<PAGE>
CLAIMSNET.COM
1998 ANNUAL REPORT
TO
STOCKHOLDERS
NOVEMBER 29, 1999
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Summary Data................................................ 1
Business.................................................... 2
Price Range of the Common Stock............................. 3
Dividend Policy............................................. 3
Selected Financial Data..................................... 4
Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 5
Management.................................................. 10
Changes in, and Disagreements with, Accountants............. 12
Index to Consolidated Financial Statements.................. F-1
</TABLE>
<PAGE>
SUMMARY DATA
<TABLE>
<S> <C> <C>
Executive Office:
12801 North Central Expressway
Suite 1515
Dallas, Texas 75243
Officers: Bo W. Lycke Chairman of the Board, President and Chief Executive
Officer
Terry A. Lee Executive Vice President and Chief Operating Officer
Paul W. Miller Vice President and Chief Financial Officer
Randall S. Lindner Vice President of Technology
C. Kelly Campbell Vice President and Secretary
Abbas R. Kafi Vice President of Information Systems
Cheryl L. Corless Vice President of Customer Operations
Ellen Opperthauser Vice President of Marketing
Sheri Larkin Vice President and Corporate Controller
Patricia Davis Vice President of Business Development
Ward L. Benson Treasurer
Directors: Bo. W. Lycke, Chairman
Terry A. Lee Sture Hedlund
Ward L. Benson John C. Willems
Robert H. Brown, Jr. Westcott W. Price III
Auditors: Ernst & Young LLP, Dallas, Texas
Counsel: Brock Silverstein LLC, New York, New York
Common Stock Market:
Nasdaq SmallCap ("CLAI")
Boston Stock Exchange ("CLA")
Transfer Agent and Registrar:
Continental Stock Transfer and Trust Company
</TABLE>
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BUSINESS
Claimsnet.com inc. is an electronic commerce company engaged in healthcare
transaction processing for the medical and dental industries by means of the
Internet. Its proprietary software, which was developed over the last six years
and resides entirely on its servers, allows healthcare providers to prepare and
enter healthcare claims interactively on the Internet and electronically
transmits the claims to Claimsnet.com for processing. It also allows
Claimsnet.com to download claims from the healthcare providers' computers
directly to its servers. The software provides real-time editing of the claims
data for compliance with the format and content requirements of payors and
converts the claims to satisfy payor's specific processing requirements.
Claimsnet.com then electronically transmit processed claims on behalf of
healthcare providers, directly or indirectly, to medical and dental payors that
accept claims processing transmissions electronically. In addition,
Claimsnet.com's software provides for secure encryption of all claims data
transmitted in compliance with the regulations of the United States Health Care
Financing Administration. The payors to which claims processed by Claimsnet.com
have been submitted, primarily through clearinghouses, such as McKesson HBOC and
Envoy Corporation with which it has agreements, include plans and affiliates of
Aetna Life & Casualty Company, Inc., MetLife Healthcare/Metropolitan Healthcare
Corporation, Cigna Healthcare, Inc., The Prudential Insurance Company of
America, Blue Shield/Blue Cross of Louisiana, and United Healthcare Corporation.
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PRICE RANGE OF COMMON STOCK
The Common Stock of Claimsnet.com has been traded on the Nasdaq SmallCap
Market and the Boston Stock Exchange since April 6, 1999. The following table
sets forth, for the fiscal periods indicated, the quarterly high and low sales
prices for our common stock, as reported by Nasdaq.
<TABLE>
<CAPTION>
SALES PRICE
-------------------
PERIOD HIGH LOW
- ------ -------- --------
<S> <C> <C>
From April 6, 1999 through June 30, 1999.................... $19.125 $7.563
Three months ended September 30, 1999....................... 8.500 4.000
From October 1, 1999 through November 24, 1999.............. 10.750 4.000
</TABLE>
The last reported sale price of the Common Stock on the Nasdaq SmallCap
Market on November 24, 1999 was $10.00 per share. As of November 10, 1999, there
were 3,122 holders of record of the Common Stock.
DIVIDEND POLICY
Claimsnet.com has not paid any cash dividends on its Common Stock and does
not intend to pay cash dividends in the foreseeable future. Claimsnet.com
intends to retain future earnings, if any, for reinvestment in the development
and expansion of its business. Any credit agreements which we may enter into
with institutional lenders may restrict its ability to pay dividends. Whether
Claimsnet.com pays cash dividends in the future will be at the discretion of its
Board of Directors and will be dependent upon its financial condition, results
of operations, capital requirements, and any other factors that the Board of
Directors determines to be relevant.
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SELECTED FINANCIAL DATA
The following selected statement of operations data of Claimsnet.com is for
the period from its inception on April 8, 1996 through December 31, 1996 and the
years ended December 31, 1997 and 1998. The selected balance sheet data as of
December 31, 1996, 1997, and 1998 and statement of operations data are derived
from Claimsnet.com's consolidated financial statements and related notes
included elsewhere in this Annual Report, audited by King Griffin & Adamson
P.C., independent certified public accountants for Claimsnet.com. The selected
statement of operations data for the year ended December 31, 1997 includes the
results of operations of Medica from June 2, 1997, its date of acquisition. The
following data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Claimsnet.com's
consolidated financial statements and the related notes included elsewhere in
this Annual Report
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 8, 1996
(INCEPTION) YEAR ENDED DECEMBER 31,
THROUGH -------------------------
DECEMBER 31, 1996 1997 1998
----------------- ----------- -----------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................................ $ -- $ 81,712 $ 154,653
---------- ----------- -----------
Total operating expense............................. 147,918 2,514,290 4,509,553
---------- ----------- -----------
Interest expense--affiliate......................... 158,123 389,548 313,680
Interest income..................................... -- (40,817) (6,113)
---------- ----------- -----------
New loss............................................ $ 306,041) $(2,781,309) $(4,662,467)
========== =========== ===========
Loss per weighted average common share outstanding
(basic and diluted)............................... $ (0.13) $ (0.98) $ (1.41)
========== =========== ===========
Weighted average common shares outstanding (basic
and diluted)...................................... 2,348,894 2,850,796 3,309,280
========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
BALANCE SHEET DATA:
Current assets......................................... $ 15,659 $ 419,329 $ 105,691
Total assets........................................... 978,332 2,174,597 1,653,479
Working capital........................................ 15,659 36,202 (1,088,978)
Long-term debt......................................... 4,408,373 3,468,320 4,323,127
Stockholders' deficit.................................. (3,430,041) (1,676,850) (3,864,317)
</TABLE>
4
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS AND OTHER PORTIONS OF THIS ANNUAL REPORT CONTAIN FORWARD LOOKING
INFORMATION THAT INVOLVE RISKS AND UNCERTAINTIES. CLAIMSNET.COM'S ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED BY THESE FORWARD LOOKING
INFORMATION. FACTORS THAT MAY CAUSE SUCH DIFFERENCES INCLUDE, BUT ARE NOT
LIMITED TO, THOSE DISCUSSED ELSEWHERE IN THIS ANNUAL REPORT. THIS MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD
BE READ IN CONJUNCTION WITH CLAIMSNET.COM'S CONSOLIDATED FINANCIAL STATEMENTS
AND THE RELATED NOTES INCLUDED ELSEWHERE IN THIS ANNUAL REPORT.
IN GENERAL
As of December 31, 1996, December 31, 1997 and December 31, 1998,
Claimsnet.com had working capital of $15,659, $36,202, and $(1,088,978),
respectively, and stockholders' equity (deficit) of $(3,430,041), $(1,676,850),
and $(3,864,317), respectively. Claimsnet.com generated revenues of $81,712
through December 31, 1997, and $154,653 for the year ended December 31, 1998.
Claimsnet.com has incurred net losses since inception and expects to continue to
operate at a loss for the foreseeable future. For the period from its inception
on April 8, 1996 through December 31, 1996, the years ended December 31, 1997,
and 1998, Claimsnet.com incurred net losses of $(306,041), $(2,781,309), and
$(4,662,467), respectively. There can be no assurance that Claimsnet.com will
ever achieve profitability. In addition, during the year ended December 31,
1998, Claimsnet.com recorded negative cash flow of $351,152.
Claimsnet.com is in the early stage of operations and, as a result, the
relationships between revenue, cost of revenue, and operating expenses reflected
in the financial information included in this Annual Report do not represent
future expected financial relationships. Much of the cost of revenue and
operating expenses reflected in Claimsnet.com's consolidated financial
statements are relatively fixed costs. Claimsnet.com expects that these expenses
will increase with the escalation of sales and marketing activities and
transaction volumes, but at a much slower rate of growth than the corresponding
revenue increase. Accordingly, Claimsnet.com believes that, at its current stage
of operations period to period comparisons of results of operations are not
meaningful.
PLAN OF OPERATIONS
Claimsnet.com's business strategy is:
- to aggressively market electronic claims processing services to outpatient
healthcare providers, including clinics, hospitals, physicians, HMOs,third
party administrators, dentists, and other outpatient service providers,
- to expand the services offered by Claimsnet.com to include additional
transaction processing functions, such as eligibility for benefit
coverage, HMO encounter forms, and practice management functions, such as
in order to diversify sources of revenue,
- to acquire and integrate electronic claims processing companies that
enable Claimsnet.com to accelerate its entry into the inpatient hospital
claims market, and
- to license its claims processing technology for stand-alone purposes,
Internet systems, private label use, and original equipment manufacturers.
Through June 30, 1999, Claimsnet.com anticipates that its primary source of
revenues will be fees paid by users for insurance claim and patient statement
services. Afterwards, Claimsnet.com expects to receive fees from commercial
medical and dental payors and other payors for delivering claims electronically.
