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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

OR

 

☐	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

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 ☒ No  ☐        

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 ☒  No  ☐   

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

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ☐ No  ☒

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

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BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

 

 

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(1)	Corporate expenses - general and administrative includes $35,236 and $52,976 of stock-based compensation expense pursuant to ASC Topic 718 for the quarters ended March 31, 2017 and 2018, respectively.

 

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

 

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ DEFICIT

(UNAUDITED)

 

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

 

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES       

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

March 31, 2018

(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, 2017.

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 March 31, 2018 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 ended March 31, 2018 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)	LIQUIDITY AND FINANCIAL RESOURCES UPDATE

The Company has historically operated with negative working capital and was able to meet its current obligations  through operating cash flows and availability on its revolving line of credit.  Recent decreases in operating cash flows led the Company to take certain actions including raising $5 million in a private placement as described below.

On July 21, 2017, the Company received notice of events of default and acceleration (the “Notice Letter”) from counsel to Guaranty Bank and Trust Company (the “Bank”) in connection with the Loan and Security Agreement, dated as of March 29, 2016, as amended (collectively, the “Loan Agreement” or the “Credit Facility”), including the Fourth Amendment to Loan and Security Agreement and Forbearance Agreement dated March 30, 2017 (the “Forbearance Agreement”).  The Notice Letter asserted events of default resulting from the Company’s failure to produce EBITDA of at least $870,000 for the second quarter of 2017 and to reduce the dollar amount of the outstanding reducing revolving loan by at least $500,000 by June 30, 2017.  The Notice Letter further asserted that, as a result of these events of default, earlier events of default related to EBITDA  and coverage ratios to which the Forbearance Agreement applied again existed.

In the Notice Letter, the Bank also declared all obligations of the Company to be immediately due and payable and demanded payment in full of all obligations.  The Notice Letter further stated that, although the Bank was not presently exercising its other rights and remedies available upon an event of default, it reserved its right to do so at any time in its sole discretion.

The Company subsequently failed to reduce the dollar amount of the outstanding reducing revolving line of credit under the Credit Facility by at least $500,000 by September 30, 2017.  The Company’s revolving line of credit with the Bank was reduced from $1.4 million to $1.1 million on October 1, 2017 as required by the Forbearance Agreement.

On December 28, 2017, following discussions and negotiations with the Bank and a number of potential investors and lenders, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) and completed a private placement of $5 million of convertible senior subordinated secured notes (the “Notes”) and attached shares of Series A Convertible Preferred Stock with Palm Active Dental, LLC and Palm Global Small Cap Master Fund LP (the “Palm Investors”). Also on December 28, 2017, the Company and the Bank entered into the Fifth Amendment to the Loan Agreement (the “Fifth Amendment”), under which the Company repaid approximately $1.5 million of the term loan portion and $1.1 million of the revolving line of credit of the Loan Agreement and the Bank waived all then-existing defaults, default interest, fees, and penalties under the Credit Facility. Among other things, the Fifth Amendment increased the revolving line of credit from $1.1 million to $2.0 million, extended the maturity date of the loans under the Credit Facility to March 31, 2023 and modified the repayment terms of the term loan and the EBITDA, leverage ratio and other financial covenants under the Credit Facility. Under the Credit Facility and related pledge and security agreements, the Bank has liens and security interests on substantially all of the assets of the Company.  See Note 7 for additional information regarding the Notes and the Credit Facility.

 

The Company has prepared its business plan for the ensuing 12 months and believes it has sufficient liquidity and financial resources to operate for the ensuing 12 month period. Although the Company met its required Bank covenant at March 31, 2018 and anticipates meeting its future Bank covenants, any non-compliance with future Bank covenants could have a material impact on the Company’s liquidity.

(3)	SIGNIFICANT ACCOUNTING POLICIES

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 operations 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 is generally recognized when services are provided and is 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.

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 March 31, 2018.

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.

A note receivable was created as part of a dental Office acquisition, of which approximately $26,000 in principal amount was outstanding at March 31, 2018.  The note has equal monthly principal and interest amortization payments and a maturity date of October 31, 2018.  The note bears interest at 6%, which is accrued monthly.  If the note is uncollectible, an allowance for doubtful accounts will be created.  There was no allowance for doubtful accounts for the note as of March 31, 2018 or December 31, 2017.

 

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 was approximately $211,000 and $212,000 for the quarters ended March 31, 2018 and 2017, 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.  There were no impairment write-downs associated with the Company’s long-lived and intangible assets during the quarters ended March 31, 2018 and 2017.

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 operations for the quarters ended March 31, 2018 and 2017 was approximately $53,000 and $35,000, respectively, related to stock options and restricted stock.  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 period ended March 31, 2018 equal to the expected option term. Expected pre-vesting forfeitures were estimated based on historical pre-vesting forfeitures over the most recent period ended March 31, 2018 for the expected option term.

 

The fair value of restricted stock granted to independent directors in June 2017 was calculated by taking the product of the number of shares granted times the stock price on the day the restricted stock was granted and spreading this value over the vesting period of the restricted stock.

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("Topic 606").  This update established a comprehensive revenue recognition standard for virtually all industries in GAAP.  Topic 606 changed the amount and timing of revenue and cost recognition, implementation, disclosures and documentation.  In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date of Topic 606 until annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period.  Topic 606 may be adopted under the full retrospective method or the modified retrospective transition method.  The Company adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method and it did not have a material effect on its consolidated financial statements. The Company has included the disclosures required by Topic 606 in Note 4.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842).  Under the new guidance, lessees will be required to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months.  ASU 2016-02 is effective for fiscal years beginning after December 15, 2018.  The Company anticipates the adoption of ASU 2016-02 will have a material impact on its consolidated financial statements by increasing both total assets and total liabilities on the balance sheet.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments.  This update addresses diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows.  The update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice.  The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.  The Company adopted ASU 2016-15 as of January 1, 2018 and it did not have a material effect on its consolidated financial statements.

 

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfer of Assets Other than Inventory. The guidance requires the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. The guidance became effective for annual reporting periods beginning after December 15, 2017. This ASU is required to be adopted using the modified retrospective approach, with a cumulative catch-up adjustment to retained earnings in the period of adoption.The Company adopted ASU 2016-16 as of January 1, 2018 and it did not have a material effect on its consolidated financial statements. 

