Executives
Greg Serrao - Chairman, President, Chief Executive Officer
Breht Feigh - Executive Vice President, Chief Financial Officer
Mark Vargo - Chief Accounting Officer
Analysts
Brooks O'Neil - Dougherty & Company
Amy Stevens - Susquehanna Financial Group
Mitra Ramgopal - Sidoti
Alex Silverman - Special Situations Fund
Graeme Rein - Bares Capital
Carrie Nelson - Sky Stone Capital Management
American Dental Partners, Inc. (ADPI) Q1 2008 Earnings Call April 29, 2008 10:00 AM ET
Operator
Good morning and welcome to the American Dental Partners First Quarter 2008 Financial Results and Detail on Litigation Settlement Accounting. At this time, all participants are in a listen-only mode. (Operator Instructions).
Now, I will turn the meeting over to Mr. Greg Serrao. Sir, you may begin.
Greg Serrao - Chairman, President, Chief Executive Officer
Good morning, and thanks for joining us. I'm joined by Breht Feigh, the Company's 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 10-K 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 discuss financial and operational highlights, allowing for questions from participants after our prepared remarks. I will now turn the call over to Breht.
Breht Feigh - Executive Vice President, Chief Financial Officer
Good morning. Thanks, Greg. Our first quarter earnings release provides both GAAP and pro-forma financial presentations. Before getting into the financial details, I'd like to spend a few minutes commenting on what is included in the GAAP results and what has been excluded from the pro forma results.
GAAP results include both ongoing operations and activities which are not ongoing in nature. With respect to the ongoing operations, the GAAP results include the following: Our 26 dental groups -- group practices affiliated with us through means of a service agreement; our pediatric Medicaid business; our dental laboratories; and our dental benefit third-party administrator, or TPA.
With respect to activities which are not ongoing in nature, those include the following: Settlement accounting related to the transfer of the 25 dental facilities to PDG on February 29th, including a gain on the assets -- on the fair market value of the assets transferred to PDG in excess of their book value; revenue in the form of expense reimbursement associated with the 25 dental facilities prior to their transfer to PDG and expenses for those PDG doctors who remain in our [six] dental facilities on a temporary basis; professional fees associated with the litigation settlement; revenue and estimated expenses of our transition services agreement with PDG; and salary of our Minnesota-based management team prior to the realignment of these management resources, including severance expenses.
We have included a pro-forma presentation in the press release so that you can better understand the results of our ongoing operations, which exclude these items just referred to as not ongoing in nature. For comparability purposes, we have prepared a pro-forma first quarter 2007 income statement on the same basis as the 2008 pro-forma. As a result, the pro forma presentation for both quarters excludes all revenue and expenses associated with the litigation and the 25 dental facilities transferred to PDG.
The supplemental non-GAAP financial measures table in the press release -- the tables provide sufficient detail to reconcile to our GAAP results.
Rather than discussing each line item of our financial results, as I normally have done, I intend to review revenue and just those expense line items that have a trend of which merit discussion. First, I'd like to refer the table entitled "Patient Revenue and Same Market Patient Revenue Growth," which is included in the press release.
Patient revenue of the affiliated practices increased 9% to $107 million for the quarter. Same market patient revenue growth was 9.8% for the quarter. In calculating same market patient revenue growth, we have excluded, as we have always done, the contribution of new platform affiliations completed in either period of comparison.
We have also excluded Park Dental in its entirety from first quarter 2007 and the six dental facilities we retained as part of the litigation settlement from first quarter 2008. As a result, we are comparing like-for-like platform affiliates. The components of same market growth for the quarter were 9.9% greater provider hours, with a slightly positive improvement in productivity per hour, offset by a slight deterioration in reimbursement rates.
Excluding the contribution of in-market affiliations to the platform affiliates, same market patient revenue growth was 2.3% for the quarter. This was the lowest growth rate we have recorded in two years. We believe our growth is being impacted by the economy, given the fact that this is the second consecutive quarter, in which productivity per hour was essentially flat.
Now, I'd like to refer to the table entitled "Pro-forma Consolidated Statement of Income for the Three Months Ended March 31, 2008 and March 31, 2007," which is included in the press release. Net revenue for the quarter was $70 or 33% increase over the prior year. Metro Dental Care represents 26% of the 33% increase.
Salaries and benefit increase 39% over the prior year to $30.9 million. As a percentage of net revenue, this expense increased [180] basis points to 44.1%. This increase is primarily due to three factors. We have not fully integrated our Minnesota management team. Temporarily, we are not able to use the full capacity of the six dental facilities we retained because there are several PDG doctors still practicing in these facilities, as agreed to as part of the settlement agreement with PDG. And Metro Dental Care's operating expenses are higher than our other affiliates.
Office occupancy expenses increased 36% to $8.1 million. As percentage of net revenue, this expense increased 20 basis points to 11.5%. The increase is largely the result of our 2007 affiliation with Barzman, Kasimov & Vieth, where office occupancy expense is greater than our overall business.
