Birner 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON , D.C. 20549

FORM 10-Q
(Mark One)

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2007

OR

[ ]
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 0-23367

BIRNER DENTAL MANAGEMENT SERVICES, INC.
(Exact name of registrant as specified in its charter)

 
COLORADO
  
84-1307044
(State or other jurisdiction of incorporation or organization)
  
(IRS Employer
Identification No.)

 
3801 EAST FLORIDA AVENUE, SUITE 508
DENVER, COLORADO
 
80210
(Address of principal executive offices)
(Zip Code)

(303) 691-0680
(Registrant’s telephone number, including area code)

 
N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes X      No___ 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer ___     Accelerated filer  _____       Non-accelerated filer  X 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes___      No  X 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
 
Shares Outstanding as of May 14, 2007
Common Stock, without par value
  
2,124,660
 
 
- 1 -



BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q

 
 
 

 
PART I - FINANCIAL INFORMATION

Item 1. Financial Statements 
Page
   
                    Unaudited Condensed Consolidated Balance Sheets as of December 31, 2006 and March 31, 2007 
3
   
Unaudited Condensed Consolidated Statements of Income for the Three
 
Months Ended March 31, 2006 and 2007 
4
   
Unaudited Condensed Consolidated Statements of Shareholders’ Equity as of March 31, 2007 
5
   
Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months
  
Ended March 31, 2006 and 2007 
6
   
Unaudited Notes to Condensed Consolidated Financial Statements 
8
   
Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations 
14
 
Item 3.        Quantitative and Qualitative Disclosures About Market Risk 
21
   
Item 4.        Controls and Procedures 
21
   
   
PART II - OTHER INFORMATION
  
   
   
Item 1.        Legal Proceedings 
22
   
Item 1A.    Risk Factors 
22
   
Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds 
22
   
Item 5.        Other Information 
22
   
Item 6.        Exhibits 
23
   
Signatures 
24
 

 
- 2 -

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
 
BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

   
December 31,
 
March 31,
  
ASSETS
  
2006
  
2007
  
   
**
  
(Unaudited)
  
CURRENT ASSETS:
          
Cash and cash equivalents
  
$
888,186
  
$
713,265
  
Accounts receivable, net of allowance for doubtful
              
accounts of $288,513 and $276,303, respectively
    
3,103,922
   
3,908,588
 
Deferred tax asset
    
185,671
   
205,642
 
Prepaid expenses and other assets
    
597,283
   
840,766
 
               
Total current assets
    
4,775,062
   
5,668,261
 
               
PROPERTY AND EQUIPMENT, net
    
5,592,672
   
5,340,792
 
               
OTHER NONCURRENT ASSETS:
              
Intangible assets, net
    
12,272,358
   
12,082,086
 
Deferred charges and other assets
    
181,860
   
173,527
 
               
Total assets
  
$
22,821,952
  
$
23,264,666
  
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
              
               
CURRENT LIABILITIES:
              
Accounts payable
 
$
1,648,498
  
$
1,773,412
  
Accrued expenses
    
1,398,267
   
1,476,062
 
Accrued payroll and related expenses
    
1,596,770
   
2,153,813
 
Income taxes payable
    
114,016
   
481,144
 
Current maturities of long-term debt
    
953,561
   
1,150,000
 
               
Total current liabilities
    
5,711,112
   
7,034,431
 
               
LONG-TERM LIABILITIES:
              
Deferred tax liability, net
    
734,234
   
846,217
 
Long-term debt, net of current maturities
    
6,502,411
   
5,170,652
 
Other long-term obligations
    
326,550
   
310,946
 
               
Total liabilities
    
13,274,307
   
13,362,246
 
               
SHAREHOLDERS' EQUITY:
              
Preferred Stock, no par value, 10,000,000 shares
              
authorized; none outstanding
    
-
   
-
 
Common Stock, no par value, 20,000,000 shares
              
authorized; 2,132,461 and 2,123,660 shares issued and
              
outstanding, respectively
    
4,515,469
   
4,324,095
 
Deferred equity compensation
    
(324,120
)
  
(243,090
)
Retained earnings
    
5,356,296
   
5,821,415
 
               
Total shareholders' equity
    
9,547,645
   
9,902,420
 
               
Total liabilities and shareholders' equity
  
$
22,821,952
  
$
23,264,666
  
               
** Derived from the Company’s audited consolidated balance sheet at December 31, 2006.
 
The accompanying notes are an integral part of these condensed consolidated balance sheets.
- 3 -
 
BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

       
Three Months Ended
      
       
March 31,
      
       
2006
      
2007
      
                       
NET REVENUE:
$
10,140,029
        
$
10,838,407
      
                               
DIRECT EXPENSES:
                      
Clinical salaries and benefits
          
3,688,987
         
3,840,292
     
Dental supplies
          
575,637
         
560,926
     
Laboratory fees
          
641,896
         
680,206
     
Occupancy
          
1,056,733
         
1,133,052
     
Advertising and marketing
          
208,954
         
148,760
     
Depreciation and amortization
          
479,775
         
610,552
     
General and administrative
          
1,190,869
         
1,176,496
     
           
7,842,851
         
8,150,284
     
 
          
 
          
 
      
Contribution from dental offices
          
2,297,178
         
2,688,123
      
                       
CORPORATE EXPENSES:
                      
General and administrative
         
1,081,063
 (1)  
 
 
  
1,246,526
  (1)
 
Depreciation and amortization
          
34,196
         
30,828
     
                               
Operating income
         
1,181,919
         
1,410,769
     
                               
Interest expense
          
39,620
         
106,153
     
                             
Income before income taxes
          
1,142,299
         
1,304,616
     
Income tax expense
          
439,974
         
521,847
     
                               
Net income
        
$
702,325
        
$
782,769
      
                               
                               
Net income per share of Common Stock - Basic
        
$
0.30
        
$
0.37
      
                               
Net income per share of Common Stock - Diluted
        
$
0.27
        
$
0.34
      
                               
Cash dividends per share of Common Stock
        
$
0.13
        
$
0.15
      
                             
Weighted average number of shares of
                              
Common Stock and dilutive securities:
                             
Basic
          
2,372,506
          
2,126,376
      
                               
Diluted
          
2,584,713
          
2,306,908
      
                               
 
(1)
Corporate expense - general and administrative includes $81,030 of deferred equity compensation for a stock award and $87,745 related to stock-based compensation expense in the three months ended March 31, 2006, and $81,030 of deferred equity compensation expense for a stock award and $90,064 related to stock-based compensation expense in the three months ended March 31, 2007.
 
The accompanying notes are an integral part of these condensed consolidated balance sheets.
 
- 4 -
 
 
BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED)
           
Deferred
  
 
      
   
Common Stock
      
Equity
  
Retained
  
Shareholders'
  
   
Shares
  
Amount
  
Compensation
  
Earnings
  
Equity
  
                       
BALANCES, December 31, 2006
    
2,132,461
  
$
4,515,469
  
$
(324,120
)
$
5,356,296
  
$
9,547,645
  
          Common Stock options exercised
    
10,667
   
78,049
   
-
   
-
   
78,049
 
          Purchase and retirement of Common Stock
    
(19,468
)
  
(415,893
)
  
-
   
-
   
(415,893
)
Tax benefit of Common Stock options exercised
    
-
   
56,406
   
-
   
-
   
56,406
 
Dividends declared on Common Stock
    
-
   
-
   
-
   
(317,650
)
  
(317,650
)
Stock-based compensation expense
    
-
   
90,064
   
-
   
-
   
90,064
 
Amortization of deferred equity compensation
     -    
- 
    
81,030
    
-
    
81,030
  
Net income
    
-
   
-
   
-
   
782,769
   
782,769
 
                                 
BALANCES, March 31, 2007
    
2,123,660
 
$
4,324,095
  
$
(243,090
)
$
5,821,415
  
$
9,902,420
  
                                 
 
The accompanying notes are an integral part of these condensed consolidated balance sheets.
 