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230) Restricted Cash, to address diversity in practice in the classification and presentation of changes in restricted cash. The accounting update requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash or restricted cash equivalents should be included with cash and cash equivalents when reconciling beginning-of-period and end-of-period amounts shown on the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.The Company adopted this update as of January 1, 2018 and it did not have a material effect on its consolidated financial statements. 

In May 2017, the FASB issued ASU No. 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting. The amendments provide guidance on determining which changes to the terms and conditions of share-based payment awards requires an entity to apply modification accounting under Topic 718. The guidance became effective for annual reporting periods beginning after December 15, 2017.The Company adopted ASU 2017-09 as of January 1, 2018 and it did not have a material effect on its consolidated financial statements.

 

(4)

Revenue

On January 1, 2018, the Company adopted Topic 606 using the modified retrospective method applied to all contracts as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company's historical accounting under Topic 605. The Company’s revenues include premium and service revenues. Service revenues include net patient revenues that are recorded based upon established billing rates, less allowances for contractual adjustments, and are recognized as services are provided.  The Company identified service revenues associated with the placement of orthodontic braces and crown and bridge procedures as contracts that will be affected with the adoption of Topic 606.  For these two revenue streams, the Company identified distinct performance obligations for the placement of  braces and crowns and bridge procedures and allocated transaction prices to these performance obligations using the available observable data and bottom up methods.

 

 

 

(5)	LOSS PER SHARE

The Company calculates net loss per share (“EPS”)  in accordance with ASC Topic 260.

For the quarters ended March 31, 2018 and 2017, options to purchase 560,666 and 500,666 shares, respectively, of the Company’s common stock (“Common Stock”) were not included in the computation of diluted EPS because their effect was anti-dilutive.

(6)	STOCK-BASED COMPENSATION PLANS

The Company’s 2005 Equity Incentive Plan, as amended (“2005 Plan”), terminated in March 2015.  The 2005 Plan provided for the grant of incentive stock options, restricted stock, restricted stock units and stock grants to eligible employees (including officers and employee-directors) and non-statutory stock options to eligible employees, directors and consultants.  As of March 31, 2018, there were 373,500 vested options and 3,166 unvested options granted under the 2005 Plan that remained outstanding in accordance with their terms and there were no shares available for issuance under the 2005 Plan due to its termination.

The Company’s shareholders approved the 2015 Equity Incentive Plan (“2015 Plan”) in June 2015.  The 2015 Plan replaces the 2005 Plan.  The maximum number of shares of Common Stock that may be delivered to participants and their beneficiaries under the 2015 Plan is 200,000.  The 2015 Plan provides for the grant of incentive stock options, stock appreciation right awards, restricted stock awards, stock unit awards and other stock-based awards to eligible recipients.  The objectives of the 2015 Plan are to attract and retain the best possible candidates for positions of responsibility and provide for additional performance incentives by providing eligible employees with the opportunity to acquire equity in the Company.  The 2015 Plan is administered by a committee ("the Committee") of two or more outside directors from the Company’s Board of Directors (the “Board”). The Committee determines the eligible individuals to whom awards under the 2015 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 term of the award, vesting terms and conditions and any other terms and conditions of the grant in addition to those contained in the 2015 Plan.  Each grant under the 2015 Plan will be confirmed by and subject to the terms of an award agreement.  As of March 31, 2018, there were 35,500 vested options and 148,500 unvested options granted under the 2015 Plan.  On June 2, 2017, the independent directors of the Board were granted 2,000 shares each of restricted Common Stock pursuant to the 2015 Plan.  Fifty percent of the shares vest 12 months from the grant date, and the remaining shares vest 24 months from the grant date.  As of March 31, 2018,  6,000 shares were available for issuance under the 2015 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:

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(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.

A summary of option activity as of March 31, 2018, and changes during the quarter then ended, is presented below:

 

The weighted average grant date fair values of options granted during the quarters ended March 31, 2018 and 2017 were $4.85 per share and $5.20 per share, respectively.  As of March 31, 2018, there was approximately $491,000 of total unrecognized compensation expense related to non-vested stock options, which is expected to be recognized over a weighted average period of 2.48 years.

A summary of restricted stock activity as of March 31, 2018, and changes during the quarter then ended, is presented below:

 

As of March 31, 2018, total unrecognized share-based compensation expense from unvested restricted stock was $66,000 which is expected to be recognized over a weighted average period of approximately 1.2 years. As of March 31, 2018, 8,000 shares were expected to vest in the future.

(7)

DEBT

On December 28, 2017, the Company and the Bank entered into the Fifth Amendment, under which the Company repaid approximately $1.5 million of the term loan portion and approximately $1.1 million of the revolving line of credit of the Credit Facility with net proceeds of the private placement discussed below, and the Bank waived all outstanding defaults, default interest, fees, and penalties under the Credit Facility. Among other things, the Fifth Amendment increased the revolving line of credit from $1.1 million to $2.0 million, extended the maturity date of the loans under the Credit Facility to March 31, 2023, and modified the repayment terms of the term loan and the EBITDA, leverage ratio and other financial covenants under the Credit Facility. The outstanding principal balance of the Term Loan (as defined in the Credit Facility) was $6.375 million as of March 31, 2018 and no amounts were drawn on the $2.0 million revolving line of credit as of March 31, 2018.

Under the Fifth Amendment, the Term Loan bears interest as follows:

 

The Company must pay the unpaid principal balance of the Term Loan as follows: (i) $125,000 on the last day of each calendar quarter in 2018, (ii) $100,000 on or before the date that is 30 days after the date the Form 10-Q for the second fiscal quarter of 2018 is filed by the Company with the SEC but only if EBITDA (as defined in the Fifth Amendment) measured for the 12 months ending June 30, 2018 is equal to or more than $2,400,000, (iii) $175,000 on March 31, 2019 and June 30, 2019, (iv) $100,000 on or before the date that is 30 days after the date the Form 10-Q for the second fiscal quarter of 2019 is filed by the Company with the SEC, but only if EBITDA measured for the 12 months ending June 30, 2019 is equal to or more than $3,000,000, (v) $200,000 on September 30, 2019 and December 31, 2019, and (vi) $250,000 on the last day of each calendar quarter thereafter, commencing with March 31, 2020, with a final payment in an aggregate amount equal to the unpaid principal balance of the Term Loan on March 31, 2023. In addition, the Company must make mandatory prepayments commencing with the quarter ending September 30, 2019 equal to the “Excess Cash Flow Amount” as defined in the Fifth Amendment. In any event, the Company must make payments so that the principal balance of the Term Loan is $5,750,000 as of December 31, 2018, $4,750,000 as of December 31, 2019, $3,600,000 as of December 31, 2020, 2,100,000 as of December 31, 2021, and $750,000 as of December 31, 2022.