Other operating expenses increased 39% to $6.4 million, or 9.2% of net revenue, a 50 basis points increased from the same period last year. Contributing to this increase were the disposal of un-depreciated assets associated with the relocation of a dental facility during the quarter, market and advertising, miscellaneous repairs and maintenance, and professional fees.
Depreciation expense increased 44% to $2.5 million. The increase is the result of 2007's affiliation activity, de novo facility development, and underutilization of the six retained dental facilities. Amortization expense increased 6% to $2.4 million the increase is the result of our 2007 affiliation activities. As a result of the above items, pro-forma EBITDA increased 27% to $10.3 million and earnings from operations increased 10% to $5.5 million.
Interest expense increased 66% to $2.5 million for the quarter. The increase is the result of greater borrowings and increased credit spreads over LIBOR associated with our new bank agreements. Also contributing to the increase is the fact that the bank fees for our new credit facilities are being amortized over just a 16-month period.
Diluted earnings per share were $0.13 for the quarter and diluted cash earnings per share were $0.24, which excludes the after tax impact of service agreement amortization expense.
Cash flow from operations was $1 million for the quarter as compare to $3.5 million for the prior year, neither of which is pro forma. The reduction is largely due to the following items: New payer contracts had to be negotiated for the six dental facilities and associated doctors retained to post-litigation settlement. This was not accomplished until late in the quarter and in some instances early in the second quarter.
While PDG has paid the interim management fee for the months ended January to April, it has not fully reimbursed us for clinic expenses incurred on its behalf by us. We are expecting payment of these amounts due to us in the second quarter. We had a $1 million deposit in transit to us at quarter end from one of our affiliated practices. And, lastly, our Texas affiliate witnessed a slowdown in the accounts receivable collection as a result of the implementation of Improvis, our proprietary practice management systems.
As we discussed during last quarters call while we continue to implement our Improvis practice management system, we have decided to maintain the pace of conversions rather than accelerating the pace, as we typically see a slowdown in accounts receivable collections post-implementation.
At quarter-end, we had implemented Improvis at 106 dental facilities as compared to 93 at year-end. Presently our intention is to have approximately 187 of our multi-specialty dental facilities operational on Improvis by year end.
Capital expenditure were $4 million for the quarter, this was comprised approximately $1 million of year-end carry-over payments $2 million for de novo's and relocation's and $1 million for our maintenance capital expenditures. As we previously disclosed we anticipate capital expenditures to be $10 million for the year, which will include eight de novo and facility relocation.
I will now turn the call back to Greg to conclude today's prepared remarks.
Greg Serrao - Chairman, President, Chief Executive Officer
Thanks Breht. We realize that the first quarter of 2008 maybe difficult to decipher for investors, which is precisely why we have provided both our actual GAAP results and pro forma results that we believe are more meaningful in terms of comparison and judging performance.
We have many challenges to deal within the first quarter of 2008 related to the settlement with PDG we had to manage the Park Dental business, as w had during the past 12 years in January and February, but do so while preparing for the February 29th transfer of operations assets and people related to the 25 dental facilities to PDG.
In addition with the clarity brought by the settlement we were finally able to properly complete the analysis of our integration plan for our Minnesota management teams, which we implemented and largely completed by the end of February 2008. While we still have to provide transitions services to PDG through September 30, 2008 the separation and locations assets and people is largely completed. This is a major achievement. We are now free of the distractions caused by the litigation, the settlement negotiations and the implementation of the settlement agreement.
As Breht mentioned our same market growth excluding rolling transactions was just 2.3% one of the lowest rates, we have experienced in recent quarters and certainly the lowest same market growth rate experienced in our first quarter in years. This result is directly related to the current economic malaise in the United States.
Many of the dental manufactures are reporting flat to down sales of dental consumable products such as impression material. Danaher Corporation and Noble Biocare are among the largest and most prominent dental manufacturers to report flat revenues in the first quarter of 2008. Accordingly, we are cautious on the economy and on its impact on our operations.
While we are cautious on the economy, we intend to continue to execute our long-term strategic plan, which includes more annual de novo practice development than we have done in the past, in addition to our corporate development activities. Our new de novo practice development model has been quite successful and we are pleased that Metro Dental Care has pursued a similar strategy of de novo practice development prior to its affiliation with ADPI with great success.
We also intend to open our first pediatric Medicaid practice outside of the state of Arizona in the third or fourth quarter of this year and to accelerate the development of pediatric Medicaid practices in 2009.
The underlying fundamentals of the dental business particularly the demographic trends in the US and the availability of qualified dental professionals still indicates strong growth in the dental industry. While the economy may have a short-term negative impact the long-term growth prospects of the dental industry are as strong as ever.
With that Tamara, I would now like to open the call up to questions, please.