In
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addition, after an initial free period of unlimited technical support,
Claimsnet.com intends to charge users a fee for technical support comparable to
those charged by other healthcare software vendors.
Claimsnet.com's principal operating costs are anticipated to be marketing,
research and development, acquisition of capital equipment, and general and
administrative expenses. Claimsnet.com intends to continue to develop and
upgrade its technology and transaction-processing systems and continually update
and improve its Web site to incorporate new technologies, protocols, and
industry standards. Claimsnet.com intends to engage in a dedicated marketing and
sales plan, including advertising at relevant sites on the Internet and in trade
publications, conducting direct mail programs targeting healthcare providers and
payors, such as commercial medical and dental payors, hiring additional sales
and marketing personnel, preparing brochures and other promotional materials,
and engaging in a public relations campaign designed to expose Claimsnet.com and
its services to healthcare providers and payors which otherwise would not be
exposed to Claimsnet.com and its products and services. In connection with the
expansion of the its business, Claimsnet.com intends to acquire additional
computers and networking equipment to permit an increased volume of claims to be
processed by it. General and administrative expenses include all corporate and
administrative functions that serve to support Claimsnet.com's current and
future operations and provide an infrastructure to support future growth. Major
items in this category include management and staff salaries and benefits,
travel, network administration and data processing, training, and rent.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 AND 1998
REVENUES. Revenues increased from $81,712 in 1997 to $154,653 in 1998. The
increase is due to an increase in the number of customers subscribing to and
using Claimsnet.com's service to file insurance claims.
COST OF REVENUES. Cost of revenues increased from $250,889 in 1997 to
$648,748 in 1998. The increase results primarily from an increase in the number
of employees involved in setting up customers as sales and marketing efforts
expanded and supporting customers as the customer base increased. The increase
in cost of revenues is disproportionately larger than the increase in revenues
because much of the cost is attributable to the initial setup of clients that
will produce recurring revenues over future periods.
RESEARCH AND DEVELOPMENT. Research and development expense increased from
$461,245 in 1997 to $530,502 in 1998. The increase is attributed to an increase
in the number of employees involved in software development and testing
activities related to improvements in the claims processing system and the
introduction of complementary products such as patient statement processing
services and eligibility verification of patient coverage.
SOFTWARE AMORTIZATION. Software amortization expense increased from
$402,835 in 1997 to $672,328 in 1998. The increase is due to the capitalization
of $911,741 of software development costs associated with the acquisition of
Medica in June 1997 and the related full-year amortization charge in 1998 versus
the partial-year charge in 1997.
SELLING, GENERAL, AND ADMINISTRATIVE. Selling, general, and administrative
expense increased from $1,399,321 in 1997 to $2,657,975 in 1998. The increase is
the result of an increase of approximately $500,000 in sales and marketing
expenses, an increase of approximately $350,000 in information systems expenses,
and the write-off of $411,641 of deferred financing costs incurred in
conjunction with an initial public offering in December 1998 that was not
completed.
INTEREST EXPENSE--AFFILIATE. Interest expense--affiliate decreased from
$389,548 in 1997 to $313,680 in 1998. The decrease is due to the completion of a
series of private equity placements in 1997 and 1998, from
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<PAGE>
which the proceeds were used to reduce the line of credit due to affiliate until
such time as the funds were needed for operating activities.
INTEREST INCOME. Interest income decreased from $40,817 in 1997 to $6,113
in 1998. The decrease is due to a reduction in the average balance of short term
investments. During late 1997, the proceeds from private equity placements were
sufficient to fully repay the line of credit due to affiliate and the excess
funds were invested in short term securities. During early 1998 all remaining
short term investments were liquidated to provide working capital and the
proceeds from the subsequent private equity placements did not exceed the
balance of the line of credit due to affiliate.
Net cash used by operating activities increased from $1,583,579 in 1997 to
$2,681,172 in 1998. The increase is generally attributable to the increase in
operating expenses, offset by an increase in non-cash amortization expense and
an increase in accrued liabilities, primarily related to deferred offering
costs. Net cash used in investing activities decreased from $436,864 in 1997 to
$120,159 in 1998. During 1997, cash used in investing activities included
non-recurring uses of $84,336 related to the Medica acquisition and $193,173
related to capitalized software development costs. Net cash provided by
financing activities increased slightly from $2,399,697 in 1997 to $2,450,179 in
1998. Proceeds from common stock issuances related to private equity placements
decreased by $226,000 and net borrowings under the line of credit due to
affiliate increased by $1,031,288 while payments for deferred offering costs
increased by $754,806.
LIQUIDITY AND CAPITAL RESOURCES
On July 31, 1996, Claimsnet.com acquired all of the Internet software,
licenses, intellectual property rights, and technology developed by an
affiliated company, American Medical Finance, in exchange for $3,740,000 in the
form of a promissory note. As discussed below, the principal amount of this note
represented a portion of the indebtedness incurred by American Medical Finance
in connection with the financing of the development of Claimsnet.com's
proprietary software. On September 23, 1997, American Medical Finance reduced
the principal amount of this note to $2,000,000 and contributed the remaining
$1,740,000 in principal amount of this note to the capital of Claimsnet.com.
American Medical Finance is affiliated to Claimsnet.com through common
stockholders, including Mr. Lycke, the Chairman of the board of directors,
President, and Chief Executive Officer of Claimsnet.com, and Messrs. Bensen and
Brown, Directors of Claimsnet.com, and as a stockholder of Claimsnet.com. The
note accrued interest at the rate of 9.50% per annum and was collateralized by
all of the Internet software, intellectual property rights, Internet technology,
and technology rights of Claimsnet.com, including software development costs.
Claimsnet.com utilized a portion of the net proceeds of its initial public
offering to offering to satisfy such obligation. The acquisition of the Internet
software, licenses, intellectual property rights, and technology was recorded at
the book value of the assets purchased.
Upon the consummation of the acquisition of the Internet software, licenses,
intellectual property rights, and technology developed by American Medical
Finance, American Medical Finance agreed to provide Claimsnet.com with a credit
line of up to $2,000,000 to facilitate additional development of Claimsnet.com's
services and technology. During June 1998, American Medical Finance purchased
nine units of Claimsnet.com's then pending 1998 private placement, each unit
consisting of 11,967 shares of common stock, for an aggregate of 107,704 shares.
As consideration for the purchase, American Medical Finance canceled $450,000 of
the principal balance then outstanding under the credit line. At December 31,
1998, advances under this line of credit were approximately $1,462,000. The line
of credit accrues interest at the rate of 9.50% per annum and is secured by all
of the assets of Claimsnet.com, other than the collateral securing the note from
Claimsnet.com to American Medical Finance described above. Accrued interest at
December 31, 1998, under the line of credit and this note totaled $860,789 and
is due on October 3, 2000. Claimsnet.com utilized a portion of the net proceeds
of its initial public offering to satisfy such obligation.
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American Medical Finance used all of the funds received from Claimsnet.com
in repayment of the note and the line of credit to repay a portion of its debt
incurred to finance Claimsnet.com's software and operations. None of
Claimsnet.com's executive officers or directors will be the recipient of any of
these funds. See "Related Party Transactions."
In May 1997, Claimsnet.com consummated the private offering of 45 units,
each unit consisting of 12,885 shares of common stock, for aggregate gross
proceeds of $2,250,000. Claimsnet.com has used, and intends to use, the net
proceeds of the 1997 private placement for ongoing working capital requirements.
On June 2, 1997, Claimsnet.com acquired 100% of the capital stock of Medica,
a software development firm from which it had licensed a portion of its
healthcare transaction processing software. In accordance with the terms of the
acquisition agreement, the purchase price for all of the outstanding capital
stock of Medica was:
- 119,671 shares of common stock,
- $100,000 in cash, paid upon the consummation of the acquisition,
- $125,000 in cash payable on February 9, 1999, and $225,000 on
December 11, 1999 and accruing interest at the rate of 8% per annum, and
- $57,797 representing 50% of amounts collected on outstanding accounts
receivable of Medica that existed on the closing date.
The software technology of Medica constitutes the primary value to
Claimsnet.com from the acquisition. Randall S. Lindner, Vice President of
Technology of Claimsnet.com, served as the President of Medica prior to the
consummation of the Medica acquisition.
During the second quarter of 1998, Claimsnet.com consummated a private
placement of 20 units, each unit consisting of 11,967 shares of common stock,
for aggregate gross proceeds of $1,000,000. From July through October 1998
Claimsnet.com consummated a private placement of 29.5 units, each unit
consisting of 9,295 shares of common stock, for aggregate gross proceeds of
approximately $1,475,000. During March 1999, Claimsnet.com consummated a private
placement of 20 units, each unit consisting of $50,000 principal amount of
Series A 12% Notes due 2000 and 6,250 shares of common stock, for aggregate
gross proceeds of $1,000,000. Claimsnet.com has used, and intends to use, the
net proceeds of its 1998 private placements and its 1999 private placement for
ongoing working capital purposes. Pursuant to the Securities Act, the rules and
regulations thereunder, and the interpretations of the Commission, Claimsnet.com
may be required to offer rescission to investors in its 1998 private placements
and its 1999 private placement. If Claimsnet.com is required to offer rescission
of the private placements and all of such investors determine to exercise such
rescission rights, Claimsnet.com would be required to refund the entirety of the
gross proceeds of such private offerings to such investors. In such event, the
business, prospects, financial condition, and results of operations of
Claimsnet.com could be materially adversely affected.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are unable
to distinguish between twentieth century dates and twenty-first century dates.
