SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
[ ] 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: 1-13263
CASTLE DENTAL CENTERS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0486898
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1360 POST OAK BOULEVARD, SUITE 1300 77056
HOUSTON, TEXAS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code: (713) 479-8000
N/A
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
YEAR)
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 [ ]
The number of shares of Common Stock issued and outstanding, par value,
$0.001 per share, as of November 9, 1999 was 6,417,206.
<PAGE>
CASTLE DENTAL CENTERS, INC.
INDEX
<TABLE>
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PAGE
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PART I. FINANCIAL INFORMATION
Item 1.Financial Statements (Unaudited)
Consolidated Balance Sheets
December 31, 1998 and September 30, 1999 ............................. 3
Consolidated Statements of Operations
For the Three Months and Nine Months Ended September 30, 1998 and 1999 4
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 1998 and 1999 ................ 5
Notes to Consolidated Financial Statements ........................... 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations ..................... 9
PART II .......................................................................
Item 1. Legal Proceedings ............................................ 16
Item 2. Changes in Securities and Use of Proceeds .................... 16
Item 3. Defaults Upon Senior Securities .............................. 16
Item 4. Submission of Matters to a Vote of Security Holders .......... 16
Item 5. Other Information ............................................ 16
Item 6. Exhibits and Reports on Form 8-K ............................. 16
SIGNATURES .................................................................... 17
</TABLE>
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<PAGE>
PART I: FINANCIAL INFORMATION
CASTLE DENTAL CENTERS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1998 1999
-------------- --------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 695 $ 286
Patient receivables, net......................................................... 10,700 17,599
Unbilled patient receivables, net................................................ 3,251 4,445
Prepaid expenses and other current assets........................................ 2,887 4,399
Deferred income taxes............................................................ 1,809 1,809
-------------- --------------
Total current assets...................................................... 19,342 28,538
-------------- --------------
Property and equipment, net............................................................ 13,861 20,019
Intangible assets, net................................................................. 65,956 64,528
Other assets........................................................................... 876 923
-------------- --------------
Total assets............................................................... $ 100,035 $ 114,008
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt and capital lease obligations.................. $ 1,795 $ 1,814
Accounts payable and accrued liabilities......................................... 6,676 10,251
Deferred compensation payable, related party..................................... 526 526
-------------- --------------
Total current liabilities................................................. 8,997 12,591
-------------- --------------
Long-term debt and capital lease obligations, net of current portion................... 44,411 52,343
Other long-term liabilities, related party............................................. 526 132
Deferred income taxes.................................................................. 5,401 6,225
Commitments and contingencies
Minority interest...................................................................... 4,303 4,354
Stockholders' equity:
Common stock, $.001 par value, 30,000,000 shares authorized;
6,417,206 shares issued and outstanding............................................ 6 6
Additional paid-in capital........................................................... 42,516 42,516
Accumulated deficit.................................................................. (6,125) (4,159)
-------------- --------------
Total stockholders' equity................................................. 36,397 38,363
-------------- --------------
Total liabilities and stockholders' equity............................................. $ 100,035 $ 114,008
============== ==============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
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<PAGE>
CASTLE DENTAL CENTERS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- --------------- -------------- ------------
1998 1999 1998 1999
-------------- --------------- -------------- ------------
<S> <C> <C> <C> <C>
Net patient revenues..................................... $ 20,175 $ 26,092 $ 54,395 $ 76,920
Expenses:
Dentist salaries and other professional costs...... 5,162 6,842 13,447 20,387
Clinical salaries.................................. 4,392 5,323 12,030 16,096
Dental supplies and laboratory fees................ 2,013 2,341 5,279 6,820
Rental and lease expense........................... 1,106 1,598 2,861 4,528
Advertising and marketing.......................... 580 1,138 1,974 2,899
Depreciation and amortization...................... 1,025 1,440 2,632 4,295
Other operating expenses........................... 1,938 1,895 5,196 6,265
General and administrative......................... 1,986 2,890 6,215 7,801
-------------- --------------- -------------- ------------
Total expenses............................... 18,202 23,467 49,634 69,091
-------------- --------------- -------------- -------------
Operating income ........................................ 1,973 2,625 4,761 7,829
Litigation settlement.................................... -- -- -- 1,366
Interest expense......................................... 560 1,140 1,178 3,155
Other expense (income), net.............................. (82) 38 (51) 41
--------------- --------------- --------------- -------------
Income before income taxes............................... 1,495 1,447 3,634 3,267
Provision for income taxes............................... 474 591 1,170 1,301
-------------- --------------- -------------- -------------
Net income ............................................ $ 1,021 $ 856 $ 2,464 $ 1,966
============== =============== ============= =============
Income per common share:
Basic and diluted:
Net income................................... $ 0.15 $ 0. 13 $ 0.38 $ 0. 29
============== =============== ============= =============
Weighted average number of common and
Common equivalent shares outstanding
Basic ........................................... 6,698 6,825 6,535 6,825
============== =============== ============== =============
Diluted............................................ 6,718 6,825 6,544 6,858
============== =============== ============== =============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
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<PAGE>
CASTLE DENTAL CENTERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------
1998 1999
----------------- ----------------
<S> <C> <C>
Net cash provided by operating activities............................................... $ 3,711 $ 357
Investing activities:
Capital expenditures.............................................................. (4,450) (8,352)
Acquisition of affiliated practices, net of cash acquired......................... (17,219) (365)
----------------- ----------------
Net cash used by investing activities................................................... (21,669) (8,717)
----------------- ----------------
Financing activities:
Payments of long-term debt and capital lease obligations.......................... (2,577) (1,249)
Proceeds from debt................................................................ 18,941 9,200
----------------- ----------------
Net cash provided by financing activities............................................... 16,364 7,951
----------------- ----------------
Net change in cash and cash equivalents..................................... (1,594) (409)
Cash and cash equivalents, beginning of period.......................................... 2,908 695
----------------- ----------------
Cash and cash equivalents, end of period................................................ $ 1,314 $ 286
================= ================
Supplemental Cash Flow Information:
Supplemental disclosure of non-cash investing
and financing activities:
Issuance of note payable for purchase of
property and equipment..................................................... $ 276 $ --
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
Castle Dental Centers, Inc. and subsidiaries (the "Company") provide
administrative and management services, non-healthcare personnel, facilities and
equipment to certain professional corporations in Texas, Florida, California and
Tennessee ("affiliated dental practices") under long-term management services
agreements.