For the quarter ended March 31, 2018, the Company’s EBITDA was $392,000, which was less than the required Bank covenant amount of $400,000.  The Bank agreed to exclude $66,500 of one-time accounting and valuation expenses associated with the $5 million financing completed in December 2017, and with this exclusion the Company was in compliance with the EBITDA covenant requirement as of March 31, 2018.

On December 28, 2017, the Company entered into the Securities Purchase Agreement with the Palm Investors. Under the Securities Purchase Agreement, the Company sold Notes in the aggregate principal amount of $4,990,000 together with 10 attached shares of Series A Convertible Preferred Stock for $1,000 per share. The Company used approximately $2.6 million of the net proceeds under the Securities Purchase Agreement to repay the Bank as described above. The balance of the net proceeds are being used for vendor payments, working capital, capital expenditures, and other general corporate purposes. The Notes and attached shares of Series A Convertible Preferred Stock are convertible at the option of the holders into shares of Series B Convertible Preferred Stock, which in turn are convertible at the option of the holders into shares of the Company’s common stock at a price of $5.00 per share. Assuming (i) the conversion of the Notes and Series A Convertible Preferred Stock into Series B Convertible Preferred Stock and (ii) conversion of the Series B Convertible Preferred Stock into Common Stock, the Palm Investors beneficially own in the aggregate 1,000,000 shares of Common Stock, representing approximately 34.8% of the Company’s outstanding shares of Common Stock.

 

Upon the occurrence of a Fundamental Transaction, as defined in the Notes, the Company must repay all unpaid principal amount of the Notes plus an amount equal to all accrued and unpaid interest and the amount of interest that would have been paid from the date of such repayment through the maturity date had the Notes remained outstanding to such date (a “Mandatory Prepayment”).  A Fundamental Transaction includes, among other things, one or more related transactions that result in holders of the Company’s common stock immediately prior to such transactions owning 50% or less of the surviving company or owning relative interests in the surviving company that are not substantially the same as prior to such transactions, liquidation or dissolution of the Company, or a change in the majority of the Board over a 12 month period.  Other than in connection with a Mandatory Prepayment, the Notes may not be prepaid by the Company without the consent of holders of the majority of the Notes.

The Notes mature on September 30, 2023 and accrue interest on a quarterly basis at a rate of 5% per annum until December 28, 2020. Thereafter, interest accrues on a quarterly basis at a rate of (i) 5% per annum if the VWAP (as defined in the Notes) for each of any 30 consecutive Trading Days (as defined in the Notes) during the immediately preceding quarter is less than $15 per share of Common Stock, (ii) 2.5% per annum if the VWAP for each of any 30 consecutive Trading Days during the immediately preceding quarter is equal to or greater than $15 per share of Common Stock and equal to or less than $20 per share of Common Stock, and (iii) 0% if the VWAP for each of any 30 consecutive Trading Days during the immediately preceding quarter exceeds $20 per share of Common Stock. Subject to the terms of the Subordination Agreement (described below), which prohibits the payment of cash interest unless the Total Cash Flow Leverage Ratio, as defined in the Fifth Amendment, is less than 2:1, the Company has the option to pay interest in cash or by increasing the principal amount of the Notes in the amount of any unpaid and accrued interest. Approximately $63,000 was recognized as interest expense during the quarter ended March 31, 2018 and the increased liability is included in convertible senior subordinated secured notes, net on the accompanying condensed consolidated balance sheets.

Certain terms of the Notes (the “Embedded Derivatives”) meet the definition of a derivative that requires bifurcation from the Notes and separate accounting under ASC Topic 815, Derivatives and Hedging. The Embedded Derivatives consist of variable interest rate and make-whole features. Because the Embedded Derivatives are to be classified together as a liability and separated from the Notes, the Company recognized a discount on the Notes as of the closing date of approximately $170,000, which will be amortized to interest expense over the term of the Notes.  As of March 31, 2018, the fair value of the Embedded Derivatives approximated the fair value at the date of issuance and is included in other long-term obligations in the accompanying condensed consolidated balance sheets.  See Note 7 for additional information regarding the Embedded Derivatives.

Concurrent with the Securities Purchase Agreement and the Fifth Amendment, the Company, the Bank and the Palm Investors entered into a Subordination Agreement and the Company and the Palm Investors entered into a Security Agreement and Registration Rights Agreement. Under the Subordination Agreement, the Palm Investors and their successors in interest subordinated their rights under the Notes, the Series A Convertible Preferred Stock and the Series B Convertible Preferred Stock to the Bank in respect of the Credit Facility. Under the Security Agreement, the Company granted the holders of the Notes a subordinate security interest in substantially all of the Company’s assets. Under the Registration Rights Agreement, the Company granted the Palm Investors and their successors in interest the right to demand registration under the Securities Act of 1933, as amended, of the resale of the shares of Common Stock underlying the Series B Convertible Preferred Stock. The Company also granted certain “piggy-back” registration rights in the Registration Rights Agreement.

 

(8)	DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

 

ASC Topic 825, ''Disclosures About Fair Value of Financial Instruments,'' requires disclosure about the fair value of financial instruments. Carrying amounts for all financial instruments included in current assets and current liabilities approximate estimated fair values due to the short maturity of those instruments. The fair values of the Company's long-term debt are based on similar rates currently available to the Company.  The Company believes the book value approximates fair value for the notes receivable.

The Company follows ASC Topic 820, “Fair Value Measurements and Disclosures,” which defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements.  The statement establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company.  Unobservable inputs are inputs that reflect the Company’s assumptions of what market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.  The hierarchy is broken down into three levels based on the reliability of the inputs as follows:

 

Level 1:

Quoted prices are available in active markets for identical assets or liabilities.

Level 2:

Quoted prices in active markets for similar assets and liabilities that are observable for the asset or liability; or

Level 3:

Unobservable pricing inputs that are generally less observable from objective sources, such as discounted cash flow models or valuations.

ASC Topic 820 requires financial assets and liabilities to be classified based on the lowest level of input that is significant to the fair value measurement.  The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels. There were no transfers between the fair value hierarchy levels during the quarters ended March 31, 2018 and 2017.

