The selected consolidated statement of income data and balance sheet data set forth below for, and at the end of, the years ended December 31, 1995, 1996 and 1997, are derived from, and are qualified by reference to the financial statements of the Company audited by Coopers & Lybrand L.L.P., independent auditors, included elsewhere in this annual report. The selected consolidated statement of income data and balance sheet data for, and at the end of, the periods ended December 31, 1993 and prior, are derived from audited financial statements of the Company not included herein. The selected consolidated financial information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements and related notes.
(1) Presents consolidated financial data of the Company's predecessor, American Prepaid, for the periods prior to the Company's Acquisition of all of the outstanding stock thereof effective in June 1993. Because of such transaction, certain aspects of the consolidated results of operations for periods prior to the period July 1, 1993 are not comparable with those for subsequent periods. Consequently, net income per share data are presented only for the years December 31, 1994 and thereafter. For purposes of the Consolidated Statements of Income Data, references to common shares include common share equivalents. Net income per common share for the years ended December 31, 1994 and 1995, has been computed after deducting $109,000 and $218,000, respectively, from net income attributable to preferred stock dividend accumulation. (2) The DentiCare and UniLife acquisitions were completed on December 28, 1994, and DentiCare and UniLife are therefor included in the consolidated balance sheet of the Company at December 31, 1994 and thereafter, and the consolidated statement of income of the Company for the years ended December 31, 1995 and thereafter. (3) The CompDent acquisition was completed on July 5, 1995, and CompDent is therefor included in the consolidated balance sheet of the Company at December 31, 1995 and thereafter, and the consolidated statement of income of the Company for the years ended December 31, 1995 and thereafter. (4) The Texas Dental acquisition was completed on January 8, 1996 and Texas Dental is therefor included in the consolidated balance sheet of the Company at December 31, 1996, and the consolidated statement of income of the Company for the year ended December 31, 1996. (5) The Dental Care Plus acquisition was completed on May 8, 1996, and Dental Care Plus is therefore included in the consolidated balance sheet of the Company at December 31, 1996, and the consolidated statement of income of the Company for the year ended December 31, 1996. (6) The American Dental Providers and Diamond Dental & Vision acquisition was completed on March 21, 1997 and is therefore included in the consolidated balance sheet of the Company at December 31, 1997, and the consolidated statement of income of the Company for the year ended December 31, 1997. (7) The Workman Management Group, Old Cutler Dental Associates, Robert T. Winfree, D.D.S. and the Stratman Management Group acquisitions were completed on July 2, 1997, July 2, 1997, September 26, 1997 and November 7, 1997 respectively and these five are included in the consolidated balance sheet of the Company at December 31, 1997, and the consolidated statement of income of the Company for the year ended December 31, 1997.
The Company is a full-service dental benefits provider. Approximately 75% of revenues are generated from managed dental care plan subscriber premiums. In addition, DHMI generates approximately 10% of the Company's revenues from providing management services and support to dental practices. The balance of revenues are generated by reduced fee-for-service plans and third-party administrator services.
In reduced fee-for-service plans, the subscriber pays a fee for access to a panel of dentists. The dentists on the panel have agreed to provide services at reduced rates. The subscriber pays the dentist at the reduced rate for services provided at the time of service delivery. Therefore, this type of plan involves no payment by the Company to the dentists. Historically, the cost structure within reduced fee-for-service plans consists of no capitation expense, commission expense of approximately 25% of revenues, and general and administrative expenses of approximately 40% of revenues, leaving an operating margin of approximately 35% of revenues.
The Company operates two distinguishable segments, dental benefits services and dental practice management. The Company will report, for the year ending December 31, 1998, its financial information in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information.
