Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the
Securities Exchange Act of 1934
of the
Securities Exchange Act of 1934
For the Quarter Ended June 30, 2005
Commission file number 000-23092
NATIONAL DENTEX CORPORATION
(Exact name of registrant as specified in its charter)
| MASSACHUSETTS | 04-2762050 | |
| (State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
| 526 Boston Post Road, Wayland, MA | 01778 | |
| (Address of Principal Executive Offices) | (Zip Code) |
(508) 358-4422
(Registrant’s Telephone No., including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
| Yesþ | Noo |
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
| Yesþ | Noo |
As of August 2, 2005, 5,326,940 shares of the registrant’s Common Stock, par value $.01 per share, were outstanding.
Table of Contents
NATIONAL DENTEX CORPORATION
FORM 10-Q
QUARTER ENDED JUNE 30, 2005
TABLE OF CONTENTS
| Page(s) | ||||||||
| 3 | ||||||||
| 4 | ||||||||
| 5 | ||||||||
| 6-13 | ||||||||
| 14-19 | ||||||||
| 20 | ||||||||
| 20 | ||||||||
| 21 | ||||||||
| 22 | ||||||||
| 23 | ||||||||
| EX-31.1 SECTION 302 CERTIFICATION OF CEO | ||||||||
| EX-31.2 SECTION 302 CERTIFICATION OF CFO | ||||||||
| EX-32.1 SECTION 906 CERTIFICATION OF CEO | ||||||||
| EX-32.2 SECTION 906 CERTIFICATION OF CFO | ||||||||
2
Table of Contents
| PART I. Financial Information |
| Item 1. Financial Statements: |
NATIONAL DENTEX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Unaudited)
| December 31, | June 30, | |||||||
| 2004 | 2005 | |||||||
ASSETS | ||||||||
| CURRENT ASSETS: | ||||||||
| Cash and cash equivalents | $ | 2,215,742 | $ | 2,572,228 | ||||
| Accounts receivable: | ||||||||
| Trade, less allowance of $181,000 in 2004 and $301,000 in 2005 | 12,299,033 | 15,404,131 | ||||||
| Other | 692,910 | 464,168 | ||||||
| Inventories | 5,838,898 | 6,872,011 | ||||||
| Prepaid expenses | 2,479,939 | 2,537,857 | ||||||
| Total current assets | 23,526,522 | 27,850,395 | ||||||
| PROPERTY, PLANT AND EQUIPMENT: | ||||||||
| Land and buildings | 6,672,945 | 9,885,122 | ||||||
| Leasehold and building improvements | 7,217,877 | 7,683,162 | ||||||
| Laboratory equipment | 12,265,565 | 13,462,348 | ||||||
| Furniture and fixtures | 5,056,849 | 5,205,234 | ||||||
| 31,213,236 | 36,235,866 | |||||||
| Less — Accumulated depreciation and amortization | 16,027,568 | 16,814,605 | ||||||
| Net property, plant and equipment | 15,185,668 | 19,421,261 | ||||||
| OTHER ASSETS, net: | ||||||||
| Goodwill | 30,384,978 | 46,960,383 | ||||||
| Trade names | 2,940,000 | 5,775,443 | ||||||
| Customer relationships | 2,598,531 | 5,921,043 | ||||||
| Non-competition agreements | 2,724,401 | 3,124,648 | ||||||
| Other assets | 4,470,568 | 5,394,479 | ||||||
| Total other assets | 43,118,478 | 67,175,996 | ||||||
| Total assets | $ | 81,830,668 | $ | 114,447,652 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| CURRENT LIABILITIES: | ||||||||
| Revolving line of credit | $ | 2,000,000 | $ | — | ||||
| Current portion of long-term debt | — | 2,134,437 | ||||||
| Accounts payable | 2,318,632 | 2,559,651 | ||||||
| Accrued liabilities: | ||||||||
| Payroll and employee benefits | 3,781,976 | 6,539,100 | ||||||
| Current portion of deferred purchase price | 745,261 | 1,398,621 | ||||||
| Other accrued expenses | 798,785 | 1,479,815 | ||||||
| Deferred tax liability, current | 131,878 | 85,844 | ||||||
| Total current liabilities | 9,776,532 | 14,197,468 | ||||||
| LONG-TERM LIABILITIES: | ||||||||
| Long-term debt | — | 17,749,908 | ||||||
| Payroll and employee benefits | 2,461,726 | 2,684,852 | ||||||
| Deferred purchase price | 112,384 | 2,190,980 | ||||||
| Deferred tax liability | 2,596,641 | 5,631,512 | ||||||
| Total long-term liabilities | 5,170,751 | 28,257,252 | ||||||
| COMMITMENTS AND CONTINGENCIES | ||||||||
| STOCKHOLDERS’ EQUITY: | ||||||||
| Preferred stock, $.01 par value Authorized — 500,000 shares None issued and outstanding | — | — | ||||||
| Common stock, $.01 par value Authorized — 8,000,000 shares Issued — 5,648,197 shares at December 31, 2004 and 5,710,814 shares at June 30, 2005. Outstanding — 5,263,798 shares at December 31, 2004 and 5,326,415 shares at June 30, 2005 | 56,482 | 57,108 | ||||||
| Paid-in capital | 18,557,911 | 19,300,560 | ||||||
| Retained earnings | 53,327,961 | 57,694,233 | ||||||
| Treasury stock at cost — 384,399 shares at December 31, 2004 and June 30, 2005 | (5,058,969 | ) | (5,058,969 | ) | ||||
| Total stockholders’ equity | 66,883,385 | 71,992,932 | ||||||
| Total liabilities and stockholders’ equity | $ | 81,830,668 | $ | 114,447,652 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
Table of Contents
NATIONAL DENTEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Unaudited)
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30, | June 30, | June 30, | June 30, | |||||||||||||
| 2004 | 2005 | 2004 | 2005 | |||||||||||||
| Net sales | $ | 28,831,120 | $ | 36,214,222 | $ | 56,759,310 | $ | 68,160,567 | ||||||||
| Cost of goods sold | 16,829,279 | 20,236,337 | 33,159,580 | 38,254,735 | ||||||||||||
| Gross profit | 12,001,841 | 15,977,885 | 23,599,730 | 29,905,832 | ||||||||||||
| Selling, general and administrative expenses | 8,517,139 | 11,327,606 | 17,401,911 | 22,091,701 | ||||||||||||
| Operating income | 3,484,702 | 4,650,279 | 6,197,819 | 7,814,131 | ||||||||||||
| Other expense | 108,051 | 161,861 | 174,629 | 289,497 | ||||||||||||
| Interest expense | 6,771 | 276,966 | 17,706 | 348,634 | ||||||||||||
| Income before provision for income taxes | 3,369,880 | 4,211,452 | 6,005,484 | 7,176,000 | ||||||||||||
| Provision for income taxes | 1,347,953 | 1,623,909 | 2,402,194 | 2,809,728 | ||||||||||||
| Net income | $ | 2,021,927 | $ | 2,587,543 | $ | 3,603,290 | $ | 4,366,272 | ||||||||
| Net income per share – basic | $ | .39 | $ | .49 | $ | .70 | $ | .82 | ||||||||
| Net income per share – diluted | $ | .37 | $ | .47 | $ | .66 | $ | .79 | ||||||||
| Weighted average shares outstanding – basic | 5,179,503 | 5,321,665 | 5,165,698 | 5,297,195 | ||||||||||||
| Weighted average shares outstanding – diluted | 5,466,998 | 5,558,070 | 5,422,841 | 5,557,365 | ||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
Table of Contents
NATIONAL DENTEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Unaudited)
| For the Six Months Ended | ||||||||
| June 30, | June 30, | |||||||
| 2004 | 2005 | |||||||
| Cash flows from operating activities: | ||||||||
| Net income | $ | 3,603,290 | $ | 4,366,272 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities, net of effects of acquisitions: | ||||||||
| Depreciation and amortization | 1,502,974 | 1,825,037 | ||||||
| Loss on disposal of property, plant and equipment | 14,645 | 39,886 | ||||||
| Impairment of long-lived assets | 77,000 | — | ||||||
| Benefit for deferred income taxes | (44,630 | ) | (256,941 | ) | ||||
| Provision for bad debts | 22,411 | 35,083 | ||||||
| Changes in operating assets and liabilities, net of effects of acquisitions: | ||||||||
| Increase in accounts receivable | (1,541,749 | ) | (793,098 | ) | ||||
| Decrease (increase) in inventories | 181,069 | (282,183 | ) | |||||
| Increase in prepaid expenses | (849,333 | ) | (5,836 | ) | ||||
| (Increase) decrease in other assets | (712,048 | ) | 7,006 | |||||
| Increase in accounts payable and accrued liabilities | 2,158,995 | 4,962,250 | ||||||