The following table represents the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2017 and March 31, 2018 by level within the fair value hierarchy:

 

As part of an Office acquisition completed in 2009, the Company recorded contingent liabilities to recognize an estimated amount to be paid as part of the acquisition agreement.  These contingent liabilities are recorded at estimated fair values as of the date of acquisition, are payable upon the exercise of a put option by the seller beginning four years after the acquisition date and no later than ten years after the acquisition date, and are calculated at a multiple of the then trailing 12 months’ operating cash flows.  The Company remeasures the contingent liability to fair value each reporting date until the contingency is resolved.  Any changes to the fair value are recognized into the income statement when determined.  As of March 31, 2018, approximately $321,000 of contingent liabilities were recorded on the condensed consolidated balance sheets in other long-term obligations.

 

Embedded Derivatives derived from the Notes are a derivative liability bifurcated from the Notes, as described in Note 6.  The fair value of the Embedded Derivatives was determined as the difference in the fair values of the Notes with and without the embedded features.  The fair value analysis utilized Monte Carlo simulations and probability-weighted discounted cash flow valuation techniques, which included the use of significant unobservable inputs. Those inputs included assumptions regarding the likelihood of occurrence of a Fundamental Transaction and projected financial results of the Company over the term of the Notes.  Other significant inputs included the Company’s historical stock price volatility and risk-adjusted borrowing rates.

 

 

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

 

Contingent liabilities

 

The significant unobservable input used in fair value measurement of the Company’s contingent liability is  the operating cash flow of one Office where the dentist has a put option whose value is calculated based on that Office’s operating cash flow over a 12 month period.  A significant increase or decrease in the performance of this Office would result in a significant change in the fair value measurement.

 

Embedded Derivatives derived from the Notes

 

The significant unobservable input used in fair value measurement of the Company’s embedded derivatives derived from the Notes is the estimated likelihood of a Fundamental Transaction.  A significant increase or decrease in the likelihood of a Fundamental Transaction taking place would result in a significant change in the fair value measurement.

 

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 (the “Securities Act”), 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 fact, 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 Company’s prospects and performance in future periods, including improvement in operating results, revenue and Adjusted EBITDA (as defined herein), the amount of bank debt, compliance with debt covenants, performance of de novo offices, the payment or nonpayment of dividends on its Common Stock, dentist count, dentist turnover and recruitment, dentist productivity, new patient visits and patient flow and the impact of certain shareholder matters.

Investors and prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties. 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 the failure to successfully recruit, retain and integrate dentists and other employees, the Company’s indebtedness and potential actions by its lending bank or the holders of its convertible securities, financial and credit markets and the availability of capital, actions by shareholders, competition, regulatory constraints, changes in health care laws and other  laws or regulations concerning the practice of dentistry or dental service organizations, the availability of suitable locations within the Company’s markets, changes in the Company’s strategy, the general economy of the United States and the specific markets in which the Company’s dental practices are located, trends and other developments 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, 2017, and other factors as may be identified from time to time in the Company’s filings with the Securities and Exchange Commission (“SEC”) 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 ended March 31, 2018 and 2017. 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 68 Offices in Colorado, New Mexico and Arizona staffed by 79 general dentists and 28 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 selective acquisitions.

 

Recent Developments

Private Placement and Debt Restructuring

Factors and Events That Led to the Debt Restructuring. During 2016 and 2017, the Company experienced losses and decreasing liquidity. The Company believes these results were caused by the following factors, among others, some of which are interrelated: Losses from several de novo Offices recently opened by the Company; a decrease in the number of dentists in the network from 116 dentists as of December 31, 2015 to a low of 98 dentists as of September 30, 2016 and December 31, 2016; and actions by a shareholder activist group including a threatened proxy contest, which were highly distracting to the management and employees of the Company and resulted in significant expenses for the Company.

On March 30, 2017, the Company and Guaranty Bank and Trust Company (the “Bank”) entered into an amendment to the Loan and Security Agreement, dated March 29, 2016 as amended (collectively, the “Loan Agreement” or the “Credit Facility”).  The March 2017 amendment to the Credit Facility included a forbearance by the Bank (the “Forbearance Agreement”) regarding covenant defaults by the Company with respect to the then-existing funded debt-to-EBITDA ratio, fixed charge coverage ratio and EBITDA. On July 21, 2017, the Company received notice of events of default and acceleration (the “Notice Letter”) from counsel to the Bank in connection with the Loan Agreement.  The Notice Letter asserted events of default resulting from the Company’s failure to produce EBITDA of at least $870,000 for the second quarter of 2017 and to reduce the dollar amount of the outstanding reducing revolving loan by at least $500,000 on June 30, 2017.  The Notice Letter further asserted that, as a result of these events of default, earlier events of default regarding coverage ratios and EBITDA to which the Forbearance Agreement applied again existed.

In the Notice Letter, the Bank also declared all obligations of the Company to be immediately due and payable and demanded payment in full of all obligations. The Notice Letter further stated that, although the Bank was not presently exercising its other rights and remedies available upon an event of default, it reserved its right to do so at any time in its sole discretion.

The Company subsequently failed to reduce the dollar amount of the outstanding reducing revolving line of credit under the Credit Facility by at least $500,000 on September 30, 2017. The Company’s revolving line of credit with the Bank was reduced from $1.4 million to $1.1 million on October 1, 2017 as required by the Forbearance Agreement.

The Private Placement. On December 28, 2017, following discussions and negotiations with the Bank and a number of potential investors and lenders, the Company entered into a Securities Purchase Agreement (“the Securities Purchase Agreement”) and completed a private placement of $5 million of convertible senior subordinated secured notes (the “Notes”) and ten attached shares of Series A Convertible Preferred Stock with Palm Active Dental, LLC and Palm Global Small Cap Master Fund LP (the “Palm Investors”). The Notes and shares of Series A Convertible Preferred Stock are convertible at the option of the holders into shares of Series B Convertible Preferred Stock, which in turn are convertible at the option of the holders into shares of the Company’s Common Stock at a price of $5.00 per share. Each share of Series A Preferred Stock entitles the holder to 100,000 votes per share.  Assuming (i) the conversion of the Notes and Series A Convertible Preferred Stock into Series B Convertible Preferred Stock and (ii) conversion of the Series B Convertible Preferred Stock into Common Stock, the Palm Investors beneficially own in the aggregate 1,000,000 shares of Common Stock, representing approximately 34.8% of the Company’s outstanding shares of Common Stock. The Company used approximately $1.5 million of the net proceeds under the Securities Purchase Agreement to pay down the term loan portion and $1.1 million to pay down the reducing revolving loan of the Loan Agreement as described below. The balance of the net proceeds is being used for vendor payments, working capital, capital expenditures, and other general corporate purposes.

