**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

**(Mark One)**

** **
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|------------|----------------------------------------------------------------------------------------------|

 

**For the quarterly period endedMarch 31, 2006.**

 

**OR**

 
| **o** | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|-----------------------------------------------------------------------------------------------|

 

**For the transition period from                    to                     **

 

**Commission file number:333-124080**

 

**INTERDENTSERVICE**

**CORPORATION**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                             | ** ** | **91-1577891**                        |
|------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of         |       | (I.R.S.  Employer Identification No.) |
| incorporation or organization)           |       |                                  |
|                                     |       |                                  |
| **222 No.  Sepulveda Blvd., Suite 740,** |       |                                  |
| **El Segundo, CA**                       | ** ** | **90245**                             |
| (Address of principal executive offices) |       | (Zip Code)                            |

 

Registrant’stelephone number, including area code: **(310)765-2400**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes  ý    No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer  o |   | Accelerated filer  o |   | Non-accelerated filer  ý |
|---------------------------------|--------|---------------------------|--------|------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes  o    No  ý

 

Number of shares of commonstock outstanding as of May 12, 2006: 105,521

 

**TABLE OF ADDITIONAL REGISTRANT**

 
| **Exact Name of Registrant** | ** ** | **State of Incorporation** | ** ** | **I.R.S. Employer  Identification Number** |
|---------------------------------------------|------------|--------------------------------------|------------|------------------------------------------------------|
| InterDent, Inc.                             |       | Delaware                             |       | 95-4710504                                           |

 

 

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INTERDENTSERVICE CORPORATION

 

TABLE OF CONTENTS

 
| PART I   |   | FINANCIAL INFORMATION                                                                                 |   | 1      |
|----------|--------|-------------------------------------------------------------------------------------------------------|--------|--------|
| Item 1.  |   | Financial Statements                                                                                  |   | 1      |
|     |   | Consolidated Balance Sheets at March  31, 2006 (unaudited) and December 31, 2005                      |   | 1      |
|     |   | Consolidated Statements of  Operations for the three months ended March 31, 2006 and 2005 (unaudited) |   | 2      |
|     |   | Consolidated Statements of  Cash Flows for the three months ended March 31, 2006 and 2005 (unaudited) |   | 3      |
|     |   | Condensed Notes to  Consolidated Financial Statements (unaudited)                                     |   | 4      |
| Item 2.  |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations           |   | 9      |
| Item 3.  |   | Quantitative and Qualitative Disclosure About Market  Risk                                            |   | 13     |
| Item 4.  |   | Controls and Procedures                                                                               |   | 13     |
|     |   |                                                                                                  |   |   |
| PART II  |   | OTHER INFORMATION                                                                                     |   | 15     |
| Item 1.  |   | Legal Proceedings                                                                                     |   | 15     |
| Item 1A. |   | Risk Factors                                                                                          |   | 15     |
| Item 6.  |   | Exhibits and Reports on Form 8-K                                                                      |   | 20     |
|     |   | Signatures                                                                                            |   | 21     |

 

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PART I – FINANCIAL INFORMATION

**Item 1. Financial Statements.**

 

**INTERDENT, INC.AND SUBSIDIARIES**

Consolidated BalanceSheets

(dollars in thousands)

 
| ** **                                                                                                         | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                         | ** ** | **(unaudited)**          | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                         | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                    |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                          |       | $                        | 1,609      |                        | $          | 1,519 |   |
| Marketable securities                                                                                              |       | 172                      |       | —                      |       |
| Accounts receivable, net of allowances of  $1,865 and $1,909 at March 31, 2006 and December 31, 2005, respectively |       | 13,007                   |       | 12,645                      |       |
| Supplies inventory                                                                                                 |       | 6,415                    |       | 6,454                       |       |
| Prepaid expenses and other current assets                                                                          |       | 3,094                    |       | 3,291                       |       |
| Total current assets                                                                                               |       | 24,297                   |       | 23,909                      |       |
|                                                                                                               |       |                     |       |                        |       |
| Property and equipment, net                                                                                        |       | 23,971                   |       | 23,883                      |       |
| Goodwill                                                                                                           |       | 74,546                   |       | 74,774                      |       |
| Intangible assets, net                                                                                             |       | 15,604                   |       | 16,006                      |       |
| Other assets                                                                                                       |       | 6,043                    |       | 6,247                       |       |
| Total assets                                                                                                       |       | $                        | 144,461    |                        | $          | 144,819 |   |
| ** **                                                                                                         | ** ** | ** **               | ** ** | ** **                  | ** ** |
| **Liabilities**                                                                                                    |       |                     |       |                        |       |
| Current liabilities:                                                                                               |       |                     |       |                        |       |
| Accounts payable                                                                                                   |       | $                        | 3,983      |                        | $          | 8,060 |   |
| Accrued payroll and related costs                                                                                  |       | 10,494                   |       | 9,461                       |       |
| Accrued interest                                                                                                   |       | 2,524                    |       | 981                         |       |
| Other current liabilities                                                                                          |       | 10,967                   |       | 9,748                       |       |
| Current portion of capital lease  obligations                                                                      |       | 93                       |       | 90                          |       |
| Total current liabilities                                                                                          |       | 28,061                   |       | 28,340                      |       |
|                                                                                                               |       |                     |       |                        |       |
| Long-term liabilities:                                                                                             |       |                     |       |                        |       |
| Capital lease obligations, net of current  portion                                                                 |       | 215                      |       | 239                         |       |
| Senior secured revolving credit facility                                                                           |       | 407                      |       | 1,308                       |       |
| Senior secured notes                                                                                               |       | 80,000                   |       | 80,000                      |       |
| Mandatorily redeemable preferred stock                                                                             |       | 4,243                    |       | 4,088                       |       |
| Other long-term liabilities                                                                                        |       | 1,527                    |       | 1,052                       |       |
| Accumulated dividends                                                                                              |       | 1,118                    |       | 998                         |       |
| Total long-term liabilities                                                                                        |       | 87,510                   |       | 87,685                      |       |
| Total liabilities                                                                                                  |       | 115,571                  |       | 116,025                     |       |
|                                                                                                               |       |                     |       |                        |       |
| **Shareholders’ equity**                                                                                      |       |                     |       |                        |       |
| Convertible preferred stock, $0.001 par  value, 281,679 shares authorized:                                         |       |                     |       |                        |       |
| Class A 229,007 shares authorized, 1,000  shares issued and outstanding at March 31, 2006 and December 31, 2005    |       | —                   |       | —                      |       |
| Class B 52,672 shares authorized, issued  and outstanding at March 31, 2006 and December 31, 2005                  |       | 8,650                    |       | 8,650                       |       |
| Common stock, $0.001 par value, 981,679  shares authorized:                                                        |       |                     |       |                        |       |
| Class A 229,007 shares authorized, zero  shares issued and outstanding at March 31, 2006 and December 31, 2005     |       | —                   |       | —                      |       |
| Class B 52,672 shares authorized, zero  shares issued and outstanding at March 31, 2006 and December 31, 2005      |       | —                   |       | —                      |       |
| Class C 700,000 shares authorized; 105,521  shares issued and outstanding at March 31, 2006 and December 31, 2005  |       | —                   |       | —                      |       |
| Additional paid-in capital                                                                                         |       | 21,599                   |       | 21,592                      |       |
| Accumulated deficit                                                                                                |       | (1,359                   | )          | (1,448                      | )          |
| Total shareholders’ equity                                                                                    |       | 28,890                   |       | 28,794                      |       |
| Total liabilities and shareholders’ equity                                                                    |       | $                        | 144,461    |                        | $          | 144,819 |   |

 

See accompanyingcondensed notes to consolidated financial statements.

