The following table sets forth certain information with respect to the principal facilities used in INSpire's operations as of June 30, 2002:
INSpire sublets part of the property in San Diego to Arrowhead Insurance Group for $85,000 a month. INSpire also subleases part of the same property to Plus Orthopedics for $19,107 a month.
INSpire believes that its existing facilities are adequate to meet its requirements for the foreseeable future.
INSpire incurs research and development costs that relate primarily to the development of new services and products and major enhancements to existing services and products. Research and development costs are comprised primarily of salaries. INSpire expenses or capitalizes, as appropriate, these costs in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." All costs incurred prior to the time management believes a project has reached "technological feasibility" are expensed. Software production costs incurred subsequent to reaching technological feasibility are capitalized, if material, and reported at the lower of unamortized cost or net realizable value. Capitalized costs are amortized over the expected service life of the related software, generally three to seven years, using the straight-line method. The cost and related accumulated amortization of projects are written off as they become fully amortized.
The Company periodically assesses the recoverability of capitalized software production costs and deferred contract costs by determining whether the carrying amount of those long lived assets can be recovered through undiscounted future operating cash flows and, if warranted, an impairment is recognized. The impairment, if any, is measured by the difference between net book value and estimated discounted future cash flows, and is charged to expense in the period identified.
Cash and cash equivalents and investments decreased $7.7 million from December 31, 2000 to December 31, 2001. This decrease was primarily due to $3.9 million in cash used to fund operations and $2.1 million property and equipment purchases, as well as $1.4 million in cash used to fund contract costs.
The Company incurred negative net cash flows from declining contract revenues without a proportional decrease in expenses. The Company may experience material declines in future revenues due to the expected decline in the Company's outsourcing business with Millers American and the Arrowhead Group. As of August 1, 2002, the Company has approximately eight months of cash and cash equivalents and investments on hand. This assumes no expense savings, new sales, or accounts receivable collection. The Company's liquidity difficulties could increase with the loss of any additional clients. There can be no assurance that the Company can successfully manage its current liquidity requirements.
The Company also negotiated with ChoicePoint Inc. ("ChoicePoint"), for the potential sale of the Company's assets. Choicepoint filed a letter of intent with the Bankruptcy Court on October 24, 2002. Under the terms of the letter of intent, ChoicePoint would pay the Company $10,700,000 for all the assets of the Company and assume $3,146,785 in liabilities, as well as assuming certain future vendor obligations and leases. The offer was subject to certain conditions. On November 4, 2002, the Company was informed by Choicepoint that they were withdrawing their offer.
The cash proceeds from a sale transaction and any remaining assets of the Company, if any (collectively, the "Trust Assets"), will be transferred to a liquidating trust (the "Trust"). Michael G. Lawrence of NACM SW (the "Trustee") will be the initial trustee for the Trust and will liquidate the Trust Assets and distribute the proceeds to the creditors of the Company.
The Trust Assets will be used to pay claims of creditors until such claims (and all expenses incurred in implementing the Plan) are paid in full, with any remaining assets being distributed to equity security holders. A total of $22,965,300 in claims have been filed in the Bankruptcy Court. The Company is in the process of analyzing these claims and, at this time, cannot give an exact amount of the claims which will be allowed; however, the Company believes that a substantial portion of these claims will be disallowed.
As described in Note 13 to the consolidated financial statements, Transactions with Major Customers, the Company is dependent on revenues from The Millers Group, Arrowhead and Clarendon National Insurance Company, which accounted for approximately 28%, 42%, and 12% of revenues for the year ended December 31, 2001, respectively. The loss of any one of these customers could result in a material reduction in Company revenues and could have a material adverse effect on the Company's business. As noted elsewhere herein, The Millers Group, Arrowhead and Clarendon have notified the Company that they each intend to reduce business with the Company, and aggregate revenues in 2002 for these customers are expected to decline from $56.2 million in 2001 to $ 23.7million in 2002. If these revenues are not replaced this revenue reduction will have a material adverse effect on the Company's future results of operations and cash flows.
Cost of Revenues. Cost of revenues, which is comprised mainly of personnel costs, was $67.9 million for the year ended December 31, 2001 compared to $106.5 million for the year ended December 31, 2000, a decrease of $38.6 million or 36.2%. Cost of outsourcing services was $65 million for the year ended December 31, 2001 compared to $100.7 million for the year ended December 31, 2000, a decrease of $35.7 million or 35.5%. This decrease is primarily attributable to a decrease in staffing, equipment and data processing costs as a result of the termination of both the Island Group and Robert Plan contracts, combined with a company-wide initiative to reduce expenses. Cost of outsourcing services as a percentage of outsourcing services revenues increased to 103.3% for the year ended December 31, 2001 from 88.1% for the year ended December 31, 2000. Cost of software and software services was $2.6 million for the year ended December 31, 2001 compared to $5.4 million for the year ended December 31, 2000, a decrease of $2.7 million or 50.4%. This decrease is primarily attributable to the decline in sales of licensed software packages and services. Cost of software and software services as a percentage of software and software services revenues increased to 53% for the year ended December 31, 2001 from 48.7% for the year ended December 31, 2000.