Question-and-Answer question
Operator
Thank you. (Operator Instructions). Our first question comes from Brooks O'Neil with Dougherty & Company. You may ask your question.
Brooks O'Neil
Good morning and congratulations on a very good quarter and I really do appreciate all of the detail you provided in the press release.
Greg Serrao
Thank you Brooks.
Brooks O'Neil
I have a couple of questions. First I guess, I'd like to understand one thing. I don't think Breht commented about. It appears to me that the amounts retained by affiliated dentists as a percentage of total revenue was up somewhat this quarter. And if in fact, I am correct in that observation, could you just comment about why you think that might be?
Breht Feigh
Correct observation. And its driven exclusively by our affiliation with Barzman, Kasimov & Vieth in the third quarter last year where we employed not just the doctors but also the dental assistants and hygienists and given the size of it, then showing up in that table.
Gregory Serrao
You mean to say, where Barzman, Kasimov & Vieth are the doctor group employees, the hygienists and dental assistants, its okay.
Brooks O'Neil
So we should probably think about modeling at higher level going forward?
Breht Feigh
Yeah, you can model it at a slightly higher level.
Brooks O'Neil
Okay. And then secondly, if I was listing Breht, to your commentary about the various clinical expense line items, I guess, I would ask if I would hearing correctly that perhaps there are some controllable things many of which you may already have addressed that might tend to reflect improved metrics in those areas in the balance of the year? So for example, I didn’t mean to leave you speechless there.
Breht Feigh
I am trying to…
Brooks O'Neil
For example, what I mean is, you mentioned that the salaries and benefits line was up somewhat, but that it included your Minnesota overhead costs. I know some of which you've already taken steps to reduce?
Greg Serrao
Right. I think hopefully we will see improvement in terms of lower cost what we know for sure we will. The change is that we made in Minnesota management team for instant did not happen until right up to the end of February. So march would have been the first month that we would have seen some of that pick up in cost or lower cost I should say. So we will see that in the second quarter and go forward. The other thins is that as Breht mentioned the Metro Dental Care's operating expenses are higher than our other affiliates and that’s an opportunity, but a longer term our opportunity. So when we manage Park Dental, we manage Park Dental at a higher profitability rate or lower operating cost at the practice level than Metro operates.
Breht Feigh
Yes.
Greg Serrao
But we have the same management team, so we hope that we will be able to replicate overtime the margins at Metro that we realized at Park Dental.
Breht Feigh
And I should interject that we -- Park Dentals retention of team members at the practice level is extremely high, actually probably one of the highest of all of the affiliates in the country. So lower costs didn’t come at the expense of turnover.
Greg Serrao
Exactly.
Brooks O'Neil
Okay. And then, just as another related item, I'm guessing that disposal of assets that you mentioned that was essentially a one-time type item that shouldn't recur, right? In other expenses?
Breht Feigh
Correct. I think we've done a pretty thorough job of going through the fixed asset ledger and making sure that we disposed off everything that we did dispose contractually, So…
Brooks O'Neil
Okay, that's good. You've provided some commentary on the state of the Minnesota market, but could you comment just a little bit more broadly on how you're feeling about things up here and what you're seeing in this key market?
Greg Serrao
Yeah, I would be happy to do that, Brooks. I will comment that, in general, we are at a 2.3% same market growth. I think we're experiencing what a lot of people in the dental business are experiencing, which is a slow growth rate. And patients are not generally opting for some of the higher-end procedures.
Brooks O'Neil
Yeah.
Greg Serrao
If you look at what's going on the dental manufacturer side, anybody that produces impression materials, whether it's Heraeus Kulzer or Ivoclar, they're reporting that their impression material sales are down, which means not as much crown or bridgework is getting done. So we're experiencing that, generally, across the board and on the other higher-end pieces, orthodontics. This past quarter, our orthodontic production per hour was down year-over-year, which is an unusual development. Danaher Corporation, which is the big orthodontic manufacturer, largely said that their revenues were flat to down in the first quarter due to orthodontics. So I think, generally, the higher-end procedures across the country are the procedures that are being put off by patients.
Brooks O'Neil
Yeah.
Greg Serrao
So having said that, we're seeing in Minnesota our orthodontic business is basically flat, which is probably better than what the national trend is. Like I said, we see productivity per hour down actually year-over-year, but we're flat in Minnesota. But on the general dental side, which is largely comprised now of Metro and the six Park Dental practices we retained, the Metro practices are doing quite well. And the growth rate is above, well above, our same market internal growth rate, which is largely due to the de novo development they've done over the past few years. So we are happy with that.
The integration of the management team at the resource group level is, like I said, largely done, if not -- yeah, pretty much largely done, just happened at the end of February. And I think the team there, led by Dr. Milbrath and Gustafson and Mike Kenneally were able to work through and pick the strongest performers of both companies to form one management company.
