costly administrative operations;
    to market our services directly to the payer community and its trading partners;
    to aggressively pursue and support strategic relationships with companies that will in turn aggressively market our
services to large volume healthcare organizations, including insurers, HMOs, third party administrators, provider
networks, re-pricing organizations, clinics, hospitals, laboratories, physicians and dentists;
    to provide total claim management services to payer organizations, including internet claim submission, paper claim
conversion to electronic transactions, and receipt of EDI transmissions;
    to continue to expand our product offerings to include additional transaction processing solutions, such as HMO
encounter forms, eligibility and referral verifications, claim status inquiries, electronic remittance advices, claim
attachments, and other healthcare administrative services, in order to diversify sources of revenue; and
    to license our technology for other applications, including stand-alone purposes, Internet systems and private label
use, and for original equipment manufacturers. 3




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There can be no assurance that any of our business strategies will succeed or that any of our
business objectives will be achieved. MARKETING EFFORTS We began in October 2002 to build a direct sales organization and launched a marketing campaign to
communicate our service capabilities and value proposition to our target market, primarily payers,
third party administrators, and provider networks. The direct sales organization currently consists
of one representative. In support of our marketing strategy, we are a member of the Cooperative Exchange Association, an
organization seeking to expand the delivery of HIPAA-defined transactions to the nations
healthcare payers. Additionally, we have entered into several relationships with strategic partners for the marketing
of our services and use of our proprietary technology, including:  
    arrangements entered into in 2000, 2003 and 2004 with
business-to-business healthcare transaction service providers and
application service providers such as Synertech Systems, Inc.,
Plexis Healthcare Systems, A&G Healthcare Services and Eldorado
Computing, Inc. to operate or provide each a co-branded or
private-labeled version of our claims processing application to be
marketed by the other party either directly throughout the United
States or, as part of its own internet-based service; and  
    an agreement entered into in September 2002 with a major
healthcare clearinghouse to operate a private-labeled version of
our claims processing application for use by certain of their
clients, including those clients acquired from us. RECENT DEVELOPMENTS In January 2005, National Financial Corporation (NFC), a related entity who, as of January 1,
2005 beneficially owned 1,081,603 shares of our common stock, representing 4.3% of our then issued
and outstanding common stock, purchased 400,000 shares of our common stock and tendered payment in
the amount of $100,000 ($0.25 per share). See Market for Common Equity and Related Shareholder
Matters  Recent Sales of Unregistered Securities. HEALTHCARE TRANSACTION PROCESSING SOFTWARE AND SECURITY Our healthcare transaction processing software is designed for processing in-patient and outpatient
healthcare claims. The software is modular, providing valuable flexibility, and generally consists
of the following components:  
    core processing software developed by us which provides claims review, claims editing, and a table-based software
coding of claims variables at a payer-specific level;
    data mapping software that allows us to accept a wide variety of data input formats;
    data format generating software developed by us that allows us to easily create a wide variety of data output formats;
    an integrated web-based user interface that can be easily configured to support co-branded and private-labeled
deployment;
    industry standard website management software; and
    state-of-the-art commercial security and encryption software. The expensive and time-consuming hard-coding routines required by traditional systems have been
replaced by a user-friendly system that is table-based. This permits payer-specific edits to meet
the requirements of payers and avoids expensive onsite software changes. Our personnel input new
edits. Once healthcare providers or trading partners connect to our secure website, our software
edits claims on-line automatically, using a database containing more than 22,000 edit variables.
In the event that a particular payer cannot accept submission of claims electronically, we either
print and mail hard copies of the claims to these payers and charge the provider for this
additional service or allow the provider to print and mail the claims. Our healthcare transaction processing software is a Web-based system, based upon a client-server
computing model, and includes a variety of different software applications. Individual applications
work together to provide the extraction and encryption of claims from a submitting system to our
Internet claims processing server, where editing and formatting occurs in a secure environment. Our
system then delivers the claims to the payer gateway. The different software applications have been
purchased, licensed, or developed by us. 4




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Our website user interface is structured into three sections: PUBLIC INTERNET, CLIENT EXTRANET,
and PRIVATE INTRANET. The PUBLIC INTERNET site provides company background, product
demonstrations, and customer enrollment forms. The CLIENT EXTRANET provides a secure individual
customer area for private customer communication and encrypted claims transmission. The United
States Centers for Medicare and Medicaid Services (formerly HCFA) has defined security requirements
for Internet communications including healthcare data. We operate in compliance with these
requirements. The PRIVATE INTRANET site is designed for internal communications, website operating
reports, customer support, and reporting. Our personnel access the web server hosting environment remotely via a secure Virtual Private
Network (VPN) for technical operations support. Examples of the type of support provided include
migrating Web site changes to production, database administration, and Claims Processing Engine
monitoring and management. With the exception of the commercial software, such as that provided by Microsoft, we have either
identified back-up sources for all the software used or, in the event of a business failure by the
licensing vendor, we own the source code. TRAINING AND HARDWARE REQUIREMENTS The training for the various products and services offered by us is included in the initial setup
fee. User manuals and reference information are available online through our client extranet to
the provider, seven days a week, 24 hours a day. The tutorial and other training documents are
always available at our Web home page, the location of which is http://www.claimsnet.com. No significant hardware investment by the customer is required in order to take advantage of our
services. We communicate with our payer gateways using our public FTP server with PGP encryption,
secure FTP with SSL protocol, secure site-to-site VPN, or point-to-point asynchronous communication
protocol. The client extranet system requires the provider to use a 28,800 bps or better
asynchronous modem and a PC with Windows 3.11 or higher operating system installed. An Internet
Service Provider, such as AT&T Worldnet, America Online or Earthlink, offers local
telecommunication to the Internet. Our customers are responsible for obtaining and maintaining
their Internet Service Provider connection. INTERNET/INTRANET The processing configuration used by us requires no electronic claims processing software to reside
at the level of the healthcare provider. All editing and formatting takes place at our Internet
application server site. All software updates and all format changes are available instantly to
all customers. Our processing does not take place on the Internet, but rather in an extranet configuration. The
main advantage of this approach is to assure that the communication between our servers and a user
takes place in a highly controlled, secure, and encrypted environment. The dual encryption utilized by us occurs at the browser software and application server level. All
processing and data storage occurs behind a firewall, providing secure and controlled access to all
data. CUSTOMERS We view our customers as (1) the payers accepting claims, (2) the strategic partners and affiliates
with which we jointly operate, and (3) the healthcare providers submitting claims. Revenues
received from two customers represented a significant portion of our total revenues during the last
two years. Revenues received from one customer represented 29% and 69% of our revenues for 2004
and 2003, respectively, and revenues received from another customer represented 24% and 24% of our
2004 and 2003 revenues, respectively. We enter into agreements with our clients. Generally, such agreements protect our intellectual
property rights and define the financial terms of our relationship. We require each healthcare
provider using our services to enter into an agreement, usually by agreeing to abide by the terms
of our standard license agreement via our website. We also enter into agreements with the
commercial medical and dental payers or clearinghouses to which we submit processed claims.
Generally, such agreements provide for setup fees, recurring flat rate fees, and transaction fees
to be received by us for certain transactions, and transaction fees to be paid by us for other
transactions. 5




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In September 2000 we entered into an agreement with Synertech Systems, Inc., a premier application
service provider and administrative outsourcer for the healthcare industry, to provide Synertech
and its customers, primarily payer organizations, with co-branded versions of our claims processing
application. Under an arrangement entered into in September 2000 with ProxyMed, a leading provider of
business-to-business healthcare transaction services, we operated a co-branded version of our
claims processing application for ProxyMed. This arrangement also provides for us to use
ProxyMeds extensive direct payer connections to submit certain claims to selected payers. On September 11, 2002, we sold certain assets consisting primarily of customer contracts (the
Assigned Contracts) and related revenue streams thereunder to ProxyMed, Inc. At the same time,
we also entered into an Affiliate and Partner Services and License Agreement pursuant to which (i)
we and ProxyMed have agreed to provide certain administrative and support services for each other
in connection with each others customers, including without limitation the customers under the
Assigned Contracts, (ii) we agreed to assist ProxyMed in establishing a hot-site which will
permit our software application to run on ProxyMeds hardware platform to service ProxyMeds
customers, and (iii) we granted ProxyMed a limited, non-exclusive, 5-year license to use our
software application at its hot-site. MARKETING We are pursuing a two fold marketing and sales strategy.  1.
    Creating strategic partnerships with organizations that:
    are engaged in electronic claims processing and expect to benefit by using our advanced technology; and
    serve or are engaged in direct sales and marketing to the healthcare market and desire to expand the products and
services they offer to their clients without incurring substantial costs by using our advanced technology in a
co-branded or private-label arrangement. We have established several valuable strategic relationships and are actively seeking additional
partners for alliances and joint ventures, including managed care companies, Internet service and
information providers, traditional healthcare information systems providers, clearinghouses, payer
organizations, and consulting firms, each seeking solutions to the costly handling of healthcare
claims and other administrative transactions. There can be no assurance that we will secure any additional alliances or joint venture relations,
or if we do, that such alliances or joint venture relationships will result in material revenues or
be profitable. 2. We also maintain a direct sales force, currently one person, and have launched an aggressive,
yet cost-effective direct sales campaign to the PPO, HMO, TPA and Medical Insurance carrier
marketplace. We continue to review and assess sales and marketing policies to enable us to
accelerate revenue growth. However, there can be no assurance that such efforts will be
successful. COMPETITION Several large companies such as WebMD, McKesson, NDC Health, Per-Se Technologies, and ProxyMed
dominate the claims processing industry in which we operate. Each of these companies operates a
regional or national clearinghouse of medical and dental claims. In most cases, these companies
have large existing capital and software investments and focus on large healthcare providers, such
as hospitals and large clinics, or act as wholesale clearinghouses for smaller electronic claims
processing companies. We estimate, based on information from various trade journals, that in
addition to these large competitors, there are approximately 300 or more small independent
electronic claims processing companies and clearinghouses which operate as local sub-clearinghouses
for the processing of medical and dental claims many of which are larger and have greater financial
resources than we do. A number of additional companies, several of which have greater financial resources and marketing
capabilities than us, have announced that they intend to enter the claims processing industry.
Some of these companies have indicated a desire to primarily serve the payer community and some are
primarily focused on the provider community. All of these companies are considered competitors, however, several of these companies are already
our strategic partners for co-branded or private label solutions using our technology. 6




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We believe that the flexibility, configurability, and operational efficiency of our claims
processing system will allow us to compete effectively in the payer market and to partner with
clearinghouses and other vendors in the provider market. We anticipate that competition will
increase in the processing of claims on the Internet. No assurance can be given that any
significant revenues will result or that we will successfully compete in any market in which we
conduct or may conduct operations. EMPLOYEES As of December 31, 2004, we had a total of 11 employees, all of which are full-time employees,
three of whom were executive officers, six were technical and service personnel, and two were sales
and marketing personnel. None of our employees are represented by a labor organization. Most of our
employees have been granted incentive stock options and we believe that our relations with our
employees are satisfactory. 7




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RISK FACTORS IN ADDITION TO THE OTHER INFORMATION IN THIS REPORT, THE FOLLOWING FACTORS
SHOULD BE CONSIDERED CAREFULLY IN EVALUATING OUR BUSINESS AND PROSPECTS. CONDITIONS EXIST WHICH CAUSE SUBSTANTIAL DOUBT ABOUT OR ABILITY TO CONTINUE AS A GOING CONCERN. The Report of our independent registered public accounting firm with respect to our financial
statements as of December 31, 2004 and the year then ended has been modified with respect to our
ability to continue as a going concern. Management believes that available cash resources, together with anticipated revenues from
operations and the proceeds of recently completed financing activities and funding commitments may
not be sufficient to satisfy our capital requirements through December 31, 2005. Necessary
additional capital may not be available on a timely basis or on acceptable terms, if at all. In any
of these events, we may be unable to implement current plans for expansion or to repay debt
obligations as they become due. If sufficient capital cannot be obtained, we may be forced to
significantly reduce operating expenses to a point which would be detrimental to business
operations, curtail research and development activities, sell certain business assets or
discontinue some or all of our business operations, take other actions which could be detrimental
to business prospects and result in charges which could be material to our operations and financial
position, or cease operations altogether. In the event that any future financing is effected, to
the extent it includes equity securities, the holders of the common stock and preferred stock may
experience additional dilution. In the event of a cessation of operations, there may not be
sufficient assets to fully satisfy all creditors, in which case the holders of equity securities
will be unable to recoup any of their investment. WE HAVE A HISTORY OF NET LOSSES, LIMITED REVENUES, AND WE ANTICIPATE FURTHER LOSSES AND HAVE A
WORKING CAPITAL DEFICIT We have incurred net losses since inception and expect to continue to operate at a loss for the
foreseeable future. For the years ended December 31, 2000, 2001, 2002, 2003 and 2004, we incurred
net losses of $(17,695,000), $(5,194,000), $(2,927,000), $(535,000) and $(657,000) respectively.
As of December 31, 2000, 2001, 2002, 2003 and 2004, we had working capital (deficits) of
$(1,348,000), $(535,000), $(1,238,000), $(419,000) and $(279,000) respectively. We generated
revenues of $1,602,000, $1,336,000, $1,104,000, $652,000 and $1,046,000 for the years ended
December 31, 2000, 2001, 2002, 2003 and 2004, respectively. See Managements Discussion and
Analysis of Financial Condition and Results of Operations  In General. TWO CUSTOMERS GENERATED A SIGNIFICANT PORTION OF OUR REVENUES AND WE ENTERED INTO AN AGREEMENT IN
2002 WHICH HAS HAD A NEGATIVE IMPACT ON OUR NEAR TERM REVENUES Revenues from two customers represented a significant portion of the Companys total revenues
during the last two years. Revenues received from one customer, the clearinghouse partner who
acquired certain of our business assets in September 2002, represented 29% and 69% of our revenues
for 2004 and 2003, respectively, and revenues received from another customer represented 24% and
24%, respectively, of our 2004 and 2003 revenues. In September 2002, we sold certain assets consisting primarily of customer contracts (the Assigned
Contracts) and the related revenue streams thereunder, which generated 76% of our total revenues
for 2002, to a customer and clearinghouse partner. At the same time, we also entered into an
agreement with the acquirer granting it a limited, non-exclusive license to use our software to
service certain of their customers, including the Assigned Contracts. We are entitled to receive
fees under the agreement; however, the acquirer has the right to terminate the contracts or
transition some or all of the customers off of the licensed software, in which case we would no
longer receive ongoing license fees for those customers. In any event, the license fee revenues are
less than the fees formerly generated by the Assigned Contracts. The transaction has, therefore,
had a material adverse effect on our near term financial results. WE CANNOT PREDICT OUR FUTURE CAPITAL NEEDS AND WE MAY NOT BE ABLE TO SECURE ADDITIONAL FINANCING We believe that our available cash resources, together with anticipated revenues from operations
and the proceeds of recently completed financing activities and funding commitments may not be
sufficient to satisfy our capital and liquidity requirements through December 31, 2005. Necessary
additional capital may not be available on a timely basis or on 8




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acceptable terms, if at all. In any of these events, we may be unable to implement current plans
for expansion or to repay debt obligations as they become due. If sufficient capital cannot be
obtained, we may be forced to:  
    significantly reduce operating expenses to a point which would be detrimental to business
operations,
    curtail research and development activities and marketing efforts,
    sell certain business assets or discontinue some or all of our business operations,
    take other actions which could be detrimental to business prospects and result in charges which
could be material to our operations and financial position, or
    cease operations altogether. In the event that any future financing should take the form of equity securities, the holders of
the common stock and preferred stock may experience additional dilution. In the event of a
cessation of operations, there may not be sufficient assets to fully satisfy all creditors, in
which case the holders of equity securities may be unable to recoup any of their investment. BECAUSE OUR OPERATIONS HAVE BEEN LIMITED, THERE IS LIMITED INFORMATION UPON WHICH YOU CAN EVALUATE
OUR BUSINESS Although we have been operating since April 1997, we are prone to all of the risks inherent to the
establishment of a new business venture. Organized in April 1996, we were a development stage
company through March 31, 1997. From March 1997 until September 2002, we operated as a full
service clearinghouse serving primarily healthcare providers. In September 2002, we sold our
healthcare provider clearinghouse service contracts to a strategic partner to generate cash,
simplify our operations, and focus our attention on the payer market. We endeavored to diversify
our business during the year ended December 31, 2000, through an asset acquisition, which due to
delay in market readiness resulted in a large non-recurring loss. We then changed our sales and
marketing strategy. Consequently, you should consider the likelihood of our future success to be
highly speculative in light of our operating history, our limited resources and problems, expenses,
risks, and complications frequently encountered by companies in the early stages of development,
particularly companies in new and rapidly evolving markets, such as electronic commerce. To address
these risks, we must, among other things:  
    maintain and increase our strategic partnerships,
    maintain and increase our customer base,
    implement and successfully execute our business and marketing strategy,
    continue to develop and upgrade our technology and transaction-processing systems,
    continually update and improve our Web site,
    provide superior customer service,
    respond to competitive developments,
    appropriately evaluate merger and acquisition opportunities, and
    attract, retain, and motivate qualified personnel. We may not be successful in addressing all or some of these risks, and our failure to do so could
have a material adverse effect on our business, prospects, financial condition, and results of
operations. WE EXPECT TO EXPERIENCE SIGNIFICANT FLUCTUATIONS IN OUR FUTURE OPERATING RESULTS DUE TO A VARIETY
OF FACTORS, MANY OF WHICH ARE OUTSIDE OUR CONTROL In comparison with our principal competitors, we are a relatively young company in the rapidly
evolving and highly competitive internet-based medical claims processing industry. Our ability to
achieve operating results in this industry will depend on several factors, including: 9




