SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 November 12, 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 September 30, 2001............... 3
Condensed Consolidated Statements of Operations
For the Three Months and Nine Months Ended
September 30, 2000 and 2001............................ 4
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 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, September 30,
2000 2001
------------ -------------
ASSETS
Current assets:
Cash and cash equivalents........................................... $ 901 $ 4,536
Patient receivables, net............................................ 8,912 5,260
Unbilled patient receivables, net................................... 2,952 2,974
Prepaid expenses and other current assets........................... 1,894 1,544
-------- --------
Total current assets............................................. 14,659 14,314
-------- --------
Property and equipment, net......................................... 18,079 15,146
Intangibles, net.................................................... 60,248 58,026
Other assets........................................................ 2,400 2,360
-------- --------
Total assets..................................................... $ 95,386 $ 89,846
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt................................... $ 63,679 $ 63,810
Accounts payable and accrued liabilities............................ 13,107 14,985
Deferred compensation payable, related party........................ 132 132
-------- --------
Total current liabilities........................................ 76,918 78,927
-------- --------
Long-term debt, net of current portion................................ 429 -
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value, 19,000,000 shares authorized, 6 6
6,417,206 shares issued and outstanding..........................
Additional paid-in capital.......................................... 42,086 42,086
Accumulated deficit................................................. (24,053) (31,173)
-------- --------
Total stockholders' equity....................................... 18,039 10,919
-------- --------
Total liabilities and stockholders' equity....................... $ 95,386 $ 89,846
======== ========
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 Nine Months
Ended Ended
September 30, September 30,
------------------------- -------------------------
2000 2001 2000 2001
-------- -------- --------- --------
Net patient revenues.............................................. $ 27,115 $23,152 $ 80,344 $75,379
Expenses:
Dentist salaries and other professional costs.................... 7,116 6,527 21,025 20,508
Clinical salaries................................................ 5,396 4,837 15,556 14,822
Dental supplies and laboratory fees.............................. 2,839 2,914 8,490 8,718
Rental and lease expense......................................... 2,281 1,499 5,645 4,914
Advertising and marketing........................................ 1,089 937 3,023 2,525
Depreciation and amortization.................................... 1,701 1,596 4,950 4,992
Other operating expenses......................................... 1,917 2,161 5,472 5,873
Bad debt expense................................................. 9,637 810 11,935 3,122
Restructuring costs and other charges............................ - 277 - 2,066
General and administrative....................................... 3,789 2,721 9,115 8,079
Asset impairment................................................. 1,910 3 1,910 537
-------- ------- -------- -------
Total expenses................................................. 37,675 24,282 87,121 76,156
-------- ------- -------- -------
Operating loss ................................................... (10,560) (1,130) (6,777) (777)
Litigation settlement............................................. - - 1,495 -
Interest expense.................................................. 1,997 1,784 5,227 6,142
Other income...................................................... (1) (23) (6) (49)
-------- ------- -------- -------
Loss before benefit for income taxes and
cumulative effect of change in accounting principle.............. (12,556) (2,891) (13,493) (6,870)
Benefit for income taxes ......................................... (2,043) - (2,382) -
-------- ------- -------- -------
Loss before cumulative effect of change
in accounting principle.......................................... (10,513) (2,891) (11,111) (6,870)
Cumulative effect of change in accounting principle (NOTE 6)...... - - - (250)
-------- ------- -------- -------
Net loss.......................................................... $(10,513) $(2,891) $(11,111) $(7,120)
======== ======= ======== =======
Loss per common share:
Loss before cumulative effect of change
in accounting principle......................................... $(1.64) $(0.45) $(1.72) $(1.07)
Cumulative effect of change in accounting principle.............. - - - (0.04)
-------- ------- -------- -------
Net loss......................................................... $(1.64) $(0.45) $(1.72) $(1.11)
======== ======= ======== =======
Weighted average number of common and common equivalent shares
outstanding
Basic and diluted................................................ 6,417 6,417 6,462 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)
Nine Months Ended
September 30,
----------------------------
2000 2001
---------- ----------
Cash flows from operating activities:
Net loss....................................................... $(11,111) $(7,120)
Adjustments:
Provisions for bad debts................................... 11,935 3,122
Depreciation and amortization.............................. 4,950 4,992
Amortization of loan cost.................................. 216 370
Asset impairment........................................... 1,910 537
Deferred income taxes ..................................... (3,091) -
