SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended September 30, 2004

OR

For the transition period from _________ to ________

Commission file number 0-13591

HEALTHAXIS INC.

5215 N. O’Connor Blvd., 800 Central Tower, Irving, Texas 75039
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number, including area code: (972) 443-5000

Former name, former address and former fiscal year, if changed since last report: N/A

     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]

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 2,768,291 shares of common stock, par value $.10, outstanding as of November 5, 2004.

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Healthaxis Inc.

Table of Contents

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PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Healthaxis Inc. and Subsidiaries

See notes to unaudited consolidated financial statements.

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Healthaxis Inc. and Subsidiaries

See notes to unaudited consolidated financial statement

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Healthaxis Inc. and Subsidiaries

See notes to unaudited consolidated financial statement

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Healthaxis Inc. and Subsidiaries

Note A – Description of business and basis of presentation

Unaudited Financial Information

     The unaudited condensed consolidated financial statements have been prepared by Healthaxis Inc. and its subsidiaries (“Healthaxis” or the “Company”), pursuant to the rules and regulations of the Securities and Exchange Commission and reflect all adjustments consisting of normal recurring entries, which, in the opinion of the Company, are necessary to present fairly the results for the interim periods. The interim financial statements do not include all disclosures provided in fiscal year end financial statements prepared in accordance with accounting principles generally accepted in the United States, although the Company believes that the accompanying disclosures are adequate to make the information presented not misleading. Results of operations for the nine-month period ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

     These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

General

     Healthaxis is a technology-enhanced provider of fully-integrated claims related solutions and services for health benefit administrators and health insurance claim processors. These solutions, which are comprised of software products and related business process services, are designed to assist health insurance payers and third party administrators (“TPA”) to provide enhanced claims related services to members, employees, employers and providers at lower cost. These services are provided through the application of Healthaxis’ flexible technology, either on a fully integrated or on an Application Service Provider (“ASP”) basis. These technology solutions are complemented by Healthaxis’ Business Process Outsourcing (“BPO”) services, which are offered to the Company’s technology clients, as well as on a stand-alone basis. BPO solutions include mailroom services and the automated capture, imaging, storage and retrieval of electronic claims, attachments, and related correspondence, in addition to rules-based claims pre-adjudication and automated PPO routing and repricing. Healthaxis uses its deep domain expertise in health insurance operations to surround the payment of a health insurance claim, to customize services to meet the specific needs of its customers and to produce value for those customers by tapping unrealized potential in the customers’ operations to achieve the best results.

Earnings Per Share

     Basic earnings per share is computed on the weighted average number of common shares outstanding, while the dilutive effect of convertible preferred stock, stock options and warrants is excluded. Diluted earnings per share is computed to show the dilutive effect, if any, of convertible preferred stock, stock options and warrants using the treasury stock method based on the average market price of the stock during the respective periods. The effect of including the convertible preferred stock, stock options and warrants, totaling 6,082,159 and 2,571,902 as of September 30, 2004 and 2003 respectively, into the computation of diluted earnings per share would be anti-dilutive. Accordingly, these items have not been included in the computation. Following is a summary of these securities:

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Stock-Based Compensation

     The Company has elected to continue to utilize the accounting method prescribed by APB Opinion No. 25 “Accounting for Stock Issued to Employees” (APB 25), and provide the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS 148”). Although the Company selected an accounting policy which requires only the excess of the market value of its common stock over the exercise price of options granted to be recorded as compensation expense (intrinsic method), pro forma information regarding net loss is required as if the Company had accounted for its employee stock options under the fair value method of SFAS 123. Pro forma net loss applicable to the option granted is not likely to be representative of the effects on reported net loss for future years. The fair value for these options is estimated at the date of grant using a Black-Scholes option pricing model. Stock compensation determined under the intrinsic method is recognized over the vesting period using the straight-line method.

     Had compensation cost for the Company’s stock option grants been determined based on the fair value at the date granted in accordance with the provisions of SFAS 123, the Company’s net loss and net loss per common share would have been increased to the following pro forma amounts:

     The Company granted 1,850 options in the third quarter 2004. The fair value of the options and warrants granted are estimated on the date of grant using the Black-Scholes option-pricing model. The major assumptions used include no dividends paid, a weighted average expected life of three years, expected stock volatility of 69% and risk free interest rates ranging from 2.75% to 3.09%. The weighted-average grant-date fair value of options granted is $1.02.

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Goodwill

     The carrying value of goodwill at September 30, 2004 is $11.3 million. The Company performs its annual impairment review during the fourth quarter of each year or upon the occurrence of any event that indicates potential impairment. It is possible that the carrying amount of goodwill could be effected in the near term because of the impact that the Company’s continued operating losses could have on the estimates used by management to calculate the fair value of the reporting units.

Segments

     The Company has historically presented information regarding its two segments based on the Company’s internal organizational structure and financial reporting. During the first quarter of 2004, the Company re-aligned its operations under a single operating manager and further consolidated its operations. As a result of this change, the Company now produces consolidated information on the operations of the Company (excluding sales, general and administrative), which is regularly reviewed by the executive management committee of the Company in assessing performance and as an aid in making decisions about how resources are allocated. Accordingly, the Company no longer has reportable segments and has discontinued disclosure of segment information for all periods.