| Net cash provided by operating activities | 4,412,624 | 9,897,476 | ||||||
| Cash flows from investing activities: | ||||||||
| Payment for acquisitions, net of cash acquired | (117,000 | ) | (25,670,113 | ) | ||||
| Payment of deferred purchase price | (1,636,740 | ) | (292,441 | ) | ||||
| Premiums paid for life insurance policies | (554,989 | ) | (699,352 | ) | ||||
| Additions to property, plant and equipment | (2,495,015 | ) | (1,506,706 | ) | ||||
| Net cash used in investing activities | (4,803,744 | ) | (28,168,612 | ) | ||||
| Cash flows from financing activities: | ||||||||
| Repayments of revolving line of credit | — | (2,000,000 | ) | |||||
| Borrowings of long-term debt | — | 19,884,346 | ||||||
| Issuance of common stock | 508,192 | 743,276 | ||||||
| Net cash provided by financing activities | 508,192 | 18,627,622 | ||||||
| Net increase in cash and cash equivalents | 117,072 | 356,486 | ||||||
| Cash and cash equivalents at beginning of period | 1,835,471 | 2,215,742 | ||||||
| Cash and cash equivalents at end of period | $ | 1,952,543 | $ | 2,572,228 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
Table of Contents
| Notes to Condensed Consolidated Financial Statements |
NATIONAL DENTEX CORPORATION
Notes to Condensed Consolidated Financial Statements
June 30, 2005
(Unaudited)
June 30, 2005
(Unaudited)
(1) Interim Financial Statements
The accompanying unaudited financial statements include all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair statement of the results of operations for the periods presented. Interim results are not necessarily indicative of the results to be expected for a full year.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s condensed consolidated financial statements for the year ended December 31, 2004 as filed with the SEC on Form 10-K. Certain amounts in the financial statements for the year ended December 31, 2004 have been classified to conform to the current period presentation.
(2) Restatement of Prior Financial Information
The fiscal 2004 amounts presented in this Form 10-Q have been restated to correct our historical accounting for certain intangible assets. In connection with its accounting for purchase business combinations, the Company had not historically recognized certain identifiable intangible assets, specifically customer relationships and trade names, apart from goodwill. However, in 2004 based upon a re-examination of the applicable accounting literature, FASB Statement No. 141 (“SFAS 141”) “Business Combinations”, FASB Statement No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets”and Emerging Issues Task Force Abstract 02-17 “Recognition of Customer Relationship Intangible Assets Acquired in a Business Combination”(“EITF 02-17”), the Company determined that the proper accounting practice is to recognize customer relationships and trade names as separate identifiable intangible assets apart from goodwill in acquisitions consummated by the Company subsequent to the applicable effective dates of SFAS 141 and EITF 02-17.
As a result of the issues discussed above, the Company restated its condensed consolidated financial statements for the quarters ended March 31, 2004, June 30, 2004 and September 30, 2004 as reported in Forms 10-Q/A, as filed with the Securities and Exchange Commission on May 24, 2005.
6
Table of Contents
Notes to Condensed Consolidated Financial Statements (Continued)
(3) Acquisitions
The Company’s acquisition strategy is to consolidate within the dental laboratory industry and use its financial and operational abilities to create a competitive advantage. Certain factors, such as the laboratory’s technical skills, reputation in the local marketplace and value as a going concern result in the recognition of goodwill.
In connection with certain acquisition agreements, the Company has incurred certain contractual obligations associated with deferred purchase price payments, which are not contingent on any future actions or performance measures. These deferred payments are recorded as a liability upon consummation of the acquisition and are included in the acquisition purchase price. Also, certain acquisition agreements contain provisions which require additional purchase price payments, contingent upon certain specified events. These contingent payments are recorded as an increase to goodwill upon the resolution of the contingency. In addition, in certain transactions, the Company executes non-compete agreements with the former owners and other key employees. The fair value of these agreements is recognized in purchase accounting as an identifiable intangible asset and is amortized over the estimated economic life of the agreement. All acquisitions have been reflected in the accompanying condensed consolidated financial statements from the date of acquisition and have been accounted for as purchase business combinations in accordance with SFAS No.141,“Business Combinations”.
During the six months ended June 30, 2005, the Company acquired the following dental laboratory operations:
| Acquisition | Form of Acquisition | Location | Period Acquired | |||
| Wornson-Polzin Dental Laboratory, Inc. | All Outstanding Capital Stock | Mankato, MN | February, 2005 | |||
| Green Dental Laboratory, Inc. | All Outstanding Capital Stock | Heber Springs, AR | March, 2005 | |||
| Midtown Brunswick Dental Laboratory, Inc. | Certain Assets | Brunswick, ME | May, 2005 |
Effective March 1, 2005, the Company acquired all of the outstanding capital stock of Green Dental Laboratories, Inc. of Heber Springs, Arkansas (“Green”). Green reported sales in excess of $16,000,000 in its last fiscal year ended December 31, 2004. The cost of the acquisition, net of cash acquired, was approximately $22,325,000. In the first quarter of 2005, the total purchase price was allocated to the acquired assets and liabilities using historical allocation percentages. The allocation now presented below is based on a preliminary valuation analysis performed by a third party. This preliminary valuation analysis is subject to future revision upon further review of assumptions and related valuation techniques.
| Green Dental Laboratory, Inc. | Preliminary Value | |||
| Total Purchase Price | $ | 23,443,000 | ||
| Less Fair Market Values Assigned to Tangible Assets and Liabilities: | ||||
| Cash | 1,118,000 | |||
| Accounts receivable | 1,488,000 | |||
| Inventories | 595,000 | |||
| Property, plant and equipment | 3,592,000 | |||
| Other assets | 36,000 | |||
| Accounts payable | (496,000 | ) | ||
| Accrued liabilities and other | (3,742,000 | ) | ||
| Assumed Long-term Debt | (96,000 | ) | ||
| Less Fair Market Values Assigned to Intangible Assets: | ||||
| Customer relationships | 2,900,000 | |||
| Trade names | 2,400,000 | |||
| Non-compete agreements | 618,000 | |||
| Goodwill | $ | 15,030,000 | ||
Effective February 1, 2005, the Company acquired all of the outstanding capital stock of Wornson-Polzin Dental Laboratory, Inc. of Mankato, Minnesota . Effective May 1, 2005, the Company acquired certain assets of Midtown Brunswick Dental Laboratory, Inc. of Brunswick, Maine. The total purchase price for these acquisitions was not material to the condensed consolidated financial statements and has been allocated to the acquired assets and liabilities based on estimates of their fair values.
