The following is a discussion of changes in the consolidated results of our operations for the years ended December 31, 2002, 2001, and 2000.
We provide medical cost containment and business process outsourcing solutions for the medical insurance and managed care industries. We provide national PPO network access, electronic claims repricing, and claims and data management services to health care payers such as insurance carriers, HMOs, self-insured employers, third party administrators, and other entities that pay claims on behalf of health plans. We also provide services for health care providers, including individual providers, PPOs, and other provider groups.
We earn most of our operating revenue in the form of fees generated from the discounts we provide for the payers that access our NPPN network. We generally enter into agreements with our healthcare payer customers under which they pay to us a percentage of the cost savings generated from our NPPN network discounts with PPOs and providers. We recognize this operating revenue when claims processing and administrative services have been performed. Operating revenue from customers with certain contingent contractual rights is not recognized until the corresponding cash is collected. A portion of our operating revenue is generated from customers that pay us a monthly fee based on eligible employees enrolled in a benefit plan covered by our health benefits payer customers. We recognize our monthly fee operating revenue at the time the services are provided. Operating revenue related to our business process outsourcing services is earned on a per claim basis at the time the associated services are provided.
Operating revenue for the year ended December 31, 2002 increased $0.2 million, or 1.0%, to $33.1 million from $32.9 million in 2001. During 2002, we added over 45 new accounts and generated operating revenue from those customers totaling $4.5 million. The increase in operating revenue from this new business was partially offset by a decrease in operating revenue from customers that no longer use our services or that have significantly reduced their utilization. Claims volume increased 0.7 million, or 24.1%, to 3.6 million claims repriced in 2002 compared to 2.9 million claims repriced in 2001. The percentage increase in operating revenue in 2002 was less than the percentage increase in claims volume because we repriced a higher percentage of generally lower dollar value physician claims in 2002 compared to 2001, resulting in a decrease in average operating revenue per claim.
Loss on sale of investments for the year ended December 31, 2002 decreased $2.5 million, to $0.0 from $2.5 million for the same period in 2001. The loss on sale of investments in 2001 was due to our sale of our investment in HealthAxis, Inc.
Operating revenue for the year ended December 31, 2001 increased $6.0 million, or 22.3%, to $32.9 million from $26.9 million in 2000. During 2001, we added more than 177 new accounts and generated revenue from those customers totaling $6.2 million. Operating revenue from existing customers was flat in 2001 compared to 2000. Claims volume increased 0.8 million, or 38.1%, to 2.9 million claims repriced in 2001 compared to 2.1 million claims repriced in 2000. The percentage increase in operating revenue in 2001 was less than the percentage increase in claims volume because we repriced a higher percentage of generally lower dollar value physician claims in 2001 compared to 2000, resulting in a decrease in average operating revenue per claim.
Personnel expense for the year ended December 31, 2001 increased $0.8 million, or 9.6%, to $9.1 million from $8.3 million in 2000. Personnel expense increased as salaries and wages increased to meet increased volume
Depreciation for the year ended December 31, 2001 increased $0.2 million, or 66.7%, to $0.5 million from $0.3 million in 2000. Amortization of intangibles was $1.4 million for each of the years ended December 31, 2001 and 2000. The increase in depreciation was primarily attributable to the amortization of internally developed software costs that were capitalized in 2001 and the depreciation of new property and equipment acquired in 2001.
Loss on sale of investments, net for the year ended December 31, 2001 was $2.5 million compared to gain on sale of investments of $0.3 million in 2000. During the second quarter of 2001, we sold all of our shares of HealthAxis, Inc. stock and realized a net pretax loss on the sale of approximately $2.5 million. During the second quarter of 2000, we sold all 109,732 of our shares of Caredata.com, Inc. stock and realized a net pretax gain on the sale of $0.3 million.
Other income for the year ended December 31, 2001 was immaterial. Other expense for the year ended December 31, 2000 was $0.9 million. During the second quarter of 2000, we expensed legal, financial advisory, and other fees associated with the termination of our merger agreement with UICI, a Texas-based financial services firm. We entered into a contract to be acquired by them in October 1999. The transaction was mutually terminated in April 2000.