 
- 5 -

Page 1 of 2
BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

   
Three Months Ended
  
   
March 31,
  
   
2006
  
2007
  
 
     CASH FLOWS FROM OPERATING ACTIVITIES:
          
Net income
  
$
702,325
  
$
782,769
  
Adjustments to reconcile net income to net
             
cash provided by operating activities:
              
Depreciation and amortization
    
513,971
   
641,379
 
Stock compensation expense
    
87,745
   
90,064
 
Provision for doubtful accounts
    
224,667
   
154,926
 
Provision for (benefit from) deferred income taxes
    
97
   
92,012
 
Amortization of deferred equity compensation
    
81,030
   
81,030
 
Changes in assets and liabilities net of effects
             
from acquisitions:
              
Accounts receivable
    
(694,898
)
  
(959,592
)
Prepaid expenses and other assets
    
(96,327
)
  
(243,483
)
Deferred charges and other assets
    
(27,565
)
  
8,333
 
Accounts payable
   
(178,524
)
  
124,914
 
Accrued expenses
    
115,372
   
38,023
 
Accrued payroll and related expenses
    
944,228
   
557,043
 
Income taxes payable
    
272,797
   
367,128
 
Other long-term obligations
    
(196
)
  
(15,604
)
Net cash provided by operating activities
    
1,944,722
   
1,718,942
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
              
Capital expenditures
    
(682,917
)
  
(199,227
)
Development of new dental centers
    
(514,755
)
  
-
 
Net cash used in investing activities
    
(1,197,672
)
  
(199,227
)
               
CASH FLOWS FROM FINANCING ACTIVITIES:
              
Advances - line of credit
    
4,023,409
   
5,871,902
 
Repayments - line of credit
    
(4,677,014
)
  
(6,973,663
)
Repayment of long-term debt
    
(43,966
)
  
(33,559
)
Proceeds from exercise of Common Stock options
    
87,411
   
78,049
 
Purchase and retirement of Common Stock
    
(20,278
)
  
(415,893
)
Tax benefit of Common Stock options exercised
    
17,081
   
56,406
 
Common Stock cash dividends
    
(235,124
)
  
(277,878
)
Net cash used in financing activities
    
(848,481
)
  
(1,694,636
)
               
NET INCREASE (DECREASE) IN CASH AND
              
CASH EQUIVALENTS
    
(101,431
)
  
(174,921
)
CASH AND CASH EQUIVALENTS, beginning of period
    
921,742
   
888,186
 
CASH AND CASH EQUIVALENTS, end of period
  
$
820,311
  
$
713,265
  
               
 
The accompanying notes are an integral part of these condensed consolidated balance sheets.
 
 
- 6 -
 
Page 2 of 2
BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

   
Three Months Ended
  
   
March 31,
  
   
2006
  
2007
  
           
 
      SUPPLEMENTAL DISCLOSURE OF CASH
         
      FLOW NFORMATION:              
               
Cash paid during the year for interest
  
$
77,139
  
$
126,062
  
Cash paid during the year for income taxes
  
$
-
  
$
-
  
               
 
The accompanying notes are an integral part of these condensed consolidated balance sheets.
 
 
- 7 -
 

BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2007

(1) UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The condensed consolidated financial statements included herein have been prepared by Birner Dental Management Services, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures included herein are adequate to make the information presented not misleading. A description of the Company’s accounting policies and other financial information is included in the audited consolidated financial statements as filed with the Securities and Exchange Commission in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company as of March 31, 2007 and the results of operations and cash flows for the periods presented. All such adjustments are of a normal recurring nature. The results of operations for the three months ended March 31, 2007 are not necessarily indicative of the results that may be achieved for a full fiscal year and cannot be used to indicate financial performance for the entire year.


(2)  SIGNIFICANT ACCOUNTING POLICIES

Intangible Assets

The Company's dental practice acquisitions involve the purchase of tangible and intangible assets and the assumption of certain liabilities of the acquired dental offices (“Offices”). As part of the purchase price allocation, the Company allocates the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed, based on estimated fair market values. Costs of acquisition in excess of the net estimated fair value of tangible assets acquired and liabilities assumed are allocated to the management agreement related to the Office (“Management Agreement”). The Management Agreement represents the Company's right to manage the Offices during the 40-year term of the agreement. The assigned value of the Management Agreement is amortized using the straight-line method over a period of 25 years. Amortization was $194,704 and $194,749 for the three months ended March 31, 2007 and 2006, respectively.

The Management Agreements cannot be terminated by the related professional corporation without cause, consisting primarily of bankruptcy or material default by the Company.

In the event that facts and circumstances indicate that the carrying value of long-lived and intangible assets may be impaired, an evaluation of recoverability would be performed. If an evaluation were required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset’s carrying amount to determine if a write-down to market value or discounted cash flow value would be required.

Stock Options

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), "Share-Based Payment." This standard revises SFAS 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees.” Under SFAS 123(R), the Company is required to measure the cost of employee services received in exchange for stock options and similar awards based on the grant date fair value of the award and recognize this cost in the income statement over the period during which an employee is required to provide service in exchange for the award.


- 8 -

The Company adopted SFAS 123(R) using the modified prospective method. Under this transition method, stock-based compensation expense for the three months ended March 31, 2007 includes: (i) compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS 123; and (ii) compensation expense for all stock-based compensation awards granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provision of SFAS 123(R). The Company recognizes compensation expense on a straight line basis over the requisite service period of the award. Total stock-based compensation expense included in the Company’s statement of income for the three months ended March 31, 2007 and 2006 was approximately $90,000 and $88,000, respectively. Total stock-based compensation expense was recorded as a component of corporate general and administrative expense.
 
The Black-Scholes option-pricing model was used to estimate the option fair values. The option-pricing model requires a number of assumptions, of which the most significant are expected stock price volatility, the expected pre-vesting forfeiture rate, expected dividend rate and the expected option term (the amount of time from the grant date until the options are exercised or expire). Expected volatility was calculated based upon actual historical stock price movements over the most recent periods ending March 31, 2007 equal to the expected option term. Expected pre-vesting forfeitures were estimated based on actual historical pre-vesting forfeitures over the most recent periods ending March 31, 2007 for the expected option term. The expected option term was calculated using the “simplified” method permitted by Staff Accounting Bulletin 107.
 

Prior to January 1, 2006, the Company accounted for stock options using the intrinsic value method wherein compensation expense was recognized on stock options granted only for the excess of the market price of the Company’s Common Stock over the option exercise price on the date of grant. All options of the Company were granted at amounts equal to or higher than the fair value of the Common Stock, so no compensation expense was recorded.

Income Taxes
 
Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 requires a company to determine whether it is more likely than not that a tax position will be sustained upon examination based upon the technical merits of the position. If the more-likely-than-not threshold is not met, a company must measure the tax position to determine the amount to recognize in the financial statements. The application of income tax law and regulations is inherently complex and subject to change. The Company is required to make many subjective assumptions and judgments regarding the income tax exposures. Changes in these subjective assumptions and judgments can materially affect amounts recognized in the Company’s financial statements.
 