The consolidated financial statements include the accounts of the Company and
all wholly-owned and beneficially-owned subsidiaries and the accounts of
affiliated dental practices in which the Company has a long-term controlling
financial interest. Because of corporate practice of medicine laws in the states
in which the Company operates, the Company does not own dental practices but
instead enters into exclusive long-term management services agreements
("Management Services Agreements") with professional corporations that operate
the dental practices. In addition, the Company has the contractual right to
designate, in its sole discretion and at any time, the licensed dentist who is
the majority shareholder of the capital stock of the professional corporation at
a nominal cost ("nominee arrangements"). At September 30, 1999, all of the
affiliated dental practices were wholly-owned by dentists with whom the Company
had a nominee arrangement. Under the Management Services Agreements, the Company
establishes annual operating and capital budgets for the professional
corporations and compensation guidelines for the licensed dental professionals.
The Management Services Agreements have initial terms of twenty-five to forty
years. The management fee charged by the Company to an affiliated dental
practice is intended to reflect and is based on the fair value of the management
services rendered by the Company to the affiliated dental practice. Subject to
applicable law, the management fee earned by the Company, except professional
corporations located in California, is generally comprised of three components:
(i) the costs incurred by it on behalf of the affiliated dental practice; (ii) a
base management fee ranging from 12.5% to 20.0% of patient revenues; and, (iii)
a performance fee equal to the patient revenues of the affiliated dental
practice less (a) the expenses of the affiliated dental practice and (b) the sum
of (i) and (ii), as described in the agreements. In California, the Company is
paid a monthly management fee comprised of two components: (i) the costs
incurred by it on behalf of the affiliated practice and (ii) a management fee in
an amount ranging from 15.0% to 30.0% of net patient revenues. The amount of the
management fee is reviewed by the Company and the affiliated dental practice at
least annually in order to determine whether such fee should be adjusted to
continue to reflect the fair value of the management services rendered by the
Company.
Through the management services agreements and the nominee arrangements, the
Company has a significant long-term controlling financial interest in the
affiliated dental practices and, therefore, according to Emerging Issues Task
Force Issue No. 97-2, "Application of FASB Statement No. 94, CONSOLIDATION OF
ALL MAJORITY-OWNED SUBSIDIARIES, and APB No. 16, BUSINESS COMBINATIONS, to
Physician Practice Management Entities and Certain Other Entities with
Contractual Management Agreements," must consolidate the results of the
affiliated practices with those of the Company. Net patient revenues are
presented in the accompanying statement of operations because the Company must
present consolidated financial statements. All significant intercompany accounts
and transactions, including management fees, have been eliminated in
consolidation.
The accompanying unaudited consolidated financial statements as of September
30, 1999 and for the three and nine months ended September 30, 1998 and 1999
include the accounts of the Company and its majority owned management company
subsidiaries and the affiliated dental practices. Pursuant to the rules and
regulations of the Securities and Exchange Commission, certain information and
footnote disclosures normally included in annual financial statements prepared
in accordance with generally accepted accounting principles have been omitted.
The unaudited consolidated financial statements have been prepared consistent
with the accounting policies reflected in the Company's annual financial
statements included in the Company's Form 10-K filed with the Securities and
Exchange Commission, and should be read in conjunction therewith. In
management's opinion, the unaudited consolidated financial statements include
all adjustments, consisting of normal recurring adjustments, considered
necessary for a fair presentation of such financial statements. Interim results
are not necessarily indicative of results for a full year.
-6-
<PAGE>
2. EARNINGS PER SHARE:
Basic earnings per share for all periods presented equals net income divided
by weighted average number of shares of common stock outstanding during each
period. Diluted earnings per share reflects the effect of dilutive stock options
and warrants.
