(1) As discussed in Note 2 of the consolidated financial statements, the Company changed its method of accounting for health plan management revenue. On a pro-forma basis, this change would have decreased 1997 net income by $1,382,000, increased 1996 net income by $494,000, decreased 1995 net income by $79,000 and decreased 1994 net income by $493,000.
A majority of the Company's revenues consist of fees for health plan management and managed care operations.
The Company's expenses are comprised of its cost of health plan management services (consisting primarily of compensation of personnel, including nurses and physicians, telephone expenses, depreciation and amortization, rent, costs related to the Company's computer operations, costs related to customer service, and costs related to development of new services), cost of managed care operations (consisting primarily of the cost of medical services and reinsurance, net of recoveries), and selling, and marketing administration expenses (including sales commissions, advertising, sales account management personnel, bad debts, compensation and depreciation).
The following table sets forth certain consolidated financial data as a percentage of total revenues for the three fiscal years ended June 30, 1996, 1997, and 1998 and compares the percentage change in the dollar amounts of these items for the period indicated.
Total Revenues: Total revenues increased $31,927,000 (51%) from fiscal 1997 to fiscal 1998 (from $62,910,000 to $94,837,000), and increased $8,245,000 (15%) from fiscal 1996 to fiscal 1997 (from $54,665,000 to $62,910,000). These increases are primarily attributable to revenues from managed care operations which began April 16, 1998, and increases in the number of clients and covered participants enrolled in the Company's health plan management services, sales of additional products to existing clients and increased sales of the QualityFIRST(R) Medical Risk Management System. Revenues for fiscal 1997 also reflect the resolution of certain financial matters with a large client resulting in an amended contract in October, 1997.
Investment income increased 80% or $150,000 from fiscal 1997 to fiscal 1998 (increasing from $187,000 to $337,000). This increase is the result of higher levels of short-term investments in fiscal 1998.
Selling, Marketing and Administration: Selling, marketing and administration expenses increased 6% from fiscal 1997 to fiscal 1998 (from $13,691,000 to $14,558,000), and increased 9% from fiscal 1996 to fiscal 1997 (from $12,602,000 to $13,691,000). This expense as a percentage of health plan management revenues (23%, 22%, and 21%) for fiscal 1996, fiscal 1997 and fiscal 1998, respectively. The increases were due primarily to additional staff, travel, commission, bad debts, insurance, training programs and other expenses.
Interest Expense: Interest expense decreased 9% from fiscal 1997 to fiscal 1998 (from $535,000 to $489,000), and decreased as a percentage of revenue from 0.9% to 0.5%. Interest expense decreased 24% from fiscal 1996 to fiscal 1997 (from $708,000 to $535,000) and decreased as a percentage of revenue from 1.3% to 0.9%. Interest expense was impacted in fiscal 1998 and fiscal 1997 by lower interest rates and lower average principal balances outstanding.
Cumulative effect of accounting change: See Note 2 in the Notes to Consolidated Financial Statements.
The Company's cash flow from operations was $23,685,000 and $10,127,000 for fiscal 1998 and 1997, respectively. Cash flow from operations has exceeded net income primarily due to non-cash charges such as depreciation and amortization, deferred income taxes, cumulative effect of the accounting change and changes in operating assets and liabilities, particularly the medical services payable.
HRM also used approximately $2,153,000 and $2,277,000 in fiscal 1998 and fiscal 1997, respectively, to repay principal on notes payable and capital leases. The Company borrowed $4,750,000 and $1,275,000 in fiscal 1998 and fiscal 1997, respectively. The Company received cash proceeds of $784,000 and $775,000 in fiscal 1998 and fiscal 1997, respectively, from stock option exercises for common stock by current or former employees and directors, and $2,500,000 from the sale of 200,000 shares of unregistered common stock in fiscal 1997.
The Company has a net operating loss carryforward of approximately $14,500,000 for income tax purposes at June 30, 1998, which can be used to reduce taxable income and reduce the current cash flow necessary to pay taxes.
The Company is reliant on technology to deliver its managed healthcare services. If a computer system or software application used by the Company or a third party dealing with the Company fails because of the inability of the system or application to properly read the year "2000," the results could conceivably have a material adverse effect on the Company.
The Company has targeted its Year 2000 efforts to address the critical systems that support and interface with our clients and vendors. The Company is in the process of requesting information from critical vendors regarding their state of readiness. As of June 30, 1998, QualityFIRST(R) is Year 2000 ready in that it processes four-digit year dates. The Company's claims system is scheduled to complete Year 2000 testing in the Fall of 1998 and the remediation of the care management system is scheduled to be completed in the quarter ending June 30, 1999. There ae expected to be ongoing maintenance tasks which will continue into the year 2000. These tasks are not expected to be significant.
Successful completion of the Company's Year 2000 Project is affected by many factors, and the information contained in this statement is based on management's best estimates. However, there can be no guarantee that these estimates will be achieved, and actual results could differ materially from those anticipated based on factors such as availability and cost of personnel trained in this area, the ability to identify relevant computer codes, and the impact of the Company's external relationships. The Company will be using contingency plans already in place and will be developing additional and/or supplemental contingency plans where necessary in an effort to be prepared should a Year 2000 issue arise.
Forward looking statements in this report reflected as expectations, plans, anticipations, prospects or future estimates are subject to the risks and the uncertainties present in the Company's business and the competitive healthcare market place where clients and vendors commonly experience mergers or acquisitions, reconciliations, volume fluctuations, participant enrollment fluctuations, fixed price contracts, contract disputes, contract modifications, contract renewals and non-renewals, various business reasons for delaying contract closings, and the operational challenges of matching case volume with optimum staffing, having fully trained staff, having computer and telephonic supported operations and managing turnover of key employees and outsourced services to performance standards. While occurrences of these risks, and others detailed in this report and the Company's other SEC reports, cannot be predicted exactly, such occurrences can be expected to have an impact on the Company's anticipated level of revenue growth or profitability.