On January 25, 1999, the Company acquired the assets and certain liabilities of Subro-Audit, Inc., a Wisconsin corporation ("SAI"), and a related entity, O'Donnell Leasing Co., LLP, a Wisconsin limited liability partnership ("ODL" and, together with SAI, "Subro Audit"), for approximately $24.4 million (the "Subro Audit Acquisition"), using available unrestricted cash. The Company paid an additional $5.3 million pursuant to an earn-out arrangement. The final amount of $2.5 million was paid on June 7, 2001, and $2.8 million was paid on May 18, 2000. Approximately $4.7 million was held in escrow for the potential earn-
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101). SAB 101 provides guidance on revenue recognition and related disclosures and was effective beginning October 1, 2000. The Company was previously following the requirements provided under SAB 101 and, accordingly, the implementation of this pronouncement had no impact on the Company's financial position or results of operations for 2002, 2001 or 2000.
Approximately $4.4 million and $4.6 million of the Company's accounts receivable balance of $9.4 million at December 31, 2002 and 2001, respectively, is attributable to provider bill audit services. The provider bill audit accounts receivable represents the amounts invoiced by the Company to its clients for its fee for completed provider audits. For each completed audit, prior to invoicing, the Company obtains a sign-off from the provider representative as evidence of agreement with the audit findings. The Company maintains an allowance for doubtful accounts for the estimated losses arising from adjustments the client may make to invoiced amounts based on the client's inability to recoup the claim overpayment from the provider. The amount of the allowance is based on the Company's historical experience related to client adjustments. However, the Company's fee for provider bill audit services is self-funding in that the client is able to adjust future claim payments made to the providers for the audit discrepancies identified. The accounts receivable balance that at December 31, 2002 and 2001 was attributable to provider bill audits completed represented approximately 2,900 completed audits for twelve clients and 3,000 completed audits for nine clients, respectively. If the Company's provider bill audit clients were to increase the value of negative adjustments made to audit results, additional allowances may be required.
All costs incurred to establish the technological feasibility of software products to be sold to others are expensed as research and development. Once technological feasibility has been established, all software production costs are capitalized. Capitalized costs are amortized based on current and future revenue for each product with an annual minimum equal to the straight-line amortization over the remaining estimated economic life of the product.
Goodwill is no longer amortized but must be tested at least annually for impairment at a level of reporting referred to as the reporting unit and more frequently if adverse events or changes in circumstances indicate that the asset may be impaired. The Company's reporting units are generally consistent with the operating segments underlying the segments in Note 17 to Item 8. "Financial Statements and Supplementary Data". All of the Company's goodwill relates to the Healthcare Recovery Services segment.
The Company engaged the services of a third party valuation firm to complete an analysis of the fair value of the reporting units during the first half of 2002. The completion of its work during the quarter ended June 30, 2002 did not indicate an impairment had occurred with respect to goodwill. The Company will perform its annual impairment review during the second quarter of each year, commencing in the second quarter of 2003 and at such other times if adverse events or changes in circumstances indicate that the goodwill may be impaired.
Long-lived assets consist of property and equipment and other identifiable intangible assets. These assets are depreciated or amortized over their estimated useful life, and are subject to impairment reviews. The Company periodically reviews long-lived assets whenever adverse events or changes in circumstances indicate the carrying value of such assets may not be recoverable. In assessing recoverability, the Company must make assumptions regarding estimated future cash flows and other factors to determine if an impairment loss may exist, and, if so, estimate fair value. The Company also must estimate and make assumptions regarding the
The Company reviews its contingent liabilities, which arise primarily from litigation and litigation defense costs, in accordance with Statement of Financial Accounting Standards No. 5 (SFAS 5), "Accounting for Contingencies". Contingent liabilities are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Contingent liabilities are often resolved over long periods. Estimating probable losses requires judgments about both the amount of liability, which may or may not be readily determinable, and the likelihood of liability, which involves ranges of probability that can at times be broad and depend on the potential actions of third parties.