At the adoption date of January 1, 2007 and at March 31, 2007, the Company had no unrecognized tax benefits which would affect the effective tax rate if recognized, and as of March 31, 2007, the Company had no accrued interest or penalties related to uncertain tax positions.
 
On initial application, FIN 48 was applied to all tax positions for which the statute of limitations remained open. The tax year 2006 federal return has been granted an extension to file until September 15, 2007. The tax years 2003-2006 remain open to examination by taxing jurisdictions to which the Company is subject. The IRS report issued in July 2006, made no changes to the return. No other federal or state exams are ongoing or have been performed in the past three years.


(3)  EARNINGS PER SHARE

The Company calculates earnings per share in accordance with SFAS No. 128, “Earnings Per Share.”

   
Three Months Ended March 31,
  
   
2006
  
2007
  
   
Income
  
Shares
  
Per Share Amount
  
Income
  
Shares
  
Per Share Amount
  
Basic EPS:
                          
Net income available to shares of Common Stock
  
$
702,325
    
2,372,506
 
$
0.30
  
$
782,769
    
2,126,376
 
$
0.37
  
                                       
Effect of dilutive shares of Common Stock from stock options and warrants
    
-
    
212,207
   
(0.03
)
  
-
    
180,532
   
(0.03
)
                                       
Diluted EPS:
                                      
Net income available to shares of Common Stock
  
$
702,325
    
2,584,713
 
$
0.27
  
$
782,769
    
2,306,908
 
$
0.34
  
                                       

The difference in weighted average shares outstanding between basic earnings per share and diluted earnings per share for the three months ended March 31, 2007 and 2006 relates to the effect of 180,532 and 212,207 shares, respectively, of dilutive shares of Common Stock from stock options, which are included in total shares for the diluted calculation. For the three months ended March 31, 2007, options to purchase 3,644 shares of the Company’s Common Stock were not included in the computation of dilutive income per share because their effect was anti-dilutive. 

 
- 9 -

 
(4) STOCK-BASED COMPENSATION PLANS

At the Company’s June 2005 annual meeting of shareholders, the shareholders approved the 2005 Equity Incentive Plan (“2005 Plan”), which reserved 300,000 shares of Common Stock for issuance. The 2005 Plan provides for the grant of incentive stock options, restricted stock, restricted stock units and stock grants to employees (including officers and employee-directors) and non-statutory stock options to employees, directors and consultants. The objectives of this plan include attracting and retaining the best personnel, providing for additional performance incentives by providing employees with the opportunity to acquire Common Stock. As of March 31, 2007, there were 30,300 shares available for issuance under the 2005 Plan. The exercise price of the stock options issued under the 2005 Plan is equal to the market price, or market price plus 10% for shareholders who own greater than 10% of the Company, at the date of grant. These stock options expire seven years, or five years for shareholders who own greater than 10% of the Company, from the date of the grant and vest annually over a service period ranging from three to five years. The 2005 Plan is administered by a committee of two or more independent directors from the Company’s Board of Directors (the “Committee”). The Committee determines the eligible individuals to whom awards under the 2005 Plan may be granted, as well as the time or times at which awards will be granted, the number of shares to be granted to any eligible individual, the life of any award, and any other terms and conditions of the awards in addition to those contained in the 2005 Plan. As of March 31, 2007 there were 21,001 vested options, 188,699 unvested options, 40,000 vested restricted shares and 20,000 unvested restricted shares outstanding under the 2005 Plan. In March 2007 the Board of Directors resolved that, subject to approval by the shareholders at the 2007 Annual Meeting of Shareholders, the number of authorized shares under the 2005 Plan be increased from 300,000 to 425,000.

The Employee Stock Option Plan (the ''Employee Plan'') was adopted by the Board of Directors effective as of October 30, 1995, and as amended on September 4, 1997, February 28, 2002, and June 8, 2004, reserved 479,250 shares of Common Stock for issuance. The Employee Plan provided for the grant of incentive stock options to employees (including officers and employee-directors) and non-statutory stock options to employees, directors and consultants. The Employee Plan expired by its terms on October 30, 2005. As of March 31, 2007, there were 271,535 vested options outstanding and 64,667 unvested options outstanding under the Employee Plan.


- 10 -

The Dental Center Stock Option Plan (“Dental Center Plan”) was adopted by the Board of Directors effective as of October 30, 1995, and as amended on September 4, 1997, reserved 160,475 shares of Common Stock for issuance. The Dental Center Plan provided for the grant of non-statutory stock options to professional corporations that operate the Offices (“P.C.s”) that are parties to Management Agreements with the Company, and to dentists or dental hygienists who are either employed by or are an owner of the P.C.s. The Dental Center Plan expired by its terms on October 30, 2005. As of March 31, 2007, there were 14,000 vested options outstanding and no unvested options outstanding under the Dental Center Plan.

The Company uses the Black-Scholes pricing model to estimate the fair value of each option granted with the following weighted average assumptions:

   
Three Months Ended
  
   
March 31,
  
Valuation Assumptions
  
2006
  
2007
  
           
Expected life (1)
    
5.0
    
4.5
  
Risk-free interest rate (2)
    
4.72
%
  
4.75
%
Expected volatility (3)
    
50
%
  
58
%
Expected dividend yield
   
2.90
%
  
3.07
%
Expected Forteiture (4)
    
4.49
%
  
5.32
%

_____________________________
(1) The expected life, in years, of stock options is estimated using the simplified-method calculation.
(2) The risk-free interest rate is based on U.S. Treasury bills whose term is consistent with the expected life of the stock options.
(3) The expected volatility is estimated based on historical and current stock price data for the Company.
(4) Forfeitures on options granted prior to the Company’s adoption of SFAS 123(R) on January 1, 2006, are recorded as they occur. Forfeitures on options granted since the Company’s adoption of SFAS 123(R), are estimated based on historical experience.
 
A summary of option activity as of March 31, 2007, and changes during the three months then ended, is presented below:
 
   
Number of Options
  
Weighted-Average Exercise Price
  
Range of Exercise Prices
 
Weighted-Average Remaining Contractual Term (years)
  
Aggregate Intrinsic Value (thousands)
  
Outstanding at December 31, 2006
    
563,235
  
$
11.63
  
$
4.80 - $19.75
              
Granted
    
17,000
  
$
21.84
  
$
21.75 - $21.85
              
Exercised
    
10,667
  
$
7.32
  
$
5.50 - $ 9.66
              
Forfeited
    
9,666
  
$
13.30
  
$
9.66 - $17.61
              
                                 
Outstanding at March 31, 2007
    
559,902
  
$
11.99
  
$
4.80 - $21.85
    
3.5
  
$
6,715
  
                                 
Exercisable at March 31, 2007
    
306,536
  
$
8.04
  
$
4.80 - $19.37
    
1.9
  
$
2,466
  
                                 

The weighted average grant date fair value of options granted was $9.16 per option and $6.87 per option during the three months ended March 31, 2007 and 2006, respectively. Net cash proceeds from the exercise of stock options during the three months ended March 31, 2007 and 2006 were $78,049 and $87,411, respectively. The associated income tax benefit from stock options exercised during the three months ended March 31, 2007 and 2006 was $56,406 and $17,081, respectively. As of the date of exercise, the total intrinsic value of options exercised during the three months ended March 31, 2007 and 2006 was $166,936 and $634,761, respectively. As of March 31, 2007, there was $1.4 million of total unrecognized compensation expense related to non-vested stock options, which is expected to be recognized over a weighted average period of 1.42 years.


