S-1/A 1 ds1a.htm AMENDMENT NO. 8 TO FORM S-1 Amendment No. 8 to Form S-1
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As filed with the Securities and Exchange Commission on April 29, 2010

Registration Number 333-163875

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

AMENDMENT NO. 8 TO

FORM S-1

REGISTRATION STATEMENT

UNDER THE SECURITIES ACT OF 1933

 

 

SMILE BRANDS GROUP INC.

(Exact name of registrant as specified in its charter)

 

Delaware   8090   20-2828458

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

 

201 E. Sandpointe

Santa Ana, California 92707

(714) 668-1300

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

Bradley E. Schmidt

Chief Financial Officer

Smile Brands Group Inc.

201 E. Sandpointe

Santa Ana, California 92707

(714) 668-1300

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

With copies to:

 

Steve Grossman, Esq.

John-Paul Motley, Esq.

O’Melveny & Myers LLP

1999 Avenue of the Stars

Los Angeles, California 90067-6035

Telephone: (310) 553-6700

Fax: (310) 246-6779

 

John D. Wilson, Esq.

Shearman & Sterling LLP

525 Market Street

San Francisco, California 94105

Telephone: (415) 616-1100

Fax: (415) 616-1199

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filed, an accelerated filed, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨

  Accelerated filer  ¨

Non-accelerated filer  x (Do not check if a smaller reporting company)

  Smaller reporting company  ¨

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where any such offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED APRIL 29, 2010

 

 

7,353,000 Shares

LOGO

COMMON STOCK

 

 

This is the initial public offering of shares of our common stock. We are selling 7,353,000 shares of common stock.

Prior to this offering, there has been no public market for our common stock. The initial public offering price of our common stock is expected to be between $16.00 and $18.00 per share. We have been authorized to list our common stock on the New York Stock Exchange under the symbol “GRIN”.

The underwriters have a 30-day option to purchase up to an additional 1,102,950 shares of common stock from us to cover over-allotments.

Investing in our common stock involves risks. See “Risk Factors” beginning on page 10.

 

     Price to
Public
   Underwriting
Discounts and
Commissions
   Proceeds,
Before
Expenses, to Us

Per Share

     $      $      $

Total

   $                 $                 $             

Delivery of the shares of common stock will be made on or about                     , 2010.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

Credit Suisse

Jefferies & Company

 

Wells Fargo Securities    William Blair & Company    Oppenheimer & Co.

The date of this prospectus is                     , 2010.


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LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   10

Forward-Looking Statements and Statistical Data and Market Information

   24

Use of Proceeds

   25

Dividend Policy

   25

Capitalization

   26

Dilution

   27

Selected Consolidated Financial and Other Data

   28

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   32

Business

   55

Management

   75

Compensation Discussion and Analysis

   85

Certain Relationships and Related Party Transactions

   98

Principal Stockholders

   100

Description of Capital Stock

   102

Shares Eligible for Future Sale

   105

Material U.S. Federal Tax Consequences for Non-U.S. Holders of Common Stock

   107

Underwriting

   109

Legal Matters

   114

Experts

   114

Where You Can Find More Information

   114

Index to Consolidated Financial Statements

   F-1

 

 

You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized anyone to provide you with information that is different from that contained in this prospectus. When you make a decision about whether to participate in this offering, you should not rely on any information other than the information contained in this prospectus. We are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information contained in this prospectus is accurate as of the date on the front of this prospectus only.

Dealer Prospectus Delivery Obligation

Until                     , 2010, all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.


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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our common stock. You should read this entire prospectus carefully, especially the risks of investing in our common stock discussed under “Risk Factors” and the consolidated financial statements and related notes included elsewhere in this prospectus, before making an investment decision. We present Adjusted EBITDA as a supplemental measure to help us describe our operating performance. Adjusted EBITDA is a non-GAAP financial measure commonly used in our industry and should not be construed as an alternative to net (loss) income attributable to Smile Brands Group Inc. (as determined in accordance with generally accepted accounting principles in the United States, or GAAP) or as a better indicator of operating performance. Other companies in our industry may calculate Adjusted EBITDA differently than we do. Please refer to note (1) to “Summary Consolidated Financial and Other Data” for a reconciliation of our net (loss) income attributable to Smile Brands Group Inc. to Adjusted EBITDA and a more thorough discussion of our use of Adjusted EBITDA in this prospectus.

Our Company

Smile Brands Group Inc. is the largest provider of support services to general and multi-specialty dental groups in the United States based on number of dental offices. We provide comprehensive business support services, non-clinical personnel, facilities and equipment through our exclusive agreements with affiliated dental groups. Our consumer-driven retail model is guided by the principle “SMILES FOR EVERYONE®”. This model attracts patients to affiliated dental groups by combining strong, recognizable brands, visible retail locations and extended office hours with affordable and comprehensive dental care. Utilizing our model, dentists spend more time caring for their patients and less time on the administrative, marketing and financial aspects of the dental practice while benefiting from a lower cost structure. Our services support more than 1,100 dentists and hygienists practicing in over 300 offices nationally. We recorded revenues of $427.2 million, $445.0 million and $456.5 million, Adjusted EBITDA of $39.7 million, $44.1 million and $56.7 million, and net (loss) income attributable to Smile Brands Group Inc. of $(8.4) million, $(12.0) million and $45.7 million, for each of the years ended December 31, 2007, 2008 and 2009, respectively. We recorded revenues of $116.2 million and $118.1 million, Adjusted EBITDA of $15.5 million and $16.3 million, and net income attributable to Smile Brands Group Inc. of $6.0 million and $4.0 million, each for the three months ended March 31, 2009 and 2010, respectively.

Affiliated dental groups operate primarily under one of three brand names, Bright Now! Dental, Castle Dental or Monarch Dental, and are typically located in highly visible retail centers in some of the largest and fastest growing markets in the U.S. On average, each dental office is approximately 3,500 square feet and contains 11 dental operatories. The affiliated dentists and hygienists offer comprehensive, convenient and high quality dental, hygiene and specialty services such as orthodontics, oral surgery, endodontics, periodontics and pediatrics.

The $102 billion U.S. dental services industry is growing and highly fragmented and services are provided mostly by sole practitioners. Dental care patients tend to be price sensitive because many pay for a significant portion of their dental services on an out-of-pocket basis. Additionally, approximately 30% to 50% of the U.S. adult population does not seek regular dental care. To address these market opportunities, we have developed a cost-effective, consumer-driven, retail model that we believe provides meaningful benefits to both affiliated dentists and their patients.

Our consumer-driven, retail model drives patient flow to affiliated dental groups by creating brand awareness through the use of highly visible office locations and traditional retail-oriented marketing techniques. In addition, we maximize our operational efficiencies through our national infrastructure that utilizes our size and the local market density of affiliated dental groups. Our two call centers and three centralized billing offices, each with specialized personnel and sophisticated technology, improve our ability to schedule patient appointments, provide consistent customer service and optimize billing and collection efforts. We actively

 

 

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manage the supply chain with our affiliated dental groups to utilize our purchasing volume to obtain favorable pricing on products and services. The operational efficiencies generated by our model enable us to leverage our operating costs and provide affiliated dentists with additional capacity to spend more of their time treating patients. These efficiencies lead to a lower cost structure that provides affiliated dental groups greater flexibility to price their dental services competitively within their local market.

The Dental Services Industry

The U.S. dental services industry is large, growing and highly fragmented, with approximately 84% of dentists working either as a sole practitioner or in a practice with only one other dentist. According to the Centers for Medicare and Medicaid Services, or CMS, dental services expenditures in the U.S. are projected to be $106 billion in 2010 and are expected to reach $161 billion by 2018. We believe that the demand for dental services will continue to grow as a result of several key drivers such as the increasing U.S. population of persons age 55 and older, the increased awareness of the benefits of perio-maintenance and hygiene, improved dental technology and the increased use of dental insurance plans.

The dental services industry’s consumer-driven nature and patient payment profile differentiates it from the broader healthcare services industry. According to CMS, consumer out-of-pocket expenditures accounted for 44% of payments for dental services in 2008, compared to 12% for other medical services. In addition, according to CMS, private sources finance 93% of all dental expenditures, with only 7% of dental costs financed by government programs, including Medicare and Medicaid.

These characteristics create an operating environment that is favorable for dental practice management, or DPM, support services organizations. DPM support services organizations provide business support services to dental practices, which may include marketing, staffing, scheduling, and billing, along with access to facilities and equipment. Currently, only a small portion of the dental services in the U.S. are provided by dentists affiliated with DPM support services organizations. We believe that the average cost of operating a dental office for a sole practitioner is 10% to 25% higher than that of a typical dental office supported by a DPM support services organization. As a result, we believe there are significant growth opportunities for DPM support services organizations.

Our Competitive Strengths

We believe the following competitive strengths contribute significantly to our success and position us for growth:

Retail, consumer-driven approach. We utilize strong, recognizable brands and a retail approach to drive patient flow to affiliated dental offices. We typically support several dental offices within a particular market and locate them in highly visible retail centers. We drive brand awareness through prominent signage on dental offices and through highly targeted marketing initiatives. Patients also have flexibility in scheduling appointments because most affiliated dental offices maintain extended hours and offer patient care six days per week within a given market. In addition, we believe the time dentists affiliated with us save by not having to attend to administrative duties allows them to spend more time treating and educating patients on the benefits of completing a comprehensive dental care plan. We believe this approach has resulted in strong brand recognition and a favorable patient experience with the addition of an average of 444,000 new patients per year over the last three years. Additionally, we have increased the number of recall patient exams by 2.0%, 4.8% and 7.5% during the years ended December 31, 2007, 2008 and 2009, respectively.

Leading market positions in large and growing markets. We support affiliated dental groups located primarily in 21 designated market areas, or DMAs, in the United States, including 13 of the 20 largest DMAs.

 

 

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Our affiliated dental groups have a significant presence in most of these markets, including Los Angeles, Dallas and Houston, which represent three of the nation’s top ten DMAs. The concentrated presence of affiliated dental groups within the markets we serve increases the effectiveness and efficiency of our marketing efforts through the use of direct mail, billboard, internet, print, local radio and television advertisements. This market presence and these techniques enable us to deliver 750 million consumer impressions annually.

Established national infrastructure driving a low cost operating structure. Our national infrastructure creates a low cost operating structure by centralizing administrative functions. We actively manage the supply chain with our affiliated dental groups, which allows us to leverage our purchasing volume to obtain favorable pricing from third party vendors. In addition to direct costs savings, we achieve operational efficiencies by sharing best practices across affiliated dental groups and supporting them with two call centers and three centralized billing offices. Our success in leveraging our cost structure is demonstrated through our dental services profit margin, which represents total revenues less dental services expenses divided by total revenues. For the years ended December 31, 2007, 2008 and 2009, our dental services profit margin was 22.4%, 23.0% and 25.8%, respectively.

Proven track record of opening de novo offices with attractive unit economics. Since October 2003, we have supported affiliated dental groups in opening and successfully operating 87 de novo offices, which are new dental offices in existing or new markets. The roll-out of de novo offices allows us to leverage our existing management team and operating costs, utilize our knowledge of the local market to secure the most attractive retail sites, and to increase office density in a market to drive additional operating and marketing efficiencies. In general, de novo offices have yielded consistent financial performance and provide a controllable strategy to achieve growth that has produced highly attractive returns on invested capital. We have internally funded all of our de novo offices and on average these de novos were cash flow positive within four months with recovery of our investment within 30 months after the office opened.

Strong and proven management team. We are led by an experienced management team with an average of over 21 years of experience in either the healthcare services or retail industries. In addition, our chief executive officer and chief financial officer have worked together at Smile Brands Inc. for over 12 years and are responsible for our strategic and cultural development and our revenue and cash flow growth during this period.

Our Growth Strategy

We believe that our growth will result from the following elements of our business strategy:

Increasing revenues from existing offices. We have a proven track record of achieving growth in revenues from existing offices. Comparable office revenue increased by 5.4%, 3.2% and 1.3% for the years ended December 31, 2007, 2008 and 2009, respectively. We plan to continue assisting affiliated dental groups to increase existing office revenues by:

 

   

attracting new patients through our retail marketing efforts;

 

   

increasing the number of recall patients;

 

   

adding dentists and hygienists;

 

   

increasing patients’ completion of their diagnosed dental treatment plan;

 

   

introducing new specialty services and treatments; and

 

   

improving dentist and hygienist efficiency and productivity through technology and workflow enhancements.

 

 

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Leveraging our scalable infrastructure to improve operating margins. We will continue to leverage our national infrastructure and the local market presence of affiliated dental groups to obtain favorable pricing from vendors and suppliers and to secure leases with attractive terms. We also plan to continue to centralize and streamline local office administrative work, such as patient scheduling, billing, collections, payroll and accounting. We have built a national infrastructure to support our de novo office roll-out and offices affiliated with other dental businesses we may acquire, which will allow us to further leverage our operating costs. In addition, our scalable and integrated management information systems track daily operational and financial performance by office so that we can identify and respond quickly to changes in a specific market and continue to improve administrative efficiency and productivity.

Building de novo offices. We plan to increase our revenues and profitability by building de novo offices for affiliated dental groups in existing and new markets where we can leverage our strong brand names and national infrastructure. We typically target locations in our affiliated dental groups’ largest markets and identify sites that support our retail-based strategy by focusing on de novo office locations with substantial street prominence, highly visible signage, the presence of desirable anchor stores, convenient access and high levels of vehicle and pedestrian traffic. Based on our experience in providing support to dental offices, we believe we have the capacity to more than double the number of offices we support in our existing markets.

Selectively pursuing acquisitions. We expect to have opportunities in the future to identify and capitalize on complementary acquisitions, including acquisitions of other DPM support services organizations. We will continue to follow a highly disciplined approach when evaluating these opportunities. We have significant experience in identifying, acquiring and integrating other DPM support services organizations as we acquired Monarch Dental (152 dental offices) in 2003 and Castle Dental (74 dental offices) in 2004.

Risks Associated with Our Business

In executing our business strategy, we face significant risks and uncertainties, which are discussed in the section entitled “Risk Factors,” and include, but are not limited to, the following:

 

   

General economic conditions, particularly in Texas and California, may have a significant impact on our revenues and profitability.

 

   

Our financial performance is dependent in large part on the delivery of patient care by affiliated dentists, specialists and hygienists over which we cannot and do not have control.

 

   

Our ability to grow depends on our success in supporting the opening of de novo offices, which contains many challenges, including the ability of affiliated dental groups to attract, train and retain new dentists, specialists and hygienists and the ability to manage losses incurred during the development and ramp-up period.

 

   

Much of our revenue is derived from payments to affiliated dental groups by third party payors, including insurance providers and government agencies, and cost containment efforts by these payors could significantly reduce our revenues.

 

   

Failure to comply with the many complex laws that apply to us and our affiliated dental groups, including the prohibition on the corporate practice of dentistry by most states, could result in significant fines and penalties and require us to terminate or alter some of our business support services agreements with affiliated dental groups.

 

 

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Our Corporate Information

We were incorporated in Delaware in 2005 for the purpose of acquiring Smile Brands Inc. (formerly Bright Now! Dental, Inc.) and its subsidiaries. Our principal executive offices are located at 201 E. Sandpointe, Santa Ana, California 92707. The telephone number of our principal executive offices is (714) 668-1300, and our main corporate website is www.smilebrands.com. The information on, or that can be accessed through, our website is not part of this prospectus.

Freeman Spogli & Co., or Freeman Spogli, beneficially owns approximately 73.3% of our outstanding common stock before this offering and will continue to beneficially own approximately 45.6% of our outstanding common stock after this offering. Freeman Spogli is a private equity firm dedicated exclusively to investing and partnering with management in consumer-related companies in the retailing, direct marketing and distribution industries in the United States. Since its founding in 1983, Freeman Spogli has invested approximately $2.5 billion of equity in 42 portfolio companies with aggregate transaction values in excess of $16 billion.

SMILE BRANDSSM, BRIGHT NOW!®, CASTLE DENTAL®, MONARCH DENTAL®, NEWPORT DENTAL® and SMILES FOR EVERYONE® are our trademarks. All other trademarks and trade names appearing in this prospectus are for informational purposes only and may be trademarks of their respective owners. We disclaim any interest in or endorsement by the respective owners of such other trademarks.

 

 

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The Offering

 

Common stock offered

7,353,000 shares

 

Common stock to be outstanding after this offering

19,468,394 shares

 

Over-allotment option offered

1,102,950 shares

 

Use of proceeds

We estimate that the net proceeds from this offering will be approximately $112.5 million (approximately $129.9 million if the underwriters exercise their over-allotment option in full) after deducting the underwriting discounts and commissions of approximately $8.7 million and our estimated offering expenses of approximately $3.8 million, which include legal, accounting, printing and other offering expenses. We intend to use the net proceeds from this offering to redeem all of our Series A preferred stock, including cumulative and unpaid dividends, and outstanding options to purchase Series A preferred stock for approximately $88.8 million and, with the remaining proceeds, repay $23.7 million of the amount outstanding under our term loan facility. See “Use of Proceeds.”

 

New York Stock Exchange symbol

“GRIN”

 

Risk Factors

You should carefully read and consider the information set forth under “Risk Factors” and all other information included in this prospectus for a discussion of factors that you should consider before deciding to invest in shares of our common stock.

Unless otherwise noted, the number of shares of common stock to be outstanding after this offering used in this prospectus is based on 12,115,394 shares outstanding as of April 29, 2010, excluding:

 

   

1,892,865 shares of common stock subject to options outstanding;

 

   

1,700,000 shares of common stock available for issuance pursuant to our 2010 Performance Incentive Plan; and

 

   

1,102,950 shares of common stock issuable upon the exercise of the underwriters’ over-allotment option.

On April 14, 2010, our board of directors approved a stock split of 11.8538 shares for one share of outstanding common stock that was effected on April 27, 2010. Unless otherwise expressly stated or the context otherwise requires, all share information included in this prospectus reflects the stock split effected on April 27, 2010.

 

 

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Summary Consolidated Financial and Other Data

The following table sets forth summary consolidated financial and other data for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010. The summary consolidated financial data for the fiscal years ended December 31, 2007, 2008 and 2009 were derived from our audited consolidated financial statements included elsewhere in this prospectus.

Our summary consolidated financial data for the three months ended March 31, 2009 and 2010 were derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The unaudited financial statements reflect, in the opinion of management, all adjustments necessary for the fair presentation of the financial condition and the results of operations for such periods. Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for the entire year ended December 31, 2010. This summary consolidated financial and other data should be read in conjunction with, and is qualified in its entirety by reference to, “Selected Consolidated Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus. The summary consolidated financial data reflects the 11.8538-for-1 split of our common stock effected on April 27, 2010.

 

    Year Ended December 31,     Three Months Ended
March 31,
    2007     2008     2009     2009   2010

Consolidated Statements of Operations:

         

($ amounts in thousands, except per share and other data)

         

Revenues:

         

Net dental services

  $ 421,111      $ 439,415      $ 450,659      $ 114,807   $ 116,627

Other

    6,042        5,609        5,865        1,380     1,450
                                   

Total revenues

    427,153        445,024        456,524        116,187     118,077

Operating costs and expenses:

         

Dental services

    331,383        342,499        338,687        85,928     86,415

Field support

    29,603        30,671        31,908        7,595     8,032

General and administrative

    28,268        29,784        30,661        7,459     7,749

Depreciation and amortization

    12,596        12,830        13,877        3,304     3,414

Loss on asset dispositions

    983        410        322        38     168

Goodwill and trademark impairment

    7,108        23,429        —          —       —  
                                   

Total operating costs and expenses

    409,941        439,623        415,455        104,324     105,778

Income from operations

    17,212        5,401        41,069        11,863     12,299

Other expense:

         

Interest expense–net

    21,307        18,188        14,676        3,862     2,762

Interest rate swap expense–net

    960        2,307        590        222     98

Write off of financing fees

    —          —          —          —       2,675
                                   

Total other expense

    22,267        20,495        15,266        4,084     5,535

Income (loss) before provision for income taxes

    (5,055     (15,094     25,803        7,779     6,764

Provision (benefit) for income taxes

    3,065        (3,322     (20,164     1,733     2,674
                                   

Net (loss) income

    (8,120     (11,772     45,967        6,046     4,090

Less: Net income attributable to non-controlling interests

    279        206        247        82     48
                                   

Net (loss) income attributable to Smile Brands Group Inc.

    (8,399     (11,978     45,720        5,964     4,042

Less: Preferred stock dividends accrued in-kind

    6,863        7,660        8,505        2,041     2,271

Dividends accrued in-kind on outstanding vested preferred stock options

    260        417        599        132     182
                                   

Net (loss) income attributable to common stockholders

  $ (15,522   $ (20,055   $ 36,616      $ 3,791   $ 1,589
                                   

Net (loss) income attributable to common stockholders per share:

         

Basic

  $ (1.28   $ (1.66   $ 3.02      $ 0.31   $ 0.13
                                   

Diluted

  $ (1.28   $ (1.66   $ 2.92      $ 0.31   $ 0.13
                                   

Weighted average common shares outstanding:

         

Basic

    12,116,674        12,115,394        12,115,394        12,115,394     12,115,394
                                   

Diluted

    12,116,674        12,115,394        12,556,802        12,352,868     12,641,821
                                   

 

 

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     Year Ended December 31,     Three Months Ended
March 31,
 
     2007     2008     2009     2009     2010  

Other Data:

          

Adjusted EBITDA (in thousands)(1)

   $ 39,681      $ 44,074      $ 56,745      $ 15,533      $ 16,260   

Number of dental offices at period end

     298        295        303        299        304   

Number of operatories at period end

     3,282        3,281        3,384        3,331        3,393   

Dental services profit margin(2)

     22.4     23.0     25.8     26.0     26.8

Revenue per dentist day(3)

   $ 3,206      $ 3,414      $ 3,657      $ 3,702      $ 3,736   

Comparable office revenue growth(4)

     5.4     3.2     1.3     1.8     (0.9 )% 

 

    As of December 31,   As of March 31, 2010
     2007   2008   2009   Actual   Pro
forma(5)
  Pro forma as
adjusted(6)

Balance Sheet Data (in thousands):

         

Cash and cash equivalents

  $ 275   $ 700   $ 4,482   $ 8,404   $ 8,404   $ 8,404

Total assets

    415,654     389,547     410,695     416,379     416,379     416,379

Long-term debt and capital lease obligations, including current portion

    183,088     166,422     141,587     140,447     140,447     116,759

Total stockholders’ equity

    144,279     133,911     181,068     185,562     97,939     209,250

 

(1)   Adjusted EBITDA represents net (loss) income attributable to Smile Brands Group Inc. plus provision (benefit) for income taxes, interest expense–net, interest rate swap expense–net, depreciation and amortization, reorganization costs, goodwill and trademark impairment, write off of financing fees, loss on asset dispositions, stock-based compensation expense and equity sponsor expenses. We have presented Adjusted EBITDA because we consider it an important supplemental measure of our operating performance and believe it is frequently used by analysts, investors and other interested parties in the evaluation of companies in our industry. Management uses Adjusted EBITDA as an additional measurement tool for purposes of business decision-making, including developing budgets, managing expenditures and evaluating potential acquisitions or divestitures. Other companies in our industry may calculate Adjusted EBITDA differently than we do. In addition, Adjusted EBITDA as presented in this prospectus differs from adjusted EBITDA as calculated for compliance with the financial covenants in our prior and current credit facilities. For purposes of our credit facilities that were entered into in February 2010, we add all of the adjustments shown below, except for equity sponsor expenses, to net (loss) income attributable to Smile Brands Group Inc. For purposes of our prior first and second lien credit facilities, we added back (in addition to the adjustments shown below) construction period rent expenses and board of directors’ fees to net (loss) income attributable to Smile Brands Group Inc. Adjusted EBITDA is not a measure of operating performance under GAAP and should not be considered as a substitute for, or superior to, net income prepared in accordance with GAAP. EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP.

 

       The following table contains a reconciliation of our net (loss) income attributable to Smile Brands Group Inc. determined in accordance with GAAP to Adjusted EBITDA:

 

     Year Ended December 31,     Three Months Ended
March 31,
      2007     2008     2009     2009    2010
(in thousands)                            

Net (loss) income attributable to Smile Brands Group Inc.

