HEALTHCARE RECOVERIES INC, 10-Q, 2000-08-11

HEALTHCARE RECOVERIES INC
10-Q, 2000-08-11
HEALTH SERVICES

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 11, 2000
-----------------------------------------------------------------------------
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

------------------------

FORM 10-Q

(MARK ONE)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ________ TO ________

COMMISSION FILE NUMBER 0-22585

HEALTHCARE RECOVERIES, INC.
(Exact Name of Registrant as Specified in its Charter)

<TABLE>
<S> <C>
DELAWARE 61-1141758
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

1400 WATTERSON TOWER, LOUISVILLE, KENTUCKY 40218
(Address of Principal Executive Offices) (Zip Code)
</TABLE>

(502) 454-1340
(Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]

As of August 11, 2000, 10,583,236 shares of the Registrant's Common Stock,
$0.001 par value were outstanding.

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<PAGE> 2

HEALTHCARE RECOVERIES, INC.

FORM 10-Q
JUNE 30, 2000

INDEX

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Balance Sheets as of June 30, 2000 and December
31, 1999............................................... 1
Condensed Statements of Income for the three and six
months ended June 30, 2000 and 1999.................... 2
Condensed Statements of Cash Flows for the six months
ended June 30, 2000 and 1999........................... 3
Notes to Condensed Financial Statements................... 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 8
Item 3. Quantitative and Qualitative Disclosures About
Market Risk............................................... 14

PART II: OTHER INFORMATION
Item 1. Legal Proceedings................................... 15
Item 4. Submission of Matters to a Vote of Security
Holders................................................... 18
Item 6. Exhibits and Reports on Form 8-K.................... 19
Signatures.................................................. 20
</TABLE>

THIS FORM 10-Q AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY
HEALTHCARE RECOVERIES, INC. OR MEMBERS OF ITS MANAGEMENT TEAM CONTAIN STATEMENTS
WHICH MAY CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE
SECURITIES ACT OF 1933, AS AMENDED, AND THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED BY THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, 15 U.S.C.A.
SECTIONS 77Z-2 AND 78U-5 (SUPP. 1996). THOSE STATEMENTS INCLUDE STATEMENTS
REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF HEALTHCARE RECOVERIES,
INC. AND MEMBERS OF ITS MANAGEMENT TEAM, AS WELL AS THE ASSUMPTIONS ON WHICH
SUCH STATEMENTS ARE BASED. PROSPECTIVE INVESTORS ARE CAUTIONED THAT ANY SUCH
FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE
RISKS AND UNCERTAINTIES, AND THAT ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS
CURRENTLY KNOWN TO MANAGEMENT THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE IN FORWARD-LOOKING STATEMENTS ARE SET FORTH IN THE SAFE
HARBOR COMPLIANCE STATEMENT FOR FORWARD-LOOKING STATEMENTS INCLUDED AS EXHIBIT
99.1 TO THIS FORM 10-Q, AND ARE HEREBY INCORPORATED BY REFERENCE. HEALTHCARE
RECOVERIES, INC. UNDERTAKES NO OBLIGATION TO UPDATE OR REVISE FORWARD-LOOKING
STATEMENTS TO REFLECT CHANGED ASSUMPTIONS OR CIRCUMSTANCES, THE OCCURRENCE OF
UNANTICIPATED EVENTS OR CHANGES TO FUTURE OPERATING RESULTS OVER TIME.
<PAGE> 3

PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

HEALTHCARE RECOVERIES, INC.

CONDENSED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
-------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 3,007 $ 1,670
Restricted cash........................................... 22,235 26,121
Accounts receivable, less allowance for doubtful accounts
of $434 in 2000 and $380 in 1999........................ 7,780 6,870
Other current assets...................................... 1,013 1,319
-------- --------
Total current assets............................... 34,035 35,980
-------- --------
Property and equipment, at cost:
Buildings and land........................................ 4,001 5,482
Furniture and fixtures.................................... 3,233 3,095
Office equipment.......................................... 1,985 1,946
Computer equipment........................................ 12,765 11,253
Leasehold improvements.................................... 1,439 1,073
-------- --------
23,423 22,849
Accumulated depreciation and amortization................. (11,859) (10,002)
-------- --------
Property and equipment, net........................ 11,564 12,847
-------- --------
Cost in excess of net assets acquired, net................ 28,632 26,296
Identifiable intangibles, net............................. 5,215 5,496
Other assets.............................................. 1,480 1,274
-------- --------
Total assets....................................... $ 80,926 $ 81,893
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable.................................... $ 1,379 $ 1,914
Accrued expenses.......................................... 6,704 12,005
Funds due clients......................................... 12,890 13,178
Income taxes payable...................................... 775 1,018
-------- --------
Total current liabilities.......................... 21,748 28,115
Other liabilities........................................... 2,126 2,055
Long-term borrowings........................................ 16,000 11,000
-------- --------
Total liabilities.................................. 39,874 41,170
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value per share; 2,000 shares
authorized; no shares issued or outstanding............. -- --
Common stock, $.001 par value per share; 20,000 shares
authorized; 10,717 and 11,209 shares issued and
outstanding as of June 30, 2000 and December 31, 1999,
respectively............................................ 12 12
Capital in excess of par value............................ 22,595 22,541
Other..................................................... (883) (369)
Treasury stock at cost; 813 shares at June 30, 2000 and
305 shares at December 31, 1999......................... (3,006) (1,373)
Retained earnings......................................... 22,334 19,912
-------- --------
Total stockholders' equity......................... 41,052 40,723
-------- --------
Total liabilities and stockholders' equity......... $ 80,926 $ 81,893
======== ========
</TABLE>

The accompanying notes are an integral part of the condensed financial
statements.

1
<PAGE> 4

HEALTHCARE RECOVERIES, INC.

CONDENSED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2000 AND 1999
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -----------------
2000 1999 2000 1999
-------- -------- ------- -------
<S> <C> <C> <C> <C>
Claims revenues........................................... $15,950 $15,793 $32,515 $29,654
Cost of services.......................................... 7,644 7,991 16,108 14,987
------- ------- ------- -------
Gross profit.................................... 8,306 7,802 16,407 14,667
Support expenses.......................................... 4,414 4,091 8,955 7,691
Depreciation and amortization............................. 1,604 1,292 3,140 2,286
------- ------- ------- -------
Operating income................................ 2,288 2,419 4,312 4,690
Interest income........................................... 308 275 547 535
Interest expense.......................................... 387 277 629 419
Other -- Special Committee expenses....................... -- -- 90 --
------- ------- ------- -------
Income before income taxes...................... 2,209 2,417 4,140 4,806
Provision for income taxes................................ 917 1,002 1,718 1,994
------- ------- ------- -------
Net income...................................... $ 1,292 $ 1,415 $ 2,422 $ 2,812
======= ======= ======= =======
Earnings per common share (basic and diluted)............. $ 0.12 $ 0.13 $ 0.22 $ 0.25
======= ======= ======= =======
</TABLE>

The accompanying notes are an integral part of the condensed financial
statements.

2
<PAGE> 5

HEALTHCARE RECOVERIES, INC.

CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999
(IN THOUSANDS)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------
2000 1999
------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 2,422 $ 2,812
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 3,140 2,286
Deferred income taxes.................................. (2) 162
Other.................................................. 3 180
Changes in operating assets and liabilities:
Restricted cash...................................... 85 1,054
Accounts receivable.................................. (910) (248)
Other current assets................................. 951 138
Other assets......................................... (362) 179
Trade accounts payable............................... (1,165) 175
Accrued expenses..................................... (719) 115
Funds due clients.................................... (287) (956)
Income taxes payable................................. (243) (1,079)
Other liabilities.................................... 71 29
------- --------
Net cash provided by operating activities......... 2,984 4,847
------- --------
Cash flows from investing activities:
Acquisitions, net of cash acquired........................ (3,881) (44,599)
Disposals of property and equipment....................... 1,409 --
Purchases of property and equipment....................... (2,079) (2,253)
------- --------
Net cash used in investing activities............. (4,551) (46,852)
------- --------
Cash flows from financing activities:
Line of credit proceeds................................... 8,800 14,300
Line of credit repayments................................. (3,800) --
Repurchase of common stock................................ (1,633) (1,373)
Issuance of common stock.................................. 51 57
Other..................................................... (514) --
------- --------
Net cash provided by financing activities......... 2,904 12,984
------- --------
Net increase (decrease) in cash and cash equivalents........ 1,337 (29,021)
Cash and cash equivalents, beginning of period.............. 1,670 31,133
------- --------
Cash and cash equivalents, end of period.................... $ 3,007 $ 2,112
======= ========
</TABLE>

The accompanying notes are an integral part of the condensed financial
statements.

3
<PAGE> 6

HEALTHCARE RECOVERIES, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)

1. ORGANIZATION AND BASIS OF PRESENTATION

Healthcare Recoveries, Inc. (hereinafter referred to as the "Company" or
"HCRI"), a Delaware corporation, was incorporated on June 30, 1988. The Company
provides complete outsourcing of insurance subrogation and certain other medical
claims recovery and cost containment services to the private healthcare payor
industry. Its primary service is medical claims recovery, and its primary
product is subrogation recovery, which generally entails the identification,
investigation and recovery of accident-related medical benefits incurred by its
clients on behalf of their insureds, but for which other persons or entities
have primary responsibility. The Company's clients' rights to recover the value
of these medical benefits, arising by law or contract, are generally known as
the right of subrogation and paid from the proceeds of liability or workers'
compensation insurance. The Company's other medical claims recovery services
include hospital bill auditing, contract compliance review and cost management
consulting, coordination of benefits and overpayments recovery services.

The accompanying financial statements are presented in a condensed format
and consequently do not include all of the disclosures normally required by
generally accepted accounting principles or those normally made in the Company's
annual financial statements. Accordingly, for further information, the reader of
this Form 10-Q may wish to refer to the Company's audited financial statements
as of and for the year ended December 31, 1999, contained in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1999, filed
with the Securities and Exchange Commission on March 14, 2000.

The financial information has been prepared in accordance with the
Company's customary accounting practices and has not been audited. In the
opinion of management, the information presented reflects all adjustments
necessary for a fair presentation of interim results. All such adjustments are
of a normal and recurring nature. Certain financial statement amounts have been
reclassified in the prior year to conform to the current period presentation.

2. CONTINGENCIES

The Company is engaged in the business of identifying and recovering
subrogation and related claims of its clients, many of which arise in the
context of personal injury lawsuits. As such, the Company operates in a
litigation-intensive environment. The Company has been, from time to time, and
in the future expects to be, named as a party in litigation incidental to its
business operations. To date, the Company has not been involved in any
litigation which has had a material adverse effect upon the Company, but there
can be no assurance that pending litigation or future litigation will not have a
material adverse effect on the Company's business, results of operations or
financial condition.

3. CREDIT FACILITY

On May 15, 2000, the Company entered into a third amendment to its February
1, 1998 revolving credit facility with National City Bank of Kentucky and the
lenders named therein (the "Credit Facility"). The Company's obligations under
the Credit Facility are secured by substantially all of the Company's assets,
subject to certain permitted exceptions. Under the Amendment, the maturity date
was extended to April 30, 2002 from January 31, 2001, the maximum borrowing
capacity decreased to $40 million from $50 million, and certain other financial
terms were amended. Principal amounts outstanding under the Credit Facility bear
interest at a variable rate based on the Prime Rate or Eurodollar Rate, as
applicable, plus the pre-determined fixed margin. The Credit Facility contains
customary covenants and events of default including, but not limited to,
financial tests for interest coverage, net worth levels and leverage that may
limit the Company's ability to pay dividends. It also contains a material
adverse change clause. The Company does not expect changes in interest rates to
have a material effect on its financial position, results of operations or
financial condition in 2000. The Credit Facility was amended in May 1998 to
enable the Company to acquire entities
4
<PAGE> 7
HEALTHCARE RECOVERIES, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

3. CREDIT FACILITY -- (CONTINUED)
that do not maintain audited financial statements, in March 1999 to permit
borrowings from the Credit Facility for repurchasing up to $10 million of
outstanding Common Stock, and in June 2000, to increase to $10 million the
amounts that qualify under the basket arrangements relating to one of the Credit
Facility's financial covenants. As of June 30, 2000, $16 million was outstanding
under the Credit Facility.

4. STOCK REPURCHASE PLAN

HCRI's Board approved a stock repurchase plan on March 12, 1999 under which
the Company is authorized to repurchase, from time to time, up to $10 million of
HCRI Common Stock in the open market, at prices per share deemed favorable by
the Company. Shares may be repurchased using cash from operations and borrowed
funds and may continue until such time as the Company has repurchased $10
million of HCRI Common Stock or until it otherwise determines to terminate the
stock repurchase plan. During 1999, HCRI acquired 305,000 shares of its Common
Stock at an average price of $4.50 per share and during the second quarter of
2000, HCRI repurchased 508,400 shares of its Common Stock at an average price of
$3.21 per share. Subsequent to June 30, 2000, HCRI acquired an additional
147,000 shares of its Common Stock at an average price of $3.86 per share. All
of the reacquired shares of Common Stock is reflected as treasury stock on the
accompanying Condensed Balance Sheets (Unaudited).

5. RELATED PARTY TRANSACTION

On June 30, 2000, at the direction of the Board of Directors and in
accordance with terms authorized by it, the Company loaned to Patrick B.
McGinnis, the Chief Executive Officer of the Company, $500,000. Under these
terms, the $500,000 loan to Mr. McGinnis was combined with his existing debt to
the Company of $350,000 of principal and $36,520 of accrued interest; Mr.
McGinnis delivered to the Company his full recourse promissory note in the
amount of $886,520, bearing interest at a fixed rate of 6.62% per annum,
compounded annually (the "Amended Promissory Note"), and the Company cancelled
the old promissory note evidencing the prior debt. The Amended Promissory Note
provides for mandatory prepayments from certain of the proceeds received by Mr.
McGinnis from his sale of the Company's securities and any related transactions.