Liquidity is our ability to generate adequate amounts of cash to meet our financial commitments. Our primary sources of cash are fees generated from the healthcare provider discounts that we make available to our network access customers. Our uses of cash consist of payments to PPOs to provide access to their networks for our customers, payments for compensation and benefits for our employees, occupancy and related costs, general and administrative expenses associated with operating our business, debt service obligations, and taxes. We had cash and cash equivalents totaling $1.2 million at December 31, 2002. Net cash flow provided by (used in) operating activities was $1.4 million, $(9.5) million, and $3.2 million during the years ended December 31, 2002, 2001, and 2000, respectively. During 2001, cash flow provided by operating activities was affected by negative cash flows from our discontinued operations.
We entered into a registration rights agreement in favor of HealthPlan Holdings with respect to the 709,757 shares we issued to them at closing. This Registration Rights Agreement required that we file a registration
Following the sale of HealthPlan Services, we reimbursed HealthPlan Services approximately $4.3 million for pre-closing liabilities that HealthPlan Services settled on our behalf and issued to HealthPlan Holdings 101,969 shares of our common stock as penalty shares relating to certain post closing disputes with respect to those pre-closing liabilities. The primary source of the funds for the reimbursement to HealthPlan Services was the proceeds of July 2001 private placements of our common stock to certain investment accounts managed by DePrince, Race & Zollo, an investment firm. John Race, who was our director at the time, is one of the principals of DePrince, Race & Zollo. In connection with the private placements, which were ratified by our stockholders at our annual meeting in July 2002, we issued an aggregate of 553,500 shares of our common stock in exchange for $3.8 million, which represented a 15.0% discount from the ten-day trading average of our common stock prior to the dates of issuance.
We are currently in discussions with HealthPlan Holdings to finalize any purchase price adjustments associated with the HealthPlan Services transaction. These adjustments relate primarily to the amount of accrued liabilities and trade accounts receivable reserves, and the classification of investments at the transaction date. HealthPlan Holdings believes it is due approximately $1.7 million from us related to the transaction, while we believe we have claims against HealthPlan Holdings amounting to approximately $4.5 million (which would be partially offset against other post-closing payments that we have agreed to pay, subject to certain limitations as provided in the transaction documents). In the event that we are unable to resolve these matters directly with HealthPlan Holdings, we will seek to resolve them through binding arbitration as provided for in the purchase agreement.
In connection with our new credit facility and debt restructuring, we were required to adopt the accounting principles prescribed by Emerging Issues Task Force ("EITF") 00-27. In accordance with the accounting requirements of EITF 00-27, we have reflected approximately $46.7 million as an increase to the carrying value of our Series C convertible preferred stock with a comparable reduction to additional paid-in capital. The amount accreted to the Series C convertible preferred stock is calculated based on (a) the difference between the closing price of our common stock on April 12, 2002 and the conversion price per share available to the holders of our Series C convertible preferred stock, multiplied by (b) our estimate of the number of shares of common stock that will be issued if the shares of our Series C convertible preferred stock are ever converted. Such shares are not convertible until October 12, 2003. This amount is accreted over the contractual life of the Series C convertible preferred stock. This non-cash entry did not affect our net income but did impact the net income deemed available to our common stockholders for reporting purposes during 2002. Net income per share applicable to common stockholders during 2002 was further reduced by preferred stock dividends totaling $2.1 million, paid in 2,092 shares of our Series C convertible preferred stock to the holders of our Series C convertible preferred stock.
On July 19, 2002, we filed an Amended Registration Statement with the Securities and Exchange Commission wherein we offered for sale an aggregate of 5,174,979 shares of our common stock (sometimes referred to as the Offering). During the fourth quarter of 2002, we decided to postpone the Offering indefinitely. Accordingly, during the fourth quarter of 2002 we expensed $1.2 million of costs associated with the Offering. We subsequently filed an application to withdraw the Registration Statement.
