The Company owns a 60,000 square foot building in Anaheim, California which it utilizes as its corporate headquarters and executive offices. In addition, the Company leases offices in Phoenix, Arizona; San Diego, California; Walnut Creek, California; Denver, Colorado; St. Louis, Missouri; Austin, Texas; Dallas, Texas; and Houston, Texas. The Company leases all of its Guards dental offices. Those leases expire on dates ranging through July 2005. In the opinion of management, the Company's facilities are adequate for its current needs.
In addition to historical information, management's discussion and analysis below includes certain forward-looking statements, including those related to the Company's growth and strategies, future operating results and financial position as well as economic and market events and trends. The Company's actual results and financial position could differ materially from those anticipated in the forward-looking statements as a result of various factors, including competition, changes in health care regulations, levels of utilization of dental care services, new technologies, rising dental care costs and other risks and uncertainties as described above under "RISK FACTORS." The following should be read in conjunction with the Consolidated Financial Statements of the Company and Notes thereto.
After restating the Company's financial statements to reflect the discontinuation of the Company's General Dental Practices, and for the adoption of a change in accounting principle (see Notes 1 and 2 of the Consolidated Financial Statement), the Company's revenues for the twelve months ended December 31, 1996, were $80,990, or a 20.7% increase on a 29.2% membership increase over the corresponding period a year ago. These increases included the impact on revenues and membership for the acquisition of First American completed September 27, 1996. Excluding the impact of the acquisition, revenues for the same period indicated above increased 16.3% on a 6.0% increase in membership. The revenue increases were a result of the following two elements. First is the managed care growth attributable to new small and mid-size clients, cross-selling of product offerings to existing clients and moderate price increases to renewing clients. The second area of revenue growth is from the Company's orthodontic practices, which grew by 30.5% due primarily to an increase in orthodontic starts which was greater in 1996 than in 1995, as well as the impact in the current year of the change in accounting principle for recognizing orthodontic revenues. The cumulative effect of the change in accounting principle as of January 1, 1996 was not reflected as an element of revenues in 1996.
Health care expenses for the twelve months ended December 31, 1996 increased $9,823, or 19.7%. Health care expense as a percentage of health care revenues improved by 0.7% from 74.2% of revenues for the twelve months ended December 31, 1995, to 73.5% for the same period in 1996. This was primarily due to the acquisition of First American on September 27, 1996, which has a lower health care cost as a percent of revenues. The Company also realized improvements in health care cost ratios for the managed care business, prior to acquisition, offset by an increase in the estimated liability for claim costs processed through the Company's indemnity dental system as well as the selected disenrollment of less profitable clients based on actuarial reviews of plan designs and utilization. The orthodontic practices reflected an improvement in health care cost ratios due primarily to the effect of the change in accounting principle on revenues.
The cumulative effect, after taxes, of the change in accounting principle, adopted as of January 1, 1996, increased net income by $824. Net income increased due to the above factors.
Pro forma operating losses for the discontinued General Dental Practices for the twelve months ended December 31, 1995, decreased due primarily to increases in revenues and more favorable costs related to the increased revenues in the dental offices.
Health care revenues increased as a result of sales to new small and mid-sized clients, the Company's indemnity insurance subsidiary, and a slowing of layoffs at the Company's major clients in the aerospace, defense and retailing industries. Membership enrollment increased primarily due to sales to new group indemnity clients and an increase in the number of persons covered under indemnity insurance products offered by the Company's indemnity insurance subsidiary. Enrollment increases as a result of sales to new groups offset entirely the continued workforce reduction in a number of the Company's major group clients.
General and administrative expenses remain virtually the same notwithstanding an increase in revenue and the number of persons to whom benefits were provided. Selling expenses increased primarily due to an increase in sales and marketing activities, along with an increase in the number of persons employed by the Company in sales and marketing positions. Selling, general and administrative expenses declined as a percentage of revenue due to increased efficiencies within the Company's administrative operations.
Other income increased as a result of an increase in the Company's investment portfolio which was realized in 1994. Net income declined as a result of the above factors.
Both the Company's California dental plan and the orthodontic practices contribute substantially all of the Company's operating earnings. Additionally, in 1996, the dental plans in each state all contributed positively towards operating earnings. Management believes that each state plan is capable of being profitable once targeted enrollment levels are attained and stable provider panels are in place. The Company's indemnity insurance subsidiary experienced a loss in 1996 primarily due to the increase in the estimated liability for claims costs.
The Company's ability to attract clients is affected by revisions in employee benefit programs, fluctuations in employment levels, increasing market competition and other factors. The orthodontic practices ability to bolster revenue from non-plan patients is dependent upon continued quality care, marketing efforts and their ability to compete in the orthodontic dental care environment. The Company's ability to increase revenues depends on many factors including existing and emerging competition. There can be no assurance that the Company's revenues will continue to increase.
In September 1996, the Company established a $30 million bank loan with Bank of America which provides for a $22 million reducing revolving acquisition sub- facility and an $8 million revolving working capital sub-facility. The Company utilized $19 million of the reducing revolving acquisition sub-facility to fund the acquisition of First American. The reducing revolving acquisition sub- facility may also be used to fund other acquisitions while the working capital sub-facility may be used for ongoing working capital needs of the Company. The loan has a maturity date of March 31, 2002, and requires that the acquisition sub-facility commitment amount be reduced quarterly in accordance with a set schedule. The interest rate for the loan was established at the LIBOR rate plus between 1.75% and 2%, depending upon the total funded debt compared to the trailing four quarters EBITDA. The loan is secured by a first priority security interest in all of the personal property, including accounts receivable, fixed assets and intangibles of the Company, a pledge of the stock of all of the Company's subsidiaries now owned or hereafter formed or acquired, a negative pledge on all of the assets of the Company's subsidiaries, and a negative pledge on the real property owned by the Company.
The Consolidated Financial Statements and the related Notes and Schedules thereto filed as part of this 1996 Annual Report on Form 10-K are listed on the accompanying Index to Financial Statements on page.