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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-23367
BIRNER DENTAL MANAGEMENT SERVICES, INC.
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(Exact name of registrant as specified in its charter)
COLORADO 84-1307044
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
3801 EAST FLORIDA AVENUE, SUITE 508
DENVER, COLORADO 80210
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (303) 691-0680
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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None. None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
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(Title of Class)
Indicate by check mark whether the Registrant (1) has 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 -------- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
1
The aggregate market value of the Registrant's voting stock held by
non-affiliates of the Registrant computed by reference to the price at which the
common equity was as of June 30, 2003, the last business day of the Registrant's
most recent completed second fiscal quarter was $11,619,699. This calculation
assumes that certain parties may be affiliates of the Registrant and that,
therefore, 851,260 shares of voting stock are held by non-affiliates. As of
March 19, 2004, the Registrant had 1,185,010 shares of its common stock, without
par value ("Common Stock") outstanding.
On February 26, 2001 the Registrant affected a reverse stock split in which the
Registrant issued one share of Common Stock for every four shares of Common
Stock then outstanding. Therefore, all shares, options, share prices, option
prices and earnings per share calculations for all periods in this document have
been restated to reflect the effect of the reverse stock split.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Report (Items 10,11,12, 13 and 14)
is incorporated by reference from the Registrant's Proxy Statement to be filed
pursuant to Regulation 14A with respect to the annual meeting of shareholders
scheduled to be held on or about June 8, 2004.
FORWARD-LOOKING STATEMENTS
Statements contained in this Annual Report on Form 10-K ("Annual Report") of
Birner Dental Management Services, Inc. (the "Company"), which are not
historical in nature, are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements include statements in Items 1. and 2., "Business and Properties,"
Item 5., "Market for the Registrant's Common Equity and Related Stockholder
Matters" and Item 7., "Management's Discussion and Analysis of Financial
Condition and Results of Operations," regarding the intent, belief or current
expectations of the Company or its officers with respect to the development or
acquisition of additional dental practices and the successful integration of
such practices into the Company's network, recruitment of additional dentists,
funding of the Company's expansion, capital expenditures, payment or nonpayment
of dividends and cash outlays for income taxes.
Such forward-looking statements involve certain risks and uncertainties that
could cause actual results to differ materially from anticipated results. These
risks and uncertainties include regulatory constraints, changes in laws or
regulations concerning the practice of dentistry or dental practice management
companies, the availability of suitable new markets and suitable locations
within such markets, changes in the Company's operating or expansion strategy,
failure to consummate or successfully integrate proposed developments or
acquisitions of dental practices, the ability of the Company to manage
effectively an increasing number of dental practices, the general economy of the
United States and the specific markets in which the Company's dental practices
are located or are proposed to be located, trends in the health care, dental
care and managed care industries, as well as the risk factors set forth in Item
7. "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Risk Factors," and other factors as may be identified from time to
time in the Company's filings with the Securities and Exchange Commission or in
the Company's press releases.
2
Birner Dental Management Services, Inc.
Form 10-K
Table of Contents
Part Item(s) Page
I. 1. and 2. Business and Properties 4
General 4
Dental Services Industry 4
Operations 5
Existing Offices 6
Patient Services 7
Dental Practice Management Model 8
Payor Mix 9
The Company Dentist Philosophy 9
Expansion Program 10
Affiliation Model 11
Competition 13
Government Regulation 13
Insurance 15
Trademark 16
Facilities and Employees 16
3. Legal Proceedings 16
4. Submission of Matters to a Vote of Security Holders 16
II. 5. Market for Registrant's Common Equity and Related
Stockholder Matters 17
6. Selected Financial Data 19
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
7A. Quantitative and Qualitative Disclosures About
Market Risk 36
8. Financial Statements and Supplementary Data 37
9. Changes in and Disagreements with Accountants on
Accounting and FinancialDisclosure 62
9A. Controls and Procedures 62
III. 10. Directors and Executive Officers of the Registrant 62
11. Executive Compensation 62
12. Security Ownership of Certain Beneficial Owners 62
and Management
13. Certain Relationships and Related Transactions 62
14. Principal Accountant Fees and Services 62
IV. 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 63
Signatures 68
3
PART I
ITEMS 1. AND 2. BUSINESS AND PROPERTIES.
General
The Company acquires, develops, and manages geographically dense dental practice
networks in select markets, currently including Colorado, New Mexico and
Arizona. With its 40 dental practices ("Offices") in Colorado and eight Offices
in New Mexico, the Company believes, based on industry knowledge and contacts,
that it is the largest provider of dental management services in Colorado and
New Mexico. The Company provides a solution to the needs of dentists, patients,
and third-party payors by allowing the Company's affiliated dentists to provide
high-quality, efficient dental care in patient-friendly, family practice
settings. Dentists practicing at the various locations provide comprehensive
general dentistry services, and the Company increasingly offers specialty dental
services through affiliated specialists. The Company currently manages 54
Offices, of which 37 were acquired and 17 were developed internally ("de novo
Offices").
Dental Services Industry
According to the Centers for Medicare and Medicaid Services ("CMS") dental
expenditures in the U.S. increased from $31.5 billion in 1990 to $70.3 billion
in 2002. CMS also projects that dental expenditures will reach approximately
$126.3 billion by 2013, representing an increase of approximately 80% over 2002
dental expenditures. The Company believes this growth is driven by (i) an
increase in the number of people covered by third-party payment arrangements and
the resulting increase in their utilization of dental services, (ii) an
increasing awareness of the benefits of dental treatments, (iii) the retention
of teeth into later stages of life, (iv) the general aging of the population, as
older patients require more extensive dental services, and (v) a growing
awareness of and demand for preventative and cosmetic services.
Traditionally, most dental patients have paid for dental services themselves
rather than through third-party payment arrangements such as indemnity
insurance, preferred provider plans or managed dental plans. More recently,
factors such as increased consumer demand for dental services and the desire of
employers to provide enhanced benefits for their employees have resulted in an
increase in third-party payment arrangements for dental services. Current market
trends, including the rise of third-party payment arrangements, have contributed
to the increased consolidation of practices in the dental services industry and
to the formation of dental practice management companies. The Company believes
that the percentage of people covered by third-party payment arrangements will
continue to increase due in part to the popularity of such arrangements.
4
Operations
Location of Offices
[MAP INSERTED HERE]
5
Existing Offices
As of the date of this Annual Report, the Company managed a total of 54 Offices
in Colorado, New Mexico, and Arizona. The following table identifies each
Office, the location of each Office, the date each Office was acquired or de
novo developed, and any specialty dental services offered at that Office in
addition to comprehensive general dental services:
Date Acquired/ Specialty
Office Name Office Address Developed* Services
- ---------------------------- ---------------------------- -------------------- -----------
Colorado
Boulder
Perfect Teeth/Boulder 4155 Darley, #F September 1997
Perfect Teeth/Folsom 1840 Folsom, Suite 302 April 1998
Castle Rock
Perfect Teeth/Castle Rock 390 South Wilcox, Unit D October 1995
Colorado Springs
Perfect Teeth/Cheyenne Meadows 827 Cheyenne Meadows Road June 1998*
Perfect Teeth/Garden of the Gods 4329 Centennial Boulevard July 1996*
Perfect Teeth/South 8th Street 1050 South Eighth Street August 1998 1,2,3,4
Perfect Teeth/Uintah Gardens 1768 West Uintah Street May 1996*
Perfect Teeth/Union & Academy 5140 North Union September 1997
Perfect Teeth/Woodman Valley 6914 North Academy Boulevard, Unit 1B April 1998*
Perfect Teeth/Powers 5929 Constitution Avenue March 1999* 1
Denver
Perfect Teeth/64th and Ward 12650 West 64th Avenue, Unit J January 1996*
Perfect Teeth/88th and Wadsworth 8749 Wadsworth Boulevard September 1997 1,2,4,5
Perfect Teeth/Arapahoe 7600 East Arapahoe Road, #311 October 1995
Perfect Teeth/Bowmar 5151 South Federal Boulevard, #G-2 October 1995
Perfect Teeth/Buckley and Quincy 4321 South Buckley Road September 1997 1,2
Perfect Teeth/Central Denver 1633 Fillmore Street, Suite 200 May 1996
Perfect Teeth/East 104th Avenue 2200 East 104th Avenue, #112 May 1996 1
Perfect Teeth/East Cornell 12200 East Cornell Avenue, # E August 1996
Perfect Teeth/East Iliff 16723 East Iliff Avenue May 1997
Glendale Dental Group 4521 East Virginia Avenue February 1999 2
Perfect Teeth/Golden 17211 South Golden Road, #100 June 1999*
Perfect Teeth/Green Mountain 13035 West Alameda Parkway December 1998*
Perfect Teeth/Highlands Ranch 9227 Lincoln Avenue, Suite 100 July 1999* 1
Perfect Teeth/Ken Caryl 7660 South Pierce September 1997
Perfect Teeth/Leetsdale 7150 Leetsdale Drive, #110A March 1996*
Mississippi Dental Group 11175 East Mississippi Avenue, #110 September 1998
Perfect Teeth/Monaco and Evans 2121 South Oneida, Suite 321 November 1995 1,2,3,4
Perfect Teeth/North Sheridan 11550 North Sheridan, #101 May 1996
Perfect Teeth/Parker 11005 South Parker Road December 1998* 1
Perfect Teeth/Sheridan and 64th Ave. 5169 West 64th Avenue May 1996
Perfect Teeth/South Holly Street 8211 South Holly Street September 1997 2
Perfect Teeth/Speer 700 East Speer Boulevard February 1997
Perfect Teeth/West 38th Avenue 7760 West 38th Avenue, #200 May 1996
Perfect Teeth/West 120th Avenue 6650 West 120th Avenue, A-6 September 1997
Perfect Teeth/West Jewell 8064 West Jewell April 1998
Perfect Teeth/Yale 7515 West Yale Avenue, Suite A April 1997 1,2,3,5
Fort Collins
Perfect Teeth/South Fort Collins 1355 Riverside Avenue, Unit D May 1996
Greeley
Perfect Teeth/Greeley 902 14th Street September 1997
Longmont
Perfect Teeth/Longmont 641 Ken Pratt Boulevard September 1997
Loveland
Perfect Teeth/ Loveland 3400 West Eisenhower Boulevard September 1996
6
Office Name Office Address Developed* Services
- ---------------------------- ---------------------------- -------------------- -----------
New Mexico
Albuquerque
Perfect Teeth/Alice 5909 Alice NE February 1998
Perfect Teeth/Candelaria 6101 Candelaria NE April 1997
Perfect Teeth/Cubero Drive 5900 Cubero Drive NE, Suite E September 1998
Perfect Teeth/Four Hills 13140-E Central Avenue, SE August 1997*
Perfect Teeth/Fourth Street 5721 Fourth Street NW August 1997
Perfect Teeth/Wyoming and Candelaria 8501 Candelaria NE, Suite D3 August 1997
Rio Rancho
Perfect Teeth/Rio Rancho 4500 Arrowhead Ridge Drive July 1999*
Santa Fe
Perfect Teeth/Plaza Del Sol 720 St. Michael Drive, Suite O May 1998*
Arizona
Goodyear
Perfect Teeth/Palm Valley 14175 West Indian School Bypass Rd, #B6 March 2000*
Mesa
Perfect Teeth/Power & McDowell 2733 North Power Road, Suite 101 October 2000*
Phoenix
Perfect Teeth/Thomas and 15th Avenue 3614 North 15th Avenue, Suite B September 1998
Scottsdale
Perfect Teeth/Bell Road & 64th Street 6345 East Bell Road, Suite 1 July 1998 1
Perfect Teeth/Shea & 90th Street 9393 North 90th Street, Suite 207 September 1998
Tempe
Perfect Teeth/Elliot and McClintock 7650 S. McClintock Dr., #110 June 1999*
(1) Orthodontics
(2) Periodontics
(3) Oral Surgery
(4) Pedodontics
(5) Endodontics
The Offices typically are located either in shopping centers, professional
office buildings or stand-alone buildings. The majority of the de novo Offices
are located in supermarket-anchored shopping centers. The Offices have from four
to 16 treatment rooms and range in size from 1,200 square feet to 7,300 square
feet.