On March 13, 2003, PVC Funding Partners LLC, an affiliate of Commonwealth Associates, LP and Comvest Venture Partners, filed a form 13D with the Securities and Exchange Commission in which they indicated that on March 7, 2003, they acquired from our senior lenders 29,651, or 96.0%, of our outstanding Series C convertible preferred stock. This Series C convertible preferred stock was purchased from the lenders on a prorata basis at a price of $33.50 per share. The original lenders continue to hold the remaining 4.0% of the Series C convertible preferred stock. In connection with the transaction, PVC Funding Partners also acquired $20.5 million in principal amount of our outstanding bank debt from the original lenders.
will be voted consistently with and on the same percentage basis as the original lenders with respect to all matters required to be submitted to a vote or consent of the lenders, except for matters related to certain fundamental changes in the loan terms. Upon the first occurrence of a Board Shift Event, which would allow PVC Funding Partners to appoint an additional board member and thus obtain control of our board of directors, PVC Funding Partners has the option of not exercising their right to obtain such control. If, within fifteen days of a first Board Shift Event, PVC Funding Partners notifies the original lenders that they will not exercise their right to control our board, then the original lenders will have the option to repurchase 14,304 of the Series C convertible preferred stock, at a price of $33.50 per share. If PVC Funding Partners exercises their right to obtain control of our board, or fails to timely notify the original lenders that they will not exercise this right, then the debt held by PVC Funding Partners will automatically be subordinated to the debt held by the original lenders.
As of December 31, 2001, we were in payment default with respect to interest payments due under notes aggregating $4.0 million payable to CENTRA Benefits, Inc. (sometimes referred to as Centra). We originally issued these notes in connection with our 1998 acquisition of a third party administration business from Centra. On April 12, 2002, we restructured these notes in connection with the closing of our restructured credit facility, which required that the maturity date of the notes be extended beyond the maturity date of the restructured facility. Under the restructured terms, we retired the original notes and issued new notes totaling $4.3 million, with a maturity date of December 1, 2004. The restructure notes accrued interest monthly at a compound rate of 12.0% per annum. Interest was payable quarterly in shares of our common stock, as calculated based on the average trading price over the last ten trading days of the quarter, unless Centra elected to receive any quarterly payment in cash on a deferred basis. Centra elected a deferred cash payment, which required us to make the cash interest payment either (1) within 90 days after the end of the fiscal year, to the extent that payment can be paid from available excess cash flow, as permitted by the terms of our restructured credit facility, or (2) on December 1, 2004, the date on which the convertible notes matured. At any time, Centra had the right to convert some or all of the notes to shares of our common stock, based on the lesser of (1) $6.40, (2) the average trading price of our common stock for the ten-day period immediately preceding notice of conversion, or (3) if any shares of the Series C convertible preferred stock have been converted into common stock, then the price at which such shares were converted. These notes were subordinated to the term loan with our senior lenders. In connection with the restructuring of the Centra notes, we issued to Centra warrants for the purchase of an aggregate of 200,000 shares of our common stock at an exercise price of $6.398 per share, subject to adjustment in accordance with the terms of the warrants.
In connection with a 1993 acquisition by our former subsidiary, HealthPlan Services, Inc., we assumed a note payable to Cal Group, Inc. As of December 31, 2002, the outstanding balance of the note was approximately $751,000.
On April 12, 2002, in connection with the restructuring of our credit facility, the maturity date of notes totaling $500,000 was extended to December 1, 2004. The notes are due to William Bennett, a member of our board of directors, and John Race, who was a member of the board at the time that the notes were issued and at the time of the April restructuring. These notes bear interest at prime plus 4.0% per annum, but payment of interest is subordinated and deferred until all senior obligations are paid.
We believe that all consolidated operating and financing obligations for the next twelve months will be met from internally generated cash flow from operations, and available cash. Although there can be no assurances, management believes based on available information, it will be able to maintain compliance with the terms of its restructured credit facility, including the financial covenants, for the foreseeable future. Our ability to fund our operations, make scheduled payments of interest and principal on our indebtedness, and maintain compliance with the terms of our restructured credit facility, including our financial covenants, depends on our future performance, which is subject to economic, financial, competitive, and other factors beyond our control. If we are unable to generate sufficient cash flows from operations to meet our financial obligations and achieve the restrictive debt covenants as required under the restructured credit facility, there may be a material adverse effect on our business, financial condition, and results of operations. Management is continuing to explore alternatives to reduce our obligations, recapitalize our company, and provide additional liquidity. There can be no assurances that we will be successful in these endeavors.
