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[March 31, 2014]
SEBRING SOFTWARE, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with our consolidated financial statements.
The purpose of this discussion is to provide an understanding of the consolidated financial results and condition of Sebring Software, Inc. and Subsidiaries (Company) and to also describe the plans for future growth and expansion.
Forward-Looking Statements This Management's Discussion and Analysis and other parts of this report contain forward-looking statements that involve risks and uncertainties, as well as current expectations and assumptions. From time to time, we may publish forward-looking statements, including those that are contained in this report, relating to such matters as anticipated financial performance, business prospects, acquisition strategies, technological developments, new products, research and development activities and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, we note that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of our business include, but are not limited to, our ability to maintain sufficient working capital, adverse changes in the economy, the ability to attract and maintain key personnel, our ability to implement our business plan. Our actual results could differ materially from those anticipated in these forward-looking statements, including those set forth elsewhere in this report. We assume no obligation to update any such forward-looking statements.
Overview We have been in the development stage and therefore had not earned any revenue until the second quarter of 2013 at which time the Company entered into the Dental Practice Management industry ("DPM"). DPM companies combine acquisition and organic growth to boost revenues while instilling best practice management infrastructure to increase the dental practices' profitability. Capital and cost efficiency have driven the dental services industry to join DPM companies rather than remain as sole practitioners. With the above stated presence in the DPM market the Company decided to acquire a DPM and control of 31 dental practices in the state of Florida as well as 2 dental practices in the state of Arizona during the second quarter. Five (5) more dental practices were acquired in the third and fourth quarter of 2013. As a result of these acquisitions, the Company currently manages thirty-eight Practices and plans to boost revenues and substantially reduce costs through increased efficiencies through the use of software solutions and best practice management techniques.
12 Results of Operations Results of Operations for the year ended December 31, 2013 compared to the year ended December 31, 2012 During the year ended December 31, 2013, the Company recorded revenues of $9,206,874. This revenue was earned from general dental practice and is the result of the acquisition of dental practices and a dental practice management company according to the Company's strategic plan. The Company also incurred direct dental costs of $4,602,970 which were primarily for employee compensation and benefits in the dental practices. In addition, other direct dental costs of $2,619,573 for the year ended December 31, 2013 were incurred for expenses in the dental practices which included items such as lab expense, dental implants and other supplies and certain rents. Indirect dental expenses of $2,083,188 were incurred at the dental practices for other expenses such as computer expense, telecommunications costs, cleaning expenses, repairs and maintenance, utilities and other general office expenses. The Company did not produce any revenue or incur any such expenses in the year ending December 31, 2012 as the Company was still in the development stage.
Corporate compensation and benefits increased $675,976 from $411,617 in the year ended December 31, 2012 to $1,087,593 for the year ended December 31, 2013. This increase is due to the additional personnel associated with the dental practice acquisition and the hiring of additional administrative management.
General and administrative expenses increased $2,167,009 from $540,360 for the year ended December 31, 2012 to $2,707,369 for the year ended December 31, 2013.
This increase was primarily due to the amortization costs of our Customer Relationships as well as due to the Company incurring higher costs for consulting, accounting and other professional fees necessary to facilitate and consummate the dental practice acquisition as well as additional costs for travel, communication and filing fees.
Interest expense increased from $693,376 for the year ended December 31, 2012 to $2,313,987 for the year ended December 31, 2013. The increase was primarily due to the interest on a Term Loan to fund the acquisitions as well as additional interest expense incurred from amortizing a portion of the debt discount associated with certain notes and warrants and the amortization of debt issuance costs incurred with the consummation of the term loan.
The $1,872,548 loss on warrant liability relates to the change in fair value of the warrant liability from April 25, 2013 to December 31, 2013. The warrants issued with the Term Loan were classified as liability due to certain provisions in such warrants and must be marked up or down to fair value at each reporting date.
Inflation and seasonality We do not believe that inflation or seasonality will significantly affect our results of operations.
Liquidity and capital resources Our cash and liquidity resources have been provided by investors through convertible and non-convertible notes, loans payable and the sale of our common stock. During the year ended December 31, 2013 we received $1,342,000 from the sale of our stock as well as proceeds from the consummation of our Term Loan which is further discussed below. These cash investments have been used primarily for general and administrative expenses including management compensation and to fund our acquisitions as discussed below.
The Company recognized a net loss of approximately $8.7 million, net cash used in operations of approximately $1.4 million for year ended December 31, 2013and negative working capital ($16.2 million), stockholders' deficit ($9.0 million) and an accumulated deficit of $17.4 million at December 31, 2013.
During 2013, the Company acquired or gained financial control of a management company and thirty-eight dental practices in the states of Florida and Arizona.
Financial control of these dental practices is expected to provide material positive cash flow to the Company. Furthermore, approximately $7.2 million of the current liabilities at December 31, 2013 are warrant liabilities and deferred revenue which we believe are unlikely to result in a cash outlay over the next twelve months. However, in order to meet our obligations when they come due, a capital infusion of approximately $3.2 million will be necessary.