3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
The Company maintains a revolving credit agreement with its bank (the "Credit
Agreement") which provides for borrowings up to $55.0 million and matures
November 2002. Revolving credit advances under the Credit Agreement require
quarterly interest payments through December 2000 when principal becomes payable
based on a five-year quarterly amortization and a final payment at maturity.
Borrowings under the bank credit facility may at no time exceed a specified
borrowing base, which is calculated as a multiple of the Company's earnings
before interest, income taxes, depreciation and amortization ("EBITDA"), as
adjusted. The Credit Agreement bears interest at variable rates, which are based
upon (a) either (i) the bank's base rate or (ii) LIBOR plus (b) a margin which
varies according to the ratio of the Company's funded debt to EBITDA, each as
defined in the Credit Agreement. A commitment fee is payable quarterly at rates
ranging from 0.125 percent to 0.5 percent of the unused amounts for such
quarter. The Credit Agreement is collateralized by substantially all of the
Company's assets and contains affirmative and negative covenants that require
the Company to maintain certain financial ratios, limit the creation or
existence of liens and set certain restrictions on acquisitions, mergers, sale
of assets and restrict the payment of dividends. At September 30, 1999,
approximately $48.6 million was outstanding under the Credit Agreement.
4. COMMITMENTS AND CONTINGENCIES
In August 1999, the Company settled a lawsuit filed by the former owner of
certain dental practices acquired by the Company in August 1996. In connection
therewith, the Company recorded a one-time charge of $1.4 million in the second
quarter of 1999 to reflect the cost of the settlement.
In December 1998, a dentist with whom the Company had entered into an
agreement to acquire his dental practice filed a demand for arbitration alleging
that the Company is liable for damages resulting from the failure to complete
the transaction. The transaction was not completed because at least one of the
conditions required for closing was not met. The dentist is claiming damages
equal to the difference between the purchase price of $6.5 million provided for
in the agreement and the fair market value of the practice. The Company believes
that the asserted claims are without merit and that it is not liable for damages
resulting from these allegations.
The Company carries insurance with coverage and coverage limits that it
believes to be customary in the dental industry. Although there can be no
assurance that such insurance will be sufficient to protect the Company against
all contingencies, management believes that its insurance protection is
reasonable in view of the nature and scope of the Company's operations.
The Company is from time to time subject to claims and suits arising in the
ordinary course of operations. In the opinion of management, the ultimate
resolution of such pending legal proceedings will not have a material adverse
effect on the Company's financial position, results of operations or liquidity.
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<PAGE>
5. SEGMENT INFORMATION
The following table sets forth the financial information with respect to the
Company and its reportable segments:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1998 1999 1998 1999
-------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C>
Net patient revenues:
Texas $ 12,174 $ 17,617 $ 34,656 $ 50,942
Florida 3,249 3,112 8,757 9,465
Tennessee 2,160 2,706 5,780 7,574
California 2,592 2,657 5,202 8,939
-------- -------- -------- --------
Total net patient revenues $ 20,175 $ 26,092 $ 54,395 $ 76,920
======== ======== ======== ========
Operating income:
Texas $ 1,610 $ 3,088 $ 4,317 $ 8,273
Florida 344 203 1,148 551
Tennessee 219 328 276 812
California 480 193 1,043 1,430
Corporate, general and administrative
expenses .............................. (680) (1,187) (2,023) (3,237)
-------- -------- -------- --------
Total operating income ............. 1,973 2,625 4,761 7,829
Interest expense ............................. 560 1,140 1,178 3,155
Other (income) expense ....................... (82) 38 (51) 41
Litigation settlement ........................ -- -- -- 1,366
-------- -------- -------- --------
Income before income taxes ......... $ 1,495 $ 1,447 $ 3,634 $ 3,267
======== ======== ======== ========
</TABLE>
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD LOOKING STATEMENTS WITHIN
THE MEANING OF THE SECURITIES ACT OF 1933 AND SECTION 21B OF THE SECURITIES AND
EXCHANGE ACT OF 1934. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE SET FORTH IN THE FORWARD-LOOKING STATEMENTS. CERTAIN FACTORS THAT MIGHT
CAUSE SUCH A DIFFERENCE INCLUDE, AMONG OTHERS, THE CHANGING ENVIRONMENT FOR
DENTAL HEALTH CARE, THE PACE OF THE COMPANY'S DEVELOPMENT AND ACQUISITION
ACTIVITIES, THE REIMBURSEMENT RATES FOR DENTAL SERVICES, AND OTHER RISK FACTORS
DETAILED IN THE COMPANY'S SECURITIES AND EXCHANGE COMMISSION FILINGS, INCLUDING
THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998, AS FILED WITH THE
U.S. SECURITIES AND EXCHANGE COMMISSION.