   $ (8,399   $ (11,978   $ 45,720      $ 5,964    $ 4,042

Provision (benefit) for income taxes

     3,065        (3,322     (20,164     1,733      2,674

Interest expense—net

     21,307        18,188        14,676        3,862      2,762

Interest rate swap expense—net

     960        2,307        590        222      98

Depreciation and amortization

     12,596        12,830        13,877        3,304      3,414

Reorganization costs(a)

     518        455        89        26      —  

Goodwill and trademark impairment

     7,108        23,429        —          —        —  

Write off of financing fees

     —          —          —          —        2,675

Loss on asset dispositions

     983        410        322        38      168

Stock-based compensation expense

     1,519        1,656        1,554        365      427

Equity sponsor expenses(b)

     24        99        81        19      —  
                                     

Adjusted EBITDA

   $ 39,681      $ 44,074      $ 56,745      $ 15,533    $ 16,260
                                     

 

 

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  (a)   Reorganization costs represent non-recurring consulting fees and related costs for review of our centralized billing office and call center functions in 2008 and severance costs related to the integration of acquisitions by us of other DPM support services organizations.

 

  (b)   Equity sponsor expenses are reimbursable costs paid to Freeman Spogli & Co., which we do not expect to continue after this offering. Equity sponsor expenses for the years ended December 31, 2008 and 2009 also include consulting fees that were paid to our director, Mr. Pulido, for services rendered pursuant to his consulting agreement, which terminated on December 31, 2009.

 

(2)   Dental services profit margin is equal to the amount obtained by dividing total revenues less dental services expenses by total revenues.

 

(3)   Revenue per dentist day is equal to net dental services revenues less net revenues produced by hygienists divided by dentist day count for the period measured. A dentist day is calculated as the time between a dentist’s or specialist’s first and last appointment on a given day divided by eight hours. A day may be fractionally reduced to the extent a dentist’s or specialist’s schedule of appointments spans less than eight hours. The following table contains a reconciliation of net dental services revenues determined in accordance with GAAP to net dental services revenues less net revenues produced by hygienists:

 

     Year Ended December 31,    Three Months
Ended March 31,
     2007    2008    2009    2009    2010
(in thousands)                         

Net dental services revenues

   $ 421,111    $ 439,415    $ 450,659    $ 114,807    $ 116,627

Less: Net revenues produced by hygienists

     42,113      47,957      52,155      12,737      13,743
                                  

Net dental services revenues less net revenues produced by hygienists

   $ 378,998    $ 391,458    $ 398,504    $ 102,070    $ 102,884
                                  

 

(4)   Comparable office revenue growth represents the comparable office revenues for the given period as a percentage of such offices’ total revenues for the comparable prior period. Comparable office revenue is composed of total revenues at dental offices that have been operating for at least 13 full months prior to the end of the given period and which have not been closed, combined or sold during such period.

 

(5)   Reflects, on a pro forma basis, the reclassification of the liquidation value of preferred stock in the amount of $87.6 million from stockholders’ equity to other current liabilities for the redemption of all outstanding preferred stock based on the intended use of proceeds of this offering. The pro forma amount does not reflect the repayment of $23.7 million of the amount outstanding under our secured term loan facility based on the intended use of proceeds of this offering.

 

(6)   Gives effect to the sale of 7,353,000 shares of common stock by us in this offering at an assumed initial public offering price of $17.00 per share, which is the midpoint of the range on the cover of this prospectus, after deducting underwriting discounts and commissions of approximately $8.7 million and estimated offering expenses payable by us of approximately $3.8 million and the use of proceeds therefrom as described under “Use of Proceeds.” A $1.00 increase (decrease) in the assumed initial public offering price of $17.00 per share would (decrease) increase long-term debt and increase (decrease) stockholders’ equity, each by $6.8 million, and would have no impact on cash and cash equivalents and total assets, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated expenses payable by us.

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this prospectus, before deciding whether to invest in our common stock. If any of the following risks actually materializes, our business, financial condition and results of operations would suffer. The trading price of our common stock could decline as a result of any of these risks, and you might lose all or part of your investment in our common stock. You should read the section entitled “Forward-Looking Statements and Statistical Data and Market Information” immediately following these risk factors for a discussion of what types of statements are forward-looking statements, as well as the significance of such statements in the context of this prospectus.

Risks Related to Our Business

Our retail-based business model is impacted by general economic conditions, particularly in Texas and California where a majority of our affiliated dental offices are located.

Dental care patients tend to be price-sensitive because many pay for a significant portion of their dental expenses on an out-of-pocket basis. According to the Centers for Medicare and Medicaid Services, or CMS, consumer out-of-pocket expenditures accounted for 44% of payments for dental services in 2008, compared to 12% for other medical services. Consequently, dental care patients tend to base their selection of a dental practice on the affordability and quality of the dental service. With the recent general economic downturn, consumer spending patterns have changed. Notwithstanding the fact that many dental expenditures arise out of necessity, the growth of our total revenue can be severely impacted with changes in consumer spending.

The majority of our affiliated dental offices are located in Texas and California and the offices in those two states generated 61%, 60%, 60%, 60% and 60% of our total revenues for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010, respectively. Adverse changes or conditions affecting our markets in Texas or California, such as healthcare reforms, changes in laws and regulations, reduced Medicaid reimbursements and government investigations, may have a particularly significant impact on the business of our affiliated dentists and our business, financial condition and results of operations. Our current concentration in these markets, as well as our strategy of focused expansion in areas in and around our existing markets, increases the risk to us that adverse economic or regulatory developments in one or more of these markets may have a material and adverse impact on our operations.

Our success depends largely on our ability to provide effective business support services to affiliated dental groups that result in increased revenues.

Our ability to continue to grow and improve profitability depends, to a significant extent, on our ability to provide quality and cost-effective business support services that enable our affiliated dental groups to increase their revenues. Affiliated dental groups rely on us to perform the non-clinical functions of their practice in order for their dentists, specialists and hygienists to spend more time with their patients. As a result, the success of our affiliated dental groups, and in turn our success, is dependent on our ability to provide effective services that result in increased revenues, such as:

 

   

determining where and when to build out and equip de novo offices, which is the most significant capital expenditure decision;

 

   

implementing a cost-effective marketing program using a retail based model that focuses on brand name;

 

   

maintaining call centers that provide consistent, high quality patient service;

 

   

providing integrated management information systems that track, among other things, service transactions and patient satisfaction data;

 

   

providing dental office administrative staff;

 

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making available patient financing and alternative methods of payment; and

 

   

providing training and other continuing education resources to affiliated dentists, specialists and hygienists.

If we do not provide services that enable affiliated dental groups to increase patient volumes, we will not be able to increase patient revenues and recognize operational efficiencies and cost savings across affiliated dental offices.

Our profitability is also dependent upon the performance of our affiliated dental groups and dentists in areas we do not control, such as the delivery of patient care.

Our profitability is dependent on the performance of our affiliated dental groups and dentists. In accordance with generally accepted accounting principles in the United States, we present our financial statements consolidated with our affiliated dental groups’ net assets and results of operations. Accordingly, our results of operations include the performance of our affiliated dental groups. However, we do not employ dentists, specialists and hygienists and do not control the clinical decisions of any affiliated dental group, except for our wholly owned subsidiary, ConsumerHealth, Inc. (dba Newport Dental), or ConsumerHealth. Because the success of any dental practice will, to some extent, depend upon the efforts of the dentists, specialists and hygienists and their professional skills and reputation, the success of our affiliated dental groups depends, in part, on factors outside of our control. While we seek to affiliate with dedicated, well-qualified dentists, specialists and hygienists, we do not control their delivery of patient care. Our lack of control over all clinical aspects of the delivery of dental services by affiliated dental groups makes it more difficult for us to improve our performance. As a result, we do not control a key determinant of our success.

If affiliated dental groups are unable to attract and retain qualified dentists, specialists and hygienists, their ability to attract and maintain patients and generate revenue could be negatively affected.

The recruitment and retention of qualified dentists, specialists, such as orthodontists, oral surgeons, endodontists, periodontists, and pediatric dentists, and hygienists is a critical factor in the success of our affiliated dental groups. In addition, affiliated dental groups must be able to recruit and retain new dentists, specialists and hygienists for de novo offices. Historically, affiliated dental groups have incurred significant costs related to turnover of dentists, specialists and hygienists and expect to continue to incur these costs in the future. In addition, affiliated dental groups may experience decreased productivity in connection with any significant turnover.

Affiliated dental groups have entered into employment agreements or independent contractor agreements with substantially all of their respective dentists and specialists, which agreements typically restrict the dentist’s or specialist’s solicitation of patients, staff and employees of the affiliated dental group and may contain non-competition provisions that prohibit the dentist or specialist from competing with the affiliated dental groups within a specified geographic area following such dentist’s or specialist’s termination. These non-competition covenants and other arrangements, however, may not be enforceable or may be significantly limited by the courts of the states in which we operate. For instance, in California, post-employment covenants not to compete are broadly prohibited by statute and post-employment covenants not to solicit customers are unenforceable unless necessary to protect trade secrets. In Texas, employers may be able to enforce covenants not to compete by meeting certain statutory requirements, but the covenant must contain reasonable limitations as to time, geographical area, and scope of activity to be restrained and it may not impose a greater restraint than is necessary to protect the goodwill or other business interest of the employer.

If affiliated dental groups are unable to consistently attract, hire and retain qualified dentists, specialists and hygienists, the ability of those affiliated dental groups to attract and maintain patients and generate revenue could be negatively affected.

 

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Affiliated dental groups may have difficulty collecting payments from third party payors and patients in a timely manner, which could impact the ability of affiliated dental groups to pay our service fees and in turn can adversely impact our profitability.

Affiliated dental groups derive significant revenue from third party payors, and delays in payment or audits leading to refunds to payors may impact the ability of affiliated dental groups to pay our service fees. In addition, many patients, including those covered by insurance, pay for all or a significant portion of the dental services they receive out-of-pocket. We assume the financial risks relating to uncollectible and delayed payments if, as a result, the affiliated dental groups are unable to pay our service fees timely and in full. As a result of the recent economic downturn, affiliated dental groups have experienced an increase in the time it takes to collect payments.

In addition, reimbursements from governmental healthcare programs may be delayed if affiliated dentists and specialists have not been properly enrolled in governmental healthcare programs, such as Medicare and Medicaid. Each time a new dentist or specialist joins an affiliated dental group, the affiliated dental group must enroll the dentist under its applicable group number for Medicare or Medicaid programs and for certain insurance programs before the affiliated dental group can receive reimbursement for services the dentist renders to patients covered by those programs. The estimated time to receive approval for the enrollment is sometimes difficult to predict and, in recent years, the Medicare program carriers often have not issued these numbers to affiliated dentists in a timely manner. These practices result in delayed reimbursement that may adversely affect affiliated dental groups and our cash flow and total revenues.

Our growth strategy depends on our ability to increase the number of dental offices through the opening of de novo offices, which contains many challenges.

Our growth strategy, and a significant percentage of our projected future growth, depends on our ability to increase our revenue by increasing the number of dental offices in which our affiliated dental groups practice. Opening de novo offices involves many challenges, including selecting the appropriate site, attracting patients to the new locations, and attracting, training and retaining dental professionals to the new offices. In addition, we could experience delays or encounter unexpected problems in opening de novo offices. Any one of these events could result in us not realizing the growth we anticipate, which could result in a decline in our profitability.

In addition, the opening of de novo offices requires substantial time and resources from us. We have used, and expect to continue to use, a significant portion of our capital resources to open de novo offices. We expect future de novo offices will be funded from internally generated cash flows, amounts available under our revolving loan facility and the proceeds of future equity or debt offerings or refinancings. Our ability to open de novo offices may be impaired if we are unable to obtain funding from these capital sources when needed and on terms acceptable to us. Our expansion strategy also requires substantial management time which may result in disruption to our existing business operations. Our inability to successfully address these challenges may adversely affect the profitability of our business operations as we pursue our growth strategy.

We may have substantial future capital requirements, and our ability to obtain additional funding is uncertain.

Our capital needs depend on many factors, including the rate of opening de novo offices, technological advances that require new equipment, such as digital radiography, and the replacement and enhancement of management information systems.

Because our growth strategy depends on expansion through de novo offices, we will need additional capital resources to expand our business. While the cost per de novo office will vary based on size and region, we estimate that the average office build-out, including tenant improvements (net of allowance), furniture and fixtures, dental equipment and computer equipment, will cost approximately $550,000. Additional factors can

 

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unexpectedly increase the costs of opening de novo offices, such as potentially higher than expected build out and construction costs, delays in completing the build outs, and permitting and construction difficulties. Also, we generally incur significant advertising and marketing expenditures to attract patients during the first year of operations. The expenses involved in developing and establishing de novo offices and in supporting them until they become profitable could consume a significant portion of our cash flow.

We may not have adequate resources to finance the growth in our business and we may not be able to obtain additional capital through subsequent equity or debt financings on terms acceptable to us or at all. If we do not have adequate resources and cannot obtain additional capital, we will not be able to implement our expansion strategy successfully, our growth could be limited and our results of operations could decline.

Our affiliated dentists compete for patients in a highly competitive environment that may make it more difficult to increase patient volumes and revenues.

The business of providing dental services is highly competitive in each of the markets in which our affiliated dental groups operate. The primary bases of such competition are quality of care and reputation, marketing and advertising strategy and implementation, convenience, traffic flow and visibility of office locations, relationships with third-party payors, price of services and hours of operation. Our affiliated dentists compete with all other dentists in their local market. Many of those dentists have established practices and reputations in their markets. In addition, a number of other DPM support services organizations are currently operating in our markets and in other parts of the country that may enter our existing markets in the future. Some of these competitors and potential competitors may have financial resources, affiliation models, reputations or management expertise that provides them competitive advantages against us, which may make it difficult to compete against them.

Our success is dependent on the dentists who control the professional corporations, or PC owners, with whom we enter into business support services agreements, and we may have difficulty locating qualified dentists to replace PC owners.

Affiliated dental groups are operated by legal entities organized under state laws as professional corporations, or PCs. Each PC controls a dental group that employs or contracts with dentists, specialists and hygienists in one or more offices. Each of the PCs is wholly owned by one or more licensed dentists, the PC owner, and we do not own any capital stock of any PC. We enter into business support services agreements with PCs to provide on an exclusive basis all non-clinical services of the dental practice. The PC owner is critical to the success of affiliated dental groups because he or she has control of all clinical aspects of the practice of dentistry and the provision of dental services.

Under our arrangements with the PC owners, the PC owners are prohibited from selling, transferring, pledging or assigning the stock of the PC to a third party without our consent. In addition, we can require the PC owner to sell his or her interest in the PC to any person designated by us that is permitted to hold an ownership interest in the PC. However, upon the departure of a PC owner, we may not be able to locate one or more suitably qualified licensed dentists to hold the ownership interest in the PC and maintain the success of the departing PC owner. Also, a court may decide not to enforce these transfer restrictions in a given situation. Dr. Roy Smith, our chief operating officer, controls eight PCs that provide dental services at 132 dental offices as of March 31, 2010, that represented approximately 42%, 43%, 43%, 43% and 43% of our total revenues for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010, respectively. In addition, three of our employees, excluding Dr. Smith, are owners of an aggregate of four PCs that provide dental services at 57 dental offices as of March 31, 2010, representing approximately 19%, 20%, 21%, 21% and 22% of our total revenues for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010, respectively. Adequate succession planning for the departure of PC owners is important to maintain our successful operations.

 

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Our revenue and that of our affiliated dental groups may be adversely affected by the actions of insurance providers and federal and state agencies, including through cost containment efforts by these entities.

Approximately 80%, 84%, 85%, 85% and 85% of total revenues for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010, respectively, were derived from patients with indemnity and preferred provider plans, capitated plans and government plans. The health care services industry, including the dental services market, is experiencing a trend toward cost containment, as third party payors seek to impose lower reimbursement rates and sometimes decide not to renew their agreements with dental providers. We believe that this trend will continue and will increasingly affect the provision of dental services. Insurance providers are continually negotiating the fees charged for dental care, with a goal of containing reimbursement and utilization rates. This may result in a reduction in per-patient and per-procedure revenue from historic levels.

In addition, capitated plans can result in lower than anticipated revenue for affiliated dental groups for certain services. Under capitated plans, affiliated dental groups receive fixed payments from third party payors, calculated on a monthly per-member basis, to provide a specified schedule of services to the covered enrollees and receive additional fees for certain enhanced services. Affiliated dental groups receive co-payments from the patients as well. To the extent that patients covered by such plans utilize services with low co-payments or for which enhanced payments are not applicable, the revenue received by affiliated dental groups for the services provided to such patients could be lower than anticipated and therefore could reduce our consolidated revenue and impair the ability of the affiliated dental group to pay our service fee.

States in which we operate and the federal government may also change the benefits they provide to dental patients. Approximately 5%, 6%, 7%, 6% and 7% of total revenues for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010, respectively, were derived from patients with government-sponsored plans. Changes in Medicaid programs affecting provider eligibility, reimbursement rates or specific dental procedures eligible for reimbursement, or an affiliated dental group’s failure to maintain its authorization as a provider under these programs, or to comply with applicable state and federal law or its contracts with the insurance providers who administer claims and make payments under these programs, could have a significant adverse impact on revenues generated by affiliated dental groups which may adversely impact our revenues. In addition, the State of California passed a budget that eliminated, among other things, adult dental benefits from the State Medicaid, or Denti-Cal, program effective July 1, 2009. Prior to the effective date of the elimination of adult dental benefits, affiliated dental groups and ConsumerHealth provided approximately $4.0 million of services to adult Denti-Cal beneficiaries annually.

Our revenue and that of our affiliated dental groups may be negatively impacted by the failure of affiliated dental groups to appropriately document services they provide.

We rely upon affiliated dental groups to appropriately and accurately complete necessary dental record documentation and assign appropriate reimbursement codes for their services. Reimbursement is conditioned on affiliated dental groups providing the correct procedure and diagnosis codes and properly documenting the services themselves, including the level of service provided and the necessity for the services. If affiliated dental groups provide incorrect or incomplete documentation or select inaccurate reimbursement codes, this could result in nonpayment for services rendered or lead to allegations of billing fraud. This could subsequently lead to civil and criminal penalties, including exclusion from government healthcare programs, such as Medicare and Medicaid. In addition, third party payors may disallow, in whole or in part, requests for reimbursement based on determinations that certain amounts are not covered, services provided were not necessary, or supporting documentation was not adequate. Retroactive adjustments may change amounts realized from third party payors and result in recoupments or refund demands, affecting revenue already received. From time to time, we have discovered, or otherwise become aware of, certain affiliated dental groups using inaccurate reimbursement codes. In such cases, we thoroughly investigated the matter and in some cases the outcome of our investigation has resulted in adjustments or refunds to third party payors.

 

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Our business model depends on proprietary and third party management information systems that we use to, among other things, track financial and operating performance of affiliated dental offices, and any failure to successfully design and maintain these systems or implement new systems could materially harm our operations.

We depend on integrated management information systems, some of which are provided by third parties, and standardized procedures for operational and financial information, as well as for patient records, patient financing and our billing operations. We may experience unanticipated delays, complications, data breaches or expenses in implementing, integrating, and operating our systems. Our management information systems regularly require modifications, improvements or replacements that may require both substantial expenditures as well as interruptions in operations. Our ability to implement these systems is subject to the availability of skilled information technology specialists to assist us in creating, implementing and supporting these systems. Our failure to successfully design, implement and maintain all of our systems could have a material adverse effect on our business, financial condition and results of operations.

Further, we rely on our systems to bill for services provided by affiliated dentists, specialists and hygienists in accordance with the terms of third party payor agreements. Our systems must be designed to accurately bill for services consistent with the requirements of third party payors. Our failure to successfully operate our billing system could lead to potential violations of third party payor agreements and healthcare laws and regulations.

The acquisition of, and failure to successfully integrate, any DPM support services organization we acquire in the future could have an adverse impact on our profitability and liquidity.

We expect to have opportunities in the future to identify and capitalize on complementary acquisitions, including acquisitions of other DPM support services organizations. Our growth has partly been the result of acquiring DPM support services organizations, Castle Dental and Monarch Dental, in 2003 and 2004, respectively. Acquisitions may result in difficulties in assimilating acquired DPM support services organizations and may result in the diversion of our capital and our management’s attention from other business issues and opportunities. We may not be able to successfully integrate other DPM support services organizations that we acquire, including their personnel, systems and general operating procedures. If we fail to successfully integrate acquisitions, we could experience increased costs associated with operating inefficiencies, which could have an adverse effect on our profitability.

We also may need to incur additional debt to acquire any DPM support services organizations in the future and to upgrade affiliated dental offices of acquired DPM support services organizations. In addition, we may uncover unexpected liabilities of acquired DPM support services organizations, including liabilities for failure to comply with healthcare laws and regulations or other past activities. As a result, our liquidity may be adversely impacted by these acquisitions.

Restrictive covenants in our debt agreements may adversely affect our operations.

Our credit facilities contain customary restrictive covenants that, among other things, limit our ability to incur and pay certain indebtedness; to create, incur, or assume certain liens and negative pledges; to sell, lease, convey, transfer or otherwise dispose of certain assets; to merge or consolidate with or into another; to liquidate or dissolve any of our subsidiaries; to make certain loans and investments; to make certain dividends and redemptions; to substantially change the nature of our business; to engage in certain transactions with affiliates; and to enter into or amend certain agreements. We are also required to comply with limitations on our capital expenditures and comply with certain financial ratios, including a leverage ratio and fixed charge coverage ratio. Our ability to comply with these covenants or meet those financial ratios can be affected by events beyond our control, and we cannot assure you that we will meet them.

Upon the occurrence of an event of default under our credit facilities, lenders could elect to declare all amounts outstanding under our credit facilities to be immediately due and payable and terminate all

 

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commitments to extend further credit. Further, the lenders under our credit facilities could proceed against the collateral granted to them to secure that indebtedness, which represents substantially all of our assets. If any of the lenders under our credit facilities accelerate the repayment of borrowings, we may not have sufficient cash flow or assets to repay our credit facilities and other indebtedness or have the ability to borrow sufficient funds to refinance such indebtedness. Even if we are able to obtain new financing, it may not be on commercially reasonable terms or terms that are acceptable to us.

Indebtedness under our credit facilities is subject to variable rates of interest, which could result in higher interest expense if interest rates increase.

Currently, all of our indebtedness under our new credit facilities is subject to variable interest rates. If interest rates increase, the higher interest expense could reduce our cash flows from operations and affect our ability to implement our growth strategy. The credit agreement governing our new credit facilities, however, requires that, prior to June 26, 2010, we must enter into, and maintain in effect for at least three years, interest rate swap agreements for a portion of such indebtedness. If our initial public offering is completed prior to June 26, 2010, the interest rate swap agreements must provide coverage for at least 25% of the then existing aggregate principal amount of the term loan facility. If our initial public offering is not completed prior to June 26, 2010, the interest rate swap agreements must provide coverage for at least 50% of the then existing aggregate principal amount of the term loan facility until we consummate our initial public offering, at which time, we can then provide coverage for at least 25% of the then existing aggregate principal amount of the term loan facility. As of April 29, 2010, we had $139.0 million outstanding under our term loan facility, none of which was hedged by any interest rate swap agreements. We did not have any amounts outstanding under our revolving loan facility as of April 29, 2010. A hypothetical 10% increase in the interest rates applicable to our new credit facilities, assuming we have no amount outstanding under our revolving credit facility and have not entered into any interest rate swap agreements, would increase interest expense by approximately $0.6 million per year. Conversely, a hypothetical decrease in the interest rates applicable to our new credit facilities, assuming we have no amount outstanding under our revolving credit facility and have not entered into any interest rate swap agreements, would decrease interest expense by approximately $0.6 million per year.

Our business support services agreements with affiliated dental groups could be challenged by a state or dentist under laws regulating the practice of dentistry.

The laws of each state in which we operate contain restrictions on the practice of dentistry and control over the provision of dental services. The laws of many states where we operate permit a dentist to conduct a dental practice only as an individual, a member of a partnership or an employee of a PC, limited liability company or limited liability partnership. These laws typically prohibit dentists from splitting fees with non-dentists and prohibit non-dental entities, such as DPM support services organizations, from engaging in the practice of dentistry and from employing dentists (and, in some states, hygienists or dental assistants). The specific restrictions against the corporate practice of dentistry, as well as the interpretation of those restrictions by state regulatory authorities, vary from state to state. However, the restrictions are generally designed to prohibit a non-dental entity from controlling or directing clinical care decision-making, engaging dentists to practice dentistry (or, in certain states, employing hygienists or dental assistants) or sharing professional fees.