In addition, on June 30, 2000, pursuant to Board authorization and in
accordance with the terms of the Amended Promissory Note, the Company and Mr.
McGinnis entered into a deferred compensation agreement (the "Agreement"). Under
the Agreement, 50% of the amount otherwise payable to Mr. McGinnis under the
Company's Management Group Incentive Compensation Plan shall be deferred until
the Amended Promissory Note is paid in full, with such deferred compensation
then being paid in full to Mr. McGinnis within 30 days thereafter, and the
Company has full right of set-off against any deferred compensation under the
Agreement should Mr. McGinnis default under the Amended Promissory Note. At the
election of Mr. McGinnis, the payment of the deferred compensation, upon payment
of the Amended Promissory Note, may be extended for a period of not more than
ten years.

5
<PAGE> 8
HEALTHCARE RECOVERIES, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

6. EARNINGS PER COMMON SHARE

Reconciliations of the average number of common shares outstanding used in
the calculation of earnings per common share and earnings per common share
assuming dilution are as follows (dollars and shares in thousands, except per
share results):

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -----------------
2000 1999 2000 1999
-------- -------- ------- -------
<S> <C> <C> <C> <C>
Weighted average number of common shares
outstanding..................................... 10,956 11,234 11,090 11,368
Add: Dilutive stock options....................... 34 1 40 51
------- ------- ------- -------
Number of common shares outstanding (diluted)..... 10,990 11,235 11,130 11,419
======= ======= ======= =======
Net earnings for earnings per common share (basic
and diluted).................................... $ 1,292 $ 1,415 $ 2,422 $ 2,812
======= ======= ======= =======
Earnings per common share:
Basic........................................... $ 0.12 $ 0.13 $ 0.22 $ 0.25
======= ======= ======= =======
Diluted......................................... $ 0.12 $ 0.13 $ 0.22 $ 0.25
======= ======= ======= =======
</TABLE>

Basic earnings per common share were computed based on the weighted-average
number of shares outstanding during the period. The dilutive effect of stock
options was calculated using the treasury stock method. Options to purchase
1,542,975 and 1,480,525 shares for the three and six month periods ended June
30, 2000, respectively, and 1,540,194 and 1,160,580 shares for the comparable
periods in 1999, respectively, were not included in the computation of diluted
earnings per common share because the exercise prices of these options were
greater than the average market price of the common shares during the respective
periods.

7. ACQUISITIONS

On January 25, 1999, HCRI acquired the assets and certain liabilities of
Subro-Audit, Inc., a Wisconsin corporation ("SAI"), and a related entity,
O'Donnell Leasing Co., LLP, a Wisconsin limited liability partnership ("ODL"
and, together with SAI, the "Subro Audit Acquisition"), for approximately $24.4
million, using available unrestricted cash. HCRI estimates that it may pay up to
$7.0 million through January 2001, pursuant to an earn-out arrangement, of which
$2.8 million was paid on May 18, 2000. Approximately $4.8 and $8.5 million was
held in escrow for the potential earn-out and was included in restricted cash at
June 30, 2000 and December 31, 1999, respectively. SAI is based in Wisconsin and
provides subrogation recovery services with respect to an installed base of
lives, which are covered by insurers, HMOs and employer-funded plans, throughout
the United States. The Subro Audit Acquisition was accounted for using the
purchase method of accounting.

On February 15, 1999, HCRI acquired the assets and certain liabilities of
MedCap Medical Cost Management, Inc., a California corporation ("MedCap"), for
approximately $10 million, using available unrestricted cash and borrowed funds
(the "MedCap Acquisition" and, together with the Subro Audit Acquisition, the
"Acquisitions"). HCRI paid approximately $4.5 million on February 15, 2000
pursuant to an amendment to the original earn-out agreement. Pursuant to the
same amendment, through January 15, 2001, HCRI may pay up to 50% of the fees
collected in relation to certain negotiated contracts, less associated expenses,
as an additional earnout. To date, the amount paid in relation to the fees
collected on those contracts approximates $282,000. MedCap provides a variety of
medical cost management services to health insurers and HMOs, primarily in
California. These services include hospital bill auditing, contract compliance
review, identification of certain other payments, and cost management consulting
services. The MedCap Acquisition was accounted for using the purchase method of
accounting.

6
<PAGE> 9
HEALTHCARE RECOVERIES, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

7. ACQUISITIONS -- (CONTINUED)
If the Acquisitions had taken place on January 1, 1999, approximate claims
revenues, net income and earnings per share for the quarter ended June 30, 1999
would have been $15.8 million, $1.4 million and $0.13, respectively, and
approximate claims revenues, net income and earnings per share for the six
months ended June 30, 1999 would have been $31.1 million, $2.7 million and
$0.24, respectively. The cost in excess of net tangible and identifiable
intangible assets acquired, allocated and recorded in connection with the
Acquisitions was approximately $30.5 million and is being amortized over an 18
to 20-year period. These results may not necessarily reflect future results of
operations or what the results of operations would have been had the
Acquisitions actually been consummated at the beginning of 1999.

7
<PAGE> 10

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW OF COMPANY

The Company's primary business is to provide medical claims recovery and
cost containment services to the private healthcare payor industry. Its primary
service is subrogation recovery, which generally entails the complete
outsourcing of the identification, investigation and recovery of
accident-related medical benefits incurred by its clients on behalf of their
insureds, but for which other persons or entities have primary responsibility.
The rights of HCRI's clients to recover the value of these medical benefits,
arising by law or contract, are known generally as the right of subrogation and
are generally paid from the proceeds of liability or workers' compensation
insurance. The Company's other medical cost containment services include
hospital bill auditing, contract compliance review, cost management consulting,
coordination of benefits and overpayment recovery services. HCRI offers its
services on a nationwide basis to health maintenance organizations, indemnity
health insurers, self-funded employee health plans, and companies that provide
claims administration services to self-funded plans (referred to as "third-party
administrators"). The Company had 53.6 million lives under contract from its
clientele at June 30, 2000.

ACQUISITIONS

On January 25, 1999, HCRI acquired the assets and certain liabilities of
Subro-Audit (which consisted of SAI and ODL), for approximately $24.4 million,
using available unrestricted cash. HCRI estimates that it may pay up to $7.0
million through January 2001, pursuant to an earn-out arrangement, of which $2.8
million was paid on May 18, 2000. Approximately $4.8 and $8.5 million was held
in escrow for the potential earn-out and was included in restricted cash at June
30, 2000 and December 31, 1999, respectively. SAI is based in Wisconsin and
provides subrogation recovery services with respect to an installed base of
lives, which are covered by insurers, HMOs and employer-funded plans, throughout
the United States. The Subro Audit Acquisition was accounted for using the
purchase method of accounting.

On February 15, 1999, HCRI acquired the assets and certain liabilities of
MedCap for approximately $10 million, using available unrestricted cash and
borrowed funds. The Company paid approximately $4.5 million on February 15, 2000
pursuant to an amendment to the original earn-out agreement. Pursuant to the
same amendment, through January 15, 2001, HCRI may pay up to 50% of the fees
collected in relation to certain negotiated contracts, less associated expenses,
as an additional earnout. To date, the amount paid in relation to the fees
collected on those contracts approximates $282,000. MedCap provides a variety of
medical cost management services to health insurers and HMOs, primarily in
California. These services include hospital bill auditing, contract compliance
review, identification of certain other payments, and cost management consulting
services. The MedCap Acquisition was accounted for using the purchase method of
accounting.

