TROVER SOLUTIONS INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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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, 2002

OR

[ ] 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

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TROVER SOLUTIONS, INC.
(Exact Name of Registrant as Specified in its Charter)

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

1600 WATTERSON TOWER, 40218
LOUISVILLE, KENTUCKY (Zip Code)
(Address of Principal Executive Offices)

(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
(502) 454-1340

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 13, 2002, 9,181,907 shares of the Registrant's Common Stock,
$0.001 par value were outstanding.
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TROVER SOLUTIONS, INC.

FORM 10-Q
JUNE 30, 2002

INDEX

THIS FORM 10-Q AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY
TROVER SOLUTIONS, INC. OR MEMBERS OF ITS MANAGEMENT TEAM CONTAIN STATEMENTS
WHICH MAY CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE
SECURITIES ACT OF 1933 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 TROVER SOLUTIONS, 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 THE TROVER
SOLUTIONS, INC. ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER
31, 2001, AS AMENDED BY EXHIBIT 99.2 TO THE TROVER SOLUTIONS, INC. QUARTERLY
REPORT ON FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2002, AND ARE HEREBY
INCORPORATED HEREIN BY REFERENCE. TROVER SOLUTIONS, 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.

i

PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

TROVER SOLUTIONS, INC.

CONDENSED BALANCE SHEETS

(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)

The accompanying notes are an integral part of the condensed financial
statements.
1

TROVER SOLUTIONS, INC.

CONDENSED STATEMENTS OF INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)

The accompanying notes are an integral part of the condensed financial
statements.
2

TROVER SOLUTIONS, INC.

CONDENSED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS)

The accompanying notes are an integral part of the condensed financial
statements.
3

TROVER SOLUTIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)

1. ORGANIZATION AND BASIS OF PRESENTATION

Trover Solutions, Inc. (hereinafter referred to as the "Company"), a
Delaware corporation, was incorporated on June 30, 1988. The Company is a
provider of outsourcing of subrogation and certain other claims recovery and
cost containment services to the private healthcare payor industry and the
property and casualty insurance industry. Its primary business is medical claims
recovery, and its primary product is subrogation recovery, 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 are generally
paid from the proceeds of liability or workers' compensation insurance. The
Company's other medical claims recovery services include (1) the auditing of the
bills of medical providers, particularly hospitals, for accuracy, correctness
and compliance with contract terms ("provider bill audit"), and (2) the recovery
of overpayments attributable to duplicate payments, failures to coordinate
benefits and similar errors in payment.

The accompanying financial statements are presented in a condensed format
and consequently do not include all of the disclosures normally required by
accounting principles generally accepted in the United States of America 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,
2001, contained in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2001, filed with the Securities and Exchange Commission on
March 27, 2002.

The financial information has been prepared in accordance with the
Company's customary accounting practices and is unaudited. In the opinion of
management of the Company, 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 period to conform to the current period presentation.

2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 141 (FAS 141), "Business
Combinations", which provides that all business combinations should be accounted
for using the purchase method of accounting and establishes criteria for the
initial recognition and measurement of goodwill and other intangible assets
recorded in connection with a business combination. The provisions of FAS 141
apply to all business combinations initiated after June 30, 2001 and to all
business combinations accounted for by the purchase method that are completed
after June 30, 2001. The Company will apply the provisions of FAS 141 to any
future business combinations.

Also, in June 2001, the FASB issued Statement of Financial Accounting
Standards No. 142 (FAS 142), "Goodwill and Other Intangible Assets", which
establishes the accounting for goodwill and other intangible assets following
their recognition. FAS 142 applies to all goodwill and other intangible assets
whether acquired singly, as part of a group, or in a business combination. FAS
142 provides that goodwill should not be amortized but should be tested for
impairment annually using a fair-value based approach. In addition, FAS 142
provides that other intangible assets other than goodwill should be amortized
over their useful lives and reviewed for impairment. FAS 142 was effective for
the Company beginning on January 1, 2002. During the three months ended June 30,
2002, the Company completed the transitional impairment test under FAS 142 for
all goodwill recorded as of January 1, 2002. See Note 12 "Cost in Excess of Net
Assets Acquired and Other Intangible Assets".

4

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 143 (FAS 143), "Accounting for Asset Retirement Obligations". FAS 143 is
effective for fiscal years beginning after June 15, 2002, and provides
accounting requirements for asset retirement obligations associated with
tangible long-lived assets. The Company believes that the adoption of FAS 143
will not have a significant impact on its financial statements.

In October 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 (FAS 144), "Accounting for the Impairment or Disposal of
Long-Lived Assets". FAS 144 is effective for fiscal years beginning after
December 15, 2001. This statement supersedes FAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of",
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a business segment. FAS 144 establishes a
single accounting model, based on the framework established in FAS 121. The
adoption of FAS 144 had no significant impact on the Company's financial
position or results of operations.

In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (FAS 146), "Accounting for Exit or Disposal Activities". FAS 146
addresses the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including costs related to
terminating a contract that is not a capital lease and termination benefits that
employees who are involuntarily terminated receive under the terms of a one-time
benefit arrangement that is not an ongoing benefit arrangement or an individual
deferred-compensation contract. FAS 146 supersedes Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)" and requires liabilities associated with exit and disposal
activities to be expensed as incurred. FAS 146 will be effective for exit or
disposal activities of the Company that are initiated after December 31, 2002.
The Company believes that the adoption of FAS 146 will not have a significant
impact on its financial statements.

3. 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.

4. CREDIT FACILITY

On November 1, 2001, the Company entered into a revolving credit facility
with National City Bank of Kentucky, Bank One Kentucky, N.A. and Fifth Third
Bank (the "Revolving Credit Facility"), replacing and terminating its existing
credit facility. The Company's obligations under the Revolving Credit Facility
are secured by substantially all of the Company's assets, subject to certain
permitted exceptions. The Revolving Credit Facility carries a maximum borrowing
capacity of $40 million and will mature October 31, 2004. Principal amounts
outstanding under the Revolving Credit Facility bear interest at a variable rate
based on the Prime Rate or Eurodollar Rate, as applicable, plus a pre-determined
fixed margin. At June 30, 2002, the interest rate was 3.59% based on the
one-month Eurodollar Rate. The Revolving Credit Facility contains customary
covenants and events of default including, but not limited to, financial tests
for interest coverage, net worth levels and leverage that may limit the
Company's ability to pay dividends. It also contains a material adverse change
clause. At June 30, 2002, $6.3 million was outstanding under the Revolving
Credit Facility.

5

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

5. STOCK REPURCHASE PLAN

The Company's Board of Directors authorized the repurchase of up to $20
million of the Company's Common Stock in the open market, including $10 million
authorized on May 10, 2002, at prices per share deemed favorable by the Company.
Shares may be repurchased using cash from operations and borrowed funds and may
continue until such time as the Company has repurchased $20 million of the
Company's Common Stock or until it otherwise determines to terminate the stock
repurchase plan. The Company repurchased 381,950 and 662,443 shares of its own
stock during the three and six months ended June 30, 2002, respectively, at an
average price of $5.26 and $5.39 per share, respectively. From inception of the
program through June 30, 2002, the total number of shares repurchased was
2,454,708 at a cost of $10.7 million, or an average cost of $4.35 per share.
Except for 10,000 shares previously repurchased but re-issued in connection with
an employee restricted stock award, all of the reacquired shares of Common Stock
through June 30, 2002 are reflected as treasury stock on the accompanying
Condensed Balance Sheets (Unaudited).

6. RELATED PARTY TRANSACTIONS

The Company has a contract for legal services with a professional service
corporation, Sharps & Associates, PSC, that is wholly owned by one of the
Company's officers. This arrangement exists solely for the benefit of the
Company and its purpose is to minimize the costs of legal services purchased by
the Company on behalf of its clients. Mr. Sharps receives no financial or other
personal benefit from his ownership of the firm. All payments to Sharps &
Associates are reviewed and approved by the Audit Committee of the Company's
Board of Directors. For the three and six months ended June 30, 2002,
approximately $822,000 and $1,656,000, respectively, was paid to this law firm
for such legal services, including all employees and expenses.

