HRM's principal corporate offices consist currently of approximately 142,500 square feet in a building in Minneapolis, MN with a lease expiring in or by 2009, 31,000 square feet in Kalamazoo, MI with a lease expiring in or by 2001, 28,000 square feet in Philadelphia, PA with a lease expiring in or by 2004 and 4,000 square feet in Sacramento, CA with a lease expiring in or by 2000. All of the Company's facilities are used exclusively by the Company for office space or computer operations and are anticipated to be adequate, but will be expanded as business needs require.
(2) Earnings per share amounts prior to 1998 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, "Earnings Per Share." For further discussion of earnings per share, see the notes to the consolidated financial statements.
(3) Certain items in the 1995, 1996, 1997 and 1998 selected consolidated financial data have been reclassified to conform to the December 31,1999 presentation.
The Company's revenues consist primarily of Medicaid premiums for providing administrative services while assuming all the medical cost risk, management service fees for health plan management and QualityFIRST revenues for software licenses and subscription fees.
The HMO has estimated receivables from insurance policies for aggregate coverage of excessive medical costs that may result in adjustments in the future. The Company's HMO had a 50% quota share agreement whereby 50% of premiums, investments, medical costs and certain administrative cost are ceded to an insurance company until a certain policy period has passed or a recapture is allowed under the policy. Subsequent to year end, the Company's HMO recaptured the business ceded effective January 2000 for a recapture fee of $300,000 which was accrued at year end.
The Company adopted SOP 98-I on July 1, 1999 which resulted in lowering the amount capitalized for internally developed computer software related to its Care Management (AutoPILOT) and Claim Administration systems by approximately $500,000 per quarter based on the year ended June 30, 1999 analysis. This resulted in additional expense in the periods subsequent to June 30, 1999. Also, with the decision that the Company's Care Management system will be web-based versus web-enabled, the Company shortened the estimated useful life on AutoPILOT from 7 years to 3 years and this resulted in approximately $250,000 additional expenses in the quarter ended December 31, 1999 and each quarter thereafter for these years unless it is impaired or replaced before that time. In addition, no additional software costs will be capitalized related to AutoPILOT.
Revenues: Total revenues prior to the reduction for ceded premiums increased $11,277,000 (12%) for the six month period ended December 31, 1999 compared to the same period in 1998 (from $93,967,000 to $105,244,000), increased $106,023,000 (112%) from fiscal 1998 to fiscal 1999 (from $94,837,000 to $200,860,000) and increased $31,927,000 (51%) from fiscal 1997 to fiscal 1998 (from $62,910,000 to $94,837,000). These increases are primarily attributable to revenues from HMO operations which began April 16, 1998 (see Note 8 of the audited financial statements) offset by lower revenues from management service fees. Management service fees were impacted by a net decrease in the number of covered participants enrolled in the Company's management services related to an HMO that terminated services on September 30, 1998. During the six months ended December 31, 1999, the Service Business Unit's profit was reduced by approximately $1,000,000 due to reduced covered lives mainly attributable to a client that was centralizing its own care management department after acquiring significantly more covered lives. The Company replaced a significant portion of these lives going forward by extending and expanding its contract with Columbia HCA, a client of many years, in January 2000.
Revenues from QualityFIRST(R) increased 1% or $29,000 for the six month period ended December 31, 1999 compared to the same period in 1998 (increasing from $2,033,000 to $2,062,000), increased 11% or $416,000, from fiscal 1998 to fiscal 1999 (increasing from $3,648,000 to $4,064,000) and was largely unchanged between fiscal 1997 and fiscal 1998. The increases were the result of an increased number of clients or expansion of systems with existing clients, but does not include sales announced in the quarter, but implemented in subsequent quarters.
Selling, Marketing and Administration, Net: Selling, marketing and administration, net of amounts ceded, decreased 23% or $1,731,000 for the six month period ended December 31, 1999 compared to the same period in 1998 (decreasing from $7,662,000 to $5,931,000), increased 5% or $663,000, from fiscal 1998 to fiscal 1999 (from $13,386,000 to $14,049,000), and decreased 5% or $695,000 from fiscal 1997 to fiscal 1998 (from $14,081,000 to $13,386,000). The increases or decreases were due primarily to additions or decreases to staff, travel, commission, bad debts, insurance, training programs and other expenses. This expense as a percentage of net revenues (22%, 14%, and 9%) for
Interest Expense: Interest expense increased 63% or $237,000 for the six month period ended December 31, 1999 compared to the same period in 1998 (increasing from $374,000 to $611,000) and increased as a percentage of net revenue from 0.4% to 0.9%. Interest expense increased 99% or $485,000 from fiscal 1998 to fiscal 1999 (from $489,000 to $974,000), and increased as a percentage of net revenue from 0.5% to 0.6%. Interest expense decreased 9% or $46,000 from fiscal 1997 to fiscal 1998 (from $535,000 to $489,000) and decreased as a percentage of net revenue from 0.9% to 0.5%. Interest expense was impacted in fiscal 1998 by lower interest rates and lower average principal balances outstanding. In fiscal 1999, additional loans were obtained to acquire the HMO.