 

1

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**INTERDENT, INC.AND SUBSIDIARIES**

Consolidated Statementsof Operations

(unaudited, dollars in thousands)

 
| ** **                                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
|                                                    |       |                                             |       |   |   |
| **Revenues:**                                           |       |                                             |       |   |   |
| Dental practice net patient service revenue             |       | $                                                | 55,377     |   | $ | 53,486 |   |
| Other fees                                              |       | 299                                              |       | 253 |   |
| Total revenues                                          |       | 55,676                                           |       | 53,739 |   |
| **Costs and expenses:**                                 |       |                                             |       |   |   |
| **Cost of revenues:**                                   |       |                                             |       |   |   |
| Clinical salaries, benefits, and provider  costs        |       | 27,262                                           |       | 26,220 |   |
| Practice non-clinical salaries and benefits             |       | 7,595                                            |       | 7,572 |   |
| Dental supplies and lab expenses                        |       | 5,481                                            |       | 5,453 |   |
| Practice occupancy expenses                             |       | 3,500                                            |       | 3,292 |   |
| Practice selling, general and  administrative expenses  |       | 4,051                                            |       | 4,513 |   |
| Provision for doubtful accounts                         |       | 372                                              |       | 233 |   |
| Total cost of revenues                                  |       | 48,261                                           |       | 47,283 |   |
| Corporate selling, general and  administrative expenses |       | 2,945                                            |       | 2,135 |   |
| Stock compensation expense                              |       | 7                                                |       | 6 |   |
| Depreciation and amortization                           |       | 1,394                                            |       | 1,309 |   |
| Total operating expenses                                |       | 52,607                                           |       | 50,733 |   |
| Operating income                                        |       | 3,069                                            |       | 3,006 |   |
| **Non-operating (income) expense:**                     |       |                                             |       |   |   |
| Interest income                                         |       | (25                                              | )          | (1 | ) |
| Interest expense                                        |       | 2,584                                            |       | 2,542 |   |
| Other income                                            |       | (6                                               | )          | — |   |
| Other expense                                           |       | 62                                               |       | 10 |   |
| Non-operating expense, net                              |       | 2,615                                            |       | 2,551 |   |
| Income before income taxes                              |       | 454                                              |       | 455 |   |
| Income tax provision                                    |       | 245                                              |       | 177 |   |
| Net income                                              |       | 209                                              |       | 278 |   |
| Accumulated dividends on preferred stock                |       | 120                                              |       | 91 |   |
| Net income attributed to common stock                   |       | $                                                | 89         |   | $ | 187 |   |

 

See accompanyingcondensed notes to consolidated financial statements.

 

2

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**INTERDENT, INC.AND SUBSIDIARIES**

Consolidated Statementsof Cash Flows

(unaudited, dollars in thousands)

 
| ** **                                                                             | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                                                                             | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| **Operating activities**                                                               |       |                                                 |       |   |   |
| Net income                                                                             |       | $                                                    | 209        |   | $ | 278 |   |
| **Adjustments to reconcile net income to net  cash provided by operating activities:** |       |                                                 |       |   |   |
| Depreciation and amortization                                                          |       | 1,394                                                |       | 1,309 |   |
| Provision for revenue adjustments and  doubtful accounts                               |       | 372                                                  |       | 233 |   |
| Loss on dental location dispositions and  disposal of assets                           |       | 62                                                   |       | — |   |
| Change in deferred taxes                                                               |       | —                                               |       | 98 |   |
| Interest paid in kind                                                                  |       | 155                                                  |       | — |   |
| Interest amortization on deferred financing  costs and discounted debt                 |       | 213                                                  |       | 196 |   |
| Stock-based compensation expense                                                       |       | 7                                                    |       | 6 |   |
| Recognition of deferred revenues                                                       |       | (142                                                 | )          | (88 | ) |
| **Changes in assets and liabilities:**                                                 |       |                                                 |       |   |   |
| Accounts receivable                                                                    |       | (734                                                 | )          | (74 | ) |
| Supplies inventory                                                                     |       | 39                                                   |       | (44 | ) |
| Prepaid expenses and other current assets                                              |       | 197                                                  |       | 381 |   |
| Other assets                                                                           |       | 219                                                  |       | 150 |   |
| Accounts payable                                                                       |       | (4,077                                               | )          | 2,122 |   |
| Accrued payroll and related costs                                                      |       | 1,033                                                |       | 698 |   |
| Accrued interest                                                                       |       | 1,543                                                |       | 1,533 |   |
| Other current liabilities                                                              |       | 1,159                                                |       | 31 |   |
| Other long-term liabilities                                                            |       | 475                                                  |       | (262 | ) |
| Net cash provided by operating activities                                              |       | 2,124                                                |       | 6,567 |   |
| **Investing activities**                                                               |       |                                                 |       |   |   |
| Marketable securities                                                                  |       | (172                                                 | )          | — |   |
| Purchase of property and equipment                                                     |       | (1,142                                               | )          | (3,200 | ) |
| Net cash used in investing activities                                                  |       | (1,314                                               | )          | (3,200 | ) |
| **Financing activities**                                                               |       |                                                 |       |   |   |
| Net payments on revolving credit facility                                              |       | (901                                                 | )          | — |   |
| Payments on long-term debt and obligations  under capital leases                       |       | (21                                                  | )          | (158 | ) |
| Changes in overdraft balances                                                          |       | 202                                                  |       | — |   |
| Net cash used in financing activities                                                  |       | (720                                                 | )          | (158 | ) |
| Increase in cash and cash equivalents                                                  |       | 90                                                   |       | 3,209 |   |
| Cash and cash equivalents, beginning of  period                                        |       | 1,519                                                |       | — |   |
| Cash and cash equivalents, end of period                                               |       | $                                                    | 1,609      |   | $ | 3,209 |   |

 

See accompanyingcondensed notes to consolidated financial statements.

 

3

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**INTERDENT, INC.**

**AND SUBSIDIARIES**

March 31, 2006 and 2005

Condensed Notes to Consolidated FinancialStatements

(Unaudited)

 

**1.****             ****Our Company**

 

InterDent ServiceCorporation, the principal operating subsidiary of InterDent, Inc.(collectively, We, InterDent or the Company) provides dental practicemanagement services to multi specialty group dental practices in the UnitedStates. Our network of affiliated dental practices seeks to providecomprehensive, convenient and high quality general dentistry as well as dentalspecialty services such as orthodontics, periodontics, endodontics,pedodontics, prosthodontics and oral surgery. We do not engage in the practiceof dentistry, but rather work with affiliated dental practices or professionalcorporations (PC) to enhance the business operations of their practices. Weenter into management service agreements with these affiliated dental practicespursuant to which we provide them, on an exclusive basis, with management andadministrative services.

 

As of March 31, 2006, we provided managementservices to 128 affiliated dental practices in Arizona, California, Hawaii,Kansas, Nevada, Oklahoma, Oregon and Washington and own and operate one dentallaboratory in Oklahoma.

 

**2.****             ****Basis of Presentation**

 

Following the rules and regulations of theSecurities and Exchange Commission, or SEC, we have omitted footnotedisclosures that would substantially duplicate the disclosures in our annualaudited financial statements. The accompanying consolidated financialstatements should be read in conjunction with the financial statementdisclosures from our 2005 Consolidated Financial Statements contained in our10-K filed April 11, 2006 with the SEC.  The same accounting policies arefollowed in preparing quarterly financial data as are followed in preparingannual data. In the opinion of management, all adjustments necessary for a fairpresentation of quarterly operating results are reflected herein and are of anormal, recurring nature.

