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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q.--QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________ to _____________________
Commission file number: 000-25549
INTERDENT, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4710504
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
222 No. Sepulveda Blvd., Suite 740, El Segundo, CA 90245-4340
(Address of principal executive offices)
(310) 765-2400
(Registrant's telephone number, including area code)
No Change
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
As of November 13, 2002, 3,963,950 shares of the issuer's common stock were
outstanding.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
INTERDENT, INC.
AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited, in thousands, except share amounts)
September 30, December 31,
Assets 2002 2001
------------------ ------------------
Current assets:
Cash and cash equivalents $ 4,388 $ 7,189
Accounts receivable, net 16,660 20,092
Management fees receivable 643 581
Supplies inventory 4,713 3,613
Prepaid and other current assets 7,840 4,051
------------------ ------------------
Total current assets 34,244 35,526
------------------ ------------------
Property and equipment, net 18,443 20,945
Intangible assets, net 149,089 147,532
Other assets 4,043 3,021
------------------ ------------------
Total assets $ 205,819 $ 207,024
================== ==================
Liabilities, Redeemable Common Stock and Shareholders' Equity
Current liabilities:
Accounts payable $ 6,121 $ 7,996
Accrued payroll and payroll related costs 10,403 9,022
Other current liabilities 14,925 11,187
Current portion of long-term debt and capital lease obligations 89,364 13,666
------------------ ------------------
Total current liabilities 120,813 41,871
------------------ ------------------
Long-term liabilities:
Obligations under capital leases, net of current portion 806 1,251
Long-term debt, net of current portion 43,804 119,738
Convertible senior subordinated debt 37,359 35,058
Other long-term liabilities 1,494 1,871
------------------ ------------------
Total long-term liabilities 83,463 157,918
------------------ ------------------
Total liabilities 204,276 199,789
------------------ ------------------
Redeemable common stock, $0.001 par value, 17,286 and 17,905 shares issued and
outstanding in 2002 and 2001, respectively 997 1,047
------------------ ------------------
Shareholders' equity:
Preferred stock, $0.001 par value, 30,000,000 shares authorized:
Preferred stock - Series A, 100 shares authorized, issued and outstanding 1 1
Convertible Preferred stock - Series B, 70,000 shares authorized, zero shares
issued and outstanding -- --
Preferred stock - Series C, 100 shares authorized, zero shares issued and
outstanding -- --
Convertible Preferred stock - Series D, 2,000,000 shares authorized, 1,574,608
and 1,628,663 shares issued and outstanding in 2002 and 2001 11,688 12,089
Common stock, $0.001 par value, 50,000,000 shares authorized, 3,946,664 and
3,976,551 shares issued and outstanding in 2002 and 2001, respectively 4 4
Additional paid-in capital 76,907 76,502
Shareholder note receivable (202) (184)
Accumulated deficit (87,852) (82,224)
------------------ ------------------
Total shareholders' equity 546 6,188
------------------ ------------------
Total liabilities, redeemable common stock and shareholders' equity $ 205,819 $ 207,024
================== ==================
See accompanying notes to condensed consolidated financial statements.
INTERDENT, INC.
and subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited, in thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
----------- ---------- ---------- -----------
Dental practice net patient service revenue $ 61,174 $ 61,255 $ 188,669 $ 201,117
Net management fees 218 149 606 19,703
Licensing and other fees 197 128 560 533
----------- ---------- ---------- -----------
Total revenues 61,589 61,532 189,835 221,353
----------- ---------- ---------- -----------
Operating expenses:
Clinical salaries, benefits, and provider costs 30,155 30,388 92,121 100,181
Practice non-clinical salaries and benefits 8,193 8,303 24,999 30,752
Dental supplies and lab expenses 6,632 6,573 20,464 26,883
Practice occupancy expenses 3,454 3,583 10,127 13,075
Practice selling, general and administrative expenses 5,058 4,562 15,822 19,482
Corporate selling, general and administrative expenses 2,299 3,319 9,607 10,060
Stock compensation expense -- 4,331 147 6,075
Loss (gain) on dental location dispositions and impairment
of long-lived assets 7 6,450 (185) 12,384
Depreciation and amortization 1,005 2,840 3,041 9,263
----------- ---------- ---------- -----------
Total operating expenses 56,803 70,349 176,143 228,155
----------- ---------- ---------- -----------
Operating income (loss) 4,786 (8,817) 13,692 (6,802)
----------- ---------- ---------- -----------
Nonoperating expense:
Interest expense, net (6,007) (4,292) (16,244) (14,971)
Debt and equity financing costs -- -- -- (3,886)
Investment impairment write-down -- (1,087) -- (1,087)
Other, net (125) (92) (382) (138)
----------- ---------- ---------- -----------
Nonoperating expense, net (6,132) (5,471) (16,626) (20,082)
----------- ---------- ---------- -----------
Loss before income taxes (1,346) (14,288) (2,934) (26,884)
Provision for income taxes 30 50 90 150
----------- ---------- ---------- -----------
Loss before extraordinary item (1,376) (14,338) (3,024) (27,034)
Extraordinary loss on debt extinguishments -- -- (2,604) (5,601)
----------- ---------- ---------- -----------
Net loss (1,376) (14,338) (5,628) (32,635)
Accretion of redeemable common stock -- -- -- (1)
----------- ---------- ---------- -----------
Net loss attributable to common stock $ (1,376) $ (14,338) $ (5,628) $ (32,636)
=========== ========== ========== ===========
Loss per share attributable to common stock - basic and dilutive $ (0.36) $ (3.69) $ (1.47) $ (8.43)
=========== ========== ========== ===========
See accompanying notes to condensed consolidated financial statements.
INTERDENT, INC.
and subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)
Nine Months Ended September 30,
2002 2001
----------------- ------------------
Cash flows from operating activities:
Net loss $ (5,628) $ (32,635)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization 3,041 9,263
Loss (gain) on dental location dispositions and impairment of long-lived assets (185) 12,384
Loss on disposal of assets 511 98
Investment impairment write down -- 1,087
Non-employee stock options granted and stock issued for fees and compensation -- 2
Amortization of stock compensation expense -- 5,742
Interest income on shareholder notes (18) (8)
Notes and warrants issued or accrued for debt amendment fees, interest
payment-in-kind and accrued interest 8,916 7,906
Interest amortization on deferred financing costs and discounted debt 3,132 7,641
Change in assets and liabilities, net of the effect of acquisitions:
Accounts receivable, net 2,779 1,244
Management fees receivable (62) (475)
Supplies inventory (1,102) 27
Prepaid expenses and other current assets 752 2,059
Other assets (179) (485)
Accounts payable (1,875) 3,520
Accrued payroll and payroll related costs 802 (331)
Accrued merger and restructure (235) (312)
Other liabilities 1,252 (827)
----------------- ------------------
Net cash provided by operating activities 11,901 15,900
----------------- ------------------
Cash flows from investing activities:
Purchase of property and equipment (1,104) (2,693)
Net payments received on notes receivable from professional associations -- 103
Net advances to professional associations -- (3,163)
Proceeds from disposition of dental locations, net direct costs paid 557 22,461
Cash paid for acquisitions and earn-outs, including direct costs, net of cash (1,461) (4,248)
acquired ----------------- ------------------
Net cash (used in) provided by investing activities (2,008) 12,460
----------------- ------------------
Cash flows from financing activities:
Net payments on credit facility (3,739) (18,415)
Payments on long-term debt and obligations under capital leases (7,616) (3,751)
Payments of deferred financing costs (1,318) (2,347)
Proceeds from issuance of common and preferred stock 4 --
Exercise of put rights (25) (376)
----------------- ------------------
Net cash used in financing activities (12,694) (24,889)
----------------- ------------------
Increase (decrease) in cash and cash equivalents (2,801) 3,741
Cash and cash equivalents, beginning of period 7,189 5,293
----------------- ------------------
Cash and cash equivalents, end of period $ 4,388 $ 8,764
================= ==================
Cash paid for interest $ 6,211 $ 9,138
================= ==================
Cash (refunded) paid for income taxes $ -- $ (1,437)
================= ==================
See accompanying notes to condensed consolidated financial statements.
INTERDENT, INC.
and subsidiaries
September 30, 2002 and 2001
Notes to Condensed Consolidated Financial Statements
(Unaudited, in thousands, except per share and share amounts)
(1) ORGANIZATION
Headquartered in El Segundo, California, InterDent, Inc. ("InterDent" or the
"Company") was incorporated on October 13, 1998 as a Delaware corporation to
facilitate the business combination of Gentle Dental Service Corporation
("GDSC") and Dental Care Alliance ("DCA") that occurred in March 1999. Prior to
the combination, GDSC and DCA were each publicly traded dental practice
management companies since 1997.
The Company is a provider of dental practice management services to
multi-specialty dental professional corporations and associations ("PAs") in the
United States. The Company provides management services to affiliated PAs under
long-term management service agreements ("MSAs"). Under the MSAs, the Company
bills and collects patient receivables and provides administrative and
management support services. Each PA is responsible for employing and directing
the professional dental staff and providing all clinical services to the
patients. The dentists employed through the Company's network of affiliated
dental associations provide patients with affordable, comprehensive dentistry
services, which include general dentistry, endodontics, oral pathology, oral
surgery, orthodontics, pedodontics, periodontics and prosthodontics.
Through May 31, 2001, the Company provided management services to dental
practices in selected markets in Arizona, California, Florida, Georgia, Hawaii,
Idaho, Indiana, Kansas, Maryland, Michigan, Nevada, Oklahoma, Oregon,
Pennsylvania, Virginia and Washington. Effective May 31, 2001, the Company
completed the stock sale of Dental Care Alliance, Inc. ("DCA"), a wholly-owned
subsidiary, and certain other assets in Maryland, Virginia, and Indiana, for
$36.0 million less the assumption of certain debt and operating liabilities. The
net sales proceeds were utilized to pay down existing borrowings under the
credit facility. Also, the Company has retained an option to repurchase the
division at a future date and entered into an ongoing collaboration agreement
and license agreement to provide the Company's proprietary software.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The Company provides management services to the PAs under long-term MSAs that
generally have an initial term of 40 years. Under the provisions of the MSAs,
the Company owns the non-professional assets at the affiliated practice
locations, including equipment and instruments, bills and collects patient
receivables, and provides all administrative and management support services to
the PAs. These administrative and management support services include:
financial, accounting, training, efficiency and productivity enhancement,
recruiting, marketing, advertising, purchasing, and related support personnel.
The PAs employ the dentists and the hygienists while the Company employs or
co-employs all administrative personnel.
The Emerging Issues Task Force ("EITF") of the Financial Accounting Standards
Board reached a consensus on the accounting for transactions between physician
practice management companies and physician practices and the financial
reporting of such entities (EITF issue number 97-2). For financial reporting
purposes, EITF 97-2 mandates the consolidation of physician practice activities
with the practice management company when certain conditions have been met, even
though the practice management company does not have a direct equity investment
in the physician practice. The accompanying condensed consolidated financial
statements are prepared in conformity with the consensus reached in EITF 97-2.