Cumulative effect of change in accounting principle........ - 250
Changes in operating assets and liabilities:
Patient receivables....................................... (3,932) 536
Unbilled patient receivables.............................. (597) (28)
Prepaid expenses and other current assets................. 893 350
Other assets.............................................. 319 (30)
Accounts payable and accrued liabilities.................. 2,419 1,628
Deferred compensation payments, related party............. (394) -
-------- -------
Net cash provided by operating activities................. 3,517 4,607
-------- -------
Cash flows from investing activities:
Capital expenditures......................................... (3,086) (674)
Acquisition of affiliated dental practices,
net of cash acquired ....................................... (5,039) -
-------- -------
Net cash used in investing activities..................... (8,125) (674)
-------- -------
Cash flows from financing activities:
Proceeds from debt........................................... 16,870 -
Repayment of debt and capital lease obligations.............. (8,976) (298)
Bank overdraft............................................... (818) -
Debt issuance costs.......................................... (857) -
-------- -------
Net cash provided by (used in) financing activities....... 6,219 (298)
-------- -------
Net change in cash and cash equivalents........................ 1,611 3,635
Cash and cash equivalents, beginning of period................. 59 901
-------- -------
Cash and cash equivalents, end of period....................... $ 1,670 $ 4,536
======== =======
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 nine months of 2001, the Company has not been in compliance with the
financial covenants of its debt agreements since June 30, 2000. At September 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
$1.1 million) on the amounts outstanding under the senior credit facility, but
has not made principal payments of $6.8 million under the senior credit facility
or principal and interest payments of $4.8 million (excluding accrued default
interest of $0.3 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 November 12, 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. The Company believes that a
private equity investment will not be available unless it involves a
restructuring of the Company's existing indebtedness or conversion of such
indebtedness into equity. 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; and, (v) 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 September 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 September
30, 2001 and for the three and nine months ended September 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 July 20, 2001, the Financial Accounting Standards Board issued 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.
On August 16, 2001, the Financial Accounting Standards Board issued SFAS
143, "Accounting for Asset Retirement Obligation". SFAS 143 addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. This
Statement amends FASB Statement No. 19, Financial Accounting and Reporting by
Oil and Gas Producing Companies. This provisions of SFAS 143 are effective for
financial statements issued for fiscal years beginning after June 15, 2002.
Earlier application is encouraged.
On October 3, 2001, the Financial Accounting Standards Board issued SFAS
144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS 144
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. This Statement supercedes SFAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and
the accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", both of which address the disposal of a segment of a business.
The provisions of SFAS 144 are effective for financial statements issued for
fiscal years beginning after December 15, 2001 and interim periods within those
fiscal years, with early application encouraged. The Company is currently
evaluating the impact of the adoption of this Statement but does not believe it
will have a material impact on the Company's net income, cash flows, or
financial condition.
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 nine month periods ended September 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
8
CASTLE DENTAL CENTERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 September 30,
2001, approximately $45.2 million was outstanding under the Credit Agreement.
The Company maintains a senior subordinated note agreement ("Subordinated
Note Agreement") and a 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 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 nine 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 $6.8 million under
the Credit Agreement in the first nine months of 2001. The Company also has not
made $4.9 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
September 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
November 12, 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 November 12, 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
9
CASTLE DENTAL CENTERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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; and, (v) cancellation of further de novo development and
reducing 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-down 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 2001 Obligations Write-down September 30, 2001
--------------- ----------- ---------- -------------------
Asset impairment............................ $ 537 $ - $ 537 $ -
Legal and professional services............. 1,292 1,093 - 199
Severance costs............................. 390 254 - 359
Dental center closures...................... 384 358 - 574
------ ------ ------ ------
Total....................................... $2,603 $1,705 $ 537 $1,132
====== ====== ====== ======
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 nine 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.