 

Certain prior year amounts have been reclassified toconform to the current year presentation.

 

We operate in one principal business segment as aprovider of dental practice management services to multi specialty group dentalpractices in the United States.

 

**3.****             ****Summary of SignificantAccounting Policies**

 

*Net revenues*

 

Dental practice net patient service revenue(Net Patient Revenue) represents the consolidated revenue of the affiliated PCsand is recorded when the related work is completed. Revenue related toprepayments, typically for multi-visit procedures, is deferred until themulti-visit procedure is completed. Revenue is recorded at the estimated netrealizable amount to be received from patients, third party payors and others,net of a provision for fee schedule adjustments.

 

Net Patient Revenue includes amounts received under capitated managed care contracts. A portion of these capitated revenue premiums are received at certain wholly-owned subsidiaries that are subject to regulatory review and oversight by various state agencies. The subsidiaries are required to, among other things, file statutory financial statements with the state agencies and maintain minimum tangible net equity balances and restricted deposits. The Company is in compliance with such requirements as of March 31, 2006. Total revenues subject to regulatory review and oversight by various state agencies were $11.1 million and $10.0 million for the three months ended March 31, 2006 and 2005, respectively.

 

*Available for sale securities*

 

The Company considers its marketablesecurities as available-for-sale as defined in the Statement of FinancialAccounting Standards (SFAS) No. 115, “Accounting for Certain Investments inDebt and Equity Securities,” or SFAS 115. These investments are recorded atfair value and are classified as marketable securities in the accompanyingconsolidated balance

 

4

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sheets as of March 31, 2006. The changes in fair values, net of applicabletaxes, are recorded as unrealized gains (losses) as a component of accumulatedother comprehensive income in shareholders’ equity. Changes in the fair valuesfor the three months ended March 31, 2006 were less than $1,000 and have notbeen presented due to immateriality.

 

*Stock-based compensation*

 

On January 1, 2006, we adopted SFAS No. 123R,“Share-Based Payment,” or SFAS 123R. In accordance with SFAS 123R, the Companymeasures the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award. That costis recognized over the period during which an employee is required to provideservice in exchange for the award – the requisite service period. Nocompensation cost is recognized for equity instruments for which employees donot render the requisite service. The Company determines the grant-date fairvalue of employee share options using the Black-Scholes option-pricing modeladjusted for the unique characteristics of these options. There were no optionsgranted or modified during the three month periods ended March 31, 2006 or2005.

 

Prior to adoption of SFAS 123R, we accountedfor grants under the stock option plan using the minimum value method aspermitted for non-public entities in SFAS No. 123 “Accounting for Stock-BasedCompensation,” or SFAS 123. Entities that used the minimum value method ofmeasuring equity share options prior to adoption of SFAS 123R are to apply SFAS123R prospectively to awards issued, modified, repurchased, or canceled afteradoption and continue to account for any portion of awards outstanding at thedate of the initial application using the accounting principles originallyapplied to those awards. Accordingly, periods prior to the adoption of SFAS123(R) will not be restated. Prior to adoption of 123R, we accounted for grantsunder the stock option plan in accordance with the intrinsic value methodprescribed by Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees”, or APB 25 adopting the disclosure only provisions of SFAS123.

 

Compensation expense of $7,000 and $6,000 forthe three months ended March 31, 2006 and 2005, respectively relates to optionsissued with an exercise price less than the market price of our stock at thetime of the grant. The pro-forma compensation costs for outstanding awardsgranted prior to adoption of SFAS 123R presented below have been calculatedusing a Black-Scholes option pricing model and may not be indicative of amountswhich should be expected in future years.

 

| ** **                                                                                                                                       | ** ** | **Quarter Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **(in thousands)**                                                                                                                          | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
|                                                                                                                                             |       |                                       |       |   |   |
| Net income, as reported                                                                                                                          |       | $                                          | 209        |   | $ | 278 |   |
|                                                                                                                                             |       |                                       |       |   |   |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effect                                       |       | 4                                          |       | 2 |   |
| Deduct: Total stock-based employee  compensation expense determined under minimumn value based method for all  awards, net of related tax effect |       | (24                                        | )          | (10 | ) |
|                                                                                                                                             |       |                                       |       |   |   |
| Net income, pro forma                                                                                                                            |       | $                                          | 189        |   | $ | 270 |   |

 

See note 5 for further discussion onstock-based compensation.

 

5

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## *Self-insurance*

## * *

The Companyutilizes high deductible insurance programs for workers’ compensation,professional liability, and substantially all of the employee medical benefitplans. The Company has utilized the medical benefit plan since 2003 and theworkers’ compensation and professional liability began in January 2005 andNovember 2005, respectively. Under these plans, the Company assumed firstdollar coverage responsibility and limits its exposure through the use ofindividual and aggregate stop-loss agreements.

 

The Companyrecords an estimated liability for self-insured deductibles and claims incurredbut not reported based on management’s estimates of the aggregate liability foruninsured claims using actuarial assumptions and historical loss patterns. Thereserve for the workers’ compensation and professional liability is recorded inother current liabilities on the balance sheet. The reserve for the employeemedical plans is recorded in accrued payroll and related costs. The aggregateamounts reserved for claims incurred but not paid under these policies was $1.1million and $1.0 million at March 31, 2006 and December 31, 2005, respectively.Although management believes it has the ability to adequately estimate lossesrelated to claims, it is possible that actual results could differ fromrecorded self-insurance liabilities.

 

*Use of estimates*

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect reported amounts ofassets and liabilities, revenues and expenses and related disclosures ofcontingent assets and liabilities in the consolidated financial statements andaccompanying notes. There is a possibility that actual results may varysignificantly from those estimates.

 

## *Goodwill*

## * *

Changes in goodwill in thethree months ended March 31, 2006 are related to the utilization ofpre-emergence deferred tax assets.

 

## *Deferredcompensation*

## * *

On January 1,2006, we adopted an elective non-qualified Deferred Incentive CompensationRetirement Plan (the 2006 Plan) to provide certain employees and affiliatedprofessionals an opportunity to voluntarily defer compensation on a pre-taxbasis. Additionally, the Company will make bonus contributions to the 2006 Planon behalf of our affiliated dentists based on predetermined performance goals.These bonus contributions vest and will be recorded as compensation expense bythe Company starting with the period earned through the end of the serviceperiod, typically 3 to 4 years. The Company intends to make its first bonuscontribution in December 2007.

 

A rabbi trustis the funding vehicle that is used to hold the deferred compensation amountsthat are invested in mutual funds within the trust. Accounting for the 2006Plan is in accordance with Emerging Issues Task Force (EITF) 97-14 “Accountingfor Deferred Compensation Arrangements Where Amounts Earned are Held in a RabbiTrust and Invested”. The rabbi trust assets held in mutual fund securities aredeemed to be “available for sale” with unrealized gains and losses excludedfrom earnings and reported in a separate component of shareholders’ equityaccording to SFAS 115. The liability for deferrals of $13,000 at March 31, 2006is included in Other Long Term Liabilities on the Consolidated Balance Sheets.