Simultaneous to the execution of an MSA with each PA, the Company also entered
into a shares acquisition agreement ("SAA"). Under all of the SAAs currently
entered into except for two, representing three clinical locations, the Company
has the right to designate the purchaser (successor dentist) to purchase from
the PA shareholders all the shares of the PA for a nominal price of a thousand
dollars or less. Under these SAAs, the Company has the unilateral right to
establish or effect a change in the PA shareholder, at will, and without consent
of the PA shareholder, on an unlimited basis. Under EITF 97-2, the agreements
with the PA shareholders qualify as a friendly doctor arrangement. Consequently,
under EITF 97-2, the Company consolidates all the accounts of those PAs in the
accompanying condensed consolidated financial statements. Accordingly, the
condensed consolidated statements of operations include the net patient service
revenues and related expenses of these PAs and all significant intercompany
transactions have been eliminated.
Each of the DCA SAAs entered into with the PAs did not have the nominal price
provision and were sold as part of the DCA sale transaction in May 2001 and the
Company currently has entered into two SAA with PAs that do not have the nominal
price provision. Rather, the SAA purchase price is based upon a multiple of
earnings, as defined. As a result, the MSAs do not meet the criteria of
consolidation under EITF 97-2 and the condensed consolidated statements of
operations exclude the net patient service revenues and expenses of these PAs.
The Company only includes net management fee revenues generated and expenses
associated with providing services under these MSAs.
Liquidity
The Company experienced losses attributed to common stock of $5,628 during the
nine months ended September 30, 2002 and for fiscal years 2001 and 2000, $35,080
and $48,712, respectively. These past significant losses included certain
charges for asset impairments, disposition of DCA and certain other dental
locations, and debt restructuring and debt extinguishments, which the Company
believes are unusual in nature. Although the Company has experienced significant
losses over the last two years due to these unusual charges, the Company's
dental facilities continue to generate significant positive cash, as reflected
in cash flows from operations of $11,901 for the nine months ended September 30,
2002 and for fiscal years 2001 and 2000, $19,379 and $9,545, respectively.
In April 2002 the Company negotiated modifications to its credit agreement,
which has an outstanding balance of $80,438 as of September 30, 2002. As more
fully described in Note 5, these modifications resulted in a permanent waiver of
past covenant violations, reset covenant levels, and the principal amortization
schedule was significantly modified such that approximately $20,700 of payments
was deferred until April 1, 2003. In exchange for these modifications, the
Company agreed to pay certain fees and expense, in addition to interest rate
increases. Based upon these modifications to the credit agreement, the Company
believes that it will be able to make all scheduled debt payments through March
31, 2003, and payments due under its earn-out agreements, along with meeting its
other obligations. However, there are significant installments due under the
credit agreement of $7,214 on April 1 and July 1, 2003, with the remainder due
on September 30, 2003. This debt must be refinanced, modified, or otherwise
retired with the proceeds of other financing or capital transactions, as the
cash flow from operations is insufficient to fund the required debt payments
beginning April 1, 2003. Also, there can be no assurance that the Company will
meet its required payment obligations as they become due prior to April 1,2003,
or that any such financing will be available or available on terms acceptable to
the Company.
Interim reporting
The accompanying unaudited interim condensed consolidated financial statements
of InterDent have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). Certain information and note
disclosures normally included in annual consolidated financial statements have
been condensed or omitted as permitted under those rules and regulations. We
believe all adjustments, consisting only of normal, recurring adjustments
considered necessary for a fair presentation, have been included and that the
disclosures made are adequate to insure that the information presented is not
misleading. To obtain a more detailed understanding of Company results, it is
suggested that these financial statements be read in conjunction with the
consolidated financial statements and related notes for the year ended December
31, 2001 included in Form 10-K filed on April 16, 2002. The results of
operations for the three and nine months ended September 30, 2002 are not
necessarily indicative of the results of operations for the entire year.
Net revenues
Revenues consist primarily of PA net patient service revenue ("net patient
revenue") and Company net management fees. Net patient revenue represents the
consolidated revenue of the PAs reported at the estimated net realizable amounts
from patients, third party payors and others for services rendered, net of
contractual adjustments. Net management fees represent amounts charged to the
unconsolidated PAs in accordance with the MSA as a percentage of the PAs net
patient service revenue under MSAs, net of provisions for contractual
adjustments and doubtful accounts. Such revenues are recognized as services are
performed based upon usual and customary rates or contractual rates agreed to
with managed care payors.
Net patient revenues include amounts received under capitated managed care
contracts from certain wholly owned subsidiaries that are subject to regulatory
review and oversight by various state agencies. The subsidiaries are required to
file statutory financial statements with the state agencies and maintain minimum
tangible net equity balances and restricted deposits. The Company is in
compliance with such requirements as of September 30, 2002. Total revenues
subject to regulatory review and oversight by various state agencies were
$37,359 and $35,156 for the nine months ended September 30, 2002 and 2001,
respectively.
Accounts receivable
Accounts receivable principally represent receivables from patients and
insurance carriers for dental services provided by the related PAs at
established billing rates, less allowances and discounts for patients covered by
third party payor contracts. Payments under these programs are primarily based
on predetermined rates. In addition, a provision for doubtful accounts is
provided based upon expected collections and is included in practice selling,
general and administrative expenses. These contractual allowances, discounts and
allowance for doubtful accounts are deducted from accounts receivable in the
accompanying condensed consolidated balance sheets. The discounts and allowances
are determined based upon historical realization rates, the current economic
environment and the age of accounts. Changes in estimated collection rates are
recorded as a change in estimate in the period the change is made.
Intangible assets
Intangible assets result primarily from the excess of cost over the fair value
of net tangible assets purchased. Such intangibles primarily relate to MSAs and
goodwill associated with dental practice acquisitions. Intangibles relating to
MSAs consist of the costs of purchasing the rights to provide management support
services to PAs over the initial noncancelable terms of the related agreements,
usually 25 to 40 years. The MSAs can be perpetually extended by virtue of the
SAAs entered into by the Company with each PA. Under these agreements, the PAs
have agreed to provide dental services on an exclusive basis only through
facilities provided by the Company, which is the exclusive administrator of all
non-dental aspects of the acquired PAs, providing facilities, equipment, support
staffing, management and other ancillary services. The agreements are
noncancelable except for performance defaults. Through December 31, 2001, the
Company's intangible assets were amortized on the straight-line method, ranging
from 5 years for service mark to 25 years for MSAs and goodwill.
In July 2001, the FASB issued Statement of Financial Accounting Standard No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which became effective
January 1, 2002. Under SFAS 142, goodwill and indefinite lived assets are no
longer amortized but are reviewed annually for impairment. As a result, the
Company's service mark, MSAs and goodwill intangible assets are no longer being
amortized. The tests for measuring impairment under SFAS 142 are more stringent
than previous tests required by Statement of Financial Accounting Standard No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." The Company is currently performing the required
impairment tests of goodwill and indefinite lived intangible assets as of
January 1, 2002. The Company has completed the first step of the two-step
transitional impairment analysis required by SFAS 142. This analysis indicated
that the carrying amount of the net assets of the Company exceeds the fair
value. Preliminary results of the second step of the transitional impairment
analysis indicates that an impairment charge totaling $50,000 to $100,000 will
be required, although such analysis in not complete. This analysis will be
completed in the fourth quarter of 2002.
The Company did not record amortization on its intangible assets during 2002 as
all such assets are determined to have indefinite lives. The following table
reflects comparable pro forma results of operations for the three and nine
months ended September 30, 2002 and 2001 as though the adoption of the
non-amortization provisions of SFAS 142 occurred as of January 1, 2001:
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
------------ ------------ ----------- -----------
Net loss attributed to common stock:
As reported $ (1,376) $ (14,338) $ (5,628) $(32,636)
Amortization of indefinite lived intangible assets -- 1,789 -- 5,215
------------ ------------ ----------- -----------
Pro forma $ (1,376) $ (12,549) $ (5,628) $(27,421)
============ ============ =========== ===========
Net loss per share attributable to common stock - basic and
diluted
As reported $ (0.36) $ (3.69) $ (1.47) $ (8.43)
Pro forma $ (0.36) $ (3.23) $ (1.47) $ (7.09)
Long-lived assets
The Company reviews its long-lived assets for impairment when events or changes
in circumstances indicate that the carrying amount of assets may not be
recoverable. To perform that review, the Company estimates the sum of expected
future undiscounted net cash flows from assets. If the estimated net cash flows
are less than the carrying amount of the asset, the Company recognizes an
impairment loss in an amount necessary to write-down the assets to their fair
value as determined from expected future discounted cash flows.
Deferred compensation
The Company made advances of $11,500 to certain officers of the Company and
provided certain other officers with a minimum guarantee of the value of their
stock options in order to retain and provide incentives to such officers. In
connection with the advances, such officers issued interest-bearing notes
payable to the Company. Shares of the Company's common stock and options owned
by such officers have been pledged to secure the notes. The notes were included
in shareholders' equity as a reduction to equity. Interest on the notes accrues
at rates ranging from 6.4% to 10.2%. The notes and accrued interest are due June
2004, payable in cash or Company common stock and options with varying minimum
values. The notes and accrued interest were with recourse to the officers until
May or June of 2002, depending upon the individual note agreement, after which
the notes and accumulated interest became non-recourse, subject only to the
underlying pledged collateral.
The difference in the amount of the notes and the value of the collateral at the
date of the loans was being amortized over the life of the notes, representing
stock compensation expense. The amortization reflected the deficit of the
underlying pledged collateral on the individual note dates. The Company also
adjusted the amortization to reflect changes in the quoted fair market value.
The decline, if any, was amortized as stock compensation expense over the life
of the notes. The amortization expense was adjusted cumulatively for changes in
fair value of the collateral. Increases in the stock price, if any, resulted in
a credit to expense, up to the amount of prior expense recognized for this
portion of the notes. In addition, the minimum guarantee of the value of the
stock options was being amortized as stock compensation expense.
The total advance included loans to certain DCA officers. The non-amortized
balance of the advances to DCA officers of $4,600 was sold in connection with
the sale of DCA. Also, during the third quarter of 2001, the entire
non-amortized balance of the remaining notes was written off as a result of the
acceleration of the non-recourse provision of the note due from the former CEO
and the significant decline in the underlying value of the pledged collateral,
which is considered to be other than temporary.
Also, in connection with the execution of an officer's amended employment
agreement, a note receivable and related accrued interest of $182 were to be
forgiven, subject to provisions of the agreement. The note and accrued interest
were being expensed over the twenty-four month service period ending May 2002.
During the third quarter of 2001, the remaining balance on the note was written
off as compensation expense since the note was converted to non-recourse
pursuant to the severance agreement with the officer.