OVERVIEW OF OPERATIONS

For a typical new client, it takes up to six months from the contract
signing (when the lives are "sold") to complete the construction of electronic
data interfaces necessary for the Company to begin providing service. At this
point, the client is considered "installed". During the installation period, the
Company must also hire and train quality staff necessary to provide contractual
services. After installation, HCRI receives files and data from the client from
which it creates an inventory of backlog.

"Backlog" is the total dollar amount of potentially recoverable claims that
the Company is pursuing or auditing on behalf of its clients at a given point in
time. These claims are gross figures, prior to estimates of claim settlements
and rejections. Backlog increases when the Company opens new files of
potentially recoverable claims and decreases when files are recovered and closed
or, after further investigation, determined to be nonrecoverable. Backlog for a
client will range from newly identified potential recoveries to potential
recoveries that are in the late stages of the recovery process. Historically,
recoveries (the amount actually recovered for the Company's clients prior to the
Company's fee) have been produced from backlog in a generally predictable cycle.
Any group of potential recoveries, sufficiently large in number to display
statistically significant characteristics and that originates from a defined
time period, tends to produce recovery results that are comparable to other
groups having similar characteristics.

8
<PAGE> 11

OVERVIEW OF OPERATIONS -- (CONTINUED)
For the most part, the Company is paid contingency fees from the amount of
claims recoveries it makes from backlog or recoveries it identifies through
other cost containment and related recovery services on behalf of its clients.
The Company's revenues are a function of recoveries and effective fee rates.
Effective fee rates vary depending on the mix between services provided and
client fee schedules. The fee schedules for each client are separately
negotiated and reflect the Company's standard fee rates, the services to be
provided and the anticipated volume of services. The Company grants volume
discounts and, for its recovery services, negotiates a lower fee when it assumes
backlog from a client because the client will have already completed some of the
recovery work. Because the Company records expenses as costs are incurred and
records revenues only when a file is settled, there is a lag between the
recording of expenses and related revenue recognition.

The Company's expenses are determined primarily by the number of employees
directly engaged in recovery activities ("cost of services") and by the number
of employees engaged in a variety of support activities ("support expenses").
Recovery personnel must be hired and trained in advance of the realization of
recoveries and revenues. The number of employees accounted for in support
expenses generally grows less rapidly than revenue due to economies of scale.

RESULTS OF OPERATIONS

The following tables present certain key operating indicators and results
of operations data for the Company for the periods indicated:

KEY OPERATING INDICATORS
(IN MILLIONS, EXCEPT FOR PERCENTAGES AND EMPLOYEES)

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Cumulative lives sold, beginning of period...... 54.7 59.4 55.6 40.5
Lives from acquisitions....................... -- -- -- 18.6
Lives from existing client loss, net.......... (1.6) (0.6) (2.8)(1) (1.8)(1)
Lives added from new contracts with existing
clients.................................... -- 0.2 -- 0.2
Lives added from contracts with new clients... 0.5 0.3 0.8 1.8
-------- -------- -------- --------
Cumulative lives sold, end of period............ 53.6 59.3 53.6 59.3
======== ======== ======== ========
Lives installed................................. 50.8 53.5 50.8 53.5
Backlog (2)..................................... $1,148.3 $1,053.6 $1,148.3 $1,053.6
Claims recoveries............................... $ 59.1 $ 57.9 $ 120.7 $ 109.1
Throughput(3)................................... 5.1% 5.5% 10.8% 10.2%
Effective fee rate.............................. 27.0% 27.3% 26.9% 27.2%
Employees
Direct operations............................. 549 574 549 574
Support....................................... 157 140 157 140
-------- -------- -------- --------
Total employees....................... 706 714 706 714
======== ======== ======== ========
</TABLE>

---------------

(1) The June 30, 2000 decrease includes approximately 1.9 million lives
associated with clients that were acquired by non-clients. The June 30, 1999
decrease includes the loss of 900,000 lives from Blue Shield of California,
a former client that terminated its services with the Company.
(2) Backlog is the total dollar amount of potentially recoverable claims that
the Company is pursuing or auditing on behalf of its clients at a given
point in time.
(3) Throughput equals claims recoveries for the period divided by the average of
backlog at the beginning and end of the period.

9
<PAGE> 12

RESULTS OF OPERATIONS -- (CONTINUED)
STATEMENTS OF INCOME AS A PERCENTAGE OF REVENUES

<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
-------------- --------------
2000 1999 2000 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
Claims revenues........................................... 100.0% 100.0% 100.0% 100.0%
Cost of services.......................................... 47.9 50.6 49.5 50.5
Support expenses.......................................... 27.7 25.9 27.5 25.9
Depreciation and amortization............................. 10.1 8.2 9.7 7.7
Operating income.......................................... 14.3 15.3 13.3 15.8
Income before income taxes................................ 13.8 15.3 12.7 16.2
Net income................................................ 8.1 9.0 7.4 9.5
</TABLE>

Three and six months ended June 30, 2000 compared to three and six months
ended June 30, 1999

Claims Revenues. Total claims revenues for the quarter ended June 30, 2000
increased 1% to $16.0 million from $15.8 million in the same quarter of 1999,
and for the six month period ended June 30, 2000 increased 9% to $32.5 million
as compared with $29.7 million in the same period of 1999. Claims recoveries for
the quarter ended June 30, 2000 increased 2% to $59.1 million from $57.9 million
in the same quarter of 1999 and for the six months ended June 30, 2000 increased
11% to $120.7 million as compared to $109.1 million in the same period of 1999.
This growth in claims recoveries and claims revenues for the six month period
ended June 30, 2000 as compared to 1999 occurred primarily because of the
Acquisitions.

The effective fee rate for the quarter ended June 30, 2000 decreased to
27.0% from 27.3% in the same quarter of 1999 and decreased to 26.9% for the six
month period ended June 30, 2000 as compared with 27.2% in the same period of
1999, primarily because of the Acquisitions. At the time of the closing on the
Acquisitions, the effective fee rates of both MedCap and SAI were lower than
that of the Company, which caused a decline in the overall effective fee rate,
post-Acquisitions. Furthermore, this decline is magnified by the comparison of
the six month period ended June 30, 2000 that includes the financial results of
the Acquisitions for the full period, with the period ended June 30, 1999 that
includes only the financial results from the respective dates of closings on the
Acquisitions.

Backlog of $1,148.3 at June 30, 2000 increased by $94.7 million, or 9%,
compared to June 30, 1999 primarily because of backlog added by the
Acquisitions. The Company had a throughput rate of approximately 5.1% and 5.5%
of average backlog during the second quarter of 2000 and 1999, respectively. The
decrease in throughput from the quarter ended June 30, 1999 is primarily due to
the fact that average subrogation backlog during the 2000 quarter increased 10%
because of an increase in hospital bill audit backlog, while related recoveries
decreased 1% because of lower productivity levels at SAI and lower than expected
production from a unit specializing in larger files. Although throughput for the
2000 quarter decreased from the comparable prior year's quarter, throughput for
the six month period ended June 30, 2000 increased from 10.2% for the comparable
period of 1999 to 10.8%, chiefly because of higher hospital bill audit
throughput. Lives installed decreased 2.7 million from 53.5 million at June 30,
1999 to 50.8 million at June 30, 2000 because of the previously announced
termination by CIGNA of its contract for prospective subrogation services, and
because of the lives lost relating to clients being acquired by non-clients.