At the practice level, if you look, we have 31 Park Dental practices, including the 6 specialty. So there are 25 general practices and six specialty. We do not manage the specialty practices with practice managers. So we didn’t have any practice managers there. So you had 25, basically, general practices at Park Dental. And of those 25 practices, we kept 6. And, of course, in those 6 we kept the six managers. Left us 19 practices and of those 19 practices, there were 18 managers, and we've kept 13 of those 18.
Brooks O'Neil
That’s great.
Greg Serrao
Yes, six of whom are managing Metro Dental practices now. And one of whom is actually in North Carolina now doing practice management for us. And the others are in scheduling manager or assistant manager positions. So the team that basically helped us run a very successful, efficient high-quality dental business for Park Dental is now in place in addition to the quality of people that Metro have. So we're pretty excited about what this year and next year should hold in terms of improvements in operating costs and profitability.
Brooks O'Neil
That’s great.
Greg Serrao
Okay.
Brooks O'Neil
Okay. Maybe, I will just ask one more and then I'll hop into the queue. I know you've spent a lot of time traveling around the United States to visit with your other affiliated dental groups. And aside from the comments you've made so far, are there any highlights? What's the morale? How's the outlook for continuing to develop those practices going forward?
Greg Serrao
I think, again, very good, Brooks. People are excited about the de novo developments, especially those that are involved in it at this point. I think everybody's worried about the economy. There's no doubt that they're seeing that. We see it worst on the West Coast, California, Arizona. That's definitely being impacted a lot more strongly than, say, the Midwest is. I think we are starting to feel overall that people are really starting to get the 180 PI concepts and the opportunity there. So I think we feel pretty good about what's going on. And I think people realize, and especially the groups that have been around for a long time, they know economic cycles come and go, but the demand for dentistry will always be there. It might be a little slack at times, but it's not going away.
Brooks O'Neil
Right.
Greg Serrao
So I don't -- while they don't like being slow, they don't fret about it too much either.
Brooks O'Neil
Sure. That’s great, okay. Thank you very much.
Operator
Thank you. Our next question comes from Amy Stevens with Susquehanna Financial group. Ma'am you may ask your question.
Amy Stevens
Thank you very much. Good morning, Greg and Breht, thank you. Thanks again. I'll just repeat what Brooks said, for all the financial detail provided. It was very helpful. Just following up on a few things. I guess to start from the big picture. In terms of the 2.3% same market growth and concerns regarding the economy, could you break it down a little bit? You kind of did just now saying geographically, okay, West Coast more so than Midwest. And I don't know if that's influenced strongly by Minnesota. Are there other Midwestern markets that you might highlight? And what about New York, or could you kind of highlight any other geographic detail on sort of that trend that you're seeing? And then in terms of the higher-end procedures or dental work being put off, is there -- can we look back to other slow periods in the economy and say, yeah we saw these being down, but they were in fact postponed and not eliminated? And so typically we see a rebound after a certain period of time, because people actually kind of require that bridge work or what have you. Could you just comment on that first?
Greg Serrao
Sure. Well, I would say it is, when I said Midwest, I'm thinking like Minnesota, Wisconsin, Missouri, St. Louis, we're in St. Louis. Those three markets had internal growth rates stronger than the 2.3%. So they're -- so I'm not just talking about Minnesota. But it seems like the West, the South, East, like Alabama, North Carolina even now, and Louisiana for us, really kind of hit by the economy. And then up in the Northeast, relatively slow. Not down, but relatively slow same market growth rates.
And what we see when we look at the business, is that we're seeing even hygiene productivity per hour come down, which is unusual, but meaning people aren't doing even the higher-end hygiene procedures, such as the periodontal therapy maintenance. But I think the ortho thing was probably the biggest standout of letting us know that people are putting off the $4500 purchases or whatever the fee is for an orthodontic treatment. And I can only say this anecdotally, but Dr. Biewald, who is the founder of our largest orthodontic group, has said over and over again about 85% of the orthodontic cases are not clinically necessary, which means they're cosmetic in nature, trying to improve appearance.
And so I think people are saying, okay, well, this is a big ticket item, $4500. Sometimes it's covered by insurance; lots of times it's not. And almost all the time, even if it's covered by insurance, it's a small percentage of the total ticket that is. So to see that, on a production-per-hour, drop as much as we've seen is a pretty good indicator that the orthodontic business has slowed down. And to see a manufacturer like Danaher report down orthodontic sales is a good indicator of what's going on nationally I think.
That will come up -- come back, because there will always be teenagers and moms and dads who want to improve teenagers' appearances. And on the crown and bridge work, I think you're exactly right. I mean, that's just being put off as well. I mean, it can't be put off forever, but it will be put off until somebody has a broken tooth or is experiencing pain and then you'll see them in the practice. I mean, I think if you talk to an endodontist today who does root canals, they'll tell you they're as busy as ever.
