The Company leases a total of approximately 68,000 square feet of office space in a single location in Aliso Viejo, California, under a lease agreement that expires in 2008. Approximately 12,000 square feet of this space is not currently used by the Company, but is subleased to a third party through April 2002. The remaining 56,000 square feet of office space is used for the Company's corporate headquarters and its National Service Center, which includes member services activities, eligibility file maintenance, billing and collections, claims processing and other similar customer support activities. In addition, the Company leases office space in Walnut Creek, California; Tamarac, Florida; St. Louis, Missouri; and Dallas and Houston, Texas. The Company leased all of the office space used by its previously owned dental and orthodontic practices, which leases have been assigned, or are in the process of being assigned, to the entities who purchased the dental practices. The Company remains contingently liable for all of these leases, which expire on various dates through 2007, as discussed in Note 10 to the accompanying consolidated financial statements. In the opinion of management, the Company's facilities are adequate for its current needs.
SELECTED FINANCIAL DATA - ----------------------------------- The selected financial data in the following table was derived from the audited consolidated financial statements of the Company. This data should be read in conjunction with such financial statements and notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations.
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements, as long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statements. The Company desires to take advantage of these safe harbor provisions.
The statements contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations concerning expected growth, the outcome of business strategies, future operating results and financial position, economic and market events and trends, future premium revenue, future health care expenses, the Company's ability to control health care, selling, general and administrative expenses, and all other statements that are not historical facts, are forward-looking statements. Words such as expects, projects, anticipates, intends, plans, believes, seeks or estimates, or variations of such words and similar expressions, are also intended to identify forward-looking statements. These forward-looking statements are subject to significant risks, uncertainties and contingencies, many of which are beyond the control of the Company. Actual results may differ materially from those projected in the forward-looking statements, which statements involve risks and uncertainties.
The Company's ability to expand its business is affected by competition from a large number of other entities, many of which are much larger and have greater financial resources than the Company, that offer dental plans in the markets in which the Company operates. There is a risk that the Company will not be able to increase revenues in the future as employer groups and other purchasers of dental coverage continue to resist premium rate increases, while demanding a wide choice of dental care providers and a high level of customer service. Securing cost-effective contracts with dentists may become more difficult due to increased competition among dental plans for contracts with dental providers, and a possible decrease in the number of dentists in practice in the markets in which the Company operates.
All of these risks and uncertainties could have a negative impact on the estimated net proceeds from the resale of the dental office assets by the Company.
Premium revenue increased by $1.0 million, or 1.1%, from $96.2 million in 1999 to $97.3 million in 2000. The average membership for which the Company provided dental coverage decreased by approximately 78,000 members, or 8.8%, from 883,000 members during 1999 to 805,000 during 2000. The decrease in the average number of members is primarily due to the loss of several customers during 2000. Premium revenue increased by 1.1% even though average membership decreased by 8.8%. This was primarily due to a shift in the product mix toward preferred provider ("PPO")/indemnity plans, which have higher premium rates than managed care plans, increases in premium rates, and a shift in the managed care product mix toward managed care plans with higher benefit levels and higher premium rates.
Health care services expense decreased by $1.2 million, or 1.8%, from $68.8 million in 1999 to $67.6 million in 2000. Health care services expense as a percentage of premium revenue (the "loss ratio") decreased from 71.5% in 1999 to 69.5% in 2000. This decrease is primarily due to a decrease in the loss ratio for managed care products, which is primarily due to a reduction in certain types of non-standard payment arrangements to managed care providers during the first quarter of 2000. The decrease in the loss ratio for managed care products was partially offset by a shift in the product mix toward PPO/indemnity plans, which have a higher loss ratio than managed care plans. However, PPO/indemnity plans also have a higher amount of gross margin (premium revenue less health care services expense) per insured individual, and the Company believes they have significantly lower general and administrative expenses than managed care plans, as a percentage of premium revenue.