Selling, General and Administrative. Selling, general and administrative expenses were $11.4 million for the year ended December 31, 2001 compared to $10 million for the year ended December 31, 2000, an increase of $1.4 million or 14%. The increase is principally the result of additions to senior management and a more aggressive marketing strategy. Selling, general and administrative expenses as a percentage of total revenues increased to 16.5% for the year ended December 31, 2001 from 7.9% for the year ended December 31, 2000. This increase is due to a decrease in total revenues without a corresponding decrease in the costs incurred for selling, general and administrative functions.
Other Income. Other income, consisting principally of investment income, decreased to $0.4 million for the year ended December 31, 2001 from $0.8 million for the year ended December 31, 2000. This decrease is due to a decrease in cash equivalents and investments.
Revenues. Total revenues decreased 10.0% from December 31, 1999 to December 31, 2000. This decrease is primarily attributable to the $15.9 million decrease in software and software services revenues. The decrease in software and software services revenues is due to the Company's decision in December 1999 to discontinue efforts directed toward increasing licensed software packages and services in order to focus on its outsourcing business. Outsourcing services revenues increased $2.6 million for the year ended December 31, 2000. This increase resulted from: (i) the Company performing outsourcing services under an agreement with The Robert Plan entered into effective April 1, 1999 and (ii) the Company performing services under five additional outsourcing contracts entered into after March 31, 1999. These increases were partially offset due to decreases in revenues during the third and fourth quarters resulting from the following actions: (i) contractual rate decreases on two contracts and (ii) an overall decrease in Millers American business. In December 2000 INSpire received notice from the Robert Plan that it would be terminating its outsourcing contract agreement. As a result of the termination of both the Island Group and Robert Plan contracts, the Company had $33.2 million in outsourcing revenues in 2000, which will not continue.
Research and Development. Research and development expense was $3.2 million for the year ended December 31, 2000 compared to $5.2 million for the year ended December 31, 1999, a decrease of $2.0 million or 38.5%. This decrease is the result of a reduction in staff in response to the Company's decision to turn its focus from software licensing.
Unusual Operating Expenses. Unusual operating expenses incurred by the Company during the year ended December 31, 2000 included: (i) bad debt expense, (ii) litigation expense, (iii) severance expense, (iv) impairment of intangible assets, (v) the cumulative effect of change in accounting policy, and (vi) other charges. For the year ended December 31, 2000 unusual operating expenses totaled $41.7 million. These charges consisted of: (i) bad debt expense of $2.3 million which reflected management's best estimate of collectibility of receivable balances; (ii) litigation expense of $1.0 million relating to lawsuits in which the Company defended itself; (iii) severance costs of $1.9 million relating to the separation of several employees; (iv) $31.6 million in intangible assets impairment charges resulting from the termination of both the Island Group and Robert Plan contracts, and (v) $4.9 million for the cumulative effect of accounting change. During 1999, the Company recognized $31.5 million in charges primarily relating to the Company's assessment of the recoverability of assets
associated with its software business. These charges consist of: (i) $11.0 million to increase the allowance for bad debts, (ii) $1.2 million of litigation expenses, (iii) $16.8 million for the impairment of intangible assets, (iv) $1.7 million for severance costs, and (v) approximately $800,000 in other charges.
Intangible Asset Impairment. The Company recognized an impairment charge in August 2000 of approximately $14.0 million for certain intangible and other assets associated with the Island Insurance policy and claims outsourcing agreement and the Pacific Service Center. The impairment charge was necessitated by the termination of the Island Agreement and closing of the Pacific Service Center. In December 2000, the Company recognized an impairment charge of approximately $17.6 million for intangible and other assets associated with the termination of the Robert Plan outsourcing contract. During 1999, the Company recognized an impairment charge of $16.8 million for certain intangible assets, including a substantial portion of the goodwill and software acquired in the purchases of Strategic Data Systems, Inc. in March 1997 and Paragon Interface, Inc. in April 1998, the software license associated with the Company's agreement with Cover-All Systems, Inc. entered into in October 1997, and internally capitalized software development costs. The impairment was necessitated by the Company's determination that future expected sales and cash flows from the Company's software operations would be significantly lower than previously expected.