Note B – Recently Adopted Accounting Pronouncements

     On May 19, 2004, the FASB issued Staff Position No. FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”, (“FSP No. 106-2”). FSP No. 106-2 is effective for the first interim period beginning after June 15, 2004 and provides that an employer shall measure the accumulated plan benefit obligation (“APBO”) and net periodic postretirement benefit cost taking into account any subsidy received under the Act. The adoption of the Statement did not have a material impact on the Company’s financial condition, results of operations or liquidity.

Note C – Post Retirement Benefits

     Healthaxis has an obligation to provide certain post retirement benefits, primarily lifetime health, dental and life insurance coverage, to a group of individuals consisting of three former executives and 17 retired employees of Provident American Corporation, which became Healthaxis, and the Company’s former Chairman. The following table sets forth the components of net postretirement benefit expense for all plans:

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Note D – Repurchase of Securities Held by UICI Inc. and Reducing Conversion Price of Series A Convertible Preferred Stock

     On September 30, 2003, the Company purchased all Healthaxis securities held by UICI Inc. (“UICI”) for $3.9 million. The UICI holdings included 2,585,769 shares of Healthaxis common stock, or 48.3% of the Company’s then outstanding common stock; 1,424 shares of Series A Convertible preferred stock, or 6.1% of the then outstanding preferred stock; and warrants to purchase 22,240 shares of common stock. The repurchased securities were retired. The total purchase price of $3.9 million included $500,000 cash at closing, and a $3.4 million promissory note, which is due over three years and bears interest at 6%. The promissory note is paid through deductions from the monthly invoices for services provided by the Company to certain UICI subsidiaries. The amount of the monthly payment is equal to the greater of one half of the invoice amount for such services or $65,000. A balloon principal payment is due at the maturity of the note if the note has not been paid through the monthly payments. As of September 30, 2004, the balance due under the promissory note is $2.8 million (of which, $627,000 is classified as short-term).

     To gain the required approval of this transaction from the Series A Preferred shareholders, the Company agreed to reduce the per share conversion price of the then remaining preferred shares from $26.25 to $15.50. The repurchase of the preferred shares held by UICI reduced the total liquidation value of the outstanding Series A preferred stock from $23.5 million to $22.1 million. As described under Note H, the terms of the Series A preferred stock were significantly modified on June 30, 2004.

Note E – Significant Customer Concentrations

     For the three months ended September 30, 2004 and 2003, each of four customers represented greater than 10% of revenues, totaling $2.4 million (62%) and $2.9 million (55%), respectively, of the Company’s total revenues. For the nine months ended September 30, 2004 and 2003, these four customers accounted for $7.6 million (63%) and $8.8 million (55%), respectively, of the Company’s total revenues. At September 30, 2004 and December 31, 2003, one customer accounted for $776, 000 (30%) and $965,000 (31%) of the Company’s accounts receivable, respectively.

Note F – Other Liabilities and Contingencies

     Other liabilities include $1.3 million of contingent tax liabilities at September 30, 2004 and December 31, 2003.

Note G – Related Party Transactions

     Historically, Healthaxis conducted a significant amount of business with a major shareholder, UICI. As further described in Note D above, on September 30, 2003, the Company purchased all Healthaxis securities held by UICI for $3.9 million and UICI is no longer considered an affiliate. Notwithstanding, Healthaxis continues to provide certain services to UICI and its subsidiaries pursuant to written agreements.

     For the three months ended September 30, 2004 and 2003, UICI and its subsidiaries and affiliates accounted for $376, 000 (10%) and $487,000 (9%), respectively, of the Company’s revenues. For the nine months ended September 30, 2004 and 2003, UICI and its subsidiaries and affiliates accounted for $1.2 million (10%) and $1.4 million (9%), respectively, of the Company’s revenues. As of September 30, 2004, Healthaxis had accounts receivable due from UICI and its subsidiaries and affiliates totaling $107,000, which represented 4% of the Company’s total accounts receivable. The accounts receivable from UICI are current under the terms and conditions of contract payment.

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Note H – Amendment of Preferred Stock

     Previously, the Company’s Series A Convertible preferred stock (“old”) had a stated value of $22.1 million and was convertible into 1,424,258 shares of Healthaxis common stock at a conversion price of $15.50 per share. The terms of the preferred stock provided that cumulative dividends be paid at the rate of 2%, or approximately $442,000 per year, payable semi-annually. In general, the Company could have paid the dividends either in cash or by issuing shares of common stock, although in some circumstances it was required to pay cash dividends. The terms of the preferred stock provided that in some situations the holders of the preferred stock could have forced Healthaxis to buy back their shares. The Company believed that the occurrence of the situations where it could be required to buy back shares of preferred stock was within its control. The preferred stock also contained, among other things, provisions providing the holders a preference in the payment of dividends and also a liquidation preference equal to at least the stated value of the preferred stock plus all accrued but unpaid dividends. The holders of the preferred stock did not have general voting rights, although they did have the right to vote separately as a class in connection with some matters.

