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.
We own and operate 37 dental laboratories located in 29 states, serving an active customer base of over 18,000 dentists. Our business consists of a single industry segment, which is the design, fabrication, marketing and sale of custom dental prosthetic appliances for dentists located primarily in the domestic marketplace. Product offerings include:
Internal revenue growth has been relatively flat over the last three years. Early in 2001, we noted that the economic climate appeared to be impacting the dental laboratory industry. In 2002, we began to believe that many patients and dentists were postponing optimal treatment plans, such as crowns, and pursuing less expensive alternatives such as direct and indirect composite fillings, for which we recognize no revenue. As a result, sales of restorative products were unfavorably impacted. We believe that while a portion of this segment can be temporarily deferred by patients, the work will eventually be required and will be done. During 2003, the economic situation was much like that in 2002, although we began to see some recent favorable signs in the marketplace that industry growth may have been returning to more positive trends. During the first and second quarters of 2004, we have seen internal sales growth stabilize and begin to grow. We are guardedly optimistic that sales growth will continue as economic conditions continue to improve.
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 $99,274,000 in 2003. However, operating margins as measured as a percentage of sales declined over this period. The main cost drivers for us are the cost of labor and related employee benefits. Competition for labor resources and increases in medical insurance costs drive these costs higher. These increased costs combined with flat internal sales growth contributed to lower operating margins. During 2003, we reviewed and adjusted staffing levels at each of our locations to minimize the costs of the slowdown in sales growth. We have been cautious about labor reductions due to the need to maintain an available and properly trained workforce in anticipation of future sales growth. During 2004, sales growth coupled with the cost containment efforts enacted in 2003 have improved operating margins in comparison to 2003.
Beginning in the fourth quarter of 2001 and continuing through 2004, we first developed and subsequently continued to invest in the “NDX Reliance Program TM”, a national marketing and branding campaign that we believe holds long term value and will help us attain our sales objectives. During 2004, we have continued to maintain our branding effort and have focused additional efforts on obtaining the measurable sales improvements we expect from this program.
Liquidity and Capital Resources
Our working capital increased from $12,252,000 at December 31, 2003 to $14,141,000 at June 30, 2004. Cash and equivalents increased $117,000 from $1,835,000 at December 31, 2003 to $1,952,000 at June 30, 2004. Operating activities provided $3,843,000 in cash flow for the six months ended June 30, 2004 compared to $2,539,000 during the six months ended June 30, 2003. Cash outflows related to dental laboratory acquisitions, including deferred purchase price payments, totaled $1,754,000 for the six months ended June 30, 2004 compared to $1,423,000 for the six months ended June 30, 2003. Additions to property, plant and equipment, including the purchase of a $2,000,000 replacement facility for our dental laboratory in Houston, Texas, were $2,480,000 for the six months ended June 30, 2004 compared to $1,557,000 for the six months ended June 30, 2003.
We have concluded a new 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 0.75% to 1.5% depending on the ratio of current liabilities to tangible net worth. Both revolving lines of credit terminate on June 30, 2007.
A commitment fee of one-eighth of 1% per annum is payable on the unused amount of the first revolving line of credit, plus an annual facility fee of $10,000 on the acquisition line of credit. At June 30, 2004, the full principal amount was available to us under both facilities. The Agreement requires compliance with certain covenants, including the maintenance of specified net worth and other financial ratios. As of June 30, 2004, we were in compliance with these covenants.
Our management believes that cash flow from operations and available financing arrangements will be sufficient to meet contemplated operating and capital requirements, including deferred payments associated with prior acquisitions and costs associated with anticipated acquisitions, if any, in the foreseeable future.
Commitments and Contingencies
The following table represents a list of our contractual obligations and commitments as of June 30, 2004:
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| | | Total | | 1 Year | | 1 – 3 Years | | 4 – 5 Years | | 5 Years | |
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| | Operating Leases: | | | | | | | | | | | | | | | | | | | | |
| | | Real Estate | | $ | 8,556,000 | | $ | 2,074,000 | | $ | 2,985,000 | | | $ | 952,000 | | | | $ | 2,545,000 | | |
| | | Vehicles | | | 953,000 | | | 334,000 | | | 619,000 | | | | — | | | | | — | | |
| | | Equipment | | | 131,000 | | | 76,000 | | | 51,000 | | | | 4,000 | | | | | — | | |
| | Laboratory Purchase Obligations | | | 1,803,000 | | | 1,498,000 | | | 305,000 | | | | — | | | | | — | | |
| | Contingent Laboratory Purchase Price | | | 2,830,000 | | | 943,000 | | | 1,887,000 | | | | — | | | | | — | | |
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| | | TOTAL | | $ | 14,273,000 | | $ | 4,925,000 | | $ | 5,847,000 | | | $ | 956,000 | | | | $ | 2,545,000 | | |
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The laboratory purchase obligations totaling $1,803,000 above are classified as deferred acquisition costs and are presented in the liability section of the balance sheet. Contingent laboratory purchase price includes amounts subject to acquisition agreements that are tied to earnings performance, as defined by the individual agreements, over a three year period. As payments become determinable, they are recorded as goodwill. 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.
