TROVER SOLUTIONS INC - 10-Q Quarterly Report

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UNITED STATES 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 SEPTEMBER 30, 2003

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 [ ]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

As of November 11, 2003, 8,456,001 shares of the Registrant's Common Stock,
$0.001 par value, were outstanding.
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TROVER SOLUTIONS, INC.

FORM 10-Q
SEPTEMBER 30, 2003

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, 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 NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(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 NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(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 provides
subrogation and certain other claims recovery and cost containment services, on
an outsourcing basis, to the private healthcare payor industry and the property
and casualty insurance industry. Its primary business is medical claims
recovery, and its primary product is subrogation recovery, i.e., the Company
identifies, investigates and recovers accident-related medical benefits incurred
by its healthcare payor and insurance clients on behalf of their insureds, but
for which other persons or entities have primary responsibility. The Company's
clients' rights to recover the value of these medical benefits, arising by law
or contract, are generally known as the right of subrogation and are generally
paid from the proceeds of liability or workers' compensation insurance. The
Company's other medical claims recovery services include (1) the auditing of the
bills of medical providers, particularly hospitals, for accuracy, correctness
and compliance with contract terms ("provider bill audit"), (2) the recovery of
overpayments attributable to duplicate payments, failures to coordinate benefits
and similar errors in payment ("overpayments"), and (3) the auditing of
physician evaluation and management claims for consistency with medical records,
in accordance with federal guidelines ("MD Audit").

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,
2002, contained in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2002, filed with the Securities and Exchange Commission on
March 27, 2003.

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.

2. STOCK-BASED COMPENSATION

In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure -- an Amendment of SFAS
123" which provides alternative methods for a voluntary change to the fair value
method of accounting for stock-based compensation and amends the disclosure
requirements of SFAS 123. The Company has elected to continue to account for its
stock-based compensation plans under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB No. 25), and related
interpretations. The following disclosures are provided in accordance with SFAS
148.

The Company has various stock-based compensation plans including stock
option plans and an employee stock purchase plan. No stock-based employee
compensation cost is reflected in net income as all options granted under those
plans had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect on net
income and earnings per share if the

4

TROVER SOLUTIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

Company had applied the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" to stock-based employee compensation
(dollars in thousands, except per share results):

3. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In November 2002, the FASB issued Emerging Issues Task Force Issue (EITF)
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables" which
addresses revenue recognition accounting by a vendor for arrangements under
which it will perform multiple revenue-generating activities. The provisions of
this statement are effective for revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have a
significant impact on the Company's financial statements.

In January 2003, the FASB issued FASB Interpretation (FIN) 46,
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51".
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. The Company does not have any
variable interest entities as defined under FIN 46.

In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" which amends and clarifies the
accounting guidance on derivative instruments and hedging activities that fall
within the scope of SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS 149 is effective (1) for contracts entered into or modified
after June 30, 2003, with certain exceptions, and (2) for hedging relationships
designated after June 30, 2003. The Company will apply the provisions of SFAS
149 to future contracts entered into or future hedging relationships.

In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" which
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise was effective for the Company on July 1, 2003. The
adoption of SFAS 150 did not have a significant impact on the Company's
financial statements.

5

TROVER SOLUTIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

4. 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
911,717 and 952,301 shares for the nine months ended September 30, 2003 and
2002, respectively, were not included in the computation of diluted earnings per
common share because their exercise price was greater than the average market
price of the common stock, and therefore the effect would be anti-dilutive.

5. INCOME TAXES

For the three and nine months ended September 30, 2003, the Company accrued
income taxes at a 40.0% effective tax rate. This is a reduction from the
Company's pre-2002 historical effective tax rate due to the implementation of
state tax planning initiatives beginning July 1, 2002.

The Company accrued its income taxes at an effective rate of 38.0% and
38.2% during the three and nine months ended September 30, 2002, respectively.
These rates were lower than the Company's historical effective income tax rate
due to research and experimental tax credits, which included a one-time
recapture for the previous four tax years, and the previously mentioned state
tax planning initiatives implemented in 2002.

6. RELATED PARTY TRANSACTIONS

The Company has entered into a contract for legal services with a
professional service corporation, Sharps & Associates, PSC, an entity owned
solely by one of the Company's officers, Douglas R. Sharps. This arrangement
exists solely for the benefit of the Company. Its purpose is to minimize the
costs of legal services purchased by the Company on behalf of its clients. Mr.
Sharps receives no financial or other personal benefit from his ownership of the
firm. All payments to Sharps & Associates, PSC are reviewed and approved by the
Audit Committee of the Company's Board of Directors. For the three and nine
months ended September 30, 2003, approximately $788,000 and $2.4 million,
respectively, was paid to this law firm for such legal services, including all
employee and other expenses. For the three and nine months ended September 30,
2002, the Company paid this law firm approximately $861,000 and $2.5 million,
respectively, for legal services, including all employee and other expenses.

6

TROVER SOLUTIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

On February 12, 1999, the Board of Directors approved a loan in the amount
of $350,000 to Patrick B. McGinnis, the Chairman and Chief Executive Officer of
the Company, 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, 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. At September 30, 2003 and December 31, 2002, the
promissory note of $886,520 and accrued interest of $85,779 and $39,908,
respectively, were outstanding. Mr. McGinnis used the proceeds of these loans to
repay debts originally incurred by him to pay income taxes related to the
ordinary income deemed to have been received by him on account of common stock
granted to him by the former shareholder of the Company in connection with the
initial public offering of the Company's stock in May 1997, and to purchase
additional stock in the initial public offering.

On June 30, 2000, pursuant to Board authorization and in accordance with
the terms of the Amended Promissory Note, the Company and Mr. McGinnis entered
into a deferred compensation agreement (the "Agreement"). Under the Agreement,
50% of the amount otherwise payable to Mr. McGinnis under the Company's
Management Group Incentive Compensation Plan 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 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
September 30, 2003, the amount of deferred compensation was $182,012, with
accrued interest of $16,140. At December 31, 2002, the amount of deferred
compensation was $72,354 with accrued interest of $7,627.