 

6

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*Accounting pronouncements*

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes andError Corrections—A Replacement of APB Opinion No. 20 and FASB Statement No. 3”or SFAS 154. SFAS 154 requires that a voluntary change in accounting principlebe applied retrospectively with all prior period financial statements presentedon the new accounting principle, unless it is impracticable to do so. SFAS 154also provides that (1) a change in method of depreciating or amortizing along-lived nonfinancial asset be accounted for as a change in estimate(prospectively) that was affected by a change in accounting principle, and (2)correction of errors in previously issued financial statements shall be termeda “restatement.” SFAS 154 is effective for accounting changes and correctionsof errors made in fiscal years beginning after December 15, 2005. Theimplementation of SFAS 154, effective January 1, 2006 did not have a materialimpact on the Company’s consolidated financial statements.

 

#### **4.**              Related party transactions

#### ** **

InApril 2005, our board of directors authorized the payment of an annualmanagement fee in the amount of $0.25 million to our majority shareholder forcertain services to be provided to us for the year and $0.25 million in annualdirector fees. This agreement is in effect until either party terminates theagreement.

 

**5.****              StockBased Compensation**

 

On April 28,2005, the Company adopted the InterDent, Inc. Amended and Restated 2003Stock Option Plan (2003 Stock Option Plan) under which the Company’s Board ofDirectors (Board) may issue incentive and non-qualified stock options topurchase up to 33,726 shares of the Company’s Class C Common Stock. Stockoptions issued under the 2003 Stock Option Plan are generally granted with anexercise price equal to the market price of our stock at the date of grant andshall be exercisable up to ten years from the grant date as determined by theBoard. Options granted under the 2003 Stock Option Plan typically vest over a 4year period. The following table summarizes stock option activity during thefirst quarter 2006.

 
| ** **                            | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in years)** | ** ** | **Aggregate  Intrinsic  Value (in  thousands)** | ** ** |
|---------------------------------------|------------|----------------------------|------------|----------------------------------------|------------|--------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Outstanding at December 31, 2005 |       | 33,387                     |       | $                                      | 157.76     |                                                                     | —     |                                                 | —     |   |
| Granted                               |       | —                     |       | —                                 |       | —                                                                   |       | —                                               |       |
| Exercised                             |       | —                     |       | —                                 |       | —                                                                   |       | —                                               |       |
| Cancelled                             |       | —                     |       | —                                 |       | —                                                                   |       | —                                               |       |
| Outstanding at March 31, 2006         |       | 33,387                     |       | $                                      | 157.76     |                                                                     | 3.6        |                                                 | $          | 600 |   |
| Exercisable at March 31, 2006         |       | 20,816                     |       | $                                      | 153.26     |                                                                     | 2.8        |                                                 | $          | 463 |   |

 

**6.****              Contingencies**

 

*Senior secured revolving creditfacility*

 

As of March 31, 2006, our borrowing base was $10.0million, of which the availability is reduced by $1.3 million for a letter ofcredit issued to satisfy the requirements of our workers compensation policy.At March 31, 2006, $0.4 million in borrowings were outstanding and $8.3 millionremained available under the Senior Revolving Credit Facility. This facilityexpires December 2009 and is secured by substantially all of our assets. Thenegative covenants include, among other items, limits on additionalindebtedness, liens, distributions, certain investments and transactions andcertain financial covenants to limit capital expenditures and require minimumEBITDA. We were in compliance of these covenants as of March 31, 2006.

 

7

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*Legal*

 

We have been named as a defendant in various lawsuitsin the normal course of business, primarily for malpractice claims. We, ouraffiliated dental practices and associated dentists’ are insured with respectto dentistry malpractice risks on a claims-made basis. Management believes allof these pending lawsuits, claims, and proceedings against us are without meritor will not have a material adverse effect on our consolidated operatingresults, liquidity or financial position, or cash flows.

 

In March 2006 the California Attorney General’sBureau of Medical Fraud and Elderly Abuse initiated an investigation followingour self reporting to Medi-Cal of billing errors we had discovered at one ofour affiliated dental practices. We continue to cooperate in the investigation;no material developments occurred during the past quarter.

 

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**Item 2. Management’s Discussion and Analysis of Financial Condition andResults of Operations.**

 

**FORWARD LOOKING STATEMENTS**

 

*This document includes forward looking statements. Forward lookingstatements are those that do not relate solely to historical fact. Theyinclude, but are not limited to, any statements that may predict, forecast,indicate or imply future results, performance, achievements or events. They maycontain words such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “project,”“plan,” “will,” or words or phrases of similar meaning. They may relate to,among other things, our strengths, strategy, growth plans, operations, revenue,earnings, expenses, financing, sources of liquidity and capital requirements.*

 

*Forward looking statements involve risks and uncertainties, including,but not limited to, economic, competitive and governmental factors outside ofour control, that may cause actual results to differ materially from trends,plans or expectations set forth in the forward looking statements. Certainfactors that might cause such a difference include, among other things,dependence upon our affiliated dental practices and the dental professionalswho generate our revenue; access to and cost of capital due to our highleverage ratio; cost containment efforts by third party payors and capitationarrangements; our growth strategy and the terms of our service agreements withaffiliated dental practices may reduce the cash we have available foroperations and funds available to meet our obligations; the geographicconcentration of our operations increases the risk that our operating resultswill suffer from adverse developments in our principal markets; governmentregulation of the dental industry and regulatory challenges to our businessmodel; professional liability and other claims that may be made against ouraffiliated dental practices; our operations and growth plans may be adverselyaffected by a highly competitive environment; and the interest of the entitiesaffiliated with our majority shareholder may conflict or differ from yourinterests. For further information about risks which may affect our futureoperating results, please see the Risk Factors set forth in Item 1A of Part IIbelow. New risks and uncertainties may emerge in the future. It is not possiblefor us to predict all of these risks or uncertainties, nor can we assess theextent to which any factor, or combination of factors, may cause actual resultsto differ from those contained in forward looking statements. Given these risksand uncertainties, we urge you to read this document completely with theunderstanding that actual future results may be materially different from whatis expressly stated or implicit in any forward looking statement.*

 

**OVERVIEW**

 

We provide practice management services to 128affiliated multi-specialty group dental practices in the United States. Ournetwork of affiliated dental practices is comprised of approximately 680affiliated general dentists, specialists and hygienists who provide dentalservices to patients in eight states. We also own and operate one dental lab inOklahoma.

 

We believelong term growth of the dental care industry in the United States is fueled by,among other things, increased availability of dental insurance, a growingpopulation of older patients who have retained their teeth and increasedinterest in cosmetic dentistry. However, certain dental procedures areconsidered elective or can be deferred and our revenue growth in the short termis subject to fluctuation based on trends in consumer confidence and theeffects that will have on our patients’ disposable income.

 

Our strategy to grow our business consists of two initiatives. We seekto drive revenue in our existing affiliated offices through the delivery ofconsistently good patient service, improving the physical appearance andinfrastructure of our offices and moving our affiliated practices to higherreimbursement plans. Additionally, our new office growth strategy seeks toenhance market penetration in existing markets as a primary driver of overallrevenue growth.

 

Our results from 2006 reflect increased stability and productivity ofour affiliated dentists, the impact of our growth initiatives and significantefforts to reduce the costs of operations.