     Healthaxis entered into a Preferred Stock Modification Agreement on May 12, 2004. On June 30, 2004, Healthaxis consummated a transaction modifying the terms of its Series A Convertible preferred stock and providing for the issuance to its preferred shareholders of warrants to purchase shares of the Company’s common stock. Under the terms of the agreements with the preferred shareholders, shares of the preferred stock (“new”) are convertible into an aggregate of 3,850,000 shares of the Company’s common stock. The preferred shareholders also received warrants with a term of five years entitling them to purchase up to 1,000,000 shares of common stock at an exercise price of $5.50 per share (subject to a cashless exercise feature that applies under some circumstances). The shares of common stock into which the shares of preferred stock are convertible and with respect to which the warrants are exercisable, represent approximately 55% of the common stock on a fully diluted basis as of June 30, 2004. Holders of the preferred stock will have no liquidation preference, no voting rights except as required by law, the right to receive a nominal dividend of $0.0001 per share semi-annually (aggregating less than $1,000 per year in total) and otherwise on a pro-rata basis to the extent that dividends are paid to holders of common stock, limited anti-dilution rights in the context of stock splits, stock dividends and similar transactions, and no redemption rights.

     The new preferred stock is convertible into shares of common stock at the option of a preferred shareholder at any time, and in any amount, on or after June 30, 2005, but prior to that date may only be converted if the preferred shareholder desiring to effect the conversion will not hold as a result of the conversion more than 750,000 shares of common stock, or if the common stock is trading on a national stock market and has had a closing price of $8.00 or more for 20 out of the 30 trading days immediately preceding the conversion date (in which case, any number of shares may be converted). Notwithstanding the foregoing, in the event of the transfer of shares of preferred stock in accordance with the terms of the agreements with the preferred shareholders, the preferred stock automatically converts into shares of common stock. Healthaxis may compel conversion of the preferred stock or exercise of the warrants granted to the preferred shareholders under some circumstances.

     Under the agreements with the preferred shareholders, Healthaxis agreed that it will not issue any equity securities in a transaction implying a pre-money valuation of Healthaxis of less than $14.5 million or at a per share price of less than $2.15 (these restrictions do not apply to the grant of stock options to Healthaxis employees or directors in most circumstances). Further, until June 30, 2005, the preferred shareholders have a right of first refusal to match the terms upon which any third party proposes to purchase from Healthaxis any equity securities having an aggregate purchase price of at least $1.0 million and to match the terms upon which Healthaxis proposes an offering of its common stock.

     Prior to conversion, the new preferred stock will only have the right to vote to the extent it is entitled to do so under applicable law. Under applicable law, the new preferred stock is entitled to vote separately as a class in certain instances, including in the event of a merger or consolidation that would effect some types of changes in the

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Company’s articles of incorporation. To the extent that applicable law entitles the new preferred stock to vote on a given merger or consolidation transaction prior to June 30, 2005 the preferred shareholders have agreed to vote their shares in favor of such a merger or consolidation if the common shareholders have approved the merger or consolidation and the per share price to be received by the preferred shareholders in the merger or consolidation is at least $3.50 in cash for each share of preferred stock. If the Company pursues a merger or consolidation on or after June 30, 2005, the preferred shareholders have agreed to vote their shares in favor of the merger or consolidation if the common shareholders approve the merger or consolidation and if the per share price to be received by the preferred shareholders in the merger or consolidation for each share of preferred stock is at least equal to what they would have received in the merger or consolidation if they had converted their shares of preferred stock into shares of common stock immediately prior to the merger or consolidation.

     The agreements require Healthaxis to register for resale the shares of common stock issuable upon conversion of the preferred stock or exercise of the warrants, but place certain restrictions on the private sale or transferability of the securities held by the preferred shareholders, and restrict the number of shares of common stock that may be sold in the public markets below a price of $3.50 per share. These stock transfer restrictions lapse on June 30, 2005. The Company filed a Form S-3 Registration Statement on September 2, 2004 to register for resale the shares of common stock issuable upon conversion of the preferred stock or exercise of the warrants. On October 28, 2004 the Securities and Exchange Commission declared the Registration Statement effective.

     The Company estimated the fair value of the new preferred stock at June 30, 2004 to be $4.8 million. The estimate assumes a willing buyer and a willing seller in an arms-length negotiation and considers factors such as the price per share of the common stock on the date of closing, the trading restrictions imposed on the new preferred stock through June 30, 2005 and the marketability of the new preferred stock based upon the number of shares of common stock into which the preferred stock is convertible (55% on a fully diluted basis). The Company estimated the fair value of the warrants to be $815,000 using the Black-Scholes pricing model, based upon volatility of the common stock since the announcement of the preferred stock modification transactions. The $261,000 difference between the carrying value of the old preferred stock of $5.9 million and the fair value of the new preferred stock and warrants has been recorded as additional paid in capital and, in accordance with EITF D-42, “The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock”, is reflected as carrying amount of preferred stock over fair value of consideration in the statement of operations.

     Additionally, while the old preferred stock had a 2% annual dividend payable semi-annually in January and July, the new preferred stock provides for the payment of a nominal semi-annual dividend (aggregating less than $1,000 per year to all preferred shareholders). In the first quarter of 2004, the Company accrued the $110,000 dividend payable in accordance with the terms of the old preferred stock, but this accrual was reversed in the second quarter of 2004 as a result of the completion of the transaction described above. This amount is also netted out of the net loss applicable to common shareholders on the condensed consolidated statement of operations.

