The Company's revenues for twelve months ended December 31, 1998 increased 2.2% from $95,350 to $97,449 on a membership decrease of 12.6%. The 1997 basis of comparison, however, includes the acquisition of Advantage in May 1997. On a pro forma basis, including the effect of the Advantage acquisition for the entire year, revenues for the same period increased $202 on a membership decrease of 12.6%. Notwithstanding the membership losses, largely in the first quarter of 1998, new business was acquired during the balance of the year that incorporated improved pricing strategies that generated a recovery of revenues that would have otherwise been lost. Additionally, cross selling of offerings to clients, moderate price increases to the existing customer base and increases in sales to small and mid-size clients contributed to the revenue stability.
Other income increased $709 for the twelve months ended December 31, 1998 from $1,632 in 1997 to $2,341, an increase of 43.4%. This is primarily due to the interest bearing notes receivable as a result of the sale of the discontinued general dentist and orthodontic practices.
Interest expense increased $1,440 for the twelve months ended December 31, 1998 from $2,871 in 1997 to $4,311 in 1998, an increase of 50.2%. Such increase is a result of the interest associated with the working capital credit facility which was entered into in 1998 and the private placement long-term debt, which was entered into during 1997.
The operating results of the discontinued orthodontic and general dental practices for the twelve months ended December 31, 1998 reflect a gain of $1,466 after a tax provision of $937 versus a loss of $4,160 for the same period in the prior year, an increase of $5,626.
After restating the Company's financial statements to reflect the discontinuation of the Company's general dental practices, and for the adoption of a change in accounting principle (see Notes 1 and 2 of the Consolidated Financial
Statement), the Company's revenues for the twelve months ended December 31, 1996, were $72,709, or a 19.7 percent increase on a 29.2 percent membership increase over the corresponding period a year ago. These increases included the impact on revenues and membership for the acquisition of First American, completed September 27, 1996. Excluding the impact of the acquisition, revenues for the same period indicated above increased 14.8 percent on a 6.0 percent increase in membership. The increase in revenue was attributable to new small and mid-size clients, cross-selling of product offerings to existing clients and moderate price increases to renewing clients.
Health care expenses for the twelve months ended December 31, 1996 increased $9,249 or 20.4 percent. Health care expense as a percentage of health care revenues increased by 0.4 percent from 74.6 percent of revenues for the twelve months ended December 31, 1995, to 75.0 percent for the same period in 1996. This was primarily due to an increase in the estimated liability for claim costs processed through the Company's indemnity dental system, as well as the selected disenrollment of less profitable clients based on actuarial reviews of plan designs and utilization.
Other income declined to $984 from $1,286 due to lower balances of cash and investments. The Company entered into a credit agreement during 1996 to facilitate the acquisition of First American, resulting in interest expense of $485.
In September 1996, the Company established a $30 million bank loan which provided for a $22 million reducing revolving acquisition sub-facility and an $8 million revolving working capital sub-facility. This agreement was terminated in September 1997.
On January 29, 1998, the Company entered into a $8,000,000 revolving working capital credit facility with Silicon Valley Bank (the "Bank"), all of which is currently being utilized by the Company. The loan had a maturity date of January 28, 1999, and is currently due and payable. The interest rate for the facility, as amended, was established at the Bank's Prime rate, plus 1.5 percent or at the Company's option, LIBOR plus 2.25 percent. The loan is secured by a first priority security interest in all the personal property of the Company, including accounts receivable, fixed assets and intangibles and a negative pledge on the stock of the Company's subsidiaries and on the real property owned by the Company. In connection with the Bank and Hancock loan, the Company is subject to certain financial and operational debt covenants. As a result of underperforming notes related to the sale of the dental offices that were previously sold and discontinued, reduction in the value of the Company's former headquarters building in Anaheim, California, which the Company is in the process of selling, severance payments to a number of former employees who left the Company in the fourth quarter as a result of the Company's continuing efforts to streamline its operations, and expenses for a reduction in its account receivable balances which may be uncollectable, as ascertained after the Company completed its systems conversion in October 1998, as of the end of the fourth quarter of 1998 the Company was not within compliance with such covenant requirements.
