10-Q 1 fm10q.txt FORM 10-Q FOR INTERDENT U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q.--QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________________ to _______________________ Commission file number: 000-25549 INTERDENT, INC. (Exact name of registrant as specified in its charter) Delaware 95-4710504 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 222 No. Sepulveda Blvd., Suite 740, El Segundo, CA 90245-4340 (Address of principal executive offices) (310) 765-2400 (Registrant's telephone number, including area code) No Change (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No As of July 17, 2002, 4,019,586 shares of the issuer's common stock were outstanding. PART I - FINANCIAL INFORMATION Item 1. Financial Statements INTERDENT, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Unaudited, in thousands, except share amounts)

See accompanying notes to condensed consolidated financial statements. InTERDENT, INC. and subsidiaries Condensed Consolidated Statements of Operations (Unaudited, in thousands, except per share amounts)

See accompanying notes to condensed consolidated financial statements. INTERDENT, INC. and subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited, in thousands)

See accompanying notes to condensed consolidated financial statements. INTERDENT, INC. and subsidiaries June 30, 2002 and 2001 Notes to Condensed Consolidated Financial Statements (Unaudited, in thousands, except per share and share amounts) (1) ORGANIZATION Headquartered in El Segundo, California, InterDent, Inc. ("InterDent" or the "Company") was incorporated on October 13, 1998 as a Delaware corporation to facilitate the business combination of Gentle Dental Service Corporation ("GDSC") and Dental Care Alliance ("DCA") that occurred in March 1999. Prior to the combination, GDSC and DCA were each publicly traded dental practice management companies since 1997. The Company is a provider of dental practice management services to multi-specialty dental professional corporations and associations ("PAs") in the United States. The Company provides management services to affiliated PAs under long-term management service agreements ("MSAs"). Under the MSAs, the Company bills and collects patient receivables and provides administrative and management support services. Each PA is responsible for employing and directing the professional dental staff and providing all clinical services to the patients. The dentists employed through the Company's network of affiliated dental associations provide patients with affordable, comprehensive dentistry services, which include general dentistry, endodontics, oral pathology, oral surgery, orthodontics, pedodontics, periodontics and prosthodontics. Through May 31, 2001, the Company provided management services to dental practices in selected markets in Arizona, California, Florida, Georgia, Hawaii, Idaho, Indiana, Kansas, Maryland, Michigan, Nevada, Oklahoma, Oregon, Pennsylvania, Virginia and Washington. Effective May 31, 2001, the Company completed the stock sale of Dental Care Alliance, Inc. ("DCA"), a wholly-owned subsidiary, and certain other assets in Maryland, Virginia, and Indiana, for $36.0 million less the assumption of certain debt and operating liabilities. The net sales proceeds were utilized to pay down existing borrowings under the credit facility. Also, the Company has retained an option to repurchase the division at a future date and entered into an ongoing collaboration agreement and license agreement to provide the Company's proprietary software. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The Company provides management services to the PAs under long-term MSAs that generally have an initial term of 40 years. Under the provisions of the MSAs, the Company owns the non-professional assets at the affiliated practice locations, including equipment and instruments, bills and collects patient receivables, and provides all administrative and management support services to the PAs. These administrative and management support services include: financial, accounting, training, efficiency and productivity enhancement, recruiting, marketing, advertising, purchasing, and related support personnel. The PAs employ the dentists and the hygienists while the Company employs or co-employs all administrative personnel. The Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board reached a consensus on the accounting for transactions between physician practice management companies and physician practices and the financial reporting of such entities (EITF issue number 97-2). For financial reporting purposes, EITF 97-2 mandates the consolidation of physician practice activities with the practice management company when certain conditions have been met, even though the practice management company does not have a direct equity investment in the physician practice. The accompanying condensed consolidated financial statements are prepared in conformity with the consensus reached in EITF 97-2. Simultaneous to the execution of an MSA with each PA, the Company also entered into a shares acquisition agreement ("SAA"). Subsequent to the sale of DCA, under all of the SAAs entered into except for one, the Company has the right to designate the purchaser (successor dentist) to purchase from the PA shareholders all the shares of the PA for a nominal price of a thousand dollars or less. Under these SAAs, the Company has the unilateral right to establish or effect a change in the PA shareholder, at will, and without consent of the PA shareholder, on an unlimited basis. Under EITF 97-2, the agreements with the PA shareholders qualify as a friendly doctor arrangement. Consequently, under EITF 97-2, the Company consolidates all the accounts of those PAs in the accompanying condensed consolidated financial statements. Accordingly, the condensed consolidated statements of operations include the net patient service revenues and related expenses of these PAs and all significant intercompany transactions have been eliminated. Each of the DCA SAAs entered into with the PAs did not have the nominal price provision. Also, subsequent to the DCA sale one remaining SAA entered into with a PA does not have the nominal price provision. Rather, the SAA purchase price is based upon a multiple of earnings, as defined. As a result, the agreements do not meet the criteria of consolidation under EITF 97-2 and the condensed consolidated statements of operations exclude the net patient service revenues and expenses of these PAs. Rather, the condensed consolidated statements of operations include only the Company's net management fee revenues generated and expenses associated with providing services under the MSAs. Liquidity The Company experienced losses attributed to common stock of $4,252 during the six months ended June 30, 2002 and for fiscal years 2001 and 2000, $35,080 and $48,712, respectively. These past significant losses included certain charges for asset impairments, disposition of DCA and certain other dental locations, and debt restructuring and debt extinguishments, which the Company believes are unusual in nature. Although the Company has experienced significant losses over the last two years due to these unusual charges, the Company's dental facilities continue to generate significant positive cash, as reflected in cash flows from operations of $7,244 for the six months ended June 30, 2002 and for fiscal years 2001 and 2000, $19,379 and $9,545, respectively. During 2001 the Company hired an advisor to review the Company's operations to determine whether improvements could be made, which could be implemented in the near and long term. The advisor, along with Company personnel, reviewed such strategies as revenue enhancements, modifications to managed care contracts, savings from procurement efficiencies, and reduction of headcount at dental office and corporate locations. As a result of this review, a number of initiatives to improve operations were implemented in late 2001 and early 2002. These initiatives are projected to increase cash flow in 2002 and in future periods through the Company's emphasis on increasing same store revenues and curtailing direct operating costs. Through June 30, 2002, the Company has met its earning projections. These initiatives and the projected improvements in operations and cash flows played a vital role in the Company's ability to negotiate modifications to its credit agreement that was consummated on April 15, 2002, as more fully described in Note 5. These modifications resulted in a permanent waiver of past covenant violations, and reset the covenants to levels, which the Company's projections indicate will be met through March 31, 2003. The Company also incurred certain fees and expenses, and the interest rate was increased by 1.0%. In addition, the principal amortization schedule was significantly modified such that approximately $20,700 of payments due through March 31, 2003 were deferred until the second quarter 2003, and only $7,907 of principal payments are due through June 30, 2003. The Company paid the $2,397 scheduled installment due April 1, 2002. The Company believes that it will be able to make all scheduled debt payments through March 31, 2003, and those due under its earn-out agreements, along with meeting its other obligations. Further, the Company has significant debt due beginning April 1, 2003, which must be refinanced, modified, or otherwise retired with the proceeds of other financing or capital transactions. There can be no assurance that the Company will meet its obligations through March 31, 2003, and that any such financing will be available or available on terms acceptable to the Company. Interim reporting The accompanying unaudited interim condensed consolidated financial statements of InterDent have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in annual consolidated financial statements have been condensed or omitted as permitted under those rules and regulations. We believe all adjustments, consisting only of normal, recurring adjustments considered necessary for a fair presentation, have been included and that the disclosures made are adequate to insure that the information presented is not misleading. To obtain a more detailed understanding of Company results, it is suggested that these financial statements be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2001 included in Form 10-K filed on April 16, 2002. The results of operations for the three and six months ended June 30, 2002 are not necessarily indicative of the results of operations for the entire year. Net revenues Revenues consist primarily of PA net patient service revenue ("net patient revenue") and Company net management fees. Net patient revenue represents the consolidated revenue of the PAs reported at the estimated net realizable amounts from patients, third party payors and others for services rendered, net of contractual adjustments. Net management fees represent amounts charged to the unconsolidated PAs in accordance with the MSA as a percentage of the PAs net patient service revenue under MSAs, net of provisions for contractual adjustments and doubtful accounts. Such revenues are recognized as services are performed based upon usual and customary rates or contractual rates agreed to with managed care payors. Net patient revenues include amounts received under capitated managed care contracts from certain wholly-owned subsidiaries that are subject to regulatory review and oversight by various state agencies. The subsidiaries are required to file statutory financial statements with the state agencies and maintain minimum tangible net equity balances and restricted deposits. The Company is in compliance with such requirements as of June 30, 2002. Total revenues subject to regulatory review and oversight by various state agencies were $24,897 and $23,407 for the six months ended June 30, 2002 and 2001, respectively. Accounts receivable Accounts receivable principally represent receivables from patients and insurance carriers for dental services provided by the related PAs at established billing rates, less allowances and discounts for patients covered by third party payor contracts. Payments under these programs are primarily based on predetermined rates. In addition, a provision for doubtful accounts is provided based upon expected collections and is