Management has received a commitment from an investor to provide the necessary funding to cover this potential shortfall.
13 Debt and contractual obligations As of December 31, 2013 we have commitments to pay investors and creditors $20,642,674 of principal and $1,656,700 of accrued interest on various convertible notes, non-convertible notes and loans payable as of December 31, 2013. We also owe $868,797 in accounts payable, $2,345,888 in accrued liabilities, $549,557 of payroll related liabilities and a capital lease obligation of $195,638 as of December 31, 2013. In addition, as of December 31, 2013, we have commitments to pay $3,521,111 to the sellers, recorded as consultant liability, as part of the initial acquisition of the thirty one dental practices in Florida.
On April 25, 2013, the Company and its subsidiaries, Sebring Dental of Arizona, LLC, AAR Acquisition, LLC, and Sebring Management FL, LLC (the "Guarantors") entered into a Loan and Security Agreement (the "Loan Agreement") with Great American Life Insurance Company, Great American Insurance Company, United Teachers Associates Insurance Company, Continental General Insurance Company (the "Lenders") and MidMarket Capital Partners, as agent for the Lenders, in order to facilitate the funding of the acquisition of dental practices according to our business plan. Under the terms of the Loan Agreement, the Lenders agreed to loan us up to Sixteen Million Dollars ($16,000,000) in two separate tranches (the "Term Loan") for this purpose. The first tranche of the Term Loan of Eleven Million Dollars ($11,000,000) was funded on the closing date of April 26, 2013.
Of this total, $6,304,984 was used for acquisitions, debt refinancing and costs associated with the transactions. The remaining $4,695,016 is for working capital requirements. We continued to pursue other acquisition opportunities in accordance with the terms of the loan agreement, although the obligation to advance the second tranche of Five Million Dollars ($5,000,000) expired on May 25, 2013.
On December 27, 2013, the Company entered into the First Amendment, Consent and Waiver (the "Amendment") to the Loan Agreement. Under the terms of the Amendment, the Lenders agreed to (i) consent to the December 2013 acquisitions, (ii) waive the identified Events of Default, (iii) extend the second tranche to (a) pay the related transaction costs of the December 2013 acquisitions and (b) fund a portion of the purchase price of said acquisitions in the amounts of $4 million, (iv) certain modifications to terms and provisions of the Loan Agreement.
Pursuant to the Loan and Security Agreement above, interest shall accrue on the outstanding balance of the Term Loan at a rate of 11 ½ percent per annum. Upon the occurrence and continuation of an Event of Default as described in the Loan Agreement, the unpaid principal balance of the Term Loan shall bear interest at a rate of 13 ½ per annum. Interest payments on all outstanding principal shall be payable quarterly in arrears on the last day of each quarter. A quarterly payment of $281,250 is due on March 31, 2014. Beginning on June 30, 2014, the quarterly principal payments increase to $375,000 per quarter. Beginning on June 30, 2015, the quarterly principal payments increase to $750,000 per quarter.
Beginning on June 30, 2017, the quarterly principal payment increases to $1,593,750 per quarter. On April 25, 2018 all remaining unpaid principal of the Term Loan shall be due. In accordance with the terms of the notes, the Company repaid $412,500 of the principal as of December 31, 2013. The $281,250 principle payment that was due on December 31, 2012 was paid on January 2, 2014.
Management Agreement - The Company has management contracts with four key members of management with lengths ranging from one to three years. These agreements will renew automatically at the expiration dates unless specifically terminated. The agreements commit the Company to pay a combined total of $892,000 per year in base salary and stock compensation as determined by the Board of Directors. In addition, the contracts have Equity Participation clauses whereby the employees have been awarded a total of 2,000,000 shares of restricted stock that will be distributed to the employees in equal installments over periods ranging from two to five years.
We have also committed to pay various stock compensation and finder fees to entities that are raising funds on the Company's behalf. Those funds are payable in the event that they are successful in raising capital described above and as more fully described in the Sebring consolidated financial statements.
Office leases Our new subsidiary in Florida leases office space for their headquarters (Clearwater, FL) and for the Practices. The leases expire at various times through 2023. Future minimum lease payments as of December 31, 2013 are as follows: 14 Amount 2014 $ 1,860,000 2015 1,539,000 2016 1,108,000 2017 824,000 2018 667,000 Thereafter 1,845,000 Total $ 7,843,000Critical Accounting Estimates and Policies Principles of Consolidation -The consolidated financial statements include the accounts of the Company and its subsidiaries combined with the accounts of the affiliated Practices with which the Company has specific management arrangements. The Company's agreements with the Practices provide that the term of the arrangements are for forty years, subject only to termination by the Company, except in the case of gross negligence, fraud or bankruptcy of the Company. The Company has the right to receive income, both as ongoing fees and as proceeds from the sale of its interest in the Practices. The Company has exclusive responsibility for the provision of all non-dental services required for the day-to-day operation and management of the Practices and establishes the guidelines for the employment and compensation of the physicians. In addition, the agreements provide that the Company has the right, but not the obligation, to purchase, or to designate a person(s) to purchase, the stock of the Practices for a nominal amount. Separately, in its sole discretion, the Company has the right to assign its interest in the agreements. Based upon the provisions of these agreements, the Company has determined that the Practices are variable interest entities and that the Company is the primary beneficiary as defined in the accounting guidance for consolidation. All significant intercompany and inter affiliate accounts and transactions have been eliminated.