In May 1997, Patrick B. McGinnis, the Chairman and Chief Executive Officer
of the Company, borrowed from a commercial bank $500,000 to finance the payment
of income taxes related to the ordinary income deemed to have been received by
him in the form of 80,000 shares of Common Stock granted to him in connection
with the Company's initial public offering and $350,000 to finance the purchase
of 25,000 additional shares of Common Stock in the initial public offering.

At Mr. McGinnis' request, following conversations with his lender, on
February 12, 1999, the Board of Directors approved a loan in the amount of
$350,000 to Mr. McGinnis, in exchange for a full recourse promissory note in the
same amount from Mr. McGinnis. On June 30, 2000, at the direction of the Board
of Directors and in accordance with terms authorized by it, the Company loaned
Mr. McGinnis an additional $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 (the applicable Federal mid-term rate in effect
for tax purposes at the date of the note), 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. The promissory note and all
accrued interest are due and payable upon the earlier of January 1, 2005 or the
termination of Mr. McGinnis's employment with the Company. At June 30, 2002, the
promissory note of $886,520 and accrued interest of $118,127 was outstanding.

On June 30, 2000, pursuant to the Board of Directors' 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 is to 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. 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

6

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

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. At June 30, 2002, the amount of deferred compensation was
$72,354, with accrued interest of $5,098.

7. 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):

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
948,517 and 928,917 shares for the three and six months ended June 30, 2002,
respectively, and 1,355,158 and 1,411,533 shares for the comparable periods in
2001, respectively, were not included in the computation of diluted earnings per
common share because their effect would be anti-dilutive.

8. OTHER COMPREHENSIVE INCOME (LOSS)

Other comprehensive income (loss) for the three and six months ended June
30, 2002 and 2001 consists of the following (in thousands):

7

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

Accumulated other comprehensive (loss) income consists of the following:

9. INCOME TAXES

The Company accrued its income tax at its historical rate of 41.5% of
pretax income, net of a research and experimental tax credit of $72,500 and
$167,500 for the three and six months ended June 30, 2002, respectively,
resulting in an effective income tax rate of 38.7% and 38.4%, respectively.

10. DERIVATIVES

On November 6, 2001, the Company entered into an interest rate swap
contract to pay 3.66% and to receive the one-month LIBOR rate on a $4 million
notional amount of the Revolving Credit Facility. The Company uses derivative
financial instruments to manage the risk that changes in interest rates will
affect the amount of its future interest payments. Under the interest rate swap
contract, the Company agrees to pay an amount equal to a specified fixed rate of
interest times a notional principal amount, and to receive in return an amount
equal to a variable rate of interest times the same notional principal amount.
The notional amounts of the contract are not exchanged. No other cash payments
are made unless the contract is terminated prior to maturity, in which case the
amount paid or received in settlement is established by agreement at the time of
termination, and represents the net present value, at current rates of interest,
of the remaining obligations to exchange payments under the terms of the
contract. The interest rate swap contract was entered into with a major
financial institution in order to minimize counterparty credit risk. The
interest rate swap transaction qualifies for hedge accounting treatment and is
accounted for in accordance with FAS 133, "Accounting for Derivative Instruments
and Hedging Activities", as amended by FAS 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities -- an Amendment of FAS
133". At June 30, 2002, the fair value of the hedge was a liability of $27,052
($15,825, net of tax, is included in Accumulated Other Comprehensive Income
(Loss)).

11. SEGMENT INFORMATION

Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information", established standards for
reporting information about operating segments in the Company's financial
statements. It also established standards for related disclosures about products
and services, and geographic areas. Operating segments are defined as components
of an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker, or decision making
group, in deciding how to allocate resources and in assessing performance.

Prior to January 1, 2002, the Company reported one segment, Healthcare
Services. The Company did not have any products or services which met the
quantitative or qualitative guidelines for segment reporting through December
31, 2001. Effective January 1, 2002, the Company has three reportable segments
based on qualitative guidelines. The Company's three segments are: (1)
Healthcare Recovery Services, which encompasses its healthcare recovery
products: healthcare subrogation, provider bill audit and overpayment
recoveries; (2) Property and Casualty Recovery Services, which includes
subrogation recovery services for property and casualty insurers, which the
Company sells under the name TransPaC Solutions; and

8

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

(3) Software, which includes the sale of subrogation recovery software in a
browser-based application service provider (ASP) form. The segment profit
measure is income before income taxes.

Segment results for the three and six months ended June 30, 2002 and 2001
are as follows (in thousands):

Unallocated Corporate amounts include corporate expenses and other
miscellaneous charges. Because this category includes a variety of miscellaneous
items not attributable to one particular segment, it is subject to fluctuation
on a quarterly and annual basis. The Company does not allocate assets.

12. COST IN EXCESS OF NET ASSETS ACQUIRED AND OTHER INTANGIBLE ASSETS

Effective January 1, 2002, the Company adopted FAS 142 under which Cost in
Excess of Net Assets Acquired is no longer amortized but instead will be
assessed for impairment at least annually which is a two step process. The first
step involves determining the estimated fair value of each reporting unit with a
view to determining whether the Cost in Excess of Net Assets Acquired value has
been impaired under FAS 142. The second step measures the amount of impairment
and is required only if impairment is indicated by the first step.

9

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

The Company engaged the services of a third party valuation firm to
complete an analysis of the fair value of the reporting units during the first
half of 2002. The completion of step one during the three months ended June 30,
2002, did not result in an impairment charge for the Company. The Company will
perform its annual impairment review during the second quarter of each year,
commencing in the second quarter of 2003. The Company's reporting units are
generally consistent with the operating segments underlying the segments
identified in Note 11 "Segment Information". All recorded Cost in Excess of Net
Assets Acquired and Other Intangible Assets relate to the Healthcare Recovery
Services segment.

Following is a reconciliation of previously reported financial information
to adjusted amounts excluding amortization of Cost in Excess of Net Assets
Acquired for the three and six months ended June 30, 2001 (in thousands, except
per share amounts):

The carrying value of Cost in Excess of Net Assets Acquired, net was
approximately $29.1 million at June 30, 2002.

The Company's intangible assets (other than Cost in Excess of Net Assets
Acquired, net) are subject to amortization. The details of the Company's
intangible assets at June 30, 2002 and December 31, 2001 are as follows (in
thousands):

Client lists are being amortized on a straight-line basis over 15 years.
Backlog is being amortized over 5 years on a straight-line basis. Non-compete
agreements are being amortized on a straight-line basis over periods ranging
from 4 years to 5 years.

10

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

Amortization expense related to intangible assets for the three and six
month periods ended June 30, 2002 was approximately $141,000 and $281,000,
respectively. Over the six month period ending December 31, 2002 and each of the
four succeeding fiscal years, amortization expense related to intangible assets
is expected to be as follows (in thousands):

Six month period ending December 31, 2002................... $281
Year ending December 31,:
2003........................................................ 496
2004........................................................ 340
2005........................................................ 327
2006........................................................ 327

13. CONCENTRATION OF CLIENTS

The Company's largest client is UnitedHealth Group (UHG). For each of the
six month periods ended June 30, 2002 and 2001, UHG generated 27% of the
Company's revenues. During the second quarter of 2002, UHG management informed
the Company of its intention to terminate subrogation services with respect to
all but approximately 1 million lives of the 9.7 million then remaining lives.
See Item 2. "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Concentration of Clients".

14. SUPPLEMENTAL BALANCE SHEET INFORMATION

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

The Company believes it is a leading independent provider of outsourcing of
subrogation and certain other medical claims recovery and cost containment
services to the private healthcare payor industry in the United States, based on
the Company's experience and assessment of its market. The Company's primary
business 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 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 claims recovery services include (1) the
auditing of the bills of medical providers, particularly hospitals, for
accuracy, correctness and compliance with contract terms ("provider bill
audit"), and (2) the recovery of overpayments attributable to duplicate
payments, failures to coordinate benefits and similar errors in payment. The
Company offers its healthcare recovery services on a nationwide basis to health
maintenance organizations ("HMOs"), indemnity health insurers, self-funded
employee health plans, companies that provide claims administration services to
self-funded plans (referred to as "third-party administrators"), Blue Cross and
Blue Shield organizations and provider organized health plans. Current clients
include UnitedHealth Group, Humana Inc., Kaiser Permanente and The Principal
Financial Group. The Company had 42.4 million and 51.1 million lives under
contract from its clientele at June 30, 2002 and 2001, respectively.

