(1) As discussed in Note 3 of the consolidated financial statements, the Company changed its method of accounting for management service 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, and decreased 1995 net income by $79,000.
The Company's operating expenses are comprised of medical costs, net (consisting primarily of the net medical costs after the ceded portion of medical services and reinsurance, net of recoveries), its cost of services, net (consisting primarily of net costs after ceded portions 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), and selling, marketing and administration expenses, net (consisting primarily of the net costs after ceded portions of sales commissions, advertising, sales account management personnel, bad debts, administration, professional services, insurance, compensation and depreciation). The medical costs, cost of services and selling, marketing and administration expenses are affected to varying degrees by the 50% quota share agreement related to the Medicaid block of business which became effective January 1, 1999 (for further discussion of the 50% quota share agreement, see Note 8 of the audited financial statements).
A significant portion of the Company's revenue is from the Risk Business Unit which owns an HMO serving a Medicaid membership. This business is subject to regulatory risks such as rate setting, reporting, net worth requirements, government agendas and the general health of the membership served. Service utilization for contracted charges payable to providers of care, pharmacies, vendors, etc. are highly variable and as such estimates are used to estimate charges incurred but not yet received. The medical loss for the plan continues to be highly subjective. In the six month transition period ended December 31, 1999, management and the board recorded an additional $2,000,000 medical services payable because it desired to set more conservative best estimate after considering the February 2000 claim payment information together with additional actuarial analysis.
Accounts receivable at times, may include performance bonus accruals which when billed, may result in amounts greater than the accrual or less than the accrual because considerable time may pass between the accrual of the revenue and the actual billing of the performance bonus. The affected parties then require time to prove up the final calculations.
The following table sets forth certain consolidated financial data as a percentage of total revenues for each of the three years in the periods ended June 30, 1997, 1998 and 1999 and for the six month transition period ended December 31, 1998, and 1999 and compares the percentage change in the dollar amounts of these items for the period indicated.
Premiums - gross are from HMO operations which were the result of obtaining in the fourth quarter of fiscal 1998 the revenue from a client contract under which the Company was at risk for the total medical services costs. The Company received a significant portion of the total premium from this HMO from April 1998 through December 1998 and the Company then acquired this HMO in January 1999. The Company did not have this business in the first three quarters of fiscal 1998. The premiums-gross increased 17% or $11,484,000, for the six month period ended December 31, 1999 compared to the same period in 1998 (increasing from $67,175,000 to $78,659,000) and increased 427% or $117,182,000, from fiscal 1998 to fiscal 1999 (increasing from $27,457,000 to $144,639,000). The increase was the result of two and one-half months of premium in fiscal 1998 compared to twelve months of premiums in fiscal 1999, membership category changes and rate adjustments effective January 1999. Total revenues include the ceding allowance and net revenues reflect the premiums that are ceded under the reinsurance agreement that was entered into January 1999.
The management services revenue decreased 7% or $1,720,000, for the six month period ended December 31, 1999 compared to the same period in 1998 (decreasing from $24,342,000 to $22,622,000) which was the result of the loss of an insurance company and bankruptcy of a health plan in the second quarter. Revenues from management services decreased 23% or $14,664,000, from fiscal 1998 to fiscal 1999 (decreasing from $63,395,000 to $48,731,000) mainly the result of the 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 and other clients who terminated services. The management services revenue increased 7% or $4,319,000, from fiscal 1997 to fiscal 1998 (increasing from $59,076,000 to $63,395,000) which was the result of the growth of existing business and new contracts entered into by the Company.
Investment income increased 15% or $61,000 for the six month period ended December 31, 1999 compared to the same period in 1998 (increasing from $417,000 to $478,000), increased 188% or $632,000 from fiscal 1998 to fiscal 1999 (increasing from $337,000 to $969,000), and 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 the periods including any increases in interest rates earned.
Medical Costs, Net: Medical costs, net of amounts ceded, for the HMO decreased 41% or $23,754,000 for the six month period ended December 31, 1999 compared to the same period in 1998 (decreasing from $58,194,000 to $34,443,000) due mainly because the ceding arrangement began in 1999. Medical costs, net of amounts ceded, increased 283% or $66,947,000 from fiscal 1998 to fiscal 1999 (from $23,625,000 to $90,572,000) due to the HMO operations that began in the fourth quarter of fiscal 1998. As a percentage of net HMO premiums, net medical costs was 86.6% for the six month period ended December 31, 1998 compared to 84.8% for the same period in 1999 and 86.0% in fiscal 1998 compared to 84.8% in fiscal 1999. This percentage is the result of higher premium rates for the years versus the cost of medical expenses, net of insurance recoveries.