The following pro forma operating results of the Company assume these acquisitions had been made as of January 1, 2004. Such information includes adjustments to reflect additional depreciation, amortization and interest expense and is not necessarily indicative of what the results of operations would actually have been, or the results of operations to be expected in future periods.
7
Table of Contents
Notes to Condensed Consolidated Financial Statements (Continued)
| Six Months Ended | ||||||||
| June 30, | June 30, | |||||||
| 2004 | 2005 | |||||||
| (unaudited) | ||||||||
| Net sales | $ | 67,647,000 | $ | 71,485,000 | ||||
| Net income | 4,957,000 | 4,781,000 | ||||||
| Net income per share: | ||||||||
| Basic | $ | .96 | $ | .90 | ||||
| Diluted | $ | .91 | $ | .86 | ||||
(4) Goodwill and Other Intangible Assets
In July 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141,“Business Combinations”and SFAS No. 142,“Goodwill and Other Intangible Assets.”SFAS No. 141 addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination, whether acquired individually or with a group of other assets, and the accounting and reporting for goodwill and other intangibles subsequent to their acquisition. These standards require that the purchase method of accounting be used for business combinations and eliminates the use of the pooling-of-interest method. Additionally, these standards require that goodwill and intangible assets with indefinite lives no longer be amortized. The Company was required to adopt SFAS No. 141 and SFAS No. 142 on a prospective basis as of July 1, 2001 and January 1, 2002, respectively. In accordance with the provisions of SFAS No. 142, the Company no longer amortizes goodwill.
The changes in the carrying amount of goodwill for the six months ended June 30, 2005 are as follows:
| Six Months Ended | ||||
| June 30, 2005 | ||||
| Balance as of January 1 | $ | 30,385,000 | ||
| Goodwill acquired during the year | 16,570,000 | |||
| Adjustments related to the finalization of preliminary purchase estimates | 5,000 | |||
| Balance as of June 30 | $ | 46,960,000 | ||
The Company’s contingent laboratory purchase price liabilities that are tied to earnings performance, generally over a three year period, as defined in the purchase agreements are approximately $4,104,000. As the contingencies are resolved, the payments are recorded as goodwill.
In connection with dental laboratory acquisitions, the Company has identified certain other intangible assets including trade names, customer relationships and non-competition agreements. The Company has applied the provisions of SFAS No. 141 and SFAS No. 142 as well as EITF No. 02-17“Recognition of Customer Relationship Intangible Assets Acquired in a Business Combination”(“EITF 02-17”) in its purchase price allocations.
Trade Names
Trade names as acquired are valued using a quantification of the income generated based on the recognition afforded by the trade name in the marketplace, using the relief-from-royalty valuation approach. Company practice is to use existing and acquired trade names in perpetuity, therefore there is no legal limit to their life and consequently they have been treated as indefinite-lived intangibles. While these assets are not subject to amortization, they are tested for impairment on an annual basis in accordance with SFAS No. 142. The Company uses the relief–from-royalty valuation approach at each fiscal year end to determine the fair value of the asset. Trade name impairment charges generally result from a decline in forecasted revenue at specific laboratories in comparison to revenue forecasts used in previous valuation calculations. Impairment charges, when recognized, are a component of selling, general and administrative expense.
The changes in the carrying amount of trade names for the six months ended June 30, 2005 are as follows:
| Six Months Ended | ||||
| June 30, 2005 | ||||
| Beginning of year | $ | 2,940,000 | ||
| Trade names acquired during the year | 2,835,000 | |||
| Trade Names | 5,775,000 | |||
| Less: Charged to Impairment Expense | — | |||
| Trade Names — End of period | $ | 5,775,000 | ||
8
Table of Contents
Notes to Condensed Consolidated Financial Statements (Continued)
Customer Relationships
Acquired dental laboratories have customer relationships in place with dentists within their market areas. Based on the criteria ofEITF 02-17, the Company recognizes customer relationship assets when established relationships exist with customers through contract or other contractual relationships such as purchase orders or sales orders. Customer relationships are valued based on an analysis of revenue and customer attrition data and amortized over their useful life. The weighted-average amortization period was 10.3 years.The amounts assigned to customer relationships are amortized on a straight-line basis over their useful lives. The Company has determined that the straight-line method is appropriate based on an analysis of customer attrition statistics.
| Six Months Ended | ||||
| June 30, 2005 | ||||
| Beginning of year | $ | 2,943,000 | ||
| Customer relationships acquired during the year | 3,599,000 | |||
| Customer Relationships, Gross | 6,542,000 | |||
| Less: Accumulated amortization | (621,000 | ) | ||
| Customer Relationships, Net — End of period | $ | 5,921,000 | ||
Amortization expense associated with customer relationships totaled approximately $277,000 for the six months ended June 30, 2005. Future amortization expense of the current customer relationship balance will be approximately:
| 2005 (six months ended December 31, 2005) | $ | 323,000 | ||
| 2006 | 646,000 | |||
| 2007 | 646,000 | |||
| 2008 | 646,000 | |||
| 2009 | 646,000 | |||
| 2010 | 646,000 | |||
| Thereafter | 2,368,000 | |||
| $ | 5,921,000 | |||
Non-competition Agreements
The Company has incurred certain deferred purchase costs relating to non-compete agreements with certain individuals, ranging over periods of 1 to 15 years. The weighted-average amortization period for acquisitions completed in 2005 was 10.6 years. The amounts assigned to non-competition agreements are amortized on a straight-line basis over the term of the agreement.
| Six Months Ended | ||||
| June 30, 2005 | ||||
| Beginning of year | $ | 9,121,000 | ||
| Non-competition agreements acquired during the year | 893,000 | |||
| Non-competition agreements, gross | 10,014,000 | |||
| Less: Accumulated amortization | (6,889,000 | ) | ||
| Non-competition agreements, net | $ | 3,125,000 | ||
Amortization expense associated with non-competition agreements totaled approximately $476,000 for the six months ended June 30, 2005.
Future amortization expense of non-competition agreements will be approximately:
| 2005 (six months ended December 31, 2005) | $ | 489,000 | ||
| 2006 | 811,000 | |||
| 2007 | 416,000 | |||
| 2008 | 260,000 | |||
| 2009 | 238,000 | |||
| 2010 | 229,000 | |||
| Thereafter | 682,000 | |||
| $ | 3,125,000 | |||
9
Table of Contents
Notes to Condensed Consolidated Financial Statements (Continued)
(5) Stock Split
On December 10, 2004 the Company announced a three-for-two stock split in the form of a stock dividend on its common stock to be paid on December 31, 2004 to stockholders of record on December 20, 2004. All references in the financial statements and the related notes as to the number of shares, per share amounts, stock option data and market prices have been adjusted to reflect this stock split.