The Company has three segments: (1) Healthcare Recovery Services, which
encompasses its healthcare recovery products: healthcare subrogation, provider
bill audit and overpayment recoveries; (2) Property and Casualty Recovery
Services, which includes subrogation recovery services for property and casualty
insurers, which the Company sells under the name TransPaC Solutions; and (3)
Software, which includes the sale of subrogation recovery software in a
browser-based application service provider (ASP) form.

HEALTHCARE RECOVERY SERVICES

OVERVIEW OF OPERATIONS

For a typical new healthcare subrogation or other medical claims recovery
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, the Company 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.

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

12

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 revenues") 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. Historically, support expenses have not grown in direct
proportion to revenues.

RESULTS OF OPERATIONS

The following tables present certain key operating indicators for the
Healthcare Recovery Services segment for the periods indicated (lives and
dollars in millions):

HEALTHCARE RECOVERY SERVICES-KEY OPERATING INDICATORS

LIVES SOLD AND INSTALLED*

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* All references to "lives" in the table, whether reported as from existing
clients, added from new contracts with existing clients or with new clients,
lives sold, lives sold eliminations/cross-sold, or as lives installed, are
derived by the Company from information provided to it by clients and may
contain estimates.

(1) Represents the net of losses from contract terminations and organic declines
in the clients' installed base measured in the number of persons covered by
clients; and gains from organic growth in the clients' installed base
measured in the number of persons covered by clients.

(2) "Lives sold eliminations/cross-sold lives" specifies the number of lives
subject to client contracts under which the Company provides or will provide
more than one healthcare recovery service to a client population. By
contrast, the number of lives reported in "Cumulative lives sold, end of
period" does not take into account instances in which multiple healthcare
recovery services are provided to the same client population.

(3) "Lives installed eliminations/cross-installed lives" specifies the number of
lives as to which the Company provides more than one healthcare recovery
service to a client population. By contrast, the number of lives reported in
"Lives installed, end of period" does not take into account instances in
which multiple recovery services are provided to the same client population.

13

OTHER KEY OPERATING INDICATORS

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

(1) 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.

(2) Throughput equals claims recoveries for the period divided by the average of
backlog at the beginning and end of the period.

THREE AND SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 2001

Claims Revenues. Total Healthcare Recovery Services revenues for the
quarter ended June 30, 2002 increased 9.3%, to $17.2 million from $15.7 million
for the same quarter of 2001, and for the six month period ended June 30, 2002,
increased 8.3%, to $34.6 million from $31.9 million in the same period of 2001.
Healthcare claims recoveries for the quarter ended June 30, 2002 were $61.4
million, an increase of $2.3 million, or 3.9%, compared to $59.1 million for the
same quarter of 2001. For the six month period ended June 30, 2002, healthcare
claims recoveries increased 4.8%, from $119.6 million to $125.4 million.

The Healthcare Recovery Services effective fee rate for the quarter ended
June 30, 2002 increased to 28.0% from 26.6% for the same quarter of 2001, and
increased to 27.7% for the six month period ended June 30, 2002 as compared with
26.7% in the same period in 2001. The increase in fee rate was primarily
attributable to the increase in the fee charged to UnitedHealth Group that was
effective January 1, 2002. See "Concentration of Clients".

Backlog for the Healthcare Recovery Services segment increased to $1,532.6
million at June 30, 2002 from $1,298.2 million at June 30, 2001, an increase of
18.1%. Approximately $220.0 million of the increase came from the provider bill
audit services backlog while the remainder came from the subrogation services
backlog.

The Healthcare Recovery Services segment had a throughput rate of
approximately 4.2% and 4.7% of average backlog during the second quarter of 2002
and 2001, respectively. The decrease in throughput from the quarter ended June
30, 2001 is primarily due to the fact that average healthcare recovery services
backlog during the 2002 quarter increased 16.4% from the same quarter of 2001
while recoveries increased only 3.9%. Throughput for the six month period ended
June 30, 2002 also decreased from 9.6% for the comparable period in 2001 to
8.5%, for the same reasons described above. Lives installed decreased 5.8
million from 47.5 million at June 30, 2001 to 41.7 million at June 30, 2002
primarily because of the lives lost relating to terminations by UnitedHealth
Group. See "Concentration of Clients".

Cost of Revenues. Cost of revenues for the Healthcare Recovery Services
segment increased 5.3% for the quarter ended June 30, 2002 to $8.0 million, from
$7.6 million for the same quarter in 2001, and was $16.1 million for the six
months ended June 30, 2002, an increase of 5.9% from $15.2 million for the same
period in 2001. As a percentage of claims revenues, cost of revenues decreased
to 46.4% for the quarter ended June 30, 2002 compared to 48.2% for the same
quarter in 2001. For the six months ended June 30, 2002, cost of revenues as a
percentage of claims revenues decreased to 46.6% from 47.6% in 2001. Both
decreases were a result of the increase in revenue described above.

Support Expenses. Support expenses for the Healthcare Recovery Services
segment decreased 23.1% to $1.0 million for the quarter ended June 30, 2002 from
$1.3 million for the same quarter in 2001 and were

14

$2.0 million for the six months ended June 30, 2002 compared to $2.4 million for
the comparable period in 2001. Support expenses decreased as a percentage of
claims revenues from 8.1% for the second quarter of 2001 to 5.9% for the same
quarter in 2002. For the six months ended June 30, 2002, support expenses as a
percentage of claims revenues were 5.7%, a decrease from 7.4% for the comparable
period in 2001. The decrease in support expenses as a percentage of claims
revenues resulted from the increase in revenue described above and from the
change in the reporting structure of certain systems support personnel from the
Healthcare Recovery Services segment to Corporate Sales & Marketing. Prior to
January 1, 2002, those personnel performed support functions primarily related
to healthcare subrogation. Effective January 1, 2002, such personnel moved under
Corporate Sales & Marketing as they assumed a more active role in the management
of client data and as members of the client solutions team. Prior year amounts
have not been reclassified because management of the Company views this as a
change in position.

PROPERTY AND CASUALTY RECOVERY SERVICES

OVERVIEW OF OPERATIONS

The Company operates in the subrogation outsourcing market that serves
property and casualty ("P&C") insurers. The Company offers its services to the
P&C market under the brand name "TransPaC Solutions". The Company currently
provides subrogation outsourcing services to 27 P&C clients, under various
contractual arrangements, including closed claims studies, referrals and full
outsourcing. The Company has established a full-time direct sales force of three
individuals experienced in P&C sales and marketing. The Company's target market
for its P&C subrogation services is P&C insurers that have reported below
average subrogation recovery results, are small regional insurers or for various
other reasons are interested in outsourcing either all or a portion of their
subrogation work.

The Company believes that the market for P&C subrogation outsourcing in the
United States is substantial and that the potential savings from subrogation
recoveries will vary depending upon the P&C line of business. The Company
believes that total potential subrogation recoveries in the automobile insurance
market exceed $6 billion per year. Based on its research and early experience
with two clients, the Company believes that there is an opportunity to increase
total subrogation recoveries across a wide spectrum of automobile insurers. The
Company's initial marketing strategy is to offer its services to smaller,
regionally oriented automobile insurers which generally lack the resources to
maximize subrogation recoveries.

The Company believes that it has an opportunity to leverage its healthcare
subrogation expertise and resources to provide service to the P&C markets. The
primary difference between the two markets is in the acquisition of claims data
for investigation of subrogation potential. The P&C industry does not have
standard data definitions regarding claims as does the health insurance
industry. Nevertheless, the Company used its healthcare subrogation expertise to
build data interfaces with its first two P&C customers, and it has created
proprietary business processes to acquire paper-based and/or imaged claims data
from its customers' claims adjusting offices and archives.