OVERVIEW
The Company develops, manages and operates integrated dental networks through
contractual affiliations with general, orthodontic and multi-specialty dental
practices in Texas, Florida, California and Tennessee. The Company does not
engage in the practice of dentistry but rather establishes integrated dental
networks through affiliations with dental practices providing quality care in
selected markets with a view to establishing broad geographic coverage within
those markets. The Company seeks to achieve operating efficiencies by
consolidating and integrating affiliated practices into regional networks,
realizing economies of scale in such areas as marketing, administration and
purchasing and enhancing the revenues of its affiliated dental practices by
increasing both patient visits and the range of specialty services offered. At
September 30, 1999 the Company managed 101 dental centers with approximately 251
affiliated dentists, orthodontists and specialists.
COMPONENTS OF REVENUES AND EXPENSES
Net patient revenues represent amounts billed by the affiliated dental
practices to patients and third-party payors for dental services rendered.
Revenues are reported at established rates reduced by contractual amounts based
on agreements with patients, third party payers and others obligated to pay for
services rendered.
Under the terms of the typical management services agreement with an
affiliated dental practice, the Company becomes the exclusive manager and
administrator of all non-dental services relating to the operation of the
practice. While actual terms of the various management service agreements may
vary from practice to practice, material aspects of all the management service
agreements, including the ability of the Company to nominate the majority
shareholder and the calculation of the management fees, are consistent. The
obligations of the Company include assuming responsibility for the operating
expenses incurred in connection with managing the dental centers. These expenses
include salaries, wages and related costs of non-dental personnel, dental
supplies and laboratory fees, rental and lease expenses, advertising and
marketing costs, management information systems, and other operating expenses
incurred at the dental centers. In addition to these expenses, the Company
incurs general and administrative expenses related to the billing and collection
of accounts receivable, financial management and control of the dental
operations, insurance, training and development, and other general corporate
expenditures.
RESULTS OF OPERATIONS
The following table sets forth the percentages of patient revenues
represented by certain items reflected in the Company's Statements of
Operations. The information that follows represents historical results of the
Company and does not include pre-acquisition results of the dental practices
that the Company has acquired. The information that follows should be read in
conjunction with the Annual Audited Financial Statements and notes thereto of
the Company included in the Company's Form 10-K filed with the Securities and
Exchange Commission, as well as the Unaudited Consolidated Financial
Information, included in this Form 10-Q. In March 1998, the Company acquired
Dental World, Inc. a dental practice management company located in Houston,
Texas. In March 1998, the Company acquired an 80.0% interest in Castle West,
which was formed to acquire Dental Consulting Services, LLC, a California-based
dental practice management company. In July 1998, the Company acquired Dentcor,
Inc., a dental management company, and five related dental practices in Florida.
In August 1998, the Company acquired
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<PAGE>
all the outstanding stock of two dental practices in the Los Angeles area and
purchased the assets of a dental office in Houston. In December 1998, the
Company acquired the assets of Crenshaw Family Dental in Los Angeles, and Dental
Centers of America, Inc., which managed 16 dental centers in San Antonio, Austin
and Dallas/Fort Worth, Texas. (All of the acquisitions in 1998 are collectively
referred to as the "Completed Acquisitions").
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -------------------------------
1998 1999 1998 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net patient revenues..................................... 100.0% 100.0% 100.0% 100.0%
Expenses:
Dentist salaries and other professional costs...... 25.6% 26.2% 24.7% 26.5%
Clinical salaries.................................. 21.8% 20.4% 22.1% 20.9%
Dental supplies and laboratory fees................ 10.0% 8.9% 9.7% 8.9%
Rental and lease expense........................... 5.4% 6.1% 5.3% 5.9%
Advertising and marketing................................ 2.9% 4.4% 3.6% 3.8%
Depreciation and amortization...................... 5.1% 5.5% 4.8% 5.6%
Other operating expenses........................... 9.6% 7.3% 9.6% 8.1%
General and administrative......................... 9.8% 11.1% 11.4% 10.1%
------------ ------------ ------------ ------------
Total expenses............................... 90.2% 89.9% 91.2% 89.8%
------------ ------------ ------------ ------------
Operating income............................. 9.8% 10.1% 8.8% 10.2%
Litigation settlement.................................... -% -% -% 1.8%
Interest expense......................................... 2.8% 4.4% 2.2% 4.1%
Other income, net........................................ (0.4%) 0.2% (0.1%) 0.1%
------------- ------------ ------------- ------------
Income before income taxes............................... 7.4% 5.5% 6.7% 4.2%
Provision for income taxes............................... 2.3% 2.2% 2.2% 1.6%
------------ ------------ ------------ ------------
Net income............................................... 5.1% 3.3% 4.5% 2.6%
============ ============ ============ ============
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998
NET PATIENT REVENUE - Net patient revenues of affiliated dental practices
increased from $20.2 million to $26.1 million, an increase of $5.9 million or
29.3%. Approximately $4.2 million of the increase was attributable to the
Completed Acquisitions. The opening of 22 de novo offices in Austin, Houston,
Dallas, and Tennessee accounted for the remaining increase in net patient
revenues.