As a result, many companies' software and computer systems may need to be
upgraded or replaced to comply with these "Year 2000" requirements.
Claimsnet.com's business is dependent on the operation of numerous systems that
could potentially be impacted by Year 2000 related problems. Those systems
include, among others:
- hardware and software systems used by Claimsnet.com to deliver services to
its customers, including Claimsnet.com's proprietary software systems as
well as hardware and software supplied by third parties,
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- communications networks, such as the Internet and private intranets, on
which Claimsnet.com depends to provide electronic transactions to its
customers,
- the internal systems of Claimsnet.com's customers and suppliers,
- the hardware and software systems used internally by Claimsnet.com in the
management of its business, and
- non-information technology systems and services used by Claimsnet.com in
its business, such as telephone systems and building systems.
Claimsnet.com has internally reviewed the proprietary software systems it
uses to deliver services to its customers. Although Claimsnet.com believes that
its internally developed applications and systems are designed to be Year 2000
compliant, Claimsnet.com utilizes third-party equipment and software that may
not be Year 2000 compliant. Failure of third-party or currently owned equipment
or software to operate properly with regard to the Year 2000 could require
Claimsnet.com to incur unanticipated expenses to remedy any problems, which
could have a material adverse effect on its business, prospects, financial
condition, and results of operations. Claimsnet.com does not believe that its
expenditures to upgrade its internal systems and applications will be material
to its business, prospects, financial condition, and results of operations.
Futhermore, the success of Claimsnet.com's efforts may depend on the success
of other healthcare participants in dealing with their Year 2000 issues. Many of
these organizations are not Year 2000 compliant, and the impact of widespread
customer failure on Claimsnet.com's systems is difficult to determine. Customer
difficulties due to Year 2000 issues could interfere with healthcare
transactions or information, which might expose Claimsnet.com to significant
potential liability. If client failures result in the failure of Claimsnet.com's
systems, its business, prospects, financial condition, and results of operations
would be materially adversely affected. Futhermore, the purchasing patterns of
these customers or potential customers may be affected by Year 2000 issues as
companies expend significant resources to become Year 2000 compliant. The costs
of becoming Year 2000 compliant for current or potential customers may result in
reduced funds being available to purchase and implement Claimsnet.com's
applications and services.
Claimsnet.com is conducting a formal assessment of its Year 2000 exposure in
order to determine what steps beyond those identified by its internal review may
be advisable. Claimsnet.com does not presently have a contingency plan for
handling Year 2000 problems that are not detected and corrected prior to their
occurrence. Any failure of Claimsnet.com to address any unforeseen Year 2000
issue could adversely affect its business, prospects, financial condition, and
results of operations.
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MANAGEMENT
The directors and executive officers of Claimsnet.com and their positions
held with Claimsnet.com are as follows:
<TABLE>
<CAPTION>
NAME POSITION
- ---- ---------------------------------------------
<S> <C>
Bo W. Lycke Chairman of the Board of Directors,
President, Chief Executive Officer, and Class
I Director
Terry A. Lee Executive Vice President, Chief Operating
Officer, and Class II Director
Paul W. Miller Vice President and Chief Financial Officer
Randall S. Lindner Vice President of Technology
C. Kelly Campbell Vice President and Secretary
Abbas R. Kafi Vice President of Information Systems
Cheryl L. Corless Vice President of Customer Operations
Ellen Opperthauser Vice President of Marketing
Sheri Larkin Vice President and Corporate Controller
Particia Davis Vice President of Corporate Development
Ward L. Bensen Class I Director, Treasurer
Robert H. Brown, Jr. Class I Director
Sture Hedlund Class II Director
John C. Willems, III Class II Director
Westcott W. Price, III Class II Director
</TABLE>
Except for the non-employee directors of Claimsnet.com, each officer and
director is principally employed by Claimsnet.com, Inc. in the capacities set
forth above.
The following is certain summary information with respect to the
non-employee directors of Claimsnet.com.
WARD L. BENSEN, age 57, has been a director of the Company since April 1996
and has served as Treasurer of the Company since inception. Since 1990, he has
served as a Director of American Medical Finance of which he was, from
June 1994, Senior Vice President where he was primarily responsible for its
marketing efforts in the western United States and receivables acquisitions
nationwide. From March 1993 until September 1993, Mr. Bensen was Vice President
of Investment of, and marketed investment programs for, both Prudential
Securities and Shearson Lehman Brothers, and, from 1991 to 1993, provided
specialized investment banking services as a partner of John Casey and
Associates, a contract wholesale securities marketing firm. From 1984 to 1991,
he served as Division Vice President for Jones International Securities and
prior thereto, held various positions with Shearson American Express, The Safeco
Insurance Co. and Procter & Gamble.
ROBERT H. BROWN, JR., age 46, has served as a Director of the Company since
April 1996 and has been a director of American Medical Finance since 1990. Since
January 1999, Mr. Brown has been President and Chief Executive Officer of Frost
Securities, Inc. He had been, from July 1998 to December 1998, President and
Chief Executive Officer of RHB Capital, LLC, a Dallas-based private investment
firm and from 1990
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to 1998, Executive Vice President of Dain Rauscher, Inc., a regional investment
banking and brokerage firm. Mr. Brown was Senior Vice President of TM Capital
Corporation during 1989 and was, from 1985 to 1989, a Vice President of Thompson
McKinnon Securities, where he was responsible for all corporate finance
activities in the southwestern United States. Mr. Brown also serves as a
Director of Emerson Radio Inc.
STURE HEDLUND has served since January 1987 as Chairman of the Board of
Directors of Scandinavian Merchant Group AB, a Swedish corporation engaged in
venture capital investing. Since 1993, Mr. Hedlund has been a director of
Ortivus AB, a public company engaged in the business of medical technology, and
has been a director of Ortivus Medical AB, a company engaged in the manufacture
of heart monitoring devices and a subsidiary of Ortivus AB.
JOHN C. WILLEMS, III served as legal counsel to the Company from April 1996
to April 1999. Since October 1999, Mr. Willems has been in private practice as
an attorney in Dallas, Texas. From September 1993 through October 1999,
Mr. Willems was an attorney with the law firm of McKinley, Ringer & Zeiger, PC,
in Dallas, Texas, practicing in the area of business law. From January 1992 to
August 1993, Mr. Willems was an attorney in the law firm of Settle & Pou, PC,
also located in Dallas, Texas.
WESTCOTT W. PRICE, III, 59, an independent consultant since February 1997,
was formerly President, Chief Executive Officer and Vice Chairman of the Board
of Directors of FHP International Corporation, a publicly-held managed health
care company ("FHP"). From 1981 to 1997, during his fifteen-year tenure at FHP,
its annual revenues grew from under $50 million to over $4 billion. In
February 1997, FHP was acquired for $2.1 billion. From 1973 to 1981, Mr. Price
was President and Chief Executive Officer of Wm. Flaggs, Inc., a restaurant
chain and from 1970 to 1973, he was the Chief Operating Officer of California
Medical Centers, a publicly-held long-term care and retail pharmacy-operating
company in Los Angeles. Mr. Price has in the past served on various boards,
including Health Maintenance Life Insurance Company and Talbert Medical
Management Company, a physician practice management company with revenues of
$460 million. He currently serves as a director of Scripps Health, a non-profit
hospital operating company, SpeedVu.com, U.S. Education Corporation, and of
StorComm, Inc., as well as other private companies. Mr. Price is a member of the
Advisory Board for the School of Medicine at the University of California-
Irvine.
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CHANGES IN, AND DISAGREEMENTS WITH, ACCOUNTANTS
On August 10, 1999, the Company dismissed King Griffin & Adamson P.C., which
served as the Company's independent public accountants since 1996. The reports
issued by King Griffin & Adamson P.C. on the financial statements for the years
ended December 31, 1997 and 1998 of the Company did not contain an adverse
opinion nor a disclaimer of opinion, and were not qualified or modified as to
uncertainty, audit scope or accounting principles. Based on the recommendation
of the Audit Committee of the Board of Directors of the Company, the Company's
Board of Directors approved the decision to change independent public
accountants. In connection with its audits for the years ended December 31, 1997
and 1998 and through August 10, 1999, there were no disagreements with King
Griffin & Adamson P.C. on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of King Griffin & Adamson
P.C., would have caused King Griffin & Adamson P.C. to make reference thereto in
their Report on the financial statements for such years or such interim periods.
King Griffin & Adamson P.C. furnished the Company with a letter addressed to the
Commission stating whether or not it agrees with the above statements. A copy of
such letter, dated August 16, 1999, is filed as Exhibit 16.1 to the Form 8-K of
the Company, dated August 10, 1999.
The Company engaged Ernst & Young LLP as its new independent public
accountants as of August 10, 1999. The Company's Board of Directors approved
this on May 21, 1999. During the years ended December 31, 1997 and 1998 and
through August 10, 1999, the Company has verbally consulted with Ernst & Young
LLP only regarding issues related to 1999 matters and, specifically, to matters
related to a bridge financing transaction, matters related to the issuance of
stock options and stock warrants to non-employees, and general matters related
to the presentation of interim financial results. The recommendations of
Ernst & Young LLP were adopted by the Company and are disclosed in the
Form 10-Q filings dated May 17, 1999 and August 16, 1999. (2) The previous
independent accountants were verbally consulted on the matter related to a
bridge financing transaction and were not in disagreement with the views of
management and Ernst & Young LLP. The Company has allowed Ernst & Young LLP to
review the aforementioned Form 8-K before it was filed with the Commission.
Ernst & Young LLP has not furnished the Company with a letter containing any new
information, clarification, or disagreement with the information set forth
herein.
