SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number: 1-13263
CASTLE DENTAL CENTERS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 76-0486898
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3701 KIRBY, SUITE 550 77098
HOUSTON, TEXAS (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (713) 490-8400
1360 Post Oak Boulevard, Suite 1300 Houston, Texas 77056
(Former address of registrant)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
The number of shares of Common Stock issued and outstanding, par value,
$0.001 per share, as of August 14, 2001 was 6,417,206.
CASTLE DENTAL CENTERS, INC.
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
December 31, 2000 and June 30, 2001.................................. 3
Condensed Consolidated Statements of Operations
For the Three Months and Six Months Ended June 30, 2000 and 2001..... 4
Condensed Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2000 and 2001...................... 5
Notes to Condensed Consolidated Financial Statements................. 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations........................ 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 20
Item 2. Changes in Securities and Use of Proceeds........................ 20
Item 3. Defaults Upon Senior Securities.................................. 20
Item 4. Submission of Matters to a Vote of Security Holders.............. 20
Item 5. Other Information................................................ 20
Item 6. Exhibits and Reports on Form 8-K................................. 20
SIGNATURES.......................................................................... 21
2
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CASTLE DENTAL CENTERS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share data)
December 31, June 30,
2000 2001
----------- ----------
ASSETS
Current assets:
Cash and cash equivalents..................................................... $ 901 $ 3,710
Patient receivables, net...................................................... 8,912 6,534
Unbilled patient receivables, net............................................. 2,952 2,926
Prepaid expenses and other current assets..................................... 1,894 2,208
----------- ----------
Total current assets........................................................ 14,659 15,378
----------- ----------
Property and equipment, net................................................... 18,079 16,008
Intangibles, net.............................................................. 60,248 58,726
Other assets.................................................................. 2,400 2,181
----------- ----------
Total assets................................................................ $ 95,386 $ 92,293
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt............................................. $ 63,679 $ 63,908
Accounts payable and accrued liabilities...................................... 13,107 14,443
Deferred compensation payable, related party.................................. 132 132
----------- ----------
Total current liabilities................................................... 76,918 78,483
----------- ----------
Long-term debt, net of current portion........................................ 429 -
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value, 19,000,000 shares authorized,
6,417,206 shares issued and outstanding..................................... 6 6
Additional paid-in capital.................................................... 42,086 42,086
Accumulated deficit........................................................... (24,053) (28,282)
----------- ----------
Total stockholders' equity.................................................. 18,039 13,810
----------- ----------
Total liabilities and stockholders' equity.................................. $ 95,386 $ 92,293
=========== ==========
The accompanying notes are an integral part of
the consolidated financial statements.
3
CASTLE DENTAL CENTERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2000 2001 2000 2001
--------- --------- --------- ---------
Net patient revenues................................................ $ 26,699 $ 24,504 $ 53,229 $ 52,227
Expenses:
Dentist salaries and other professional costs...................... 6,931 6,629 13,909 13,981
Clinical salaries.................................................. 5,127 4,852 10,161 9,985
Dental supplies and laboratory fees................................ 2,965 2,856 5,651 5,804
Rental and lease expense........................................... 1,703 1,683 3,364 3,415
Advertising and marketing.......................................... 984 805 1,934 1,588
Depreciation and amortization...................................... 1,664 1,670 3,249 3,396
Other operating expenses........................................... 1,839 1,811 3,555 3,712
Bad debt expense................................................... 1,129 1,164 2,297 2,312
Restructuring costs and other charges.............................. - 1,323 - 1,789
General and administrative......................................... 2,570 2,722 5,326 5,358
Asset impairment................................................... - 534 - 534
--------- --------- --------- ---------
Total expenses.................................................. 24,912 26,049 49,446 51,874
--------- --------- --------- ---------
Operating income (loss)............................................. 1,787 (1,545) 3,783 353
Litigation settlement............................................... 1,495 - 1,495 -
Interest expense.................................................... 1,743 2,158 3,229 4,358
Other income...................................................... (1) (17) (3) (26)
--------- --------- --------- ---------
Loss before provision for income taxes and
cumulative effect of change in accounting principle................ (1,450) (3,686) (938) (3,979)
Provision for income taxes.......................................... (539) - (339) -
--------- --------- --------- ---------
Loss before cumulative effect of change
in accounting principle............................................ (911) (3,686) (599) (3,979)
Cumulative effect of change in accounting principle (NOTE 6)........ - - - (250)
--------- --------- --------- ---------
Net loss............................................................ $ (911) $ (3,686) $ (599) $ (4,229)
========= ========= ========= =========
Loss per common share:
Loss before cumulative effect of change
in accounting principle........................................... $ (0.14) $ (0.57) $ (0.09) $ (0.62)
Cumulative effect of change in accounting principle................ - - - (0.04)
--------- --------- --------- ---------
Net loss........................................................... $ (0.14) $ (0.57) $ (0.09) $ (0.66)
========= ========= ========= =========
Weighted average number of common and
common equivalent shares outstanding
Basic and diluted.................................................. 6,417 6,417 6,484 6,417
========= ========= ========= =========
The accompanying notes are an integral part of
the consolidated financial statements.
4
CASTLE DENTAL CENTERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
Six Months Ended
June 30,
---------------------------
2000 2001
---------- ------------
Cash flows from operating activities:
Net loss................................................................. $ (599) $ (4,229)
Adjustments:
Provisions for bad debts............................................... 2,297 2,312
Depreciation and amortization.......................................... 3,249 3,396
Amortization of loan cost.............................................. 134 208
Asset impairment....................................................... - 534
Deferred income taxes.................................................. (340) -
Cumulative effect of change in accounting principle.................... - 250
Changes in operating assets and liabilities:
Patient receivables.................................................. (2,375) 60
Unbilled patient receivables......................................... (359) 32
Prepaid expenses and other current assets............................ 70 (314)
Other assets......................................................... (67) 11
Accounts payable and accrued liabilities............................. (66) 1,086
Deferred compensation payments, related party........................ (263) -
---------- ------------
Net cash provided by operating activities........................... 1,681 3,346
---------- ------------
Cash flows used in investing activities:
Capital expenditures.................................................... (2,364) (337)
Acquisition of affiliated dental practices, net of cash acquired ....... (5,039) -
---------- ------------
Net cash used in investing activities............................... (7,403) (337)
---------- ------------
Cash flows from financing activities:
Proceeds from debt...................................................... 15,570 -
Repayment of debt and capital lease obligations......................... (8,792) (200)
Bank overdraft.......................................................... (258) -
Debt issuance costs..................................................... (797) -
---------- ------------
Net cash provided by (used in) financing activities................. 5,723 (200)
---------- ------------
Net change in cash and cash equivalents.................................. 1 2,809
Cash and cash equivalents, beginning of period........................... 59 901
---------- ------------
Cash and cash equivalents, end of period................................. $ 60 $ 3,710
========== ============
The accompanying notes are an integral part of
the consolidated financial statements.