- 11 -

(5) RESTRICTED STOCK GRANT

On July 1, 2005, the Company granted 60,000 shares of restricted Common Stock to the Company’s Chairman and Chief Executive Officer (the “Employee”) under the 2005 Plan. In connection with the grant of restricted stock, the Company agreed to reimburse the Employee an amount equal to the tax liability associated with the grant. Such reimbursement was made by the Company and totaled approximately $586,000 which was recognized as an expense during the third quarter of 2005. As of March 31, 2007, there was approximately $243,000 of unrecognized compensation expense related to the restricted stock grant. The remaining expense is expected to be recognized in 2007.

A summary of the vesting status of the shares of restricted stock as of March 31, 2007, and the changes during the three months then ended, is presented below:
   
Three Months Ended
  
   
March 31, 2007
  
   
Number of Restricted Shares
  
Weighted-Average Grant-Date Fair Value
  
           
Non-vested at December 31, 2006
    
40,000
  
$
13.51
  
Granted
   
-
   
-
 
Vested
    
(20,000
)
  
13.51
 
Forfeited
    
-
   
-
 
Non-vested at March 31, 2007
    
20,000
  
$
13.51
  
               
 
(6)  DIVIDENDS

On March 9, 2004, the Company announced a quarterly cash dividend of $.0375 per share. On February 10, 2005, the Company announced an increase in the amount of the quarterly dividend to $.10 per share. On January 10, 2006, the Company announced an increase in the amount of the quarterly dividend to $.13 per share. On January 11, 2007, the Company announced an increase in the amount of the quarterly dividend to $.15 per share. The payment of dividends in the future is subject to the discretion of the Company’s Board of Directors, and various factors may prevent the Company from paying dividends. Such factors include the Board of Directors’ assessment of the Company’s financial position, capital requirements and liquidity, the existence of a stock repurchase program, loan agreement restrictions, results of operations and such other factors the Company’s Board of Directors may consider relevant.

(7) LINE OF CREDIT

On April 30, 2007, the Company amended its bank line of credit (“Credit Facility”). The amended Credit Facility decreases the LIBOR rate margin from 1.50% to 1.25% and extends the expiration of the credit agreement from May 31, 2008 to May 31, 2009. The Credit Facility allows the Company to borrow, on a revolving basis, an aggregate principal amount not to exceed $7.0 million at either, or a combination of, the lender’s Base Rate or at LIBOR plus a LIBOR rate margin, at the Company’s option. The lender’s Base Rate computes interest at the higher of the lender’s “prime rate” or the Federal Funds Rate plus one-half percent (0.5%). The LIBOR option computes interest at the LIBOR rate as of the date such LIBOR Rate loan was made plus a LIBOR rate margin of 1.25%. A commitment fee of 0.25% on the average daily unused amount of the revolving loan commitment during the preceding quarter is also assessed. The Company may prepay any Base Rate loan at any time and any LIBOR rate loan upon not less than three business days prior written notice given to the lender, but the Company is responsible for any loss or cost incurred by the lender in liquidating or employing deposits required to fund or maintain the LIBOR rate loan. At March 31, 2007, the Company had $2.0 million outstanding and $5.0 million available for borrowing under the Credit Facility. This consisted of $1.8 million outstanding under the LIBOR rate option and $151,000 outstanding under the Base Rate option. The Credit Facility requires the Company to maintain certain financial ratios on an ongoing basis. At March 31, 2007, the Company was in full compliance with all of its covenants under the Credit Facility.
 
(8) CAPITAL EXPENDITURES
 
The Company’s retained earnings as of March 31, 2007 were approximately $5.8 million, and the Company had a working capital deficit on that date of approximately $1.3 million. During the three months ended March 31, 2007, the Company had capital expenditures of approximately $199,000 and purchased approximately $416,000 of Common Stock while decreasing total bank debt by approximately $1.1 million.


- 12 -

(9) DUTCH AUCTION TENDER OFFER AND TERM LOAN
 
On October 5, 2006, the Company accepted for payment, at a purchase price of $21.75 per share, 212,396 shares of its Common Stock that were properly tendered and not withdrawn pursuant to the Company’s “Dutch Auction” tender offer. The 212,396 shares purchased were comprised of the 175,000 shares the Company offered to purchase and 37,396 shares that were purchased pursuant to the Company's right to purchase up to an additional 2% of the outstanding shares as of August 31, 2006, without extending the Dutch Auction tender offer in accordance with applicable securities laws. These shares represented approximately 9.2% of the shares outstanding as of September 30, 2006. The Dutch Auction tender offer was funded from a $4.6 million term loan (“Term Loan”). Under the Term Loan, $2.3 million is borrowed at a fixed interest rate of 7.05% and the remaining $2.3 million is borrowed at a floating interest rate of LIBOR plus 1.5%. The principal amount borrowed will be paid quarterly in 20 equal payments of approximately $230,000 plus interest beginning December 31, 2006. The Term Loan matures on September 30, 2011. On October 12, 2006, the Company entered into a fixed-for-floating interest rate swap transaction on the Term Loan and in February 2007 designated it as a cash flow hedge under Statement of Financial Accounting Standards (“SFAS”) No. 133, "Accounting for Derivatives." Under SFAS 133, the Company is required to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value unless (i) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (ii) a hedge of the exposure to variable cash flows of a forecasted transaction, or (iii) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The swap was entered into for purposes other than trading purposes. At March 31, 2007, the Company was in full compliance with all of its covenants under the Term Loan.


- 13 -

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Forward-Looking Statements
 
The statements contained in this report that are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, included in this report that address activities, events or developments that we expect, believe, intend or anticipate will or may occur in the future, are forward-looking statements. When used in this document, the words “estimate,” “believe,” anticipate,” “project” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted with accuracy and some of which might not even be anticipated. These forward-looking statements include statements in this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” regarding intent, belief or current expectations of the Company or its officers with respect to the development or acquisition of additional dental practices (“Offices”) and the successful integration of such Offices into the Company’s network, recruitment of additional dentists, funding of the Company’s expansion, capital expenditures, payment or nonpayment of dividends and cash outlays for income taxes and other purposes.

Such forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from anticipated results. These risks and uncertainties include regulatory constraints, changes in laws or regulations concerning the practice of dentistry or dental practice management companies, the availability of suitable new markets and suitable locations within such markets, changes in the Company’s operating or expansion strategy, the general economy of the United States and the specific markets in which the Company’s Offices are located or are proposed to be located, trends in the health care, dental care and managed care industries, as well as the risk factors set forth in Item 1A. “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, this report, and other factors as may be identified from time to time in the Company’s filings with the Securities and Exchange Commission or in the Company’s press releases.
 
General
 
The following discussion relates to factors that have affected the results of operations and financial condition of the Company for the three months ended March 31, 2006 and 2007. This information should be read in conjunction with the Company’s condensed consolidated financial statements and related notes thereto included elsewhere in this report.
 
Overview
 
The Company was formed in May 1995 and currently manages 60 Offices in Colorado, New Mexico and Arizona staffed by 81 general dentists and 26 specialists. The Company derives all of its Revenue (as defined below) from its Management Agreements with professional corporations (“P.C.s”), which conduct the practice at each Office. In addition, the Company assumes a number of responsibilities when it acquires a new practice or develops a de novo Office, which are set forth in a Management Agreement, as described below.

