American Dental Partners Q4 2007 Earnings Call Transcript

American Dental Partners, Inc. (ADPI)

Q4 2007 Earnings Call

March 5, 2008 1:00 pm ET

Executives

Gregory A. Serrao – Chairman of the Board, President & Chief Executive Officer

Breht T. Feigh – Chief Financial Officer, Executive Vice President & Treasurer

Mark W. Vargo – Vice President & Chief Accounting Officer

Analysts

Unidentified Analyst

Brooks O’Neil – Dougherty & Company LLC

Graham [Rain] – Bares Capital

Kerry Nelson – Skystone Capital Management

Brian Millbline – DRW Investments

Presentation

Operator

Welcome and thank you for standing by. At this time all participants are in a listen-only until the question & answer session of today’s conference. I’d like to turn the call over to your host today, Mr. Greg Serrao, you may begin.

Gregory A. Serrao

Good afternoon and thanks for joining us. Today I’m joined by Breht Feigh, the company chief financial officer, and Mark Vargo the company’s chief accounting officer. I’d like to begin this conference call by reading a brief, but important disclaimer. During the course of this conference call we may make forward-looking statements regarding the future financial performance or business trends of American Dental Partners or other future events impacting the company within the meanings of the Private Securities Litigation Reform Act of 1995. The words believe, expect, anticipate, project, intend and similar expressions among others identify forward looking statements.

We caution you that such statements are only predictions and that actual results might differ materially from those projected in the forward-looking statements. Certain factors that might cause such a difference include among others the company’s risks associated with its affiliated dental group contracts with third party payers, and the impact of any terminations or potential terminations of such contract, the cost of and access to capital, fluctuating labor markets, the loss of key personnel, professional liability claims against the affiliated practices, the company’s acquisition and affiliation strategy, dependence upon affiliated dental group practices, dependence upon service agreements and government regulation of the dental industry. For a detailed discussion of the factors that could cause such a difference and other risk factors and uncertainties that could materially affect the company’s business and financial results, please refer to our form 10K filed with the Securities & Exchange Commission.

In our call today we will discuss certain financial measures that are not in accordance with generally acceptable accounting principles. Please see our press release which is available on our website www.amdpi.com for a presentation of the most comparable GAAP measures and a reconciliation of these non-GAAP measures. Breht and I will make an abbreviated financial and operational remarks, allowing for questions from participants after our prepared remarks. I’ll now turn the call over to Breht.

Breht T. Feigh

Before getting into the financial details I’d like to comment on our financial presentation, our net revenues include fees earned from dental group practices affiliated with us through the means of a service agreement, our dental laboratory, our dental benefits third party administer or TPA, Arizona’s Tooth Doctor for Kids and other miscellaneous revenues. It’s important for investors to understand that our net revenues and operating expenses are significantly impacted by the patient revenue of the dental group practices that are affiliated with us through the means of a service agreement. In emphasis where we believe it’s important to discuss our results in terms of patient revenue of all the affiliated practices we will do just that, otherwise I’ll discuss our results in terms of our GAAP net revenue. We’ve included in our press release a non-GAAP cash earnings calculation which excludes amortization expense related to service agreement and tangible assets, and a pro forma disclosure of financial results excluding the accounting impact of the PDG litigation. We believe it is important in understanding our operating results to include these pro forma adjustments. The supplemental non-GAAP financial measure tables in the press release provides sufficient detail to reconcile to our GAAP results. Rather than discussing each line item of our financial results, as I’ve normally done, I intend to review revenue and just those expense line items that have a trend which merits discussion.

First I’d like to refer to the table entitled patient revenue and same market patient revenue growth which is included in the press release. Patient revenue of the affiliated dental group practices increased 38% to $118 million for the quarter. Included in this patient revenue is $24.9 million from the six new platform affiliations completed during the periods of comparison, Assure Dental, Arizona’s Tooth Doctor for Kids, Texas Oral Maxillofacial Surgical Associates, Sacramento Oral Surgery, Valley Dental Group and Metro Dental Care. Excluding these six platform affiliations, same market patient revenue was $93 million for the quarter and same market patient revenue growth was 11% for the quarter. The components of same market patient revenue growth were 9.5% greater provider hours, 1.4% due to improved reimbursement rates, and .1% due to improved productivity per hour. For the year same market patient revenue growth was 10%. As a reminder our objective is to help the affiliated dental group practices growth their patient revenue 8% to 10% per annum and this was the fourth consecutive year that we’ve achieved our 8% to 10% growth objective. Excluding the contribution of in market affiliation to the platform affiliates, same market patient revenue growth was 3.5% for the quarter, and 5.2% for the year.