10
CASTLE DENTAL CENTERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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, 2000. The
Company implemented SFAS 133 effective January 1, 2001. 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. The term of the swap contract expired
July 10, 2001. During the first six month period ended June 30, 2001 the
Company accrued $0.3 million in additional interest expense under the swap
agreement. The cumulative effect of the 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.
7. SEGMENT INFORMATION
The following table sets forth the financial information with respect to the
Company and its reportable segments:
Three Months Nine Months
Ended Ended
September 30, September 30,
------------------------- --------------------------
2000 2001 2000 2001
--------- -------- ---------- ---------
Net patient revenues:
Texas............................................. $ 18,434 $15,997 $ 54,006 $51,333
Florida........................................... 2,644 2,641 8,630 8,394
Tennessee ........................................ 3,268 2,602 9,608 8,415
California........................................ 2,769 1,912 8,100 7,237
-------- ------- -------- -------
Total revenue..................................... 27,115 23,152 80,344 75,379
-------- ------- -------- -------
Operating expenses:
Texas ............................................ 19,542 15,245 50,145 46,557
Florida........................................... 3,775 2,601 9,468 8,278
Tennessee ........................................ 3,118 2,442 8,800 7,875
California........................................ 3,094 1,929 7,685 6,434
Restructuring costs and other charges............. - 277 - 2,066
Corporate, general and administrative expenses.... 8,146 1,788 11,023 4,946
-------- ------- -------- -------
Total operating expenses.......................... 37,675 24,282 87,121 76,156
-------- ------- -------- -------
Operating income (loss):
Texas ............................................ (1,108) 752 3,861 4,776
Florida........................................... (1,131) 40 (838) 116
Tennessee ........................................ 150 160 808 540
California........................................ (325) (17) 415 803
Restructuring costs and other charges............. - (277) - (2,066)
Corporate, general and administrative expenses.... (8,146) (1,788) (11,023) (4,946)
-------- ------- -------- -------
Total operating loss.............................. (10,560) (1,130) (6,777) (777)
-------- ------- -------- -------
Litigation expense....................................... - - 1,495 -
Interest expense......................................... 1,997 1,784 5,227 6,142
Other income............................................. (1) (23) (6) (49)
-------- ------- -------- -------
Loss before benefit for income taxes and
cumulative effect of change in accounting principle.... $(12,556) $(2,891) $(13,493) $(6,870)
======== ======= ======== =======
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
September 30, 2001 the Company managed 89 dental centers with approximately 190
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 Nine Months
Ended Ended
September 30, September 30,
----------------------------- ------------------------------
2000 2001 2000 2001
--------- -------- --------- ----------
Net patient revenues................................. 100.0% 100.0% 100.0% 100.0%
Expenses:
Dentist salaries and other professional costs...... 26.2% 28.2% 26.2% 27.2%
Clinical salaries.................................. 19.9% 20.9% 19.4% 19.7%
Dental supplies and laboratory fees................ 10.5% 12.6% 10.6% 11.6%
Rental and lease expense........................... 8.4% 6.5% 7.0% 6.5%
Advertising and marketing.......................... 4.0% 4.0% 3.8% 3.3%
Depreciation and amortization...................... 6.3% 6.9% 6.2% 6.6%
Other operating expenses........................... 7.1% 9.3% 6.8% 7.8%
Bad debt expense................................... 35.5% 3.5% 14.9% 4.1%
Restructuring costs and other charges.............. 0.0% 1.2% 0.0% 2.7%
General and administrative......................... 14.0% 11.8% 11.3% 10.7%
Asset impairment................................... 7.0% 0.0% 2.4% 0.7%
------ ------ ------ ------
Total expenses................................... 138.9% 104.9% 108.4% 101.0%
------ ------ ------ ------