included in practice selling, general and administrative expenses. These contractual allowances, discounts and allowance for doubtful accounts are deducted from accounts receivable in the accompanying condensed consolidated balance sheets. The discounts and allowances are determined based upon historical realization rates, the current economic environment and the age of accounts. Changes in estimated collection rates are recorded as a change in estimate in the period the change is made. Intangible assets Intangible assets result primarily from the excess of cost over the fair value of net tangible assets purchased. Such intangibles primarily relate to MSAs and goodwill associated with dental practice acquisitions. Intangibles relating to MSAs consist of the costs of purchasing the rights to provide management support services to PAs over the initial noncancelable terms of the related agreements, usually 25 to 40 years. The MSAs can be perpetually extended by virtue of the SAAs entered into by the Company with each PA. Under these agreements, the PAs have agreed to provide dental services on an exclusive basis only through facilities provided by the Company, which is the exclusive administrator of all non-dental aspects of the acquired PAs, providing facilities, equipment, support staffing, management and other ancillary services. The agreements are noncancelable except for performance defaults. Through December 31, 2001, the Company's intangible assets were amortized on the straight-line method, ranging from 5 years for service mark to 25 years for MSAs and goodwill. In July 2001, the FASB issued Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which became effective January 1, 2002. Under SFAS 142, goodwill and indefinite lived assets are no longer amortized but are reviewed annually for impairment. As a result, the Company's service mark, MSAs and goodwill intangible assets are no longer being amortized. The tests for measuring impairment under SFAS 142 are more stringent than previous tests required by Statement of Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." The Company is currently performing the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002. The Company has completed the first step of the two-step transitional impairment analysis required by SFAS 142. This analysis indicated that the carrying amount of the net assets of the Company exceeds the fair value. Preliminary results of the second step of the transitional impairment analysis indicates that an impairment charge totaling $50,000 to $100,000 will be required, although such analysis in not complete. The Company expects to complete this analysis in the fourth quarter of 2002. During 2002, the Company did not record amortization on its intangible assets as all such assets are determined to have indefinite lives. The following table reflects comparable pro forma results of operations for the three and six months ended June 30, 2002 and 2001 as though the adoption of the non-amortization provisions of SFAS 142 occurred as of January 1, 2001:

Long-lived assets The Company reviews its long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. To perform that review, the Company estimates the sum of expected future undiscounted net cash flows from assets. If the estimated net cash flows are less than the carrying amount of the asset, the Company recognizes an impairment loss in an amount necessary to write-down the assets to their fair value as determined from expected future discounted cash flows. No impairment of long-lived assets was recorded during the three and six months ended June 30, 2002 and 2001. Deferred compensation The Company made advances of $11,500 to certain officers of the Company and provided certain other officers with a minimum guarantee of the value of their stock options in order to retain and provide incentives to such officers. In connection with the advances, such officers issued interest-bearing notes payable to the Company. Shares of the Company's common stock and options owned by such officers have been pledged to secure the notes. The notes were included in shareholders' equity as a reduction to equity. Interest on the notes accrues at rates ranging from 6.4% to 10.2%. The notes and accrued interest are due June 2004, payable in cash or Company common stock and options with varying minimum values. The notes and accrued interest were with recourse to the officers until May or June of 2002, depending upon the individual note agreement, after which the notes and accumulated interest became non-recourse, subject only to the underlying pledged collateral. The difference in the amount of the notes and the value of the collateral at the date of the loans was being amortized over the life of the notes, representing stock compensation expense. The amortization reflected the deficit of the underlying pledged collateral on the individual note dates. The Company also adjusted the amortization to reflect changes in the quoted fair market value. The decline, if any, was amortized as stock compensation expense over the life of the notes. The amortization expense was adjusted cumulatively for changes in fair value of the collateral. Increases in the stock price, if any, resulted in a credit to expense, up to the amount of prior expense recognized for this portion of the notes. In addition, the minimum guarantee of the value of the stock options was being amortized as stock compensation expense. The total advance included loans to certain DCA officers. The non-amortized balance of the advances to DCA officers of $4,600 was sold in connection with the sale of DCA. Also, during the third quarter of 2001, the entire non-amortized balance of the remaining notes was written off as a result of the acceleration of the non-recourse provision of the note due from the former CEO and the significant decline in the underlying value of the pledged collateral, which is considered to be other than temporary. Also, in connection with the execution of an officer's amended employment agreement, a note receivable and related accrued interest of $182 were to be forgiven, subject to provisions of the agreement. The note and accrued interest were being expensed over the twenty-four month service period ending May 2002. During the third quarter of 2001, the remaining balance on the note was written off as compensation expense since the note was converted to non-recourse pursuant to the severance agreement with the officer. Net loss per share The Company has adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). In accordance with SFAS 128, the Company presents "basic" earnings per share, which is net income or loss divided by the average weighted common shares outstanding during the period, and "diluted" earnings per share, which considers the impact of common share equivalents. Dilutive potential common shares represent shares issuable using the treasury stock method. For the six months ended June 30, 2002, and 2001, dilutive potential common shares of approximately 2,250,000 and 2,850,000, respectively, consisting of convertible subordinated debt, convertible preferred stock, and the exercise of certain options and warrants have been excluded from the computation of diluted income per share as their effect is anti-dilutive. The following table summarizes the computation of net loss per share:

Segment reporting The Company has adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 supersedes SFAS 14, "Financial Reporting for Segments of a Business Enterprise", replacing the "industry segment" approach with the "management" approach. The management approach designates the internal reporting that is used by management for making operating decisions and assessing the performance as the source of the Company's reportable segments. The adoption of SFAS 131 did not have an impact for the reporting and display of segment information as each of the affiliated dental practices is evaluated individually by the chief operating decision maker and considered to have similar economic characteristics, as defined in the pronouncement, and therefore are aggregated. Income taxes Income taxes are accounted for under the asset and liability method in accordance with Statement of Financial and Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under the asset and liability approach of SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Income tax expense recorded for the three and six months ended June 30, 2002 and 2001 represents the Company's estimate of state income tax payable. The Company has a valuation allowance to offset the entire amount of federal and state tax benefit of loss carryforwards. Use of estimates In preparing the financial statements conforming to Generally Accepted Accounting Principals ("GAAP"), we have made estimates and assumptions that affect the following: o Reported amounts of assets and liabilities at the date of the financial statements; o Disclosure of contingent assets and liabilities at the date of the financial statements; and o Reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. New accounting pronouncements In July 2001, the FASB issued Statement of Financial Accounting Standard No. 141, "Business Combinations" ("SFAS 141"). SFAS 141 eliminates the pooling-of-interest method of accounting for business combinations and clarifies the criteria to recognize intangible assets separately from goodwill. SFAS 141 is effective for any business combination accounted for by the purchase method that is completed after June 30, 2001. The adoption of SFAS 141 is not expected to have any impact on the Company's financial position or results of operations. In July 2001, the FASB issued Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill and indefinite lived assets are no longer amortized but are reviewed annually for impairment. Separate intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to June 30, 2001, the provisions of SFAS 142 are effective upon its adoption effective beginning fiscal year 2002. The Company is currently performing the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002. The Company has completed the first step of the two-step transitional impairment analysis required by SFAS 142. This analysis indicated that the carrying amount of the net assets of the Company exceeds the fair value. Preliminary results of the second step of the transitional impairment analysis indicates that an impairment charge totaling $50,000 to $100,000 will be required, although such analysis in not complete. The Company expects to complete this analysis in the fourth quarter of 2002. In June 2001, the FASB issued Statement of Financial Accounting Standard No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, and development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. This Statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of SFAS 143 is not expected to have a significant impact on the Company's financial position or results of operations. In August 2001, the FASB issued Statement of Financial Accounting Standard No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for the Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001. The provisions of this Statement generally are to be applied prospectively. The adoption of SFAS 144 is not expected to have a significant impact on the Company's financial position or results of operations. Reclassifications Certain reclassifications have been made to the 2001 financial statements to conform to the 2002 presentation. (3) REVENUES Revenues consist primarily of PA net patient service revenue and Company net management fees. Net patient service revenue represents the consolidated revenue of the PAs at normal and customary rates from patients, third party payors and others for services rendered, net of contractual adjustments. Net management fees represent amounts charged under MSAs to the unconsolidated PAs on an agreed-upon percentage of the PAs net patient service revenue, net of provisions for contractual adjustments and doubtful accounts. The following represents amounts included in the determination of dental practice net patient service revenue and net management fees:

(4) DENTAL PRACTICE AFFILIATIONS AND DISPOSITIONS Dental practice affiliations In connection with certain completed affiliation transactions, the Company has agreed to pay to the sellers' future consideration. The amount of future consideration payable under earn-outs is generally computed based upon financial performance of the affiliated dental practices during certain specified periods. The Company accrues for earn-out payments with respect to these acquisitions when such amounts are probable and reasonably estimable. In addition to cash earn-out payments of $938 during the six months ended June 30, 2002, the Company also converted $1,067 in earn-out amounts due into long-term notes payable. As of June 30, 2002, future anticipated earn-out payments of $2,814 are accrued and included in other current liabilities. For those acquisitions with earn-out provisions, the Company estimates the total maximum earn-out that could be paid, including amounts already accrued, is between $5,000 and $6,000 from July 2002 to December 2005, which is expected to be paid in a combination of cash and notes. Dental practice dispositions Effective May 31, 2001, the Company completed the sale of its east coast division to Mon Acquisition Corp., a group led by Steven Matzkin, DDS, former president of the Company. The assets in the sale (the "East Coast Assets") included the stock of Dental Care Alliance, Inc. ("DCA"), a wholly-owned subsidiary, and assets used in the operation and management of certain dental practices in Maryland, Virginia and Indiana. The transaction also included the assets associated with the notes receivable made by officers of DCA as discussed in note 6. The total consideration was $36,000 less the assumption of related debt and operating liabilities. Upon the two-year anniversary of the transaction close, InterDent shall have the right to repurchase the East Coast Assets, based upon a multiple of earnings and subject to a minimum price, as defined in the agreement. In connection with the sale of assets, InterDent entered into a five-year license agreement dated May 16, 2001 and amended on May 31, 2001 effective June 1, 2001 for $2,554, payable in installments, for its proprietary practice management system, subject to negotiations for additional term extensions. Such amount has been recorded as deferred revenues and is being amortized over the life of the agreement. The parties also entered into the transition services agreement dated as of May 16, 2001 and a business collaboration agreement dated as of April 17, 2001 effective June 1, 2001 delineating the use of the practice management system, the joint purchase of supplies, the joint negotiation for managed care contracts, training systems and other similar operational matters. In the second half of 2001, the Company disposed of six under performing dental locations. The Company also disposed of one additional dental location in June 2002. (5) DEBT In April 2001, the Company entered into amendments to its existing senior revolving credit facility (the "Credit Facility") to amend certain covenants. In connection with the execution of the amendments, the banks waived the defaults under the Credit Facility that existed at December 31, 2000 due to failure to meet certain financial ratio covenants and reset all covenants for 2001 and subsequent years. Additionally, the banks agreed to certain other changes including a revised term and provisions regarding asset sales and new financing. As consideration for these modifications, the Company agreed to an amendment fee of $1,000, which was paid during the three months ended June 30, 2001, and an additional fee of $1,000 payable at maturity of the term loan if certain conditions are not met. The additional fee was paid in connection with an additional amendment to the Credit Facility consummated in April 2002, as discussed below. On October 1, 2001, the Credit Facility converted into a term loan, with required quarterly payments. On April 15, 2002, the Company entered into an amendment to the existing Credit Facility. In connection with the execution of the amendment, the bank agreed, among other things, to reset certain covenants and reduce the required future quarterly principal payments of $7,214, which began on October 1, 2001. In connection with these modifications, the Company accrued as note principal the remaining $1,000 due as a result of the amendment in 2001 as discussed above, which is payable upon maturity. The Company also agreed to an additional amendment fee of $1,000, with cash of $500 payable at closing and $250 to accrue as additional principal on July 1, 2002 and October 1, 2002, payable upon final maturity of the Credit Facility on September 30, 2003. The July 1 and October 1, 2002 accrual dates are subject to change, as outlined in the amendment. Principal amounts owed under the Credit Facility bear interest at LIBOR plus 7.50% or the prime rate plus 5.75%, at the Company's option. In addition to the cash interest charges outlined above, the Company is to pay an incremental PIK interest on the outstanding principal balance of 1.0% from April 15, 2002 though March 31, 2003, increasing to 2.0% from April 1, 2003 through maturity. The incremental PIK interest is payable upon maturity. The Company is also to pay a PIK fee equal to 1.0% of the outstanding principal balance on April 15, 2002, 2.0% on October 1, 2002, and 3.0% on April 1, 2003. PIK fees are payable upon maturity. Required principal installments are $2,397, which was paid on April 1, 2002, $300 due on July 1, 2002, October 1, 2002, January 1, 2003, and payments of $7,214 on April 1, 2003 and July 1, 2003, with the remaining balance due at maturity on September 30, 2003. The Credit Facility also has mandatory prepayment provisions for certain asset sale transactions and excess cash flows, as defined. These prepayment provisions are applied to future required quarterly installments. Accordingly, $207 of the $300 due on October 1, 2002 was paid in July as a result of the disposition of one dental location in June 2002. The Credit Facility contains several covenants, including but not limited to, restrictions on the Company's ability to incur indebtedness or repurchase shares, a prohibition on dividends without prior approval, prohibition on acquisitions, and fees for excess earnout and debt payments, as defined. There are also financial covenant requirements relating to compliance with specified cash flow, liquidity, and leverage ratios. The Company's obligations, including all subsidiaries in the guarantees, under the Credit Facility are secured by a security interest in the equipment, fixtures, inventory, receivables, subsidiary stock, certain debt instruments, accounts and general intangibles of each of such entities. The 2002 amendment to the Credit Facility met the criteria of substantial modification as outlined under the provisions of EITF 96-19. As such, the amendment met the requirements of an extinguishment of debt. Accordingly, in the second quarter of 2002 the Company recorded an extraordinary loss of approximately $2,604. The extraordinary loss represents amendment fees of $2,000 incurred to extinguish the original Credit Facility and $604 for the write-off of the non-amortized portion of deferred financing costs associated with the original note agreement. Professional fees and bank PIK fees paid, or anticipated to be paid, of $5,902 for the execution of the amended Credit Facility have been capitalized and are being amortized over the remaining life of the Credit Facility. At June 30, 2002 $4,428 in anticipated future PIK fees are included in other current liabilities. In June 2000, the Company raised $36,500 from the sale of debt and equity to Levine Leichtman Capital Partners II, L.P. ("Levine") under a securities purchase agreement (the "Securities Purchase Agreement"). The equity portion of the transaction comprised 458,333 shares of common stock valued at $11,000. The debt portion of the transaction comprised a senior subordinated note with a face value of $25,500 (the "Levine Note"). As part of the transaction with Levine, the Company also issued a warrant to purchase 354,167 shares of the Company's common. In April 2001, the Company entered into an amendment to the Levine Note that met the criteria of substantial modification as outlined in EITF 96-19. As such, the Levine Note was considered extinguished, with a new note issued in its place. In connection with the amendment, the lender waived the defaults under the Levine Note that existed at December 31, 2000 due to failure to meet certain financial ratio covenants and reset all covenants for 2001 and subsequent years, in addition to certain other modifications. As consideration for the amendment, the Company paid an amendment fee of $2,250, payable in additional notes, increased the payment-in-kind ("PIK") interest rate to 16.5% and reduced the price of the warrants from an initial strike price of $41.04 per share to $20.88 per share. In April 2002, the Company entered into an additional amendment to the Levine Note. In connection with the amendment, the lender reset all covenants for 2002 and subsequent years, in addition to certain other modifications. As consideration for the amendment, the Company has agreed to pay an amendment fee of $2,000, payable in additional notes and increase the PIK interest rate by one-half percentage point. The amendment fee has been capitalized and is being amortized over the remaining life of the Levine Note. The entire principal of the Levine Note is due September 2005 but may be paid earlier at the Company's election, subject to a prepayment penalty. Additionally, the Levine Note has mandatory principal prepayments based upon a change in ownership, certain asset sales, or excess cash flows. The Levine Note bears interest at 12.5%, payable monthly, with an option to pay the interest in a PIK note. The Company is currently issuing PIK notes at 17.0% for payment of current interest amounts owed. The Securities Purchase Agreement contains covenants, including but not limited to, restricting the Company's ability to incur certain indebtedness, liens or investments, restrictions relating to agreements affecting capital stock, maintenance of a specified net worth and compliance with specified financial ratios. In 1998, the Company issued $30,000 of subordinated convertible notes ("Convertible Notes"). The Convertible Notes mature June 2006 and currently bear interest at 8.0%, payable semi-annually with an option to pay the interest in a PIK note also bearing interest at 8.0%, which the Company is currently exercising for payment of current interest amounts due. In April 2001, the Company entered into an amendment to the Convertible Notes and the lender waived the cross-default provision that existed at December 31, 2000 due to the covenant violations under the Credit Facility and agreed to reset all covenants for 2001 and subsequent years, in addition to certain other modifications. As consideration for the amendment, the Company has agreed to reduce the conversion price of the notes. The Convertible Notes are convertible into shares of the common stock at $39.00 for each share of common stock issuable upon conversion of outstanding principal and accrued but unpaid interest on such subordinated notes and shall be automatically converted into common stock if the rolling 21-day average closing market price of the common stock on 20 out of any 30 consecutive trading days is more than $107.40 (6) SHAREHOLDERS' EQUITY The Company made advances of $11,500 to certain officers of the Company and provided certain other officers with a minimum guarantee of the value of their stock options in order to retain and provide incentives to such officers. In connection with the advances, such officers issued interest-bearing notes payable to the Company. Shares of the Company's common stock and options owned by such officers have been pledged to secure the notes. The notes were included in shareholders' equity as a reduction to equity. Interest on the notes accrues at rates ranging from 6.4% to 10.2%. The notes and accrued interest are due June 2004, payable in cash or Company common stock and options with varying minimum values. The notes and accrued interest were with recourse to the officers until May or June of 2002, depending upon the individual note agreement, after which the notes and accumulated interest became non-recourse, subject only to the underlying pledged collateral. The difference in the amount of the notes and the value of the collateral at the date of