Now I’d like to refer to the table entitled pro forma consolidated statement of income for the three months ended December 31, 2007 and 2006 which is included in the press release. Net revenue for the quarter was $79.6 million a 45% increase over the prior year. Revenue earned from dental groups affiliated with us by means of a service agreement increased 40% to $73 million, while revenue earned from our dental lab, dental TPA, Arizona’s Tooth Doctor for Kids, and other misc revenue increased 145% to $6.3 million. This 145% increase was largely driven by Arizona’s Tooth Doctor for Kids which we acquired on December 1, 2006. Salaries and benefits increased 51% over the prior year to $35.5 million, as a percentage of net revenue this expense increased 191 basis points to 44.6%. This is due to the fact that we employed the dentists at Arizona’s Tooth Doctor for Kids. General corporate expenses increased 31% to $3.6 million a decrease of 50 basis points as a percentage of net revenue to 4.5% from 5%. This line item generated a lot of discussion in the third quarter earnings call sequentially this line item increased approximately $850,000 from the second to the third quarter of 2007. As we explained at the time, this was the result of increased litigation and FAS 123R stock option expenses and also other expense items, some of which we felt would be non-recurring in nature. At the time we indicated about half of the increase was non-recurring, excluding litigation and FAS 123R expense, the sequential trends for the general corporate expense was $2,939,000, $2,819,000, $3,675,000 and $3,095,000 for Q1, Q2, Q3 and Q4 of 2007, respectively. The fourth quarter general corporate expense decreased sequentially by more than we had commented during last quarter’s call.

Amortization expense increased 75% to $2.4 million which is the result of a record year of acquisition and affiliation. Acquisitions and affiliations completed during 2007 generate patient revenue of approximately $109 million on an annualized basis. Litigation expense was $34,560,000 for the quarter which was largely non-cash in nature. This amount is comprised of four items: the fair market value of the assets transferred to PDG as part of the litigation settlement, reserving the accounts receivable due from PDG, offset by the transition service fee that is deemed to be in excess of fair market value and professional fees associated with the litigation. As we stated in our press release, we will recognize a gain of approximately $32 million in the first quarter of 2008 on the assets transferred to PDG as their fair market value is in excess of their book value. Also during the first three quarters of 2008 we’ll recognize a transition management service fee from PDG of $10 million, or approximately $3.3 million per quarter. Excluding the non-cash write off of deferred financing cost of $851,000 which was required as a result of the December 18^th forbearance agreement with our banks, interest expense increased to $2,376,000 for the quarter, this is largely the result of increased borrowings as a result of the 2007 affiliation activities.

Finally, while net income and diluted income per share decreased 2% and 4% respectively for the quarter. Cash net earnings increased 10% to $4,368,000 and diluted cash earnings per share increased 10% to $0.33. As we previously communicated, while we expected the Metro Dental Care and Barzman, Kasimov & Veith affiliations to be diluted on a GAAP basis because of increased amortization and interest expense, we did not expect our cash net earnings to be diluted by these transactions and that turned out to be the case, even though our efforts to integrate these two transactions really will not occur in large measure until 2008.

I’d like to spend just a few minutes providing some context for you to consider how the litigation settlement might impact our future ongoing operating results. As it relates to growth, patient revenues by our affiliated dental groups, excluding PDG will still approximate $400 million annually. Our same market revenue growth rate, excluding the impact of in market affiliations has historically been in the range of 3% to 7% with a three year average being just at 5%. Thus to achieve an 8% same market growth rate, the balance of 3% would need to be generated from in market affiliations. Based on historical affiliation and acquisition multiples this would require $6 to $7 million of capital. Our internally generated cash flow, available bank borrowing, and a transition service fee to be received from PDG provides ample capital in 2008 to fund this level of activity as well as our ongoing capital expenditure program. As it relates to the loss of the PDG business, we disclosed in the earnings press release that Park Dental generated $89 million of patient revenue in 2007. New affiliations competed in 2007 generated approximately $109 million of annualized patient revenue. Thus in 2008 our results will be negatively impacted by that portion of the Park Dental business that was transferred as part of the settlement with PDG but positively impacted by the full impact of the 2007 affiliation. In other words, there will be some level of offset between these two; although I would caution that the affiliation completed in 2007 do not have the same level of profit margins to American Dental Partners as the business loss. Rest assured though with clarity now in the Minnesota market place, we’re working diligently to integrate our recently completed affiliations and begin to add value of our management expertise.