Effective January 1, 2003, the Company entered into an employment agreement
with Mr. McGinnis. Upon signing the employment agreement, Mr. McGinnis received
a bonus of $200,000. The bonus is subject to full or partial reimbursement by
Mr. McGinnis to the Company, based on the date of termination, if Mr. McGinnis
terminates his employment with the Company during the initial three-year term of
his employment. The bonus payment was recorded in "Other Current Assets" on the
accompanying Condensed Balance Sheets and is being amortized over the term of
the agreement. The unamortized balance at September 30, 2003 and December 31,
2002 was $150,000 and $200,000, respectively.

7

TROVER SOLUTIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

7. PROPERTY AND EQUIPMENT

The property and equipment consists of the following at September 30, 2003
and December 31, 2002 (in thousands):

8. GOODWILL AND OTHER INTANGIBLE ASSETS

Effective January 1, 2002, the Company adopted FAS 142 under which goodwill
is no longer amortized but instead will be assessed for impairment at least
annually. The Company performs its annual impairment review during the second
quarter of each year. The review performed during the quarter ended June 30,
2003 did not result in an impairment charge for the Company. The Company's
reporting units are generally consistent with the operating segments underlying
the segments identified in Note 15 "Segment Information". All recorded goodwill
and other intangible assets relate to the Healthcare Recovery Services segment.

The carrying value of goodwill, net was approximately $29.1 million at
September 30, 2003 and December 31, 2002. There were no goodwill impairment
losses recorded during the three and nine months ended September 30, 2003.

All of the Company's intangible assets (other than goodwill, net) are
subject to amortization. The details of the Company's intangible assets at
September 30, 2003 and December 31, 2002 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.

Amortization expense related to intangible assets for the three and nine
months ended September 30, 2003 was approximately $122,000 and $374,000,
respectively. Over the three months ended December 31,

8

TROVER SOLUTIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

2003 and each of the four succeeding fiscal years, amortization expense related
to intangible assets is expected to be as follows (in thousands):

Three months ended December 31, 2003........................ $122
Year ended December 31,:
2004........................................................ 340
2005........................................................ 327
2006........................................................ 327
2007........................................................ 327

9. 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 September 30, 2003, the fair value of the hedge was a liability of
$114,050 ($68,430, net of tax). At December 31, 2002, the fair value of the
hedge was a liability of $144,804 ($86,882, net of tax).

10. 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"), and the existing Credit Facility was
terminated. 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 September 30, 2003 and December 31, 2002, the interest rate was
2.87% and 3.19%, respectively, based on the one-month Eurodollar Rate plus the
fixed margin. The Revolving Credit Facility contains customary covenants and
events of default including, but not limited to, financial tests for interest
coverage, net worth levels and leverage that may limit the Company's ability to
pay dividends. It also contains a material adverse change clause. At September
30, 2003 and December 31, 2002, $4 million was outstanding under the Revolving
Credit Facility.

11. 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

9

TROVER SOLUTIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

involved in any litigation which resulted in 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.

12. 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 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
terminates the stock repurchase plan. The Company did not repurchase any common
stock during the three months ended September 30, 2003. The Company repurchased
172,622 shares of common stock during the nine months ended September 30, 2003
at a cost of $0.9 million, or an average price of $5.23 per share. From
inception of the program through September 30, 2003, the Company repurchased
3,269,630 shares at a cost of $14.5 million, or an average cost of $4.43 per
share. Except for 9,397 shares previously repurchased but reissued in connection
with an employee restricted stock award, all of the reacquired shares of Common
Stock through September 30, 2003 are reflected as treasury stock on the
accompanying Condensed Balance Sheets (Unaudited).

13. OTHER COMPREHENSIVE INCOME (LOSS)

Other comprehensive income (loss) for the three and nine months ended
September 30, 2003 and 2002 consists of the following (in thousands):

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

10

TROVER SOLUTIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

14. CONCENTRATION OF CLIENTS AND CREDIT RISK

The Company has two clients that individually comprise more than 10% of the
Company's revenue. The Company's largest source of revenue is UnitedHealth Group
("UHG"). For the three and nine month periods ended September 30, 2003, UHG
generated 22% and 25% of the Company's revenues, respectively. Wellpoint Health
Network Inc. accounted for 18% and 16% of the Company's total revenues for the
three and nine months ended September 30, 2003, respectively, as well as 38% and
32% of the Company's accounts receivable balance at September 30, 2003 and
December 31, 2002, respectively. Health Net, Inc. accounted for 9% and 15% of
the Company's accounts receivable balance at September 30, 2003 and December 31,
2002, respectively.

During 2002, UHG management informed the Company of its intention to
terminate subrogation services with respect to all but 1.8 million lives of the
9.7 million lives then subject to the Company's services under a contract with
UHG. UHG's termination of these services resulted from its decision to bring
subrogation recovery services back inside UHG, where they will be performed by
its Ingenix strategic business unit. The Company expects to continue recovering
on the backlog as to which UHG terminated the Company's services, a process that
the Company expects will be completed in 5 to 6 years. The Company's contract
with UHG expired in accordance with its terms on February 1, 2003, except with
respect to 1.8 million lives as to which the Company continues to provide
healthcare subrogation recovery services.

15. SEGMENT INFORMATION

The accounting policies of the Company's reportable segments are the same
as those accounting policies described in the summary of significant accounting
policies in the Company's Annual Report on Form 10-K for the year ended December
31, 2002. The Company has three reportable segments based on qualitative
guidelines. The Company's three segments are: (1) Healthcare Recovery Services,
which encompasses its four healthcare recovery products: healthcare subrogation,
provider bill audit, overpayments and MD Audit; (2) Property and Casualty
Recovery Services, which is subrogation recovery services for property and
casualty insurers, sold under the name TransPaC Solutions; and (3) Software,
which is subrogation recovery software in a browser-based application service
provider (ASP) form, sold under the name Troveris. The segment profit measure is
income before income taxes.