The Company has assessed the competitive environment for P&C subrogation
outsourcing, and believes that the competition is fragmented and characterized
by claims adjusting companies that operate on a local or regional basis and law
firms that specialize in low volume, but legally complex, subrogation claims.
The Company has identified only one competitor that attempts to serve a national
market. It believes that this competitor has enjoyed limited success because it
is owned and controlled by a P&C insurer.

On May 1, 2002, the Company disclosed that it expected the following from
TransPaC Solutions for the year ended December 31, 2002: pretax income (loss) in
2002 to range from a pretax loss of between $0.8 million and $1.0 million;
recoveries from TransPaC Solutions to be $5.0 million to $6.0 million; and
revenues to be $1.2 million to $1.5 million. The Company now estimates that it
will incur pretax losses of between $0.8 million and $1.0 million; recoveries
will be from $2.5 million to $3.2 million; and revenue will range from $0.6
million to $0.8 million. The changes in guidance for recoveries and revenue are
due to slower than anticipated installation of business from recently signed
clients. The Company cautions that the foregoing forecasts and estimates are not
guarantees of future performance and that actual results of TransPaC Solutions
will be dependent upon future facts and circumstances, many of which are outside
the control of

15

management of the Company. See "Safe Harbor Compliance Statement for Forward
Looking Statements" included as Exhibit 99.1 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001, as amended by Exhibit
99.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March
31, 2002, which is hereby incorporated herein by reference.

RESULTS OF OPERATIONS

The following tables present certain key operating indicators for the
Property and Casualty Recovery Services segment for the periods indicated
(dollars in millions):

PROPERTY AND CASUALTY RECOVERY SERVICES-KEY OPERATING INDICATORS

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

(1) Outsourcing refers to the full replacement of a client's internal
subrogation recovery function by TransPaC Solutions, typically with a view
to an ongoing relationship of indefinite period.

(2) Referrals and Closed Claims refer to project-related work assumed by
TransPaC Solutions, typically with files transmitted by clients from time to
time.

The new outsource client shown in the table above is Safe Auto, for which
TransPaC Solutions will take over all subrogation recovery work as well as Safe
Auto's existing work-in-process. Safe Auto reported direct written premiums of
approximately $87.4 million in 2001. Safe Auto currently has in place
approximately 94,000 policies.

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

(1) Backlog is the total dollar amount of potentially recoverable claims that
the Company is pursuing on behalf of its clients at a given point in time.

(2) Throughput equals claims recoveries for the period divided by the average of
backlog at the beginning and end of the period.

THREE AND SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 2001

Claims Revenues. Total Property and Casualty Recovery Services revenues
for the quarter ended June 30, 2002 increased approximately $81,000, or 231%,
from the same quarter in 2001 and increased 165% to $183,000 for the six month
period ended June 30, 2002 from $69,000 in the comparable period of 2001.
Property and Casualty Recovery Services claims recoveries for the quarter ended
June 30, 2002 were $0.4 million, an increase of $0.3 million over the same
quarter in 2001. For the six-month period ended June 30, 2002, claims recoveries
increased 250% to $0.7 million from $0.2 million during the comparable period in
2001.

16

The Property and Casualty Recovery Services effective fee rate for the
quarter ended June 30, 2002 decreased to 26.1% from 30.0% for the same quarter
of 2001 and decreased to 25.2% for the six months ended June 30, 2002 as
compared to 30.8% in the same period in 2001. The decrease in fee rate was
primarily attributable to the change in mix of referral and closed claim
contracts, which typically bear higher fees, and full outsourcing contracts,
which typically bear lower fees, that occurred in the six months ended June 30,
2002.

Backlog. Backlog for the Property and Casualty Recovery Services segment
increased to $9.5 million at June 30, 2002 from $4.0 million at June 30, 2001
due to additional contracts entered into by the Company during the six months
ended June 30, 2002.

The Property and Casualty Recovery Services segment had a throughput rate
of approximately 5.4% and 3.7% of average backlog during the second quarter of
2002 and 2001, respectively. Throughput for the six month period ended June 30,
2002 also increased from 5.6% for the comparable period of 2001 to 11.1%. The
increases were due to recoveries growing more quickly than the average backlog
over the three and six month periods ended June 30, 2002.

Cost of Revenues. Cost of revenues for the Property and Casualty Recovery
Services segment increased 200% for the quarter ended June 30, 2002 to $0.3
million, from $0.1 million for the same quarter in 2001, and was $0.5 million
for the six months ended June 30, 2002, an increase of 150% from $0.2 million
for the same period in 2001. As a percentage of claims revenues, cost of
revenues decreased to 218% for the quarter ended June 30, 2002 compared to 349%
for the same quarter in 2001. For the six months ended June 30, 2002, the cost
of revenues as a percentage of revenue decreased to 263% from 323% in 2001. The
increase in cost of revenues is due to expenses being incurred prior to revenue
being recognized, as is the nature of the subrogation business.

Support Expenses. Support expenses for the Property and Casualty Recovery
Services segment decreased 50% to $0.1 million for the quarter ended June 30,
2002 from $0.2 million for the same quarter in 2001 and were $0.2 million for
the six months ended June 30, 2002 compared to $0.3 million for the comparable
period in 2001. Support expenses decreased as a percentage of claims revenues
from 494% for the first quarter of 2001 to 103% for the same quarter in 2002.
For the six months ended June 30, 2002, support expenses as a percentage of
claims revenues were 123%, a decrease from 483% in the comparable period of
2001. The decrease in support expenses as a percentage of claims revenues
resulted from the increase in revenue described above and from the movement of
certain sales and marketing personnel from the Property and Casualty Services
segment to Corporate Sales & Marketing.

SOFTWARE

OVERVIEW OF OPERATIONS

The Company has developed a web-enabled subrogation software application.
The Company intends to sell this product as an application service provider
("ASP"), under the trade name "Troveris", to participants in both the health
insurance and benefits market and the P&C market which historically have not
outsourced subrogation recoveries. The Company currently estimates that 40% to
50% of the private health insurance and health benefits markets do not outsource
subrogation recoveries. Public sector markets, such as Medicaid and Medicare,
have virtually no outsourcing of subrogation recoveries. These programs
typically rely on their claims administration contractors to provide subrogation
services as part of a bundled service contract. The Company believes that, like
the health insurance market, certain participants in the P&C insurance market
are less likely to outsource subrogation services. The Company believes mutual
insurers have organizational and cultural biases against outsourcing and larger
P&C insurers have sufficient resources to develop relatively sophisticated
internal departments. During the three months ended June 30, 2002, the Company
made its first sale of the Troveris software to an outside party (United Medical
Resources). Additionally, the Company has received indications of interest from
other potential purchasers.

The Troveris marketing strategy combines the opportunity for an internal
subrogation department to gain operating efficiency through the functionality of
state-of-the-art desktop software and to leverage its ability to

17

produce recoveries through the purchase of unbundled components of the Company's
traditional subrogation outsourcing services. The Troveris software application
allows the Company to administer these customized relationships using the same
proprietary processes as it uses for those customers who purchase turnkey
subrogation outsourcing services. An additional benefit of the Troveris software
application is that the Company believes that it will substantially reduce
future expenses for maintaining software applications that it uses to provide
turnkey outsourcing services.

During the fourth quarter of 2001, the Company began migrating its own
subrogation operations to the Troveris application. The Company currently
expects the migration to be completed in the third quarter of 2003. The Company
previously said that it expected the migration to be completed during the fourth
quarter of 2002. The migration schedule has been extended in order to focus
resources on the installation of United Medical Resources to the system and to
allow for additional system enhancements. The Company does not anticipate any
adverse financial effects from the extension of the migration schedule. After
migration is complete, the Company expects to abandon its legacy subrogation
system, thereby reducing its technology expense, net of the expense of
maintaining the Troveris application, by at least $600,000 per year. The
Troveris application will also enable the Company to expand its ability to
manage its knowledge workers via telecommuting arrangements. While the Company
believes it can achieve the foregoing transition and corresponding reduction of
expenses in the outlined timeframe, future facts and circumstances could change
these estimates. See "Safe Harbor Compliance Statement for Forward-Looking
Statements" included as Exhibit 99.1 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2001, as amended by Exhibit 99.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002,
which is hereby incorporated herein by reference.