Income Taxes: Income tax benefit decreased 21% or $152,000 for the six month period ended December 31, 1999 compared to the same period in 1998 (from an income tax benefit of $735,000 to $583,000). Income tax expense decreased in fiscal 1999 from fiscal 1998 by $586,000, or 68% (from $868,000 to $282,000), and decreased in fiscal 1998 from fiscal 1997 by $545,000, or 39% (from $1,413,000 to $868,000) primarily due to fluctuations in levels of income (loss) before income taxes and cumulative effect of accounting change. Net income has been reported as fully taxed in the periods at the federal tax rate of 34% with the effective tax rate varying due to state income taxes, expired NOL's and nondeductible expenses. See Note 10 in the Notes to Consolidated Financial Statements.
Cumulative effect of accounting change: See Note 3 in the Notes to Consolidated Financial Statements.
The Company has a net operating loss carryforward of approximately $30,000,000 for income tax purposes at December 31, 1999, which can be used to reduce taxable income and cash flow necessary to pay taxes. The Company changed its tax accounting treatment to one of capitalizing computer software costs versus expensing them when incurred. This change should protect carry forward net operating loss (NOLs) for tax purposes going forward.
The Company believes that its cash and cash flow from operations, together with credit facilities which the Company has obtained, will be sufficient to finance the Company's anticipated normal expansion in calendar year 2000. The loss in the quarter ended December 31, 1999 resulted in the Company not meeting bank covenants under the bank loan agreements. Subsequent to December 31, 1999, the Company and the bank amended the loan agreement which will amend the covenants going forward and waived defaults that existed at December 31, 1999. The two new web-based business plans will require on-going support from the Company until external financing is obtained. The quarter ended December 31, 1999 included approximately $250,000 of expenses related to these business plans and more than double that amount will be required going forward until they are financed, estimated by mid-year, and it is expected that they will then create positive cash flow back to the Company.
The Company began work on its Year 2000 Project in 1997 and established a Year 2000 Project Office and Year 2000 Project Team in early 1998. There were five phases to the Company's Year 2000 Project: Phase 1: Identify and Analyze; Phase 2: Plan and Schedule; Phase 3: Execute the Plan (Remediate; Upgrade; Replace; or Eliminate); Phase 4: Test and Integrate; and Phase 5: Maintain Year 2000 Integrity. The primary focus of the Year 2000 Project effort was on the Company's mission critical systems, which are those that support and interface with our clients or vendors. The Company's Year 2000 Project is currently in Phase 5, maintenance of year 2000 integrity of all of our mission critical components.
The Company completed all year 2000 readiness work according to our Project plans and experienced no significant problems as a result of the transition to the year 2000. The Company continues to monitor its systems for any year 2000 issues. Because of the unique nature of the year 2000 issue, including the existence of critical dates in the year 2000, ongoing maintenance activities will necessarily continue into the year 2000.
Costs of the Company's Year 2000 Project through June 30, 1999 were approximately $1.1 million. An additional $.4 million was incurred in the six month transition period ended December 31, 1999. Costs to be incurred after December 31, 1999 are not expected to be significant. The costs associated with the Year 2000 Project have been and will be expensed as incurred.
The Company is reliant on technology and outside vendors to deliver its services. There could be a material adverse effect on the Company if there is a failure by the Company, or a third party dealing with the Company, to be year 2000 ready on a go forward basis. Possible consequences of such a failure include temporary disruption of the Company's ability to deliver services to its clients.
The Company's Year 2000 Project plans are subject to change and are necessarily dependent upon management business decisions and other factors, both internal and external. The Company will continue to monitor systems and activities relating to its Year 2000 Project.
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 marketplace including, but not limited to clients and vendors commonly experiencing mergers or acquisitions, use of estimates for incurred but not yet reported claims including medical services payable, use of estimates of bonus accruals including accounts receivable, reconciliations, volume fluctuations, provider relations and contracting, participant enrollment fluctuations, changes in member mix or utilization levels, fixed price contracts, contract disputes, contract modifications, contract renewals and non-renewals, regulatory issues and requirements, 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 periodically detailed in the Company's 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.