5
CASTLE DENTAL CENTERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
Going Concern Basis
The accompanying financial statements of Castle Dental Centers, Inc. and
subsidiaries (the "Company") have been prepared on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. As a result of losses incurred in 2000 and in the
first six months of 2001, the Company has not been in compliance with the
financial covenants of its debt agreements since June 30, 2000. At June 30,
2001, approximately $45.2 million in senior debt and $15.0 million in
subordinated debt were outstanding under its debt agreements in addition to
approximately $3.5 million in other outstanding subordinated debt. Since the
Company is in default under these agreements, all amounts outstanding are
subject to acceleration and have been classified as current liabilities. The
Company has continued to pay interest (other than cumulative default interest of
$0.9 million) on the amounts outstanding under the senior credit facility, but
has not made principal payments of $4.5 million under the senior credit facility
or principal and interest payments of $4.4 million (excluding accrued default
interest of $0.2 million) owed to subordinated creditors since July 2000. The
Company has requested waivers of these covenant violations and a forbearance of
scheduled principal payments and is negotiating with its lenders to restructure
the debt agreements. However, these negotiations have not resulted in a
forbearance agreement or waivers of the defaults as of August 14, 2001. Given
the financial position of the Company and the current condition of financial
markets, the Company believes that it is unlikely a new lender group will be
found to refinance indebtedness owed to the existing lender group. The Company
is also pursuing equity investments by private investors. Any such debt
restructuring or private equity investment, if available, could substantially
dilute existing holders of the Company's equity. There can be no assurances as
to the terms of any such restructuring or investment, or that the Company will
be able to restructure its indebtedness or arrange for an additional equity
investment.
The Company has developed a plan that it believes will allow it to continue to
operate without the need for additional borrowings and to make principal
payments to its senior bank creditors out of available funds. Components of this
plan include: (i) reorganization of field management to improve efficiency and
reduce regional overhead costs; (ii) reduction in corporate general and
administrative costs through job eliminations and reduction in other overhead
expenses; (iii) closing of unprofitable and under-performing dental centers;
(iv) realignment of accounts receivable management to focus on improved
collection of insurance and patient receivables; (v) restructuring of
compensation for management to emphasize performance-based incentives; and, (vi)
cancellation of further de novo development and reducing capital expenditures to
maintenance levels of approximately $1.2 million for 2001.
Implementation of the Company's plan will require the consent of its lenders
and the holders of its subordinated indebtedness. No assurances can be made that
the Company's creditors will agree with the plan. In addition, there can be no
assurances that the Company's efforts to improve operating results and cash
flows will be sufficient to allow the Company to meet its obligations in a
timely manner. Therefore, there is substantial doubt about the Company's
ability to continue in existence. The financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amount and classification of liabilities that might be necessary
should the Company be unable to continue in existence.
6
CASTLE DENTAL CENTERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Corporate Organization and Basis of Presentation
The Company provides administrative and management services, non-healthcare
personnel, facilities and equipment to certain professional corporations in
Texas, Florida, California and Tennessee ("affiliated dental practices") under
long-term management services agreements.
The consolidated financial statements include the accounts of the Company and
all wholly-owned and beneficially-owned subsidiaries and the accounts of
affiliated dental practices in which the Company has a long-term controlling
financial interest. Because of corporate practice of medicine laws in the states
in which the Company operates, the Company does not own dental practices but
instead enters into exclusive long-term management services agreements
("Management Services Agreements") with professional corporations that operate
the dental practices. In addition, the Company has the contractual right to
designate the licensed dentist who is the majority shareholder of the capital
stock of the professional corporation at a nominal cost ("nominee
arrangements"). At June 30, 2001, all of the affiliated dental practices were
wholly-owned by dentists with whom the Company had a nominee arrangement. Under
the Management Services Agreements, the Company establishes annual operating and
capital budgets for the professional corporations and compensation guidelines
for the licensed dental professionals. The Management Services Agreements have
initial terms of twenty-five to forty years. The management fee charged by the
Company to an affiliated dental practice is intended to reflect and is based on
the fair value of the management services rendered by the Company to the
affiliated dental practice. Subject to applicable law, the management fee
earned by the Company, except professional corporations located in California,
is generally comprised of three components: (i) the costs incurred by it on
behalf of the affiliated dental practice; (ii) a base management fee ranging
from 12.5% to 20.0% of patient revenues; and, (iii) a performance fee equal to
the patient revenues of the affiliated dental practice less (a) the expenses of
the affiliated dental practice and (b) the sum of (i) and (ii), as described in
the agreements. In California, the Company is paid a monthly management fee
comprised of two components: (i) the costs incurred by it on behalf of the
affiliated practice and (ii) a management fee in an amount ranging from 15.0% to
30.0% of net patient revenues. The amount of the management fee is reviewed by
the Company and the affiliated dental practice at least annually in order to
determine whether such fee should be adjusted to continue to reflect the fair
value of the management services rendered by the Company.
Through the management services agreements and the nominee arrangements, the
Company has a significant long-term controlling financial interest in the
affiliated dental practices and, therefore, according to Emerging Issues Task
Force Issue No. 97-2, "Application of FASB Statement No. 94, Consolidation of
All Majority-Owned Subsidiaries, and APB No. 16, Business Combinations, to
Physician Practice Management Entities and Certain Other Entities with
Contractual Management Agreements," must consolidate the results of the
affiliated practices with those of the Company. Net patient revenues are
presented in the accompanying statement of operations because the Company must
present consolidated financial statements. All significant intercompany accounts
and transactions, including management fees, have been eliminated in
consolidation.
The accompanying unaudited consolidated financial statements as of June 30,
2001 and for the three and six months ended June 30, 2000 and 2001 include the
accounts of the Company and its majority owned management company subsidiaries
and the affiliated dental practices. Pursuant to the rules and regulations of
the Securities and Exchange Commission, certain information and footnote
disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles have been omitted. The
unaudited consolidated financial statements have been prepared consistent with
the accounting policies reflected in the Company's annual financial statements
included in the Company's Form 10-K filed with the Securities and Exchange
Commission, and should be read in conjunction therewith. In management's
opinion, the unaudited consolidated financial statements include all
adjustments, consisting of normal recurring adjustments, considered necessary
for a fair presentation of such financial statements. Interim results are not
necessarily indicative of results for a full year.