Finally while I anticipate questions for specific 2008 earnings guidance, we have not provided such guidance since 2001 and do not intend to change our policy or philosophy at this time. For those of you who’ve followed our company for many years, you may recall we decided to stop providing earnings guidance after Cigna Dental chose to terminate three managed care contracts in 2001. We decided at the that it would be far more productive for us to focus our energies on managing the business through what was a very challenging situation, rather than devoting the time and energy to providing, communicating and managing earnings expectations. We faced that challenge head on, and emerged a stronger company. We intend to concur conquer this challenge as well and do it in much the same way we did in 2001 with the relentless focus on improving our business at all levels. I’ll now turn the call back to Greg to conclude today’s prepared remarks.

Gregory A. Serrao

I’d like to spend a few minutes on operating comments before opening the call to investors. I must say that we absolutely disagree with the jury’s verdict in the PDG litigation, furthermore, we do not believe that the verdict is supported by the evidence presented at trial, and most importantly we do not believe the outcome of the litigation reflects the benefit we brought to the PDG practice and the patients of Park Dental as PDG’s business partners for 11 years.

Despite the outcome and resulting transfer of 25 dental offices and other operating assets to PDG we must focus on the future of American Dental Partners and its affiliated dental groups, including those in Minnesota. Despite the settlement, we are still affiliated with five dental groups in Minnesota comprising 66 dental practices and 107 full time equivalent dentists. The work to integrate our management capabilities has just begun in Minnesota and with the distraction of the litigation behind us we can now move forward. We are pleased that our bank group worked so responsively and professionally through what was a challenging 11 weeks, particularly given the overall challenges the banks are facing these days. As you have read, we entered into new credit agreements that allow for continued capital expenditures and affiliations. Between borrowing capacity under these credit agreements and our internal generated cash flow, we intend to continue our ongoing capital investment program. We currently anticipate eight de novo, or facility relocation projects for our affiliates in 2008 in addition to normal recurring maintenance capital expenditures. And while we do not expect affiliation activities to be as busy in 2008, opportunities are abundant. We would anticipate that this year’s affiliation efforts would be more focused on in market opportunities for our existing affiliated dental groups.

Finally, I remain steadfast in my commitment to American Dental Partners business model and affiliated dental groups. American Dental Partners will continue to reinvest capital and provided the management support necessary to grow market leading high quality dental groups. As a shareholder you should be pleased that our team members have been extremely resilient through what was a very trying period, and that they remain as equally business model and affiliated dental groups as I do. Furthermore, I think you will enjoy our soon to be released annual report and the letters written by several of our largest affiliated dental groups that demonstrate the tremendous value we bring to them and consequently their appreciation and support of American Dental Partners. With that, Joyce I would like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Unidentified Analyst. Your line is open.

Unidentified Analyst

Just a couple of questions with regards to the pipeline for affiliations, and what you’re able to spend on it, I believe you mentioned you have about $15 million that’s allocated to that. Are you also allowed to use any of the cash flow you’re generating from existing operations covers that?

Gregory A. Serrao

The max that we can invest in new affiliations, irrespective of the cash flow, is $15 million.

Unidentified Analyst

Also, just based on what you’ve seen in the fourth quarter, clearly it was a fairly strong quarter and again you’re not providing guidance as you go into 08. But is there anything out there you’re seeing that would lead you to believe the business outlook is more difficult for you or pretty much the same?

Gregory A. Serrao

I guess, my answer to that would be that we’re experiencing so far in 08 similarly trends to what we’ve experienced in prior years, which is improvement in productivity per hour in the first quarter. We are cognoscente obviously of what’s going on in the economy I think we’re all keeping our eyes and ears open to that. We have seen not so much in the first quarter of 08, but certainly in the fourth quarter of 07 we say weakness in particular areas such as California, Arizona where productivity per hour had dropped off from prior periods. But so far into 08 we started off fairly strong on a productivity per hour basis and looks like we can continue at this pace, hopefully we will experience what we’ve experienced in prior years which is strong first and second quarter weaker second half of the year.

Unidentified Analyst

Okay thanks. Just looking at the outline of salaries and benefits as a percentage of service revenue it was spiked a little. Was there anything unusual in the quarter on that?

Gregory A. Serrao

I think one of the things Breht mentioned that when you look at it comparatively that would cause that is the fact that we employed the doctors at Tooth Doctor and another thing is I think Metro, the salaries and benefits as a percentage of revenue were higher than they will be in the future let’s put it that way.

Unidentified Analyst

Right, and just coming back, I know a number shareholder lawsuits were announced, etcetera. Will that have a material impact in terms of litigation expense you expect to incur in 08 or is it pretty minimal?

Gregory A. Serrao

I think it all depends on what the ultimate path is on the shareholder litigation. Of course, we don’t think these cases have any merit. We weren’t surprise, we were told, obviously after that verdict that we should expect that something like this might occur. If these cases get dismissed, which is our preferred outcome then the litigation expense related to them should not be much at all if these cases get into a discovery phase then the dollars could be more significant.

