CORE, INC. is a national provider of employee absence management services to Fortune 500 companies and other self-insured employers, third-party administrators and insurance carriers. The Company's services include Integrated Disability Management (which consist of the Company's proprietary WorkAbility(R) Absence Management program, disability reinsurance management services, social security disability benefits advocacy, analytic consulting services, onsite job profiling and analysis and workplace risk management services, and licensing), Peer Review Analysis (which consist of specialty physician and behavioral health review services), and other services including Medicare coordination of benefits, health care benefits utilization review and case management services. CORE's services are designed to prevent absence, promote early return to work, improve productivity, and manage disabilities from "day one" through return to work or retirement, without compromising the quality of health care services provided to patients.
The following table sets forth the contribution to total revenues of each of the Company's principal service lines for the periods indicated:
Revenues from services that the Company exited in 1998 or expects to exit in 1999 increased overall by 17% during 1998, as compared to the prior year. These service lines consist of regional workers' compensation case management services (of both CRS and TCM), regional bill audit activities of CRS, and the behavioral health programs of the Company's wholly-owned subsidiary, Integrated Behavioral Health ("IBH"). The net increase in these services during 1998 related principally to the acquisition of TCM in March 1998. Specifically, TCM contributed $1,287,000 in new workers' compensation case management revenues, however TCM operations were exited in December 1998 due to poor net operating performance. The CRS operations were closed as of October 31, 1998 due to the loss of a significant portion of its customer base. The Company expects revenues in these service lines to decrease significantly in 1999 due to the exiting of the CRS and TCM operations together with its intent to exit the operations of IBH in 1999.
to the utilization review program stemming from a decline in enrollment in our clients' indemnity plan based group health business. Although the Company expects revenues from utilization review and other case management services to further decline during 1999, these anticipated decreases may be partially offset by an increase in revenues from its Medicare coordination of benefits program, following the introduction of certain new products developed during 1998.
For 1998, the Company's top five clients represented 45% of revenues compared to 43% during 1997. Bell Atlantic accounted for approximately 21% of revenue in 1998 and 23% of revenues for 1997. No other single client represented more than 10% of total revenues in 1998 or 1997.
CORE's gross profit performance for 1998 remained unchanged compared to 1997 at 39%. Gross profit performance for each of the Company's principal lines of service for the years ended 1998 and 1997, respectively, are: 41% and 35% for Integrated Disability Management, 36% and 39% for Peer Review Analysis, 16% and 27% for exiting/exited services and 47% and 52% for other service lines. The increase in gross margins realized under Integrated Disability Management is primarily due to the addition of disability reinsurance management services now provided by the Company pursuant to the acquisition of DRMS. The decline in gross margins realized under Peer Review Analysis is due mostly to the decrease in revenues generated under the behavioral health program and an increase in expenses (mostly payroll) added in advance of expected program revenues with certain new Peer Review Analysis clients. The decline in gross margins realized under other service lines is primarily due to a decrease in revenues generated from the utilization review and Medicare coordination of benefits programs.
On June 2, 1998, the Company entered into a settlement agreement with the former shareholders of CRS. The settlement agreement related to an arbitration dispute and included the immediate payment by CORE of $425,000 and CORE's issuance of promissory notes in the amount of $190,000 payable in twelve monthly installments beginning January 1999. In addition, the Company incurred approximately $121,000 in other costs related to the arbitration (primarily legal and travel expenses).
Other income and expense, net, consists primarily of interest expense as offset by interest income. Interest expense represents amounts incurred related to outstanding borrowings under the Company's August 1998 Credit Agreement with Fleet National Bank. Interest income represents amounts earned by the Company's investments. Other income and expense, net, decreased $765,000 from a net other income of $563,000 in 1997 to a net other expense of $202,000 in 1998. The decrease is due to a decrease in funds available for investment and an increase in borrowings outstanding used to complete the acquisition of DRMS in September 1998.