Selling, general and administrative ("SG&A") expenses decreased by $3.6 million, or 10.1%, from $35.8 million in 1999 to $32.2 million in 2000. SG&A expenses as a percentage of premium revenue decreased from 37.2% in 1999 to 33.1% in 2000. The decrease in SG&A expenses is primarily due to the following reasons. Salaries and benefits decreased due to a reduction in the number of employees during the first quarter of 2000, in connection with a consolidation of the Company's administrative services into a single location. The decrease is also partially due to a decrease in computer programming expenses, as the Company has completed several enhancements to its proprietary management information system that were in process during 1999. Part of the decrease is due to a decrease in amortization expense related to intangible assets. During the third quarter of 1999, the Company recorded a $24.6 million impairment loss to reduce the carrying values of its intangible assets to their estimated realizable values, which caused a decrease in amortization expense in 2000.
Loss on impairment of assets decreased from $24.6 million in 1999 to $450,000 in 2000. The loss on impairment in 1999 is primarily due to a reduction in the carrying value of the goodwill and non-compete covenants related to the acquisition of First American Dental Benefits, Inc. in 1996, and the acquisition of Advantage Dental HealthPlans in 1997. The amount of the impairment loss was determined in accordance with Accounting Principles Board Opinion No. 17, as discussed in Note 5 to the accompanying consolidated financial statements. The loss on impairment in 2000 is due to an increase in the reserve related to notes receivable, as discussed in Note 5 to the accompanying financial statements.
The loss before income taxes and discontinued operations decreased from $36.7 million, or 38.2% of premium revenue, in 1999, to $6.5 million, or 6.6% of premium revenue, in 2000. This decrease in the loss was primarily due to a $24.6 million loss on impairment of assets in 1999, a $3.6 million decrease in SG&A expenses, and a decrease in the loss ratio from 71.5% in 1999 to 69.5% in 2000, which is equal to a $1.9 million decrease in health care services expense.
Premium revenue decreased by $1.2 million, or 1.3%, from $97.4 million in 1998 to $96.2 million in 1999. The average membership for which the Company provided dental coverage decreased by approximately 60,000 members, or 6.4%, from 943,000 members during 1998 to 883,000 during 1999. Premium revenue decreased by only 1.3% even though average membership decreased by 6.4%. This was primarily due to a shift in the product mix toward PPO/indemnity plans, which have higher premium rates than managed care plans, increases in premium rates, and a shift in the managed care product mix toward plans with higher benefit levels and higher premium rates.
Health care services expense increased by $2.8 million, or 4.2%, from $66.0 million in 1998 to $68.8 million in 1999. Health care services expense as a percentage of premium revenue (the "loss ratio") increased from 67.7% in 1998 to 71.5% in 1999. This increase is primarily due to an increase in the loss ratio for managed care products, which is due to an increase in specialist referral claims and an increase in supplemental payments to capitated providers, both as a percentage of managed care premium revenue. The increase in specialist referral claims is primarily due to a shift in the managed care product mix toward richer benefit plans that include coverage of more specialist services. The increase in supplemental payments is due to the fact that the richer benefit plans also cover more services for which general dentists receive supplemental payments from the Company, in addition to the monthly capitation payments.
SG&A expenses decreased by $456,000, or 1.3%, from $36.3 million in 1998 to $35.8 million in 1999. SG&A expenses as a percentage of premium revenue was 37.2% in both 1998 and 1999. There was not a significant change in SG&A expenses from 1998 to 1999.
Income tax expense was $10.9 million in 1999, compared to an income tax benefit of $3.4 million in 1998. The income tax expense in 1999 primarily represents a charge to earnings to establish a deferred tax asset valuation allowance that is equal to the entire balance of the Company's net deferred tax assets. This valuation allowance was established due to uncertainty about whether the deferred tax assets will be realized in the future, primarily due to operating losses incurred by the Company in 1999 and 1998 and the existence of significant net operating loss carry-forwards. See Note 9 to the accompanying financial statements for more information.