The Company's predecessor, American Prepaid Professional Services, Inc. (American Prepaid), began operations in Florida in 1978. Since 1987 the Company has begun de novo operations in seven additional states. In December 1994, the Company entered the Texas market through the acquisitions of DentiCare, Inc. (DentiCare), a Houston-based managed dental care company, and UniLife Insurance Company, an indemnity insurer (UniLife). In July 1995, the Company entered or expanded its presence in additional markets, including Kentucky, Indiana, Missouri, Kansas and West Virginia, through the acquisition of CompDent Corporation (CompDent), a Louisville, Kentucky-based managed dental care company. In January 1996, the Company acquired Texas Dental Plans, Inc. and affiliated entities (Texas Dental), a reduced fee-for-service dental company based in San Antonio, Texas, which increased the Company's presence in Texas, broadened the Company's product line, and expanded the Company's operations to an additional seven states. Dental Care Plus Management, Corp. and its wholly owned subsidiary, CompDent of Illinois (formerly known as I.H.C.S., Inc.), a Chicago, Illinois-based third-party administrator and managed dental care provider, respectively, were acquired in May 1996 and greatly expanded the Company's presence in Illinois.
On December 28, 1994, the Company acquired DentiCare and UniLife for $17.0 million plus approximately $600,000 in transaction costs. These acquisitions were funded through the incurrence of $12.0 million of senior indebtedness (the "1994 Loan") and the issuance of $4.0 million of Redeemable Preferred Stock and $1.0 million of common stock. On June 1, 1995, the Company repaid the entire outstanding balance of the 1994 loan and retired all outstanding Subordinated Notes and Redeemable Preferred Stock (including accrued unpaid interest and accumulated dividends) with a portion of the net proceeds from its initial public offering. The DentiCare and UniLife acquisitions have been accounted for using the purchase method of accounting. The acquired assets and liabilities were recorded at their estimated fair market values at the date of acquisition, which in the case of UniLife resulted in a write-down of certain assets. In connection with the DentiCare acquisition, the Company recorded $15.6 million of goodwill, which is being amortized on a straight-line basis over 40 years. The Company's strategy regarding UniLife has been to wind down over time UniLife's dental indemnity insurance business. As of October 1, 1995, the Company reinsured UniLife's dental indemnity insurance business and its group term policies with another insurance company. In April 1996, the Company completed the conversion of all of UniLife's real estate and other assets into cash and cash equivalents.
On July 5, 1995, the Company acquired CompDent for $32.5 million plus approximately $1.1 million in transaction costs. The CompDent acquisition was funded through the incurrence of $25.0 million of senior indebtedness under the Company's revolving credit facility and proceeds from the Company's initial public offering. The Company then repaid the outstanding indebtedness under its revolving credit facility with a portion of the net proceeds received from its second stock offering. The CompDent acquisition has been accounted for using the purchase method of accounting. The acquired assets and liabilities were recorded at their estimated fair market values at the date of acquisition. In connection with the CompDent acquisition, the Company recorded $34.3 million of goodwill which is being amortized on a straight-line basis over 40 years.
On January 8, 1996, the Company acquired Texas Dental, a Texas-based reduced fee-for-service dental company for an aggregate cash purchase price of approximately $23.0 million including approximately $540,000 in transaction costs. The Texas Dental acquisition was funded with net proceeds remaining from the Company's second stock offering. The Texas Dental acquisition was accounted for using the purchase method of accounting, with the acquired assets and liabilities recorded at their estimated fair market values at the date of acquisition. Goodwill of $26.0 million was recorded in the acquisition and is being amortized over 40 years on a straight-line basis. The reduced fee-for-service products offered by Texas Dental broaden the Company's existing product line.
