The Company leases 36,588 square feet of office space for its corporate offices in Dallas, Texas under a lease expiring March 31, 2002. In addition, the Company leases an aggregate of approximately 87,106 square feet of space for its other regional and local offices with lease terms expiring at various times through May 20, 2002.
This document includes "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. All statements other than statements of historical fact included in this document, including, without limitation, statements under Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 1. "Business," regarding the Company's financial position, business strategy and plans and objectives of management of the Company for future operations are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the Company's expectations are disclosed throughout this Form 10-K, including, without limitation, in conjunction with the forward-looking statements included herein. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are hereby expressly qualified in their entirety.
Effective February 1, 1996, the Company completed the acquisition of all of the outstanding common stock of AHP for $15.0 million, which includes the present value of amounts payable under 36-month non-competition agreements with four former stockholders of AHP.
by a subsidiary of the Company in connection with dual choice plans and individual policies offered by the Company. Dual choice plans permit members to select between the Company's prepaid dental plans and traditional dental indemnity insurance. The dental indemnity insurance subsidiary was acquired effective September 1, 1994, so the Company had no revenue from this source prior to that date. The Company primarily seeks to generate its revenues through employer groups, specifically medium to large groups, although approximately 7.2% of the Company's prepaid members are individuals not associated with a group.
The Company's premium revenues increased from $10.8 million for the year ended December 31, 1991 to $111.9 million for the year ended December 31, 1996, a compound annual growth rate of 59.6%. Such increase would have been approximately 21.3% assuming the acquisitions of IDH and US Dental had not occurred in 1994 and 1995, respectively, and the acquisitions of AHP, Independent, Association, OraCare and KCDC had not occurred in 1996. The increase is primarily related to the growth in the number of members, both from internal growth and from acquisitions, and secondarily due to premium rate increases. IDH had approximately 370,000 prepaid members and 90,000 indemnity members when it was acquired by the Company effective September 1, 1994. The Company had approximately 267,000 prepaid members at that date. Subsequent acquisitions added the following membership:
General and Administrative. General and administrative expenses increased $3.8 million, or 25.7%, to $18.6 million in 1996 from $14.8 million in 1995. The decline in general and administrative expenses as a percentage of revenues to 16.4% in 1996 from 18.7% in 1995 was primarily attributable to efficiencies achieved through the consolidation of executive staffs and accounting departments due to the Company's integration of its acquisitions. In addition, there was a decrease in premium taxes as a percentage of revenue because the Company now generates a greater percentage of its revenues in states that charge lower premium taxes.
Depreciation and Amortization. Depreciation and amortization expenses increased $1.1 million, or 91.7% to $2.3 million in 1996 from $1.2 million in 1995. Most of this increase was the result of amortization of goodwill and the Agreements entered into in connection with the acquisitions of IDH, US Dental and AHP and the depreciation of the assets acquired.
Interest. Interest expense decreased to $0.5 million in 1996 from $1.0 in 1995. The $0.5 million was entirely attributable to the imputed interest on the Agreements incurred to finance the IDH, US Dental and AHP acquisitions and the interest on the OraCare Promissory Note. The weighted average interest rates on the Agreements and the OraCare Promissory Note during 1996 were 7.9% and 4.8%, respectively. The weighted average interest rate on the Agreements includes the effects of the fees for the related letters of credit
Revenues. Revenues increased by $41.8 million, or 112.0%, to $79.2 million in 1995 from $37.4 million in 1994. Of this increase, $2.2 million, or 5.3% was attributable to the operations added through the acquisition of US Dental in November 1995. The remaining $39.6 million increase was a 105.9% increase in revenues to $77.0 million in 1995 from $37.4 million in 1994, in markets where the Company had operations in both periods. This increase was primarily a result of having IDH operations for the full year in 1995 compared to only four months in 1994 and the increase in the membership numbers. During 1995, members increased from 740,984 at December 31, 1994 to 937,355 at December 31, 1995. The increase in the comparable period in 1994 was from 214,455 to 740,984. Interest income increased $0.4 million, or 200.0% from $0.2 million to $0.6 million in 1995. This increase was due to the interest income derived from the cash proceeds of the initial public offering in September 1995.
Dental Services. Dental services expenses increased $26.6 million, or 132.3 %, to $46.7 million in 1995 from $20.1 million in 1994. Total dental services as a percentage of revenue increased to 59.0% in 1995 from 53.8% in 1994, primarily due to the effect of a higher dental expense loss ratio in the indemnity insurance business that the Company acquired through IDH. Claims expense for the indemnity business was 82.4% of indemnity revenues in 1995 as compared to 82.8% in 1994. Dental service expenses for the Company's managed benefits plans ("Plans"), which consist primarily of capitation payments to general dentists, increased to 53.3% of managed benefits revenues in 1995, from 49.1% in 1994. This increase is attributable to the fact that the Plans offered by IDH have historically paid general dentists a higher percentage of premiums than the Company's pre-existing Plans. It is management's intention to increase premiums over the next several years, as market conditions permit, thereby increasing revenues. In most markets, amounts paid to general dentists will also be increased to maintain the Company's competitive position and to improve the economics for general dentists. The acquisition of Associated will result in an increase of approximately 5% in the percentage of dental services expenses for all of its managed dental benefits Plans relative to managed benefits revenues in 1996 over the percentage experienced in 1995.
