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, 1994, 1995, 1996, 1997 and 1998, are derived from the consolidated financial statements of the Company. 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) The DentiCare and UniLife acquisitions were completed on December 28, 1994, and DentiCare and UniLife are therefore included in the consolidated balance sheet of the Company at December 31, 1994, and the consolidated statement of income of the Company for the years ended December 31, 1995. (2) The CompDent acquisition was completed on July 5, 1995, and CompDent is therefore included in the consolidated balance sheet of the Company at December 31, 1995, and the consolidated statement of income of the Company for the years ended December 31, 1995. (3) The Texas Dental acquisition was completed on January 8, 1996 and Texas Dental 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. (4) 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. (5) 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. (6) 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. (7) The Michael H. Reznik, D.D.S., P.C. and R. Kendall Roberts, D.D.S., P.C., d/b/a Newhealth Dental Group, acquisitions were completed on January 2, 1998 and April 30, 1998, respectively, and are included in the consolidated balance sheet of the Company at December 31, 1998, and the consolidated statement of income of the Company for the year ended December 31, 1998.
but marketed and administered by the Company under agreements with the underwriting insurers. A small portion of the Company's revenues is generated from commissions earned from the insurance companies underwriting such dental indemnity insurance.
Revenues from third-party administrator arrangements are earned by managing the claims processing and paying function for groups. The groups fund the claims and pay a service fee to the Company. Historically, the cost structure within third-party administrator arrangements consists of no capitation expense, commission expense of approximately 5% of revenues, and general and administrative expenses of approximately 70% of revenues, leaving an operating margin of approximately 25% of revenues.
DHMI earns its revenues from the provision of management services to the dental practices. These services include billing and collections, accounting, marketing, materials management, human resources, facility management and payor relations. Affiliated practice revenue represents the gross revenue of the affiliated dental practices, reported at estimated realizable amounts, received from third-party payors and patients for dental services rendered. DHMI operating expenses consist of the expenses incurred by DHMI in connection with managing the affiliated dental practices, including salaries and benefits of personnel, dental supplies, dental laboratory fees, occupancy costs, equipment leases, management information systems and other expenses related to affiliated dental practice operations. The Company also incurs personnel and administrative expenses in connection with maintaining a corporate function that provides management, administrative, marketing and development services to the affiliated dental practices.
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. In accordance with the transaction, the management agreement resulted in fair value of an intangible asset of $16.6 million which is currently being amortized over 40 years.
completed the acquisition of Stratman Management Group ("Stratman") and its six dental facilities located in Indiana. The purchase price of these facilities consisted of $5.0 million in cash less discharge of liabilities related to the purchased assets. Funding for the acquisitions was obtained from cash available from operations and from the Company's revolving line of credit. Concurrent with the acquisitions, the Company entered into forty-year agreements to manage the dental practices which are operating in the dental facilities. Each acquisition 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. In accordance with the transaction, the management agreement resulted in fair value of an intangible asset of $6.2 million which is currently being amortized over 40 years.
During the fourth quarter of 1997, management evaluated goodwill impairment pursuant to the Company's existing policy. The evaluation indicated no impairment which was deemed contrary to events occurring in the fourth quarter. The events that led to this conclusion and to the Company experiencing declines in historic growth rates, pricing, and margins are as follows: predatory pricing of traditionally more expensive indemnity and preferred provider organization products, a significant penetration of the Company's market by large insurance carriers either by acquiring the Company's competitors or starting their own dental health maintenance organization (HMO), and difficulty the Company experienced in recruiting new panel dentists in certain markets where there was not full acceptance of the prepaid concept. These events combined with a significant unanticipated decrease in the growth of the overall dental HMO market forced the Company's projected growth rates from their historic levels of approximately 20% to 6% to 8% per annum. Although these events were occurring throughout 1997, the Company believed that historic growth rates could be achieved in 1998. However, it became apparent that new business and renewals, which are traditionally sold in the fourth quarter for the following year, did not support this assertion.
The Company's discounted cash flow analysis was calculated using projections for a period of 5 years and a discount rate and terminal value multiple that would be customary for evaluating current dental benefit company transactions and multiples. At December 31, 1997 the discount rate and the terminal multiple used was 13% and 7, respectively. The assumptions were selected by utilizing a weighted average cost of capital and multiple for the Company's peer group. In addition, the Company estimated a growth rate of 6% per annum. The assumptions used in this analysis represent management's best estimate of future results. However, actual results could differ from these estimates.
Effective April 30, 1998, the Company completed the acquisition of two dental facilities from R. Kendall Roberts, D.D.S., P.C., d/b/a Newhealth Dental Group, ("Roberts"). The dental facilities are located in Fort
Smith, Arkansas. The purchase price consisted of $1.4 million in cash. Funding for the acquisition was obtained from cash available from operations and from the Company's revolving line of credit. Concurrent with the acquisition, the Company entered into a 40-year agreement to manage the dental practices, which are operating in the dental facilities. The acquisition of Roberts 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. There were no liabilities, material assets acquired or material transaction costs incurred. In accordance with the transaction, the management agreement resulted in fair value of an intangible asset of $1.4 million which is being amortized over 40 years.