We have included below a discussion of the accounting policies that we believe are affected by the more significant judgments and estimates used in the preparation of our condensed consolidated financial statements, how we apply such policies, and how results differing from our estimates and assumptions would affect the amounts presented in our condensed consolidated financial statements. Other accounting policies also have a significant effect on our condensed consolidated financial statements, and some of these policies also require the use of estimates and assumptions.
We earn operating revenues in the form of fees generated from the repricing of medical claims. We generally enter into agreements with our health benefit payer clients that require them to pay a percentage of the cost savings generated from our network discounts with participating providers. These agreements are generally terminable upon 90 days notice. Operating revenues from percentage of savings contracts are generally recognized when claims processing and administrative services have been performed. Operating revenues from customers with certain contingent contractual rights are generally not recognized until the corresponding cash is collected. The remainder of our operating revenues is generated from customers that pay us a monthly fee based on eligible employees enrolled in a benefit plan covered by our health benefits payers clients. Operating revenues under such agreements are recognized when the network access services are provided.
We evaluate the collectibility of our accounts receivable based on a combination of factors. In circumstances where we are aware of a specific customer's inability to meet its financial obligations to us, we record a specific reserve for bad debts against amounts due to reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers, we recognize reserves for bad debts based on past write-off history, average percentage of receivables written off historically, and the length of time the receivables are past due. To the extent historical credit experience is not indicative of future performance or other assumptions used by management do not prevail, loss experience could differ significantly, resulting in either higher or lower future provision for losses.
net of the related income tax effect. SFAS No. 145 also eliminates an inconsistency between the accounting for sale-leaseback transactions and certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Generally, SFAS No. 145 is effective for transactions occurring after May 15, 2002. We do not expect the adoption of the standard to have any impact on us.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. We will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of our commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized. The adoption of SFAS No. 146 will not have an impact on us.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123," and is effective for fiscal years ending after December 15, 2002. SFAS No. 148 provides for alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Additionally, SFAS No. 148 requires prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation. The adoption of SFAS No. 148 will not have a material impact on us.
We completed a restructuring of our credit facilities with our lenders in April 2002. We replaced approximately $69.0 million of indebtedness to our lenders, including outstanding principal and accrued and unpaid interest and bank fees, with a $40.0 million term loan, collateralized by all of our assets. The term loan requires us to achieve financial covenants, including minimum monthly EBITDA levels, maximum quarterly and annual capital expenditures, a minimum quarterly fixed charge ratio, and maximum quarterly and annual extraordinary expenses. Failure to comply with the term loan's financial covenants is an event of default and would permit the lenders to immediately require us to repay the term loan. This may have a material adverse effect on our business, operating results and financial condition, and could require us to seek protection under available bankruptcy laws. From April 12, 2002 through November 30, 2002, we were in compliance with these financial covenants for each reporting period required under the terms of the restructured agreement. During December 2002, we were not in compliance with our EBITDA covenant and we subsequently obtained a waiver from our senior lenders for this non-compliance.
In exchange for retirement of the remaining amounts due to the lenders, we issued to the lenders 29,000 shares of our newly authorized Series C convertible preferred stock. The Series C convertible preferred stockholders are entitled to elect three out of seven members of our board of directors. In addition, the Series C holders may immediately elect one additional member to our board, and thereby gain control of our board, upon the occurrence of specified events. These events include a default of any of our payment obligations or our failure to achieve mandated minimum cash levels.
