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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
 
(Mark One)

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended 
September 30, 2012

OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from 
 
to  

Commission file number 0-23367

BIRNER DENTAL MANAGEMENT
SERVICES, INC.
(Exact name of registrant as specified in its charter)
 
COLORADO
 
84-1307044
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
 
1777 S. HARRISON STREET, SUITE 1400
DENVER, COLORADO
 
 
80210
(Address of principal executive offices)
 
(Zip Code)

(303) 691-0680
(Registrant’s telephone number, including area code)
 
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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer  o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company x
   
(Do not check if a smaller reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  o  No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Shares Outstanding as of November 5, 2012
Common Stock, no par value
 
1,842,402



 
 

 

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
 
PART I - FINANCIAL INFORMATION

Item 1.   Financial Statements
Page
     
 
3
     
 
4
     
 
5
     
 
5
     
 
6
     
 
8
     
Item 2.
14
     
Item 4.
23
     
PART II - OTHER INFORMATION  
     
Item 2.
24
     
Item 6.
25
     
Signatures
26

 
2

 
PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
(UNAUDITED)

   
December 31,
   
September 30,
 
ASSETS
 
2011
   
2012
 
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 923,878     $ 502,407  
Accounts receivable, net of allowance for doubtful accounts of $302,000 and $314,000, respectively
    2,855,726       3,046,507  
Deferred tax asset
    197,327       197,327  
Prepaid expenses and other assets
    639,116       669,146  
                 
Total current assets
    4,616,047       4,415,387  
                 
PROPERTY AND EQUIPMENT, net
    5,789,521       7,343,237  
                 
OTHER NONCURRENT ASSETS:
               
Intangible assets, net
    11,095,926       10,418,631  
Deferred charges and other assets
    165,267       159,441  
Notes receivable
    155,419       132,318  
                 
Total assets
  $ 21,822,180     $ 22,469,014  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
                 
CURRENT LIABILITIES:
               
Accounts payable
  $ 2,111,155     $ 2,011,963  
Accrued expenses
    1,973,593       1,742,338  
Accrued payroll and related expenses
    1,731,273       2,129,467  
Income taxes payable
    115,038       250,582  
Current maturities of long-term debt
    -       400,000  
                 
Total current liabilities
    5,931,059       6,534,350  
                 
LONG-TERM LIABILITIES:
               
Deferred tax liability, net
    2,309,279       2,309,279  
Long-term debt, net of current maturities
    4,251,068       4,835,158  
Other long-term obligations
    1,504,684       1,496,253  
                 
Total liabilities
    13,996,090       15,175,040  
                 
SHAREHOLDERS' EQUITY:
               
Preferred Stock, no par value, 10,000,000 shares authorized; none outstanding
    -       -  
Common Stock, no par value, 20,000,000 shares authorized;1,837,519 and 1,842,402 shares issued and outstanding, respectively
    368,186       219,074  
Retained earnings
    7,457,904       7,074,900  
                 
Total shareholders' equity
    7,826,090       7,293,974  
                 
Total liabilities and shareholders' equity
  $ 21,822,180     $ 22,469,014  

The accompanying notes are an integral part of these financial statements.
 
 
3


BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
(UNAUDITED)

   
Quarters Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2012
   
2011
   
2012
 
                         
REVENUE:
  $ 15,492,724     $ 15,709,423     $ 48,984,473     $ 47,684,538  
                                 
DIRECT EXPENSES:
                               
Clinical salaries and benefits
    8,767,612       8,823,264       27,716,934       26,912,387  
Dental supplies
    658,705       689,283       2,157,987       2,078,765  
Laboratory fees
    679,304       751,534       2,188,635       2,303,063  
Occupancy
    1,381,849       1,401,550       4,060,977       4,137,110  
Advertising and marketing
    758,776       353,004       1,944,036       1,730,667  
Depreciation and amortization
    633,200       725,719       1,860,980       2,060,675  
General and administrative
    1,364,070       1,249,314       4,398,635       3,694,149  
      14,243,516       13,993,668       44,328,184       42,916,816  
                                 
Contribution from dental offices
    1,249,208       1,715,755       4,656,289       4,767,722  
                                 
CORPORATE EXPENSES:
                               
General and administrative
    580,564 (1)     1,018,319 (1)     2,658,299 (2)     3,205,073 (2)
Depreciation and amortization
    35,575       41,308       86,578       118,467  
                                 
OPERATING INCOME
    633,069       656,128       1,911,412       1,444,182  
Interest expense, net
    19,883       28,018       66,178       76,796  
                                 
INCOME BEFORE INCOME TAXES
    613,186       628,110       1,845,234       1,367,386  
Income tax expense
    239,141       244,963       719,641       533,281  
                                 
NET INCOME
  $ 374,045     $ 383,147     $ 1,125,593     $ 834,105  
                                 
Net income per share of Common Stock - Basic
  $ 0.20     $ 0.21     $ 0.61     $ 0.45  
                                 
Net income per share of Common Stock - Diluted
  $ 0.20     $ 0.21     $ 0.59     $ 0.45  
                                 
Cash dividends per share of Common Stock
  $ 0.22     $ 0.22     $ 0.64     $ 0.66  
                                 
Weighted average number of shares of Common Stock and dilutive securities:
                               
Basic
    1,859,362       1,841,817       1,855,984       1,839,788  
                                 
Diluted
    1,914,075       1,851,445       1,917,594       1,849,842  

(1)
Corporate expense - general and administrative includes $104,759 of stock-based compensation expense pursuant to ASC Topic 718 and ($162,828) related to a long-term incentive program for the quarter ended September 30, 2011 and  $127,621 of stock-based compensation expense pursuant to ASC Topic 718 for the quarter ended September 30, 2012.
(2)
Corporate expense - general and administrative includes $238,415 of stock-based compensation expense pursuant to ASC Topic 718 for the nine months ended September 30, 2011 and  $472,585 of stock-based compensation expense pursuant to ASC Topic 718 for the nine months ended September 30, 2012.

The accompanying notes are an integral part of these financial statements.
 
 
4


BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
(UNAUDITED)

   
Common Stock
             
               
Retained
   
Shareholders'
 
   
Shares
   
Amount
    Earnings     Equity  
               
 
       
BALANCES, December 31, 2011
    1,837,519     $ 368,186     $ 7,457,904     $ 7,826,090  
Common Stock options exercised
    7,790       -       -       -  
Purchase and retirement of Common Stock
    (37,787 )     (621,697 )     -       (621,697 )
LTIP restricted stock units issued
    34,880       -       -       -  
Dividends declared on Common Stock
    -       -       (1,217,109 )     (1,217,109 )
Stock-based compensation expense
    -       472,585       -       472,585  
Net income, nine months ended September 30, 2012
    -       -       834,105       834,105  
                                 
BALANCES, September 30, 2012
    1,842,402     $ 219,074     $ 7,074,900     $ 7,293,974  
 
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)

   
2011
   
2012
 
Net income
  $ 1,125,593       834,105  
Other comprehensive income
    5,150       -  
                 
Comprehensive income
  $ 1,130,743     $ 834,105  

The accompanying notes are an integral part of these financial statements.
 