Effective January 1, 2002, the Company instituted a program of self-insurance that offers group healthcare coverage to its employees and their spouses and dependent children. The Company's provision for loss from future claims under this self-insurance program is based upon an independent actuarial estimate. This provision includes estimated liabilities determined from both reported paid claims and claims liabilities incurred but not reported (IBNR). As noted, the accrual for these liabilities is based on estimates and while management believes that the provision for loss is adequate, the ultimate liability may be in excess of or less than the amounts recorded. The methods used in determining these liabilities are periodically reviewed and adjustments are reflected in current earnings. The provision for future healthcare claims of $524,000 at December 31, 2002 is recorded in Accrued Expenses as a current liability in the accompanying Balance Sheet.
Also, in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (FAS 142), "Goodwill and Other Intangible Assets", which establishes the accounting for goodwill and other intangible assets following their recognition. FAS 142 applies to all goodwill and other intangible assets whether acquired singly, as part of a group, or in a business combination. FAS 142 provides that goodwill should not be amortized but should be tested for impairment annually, and at other times as events or circumstances indicate an impairment may have occurred, using a fair-value based approach. In addition, FAS 142 provides that other intangible assets other than goodwill should be amortized over their useful lives and reviewed for impairment. FAS 142 was effective for the Company beginning on January 1, 2002. The Company was required to perform a transitional impairment test under FAS 142 for all goodwill recorded as of January 1, 2002. During the three months ended June 30, 2002, the Company completed a transitional impairment test under FAS 142 for all goodwill recorded as of January 1, 2002. See Note 8 "Goodwill and Other Intangible Assets" in Item 8. "Financial Statements and Supplementary Data".
In July 2002, the FASB issued Statement of Financial Accounting Standards No. 146 (FAS 146), "Accounting for Exit or Disposal Activities". FAS 146 addresses the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive
under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. FAS 146 supersedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" and requires liabilities associated with exit and disposal activities to be expensed as incurred. FAS 146 will be effective for exit or disposal activities of the Company that are initiated after December 31, 2002. The Company will apply the provisions of FAS 146 to any future restructuring activities.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51". FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provision of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company does not have any variable interest entities as defined under FIN 46.
Cost of Revenues. Cost of revenues for the Healthcare Recovery Services segment increased 2.3% in 2002 to $31.8 million from $31.1 million in 2001. As a percentage of claims revenues, cost of revenues decreased to 46.2% in 2002 from 48.6% in 2001. The increase in cost of revenues in total is due to the increase in volume from provider bill audit. The decrease in cost of revenues as a percentage of claims revenues in 2002 compared to 2001 was primarily due to the increase in claims revenues described above.
Support Expenses. Support expenses for the Healthcare Recovery Services segment decreased 14.3% to $4.2 million in 2002, from $4.9 million in 2001. Support expenses as a percentage of claims revenues decreased from 7.6% in 2001 to 6.2% in 2002. The decrease in support expenses as a percentage of claims revenues resulted from the increase in claims revenues described above and from the change in the reporting structure of certain systems support personnel from the Healthcare Recovery Services segment to Corporate Sales & Marketing. Prior to January 1, 2002, those personnel performed support functions primarily related to healthcare subrogation. Effective January 1, 2002, such personnel moved under Corporate Sales & Marketing as they assumed a more active role in the management of client data and as members of the client solutions team. Prior year amounts have not been reclassified because management of the Company views this as a change in position.
was due to the adoption of FAS 142 by the Company on January 1, 2002. See Item 8. "Financial Statements and Supplementary Data -- Note 8 -- Goodwill and Other Intangible Assets".
Total healthcare claims recoveries for 2001 increased approximately $1.2 million, or 0.5%, from 2000 healthcare claims recoveries. Healthcare subrogation recoveries for 2001 were approximately $2.1 million, or 1.0%, more than in 2000, primarily due to an increase in throughput. Provider bill audit recoveries decreased approximately $1.2 million, or 3.9%, compared to 2000, in large part due to hospital access issues encountered during the first three quarters of 2001. These access issues, which mainly stemmed from the delaying tactics of hospitals that wanted to minimize the costs of being audited and potential negative audit adjustments, were the primary reason that provider bill audit backlog grew to be approximately 35% of total Healthcare Recovery Services backlog as of December 31, 2001 compared to only 24% of total Healthcare Recovery Services backlog as of December 31, 2000. Total Healthcare Recovery Services backlog increased 19.7% to $1,414.8 million as of December 31, 2001 from $1,182.0 million as of December 31, 2000. Although most of the backlog growth related to provider bill audit, healthcare subrogation backlog at December 31, 2002 increased approximately $11.8 million, or 1.3%, compared to December 31, 2000. The decline in Healthcare Recovery Services throughput from 20.9% in 2000 to 18.4% in 2001, was entirely attributable to the increase in provider bill audit backlog, while related recoveries decreased.