On March 7, 2003, PVC Funding Partners, LLC, an affiliate of Commonwealth Associates, LP and Comvest Venture Partners, acquired 29,851 shares, or 96.0%, of our Series C convertible preferred stock, and also acquired $20.5 million in principal amount of our outstanding debt from our senior lenders. In connection with its acquisition of a portion of our debt, PVC Funding Partners has agreed that, subject to certain exceptions for fundamental changes in loan terms, it will vote its debt consistently with and on the same percentage basis as the other senior lenders with respect to all matters submitted or required to be submitted to a vote or consent of senior lenders under our credit agreement.
We have issued an aggregate of 1,866,551 shares of our common stock in connection with the HealthPlan Holdings transaction. At the closing, we issued to HealthPlan Holdings 709,757 shares of our common stock and a convertible subordinated note, which automatically converted into 813,273 shares of our common stock in April 2002. The number of conversion shares is equal to $5.0 million, divided by $6.14, which was the average closing price of the stock on the New York Stock Exchange during the ten trading days immediately prior to the conversion. Our agreement with HealthPlan Holdings requires that we issue and distribute to them additional shares of our common stock to compensate them to the extent that the amount of proceeds it realizes from the sale of the conversion shares is less than $5.0 million. We have granted HealthPlan Holdings registration rights with respect to these additional shares. During 2001 and 2002, we issued a total of 343,521 additional shares of our common stock in settlement of certain post-closing disputes and to meet certain obligations under the terms of the subordinated note and a registration rights agreement we entered into at closing. We have granted HealthPlan Holding registration rights with respect to their outstanding shares of our common stock, except for 100,000 shares issued as penalty shares under HealthPlan Holdings' registration rights agreement.
In connection with the restructuring of our credit facility in April 2002, we issued to our senior lenders 29,000 shares of our newly authorized Series C convertible preferred stock, and have issued an additional 2,092 Series C shares as dividends on the stock. On March 7, 2003, PVC Funding Partners, LLC, an affiliate of Commonwealth Associates, LP and Comvest Venture Partners, acquired 29,851 shares of our Series C convertible preferred stock, representing 96.0% of the outstanding Series C convertible preferred stock. At any time after October 12, 2003, the Series C convertible preferred stock may be converted into shares of our common stock at the rate of 703.37 shares of common stock for each preferred share, or a total of 20,996,298 shares (or 55.6%) of our common stock upon full conversion, subject to adjustment. The Series C convertible preferred stock has weighted-average anti-dilution protection and a provision that in no event will the Series C convertible preferred stock convert into less than 51.0% of our outstanding shares of common stock. We granted the Series C
On March 31, 2003, we renegotiated approximately $4.3 million in convertible notes that were originally issued to Centra Benefit Services, Inc. (sometimes referred to as Centra). In connection with the restructuring, PVC Funding Partners acquired slightly more than 50% of the value of the notes. The remaining interest is held by Centra. At any time, Centra or PVC Funding Partners may convert the notes into shares of our common stock, at a price of $1.00 per share, subject to adjustment in accordance with anti-dilution protections. In connection with the previous restructuring of the convertible notes, we also issued to Centra warrants for the purchase of an aggregate of 200,000 shares of our common stock at an exercise price of $6.398 per share. Centra and PVC Funding Partners have registration rights with respect to all shares of our common stock that are issuable pursuant to the convertible notes and warrants.
Certain of our existing stockholders have significant voting control over matters requiring stockholder approval.
The holders of our Series C convertible preferred stock may have the right in certain circumstances to vote as a single class with the common stockholders on all matters other than the election of directors on an "as-converted" basis, with each share of Series C convertible preferred stock having a number of votes equal to the number of shares of common stock into which it would be converted. The "as-converted" rights take effect upon the earliest to occur of (1) any default in connection with the payment of principal or interest under our restructured credit facility, after the lapse of any applicable grace period, (2) our failure to redeem all of the Series C convertible preferred stock by October 12, 2003, or (3) the date on which fewer than 12,000 shares of Series C convertible preferred stock are outstanding. In addition to the rights of Series C convertible preferred stockholders, certain holders of our common stock also have significant voting control over matters requiring stockholder approval. As of March 24, 2003, our executive officers, directors, and their affiliates beneficially owned, in the aggregate, approximately 4.2% of our outstanding common stock, and our other existing 5.0% or greater stockholders beneficially owned, in the aggregate, approximately 60.0% of our outstanding common stock. In the event that the Series C convertible preferred stock is converted as described above, based on the number of shares of our common stock outstanding as of March 24, 2003, our executive officers, directors and their affiliates, in the aggregate, would beneficially own approximately 55.5% of our outstanding common stock, and our other existing 5.0% or greater stockholders would beneficially own, in the aggregate, approximately 20.4% of our outstanding common stock.