11

TROVER SOLUTIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

Segment results for the three and nine months ended September 30, 2003 and
2002 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

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

The Company believes that 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"), (2) the recovery of overpayments attributable to
duplicate payments, failures to coordinate benefits and similar errors in
payment ("overpayments"), and (3) the auditing of physician evaluation and
management claims for consistency with medical records, in accordance with
federal guidelines ("MD Audit"). 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 Humana Inc., Kaiser
Permanente, Wellpoint Health Network Inc., and The Principal Financial Group.
The Company had 35.0 million and 41.8 million lives under contract from its
clientele at September 30, 2003 and 2002, respectively.

The Company has three segments: (1) Healthcare Recovery Services, which
encompasses its four healthcare recovery products: healthcare subrogation,
provider bill audit, overpayments and MD Audit; (2) Property and Casualty
Recovery Services, which is subrogation recovery services for property and
casualty insurers, sold under the name TransPaC Solutions; and (3) Software,
which is subrogation recovery software in a browser-based application service
provider (ASP) form, sold under the name Troveris.

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
payment of 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

13

the anticipated volume of services. The Company grants volume discounts and, for
its recovery services, negotiates a lower fee when it assumes backlog from a
client because the client will have already completed some of the recovery work.
Because the Company records expenses as costs are incurred and records revenues
only when a file is settled, there is a lag between the recording of expenses
and related revenue recognition.

The Company's expenses are determined primarily by the number of employees
directly engaged in recovery activities ("cost of 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*

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

* All references to "lives" in the table, whether reported as from existing
client loss, added from new contracts with existing clients or with new
clients, lives sold, lives sold eliminations/cross-sold lives, lives
installed, or lives installed eliminations/cross-installed lives, are
derived by the Company from information provided to it by clients, which 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 include the overlap (i.e., "double counting") that occurs
when 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 include the overlap (i.e., "double
counting") that occurs when multiple healthcare recovery services are
provided to the same client population.

14

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) At September 30, 2003 and 2002, approximately $282.1 million and $411.4
million, respectively, of the backlog derived from terminated clients and
clients that, by that date, had given notice of termination. See
"Concentration of Clients".

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

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 2002

Claims Revenues. Total Healthcare Recovery Services revenues for the
quarter ended September 30, 2003 decreased 10.2%, to $15.8 million from $17.6
million for the same quarter of 2002, and for the nine month period ended
September 30, 2003, decreased 6.8%, to $48.6 million from $52.2 million in the
comparable period of 2002. Healthcare claims recoveries for the quarter ended
September 30, 2003 were $58.8 million, a decrease of $3.7 million, or 5.9%,
compared to $62.5 million for the same quarter of 2002. For the nine month
period ended September 30, 2003, healthcare claims recoveries decreased 5.7%, to
$177.1 million from $187.9 million in the comparable period of 2002. The lower
recoveries resulted from two causes. The first is lower throughput (i.e., yield)
from the healthcare subrogation backlog attributable to a shift in its
composition; relative to prior periods, the healthcare subrogation backlog
contains a higher percentage derived from terminated clients. Backlog derived
from terminated clients exhibits a lower throughput rate than does backlog
derived from active clients, whose files are replenished on an on-going basis.
Second, the Healthcare Recovery Services segment had fewer installed lives
during the three and nine months ended September 30, 2003 because of attrition
from client terminations, including the UnitedHealth Group termination (see
"Concentration of Clients"), and organic losses of client lives.

The Healthcare Recovery Services effective fee rate for the quarter ended
September 30, 2003 decreased to 26.9% from 28.2% for the same quarter of 2002,
and was 27.5% for the nine month period ended September 30, 2003, compared to
27.9% for the same period in 2002. The decrease in fee rate for the quarter
ended September 30, 2003 was primarily attributable to a shift in the mix of
recoveries, with relatively more recoveries coming from lower priced contract
arrangements.

Backlog for the Healthcare Recovery Services segment decreased to $1,486.1
million at September 30, 2003 from $1,531.0 million at September 30, 2002, a
decrease of 2.9%. The provider bill audit services backlog increased
approximately $62.5 million while the healthcare subrogation backlog decreased
approximately $109.7 million.

The Healthcare Recovery Services segment had a throughput rate of
approximately 3.8% and 4.1% of average backlog during the third quarter of 2003
and 2002, respectively. The decrease in throughput from the quarter ended
September 30, 2002 results from two causes. The first is the effect of a
continuing shift in the backlog mix, with a greater percentage of backlog and
recoveries coming from provider bill audit, which typically exhibits a lower
throughput rate than does healthcare subrogation. Second, as discussed above,
the healthcare subrogation backlog at September 30, 2003 contains, relative to
prior periods, a higher percentage

15

of files derived from terminated clients which exhibit a lower throughput rate
than backlog derived from active clients. Throughput for the nine month period
ended September 30, 2003 also decreased to 11.6% from 12.8% for the comparable
period in 2002, for the same reasons described above. Lives installed decreased
7.3 million from 40.8 million at September 30, 2002 to 33.5 million at September
30, 2003 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 decreased 9.8% for the quarter ended September 30, 2003 to $7.4 million,
from $8.2 million for the same quarter in 2002, and was $22.9 million for the
nine months ended September 30, 2003, a decrease of 5.8% from $24.3 million for
the same period in 2002. As a percentage of claims revenues, cost of revenues
decreased to 46.7% for the quarter ended September 30, 2003 compared to 46.8%
for the same quarter in 2002. For the nine months ended September 30, 2003, cost
of revenues as a percentage of claims revenues increased to 47.1% from 46.7% in
2002, due primarily to a greater percentage of the revenue and recoveries coming
from the provider bill audit division. The provider bill audit product has a
lower gross margin than does the healthcare subrogation product.