Cost of Revenues. Cost of revenues for the Healthcare Recovery Services segment increased 2.3% in 2001 to $31.1 million from $30.4 million in 2000. As a percentage of healthcare claims revenues, cost of revenues increased to 48.6% in 2001 from 47.7% in 2000. The increase in cost of revenues in total and as a percentage of claims revenues in 2001 compared to 2000 was primarily due to additional expenses for the investigation of files, including increases in staffing levels for the provider bill audit and overpayment recovery services related to new business sold during the year.
performance based incentive compensation and the remainder was due to growth in support expenses related to the provider bill audit product.
Depreciation and Amortization. Depreciation and amortization expenses for the Healthcare Recovery Services segment were $6.0 million for the year ended December 31, 2001 compared to $5.7 million in 2000, an increase of 4.7%. The increase was primarily due to the addition of intangible assets related to the Subro Audit Acquisition final earn-out payment.
Income before Income Taxes. Income before income taxes for the Healthcare Recovery Services segment for the year ended December 31, 2001 of $22.3 million was approximately $0.4 million or 1.9% more than income before income taxes of $21.9 million for the year ended December 31, 2000. Increases in Cost of Revenues and Support Expenses for the year ended December 31, 2001, compared to the year ended December 31, 2000, described above offset the Litigation Settlement expense, described above, incurred for the year ended December 31, 2000.
(1) Outsourcing refers to the full replacement of a client's internal subrogation recovery function by TransPaC Solutions, typically with a view to an ongoing relationship of indefinite period. (2) Referrals/Closed Claims refer to project-related work assumed by TransPaC Solutions, typically with files transmitted by clients from time to time.
reported direct written premiums of approximately $87.4 million in 2001. Safe Auto currently has in place approximately 94,000 policies.
(1) Backlog is the total dollar amount of potentially recoverable claims that the Company is pursuing on behalf of its clients at a given point in time. (2) Throughput equals claims recoveries for the period divided by the average of backlog at the beginning and end of the period.
The Property and Casualty Recovery Services effective fee rate for the year ended December 31, 2002 decreased to 24.2% from 29.2% in 2001. The decrease in fee rate was primarily attributable to the change in mix of referral and closed claim contracts, which typically bear higher fees, and full outsourcing contracts, which typically bear lower fees, that occurred during the year ended December 31, 2002.
Claims Revenues. Total Property and Casualty Recovery Services revenues for 2001 were $187,000, an increase of $176,000 over 2000. Property and Casualty Recovery Services claims recoveries for the year ended December 31, 2001 were $640,000, an increase of $602,000 over 2000. The increases in both revenues and recoveries were due to the fact that TransPaC Solutions did not begin operations until the quarter ended September 30, 2000.
The Property and Casualty Recovery Services effective fee rate for the year ended December 31, 2001 increased to 29.2% from 29.0% for 2000.
Support Expenses. Support expenses for the Property and Casualty Recovery Services segment were $754,000 in 2001 compared to $314,000 in 2000, primarily due to the addition of management and other resources to support operations. TransPaC began operations during the quarter ended September 30, 2000. Prior to that time and for the year ended December 31, 2000, support expenses consisted of sales resources and marketing expenses.
Support Expenses. For the year ended December 31, 2002, the Software segment incurred approximately $1.9 million in expenditures in connection with the creation of new software products for the insurance industry. Approximately $1.1 million of support expenditures were capitalized in 2002, resulting in net reported expenses of $0.8 million.
Research and Development. The Company incurred approximately $1.6 million of expenses in 2001 related to research and development activities in connection with the creation of new products for the insurance industry, of which approximately $1.1 million were capitalized, resulting in net reported expenses of $0.5 million. There were no research and development expenses in the year ended December 31, 2002 because the products that were in development in 2001 became operational in 2002. See Item 1. "Business -- Industry -- Software".
