Revenues from outsourcing services are recognized as services are rendered. INSpire is typically paid a percentage of premiums written for policy administration services, a percentage of premiums earned or claims incurred for claims administration services, and a percentage of premiums written subject to a minimum fee for IT services. Outsourcing services contracts generally are for terms of two to ten years. Due to the ongoing nature of these outsourcing services and the length of the terms of the service contracts, outsourcing services generate recurring revenues. Initial installations of software systems generally include a one-time license fee and a contract for the installation and customization of the system to meet the customer's specifications, which INSpire bills at an hourly rate. Amounts charged for the initial license and the installation and customization of systems are recognized as revenue during the installation period in proportion to the hours expended for installation compared to the total hours projected for installation. In other instances, revenues are recognized based on performance milestones specified in the contract. INSpire recognizes the annual fee charged for maintenance of the customer's system over the maintenance contract period. Revenues from computer hardware and equipment sales, included in other revenues, are recognized when INSpire receives notification that the equipment has been shipped by the manufacturer and title has passed to the customer. Changes in estimates of percentage of completion or losses, if any, associated with outsourcing or software services are recognized in the period in which they are determined. Unearned revenues consist of billings to customers in advance of revenues recognized on such services. Unbilled receivables consist of revenues recognized in advance of billings due to timing differences related to billing schedules specified in contracts.
Cash and cash equivalents and investments decreased $4.2 million from December 31, 1999 to December 31, 2000. This decrease is primarily due to (i) $14.4 million in cash used for contract acquisitions and deferred contract costs, (ii) $700,000 in capitalized R&D costs and (iii) cash received from sale of property and equipment of $700,000 which were partially offset by $9.6 million of cash provided by operating activities.
The Company incurred negative net cash flows due to contract implementation costs, declining revenues without a proportional decrease in expenses, and delayed collections on significant receivable balances. 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 termination 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, or continues to experience delays in collection of receivables, the Company's liquidity will be adversely affected. As of March 1, 2001, the Company has ten months of cash and cash equivalents and investments on hand. This assumes no expense savings, new sales, or accounts receivable collection. The Company intends to seek outside financing to address its potential cash needs, but current debt and equity markets are presently very strained. 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 or obtain any such additional financing.
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.
Depreciation and Amortization. Depreciation and amortization expense decreased $842,000 for the year ended December 31, 2000. This decrease of 9.2% was primarily due to the impairment of intangible and other assets associated with the Island Agreement which no longer had amortization expense after August of 2000 and the Robert Plan which did not incur any amortization expense in December 2000.
associated with the collection of accounts receivable, as well as penalties or settlements to be paid in connection with various pending matters.
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.
Cumulative Effect of Change in Accounting. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 is effective for the Company's financial statements no later than the fourth quarter of fiscal year 2000. Effective with the beginning of the fourth quarter of fiscal year 2000, the Company adopted SAB 101. The cumulative effect of the adoption of SAB 101 had a negative impact of $4.9 million on net income after tax effects for the year ended December 31, 2000.
Cost of Revenues. Cost of revenues increased $54.8 million. This increase in costs was due to an increase in outsourcing costs. Cost of outsourcing services increased $55.2 million, or 210%. This increase is primarily attributable to costs associated with the performance of outsourcing services under the contracts described above. Cost of outsourcing services as a percentage of outsourcing services revenues increased to 73% for the year ended December 31, 1999 from 52% for the year ended December 31, 1998. This increase is a result of additional staffing and equipment to support the growth of the outsourcing division, and lower operating margins during the initial phases of the new outsourcing contracts described above. Cost of software and software services remained relatively constant over the two years. Cost of software and software services as a percentage of software and software services revenues increased to 71% for the year ended December 31, 1999 from 56% for the year ended December 31, 1998, primarily as a result of the costs associated with providing consulting services, which comprised a larger proportion of total software revenues during the year ended December 31, 1999 compared to the year ended December 31, 1998, as well as a decrease in the productivity of software personnel.
Unusual Operating Expenses. Unusual operating expenses totaled $31.5 million for the year ended December 31, 1999 compared to $500,000 for the year ended December 31, 1998. 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 consisted 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.
Paragon Acquisition, the software license associated with the Company's agreement with Cover-All Systems, Inc. entered into in October 1997, and internally capitalized software production costs. The Company periodically evaluates the carrying value of long lived assets to determine if impairment exists based upon estimated undiscounted future cash flows. 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. The impairment charge was necessitated by the Company's determination, based on recent operating results, that the future expected sales and cash flows from the Company's software operation would be significantly lower than previously expected.
Severance Expense. Severance costs of $1.7 million incurred during 1999 represent expenses associated with staff reductions and executive resignations, primarily as a result of the Company's decision in December 1999 to discontinue efforts toward licensing new software systems.
Net Income (Loss). Net loss was $19.7 million, or $1.04 per diluted share ($1.04 per basic share), for the year ended December 31, 1999 compared to net income of $11.6 million, or $.58 per diluted share ($.65 per basic share), for the year ended December 31, 1998. Excluding the impact on net income resulting from the $31.5 million nonrecurring operating expenses discussed above, and the tax effects thereof, net income for the year ended December 31, 1999 would have been $4.0 million or $.20 per diluted share ($.21 per basic share). Excluding the impact on net income resulting from the $500,000 write-off of purchased research and development associated with the Paragon Acquisition, net income for the year ended December 31, 1998 would have been $12.1 million, or $.61 per diluted share ($.68 per basic share).