Amy Stevens
Yes, I wouldn't be surprised.
Greg Serrao
Oh, yes.
Amy Stevens
So just drilling down on that, even a little further, because I think it's really important. The orthodontic work that's done, and I don't know what statistics you do collect on this or have access to. But it would make sense, of course, that the orthodontic work being done to teenagers would be, perhaps, put off and not eliminated. Whereas, perhaps, orthodontic work for adults that might be truly cosmetic, I mean it's equally cosmetic, but more of a luxury item in people's minds than taking care of their children, that might be permanently put off. So what percentage of the total orthodontic work that's done might be in those two buckets. And orthodontics specifically, as a percentage of the total dental work that your affiliates are doing. How important is orthodontics within that largest bucket, the total dental work?
Greg Serrao
Right. I can't give you a breakdown for ADP as to a teenager or a child orthodontic patient to an adult patient. My guess would be that it's largely child or teenager, not adult. I think we can, all of us, look for the release of earnings from Invisalign or Align Technology and see, because their patient population would largely be the more cosmetic adult patient population.
Amy Stevens
Right.
Greg Serrao
We can look and see what result they've seen.
Breht Feigh
It represents about10% of our business.
Amy Stevens
Okay.
Greg Serrao
Orthodontics does, yes.
Amy Stevens
Okay, so it's 10% of your business. Alright.
Greg Serrao
Right.
Amy Stevens
That's really helpful. And then….?
Greg Serrao
And it's about 9% of the dental market nationally.
Amy Stevens
Okay. Alright. And is that -- well, I think maybe I could guess at some of the different distributions, you might see of that geographically. Is there another big bucket other than the 10% that you would call high end procedures? What's the other big group is would you call it the bridge and dental work?
Greg Serrao
Crown and bridge, right.
Amy Stevens
Crowns and bridge, right. So what percentage would that be either just nationally or what you know of ADPI's?
Greg Serrao
Yeah, I'd have to say, Amy, we actually don't track that.
Amy Stevens
Okay.
Greg Serrao
We track more the productivity per hour. But in terms of the -- when it gets to like general dentistry and the specific procedures that are done, we just have never really tracked that. Because that's really all a clinical nature and decisions made by the doctors.
Amy Stevens
So on that productivity per hour, though, obviously you do track that very closely. And I don't know, this detail you might not, though. But we've talked about it in terms of when you go into practices that you try to work on if someone is scheduled three weeks out. Let say, getting them down to two and a half and one and a half weeks out, with a higher reimbursement rate per procedure or per visit. Viewing that as the priority rather than being many weeks out with less lucrative visits. Do you know, if there is any change in how far out people are scheduled?
Greg Serrao
Well, I'm not sure on your introduction there that I would necessarily agree with that. But we do know that the schedules are you know, what's the industry terms softer, see more holes in schedule.
Amy Stevens
Okay.
Greg Serrao
We're having to work harder in the 48 hours before. Typically, we are reconfirming schedules 48 hours in advanced and we are having to work harder to get those schedules full. I think most of the doctors, again, I can't -- you can't speak for every single doctor, but I think most -- I would say most of the group practice affiliated with us would tell you that they're seeing more openings in their schedule you know, a week out than they normally would see. And then the job is for us to fill those schedules.
Amy Stevens
Okay. So, just to shift gears, I'll ask one more question and I'll get out of line. The contract, this is relating to the Park Dental litigation. Do you -- subsequent to signing or establishing your contract with them, when you went into other affiliations later, even more recently than that, did you make changes -- is there any sense that when you did that one you had less experience and perhaps clauses were written in differently then they might be later. I mean, are there any kind of differences that would cause one to believe that you might have less problems with other later signed contracts?
Greg Serrao
No, the only thing that we would do different [substantively] than we're doing right now is to negotiate for a trial by judge, not a trial by jury. And then Minnesota jury, or trial, was by judge, we would have had a very different outcome.
Amy Stevens
Okay.
Greg Serrao
In my opinion.
Amy Stevens
Yeah. And what about all of your other affiliate contracts right now, do they all specify trial by jury?
Greg Serrao
Yeah, I mean, well, I can't say they all do. I think there's a couple of the new ones that we just are doing that that will be trial by judge. But, substantively, all of them are trial by -- well, actually the plaintiff will choose, but they could be trial by jury.
Amy Stevens
The plaintiff has the right to choose in the established contracts, okay.
Greg Serrao
Right.
Amy Stevens
And are they substantively the same in all other respects? So they're all fairly similar to the Park Dental contracts?
Greg Serrao
They're all the same. And I'm glad they are. And I think one of the -- I mean, it's hard to find any silver linings in the outcome of the Park Dental litigation, but one of them was that that contract is rock solid. I mean, it wasn't illegal. It was clear that we owned what we owned and they owned what they owned. Obviously, we were able to use what we own, the 25 offices and stuff, to satisfy a relatively high, and in my opinion ridiculous, jury verdict. But we think one of the things that was shown is that the contract is a very well designed contract, both in structure and in implementation. So we are very pleased with the contract.