Other Income. Other income, consisting principally of investment income and the loss incurred from the sale of the Company's interest in two planes, decreased to $521,000 for the year ended December 31, 2000 from $1.4 million for the year ended December 31, 1999. The decrease of $900,000, or 64.3%, is due to a decrease in cash equivalents and investments primarily as a result of liquidating these investments to fund operations and deferred contract costs.
The Plan anticipates a potential sale of substantially all of the Company's assets including real property, intellectual property, cash, receivables, other current and long term assets, contractual rights, and other assets to CGI Group, Inc. ("CGI"), as set forth in a letter of intent that the Company and CGI executed on or about July 24, 2002 (the "Letter of Intent"). In exchange for such assets, CGI agreed to pay the Company $8,200,000 in cash (the "Cash Purchase Price") and assume up to $14,000,000 in liabilities including pre and post petition obligations incurred in the ordinary course of business, contractual obligations, unearned revenue and tax liabilities. The specific assets and liabilities to be included in a final definitive agreement are subject to ongoing negotiations. The Cash Purchase Price is based on the assumption that the "Net Asset Value" (as defined in the Letter of Intent) will be $7,000,000 (the "Assumed Net Asset Value"). Seven business days prior to the closing of this transaction, which must occur prior to November 15, 2002, the Company will deliver to the CGI a revised estimate of the Net Asset Value (the "Estimated Net Asset Value"). The Cash Purchase Price will be adjusted (upward or downward, as appropriate) by the amount that the Estimated Net Asset Value differs from the Assumed Net Asset Value; provided, however, that no adjustment will be made to the extent that the Estimated Net Asset Value exceeds $8,400,000. The Company currently estimates the Cash Purchase Price to be adjusted to approximately $5,400,000.
The cash proceeds from a sale transaction and any remaining assets of the Company, if any (collectively, the "Trust Assets") will be transferred to a liquidating trust (the "Trust"). Michael G. Lawrence of NACM SW (the "Trustee") will be the initial trustee for the Trust and will liquidate the Trust Assets and distribute the proceeds to the creditors of the Company.
Each equity security holder will receive a pro rata portion of such remaining assets, if any, based on the number of shares held as of the record date. The record date for such distributions will be the effective date of the Plan (the "Distribution Record Date"), which will be a date, as determined by the Company, on or after the date in which (i) a sale has been completed and (ii) the Trust has been formed, and the Trustee has been appointed. At such time, trading of the shares of the equity security interests of the Company will cease.
Negative cash flows. The Company incurred negative net cash flows due to declining revenues without a proportional decrease in expenses. The Company expects to experience material declines in future revenues due to the expected decline in the Company's outsourcing business with Millers American and Arrowhead and other customers and the terminations of both the Island Group and Robert Plan contracts. If the Company is unable to replace its declining revenues or to proportionately reduce its expenses, the Company's liquidity will be adversely affected. As of August 1, 2002, the Company has approximately eight months of cash and cash equivalents and investments on hand. The Company's liquidity difficulties could increase with the loss of any additional clients. There can be no assurance that the Company can successfully manage its current liquidity requirements.
Limited operating history and net losses. INSpire commenced operations in 1995 and has a limited operating history in the P&C insurance outsourcing business. The Company cannot assure that it will be successful in implementing its long-term operating strategy. The Company's operations generated net losses for the last three years. Net losses were approximately $68.1 million for the year ended December 31, 2001, $30.2 million for the year ended December 31, 2000, and $19.7 million for the year ended December 31, 1999. On February 15, 2002, the Company filed for relief under Chapter 11 of the U.S. Bankruptcy Code. INSpire cannot assure that it will be able to attain revenue growth or that the Company will not sustain net losses in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The sales cycles for INSpire's services are generally between three and twelve months and subject to a number of factors beyond the Company's control. Customer decisions to enter into outsourcing services agreements may be significantly affected by their decisions to replace current systems. In addition, demand for INSpire's claims administration services fluctuates greatly depending on the concentration of large-scale catastrophes, such as hurricanes. For these and other reasons, the revenues of the Company are difficult to forecast, and INSpire believes that period-to-period comparisons of results of operations are not necessarily meaningful or indicative of the results that INSpire may achieve for any subsequent quarter or fiscal year. Therefore, past operating results should not be considered a reliable indicator of future performance.
Dependence on major customers. INSpire derives a substantial portion of its revenues from outsourcing services provided to a few large customers, including The Millers Group, Arrowhead, and Clarendon, who represented 28%, 42%,
and 12% of 2001 revenues. Any loss of or material decrease in the business from any of these customers would have a material adverse effect on the Company's business, financial condition, cash flows, and results of operations. The Company has renegotiated contracts with The Millers Group, Arrowhead, and Clarendon and will experience reduced revenues from these customers as a group from approximately $56.2 million to $23.7 million in 2002.