(6) Earnings per Share
In accordance with the disclosure requirements of SFAS Statement No. 128,“Earnings per Share,” basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding and diluted earnings per share reflects the dilutive effect of stock options. The weighted average number of shares outstanding, the dilutive effects of outstanding stock options, and the shares under option plans that were anti-dilutive for the three and six months ended June 30, 2005 and 2004 are as follows:
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2004 | 2005 | 2004 | 2005 | |||||||||||||
| Weighted average number of shares used in basic earnings per share calculation | 5,179,503 | 5,321,665 | 5,165,698 | 5,297,195 | ||||||||||||
| Incremental shares under option plans | 287,495 | 236,405 | 257,143 | 260,170 | ||||||||||||
| Weighed average number of shares used in diluted earnings per share calculation | 5,466,998 | 5,558,070 | 5,422,841 | 5,557,365 | ||||||||||||
| Shares under option plans excluded in computation of diluted earnings per share due to anti-dilutive effects | None | None | None | None | ||||||||||||
(7) Stock-Based Compensation
The Company adopted the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.”The Company has elected to continue to account for employee stock options at intrinsic value, in accordance with Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees,”with disclosure of the effects of fair value accounting on net income and earnings per share on a pro forma basis. Had compensation costs for the Company’s 1992 Long-Term Incentive Plan, 2001 Stock Plan and 1992 Employees’ Stock Purchase Plan been determined consistent with SFAS No. 123, the Company’s net income and earnings per share would have been reduced to the following pro forma amounts:
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2004 | 2005 | 2004 | 2005 | |||||||||||||
| Net income, as reported: | $ | 2,021,927 | $ | 2,587,543 | $ | 3,603,290 | $ | 4,366,272 | ||||||||
| Add: Stock-based employee compensation expense included in reported net income | — | — | — | — | ||||||||||||
| Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | 38,592 | 19,890 | 82,686 | 39,323 | ||||||||||||
| Pro forma net income | $ | 1,983,335 | $ | 2,567,653 | $ | 3,520,604 | $ | 4,326,949 | ||||||||
| Earnings per share: | ||||||||||||||||
| As reported, basic | $ | .39 | $ | .49 | $ | .70 | $ | .82 | ||||||||
| Pro forma, basic | .38 | .48 | .68 | .82 | ||||||||||||
| As reported, diluted | .37 | .47 | .66 | .79 | ||||||||||||
| Pro forma, diluted | .36 | .46 | .65 | .78 | ||||||||||||
10
Table of Contents
Notes to Condensed Consolidated Financial Statements (Continued)
(8) Inventories
Inventories consist of the following:
| December 31, 2004 | June 30, 2005 | |||||||
| Raw Materials | $ | 4,804,115 | $ | 5,556,253 | ||||
| Work in Process | 861,984 | 1,137,272 | ||||||
| Finished Goods | 172,799 | 178,486 | ||||||
| $ | 5,838,898 | $ | 6,872,011 | |||||
Inventories are stated at the lower of cost (first-in, first-out) or market. Work in process represents an estimate of the value of specific orders in production yet incomplete at period end. Finished goods consist of completed orders that were shipped to customers immediately subsequent to period end.
(9) Lines of Credit and Term Loan Facility
The Company has executed a financing agreement (the “Agreement”) with Bank of America, N.A. (the “Bank”). The Agreement, dated June 30, 2004, includes a revolving line of credit of $5,000,000 and a revolving acquisition line of credit of $20,000,000. The interest rate on both revolving lines of credit is the prime rate or, at the Company’s option, the London Interbank Offered Rate (“LIBOR”) or a cost of funds rate plus a range of .75% to 1.5% depending on the ratio of total liabilities to tangible net worth. Both revolving lines of credit terminate on June 30, 2007. The Agreement requires compliance with certain covenants, including the maintenance of specified net worth and other financial ratios.
An unused facility fee of one eighth of 1% per annum is payable on the unused amount of the first revolving line of credit. A facility fee of $10,000 per year is required on the acquisition line of credit. At June 30, 2005, the Company had borrowed $19,884,000 on the revolving acquisition line of credit with $116,000 remaining available. As of June 30, 2005, the interest rate associated with current borrowings was 5.50% and the entire $5,000,000 was available under the first line of credit.
On August 9, 2005 the Company executed an amended and restated agreement with the Bank for an additional five year credit facility in the form of a term loan in the principal amount of $20,000,000. Accordingly, amounts previously borrowed under the revolving acquisition line of credit were repaid under the term loan facility, creating $20,000,000 of availability under the acquisition line of credit. The interest rate on both revolving lines of credit and the term loan is the prime rate or, at the Company’s option, the London Interbank Offered Rate (“LIBOR”), a cost of funds rate or the Bank’s fixed rate plus a range of 1.25% to 2.25% depending on the ratio of consolidated funded debt to consolidated “EBITDA”, as defined in the agreement. The agreement requires monthly payments of principal, based on a seven year amortization schedule, with a final payment due on the fifth anniversary of the revised agreement.
| June 30, 2005 | ||||
| Total long-term debt | $ | 19,884,000 | ||
| Less: Current maturities | (2,134,000) | |||
| Long-term debt, less current portion | $ | 17,750,000 | ||
The table below reflects the expected repayment terms associated with this new term loan facility at June 30, 2005:
| Principal Due | ||||
| For the remainder of fiscal 2005 | $ | 955,000 | ||
| Fiscal 2006 | 2,398,000 | |||
| Fiscal 2007 | 2,558,000 | |||
| Fiscal 2008 | 2,729,000 | |||
| Fiscal 2009 | 2,911,000 | |||
| Fiscal 2010 | 8,333,000 | |||
| Total | $ | 19,884,000 | ||
11
Table of Contents
Notes to Condensed Consolidated Financial Statements (Continued)
(10) Segment Information
The Company follows Statement of Financial Accounting Standards No. 131 (“SFAS 131”),“Disclosures about Segments of an Enterprise and Related Information”. SFAS 131 establishes standards for disclosing information about reportable segments in financial statements. The Company owns and operates 45 dental laboratories throughout the United States which custom design and fabricate dentures, crowns and fixed bridges, and other dental appliances.
In March of 2005, the Company acquired Green Dental Laboratories, Inc. of Heber Springs, Arkansas. Green is now the Company’s largest laboratory with sales in excess of $16,000,000 per year. In accordance with SFAS 131, the Company identified Green as a separate operating segment that did not meet the aggregation criteria of SFAS 131. As a result, the Company has two reportable segments. The accounting policies of this segment are consistent with those described for the consolidated financial statements in the summary of significant accounting policies.