7
CASTLE DENTAL CENTERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
New Accounting Pronouncements
On June 29, 2001, the Financial Accounting standards Board approved Statement
of Financial Accounting Standards (SFAS) No. 141, Business Combinations and SFAS
No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 supercedes APB
Opinion No. 16, Business Combinations, to prohibit use of the pooling-of-
interest (pooling) method of accounting for business combinations initiated
after the issuance date of the final Statement. SFAS No. 142 supercedes APB
Opinion No. 17, Intangible Assets, by stating that goodwill will no longer be
amortized, but will be tested for impairment in a manner different from how
other assets are tested for impairment. SFAS No. 142 establishes a new method of
testing goodwill for impairment by requiring that goodwill be separately tested
for impairment using a fair value approach rather than an undiscounted cash flow
approach.
The provisions of SFAS No. 141 and SFAS No. 142 will be effective for fiscal
years beginning after December 15, 2001. SFAS No. 142 must be adopted at the
beginning of a fiscal year. The Company is currently evaluating the impact of
the adoption of these Statements.
2. EARNINGS PER SHARE:
Basic earnings per share for all periods presented equals net loss divided by
weighted average number of shares of common stock outstanding during each
period. For the three and six month periods ended June 30, 2000 and 2001, the
effect of stock options and convertible debt was excluded from the calculation
of diluted loss per share because their effect would have been anti-dilutive.
3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS:
The Company maintains a revolving credit agreement with its bank (the "Credit
Agreement") that provides for borrowings up to $55.0 million and matures
November 2002. Advances under the Credit Agreement required quarterly interest
payments through March 2001 at which time principal became payable based on a
five-year quarterly amortization with final payment at maturity. Borrowings
under the Credit Agreement may at no time exceed a specified borrowing base,
which is calculated as a multiple of the Company's earnings before interest,
income taxes, depreciation and amortization ("EBITDA"), as adjusted. The Credit
Agreement bears interest at variable rates, which are based upon either the
bank's base rate or LIBOR, plus, in either case, a margin which varies according
to the ratio of the Company's funded debt to EBITDA, each as defined in the
Credit Agreement. A commitment fee is payable quarterly at rates ranging from
0.125 percent to 0.5 percent of the unused amounts for such quarter. The Credit
Agreement is collateralized by substantially all of the Company's assets and
contains affirmative and negative covenants that require the Company to maintain
certain financial ratios, limit the amount of additional indebtedness, limit the
creation or existence of liens, set certain restrictions on acquisitions,
mergers, sale of assets and restrict the payment of dividends. At June 30,
2001, approximately $45.2 million was outstanding under the Credit Agreement.
The Company maintains a senior subordinated note agreement ("Subordinated
Note Agreement") and subordinated convertible note agreement ("Convertible Note
Agreement") with two lenders. The Subordinated Note Agreement and Convertible
Note Agreement provide for borrowings of $13.7 million and $1.3 million,
respectively. Loans under the Subordinated Note Agreement bear interest at the
90-day LIBOR rate plus five and one-half percent, payable quarterly, and are due
in eight quarterly installments beginning in the sixty-third month following the
closing date. Loans under the Convertible Note Agreement bear interest at the
same rate as loans under the Subordinated Note Agreement and are due on demand
beginning seven years after the closing date with a final maturity date of
January 30, 2009. The convertible note is convertible at any time into 442,880
shares of Company common stock at the request of the holders at a fixed
conversion price of $3.1125 per share. The Subordinated Note Agreement and
Convertible Note Agreement contain affirmative and
8
CASTLE DENTAL CENTERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
negative covenants that require that the Company maintain certain financial
ratios, limit the amount of additional indebtedness, limit the creation or
existence of liens, set certain restrictions on acquisitions, mergers and sales
of assets and restrict the payment of dividends.
As a result of losses incurred in 2000 and the first six months of 2001, the
Company has not been in compliance with the financial covenants of the Credit
Agreement, the Subordinated Note Agreement and the Convertible Note Agreement
(collectively the "Debt Agreements") since June 30, 2000. In addition, the
Company was not able to make scheduled principal payments of $4.5 million under
the Credit Agreement in the first six months of 2001. The Company also has not
made $4.4 million in principal and interest payments (excluding default
interest) due under the Subordinated Note Agreement, the Convertible Note
Agreement and its other subordinated notes since July 2000, because it did not
have sufficient resources to make such payments and it is restricted from making
such payments as long as the Company is in default of the Credit Agreement.
Since the Company is in default under these agreements, all amounts outstanding
are subject to acceleration and have been classified as current liabilities at
June 30, 2001. The Company has requested waivers of these covenant violations
and a forbearance of scheduled principal payments and is negotiating with its
lenders to restructure the Debt Agreements. However, these negotiations have not
resulted in a forbearance agreement or waivers of the defaults as of August 14,
2001. There can be no assurance that the Company's lenders will consent to the
waivers and restructuring necessary to allow the Company to continue to operate.
If the Company and the lenders cannot reach an agreement, it may be necessary
for the Company to seek protection under Chapter 11 of the Bankruptcy Code.
4. COMMITMENTS AND CONTINGENCIES:
In June 2000, the Company recorded litigation expenses of $1,495,000 resulting
from an arbitration award against two subsidiaries of the Company in an
arbitration proceeding in Los Angeles, California. The arbitrator found that
the subsidiaries had breached a contractual agreement to acquire a dental
practice and awarded the plaintiffs actual damages and costs of $442,000. In
August 2000, the arbitrator awarded the plaintiffs an additional $666,000 for
attorney fees and costs, resulting in a total judgment of $1,108,000 against the
Company's subsidiaries. This amount, as well as additional legal expenses
incurred by the Company, was included in the litigation expenses recorded in
June 2000. None of the judgment amount awarded to the plaintiffs has been paid
as of August 14, 2001.
The Company carries insurance with coverage and coverage limits that it
believes to be customary in the dental industry. Although there can be no
assurance that such insurance will be sufficient to protect the Company against
all contingencies, management believes that its insurance protection is
reasonable in view of the nature and scope of the Company's operations.
The Company is from time to time subject to claims and suits arising in the
ordinary course of operations. In the opinion of management, the ultimate
resolution of such pending legal proceedings will not have a material adverse
effect on the Company's financial position, results of operations or liquidity.
5. RESTRUCTURING CHARGES AND OTHER COSTS
In the first quarter of 2001, the Company announced plans to restructure the
Debt Agreements (Note 3) and reduce overhead costs. Components of this plan
include: (i) reorganization of field management to improve efficiency and reduce
regional overhead costs; (ii) reduction in corporate general and administrative
costs through job eliminations and reduction in other overhead expenses; (iii)
closing of unprofitable and under-performing dental centers; (iv) realignment of
accounts receivable management to focus on improved collection of insurance and
patient receivables; (v) restructuring of compensation for management to
emphasize performance-based incentives; and, (vi) cancellation of further de
novo development and reducing
9
CASTLE DENTAL CENTERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
capital expenditures to maintenance levels of approximately $1.2 million for
2001. The Company has recorded the following costs in 2000 and 2001 related to
the restructuring.