We may not be able to fund expansion, develop or enhance our products or services, or respond to competitive pressures if we lack adequate funds, which would hurt our business. We do not currently have an available line of credit with a lender, and we manage our business from existing cash flow. We may need to raise
We sold several units of our third party administration business in 2000 and sold the balance of that segment, as well as our managing general underwriter business, in June 2001. Revenue from discontinued operations was $0 in 2002, $36.4 million in 2001, and $157.9 million in 2000, which significantly exceeded operating revenue from continuing operations for 2001 and 2000. Operating revenue from continuing operations was $33.1 million, $32.9 million and $27.0 million in 2002, 2001 and 2000, respectively. Accordingly, our operating history is not indicative of our future performance under our new business strategy of increasing the market share of our medical cost containment business and building our business process outsourcing unit. This change in focus has resulted in a significant reduction in the size of our management and support operations. While our network access business historically operated as an independent part of our larger business, this change in focus requires it to operate with less support than was previously available and this may affect its performance. We are also facing new risks and challenges, including a lack of meaningful historical financial data upon which to plan future budgets.
facing. You should evaluate our prospects in light of the risks and uncertainties encountered by companies in the early stages of development, particularly companies in new and rapidly evolving markets. These risks include:
. a concentration on relatively few customers; . unproven market acceptance of our new products; . dependence on healthcare payers, provider networks, strategic relationships, and technology solutions; . industry consolidation and increased in-house performance of the services we offer; . unpredictability of operating results and future revenues; . increased competition; and . general economic and market conditions.
We will have difficulty predicting future revenues because we are implementing a new business strategy with our new network and data management business process outsourcing business. We also will have difficulty in accurately forecasting operating revenues from sales of our services because we do not know the sales cycle involved in selling our new services, and we cannot predict customer claims experience. This makes it difficult to predict the quarter in which sales will occur. Any significant shortfall of operating revenues in relation to our expectations could cause significant declines in our quarterly operating results or cause us to not meet certain financial covenants with our senior lenders.
Our expense levels are based, in part, on our expectations regarding future operating revenues, and our expenses are generally fixed, particularly in the short term. We may be unable to adjust spending in a timely manner to compensate for unexpected revenue shortfalls. A shortfall in operating revenues or a delay in the collection of outstanding accounts receivable could have an adverse impact on our ability to meet payment obligations or meet financial covenants to our senior lenders and vendors, and could have a material adverse effect on our business, operating results, and financial condition.
Many of our products and services, such as ClaimPassXL v. 3.5, our internet repricing system, are geared toward the Internet and electronic healthcare information markets. These markets are in the early stages of development and are rapidly evolving. A number of market entrants have introduced or developed products and services that are competitive with our products and services. We expect that additional companies will continue to enter these markets. In new and rapidly evolving industries, there is significant uncertainty and risk as to the demand for, and market acceptance of, recently introduced products and services. Because the markets for certain of our products and services are new and evolving, we are not able to predict the size and growth rate of those markets with any certainty. We cannot assure you that markets for our products and services will develop or that, if they do, they will be strong and continue to grow at a sufficient pace. If markets fail to develop, develop more slowly than expected, or become saturated with competitors, our business prospects will be impaired.
If our ability to expand our network infrastructure is constrained in any way, we could lose customers and damage our operating results.
Many of these factors are beyond our control. In addition, the stock market has in the past experienced price and volume fluctuations that have particularly affected companies in the healthcare and managed care markets, resulting
The volatility of our common stock or substantial dilution to our stockholders could subject us to costly litigation.