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
    our ability to satisfy capital requirements in an investment climate that has been more reluctant generally to invest
in Internet companies,
    our ability to retain existing customers, attract new customers at a steady rate, and maintain customer satisfaction in
an industry in which significant changes are occurring,
    our ability to introduce new sites, services and products,
    our ability to effectively develop and implement plans to potentially reposition our products, services and marketing
efforts,
    the effect of announcements or introductions of new sites, services, and products by our competitors in a rapidly
evolving industry,
    price competition or price increases in our industry,
    the level of use of the Internet and online services and the rate of market acceptance of the Internet and other online
services for the purchase and delivery of health claims processing services,
    our ability to upgrade and develop our systems and infrastructure in a timely and effective manner,
    the amount of traffic on our Web site,
    the incurrence of technical difficulties, system downtime, or Internet brownouts to which we are acutely sensitive
insofar as our medical claims processing service is Internet-based,
    the amount and timing of operating costs and capital expenditures relating to expansion of our business, operations,
and infrastructure which cannot be predicted with any large degree of accuracy in light of the rapidly evolving nature
of the medical claims processing industry,
    our ability to comply with existing and added government regulation such as HIPAA, and
    general economic conditions and economic conditions specific to the Internet, electronic commerce, and the medical
claims processing industry. If we are unable to handle or satisfactorily respond to these factors, the market price of our
common stock would likely be materially adversely affected. OUR MARKETING STRATEGY HAS NOT BEEN SUFFICIENTLY TESTED AND MAY NOT RESULT IN SUCCESS In 2002, we modified our marketing strategy from heavy reliance on the development and maintenance
of strategic relationships with companies that will aggressively market electronic claims
processing and our other services to payers and healthcare providers to a two-fold approach that
also includes a direct sales and marketing campaign to the PPO, HMO, TPA and Medical Insurance
Carrier marketplace. To penetrate our market we will have to exert significant efforts and devote
material resources to create awareness of and demand for our products and services. No assurance
can be given that our strategic partners will devote significant efforts and resources to, and be
successful in, these marketing services or that they will result in material sales of our products
and services. No representation can be made that our strategy will prove successful or that we
will have adequate resources to support direct marketing of our products and services. Our failure
to develop our marketing capabilities, successfully market our products or services, or recover the
cost of our services will have a material adverse effect on our business, prospects, financial
condition, and results of operations. IF WE ARE UNABLE TO UPGRADE OUR SYSTEMS, WE MAY BE UNABLE TO PROCESS AN INCREASED VOLUME OF CLAIMS
OR MAINTAIN COMPLIANCE WITH REGULATORY REQUIREMENTS A key element of our strategy is to generate a high volume of traffic on, and use of, our Web site
and processing system. We are currently processing less than 10 million medical claims per year
in an industry that processes approximately 4.7 billion claims annually. If the volume of traffic
on our Web site or the number of claims submitted by customers substantially increases, we will
have to expand and further upgrade our technology, claims processing systems, and network
infrastructure to accommodate these increases or our systems may suffer from unanticipated system
disruptions, slower response times, degradation in levels of customer service, impaired quality and
speed of claims processing, and delays in reporting accurate financial information. We operate in
an industry that is undergoing change due to increasing regulatory requirements, some of which
require us to upgrade our systems. We may be unable to effectively upgrade and 10




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expand our claims processing system or to integrate smoothly any newly developed or purchased
modules with our existing systems, which could have a material adverse effect on our business,
prospects, financial condition, and results of operations. BECAUSE WE DEPEND UPON ONLY TWO SITES FOR OUR COMPUTER SYSTEMS WE ARE VULNERABLE TO THE EFFECTS OF
NATURAL DISASTERS, COMPUTER VIRUSES, AND SIMILAR DISRUPTIONS Our ability to successfully receive and process claims and provide high-quality customer service
largely depends on the efficient and uninterrupted operation of our computer and communications
hardware systems. Our proprietary software serving the majority of our customers currently resides
solely on our servers, most of which are currently located in a monitored server facility in
Dallas, TX. Our systems and operations are in a secured facility with hospital-grade electrical
power, redundant telecommunications connections to the Internet backbone, uninterruptible power
supplies, and generator back-up power facilities. Further, we maintain copies of our system and
backup copies of our data at off-site locations for backup and disaster recovery. Despite such
safeguards, we remain vulnerable to damage or interruption from fire, flood, power loss,
telecommunications failure, break-ins, earthquake, terrorist attacks, and similar events. Our
proprietary software serving our largest customer currently resides solely on the customers
servers, in which case we are reliant on the customer to ensure a secure, efficient and
uninterrupted operation of computer and communication systems. In addition, we do not, and may not
in the future, carry sufficient business interruption insurance to compensate us for losses that
may occur. Despite our implementation of network security measures, our servers are vulnerable to
computer viruses, physical or electronic break-ins, and similar disruptions, which could lead to
interruptions, delays, loss of data, or the inability to accept and process customer claims. The
occurrence of any of these events could have a material adverse effect on our business, prospects,
financial condition, and results of operations. WE RELY ON INTERNALLY DEVELOPED ADMINISTRATIVE SYSTEMS THAT ARE INEFFICIENT, WHICH MAY PUT US AT A
COMPETITIVE DISADVANTAGE Some of the systems and processes used by our business office to prepare information for financial,
accounting, billing, and reporting, are inefficient and require a significant amount of manual
effort. For example, our systems require cumbersome data manipulation using spreadsheets in order
to prepare information for both billing and client reporting purposes. These inefficiencies may
place us at a competitive disadvantage when compared to competitors with more efficient systems. We
intend to continue to upgrade and expand our administrative systems and to integrate
newly-developed and purchased modules with our existing systems in order to improve the efficiency
of our reporting methods, although we are unable to predict whether these upgrades will improve our
competitive position or whether we will have sufficient resources to implement these upgrades. WE HAVE LIMITED SENIOR MANAGEMENT RESOURCES, AND WE NEED TO ATTRACT AND RETAIN HIGHLY SKILLED
PERSONNEL; WE MAY BE UNABLE TO EFFECTIVELY MANAGE GROWTH WITH OUR LIMITED RESOURCES Our senior management currently consists of Don Crosbie, our President and Chief Executive Officer,
Laura Bray, our Chief Financial Officer, and Gary Austin, our Chief Operating Officer. We have
undergone a number of staffing reductions since June 2000, requiring remaining employees to handle
an increasingly large and more diverse amount of responsibility. Expansion of our business would
place a significant additional strain on our limited managerial, operational, and financial
resources. In such event, we will be required to expand our operational and financial systems and
to expand, train, and manage our work force in order to manage the expansion of our operations. Our
failure to fully integrate our new employees into our operations could have a material adverse
effect on our business, prospects, financial condition, and results of operations. Our ability to
attract and retain highly skilled personnel is critical to our operations and expansion. We face
competition for these types of personnel from other technology companies and more established
organizations, many of which have significantly larger operations and greater financial, marketing,
human, and other resources than we have. We may not be successful in attracting and retaining
qualified personnel on a timely basis, on competitive terms, or at all. If we are not successful in
attracting and retaining these personnel, our business, prospects, financial condition, and results
of operations will be materially adversely affected. In addition, compliance with Sarbanes-Oxley
Section 404 will place additional strain on our limited managerial, operational, and financial
resources which we believe will be very significant and could have a material adverse effect on our
business, prospects, financial condition and results of operations. BECAUSE OF THEIR SPECIALIZED KNOWLEDGE OF OUR PROPRIETARY TECHNOLOGY AND THE MEDICAL CLAIMS
PROCESSING INDUSTRY, WE DEPEND UPON OUR SENIOR MANAGEMENT AND 11




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CERTAIN KEY PERSONNEL; THE LOSS OR UNAVAILABILITY OF ANY OF THEM COULD PUT US AT A COMPETITIVE
DISADVANTAGE; OUR LIMITED RESOURCES WILL ADVERSELY AFFECT OUR ABILITY TO HIRE ADDITIONAL MANAGEMENT
PERSONNEL We currently depend upon the efforts and abilities of our senior executives and key employees,
currently comprising of Don Crosbie, our President and Chief Executive Officer, Laura Bray, our
Chief Financial Officer, Gary Austin, our Chief Operating Officer, Scott Spurlock, our Vice
President of Development, and Mike Hix, our Vice President of Sales, each of whom has a distinctive
body of knowledge regarding electronic claims submissions and related technologies, the medical
claims processing industry and our services. We may be unable to retain and motivate remaining
personnel for an extended period of time in this environment. The additional loss or
unavailability of the services of any senior management or such key personnel for any significant
period of time could have a material adverse effect on our business, prospects, financial
condition, and results of operations. We have not obtained key-person life insurance on any of our
senior executives or key personnel. In addition, we do not have employment agreements with any of
our senior executives or key personnel. WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS AND WE MAY BE LIABLE FOR INFRINGING
THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS Our business is based in large part upon the proprietary nature of our services and technologies.
Accordingly, our ability to compete effectively will depend on our ability to maintain the
proprietary nature of these services and technologies, including our proprietary software and the
proprietary software of others with which we have entered into software licensing agreements. We
hold no patents and rely on a combination of trade secrets and copyright laws, nondisclosure, and
other contractual agreements and technical measures to protect our rights in our technological
know-how and proprietary services. In addition, we have been advised that trademark and service
mark protection of our corporate name is not available. We depend upon confidentiality agreements
with our officers, directors, employees, consultants, and subcontractors to maintain the
proprietary nature of our technology. These measures may not afford us sufficient or complete
protection, and others may independently develop know-how and services similar to ours, otherwise
avoid our confidentiality agreements, or produce patents and copyrights that would materially and
adversely affect our business, prospects, financial condition, and results of operations. We
believe that our services are not subject to any infringement actions based upon the patents or
copyrights of any third parties; however, our know-how and technology may in the future be found to
infringe upon the rights of others. Others may assert infringement claims against us, and if we
should be found to infringe upon their patents or copyrights, or otherwise impermissibly utilize
their intellectual property, our ability to continue to use our technology could be materially
restricted or prohibited. If this event occurs, we may be required to obtain licenses from the
holders of their intellectual property, enter into royalty agreements, or redesign our products so
as not to utilize their intellectual property, each of which may prove to be uneconomical or
otherwise impossible. Licenses or royalty agreements required in order for us to use this
technology may not be available on terms acceptable to us, or at all. These claims could result in
litigation, which could materially adversely affect our business, prospects, financial condition,
and results of operations. BECAUSE WE ARE NOT CURRENTLY PAYING CASH DIVIDENDS, INVESTORS MAY HAVE TO SELL OUR SHARES IN ORDER
TO REALIZE THEIR INVESTMENT Whether we pay cash dividends in the future will be at the discretion of our board of directors and
will be dependent upon our financial condition, results of operations, capital requirements, and
any other factor that the board of directors decides is relevant. In view of our losses and
substantial financial requirements, we will not be in a position to pay cash dividends at any time
in the reasonable future. Holders of our common stock may have to sell all or a part of their
shares in order to recover all or a part of their investment. SOME PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BY-LAWS MAY DETER OUR ACQUISITION A number of provisions of our amended certificate of incorporation and Delaware law may be deemed
to have an anti-takeover effect. Our certificate of incorporation and by-laws provide that our
board of directors is divided into two classes serving staggered two-year terms, resulting in
approximately one-half of the directors being elected each year and contain other provisions
relating to voting and the removal of the officers and directors. Further, our by-laws contain
provisions which regulate the introduction of business at annual meetings of our stockholders by
other than the board of directors. In addition, we are subject to the anti-takeover provisions of
Section 203 of the Delaware General Corporation Law. In general, this statute prohibits a publicly
held Delaware corporation from engaging in a business combination with an 12




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interested stockholder for a period of three years after the date of the transaction in which the
person became an interested stockholder, unless the business combination is approved in a
prescribed manner. In addition, our certificate of incorporation, as amended, authorizes our board of directors to
issue up to 4,000,000 shares of preferred stock, which may be issued in one or more series, the
terms of which may be determined at the time of issuance by the board of directors, without further
action by stockholders, and may include voting rights (including the right to vote as a series on
particular matters), preferences as to dividends and liquidation, conversion, and redemption
rights, and sinking fund provisions. ISSUANCE OF NEW SERIES OF PREFERRED STOCK COULD MATERIALLY ADVERSELY AFFECT HOLDERS OF COMMON STOCK
AND ANY EXPANSION OR SALES OPPORTUNITIES We may be required to issue a new series of preferred stock for continued funding of operations.
The issuance of any new series of preferred stock could materially adversely affect the rights of
holders of shares of our common stock and, therefore, could reduce the value of the common stock.
In addition, specific rights granted to holders of preferred stock could be used to restrict our
ability to merge with, or sell our assets to, a third party. The ability of the board of directors
to issue preferred stock could have the effect of rendering more difficult, delaying, discouraging,
preventing, or rendering more costly an acquisition of us or a change in control of us, thereby
preserving our control by the current stockholders. INTERNET SECURITY POSES RISKS TO OUR ENTIRE BUSINESS The electronic submission of healthcare claims and other electronic healthcare transaction
processing services by means of our proprietary software involves the transmission and analysis of
confidential and proprietary information of the patient, the healthcare provider, or both, as well
as our own confidential and proprietary information. The compromise of our security or
misappropriation of proprietary information could have a material adverse effect on our business,
prospects, financial condition, and results of operations. We rely on encryption and authentication
technology licensed from other companies to provide the security and authentication necessary to
effect secure Internet transmission of confidential information, such as medical information.
Advances in computer capabilities, new discoveries in the field of cryptography, or other events or
developments may result in a compromise or breach of the technology used by us to protect customer
transaction data. Anyone who is able to circumvent our security measures could misappropriate
proprietary information or cause interruptions in our operations. We may be required to expend
significant capital and other resources to protect against security breaches or to minimize
problems caused by security breaches. Concerns over the security of the Internet and other online
transactions and the privacy of users may also inhibit the growth of the Internet and other online
services generally, and the Web site in particular, especially as a means of conducting commercial
transactions. To the extent that our activities or the activities of others involve the storage and
transmission of proprietary information, such as diagnostic and treatment data, security breaches
could damage our reputation and expose us to a risk of loss or litigation and possible liability.
Our security measures may not prevent security breaches. Our failure to prevent these security
breaches may have a material adverse effect on our business, prospects, financial condition, and
results of operations. WE WILL ONLY BE ABLE TO EXECUTE OUR BUSINESS PLAN IF ELECTRONIC COMMERCE CONTINUES TO GROW
GENERALLY AND SPECIFICALLY IN THE HEALTH CARE INDUSTRY The public in general, and the healthcare industry in particular, may not accept the Internet and
other online services as a viable commercial marketplace for a number of reasons, including
potentially inadequate development of the necessary network infrastructure or delayed development
of enabling technologies and performance improvements. To the extent that the Internet and other
online business to business services continue to experience significant growth in the number of
users, their frequency of use, or in their bandwidth requirements, the infrastructure for the
Internet and online services may be unable to support the demands placed upon them. In addition,
the Internet or other online services could lose their viability due to delays in the development
or adoption of new standards and protocols required to handle increased levels of Internet
activity, or due to increased governmental regulation. Changes in, or insufficient availability of,
telecommunications services to support the Internet or other online services also could result in
slower response times and adversely affect usage of the Internet and other online services
generally and our product and services in particular. If use of the Internet and other online
services does not continue to grow or grows more slowly than we expect, if the infrastructure for
the Internet and other online services does not effectively support the growth that may occur, or
if the Internet and other online services do not become a viable commercial marketplace, our
business, prospects, financial condition, and results of operations could be materially adversely
affected. WE MAY NOT BE ABLE TO ADAPT AS THE INTERNET, ELECTRONIC COMMERCE, AND CUSTOMER DEMANDS CONTINUE TO
EVOLVE 13




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The Internet and the medical claims processing industry are characterized by:  
    rapid technological change,
    changes in user and customer requirements and preferences,
    changes in federal legislation and regulation,
    frequent new product and service introductions embodying new technologies, and
    the emergence of new industry standards and practices that could render our existing Web site and
proprietary technology and systems obsolete. Our success will depend, in part, on our ability to:  
    enhance and improve the responsiveness and functionality of our online claims processing services,
    license leading technologies useful in our business and to enhance our existing services,
    comply with all applicable regulations regarding our industry and the Internet,
    develop new services and technology that address the increasingly sophisticated and varied needs
of our prospective or current customers, and
    respond to technological advances and emerging industry standards and practices on a
cost-effective and timely basis. The development of our Web site and other proprietary technology will involve significant technical
and business risks and require material financial commitment. We may not be able to adapt
successfully to such demands. Our failure to respond in a timely manner to changing market
conditions or customer requirements could have a material adverse effect on our business,
prospects, financial condition, and results of operations. WE HAVE NOT COMPETED AND MAY NOT BE ABLE TO COMPETE EFFECTIVELY IN OUR INDUSTRY Based on total assets and annual revenues for the fiscal year ended in 2004, we are significantly
smaller than the majority of our national competitors. We have not successfully competed and may
not in the future successfully compete in any market in which we conduct or may conduct operations. REGULATORY AND LEGAL UNCERTAINTIES COULD HARM OUR BUSINESS We are not currently subject to direct regulation by any government agency other than laws or
regulations applicable to electronic commerce, but we process information which, by law, must
remain confidential. The U.S. Centers for Medicare and Medicaid Services (formerly HCFA) has
defined security requirements for Internet communications including healthcare data. We must
operate in compliance in all material respects with these requirements. Due to the increasing
popularity and use of the Internet and other online services, federal, state, and local governments
may adopt laws and regulations, or amend existing laws and regulations, with respect to the
Internet or other online services covering issues such as user privacy, pricing, content,
copyrights, distribution, and characteristics and quality of products and services. Furthermore,
the growth and development of the market for electronic commerce may prompt calls for more
stringent consumer protection laws to impose additional burdens on companies conducting business
online. The adoption of any additional laws or regulations may decrease the growth of the Internet
or other online services, which could, in turn, decrease the demand for our services and increase
our cost of doing business, or otherwise have a material adverse effect on our business, prospects,
financial condition, and results of operations. Moreover, the relevant governmental authorities
have not resolved the applicability to the Internet and other online services of existing laws in
various jurisdictions governing issues such as property ownership and personal privacy, and it may
take time to resolve these issues definitively. Any new legislation or regulation, the application
of laws and regulations from jurisdictions whose laws do not currently apply to our business, or
the application of existing laws and regulations to the Internet and other online services could
have a material adverse effect on our business, prospects, financial condition, and results of
operations. WE MAY HAVE DIFFICULTY IMPLEMENTING IN A TIMELY MANNER THE INTERNAL CONTROLS PROCEDURES NECESSARY
TO ALLOW OUR MANAGEMENT TO REPORT ON THE EFFECTIVENESS OF OUR INTERNAL CONTROLS, AND WE MAY INCUR
SUBSTANTIAL COSTS IN ORDER TO COMPLY WITH THE REQUIREMENTS OF THE SARBANES-OXLEY ACT OF 2002. 14