Interest Expense. Interest expense totaled $0.5 million and $0.9 million for the years ended December 31, 2002 and 2001, respectively. The decrease in interest expense for 2002 was primarily due to a decrease in borrowed funds resulting from the release of restricted cash in July 2001, the proceeds from the sale of the Milwaukee building in November 2001 and to lower interest rates in 2002.
Other -- Loss on Disposal of Assets. In November 2001, the Company sold its building in New Berlin, Wisconsin to a third party at a loss of $1.0 million. The Company acquired the building on January 25, 1999 in the Subro Audit Acquisition.
Tax. The Company accrued its income tax at an effective rate of 38.3% for the year ended December 31, 2002. This rate was lower than the Company's historical effective income tax rate due to research and experimental tax credits, which included a one-time recapture for the previous four tax years, and state tax planning initiatives implemented during 2002.
accrual related primarily to certain non-cash compensation charges taken in connection with the initial public offering of the Company's stock in 1997.
Net Income. Net income for the year ended December 31, 2002 increased $2.2 million, or 48.6%, to $6.8 million or $0.72 per diluted common share, from $4.6 million, or $0.46 per diluted common share, for the year ended December 31, 2001. The primary reasons for the increases in net income and diluted earnings per share were: the loss on the sale of the Milwaukee building ($591,000 after tax) in 2001, the reversal of previously accrued income taxes described below under "Tax" in 2001, the adoption of FAS 142 on January 1, 2002 as described under "Depreciation and Amortization" above and the incremental Healthcare Recovery Services revenue from the UHG contract termination in 2002. See "Concentration of Clients".
Depreciation and Amortization. Depreciation and amortization expenses increased 5.2% to $6.7 million for the year ended December 31, 2001 from $6.4 million in 2000. The increase in depreciation expense was attributable to the purchased property and equipment and internally developed software related to the system upgrades. The increase in amortization expense was attributable to the addition of intangible assets related to the Subro Audit Acquisition final earn-out payment.
Other -- Special Committee Expenses. In August 1999, the Company's Board of Directors appointed the Special Committee to evaluate strategic alternatives available to the Company, including its possible sale. During the first quarter of 2000, the Company incurred $90,000 of expenses related to the work of the committee. In March 2000, after determining that the interests of the Company's shareholders would be best served by focusing on building the Company's business, the Special Committee ceased seeking a buyer for the Company and its efforts to enhance shareholder value were assumed by the full Board of Directors. See Item 8. "Financial Statements and Supplementary Data -- Note 16 -- Special Committee".
Net Income. Net income for the year ended December 31, 2001 increased $1.0 million, or 29.5%, to $4.6 million or $0.46 per diluted share, from $3.6 million, or $0.33 per diluted share, for the year ended
Net cash provided by operating activities increased $7.8 million for the year ended December 31, 2002 over the year ended December 31, 2001 primarily as a result of the $3.0 million litigation settlement that was accrued as an expense in 2000 and paid in 2001. In addition, an increase of approximately $2.0 million in accrued expenses, primarily related to incentive compensation and benefit accruals, including the healthcare self-insurance provision for future claims that the Company began to accrue on January 1, 2002, contributed to the increase in net cash provided by operating activities. Although accounts receivable as of December 31, 2002 were approximately the same as the balance as of December 31, 2001, the number of days' sales outstanding decreased from 55 days to 49 days because the Company resolved a collection issue with a provider bill audit client. Net cash provided by operating activities for the year ended December 31, 2001 of $6.0 million declined approximately $2.5 million from the year ended December 31, 2000 primarily because of an increase in the accounts receivable balance as well as in days' sales outstanding, this latter increase being attributable to the 2001 provider bill audit collection issue described above. Net cash provided by operating activities was used to repay amounts outstanding under the Company's Revolving Credit Facility and to repurchase the Company's common stock on the open market.
The Company provides services to healthcare plans that as of December 31, 2002 covered approximately 41.6 million lives. The Company's clients are national and regional healthcare payors, large third-party administrators or self-insured corporations. The Company has two clients that individually comprise more than 10% of the Company's revenue. The Company's largest source of revenue is UnitedHealth Group ("UHG"). For the years ended December 31, 2002, 2001 and 2000, UnitedHealth Group generated 28%, 27% and 24% of the Company's revenues, respectively. Wellpoint Health Network Inc. accounted for 14%, 11% and 7% of the Company's total revenues for the years ended December 31, 2002, 2001 and 2000, respectively as well as 32% and 40% of the Company's accounts receivable balance at December 31, 2002 and 2001, respectively. HealthNet accounted for 15% and 9% of the Company's accounts receivable balance at December 31, 2002 and 2001, respectively.
