(1) The increase in working capital, including cash and cash equivalents, is primarily attributable to the $19.2 million of proceeds received by the Company from the exercise of the underwriters' over-allotment option granted by the Company in connection with the May 1997 initial public offering.
The Company has three segments: (1) Healthcare Recovery Services, which encompasses its four healthcare recovery products: healthcare subrogation, provider bill audit, overpayment recovery and physician bill audit ("MD Audit"); (2) Property and Casualty Recovery Services, which includes subrogation recovery services for property and casualty insurers, which the Company sells under the brand name "TransPaC Solutions"; and (3) Software, which includes the sale of subrogation recovery software in a browser-based application service provider (ASP) form.
Subrogation revenues are generally derived from contingent fee arrangements based on the recoveries effected by the Company on behalf of its clients. Revenue is generally recognized when a fee is earned based on the settlement of a case. A case is deemed settled when the Company can confirm that the parties agree on all material terms associated with the settlement.
Approximately $4.4 million and $4.7 million of the Company's accounts receivable balance of $9.4 million at December 31, 2002 and 2001, respectively, is attributable to subrogation services. The subrogation accounts receivable represents the Company's fees for cases in which the parties have reached settlements (including settlements of the subrogation claims of the Company's clients), but the Company has not yet received the cash from the settlement of the subrogation claim. The Company withholds its fee from the gross recovery proceeds of the subrogation claims that it collects on behalf of its clients. An allowance for doubtful accounts is maintained for the estimated loss from settlements that are later broken or significantly delayed, based on the Company's historical experience. The accounts receivable balance that at December 31, 2002 and 2001 was attributable to subrogation claims represented approximately 4,000 settled cases for approximately 140 clients and approximately 3,800 settled cases for approximately 150 clients, respectively, each one subject to its own settlement agreement with its own settling parties. If the receipt of cash from a significant number of the settled cases comprising the subrogation accounts receivable balance were significantly delayed
by third parties to those settled cases (because of broken settlement agreements, for example), additional allowances may be required.
At December 31, 2002, goodwill and other long-lived assets represented 54% of the Company's total assets and 91% of the Company's total stockholders' equity.
useful lives assigned to its long-lived assets. If these estimates, or their related assumptions, change in the future, the Company may be required to record impairment losses or change the useful life including accelerating depreciation or amortization for these assets.
Provision for income taxes is based upon the Company's estimate of taxable income or loss for each respective accounting period. An asset or liability is recognized for the deferred tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. These temporary differences will result in taxable or deductible amounts in future periods when the reported amounts of assets are recovered or liabilities are settled. The Company regularly reviews its deferred tax assets to determine the amount that is more likely than not to be realized. When this amount is less than the deferred tax asset recorded, the Company records a valuation allowance to reduce the asset to its estimated realizable value. If the Company determined that it was not going to be able to fully realize its recorded deferred tax assets, it would make an adjustment to the valuation allowance. This would reduce net income in the period that the Company made its determination. Similarly, if the Company realized that it was going to be able to fully realize a deferred tax asset in excess of its net recorded value, net income would be increased in the period that the Company made its determination.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure -- an Amendment of SFAS 123" which provides alternative methods for a voluntary change to the fair value method of accounting for stock-based compensation and amends the
disclosure requirements of FAS 123. The Company has elected to continue to account for options granted under its employee stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". As a result, the Company has not recognized compensation expense for stock options granted with an exercise price equal to the quoted market price of the common stock on the date of grant and that vest based solely on continuation of employment by the recipient of the option award. The Company adopted Statement of Financial Accounting Standards No. 123 (SFAS No. 123) for disclosure purposes in 1996. For SFAS No. 123 purposes, the fair value of each option grant and stock-based award has been estimated as of the date of grant using the Black-Scholes option pricing model. If the Company were to adopt SFAS No. 123 to account for options, compensation expense would be recognized resulting in a decrease in net income and earnings per share for the years ended December 31, 2002, 2001 and 2000, as set forth in Notes 2 and 13 in Item 8. "Financial Statements and Supplementary Data".
