(1) Represents reductions in the carrying value of notes receivable in 2000, intangible assets in 1999, and notes receivable and real estate in 1998, to their estimated realizable values. See Note 5 to the accompanying consolidated financial statements. (2) The 1999 amount primarily represents a charge to establish a valuation allowance against net deferred tax assets. See Note 9 to the accompanying consolidated financial statements. (3) Represents reductions in the carrying value of assets transferred under contractual arrangements to their estimated realizable value. See Note 5 to the accompanying consolidated financial statements. (4) Represents operating losses related to discontinued operations prior to the date they were sold, and subsequent expenses related to those operations. See Note 2 to the accompanying consolidated financial statements. (5) Pro forma balance sheet as though the conversion of debt and accrued interest to convertible preferred stock had occurred as of December 31, 2000. See Note 14 to the accompanying consolidated financial statements. (6) The increase in current liabilities in 2000 is primarily due to debt and accrued interest that was converted to convertible preferred stock in 2001. See the accompanying consolidated balance sheets.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATIONS - --------------
There are risks associated with changes in the Company's operating and expansion strategies, and the possible inability to realize all of the proceeds from the recent resale of certain dental office assets to a third party. There is a risk that the Company will be unable to continue to improve its earnings before interest, taxes, depreciation and amortization ("EBITDA"), as any such improvement is dependent upon a multitude of factors including, but not limited to, the ability of the Company to identify additional opportunities to reduce costs.
There is a risk that the purchaser of certain resold dental office assets will not comply with its agreement to make rental payments on the related office lease agreements, for which the Company remains contingently liable, and there is a risk that other dentists who previously purchased dental practices from the Company will not make the required payments on their assigned or sublet lease agreements, for which the Company remains contingently liable.
There is a risk that the Company may incur additional expenses in connection with the delivery of the dental office assets resold to the Purchaser, and there are risks associated with additional health care expenses that may be incurred by the Company for the cost of the completion of orthodontic and dental treatment that may be required to be paid in connection with the transfer of the recently resold dental office assets. There is a risk that the dentists who purchased a number of dental practices from the Company and issued promissory notes to the Company, will not make payments on such promissory notes.
The Company's profitability depends, in part, on its ability to maintain effective control over its health care costs, while providing members with quality dental care. A variety of factors, such as utilization rates of dental services, changes in the value of the Company's assets, new technologies, the cost of dental services delivered by referral specialists, the amount of claims incurred by patients insured by the Company, and numerous other external influences could affect the Company's operating results.
All of the risks set forth herein could negatively impact the earnings of the Company in the future. The Company's expectations for the future are based on current information and its evaluation of external influences. Changes in any one factor could materially impact the Company's expectations related to premium rates, benefits plans offered, membership enrollment, the amount of health care expenses incurred, and profitability, and therefore, affect the forward-looking statements which may be included in this report. In addition, past financial performance is not necessarily a reliable indicator of future performance. An investor should not use historical performance alone to anticipate future results or future period trends.
Investment and other income decreased by $0.6 million, or 30.8%, from $2.0 million in 1999 to $1.4 million in 2000. This decrease was primarily due to net realized gains on the sale of investments of $1.2 million in 1999, compared to nearly zero in 2000. This was partially offset by an increase in interest income in 2000, primarily due to investment of the proceeds of the $8.0 million borrowing on March 1, 2000, as discussed in Note 7 to the accompanying financial statements.
Total interest expense decreased by $1.0 million, or 16.1%, from $5.9 million in 1999 to $4.9 million in 2000. This decrease is primarily due to $1.9 million of deferred loan costs that were charged to expense during 1999. This decrease was partially offset by interest expense and amortization of deferred loan costs in 2000, related to the $8.0 million borrowing on March 1, 2000, as discussed in Note 7 to the accompanying financial statements.
The loss from discontinued operations decreased from $4.4 million in 1999 to $2.5 million in 2000. The losses in both 1999 and 2000 represent reductions in the carrying value of the net assets related to certain discontinued operations, which were reflected under the caption "Assets of discontinued operations transferred under contractual arrangements" on the accompanying consolidated balance sheet. These assets were resold in October 2000, as discussed in Note 2 to the accompanying financial statements.
Loss on impairment of assets increased from $2.4 million in 1998 to $24.6 million in 1999. 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 financial statements.
Investment and other income increased by $1.4 million, or 231.3%, from $624,000 in 1998 to $2.1 million in 1999. This increase was primarily due to net realized gains on the sale of investments of $1.2 million in 1999, compared to net realized losses of $618,000 in 1998.