Patient Services
The Company seeks to develop long-term relationships with patients. A
comprehensive exam and evaluation is conducted during a patient's first visit.
Through patient education, the patients develop an awareness of the benefits of
a comprehensive, long-term dental care plan. The Company believes that it will
retain these patients longer and that these patients will have a higher
utilization of the Company's dental services including specialty, elective, and
cosmetic services.
Dentists practicing at the Offices provide comprehensive general dentistry
services, including crowns and bridges, fillings (including state-of-the-art
gold, porcelain and composite inlays/onlays), and aesthetic procedures such as
porcelain veneers and bleaching. In addition, hygienists provide cleanings and
periodontal services including root planing and scaling. If appropriate, the
patient is offered specialty dental services, such as orthodontics, oral surgery
and periodontics, which are available at certain of the Company's Offices, as
indicated on the table above. These services are provided by affiliated
specialists who rotate through certain offices in the Company's existing
markets. The addition of specialty services is a key component of the Company's
strategy, as it enables the Company to capture revenue from typically higher
margin services that would otherwise be referred to non-affiliated providers. In
addition, by offering a broad range of dental services within a single practice,
the Company is able to distinguish itself from its competitors and realize
operating efficiencies and economies of scale through higher utilization of
professionals and facilities.
7
Dental Practice Management Model
The Company has developed a dental practice management model designed to achieve
its goal of providing personalized, high-quality dental care in a patient
friendly setting similar to that found in a traditional private practice. The
Company's dental practice management model consists of the following components:
Recruiting of Dentists. The Company seeks dentists with excellent skills and
experience, who are sensitive to patient needs, interested in establishing
long-term patient relationships and are motivated by financial incentives to
enhance Office operating performance. The Company believes that practicing in
its network of Offices offers both recently graduated dentists and more
experienced dentists advantages over a solo or smaller group practice, including
relief from the burden of administrative responsibilities and the resulting
ability to focus almost exclusively on practicing dentistry. Advantages to
dentists affiliated with the Company also include the relief from not having to
make a capital commitment, a compensation structure that rewards productivity,
employee benefits such as health insurance, a 401(k) plan, continuing education,
payment of professional membership fees and malpractice insurance. The Company's
effort to recruit managing dentists is primarily focused on dentists with three
or more years of practice experience. The Company typically recruits associate
dentists graduating from residency programs. It has been the Company's
experience, that many dentists in the early stages of their careers have
incurred substantial student loans. As a result, they face significant financial
constraints in starting their own practices or buying into existing practices,
especially in view of the capital-intensive nature of modern dentistry.
The Company advertises for the dentists it seeks in national and regional dental
journals, local market newspapers, professional conferences and directly at
dental schools with strong residency programs. In addition, the Company has
found that its existing affiliated dentists provide a good referral source for
recruiting future dentists.
Training of Non-Dental Employees. The Company has developed a formalized
training program for non-dental employees, which is conducted by the Company's
staff. This program includes training in patient interaction, scheduling, use of
the computer system, office procedures and protocols, and third-party payment
arrangements. The Company also offers formalized mandatory training programs for
employees regarding the Occupational Safety and Health Act (OSHA) and the Health
Insurance Portability and Accountability Act (HIPAA) to ensure compliance with
government regulations. Additionally, the Company encourages its employees to
attend continuing education seminars as a supplement to the Company's formalized
training program. In addition, Company regional directors also meet weekly with
the Company's senior management and administrative staff to review pertinent and
timely topics and generate ideas that can be shared with all Offices. Management
believes that its training program and the on-going meetings with employees have
contributed to an improvement in the operations at its Offices.
Staffing Model. The Company's staffing model attempts to maximize profitability
in the Offices by adjusting personnel according to an Office's revenue level.
Staffing at mature Offices can vary based on the number of treatment rooms, but
generally includes one to three dentists, two to four dental assistants, one to
three hygienists, one to three hygiene assistants and two to five front office
personnel. Staffing at de novo Offices typically consists initially of one
dentist, one dental assistant and one front office person. As the patient base
builds at an Office, additional staff is added to accommodate the growth as
provided in the staffing model developed by the Company. The Company currently
has a staff of five regional directors in Colorado and one regional director for
New Mexico and Arizona. These regional directors, who are each responsible for
four to 14 Offices and the specialty practice, oversee operations, development
of non-dental employees, recruiting and work to implement the Company's dental
practice management model to maximize revenues and profitability.
Management Information Systems. All of the Offices have the same management
information system, which allows the Company to receive uniform data that can be
analyzed easily in order to measure and improve operating performance in the
Offices. As part of its acquisition integration process, the Company converts
acquired Offices to its management information system as soon as practicable.
The Company's current system enables it to maintain on-line contact with each of
its Offices and allows the Company to monitor the Offices by obtaining real-time
data relating to patient and insurance information, treatment plans, scheduling,
revenues and collections. The Company provides each Office with monthly
operating and financial data, which is analyzed and used to improve the Office's
performance.
8
Advertising and Marketing. The Company seeks to increase patient volume at its
Offices from time to time through television, radio, print advertising and other
marketing techniques. The Company's advertising efforts are primarily aimed at
increasing its fee-for-service business and emphasizes the high-quality care
provided, as well as the timely, individualized attention received from the
Company's affiliated dentists.
Quality Assurance. The Company has designed and implemented a quality assurance
program for dental personnel, including a background check. Each affiliated
dentist is a graduate of an accredited dental program, and most State licensing
authorities require dentists to undergo annual training. The dentists and
hygienists practicing at the Offices obtain a portion of their required
continuing education through the Company's internal training programs.
Purchasing / Vendor Relationships. The Company has negotiated arrangements with
a number of its more significant vendors, including dental laboratory and supply
providers, to reduce per unit costs. By aggregating supply purchasing and
laboratory usage, the Company believes that it has received favorable pricing
compared to solo or smaller group practices. This system of centralized buying
and distribution on an as-needed basis reduces the storage of inventory and
supplies at the Offices.
Payor Mix
The Company's payors include indemnity insurers, preferred provider plans,
managed dental care plans, and uninsured patients. The Company seeks to optimize
the revenue mix at each Office between fee-for-service business and capitated
managed care plans, taking into account the local dental market. While
fee-for-service business generally provides a greater margin than capitated
managed dental care business, capitated managed dental care business serves to
increase facility utilization and dentist productivity. Consequently, the
Company seeks to supplement its fee-for-service business with revenue derived
from contracts with capitated managed dental care plans. The Company negotiates
the managed care contracts on behalf of the professional corporations that
operate the Offices (the "P.C.s"), although the P.C.s enter into the contracts
with the various managed care plans. Managed care relationships also provide
increased co-payment revenue, referrals of additional fee-for-service patients
and opportunities for dentists practicing at the Offices to educate patients
about the benefits of elective dental procedures that may not be covered by the
patients' capitated managed dental care plans.
During the years ended December 31, 2001, 2002, and 2003 the following companies
were responsible for the corresponding percentages of the Company's total dental
group practice revenue (includes capitation premiums and co-payments): Aetna
Healthcare was responsible for 7.4%, 6.6% and 6.9%, respectively, CIGNA Dental
Health was responsible for 6.0%, 6.3% and 6.7%, respectively and Delta Care was
responsible for 8.0%, 6.6% and 4.9%, respectively.
The Company has successfully reduced the percentage of its business that comes
from managed dental care plans, from 51.4% of gross revenues in 1998 to 27.3% of
gross revenues in 2003, and replaced that revenue stream with higher margin
fee-for-service revenues. This higher margin fee-for-service revenue has
predominantly been business derived from preferred provider plans.
The Company Dentist Philosophy
The Company seeks to develop long-term relationships with its dentists by
building the practice at each of its Offices around a managing dentist. The
Company's dental practice management model provides managing dentists the
autonomy and independence of a private family practice setting without the
capital commitment and without the administrative burdens such as
billing/collections, payroll, accounting, and marketing. This gives the managing
dentists the ability to focus primarily on providing high-quality dental care to
their patients. The managing dentist retains the responsibilities of team
building and developing long-term relationships with patients and staff by
building trust and providing a friendly, relaxed atmosphere in his or her
Office. The managing dentist exercises his or her own clinical judgment in
matters of patient care. In addition, managing dentists are given an economic
incentive to improve the operating performance of their Offices, in the form of
a bonus based upon the operating performance of the Office. In addition,
managing dentists may be granted stock options in the Company that ordinarily
vest over a three-to-five year period.
9
When the revenues of an Office justify expansion, associate dentists can be
added to the team. Associate dentists are typically recent graduates from
residency programs, and usually spend up to two years working with a managing
dentist. Depending on performance and abilities, an associate dentist may be
given the opportunity to become a managing dentist.
Expansion Program
Overview
Since its formation in May 1995, the Company has acquired 42 practices,
including five practices that have been consolidated with existing Offices. Of
those acquired practices (including the five practices consolidated with
existing Offices), 34 were located in Colorado, five were located in New Mexico,
and three were located in Arizona. Although the Company has acquired and
integrated several group practices, many of the Company's acquisitions have been
solo dental practices. The Company has developed 18 de novo Offices (including
one practice that was consolidated with an existing Office). In 2003 the Company
embarked on a strategy to increase revenues. Some of the initiatives begun were
the signing of a lease for a de novo site in the Phoenix area, negotiating other
leases for de novo sites, evaluating potential acquisitions, expanding the
specialty services side of the business, aggressively recruiting additional
dentists and an expanded marketing plan.
