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 March 31, 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 May 13, 1999 was 6,417,206.
<PAGE>
CASTLE DENTAL CENTERS, INC.
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets
December 31, 1998 and March 31, 1999 ............................ 3
Consolidated Statements of Operations
For the Three Months Ended March 31, 1998 and 1999 .............. 4
Condensed Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 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
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
PART II.
Item 1. Legal Proceedings ........................................ 14
Item 2. Changes in Securities and Use of Proceeds ................ 14
Item 3. Defaults Upon Senior Securities .......................... 14
Item 4. Submission of Matters to a Vote of Security Holders ...... 14
Item 5. Other Information ........................................ 14
Item 6. Exhibits and Reports on Form 8-K ......................... 14
SIGNATURES ................................................................. 15
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<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
CASTLE DENTAL CENTERS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................. $ 695 $ 427
Patient receivables, net .................................. 10,700 12,518
Unbilled patient receivables, net ......................... 3,251 3,353
Prepaid expenses and other current assets ................. 2,887 3,439
Deferred income taxes ..................................... 1,809 1,628
------------- ---------
Total current assets ................................. 19,342 21,365
------------- ---------
Property and equipment, net .................................. 13,861 15,908
Intangible assets, net ....................................... 65,956 65,633
Other assets ................................................. 876 897
------------- ---------
Total assets .......................................... $ 100,035 $ 103,803
============= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ......................... $ 1,795 $ 1,788
Accounts payable and accrued liabilities .................. 6,676 8,028
Deferred compensation payable, related party .............. 526 526
------------- ---------
Total current liabilities ............................ 8,997 10,342
------------- ---------
Long-term debt, net of current portion ....................... 44,411 45,561
Other long-term liabilities, related party ................... 526 395
Deferred income taxes ........................................ 5,401 5,797
Commitments and contingencies
Minority interest ............................................ 4,303 4,308
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) (5,122)
------------- ---------
Total stockholders' equity ............................ 36,397 37,400
------------- ---------
Total liabilities and stockholders' equity ................... $ 100,035 $ 103,803
============= =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
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CASTLE DENTAL CENTERS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
THREE MONTHS ENDED
MARCH 31,
----------------------
1998 1999
-------- --------
Net patient revenues ................................ $ 14,541 $ 25,167
Expenses:
Dentist salaries and other professional costs .... 3,746 6,598
Clinic salaries .................................. 3,191 5,329
Dental supplies and laboratory fees .............. 1,318 2,294
Rental and lease expense ......................... 759 1,447
Advertising and marketing ........................ 594 814
Depreciation and amortization .................... 621 1,413
Other operating expenses ......................... 1,378 2,224
General and administrative ....................... 1,858 2,409
-------- --------
Total expenses ............................... 13,465 22,528
-------- --------
Operating income .................................... 1,076 2,639
Interest expense .................................... 124 993
Other expense (income), net ......................... (22) 1
-------- --------
Income before income taxes .......................... 974 1,645
Provision for income taxes .......................... 312 642
-------- --------
Net income .......................................... $ 662 $ 1,003
======== ========
Income per common share:
Basic and diluted:
Net income ................................... $ 0.11 $ 0.15
======== ========
Weighted average number of common and
common equivalent shares outstanding
Basic ............................................ 6,236 6,825
======== ========
Diluted .......................................... 6,236 6,873
======== ========
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
(in thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1999
-------- --------
<S> <C> <C>
Net cash provided by operating activities ......................... $ 481 $ 1,756
Investing activities:
Capital expenditures ........................................... (1,471) (2,822)
Acquisition of affiliated dental practices, net of cash acquired (13,108) (214)
-------- --------
Net cash used by investing activities ............................. (14,579) (3,036)
-------- --------
Financing activities:
Payments of long-term debt and capital lease obligations ....... (1,731) (588)
Proceeds from debt ............................................. 14,700 1,600
-------- --------
Net cash provided by financing activities ......................... 12,969 1,012
-------- --------
Net change in cash and cash equivalents .................... (1,129) (268)
Cash and cash equivalents, beginning of period .................... 2,908 695
-------- --------
Cash and cash equivalents, end of period .......................... $ 1,779 $ 427
======== ========
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
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 March 31, 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 March 31,
1999 and for the three months ended March 31, 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.
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<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 $47.5 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 March 31, 1999,
approximately $41.0 million was outstanding under the Credit Agreement.
