Under managed dental care plans, Subscribers pay a premium to receive dental services from a dentist which the subscriber selects from a panel of dentists. The Panel dentists are paid by the Company a monthly capitation fee which is fixed under the participating dental agreement regardless of the extent of services provided. Historically, the cost structure within managed dental care plans results in capitations of approximately 60% of revenues, commission expense of approximately 10% of revenues, and general and administrative expenses of
approximately 20% of revenues, leaving an operating margin of approximately 10% of revenues. Dual Choice plans allow members to choose between a managed dental care plan offered by the Company or a traditional dental indemnity insurance plan underwritten by an unaffiliated insurance company, 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.
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. In most markets, DHMI is paid a percent of practice revenues; however, because of regulatory limitations, DHMI receives a flat fee in several markets.
In addition to growth by acquisitions, the Company has achieved internal revenue growth from increases in the number of subscribers, a shift toward products with higher benefit levels and higher premiums and, to a much more limited extent, premium rate increases. The Company has historically introduced an across-the-board rate/benefit increase of approximately 6% to 8% every three years with a gradual implementation of the new rates/benefits throughout the subscriber base resulting in price increases of approximately 3% per year on average.
On June 29, 1993, the Company acquired all of the issued and outstanding capital stock of American Prepaid for approximately $29.5 million in cash. The 1993 acquisition was funded through the incurrence of $20.0 million of senior indebtedness (the "1993 Loan") and the issuance of $6.85 million of Subordinated Notes, $1.0 million of Redeemable Preferred Stock and $1.7 million of common stock. The Company repaid the entire
outstanding balance of the 1993 Loan and retired all outstanding Subordinated Notes and Redeemable Preferred Stock (including accrued unpaid interest and accumulated dividends) on June 1, 1995, with a portion of the net proceeds from its initial public offering. The 1993 acquisition has been accounted for using the purchase method of accounting. The Company recorded $3.0 million related to a non-competition agreement and $23.5 million of goodwill, which are being amortized on a straight-line basis over 5 and 40 years, respectively.
Effective May 8, 1996, the Company acquired Dental Care Plus. The aggregate purchase price for Dental Care Plus was $38.0 million (including approximately $843,000 in transaction costs), of which the Company paid approximately $27.0 million in cash and assumed approximately $11.0 million in accrued liabilities. Dental Care Plus is based in Chicago, Illinois, and provides managed dental care services through a network of dental care providers. Dental Care Plus also acts as a third-party administrator and provides management services to Health Care Systems, Inc., a non-profit dental company. The Company financed the purchase of Dental Care Plus as well as satisfaction of the assumed liabilities by drawing down the Company's revolving credit facility. The acquisition of Dental Care Plus was accounted for using the purchase method of accounting, resulting in the Company recording $41.2 million in goodwill which is being amortized over 40 years on a straight-line basis.
being amortized over 40 years. During the second quarter of 1997, the Company revised its allocation of the purchase price of AMDP and DDV which resulted in a decrease to the excess of purchase price over net assets acquired of $0.5 million to $2.4 million.
During the third and fourth quarter of 1997, the Company completed the acquisition of several dental facilities from three additional dental groups. Effective July 2, 1997, the Company completed the acquisition of one dental facility located in southern Florida from the Old Cutler Dental Associates, P.A. ("Old Cutler"). Effective September 26, 1997, the Company completed the acquisition of one dental facility located in central Tennessee from Robert T. Winfree, D.D.S., P.C. ("Winfree"). Effective November 7, 1997, the Company 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. The acquisitions resulted in excess of cost over fair value of net assets acquired of $5.5 million which is being amortized over 40 years.
During the fourth quarter, management concluded that the Company's accounting policy with respect to the recoverability of goodwill should be changed to discounted projections of future cash flows using an economic rate of return that would be customary for evaluating the present value of future cash flows in connection with current dental benefit company transactions. As a result of this accounting change, the goodwill attributable to the acquisition of CompDent Corporation was reduced from $32.1 million to $13.9 million. Additionally, the goodwill attributable to the acquisition of Dental Care Plus Management, Corp. was reduced from $39.1 million to $8.8 million, DentiCare, Inc. was reduced from $14.4 million to $6.0 million and American Dental Providers, Inc. and Diamond Dental & Vision, Inc. was reduced from $2.1 million to $0, or a total reduction of $59.0 million. The goodwill associated with these acquisitions will be amortized over the remaining forty-year life.
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 in dental care providers' fees and claim costs was due in part to a $2.0 million one-time charge associated with terminating an indemnity relationship. Dental care providers' fees and claims costs increased to 57.0% from 54.1% of subscriber premiums in 1997 and 1996, respectively. The increase was partially the result of the one-time charge mentioned above.
Commission expense increased $1.1 million, or 9.0%, to $13.3 million in 1997 from $12.2 million in 1996. The $1.0 million increase in commission expense was the result of internal growth in subscriber premiums. As a percentage of subscriber premiums, commissions increased to 9.3% in 1997 from 9.0% in 1996.