 
5

 
BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
(UNAUDITED)

   
Nine Months Ended
 
   
September 30,
 
   
2011
   
2012
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 1,125,593     $ 834,105  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    1,947,558       2,179,142  
Stock-based compensation expense
    238,415       472,585  
Provision for doubtful accounts
    451,739       422,261  
Discontinued operations costs
    (50,207 )     -  
Changes in assets and liabilities net of effects from acquisitions:
               
Accounts receivable
    (260,684 )     (613,042 )
Prepaid expenses and other assets
    (75,085 )     (30,030 )
Deferred charges and other assets
    14,151       5,826  
Accounts payable
    266       (99,192 )
Accrued expenses
    (459,904 )     (230,445 )
Accrued payroll and related expenses
    205,037       398,194  
Income taxes payable
    1,289,385       135,544  
Other long-term obligations
    89,987       (8,431 )
Net cash provided by operating activities
    4,516,251       3,466,517  
                 
CASH FLOWS USED IN INVESTING ACTIVITIES:
               
Capital expenditures
    (2,295,029 )     (3,055,563 )
Notes receivable - related parties, net
    12,014       23,101  
Net cash used in investing activities
    (2,283,015 )     (3,032,462 )
                 
CASH FLOWS USED IN FINANCING ACTIVITIES:
               
Advances – line of credit
    12,045,890       15,414,758  
Repayments – line of credit
    (12,214,867 )     (16,430,668 )
Advances – term loan
    -       2,000,000  
Repayments – term loan
    (460,000 )     -  
Purchase and retirement of Common Stock
    (295,618 )     (621,697 )
Common Stock cash dividends
    (1,149,823 )     (1,217,919 )
Net cash used in financing activities
    (2,074,418 )     (855,526 )
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    158,818       (421,471 )
CASH AND CASH EQUIVALENTS, beginning of period
    406,208       923,878  
CASH AND CASH EQUIVALENTS, end of period
  $ 565,026     $ 502,407  

The accompanying notes are an integral part of these financial statements.
 
 
6

 
BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

   
Nine Months Ended
 
   
September 30,
 
   
2011
   
2012
 
             
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
           
             
Cash paid for interest
  $ 95,529     $ 77,831  
Cash paid for income taxes
  $ 61,896     $ 397,737  
Cash received for income taxes
  $ 631,640     $ -  
                 
NON-CASH ITEM:
               
                 
Gain recognized on interest rate swap (net of taxes)
  $ 5,150     $ -  

The accompanying notes are an integral part of these financial statements.
 
 
7

 
BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
September 30, 2012

(1)
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The condensed consolidated financial statements included herein are unaudited and have been prepared by Birner Dental Management Services, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures included herein are adequate to make the information presented not misleading. A description of the Company’s accounting policies and other financial information is included in the audited consolidated financial statements as filed with the SEC in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company as of September 30, 2012 and the results of operations and cash flows for the periods presented.  All such adjustments are of a normal recurring nature.  The results of operations for the quarter and nine months ended September 30, 2012 are not necessarily indicative of the results that may be achieved for a full fiscal year and cannot be used to indicate financial performance for the entire year.
 
(2)
SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation/Basis of Consolidation

The accompanying condensed consolidated financial statements have been prepared on the accrual basis of accounting. These financial statements present the financial position and results of operations of the Company and the dental offices (“Offices”), which are under the control of the Company.  The Offices are organized as professional corporations (“P.C.s”) and the Company provides business services to the Offices under long-term management agreements (the “Management Agreements”).  All intercompany accounts and transactions have been eliminated in the consolidation.

The Company treats Offices as consolidated subsidiaries where it has a long-term and unilateral controlling financial interest over the assets and operations of the Offices. The Company maintains control of substantially all of its Offices via the Management Agreements. The Company is a business service organization and does not engage in the practice of dentistry or the provision of dental hygiene services. These services are provided by licensed professionals. Certain key features of these arrangements either enable the Company at any time and in its sole discretion to cause a change in the shareholder of the P.C. (i.e., ''nominee shareholder'') or allow the Company to vote the shares of stock held by the owner of the P.C. and to elect a majority of the board of directors of the P.C.  The accompanying condensed consolidated statements of income reflect revenue, which is the amount billed to patients less contractual adjustments. Direct expenses consist of all the expenses incurred in operating the Offices and paid by the Company.  Under the Management Agreements, the Company assumes responsibility for the management of most aspects of the Offices' business (the Company does not engage in the practice of dentistry or the provision of dental hygiene services), including personnel recruitment and training; comprehensive administrative, business and marketing support and advice; and facilities, equipment, and support personnel as required to operate the practices.

The Company prepares its consolidated financial statements in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, which provides for consolidation of variable interest entities (“VIEs”) of which the Company is the primary beneficiary. The Company has concluded that the P.C.s meet the definition of VIEs as defined by this standard and that the Company is the primary beneficiary of these VIEs.  This conclusion was reached because the Company has the power to direct significant activities of the VIEs and the Company is obligated to absorb losses of and/or provide rights to receive benefits from the VIEs.

Revenue

Revenue is generally recognized when services are provided and are reported at estimated net realizable amounts due from insurance companies, preferred provider and health maintenance organizations (i.e., third-party payors) and patients for services rendered, net of contractual and other adjustments.  Dental services are billed and collected by the Company in the name of the Offices.
 
 
8


Revenue under certain third-party payor agreements is subject to audit and retroactive adjustments. To the Company’s knowledge, there are no material claims, disputes or other unsettled matters that exist concerning third-party reimbursements as of September 30, 2012.

Most of the Company’s patients are insured under third-party payor agreements. The Company’s billing system generates contractual adjustments for each patient encounter based on fee schedules for the patient’s insurance plan.  The services provided are attached to the patient’s fee schedule based on the insurance the patient has at the time the service is provided.  Therefore, the revenue that is recorded by the billing system is based on insurance contractual amounts. Additionally, each patient at the time of service signs a form agreeing that the patient is ultimately responsible for the contracted fee if the insurance company does not pay the fee for any reason.

Intangible Assets

The Company's dental practice acquisitions involve the purchase of tangible and intangible assets and the assumption of certain liabilities of the acquired dental Offices. As part of the purchase price allocation, the Company allocates the purchase price to the tangible and identifiable 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 related to the Office. The Management Agreement represents the Company's right to manage the Offices during the 40-year term of the Management Agreement. The assigned value of the Management Agreement is amortized using the straight-line method over a period of 25 years.  Amortization remained constant at approximately $225,000 for the quarters ended September 30, 2012 and 2011, respectively.  Amortization was approximately $677,000 and $675,000 for the nine months ended September 30, 2012 and 2011, respectively.

The Management Agreements cannot be terminated by a P.C. without cause, consisting primarily of bankruptcy or material default by the Company.

If facts and circumstances indicate that the carrying value of long-lived and intangible assets may be impaired, the Company will perform an evaluation of recoverability. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset will be compared to the asset’s carrying amount to determine if a write-down to market value or discounted cash flow value is required.

Stock Options

The Company recognizes compensation expense on a straight line basis over the requisite service period of the award. Total stock-based compensation expense included in the Company’s condensed consolidated statements of income for the quarters ended September 30, 2012 and 2011 was approximately $128,000 and ($58,000), respectively.  For the quarter ended September 30, 2012, stock-based compensation expense consisted of approximately $128,000 related to stock option expense.  For the quarter ended September 30, 2011, stock-based compensation expense consisted of approximately $105,000 related to stock option expense and approximately ($163,000) for reversal of an accrual related to restricted stock units granted under the Company’s long-term incentive program (the “LTIP”).  The LTIP was adopted by the Board of Directors on June 3, 2009 and provided for long-term performance-based cash and stock opportunities for the executive officers of the Company.  The LTIP terminated on December 31, 2011, and cash and stock earned under the LTIP were paid to the executive officers in January 2012.  Total stock-based compensation expense included in the Company’s condensed consolidated statements of income for the nine months ended September 30, 2012 and 2011 was approximately $473,000 and $238,000, respectively.  For the nine months ended September 30, 2012, stock-based compensation expense related to stock option expense.  For the nine months ended September 30, 2011, stock-based compensation expense related to stock option expense.  Total stock-based compensation expense was recorded as a component of corporate general and administrative expense.
 