In April 1999, the Company and its bank amended the Credit Agreement to
increase the borrowing limit to $55.0 million.
4. COMMITMENTS AND CONTINGENCIES:
In August 1998, the former owner of certain dental practices acquired by the
Company in August 1996, filed a lawsuit against the Company in the 190th
District Court of Harris County, Texas. The lawsuit alleges that the Company
committed various acts of fraud, securities fraud, conspiracy, breach of
contract and misrepresentation concerning the value of the Company's common
stock issued in the acquisition of the dental practices. The lawsuit seeks
damages and exemplary damages in the amount of $11 million. The Company believes
that the asserted claims are without merit and intends to defend itself
vigorously. In the opinion of management, resolution of these claims will not
have a material adverse effect on the Company's financial position, results of
operations or cash flows.
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 provided for in the agreement
of $6.5 million 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. In the opinion of management, resolution of
these claims will not have a material adverse effect on the Company's financial
position, results of operations or cash flows.
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:
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1999
-------- --------
(In thousands)
Net patient revenues:
Texas ............................................ $ 10,027 $ 16,307
Florida .......................................... 2,873 3,210
Tennessee ........................................ 1,641 2,276
California ....................................... -- 3,374
-------- --------
Total net patient revenues ............... 14,541 25,167
Operating income (loss):
Texas ............................................ 1,283 2,428
Florida .......................................... 570 205
Tennessee ........................................ (97) 217
California ....................................... -- 827
-------- --------
Total operating income (loss) ............ 1,756 3,677
Corporate, general and administrative expenses........... 680 1,038
Interest expense ..................................... 124 993
Other income ......................................... (22) 1
-------- --------
Income before income taxes ............... $ 974 $ 1,645
======== ========
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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
March 31, 1999 the Company managed 93 dental centers with approximately 235
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
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<PAGE>
Dentcor, Inc., a dental management company, and five related dental practices in
Florida. In August 1998, the Company acquired 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 Dental
Centers of America, Inc., which managed 16 dental centers in San Antonio, Austin
and Dallas/Fort Worth, Texas, and Crenshaw Family Dental in Los Angeles. (All of
the acquisitions in 1998 are collectively referred to as the "Completed
Acquisitions").
FOR THE THREE MONTHS
ENDED MARCH 31,
--------------------
1998 1999
------- -------
Net patient revenue ..................................... 100.0% 100.0%
Expenses:
Dentist salaries and other professional costs ........ 25.8% 26.2%
Clinic salaries ...................................... 21.9% 21.2%
Dental supplies and laboratory fees .................. 9.1% 9.1%
Rental and lease expense ............................. 5.2% 5.7%
Advertising and marketing ............................ 4.1% 3.2%
Depreciation and amortization ........................ 4.3% 5.6%
Other operating expenses ............................. 9.5% 8.8%
General and administrative ........................... 12.8% 9.6%
------- -------
Total expenses ................................... 92.6% 89.5%
------- -------
Operating income ................................. 7.4% 10.5%
Interest expense ........................................ 0.9% 3.9%
Other income, net ....................................... (0.2%) -- %
------- -------
Income before income taxes .............................. 6.7% 6.5%
Provision for income taxes .............................. 2.1% 2.5%
------- -------
Net income .............................................. 4.6% 4.0%
======= =======
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
NET PATIENT REVENUE - Net patient revenues of affiliated dental practices
increased from $14.5 million to $25.2 million, an increase of $10.6 million or
73.1%. Approximately, $9.4 million of the increase was attributable to the
Completed Acquisitions. The opening of 14 de novo offices in Houston, Austin,
Dallas, Clearwater, and Nashville 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 three months ended March 31, 1999, dentist salaries and other professional
costs were $6.6 million, an increase of $2.9 million or 76.1% from the
comparable period of 1998. The increase was due primarily to the Completed
Acquisitions, staffing of new 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 25.8% for
the three months ended March 31, 1998 to 26.2% for the comparable 1999 period.
CLINIC SALARIES - Clinic salaries increased from $3.2 million for the three
months ended March 31, 1998, to $5.3 million for the three months ended March
31, 1999, an increase of $2.1 million or 67.0%. The Completed Acquisitions and
de novo dental centers accounted for approximately $2.5 million of the increase
in clinic salaries, offset by a decrease in existing centers' clinic salaries of
$400,000. Expressed as a percentage of net patient revenues, clinic salaries
decreased from 21.9% for three months ended March 31, 1998 to 21.2% for the
comparable 1999 period.