The Company is not aware of any competition in subrogation software in an
ASP model for the health insurance industry, and it can only identify a single
large competitor in the P&C insurance industry. This competitor is partially
owned and controlled by a major P&C insurer, and the Company believes that this
relationship will reduce the ability of the competitor to sell its services to
other P&C insurers.

RESULTS OF OPERATIONS

THREE AND SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 2001

Revenues. The Software segment recognized $165,000 and $280,000 in revenue
during the three and six months ended June 30, 2002, respectively, all of which
was derived internally.

Cost of revenues. Cost of revenues for the Software segment for the three
and six months ended June 30, 2002 was approximately $148,000 and $263,000,
respectively. This includes approximately $107,000 and $187,000 for the three
and six month periods ended June 30, 2002, respectively, of depreciation and
amortization of software in service. Approximately $41,000 and $76,000 of the
cost of revenues for the three and six month periods ended June 30, 2002,
respectively, relates to the support and maintenance of the software.

Support expenses. For the three and six months ended June 30, 2002, the
Software segment incurred approximately $507,000 and $908,000, respectively, in
expenditures in connection with the creation of new products for the insurance
industry. Approximately $292,000 of support expenditures were capitalized in the
quarter ended June 30, 2002, resulting in net reported expenses of approximately
$215,000. During the six months ended June 30, 2002, approximately $546,000 of
support expenditures were capitalized, resulting in net reported expenses of
$362,000.

The Company expects to incur additional expenses of between $0.8 million
and $1.0 million for research and development with respect to the creation of
enhancements of existing software applications over the remainder of 2002, of
which approximately $450,000 is expected to be capitalized. In addition, as of
June 30, 2002, the Company has capitalized approximately $1.7 million of costs
in accordance with accounting principles generally accepted in the United States
of America for the development of software for sale to unrelated parties.

18

ENTIRE COMPANY

STATEMENTS OF INCOME AS A PERCENTAGE OF REVENUES

EMPLOYEES

Depreciation and Amortization. Depreciation and amortization expense
decreased 24.5% to $1.2 million for the quarter ended June 30, 2002 from $1.6
million for the same quarter in 2001, and decreased 21.6% to $2.5 million for
the six months ended June 30, 2002 from $3.2 million for the comparable period
in 2001. The decreases were due to the adoption of FAS 142 by the Company on
January 1, 2002. See Item 1. "Financial Statements (Unaudited) -- Note
12 -- Cost in Excess of Net Assets Acquired and Other Intangible Assets".

Research and Development. The Company incurred $157,000 and $291,000 for
the three and six months ended June 30, 2001, respectively, related to research
and development activities in connection with the creation of new products for
the insurance industry. There are no research and development expenses in the
three and six months ended June 30, 2002 because the products that were in
development in 2001 became operational in 2002. See "Software -- Overview of
Operations".

Interest Income. Interest income decreased 78.2%, or $208,000, for the
quarter ended June 30, 2002 as compared to the same quarter in 2001. For the six
months ended June 30, 2002, interest income decreased $491,000, or 79.7%, from
$616,000 to $125,000. The decreases were due to the payment, during the quarter
ended June 30, 2001, of an earn-out relating to an acquisition which reduced the
restricted cash balance and lower interest rates.

Interest Expense. Interest expense totaled approximately $125,000 and
$264,000 for the three and six months ended June 30, 2002, respectively. The
decreases in interest expense for the three and six months ended June 30, 2002,
as compared with the same periods in 2001, were primarily due to a decrease in
borrowed funds resulting from the release of restricted cash in July 2001 and
the proceeds from the sale of the Milwaukee building in November 2001 and lower
interest rates in 2002.

Tax. During the three and six months ended June 30, 2002, the Company
accrued an income tax benefit of $72,500 and $167,500, respectively, related to
a research and experimental income tax credit. The

19

Company accrued its income tax at its historical rate of 41.5% of pretax income,
net of the research and experimental tax credit, resulting in an effective
income tax rate of 38.7% and 38.4%, during the three and six months ended June
30, 2002, respectively. For the comparable periods in 2001, the provision for
income tax was accrued at 41.5% of pretax income.

Net Income. Net income for the quarter ended June 30, 2002 increased
$546,000, or 51.1%, to $1.6 million, or $0.17 per diluted common share, from
$1.1 million, or $0.11 per diluted common share, for the comparable quarter in
2001. For the six months ended June 30, 2002, net income increased 35.3% to $3.3
million, or $0.34 per diluted common share, from $2.4 million, or $0.25 per
diluted common share, for the comparable period in 2001. The primary reasons for
the increases in net income and diluted earnings per share were the adoption of
FAS 142 as described above under Depreciation and Amortization and the
incremental Healthcare Recovery Services revenue from the UHG contract
termination. See "Concentration of Clients".

LIQUIDITY AND CAPITAL RESOURCES

The Company's statements of cash flows for the six months ended June 30,
2002 and 2001 are summarized below:

The Company had working capital of $8.9 million at June 30, 2002, including
cash and cash equivalents of $2.1 million, compared with working capital of
$10.4 million at December 31, 2001. The primary reason for the decrease in
working capital was the use of excess cash and cash equivalents to pay down the
Revolving Credit Facility and to repurchase shares of the Company's stock.

Net cash provided by operating activities was $7.0 million, an increase of
$2.7 million for the six months ended June 30, 2002, compared to the same six
months in 2001, primarily as a result of the reduction in the accounts
receivable balance during the six months ended June 30, 2002.

Net cash used in investing activities includes purchases of property and
equipment. During each of the six month periods ended June 30, 2002 and 2001,
the Company capitalized approximately $1.0 million of internally-developed
software.

Net cash used in financing activities for the six months ended June 30,
2002 reflects $1.7 million in net cash payments with respect to the Company's
Revolving Credit Facility, as well as approximately $3.6 million of treasury
stock purchases.

On November 1, 2001, the Company entered into a revolving credit facility
with National City Bank of Kentucky, Bank One Kentucky, N.A. and Fifth Third
Bank (the "Revolving Credit Facility"). The Company's obligations under the
Revolving Credit Facility are secured by substantially all of the Company's
assets, subject to certain permitted exceptions. The Revolving Credit Facility
carries a maximum borrowing capacity of $40 million and will mature October 31,
2004. Principal amounts outstanding under the Revolving Credit Facility bear
interest at a variable rate based on the Prime Rate or Eurodollar Rate, as
applicable, plus a pre-determined fixed margin. At June 30, 2002, the interest
rate was 3.59% based on the one-month Eurodollar Rate. The Revolving Credit
Facility contains customary covenants and events of default including, but not
limited to, financial tests for interest coverage, net worth levels and leverage
that may limit the Company's ability to pay dividends. It also contains a
material adverse change clause. At June 30, 2002, $6.3 million was outstanding
under the Revolving Credit Facility. (See Item 1. "Financial Statements
(Unaudited) -- Note 4 -- Credit Facility" and "-- Note 10 -- Derivatives".)

20

At June 30, 2002 and December 31, 2001, the Company reported on its balance
sheets, as a current asset, restricted cash of $17.6 million and $18.0 million,
respectively. Restricted cash at June 30, 2002 and December 31, 2001 represented
claims recoveries by the Company for its clients. At June 30, 2002 and December
31, 2001, the Company reported on its balance sheets, as a current liability,
funds due clients of $12.5 million and $12.9 million, respectively, representing
claims recoveries to be distributed to clients, net of the fee earned on such
recoveries.

In light of its acquisition strategy, the Company from time to time
assesses its opportunities for capital formation. The Company believes that its
available cash resources, together with the borrowings available under the
Revolving Credit Facility, will be sufficient to meet its current operating
requirements and acquisition and internal development activities.