     The Company will not recognize any taxable gain or loss as a result of the closing of the preferred stock modification transaction on June 30, 2004. The closing of the transaction may, however, result in the imposition of substantial limitations on the amount of the Company’s net operating losses that may be applied to any future taxable income of the Company.

Note I – Significant Contract

     The Company had a contract for software licensing, development and systems implementation with the State of Washington Health Care Authority (“HCA”), which began in mid 2002. For both three-month periods ending September 30, 2004 and 2003, the Company earned no revenue from HCA. For the nine months ended September 30, 2004 and 2003, HCA accounted for $0 and $946,000 (6%), respectively, of the Company’s revenues.

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     The Company was the prime contractor on the HCA project and utilized the services of an offshore development partner to perform a significant part of the work. A dispute arose under the HCA contract in late 2003, which has now been resolved by the Company and HCA entering into an agreement to terminate the HCA contract. The Company has also simultaneously entered into a cancellation agreement with its development partner canceling and terminating its master software services agreement with the development partner and the work order associated with subcontracted portions of the HCA project.

     Under the terms of the agreement with HCA, the Company paid HCA $300,000 and transferred title to certain project documentation to HCA. The agreement also contains full mutual releases of all parties including HCA, Healthaxis and the development partner, and an express denial of liability or wrongdoing by all parties.

     Under the terms of the agreement between the Company and its development partner, Healthaxis received $208,000, and any rights the development partner may have in the documentation being transferred by Healthaxis to HCA, resulting in a net cash payment by Healthaxis to HCA of $92,000. The agreement also contains full mutual releases between Healthaxis and the development partner, and an express denial of liability or wrongdoing by either party.

     The Company entered into these agreements solely to avoid the potential time and cost of dispute resolution. The execution and funding of these agreements, which occurred in the second quarter of 2004, resolves all outstanding issues related to the HCA project. The net impact of these transactions is included in general and administrative expense in the accompanying condensed consolidated statement of operations.

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Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

Forward-Looking Statements

     All statements other than statements of historical fact contained in this report, including statements in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” concerning the Company’s financial position and liquidity, results of operations, prospects for future growth, and other matters are forward-looking statements. These statements may be identified with words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “should,” “could,” “goal,” “target,” “designed,” “on track,” “comfortable with,” “optimistic” and other similar expressions, and constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors, which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include the risks and uncertainties identified in Healthaxis documents filed with, or furnished to, the Securities and Exchange Commission, including without limitation those identified under the caption “Business–Risk Factors” in the Company’s Form 10-K for the year ended December 31, 2003, and under the caption “Proposal I – Approval of Issuance of Common Stock and Related Securities Transactions-Factors Affecting Current Common Shareholders” in the Company’s Proxy Statement dated June 1, 2004. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are cautioned not to place undue reliance on forward-looking statements.

Overview

     Healthaxis is a technology-enhanced provider of fully integrated solutions and services for health benefit administrators and health insurance claim processors. These solutions, which are comprised of software products and related business process services, are designed to assist health insurance payers and third party administrators (“TPA”) provide enhanced services to members, employees, employers and providers at lower cost. These services are provided through the application of Healthaxis’ flexible technology, either on a fully integrated or on an Application Service Provider (“ASP”) basis. These technology solutions are complemented by Healthaxis’ Business Process Outsourcing (“BPO”) services, which are offered to the Company’s technology clients and on a stand-alone basis. BPO solutions include the automated capture, imaging, storage and retrieval of electronic claims, attachments, and related correspondence, in addition to rules-based claims pre-adjudication and automated PPO routing and repricing. Healthaxis uses its deep domain expertise in health insurance operations to surround the payment of a health insurance claim, to customize services to meet the specific needs of its customers and to produce value for those customers by tapping unrealized potential in the customers’ operations to achieve the best results.

     Healthaxis Inc. is a Pennsylvania corporation, which was organized in 1982. Healthaxis’ common stock trades on the NASDAQ SmallCap Market under the symbol “HAXS.” The operations of Healthaxis are conducted through its subsidiary, Healthaxis, Ltd. Unless otherwise indicated, or the context otherwise requires, all references in this document to the “Company,” “Healthaxis,” “we,” “our” or “us” include Healthaxis Inc. and all of its subsidiaries. Healthaxis maintains a website at www.healthaxis.com. The Healthaxis Code of Conduct can be found on the Healthaxis website. Information found on the Healthaxis website is not a part of this report.

     Revenue Model. The Company’s revenues consist primarily of software-use license fees, transaction fees and professional services. These revenue sources are described below.

     A significant portion of the Company’s revenue is based on providing application service provider (ASP) services to our insurance, third-party administrator and self-insured plan customers. The ASP service includes a license to use our benefits administration and claims processing software, including hosting, maintenance and

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support, which is typically charged on a per-employee-per-month (PEPM) or per-member-per-month (PMPM) basis. In addition, the Company surrounds these software-use rights with such services as imaging, data capture and retrieval, EDI and print and mail services, and PPO routing and repricing services. These services are typically charged on a transaction fee basis, such as per claim, per image and per document. Due to the long term nature of the software license under the ASP arrangement and because all revenue elements included in the collective services are typically not sold separately, the ASP service revenues are recognized ratably over the term of the agreement and/or as transaction services are provided. With some exceptions, the Company has not historically sold its benefits administration and claims processing software for installation on customers’ systems.