Effective March 21, 1997, the Company completed the acquisition of American Dental Providers, Inc. ("AMDP"), and Diamond Dental & Vision, Inc. ("DDV"). The aggregate purchase price of $1.7 million consisted of $0.5 million in cash and $1.2 million of Company common stock issued at fair market value. AMDP provides managed dental care services through a network of dental care providers, and DDV provides a vision plan and referral fee-for-service dental plan to the Arkansas market. The Company funded the cash portion of the purchase with cash available from operations. The acquisition of AMDP and DDV was accounted for using the purchase method of accounting with the results of operations of the businesses acquired included from the effective date of the acquisition. The acquisition resulted in excess of cost over fair value of net assets acquired of $2.9 million which is
Effective July 2, 1997, the Company completed the acquisition of 21 dental facilities from The Workman Management Group, LTD ("Workman"). The dental facilities are located in central and southern Illinois. The purchase price consisted of $15.5 million in cash, and with funding mainly from the revolving line of credit. Concurrent with the acquisition, the Company entered into a forty-year agreement to manage the dental practices which are operating in the dental facilities. The acquisition of Workman was accounted for using the purchase method of accounting with the results of operations of the business acquired included from the effective date of the acquisition. The acquisition resulted in excess of cost over fair value of net assets acquired of $15.2 million which is being amortized over 40 years. During the fourth quarter of 1997, the Company revised its allocation of the purchase price of Workman which resulted in an increase to the excess of purchase price over net assets acquired of $1.8 million to $17.0 million.
Year ended December 31, 1997, compared to the year ended December 31, Revenues increased by $17.6 million, or 12.5%, to $158.7 million in 1997 from $141.1 million in 1996. Of the increase, $7.9 million, was primarily attributable to revenues contributed by DHMI which commenced operations in 1997. The addition of AMDP and DDV and Dental Care Plus revenues following the acquisitions of these companies accounted for $0.9 million and $2.1 million, respectively, of this increase. Internal growth accounted for $6.7 million of the growth in subscriber premiums.
Interest income increased from $585,000 in 1996 to $725,000 in 1997. This increase is primarily attributed to the rise in interest rates and a concerted effort to invest cash in higher yielding instruments.
Other revenue increased by $3.5 million, or 198.5%, to $5.3 million in 1996 from $1.8 million 1995. The increase was primarily attributable to $3.2 million of Dental Care Plus third-party administrator fees and management fees in 1996 following the May 1996 Dental Care Plus acquisition.
Dental care providers' fees and claims costs increased $11.2 million, or 18.0%, to $73.4 million in 1996 from $62.2 million in 1995. Dental care providers' fees represent capitation payments paid to panel dentists under the Company's managed dental care plans. Under managed dental care plans, capitation payments to panel dentists are fixed under the participating dental agreement regardless of the extent of services provided. Dental claim costs represent amounts payable to dental care providers under certain non-capitated plans. Dental care providers' fees and claims costs decreased to 54.1% from 59.3% of subscriber premiums in 1996 and 1995, respectively. This decrease as a percentage of subscriber premiums is due to the acquisition of Texas Dental which, as a reduced fee-for-service dental company, has subscriber premiums with no corresponding capitation expense. Providers' fees and claim costs as a percentage of subscriber premiums were also lowered by the elimination of UniLife claims costs. As discussed above, effective October 1, 1995, UniLife entered into a reinsurance agreement and thus incurred no claims cost after this date. The addition of Dental Care Plus providers' fees and claims at 61.2% of subscriber premiums following the May 1996 acquisition partially offset these decreases.
Commission expense increased $1.4 million, or 13.2%, to $12.2 million in 1996 from $10.8 million in 1995. The addition of Texas Dental and Dental Care Plus commissions in 1996 resulted in a $1.4 million increase while the elimination of UniLife commissions resulted in a $1.9 million decrease. The acquisition of CompDent in July of 1995 impacted 1995 for part of the year and impacted 1996 for the full year, resulting in higher commission expense in 1996 of approximately $0.9 million. The remaining $1.0 million increase in commission expense was the result of internal growth in subscriber premiums. As a percentage of subscriber premiums, commissions decreased to 9.0% in 1996 from 10.3% in 1995. This decease related primarily to the addition of Dental Care Plus commissions at 1.0% of subscriber premiums and the elimination of UniLife commissions at 13.4% of subscriber premiums, partially offset by the addition of Texas Dental commissions at 15.4% of subscriber premiums. Without the effects of Dental Care Plus, UniLife, and Texas Dental on subscriber premiums and commissions, commissions as a percentage of subscriber premiums decreased slightly from 9.8% in 1995 to 9.2% in 1996. The slight decrease as a percentage of subscriber premiums was primarily attributable to an increase in the number of large employer groups for which the Company's direct sales force typically plays an active role in sales and servicing, resulting in a lower commission rate or no commissions being paid to independent agents with respect to these accounts. The expenses associated with the increased number of sales representatives employed by the Company were reflected in general and administrative expenses, rather than commissions.