Support Expenses. Support expenses for the Healthcare Recovery Services
segment were $1.0 million and $1.2 million for the quarters ended September 30,
2003 and 2002, respectively, and were $2.8 million for the nine months ended
September 30, 2003 compared to $3.2 million for the comparable period in 2002.
Support expenses decreased as a percentage of claims revenues from 6.8% for the
third quarter of 2002 to 6.4% for the same quarter in 2003. For the nine months
ended September 30, 2003, support expenses as a percentage of claims revenues
were 5.8%, a decrease from 6.1% for the comparable period in 2002. The decrease
in support expenses resulted primarily from a decrease in incentive compensation
in the nine months ended September 30, 2003 as compared to the nine months ended
September 30, 2002.

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 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,
the Company believes that there is an opportunity to increase total subrogation
recoveries across a wide spectrum of automobile insurers. The Company's
marketing strategy is to offer its services to automobile insurers and
multi-lines carriers that 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 several of its 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 by law
firms that specialize in a low volume of legally complex subrogation claims. The
Company has identified three competitors that attempt to serve a national
market. Two of these competitors are owned and controlled by P&C insurers, and
the Company believes that this fact may deter potential buyers of these
competitors' services if those potential buyers also compete against the
competitors' parent organizations.

16

The Company currently provides subrogation outsourcing services to 17 P&C
insurers, of which 3 are full outsource clients with the remainder being clients
for either referral services, in which the Company supplements the capacity of
an internal recovery unit, or closed claims reviews, in which the Company
recovers subrogation claims missed or ignored by an internal recovery unit. The
Company has established a full-time direct sales force of four individuals
experienced in P&C sales and marketing. The Company's target market for its P&C
subrogation services is P&C insurers that are personal lines automobile carriers
or that are multi-lines carriers which focus on automobile coverage, as well as
entities that self-insure P&C liabilities and third party administrators of P&C
claims.

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.

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

(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 NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 2002

Claims Revenues. Total Property and Casualty Recovery Services revenues
for the quarter ended September 30, 2003 increased approximately $23,000, or
11%, from the same quarter in 2002 and increased 86% to $745,000 for the nine
month period ended September 30, 2003 from $400,000 in the comparable period of
2002. Property and Casualty Recovery Services claims recoveries for the quarter
ended September 30, 2003 were $1.2 million, an increase of $0.4 million over the
same quarter in 2002. For the nine months
17

ended September 30, 2003, claims recoveries increased 125% to $3.6 million from
$1.6 million during the comparable period in 2002.

The Property and Casualty Recovery Services effective fee rate for the
quarter ended September 30, 2003 decreased to 19.6% from 25.8% for the same
quarter of 2002 and decreased to 20.5% for the nine months ended September 30,
2003 as compared to 25.6% for the same period in 2002. 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 over the past eighteen months.

Backlog. Backlog for the Property and Casualty Recovery Services segment
increased to $18.4 million at September 30, 2003 from $14.5 million at September
30, 2002 due to the creation of additional backlog related to a significant
outsourcing contract which was entered into in late June 2002.

The Property and Casualty Recovery Services segment had a throughput rate
of approximately 7.1% of average backlog during the quarters ended September 30,
2003 and 2002. Throughput for the nine month period ended September 30, 2003
increased to 21.6% from 17.4% for the comparable period of 2002. The increase
was due to recoveries growing more quickly than the average backlog over the
nine month period ended September 30, 2003 because of a significant increase to
backlog in 2002 which did not begin to produce significant recoveries until
2003.

Cost of Revenues. Cost of revenues for the Property and Casualty Recovery
Services segment increased 33% for the quarter ended September 30, 2003 to $0.4
million, from $0.3 million for the same quarter in 2002, and was $1.1 million
for the nine months ended September 30, 2003, an increase of 38% from $0.8
million for the same period in 2002. The increase in cost of revenues results
from production expenses that are incurred prior to the recognition of revenue,
which reflects the nature of the subrogation business. As a percentage of claims
revenues, cost of revenues were 180% for the quarter ended September 30, 2003
compared to 127% for the same quarter in 2002. For the nine months ended
September 30, 2003, the cost of revenues as a percentage of revenue decreased to
152% from 189% in 2002. The decrease in cost of revenues as a percentage of
claims revenues for the nine months ended September 30, 2003 resulted from the
increase in revenue described above.

Support Expenses. Support expenses for the Property and Casualty Recovery
Services segment were $0.1 million for the quarters ended September 30, 2003 and
2002, and were $0.3 million for the nine months ended September 30, 2003 and
2002. Support expenses decreased as a percentage of claims revenues from 44% for
the third quarter of 2002 to 39% for the same quarter in 2003. For the nine
months ended September 30, 2003, support expenses as a percentage of claims
revenues were 37%, a decrease from 80% in the comparable period of 2002. The
decrease in support expenses as a percentage of claims revenues resulted from
the increase in revenue described above.

SOFTWARE

OVERVIEW OF OPERATIONS

The Company has developed a web-enabled subrogation software application.
The Company sells 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 that
mutual insurers have organizational and cultural biases against outsourcing and
larger P&C insurers have sufficient resources to develop relatively
sophisticated internal departments. In June 2002, the Company made its first
sale of the Troveris

18

software to an outside client (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 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 has reduced expenses for maintaining software
applications that it uses to provide turnkey outsourcing services.

In addition to being offered for sale as an on-line subrogation recovery
system in an ASP-model, Troveris also constitutes the systems platform for the
Company's recovery operations. All of those operations are currently conducted
on Troveris. The Company began to migrate its internal healthcare subrogation
operations to a version of Troveris during the fourth quarter of 2001, at which
time it anticipated reducing its technology expense, net of the expense of
maintaining the Troveris application, by at least $600,000 per year. At present,
substantially all of that expense reduction has been captured and is included in
the Company's guidance for 2003 financial results. The Company completed the
migration to Troveris in the third quarter of 2003. The Troveris application
also enables the Company to expand its ability to manage its knowledge workers
via telecommuting arrangements. While the Company believes it can continue to
achieve the reduced level of maintenance expenses, 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,
2002.