Unidentified Analyst

Okay, just finally if you can just give us an update in terms of the Metropolitan affiliation and how that’s progressing since you’ve complete this transaction?

Gregory A. Serrao

I appreciate you asking that, the deal basically closed right at the end of September, so say October 1^st and we began immediately working on an integration plan, but it was a fussy plan because we didn’t know what would be the outcome of the litigation and of course we were anticipating a very, very different outcome. So we were planning that we would have all 31 of the Park Dental offices so all of our planning on how we would integrate the management team really went around that but we couldn’t really take any action until the trial ended. So now with the outcome of the trial obviously the verdict was very unexpected we had to redo our planning process, but that was completed and in the middle of February we basically started to implement our integration plan in Minnesota. All that is going very well, the Metropolitan management team and our PDHC management team have been integrated together, they’re working well together, we’ve made changes at the practice level with managers, all that’s been done. Metro Dentalcare’s business is doing very well in terms of revenue production. So far, knock on wood, things are going well but as I said it we’re probably a month and a half, two months later into implementation because of what the outcome of that verdict was.

Breht T. Feigh

If I can just on the question you had on the shareholder lawsuits, we do carry D&O insurance. We’re hopeful that these will be situations that are covered by the insurance, so there is a retention or a deductable, those aren’t exactly the same words, but there is a retention that we’ll have to pay then above that then it becomes the responsibility of the insurance company. And then just also for investors in general, as Greg’s talking about the integration of Metro and the adjustments that we’re making at Park, we’re going to endeavor our best in the first quarter to provide pro forma disclosure similar to what you’ve seen in this press release so that you can actually see what’s happening with the business on an ongoing basis as compared to expenses for example that we’re going to carry while we still have to meet the obligation of the $19 million transition services agreement that we have with PDG. So we will try to provide as much clarity as we can as we go forward basis for investors.

Operator

Next question comes from Brooks O’Neil – Dougherty & Company LLC, you’re line’s open.

Brooks O’Neil – Dougherty & Company LLC

Just following on the comments Breht made just a minute ago related to the pro forma helping us to understand the impact of the separation with PDG in 2008. Breht do you expect to include the $10 million payment in revenue and throughout the income statement or will you separate that out as a non-recurring type item?

Breht T. Feigh

It will be recorded as revenue.

Brooks O’Neil – Dougherty & Company LLC

Okay.

Breht T. Feigh

Just as a parallel we record service receipts from all of our dental groups as revenue. I spent some time thinking about how we’re going to handle it. I think that pro forma column for example, you see in the current press release, what you would see in the ensuing quarters is that $10 million of revenue of $3.3 million each quarter will be in that pro forma column and then the expenses related to providing the interim management services we’ll also try to put them in that column as well. What’s a little bit less clear with me at this point is how we’ll present Park Dental as the business in essence was divided up, so I still have to think through how we’re going to present that because we’ll have six of the 25 facilities. We’ll figure that out once we have some actual financial results and start penciling it out. Again, we want to make it as clear to investors to see how the business is doing on an ongoing basis.

Brooks O’Neil – Dougherty & Company LLC

So following on that, I assume you’ll make some effort to separate out in the 2007 results the impact of the 25 offices for PDG that you’ll no longer manage and be affiliated with?

Breht T. Feigh

Right.

Brooks O’Neil – Dougherty & Company LLC

Okay, I think that will be real helpful. And you would expect to show that on a quarterly basis as we move through 2008.

Breht T. Feigh

Yes.

Brooks O’Neil – Dougherty & Company LLC

Okay, that’s good.

Breht T. Feigh

Not totally clear as to how we’ll do it yet because there are some doctors that are leaving one another’s respective groups that maybe a little bit complicated, but we’ll figure out a way to make it clear as possible for investors.

Brooks O’Neil – Dougherty & Company LLC

I think that will be great. I’m going to try to figure it out this afternoon so any help will be much appreciated. Another question I had is, is there any way you can give us any feel for the approximate cost of the resource group that you’re retaining here in Minnesota at least in terms of the round number cost that you might of incurred in 2007 to have that group in place?

Breht T. Feigh

I think I’d prefer not to say because what one might conclude from that number could be way off what would be the future. As Greg was saying, we’re having to make some very significant changes within those two management teams so I’d rather wait and just disclose that once we have the first quarter financial results.

Brooks O’Neil – Dougherty & Company LLC

That makes a lot of sense to me. Let see here, can you give us any update, Greg gave us a good update on what’s happening in terms of integration in Minnesota, I think you also completed a very significant affiliation in Buffalo as well, how’s that going?