Net loss per share
Basic earning per share is computed by dividing the net income or loss by the
average weighted common shares outstanding during the period. Diluted earnings
per share represent basic income or loss per share adjusted for the effects of
common share equivalents issuable using the treasury stock method.
For the nine months ended September 30, 2002, and 2001, dilutive potential
common shares of approximately 2,200,000 and 2,500,000, respectively, have been
excluded from the computation of diluted income per share as their effect is
anti-dilutive. Such anti-dilutive potential common shares consist of convertible
subordinated debt, convertible preferred stock, and the exercise of certain
options and warrants.
The following table summarizes the computation of net loss per share:
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
------------- -------------- -------------- -------------
Loss before extraordinary item $ (1,376) $ (14,338) $ (3,024) $ (27,034)
Extraordinary loss on debt extinguishments -- -- (2,604) (5,601)
Accretion of redeemable common stock -- -- -- (1)
------------- -------------- -------------- -------------
Net loss attributable to common stock $ (1,376) (14,338) (5,628) (32,636)
============= ============== ============== =============
Outstanding Shares Reconciliation:
Weighted average common shares outstanding 3,835,457 3,888,152 3,839,172 3,906,398
Contingent returnable common shares -- -- -- (36,503)
------------- -------------- -------------- -------------
Outstanding basic and diluted shares 3,835,457 3,888,152 3,839,172 3,869,895
============= ============== ============== =============
Loss per share - basic and diluted:
Before extraordinary item $ (0.36) $ (3.69) $ (0.79) $ (6.98)
Extraordinary loss on debt extinguishments -- -- (0.68) (1.45)
------------- -------------- -------------- -------------
Attributable to common stock $ (0.36) $ (3.69) $ (1.47) $ (8.43)
============= ============== ============== =============
Segment reporting
The Company has adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"). SFAS 131 supersedes SFAS 14, "Financial Reporting for Segments of a
Business Enterprise", replacing the "industry segment" approach with the
"management" approach. The management approach designates the internal reporting
that is used by management for making operating decisions and assessing the
performance as the source of the Company's reportable segments. The adoption of
SFAS 131 did not have an impact for the reporting and display of segment
information as each of the affiliated dental practices is evaluated individually
by the chief operating decision maker and considered to have similar economic
characteristics, as defined in the pronouncement, and therefore are aggregated.
Income taxes
Income taxes are accounted for under the asset and liability method in
accordance with Statement of Financial and Accounting Standards No. 109,
"Accounting for Income Taxes" ("SFAS 109"). Under the asset and liability
approach of SFAS 109, deferred tax assets and liabilities are recognized for the
future tax consequences attributed to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. Income tax expense recorded for the three and nine months
ended September 30, 2002 and 2001 represents the Company's estimate of state
income tax payable. The Company has a valuation allowance to offset the entire
amount of federal and state tax benefit of loss carryforwards.
Use of estimates
In preparing the financial statements conforming to Generally Accepted
Accounting Principals ("GAAP"), certain estimates and assumptions have been made
that affect the following:
o Reported amounts of assets and liabilities at the date of the financial
statements; o Disclosure of contingent assets and liabilities at the date of the
financial statements; and o Reported amounts of revenues and expenses during the
period.
Actual results could differ from those estimates.
New accounting pronouncements
In July 2001, the FASB issued Statement of Financial Accounting Standard No.
141, "Business Combinations" ("SFAS 141"). SFAS 141 eliminates the
pooling-of-interest method of accounting for business combinations and clarifies
the criteria to recognize intangible assets separately from goodwill. SFAS 141
is effective for any business combination accounted for by the purchase method
that is completed after June 30, 2001. The adoption of SFAS 141 is not expected
to have any impact on the Company's financial position or results of operations.
In July 2001, the FASB issued Statement of Financial Accounting Standard No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142,
goodwill and indefinite lived assets are no longer amortized but are reviewed
annually for impairment. Separate intangible assets that are not deemed to have
an indefinite life will continue to be amortized over their useful lives. The
amortization provisions of SFAS 142 apply to goodwill and intangible assets
acquired after June 30, 2001. With respect to goodwill and intangible assets
acquired prior to June 30, 2001, the provisions of SFAS 142 are effective upon
its adoption effective beginning fiscal year 2002. The Company is currently
performing the required impairment tests of goodwill and indefinite lived
intangible assets as of January 1, 2002. The Company has completed the first
step of the two-step transitional impairment analysis required by SFAS 142. This
analysis indicated that the carrying amount of the net assets of the Company
exceeds the fair value. Preliminary results of the second step of the
transitional impairment analysis indicates that an impairment charge totaling
$50,000 to $100,000 will be required, although such analysis in not complete.
This analysis will be completed in the fourth quarter of 2002.
In June 2001, the FASB issued Statement of Financial Accounting Standard No.
143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. It applies to legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction, and
development and (or) the normal operation of a long-lived asset, except for
certain obligations of lessees. This Statement is effective for financial
statements issued for fiscal years beginning after June 15, 2002. The adoption
of SFAS 143 is not expected to have a significant impact on the Company's
financial position or results of operations.
In August 2001, the FASB issued Statement of Financial Accounting Standard No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS 144 addresses financial accounting and reporting for the impairment
or disposal of long-lived assets. This Statement supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for the Long-Lived
Assets to Be Disposed Of," and the accounting and reporting provisions of APB
Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a segment of a business.
The provisions of this Statement are effective for financial statements issued
for fiscal years beginning after December 15, 2001. The provisions of this
Statement generally are to be applied prospectively. The adoption of SFAS 144 is
not expected to have a significant impact on the Company's financial position or
results of operations.
Reclassifications
Certain reclassifications have been made to the 2001 financial statements to
conform to the 2002 presentation.
(3) REVENUES
Revenues consist primarily of PA net patient service revenue and Company net
management fees. Net patient service revenue represents the consolidated revenue
of the PAs at normal and customary rates from patients, third party payors and
others for services rendered, net of contractual adjustments. Net management
fees represent amounts charged under MSAs to the unconsolidated PAs on an
agreed-upon percentage of the PAs net patient service revenue, net of provisions
for contractual adjustments and doubtful accounts. As discussed more fully in
note 4, the decrease in total net patient service revenue and management fees is
associated with the disposition of the Company's DCA subsidiary and certain
other dental locations.
The following represents amounts included in the determination of dental
practice net patient service revenue and net management fees:
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
----------- ----------- ---------- -----------
Dental practice net patient service revenue - all PAs $ 61,658 $ 61,510 $ 189,841 $ 232,103
Dental practice net patient service revenue -
unconsolidated PAs (484) (255) (1,172) (30,986)
----------- ----------- ---------- -----------
Reported practice net patient service revenue $ 61,174 $ 61,255 $ 188,669 $ 201,117
=========== =========== ========== ===========
Dental practice net patient service revenue -
unconsolidated PAs $ 484 $ 255 $ 1,172 $ 30,986
Amounts retained by dentists (266) (106) (566) (11,283)
----------- ----------- ---------- -----------
Net management fees $ 218 $ 149 $ 606 $ 19,703
=========== =========== ========== ===========
(4) DENTAL PRACTICE AFFILIATIONS AND DISPOSITIONS
Dental practice affiliations
In connection with certain completed affiliation transactions, the Company has
agreed to pay future consideration to the sellers. The amount of future
consideration payable is generally computed based upon financial performance of
the affiliated dental practices during certain specified periods ("Earn-Out").
The Company accrues for Earn-Out payments with respect to these acquisitions
when such amounts are probable and reasonably estimable. In addition to cash
Earn-Out payments of $1,038 during the nine months ended September 30, 2002, the
Company also converted $1,429 in Earn-Out amounts due into long-term notes
payable. As of September 30, 2002, future anticipated Earn-Out payments of
$2,742 are accrued and included in other current liabilities. For those
acquisitions with Earn-Out provisions, the Company estimates the total maximum
Earn-Out that could be paid, including amounts already accrued, is between
$3,000 and $4,000 from October 2002 to December 2005, which is expected to be
paid in a combination of cash and notes.
Dental practice dispositions
Effective May 31, 2001, the Company completed the sale of its east coast
division to Mon Acquisition Corp., a group led by Steven Matzkin, DDS, former
president of the Company. The assets in the sale (the "East Coast Assets")
included the stock of Dental Care Alliance, Inc. ("DCA"), a wholly-owned
subsidiary, and assets used in the operation and management of certain dental
practices in Maryland, Virginia and Indiana. The transaction also included the
assets associated with the notes receivable made by officers of DCA as discussed
in note 6. Total consideration was $36,000 less the assumption of related debt
and operating liabilities.
Upon the two-year anniversary of the transaction close, InterDent shall have the
right to repurchase the East Coast Assets, based upon a multiple of earnings and
subject to a minimum price, as defined in the agreement. In connection with the
sale of assets, InterDent entered into a five-year license agreement dated May
16, 2001 and amended on May 31, 2001 effective June 1, 2001 for $2,554, payable
in installments, for its proprietary practice management system, subject to
negotiations for additional term extensions. Such amount has been recorded as
deferred revenues and is being amortized over the life of the agreement. The
parties also entered into a transition services agreement dated as of May 16,
2001 and a business collaboration agreement dated as of April 17, 2001 effective
June 1, 2001, delineating the use of the practice management system, the joint
purchase of supplies, the joint negotiation for managed care contracts, training
systems and other similar operational matters.
In the second half of 2001, the Company disposed of six under performing dental
locations. The Company also disposed of one additional dental location in June
2002.
(5) DEBT
In April 2001, the Company entered into amendments to its existing senior
revolving credit facility (the "Credit Facility") to amend certain covenants. In
connection with the execution of the amendments, the banks waived the defaults
under the Credit Facility that existed at December 31, 2000 due to failure to
meet certain financial ratio covenants and reset all covenants for 2001 and
subsequent years. Additionally, the banks agreed to certain other changes
including a revised term and provisions regarding asset sales and new financing.
As consideration for these modifications, the Company agreed to an amendment fee
of $1,000, which was paid during the three months ended June 30, 2001, and an
additional fee of $1,000 payable at maturity of the term loan if certain
conditions were not met. The additional fee was paid in connection with an
additional amendment to the Credit Facility consummated in April 2002, as
discussed below.
On October 1, 2001, the Credit Facility converted into a term loan, with
required quarterly payments. On April 15, 2002, the Company entered into an
amendment to the existing Credit Facility. In connection with the execution of
the amendment, the bank agreed, among other things, to reset certain covenants
and reduce the required future quarterly principal payments of $7,214, which
were to begin on October 1, 2001. In connection with these modifications, the
Company accrued as note principal the remaining $1,000 due as a result of the
amendment in 2001 as discussed above, which is payable upon maturity. The
Company also agreed to an additional amendment fee of $1,000, with cash of $500
paid at closing and $250 accrued as additional principal on July 1, 2002 and
additional $250 to be accrued as principal on October 1, 2002, payable upon
final maturity of the Credit Facility on September 30, 2003.