The following table sets forth the change in the number of Offices managed by
the Company from January 1, 1999 through December 31, 2003.
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
Offices at beginning of the period 49 54 56 54 54
De novo Offices 5 2 0 0 0
Acquired Offices 1 0 0 0 0
Consolidation of Offices (1) 0 (2) 0 0
---- ---- ---- ---- ----
Offices at end of the period 54 56 54 54 54
==== ==== ==== ==== ====
Capacity Utilization
The Company expects to expand in existing markets primarily by
enhancing the operating performance of its existing Offices. Enhancing operating
performance will principally be accomplished through the expansion of the
specialty services side of the business and the aggressive recruitment of
additional dentists and hygienists to further utilize existing physical capacity
in the Offices.
De Novo Office Developments
One method by which the Company enters new markets and expands its operations in
existing markets is through the development of de novo Offices. Five of the
Company's seven Colorado Springs Offices, six of the Company's 29 Denver metro
area Offices, three of the Company's eight New Mexico Offices and three of the
Company's six Arizona Offices were de novo developments. The Company generally
locates de novo Offices in prime retail locations in areas where there is
significant population growth. These locations provide high visibility for the
Company's signage and easy walk-in access for its customers. Historically, the
Company has used consistent office designs, colors, logo and signage for each of
its de novo Offices.
10
The average investment by the Company in each of its 17 de novo Offices has been
approximately $194,000, which includes the cost of equipment, leasehold
improvements and working capital associated with the initial operations.
On February 19, 2004 the Company entered into a contract to lease approximately
2,800 square feet of office space at a shopping center in Phoenix, Arizona at
which site the Company will develop a de novo office. The Company is also in the
process of evaluating other sites for de novo development.
Acquisition Strategy
Prior to entering a new market, the Company considers the population,
demographics, market potential, competitive and regulatory environment, supply
of available dentists, needs of managed care plans or other large payors and
general economic conditions within the market. Once the Company has established
a presence in a new market, the Company seeks to increase its presence in that
market through acquisitions and by developing de novo Offices. The Company
identifies potential acquisition candidates through a variety of means,
including selected inquiries of dentists by the Company, direct inquiries by
dentists, referrals from other dentists, participation in professional
conferences and referrals from practice brokers. The Company seeks to identify
and acquire dental practices for which the Company believes application of its
dental practice management model will improve revenue and operating performance.
Affiliation Model
Relationship with Professional Corporations (P.C.s)
Each Office is operated by a P.C., which is owned by one of four different
licensed dentists practicing within the Company's network. The Company's
President, Mark A. Birner, DDS is one of these four dentists and individually
owns 45 P.C.'s. The Company has entered into agreements with owners of 53 of the
P.C.s which provide that upon the death, disability, incompetence or insolvency
of the owner, a loss of the owner's license to practice dentistry, a termination
of the owner's employment by the P.C. or the Company, a conviction of the owner
for a criminal offense, or a breach by the P.C. of the Management Agreement (as
defined below) with the Company, the Company may require the owner to sell his
or her shares in the P.C. for a nominal amount to a third-party designated by
the Company. These agreements also prohibit the owner from transferring or
pledging the shares in the P.C.s except to parties approved by the Company who
agree to be bound by the terms of the agreements. Upon a transfer of the shares
to another party, the owner agrees to resign all positions held as an officer or
the director of the P.C.
One licensed dentist who owns a P.C. operating an Office in Colorado has entered
into stock purchase, pledge and security agreements with the Company. Under this
agreement, if certain events occur including the failure to perform the
obligations under the employment agreement with the P.C., cessation of
employment with the P.C. for any reason, death or insolvency or directly or
indirectly causing the P.C. to breach its obligations under the Management
Agreement, then the Company may cause the P.C. to redeem the dentist's ownership
interest in the P.C. for an agreed price which is not considered to be material
by the Company. Two of the three directors of this P.C. are nominees of the
Company and the dentist has given the Company's Chief Executive Officer, Fred
Birner an irrevocable proxy to vote his shares in the P.C.
Management Agreements with Affiliated Offices
The Company derives all of its revenue from its management agreements with the
P.C.s (the "Management Agreements"). Under each of the Management Agreements,
the Company manages the business and marketing aspects of the Offices, including
(i) providing capital, (ii) designing and implementing marketing programs, (iii)
negotiating for the purchase of supplies, (iv) staffing, (v) recruiting, (vi)
training of non-dental personnel, (vii) billing and collecting patient fees,
(viii) arranging for certain legal and accounting services, and (ix) negotiating
with managed care organizations. The P.C. is responsible for, among other
things, (i) supervision of all dentists and dental hygienists, (ii) ensuring
compliance with all laws, rules and regulations relating to dentists and dental
hygienists, and (iii) maintaining proper patient records. The Company has made,
and intends to make in the future, loans to P.C.s in Colorado, New Mexico and
Arizona to fund their acquisition of dental assets from third parties in order
to comply with the laws of such states. Because the Company's financial
statements are consolidated with the financial statements of the P.C.s, these
loans are eliminated in consolidation.
11
Under the typical Management Agreement used by the Company, the P.C. pays the
Company a management fee equal to the Adjusted Gross Center Revenue of the P.C.
less compensation paid to the dentists and dental hygienists employed at the
Office of the P.C. Adjusted Gross Center Revenue is comprised of all fees and
charges booked each month by or on behalf of the P.C. as a result of dental
services provided to patients at the Office, less any adjustments for
uncollectible accounts, professional courtesies and other activities that do not
generate a collectible fee. The Company's costs include all direct and indirect
costs, overhead and expenses relating to the Company's provision of management
services at the Office under the Management Agreement, including (i) salaries,
benefits and other direct costs of Company employees who work at the Office,
(ii) direct costs of all Company employees or consultants who provide services
to or in connection with the Office, (iii) utilities, janitorial, laboratory,
supplies, advertising and other expenses incurred by the Company in carrying out
its obligations under the Management Agreement, (iv) depreciation expense
associated with the P.C.'s assets and the assets of the Company used at the
Office, and the amortization of intangible asset value relating to the Office,
(v) interest expense on indebtedness incurred by the Company to finance any of
its obligations under the Management Agreement, (vi) general and malpractice
insurance expenses, lease expenses and dentist recruitment expenses, (vii)
personal property and other taxes assessed against the Company's or the P.C.'s
assets used in connection with the operation of the Office, (viii) out-of-pocket
expenses of the Company's personnel related to mergers or acquisitions involving
the P.C., (ix) corporate overhead charges or any other expenses of the Company
including the P.C.'s pro rata share of the expenses of the accounting and
computer services provided by the Company, and (x) a collection reserve in the
amount of 5.0% of Adjusted Gross Center Revenue. As a result, substantially all
costs associated with the provision of dental services at the Office are borne
by the Company, other than the compensation and benefits of the dentists and
hygienists who work at the Offices of the P.C.s. This enables the Company to
manage the profitability of the Offices. Each Management Agreement is for a term
of 40 years. Further, each Management Agreement generally may be terminated by
the P.C. only for cause, which includes a material default by or bankruptcy of
the Company. Upon expiration or termination of a Management Agreement by either
party, the P.C. must satisfy all obligations it has to the Company.
The Company plans to continue to use the current form of its Management
Agreement to the extent possible. However, the terms of the Management Agreement
are subject to change to comply with existing or new regulatory requirements or
to enable the Company to compete more effectively.
Employment Agreements
Most dentists practicing at the Offices have entered into employment agreements
or independent contractor agreements with a P.C. The majority of such agreements
can be terminated by either party without cause with 90 days notice. The
employment agreement for one of the managing dentists who is also a shareholder
of a P.C. has a term of 20 years and can only be terminated by the employer P.C.
upon the occurrence of certain events. If the employment of the managing dentist
is terminated for any reason, the employer P.C. has the right to redeem the
shares of the P.C. operating the Office held by the managing dentist. Such
agreements typically contain non-competition provisions for a period of up to
three to five years following their termination within a specified geographic
area, usually a specified number of miles from the associated Office, and
restrict solicitation of patients and employees. Managing dentists receive
compensation based upon a specified amount per hour worked or a percentage of
revenue or collections attributable to their work, or a bonus based upon the
operating performance of the Office, whichever is greater. Associate dentists
are compensated based upon a specified amount per hour worked or a percentage of
revenue or collections attributable to their work, whichever is greater.
Specialists are compensated based upon a percentage of revenue or collections
attributable to their work. The P.C. with whom the dentist has entered into an
employment agreement pays the dentists' compensation and benefits.
12
Competition
The dental services industry is highly fragmented, consisting primarily of solo
and smaller group practices. The dental practice management segment of this
industry is highly competitive and is expected to become more competitive. In
this regard, the Company expects that the provision of multi-specialty dental
services at convenient locations will become increasingly more common. The
Company is aware of several dental practice management companies that are
operating in its markets, including Dental One, American Dental Partners, Inc.
and Dental Health Centers of America. Companies with dental practice management
businesses similar to that of the Company which currently operate in other parts
of the country, may begin targeting the Company's existing markets for
expansion. Such competitors may have greater financial resources or otherwise
enjoy competitive advantages, which may make it difficult for the Company to
compete against them or to acquire additional Offices on terms acceptable to the
Company.
The business of providing general and specialty dental services is highly
competitive in the markets in which the Company operates. The Company believes
it competes with other providers of dental and specialty services on the basis
of factors such as brand name recognition, convenience, cost and the quality and
range of services provided. Competition may include practitioners who have more
established practices and reputations. The Company also competes against
established practices in the retention and recruitment of general dentists,
specialists, hygienists and other personnel. If the availability of such
individuals begins to decline in the Company's markets, it may become more
difficult to attract and retain qualified personnel to sufficiently staff the
existing Offices or to meet the staffing needs of the Company's planned
expansion.
Government Regulation
The practice of dentistry is regulated at both the state and federal levels, and
the regulation of health care-related companies is increasing. There can be no
assurance that the regulatory environment in which the Company or the P.C.s
operate will not change significantly in the future. The laws and regulations of
all states in which the Company operates impact the Company's operations but do
not currently materially restrict the Company's operations in those states. In
addition, state and federal laws regulate health maintenance organizations and
other managed care organizations for which dentists may be providers. In
connection with its operations in existing markets and expansion into new
markets, the Company may become subject to additional laws, regulations and
interpretations or enforcement actions. The laws regulating health care are
broad and subject to varying interpretations, and there is currently a lack of
case law construing such statutes and regulations. The ability of the Company to
operate profitably will depend in part upon the ability of the Company and the
P.C.s to operate in compliance with applicable health care regulations.