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, 2002
covered approximately 42.4 million lives. The Company's clients are national and
regional healthcare payors, large third-party administrators or self-insured
corporations. The Company has two clients that individually comprise more than
10% of the Company's revenue. The Company's largest client is UnitedHealth Group
("UHG"). For each of the six month periods ended June 30, 2002 and 2001, UHG
generated 27% of the Company's revenues. Wellpoint Health Networks accounted for
13% and 10% of the Company's revenues for the six month periods ended June 30,
2002 and 2001, respectively.

The Company's revenues are earned under written contracts with its clients
that generally provide for contingency fees from recoveries under a variety of
pricing regimes. The pricing arrangements offered by the Company to its clients
include a fixed fee percentage, a fee percentage that declines as the number of
lives covered by the client and subject to the Company's service increases and a
fee percentage that varies with the Company's recovery performance.

The Company performs its services on a reasonable efforts basis and does
not obligate itself to deliver any specific result. 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. The Company's contracts
generally provide that in the event of termination, the Company is entitled to
complete the recovery process on the existing backlog or to receive a cash
payment designed to approximate the gross margin that would otherwise have been
earned from the recovery on the backlog of the terminating client. On June 30,
2002, the Company had Healthcare Recovery Services backlog of $1,532.6 million.

21

During the second quarter of 2002, UHG management informed the Company of
its intention to terminate subrogation services with respect to all but
approximately 1 million lives of the 9.7 million then remaining lives
attributable to UHG. UHG's termination of these services resulted from its
decision to bring subrogation recovery services back inside UHG, where they will
be performed by its Ingenix strategic business unit. The Company expects to
continue recovering on the backlog created for UHG (and for the plans and
employer groups that UHG services), a process that the Company expects will be
completed in 5 to 6 years. UHG is the Company's largest client, accounting for
27% of its total revenue in 2001.

As reported in the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002, the effects of the loss of the prospective UHG business,
coupled with an increase in the fee rate that has occurred, and without regard
to replacement of the UHG business, will be as follows:

- In 2002, the Healthcare Recovery Services segment will report $1.4
million to $1.6 million more in revenue and pretax income than was
indicated in the guidance previously published on January 4, 2002;

- In 2003, the subrogation product of the Healthcare Recovery Services
segment will report approximately $1.8 million less in revenue, without
any reduction in the gross margin percentage; and

- In 2004, the subrogation product of the Healthcare Recovery Services
segment will report approximately $7.0 million less in revenue, without
any reduction in the gross margin percentage.

The Company previously announced that it expected to receive monthly
termination notices from UHG over a six-month period, with termination dates
effective 180 days after each notice. The Company is currently in discussions
with UHG over a possible extension of the termination schedule that may entail
the Company receiving claims data for up to another six months after the current
contract's February 1, 2003 expiration date.

In addition, the Company now expects that the Healthcare Recovery Services
segment will report for the year pretax income in the range of $28.0 million to
$28.3 million on revenues in the range of $68.0 million to $68.8 million. This
represents a change from the May 1, 2002 guidance, which gave a range for
revenue of $68.8 million to $72.1 million and for pretax income of $28.0 million
to $28.8 million. These changes are primarily attributable to the decrease in
expected revenue for the year and to development expenses for a new Healthcare
Recovery Services segment product. Both the current guidance and that given on
May 1, 2002 include the additional revenue and pretax income, in the range of
$1.4 million to $1.6 million, from the termination of the UHG contract.

CRITICAL ACCOUNTING POLICIES

The Company has identified critical accounting policies that, as a result
of the judgments, uncertainties, uniqueness and complexities of the underlying
accounting standards and operations involved, could result in material changes
to its financial condition or results of operations under different conditions
or using different assumptions. The Company believes its most significant
accounting policies are related to the following areas, among others: revenue
recognition, accounts receivable and collectibility, valuation of long-lived and
intangible assets, accrued expenses and common stock options. Details regarding
the Company's use of these policies and the related estimates are described more
fully in the Company's Annual Report on Form 10-K for the year ended December
31, 2001, filed with the Securities and Exchange Commission on March 27, 2002.
During the second quarter of 2002, there have been no material changes to the
Company's critical accounting policies that impacted the Company's financial
condition or results of operations.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 141 (FAS 141), "Business
Combinations", which provides that all business combinations should be accounted
for using the purchase method of accounting and establishes criteria for the
initial recognition and measurement of goodwill and other intangible assets
recorded in connection with a business combination. The provisions of FAS 141
apply to all business combinations initiated after June 30,
22

2001 and to all business combinations accounted for by the purchase method that
are completed after June 30, 2001. The Company will apply the provisions of FAS
141 to any future business combinations.

Also, in June 2001, the FASB issued Statement of Financial Accounting
Standards No. 142 (FAS 142), "Goodwill and Other Intangible Assets", which
establishes the accounting for goodwill and other intangible assets following
their recognition. FAS 142 applies to all goodwill and other intangible assets
whether acquired singly, as part of a group, or in a business combination. FAS
142 provides that goodwill should not be amortized but should be tested for
impairment annually using a fair-value based approach. In addition, FAS 142
provides that other intangible assets other than goodwill should be amortized
over their useful lives and reviewed for impairment. FAS 142 was effective for
the Company beginning on January 1, 2002. During the three months ended June 30,
2002, the Company performed the transitional impairment test under FAS 142 for
all goodwill recorded as of January 1, 2002 which did not result in an
impairment charge.

In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 143 (FAS 143), "Accounting for Asset Retirement Obligations". FAS 143 is
effective for fiscal years beginning after June 15, 2002, and provides
accounting requirements for asset retirement obligations associated with
tangible long-lived assets. The Company believes that the adoption of FAS 143
will not have a significant impact on its financial statements.

In October 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 (FAS 144), "Accounting for the Impairment or Disposal of
Long-Lived Assets". FAS 144 is effective for fiscal years beginning after
December 15, 2001. This statement supersedes FAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of",
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a business segment. FAS 144 establishes a
single accounting model, based on the framework established in FAS 121. The
adoption of FAS 144 had no significant impact on the Company's financial
position or results of operations.

In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (FAS 146), "Accounting for Exit or Disposal Activities". FAS 146
addresses the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including costs related to
terminating a contract that is not a capital lease and termination benefits that
employees who are involuntarily terminated receive under the terms of a one-time
benefit arrangement that is not an ongoing benefit arrangement or an individual
deferred-compensation contract. FAS 146 supersedes Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)" and requires liabilities associated with exit and disposal
activities to be expensed as incurred. FAS 146 will be effective for exit or
disposal activities of the Company that are initiated after December 31, 2002.
The Company believes that the adoption of FAS 146 will not have a significant
impact on its financial statements.

STOCK REPURCHASE PLAN

The Company's Board of Directors authorized the repurchase of up to $20
million of the Company's Common Stock in the open market (including $10 million
authorized on May 10, 2002), at prices per share deemed favorable by the
Company. Shares may be repurchased using cash from operations and borrowed funds
and may continue until such time as the Company has repurchased $20 million of
the Company's Common Stock or until it otherwise determines to terminate the
stock repurchase plan. The Company repurchased 381,950 and 662,443 shares of its
own stock during the three and six months ended June 30, 2002, respectively, at
an average price of $5.26 and $5.39, respectively. From inception of the program
through June 30, 2002, the total number of repurchased shares is 2,454,708 at a
cost of $10.7 million, or an average cost of $4.35 per share. Except for 10,000
shares previously repurchased but re-issued in connection with an employee
restricted stock award, all of the reacquired shares of Common Stock through
June 30, 2002 are reflected as treasury stock on the accompanying Condensed
Balance Sheets (Unaudited).

23

RECENT DEVELOPMENTS

RESIGNATION OF DIRECTOR

Effective May 10, 2002, Herbert A. Denton resigned as a director of the
Company. Under the Company's Certificate of Incorporation and Bylaws, a vacancy
on the Board of Directors created by a resignation may be filled by a majority
vote of the remaining directors. A director so chosen to fill the vacancy would
hold office until the next succeeding Annual Meeting. The Board of Directors,
through its Nominating Committee, is currently engaged in identifying candidates
for the vacant position.