Principal amounts owed under the Credit Facility bear interest at LIBOR plus
7.50% or the prime rate plus 5.75%, at the Company's option. In addition to the
cash interest charges outlined above, the Company is to pay an incremental
payment-in-kind ("PIK") interest on the outstanding principal balance of 1.0%
from April 15, 2002 though March 31, 2003, increasing to 2.0% from April 1, 2003
through maturity. The incremental PIK interest is payable upon maturity. The
Company also paid a PIK fee equal to 1.0% of the outstanding principal balance
on April 15, 2002 and is also to pay 2.0% on October 1, 2002, and 3.0% on April
1, 2003. PIK fees are payable upon maturity.
The entire outstanding Credit Facility balance at September 30, 2002 of $80,438
is included in the current portion of long-term debt and capital leases in the
accompanying condensed consolidated balance sheets. Required principal
installments due are $300 on October 1, 2002 and January 1, 2003, and payments
of $7,214 on April 1, 2003 and July 1, 2003, with the remaining balance due at
maturity on September 30, 2003. The Credit Facility also has mandatory
prepayment provisions for certain asset sale transactions and excess cash flows,
as defined. These prepayment provisions are applied to future required quarterly
installments. Accordingly, $207 of the $300 due on October 1, 2002 was paid in
July as a result of the disposition of one dental location in June 2002.
The Credit Facility contains several covenants, including but not limited to,
restrictions on the Company's ability to incur indebtedness or repurchase
shares, a prohibition on dividends without prior approval, prohibition on
acquisitions, and fees for excess earnout and debt payments, as defined. There
are also financial covenant requirements relating to compliance with specified
cash flow, liquidity, and leverage ratios. The Company's obligations, including
all subsidiaries in the guarantees, under the Credit Facility are secured by a
security interest in the equipment, fixtures, inventory, receivables, subsidiary
stock, certain debt instruments, accounts and intangibles of each of such
entities.
The 2002 amendment to the Credit Facility met the criteria of substantial
modification as outlined under the provisions of EITF 96-19. As such, the
amendment met the requirements of an extinguishment of debt. Accordingly, in the
second quarter of 2002 the Company recorded an extraordinary loss of
approximately $2,604. The extraordinary loss represents amendment fees of $2,000
incurred to extinguish the original Credit Facility and $604 for the write-off
of the non-amortized portion of deferred financing costs associated with the
original note agreement. Professional fees and bank PIK fees paid, or
anticipated to be paid, of $5,924 for the execution of the amended Credit
Facility have been capitalized and are being amortized over the remaining life
of the Credit Facility. At September 30, 2002, $4,179 in anticipated future PIK
fees is included in other current liabilities.
In June 2000, the Company raised $36,500 from the sale of debt and equity to
Levine Leichtman Capital Partners II, L.P. ("Levine") under a securities
purchase agreement (the "Securities Purchase Agreement"). The equity portion of
the transaction comprised 458,333 shares of common stock valued at $11,000. The
debt portion of the transaction comprised a senior subordinated note with a face
value of $25,500 (the "Levine Note"). As part of the transaction with Levine,
the Company also issued a warrant to purchase 354,167 shares of the Company's
common.
In April 2001, the Company entered into an amendment to the Levine Note that met
the criteria of substantial modification as outlined in EITF 96-19. As such, the
Levine Note was considered extinguished, with a new note issued in its place. In
connection with the amendment, the lender waived the defaults under the Levine
Note that existed at December 31, 2000 due to failure to meet certain financial
ratio covenants and reset all covenants for 2001 and subsequent years, in
addition to certain other modifications. As consideration for the amendment, the
Company paid an amendment fee of $2,250, payable in additional notes, increased
the PIK interest rate to 16.5% and reduced the price of the warrants from an
initial strike price of $41.04 per share to $20.88 per share.
In April 2002, the Company entered into an additional amendment to the Levine
Note. In connection with the amendment, the lender reset all covenants for 2002
and subsequent years, in addition to certain other modifications. As
consideration for the amendment, the Company has agreed to pay an amendment fee
of $2,000, payable in additional notes and increase the PIK interest rate by
one-half percentage point. The amendment fee has been capitalized and is being
amortized over the remaining life of the Levine Note.
The entire principal of the Levine Note is due September 2005 but may be paid
earlier at the Company's election, subject to a prepayment penalty.
Additionally, the Levine Note has mandatory principal prepayments based upon a
change in ownership, certain asset sales, or excess cash flows. The Levine Note
bears interest at 12.5%, payable monthly, with an option to pay the interest in
a PIK note. The Company is currently issuing PIK notes at 17.0% for payment of
current interest amounts owed. The Securities Purchase Agreement contains
covenants, including but not limited to, restricting the Company's ability to
incur certain indebtedness, liens or investments, restrictions relating to
agreements affecting capital stock, maintenance of a specified net worth and
compliance with specified financial ratios.
In 1998, the Company issued $30,000 of subordinated convertible notes
("Convertible Notes"). The Convertible Notes mature June 2006 and currently bear
interest at 8.0%, payable semi-annually with an option to pay the interest in a
PIK note also bearing interest at 8.0%, which the Company is currently
exercising for payment of current interest amounts due. In April 2001, the
Company entered into an amendment to the Convertible Notes and the lender waived
the cross-default provision that existed at December 31, 2000 due to the
covenant violations under the Credit Facility and agreed to reset all covenants
for 2001 and subsequent years, in addition to certain other modifications. As
consideration for the amendment, the Company has agreed to reduce the conversion
price of the notes. The Convertible Notes are convertible into shares of the
common stock at $39.00 for each share of common stock issuable upon conversion
of outstanding principal and accrued but unpaid interest on such subordinated
notes and shall be automatically converted into common stock if the rolling
21-day average closing market price of the common stock on 20 out of any 30
consecutive trading days is more than $107.40
(6) SHAREHOLDERS' EQUITY
The Company made advances of $11,500 to certain officers of the Company and
provided certain other officers with a minimum guarantee of the value of their
stock options in order to retain and provide incentives to such officers. In
connection with the advances, such officers issued interest-bearing notes
payable to the Company. Shares of the Company's common stock and options owned
by such officers have been pledged to secure the notes. The notes were included
in shareholders' equity as a reduction to equity. Interest on the notes accrues
at rates ranging from 6.4% to 10.2%. The notes and accrued interest are due June
2004, payable in cash or Company common stock and options with varying minimum
values. The notes and accrued interest were with recourse to the officers until
May or June of 2002, depending upon the individual note agreement, after which
the notes and accumulated interest became non-recourse, subject only to the
underlying pledged collateral.
The difference in the amount of the notes and the value of the collateral at the
date of the loans was being amortized over the life of the notes, representing
stock compensation expense. The amortization reflected the deficit of the
underlying pledged collateral on the individual note dates. The Company also
adjusted the amortization to reflect changes in the quoted fair market value.
The decline, if any, was amortized as stock compensation expense over the life
of the notes. The amortization expense was adjusted cumulatively for changes in
fair value of the collateral. Increases in the stock price, if any, resulted in
a credit to expense, up to the amount of prior expense recognized for this
portion of the notes. In addition, the minimum guarantee of the value of the
stock options was being amortized as stock compensation expense.
The total advance included loans to certain DCA officers. The non-amortized
balance of the advances to DCA officers of $4,600 was sold in connection with
the sale of DCA. Also, during the third quarter of 2001, the entire
non-amortized balance of the remaining notes was written off as a result of the
acceleration of the non-recourse provision of the note due from the former CEO
and the significant decline in the underlying value of the pledged collateral,
which is considered to be other than temporary.
Also, in connection with the execution of an officer's amended employment
agreement, a note receivable and related accrued interest of $182 were to be
forgiven, subject to provisions of the agreement. The note and accrued interest
were being expensed over the twenty-four month service period ending May 2002.
During the third quarter of 2001, the remaining balance on the note was written
off as compensation expense based on the note being converted to non-recourse
pursuant to the severance agreement with the officer.
(7) CONTINGENCIES
On November 28, 2000, the Court entered its Order of Related Cases with regard
to an action previously filed by InterDent on September 28, 2000 in Los Angeles
Superior Court Case No. BC237600, wherein InterDent alleged causes of action
against Amerident for breach of contract, breach of the implied covenant of good
faith and fair dealing, intentional misrepresentation and negligent
misrepresentation. On October 18, 2000, Amerident Dental Corp. ("Amerident")
filed a lawsuit against InterDent and Gentle Dental Management, Inc. seeking
damages related to the July 21, 1999 sale of substantially all of the assets of
ten dental practices in California and Nevada. On January 19, 2001, Amerident
filed another action against InterDent and Gentle Dental Management, Inc. for
Breach of a Promissory Note and related common counts, that action was similarly
deemed related and consolidated with the earlier filed InterDent action. The
caset went to trial in July 2002, with the judge ultimately rendering a
mistrial. The case is expected to go back to trial in the first quarter of 2003.
The Company has been named as a defendant in various other lawsuits in the
normal course of business, primarily for malpractice claims. The Company and
affiliated dental practices, and associated dentists are insured with respect to
dentistry malpractice risks on a claims-made basis. Management believes all of
these pending lawsuits, claims, and proceedings against the Company are without
merit or will not have a material adverse effect on the Company's consolidated
operating results, liquidity or financial position.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-looking and Cautionary Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for certain forward-looking statements. Certain information included in this
Form 10-Q and other materials filed with the Securities and Exchange Commission
(as well as information included in oral statements or other written statements
made or to be made by the Company) contain statements that are forward looking,
such as statements relating to business strategies, plans for future development
and upgrading, capital spending, financing sources, changes in interest rates,
and the effects of regulations. Such forward-looking statements involve
important known and unknown risks and uncertainties that could cause actual
results and liquidity to differ materially from those expressed or anticipated
in any forward-looking statements. Such risks and uncertainties include, but are
not limited to: those related to the effects of competition; leverage and debt
service; financing needs or efforts; actions taken or omitted to be taken by
third parties, including the Company's customers, suppliers, competitors, and
stockholders, as well as legislative, regulatory, judicial, and other
governmental authorities; changes in business strategy; general economic
conditions; changes in health care laws, regulations or taxes; risks related to
development and upgrading systems; and other factors described from time to time
in the Company's reports filed with the Securities and Exchange Commission.
Accordingly, actual results may differ materially from those expressed in any
forward-looking statement made by or on behalf of the Company. Any
forward-looking statements are made pursuant to the Private Securities
Litigation Reform Act of 1995, and, as such, speak only as of the date made. The
Company undertakes no obligation to revise publicly these forward-looking
statements to reflect subsequent events or circumstances
Overview
We are a leading provider of dental practice management services to
multi-specialty dental professional corporations and associations ("PAs") in the
United States. The dentists employed through our network of affiliated PAs
provide patients with affordable, comprehensive, convenient and high quality
dentistry services, which include general dentistry, endodontics, oral
pathology, oral surgery, orthodontics, pedodontics, periodontics and
prosthodontics.