Premium taxes remained the same in 1997 as a percentage of subscriber premiums at 0.7%
General and administrative expenses increased $13.9 million, or 45.7%, to $44.3 million in 1997 from $30.4 million in 1996. As a percentage of total revenues, this expense increased to 27.9 % in 1997 from 21.5% in 1996. Of this increase, $5.0 million, or 35.5%, was related to the operating costs of DHMI's dental facilities. This increase as a percentage of revenues is due to higher general and administrative costs ($2.1 million or 14.8%) added following the January startup of DHMI. The remaining increase related to the $7.4 million in unusual and one-time charges which were recorded in the fourth quarter of 1997. The unusual and one-time charges included a reserve for a surplus note ($2 million), reserve for incurred practice management startup costs ($1.4 million), litigation settlement costs ($1.6 million) and other costs ($2.4 million). The increases were partially offset by a $0.6 million decrease from further assimilation of acquired business which resulted in reductions of general and administrative costs.
As a result of the above mentioned factors, the net loss for 1997 was $53.7 million or $5.32 per share compared to net income of $9.9 million or $0.97 per share for 1996.
Year ended December 31, 1996, compared to the year ended December 31, Revenues increased by $34.4 million, or 32.3%, to $141.1 million in 1996 from $106.7 million in 1995. This increase was primarily attributable to a $30.9 million, or 29.5% increase in subscriber premiums to $135.8 million in 1996 from $104.9 million in 1995. The addition of Texas Dental and Dental Care Plus subscriber premiums following the acquisitions of these companies accounted for $8.8 million and $10.0 million, respectively, of this increase. The acquisition of CompDent in July of 1995 impacted 1995 for part of the year and impacted 1996
for the full year, resulting in higher subscriber premiums in 1996 of approximately $16.6 million. Internal growth accounted for $9.7 million of the growth in subscriber premiums. These increases in subscriber premiums were partially offset by a decrease of $14.2 million in UniLife premiums. Effective October 1, 1995, UniLife reinsured all of its indemnity insurance with another insurance company. This completed the Company's strategy upon acquiring UniLife to wind down UniLife's dental indemnity insurance business.
Premium taxes decreased as a percentage of subscriber premiums to 0.7% in 1996 compared with 1.3% in 1995. This decrease was a result of the addition of Texas Dental and Dental Care Plus subscriber premiums in 1996 and the elimination of UniLife subscriber premiums in the third quarter of 1995. Texas Dental is a reduced fee-for-service dental company and, accordingly, its revenues are not subject to premium tax in the state of Texas. Dental Care Plus revenues are not subject to a premium tax in the state of Illinois. UniLife premiums in 1995 were subject to the Texas premium tax rate of approximately 2.5%.
General and administrative expenses increased $11.0 million, or 56.4%, to $30.4 million in 1996 from $19.4 million in 1995. As a percentage of total revenues, this expense increased to 21.5% in 1996 from 18.2% in 1995. This increase as a percentage of revenues is due to a higher general and administrative level added following the January 1996 acquisition of Texas Dental and the May 1996 acquisition of Dental Care Plus. The increased use of in-house sales and new marketing staff, as opposed to independent agents paid commissions also contributed to the increase. The Company's strategy regarding acquisitions includes, in part, the reduction of general and administrative expenses through the elimination of redundant overhead functions and the extension of the Company's management systems and policies. While comparing 1996 with 1995, general and administrative expenses as a percentage of revenue show a year-to-year increase; quarterly results show that since the second quarter of 1996,
Depreciation and amortization expense increased $2.4 million, or 89.7%, to $5.1 million in 1996 from $2.7 million in 1995. Amortization of intangible assets (goodwill and non-compete agreements) increased $l.8 million to $3.8 million in 1996. Of this increase, $1.3 million is the result of additional goodwill amortization recorded following the Texas Dental and Dental Care Plus acquisitions. The remaining $0.5 million of the increase is primarily due to the amortization of CompDent goodwill being recorded for only that portion of 1995 following the acquisitions compared to the full 12 months in 1996. Depreciation expense increased $636,000 due to additional office furniture, equipment, and leasehold improvements obtained in conjunction with the acquisitions in January 1996 and May 1996, and for new office space occupied by the Company in September 1996. Depreciation expense in 1997 is expected to be slightly higher due to the addition of leasehold improvements, and computer and phone equipment.
In 1996, the Company's effective income tax rate increased to 44.3% compared with 42.0% in 1995. The increase is primarily attributable to additional nondeductible goodwill amortization recorded in 1996 following the recent acquisitions.
Dental Care Plus in 1996. The $1.6 million increase in capital expenditures for 1997 compared with 1996 is due primarily to purchases of equipment and leasehold improvements, and enhancements and upgrades to computer and communications equipment. The Company expects to make additional capital expenditures of approximately $2.0 million in 1998, mainly for further enhancements to its computer and telephone equipment.
While the Company believes its interpretation and administration of the Participating Dentist Agreements are correct, the Company recently entered into a proposed settlement, which awaits final approval by the Court. The general terms of the settlement provide for a total payment of $1.3 million to be divided among (1) the class members who are no longer with ADP, (2) the class representatives, and (3) the attorneys for the plaintiff class. Additional costs associated with this settlement will be approximately $0.3 million.
The settlement also requires that ADP amend its Participating Dental Agreement to provide that it will pay capitation to the dentist when there has been a delay between the time a subscriber initially enrolls in the dental plan and the date they select a dentist, for all subscribers who enroll after January 1, 1999. In addition, ADP has agreed to provide additional notices to subscribers who have not selected a dentist.
Management does not believe there are currently any asserted or unasserted claims that will have a material adverse effect on the financial position of the Company.
The consolidated financial statements of the Company for the fiscal year ended December 31, 1997 set forth on pages through herein.