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 framework established in FAS 121. The adoption of FAS 144 had no impact on the Company's financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure -- an Amendment of SFAS 123", which provides alternative methods for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure requirements of SFAS 123 to require more prominent disclosures in annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition guidance and annual disclosure provisions of SFAS 148 are effective for fiscal years ending after December 15, 2002 and for interim periods beginning after December 15, 2002. See Item 8. "Financial Statements and Supplementary Data -- Note 2 -- Summary of Significant Accounting Policies" and "-- Note 13 -- Stock Based Compensation" for required disclosures.
(3) At December 31, 2001, approximately $133.0 million of the backlog derived from terminated clients and clients that, by that date, had given notice of termination. (4) At December 31, 2000, approximately $126.4 million of the backlog derived from terminated clients and clients that, by that date, had given notice of termination. (5) Throughput equals claims recoveries for the period divided by the average of backlog at the beginning and end of the period.
Claims Revenues. Healthcare Recovery Services revenues for the year ended December 31, 2002 increased 7.5%, to $68.8 million from $64.0 million in 2001. This growth in claims revenues came primarily from two sources. First, provider bill audit revenue increased $3.4 million in 2002 compared to 2001. The Company realized approximately $300,000 from a special provider bill audit project during 2002. The remainder of the increase in provider bill audit revenue was primarily the result of procedures implemented by the Company in late 2001 in response to various hospitals' attempts to limit the Company's access to medical records, which impeded the audit of provider bills. Second, the Company realized $1.7 million of incremental healthcare subrogation revenue from the fee increase associated with the decline in lives from UHG. The effective fee rate increased to 27.6% in 2002 from 26.8% in 2001, primarily as a result of the UHG fee increase.
Depreciation and Amortization. Depreciation and amortization expenses decreased 31.8% to $4.1 million for the year ended December 31, 2002 from $6.0 million in 2001. The decrease in amortization expense
Income before Income Taxes. Income before income taxes for the year ended December 31, 2002 increased $6.5 million, or 28.9%, to $28.8 million from $22.3 million for the year ended December 31, 2001. The reasons for the increase were the additional provider bill audit revenue of $3.4 million in 2002 compared to 2001 and the incremental Healthcare Recovery Services revenue from the UHG contract termination in 2002 of $1.7 million, both described above under "Claims Revenues", as well as the adoption of FAS 142 on January 1, 2002, as described under "Depreciation and Amortization".
Claims Revenues. Healthcare Recovery Services claims revenues for the year ended December 31, 2001 increased 0.5%, to $64.0 million from $63.6 million in 2000. This growth in claims revenues occurred primarily because of a 0.5% growth in healthcare claims recoveries, from $237.3 million in 2000 to $238.5 million in 2001. The effective fee rate remained the same for the two years at 26.8%.
The decrease in Healthcare Recovery Services installed lives from 48.7 million at December 31, 2000 to 45.5 million at December 31, 2001 was caused by three factors. First, approximately 2.6 million lives were lost because clients were acquired by non-clients. Second, approximately 2.0 million lives associated with provider bill audit service clients which were not furnishing electronic claims data to the Company and were, therefore, relatively unproductive, were removed from the installed lives count. Third, approximately 1.3 million lives from UHG and 1.5 million lives from a managed care health organization based in the Northeast were terminated. These terminations did not, as a matter of contract, result in a decrease to the backlog.
Other -- Litigation Settlement. In the fourth quarter of 2000, the Company recorded a litigation settlement of approximately $3.0 million after it had reached an agreement in principle to settle the DeGarmo class action litigation against the Company in federal court in West Virginia. The settlement was paid in July 2001. See Item 3. "Legal Proceedings".
The new outsource client shown in the table above for 2002 is Safe Auto, for which TransPaC Solutions will take over all subrogation recovery work as well as Safe Auto's existing work-in-process. Safe Auto
The Property and Casualty Recovery Services segment had a throughput rate of approximately 29.6% and 16.7% of average backlog for the years ended December 31, 2002 and 2001, respectively. The increase was due to recoveries growing more quickly than the average backlog over the year ended December 31, 2002.