Net cash used by operating activities decreased by $0.4 million, from $1.8 million in 1999 to $1.4 million in 2000. This improvement was due to several reasons, the largest of which are described below. Net cash used by the net loss, including the adjustments to reconcile net loss to net cash provided by (used in) operating activities, decreased from $6.7 million in 1999 to $3.0 million in 2000, primarily due to a $3.6 million decrease in SG&A expenses, as discussed above. The increase in accrued expenses was $3.3 million in 2000, compared to a decrease of $461,000 in 1999. The increase in 2000 was primarily due to liabilities related to the sale of "Assets transferred under contractual arrangements" in October 2000, as discussed in Note 2 to the accompanying financial statements. These factors were partially offset by a net $668,000 decrease in accounts payable and claims payable in 2000, compared to a combined increase of $3.7 million in those liabilities in 1999. The increases in these liability accounts in 1999 were primarily due to increases in the processing time for both accounts payable and dental claim payments during 1999. The processing time for both accounts payable and claims payable decreased significantly during 2000. However, in the case of claims payable, this decrease was offset by an increase in the amount of claims payable, due to a shift in the product mix toward PPO/indemnity plans, for which the health care expenses are reimbursed based on claims submitted, instead of capitation payments. In addition, deferred revenue decreased by $562,000 in 2000, compared to a $953,000 increase in 1999. The decrease in 2000 was primarily due to a decrease in the enrollment of individual subscribers who pay an annual premium in advance. The increase in 1999 was primarily due to earlier payment by employer groups due to an advance in the Company's billing cycle.
Net cash used by investing activities was $10.1 million during 2000, compared to $1.9 million of net cash provided in 1999. The net cash used in 2000 consisted primarily of the purchase of investments using the proceeds from the $8.0 million loan in March 2000, and the proceeds from $1.3 million of payments on notes receivable. Net cash provided by financing activities was $11.3 million in 2000, compared to $1.4 million of net cash used in 1999. The net cash provided by financing activities in 2000 consisted primarily of the proceeds from the $8.0 million loan in March 2000, and the increase in accrued interest that was converted to convertible preferred stock in 2001, as discussed below.
The Company's total debt increased from $39.8 million at December 31, 1999, to $48.0 million at December 31, 2000. This increase was primarily due to the $8.0 million borrowing in March 2000, as discussed below. See Note 7 to the accompanying financial statements for a description of all the debt outstanding as of December 31, 2000.
Effective as of January 31, 2001, the Company completed the conversion of the investor senior loan ($8.0 million), the outstanding balance under the revolving credit facility ($7.0 million), the senior notes payable ($32.5 million), and the accrued interest on the revolving credit facility and the senior notes payable ($5.0 million as of December 31, 2000) into 300,000 shares of convertible preferred stock. The estimated value of the convertible preferred stock as of January 31, 2001, was $137.50 per share, which is based on the closing price of the Company's common stock on January 31, 2001, which was $1.375 per share, and the fact that each share of convertible preferred stock is convertible into 100 shares of common stock. Based on this estimated value, the conversion transaction resulted in a gain of $11.3 million. It is expected that there will be no income tax effect related to this transaction, due to the Company's net operating loss carry-forwards for tax purposes, as discussed in Note 10 to the accompanying financial statements.
The convertible preferred stock does not accrue dividends of any kind. Each share of convertible preferred stock is convertible into 100 shares of common stock at the option of the holder. The convertible preferred stock entitles the holder to one vote for each share of common stock into which the preferred stock is convertible, with respect to all matters voted on by the common stockholders of the Company, except for the election of directors. The holders of the convertible preferred stock have the right to elect a total of five members of the board of directors, and the holders of the common stock have the right to elect the remaining two directors. The convertible preferred stock has a liquidation preference over the common stock of the Company.
In March 2000, the FASB issued FASB Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation." FIN 44 is effective July 1, 2000 with respect to certain provisions applicable to new awards, exchanges of awards in a business combination, modifications to outstanding awards, and changes in grantee status that occur on or after that date. FIN 44 addresses certain issues related to the application of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." The adoption of FIN 44 had no significant effect on the Company's financial statements.
The Company's operations are potentially impacted by inflation, which can affect premium rates, health care services expense, and selling, general and administrative expenses. The Company expects that its earnings will be positively impacted by inflation in premium rates, because premium rates for dental benefit plans in general have been increasing due to inflation in recent years. The Company expects that its earnings will be negatively impacted by inflation in health care costs, because fees charged by dentists and other dental providers have been increasing due to inflation in recent years. The impact of inflation on the Company's health care expenses is mitigated in the short-term by the fact that approximately 40% of total health care services expense consists of capitation payments to providers. In addition, most of the Company's selling, general and administrative expenses are impacted by general inflation in the economy.