Through May 31, 2001, we provided management services to dental practices in
Arizona, California, Florida, Georgia, Hawaii, Idaho, Indiana, Kansas, Maryland,
Michigan, Nevada, Oklahoma, Oregon, Pennsylvania, Virginia and Washington.
Effective May 31, 2001, we completed the sale of all of the common stock of
Dental Care Alliance, Inc. ("DCA"), a wholly-owned subsidiary, and certain other
assets in Maryland, Virginia, and Indiana. Total consideration was $36.0
million, less the assumption of related debt and operating liabilities. The net
sales proceeds were utilized to pay down existing borrowings under our credit
facility. We also have retained an option to repurchase the division at a future
date and entered into an ongoing collaboration agreement and license agreement
to provide our proprietary software. As of September 30, 2002 we provide
management services to 139 dental offices that employ 559 dentists, including
111 specialists. We currently operate in Arizona, California, Hawaii, Idaho,
Kansas, Nevada, Oklahoma, Oregon, and Washington.
We have historically affiliated with PAs by purchasing the operating assets of
those practices, including furniture and fixtures, equipment and instruments,
and entering into long-term (typically 40 years) management service agreements
("MSAs") with the PAs associated with the practice. Under the terms of these
agreements, we are the exclusive administrator of all non-clinical aspects of
the dental practices, whereas the affiliated PAs are exclusively in control of
all aspects of the practice and delivery of dental services. As compensation for
services provided under the MSAs, we receive a management fee typically equal to
the reimbursement of expenses incurred in operating the practice plus a
percentage of the net revenues of the affiliated dental practice.
As compensation for services provided under the MSAs, we receive management fees
from our affiliated dental practices. Depending upon the individual MSA
provisions, the management fee is calculated based upon one of two methods.
Under one method, the management fee is equal to reimbursement of expenses
incurred in the performance of our obligations under the management service
agreements, plus an additional fee equal to a percentage of the net revenues of
the affiliated dental practices. Under the other method, the management fee is a
set percentage of the net revenues of the affiliated dental practices.
The Emerging Issues Task Force ("EITF") of the Financial Accounting Standards
Board reached a consensus on the accounting for transactions between physician
practice management companies and physician practices and the financial
reporting of such entities (EITF issue number 97-2). For financial reporting
purposes, EITF 97-2 mandates the consolidation of physician practice activities
with the practice management company when certain conditions have been met, even
though the practice management company does not have a direct equity investment
in the physician practice. The accompanying condensed consolidated financial
statements are prepared in conformity with the consensus reached in EITF 97-2.
Simultaneous to the execution of an MSA with each PA, the Company also entered
into a shares acquisition agreement ("SAA"). Under all of the SAAs currently
entered into except for two, representing three clinical locations, the Company
has the right to designate the purchaser (successor dentist) to purchase from
the PA shareholders all the shares of the PA for a nominal price of a $1,000 or
less. Under these SAAs, the Company has the unilateral right to establish or
effect a change in the PA shareholder, at will, and without consent of the PA
shareholder, on an unlimited basis. Under EITF 97-2, the agreements with the PA
shareholders qualify as a friendly doctor arrangement. Consequently, under EITF
97-2, the Company consolidates all the accounts of those PAs in the accompanying
condensed consolidated financial statements. Accordingly, the condensed
consolidated statements of operations include the net patient service revenues
and related expenses of these PAs and all significant intercompany transactions
have been eliminated.
Each of the DCA SAAs entered into with the PAs did not have the nominal price
provision and were sold as part of the DCA sale transaction in May 2001 and the
Company currently has entered into two SAA with PAs that do not have the nominal
price provision. Rather, the SAA purchase price is based upon a multiple of
earnings, as defined. As a result, the agreements do not meet the criteria of
consolidation under EITF 97-2 and the condensed consolidated statements of
operations exclude the net patient service revenues and expenses of these PAs.
The Company only includes net management fee revenues generated and expenses
associated with providing services under the MSAs.
Critical Accounting Policies and Estimates
The preparation of our condensed consolidated financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities and revenues and expenses. On an on-going basis we evaluate
these estimates, including those related to the carrying value of accounts
receivables, intangible and long-lived assets, income taxes and any potential
future impairment. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
We have identified the policies below as critical to our business operations and
the understanding of our results of operations:
Valuation of accounts receivables. The carrying amount of accounts receivables
requires management to assess the future collectibility of our accounts
receivable and establish an allowance for patients covered by third-party payor
contracts, anticipated discounts and doubtful accounts. Our established
allowance is determined based upon historical realization rates, the current
economic environment and the age of accounts. Changes in our estimated
collection rates are recorded as a change in estimate in the period the change
is made.
Intangibles and long-lived Assets. Our business acquisitions typically result in
intangible and long-lived assets. Effective January 1, 2002, we adopted FASB
Statement of Financial Accounting Standard No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). Under SFAS 142, our service mark, MSAs and
goodwill intangible assets are no longer amortized but are reviewed annually for
impairment. The determination of the value of such intangible assets, utilized
for determining whether impairment exits, requires management to make estimates
and assumptions that affect our consolidated financial statements. We are
currently performing the required impairment tests of goodwill and indefinite
lived intangible assets as of January 1, 2002. We have completed the first step
of the two-step transitional impairment analysis required by SFAS 142. This
analysis indicated that the carrying amount of our net assets exceeds the fair
value. Preliminary results of the second step of the transitional impairment
analysis indicates that an impairment charge totaling $50 to $100 million will
be required, although such analysis in not complete. This analysis will be
completed in the fourth quarter of 2002.
Income Taxes. We record a valuation allowance to reduce our deferred income tax
assets to the amount that is more likely than not to be realized. Our assessment
of the realization of deferred income tax assets requires that estimates and
assumptions be made as to taxable income of future periods. Projection of future
period earnings is inherently difficult as it involves consideration of numerous
factors such as our overall strategies, market growth rates, responses by
competitors, assumptions as to operating expenses and other industry specific
factors.
Results of Operations
The following discussion highlights changes in historical revenues and expense
levels for the three and nine-month period ended September 30, 2002, compared to
the three and nine-month period ended September 30, 2001, as reported in our
condensed consolidated financial statements and the related notes thereto
appearing elsewhere herein.
Three Months Ended September 30, 2002 Statement of Operations Compared to Three
Months Ended September 30, 2001
Dental Practice Net Patient Service Revenue. Dental practice net patient service
revenue represents the clinical patient revenues at affiliated dental practices
where the consolidation requirements of EITF 97-2 have been met. There were 151
such clinical locations at June 30, 2001. We sold 7 under performing locations
in the second half of 2001, and in 2002 merged several practice locations into
other existing facilities. At September 30, 2002, we currently have 136 such
locations under management.
Dental practice net patient service revenue was $61.2 million for 2002 compared
to $61.3 million for 2001. For those locations affiliated as of January 1, 2001,
where the management service agreements meet the EITF criteria for
consolidation, same-store daily dental practice net patient service revenue for
2002 decreased by approximately 2.1% when compared to revenue for 2001. While
there are still some under performing locations, the major factor contributing
to the shift from a growth in same-store revenue in previous quarters to the
decline in the third quarter of 2002 is a very poor economy and high
unemployment rate in several of our markets.
Net Management Fees. Net management fees consist of revenue earned in the
performance of our obligations under management service agreements at affiliated
dental practices where the consolidation requirements of EITF 97-2 are not met.
At September 30, 2002, we have 3 such locations under management, representing
one additional location since June 30, 2001. These revenues were $0.22 million
for 2002 and $0.15 million for 2001.
Licensing and Other Fees. We earn certain fees from unconsolidated affiliated
dental practices for various licensing and consulting services. These revenues
were approximately $0.20 million for 2002 and $0.13 million for 2001.
Practice Operating Expenses. Practice operating expenses represent the direct
costs associated with operating and managing the practice facility locations,
including regional support departments. These costs are comprised of the
following expenses:
Clinical Salaries, Benefits and Provider Costs include all patient service
provider staff compensation and related payroll costs at the consolidated
affiliated dental practices, including dentists, hygienists and dental
assistants for the unconsolidated affiliated dental practices;
Practice Non-clinical Salaries and Benefits include all staff compensation
and related payroll costs at all dental and regional facilities other than
dentists, hygienists, and dental assistants;
Dental Supplies and Lab Expenses include all direct supply costs in the
performance of patient treatment programs;
Practice Occupancy Expenses include facility leases, property taxes,
utilities, janitorial services, repairs and maintenance; and
Practice Selling, General, and Administrative Expenses include general
office, advertising, professional services (excluding dentistry), office
supplies, bank processing fees, local taxes, insurance, bad debt expense,
and other miscellaneous costs at the dental facilities and regional
centers.
Practice operating expenses were $53.5 million for 2002 compared to $53.4
million for 2001. Excluding all revenues and expenses of the offices disposed of
during 2001 and 2002, practice operating expenses at the remaining offices (the
"Remaining Offices") for 2002 were 86.9% of total revenue compared to 86.4% for
2001. The practice operating margin at the Remaining Offices for 2002 was 13.1%
compared to 13.6% for 2001.
Corporate Selling, General and Administrative Expenses. Corporate selling,
general and administrative expenses include: corporate salaries, general office
costs, investor relations expense, legal and audit fees, general insurance,
director and officer liability insurance, corporate office supplies, and other
miscellaneous costs at our corporate facilities. Corporate selling, general and
administrative expenses were $2.3 million for 2002 compared to $3.3 million for
2001, representing a 30.7% decrease. The decrease in total corporate selling,
general and administrative expenses is the result of a $0.52 million reduction
in previously expensed amounts in 2002 for certain incentive plans where
threshold amounts have not been met and $0.15 million in the reduction of
certain one-time consulting and litigation fees paid. The remaining decrease in
total corporate expenses is attributed to the implementation of strategic
management initiatives in corporate staffing levels to leverage the
infrastructure needs of the Company.
Stock Compensation Expense. During the second and third quarter of 2000, we
advanced $11.5 million under notes that became non-recourse after two years to
certain officers in order to retain and provide incentives to such officers,
where shares of our stock owned by each officer serve as collateral for the
advances. The entire balance was recorded as deferred compensation in
shareholders' equity in the condensed consolidated balance sheets. The deferred
compensations was being amortized over the life of the advances as stock
compensation expense, representing the difference in the amount of the advances
and the value of the collateral at the date of the loans. The total original
advance included advances of $5.9 million to DCA officers. These advances were
sold in connection with the sale of DCA. The remaining non-amortized outstanding
balance of deferred compensation associated with the advances to DCA officers at
the time of the sale transaction was $4.6 million. During the third quarter of
2001, the entire remaining non-amortized balance of deferred compensation was
written off as a result of the acceleration of the non-recourse provision of the
advance due from the former CEO and the significant decline in the underlying
value of the pledged collateral, which was considered to be other than
temporary.