 

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**RESULTS OF OPERATIONS FOR THE QUARTERS**

**ENDED MARCH 31, 2006 AND 2005**

 

The following table sets forth, for the periods indicated, the percentageof certain items in the consolidated Statement of Operations relative to totalrevenue.

 
| ** **                                              | ** ** | **Quarter ended March 31,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| Total revenues                                          |       | 100.0                                      | %          | 100.0 | % |
|                                                    |       |                                       |       |   |   |
| Cost of revenues                                        |       | 86.7                                       |       | 88.0 |   |
| Corporate selling, general and administrative  expenses |       | 5.3                                        |       | 4.0 |   |
| Depreciation and amortization                           |       | 2.5                                        |       | 2.4 |   |
| Total operating expenses                                |       | 94.5                                       |       | 94.4 |   |
| Operating income                                        |       | 5.5                                        |       | 5.6 |   |
| Other non-operating (income) expense, net               |       | 0.1                                        |       | — |   |
| Interest expense, net                                   |       | 4.6                                        |       | 4.8 |   |
| Net (loss) income before income taxes                   |       | 0.8                                        |       | 0.8 |   |
| Provision for income taxes                              |       | 0.4                                        |       | 0.3 |   |
| Net income                                              |       | 0.4                                        |       | 0.5 |   |

 

**Revenues**

 

Forour first quarter ended March 31, 2006, we posted net revenues of $55.7million, an increase of $1.9 million, or 3.6% from the same period last year.The increase in our overall revenue is driven primarily by improvedproductivity and stability of our affiliated providers and new office growth.We opened 6 new offices and closed 2 existing offices in the twelve monthsending March 31, 2006.

 

Ournet revenue from offices open for at least one year, or same-office revenue,increased by 2.7% to $53.2 million over the same period last year. The increasein same office revenue is the result of improved productivity and stability of ouraffiliated providers.

 

**Costsand expenses**

 

*Cost of revenues.*Cost of revenuesconsists of costs directly associated with activities of operating and managingthe practice facility locations, including regional support departments. Thecomponents of cost of revenues are largely variable or semi-variable costs andinclude clinical and non-clinical salaries and benefits, dental supplies andlab expenses, occupancy, practice selling, general and administrative expensesand provision for doubtful accounts.

 

Although our overall cost of revenues increased to$48.3 million as compared to $47.3 million for the same period last year, costof revenues as a percentage of net revenues decreased to 86.7% for the quarterended March 31, 2006 compared to 88.0% for the same period last year. Theoverall cost increase is attributed to the revenue growth while the primarydrivers of the percentage decrease in the quarter are as follows:

 

•                  Decrease as apercentage of revenue in non clinical salaries and related benefits and dentalsupplies and lab expense of 0.7% as we focused on cost containment in the firstquarter of 2006. This decrease was primarily due to a reduction in back officehead count during the quarter. Dental supply costs continue to improve as wecomplete our roll out of supply management tools to our affiliated dentallocations.

 

•                  Practice selling,general and administrative expenses decreased as a percentage of revenue 0.9%resulting from lower marketing expenditures in 2006 as compared to a plannedincremental increase in 2005 designed to build brand equity

 

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in our newly rebranded practices and to generate newpatient growth. We expect to continue this incrementally lower expenditure formarketing for the remainder of 2006.

 

•                  The decreases areoffset by a 0.3% increase as a percentage of revenue in clinical salaries andbenefits and occupancy costs. The increase in clinical salaries and benefits asa percentage of revenue is due primarily to a increase in temporary salary guaranteesto new affiliated doctors during their initial ramp up period, combined withthe typically lower productivity of these new doctors. We customarily providenew affiliated dentists with guaranteed minimum compensation for a period ofthree to six months while they establish their practice. At the end of thisperiod, the affiliated dentists shift to a variable commission model. Theguarantees are a residual effect of the increase in doctor turnover that weexperienced in late 2005.

 

*Corporate selling, general andadministrative expenses.*Corporate selling, general and administrative expenses include:corporate salaries, general office costs, investor relations expense, legal andaudit fees, general insurance, director and officer liability insurance andother miscellaneous costs at our corporate facilities.

 

Forthe quarter ended March 31, 2006 our corporate selling, general andadministrative costs increased $0.8 million from the same period last year.This increase is attributed to:

 

•      Additionalcompensation costs related to an increase in our vacation liability and ouraccrued bonuses;

•      Higherprofessional services related to continuing information technology (IT)initiatives and audit costs resulting from a stub period audit in the prioryear and a full year audit for 2005; and

•      Non-employeedirector and management fees payable to our majority shareholder for thequarter. Amounts paid for services provided in the prior year began in thesecond quarter.

 

*Depreciation and amortization.* Depreciation expense is attributed to depreciation of dentalequipment, furniture, fixtures and computer equipment and amortization ofleasehold improvements and identifiable intangibles. Depreciation andamortization expense was slightly up for the quarter ended March 31, 2006compared to the same period prior year due to the incremental depreciation andamortization for new equipment and new office expansion.

 

Weexpect to continue to incur capital expenditures, primarily as part of our newoffice expansion program and the on-going remodel or relocation of offices.Because of this, depreciation and amortization expense may increase as apercentage of revenue in future periods depending on the timing and amount ofthe capital expenditure.

 

**Non-operating expenses**

 

*Interest expense.* Net interest expense in both periods is aresult of $80.0 million in principal of our Senior Secured Notes due 2011, orthe Notes, and amortization of deferred financing costs associated with theNotes. Our obligations under the Notes will result in substantial interestexpense in future periods. The Notes bear interest at 10 3⁄4% per year, payablesemiannually on June 15 and December 15 of each year.

 

**Income taxes**

 

*Provision for income taxes.* Our effective taxrate was approximately 54.0% and 38.1% for the quarter ended March 31, 2006 and2005, respectively. The 2006 income tax provision consists of state minimumtaxes and benefits realized from utilizing pre-reorganization deferred taxes. Theincrease in the effective tax rate is due to the payment of certainnon-deductible expenses and accrued interest/dividend on the mandatorilyredeemable preferred stock, which result in permanent differences.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

Historically, we have financed our operating andcapital needs through cash generated by operations and borrowings. Our primarysources of liquidity for the near future will be cash flow from our operationsand availability under our $10 million senior secured revolving creditfacility. Advances under this facility are limited to the lesser of (i) $10million or (ii) a borrowing base formula calculated at 0.75 times our trailing12 month earnings beforeinterest, taxes, depreciation and amortization, or EBITDA, as defined in the agreement. In addition, we are required tomaintain a monthly minimum EBITDA, as measured on a trailing 12 month basis, ofat least $12 million. We had trailing 12 month EBITDA of $15.1 million as ofMarch 31, 2006 and December 31, 2005.

 

Asof March 31, 2006, our borrowingbase was $10.0 million and the amount available under our revolving creditfacility was $8.3 million from which we have borrowed $0.4 million. The $1.3million reduction on the amount available under our revolving credit facilityresulted from the issuance on our behalf of a letter of credit in conjunctionwith our self insured workers’ compensation programs.

 

Our primary cash requirements include generaloperating expenses, debt service requirements and capital expenditures. Our SeniorSecured Notes are interest only, payable semi-annually, until due in 2011in the amount of approximately $4.3 million, or approximately $8.6 million overa 12 month period. We currently anticipate funding interest payments from cashgenerated by our operations, supplemented as necessary with borrowings underour revolving credit facility. Dividends on the mandatorily redeemablepreferred stock accrue annually, and are payable monthly. We are permitted topay required dividends either in cash (if permitted by other applicable debtcovenants) or “in kind” through the issuance of additional shares of thepreferred stock. We currently intend to settle the dividends on the preferredstock through additional shares of Class C Preferred Stock.