The Property and Casualty Recovery Services segment had a throughput rate of approximately 16.7% of average backlog for the year ended December 31, 2001.
Cost of Revenues. Cost of revenues for the Property and Casualty Recovery Services segment increased 757% for the year ended December 31, 2001 to $497,000, from $58,000 in 2000. As a percentage of claims revenues, cost of revenues decreased to 266% in 2001 compared to 527% in 2000, due to the increase in revenue described above. In the subrogation industry, typically expenses related to investigations and other recovery-related activities are incurred well in advance of revenue recognition.
The Company expects to incur additional expenses of between $2.0 million and $2.5 million for research and development with respect to the creation of enhancements of existing software applications in 2003, of which approximately $925,000 is expected to be capitalized. In addition, as of December 31, 2002, the Company has capitalized approximately $2.4 million of costs in accordance with accounting principles generally accepted in the United States of America for the development of software for sale to unrelated parties.
Support Expenses. The Company began development of new software products during the quarter ended September 30, 2000. For the year ended December 31, 2000, support expenses consisted of sales and marketing related expenses.
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. For the year ended December 31, 2000, the Company incurred approximately $0.5 million in costs related to research and development activities of which approximately $0.1 million were capitalized, resulting in net reported expenses of $0.4 million.
Depreciation and Amortization. Depreciation and amortization expenses decreased 29.0% to $4.8 million for the year ended December 31, 2002 from $6.7 million in 2001. The decrease in amortization expense 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". In addition, approximately $454,000 of depreciation and amortization related to the Software segment is included in Cost of Revenues for the year ended December 31, 2002 as it is a direct cost of software in service. For the year ended December 31, 2001, the corresponding depreciation and amortization was recorded in the Depreciation and Amortization line item.
Interest Income. Interest income decreased $0.5 million, or 66.6%, for the year ended December 31, 2002 as compared to the year ended December 31, 2001. The decrease was primarily due to the payment, during the quarter ended June 30, 2001, of an earn-out relating to an acquisition which reduced the restricted cash balance and to lower interest rates in 2002.
The effective income tax rate was approximately 31.3% for the year ended December 31, 2001. The lower effective income tax rate as compared to 2002, resulted from the reversal in 2001 of previously accrued taxes reducing the tax provision for the third quarter by $681,000, net, or approximately $0.07 per share. This
December 31, 2000. Net income increased primarily as a result of the accrual of $1.8 million of expenses, net of income taxes, at December 31, 2000 related to the DeGarmo litigation settlement described above. However, the increase in net income resulting from the DeGarmo litigation settlement was partially offset by an increase in net after tax expenses related to the Company's business development activities of approximately $1.1 million in 2001. In addition, there were two significant, non-recurring items in 2001 which together resulted in an increase to net income of $90,000: the loss on the disposal of property of approximately $591,000, net of tax; and the reversal of income taxes previously accrued for the non-cash compensation charge in 1997 of approximately $681,000, net of tax.
The Company's statements of cash flows for the years ended December 31, 2002, 2001 and 2000 are summarized below:
The Company had working capital of $8.8 million at December 31, 2002, including cash and cash equivalents of $2.3 million, compared with working capital of $10.4 million at December 31, 2001.
Net cash used in financing activities for the years ended December 31, 2002 and 2001 reflects $4.0 million and $6.0 million in net cash repayments, respectively, with respect to the Company's Revolving Credit Facility. The Company repurchased approximately $6.5 million and $79,000 of treasury stock during the years ended December 31, 2002 and 2001, respectively.
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"). 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 will 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, $4 million was outstanding under the Revolving Credit Facility. See Item 8. "Financial Statements and Supplementary Data -- Note 11 -- Derivatives" and "-- Note 12 -- Credit Facility".
In light of its acquisition strategy, the Company is currently assessing its opportunities for capital formation. The Company believes that its available cash resources, together with the borrowings available under the Revolving Credit Facility, will be sufficient to meet its current operating requirements and acquisition and internal development activities. See Item 1. "Business -- Business Developments".