For example, the contractual arrangements of an orthodontic practice management support services organization, Orthalliance, have been successfully challenged in Texas and Washington as violating the state laws prohibiting the corporate practice of dentistry. In the Washington case, the court found the fact that Orthalliance was a third party beneficiary of the employment agreements between the dental practice affiliate and the dentists put Orthalliance in the position of a virtual employer of the orthodontists. The contractual relationship between the affiliated dental group and Orthalliance also provided a minimum management fee that was personally guaranteed by the service provider. The totality of the contractual relationships was held to violate Washington’s laws against the corporate practice of dentistry and such contracts were voided as illegal and against public policy. The Orthalliance case in Washington is on appeal to the Ninth Circuit and was selected

 

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for inclusion in the mediation program in October 2004. In April 2005, OCA, Inc. announced an agreement in principle to settle lawsuits and disputes pending between its subsidiary OrthoAlliance and its affiliated practitioners. Recently, the United States Court of Appeal for the Fifth Circuit affirmed a decision by the United States Bankruptcy Court for the Eastern District of Louisiana that the Orthalliance management agreements violated Texas law.

The laws of many states also prohibit dental practitioners from paying any portion of fees received for dental services in consideration for the referral of a patient. In addition, many states impose limits on the tasks that may be delegated by dentists to dental assistants.

Any challenge to our contractual relationships with affiliated dental groups by dentists or regulatory authorities could result in a finding that could have a material adverse effect on our operations, such as voiding one or more business support services agreements. Moreover, the laws and regulatory environment may change to restrict or limit the enforceability of our business support services agreements. We could be prevented from affiliating with dental groups or providing comprehensive business services to them in one or more states.

We and our affiliated dental groups are subject to complex laws, rules and regulations, compliance with which may be costly and burdensome.

The affiliated dental groups and we are subject to extensive federal, state and local laws, rules and regulations, including:

 

   

state regulations on the practice of dentistry;

 

   

the Health Insurance Portability and Accountability Act of 1996, or HIPAA, and other federal and state laws governing the collection, dissemination, use, security and confidentiality of patient-identifiable health and financial information;

 

   

federal and state regulations, such as Medicare and Medicaid, which contain anti-kickback provisions and restrictions on referrals;

 

   

the federal Fair Debt Collection Practices Act and similar state laws that restrict the methods that we and third party collection companies may use to contact and seek payment from patients regarding past due accounts;

 

   

the Occupation Safety and Health Administration Bloodborne Pathogens Standard, which requires affiliated dental groups to institute training programs and procedures designed to eliminate or minimize occupational exposure to Hepatitis B Virus (HBV), Human Immunodeficiency Virus (HIV) and other bloodborne pathogens;

 

   

the Knox-Keene Healthcare Service Plan Act of the State of California, which requires our subsidiary, ConsumerHealth, in connection with its managed dental care plan, to file periodic financial data and other information with the California Department of Managed Health Care, maintain substantial net equity on its balance sheet and maintain adequate medical, financial and operating personnel; and

 

   

state and federal labor laws, including wage and hour laws.

We and our affiliated dental groups are also exposed to certain insurance and regulatory risks associated with our respective activities. Our wholly owned subsidiary ConsumerHealth is licensed under the Knox-Keene Act and therefore is subject directly to the laws and regulations promulgated thereunder and regulation by the California Department of Managed Health Care. In addition, ConsumerHealth and affiliated dental groups may become subject to state insurance laws and regulations because of the contracts they enter into with third party payors to provide services to patients and we may become subject to such laws and regulations because of our support to affiliated dental groups in negotiating and administering third party payor contracts and providing billing, collection and claims administration services under these contracts. The application of state insurance laws and regulations to these activities is an unsettled area of law and subject to interpretation by regulators with broad discretion.

 

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Many of the above laws, rules and regulations applicable to us and our affiliated dental groups are ambiguous, have not been definitively interpreted by courts or regulatory authorities and vary from jurisdiction to jurisdiction. Accordingly, we may not be able to predict how these laws and regulations will be interpreted or applied by courts and regulatory authorities, and some of our activities could be challenged. In addition, we must consistently monitor changes in the laws and regulatory schemes that govern our operations. For example, numerous legislative proposals to reform the U.S. health care system have been introduced in Congress and in various state legislatures recently and over the past several years, including a proposed tax on high-end health plans that could negatively impact employers’ willingness to maintain dental benefits. We cannot predict whether any of these proposals will be adopted and, if adopted, what impact this legislation would have on our business. Although we have tried to structure our business and contractual relationships in compliance with these laws, rules and regulations in all material respects, if any aspect of our operations was found to violate applicable laws, rules or regulations, we could be subject to significant fines or other penalties, required to cease operations in a particular jurisdiction, prevented from commencing operations in a particular state or otherwise be required to revise the structure of our business or legal arrangements. Our efforts to comply with these laws, rules and regulations may impose significant costs and burdens, and failure to comply with these laws, rules and regulations may result in fines or other charges being imposed on us.

We along with our affiliated dental groups and their dentists may be subject to malpractice and other similar claims and may be unable to obtain or maintain adequate insurance against these claims.

The provision of dental services by dentists entails an inherent risk of potential malpractice and other similar claims. Although we do not have responsibility for compliance by affiliated dental groups and their dentists with regulatory and other requirements directly applicable to dentists and dental groups, claims, suits or complaints relating to services provided at the offices of our affiliated dental groups have been and in the future may be asserted against us. The assertion or outcome of these claims could result in higher administrative and legal expenses, including settlement costs or litigation damages. Our current professional liability insurance coverage is $1.0 million per occurrence and $6.0 million in annual aggregate, with a self-insured retention of $50,000 per claim and $500,000 annual aggregate. The dental providers covered under our policy have a $1.0 million per occurrence and $3.0 million annual aggregate sublimit. Under this professional liability insurance policy, we arrange and are reimbursed for the cost of the professional liability insurance for our affiliated dental groups and most of their employed or contracted dentists. Certain specialty dentists that are employed by or contracted with affiliated dental groups are required to obtain their own insurance. Our inability to obtain adequate insurance or an increase in the future cost of insurance to us and the dentists and specialists who provide dental services or an increase in the amount we have to self insure may have a material adverse effect on our business and financial results.

We are self-insured for purposes of our health care insurance program and have high deductibles on our workers compensation insurance, and increases in the size or frequency of future claims incurred under these programs could adversely affect our financial performance.

We are self-insured for our health care insurance and we have high deductibles on our workers compensation insurance. While we have purchased excess umbrella liability insurance coverage for the amounts above which we are self-insured, we are responsible for $175,000 per individual claim, up to an annual aggregate limit of $10.9 million, of health care coverage. Our workers compensation insurance deductible is $250,000 per claim, up to an annual aggregate deductible of $2.4 million. If the number or amount of claims for which we are self-insured or are required to pay a deductible amount increases from historical levels, our operating results could be adversely affected.

We establish reserves in our financial statements for estimated costs related to pending claims and claims incurred but not reported. Because establishing reserves is an inherently uncertain process involving estimates, currently established reserves may not be adequate to cover the actual liability for claims made under our health care and workers compensation insurance programs. If we conclude that our estimates are incorrect and our reserves are inadequate for these claims, we will need to increase our reserves, which could adversely affect our financial performance.

 

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Our operating results are subject to seasonal variability.

We have historically experienced and expect to continue to experience quarterly fluctuations in revenue and net income. Absent the impact and timing of the opening of de novo offices and any acquisitions, our total revenues have historically been higher in the first quarter of the year due to fluctuations in patient volumes, which are primarily impacted by the amount of third party payor benefits remaining for a patient during the year and the timing of holidays. As a result of the fluctuations caused by these factors and due to the timing of the opening of de novo offices and any acquisitions, our results of operations for any quarter are not necessarily indicative of results of operations for any future period or full year.

A loss of the services of our key management team members could have a material adverse effect on our business.

Our continued success depends upon the retention of our senior officers, in particular Steven C. Bilt and Bradley E. Schmidt, who have been instrumental in our success and upon our ability to attract and retain other highly qualified individuals. The loss of some of our senior officers, or an inability to attract or retain other key individuals, could materially adversely affect us. Continued growth and success in our business depends, to a large degree, on our ability to retain and attract such officers and employees.

We may not realize the expected value of our goodwill and intangible assets.

As of March 31, 2010, approximately 65.9% of our total assets were represented by goodwill and intangible assets, net of amortization. Management performs an impairment test on goodwill and intangible assets with indefinite lives at least annually or when facts and circumstances exist which would suggest that the goodwill or intangible assets with indefinite lives are impaired. We had impairment charges of $7.1 million and $23.4 million for the years ended December 31, 2007 and 2008, respectively, and no impairment charges for the year ended December 31, 2009 and the three months ended March 31, 2009 and 2010. The impairment charge in 2008 resulted primarily from changes in estimates used to determine the fair market value of our reporting units resulting from changes in general economic conditions. The impairment charge in 2007 resulted primarily from declining operating performance in certain reporting units.

An impairment test on goodwill and intangible assets with indefinite lives is performed when facts and circumstances exist which would suggest that the goodwill or intangible asset may be impaired, such as reduced future expected cash flows, changes in discount rates, and changes in current estimates that result from, for example, federal and state government regulation, competition and general market conditions in the areas in which we operate. Impairment assessment inherently involves judgment as to assumptions about expected future cash flows and the impact of market conditions on those assumptions. If impairment were determined, we would make the appropriate adjustment to the intangible asset to reduce the asset’s carrying value to fair value. In the event of any sale or liquidation of us or a portion of our assets, the value of our intangible assets may not be realized. Any future determination requiring the write off of goodwill or a significant portion of unamortized intangible assets could have an adverse effect on our financial condition and results of operations.

Our inability or failure to protect our intellectual property could have a negative impact on our operating results.

We own 10 trademark registrations that we currently use and consider to be material to the successful operation of our business, including the marks BRIGHT NOW!®, CASTLE DENTAL®, MONARCH DENTAL®, NEWPORT DENTAL® and SMILES FOR EVERYONE®. We also have several additional pending trademark applications for marks that we currently use and consider to be material to the successful operation of our business, including SMILE BRANDSSM. We regard our trademarks, copyrights, service marks and other intellectual property as critical to our success. In addition to our registered marks and pending applications, our principal intellectual property rights include rights to our domain names, databases and information management

 

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systems. The steps we take to protect our proprietary rights may be inadequate. Our trademark applications may not be granted, and we may not be able to secure the right to use the filed for marks. Our competitors or others may adopt trademarks or service marks similar to our marks or try to prevent us from using our marks because laws protecting trademarks and similar proprietary rights are unclear. Therefore, we may be unable to prevent third parties from acquiring trademarks or service marks that are similar to, infringe upon or otherwise decrease the value of our trademarks and other proprietary rights. If we are unable to protect or preserve the value of our trademarks, or other proprietary rights for any reason, our brand and reputation could be impaired or diluted and we may see a decline in revenues.

Events or rumors relating to our brand names could significantly impact our business.

Recognition of our brand names, including SMILE BRANDSSM, BRIGHT NOW!®, MONARCH DENTAL®, CASTLE DENTAL®, and NEWPORT DENTAL® and the association of those brands with quality, comprehensive dental care are an integral part of our business. The occurrence of any events or rumors that cause patients to no longer associate the brands with quality, comprehensive dental care may materially adversely affect the value of the brand names and demand for dental services at our affiliated dental groups.

Risks Related to our Common Stock and this Offering

Freeman Spogli will beneficially own approximately 45.6% of our common stock after this offering and its interests may conflict with or differ from your interests as a stockholder.

After the consummation of this offering, Freeman Spogli will beneficially own approximately 45.6% of our common stock. As a result, Freeman Spogli will have significant influence over the election of all of our directors and the approval of significant corporate transactions that require the approval of our board of directors or stockholders, such as mergers and the sale of substantially all of our assets. So long as Freeman Spogli continues to own a significant amount of the outstanding shares of our common stock, it will have the ability to exert significant influence over our corporate decisions. Freeman Spogli may act in a manner that advances its best interests and not necessarily those of other stockholders, including investors in this offering, by, among other things:

 

   

delaying, deferring or preventing a change in control of us;

 

   

entrenching our management and/or our board of directors;

 

   

impeding a merger, consolidation, takeover or other business combination involving us;

 

   

discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us; or

 

   

causing us to enter into transactions or agreements that are not in the best interests of all stockholders.

Additionally, Freeman Spogli is in the business of making investments in companies and may in the future acquire interests in businesses that directly or indirectly compete with certain portions of our business or our suppliers or customers. Freeman Spogli may also pursue acquisitions that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us.

There has been no prior public market for our common stock and an active market may not develop or be maintained, which could limit your ability to sell shares of our common stock.

Prior to this offering, there has been no public market for our common stock, and the initial public offering price may bear no relationship to our book value, earnings history or other established criteria of value or to the price at which the common stock will trade after the offering. The initial public offering price for the shares of

 

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our common stock will be determined by negotiations between us and the underwriters and may not be indicative of prices that will prevail in the open market after the offering. An active public market for our common stock may not develop or be sustained after the offering. As a result, investors may not be able to sell their common stock at or above the initial public offering price or at the time that they would like to sell.

We expect that the price of our common stock will fluctuate significantly.

Volatility in the market price of our common stock may prevent you from being able to sell your common stock at or above the price you paid for your common stock. The market price for our common stock could fluctuate significantly for various reasons, including:

 

   

our operating and financial performance and prospects, including seasonal fluctuations in our financial performance;

 

   

conditions that impact demand for the services of our affiliated dentists;

 

   

the public’s reaction to our press releases, other public announcements and filings with the Securities and Exchange Commission;

 

   

changes in earnings estimates or recommendations by securities analysts who track our common stock;

 

   

market and industry perception of our success, or lack thereof, in pursuing our growth strategy;

 

   

strategic actions by us or our competitors, such as acquisitions or restructurings;

 

   

changes in federal and state government regulation;

 

   

changes in accounting standards, policies, guidance, interpretations or principles;

 

   

arrival or departure of key personnel;

 

   

sales of common stock by us or members of our management team; and

 

   

changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural disasters, terrorist attacks, acts of war and responses to such events.

In addition, if the market for stocks in our industry, or the stock market in general, experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, financial condition or results of operations. If any of the foregoing occurs, it could cause our stock price to fall and may expose us to lawsuits that, even if unsuccessful, could be costly to defend and a distraction to management.

Future sales of our common stock, or the perception that such sales may occur, could depress our common stock price.

Upon completion of this offering, our current stockholders will hold a substantial number of shares of our common stock that they will be able to sell in the public market in the near future. Sales, or the perception that such sales may occur, by our current stockholders, in particular by our directors and executive officers and our largest stockholder, Freeman Spogli, of a substantial number of shares after this offering could significantly reduce the market price of our common stock.

We, our directors and executive officers, and all of our stockholders have agreed with the underwriters that, without the prior written consent of Credit Suisse Securities (USA) LLC and Jefferies & Company, Inc., we and they will not, subject to certain exceptions and an 18-day extension, during the period ending 180 days after the date of this prospectus offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend, or otherwise transfer or dispose of

 

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directly or indirectly, or enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of shares of common stock or any securities convertible into or exercisable or exchangeable for common stock.

All of our shares of common stock will be freely tradable after the expiration of the lock-up agreements, excluding any shares acquired by persons who may be deemed to be our affiliates. Approximately 9,190,700 shares of our common stock held by our affiliates will continue to be subject to the volume and other restrictions of Rule 144 under the Securities Act of 1933, or the Securities Act. The underwriters, in their sole discretion and at any time without notice, may release all or any portion of the shares of our common stock subject to the lock-up agreements.

In addition, immediately following this offering, we intend to file a registration statement registering under the Securities Act the shares of common stock reserved for issuance in respect of incentive awards to our officers and certain of our employees. If any of these holders cause a large number of securities to be sold in the public market, the sales could reduce the trading price of our common stock. These sales also could impede our ability to raise future capital. See the information under the heading “Shares Eligible for Future Sale” for a more detailed description of the shares that will be available for future sales upon completion of this offering.

Investors in this offering will experience immediate and substantial dilution.

If you purchase common stock in this offering, you will pay more for your shares than the amounts paid by existing stockholders for their shares. As a result, you will incur immediate dilution of $20.36 per share, representing the difference between the assumed initial public offering price of $17.00 per share, which is the mid-point of the range set forth on the cover of this prospectus, and our as adjusted net tangible book deficit per share after giving effect to this offering.

The obligations associated with being a public company will require significant resources and management attention, which may divert from our business operations.

As a result of this offering, we will become subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. The Exchange Act requires that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act requires, among other things, that we establish and maintain effective internal controls and procedures for financial reporting. As a result, we will incur significant legal, accounting and other expenses that we did not previously incur. We anticipate that we may need to upgrade our systems, implement additional financial and management controls, reporting systems and procedures, implement an internal audit function, and hire additional accounting and internal audit staff. Furthermore, the need to establish the corporate infrastructure demanded of a public company may divert management’s attention from implementing our growth strategy, which could prevent us from improving our business, results of operations and financial condition. We have made, and will continue to make, changes to our internal controls and procedures for financial reporting and accounting systems to meet our reporting obligations as a stand-alone public company. However, the measures we take may not be sufficient to satisfy our obligations as a public company. In addition, we cannot predict or estimate the amount of additional costs we may incur in order to comply with these requirements. We anticipate that these costs will materially increase our general and administrative expenses.

Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal control over financial reporting, starting with the second annual report that we would expect to file with the Securities and Exchange Commission in March 2012, and will require in the same report, a report by our independent registered public accounting firm on the effectiveness of our internal control over financial reporting. In connection with the implementation of the necessary procedures and practices related to internal control over financial reporting, we may identify additional deficiencies. We may not be able to remediate any

 

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future deficiencies in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. In addition, failure to achieve and maintain an effective internal control environment could have a material adverse effect on our business and stock price.

If equity research analysts do not publish research or reports about our business or if they issue unfavorable commentary or downgrade our common stock, the price of our common stock could decline.

The trading market for our common stock will rely in part on the research and reports that equity research analysts publish about us and our business. We do not control these analysts. The price of our stock could decline if one or more equity analysts downgrade our stock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business.

Investors must look solely to stock appreciation for a return on their investment in us because we do not currently intend to pay cash dividends on our common stock.

We do not anticipate paying cash dividends to the holders of our common stock in the foreseeable future. We anticipate that we will retain all of our future earnings, if any, for use in the development and expansion of our business and for general corporate purposes. Any determination to pay dividends on our common stock in the future will be at the discretion of our board of directors. Investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize a return on their investment. Investors seeking cash dividends should not purchase our common stock.

Our amended and restated bylaws will contain, and our restated certificate of incorporation and Delaware law contain, provisions that could discourage another company from acquiring us and may prevent attempts by our stockholders to replace or remove our current management.

Provisions of our amended and restated bylaws that will be adopted by us upon the consummation of this offering and provisions of our restated certificate of incorporation and Delaware law may discourage, delay or prevent a merger or acquisition that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace or remove our board of directors. These provisions include:

 

   

authorizing the issuance of “blank check” preferred stock without any need for action by stockholders;

 

   

eliminating the ability of stockholders to call special meetings of stockholders;

 

   

prohibiting stockholder action by written consent; and

 

   

establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.

We are also subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder’s acquisition of our stock was approved in advance by our board of directors. Together, these charter and statutory provisions could make the removal of management more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.

The existence of the foregoing provisions and anti-takeover measures, as well as the significant common stock beneficially owned by Freeman Spogli, could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that you could receive a premium for your common stock in an acquisition.

 

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FORWARD-LOOKING STATEMENTS AND

STATISTICAL DATA AND MARKET INFORMATION

This prospectus contains forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words, although not all forward-looking statements contain these words. These statements are only predictions.

Any forward-looking statements contained in this prospectus are based upon our historical performance and on our current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us, the underwriters or any other person that the future plans, estimates or expectations contemplated by us will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions relating to our operations, financial results, financial condition, business, prospects, growth strategy and liquidity. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may vary materially from those indicated in these statements.

These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this prospectus. The forward-looking statements made in this prospectus relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

This prospectus also contains estimates and other statistical data made by independent parties and by us relating to market size and growth and other industry data. This data involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have not independently verified the statistical and other industry data generated by independent parties and contained in this prospectus and, accordingly, we cannot guarantee their accuracy or completeness.

 

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USE OF PROCEEDS

We estimate that the net proceeds from the sale of the common stock will be approximately $112.5 million, based on an assumed initial public offering price of $17.00 per share, which is the midpoint of the range listed on the cover page of this prospectus, after deducting underwriting discounts and commissions of approximately $8.7 million and estimated offering expenses payable by us of approximately $3.8 million, which include legal, accounting, printing and other offering expenses. Our net proceeds will increase by approximately $17.4 million if the underwriters’ option to purchase additional shares is exercised in full. Each $1.00 increase (decrease) in the assumed initial public offering price of $17.00 per share, which is the midpoint of the range listed on the cover page of this prospectus, would increase (decrease) the net proceeds to us of this offering by approximately $6.8 million, assuming the number of shares offered by us, as listed on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

We intend to use the net proceeds from this offering to redeem all of our Series A preferred stock, including accrued and unpaid dividends, and the outstanding option to purchase shares of Series A preferred stock, for approximately $88.8 million and, with the remaining proceeds, repay $23.7 million of the amount outstanding under our term loan facility. The term loan facility has a maturity date of February 26, 2015. At April 29, 2010, we had $139.0 million outstanding under the term loan facility that bore interest at a weighted average rate of 4.16% per annum.

Pending the uses described herein, we will invest the net proceeds in short-term, investment grade, interest-bearing securities.

DIVIDEND POLICY

We have never paid cash dividends on our common stock. We currently intend to retain any future earnings to fund the development and growth of our business, and we do not anticipate paying any cash dividends in the future.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of March 31, 2010:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect the reclassification of the liquidation value of preferred stock in the amount of $87.6 million from stockholders’ equity to other current liabilities for the redemption of all outstanding preferred stock based on the intended use of proceeds of this offering; and

 

   

on a pro forma as adjusted basis to reflect the sale of shares of common stock by us in this offering at an assumed initial public offering price of $17.00 per share (the midpoint of the range indicated on the cover of this prospectus), after deducting underwriting discounts and commissions of approximately $8.7 million and estimated offering expenses payable by us of approximately $3.8 million and the application of the net proceeds of this offering as described under “Use of Proceeds.”

 

     As of
March 31, 2010
(in thousands)    Actual    Pro forma    Pro forma
as adjusted

Cash and cash equivalents

   $ 8,404    $ 8,404    $ 8,404
                    

Long-term debt and capital lease obligations (including current portion)(1)

   $ 140,447    $ 140,447    $ 116,759

Stockholders’ equity:

        

Preferred stock, $0.01 par value; 10,000,000 shares authorized and 511,039 shares outstanding, actual; 10,000,000 shares authorized and no shares outstanding, as adjusted

     34,922      —        —  

Common stock, $0.01 par value; 100,000,000 shares authorized and 12,115,394 shares issued and outstanding, actual; 100,000,000 shares authorized and 19,468,394 shares issued and outstanding, as adjusted

     121      121      195

Additional paid-in capital

     141,387      88,686      201,062

Retained earnings(2)

     8,629      8,629      7,490

Noncontrolling interest

     503      503      503
                    

Total stockholders’ equity

     185,562      97,939      209,250
                    

Total capitalization

   $ 326,009    $ 238,386    $ 326,009
                    

 

(1)   As of April 29, 2010, we had $139.0 million outstanding under our term loan facility and we did not have any amounts outstanding under our revolving loan facility. We intend to repay $23.7 million of the amount outstanding under our term loan facility with a portion of the net proceeds from this offering.
(2)   The amount of retained earnings under the pro forma as adjusted column reflects the reduction of pro forma retained earnings by approximately $1.1 million, which represents the accretion of the preferred stock and preferred stock options from $87.6 million as of March 31, 2010 to approximately $88.8 million as of the expected redemption date.