The Securities Purchase Agreement, the Notes, the articles of amendment for the Series A Convertible Preferred Stock, and the articles of amendment for the Series B Convertible Preferred Stock (collectively, the “Investment Documents”) contain covenants that, among other things, prohibit the Company from incurring debt, except Permitted Indebtedness (as defined in the Investment Documents), permitting the existence of liens, other than Permitted Liens, issuing securities, other than under an Approved Stock Plan or Excluded Securities (each, as defined in the Investment Documents), with a purchase, conversion, exchange, or exercise price less than the conversion price of the Notes, the Series A Convertible Preferred Stock, and the Series B Convertible Preferred Stock, issuing additional securities with rights senior or on par with the Notes, the Series A Convertible Preferred Stock, or the Series B Convertible Preferred Stock, paying dividends or distributions on the Company’s capital stock (other than on the Series A Convertible Preferred Stock and Series B Convertible Preferred Stock), or selling any of the Company’s managed professional corporations or any assets, except in the ordinary course of business.

 

The Investment Documents also provide that as long as any amounts remain due under the Notes or any Series A Convertible Preferred Stock or Series B Convertible Preferred Stock remain outstanding, the holders of the Notes, the Series A Convertible Preferred Stock, and the Series B Convertible Preferred Stock, voting as separate class, have the right to elect two members to the Company’s Board, which number increases to three if the Company fails to meet performance targets as discussed below.

The Notes mature on September 30, 2023 and accrue interest on a quarterly basis at a rate of 5% per annum until December 28, 2020. Thereafter, interest accrues on a quarterly basis at a rate of (i) 5% per annum if the VWAP (as defined in the Notes) for each of any 30 consecutive Trading Days (as defined in the Notes) during the immediately preceding quarter is less than $15 per share of Common Stock, (ii) 2.5% per annum if the VWAP for each of any 30 consecutive Trading Days during the immediately preceding quarter is equal to or greater than $15 per share of Common Stock and equal to or less than $20 per share of Common Stock, and (iii) 0% if the VWAP for each of any 30 consecutive Trading Days during the immediately preceding quarter exceeds $20 per share of Common Stock. Subject to the terms of the Subordination Agreement (described below), which prohibits the payment of cash interest unless the Total Cash Flow Leverage Ratio, as defined in the Fifth Amendment (described below), is less than 2:1, the Company has the option to pay interest in cash or by increasing the principal amount of the Notes in the amount of any unpaid and accrued interest.

Holders of the Series A Convertible Preferred Stock and Series B Convertible Preferred Stock are entitled to receive dividends on a quarterly basis at a rate of 5% per annum until December 28, 2020. Thereafter, dividends accrue on a quarterly basis at the same rates as interest for the Notes as described above. Subject to the terms of the Subordination Agreement, which prohibits the payment of cash dividends unless the Total Cash Flow Leverage Ratio is less than 2:1, the Company has the option to pay dividends in cash or by issuing additional shares of preferred stock in the amount of any unpaid and accrued interest. Shares of Series A Preferred Stock and Series B Preferred Stock may be redeemed at any time at the option of the holder beginning on the sixth anniversary date of the date of issuance of the Notes and the shares of Series A Preferred Stock.

Concurrent with the Securities Purchase Agreement, the Company, the Bank, and the Palm Investors entered into a Subordination Agreement and the Company and the Palm Investors entered into a Security Agreement and Registration Rights Agreement. Under the Subordination Agreement, the Palm Investors and their successors in interest subordinated their rights under the Notes, the Series A Convertible Preferred Stock and the Series B Convertible Preferred Stock to the Bank in respect of the Credit Facility. Under the Security Agreement, the Company granted the holders of the Notes a subordinate security interest in substantially all of the Company’s assets. Under the Registration Rights Agreement, the Company granted the Palm Investors and their successors in interest the right to demand registration under the Securities Act of the resale of the shares of Common Stock underlying the Series B Convertible Preferred Stock. The Company also granted certain “piggy-back” registration rights in the Registration Rights Agreement.

In connection with the investment by the Palm Investors, two Palm representatives, Joshua S. Horowitz and Bradley Tirpak, were appointed to the Company’s Board, replacing Brooks G. O’Neil and Dennis N. Genty, the Company’s Chief Financial Officer, both of whom resigned from the Board. Additionally, if the Company fails to meet certain performance targets set forth in the Securities Purchase Agreement, the Palm Investors have the exclusive right, voting separately as a class, to designate to the Board a third Palm Investor director, in which case the Board must take all actions necessary to cause and accept the resignation of one additional current director and cause such third Palm Investor director to be appointed as a director.  Further, if the Company (a) fails to meet any of the modified performance targets set forth in the Securities Purchase Agreement or (b) fails to comply with a financial covenant under the Loan Agreement, the Board is required to immediately form a special committee of the Board with (i) the power to initiate searches for, and to recruit, retain or replace the Chief Executive Officer, Chief Financial Officer and Chief Operating Officer of the Company, (ii) the ability to retain an executive search firm, at the Company’s expense, to manage any search for Chief Executive Officer, Chief Financial Officer and Chief Operating Officer initiated by the search committee, and (iii) the ability to engage such advisors, at the Company’s expense, as necessary to assist with the search committee’s efforts. Any search committee created due to the Company’s failure to meet any of the modified performance targets will be chaired by one of the Palm Investor directors and consist solely of independent directors, while any search committee created due to the Company’s failure to comply with the financial covenants will be composed of a majority of Palm Investor directors.

 

The Debt Restructuring.  Also on December 28, 2017, the Company and the Bank entered into the Fifth Amendment to the Loan Agreement (“Fifth Amendment”), under which the Company repaid approximately $1.5 million under the term loan portion and $1.1 million under the revolving line of credit of the Loan Agreement and the Bank waived all then-existing defaults, default interest, fees, and penalties under the Credit Facility. Among other things, the Fifth Amendment increased the revolving line of credit from $1.1 million to $2 million, extended the maturity date of the loans under the Credit Facility to March 31, 2023 and modified the repayment terms of the term loan and the EBITDA, leverage ratio and other financial covenants under the Credit Facility. For a discussion of other terms of the Fifth Amendment and the terms of the Notes, see Note 6 to the notes to condensed consolidated financial statements.