 

Under our new office**growthstrategy we currently plan to initiate approximately seven new dental officesin leased facilities this year and complete 10 – 15 per year thereafter,depending upon our liquidity and our ability to identify opportunities thatmeet our expectations. We expect to fund most of these offices on a “pay as yougo” basis using our cash flow from operations. We may also from time to timeconsider acquisitions of dental practices, although we have no current plansfor any acquisitions.

 

We believe that our current sources of liquiditywill be sufficient to meet our requirements in 2006. However, an unexpecteddecline in cash flow from operations or in our EBITDA could materially impairour liquidity. In such event, we may not be able to access our revolving creditfacility and we may be unable to generate sufficient free cash flow to meet allof our operating requirements. Moreover, the indenture governing our notes andthe terms of our senior secured revolving credit facility limit our ability toincur additional indebtedness. As a result, in the event of a material declinein our operating performance, we may encounter substantial difficulty insecuring additional sources of liquidity.

 

Our cash flow sourcesand uses by operating, investing and financing activities are shown below:

 
| ** **                            | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Net cash provided by operations       |       | $                                                    | 2,124      |   | $ | 6,567 |   |
| Net cash used in investing activities |       | $                                                    | (1,314     | ) | $ | (3,200 | ) |
| Net cash used in financing activities |       | $                                                    | (720       | ) | $ | (158 | ) |

 

*Cash flow from operations*. The decrease incash flow from operations from the same period last year is due primarily to adecrease in trade payables resulting from cash management strategies designedto conserve cash flow to meet construction costs, information technologyinitiatives and bond interest payments in 2005.

 

*Cash flow used in investingactivities*. Our spending on property and equipment during the first three months of2006 decreased $2.1 million from the same period in the prior year. Weopened one new office in the first quarter 2006 versus opening 2 new offices inthe same period prior year. Additionally, we completed or were near completionon 2 relocations during the first quarter 2005 versus minimal activity in thecurrent year.We expect to continue to incur significant capital expenditures, primarily

 

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as part of our new office growth strategy and theon-going remodel or relocation of offices.

 

*Cash flow used in financingactivities*. Cash used in financing activities was due primarily to pay down on ourrevolving line of credit and capital leases. Our subordinated seller debt waspaid off in 2005. We will pay the remaining balance on the capital leaseobligation of $0.4 million as scheduled through March 2009.

 

**CRITICALACCOUNTING POLICIES****AND ESTIMATES**

 

Ourdiscussion and analysis of our financial condition and results of operationsare based upon our consolidated financial statements, which have been preparedin accordance with accounting principles generally accepted in the UnitedStates. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities.

 

Webelieve that the estimates, assumptions and judgments involved in theaccounting policies described in the “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” section of our most recentAnnual Report on Form 10-K have the greatest potential impact on our financialstatements, so we consider these to be our critical accounting policies.Because of the uncertainty inherent in these matters, actual results coulddiffer from the estimates we use in applying the critical accounting policies.Certain of these critical accounting policies affect working capital accountbalances, including the policies for revenue recognition, the reserve foruncollectible accounts receivable and inventory balances. These policiesrequire that we make estimates in the preparation of our financial statementsas of a given date.

 

Withinthe context of these critical accounting policies, we are not currently awareof any reasonably likely events or circumstances that would result inmaterially different amounts being reported.

 

#### **AccountingStandards Not Yet Adopted by the Company**

#### ** **

On November 10, 2005, the FinancialAccounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects ofShare-Based Payment Awards”. This FSP allows companies using either themodified retrospective or modified prospective application to make a one-timeelection to adopt the transition method described in the FSP and also allowedcompanies to take up to one year from the later of its initial adoption ofStatement 123 (R) or the effective date of this FSP to evaluate its availabletransition alternatives and make its one-time election. We are currentlyevaluating the available transition alternatives and have not yet made adetermination of which method we will be using.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk.**

 

Inthe ordinary course of business, we are exposed to interest rate risk. Forfixed rate debt, interest rate changes affect the fair value but do not impactearnings or cash flow. Conversely, for floating rate debt, interest ratechanges generally do not affect the fair market value but do impact futureearnings and cash flow. We do not believe a one percentage point change ininterest rates would have a material impact on the fair market value of ourfixed rate debt.

 

Ourinterest expense is sensitive to changes in the general level of interest ratesas our senior revolving credit facility has interest rates based upon LIBOR orthe prime rate plus for the banks’ applicable margins ranging from 1.0% to3.25%. At March 31, 2006, there were $0.4 million in borrowings outstandingunder this facility. The annual pre-tax earnings and cash flow impact for a onepercentage point change in interest rates would not be significant to ouroperations. The hypothetical change used in this analysis may be different fromwhat actually occurs in the future. We do not presently undertake any specificactions to cover our exposure to interest rate risk and we are not party to anyinterest rate risk management transactions.

 

**Item 4. Controls and Procedures**

 

Ourmanagement, with the participation of our Chief Executive Officer and ChiefFinancial Officer, evaluated the effectiveness of our disclosure controls andprocedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of1934) as of the end of the period covered by this report. Our management, withthe participation of our Chief Executive Officer and Chief Financial Officer,also conducted an evaluation of our internal control over financial reportingto determine whether any changes occurred during the first quarter of fiscal2006 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting. Based upon theseevaluations, and solely because of the material weakness in internalcontrol over financial reporting discussed below, the Chief Executive Officerand Chief Financial Officer have concluded that our disclosure controls andprocedures were not effective in providing reasonable assurance thatinformation required to be disclosed in the reports we file or submit under theExchange Act is recorded, processed, summarized and reported as and whenrequired and that such information is accumulated and communicated tomanagement, including the Chief Executive Officer and Chief Financial Officer,in a manner that allows timely decisions regarding required disclosure.However, we believe that the accompanying consolidated financial statementsfairly present in all material respects our financial position and results ofoperations presented in this Form 10-Q.

 

A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. While no material misstatement oradjustment was noted, management concluded that we did not maintain effectivecontrols to

 

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mitigatethe likelihood to less than remote that a material misstatement in our patientservice revenue and related accounts receivable process would be prevented ordetected, including the estimation and establishment of allowances for baddebts and fee rate change adjustments. Management’s conclusion was based on theeffect of limitations of our industry standard dental practice managementsoftware on the estimation of our allowances and our need to strengthen thepreventative controls surrounding our billing process.

 

In order to proactively address the materialweakness noted above, in mid 2005, we began preparations to implement a newdental practice management system and are in the process of implementing thissystem and designing new controls and processes in conjunction with ourpreparations to be compliant with Section 404 of the Sarbanes Oxley Act byDecember 31, 2007.

 

There were no changes in the internal control overfinancial reporting that occurred during the period covered by this report thatmaterially affected, or that are reasonably likely to materially affect,internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

**Item 1. Legal Proceedings**

 

Wehave been named as a defendant in various lawsuits in the normal course ofbusiness, primarily for malpractice claims. We, our affiliated dental practicesand associated dentists’ are insured with respect to dentistry malpracticerisks on a claims-made basis. Management believes all of these pendinglawsuits, claims, and proceedings against us are without merit or will not havea material adverse effect on our consolidated operating results, liquidity or financialposition, or cash flows.

 

As previously reported the CaliforniaAttorney General’s Bureau of Medical Fraud and Elderly Abuse initiated aninvestigation following our self reporting to Medi-Cal of billing errors we haddiscovered at one of our affiliated dental practices. We continue to cooperatein the investigation; no material developments occurred during the pastquarter.