the loans was being amortized over the life of the notes, representing stock compensation expense. The amortization reflected the deficit of the underlying pledged collateral on the individual note dates. The Company also adjusted the amortization to reflect changes in the quoted fair market value. The decline, if any, was amortized as stock compensation expense over the life of the notes. The amortization expense was adjusted cumulatively for changes in fair value of the collateral. Increases in the stock price, if any, resulted in a credit to expense, up to the amount of prior expense recognized for this portion of the notes. In addition, the minimum guarantee of the value of the stock options was being amortized as stock compensation expense. The total advance included loans to certain DCA officers. The non-amortized balance of the advances to DCA officers of $4,600 was sold in connection with the sale of DCA. Also, during the third quarter of 2001, the entire non-amortized balance of the remaining notes was written off as a result of the acceleration of the non-recourse provision of the note due from the former CEO and the significant decline in the underlying value of the pledged collateral, which is considered to be other than temporary. Also, in connection with the execution of an officer's amended employment agreement, a note receivable and related accrued interest of $182 were to be forgiven, subject to provisions of the agreement. The note and accrued interest were being expensed over the twenty-four month service period ending May 2002. During the third quarter of 2001, the remaining balance on the note was written off as compensation expense based on the note being converted to non-recourse pursuant to the severance agreement with the officer. (7) CONTINGENCIES On November 28, 2000, the Court entered its Order of Related Cases with regard to an action previously filed by InterDent on September 28, 2000 in Los Angeles Superior Court Case No. BC237600, wherein InterDent alleged causes of action against Amerident for breach of contract, breach of the implied covenant of good faith and fair dealing, intentional misrepresentation and negligent misrepresentation. On October 18, 2000, Amerident Dental Corp. ("Amerident") filed a lawsuit against InterDent and Gentle Dental Management, Inc. seeking damages related to the July 21, 1999 sale of substantially all of the assets of ten dental practices in California and Nevada. On January 19, 2001, Amerident filed another action against InterDent and Gentle Dental Management, Inc. for Breach of a Promissory Note and related common counts, that action was similarly deemed related and consolidated with the earlier filed InterDent action. Discovery is ongoing. The trial began July 2002 and is currently in process. InterDent believes that this case is without merit and intends to vigorously defend all allegations. Accordingly, no liability for this suit has been recorded at this time. The Company has been named as a defendant in various other lawsuits in the normal course of business, primarily for malpractice claims. The Company and affiliated dental practices, and associated dentists are insured with respect to dentistry malpractice risks on a claims-made basis. Management believes all of these pending lawsuits, claims, and proceedings against the Company are without merit or will not have a material adverse effect on the Company's consolidated operating results, liquidity or financial position. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-looking and Cautionary Statements The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for certain forward-looking statements. Certain information included in this Form 10-Q and other materials filed with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) contain statements that are forward looking, such as statements relating to business strategies, plans for future development and upgrading, capital spending, financing sources, changes in interest rates, and the effects of regulations. Such forward-looking statements involve important known and unknown risks and uncertainties that could cause actual results and liquidity to differ materially from those expressed or anticipated in any forward-looking statements. Such risks and uncertainties include, but are not limited to: those related to the effects of competition; leverage and debt service; financing needs or efforts; actions taken or omitted to be taken by third parties, including the Company's customers, suppliers, competitors, and stockholders, as well as legislative, regulatory, judicial, and other governmental authorities; changes in business strategy; general economic conditions; changes in health care laws, regulations or taxes; risks related to development and upgrading systems; and other factors described from time to time in the Company's reports filed with the Securities and Exchange Commission. Accordingly, actual results may differ materially from those expressed in any forward-looking statement made by or on behalf of the Company. Any forward-looking statements are made pursuant to the Private Securities Litigation Reform Act of 1995, and, as such, speak only as of the date made. The Company undertakes no obligation to revise publicly these forward-looking statements to reflect subsequent events or circumstances Overview We are a leading provider of dental practice management services to multi-specialty dental professional corporations and associations ("PAs") in the United States. The dentists employed through our network of affiliated PAs provide patients with affordable, comprehensive, convenient and high quality dentistry services, which include general dentistry, endodontics, oral pathology, oral surgery, orthodontics, pedodontics, periodontics and prosthodontics. Through May 31, 2001, we provided management services to dental practices in Arizona, California, Florida, Georgia, Hawaii, Idaho, Indiana, Kansas, Maryland, Michigan, Nevada, Oklahoma, Oregon, Pennsylvania, Virginia and Washington. Effective May 31, 2001, we completed the sale of all of the common stock of Dental Care Alliance, Inc. ("DCA"), a wholly-owned subsidiary, and certain other assets in Maryland, Virginia, and Indiana. Total consideration was $36.0 million, less the assumption of related debt and operating liabilities. The net sales proceeds were utilized to pay down existing borrowings under our credit facility. We also have retained an option to repurchase the division at a future date and entered into an ongoing collaboration agreement and license agreement to provide our proprietary software. As of June 30, 2002 we provided management services to 140 dental offices that employ 536 dentists, including 105 specialists. We currently operate in Arizona, California, Hawaii, Idaho, Kansas, Nevada, Oklahoma, Oregon, and Washington. We have historically affiliated with PAs by purchasing the operating assets of those practices, including furniture and fixtures, equipment and instruments, and entering into long-term (typically 40 years) management service agreements ("MSAs") with the PAs associated with the practice. Under the terms of these agreements, we are the exclusive administrator of all non-clinical aspects of the dental practices, whereas the affiliated PAs are exclusively in control of all aspects of the practice and delivery of dental services. As compensation for services provided under the MSAs, we receive a management fee typically equal to the reimbursement of expenses incurred in operating the practice plus a percentage of the net revenues of the affiliated dental practice. As compensation for services provided under the MSAs, we receive management fees from our affiliated dental practices. Depending upon the individual MSA provisions, the management fee is calculated based upon one of two methods. Under one method, the management fee is equal to reimbursement of expenses incurred in the performance of our obligations under the management service agreements, plus an additional fee equal to a percentage of the net revenues of the affiliated dental practices. Under the other method, the management fee is a set percentage of the net revenues of the affiliated dental practices. The Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board reached a consensus on the accounting for transactions between physician practice management companies and physician practices and the financial reporting of such entities (EITF issue number 97-2). For financial reporting purposes, EITF 97-2 mandates the consolidation of physician practice activities with the practice management company when certain conditions have been met, even though the practice management company does not have a direct equity investment in the physician practice. The accompanying condensed consolidated financial statements are prepared in conformity with the consensus reached in EITF 97-2. Simultaneous to the execution of an MSA with each PA, we also entered into a shares acquisition agreement ("SAA"). Subsequent to the sale of DCA, under all of the SAAs entered into except for one, we have the right to designate the purchaser (successor dentist) to purchase from the PA shareholders all the shares of the PA for a nominal price of $1,000 or less. Under these SAAs, we have the unilateral right to establish or effect a change in the PA shareholder, at will, and without consent of the PA shareholder, on an unlimited basis. Under the provisions of EITF 97-2, the agreements with the PA shareholders qualify as a friendly doctor arrangement. Consequently, under EITF 97-2, we consolidate all the accounts of those PAs in the accompanying condensed consolidated financial statements. Accordingly, the condensed consolidated statements of operations include the net patient service revenues and related expenses of these PAs and all significant intercompany transactions have been eliminated. Each of the DCA SAAs entered into with the PAs did not have the nominal price provision. Also, subsequent to the DCA sale one remaining SAA entered into with a PA does not have the nominal price provision. Rather, the SAA purchase price is based upon a multiple of earnings, as defined. As a result, the agreements do not meet the criteria of consolidation under EITF 97-2 and the condensed consolidated statements of operations exclude the net patient service revenues and expenses of these PAs. The condensed consolidated statements of operations include only our net management fee revenues generated and expenses associated with providing services under the MSAs. Critical Accounting Policies and Estimates The preparation of our condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and revenues and expenses. On an on-going basis we evaluate these estimates, including those related to the carrying the value of accounts receivables, intangible and long-lived assets, income taxes and any potential future impairment. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We have identified the policies below as critical to our business operations and the understanding of our results of operations: Valuation of accounts receivables. The carrying amount of accounts receivables requires management to assess the future collectibility of our accounts receivables and establish an allowance for patients covered by third-party payor contracts, anticipated discounts and doubtful accounts. Our established allowance is determined based upon historical realization rates, the current economic environment and the age of accounts. Changes in our estimated collection rates are recorded as a change in estimate in the period the change is made. Intangibles and long-lived Assets. Our business acquisitions typically result in intangible and long-lived assets. Effective January 1, 2002, we adopted FASB Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, our service mark, MSAs and goodwill intangible assets are no longer amortized but are reviewed annually for impairment. The determination of the value of such intangible assets, utilized for determining whether impairment exits, requires management to make estimates and assumptions that affect our consolidated financial statements. We are currently performing the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002. We have completed the first step of the two-step transitional impairment analysis required by SFAS 142. This analysis indicated that the carrying amount of our net assets exceeds the fair value. Preliminary results of the second step of the transitional impairment analysis indicates that an impairment charge totaling $50 to $100 million will be required, although such analysis in not complete. We expect to complete this analysis in the fourth quarter of 2002. Income Taxes. We record a valuation allowance to reduce our deferred income tax assets to the amount that is more likely than not to be realized. Our assessment of the realization of deferred income tax assets requires that estimates and assumptions be made as to taxable income of future periods. Projection of future period earnings is inherently difficult as it involves consideration of numerous factors such as our overall strategies, market growth rates, responses by competitors, assumptions as to operating expenses and other industry specific factors. Results of Operations The following discussion highlights changes in historical revenues and expense levels for the three and six-month period ended June 30, 2002, compared to the three and six-month period ended June 30, 2001, as reported in our condensed consolidated financial statements and the related notes thereto appearing elsewhere herein. Three Months Ended June 30, 2002 Statement of Operations Compared to Three Months Ended June 30, 2001 Dental Practice Net Patient Service Revenue. Dental practice net patient service revenue represents the clinical patient revenues at affiliated dental practices where the consolidation requirements of EITF 97-2 have been met. There were 166 such clinical locations through May 31, 2001 and 146 such locations immediately subsequent to the DCA sale transaction, and 139 such locations at June 30, 2002. Dental practice net patient service revenue was $64.1 million for 2002 compared to $68.0 million for 2001, representing a 5.7% decrease. This revenue decrease is due to the sale of 21 clinical locations during fiscal 2001, including 15 locations sold as part of the DCA sale on May 31, 2001. For those locations affiliated as of January 1, 2001, where the management service agreements meet the EITF criteria for consolidation, same-store dental practice net patient service revenue for 2002 increased by approximately 0.5% when compared to revenue for 2001. Net Management Fees. Net management fees consist of revenue earned in the performance of our obligations under management service agreements at affiliated dental practices where the consolidation requirements of EITF 97-2 are not met. The decrease in these revenues, $0.19 million in 2002 as compared to $8.0 million in 2001, is entirely related to the DCA sale transaction as essentially all of our management fees revenues were earned by our DCA subsidiary. There were 78 such clinical locations through May 31, 2001 and 2 such locations subsequent to the DCA sale transaction through May 2002, and 3 locations effective June 1, 2002. Licensing and Other Fees. We earn certain fees from unconsolidated affiliated dental practices for various licensing and consulting services. These revenues were approximately $0.20 million for 2002 and 2001. Practice Operating Expenses. Practice operating expenses represent the direct costs associated with operating and managing the practice facility locations, including regional support departments. These costs are comprised of the following expenses: Clinical Salaries, Benefits and Provider Costs include all patient service provider staff compensation and related payroll costs at the consolidated affiliated dental practices, including dentists, hygienists and dental assistants, and dental assistants for the unconsolidated affiliated dental practices; Practice Non-clinical Salaries and Benefits include all staff compensation and related payroll costs at all dental and regional facilities other than dentists, hygienists, and dental assistants; Dental Supplies and Lab Expenses include all direct supply costs in the performance of patient treatment programs; Practice Occupancy Expenses include facility leases, property taxes, utilities, janitorial services, repairs and maintenance; and Practice Selling, General, and Administrative Expenses include general office, advertising, professional services (excluding dentistry), office supplies, bank processing fees, local taxes, insurance, bad debt expense, and other miscellaneous costs at the dental facilities and regional centers. Practice operating expenses were $55.2 million for 2002 compared to $65.7 million for 2001, representing a 16.0% decrease. The decrease in practice operating expenses is primarily due to the sale of the DCA subsidiary on May 31, 2001 and six clinical locations disposed of during the second half of 2001. Excluding all revenues and expenses of the offices disposed of during 2001, practice operating expenses at the remaining offices (the "Remaining Offices") for 2002 were 86.0% of total revenue compared to 86.2% for 2001. The practice operating margin at the Remaining Offices for 2002 was 14.0% compared to 13.8% for 2001. The increase in operating margin resulted from a decrease in nonclinical salaries and benefits, dental and lab supplies, occupancy, and SG&A costs at the Remaining Offices, as a percent of revenues, offset by an increase clinical salaries, benefits and provider costs. We are seeking to reduce clinical costs as a percentage of revenue by a combination of revenue enhancement and cost cutting initiatives. Such costs are expected to decline as a percent of revenue and reflect costs in line with our better practices once our initiatives are completed. Corporate Selling, General and Administrative Expenses. Corporate selling, general and administrative expenses include: corporate salaries, general office costs, investor relations expense, legal and audit fees, general insurance, director and officer liability insurance, corporate office supplies, and other miscellaneous costs at our corporate facilities. Corporate selling, general and administrative expenses were $3.1 million for 2002 compared to $3.5 million for 2001, representing a 12.7% decrease. The decrease in total corporate selling, general and administrative expenses is the result of implementation of strategic management initiatives in corporate staffing levels in our accounting and finance, plan management, operations, human resource, and other corporate support departments to leverage cost effective solutions in solving the infrastructure needs of the Company. Stock Compensation Expense. During the second and third quarter of 2000, we advanced $11.5 million under notes that became non-recourse after two years to certain officers in order to retain and provide incentives to such officers, where shares of our stock owned by each officer serve as collateral for the advances. The entire balance was recorded as deferred compensation in shareholders' equity in the condensed consolidated balance sheets. The deferred compensations was being amortized over the life of the advances as stock compensation expense, representing the difference in the amount of the advances and the value of the collateral at the date of the loans. The total original advance included advances of $5.9 million to DCA officers. These advances were sold in connection with the sale of DCA. The remaining non-amortized outstanding balance of deferred compensation associated with the advances to DCA officers at the time of the sale transaction was $4.6 million. During the third quarter of 2001, the entire remaining non-amortized balance of deferred compensation was written off as a result of the acceleration of the non-recourse provision of the advance due from the former CEO and the significant decline in the underlying value of the pledged collateral, which was considered to be other than temporary. In connection with the execution of an officer's amended employment agreement, a note receivable and related accrued interest of approximately $0.20 million were to be forgiven, subject to provisions of the agreement. The note and accrued interest were being expensed over the twenty-four month service period ending May 2002. During the third quarter of 2001, the remaining balance on the note was written off as compensation expense based on the note being converted to non-recourse pursuant to the severance agreement with the officer. In 2000 we also began accruing for a stock based incentive program to certain employees that was paid in June 2002. For 2002, we recorded total stock compensation expense of $0.07 million as compared to $0.85 million for 2001. No additional stock compensation expense is anticipated in 2002. (Gain) loss on dental location dispositions and impairment of long-lived assets. For 2002, we recognized a gain of $0.19 million, representing $0.32 million in insurance reimbursement relating the sale of certain dental locations in 2002, which was partially offset by a recorded loss of $0.13 upon consummation of the sale of an additional dental location in June 2002. For 2001, we completed a stock sale of DCA, a wholly-owned subsidiary, and certain other assets in Maryland, Virginia, and Indiana for total consideration of $36 million, including cash of $26.5 million and the assumption of related debt and operating liabilities, and a license fee of $2.6 million, payable in future installments. The loss of $5.9 million recorded in 2001 included a provision for transaction related closing costs. Depreciation and Amortization. Depreciation and amortization was $1.0 million for 2002 compared to $3.2 million for 2001. Of this decrease of $2.2 million, $0.39 million is due to depreciation and amortization associated with the sale of DCA and $1.8 million as a result of the implementation of FASB issued Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets", which eliminated the amortization of our intangible assets as discussed in Note 2 to the accompanying condensed consolidated financial statements. Interest Expense. Interest expense, net of interest income, was $5.8 million for 2002 compared to $5.2 million for 2001. In April 2002 and 2001, we entered into various amendments to our outstanding Credit Facility and Levine Notes, as further described in note 5 to the condensed consolidated financial statements. These amendments increased our borrowing costs due to escalations in interest rates and the amortization of deferred closing costs over the life of the loans. These increases were partially offset by a reduction in borrowings under the credit facility (the "Credit Facility") as a result of the principal payments made in 2001 in connection with the sale of DCA. Debt and equity financing costs. In April 2001, we entered into various amendments to our existing Credit Facility and convertible senior subordinate debt as described in note 5 to the condensed consolidated financial statements. As a result, we recorded a charge of $3.9 million for the write-off of certain prepaid debt costs related to previously entered credit facility agreements, loan amendment fees, warrant issuance valuations, and associated professional fees incurred in connection with the execution of the various loan amendments. Extraordinary loss on debt extinguishments. In April 2002, we entered into an additional amendment to the Credit Facility. The amendment meets the criteria of substantial modification as outlined in EITF 96-19. As such, the original Credit Facility is considered extinguished, with a new Credit Facility issued in its place. Accordingly, we recorded an extraordinary charge of $2.6 million for 2002. No tax benefit was recorded as a result of the charge as the realization of available deferred tax assets is not assured. The extraordinary loss represents the amendment fees of $2.0 million incurred and $0.60 million for the write-off of the non-amortized portions of previously recorded deferred financing costs associated with the original facility agreement. In April 2001, we entered into an agreement to amend our senior subordinated debt ("Levine Note"). The amendment to the Levine Note met the criteria of substantial modification as outlined in EITF 96-19, resulting in an extraordinary charge of $5.6 million for 2001. No tax benefit was recorded as a result of the charge as the realization of available deferred tax assets is not assured. The extraordinary loss represents the amendment fee of $2.2 million incurred to extinguish