The following table sets forth information about the Company’s operating segments for the three and six months ended June 30, 2005.
| Three Months Ended | Six Months Ended | |||||||
| June 30, 2005 | June 30, 2005 | |||||||
| Revenue: | ||||||||
| NDX Laboratories | $ | 31,745,638 | $ | 62,097,566 | ||||
| Green Dental Laboratory | 4,468,584 | 6,063,001 | ||||||
| $ | 36,214,222 | $ | 68,160,567 | |||||
| Laboratory Operating Income: | ||||||||
| NDX Laboratories | $ | 6,099,357 | $ | 11,537,193 | ||||
| Green Dental Laboratory | 1,203,037 | 1,687,730 | ||||||
| $ | 7,302,394 | $ | 13,224,923 | |||||
| Total Assets: | ||||||||
| NDX Laboratories | $ | 78,613,040 | $ | 78,613,040 | ||||
| Green Dental Laboratory | 26,989,527 | 26,989,527 | ||||||
| Corporate | 8,845,085 | 8,845,085 | ||||||
| $ | 114,447,652 | $ | 114,447,652 | |||||
| Capital Expenditures: | ||||||||
| NDX Laboratories | $ | 692,784 | $ | 1,365,795 | ||||
| Green Dental Laboratory | 13,208 | 24,916 | ||||||
| Corporate | 80,002 | 115,995 | ||||||
| $ | 785,994 | $ | 1,506,706 | |||||
| Depreciation & Amortization on Property, Plant & Equipment: | �� | |||||||
| NDX Laboratories | $ | 406,065 | $ | 757,609 | ||||
| Green Dental Laboratory | 79,461 | 95,234 | ||||||
| Corporate | 143,489 | 213,373 | ||||||
| $ | 629,015 | $ | 1,066,216 | |||||
Reconciliation of Laboratory Operating Income with reported Consolidated Operating Income:
| Three Months Ended | Six Months Ended | |||||||
| June 30, 2005 | June 30, 2005 | |||||||
| Laboratory Operating Income | $ | 7,302,394 | $ | 13,224,923 | ||||
| Less: | ||||||||
| Corporate Selling, General and Administrative Expenses | 2,436,252 | 4,941,468 | ||||||
| Amortization Expense – Intangible Assets | 377,724 | 758,821 | ||||||
| Add: | ||||||||
| Other Expense | 161,861 | 289,497 | ||||||
| Consolidated Operating Income | $ | 4,650,279 | $ | 7,814,131 | ||||
12
Table of Contents
Notes to Condensed Consolidated Financial Statements (Continued)
(11) Recent Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs – An Amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends the guidance in Accounting Research Bulletin (ARB) No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005, and is required to be adopted by the Company effective January 1, 2006. The Company does not expect SFAS No. 151 to have a material impact on its consolidated results of operations or financial condition.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment”. SFAS No. 123R supersedes APB Opinion No. 25, which requires recognition of an expense when goods or services are provided. SFAS No. 123R requires the determination of the fair value of the share-based compensation at the grant date and the recognition of the related expense over the period in which the share-based compensation vests. SFAS No. 123R permits a prospective or two modified versions of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by the original SFAS No. 123. The Company is required to adopt the provisions of SFAS No. 123R effective January 1, 2006, at which time the Company will begin recognizing an expense for unvested share-based compensation that has been issued or will be issued after that date. The Company has not yet finalized its decision concerning the transition option it will utilize to adopt SFAS No. 123R. Based on pro-forma financial statements, the Company expects the impact of the adoption of SFAS No. 123R to be immaterial as it relates to the Company’s currently outstanding options. The Company will continue to assess the impact SFAS No. 123R will have on any future grants.
On October 22, 2004, the President signed the “American Jobs Creation Act of 2004”(the “Act”). The Act provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. In return, the Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. The Company expects the net effect of the phase out of the ETI and the phase in of this new deduction to result in a decrease in the effective tax rate for fiscal years 2005 and 2006 of approximately 1 percentage-point, based on current earnings levels. In the long-term, the Company expects that the new deduction will result in a decrease of the annual effective tax rate by 3 percentage-points based on current earnings levels.
Under the guidance in FASB Staff Position No. FAS 109-1, “Application of SFAS No. 109, Accounting for Income Taxes,”to the Tax Deduction on Qualified Production Activities Provided by the Act, the deduction will be treated as a “special deduction” as described in SFAS No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction will be reported in the period in which the deduction is claimed on the Company’s tax return.
(12) Legal Proceedings
The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of current litigation will not have a material adverse effect upon the operations or financial condition of the Company and will not disrupt the normal operations of the Company.
(13) Subsequent Events
On August 9, 2005 the Company executed an amended and restated agreement with the Bank for an additional five year credit facility in the form of a term loan in the principal amount of $20,000,000. Accordingly, amounts previously borrowed under the revolving acquisition line of credit were repaid under the term loan facility, creating $20,000,000 of availability under the acquisition line of credit. The interest rate on both revolving lines of credit and the term loan is the prime rate or, at the Company’s option, the London Interbank Offered Rate (“LIBOR”), a cost of funds rate or the Bank’s fixed rate plus a range of 1.25% to 2.25%, depending on the ratio of consolidated funded debt to consolidated “EBITDA”, as defined in the agreement. The agreement requires monthly payments of principal, based on a seven year amortization schedule, with a final payment due on the fifth anniversary of the revised agreement.
13
Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
This Quarterly Report on Form 10-Q, including this discussion and analysis by management, contains or incorporates forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which we operate and our management’s beliefs and assumptions. In addition, other written or oral statements that constitute forward-looking statements may be made by or on our behalf. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. We have included important factors in the cautionary statements below under the heading “Factors That May Affect Future Results” that we believe could cause our actual results to differ materially from the forward-looking statements we make. We do not intend to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
Overview
We own and operate 45 dental laboratories located in 30 states, serving an active customer base of over 22,000 dentists. Our business consists of the design, fabrication, marketing and sale of custom dental prosthetic appliances for dentists located primarily in the domestic marketplace.
Our products are grouped into the following three main categories:
Restorative Products.Restorative products that our dental laboratories sell consist primarily of crowns and bridges. A crown replaces the part of a tooth that is visible, and is usually made of gold or porcelain. A bridge is a restoration of one or more missing teeth that is permanently attached to the natural teeth or roots. In addition to the traditional crown, we also make porcelain jackets, which are crowns constructed entirely of porcelain; onlays, which are partial crowns which do not cover all of the visible tooth; and precision crowns, which are restorations designed to receive and connect a removable partial denture. We also make inlays, which are restorations made to fit a prepared tooth cavity and then cemented into place.
Reconstructive Products.Reconstructive products sold by our dental laboratories consist primarily of partial dentures and full dentures. Partial dentures are removable dental prostheses that replace missing teeth and associated structures. Full dentures are dental prostheses that substitute for the total loss of teeth and associated structures. We also sell precision attachments, which connect a crown and an artificial prosthesis, and implants, which are fixtures anchored securely in the bone of the mouth to which a crown, partial or full denture is secured by means of screws or clips.
Cosmetic Products.Cosmetic products sold by our dental laboratories consist primarily of porcelain veneers and ceramic crowns. Porcelain veneers are thin coverings of porcelain cemented to the front of a tooth to enhance personal appearance. Ceramic crowns are crowns made from ceramic materials that most closely replicate natural teeth. We also sell composite inlays and onlays, which replace silver fillings for a more natural appearance, and orthodontic appliances, which are products fabricated to move existing teeth to enhance function and appearance.
Internal revenue growth has been relatively flat since 2001, when we made note that the economic climate appeared to be impacting the dental laboratory industry. We believe that many patients and dentists have postponed optimal treatment plans, such as crowns, and have been pursuing less expensive alternatives such as amalgam fillings, for which we recognize no revenue. The general economic conditions affecting our operations in the dental laboratory industry have remained less than favorable as consumers continue this conservative practice. For the first six months of 2005, while we have experienced internal sales growth of 3.2%, which included selling price increases during the period ranging from 3.5% to 10.0% at various laboratories and on various product lines and indicate a decline in unit volume.