Breht T. Feigh

Again, I think Brooks, well on the integration aspect, this group in Buffalo has had experience, a lot of experience integrating acquisition into their business and this is a very similar group to their group so they’re working I think well with that. I think the opportunities for reimbursement gains have been identified and I think we’ve been pretty successful and those are starting to kick in here in 2008. Certainly not as much of an integration challenge as Minnesota, because we wound up with two resource groups, the PDHC resource group and the Metro resource group and we needed to rationalize that, and we knew that going into the deal we just didn’t know what we rationalizing for, we thought we were rationalizing for obviously all thirty one Park Dental practices and all the Metro practices, and that didn’t turn out to be the case so it became a different challenge. I think in Buffalo they were able to get on that right away and move through it.

Brooks O’Neil – Dougherty & Company LLC

Great, maybe you can give us an update on Arizona too as well. How’s that going?

Gregory A. Serrao

I believe it’s going well and I think they’re getting ready to do their accreditation. I would say there’s a lot of processes and procedures, policies and systems implemented in 2007 in the first full year that we were with Tooth Doctor, we’re long into that now, we’re getting ready for the accreditation process which will be significant. I think we’ve identified Texas as a market that probably we should bring the Tooth Doctor into next, it’s a good marketplace in terms of the need for that type of care, it’s a good market place, in terms of a willing partner our existing partner dental group here is excited and looking forward to the prospect of doing that and the reimbursement is very attractive. So I think we’re getting ready to start to do our first copies I guess you could call it of Tooth Doctors here in 2008.

Brooks O’Neil – Dougherty & Company LLC

I think that’s very exciting, just one little detail question. Breht how will you account for the earn out payments to Metro and BKV is that something that just goes on the balance sheet or will there be any income statement impact from that?

Breht T. Feigh

No. Under the current accounting rules, we’ve accrued earn out for Metro as of 12/31 and it will go straight to the purchase prices. BKV there wasn’t an earn out and I don’t even think any type of contingent payment, I’m think off the top of my head, it was cash at close and it was done.

Gregory A. Serrao

On BKV right, no earn out.

Operator

Next question comes from Graham [Rain] from Bears Capital, your line’s open.

Graham [Rain] – Bares Capital

[inaudible] your limited capital that you can spend or is it more driven by unattractive valuations on some of the affiliations you’re looking at?

Gregory A. Serrao

I’m sorry Graham I missed the first part of that.

Graham [Rain] – Bares Capital

I was just curious as to what you’re seeing in the acquisition pipeline and your tendency to look more for de novos and in market affiliations as opposed to a larger affiliation, is that driven by evaluation or is that driven by your limited capital?

Gregory A. Serrao

Right now it’s just limited capital, not by valuation at all.

Graham [Rain] – Bares Capital

Okay, and how have you seen valuations in the pipeline change, are they the same as they’ve been in the last years or have you seen anything different?

Gregory A. Serrao

Again, we’re seeing on the large scale transactions, the Metro type or bigger, we’re seeing very high multiples. There was just deal done recently in the United Kingdom for a dental group practice that was at 12 times EBITDA, but again these are the large scale I would say fully integrated independent businesses that can serve as a platform for an ADP type of business. But in what we traditionally do, we haven’t seen any change in multiples and we don’t see a lot competition for deals. Still the biggest competition we have is whether the group wants a partner or they don’t.

Graham [Rain] – Bares Capital

And then, last kind of general question for you, what are you most concerned about in 2008? What do you think are the biggest hurdles you guys need to get through?

Breht T. Feigh

I think, I don’t know that I would say what concerned, what’s most exciting I think is just again the opportunity in Minnesota is tremendous. We spent 11 almost 12 years there with PDG and Park Dental and that business performed extremely well. Metro Dentalcare is a very good business but we have a significant opportunity to improve their operating results, whether it’s from reimbursement, cost management for the benefit obviously of us and the doctor group there so we’re really excited about the Minnesota opportunity. Very excited about bringing Tooth Doctor into new market places or in new market place for the first time. I think that Medicaid opportunity that we saw as big, if not bigger than what we thought it was. For instance when we did Tooth Doctor, I think at the time we said we thought we’d see more states start to try to attract more care, more doctors to their programs by increasing reimbursements. Sure enough the state of Texas doubled their reimbursement in late 2007 and I think we’ll see more states do that.

So I don’t think that we’ve got concerns, I think have a lot of great opportunities. And I guess if you are going to say what’s the concern, the concern is that we actually capitalize on everything that’s in front of us. The PDG thing being out of our way now is, obviously we didn’t expect that outcome, didn’t want that outcome, but at least we didn’t have to spend more time and effort on that anymore. It’ll be a nice change to be able to work positively on a go forward basis.

