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 Company pays the Panel Dentists 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,
Effective March 21, 1997, the Company completed the acquisition of American Dental Providers, Inc. ("AMDP"), an Arkansas based managed dental care company, and Diamond Dental & vision, Inc. ("DDV"), which provided to the Arkansas market a vision plan and referral fee-for-service dental plan. The aggregate purchase price of $1.7 million consisted of $0.5 million in cash and $1.2 million of Company common stock issued at fair market value. AMDP provides managed dental care services through a network of dental care providers, and DDV provides a vision plan and referral fee-for-service dental plan to the Arkansas market. The Company funded the cash portion of the purchase with cash available from operations. The acquisition of AMDP and DDV 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 acquisition resulted in excess of cost over fair value of net assets acquired of $2.4 million which is being amortized over 40 years.
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
As a result of this accounting change, the goodwill attributable to the acquisition of CompDent was reduced from $32.1 million to $13.9 million. Additionally, the goodwill attributable to the acquisition of Dental Care Plus was reduced from $39.1 million to $8.8 million, DentiCare was reduced from $14.4 million to $6.0 million and AMDP and DDV was reduced from $2.1 million to $0, or a total reduction of $59.0 million. The goodwill associated with these acquisitions is being amortized over the remaining forty-year life.
Effective January 2, 1998, the Company completed the acquisition of five dental facilities from Michael H. Reznik, D.D.S., P.C. ("Reznik"). The dental facilities are located in Atlanta, Georgia. The purchase price consisted of $3.5 million in cash less discharge of liabilities related to the purchased assets. 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 Reznik 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 $5.1 million which is being amortized over 40 years.
Year ended December 31, 1998, compared to the year ended December 31, 1997
Revenues increased by $14.6 million, or 9.2%, to $173.3 million in 1998 from $158.7 million in 1997. Of the increase, $14.1 million was attributable to an increase in affiliated practice revenues at DHMI and $2.2 million was attributable to management fees received from Dental Health Development Corporation ("DHDC"), which commenced operations in the third quarter of 1997. The increase was offset by a reduction in subscriber premiums and other revenue of $1.7 million for 1998, compared to 1997. The decrease in subscriber premiums and other revenue in 1998 as compared to 1997 was the result of factors beginning in the latter part of 1997 and continuing through 1998, including increased competition for subscribers and aggressive pricing by competitors, especially larger indemnity insurance companies via PPOs and indemnity insurance plans. A number of these larger competitors also entered the dental HMO market by either acquiring small dental HMO companies or starting their own dental HMO plans. The inability to increase subscribers also had a significant adverse effect on the Company's ability to expand its panel of dentists. This in turn has made it more difficult to attract new subscribers. In addition, growth through acquisitions in 1998 was more difficult to achieve because of an overall increase in acquisition prices as well as the fact the Company's inability to finance acquisitions through the issuance of its stock due to its reduced stock price.
Commission expense increased $0.2 million, or 1.5%, to $13.5 million in 1998 from $13.3 million in 1997. The increase reflects a shift in emphasis toward reliance on independent agents and away from a larger direct sales force. As a percentage of subscriber premiums, commissions increased to 9.5% in 1998 from 9.3% in 1997.
million in unusual charges which were recorded in the fourth quarter of 1997. The unusual 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). As a percentage of total revenues, this expense increased to 31.0% in 1998 from 27.9% in 1997.
Depreciation and amortization expense, including goodwill impairment, decreased $59.2 million, or 91.5%, to $5.5 million in 1998 from $64.7 million in 1997. This decrease was primarily due to the $59.0 million in write-offs for goodwill impairment in the fourth quarter of 1997. The goodwill impairment resulted from the Company's determination that the recoverability of goodwill should be determined through discounted projections of future cash flows instead of un-discounted cash flows, utilizing an economic rate of return that would be customary for evaluating the present value of future cash flows of current dental benefit company transactions. The remaining $0.2 million decrease was comprised of a decrease in goodwill amortization from 1997 to 1998 of $1.4 million due to the goodwill impairment which was offset by an increase from 1997 to 1998 of $1.2 million in depreciation expense derived from purchases of leasehold improvements and dental equipment for the Company's dental office management business. Effective January 1, 1999, the Company has implemented a change in estimate, for the dental office management business, from 40 to 25 years, to amortize the remaining intangible assets prospectively using the remaining life as of January 1, 1999. The remaining life will be calculated using the original purchase date. This change in estimate will result in an increase of amortization from 1998 to 1999.
in dental care providers' fees and claim costs was due in part to a $2.0 million unusual charge associated with the settlement of the risk-sharing provisions of one of its indemnity relationships. 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 unusual charge mentioned above.
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 other costs consisted of the following amounts: $700 revenue reserve, $525 termination benefits, $313 office closures and consolidations, $250 legal expenses related to litigation settlement, $295 of costs related to a proposed business combination that was never consummated, and $250 of other miscellaneous charges. 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.
Depreciation and amortization expense increased $59.5 million, or 115.5%, to $64.7 million in 1997 from $5.2 million in 1996. This includes $59.0 million in write-offs for goodwill impairment. The goodwill impairment resulted from the Company's determination that the recoverability of goodwill should be determined through discounted projections of future flows instead of un-discounted cash flows, utilizing an economic rate of return that would be customary for evaluating the present value of future cash flows of current dental benefit company transactions. Depreciation expense increased $600,000 due to additional office furniture, equipment, and leasehold improvements and capital expenditures at DHMI.