The Company has identified one competitor offering subrogation software in
an ASP model for the healthcare payor industry, and one large competitor in the
P&C insurance industry. The P&C 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 NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 2002

Revenue. Revenue for the Software segment increased $269,000, or 116%, for
the quarter ended September 30, 2003 compared to the quarter ended September 30,
2002. For the nine months ended September 30, 2003, revenue increased to $1.2
million from $512,000 for the comparable period in 2002. All but $20,000 and
$52,000 of the revenue for the three and nine months ended September 30, 2003,
respectively, was derived from internal clients (i.e., the Healthcare Recovery
Services and Property and Casualty Services segments). For the three and nine
months ended September 30, 2002, all but $1,000 of the revenue was derived from
internal clients.

Cost of Revenues. Cost of revenues for the Software segment for the three
months ended September 30, 2003 was approximately $229,000, an increase of
$67,000, or 41%, over the comparable period in 2002. This includes approximately
$214,000 and $126,000 for the three months ended September 30, 2003 and 2002,
respectively, of depreciation and amortization of software in service.
Approximately $15,000 and $36,000 of the cost of revenues for the three months
ended September 30, 2003 and 2002, respectively, relate to the support and
maintenance of the software. For the nine months ended September 30, 2003, cost
of revenues was $724,000, an increase of 70% from $425,000 for the nine months
ended September 30, 2002. Depreciation and amortization of software in service
comprised $601,000 and $313,000 of the cost of revenues for the nine months
ended September 30, 2003 and 2002, respectively. Approximately $123,000 and
$112,000 of the cost of revenues for the nine months ended September 30, 2003
and 2002, respectively, relate to the support and maintenance of the software.

19

Support Expenses. For the three months ended September 30, 2003 and 2002,
the Software segment incurred approximately $559,000 and $525,000, respectively,
in expenditures in connection with the creation of new products for the
insurance industry. Approximately $191,000 and $328,000 of support expenditures
were capitalized in the quarters ended September 30, 2003 and 2002,
respectively, resulting in net reported support expenses of approximately
$368,000 and $197,000, respectively. For the nine months ended September 30,
2003 and 2002, approximately $1.6 million and $1.4 million, respectively, in
expenditures were incurred in connection with the creation of new products for
the insurance industry. Approximately $636,000 and $874,000 of support
expenditures were capitalized during the nine months ended September 30, 2003
and 2002, respectively, resulting in net reported support expenses of $947,000
and $559,000, respectively.

ENTIRE COMPANY

EMPLOYEES

STATEMENTS OF INCOME AS A PERCENTAGE OF REVENUES

Depreciation and Amortization. Depreciation and amortization expense
decreased 32.4% to $803,000 for the quarter ended September 30, 2003 from $1.2
million for the same quarter in 2002, and decreased 29.5% to $2.6 million for
the nine months ended September 30, 2003 from $3.7 million for the comparable
period in 2002. The decreases were due to a significant number of fixed assets
acquired in 1997 becoming fully depreciated during the twelve months ended
September 30, 2003.

Interest Income. Interest income decreased 40.3%, or $27,000, for the
quarter ended September 30, 2003 as compared to the same quarter in 2002. For
the nine months ended September 30, 2003, interest income decreased $63,000, or
32.6%, from $193,000 to $130,000. The decreases were due primarily to lower
interest rates.

Interest Expense. Interest expense totaled approximately $105,000 for the
quarter ended September 30, 2003, a decrease of 8.7%, or $10,000, from the
quarter ended September 30, 2002. For the nine months ended September 30, 2003,
interest expense decreased 18.5% to $309,000 from $379,000 in the comparable
period in 2002. The decreases in interest expense for the three and nine months
ended September 30, 2003, as compared with the same periods in 2002, were
primarily due to a decrease in borrowed funds during the 2003 periods.

20

Tax. For the three and nine months ended September 30, 2003, the Company
accrued income taxes at a 40.0% effective tax rate. This is a reduction from the
Company's pre-2002 historical effective tax rate due to the implementation of
state tax planning initiatives beginning July 1, 2002.

The Company accrued its income taxes at an effective rate of 38.0% and
38.2% during the three and nine months ended September 30, 2002, respectively.
These rates were lower than the Company's historical effective income tax rate
due to research and experimental tax credits, which included a one-time
recapture for the previous four tax years, and state tax planning initiatives
implemented in 2002.

Net Income. Net income for the quarter ended September 30, 2003 decreased
$310,000, or 17.3%, to $1.5 million, or $0.17 per diluted common share, from
$1.8 million, or $0.19 per diluted common share, for the comparable quarter in
2002. For the nine months ended September 30, 2003, net income decreased 9.1% to
$4.6 million, or $0.53 per diluted common share, from $5.1 million, or $0.53 per
diluted common share, for the comparable period in 2002. The diluted earnings
per share were the same for the nine months ended September 30, 2003 and 2002
because the number of diluted shares outstanding decreased between the two
periods as a result of the Company's stock repurchase plan. See "-- Stock
Repurchase Plan".

LIQUIDITY AND CAPITAL RESOURCES

The Company's statements of cash flows for the nine months ended September
30, 2003 and 2002 are summarized below:

The Company had working capital of $13.9 million at September 30, 2003,
including cash and cash equivalents of $6.7 million, compared with working
capital of $8.8 million at December 31, 2002. The primary reason for the
increase in working capital was the accumulation of cash generated from
operating activities, coupled with the reduction in the amount of stock
repurchased during the nine months ended September 30, 2003 compared to the nine
months ended September 30, 2002.

Net cash provided by operating activities was $7.4 million, a decrease of
$2.4 million for the nine months ended September 30, 2003, compared to the same
nine months in 2002. A decrease in accrued expenses primarily as a result of
payment of more incentive compensation during the first nine months of 2003
compared to 2002, was off-set by a decrease in accounts receivable, caused by
improved collections. In addition, net income plus depreciation and amortization
is approximately $1.3 million less for the nine months ended September 30, 2003
compared to the same period in 2002.