Revenues increased by $9,701,000 (34%) from $28,806,000 in 1996 to $38,507,000 in 1997. Growth in Integrated Disability Management contributed $7,818,000 (81%) of the Company's increase in revenues which included revenues from the June and July 1997 acquisitions of SSDC and Protocol Work Systems, respectively. Approximately 50% of the total revenue increase for the year is attributable to revenues generated from Bell Atlantic Corporation. CORE continued to expand its services provided to Bell Atlantic Corporation during 1997, its first full year as a client. Each of the revenue components of Integrated Disability Management services grew during 1997, except for analytic consulting which had a slight decline of 2%. An increase in the volume of referrals resulted in increased revenues realized from Peer Review Analysis, growing 10% for the year ended 1997, as compared to the prior year.
Revenues from other service lines increased 42% overall for 1997 as compared to 1996 despite a slight decline in enrollment in our clients' indemnity plan based group health business. The increase was primarily attributable to the June 1997 acquisition of SSDC (which expanded CORE's programs to include Medicare coordination of benefits services). The Company expects utilization review and case management revenues to decline in future periods, as compared to current year levels.
For 1997, the Company's top five clients represented 43% of revenues compared to 36% during 1996. Bell Atlantic accounted for approximately 23% of revenue in 1997 and 13% of revenues for 1996. No other single client represented more than 10% of total revenues in 1997 or 1996.
Cost of services increased $5,589,000 (32%) from $17,741,000 in 1996 to $23,330,000 in 1997. The increase is primarily the result of additional payroll costs associated with business acquisitions completed in June and July of 1997 and increased staffing levels required to service new and growing WorkAbility clients and growth in the Company's Peer Review Analysis services. Additionally, increased amortization expense was incurred as software enhancements to the Company's operating systems were placed into service.
General and administrative expenses increased $1,655,000 (26%) from $6,285,000 in 1996 to $7,940,000 in 1997. Expenses increased due primarily to higher costs associated with additional staffing in the information services areas to support the growth of the Company. Higher costs in rent, insurance costs, equipment rental and other general and administrative expenses relate primarily to the Company's Silver Spring, Maryland operating center that opened in July 1996, the expansion of space in the Company's Burlington, Massachusetts facility in early 1997, and the acquisitions of SSDC and Protocol Work Systems in June and July 1997, respectively. General and administrative expenses, as a percentage of revenues, decreased from 22% for 1996 to 21% for 1997. This improvement is generally due to greater economies of scale related to higher revenues.
Sales and marketing expenses increased $739,000 (42%) from $1,744,000 in 1996 to $2,483,000 in 1997. The increase is primarily due to increased staffing to support the sales and product development departments as well as additional travel costs and costs for participation in tradeshows. During 1997, the Company expanded its sales organization to focus its efforts on Fortune 500 company prospects. Additionally, a sales tracking system was implemented in 1997 to streamline prospective sales activities, centrally manage the Company's sales activities and assist in identifying cross-selling opportunities of the Company's products and services to take advantage of the acquisitions of SSDC and Protocol Work Systems.
Depreciation and amortization expenses increased $617,000 (46%) from $1,338,000 in 1996 to $1,955,000 in 1997. The increase is largely attributable to increased depreciation expense on assets purchased for the operating center in Silver Spring, Maryland to service the Bell Atlantic Corporation contract as well as increased amortization expense on the goodwill acquired in the purchases of SSDC and Protocol Work Systems.
Other income consists primarily of interest income, which represents amounts earned by the Company's investments as reduced by interest expense. Other income increased $196,000 (54%) from $366,000 in 1996 to $562,000 in 1997. The increase is due to an increase in funds available for investment following a public offering in August 1996 and a reduction in the use of the Company's line of credit.
In connection with the Credit Agreement, the Company issued a Warrant to purchase shares of its Common Stock to Fleet. The Warrant entitles the holder to purchase up to 156,322 shares of the Company's Common Stock (subject to certain adjustments), at an exercise price of $6.92 per share. The Warrant is exercisable beginning August 31, 1999 and expires August 31, 2003.