The Company performs its services on a reasonable efforts basis and does not obligate itself to deliver any specific result. Contracts with its customers are generally terminable on 60 to 180 days' notice by either party, although in a few cases the contracts extend over a period of years. The Company's contracts generally provide that in the event of termination, the Company is entitled to complete the recovery process on the existing backlog or to receive a cash payment designed to approximate the gross margin that would otherwise have been earned from the recovery on the backlog of the terminating client. On December 31, 2002, the Company had Healthcare Recovery Services backlog of $1,559.0 million.
Effective May 10, 2002, Herbert A. Denton resigned as a director of the Company. Under the Company's Certificate of Incorporation and Bylaws, a vacancy on the Board of Directors created by a resignation may be filled by a majority vote of the remaining directors. A director so chosen to fill the vacancy would hold office until the next succeeding Annual Meeting. The Board of Directors, through its Nominating Committee, is currently engaged in identifying candidates for the vacant position.
On February 12, 1999, the Board of Directors adopted a Stockholder Rights Plan and declared a dividend of one preferred stock purchase right (a "Right") for each outstanding share of Common Stock of the Company. The dividend was payable to stockholders of record on March 1, 1999. The Rights, which initially trade with the Common Stock, separate and become exercisable only upon the earlier to occur of (i) 10 days after the date (the "Stock Acquisition Date") of a public announcement that a person or group of affiliated persons has acquired 20% or more of the Common Stock (such person or group being hereinafter referred to as an "Acquiring Person") or (ii) 10 days (or such later date as the Board of Directors shall determine) after the commencement of, or announcement of an intention to make, a tender offer or exchange offer that could result in such person or group owning 20% or more of the Common Stock (the earlier of such dates being called the "Distribution Date"). When exercisable, each Right initially entitles the registered holder to purchase from the Company one one-hundredth of a share of a newly created class of preferred stock of the Company at a purchase price of $65 (the "Purchase Price"). The Rights are redeemable for $0.001 per Right at the option of the Board of Directors. The Rights expire on March 1, 2009.
In May 1997, Patrick B. McGinnis, the Chairman and Chief Executive Officer of the Company, borrowed from a commercial bank $500,000 to finance the payment of income taxes related to the ordinary income deemed to have been received by him in the form of 80,000 shares of Common Stock granted to him in connection with the Company's initial public offering and $350,000 to finance the purchase of 25,000 additional shares of Common Stock in the initial public offering.
At Mr. McGinnis' request, following conversations with his lender, on February 12, 1999, the Board of Directors approved a loan in the amount of $350,000 to Mr. McGinnis, in exchange for a full recourse promissory note in the same amount from Mr. McGinnis. On June 30, 2000, at the direction of the Board of
Directors and in accordance with terms authorized by it, the Company loaned Mr. McGinnis an additional $500,000. Under these terms, the $500,000 loan to Mr. McGinnis was combined with his existing debt to the Company of $350,000 of principal and $36,520 of accrued interest. Mr. McGinnis delivered to the Company his full recourse promissory note in the amount of $886,520, bearing interest at a fixed rate of 6.62% per annum (the applicable Federal mid-term rate in effect for tax purposes at the date of the note), compounded annually (the "Amended Promissory Note"), and the Company cancelled the old promissory note evidencing the prior debt. The Amended Promissory Note provides for mandatory prepayments from certain of the proceeds received by Mr. McGinnis from his sale of the Company's securities and any related transactions. The promissory note and all accrued interest are due and payable upon the earlier of January 1, 2005 or the termination of Mr. McGinnis's employment with the Company. At December 31, 2002, the promissory note of $886,520 and accrued interest of $39,908 were outstanding.