Operating loss....................................... -38.9% -4.9% -8.4% -1.0%
Litigation settlement................................ 0.0% 0.0% 1.9% 0.0%
Interest expense..................................... 7.4% 7.7% 6.5% 8.1%
Other income......................................... 0.0% -0.1% 0.0% -0.1%
------ ------ ------ ------
Loss before benefit for income taxes and
cumulative effect of change in accounting
principle.......................................... -46.3% -12.5% -16.8% -9.1%
Benefit for income taxes............................. -7.5% 0.0% -3.0% 0.0%
------ ------ ------ ------
Loss before cumulative effect of
change in accounting principle..................... -38.8% -12.5% -13.8% -9.1%
Cumulative effect of change in accounting
principle.......................................... 0.0% 0.0% 0.0% -0.3%
------ ------ ------ ------
Net loss............................................. -38.8% -12.5% -13.8% -9.4%
====== ====== ====== ======
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS
ENDED SEPTEMBER 30, 2000
Net Patient Revenues - Net patient revenues decreased from $27.1 million for
the three months ended September 30, 2000 to $23.2 million for the same period
of 2001, a decrease of $3.9 million or 14.6%. Patient revenues for dental
centers open for more than one year decreased approximately $2.4 million, or
8.7%, from the third quarter of 2000. Patient revenues were impacted by the slow
down in retail sales resulting from the general economic conditions and
specifically, by the tragic events of September 11, 2001 that resulted in
particularly weak revenues in the month of September. Patient revenues from 14
dental centers closed in the last year accounted for approximately $1.6 million
of the decrease.
Dentist Salaries and Other Professional Costs - Dentist salaries and other
professional costs consist primarily of compensation paid to dentists,
orthodontists, and hygienists employed by the affiliated dental practices. For
the three months ended September 30, 2001, dentist salaries and other
professional costs were $6.5 million, $0.6 million, or 8.3%, 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 26.2% to 28.2% for the three months ended
September 30, 2000 and 2001, respectively.
Clinical Salaries - Clinical salaries decreased from $5.4 million for the
three months ended September 30, 2000 to $4.8 million for the three months ended
September 30, 2001, a decrease of $0.6 million or 10.4%. Expressed as a
percentage of net patient revenues, however, clinical salaries increased from
19.9% for the
13
three months ended September 30, 2000 to 20.9% 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
increased from $2.8 million for the three months ended September 30, 2000 to
$2.9 million for the three months ended September 30, 2001, an increase of 2.6%.
Expressed as a percentage of patient revenues, dental supplies and laboratory
fees increased from 10.5% for the three months ended September 30, 2000 to 12.6%
for the three months ended September 30, 2001, primarily as a result of higher
laboratory fees.
Rental and Lease Expense - Rental and lease expense decreased from $2.3
million for the three months ended September 30, 2000 to $1.5 million for the
comparable period of 2001, a decrease of $0.8 million, or 34.3%. The decrease
is attributable to the closure of 14 dental centers in the last twelve months.
Expressed as a percentage of net patient revenues, rent and lease expense
decreased from 8.4% for the three months ended September 30, 2000 to 6.5% for
the three-month period ended September 30, 2001.
Advertising and Marketing - Advertising and marketing expenses fell from $1.1
million in the third quarter of 2000 to $0.9 million in 2001, a decrease of $0.2
million, or 14.0%. 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 were 4.0% for the three months ended September 30, 2001 unchanged from
the same period of 2000.
Depreciation and Amortization - Depreciation and amortization decreased from
$1.7 million for the three months ended September 30, 2000 to $1.6 million for
the third quarter of 2001, a decrease of $0.1 million, or 6.2%. The decrease is
attributable to the impairment of certain property and equipment and intangible
assets in the last twelve months. Expressed as a percentage of net patient
revenues, depreciation and amortization increased from 6.3% in the prior year
period to 6.9% for the three months ended September 30, 2001.