The Company was formed with the intention of becoming the leading provider of business services to dental practices in Colorado. The Company’s growth and success in the Colorado market led to its expansion into the New Mexico and Arizona markets. The Company’s growth strategy is to focus on greater utilization of existing physical capacity through recruiting more dentists and support staff and through development of de novo Offices and selective acquisitions.
 
Critical Accounting Policies
 
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109,” which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company adopted the provisions of FIN 48 on January 1, 2007 and has analyzed filing positions in its federal and state jurisdictions where the Company is required to file income tax returns, as well as for all open tax years in these jurisdictions. The Company believes its income tax filing positions and deductions will be sustained under audit and believes it does not have significant uncertain tax positions that, in the event of adjustment, will result in a material effect on the results of operations or financial position, see Notes to Condensed Consolidated Financial Statements, (2) Significant Accounting Policies.


- 14 -

The Company’s critical accounting policies are set forth in its Annual Report on Form 10-K for the year ended December 31, 2006. Except for FIN 48, there have been no changes to these policies since the filing of that report.
 
Components of Revenue and Expenses
 
Total dental group practice revenue (“Revenue”) represents the revenue of the Offices reported at estimated realizable amounts, received from dental plans, other third-party payors and patients for dental services rendered at the Offices. The Company’s Revenue is derived principally from fee-for-service revenue and managed dental care revenue. Fee-for-service revenue consists of revenue received from indemnity dental plans, preferred provider plans and direct payments by patients not covered by any third-party payment arrangement. Managed dental care revenue consists of revenue received from capitated managed dental care plans, including capitation payments and patient co-payments. Capitated managed dental care contracts are between dental benefits organizations and the P.C.s.

Net revenue represents Revenue less amounts retained by the Offices. The amounts retained by the Offices represent amounts paid as compensation to employed dentists and hygienists. The Company’s net revenue is dependent on the Revenue of the Offices. Direct expenses consist of the expenses incurred by the Company in connection with managing the Offices, including salaries and benefits for personnel other than dentists and hygienists, dental supplies, dental laboratory fees, occupancy costs, advertising and marketing, depreciation and amortization and general and administrative (including office supplies, equipment leases, management information systems and other expenses related to dental practice operations). The Company also incurs personnel and administrative expenses in connection with maintaining a corporate function that provides management, administrative, marketing, advertising, development and professional services to the Offices.

Under each of the Management Agreements, the Company manages the business and marketing aspects of the Offices, including (i) providing capital, (ii) designing and implementing marketing and advertising programs, (iii) negotiating for the purchase of supplies, (iv) staffing, (v) recruiting, (vi) training of non-dental personnel, (vii) billing and collecting certain fees for dental services provided by the Offices, (viii) arranging for certain legal and accounting services, and (ix) negotiating with third party payors. Under the Management Agreements, the P.C. is responsible for, among other things (i) supervision of all dentists and dental hygienists, (ii) complying with all laws, rules and regulations relating to dentists and dental hygienists, and (iii) maintaining proper patient records. The Company has made, and intends to make in the future, loans to P.C.s in Colorado, New Mexico and Arizona to fund their acquisition of dental assets from third parties in order to comply with the laws of such states.

Under the typical Management Agreement used by the Company, the P.C. pays the Company a management fee equal to the “Adjusted Gross Center Revenue” of the P.C. less compensation paid to the dentists and dental hygienists employed at the Office of the P.C. Adjusted Gross Center Revenue is comprised of all fees and charges booked each month by or on behalf of the P.C. as a result of dental services provided to patients at the Office, less any adjustments for uncollectible accounts, professional courtesies and other activities that do not generate a collectible fee. The Company’s costs include all direct and indirect costs, overhead and expenses relating to the Company’s provision of management services at each Office under the Management Agreement, including (i) salaries, benefits and other direct costs of employees who work at the Office (other than dentist and hygienist salaries), (ii) direct costs of all Company employees or consultants who provide services to or in connection with the Office, (iii) utilities, janitorial, laboratory, supplies, advertising and other expenses incurred by the Company in carrying out its obligations under the Management Agreement, (iv) depreciation expense associated with the P.C.’s assets and the assets of the Company used at the Office, and the amortization of intangible asset value relating to the Office, (v) interest expense on indebtedness incurred by the Company to finance any of its obligations under the Management Agreement, (vi) general and malpractice insurance expenses, lease expenses and dentist recruitment expenses, (vii) personal property and other taxes assessed against the Company’s or the P.C.’s assets used in connection with the operation of the Office, (viii) out-of-pocket expenses of the Company’s personnel related to mergers or acquisitions involving the P.C., (ix) corporate overhead charges or any other expenses of the Company, including the P.C.’s pro rata share of the expenses of the accounting and computer services provided by the Company, and (x) a collection reserve in the amount of 5.0% of Adjusted Gross Center Revenue. As a result, substantially all costs associated with the provision of dental services at the Offices are borne by the Company, except for the compensation of the dentists and hygienists who work at the Offices of the P.C.s. This enables the Company to manage the profitability of the Offices. Each Management Agreement is for a term of 40 years. Further, each Management Agreement generally may be terminated by the P.C. only for cause, which includes a material default by or bankruptcy of the Company. Upon expiration or termination of a Management Agreement by either party, the P.C. must satisfy all obligations it has to the Company.


- 15 -

Under the Management Agreements, the Company negotiates and administers the capitated managed dental care contracts on behalf of the P.C.s. Under a capitated managed dental care contract, the dental group practice provides dental services to the members of the dental benefits organization and receives a fixed monthly capitation payment for each plan member covered for a specific schedule of services regardless of the quantity or cost of services to the participating dental group practice obligated to provide them. This arrangement shifts the risk of utilization of these services to the dental group practice providing the dental services. Because the Company assumes responsibility under the Management Agreements for all aspects of the operation of the dental practices (other than the practice of dentistry) and thus bears all costs of the P.C.s associated with the provision of dental services at the Offices (other than compensation of dentists and hygienists), the risk of over-utilization of dental services at the Offices under capitated managed dental care plans is effectively shifted to the Company. In addition, dental group practices participating in a capitated managed dental care plan often receive supplemental payments for more complicated or elective procedures. In contrast, under traditional indemnity insurance arrangements, the insurance company pays whatever reasonable charges are billed by the dental group practice for the dental services provided. Under a preferred provider plan, the dental group practice is paid for dental services provided based on a fee schedule that is a discount to the usual and customary fees paid under an indemnity insurance agreement.

The Company seeks to increase its fee-for-service business by increasing the patient volume at existing Offices through effective marketing and advertising programs and by opening de novo Offices. The Company seeks to supplement this fee-for-service business with revenue from contracts with capitated managed dental care plans. Although the Company’s fee-for-service business generally is more profitable than its capitated managed dental care business, capitated managed dental care business serves to increase facility utilization and dentist productivity. The relative percentage of the Company’s Revenue derived from fee-for-service business and capitated managed dental care contracts varies from market to market depending on the availability of capitated managed dental care contracts in any particular market and the Company’s ability to negotiate favorable contract terms. In addition, the profitability of managed dental care Revenue varies from market to market depending on the level of capitation payments and co-payments in proportion to the level of benefits required to be provided. 
 