Our capitalization information represented above excludes:

 

   

1,892,865 shares of common stock subject to options outstanding;

 

   

1,700,000 shares of common stock available for issuance pursuant to our 2010 Performance Incentive Plan; and

 

   

1,102,950 shares of common stock issuable upon the exercise of the underwriters’ over-allotment option.

 

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DILUTION

If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of common stock you pay and the as adjusted net tangible book value per share of our common stock after this offering. Our net tangible book deficit as of March 31, 2010 was $89.0 million, or $7.35 per share of common stock. We calculate net tangible book value per share by calculating the total assets less goodwill and other intangible assets and total liabilities, and dividing by the number of shares of common stock outstanding.

Net tangible book value dilution per share represents the difference between the amount per share paid by new investors who purchase shares in this offering and the as adjusted net tangible book value per share of common stock immediately after completion of this offering. As of March 31, 2010, after giving effect to the application of the estimated net proceeds to us in this offering as described under “Use of Proceeds,” our as adjusted net tangible book deficit would have been $65.3 million, or $3.36 per share, assuming that the shares offered under this prospectus are sold at a public offering price of $17.00 per share (the mid-point of the range set forth in the cover page of this prospectus). This represents an immediate increase in net tangible book value of $3.99 per share to existing stockholders, and an immediate dilution in net tangible book value of $20.36 per share to new investors in the offering. The table below illustrates this per share dilution as of March 31, 2010:

 

Assumed initial public offering price per share

     $ 17.00   

Net tangible book deficit per share of common stock as of March 31, 2010

   $ (7.35  

Increase in net tangible book value per share attributable to new investors

   $ 3.99     
          

As adjusted net tangible book deficit per share after this offering

     $ (3.36
          

Dilution in net tangible book value per share to new investors

     $ 20.36   
          

A $1.00 increase (decrease) in the assumed public offering price of $17.00 per share would increase (decrease) our as adjusted net tangible book deficit per share after this offering by $0.36, and the dilution to new investors by $0.36 per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

If the underwriters exercise their over-allotment option in full, our as adjusted net tangible book deficit will increase to $2.33 per share, representing an increase to existing holders of $5.02 per share, and there will be an immediate dilution of $19.33 per share to new investors.

The following table sets forth, on an as adjusted basis as of March 31, 2010, the number of shares of common stock purchased or to be purchased from us, the total consideration paid or to be paid and the average price per share paid or to be paid by existing holders of common stock and by new investors, at an assumed initial public offering price of $17.00 per share, before deducting underwriting discounts and estimated offering expenses payable by us.

 

     Shares Purchased     Total Consideration     Average
Price

Per  Share
     Number    Percent     Amount    Percent    

Existing stockholders

   12,115,394    62.2   $ 102,229,362    45.0   $ 8.44

New investors

   7,353,000    37.8        125,001,000    55.0        17.00
                          

Total

   19,468,394    100.0   $ 227,230,362    100.0   $ 11.67
                          

The above table excludes 1,892,865 shares of common stock subject to options outstanding, 1,700,000 shares of common stock available for issuance pursuant to our 2010 Performance Incentive Plan and 1,102,950 shares of common stock issuable upon the exercise of the underwriters’ over-allotment option.

 

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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

We were founded in March 2005 for the purpose of acquiring Smile Brands Inc. (formerly Bright Now! Dental, Inc.) and its subsidiaries, or Smile Brands Inc. We acquired Smile Brands Inc. in a merger combination on May 24, 2005. In connection with the merger, Smile Brands Inc. became our wholly owned subsidiary. In the presentation of financial information below, Smile Brands Inc., prior to the acquisition, is referred to as the “predecessor” and we, together with our wholly owned subsidiaries, including Smile Brands Inc., are referred to as the “successor.” The financial data reflects the 11.8538-for-1 split of our common stock effected on April 27, 2010.

The following table sets forth selected consolidated financial data for us and our predecessor for the periods ended May 24, 2005, December 31, 2005, December 31, 2006, December 31, 2007, December 31, 2008 and December 31, 2009 and the three months ended March 31, 2009 and 2010. The selected consolidated financial data for the fiscal years ended December 31, 2007, 2008 and 2009 were derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected consolidated financial data for the periods ended May 24, 2005, December 31, 2005 and December 31, 2006 were derived from our and our predecessor’s audited consolidated financial statements not included in this prospectus. Our selected consolidated financial data for the three months ended March 31, 2009 and 2010 were derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The unaudited financial statements reflect, in the opinion of management, all adjustments necessary for the fair presentation of the financial condition and the results of operations for such periods. Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for the entire year ended December 31, 2010.

The financial and other data set forth below should be read in conjunction with, and are qualified in their entirety by, reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

    Predecessor          Successor
    Jan. 1
through
May 24,

2005
         May 25
through
Dec.  31,

2005
    Year
Ended

Dec. 31,
2006
    Year
Ended

Dec. 31,
2007
    Year
Ended

Dec. 31,
2008
    Year
Ended

Dec. 31,
2009
    Three Months
Ended Mar. 31,
                     2009   2010
    ($ amounts in thousands except per share and other data)

Consolidated Statements of Operations:

                   

Revenues:

                   

Net dental services

  $ 144,092          $ 214,438      $ 386,458     $ 421,111      $ 439,415      $ 450,659      $ 114,807   $ 116,627

Other

    2,652            3,750        6,214        6,042        5,609        5,865        1,380     1,450
                                                               

Total revenues

    146,744            218,188        392,672        427,153        445,024        456,524        116,187     118,077

Operating costs and expenses:

                   

Dental services

    111,986            171,004        304,019        331,383        342,499        338,687        85,928     86,415

Field support

    10,434            15,563        28,662        29,603        30,671        31,908        7,595     8,032

General and administrative

    12,000            14,603        25,920        28,268        29,784        30,661        7,459     7,749

Depreciation and amortization

    3,215            6,538        12,255        12,596        12,830        13,877        3,304     3,414

Loss (gain) on asset dispositions

    92            (2     25        983        410        322        38     168

Goodwill and trademark impairment

    —              —          —          7,108        23,429        —          —       —  

Merger transaction and related costs

    16,848            —          —          —          —          —          —       —  
                                                               

Total operating costs and expenses

    154,575            207,706        370,881        409,941        439,623        415,455        104,324     105,778

Income (loss) from operations

    (7,831         10,482        21,791        17,212        5,401        41,069        11,863     12,299

Other expense (income):

                   

Financing fees and loss on debt extinguishments–net

    12,804            —          —          —          —          —          —       —  

Interest expense–net

    9,301            11,218        19,878        21,307        18,188        14,676        3,862     2,762

Interest rate swap expense (income)–net

    (256         (832     (610     960        2,307        590        222     98

Write off of financing fees

    —              —          —          —          —          —          —       2,675
                                                               

Total other expense

    21,849            10,386        19,268        22,267        20,495        15,266        4,084     5,535

Income (loss) before provision for income taxes

    (29,680         96        2,523        (5,055     (15,094     25,803        7,779     6,764

Provision (benefit) for income taxes

    1,607            2,689        4,482        3,065        (3,322     (20,164     1,733     2,674
                                                               

Net (loss) income

    (31,287         (2,593     (1,959     (8,120     (11,772     45,967        6,046     4,090

 

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    Predecessor          Successor  
  Jan. 1
through
May 24,

2005
         May 25
through
Dec.  31,

2005
    Year
Ended

Dec. 31,
2006
    Year
Ended

Dec. 31,
2007
    Year
Ended

Dec. 31,
2008
    Year
Ended

Dec. 31,
2009
    Three Months
Ended Mar. 31,
 
                     2009     2010  
    ($ amounts in thousands except per share and other data)  

Less: Net income attributable to non-controlling interests

    66            115        258        279        206        247        82        48   
                                                                   

Net (loss) income attributable to Smile Brands Group Inc.

    (31,353         (2,708     (2,217     (8,399     (11,978     45,720        5,964        4,042   

Less: Preferred stock dividends accrued in-kind

    1,600            3,452        6,166        6,863        7,660        8,505        2,041        2,271   

Dividends accrued in-kind on outstanding vested preferred stock options

    —              —          145        260        417        599        132        182   
                                                                   

Net (loss) income attributable to common stockholders

  $ (32,953       $ (6,160   $ (8,528   $ (15,522   $ (20,055   $ 36,616      $ 3,791      $ 1,589   
                                                                   

Net (loss) income attributable to common stockholders per share:

                   

Basic

  $ (1.24       $ (0.51   $ (0.70   $ (1.28   $ (1.66   $ 3.02      $ 0.31      $ 0.13   
                                                                   

Diluted

  $ (1.24       $ (0.51   $ (0.70   $ (1.28   $ (1.66   $ 2.92      $ 0.31      $ 0.13   
                                                                   

Weighted average common shares outstanding:

                   

Basic

    26,616,593            12,115,394        12,115,536        12,116,674        12,115,394        12,115,394        12,115,394        12,115,394   
                                                                   

Diluted

    26,616,593            12,115,394        12,115,536        12,116,674        12,115,394        12,556,802        12,352,868        12,641,821   
                                                                   

Other Data:

                   

Adjusted EBITDA (in thousands)(1)

  $ 15,651          $ 17,863      $ 35,655      $ 39,681      $ 44,074      $ 56,745      $ 15,533      $ 16,260   

Number of dental offices at period end

    276            276        291        298        295        303        299        304   

Number of operatories at period end

    2,920            2,972        3,143        3,282        3,281        3,384        3,331        3,393   

Dental services profit margin(2)

    23.7         21.6     22.6     22.4     23.0     25.8     26.0     26.8

Revenue per dentist day(3)

    N/A            N/A        N/A      $ 3,206      $ 3,414      $ 3,657      $ 3,702      $ 3,736   

Comparable office revenue growth(4)

    N/A            N/A        6.4     5.4     3.2     1.3     1.8     (0.9 )% 

 

     As of March 31, 2010
     Actual    Pro forma(5)    Pro forma
as adjusted(6)
           

Balance Sheet Data (in thousands):

  

Cash and cash equivalents

   $ 8,404    $ 8,404    $ 8,404

Total assets

     416,379      416,379      416,379

Long-term debt and capital lease obligations, including current portion

     140,447      140,447      116,759

Total stockholders’ equity

     185,562      97,939      209,250

 

(1)   Adjusted EBITDA represents net (loss) income attributable to Smile Brands Group Inc. plus provision (benefit) for income taxes, interest expense–net, interest rate swap expense (income)–net, depreciation and amortization, financing fees and loss on debt extinguishments–net, merger transaction and related costs, integration costs related to acquisitions, reorganization costs, one-time management equity accretion incentive, goodwill and trademark impairment, write off of financing fees, loss (gain) on asset dispositions, stock-based compensation expense and equity sponsor expenses. We have presented Adjusted EBITDA because we consider it an important supplemental measure of our operating performance and believe it is frequently used by analysts, investors and other interested parties in the evaluation of companies in our industry. Management uses Adjusted EBITDA as an additional measurement tool for purposes of business decision-making, including developing budgets, managing expenditures, and evaluating potential acquisitions or divestitures. Other companies in our industry may calculate Adjusted EBITDA differently than we do. In addition, Adjusted EBITDA as presented in this prospectus differs from adjusted EBITDA as calculated for compliance with the financial covenants in our prior and current credit facilities. For purposes of our credit facilities that we entered into in February 2010, we add all of the adjustments shown below, except for equity sponsor expenses, to net (loss) income attributable to Smile Brands Group Inc. For purposes of our prior first and second lien credit facilities, we added back (in addition to the adjustments shown below) construction period rent expenses and board of directors’ fees to net (loss) income attributable to Smile Brands Group, Inc. Adjusted EBITDA is not a measure of operating performance under GAAP and should not be considered as a substitute for, or superior to, net income prepared in accordance with GAAP. EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP.

 

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       The following table contains a reconciliation of our net (loss) income attributable to Smile Brands Group Inc. determined in accordance with GAAP to Adjusted EBITDA:

 

    Predecessor          Successor
    Jan. 1
through
May 24,

2005
         May 25
through
Dec.  31,

2005
    Year
Ended
Dec. 31,

2006
    Year
Ended
Dec. 31,
2007
    Year
Ended
Dec. 31,
2008
    Year
Ended
Dec. 31,
2009
    Three  Months
Ended
March 31,
                  2009   2010
              (in thousands)

Net (loss) income attributable to Smile Brands Group Inc.

  $ (31,353       $ (2,708   $ (2,217   $ (8,399   $ (11,978   $ 45,720      $ 5,964   $ 4,042

Provision (benefit) for income taxes

    1,607            2,689        4,482        3,065        (3,322     (20,164     1,733     2,674

Interest expense–net

    9,301            11,218        19,878        21,307        18,188        14,676        3,862     2,762

Interest rate swap expense (income)–net

    (256         (832     (610     960        2,307        590        222     98

Depreciation and amortization

    3,215            6,538        12,255        12,596        12,830        13,877        3,304     3,414

Financing fees and loss on debt extinguishments–net

    12,804            —          —          —          —          —          —       —  

Merger transaction and related costs(a)

    16,848            —          —          —          —          —          —      

Integration costs related to acquisitions(b)

    1,645            —          —          —          —          —          —      

Reorganization costs(c)

    —              596        93        518        455        89        26    

One-time management equity accretion incentive(d)

    1,042            —          —          —          —          —          —      

Goodwill and trademark impairment

    —              —          —          7,108        23,429        —          —      

Write off of financing fees

    —              —          —          —          —          —          —       2,675

Loss (gain) on asset dispositions

    92            (2     25        983        410        322        38     168

Stock-based compensation expense

    —              312        1,720        1,519        1,656        1,554        365     427

Equity sponsor expenses(e)

    706            52        29        24        99        81        19     —  
                                                               

Adjusted EBITDA

  $ 15,651          $ 17,863      $ 35,655      $ 39,681      $ 44,074      $ 56,745      $ 15,533   $ 16,260
                                                               

 

  (a)   Merger transaction and related costs reflects costs incurred in connection with our acquisition of Smile Brands Inc. in May 2005.
  (b)   Integration costs related to acquisitions consist primarily of costs incurred in connection with our acquisition of Smile Brands Inc. in May 2005.
  (c)   Reorganization costs represent non-recurring consulting fees and related costs for review of our centralized billing office and call center functions in 2008 and severance costs related to the integration of acquisitions by us of other DPM support services organizations.
  (d)   One-time management equity accretion incentive represents the redemption of outstanding equity incentive awards of certain officers of Smile Brands Inc. in connection with our acquisition of Smile Brands Inc. in May 2005.
  (e)   Equity sponsor expenses are fees and reimbursable costs paid to Gryphon Investors during the predecessor periods and reimbursable costs paid to Freeman Spogli & Co. during the successor periods, which we do not expect to continue after this offering. Equity sponsor expenses for the years ended December 31, 2008 and 2009 also include consulting fees that were paid to our director, Mr. Pulido, for services rendered pursuant to his consulting agreement, which terminated on December 31, 2009.

 

(2)   Dental services profit margin is equal to the amount obtained by dividing total revenues less dental services expenses by total revenues.
(3)   Revenue per dentist day is equal to net dental services revenues less net revenues produced by hygienists divided by dentist day count for the period measured. A dentist day is calculated as the time between a dentist’s or specialist’s first and last appointment on a given day divided by eight hours. A day may be fractionally reduced to the extent a dentist’s or specialist’s schedule of appointments spans less than eight hours. Prior to April 2006, we did not track dentist day count in the same manner. Therefore the data prior to 2007 is not comparable. The following table contains a reconciliation of net dental services revenues determined in accordance with GAAP to net dental services revenues less net revenues produced by hygienists:

 

     Year Ended December 31,    Three Months
Ended March 31,
     2007    2008    2009    2009   2010
(in thousands)                        

Net dental services revenues

   $ 421,111    $ 439,415    $ 450,659    $ 114,807   $ 116,627

Less: Net revenues produced by hygienists

     42,113      47,957      52,155      12,737     13,743
                                 

Net dental services revenues less net revenues produced by hygienists

   $ 378,998    $ 391,458    $ 398,504    $ 102,070   $ 102,884
                                 
(4)  

Comparable office revenue growth represents the comparable office total revenues for the given period as a percentage of such office’s total revenues for the comparable prior period. Comparable office revenue is composed of total revenues at dental offices that have been operating for at least 13 full months prior to the end of the given period and which have not been closed, combined

 

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  or sold during such period. Comparable office revenues have not been provided for periods prior to January 1, 2006 because of the inability to provide such information for Castle Dental prior to Smile Brands Inc.’s acquisition of Castle Dental in 2004.
(5)   Reflects, on a pro forma basis, the reclassification of the liquidation value of preferred stock in an amount of $87.6 million from stockholders’ equity to other current liabilities for the redemption of all outstanding preferred stock based on the intended use of proceeds of this offering. The pro forma amount does not reflect the repayment of $23.7 million of the amount outstanding under our secured term loan facility based on the intended use of proceeds of this offering.
(6)   Gives effect to the sale of 7,353,000 shares of common stock by us in this offering at an assumed initial public offering price of $17.00 per share, which is the midpoint of the range on the cover of this prospectus, after deducting underwriting discounts and commissions of approximately $8.7 million and estimated offering expenses payable by us of approximately $3.8 million and the use of proceeds therefrom as described under “Use of Proceeds.” A $1.00 increase (decrease) in the assumed initial public offering price of $17.00 per share would (decrease) increase long-term debt and increase (decrease) stockholders’ equity, each by $6.8 million, and would have no impact on cash and cash equivalents and total assets, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated expenses payable by us.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this prospectus. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly in “Risk Factors.” In accordance with factors for consolidation under generally accepted accounting principles in the United States, we consolidate the net assets and results of operations of the affiliated dental groups operating under business support services agreements with us. As a result, references to our revenues, our expenses and similar items relating to our results of operations and net assets includes the revenues, expenses and similar items of affiliated dental groups and all transactions between the affiliated dental groups and us, such as the service fees we charge, are eliminated in consolidation.

Overview

We provide support services on an exclusive basis to dental groups in some of the largest and fastest growing demographic markets in the United States. We operate under long term agreements with affiliated dental groups pursuant to which we provide business support services, non-clinical personnel, facilities and equipment. In exchange for providing these services, we receive a fee based on the number of dental operatories provided to the affiliated dental groups plus reimbursement of certain costs incurred by us in connection with fulfilling our responsibilities under these services agreements. Each of these agreements is for an initial term of five to ten years with successive automatic one-year renewal terms, unless terminated at least six months before the end of the initial term or any renewal term. Our services support more than 1,100 dentists and hygienists practicing in over 300 offices nationally.

Our revenues are comprised primarily of dental services, which consist of the consolidated revenues of our affiliated dental groups and revenues earned by ConsumerHealth. ConsumerHealth is our wholly owned subsidiary that operates 14 dental offices and a dental plan under the Knox-Keene Health Care Service Plan Act of 1975, as amended. Our other revenues primarily consist of dental plan premiums received by our capitated plan operated by ConsumerHealth and interest income earned on the dental services fees we finance for patients. Approximately 75%, 77%, 78%, 79% and 78% of total revenues for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010, respectively, were derived from patients with private insurance plans. Our revenues have increased over the past several years, driven primarily by the opening of de novo offices, growth in new and recall patient flow, increased dentist and hygienist productivity, the expansion of specialty services, increased volume of hygiene services and the hiring of additional dentists and hygienists.

We intend to grow our revenues primarily through supporting the opening of de novo offices in our existing and new markets where we can leverage our strong brand names and national infrastructure. We supported the opening of 15, 5 and 12 de novo offices for the years ended December 31, 2007, 2008 and 2009, respectively. We reduced the number of de novo openings in 2008 in reaction to our concerns over the weakening U.S. economy. While the cost per de novo office will vary based on size and region, we estimate that the average office build-out, including tenant improvements (net of allowances), furniture and fixtures, dental equipment and computer equipment, will cost approximately $550,000. Based on our historical results, we expect de novo offices, on average, to become cash flow positive within six months, with recovery of our investment occurring within 30 months after the office opens.

Our operating costs and expenses consist of dental services expenses, field support expenses, general and administrative expenses, depreciation and amortization, loss (gain) on asset dispositions, and goodwill and trademark impairment charges. Substantially all of our dental services expenses are directly associated with operating the dental facilities and consist principally of dental office labor, dental supplies, lab fees, rent,

 

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provision for doubtful accounts and other operating costs. Field support expenses consists primarily of regional management expenses, the costs of our centralized billing offices and call centers, and marketing and advertising expenses. General and administrative expenses consists of our corporate expenses including the costs of our executive and senior management and centralized functions, such as accounting, finance, human resources, information technology, operations services, purchasing, real estate and other similar functions.

Our operating costs have increased over the last several years as we have grown our business. However, excluding non-cash charges for depreciation and amortization and goodwill and trademark impairments, our operating costs as a percentage of total revenues have consistently decreased as we gained additional leverage over our operating cost structure. Much of the improvement in our cost structure over the last several years has occurred within dental services expenses, while our field support and general and administrative costs have remained relatively stable. Improvements in our cost structure have been driven largely by (i) removing administrative functions from the dental offices and centralizing them into our regional and corporate support departments where they can be more cost effectively performed and managed, (ii) leveraging our purchasing volumes to obtain favorable pricing from vendors for products and services, (iii) streamlining our business processes to optimize their effectiveness and minimize their cost and (iv) closing underperforming offices that were included in our acquisitions of Monarch Dental and Castle Dental. At the same time, we believe our business model has allowed affiliated dentists and hygienists to increase productivity as a result of their ability to treat an increased volume of patients. We expect to gain additional leverage over our operating cost structure in the future because we plan to continue leveraging our national infrastructure to support our de novo office roll-out and offices affiliated with other dental businesses we may acquire.

Other expense (income) consists primarily of interest expense, net, and interest rate swap expense (income), net. These expenses have generally decreased over the last several years as we have reduced our outstanding debt. In connection with the refinancing of our credit facilities in February 2010, we increased the amount of our outstanding debt by approximately $4.0 million but decreased the applicable interest rate. As a result of the refinancing, we expect interest expense will continue to decrease over the next twelve months unless we make acquisitions or otherwise utilize our revolving loan facility.

Absent the impact and timing of the opening of de novo offices and any acquisitions, our revenues have historically been higher in the first quarter and lower in the fourth quarter of the year due to timing of holidays and fluctuations in patient volumes, which are primarily impacted by the amount of third party payor benefits remaining for a patient during the year.

Our primary sources of liquidity are cash provided by operations and available borrowings under our credit facilities. The service fees we receive from PCs and their reimbursements of certain costs we incur on their behalf are our primary source of cash from operations. To the extent the affiliated dental groups do not generate sufficient revenues to pay a significant portion of our service fee, after paying for their expenses and reimbursing us for our costs, we may not have sufficient cash to meet our debt obligations.

In accordance with generally accepted accounting principles in the United States, or GAAP, we consolidate the operating results and net assets of affiliated dental groups with our financial statements. Affiliated dental groups, however, do not guaranty or pledge their assets to secure our indebtedness under our credit facilities and our stockholders do not have direct recourse to the PC’s assets. Each PC, though, has granted to us a security interest in its assets (other than patient records and other assets that cannot be pledged under applicable law) as security for the PC’s payment of our service fee and reimbursable costs. The primary assets of PCs are cash and receivables from patients and third party payors and their primary liabilities are payables for their direct expenses, such as payables for salaries of dental professionals and payables due to us, which are eliminated through consolidation.

 

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Key Financial Measures and Performance Indicators

In assessing the performance of our business, we consider a variety of financial measures and performance indicators that directly or indirectly impact our revenue and profitability. We believe the most important measures and indicators for our business are:

Revenue Related Financial Measures and Performance Indicators

Comparable Office Revenues. Comparable office revenues represent total revenues for dental offices that have been operating for at least 13 full months prior to the end of a given period and which have not been closed, combined or sold during such period. Measuring the year-over-year change in comparable office revenues allows us to evaluate how affiliated dental offices are performing. We believe various factors affect comparable office revenues, including patient demand for dental services, economic trends, dentist and hygienist staffing levels, availability of dentists and hygienists, pricing, competition, visibility and accessibility of the dental offices, quality of the tenants surrounding the dental offices, office hours and the level of customer service provided inside and outside of the dental offices.