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The Sarbanes-Oxley Act of 2002 has introduced many new requirements applicable to us regarding
corporate governance and financial reporting. Among many other requirements is the requirement
under Section 404 of the Act for management to report on our internal controls over financial
reporting and for our registered public accountant to attest to this report. We are required to
comply with Section 404 effective the fiscal year ending December 31, 2006. Our management has not
yet begun the necessary processes and procedures for issuing its report on our internal controls. We expect to devote substantial time and incur substantial costs during fiscal 2005 to implement
appropriate controls and procedures to ensure compliance. We cannot, however, be certain that we
will be successful in complying with Section 404. THE MARKET PRICE FOR OUR COMMON STOCK MAY BE HIGHLY VOLATILE The market price of our common stock has experienced, and may continue to experience, significant
volatility. Our operating results, announcements by us or our competitors regarding acquisitions or
dispositions, new procedures or technology, changes in general conditions in the economy, and
general market conditions have caused and could in the future cause the market price of our common
stock to fluctuate substantially. The equity markets have, on occasion, experienced significant
price and volume fluctuations that have affected the market prices for many companies common stock
and have often been unrelated to the operating performance of these companies. There are many days
on which there are no trades or a low volume of trades of our common stock and the lack of trading
volume may contribute to the volatility of the market price of our common stock. OUR COMMON STOCK TRADES ON THE OTC BULLETIN BOARD; OUR COMMON STOCK IS SUBJECT TO PENNY STOCK
RULES Since the opening of trading on March 6, 2002, our common stock has been trading in the
over-the-counter market on the OTC Bulletin Board (OTCBB) established for securities that do not
meet the Nasdaq SmallCap Market listing requirements. As a result, an investor may find it more
difficult to dispose of, or to obtain accurate quotations as to the price of, our shares. As a result and based on the fact that our common stock trades below $5.00 per share, our common
stock is subject to the penny stock rules, which impose additional sales practice requirements on
broker-dealers who sell these securities to persons other than established customers as defined
under applicable rules and institutional accredited investors. For transactions covered by these
rules, the broker-dealer must make a special suitability determination for the purchase, and must
have received the purchasers written consent to the transaction prior to sale. As a result, the
ability of broker-dealers to sell our common stock and the ability of purchasers of our stock to
sell their shares in the secondary market is materially adversely affected. FUTURE SALES OF COMMON STOCK BY OUR EXISTING STOCKHOLDERS COULD ADVERSELY AFFECT OUR STOCK PRICE The market price of our common stock could decline as a result of sales of a large number of shares
of our common stock in the market, or the perception that these sales could occur. These sales also
might make it more difficult for us to sell equity securities in the future at a time and at a
price that we deem appropriate. As of March 16, 2005, we had outstanding 25,626,180 shares of common stock, of which approximately
11,775,000 shares were restricted securities as that term is defined under Rule 144 promulgated
under the Securities Act of 1933, as amended. These restricted shares are eligible for sale under
Rule 144 at various times. We have entered into registration rights agreements requiring us to
register the resale of approximately 15,400,000 shares of our common stock, including shares of
common stock issuable upon the exercise of warrants and options. No prediction can be made as to
the effect, if any, that sales of shares of common stock or the availability of such shares for
sale will have on the market prices of our common stock prevailing from time to time. Nevertheless,
the possibility that substantial amounts of our common stock may be sold in the public market may
adversely affect prevailing market prices for the common stock and could impair our ability to
raise capital through the sale of our equity securities. CAUTIONARY NOTES REGARDING THE FORWARD-LOOKING STATEMENTS This report contains, and incorporates by reference, forward-looking statements, within the meaning
of the Private Securities Litigation Reform Act of 1995, regarding our plans and objectives for the
future. Forward looking statements sometimes include words such as anticipate, estimate,
project, forecast, may will, 15




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intend, should, could, would, expect, believe and words of similar meaning.
These forward-looking statements are based on current expectations that involve numerous risks and
uncertainties. Our plans and objectives are based on a successful execution of our operational and
expansion strategy and are based upon a number of assumptions, including assumptions relating to
the growth in the use of the Internet and that there will be no unanticipated material adverse
change in our operations or business. These assumptions involve judgments with respect to, among
other things, future economic, political, competitive, and market conditions, and future business
decisions, all of which are difficult or impossible to predict accurately and many of which are
beyond our control. Although we believe that the assumptions underlying our forward-looking
statements are reasonable, any of the assumptions could prove inaccurate. The forward-looking
statements included, or incorporated by reference, in this report may prove to be inaccurate. In
light of the significant uncertainties inherent in these forward-looking statements, you should not
regard these statements as representations by us or any other person that we will achieve our
objectives and plans. 
 ITEM 2. PROPERTIES We currently sublease 4,703 square feet of office space at a rent of approximately $3,900 per
month, at 14860 Montfort Dr, Suite 250, Dallas, Texas 75254. The sublease expires May 31, 2006. We
believe that, in the event alternative or larger offices are required, such space is available at
competitive rates. For our servers, we currently utilize at a cost of approximately $5,500 per
month The Planet Internet Solutions, including a nationwide DS-3 backbone, a substantial dedicated
Web server management facility, and a 24-hour per day, 7 day per week Network Operations pursuant
to an agreement expiring on April 30, 2005. No assurance can be given that an extension can be
obtained without a material cost increase. 
 ITEM 3. LEGAL PROCEEDINGS We are not currently party to any litigation proceedings. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 16




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PART II 
 ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND SMALL BUSINESS ISSUER PURCHASES
OF EQUITY SECURITIES. PRICE RANGE OF COMMON STOCK The Common Stock of Claimsnet.com traded on the OTC BB under the symbol CLAI.OB and on the Boston
Stock Exchange under the trading symbol CLAI from March 6, 2002 to August 4, 2003. Since August
5, 2003 the Common Stock of Claimsnet.com has traded only on the OTC BB under the symbol CLAI.OB.
The following table sets forth the quarterly high and low bid prices, as reported by the OTC BB the
period from January 1, 2003 through December 31, 2004: HIGH
    
    LOW2003Three months ended March 31, 2003
    
    0.240
    
    0.080Three months ended June 30, 2003
    
    0.500
    
    0.080July 1, 2003 to August 4, 2003
    
    0.400
    
    0.210August 5, 2003 to September 30, 2003
    
    0.260
    
    0.140Three months ended December 31, 2003
    
    0.530
    
    0.1702004Three months ended March 31, 2004
    
    0.490
    
    0.260Three months ended June 30, 2004
    
    0.380
    
    0.260Three months ended September 30, 2004
    
    0.400
    
    0.160Three months ended December 31, 2004
    
    0.300
    
    0.150
 All price quotations represent prices between dealers, without retail mark-ups, mark-downs or
commissions and may not represent actual transactions. The high bid for the Common Stock on the
OTCBB on January 28, 2005 was $0.20 per share. As of December 31, 2004, there were 119 holders of
record of the Common Stock. DIVIDEND POLICY We have not paid any cash dividends on our Common Stock and, in view of net losses and our
operating requirements, do not intend to pay cash dividends in the foreseeable future. If we
achieve profitability, we intend to retain future earnings for reinvestment in the development and
expansion of our business. Delaware law, where we are incorporated, contains certain restrictions
on the payment of dividends. Any credit agreements, which we may enter into with institutional
lenders, may restrict our ability to pay dividends. Any preferred stock shareholders may receive
preferential rights in the distribution of dividends, if any. Whether we pay cash dividends in the
future will be at the discretion of our Board of Directors and will be dependent upon our financial
condition, results of operations, capital requirements, and any other factors that the Board of
Directors determines to be relevant. SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS The information required by Item 201(d) of Regulation S-B is disclosed in Item 11. RECENT SALES OF UNREGISTERED SECURITIES In January 2005, National Financial Corporation (NFC), a related entity who, as of January 1,
2005 beneficially owned 1,081,603 shares of our common stock, representing 4.3% of our then issued
and outstanding common stock, purchased 400,000 shares of our common stock and tendered payment in
the amount of $100,000 ($0.25 per share). In June 2004, we completed the private placement of 25,000 shares of common stock to a member of
our Board of Directors at $0.20 per share, for the satisfaction of $5,000 of notes payable and
accrued interest. We also issued warrants to the Director to purchase an aggregate of 25,000 shares
of common stock at an exercise price of $0.20 per share on or prior to December 31, 2007. 17




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From February through August 2004, Elmira United Corporation, a greater than 5% shareholder,
exercised previously issued warrants to purchase 2,000,000 shares of our common stock at $0.20 per
share for an aggregate amount of $400,000. During 2003, we completed the private placement of 3,800,000 shares of common stock to accredited
investors at $0.20 per share, resulting in net proceeds to us of $683,000 and the extinguishment of
$75,000 of notes payable and accrued interest. In connection with these private placements, we also
issued warrants to the investors to purchase an aggregate of 3,800,000 shares of common stock.
These warrants contain an exercise price of $0.20 per share and expire December 31, 2007. The
investors included National Financial Corporation, a related party which purchased both 350,000
shares of common stock plus warrants to acquire an additional 350,000 shares of common stock for
net proceeds of $20,000 and retirement of debt of $50,000; Elmira, our principal shareholder, which
purchased 2,125,000 shares of common stock plus warrants to acquire an additional 2,125,000 shares
of common stock for net proceeds of $425,000; a 5% shareholder who purchased 100,000 shares of
common stock plus warrants to acquire an additional 100,000 shares of common stock for retirement
of debt plus accrued interest of $20,000, and a director of the Company who purchased 150,000
shares of common stock plus warrants to acquire an additional 150,000 shares of common stock for
net proceeds of $25,000 and payment of accrued interest of $5,000. From May through August 2003, we issued an aggregate 2,701,000 shares of our common stock upon
conversion and surrender of 2,701 shares of preferred stock by the holders thereof. In April and October 2003, Elmira exercised previously issued warrants to purchase 1,875,000 shares
of our common stock for $375,000 ($0.20 per share). From June through December 2002, we completed the private placement of 3,675,000 shares of common
stock to accredited investors at $0.20 per share for net proceeds of $735,000. In connection with
the private placement, we also issued warrants to purchase an aggregate of 3,675,000 shares of
common stock. The warrants contain an exercise price of $0.20 per share and expire between June
and December 2007. Included in the investors was Elmira, which purchased 1,750,000 shares of common
stock plus warrants to acquire an additional 1,750,000 shares of common stock. In October 2002, pursuant to a commitment in June 2002, we issued and sold to four Directors at a
price of $300 per share (an aggregate of $50,000), an aggregate of 167 shares of Series E Preferred
Stock, convertible into 166,667 shares of common stock. The terms were set by a committee of
disinterested directors. In May 2002, we completed the sale of 3,304 shares of Series D Preferred Stock, convertible into
3,304,000 shares of common stock, to accredited investors at $250 per share for net proceeds of
$826,000. The private placement included 100 shares of Series D Preferred Stock purchased by Mr.
Michel, a Director, 565 shares of Series D Preferred Stock purchased by Mr. Dubach, a Director,
1,600 shares of Series D Preferred Stock purchased by Elmira, our principal shareholder, and 620
shares of Series D Preferred Stock purchased by New York Venture Corp., an entity for which Jeffrey
Black, a Director of the Company, was the corporate secretary. Except as otherwise indicated, in each of the security issuances referenced above, we provided
certain rights to register resale of the shares at our expense under the Securities Act of 1933
(the Act); none of the sales of securities involved the use of an underwriter or the payment of
any commissions, and the proceeds were used for general corporate purposes. The certificates
evidencing the common stock issued in each of the transactions referenced above bear legends
restricting their transfer. The offer and sale of the securities in each of the foregoing transactions were exempt from
registration under the Act by virtue of Section 4(2) thereof and the rules promulgated thereunder.
Each of the investors in such private placements provided representations to us that the investor
is an accredited investor, as defined in Rule 501 under the Act. Each investor was afforded the
right to conduct a complete due diligence review of us and the opportunity to ask questions of, and
receive answers from, our management. 18




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ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND OTHER
PORTIONS OF THIS REPORT CONTAIN FORWARD-LOOKING INFORMATION THAT INVOLVES RISKS AND UNCERTAINTIES.
OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED BY THE FORWARD-LOOKING
INFORMATION. FACTORS THAT MAY CAUSE SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, AVAILABILITY
OF FINANCIAL RESOURCES FOR LONG TERM NEEDS, PRODUCT DEMAND, MARKET ACCEPTANCE AND OTHER FACTORS
DISCUSSED ELSEWHERE IN THIS REPORT. THIS MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL
STATEMENTS AND THE RELATED NOTES INCLUDED ELSEWHERE IN THIS REPORT. IN GENERAL As of December 31, 2004, we had a working capital deficit of $(279,000) and stockholders deficit
of $(606,000). We generated revenues of $1,046,000 for the year ended December 31, 2004. We have
incurred net losses since inception and had an accumulated deficit of $(43,616,000) at December 31,
2004. We expect to continue to operate at a loss for the foreseeable future. There can be no
assurance that we will ever achieve profitability. In addition, during the year ended December 31,
2004, net cash used in operating activities was $722,000. We have been in existence since 1996, and have operated under several different business
strategies. As a result, the relationships between revenue and cost of revenue, and operating
expenses reflected in the financial information included in this report may not represent future
expected financial relationships. Much of the cost of revenue and operating expenses reflected in
our consolidated financial statements are associated with people costs, and not directly related to
transaction volumes. Our expenses decreased during the year ended December 31, 2003 and December
31, 2004 due to staffing reductions and relocation of our offices and servers to more cost
efficient facilities. The Company generally enters into services agreements with its customers to provide access to its
software application for processing of customer transactions. The Company operates the software
application for all customers and the customers are not entitled to ownership of the Companys
software at any time during or at the end of the agreements. The customers either host the
application on their own servers or access the Companys hosted software platform via the internet.
Customers pay implementation fees, transaction fees, and time and materials charges for additional
services. Revenues primarily include fees for implementation and transaction fees, which may be
subject to monthly minimum provisions. Customer agreements may also provide for development fees
related to private labeling of the Companys software platform (i.e. access to the Companys
servers through a web site which is in the name of and/or has the look and feel of the customers
other web sites) and some customization of the offering and business rules. The Company accounts
for its service agreements by combining the contractual revenues from development, implementation,
license, support and certain additional service fees and recognizing the revenue ratably over the
expected period of the business arrangement. The Company currently uses an estimated expected
business arrangements term of three years, which is currently the term of the typical contract
signed by its customers. The Company does not segment these services and uses the underlying
contractual terms to recognize revenue because it does not have objective and reliable evidence of
fair value to allocate the arrangement consideration to the deliverables in the arrangement. To
the extent that implementation fees are received in advance of recognizing the revenue, the Company
defers these fees and records deferred revenue. The Company recognizes service fees for
transactions and some additional services as the services are performed. The Company expenses the
costs associated with its customer service agreements as those costs are incurred. PRIVATE PLACEMENTS, OPTIONS AND WARRANTS We have been dependent on issuances of our capital stock to meet our capital and liquidity needs.
We anticipate we will continue to require similar infusions of capital for the foreseeable future.
There is no assurance we will be able to obtain such funding. In January 2005, National Financial Corporation (NFC), a related entity who, as of January 1,
2005 beneficially owned 1,081,603 shares of our common stock, representing 4.3% of our then issued
and outstanding common stock, purchased 400,000 shares of our common stock and tendered payment in
the amount of $100,000 ($0.25 per share). 19




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In September 2004, we issued warrants to acquire an aggregate of 550,000 shares of common stock to
certain employees. These warrants have an exercise price of $0.29 per share, the fair market value
of the stock on the date of grant, vest over three years, and expire in September 2014. In June 2004, we completed the private placement of 25,000 shares of common stock to a member of
our Board of Directors at $0.20 per share, for the satisfaction of $5,000 of notes payable and
accrued interest. We also issued warrants to the Director to purchase an aggregate of 25,000 shares
of common stock at an exercise price of $0.20 per share on or prior to December 31, 2007. From February through August 2004, Elmira exercised previously issued warrants to purchase
2,000,000 shares of our common stock at $0.20 per share for an aggregate amount of $400,000. In March 2004, we issued options to acquire an aggregate of 500,000 shares of common stock to
certain employees. These options have an exercise price of $0.35 per share, the fair market value
of the stock on the date of grant, vest over three years and expire in March 2014. During 2003, we completed the private placement of 3,800,000 shares of common stock to accredited
investors at $0.20 per share, resulting in net proceeds to us of $683,000 and the extinguishment of
$75,000 of notes payable and accrued interest. In connection with these private placements, we also
issued warrants to the investors to purchase an aggregate of 3,800,000 shares of common stock.
These warrants contain an exercise price of $0.20 per share and expire December 31, 2007. These
private placements included 350,000 shares of common stock plus warrants to acquire an additional
350,000 shares of common stock purchased by National Financial Corporation, a related entity, for
net proceeds of $20,000 and retirement of debt of $50,000, 2,125,000 shares of common stock plus
warrants to acquire an additional 2,125,000 shares of common stock purchased by Elmira, which owned
at the time and continues to own more than 5% of the outstanding shares of our common stock for net
proceeds of $425,000; 100,000 shares of common stock plus warrants to acquire an additional 100,000
shares of common stock purchased by a 5% shareholder for retirement of debt plus accrued interest
of $20,000; and 150,000 shares of common stock plus warrants to acquire an additional 150,000
shares of common stock purchased by a director for net proceeds of $25,000 and payment of accrued
interest of $5,000. In November 2003, the Company issued 9,000 shares of common stock to a non-employee for
professional services rendered. The stock was valued at $0.25 per share, the closing price on the
date of grant. The Company recognized an expense of $2,250 related to the stock grant. In June 2003, the Company issued ten-year warrants to acquire an aggregate of 3,450,000 shares of
common stock to certain employees at an exercise price of $0.15 per share, and ten-year warrants to
acquire an aggregate of 1,200,000 shares of common stock to two directors as compensation for
services outside of their director duties at an exercise price of $0.15 per share. The warrants
issued to directors were valued at $0.15 per warrant resulting in a total charge against earnings
of approximately $180,000 based on the Black-Scholes valuation method. The warrants were valued
using the following assumptions: life of ten years, risk free rate of 4.77%, no dividends during
the term, and a volatility of 204%. From May through August 2003, we issued an aggregate 2,701,000 shares of our common stock upon
conversion and surrender of 2,701 shares of preferred stock by the holders thereof. Between April and December 2003, Elmira exercised previously issued warrants to purchase 1,875,000
shares of our common stock for $375,000 ($0.20 per share). We used $217,000 of the proceeds from the April 2003 private placement and warrant exercise to make
payments pursuant to creditor agreements, as described in Note I to the consolidated financial
statements. PLAN OF OPERATIONS Our business strategy is as follows:  
    to utilize our state of the art technology to help large healthcare organizations achieve more efficient and less
costly administrative operations;
    to market our services directly to the payer community and its trading partners;
    to aggressively pursue and support strategic relationships with companies that will in turn aggressively market our
services to large volume healthcare organizations, including insurers, HMOs, third party administrators, provider
networks, re-pricing organizations, clinics, hospitals, laboratories, physicians and dentists; 20