Interest expense increased by $1.6 million, or 35.8%, from $4.3 million in 1998 to $5.9 million in 1999. This increase was primarily due to expenses incurred in connection with restructuring the credit agreements related to the senior notes payable and the revolving line of credit in May 1999. Those expenses consisted of $1.0 million of consulting and legal fees and the issuance of stock warrants with an estimated value of $320,000 to the holder of the senior notes payable. In addition, approximately $600,000 of other deferred loan costs were charged to expense in the third quarter of 1999, due to acceleration of the maturity dates of the senior notes payable and revolving line of credit.
The loss before income taxes and discontinued operations increased from $10.9 million, or 11.2% of premium revenue, in 1998, to $36.7 million, or 38.2% of premium revenue, in 1999. This increase in the loss was primarily due to the $24.6 million loss on impairment of assets, and an increase in the loss ratio from 67.7% in 1998 to 71.5% in 1999. These factors were partially offset by an increase in investment and other income from $624,000 in 1998 to $2.1 million in 1999.
The loss from discontinued operations to be disposed of increased from $2.4 million in 1998 to $4.4 million in 1999. The loss in 1999 is due to a $6.5 million reduction, before income tax effect of $2.1 million, in the carrying value of the net assets related to certain discontinued operations, which are reflected under the caption "Assets of discontinued operations transferred under contractual arrangements" on the consolidated balance sheet. During the second quarter of 1999, the Company recorded a $6.5 million charge to earnings to reduce the carrying value of these assets to their estimated realizable value.
On March 1, 2000, the Company entered into a recapitalization transaction with an investor group (the "Investors"), the revolving credit facility lender (the "Bank"), and the holder of the senior notes payable (the "Senior Note Holder"). In this transaction, the Investors loaned $8.0 million to the Company in the form of an investor senior loan, which was due April 30, 2001, and had an interest rate of 10% annually. The Investors, the Bank, and the Senior Note Holder agreed to convert the $8.0 million investor senior loan, the outstanding balance of $7.0 million under the revolving credit facility, and the $32.5 million of senior notes payable to convertible preferred stock, subject to regulatory and stockholder approval.
In connection with the recapitalization transaction, both the Bank and the Senior Note Holder agreed not to demand or accept any payment of principal or interest under their respective credit agreements, and not to take any enforcement actions of any kind under those agreements until April 30, 2001. As of December 31, 2000, the Company was subject to various financial covenant requirements under the credit agreements with the Bank and the Senior Note Holder. The Company was not in compliance with those requirements as of December 31, 2000. Accordingly, these outstanding balances are reflected as short-term debt on the accompanying balance sheet as of December 31, 2000.
As a result of the conversion transaction, the previously existing common stockholders of the Company now own approximately 14% of the common stock interests of the Company. In March 2000, in connection with the conversion transaction, the Company agreed to place four new directors, who represent the Investors, the Bank, and the Senior Note Holder, on its board of directors. Three of those directors were placed on the board in March 2000, and the fourth director was placed on the board as of January 31, 2001. These new directors constitute a majority of the board of directors, which currently has a total of seven members.
In 1999, in connection with a transaction in which the Company restructured its credit agreement with the Senior Note Holder, the Company issued warrants to purchase 382,000 shares of common stock for $4.51 per share to the Senior Note Holder. The warrants were exercisable at any time from January 1, 2000 to December 31, 2003. In connection with the recapitalization transaction, the Senior Note Holder agreed to cancel the warrants upon conversion of the Company's outstanding debt into convertible preferred stock. The warrants were cancelled as of January 31, 2001, in connection with the conversion of the Senior Notes Payable to convertible preferred stock.
Under the credit agreements related to both the revolving credit facility and the senior notes payable, the Company is subject to various loan covenant requirements. The Company was not in compliance with those requirements as of December 31, 2000, and, therefore, the balances outstanding under these agreements are classified as short-term debt as of December 31, 2000. However, as noted above, the outstanding balances under these agreements were converted into convertible preferred stock in January 2001.
The Company believes it has adequate financial resources to continue its current operations for the foreseeable future. However, there can be no assurance that there will not be any unforeseen events that could have a material adverse impact on the Company's financial position and the adequacy of its cash balances.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 was amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of SFAS No. 133" in June 1999, and by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" in June 2000. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS 133, as amended, requires derivatives to be reported on the balance sheet at fair value, and was adopted on January 1, 2001. The adoption of SFAS 133, as amended, had no significant effect on the Company's financial statements.
The Consolidated Financial Statements and the related Notes and Schedules thereto filed as part of this 2000 Annual Report on Form 10-K are listed on the accompanying Index to Financial Statements on page .