New and Recall Patient Count. A new patient is counted when service is provided to a patient with no previous transaction history with one of our affiliated dental offices. A recall patient is counted when a patient of record receives a recall exam appropriate to their periodontal condition. While some services may require a patient to visit an office multiple times before the service is complete, those follow-on visits are not included in the count of either new or recall patients. Measuring the year-over-year change in new and recall patient count helps us to evaluate how the affiliated dental offices are performing. It also helps with evaluating demand for services which influences decision-making relating to matters such as appropriate staffing levels and recruiting needs. In addition, it influences decision-making processes relating to our marketing, sales and advertising strategies and helps us with evaluating the effectiveness of those strategies. Further, with respect to recall patient count, it allows us to evaluate the ability of affiliated dentists to encourage patients to complete their diagnosed dental treatment plans.

Dentist Day Count. A dentist day is calculated as the time between a dentist’s or specialist’s first and last appointment on a given day divided by eight hours. A day may be fractionally reduced to the extent a dentist’s or specialist’s schedule of appointments spans less than eight hours. Measuring the year-over-year and quarter-over-quarter change in dentist day count allows us to evaluate the productivity and efficiency of affiliated dental offices and affiliated dentists. It also helps us with evaluating the production capacity of affiliated dental offices which influences decision-making relating to matters such as appropriate staffing levels and recruiting needs.

Revenue per Dentist Day. Revenue per dentist day is equal to net dental services revenues less net revenues produced by hygienists divided by the dentist day count for the period measured. Measuring the year-over-year and quarter-over-quarter change in revenue per dentist day allows us to evaluate the productivity levels of the dental offices and affiliated dentists which influence decision-making around matters such as appropriate levels of training, development, staffing, recruiting, advertising and facility expansion opportunities.

Profitability Related Financial Measures

Adjusted EBITDA. We define Adjusted EBITDA as net (loss) income attributable to Smile Brands Group Inc. plus provision (benefit) for income taxes, interest expense–net, interest rate swap expense (income)–net, depreciation and amortization, reorganization costs, goodwill and trademark impairment, write off of financing fees, loss on asset dispositions, stock-based compensation expense and equity sponsor expenses. We believe the exclusion of certain non-recurring items is necessary to provide the most accurate measure of our core operating results and as a means to evaluate period-to-period results. We use Adjusted EBITDA as a measurement tool for purposes of business decision-making, including developing budgets, managing expenditures, and evaluating potential acquisitions or divestitures.

 

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Dental Services Profit Margin. Dental services profit margin is equal to the amount obtained by dividing total revenues minus dental services expenses by total revenues. Measuring the year-over-year change in dental services profit margin allows us to evaluate how affiliated dental offices are performing. It also influences our decision-making process related to cost management strategies and helps us with evaluating the effectiveness of those strategies.

Field Support Expenses as a Percentage of Total Revenues. Field support expenses as a percentage of total revenues is equal to the amount obtained by dividing field support expenses by total revenues. Measuring the year-over-year change in field support expenses as a percentage of revenues allows us to evaluate the efficiency of our field support functions. It also influences our decision-making process around cost management strategies and helps us with evaluating the effectiveness of those strategies.

General and Administrative Expenses as a Percentage of Total Revenues. General and administrative expenses as a percentage of total revenues is equal to the amount obtained by dividing general and administrative expenses by total revenues. Measuring the year-over-year change in general and administrative expenses as a percentage of revenues allows us to evaluate the efficiency of our corporate support functions. It also influences our decision-making process related to cost management strategies and helps us with evaluating the effectiveness of those strategies.

Critical Accounting Policies and Estimates

This discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. To prepare our financial statements in conformity with GAAP, we must make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses in the reporting period. Our actual results may differ from these estimates. We have provided a summary of our significant accounting policies in Note 2 to each of our consolidated financial statements included elsewhere in this prospectus. We describe below those accounting policies that require material subjective or complex judgments and that have the most significant impact on our financial condition and results of operations. Our management evaluates these estimates on an ongoing basis, based upon information currently available and on various assumptions management believes are reasonable as of the date on the front cover of this prospectus.

Basis of Consolidation. We prepare our consolidated financial statements in accordance with Accounting Standards Codification Topic 810-10, or ASC 810, which provides for consolidation of variable interest entities of which we are the primary beneficiary. We have concluded that the PCs meet the definition of variable interest entities as defined by this standard and that we are the primary beneficiary of these variable interest entities as defined therein. We concluded that the PCs meet the definition of variable interest entities because we determined that the equity investment at risk by each PC owner, which has not been more than $1,000, is not sufficient on a quantitative or qualitative basis to support each PC’s activities without additional financial support from us, which is provided through (i) our deferral of service fees due to us from the PCs when the PCs lack sufficient cash flow to pay the service fees in full and (ii) our capital investments in facilities and dental equipment used by the PCs in the operation of their dental practices. We determined that we are the primary beneficiary, as defined in ASC 810-10-38, of the PCs because (i) we absorb the majority of expected losses of the PCs through our deferral of the PCs’ service fees and the fact that we have, since our inception, had to continuously defer service fees for all PCs, (ii) no other party provides financial support to the PCs and (iii) we have the power to direct the activities of the PCs that most significantly impact the PCs’ economic performance, such as determining where and when to build out and equip de novo offices, which is the most significant capital expenditure decision, and advising on how to effectively advertise and determining the amount to expend on such advertising. Accordingly, the assets and liabilities and results of operations of the affiliated dental groups operating under the business support services agreements are included in our consolidated financial statements and all transactions between the affiliated dental groups and us, such as the service fees we charge, have been eliminated.

 

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Revenue Recognition. Dental services revenue is generally recognized as services are provided and reported at estimated net realizable amounts due from patients, third party payors and others for services rendered. Through our billing system, we record and report net dental service revenue for each patient at rates that reflect the amount expected to be collected, based on unique fee schedules for each insurance plan which include pre-determined contractual rates with the insurance providers and co-payments and deductibles to be received from patients. The process of estimating the ultimate amount of revenue to be collected is subjective and requires the application of judgment based on many factors, including contractual reimbursement rates, the determination of covered and uncovered benefits under the insurance plans and other relevant information. As a result of the inherent complexity of these calculations, our actual revenues, net income, and accounts receivable could vary from the amounts reported.

Orthodontic revenues, which are included in net dental services revenues, are recognized on the proportional performance method based on the ratio of costs incurred to the total estimated costs over the life of an orthodontic contract. Recognition of orthodontic revenues is dependent on a number of factors, including the accuracy of a variety of estimates involving progress of the orthodontic procedure and total costs for the treatment.

ConsumerHealth and our affiliated dental groups have agreements with various dental maintenance organizations, or DMOs, to provide dental services to subscribing participants. Under these agreements, monthly capitation payments are received based on the number of DMO enrollees assigned to ConsumerHealth and our affiliated dental groups. ConsumerHealth and our affiliated dental groups are then responsible for providing the necessary dental services and collecting any appropriate co-payment from the enrollees. Capitation revenues are recognized in the month that ConsumerHealth and our affiliated dental groups are obligated to provide dental services.

Accounts Receivable and Allowances for Doubtful Accounts. Accounts receivable include amounts due from patients and third party payors, including indemnity and preferred provider organizations, capitated plans, and government plans. Most accounts, other than for orthodontic treatments, are due as services are provided. However, we extend credit for terms up to 24 months to some patients in the normal course of business. Estimated co-payments are generally collected at the time of service based on the insurance plan fee schedule, deductible provisions and list of covered benefits for each plan. If the proper amount of co-payment is not fully collected at the time of service, the patient will be billed for the difference and an account receivable from the patient will be established on such date of service.

We provide an allowance for doubtful accounts against the accounts receivable and report those receivables on the balance sheet at their estimated net realizable value. The allowance for doubtful accounts provides for those accounts for which payment is not expected to be received and is determined based upon management’s periodic analyses and evaluation of accounts receivable, which considers historical realization data, receivable aging trends, collection trends, other operating trends, and relevant business conditions. Following this methodology, reserves for doubtful accounts are established based on the number of months receivables are past their due date. The reserve percentages established against the receivables increase with each month that receivables age past their due date. The reserve percentages ultimately reach the full amount of the receivable once receivables are 12 months past their due date, except for certain orthodontic receivables, which become fully reserved once they are 18 months past their date of service. Determination of the allowance requires management to make certain estimates and assumptions that affect the reported amount of the allowance. Actual results could differ from those estimates.

Collection efforts on accounts receivable differ by the type of receivable being collected. We dedicate different teams to collecting insurance receivables versus patient receivables. Insurance collections depend more heavily on supplying all required documentation and ensuring that all questions are answered regarding a patient’s eligibility, the type of service rendered, and other questions the insurance company may raise. Differences between amounts billed and amounts collected from insurance companies generally stem from issues related to fee schedules, covered benefits, and the patient’s eligibility. In the event an insurance company denies payment of a claim and such denial

 

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is determined to be valid or we are unsuccessful at resolving the denial, such amounts are billed to the patient for settlement and are due immediately. Collection from patients requires a more personal effort, including follow-up by phone and a series of collection letters that are automatically generated by our systems.

It is our policy to write off receivables once all reasonable collection efforts have been exhausted. As a result of this policy, a significant amount of management’s judgment is required and the age of the receivables written off will vary. However, because of our experience and expertise with collecting on delinquent accounts, receivables are typically not written off prior to 12 months past their due date and may remain on the aging schedule for several months beyond this threshold if management has reason to believe a past due balance has potential to be collected. For example, at March 31, 2010, we carried $6.8 million of patient receivables that had aged more than 360 days beyond their date of billing. While receivables may remain on the aging schedule beyond 12 months past their due date, substantially all receivables, other than those for certain orthodontic services, are fully reserved for regardless of amount once they reach 12 months past their due date.

The following tables summarize our accounts receivable agings as of March 31, 2010, December 31, 2009 and December 31, 2008. We age our accounts receivable differently depending on payor billing arrangements and, in the case of orthodontic receivables, the configuration of the billing system on which the receivables are billed and collected:

 

   

Receivables due from third party payors are aged by date of service because we generally bill third-party payors within three to five business days of delivering the service to the patient. Receivables due from third-party payors include amounts pending approval by third party payors.

 

   

Receivables due from patients are aged by date of billing because we bill patients at different times. Some amounts are billed to patients at the time of service but other amounts may be billed after the claim has been submitted to a third party payor, which could be significantly later than the date of service.

 

   

Certain receivables for orthodontic services are aged by date of service and other receivables for orthodontic services are aged by date of billing. We use two separate billing systems for orthodontic services that track accounts receivable aging differently: one system ages receivables by date of billing and the other ages receivables by date of service.

 

   

For patients to whom we have extended credit, for terms that can be up to 24 months, we age those receivables by days the receivable is past due. The receivables included within this category are aged based on the number of days by which a given account’s oldest delinquent amount due is beyond its scheduled payment date. Each account’s entire outstanding balance is included in the age range associated with the date of its oldest scheduled payment outstanding as of the date of the aging report.

 

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     Days Aged as of March 31, 2010  

Aging Type / Receivable Type

   0-90     91-180     181-270     271-360     360+     Total  
     (in thousands)  

Aged by date of service:

            

Third-party payors

   $ 17,278      $ 3,349      $ 1,572      $ 871      $ 1,738      $ 24,808   

Orthodontics (third-party & patient)

     2,671        1,727        1,216        709        1,705        8,028   

Allowance for doubtful accounts

     (1,106     (1,031     (1,066     (975     (3,218     (7,396
                                                

Total aged by date of service, net

   $ 18,843      $ 4,045      $ 1,722      $ 605      $ 225        25,440   
                                          

Aged by date of billing:

            

Patient self-pay

   $ 6,425      $ 3,269      $ 2,397      $ 1,773      $ 6,800        20,664   

Orthodontics (third-party & patient)

     1,870        589        349        243        1,549        4,600   

Allowance for doubtful accounts

     (1,266     (1,364     (1,519     (1,586     (8,295     (14,030
                                                

Total aged by date of billing, net

   $ 7,029      $ 2,494      $ 1,227      $ 430      $ 54        11,234   
                                          

Aged by days past due:

            

Patient financed

   $ 7,126      $ 772      $ 827      $ 318      $ 138        9,181   

Allowance for doubtful accounts

     (669     (677     (820     (318     (138     (2,622
                                                

Total aged by day past due, net

   $ 6,457      $ 95      $ 7      $      $        6,559   
                                          
Subtotal        43,233   
Less: Unposted cash(1)        (426
Less: Amounts reclassified to long term assets(2)        (516
Plus: Unbilled orthodontic revenue, net(3)        3,316   
Plus: Other receivables, net        158   
                  
Total accounts receivable, net      $ 45,765   
                  

 

     Days Aged as of December 31, 2009  

Aging Type / Receivable Type

   0-90     91-180     181-270     271-360     360+     Total  
     (in thousands)  

Aged by date of service:

            

Third-party payors

   $ 16,863      $ 3,108      $ 1,444      $ 810      $ 1,603      $ 23,828   

Orthodontics (third-party & patient)

     2,544        1,954        1,282        825        1,881        8,486   

Allowance for doubtful accounts

     (1,108     (1,101     (1,037     (979     (3,252     (7,477
                                                

Total aged by date of service, net

   $ 18,299      $ 3,961      $ 1,689      $ 656      $ 232        24,837   
                                          

Aged by date of billing:

            

Patient self-pay

   $ 6,791      $ 3,726      $ 2,576      $ 1,803      $ 7,240        22,136   

Orthodontics (third-party & patient)

     2,012        683        389        265        1,495        4,844   

Allowance for doubtful accounts

     (1,398     (1,607     (1,660     (1,643     (8,690     (14,998
                                                

Total aged by date of billing, net

   $ 7,405      $ 2,802      $ 1,305      $ 425      $ 45        11,982   
                                          

Aged by days past due:

            

Patient financed

   $ 6,498      $ 941      $ 803      $ 294      $ 110        8,646   

Allowance for doubtful accounts

     (776     (814     (799     (294     (110     (2,793
                                                

Total aged by day past due, net

   $ 5,722      $ 127      $ 4      $      $        5,853   
                                          
Subtotal        42,672   
Less: Unposted cash(1)        (496
Less: Amounts reclassified to long term assets(2)        (495
Plus: Unbilled orthodontic revenue, net(3)        3,319   
Plus: Other receivables, net        166   
                  
Total accounts receivable, net      $ 45,166   
                  

 

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     Days Aged as of December 31, 2008  

Aging Type / Receivable Type

   0-90     91-180     181-270     271-360     360+     Total  
     (in thousands)  

Aged by date of service:

            

Third-party payors

   $ 15,485      $ 2,814      $ 1,236      $ 836      $ 2,547      $ 22,918   

Orthodontics (third-party & patient)

     2,496        1,845        1,363        855        2,020        8,579   

Allowance for doubtful accounts

     (1,312     (1,160     (1,063     (1,055     (4,333     (8,923
                                                

Total aged by date of service, net

   $ 16,669      $ 3,499      $ 1,536      $ 636      $ 234        22,574   
                                          

Aged by date of billing:

            

Patient self-pay

   $ 7,276      $ 3,909      $ 3,349      $ 2,471      $ 13,751        30,756   

Orthodontics (third-party & patient)

     1,889        718        433        308        2,718        6,066   

Allowance for doubtful accounts

     (1,651     (1,798     (2,153     (2,091     (16,235     (23,928
                                                

Total aged by date of billing, net

   $ 7,514      $ 2,829      $ 1,629      $ 688      $ 234        12,894   
                                          

Aged by days past due:

            
            

Patient financed

   $ 2,682      $ 341      $ 186      $ 68      $ 26        3,303   

Allowance for doubtful accounts

     (281     (201     (181     (68     (26     (757
                                                

Total aged by day past due, net

   $ 2,401      $ 140      $ 5      $      $        2,546   
                                          
Subtotal        38,014   
Less: Unposted cash(1)        (171
Plus: Unbilled orthodontic revenue, net(3)        3,193   
Plus: Other receivables, net        173   
                  
Total accounts receivable, net      $ 41,209   
                  

 

(1)   Unposted cash represents cash receipts that have been deposited into the bank accounts of the affiliated dental groups but have not been posted to the aged accounts in our billing system.
(2)   Amounts reclassified to long-term assets represent those portions of financed accounts receivable balances that have scheduled payment dates that extend more than 12 months beyond the end of the financial reporting period.
(3)   Unbilled orthodontic revenue represents the net revenue for orthodontic services that have been provided to patients but for which a bill has not yet been processed by us.

Our net accounts receivable increased by $0.6 million from December 31, 2009 to March 31, 2010, primarily as a result of an increase in net dental services revenues that were earned toward the end of the first quarter of 2010, as compared to revenue earned toward the end of the last quarter of 2009. As a result of increased revenues at the end of the first quarter of 2010, we did not have the opportunity to bill and collect on all of the new receivables generated prior to the end of the quarter. Our net accounts receivable also increased due to the continued expansion of our internal financing program. Our net accounts receivable increased by $4.0 million from December 31, 2008 to December 31, 2009 primarily as a result of expanding our internal financing program across more of our markets and our addition of 12 new dental locations. Our consolidated net days’ sales outstanding, excluding the impact of unbilled orthodontic receivables, was 33, 36 and 34 days at December 31, 2008 and 2009 and March 31, 2010, respectively. The change in days’ sales outstanding from December 31, 2009 to March 31, 2010 was due primarily to the increase in average daily sales, due to increased net dental services revenues earned toward the end of the first quarter of 2010. The change in days’ sales outstanding from 2008 to 2009 was due primarily to the expansion of our internal financing program, which extended the collection cycle on a greater percentage of our accounts receivable.

Concentration of credit risk with respect to accounts receivable is limited due to the large number of payors.

Goodwill and Intangible Assets. Goodwill and intangible assets represent the excess of purchase price over the fair value of net tangible assets acquired in business combinations accounted for under the purchase method of accounting. Intangible assets with indefinite useful lives include our acquired trademarked brand names, which are not subject to amortization. Intangible assets with definite lives include amounts assigned to our

 

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business support services agreements and non-compete agreements with certain administrative employees. Such intangible assets are amortized on a straight-line basis over the term of their estimated useful lives. Our business support services agreements are amortized between two and ten years, depending upon the nature of the agreement. Non-compete agreements are amortized over the terms of the related agreements, which range from one to four years. Intangible assets with definite lives are removed from the gross asset and accumulated amortization amounts in the reporting period in which the asset becomes fully amortized.

In accordance with Accounting Standards Codification Topic 350-20, Goodwill and Other Intangible Assets, or ASC 350, we test goodwill and intangible assets with indefinite lives for impairment annually or more frequently if circumstances indicate that impairment may have occurred. The impairment tests are conducted at the reporting unit level, as determined in accordance with ASC 350. As required by ASC 350, we evaluate the recoverability of goodwill based on a two-step impairment test. The first step compares the fair value of each reporting unit with its carrying amount, including goodwill. If the carrying amount exceeds the fair value, then the second step of the impairment test is performed to measure the amount of the impairment loss. The fair value of each reporting unit is determined using a combination of discounted cash flows and market approaches. We test for impairment on an annual basis at December 31.

Stock-Based Compensation Plans. We have stock-based incentive plans that allow us to grant incentive stock options, nonqualified stock options, stock appreciation rights, and stock awards to our employees and certain nonemployees. We account for our stock-based compensation plans in accordance with the provisions of Accounting Standards Codification Topic 718, Compensation-Stock Compensation, or ASC 718. ASC 718 established the accounting for equity instruments exchanged for employee services. Under ASC 718, share-based compensation cost is measured at the grant date based on the calculated fair value of the award and this cost is recognized in the statement of operations over the period during which an employee is required to provide service in exchange for the award. We determine the grant-date fair value of employee stock options using the Black-Scholes option-pricing model and recognize within general and administrative expenses the related compensation expense on a straight line basis over the requisite service period of the award.

There are two significant elements in the Black-Scholes option pricing model: expected volatility and expected term. We use an independent valuation advisor to assist us in projecting expected stock price volatility. We also consider both the historical volatility of our peer group’s stock price as well as implied volatilities from exchange-traded options on our peer group’s stock. Our expected term represents the period that our stock options are expected to be outstanding and is determined using the simplified method described in ASC 718-10-30. The assumptions used in calculating the fair value of stock-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and we use different assumptions, stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate, and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period.

Variable Compensation Accruals. We estimate variable compensation accruals related to annual compensation plans quarterly based upon the annual amounts expected to be earned and paid resulting from the achievement of certain financial and operating goals. Our estimates, which include compensation incentives for bonuses and other awards, are updated periodically based on changes in our financial and operating performance that could ultimately impact the amount of the actual final awards. Actual results reflected in our quarterly financial statements may vary due to the subjectivity involved in anticipating fulfillment of specific financial and operating goals, as well as the final determination and approval of amounts by our executive management.

Income Taxes. We account for income taxes under the provisions of Accounting Standards Codification Topic 740-10, Accounting for Income Taxes, or ASC 740. Under this method, we estimate our income tax provision to recognize our tax expense for the current period, and deferred income tax assets and liabilities are

 

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computed for differences between the financial statement and tax basis of assets and liabilities based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. In accordance with FASB Interpretation No. 48, Accounting for Income Tax Uncertainties, which has been incorporated into ASC 740 and was retroactively adopted effective January 1, 2007, we assess our tax positions on a more-likely-than-not standard to determine the actual amount of benefit or expense to recognize in the financial statements. Deferred tax assets are assessed based upon the likelihood or recoverability from future taxable income and, to the extent that recovery is not likely, a valuation allowance is established. The allowance is regularly reviewed and updated for changes in circumstances that would cause a change in judgment about the ability to realize the related deferred tax assets. These calculations and assessments involve complex estimates and judgments because the ultimate tax outcomes can be uncertain and future events unpredictable.

Results of Operations

The following table sets forth, for the periods indicated, our consolidated statements of operations and certain other information, each expressed as a percentage of total revenues. Amounts may not add to the totals due to rounding.

 

     Year Ended December 31,     Three Months
Ended March 31,
 
     2007     2008     2009     2009     2010  

Total revenues

   100.0   100.0   100.0   100.0   100.0

Operating costs and expenses:

          

Dental services

   77.6      77.0      74.2      74.0
  
  73.2   

Field support

   6.9      6.9      7.0      6.5      6.8   

General and administrative

   6.6      6.7      6.7      6.4      6.6   

Depreciation and amortization

   2.9      2.9      3.0      2.9      2.9   

Loss on asset dispositions

   0.2      0.1      0.1      —        0.1   

Goodwill and trademark impairment

   1.7      5.3      —        —        —     
                              

Total operating costs and expenses

   96.0      98.8      91.0      89.8      89.6   

Income from operations

   4.0      1.2      9.0      10.2      10.4   

Other expense (income):

          

Interest expense—net

   5.0      4.1      3.2      3.3      2.3   

Interest rate swap expense—net

   0.2      0.5      0.1      0.2      0.1   

Write off of financing fees

   —        —        —        —        2.3   
                              

Total other expense (income)

   5.2      4.6      3.3      3.5      4.7   
                              

Income (loss) before provision for income taxes

   (1.2   (3.4   5.7      6.7      5.7   

Provision (benefit) for income taxes

   0.7      (0.7   (4.4   1.5      2.3   
                              

Net (loss) income

   (1.9   (2.6   10.1      5.2      3.5   

Less: Net income attributable to non-controlling interest

   0.1      0.0      0.1      0.1      0.0   
                              

Net (loss) income attributable to Smile Brands Group Inc.

   (2.0 )%    (2.7 )%    10.0   5.1   3.4
                              

Adjusted EBITDA

   9.3   9.9   12.4   13.4   13.8
                              

Three Months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009

Revenues

Total revenues for the three months ended March 31, 2010 increased $1.9 million, or 1.6%, to $118.1 million from $116.2 million for the three months ended March 31, 2009. This increase in revenues was primarily attributable to $2.4 million in revenues from the addition of nine de novo offices since March 31, 2009 partially offset by a 0.9% decline in our comparable office revenues during the three months ended March 31, 2010. Additionally, the increase in revenues was offset by a $0.6 million reduction in revenues attributed to the closure or combination of four offices between January 1, 2009 and March 31, 2010.

 

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The comparable office revenues decline was largely caused by unusually adverse weather conditions in some of our markets that resulted in numerous temporary office closures and patient scheduling disruptions during the three months ended March 31, 2010.