The Black-Scholes option-pricing model was used to estimate the option fair values. The option-pricing model requires a number of assumptions, of which the most significant are expected stock price volatility, the expected pre-vesting forfeiture rate, expected dividend rate and the expected option term (the amount of time from the grant date until the options are exercised or expire). Expected volatility was calculated based upon actual historical stock price movements over the most recent periods ended September 30, 2012 equal to the expected option term. Expected pre-vesting forfeitures were estimated based on historical pre-vesting forfeitures over the most recent periods ended September 30, 2012 for the expected option term.
 
 
9

 
Recent Accounting Pronouncements
 
In July 2011, the FASB issued ASU No. 2011-07, Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities (“ASU 2011-07”).  In accordance with ASU 2011-07, an entity will be required to present its provision for doubtful accounts related to patient service revenue as a deduction from revenue, similar to contractual discounts.  Accordingly, an entity’s patient service revenue will be reported net of both contractual discounts and its provision for doubtful accounts related to patient service revenue.  Additionally, ASU 2011-07 requires entities to make certain additional disclosures designed to help investors understand how contractual discounts and bad debts affect recorded revenue in both interim and annual financial statements.  ASU 2011-07 requires retrospective application and is effective for public companies for fiscal years beginning after December 15, 2011, and interim periods within those fiscal years.  ASU 2011-07 did not have a material effect on the Company’s consolidated financial statements.

In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.  The update simplifies the guidance for testing the decline in the realizable value (impairment) of indefinite-lived intangible assets other than goodwill.  Examples of intangible assets subject to the guidance include indefinite-lived trademarks, licenses, and distribution rights.  ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012.  This update will not have a material effect on the Company’s consolidated financial statements.  

(3)
EARNINGS PER SHARE

The Company calculates earnings per share in accordance with ASC Topic 260.

   
Quarters Ended September 30,
 
   
2011
   
2012
 
   
Net Income
   
Shares
   
Per Share Amount
   
Net Income
   
Shares
   
Per Share Amount
 
                                     
Basic EPS
  $ 374,045       1,859,362     $ 0.20     $ 383,147       1,841,817     $ 0.21  
                                                 
Effect of Dilutive Stock Options
    -       54,713       -       -       9,628       -  
                                                 
Diluted EPS
  $ 374,045       1,914,075     $ 0.20     $ 383,147       1,851,445     $ 0.21  

The difference in weighted average shares outstanding between basic earnings per share and diluted earnings per share for the quarters ended September 30, 2012 and 2011 relates to the effect of 9,628 and 54,713, respectively, dilutive shares of the Company’s Common Stock (“Common Stock”) from stock options, which are included in total shares for the diluted earnings per share calculation.  For the quarters ended September 30, 2012 and 2011, options to purchase 423,600 and 313,500 shares, respectively, of Common Stock were not included in the computation of dilutive earnings per share because their effect was anti-dilutive.

   
Nine Months Ended September 30,
 
   
2011
   
2012
 
   
Net Income
   
Shares
   
Per Share Amount
   
Net Income
   
Shares
   
Per Share Amount
 
                                     
Basic EPS
  $ 1,125,593       1,855,984     $ 0.61     $ 834,105       1,839,788     $ 0.45  
                                                 
Effect of Dilutive Stock Options
    -       61,610       (0.02 )     -       10,054       -  
                                                 
Diluted EPS
  $ 1,125,593       1,917,594     $ 0.59     $ 834,105       1,849,842     $ 0.45  

The difference in weighted average shares outstanding between basic earnings per share and diluted earnings per share for the nine months ended September 30, 2012 and 2011 relates to the effect of 10,054 and 61,610, respectively, dilutive shares of Common Stock from stock options, which are included in total shares for the diluted earnings per share calculation.  For the nine months ended September 30, 2012 and 2011, options to purchase 423,600 and 279,500 shares, respectively, of Common Stock were not included in the computation of dilutive earnings per share because their effect was anti-dilutive.
 
10

 
(4)
STOCK-BASED COMPENSATION PLANS

The Company’s shareholders approved the 2005 Equity Incentive Plan (“2005 Plan”) in June 2005.  An amendment to the 2005 Plan was approved at the June 2009 annual meeting of shareholders to increase the number of authorized shares of Common Stock issuable under the 2005 Plan from 425,000 shares to 625,000 shares.  An additional amendment to the 2005 Plan was approved at the June 2012 annual meeting of shareholders to increase the number of authorized shares of Common Stock issuable under the 2005 Plan by 150,000 shares from 625,000 shares to 775,000 shares.  The 2005 Plan provides for the grant of incentive stock options, restricted stock, restricted stock units and stock grants to employees (including officers and employee-directors) and non-statutory stock options to employees, directors and consultants. The objectives of the 2005 Plan are to attract and retain the best personnel and provide for additional performance incentives by providing employees with the opportunity to acquire equity in the Company.  As of September 30, 2012, there were 103,768 shares available for issuance under the 2005 Plan.  The 2005 Plan is administered by a committee of two or more independent directors from the Company’s Board of Directors (the “Committee”). The Committee determines the eligible individuals to whom awards under the 2005 Plan may be granted, as well as the time or times at which awards will be granted, the number of shares subject to awards to be granted to any eligible individual, the life of any award, and any other terms and conditions of the awards in addition to those contained in the 2005 Plan. As of September 30, 2012, there were 254,937 vested options and 233,330 unvested options under the 2005 Plan.

The Company uses the Black-Scholes option-pricing model to estimate the fair value of each option granted with the following weighted average assumptions:

   
Quarters Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
Valuation Assumptions
 
2011 (5)
   
2012 (5)
   
2011
   
2012
 
                         
Expected life (1)
    -       -       2.97       5.11  
Risk-free interest rate (2)
    -       -       1.25 %     0.90 %
Expected volatility (3)
    -       -       57 %     50 %
Expected dividend yield
    -       -       4.46 %     4.83 %
Expected Forfeiture (4)
    -       -       10.50 %     -  
 

(1)
The expected life, in years, of stock options is estimated based on historical experience.
(2)
The risk-free interest rate is based on U.S. Treasury bills whose term is consistent with the expected life of the stock options.
(3)
The expected volatility is estimated based on historical and current stock price data for the Company.
(4)
Forfeitures are estimated based on historical experience.
(5)
The Company did not issue any options during the quarters ended September 30, 2011 and 2012.
 
 
11

 
A summary of option activity as of September 30, 2012, and changes during the nine months then ended, is presented below:

   
Number of Options
   
Weighted-Average Exercise
Price
   
Range of Exercise Prices
   
Weighted-Average Remaining Contractual Term (years)
   
Aggregate Intrinsic
Value (thousands)
 
Outstanding at December 31, 2011
    410,689     $ 18.41     $ 10.20 - $21.85       4.0     $ 219  
Granted
    112,000     $ 18.23     $ 16.88 - $18.39                  
Exercised
    (34,422 )   $ 14.35     $ 10.20 - $17.61                  
                                         
Outstanding at September 30, 2012
    488,267     $ 18.65     $ 10.75 - $21.85       4.2     $ 189  
                                         
Exercisable at September 30, 2012
    254,937     $ 19.02     $ 10.75 - $21.85       3.0     $ 120  

The weighted average grant date fair values of options granted were $5.30 per share and $5.98 per share during the nine months ended September 30, 2012 and 2011, respectively.  No stock options were exercised during the nine months ended September 30, 2012 and 2011.  As of the date of exercise, the total intrinsic values of options exercised during the nine months ended September 30, 2012 and 2011 were $141,964 and $284,259, respectively. As of September 30, 2012, there was approximately $763,667 of total unrecognized compensation expense related to non-vested stock options, which is expected to be recognized over a weighted average period of 1.77 years.