Dental care providers' fees and claim costs decreased $3.2 million, or 3.9%, to $78.5 million in 1998 from $81.7 million in 1997. 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. The decrease in dental care providers' fees and claim costs was due in part to a $2.0 million unusual charge in 1997 associated with the settlement of the risk-sharing provisions of one of its indemnity relationships. The remainder of the decrease was due to the decrease in subscriber premiums. Dental care providers' fees and claims costs decreased to 55.1% from 56.9% of subscriber premiums in 1998 and 1997, respectively. In December 1997, the Company settled the claims of certain of its participating dentists with respect to the failure to make capitation payments to the participating dentists for the period of time between when the affected subscribers enrolled and the time at which the subscribers selected a dentist. In connection with its settlement of these claims, various subsidiaries of the Company amended their Participating Dentist Agreements to provide that they will pay capitation fees to the dentist when there has been a delay between the time a subscriber initially enrolled in the dental plan and the date they selected a dentist for all subscribers who enroll after January 1, 1999. Although the Company believes the impact of the amendments will have an insignificant effect on providers' fees and claim costs, no reasonable estimate of this effect can be made at this time.
General and administrative and DHMI operating expenses increased $9.4 million, or 21.2%, to $53.7 million in 1998 from $44.3 million in 1997. Of the increase, $16.4 million was the result of expenses related to the generation of affiliated practice revenue from DHMI which was offset by the absence in 1998 of the $7.4
Interest income increased $0.2 million, or 28.6%, to $0.9 in 1998 from $0.7 in 1997. This increase was primarily due to a shift in investing cash in higher yielding liquid instruments.
Interest expense increased $1.1 million, or 34.4%, to $4.3 million in 1998 from $3.2 million in 1997. The Company had $55.5 million of debt outstanding at December 31, 1998. The increase was primarily related to interest on additional debt incurred to finance DHMI acquisitions during the third and fourth quarters in 1997 and the first and second quarters of 1998. Any future acquisitions may cause the Company to incur additional indebtedness under its revolving credit facility or otherwise. The Pending Re-capitalization Transaction contemplates a substantial increase in the Company's indebtedness which will in turn increase the Company's interest expense.
In 1998, the Company's effective income tax rate decreased to 43.0% compared with 48.3% (excluding the $59.0 million in write-offs for goodwill impairment) in 1997. The decrease is primarily attributable to the reduction of non-deductible goodwill amortization and an increased level of net income.
As a result of the above mentioned factors, the net income for 1998 was $10.1 million, or $1.00 per share -- basic ($0.99 per share-diluted), compared to net loss of $53.7 million, or $5.32 per share -- basic and diluted, for 1997.
Year ended December 31, 1997, compared to the year ended December 31, 1996
Revenues increased by $17.6 million, or 12.5%, to $158.7 million in 1997 from $141.1 million in 1996. Of the increase, $6.1 million, was attributable to revenues contributed by DHMI and $1.8 was attributable to management fees received from DHDC, 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.
Other revenue increased by $2.9 million, or 54.7%, to $8.2 million in 1997 from $5.3 million in 1996. The increase was primarily attributable to $2.0 million of Dental Care Plus third-party administrator fees and management fees in 1997 following the May 1996 Dental Care Plus acquisition.
Dental care providers' fees and claim costs increased $8.3 million, or 11.3%, to $81.7 million in 1997 from $73.4 million in 1996. 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. The increase
Interest income increased from $0.6 million in 1996 to $0.7 in 1997. This increase is primarily attributed to the rise in interest rates and a concerted effort to invest cash in higher yielding instruments.
In 1997, the Company's effective income tax rate increased to 48.3% (excluding the $59.0 million in write-offs for goodwill impairment) compared with 44.3% in 1996. The increase is primarily attributable to additional nondeductible goodwill amortization recorded in 1997 following the recent acquisitions and the relatively lower base of net income.
The Company's primary source of cash in 1998 was $8.0 million provided by operating activities. The primary uses of cash for the period were the acquisitions of Reznik and Roberts and capital expenditures related to the expansion of the Company's dental practice management business.
Cash flows used in financing activities in 1998 were $1.1 million, representing repayments under the Company's revolving line of credit. 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.
1998, primarily due to the significant capital expenditures associated with DHMI operations. The Company has received a waiver with respect to all such violations. On August 10, 1998, the Company entered into the Fourth Amendment which adjusted one of the financial ratios to acknowledge the increased capital expenditures. On March 23, 1999, the Company entered into the Fifth Amendment which extends the required 50% reduction of the Credit Facility to March 31, 2000. On March 29, 1999, the Company entered into the Sixth Amendment which revised certain financial ratios. The Company had $55.5 million of borrowings outstanding as of December 31, 1998, 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 12 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. The Pending Re-capitalization Transaction contemplates a substantial increase in the Company's indebtedness which will in turn increase the Company's interest expense.
The Company recognizes the significance of the Year 2000 problem and is executing a project to achieve Year 2000 readiness. The Company's goal is to have its major internal systems ready for the year 2000 by
December 31, 1998, and to complete testing of the major application systems, supporting hardware and operating systems by September 30, 1999. A dedicated machine has been put in place to undertake the appropriate Year 2000 validation testing. All major application systems, supporting hardware and operating systems appear to be Year 2000 capable. Secondary systems, such as desktop computers and phone systems, in field offices were addressed in 1998 and will continue to be addressed in early 1999. This goal allows for twelve months of internal testing prior to the year 2000. At September 30, 1999, if testing indicates the Company has not achieved Year 2000 readiness, a contingency plan will be established.