the original note and $3.4 million for the write-off of the non-amortized portions of warrant discount and deferred financing costs also associated with the original note agreement Provision for Income Taxes. Our statutory tax rate for federal and state purposes is approximately 40%. The income tax expense of $0.03 million for 2002 and $0.05 million for 2001 represents our estimated state tax payable. We expect to utilize existing loss carryforwards to offset any federal tax payable for 2002 and 2001. Six Months Ended June 30, 2002 Statement of Operations Compared to Six Months Ended June 30, 2001 Dental Practice Net Patient Service Revenue. Dental practice net patient service revenue represents the clinical patient revenues at affiliated dental practices where the consolidation requirements of EITF 97-2 have been met. There were 166 such clinical locations through May 31, 2001 and 146 such locations immediately subsequent to the DCA sale transaction, and 139 such locations at June 30, 2002. Dental practice net patient service revenue was $127.5 million for 2002 compared to $139.9 million for 2001, representing an 8.9% decrease. This revenue decrease is due to the sale of 21 clinical locations during fiscal 2001, including 15 locations sold as part of the DCA sale on May 31, 2001. For those locations affiliated as of January 1, 2001, where the management service agreements meet the EITF criteria for consolidation, same-store dental practice net patient service revenue for 2002 increased by approximately 1.5% when compared to revenue for 2001. Net Management Fees. Net management fees consist of revenue earned in the performance of our obligations under management service agreements at affiliated dental practices where the consolidation requirements of EITF 97-2 are not met. The decrease in these revenues, $0.39 million in 2002 as compared to $19.6 million in 2001, is entirely related to the DCA sale transaction as essentially all of our management fees revenues were earned by our DCA subsidiary. There were 78 such clinical locations through May 31, 2001 and 2 such locations subsequent to the DCA sale transaction through May 2002, and 3 locations effective June 1, 2002. Licensing and Other Fees. We earn certain fees from unconsolidated affiliated dental practices for various licensing and consulting services. These revenues were approximately $0.40 million for 2002 and 2001. Practice Operating Expenses. Practice operating expenses represent the direct costs associated with operating and managing the practice facility locations, including regional support departments. These costs are comprised of the following expenses: Clinical Salaries, Benefits and Provider Costs include all patient service provider staff compensation and related payroll costs at the consolidated affiliated dental practices, including dentists, hygienists and dental assistants, and dental assistants for the unconsolidated affiliated dental practices; Practice Non-clinical Salaries and Benefits include all staff compensation and related payroll costs at all dental and regional facilities other than dentists, hygienists, and dental assistants; Dental Supplies and Lab Expenses include all direct supply costs in the performance of patient treatment programs; Practice Occupancy Expenses include facility leases, property taxes, utilities, janitorial services, repairs and maintenance; and Practice Selling, General, and Administrative Expenses include general office, advertising, professional services (excluding dentistry), office supplies, bank processing fees, local taxes, insurance, bad debt expense, and other miscellaneous costs at the dental facilities and regional centers. Practice operating expenses were $110.0 million for 2002 compared to $137.0 million for 2001, representing a 19.7% decrease. The decrease in practice operating expenses is primarily due to the sale of the DCA subsidiary on May 31, 2001 and six clinical locations disposed of during the second half of 2001. Excluding all revenues and expenses of the offices disposed of during 2001, practice operating expenses at the remaining offices (the "Remaining Offices") for 2002 were 85.8% of total revenue compared to 86.3% for 2001. The practice operating margin at the Remaining Offices for 2002 was 14.2% compared to 13.7% for 2001. The increase in operating margin resulted from a decrease in nonclinical salaries and benefits, dental and lab supplies, occupancy, and SG&A costs at the Remaining Offices, as a percent of revenues, offset by an increase clinical salaries, benefits and provider costs. We are seeking to reduce clinical costs as a percentage of revenue by a combination of revenue enhancement and cost cutting initiatives. Such costs are expected to decline as a percent of revenue and reflect costs in line with our better practices once our initiatives are completed. Corporate Selling, General and Administrative Expenses. Corporate selling, general and administrative expenses include: corporate salaries, general office costs, investor relations expense, legal and audit fees, general insurance, director and officer liability insurance, corporate office supplies, and other miscellaneous costs at our corporate facilities. Corporate selling, general and administrative expenses were $7.3 million for 2002 compared to $6.7 million for 2001, representing an 8.4% increase. The increase in total corporate selling, general and administrative expenses is the result of $0.45 million relating to consulting fees associated with our operational improvement initiatives discussed in the liquidity section below, the majority of which were incurred during the first three months of 2002. Stock Compensation Expense. During the second and third quarter of 2000, we advanced $11.5 million under notes that became non-recourse after two years to certain officers in order to retain and provide incentives to such officers, where shares of our stock owned by each officer serve as collateral for the advances. The entire balance was recorded as deferred compensation in shareholders' equity in the Condensed Consolidated Balance Sheets. The deferred compensation was being amortized over the life of the advances as stock compensation expense, representing the difference in the amount of the advances and the value of the collateral at the date of the loans. The total original advance included advances of $5.9 million to DCA officers. These advances were sold in connection with the sale of DCA. The remaining non-amortized outstanding balance of deferred compensation associated with the advances to DCA officers at the time of the sale transaction was $4.6 million. During the third quarter of 2001, the entire remaining non-amortized balance of deferred compensation was written off as a result of the acceleration of the non-recourse provision of the advance due from the former CEO and the significant decline in the underlying value of the pledged collateral, which was considered to be other than temporary. In connection with the execution of an officer's amended employment agreement, a note receivable and related accrued interest of approximately $0.20 million were to be forgiven, subject to provisions of the agreement. The note and accrued interest were being expensed over the twenty-four month service period ending May 2002. During the third quarter of 2001, the remaining balance on the note was written off as compensation expense based on the note being converted to non-recourse pursuant to the severance agreement with the officer. In 2000 we also began accruing for a stock based incentive program to certain employees that was paid in June 2002. For 2002, we recorded total stock compensation expense of $0.15 million as compared to $1.7 million for 2001. No additional stock compensation expense is anticipated in 2002. (Gain) loss on dental location dispositions and impairment of long-lived assets. For 2002, we recognized a gain of $0.19 million, representing $0.32 million in insurance reimbursement relating the sale of certain dental locations in 2002, which was partially offset by a recorded loss of $0.13 upon consummation of the sale of an additional dental location in June 2002. For 2001, we completed a stock sale of DCA, a wholly-owned subsidiary, and certain other assets in Maryland, Virginia, and Indiana for total consideration of $36 million, including cash of $26.5 million and the assumption of related debt and operating liabilities, and a license fee of $2.6 million, payable in future installments. The loss of $5.9 million recorded in 2001 included a provision for transaction related closing costs. Depreciation and Amortization. Depreciation and amortization was $2.0 million for 2002 compared to $6.4 million for 2001. Of this decrease of $4.4 million, $0.92 million is due to depreciation and amortization associated with the sale of DCA and $3.4 million as a result of the implementation of FASB issued Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets", which eliminated the amortization of our intangible assets as discussed in note 2 to the accompanying condensed consolidated financial statements. Interest Expense. Interest expense, net of interest income, was $10.2 million for 2002 compared to $10.7 million for 2001. In April 2002 and 2001, we entered into various amendments to our outstanding Credit Facility and Levine Notes, as further described in note 5 to the condensed consolidated financial statements. These amendments increased our borrowing costs due to escalations in interest rates and the amortization of deferred closing costs over the life of the loans. These increases were partially offset by a reduction in borrowings under the credit facility (the "Credit Facility") as a result of the principal payments made in 2001 in connection with the sale of DCA. Debt and equity financing costs. In April 2001, we entered into various amendments to our existing Credit Facility and convertible senior subordinate debt as described in note 5 to the condensed consolidated financial statements. As a result, we recorded a charge of $3.9 million for the write-off of certain prepaid debt costs related to previously entered credit facility agreements, loan amendment fees, warrant issuance valuations, and associated professional fees incurred in connection with the execution of the various loan amendments. Extraordinary loss on debt extinguishments. In April 2002, we entered into an additional amendment to the Credit Facility. The amendment meets the criteria of substantial modification as outlined in EITF 96-19. As such, the original Credit Facility is considered extinguished, with a new Credit Facility issued in its place. Accordingly, we recorded an extraordinary charge of $2.6 million for 2002. No tax benefit was recorded as a result of the charge as the realization of available deferred tax assets is not assured. The extraordinary loss represents the amendment fees of $2.0 million incurred and $0.60 million for the write-off of the non-amortized portions of previously recorded deferred financing costs associated with the original facility agreement. In April 2001, we entered into an agreement to amend our senior subordinated debt ("Levine Note"). The amendment to the Levine Note met the criteria of substantial modification as outlined in EITF 96-19, resulting in an extraordinary charge of $5.6 million for 2001. No tax benefit was recorded as a result of the charge as the realization of available deferred tax assets is not assured. The extraordinary loss represents the amendment fee of $2.2 million incurred to extinguish the original note and $3.4 million for the write-off of the non-amortized portions of warrant discount and deferred financing costs also associated with the original note agreement Provision for Income Taxes. Our statutory tax rate for federal and state purposes is approximately 40%. The income tax expense of $0.06 million for 2002 and $0.10 million for 2001 represents our estimated state tax payable. We expect to utilize existing loss carryforwards to offset any federal tax payable for 2002 and 2001. Liquidity and Capital Resources Liquidity We have experienced losses attributed to common stock of $4.3 million the six months ended June 30, 2002 and for fiscal years ended 2001 and 2000, $35.1 million and $48.7 million, respectively. These past significant losses included certain charges for asset