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 on April 22, 2004 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.
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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:
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June 30 | | Six Months Ended
June 30 | |
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| Net sales | | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| Cost of goods sold | | | 59.1 | | | 58.4 | | | 59.5 | | | 58.4 | |
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| Gross profit | | | 40.9 | | | 41.6 | | | 40.5 | | | 41.6 | |
| Selling, general and administrative expenses | | | 29.9 | | | 29.3 | | | 30.3 | | | 30.2 | |
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| Operating income | | | 11.0 | | | 12.3 | | | 10.2 | | | 11.4 | |
| Other expense | | | 0.2 | | | 0.4 | | | 0.3 | | | 0.4 | |
| Interest income | | | 0.0 | | | 0.0 | | | 0.0 | | | 0.0 | |
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| Income before provision for income taxes | | | 10.8 | | | 11.9 | | | 9.9 | | | 11.0 | |
| Provision for income taxes | | | 4.2 | | | 4.8 | | | 3.8 | | | 4.4 | |
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| Net income | | | 6.6 | % | | 7.1 | % | | 6.1 | % | | 6.6 | % |
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Six Months Ended June 30, 2004 Compared with Six Months Ended June 30, 2003
Net Sales
For the six months ended June 30 2004, net sales increased $7,612,000 or 15.5% from the prior year. Net sales increased by approximately $5,708,000, or 11.6%, as a result of acquisitions, measured by business at dental laboratories owned less than one year. Net sales increased approximately $1,904,000, an increase of 3.9%, at dental laboratories owned for both the six months ended June 30, 2004 and the comparable six months ended June 30, 2003. We believe sales growth was primarily attributable to a moderate improvement in industry economic conditions.
Cost of Goods Sold
Cost of goods sold as a percentage of sales was 58.4% in the six months ended June 30, 2004 compared with 59.5% in the same period of 2003. Headcount reductions, productivity improvements and purchasing cost savings helped improve our gross margin, despite increases in employee benefit and general insurance costs and the occupancy costs related to four acquisitions completed in the last half of 2003.
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 $17,136,000 or 30.2% of sales in 2004 compared to $14,872,000 or 30.3% in 2003. The increase of $2,264,000 was related to the added administrative and delivery costs for recent acquisitions as well as the overall increases in insurance, benefits and utility costs. As a percentage of sales, declines in selling, delivery and laboratory administrative costs were offset by increases in our laboratory and executive incentive compensation programs. Improving profit margins resulting from sales growth and operational efficiencies increased our required contribution to these programs.
Operating Income
As a result of the factors discussed above, our operating income increased by $1,475,000 to $6,463,000 for the six months ended June 30, 2004 from $4,989,000 for the comparable six months ended June 30, 2003. As a percentage of net sales, operating income increased from 9.9% in 2003 to 11.0% in 2004.
Interest (Income) Expense
Interest expense was $18,000 in the first six months of 2004 compared with interest income of $16,000 in the first six months of 2003. The change of $33,000 was primarily due to periodic borrowings under the line of credit during 2004 and a decrease in the average cash and cash equivalents balance from 2003 to 2004.
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Provision for Income Taxes
The provision for income taxes increased to $2,508,000 in 2004 from $1,894,000 in 2003 due to an increase in operating income and a higher effective tax rate. The effective tax rate increased to 40.0% in 2004 from 38.8% in 2003 due to expected increases in non-deductible expenses.
Net Income
As a result of all of the factors discussed above, net income increased to $3,763,000 or $1.04 per share on a diluted basis in the first six months of 2004 from $2,982,000 or $.86 per share on a diluted basis in the first six months of 2003.
Three Months Ended June 30, 2004 Compared with Three Months Ended June 30, 2003
Net Sales
For the three months ended June 30 2004, net sales increased $3,649,000 or 14.5% from the prior year. Net sales increased by approximately $2,928,000, or 11.6%, as a result of acquisitions, measured by business at dental laboratories owned less than one year. Net sales increased approximately $721,000, an increase of 2.9%, at dental laboratories owned for both the three months ended June 30, 2004 and the comparable three months ended June 30, 2003.