As of March 31, 2018, $6.375 million was outstanding under the Credit Facility. Under the Credit Facility and related pledge and security agreements, the Bank has liens and security interests on substantially all of the assets of the Company.  There are also subordinated liens and security interests in favor of the holders of the Notes. Any failure by the Company to maintain compliance with the Credit Facility in the future, including compliance with the EBITDA, leverage ratio and other financial covenants under the Credit Facility, could have a material adverse effect on the Company.

Recent Business Developments

The Company’s management and Board, which now includes two representatives of the Palm Investors and two directors who were appointed in 2017 in connection with settlement of a potential proxy contest, are intensely focused on improving the Company’s financial performance. In addition to promoting GOLD STANDARD patient care and service every day with every patient throughout the organization, management and the Board are actively supporting efforts not only to recruit dentists to increase the dentist count but also to retain the best dental professionals in the country through attractive compensation and benefits arrangements and support of dentists to grow their practices. The Company also is looking to improve dentist productivity through extended office hours and targeted technology improvements and capital expenditures including converting to digital radiography all Offices, migration of records to the cloud and improvements to the Company’s website to attract and retain new patients. The Company also is looking to improve its accounts receivable and collections processes.

Related in part to the factors noted previously, the Company believes much of the decline in revenue, earnings before interest, taxes, depreciation, amortization, stock-based compensation expense, stock grant expense and change in fair value of contingent liabilities (“Adjusted EBITDA”) and liquidity has been driven by a decrease in the number of dentists in the network from 116 dentists as of December 31, 2015 to a low of 98 dentists at September 30, 2016 and December 31, 2016.  The following table shows the Company’s dentist count since December 31, 2015.

In March 2018, the Company hired a new experienced dentist recruiter to replace its most recent dentist recruiter who departed in February 2018.  The Company believes the new dentist recruiter will continue the dentist hiring momentum established by the previous recruiter in the second half of 2017. In January 2017, the Company added a highly experienced Chief Dental Officer to work directly with its network dentists in their offices, which the Company believes will help reduce dentist turnover, improve dentist performance and enhance dentist recruitment going forward.  In addition, the Company has begun to offer equity buy-in opportunities for dentists, which it believes will also aid in recruiting and retaining dentists and reducing dentist turnover. The Company believes that these were contributing factors in the increase in dentist count from 99 at June 30, 2017 to 107 at March 31, 2018.  The Company believes it has now achieved more stability in its affiliated dentists.

 

Management is also continuously seeking to reduce expenses and, on February 1, 2017, the Company’s Chief Executive Officer, Chief Financial Officer and outside directors all took 20 percent reductions in base salary and director fees, respectively, amounting to approximately $175,000 in annual expense savings.  Additionally, one of the Company’s two offices in Fort Collins, Colorado that had negative Adjusted EBITDA of $78,000 in 2016 was consolidated with a newer second office at the end of January 2017.  The Company is aggressively considering other actions to reduce expenses and improve profitability including the sale of one of its Colorado offices that had negative Adjusted EBITDA of $182,000 in 2017. The Company has taken other actions to reduce expenses and improve profitability. These efforts, which commenced in September 2017, included suspension of certain bonus programs and the Company’s contribution to the 401(k) plan along with the elimination of certain support personnel in the dental offices.

Revenue increased 3.1% in the fourth quarter of 2017 compared to the same quarter in 2016 after increasing 2.6% in the third quarter of 2017 compared to the third quarter of 2016.  The increase in revenue in each of the third and fourth quarters of 2017 over the same quarters in 2016 represented the first time in ten quarters that the Company achieved consecutive quarterly year-over-year increases in revenue. Revenue increased by 1% in the first quarter of 2018 compared to the same quarter in 2017. The Company believes these results are directly related to the Company increasing its dentist count as disclosed in “Recent Developments” above.

Additionally, the Company continues to experience strong patient flow with new patient visits up  5.9% in the first quarter of 2018 compared to the first quarter  of 2017 and total patient visits up 4.6% in the first quarter of 2018 compared to the first quarter of 2017.

In January 2016, the Company started the process of credentialing some of its Offices for Medicaid, a revenue source that the Company had not previously accessed.  As of March 31, 2018, the Company had 31 Offices credentialed for Medicaid in Colorado and five Offices credentialed for Medicaid in New Mexico.  Revenue from Medicaid accounted for 2.9% of the Company’s revenue in the quarter ended March 31, 2017 and 5.0% in the quarter ended March 31, 2018. The Company expects revenue from Medicaid to continue to  increase in 2018.

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, 2017.  There have been no significant 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.

Direct expenses consist of clinical salaries and benefits paid to dentists, dental hygienists 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 on 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. 

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 selective 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 90 days old.  Patient accounts receivable that are over 120 days past due and that appear to not be collectible are written off as bad debt, and those in excess of $100 are sent to an outside collections agency.

 

Results of Operations

For the quarter ended March 31, 2018, revenue increased $161,000, or 1.0%, to $15.8 million compared to $15.7 million for the quarter ended March 31, 2017.  For the quarter ended March 31, 2018, net loss increased $253,000 to $(478,000), or $(.25) per share, compared to $(225,000), or $(0.12) per share, for the quarter ended March 31, 2017.

The Company continues to experience strong patient flow with new patient visits up 5.9% in the first quarter of 2018 compared to the first quarter of 2017 and total patient visits up 4.6% in the first quarter of 2018 compared to the first quarter of 2017.  The Company had 107 dentists at March 31, 2018 compared to 112 dentists at December 31, 2017 and 102 dentists at March 31, 2017.

During the quarter ended March 31, 2018, the Company generated $300,000 of cash from operations.  During this period, the Company had capital expenditures of approximately $126,000.

The Company’s Adjusted EBITDA decreased $385,000, or 49.6%, to $392,000 for the quarter ended March 31, 2018 compared to $777,000 for the quarter ended March 31, 2017.  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 loss is made by adding depreciation and amortization expense - Offices, depreciation and amortization expense – Corporate, stock-based compensation expense, interest expense, net and income tax benefit to net loss as in the following table:

 

The following table sets forth the percentages of revenue represented by certain items reflected in the Company’s condensed consolidated statements of operations. 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.  Percentage amounts may not add due to rounding.