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
    to provide total claim management services to payer organizations, including internet claim submission, paper claim
conversion to electronic transactions, and receipt of EDI transmissions;
    to continue to expand our product offerings to include additional transaction processing solutions, such as HMO
encounter forms, eligibility and referral verifications, claim status inquiries, electronic remittance advices, claim
attachments, and other healthcare administrative services, in order to diversify sources of revenue; and
    to license our technology for other applications, including stand-alone purposes, Internet systems and private label
use, and for original equipment manufacturers. We anticipate that our primary source of revenues will be revenue paid by healthcare payers and
vendors for private-label or co-branded licenses and services. Historically, our primary sources
of revenue were fees paid by healthcare providers for insurance claims and patient statement
services and fees from medical and dental payers for processing claims electronically. We expect
most of our revenues to be recurring in nature. Our principal costs to operate are anticipated to be technical and customer support,
transaction-based vendor services, sales and marketing, research and development, acquisition of
capital equipment, and general and administrative expenses. We intend to continue to develop and
upgrade our technology and transaction-processing systems and continually update and improve our
website to incorporate new technologies, protocols, and industry standards. Selling, general and
administrative expenses include all corporate and administrative functions that serve to support
our current and future operations and provide an infrastructure to support future growth. Major
items in this category include management and staff salaries and benefits, travel, professional
fees, network administration, business insurance, and rent. CRITICAL ACCOUNTING POLICIES REVENUE RECOGNITION We generally enter into services agreements with our customers to provide access to our hosted
software platform for processing of customer transactions. We operate the software application for
all customers and the customers are not entitled to ownership of our software at any time during or
at the end of the agreements. The end users of our software application access our hosted software
platform or privately hosted versions of our software application via the internet with no
additional software required to be located on the customers systems. Customers pay implementation
fees, transaction fees and time and materials charges for additional services. Revenues primarily
include fees for implementation and transaction fees, which may be subject to monthly minimum
provisions. Customer agreements may also provide for development fees related to private labeling
of our software platform (i.e. access to our servers through a web site which is in the name of
and/or has the look and feel of the customers other web sites) and some customization of the
offering and business rules. We account for our service agreements by combining the contractual
revenues from development, implementation, license, support and certain additional service fees and
recognizing the revenue ratably over the expected period of performance. We currently use an
estimated expected business arrangement term of three years which is currently the term of the
typical contracts signed by our customers. We do not segment these services and use the underlying
contractual terms to recognize revenue because we do not have objective and reliable evidence of
fair value to allocate the arrangement consideration to the deliverables in the arrangement. To
the extent that implementation fees are received in advance of recognizing the revenue, we defer
these fees and record deferred revenue. We recognize service fees for transactions and some
additional services as the services are performed. We expense the costs associated with our
customer service agreements as those costs are incurred. SOFTWARE FOR SALE OR LICENSE We begin capitalizing costs incurred in developing a software product once technological
feasibility of the product has been determined. Capitalized computer software costs include direct
labor, and labor-related costs. The software is amortized over its expected useful life of 3 years
or the contract term, as appropriate. Management evaluates the recoverability, valuation, and amortization of capitalized software costs
to be sold, leased, or otherwise marketed whenever events or changes in circumstances indicate that
the carrying amount on the software may not be recoverable. As part of this review, management
considers the expected undiscounted future net cash flows. If they are less than the stated value,
capitalized software costs will be written down to fair value. RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123R, Share-Based
Payment, which is a revision of SFAS 123 Accounting for Stock-Based Compensation and supersedes
APB Opinion 25, 21




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Accounting for Stock Issued to Employees. SFAS 123R focuses primarily on share-based payments for
employee services, requiring these payments to be recorded using a fair-value-based method. The use
of APB 25s intrinsic value method of accounting for employee stock options has been eliminated. As
a result, the fair value of stock options granted to employees in the future will be required to be
expensed. The impact on the results of operations of the Company will be dependent on the number of
options granted and the fair value of those options. For the Company, FASB 123R will be effective
in 2006. 22




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RESULTS OF OPERATIONS COMPARISON OF THE YEARS ENDED DECEMBER 31, 2004 AND 2003 REVENUES Revenues increased 60% to $1,046,000 in 2004 from $652,000 in 2003. The increase in revenues was
due to the addition of several large customers offset by a decrease in revenues received from one
customer. Revenues received from one customer represented 29% and 69% of our revenues for 2004 and
2003, respectively, and revenues received from another customer represented 24% and 24% of our 2004
and 2003 revenues, respectively. COST OF REVENUES Cost of revenues were $663,000 in 2004 compared to $616,000 for the prior year. The four recurring
components of cost of revenues are data center expenses, third party transaction processing
expenses, customer support operation expenses and amortization of software. Data center expenses
were $63,000 for the year ended December 31, 2004 compared with $187,000 for 2003, a decrease of
66%. Third party transaction processing expenses were $51,000 in 2004 compared to $2,000 in 2003.
Customer support operations expense increased by 37% to $530,000 in 2004 from $386,000 in 2003.
Data center expenses decreased due to the relocation of our servers and the reconfiguration of our
server network. The increase in third party transaction processing expenses was primarily
attributable to new contracts with clearing houses. The increase in customer support operations
expense was primarily attributable to additional staffing added during 2004. Software amortization
and development project amortization expenses decreased to $18,000 in 2004 compared to $41,000 in
2003, representing a 56% decrease. RESEARCH AND DEVELOPMENT Research and development expenses were $0 in 2004, compared with $30,000 in 2003, representing a
decrease of 100%. Research and development expenses are comprised of personnel costs and related
expenses. Development efforts during 2003 were concentrated on enhancements to assure compliance
with HIPAA requirements. Development efforts of $5,000 in 2004 and $55,000 in 2003 were
capitalized. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses were $1,106,000 in 2004, compared with $1,412,000 in
2003, a decrease of 22%. The $306,000 decrease is primarily related to reduction in personnel and
personnel related expenses. INTEREST INCOME (EXPENSE) Interest expense was $25,000 for 2004 compared with $18,000 for 2003. Included in the 2004 expense
was $17,000 related to interest on notes payable to related parties compared with $12,000 for 2003.
Interest expense of $6,000 in 2004 and $5,000 in 2003 related to other notes payable. Interest of
$2,000 and $1,000 respectively was paid to vendors in 2004 and 2003 for financing fees. LOSS ON SALE OF BUSINESS ASSETS In 2003, we recorded a loss of $27,000 on sale of assets related to the relocation of our offices. GAIN ON NEGOTIATED SETTLEMENTS In May 2004, the Company entered into a settlement agreement with a creditor, contingent upon the
Company making payment within twenty days of the date of agreement. When the agreed payment was
made by the Company, the creditor released the Company from all other liabilities. The agreement
entered into required a payment totaling $20,000 to settle certain accounts payable totaling
$111,000, resulting in a gain on settlement of liabilities totaling $91,000. During March and April 2003, the Company entered into settlement agreements with various creditors,
contingent upon the Company making payment within ten days of the date of agreement. When the
agreed payment was made by the Company, the creditor released the Company from all other
liabilities. The agreements entered into required payments totaling $217,000 to settle certain
accounts payable, accrued severance and accrued acquisition cost liabilities totaling $1,133,000,
resulting in a gain on settlement of liabilities totaling $916,000. 23




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LIQUIDITY AND CAPITAL RESOURCES For the year ended December 31, 2004, net cash used in operating activities of $718,000 was
primarily attributable to a net loss of $657,000, adjusted for a gain on settlement of liabilities
of $91,000, depreciation of $41,000, a decrease in deferred revenue of $30,000 and a change in
other working capital accounts of $19,000. For the year ended December 31, 2003, net cash used in operating activities of $1,168,000 was
primarily attributable to a net loss of $535,000, adjusted for a gain on settlement of liabilities
of $916,000, a loss on sale of assets of $27,000, warrants issued for services of $182,000,
depreciation of $87,000, a decrease in accrued severance of $80,000, an increase in deferred
revenue of $160,000 and a change in other working capital accounts of $93,000. Net cash used in investing activities was $14,000 in 2004, attributable to $9,000 for the purchase
of equipment and leasehold improvements and $5,000 for capitalized software development costs. Net cash used in investing activities was $75,000 in 2003, attributable to proceeds of $6,000 from
the sale of assets, offset by $26,000 for the purchase of equipment and leasehold improvements and
$55,000 for capitalized software development costs. Net cash provided by financing activities in 2004 was $734,000 as a result of the exercise of stock
warrants for net proceeds of $400,000 and proceeds of $420,000 from debt financing, offset by
$86,000 used to repay debt. Net cash provided by financing activities in 2003 was $1,156,000 as a result of the private
placement of common and preferred stock for net proceeds of $683,000, exercise of stock warrants
for net proceeds of $375,000 and proceeds of $100,000 from debt financing, offset by $2,000 used to
repay debt. In January 2005, NFC, a related entity, purchased 400,000 unregistered shares of the Companys
common stock for $100,000 ($0.25 per share). Management believes that available cash resources, together with anticipated revenues from
operations and the proceeds of recently completed financing activities and funding commitments
including the foregoing exercise of warrants by Elmira, our principal shareholder, may not be
sufficient to satisfy our capital requirements through December 31, 2005. Necessary additional
capital may not be available on a timely basis or on acceptable terms, if at all. In any of these
events, we may be unable to implement current plans for expansion or to repay debt obligations as
they become due. If sufficient capital cannot be obtained, we may be forced to significantly
reduce operating expenses to a point which would be detrimental to business operations, curtail
research and development activities, sell certain business assets or discontinue some or all of our
business operations, take other actions which could be detrimental to business prospects and result
in charges which could be material to our operations and financial position, or cease operations
altogether. In the event that any future financing is effected, to the extent it includes equity
securities, the holders of our common stock and preferred stock may experience additional dilution.
In the event of a cessation of operations, there may not be sufficient assets to fully satisfy all
creditors, in which case the holders of equity securities may be unable to recoup any of their
investment. In addition, compliance with Sarbanes-Oxley Section 404 will place additional strain on
our limited managerial, operational, and financial resources which we believe will be very
significant and could have a material adverse effect on our business, prospects, financial
condition and results of operations. 24




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ITEM 7. FINANCIAL STATEMENTS Below is an index of financial statements. The financial statements required by this item begin at
page 26 hereof. PageReports of Independent Registered Public Accounting Firms
    
    26Consolidated Balance Sheet  December 31, 2004
    
    28Consolidated Statements of Operations for the Years Ended
December 31, 2004 and 2003
    
    29Consolidated Statements of Changes in Stockholders Deficit
for the Years Ended December 31, 2004 and 2003
    
    30Consolidated Statements of Cash Flows for the Years Ended
December 31, 2004 and 2003
    
    31Notes to Consolidated Financial Statements
    
    32
 25




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders
Claimsnet.com, inc. We have audited the accompanying consolidated balance sheet of Claimsnet.com, Inc. and
subsidiaries as of December 31, 2004, and the related consolidated statements of operations,
changes in stockholders deficit and cash flows for the year then ended. These financial statements
are the responsibility of the Companys management. Our responsibility is to express an opinion on
these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Claimsnet.com, inc. and subsidiaries at
December 31, 2004, and the consolidated results of their operations and their cash flows for the
year then ended, in conformity with accounting principles generally accepted in the United States
of America. The accompanying financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Note A to the financial statements, the Company has
generated losses since inception, incurred negative cash flows from operations, and has a
stockholders deficit at December 31, 2004. Additionally, management does not believe that
available cash resources, anticipated revenues from operations or proceeds from financing
activities and funding commitments will be sufficient to satisfy the Companys near term capital
requirements. These conditions raise substantial doubt about the Companys ability to continue as
a going concern. These financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts and classification
of liabilities that may result from the outcome of this uncertainty. /s/ Whitley Penn
Dallas, Texas
January 24, 2005 26




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders
Claimsnet.com, inc. We have audited the accompanying consolidated statements of operations, changes in
stockholders deficit and cash flows of Claimsnet.com, inc. and subsidiaries for the year ended
December 31, 2003. These financial statements are the responsibility of the Companys management.
Our responsibility is to express an opinion on these consolidated financial statements based on our
audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated results of operations and cash flows of Claimsnet.com, inc. and
subsidiaries for the year ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Note A to the financial statements, the Company has
generated losses since inception, incurred negative cash flows from operations, and has a
stockholders deficit at December 31, 2003. Additionally, management does not believe that
available cash resources, anticipated revenues from operations or proceeds from financing
activities and funding commitments will be sufficient to satisfy the Companys near term capital
requirements. These conditions raise substantial doubt about the Companys ability to continue as
a going concern. These financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts and classification
of liabilities that may result from the outcome of this uncertainty. /s/ KBA Group LLP
Dallas, Texas
January 28, 2004 27




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CLAIMSNET.COM INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In Thousands, Except Share Data) December 31,2004ASSETSCURRENT ASSETSCash and equivalents
    
    $
    68Accounts receivable, net of allowance for doubtful accounts of $5
    
    
    170Prepaid expenses and other current assets
    
    
    22Total current assets
    
    
    260EQUIPMENT, FIXTURES AND SOFTWAREComputer hardware and software
    
    
    1,078Software development costs
    
    
    1,982Furniture and fixtures
    
    
    31Office equipment
    
    
    25Leasehold improvements
    
    
    353,151Accumulated depreciation and amortization
    
    
    (3,078
    )Total equipment, fixtures and software, net
    
    
    73TOTAL ASSETS
    
    $
    333LIABILITIES AND STOCKHOLDERS DEFICITCURRENT LIABILITIESAccounts payable
    
    $
    91Accrued payroll and other current liabilities
    
    
    150Deferred revenues
    
    
    179Notes payable to related parties  short term
    
    
    94Notes payable  short term
    
    
    25Total current liabilities
    
    
    539LONG TERM LIABILITIESNotes payable to related parties  long term
    
    
    200Notes payable  long term
    
    
    200Total long term liabilities
    
    
    400Total liabilities
    
    
    939COMMITMENTS AND CONTINGENCIES
    
    
    STOCKHOLDERS DEFICITPreferred stock, $.001 par value; 4,000,000 shares authorized, 720 shares
of Series D (liquidation preference of $180) and 50 shares of Series E
(liquidation preference of $15) issued and outstanding
    
    
    Common stock, $.001 par value; 40,000,000 shares authorized; 25,226,000
shares issued and outstanding
    
    
    25Additional capital
    
    
    42,985Accumulated deficit
    
    
    (43,616
    )Total stockholders deficit
    
    
    (606
    )TOTAL LIABILITIES AND STOCKHOLDERS DEFICIT
    
    $
    333
 See accompanying notes to consolidated financial statements. 28




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CLAIMSNET.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data) Year Ended December 31,2004
    
    
    2003REVENUES
    
    $
    1,046
    
    
    $
    652COST OF REVENUES
    
    
    663
    
    
    
    616GROSS PROFIT
    
    
    383
    
    
    
    36OPERATING EXPENSES:Research and development
    
    
    
    
    
    
    30Selling, general and administrative
    
    
    1,106
    
    
    
    1,412LOSS FROM OPERATIONS
    
    
    (723
    )
    
    
    (1,406
    )OTHER INCOME (EXPENSE):Interest expense-related parties
    
    
    (17
    )
    
    
    (12
    )Interest expense-other
    
    
    (8
    )
    
    
    (6
    )Loss on sale of business assets
    
    
    
    
    
    
    (27
    )Gain on negotiated settlements of liabilities
    
    
    91
    
    
    
    916Total other income, net
    
    
    66
    
    
    
    871NET LOSS
    
    $
    (657
    )
    
    $
    (535
    )NET LOSS PER SHARE  BASIC AND DILUTED
    
    $
    (0.03
    )
    
    $
    (0.03
    )WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC AND DILUTED
    
    
    24,461
    
    
    
    19,101
 See accompanying notes to consolidated financial statements. 29




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##### Table of Contents



CLAIMSNET.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS DEFICIT
(In Thousands) Number of
    
    
    
    
    
    
    Number ofPreferred
    
    
    
    
    
    
    Common
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    TotalShares
    
    
    Preferred
    
    
    Shares
    
    
    Common
    
    
    Additional
    
    
    Accumulated
    
    
    StockholdersOutstanding
    
    
    Stock
    
    
    Outstanding
    
    
    Stock
    
    
    Capital
    
    
    Deficit
    
    
    DeficitBalances at January 1, 2003
    
    
    3
    
    
    $
    
    
    
    
    14,816
    
    
    $
    15
    
    
    $
    41,275
    
    
    $
    (42,424
    )
    
    $
    (1,134
    )Sale of common stock
    
    
    
    
    
    
    
    
    
    
    3,425
    
    
    
    3
    
    
    
    680
    
    
    
    
    
    
    
    683Issuance of common stock in
payment of notes payable and
accrued interest
    
    
    
    
    
    
    
    
    
    
    375
    
    
    
    
    
    
    
    75
    
    
    
    
    
    
    
    75Warrants exercised for
common stock
    
    
    
    
    
    
    
    
    
    
    1,875
    
    
    
    2
    
    
    
    373
    
    
    
    
    
    
    
    375Preferred stock converted
into common stock
    
    
    (2
    )
    
    
    
    
    
    
    2,701
    
    
    
    3
    
    
    
    (3
    )
    
    
    
    
    
    
    Issuance of common stock for
services
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    2Issuance of warrants and
options to related parties
for services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    180
    
    
    
    
    
    
    
    180Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (535
    )
    
    
    (535
    )Balances at December 31, 2003
    
    
    1
    
    
    
    
    
    
    
    23,201
    
    
    
    23
    
    
    
    42,582
    
    
    
    (42,959
    )
    
    
    (354
    )Issuance of common stock in
payment of notes payable and
accrued interest  related
party
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    5Warrants exercised for
common stock
    
    
    
    
    
    
    
    
    
    
    2,000
    
    
    
    2
    
    
    
    398
    
    
    
    
    
    
    
    400Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (657
    )
    
    
    (657
    )Balances at December 31, 2004
    
    
    1
    
    
    $
    
    
    
    
    25,226
    
    
    $
    25
    
    
    $
    42,985
    
    
    $
    (43,616
    )
    
    $
    (606
    )
 See accompanying notes to consolidated financial statements. 30




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##### Table of Contents



CLAIMSNET.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands) Year Ended December 31,2004
    
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (657
    )
    
    $
    (535
    )Adjustments to reconcile net loss to net cash
used by operating activities:Depreciation and amortization
    
    
    41
    
    
    
    87Common stock and warrants issued for services
    
    
    
    
    
    
    182Provision for doubtful accounts
    
    
    
    
    
    
    (3
    )Loss on sale and write-off of equipment and fixtures
    
    
    
    
    
    
    27Gain on negotiated settlement of liabilities
    
    
    (91
    )
    
    
    (916
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (56
    )
    
    
    40Prepaid expenses and other current assets
    
    
    34
    
    
    
    22Accounts payable, accrued payroll and other current liabilities
    
    
    41
    
    
    
    (152
    )Accrued severance
    
    
    
    
    
    
    (80
    )Deferred revenues
    
    
    (30
    )
    
    
    160Net cash used in operating activities
    
    
    (718
    )
    
    
    (1,168
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of equipment and leasehold improvements
    
    
    (9
    )
    
    
    (26
    )Proceeds from sale of property and equipment
    
    
    
    
    
    
    6Capitalized software development costs
    
    
    (5
    )
    
    
    (55
    )Net cash used in investing activities
    
    
    (14
    )
    
    
    (75
    )CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from notes payable
    
    
    200
    
    
    
    Proceeds from notes payable  related parties
    
    
    220
    
    
    
    100Payments of notes payable  related parties
    
    
    (86
    )
    
    
    (2
    )Proceeds from issuance of common and preferred stock
    
    
    
    
    
    
    683Proceeds from exercise of common stock warrants
    
    
    400
    
    
    
    375Net cash provided by financing activities
    
    
    734
    
    
    
    1,156NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS
    
    
    2
    
    
    
    (87
    )CASH AND EQUIVALENTS, BEGINNING OF YEAR
    
    
    66
    
    
    