Results of Operations
 
For the three months ended March 31, 2007, Revenue increased $1.2 million, or 7.9%, to $15.7 million compared to $14.6 million for the three months ended March 31, 2006. For the three months ended March 31, 2007, net revenue increased $698,000, or 6.9%, to $10.8 million compared to $10.1 million for the three months ended March 31, 2006.

For the three months ended March 31, 2007, net income increased 11.5% to $783,000, or $.34 per share compared to $702,000, or $.27 per share for the three months ended March 31, 2006.

The Company continues to generate strong cash flow from operations. During the first three months of 2007, the Company purchased $416,000 of its outstanding common stock, incurred $199,000 in capital expenditures, paid $278,000 in dividends, and repaid $34,000 of long term debt while decreasing borrowings under its Credit Facility by $1.1 million.

Revenue is total dental group practice revenue generated at the Company’s Offices from professional services provided to its patients. Amounts retained by dental Offices represents compensation expense to the dentists and hygienists and is subtracted from total dental group practice revenue to arrive at net revenue. The Company reports net revenue in its financial statements to comply with Emerging Issues Task Force Issue No. 97-2, Application of SFAS No. 94 (Consolidation of All Majority Owned Subsidiaries) and APB Opinion No. 16 (Business Combinations) to Physician Practice Management Entities and Certain Other Entities With Contractual Management Arrangements. Revenue is not a U.S. generally accepted accounting principles (“GAAP”) measure. The Company discloses Revenue and believes it is useful to investors because it is a critical component for management’s evaluation of Office performance. However, investors should not consider this measure in isolation or as a substitute for net revenue, operating income, cash flows from operating activities or any other measure for determining the Company’s operating performance that is calculated in accordance with generally accepted accounting principles. The following table reconciles Revenue to net revenue.

   
Three Months Ended
  
   
March 31,
  
   
2006
  
2007
  
           
Total dental group practice revenue
  
$
14,579,914
  
$
15,733,695
  
Less - amounts retained by dental Offices
    
(4,439,885
)
  
(4,895,288
)
               
Net revenue
  
$
10,140,029
  
$
10,838,407
  
               
 

- 16 -

The following table sets forth the percentages of net revenue represented by certain items reflected in the Company’s condensed consolidated statements of income. The information contained in the following table represents the historical results of the Company. The information that follows should be read in conjunction with the Company’s condensed consolidated financial statements and related notes thereto contained elsewhere in this report.
 
BIRNER DENTAL MANAGEMENT SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

   
Three Months Ended
  
   
March 31,
  
   
2006
  
2007
  
           
NET REVENUE:
    
100.0
%
  
100.0
%
               
DIRECT EXPENSES:
              
Clinical salaries and benefits
    
36.4
%
  
35.4
%
Dental supplies
    
5.7
%
  
5.2
%
Laboratory fees
    
6.3
%
  
6.3
%
Occupancy
    
10.4
%
  
10.5
%
Advertising and marketing
    
2.1
%
  
1.4
%
Depreciation and amortization
    
4.7
%
  
5.6
%
General and administrative
    
11.7
%
  
10.9
%
     
77.3
%
  
75.2
%
               
Contribution from dental offices
    
22.7
%
  
24.8
%
               
CORPORATE EXPENSES:
              
General and administrative
   
10.7
%
  
11.5
%
Depreciation and amortization
    
0.3
%
  
0.3
%
               
Operating income
   
11.7
%
  
13.0
%
               
Interest expense
    
0.4
%
  
1.0
%
               
Income before income taxes
    
11.3
%
  
12.0
%
Income tax expense
    
4.3
%
  
4.8
%
               
Net income
    
7.0
%
  
7.2
%
               
 
Three Months Ended March 31, 2007 Compared to Three Months Ended March 31, 2006:
 
Net revenue. For the three months March 31, 2007, net revenue increased $698,000, or 6.9%, to $10.8 million compared to $10.1 million for the three months ended March 31, 2006. This increase is attributable to an increase in net revenue of $311,000 at the 56 Offices that were open during each full quarter and $387,000 in net revenue from the addition of four de novo Offices opened either during the quarter ended March 31, 2006 or after March 31, 2006.

Clinical salaries and benefits. For the three months ended March 31, 2007, clinical salaries and benefits increased $151,000, or 4.1%, to $3.8 million compared to $3.7 million for the three months ended March 31, 2006. This increase was primarily due to additional employees at the four de novo Offices opened either during the quarter ended March 31, 2006 or after March 31, 2006 and annual wage increases that became effective February 1, 2007. As a percentage of net revenue, clinical salaries and benefits decreased to 35.4% for the three months ended March 31, 2007 compared to 36.4% for the three months ended March 31, 2006.
 

- 17 -


 
Dental supplies. For the three months ended March 31, 2007, dental supplies decreased to $561,000 compared to $576,000 for the three months ended March 31, 2006, a decrease of $15,000 or 2.6%. As a percentage of net revenue, dental supplies decreased to 5.2% for the three months ended March 31, 2007 compared to 5.7% for the three months ended March 31, 2006.
 
Laboratory fees. For the three months ended March 31, 2007, laboratory fees increased to $680,000 compared to $642,000 for the three months ended March 31, 2006, an increase of $38,000 or 6.0%. This increase was primarily related to the addition of the four de novo Offices opened either during the quarter ended March 31, 2006 or after March 31, 2006. As a percentage of net revenue, laboratory fees remained constant at 6.3% for the three months ended March 31, 2007 and 2006.
 
Occupancy. For the three months ended March 31, 2007, occupancy expense increased $76,000 or 7.2% to $1.1 million. This increase was primarily due to the four de novo Offices opened either during the quarter ended March 31, 2006 or after March 31, 2006 and increased rental payments resulting from the renewal of Office leases at current market rates for Offices whose leases expired subsequent to March 31, 2006. As a percentage of net revenue, occupancy expense increased to 10.5% for the three months ended March 31, 2007 compared to 10.4% for the three months ended March 31, 2006.
 
Advertising and marketing. For the three months ended March 31, 2007, advertising and marketing expense decreased to $149,000 compared to $209,000 for the three months ended March 31, 2006, a decrease of $60,000 or 28.8%. This decrease is attributable to a shift away from a comprehensive television and print advertising campaign in the Albuquerque, New Mexico and Colorado Springs, Colorado markets in 2006. The Company began a television advertising campaign in the Denver, Colorado market in March 2007 that will increase advertising and marketing expense. As a percentage of net revenue, advertising and marketing expense decreased to 1.4% for the three months ended March 31, 2007 compared to 2.1% for the three months ended March 31, 2006.
 
Depreciation and amortization-Offices. For the three months ended March 31, 2007, depreciation and amortization expenses attributable to the Offices increased to $611,000 compared to $480,000 for the three months ended March 31, 2006, an increase of $131,000 or 27.3%. The increase in the Company’s depreciable asset base is a result of purchasing tenant improvements and new equipment for four de novo Offices and the expansion of one existing Office. As a percentage of net revenue, depreciation and amortization increased to 5.6% for the three months ended March 31, 2007 compared to 4.7% for the three months ended March 31, 2006.

General and administrative-Offices. For the three months ended March 31, 2007 and 2006, general and administrative expenses attributable to the Offices remained constant at $1.2 million. As a percentage of net revenue, general and administrative expenses decreased to 10.9% for the three months ended March 31, 2007 compared to 11.7% for the three months ended March 31, 2006.
 