(5)
LONG-TERM INCENTIVE PROGRAM

The Compensation Committee of the Board of Directors adopted the LTIP in June 2009.  The LTIP, which operated under the 2005 Plan, provided for long-term performance-based cash and stock opportunities for the executive officers of the Company.  The LTIP terminated on December 31, 2011, cash and stock amounts earned under the LTIP were paid in January 2012.  Details of the LTIP are as follows:

The Company’s executive officers were able to earn an aggregate of up to $1,050,000 in cash and up to 80,000 shares of Common Stock of the Company.  The Company issued restricted stock units with respect to the 80,000 shares.  Frederic W. Birner, the Company’s Chairman and Chief Executive Officer, Dennis N. Genty, the Company’s Chief Financial Officer, and Mark A. Birner, D.D.S., the Company’s President, were able to earn up to 50%, 25% and 25% of the foregoing amounts, respectively.  Of the foregoing amounts, 24%, 33% and 43% were able to be earned in each of 2009, 2010 and 2011, respectively.

The executive officers were able to earn the foregoing amounts through achievement by the Company of performance targets related to patient revenue growth, practice additions, adjusted EBITDA margin and earnings per share growth.  The executive officers were able to earn 100% of the amounts allocated to a particular year if the Company exceeded all four of the annual performance targets, 90% if the Company exceeded three of the four annual performance targets, 66.7% if the Company exceeded two of the four annual performance targets, and 0% if the Company achieved fewer than two of the four annual performance targets.  The Compensation Committee reviewed each of the performance targets annually and administered the LTIP.

All amounts vested for each executive officer on December 31, 2011.  These amounts were paid during the first quarter of 2012.
 
 
12


(6)
DIVIDENDS

The Company has declared and paid the following quarterly cash dividends.

Date Dividend Paid     
Quarterly Dividend Paid per Share 
 
April 10, 2009; July 10, 2009; October 9, 2009; January 8, 2010
  $ 0.17  
April 9, 2010; July 9, 2010; October 8, 2010; January 14, 2011; April 8, 2011
  $ 0.20  
July 8, 2011; October 14, 2011; January 13, 2012; April 13, 2012; July 13, 2012 October 12, 2012
  $ 0.22  

The payment of dividends in the future is subject to the discretion of the Company’s Board of Directors, and various factors may prevent the Company from paying dividends or require the Company to reduce the dividends. Such factors include the Company’s financial position, capital requirements and liquidity, the existence of a stock repurchase program, any loan agreement restrictions, state corporate law restrictions, results of operations and such other factors that the Company’s Board of Directors may consider relevant.
 
(7)
LINE OF CREDIT

On June 29, 2012, the Company amended its Credit Facility (the “Credit Facility”).  The amendment extended the expiration of the Credit Facility from May 31, 2013 to May 31, 2014.  The Credit Facility allows the Company to borrow, on a revolving basis, an aggregate principal amount not to exceed $7.0 million at either, or a combination of, the lender’s Base Rate or at LIBOR plus a LIBOR rate margin, at the Company’s option.  The Base Rate computes interest at the higher of the lender’s “prime rate” or the Federal Funds Rate.  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%.  As of September 30, 2012, the Company’s LIBOR borrowing rate was 2.23% and the Base Rate borrowing rate was 3.25%.  A commitment fee on the average daily unused amount of the revolving loan commitment during the preceding quarter is also assessed at 0.25%.  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 is responsible for any loss or cost incurred by the lender in liquidating or employing deposits required to fund or maintain the LIBOR rate loan.  At September 30, 2012, the Company had approximately $3.2 million outstanding and approximately $3.8 million available for borrowing under the Credit Facility.  The outstanding amounts consisted of $2.8 million outstanding under the LIBOR rate option and $435,000 outstanding under the Base Rate option.  The Credit Facility is collateralized by the Company’s accounts receivable and Management Agreements.  The amended Credit Facility requires the Company to comply with certain covenants and financial ratios.  At September 30, 2012, the Company was in full compliance with all of its covenants under the Credit Facility.

(8)
TERM LOAN

On June 29, 2012, the Company entered into a $2.0 million term loan (the “Term Loan”) with an interest rate of LIBOR plus a LIBOR rate margin of 2.0%.  The principal amount borrowed is payable quarterly in 20 equal payments of $100,000 plus interest beginning September 30, 2012.  The Term Loan matures on June 30, 2017.  The Term Loan requires the Company to comply with certain covenants and financial ratios.  At September 30, 2012, the Company was in full compliance with all of its covenants under the Term Loan.

(9)
SUBSEQUENT EVENTS

The Company has leased space for two de novo Offices. One Office, which is located in the Tucson, Arizona market, opened on October 31, 2012. The Company anticipates the other Office, which is located in the Denver/Boulder, Colorado market, will open in December 2012. The Company anticipates approximately $500,000 in capital expenditures at each de novo Office.  The Company also has signed letters of intent for two additional de novo Office locations.  The Company does not anticipate opening either of these additional Offices until after the first quarter of 2013.
 
 
13

 

Forward-Looking Statements
 
The statements contained in this report that are not historical in nature are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, included in this report that address activities, events or developments that we expect, believe, intend or anticipate will or may occur in the future, are forward-looking statements. When used in this document, the words “estimate,” “believe,” anticipate,” “project” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted with accuracy and some of which might not even be anticipated. These forward-looking statements include statements in this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” regarding intent, belief or current expectations of the Company or its officers with respect to the development of de novo offices or acquisition of additional dental practices (“Offices”) and the successful integration of such Offices 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 and other purposes.

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, the general economy of the United States and the specific markets in which the Company’s Offices are located, trends in the health care, dental care and managed care industries, as well as the risk factors set forth in Item 1A. “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, 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.
 
General
 
The following discussion relates to factors that have affected the results of operations and financial condition of the Company for the quarters and nine months ended September 30, 2012 and 2011. This information should be read in conjunction with the Company’s condensed consolidated financial statements and related notes thereto included elsewhere in this report.
 
Overview
 
The Company was formed in May 1995 and currently manages 65 Offices in Colorado, New Mexico and Arizona staffed by 79 general dentists and 37 specialists. The Company derives all of its revenue from its Management Agreements with professional corporations (“P.C.s”), which conduct the practice at each Office. In addition, the Company assumes a number of responsibilities when it develops a de novo Office or acquires an existing dental practice.  These responsibilities are set forth in a Management Agreement, as described below.

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 the 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 development of de novo Offices and selected acquisitions.

Critical Accounting Policies
 
The Company’s critical accounting policies are set forth in its Annual Report on Form 10-K for the year ended December 31, 2011.  There have been no changes to these policies since the filing of that report.
 
Components of Revenue and Expenses
 
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 of contractual and other adjustments.  Substantially all of the Company’s patients are insured under third-party payor agreements.  The Company’s billing system generates contractual adjustments for each patient encounter based on fee schedules for the patient’s insurance plan.  The services provided are attached to the patient’s fee schedule based on the insurance the patient has at the time the service is provided.  Therefore, the revenue that is recorded by the billing system is based on insurance contractual amounts.  Additionally, each patient at the time of service signs a form agreeing that the patient is ultimately responsible for the contracted fee if the insurance company does not pay the fee for any reason.
 