Amy Stevens
Okay.
Greg Serrao
That why, I would say the only thing that we would like to change is this -- if we were to have a dispute, we would rather have it be decided by an unemotional legal mind like a judge.
Amy Stevens
Got it, okay. And are there any new legal actions, we should be aware of?
Greg Serrao
No just the shareholder litigation, which is on going but that’s not new.
Amy Stevens
Beyond that nothing?
Greg Serrao
No.
Amy Stevens
Okay. Thanks. I will jump back in queue.
Greg Serrao
Thank you.
Operator
Thank you. Our next question comes from Mitra Ramgopal with Sidoti. You may ask your question.
Mitra Ramgopal
Yes, hi guys, just give me your comments that the economy is having some impact on the business. I know, if you could comment on your affiliation pipeline and if you are more hesitant now to look to expand until things pick up again?
Greg Serrao
You know, we are not more hesitant to expand Mitra, but I think we are finding in many cases, we are the only buyer. And people maybe having unrealistic expectation of value. And so we will be patient to wait that out. That won't be in all cases, I am sure. But I think a lot of people are seeing business slow maybe a lot more people are starting to think about maybe now is the time for us to sell. We are definitely seeing, I know and for instance in Minnesota we're seeing orthodontists that are looking for time. In other words their practices aren't busy enough. They are wanting to practice a day or two days a week with our group practice. We are seeing that a lot in general in dentistry. So I don't think its changed the pipeline at all and maybe increased it. But if we are the only game in town, we are trying to use that to our advantage.
Mitra Ramgopal
Okay. And also with the month of the second quarter pretty much out of the way, are you seeing the same trends continuing from the first quarter?
Greg Serrao
Pretty much so, yeah.
Mitra Ramgopal
Okay, thanks.
Greg Serrao
You're welcome.
Operator
Our next question comes from Alex Silverman with Special Situations Fund. You may ask your question.
Alex Silverman
Good morning.
Greg Serrao
Hey Al.
Alex Silverman
Most of my questions have been asked, just a quick question. Can you comment on what your D&O insurance is vis-à-vis the shareholder action?
Breht Feigh
The coverage is 10 million.
Alex Silverman
10 million?
Breht Feigh
Yeah.
Alex Silverman
And that covers the outcome or does that cover the cost of the litigation as well?
Breht Feigh
Cost that is included.
Alex Silverman
Great. Thank you very much.
Operator
Our next question comes from Graeme Rein with Bares Capital. You may ask your question.
Graeme Rein
Hi Greg. Could you just talk a little bit more about the expansion plans you were just mentioning? Did the valuations for the acquisitions ever become so attractive that you kind of focus more on those as opposed to de novo's? I know there's been more de novo's and [tokens] recently. Just wanted to get a feel for how attractive the valuations are out there and does that affect your strategy?
Greg Serrao
What we are finding for sure is long-term the de novo strategy is the best return on capital. Especially, the new model that we introduced a couple of years ago has performed very well. But you have to [whether] several – while depending on whether its we call out of market or in market you have to weather the negative cash flow and the capital outflow versus doing a transaction to immediately producing cash flow and positive results. But the return on capital never approximates what we are realizing on the de novo's.
So the de novo's are predictable. In other words we could decide, which ones we want to do. We go out and find the real estate, we enter into a lease, we build the facility and off we go. Where the affiliations are – they are unpredictable. We had a deal where we were supposed to close recently and the doctor had a major heart attack that all holds up the transaction and who knows what will happen with that. So it’s a shard to plan for that growth, but we are going to keep all funds moving forward.
Graeme Rein
Okay, that’s helpful. And I think, you mentioned you have one Medicaid rolling out in the third or fourth quarter similar to the Tooth Doctor.
Greg Serrao
Yeah.
Graeme Rein
Is that in Texas and are there any other states that reimbursements are becoming more attractive for that type of model.
Greg Serrao
It is in Texas. We are not sure exactly where yet in Texas. Our market development team is been working with the team out of Arizona to pick the right location. There is a lot of opportunity as you know, living in Texas. And there are other market places here on the East Coast, Virginia, Maryland are starting to improve their reimbursement profile. I think we are going to see that to be a pretty consistent trend. It almost seems now on a pretty regular basis that there is a highlight of some child who had some severe malady, if not including death because they couldn't get dental care and as soon as that happens the legislature run like crazy to improve the reimbursements. So we are seeing improved reimbursements on the child Medicaid not on adult Medicaid.
Graeme Rein
Okay. And then how much of the 15 million do you expect to use this year, 15 million available for…
Greg Serrao
For acquisitions?
Graeme Rein
Yeah.
Greg Serrao
I hope of all it.