Operating Costs and Expenses

Our total operating costs and expenses for the three months ended March 31, 2010 increased $1.5 million, or 1.4%, to $105.8 million from $104.3 million for the three months ended March 31, 2009. The increase in our operating costs and expenses resulted primarily from a $0.5 million increase in dental services expenses, a $0.4 million increase in field support expenses and additional increases in general and administrative expenses. As a percentage of revenues, our operating expenses decreased to 89.6% in the three months ended March 31, 2010 from 89.8% in the three months ended March 31, 2009. This, in turn, resulted in our income from operations as a percentage of revenue improving 20 basis points to 10.4% for the three months ended March 31, 2010 from 10.2% for the three months ended March 31, 2009.

Dental services. Dental services expenses for the three months ended March 31, 2010 increased $0.5 million, or 0.6%, to $86.4 million from $85.9 million for the three months ended March 31, 2009. The increase in dental services expenses was primarily attributable to a $2.6 million increase in expense from offices opened after January 1, 2009. This increase was offset by a $1.6 million reduction in expenses attributable to offices opened prior to January 1, 2009 and a $0.5 million reduction in expenses primarily from the closure or combination of four offices after January 1, 2009. As a percentage of revenues, our dental services expenses decreased to 73.2% for the three months ended March 31, 2010 from 74.0% for the three months ended March 31, 2009. This in turn resulted in our dental services profit margin improving 80 basis points to 26.8% for the three months ended March 31, 2010 from 26.0% for the three months ended March 31, 2009. The improvement in our dental services profit margin resulted primarily from a 90 basis point improvement in the provision for doubtful accounts as a percentage of revenues over the prior year period, as well as improvements as a percentage of revenues in lab fees and other dental operating costs.

Field support. Field support expenses for the three months ended March 31, 2010 increased $0.4 million, or 5.8%, to $8.0 million from $7.6 million for the three months ended March 31, 2009. The increase resulted primarily from a $0.4 million increase in advertising expenses, which was primarily a result of starting various annual advertising campaigns earlier in 2010 as compared to the timing of those campaigns in 2009. As a percentage of revenues, field support expenses increased to 6.8% for the three months ended March 31, 2010 as compared to 6.5% for the three months ended March 31, 2009.

General and administrative. General and administrative expenses for the three months ended March 31, 2010 increased $0.3 million, or 4.0%, to $7.7 million from $7.5 million for the three months ended March 31, 2009. This increase resulted largely from a $0.4 million increase in telecommunication costs and a $0.1 million increase in other general and administrative costs offset primarily by a $0.2 million reduction in labor costs. The increase in telecommunication costs resulted from the 2009 implementation of our new telecommunications platform, which drove a shift of telecommunication costs out of dental service expenses and into our corporate expenses, which are included in our general and administrative expenses. Our overall consolidated telecommunication costs were reduced $0.1 million for the three months ended March 31, 2010 as compared to the three months ended March 31, 2009. Due to the increase in general and administrative expenses, these expenses as a percentage of revenue increased 20 basis points to 6.6% for the three months ended March 31, 2010 compared to 6.4% for the three months ended March 31, 2009.

Depreciation and amortization. Depreciation and amortization expense for the three months ended March 31, 2010 increased $0.1 million, or 3.3%, to $3.4 million from $3.3 million for the three months ended March 31, 2009. This increase resulted primarily from a $0.2 million increase in depreciation associated with stores opened after January 1, 2009.

 

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Other Expense (Income)

Write off of financing fees. Write off of financing fees for the three months ended March 31, 2010 was $2.7 million as compared to none for the three months ended March 31, 2009. This one time expense was incurred in February 2010 as a result of the refinancing of our first and second lien credit facilities, which required us to write off the remaining unamortized financing fees associated with our prior credit facilities.

Interest expense, net. Interest expense, net, for the three months ended March 31, 2010 decreased $1.1 million, or 28.5% to $2.8 million from $3.9 million for the three months ended March 31, 2009. This decrease was primarily the result of reductions in outstanding debt over the course of 2009 and the three months ended March 31, 2010. For the three months ended March 31, 2010, our average debt outstanding was $141.9 million, a reduction of $24.6 million from the average debt outstanding of $166.5 million for the three months ended March 31, 2009. Our interest expense also decreased because of reductions in the interest rates on our variable rate debt for the three months ended March 31, 2010 as compared to the three months ended March 31, 2009.

Interest rate swap expense, net. Interest rate swap expense, net, for the three months ended March 31, 2010 decreased $0.1 million or 55.8% to $0.1 million from $0.2 million for the three months ended March 31, 2009. The expense in both the three months ended March 31, 2009 and March 31, 2010 stems from changes in the mark-to-market valuations of our London Interbank Offered Rate, or LIBOR, interest rate swap and collar instruments. LIBOR interest rates declined significantly during 2009, which affected the spread between market LIBOR interest rates and the fixed LIBOR rates of our interest rate swap and collar instruments. While LIBOR interest rates continued to decline during the three months ended March 31, 2010, they did so at a lesser rate than during the three months ended March 31, 2009. Thus the related expense in the three months ended March 31, 2010 was less than the expense in the three months ended March 31, 2009. See “—Liquidity and Capital Resources—Outstanding indebtedness—Interest Rate Swap Agreements.”

Income Taxes

Provision (benefit) for income taxes. Income tax expense for the three months ended March 31, 2010 was $2.7 million compared to $1.7 million of income tax expense for the three months ended March 31, 2009. The $0.9 million increase in expense resulted primarily from the recording of our tax expense at a lower effective rate for the three months ended March 31, 2009 due to a partial reversal of a valuation allowance on deferred tax assets.

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

Revenues

Total revenues for the year ended December 31, 2009 increased $11.5 million, or 2.6%, to $456.5 million from $445.0 million for the year ended December 31, 2008. This increase in revenues was primarily attributable to $5.2 million in revenues from the addition of 12 de novo offices during 2009 and a 1.3% increase in comparable office revenues during 2009. This increase in revenues was offset by a $3.7 million reduction in revenues attributed to the closure, combination or sale of 10 offices between January 1, 2008 and December 31, 2009.

The increase in comparable office revenue was primarily driven by a 8.9% increase in comparable office recall patients, which helped drive a 7.3% increase in comparable office revenue generated by hygienists. In addition, dentist productivity improved as revenue per dentist day increased 7.1% during 2009 as compared to 2008.

Operating Costs and Expenses

Our total operating costs and expenses for the year ended December 31, 2009 decreased $24.2 million, or 5.5%, to $415.5 million from $439.6 million for the year ended December 31, 2008. As a percentage of revenues,

 

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our operating expenses decreased to 91.0% in 2009 from 98.8% in 2008. This, in turn, resulted in our income from operations as a percentage of revenue improving 780 basis points to 9.0% for the year ended December 31, 2009 from 1.2% for the year ended December 31, 2008. The decrease in our operating costs and expenses resulted primarily from a $23.4 million decrease in goodwill and trademark impairment charges and a $3.8 million decrease in dental services expenses, offset by increases in field support and general and administrative expenses.

Dental services. Dental services expenses for the year ended December 31, 2009 decreased $3.8 million, or 1.1%, to $338.7 million from $342.5 million for the year ended December 31, 2008. The decrease in dental services expenses was primarily attributable to an $8.3 million reduction in expenses attributable to offices opened prior to January 1, 2008 and a $3.2 million reduction in expenses primarily from the closure, combination or sale of 10 offices between January 1, 2008 and December 31, 2009. These decreases were offset by an increase in expenses of $7.7 million from offices that opened after January 1, 2008. As a percentage of revenues, our dental services expenses decreased to 74.2% for the year ended December 31, 2009 from 77.0% for the year ended December 31, 2008. This in turn resulted in our dental services profit margin improving 280 basis points to 25.8% for the year ended December 31, 2009 from 23.0% for the year ended December 31, 2008. The improvement in our dental services profit margin resulted primarily from a 170 basis point improvement in dental office labor costs as a percentage of revenues over the prior year period, as well as improvements as a percentage of revenues in the provision for doubtful accounts, lab fees, facilities costs, and other dental operating costs. Aside from improvements realized through operating leverage over fixed costs, we achieved many of our cost improvements as a result of numerous cost reduction and process improvement initiatives we implemented over the previous 12 to 24 months. Some of these initiatives included the implementation of various labor management tools, standardization of dental office administration tasks, transitioning of lab services to preferred labs, enhancements to our accounts receivable management system, improvements in our billing and collection processes within our centralized billing offices and on-going consolidation of our vendor base.

Field support. Field support expenses for the year ended December 31, 2009 increased $1.2 million, or 4.0%, to $31.9 million from $30.7 million for the year ended December 31, 2008. The increase resulted primarily from a $1.1 million increase in labor costs and a $0.4 million increase in advertising expenses. The increase in labor costs was principally the result of an increase in incentive compensation across our field operations, sales and marketing teams and an increase in headcount within our centralized billing offices. The increase in advertising expenses was primarily as a result of the opening of 12 de novo offices during the year ended December 31, 2009, which we typically support with dedicated advertising campaigns during their first few months of operation. As a percentage of revenues, field support expenses increased to 7.0% for the year ended December 31, 2009 as compared to 6.9% for the year ended December 31, 2008.

General and administrative. General and administrative expenses for the year ended December 31, 2009 increased $0.9 million, or 2.9%, to $30.7 million from $29.8 million for the year ended December 31, 2008. This increase resulted largely from a $2.6 million increase in labor costs offset by reductions of $0.4 million in consulting and legal costs, $0.4 million in integration related expenses, $0.1 million in stock based compensation expenses and $0.4 million in other general and administrative expenses. The increase in labor costs was principally the result of an increase in incentive compensation expense and a higher employee headcount. The reduction of other general and administrative expenses was primarily the result of several cost reduction initiatives we implemented over the previous 12 to 24 months. These initiatives included the integration and streamlining of our telecommunications network, optimization of our management information systems network and reductions in the usage of delivery and courier services. While general and administrative expenses increased over the prior year, as a percentage of revenues they remained flat at 6.7% compared to the year ended December 31, 2008.

Depreciation and amortization. Depreciation and amortization expense for the year ended December 31, 2009 increased $1.0 million, or 8.2%, to $13.9 million from $12.8 million for the year ended December 31, 2008.

 

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This increase resulted primarily from a $0.7 million increase in depreciation associated with stores opened after January 1, 2008 and investments we made in new computer and telecommunications equipment.

Goodwill and trademark impairment. We had no goodwill and trademark impairment expense for the year ended December 31, 2009, as compared to goodwill and trademark impairment expense of $23.4 million for the year ended December 31, 2008. The impairment charge in 2008 resulted primarily from changes in estimates used to determine the fair market value of our reporting units resulting from changes in general economic conditions.

Other Expense (Income)

Interest expense, net. Interest expense, net, for the year ended December 31, 2009 decreased $3.5 million, or 19.3% to $14.7 million from $18.2 million for the year ended December 31, 2008. This decrease was primarily the result of reductions in outstanding debt over the course of 2009 and 2008 along with reductions in the interest rates on our variable rate debt in 2009 as compared to 2008. For the year ended December 31, 2009, our average debt outstanding was $154.3 million, a reduction of $20.8 million from the average debt outstanding of $175.1 million for the year ended December 31, 2008.

Interest rate swap expense, net. Interest rate swap expense, net, for the year ended December 31, 2009 decreased $1.7 million or 74.4% to $0.6 million from $2.3 million for the year ended December 31, 2008. The expense in both 2008 and 2009 stems from changes in the mark-to-market valuations of our LIBOR interest rate swap and collar instruments. LIBOR interest rates declined significantly during 2008, which affected the spread between market LIBOR interest rates and the fixed LIBOR rates of our interest rate swap and collar instruments. While LIBOR interest rates continued to decline during 2009, they did so at a lesser rate than in 2008. Thus the related expense in 2009 was less than the expense in 2008.

Income Taxes

Provision (benefit) for income taxes. Income tax benefit for the year ended December 31, 2009 was $20.2 million compared to $3.3 million of income tax benefit for the year ended December 31, 2008. The $16.8 million reduction in expense resulted primarily from the reversal in 2009 of a valuation allowance we had recorded against certain of our deferred tax assets.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

Revenues

Total revenues for the year ended December 31, 2008 increased $17.9 million, or 4.2%, to $445.0 million from $427.2 million for the year ended December 31, 2007. This increase in revenues was primarily attributable to $1.6 million in revenues from the addition of five de novo offices during 2008 and a 3.2% increase in comparable office revenues during 2008. This increase in revenues was offset by a $3.9 million reduction in revenues attributed to the closure, combination or sale of 16 offices between January 1, 2007 and December 31, 2008.

The increase in comparable office revenues was driven by increases in specialty services, recall patient exams and hygiene services along with improvements in dentist productivity. We measure dentist productivity through revenue per dentist day, which increased 6.5% during 2008 as compared to 2007.

Operating Costs and Expenses

Our total operating costs and expenses for the year ended December 31, 2008 increased $29.7 million, or 7.2%, to $439.6 million from $409.9 million for the year ended December 31, 2007. As a percentage of revenues, our operating expenses increased to 98.8% in 2008 from 96.0% in 2007. This increase in our operating costs and

 

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expenses resulted primarily from the $16.3 million increase in goodwill and trademark impairment charges and $11.1 million increase in dental services expenses. Although dental services expenses increased in 2008, dental services profit margin improved 60 basis points year-over-year as dental services expenses grew at a slower rate than dental service revenues.

Dental services. Dental services expenses for the year ended December 31, 2008 increased $11.1 million, or 3.4%, to $342.5 million from $331.4 million for the year ended December 31, 2007. The increase in dental services expenses was primarily attributable to the $8.6 million increase in expenses from offices that opened after January 1, 2007 and a $5.8 million increase in expenses attributable to offices opened prior to January 1, 2007. The increase was offset by a $3.3 million reduction in expenses primarily from the closure, combination or sale of 16 offices between January 1, 2007 and December 31, 2008. As a percentage of revenues, dental services expenses decreased to 77.0% in 2008 from 77.6% in 2007. This in turn resulted in our dental services profit margin improving to 23.0% in 2008 from 22.4% in 2007. The improvement in our dental services profit margin resulted primarily from an 82 basis point improvement in lab fees as a percentage of revenues and improvements in the provision for doubtful accounts and other dental operating costs, which were offset by a 70 basis point decline in dental office labor costs as a percentage of revenues. Many of these cost improvements were achieved as a result of various cost reduction and process improvement initiatives we implemented over the course of 2008. Some of these initiatives included the transitioning of lab services to preferred labs, on-going consolidation of our vendor base, enhancements to our accounts receivable management system and improvements in our billing and collection processes within our centralized billing offices.

Field support. Field support expenses for the year ended December 31, 2008 increased $1.1 million, or 3.6%, to $30.7 million from $29.6 million for the year ended December 31, 2007. The increase resulted from a $0.6 million increase in advertising expenses and a $0.5 million increase in labor costs. The increase in advertising expenses primarily resulted from the expansion of marketing initiatives within many of our markets in 2008 and the increase in labor costs was primarily attributable to incentive compensation. The increase in labor costs was principally the result of increased headcount within our centralized billing offices and the increase in advertising expenses primarily resulted from the expansion of marketing initiatives within many of our markets in 2008. While field support expenses increased over the prior year, as a percentage of revenues they remained flat at 6.9% in 2008 as compared to 2007.

General and administrative. General and administrative expenses for the year ended December 31, 2008 increased $1.5 million, or 5.4%, to $29.8 million from $28.3 million for the year ended December 31, 2007. This increase resulted primarily from a $2.3 million increase in labor costs and a $0.3 million increase in recruiting costs, which were offset by reductions of $0.6 million in telecommunication costs and $0.4 million in facility costs. The increase in labor costs was principally the result of an increase in incentive compensation expense and a higher employee headcount. General and administrative expenses as a percentage of revenues remained relatively stable at 6.7% in 2008 compared to 6.6% in 2007.

Depreciation and amortization. Depreciation and amortization expense for the year ended December 31, 2008 increased $0.2 million, or 1.9% to $12.8 million from $12.6 million for the year ended December 31, 2007. This increase resulted primarily from a $1.2 million increase in depreciation associated with our purchases of property, plant and equipment of $18.3 million and $10.7 million for the years ended December 31, 2007 and December 31, 2008, respectively. The increase was offset by a $0.9 million decrease in amortization expense associated with our intangible assets with definite lives.

Goodwill and trademark impairment. Goodwill and trademark impairment expense for the year ended December 31, 2008 increased $16.3 million, or 229.6%, to $23.4 million from $7.1 million for the year ended December 31, 2007. The impairment charge in 2008 resulted primarily from changes in estimates used to determine the fair market value of our reporting units resulting from changes in general economic conditions. The impairment charge in 2007 resulted primarily from declining operating performance in certain reporting units.

 

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Other Expense (Income)

Interest expense, net. Interest expense, net, for the year ended December 31, 2008 decreased $3.1 million, or 14.6%, to $18.2 million from $21.3 million for the year ended December 31, 2007. This decrease was primarily the result of reductions in outstanding debt over the course of 2008 and 2007 along with reductions in the interest rates on our variable rate debt in 2008 as compared to 2007. For the year ended December 31, 2008, our average debt outstanding was $175.1 million, a reduction of $9.9 million from the average debt outstanding of $184.9 million for the year ended December 31, 2007.

Interest rate swap expense, net. Interest rate swap expense, net, for the year ended December 31, 2008 increased $1.3 million, or 140.3% to $2.3 million from $1.0 million for the year ended December 31, 2007. This increase resulted primarily from mark-to-market valuation changes to our LIBOR, interest rate swap and collar instruments in 2008. The increase in mark-to-market valuations were due to significant reductions in LIBOR interest rates during 2008, which widened the spread between those rates and the fixed LIBOR rates of our interest rate swap and collar instruments.

Income Taxes

Provision (benefit) for income taxes. Income tax benefit for the year ended December 31, 2008 was $3.3 million compared to $3.1 million of income tax expense for the year ended December 31, 2007. The $6.4 million reduction in expense was primarily due to the tax benefit associated with our 2008 goodwill impairment charge.

 

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Quarterly Results of Operations

The following table presents unaudited consolidated statement of operations data for each of the nine quarters for the period ended March 31, 2010. We believe that all necessary adjustments have been included to fairly present the quarterly information when read in conjunction with our annual financial statements and related notes included elsewhere in this prospectus.

We have historically experienced quarterly fluctuations in revenue and net income. Absent the impact and timing of the opening of de novo offices and any acquisitions, our total revenues have historically been higher in the first quarter and lower in the fourth quarter of the year due to fluctuations in patient volumes, which are impacted by the timing of holidays and the amount of third party payor benefits remaining for a patient during the year. The operating results for any quarter are not necessarily indicative of the results for any subsequent quarter.

 

     Three Months Ended
     2008     2009     2010
     Mar. 31    Jun. 30     Sep. 30    Dec. 31     Mar. 31    Jun. 30    Sep. 30     Dec. 31     Mar. 31
     (in thousands)

Revenues:

                      

Net dental services

   $ 112,209    $ 111,605      $ 109,440    $ 106,161      $ 114,807    $ 113,818    $ 112,930      $ 109,103      $ 116,627

Other

     1,364      1,373        1,367      1,505        1,380      1,451      1,615        1,420        1,450
                                                                  

Total revenues

     113,573      112,978        110,807      107,666        116,187      115,269      114,545        110,523        118,077

Operating costs and expenses:

                      

Dental services

     86,279      86,969        85,966      83,285        85,928      84,994      84,541        83,224        86,415

Field support

     7,314      8,154        8,339      6,864        7,595      8,683      8,420        7,210        8,032

General and administrative

     7,551      7,466        7,423      7,344        7,459      7,513      7,780        7,909        7,749

Depreciation and amortization

     3,153      3,196        3,219      3,262        3,304      3,360      3,753        3,460        3,414

Loss on asset dispositions

     122      229        57      2        38      75      105        104        168

Goodwill and trademark impairment

     —        —          —        23,429        —        —        —          —          —  
                                                                  

Total operating costs and expenses

     104,419      106,014        105,004      124,186        104,324      104,625      104,599        101,907        105,778

Income (Loss) from operations

     9,154      6,964        5,803      (16,520     11,863      10,644      9,946        8,616        12,299

Other expense (income):

                      

Interest expense-net

     4,906      4,760        4,120      4,402        3,862      3,817      3,590        3,407        2,762

Interest rate swap (income) expense-net

     1,389      (1,018     304      1,632        222      178      312        (122     98

Write off of financing fees

     —        —          —        —          —        —        —          —          2,675
                                                                  

Total other expense

     6,295      3,742        4,424      6,034        4,084      3,995      3,902        3,285        5,535

Income (loss) before provision for income taxes

     2,859      3,222        1,379      (22,554     7,779      6,649      6,044        5,331        6,764

Provision (benefit) for income taxes

     1,362      1,400        1,238      (7,322     1,733      1,523      (24,583     1,163        2,674
                                                                  

Net income (loss)

     1,497      1,822        141      (15,232     6,046      5,126      30,627        4,168        4,090

Less: Net income attributable to non-controlling interests

     66      58        43      39        82      50      62        53        48
                                                                  

Net income (loss) attributable to Smile Brands Group Inc.

   $ 1,431    $ 1,764      $ 98    $ (15,271   $ 5,964    $ 5,076    $ 30,565      $ 4,115      $ 4,042
                                                                  

 

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Liquidity and Capital Resources

We finance our operations and growth through a combination of cash provided by operating activities and borrowings under our revolving loan facility. Cash and cash equivalents were $275,000, $700,000, $4.5 million and $8.4 million at December 31, 2007, 2008 and 2009 and March 31, 2010, respectively.

Cash flows from operating activities

Cash flows provided by operating activities were $14.2 million for the three months ended March 31, 2010 compared to $15.8 million for the three months ended March 31, 2009. The $1.6 million decrease in cash flows provided by operating activities was due primarily to a $2.0 million decrease in net income, a $2.6 million decrease for the change in operating assets and liabilities and a $1.0 million decrease for the change in bad debt expense which were offset in part by a $2.7 million increase associated with the non-cash write off of financing fees and a $1.0 million increase for the non-cash change in deferred income taxes. Cash flows provided by operating activities were $25.0 million, $30.0 million and $43.4 million for the years ended December 31, 2007, 2008 and 2009, respectively. The $13.4 million increase in cash flows provided by operating activities for the year 2009 compared to the same period in 2008 was due primarily to a $57.7 million increase in net income offset in part by a reduction for the $23.4 million non-cash change in goodwill and trademark impairment, the $17.2 million reduction for the non-cash change in deferred income taxes, and the $3.7 million decrease for the change in operating assets and liabilities. The $5.0 million increase in cash flows provided by operating activities for the year 2008 compared to the year 2007 was due primarily to the $16.3 million increase for the non-cash change in goodwill and trademark impairment offset in part by the $3.7 million increase in net loss, the $6.2 million reduction for the non-cash change in deferred income taxes and a $0.5 million decrease for the change in operating assets and liabilities.

Cash flows from investing activities

Our investing activities are primarily related to capital expenditures for de novo offices, replacing and adding capital improvements in existing facilities and technology related projects. Cash flows used in investing activities were $3.3 million for the three months ended March 31, 2010 compared to $3.4 million for the three months ended March 31, 2009. The $0.1 million decrease in investing activities was due primarily to a decrease in capital expenditures for de novo offices. Cash flows used in investing activities were $17.8 million, $10.4 million and $14.0 million for the years ended December 31, 2007, 2008 and 2009, respectively. The $3.6 million increase in cash flows used in investing activities for the year ended December 31, 2009 compared to the year ended December 31, 2008 was due primarily to the increase in capital expenditures for de novo offices as we increased the number of dental office openings in 2009. The decision to increase the number of dental office openings occurred after assessing the impact of the weakening U.S. economy on our business, especially de novo offices, and realizing our business, including de novo offices, performed well throughout the economic recession. The $7.4 million decrease in cash flows used in investing activities for the year ended December 31, 2008 compared to the year ended December 31, 2007 was due primarily to the $5.8 million reduction in spending on de novo offices from 2007 to 2008. We reduced the number of dental office openings in 2008 in reaction to our concerns over the weakening U.S. economy.