Net cash used in investing activities includes purchases of property and
equipment principally related to the development of and conversion to the
Troveris software. During the nine month periods ended September 30, 2003 and
2002, the Company capitalized approximately $0.9 million and $1.5 million of
internally-developed software, respectively.

Net cash used in financing activities for the nine months ended September
30, 2003 and 2002, reflects $0.9 million and $5.1 million in treasury stock
purchases, respectively. During the nine months ended September 30, 2002, the
Company paid down a net of $2.5 million on its long-term borrowings.

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
21

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 September 30, 2003 and December 31, 2002, the interest rate was
2.87% and 3.19%, respectively, based on the one-month Eurodollar Rate plus the
fixed margin. The Revolving Credit Facility contains customary covenants and
events of default including, but not limited to, financial tests for interest
coverage, net worth levels and leverage that may limit the Company's ability to
pay dividends. It also contains a material adverse change clause. At September
30, 2003 and December 31, 2002, $4 million was outstanding under the Revolving
Credit Facility. (See Item 1. "Financial Statements (Unaudited) -- Note
9 -- Derivatives and Note 10 -- Credit Facility".)

At September 30, 2003 and December 31, 2002, the Company reported on its
balance sheets, as a current asset, restricted cash of $17.8 million. Restricted
cash at September 30, 2003 and December 31, 2002 represented claims recoveries
by the Company for its clients. At September 30, 2003 and December 31, 2002, the
Company reported on its balance sheets, as a current liability, funds due
clients of $12.4 million, representing claims recoveries to be distributed to
clients, net of the fee earned on such recoveries.

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

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 September 30,
2003 covered approximately 35.0 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 source of
revenue is UnitedHealth Group ("UHG"). For the nine month periods ended
September 30, 2003 and 2002, UnitedHealth Group generated 25% and 27% of the
Company's revenues, respectively. Wellpoint Health Network Inc. accounted for
16% and 14% of the Company's total revenues for the nine months ended September
30, 2003 and 2002, respectively, as well as 38% and 32% of the Company's
accounts receivable balance at September 30, 2003 and December 31, 2002,
respectively. Health Net, Inc. accounted for 9% and 15% of the Company's
accounts receivable balance at September 30, 2003 and December 31, 2002,
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
22

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 September
30, 2003, the Company had Healthcare Recovery Services backlog of $1,486.1
million.

During 2002, UHG management informed the Company of its intention to
terminate subrogation services with respect to all but 1.8 million lives of the
9.7 million lives then subject to the Company's services under a contract with
UHG. UHG's termination of these services resulted from its decision to bring
subrogation recovery services back inside UHG, where they will be performed by
its Ingenix strategic business unit. The Company expects to continue recovering
on the backlog as to which UHG terminated the Company's services, a process that
the Company expects will be completed in 5 to 6 years. The Company's contract
with UHG expired in accordance with its terms on February 1, 2003, except with
respect to 1.8 million lives as to which the Company continues to provide
healthcare subrogation recovery services.

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, capitalization of software
costs, 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, 2002, filed with the Securities and
Exchange Commission on March 27, 2003. During the nine months ended September
30, 2003, 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 November 2002, the FASB issued Emerging Issues Task Force Issue (EITF)
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables" which
addresses revenue recognition accounting by a vendor for arrangements under
which it will perform multiple revenue-generating activities. The provisions of
this statement are effective for revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have a
significant impact on the Company's financial statements.

In January 2003, the FASB issued FASB Interpretation (FIN) 46,
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51".
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. The Company does not have any
variable interest entities as defined under FIN 46.

In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" which amends and clarifies the
accounting guidance on derivative instruments and hedging activities that fall
within the scope of SFAS 133, "Accounting for Derivative Instruments and
23

Hedging Activities". SFAS 149 is effective (1) for contracts entered into or
modified after June 30, 2003, with certain exceptions, and (2) for hedging
relationships designated after June 30, 2003. The Company will apply the
provisions of SFAS 149 to future contracts entered into or future hedging
relationships.

In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" which
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise was effective for the Company on July 1, 2003. The
adoption of SFAS 150 did not have a significant impact on the Company's
financial statements.

EVALUATION OF STRATEGIC ALTERNATIVES

As previously announced in a press release issued August 1, 2003, the
Company's Board of Directors has formed a Special Committee to evaluate
strategic alternatives available to the Company, including a leveraged
recapitalization, a sale of all or any portion of the Company to a third party,
or the formation of an employee stock ownership plan which would acquire the
Company. The Special Committee has engaged Houlihan Lokey Howard and Zukin as
its financial advisor.

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. During the quarter ended September 30, 2003, the Company did
not repurchase any shares of common stock. The Company repurchased 172,622
shares of common stock during the nine months ended September 30, 2003 at a cost
of $0.9 million, or an average price of $5.23 per share. From inception of the
program through September 30, 2003, the Company repurchased 3,269,630 shares at
a cost of $14.5 million, or an average cost of $4.43 per share. Except for 9,397
shares previously repurchased but reissued in connection with an employee
restricted stock award, all of the reacquired shares of Common Stock through
September 30, 2003 are reflected as treasury stock on the accompanying Condensed
Balance Sheets (Unaudited).

During the term of the Special Committee, the Company does not anticipate
repurchasing shares of its common stock.

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 value of any debt on the Company's balance sheets are
subject to change as a result of movements in market rates and prices as the
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 2003. As of
September 30, 2003, the Company had $4 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 the entire $4 million of the
Revolving Credit Facility at 5.41% or 5.66% (contingent on the status of a
financial ratio). See Item 1. "Financial Statements (Unaudited) -- Note
9 -- Derivatives" and "-- Note 10 -- Credit Facility" and Item 2. "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources".