State Regulation
The laws of many states, including Colorado and New Mexico, permit a dentist to
conduct a dental practice only as an individual, a member of a partnership or an
employee of a professional corporation, limited liability company or limited
liability partnership. These laws typically prohibit, either by specific
provision or as a matter of general policy, non-dental entities, such as the
Company, from practicing dentistry, from employing dentists and, in certain
circumstances, hygienists or dental assistants, or from otherwise exercising
control over the provision of dental services. Under the Management Agreements,
the P.C.s control all clinical aspects of the practice of dentistry and the
provision of dental services at the Offices, including the exercise of
independent professional judgment regarding the diagnosis or treatment of any
dental disease, disorder or physical condition. Persons to whom dental services
are provided at the Offices are patients of the P.C.s and not of the Company.
The Company does not employ the dentists who provide dental services at the
Offices nor does the Company have or exercise any control or direction over the
manner or methods in which dental services are performed or interfere in any way
with the exercise of professional judgment by the dentists.
13
Many states, including Colorado, limit the ability of a person other than a
licensed dentist, to own or control dental equipment or offices used in a dental
practice. Some states allow leasing of equipment and office space to a dental
practice, under a bona fide lease, if the equipment and office remain under the
control of the dentist. Some states, including Arizona and New Mexico, require
all advertisements to be in the name of the dentist. A number of states,
including Arizona, Colorado and New Mexico, also regulate the content of
advertisements of dental services. In addition, Colorado, New Mexico and
Arizona, and many other states impose limits on the tasks that may be delegated
by dentists to hygienists and dental assistants. Some states require entities
designated as "clinics" to be licensed, and may define clinics to include dental
practices that are owned or controlled in whole or in part by non-dentists.
These laws and their interpretations vary from state to state and are enforced
by the courts and by regulatory authorities with broad discretion.
Many states have fraud and abuse laws which are similar to the federal fraud and
abuse law described below, and which in many cases apply to referrals for items
or services reimbursable by any third-party payor, not just by Medicare and
Medicaid. A number of states, including Arizona, Colorado and New Mexico,
prohibit the submitting of false claims for dental services.
Many states, including Colorado and New Mexico, also prohibit "fee-splitting" by
dentists with any party except other dentists in the same Professional
Corporation or practice entity. In most cases, these laws have been construed to
apply to the practice of paying a portion of a fee to another person for
referring a patient or otherwise generating business, and not to prohibit
payment of reasonable compensation for facilities and services (other than the
generation of referrals), even if the payment is based on a percentage of the
practice's revenues.
In addition, many states have laws prohibiting paying or receiving any
remuneration, direct or indirect, that is intended to include referrals for
health care items or services, including dental items and services.
In addition, there are certain regulatory risks associated with the Company's
role in negotiating and administering managed care contracts. The application of
state insurance laws to third party payor arrangements, other than
fee-for-service arrangements, is an unsettled area of law with little guidance
available. As the P.C.s contract with third-party payors, on a capitation or
other basis under which the relevant P.C. assumes financial risk, the P.C.s may
become subject to state insurance laws. Specifically, in some states, regulators
may determine that the Company or the P.C.s are engaged in the business of
insurance, particularly if they contract on a financial-risk basis directly with
self-insured employers or other entities that are not licensed to engage in the
business of insurance. In Arizona, Colorado and New Mexico, the P.C.s currently
only contract on a financial-risk basis with entities that are licensed to
engage in the business of insurance and thus are not subject to the insurance
laws of those states. To the extent that the Company or the P.C.s are determined
to be engaged in the business of insurance, the Company may be required to
change the method of payment from third-party payors and the Company's revenue
may be materially and adversely affected.
Federal Regulation
Federal laws generally regulate reimbursement, billing and self-referral
practices under Medicare and Medicaid programs. Because the P.C.s currently
receive no revenue under Medicare or Medicaid, the impact of these laws on the
Company to date has been negligible. There can be no assurance, however, that
the P.C.s will not have patients in the future covered by these laws, or that
the scope of these laws will not be expanded in the future, and if expanded,
such laws or interpretations thereunder could have a material adverse effect on
the Company's business, financial condition and operating results.
Federal regulations also allow state licensing boards to revoke or restrict a
dentist's license in the event such dentist defaults in the payment of a
government-guaranteed student loan, and further allow the Medicare program to
offset such overdue loan payments against Medicare income due to the defaulting
dentist's employer. The Company cannot assure compliance by dentists with the
payment terms of their student loans, if any.
14
Revenues of the P.C.s or the Company from all insurers, including governmental
insurers, are subject to significant regulation. Some payors limit the extent to
which dentists may assign their revenues from services rendered to
beneficiaries. Under these "reassignment" rules, the Company may not be able to
require dentists to assign their third-party payor revenues unless certain
conditions are met, such as acceptance by dentists of assignment of the payor
receivable from patients, reassignment to the Company of the sole right to
collect the receivables, and written documentation of the assignment. In
addition, governmental payment programs such as Medicare and Medicaid limit
reimbursement for services provided by dental assistants and other ancillary
personnel to those services which were provided "incident to" a dentist's
services. Under these "incident to" rules, the Company may not be able to
receive reimbursement for services provided by certain members of the Company's
Offices' staff unless certain conditions are met, such as requirements that
services must be of a type commonly furnished in a dentist's office and must be
rendered under the dentist's direct supervision and that clinical Office staff
must be employed by the dentist or the P.C. The Company does not currently
derive a significant portion of its revenue under such programs.
The operations of the Offices are also subject to compliance with regulations
promulgated by the Occupational Safety and Health Administration ("OSHA"),
relating to such matters as heat sterilization of dental instruments and the use
of barrier techniques such as masks, goggles and gloves. The Company incurs
expenses on an ongoing basis relating to OSHA monitoring and compliance.
Although the Company believes its operations as currently conducted are in
material compliance with existing applicable laws and regulations, there can be
no assurance that the Company's contractual arrangements will not be
successfully challenged as violating applicable laws and regulations or that the
enforceability of such arrangements will not be limited as a result of such laws
and regulations. In addition, there can be no assurance that the business
structure under which the Company operates, or the advertising strategy the
Company employs will not be deemed to constitute the unlicensed practice of
dentistry or the operation of an unlicensed clinic or health care facility. The
Company has not sought judicial or regulatory interpretations with respect to
the manner in which it conducts its business. There can be no assurance that a
review of the business of the Company and the P.C.s by courts or regulatory
authorities will not result in a determination that could materially and
adversely affect their operations or that the regulatory environment will not
change so as to restrict the Company's existing or future operations. In the
event that any legislative measures, regulatory provisions or rulings or
judicial decisions restrict or prohibit the Company from carrying on its
business or from expanding its operations to certain jurisdictions, structural
and organizational modifications of the Company's organization and arrangements
may be required which could have a material adverse effect on the Company, or
the Company may be required to cease operations.
On April 14, 2003, health care providers, including the Company, were required
to comply with the electronic data security and privacy requirements of HIPAA.
HIPAA delegates enforcement authority to the Centers for Medicare Services
Office for Civil Rights. Noncompliance with HIPAA regulations can result in
severe penalties up to $250,000 in fines and up to ten years in prison. As of
December 31, 2003, the Company was in full compliance with all requirements of
HIPPA and there has been no material impact on the Company due to the
implementation of these new regulations.
Insurance
The Company believes that its existing insurance coverage is adequate to protect
it from the risks associated with the ongoing operation of its business. This
coverage includes property and casualty, general liability, workers
compensation, director's and officer's corporate liability, employment practices
liability, excess liability and professional liability insurance for the Company
and for dentists, hygienists and dental assistants at the Offices.
15
Trademark
The Company is the registered owner of the PERFECT TEETH(R) trademark in the
United States.
Facilities and Employees
The Company's corporate headquarters are located at 3801 E. Florida Avenue,
Suite 508, Denver, Colorado, in approximately 9,500 square feet occupied under a
lease, which expires in January 2006. The Company believes that this space is
adequate for its current needs. The Company also leases real estate at the
location of each Office under leases ranging in term from one to 10 years. The
Company believes the facilities at each of its Offices are adequate for their
current level of business. The Company generally anticipates leasing and
developing new Offices in its current markets rather than significantly
expanding the size of its existing Offices.
As of December 31, 2003, the Company had 82 general dentists, 13 specialists and
63 affiliated hygienists that were employed by the P.C.'s, and 329 non-dental
employees.
Company Website
Information related to the following items can be found on the Company's website
at www.bdms-perfectteeth.com: i) Company filings with the Securities and
Exchange Commission, ii) Officers, Directors and ten percent shareholders
filings on Forms 3, 4 and 5, and iii) the Company's Code of Ethics.
ITEM 3. LEGAL PROCEEDINGS.
From time to time the Company is subject to litigation incidental to its
business. Such claims, if successful, could result in damage awards exceeding,
perhaps substantially, applicable insurance coverage. The Company is not
presently a party to any material litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Common Stock is quoted on the Nasdaq SmallCap Market under the symbol
"BDMS". The following table sets forth, for the period indicated, the range of
high and low sales prices per share of Common Stock, as reported on The Nasdaq
SmallCap Market:
HIGH LOW
2002 ------ -------
First Quarter $ 7.55 $ 4.33
Second Quarter 11.85 6.16
Third Quarter 11.50 8.11
Fourth Quarter 11.00 9.02
2003
First Quarter $ 14.86 $ 9.31
Second Quarter 14.69 11.71
Third Quarter 16.80 12.75
Fourth Quarter 14.49 10.00
2004
First Quarter (January 1, 2004
through March 19, 2004) $ 16.50 $ 12.22
At March 19, 2004 the last reported sale price of the Company's Common Stock was
$15.99 per share. As of the same date, there were 1,185,010 shares of Common
Stock outstanding held by 84 holders of record and approximately 522 beneficial
owners.
On March 9, 2004, the Company announced that its Board of Directors had declared
a quarterly cash dividend of $.075 per share of common stock payable April 14,
2004 to shareholders of record March 31, 2004.
17
Equity Compensation Plan Information
The following table sets forth information concerning options, warrants and
rights outstanding and available for granting as of December 31, 2003:
(a) (b) (c)
Number of securities
remaining available for
Number of securities to be Weighted-average exercise future issuance under
issued upon exercise of price of outstanding equity compensation plans
outstanding options, options, warrants and (excluding securities
Plan category warrants and rights rights reflected in column (a))
- ------------------------- ----------------------- ----------------------- -----------------------
Equity compensation plans
approved by security holders 301,998 $8.60 102,077
Equity compensation plans
not approved by security holders - - -
----------- ----------- -----------
Total 301,998 $8.60 102,077
=========== =========== ===========
Options and Warrants are issued for a period of five years and vest 33% each
year for three years, provided however, that upon a sale of the Company, all
Options and Warrants shall automatically become vested.