Other Operating Expenses - Other operating expenses increased from $1.9
million for the three months ended September 30, 2000 to $2.2 million for the
three months ended September 30, 2001, an increase of $0.2 million, or 12.7%.
The increase is attributable primarily to higher insurance costs, executive
recruiting expenses and third-party financing costs. Expressed as a percentage
of net patient revenues, other operating expenses increased from 7.1% for the
three months ended September 30, 2000 to 9.3% for the comparable 2001 period.
Bad Debt Expense - Bad debt expense decreased from $9.6 million for the three
months ended September 30, 2000 to $0.8 million for the three months ended
September 30, 2001, a decrease of 91.6%. In the third quarter of 2000 the
Company changed its estimates for the collectibility of certain categories of
accounts receivable resulting in additional charges of $6.4 million on billed
accounts receivable and $2.1 million on unbilled accounts receivable from
orthodontic patients. Excluding these charges, bad debt expense, expressed as a
percentage of net patient revenues, decreased from 4.3% for the three months
ended September 30, 2000 to 3.5% for the comparable 2001 period as collection
experience has improved during 2001.
Restructuring Costs and Other Charges -For the three months ended September
30, 2001 the Company recorded restructuring costs of $0.3 million, primarily for
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 - General and administrative expenses of $2.7 million
for the three months ended September 30, 2001 decreased by $1.1 million, or
28.2% from the third quarter of 2000. The decrease is attributable to
reductions in corporate and regional overhead costs and the reorganization of
field management. Expressed as a percentage of net patient revenues, general
and administrative expense decreased from 14.0% for the three months ended
September 30, 2000 to 11.8% for the comparable period of 2001.
Interest Expense - Interest expense of $1.8 million for the three months ended
September 30, 2001 decreased $0.2 million from $2.0 million for the same period
of 2000, resulting primarily from lower interest rates during the 2001 period.
14
Benefit for Income Taxes - For the three months ended September 30, 2001, the
Company did not record a benefit for income taxes resulting from a loss before
income taxes of $2.9 million because there is no assurance that the Company will
be able to recognize the benefit for income taxes in future periods. In the
third quarter of 2000, the Company recorded a benefit for income taxes of $2.0
million against a loss before income taxes of $12.6 million.
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED
TO NINE MONTHS ENDED SEPTEMBER 30, 2000
Net Patient Revenues - Net patient revenues decreased from $80.3 million for
the nine months ended September 30, 2000 to $75.4 million for the same period of
2001, a decrease of $5.0 million or 6.2%. Patient revenues for dental centers
open for more than one year decreased approximately $1.9 million, or 2.4%, from
the first nine months of 2000. The closing of 14 dental centers in the last
year accounted for $3.3 million of the decrease in revenues. The slowdown in
general economic activity and the impact of the tragic events of September 11,
2001 resulted in particularly weak revenues in September 2001.
Dentist Salaries and Other Professional Costs - For the nine months ended
September 30, 2001, dentist salaries and other professional costs were $20.5
million, $0.5 million, or 2.5% lower than dentist compensation of $21.0 million
in the third quarter of 2000. Expressed as a percentage of net patient
revenues, dentist salaries and other professional costs increased from 26.2% to
27.2% for the nine months ended September 30, 2000 and 2001, respectively.
Clinical Salaries - Clinical salaries decreased from $15.6 million for the
nine months ended September 30, 2000 to $14.8 million for the nine months ended
September 30, 2001, a decrease of $0.7 million or 4.7%. Expressed as a
percentage of net patient revenues, clinical salaries increased slightly from
19.4% for the nine months ended September 30, 2000 to 19.7% for the same nine-
month period of 2001.
Dental Supplies and Laboratory Fees - Dental supplies and laboratory fees
increased from $8.5 million for the nine months ended September 30, 2000 to $8.7
million for the nine months ended September 30, 2001, an increase of $0.2
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 nine months ended September 30, 2000 to 11.6% for the nine
months ended September 30, 2001.