Business Acquisitions - In accordance with the acquisition method of accounting, any identifiable assets acquired and any liabilities assumed are recognized and measured at their fair values on the acquisition date. If information about facts and circumstances existing as of the acquisition date is incomplete at the end of the reporting period in which a business acquisition occurs, the Company will report provisional amounts for the items for which the accounting is incomplete. The measurement period ends once the Company receives sufficient information to finalize the fair values; however, the period will not exceed one year from the acquisition date. Any material adjustments recognized during the measurement period will be reflected retrospectively in the consolidated financial statements of the subsequent period.
Goodwill and Other Intangible Assets - The Company records acquired assets and liabilities at their respective fair values under the acquisition method of accounting. Goodwill represents the excess of cost over the fair value of the net assets acquired. Intangible assetswith finite lives, principally customer relationships, are recognized apart from goodwill at the time of acquisition based on the contractual-legal and separability criteria established in the accounting guidance for business combinations. Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives.
Customer relationships are amortized over 7 years for orthodontic practices and fifteen years for general dental practices.
Goodwill is tested for impairment at a reporting unit level on at least an annual basis in accordance with the subsequent measurement provisions of the accounting guidance for goodwill. The Company defines a reporting unit based upon its management structure for services provided in specific regions of the United States. The testing for impairment is completed using a three-step test.
The first step compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, a second step is performed to determine the amount of any impairment loss. The Company uses income and market-based valuation approaches to determine the fair value of its reporting units. These approaches focus on discounted cash flows and market multiples based on the Company's market capitalization to derive the fair value of a reporting unit. The Company also considers the economic outlook for the dental services industry and various other factors during the testing process, including local market developments and other publicly available information.
15 Long-Lived Assets - The Company is required to evaluate long-lived assets, including intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying value of the assets may not be fully recoverable. The recoverability of such assets is measured by a comparison of the carrying value of the assets to the future undiscounted cash flows before interest charges to be generated by the assets. If long-lived assets are impaired, the impairment to be recognized is measured as the excess of the carrying value over the fair value. Long-lived assets held for disposal are reported at the lower of the carrying value or fair value less disposal costs.
The Company does not believe there are any indicators that would require an adjustment to such assets or their estimated periods of recovery at December 31, 2013 pursuant to current accounting standards.
Revenue Recognition. Revenues are earned from dental, primarily orthodontic, services provided to patients in approximately thirty-eight dental facilities in the states of Florida and Arizona. Orthodontic patients agree to a fee structure in advance by signing a written agreement that details the services to be provided and the terms of the payment(s) for services. The services are typically rendered over eighteen to twenty-four months. Revenue is generally recognized over the service period on a straight line basis as the services are provided at a value net of refunds and other adjustments. Amounts collected in excess of amounts earned are deferred.
Stock Based Compensation -Certain employees may be granted stock options or restricted stock. The Company adopted the disclosure requirements of ASC 718 (formerly SFAS No. 123R) "Share-Based Payment" ("ASC 718") for stock options and similar equity instruments (collectively, "options") issued to employees. We apply the fair value base method of accounting as prescribed by ASC 718. Under the fair value based method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. For stock options, the fair value is determined using an option-pricing model that takes into account the stock price at the grant date, the exercise price, the expected life of the option, the volatility of the underlying stock and the expected dividends on it, and the risk-free interest rate over the expected life of the option. For restricted stock, the fair value is determined based on the quoted market price. Restricted shares or restricted shares units are measured at their fair value as if they were vested and issued on the grant date value determined based on the close trading price of our shares known at the grant date.
We apply ASC 718 and ASC 505 (EITF 96-18), "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services", with respect to options and warrants issued to non-employees. ASC 718 requires the use of option valuation models to measure the fair value of the options and warrants at the measurement date. ASC 718 also applies to transactions in which an entity issues its equity instruments to acquire goods or services from non-employees. Those transactions must be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.
Stock-based compensation is considered critical accounting policy due to the significant expenses of options, restricted stock and restricted stock units which were granted to our employees, directors and consultants.
Off Balance Sheet Arrangements We do not have any off balance sheet arrangements.
Recent Accounting Pronouncements Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the financial statements upon adoption.
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