Operator

Kerry Nelson from Skystone Capital Management, your line is open.

Kerry Nelson – Skystone Capital Management

I guess I have a couple of questions as I try to figure out how to look at the fourth quarter in context of what to expect over the course of the next year and I guess to start if you could maybe help us understand, I know the fourth quarter is seasonally weak for you. Can you give us some sense of what the fourth quarter typically is as a percentage of revenue? If I look back at the last several years, you did acquisitions during the course of the year, so that would have masked some of that lower seasonality. And if I look at the last year you didn’t do any acquisitions, which was several years ago, I come up with a number of maybe 22% of the full year in the fourth quarter. Is that about right?

Gregory A. Serrao

You know Kerry, you bring up a good point because the acquisitions kind of mask things, but I think the way we’ve looked at it. If you look at the first quarter of 07, our doctor productivity per hour was $457 an hour, in the fourth quarter of 07 its $438.

Kerry Nelson – Skystone Capital Management

Sorry the first quarter is $457 did you say?

Gregory A. Serrao

Right. It’s $457 but in the fourth quarter it’s $438 and this is on a same market basis, this is taken deals out, same market basis. In the fourth quarter of 06 it was $433, so we went from $433 per hour in the fourth quarter of 06 to $457 and this is pretty significant because the number of hours per quarter are quite large. So we went from $433 in the fourth quarter of 06 to $457 in Q1 of 07, and then $468 in Q2, and then down to $434 in Q3, and then in Q4 $438.

Now we typically have seen actually a bounce back in Q4 from the Q3 level, not much, but a little bit more. We didn’t see that this past year. We keep talking more and more, we’re feeling like we’re becoming a two quarter company, or dentistry is a two quarter business. It used to be always the third quarter was always the weak quarter, and then the fourth quarter was an opportunity to get people to finalize using their insurance benefits, get into their flex spending, but as the years have gone by and as we’ve seen as fees have gone up people are utilizing or exhausting is probably a better word, their flex spending and their dental benefit long before that fourth quarter starts, because fees are going up but the dental benefits maximum don’t change or haven’t change. So I don’t know if I’m answering your question, because I don’t know how to say how much of our revenue comes in the fourth quarter stripping out the deals. I don’t have that data in front of me. But I am looking at the per hour numbers, because I think that is the key question what happening in productivity per hour, cause the hours don’t change a lot but the productivity does.

Kerry Nelson – Skystone Capital Management

I think that math is going to foot, I didn’t have an opportunity to do it on the fly here, but I think the math will foot to something like the fourth quarter typically 22% that’s on a revenue basis and I’m assuming it’s lower on a EBIT basis just because of the negative leverage.

Gregory A. Serrao

Right and I think a lot of people have assumed incorrectly that we have a variable cost business, and we don’t. Doctor Serrao is at the practice in December and typically works with two assistants, Dr. Serrao is still going to working with two assistants and is going to be hoping that he can produce per hour what he’s accustomed to producing and if that doesn’t happen because the patients are not accepting treatment or putting treatment off. We don’t change the staffing level, because we just don’t know how to anticipate that, you never know what’s really going to happen.

Kerry Nelson – Skystone Capital Management

Okay, so the next thing I wanted to just make sure I can clarify is primarily in the second half of 07 if you exclude the Metro Dental acquisition it looks like you did maybe $24 million in revenues or so of other acquisitions, BKV and FAC some other acquisitions. Are those already at the corporate average run rate and if not how long do you think it’ll take to get there?

Gregory A. Serrao

Corporate average run rate for?

Kerry Nelson – Skystone Capital Management

Run rate of profitability?

Gregory A. Serrao

No they’re not.

Kerry Nelson – Skystone Capital Management

How long do you think it might take to get there?

Gregory A. Serrao

That’s a good question, I’d have to think about each deal on its own. The bigger deals could take I think a couple of years.

Kerry Nelson – Skystone Capital Management

And that’s to get to something like last year, 11% average EBIT margin?

Gregory A. Serrao

I’m thinking about it more on a contribution margin level to get to our company kind of average contribution margin could take a couple of years.

Kerry Nelson – Skystone Capital Management

Okay. And then on Metro, similar question, so you have three quarters in 08 to experience Metro and you mentioned that there’s a lot of cost to come out of Metro and also contracts to renegotiate to get better pricing. How quickly do you think you can get at some of those and when can we start to see the Metro contribution margin go up?