In connection with the execution of an officer's amended employment agreement, a
note receivable and related accrued interest of approximately $0.18 million were
to be forgiven, subject to provisions of the agreement. The note and accrued
interest were being expensed over the twenty-four month service period ending
May 2002. During the third quarter of 2001, the remaining balance on the note
was written off as compensation expense based on the note being converted to
non-recourse pursuant to the severance agreement with the officer. In 2000 we
also began accruing for a stock based incentive program to certain employees
that was paid in June 2002.
No stock compensation expense was recorded for 2002. Such total expense for 2001
was $4.3 million.
Loss (gain) on dental location dispositions and impairment of long-lived assets.
For 2002, we recognized a minimal level of additional closing costs associated
with the sale of a dental location that was consummated in June 2002. For 2001,
we identified several dental practices to be disposed of in the second half of
2001 and recorded a non-cash impairment charge of $6.5 million, representing the
excess of the carrying value of the underlying assets to be disposed, including
intangibles, property and equipment, and other assets, over their fair values.
Depreciation and Amortization. Depreciation and amortization was $1.0 million
for 2002 compared to $2.8 million for 2001. This decrease is directly attributed
to a $1.8 million reduction in goodwill amortization as a result of the
implementation of FASB issued Statement of Financial Accounting Standard No.
142, "Goodwill and Other Intangible Assets", which eliminated the amortization
of our intangible assets as discussed in Note 2 to the accompanying condensed
consolidated financial statements.
Interest Expense. Interest expense, net of interest income, was $6.0 million for
2002 compared to $4.3 million for 2001. In April 2002, we entered into various
amendments to our outstanding Credit Facility and Levine Notes, as further
described in note 5 to the condensed consolidated financial statements. These
amendments increased our borrowing costs due to escalations in interest rates,
PIK fees, and the amortization of deferred closing costs over the life of the
loans.
Provision for Income Taxes. Our statutory tax rate for federal and state
purposes is approximately 40%. The income tax expense of $0.03 million for 2002
and $0.05 million for 2001 represents our estimated state tax payable. We expect
to utilize existing loss carryforwards to offset any federal tax payable for
2002 and 2001.
Nine Months Ended September 30, 2002 Statement of Operations Compared to Nine
Months Ended September 30, 2001
Dental Practice Net Patient Service Revenue. Dental practice net patient service
revenue represents the clinical patient revenues at affiliated dental practices
where the consolidation requirements of EITF 97-2 have been met. There were 166
such clinical locations through May 31, 2001, at which point revenues of 15
locations were eliminated as a result of the DCA sale transaction. We also sold
7 under performing locations in the second half of 2001, and in 2002 merged
several practice locations into other existing facilities. At September 30,
2002, we currently have 136 such locations under management.
Dental practice net patient service revenue was $188.7 million for 2002 compared
to $201.1 million for 2001, representing a 6.2% decrease. This revenue decrease
is due to the sale of 22 clinical locations as discussed above. For those
locations affiliated as of January 1, 2001, where the management service
agreements meet the EITF criteria for consolidation, same-store daily dental
practice net patient service revenue for 2002 increased by approximately 0.3%
when compared to revenue for 2001. While there are still some under performing
locations, the major factor contributing to the relatively flat same-store
revenue for 2002 is a very poor economy and high unemployment rate in several of
our markets.
Net Management Fees. Net management fees consist of revenue earned in the
performance of our obligations under management service agreements at affiliated
dental practices where the consolidation requirements of EITF 97-2 are not met.
The decrease in these revenues, $0.60 million in 2002 as compared to $19.7
million in 2001, is entirely related to the DCA sale transaction as essentially
all of our management fees revenues were earned by our DCA subsidiary that was
sold effective May 31, 2001. At September 30, 2002, we currently have 3 such
locations under management.
Licensing and Other Fees. We earn certain fees from unconsolidated affiliated
dental practices for various licensing and consulting services. These revenues
were approximately $0.50 million for 2002 and 2001.
Practice Operating Expenses. Practice operating expenses represent the direct
costs associated with operating and managing the practice facility locations,
including regional support departments. These costs are comprised of the
following expenses:
Clinical Salaries, Benefits and Provider Costs include all patient service
provider staff compensation and related payroll costs at the consolidated
affiliated dental practices, including dentists, hygienists and dental
assistants for the unconsolidated affiliated dental practices;
Practice Non-clinical Salaries and Benefits include all staff compensation
and related payroll costs at all dental and regional facilities other than
dentists, hygienists, and dental assistants;
Dental Supplies and Lab Expenses include all direct supply costs in the
performance of patient treatment programs;
Practice Occupancy Expenses include facility leases, property taxes,
utilities, janitorial services, repairs and maintenance; and
Practice Selling, General, and Administrative Expenses include general
office, advertising, professional services (excluding dentistry), office
supplies, bank processing fees, local taxes, insurance, bad debt expense,
and other miscellaneous costs at the dental facilities and regional
centers.
Practice operating expenses were $163.5 million for 2002 compared to $190.4
million for 2001, representing a 14.1% decrease. The decrease in practice
operating expenses is primarily due to the sale of the DCA subsidiary on May 31,
2001 and seven clinical locations disposed of during 2001 and 2002. Excluding
all revenues and expenses of the offices disposed of during 2001 and 2002,
practice operating expenses at the remaining offices (the "Remaining Offices")
was 86.1 % of total revenue for 2002 and 86.3% for 2001. The Remaining Practice
operating margin was 13.9% and 13.7%, for 2002 and 2001, respectively.
Corporate Selling, General and Administrative Expenses. Corporate selling,
general and administrative expenses include: corporate salaries, general office
costs, investor relations expense, legal and audit fees, general insurance,
director and officer liability insurance, corporate office supplies, and other
miscellaneous costs at our corporate facilities. Corporate selling, general and
administrative expenses were $9.6 million for 2002 compared to $10.1 million for
2001, representing a 4.5% decrease. The decrease in total corporate selling,
general and administrative expenses is primarily the result of the DCA sale in
May 2001.
Stock Compensation Expense. During the second and third quarter of 2000, we
advanced $11.5 million under notes that became non-recourse after two years to
certain officers in order to retain and provide incentives to such officers,
where shares of our stock owned by each officer serve as collateral for the
advances. The entire balance was recorded as deferred compensation in
shareholders' equity in the Condensed Consolidated Balance Sheets. The deferred
compensation was being amortized over the life of the advances as stock
compensation expense, representing the difference in the amount of the advances
and the value of the collateral at the date of the loans. The total original
advance included advances of $5.9 million to DCA officers. These advances were
sold in connection with the sale of DCA. The remaining non-amortized outstanding
balance of deferred compensation associated with the advances to DCA officers at
the time of the sale transaction was $4.6 million. During the third quarter of
2001, the entire remaining non-amortized balance of deferred compensation was
written off as a result of the acceleration of the non-recourse provision of the
advance due from the former CEO and the significant decline in the underlying
value of the pledged collateral, which was considered to be other than
temporary.
In connection with the execution of an officer's amended employment agreement, a
note receivable and related accrued interest of approximately $0.18 million were
to be forgiven, subject to provisions of the agreement. The note and accrued
interest were being expensed over the twenty-four month service period ending
May 2002. During the third quarter of 2001, the remaining balance on the note
was written off as compensation expense based on the note being converted to
non-recourse pursuant to the severance agreement with the officer. In 2000 we
also began accruing for a stock based incentive program to certain employees
that was paid in June 2002.
For 2002, we recorded total stock compensation expense of $0.15 million as
compared to $6.1 million for 2001. No additional stock compensation expense is
anticipated in 2002.
Loss (gain) on dental location dispositions and impairment of long-lived assets.
For 2002, we recognized a gain of $0.19 million, representing $0.32 million in
insurance reimbursement relating the sale of certain dental locations in 2002,
which was partially offset by a recorded loss of $0.13 upon consummation of the
sale of an additional dental location in June 2002. For 2001, we completed a
stock sale of DCA, a wholly-owned subsidiary, and certain other assets in
Maryland, Virginia, and Indiana for total consideration of $36 million,
including cash of $26.5 million and the assumption of related debt and operating
liabilities, and a license fee of $2.6 million, payable in future installments.
The loss of $5.6 million recorded in 2001 included a provision for transaction
related closing costs.
Additionally, during 2001 we identified several dental practices to be disposed
of in the second half of 2001 and recorded a non-cash impairment charge of $6.5
million, representing the excess of the carrying value of the underlying assets
to be disposed, including intangibles, property and equipment, and other assets,
over their fair values.
Depreciation and Amortization. Depreciation and amortization was $3.0 million
for 2002 compared to $9.3 million for 2001. Of this decrease of $6.2 million,
$0.92 million is due to depreciation and amortization associated with the sale
of DCA and $5.2 million as a result of the implementation of FASB issued
Statement of Financial Accounting Standard No. 142, "Goodwill and Other
Intangible Assets", which eliminated the amortization of our intangible assets
as discussed in note 2 to the accompanying condensed consolidated financial
statements.
Interest Expense. Interest expense, net of interest income, was $16.2 million
for 2002 compared to $15.0 million for 2001. In April 2002 and 2001, we entered
into various amendments to our outstanding Credit Facility and Levine Notes, as
further described in note 5 to the condensed consolidated financial statements.
These amendments increased our borrowing costs due to escalations in interest
rates and the amortization of deferred closing costs over the life of the loans.
These increases were partially offset by a reduction in borrowings under the
credit facility (the "Credit Facility") as a result of the principal payments
made in 2001 in connection with the sale of DCA.
Debt and equity financing costs. In April 2001, we entered into various
amendments to our existing Credit Facility and convertible senior subordinate
debt as described in note 5 to the condensed consolidated financial statements.
As a result, we recorded a charge of $3.9 million for the write-off of certain
prepaid debt costs related to previously entered credit facility agreements,
loan amendment fees, warrant issuance valuations, and associated professional
fees incurred in connection with the execution of the various loan amendments.
Extraordinary loss on debt extinguishments. In April 2002, we entered into an
additional amendment to the Credit Facility. The amendment meets the criteria of
substantial modification as outlined in EITF 96-19. As such, the original Credit
Facility is considered extinguished, with a new Credit Facility issued in its
place. Accordingly, we recorded an extraordinary charge of $2.6 million for
2002. No tax benefit was recorded as a result of the charge as the realization
of available deferred tax assets is not assured. The extraordinary loss
represents the amendment fees of $2.0 million incurred and $0.60 million for the
write-off of the non-amortized portions of previously recorded deferred
financing costs associated with the original facility agreement.
In April 2001, we entered into an agreement to amend our senior subordinated
debt ("Levine Note"). The amendment to the Levine Note met the criteria of
substantial modification as outlined in EITF 96-19, resulting in an
extraordinary charge of $5.6 million for 2001. No tax benefit was recorded as a
result of the charge as the realization of available deferred tax assets is not
assured. The extraordinary loss represents the amendment fee of $2.2 million
incurred to extinguish the original note and $3.4 million for the write-off of
the non-amortized portions of warrant discount and deferred financing costs also
associated with the original note agreement
Provision for Income Taxes. Our statutory tax rate for federal and state
purposes is approximately 40%. The income tax expense of $0.09 million for 2002
and $0.15 million for 2001 represents our estimated state tax payable. We expect
to utilize existing loss carryforwards to offset any federal tax payable for
2002 and 2001.