DENTIST SALARIES AND OTHER PROFESSIONAL COSTS - Dentist salaries and other
professional costs consist primarily of compensation paid to dentists,
orthodontists, and hygienists employed by the affiliated dental practices. For
the three months ended September 30, 1999, dentist salaries and other
professional costs were $6.8 million, an increase of $1.7 million or 32.5% from
the comparable period of 1998. The increase was due primarily to the Completed
Acquisitions, staffing of de novo dental centers and increased dentist
compensation resulting from higher patient revenues. Expressed as a percentage
of net patient revenues, dentist salaries and other professional costs increased
from 25.6% for the three months ended September 30, 1998 to 26.2% for the
comparable 1999 period.
CLINICAL SALARIES - Clinical salaries increased from $4.4 million for the
three months ended September 30, 1998, to $5.3 million for the three months
ended September 30, 1999, an increase of $900,000 or 21.2%. The Completed
Acquisitions and de novo dental centers accounted for the increase. Expressed as
a percentage of net patient revenues, clinical salaries decreased from 21.8% for
the three months ended September 30, 1998 to 20.4% for the comparable 1999
period.
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<PAGE>
DENTAL SUPPLIES AND LABORATORY FEES - Dental supplies and laboratory fees
increased from $2.0 million for the three months ended September 30, 1998 to
$2.3 million for the three months ended September 30, 1999, an increase of
$300,000 or 16.3%. The increase is attributable to the Completed Acquisitions
and the de novo dental centers. Expressed as a percentage of patient revenues,
dental supplies and laboratory fees decreased from 10.0% for the three months
ended September 30, 1998 to 8.9% for the comparable 1999 period.
RENT AND LEASE EXPENSE - Rent and lease expense increased from $1.1 million
for the three months ended September 30, 1998, to $1.6 million for the three
months ended September 30, 1999, an increase of $500,000 or 44.5%. The Completed
Acquisitions along with the opening of de novo centers in Austin, Houston,
Dallas, and Tennessee accounted for the increase. Expressed as a percentage of
net patient revenues, rent and lease expense increased from 5.4% for the three
months ended September 30, 1998 to 6.1% for the comparable 1999 period.
ADVERTISING AND MARKETING - Advertising and marketing expense increased from
$580,000 for the three months ended September 30, 1998, to $1.1 million for the
three months ended September 30, 1999, an increase of $560,000 or 96.2%.
Expressed as a percentage of net patient revenues, advertising and marketing
increased from 2.9% for the three months ended September 30, 1998 to 4.4% for
the comparable 1999 period. The increased advertising and marketing expense
results from increased television advertising in certain existing markets, the
Completed Acquisitions and advertising associated with the opening of de novo
centers.
DEPRECIATION AND AMORTIZATION - Depreciation and amortization increased from
$1.0 million for the three months ended September 30, 1998, to $1.4 million for
the three months ended September 30, 1999, an increase of $400,000 or 40.5%. The
increase is attributable primarily to depreciation of fixed assets and
amortization of intangible assets acquired in connection with Completed
Acquisitions and depreciation of fixed assets associated with the opening of de
novo centers. Expressed as a percentage of net patient revenues, depreciation
and amortization increased from 5.1% for the three months ended September 30,
1998 to 5.5% for the comparable 1999 period.
OTHER OPERATING EXPENSES - Other operating expenses were $1.9 million for the
three months ended September 30, 1999, relatively unchanged from the comparable
period of 1998. Other operating expenses include certain expenses related to the
operation of the Company's dental centers and bad debt expense incurred in
financing of patient receivables at the affiliated dental practices. Expressed
as a percentage of net patient revenues, other operating expenses decreased from
9.6% for the three months ended September 30, 1998 to 7.3% for the comparable
1999 period. Higher operating expenses associated with additional centers
acquired in the Completed Acquisitions and new de novo centers were offset by a
reduction in bad debt expense.
GENERAL & ADMINISTRATIVE EXPENSE - General and administrative expenses
increased from $2.0 million for the three months ended September 30, 1998, to
$2.9 million for the three months ended September 30, 1999, an increase of
$900,000, or 45.5%. Expressed as a percentage of net patient revenues, general
and administrative expense increased from 9.8% for the three months ended
September 30, 1998 to 11.1% for the 1999 period. This increase in general and
administrative expenses is attributable to the centralization of certain
administrative functions from the regions to corporate, increased professional
fees and increased support in management information services.
INTEREST EXPENSE - Interest expense increased from $560,000 for the three
months ended September 30, 1998 to $1.1 million for three months ended September
30, 1999, an increase of $580,000. The increase is attributable to higher
borrowings under the Company's Credit Agreement, primarily for acquisitions
completed during 1998 and working capital.
PROVISION FOR INCOME TAXES - The provision for income taxes increased from
$470,000 for the three months ended September 30, 1998, to $590,000 for the
three months ended September 30, 1999, an increase of $120,000, or 24.7%. The
estimated effective income tax rate of 31.7% for the three months ended
September 30, 1998 was lower than the statutory tax rate due to adjustments in
the Company's net operating loss carryforwards that were realized in 1998. The
estimated effective income tax rate for the three months ended September 30,
1999 was 40.8% resulting from non-deductible expenses associated with a
litigation settlement reached in August 1999 (Note 4).