We have also continued to pursue an acquisition strategy, which has played an important role in helping us increase sales from $75,680,000 in 2000 to $111,753,000 in 2004. However, operating margins as measured as a percentage of sales declined over this period. The main components of costs for us are the cost of labor and related employee benefits. Competition for labor resources and increases in medical insurance costs have driven these costs higher. These increased costs, combined with somewhat flat internal sales growth have contributed to lower operating margins during the period of 2000 to 2004. Conversely, improvements in these factors in the first six months of 2005 helped increase operating margins compared to the prior year. We continually review and adjust staffing levels as appropriate at each of our locations while recognizing the need to maintain an available and properly trained workforce.
14
Table of Contents
We have also experienced cost pressure resulting from the implementation costs to comply with Section 404 of the Sarbanes Oxley Act. Due in large part to the decentralized nature of our business, approximately half of our laboratories were subject to detailed onsite testing. The scope and complexity of the project required us to engage the accounting firm of Deloitte and Touche, LLP. In addition, external audit fees for PricewaterhouseCoopers, LLP were significantly higher than in the prior years. The impact on these various Section 404 implementation costs on earnings in 2004 was approximately $1,027,000, or approximately $0.11 per diluted share, net of taxes, with most of that occurring in the fourth quarter. We believe that these compliance costs will decrease somewhat during 2005, however significant ongoing expenditures will be required to maintain our efforts within the internal controls framework required by the Sarbanes-Oxley Act.
Beginning in 2004 we recognized acquired customer relationships and trade names as intangible assets which requires the recognition of amortization expense and impairment testing, respectively. On a prospective basis, amortization expense will increase dependent on our acquisition activity in rough proportions with the expected profitability of the acquired businesses.
Effective March 1, 2005 we completed our largest acquisition to date, Green Dental Laboratories, Inc (“Green”). Green is notable for several reasons. We believe that the synergies created by the addition of this unique laboratory will create value for the organization as a whole. Annual sales are expected to approximate $16,000,000, making Green our largest laboratory. Green will be treated as a separate operating segment for reporting purposes and will retain a separate company identity as a wholly owned subsidiary. In order to finance the purchase of Green, we borrowed approximately $20,000,000 in long term debt and as a result, are more highly leveraged than we were prior to the Green acquisition. Interest expense has therefore become a more significant component of our pre-tax earnings.
Liquidity and Capital Resources
Our working capital decreased slightly from $13,750,000 at December 31, 2004 to $13,653,000 at June 30, 2005. Cash and cash equivalents increased $356,000 from $2,216,000 at December 31, 2004 to $2,572,000 at June 30, 2005. Operating activities provided $9,897,000 in cash flow for the six months ended June 30, 2005 compared to $4,413,000 during the six months ended June, 2004, an increase of $5,485,000. This increase was primarily attributable to timing differences related to accrued liabilities ($2,803,000, including increases in accrued payroll and related benefits of $2,025,000, audit fee accruals of $270,000, taxes of $200,000 and interest of $125,000), decreases in prepaid expenses ($845,000, primarily prepaid income taxes) and accounts receivable ($749,000, resulting primarily from higher sales volume) offset by an increase in inventory ($463,000, including $290,000 of work in process).
Cash outflows related to dental laboratory acquisitions, including deferred purchase price payments associated with prior period acquisitions, totaled $25,963,000 for the six months ended June 30, 2005 compared to $1,754,000 for the six months ended June 30, 2004, primarily due to the acquisitions of Green and Wornson-Polzin Dental Laboratory. Additions to property, plant and equipment, were $1,507,000 for the six months ended June 30, 2005, significantly less than the $2,495,000 spent for the six months ended June 30, 2004. In the first quarter of 2004 we purchased a $2,000,000 replacement facility for our dental laboratory in Houston, Texas. We expect that facility to be placed in service in the fourth quarter of 2005, at the completion of a build-out project expected to require an additional investment in building improvements and equipment of approximately $3,000,000 in 2005.
We have executed a financing agreement (the “Agreement”) with Fleet National Bank, a Bank of America Company (the “Bank”). The Agreement, dated June 30, 2004, includes a revolving line of credit of $5,000,000 and a revolving acquisition line of credit of $20,000,000. The interest rate on both revolving lines of credit is the prime rate or, at our option, the London Interbank Offered Rate (“LIBOR”) or a cost of funds rate plus a range of .75% to 1.5% depending on the ratio of total liabilities to tangible net worth. Both revolving lines of credit terminate on June 30, 2007. The Agreement requires compliance with certain covenants, including the maintenance of specified net worth and other financial ratios.
An unused facility fee of one eighth of 1% per annum is payable on the unused amount of the first revolving line of credit. A facility fee of $10,000 per year is required on the acquisition line of credit. At June 30, 2005, we had borrowed $19,884,000 on the revolving acquisition line of credit with $116,000 remaining available. As of June 30, 2005, the interest rate associated with current borrowings was 5.50% and the entire $5,000,000 was available under the first line of credit.
On August 9, 2005 we executed an amended and restated agreement with the Bank for an additional five year credit facility in the form of a term loan in the principal amount of $20,000,000. Accordingly, amounts previously borrowed under the revolving acquisition line of credit were repaid under the term loan facility, creating $20,000,000 of availability under the acquisition line of credit. The interest rate on both revolving lines of credit and the term loan is the prime rate or, at our option, the London Interbank Offered Rate (“LIBOR”), a cost of funds rate, or the Bank’s fixed rate plus a range of 1.25% to 2.25% depending on the ratio of consolidated funded debt to consolidated “EBITDA”, as defined in the agreement. The agreement requires monthly payments of principal, based on a seven year amortization schedule, with a final payment due on the fifth anniversary of the revised agreement.
15
Table of Contents
| June 30, 2005 | ||||
| Total long-term debt | $ | 19,884,000 | ||
| Less: Current maturities | (2,134,000) | |||
| Long-term debt, less current portion | $ | 17,750,000 | ||
The table below reflects the expected repayment terms associated with this new term loan facility at June 30, 2005:
| Principal Due | ||||
| For the remainder of fiscal 2005 | $ | 955,000 | ||
| Fiscal 2006 | 2,398,000 | |||
| Fiscal 2007 | 2,558,000 | |||
| Fiscal 2008 | 2,729,000 | |||
| Fiscal 2009 | 2,911,000 | |||
| Fiscal 2010 | 8,333,000 | |||
| Total | $ | 19,884,000 | ||
We believe that cash flow from operations and available financing will be sufficient to meet contemplated operating and capital requirements and deferred payments associated with prior acquisitions for the foreseeable future.