Restructuring Payments
and Other Costs to Settle Asset Balance at
in 2000 Obligations Write-downs Dec. 31, 2000
------------ ------------ ------------ ----------
Asset impairment............................ $ 3,567 $ - $ 3,567 $ -
Severance costs............................. 269 46 - 223
Dental center closures...................... 746 198 - 548
------------ ------------ ------------ ----------
Total....................................... $ 4,582 $ 244 $ 3,567 $ 771
============ ============ ============ ==========
Restructuring Payments
and Other Costs to Settle Asset Balance at
in 2000 Obligations Write-downs Dec. 31, 2000
------------ ------------ ------------ ----------
Asset impairment............................ $ 533 $ - $ 534 $ -
Legal and professional services............. 1,015 681 - 334
Severance costs............................. 390 128 - 485
Dental center closures...................... 384 177 - 755
------------ ------------ ------------ ----------
Total....................................... $ 2,323 $ 986 $ 534 $ 1,574
============ ============ ============ ==========
The Company has recognized and accounted for these costs in accordance with
the provisions of Emerging Issues Task Force Consensus No. 94-3 "Accounting for
Restructuring Costs". The severance costs include estimated payments to former
executives and staff personnel, including the former chief executive officer of
the Company, and are expected to be paid over the next twelve months. The
Company is also negotiating the sale of two dental centers to the former chief
executive officer and has recorded an asset impairment of those dental centers
based on the anticipated sale price.
6. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
During June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", which
requires that companies recognize all derivative instruments as either assets or
liabilities on the balance sheet and measure those instruments at fair value.
SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133," deferred the
implementation of SFAS 133 until the fiscal year ending December 31, 2001. The
Company implemented SFAS 133 effective January 1, 2001. During the three and six
month periods ended June 30, 2001, the Company accrued $0.2 million and $0.3
million, respectively in additional interest expense under a hedging
arrangement. The cumulative effect of accounting change as of January 1, 2001,
was a charge of $0.3 million, or $0.04 per common share, that was reflected in
the first quarter of 2001.
10
CASTLE DENTAL CENTERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. SEGMENT INFORMATION
The following table sets forth the financial information with respect to the
Company and its reportable segments:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
2000 2001 2000 2001
---------- ---------- ---------- ----------
Net patient revenues:
Texas...................................................... $ 17,966 $ 16,472 $ 35,574 $ 35,336
Florida.................................................... 3,024 2,895 5,986 5,753
Tennessee ................................................. 3,160 2,853 6,340 5,813
California................................................. 2,549 2,284 5,329 5,325
---------- ---------- ---------- ----------
Total revenue.............................................. 26,699 24,504 53,229 52,227
---------- ---------- ---------- ----------
Operating expenses:
Texas...................................................... 15,528 15,255 30,604 31,312
Florida.................................................... 2,888 2,858 5,693 5,677
Tennessee.................................................. 2,790 2,825 5,683 5,433
California................................................. 2,293 2,141 4,589 4,505
Restructuring costs and other charges...................... - 1,323 - 1,789
Corporate, general and administrative expenses............. 1,413 1,647 2,877 3,158
---------- ---------- ---------- ----------
Total operating expenses................................... 24,912 26,049 49,446 51,874
---------- ---------- ---------- ----------
Operating income (loss):
Texas...................................................... 2,438 1,217 4,970 4,024
Florida.................................................... 136 37 293 76
Tennessee.................................................. 370 28 657 380
California................................................. 256 143 740 820
Restructuring costs and other charges...................... - (1,323) - (1,789)
Corporate, general and administrative expenses............. (1,413) (1,647) (2,877) (3,158)
---------- ---------- ---------- ----------
Total operating income (loss).............................. 1,787 (1,545) 3,783 353
---------- ---------- ---------- ----------
Litigation expense............................................ 1,495 - 1,495 -
Interest expense.............................................. 1,743 2,158 3,229 4,358
Other income ................................................. (1) (17) (3) (26)
---------- ---------- ---------- ----------
Loss before provision for income taxes and
cumulative effect of change in accounting principles......... $ (1,450) $ (3,686) $ (938) $ (3,979)
========== ========== ========== ==========
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q contains forward looking statements within
the meaning of the Securities Act of 1933 and Section 21B of the Securities and
Exchange Act of 1934. The Company's actual results could differ materially from
those set forth in the forward-looking statements. Certain factors that might
cause such a difference include, among others, the changing environment for
dental health care, the pace of the Company's development and acquisition
activities, the reimbursement rates for dental services, and other risk factors
detailed in the Company's Securities and Exchange Commission filings, including
the Company's Form 10-K for the year ended December 31, 2000, as filed with the
U.S. Securities and Exchange Commission.
OVERVIEW
The Company develops, manages and operates integrated dental networks through
contractual affiliations with general, orthodontic and multi-specialty dental
practices in Texas, Florida, California and Tennessee. The Company does not
engage in the practice of dentistry but rather establishes integrated dental
networks through affiliations with dental practices providing quality care in
selected markets with a view to establishing broad geographic coverage within
those markets. The Company seeks to achieve operating efficiencies by
consolidating and integrating affiliated practices into regional networks,
realizing economies of scale in such areas as marketing, administration and
purchasing and enhancing the revenues of its affiliated dental practices by
increasing both patient visits and the range of specialty services offered. At
June 30, 2001 the Company managed 89 dental centers with approximately 200
affiliated dentists, orthodontists and specialists.
COMPONENTS OF REVENUES AND EXPENSES
Net patient revenues represent amounts billed by the affiliated dental
practices to patients and third-party payors for dental services rendered.
Revenues are reported at established rates reduced by contractual amounts based
on agreements with patients, third party payers and others obligated to pay for
services rendered.
Under the terms of the typical management services agreement with an
affiliated dental practice, the Company becomes the exclusive manager and
administrator of all non-dental services relating to the operation of the
practice. While actual terms of the various management service agreements may
vary from practice to practice, material aspects of all the management service
agreements, including the ability of the Company to nominate the majority
shareholder and the calculation of the management fees, are consistent. The
obligations of the Company include assuming responsibility for the operating
expenses incurred in connection with managing the dental centers. These
expenses include salaries, wages and related costs of non-dental personnel,
dental supplies and laboratory fees, rental and lease expenses, advertising and
marketing costs, management information systems, and other operating expenses
incurred at the dental centers. In addition to these expenses, the Company
incurs general and administrative expenses related to the billing and collection
of accounts receivable, financial management and control of the dental
operations, insurance, training and development, and other general corporate
expenditures.