The following summarizes the Company's contractual obligations at December 31, 2002, and the effect such obligations are expected to have on its liquidity and cash flows in future periods (in thousands):
The Company's revenues are earned under written contracts with its clients that generally provide for contingency fees from recoveries under a variety of pricing regimes. The pricing arrangements offered by the Company to its clients include a fixed fee percentage, a fee percentage that declines as the number of lives covered by the client and subject to the Company's service increases and a fee percentage that varies with the Company's recovery performance.
During 2002, UHG management informed the Company of its intention to terminate subrogation services with respect to all but 1.8 million lives of the 9.7 million lives then subject to the Company's services under a contract with UHG. UHG's termination of these services resulted from its decision to bring subrogation recovery services back inside UHG, where they will be performed by its Ingenix strategic business unit. The Company expects to continue recovering on the backlog as to which UHG terminated the Company's services, a process that the Company expects will be completed in 5 to 6 years. The Company's contract with UHG expired in accordance with its terms on February 1, 2003 except with respect to 1.8 million lives as to which the Company continues to provide healthcare subrogation recovery services.
The Company's Board of Directors authorized the repurchase of up to $20 million of the Company's Common Stock in the open market, including $10 million authorized on May 10, 2002, at prices per share deemed favorable by the Company. Shares may be repurchased using cash from operations and borrowed funds and may continue until such time as the Company has repurchased $20 million of the Company's Common Stock or until it otherwise determines to terminate the stock repurchase plan. The Company repurchased 1,304,743 shares of its own stock during the year ended December 31, 2002, respectively, at an average price of $4.96. From inception of the program through December 31, 2002, the total number of repurchased shares is 3,097,008 at a cost of $13.6 million, or an average cost of $4.39 per share. Except for
9,397 shares previously repurchased but re-issued in connection with an employee restricted stock award, all of the reacquired shares of Common Stock through December 31, 2002 are reflected as treasury stock on the accompanying Balance Sheets.
If any person becomes an Acquiring Person, each holder of a Right will thereafter have the right (the "Flip-In Right") to receive, in lieu of shares of preferred stock and upon payment of the Purchase Price, shares of Common Stock having a value equal to two times the Purchase Price of the Right. Also, if at any time on or after the Stock Acquisition Date, (i) the Company is acquired in a transaction in which the holders of all the outstanding shares of Common Stock immediately prior to the consummation of the transaction are not the holders of all of the surviving corporation's voting power, or (ii) more than 50% of the Company's assets, cash flow or earning power is sold or transferred other than in the ordinary course of business, then each holder of a Right shall thereafter have the right (the "Flip-Over Right") to receive, in lieu of shares of preferred stock and upon exercise and payment of the Purchase Price, common shares of the acquiring company having a value equal to two times the Purchase Price. If a transaction would otherwise result in a holder having a Flip-In as well as a Flip-Over Right, then only the Flip-Over Right will be exercisable. If a transaction results in a holder having a Flip-Over Right subsequent to a transaction resulting in the holder having a Flip-In Right, a holder will have a Flip-Over Right only to the extent such holder's Flip-In Rights have not been exercised.
The Company has a contract for legal services with a professional service corporation, Sharps & Associates, PSC, an entity owned solely by one of the Company's officers, Douglas R. Sharps. This arrangement exists solely for the benefit of the Company. Its purpose is to minimize the costs of legal services purchased by the Company on behalf of its clients. Mr. Sharps receives no financial or other personal benefits from his ownership of this firm. All payments to Sharps & Associates are reviewed and approved by the Audit Committee of the Company's Board of Directors. For the years ended December 31, 2002, 2001 and 2000, approximately $3,346,000, $3,385,000 and $2,484,000 was paid to this law firm for such legal services, including all employees and expenses.