Commitments and Contingencies
The following table represents a list of our contractual obligations and commitments as of June 30, 2005:
| Payments Due By Period | ||||||||||||||||||||
| Less Than | Greater Than | |||||||||||||||||||
| Total | 1 Year | 1 – 3 Years | 4 – 5 Years | 5 Years | ||||||||||||||||
| Revolving line of credit – acquisition | $ | 19,884,000 | $ | 2,134,000 | $ | 5,119,000 | $ | 5,824,000 | $ | 6,807,000 | ||||||||||
| Operating Leases: | ||||||||||||||||||||
| Real Estate | 11,875,000 | 2,307,000 | 4,421,000 | 1,678,000 | 3,469,000 | |||||||||||||||
| Vehicles | 767,000 | 547,000 | 220,000 | — | — | |||||||||||||||
| Equipment | 56,000 | 38,000 | 18,000 | — | — | |||||||||||||||
| Construction Contracts | 2,670,000 | 2,670,000 | — | — | — | |||||||||||||||
| Laboratory Purchase Obligations | 3,590,000 | 1,399,000 | 2,191,000 | — | — | |||||||||||||||
| Contingent Laboratory Purchase Price | 4,104,000 | 1,802,000 | 2,302,000 | — | — | |||||||||||||||
| TOTAL | $ | 42,946,000 | $ | 10,897,000 | $ | 14,271,000 | $ | 7,502,000 | $ | 10,276,000 | ||||||||||
Bank borrowings on the acquisition line of credit, net of the current portion, are classified as long-term debt on the balance sheet. The interest rate associated with this borrowing is 5.50%. As previously discussed, in August, 2005 we executed an agreement for an additional five year credit facility, providing an additional $20,000,000 in available financing. Borrowings on the acquisition line of credit were credited to this new facility in August, 2005. The above table reflects the expected payment terms associated with this new credit facility.
We are committed under various non-cancelable operating lease agreements covering office space and dental laboratory facilities, vehicles and certain equipment. Certain of these leases also require us to pay maintenance, repairs, insurance and related taxes. We also have contractual commitments related to construction projects currently in process at certain dental laboratory facilities.
Laboratory purchase obligations totaling $3,590,000, classified as deferred acquisition costs, are presented in the liability section of the balance sheet. These obligations represent purchase price commitments arising from dental laboratory acquisitions, irrespective of the acquired laboratory’s earnings performance, including deferred obligations associated with non-competition agreements. Contingent laboratory purchase price includes amounts subject to acquisition agreements that are tied to laboratory earnings performance, as defined within the acquisition agreements, generally over a three year period. As payments become determinable, they are recorded as goodwill.
As sponsor of the National Dentex Corporation Dollars Plus Plan, (the “Plan”), a qualified plan under Section 401(a) of the Internal Revenue Code, we filed a retroactive plan amendment under the Internal Revenue Service’s Voluntary Correction Program to clarify the definition of compensation in the Plan. Based on our consultation with our ERISA counsel, we believe this issue will be favorably resolved without requiring additional employer contributions or jeopardizing the tax-qualified status of the Plan.
16
Table of Contents
Results of Operations
The following table sets forth for the periods indicated the percentage of net sales represented by certain items in our condensed consolidated financial statements:
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30 | June 30 | |||||||||||||||
| 2004 | 2005 | 2004 | 2005 | |||||||||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
| Cost of goods sold | 58.4 | 55.9 | 58.4 | 56.1 | ||||||||||||
| Gross profit | 41.6 | 44.1 | 41.6 | 43.9 | ||||||||||||
| Selling, general and administrative expenses | 29.5 | 31.3 | 30.7 | 32.4 | ||||||||||||
| Operating income | 12.1 | 12.8 | 10.9 | 11.5 | ||||||||||||
| Other expense | 0.4 | 0.4 | 0.4 | 0.4 | ||||||||||||
| Interest expense | 0.0 | 0.8 | 0.0 | 0.5 | ||||||||||||
| Income before provision for income taxes | 11.7 | 11.6 | 10.5 | 10.5 | ||||||||||||
| Provision for income taxes | 4.7 | 4.5 | 4.2 | 4.1 | ||||||||||||
| Net income | 7.0 | % | 7.1 | % | 6.3 | % | 6.4 | % | ||||||||
Six Months Ended June 30, 2005 Compared with Six Months Ended June 30, 2004
Net Sales
For the six months ended June 30, 2005, net sales increased $11,401,000 or 20.1% from the prior year. Net sales increased by approximately $9,560,000, or 16.9%, as a result of acquisitions, measured by business at dental laboratories owned less than one year. Net sales increased approximately $1,841,000 an increase of 3.2%, at dental laboratories owned for both the six months ended June 30, 2005 and the comparable six months ended June 30, 2004, primarily due to price increases ranging from 3.5% to 10.0% at various laboratories and on various product lines, offset by a decline in the total number of units produced.
Cost of Goods Sold
Cost of goods sold as a percentage of sales was 56.1% in the six months ended June 30, 2005 compared with 58.4% in the same period of 2004. Materials costs of 13.7% decreased as a percentage of sales in 2005 compared to 14.7% in 2004. This decrease was attributable to declines in the cost of the precious metal palladium, a key component in many dental alloys, and other purchasing cost savings measures. Labor productivity improvements also helped improve our gross margin, offsetting increases in employee health insurance costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, which consist of selling, delivery and administrative expenses both at the laboratory and corporate level, were $22,092,000 or 32.4% of sales in 2005 compared to $17,402,000 or 30.7% in 2004. As a percentage of sales, delivery and selling expenses declined while administrative expenses at the corporate level rose sharply in 2005 compared to 2004. The increase of $4,690,000 was primarily attributable to the following items:
| • | additional operating and amortization expense associated with acquisitions completed subsequent to June 30, 2004 — $2,315,000; | ||
| • | increases in salaries and benefits at the corporate and lab level, in part due to the addition of accounting and management staff and increases in health insurance — $808,000; | ||
| • | increases in professional fees, including audit and compliance costs — $543,000; | ||
| • | increases in laboratory incentive compensation as a result of improved laboratory profit performance — $427,000; | ||
| • | increases in training and recruiting expenses — $155,000; | ||
| • | increases in bad debt reserves — $133,000; | ||
| • | increases in delivery costs — $155,000. |
Operating Income
As a result of the factors discussed above, our operating income increased by $1,616,000 to $7,814,000 for the six months ended June 30, 2005 from $6,198,000 for the comparable six months ended June 30, 2004. As a percentage of net sales, operating income increased from 10.9% in 2004 to 11.5% in 2005.
17
Table of Contents
Interest Expense
Interest expense was $349,000 in the first six months of 2005 compared with $18,000 in the first six months of 2004. The change of $331,000 was primarily due to the use of the line of credit to fund dental laboratory acquisitions.
Provision for Income Taxes
The provision for income taxes increased to $2,810,000 in 2005 from $2,402,000 in 2004. The effective tax rate decreased from 40.0% in 2004 to 39.2% in 2005. The decrease was due to the recognition of lower federal tax expense resulting from the domestic manufacturing tax credit provisions of the American Jobs Creation Act of 2004 which is expected to reduce the effective tax rate by 1%.
Net Income
As a result of all of the factors discussed above, net income increased to $4,366,000 or $.79 per share on a diluted basis in the first six months of 2005 from $3,603,000 or $.66 per share on a diluted basis in the first six months of 2004.
Three Months Ended June 30, 2005 Compared with Three Months Ended June 30, 2004
Net Sales
For the three months ended June 30, 2005, net sales increased $7,383,000 or 25.6% from the prior year. Net sales increased by approximately $6,324,000, or 21.9%, as a result of acquisitions, measured by business at dental laboratories owned less than one year. Net sales increased approximately $1,059,000 an increase of 3.8%, at dental laboratories owned for both the quarter ended June 30, 2005 and the comparable quarter ended June 30, 2004, primarily due to price increases ranging from 3.5% to 10.0% at various laboratories and on various product lines, offset by a decline in the total number of units produced.