Negative cash flows. The Company incurred negative net cash flows due to contract implementation costs, declining revenues without a proportional decrease in expenses, and delayed collections on significant receivable balances. 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 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, or continues to experience delays in collection of receivables, the Company's liquidity will be adversely affected. As of March 1, 2001, the Company has ten months of cash and cash equivalents and investments on hand. This assumes no expense savings, new sales or accounts receivable collection. The Company intends to seek outside financing to address its potential cash needs, but current debt and equity markets are presently very strained. 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 or obtain any such additional financing.
Replacement of current business. In order to maintain the Company's operations it will have to replace revenues lost due to the termination of both the Island Group and Robert Plan contracts and the reduction of Millers American business during 2000. Without the replacement of these revenues the Company will need to significantly reduce expenses to meet its liquidity requirements. If the Company cannot meet its liquidity requirements, its operations and financial conditions will be materially and adversely affected.
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 three of the past five years. Net losses were approximately $30.2 million for the year ended December 31, 2000, $19.7 million for the year ended December 31, 1999, and $515,000 for the year ended December 31, 1996. INSpire cannot assure that it will be able to maintain 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."
Fluctuations in quarterly operating results. INSpire has experienced in the past and will experience in the future quarterly variations in net revenues and net income. Thus, operating results for any particular quarter are not necessarily indicative of results for any future period. Factors that have affected quarterly operating results include: (i) the introduction of new or enhanced services and products by INSpire or its competitors, (ii) customer acceptance or rejection of new services and products, (iii) product development expenses, (iv) the timing of new contract signings, (v) the volume of usage of INSpire's services, (vi) acquisitions, (vii) competitive conditions in its industry, (viii) general economic conditions, and (ix) the level of selling and administrative expenses. Many of these factors are beyond INSpire's control.
Volatility of trading price. The trading price of INSpire's Common Stock has fluctuated widely in response to variations in INSpire's quarterly operating results, changes in earnings estimates by securities analysts, changes in the Company's business, and changes in general market and economic conditions. In addition, in recent years the stock market has experienced extreme price and volume fluctuations. These fluctuations have significantly affected the trading prices of the securities of many emerging growth companies without regard to their specific operating performance. Such market fluctuations could have a material adverse effect on the trading price of the Common Stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
NASDAQ regulations require a Company's Common Stock trading price to remain above $1.00. The NASDAQ closely monitors the compliance with its financial and corporate governance requirements, including the requirement that Company's maintain a $1.00 share price, which INSpire failed to do at times in 2000. If the Company fails to comply with these regulations it risks beings
delisted from NASDAQ, which could adversely affect the liquidity of the Company's shares.
Competition. The markets for policy and claims administration and IT service are highly competitive. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Although the Company remains vigilant in assessing its competitors, the Company faces the chance of a sudden entrant from an unknown source into the market. The Company cannot assure that it will be able to compete successfully against current and future competitors. See "Business -- Competition."
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 "Business -- Intellectual Property."
Government regulation. The P&C insurance industry is subject to extensive regulation by state governments. Certain aspects of INSpire's business are affected by such regulations, requiring the Company to periodically update its software to reflect changes in regulations. In addition, changes in regulations that adversely affect INSpire's existing and potential customers could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. Although INSpire's services and its products are not directly subject to insurance regulations in the states where INSpire currently provides them, the Company's outsourcing services may be subject to insurance regulations in states where INSpire may do business in the future. Such regulations could require INSpire to obtain a license as a managing general agent or third party administrator. INSpire cannot give any assurance with respect to the extent to which it may become subject to regulation in the future, the ability of the Company to comply with any such regulation, or the cost of compliance. See "Business -- Government Regulation."
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 preferred stock may be issued by INSpire in the future without shareholder approval and upon such terms and conditions, and having such rights, privileges, and preferences, as the Board of Directors may determine. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, any such preferred stock. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions, financings, and other corporate transactions, could have the effect of discouraging a third party's acquisition of a majority of the Common Stock. INSpire has no present plans to issue any shares of preferred stock. In addition, INSpire has adopted a shareholder rights plan that could further discourage attempts to acquire control of the Company. Finally, the TBCA restricts certain business combinations with any "affiliated shareholder," as defined therein and provides that directors serving on staggered boards of directors may be removed only for cause unless the articles of incorporation otherwise provide. INSpire's Restated Articles do not otherwise so provide.
Recession. The U.S. economy is experiencing a significant business slow down and possibly a 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 may adversely affect the Company's operations and business condition.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133, as amended, is effective for fiscal years beginning after June 15, 2000. SFAS 133 requires all derivative instruments to be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designed as part of a hedge transaction and, if it is, the type of hedge transaction. The Company does not expect that the adoption of SFAS 133 will have a material impact on its financial statements because the Company does not currently hold any derivative instruments.
The following table sets forth certain unaudited historical quarterly financial data for each of the eight consecutive quarters in fiscal 2000 and 1999. This information is derived from unaudited financial statements that include, in the opinion of INSpire, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation when read in conjunction with the financial statements of INSpire and notes thereto included elsewhere in this Form 10-K.