Cost of Services. Cost of services decreased 5% for quarter ended June 30,
2000 to $7.6 million, from $8.0 million for the comparable period in 1999 and
was $16.1 million for the six months ended June 30, 2000, an increase of 7% from
$15.0 million for the same period in 1999. The increase for the six month period
reflected the inclusion of a full six months of cost of services for the
Acquisitions in 2000. As a percentage of claims revenues, cost of services
decreased to 48% for the quarter ended June 30, 2000 compared to 51% for the
prior year quarter. For the six months ended June 30, 2000 cost of services as a
percentage of claims revenues decreased to 50% from 51% in 1999. The decrease in
cost of services as a percentage of claims revenues for the comparable quarters
and the six month periods resulted from a reduction in the growth rates

10
<PAGE> 13

RESULTS OF OPERATIONS -- (CONTINUED)
of cost of services. The gross margin expansion reflects certain productivity
enhancements instituted earlier in the year.

Support Expenses. Support expenses increased 7% to $4.4 million for the
quarter ended June 30, 2000 from $4.1 million for the comparable quarter in 1999
and was $9.0 million for the six month period ended June 30, 2000, an increase
of 17% from $7.7 million for the same period in 1999. The increases were due to
hiring additional systems and other staff to support the planned growth and
development of new operations. Support expenses increased as a percentage of
claims revenues from 26% for the six month period ended June 30, 1999 to 28% for
the same period in 2000. The increase in support expenses as a percentage of
claims revenues resulted primarily from expenses incurred in the development of
new operations. Support costs typically do not vary in proportion to revenues.

Depreciation and Amortization. Depreciation and amortization expenses
increased 23% to $1.6 million for the quarter ended June 30, 2000 from $1.3
million for the same period in 1999, and increased 35% to $3.1 million for the
six months ended June 30, 2000 from $2.3 million for the comparable period in
1999. The increase in depreciation expense was attributable to the purchased
property and equipment related to the Acquisitions and system upgrades. The
increase in amortization expense was attributable to the addition of intangible
assets acquired in the Acquisitions.

Interest Expense. Interest expense totaled $387,000 and $277,000 for the
quarter ended June 30, 2000 and 1999, respectively, and $629,000 and $419,000
for the six months ended June 30, 2000 and 1999, respectively. The increase in
interest expense for the quarter and six months ended June 30, 2000, as compared
with the respective periods in 1999, is due to an increase in borrowed funds
relating to the stock repurchase program and the earnout payment with respect to
MedCap and higher applicable interest rates during 2000.

Other -- Special Committee Expenses. In August 1999, HCRI's Board of
Directors appointed a Special Committee to evaluate strategic alternatives
available to the Company, including its possible sale. During the first quarter
of 2000, the Company incurred $90,000 of expenses related to the work of the
committee. In March 2000, the Special Committee ceased seeking a buyer for the
Company and its efforts to enhance shareholder value were assumed by the full
Board of Directors.

Tax. Provision for income taxes was approximately 41.5% of pre-tax income
for the three and six months ended June 30, 2000 and 1999. The effective tax
rate exceeded the Federal statutory tax rate as a consequence of state and local
taxes and non-deductible expenses.

Net Income. Net income for the quarter ended June 30, 2000 decreased $0.1
million, or 7%, to $1.3 million or $0.12 per diluted common share, from $1.4
million or $0.13 per diluted common share for the comparable period in 1999, and
for the six months ended June 30, 2000 decreased $0.4 million, or 14%, to $2.4
million, or $0.22 per diluted common share, from $2.8 million, or $0.25 per
diluted common share for the comparable period in 1999. The primary factors
offsetting the increases in claims revenues between the comparable three and six
month periods, and contributing to the decline in earnings for the six months
ended June 30, 2000, were support, interest and amortization expenses related to
the Acquisitions.

11
<PAGE> 14

LIQUIDITY AND CAPITAL RESOURCES

The Company's statements of cash flows for the six months ended June 30,
2000 and 1999 are summarized below (in thousands):

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------
2000 1999
------- --------
(IN THOUSANDS)
<S> <C> <C>
Net cash provided by operating activities................... $ 2,984 $ 4,847
Net cash used in investing activities....................... (4,551) (46,852)
Net cash provided by financing activities................... 2,904 12,984
------- --------
Net increase (decrease) in cash and cash equivalents........ $ 1,337 $(29,021)
======= ========
</TABLE>

The Company had working capital of $12.3 million at June 30, 2000,
including cash and cash equivalents of $3.0 million, compared with working
capital of $7.9 million at December 31, 1999. The primary reason for the
increase was the reduction in accrued expenses by the payment of the MedCap
earnout, which was accrued as of December 31, 1999 and an increase in cash and
cash equivalents.

Net cash provided by operating activities was $3.0 million, a decrease of
$1.9 million for the six months ended June 30, 2000, compared to the same period
in 1999, primarily as a result of the timing of recurring cash receipts and
disbursements related to accounts receivables, accrued expenses and claims
recoveries.

Net cash used in investing activities includes $4.8 million paid under the
earnout agreements related to the Acquisitions. Purchases of property and
equipment for the six months ended June 30, 2000 were approximately $2.1
million. Disposals of property and equipment of $1.4 million included the sale
of a building owned in Atlanta, Georgia. Throughout 2000, excluding any future
acquisitions, the Company anticipates capital requirements of $3.8 million,
which reflects a lower estimate of capital expenditures in the current year.

Net cash provided by financing activities for the six months ended June 30,
2000 reflects $5.0 million in net cash borrowings from the Company's credit
facility, as discussed below.

At June 30, 2000 and December 31, 1999, the Company reported on its balance
sheets, as a current asset, restricted cash of $22.2 million and $26.1 million,
respectively. Restricted cash at June 30, 2000 and December 31, 1999 represented
claims recoveries effected by HCRI for its clients and also included an escrowed
amount of $4.8 million and $8.5 million, respectively, for a potential earn-out
in connection with the Subro-Audit Acquisition. At June 30, 2000 and December
31, 1999, HCRI reported on its balance sheets, as a current liability, funds due
clients of $12.9 million and $13.2 million, respectively, representing claims
recoveries to be distributed to clients, net of the fee earned on such
recoveries.

12
<PAGE> 15

LIQUIDITY AND CAPITAL RESOURCES -- (CONTINUED)
The Company believes that its available cash resources, together with the
borrowings available under the Credit Facility, will be sufficient to meet its
2000 operating requirements and internal development initiatives.

EXTERNAL FACTORS

The business of recovering subrogation and other claims for healthcare
payors is subject to a wide variety of external factors. Prominent among these
are factors that would materially change the healthcare payment, fault-based
liability or workers' compensation systems. Examples of these factors include,
but are not limited to, 1) the non-availability of recovery from such sources as
property and casualty and workers' compensation coverages, 2) law changes that
limit the use of or access to claims and medical records, or 3) the ability of
healthcare payors to recover related claims and audit medical records. Because
the Company's profitability depends in large measure upon obtaining and using
claims data and medical records, the non-availability or decrease in their
availability could have a material adverse effect on the Company.

