During 1997, the Company entered into an agreement to lease office space consisting of approximately 68,000 square feet in Aliso Viejo, California. The Company moved its corporate headquarters and executive offices from its previous location in Anaheim, California to Aliso Viejo, California during the third quarter of 1998. The Company previously owned a 60,000 square foot building in Anaheim, California, which it previously utilized as its corporate headquarters and executive offices. The Company sold this building during the second quarter of 1999. In addition, the Company leases offices in Phoenix, Arizona; Walnut Creek, California; Denver, Colorado; Fort Lauderdale, Florida; St. Louis, Missouri; and Austin, Dallas, and Houston, Texas. The Company leased all of the office space used by its previously owned dental practices, which leases have been assigned to the entities who purchased the dental practices, but for which
the Company remains secondarily liable. Those leases expire on dates ranging through July 2005. In the opinion of management, the Company's facilities are adequate for its current needs.
The Private Securities Litigation Reform Act of 1995 (the "1995 Act") 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 statement. 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 levels, future dental health care expense levels, the Company's ability to control health care, selling, general and administrative expenses, items discussed under the heading "Year 2000" 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 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, not only in benefit program choices, but also the number of dental plan competitors in the markets in which the Company operates. Certain large employer groups and other purchasers of commercial dental health care services continue to demand minimal premium rate increases, while limiting the number of choices offered to employees. In addition, securing cost effective contracts with dentists may become more difficult in part due to the increased competition among dental plans for dentist contracts. Other risks include the Company's potential inability to obtain waivers and/or extensions from its lenders, whether or not the Company enters into any extraordinary transaction, changes in the Company's operating or expansion strategy, or failure to consummate proposed resale of dental offices and/or promissory notes. The Company's profitability depends, in part, on its ability to maintain effective control over health care costs, while providing members with quality dental care. Factors such as levels of utilization of dental health care services, new technologies, specialists costs, and numerous other external influences may effect the Company's operating results. Any critical unresolved Year 2000 issues at the Company or its vendors could have a material adverse effect on the Company's results of operations, liquidity or financial condition. The Company's expectations for the future are based on current information and evaluation of external influences. Changes in any one factor could materially impact the Company's expectations relating to premium rates, benefits plans offered, membership growth, the percentage of health care expenses, and as a result, profitability and therefore, effect the forward-looking statements which may be included in these reports. 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.
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 indemnity plans, which have higher premium rates than managed care plans, increases in premium rates, and a shift in the product mix toward managed care plans with higher benefit levels and higher premium rates.
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 70.2% 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.
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 consolidated financial statements for more information.
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.
The Company's revenues for twelve months ended December 31, 1998 increased 2.2% from $95,350 to $97,449 on a membership decrease of 12.6%. The 1997 basis of comparison, however, includes the acquisition of Advantage in May 1997. On a pro forma basis, including the effect of the Advantage acquisition for the entire year, revenues for the same period increased $202 on a membership decrease of 12.6%. Notwithstanding the membership losses, largely in the first quarter of 1998, the average revenue per member increased due to price increases implemented by the Company and an increase in the volume of indemnity business, which has significantly higher revenue per member than the dental HMO business.
Selling, general and administrative expenses increased $11,156 or 44.4%. Including the Advantage acquisition for all of 1997, such increase would be $10,586. The increase experienced in 1998 is attributable to various factors, including a charge for uncollectible accounts receivable, increases in the sales and management staff and other infrastructure components to support anticipated growth of the Company in the future, the cost of the Company's relocation of its corporate headquarters from Anaheim, California to Aliso Viejo, California, and the associated operating leases, the costs associated with the elimination of various job functions at year-end, and the continuing increases in costs associated with telecommunications and computer networks.
Other income decreased by 52.6%, or $692, for the twelve months ended December 31, 1998 from $1,316 in 1997 to $624. This is primarily due to capital losses on the sale of investments in 1998.
The net loss related to the discontinued orthodontic and general dental practices for the twelve months ended December 31, 1998 was $2,430 versus a loss of $7,112 for the same period in the prior year, a decrease of $4,682.
Net loss of $9,938 for the twelve months ended December 31, 1998 was an increase of $4,445 over the loss of $5,493 reported for the same period a year ago. This was primarily due to the increase in selling, general and administrative expenses discussed above, which was partially offset by the decrease in the loss from discontinued operations.
In January 1998 the Company entered into an $8 million revolving line of credit facility with a bank, under which $7.0 million was outstanding at December 31, 1999. The outstanding balance under the credit facility was payable in full on January 29, 2000. The interest rate on the facility as of December 31, 1999, was equal to the bank's prime rate plus 3.0 % (11.0% at December 31, 1999). The loan is secured by all assets of the Company, including accounts receivable, property and equipment, intangible assets, and a negative pledge on the stock of all the Company's subsidiaries.
The convertible preferred stock would not accrue dividends of any kind, and would be convertible into an aggregate of 30.0 million shares of common stock of the Company, at the option of the holder. The convertible preferred stock would entitle the holder to one vote for each share of common stock into which the
As of December 31, 1999, the net worth of one of the Company's subsidiaries, SafeHealth, was approximately $4.5 million below the minimum capital and surplus required by the applicable state laws and regulations. Of the proceeds of the $8.0 million borrowing on March 1, 2000, as discussed above, $5.0 million was invested in SafeHealth to increase its net worth above the minimum amount of capital and surplus required.
As of December 31, 1999, the Company's current liabilities exceeded its current assets by $9.0 million. The Company believes this negative working capital position is mitigated by the $8.0 million proceeds of a long-term borrowing completed on March 1, 2000, as discussed above. The Company also intends to sell certain long-term assets during the next several months, although there can be no assurance that it will be successful in doing so. Management's plans to continue the Company's operations as a going concern and to return the Company to profitability include plans to increase premium rates, reduce certain types of non-standard provider payments, reduce the number of its employees by consolidating certain administrative functions in one location, reduce the amount of office space used, and reduce various other selling, general and administrative expenses. However, there can be no assurance that the Company's actual results for future periods will meet current expectations. Based on these factors and other relevant considerations, the Company's current expectation is that it has an adequate amount of cash to operate its business for the foreseeable future. Also, the Company believes it will be able to obtain additional financing, if necessary, to support operations.
The Company relies heavily upon information technology, including its primary transaction processing systems, its telephones, its building access control systems, heating and ventilation equipment, and other computerized systems, to conduct its business. The Company also has numerous business relationships with employer groups and other customers, dental health care providers, other vendors, financial institutions, and other third parties, including state regulators, who are reliant upon information technology to conduct their businesses. There can be no assurance that none of these entities will experience business disruptions related to the Year 2000 issue that could, in turn, cause business disruptions for the Company.
The Company believes it has adequately modified its information systems so that dates in the year 2000 are properly recognized by all of its significant applications. As of March 31, 2000, the Company has experienced no significant impact on its business related to the year 2000 issue, from either its own information systems or those of third parties with which it does business.