On June 30, 2000, pursuant to the Board of Directors' authorization and in accordance with the terms of the Amended Promissory Note, the Company and Mr. McGinnis entered into a deferred compensation agreement (the "Agreement"). Under the Agreement, 50% of the amount otherwise payable to Mr. McGinnis under the Company's Management Group Incentive Compensation Plan is to be deferred until the Amended Promissory Note is paid in full, with such deferred compensation then being paid in full to Mr. McGinnis within 30 days thereafter. The Company has full right of set-off against any deferred compensation under the Agreement should Mr. McGinnis default under the Amended Promissory Note. At the election of Mr. McGinnis, the payment of the deferred compensation, upon payment of the Amended Promissory Note, may be extended for a period of not more than ten years. At December 31, 2002, the amount of deferred compensation was $72,354, with accrued interest of $7,627.
As discussed in Note 2 to the financial statements, the Company ceased amortizing goodwill effective January 1, 2002.
BALANCE SHEETS DECEMBER 31, 2002 AND 2001 (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (DOLLARS IN THOUSANDS)
Substantially all of the Company's cash, cash equivalents and restricted cash have been placed with one financial institution.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101). SAB 101 provides guidance on revenue recognition and related disclosures and was effective beginning October 1, 2000. The Company was previously
following the requirements provided under SAB 101 and, accordingly, the implementation of this pronouncement had no impact on the Company's financial position or results of operations for 2002, 2001 or 2000.
During 2000, the Company began research and development activities in connection with the creation of new products for the insurance industry. The Company charges all research and development costs to expense when incurred. The Company incurred $537,000 and $366,000 of expenses related to research and development during 2001 and 2000, respectively.
The provision for income taxes has been prepared in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes". The Company recognizes an asset or liability for the deferred tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. A valuation allowance is provided against these deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The effects of applying SFAS No. 123 in the pro forma disclosures are not likely to be representative of the effects on pro forma net income or earnings per common share for future years because variables such as
option grants, option exercises, and stock price volatility included in the disclosures may not be indicative of actual future activity.
Basic earnings per common share were computed based on the weighted-average number of shares outstanding during the year. The dilutive effect of stock options is calculated using the treasury stock method. Options to purchase 947,834, 1,298,653 and 1,470,978 shares for the years ended December 31, 2002, 2001 and 2000, respectively, were not included in the computation of diluted earnings per common share because the exercise prices of these options were greater than the average market price of the common shares during the respective years, and therefore, the effect would have been antidilutive.
Also, in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (FAS 142), "Goodwill and Other Intangible Assets", which establishes the accounting for goodwill and other intangible assets following their recognition. FAS 142 applies to all goodwill and other intangible assets whether acquired singly, as part of a group, or in a business combination. FAS 142 provides that goodwill should not be amortized but should be tested for impairment at the reporting unit annually, and at other times as events or circumstances indicate an impairment may have occurred, using a fair-value based approach. In addition, FAS 142 provides that other intangible assets other than goodwill should be amortized over their useful lives and reviewed for impairment. FAS 142 was effective for the Company beginning on January 1, 2002. The Company was required to perform a transitional impairment test under FAS 142 for all goodwill recorded as of January 1, 2002. During the three months ended June 30, 2002, the Company completed the transitional impairment test under FAS 142 for all goodwill recorded as of January 1, 2002. See Note 8 "Goodwill and Other Intangible Assets".
In July 2001, the FASB issued Statement of Financial Accounting Standards No. 143 (FAS 143), "Accounting for Asset Retirement Obligations". FAS 143 is effective for fiscal years beginning after June 15, 2002, and provides accounting requirements for asset retirement obligations associated with tangible long-lived assets. The Company believes that the adoption of this standard will not have a significant effect on its financial statements.
In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (FAS 144), "Accounting for the Impairment or Disposal of Long-Lived Assets". FAS 144 is effective for fiscal years beginning after December 15, 2001. This statement supersedes FAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a business segment. FAS 144 establishes a single accounting model, based on the
The following is a reconciliation of the effective tax rate to the federal statutory rate for the years ended December 31, 2002, 2001 and 2000:
Temporary differences giving rise to deferred taxes in the accompanying balance sheets at December 31, 2002 and 2001 consist of the following (in thousands):
UnitedHealth Group accounted for 28%, 27% and 24% of the Company's total revenues for the years ended December 31, 2002, 2001, and 2000, respectively. Wellpoint Health Network Inc. accounted for 14%, 11% and 7% of the Company's total revenues for the years ended December 31, 2002, 2001 and 2000, respectively. No other client accounted for more than 10% of the Company's total revenues. The loss of these clients could have a material adverse effect on the Company's results of operations, financial position and cash flows.