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

		Quarters Ended March 31,
		2017				2018
Revenue			100.0	%			100.0	%
Direct Expenses:
Clinical salaries and benefits			60.4	%			62.1	%
Dental supplies			4.0	%			4.4	%
Laboratory fees			5.6	%			5.6	%
Occupancy			9.9	%			10.2	%
Advertising and marketing			1.1	%			0.8	%
Depreciation and amortization			6.2	%			4.9	%
General and administrative			8.1	%			8.4	%
			95.3	%			96.5	%
Contribution from dental offices			4.7	%			3.5	%
Corporate Expenses:
General and administrative			6.1	%	(1)		6.3	%	(1)
Depreciation and amortization			0.3	%			0.2	%
Operating loss			( 1.7	)%			( 2.7	)%
Interest expense			0.5	%			1.0	%
Loss before income taxes			( 2.2	)%			( 4.0	)%
Income tax benefit			( 0.7	)%			( 1.0	)%
Net loss			( 1.4	)%			( 3.0	)%

 

(1)

Corporate expenses - general and administrative includes $35,236 and $52,976 of stock-based compensation expense pursuant to ASC Topic 718 for the quarters ended March 31, 2017 and 2018, respectively.

 

Quarter Ended March 31, 2018 Compared to Quarter Ended March 31, 2017:

 

Revenue

For the quarter ended March 31, 2018, revenue increased $161,000, or 1.0%, to $15.8 million compared to $15.7 million for the quarter ended March 31, 2017. 

Direct expenses

 

Clinical salaries and benefits. For the quarter ended March 31, 2018, clinical salaries and benefits increased $354,000, or 3.7%, to $9.8 million compared to $9.5 million for the quarter ended March 31, 2017.  This increase in clinical salaries and benefits is related to increases of $315,000 in dentist wages, $70,000 in support personnel wages, and $35,000 in hygienist wages offset by decreases of $56,000 in 401(k) match expense and $29,000 in contract labor expense. As a percentage of revenue, clinical salaries and benefits increased to 62.1% for the quarter ended March 31, 2018 compared to 60.4% for the quarter ended March 31, 2017.

 

Dental supplies. For the quarter ended March 31, 2018, dental supplies increased to $696,000 compared to $628,000 for the quarter ended March 31, 2017, an increase of $68,000, or 10.8%.  This increase is directly related to the increase in revenue during the quarter ended March 31, 2018.  There were increases of $68,000 in general dental supplies and $11,000 in specialty dental supplies offset by a decrease of $11,000 in hygiene dental supplies. As a percentage of revenue, dental supplies increased to 4.4% for the quarter ended March 31, 2018 compared to 4.0% for the quarter ended March 31, 2017.

 

Laboratory fees. For the quarter ended March 31, 2018, laboratory fees increased to $883,000 compared to $881,000 for the quarter ended March 31, 2017, an increase of $2,000, or 0.3%.  As a percentage of revenue, laboratory fees remained constant at  5.6% for the quarters ended March 31, 2018

and March 31, 2017.

 

Occupancy. For the quarter ended March 31, 2018, occupancy expense increased $64,000, or 4.1%, to $1.6 million compared to the quarter ended March 31, 2017.  This increase is primarily related to increases in rent expense and other landlord reimbursable expenses such as common area maintenance, insurance and property taxes.  As a percentage of revenue, occupancy expense increased to 10.2% for the quarter ended March 31, 2018 compared to 9.9% for the quarter ended March 31, 2017.

 

Advertising and marketing. For the quarter ended March 31, 2018, advertising and marketing expenses decreased to $131,000 compared to $170,000 for the quarter ended March 31, 2017, a decrease of $38,000, or 22.6%. The decrease in advertising and marketing expenses is attributable to a decrease in internet and social media advertising.  As a percentage of revenue, advertising and marketing expenses decreased to 0.8% for the quarter ended March 31, 2018 compared to 1.1% for the quarter ended March 31, 2017.  The Company regularly adjusts its advertising and marketing expenditures in response to market conditions and performance in individual markets.

 

Depreciation and amortization-Offices.  For the quarter ended March 31, 2018, depreciation and amortization expenses attributable to the Offices decreased to $779,000 compared to $965,000 for the quarter ended March 31, 2017, a decrease of $186,000, or 19.3% as additional assets became fully depreciated.  As a percentage of revenue, depreciation and amortization expense decreased to 4.9% for the quarter ended March 31, 2018 compared to 6.2% for the quarter ended March 31, 2017.

 

General and administrative-Offices.  For the quarter ended March 31, 2018, general and administrative expenses attributable to the Offices increased $72,000, or 5.7%, to $1.3 million compared to the quarter ended March 31, 2017.  The increase in general and administrative expenses is attributable to increases of $27,000 in bad debt expense, $27,000 for the settlement of a civil lawsuit,  $25,000 in equipment repairs and maintenance expense, and $16,000 in recruiting expenses offset by decreases of $14,000 in travel expenses and $10,000 in malpractice insurance expense.  As a percentage of revenue, general and administrative expenses increased to 8.4% for the quarter ended March 31, 2018 compared to 8.1% for the quarter ended March 31, 2017.

 

Contribution from dental Offices

 

As a result of revenue increasing $161,000 and direct expenses increasing $335,000 during the quarter ended March 31, 2018, contribution from dental Offices decreased $175,000, or 23.7%, to $562,000 for the quarter ended March 31, 2018 compared to $736,000 for the quarter ended March 31, 2017.  As a percentage of revenue, contribution from dental Offices decreased to 3.5% for the quarter ended March 31, 2018 compared to 4.7% for the quarter ended March 31, 2017.

 

Corporate expenses

 

Corporate expenses - general and administrative. For the quarter ended March 31, 2018, Corporate expenses – general and administrative  increased to approximately $1.0 million compared to $959,000 for the quarter ended March 31,2017, an increase of approximately $42,000, or 4.4% .  Health insurance expense increased $66,000, auditor fees increased $35,000, stock-based compensation expense pursuant to ASC Topic 718 increased $18,000, corporate wages increased $13,000 and recruiting fees increased $10,000. These increases were offset by decreases in legal fees of $26,000 and other professional fees of $72,000.   During the quarter ended March 31, 2018, the Company had $66,500 in one-time expenses  associated with accounting and valuation consulting services related to the $5 million  financing completed in December 2017.  As a percentage of revenue, corporate expenses - general and administrative increased to 6.3% for the quarter ended March 31, 2018 compared to  6.1% for the quarter ended March 31, 2017.