DENTAL SUPPLIES AND LABORATORY FEES - Dental supplies and laboratory fees
increased from $1.3 million for the three months ended March 31, 1998 to $2.3
million for the three months ended March 31, 1999, an increase of $1.0
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<PAGE>
million or 74.0%. The increase is attributable to the Completed Acquisitions and
the new dental centers. Expressed as a percentage of patient revenues, dental
supplies and laboratory fees remained unchanged at 9.1% for the three months
ended March 31, 1998 and 1999.
RENT AND LEASE EXPENSE - Rent and lease expense increased from $0.8 million
for the three months ended March 31, 1998, to $1.4 million for the three months
ended March 31, 1999, an increase of $0.7 million or 90.7%. The Completed
Acquisitions accounted for $0.5 million of the increase with the opening of 14
de novo centers in Texas, Florida and Tennessee accounting for the balance of
the increase. Expressed as a percentage of net patient revenues, rent and lease
expense increased from 5.2% for three months ended March 31, 1998 to 5.7% for
the comparable 1999 period.
ADVERTISING AND MARKETING - Advertising and marketing expense increased from
$0.6 million for the three months ended March 31, 1998, to $0.8 million for the
three months ended March 31, 1999, an increase of $0.2 million or 37.1%.
Expressed as a percentage of net patient revenues, advertising and marketing
decreased from 4.1% for three months ended March 31, 1998 to 3.2% for the
comparable 1999 period. The lower advertising and marketing expense expressed as
a percentage of patient revenues results from favorably leveraging advertising
expenditures in existing regions as new dental centers are opened.
DEPRECIATION AND AMORTIZATION - Depreciation and amortization increased from
$0.6 million for the three months ended March 31, 1998, to $1.4 million for the
three months ended March 31, 1999, an increase of $0.8 million or 127.6%. The
increase is attributable to depreciation of fixed assets and amortization of
intangible assets acquired in connection with Completed Acquisitions. Expressed
as a percentage of net patient revenues, depreciation and amortization increased
from 4.3% for three months ended March 31, 1998 to 5.6% for the comparable 1999
period.
OTHER OPERATING EXPENSES - Other operating expenses increased from $1.4
million for the three months ended March 31, 1998, to $2.2 million for the three
months ended March 31, 1999, an increase of $0.8 million or 61.4%. 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 9.5% for three months
ended March 31, 1998 to 8.8% for the comparable 1999 period, primarily resulting
from relatively greater percentage increase in revenues than in other operating
expenses.
GENERAL & ADMINISTRATIVE EXPENSE - General and administrative expenses
increased from $1.9 million for the three months ended March 31, 1998, to $2.4
million for the three months ended March 31, 1999, an increase of $0.5 million,
or 29.7%. Expressed as a percentage of net patient revenues, general and
administrative expense decreased from 12.8% for the three months ended March 31,
1998 to 9.6% for the 1999 period. This 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.
INTEREST EXPENSE - Interest expense increased from $124,000 for the three
months ended March 31, 1998 to $1.0 million for three months ended March 31,
1999, an increase of $0.9 million. The increase is attributable higher
borrowings under the Company's Credit Agreement, primarily for acquisitions
completed during 1998.
PROVISION FOR INCOME TAXES - The provision for income taxes increased from
$300,000 for the three months ended March 31, 1998, to $0.6 million for the
three months ended March 31, 1999, an increase of $0.3 million, or 105.9%.
Expressed as a percentage of net patient revenues, provision for income taxes
expense increased from 2.1% for the three months ended March 31, 1998 to 2.5%
for the 1999 period. The increase in percentage, as a percent of net patient
revenues, is attributable to an increase in the estimated effective tax rate of
39.0% compared to 32.0% in the first quarter of 1998, that resulted from the
recognition of the Company's net operating loss in 1998.