Cost of Services, Net: Cost of services, net of amounts ceded, decreased 2% or $459,0000 for the six month period ending December 31, 1999 compared to the same period in 1998 (decreasing from $28,456,000 to $27,997,000), increased 1% or $300,000 from fiscal 1998 to fiscal 1999 (from $55,141,000 to $55,441,000), and increased 24% or $10,501,000 from fiscal 1997 to fiscal 1998 (from $44,640,000 to $55,141,000). The increases were primarily due to increased payroll and expenses related to the HMO and implementing management services for additional covered lives. As a percentage of net revenues, the cost of service, net of amounts ceded, was 71% in fiscal 1997, 58% in fiscal 1998 and 34% in fiscal 1999 and was 30% for the six months ended December 31, 1998 and 42% for the same period in 1999. These decreasing percentages were the result of higher premium revenue in fiscal 1998 and still higher premium revenue in fiscal 1999. The six month period change from 1998 to 1999 resulted mainly from the reinsurance agreement entered into in January 1999 and the ceding of a portion of premium and expense to the insurance company.
fiscal 1997, fiscal 1998 and fiscal 1999, respectively, decreased because of the higher premium revenue in fiscal 1998 and still higher premium revenue in fiscal 1999. This expense was 8% for the six months ended December 31, 1998 and 9% for the same period in 1999. The six month period change from 1998 to 1999 resulted mainly from the reinsurance agreement entered into in January 1999 and the ceding of a portion of premium and expense to the insurance company.
Oxford Transition Costs : The Company incurred transition costs related to the purchase of Oxford Health Plans (PA), Inc., now named HRM Health Plans (PA), Inc., of approximately $920,000 in the quarter ended December 31, 1998, and $430,000 in the quarter ended September 30, 1998 , due to increased operational costs for HMO related activities without a corresponding increase in the management service fees.
The Company's cash flow from operations was $4,510,000 and used in operations was $5,295,000 for the six months ended December 31, 1999 and 1998, respectively. The Company's cash flow from operations was $6,892,000 and $23,685,000 for fiscal 1999 and 1998, respectively. Cash flow from operations have exceeded net income (loss) 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. For the six month period ended December 31, 1998, cash flow used in operations exceeded the net loss due to an increase in accounts receivables.
Cash of $7,734,000, net of cash acquired, was used in the third quarter of fiscal 1999 to purchase Oxford Health Plans (PA), Inc., now named HRM Health Plans (PA), Inc., on January 27, 1999. Cash has been used to invest in software and program enhancements ($3,146,000 and $4,864,000 for the six months ended December 31, 1999 and 1998, respectively and $8,696,000 and $9,057,000 in fiscal 1999 and fiscal 1998, respectively). The Company also used cash to acquire property and equipment ($603,000 and $4,858,000 for the six months ended December 31, 1999 and 1998, respectively and $5,602,000 and $2,734,000 for fiscal 1999 and fiscal 1998, respectively). Approximately $3,000,000 of the fiscal 1999 property and equipment purchases were related to the corporate office move in the first quarter of fiscal 1999. Cash of $1,641,000 was generated in the six month transition period ended December 31, 1999 from the sale of fixed maturity investments and $234,000 was used in fiscal 1999 from the purchase of fixed maturity investments. The Company expects to continue to acquire property and equipment and enhance software and products.
The Company had a working capital deficit of $7,581,000 and $8,511,000 at December 31, 1999 and June 30, 1999, respectively and working capital of $3,474,000 at June 30, 1998. The medical services payables reduced working capital by $22,506,000, $21,215,000 and $15,452,000 at December 31, 1999, June 30, 1999 and 1998, respectively. The Company has fixed maturity investments of $6,675,000 and $8,406,000 available at December 31, 1999 and June 30, 1999, respectively, to be used to pay medical services payables, if the need arises.
The Company has a term loan and revolving loan (principal balance of $7,195,000 and $2,925,000, respectively, as of December 31, 1999.) with its bank and a revolving credit facility expiring January 30, 2001, under which the Company has $75,000 and $235,000 additional available under the facility at December 31, 1999 and June 30, 1999, respectively. The revolving credit and term loan are secured by liens on the assets of the Company.