RESULTS OF OPERATIONS
The following table sets forth the percentages of patient revenues represented
by certain items reflected in the Company's Income Statement. The information
that follows should be read in conjunction with the Annual audited Financial
Statements and notes thereto of the Company included in the Company's Form 10-K
filed with the Securities and Exchange Commission, as well as the Unaudited
Financial Information, included in this Form 10-Q.
12
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2000 2001 2000 2001
----- ----- ----- -----
Net patient revenues................................................ 100.0% 100.0% 100.0% 100.0%
Expenses:
Dentist salaries and other professional costs...................... 26.0% 27.1% 26.1% 26.8%
Clinical salaries.................................................. 19.2% 19.8% 19.1% 19.1%
Dental supplies and laboratory fees................................ 11.1% 11.7% 10.6% 11.1%
Rental and lease expense........................................... 6.4% 6.9% 6.3% 6.5%
Advertising and marketing.......................................... 3.7% 3.3% 3.6% 3.0%
Depreciation and amortization...................................... 6.2% 6.8% 6.1% 6.5%
Other operating expenses........................................... 6.9% 7.4% 6.7% 7.1%
Bad debt expense................................................... 4.2% 4.8% 4.3% 4.4%
Restructuring costs and other charges.............................. 0.0% 5.4% 0.0% 3.4%
General and administrative......................................... 9.6% 11.1% 10.0% 10.3%
Asset impairment................................................... 0.0% 2.2% 0.0% 1.0%
----- ----- ----- -----
Total expenses.................................................... 93.3% 106.3% 92.9% 99.3%
----- ----- ----- -----
Operating income (loss)............................................. 6.7% -6.3% 7.1% 0.7%
Litigation expense.................................................. 5.6% 0.0% 2.8% 0.0%
Interest expense.................................................... 6.5% 8.8% 6.1% 8.3%
Other (income) expense.............................................. 0.0% -0.1% 0.0% 0.0%
----- ----- ----- -----
Loss before provision for income taxes and
cumulative effect of change in accounting principle................ -5.4% -15.0% -1.8% -7.6%
Provision for income taxes.......................................... -2.0% 0.0% -0.6% 0.0%
----- ----- ----- -----
Loss before cumulative effect of
change in accounting principle..................................... -3.4% -15.0% -1.1% -7.6%
Cumulative effect of change in accounting principle................. 0.0% 0.0% 0.0% -0.5%
----- ----- ----- -----
Net loss............................................................ -3.4% -15.0% -1.1% -8.1%
===== ===== ===== =====
THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000
Net Patient Revenue - Net patient revenues decreased from $26.7 million for
the three months ended June 30, 2000 to $24.5 million for the same period of
2001, a decrease of $2.2 million or 8.2%. Patient revenues for dental centers
open for more than one year decreased approximately $1.4 million, or 5.0%, from
the second quarter of 2000. Revenues from de novo dental centers opened in 2000
contributed revenues of $0.4 million, more than offset by decreased revenues of
approximately $1.2 million from 14 dental centers closed in the last year.
Dentist Salaries and Other Professional Costs - Dentist salaries and other
professional costs consist primarily of compensation paid to dentists,
orthodontists, and hygienists employed by the affiliated dental practices. For
the three months ended June 30, 2001, dentist salaries and other professional
costs were $6.6 million, $0.3 million, or 4.4%, lower than dentist compensation
in the prior year period. Lower revenues contributed to the decrease as
compensation of most dentists is based on billings or collections. Expressed as
a percentage of net patient revenues, dentist salaries and other professional
costs increased from 26.0% to 27.1% for the three months ended June 30, 2000 and
2001, respectively.
Clinical Salaries - Clinical salaries decreased from $5.1 million for the
three months ended June 30, 2000 to $4.9 million for the three months ended June
30, 2001, a decrease of $0.3 million or 5.4%. Expressed as a percentage of net
patient revenues, however, clinical salaries increased from 19.2% for the three
months ended
13
June 30, 2000 to 19.8% for the comparable 2001 period, as the decline in
revenues was relatively greater than the decrease in clinical salaries.
Dental Supplies and Laboratory Fees - Dental supplies and laboratory fees
decreased from $3.0 million for the three months ended June 30, 2000 to $2.9
million for the three months ended June 30, 2001, a decrease of 3.7%. Expressed
as a percentage of patient revenues, dental supplies and laboratory fees
increased from 11.1% for the three months ended June 30, 2000 to 11.7% for the
three months ended June 30, 2001, primarily as a result of higher laboratory
fees.
Rent and Lease Expense - Rent and lease expense of $1.7 million for the three
months ended June 30, 2001 was essentially unchanged from the prior year.
Expressed as a percentage of net patient revenues, rent and lease expense
increased from 6.4% for the three months ended June 30, 2000 to 6.9% for the
three-month period ended June 30, 2001.
Advertising and Marketing - Advertising and marketing expenses fell from $1.0
million in the second quarter of 2000 to $0.8 million in 2001, a decrease of
$0.2 million, or 18.2%. Lower expenditures on television advertising, yellow
pages advertisements and reduced promotional costs accounted for the decrease.
Expressed as a percentage of net patient revenues, advertising and marketing
expenses decreased from 3.7% in the prior year period to 3.3% for the three
months ended June 30, 2001.
Depreciation and Amortization - Depreciation and amortization of $1.7 million
for the three months ended June 30, 2001 was relatively unchanged from the same
period of 2000. Expressed as a percentage of net patient revenues, depreciation
and amortization increased from 6.2% in the prior year period to 6.8% for the
three months ended June 30, 2001.
Other Operating Expenses - Other operating expenses of $1.8 million for the
three months ended June 30, 2001 were flat compared to the second quarter of
2000. Expressed as a percentage of net patient revenues, other operating
expenses increased from 6.9% for the three months ended June 30, 2000 to 7.4%
for the comparable 2001 period.
Bad Debt Expense - Bad debt expense of $1.1 million for the three months ended
June 30, 2000 increased by 3.1% to $1.2 million for the three months ended June
30, 2001. Expressed as a percentage of net patient revenues, bad debt expense
increased from 4.2% for the three months ended June 30, 2000 to 4.8% for the
same period of 2001. Increased reserves were the primary reason for the slight
increase in the second quarter of 2001.
Restructuring Costs and Other Charges - For the three months ended June 30,
2001 the Company recorded restructuring costs of $1.3 million including
severance costs, remaining lease obligations on closed offices, and legal and
professional fees related to the implementation of the plan to improve operating
results and restructure the Company's credit facilities. (Note 5 of Notes to
Condensed Consolidated Financial Statements).