12
<PAGE>
CLAIMSNET.COM INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
CLAIMSNET.COM INC.
Report of Independent Certified Public Accountants...... F-2
Financial Statements
Balance Sheets as of December 31, 1996, 1997, and
1998................................................. F-3
Statements of Operations for the period from
April 8, 1996 (inception) to December 31, 1996, and
the years ended December 31, 1997, and 1998.......... F-4
Statements of Changes in Stockholders' Deficit for
the period from April 8, 1996 (inception) to
December 31, 1996, and the years ended December 31,
1997, and 1998....................................... F-5
Statements of Cash Flows for the period from
April 8, 1996 (inception) to December 31, 1996, and
the years ended December 31, 1997 and 1998........... F-6
Notes to Financial Statements for the period from
April 8, 1996 (inception) to December 31, 1996, and
the years ended December 31, 1997 and 1998........... F-8
MEDICA SYSTEMS, INC.
Report of Independent Certified Public Accountants...... F-17
Financial Statements
Balance Sheets as of December 31, 1996 and 1995..... F-18
Statements of Operations for the years ended
December 31, 1996 and 1995
and the period from May 1, 1994 (inception) to
December 31, 1994.................................... F-19
Statements of Changes in Stockholders' Equity
(Deficit) for the years ended December 31, 1996 and
1995 and the period from May 1, 1994 (inception) to
December 31, 1994.................................... F-20
Statements of Cash Flows for the years ended
December 31, 1996 and 1995
and the period from May 1, 1994 (inception) to
December 31, 1994.................................... F-21
Notes to Financial Statements for the years ended
December 31, 1996 and 1995
and the period from May 1, 1994 (inception) to
December 31, 1994.................................... F-22
Unaudited Balance Sheet as of March 31, 1997........ F-25
Unaudited Statement of Operations for the three
months ended March 31, 1997.......................... F-26
Unaudited Statement of Cash Flows for the three
months ended March 31, 1997.......................... F-27
Notes to Unaudited Financial Statements as of
March 31, 1997....................................... F-28
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Claimsnet.com inc.
(formerly American NET Claims)
We have audited the accompanying consolidated balance sheets of
Claimsnet.com inc. (formerly American NET Claims) and subsidiary as of
December 31, 1998, 1997 and 1996, and the related statements of operations,
stockholders' deficit, and cash flows for the years ended December 31, 1998 and
1997 and the period from April 8, 1996 (inception) to December 31, 1996. 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 in accordance with generally accepted auditing
standards. Those standards 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 that balance sheet. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Claimsnet.com inc. and
subsidiary as of December 31, 1998, 1997 and 1996, and the results of their
operations and their cash flows for the years ended December 31, 1998 and 1997
and the period from April 8, 1996 (inception) to December 31, 1996, in
conformity with generally accepted accounting principles.
KING GRIFFIN & ADAMSON P.C.
Dallas, Texas
January 22, 1999, except for Note M which is as of February 28, 1999.
F-2
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash...................................................... $ 15,659 $ 394,913 $ 43,761
Accounts receivable net of allowance for doubtful accounts
of $10,000 and $43,700 in 1997 and 1998, respectively... -- 13,240 41,996
Employee receivable....................................... -- 3,000 1,450
Prepaid assets............................................ -- 8,176 18,484
----------- ----------- -----------
Total current assets.................................... 15,659 419,329 105,691
----------- ----------- -----------
FIXED ASSETS
Computer hardware and software............................ 29,135 184,971 272,917
Furniture and fixtures.................................... -- 3,519 10,732
Office equipment.......................................... -- 24,694 24,694
----------- ----------- -----------
29,135 213,184 308,343
Accumulated depreciation and amortization................. -- (18,620) (75,479)
----------- ----------- -----------
Total fixed assets...................................... 29,135 194,564 232,864
----------- ----------- -----------
OTHER ASSETS
Software development costs net of accumulated amortization
of $398,535 and $1,049,154 at December 31, 1997 and
1998, respectively...................................... 831,869 1,524,001 873,382
Note receivable from employee............................. -- -- 25,000
Deferred offering costs................................... 101,669 36,703 416,542
----------- ----------- -----------
Total other assets...................................... 933,538 1,560,704 1,314,924
----------- ----------- -----------
TOTAL ASSETS................................................ $ 978,332 $ 2,174,597 $ 1,653,479
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable.......................................... $ -- $ 98,278 $ 173,412
Accrued expenses.......................................... -- 159,849 671,257
Contingent payable........................................ -- 125,000 125,000
Notes payable............................................. -- -- 225,000
----------- ----------- -----------
Total current liabilities............................... -- 383,127 1,194,669
----------- ----------- -----------
LONG-TERM LIABILITIES
Line of credit--affiliate................................. 510,250 695,650 1,462,338
Note payable--affiliate................................... 3,740,000 2,000,000 2,000,000
Notes payable............................................. -- 225,000 --
Accrued interest--affiliate............................... 158,123 547,670 860,789
----------- ----------- -----------
Total long-term liabilities............................. 4,408,373 3,468,320 4,323,127
----------- ----------- -----------
TOTAL LIABILITIES........................................... 4,408,373 3,851,447 5,517,796
----------- ----------- -----------
COMMITMENTS AND CONTINGENCIES (Notes A, B, C, D, H, I, J and
L)
STOCKHOLDERS' DEFICIT
Preferred stock--$.001 par value; 4,000,000 shares
authorized; no shares issued or outstanding.............
Common stock--$.001 par value; 40,000,000 shares
authorized; 2,365,596 shares issued and outstanding at
December 31, 1996, 3,111,458 shares issued and
outstanding at December 31, 1997 and 3,625,000 shares
issued and outstanding at December 31, 1998............. 2,365 3,111 3,625
Additional paid-in capital................................ (3,125,365) 1,407,389 3,881,875
Accumulated deficit....................................... (306,041) (3,087,350) (7,749,817)
----------- ----------- -----------
(3,429,041) (1,676,850) (3,864,317)
Less note receivable for shares........................... (1,000) -- --
----------- ----------- -----------
TOTAL STOCKHOLDERS' DEFICIT................................. (3,430,041) (1,676,850) (3,864,317)
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT................. $ 978,332 $ 2,174,597 $ 1,653,479
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
CONSOLIDATED STATEMENTS OF OPERATIONS
PERIOD FROM APRIL 8, 1996 (INCEPTION) TO DECEMBER 31, 1996, AND
THE YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
PERIOD ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ -------------
<S> <C> <C> <C>
REVENUES............................................... $ -- $ 81,712 $ 154,653
COST OF REVENUES....................................... -- 250,889 648,748
----------- ----------- -----------
GROSS LOSS............................................. -- (169,177) (494,095)
----------- ----------- -----------
OPERATING EXPENSES
Research and development............................. -- 461,245 530,502
Software amortization................................ -- 402,835 672,328
Selling, general and administrative.................. 147,918 1,399,321 2,657,975
----------- ----------- -----------
LOSS FROM OPERATIONS................................... (147,918) (2,432,578) (4,354,900)
----------- ----------- -----------
OTHER INCOME (EXPENSE)
Interest expense--affiliate.......................... (158,123) (389,548) (313,680)
Interest income...................................... -- 40,817 6,113
----------- ----------- -----------
Total Other Income (Expense)....................... (158,123) (348,731) (307,567)
----------- ----------- -----------
NET LOSS............................................... $ (306,041) $(2,781,309) $(4,662,467)
=========== =========== ===========
BASIC LOSS PER SHARE................................... $ (0.13) $ (0.98) $ (1.41)
=========== =========== ===========
DILUTED LOSS PER SHARE................................. $ (0.13) $ (0.98) $ (1.41)
=========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (Basic and
diluted)............................................. 2,348,894 2,850,796 3,309,280
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS, INC.)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
PERIOD FROM APRIL 8, 1996 (INCEPTION) TO DECEMBER 31, 1996, AND
THE YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
ADDITIONAL
NUMBER OF COMMON PAID-IN NOTE ACCUMULATED
SHARES STOCK CAPITAL RECEIVABLE DEFICIT
--------- -------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
April 8, 1996--Issuance of common stock
at inception......................... 2,342,404 $2,342 $ (1,342) $-- $ --
Issuance of common stock for note...... 23,192 23 977 (1,000) --
Deemed distribution related to purchase
of asset from affiliate (Note H)..... -- -- (3,125,000) -- --
Net loss for 1996...................... -- -- -- -- (306,041)
--------- ------ ----------- ------- -----------
Balances at December 31, 1996.......... 2,365,596 2,365 (3,125,365) (1,000) (306,041)
--------- ------ ----------- ------- -----------
Issuance of stock for compensation..... 46,385 46 78,454 -- --
Issuance of stock for cash pursuant to
PPM.................................. 579,806 580 2,249,420 -- --
Issuance of stock related to the
purchase of Medica................... 119,671 120 464,880 -- --
American Medical Finance capital
contribution......................... -- -- 1,740,000 1,000 --
Net loss for the year ended December
31, 1997............................. -- -- -- -- (2,781,309)
--------- ------ ----------- ------- -----------
Balances at December 31, 1997.......... 3,111,458 3,111 1,407,389 -- (3,087,350)
--------- ------ ----------- ------- -----------
Issuance of stock pursuant to private
placements........................... 513,542 514 2,474,486 -- --
Net loss for the year ended
December 31, 1998.................... -- -- -- -- (4,662,467)
--------- ------ ----------- ------- -----------
Balances at December 31, 1998.......... 3,625,000 $3,625 $ 3,881,875 $-- $(7,749,817)
========= ====== =========== ======= ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIOD FROM APRIL 8, 1996 (INCEPTION) TO DECEMBER 31, 1996, AND
THE YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
PERIOD ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES
Net loss................................................ $ (306,041) $(2,781,309) $(4,662,467)
Adjustments to reconcile net loss to net cash used by
operating activities
Depreciation and amortization....................... -- 417,155 707,478
Common stock issued for compensation................ -- 78,500 --
Allowance for doubtful accounts..................... -- 10,000 33,700
Offering costs written off.......................... -- 101,669 411,671
Changes in assets and liabilities net of effects of
acquisition:
(Increase) decrease in accounts receivable........ -- 93,069 (62,456)
Increase in other current assets.................. -- (10,988) (8,758)
Increase in accounts payable and other current
liabilities..................................... -- 118,776 586,539
Increase in accrued interest...................... 158,123 389,549 313,121
---------- ----------- -----------
Net cash used by operating activities............... (147,918) (1,583,579) (2,681,172)
---------- ----------- -----------
CASH FLOWS USED IN INVESTING ACTIVITIES
Cash in acquired subsidiary............................. -- 15,664 --
Cash paid to acquire subsidiary......................... -- (100,000) --
Issuance of employee note receivable.................... -- -- (25,000)
Purchases of property and equipment..................... (29,135) (159,355) (95,159)
Software development costs.............................. (216,869) (193,173) --
---------- ----------- -----------
Net cash used in investing activities............... (246,004) (436,864) (120,159)
---------- ----------- -----------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Increase in line of credit--affiliate................... 510,250 185,400 1,216,688
Payments for deferred offering costs.................... (101,669) (36,703) (791,509)
Proceeds from common stock issuances.................... 1,000 2,251,000 2,025,000
---------- ----------- -----------
Net cash provided by financing activities........... 409,581 2,399,697 2,450,179
---------- ----------- -----------
NET INCREASE IN CASH.................................... 15,659 379,254 (351,152)
Cash--beginning balance................................. -- 15,659 394,913
---------- ----------- -----------
Cash--ending balance.................................... $ 15,659 $ 394,913 $ 43,761
========== =========== ===========
</TABLE>
F-6
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
PERIOD FROM APRIL 8, 1996 (INCEPTION) TO DECEMBER 31, 1996, AND
THE YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
PERIOD ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES
Purchase of asset from affiliate--net................... $ 615,000 $ -- $ --
========== =========== ===========
Common stock issued for compensation.................... $ -- $ 78,500 $ --
========== =========== ===========
Common stock issued for acquisition of subsidiary....... $ -- $ 465,000 $ --
========== =========== ===========
Other liabilities incurred for acquisition of
subsidiary............................................ $ -- $ 57,798 $ --
========== =========== ===========
Conversion of portion of note payable--affiliate to
equity................................................ $ -- $ 1,740,000 $ --
========== =========== ===========
Conversion of portion of line of credit--affiliate to
equity................................................ $ -- $ -- $ 450,000
========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
NOTE A--ORGANIZATION AND BACKGROUND
Claimsnet.com inc. (formerly American Net Claims) ("Claimsnet.com" or the
"Company") was incorporated in the state of Texas on April 8, 1996. Effective
February 3, 1997, the Company assumed the name Claimsnet.com in the State of
Texas. On December 7, 1998, the Company reincorporated under the laws of the
state of Delaware. The Company owns and licenses software used for processing
medical insurance claims on the internet.
On July 31, 1996, the Company acquired all the internet software, licenses,
intellectual property rights and technology developed by an affiliated company,
American Medical Finance ("American Medical Finance"). American Medical Finance
is affiliated through common stockholders, and as a stockholder of the Company.
On June 2, 1997, the Company acquired Medica Systems, Inc., which owned the
CyberClaim software source code previously licensed to the Company for use in
conjunction with the software purchased from American Medical Finance. (See
Note C). The acquisition was completed through a merger with a newly created,
wholly-owned subsidiary, ANC Holdings, Inc. which is the surviving corporation
in the merger.
The Company has generated losses of $306,041 during the period ended
December 31, 1996, and $2,781,309 and $4,662,467 during the years ended
December 31, 1997 and 1998, respectively. During these same periods, the Company
used cash in its operations of $147,918, $1,583,579 and $2,792,843,
respectively. Through the date of this report, the Company has generated minimal
revenues and has relied on private equity placement proceeds and financing from
an affiliate to fund its operations and development activities. At December 31,
1998 liabilities significantly exceeds assets.
During the period from April to October 1998, the Company completed two
private equity placements which raised gross proceeds of $2,475,000, for which
the Company received net proceeds of $2,025,000 cash and conversion of $450,000
of debt outstanding under a line of credit agreement (see Note D). In order to
make the investment necessary to expand its business and to meet its cash flow
requirements, the Company plans to raise additional capital. The Company is in
the process of completing an initial public offering ("Offering") to raise net
proceeds of approximately $17,000,000 (excluding underwriters overallotment
options), although no assurance can be given that such offering will be
successful. The Company received net proceeds of $900,000 pursuant to the note
agreement (See Note M). Based on the above and managements belief that
additional equity and debt financing can be raised, management believes that the
Company has the ability to continue its business through December 31, 1999.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The accompanying financial statements include the accounts of Claimsnet.com
inc. and its subsidiary from the date of acquisition. All material intercompany
accounts and transactions from that date have been eliminated in consolidation.
F-8
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STATEMENT OF CASH FLOWS
For purposes of the statement of cash flows, cash equivalents include time
deposits, certificates of deposits, and all highly liquid debt instruments with
original maturities of 3 months or less when purchased.
SOFTWARE
Financial Accounting Standard No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed," provides for the
capitalization of certain costs related to development of computer software
products. Software development costs through December 31, 1998 include
internally developed costs totaling $395,322, software purchased from American
Medical Finance totaling $615,000 (See Note G), and software purchased through
the acquisition of Medica totaling $911,741 (See Note C). Capitalized computer
software costs include direct labor, labor-related overhead costs and interest.
The software is amortized over its expected useful life of 3 years. Amortization
expense related to developed software since the product was introduced in 1997
totaled $398,535 and $650,619 for 1997 and 1998, respectively. Management
periodically evaluates the recoverability, valuation, and amortization of
capitalized software cost. As part of this review, management considers the
undiscounted projected future net cash flows. If the undiscounted future net
cash flows is less than the stated value, software costs will be written down to
fair value.
REVENUE
Monthly subscription fee revenue is recognized ratably over the applicable
subscription period. Claim processing revenues are recognized when the claims
are processed. Enrollment fee revenue is recognized upon enrollment of
customers. Customer support fees are recognized when support services are
rendered.
FIXED ASSETS
Fixed assets are stated at cost. Depreciation is provided using the straight
line method over the estimated useful lives of the depreciable assets which
range from three to seven years. Maintenance and repairs are expensed as
incurred. Replacements and betterments are capitalized. Depreciation and
amortization related to fixed assets totaled $0, $18,620 and $56,859 in 1996,
1997 and 1998, respectively.
DEFERRED OFFERING COSTS
Deferred offering costs are capitalized and recorded as a reduction to
stockholders' equity upon completion of a Company Offering, or expensed if an
Offering is unsuccessful.
INCOME TAXES
The Company accounts for income taxes in accordance with the asset and
liability approach. Deferred income tax assets and liabilities are computed
annually for differences between the financial statement and tax bases of assets
and liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount
F-9
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
expected to be realized. Income tax expense is the tax payable or refundable for
the period plus or minus the change during the period in deferred tax assets and
liabilities.
LOSS PER SHARE
The Company adopted SFAS No. 128, "Earnings Per Share", in 1997, which
requires the disclosure of basic and diluted net income (loss) per share. Basic
net income (loss) per share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding for the period. Diluted net
income (loss) per share is computed by dividing net income (loss) by the
weighted average number of common shares and common stock equivalents
outstanding for the period. The Company's common stock equivalents are not
included in the diluted loss per share for 1996, 1997 and 1998 as they are
antidilutive. As such, diluted and primary loss per share is identical. Net loss
per share has been stated for all periods presented in accordance with SFAS No.
128.
CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
One customer acquired as part of the Medica acquisition generated revenue of
$51,011, representing 62% of the Company's total revenue for the year ended
December 31, 1997. The Company has subsequently cancelled its contract with this
customer. The Company does not generally require collateral. Management provides
an allowance for doubtful accounts which reflects its estimate of the
uncollectible receivables. In the event of non-performance, the maximum exposure
to the Company is the recorded amount of the receivable at the balance sheet
date.
USE OF ESTIMATES AND ASSUMPTIONS
Management uses estimates and assumptions in preparing financial statements
in accordance with generally accepted accounting principles. Those estimates and
assumptions affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities, and the reported amounts of
revenues and expenses. Actual results could vary from the estimates that were
used.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 "Reporting Comprehensive Income", which
establishes new guidance for the reporting and display of comprehensive income
and its components. The Company has adopted this Statement as of January 1,
1998, however, this standard does not currently impact disclosures.
In July 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131, "Disclosures about Segments of an
Enterprise and Related Information." This Statement expands certain reporting
and disclosure requirements for segments from current Standards and was adopted
January 1, 1998. Claimsnet currently operates only one segment of business,
therefore, this standard does not currently impact disclosures.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position No. 98-1
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" (SOP 98-1), to be effective for fiscal years beginning after
F-10
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
December 15, 1998. The Statement establishes the criteria for capitalizing and
expensing costs incurred for such development activities, measuring and
recognizing impairment, and amortization of capitalized costs. The Company is
reviewing the effect, if any, of the adoption of this pronouncement.