Cash flows from financing activities

Cash flows from financing activities primarily reflect our borrowings and repayments under our current and prior credit facilities. Cash flows used in financing activities were $7.0 million for the three months ended March 31, 2010 compared to $0.5 million for the same period in fiscal year 2009. The $6.5 million increase in cash used in financing activities was due primarily to $4.2 million of fees paid in connection with our February 2010 refinancing of our first lien and second lien credit facilities with a $144.0 million secured term loan facility and a

 

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$25.0 million secured revolving loan facility, and $1.6 million paid to settle in full our obligations due under our interest rate swap agreements. Cash flows used in financing activities were $7.9 million, $19.2 million and $25.6 million for the years ended December 31, 2007, 2008 and 2009, respectively. The $6.4 million increase in cash flows used in financing activities for the year ended December 31, 2009 compared to the year ended December 31, 2008 was due primarily to our payments of $24.8 million on our first lien credit facility for the year ended December 31, 2009 compared to payments of $18.2 million for the year ended December 31, 2008. The $11.3 million increase in cash flows used in financing activities for the year ended 2008 compared to 2007 was due primarily to our payments of $18.2 million on our first lien credit facility in 2008 compared to payments of $6.8 million in 2007.

Outstanding indebtedness

Our primary sources of liquidity are cash provided by operations and available borrowings under our revolving loan facility. The service fees we receive from PCs and their reimbursement to us of certain costs we incur on their behalf are our primary source of cash from operations. We do not, however, have direct recourse to the assets of affiliated dental groups, which consist primarily of cash and receivables from patients and third party payors. To the extent the affiliated dental groups do not generate sufficient revenues to pay a significant portion of our service fee, after paying for their expenses and reimbursing us for our costs, we may not have sufficient cash to meet our debt obligations.

Current Credit Facilities. On February 26, 2010, we refinanced our first lien and second lien credit facilities with a $144.0 million secured term loan facility and a $25.0 million secured revolving loan facility. Our new credit facilities mature on February 26, 2015.

Principal payments on the term loan facility are due and payable in quarterly installments beginning on June 30, 2010 and on the last business day of each calendar quarter thereafter through December 31, 2014. These quarterly installments are $2.5 million from June 30, 2010 to March 31, 2011, $3.0 million from June 30, 2011 to March 31, 2012, $3.5 million from June 29, 2012 to March 31, 2013, approximately $4.5 million from June 28, 2013 to March 31, 2014, and approximately $6.1 million from June 30, 2014 to December 31, 2014. On the maturity date, we must pay all outstanding principal remaining on the term loan facility, together with all accrued and unpaid interest thereon.

We may be required to make mandatory prepayments under the credit facilities in the event of certain asset sales, upon the issuance of certain debt or equity securities, including an initial public offering of our common stock, in the event of receipt of certain net insurance proceeds or net condemnation proceeds, or, depending on our total leverage ratio, in the event of excess cash flow (as defined in the credit agreement). As described in “Use of Proceeds,” we intend to repay approximately $23.7 million of the outstanding amounts under our term loan facility with proceeds from this offering.

Borrowings under our credit facilities bear interest based on either, at our option, the base rate for base rate loans or LIBOR for LIBOR loans, in each case plus the applicable margin stipulated in the credit agreement. The base rate is the higher of (i) Wells Fargo’s prime rate, (ii) the federal funds rate (as defined in the credit agreement) plus 1.50% and (iii) the one month LIBOR rate (as defined in the credit agreement) plus 1.50%. The applicable margin for loans under our credit facilities, which are based on our total leverage ratio, range from 1.250% to 2.750% per annum for base rate loans and 2.250% to 3.750% per annum for LIBOR loans.

Interest on base rate loans is payable quarterly in arrears and interest on LIBOR loans is payable either monthly or quarterly depending on the interest period selected by us. All amounts that are not paid when due under our credit facilities will accrue interest at the rate otherwise applicable plus 2.00% until such amounts are paid in full. Borrowings under the credit facilities bore interest at a weighted average rate of 4.16% per annum and ranged between 4.00% and 6.00%, in each case, including the applicable margin, at April 29, 2010.

 

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We are required to pay a commitment fee for the unused portion of the revolving loan facility that is based on our total leverage ratio, ranging from 0.375% to 0.500% per annum, and is payable in arrears on the last business day of each quarter. There are no scheduled reductions of commitments under the revolving loan facility.

Our obligations under the credit facilities are secured by a first priority lien on substantially all of our tangible and intangible assets and the tangible and intangible assets of our wholly-owned subsidiaries, except for the assets of ConsumerHealth, including a first priority pledge of all capital stock of each of our wholly-owned subsidiaries, except for ConsumerHealth.

The credit facilities contain customary restrictive covenants that, among other things, limit our ability to incur and pay certain indebtedness; to create, incur, or assume certain liens and negative pledges; to sell, lease, convey, transfer or otherwise dispose of certain assets; to merge or consolidate with or into another; to liquidate or dissolve any of our subsidiaries; to make certain loans and investments; to make certain dividends and redemptions; to substantially change the nature of our business; to engage in certain transactions with affiliates; and to enter into or amend certain agreements. We are also required to comply with limitations on our capital expenditures and comply with certain financial ratios, including a leverage ratio and fixed charge coverage ratio. As of March 31, 2010, we were in compliance with all covenants under our credit facilities.

Prior Credit Facilities. Prior to the refinancing of our credit facilities in February 2010, we had outstanding first lien and second lien credit facilities. The first lien facility consisted of a revolving loan facility and a first lien term loan and our second lien credit facility consisted of a second lien term loan. As of December 31, 2009, we had $77.6 million outstanding under our first lien term loan, $62.5 million outstanding under our second lien term loan and no amounts outstanding under our first lien revolving loan facility. The maximum borrowing under the revolving loan facility was $20.0 million.

Our obligations under our first lien credit facility and second lien credit facility were secured by a first-priority lien and second-priority lien, respectively, on substantially all of our assets, except for the assets of ConsumerHealth, which was not party to the first and second lien credit facilities.

Borrowings under the credit facilities had interest rates per annum based on either, at our option, (i) the base rate or (ii) LIBOR, in each case, plus the applicable margin specified in the credit facility. The base rate was the higher of (a) the prime rate published in The Wall Street Journal or (b) the Federal Funds Rate plus 0.5%. Selection of LIBOR was subject to a minimum floor of 3.0% plus the applicable margin per annum. The applicable margin for our first lien credit facility changed based on our then current leverage ratio and ranged from 3.0% to 3.5% when base rates were selected and 4.25% to 4.75% when LIBOR was selected. The applicable margin for our second lien term loan was 7.0% when base rates were selected and 8.25% when LIBOR was selected. At December 31, 2009, our first lien term loan bore interest of 6.25% per annum, including the applicable margin, and our second lien term loan bore interest of 10.25% per annum, including the applicable margin.

The first and second lien credit facilities contained customary restrictive covenants that, among other things, limited our ability to incur indebtedness or repurchase equity, to make certain loans and investments, to sell, transfer, license, lease or dispose of certain assets, to merge or consolidate with or acquire other companies, to issue dividends without prior approval, to engage in certain transactions with affiliates and to substantially change the nature of our business. We were also required to comply with limitations on our capital expenditures and meet certain specified adjusted EBITDA levels (as defined in the credit facilities) and financial ratios, including a leverage ratio and a fixed charge coverage ratio. Adjusted EBITDA as presented in this prospectus differs from adjusted EBITDA as defined under our credit facilities. For purposes of our credit facilities, we added back (in addition to the adjustments shown in this prospectus) construction period rent expenses and board of directors’ fees to net (loss) income attributable to Smile Brands Group Inc. As of December 31, 2009, we were in compliance with all covenants under our first and second lien credit facilities.

 

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Capital Leases. In October 2008, we entered into an agreement to lease certain equipment, with payments commencing in March 2009 and maturing in February 2014. The agreement includes provisions that allow us to prepay the obligation without penalty and the option to purchase the equipment for $1 once the lease obligation is paid in full.

Interest Rate Swap Agreements. In February 2010, we repaid our interest rate swap agreement and interest rate collar agreement. The interest rate swap agreement fixed LIBOR at 4.77% on $25.0 million of our variable rate debt under our first lien and second lien credit facilities. The interest rate collar agreement protected us from fluctuations in the LIBOR interest rate on $25.0 million of our variable rate debt under our first lien and second lien credit facilities. The interest rate collar agreement included an interest rate floor of 4.17% and ceiling of 5.5%. The interest rate swap and collar did not qualify as hedges for accounting purposes and accordingly all changes in their fair value were recorded in income. The agreement governing our new credit facilities requires that we enter into one or more interest rate swap agreements with financial institutions by June 26, 2010. If our initial public offering is completed prior to June 26, 2010, the interest rate swap agreements must provide coverage for at least 25% of the then existing aggregate principal amount of the term loan facility. If our initial public offering is not completed prior to June 26, 2010, the interest rate swap agreements must provide coverage for at least 50% of the then existing aggregate principal amount of the term loan facility until the consummation of our initial public offering, at which time, we can then provide coverage for at least 25% of the then existing aggregate principal amount of the term loan facility.

Expected Use of Cash Flows. We believe that our cash on hand, cash provided by operating activities and borrowings under our new revolving loan facility will be sufficient to permit us to fund our contractual obligations and operations for at least the next twelve months.

We have used, and expect to continue to use, a significant portion of our capital resources to open de novo offices. We expect future de novo offices will be funded from internally generated cash flows, amounts available under our revolving loan facility, and the proceeds of future equity or debt offerings or refinancings. Our ability to open de novo offices may be impaired if we are unable to obtain funding from these capital sources when needed and on terms acceptable to us. As a result, we may not be able to increase our revenues at the same rate as we have in recent years.

Contractual Obligations and Contingencies

We have certain cash obligations and other commitments, which will impact our short- and long-term liquidity. As of December 31, 2009, our contractual cash obligations were as follows (in thousands):

 

Contractual Obligations

   Total    Less than
1 Year
   1-3
Years
   3-5 Years    After 5
Years

Long term loans payable (including interest)

   $ 167,193    $ 15,283    $ 35,743    $ 48,151    $ 68,016

Operating leases

     109,870      23,159      39,651      25,552      21,508

Capital leases (including interest)

     1,737      438      829      470      —  
                                  

Total contractual cash obligations

   $ 278,800    $ 38,880    $ 76,223    $ 74,173    $ 89,524
                                  

In the table above, long term loans payable reflects the principal amount outstanding under our prior first lien and second lien credit facilities of $140.0 million as of December 31, 2009, but reflects payments of the principal amount based on the amortization schedule under the new credit facilities. Interest on long term loans payable in the table above reflects the amount of interest that is expected to be paid under the new credit facilities that we entered into on February 25, 2010, except for the period from December 31, 2009 to February 25, 2010, which reflects the amount paid under our prior credit facilities of approximately $2.7 million during that period.

We lease all of our offices under operating leases. Some of these leases are with the owners of the professional corporations that control the affiliated dental group. Total rent expense, net of sublease income, was approximately $22.1 million, $22.9 million and $23.6 million for the years ended December 31, 2007, 2008 and 2009, respectively.

 

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Off Balance Sheet Arrangements

Other than operating leases, we do not have any off balance sheet arrangements. A summary of our operating lease obligations by fiscal year is included in “—Contractual Obligations and Contingencies.” Additional information regarding our operating leases is available in Note 7, Commitments and Contingencies, and Note 10, Commitments and Contingencies, to our consolidated financial statements for the three months ended March 31, 2010 and the year ended December 31, 2009, respectively, included elsewhere in this prospectus.

Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market risk is currently confined to our cash and cash equivalents and changes in interest rates related to borrowings under our credit facilities. Because of the short-term maturities of our cash and cash equivalents, we do not believe that an increase in market rates would have any significant impact on the realized value of our investments. We are not exposed to the impact of foreign currency or commodity price fluctuations.

As described under “—Liquidity and Capital Resources—Outstanding Indebtedness—Interest Rate Swap Agreements,” we no longer have interest rate swap agreements at March 31, 2010. We are exposed to changes in interest rates on our variable rate credit facilities that are not hedged with our interest rate swap agreements. A hypothetical 10% increase in the interest rates applicable to our credit facilities for the three months ended March 31, 2010, assuming we have no amount outstanding under our revolving credit facility and have not entered into any interest rate swap agreements, would have increased interest expense by approximately $0.6 million per year. Conversely, a hypothetical decrease in the interest rates applicable to our credit facilities for the three months ended March 31, 2010, assuming we have no amount outstanding under our revolving credit facility and have not entered into any interest rate swap agreements, would have decreased interest expense by approximately $0.6 million per year.

Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board, or FASB, issued FIN No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, which has since been incorporated into Accounting Standards Codification Topic, or ASC 740. This pronouncement prescribes a recognition threshold and measurement criteria for the recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The guidance was effective for fiscal years beginning after December 15, 2008 for nonpublic enterprises. We retroactively adopted ASC 740 as of January 1, 2007 with immaterial impact on our consolidated financial position, results of operations, and cash flows. We accounted for uncertain tax positions through December 31, 2006 in accordance with ASC 450-10, Accounting for Contingencies.

In January 2009, we adopted ASC Topic 805-10 Business Combinations, or ASC 805. ASC 805 establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their fair values as of the acquisition date. ASC 805 significantly changes the accounting for business combinations in a number of areas including the treatment of contingent consideration, preacquisition contingencies, transaction costs, in-process research and development and restructuring costs. In addition, under ASC 805, changes in an acquired entity’s deferred tax assets and uncertain tax positions after the measurement period will impact income tax expense. ASC 805 provides guidance regarding what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. ASC 805 is effective for fiscal years beginning after December 15, 2008, with early application prohibited. Adoption of ASC 805 had no impact on our pre-tax earnings. However, in 2005, in connection with the acquisition of Smile Brands, a valuation allowance of $20.9 million was placed on certain acquired deferred tax assets. This valuation allowance was reduced in 2009 in accordance with ASC 805. See Note 8 to our consolidated financial statements for the year ended December 31, 2009 contained elsewhere in this prospectus.

 

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On January 1, 2009 we adopted ASC 810-10-65-1, Noncontrolling Interests in Consolidated Financial Statements, or ASC 810, which amends Accounting Research Bulletin No. 51 Consolidated Financial Statements. This standard requires noncontrolling interests to be treated as a separate component of equity, but apart from the controlling party’s equity, and not as a liability or other item outside of equity. This standard also specifies that consolidated net income attributable to the controlling and noncontrolling interests be clearly identified and presented on the face of the consolidated statement of operations, and that changes in the controlling party’s ownership interest while it retains a controlling financial interest should be accounted for as equity transactions. This standard also expands disclosures on the financial statements to include a reconciliation of the beginning and ending balances of the equity attributable to the controlling and non-controlling owners and a schedule showing the effects on the controlling party’s equity attributed to changes in the controlling party’s ownership interest in the subsidiary. This standard is effective, on a prospective basis, for fiscal years beginning after December 15, 2008. However, presentation and disclosure must be retrospectively applied to comparative financial statements. Accordingly, we retroactively adopted ASC 810-10-65-1 as of January 1, 2006. The adoption of this standard has not had a material impact on our consolidated financial statements; however, it has changed the presentation of minority interests in our consolidated financial statements.

In March 2008, the FASB issued ASC Topic 815, Disclosure about Derivative Instruments and Hedging Activities—An Amendment of FASB Statement No. 133, or ASC 815, which enhances the current guidance on disclosure requirements for derivative instruments and hedging activities. This statement requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. Specifically, ASC 815 requires disclosure about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under ASC 815 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flow. This statement requires qualitative disclosure about the objectives and strategies for using derivatives in terms of the risks that the entity is intending to manage, quantitative disclosures about fair value amounts of gains and losses on derivative instruments in a tabular format, and disclosures about credit-risk-related contingent features in derivative agreements to provide information on potential effect on an entity’s liquidity from using derivatives. The derivative instruments will be distinguished between those used for risk management purposes and those used for other purposes. ASC 815 is effective for fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008, with early application encouraged. We adopted ASC 815 effective January 1, 2009. As ASC 815 provides only disclosure requirements, the adoption of this standard has had no impact on our results of operations, cash flows or financial position.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events, which has since been incorporated into ASC Topic 855 (“ASC 855”). The objective of ASC 855 is to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Entities are required to disclose the date through which subsequent events were evaluated as well as the rationale for why that date was selected. ASC 855 is effective for interim and annual period ending after June 15, 2009. We adopted ASC 855 during the period ended September 30, 2009.

In June 2009, the FASB issued FAS No. 167, Amendments to FASB Interpretation No. 46(R), which has since been incorporated into ASC Topic 810-10 (“ASC 810-10”). ASC 810-10 requires ongoing assessments using a primarily qualitative approach rather than the quantitative-based risks and rewards calculation in determining which entity has a controlling interest in a variable interest entity. In addition, an additional reconsideration assessment should be completed when an event causes a change in facts or circumstances. Lastly, ASC 810-10 requires additional disclosures about an entity’s involvement in variable interest entities. ASC 810-10 is effective for fiscal years beginning after November 15, 2009, and interim periods within that first annual reporting period. We adopted the standard effective January 1, 2010 and concluded that consolidation of our affiliated entities is required as described further under Basis of Consolidation in Note 2 of our consolidated financial statements for the three months ended March 31, 2010 contained elsewhere in this prospectus.

 

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BUSINESS

Overview

We are the largest provider of support services to general and multi-specialty dental groups in the United States based on number of dental offices. We provide comprehensive business support services, non-clinical personnel, facilities and equipment through our exclusive agreements with affiliated dental groups. Our consumer-driven retail model is guided by the principle “SMILES FOR EVERYONE®”. This model attracts patients to affiliated dental groups by combining strong, recognizable brands, visible retail locations and extended office hours with affordable and comprehensive dental care. Utilizing our model, dentists spend more time caring for their patients and less time on the administrative, marketing and financial aspects of the dental practice while benefiting from a lower cost structure. Our services support more than 1,100 dentists and hygienists practicing in over 300 offices nationally.

Affiliated dental groups operate primarily under one of three brand names, Bright Now! Dental, Castle Dental or Monarch Dental, and are typically located in highly visible retail centers in some of the largest and fastest growing markets in the U.S. On average, each dental office is approximately 3,500 square feet and contains 11 dental operatories. The affiliated dentists and hygienists offer comprehensive, convenient and high quality dental, hygiene and specialty services such as orthodontics, oral surgery, endodontics, periodontics and pediatrics.

The $102 billion U.S. dental services industry is growing and highly fragmented and services are provided mostly by sole practitioners. Dental care patients tend to be price sensitive because many pay for a significant portion of their dental services on an out-of-pocket basis. Additionally, approximately 30% to 50% of the U.S. adult population does not seek regular dental care. To address these market opportunities, we have developed a cost-effective, consumer-driven, retail model that we believe provides meaningful benefits to both affiliated dentists and their patients.

Our consumer-driven, retail model drives patient flow to affiliated dental groups by creating brand awareness through the use of highly visible office locations and traditional retail-oriented marketing techniques. In addition, we maximize our operational efficiencies through our national infrastructure that utilizes our size and the local market density of affiliated dental groups. Our two call centers and three centralized billing offices, each with specialized personnel and sophisticated technology, improve our ability to schedule patient appointments, provide consistent customer service and optimize billing and collection efforts. We actively manage the supply chain with our affiliated dental groups to utilize our purchasing volume to obtain favorable pricing on products and services. The operational efficiencies generated by our model enable us to leverage our operating costs and provide affiliated dentists with additional capacity to spend more of their time treating patients. These efficiencies lead to a lower cost structure that provides affiliated dental groups greater flexibility to price their dental services competitively within their local market.

Our affiliated dentists offer patients affordable yet comprehensive treatment plans along with access to financing alternatives as needed. At the same time, multiple offices within a market provide patients flexibility and convenience in scheduling appointments. Over the last three years, our marketing services have generated an average of 444,000 new patients per year for affiliated dental groups. These patients are typically from middle-income households and often have not been receiving regular dental care.

We were incorporated in Delaware in 2005 for the purpose of acquiring Smile Brands Inc. (formerly Bright Now! Dental, Inc.) and its subsidiaries, which was founded in 1998 through the acquisition of three west coast DPM support services organizations and grew through the acquisitions of Monarch Dental in February 2003 and Castle Dental in June 2004. In May 2005, Freeman Spogli & Co. purchased a controlling interest in us and after this offering will continue to beneficially own approximately 45.6% of our outstanding common stock.

 

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The Dental Services Industry

Overview

The U.S. dental services industry is large, growing and highly fragmented, with approximately 84% of dentists working either as a sole practitioner or in a practice with only one other dentist. According to the Centers for Medicare and Medicaid Services, or CMS, dental services expenditures in the U.S. are projected to be $106 billion in 2010 and are expected to reach $161 billion by 2018. The dental services industry, however, is characterized by factors that differentiate it from the broader healthcare services industry. The dental services market tends to be more consumer-driven than the healthcare services industry because most patients pay for a significant portion of their dental expenditures out-of-pocket. In addition, opportunities to achieve economies of scale often found in the broader healthcare services industry are less prevalent for the sole practitioners and small dental practices that comprise a significant majority of the dental services industry.

Factors Contributing to Continued Growth of the Dental Services Industry

We believe that demand for dental services will continue to grow as a result of the following key drivers.

 

   

An aging population. According to the U.S. Census Bureau, the 55 and over age group is the fastest growing segment of the population and is expected to grow 46.8% from the year 2010 to 2030. As people retain their teeth into later stages of life due to improvements in dental care, better hygiene and nutrition awareness, dental procedures and dental prosthetics, such as crowns and implants, are expected to increase.

 

   

An increased awareness of perio-maintenance and hygiene. Research suggests a strong link between periodontal disease and cardiovascular disease due to increased bacterial levels in the mouth. Because the National Institute of Health estimates that approximately 80% of individuals have some level of periodontal disease and the U.S. government has mounted a public awareness campaign to warn the public of the risks of periodontal disease, demand for preventative dental care is expected to increase as the risks become more commonly known.

 

   

Improved dental technology and increased demand for procedures. Improvements in technology and procedures are increasing the efficiency and availability of dental work and decreasing the discomfort associated with dental procedures, which is expected to increase demand for general and specialty dental services. In addition, the number of cosmetic dental procedures is expected to grow as a result of increased consumer awareness and acceptance of the benefits of cosmetic dentistry.

 

   

An increased use of dental insurance plans. The dental services industry has experienced an increase in insurance payment arrangements as more employers are adding dental insurance to the benefits packages offered to their employees. As a greater number of individuals become insured under third party dental health payment arrangements, it will likely increase the number of preventive care visits and result in a greater utilization of general and specialty dentistry services.

Differentiating Factors from the Broader Healthcare Services Industry

The dental services industry’s consumer-driven nature and patient payment profile differentiates it from the broader healthcare services industry. According to CMS, consumer out-of-pocket expenditures accounted for 44% of payments for dental services in 2008, compared to 12% for other medical services. In addition, according to CMS, private sources finance 93% of all dental expenditures, with only 7% of dental costs financed by government programs, including Medicare and Medicaid.

More recently, the dental services industry has experienced an increase in insurance plans, which are often provided by employers seeking enhanced benefits for their employees. As employers have offered more dental benefit choices, employees have elected to increase their dental coverage, recognizing dental health as a bigger piece of their overall personal healthcare. According to the National Association of Dental Plans, the number of

 

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Americans covered by dental benefit plans has increased 13.5%, from 153 million in 1999 to 174 million in 2007. Due to the increase in number of people covered by insurance plans, we expect patient flow and procedures to continue to rise. As opposed to other healthcare services subsectors where insurance pricing pressures and other limitations affect the profitability of the medical providers, we view the increase in plans for dental services as a positive development. This trend leads to greater utilization of dental services that would otherwise be paid for on an out-of-pocket basis.

From a dental provider perspective, the dental services sector is also differentiated from the broader healthcare services industry. Due to various factors, including less pressure to consolidate from third party payors, dentists in the U.S. have not formed practice groups as aggressively as other physicians, and the segment continues to remain highly fragmented. According to the ADA, approximately 84% of dentists work either as a sole practitioner or in a practice with only one other dentist. This practice structure puts additional burdens on the sole practitioner or small dental group as there are typically substantial capital investments required to open a practice. As the costs associated with individual practices continue to rise, we believe that the number of dentists operating within a DPM support services organization, like ours, will continue to grow.