Rental and Lease Expense - Rental and lease expense decreased from $5.6
million for the nine months ended September 30, 2000 to $4.9 million for the
2001 period, a decrease of $0.7 million, or 12.9%. The decrease resulted from
the closing of 14 dental centers in the last year. Expressed as a percentage of
net patient revenues, rent and lease expense decreased from 7.0% for the nine
months ended September 30, 2000 to 6.5% for the nine-month period ended
September 30, 2001.
Advertising and Marketing - Advertising and marketing expenses decreased from
$3.0 million in the first nine months of 2000 to $2.5 million in 2001, a
decrease of $0.5 million, or 16.5%. 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 3.8% in the prior year period
to 3.3% for the nine months ended September 30, 2001.
Depreciation and Amortization - Depreciation and amortization was $5.0 million
for the nine months ended September 30, 2001, approximately the same as in the
prior year period. Expressed as a percentage of net patient revenues, however,
depreciation and amortization increased from 6.2% in the prior year period to
6.6% for the nine months ended September 30, 2001.
Other Operating Expenses - Other operating expenses increased from $5.5
million for the nine months ended September 30, 2000, to $5.9 million for the
nine months ended September 30, 2001, an increase of $0.4 million or 7.3%. The
increase is attributable primarily to higher insurance costs, executive
recruiting expenses
15
and third-party financing costs. Expressed as a percentage of net patient
revenues, other operating expenses increased from 6.8% for the nine months ended
September 30, 2000 to 7.8% for the comparable 2001 period.
Bad Debt Expense - Bad debt expense of $11.9 million for the nine months ended
September 30, 2000 decreased $8.8 million, or 73.8%, to $3.1 million for the
nine-month period of 2001. In the third quarter of 2000 the Company changed its
estimates for the collectibility of certain categories of accounts receivable
resulting in additional charges of $6.4 million on billed accounts receivable
and $2.1 million of unbilled accounts receivable from orthodontic patients.
Excluding these charges, bad debt expense, expressed as a percentage of net
patient revenues, decreased from 4.3% for the nine months ended September 30,
2000 to 4.1% for the comparable 2001 period.
Restructuring Costs and Other Charges - For the nine months ended September
30, 2001 the Company recorded restructuring costs of $2.1 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 - General and administrative expenses decreased from
$9.1 million for the first nine months of 2000 to $8.1 million for the 2001
period, a decrease of $1.0 million, or 11.4%. The decrease is attributable to
reductions in corporate and regional overhead costs and the reorganization of
field management during 2001. Expressed as a percentage of net patient
revenues, general and administrative expense decreased from 11.3% to 10.7% for
the nine months ended September 30, 2000 and 2001, respectively.
Asset Impairment - The closing of under-performing dental centers in Florida,
Tennessee and Texas resulted in the write-off of leasehold improvements and
intangible assets related to those offices and associated acquisitions.
Litigation settlement - For the nine months ended September 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 $5.0 million for the nine
months ended September 30, 2000 to $6.1 million for the nine months ended
September 30, 2001, an increase of $0.9 million or 17.5%. The increase resulted
from higher borrowings level and the accrual of default interest related to the
various defaults under the Company's credit agreements.
Benefit for Income Taxes - For the nine months ended September 30, 2001, the
Company did not record a benefit for income taxes resulting from a loss before
income taxes of $6.9 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 nine months of 2000, the Company recorded a benefit for income taxes of
$2.4 million against a loss before income taxes of $13.5 million.
Cumulative Effect of Change in Accounting Principle - During September 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. In July 2000, the Company entered into swap
agreement with a bank. The term of the swap contract expired July 10, 2001.