18
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected consolidated financial and operating
data for the Company. The data for the years ended December 31, 2001, 2002, and
2003 should be read in conjunction with the Company's consolidated financial
statements included elsewhere in this document. The selected consolidated
financial data for the 1999 and 2000 periods are derived from the Company's
historical consolidated financial statements.
A one-for-four split of the Company's stock became effective as of February 26,
2001. As a result, all earnings per share data presented in the following table
has been restated to reflect this reverse stock split.
The data in the following table is in thousands except per share data, number of
offices and number of dentists:
Years Ended December 31,
--------------------------------------------------------
1999 2000 2001 2002 2003
-------- -------- ------- ------- -------
Statements of Operations Data: (1)
Net revenue ................................ $ 28,553 $ 29,419 $ 29,249 $ 30,255 $ 30,295
Direct expenses ............................ 24,425 25,475 25,158 25,105 24,905
Contribution from dental offices ........... 4,128 3,944 4,092 5,150 5,390
Corporate expenses ......................... 4,038 3,747 3,270 3,304 3,292
Operating income ........................... 90 197 822 1,846 2,098
Income (loss) before income taxes .......... (389) (434) 371 1,501 1,945
Income tax (expense) benefit ............... 111 113 (121) (567) (761)
Net income (loss) .......................... (278) (321) 250 934 1,184
Basic earnings per share of Common Stock:
Net income (loss)(2) ....................... (.18) (.21) .17 .63 .91
Diluted earnings per share of Common Stock:
Net income (loss)(2) ....................... (.18) (.21) .16 .58 .83
Balance Sheet Data (3):
Cash and cash equivalents .................. $ 807 $ 691 $ 949 $ 1,073 $ 1,111
Working capital (deficit) .................. 1,467 2,043 301 (1,541) 109
Total assets ............................... 27,949 26,333 24,762 24,230 22,210
Long-term debt, less current maturities .... 6,771 6,682 3,296 1,087 2,736
Total shareholders' equity ................. 16,905 16,471 16,721 16,759 14,411
Dividends declared per share of Common Stock -- -- -- -- --
Operating Data:
Number of offices (3) ...................... 54 56 54 54 54
Number of dentists (3)(4) .................. 90 91 86 90 95
Total net revenue per office ............... $ 529 $ 525 $ 542 $ 560 $ 561
(1) Acquisitions of Offices and development of de novo Offices affect the
comparability of the data. In 1999, the Company acquired one Office,
opened five de novo Offices and consolidated two existing Offices into
one. In 2000, the Company opened two de novo Offices. During 2001, the
Company consolidated four existing Offices into two.
(2) Computed on the basis described in Note 2 of Notes to Consolidated
Financial Statements of the Company. (3) Data is as of the end of the
respective periods presented. (4) This represents the actual number of
dentists employed by the P.C.s and specialists who contract with the
P.C.s to provide specialty dental services.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
General
The following discussion and analysis relates to factors, which have affected
the consolidated results of operations and financial condition of the Company
for the three years ended December 31, 2003. Reference should also be made to
the Company's consolidated financial statements and related notes thereto and
the Selected Financial Data included elsewhere in this document. This document
contains forward-looking statements. Discussions containing such forward-looking
statements may be found in the material set forth below and under Items 1 and 2.
"Business and Properties," Item 5., "Market for the Registrant's Common Equity
and Related Stockholder Matters" as well as in this document generally.
Prospective investors are cautioned that any such forward-looking statements are
not guarantees of future performance and involve risks and uncertainties. Actual
events or results may differ materially from those discussed in the
forward-looking statements as a result of various factors, including, without
limitation the risk factors set forth in this Item 7 under the heading "Risk
Factors."
Overview
The Company was formed in May 1995, and as of December 31, 2003 managed 54
Offices in Colorado, New Mexico, and Arizona staffed by 82 dentists and 13
specialists. The Company has acquired 42 practices (five of which were
consolidated into existing Offices) and opened 18 de novo Offices (one of which
was consolidated into an existing Office). Of the 42 acquired practices, only
three (the first three practices, which were acquired from the Company's
President, Mark Birner, D.D.S.) were acquired from affiliates of the Company.
The Company derives all of its Revenue (as defined below) from its Management
Agreements with the P.C.s. In addition, the Company assumes a number of
responsibilities when it acquires a new practice or develops a de novo Office,
which are set forth in the Management Agreement, as described below. The Company
expects to expand in existing markets primarily by enhancing the operating
performance of its existing Offices, by acquiring dental practices and by
developing de novo Offices. The Company has historically expanded in existing
markets by acquiring solo and group dental practices and may do so in the future
if an economically feasible opportunity presents itself. Generally, the Company
seeks to acquire dental practices for which the Company believes application of
its Dental Practice Management Model will improve operating performance. See
Items 1 and 2. "Business and Properties - Operations - Dental Practice
Management Model."
The Company was formed with the intention of becoming the leading provider of
business services to dental practices in Colorado. The Company's growth and
success in the Colorado market led to its expansion into New Mexico and Arizona
markets. The Company's growth strategy is to focus on greater utilization of
existing physical capacity through recruiting more dentists and support staff
and through selective acquisitions and development of de novo Offices
In 2003 the Company embarked on a strategy to increase revenues. Some of the
initiatives begun were the signing of a lease for a de novo site in the Phoenix
area, negotiating other leases for de novo sites, evaluating potential
acquisitions, expanding the specialty services side of the business,
aggressively recruiting additional dentists and an expanded marketing plan.
The Company has grown primarily through the ongoing development of a dense
dental practice network and the implementation of its dental practice management
model. During the three years ended December 31, 2003, net revenue was $29.2
million in 2001, $30.3 million in 2002, and $30.3 million in 2003. During the
three years ended December 31, 2003, contribution from dental offices increased
from $4.1 million in 2001 to $5.1 million for 2002, and increased to $5.4
million for 2003. During the three years ended December 31, 2003, operating
income increased from $822,000 for 2001 to $1.8 million in 2002 and to $2.1
million in 2003.
20
At December 31, 2003, the Company's total assets of $22.2 million included $14.7
million of identifiable intangible assets related to Management Agreements. At
that date, the Company's total shareholders' equity was $14.4 million. The
Company reviews the recorded amount of intangible assets and other long-lived
assets for impairment for each Office whenever events or changes in
circumstances indicate the carrying amount of the assets may not be recoverable.
If this review indicates that the carrying amount of the assets may not be
recoverable as determined based on the undiscounted cash flows of each Office,
whether acquired or developed, the carrying value of the asset is reduced to
fair value. Among the factors that the Company will continually evaluate are
unfavorable changes in each Office, relative market share and local market
competitive environment, current period and forecasted operating results, cash
flow levels of Offices and the impact on the net revenue earned by the Company,
and the legal and regulatory factors governing the practice of dentistry. As of
December 31, 2003 a review by the Company determined that there was no permanent
impairment of any long-lived or intangible asset at any Office.
Components of Revenue and Expenses
Total dental group practice revenue ("Revenue") represents the revenue of the
Offices, reported at estimated realizable amounts, received from third-party
payors and patients for dental services rendered at the Offices. Net revenue
represents Revenue less amounts retained by the Offices. The amounts retained by
the Offices represent amounts paid as salary, benefits and other payments to
employed dentists and hygienists. The Company's net revenue is dependent on the
Revenue of the Offices. Management service fee revenue represents the net
revenue earned by the Company for the Offices for which the Company has
management agreements, but does not have control. Direct expenses consist of the
expenses incurred by the Company in connection with managing the Offices,
including salaries and benefits (for personnel other than dentists and
hygienists), dental supplies, dental laboratory fees, occupancy costs,
advertising and marketing, depreciation and amortization and general and
administrative (including office supplies, equipment leases, management
information systems and other expenses related to dental practice operations).
The Company also incurs personnel and administrative expenses in connection with
maintaining a corporate function that provides management, administrative,
marketing, development and professional services to the Offices.
Under each of the Management Agreements, the Company manages the business and
marketing aspects of the Offices, including (i) providing capital, (ii)
designing and implementing marketing programs, (iii) negotiating for the
purchase of supplies, (iv) staffing, (v) recruiting, (vi) training of non-dental
personnel, (vii) billing and collecting patient fees, (viii) arranging for
certain legal and accounting services, and (ix) negotiating with managed care
organizations. The P.C. is responsible for, among other things, (i) supervision
of all dentists and dental hygienists, (ii) complying with all laws, rules and
regulations relating to dentists and dental hygienists, and (iii) maintaining
proper patient records. The Company has made, and intends to make in the future,
loans to P.C.s in Colorado, New Mexico and Arizona to fund their acquisition of
dental assets from third parties in order to comply with the laws of such
states.
Under the typical Management Agreement used by the Company, the P.C. pays the
Company a management fee equal to the Adjusted Gross Center Revenue of the P.C.
less compensation paid to the dentists and dental hygienists employed at the
Office of the P.C. Adjusted Gross Center Revenue is comprised of all fees and
charges booked each month by or on behalf of the P.C. as a result of dental
services provided to patients at the Office, less any adjustments for
uncollectible accounts, professional courtesies and other activities that do not
generate a collectible fee. The Company's costs include all direct and indirect
costs, overhead and expenses relating to the Company's provision of management
services at the Office under the Management Agreement, including (i) salaries,
benefits and other direct costs of Company employees who work at the Office,
(ii) direct costs of all Company employees or consultants who provide services
to or in connection with the Office, (iii) utilities, janitorial, laboratory,
supplies, advertising and other expenses incurred by the Company in carrying out
its obligations under the Management Agreement, (iv) depreciation expense
associated with the P.C.'s assets and the assets of the Company used at the
Office, and the amortization of intangible asset value relating to the Office,
(v) interest expense on indebtedness incurred by the Company to finance any of
its obligations under the Management Agreement, (vi) general and malpractice
insurance expenses, lease expenses and dentist recruitment expenses, (vii)
personal property and other taxes assessed against the Company's or the P.C.'s
21
assets used in connection with the operation of the Office, (viii) out-of-pocket
expenses of the Company's personnel related to mergers or acquisitions involving
the P.C., (ix) corporate overhead charges or any other expenses of the Company
including the P.C.'s pro rata share of the expenses of the accounting and
computer services provided by the Company, and (x) a collection reserve in the
amount of 5.0% of Adjusted Gross Center Revenue. As a result, substantially all
costs associated with the provision of dental services at the Office are borne
by the Company, other than the compensation and benefits of the dentists and
hygienists who work at the Offices of the P.C.s. This enables the Company to
manage the profitability of the Offices. Each Management Agreement is for a term
of 40 years. Further, each Management Agreement generally may be terminated by
the P.C. only for cause, which includes a material default by or bankruptcy of
the Company. Upon expiration or termination of a Management Agreement by either
party, the P.C. must satisfy all obligations it has to the Company.