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 Revolving Credit Facility, which matures October 31, 2004.
The impact on earnings and the 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 a
portion of the Revolving 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 2002. As of June 30, 2002, the Company had $6.3 million outstanding under its
Revolving Credit Facility. Through the interest rate swap contract the Company
has entered into, the Company has fixed the interest rate on $4 million of the
Revolving Credit Facility at 5.41% or 5.66% (contingent on the status of a
financial ratio). The remaining $2.3 million outstanding had an interest rate of
3.59%. See Item 1. "Financial Statements (Unaudited) -- Note 13 -- Concentration
of Clients" and Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources".

24

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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. Moreover, 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, including class actions brought by nationally prominent
attorneys, directed at healthcare payors and related parties.

The Company has, since its founding in 1988, been involved with many
litigation matters related to its subrogation business, sometimes as a defendant
and sometimes through its defendant client. Plaintiffs' attorneys attempting to
defeat the clients' subrogation liens often threaten litigation against the
Company and its clients as a negotiating tactic. Most of the lawsuits that have
been filed against the Company or its clients concern the entitlement to recover
a specific, individual subrogation claim or the amount of the subrogation claim.
Typically, these actions do not ask for punitive damages, are not pled as class
actions, and do not have wide implications with respect to the Company's ongoing
business practices.

To date, however, the Company has encountered eight noteworthy instances in
addition to the lawsuits described under "-- Current Litigation", in which
lawsuits were filed against it or its clients that sought punitive damages, were
pled as class actions or otherwise made claims or requested relief that could
have materially affected the Company's business practices. The risk profile for
this sort of business practices litigation includes not only the usual
considerations of the potential amount, effect, and likelihood of loss, but also
specifically the potential for punitive damages and class certification, the
possible effects of an adverse verdict on the Company's business practices, and
the likelihood of specific plaintiffs' attorneys bringing similar actions in
other jurisdictions.

Each of these cases has been completely resolved, by decision of a court or
settlement by the parties, but prior to resolution the Company did not regard
all of these cases as being material in and of themselves. In management's
opinion, these eight cases share a common profile with each other and with the
lawsuits described below under the caption "-- Current Litigation".

Five of the eight lawsuits named the Company as a defendant and were pled
as class actions. Two of the cases, one in federal court and the other in state
court, alleged that the Company violated state and federal laws on fair debt
collection practices. In the state court action, the court granted the Company's
motion for summary judgment on all claims in the complaint, which the court of
appeals affirmed. In the federal court action, the Company settled the matter,
prior to the court's ruling on the Company's motion for summary judgment, for a
nominal amount.

Three other lawsuits, all in federal court, charged the Company with a
variety of violations of laws and sought punitive damages. The complaints
alleged, among other things, that the Company committed negligence, fraud and
breach of its duties under ERISA by attempting to recover and actually
recovering, by subrogation, the reasonable value of medical benefits which were
provided by the Company's clients under capitation or discounted-fee-for-service
arrangements. One of these lawsuits was dismissed in a ruling on the merits.
Another was settled, after the court denied class certification, for a nominal
amount paid by the Company's client, a co-defendant in the case. The third case,
DeGarmo et al. v. Healthcare Recoveries, Inc., was concluded in mid-July 2001
for a settlement payment of $3 million and nonmonetary terms that management
regards as immaterial to the Company's ongoing business.

Although the Company was not named as a defendant in any of them, there
have been three other lawsuits involving the Company's clients that implicated
the Company's business practices. The complaints in these cases alleged, among
other things, violation of state law with respect to the payment of plaintiffs'
attorneys' fees and unfair trade practices, violation of the federal Health
Maintenance Organization Act of 1973, misrepresentation of the rightful amounts
of subrogation claims, and impermissible enforcement of

25

recovery rights. Two of these cases resulted in judgments in favor of the
Company's clients after litigation of the merits before trial and appellate
courts. The other case was settled for an immaterial amount.

Management believes that the lawsuits described above will not, as a
general matter, have precedential value for either the cases described below
under the caption "-- Current Litigation" or for any future litigation matters
(all these cases being referred to as the "Pending and Potential Cases").
Indeed, the courts hearing the Pending and Potential Cases may not even become
aware of the outcomes in the eight lawsuits described above. Management expects
that each of the Pending and Potential Cases will be decided on its own merits
under the relevant state and federal laws, which will vary from case to case and
jurisdiction to jurisdiction. The descriptions of the outcomes in the eight
cases dealing with business practices are included here in order to describe the
contexts for this kind of litigation and the Company's relative successes in
handling past business practices litigation, but are not necessarily predictive
of the outcomes of any of the Pending and Potential Cases.

Moreover, there can be no assurance that the Company will not be subject to
further class action litigation similar to that described below under the
caption "-- Current Litigation", that existing and/or future class action
litigation against the Company and its clients will not consume significant
management time and/or attention or that the cost of defending and resolving
such litigation will not be material.

CURRENT LITIGATION

CONTE V. HEALTHCARE RECOVERIES

On October 1, 1999, a First Amended Class Action Complaint ("Amended
Complaint") was filed against the Company 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 complaint, Conte v. Healthcare Recoveries, Inc., No.
99-10062, plaintiffs assert that the Company'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 Amended Complaint also seeks a declaratory judgment that the Company,
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 the Company's alleged assertion and/or recovery of
unlawful subrogation/reimbursement rights of its clients. Each count of the
Amended Complaint seeks compensatory and/or statutory damages as well as
exemplary and punitive damages. Plaintiffs also seek injunctive relief,
prejudgment interest, costs and attorneys' fees.

On November 5, 1999, the Company filed a motion to dismiss the Amended
Complaint. On June 29, 2001, the court issued a decision dismissing plaintiffs'
common law claims for fraud and unjust enrichment as well as plaintiffs' claims
under the federal Fair Debt Collection Practices Act and the Florida Consumer
Collection Practices Act. The court did not, however, dismiss the remaining
count of the Amended Complaint ("Count I"), which seeks a declaratory judgment
and damages under ERISA based on the Company's alleged violation of the "make
whole" rule. The Company has now filed an answer with respect to Count I of the
Amended Complaint.

Plaintiffs' motion to certify a nationwide class, which the Company
opposed, was submitted to the court in September 2000. In an order entered
January 8, 2002, the court referred the class certification motion to the Chief
Magistrate Judge for a report and recommendation. In a report dated March 20,
2002, the Chief Magistrate Judge recommended denial of the motion to certify a
class. Plaintiffs filed timely objections in the court to the report and the
Company filed a response. On June 5, 2002, the court entered an order adopting
the Chief Magistrate Judge's report and recommendation in its entirety and
denying class certification. Plaintiffs' time to seek leave to file an
interlocutory appeal from that ruling has expired.

26

CAJAS ET AL. V. PRUDENTIAL HEALTH CARE PLAN AND HEALTHCARE RECOVERIES

On October 28, 1999, a class action Plaintiff's Original Petition
("Petition") was filed against the Company and one of the Company's clients 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 the Company'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 the Company, 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 Company was served
with the Petition in early November 1999, and has answered, denying all
allegations. The court has not yet addressed the question of whether to certify
the putative class. After the defendants filed a motion for summary judgment
during January 2002, the plaintiff moved the court to delay consideration of the
motion until plaintiff could complete additional discovery. The plaintiff's
motion to delay consideration was granted and discovery is in progress.

FRANKS ET AL. V. PRUDENTIAL HEALTH CARE PLAN AND HEALTHCARE RECOVERIES

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 the
Company and one of the Company's clients 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 Complaint asserted claims on behalf of
members of ERISA governed health plans and alleged that the Company'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 alleged
that the Company, 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 alleged
that the Company unlawfully pursued subrogation and reimbursement claims by (1)
failing to pay pro rata attorney's fees to attorneys who represented purported
class members with respect to tort claims underlying the subrogation and
reimbursement claims; and (2) recovering subrogation and reimbursement claims
from purported class members who have not been fully compensated for their
injuries. Plaintiffs, on behalf of the purported class, demanded compensatory
damages, punitive damages, and treble damages under RICO, costs and reasonable
attorneys' fees. On January 18, 2000, the defendants filed a motion to dismiss
the Complaint.