Contribution from dental Offices. As a result of the above, contribution from dental Offices increased $391,000, or 17.0%, to $2.7 million for the three months ended March 31, 2007 compared to $2.3 million for the three months ended March 31, 2006. As a percentage of net revenue, contribution from dental offices increased to 24.8% for the three months ended March 31, 2007 compared to 22.7% for the three months ended March 31, 2006.
 
Corporate expenses - general and administrative. For the three months ended March 31, 2007, corporate expenses - general and administrative increased to $1.2 million compared to $1.1 million for the three months ended March 31, 2006, an increase of $165,000 or 15.3%. This increase is primarily related to an increase in executive bonuses, an increase in employee wages related to the addition of key personnel and annual wage increases. As a percentage of net revenue, corporate expenses - general and administrative increased to 11.5% for the three months ended March 31, 2007 compared to 10.7% for the three months ended March 31, 2006.
 
Corporate expenses - depreciation and amortization. For the three months ended March 31, 2007, corporate expenses - depreciation and amortization decreased to $31,000 compared to $34,000 for the three months ended March 31, 2006, a decrease of $3,000 or 9.8%. The decrease is related to the decrease in the Company’s depreciable asset base. As a percentage of net revenue, corporate expenses - depreciation and amortization remained constant at 0.3% for the three months ended March 31, 2007 and 2006.
 
Operating income. As a result of the matters discussed above, the Company’s operating income increased to $1.4 million for the three months ended March 31, 2007 compared to $1.2 million for the three months ended March 31, 2006, an increase of $229,000 or 19.4%. As a percentage of net revenue, operating income increased to 13.0% for the three months ended March 31, 2007 compared to 11.7% for the three months ended March 31, 2006.
 

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Interest expense. For the three months ended March 31, 2007, interest expense increased to $106,000 compared to $40,000 for the three months ended March 31, 2006, an increase of $67,000. This increase in interest expense is attributable to higher interest expense on the Credit Facility and the addition of a Term Loan to finance the Dutch Auction tender offer completed in October 2006. As a percentage of net revenue, interest expense, increased to 1.0% for the three months ended March 31, 2007 compared to 0.4% for the three months ended March 31, 2006.
 
Net income. As a result of the above, the Company reported net income of $783,000 for the three months ended March 31, 2007 compared to net income of $702,000 for the three months ended March 31, 2006, an increase of $80,000 or 11.5%. Net income for the three months ended March 31, 2007 was net of income tax expense of $522,000, while net income for the three months ended March 31, 2006 was net of income tax expense of $440,000. As a percentage of net revenue, net income increased to 7.2% for the three months ended March 31, 2007 compared to 7.0% for the three months ended March 31, 2006.
 
Liquidity and Capital Resources
 
The Company finances its operations and growth through a combination of cash provided by operating activities and the Credit Facility. As of March 31, 2007, the Company had a working capital deficit of approximately $1.4 million.
 
Net cash provided by operating activities was approximately $1.7 million and $1.9 million for the three months ended March 31, 2007 and 2006, respectively. During the 2007 period, excluding net income and after adding back non-cash items, the Company’s cash provided by operating activities consisted primarily of an increase in accounts payable and accrued expenses of approximately $720,000, an increase in income taxes payable of approximately $367,000 and a decrease in deferred charges and other assets of approximately $8,000, offset by an increase in accounts receivable of approximately $960,000 (primarily due to higher Revenue), an increase in prepaid expenses and other assets of approximately $243,000, and a decrease in other long-term obligations of approximately $16,000. During the 2006 period, excluding net income and after adding back non-cash items, the Company’s cash provided by operating activities consisted primarily of an increase in accounts payable and accrued expenses of approximately $881,000 and an increase in income taxes payable of approximately $273,000, offset by an increase in prepaid expenses and other assets of approximately $96,000, an increase in accounts receivable of approximately $695,000 (primarily due to higher Revenue) and an increase in deferred charges and other assets of approximately $28,000.
 
Net cash used in investing activities was approximately $199,000 and $1.2 million for the three months ended March 31, 2007 and 2006, respectively. For the three months ended March 31, 2007, the Company invested approximately $199,000 in the purchase of additional equipment. For the three months ended March 31, 2006, the Company invested approximately $683,000 in the purchase of additional property and equipment and approximately $515,000 in the development of de novo Offices.
 
Net cash used in financing activities was approximately $1.7 million for the three months ended March 31, 2007 and $848,000 for the three months ended March 31, 2006. During the three months ended March 31, 2007, net cash used in financing activities was comprised of approximately $1.1 million used to pay down the Credit Facility, approximately $416,000 used in the purchase and retirement of Common Stock, approximately $34,000 for the repayment of long-term debt and approximately $278,000 for the payment of dividends, partially offset by approximately $78,000 in proceeds from the exercise of Common Stock options and $56,000 in tax benefit of Common Stock options exercised. During the three months ended March 31, 2006, net cash used in financing activities was comprised of approximately $654,000 used to pay down the Credit Facility, approximately $20,000 used in the purchase and retirement of Common Stock, approximately $44,000 for the repayment of long-term debt and approximately $235,000 for the payment of dividends, partially offset by approximately $87,000 in proceeds from the exercise of Common Stock options and $17,000 in tax benefit of Common Stock options exercised.
 
On April 30, 2007, the Company amended its bank line of credit (“Credit Facility”). The amended Credit Facility decreases the LIBOR rate margin from 1.50% to 1.25% and extends the expiration of the credit agreement from May 31, 2008 to May 31, 2009. The Credit Facility allows the Company to borrow, on a revolving basis, an aggregate principal amount not to exceed $7.0 million at either, or a combination of, the lender’s Base Rate or at LIBOR plus a LIBOR rate margin, at the Company’s option. The lender’s Base Rate computes interest at the higher of the lender’s “prime rate” or the Federal Funds Rate plus one-half percent (0.5%). The LIBOR option computes interest at the LIBOR rate as of the date such LIBOR Rate loan was made plus a LIBOR rate margin of 1.25%. A commitment fee of 0.25% on the average daily unused amount of the revolving loan commitment during the preceding quarter is also assessed. The Company may prepay any Base Rate loan at any time and any LIBOR rate loan upon not less than three business days prior written notice given to the lender, but the Company is responsible for any loss or cost incurred by the lender in liquidating or employing deposits required to fund or maintain the LIBOR rate loan. At March 31, 2007, the Company had $2.0 million outstanding
 

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and $5.0 million available for borrowing under the Credit Facility. This consisted of $1.8 million outstanding under the LIBOR rate option and $151,000 outstanding under the Base Rate option. The Credit Facility requires the Company to maintain certain financial ratios on an ongoing basis. At March 31, 2007, the Company was in full compliance with all of its covenants under the Credit Facility.
 
The Company’s retained earnings as of March 31, 2007 were approximately $5.8 million. The Company expects increased costs over the next 12 to 18 months as it prepares to comply with Sarbanes-Oxley Act Section 404.
 
On October 5, 2006, the Company entered into a $4.6 million Term Loan to finance its Dutch Auction tender offer. Under the Term Loan, $2.3 million is borrowed at a fixed interest rate of 7.05% and the remaining $2.3 million is borrowed at a floating interest rate of LIBOR plus 1.5%. The principal amount borrowed will be paid quarterly in 20 equal payments of approximately $230,000 plus interest beginning December 31, 2006. The Term Loan expires September 30, 2011. The Company designates this fixed-for-floating interest rate swap as a cash flow hedge under SFAS No. 133. The Term Loan requires the Company to maintain certain financial ratios on an ongoing basis. At March 31, 2007, the Company was in full compliance with all of its covenants under the Term Loan.