A Second Amendment to the Credit Agreement, dated February 19, 1999 revised the scheduled maximum commitment available from $16,000,000 as of the date of the second amendment to $17,000,000, subject to a revised schedule of mandatory commitment reductions.
The Company has net operating loss carryforwards for income tax purposes of approximately $5.5 million as of December 31, 1998, which can be used to reduce future obligations for federal and state income taxes. The amount of net operating loss carryforwards that can be utilized in any future year are limited due to "equity structure shifts" in 1995 involving "5% shareholders" (as these terms are defined in Section 382 of the Internal Revenue Code), which resulted in a more than 50 percentage point change in ownership. The utilization of the net operating loss carryforwards may be subject to further limitation provided by the Internal Revenue Code of 1986 and similar state provisions.
The Company has recently entered into certain client service agreements and is currently negotiating other client service agreements that may require the Company to expend working capital ahead of the contractual billing periods. To the extent that such working capital needs exceed currently available working capital, the Company believes that it can obtain such additional working capital from its present lender or others. The Company believes that this additional financing, along with future earnings from operations and other sources of available funds will be sufficient to meet its liquidity and funding requirements through at least the year 1999.
The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. As a result, the Company's computer programs or hardware that have date-sensitive software or embedded chips may not properly recognize a year that begins with "20" instead of the familiar "19." If not corrected, the Company is at risk of a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
The Company's plan to resolve the Year 2000 issue involves the following five phases: assessment, remediation, testing, implementation, and certification. To date the Company has fully completed its assessment of all systems that could be significantly affected by the year 2000. The completed assessment indicated that most of the Company's major systems are effectively Year 2000 compliant and will require only minor modifications. The Company believes that with modifications to existing software and conversions to new software, the Year 2000 issue will not pose significant operational problems for its computer systems. The Company has initiated formal communications with all of its significant vendors and large customers to determine the extent to which the Company's interface systems are vulnerable to those third parties'
For its internal applications and licensed operating systems, software tools and utilities exposures, to date the Company is approximately 80% complete on the remediation phase and expects to complete the software reprogramming and replacement no later than the second quarter of 1999. Once software is reprogrammed and replaced for a system, the Company begins testing and implementation. These phases run concurrently for different systems. To date, the Company has completed approximately 70% of its testing and has implemented approximately 80% of its remediated systems. The testing phase for all significant systems is expected to be completed in the second quarter of 1999, with all remediated systems fully tested and certified in the third quarter of 1999, which is prior to any anticipated impact on its operating systems. Also, during the third quarter of 1999, the Company plans to carry out a certification process to validate the whole information technology environment, once again, to ensure Year 2000 compliance.
Because the results to date of the completed assessment have indicated that most of the Company's major systems are effectively Year 2000 compliant and will require only minor modifications, no contingency plans have been developed at this time. The Company will develop contingency plans as deemed necessary if a significant risk related to our Year 2000 compliance or a delay in the anticipated timeline for compliance occurs. These contingency plans may involve, among other actions, manual workarounds.
The Company will utilize both internal and external resources to reprogram, or replace, test, and implement software for Year 2000 modifications. The total cost of the Year 2000 project is estimated at $800,000 and is being funded through operating cash flows. These costs include internal information systems resources redirected to the Company's Year 2000 program. To date, the costs incurred by the Company related to all phases of the Year 2000 project have been immaterial and have been expensed as incurred. Of the total remaining project costs, approximately $200,000 is attributable to the purchase of new software and operating equipment, which will be capitalized. The remaining $580,000 related to repair of hardware and software and will be expensed as incurred.
The costs of the Year 2000 project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, and other factors. Estimates on the status of completion and the expected completion dates are based on costs incurred to date compared to total expected costs. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. Readers are cautioned that forward-looking statements contained in this discussion should be read in conjunction with our disclosure with regard to forward-looking statements, see "Item 1. Business."