General & Administrative Expense - General and administrative expenses of $2.7
million for the three months ended June 30, 2001 increased by $0.1 million, or
5.9% from the second quarter of 2000. Expressed as a percentage of net patient
revenues, general and administrative expense increased from 9.6% for the three
months ended June 30, 2000 to 11.1% for the comparable period of 2001.
Asset Impairment - The closing of eleven under-performing dental centers in
Florida, Tennessee and Texas resulted in the write-off of $0.5 million in
leasehold improvements and intangible assets related to those offices and
associated acquisitions. The closed offices included two dental centers in
Florida, two centers in Tennessee and seven in the Texas area.
Litigation expense - For the quarter ended June 30, 2000, the Company recorded
a $1.5 million charge resulting from an adverse arbitration award in an
arbitration proceeding in Los Angeles, California (Note 4 of Notes to Condensed
Consolidated Financial Statements).
Interest Expense - Interest expense increased from $1.7 million for the three
months ended June 30, 2000 to $2.2 million for the three months ended June 30,
2001, an increase of $0.4 million or 23.8%. The increase
14
resulted from higher borrowings and the accrual of default interest related to
the various defaults under the Company's credit agreements.
Provision for Income Taxes - For the three months ended June 30, 2001, the
Company did not record a benefit for income taxes resulting from a loss before
income taxes of $3.7 million because there is no assurance that the Company will
be able to recognize the benefit for income taxes in future periods. In the
second quarter of 2000, the Company recorded a benefit for income taxes of $0.5
million against income a loss before income taxes of $1.5 million.
SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000
Net Patient Revenue - Net patient revenues decreased from $53.2 million for
the six months ended June 30, 2000 to $52.2 million for the same period of 2001,
a decrease of $1.0 million or 1.9%. Patient revenues for dental centers open for
more than one year increased approximately $0.3 million, less than one percent,
from the first quarter of 2000. Revenues from de novo dental centers opened in
2000 contributed revenues of $0.8 million, more than offset by decreased
revenues of approximately $2.1 million from 14 dental centers closed in the last
year.
Dentist Salaries and Other Professional Costs - For the six months ended June
30, 2001, dentist salaries and other professional costs were $14.0 million, $0.1
million, or 0.5% higher than dentist compensation of $13.9 million in the six
months ended 2000. Expressed as a percentage of net patient revenues, dentist
salaries and other professional costs increased from 26.1% to 26.8% for the six
months ended June 30, 2000 and 2001, respectively.
Clinical Salaries - Clinical salaries decreased from $10.2 million for the six
months ended June 30, 2000 to $10.0 million for the six months ended June 30,
2001, a decrease of $0.2 million or 1.7%. Expressed as a percentage of net
patient revenues, clinical salaries were 19.1% in the first six months of 2001,
unchanged from the prior year.
Dental Supplies and Laboratory Fees - Dental supplies and laboratory fees
increased from $5.7 million for the six months ended June 30, 2000 to $5.8
million for the six months ended June 30, 2001, an increase of $0.1 million or
2.7%. Higher laboratory fees resulting from price increases and outsourcing of
certain lab functions accounted for the increase. Expressed as a percentage of
patient revenues, dental supplies and laboratory fees increased from 10.6% for
the six months ended June 30, 2000 to 11.1% for the six months ended June 30,
2001.
Rent and Lease Expense - Rent and lease expense of $3.4 million for the six
months ended June 30, 2001 increased by 1.5% from the six months ended 2000.
Rent increases on existing leases and higher property taxes accounted for the
increase. Expressed as a percentage of net patient revenues, rent and lease
expense increased from 6.3% for the six months ended June 30, 2000 to 6.5% for
the six-month period ended June 30, 2001.
Advertising and Marketing - Advertising and marketing expenses decreased from
$1.9 million in the first half of 2000 to $1.6 million in 2001, a decrease of
$0.3 million, or 17.9%. Lower expenditures on television advertising, yellow
pages advertisements and reduced promotional costs accounted for the decrease.
Expressed as a percentage of net patient revenues, advertising and marketing
expenses decreased from 3.6% in the prior year period to 3.0% for the six months
ended June 30, 2001.
Depreciation and Amortization - Depreciation and amortization increased from
$3.2 million for the six months ended June 30, 2000, to $3.4 million for the six
months ended June 30, 2001, an increase of $0.2 million or 4.5%. The increase
is attributable to the depreciation of leasehold improvements and dental
equipment associated with the opening of de novo dental centers in Texas,
Florida and Tennessee in 2000. Expressed as a percentage of net patient
revenues, depreciation and amortization increased from 6.1% in the prior year
period to 6.5% for the six months ended June 30, 2001.
15
Other Operating Expenses - Other operating expenses increased from $3.6
million for the six months ended June 30, 2000, to $3.7 million for the six
months ended June 30, 2001, an increase of $0.1 million or 4.4%. The increase is
attributable primarily to higher insurance, maintenance and third-party
financing costs. Expressed as a percentage of net patient revenues, other
operating expenses increased from 6.7% for the six months ended June 30, 2000 to
7.1% for the comparable 2001 period.
Bad Debt Expense - Bad debt expense of $2.3 million for the six months ended
June 30, 2001 was relatively unchanged from the year earlier period. Expressed
as a percentage of net patient revenues, bad debt expense increased from 4.3%
for the six months ended June 30, 2000 to 4.4% for the same period of 2001.
Restructuring Costs and Other Charges - For the six months ended June 30, 2001
the Company recorded restructuring costs of $1.8 million including severance
costs, remaining lease obligations on closed offices and legal and professional
fees related to the implementation of the plan to improve operating results and
restructure the Company's credit facilities. (Note 5 of Notes to Condensed
Consolidated Financial Statements)
General & Administrative Expense - General and administrative expenses of $5.4
million for the six months ended June 30, 2001 increased by less than one
percent from general and administrative expenses in the first six months of
2000. Expressed as a percentage of net patient revenues, general and
administrative expense increased from 10.0% to 10.3% or the six months ended
June 30, 2000 and 2001, respectively.
Asset Impairment - The closing of eleven under-performing dental centers in
Florida, Tennessee and Texas resulted in the write-off of $0.5 million in
leasehold improvements and intangible assets related to those offices and
associated acquisitions. The closed offices included two dental centers in
Florida, two centers in Tennessee and seven in the Texas area.
Litigation expense - For the six months ended June 30, 2000, the Company
recorded a $1.5 million charge resulting from an adverse arbitration award in an
arbitration proceeding in Los Angeles, California (Note 4 of Notes to Condensed
Consolidated Financial Statements).