Interest expense increased to $3.2 million in 1997 from $1.9 million in 1996. The Company had $56.6 million of debt outstanding at December 31, 1997. At each quarter end, the Company draws from its credit facility to pay down inter-company balances. The increase is primarily related to the increase in interest rates and in the amounts outstanding under the Company's credit facility. Any future acquisitions may cause the Company to incur additional indebtedness under its revolving credit facility or otherwise.
As a result of the above mentioned factors, the net loss for 1997 was $53.7 million, or $5.32 per share -- basic and diluted, compared to net income of $9.9 million, or $0.98 per share -- basic and $0.97 per share -- diluted, for 1996.
Cash used in investing activities was $17.6 million in 1998 and $24.9 million in 1997. The decrease, in 1998, relates primarily to decreased use of cash for acquisitions of dental practices which was partially offset by an increased use of cash for build out of dental offices and purchases of leasehold improvements and dental equipment. Capital expenditures increased $8.4 million in 1998 from $4.0 million in 1997, due primarily to purchases of leasehold improvements and dental equipment for the Company's dental office management business, and telephone and computer purchases. The Company has entered into a joint venture with Golder, Thoma, Cressey, Rauner Fund V, a leading private equity firm ("GTCR"), relating to the development of 35 to 50 de novo dental offices within the next two years. The Company invested approximately $1.5 million in DHDC and owns 150 shares of its Series B Preferred Stock. The Series B Preferred Stock is voting but the Company's voting interest represents less than 1 percent of the voting shares. The Company's ownership of the Series B Preferred Stock allows the Company to elect one of six members of the Board of Directors. While it is not exercisable until February 28, 2001, the Company has the unilateral option to purchase all of the outstanding shares of voting stock. The rights under the option terminate on August 30, 2003. The Company does not have any requirements, directly or indirectly, to exercise its rights under the option. The Company carries its investment in DHDC at cost. Under the joint venture with GTCR, the Company has agreed to fund certain development costs (including the purchase of dental equipment, supplies, and leasehold improvements) in an amount equal to amounts funded by GTCR in connections with the joint initiative, not to exceed $15.0 million. At December 31, 1998, the Company had funded approximately $10.0 million of this $15.0 million commitment.
The Company, through DHMI, a wholly-owned subsidiary of the Company, has entered into an Administrative Service Agreement with DHDC whereby DHMI provides DHDC a range of services, including the services of a management team, business development, and managed care contracting, as well as a variety of other financial, administrative, and support services. DentLease, Inc., a wholly owned subsidiary of the Company, also leases facility space and equipment to DHDC. The lease arrangements are at arm's length and provide for monthly fair market value rental payments.
On June 30, 1995, the Company obtained a reducing revolving $35 million line of credit (the "Credit Facility") from banks. On July 5, 1995, to partially finance the acquisition of CompDent, the Company borrowed $25 million under the Credit Facility. On May 3, 1996, the Credit Facility was amended to increase the available line of credit to $65 million. On May 7, 1996, the Company borrowed $38 million under the Credit Facility to finance the acquisition of Dental Care Plus. The Credit Facility, pursuant to a second amendment entered into on March 16, 1998 requires a 50% reduction in available borrowings on December 31, 1999, and expiration of the Credit Facility on December 31, 2000. Outstanding indebtedness under the Credit Facility bears interest, at the Company's option, at a rate equal to the prime rate plus up to 1/4% or LIBOR plus up to 1 3/4%, with the margin over the prime rate and LIBOR decreasing as the ratio of consolidated debt to EBITDA decreases. Currently borrowings under the Credit Facility bear interest at the LIBOR-based rate. The Credit Facility prohibits payment of dividends and other distributions and restricts or prohibits the Company from making certain acquisitions, incurring indebtedness, incurring liens, disposing of assets or making investments; and requires it to maintain certain financial ratios on an ongoing basis. The Credit Facility is collateralized by pledges of the stock of the Company's direct and indirect subsidiaries. The Company was in technical default of certain financial ratios periodically throughout 1998 and at December 31,
During the fourth quarter of 1997, the Company completed an extensive review of its operation and determined there were changes that occurred that necessitated a number of unusual and one-time charges for 1997. The charges include $2.0 million for the termination of an indemnity contract with risk-sharing provisions, $2.0 million for reserve for a surplus note, $1.6 million for litigation settlement costs, $1.4 million for a reserve for incurred practice management costs and $2.4 million in other costs. There was also $59.0 million in a write off for a goodwill impairment. Historically, the goodwill was reviewed on an undiscounted cash flow basis. It was determined that potential goodwill impairment should be analyzed on a discounted cash flow basis utilizing an economic rate of return that would be customary for evaluating the present value of future cash flows of current dental benefit company transactions. The Company believes that this method of valuation better reflects the performance of each acquisition.
The statements in the following section include "Year 2000 Readiness Disclosure" within the meaning of the Year 2000 Information and Readiness Disclosure Act.
The Company is reviewing, and has initiated formal communications with, third parties which provide goods or services which are essential to the Company's operations in order to: (1) determine the extent to which the Company is vulnerable to any failure by such material third parties to remediate their respective Year 2000 problems: and (2) resolve such problems to the extent practicable. The failure to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-party suppliers and customers, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's results of operations, liquidity or financial condition. In response to the lack of readiness on the part of certain third-party customers, the Company is utilizing a rolling 100-year methodology in its interface programs for customer supplied data. The Company believes that, with the implementation of upgrades of select phone systems and completion of the Project as scheduled, the possibility of significant interruptions of normal operations should be reduced.