Moreover, because the Company's revenues are derived from the recovery of
the costs of medical treatment, material changes in such costs will tend to
affect the Company's backlog or its rate of backlog growth, as well as its
revenue or its rate of revenue growth. The healthcare industry, and particularly
the business of healthcare payors, is subject to various external factors that
may have the effect of significantly altering the costs of healthcare and the
environment for the sale or delivery of medical claims recovery and cost
containment services. The Company is unable to predict which of these factors,
if any, could have a potentially material impact on healthcare payors and
through them, the healthcare recovery and cost containment industry.

CONCENTRATION OF CLIENTS

The Company provides services to healthcare plans that as of June 30, 2000
covered approximately 53.6 million lives. HCRI's clients are national and
regional healthcare payors, large third-party administrators or self-insured
corporations. For each of the six month periods ended June 30, 2000 and 1999,
HCRI's largest client, UnitedHealth Group, generated 23% of HCRI's revenues. The
loss of this account could have a material adverse effect on the Company's
business, results of operations and financial condition. On June 30, 2000, HCRI
had backlog of $1,148.3 million. Claims revenues are earned under written
contracts with HCRI's clients that generally provide for contingency fees from
recoveries under a variety of pricing regimes. The pricing arrangements offered
by HCRI to its clients include a fixed fee percentage, a fee percentage that
declines as the number of lives covered by the client and subject to HCRI's
service increases and a fee percentage that varies with HCRI's recovery
performance.

HCRI does not obligate itself to deliver any specific result from the
performance of its services. Contracts with its customers are generally
terminable on 60 to 180 days' notice by either party, although in a few cases
the contracts extend over a period of years. Pursuant to the terms of its client
contracts, HCRI is generally entitled to continue to make recoveries for the
client and earn a fee on the backlog existing at the time of termination.

RECENT DEVELOPMENTS

Related Party Transaction

13
<PAGE> 16

RECENT DEVELOPMENTS -- (CONTINUED)
certain of the proceeds received by Mr. McGinnis from his sale of the Company's
securities and any related transactions.

Stock Repurchase Plan

HCRI's Board approved a stock repurchase plan on March 12, 1999 under which
the Company is authorized to repurchase, from time to time, up to $10 million of
HCRI Common Stock in the open market, at prices per share deemed favorable by
the Company. Shares may be repurchased using cash from operations and borrowed
funds and may continue until such time as the Company has repurchased $10
million of HCRI Common Stock or until it otherwise determines to terminate the
stock repurchase plan. During 1999, HCRI acquired 305,000 shares of its Common
Stock, at an average price of $4.50 per share, and during the second quarter of
2000, HCRI repurchased 508,400 shares of its Common Stock at an average price of
$3.21 per share. Subsequent to June 30, 2000, HCRI acquired an additional
147,000 shares of its Common Stock at an average price of $3.86 per share. All
of the reacquired shares of Common Stock is reflected as treasury stock on the
accompanying Condensed Balance Sheets (Unaudited).

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

An element of market risk exists for the Company from changes in interest
rates related to its amended Credit Facility, which matures April 30, 2002. The
impact on earnings and value of any debt on the Company's balance sheets are
subject to change as a result of movements in market rates and prices as the
Credit Facility is subject to variable interest rates. However, the Company does
not expect changes in interest rates to have a material effect on its financial
position, results of operations or cash flows in 2000. As of June 30, 2000, the
Company had $16.0 million outstanding under its Credit Facility, with interest
rates ranging from 8.8% to 9.0%. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources".

14
<PAGE> 17

PART II

OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On March 15, 1994, a class action complaint ("Complaint") was filed against
HCRI in the United States District Court for the Northern District of West
Virginia, Michael L. DeGarmo, et al. v. Healthcare Recoveries, Inc. The
plaintiffs assert that HCRI's subrogation recovery efforts on behalf of its
clients violate a number of state and federal laws, including the Fair Debt
Collection Practices Act and the Racketeering Influenced and Corrupt
Organizations Act ("RICO"). The Complaint alleges that HCRI engaged in
fraudulent or negligent practices on behalf of its clients by attempting to
recover, via subrogation, amounts in excess of the actual amounts paid for those
services and that HCRI pursued subrogation recoveries from individuals whose
health insurance plans did not specifically provide for subrogation. HCRI has
responded to these allegations by maintaining that the subrogation rights of its
clients provide for recovery of medical treatment at the "prevailing rates" or
"reasonable value" of those services and that instances in which recoveries were
made or sought against individuals without specific plan language occurred due
to either mistaken referrals from clients or reliance on equitable or common law
subrogation rights. On March 30, 1999, the court entered an order certifying a
class of all members of one HCRI client health plan located in Wheeling, West
Virginia (The Health Plan of the Upper Ohio Valley) who have been subject to
subrogation and/or reimbursement collection practices by HCRI. Plaintiffs, on
behalf of the class as certified, demand compensatory damages, punitive damages,
and treble damages under RICO, costs and reasonable attorneys' fees. The court
has ordered that all dispositive motions in the case be filed by late November
2000. Trial is scheduled to begin in March 2001.

On October 1, 1999, a First Amended Class Action Complaint ("Amended
Complaint") was filed against HCRI in the United States District Court for the
Southern District of Florida, in a putative class action brought by William
Conte and Aaron Gideon, individually and on behalf of all others similarly
situated. In that action, Conte v. Healthcare Recoveries, Inc., No. 99-10062,
plaintiffs assert that HCRI's subrogation recovery efforts on behalf of its
clients violate a number of state and federal laws, including the Fair Debt
Collection Practices Act and the Florida Consumer Collection Practices Act. The
Complaint also seeks a declaratory judgment that HCRI, as the subrogation agent
for various healthcare payors, is not entitled to assert and recover upon
subrogation or reimbursement liens it asserts on settlements obtained from third
party tortfeasors when the settlement is in an amount less than the amount
required to fully compensate (or "make whole") the injured party for all
elements of damage caused by the tortfeasor. Plaintiffs purport to represent a
class consisting of all participants or beneficiaries of ERISA plans nationwide
whose net recovery of damages through judgments, settlements or otherwise
against liable third parties has been reduced or potentially reduced by HCRI's
alleged assertion and/or recovery of unlawful subrogation/reimbursement rights
of its clients. Plaintiffs also seek compensatory and statutory damages,
exemplary and punitive damages, injunctive relief, prejudgment interest, costs
and attorneys' fees.

The original complaint in the Conte matter, filed in June 1999, asserted
similar claims on behalf of a putative class of participants or beneficiaries of
one client's health plans located in Florida, Alabama, and Georgia. In response
to HCRI's motion to dismiss that complaint, the plaintiffs filed the Amended
Complaint on behalf of a putative national class. On November 5, 1999, HCRI
filed a motion to dismiss the Amended Complaint. That motion, now fully briefed,
remains pending. The court has not yet addressed the question of whether to
certify the putative class. In early May, the plaintiffs filed a motion seeking
class certification. HCRI has filed a response in opposition to that motion.
Plaintiffs' reply is due in early September 2000.