Interest Expense - Interest expense increased from $3.2 million for the six
months ended June 30, 2000 to $4.4 million for the six months ended June 30,
2001, an increase of $1.1 million or 35.0%. The increase resulted from higher
borrowings, an increase in the variable interest rate under the bank credit
facility and the accrual of default interest related to the various defaults
under the Company's credit agreements.
Provision for Income Taxes - For the six months ended June 30, 2001, the
Company did not record a benefit for income taxes resulting from a loss before
income taxes of $4.0 million because there is no assurance that the Company will
be able to recognize the benefit for income taxes in future periods. In the
first six months of 2000, the Company recorded a benefit for income taxes of
$0.3 million against a loss before income taxes of $0.9 million.
Cumulative Effect of Change in Accounting Principle - During June 1998, the
Financial Accounting Standards Board issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which requires that companies
recognize all derivative instruments as either assets or liabilities on the
balance sheet and measure those instruments at fair value. SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133," deferred the implementation of SFAS
133 until the fiscal year ending December 31, 2001. The Company implemented SFAS
133 effective January 1, 2001, resulting in a cumulative effect adjustment of
$0.3 million during the first half of 2001.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2001 the Company had a net working capital deficit of $63.1
million, resulting primarily from the classification as a current liability of
$45.2 million of outstanding borrowings under the Company's senior bank credit
facility and $15.0 million in senior subordinated note and convertible note
agreements (see below). Current assets consisted of cash and cash equivalents of
$3.7 million, billed and unbilled accounts receivable of $9.5 million and
prepaid expenses and other current assets of $2.2 million. Current liabilities
totaled $78.5 million,
16
consisting of $14.4 million in accounts payable and accrued liabilities, $63.9
million in current maturities of long-term debt and $0.1 million of deferred
compensation payable to a stockholder.
For the six months ended June 30, 2000 and 2001, cash provided by operating
activities was $1.7 million and $3.3 million, respectively. In the six months
ended June 30, 2000, cash used in investing activities amounted to $7.4 million,
consisting primarily of $5.0 million to acquire a 20% minority interest in the
Company's California subsidiary and $2.4 million for capital expenditures. For
the six months ended June 30, 2001, cash used in investing activities was only
$0.3 million for capital expenditures because the Company stopped development of
new dental centers in mid-2000. For the six months ended June 30, 2000, cash
provided by financing activities totaled $5.7 million representing $15.6 million
in proceeds from long-term debt offset partially by $8.8 million in repayments
of long-term debt and capital lease obligations, $0.3 million in the reduction
of a bank overdraft and payment of $0.8 million in debt issuance costs. For the
six months ended June 30, 2001, cash used in financing activities totaled $0.2
million representing repayments of long-term debt and capital lease obligations.
During the first six months of 2001, the Company's principal sources of
liquidity consisted primarily of cash and cash equivalents and net accounts
receivable. The Company has not been able to borrow under its senior credit
facility since August 2000, at which time the Company advised its lenders that
it was in violation of certain financial covenants of the Credit Agreement, the
Subordinated Note Agreement and the Convertible Note Agreement (collectively the
"Debt Agreements") as a result of losses incurred in the second quarter of 2000.
The Credit Agreement provides for borrowings up to $55.0 million and matures
November 2002. Advances under the Credit Agreement require quarterly interest
payments through March 2001 at which time principal becomes payable quarterly
based on a five-year amortization with final payment at maturity. Borrowings
under the Credit Agreement may at no time exceed a specified borrowing base,
which is calculated as a multiple of the Company's earnings before interest,
income taxes, depreciation and amortization ("EBITDA"), as adjusted. The Credit
Agreement bears interest at variable rates, which are based upon either the
bank's base rate or LIBOR, plus, in either case, a margin which varies according
to the ratio of the Company's funded debt to the EBITDA, each as defined in the
Credit Agreement. A commitment fee is payable quarterly at rates ranging from
0.125 percent to 0.5 percent of the unused amounts for such quarter. The Credit
Agreement contains affirmative and negative covenants that require the Company
to maintain certain financial ratios, limit the amount of additional
indebtedness, limit the creation or existence of liens, set certain restrictions
on acquisitions, mergers, capital expenditures and sales of assets and restrict
the payment of dividends. At June 30, 2001, $45.2 million was outstanding under
the Credit Agreement.
The Subordinated Note Agreement and Convertible Note Agreement provided
borrowings of $13.7 and $1.3 million, respectively. Proceeds from these notes
were used to reduce borrowings under the bank credit facility, to acquire a 20%
minority interest in the Company's California subsidiary and to reduce other
accrued liabilities and accounts payable. Loans under the Subordinated Note
Agreement bear interest at the 90-day LIBOR rate plus five and one-half percent,
payable quarterly, and are due in eight quarterly installments beginning in the
sixty-third month following the closing date. Loans under the Convertible Note
Agreement bear interest at the same rate as loans under the Subordinated Note
Agreement and are due on demand beginning seven years after the closing date
with a final maturity date of January 30, 2009. The convertible note is
convertible at any time into 442,880 shares of Company common stock at the
request of the holders at a fixed conversion price of $3.1125 per share. The
Subordinated Note Agreement and Convertible Note Agreement contain affirmative
and negative covenants that require that Company to maintain certain financial
ratios, limit the amount of additional indebtedness, limit the creation or
existence of liens, set certain restrictions on acquisitions, mergers and sales
of assets and restrict the payment of dividends. At June 30, 2001, the Company
was not in compliance with the financial covenants of the Subordinated Note
Agreement and Convertible Note Agreement. In addition, through June 2001, the
Company has not made $1.7 million in interest payments (excluding default
interest) due to the holders of the senior subordinated notes and $2.7 million
in principal and interest payments to other subordinated note holders, because
it did not have sufficient
17
resources to make such payments and it is restricted from making any payments to
subordinated debt holders as long as the Company is in default under the Credit
Agreement.
As a result of losses incurred in 2000 and the first six months of 2001, the
Company has not been in compliance with the financial covenants of the Debt
Agreements since June 30, 2000. At June 30, 2001, approximately $45.2 million in
senior debt and $15.0 million in subordinated debt were outstanding under the
Debt Agreements in addition to approximately $3.5 million in other outstanding
subordinated debt. Since the Company is in default under these agreements, all
amounts outstanding are subject to acceleration and have been classified as
current liabilities. The Company has continued to pay interest (other than
default interest) on the amounts outstanding under the Credit Agreement, but has
not made principal or interest payments due to subordinated creditors since July
2000. The Company has requested waivers of these covenant violations and a
forbearance of scheduled principal payments and is negotiating with its lenders
to restructure the Debt Agreements. However, these negotiations have not
resulted in a forbearance agreement or waivers of the defaults as of August 14,
2001. Given the financial position of the Company and the current condition of
financial markets, the Company believes that it is unlikely a new lender group
will be found to refinance indebtedness owed to the existing lender group. The
Company is also pursuing equity investments by investors. Any such debt
restructuring or private equity investment, if available, could substantially
dilute existing holders of the Company's equity. There can be no assurances as
to the terms of any such restructuring or investment, or that the Company will
be able to restructure its indebtedness or arrange an additional equity
investment.