     In preparation for providing services under these multi-year ASP contracts, the Company also usually contracts to perform certain start-up activities directly related to customizing and configuring the licensed software and loading insurance plan data for performance under the contract. The Company defers costs and revenues relating to these start-up activities and recognizes such costs and revenues ratably over the term of the ASP contract.

     Periodically, while an ASP contract is in place, the Company also performs professional services upon request and recognizes the related revenue on a time and materials basis as services are performed. Such professional services are not sold in conjunction with a software license or other revenue elements and, therefore, are separate from the sale of software licenses.

     The Company uses contract accounting for contracts where significant software modification is performed or where services are performed that are essential to the functionality of the delivered software. Generally, contracts that include significant software modification are accounted for using the percentage of completion method with progress measured based on the cost-to-cost method. If the ultimate achievement of customer billing milestones is not reasonably assured, revenue recognition is discontinued until those payment milestones have been achieved. The assumptions used for recording revenue are adjusted in the period of change to reflect revisions. Contracts with significant customer acceptance provisions are recognized using the completed contract method upon achieving customer acceptance of the completed project. The cumulative impact of any revision in estimates of the percent complete or recognition of losses on loss contracts is generally reflected in the period in which the changes or losses become known. The Company currently has no contracts in progress for which contract accounting is being applied.

     Significant Project Update:

     As previously disclosed, the Company had a contract for software licensing, development and systems implementation with the State of Washington Health Care Authority (“HCA”), which began in mid 2002. The Company was the prime contractor on the HCA project and utilized the services of an offshore development partner to perform a significant part of the work. Also, as previously disclosed, a dispute arose under the HCA contract in late 2003, which has now been resolved by the Company and HCA entering into an agreement to terminate the HCA contract. The Company has also simultaneously entered into a cancellation agreement with its development partner canceling and terminating its master software services agreement with the development partner and the work order associated with subcontracted portions of the HCA project.

     Under the terms of the agreement with HCA, the Company paid HCA $300,000 and transferred title to certain project documentation to HCA. The agreement also contains full mutual releases of all parties including HCA, Healthaxis and the development partner, and an express denial of liability or wrongdoing by all parties.

     Under the terms of the agreement between the Company and its development partner, Healthaxis received $208,000 and any rights the development partner may have in the documentation being transferred by Healthaxis to HCA, resulting in a net cash payment by Healthaxis to HCA of $92,000. The agreement also contains full

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mutual releases between Healthaxis and the development partner, and an express denial of liability or wrongdoing by either party.

     The Company entered into these agreements solely to avoid the potential time and cost of dispute resolution. The execution and funding of these agreements, which occurred in the second quarter of 2004, resolves all outstanding issues related to the HCA project. The net impact of these transactions is included in general and administrative expense in the accompanying condensed consolidated statement of operations.

Goodwill

     The carrying value of goodwill at September 30, 2004 is $11.3 million. The Company performs its annual impairment review during the fourth quarter of each year or upon the occurrence of any event that indicates potential impairment. It is possible that the carrying amount of goodwill could be effected in the near term because of the impact that the Company’s continued operating losses could have on the estimates used by management to calculate the fair value of the reporting units.

Segments

     The Company has historically presented information regarding two segments based on the Company’s internal organizational structure and financial reporting. During the first quarter of 2004, the Company re-aligned its operations under a single operating manager and further consolidated the operations. As a result of this change, the Company now produces consolidated information on the operations (excluding sales, general and administrative), which is regularly reviewed by the executive management committee of the Company in assessing performance and as an aid in making decisions about how resources are allocated. Accordingly, the Company no longer has reportable segments and has discontinued disclosure of segment information for all periods.

Critical Accounting Policies

     Critical accounting policies are those which are most important to the financial statement presentation and that require the most difficult, subjective complex judgments. There have been no changes in the Company’s critical accounting policies as described in the Company’s Form 10-K for the year ended December 31, 2003.

Results of Operations

Three months ended September 30, 2004 compared to three months ended September 30, 2003

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     Revenues were down approximately $1.4 million (26%) in the three months ended September 30, 2004 compared to the same period in 2003. Cessation of work on the ACS/State of Georgia project accounted for $584,000 of the reduction. Recurring PEPM license fee revenue declined $278,000 primarily as the result of customers in a terminated or in a run-off stage, while other reductions in the number of covered lives administered by our clients was largely offset by increased revenues from new data mining services. Transaction fee revenue decreased $188,000 primarily as a result of the decreased number of covered lives. Professional service fees decreased $172,000 as a result of decreased customer dependence upon our technical staff and a decrease in the number of one-time projects, compared to the same period in 2003. Data capture service revenue declined $133,000 as a result of lower claims volume and, in part, to the reduced number of lives covered by certain customers which also use our data capture services.

     Cost of revenues includes all expenses directly associated with the production of revenue, and consists primarily of salaries and related benefits, rent, amortization and depreciation, system expenses such as maintenance and repair, as well as other related consumables. Cost of revenues declined $970,000 (20%) in the three months ended September 30, 2004 compared to the same period in 2003. Cost of revenues was 97% of revenues in the 2004 period compared to 90% in the 2003 period. Many of the components of cost of revenues are fixed expenses that did not decline proportionately with revenue. Approximately $294,000 of the cost decline was related to termination of contract labor, primarily associated with the ACS/State of Georgia project, which was underway in 2003. Approximately $244,000 was due to lower personnel costs resulting from staff reductions and another $244,000 was due to lower vendor costs directly associated with a reduction in transaction and license fee revenue. An additional $111,000 of the decline was due to reduced amortization and depreciation expenses resulting from a decline in capital spending for property, plant and equipment over the last three years.