 
14


Direct expenses consist of clinical salaries and benefits paid to dentists, dental hygienist and dental assistants and the expenses incurred by the Company in connection with managing the Offices, including salaries and benefits of other employees at the Offices, supplies, laboratory fees, occupancy costs, advertising and marketing, depreciation and amortization and general and administrative expenses (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 provides business and marketing services at the Offices, including (i) providing capital, (ii) designing and implementing advertising and 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, dental hygienists and dental assistants, (ii) complying with all laws, rules and regulations relating to dentists, dental hygienists and dental assistants, and (iii) maintaining proper patient records. The Company has made, and intends to make in the future, loans to P.C.s to fund their acquisition of dental assets from third parties in order to comply with state dental practice laws.  Because the Company’s financial statements are consolidated with the financial statements of the P.C.s, these loans are eliminated in consolidation.

Under the typical Management Agreement, 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, dental hygienists and dental assistants 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 to 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, except for the compensation of the dentists, dental hygienists and dental assistants who work at the Office.  This enables the Company to manage the profitability of the Offices.  Each Management Agreement is for a term of 40 years.  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.

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 of dentists, dental hygienists and dental assistants), 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.  
 
 
15

 
The Company seeks to increase its revenue by increasing the patient volume at existing Offices through effective advertising and marketing programs and by adding additional specialty services.  The Company also seeks to increase revenue by opening de novo Offices and by making selected acquisitions of dental practices.  The Company seeks to supplement fee-for-service revenue 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 increases 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 capitated 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.

The Company’s policy is to collect any patient co-payments at the time the service is provided.  If the patient owes additional amounts that are not covered by insurance, Offices collect by sending monthly invoices, placing phone calls and sending collection letters.  Interest at 18% per annum is charged on all account balances greater than 60 days old.  Patient accounts receivable in excess of $50 that are over 120 days past due and that appear are not collectible are written off as bad debt and sent to an outside collections agency.

Results of Operations
 
For the quarter ended September 30, 2012, revenue increased $217,000, or 1.4%, to $15.7 million compared to $15.5 million for the quarter ended September 30, 2011.  For the quarter ended September 30, 2012, net income increased $9,000, or 2.4% to $383,000, or $0.21 per share, compared to $374,000, or $0.20 per share, for the quarter ended September 30, 2011.
 
For the nine months ended September 30, 2012, revenue decreased $1.3 million, or 2.7%, to $47.7 million compared to $49.0 million for the nine months ended September 30, 2011.  For the nine months ended September 30, 2012, net income decreased $291,000, or 25.9% to $834,000, or $0.45 per share, compared to $1.1 million, or $0.59 per share, for the nine months ended September 30, 2011.  In addition to the impact of lower revenue, net income was negatively affected by a period to period increase of $234,000 in stock-based compensation expense pursuant to ASC Topic 718.
 
For the three months ended September 30, 2012, the revenue increase was largely due to patients accepting more expensive treatment plans.  For the nine months ended September 30, 2012, revenue was negatively impacted, in the first and second quarters, by the general economic weakness in the Company’s markets which resulted in patients accepting less expensive treatment plans relative to the same period of 2011.

During the first nine months of 2012, the Company generated $3.5 million of cash from operations.  During this period, the Company had capital expenditures of approximately $3.1 million, paid dividends of approximately $1.2 million and repurchased outstanding Common Stock for $622,000 pursuant to the Company’s stock repurchase program.  Between December 31, 2011 and September 30, 2012, bank debt increased by approximately $984,000.  The Company’s outstanding bank debt has increased because of the Company’s commitment to upgrading its existing Offices through extensive remodels and/or Office relocations and its continued commitment to converting its Offices to digital radiography.  During the nine month period ended September 30, 2012, the Company completed remodels and/or relocations on four of its Offices, and converted four additional Offices to digital radiography.
 
 
16


The Company’s earnings before interest, taxes, depreciation, amortization and non-cash expense associated with stock-based compensation (“Adjusted EBITDA”) remained constant at $4.1 million for the nine months ended September 30, 2012 and 2011.  Although Adjusted EBITDA is not a GAAP measure of performance or liquidity, the Company believes that it may be useful to an investor in evaluating the Company’s ability to meet future debt service, capital expenditures and working capital requirements. However, investors should not consider this measure in isolation or as a substitute for operating income, cash flows from operating activities or any other measure for determining the Company’s operating performance or liquidity that is calculated in accordance with GAAP. In addition, because Adjusted EBITDA is not calculated in accordance with GAAP, it may not necessarily be comparable to similarly titled measures employed by other companies. A reconciliation of Adjusted EBITDA to net income is made by adding depreciation and amortization expense - Offices, depreciation and amortization expense – corporate, stock-based compensation expense, interest expense, net and income tax expense to net income as in the following table:

   
Quarters
   
Nine Months
 
   
Ended September 30,
   
Ended September 30,
 
   
2011
   
2012
   
2011
   
2012
 
RECONCILIATION OF ADJUSTED EBITDA:
                       
Net income
  $ 374,045     $ 383,147     $ 1,125,593     $ 834,105  
Add back:
                               
Depreciation and amortization - Offices
    633,200       725,719       1,860,980       2,060,675  
Depreciation and amortization - Corporate
    35,575       41,308       86,578       118,467  
Stock-based compensation expense
    (58,069 )     127,621       238,414       472,585  
Interest expense, net
    19,883       28,018       66,178       76,796  
Income tax expense
    239,141       244,963       719,641       533,281  
                                 
Adjusted EBITDA
  $ 1,243,775     $ 1,550,776     $ 4,097,384     $ 4,095,909  
 
 
17

 
The following table sets forth the percentages of revenue represented by certain items reflected in the Company’s condensed consolidated statements of income. The information contained in the following table represents the historical results of the Company. The information that follows should be read in conjunction with the Company’s condensed consolidated financial statements and related notes thereto contained elsewhere in this report.
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

   
Quarters Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2012
   
2011
   
2012
 
                         
REVENUE:
    100.0 %     100.0 %     100.0 %     100.0 %
                                 
DIRECT EXPENSES:
                               
Clinical salaries and benefits
    56.6 %     56.2 %     56.6 %     56.4 %
Dental supplies
    4.3 %     4.4 %     4.4 %     4.4 %
Laboratory fees
    4.4 %     4.8 %     4.5 %     4.8 %
Occupancy
    8.9 %     8.9 %     8.3 %     8.7 %
Advertising and marketing
    4.9 %     2.2 %     4.0 %     3.6 %
Depreciation and amortization
    4.1 %     4.6 %     3.8 %     4.3 %
General and administrative
    8.8 %     8.0 %     9.0 %     7.7 %
      91.9 %     89.1 %     90.5 %     90.0 %
                                 
Contribution from dental offices
    8.1 %     10.9 %     9.5 %     10.0 %
                                 
CORPORATE EXPENSES:
                               
General and administrative
    3.7 %(1)     6.5 %(1)     5.4 %(2)     6.7 %(2) 
Depreciation and amortization
    0.2 %     0.3 %     0.2 %     0.2 %
                                 
OPERATING INCOME
    4.1 %     4.2 %     3.9 %     3.0 %
Interest expense
    0.1 %     0.2 %     0.1 %     0.2 %
                                 
INCOME BEFORE INCOME TAXES
    4.0 %     4.0 %     3.8 %     2.9 %
Income tax expense
    1.5 %     1.6 %     1.5 %     1.1 %
                                 
NET INCOME
    2.4 %     2.4 %     2.3 %     1.7 %

(1)
Corporate expense - general and administrative includes $104,759 of stock-based compensation expense pursuant to ASC Topic 718 and ($162,828) related to a long-term incentive program for the quarter ended September 30, 2011 and  $127,621 of  stock-based compensation expense pursuant to ASC Topic 718 for the quarter ended September 30, 2012.
(2)
Corporate expense - general and administrative includes $238,415 of stock-based compensation expense pursuant to ASC Topic 718 for the nine months ended September 30, 2011 and  $472,585 of  stock-based compensation expense pursuant to ASC Topic 718 for the nine months ended September 30, 2012.
 