The Company believes that it will be able to continue to make interest
payments, exclusive of default interest, on its outstanding debt, but did not
make scheduled principal payments of $4.5 million on its senior debt through
June 2001. There can be no assurance that the Company's lenders will consent to
the waivers and restructuring necessary to allow the Company to continue to
operate. If the Company and its lenders cannot reach an agreement, it may be
necessary for the Company to seek protection under Chapter 11 of the Bankruptcy
Code.
In January 2001, the Company retained Getzler and Co., a New York based
turnaround specialist, to assist the Company in addressing its operational
issues and restructuring of the Company's debt. In February 2001, the Company
appointed Getzler's designee, Ira Glazer, to serve as the interim Chief
Executive Officer. On July 1, 2001, the Company appointed James M. Usdan as
President and Chief Executive Officer. Getzler & Co. and management have
developed a plan that will allow the Company to continue to operate without the
need for additional borrowings and to make principal payments to its senior bank
creditors out of available funds. Components of this plan include: (i)
reorganization of field management to improve efficiency and reduce regional
overhead costs; (ii) reduction in corporate general and administrative costs
through job eliminations and reduction in other overhead expenses; (iii) closing
of unprofitable and under-performing dental centers; (iv) realignment of
accounts receivable management to focus on improved collection of insurance and
patient receivables; (v) restructuring of compensation for management to
emphasize performance-based incentives; and, (vi) cancellation of further de
novo development and reducing capital expenditures to maintenance levels of
approximately $1.2 million for 2001.
Implementation of the Company's plan will require the consent of its lenders
and the holders of its subordinated indebtedness. No assurances can be made that
the Company's creditors will agree with the plan. In addition, there can be no
assurances that the Company's efforts to improve operating results and cash
flows will be sufficient to allow the Company to meet its obligations in a
timely manner. Therefore, there is substantial doubt about the Company's ability
to continue in existence.
18
OTHER MATTERS
On June 29, 2001, the Financial Accounting standards Board approved Statement
of Financial Accounting Standards (SFAS) No. 141, Business Combinations and SFAS
No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 supercedes APB
Opinion No. 16, Business Combinations, to prohibit use of the pooling-of-
interest (pooling) method of accounting for business combinations initiated
after the issuance date of the final Statement. SFAS No. 142 supercedes APB
Opinion No. 17, Intangible Assets, by stating that goodwill will no longer be
amortized, but will be tested for impairment in a manner different from how
other assets are tested for impairment. SFAS No. 142 establishes a new method of
testing goodwill for impairment by requiring that goodwill be separately tested
for impairment using a fair value approach rather than an undiscounted cash flow
approach.
The provisions of SFAS No. 141 and SFAS No. 142 will be effective for fiscal
years beginning after December 15, 2001. SFAS No. 142 must be adopted at the
beginning of a fiscal year. The Company is currently evaluating the impact of
the adoption of these Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company's financial instruments with market risk exposure are revolving
credit borrowings under its Debt Agreements, which total $60.2 million at June
30, 2001. Based on this balance, a change of one percent in the interest rate
would cause a change in interest expense of approximately $602,000, or $0.09 per
share, on an annual basis. The bank credit facility was not entered into for
trading purposes and carries interest at a pre-agreed upon percentage point
spread from either the prime interest rate or Eurodollar interest rate.
In July 2000, the Company entered into a swap agreement with a bank to
receive variable rate interest payments in exchange for fixed rate interest
payments on original notional amounts of $32.0 million. The amounts exchanged
are based on the notional amounts multiplied by the difference between the fixed
interest rate and variable interest rate in effect. At June 30, 2001, the fixed
interest rate applicable to this agreement was 7.37% and the variable rate of
interest, based upon a six-month LIBOR rate, was 4.09%. For 2001, the weighted-
average variable rates are subject to change over time as LIBOR fluctuates.
During the six month period ended June 30, 2001, the Company accrued $0.3
million in additional interest expense under the swap agreement. The term of the
swap contract expired July 10, 2001.
19
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
In June 2000, the Company recorded litigation expenses of $1,495,000 resulting
from an arbitration award against two subsidiaries of the Company in an
arbitration proceeding in Los Angeles, California. The arbitrator found that
the subsidiaries had breached a contractual agreement to acquire a dental
practice and awarded the plaintiffs actual damages and costs of $442,000. In
August 2000, the arbitrator awarded the plaintiffs an additional $666,000 for
attorney fees and costs, resulting in a total judgment of $1,108,000 against the
Company's subsidiaries. This amount, as well as additional legal expenses
incurred by the Company, was included in the litigation expenses recorded in
June 2000. None of the judgment amount awarded to the plaintiffs has been paid
as of August 10, 2001.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
The Company was in default of its senior bank credit facility, senior
subordinated note agreement and subordinated convertible note agreement (the
"Debt Agreements") at June 30, 2001, resulting from non-compliance with certain
financial covenants of the Debt Agreements and non-payment of scheduled interest
and principal payments. As a result, amounts outstanding under these Agreements
at June 30, 2001 were subject to acceleration and the Company has classified the
related debt as a current liability at June 14, 2001. The Company has continued
to pay interest (excluding default interest) on the amounts outstanding under
the Credit Agreement but has not made principal payments of $4.5 million through
June 2001. The Company has not made interest payments totaling $1.7 million
(other than default interest) under the Subordinated Note Agreement and
Convertible Note Agreement that have accrued since July 2000. The Company has
requested waivers of these covenant violations and a forbearance of scheduled
principal payments and is negotiating with its lenders to restructure the Debt
Agreements. However, these negotiations have not resulted in a forbearance
agreement or waivers of the defaults as of August 14, 2001. Given the financial
position of the Company and the current condition of financial markets, the
Company believes that it is unlikely that either a new lender group will be
brought in to replace the existing lender group or that an equity investment by
a third party in the Company will be obtained that would be sufficient to
satisfy its capital needs. There can be no assurance that the Company's lenders
will consent to the waivers and restructuring necessary to allow the Company to
continue to operate.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
The following exhibits are filed with this report:
(b) Reports on Form 8-K
None
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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.
CASTLE DENTAL
CENTERS, INC.
Date: August 14, 2001 By: JAMES M. USDAN
----------------------------------------
James M. Usdan
President and Chief Executive Officer
Date: August 14, 2001 By: JOHN M. SLACK
----------------------------------------
John M. Slack
Chief Financial Officer
21