Gregory A. Serrao

The reimbursement is probably where we look at the book a business a little probably about 40 to 45% of the book a business has already been renegotiated. We expect to implement in the first quarter a new fee increase at Metro which will come along with the increases and reimbursements with the third party so we’re not going to see any reimbursement impact in Q1 at Metro, but we’ll start to see that impact positively starting in Q2 and then hopefully continuing throughout the year. In terms of the corporate or resource group expenses, as I said, in the middle of February we made the changes that we’re going to make at this time and so again you’ll have a month, because of severance and everything, you’ll have only one month of that impact in this quarter, but next quarter you’ll see all of the positive impact from that and then after September 30th when we stop providing services to PDG you’ll see some more positive impact. As far as if you were to stack up kind of when we ran Park Dental, the margins at Park Dental versus Metro, and Park Dental’s margins are significantly higher than Metros, if you were to look at those two that’s the really good opportunity that we’re going to start getting at now. That’s the opportunity that will take more time and obviously it’d take a lot of time communicating with the doctor group, getting their buy in and acceptance of doing things more efficiently, or things that we can do more efficiently and still allow them to provide the high level of patient care that Metro is known to providing. That’s what takes the longest part of the time.

Kerry Nelson – Skystone Capital Management

So, but that’s quite a wide gap to get to, so if you just looked at maybe phase one which is the new contracting on half of the business to see increases in the second quarter and the cost cuts you did. If you look at the second quarter as your run rate basis, will you have gotten Metro to the corporate average operating margin or would it be below?

Gregory A. Serrao

No, no it will still be below.

Kerry Nelson – Skystone Capital Management

Okay, so when you think about getting from something below 11 to 11 and then on its way to 15 if you want to get to Park Dental. How long do you think that’ll take?

Gregory A. Serrao

Third, fourth quarter of 09 kind of time frame.

Kerry Nelson – Skystone Capital Management

Okay, to get to 15?

Gregory A. Serrao

Well to get more towards the goal of the margin. I’m talking about contribution margin.

Kerry Nelson – Skystone Capital Management

Okay, and then one last thing, on PDG you mentioned that you’re keeping 20% of the offices. Is that going to translate into roughly 20% of the revenue, and 20% of that $13 million in EBIT that they had?

Gregory A. Serrao

Not exactly, but I think over time it will get more approximate. Here’s the challenge, we’re keeping six offices, so we’re keeping Apple Valley, and in Apple Valley they’re two doctors there both former PDG doctors, they stayed with our new group there, Northland Dental Group, so we shouldn’t see much of any change there, it should all be positive. [Prior Lake] there’s one doctor and we’re keeping him and he’s a former PDG going to Northland, so we shouldn’t see any change but positive in those two practices. And then of the four other practices, three of those four practices we’re keeping the majority of the doctors, what I mean by majority, like five out of six, four out of five. So we will see the loss of a doctor, and that doctor’s revenue for sure, because that doctor is still allowed to practice in that location until PDG moves him or her to a new location, so we won’t be able to replace that doctor until that time comes and they have until May 30th to do that. One of four practices, they’re keeping, of the original five doctors, they’re keeping four out of that five, and those four will undoubtedly move off to a new practice I’m sure PDG will build them so there will be some revenue challenges, let’s put it that way. That practice called Ridges today January, February, March, in Ridges if four fifths of the doctors are theirs, four fifths of the revenue is still going to them. Until those doctors leave all these practices we won’t have an opportunity to have our doctors in there generating the level of revenue that we know these practices are capable of generating.

Kerry Nelson – Skystone Capital Management

And they to all exit by May 30?

Gregory A. Serrao

By the agreement, they have until May 30^th, right.

Kerry Nelson – Skystone Capital Management

Is this the sort of thing where you can line up a replacement starting in June or is this going to take a lot longer?

Gregory A. Serrao

Well, no it not that it will take a longer, but they have until May 30^th unless they can show for good reason they need to stay until July 31^st I believe. They have to show the special master, to mediator that. So we’re really not going to know until they let us know, “Okay we’re leaving.” Then at that point that we know they’re leaving we’ll be able to start lining up replacements.

Kerry Nelson – Skystone Capital Management

Got it, Okay, that makes sense.

Gregory A. Serrao

I think we’re going to go certainly through this first quarter and into Q2 where Apple Valley and [Prior Lake] should go along just the way they were, of the other four practice three of them we’re going to have four fifths of their revenue or five sixths of the revenue but one of them, the Ridges practice we’re going to have one fifth of the revenue. They’re going to have four fifths of the revenue and obviously so we’re not going to have the revenue and contribution that we know those practices are capable of until, 09 will look a lot better at those practices, let’s put it that way than 08 will.