In our opinion, the accompanying balance sheets and the related statements of income, changes in stockholders' equity and comprehensive income and cash flows appearing on pages 44 through 47 of this annual report on Form 10-K present fairly, in all material respects, the financial position of Trover Solutions, Inc. (the "Company") at December 31, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
Trover Solutions, Inc., a Delaware corporation, was incorporated on June 30, 1988. The Company provides subrogation and certain other claims recovery and cost containment services, on an outsourcing basis, to the private healthcare payor industry and the property and casualty insurance industry. Its primary business is medical claims recovery, and its primary product is subrogation recovery, i.e., the Company identifies, investigates and recovers accident-related medical benefits incurred by its healthcare payor and insurance clients on behalf of their insureds, but for which other persons or entities have primary responsibility. The Company's clients' rights to recover the value of these medical benefits, arising by law or contract, are generally known as the right of subrogation and are generally paid from the proceeds of liability or workers' compensation insurance. The Company's other medical claims recovery services include (1) the auditing of the bills of medical providers, particularly hospitals, for accuracy, correctness and compliance with contract terms ("provider bill audit"), (2) the recovery of overpayments attributable to duplicate payments, failures to coordinate benefits and similar errors in payment ("overpayments"), and (3) the auditing of physician evaluation and management claims for consistency with medical records, in accordance with federal guidelines ("MD Audit").
Restricted cash represents the balance in client-specific bank accounts of amounts collected on behalf of certain clients. A portion of the balance will be disbursed to clients in accordance with the terms of the contracts between the Company and its clients, while the remainder will be released to the Company.
Property and equipment are recorded at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets. Estimated useful lives of property and equipment are as follows:
Depreciation expense for the years ended 2002, 2001 and 2000 was $4.1 million, $4.0 million, and $3.8 million, respectively.
Goodwill represented the unamortized excess of cost over the fair value of tangible and identifiable intangible assets acquired and was amortized on a straight-line basis over twenty years through December 31, 2001. Effective January 1, 2002, the Company adopted FAS 142 under which goodwill is no longer amortized but instead is assessed for impairment at least annually. See Note 8, "Goodwill and Other Intangible Assets". Identifiable intangible assets are being amortized on a straight-line basis over varying periods, ranging from four to fifteen years. Amortization expense for the years ended 2002, 2001 and 2000 was $1.1 million, $2.7 million, and $2.6 million, respectively.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure -- an Amendment of SFAS 123" which provides alternative methods for a voluntary change to the fair value method of accounting for stock-based compensation and amends the disclosure requirements of SFAS 123. The Company has elected to continue to account for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25), and related interpretations. The following disclosures are provided in accordance with SFAS 148.
The Company has various stock-based compensation plans, which are described in Note 13. No stock-based employee compensation cost is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123. "Accounting for Stock-Based Compensation" to stock-based employee compensation (dollars in thousands, except per share results):
framework established in FAS 121. The adoption of FAS 144 had no significant impact on the Company's financial statements.
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 activity.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN 45 elaborates on required disclosures by a guarantor in its financial statements about obligations under certain guarantees it has issued and clarifies the need for a guarantor to recognize, at the inception of certain guarantees, a liability for the fair value of the obligation undertaken in issuing the guarantee. The interpretation is effective for qualified guarantees entered into or modified after December 31, 2002. This interpretation is not expected to have a material impact on the Company's financial position, results of operations or cash flows. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company has no guarantees requiring disclosure under FIN 45 at December 31, 2002.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure -- an Amendment of SFAS 123", which provides alternative methods for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure requirements of SFAS 123 to require more prominent disclosures in annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition guidance and annual disclosure provisions of SFAS 148 are effective for fiscal years ending after December 15, 2002 and for interim periods beginning after December 15, 2002. See "-- Stock Based Compensation Plans" and Note 13 "Stock Based Compensation" for the disclosures required by this statement.
Preparation of the Company's financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect (i) reported amounts of assets and liabilities, (ii) disclosure of contingent assets and liabilities at the date of the financial statements and (iii) reported amounts of revenues and expenditures during the reporting period. Actual results may differ from those estimates.
In September 2001, the Company concluded that, in light of the passage of time with respect to the filing of the Company's income tax returns for years up to and including 1997, it was proper to reverse previously accrued taxes by reducing the tax provision for the year ended December 31, 2001 by $681,000, net. This accrual related primarily to certain non-cash compensation charges taken in connection with the initial public offering of the Company's stock in 1997. Management believes that adequate amounts of tax and related interest and penalties, if any, have been provided for any adjustments that may be required.