    153CASH AND EQUIVALENTS, END OF YEAR
    
    $
    68
    
    
    $
    66SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid for interest
    
    $
    13
    
    
    $
    3SUPPLEMENTAL DISCLOSURES OF NON-CASH FINANCING ACTIVITIES:Payment of notes payable and accrued interest through issuance of
common stock
    
    $
    5
    
    
    $
    75
 See accompanying notes to consolidated financial statements. 31




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CLAIMSNET.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003 NOTE AORGANIZATION, BACKGROUND AND LIQUIDITY Claimsnet.com inc. (Claimsnet.com or the Company) is a Delaware corporation originally formed
in April 1996. The Company owns, operates and licenses software used for processing medical
insurance claims on the internet. The Company completed an initial public offering in April 1999. During 2003, the Company issued an aggregate 2,701,000 shares of common stock upon conversion and
surrender of 2,701 shares of preferred stock by the holders thereof, issued 1,875,000 shares of
common stock to accredited investors at $.20 per share upon exercise of previously issued warrants,
and sold 3,800,000 shares of common stock to accredited investors at $.20 per share. During 2003,
the Company borrowed an aggregate of $100,000 pursuant to an unsecured short-term loan agreement
with NFC, a related entity, and repaid NFC an aggregate of $52,000 plus accrued interest at 9.5%.
During 2003, the Company repaid $15,000 plus accrued interest related to an unsecured note payable
to a 5% shareholder. During 2004, the Company issued 2,000,000 shares of common stock to accredited investors at $.20
per share upon exercise of previously issued warrants, and issued 25,000 shares of common stock to
a related entity in retirement of an aggregate of $1,000 unsecured short-tem loan plus accrued
interest at 9.5%. During 2004, the Company borrowed an aggregate of $20,000 pursuant to an
unsecured short-term loan agreement with NFC, a related entity, and repaid NFC an aggregate of
$86,000 plus accrued interest at 9.5%. During 2004, the Company borrowed an aggregate of $200,000
pursuant to convertible long-term loan agreements, and an aggregate of $200,000 pursuant to
convertible long-term loan agreements with Elmira, a related entity. In January 2005, the Company issued 400,000 shares of common stock to NFC, a related entity, at
$.25 per share for net proceeds of $100,000. The Company has generated losses since inception and has incurred negative cash flow from
operations. Through 2004, the Company generated minimal revenues and relied on an initial public
offering, private equity placements, secured and unsecured debt, the sale of certain assets, and
funding from a related entity to fund its operations and development activities. The Companys
business strategy and organization has been modified on several occasions to improve near-term
financial performance. Management believes that available cash resources, together with anticipated revenues from
operations and the proceeds of recently completed financing activities and funding commitments may
not be sufficient to satisfy the Companys capital requirements through December 31, 2005.
Necessary additional capital may not be available on a timely basis or on acceptable terms, if at
all. Accordingly, the Company may be unable to implement current plans for expansion or to repay
debt obligations as they become due. If sufficient capital cannot be obtained, the Company may be
forced to significantly reduce operating expenses to a point which would be detrimental to business
operations, curtail research and development activities, sell business assets or discontinue some
or all of its business operations, take other actions which could be detrimental to business
prospects and result in charges which could be material to the Companys operations and financial
position, or cease operations altogether. In the event that any future financing is effected, to
the extent it includes equity securities, the holders of the common stock and preferred stock may
experience additional dilution. In the event of a cessation of operations, there may not be
sufficient assets to fully satisfy all creditors, in which case the holders of equity securities
may be unable to recoup any of their investment. NOTE BSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION The accompanying consolidated financial statements include the accounts of Claimsnet.com and its
subsidiaries. All material intercompany accounts and transactions have been eliminated in
consolidation. CASH AND EQUIVALENTS Cash and equivalents include time deposits, certificates of deposits and all highly liquid debt
instruments with original maturities of three months or less when purchased. 32




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##### Table of Contents



REVENUE RECOGNITION The Company generally enters into services agreements with its customers to provide access to its
software application for processing of customer transactions. The Company operates the software
application for all customers and the customers are not entitled to ownership of the Companys
software at any time during or at the end of the agreements. The customers either host the
application on their own servers or access the Companys hosted software platform via the internet.
Customers pay implementation fees, transaction fees, and time and materials charges for additional
services. Revenues primarily include fees for implementation and transaction fees, which may be
subject to monthly minimum provisions. Customer agreements may also provide for development fees
related to private labeling of the Companys software platform (i.e. access to the Companys
servers through a web site which is in the name of and/or has the look and feel of the customers
other web sites) and some customization of the offering and business rules. The Company accounts
for its service agreements by combining the contractual revenues from development, implementation,
license, support and certain additional service fees and recognizing the revenue ratably over the
expected period of the business arrangement. The Company currently uses an estimated expected
business arrangements term of three years, which is currently the term of the typical contract
signed by its customers. The Company does not segment these services and uses the underlying
contractual terms to recognize revenue because it does not have objective and reliable evidence of
fair value to allocate the arrangement consideration to the deliverables in the arrangement. To
the extent that implementation fees are received in advance of recognizing the revenue, the Company
defers these fees and records deferred revenue. The Company recognizes service fees for
transactions and some additional services as the services are performed. The Company expenses the
costs associated with its customer service agreements as those costs are incurred. SOFTWARE FOR SALE OR LICENSE The Company begins capitalizing costs incurred in developing a software product once technological
feasibility of the product has been determined. Software development costs of $17,000 were
amortized in 2004 related to software development costs capitalized during the year ended December
31, 2003 totaling $55,000. There was no amortization expense related to software development costs
capitalized during the year ended December 31, 2004 totaling $5,000 due to the future release dates
of the new software. Capitalized computer software costs include direct labor and labor-related
costs. The software is amortized after it is put into use over its expected useful life of 3
years. Management evaluates the recoverability, valuation, and amortization of capitalized software costs
to be sold, leased, or otherwise marketed whenever events or changes in circumstances indicate that
the carrying amount of the software may not be recoverable. As part of this review, management
considers the expected undiscounted future net cash flows. If the cash flows are less than the
stated value, capitalized software costs would be written down to fair value. EQUIPMENT, FIXTURES AND INTERNAL USE SOFTWARE Equipment and fixtures are stated at cost. Depreciation is provided using the straight-line method
over the estimated useful lives of the depreciable assets which range from three to seven years.
Maintenance and repairs are expensed as
incurred. Significant replacements and betterments are capitalized. Depreciation
expense related to equipment and fixtures totaled $23,000 and $46,000 in 2004 and 2003,
respectively. The Company applies Statement of Position 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. No internal use development costs were capitalized in
2004 or 2003. This software is amortized over its expected useful life of three years.
Amortization expense related to costs of software developed or obtained for internal use totaled
$1,000 and $41,000 in 2004 and 2003, respectively. INCOME TAXES Deferred income taxes are provided for the tax effects of differences between the carrying amounts
of assets and liabilities for financial reporting purposes and the amounts used for income tax
purposes. Valuation reserves are provided for the deferred tax assets when, based on available
evidence, it is more likely than not that some portion or all of the deferred tax assets will not
be realized. 33




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NOTE BSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) LOSS PER SHARE Basic net loss per share is computed by dividing net loss by the weighted average number of common
shares outstanding for the period. Diluted net loss per share is computed by dividing net loss by
the weighted average number of common shares and dilutive common stock equivalents outstanding for
each respective year. Common stock equivalents, representing convertible Preferred Stock, options
and warrants totaling approximately 11,433,385 and 12,839,539 shares at December 31, 2004 and 2003,
respectively, are not included in the diluted loss per share as they would be antidilutive.
Accordingly, diluted and basic loss per share are the same. COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130). SFAS 130 requires that
total comprehensive income (loss) be disclosed with equal prominence as net income (loss). The
Companys comprehensive net loss is equal to its net loss for both years presented. STOCK-BASED COMPENSATION The Company accounts for employee stock awards in accordance with Accounting Principles Board
Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. Under APB 25, the Company
recognizes no compensation expense related to employee stock awards when awards are granted with
exercise prices equal to the estimated fair value of the stock on the date of grant. The Company
provides the supplemental disclosures required by Statement of Financial Accounting Standard No.
123 (SFAS 123), Accounting for Stock-Based Compensation, as amended by SFAS No 148, Accounting
for Stock-Based Compensation - Transition and Disclosure, which assumes the recognition of
compensation expense based on the fair value of options on the grant date. The Company follows the
provisions of SFAS 123, as amended, and Emerging Issues Task Force No. 96-18, Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Connection with
Selling Goods or Services, for equity instruments granted to non-employees. SFAS 123, as amended, requires the disclosure of pro forma net loss and net loss per share as if
the Company applied the fair value method. The Companys computations for employee grants were made
using a Black-Scholes model using the following assumptions: 2004- expected life of ten years;
weighted average risk free rate of 4.0%; no dividends during the expected life; and a weighted
average volatility of 150%; 2003 - expected life of ten years; risk free rate of 3.5%; no dividends
during the expected life; and a volatility of 204%. If the computed fair values of all the Companys stock based awards were amortized to expense over
the vesting period of the awards as specified under SFAS 123, as amended, net loss would have been: Year Ended December 31,2004
    
    
    2003Net loss (thousands)As reported
    
    $
    657
    
    
    $
    535Add: Stock-based compensation expense included in net loss
    
    
    
    
    
    
    Deduct: Stock-based compensation expense
determined under the fair value based method
    
    
    236
    
    
    
    117Pro forma
    
    $
    893
    
    
    $
    652Loss per shareAs reported
    
    $
    0.03
    
    
    $
    0.03Pro forma
    
    $
    0.04
    
    
    $
    0.03
 34




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NOTE BSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SEGMENT REPORTING The Company operated during the two years presented in a single segment when applying the
management approach defined in Statement of Financial Accounting Standards No. 131, Disclosures
about Segments of an Enterprise and Related Information. CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS Revenues from two customers represented a significant portion of the Companys total revenues
during 2004 and 2003. Revenues received from one customer represented 29% and 69% of the Companys
revenues for 2004 and 2003, respectively, and revenues received from another customer represented
24% and 24%, respectively, during 2004 and 2003. Trade accounts receivable are stated at the amount the Company expects to collect. The Company
maintains allowances for doubtful accounts for estimated losses resulting from the inability of its
customers to make required payments. Management considers the following factors when determining
the collectibility of specific customer accounts: customer credit-worthiness, past transaction
history with the customer, current economic industry trends, and changes in customer payment terms.
If the financial condition of the Companys customers were to deteriorate, adversely affecting
their ability to make payments, additional allowances would be required. Based on managements
assessment, the Company provides for estimated uncollectible amounts through a charge to earnings
and a credit to a valuation allowance. Balances that remain outstanding after the Company has used
reasonable collection efforts are written off through a charge to the valuation allowance and a
credit to accounts receivable. The Company generally does not require collateral. At December 31,
2004, the Company had three customers that made up 80% of the outstanding accounts receivable
balance. At December 31, 2003, the Company had two customers that made up 77% of the outstanding
accounts receivable balance. USE OF ESTIMATES AND ASSUMPTIONS Management uses estimates and assumptions in preparing financial statements in accordance with
generally accepted accounting principles. Those estimates and assumptions affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the
reported amounts of revenues and expenses. On an ongoing basis, management evaluates its
estimates, including those related to customer programs and incentives including expected customer
business arrangement periods, bad debts, intangible assets, and contingencies and litigation.
Estimates are based on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily apparent from other
sources. Estimates could change based on changing historical experience and changes in
circumstances and assumptions. Actual results could vary from the estimates that were used. ADVERTISING COSTS Advertising costs are expensed as incurred. Advertising costs of $46,000 and $40,000 were incurred
for the years ended December 31, 2004 and 2003, respectively. RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the FASB issued SFAS 123R, Share-Based Payment, which is a revision of SFAS 123
Accounting for Stock-Based Compensation and supersedes APB Opinion 25, Accounting for Stock
Issued to Employees. SFAS 123R focuses primarily on share-based payments for employee services,
requiring these payments to be recorded using a fair-value-based method. The use of APB 25s
intrinsic value method of accounting for employee stock options has been eliminated. As a result,
the fair value of stock options granted to employees in the future will be required to be expensed.
The impact on the results of operations of the Company will be dependent on the number of options
granted and the fair value of those options. For the Company, FASB 123R will be effective in 2006. NOTE CSALE OF ASSETS On September 11, 2002 the Company sold certain assets consisting primarily of customer contracts
(the Assigned Contracts) and related revenue streams thereunder to ProxyMed, Inc. (Purchaser)
in a negotiated arms-length transaction for purchase price consideration of $700,000. The Company
received cash consideration of $690,000, net of contractual expenses, recognized a gain of $640,000
on the sale, and recorded $50,000 as deferred revenue. 35




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NOTE CSALE OF ASSETS (CONTINUED) The Company and Purchaser also entered into an Affiliate and Partner Services and License Agreement
dated September 11, 2002, pursuant to which (i) the Company and Purchaser have agreed to provide
certain administrative and support services for each other in connection with each others
customers, including without limitation the customers under the Assigned Contracts, in each case
pursuant to an agreed upon fee schedule, (ii) the Company has agreed to assist Purchaser in
establishing a hot-site which will permit Purchaser to run from its own hardware platform, the
Companys software application to service Purchasers customers, and (iii) the Company granted
Purchaser a limited, non-exclusive, 5-year license to use the Companys software application at its
hot-site. The Company is entitled to receive fees for its services and use of the Companys
software application unless and until the occurrence of certain bankruptcy and liquidation events
set forth in such agreement in respect of the Company. In addition to the transaction fees, the
Company is also recognizing the $50,000 of deferred revenue ratably over the term of the agreement. The Company and Purchaser also entered into a Preferred Escrow Agreement with DSI Technology Escrow
Services, Inc., pursuant to which the Company has deposited into escrow its proprietary claims
processing software and related materials for potential release to Purchaser for use pursuant to a
limited, non-exclusive license upon the occurrence of certain bankruptcy and liquidation events. NOTE DINCOME TAXES There was no provision or benefit for federal or state income taxes during the two years ended
December 31, 2004 and 2003. The differences between the actual income tax benefit and the amount computed by applying the
statutory federal tax rate to the loss before incomes taxes are as follows: Year Ended December 31,2004
    
    
    2003Benefit computed at federal statutory rate
    
    $
    (223,306
    )
    
    $
    (182,145
    )Permanent differences
    
    
    29,593
    
    
    
    99,146State income tax benefit, net of federal
tax effect at state statutory rate
    
    
    (19,703
    )
    
    
    (14,922
    )Increase in valuation reserve
    
    
    130,260
    
    
    
    230,977Change in prior year estimate
    
    
    83,156
    
    
    
    (130,570
    )Other
    
    
    
    
    
    
    (2,486
    )$
    
    
    
    $
    
 The components of the deferred tax assets and liabilities are as follows: December 31,2004
    
    
    2003Deferred tax assets:Net operating loss carryforwards
    
    $
    15,431,549
    
    
    $
    15,240,798Fixed assets
    
    
    
    
    
    
    39,044Allowance for doubtful accounts
    
    
    1,886
    
    
    
    3,397Deferred revenue
    
    
    65,977
    
    
    
    76,621Other
    
    
    27,120
    
    
    
    24,166Total deferred tax assets
    
    
    15,526,532
    
    
    
    15,384,026Valuation allowance for deferred tax assets
    
    
    (15,514,286
    )
    
    
    (15,384,026
    )12,246
    
    
    
    Deferred tax liabilities:Fixed assets
    
    
    (12,246
    )
    
    
    Deferred
income tax assets, net of deferred tax liabilities
    
    $
    
    
    
    $
    
 36




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##### Table of Contents



NOTE DINCOME TAXES (CONTINUED) At December 31, 2004, the Company has approximately $41,900,000 of federal net operating loss
carryforwards, which begin to expire in 2012 subject to certain limitations as described below.
The Company has approximately $25,600,000 of state net operating losses as of December 31, 2004. As a result of stock issued during 2001, 2002, 2003 and 2004, the Company may have experienced an
ownership change as defined in Internal Revenue Code section 382. As a result, the Companys
ability to use net operating loss carryforwards and certain other deductions to offset future
taxable income may be limited. The annual limit is an amount equal to the value of the Company at
the date of an ownership change multiplied by approximately 5%. In addition, as the ability to
generate future taxable income is highly uncertain, the Company has recorded valuation allowance
against all of its net deferred tax assets. NOTE ERELATED PARTY TRANSACTIONS In September and December 2004, the Company borrowed an aggregate of $200,000 pursuant to two
separate convertible long-term loan agreements with a 5% shareholder. In June 2004, the Company entered into an unsecured loan agreement in the amount of $20,000
pursuant to an unsecured short-term loan agreement with National Financial Corporation, a related
party. In December 2004, upon the demand of NFC, the Company repaid principal on the above note in
the aggregate amount of $20,000 plus accrued interest thereon. In June 2003, the Company issued warrants to two directors as compensation for services outside of
their director duties. (See Note F). In May 2003, the Company entered into an unsecured loan agreement in the amount of $100,000
pursuant to an unsecured short-term loan agreement with NFC. In June 2003, upon the demand of NFC,
the Company repaid principal on the above note in the aggregate amount of $32,000 by issuing
160,000 shares of Company common stock and warrants to purchase 160,000 shares of Company common
stock. Also in June 2003, an aggregate of $2,000 plus accrued interest on the note was paid. In
December 2004, upon the demand of NFC, the Company repaid principal on the above note in the
aggregate amount of $66,000 plus accrued interest thereon. NOTE FSTOCKHOLDERS DEFICIT In September 2004, the Company issued ten-year warrants to acquire an aggregate of 550,000 shares
of common stock to certain employees at an exercise price of $0.29 per share. In June 2004, the Company completed the private placement of 25,000 shares of common stock to a
director of the company at $0.20 per share, resulting in the extinguishment of $1,000 of notes
payable and $4,000 of accrued interest. In connection with this private placement, the Company
also issued warrants to a director to purchase 25,000 shares of common stock. This warrant contains
an exercise price of $0.20 per share and expires December 31, 2007. Between February and August 2004, Elmira United Corporation (Elmira), a 5% shareholder, exercised
previously issued warrants to purchase 2,000,000 shares of the Companys common stock for $400,000
($0.20 per share). During 2003, the Company completed the private placement of 3,800,000 shares of common stock to
accredited investors at $0.20 per share, resulting in net proceeds of $683,000 and the
extinguishment of $75,000 of notes payable and accrued interest. In connection with these private
placements, the Company also issued warrants to the investors to purchase an aggregate of 3,800,000
shares of common stock. These warrants contain an exercise price of $0.20 per share and expire
December 31, 2007. These private placements included 350,000 shares of common stock plus warrants
to acquire an additional 350,000 shares of common stock purchased by NFC for net proceeds of
$20,000 and retirement of debt of $50,000; 2,125,000 shares of common stock plus warrants to
acquire an additional 2,125,000 shares of common stock purchased by Elmira, which owned at the time
more than 5% of the outstanding shares of our common stock for net proceeds of $425,000; 100,000
shares of common stock plus warrants to acquire an additional 100,000 shares of common stock
purchased by a 5% shareholder for retirement of debt plus accrued interest of $20,000; and 150,000
shares of common stock plus warrants to acquire an additional 150,000 shares of common stock
purchased by a director of the Company for net proceeds of $25,000 and payment of accrued interest
of $5,000. 37