On February 12, 1999, the Board of Directors approved a loan in the amount of $350,000 to Patrick B. McGinnis, the Chairman and Chief Executive Officer of the Company, in exchange for a full recourse promissory note in the same amount from Mr. McGinnis. On June 30, 2000, at the direction of the Board of Directors and in accordance with terms authorized by it, the Company loaned Mr. McGinnis an additional $500,000. Under these terms, the $500,000 loan to Mr. McGinnis was combined with his existing debt to the Company of $350,000 of principal and $36,520 of accrued interest. Mr. McGinnis delivered to the Company his full recourse promissory note in the amount of $886,520, bearing interest at a fixed rate of 6.62% per annum, compounded annually (the "Amended Promissory Note"), and the Company cancelled the old promissory note evidencing the prior debt. The Amended Promissory Note provides for mandatory prepayments from certain of the proceeds received by Mr. McGinnis from his sale of the Company's securities and any related transactions. At December 31, 2002 and 2001, the promissory note of $886,520 and accrued interest of $39,908 and $86,195 were outstanding, respectively. Mr. McGinnis used the proceeds of these loans to repay debts originally incurred by him to pay income taxes related to the ordinary income deemed to have been received by him on account of Common Stock granted to him in connection with the initial public offering of the Company's stock in May 1997, and to purchase additional stock in the initial public offering.
On June 30, 2000, pursuant to Board authorization and in accordance with the terms of the Amended Promissory Note, the Company and Mr. McGinnis entered into a deferred compensation agreement (the "Agreement"). Under the Agreement, 50% of the amount otherwise payable to Mr. McGinnis under the Company's Management Group Incentive Compensation Plan is to be deferred until the Amended Promissory Note is paid in full, with such deferred compensation then being paid in full to Mr. McGinnis within 30 days thereafter. The Company has full right of set-off against any deferred compensation under the Agreement should Mr. McGinnis default under the Amended Promissory Note. At the election of Mr. McGinnis, the payment of the deferred compensation, upon payment of the Amended Promissory Note, may be extended for a period of not more than ten years. At December 31, 2002 and 2001, the amount of deferred compensation was $72,354 and $52,648, with accrued interest of $7,627 and $2,779, respectively.
"Subro Audit Acquisition"), using available unrestricted cash. The Company paid an additional $5.3 million pursuant to an earn-out arrangement. The final amount of $2.5 million was paid on June 7, 2001, and $2.8 million was paid on May 18, 2000. Approximately $4.7 million was held in escrow for the potential earn-out and was included in restricted cash at December 31, 2000. SAI is based in Wisconsin and provides subrogation recovery services with respect to an installed base of lives, which are covered by insurers, HMOs and employer-funded plans, throughout the United States of America. The Subro Audit Acquisition was accounted for using the purchase method of accounting.
Effective on January 1, 1997, the Company's employees began participation in the Company's 401(k) defined contribution pension plan. An annual expense provision for the plan is based upon the level of employee participation, as the plan requires the Company to match a certain portion of the employees' contributions. For the years ended December 31, 2002 and 2001, participants were given the option of receiving their match in cash or in common stock of the Company. For participants choosing the stock match, the Company contributed up to 100% of the participant's contribution, not to exceed 6% of the participant's annual compensation. For participants choosing the cash match, the Company contributed up to 50% of the participant's contribution, not to exceed 6% of the participant's annual compensation. For the year ended December 31, 2000, the Company match was made in common stock of the Company, up to 6% of the participant's annual compensation. Total retirement plan expense was approximately $785,900, $707,100 and $818,300 for the years ended December 31, 2002, 2001 and 2000, respectively.
Accrued bonuses included in the accompanying balance sheets at December 31, 2002 and 2001 approximate $3.7 million and $3.5 million, respectively.
Should the Company enter into contracts that are not considered to be perfectly effective in offsetting the change in the value of the interest payments being hedged, any changes in fair value relating to the ineffective portion of this contract is immediately recognized in income. The net effect of this accounting on the Company's operating results is that interest expense on the portion of the variable rate Revolving Credit Facility being hedged is generally recorded based on fixed interest rates.