On October 20, 1999, a class action complaint ("Baker Complaint") was filed
against HCRI and one HCRI client in the Circuit Court of Jefferson County
Alabama, Darrell DeWayne Baker v. Healthcare Recoveries, Inc., United Healthcare
of Alabama, and Fictitious Party Defendants A, B, C et al. On December 6, 1999,
the defendants removed the lawsuit to the United States District Court for the
Northern District of Alabama, Southern Division. On January 3, 2000, a First
Amended Complaint was filed, retaining all counts from the original complaint
and seeking an additional declaratory judgment that the health plan and

15
<PAGE> 18

HCRI have a right to recover through subrogation only the actual benefits paid
to medical providers on behalf of the class. The Baker Complaint, as amended,
asserts claims on behalf of two putative subclasses, both consisting of members
nationwide of the client health plan, who either: (1) allegedly paid inflated
subrogation claims due to alleged failure by the health plan or by HCRI to
disclose discounts in the health plan's payments to medical providers; or (2)
allegedly were denied coverage of certain claims by the health plan. The
plaintiffs assert claims against HCRI under a variety of theories including
unjust enrichment, breach of contract, breach of fiduciary duty and violations
of RICO. Plaintiffs demand, on behalf of the putative classes, compensatory
damages, punitive damages, treble damages under RICO, and reasonable attorneys'
fees. On January 27, 2000, the defendants filed a motion to dismiss the Amended
Complaint, which remains pending. The court has not yet addressed the question
of whether to certify the putative class.

On October 28, 1999, a class action Plaintiff's Original Petition
("Petition") was filed against HCRI and one HCRI client in the District Court
for the 150th Judicial District, Bexar County, Texas, Joseph R. Cajas, on behalf
of himself and all others similarly situated v. Prudential Health Care Plan,
Inc. and Healthcare Recoveries, Inc. The plaintiff asserts that HCRI's
subrogation recovery efforts on behalf of its client Prudential Health Care
Plan, Inc. ("Prudential") violated a number of common law duties, as well as the
Texas Insurance Code and the Texas Business and Commerce Code. The Petition
alleges that HCRI, as the subrogation agent for Prudential, made fraudulent
misrepresentations in the course of unlawfully pursuing subrogation and
reimbursement claims that plaintiffs assert are unenforceable because (1)
prepaid medical service plans may not exercise rights of subrogation and
reimbursement; (2) the subrogation and reimbursement claims asserted by the
Company are not supported by contract documents that provide enforceable
recovery rights and/or do not adequately describe the recovery rights; and (3)
the sums recovered pursuant to such claims unlawfully exceed the amount
Prudential paid for medical goods and services. HCRI was served with the
Petition in early November, and has answered, denying all allegations. The court
has not yet addressed the question of whether to certify the putative class.

In late 1999, the Cajas plaintiff's counsel filed two lawsuits in Texas and
South Carolina that raise issues similar to those in the Cajas lawsuit. On
December 7, 1999, a class action complaint ("Complaint") was filed against HCRI
and one HCRI client in the United States District Court for the Western District
of Texas, San Antonio Division, Timothy Patrick Franks, on behalf of himself and
similarly situated persons v. Prudential Health Care Plan, Inc. and Healthcare
Recoveries, Inc. The plaintiff asserts claims on behalf of members of ERISA
governed health plans. The Complaint alleges that HCRI's subrogation recovery
efforts on behalf of its client Prudential violated a number of common law
duties, as well as the terms of certain ERISA plan documents, RICO, the federal
Fair Debt Collection Practices Act, the Texas Insurance Code and the Texas
Business and Commerce Code. The Complaint alleges that HCRI, as the subrogation
agent for Prudential, made fraudulent misrepresentations in the course of
unlawfully pursuing subrogation and reimbursement claims that plaintiffs assert
are unenforceable because (1) prepaid medical service plans may not exercise
rights of subrogation and reimbursement; (2) the subrogation and reimbursement
claims asserted by the Company are not supported by contract documents that
provide enforceable recovery rights and/or do not adequately describe the
recovery rights; and (3) the sums recovered pursuant to such claims unlawfully
exceed the amount Prudential paid for medical goods and services. The Complaint
further alleges that HCRI unlawfully pursued subrogation and reimbursement
claims by (1) failing to pay pro rata attorney's fees to attorneys who
represented class members with respect to tort claims underlying the subrogation
and reimbursement claims; and (2) recovering subrogation and reimbursement
claims from class members who have not been fully compensated for their
injuries. Plaintiffs, on behalf of the class, demand compensatory damages,
punitive damages, and treble damages under RICO, costs and reasonable attorneys'
fees. In April 2000, the court permitted Franks to amend the Complaint (the
"Amended Complaint"), thus rendering moot a motion to dismiss which had been
filed by HCRI and Prudential. On May 2, 2000, HCRI and Prudential filed a motion
to dismiss the Amended Complaint. The motion to dismiss the Amended Complaint is
now pending before the court. The court has not yet addressed the question of
whether to certify the putative class.

On December 22, 1999, a class action Complaint was filed against HCRI and
one HCRI client in the Court of Common Pleas of Richland County, South Carolina,
Estalita Martin et al. vs. Companion Health Care Corp., and Healthcare
Recoveries, Inc. On January 21, 2000, defendant Companion Healthcare Corp.

16
<PAGE> 19

("CHC") filed an Answer and Counterclaim and plaintiff Martin filed a First
Amended Complaint ("Amended Complaint"). The Amended Complaint asserts that
HCRI's subrogation recovery efforts on behalf of its client CHC violated a
number of common law duties, as well as the South Carolina Unfair Trade
Practices Act. The Amended Complaint alleges that HCRI as the subrogation agent
for CHC, made fraudulent misrepresentations in the course of unlawfully pursuing
subrogation and reimbursement claims that plaintiffs assert are unenforceable
because (1) prepaid medical service plans may not exercise rights of subrogation
and reimbursement; (2) the subrogation and reimbursement claims asserted by the
Company are not supported by contract documents that provide enforceable
recovery rights and/or do not adequately describe the recovery rights; and (3)
the sums recovered pursuant to such claims unlawfully exceed the amount CHC was
entitled to collect for such medical goods and services. The Amended Complaint
further alleges that HCRI and CHC unlawfully pursued subrogation and
reimbursement claims by (1) failing to pay pro rata costs and attorney's fees to
attorneys who represented class members with respect to tort claims underlying
the subrogation and reimbursement claims; and (2) failing to include in
subrogation and reimbursement claims all applicable discounts that CHC received
for such medical goods and services. Plaintiffs, on behalf of the class, demand
compensatory damages, punitive damages, and treble damages, disgorgement of
unjust profits, costs, and prejudgment interest and attorneys' fees. HCRI was
served with the original Complaint in late December and is preparing a formal
response. The court has not yet addressed the question of whether to certify the
putative class.

The DeGarmo, Cajas, Franks, Baker and Martin lawsuits, or any one of them,
if successful, could prevent the Company from recovering the "reasonable value"
of medical treatment under discounted fee for service ("DFS"), capitation and
other payment arrangements. The DeGarmo, Conte, Cajas, Franks, Baker and Martin
lawsuits, or any one or more of them, if successful, could require the Company
to refund, on behalf of its clients, recoveries in a material number of cases.
In addition, an adverse outcome in any of the above referenced lawsuits could
impair materially HCRI's ability to assert subrogation or reimbursement claims
on behalf of its clients in the future.