Management believes that the deferred tax assets are realizable based primarily on the existence of sufficient taxable income within the allowable carryback period. Accordingly, management has determined that no valuation allowance is necessary.
Wellpoint Health Network Inc., which accounted for more than 65% of the Company's revenue from its provider bill audit product in 2002 and 2001, accounted for 31% and 40% of the Company's accounts receivable balance at December 31, 2002 and 2001, respectively. In addition, HealthNet, which accounted for 30% and 27% of the revenue from the provider bill audit product in 2002 and 2001, respectively, accounted for 15% and 9% of the Company's accounts receivable balance at December 31, 2002 and 2001, respectively. Should a substantial portion of the current balance of either of these accounts receivable balances become uncollectible, it could have a material adverse effect on the Company's results of operations and cash flows. No other client accounted for 10% or more of accounts receivable at December 31, 2002 or 2001.
The Company has entered into a contract for legal services with a professional service corporation, Sharps & Associates, PSC, an entity owned solely by one of the Company's officers, Douglas R. Sharps. This arrangement exists solely for the benefit of the Company. Its purpose is to minimize the costs of legal services purchased by the Company on behalf of its clients. Mr. Sharps receives no financial or other personal benefit from his ownership of the firm. All payments to Sharps & Associates, PSC are reviewed and approved by the Audit Committee of the Company's Board of Directors. For the years ended December 31, 2002, 2001 and 2000, approximately $3,346,000, $3,385,000 and $2,484,000, respectively, was paid to this law firm for such legal services, including all employees and expenses.
Property and equipment consists of the following at December 31, 2002 and 2001 (in thousands):
On November 13, 2001, the Company sold its building in New Berlin, Wisconsin to a third party. The building was acquired on January 25, 1999 in the Subro Audit Acquisition. The Company recorded a loss on the disposal of the building of approximately $1.0 million during the year ended December 31, 2001.
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
Effective January 1, 2002, the Company adopted FAS 142 under which Goodwill is no longer amortized but instead will be assessed for impairment at least annually which is a two step process. The first step involves determining the estimated fair value of each reporting unit with a view to determining whether the Goodwill value has been impaired under FAS 142. The second step measures the amount of impairment and is required only if impairment is indicated by the first step.
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 step one during the three months ended June 30, 2002, did not result in an impairment charge for the Company. The Company will perform its annual impairment review during the second quarter of each year, commencing in the second quarter of 2003. The Company's reporting units are generally consistent with the operating segments underlying the segments identified in Note 17 "Segment Information". All recorded Goodwill and Other Intangible Assets relate to the Healthcare Recovery Services segment.
The carrying value of Goodwill, net was approximately $29.1 million at December 31, 2002 and 2001.
The Company's intangible assets (other than Goodwill, net) are subject to amortization. The details of the Company's intangible assets at December 31, 2002 and December 31, 2001 are as follows (in thousands):
Amortization expense related to intangible assets for the years ended December 31, 2002, 2001 and 2000 was approximately $562,000 for each year. Over the five succeeding fiscal years, amortization expense related to intangible assets is expected to be as follows (in thousands):
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.
The interest rate swap contract under which the Company agrees to pay fixed rates of interest is considered a hedge against changes in the amount of future cash flows associated with the Company's interest payments on its variable rate Revolving Credit Facility. Accordingly, the interest rate swap contract is considered a cash flow hedge and is reported at fair value on the balance sheet in "Other Liabilities" at December 31, 2002 and in "Other Assets" at December 31, 2001 and the related gain (or loss) on the contract is deferred in shareholders' equity (as a component of accumulated other comprehensive income). This deferred gain (or loss) is then amortized as an adjustment to interest expense over the same period in which the related interest payments being hedged are recognized in income.
At the inception of the interest rate contract, the fair value of the hedge was $0. At December 31, 2002, the fair value of the hedge was a liability of $144,804 (($86,882), net of tax, included in Other Comprehensive Income (Loss)). At December 31, 2001, the fair value of the hedge was an asset of $45,446 ($26,586, net of tax, included in Other Comprehensive Income).