On November 1, 2001, the Company entered into a revolving credit facility with National City Bank of Kentucky, Bank One Kentucky, N.A. and Fifth Third Bank (the "Revolving Credit Facility"), and the existing credit facility was terminated. The Company's obligations under the Revolving Credit Facility are secured by substantially all of the Company's assets, subject to certain permitted exceptions. The Revolving Credit Facility carries a maximum borrowing capacity of $40 million and will mature October 31, 2004. Principal amounts outstanding under the Revolving Credit Facility bear interest at a variable rate based on the Prime Rate or Eurodollar Rate, as applicable, plus a pre-determined fixed margin. At December 31, 2002, the interest rate was 3.19% based on the one-month Eurodollar Rate plus the fixed margin. The Revolving Credit Facility contains customary covenants and events of default including, but not limited to, financial tests for interest coverage, net worth levels and leverage that may limit the Company's ability to pay dividends. It also contains a material adverse change clause. At December 31, 2002 and 2001, $4 million and $8 million, respectively, was outstanding under the Revolving Credit Facility.
In May 1997, the Company adopted the Trover Solutions, Inc. Non-Qualified Stock Option Plan for Eligible Employees (the "Employees' Plan"), the Trover Solutions, Inc. Amended and Restated Directors' Stock Option Plan (the "Directors' Plan") and the Trover Solutions, Inc. Employee Stock Purchase Plan (the "Purchase Plan"). On December 8, 1997, the Company adopted the Trover Solutions, Inc. 1997 Stock Option Plan for Eligible Participants (the "1997 Plan"). On May 10, 2002, the Company adopted the Trover Solutions, Inc. Outside Directors Equity Compensation Plan (the "2002 Outside Directors Stock Plan").
The Directors' Plan provided for the grant of options to purchase the Company's Common Stock to each non-employee director of the Company. Options under the Directors' Plan are exercisable at 100% of the market value of the Company's Common Stock on the date of grant. Pursuant to the Directors' Plan, each eligible director was granted on the date he or she first becomes a director an option to purchase 10,000 shares of Common Stock, and each eligible director was granted on the date of each annual meeting of stockholders of the Company beginning in 1998 an option to purchase 2,000 shares of Common Stock, for so long as shares are available under the Directors' Plan, but not after March 31, 2002 at which time the plan terminated. Terms of options granted under this plan commence on the date of grant and expire on the tenth anniversary
Activity related to the Employees' Plan, Directors' Plan, 1997 Plan and 2002 Outside Directors Stock Plan for the years ended December 31, 2002, 2001 and 2000 is summarized as follows:
The following table summarizes information about options outstanding under the Employees' Plan, Directors' Plan, 1997 Plan and 2002 Outside Directors Stock Plan at December 31, 2002:
Under the Purchase Plan, eligible employees may purchase shares of the Company's Common Stock, subject to certain limitations, at the lesser of 85% of its market value on the first day of the purchase period or 85% of its market value on the last day of the purchase period. The plan provides for semi-annual purchase periods. Purchases are made from payroll deductions up to a maximum of 15% of an employee's eligible annual compensation. During the years ended December 31, 2002, 2001 and 2000, employees paid the Company $89,000, $91,000 and $92,000, respectively, to purchase 22,608 shares, 35,782 shares and 29,929 shares, respectively. As of December 31, 2002, there were 194,224 shares of Common Stock reserved for future purchase under the Purchase Plan.
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information", established standards for reporting information about operating segments in the Company's financial statements. It also established standards for related disclosures about products and services, and geographic areas. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.
(3) Software, which includes the sale of subrogation recovery software in a browser-based application service provider (ASP) form. The segment profit measure is income before income taxes.
Unallocated Corporate amounts include corporate expenses and other miscellaneous charges. Because this category includes a variety of miscellaneous items not attributable to one particular segment, it is subject to fluctuation on a quarterly and annual basis. The Company does not allocate assets.
The Company is engaged in the business of identifying and recovering subrogation and related claims of its clients, many of which arise in the context of personal injury lawsuits. As such, the Company operates in a litigation-intensive environment. The Company has, from time to time, been, and in the future expects to be, named as a party in litigation incidental to its business operations. There can be no assurance that pending litigation or future litigation will not have a material adverse effect on the Company's business, results of operations and financial condition.
A summary of the Company's quarterly results of operations follows (dollars in thousands, except per share amounts):