The Company's revenue is derived principally from fee-for-service revenue and
revenue from capitated managed dental care plans. Fee-for-service revenue
consists of P.C. revenue received from indemnity dental plans, preferred
provider plans and direct payments by patients not covered by any third-party
payment arrangement. Managed dental care revenue consists of P.C. revenue
received from capitated managed dental care plans, including capitation payments
and patient co-payments. Capitated managed dental care contracts are between
dental benefits organizations and the P.C.s. Under the Management Agreements,
the Company negotiates and administers these contracts on behalf of the P.C.s.
Under a capitated managed dental care contract, the dental group practice
provides dental services to the members of the dental benefits organization and
receives a fixed monthly capitation payment for each plan member covered for a
specific schedule of services regardless of the quantity or cost of services to
the participating dental group practice obligated to provide them. This
arrangement shifts the risk of utilization of these services to the dental group
practice providing the dental services. Because the Company assumes
responsibility under the Management Agreements for all aspects of the operation
of the dental practices (other than the practice of dentistry) and thus bears
all costs of the P.C.s associated with the provision of dental services at the
Office (other than compensation and benefits of dentists and hygienists), the
risk of over-utilization of dental services at the Office under capitated
managed dental care plans is effectively shifted to the Company. In addition,
dental group practices participating in a capitated managed dental care plan
often receive supplemental payments for more complicated or elective procedures.
In contrast, under traditional indemnity insurance arrangements, the insurance
company pays whatever reasonable charges are billed by the dental group practice
for the dental services provided. See Items 1 and 2. "Business and Properties -
Payor Mix."
The Company seeks to increase its fee-for-service business by increasing the
patient volume of existing Offices through effective marketing and advertising
programs and by opening new Offices. The Company seeks to supplement this
fee-for-service business with Revenue from contracts with capitated managed
dental care plans. Although the Company's fee-for-service business generally
provides a greater margin than its capitated managed dental care business,
capitated managed dental care business serves to increase facility utilization
and dentist productivity. The relative percentage of the Company's Revenue
derived from fee-for-service business and capitated managed dental care
contracts varies from market to market depending on the availability of
capitated managed dental care contracts in any particular market and the
Company's ability to negotiate favorable contractual terms. In addition, the
profitability of managed dental care Revenue varies from market to market
depending on the level of capitation payments and co-payments in proportion to
the level of benefits required to be provided.
Results of Operations
In 2003 the Company embarked on a strategy to increase revenues. Some of the
initiatives begun were the signing of a lease for a de novo site in the Phoenix
area, negotiating other leases for de novo sites, evaluating potential
acquisitions, expanding the specialty services side of the business,
aggressively recruiting additional dentists and an expanded marketing plan. As
these initiatives are continuing, the Company believes that the period-to-period
comparisons set forth below may not be representative of future operating
results.
For the year ended December 31, 2003, Revenue increased to $43.1 million
compared to $42.7 million for the year ended December 31, 2002, an increase of
$441,000 or 1.0%. This was attributable to higher revenues generated in the 54
Offices in existence during both full periods.
22
For the year ended December 31, 2002, Revenue increased to $42.7 million
compared to $41.4 million for the year ended December 31, 2001, an increase of
$1.3 million or 3.1%. This was attributable to higher revenues generated in the
54 Offices in existence during both full periods.
The Company has successfully reduced the percentage of its business which comes
from capitated managed dental care plans from 51.4% of Revenue in 1998 to 31.7%
of Revenue in 2003, and replaced that capitated revenue stream with higher
margin fee-for-service business. This higher margin fee-for-service revenue has
predominately been business derived from preferred provider plans.
The following table sets forth the percentages of Net Revenue represented by
certain items reflected in the Company's Consolidated Statements of Operations.
The information contained in the table represents the historical results of the
Company. The information that follows should be read in conjunction with the
Company's consolidated financial statements and related notes thereto.
Years Ended December 31,
-------------------------------------------------------------------
2001 2002 2003
------------------ ----------------- ----------------
Net revenue 100.0 % 100.0 % 100.0 %
Direct expenses:
Clinical salaries and benefits 40.4 38.3 38.4
Dental supplies 6.0 5.9 5.9
Laboratory fees 8.4 7.8 7.9
Occupancy 11.2 11.3 11.5
Advertising and marketing 1.1 1.2 1.2
Depreciation and amortization 8.4 7.9 7.2
General and administrative 10.5 10.6 10.1
------------------ ----------------- ----------------
86.0 83.0 82.2
------------------ ----------------- ----------------
Contribution from dental offices 14.0 17.0 17.8
Corporate expenses:
General and administrative 10.1 9.8 9.9
Depreciation and amortization 1.1 1.1 1.0
------------------ ----------------- ----------------
Operating income 2.8 6.1 6.9
Interest expense, net 1.5 1.1 0.5
------------------ ----------------- ----------------
Income before income taxes 1.3 5.0 6.4
Income tax expense 0.4 1.9 2.5
------------------ ----------------- ----------------
Net income 0.9 % 3.1 % 3.9 %
================== ================= ================
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Net revenue. Net revenue remained constant at $30.3 million for the years
ended December 31, 2002 and December 31, 2003.
Clinical salaries and benefits. Clinical salaries and benefits remained constant
at $11.6 million for the years ended December 31, 2002 and December 31, 2003. As
a percentage of net revenue, clinical salaries and benefits increased from 38.3%
in 2002 to 38.4% in 2003.
Dental supplies. Dental supplies remained constant at $1.8 million for the years
ended December 31, 2002 and December 31, 2003. As a percentage of net revenue,
dental supplies were 5.9% for both 2002 and 2003.
Laboratory fees. Laboratory fees remained constant at $2.4 million for the years
ended December 31, 2002 and December 31, 2003. As a percentage of net revenue,
laboratory fees increased from 7.8% in 2002 to 7.9% in 2003.
23
Occupancy. Occupancy expenses increased from $3.4 million for the year ended
December 31, 2002 to $3.5 million for the year ended December 31, 2003, an
increase of $80,000 or 2.3%. This increase was due to increased rental payments
resulting from the renewal of Office leases at current market rates for Offices
whose leases expired subsequent to the 2002 period. As a percentage of net
revenue, occupancy expense increased from 11.3% in 2002 to 11.5% in 2003.
Advertising and marketing. Advertising and marketing increased from $353,000 for
the year ended December 31, 2002 to $362,000 for the year ended December 31,
2003, an increase of $9,000 or 2.5%. This increase was primarily due to
additional yellow page advertising in local directories. As a percentage of net
revenue, advertising and marketing was 1.2% for both 2002 and 2003.
Depreciation and amortization. Depreciation and amortization, which consists of
depreciation and amortization expense incurred at the Offices, decreased from
$2.4 million for the year ended December 31, 2002 to $2.2 million for the year
ended December 31, 2003, a decrease of $217,000 or 9.1%. This decrease was a
result of older assets becoming fully depreciated somewhat offset by the
addition of new depreciable assets being purchased. As a percentage of net
revenue, depreciation and amortization decreased from 7.9% in 2002 to 7.2% in
2003.
General and administrative. General and administrative costs which are
attributable to the Offices, decreased from $3.2 million for the year ended
December 31, 2002 to $3.1 million for the year ended December 31, 2003, a
decrease of $123,000 or 3.9%. This decrease was the result of lower expenses for
office supplies, which includes the cost of the data telecommunication network
between the individual Offices and the Corporate Office as well as lower gross
receipt taxes paid in New Mexico. As a percentage of net revenue, general and
administrative expenses decreased from 10.6% in 2002 to 10.1% in 2003.
Contribution from dental offices. As a result of the above, contribution from
dental offices increased from $5.1 million for the year ended December 31, 2002
to $5.4 million for the year ended December 31, 2003, an increase of $240,000 or
4.7%. As a percentage of net revenue, contribution from dental offices increased
from 17.0% in 2002 to 17.8% in 2003.
Corporate expenses - general and administrative. Corporate expenses - general
and administrative remained constant at $3.0 million for the years ended
December 31, 2002 and December 31, 2003. As a percentage of net revenue,
corporate expense - general and administrative increased from 9.8% in 2002 to
9.9% in 2003.
Corporate expenses - depreciation and amortization. Corporate expenses -
depreciation and amortization decreased from $327,000 for the year ended
December 31, 2002 to $292,000 for the year ended December 31, 2003, a decrease
of $35,000 or 10.7%. This decrease was a result of older assets becoming fully
depreciated somewhat offset by the addition of new depreciable assets. As a
percentage of net revenue, corporate expenses - depreciation and amortization
decreased from 1.1% in 2002 to 1.0% in 2003.
Operating income. As a result of the above, operating income increased from $1.8
million for the year ended December 31, 2002 to $2.1 million for the year ended
December 31, 2003, an increase of $252,000 or 13.7%. As a percentage of net
revenue, operating income increased from 6.1% in 2002 to 6.9% in 2003.
Interest expense, net. Interest expense, net decreased from $345,000 for the
year ended December 31, 2002 to $153,000 for the year ended December 31, 2003, a
decrease of $191,000 or 55.5%. This decrease was primarily the result of a lower
average interest rate and a lower average outstanding debt balance during 2003,
lower amortization during 2003 of loan acquisition costs and higher interest
income which is the result of the Company implementing, during 2003, a late
charge on accounts receivable. As a percentage of net revenue, interest expense,
net decreased from 1.1% in 2002 to 0.5% in 2003.
Net income. As a result of the above, the Company reported net income of $1.2
million for the year ended December 31, 2003 compared to net income of $934,000
for the year ended December 31, 2002, an increase of $250,000 or 26.8%. As a
percentage of net revenue, net income increased from 3.1% in 2002 to 3.9% in
24
2003. Net income for the year ended December 31, 2003 was net of income tax
expense of $761,000 while net income for the year ended December 31, 2002 was
net of income tax expense of $567,000.
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Net revenue. Net revenue increased from $29.2 million for the year ended
December 31, 2001 to $30.3 million for the year ended December 31, 2002, an
increase of $1.0 million or 3.4%. The increase in net revenue was attributable
to the 54 practices in existence during both full periods.