In June 1998, the Financial Accounting Standards Board issued Standard
No. 133 "Accounting for Derivative Instruments and Hedging Activities." The
Standard establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
The new Standard is effective for all fiscal quarters of all fiscal years
beginning after June 15, 1999. Claimsnet does not expect the adoption of the new
Standard to have a material impact on its financial position or results of
operations.
ADVERTISING COSTS
Advertising costs are expensed as incurred. Advertising expense totaled
$1,720, $45,606 and $98,970 for the periods ended December 31, 1996, 1997 and
1998, respectively.
RECLASSIFICATION
Certain 1996 and 1997 amounts have been reclassified to conform with the
1998 presentation.
NOTE C--MEDICA SYSTEMS, INC. ACQUISITION
On June 2, 1997, the Company completed the acquisition of Medica Systems,
Inc. ("Medica"), giving them ownership of the underlying source code of a
software program which processes medical insurance claims. The software was
previously licensed from Medica under a software licensing agreement. The
transaction was accounted for as a purchase. The Company received all of the
outstanding stock of Medica in exchange for a purchase price of $972,798 which
consisted of $100,000 cash at closing, 119,671 shares of the Company's common
stock, a contingent cash payment of $125,000 due within 60 days of the effective
date of a registration statement (February 9, 1999), notes for $225,000 due one
year from the effective date of a registration statement (December 11, 1999),
and 50% of the amounts collected relating to the accounts receivable of Medica
existing on the closing date. The fair value of the common stock given as
consideration in the transaction totaled $465,000 or $3.89 per share. The
Company collected $115,595 of Medica's outstanding receivables at the closing
date and has included $57,797 (50%) as a part of the purchase price. The
contingent cash and notes payable have been recorded as a part of the purchase
price as they were determinable at the date of closing.
F-11
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
NOTE C--MEDICA SYSTEMS, INC. ACQUISITION (CONTINUED)
The fair value of assets and liabilities acquired consisted of:
<TABLE>
<S> <C>
Software development costs.................................. $ 911,741
Accounts receivable, net.................................... 115,595
Fixed assets................................................ 24,694
Other current assets........................................ 2,319
Current liabilities......................................... (81,551)
----------
$ 972,798
==========
</TABLE>
Unaudited pro forma financial information for the years ended December 31,
1996 and 1997 as though the acquistion had occurred on January 1, 1996 is as
follows:
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
Revenues.................................................... $ 395,396 $ 407,656
========== ==========
Net loss.................................................... $ (551,920) $2,855,702
========== ==========
Net loss per common share (basic and diluted)............... $ (0.22) $ (0.99)
========== ==========
Weighted average common shares outstanding (basic and
diluted).................................................. $2,471,630 $2,900,632
========== ==========
</TABLE>
NOTE D--LINE OF CREDIT AND NOTES PAYABLE
The Company has a line of credit facility with American Medical Finance of
up to $2,000,000. The line of credit bears interest at 9.50%, is due on October
3, 2000, and is collaterized by all of the assets of the Company, other than
that collateral specified by the note payable to American Medical Finance below.
The Company has a note payable to American Medical Finance (see Note G). The
note bears interest at 9.5%, is due on October 3, 2000, and is collaterized by
all internet software and technology of the Company including software
development costs.
Accrued interest under the note and line of credit with American Medical
Finance totaled $158,123, $547,670 and $860,789, respectively and is due on
October 3, 2000.
Notes payable at December 31, 1997 and 1998 relate to debt incurred in
conjunction with the purchase of Medica (see Note C). The notes are unsecured,
due one year from the effective date of the registration statement (December 11,
1999), and bear interest at 8%.
NOTE E--FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosure About Fair
Value of Financial Instruments", requires disclosure about the fair value of all
financial assets and liabilities for which it is practicable to estimate. The
note payable and the line of credit (both amounts are fixed rate debt) have a
carrying amount of $3,462,338 and a fair value of approximately the same amount
at December 31, 1998.
F-12
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
NOTE E--FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The fair value of the Company's fixed rate debt has been estimated based upon
relative changes in the Company's variable borrowing rates since origination of
the fixed rate debt.
NOTE F--INCOME TAXES
Deferred tax assets and liabilities at December 31, 1996, 1997 and 1998 are
as follows:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Current deferred tax asset............. $ -- $ 3,697 $ 16,156
Non-current deferred tax asset......... 150,730 1,289,723 2,953,345
Non-current deferred tax liability..... (37,587) (417,382) (191,029)
Valuation allowance.................... (113,143) (876,038) (2,778,472)
----------- ----------- -----------
Net non-current deferred taxes....... $ -- $ -- $ --
=========== =========== ===========
</TABLE>
The current deferred tax asset results from the provision for doubtful
accounts which is not currently deductible for income tax purposes. The
non-current deferred tax asset results from the net operating loss generated by
the Company. The non-current deferred tax liability results from depreciation
and amortization deducted for income tax purposes in excess of that expensed for
financial reporting purposes and the remaining deferred tax liability
established in connection with software development costs acquired in the Medica
acquisition. The net deferred tax asset has a 100% valuation allowance recorded
against it due to the uncertainty of generating future taxable income.
The Company's effective income tax rate differed from the Federal statutory
rate of 34% as follows:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Statutory rate of 34% applied to net
loss................................. $ 104,054 $ 945,645 $ 1,585,239
Permanent differences.................. -- 14,289 61,854
State income taxes, net of federal tax
effect............................... -- 83,853 142,985
Change in valuation allowance.......... (104,054) (1,043,787) (1,790,078)
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
</TABLE>
At December 31, 1998, the Company has a net operating loss carryforward of
approximately $7,988,000 which begins to expire in 2011 subject to the
limitations of the Internal Revenue Code Section 382.
NOTE G--RELATED PARTY TRANSACTIONS
On July 31, 1996, the Company purchased software, licenses, intellectual
property rights and technology from American Medical Finance. As the software
was purchased from a related entity, the asset was recorded by the Company at
the basis (in accordance with Generally Accepted Accounting Principles) of
American Medical Finance. Accordingly, the asset was recorded at $615,000 with a
corresponding note payable to American Medical Finance $3,740,000. The
difference between the recorded cost of the asset and the note payable
($3,125,000) was reflected as a contra to paid-in capital (a deemed
distribution). The
F-13
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
NOTE G--RELATED PARTY TRANSACTIONS (CONTINUED)
asset was recorded at the net book value per the affiliates records, which was
less than the estimated fair market value.
On September 23, 1997, American Medical Finance agreed to reduce its note
receivable from the Company by $1,740,000. The reduction in the note was
recorded as a capital contribution by American Medical Finance and effectively
reduced the $3,125,000 contra to paid-in capital described above.
The Company has a note payable and a line of credit facility with American
Medical Finance (see Note D).
Certain of the Company's expenses were paid by American Medical Finance and
represent costs such as rent, printing and office supplies. All such expenses
were accounted for as increases in the line of credit. The relationship with
American Medical Finance could result in operating results or financial position
significantly different from that which would have been obtained if the entities
were autonomous.
NOTE H--STOCKHOLDERS' DEFICIT
During 1997, the Company raised $2,250,000 in gross proceeds under a private
placement memorandum which closed on May 7, 1997. The Company sold 45 units,
each unit consisting of 12,885 shares of common stock at $50,000 per unit, which
totaled 579,806 shares.
On May 15, 1997, the Board of Directors authorized a 2.325578 for 1 split in
common shares and an increase in authorized common shares to 40,000,000. In
addition, on November 18, 1998 the Board authorized a 1 for 2.796117 reverse
split in common shares. In addition, in February 1999, the Board authorized a
1.115385 for 1 split in common shares. The financial statements, including all
references to the number of shares of common stock and all per share
information, have been adjusted on a retroactive basis to reflect these equity
transactions.
During the second quarter of 1998, the Company consummated a private
offering of 20 units, each unit consisting of 11,967 shares of common stock, for
aggregate gross proceeds of $1,000,000 in the form of $550,000 cash and $450,000
debt cancellation related to a portion of the line of credit--affiliate. During
the period from July to October 1998, the Company consummated an additional
private offering of 29.5 units, each unit consisting of 9,295 shares of the
Company's common stock for aggregate gross proceeds of $1,475,000. Pursuant to
the Securities Act of 1933, as amended, the rules and regulations thereunder,
and the interpretations of the Securities and Exchange Commission, the Company
may be required to offer rescission to investors in these offerings and the 1999
private placement offering described in Note M. In the event that the Company is
so required and all of such investors determine to exercise such rescission
rights, the Company would be required to refund the entirety of the gross
proceeds of such private offerings to such investors. In such event, the
business, prospects, financial condition, and results of operations of the
Company could be materially adversely affected.
In July 1998, the Company issued warrants to acquire an aggregate of 11,154
shares of common stock to a non-employee. Such warrants are exercisable for a
period of four years commencing one year following the IPO at a price per share
equal to 110% of the IPO price.
F-14
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
NOTE I--COMMITMENTS AND CONTINGENCIES
The Company has entered into employment agreements with several key
employees. The agreements generally provide for an annual base salary, incentive
compensation and termination provisions. Certain of the provisions are
contingent upon the completion of an initial public offering. The minimum
commitments under the agreements are set forth in the following table:
<TABLE>
<CAPTION>
CONTINGENT
COMMITMENTS COMMITMENTS
----------- -----------
<S> <C> <C>
1999............................................... 175,000 220,000
2000............................................... 72,917 250,000
2001............................................... -- 250,000
2002............................................... -- 250,000
</TABLE>
Compensation expense of $78,500 related to the 46,385 common shares issued
under these agreements is included in the statement of operations for the year
ended December 31, 1997. Such compensation expense was computed by .