Kerry Nelson – Skystone Capital Management

But on the flip side I think maybe one way to think about it is $9 million in service fees that you’re getting, even though you’re going to pull that out of pro forma, somewhat compensates for the fact that you’ve got some temporary loss of leverage on those particular offices. Is that fair?

Gregory A. Serrao

Those offices won’t generate the kind of EBITDA in 08 that they will in 09, and in 08 we’re going to have this service fee coning in that we won’t have in 09, so that will be somewhat offsetting.

Kerry Nelson – Skystone Capital Management

Alright lastly, the de novo and relos that you’re planning for 08, should we think about those as pro rata to the course of the year or front end or how should we think about your plans of those?

Gregory A. Serrao

Again, I’m sorry Breht and I are in different spots, I know we just opened one of the de novos, but I don’t know the schedule on the others. Breht can you answer that?

Breht T. Feigh

Some of them are coming on line as we speak. Then I would say the majority are looking, last half of the year.

Operator

Brian Millbline from DRW Investments, your line’s open.

Brian Millbline – DRW Investments

Just a follow up on the de novos if you just kind of talk about, are there certain markets that you’re looking at, you said that there’s going to be eight this year, or is it market focus is it the new Medicaid operations and also just kind of talk about that with your strategy on acquisitions, is those kind of the same?

Gregory A. Serrao

Well I just want to make sure I’m clear, I think the eight we’re saying are going to be de novos and relocations. I don’t know that’s going to be eight de novos in 08 but we just finished the de novo, for instance in North Carolina, we’re in Winston Salem and we just built a new facility in Winston Salem. The de novos that we’re focused on now we call in market de novos. So, we have a practice with our partner, Universality Dental Associates in Winston Salem that’s very, very busy, there is no more physical capacity and it’s already a large facility. So we have found another attractive part of Winston Salem, another attractive community. We built a practice and one of their lead doctors from the existing practice is moving over to the other practice. So that practice is going to open up with a book a business, because it’s going to open up largely with his book a business. So we just did one of those also in Wisconsin last year, we did one in Missouri last year. The nice thing about what we call these in market de novos is they open up with a doctor with a pretty full schedule the day it opens so they get the profitability very quickly and that’s where we’re going to be focused on. Looking at our affiliated dental groups that have practices that are very busy where they physically can’t really put anybody else in there. Seeing if there’s an opportunity to go a mile, two, three miles away, take one of the doctor’s from that existing practice and have them open a new location that will start off profitable right away.

Brian Millbline – DRW Investments

So is that sort of a strategy that will help you kind of get around the acquisition constraints? Is that actually a higher return on investment than an buying in market acquisition?

Gregory A. Serrao

Generally it is, yeah. The de novos prove over time to be the highest return on capital.

Breht T. Feigh

And then the other probably two of the de novos will be Care for Kids for the Medicaid opportunity.

Brian Millbline – DRW Investments

Okay, and is there any focus on the kind of in market acquisition, are you looking to ramp up Medicaid?

Gregory A. Serrao

No I think on the Medicaid side it’s going to be more of a build versus buy. It’s a very inexpensive facility proposition, it doesn’t have the same finishing and touches we do in our general practices and the patient demand and the needs are very high.

Brian Millbline – DRW Investments

Got it, and then on the $10 million cap ex, how does that break down between maintenance and de novo relocation cost?

Gregory A. Serrao

It’s probably about 70% de novo relocations Breht?

Breht T. Feigh

It’s about 65/35, maintenance.

Brian Millbline – DRW Investments

Okay, and maintenance would include any IT?

Breht T. Feigh

No.

Breht T. Feigh

We have to capitalize some of the development costs on [inaudible] and we typically put that over on the non-recurring side, so.

Gregory A. Serrao

It’s generally not a big number though.

Brian Millbline – DRW Investments

And, as far as the litigation expense that you’ve rolled up into that pro forma, $36.7 million number. Does that include litigation expenses incurred in Q1 that they’re just kind of part of that settlement?

Gregory A. Serrao

No.

Brian Millbline – DRW Investments

So it will be incremental Q1 litigation expenses that are pretty high run rate?

Breht T. Feigh

I wouldn’t characterize it maybe any higher than the fourth quarter because we had fewer people involved in the settlement process than we did in the litigation process. But there will be expenses, yes.

Brian Millbline – DRW Investments

And is there any kind of guidance on a tax rate assumption for 08?

Breht T. Feigh

That come in at about 39.5% I believe it is for 08 as we currently look at it.

Operator

(Operator Instructions) I’m showing no one in queue.

Gregory A. Serrao

Well thank you very much everybody for your support and attention and we look forward to talking to you next quarter.

Operator

That concludes today’s conference everyone may disconnect at this time.

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