impairments, disposition of DCA and certain other dental locations, and debt restructuring and debt extinguishments, which we believe are unusual in nature. Although we have experienced losses over the two years ended December 31, 2001 due to these unusual charges, our dental facilities continue to generate significant positive cash, as reflected in cash flows from operations of $7.2 million for the six months ended June 30, 2002 and for fiscal years ended 2001 and 2000, $19.4 million and $9.5 million, respectively. During 2001, we hired an advisor to review our operations to determine whether improvements could be made, which could be implemented in the near and long term. The advisor, along with our personnel, reviewed such strategies as revenue enhancements, modifications to managed care contracts, savings from procurement efficiencies, and reduction of headcount at dental office and corporate locations. As a result of this review, a number of initiatives to improve operations were implemented in late 2001 and early 2002. These initiatives are projected to increase cash flow in 2002 and in future periods through our emphasis on increasing same store revenues and curtailing direct operating costs. Through June 30, 2002, we have met our earning projections. These initiatives and the projected improvements in operations and cash flows played a vital role in our ability to negotiate modifications to our credit agreement that was consummated on April 15, 2002, as more fully described in Note 5 to the notes to the condensed consolidated financial statements. These modifications resulted in a permanent waiver of our past covenant violations, and reset the covenants to levels, which our projections indicate will be met throughout all of 2002. We also incurred certain fees and expenses, and the interest rate was increased by 1%. In addition, the principal amortization schedule was significantly modified such that approximately $20.7 million of payments due through March 31, 2003 were deferred until the second quarter 2003, and only $7.9 million of principal payments are due through June 30, 2003. We paid the $2.4 million scheduled installment due April 1, 2002. Management believes that we will be able to make all scheduled debt payments through March 31, 2003, and those due under earn-out agreements, along with meeting other obligations. Further, we have significant debt due beginning April 1, 2003, which must be refinanced, modified, or otherwise retired with the proceeds of other financing or capital transactions. There can be no assurance that we will meet its obligations through March 31, 2003, and that any such financing will be available or available on terms acceptable to InterDent. Current Financial Condition and Cashflows At June 30, 2002, cash and cash equivalents were $5.6 million, representing a $1.6 million decrease in cash and cash equivalents from $7.2 million at December 31, 2001. The decrease is primarily due to the pay down of accounts payable and our outstanding Credit Facility. Our working capital deficit at June 30, 2002 of $18.1 million represents an increase from a working capital deficit at December 31, 2001 of $6.3 million. The increase in the working capital deficit is primarily due to a $5.7 million increase in the current portion of long-term debt and capital lease obligations and $4.4 million in accrued Credit Facility fees to be paid in 2002 and 2003, as discussed in note 5 to the condensed consolidated financial statements. Net cash provided by operations amounted to $7.2 million for 2002 compared to $12.7 million for 2001. The decrease in net cash provided by operations is primarily attributed to $5.6 million in net cash used for accounts payable activity between the two periods. Additionally, during 2001 we received an income tax refund of $1.4 million. Net cash used in investing activities was $1.4 million for 2002 as compared to cash provided by investing activities of $13.4 million for 2001. Included in the investing activities for 2002 is cash paid of $1.2 million for earnout and other payments on affiliated dental practice acquisitions that closed in prior years. Cash paid for earnouts and acquisition closing costs were $3.6 million for 2001. Proceeds from the disposition of dental locations were $0.60 million in 2002 compared to $22.1 million in 2001. The 2001 proceeds were primarily associated with the DCA sale transaction in May 2001. We also paid $0.80 million for property and equipment for 2002 compared to $2.1 million for 2001. There were no advances to unconsolidated affiliated practices in 2002 and $3.2 million for 2001. Advances consisted primarily of receivables from PAs due in connection with cash advances for working capital and operating purposes to certain unconsolidated PAs. We advanced funds to these certain PAs during the initial years of operations, until the PA owner could repay the seller debt, and the operations improve. Such advances entirely related to our DCA division facilities, which were eliminated upon consummation of the DCA stock sale transaction in May 2001. Net cash used in financing activities was $7.4 million for 2002, comprising of $6.1 million in debt payments and $1.3 million for payments of deferred financing costs associated with the amendment to the Credit Facility and Levine Note that consummated in April 2002. Cash used in financing activities for 2001 was $28.3 million and primarily related to $25.6 million net debt payments from the DCA sale and $2.3 million in deferred financing costs associated with the amendment to the Credit Facility and Levine Note that consummated in April 2001. In connection with certain completed affiliation transactions, we have agreed to pay to the sellers' future consideration. The amount of future consideration payable under earn-outs is generally computed based upon financial performance of the affiliated dental practices during certain specified periods. We accrue for earn-out payments with respect to these acquisitions when such amounts are probable and reasonably estimable. In addition to cash earn-out payments of $0.94 million during the six months ended June 30, 2002, we also converted $1.1 million in earn-out amounts due into long-term notes payable. As of June 30, 2002, future anticipated earn-out payments of $2.8 million are accrued and included in other current liabilities. For those acquisitions with earn-out provisions, we estimate the total maximum earn-out that could be paid, including amounts already accrued, is between $5.0 and $6.0 million from July 2002 to December 2005, which is expected to be paid in a combination of cash and notes. Outstanding Debt and Other Financing Arrangements Credit Facility Term Note In April 2001, we entered into amendments to its existing senior revolving credit facility (the "Credit Facility") to amend certain covenants. In connection with the execution of the amendments, the banks waived the defaults under the Credit Facility that existed at December 31, 2000 due to failure to meet certain financial ratio covenants and reset all covenants for 2001 and subsequent years. Additionally, the banks agreed to certain other changes including a revised term and provisions regarding asset sales and new financing. As consideration for these modifications, we agreed to an amendment fee of $1.0 million, which was paid during the three months ended June 30, 2001, and an additional fee of $1.0 million payable at maturity of the term loan if certain conditions are not met. The additional fee was paid in connection with an additional amendment to the Credit Facility consummated in April 2002, as discussed below. On October 1, 2001, our Credit Facility converted into a term loan, with required quarterly payments. On April 15, 2002, we entered into an amendment to our Credit Facility, which has an outstanding balance of $79.4 million. In connection with the execution of the amendment, the bank agreed, among other things, to reset certain covenants and reduce the required future quarterly principal payments of $7.2 million, which began on October 1, 2001. In connection with these modifications, we accrued as note principal the remaining $1.0 million due as a result of an amendment conducted in April 2001, which is payable upon maturity. We also agreed to an additional amendment fee of $1.0 million, with cash of $0.50 million payable at closing and $0.25 million to accrue as additional principal on July 1, 2002 and October 1, 2002, payable upon final maturity of the Credit Facility on September 30, 2003. The July 1 and October 1, 2002 accrual dates are subject to change, as outlined in the amendment. Principal amounts owed under the Credit Facility bear interest at LIBOR plus 7.50% or the prime rate plus 5.75%, at the Company's option. In addition to the cash interest charges outlined above, we are to pay an incremental PIK interest on the outstanding principal balance of 1.0% from April 15, 2002 though March 31, 2003, increasing to 2.0% from April 1, 2003 through maturity. The incremental PIK interest is payable upon maturity. We are also to pay a PIK fee equal to 1.0% of the outstanding principal balance on April 15, 2002, 2.0% on October 1, 2002, and 3.0% on April 1, 2003. PIK fees are payable upon maturity. Required principal installments are $0.30 million on July 1, 2002, October 1, 2002, and January 1, 2003, and payments of $7.2 million on April 1, 2003 and July 1, 2003, with the remaining balance due at maturity on September 30, 2003. The Credit Facility also has mandatory prepayment provisions for certain asset sale transactions and excess cash flows, as defined. These prepayment provisions are applied to future required quarterly installments. Accordingly, $0.21 of the $0.30 due on October 1, 2002 was paid in July as a result of the disposition of one dental location in June 2002. The Credit Facility contains several covenants, including but not limited to, restrictions on our ability to incur indebtedness or repurchase shares, a prohibition on dividends without prior approval, prohibition on acquisitions, and fees for excess earnout and debt payments, as defined. There are also financial covenant requirements relating to compliance with specified cash flow, liquidity, and leverage ratios. Our obligations, including all subsidiaries in the guarantees, under the Credit Facility are secured by a security interest in the equipment, fixtures, inventory, receivables, subsidiary stock, certain debt instruments, accounts and general intangibles of each of such entities. The amendment to the Credit Facility met the criteria of substantial modification as outlined under the provisions of EITF 96-19. As such, the amendment met the requirements of an extinguishment of debt. Accordingly, in the second quarter of 2002 we recorded an extraordinary loss of approximately $2.6 million. The extraordinary loss represents amendment fees of $2.0 million incurred to extinguish the original note and $0.60 million for the write-off of the non-amortized portion of deferred financing costs associated with the original Credit Facility agreement. Professional fees and bank PIK fees paid, or anticipated to be paid, of $5.9 million for the execution of the amended Credit Facility have been capitalized and are being amortized over the remaining life of the Credit Facility. At June 30, 2002 $4.4 million in anticipated future PIK fees are included in other current liabilities. Senior Subordinated Notes In June 2000, we raised $36.5 million from the sale of debt and equity to Levine Leichtman Capital Partners II, L.P. ("Levine") under a securities purchase agreement (the "Securities Purchase Agreement"). The equity portion of the transaction comprised 458,333 shares of common stock valued at $11.0 million. The debt portion of the transaction comprised a senior subordinated note with a face value of $25.5 million (the "Levine Note"). As part of the transaction with Levine, we also issued a warrant to purchase 354,167 shares of the Company's common. In April 2001, we entered into an amendment to the Levine Note that met the criteria of substantial modification as outlined in EITF 96-19. As such, the Levine Note was considered extinguished, with a new note issued in its place. In connection with the amendment, the lender waived the defaults under the Levine Note that existed at December 31, 2000 due to failure to meet certain