In response to the defendants' motion, on February 28, 2001, the court
rendered its opinion and entered an order dismissing all of the plaintiff's
claims with the exception of the plaintiff's claim for attorney fees, which
remains pending before the court for disposition. On March 14, 2001, the Company
filed an answer to the Complaint denying all of the plaintiff's allegations.
Also on March 14, 2001, the plaintiff filed a motion to alter or amend the
court's ruling on the motion to dismiss. On July 15, 2002, the court denied
plaintiff's motion to alter or amend the court's ruling on the motion to
dismiss. The court has not addressed the issue of class certification.

27

MARTIN ET AL. V. COMPANION HEALTH CARE AND HEALTHCARE RECOVERIES

On December 22, 1999, a purported class action complaint ("Complaint") was
filed against the Company and one of the Company's clients 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. ("CHC") filed an Answer and
Counterclaim and plaintiff Martin filed a First Amended Complaint ("Amended
Complaint"). The Amended Complaint asserts that the Company'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 the Company, 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 the Company and CHC unlawfully pursued subrogation and
reimbursement claims by (1) failing to pay pro rata costs and attorney's fees to
attorneys who represented purported 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
purported class, demand compensatory damages, punitive damages, and treble
damages, disgorgement of unjust profits, costs, prejudgment interest and
attorneys' fees. The Company was served with the original Complaint in late
December 1999 and answered denying all allegations. The Company filed a motion
to dismiss in August 2000. During June 2001, the court granted the Company's
motion to dismiss. Plaintiffs filed a notice of appeal on July 20, 2001. All
parties have filed briefs but the court has not yet ruled on plaintiffs' appeal
of the dismissal, nor has oral argument been scheduled.

HAMILTON V. HEALTHCARE RECOVERIES

On March 12, 2001, a Complaint ("Complaint") was filed against the Company
in the United States District Court for the Eastern District of Louisiana, in a
putative class action brought by Kyle M. Hamilton. In that action, Hamilton v.
Healthcare Recoveries, Inc., No. 01-650, plaintiff asserts that the Company's
subrogation recovery efforts on behalf of its clients violate certain Louisiana
state laws, the federal Fair Debt Collection Practices Act and the Louisiana
Unfair Trade Practices Act. The Complaint alleges that the Company intentionally
and negligently interfered with the plaintiff's and the putative class members'
rights to settle certain personal injury claims. The Complaint further alleges
that the Company unlawfully pursued subrogation and reimbursement claims that
plaintiff asserts are unenforceable because the clauses in the Company's
clients' coverage documents that create such recovery rights are rendered null
and void by Louisiana statutes that generally prohibit coordination of benefits
with individually underwritten insurance coverages. Plaintiff purports to
represent a class consisting of all persons covered under group health policies
that were issued or delivered in the State of Louisiana and who received any
communication from the Company attempting to enforce any clauses that allegedly
were rendered null and void by Louisiana law. Plaintiff seeks on behalf of the
purported class compensatory and statutory damages, interest, costs, attorneys'
fees and such additional damages and relief as may be allowed by any applicable
law. On July 17, 2001, the court granted a motion for summary judgment filed by
the Company as concerned the plaintiff's Fair Debt Collection Practices Act
claim, dismissing those claims with prejudice. The court denied the Company's
motion for summary judgment, without prejudice to the right of the Company to
reassert its motion, with respect to the plaintiff's state law claims. The court
ordered that the parties submit memoranda addressing whether the court still had
subject matter jurisdiction, given dismissal of the federal claim. On August 21,
2001, the court ruled that it lacked subject matter jurisdiction, thus
dismissing the remaining claims, without prejudice. Plaintiff filed an appeal to
the United States Fifth Circuit Court of Appeals. The parties completed
appellate briefing in January 2002 and oral arguments were heard on May 9, 2002.

28

In addition to filing the appeal in federal court, the Hamilton plaintiff
on October 1, 2001 filed a new complaint in the Civil District Court for the
Parish of Orleans, Louisiana, in a putative class action styled Hamilton v.
Healthcare Recoveries, Inc., 2001-15989. This state court action asserts claims
substantially similar to those in the federal court action. During November
2001, the Company filed preliminary exceptions to this new complaint.

ROGALLA V. CHRISTIE CLINIC, PERSONALCARE HEALTH MANAGEMENT AND HEALTHCARE
RECOVERIES

On December 14, 2001, Valerie Rogalla, the plaintiff in a putative class
action against a health care provider, amended her complaint to add Healthcare
Recoveries, Inc. as a defendant in Valerie Rogalla v. Christie Clinic, P.C.,
PersonalCare Health Management, Inc. and Healthcare Recoveries, Inc., No.
01-L-203, Circuit Court of the Sixth Judicial Circuit, Champaign County,
Illinois. In her complaint, the plaintiff makes allegations on behalf of herself
and all others similarly situated. The complaint asserts that the Company, as
subrogation agent for PersonalCare Health Management, made fraudulent
misrepresentations in the course of unlawfully pursuing subrogation and
reimbursement claims. The complaint seeks recovery from the Company for
compensatory damages, punitive damages and costs. The Company disputes the
plaintiff's allegations and intends to vigorously defend its position in this
case. Each defendant has filed a motion to dismiss the action.

The Cajas, Franks 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 Conte, Cajas, Franks, Martin, Hamilton and Rogalla 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 the Company'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 Cajas, Franks, and Martin cases, at the end of 1993 the Company had ceased
the practice of recovering the "reasonable value" of medical treatment provided
by medical providers under DFS arrangements with the Company's clients. From
that date, the Company's policy has been not to recover the "reasonable value"
of medical treatment in DFS arrangements. However, the Company 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
one or more other lawsuits 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, including
class actions brought by nationally prominent attorneys, directed at healthcare
payors and related parties. 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 or that the cost of defending and resolving such litigation will not
be material.

29

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

The Company held its Annual Meeting of Stockholders on May 10, 2002. Of the
9,549,466 shares of Common Stock outstanding as of the record date, March 19,
2002, and entitled to vote at this meeting, 8,895,706 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:

The Company's other directors continuing after the Annual Meeting are as
follows:

Jill L. Force
Patrick B. McGinnis
John H. Newman
Chris B. VanArsdel

(b) The approval of the adoption of the Trover Solutions, Inc. Outside
Directors Equity Compensation Plan. The result of the vote was 7,375,428 shares
in favor, 1,479,565 opposed and 40,713 abstained. Accordingly, the adoption of
the Trover Solutions, Inc. Outside Directors Equity Compensation Plan was
approved.

(c) The ratification of the appointment of PricewaterhouseCoopers LLP as
independent public accountants of the Company to serve for 2002. The result of
the vote was 8,860,055 shares in favor, 18,680 opposed and 16,971 abstained.
Accordingly, the appointment of PricewaterhouseCoopers LLP was ratified.

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:

3.1 -- Restated Certificate of Incorporation of the Registrant.
3.2 -- Amended and Restated Bylaws of the Registrant (incorporated
by reference to Exhibit 3.2 of Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2000).
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 -- Trover Solutions, Inc. Outside Directors Equity Compensation
Plan (incorporated by reference to Appendix B to the Proxy
Statement for the Annual Meeting of Stockholders, dated
April 3, 2002).
99.1 -- Trover Solutions, 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, 2001).
99.2 -- Amendment to Trover Solutions, Inc. Private Securities
Litigation Reform Act of 1995 Safe Harbor Compliance
Statement for Forward-Looking Statements (incorporated by
reference to Exhibit 99.2 of Registrant's Quarterly Report
on Form 10-Q for the quarter ended March 31, 2002).
99.3 -- Certifications Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.

(b) Reports on Form 8-K

No reports filed during the second quarter of 2002.

30

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.

TROVER SOLUTIONS, INC.

Date: August 14, 2002 /s/ PATRICK B. MCGINNIS
--------------------------------------------------------
Patrick B. McGinnis
Chairman, President and Chief Executive Officer

Date: August 14, 2002 /s/ DOUGLAS R. SHARPS
--------------------------------------------------------
Douglas R. Sharps
Executive Vice President and Chief Financial Officer
Principal Financial and Accounting Officer