Cost of Goods Sold
Cost of goods sold as a percentage of sales was 58.4% in the quarter ended June 30, 2004 compared with 59.1% in the same period of 2003 for reasons comparable to the six-month period discussed above.
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 $8,458,000 or 29.3% of sales in 2004 compared to $7,528,000 or 29.9% in 2003 for reasons comparable to the six-month period discussed above.
Operating Income
As a result of the factors discussed above, and for reasons comparable to the six-month period discussed above, our operating income increased by $767,000 to $3,544,000 for the three months ended June 30, 2004 from $2,778,000 for the comparable three months ended June 30, 2003. As a percentage of net sales, operating income increased from 11.0% in 2003 to 12.3% in 2004.
Interest (Income) Expense
Interest expense was $7,000 in the second quarter of 2004 compared with interest income of $7,000 in the second quarter of 2003 for reasons comparable to the six-month period discussed above.
Provision for Income Taxes
The provision for income taxes increased to $1,372,000 in 2004 from $1,058,000 in 2003 and the effective tax rate increased to 40.0% in 2004 from 39.1% in 2003 for reasons comparable to the six-month period discussed above.
Net Income
As a result of all of the factors discussed above, net income increased to $2,058,000 or $.57 per share on a diluted basis in the second quarter of 2004 from $1,650,000 or $.48 per share on a diluted basis in the second quarter of 2003.
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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 needed or elective dental work, |
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| | • | our ability to acquire and successfully operate additional laboratories, |
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| | • | governmental regulation of health care, |
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| | • | trends in the dental industry towards managed care, |
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| | • | competition within the dental laboratory industry, including from foreign competitors, |
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| | • | increases in labor and benefits costs, |
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| | • | increases in material costs, particularly related to the purchase of dental alloys, which contain gold, palladium, and other precious metals, |
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| | • | product development risks, and |
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| | • | technological innovations by third parties. |
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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.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of June 30, 2004. 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 CEO and CFO concluded that, as of June 30, 2004, our disclosure controls and procedures were (1) designed to ensure that material information relating to us, including our consolidated subsidiaries, is made known to our CEO and CFO by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act is 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 Securities Exchange Act) occurred during the fiscal quarter ended June 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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| PART II OTHER INFORMATION |
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Item 1. Legal Proceedings: |
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| We are involved from time to time in litigation incidental to its 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. |
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Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities: |
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| We did not repurchase any of our equity securities during the fiscal quarter ended June 30, 2004 or engage in any transactions during such period reportable pursuant to Item 703 of Regulation S-K. |
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Item 3. Defaults upon Senior Securities: |
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| Not Applicable |
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Item 4. Submission of Matters to a Vote of Security Holders: |
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| Not Applicable |
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Item 5. Other Information: |
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| Not Applicable |
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Item 6. Exhibits and Reports on Form 8-K: |
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| (a) Exhibits |
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| | The exhibits listed in the Exhibit Index immediately preceding the exhibits are filed as part of this Quarterly Report of Form 10-Q |
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| (b) Reports on Form 8-K |
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| | On April 28, 2004, we furnished a Current Report on Form 8-K under Item 7 and Item 9, containing a press release announcing our financial results for the fiscal quarter ended March 31, 2004. |
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| | On July 7, 2004, we furnished a Current Report on Form 8-K under Item 9, containing the loan agreement documenting the Company’s new credit facility with Fleet National Bank. |
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| | On July 29, 2004, we furnished a Current Report on Form 8-K under Item 12, containing a press release announcing our financial results for the fiscal quarter ended June 30, 2004. |
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| | On August 9, 2004, we furnished a Current Report on Form 8-K under Item 12 containing a correction to the press release we furnished on July 29, 2004. |
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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 | |
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| August 9, 2004 | By: | /s/ DAVID L. BROWN | |
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| | David L. Brown | |
| | President, CEO and Director | |
| | (Principal Executive Officer) | |
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| August 9, 2004 | By: | /s/ RICHARD F. BECKER, JR. | |
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| | Richard F. Becker, Jr. | |
| | Vice President, Treasurer and Chief Financial Officer | |
| | (Principal Financial Officer) | |
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Exhibit Index
Exhibit
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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). |
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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). |
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32.1 | | Certification pursuant to 18 U.S.C. Section 1350 (Chief Executive Officer) |
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32.2 | | Certification pursuant to 18 U.S.C. Section 1350 (Chief Financial Officer) |
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