Clinical salaries and benefits. Clinical salaries and benefits decreased from
$11.8 million for the year ended December 31, 2001 to $11.6 million for the year
ended December 31, 2002, a decrease of $205,000 or 1.7%. This decrease was due
primarily to attrition of support staff at the Offices that began in the second
quarter of 2001 and continued into the third quarter of 2002 as well as a wage
freeze that was implemented during 2001 and continued through 2002. As a
percentage of net revenue, clinical salaries and benefits decreased from 40.4%
in 2001 to 38.3% in 2002.
Dental supplies. Dental supplies remained constant at $1.8 million for the years
ended December 31, 2001 and December 31, 2002. As a percentage of net revenue,
dental supplies decreased from 6.0% in 2001 to 5.9% in 2002.
Laboratory fees. Laboratory fees decreased from $2.5 million for the year ended
December 31, 2001 to $2.4 million for the year ended December 31, 2002, a
decrease of $104,000 or 4.2%. This decrease was primarily due to the Company's
efforts to consolidate the use of dental laboratories so that improved pricing
could be obtained based upon the Company's laboratory case volume. As a
percentage of net revenue, laboratory fees decreased from 8.4% in 2001 to 7.8%
in 2002.
Occupancy. Occupancy increased from $3.3 million for the year ended December 31,
2001 to $3.4 million for the year ended December 31, 2002, an increase of
$127,000 or 3.9%. This increase was due to increased rental payments resulting
from the renewal of Office leases at current market rates for Offices whose
leases expired subsequent to the 2001 period. As a percentage of net revenue,
occupancy expense increased from 11.2% in 2001 to 11.3% in 2002.
Advertising and marketing. Advertising and marketing increased from $315,000 for
the year ended December 31, 2001 to $353,000 for the year ended December 31,
2002, an increase of $38,000 or 12.0%. This increase was primarily due to
additional yellow page advertising in local directories. As a percentage of net
revenue, advertising and marketing increased from 1.1% in 2001 to 1.2% in 2002.
Depreciation and amortization. Depreciation and amortization, which consists of
depreciation and amortization expense incurred at the Offices, decreased from
$2.5 million for the year ended December 31, 2001 to $2.4 million for the year
ended December 31, 2002, a decrease of $73,000 or 3.0%. This decrease is related
to the decrease in the Company's depreciable asset base. As a percentage of net
revenue, depreciation and amortization decreased from 8.4% in 2001 to 7.9% in
2002.
General and administrative. General and administrative costs which are
attributable to the Offices, increased from $3.1 million for the year ended
December 31, 2001 to $3.2 million for the year ended December 31, 2002, an
increase of $132,000 or 4.3%. This increase was the result of higher expenses
for office supplies and computer supplies, which includes the cost of the data
network between the individual Offices and the Corporate Office. As a percentage
of net revenue, general and administrative expenses increased from 10.5% in 2001
to 10.6% in 2002.
Contribution from dental offices. As a result of the above, contribution from
dental offices increased from $4.1 million for the year ended December 31, 2001
to $5.1 million for the year ended December 31, 2002, an increase of $1.1
million or 25.9%. As a percentage of net revenue, contribution from dental
offices increased from 14.0% in 2001 to 17.0% in 2002.
25
Corporate expenses - general and administrative. Corporate expenses - general
and administrative increased from $2.9 million for the year ended December 31,
2001 to $3.0 million for the year ended December 31, 2002, an increase of
$29,000 or 1.0%. As a percentage of net revenue, corporate expense - general and
administrative decreased from 10.1% in 2001 to 9.8% in 2002.
Corporate expenses - depreciation and amortization. Corporate expenses -
depreciation and amortization increased from $322,000 for the year ended
December 31, 2001 to $327,000 for the year ended December 31, 2002, an increase
of $5,000 or 1.6%. This increase was a result of higher depreciation expense as
a result of the development of computer software relating to the implementation
of the Perfect Teeth Dental Plan which began in 2001. As a percentage of net
revenue, corporate expenses - depreciation and amortization remained constant at
1.1% from 2001 to 2002.
Operating income. As a result of the above, operating income increased from
$822,000 for the year ended December 31, 2001 to $1.8 million for the year ended
December 31, 2002, an increase of $1.0 million or 124.6%. As a percentage of net
revenue, operating income increased from 2.8% in 2001 to 6.1% in 2002.
Interest expense, net. Interest expense, net decreased from $451,000 for the
year ended December 31, 2001 to $345,000 for the year ended December 31, 2002, a
decrease of $106,000 or 23.5%. This decrease was primarily the result of a lower
average interest rate and a lower average outstanding debt balance during 2002.
As a percentage of net revenue, interest expense, net decreased from 1.5% in
2001 to 1.1% in 2002.
Net income. As a result of the above, the Company reported net income of
$934,000 for the year ended December 31, 2002 compared to net income of $250,000
for the year ended December 31, 2001, an increase of $684,000 or 273.6%. As a
percentage of net revenue, net income increased from 0.9% in 2001 to 3.1% in
2002. Net income for the year ended December 31, 2002 was net of income tax
expense of $567,000 while net income for the year ended December 31, 2001 was
net of income tax expense of $121,000.
Critical Accounting Policies
The Company's financial statements have been prepared in accordance with
accounting principles generally accepted in the United States, which require the
Company to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and the related disclosures. A
summary of those significant accounting policies can be found in the Company's
Notes to Consolidated Financial Statements. The estimates used by management are
based upon the Company's historical experiences combined with management's
understanding of current facts and circumstances. Certain of the Company's
accounting policies are considered critical as they are both important to the
portrayal of the Company's financial condition and the results of its operations
and require significant or complex judgments on the part of management.
Management has not determined how reported amounts would differ based on the
application of different accounting policies. Management has also not determined
the likelihood that materially different amounts could be reported under
different conditions or using different assumptions. Management believes that
the following represent the critical accounting policies of the Company as
described in Financial Reporting Release No. 60, "Cautionary Advice Regarding
Disclosure About Critical Accounting Policies", which was issued by the
Securities and Exchange Commission: Impairment of intangible and long-lived
assets, allowance for doubtful accounts and deferred income taxes.
The Company's dental practice acquisitions involve the purchase of tangible and
intangible assets and the assumption of certain liabilities of the acquired
Offices. As part of the purchase price allocation, the Company allocates the
purchase price to the tangible and intangible assets acquired and liabilities
assumed, based on estimated fair market values. Costs of acquisition in excess
of the net estimated fair value of tangible assets acquired and liabilities
assumed are allocated to the Management Agreement. The Management Agreement
represents the Company's right to manage the Offices during the 40-year term of
the agreement. The assigned value of the Management Agreement is amortized using
the straight-line method over a period of 25 years. In the event that facts and
26
circumstances indicate that the carrying value of long-lived and intangible
assets may be impaired, an evaluation of recoverability would be performed. If
this evaluation indicates that the carrying amount of the assets may not be
recoverable as determined based on the undiscounted cash flows of each Office,
whether acquired or developed, the carrying value of the asset is reduced to
fair value. Among the factors that the Company will continually evaluate are
unfavorable changes in each Office, relative market share and local market
competitive environment, current period and forecasted operating results, cash
flow levels of Offices and the impact on the net revenue earned by the Company,
and the legal and regulatory factors governing the practice of dentistry.
The Company's allowance for doubtful accounts reflects a reserve that reduces
customer accounts receivable to the net amount estimated to be collectible.
Estimating the credit worthiness of customers and the recoverability of customer
accounts requires management to exercise considerable judgment. In estimating
uncollectible amounts, management considers factors such as general economic and
industry-specific conditions, historical customer performance and anticipated
customer performance. While management considers the Company's processes to be
adequate to effectively quantify its exposure to doubtful accounts, changes in
economic, industry or specific customer conditions may require the Company to
adjust its allowance for doubtful accounts.
Deferred income taxes are recognized for the expected tax consequences in future
years for differences between the tax bases of assets and liabilities and their
financial reporting amounts, based upon enacted tax laws and statutory tax rates
applicable to the periods in which the differences are expected to affect
taxable income. The Company's significant deferred tax assets are related to:
Accruals not currently deductible, allowance for doubtful accounts, AMT tax
credit carry-forward and depreciation expense for tax which is less than
depreciation expense for books. The Company has not established a valuation
allowance to reduce deferred tax assets as the Company expects to fully recover
these amounts in future periods. The Company's significant deferred tax
liability is the result of intangible asset amortization expense for tax being
greater than the intangible asset amortization expense for books. Management
reviews and adjusts those estimates annually based upon the most current
information available. However, because the recoverability of deferred taxes are
directly dependent upon the future operating results of the Company, actual
recoverability of deferred taxes may differ materially from management's
estimates.
Liquidity and Capital Resources
The Company finances its operations and growth through a combination of cash
provided by operating activities, a bank line of credit (the "Credit Facility")
and, from time to time, seller notes.
Net cash provided by operating activities was $4.0 million, $5.0 million, and
$4.2 million for the years ended December 31, 2001, 2002 and 2003, respectively.
During the year ended December 31, 2003, the Company's cash provided by
operating activities, excluding net income and non-cash items, consisted
primarily of an increase in deferred income taxes of approximately $325,000 and
an increase in income taxes payable of approximately $161,000. During the year
ended December 31, 2002, the Company's cash provided by operating activities
excluding net income and non-cash items, consisted primarily of an increase in
accounts payable and accrued expenses of approximately $738,000 and a decrease
in accounts receivable of approximately $367,000. During the year ended December
31, 2001 the Company's cash provided by operating activities, excluding net
income and non-cash items, consisted primarily of a decrease in accounts
receivable of approximately $784,000, an increase in accounts payable and
accrued expenses of approximately $294,000 offset, in part, by an increase in
prepaid expenses of approximately $289,000.
Net cash used in investing activities was $1.1 million, $1.4 million, and
$465,000 for the years ended December 31, 2001, 2002 and 2003, respectively.
During the year ended December 31, 2003, $465,000 was invested in the purchase
of additional property and equipment. During the year ended December 31, 2002,
$514,000 was invested in the purchase of additional property and equipment and
$1.2 million was used for acquiring the remaining 50% interest in two existing
Offices. This was partially offset by the repayment of $284,000 in notes
receivable from related parties. During the year ended December 31, 2001,
$547,000 was invested in the purchase of additional property and equipment and
$435,000 was used for acquiring the remaining 50% interest in one existing
Office.