Liquidity and Capital Resources
Liquidity
We have experienced losses attributed to common stock of $5.6 million the nine
months ended September 30, 2002 and for fiscal years ended 2001 and 2000, $35.1
million and $48.7 million, respectively. These past significant losses included
certain charges for asset impairments, disposition of DCA and certain other
dental locations, and debt restructuring and debt extinguishments, which we
believe are unusual in nature. Although we have experienced losses over the two
years ended December 31, 2001 due to these unusual charges, our dental
facilities continue to generate significant positive cash, as reflected in cash
flows from operations of $11.9 million for the nine months ended September 30,
2002 and for fiscal years ended 2001 and 2000, $19.4 million and $9.5 million,
respectively.
In April 2002 the Company negotiated modifications to its credit agreement,
which has an outstanding balance of $80.4 million as of September 30, 2002. As
more fully described in Note 5, these modifications resulted in a permanent
waiver of past covenant violations, reset covenant levels, and the principal
amortization schedule was significantly modified such that approximately $20.7
million of payments was deferred until April 1, 2003. In exchange for these
modifications, the Company agreed to pay certain fees and expense, in addition
to interest rate increases. Based upon these modifications to the credit
agreement, the Company believes that it will be able to make all scheduled debt
payments through March 31, 2003, and payments due under its earn-out agreements,
along with meeting its other obligations. However, there are significant
installments due under the credit agreement of $7.2 million on April 1 and July
1, 2003, with the remainder due on September 30, 2003. This debt must be
refinanced, modified, or otherwise retired with the proceeds of other financing
or capital transactions, as the cash flow from operations is insufficient to
fund the required debt payments beginning April 1, 2003. Also, there can be no
assurance that the Company will meet its required payment obligations as they
become due prior to April 1,2003, or that any such financing will be available
or available on terms acceptable to the Company.
Current Financial Condition and Cashflows
At September 30, 2002, cash and cash equivalents were $4.4 million, representing
a $2.8 million decrease in cash and cash equivalents from $7.2 million at
December 31, 2001. Our working capital deficit at September 30, 2002 of $86.6
million represents an increase from a working capital deficit at December 31,
2001 of $6.3 million. This significant increase in the working capital deficit
is directly attributed to the $80.4 million in Credit Facility debt included in
the current portion of long-term debt which matures on September 30, 2003, as
discussed in note 5 to the condensed consolidated financial statements.
Net cash provided by operations amounted to $11.9 million for 2002 compared to
$15.9 million for 2001. The decrease in net cash provided by operations is
primarily attributed to $5.4 million in net cash used for accounts payable
activity between the two periods. Additionally, during 2001 we received an
income tax refund of $1.4 million.
Net cash used in investing activities was $2.0 million for 2002 as compared to
cash provided by investing activities of $12.5 million for 2001. In connection
with certain completed affiliation transactions, we have agreed to pay future
consideration to the sellers. The amount of future consideration payable is
generally computed based upon financial performance of the affiliated dental
practices during certain specified periods ("Earn-Out"). Included in the
investing activities for 2002 is cash paid of $1.5 million for Earn-Out and
other payments on affiliated dental practice acquisitions that closed in prior
years. Cash paid for Earn-Out and acquisition closing costs were $4.2 million
for 2001. Net proceeds from the disposition of dental locations were $0.56
million in 2002 compared to $22.5 million in 2001. The 2001 proceeds were
primarily associated with the DCA sale transaction in May 2001. We also paid
$1.1 million for property and equipment for 2002 compared to $2.7 million for
2001. There were no advances to unconsolidated affiliated practices in 2002 and
$3.2 million for 2001. Advances consisted primarily of receivables from PAs due
in connection with cash advances for working capital and operating purposes to
certain unconsolidated PAs. We advanced funds to these certain PAs during the
initial years of operations, until the PA owner could repay the seller debt, and
the operations improve. Such advances entirely related to our DCA division
facilities, which were eliminated upon consummation of the DCA stock sale
transaction in May 2001.
Net cash used in financing activities was $12.7 million for 2002, comprised of
$11.4 million in debt payments and $1.3 million for payments of deferred
financing costs associated with the amendment to the Credit Facility and Levine
Note that was consummated in April 2002. Cash used in financing activities for
2001 was $24.9 million and primarily related to $18.4 million net credit
facility payments from the DCA sale, $3.7 million on other long-term debt and
capital leases payments, and $2.4 million in deferred financing costs associated
with the amendment to the Credit Facility and Levine Note that consummated in
April 2001.
We accrue for Earn-Out payments with respect to completed acquisitions when such
amounts are probable and reasonably estimable. In addition to cash Earn-Out
payments of $1.0 million during the nine months ended September 30, 2002, we
also converted $1.4 million in Earn-Out amounts due into long-term notes
payable. As of September 30, 2002, future anticipated Earn-Out payments of $2.7
million are accrued and included in other current liabilities. For those
acquisitions with Earn-Out provisions, we estimate the total maximum Earn-Out
that could be paid, including amounts already accrued, is between $3.0 and $4.0
million from July 2002 to December 2005, which is expected to be paid in a
combination of cash and notes.
Outstanding Debt and Other Financing Arrangements
Credit Facility Term Note
In April 2001, we entered into amendments to its existing senior revolving
credit facility (the "Credit Facility") to amend certain covenants. In
connection with the execution of the amendments, the banks waived the defaults
under the Credit Facility that existed at December 31, 2000 due to failure to
meet certain financial ratio covenants and reset all covenants for 2001 and
subsequent years. Additionally, the banks agreed to certain other changes
including a revised term and provisions regarding asset sales and new financing.
As consideration for these modifications, we agreed to an amendment fee of $1.0
million, which was paid during the three months ended June 30, 2001, and an
additional fee of $1.0 million payable at maturity of the term loan if certain
conditions were not met. The additional fee was paid in connection with an
additional amendment to the Credit Facility consummated in April 2002, as
discussed below.
On October 1, 2001, our Credit Facility converted into a term loan, with
required quarterly payments. On April 15, 2002, we entered into an amendment to
our Credit Facility. In connection with the execution of the amendment, the
lenders agreed, among other things, to reset certain covenants and reduce the
required future quarterly principal payments of $7.2 million, which were to
begin on October 1, 2001. In connection with these modifications, we accrued as
note principal the remaining $1.0 million due as a result of an amendment
conducted in April 2001, which is payable upon maturity. We also agreed to an
additional amendment fee of $1.0 million, with cash of $0.50 million payable at
closing and $0.25 million to accrue as additional principal on July 1, 2002 and
October 1, 2002, payable upon final maturity of the Credit Facility on September
30, 2003.
Principal amounts owed under the Credit Facility bear interest at LIBOR plus
7.50% or the prime rate plus 5.75%, at the Company's option. In addition to the
cash interest charges outlined above, we are to pay an incremental
payment-in-kind ("PIK") interest on the outstanding principal balance of 1.0%
from April 15, 2002 though March 31, 2003, increasing to 2.0% from April 1, 2003
through maturity. The incremental PIK interest is payable upon maturity. We also
paid a PIK fee equal to 1.0% of the outstanding principal balance on April 15,
2002, and are to pay 2.0% on October 1, 2002, and 3.0% on April 1, 2003. PIK
fees are payable upon maturity.
The entire outstanding Credit Facility balance at September 30, 2002 of $80.4
million is included in the current portion of long-term debt and capital leases
in the accompanying condensed consolidated balance sheets. Required principal
installments are $0.30 million on October 1, 2002, and January 1, 2003, and
payments of $7.2 million on April 1, 2003 and July 1, 2003, with the remaining
balance due at maturity on September 30, 2003. The Credit Facility also has
mandatory prepayment provisions for certain asset sale transactions and excess
cash flows, as defined. These prepayment provisions are applied to future
required quarterly installments. Accordingly, $0.21 million of the $0.30 million
due on October 1, 2002 was paid in July as a result of the disposition of one
dental location in June 2002.
The Credit Facility contains several covenants, including but not limited to,
restrictions on our ability to incur indebtedness or repurchase shares, a
prohibition on dividends without prior approval, prohibition on acquisitions,
and fees for excess earnout and debt payments, as defined. There are also
financial covenant requirements relating to compliance with specified cash flow,
liquidity, and leverage ratios. Our obligations, including all subsidiaries in
the guarantees, under the Credit Facility are secured by a security interest in
the equipment, fixtures, inventory, receivables, subsidiary stock, certain debt
instruments, accounts and general intangibles of each of such entities.
The amendment to the Credit Facility met the criteria of substantial
modification as outlined under the provisions of EITF 96-19. As such, the
amendment met the requirements of an extinguishment of debt. Accordingly, in the
second quarter of 2002 we recorded an extraordinary loss of approximately $2.6
million. The extraordinary loss represents amendment fees of $2.0 million
incurred to extinguish the original note and $0.60 million for the write-off of
the non-amortized portion of deferred financing costs associated with the
original Credit Facility agreement. Professional fees and bank PIK fees paid, or
anticipated to be paid, of $5.9 million for the execution of the amended Credit
Facility have been capitalized and are being amortized over the remaining life
of the Credit Facility. At September 30, 2002 $4.2 million in anticipated future
PIK fees are included in other current liabilities.
Senior Subordinated Notes
In June 2000, we raised $36.5 million from the sale of debt and equity to Levine
Leichtman Capital Partners II, L.P. ("Levine") under a securities purchase
agreement (the "Securities Purchase Agreement"). The equity portion of the
transaction comprised 458,333 shares of common stock valued at $11.0 million.
The debt portion of the transaction comprised a senior subordinated note with a
face value of $25.5 million (the "Levine Note"). As part of the transaction with
Levine, we also issued a warrant to purchase 354,167 shares of the Company's
common.
In April 2001, we entered into an amendment to the Levine Note that met the
criteria of substantial modification as outlined in EITF 96-19. As such, the
Levine Note was considered extinguished, with a new note issued in its place. In
connection with the amendment, the lender waived the defaults under the Levine
Note that existed at December 31, 2000 due to failure to meet certain financial
ratio covenants and reset all covenants for 2001 and subsequent years, in
addition to certain other modifications. As consideration for the amendment, we
paid an amendment fee of $2.3 million, payable in additional notes, increased
the PIK interest rate to 16.5% and reduced the price of the warrants from an
initial strike price of $41.04 per share to $20.88 per share.
In April 2002, we entered into an additional amendment to the Levine Note. In
connection with the amendment, the lender reset all covenants for 2002 and
subsequent years, in addition to certain other modifications. As consideration
for the amendment, we agreed to pay an amendment fee of $2.0 million, payable in
additional notes and increase the PIK interest rate by one-half percentage
point. The amendment fee has been capitalized and is being amortized over the
remaining life of the Levine Note.