See also the section entitled Recent Developments for a description of restructuring of credit facilities in April 1999.
The Year 2000 issue results from computer programs using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruption of operations, including among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
As part of the Company's proactive approach to automation, the Company began planning an awareness activity as early as January 1996 and incorporated Year 2000 compliance into its business continuity plans. As a result, the Company purchased and is in the final implementation process of upgrading any and all information systems software and hardware. The implementation of such new and upgraded computer information systems will recognize the Year 2000 and process date data correctly, including the Company's manipulation of data when dates are in the 20th or 21st century. The Company executed its initial steps in 1996 when it continued to enhance its information systems, including all hardware and software products, individually and in combination, to better manage operational resources and analysis of data. A review was also performed to determine the future needs of the Company and to enhance technology to better enable the Company to provide its services. In addition, as a foundation for developing and executing its Year 2000 compliance program, SafeGuard utilized and integrated Year 2000 compliance programs developed by both Federal and State governments and corporate industry leaders. Moreover, SafeGuard developed a comprehensive five-phase approach for all of its Year 2000 program activities and management processes. The five phases are included in the following table that indicates the percentage completed as of November 1998.
(3) Phase 3: Renovation - reprogram or replace when necessary, inventoried items to ensure that they are Year 2000 compliant;
(4) Phase 4: Validation - test the code modifications and new inventory of other associated systems, including extensive date testing and performing quality assurance testing to ensure successful operation in a post-1999 environment; and
(5) Phase 5: Implementation of Year 2000 Compliant IT and other systems.
As indicated in the above-referenced chart, the Company completed Phase 1 Planning and Awareness on or about June 1, 1997, Phase 2 Assessment on or about January 1, 1998 and Phase 3 Renovation of all of its IT and other systems and related facilities on or about January 1, 1999. The Company anticipates completing Phase 4 Validation and beginning Phase 5 Implementation of such Year 2000 Compliant IT and other systems and facilities by June 1999.
The Company has also inventoried and risk rated its systems. Substantially all of the tested systems have been found to be compliant.
The Company has previously compiled a comprehensive list of any and all Vendors and Vendor products, which was included in a Vendor identification matrix. Although the Company does not currently rely upon external Vendors for proprietary software or data services, all other Vendors have been identified and have either stated their full compliance or partial compliance with contingent solutions to Year 2000 issues. The Company believes that its Vendors with which it has a material relationship are Year 2000 Compliant, based upon such vendor's assurances. Nonmaterial Vendors of the Company currently have provided either full and/or partial certification of compliance with the Year 2000 issue. The Company will continue to monitor such nonmaterial Vendor compliance activity in order to determine the risk to overall company operations.
The cost the Company incurred to address Year 2000 Compliance issues from a historical perspective is approximately $2.5 million. Whereas, the estimated cost of the Company's completion of the final phases of renovation, validation and implementation is estimated to be approximately $0.5 million. A large majority of these costs are expected to be incremental expenses that will not recur in Year 2000 or thereafter. The Company's current estimates primarily reflect increased remediation and testing efforts. The source of funds for the Year 2000 Compliance Program costs, including the percentage of the information technology budget utilized for the program was $3.0 million. Year 2000 Compliance
The Company has begun to develop contingency/recovery plans aimed at ensuring the continuity of critical business functions before and after December 31, 1999. As part of that process, the Company has begun to develop reasonably likely failure scenarios for its critical IT systems and external relationships and the embedded systems. Once these scenarios are identified, the Company will develop plans that are designed to reduce the impact on the Company, and provide methods of returning to normal operations, if one or more of those scenarios occur. The Company expects contingency/recovery planning to be substantially complete by June 1999.
To reduce the risk of the Company presented by the Year 2000, the Company has also increased its on-hand supplies of inventory for printed documents and materials that are provided to client groups, and has identified alternative Vendors, whether such Vendors have previously provided assurances that they are fully Year 2000 Compliant or are in the process of becoming Year 2000 Compliant. Therefore, based upon the Company's proactive Year 2000 Compliance Program, the Company anticipates that the Year 2000 issue will not have a material impact on the Company's results or operations.