 
18

 
Quarter Ended September 30, 2012 Compared to Quarter Ended September 30, 2011:
 
Revenue

For the quarter ended September 30, 2012, revenue increased $217,000, or 1.4%, to $15.7 million compared to $15.5 million for the quarter ended September 30, 2011.  The increase in revenue is largely due to patients accepting more expensive treatment plans.

Direct expenses
 
Clinical salaries and benefits. For the quarter ended September 30, 2012, clinical salaries and benefits increased $56,000, or 0.6%, to $8.8 million compared to the quarter ended September 30, 2011.  As a percentage of revenue, clinical salaries and benefits decreased to 56.2% for the quarter ended September 30, 2012 compared to 56.6% for the quarter ended September 30, 2011.
 
Dental supplies. For the quarter ended September 30, 2012, dental supplies increased to $689,000 compared to $659,000 for the quarter ended September 30, 2011, an increase of $31,000 or 4.6%.  As a percentage of revenue, dental supplies increased to 4.4% for the quarter ended September 30, 2012 compared to 4.3% for the quarter ended September 30, 2011.
 
Laboratory fees. For the quarter ended September 30, 2012, laboratory fees increased to $752,000 compared to $679,000 for the quarter ended September 30, 2011, an increase of $72,000 or 10.6%. The increase in laboratory fees is a result of a larger number of implant procedures during the quarter ended September 30, 2012 relative to the quarter ended September 30, 2011.  As a percentage of revenue, laboratory fees increased to 4.8% for the quarter ended September 30, 2012 compared to 4.4% for the quarter ended September 30, 2011.
 
Occupancy. For the quarter ended September 30, 2012, occupancy expense increased $20,000 or 1.4%, to $1.4 million compared to the quarter ended September 30, 2011.  The increase in occupancy expense was caused by an increase in repair and maintenance expense at the Offices.  As a percentage of revenue, occupancy expense remained constant at 8.9% for the quarters ended September 30, 2012 and 2011.
 
Advertising and marketing. For the quarter ended September 30, 2012, advertising and marketing expense decreased to $353,000 compared to $759,000 for the quarter ended September 30, 2011, a decrease of $406,000 or 53.5%.   The decrease in advertising and marketing is primarily attributable to a decrease in television advertising due to the 2012 election, which has dominated television commercial advertising in the Company’s markets for much of the third quarter of 2012 and limited the Company’s ability to engage in television advertising at affordable costs.  As a percentage of revenue, advertising and marketing expense decreased to 2.2% for the quarter ended September 30, 2012 compared to 4.9% for the quarter ended September 30, 2011.  The Company adjusts its advertising and marketing expenditures from time to time in response to market conditions and performance in individual markets.
 
Depreciation and amortization-Offices. For the quarter ended September 30, 2012, depreciation and amortization expenses attributable to the Offices increased to $726,000 compared to $633,000 for the quarter ended September 30, 2011, an increase of $93,000 or 14.6%.  The increase in depreciation and amortization expenses is a result of the Company’s ongoing efforts to upgrade the capital assets and tenant improvements in certain of the Company’s Offices.  As a percentage of revenue, depreciation and amortization expenses attributable to the Offices increased to 4.6% for the quarter ended September 30, 2012 compared to 4.1% for the quarter ended September 30, 2011.

General and administrative-Offices.  For the quarter ended September 30, 2012, general and administrative expenses attributable to the Offices decreased to $1.2 million compared to $1.4 million for the quarter ended September 30, 2011, a decrease of $115,000 or 8.4%.  The decrease in general and administrative expenses is primarily attributable to a decrease in training expenses paid in the 2012 quarter to an outside consultant for the Company’s clinical quality improvement program.  As a percentage of revenue, general and administrative expenses decreased to 8.0% for the quarter ended September 30, 2012 compared to 8.8% for the quarter ended September 30, 2011.
 
Contribution from dental Offices
 
As a result of revenue increasing $217,000 and direct expenses decreasing $250,000 during the quarter ended September 30, 2012, contribution from dental Offices increased to $1.7 million for the quarter ended September 30, 2012 compared to $1.2 million for the quarter ended September 30, 2011, an increase of $467,000 or 37.3%. As a percentage of revenue, contribution from dental Offices increased to 10.9% for the quarter ended September 30, 2012 compared to 8.1% for the quarter ended September 30, 2011.
 
 
19

 
Corporate expenses
 
Corporate expenses - general and administrative.  For the quarter ended September 30, 2012, corporate expenses – general and administrative increased to $1.0 million compared to $581,000 for the quarter ended September 30, 2011, an increase of $438,000 or 75.4%.  There were increases of $313,000 related to the reversal of the expense for the long-term incentive program (“LTIP”) for the executive officers during the third quarter of 2011 and $133,000 in executive officers’ bonuses.  As a percentage of revenue, corporate expenses - general and administrative increased to 6.5% for the quarter ended September 30, 2012 compared to 3.7% for the quarter ended September 30, 2011.
 
Corporate expenses - depreciation and amortization. For the quarter ended September 30, 2012, corporate expenses - depreciation and amortization increased to $41,000 compared to $36,000 for the quarter ended September 30, 2011, an increase of $6,000 or 16.1%.  This increase is attributable to new capital assets related to the Company’s new corporate office and for the development of its new website.  As a percentage of revenue, corporate expenses – depreciation and amortization increased to 0.3% for the quarter ended September 30, 2012 compared to 0.2% for the quarter ended September 30, 2011.
 
Operating income
 
As a result of the increases in contribution from dental Offices and corporate expenses discussed above, the Company’s operating income increased by $23,000, or 3.6%, to $656,000 for the quarter ended September 30, 2012 compared to $633,000 for the quarter ended September 30, 2011.  As a percentage of revenue, operating income increased to 4.2% for the quarter ended September 30, 2012 compared to 4.1% for the quarter ended September 30, 2011.
 
Interest expense/(income), net
 
For the quarter ended September 30, 2012, interest expense, net increased to $28,000 compared to $20,000 for the quarter ended September 30, 2011, an increase of $8,000 or 40.9%.  This increase in interest expense is attributable to increases in the Term Loan and Credit Facility balances.  As a percentage of revenue, interest expense, net increased to 0.2% for the quarter ended September 30, 2012 compared to 0.1% for the quarter ended September 30, 2011.
 
Net income
 
As a result of the above, the Company’s net income was $383,000 for the quarter ended September 30, 2012 compared to net income of $374,000 for the quarter ended September 30, 2011, an increase of $9,000 or 2.4%.  As a percentage of revenue, net income remained constant at 2.4% for the quarters ended September 30, 2012 and 2011.  Net income for the quarter ended September 30, 2012 was net of income tax expense of $245,000 while net income for the quarter ended September 30, 2011 was net of income tax expense of $239,000. The effective tax rate was constant at 39.0% for the quarters ended September 30, 2012 and 2011.
 
Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011:
 
Revenue

For the nine months ended September 30, 2012, revenue decreased $1.3 million, or 2.7%, to $47.7 million compared to $49.0 million for the nine months ended September 30, 2011.  For the nine months ended September 30, 2012, revenue was negatively impacted, in the first and second quarters, by the general economic weakness in the Company’s markets which resulted in patients accepting less expensive treatment plans relative to the same period of 2011.

Direct expenses

Clinical salaries and benefits. For the nine months ended September 30, 2012, clinical salaries and benefits decreased $805,000, or 2.9%, to $26.9 million compared to $27.7 million for the nine months ended September 30, 2011.  The decrease in clinical salaries and benefits is directly related to the decrease in revenue as most of the dentists in the Offices are compensated based on revenue.  As a percentage of revenue, clinical salaries and benefits decreased to 56.4% for the nine months ended September 30, 2012 compared to 56.6% for the nine months ended September 30, 2011.
 
 
20

 
Dental supplies. For the nine months ended September 30, 2012, dental supplies decreased to $2.1 million compared to $2.2 million for the nine months ended September 30, 2011, a decrease of $79,000 or 3.7%.  The decrease in dental supplies is directly related to the decrease in revenue.  As a percentage of revenue, dental supplies remained constant at 4.4% for the nine months ended September 30, 2012 and 2011.
 
Laboratory fees. For the nine months ended September 30, 2012, laboratory fees increased to $2.3 million compared to $2.2 million for the nine months ended September 30, 2011, an increase of $114,000 or 5.2%.  The increase in laboratory fees is a result of a larger number of implant procedures during the nine months ended September 30, 2012 relative to the nine months ended September 30, 2011.  As a percentage of revenue, laboratory fees increased to 4.8% for the nine months ended September 30, 2012 compared to 4.5% for the nine months ended September 30, 2011.
 
Occupancy. For the nine months ended September 30, 2012, occupancy expense increased $76,000, or 1.9%, to $4.1 million compared to the nine months ended September 30, 2011.  The increase in occupancy expense was caused by an increase in repair and maintenance expense at the Offices.  As a percentage of revenue, occupancy expense increased to 8.7% for the nine months ended September 30, 2012 compared to 8.3% for the nine months ended September 30, 2011.
 
Advertising and marketing. For the nine months ended September 30, 2012, advertising and marketing expense decreased to $1.7 million compared to $1.9 million for the nine months ended September 30, 2011, a decrease of $213,000 or 11.0%.  The decrease in advertising and marketing is primarily attributable to a decrease in television advertising due to the 2012 election, which has dominated television commercial advertising in the Company’s markets for much of the third quarter of 2012 and limited the Company’s ability to engage in television advertising at affordable costs.  As a percentage of revenue, advertising and marketing expense decreased to 3.6% for the nine months ended September 30, 2012 compared to 4.0% for the nine months ended September 30, 2011.  The Company adjusts its advertising and marketing expenditures from time to time in response to market conditions and performance in individual markets.
 
Depreciation and amortization-Offices.  For the nine months ended September 30, 2012, depreciation and amortization expenses attributable to the Offices increased to $2.1 million compared to $1.9 million for the nine months ended September 30, 2011, an increase of $200,000 or 10.7%.  The increase in depreciation and amortization expense is a result of the Company’s ongoing efforts to upgrade the capital assets and tenant improvements in certain of the Company’s Offices. As a percentage of revenue, depreciation and amortization expenses attributable to the Offices increased to 4.3% for the nine months ended September 30, 2012 compared to 3.8% for the nine months ended September 30, 2011.
 
General and administrative-Offices.  For the nine months ended September 30, 2012, general and administrative expenses attributable to the Offices decreased to $3.7 million compared to $4.4 million for the nine months ended September 30, 2011, a decrease of $704,000 or 16.0%.  The decrease in general and administrative expenses is primarily attributable to a decrease in training expenses paid in the 2012 period to an outside consultant for the Company’s clinical quality improvement program.  As a percentage of revenue, general and administrative expenses decreased to 7.7% for the nine months ended September 30, 2012 compared to 9.0% for the nine months ended September 30, 2011.
 
Contribution from dental Offices
 
As a result of revenue decreasing $1.3 million and direct expenses decreasing $1.4 million during the nine months ended September 30, 2012, contribution from dental Offices increased to $4.8 million for the nine months ended September 30, 2012 compared to $4.7 million for the nine months ended September 30, 2011, an increase of $111,000 or 2.4%. As a percentage of revenue, contribution from dental Offices increased to 10.0% for the nine months ended September 30, 2012 compared to 9.5% for the nine months ended September 30, 2011.
 
Corporate expenses
 
Corporate expenses - general and administrative. For the nine months ended September 30, 2012, corporate expenses – general and administrative increased to $3.2 million compared to $2.7 million for the nine months ended September 30, 2011, an increase of $547,000 or 20.6%.  This increase is attributable to increases of $234,000 related to stock-based compensation expense pursuant to ASC Topic 718, $133,000 in executive officers’ bonuses, and $129,000 in social media consulting fees.  As a percentage of revenue, corporate expenses - general and administrative increased to 6.7% for the nine months ended September 30, 2012 compared to 5.4% for the nine months ended September 30, 2011.
 
Corporate expenses - depreciation and amortization. For the nine months ended September 30, 2012, corporate expenses - depreciation and amortization increased to $118,000 compared to $87,000 for the nine months ended September 30, 2011, an increase of $32,000 or 36.8%.  This increase is attributable to new capital assets related to the Company’s new corporate office and for the development of its new website.  As a percentage of revenue, corporate expenses – depreciation and amortization remained constant at 0.2% for the nine months ended September 30, 2012 and 2011.
 
 
21

 
Operating income
 
As a result of the increases in contribution from dental Offices and corporate expenses discussed above, the Company’s operating income decreased by $467,000, or 24.4% to $1.4 million for the nine months ended September 30, 2012 compared to $1.9 million for the nine months ended September 30, 2011.  As a percentage of revenue, operating income decreased to 3.0% for the nine months ended September 30, 2012 compared to 3.9% for the nine months ended September 30, 2011.
 
Interest expense/(income), net
 
For the nine months ended September 30, 2012, interest expense, net increased to $77,000 compared to $66,000 for the nine months ended September 30, 2011, an increase of $11,000 or 16.0%.  This increase in interest expense is attributable to increases in the Term Loan and Credit Facility balances.  As a percentage of revenue, interest expense, net increased to 0.2% for the nine months ended September 30, 2012 compared to 0.1% for the nine months ended September 30, 2011.
 
Net income
 
As a result of the above, the Company’s net income was $834,000 for the nine months ended September 30, 2012 compared to net income of $1.1 million for the nine months ended September 30, 2011, a decrease of $291,000 or 25.9%.  As a percentage of revenue, net income decreased to 1.7% for the nine months ended September 30, 2012 compared to 2.3% for the nine months ended September 30, 2011.  Net income for the nine months ended September 30, 2012 was net of income tax expense of $533,000, while net income for the nine months ended September 30, 2011 was net of income tax expense of $720,000. The effective tax rate was constant at 39.0% for the nine months ended September 30, 2012 and 2011.
 
Liquidity and Capital Resources
 
The Company finances its operations and growth through a combination of cash provided by operating activities, the Credit Facility and the Term Loan.  As of September 30, 2012, the Company had a working capital deficit of approximately $2.1 million, retained earnings of $7.1 million and a cash balance of $502,000.
 