The Company leases office space under a lease agreement that expires on
September 30, 1999. Rent expense totaled $10,000, $56,225 and $116,008 for the
years ended December 31, 1996, 1997 and 1998, respectively.
NOTE J--STOCK OPTIONS
In April 1997 the Board of Directors adopted the 1997 Stock Option Plan (the
"1997 Plan") which was amended in April 1998 to authorize the grant of 557,692
options to purchase shares of the Company's common stock. The 1997 Plan
authorized the grant of such options to employees, officers, directors, and
consultants of the Company.
In April 1998, the Board of Directors adopted the Non-Employees and
Directors Plan (the "Directors Plan"). The Directors Plan authorized the grant
of options to outside directors to purchase up to 111,538 shares of common
stock.
NOTE K--RETIREMENT PLAN
The Company utilizes a third party for the processing and administration of
its payroll and benefits. Under the agreement, the third party is legally a
co-employer of all of the Company's employees, which are covered by the third
party's 401(k) retirement plan. Under the plan, employer contributions are
discretionary. The Company has made no contributions to the plan through
December 31, 1998.
NOTE L--YEAR 2000
Many currently installed computer systems and software products are unable
to distinguish between twentieth century dates and twenty-first century dates.
As a result, many companies' software and computer systems may need to be
upgraded or replaced to comply with each "Year 2000" requirements.
Claimsnet.com's business is dependent on the operation of numerous systems that
could potentially be impacted by Year 2000 related problems. Those systems
include, among others; hardware and software systems used by Claimsnet.com to
deliver services to its customers (including Claimsnet.com's proprietary
software systems as well as hardware and software supplied by third parties;
communications networks,
F-15
<PAGE>
CLAIMSNET.COM INC. AND SUBSIDIARY
(FORMERLY AMERICAN NET CLAIMS)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996, 1997 AND 1998
NOTE L--YEAR 2000 (CONTINUED)
such as the Internet and private intranets, which Claimsnet.com depends on to
provide electronic transactions to its customers, the internal systems of
Claimsnet.com's customers and suppliers, the hardware and software systems used
internally by Claimsnet.com in the management of its business; and
non-information technology systems and services used by Claimsnet.com in its
business, such as telephone systems and building systems.
Claimsnet.com has internally reviewed the proprietary software systems it
uses to deliver services to its customers. Although Claimsnet.com believes that
its internally developed applications and systems are designed to be Year 2000
compliant Claimsnet.com utilizes third-party equipment and software that may not
be Year 2000 compliant. Failure of such third-party or currently owned equipment
or software to operate properly with regard to the Year 2000 and thereafter
could require Claimsnet.com to incur unanticipated expenses to remedy any
problems, which could have a material adverse effect on its business, prospects,
financial condition, and results of operations. Claimsnet.com does not believe
that its expenditures to upgrade its internal systems and applications will be
material to its business, prospects, financial condition, and results of
operations.
Futhermore, the success of Claimsnet.com's efforts may depend on the success
of other healthcare participants in dealing with their Year 2000 issues. Many of
these organizations are not Year 2000 compliant and the impact of widespread
customer failure on Claimsnet.com's systems is difficult to determine. Customer
difficulties due to Year 2000 issues could interfere with healthcare
transactions or information, which might expose Claimsnet.com to significant
potential liability. If client failures result in the failure of Claimsnet.com's
systems, its business, prospects, financial condition, and results of operations
would be materially adversely affected. Furthermore, the purchasing patterns of
these customers or potential customers may be affected by Year 2000 issues as
companies expend significant resources to become Year 2000 compliant. The costs
of becoming Year 2000 compliant for current or potential customers may result in
reduced funds being available to purchase and implement Claimsnet.com's
applications and services.
Claimsnet.com is conducting a formal assessment of its Year 2000 exposure in
order to determine what steps beyond those identified by its internal review may
be advisable. Claimsnet.com does not presently have a contingency plan for
handling Year 2000 problems that are not detected and corrected prior to their
occurrence. Any failure of Claimsnet.com to address any unforeseen Year 2000
issue could adversely affect its business, prospects, financial condition, and
results of operations.
NOTE M--SUBSEQUENT EVENTS
In February 1999, the Board of Directors authorized a 1.115385 for 1 split
in common shares. (See Note H)
On February 28, 1999 the Company completed the sale of the 1999 private
placement for which the Company will issue 125,000 shares of common stock, and
enter into note agreements in the amount of $1,000,000. Net proceeds from the
transaction will be $900,000. The notes and all accrued interest will be due
upon the earlier of the first day subsequent to the closing of the Company's
initial public offering or one year from the closing of the private placement.
The notes will bear interest at the rate of 12% per annum.
F-16
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Medica Systems, Inc.
We have audited the accompanying balance sheets of Medica Systems, Inc. as
of December 31, 1996 and 1995, and the related statements of operations,
stockholders' equity (deficit), and cash flows for the years then ended and the
period from May 1, 1994 (inception) to December 31, 1994. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Medica Systems, Inc. as of
December 31, 1996 and 1995 and the results of its operations and cash flows for
the years then ended and for the period from May 1, 1994 (inception) to
December 31, 1994 in conformity with generally accepted accounting principles.
KING GRIFFIN & ADAMSON P.C.
Dallas, Texas
June 2, 1997
F-17
<PAGE>
MEDICA SYSTEMS, INC.
BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
ASSETS
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
CURRENT ASSETS
Cash...................................................... $23,046 $21,271
Accounts receivable, net of allowance of $24,000 and
$-0-...................................................... 32,216 6,991
Prepaid expenses.......................................... 4,388 --
Deferred income taxes..................................... 3,316 10,465
------- -------
Total current assets.................................... 62,966 38,727
------- -------
FIXED ASSETS
Office equipment.......................................... 33,217 21,626
Software.................................................. 10,329 6,332
Accumulated depreciation and amortization................. (12,640) (4,893)
------- -------
30,906 23,065
------- -------
OTHER ASSETS................................................ 560 770
------- -------
TOTAL ASSETS................................................ $94,432 $62,562
======= =======
</TABLE>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
CURRENT LIABILITIES
<S> <C> <C>
Accounts payable.......................................... $ 8,683 $ 3,469
Accrued liabilities, including $1,300 due to
stockholder............................................... 51,978 1,300
Deferred revenue.......................................... -- 75,000
Federal income taxes payable.............................. 1,011 129
------- -------
Total current liabilities............................... 61,672 79,898
------- -------
DEFERRED INCOME TAXES, NON-CURRENT.......................... 1,287 1,532
TOTAL LIABILITIES........................................... 62,959 81,430
------- -------
COMMITMENTS AND CONTINGENCIES (Notes E, F and G)
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock--no par value; 1,000 shares
authorized; 730 shares issued and outstanding........... 33,595 33,595
Accumulated deficit....................................... (2,122) (52,463)
------- -------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT)........................ 31,473 (18,868)
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)........ $94,432 $62,562
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-18
<PAGE>
MEDICA SYSTEMS, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
MAY 1, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
CONSULTING INCOME........................................... $395,396 $120,902 $79,952
-------- -------- -------
OPERATING EXPENSES
Bad debt provision........................................ 24,000 -- --
Claims processing......................................... 7,536 -- --
Depreciation and amortization............................. 7,957 4,103 1,070
Legal settlement.......................................... 50,000 -- --
Professional fees......................................... 46,788 17,522 1,825
Rents..................................................... 2,625 -- --
Salaries and payroll taxes................................ 161,253 150,086 62,767
Telephone................................................. 12,977 6,556 2,449
Travel.................................................... 8,352 8,779 1,000
Other..................................................... 15,652 7,790 (1,826)
-------- -------- -------
Total operating expense................................. 337,140 194,836 67,285
-------- -------- -------
NET INCOME (LOSS) BEFORE INCOME TAXES....................... 58,256 (73,934) 12,667
INCOME TAX BENEFIT (EXPENSE)................................ (7,915) 10,779 (1,975)
-------- -------- -------
NET INCOME (LOSS)........................................... $ 50,341 $(63,155) $10,692
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-19
<PAGE>
MEDICA SYSTEMS, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
MAY 1, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
RETAINED
EARNINGS
NUMBER OF COMMON (ACCUMULATED
SHARES STOCK DEFICIT)
--------- -------- ------------
<S> <C> <C> <C>
Capital contribution at inception......................... 730 $33,595 $--
Net income................................................ -- -- 10,692
--- ------- -------
Balances at December 31, 1994............................. 730 33,595 10,692
Net loss.................................................. -- -- (63,155)
--- ------- -------
Balances at December 31, 1995............................. 730 33,595 (52,463)
Net income................................................ -- -- 50,341
--- ------- -------
Balances at December 31, 1996............................. 730 $33,595 $(2,122)
=== ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-20
<PAGE>
MEDICA SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
MAY 1, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)......................................... $50,341 $(63,155) $10,692
Adjustments to reconcile net income (loss) to net
cash provided (used) by operating activities............