27
For the years ended December 31, 2001, 2002 and 2003 net cash used in financing
activities was $2.7 million, $3.4 million and $3.7 million, respectively. For
the year ended December 31, 2003, net cash used in financing activities was
comprised of $1.8 million for the pay-down on the bank term-loan, $345,000 for
the repayment of long-term debt and $3.9 million for the purchase and retirement
of common stock. This was partially offset by $2.0 million in advances from the
line of credit, $224,000 of proceeds from the exercise of Common Stock options
and $158,000 from the tax benefit of Common Stock options exercised. For the
year ended December 31, 2002, net cash used in financing activities was
comprised of $2.1 million for the pay-down on the bank term-loan, $168,000 for
the pay-down on the Company's line of credit, $312,000 for the repayment of
long-term debt and $1.2 million for the purchase and retirement of common stock.
This was partially offset by $111,000 of proceeds from the exercise of Common
Stock options and $95,000 from the tax benefit of Common Stock options
exercised. For the year ended December 31, 2001, net cash used in financing
activities was comprised of $2.4 million for the pay-down on the Company's line
of credit, $203,000 for the repayment of long-term debt and $67,000 for the
payment of financing costs.
On August 7, 2003 the Company's current Credit Facility Agreement was amended.
The new Credit Facility allows the Company to borrow, on a revolving basis, an
aggregate principal amount not to exceed $4.0 million at either, or a
combination of, the Lender's Base Rate plus a Base Rate Margin or at a LIBOR
rate plus a LIBOR Rate Margin, at the Company's option. The Lender's Base Rate
computes interest at the higher of the Lender's "prime rate" plus a Base Rate
Margin of one-half percent (0.5%) or the Federal Funds Rate plus one-half
percent (0.5%), plus a Base Rate Margin of one-half percent (0.5%). The LIBOR
option computes interest at the LIBOR Rate as of the date such LIBOR rate Loan
was made plus a LIBOR Rate Margin of 2.0%. A commitment fee of 0.25% on the
average daily unused amount of the Revolving Loan commitment during the
preceding quarter will also be assessed. The Company may prepay any Base Rate
Loan at any time and any LIBOR Rate Loan upon not less than three business days
prior written notice given to the Lender, but the Company will be responsible
for any loss or cost incurred by the Lender in liquidating or employing deposits
required to fund or maintain the LIBOR rate Loan. The amended Credit Facility
expires on May 31, 2005. At December 31, 2003, the Company had $2.0 million
outstanding and $2.0 million available for borrowing under the revolving loan.
This consisted of $600,000 outstanding under the Base Rate Option and $1.4
million outstanding under the LIBOR Rate option. The Credit Facility requires
the Company to maintain certain financial ratios on an ongoing basis. At
December 31, 2003 the Company was in full compliance with all of its covenants
under this agreement.
As of December 31, 2003, the Company had approximately $1.1 million in notes
payable issued in connection with various Office acquisitions, which bear
interest at 8.0%. At December 31, 2003, the Company's material commitments for
capital expenditures totaled approximately $400,000, which includes the
development of two de novo offices. The Company anticipates that these capital
expenditures will be funded by cash on hand, cash generated by operations, or
borrowings under the Company's Credit Facility. The Company's retained earnings
as of December 31, 2003 were approximately $2.0 million and the Company had
working capital on that date of approximately $109,000. The Company's earnings
before interest, taxes, depreciation and amortization ("EBITDA") remained
constant at $4.6 million for the twelve months ended December 31, 2003 compared
to the same twelve-month period in 2002. During the 2003 fiscal year, the
Company purchased approximately $3.9 million of treasury stock while total bank
debt increased only $175,000.
As of December 31, 2003, the Company had the following known contractual
obligations:
Payments due by Period
--------------------------------------------------------------------------------
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
--------------------- -------------- -------------- ------------- --------------
Long-Term Debt Obligations ................ 3,087,422 351,846 2,658,646 76,930 -
Operating Lease Obligations ............... 6,934,636 2,137,710 3,273,768 1,523,158 -
Other Long-Term Liabilities Reflected on
the Balance Sheet Under GAAP of the
financial statements .................... 173,505 6,424 99,109
65,572 2,400
--------------------- -------------- -------------- ------------- --------------
Total 10,195,563 2,495,980 6,031,523 1,665,660 2,400
28
On March 9, 2004, the Company announced the beginning of a quarterly cash
dividend, the first of which will be $.075 per share of Common Stock to be paid
April 14, 2004 to shareholders of record March 31, 2004.
The Company believes that cash generated from operations will be sufficient to
fund its anticipated working capital needs, capital expenditures and dividend
payments for at least the next 12 months. In order to meet its long-term
liquidity needs the Company may need to issue additional equity and debt
securities, subject to market and other conditions. There can be no assurance
that such additional financing will be available on terms acceptable to the
Company. The failure to raise the funds necessary to finance its future cash
requirements could adversely affect the Company's ability to pursue its strategy
and could negatively affect its operations in future periods. See "Risk Factors
- - Need for Additional Capital; Uncertainty of Additional Financing" in this Item
7.
The Company from time to time may purchase its Common Stock on the open market
for treasury stock. On May 8, 2002 the Company's Board of Directors unanimously
approved the purchase of shares of the Company's Common Stock on the open market
up to $1.0 million. On October 24, 2002 the Company's Board of Directors
unanimously approved an incremental increase of $500,000 in the amount that
could be used to purchase shares of the Company's Common Stock on the open
market to $1.5 million. On February 19, 2003 the Company's Board of Directors
unanimously approved an increase, to $2.4 million from $1.5 million, in the
amount that could be used to purchase shares of the Company's Common Stock on
the open market. On May 6, 2003 the Company's Board of Directors unanimously
approved an incremental increase of $1.0 million in the amount that could be
used to purchase shares of the Company's Common Stock on the open market at
prices up to $14.00 per share. On July 15, 2003, the Company's Board of
Directors approved the purchase of 83,975 shares of the company's Common Stock
from a private shareholder of the Company, at an aggregate cost of $1,154,656.
As a condition of this purchase, the Company and the private shareholder have
entered into a stock repurchase agreement whereby the private shareholder and
his affiliated companies, among other items, agree that for a period of two
years from July 16, 2003 will not: 1) acquire, directly or indirectly, any
voting securities of the Company; 2) solicit proxies with respect to the
Company's voting securities under any circumstances; and 3) take any action or
assist in any manner, directly or indirectly, to influence or affect control of
the Company. During 2002, the Company, in 93 separate transactions, purchased
117,236 shares of its Common Stock for total consideration of approximately $1.2
million at prices ranging from $7.35 to $11.25 per share, of which approximately
$60,000 was recorded as compensation expense in accordance with Financial
Accounting Standards Board Interpretation Number 44. During 2003, the Company,
in 84 separate transactions, purchased 296,195 shares of its Common Stock for
total consideration of approximately $3.9 million at prices ranging from $9.54
to $14.20 per share.
Recent Accounting Pronouncements
In May 2003, the FASB issued Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity ("SFAS 150").
SFAS 150 requires that three classes of freestanding financial statements that
embody obligations for entities be classified as liabilities. Generally, SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003 and is otherwise effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of SFAS 150 did not have a material
impact on its financial position or results of operations.
The FASB issued Interpretation ("FIN") No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, in November 2002 and FIN No. 46, Consolidation of
Variable Interest Entities, in January 2003. FIN No. 45 is applicable on a
prospective basis for initial recognition and measurement provisions to
guarantees issued after December 2002; however, disclosure requirements are
effective immediately. FIN No. 45 requires a guarantor to recognize, at the
inception of a guarantee, a liability for the fair value of the obligations
undertaken in issuing the guarantee and expands the required disclosures to be
made by the guarantor about its obligation under certain guarantees that it has
issued. The adoption of FIN No. 45 did not have a material impact on the
Company's financial position or results of operations. FIN No. 46 requires that
a company that controls another entity through interest other than voting
interest should consolidate such controlled entity in all cases for interim
periods beginning after June 15, 2003. The adoption of FIN No. 46 did not have a
material impact on its financial position or results of operations.
29
Risk Factors
This Annual Report contains forward-looking statements. Discussions containing
such forward-looking statements may be found in the material set forth in this
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations," Items 1 and 2. "Business and Properties" and Item 5. "Market for
the Registrant's Common Equity and Related Stockholder Matters," as well as in
this Annual Report generally. Investors are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties. Actual events or results may differ materially from
those discussed in the forward-looking statements as a result of various
factors, including, without limitation, the risk factors set forth below and the
matters set forth in this Annual Report generally.
Demands on Management. The Company's ability to compete effectively will depend
upon its ability to hire, train and assimilate additional management and other
employees, and its ability to expand, improve and effectively utilize its
operating, management, marketing and financial systems to accommodate its
expanded operations. Any failure by the Company's management to effectively
anticipate, implement and manage the changes required to sustain the Company's
growth may have a material adverse effect on the Company's business, financial
condition and operating results. See Items 1 and 2. "Business and Properties -
Expansion Program."
Dependence Upon Availability of Dentists and Other Personnel. The Company
believes that the profitability and operations of its Offices and its expansion
strategy are dependent on the availability and successful recruitment and
retention of dentists, dental assistants, hygienists, specialists and other
personnel. The Company may not be able to recruit or retain dentists and other
personnel for its existing and newly established Offices, which may have a
material adverse effect on the Company's expansion strategy and its business,
financial condition and operating results. See Items 1 and 2. "Business and
Properties - Operations - Dental Practice Model."
Dependence on Management Agreements, the P.C.s and Affiliated Dentists. The
Company receives management fees for services provided to the P.C.s under
Management Agreements. The Company owns most of the non-dental operating assets
of the Offices but does not employ or contract with dentists, employ hygienists
or control the provision of dental care. The Company's revenue is dependent on
the revenue generated by the P.C.s. Therefore, effective and continued
performance of dentists providing services for the P.C.s is essential to the
Company's long-term success. Under each Management Agreement, the Company pays
substantially all of the operating and non-operating expenses associated with
the provision of dental services except for the salaries and benefits of the
dentists and hygienists and principal and interest payments of loans made to the
P.C. by the Company. Any material loss of revenue by the P.C.s would have a
material adverse effect on the Company's business, financial condition and
operating results, and any termination of a Management Agreement (which is
permitted in the event of a material default or bankruptcy by either party)
could have such an effect. In the event of a breach of a Management Agreement by
a P.C., there can be no assurance that the legal remedies available to the
Company will be adequate to compensate the Company for its damages resulting
from such breach. See Items 1 and 2. "Business and Properties - Affiliation
Model."
Risks Associated with De Novo Office Development. The Company utilizes internal
and external resources to identify locations in suitable markets for the
development of de novo Offices. Identifying locations in suitable geographic
markets and negotiating leases can be a lengthy and costly process. Furthermore,
the Company will need to provide each new Office with the appropriate equipment,
furnishings, materials and supplies. To date, the Company's average cost to open
a de novo Office has been approximately $194,000. Future de novo Office
development may require a greater investment by the Company. Additionally, new
Offices must be staffed with one