The Employees' Plan provides for the award of stock options to certain officers and key employees of the Company. Options under the Employees' Plan may be granted with an exercise price greater than or less than the market value of the Company's Common Stock on the date of grant. Awards under the Employees' Plan expire ten years from the date of grant, and pursuant to individual option agreements under the Employees' Plan, vest ratably over at least a three-year period. As provided in the Employees' Plan, all options granted to the Company's employees automatically vest in the event of a change in control. At December 31, 2002, 673,750 shares of Common Stock were reserved for issuance under the Employees' Plan, including 161,383 shares available for future award.
of the grant date. Each option is to become exercisable when vested. Pursuant to individual option agreements under the Directors' Plan, options granted under the Directors' Plan vest ratably over a three-year period, provided that the optionee must be a non-employee director of the Company on each such anniversary in order for options to vest on such date. At December 31, 2002, 150,000 shares of Common Stock were reserved for issuance under the Directors' Plan, none for future award.
The 1997 Plan provides for the grant of options to purchase the Company's Common Stock to eligible participants of the Company at 100% of the market value of the Company's Common Stock on the date of grant. Awards under the 1997 Plan expire ten years from the date of grant and vest according to the terms that the compensation committee of the Board of Directors determines in its sole discretion. As provided in the 1997 Plan, all options granted to the Company's employees automatically vest in the event of a change in control. At December 31, 2002, 1,689,198 shares of Common Stock have been reserved under the 1997 Plan, of which 47,330 shares are available for future award.
The 2002 Outside Directors Stock Plan was approved on May 10, 2002. Each director of the Company that is not an employee of the Company has a right to elect to receive Common Stock in lieu of cash for all or part of his or her outside director compensation package. In any event, each director will receive not less than one-third of his or her annual retainer fee in Common Stock regardless of whether he or she makes an election under the plan. In addition, each director automatically will be granted an option under the plan to purchase 10,000 shares of Common Stock on the effective date of his or her initial election or appointment as a member of the Board at an option exercise price equal to the fair market value of a share of Common Stock on such date. Further, each director automatically will be granted each calendar year subsequent to the calendar year in which his or her initial election or appointment as a member of the Board becomes effective, options under the plan to purchase 1,000 shares of Common Stock as of each March 31, June 30, September 30 and December 31, if he or she is still a director on such grant date, at an exercise price equal to the fair market value of a share on such date. At December 31, 2002, 247,520 shares of Common Stock have been reserved under the 2002 Outside Directors Stock Plan, of which 232,520 shares are available for future issue.
As of December 31, 2002, 2001 and 2000 there were 1.6 million, 1.4 million and 1.0 million options exercisable, respectively.
The Company's Board of Directors authorized the repurchase of up to $20 million of the Company's Common Stock in the open market, including $10 million authorized on May 10, 2002, at prices per share deemed favorable by the Company. Shares may be repurchased using cash from operations and borrowed funds and may continue until such time as the Company has repurchased $20 million of the Company's Common Stock or until it otherwise determines to terminate the stock repurchase plan. The Company repurchased 1,304,743 shares of its own stock during the year ended December 31, 2002 at an average price of $4.96. From inception of the program through December 31, 2002, the total repurchased shares are 3,097,008
at a cost of $13.6 million, or an average cost of $4.39 per share. Except for 9,397 shares of previously repurchased but reissued in connection with an employee restricted stock award, all of the reacquired shares of Common Stock through December 31, 2002 are reflected as treasury stock on the accompanying Balance Sheets.
Other comprehensive income (loss) for the years ended December 31, 2002, 2001 and 2000 consists of the following (in thousands):
In August 1999, the Board of Directors appointed a Special Committee to evaluate strategic alternatives available to the Company, including its possible sale. In March 2000, 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. The Company incurred $90,000 of expenses related to the work of the Special Committee during 2000.
Future minimum lease payments for office space, by year, under noncancelable operating leases with initial or remaining terms in excess of one year at December 31, 2002 are as follows (in thousands):
Rental expense, which includes amounts applicable to short-term leases, was approximately $2,386,000, $2,092,000, and $1,951,000 for the years ended December 31, 2002, 2001 and 2000, respectively.