 

**Item 1A. Risk Factors**

** **

**Our ability to manage our business is limitedby our lack of control over the dental professionals who generate our revenues.**

 

We provide a number of services designed toenhance the productivity of affiliated dental practices. Our revenues dependupon the success of those dental practices. The success of any dental practicewill, to a large extent, depend upon the efforts of the dentists and theirprofessional skills and reputation. We do not employ the dentists nor do wecontrol their clinical practices. While we seek to affiliate with dedicated,well-qualified dentists, we cannot control their delivery of patient care. Ourlack of control over all clinical aspects of the delivery of dental services byour affiliated dental practices makes it more difficult for us to improve ourperformance. As a result, a key determinant of our success is beyond our controlto effectively manage.

 

**Our revenue may be adversely affected by third party payor costcontainment efforts and capitation arrangements.**

** **

A portion of the payments for dental carethat is received by our affiliated dental practices is paid or reimbursed underinsurance programs, or by third party payors. We are responsible fornegotiating the terms of these third party payor arrangements. Third partypayors are continually negotiating the fees charged for dental care, with agoal of containing reimbursement and utilization rates. In recent years, wehave been able to increase some reimbursement rates. However, we believe thatpressure by third party payors to reduce fees and reimbursement rates willcontinue and will increasingly affect the provision of dental services. Thismay result in a reduction in per-patient and per-

 

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procedure revenue from currentlevels. Loss of revenue by our affiliated dental practices caused by thirdparty payor cost containment efforts could have a material adverse effect onour business, financial condition and results of operations.

 

Additionally, some third-party payorcontracts are capitated arrangements. Approximately 23% of our revenue wasderived from capitated arrangements for the quarter ended March 31, 2006. Underthose contracts, the affiliated dental practice receives a capitated payment,calculated on a monthly per-member basis, to provide care to the coveredenrollees and generally receives a co-payment from the patient at the time careis provided. These payment methods shift a portion of the risk of providingcare from the third party payors to the affiliated dental practices. To theextent that patients covered by these contracts require more frequent or extensivecare than is anticipated, there may be a shortfall between the capitatedpayments received by the affiliated dental practices and the costs to providethe contracted services. These shortfalls may result in our affiliated dentalpractices being unable to reimburse us for expenses and contribute to ourservice fees.

 

**The terms of our service agreements withaffiliated dental practices may result in losses which cannot berecovered, thereby reducing our cash flow from operations and the funds we haveavailable to meet our obligations.**

 

Substantially all of our operating revenue isderived from our service agreements with affiliated dental practices. Underthese agreements, we assume responsibility for operating expenses of the dentalpractice, such as salaries and benefits for non-dentist personnel, dentalsupplies, lab fees, office occupancy costs and marketing expenses. The dentalpractice is contractually obligated to reimburse us for such expenses and payus a fee equal to a percentage of their revenue plus a bonus. However, a newlyopened dental practice or an under-performing practice may not generatesufficient revenues to fully reimburse us for expenses advanced on behalf ofthe practice and may not have net revenues to contribute to our servicefees. Therefore, we may incur expenses that will not be reimbursedequivalent to the amount of losses incurred by these practices.

 

The losses we incur as a result of anaffiliated practice’s failure to pay our service fees and fully reimburseexpenses advanced on its behalf may never be recovered. We have noeffective recourse to obtain reimbursement for these losses. We also do nothave any guaranties from our affiliated dental practices or affiliated dentiststo cover such losses. To the extent that we are unable to collect the amountsdue us under our service agreements, our revenues and cash flowmay suffer, thereby reducing the funds we have available to pay interestand principal on the notes.

 

**Our operating results may be adverselyaffected by professional liability or other claims against us or our affiliateddental practices.**

 

Our affiliated dental practices could beexposed to the risk of professional liability and other claims. These claims,if successful, could result in substantial damages that could exceed the limitsof any applicable insurance coverage. Our standard professional liabilityinsurance coverage is $1 million per occurrence and $15 million inannual aggregate. Per the terms of the management agreement, we arrange for andpay the cost of the professional liability insurance for our affiliatedpractices. We also arrange for and pay the cost of the professional liabilityinsurance for the dentists employed by our affiliated dental practices. It ispossible that professional liability claims could be asserted against us aswell as the affiliated dental practices. If such a claim is brought against an

 

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affiliated dental practice ordentist, the professional liability insurance premiums of that affiliateddental practice could materially increase. Also, fees payable to us from anaffiliated dental practice could be adversely affected if damages payable bythat practice exceed insurance coverage limits. While we attempt to cover boththe affiliated practices as well as ourselves from all types of risks andliabilities, we may still be subject to claims that either exceed ourcoverage limitations or are not covered at all by insurance. In the future,insurance coverage may not be available upon terms satisfactory to us orthe coverage may not be adequate to cover losses. In addition, wemay be subject to other claims such as claims in which it is alleged thatwe have been negligent in performing our duties under management servicesagreements. A successful professional liability claim or any other claimagainst us or an affiliated dental practice could have a material adverseeffect on our available cash.

 

**Our growth strategy may reduce the cashwe have available for operations.**

 

Our growth strategy includes expansionthrough opening new affiliated dental offices as well as the expansion ofexisting affiliated dental practices. We opened one new affiliated office in February2006 in Arizona under our new office growth strategy. While the cost per new officewill vary based on size and region, we estimate that the average officebuildout will cost between $0.4 million and $0.6 million. Thestrategy is to fund these offices with cash flow from operations. Typicallyeach buildout takes between 6 to 9 months. While we will seek to supporttheses new offices with staffing from existing offices, we still expect toincur losses of approximately $0.1 million during the first year ofoperations. We believe that the addition of these new offices will providesynergies such as giving us greater purchasing power as well as allowing us tospread fixed overhead across a larger revenue base. The emphasis on growingthrough opening new offices, however, is a new strategy; previously, our growthstrategy emphasized the acquisition of existing practices. We do not havesufficient experience with our new growth strategy to evaluate itseffectiveness.

 

Opening new affiliated dental officesinvolves numerous risks, including potentially higher than expected buildoutand construction costs, delays in completing the buildouts related to officesite selection, permitting and construction difficulties, and the failure torecruit affiliated providers and other key personnel on a timely basis to staffthese new offices. Identifying locations in suitable geographic markets andnegotiating leases can be a lengthy and costly process. Furthermore, we willneed to provide each new office with appropriate non-clinical staff, equipment,furnishings, materials and supplies. Additionally, new offices must be staffedwith one or more dentists. Because a new office may be staffed with adentist with no established patient base, significant advertising and marketingexpenditures may be required to attract patients. Revenue for new officesmay be less than expected or take longer than expected to reach acceptablelevels, and operating costs may be higher than expected, resulting in ourinability to operate these new offices profitably within expected timeframes.

 

The expenses involved in opening new officesand in supporting such offices until they become profitable will consume asignificant portion of our cash flow. We believe that most new offices shouldbecome profitable within 9 to 15 months of opening. However, as this is anew competency we lack the experience to validate this.

 

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**We are highly leveraged, whichmay impair our ability to obtain additional financing to pursue growthopportunities.**

 

We are highly leveraged whichmay constrain our ability to obtain additional financing to pursue growthopportunities. Prospective lenders and other providers of capital will considerthe extent of our leverage in determining whether to make any funds availableto us. Our current leverage ratios effectively limit our ability to obtainadditional funding from third parties. We are therefore unlikely to be able topursue in the near future business opportunities that we cannot finance out ofour cash flow. Our current financial leverage effectively precludes us frompursuing significant acquisition opportunities or other opportunities thatrequire a substantial cash payment. Our near term growth may suffer as aresult, particularly in comparison with certain competitors who are betterpositioned to obtain additional financing.