     Sales and marketing expenses consist primarily of employee salaries and related benefits, as well as promotional costs such as direct mailing campaigns, trade shows and media advertising. Company wide sales and marketing expenses increased $153,000 (68%) in the three months ended September 30, 2004 compared to the same quarter of 2003. The increase is primarily due to additional personnel expenses related to sales and marketing management and staff additions in early 2004.

     General and administrative expenses include executive management, accounting, legal and human resources compensation and related benefits, as well as expenditures for applicable overhead costs. These expenses decreased $40,000 (5%) in the three months ended September 30, 2004 compared to the same quarter of 2003 due primarily to lower personnel costs.

     Amortization of intangibles includes the amortization of developed software and customer base acquired in the January 2001 Healthaxis merger. These expenses were reduced $72,000 (22%) in the three months ended September 30, 2004 compared to the same quarter of 2003, as the acquired developed software was fully amortized in January 2004.

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     Interest and other income, net decreased slightly from the same quarter of 2003 due primarily to lower balances on notes receivable resulting from the normal course of collections.

     Interest expense increased $42,000 (221%) in the three months ended September 30, 2004 compared to the same quarter of 2003 due to interest payments under the $3.4 million note payable to UICI dated September 30, 2003, related to the Company’s purchase of UICI’s Healthaxis stock and warrants.

Nine months ended September 30, 2004 compared to nine months ended September 30, 2003

     Revenues were down approximately $4.0 million (25%) in the nine months ended September 30, 2004 compared to the same period in 2003. Cessation of work on the ACS/State of Georgia project and the State of Washington project accounted for $1.5 million of the reduction. Recurring PEPM license fee revenue declined $587,000 primarily as the result of customers in a terminated or in a run-off stage, while other reductions in the number of covered lives administered by our clients was largely offset by increased revenues from new data mining services. Transaction fee revenue decreased $657,000 as a result of the consolidation of print and mailings across certain customers, and as a result of the decreased number of covered lives. Bundling of checks to the same provider of medical services and combining multiple payers into the same envelope for mailing, resulted in decreased print and mailing revenue. This evolution was necessary to remain competitive within the industry. Professional service fees decreased $599,000 as a result of decreased customers’ dependence upon our technical staff and to a decrease in the number of one-time projects, as compared to the same period in 2003. Data capture service revenue declined $518,000 as a result of lower claims volume and due to the reduced number of covered lives in certain customers which also use our data capture services.

     Cost of revenues declined $2.7 million (18%) in the nine months ended September 30, 2004 compared to the same period in 2003. Cost of revenues was 101% of revenues in the 2004 period compared to 93% in the 2003 period. Approximately $1.1 million of the cost decline was related to termination of contract labor, primarily associated with the ACS/State of Georgia and the State of Washington projects, which were underway in 2003. An additional $464,000 of the decline was due to reduced amortization and depreciation expenses resulting from a decline in capital spending for property, plant and equipment over the last three years. Approximately $342,000 of the savings was due to lower vendor costs directly associated with a reduction in transaction revenue. The remaining reduction was largely the result of lower costs for salary, benefits, travel and other expenses associated with personnel.

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     Sales and marketing expenses increased $249,000 (33%) in the nine months ended September 30, 2004 compared to the same period of 2003. The increase is primarily due to additional personnel and recruiting expenses related to sales and marketing management and staff additions in early 2004.

     General and administrative expenses increased $288,000 (11%) in the nine months ended September 30, 2004 compared to the same period of 2003. The increase was primarily due to the $92,000 settlement on of the State of Washington project and $452,000 of legal, accounting and other professional fees primarily associated with the preferred stock transaction. These cost increases were partially offset by lower personnel and insurance costs totaling $155,000 plus other smaller cost reductions.

     Research and development expenses were reduced to zero in the nine months ended September 30, 2004 compared to $30,000 in the same period of 2003, as the Company has placed a greater emphasis on completing existing development projects and the maintenance of existing customer accounts.

     Amortization of intangibles was reduced $192,000 (20%) in the nine months ended September 30, 2004 compared to the same period of 2003, as the acquired developed software was fully amortized in January 2004.

     Interest and other income, net decreased slightly from the same period in 2003 due primarily to lower balances on notes receivable resulting from the normal course of collections.

     Interest expense increased $129,000 (226%) in the nine months ended September 30, 2004 compared to the same period of 2003 due to interest payments under the $3.4 million note payable to UICI dated September 30, 2003, related to the Company’s purchase of UICI’s Healthaxis stock and warrants.