Graeme Rein
Okay. Alright. Thanks for your time.
Greg Serrao
Okay.
Operator
Thank you. Our next question comes from Quincy Lee with Seton Capital. You may ask your question.
Quincy Lee
Yeah hi, a few questions. On the PDG separation, so the six locations that your keeping, I just wanted to make sure, it's a little cloudy to me. You haven't started recognizing revenue from those yet, is that right?
Greg Serrao
No we have. But in those location -- four of the six locations PDG still has doctors there. So the revenue that is generated by those doctors goes to PDG and not to us.
Quincy Lee
Got it, okay.
Greg Serrao
Yeah. So we wont have probably until really the third quarter would be the first -- the first real quarter that we'll have, where there will be no PDG doctors in our facilities.
Quincy Lee
So, if we took -- I think PDG 2007 revenue as a whole is like 64 million is that right?
Greg Serrao
PDG as a whole?
Quincy Lee
Yeah.
Greg Serrao
Was it 88 that we report?
Breht Feigh
89 patients. Net revenue was 64, you are right.
Greg Serrao
Okay.
Breht Feigh
1 million patient -- and net revenue.
Quincy Lee
64. And so, if we said by the end of the year, you will take 6 of 25 of that? Is it proportionate that you'll keep or not?
Greg Serrao
No, because in two of the practices we're keeping all of the doctors, because we're – as I said two of the four practices, they don't have any doctors in their. And we are not seeing any change in revenue there.
Quincy Lee
Okay.
Greg Serrao
In the other four practices three of those four we have the majority of the doctors. But we don't have all the doctors. So we will lose a percentage of the revenue in everyone of those practices. And one of the practices, they actually have the majority of the doctors. So we would anticipate losing a significant amount of the patient flow there. And so, we are not going to have – first of all those practices, I don't believe generated 620. Let me see if I did the math. They didn't quite generate….
Breht Feigh
Six thirty-first.
Greg Serrao
Six thirty-first, but I was doing it on general practice. Yeah they didn't quite generate that revenue in the first place. And then secondly, though we are not going to keep all the doctors and therefore not all the patients. So it's not our anticipation that those practices will perform at the same level this year as they did last year. But they will.
Quincy Lee
There was something less than sixth twenty-fifths. But by the end of the year, you will be keeping some portion of that?
Greg Serrao
Absolutely.
Quincy Lee
Okay. And then in terms of the ability to and I don't know even if you want to discuss this. But ability for Metro to take some of that market share from PDG. I mean at this point now you can compete head on with them is that right? There is no legal restrictions, is there?
Greg Serrao
Compete for patients?
Quincy Lee
Yeah with PDG.
Greg Serrao
I mean, we cannot specifically solicit PDG patients. But we compete in the market place. You know we can…
Quincy Lee
Okay. But you can't send flyers out to those specific patients and all that?
Greg Serrao
No, but we send flyers out to the general population.
Quincy Lee
Right, okay. Well then, I guess, I mean, it would be -- I would assume, its your intention to compete fairly, but get some of that volume back from them. Is that a fair statement or not?
Greg Serrao
Well, it's certainly is our intention always to compete fairly and I don't know that we are going to be too focused on PDG. We re going to be focused on growing Metro Dental and providing convenient hours for patients and providing high levels of service and high quality and hopefully by doing that to win market share, as we have done in other places.
Quincy Lee
Okay, that makes sense. A quick just housekeeping. As far as 2008 cash taxes, do you have any net operating losses carried over from last year or your cash taxes will approximate GAAP taxes?
Breht Feigh
I think, we probably should discuss this offline because there's the gain that we just had, but offset by the loss last quarter. So I think you have to take it apart piece by piece. But, generally, there's nothing unusual in the taxes that would cause us not to have to pay more or less than what our book is, but….
Quincy Lee
Okay. That's fair enough. That's fair enough. And, then, I guess last question, it's interesting on the de novo. The economics -- the return on capital of a de novo in-market expansion, is it -- I mean, is it 30, 40, 50 kind of percent returns or is it -- I mean, could you just help give me kind of a broad sense of what the returns are on the de novo expansion?
Greg Serrao
It's like the midpoint of what you just said.
Quincy Lee
Okay. Alright, great. Thanks, guys. I really appreciate it.
Greg Serrao
Thank you.
Operator
Our next question comes from Carrie Nelson with Sky Stone Capital Management. You may ask your question.
Carrie Nelson
Hi, good morning. I was just wondering if you could quantify some of the things you talked about in terms of the transition on the Metro Dental side overtime. So I think, Greg, you mentioned that the operating margins at Metro Dental are below. Could you just sort of quantify what the delta is for Metro Dental relative to the average for ADPI? And then also can you just sort of give us some color as to your thoughts on timing to narrow that gap? And what are some of the key things that you're working on as it relates to that?