when the acquisition of Dental Care Plus took place, general and administrative expenses as a percentage of revenues have decreased from 22.5% in the second quarter of 1996 to 20.7% in the fourth quarter of 1996. The Company believes further assimilation of acquired business will continue to result in reductions of general and administrative costs, subject to the temporary increases caused by any future acquisitions.
Interest income decreased from $735,000 in 1995 to $585,000 in 1996. Interest income consists of interest earned on available cash balances as well as interest earned on cash balances which are restricted by state regulatory agencies. Interest income declined due to the Company having less cash to invest in 1996, due to the completion of the Texas Dental and Dental Care Plan acquisitions.
Interest expense decreased slightly to $1.9 million in 1996 from $2.0 million in 1995. The Company had $26.6 million of debt outstanding from January 1995, of which $1.0 million was retired with proceeds from operating cash flows and the remainder with proceeds from the Company's initial public offering in June 1995. The Company incurred $25.0 million of new indebtedness in July 1995 under its revolving credit facility to partially finance the CompDent acquisition and repaid this indebtedness in August 1995 with proceeds from the second stock offering. In May 1996, $38.0 million was borrowed under the revolving credit facility to finance the acquisition of Dental Care Plus. At each quarter end, the Company draws from its credit facility to pay down inter-company balances. Any future acquisitions may cause the Company to incur additional indebtedness under its revolving credit facility or otherwise.
Other expense and income items total $219,000 in 1996, consisting mainly of the gain on sale of unneeded properties obtained in past acquisitions.
The Company's primary sources of cash in 1997 have been operating activities and borrowings under its revolving line of credit. The primary uses of cash for the period were the acquisitions of various dental practices, AMDP and capital expenditures at DentLease. During 1997, the Company invested excess funds in reverse repurchase agreements for U.S. government securities. The carrying value of the agreements approximates fair value because of the short maturity of the investments and the Company believes that it is not exposed to any significant risks on its investments in reverse repurchase agreements.
Cash flows from operating activities were $4.3 million and $9.5 million for 1997 and 1996, respectively. Cash flows from operations consist primarily of subscriber premiums and investment income net of capitation payments to panel dentists, claims paid, brokers' and agents' commissions, general and administrative expenses, and income tax payments. The Company receives some premium payments in advance of anticipated capitation payments and claims and invests cash balances in excess of current needs in interest-bearing accounts.
Cash used in investing activities was $24.9 million in 1997 and $64.5 million in 1996. The decrease, in 1997, in cash used relates primarily to a reduction in acquisitions. While cash of $20.8 million was used in 1997 to acquire AMDP and various dental practices, the Company used cash of $62.5 million to purchase Texas Dental and
Cash flows from financing activities in 1997 were $15.6 million, primarily representing borrowings under the Company's revolving line of credit to finance the acquisitions of various dental care practices and to repay inter-company borrowings to its regulated subsidiary companies at quarter-ends.