Liquidity and Capital Resources

Overview of Cash Resources

     At September 30, 2004, our cash and cash equivalents amounted to $4.4 million. We have experienced repeated losses, with the result that our cash resources have declined. The Company’s focus is on positive cash generation. We are taking further measures to address our liquidity needs, including increasing our marketing and sales efforts, implementing further productivity improvements and seeking new sources of capital. No assurance can be given that any or all of these initiatives will prove successful. We believe that the Company will maintain sufficient liquidity to fund operations for at least the next 12 months. In the event that we are unable to maintain or increase our revenues, or effectively reduce our expenses to a level commensurate with our revenues, or raise additional capital, then our business would likely be adversely affected. To the extent that we are successful in raising additional capital to fund the Company’s organic and strategic growth through the issuance of equity securities, our shareholders could experience significant dilution.

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Analysis of Cash Flows

     Cash used in operating activities for the nine months ended September 30, 2004 was approximately $2.2 million as compared to $988,000 for the same period in 2003, an increase of $1.2 million. The increase in cash used was primarily due to a $1.8 million increase in the net loss and a $647,000 reduction in depreciation expenses from 2003, partially offset by an improvement in working capital of $1.3 million.

     Cash used in investing activities for the nine months ended September 30, 2004 was $598,000 as compared to $837,000 for the same period in 2003, a decrease of $239,000 due to less spending on property, equipment, and software. The Company’s investing activities continue to be primarily in the areas of developing software enhancements, contract start-up activities and acquisition of property, equipment and software.

     Cash used in financing activities for the nine months ended September 30, 2004 was $679,000 as compared to $1.2 million for the same period in 2003, for a decrease of $526, 000. The decreased use of cash was due primarily to a $482,000 reduction in payments on preferred stock dividends resulting from amending and restating the terms of the preferred stock agreements. See “Preferred Stock” below. The initial payment to UICI for purchasing Healthaxis’ stock and warrants in 2003 was balanced to a significant degree in 2004 by payments on the note payable to UICI related the same transaction. See “Repurchase of Securities Held by UICI and Reducing Conversion Price of Series A Convertible Preferred Stock” below.

Preferred Stock

     Previously, the Company’s Series A Convertible preferred stock (“old”) had a stated value of $22.1 million and was convertible into 1,424,258 shares of Healthaxis common stock at a conversion price of $15.50 per share. The terms of the preferred stock provided that cumulative dividends be paid at the rate of 2%, or approximately $442,000 per year, payable semi-annually. In general, the Company could have paid the dividends either in cash or by issuing shares of common stock, although in some circumstances it was required to pay cash dividends. The terms of the preferred stock provided that in some situations the holders of the preferred stock could have forced Healthaxis to buy back their shares. The Company believed that the occurrence of the situations where it could be required to buy back shares of preferred stock was within its control. The preferred stock also contained, among other things, provisions providing the holders a preference in the payment of dividends and also a liquidation preference equal to at least the stated value of the preferred stock plus all accrued but unpaid dividends. The holders of the preferred stock did not have general voting rights, although they did have the right to vote separately as a class in connection with some matters.

     Healthaxis entered into a Preferred Stock Modification Agreement on May 12, 2004. On June 30, 2004, Healthaxis consummated a transaction modifying the terms of its Series A Convertible preferred stock and providing for the issuance to its preferred shareholders of warrants to purchase shares of the Company’s common stock. Under the terms of the agreements with the preferred shareholders, shares of the preferred stock are convertible into an aggregate of 3,850,000 shares of the Company’s common stock. The preferred shareholders also received warrants with a term of five years entitling them to purchase up to 1,000,000 shares of common stock at an exercise price of $5.50 per share (subject to a cashless exercise feature that applies under some circumstances). The shares of common stock into which the shares of preferred stock are convertible and with respect to which the warrants are exercisable represent approximately 55% of our common stock on a fully diluted basis as of June 30, 2004. Holders of the preferred stock have no liquidation preference, no voting rights except as required by law, the right to receive a nominal dividend of $0.0001 per share semi-annually (aggregating less than $1,000 per year in total) and otherwise on a pro-rata basis to the extent that dividends are paid to holders of common stock, limited anti-dilution rights in the context of stock splits, stock dividends and similar transactions, and no redemption rights.

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     The new preferred stock is convertible into shares of common stock at the option of a preferred shareholder at any time, and in any amount, on or after June 30, 2005, but prior to that date may only be converted if the preferred shareholder desiring to effect the conversion will not hold as a result of the conversion more than 750,000 shares of common stock, or if the common stock is trading on a national stock market and has had a closing price of $8.00 or more for 20 out of the 30 trading days immediately preceding the conversion date (in which case, any number of shares may be converted). Notwithstanding the foregoing, in the event of the transfer of shares of preferred stock in accordance with the terms of the agreements with the preferred shareholders, the preferred stock automatically converts into shares of common stock. Healthaxis may compel conversion of the preferred stock or exercise of the warrants granted to the preferred shareholders under some circumstances.

     Under the agreements with the preferred shareholders, Healthaxis agreed that it will not issue any equity securities in a transaction implying a pre-money valuation of Healthaxis of less than $14.5 million or at a per share price of less than $2.15 (these restrictions do not apply to the grant of stock options to Healthaxis employees or directors in most circumstances). Further, until June 30, 2005, the preferred shareholders have a right of first refusal to match the terms upon which any third party proposes to purchase from Healthaxis any equity securities having an aggregate purchase price of at least $1.0 million and to match the terms upon which Healthaxis proposes an offering of its common stock.