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In November 2003, the Company issued 9,000 shares of common stock to a non-employee for
professional services rendered. The stock was valued at $0.25 per share, the closing price on the
date of grant. The Company recognized an expense of $2,250 related to the stock grant. In June 2003, the Company issued ten-year warrants to acquire an aggregate of 3,450,000 shares of
common stock to certain employees at an exercise price of $0.15 per share. In June 2003, the
Company issued ten-year warrants to acquire an aggregate of 1,200,000 shares of common stock to two
directors as compensation for services outside of their director duties at an exercise price of
$0.15 per share. The 1,200,000 warrants were valued at $0.15 per warrant resulting in a total
charge against earnings on the date of grant of approximately $180,000 based on the Black-Scholes
valuation method. The warrants were valued using the following assumptions: expected life of ten
years, risk free rate of 4.77%, no dividends during the term, and a volatility of 204%. From May through August 2003, the Company issued an aggregate 2,701,000 shares of common stock upon
conversion and surrender of 2,584 shares of Series D and 117 shares of Series E preferred stock by
the holders thereof. Between April and December 2003, Elmira, a 5% shareholder, exercised previously issued warrants to
purchase 1,875,000 shares of the Companys common stock for $375,000 ($0.20 per share). The Company used $217,000 of the proceeds from the 2003 private placement and warrant exercise to
make payments pursuant to creditor agreements, as described in Note I to the consolidated financial
statements. NOTE G STOCK BASED COMPENSATION ARRANGEMENTS The Companys 1997 Plan provides for the issuance to employees, officers, directors, and
consultants of incentive and/or non-qualified options to acquire 1,307,692 shares of common stock.
The options are to be issued at fair market value, as defined, and generally vest 25% each
anniversary of the date of the option grant. Options generally expire 10 years from the date of
grant and automatically expire on termination of employment. The Companys Directors Plan provides for the issuance to non-employee directors of options to
acquire 361,538 shares of common stock. The options are to be issued at fair market value, as
defined, and vest on the first anniversary from the date of the option grant. Options generally
expire 10 years from the date of grant and automatically expire one year from the date upon which
the participant ceases to be a Director. The following table summarizes the stock option activity under the two Plans related to the
Company: WEIGHTEDAVERAGENUMBER
    
    
    PER SHARE
    
    
    EXERCISEOF SHARES
    
    
    EXERCISE PRICE
    
    
    PRICEOutstanding options-January 1, 2003
    
    
    1,060,567
    
    
    $
    0.30-8.00
    
    
    $
    2.23Granted
    
    
    
    
    
    
    
    
    
    
    Expired
    
    
    (361,125
    )
    
    
    7.00-8.00
    
    
    
    2.61Outstanding options-December 31, 2003
    
    
    699,442
    
    
    
    0.30-8.00
    
    
    
    2.04Granted
    
    
    500,000
    
    
    
    0.35
    
    
    
    0.35Expired
    
    
    
    
    
    
    
    
    
    
    Outstanding options-December 31, 2004
    
    
    1,199,442
    
    
    $
    0.30-8.00
    
    
    $
    1.33Options exercisable-December 31, 2004
    
    
    699,442
    
    
    $
    0.30-8.00
    
    
    $
    2.04
 Outstanding options as of December 31, 2004, had a weighted average remaining contractual life of
approximately 7.6 years. No compensation expense has been recognized for options granted to
employees in 2004. There were no stock options granted to employees during 2003. At December 31,
2004, options available for grant under the Companys 1997 Plan were 138,250, and under the
Companys Directors Plan were 331,538. 38




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##### Table of Contents



The following table summarizes the warrant activity related to employee grants: WEIGHTEDNUMBER
    
    
    PER SHARE
    
    
    AVERAGEOF SHARES
    
    
    EXERCISE PRICE
    
    
    EXERCISE PRICEOutstanding warrants- January 1, 2003
    
    
    459,227
    
    
    $
    0.20-3.00
    
    
    $
    0.54Granted
    
    
    3,450,000
    
    
    
    0.15
    
    
    
    0.15Expired
    
    
    (204,284
    )
    
    
    0.35-3.00
    
    
    
    0.66Outstanding warrants-December 31, 2003
    
    
    3,704,943
    
    
    
    0.15-3.00
    
    
    
    0.17Granted
    
    
    550,000
    
    
    
    0.29
    
    
    
    0.29Expired
    
    
    (200,000
    )
    
    
    0.15
    
    
    
    0.15Outstanding warrants-December 31, 2004
    
    
    4,054,943
    
    
    $
    0.15-3.00
    
    
    $
    0.19Warrants exercisable-December 31, 2004
    
    
    1,338,276
    
    
    $
    0.15-3.00
    
    
    $
    0.20
 Outstanding employee warrants as of December 31, 2004, had a weighted average contractual life of
approximately 5.7 years. NOTE HNOTES PAYABLE TO RELATED PARTIES AND OTHER NOTE PAYABLE The following is a summary of notes payable at December 31, 2004: Note payable to a Director. Principal due
on demand; unsecured. Interest payable at 9.5%.
    
    $
    49,000Note payable to a 5% shareholder. Principal due
on demand; unsecured. Interest payable at 9.5%.
    
    
    35,000Note payable to a 5% shareholder. Principal due August 31,
2005; unsecured. Interest payable at 8%.
    
    
    10,000Notes payable
 related party
    
    $
    94,000Note payable. Principal due August 31,
2005; unsecured. Interest payable at 8%.
    
    $
    25,000Notes payable
    
    $
    25,000
 The following is a summary of convertible notes payable at December 31, 2004: Convertible note to a 5% shareholder. Principal due
September 22, 2007; unsecured. Interest payable at 7%.
    
    $
    50,000Convertible note to a 5% shareholder. Principal due
December 28, 2007; unsecured. Interest payable at 7%.
    
    
    150,000Convertible
notes payable  related party
    
    $
    200,000Convertible note. Principal due September 21, 2007; unsecured.
Interest payable at 7%.
    
    $
    50,000Convertible note. Principal due October 4, 2007; unsecured.
Interest payable at 7%.
    
    
    50,000Convertible note. Principal due October 5, 2007; unsecured.
Interest payable at 7%.
    
    
    100,000Convertible notes payable
    
    $
    200,000
 39




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##### Table of Contents



The convertible notes bear interest at the rate of 7.0% per annum. Payments equal to the
principal and accrued and unpaid interest on the note are due in 2007. At the option of the
holder, at any time or from time to time prior to the maturity date, all or any portion of the
outstanding principal and interest may be converted into a number of shares of the Companys
common stock at a conversion price of $0.40 per share. The following are the maturities of notes payable for years ended December 31: 2005
    
    $
    119,0002006
    
    
    02007
    
    
    400,000Total
    
    $
    519,000
 NOTE I GAIN ON SETTLEMENT OF LIABILITIES In May 2004, the Company entered into a settlement agreement with a creditor, contingent upon the
Company making payment within twenty days of the date of agreement. When the agreed payment was
made by the Company, the creditor released the Company from all other liabilities. The agreement
entered into required a payment totaling $20,000 to settle certain accounts payable totaling
$111,000, resulting in a gain on settlement of liabilities totaling $91,000. During March and April 2003, the Company entered into settlement agreements with various creditors,
contingent upon the Company making payment within ten days of the date of agreement. When the
agreed payment was made by the Company, each creditor released the Company from all other
liabilities. The agreements entered into required payments totaling $217,000 to settle certain
accounts payable, accrued severance and accrued acquisition cost liabilities totaling $1,133,000,
resulting in a gain on settlement of liabilities totaling $916,000. NOTE JCOMMITMENTS AND CONTINGECIES The Company leases office space under a lease agreement that expires on May 31, 2006. Rent expense
totaled $47,000 and $109,000 for the years ended December 31, 2004 and 2003, respectively. The
Company leases servers and Web server management facilities under an agreement that expires in
2005. The Company has also entered into a software license commitment related to HIPAA validation
software totaling $20,000 per year that expires in 2006. The Companys aggregate lease and software
license commitments are shown below. Year ended December 31,2005
    
    $
    95,8702006
    
    
    19,596
 From time to time in the normal course of business, the Company is a party to various matters
involving claims or possible litigation. Currently there are no such asserted claims. NOTE KRETIREMENT PLAN The Company utilizes a third party for the processing and administration of its payroll and
benefits. Under the agreement, the third party is legally a co-employer of all of the Companys
employees, which are covered by the third partys 401(k) retirement plan. Under the plan, employer
contributions are discretionary. During 2004, the Company made $7,000 in matching contributions and
$3,000 in fee contributions. The Company made no contributions to the plan during 2003. NOTE LFAIR VALUE OF FINANCIAL INSTRUMENTS SFAS 107, Disclosure About Fair Value of Financial Instruments, requires disclosure about the
fair value of all financial assets and liabilities for which it is practicable to estimate. Cash,
accounts receivable, accounts payable, notes payable and other liabilities are carried at amounts
that reasonably approximate their fair values. 40




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##### Table of Contents



NOTE MSUBSEQUENT EVENTS In January 2005, the Company issued 400,000 shares of common stock to NFC, a related entity, at
$0.25 per share for net proceeds of $100,000. 41




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##### Table of Contents



ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On April 26, 2004, KBA Group LLP, which served as our independent public accountants since February
2003, notified us of their intention not to stand for re-election as our principal accountants. The
report issued by KBA Group LLP on the financial statements for the years ended December 31, 2003
and 2002 did not contain an adverse opinion nor a disclaimer of opinion, and was not qualified or
modified as to uncertainty, audit scope or accounting principles except that each such report
included an explanatory paragraph describing conditions that raised substantial doubt about our
ability to continue as a going concern. In connection with their audits for the years ended
December 31, 2003 and 2002 and through April 26, 2004, there were no disagreements with KBA Group
LLP on any matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which disagreements, if not resolved to the satisfaction of KBA Group
LLP, would have caused KBA Group LLP to make reference thereto in their report on the financial
statements for such years or such interim periods. KBA Group LLP furnished us with a letter
addressed to the Commission stating that it agrees with the above statements. A copy of such
letter, dated April 27, 2004, is filed as Exhibit 16 to the Form 8-K, dated April 28, 2004. We engaged Whitley Penn as our new independent auditors as of April 26, 2004. Our Board of
Directors approved the engagement. During the two most recent fiscal years and through April 26,
2004, we had not consulted with Whitley Penn with respect to the application of accounting
principles to a specified transaction, either completed or proposed, or the type of audit opinion
that might be rendered on our consolidated financial statements, or any other matters or reportable
events as set forth in Items 304(a)(1)(iv) of Regulation S-B. We allowed Whitley Penn to review
the aforementioned Form 8-K before it was filed with the Commission. Whitley Penn has not furnished
us with a letter containing any new information, clarification, or disagreement with the
information set forth herein. 
 ITEM 8A. CONTROLS AND PROCEDURES. The Companys management, including the Companys principal executive officer and principal
financial officer, has evaluated the effectiveness of the Companys disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934)
as of the year ended December 31, 2004, the period covered by the Annual Report on Form 10-KSB.
Based upon that evaluation, the Companys principal executive officer and principal financial
officer have concluded that the disclosure controls and procedures were effective as of December
31, 2004 to provide reasonable assurance that material information relating to the Company is made
known to management including the CEO and CFO. There were no changes in the Companys internal control over financial reporting that occurred
during the Companys last fiscal quarter of 2004 that have materially affected, or are reasonable
likely to materially affect, the Companys internal control over financial reporting. 
 ITEM 8B. OTHER INFORMATION. None. 42




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##### Table of Contents



PART III 
 ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a)
OF THE EXCHANGE ACT. MANAGEMENT
Our directors and executive officers, their ages, and their positions held with us are as follows: NAME
    
    AGE
    
    POSITIONDon Crosbie
    
    61
    
    President, Chief Executive Officer, Chairman of the Board of Directors and Class I DirectorLaura M. Bray
    
    47
    
    Chief Financial OfficerGary J. Austin
    
    60
    
    Chief Operating OfficerAlfred Dubach
    
    57
    
    Vice Chairman of the Board of Directors and Class I DirectorJohn C. Willems, III
    
    49
    
    Class II DirectorJeffrey M. Black
    
    48
    
    Class I DirectorThomas Michel
    
    53
    
    Class II DirectorMike Hix
    
    44
    
    Vice President of SalesK. Scott Spurlock
    
    37
    
    Vice President of Development
 The following is certain summary information with respect to our executive officers, directors and
key employees. DON CROSBIE has served as our President, Chief Executive Officer and Chairman of the Board since
October 2002. From July 2001 until October 2002, Mr. Crosbie was President and CEO of Xactimed, a
claims processing and clearinghouse company serving the hospital market. In the year he was at
Xactimed, it experienced a dramatic turnaround, with revenue growing 150% over the prior year and
an operating profit was achieved as compared to a significant operating loss for the prior year.
From September 2000 to July 2001, Mr. Crosbie served as CFO and President of North American
Operations of Blue Wave Systems, a high density DSP board supplier to the telecom infrastructure
market, including media gateways and 2 -1/2 and 3 G wireless. He joined Blue Wave with a corporate
strategic direction to identify and complete a sale of the company. This was accomplished in July
2001 with the sale of the company to Motorola for $125 million. From September 1999 to June 2000,
Mr. Crosbie served as President, COO and CFO of Ypay.com, an internet start up company in the free
ISP/media rich advertising space. From June 1997 to December 1998, Mr. Crosbie served as CEO of
Rheumatology Research International, a Site Management Organization performing clinical trials for
pharmaceutical and biotech companies in pre-FDA approval trials for new arthritis drugs. Prior to
Rheumatology Research International, Mr. Crosbie served as founder, Chairman and CEO of ComVest
Partners Inc., an institutional research boutique with an emphasis on networking, wireless, voice
and remote access; and Executive Vice President and Chief Financial Officer of InterVoice Inc, a
high technology provider of customized voice response systems. LAURA M. BRAY, a Certified Public Accountant, was promoted to Chief Financial Officer in November
2004. Ms. Bray joined Claimsnet in January 2003 as Controller from Xactimed, where she served as
Controller. Xactimed is a claims processing and clearing house company serving the hospital market.
Ms. Bray has more than 20 years of financial management experience, including Accounting Manager
of Blue Wave Systems, a high density DSP board supplier to the telecom infrastructure market, and
Controller of EFS, a software sales and document management services firm. Ms. Bray began her
career in the audit division of Alexander Grant & Co., followed by more than ten years as Business
Manager and Controller in the radio broadcasting industry. GARY J. AUSTIN joined us in March 2004 as our Chief Operating Officer. From September 2002 to
December 2003, Mr. Austin served as the President and Chief Operating Officer of Gold Lake
Technologies Corporation, a document management services firm. From March 1999 to September 2002,
Mr. Austin served as the Senior Vice President and Chief Operating Officer of GTESS Corporation, a
health claim processing service provider. Mr. Austin previously held a variety of executive and
management positions with Peerless Group, Electronic Data Systems, Shared Medical Systems, and
Crittenden Memorial Hospital. ALFRED DUBACH has served as the Vice Chairman of our board of directors since January 2002. He has
been an independent business consultant and financial advisor in Zurich, Switzerland for more than
10 years, working with non-food consumer goods, luxury goods, cosmetics, retail and wholesale,
banking, e-banking, e-commerce, and pharmaceuticals. From March 2001 to February 2002, Mr. Dubach
served as the Chief Investment Officer for Swissquote Bank and a member of the Executive Management
Team that developed the first pure Internet Bank in Switzerland.
CASH magazine voted Swissquote Bank the best Swiss online broker in Autumn 2001 and the bank
reached a market 43




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##### Table of Contents



share of twenty percent by the end of 2001. From June 1994 to February 2001, Mr.
Dubach was a Director of Credit Suisse, where he served as a member of the project team for the
legal integration of Volksbank and Credit Suisse as well as the restructuring of the Credit Suisse
Group. Prior to June 1994, Mr. Dubach served in several capacities within management and executive
management in the pharmaceutical industry and other leading Swiss banks (Louis Widmer Intl, Union
Bank of Switzerland, Swiss Volksbank). JOHN C. WILLEMS, III has served as a director of our Company since 1998 and has been our legal
counsel since April 1996. Since September 1993, Mr. Willems has been an attorney with the law firm
of McKinley, Ringer & Zeiger, PC, in Dallas, Texas, practicing in the area of business law. From
January 1992 to August 1993, Mr. Willems was an attorney in the law firm of Settle & Pou, PC, also
located in Dallas, Texas. JEFFREY M. BLACK was elected a director of our Company in February 2002. He has been engaged for
over 20 years in advising and developing publicly traded companies in strategic planning and
procedures for many aspects concerning the business of operating in a public arena. For the past
18 months Mr. Black has concentrated much of his efforts on Connectifi, Inc., a national Wireless
Internet Service Provider (WISP), that primarily targets the recreational vehicle resort industry
by building wireless high-speed PoPs. Mr. Black serves Connectifi, Inc. which he founded as a
director and investor. THOMAS MICHEL was elected as a director of our Company in February 2002. Since 1996, Mr. Michel
has been a Principal of Switzerland based CIMA Consulting, AG, of which he was a founder, and which
provides financial and fund raising services in the form of venture capital, private equity, and
bridge loan facilities. From 1980 to 1996, he served in various capacities at Swiss Bank
Corporation in Zurich, Switzerland. Mr. Michel currently serves on the Board of Directors for Best
243 AG, and Spirit of Covey AG, a manufacturer of natural skincare products. MIKE HIX was promoted to Vice President of Sales in July 2004. Mr. Hix joined Claimsnet in March
2003 as Sales Executive. Mr. Hix has more than 20 years of sales and management experience in the
Healthcare industry. From 1985 to 1999, Mr. Hix held a variety of sales and management positions
with Electronic Data Systems, who deliver cutting edge claims processing, finance administration,
and disease management applications to key healthplans worldwide. From 1999 to 2004, Mr. Hix
served as the Director of Sales of Infowise Solutions, which provided packaged, CRM enterprise
reporting solutions for Healthcare and other industries to deliver business value utilizing todays
leading edge business intelligence technologies and as National Sales Executive of HNC Software, a
leading provider of predictive solutions and medical bill repricing software and Business Process
Outsourcing (BPO) to the Health Insurance industry. K. SCOTT SPURLOCK has served as our Vice President of Development since joining us in June of 1997
through our acquisition of Medica Systems, Inc., a software development company serving the
healthcare industry. From September 1994 through June 1997, Mr. Spurlock served as the Vice
President and acted as architect and lead developer of a majority of the software developed by
Medica. Mr. Spurlock has extensive software development experience in the healthcare arena,
including more than a decade developing software for medical electronic data interchange (EDI).
From August 1993 to September 1994, Mr. Spurlock was a Senior Developer for Vision Software, a
vendor of healthcare practice management system software. Previously, Mr. Spurlock was an
independent consultant developing customized accounting, appointment and patient record programs
for various hospitals and medical groups. Messrs. Crosbie, Austin and Ms. Bray are our executive officers. STRUCTURE OF THE BOARD OF DIRECTORS The Board of Directors is divided into two classes with each class consisting of, as nearly as
possible, one-half of the total number of directors constituting the entire board of directors. The
Class I directors currently are Messrs. Crosbie, Dubach and Black, whose terms expire at the next
annual meeting of stockholders, which we expect to hold in 2005. The Class II directors currently
are Messrs. Willems and Michel, whose terms expire at the following annual meeting of stockholders.
Each director is elected for a term of two years, except when the election is by the Board to fill
a vacancy, in which case, the directors term expires at the next annual meeting of stockholders. There are no family relationships among our directors and executive officers. AUDIT COMMITTEE At present, we do not have a separately standing audit committee and our entire board of directors
acts as our audit committee. None of the members of our board of directors meet the definition of
audit committee financial expert as
defined in Item 401(e) of Regulation S-B promulgated by the Securities and Exchange Commission. We
have not retained 44