Sales and Marketing. Sales and marketing expenses increased $3.8 million or 67.4%, to $9.6 million in 1995 from $5.8 million in 1994. Sales and marketing expenses as a percentage of revenue declined to 12.2% in 1995 from 15.4% in 1994. This decrease was largely attributable to the change in product mix from primarily Plans in 1994 to a combination of indemnity and Plans in 1995, resulting from the acquisition of IDH effective September 1, 1994. Since the indemnity business generates a higher per-member-per-month revenue than is generated by the Plans, and a portion of the sales and marketing costs, such as base salaries and printing costs, are fixed, the expenses as a percentage of revenues decline. In addition, the commissions paid on the indemnity business are lower as a percentage of revenues than those paid on the Plans.
In September 1995, the Company completed an initial public offering of 2,375,000 shares of its common stock for $22.00 per share (the "Offering"), resulting in net proceeds of $48.0 million. The Company used approximately $9.9 million of such proceeds for the repayment of all outstanding bank indebtedness, which had been incurred in 1994 to finance the acquisition of IDH.
The Company's historical operating cash requirements have been met through cash provided by operations. Net cash provided by operating activities was $1.3 million and $2.9 million for the years ended December 31, 1996 and 1995, respectively. The reduced amount of cash provided by operating activities in 1996 as compared to 1995 was a result of (i) a change to earlier capitation payments to certain network dentists that resulted in a one-time increase in cash outflow and (ii) a change to later collection of prepaid revenues from certain groups that resulted in a one-time decrease in cash inflows. Both changes were instituted to provide better
customer service and had no direct effect on operating earnings. The increase in premiums receivable of $4.9 million, the decrease in unearned premiums of $2.1 million and the decrease in accounts payable, accrued expenses and claims reserves of $2.2 million all reflect this one-time impact on cash from operating activities. Management believes that active management of receivables balances will result in a significant improvement in cash receipts during 1997.
The Company's primary cash need is for debt service on the Agreements. The principal amount of the outstanding indebtedness of the Company at December 31, 1996 was $28.9 million, consisting of the OraCare Promissory Note of $24.9 million and the liability for the Agreements of $4.1 million. The Promissory Note was paid off on January 2, 1997. The IDH Agreements require payments of $0.1 million on January 1 and $0.8 million on September 16 each year. The US Dental Agreements require monthly payments totaling $0.3 million per year. The AHP agreements require monthly payments totaling $0.2 million per year.
On November 14, 1996, the Company signed a revolving credit agreement providing a $35.0 million revolving credit facility with an unaffiliated bank. The purpose of the revolving credit facility is to provide (i) for funding future acquisitions of managed dental benefits companies, (ii) for the issuance of letters of credit, (iii) for capital expenditures and (iv) at the election of the company, a working capital line of credit in an amount up to $5.0 million out of the total amount available under the revolving credit facility. The revolving credit facility has a term of four years, expiring November 30, 2000. Outstanding indebtedness under the revolving line of credit will bear interest payable quarterly, at the Company's option, at: (i) up to 0.25% over the base rate of the lender or (ii) up to 1.85% over LIBOR, with the margin over the respective rates decreasing as the ratio of total funded debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") decreases. The Company pays an annual fee of up to 0.25% of the amount remaining available to be drawn under the credit facility and up to 0.85% of the amount available to be drawn under the letters of credit.
In 1994, the Company arranged for the issuance of two letters of credit in the aggregate amount of $4.8 million. The letters of credit secure the obligations of the Company under certain agreements executed in connection with the IDH acquisition. The letters of credit decline in amount annually and expire in September 1998. The Company pays an annual fee of up to 0.85% of the amount remaining to be drawn under the letters of credit.
Capital expenditures were $4.5 million during the year ended December 31, 1996 and $2.2 million in the year ended December 31, 1995. Such expenditures in 1996 primarily consisted of the capitalized costs related to the new information system, expected to be completed in 1997. In June 1995, the Company entered into a contract to acquire a new information system to replace its existing system. The capital cost of the conversion of all current systems is expected to be approximately $6.6 million. This capital cost includes the capitalization of certain direct internal costs associated with the new system in addition to external costs such as consulting fees and hardware and software expenditures.