     Prior to conversion, the new preferred stock will only have the right to vote to the extent it is entitled to do so under applicable law. Under applicable law, the new preferred stock is entitled to vote separately as a class in certain instances, including in the event of a merger or consolidation that would effect some types of changes in the Company’s articles of incorporation. To the extent that applicable law entitles the new preferred stock to vote on a given merger or consolidation transaction prior to June 30, 2005 the preferred shareholders have agreed to vote their shares in favor of such a merger or consolidation if the common shareholders have approved the merger or consolidation and the per share price to be received by the preferred shareholders in the merger or consolidation is at least $3.50 in cash for each share of preferred stock. If the Company pursues a merger or consolidation on or after June 30, 2005, the preferred shareholders have agreed to vote their shares in favor of the merger or consolidation if the common shareholders approve the merger or consolidation and if the per share price to be received by the preferred shareholders in the merger or consolidation for each share of preferred stock is at least equal to what they would have received in the merger or consolidation if they had converted their shares of preferred stock into shares of common stock immediately prior to the merger or consolidation.

     The agreements require Healthaxis to register for resale the shares of common stock issuable upon conversion of the preferred stock or exercise of the warrants, but place certain restrictions on the private sale or transferability of the securities held by the preferred shareholders, and restrict the number of shares of common stock that may be sold in the public markets below a price of $3.50 per share. These stock transfer restrictions lapse on June 30, 2005. The Company filed a Form S-3 Registration Statement on September 2, 2004 to register for resale the shares of common stock issuable upon conversion of the preferred stock or exercise of the warrants. On October 28, 2004 the Securities and Exchange Commission declared the Registration Statement effective.

Repurchase of Securities Held by UICI and Reducing Conversion Price of Series A Convertible Preferred Stock

     On September 30, 2003, the Company purchased all Healthaxis securities held by UICI for $3.9 million. The UICI holdings included 2,585,769 shares of Healthaxis common stock, or 48.3% of the Company’s then outstanding common stock; 1,424 shares of Series A Convertible preferred stock, or 6.1% of the then outstanding preferred stock; and warrants to purchase 22,240 shares of common stock. The repurchased securities were retired. The total purchase price of $3.9 million included $500,000 cash at closing, and a $3.4 million promissory note, which is due over three years and bears interest at 6%. The promissory note will be paid through deductions from the monthly invoices for services provided by the Company to certain UICI subsidiaries. The amount of the monthly payment is equal to the greater of one half of the invoice amount for such services or $65,000. A balloon

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principal payment is due at the maturity of the note if the note has not been paid through the monthly payments. During the three-month period ended September 30, 2004, the Company paid UICI an aggregate of $199, 000 under the promissory note, of which $156,000 was principal and $43,000 was interest. As of September 30, 2004, the balance due under the promissory note is $2.8 million (of which $627, 000 is classified as short-term).

     To gain the required approval of this transaction from the Series A Preferred shareholders, the Company agreed to reduce the per share conversion price of the then remaining preferred shares from $26.25 to $15.50. The repurchase of the preferred shares held by UICI reduced the total liquidation value of the outstanding Series A preferred stock from $23.5 million to $22.1 million. As described under Note H to the Condensed Consolidated Financial Statements above, the terms of the Series A preferred stock were significantly modified on June 30, 2004.

Lease and Other Commitments

     Healthaxis has certain capital and operating lease commitments over the next five years. These leases are primarily for office space and data processing equipment. Healthaxis has no other significant cash commitments other than those required by the normal day-to-day operations of its business.

Recently Adopted Accounting Pronouncements

     See Note B to the Condensed Consolidated Financial Statements herein for a discussion of the impact on the Company’s financial statements of new accounting standards.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     Exposure to market risk for changes in interest rates relate primarily to short-term investments. The Company does not use derivative financial instruments. The primary objective of its investment activities is to preserve principal while maximizing yields without significantly increasing risk. Due to the nature of the Company’s investments, we believe that there is no material risk exposure.

     Our cash equivalents and other investment instruments are exposed to financial market risk due to fluctuation in interest rates, which may affect our interest income. These instruments are not entered into for trading purposes. We do not expect our interest income to be significantly affected by a sudden change in market interest rates.

     The dividend rate on our old preferred stock was fixed at 2%, while the dividend rate on our new preferred stock as described in Note H above, is fixed at a nominal rate of $0.0001 per share of the new preferred stock, payable semi-annually (aggregating less than $1,000 in dividend payments to all preferred shareholders annually). The interest rate on our note payable is fixed at 6%. The fair value of these instruments is therefore subject to market fluctuation as interest rates change.

Item 4. Controls and Procedures

     As of the end of the period covered by this quarterly report, the Company carried out an evaluation, under the supervision and with the participation of the Company management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that these disclosure controls and procedures are effective as of the end of the period covered by this report. There has been no change in the Company’s internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

     The Company is involved in litigation arising in the ordinary course of its business. Management is of the opinion that no currently pending litigation will have a material adverse effect on the Company’s results of operations or financial position.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

     Not applicable

Item 3. Defaults Upon Senior Securities.

     Not applicable

Item 4. Submission of Matters to a Vote of Security Holders.

     Not applicable.

Item 5. Other Information.

     Not Applicable.

Item 6. Exhibits

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Signature

     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.

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Exhibit Index

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