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<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1998
NET PATIENT REVENUE - Net patient revenues of affiliated dental practices
increased from $54.4 million for the nine months ended September 30, 1998, to
$76.9 million for the nine months ended September 30, 1999, an increase of $22.5
million or 41.4%. Approximately $18.9 million of the increase was attributable
to the Completed Acquisitions. The opening of 22 de novo offices in Austin,
Houston, Dallas, and Tennessee primarily accounted for the remaining increase in
net patient revenues.
DENTIST SALARIES AND OTHER PROFESSIONAL COSTS - Dentist salaries and other
professional costs consist primarily of compensation paid to dentists,
orthodontists, and hygienists employed by the affiliated dental practices. For
the nine months ended September 30, 1999, dentist salaries and other
professional costs were $20.4 million, an increase of $6.9 million or 51.6% from
the comparable period of 1998. The increase was due primarily to the Completed
Acquisitions, staffing of de novo dental centers and increased dentist
compensation resulting from higher patient revenues. Expressed as a percentage
of net patient revenue, dentist salaries and other professional costs increased
from 24.7% for the nine months ended September 30, 1998 to 26.5% for the
comparable 1999 period.
CLINICAL SALARIES - Clinical salaries increased from $12.0 million for the
nine months ended September 30, 1998, to $16.1 million for the nine months ended
September 30, 1999, an increase of $4.1 million or 33.8%. The Completed
Acquisitions and de novo dental centers accounted for the increase in clinical
salaries. Expressed as a percentage of net patient revenues, clinical salaries
decreased from 22.1% for the nine months ended September 30, 1998 to 20.9% for
the comparable 1999 period.
DENTAL SUPPLIES AND LABORATORY FEES - Dental supplies and laboratory fees
increased from $5.3 million for the nine months ended September 30, 1998 to $6.8
million for the nine months ended September 30, 1999, an increase of $1.5
million or 29.2%. The increase is attributable to the Completed Acquisitions and
the de novo dental centers. Expressed as a percentage of patient revenues,
dental supplies and laboratory decreased from 9.7% for the nine months ended
September 30, 1998 to 8.9% for the comparable 1999 period.
RENT AND LEASE EXPENSE - Rent and lease expense increased from $2.9 million
for the nine months ended September 30, 1998, to $4.5 million for the nine
months ended September 30, 1999, an increase of $1.7 million or 58.3%. The
Completed Acquisitions accounted for $700,000 of the increase with the opening
of 22 de novo centers in Austin, Houston, Dallas, and Tennessee accounting for
the balance of the increase. Expressed as a percentage of net patient revenues,
rent and lease expense increased from 5.3% for the nine months ended September
30, 1998 to 5.9% for the comparable 1999 period.
ADVERTISING AND MARKETING - Advertising and marketing expense increased from
$2.0 million for the nine months ended September 30, 1998, to $2.9 million for
the nine months ended September 30, 1999, an increase of $900,000 or 46.9%.
Expressed as a percentage of net patient revenues, advertising and marketing
increased from 3.6% for the nine months ended September 30, 1998 to 3.8% for the
comparable 1999 period. The increase in advertising and marketing expense
results from increased television advertising in certain existing markets, the
Completed Acquisitions and advertising associated with the opening of de novo
centers.
DEPRECIATION AND AMORTIZATION - Depreciation and amortization increased from
$2.6 million for the nine months ended September 30, 1998, to $4.3 million for
the nine months ended September 30, 1999, an increase of $1.7 million or 63.2%.
The increase is attributable to depreciation of fixed assets and amortization of
intangible assets acquired in connection with Completed Acquisitions and
depreciation of fixed assets associated with the opening of de novo centers.
Expressed as a percentage of net patient revenues, depreciation and amortization
increased from 4.8% for the nine months ended September 30, 1998 to 5.6% for the
comparable 1999 period.
OTHER OPERATING EXPENSES - Other operating expenses increased from $5.2
million for the nine months ended September 30, 1998, to $6.3 million for the
nine months ended September 30, 1999, an increase of $1.1 million or 20.6%.
Other operating expenses include certain expenses related to the operation of
the Company's dental centers and bad debt expense incurred in financing of
patient receivables at the affiliated dental practices. Expressed as a
percentage of net patient revenues, other operating expenses decreased from 9.6%
for the nine months ended
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<PAGE>
September 30, 1998 to 8.1% for the comparable 1999 period. Increased operating
expenses associated with additional centers acquired in Completed Acquisitions
and new de novo centers were offset partially by a decrease in bad debt expense.
GENERAL & ADMINISTRATIVE EXPENSE - General and administrative expenses
increased from $6.2 million for the nine months ended September 30, 1998, to
$7.8 million for the nine months ended September 30, 1999, an increase of $1.6
million, or 25.5%. Expressed as a percentage of net patient revenues, general
and administrative expense decreased from 11.4% for the nine months ended
September 30, 1998 to 10.1% for the 1999 period. The decrease in general and
administrative expenses, expressed as a percentage of net patient revenues, is
attributable to relatively lower percentage increases in corporate and regional
general and administrative expenses compared to the increase in net patient
revenues.