Net cash provided by operating activities was approximately $3.5 million and $4.5 million for the nine months ended September 30, 2012 and 2011, respectively.  During the nine months ended September 30, 2012, excluding net income and after adding back non-cash items, the Company’s cash provided by operating activities consisted primarily of an increase in income taxes payable of $136,000 and an increase of $69,000 in accounts payable and accrued expenses, offset by an increase in accounts receivable of approximately $613,000, and an increase in prepaid expenses and other assets of approximately $30,000.  During the nine months ended September 30, 2011, excluding net income and after adding back non-cash items, the Company’s cash provided by operating activities consisted primarily of an increase in income taxes payable of $1.3 million, an increase in other long-term obligations of approximately $90,000, and a decrease in deferred charges and other assets of $14,000, offset by an increase in accounts receivable of approximately $261,000, an increase in prepaid expenses and other assets of approximately $75,000, and a decrease of approximately $255,000 in accounts payable and accrued expenses.
 
Net cash used in investing activities was approximately $3.0 million and $2.3 million for the nine months ended September 30, 2012 and 2011, respectively.  For the nine months ended September 30, 2012, the Company invested approximately $3.1 million in capital expenditures, offset by a decrease in notes receivable of $23,000.  For the nine months ended September 30, 2011, the Company invested approximately $2.3 million in capital expenditures, offset by a decrease in notes receivable of $12,000.  
 
Net cash used in financing activities was approximately $856,000 for the nine months ended September 30, 2012 and $2.1 million for the nine months ended September 30, 2011. During the nine months ended September 30, 2012, net cash used in financing activities was comprised of approximately $1.2 million for the payment of dividends, $1.0 million used to pay down the Credit Facility, and approximately $622,000 for the purchase and retirement of Common Stock, offset by $2.0 million in advances under the Term Loan.  During the nine months ended September 30, 2011, net cash used in financing activities was comprised of approximately $1.1 million for the payment of dividends, $460,000 for the repayment of a prior term loan, $169,000 used to pay down the Credit Facility, and $296,000 for the purchase and retirement of Common Stock.
 
 
22

 
On June 29, 2012, the Company amended its Credit Facility.  The amendment extended the expiration of the Credit Facility from May 31, 2013 to May 31, 2014.  The Credit Facility allows the Company to borrow, on a revolving basis, an aggregate principal amount not to exceed $7.0 million at either, or a combination of, the lender’s Base Rate or at LIBOR plus a LIBOR rate margin, at the Company’s option.  The Base Rate computes interest at the higher of the lender’s “prime rate” or the Federal Funds Rate.  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%.  As of September 30, 2012, the Company’s LIBOR borrowing rate was 2.23% and the Base Rate borrowing rate was 3.25%.  A commitment fee on the average daily unused amount of the revolving loan commitment during the preceding quarter is also assessed at 0.25%.  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 is responsible for any loss or cost incurred by the lender in liquidating or employing deposits required to fund or maintain the LIBOR rate loan.  At September 30, 2012, the Company had approximately $3.2 million outstanding and approximately $3.8 million available for borrowing under the Credit Facility.  The outstanding amounts consisted of $2.8 million outstanding under the LIBOR rate option and $435,000 outstanding under the Base Rate option.  The Credit Facility is collateralized by the Company’s accounts receivable and Management Agreements.  The amended Credit Facility requires the Company to comply with certain covenants and financial ratios.  At September 30, 2012, the Company was in full compliance with all of its covenants under the Credit Facility.  

On June 29, 2012, the Company entered into a $2.0 million Term Loan with an interest rate of LIBOR plus a LIBOR rate margin of 2.0%.  Proceeds from the Term Loan were used to reduce amounts outstanding under the Credit Facility.  The principal amount borrowed is payable quarterly in 20 equal payments of $100,000 plus interest beginning September 30, 2012.  The Term Loan matures on June 30, 2017.  The Term Loan requires the Company to comply with certain covenants and financial ratios.  At September 30, 2012, the Company was in full compliance with all of its covenants under the Term Loan.
 
As of September 30, 2012, the Company had the following debt and lease obligations:

         
Payments due by Period
       
   
Total
   
Less than 1 year
   
1-3 years
   
3-5 years
   
More than 5 years
 
                               
Debt obligations
  $ 5,235,158     $ 400,000     $ 4,035,158     $ 800,000     $ -  
Operating lease obligations
    11,527,891       3,573,638       5,389,892       2,440,853       123,508  
Total
  $ 16,763,049     $ 3,973,638     $ 9,425,050     $ 3,240,853     $ 123,508  

The Company believes that cash generated from operations and borrowings under its Credit Facility and the Term Loan 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 or capital needs, the Company may issue equity or debt securities, subject to market and other conditions, or enter into additional term loans or revolving credit facilities.  There can be no assurance that such additional financing will be available on terms acceptable to the Company or at all. The failure to obtain 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.

 
Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, the Company evaluated the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, or the “Exchange Act”) as of September 30, 2012.  On the basis of this review, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2012.
 
There has been no change in the Company’s internal control over financial reporting during the three months ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
 
23

 
PART II.  OTHER INFORMATION
 
 
Issuer Purchases of Equity Securities 

The Company did not purchase any shares of its Common Stock during the period July 1, 2012 through September 30, 2012.  The Company’s stock repurchase program has been ongoing for more than five years and the program has no expiration date.  Common Stock repurchases may be made from time to time as the Company’s management deems appropriate.  As of September 30, 2012, the dollar value of shares that may be purchased under the stock repurchase program was approximately $891,000.
 
 
24

 
 
Exhibit
 
Number
Description of Document
   
3.1
Amended and Restated Articles of Incorporation, incorporated herein by reference to Exhibits 3.1 and 3.2 to the Company’s Registration Statement on Form S-1 (SEC File No. 333-36391), as filed with the Securities and Exchange Commission on September 25, 1997.
   
3.2
Amended and Restated Bylaws, incorporated herein by reference to Exhibit 3.3 to the Company’s Registration Statement on Form S-1 (SEC File No. 333-36391), as filed with the Securities and Exchange Commission on September 25, 1997.
   
4.1
Reference is made to Exhibits 3.1 and 3.2.
   
4.2
Specimen Stock Certificate, incorporated herein by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1/A (SEC File No. 333-36391), as filed with the Securities and Exchange Commission on November 25, 1997.
   
Rule 13a-14(a) Certification of the Chief Executive Officer.
   
Rule 13a-14(a) Certification of the Chief Financial Officer.
   
Section 1350 Certifications of the Chief Executive Officer and the Chief Financial Officer.
   
101.INS
XBRL Instance Document *
   
101.SCH
XBRL Taxonomy Extension Schema Document*
   
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document*
   
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document*
   
101.LAB
XBRL Taxonomy Extension Label Linkbase Document*
   
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document*

*
Pursuant to Rule 406T of Regulation S-T, these Interactive Data Files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to the liability under these sections.

 
25

 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
BIRNER DENTAL MANAGEMENT SERVICES, INC.
         
Date:  November 13, 2012
By:
 
 /s/ Frederic W.J. Birner
 
 
Name:
 
Frederic W.J. Birner
 
Title:
 
Chairman of the Board and Chief Executive Officer
     
(Principal Executive Officer)
         
Date:  November 13, 2012
By:  
/s/ Dennis N. Genty
 
 
Name:
 
Dennis N. Genty
 
Title:
 
Chief Financial Officer, Secretary, and Treasurer
     
(Principal Financial and Accounting Officer)
 
 
26