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##### Table of Contents



an audit committee financial expert because we do not believe that we can do so
without undue cost and expense. Moreover, we believe that the present members of our board of
directors, taken as a whole, have sufficient knowledge and experience in financial affairs to
effectively perform their duties. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, (the Exchange Act), requires
officers, directors and persons who beneficially own more than 10% of a class of our equity
securities registered under the Securities and Exchange Commission to file reports of ownership and
changes in ownership with the Securities and Exchange Commission. Based solely upon a review of
Forms 3 and 4 and amendments thereto furnished to us during fiscal 2004 and Forms 5 and amendments
thereto furnished to us with respect to fiscal 2004, or written representations that Form 5 was not
required for fiscal 2004, we believe that all Section 16(a) filing requirements applicable to each
of our officers, directors and greater-than-ten-percent stockholders were not fulfilled in a timely
manner. During 2004, five reports concerning fourteen transactions were not fulfilled in a timely
manner. Gary Austin, COO, failed to report two transactions and Laura Bray, CFO, failed to report
two transactions when they were appointed to their positions. Don Crosbie, CEO, failed to report
one transaction and Thomas Michel, Director, failed to report one transaction. Elmira United
Corporation, an owner of more than 10%, failed to report eight transactions. All of our officers
and directors have filed Forms 5 to regain compliance, and we have notified all known beneficial
owners of more than 10% of our common stock of their requirement to file ownership reports with the
Securities and Exchange Commission. CODE OF ETHICS We have adopted a code of ethics that applies to all of our employees, executive officers and
directors, including our principal executive officer, principal financial officer and principal
accounting officer. The code of ethics includes provisions covering compliance with laws and
regulations, insider trading practices, conflicts of interest, confidentiality, protection and
proper use of our assets, accounting and record keeping, fair competition and fair dealing,
business gifts and entertainment, payments to government personnel and the reporting of illegal or
unethical behavior. The code of ethics is posted on our website at www.claimsnet.com. 
 ITEM 10. EXECUTIVE COMPENSATION The following table sets forth the compensation paid or accrued by us for services rendered in all
capacities during the years ended December 31, 2004, 2003, and 2002 by the chief executive officer
and each of the most highly compensated executive officers of our Company whose compensation
exceeded $100,000 during the year ended December 31, 2004. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION SECURITIESUNDERLYING401K
    
    
    OPTIONS/NAME AND PRINCIPAL POSITION
    
    YEAR
    
    
    SALARY
    
    
    BONUS
    
    
    MATCH
    
    
    SARS (#) (3)Don Crosbie(1).
    
    
    2004
    
    
    $
    145,385
    
    
    $
    
    
    
    $
    1,383
    
    
    
    200,000President and Chief Executive Officer
    
    
    2003
    
    
    
    140,000
    
    
    
    
    
    
    
    
    
    
    
    1,500,0002002
    
    
    
    21,538
    
    
    
    
    
    
    
    
    
    
    
    200,000Paul W. Miller (2)
    
    
    2004
    
    
    
    122,529
    
    
    
    
    
    
    
    1,173
    
    
    
    Chief Financial Officer and, formerly,
    
    
    2003
    
    
    
    135,000
    
    
    
    
    
    
    
    
    
    
    
    900,000Chief Operating Officer
    
    
    2002
    
    
    
    124,231
    
    
    
    
    
    
    
    
    
    
    
    189,285K. Scott Spurlock
    
    
    2004
    
    
    
    124,615
    
    
    
    2,500
    
    
    
    
    
    
    
    Vice President of Development
    
    
    2003
    
    
    
    120,000
    
    
    
    1,750
    
    
    
    
    
    
    
    400,0002002
    
    
    
    120,000
    
    
    
    
    
    
    
    
    
    
    
    30,000
   (1)
    
    Mr. Crosbie joined us in October 2002.(2)
    
    Mr. Miller served as our Chief Operating Officer until March 2004 and as our Chief Executive
Officer between March 2002 and October 2002. Mr. Miller resigned as of November 23, 2004.(3)
    
    Includes warrants issued. 45




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The following table provides information on the value of each of the named executive officers
options at December 31, 2004: AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION/SAR VALUES NUMBER OF
    
    
    VALUE OFSECURITIES
    
    
    UNEXERCISEDUNDERLYING
    
    
    IN THE MONEYUNEXERCISED
    
    
    OPTIONS/OPTIONS/SARS AT
    
    
    SARS ATSHARES
    
    
    
    
    
    
    DECEMBER 31, 2004 (#)(1)
    
    
    DECEMBER 31, 2004($)ACQUIRED
    
    
    VALUEON EXERCISE
    
    
    REALIZED
    
    
    EXERCISABLE/
    
    
    EXERCISABLE/NAME
    
    (#)
    
    
    ($)
    
    
    UNEXERCISABLE
    
    
    UNEXERCISABLEDon Crosbie
    
    
    
    
    
    
    
    
    
    
    700,000 / 1,200,000
    
    
    
    168,000 / 288,000Paul W. Miller
    
    
    
    
    
    
    
    
    
    
    601,285 / 600,000
    
    
    
    144,308 / 144,000
   (1)
    
    Includes warrants issued. All options were granted at an exercise price not less than the fair value of the common stock on
the date of the grant. The value of unexercised in the money options/warrants was calculated based on the closing bid
price for our common stock on the NASD Electronic Bulletin Board on December 31, 2004, $.24. AGGREGATED OPTION/SAR GRANTS IN LAST FISCAL YEAR NUMBER OFOPTIONS/SARS GRANTEDDECEMBER 31, 2004 (#)EXERCISABLE/NAME
    
    UNEXERCISABLEDon Crosbie
    
    
    200,000 / 200,000Paul W. Miller
    
    
    - / -
 DIRECTOR COMPENSATION During the year ended December 31, 2004, directors received no compensation for their services as
directors other than reimbursement of expenses relating to attending meetings of the board of
directors. In June 2003, we issued ten-year warrants to acquire an aggregate of 1,200,000 shares of
common stock at an exercise price of $.15 to two directors as compensation for services outside of
their director duties. DIRECTORS STOCK OPTION PLAN (THE DIRECTORS PLAN) In April 1998, we adopted the Directors Plan to tie the compensation of outside (non-employee)
directors to future potential growth in our earnings, and encourage them to remain on our board of
directors, to provide them with an increased incentive to make significant and extraordinary
contributions to our long-term performance and growth, and to align their interests through the
opportunity for increased stock ownership, with the interests of our stockholders. Only outside
directors are eligible to receive options under the Directors Plan. An aggregate of 361,538 shares of common stock are reserved for issuance to participants under the
Directors Plan. In the event of any changes in the common stock by reason of stock dividends,
split-ups, recapitalization, mergers, consolidations, combinations, or other exchanges of shares
and the like, appropriate adjustments will be made by the board of directors to the number of
shares of common stock available for issuance under the Directors Plan, the number of shares
subject to outstanding options, and the exercise price per share of outstanding options, as
necessary substantially to preserve option holders economics interests in their options. 46




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##### Table of Contents



The period for exercising an option ends ten years from the date the option is granted. Fifty
percent of the options granted become exercisable on the first anniversary of the date of grant
with the remainder becoming exercisable on the second anniversary of the date of grant. During the
period an option is exercisable, the option holder may pay the purchase price in cash or, under
some circumstances, by surrender of shares of common stock, valued at their then fair market value
on the date of exercise, or by a combination of cash and shares. Shares subject to an option which has not been exercised at the expiration, termination, or
cancellation of an option will be available for future grants under the Directors Plan, but shares
surrendered as payment for an option, as described above will not again be available for use under
the Directors Plan. As of December 31, 2004 there were outstanding options to purchase an
aggregate of 30,000 shares at exercise prices ranging from $.30 to $8.00 per share and 331,538
shares remained available for option grants. Unless earlier terminated, the Directors Plan will terminate on December 31, 2007. 1997 STOCK OPTION PLAN In April 1997, our board of directors and stockholders adopted the 1997 Plan. The 1997 Plan
provides for the grant of options to purchase up to 1,307,692 shares of common stock to our
employees, officers, directors, and consultants. Options may be either incentive stock options or
non-qualified options under the Federal tax laws. Incentive stock options may be granted only to
our employees, while non-qualified options may be issued to non-employee directors, consultants,
and others, as well as to our employees. The 1997 Plan is administered by disinterested members of the board of directors or the
compensation committee, who determine, among other things, the individuals who shall receive
options, the period during which the options may be exercised, the number of shares of common stock
issuable upon the exercise of each option, and the option exercise price. Subject to some exceptions, the exercise price per share of common stock subject to an incentive
option may not be less than the fair market value per share of common stock on the date the option
is granted. The per share exercise price of the common stock subject to a non-qualified option may
be established by the board of directors, but shall not, however, be less than 85% of the fair
market value per share of common stock on the date the option is granted. The aggregate fair market
value of common stock for which any person may be granted incentive stock options which first
become exercisable in any calendar year may not exceed $100,000 on the date of grant. No stock option may be transferred by an optionee other than by will or the laws of descent and
distribution, and, during the lifetime of an optionee, the option will be exercisable only by the
optionee. In the event of termination of employment or engagement other than by death or
disability, the optionee will have no more than three months after such termination during which
the optionee shall be entitled to exercise the option to the extent exercisable at the time of
termination, unless otherwise determined by the board of directors. Upon termination of employment
of an optionee by reason of death or permanent and total disability, the optionees incentive stock
options remain exercisable for one year to the extent the options were exercisable on the date of
such termination. Options may not be granted under the 1997 Plan beyond a date ten years from the
effective date of the 1997 Plan. Subject to some exceptions, holders of incentive stock options
granted under the 1997 Plan cannot exercise these options more than ten years from the date of
grant. Options granted under the 1997 Plan generally provide for the payment of the exercise price
in cash and may provide for the payment of the exercise price by delivery to us of shares of common
stock already owned by the optionee having a fair market value equal to the exercise price of the
options being exercised, or by a combination of these methods. Any unexercised options that expire or that terminate upon an employees ceasing to be employed by
us become available again for issuance under the 1997 Plan. As of December 31, 2004, there were
outstanding options to purchase an aggregate of 1,199,442 shares at exercise prices ranging from
$.30 to $8.00 per share and 138,250 shares remain available for option grants. The following table summarizes the stock option activity under the 1997 Plan and the Directors
Plan through December 31, 2004 (none of the options granted have been exercised): 47




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##### Table of Contents



NUMBER
    
    
    PER SHARE
    
    
    WEIGHTED AVERAGEOF SHARES
    
    
    EXERCISE PRICE
    
    
    EXERCISE PRICEOutstanding options-January 1, 2003
    
    
    1,060,567
    
    
    $
    0.30-8.00
    
    
    $
    2.23Granted
    
    
    
    
    
    
    
    
    
    
    Expired
    
    
    (361,125
    )
    
    
    7.00-8.00
    
    
    
    2.61Outstanding options-December 31, 2003
    
    
    699,442
    
    
    
    0.30-8.00
    
    
    
    2.04Granted
    
    
    500,000
    
    
    
    0.35
    
    
    
    0.35Expired
    
    
    
    
    
    
    
    
    
    
    Outstanding options-December 31, 2004
    
    
    1,199,442
    
    
    $
    0.30-8.00
    
    
    $
    2.04Options exercisable-December 31, 2004
    
    
    699,442
    
    
    $
    0.30-8.00
    
    
    $
    2.04
 Outstanding options as of December 31, 2004, had a weighted average remaining contractual life of
approximately 7.6 years. WARRANTS The Company has from time to time, issued warrants to its employees and directors. The following table summarizes the warrant activity related to employee grants: WEIGHTEDNUMBER
    
    
    PER SHARE
    
    
    AVERAGEOF SHARES
    
    
    EXERCISE PRICE
    
    
    EXERCISE PRICEOutstanding warrants- January 1, 2003
    
    
    459,227
    
    
    $
    0.20-3.00
    
    
    $
    0.54Granted
    
    
    3,450,000
    
    
    
    0.15
    
    
    
    0.15Expired
    
    
    (204,284
    )
    
    
    0.35-3.00
    
    
    
    0.66Outstanding warrants-December 31, 2003
    
    
    3,704,943
    
    
    
    0.15-3.00
    
    
    
    0.17Granted
    
    
    550,000
    
    
    
    0.29
    
    
    
    0.29Expired
    
    
    (200,000
    )
    
    
    0.15
    
    
    
    0.15Outstanding warrants-December 31, 2004
    
    
    4,054,943
    
    
    $
    0.15-3.00
    
    
    $
    0.19Warrants exercisable-December 31, 2004
    
    
    1,338,276
    
    
    $
    0.15-3.00
    
    
    $
    0.20
 Outstanding employee warrants as of December 31, 2004, had a weighted average contractual life of
approximately 5.7 years. No employee options or warrants were exercised during 2004. The following table sets forth
information with respect to options and warrants granted during 2004 to the individuals set forth
in the Summary Compensation Table above: INDIVIDUAL GRANTS Number of
    
    
    % of Total
    
    
    
    
    
    
    
    
    
    
    Potential RealizableSecurities
    
    
    Options and
    
    
    
    
    
    
    
    
    
    
    Value at Assumed AnnualUnderlying
    
    
    Warrants
    
    
    
    
    
    
    
    
    
    
    Rates of Stock PriceOptions and
    
    
    Granted to
    
    
    Exercise
    
    
    
    
    
    
    Appreciation for OptionWarrants
    
    
    Employees in
    
    
    Price
    
    
    Expiration
    
    
    or Warrant Term (1)Name
    
    Granted
    
    
    Fiscal Year
    
    
    ($/Share)
    
    
    Date
    
    
    5%
    
    
    10%Don Crosbie
    
    
    200,000
    
    
    
    36.4
    %
    
    $
    0.29
    
    
    September 21, 2014
    
    $
    36,476
    
    
    $
    92,437Paul W. Miller
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    K. Scott Spurlock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
   (1)
    
    In accordance with the rules of the Securities and Exchange Commission (the Commission),
shown are the gains or option or warrant spreads that would exist for the options or
warrants granted, based on the assumed rates of annually compounded stock price appreciation
of 5% and 10%, respectively, from the date the option or warrant 48




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##### Table of Contents



was granted over the full option or warrant term, without adjustment for the present valuation
of such potential future option or warrant spread. We account for our stock based awards to employees using the intrinsic value method in accordance
with APB 25, Accounting for Stock Issued to Employees, and its related interpretations. DIRECTORS LIMITATION OF LIABILITY Our certificate of incorporation and by-laws include provisions to (1) indemnify the directors and
officers to the fullest extent permitted by the Delaware General Corporation Law, including
circumstances under which indemnification is otherwise discretionary and (2) eliminate the personal
liability of directors and officers for monetary damages resulting from breaches of their fiduciary
duty, except for liability for breaches of the duty of loyalty, acts or omissions not in good faith
or which involve intentional misconduct or a knowing violation of law, violations under Section 174
of the Delaware General Corporation Law, or for any transaction from which the director derived an
improper personal benefit. We believe that these provisions are necessary to attract and retain
qualified persons as directors and officers. We provide directors and officers liability insurance coverage of $5,000,000. Insofar as indemnification for liability arising under the Securities Act of 1933 may be permitted
to our directors, officers, and controlling persons as stated in the foregoing provisions or
otherwise, we have been advised that, in the opinion of the Commission, this indemnification is
against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. 49




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##### Table of Contents



ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS The following table sets forth, as of February 8, 2005,  
    each person who is known by us to be the beneficial owner of more than 5% of the
outstanding common stock,
    each director and each of our executive officers, named in the compensation table under Item 11,
    all our directors and executive officers as a group, and
    the number of shares of common stock beneficially owned by each such person and such
group and the percentage of the outstanding shares owned by each such person and such
group. As used in the table below and elsewhere in this report, the term BENEFICIAL OWNERSHIP with respect
to a security consists of sole or shared voting power, including the power to vote or direct the
vote, and/or sole or shared investment power, including the power to dispose or direct the
disposition, with respect to the security through any contract, arrangement, understanding,
relationship, or otherwise, including a right to acquire such power(s). Except as otherwise
indicated, the stockholders listed in the table have sole voting and investment powers with respect
to the shares indicated. Beneficial ownership includes shares issuable upon exercise of options
exercisable within sixty days of February 8, 2005, and issuable upon conversion of the preferred
stock. The shares of preferred stock allow the holder to vote with the holders of common stock as
though one class to the extent of the number of shares issuable upon conversion of the preferred. Except as otherwise noted below, the address of each of the persons in the table is c/o
Claimsnet.com inc., 14860 Montfort Dr., Suite 250, Dallas, Texas 75254. Unless otherwise noted, beneficial ownership consists of sole ownership, voting, and investment
power with respect to all common stock shown as beneficially owned by them. SHARES BENEFICIALLY OWNEDAmount andNature of
    
    
    
    
    
    
    Percent ofName and Address of
    
    
    
    
    
    Beneficial
    
    
    Percent of
    
    
    VotingBeneficial Owner
    
    Class of Security
    
    
    Owner
    
    
    Class
    
    
    PowerDon Crosbie (1)
    
    Common Stock
    
    
    700,000
    
    
    
    2.7
    
    
    
    2.1Paul W. Miller (2)
    
    Common Stock
    
    
    602,885
    
    
    
    2.4
    
    
    
    1.8Laura Bray (3)
    
    Common Stock
    
    
    16,667
    
    
    
    *
    
    
    
    *John C. Willems, III (5)
    
    Common Stock
    
    
    24,277
    
    
    
    *
    
    
    
    *Thomas Michel (6)
    
    Common Stock
    
    
    718,000
    
    
    
    2.08
    
    
    
    2.2Series D Preferred Stock
    
    
    100
    
    
    
    13.9Series E Preferred Stock
    
    
    50
    
    
    
    100.0Jeffrey M. Black (7)
    
    Common Stock
    
    
    5,000
    
    
    
    *
    
    
    