ITEM 4. CONTROLS AND PROCEDURES

As required by Securities and Exchange Commission rules, the Company's
management, with the participation of the Company's Chief Executive Officer and
Chief Financial Officer, has evaluated the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as defined in
24

Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of
the end of the period covered by this quarterly report. Based on that
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
have concluded that the design and operation of the Company's disclosure
controls and procedures are effective. The Company's management, including the
Chief Executive Officer and Chief Financial Officer, also conducted an
evaluation of the Company's internal control over financial reporting to
determine whether any changes occurred during the quarter covered by this report
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting. Based on that
evaluation, there has been no such change during the quarter covered by this
report.

25

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. Consequently, since its founding in 1988 the
Company has been involved with many litigation matters related to its
subrogation business, sometimes as a defendant and sometimes through a defendant
client. The 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 pending 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 these five 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 of those five lawsuits pled as class actions and naming the Company
as a defendant were filed in federal court and 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.

The remaining three lawsuits did not name the Company as a defendant. These
three lawsuits did, however, involve the Company's clients and implicate
important Company 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 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.

26

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

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 the plaintiff asserts 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 November 1999, and has answered, denying all allegations.
After the defendants filed a motion for summary judgment in January 2002, the
plaintiff moved the court to delay consideration of the motion until the
plaintiff could complete additional discovery. The plaintiff's motion to delay
consideration was granted. On October 25, 2002, the plaintiff filed an amended
petition naming one additional plaintiff as a purported class representative.
The amended petition does not add any new claims. The defendants filed a motion
for summary judgment on January 24, 2003, and the plaintiffs filed a cross
motion for summary judgment. On February 25, 2003, a state court judge denied
the defendants' motion for summary judgment that the defendants were entitled to
enforce the terms of Prudential's policies. The same judge granted the
plaintiffs' motion for summary judgment to the extent that Prudential could not
recover more than its costs. The plaintiffs have not yet moved the court to
certify the case as a class action.

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

In December 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. In January 2000,
the defendant Companion Healthcare Corp. ("CHC") filed an Answer and
Counterclaim and the 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 the plaintiffs assert are unenforceable because
(1) prepaid medical service plans may not exercise rights of subrogation and
reimbursement; (2) the subrogation and

27

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. The
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 and in June 2001 the court
granted the Company's motion to dismiss. The plaintiffs filed a notice of appeal
in July 2001. All parties have filed briefs, but the appellate court has not yet
ruled on the 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, the 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 the 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. The
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. The
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. In July 2001, the court granted a
motion for summary judgment filed by the Company as concerned the plaintiff's
Fair Debt Collection Practices Act ("FDCPA") 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. In August 2001, the court ruled that it
lacked subject matter jurisdiction, thus dismissing the remaining claims,
without prejudice. The plaintiff filed an appeal to the United States Fifth
Circuit Court of Appeals. In November 2002, the Court of Appeals rendered its
opinion reversing the dismissal of the FDCPA claims. The court also affirmed the
trial court's determination that diversity jurisdiction did not exist in the
case. The court remanded the case to the federal district court for further
proceedings. On April 29, 2003, the Company filed a Petition for Writ of
Certiorari asking the U.S. Supreme Court to accept an appeal of the Court of
Appeals ruling. The Supreme Court denied the Petition on June 9, 2003.

After the case was remanded to the trial court, the Company filed a second
Motion for Summary Judgment. On May 13, 2003, the Court entered an Order
granting the Company's Motion for Summary Judgment, dismissing with prejudice
the Plaintiff's claims under the FDCPA and dismissing without prejudice the
Plaintiff's remaining state law claims. On May 27, 2003, the plaintiff filed a
Notice of Appeal to the United States Fifth Circuit Court of Appeals. On August
18, 2003, the Company filed its Appellate brief. A hearing before a panel of the
United States Fifth Circuit Court of Appeals is set for December 3, 2003.

The Company disputes the plaintiff's allegations regarding the
applicability of the FDCPA and intends to vigorously defend its position in this
case.

28

In addition to filing the appeal in federal court, the Hamilton plaintiff
in October 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. In November 2001,
the Company filed preliminary exceptions to this new complaint. There were no
further proceedings in the case until March 2003 when the Company filed a motion
to stay any further proceedings in that case due to the related case pending in
federal court. On April 25, 2003, the state court entered an order granting the
Company's motion to stay the lawsuit. Thereafter, the Company removed the case
from state court to Federal court on August 5, 2003. On September 4, 2003, the
plaintiff filed a Motion to Remand the case back to state court, and on
September 22, 2003, the Company filed an Opposition to the plaintiff's Motion to
Remand. The Court has not yet ruled upon the Motion to Remand. In the interim,
the Federal court consolidated the removed lawsuit with the pending federal
court case, Hamilton v. Healthcare Recoveries, Inc., Case Number 01-650,
currently on appeal to the United States Fifth Circuit Court of Appeals, as
described above.

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 asserted 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 disputed the
plaintiff's allegations and each defendant filed a motion to dismiss the action.
In October 2002, the Court granted each of the defendants' motions and dismissed
the plaintiff's action entirely. The plaintiff subsequently filed an appeal and,
on June 20, 2003, the Appellate Court entered an order affirming the trial
court's ruling. On July 3, 2003, the plaintiff filed a motion seeking leave to
appeal the case to the Illinois Supreme Court. On October 7, 2003, the Illinois
Supreme Court denied the plaintiff's motion. No further potential appeals are
available to the plaintiff and the case has been finally dismissed with
prejudice.

CHAN V. TROVER SOLUTIONS

On November 19, 2002, a Complaint ("Complaint") was filed against the
Company in the Superior Court of the State of California for the County of Los
Angeles in a putative class action brought by Roger Chan. In that action, Roger
Chan v. Healthcare Recoveries, Inc. and Trover Solutions, Inc. and Does 1
through 100, inclusive, No. CV 03-0465 FMC, the plaintiff asserts that the
Company's subrogation recovery efforts violate California's unfair trade
practices statute by pursuing recovery from ERISA members' personal injury
recoveries when case law allegedly held that ERISA plans could not enforce their
recovery rights. The Company timely removed the action to federal court and
filed a motion to dismiss. The plaintiff filed a motion to remand the case back
to the state court. On March 3, 2003, the Court entered an order denying the
plaintiff's motion to remand and denying the defendant's motion to dismiss. In
June 2003, the plaintiff and the Company agreed to settle all claims in the case
in exchange for payment of $7,000 from the Company to the plaintiff. The
settlement was approved by the court on September 3, 2003 and is now final.