Risks of software defects. The sale and support of software by INSpire entails the risks of product liability and warranty claims, which could be substantial. Software products may contain errors or defects, especially when first introduced or when new versions or enhancements are released. Any such defects in INSpire's software products could result in product liability or warranty claims, which could have a material adverse effect on the Company's business, financial condition, cash flows, and results of operations. INSpire's license agreements with its customers typically contain provisions designed to limit INSpire's exposure to product liability or warranty claims. These limitations of liability provisions, however, may be ineffective because of existing or future federal, state, or local laws or unfavorable judicial decisions. From time to time INSpire receives various claims alleging breach of warranty, breach of contract, deceptive trade practices, and similar claims
Reliance on information processing systems. INSpire's outsourcing services depend on its ability to store, retrieve, process, and manage significant databases, and expand and upgrade periodically its information processing capabilities. INSpire's principal computer equipment and software systems are maintained at INSpire's facilities in Fort Worth, Texas and San Diego, California. Interruption or loss of INSpire's information processing capabilities through loss of stored data, breakdown or malfunctioning of computer equipment and software systems, telecommunications failure or damage caused by fire, tornadoes, lightning, electrical power outage, or other disruption could have a material adverse effect on INSpire's business, financial condition, cash flows, and results of operations. Although INSpire maintains business interruption insurance with an aggregate limit of $12.5 million per occurrence, and has entered into an agreement with International Business Machines, Inc., which was rejected as part of the bankruptcy process and SunGard Recovery Services LP to provide disaster recovery services, if needed, INSpire cannot assure that such insurance or services will continue to be available at reasonable prices, cover all such losses, or compensate the Company for the possible loss of customers occurring during any period that INSpire is unable to provide services. See " Item 1 - Business Customer Support and Operations".
Dependence on proprietary rights and risks of infringement. INSpire relies on contract rights and copyright and other intellectual property laws to protect its products, including software source code, as trade secrets and confidential proprietary information. See " Item 1 - Business Intellectual Property."
Shares eligible for future sale. Sales of a substantial number of shares of common stock in the open market could adversely affect the trading price of the common stock. Millers Insurance currently holds 4,606,875 shares, representing approximately 24% of the outstanding shares of common stock. A decision by Millers Insurance to sell shares of common stock could adversely affect the trading price of the common stock. INSpire has an aggregate of 27,033,906 shares of common stock authorized but unissued and not reserved for specific purposes. All of such shares may be issued without any action or approval by INSpire's shareholders. Any shares issued would dilute the percentage ownership of the Company held by the current investors. INSpire has 19,153,708 shares of common stock outstanding, all of which are freely transferable. In addition, 4,575,000 shares of common stock are reserved for issuance under the Stock Option Plan, 2,353,908 of which will be issuable upon exercise of outstanding options, including currently exercisable options to purchase 1,221,323 shares, and 75,000 of those shares are reserved for issuance under the Director's Plan, 37,500 of which will be issuable upon exercise of options that are currently outstanding.]. An additional 637,500 shares are reserved for issuance to Inspire employees upon their purchase pursuant to the Employee Stock Purchase Plan. INSpire currently has 155,727 shares available that have been purchased to support future offerings of the Employee Stock Purchase Plan. INSpire has registered on Form S-8 under the Securities Act the offering and sale of common stock issuable under the Stock Option Plan, the Director Plan and the Stock Purchase Plan.
Anti-takeover considerations. Certain provisions of INSpire's Restated Articles of Incorporation (the "Restated Articles"), INSpire's Bylaws (the "Bylaws") and the Texas Business Corporation Act ("TBCA") may have the effect of discouraging unsolicited proposals for acquisition of the Company. The Restated Articles and the Bylaws divide the Board of Directors into three classes serving staggered three-year terms. Pursuant to the Restated Articles, shares of
Recession. The U.S. economy is experiencing a significant business slow down and is in recession, which adversely affects the ability of the Company to obtain new business, to obtain financing for its business and to maintain operating margins. A further contraction in business conditions may adversely affect the Company's operations and business condition.
The FASB issued Statement No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143") in August 2001 and Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144") in October 2001. SFAS 143 addresses reporting for obligations associated with the retirement of tangible long-lived assets and the related asset retirement costs. SFAS 143 is effective for fiscal years beginning after June 15, 2002 with earlier application permitted. SFAS 144 supercedes earlier guidance with respect to such accounting and is effective for years beginning after December 15, 2001. The Company does not expect the adoption of SFAS 143 and SFAS 144 to have a material effect on its consolidated financial statements.
corrections, clarify meanings, or describe their applicability under changed conditions. SFAS 145 is effective for financial statements issued on or after May 15, 2002. The Company does not expect the adoption of SFAS 145 to have a material effect on its consolidated financial statements.