Greg Serrao
I could say relative to Park Dental, the [gap] is, like, 400 basis points on margin.
Carrie Nelson
Relative to Park Dental or relative to ADPI?
Greg Serrao
Relative to Park Dental, which was in line with ADPI.
Carrie Nelson
Okay.
Greg Serrao
But I'm doing apples-to-apples in that marketplace.
Carrie Nelson
Okay.
Greg Serrao
And I'm doing this at the practice level, so it wouldn't include the management infrastructure. And to bring that up is going to take, I think we talked about this on the last call, it will be -- we'll start -- it will be into 2009. Because it's mainly going to be due to the staffing level, and that's really where the big changes are. But Park -- we can get into this operationally, but the way Metro Dental ran their practices prior to affiliation is different than the way we ran the practices. In other words, what was done at the practice level by the practice manager. We believe we had -- the Park Dental managers had significantly more responsibility. So we have now -- we have to work with the managers at Metro Dental, many of whom now are former Park Dental managers, but work with them. And then from there, start working towards having the doctors understand that they can provide the same level of high quality care, but do it more efficiently. And it's just going to take some time. But we have the right people in place from a management perspective to show that and the doctor leadership in Minnesota. Locally there, Dr. Milbrath and Dr. Gustafson are -- they're all in favor of high quality care delivered in an efficient manner.
Carrie Nelson
So does that mean, when you say staffing levels, now that you have it staffed with the managers that were achieving a higher operating profit at PDG, does that mean you're requiring higher productivity out of the doctors at Metro Dental or how do you get there?
Greg Serrao
No. Actually, the doctors at Metro Dental are more productive per hour than a lot of general dentists. And certainly more productive than the general dental group that we used to work with in Minnesota. So their productivity per hour is good. The hygiene productivity per hour can be better and we're actually starting to work on that. We have what we call a resident hygiene program that will start being implemented in Metro Dental this year, so that will help. But at the staffing levels, I'm just talking about front desk staff, support staff in the practices, not necessarily clinical staff, but staff that does billing, collections, insurance, filing, patient record filing and maintenance, all of that kind of stuff.
Carrie Nelson
Got it. So there is some transition period here then between working with maybe too much support staff to a point where you can get the better efficiencies. Do you think we are going to see that impact during the course of this year and then get that full run rate in 2009 or?
Greg Serrao
I think you'll see more of it late, beginning in late '08 and then coming into '09.
Carrie Nelson
Okay. And then could you also help quantify at all the operating costs, maybe just from a clarification standpoint. In Q2, are there any lower operating costs as it relates to PDG, that we will see sequentially?
Greg Serrao
I'm not sure, I understand that question.
Carrie Nelson
So from some of the things I guess, I want to make sure that the pro forma pulls out all of the costs as it relates to running the offices, you mentioned that you got underway in terms of some of the headcount changes in February. Can you quantify for us what sort of impact that's going to have going forward?
Breht Feigh
The low costs for supporting PDG are in the pro forma column.
Carrie Nelson
Okay. So it's all apples-and-apples, okay.
Breht Feigh
It's their responsibility for PDG goes away, we'll make adjustments accordingly.
Carrie Nelson
Got it , okay. And then lastly from a clarification standpoint. Can you just -- I think you mentioned this once before, but can you just give us an update on your thoughts on, if someone is not doing a crown, how long can they typically defer those purchases? Or those services?
Greg Serrao
I don't know that anybody can answer that. I mean, that all depends on the -- I mean, somebody made -- maybe doing it as a cosmetic thing, somebody might be doing it because they have an issue. For instance, if I wanted to replace my existing crowns even some of my large amalgam fillings and go with composite materials or crowns, I can postpone that for a long time because what I have is fine, it's more of a cosmetic thing. If I have a tooth that has a crack in it, I could postpone it and maybe that crack will just stay the way it is and not change for a long time or maybe the next time I bite an apple I've got a problem. I don't know that anybody can time that.
Carrie Nelson
Got it, okay. So some mix of the both cosmetic and clinical and you don't have any prior experience in other downturns that would suggest some sort of average on that?
Greg Serrao
Yeah. No. I would say, and we've said, -- as we've always said, our practices aren't focused on the high-end marketplace. But there is that component of it and so you're -- if our same market non-rolling growth was running between 5 and 6% and now it’s a 2.3, we are seeing obviously maybe some component of what is being [hurt]. You know what I mean? In other words, if we were a practice that solely focused on orthodontics or solely focused on what they call the boutique dentistry, I think we would see flat to down same market growth rate right now.
Carrie Nelson
Got it. Okay, that's helpful. Thanks so much.
Operator
(Operator Instructions). At this time, we have no further questions.
Greg Serrao
Thank you Tamara. Thank you everybody for joining our call. We hope that the pro forma presentation was helpful to you and we look forward to visiting with you again on the next call.
Operator
This concludes today's conference. You may disconnect at this time.
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