The entire principal of the Levine Note is due September 2005 but may be paid
earlier at our election, subject to a prepayment penalty. Additionally, the
Levine Note has mandatory principal prepayments based upon a change in
ownership, certain asset sales, or excess cash flows. The Levine Note bears
interest at 12.5%, payable monthly, with an option to pay the interest in a PIK
note. The Company is currently issuing PIK notes at 17.0% for payment of current
interest amounts owed. The Securities Purchase Agreement contains covenants,
including but not limited to, restricting our ability to incur certain
indebtedness, liens or investments, restrictions relating to agreements
affecting capital stock, maintenance of a specified net worth and compliance
with specified financial ratios.
Convertible Subordinated Notes
In 1998, we issued $30 million of subordinated convertible notes ("Convertible
Notes"). The Convertible Notes mature June 2006 and currently bear interest at
8.0%, payable semi-annually with an option to pay the interest in a PIK note
also bearing interest at 8.0%, which we are currently exercising for payment of
current interest amounts due. In April 2001, we entered into an amendment to the
Convertible Notes and the lender waived the cross-default provision that existed
at December 31, 2000 due to the covenant violations under the Credit Facility
and agreed to reset all covenants for 2001 and subsequent years, in addition to
certain other modifications. As consideration for the amendment, we agreed to
reduce the conversion price of the notes. The Convertible Notes are convertible
into shares of the common stock at $39.00 for each share of common stock
issuable upon conversion of outstanding principal and accrued but unpaid
interest on such subordinated notes and shall be automatically converted into
common stock if the rolling 21-day average closing market price of the common
stock on 20 out of any 30 consecutive trading days is more than $107.40.
Preferred and Common Stock
We are authorized to issue 30,000,000 shares of Preferred Stock. Presently
authorized series of our Preferred Stock include the following series:
o Series A--100 shares authorized, issued and outstanding;
o Series B--70,000 shares authorized, zero issued or outstanding;
o Series C--100 shares authorized, zero shares issued or outstanding;
and
o Series D--2,000,000 shares authorized, 1,574,608 shares are issued
and outstanding.
Our presently authorized Preferred Stock rank senior to outstanding Common
Stock. The shares of Series B Preferred Stock were authorized in connection with
issuance of the Convertible Notes as discussed above. The Series B Preferred
Stock conversion provision of the Convertible Notes has expired. Accordingly,
although the Series B Preferred Stock is authorized, the Company does not expect
any such shares to ever be issued. Similarly, 100 shares of Series C Preferred
Stock were authorized and issued in connection with the Convertible Note
issuance, but then converted into 10 shares of common stock in the March 1999
merger transaction. The Company does not expect any shares of Series C Preferred
Stock to be issued. The shares of Series D Preferred Stock are convertible into
shares of our Common Stock at the rate of one-sixth of a share of Common Stock
for each share of Series D Preferred Stock (assuming there are no declared but
unpaid dividends on the Series D Preferred Stock), in each case subject to
adjustment for stock splits, reverse splits, stock dividends, reorganizations
and similar anti-dilutive provisions. The Series D Preferred Stock holders are
entitled to vote on all matters as to which the Common Stock shareholders are
entitled to vote, based upon the number of shares of Common Stock the Series D
Preferred Stock is convertible into. The Series A Preferred Stock is not
convertible, is entitled to elect a director, and is otherwise non-voting.
A total of 36,920 and 56,541 outstanding shares of Common Stock issued at a
price of $2.70 and $1.35 per share, respectively, are subject to repurchase by
us at the original issue price at our election.
Dental Location Dispositions
Effective May 31, 2001, we also completed the stock sale of DCA, a wholly-owned
subsidiary, and certain other assets in Maryland, Virginia and Indiana. The
transaction also includes the assets associated with the notes receivable made
to officers of DCA as discussed in the notes to the Consolidated Financial
Statements. Total consideration was $36.0 million, less the assumption of
related debt and operating liabilities. Upon the two-year anniversary of the
transaction close, we shall have the right to repurchase the assets of DCA,
based upon a multiple of EBITDA subject to a minimum price, as defined in the
agreement. In connection with the sale of assets, we entered into a five-year
license agreement for $2.6 million in cash, payable in installments, for use of
our proprietary practice management system, subject to negotiations for
additional term extensions. Such amount is recorded as deferred revenues and
amortized over the life of the agreement. The parties also entered into the
transition services agreement and a business collaboration agreement delineating
the use of the practice management system, the joint purchase of supplies, the
joint negotiation for managed care contracts, training systems, and other
similar operational matters.
During 2002, we disposed of one dental location for net proceeds of $0.24
million and our insurance carrier reimbursed us for $0.32 million on certain
dispositions that occurred in 2001, resulting in total proceeds of $0.56 million
and a gain of $0.19 million. During 2001, we disposed or identified under
performing dental locations for disposition ("Disposed Locations"). In
connection with the sale of DCA and Disposed Locations the Company wrote off
$40.2 million in total assets, yielded proceeds of $21.4 million, net of closing
costs and recorded a total loss of $12.3 million for the year ended December 31,
2001. The total recorded loss includes $1.7 million for the provision of direct
transaction closing costs.
Impairment of long-lived assets
In July 2001, the FASB issued Statement of Financial Accounting Standard No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142,
goodwill and indefinite lived assets are no longer amortized but are reviewed
annually for impairment. Separate intangible assets that are not deemed to have
an indefinite life will continue to be amortized over their useful lives. The
amortization provisions of SFAS 142 apply to goodwill and intangible assets
acquired after September 30, 2001. With respect to goodwill and intangible
assets acquired prior to September 30, 2001, the provisions of SFAS 142 are
effective upon its adoption effective beginning fiscal year 2002. We are
currently performing the required impairment tests of goodwill and indefinite
lived intangible assets as of January 1, 2002. We have completed the first step
of the two-step transitional impairment analysis required by SFAS 142. This
analysis indicated that the carrying amount of our net assets exceeds the fair
value. Preliminary results of the second step of the transitional impairment
analysis indicates that an impairment charge totaling $50 to $100 million will
be required, although such analysis in not complete. This analysis will be
completed in the fourth quarter of 2002.
Item 3. Quantitative and Qualitative Disclosures About Market Risks
We do not utilize financial instruments for trading purposes and hold no
derivative financial instruments, which could expose us to significant market
risk. Our interest expense is sensitive to changes in the general level of
interest rates as our credit facility has interest rates based upon market LIBOR
or prime rates, as discussed in Note 5 to the condensed consolidated financial
statements. To mitigate the impact of fluctuations in market rates, we purchase
fixed interest rates for periods of up to 180 days on portions of the
outstanding credit facility balance.
At September 30, 2002, we had $80.4 million in floating rate debt under the
credit facility. The detrimental effect on our pre-tax earnings of a
hypothetical 100 basis point increase in the interest rate under the credit
facility would have been approximately $0.60 million for the nine-months ended
September 30, 2002. This sensitivity analysis does not consider any actions we
might take to mitigate our exposure to such a change in the credit facility
rate. The hypothetical change used in this analysis may be different from what
actually occurs in the future. Our remaining subordinated notes and long-term
debt obligations of $90.9 million are at fixed rates of interest.
Item 4. Controls and Procedures
The Chief Executive Officer and Vice President, Finance of the company (its
principal executive officer and principal financial officer, respectively) have
concluded, based on their evaluation as of a date within 90 days prior to the
date of the filing of this report, that the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in the reports filed or submitted by it under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and include controls and
procedures designed to ensure that information required to be disclosed by the
company in such reports is accumulated and communicated to the company's
management, including the Chief Executive Officer and Vice President, Finance,
as appropriate to allow timely decisions regarding required disclosure.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
such evaluation.
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
The payment of dividends is within the discretion of the Board of Directors;
however, we intend to retain earnings from operations for use in the operation
and expansion of our business and do not expect to pay cash dividends in the
foreseeable future. In addition, our senior credit lender currently prohibits
the payment of cash dividends. Any future decision with respect to dividends
will depend on future earnings, operations, capital requirements and
availability, restrictions in future financing agreements and other business and
financial considerations.
Item 3. Defaults Upon Senior Securities
As of December 31, 2001, the Company was in default under its existing senior
revolving Credit Facility and Levine Note due to failure to meet certain
financial ratio covenants. In April 2002, we entered into an amendment to our
Credit Facility and Levine Note, which, among other provisions, waived the
defaults that existed at December 31, 2001 and reset all covenants for 2002 and
subsequent years. For further information, see note 5 to the condensed
consolidated financial statements.
Item 5. Other Information
Nasdaq in a letter dated May 16, 2002, notified the Company that it failed to
comply with the minimum bid price and the minimum market value of publicly held
shares requirements for continued listing set forth in Market Place Rules
4450(b)(3) and 4450(b)(4), and that its securities were, therefore, subject to
delisting from the Nasdaq National Market. In June, the Company was also
notified that it also did not meet the minimum market value of publicly held
shares requirement for transfer to the Nasdaq SmallCap Market and, as a result,
the Company's common stock began trading on the OTC Bulletin Board on June 13,
2002. The Interdent, Inc. common stock symbol was also changed to DENT.OB to
reflect the change in market listings.
First Union National Bank is the Transfer Agent and Registrar for the stock of
InterDent, Inc. Shareholder matters, such as a transfer of shares, stock
transfer requirements, missing stock certificates and changes of address, should
be directed to First Union at the following address and telephone number:
First Union National Bank
Shareholder Services Group
1525 W. WT Harris Blvd., 3C3
Charlotte, North Carolina 28288-1153
Telephone Numbers: 704/590-0394, or toll-free 800/829-8432
Item 6. Exhibits, Financial Statement Schedules and Reports on Form 8-K
- -------
(a) Exhibits
99.1 Chief Executive Officer's Certification Pursuant to Section 1350 of
Chapter 63 of Title 18 of the United States Code.
99.2 Vice President, Finance's Certification Pursuant to Section 1350 of
Chapter 63 of Title 18 of the United States Code.
(b) Reports on Form 8-K
No reports on Form 8-K were filed in the three months ended September
30, 2002.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTERDENT, INC.
(Registrant)
Date: November 13, 2002 By: \s\ H. WAYNE POSEY
--------------------------------------- -------------------------------------------
H. Wayne Posey
Chief Executive Officer
By: \s\ ROBERT W. HILL
----------------------------------------------------
Robert W. Hill
Vice President, Finance
CERTIFICATION
I, H. Wayne Posey, certify that:
1. I have reviewed this quarterly report on Form 10-Q of InterDent, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 13, 2002
\s\ H. WAYNE POSEY
----------------------------
H. Wayne Posey
Chief Executive Officer
CERTIFICATION
I, Robert W. Hill, certify that:
1. I have reviewed this quarterly report on Form 10-Q of InterDent, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 13, 2002
\s\ ROBERT W. HILL
-------------------------
Robert W. Hill
Vice President, Finance