Cost of Goods Sold
Cost of goods sold as a percentage of sales was 55.9% in the quarter ended June 30, 2005 compared with 58.4% in the same period of 2004. Materials costs of 14.1% decreased as a percentage of sales in 2005 compared to 14.7% in 2004. This decrease was attributable to declines in the cost of the precious metal palladium, a key component in many dental alloys, and other purchasing cost savings measures. Labor productivity improvements also helped improve our gross margin, offsetting increases in employee health insurance costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, which consist of selling, delivery and administrative expenses both at the laboratory and corporate level, were $11,328,000 or 31.3% of sales in 2005 compared to $8,517,000 or 29.5% in 2004. As a percentage of sales, delivery expenses declined while administrative expenses at the corporate level rose sharply in 2005 compared to 2004. The increase of $2,810,000 was primarily attributable to the following items:
| • | additional operating and amortization expense associated with acquisitions completed subsequent to June 30, 2004 — $1,570,000; | ||
| • | increases in salaries and benefits at the corporate and lab level, in part due to the addition of accounting and management staff and increases in health insurance — $350,000; | ||
| • | increases in professional fees, including audit and compliance costs — $413,000; | ||
| • | increases in laboratory incentive compensation as a result of improved laboratory profit performance — $292,000. |
Operating Income
As a result of the factors discussed above, our operating income increased by $1,166,000 to $4,650,000 for the quarter ended June 30, 2005 from $3,485,000 for the comparable quarter ended June 30, 2004. As a percentage of net sales, operating income increased from 12.1% in 2004 to 12.8% in 2005.
Interest Expense
Interest expense was $277,000 in the second quarter of 2005 compared with $7,000 in the second quarter of 2004. The change of $270,000 was primarily due to the use of the line of credit to fund dental laboratory acquisitions.
18
Table of Contents
Provision for Income Taxes
The provision for income taxes increased to $1,624,000 in 2005 from $1,348,000 in 2004. The effective tax rate decreased from 40.0% in 2004 to 38.6% in 2005. The decrease was due to the recognition of lower federal tax expense resulting from the domestic manufacturing tax credit provisions of the American Jobs Creation Act of 2004 which is expected to reduce the 2005 effective tax rate by 1%.
Net Income
As a result of all of the factors discussed above, net income increased to $2,587,000 or $.47 per share on a diluted basis in the second quarter of 2005 from $2,022,000 or $.37 per share on a diluted basis in the second quarter of 2004.
Factors That May Affect Future Results
Various risks, uncertainties and contingencies could cause our actual results, performance or achievements to differ materially from those expressed in, or implied by, statements contained in this Quarterly Report on Form 10-Q, including, but not limited to, the following:
| • | the timing, duration and effects of adverse changes in overall economic conditions, particularly those affecting employment patterns or likely to cause individuals to defer or substitute needed or elective dental work, | ||
| • | our ability to acquire and successfully operate additional laboratories, | ||
| • | governmental regulation of health care, | ||
| • | trends in the dental industry towards managed care, | ||
| • | competition within the dental laboratory industry, including new sources of foreign competition, | ||
| • | increases in labor and benefits costs, | ||
| • | increases in material costs, particularly related to the purchase of dental alloys, which contain gold, palladium, and other precious metals, | ||
| • | product development risks, | ||
| • | technological innovations by third parties, | ||
| • | compliance with evolving federal securities, accounting, and marketplace rules and regulations applicable to publicly-traded companies on the Nasdaq National Market; and | ||
| • | other risks indicated from time to time in our filings with the Securities and Exchange Commission. |
19
Table of Contents
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our market risk exposure includes potential price volatility of commodities we use in our manufacturing processes. We purchase dental alloys that contain gold, palladium and other precious metals. We have not participated in hedging transactions. We have relied on pricing practices that attempt to pass increased costs on to the customer, in conjunction with materials substitution strategies.
At June 30, 2005, we had variable rate debt of $19.9 million. Based on this amount, the earnings and cash flows impact for the next year resulting from a one percentage point increase in interest rates would be approximately $121,000, net of tax, holding other variables constant.
Item 4. Controls and Procedures
(a)Evaluation of Disclosure Controls and Procedures.
We carried out an evaluation, with the participation of our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures as of June 30, 2005. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of June 30, 2005, our disclosure controls and procedures, as defined in the Securities Exchange Act (the “Exchange Act”) Rule 13a-15(e) and 15d-15(e), were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
(b)Changes in Internal Controls.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended June 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
20
Table of Contents
PART II. OTHER INFORMATION
Item 1. Legal Proceedings:
We are involved from time to time in litigation incidental to our business. Our management believes that the outcome of current litigation will not have a material adverse effect upon our operations or financial condition and will not disrupt our normal operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds:
We did not repurchase any of our equity securities during the fiscal quarter ended June 30, 2005 or engage in any transactions during such period reportable pursuant to Item 703 of Regulation S-K.
Item 3. Defaults upon Senior Securities:
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders:
Our Special Meeting in Lieu of an Annual Meeting of Stockholders was held on June 22, 2005. On May 2, 2005, the record date of the meeting, there were 5,324,306 shares of our common stock outstanding and entitled to vote, of which 4,929,265 shares or 92.6% were represented at the meeting in person or by proxy. At the meeting, the following matters were voted upon and approved:
(a) Proposal to elect the following persons as directors.
| Number of Votes Cast | Number of Votes Witheld | |||||||
| Name | FOR Nominee | FROM Nominee | ||||||
| David L. Brown | 4,547,998 | 381,267 | ||||||
| Thomas E. Callahan | 4,759,920 | 169,345 | ||||||
| Jack R. Crosby | 4,546,551 | 382,714 | ||||||
| David V. Harkins | 4,547,451 | 381,814 | ||||||
| Norman F. Strate | 4,772,520 | 156,745 | ||||||
(b) Proposal to approve the appointment of PricewaterhouseCoopers LLP as our auditors for the fiscal year ending December 31, 2005.
| Number of Votes Cast | Number of Votes Cast | Number of Votes | ||
| FOR Proposal | AGAINST Proposal | ABSTAINED | ||
| 4,806,446 | 30,666 | 22,853 |
Item 5. Other Information:
Not Applicable
Item 6. Exhibits:
The exhibits listed in the Exhibit Index immediately preceding the exhibits are filed as part of this Quarterly Report of Form 10-Q.
21
Table of Contents
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.
| NATIONAL DENTEX CORPORATION Registrant | ||||
| August 9, 2005 | By: | /s/ DAVID L. BROWN | ||
| David L. Brown | ||||
| President, CEO and Director (Principal Executive Officer) | ||||
| August 9, 2005 | By: | /s/ RICHARD F. BECKER, JR. | ||
| Richard F. Becker, Jr. | ||||
| Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer) | ||||
22
Table of Contents
Exhibit Index
| Exhibit | ||
| No. | Description | |
| 31.1 | Certification Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act (Chief Executive Officer). | |
| 31.2 | Certification Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act (Chief Financial Officer). | |
| 32.1 | Certification pursuant to 18 U.S.C. Section 1350 (Chief Executive Officer). | |
| 32.2 | Certification pursuant to 18 U.S.C. Section 1350 (Chief Financial Officer). |
23