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<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999 the Company had net working capital of $11.0 million,
representing an increase in working capital of $0.7 million from net working
capital of $10.3 million at December 31, 1998. Current assets consisted of cash
and cash equivalents of $427,000, billed and unbilled accounts receivable of
$15.9 million and prepaid expenses and other current assets, including deferred
income taxes, of $5.1 million. These current assets were partially offset by
current liabilities of $10.3 million, consisting of $8.0 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 three months ended March 31, 1998 and 1999, cash provided by
operating activities was $0.5 million and $1.8 million, respectively. In the
three months ended March 31, 1998, cash used in investing activities amounted to
$14.6 million primarily to fund acquisitions and capital expenditures. For the
three months ended March 31, 1999, cash used in investing activities was $3.0
million, consisting primarily of $200,000 to fund acquisitions and $2.8 million
for capital expenditures. For the three months ended March 31, 1998, cash
provided by financing activities was $13.0 million representing $14.7 million in
advances under the Company's bank credit agreement, offset partially by $1.7
million in repayments of debt and capital lease obligations. For the three
months ended March 31, 1999, cash provided by financing activities totaled $1.0
million representing $1.6 million in advances under the Company's bank credit
agreement, offset partially by $0.6 million in repayments of long term debt and
capital lease obligations.
During the first three 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
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 March 31, 1999, approximately $41.0 million was
outstanding under the Credit Agreement.
Management believes that cash flow from operations and borrowings available
under the Credit Agreement should be sufficient to meet its anticipated capital
expenditures and other operating requirements. However, because future cash
flows and the availability of financing are subject to a number of variables,
such as the number and size of acquisitions made by the Company, the Company's
financial performance and other factors, there can be no assurance that the
Company's capital resources will be sufficient to maintain currently planned
levels of capital expenditures or to fund future acquisitions. Additional debt
and equity financing may be required in connection with future acquisitions. The
availability of these capital sources will depend on prevailing market
conditions and interest rates and the then-existing financial condition of the
Company.
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.
-12-
<PAGE>
As part of the Company's continuing program to upgrade its information
systems in anticipation of future growth, the Company is currently involved in
the installation of year 2000 compliant software for its corporate and regional
operations. This installation is currently expected to be complete by the second
quarter of 1999. 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 inquires 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 scheduled 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 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 March 31, 1999, approximate costs incurred
for the Year 2000 project are less than $100,000.
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 $41.0 million
at March 31, 1999. Based on this balance, a change of one percent in the
interest rate would cause a change in interest expense of approximately
$410,000, 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.
-13-
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
In August 1998, the former owner of certain dental practices
acquired by the Company in August 1996, filed a lawsuit against the
Company in the 190th District Court of Harris County, Texas. The lawsuit
alleges that the Company committed various acts of fraud, securities
fraud, conspiracy, breach of contract and misrepresentation concerning the
value of the Company's common stock issued in the acquisition of the
dental practices. The lawsuit seeks damages and exemplary damages in the
amount of $11 million. The Company believes that the asserted claims are
without merit and intends to defend itself vigorously. In the opinion of
management, resolution of these claims will not have a material adverse
effect on the Company's financial position, results of operations or cash
flows.
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
provided for in the agreement of $6.5 million 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. In the opinion of management, resolution of these claims will
not have a material adverse effect on the Company's financial position,
results of operations or cash flows.
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.
None.
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) REPORTS ON FORM 8-K
(1) On January 14, 1999, the Company filed a Current Report on Form
8-K (the "December 30 8-K") regarding the Company's December
30, 1998 acquisition ("DCA Acquisition") of the assets of DCA
Limited Partnership, L.L.P., Dental Administrators of Texas
Limited Partnership, L.L.P. and 16 related dental practices
(collectively, the "DCA Entities"). This Current Report on Form
8-K included the historical financial statements of the DCA
Entities.
-14-
<PAGE>
(2) On March 30, 1999, the Company filed a Current Report on Form
8-K/A amending the December 30 8-K and the Company's Current
Report on Form 8-K filed April 14, 1998 regarding the Company's
March 30, 1998 acquisition ("DCS Acquisition") of an 80%
interest in Castle Dental Centers of California, L.L.C., an
entity formed to acquire all of the assets of Dental Consulting
Services, LLC ("DCS"). This Current Report on Form 8-K included
the historical financial statements of DCS and dental practices
it managed as well as Pro Forma Consolidated Statements of
Operations of the Company for the years ended December 31, 1997
and 1998 reflecting the DCA Acquisition and the DCS
Acquisition.
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: May 13, 1999 By: JACK H. CASTLE, JR.
-----------------------
Jack H. Castle, Jr.
Chief Executive Officer
Date: May 13, 1999 By: JOHN M. SLACK
----------------
John M. Slack
Chief Financial Officer
-15-
<TABLE> <S> <C>
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<LEGEND>
THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AS OF MARCH 31, 1999 AND
THE THREE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
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