BRUUN ET AL. V. PRUDENTIAL HEALTH CARE PLAN, PRUDENTIAL INSURANCE COMPANY OF
AMERICA, AETNA, INC. AND TROVER SOLUTIONS

On October 30, 2002, the Cajas and Franks plaintiff's counsel filed a class
action lawsuit in the United States District Court for the District of New
Jersey on behalf of two Texas residents against the Company, one of the
Company's clients, Prudential Insurance Company, a subsidiary of the client,
PruCare HMO, and a company which had acquired the business of the client
company, Aetna. The complaint was served on the Company on February 27, 2003.

29

In the complaint, plaintiffs Kimberly Bruun and Ashley Emanis, on behalf of
themselves and similarly situated persons, asserted claims on behalf of a
nationwide class of persons who were members of PruCare HMO health plans
governed by ERISA from whom the Company, under its contract with the client,
recovered reimbursement. The complaint alleged that reimbursement recoveries
made by PruCare HMO and the Company violate the terms of the standard PruCare
HMO plan documents, and that reimbursement recoveries violate the Conformity
with Law provision in the standard plan documents because subrogation and
reimbursement are prohibited under the federal HMO Act. The complaint further
alleged that the defendants' subrogation and reimbursement recoveries resulted
in a double recovery to PruCare HMO because PruCare HMO did not account for
subrogation and reimbursement recoveries as offsets to expenses when setting
premium rates. The complaint further alleged that the defendants improperly
recovered in subrogation or reimbursement for services provided by capitated
providers, or that in the alternative, the defendants improperly recovered more
for capitated services than was paid for the services, or alternatively, that
the defendants improperly collected amounts that exceeded the reasonable cash
value of capitated services. The plaintiffs allege that PruCare HMO, Prudential,
Aetna and the Company are fiduciaries and that they each have breached their
fiduciary duty to the plaintiffs. Alternatively, the plaintiffs allege that if
Aetna, Prudential and the Company are not fiduciaries, that they knowingly
participated in PruCare HMO's breach of fiduciary duty.

The plaintiffs, on behalf of the class, demand enforcement of the plan
documents under certain sections of ERISA. The plaintiffs also demand
restitution and disgorgement of sums recovered by defendants and the
establishment of a constructive trust. The plaintiffs also demand an accounting
of PruCare HMO's and Aetna's rate documents, the subrogation and reimbursement
claims for capitated services, and/or the actual costs paid by PruCare HMO and
Aetna for the capitated services.

On April 16, 2003, the defendants filed motions seeking to dismiss the
lawsuit or to change the venue of the lawsuit to a federal court in Texas. On
October 16, 2003, the court entered an order granting the defendants' motions to
dismiss and dismissing all of the plaintiff's claims. The period of time in
which plaintiffs may file an appeal has not yet expired.

GODAIR V. AMERICAN HOME ASSURANCE COMPANY, TROVER SOLUTIONS, AND HMO PARTNERS

On March 14, 2003, Lawrence Godair, the plaintiff in a putative class
action against a motor vehicle insurer, amended his complaint to add the
Company, and a client of the company, HMO Partners, as defendants in Lawrence
Godair v. American Home Assurance Company, Trover Solutions, Inc. and HMO
Partners, Inc., No. 4:02 CV 00407 SMR, United States District Court for the
Eastern District of Arkansas, Western Division. In the amended complaint (the
"Amended Complaint"), the plaintiff makes allegations on behalf of himself and a
purported class of others similarly situated. The complaint asserts that the
Company, as subrogation agent for HMO Partners, unlawfully demanded payment of a
subrogation claim against proceeds of a medical payments insurance policy issued
to the plaintiff by American Home. The Amended Complaint also alleges that the
Company was unjustly enriched because the plaintiff was not fully compensated
("made whole") for his injuries in violation of the Arkansas no-fault motor
vehicle insurance statute and because the payment constituted a double recovery
to the Company and to HMO Partners, in violation of the Arkansas Health
Maintenance Organizations Act. The Amended Complaint further alleges that in
recovering the subrogation claim the Company acted negligently, that it
interfered with the plaintiff's contractual relationship with the motor vehicle
insurer and that the Company may be directly or vicariously liable for the acts
of other defendants. The Amended Complaint demands relief on behalf of a
purported class of persons who purchased medical payments coverage as required
by the Arkansas no-fault motor vehicle insurance statute and who were entitled
to but did not receive benefits under such policies due to the payment of those
benefits to third parties, including the Company and HMO Partners. The Amended
Complaint demands compensatory and punitive damages, 12% statutory penalties,
costs, expenses, interest and attorney's fees.

The Company was served with the Amended Complaint on March 18, 2003 and
filed an Answer denying the plaintiff's claims on May 5, 2003. The Company
intends to vigorously defend itself against these allegations. The Company and
the plaintiff are currently engaged in the discovery process.
30

The Cajas, Martin or Bruun 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 Cajas, Martin, Hamilton, and Bruun 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. Based on the current disposition of these lawsuits, the
Company regards such an adverse outcome to be a remote possibility.

In terms of the Company's business practices and the allegations underlying
the Cajas, Martin and Bruun 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.

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
(incorporated by reference to Exhibit 3.1 of the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002).
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).
31.1 -- Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 -- Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.

31

32 -- Certifications Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
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, 2002).

(b) Reports on Form 8-K

32

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: November 14, 2003 /s/ PATRICK B. MCGINNIS
--------------------------------------------------------
Patrick B. McGinnis
Chairman, President and Chief Executive Officer

Date: November 14, 2003 /s/ DOUGLAS R. SHARPS
--------------------------------------------------------
Douglas R. Sharps
Executive Vice President and Chief Financial Officer
Principal Financial and Accounting Officer