financial ratio covenants and reset all covenants for 2001 and subsequent years, in addition to certain other modifications. As consideration for the amendment, we paid an amendment fee of $2.3 million, payable in additional notes, increased the payment-in-kind ("PIK") interest rate to 16.5% and reduced the price of the warrants from an initial strike price of $41.04 per share to $20.88 per share. In April 2002, we entered into an additional amendment to the Levine Note. In connection with the amendment, the lender reset all covenants for 2002 and subsequent years, in addition to certain other modifications. As consideration for the amendment, we agreed to pay an amendment fee of $2.0 million, payable in additional notes and increase the PIK interest rate by one-half percentage point. The amendment fee has been capitalized and is being amortized over the remaining life of the Levine Note. The entire principal of the Levine Note is due September 2005 but may be paid earlier at our election, subject to a prepayment penalty. Additionally, the Levine Note has mandatory principal prepayments based upon a change in ownership, certain asset sales, or excess cash flows. The Levine Note bears interest at 12.5%, payable monthly, with an option to pay the interest in a PIK note. The Company is currently issuing PIK notes at 17.0% for payment of current interest amounts owed. The Securities Purchase Agreement contains covenants, including but not limited to, restricting our ability to incur certain indebtedness, liens or investments, restrictions relating to agreements affecting capital stock, maintenance of a specified net worth and compliance with specified financial ratios. Convertible Subordinated Notes In 1998, we issued $30 million of subordinated convertible notes ("Convertible Notes"). The Convertible Notes mature June 2006 and currently bear interest at 8.0%, payable semi-annually with an option to pay the interest in a PIK note also bearing interest at 8.0%, which we are currently exercising for payment of current interest amounts due. In April 2001, we entered into an amendment to the Convertible Notes and the lender waived the cross-default provision that existed at December 31, 2000 due to the covenant violations under the Credit Facility and agreed to reset all covenants for 2001 and subsequent years, in addition to certain other modifications. As consideration for the amendment, we agreed to reduce the conversion price of the notes. The Convertible Notes are convertible into shares of the common stock at $39.00 for each share of common stock issuable upon conversion of outstanding principal and accrued but unpaid interest on such subordinated notes and shall be automatically converted into common stock if the rolling 21-day average closing market price of the common stock on 20 out of any 30 consecutive trading days is more than $107.40 Preferred and Common Stock We are authorized to issue 30,000,000 shares of Preferred Stock. Presently authorized series of our Preferred Stock include the following series: o Series A--100 shares authorized, issued and outstanding; o Series B--70,000 shares authorized, zero issued or outstanding; o Series C--100 shares authorized, zero shares issued or outstanding; and o Series D--2,000,000 shares authorized, 1,574,608 shares are issued and outstanding. The Company's presently authorized Preferred Stock rank senior to outstanding Common Stock. The shares of Series B Preferred Stock were authorized in connection with issuance of the Convertible Notes as discussed above. The Series B Preferred Stock conversion provision of the Convertible Notes has expired. Accordingly, although the Series B Preferred Stock is authorized, the Company does not expect any such shares to ever be issued. Similarly, 100 shares of Series C Preferred Stock were authorized and issued in connection with the Convertible Note issuance, but then converted into 10 shares of common stock in the March 1999 merger transaction. The Company does not expect any shares of Series C Preferred Stock to be issued. The shares of Series D Preferred Stock are convertible into shares of our Common Stock at the rate of one-sixth of a share of Common Stock for each share of Series D Preferred Stock (assuming there are no declared but unpaid dividends on the Series D Preferred Stock), in each case subject to adjustment for stock splits, reverse splits, stock dividends, reorganizations and similar anti-dilutive provisions. The Series D Preferred Stock holders are entitled to vote on all matters as to which the Common Stock shareholders are entitled to vote, based upon the number of shares of Common Stock the Series D Preferred Stock is convertible into. The Series A Preferred Stock is not convertible, is entitled to elect a director, and is otherwise non-voting. A total of 36,920 and 56,541 outstanding shares of Common Stock issued at a price of $2.70 and $1.35 per share, respectively, are subject to repurchase by us at the original issue price at our election. Dental Location Dispositions Effective May 31, 2001, we also completed the stock sale of DCA, a wholly-owned subsidiary, and certain other assets in Maryland, Virginia and Indiana. The transaction also includes the assets associated with the notes receivable made to officers of DCA as discussed in the notes to the Consolidated Financial Statements. Total consideration was $36.0 million, less the assumption of related debt and operating liabilities. Upon the two-year anniversary of the transaction close, we shall have the right to repurchase the assets of DCA, based upon a multiple of EBITDA subject to a minimum price, as defined in the agreement. In connection with the sale of assets, we entered into a five-year license agreement for $2.6 million in cash, payable in installments, for use of our proprietary practice management system, subject to negotiations for additional term extensions. Such amount is recorded as deferred revenues and amortized over the life of the agreement. The parties also entered into the transition services agreement and a business collaboration agreement delineating the use of the practice management system, the joint purchase of supplies, the joint negotiation for managed care contracts, training systems, and other similar operational matters. During 2002, we disposed of one dental location for proceeds of $0.28 million and our insurance carrier reimbursed us for $0.32 million on certain dispositions that occurred in 2001, resulting in a net gain of $0.19 million. During 2001, we disposed or identified under performing dental locations for disposition ("Disposed Locations"). In connection with the sale of DCA and Disposed Locations the Company wrote off $40.2 million in total assets, yielded proceeds of $21.4 million, net of closing costs and recorded a total loss of $12.3 million for the year ended December 31, 2001. The total recorded loss includes $1.7 million for the provision of direct transaction closing costs. Impairment of long-lived assets In July 2001, the FASB issued Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill and indefinite lived assets are no longer amortized but are reviewed annually for impairment. Separate intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to June 30, 2001, the provisions of SFAS 142 are effective upon its adoption effective beginning fiscal year 2002. We are currently performing the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002. We have completed the first step of the two-step transitional impairment analysis required by SFAS 142. This analysis indicated that the carrying amount of our net assets exceeds the fair value. Preliminary results of the second step of the transitional impairment analysis indicates that an impairment charge totaling $50 to $100 million will be required, although such analysis in not complete. We expect to complete this analysis in the fourth quarter of 2002. Item 3. Quantitative and Qualitative Disclosures About Market Risks We do not utilize financial instruments for trading purposes and hold no derivative financial instruments, which could expose us to significant market risk. Our interest expense is sensitive to changes in the general level of interest rates as our credit facility has interest rates based upon market LIBOR or prime rates, as discussed in Note 5 to the condensed consolidated financial statements. To mitigate the impact of fluctuations in market rates, we purchase fixed interest rates for periods of up to 180 days on portions of the outstanding credit facility balance. At June 30, 2002, we had $81.1 million in floating rate debt under the credit facility. The detrimental effect on our pre-tax earnings of a hypothetical 100 basis point increase in the interest rate under the credit facility would have been approximately $0.40 million for the six-months ended June 30, 2002. This sensitivity analysis does not consider any actions we might take to mitigate our exposure to such a change in the credit facility rate. The hypothetical change used in this analysis may be different from what actually occurs in the future. Our remaining subordinated notes and long-term debt obligations of $90.1 million are at fixed rates of interest. PART II - OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds The payment of dividends is within the discretion of the Board of Directors; however, we intend to retain earnings from operations for use in the operation and expansion of our business and do not expect to pay cash dividends in the foreseeable future. In addition, our senior credit lender currently prohibits the payment of cash dividends. Any future decision with respect to dividends will depend on future earnings, operations, capital requirements and availability, restrictions in future financing agreements and other business and financial considerations. Item 3. Defaults Upon Senior Securities As of December 31, 2001, the Company was in default under its existing senior revolving Credit Facility and Levine Note due to failure to meet certain financial ratio covenants. In April 2002, we entered into an amendment to our Credit Facility and Levine Note, which, among other provisions, waived the defaults that existed at December 31, 2001 and reset all covenants for 2002 and subsequent years. For further information, see note 5 to the condensed consolidated financial statements. Item 5. Other Information Nasdaq in a letter dated May 16, 2002, notified the Company that it failed to comply with the minimum bid price and the minimum market value of publicly held shares requirements for continued listing set forth in Market Place Rules 4450(b)(3) and 4450(b)(4), and that its securities were, therefore, subject to delisting from the Nasdaq National Market. In June, the Company was also notified that it also did not meet the minimum market value of publicly held shares requirement for transfer to the Nasdaq SmallCap Market and, as a result, the Company's common stock began trading on the OTC Bulletin Board on June 13, 2002. The Interdent, Inc. common stock symbol was also changed to DENT.OB to reflect the change in market listings. First Union National Bank is the Transfer Agent and Registrar for the stock of InterDent, Inc. Shareholder matters, such as a transfer of shares, stock transfer requirements, missing stock certificates and changes of address, should be directed to First Union at the following address and telephone number: First Union National Bank Shareholder Services Group 1525 W. WT Harris Blvd., 3C3 Charlotte, North Carolina 28288-1153 Telephone Numbers: 704/590-0394, or toll-free 800/829-8432 Item 6. Exhibits, Financial Statement Schedules and Reports on Form 8-K ------- (a) Exhibits 3.1 Bylaws of InterDent, Inc., a Delaware Corporation. 99.1 Chief Executive Officer's Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code. 99.2 Chief Financial Officer's Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code. (b) Reports on Form 8-K No reports on Form 8-K were filed in the three months ended June 30, 2002. SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INTERDENT, INC. (Registrant) Date: August 13, 2001 By: \s\ H. WAYNE POSEY ------------------------------ --------------------------------- H. Wayne Posey Chief Executive Officer By: \s\ L. THEODORE VAN EERDEN -------------------------------- L. Theodore Van Eerden Chief Financial Officer

INTERDENT INC 10-Q