Depreciation and amortization........................... 7,957 4,103 1,070
Provision for bad debts................................. 24,000 -- --
Changes in assets and liabilities:
Accounts receivable................................. (49,225) 23,460 (30,451)
Prepaid expenses.................................... (4,388) -- --
Organization costs.................................. -- -- (1,050)
Accounts payable.................................... 5,214 2,504 965
Accrued liabilities................................. 50,677 (1,850) 3,150
Deferred revenue.................................... (75,000) 75,000 --
Federal income taxes payable........................ 882 129 --
Deferred income taxes............................... 6,904 (10,908) 1,975
------- -------- -------
Net cash provided (used) by operating activities...... 17,362 29,283 (13,649)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment....................... (15,587) (13,979) (11,164)
------- -------- -------
Net cash used in investing activities................. (15,587) (13,979) (11,164)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from common stock................................ -- -- 30,780
------- -------- -------
Net cash provided by financing activities............. -- -- 30,780
NET INCREASE IN CASH........................................ 1,775 15,304 5,967
Cash--beginning balance................................... 21,271 5,967 --
------- -------- -------
Cash--ending balance...................................... $23,046 $ 21,271 $ 5,967
======= ======== =======
Supplemental disclosure of income taxes paid................ $ 129 $ -- $ --
======= ======== =======
Supplemental schedule of non-cash investing and financing
activities
Equipment contributed by shareholder...................... $ -- $ -- $ 2,815
======= ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE>
MEDICA SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
MAY 1, 1994 (INCEPTION) TO DECEMBER 31, 1994
NOTE A--BACKGROUND AND ORGANIZATION
Medica Systems, Inc. ("Medica" or the "Company") was incorporated in the
state of Texas on May 1, 1994. Medica was formed for the purpose of developing
software in the healthcare industry. The Company provides consulting services
for medical billing processing.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
STATEMENT OF CASH FLOWS
For purposes of the statement of cash flows, cash equivalents include time
deposits, certificates of deposits, and all highly liquid debt instruments with
original maturities of 3 months or less when purchased.
OFFICE EQUIPMENT
Office equipment is stated at cost. Depreciation is provided using the
straight line method over the estimated useful lives of the assets of five to
seven years. Maintenance and repairs are expensed as incurred. Replacements and
betterments are capitalized.
SOFTWARE
Software is stated at cost. Amortization is calculated using the straight
line method over the estimated useful lives of the software of five years.
INCOME TAXES
The Company accounts for income taxes in accordance with the asset and
liability approach. Deferred income tax assets and liabilities are computed
annually for differences between the financial statement and tax bases of assets
and liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized. Income tax expense is the tax payable or refundable for the
period plus or minus the change during the period in deferred tax assets and
liabilities.
REVENUE RECOGNITION
Revenue relating to services is recognized upon completion of services,
which are usually completed within one fiscal year. Payments for services
received in advance are deferred and recognized when services have been
rendered.
USE OF ESTIMATES AND ASSUMPTIONS
Management uses estimates and assumptions in preparing financial statements
in accordance with generally accepted accounting principles. Those estimates and
assumptions affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities, and the reported amounts of
revenues and expenses. Actual results could vary from the estimates that were
used.
F-22
<PAGE>
MEDICA SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
MAY 1, 1994 (INCEPTION) TO DECEMBER 31, 1994
NOTE C--FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosure About Fair
Value of Financial Instruments", requires disclosure about the fair value of all
financial assets and liabilities for which it is practicable to estimate. All
financial assets and liabilities are current and have carrying amounts and fair
values of approximately the same amount.
NOTE D--INCOME TAXES
Deferred tax assets and liabilities at December 31, 1996 and 1995 are as
follows:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Current deferred tax asset................................ $ 3,316 $10,465
Current deferred tax liability............................ -- --
------- -------
Net current deferred income taxes....................... 3,316 10,465
======= =======
Non-current deferred tax asset............................ -- --
Non-current deferred tax liability........................ (1,287) (1,532)
------- -------
Net non-current deferred income taxes................... $(1,287) $(1,532)
======= =======
</TABLE>
The current deferred tax asset results from the differences in timing of
revenue recognition for income tax and financial reporting purposes and use of
cash basis for income tax purposes. The non-current deferred tax liability
results from differences in depreciation for income tax and financial reporting
purposes.
The components of income tax expense (benefit) for the years ended
December 31, 1996 and 1995 and the period from May 1, 1994 to December 31, 1994
are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Federal:
Current......................................... $1,011 $ 129 $--
Deferred........................................ 6,904 (10,908) 1,975
------ -------- ------
$7,915 $(10,779) $1,975
====== ======== ======
</TABLE>
The Company's effective income tax rate differed from the Federal statutory
rate of 15% as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Statutory rate of 15% (the Company's effective tax
rates during the periods presented) applied to
net income (loss)............................... $8,738 $(11,090) $1,900
Non deductible expenses........................... (228) (240) 75
Other............................................. (595) 551 --
------ -------- ------
$7,915 $(10,779) $1,975
====== ======== ======
</TABLE>
F-23
<PAGE>
MEDICA SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
MAY 1, 1994 (INCEPTION) TO DECEMBER 31, 1994
NOTE E--CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
The Company's business activities are primarily with customers located
within the state of Texas. During 1996, four customers accounted for
approximately 96% of revenues. One of the customers, American Medical Finance
("American Medical Finance"), accounted for 22% of the revenues for 1996. The
remaining three customers accounted for 39%, 22% and 13%, respectively. American
Medical Finance is an affiliate of ANC (See Note G). At December 31, 1996, one
customer comprised approximately 43% of trade accounts receivable. The Company
has recorded an allowance of $24,000 related to this receivable. A second
customer, American Medical Finance, comprised approximately 29% of trade
accounts receivable. Management evaluates accounts receivable balances on an
on-going basis and provides allowances as necessary for amounts estimated to
eventually become uncollectible. In the event of complete non- performance of
accounts receivable, the maximum exposure to the Company is the recorded amount
shown on the balance sheet.
NOTE F--COMMITMENT
The Company entered into a lease for office space in November, 1996 which
expires in April, 1997. Minimum lease payments under this lease for 1997 total
$3,500.
NOTE G--SUBSEQUENT EVENTS
The Company was involved in litigation which was settled subsequent to
December 31, 1996. In terms of the settlement, the Company is obligated to pay
$50,000. This amount was accrued and has been reflected as legal settlement
expense for the year ended December 31, 1996.
On May 30, 1997, the Company was acquired by American Net Claims ("ANC") in
exchange for cash, notes and common stock of ANC.
F-24
<PAGE>
MEDICA SYSTEMS, INC.
BALANCE SHEET
MARCH 31, 1997
(UNAUDITED)
<TABLE>
<S> <C>
ASSETS
CURRENT ASSETS
Cash...................................................... $ 36,113
Accounts receivable, net of allowance of $30,000.......... 37,226
Deferred income taxes..................................... 4,063
--------
Total current assets.................................... 77,402
--------
FIXED ASSETS
Office equipment.......................................... 35,322
Software.................................................. 10,329
Accumulated depreciation and amortization................. (14,715)
--------
30,936
--------
OTHER ASSETS................................................ 507
--------
TOTAL ASSETS................................................ $108,845
========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable.......................................... $ 12,018
Accrued liabilities, including $1,300 due to
stockholder............................................. 57,010
Federal income taxes payable.............................. 1,208
--------
Total current liabilities............................... 70,236
--------
DEFERRED INCOME TAXES, NON-CURRENT.......................... 1,487
TOTAL LIABILITIES........................................... 71,723
--------
STOCKHOLDERS' EQUITY
Common stock--no par value; 1,000 shares authorized; 730
shares issued and outstanding........................... 33,595
Retained earnings......................................... 3,527
--------
TOTAL STOCKHOLDERS' EQUITY.................................. 37,122
--------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $108,845
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-25
<PAGE>
MEDICA SYSTEMS, INC.
STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1997
(UNAUDITED)
<TABLE>
<S> <C>
CONSULTING INCOME........................................... $106,507
--------
OPERATING EXPENSES
Bad debt provision........................................ 6,000
Claims processing......................................... 5,775
Depreciation and amortization............................. 2,128
Professional fees......................................... 11,530
Rents..................................................... 2,625
Salaries and payroll taxes................................ 62,206
Telephone................................................. 4,345
Travel.................................................... 1,771
Other..................................................... 3,817
--------
Total operating expense................................. 100,197
--------
NET INCOME BEFORE INCOME TAXES.............................. 6,310
INCOME TAX EXPENSE.......................................... (661)
--------
NET INCOME.................................................. $ 5,649
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE>
MEDICA SYSTEMS, INC.
STATEMENT OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
CASH FLOWS PROVIDED BY IN OPERATING ACTIVITIES
<S> <C>
Net income................................................ $ 5,649
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization........................... 2,128
Provision for bad debts................................. 6,000
Changes in assets and liabilities:
Accounts receivable................................. (11,010)
Prepaid expenses.................................... 4,388
Accounts payable.................................... 3,335
Accrued liabilities................................. 5,032
Federal income taxes payable........................ 197
Deferred income taxes............................... (547)
--------
Net cash provided by operating activities............. 15,172
CASH FLOWS USED IN INVESTING ACTIVITIES
Purchases of property and equipment....................... (2,105)
--------
Net cash used in investing activities................... (2,105)
NET INCREASE IN CASH........................................ 13,067
Cash--beginning balance................................... 23,046
--------
Cash--ending balance...................................... $ 36,113
========
Supplemental disclosure of income taxes paid................ $ 1,011
--------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE>
MEDICA SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 1997 (UNAUDITED)
NOTE A--INTERIM INFORMATION
Interim information is unaudited; however, in the opinion of the Company's
management, all adjustments necessary for a fair statement of interim results
have been included in accordance with generally accepted accounting principles.
All adjustments are of a normal recurring nature. The results for interim
periods are not necessarily indicative of results to be expected for the entire
year. These financial statements and notes should be read in conjunction with
the Company's annual financial statements and the notes thereto for the fiscal
year ended December 31, 1996.
NOTE B--SUBSEQUENT EVENT
On June 2, 1997, the Company was acquired by American Net Claims ("ANC") in
exchange for cash, notes and common stock of ANC.
F-28