In terms of the Company's business practices and the allegations underlying
the DeGarmo, Cajas, Franks, Baker and Martin cases, at the end of 1993 HCRI had
ceased the practice of recovering the "reasonable value" of medical treatment
provided by medical providers under DFS arrangements with such clients. From
that date, the Company's policy has been not to recover the "reasonable value"
of medical treatment in DFS arrangements. However, HCRI historically and
currently recovers the "reasonable value" of medical treatment provided under
capitation arrangements and other payment arrangements with medical providers on
behalf of those clients that compensate medical providers under these payment
mechanisms, to the extent that these benefits are related to treatment of the
injuries as to which clients have recovery rights. The Company believes that its
clients' contracts, including the contracts that provide for recovery under DFS,
capitation and other payment arrangements are enforceable under the laws
potentially applicable in these cases. As a result, and taking into account the
underlying facts in each of these cases, the Company believes it has meritorious
grounds to defend these lawsuits, it intends to defend the cases vigorously, and
it believes that the defense and ultimate resolution of the lawsuits should not
have a material adverse effect upon the business, results of operations or
financial condition of the Company. Nevertheless, if any of these lawsuits or
another lawsuit seeking relief under similar theories were to be successful, it
is likely that such resolution would have a material adverse effect on the
Company's business, results of operations and financial condition.

Management of the Company has observed that, in parallel with
widely-reported legislative concerns with the healthcare payment system, there
also has occurred an increase in litigation, actual and threatened, directed at
healthcare payors and related parties. In addition, certain attorneys who have
gained prominence in representing plaintiffs in recent actions against tobacco
companies have publicly stated their intentions to institute class action
lawsuits against healthcare payors, particularly those in the so-called "managed
care industry", and related parties including, specifically, the Company. As a
result of the foregoing, there can be no assurance that the Company will not be
subject to further class action litigation, that existing and/or future class
action litigation against the Company and its clients will not consume
significant management time and/or attention and that the cost of defending and
resolving such litigation will not be material.

17
<PAGE> 20

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company held its Annual Meeting of Stockholders on April 28, 2000. Of
the 11,225,188 shares of Common Stock outstanding as of the record date, March
13, 2000, and entitled to vote at this meeting, 9,370,521 were represented at
the meeting in person or by proxy. The following matters were voted upon:

(a) The following members were elected to the Board of Directors to hold
office for a three year term:

<TABLE>
<CAPTION>
NOMINEE SHARES VOTED FOR SHARES AGAINST TERM
------- ---------------- -------------- ----
<S> <C> <C> <C>
Patrick B. McGinnis................................ 9,280,671 89,850 2003
Jill L. Force...................................... 8,193,171 1,177,350 2003
</TABLE>

The Company's other directors continuing after the Annual Meeting are as
follows:
William C. Ballard
John H. Newman
Elaine J. Robinson
Chris B. Van Arsdel

(b) The ratification of the appointment of PricewaterhouseCoopers LLP as
independent public accountants of the Company to serve for 2000. The result of
the vote was 9,342,720 shares favor, 11,900 opposed and 15,901 abstained.
Accordingly, the appointment of PricewaterhouseCoopers LLP was ratified.

18
<PAGE> 21

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

The following list of Exhibits includes both exhibits submitted with this
Form 10-Q as filed with the Commission and those incorporated by reference to
other filings:

<TABLE>
<C> <C> <S>
2.1 -- Asset Purchase Agreement, dated as of December 4, 1998, by
and among the Registrant, MedCap Medical Cost Management,
Inc. and Marcia Deutsch (incorporated by reference to
Exhibit 2.1 of Registrant's Current Report on Form 8-K,
filed December 11, 1998, File No. 0-22585).
2.2 -- Amendment to Asset Purchase Agreement, dated as of December
8, 1999, by and among the Registrant, MedCap Medical Cost
Management, Inc. and Marcia Deutsch (incorporated by
reference to Exhibit 2.1 of Registrant's Current Report on
Form 8-K, filed December 20, 1999, File No. 0-22585).
2.3 -- Asset Purchase Agreement, dated as of January 3, 1999, by
and among the Registrant, Subro-Audit, Inc., O'Donnell
Leasing Co., LLP, Kevin O'Donnell and Leah Lampone
(incorporated by reference to Exhibit 2.1 of Registrant's
Current Report on Form 8-K, filed January 11, 1999, File No.
0-22585).
2.4 -- Amendment to Asset Purchase Agreement by and among the
Registrant, Subro-Audit, Inc., O'Donnell Leasing Co., LLP,
Kevin O'Donnell and Leah Lampone, dated as of January 25,
1999 (incorporated by reference to Exhibit 2.2 of
Registrant's Current Report on Form 8-K, filed February 3,
1999, File No. 0-22585).
3.1 -- Amended and Restated Certificate of Incorporation of the
Registrant (incorporated by reference to Exhibit 3.1 of
Registrant's Amendment No. 2 to Registration Statement on
Form S-1, File No. 333-23287).
3.2 -- Amended and Restated Bylaws of the Registrant (incorporated
by reference to Exhibit 3.2 of Registrant's Amendment No. 2
to Registration Statement on Form S-1, File No. 333-23287).
4.1 -- Specimen Common Stock Certificate (incorporated by reference
to Exhibit 4.1 of Registrant's Amendment No. 1 to
Registration Statement on Form S-1, File No. 333-23287).
4.2 -- Rights Agreement, dated February 12, 1999, between the
Registrant and National City Bank of Kentucky, as Rights
Agent, which includes as Exhibit A the Form of Certificate
of Designations of the Preferred Stock, as Exhibit B the
Form of Right Certificate and as Exhibit C the Summary of
Rights to Purchase Preferred Stock (incorporated by
reference to Exhibit 4.1 of Registrant's Form 8-A, filed
February 16, 1999, File No. 0-22585).
10.1 -- Amendment No. 3, dated as of May 15, 2000, to the Credit
Agreement, by and among the Registrant, the Lending
Institutions named therein and National City Bank of
Kentucky.
10.2 -- Amendment No. 4, dated as of June 23, 2000, to the Credit
Agreement, by and among the Registrant, the Lending
Institutions named therein and National City Bank of
Kentucky.
10.3 -- Amended and Restated Promissory Note Payable, dated June 30,
2000, to the Registrant from Patrick B. McGinnis.
10.4 -- Deferred Compensation Agreement, dated June 30, 2000, by and
between the Registrant and Patrick B. McGinnis.
27.1 -- Financial Data Schedule (for SEC use only).
99.1 -- Healthcare Recoveries, Inc. Private Securities Litigation
Reform Act of 1995 Safe Harbor Compliance Statement for
Forward-Looking Statements (incorporated by reference to
Exhibit 99.1 of Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 1999, filed March 14,
2000, File No. 0-22585).
</TABLE>

(b) Reports on Form 8-K

The Company did not file any Current Reports on Form 8-K during the quarter
ended June 30, 2000.

19
<PAGE> 22

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

HEALTHCARE RECOVERIES, INC.

Date: August 11, 2000
/s/ PATRICK B. MCGINNIS
--------------------------------------
Patrick B. McGinnis
Chairman, President and
Chief Executive Officer

Date: August 11, 2000 /s/ DOUGLAS R. SHARPS
--------------------------------------
Douglas R. Sharps
Executive Vice President and Chief
Financial Officer
Principal Financial and Accounting
Officer