LITIGATION SETTLEMENT - In August 1999, the Company reached a settlement of a
lawsuit filed by the former owner of certain dental practices acquired by the
Company in 1996. In connection therewith, the Company recorded a charge of $1.4
million in the second quarter of 1999 (Note 4).
INTEREST EXPENSE - Interest expense increased from $1.2 million for the nine
months ended September 30, 1998 to $3.2 million for the nine months ended
September 30, 1999, an increase of $2.0 million. The increase is attributable to
higher borrowings under the Company's Credit Agreement, primarily for
acquisitions completed during 1998 and working capital.
PROVISION FOR INCOME TAXES - The provision for income taxes increased from
$1.2 million for the nine months ended September 30, 1998, to 1.3 million for
the nine months ended September 30, 1999. The estimated effective income tax
rate of 32.2% for the nine months ended September 30, 1998 was lower than the
statutory tax rate due to adjustments in the Company's net operating loss
carryforwards realized in 1998. The estimated effective income tax rate for the
nine months ended September 30, 1999 was 39.8% resulting from non-deductible
expenses associated with a litigation settlement reached in August 1999 (Note
4).
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999 the Company had net working capital of $15.9 million,
representing an increase in working capital of $5.6 million from net working
capital of $10.3 million at December 31, 1998. Current assets consisted of cash
and cash equivalents of $286,000, billed and unbilled accounts receivable of
$22.0 million and prepaid expenses and other current assets, including deferred
income taxes, of $6.2 million. These current assets were partially offset by
current liabilities of $12.6 million, consisting of $10.3 million in accounts
payable and accrued liabilities, $1.8 million in current maturities of long-term
debt and $0.5 million of deferred compensation payable to a stockholder.
For the nine months ended September 30, 1998 and 1999, net cash provided by
operating activities was $3.7 million and $357,000, respectively. In the nine
months ended September 30, 1998, cash used in investing activities totaled $21.7
million primarily to fund acquisitions and capital expenditures. For the nine
months ended September 30, 1999, cash used in investing activities was $8.7
million, consisting primarily of $365,000 to fund acquisitions and $8.4 million
for capital expenditures primarily for the construction of new dental offices
and equipment. For the nine months ended September 30, 1998, cash provided by
financing activities was $16.4 million representing $18.9 million in advances
under the Company's bank credit agreement, offset partially by $2.6 million in
repayments of debt and capital lease obligations. For the nine months ended
September 30, 1999, cash provided by financing activities totaled $8.0 million
representing $9.2 million in advances under the Company's bank credit agreement,
offset partially by $1.2 million in repayments of long term debt and capital
lease obligations.
During the first nine months of 1999, the Company's principal sources of
liquidity consisted of cash and cash equivalents, net accounts receivable and
borrowing availability under the Company's bank credit facility. The Company
maintains a revolving credit agreement with its bank (the "Credit Agreement")
which provides for borrowings up to $55.0 million and matures November 2002.
Revolving credit advances under the Credit Agreement require quarterly interest
payments through December 2000 when principal becomes payable based on a
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<PAGE>
five-year quarterly amortization and a final payment at maturity. Borrowings
under the bank credit facility may at no time exceed a specified borrowing base,
which is calculated as a multiple of the Company's earnings before interest,
income taxes, depreciation and amortization ("EBITDA"), as adjusted. The Credit
Agreement bears interest at variable rates, which are based upon (a) either (i)
the bank's base rate or (ii) LIBOR plus (b) a margin which varies according to
the ratio of the Company's funded debt to EBITDA, each as defined in the Credit
Agreement. A commitment fee is payable quarterly at rates ranging from 0.125
percent to 0.5 percent of the unused amounts for such quarter. The Credit
Agreement is collateralized by substantially all of the Company's assets and
contains affirmative and negative covenants that require the Company to maintain
certain financial ratios, limit the creation or existence of liens and set
certain restrictions on acquisitions, mergers, sale of assets and restrict the
payment of dividends. At September 30, 1999, approximately $48.6 million was
outstanding under the Credit Agreement.
Management believes that cash flow from operations and borrowings available
under the Credit Agreement may not be sufficient to meet its anticipated capital
expenditures and working capital requirements. Accordingly, the Company is
planning to raise up to $20 million in subordinated debt financing in order to
provide additional capital resources to meet currently planned levels of capital
expenditures and working capital requirements. The Company also plans to
renegotiate the terms of the Credit Agreement consistent with the terms of the
subordinated debt financing. There can be no assurance that the Company will be
able to obtain the required financing. The availability of these capital sources
will depend on prevailing market conditions and interest rates and the financial
condition of the Company. If the company is not able to raise additional
financing, it may be required to curtail its expansion plans and limit future
capital expenditures.
YEAR 2000 ISSUE
The year 2000 issue is the result of computer programs using two digits to
define the applicable year instead of four. Any programs that have time
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. A computer system that is not year 2000 compliant would not be
able to correctly process certain data, or in extreme situations, system failure
could result.
During 1999, as part of the Company's continuing program to upgrade its
information systems in anticipation of future growth, the Company upgraded its
software to year 2000 compliant software for its corporate and regional
operations. The Company presently believes that, with such upgrades, the year
2000 problem will not pose significant operational problems for the Company's
computer systems.