On June 30, 1995, the Company obtained a reducing revolving $35 million line of credit (the "Credit Facility") from banks. On July 5, 1995, to partially finance the acquisition of CompDent, the Company borrowed $25 million under the Credit Facility. On May 3, 1996, the Credit Facility was amended to increase the available line of credit to $65 million. On May 7, 1996, the Company borrowed $38 million under the Credit Facility to finance the acquisition of Dental Care Plus. The Credit Facility pursuant to a second amendment, entered into on March 16, 1998 requires a 50% reduction in available borrowings on December 31, 1999, and expiration of the Credit Facility on December 31, 2000. Outstanding indebtedness under the Credit Facility bears interest, at the Company's option, at a rate equal to the prime rate plus up to 1/4% or LIBOR plus up to 1 3/4%, with the margin over the prime rate and LIBOR decreasing as the ratio of consolidated debt to EBITDA decreases. Currently borrowings under the Credit Facility bear interest at the LIBOR-based rate. The Credit Facility prohibits payment of dividends and other distributions and restricts or prohibits the Company from making certain acquisitions, incurring indebtedness, incurring liens, disposing of assets or making investments; and requires it to maintain certain financial ratios on an ongoing basis. The Credit Facility is collateralized by pledges of the stock of the Company's direct and indirect subsidiaries. At December 31, 1997, the Company was in technical violation of three of the financial ratios as a result of the goodwill impairment and one-time charges recorded in the fourth quarter. The Company has received a waiver with respect to such covenants from its lenders. The Company had $56.6 million of borrowings outstanding as of December 31, 1997, under the Credit Facility.
The Company believes that cash flow generated by operations will be sufficient to fund its normal working capital needs and capital expenditures for at least the next 24 months. Historically, the Company's operations have not been capital intensive; however, the Company's recent initiative in the establishment of dental offices through its subsidiary operation Dental Health Management, Inc. will present capital needs, the extent of which is indeterminate. Additional financing, under the Credit Facility or otherwise, will be required in connection with an acquisition or acquisitions which the Company may consummate in the future.
During the fourth quarter of 1997, the Company completed an extensive review of its operation and determined there were changes that occurred that necessitated a number of unusual and one-time charges. The charges include $2.0 million for the termination of an exclusive indemnity relationship, $2.0 million for reserve for a surplus note, $1.6 million for litigation settlement costs, $1.4 million for a reserve for incurred practice management costs and $2.4 million in other costs. There was also $59.0 million in a write off for a goodwill impairment. Historically, the goodwill was reviewed on an undiscounted cash flow basis. It was determined that potential goodwill impairment should be analyzed on a discounted cash flow basis utilizing an economic rate of return that would be customary for evaluating the present value of future cash flows of current dental benefit company transactions. The Company believes that this method of valuation better reflects the performance of each acquisition. The Company does not believe these unusual and one-time charges will adversely affect its normal cash flow in 1998.
The Company's wholly-owned subsidiary, American Prepaid and its Florida subsidiary, American Dental Plan, Inc. ("ADP"), are currently defendants to a civil complaint filed by three participating dentists (one of which has since withdrawn) who have entered into Participating Dentist Agreements with various subsidiaries of the Company ("Subsidiaries"). The complaint alleges a breach of contract and seeks damages based on the failure of ADP to make capitation payments to its participating dentists for the period of time between when a subscriber enrolls and the time at which the subscriber selects a participating dentist. The plaintiffs sought to bring the suit as a class action. On December 4, 1997, a class was certified consisting of all participating dentists in the states of Florida, Mississippi, South Carolina, and Tennessee who, since September 1, 1989, have had Participating Dentist Agreements with American Dental Plan, Inc.
The Company does not believe that its financial performance has been or will be materially affected by inflation.
The Company's actual results could differ materially from its historical results or from any forward-looking statements made or incorporated into this Annual Report. Factors that may cause such differences include: the Company's ability to successfully complete new acquisitions and integrate acquired companies; the Company's ability to successfully expand its business to include the management of dental practices; the Company's ability to attract and retain qualified personnel and management; changes in state insurance laws and related government regulations; increased competition and growth in the dental benefits coverage market, and other unanticipated changes in economic conditions.
By the end of 1998, the Company expects that its various administrative systems will have the capability to process transactions dated beyond 1999. The costs to complete its efforts to modify or replace such systems are not expected to be material.