 

Corporate expenses - depreciation and amortization. For the quarter ended March 31, 2018, corporate expenses - depreciation and amortization decreased to $33,000 compared to $46,000 for the quarter ended March 31, 2017, a decrease of $13,000, or 27.6% as additional assets became fully depreciated.   As a percentage of revenue, corporate expenses – depreciation and amortization decreased to 0.2% for the quarter ended March 31, 2018 compared to 0.3% for the quarter ended March 31, 2017.

 

Operating loss

 

As a result of the matters discussed above, the Company’s operating loss increased by $204,000 to $(473,000) for the quarter ended March 31, 2018 compared to $(269,000) for the quarter ended March 31, 2017.  As a percentage of revenue, operating loss increased to (3.0%) for the quarter ended March 31, 2018 compared to (1.7%) for the quarter ended March 31, 2017.

 

Interest expense, net

 

For the quarter ended March 31, 2018, interest expense, net increased to $164,000 compared to $72,000 for the quarter ended March 31, 2017, an increase of $92,000, or 126.6%.  This increase in interest expense, net is related to $63,000 of interest expense on the convertible senior subordinated secured note and higher interest rates on the Credit Facility.  As a percentage of revenue, interest expense increased to 1.0% for the quarter ended March 31, 2018 compared to 0.5% for the quarter ended March 31, 2017.

 

Net loss

 

As a result of the above, the Company’s net loss was $(478,000) for the quarter ended March 31, 2018 compared to $(225,000) for the quarter ended March 31, 2017, an increase of $253,000, or 112.4%.  Net loss for the quarter ended March 31, 2018 was net of income tax benefit of $(159,000), while net loss for the quarter ended March 31, 2017 was net of income tax benefit of $(117,000).  The effective tax rate for the quarter ended March 31, 2018 was 25.0%, while the effective tax rate for the quarter ended March 31, 2017 was 34.0%.  As a percentage of revenue, net loss increased to (3.0%) for the quarter ended March 31, 2018 compared to (1.4%) for the quarter ended March 31, 2017.

 

Liquidity and Capital Resources

 

The Company has financed its operations and growth primarily through a combination of cash provided by operating activities and bank credit facilities and term loans. During 2016 and 2017, the Company experienced losses and decreasing liquidity. The factors that contributed to the losses, along with the events leading up to the Company’s events of default under the Credit Facility and the private placement and the restructuring of the Credit Facility to cure the defaults, along with the terms of the private placement and restructuring, are discussed in “Recent Developments” above. As of March 31, 2018, the Company had a working capital deficit of approximately $1.1 million, an accumulated deficit of $4.1 million and a cash balance of $2.0 million.

 

Net cash provided by operating activities was approximately $300,000 and $854,000 for the quarters ended March 31, 2018 and 2017, respectively.  During the quarter ended March 31, 2018, excluding net loss and after adding back non-cash items, the Company’s cash provided by operating activities consisted primarily of an increase of approximately $328,000 in accounts payable and accrued expenses offset by increases of approximately $262,000 in prepaid expenses and other assets and $177,000 in accounts receivable.  During the quarter ended March 31, 2017, excluding net loss and after adding back non-cash items, the Company’s cash provided by operating activities consisted primarily of increases of approximately $775,000 in accounts payable and accrued expenses, $122,000 in income taxes payable and $18,000 in prepaid expenses and other assets, offset by an increase in accounts receivable of approximately $797,000.

 

Net cash used in investing activities was approximately $118,000 and $148,000 for the quarters ended March 31, 2018 and 2017, respectively.  For the quarter ended March 31, 2018, the Company invested approximately $126,000 in capital expenditures, offset by a decrease in a note receivable of $8,000. For the quarter ended March 31, 2017, the Company invested approximately $156,000 in capital expenditures, offset by a decrease in a note receivable of $8,000.

 

Net cash used in financing activities was approximately $62,000 and $655,000 for the quarters ended March 31, 2018 and 2017, respectively.  During the quarter ended March 31, 2018, net cash used in financing activities was comprised of approximately $125,000 used to pay down the Credit Facility offset by approximately $63,000 of accrued interest on the Notes. During the quarter ended March 31, 2017, net cash used in financing activities was comprised of approximately $655,000 used to pay down the Credit Facility. 

 

As of March 31, 2018, the Company had the following debt and lease obligations:

 

						Payments due by Period
		Total				1 year				2-3 years				4-5 years				More than 5 years
Debt obligations		$	11,427,635			$	800,000			$	2,225,000			$	3,350,000			$	5,052,635
Operating lease obligations			15,807,477				4,337,541				6,624,650				3,047,652				1,797,634
Total		$	27,235,112			$	5,137,541			$	8,849,650			$	6,397,652			$	6,850,269

 

The Company has historically operated with negative working capital and prior to 2017 was able to meet its current obligations through operating cash flows and availability on its revolving lines of credit.  The Company believes that the net proceeds from the private placement completed in December 2017, cash generated from operations and borrowings under the revolving line of credit, which was increased from $1.1 million to $2.0 million under the Fifth Amendment, will be sufficient to fund its anticipated working capital needs and capital expenditures for at least the next 12 months.  In order to meet its long-term liquidity needs, the Company may need to issue additional equity or debt securities or engage in other borrowings or financing activities, subject to market and other conditions.  The Credit Facility and the Investment Documents contain covenants that, among other things, significantly limit the Company’s ability to incur or issue debt or equity securities. There can be no assurance that such additional financing will be available on terms acceptable to the Company or at all. 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.

 

 

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 March 31, 2017.  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 March 31, 2018.

There has been no change in the Company’s internal control over financial reporting during the three months ended March 31, 2018 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

Issuer Purchases of Equity Securities

The Company’s stock repurchase program has been in place for more than ten years, and there is no expiration date for the program.  As of March 31, 2018, the dollar value of shares that may be purchased under the stock repurchase program was approximately $876,000.  However, Common Stock repurchases are prohibited under the Credit Facility and the Company did not purchase any shares of its Common Stock during the quarter ended March 31, 2018.

 

 

 

Exhibit Number

Description of Document

 

*	Furnished herewith.

P	Filed on paper

 

SIGNATURES

 

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.

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