    *Alfred Dubach (8)
    
    Common Stock
    
    
    820,000
    
    
    
    3.2
    
    
    
    2.5Bo W. Lycke (4) (9)
    
    Common Stock
    
    
    3,011,326
    
    
    
    11.8
    
    
    
    9.14730 Melissa
Ln.
Dallas, Texas 75229Robert H. Brown, Jr. (4) (10)
    
    Common Stock
    
    
    1,792,354
    
    
    
    7.0
    
    
    
    5.42626 Cole
Ave, #400

Dallas, Texas 75204McKesson Corporation
    
    Common Stock
    
    
    1,514,285
    
    
    
    5.9
    
    
    
    4.6One Post
Street

San Francisco, CA 94104
 50




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##### Table of Contents



SHARES BENEFICIALLY OWNEDAmount andNature of
    
    
    
    
    
    
    Percent ofName and Address of
    
    
    
    
    
    Beneficial
    
    
    Percent of
    
    
    VotingBeneficial Owner
    
    Class of Security
    
    
    Owner
    
    
    Class
    
    
    PowerJ. R. Schellenberg (4) (11)
    
    Common Stock
    
    
    2,143,603
    
    
    
    8.4
    
    
    
    6.5Kohlrainstrasse 1
Kusnacht
Switzerland CH-8700Elmira
United Corporation (12)
    
    Common Stock
    
    
    9,350,000
    
    
    
    36.5
    
    
    
    28.3Swiss Tower -
16th
Floor

Panama
Republic of PanamaNew York Ventures(13)
    
    Common Stock
    
    
    620,000
    
    
    
    2.4
    
    
    
    1.9c/o BDO Visura
    
    Series D Preferred Stock
    
    
    620
    
    
    
    86.1Entfelderstrasse
1

CH-5001 AarauAll our
directors and executive officers as a
    
    Common Stock
    
    
    2,886,829
    
    
    
    11.3
    
    
    
    8.7group (8 persons) (14)
    
    Series D Preferred Stock
    
    
    100
    
    
    
    13.9Series E Preferred Stock
    
    
    50
    
    
    
    100.0
   *
    
    Less than one percent.(1)
    
    Consists of 700,000 shares which Mr. Crosbie has the right to acquire upon exercise of
options or warrants.(2)
    
    Consists of 1,600 shares of common stock owned of record by Mr. Miller and 601,285 shares
which Mr. Miller has the right to acquire upon exercise of options or warrants.(3)
    
    Consists of 16,667 shares which Ms. Bray has the right to acquire upon exercise of options or
warrants.(4)
    
    Includes 1,481,603 shares of common stock owned of record by National Financial Corporation
(based upon last information reported to or known by the Company). Messrs. Lycke and Brown
own 71.1% and 17.7%, respectively, of the outstanding capital stock of National Financial
Corporation. MNS Enterprises, Inc. manages all activities of National Financial Corporation
pursuant to a Management Agreement. Mr. Schellenberg is the President and a Director of MNS
Enterprises, Inc. Therefore, Messrs. Lycke, Brown and Schellenberg may be deemed to
beneficially own the shares of common stock owned by National Financial Corporation.(5)
    
    Consists of 9,277 shares of common stock owned of record by Mr. Willems and 15,000 shares
which Mr. Willems has the right to acquire upon exercise of options or warrants.(6)
    
    Common Stock consists of 185,000 shares of common stock owned of record by Mr. Michel,
150,000 shares which may be issued to Mr. Michel upon conversion of preferred stock, and
383,000 shares which Mr. Michel has the right to acquire upon exercise of options or warrants.(7)
    
    Consists of 5,000 shares which Mr. Black has the right to acquire upon exercise of options or
warrants.(8)
    
    Consists of 615,000 of common stock owned of record by Mr. Dubach, and 205,000 shares which
Mr. Dubach has the right to acquire upon exercise of options or warrants.(9)
    
    Consists of 1,279,723 shares of common stock owned of record by Mr. Lycke (based upon last
information reported to or known by the Company), 250,000 shares which Mr. Lycke has the right
to acquire upon exercise of options or warrants, and 1,081,603 shares of common stock owned of
record by National Financial Corporation.(10)
    
    Consists of 310,751 shares of common stock owned of record by Mr. Brown (based upon last
information reported to or known by the Company) and 1,081,603 shares of common stock owned of
record by National Financial Corporation.(11)
    
    Consists of 562,000 shares of common stock owned of record by Mr. Schellenberg (based upon
last information reported to or known by the Company), 100,000 shares which Mr. Schellenberg
has the right to acquire upon exercise of options or warrants, and 1,081,603 shares of common
stock owned of record by National Financial Corporation.(12)
    
    Consists of 9,350,000 shares of common stock owned of record by Elmira United based upon last
information reported to or known by the Company.(13)
    
    Common Stock consists of 620,000 shares which may be issued to New York Ventures upon
conversion of preferred stock.(14)
    
    Includes an aggregate of 1,925,952 shares which they have a right to acquire upon exercise of
options or warrants. 51




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SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS The following table sets forth, as of December 31, 2004, information regarding compensation plans
under which equity securities are authorized for issuance. NUMBER OF
    
    
    WEIGHTED
    
    
    NUMBER OF SECURITIESSECURITIES TO BE
    
    
    -AVERAGE
    
    
    REMAINING AVAILABLEISSUED UPON
    
    
    EXERCISE PRICE
    
    
    FOR FUTURE ISSUANCEEXERCISE OF
    
    
    OF OUTSTANDING
    
    
    UNDER EQUITYOUTSTANDING OPTIONS
    
    
    OPTIONS AND
    
    
    COMPENSATIONSAND WARRANTS
    
    
    WARRANTS
    
    
    PLANS*(a)
    
    
    (b)
    
    
    (c)Equity Compensation
Plans Approved By
Stockholders
    
    
    1,199,442
    
    
    $
    2.04
    
    
    
    469,788Equity
Compensations Plans
Not Approved By
Stockholders**
    
    
    5,838,943
    
    
    
    0.77
    
    
    
    Total
    
    
    7,308,385
    
    
    $
    0.84
    
    
    
    469,788
   *Excludes
securities reflected in column (a).
**Excludes warrants to acquire 3,625,000 shares of common stock at an exercise price of $0.20 per
share which were outstanding at December 31, 2004 pursuant to private equity placements. Equity compensation plans approved by shareholders include the 1997 Stock Option Plan and the
Directors Plan, as more fully described in Item 10. Equity compensation plans not approved by shareholders are described below. In June 2000, the Company granted certain employees warrants to purchase shares of common stock at
$3.00 per share, of which 19,500 warrants remain outstanding. The warrants are fully exercisable
and expire on the 10th anniversary of the grant. In February 2002, the Company granted executive officers warrants to purchase 35,443 shares of
common stock in exchange for voluntary salary reductions. The warrants contain an exercise price of
$0.35 per share, expire on the tenth anniversary of the grant, and are fully exercisable. In June 2002, the Company issued warrants to acquire an aggregate of 50,000 shares of common stock
to a non-employee in connection with an agreement for professional services to be rendered. The
warrants contain an exercise price of $0.30 per share, are fully exercisable, and expire in June
2007. In October 2002, the Company issued warrants to acquire an aggregate of 500,000 shares of common
stock to a non-employee in connection with an agreement for professional services to be rendered.
The warrants contain an exercise price of $0.20 per share, are fully exercisable and expire in
September 2007. In October 2002, the Company hired a new president and chief executive officer and issued him
warrants to acquire an aggregate of 200,000 shares of common stock. The warrants contain an
exercise price of $0.20 per share, are fully exercisable and expire in October 2007. In January 2003, the Company issued warrants to acquire an aggregate of 34,000 shares of common
stock to a non-employee for services rendered. The warrants contain an exercise price of $0.25 per
share, are fully exercisable, and expire in April 2007. In June 2003, the Company issued warrants to acquire an aggregate of 3,450,000 shares of common
stock to certain employees. These warrants contain an exercise price of $0.15 per share and expire
in June 2013. The warrants became one-third exercisable in June 2004 and will become two-thirds
exercisable in June 2005 and fully exercisable in June 2006. 52




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##### Table of Contents



In June 2003, the Company issued ten-year warrants to acquire an aggregate of 1,200,000 shares of
common stock to two directors as compensation for services outside of their director duties. These
warrants contain an exercise price of $0.15 per share and expire in June 2013. The warrants became
50% exercisable in June 2004 and will become fully exercisable in June 2005. In September 2004, the Company issued ten-year warrants to acquire an aggregate of 550,000 shares
of common stock to certain employees at an exercise price of $0.29 per share. 
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Bo W. Lycke, formerly our Chairman of the Board, President and Chief Executive Officer, Ward L.
Bensen, a former Director, and Robert H. Brown, Jr., a former Director, are, respectively, the
Chairman of the Board, a Director and Senior Vice President and a Director, and owners,
respectively, of 71.1%, 11.1%, and 17.8% of the outstanding capital stock of NFC. In May 2003, we borrowed $100,000 under an unsecured short-term loan agreement with NFC. In June
2003, upon the demand of NFC, we repaid principal on the above note in the aggregate amount of
$34,000 plus accrued interest thereon. In December 2004, we repaid the remaining principal in the
aggregate amount of $66,000 plus accrued interest thereon. During 2002 and 2003, we completed the private placement of 7,475,000 shares of common stock to
accredited investors at $0.20 per share for net proceeds of $1,491,000. In connection with the
private placement, we also issued five-year warrants to purchase an aggregate of 7,475,000 shares
of common stock at an exercise price of $0.20 per share. The private placement included: (i)
3,875,000 shares of common stock plus warrants to acquire an additional 3,875,000 shares of common
stock purchased by Elmira, a principal stockholder, (ii) 350,000 shares of common stock plus
warrants to acquire an additional 350,000 shares of common stock purchased by NFC, and (iii)
150,000 shares of common stock plus warrants to acquire an additional 150,000 shares of common
stock purchased by Mr. Thomas Michel. Between April 2003 and March 2004, Elmira exercised warrants
to acquire an aggregate of 2,375,000 shares of common stock. During the year ended December 31, 2004, directors received no compensation for their services as
directors other than reimbursement of expenses relating to attending meetings of the board of
directors. In June 2003, we issued ten-year warrants to acquire an aggregate of 1,200,000 shares of
common stock at an exercise price of $.15 to two directors as compensation for services outside of
their director duties. In June 2004, we entered into an unsecured loan agreement in the amount of $20,000 pursuant to an
unsecured short-term loan agreement with NFC. In December 2004, upon the demand of NFC, we repaid
principal on the above note in the aggregate amount of $20,000 plus accrued interest thereon. In September and December 2004, we borrowed an aggregate of $200,000 pursuant to two separate
convertible long-term loan agreements with a 5% shareholder. The foregoing transactions and all future transactions between us and our officers, directors, and
5% stockholders were and will be on terms at least as favorable to us than as obtainable from
unaffiliated third parties and have been approved and will be subject to approval by a majority of
our independent and disinterested directors. 53




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ITEM 13. EXHIBITS The following exhibits are filed herewith or are incorporated herein by reference: 3.1(2)
    
    Certificate of Incorporation3.1(a)(2)
    
    Certificate of Amendment to Certificate of Incorporation3.1(b)(4)
    
    Certificate of Designation of Series A Preferred Stock3.1(c)(4)
    
    Certificate of Designation of Series B Preferred Stock3.1(d)(4)
    
    Certificate of Designation of Series C Preferred Stock3.1(e)(4)
    
    Certificate of Designation of Series D Preferred Stock3.1(f)(1)
    
    Certificate of Designation of Series E Preferred Stock3.2(2)
    
    Bylaws, as amended4.1(2)
    
    Form of warrant issued to Cruttenden Roth Inc.4.2(2)
    
    Form of Common Stock Certificate4.3(a)(4)
    
    Form of Warrant issued to Bo W. Lycke dated February 21, 20024.3(b)(4)
    
    Form of Warrant issued to Paul W. Miller dated February 21, 2002*4.3(c)(1)
    
    Form of Warrant issued to Don Crosbie dated October 21, 2002*4.3(d)(7)
    
    Form of Warrant issued to Don Crosbie dated June 3, 2003*4.3(e)(7)
    
    Form of Warrant issued to Paul W. Miller dated June 3, 2003*4.3(f)(7)
    
    Form of Warrant issued to certain employees dated June 3, 2003*4.3(g)(7)
    
    Form of Warrant issued to Thomas Michel dated June 3, 2003*4.3(h)(7)
    
    Form of Warrant issued to Alfred Dubach dated June 3, 2003*4.3(i)
    
    Form of Warrant issued to Thomas Michel dated June 30, 2004.*4.3(j)
    
    Form of Warrant issued to Gary J. Austin dated September 21, 2004.*4.3(k)
    
    Form of Warrant issued to Laura M. Bray dated September 21, 2004.*4.3(l)
    
    Form of Warrant issued to Don Crosbie dated September 21, 2004.*10.2(2)
    
    1997 Stock Option Plan, as amended through October 19, 2000*10.2(a)(3)
    
    Amendment dated October 20, 2000 to 1997 Stock Option Plan*10.3(2)
    
    Form of Indemnification Agreement*10.4(2)
    
    Form of Non-Employee Directors Plan10.5(1)
    
    Note dated June 6, 2002 between Claimsnet.com and J. R. Schellenberg related to
$50,000 loan.10.6(1)
    
    Note dated August 1, 2002 between Claimsnet.com and J. R. Schellenberg related to $10,000 loan.*10.7(1)
    
    Note dated August 1, 2002 between Claimsnet.com and Thomas Michel related to $50,000 loan.10.8(5)
    
    Note dated August 20, 2002 between Claimsnet.com and J. D. Stauffer related to $25,000 loan.10. 9(6)
    
    Affiliate and Partner Services and License Agreement dated September 11, 2002,
by and between Claimsnet.com, Inc. and ProxyMed, Inc.
 54




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10.10(6)
    
    Form of Preferred Escrow Agreement by and among Claimsnet.com, Inc., ProxyMed,
Inc. and DSI Technology
Escrow Services, Inc.10.11
    
    Note dated June 10, 2004 between Claimsnet.com and National Financial Corporation related to
$20,000 loan.10.12
    
    Note dated September 21, 2004 between Claimsnet.com and R.L. Armstrong Limited Partnership related to
$50,000 loan.10.13
    
    Note dated September 22, 2004 between Claimsnet.com and Elmira United Corporation related to
$50,000 loan.10.14
    
    Note dated October 4, 2004 between Claimsnet.com and Douglas R. Urquhart related to $50,000 loan.10.15
    
    Note dated October 5, 2004 between Claimsnet.com and Newman Family Trust related to $100,000 loan.10.16
    
    Note dated December 28, 2004 between Claimsnet.com and Elmira United Corporation related to
$150,000 loan.10.17
    
    Form of Registration Rights Agreement31.1
    
    Certification of Don Crosbie31.2
    
    Certification of Laura M. Bray32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 of Don Crosbie32.2
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 of Laura M. Bray*
    
    Contract with management or compensatory arrangement.(1)
    
    Incorporated by reference to the corresponding exhibit filed by the Registrant with
its Annual Report on Form 10-K, for the Year Ended December 31, 2002 filed on April 1, 2003.(2)
    
    Incorporated by reference to the corresponding exhibit filed by the Registrant with
the registration statement on Form S-1 (Registration No. 333-36209).(3)
    
    Incorporated by reference to the corresponding exhibit filed by the Registrant with
its Annual Report on Form 10-K for the year ended December 31, 2000 filed on April 16, 2001
and amended on October 3, 2001.(4)
    
    Incorporated by reference to the corresponding exhibit filed by the Registrant
with its Annual Report on Form 10-K for the year ended December 31, 2001 filed on April 15,
2002.(5)
    
    Incorporated by reference to the corresponding exhibit filed by the Registrant with
its Current Report on Form 8-K dated September 4, 2002.(6)
    
    Incorporated by reference to the corresponding exhibit filed by the Registrant its
Current Report on Form 8-K dated September 17, 2002.(7)
    
    Incorporated by reference to the corresponding exhibit filed by the Registrant its
Current Report on Form 10-KSB dated March 29, 2004.
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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The following is a summary of the fees billed to us by Whitley Penn, our current independent
auditors, and KBA Group LLP, our former independent auditors, for professional services rendered
during the fiscal years ended December 31, 2004 and 2003. Fiscal year ended December 31, 2004 FEE CATEGORY
    
    WHITLEY PENN
    
    
    TIMOTHY CARMODY, CPA
    
    
    KBA GROUP LLPAudit Fees (1)
    
    $
    39,000
    
    
    $
    
    
    
    $
    Audit-Related Fees (2)
    
    
    
    
    
    
    
    
    
    
    Tax Fees (3)
    
    
    
    
    
    
    2,875
    
    
    
    All Other Fees (4)
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    39,000
    
    
    $
    2,875
    
    
    $
    
 Fiscal year ended December 31, 2003 FEE CATEGORY
    
    WHITLEY PENN
    
    
    KBA GROUP LLPAudit Fees (1)
    
    $
    
    
    
    $
    34,000Audit-Related Fees (2)
    
    
    
    
    
    
    16,400Tax Fees (3)
    
    
    
    
    
    
    5,300All Other Fees (4)
    
    
    
    
    
    
    Total
    
    $
    
    
    
    $
    55,700
   (1)
    
    Audit Fees consist of aggregate fees billed for professional services rendered for the audit
of our annual financial statements and review of the interim financial statements included in
quarterly reports or services that are normally provided by the independent auditor in
connection with statutory and regulatory filings or engagements during the fiscal years ended
December 31, 2004 and December 31, 2003.(2)
    
    Audit-Related Fees consist of aggregate fees billed for assurance and related services that
are reasonably related to the performance of the audit or review of our financial statements
and are not reported under Audit Fees. These fees include review of registration statements
and participation at meetings of the board of directors and audit committee and restatement of
the interim financial data for the quarters ended December 31, 2003.(3)
    
    Tax Fees consist of aggregate fees billed for professional services for tax compliance, tax
advice and tax planning.(4)
    
    All Other Fees consist of aggregate fees billed for products and services provided by the
independent auditor, other than those disclosed above. These fees include services related to
certain accounting research and assistance with a regulatory matter. POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT SERVICES OF INDEPENDENT
AUDITORS At present, our entire board of directors acts as our audit committee and approves each engagement
for audit or non-audit services before we engage a firm to provide those services. 56




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SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has duly caused this
report to be signed on its behalf by the undersigned, on March 16, 2005, thereunto duly authorized. CLAIMSNET.COM INC.
(Registrant) By:
    
    /s/ Don CrosbieDon CrosbiePresident andChief Executive Officer,
 In accordance with the Exchange Act, this report has been signed below by the following persons on
behalf of the Registrant and in the capacities indicated on March 16, 2005 /s/ Don Crosbie 
 
 /s/ Laura M. Bray 
 
 /s/ Alfred Dubach 
 
 /s/ John C. Willems, III 
 
 /s/ Thomas Michel 
 
 /s/ Jeffrey M. Black