 

**The geographic concentration of ouroperations increases the risk that our operating results will suffer fromadverse developments in our principal markets.**

 

We manage 128 affiliated dental practices,and own and operate one dental laboratory. The following table illustrates thenumber of dental offices we have in each state on March 31, 2006.

 

| ** ** | ** ** | **Dental**  | ** ** |
|------------|------------|-------------|------------|
| **State**  | ** ** | **Offices** | ** ** |
| California |       | 56          |       |
| Oregon     |       | 27          |       |
| Washington |       | 13          |       |
| Nevada     |       | 10          |       |
| Arizona    |       | 10          |       |
| Hawaii     |       | 6           |       |
| Oklahoma   |       | 5           |       |
| Kansas     |       | 1           |       |
|       |       | 128         |       |

 

The current geographic concentration of our operations in the westernUnited States, and especially in California, increases the risk to us ofadverse economic or regulatory developments within these markets.

 

In addition, our growth strategy includesfocusing our growth within our existing markets. Our current concentration inthese markets, as well as our strategy of focused expansion within our existingmarkets, increases the risk to us that adverse economic or regulatorydevelopments in one or more of these markets may have a material adverseeffect on our business, financial condition and operating results.

 

**Our management arrangement with affiliateddental practices could be challenged by a state or dentist under lawsregulating the practice of dentistry.**

 

The laws of each state in which we operatecontain restrictions on the practice of dentistry and control over theprovision of dental services. In some states in which we operate, includingCalifornia, Oregon, Washington, Arizona, Hawaii and Oklahoma, the statutesregarding the practice of dentistry include broad and vaguely statedrestrictions on owning, managing, maintaining and/or operating an office wheredental services are performed.

 

Our management agreements with eachaffiliated dental practice provide that the affiliated dental practice, and notus, retains responsibility for all activities that are within

 

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the scope of a dentist’slicense and cannot be performed by a person who is not licensed to practicedentistry in that state. We do not have an ownership interest in any entitythat provides dental services. The affiliated dental practices each retain fullauthority and control with respect to all dental, professional and ethicaldeterminations over the practice.

 

We do not, and do not intend to, control thepractice of dentistry by our affiliated dental practices or their compliancewith the regulatory requirements directly applicable to dentists or thepractice of dentistry. However, any challenge to our contractual relationshipswith our affiliated dental practices by dentists or regulatory authoritiescould result in a finding that could have a material adverse effect on ouroperations, such as voiding one or more long-term management agreements.Moreover, the laws and regulatory environment may change to restrict orlimit the enforceability of our management service agreements. We could beprevented from affiliating with dental practices or providing comprehensivebusiness services to dental practices in one or more states.

 

**We are subject to health care and insuranceregulations. Keeping abreast of and in compliance with these laws is costly;failure to comply could result in fines, penalties or exclusion from theMedicare or Medicaid Programs.**

 

Our dental practice affiliates are subject tothe Health Insurance Portability and Accountability Act of 1996, or HIPAA.HIPAA regulations include various requirements on privacy and security ofpatient records. Federal and state regulations, such as Medicare and Medicaid,also contain anti-kickback provisions and restrictions on referrals. Our dentalpractice affiliates also must comply with federal Occupation Safety and HealthAdministration Bloodborne Pathogens Standard, which requires them to institutetraining programs and procedures design to eliminate or minimize occupationalexposure to Hepatitis B Virus (HBV), Human Immunodeficiency Virus (HIV) andother bloodborne pathogens. Our subsidiary, Dedicated Dental, is also subject tothe Knox-Keene Healthcare Service Plan Act of the State of California inconnection with its managed dental care plan, which requires our subsidiary,among other things, to file periodic financial data and other information withthe California Department of Managed Health Care, maintain substantial netequity on its balance sheet and maintain adequate medical, financial andoperating personnel. These regulations require consistent monitoring tomaintain compliance. Failure to comply with these regulations could result inpenalties and fines being imposed.

 

**Entities affiliated with Levine LeichtmanCapital Partners, or LLCP hold substantially all of the outstanding votingpower of the capital stock of our parent, InterDent, Inc., and theirinterests may conflict with or be different from your interests.**

 

Entities affiliated with LLCP holdsubstantially all of the voting power of InterDent, Inc. As a result,these entities affiliated with LLCP hold, and will for the foreseeable futurecontinue to hold, sufficient voting power to direct our actions and affairs,including the election of all of our directors and, except as otherwiseprovided by law, approving or disapproving all other matters submitted to avote of stockholders of InterDent, Inc., including a merger, consolidationor sale of assets. These stockholders are permitted to act in their owninterests, which may conflict with or be different from your interests.Furthermore, if these stockholders were to sell their shares to a single orlimited group of investors, thereby resulting in those investors’ beneficialownership of

 

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50% or more ofInterDent, Inc.’s voting stock, a change of control could be deemed tohave occurred under the terms of the indenture governing the notes, whichcould, among other things, give rise to an option in favor of each holder ofthe notes to require us to repurchase all or any part of that holder’snotes.

 

**Item 6. Exhibits**

 

Setforth below is a list of the exhibits included as part of this quarterlyreport.

 
| ****Exhibit No.**** | **** **** | ****Description****                                                                            |
|--------------------------|----------------|------------------------------------------------------------------------------------------------|
| ****10.1****             |           | InterDent Deferred Incentive Compensation Retirement Plan                                      |
| 31.1                     |           | Certification  of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of  2002 |
| 31.2                     |           | Certification  of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of  2002 |
| 32.1                     |           | Certification  of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of  2002 |
| 32.2                     |           | Certification  of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of  2002 |

 

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**SIGNATURES**

 

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|   |         |   |   |   | **INTERDENT SERVICE CORPORATION**               |
|--------|--------------|--------|--------|--------|-------------------------------------------------|
|   |         |   |   |   | (Registrant)                                    |
|   |         |   |   |   |                                            |   |   |
| Date:  | May 12, 2006 |   |   | By:    |                                            | /s/  IVAR  S. CHHINA |   |
|   |         |   |   |   | Ivar S. Chhina                                  |
|   |         |   |   |   | President, Chief Executive Officer andChairman  |
|   |         |   |   |   |                                            |
|   |         |   |   |   |                                            |
|   |         |   |   | By:    |                                            | /s/  ROBERT W. HILL |   |
|   |         |   |   |   | Robert W. Hill                                  |
|   |         |   |   |   | Chief Financial Officer, Treasurerand Secretary |

 

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**SIGNATURES**

 

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|   |         |   |   |   | **INTERDENT, INC.**                             |
|--------|--------------|--------|--------|--------|-------------------------------------------------|
|   |         |   |   |   | (Registrant)                                    |
|   |         |   |   |   |                                            |   |   |
| Date:  | May 12, 2006 |   |   | By:    |                                            | /s/  IVAR  S. CHHINA |   |
|   |         |   |   |   | Ivar S. Chhina                                  |
|   |         |   |   |   | President, Chief Executive Officer andChairman  |
|   |         |   |   |   |                                            |
|   |         |   |   |   |                                            |
|   |         |   |   | By:    |                                            | /s/  ROBERT W. HILL |   |
|   |         |   |   |   | Robert W. Hill                                  |
|   |         |   |   |   | Chief Financial Officer, Treasurerand Secretary |

 

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