The Dental Practice Management Support Services Model

A DPM support services organization generally provides a professional management team that is separate from the dental group to handle non-clinical functions, such as marketing, staffing, scheduling and billing, along with access to facilities and equipment. This adds capacity to the number of patients a dentist can treat and enables a dentist to focus on providing high quality dental services and enhancing his or her professional development. Currently, only a small portion of the dental services in the U.S. are provided by dentists affiliated with DPM support services organizations. We believe opportunities exist for DPM support services organizations to support a larger portion of the dental services industry due to the factors described below:

Access to underserved demographic sectors. We believe the DPM support services model allows affiliated dental groups to access underserved portions of the dental industry. For example, according to the ADA, cost was the most cited reason for why persons did not regularly visit a dentist. Many DPM support services organizations like us provide affiliated dental groups with the ability to offer patients payment plans and other financing alternatives that mitigate the out-of-pocket cost burden on the patients. In addition, a DPM support services model that relies on a retail-branded strategy can help affiliated dental groups attract new patients through extensive marketing and the use of recognizable brand names.

Decreased complexity and cost of establishing a dental practice. Recent dental school graduates generally have limited experience establishing or operating a dental practice. According to the American Dental Education Association, graduating dental students in 2007 had debt that, on average, exceeded $150,000. As a result, it is both logistically and financially challenging for a dentist, within the first few years after graduation, to build or buy a dental practice, which the ADA estimated in 2006 could cost an average of $573,000. The DPM support services model minimizes, and in some cases eliminates, capital investment on the part of the dentist, thus alleviating the significant cash outlay by the dentist and providing an attractive alternative to dentists who recently graduated or are seeking to change where they practice dentistry. In addition, the DPM support services model reduces the barriers to establish a dental practice by providing both new and experienced dentists with DPM support services such as marketing support to establish patient flow, management information systems to track operational and financial information, training and continuing education to increase the dentist’s knowledge of new procedures, and a platform to share best practices across affiliated dental groups.

Lower operating cost structure. We estimate that a sole practitioner has a ratio of operating costs to revenues of 65% to 75%. In comparison, we estimate the ratio of operating costs to revenue for a practice supported by a DPM support services organization to be 50% to 55%. The DPM support services model provides economies of scale by leveraging, among other things, infrastructure investment, supply and equipment purchasing, and marketing, over multiple offices, giving dentists additional flexibility in pricing their services to attract new patients and to maintain and foster relationships with existing patients.

 

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Shift in gender profile. Since the mid-1970s, women have begun to enroll in dental schools and, subsequently, enter into dental practices in increasing numbers. According to the ADA, female dentists represented approximately 20.6% of practicing dentists in 2007. The percentage of female dentists is projected to increase to 29% of practicing dentists in 2020. Historically, a higher percentage of female dentists seek part-time work compared to male counterparts and the gender shift implies that a higher percentage of the overall dentist population will seek part-time work scheduling. A DPM support services organization with multiple affiliated dentists makes it easier to accommodate part-time working hours as dentists can share working hours with each other.

Our Competitive Strengths

We believe the following competitive strengths contribute significantly to our success and position us for growth:

Retail, consumer-driven approach. We utilize strong, recognizable brands and a retail approach to drive patient flow to affiliated dental offices. We typically support several dental offices within a particular market and locate them in highly visible retail centers. Multiple offices in a market increase the ability of affiliated dental groups to attract and retain patients because most patients travel only a few miles to their dentists. We drive brand awareness through prominent signage on dental offices and through highly targeted marketing initiatives. Patients also have flexibility in scheduling appointments because most affiliated dental offices maintain extended hours and offer patient care six days per week within a given market.

We believe the time dentists affiliated with us save by not having to attend to administrative duties allows them to spend more time treating and educating patients on the benefits of completing a comprehensive dental care plan. All aspects of a comprehensive dental care plan, which may include specialty services such as endodontic or periodontal work, typically can be conveniently fulfilled through affiliated dentists within a single market. In addition, affiliated dentists are able to attract and serve more patients by having the ability to accept multiple forms of payment and offer discount plans, payment plans and other financing alternatives, including credit to qualified patients. By spending the time to help patients understand their long-term dental goals and providing comprehensive services at affordable prices, we believe patients are more likely to follow their dental care plan and request the specialty services recommended by their dentists. We believe this approach has resulted in strong brand recognition and a favorable patient experience with the addition of an average of 444,000 new patients per year over the last three years. Additionally, we have increased the number of recall patient exams by 2.0%, 4.8% and 7.5% for the years ended December 31, 2007, 2008 and 2009, respectively.

Leading market positions in large and growing markets. We support affiliated dental groups located primarily in 21 designated market areas, or DMAs, in the United States, including 13 of the 20 largest DMAs. Our affiliated dental groups have a significant presence in most of these markets, including Los Angeles, Dallas and Houston, which represent three of the nation’s top ten DMAs. The concentrated presence of affiliated dental groups within the markets we serve increases the effectiveness and efficiency of our marketing efforts through the use of direct mail, billboard, internet, print, local radio and television advertisements. This market presence and these techniques enable us to deliver 750 million consumer impressions annually.

Established national infrastructure driving a low cost operating structure. Our national infrastructure creates a low cost operating structure by centralizing administrative functions. We actively manage the supply chain for affiliated dental groups, which allows us to leverage our purchasing volume to obtain favorable pricing from third party vendors for dental office expenditures, such as dental equipment and supplies, lab fees, and marketing and advertising costs. For example, we believe we receive, on average, 20% to 30% discounts on dental equipment, supplies and lab fees as compared to the prices typically charged to sole practitioners.

In addition to direct costs savings, we achieve operational efficiencies by sharing best practices across affiliated dental groups and supporting these affiliated dental groups with two call centers and three centralized

 

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billing offices. We have a clinical board composed of PC owners and affiliated dentists that meets quarterly and shares ideas relating to, among other things, new dental procedures and techniques and new or improved dental materials and supplies. The affiliated dental groups are encouraged to implement any recommendations of the clinical board, but they are not required to do so. Our two call centers in Dallas, Texas and Fullerton, California handle over 50,000 calls monthly for affiliated dental groups, reducing the number of calls received directly by the dental offices and improving in-office service levels. By centralizing functions such as patient scheduling, billing, collections, accounting and finance, we are able to optimize the use of specialized personnel for these activities across a large group of offices and reduce the amount of staff required at the individual office level, while allowing the in-office staff to focus on tending to patient needs. Our success in leveraging our cost structure is demonstrated through our dental services profit margin, which represents total revenues less dental services expenses divided by total revenues. For the years ended December 31, 2007, 2008 and 2009, our dental services profit margin was 22.4%, 23.0% and 25.8%, respectively.

Proven track record of opening de novo offices with attractive unit economics. Since October 2003, we have supported affiliated dental groups in opening and successfully operating 87 de novo offices, which are new dental offices in existing markets or new markets. The roll-out of de novo offices allows us to leverage our existing management team and operating costs, utilize our knowledge of the local market to secure the most attractive retail sites, and to increase office density in a market to drive additional operating and marketing efficiencies. In general, de novos have yielded consistent financial performance and provided a controllable strategy to achieve growth that has produced highly attractive returns on invested capital. We have internally funded all of our de novo offices and on average these de novos were cash flow positive within four months with recovery of our investment within 30 months after the office opened.

Strong and proven management team. We are led by an experienced management team with an average of over 21 years of experience in either the healthcare services or retail industries. In addition, our chief executive officer and chief financial officer have worked together at Smile Brands Inc. for over 12 years and are responsible for our strategic and cultural development and our revenue and cash flow growth. Our management team has executed a successful de novo strategy that has resulted in the opening of 87 de novo offices since October 2003, while also successfully integrating the acquisitions of Monarch Dental (152 dental offices) and Castle Dental (74 dental offices).

Our Growth Strategy

We believe that our growth will result from the following elements of our business strategy:

Increasing revenues from existing offices. We have a proven track record of achieving growth in revenues from existing offices. Comparable office revenues increased by 5.4%, 3.2% and 1.3% for the years ended December 31, 2007, 2008 and 2009, respectively. We plan to continue assisting affiliated dental groups to increase existing office revenues by:

 

   

attracting new patients through our retail marketing efforts;

 

   

increasing the number of recall patients;

 

   

adding dentists and hygienists;

 

   

increasing patients’ completion of their diagnosed dental treatment plan;

 

   

introducing new specialty services and treatments; and

 

   

improving dentist and hygienist efficiency and productivity through technology and workflow enhancements.

Leveraging our scalable infrastructure to improve operating margins. We will continue to leverage our national infrastructure and the local market presence of affiliated dental groups to obtain favorable pricing from vendors and suppliers and to secure leases with attractive terms. We also plan to continue to centralize and streamline local office administrative work, such as patient scheduling, billing, collections, payroll and accounting. In addition, we have built a national infrastructure to support our de novo office roll-out and offices affiliated with other dental businesses we may acquire, which will allow us to further leverage our operating costs.

 

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Our scalable and integrated management information systems track daily operational and financial performance by office, such as patient visits, payor types, cash collections, revenues per visit, practitioner scheduling and service mix, so that we can identify and respond quickly to changes in a specific market and continue to improve our operating efficiency and productivity, as well as that of our affiliated dental groups.

Building de novo offices. We plan to increase our revenues and profitability by building de novo offices for affiliated dental groups in existing and new markets where we can leverage on our strong brand names and national infrastructure. We typically target locations in our affiliated dental groups’ largest markets and identify sites that support our retail-based strategy by focusing on de novo office locations with substantial street prominence, highly visible signage, the presence of desirable anchor stores, convenient access and high levels of vehicle and pedestrian traffic. Based on our historical results, we expect de novo offices to become cash flow positive within six months, with recovery of our investment typically occurring within 30 months after the office opens. Since October 2003, we have assisted our affiliated dental groups in opening 87 de novo offices. Based on our experience in providing support to dental offices, we believe we have the capacity to more than double the number of offices we support in our existing markets.

Selectively pursuing acquisitions. We expect to have opportunities in the future to identify and capitalize on complementary acquisitions, including acquisitions of other DPM support services organizations. We will continue to follow a highly disciplined approach when evaluating these opportunities. We have significant experience in identifying, acquiring and integrating other DPM support services organizations as we acquired Monarch Dental (152 dental offices) and Castle Dental (74 dental offices). These acquisitions enabled us to establish a presence in new markets and strengthen our position in existing markets.

 

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Affiliated Dental Groups

We provide business support services to affiliated dental groups operating in more than 300 offices nationally. The following table provides, as of March 31, 2010, a list of the DMAs we serve and the respective number of dental offices, operatories and affiliated dentists and hygienists in each.

 

DMAs(1)

   Number of
Dental
Offices
   Number of
Operatories(2)
   Number of
Dentists and
Hygienists(3)

Dallas

   55    717    198

Los Angeles(4)

   42    487    163

Houston

   31    382    82

San Antonio

   19    212    63

Tampa–Orlando(5)

   19    188    74

Northern California(6)

   15    173    49

Denver–Colorado Springs

   14    118    43

Austin–Waco

   14    165    66

Dayton–Cincinnati–Indianapolis

   12    70    41

Nashville–Chattanooga

   10    107    35

Portland

   9    97    46

Salt Lake City

   9    98    52

Phoenix–Tucson

   9    94    29

Washington, DC

   9    95    34

Little Rock–Fort Smith–Fayetteville(7)

   8    77    31

Seattle–Tacoma

   9    96    56

Cleveland–Akron

   6    91    54

Other

   14    126    56
              

Total

   304    3,393    1,172
              

 

(1)   A DMA is a geographic area defined by Nielsen Media Research based upon a particular television market. The number of dental offices in each DMA includes dental offices adjacent to the designated market area that utilize the same marketing campaigns and same management team.
(2)   An operatory is an individual area within the dental office that includes one dental chair and related equipment necessary to provide dental services.
(3)   Includes part-time and full-time dentists and hygienists.
(4)   Includes 14 dental offices that are operated through ConsumerHealth. See “—ConsumerHealth.”
(5)   Tampa–Orlando is composed of the following two DMAs: (a) Tampa–St. Petersburg–Sarasota and (b) Orlando–Daytona Beach–Melbourne.
(6)   Northern California is composed of the following three DMAs: (a) San Francisco–Oakland–San Jose, (b) Sacramento–Stockton–Modesto and (c) Fresno–Visalia.
(7)   Little Rock–Fort Smith–Fayetteville is composed of the following two DMAs: (a) Little Rock–Pine Bluff and (b) Fort Smith–Fayetteville–Springdale–Rogers.

Affiliated dental groups operate from dental offices that we lease from third parties under long-term operating leases. The dental offices are constructed to be attractive and inviting to patients and have, on average, eleven operatories. The dental offices generally include one lead dentist and up to three supporting dentists, three to four dental assistants, one to two hygienists and three to four front office personnel, but can vary depending on the number of operatories in the office. Nearly all of our markets have access to one or more specialists and larger markets generally have access to all or most of the following: orthodontists, oral surgeons, endodontists, periodontists, and/or pediatric dentists. These specialists typically work within four to eight offices in order to maximize each specialist’s utilization and productivity. All clinical activities are performed by or under the supervision of the dentists who are employed by or contracted with an affiliated dental group.

 

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Affiliated dental groups are operated by legal entities organized under state laws as professional corporations, or PCs. Each PC controls a single dental group, which employs or contracts with dentists, specialists and hygienists to provide dental services in multiple offices. Each PC is wholly owned by one or more licensed dentists. We do not own capital stock of any PC. We have agreements with the PC owners pursuant to which the PC owners are prohibited from selling, transferring or encumbering the ownership interests of the PC to a third party without our consent. In addition, our agreements with the PC owners give us the right to designate the licensed dentist to whom the owner of a PC must sell his or her ownership interest in the PC. We can designate a licensed dentist upon notice to the PC owner of our intent to exercise our right to require the transfer of a PC’s ownership interest. The total purchase price to be paid by the designated licensed dentist to the selling PC owner is set forth in the PC owner’s agreement with us. The purchase prices range from $10 to $1,000 and reflect the initial equity contribution by the PC owner, the expectation by the PC owner and us that no additional equity contribution will be required, the expected obligations of the PC for service fees and dentist compensation and the expected monthly stipend payable to the PC owner, the likelihood that the equity value at the time of sale will be greater or less than the initial equity contributed by the PC owner, and the expected price to be paid by a subsequent buyer that will assume the obligations of the PC owner.

Our rights with respect to the transfer of the ownership interests in, and designation of the owners of, the PC further the stability of the PC by assuring the integrity of its legal structure and its ability to sustain ongoing operations in the event of a change of ownership. If an event occurs that requires or leads to a change in the ownership of the PC, such as the retirement or death of the PC owner or the decision of a PC owner to move into a solo practice, these rights allow for a prompt, efficient and uninterrupted change of ownership, thereby sustaining the operations of the PC and preserving continuity for the dentists, hygienists and clinical staff of the PC and their patients.

Notwithstanding our rights regarding the transfer of the stock of PCs and the designation of owners of the PCs, we do not own any capital stock of any PC and we do not have any control over the clinical or professional decision making of the PCs or their professional staff. Under the terms of our business support services agreements, each PC retains full responsibility for all clinical decisions made by it and its professional staff and all other activities that are within the scope of the practice of dentistry, and we do not perform those activities. The ability of the PCs and us to operate under our business support services agreements is dependent on our mutual compliance with these corporate practice restrictions. We believe that the stock transfer restrictions are consistent with corporate practice restrictions because we can designate only individuals that are permitted to be PC owners under applicable state law and we can never have an ownership interest in the PC. In addition, the transfer restrictions and our rights regarding the designation of the PC owners do not allow us in any way to control the clinical decisions of the dental group and its professionals.

PCs generally compensate their dentists on a production-based model under which an individual dentist receives a percentage of the revenues attributable to the dentist. A PC owner, in addition to any compensation he or she may receive if the PC owner continues to treat patients, receives a fixed monthly stipend from the PC, which generally varies depending on the size of the PC and is intended to compensate the PC owner for his or her responsibility in leading, directing, managing and implementing the clinical decision making and related activities for the PC. The fixed monthly stipend is determined by the PC owner after first consulting with us and reviewing past practices and market compensation data. Also, PC owners who serve as their respective PC’s Market Dental Director receive supplemental fixed daily fees for the days such PC owner spends training and working with other licensed professionals within the PC to improve their clinical skills. The supplemental fees paid to the PC owner for serving as a Market Dental Director are determined in the same manner as the fixed daily fees paid to a Market Dental Director who is not a PC owner, which includes a review of past practices and market compensation data. See “—Training, Recruiting and Quality Assurance Programs” for additional information on the role of the Market Dental Director.

Our chief operating officer, Dr. Roy Smith, is the owner of eight PCs that provide dental services at 132 dental offices as of March 31, 2010, representing approximately 42%, 43%, 43%, 43% and 43% of our total

 

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revenues for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010, respectively. In addition, three of our employees, excluding Dr. Smith, are owners of an aggregate of four PCs that provide dental services at 57 dental offices as of March 31, 2010, representing approximately 19%, 20%, 21%, 21% and 22% of our total revenues for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010, respectively.

Business Support Services Agreements with the Professional Corporations

We have entered into a business support services agreement with each PC to provide on an exclusive basis all non-clinical services of the dental group. We anticipate that each new affiliated dental group will enter into a similar business support services agreement. We are generally responsible for the following services under these agreements:

 

   

providing offices and facilities, including dental equipment and office furnishings;

 

   

ordering and purchasing all dental equipment and supplies on behalf of affiliated dental groups;

 

   

performing all billing and collection services primarily through our centralized billing offices;

 

   

providing non-clinical personnel at each dental office;

 

   

recruiting, training and retaining all non-clinical personnel, such as front-office personnel and office administrators;

 

   

providing cash management services, including the management of deposit accounts in the name of, and on behalf of, the dental group;

 

   

providing bookkeeping, tax and financial reporting services;

 

   

establishing and administering accounting controls and systems;

 

   

preparing annual capital and operating budgets for the dental group;

 

   

implementing retail-oriented marketing and public relations programs; and

 

   

negotiating and executing on behalf of the PC certain agreements in connection with, and in furtherance of, our business support services.

The PCs and their dental groups are solely responsible for all clinical aspects of dentistry and the provision of dental services, including:

 

   

providing all dental treatment, evaluation, examination and diagnostic procedures and all referrals to appropriate dental specialists and other health care professionals;

 

   

employing and contracting with all licensed providers of dental related services, such as dentists, specialists, hygienists and dental assistants;

 

   

selecting dental equipment and supplies; and

 

   

ensuring the PC’s material compliance with all laws, rules and regulations relating to the professional activities of the dentists, specialists, hygienists and dental assistants and with the ethics and standard of care of the dental community in which the dental group operates.

In addition, after consulting with us, the PC establishes the hours of operation of the dental offices and the fees, charges, premiums and other amounts due from patients in connection with the delivery of dental services by affiliated dentists and specialists.

As compensation for our services under the business support services agreements, the PC pays us a monthly service fee based on the number of operatories located at its dental offices. Our service fee is negotiated with each PC and is not a standard fee among affiliated dental groups. We assess the adequacy of the service fee based

 

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on many factors, including the amount of capital invested in support of the PC, the number of de novo offices built and proposed to be built in the PC’s market, the amount of marketing and strategic initiatives implemented for the PC and its market, the time required of management and administrative personnel to support the PC’s operations and the profitability of the PC. We tend to adjust the fee in response to changes in these factors. We may review the service fee at any time to determine if any adjustments up to five percent per year should be made. In addition to our service fee, each PC reimburses us for all of the costs we incur while carrying out our obligations to the dental groups, such as the costs of non-clinical staff at the dental office, supplies, lab services, facilities, utilities, and other costs of dental office operations. The service fee we charge to affiliated dental groups is not reflected in our revenues presented in our consolidated financial statements, because the fee is eliminated in consolidation.

A PC may not generate sufficient revenues to cover our service fee in full after paying for its direct expenses and reimbursing us for our costs. In such instances, we allow the PC to defer the portion of its service fee owed to us for which it does not have sufficient revenues and we retain the right to be reimbursed for such shortfall if and when the PC generates excess revenues in subsequent years. Since our inception in 2005, we have deferred a portion of the service fees owed to us by each of the PCs. While the deferred service fees of individual PCs may increase or decrease from year to year, the annual aggregate amount of service fees deferred by us has ranged from $23 million to $67 million and each PC currently has a substantial deferred service fee balance with us. We do not charge interest for any deferred service fee. As security for the PC’s reimbursement to us of certain costs and for payment of our service fee, each PC has granted to us a security interest in its current and future assets (other than patient records and other assets that cannot be pledged under applicable law).

The PCs have also agreed to indemnify us for all liabilities, losses and expenses, including reasonable attorneys’ fees, caused by the performance of dental services or any other acts or omissions by the PC and/or its shareholders, directors, agents or employees during the term of such agreement.

Our business support services agreements generally have an initial term of five to ten years with successive automatic one-year renewal terms, unless terminated at least six months before the end of the initial term or any renewal term.

Additional Benefits Provided to Affiliated Dental Groups

In addition to the administrative and operational services enumerated in the business support services agreements, we provide the following additional benefits to affiliated dentists:

 

   

financing alternatives for affiliated dentists to offer their patients through arrangements with third party financing companies and by extending credit ourselves to qualified patients;

 

   

establishing guidelines for the selection, hiring and termination of the employees and contractors of the dental group;

 

   

a clinical board composed of PC owners and affiliated dentists that provides a forum for the sharing of “best practices” among affiliated dentists, feedback on the services we offer the dentists and recommendations for, among other things, future enhancements on our business support services;

 

   

call centers that improve the efficiency of the dental office by performing such functions as initial patient inquiries, entry of new patient data into the billing database and patient scheduling;

 

   

centralized billing offices that standardize and provide a single point of contact for billing and collection efforts with patients and insurance providers;

 

   

arranging for training of affiliated dentists and hygienists and providing training to non-clinical employees to ensure quality patient service; and

 

   

the use of monthly metrics to measure patient satisfaction, such as the percentage of return appointments.

 

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Employment Agreements and Independent Contractor Agreements with Affiliated Dentists and Specialists

Substantially all of the dentists and specialists practicing with affiliated dental groups have entered into employment agreements or independent contractor agreements with the PC that controls the dental group. The majority of these employment and independent contractor agreements can be terminated by either party without cause with up to 60 days’ notice or upon the occurrence of certain events that would render the dentist or specialist unfit or unable to legally practice dentistry. The agreements typically restrict such dentist’s or specialist’s solicitation of patients, staff and employees of the PC and may contain non-competition provisions for 12 months following such dentist’s or specialist’s termination within a specified geographic area, usually a specified number of miles from the affiliated dental office. We are not a party to any of these employment or independent contractor agreements. These non-solicitation and non-competition covenants may not be enforceable or may be significantly limited by the courts of the states in which we operate. See “Risk Factors—Risks Related to Our Business—If affiliated dental groups are unable to attract and retain qualified dentists, specialists and hygienists, their ability to attract and maintain patients and generate revenue could be negatively affected” and “—Our business support services agreements with affiliated dental groups could be challenged by a state or dentist under laws regulating the practice of dentistry.”

An affiliated dentist generally receives compensation from the PC based upon the percentage of revenues attributable to the dentist or, in certain cases, the greater of such percentage of revenue attributable to the dentist and a fixed amount. A specialist, other than an orthodontist, is generally compensated by the PC at the higher of the percentage of amounts attributable to such specialist for services rendered and a fixed amount. A PC will generally pay an orthodontist a fixed amount plus an amount based upon a percentage of the revenues, subject to a number of adjustments, attributable to the orthodontist. We do not determine the compensation level of dentists, specialists, including orthodontists, and hygienists. We assist PCs however in deciding compensation by providing them with market data relating to the compensation levels of dentists and specialists in the markets in which the PC operates and among our affiliated dental groups as a whole. We also can develop compensation models for the PCs that allow them to understand the impact on their profitability for different compensation levels and plans.

ConsumerHealth

ConsumerHealth, Inc. (dba Newport Dental) is our wholly owned subsidiary that operates as a staff-model dental health service plan licensed by the state of California under the provisions of the California Knox-Keene Health Care Service Plan Act of 1975, as amended, or the Knox-Keene Act. ConsumerHealth is considered a “mixed model” plan that provides dental services to its enrollees through its individual, group and Medicaid product lines and through agreements to service group enrollees of other dental health plans.

As of March 31, 2010, ConsumerHealth owned and operated a network of 14 staff-model dental facilities located in California, which o