The Company leases 45,889 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 97,066 square feet of space for its other regional and local offices with lease terms expiring at various times through July 31, 2002.
- - ------------------------ (1) Results of operations for IDH after August 31, 1994 are included in historical results of operations for the Company on a consolidated basis for the years ended December 31, 1994, 1995, 1996 and 1997. See the Company's Consolidated Financial Statements and the Notes thereto. (2) Results of operations for US Dental after October 31, 1995 are included in historical results of operations for the Company on a consolidated basis for the years ended December 31, 1995, 1996 and 1997. See the Company's Consolidated Financial Statements and the Notes thereto. (3) Results of operations for AHP after January 31, 1996, Independent and Association after September 30, 1996 and for KCDC and OraCare after October 31, 1996 are included in historical results of operations for the Company on a consolidated basis for the years ended December 31, 1996 and 1997. See the Company's Consolidated Financial Statements and the Notes thereto. (4) Results of operations for United after December 31, 1996 and for IDP after May 31, 1997 are included in historical results of operations for the year ended December 31, 1997. See the company's Consolidated Financial statements and the Notes thereto.
Effective October 1, 1996, the Company completed the acquisitions of all of the outstanding common stock of Independent for $1.3 million in cash and of Association for $3.2 million in cash.
Effective November 1, 1996, the Company completed the acquisitions of all of the outstanding common stock of KCDC for $12.5 million in cash and of OraCare for $5.6 million in cash and a promissory note, maturing January 2, 1997, in the amount of $24.9 million (the "OraCare Promissory Note"). The OraCare Promissory Note was paid in full at maturity on January 2, 1997.
The Company's revenues consist primarily of managed benefits premiums for the prepaid dental plans offered by the Company, such premiums representing 85.1% and 86.4% of total revenues for the years ended December 31, 1997 and 1996, respectively. A secondary source of revenue (representing 13.3% and 10.4% of total revenues for the years ended December 31, 1996 and 1997, respectively) is the indemnity premiums received 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 estimates that premium rate increases have generally averaged about 3.5% per year during the five-year period ended December 31, 1997.
Dental Services. Dental services expense increased by $56.0 million, or 82.8%, to $123.6 million in 1997 from $67.6 million in 1996. Dental services expense as a percentage of total revenues increased to 70.8% in 1997 from 59.5% in 1996. Dental services expense for the Company's managed benefits plans, which consist primarily of capitation payments to general dentists, increased to 67.6% of managed benefits revenues in 1997, from 59.5% in 1996. Dental services expense as a percentage of total revenues was higher in 1997 than 1996 due primarily to (i) higher dental services expense on the Company's fee-for-service products, consisting of indemnity and point-of-service,
Sales and Marketing. Sales and marketing expenses increased $6.2 million, or 49.2%, to $18.8 million in 1997 from $12.6 million in 1996. Sales and marketing expenses as a percentage of revenues declined to 10.8% in 1997 from 11.1% in 1996. A portion of the sales and marketing costs, such as base salaries of field sales personnel and office rents, are fixed so that the expenses as a percentage of revenues decline as revenues increase.
General and Administrative. General and administrative expenses increased $11.3 million, or 60.8%, to $29.9 million in 1997 from $18.6 million in 1996. The increase in general and administrative expenses as a percentage of revenues to 17.1% in 1997 from 16.4% in 1996 was primarily attributable to an increase in salaries and benefits of additional administrative personnel and certain one-time consulting fees incurred during the year. The Company substantially increased such staffing and related expenses through the acquisitions completed within the last year. Until the systems of the acquired entities are fully integrated, the Company will not be able to achieve significant administrative cost reduction. In addition, costs associated with the payment of fee-for-service claims are greater in 1997 due to the larger volume of claims paid relative to revenues during the period as well as an increase in the percentage fee paid to the third-party administrator.
Dental Services. Dental services expenses increased $20.9 million, or 44.7% to $67.6 million in 1996 from $46.7 million in 1995. Total dental services as a percentage of revenues increased to 59.5% in 1996 from 59.0% in 1995 primarily due to the increase in the dental services expenses related to the managed benefits business. Dental service expenses for the Company's managed benefits business (before intercompany eliminations), which consist primarily of capitation to dentists, increased to 59.5% of managed benefits revenues in 1996 from 53.3% in 1995. This increase is attributable to the fact that the managed benefits plans offered by IDH, US Dental and AHP have historically paid dentists a higher percentage of premiums than the Company's pre-existing plans paid. Claims expense for the indemnity business was 70.0% of indemnity revenues.
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.
In October 1996, the Company completed a public offering of 2,000,000 shares of its common stock for $30.00 per share (the "1996 Offering"), resulting in net proceeds of $56.2 million. The Company used a portion of the proceeds to complete the acquisitions of Independent, Association, OraCare and KCDC in 1996 and of United and IDP in 1997.
The Company's historical operating cash requirements have been met through cash provided by operations. However, net cash used in operating activities was $1.3 million for the year ended December 31, 1997. The increased use of cash for operating activities in 1997 was a result of reduced net income due to the losses incurred with the Arizona Medicaid contract, the need to increase the indemnity and POS reserves and the writeoff of uncollectible receivables. Additionally, at December 31, 1997, the Company had approximately $1.8 million of income taxes receivable related to current year losses and overpayments of estimated federal income taxes.
The Company's primary cash need is for capital expenditures and debt service on the Agreements and bank loans. The principal amount of the outstanding indebtedness of the Company at December 31, 1997 was $9.4 million, consisting of $6.6 million outstanding balance under the revolving credit facility and the liability for the Agreements of $2.8 million. The IDH Agreements require a payment of $0.8 million 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. The OraCare capital leases require payments of $0.2 million over the next four years.
On June 29, 1997, the Company signed the first amendment to the revolving credit facility. The first amendment modified the Minimum Liquidity Coverage Ratio covenant and allowed the Company to repurchase outstanding shares of its capital stock. The amendment also allowed the Company to exceed the capital expenditure limit for 1997 only. On February 20, 1998, the Company executed the second amendment to the revolving credit facility. The second amendment increased the limit for capital expenditures and working capital not to exceed $15,000,000 in the aggregate at any one time. Additionally, the second amendment provided for certain changes in the financial covenants increasing the availability of advances to the Company. Approximately $8.4 million remained available for working capital and capital expenditures under the revolving credit facility at December 31, 1997.
Capital expenditures were approximately $7.5 million during the year ended December 31, 1997 and $4.5 million in the year ended December 31, 1996. Such expenditures in 1997 primarily consisted of the capitalized costs related to the new information system, expected to be completed in 1998. 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 $10.2 million, of which $8.8 million had been incurred by December 31, 1997. 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.
The Company has reviewed its computer software and hardware for any issues that may occur as a result of the arrival of the year 2000 and has determined that none of its software and hardware require a material expenditure of funds or effort in order to continue functioning properly beyond the year 2000. As discussed above, the Company currently relies upon Harrington as a third-party administrator for the provision of indemnity claims administrative services to the Company. While the Company has received assurances from Harrington that such systems will be modified, at Harrington's expense, before the year 2000 in order to continue functioning properly, there is no assurance that this goal will be achieved, and, while no costs to the Company are expected to arise, costs resulting from any operational difficulties of Harrington or resulting from the Company's change of vendors for this service could nevertheless arise and such amounts could be material.