The Company is currently making inquiries of certain of its vendors and banks
to determine what impact, if any, their year 2000 compliance exposure might have
on the Company's operations. The Company expects to receive assurances that
those vendors' systems are or will be year 2000 compliant in a timely manner.
The failure to correct a material year 2000 problem could possibly result in
an interruption in or failure of, certain normal business activities or
operations. Such failure can materially and adversely affect the Company's
financial position, results of operations and cash flows. Due to the general
uncertainty inherent in the year 2000 problem, including uncertainty regarding
the year 2000 readiness of third party suppliers and potential future
acquisitions, the Company is unable to determine at this time whether the
consequences of any possible year 2000 failures will have a material impact on
the Company's financial position, results of operations and cash flows. The
Company believes that, with the completion of its computer system upgrades, the
possibly of any material interruption to normal operations should be
significantly reduced.
The Company's plans to comply with year 2000 requirements and completion
dates are based on management's best estimates, which were derived utilizing
numerous assumptions of future events including the continued availability of
certain resources and other factors. There can no assurance, however, that these
estimates will be achieved and actual results could differ materially from those
estimates. Specific factors that might cause such material differences include,
but are not limited to, the availability and cost of personnel trained in this
area, the ability to identify and correct potential problems, and similar
uncertainties.
To date, the incremental costs incurred by the Company that relate solely to
the year 2000 compliance problem have not been and are not expected to be
material. These costs are exclusive of upgrades made to the Company's
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<PAGE>
systems in the ordinary course of business and consist primarily of internal
employee time. The Company does not separately track the internal costs incurred
for the Year 2000 project, which consists primarily of payroll and related costs
associated with employee time. Based upon the Company's current assessments, the
costs to complete the Company's year 2000 compliance program will not have a
material effect on the Company's financial condition, results of operations or
cash flows. All the current and future costs related to the Company's year 2000
compliance program have been and are expected to be funded with cash generated
from the Company's operations. As of September 30, 1999, approximate costs
incurred for the Year 2000 project are less than $125,000.
If during the course of the Company's assessment of its critical systems, it
is determined that the risk of year 2000 disruptions is significant, contingency
plans will be developed as appropriate. Such plans might include the use of
alternative service providers or product suppliers. Currently, the Company does
not have any contingency plans in place based on current year 2000 readiness
assessments.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's only financial instruments with market risk exposure are
revolving credit borrowings under its Credit Agreement which total $48.6 million
at September 30, 1999. Based on this balance, a change of one percent in the
interest rate would cause a change in interest expense of approximately
$486,000, or $0.04 per share, on an annual basis. The bank credit facility was
not entered into for trading purposes and carries interest at a pre-agreed upon
percentage point spread from either the prime interest rate or Eurodollar
interest rate.
-15-
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
In August 1999, the Company settled a lawsuit filed by the former owner of
certain dental practices acquired by the Company in August 1996. In connection
therewith, the Company recorded a one-time charge of $1.4 million in the second
quarter of 1999 to reflect the cost of the settlement.
In December 1998, a dentist with whom the Company had entered into an
agreement to acquire his dental practice filed a demand for arbitration alleging
that the Company is liable for damages resulting from the failure to complete
the transaction. The transaction was not completed because at least one of the
conditions required for closing was not met. The dentist is claiming damages
equal to the difference between the purchase price of $6.5 million provided for
in the agreement and the fair market value of the practice. The Company believes
that the asserted claims are without merit and that it is not liable for damages
resulting from these allegations.
The Company carries insurance with coverage and coverage limits that it
believes to be customary in the dental industry. Although there can be no
assurance that such insurance will be sufficient to protect the Company against
all contingencies, management believes that its insurance protection is
reasonable in view of the nature and scope of the Company's operations.
The Company is from time to time subject to claims and suits arising in the
ordinary course of operations. In the opinion of management, the ultimate
resolution of such pending legal proceedings will not have a material adverse
effect on the Company's financial position, results of operations or liquidity.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following exhibits are filed with this report:
27. Financial Data Schedule.
(b) The company filed no reports on Form 8-K during the quarter for
which this report is filed.
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<PAGE>
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.
CASTLE DENTAL CENTERS, INC.
Date: November 15, 1999 By: JACK H. CASTLE, JR.
Jack H. Castle, Jr.
Chief Executive Officer
Date: November 15, 1999 By: JOHN M. SLACK
John M. Slack
Chief Financial Officer
-17-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 1999
AND THE NINE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 286
<SECURITIES> 0
<RECEIVABLES> 27,715
<ALLOWANCES> 10,117
<INVENTORY> 0
<CURRENT-ASSETS> 28,538
<PP&E> 27,110
<DEPRECIATION> 7,091
<TOTAL-ASSETS> 114,008
<CURRENT-LIABILITIES> 12,591
<BONDS> 52,343
0
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<COMMON> 6
<OTHER-SE> 38,357
<TOTAL-LIABILITY-AND-EQUITY> 114,008
<SALES> 76,920
<TOTAL-REVENUES> 76,920
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