The cumulative effect of the 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.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2001 the Company had a net working capital deficit of $64.6
million, resulting primarily from the classification as a current liability of
$45.2 million of outstanding borrowings under the Company's
16
senior bank credit facility and $15.0 million in senior subordinated note and
convertible note agreements. Current assets consisted of cash and cash
equivalents of $4.5 million, billed and unbilled accounts receivable of $8.2
million and prepaid expenses and other current assets of $1.5 million. Current
liabilities totaled $78.9 million, consisting of $15.0 million in accounts
payable and accrued liabilities, $63.8 million in current maturities of long-
term debt and $0.1 million of deferred compensation payable to a stockholder.
For the nine months ended September 30, 2000 and 2001, cash provided by
operating activities was $3.5 million and $4.6 million, respectively. In the
nine months ended September 30, 2000, cash used in investing activities amounted
to $8.1 million, consisting primarily of $5.0 million to acquire a 20% minority
interest in the Company's California subsidiary and $3.1 million for capital
expenditures, primarily for new dental centers. For the nine months ended
September 30, 2001, cash used in investing activities was only $0.7 million for
capital expenditures because the Company stopped development of new dental
centers in mid-2000. For the nine months ended September 30, 2000, cash provided
by financing activities totaled $6.2 million representing $16.9 million in
proceeds from long-term debt offset partially by $9.0 million in repayments of
long-term debt and capital lease obligations, $0.8 million in the reduction of a
bank overdraft and payment of $0.9 million in debt issuance costs. For the nine
months ended September 30, 2001, cash used in financing activities totaled $0.3
million representing repayments of long-term debt and capital lease obligations.
During the first nine 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 the Credit Agreement
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 September 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 Credit Agreement, 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
ninety-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 September 30, 2001, the
Company was not in compliance with the financial covenants of the Subordinated
Note
17
Agreement and Convertible Note Agreement. In addition, through September 2001,
the Company has not made $2.1 million in interest payments (excluding default
interest) due to the holders of the senior subordinated notes and $2.7 million
(excluding default interest) in principal and interest payments to other
subordinated note holders, because it did not have sufficient 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 nine months of 2001, the
Company has not been in compliance with the financial covenants of the Debt
Agreements since June 30, 2000. At September 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
November 12, 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. Given the
current financial condition of the Company, the Company believes that a private
equity investment will not be available unless it involves a restructuring of
the Company's existing indebtedness or conversion of such indebtedness into
equity. 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. 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; and, (v) 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.
OTHER MATTERS
On July 20, 2001, the Financial Accounting standards Board issued
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
18
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.
On August 16, 2001 the Financial Accounting Standards Board issued SFAS
143, "Accounting for Asset Retirement Obligation". SFAS 143 addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. This
Statement amends FASB Statement No. 19, Financial Accounting and Reporting by
Oil and Gas Producing Companies. The provisions of SFAS 143 are effective for
financial statements issued for fiscal years beginning after June 15, 2002.
Earlier application is encouraged.
On October 3, 2001 the Financial Accounting Standards Board issued SFAS
144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS 144
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. This Statement supercedes SFAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and
the accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", both of which address the disposal of a segment of a business.
The provisions of SFAS 144 are effective for financial statements issued for
fiscal years beginning after December 15, 2001 and interim periods within those
fiscal years, with early application encouraged. The Company is currently
evaluating the impact of the adoption of this Statement but does not believe it
will have a material impact on the Company's net income, cash flows, or
financial condition.
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
September 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 Credit Agreement 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.
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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 November 12, 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 September 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 September 30, 2001 were subject to acceleration and the Company
has classified the related debt as a current liability at September 30, 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 $6.8 million through September 2001. The Company has not made
interest payments totaling $2.1 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 November
12, 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. The Company
believes that a private equity investment will not be available unless it
involves a restructuring of the Company's existing indebtedness or conversion of
such indebtedness into equity. 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.
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: November 14, 2001 By: /s/ James M. Usdan
---------------------------------
James M. Usdan
President and Chief Executive Officer
Date: November 14, 2001 By: /s/ John M. Slack
-----------------------------------
John M. Slack
Chief Financial Officer
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