The Company’s earnings before interest, taxes, depreciation, amortization and non cash expense associated with stock-based compensation (“Adjusted EBITDA”) increased $359,000, or 19.2% to $2.2 million for the three months ended March 31, 2007 compared to $1.9 million for the corresponding three month period in 2006. Although Adjusted EBITDA is not a GAAP measure of performance or liquidity, the Company believes that it may be useful to an investor in evaluating the Company’s ability to meet future debt service, capital expenditures and working capital requirements. However, investors should not consider these measures in isolation or as a substitute for operating income, cash flows from operating activities or any other measure for determining the Company’s operating performance or liquidity that is calculated in accordance with GAAP. In addition, because Adjusted EBITDA is not calculated in accordance with GAAP, it may not necessarily be comparable to similarly titled measures employed by other companies. A reconciliation of Adjusted EBITDA to net income can be made by adding depreciation and amortization expense - offices, depreciation and amortization expense - corporate, amortization of equity compensation, stock-based compensation related to SFAS 123(R), interest expense/(income), net and income tax expense to net income as in the table below.
 

   
Three Months
 
   
Ended March 31,
  
   
2006
 
2007
  
RECONCILIATION OF ADJUSTED EBITDA:
          
Net income
  
$
702,325
  
$
782,769
  
Depreciation and amortization - Offices
    
479,775
   
610,552
 
Depreciation and amortization - Corporate
    
34,196
   
30,828
 
Amortization of deferred equity compensation expense
    
81,030
   
81,030
 
Stock-based compensation expense related to
   
87,745
   
90,064
 
SFAS 123 (R)
             
Interest expense/(income), net
    
39,620
   
106,153
 
Income tax expense
    
439,974
   
521,847
 
               
Adjusted EBITDA
  
$
1,864,665
  
$
2,223,243
  
               
 
As of March 31, 2007, the Company had the following known contractual obligations:
 

   
 
 
Less than
 
 
 
 
 
 
 
 
 
More than
 
 
 
Total
 
1 year
 
1-3 years
 
 
 
3-5 years
 
 
 
5 years
  
Long-term debt obligations
  
$
6,320,652
  
$
1,150,000
  
$
3,560,652
        
$
1,610,000
        
$
-
  
Operating lease obligations
    
8,132,342
   
2,748,407
   
3,949,228
         
1,385,541
         
49,166
 
Other long-term liabilities reflected on the balance sheet under GAAP
    
387,695
   
76,749
   
203,338
         
105,891
         
1,717
 
Total
  
$
14,840,689
  
$
3,975,156
  
$
7,713,218
        
$
3,101,432
        
$
50,883
  

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The Company from time to time may purchase its Common Stock on the open market. During 2006, the Company, in 67 separate transactions, purchased 305,161 shares of its Common Stock for total consideration of approximately $6.1 million at prices ranging from $15.00 to $21.75 per share. In April 2006, the Company purchased 54,250 shares through a private transaction that was approved by the Board of Directors. On October 5, 2006, the Company purchased, through a Dutch Auction tender offer that was approved by the Board of Directors, 212,396 shares of its Common Stock at $21.75 for total consideration of $4.6 million. During the three month period ended March 31, 2007, the Company, in 14 separate transactions, purchased 19,468 shares of its Common Stock for total consideration of approximately $416,000 at prices ranging from $19.00 to $24.00. On March 16, 2007, the Board of Directors authorized the Company to increase by approximately $679,000 the amount available to make open market purchases of its Common Stock. As of March 31, 2007, approximately $791,000 of the previously authorized amount was available for open market purchases. There is no expiration date on these plans. Such purchases may be made from time to time as the Company’s management deems appropriate.

The Company believes that cash generated from operations and borrowings under its Credit Facility will be sufficient to fund its anticipated working capital needs, capital expenditures and dividend payments for at least the next 12 months. In order to meet its long-term liquidity needs, the Company may issue additional equity and debt securities, subject to market and other conditions. There can be no assurance that such additional financing will be available on terms acceptable to the Company. The failure to obtain the funds necessary to finance its future cash requirements could adversely affect the Company’s ability to pursue its strategy and could negatively affect its operations in future periods.
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Market risk represents the risk of loss that may impact the financial position, results of operations or cash flows of the Company due to adverse changes in financial and commodity market prices and rates. Historically, the Company has not used derivative instruments or engaged in hedging activities. On October 12, 2006, the Company entered into a fixed-for-floating interest rate swap transaction on the Term Loan and designated it as a cash flow hedge under SFAS No. 133.

Interest Rate Risk. The interest payable on the Credit Facility and a portion of the Term Loan is variable based on floating interest rates (either LIBOR or Base Rate) and, therefore is affected by changes in market interest rates. At March 31, 2007, the variable portion outstanding under the Term Loan was $2.2 million and $2.0 million was outstanding under the Credit Facility with either variable LIBOR (6.82%) or Base Rate (8.25%). The Company may repay the Credit Facility and Term Loan balances in full at any time without penalty. As a result, the Company does not believe that any reasonably possible near-term changes in interest rates would result in a material effect on future earnings, fair values or cash flows of the Company. The Company estimates that a 1.0% increase in the interest rate on the Credit Facility and Term Loan would have resulted in additional interest expense of approximately $12,000 for the three months ended March 31, 2007.
 
ITEM 4. CONTROLS AND PROCEDURES
 
Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, the Company evaluated the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, or the “Exchange Act”) as of March 31, 2007. On the basis of this review, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures are designed, and are effective, to give reasonable assurance that the information required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, in a manner that allows timely decisions regarding required disclosure. There were no changes in the Company’s internal controls over financial reporting that occurred in the three months ended March 31, 2007 that materially affected, or were reasonably likely to materially affect, its internal control over financial reporting.

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PART II. OTHER INFORMATION


ITEM 1. LEGAL PROCEEDINGS
 
From time to time the Company is subject to litigation incidental to its business. The Company is not presently a party to any material litigation. Such claims, if successful, could result in damage awards exceeding, perhaps substantially, applicable insurance coverage.

ITEM 1A. RISK FACTORS
 
There have been no material changes in our risk factors from those disclosed  in our Annual Report on Form 10-K for the year ended December 31, 2006.

 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
The following chart provides information regarding Common Stock purchases by the Company during the period January 1, 2007 through March 31, 2007.
 

Issuer Purchases of Equity Securities
  
Period
  
Total Number Of Shares Purchased
  
Average Price Paid per Share
  
Total Number Of Shares Purchased as Part of Publicly Announced Plans or Programs
  
Approximate Dollar Value Of Shares That May Yet Be Purchased Under the Plans or Programs
 
January 1, 2007 through January 31, 2007
    
7,750
 
$
19.60
    
7,750
 
$
376,472
  
February 1, 2007 through February 28, 2007
    
1,518
   
21.11
   
1,518
 
$
337,717
  
March 1, 2007 through March 31, 2007
    
10,200
   
22.74
   
10,200
 
$
791,266
  
Total
    
19,468
 
$
21.36
    
19,468
     

All purchases were made on the open market pursuant to publicly announced plans that were approved by the Board of Directors. As of March 31, 2007, there was approximately $791,000 available for the purchase of the Company’s Common Stock under publicly announced plans that have been approved by the Board of Directors. There is no expiration date on these plans. Purchases under these plans may be made from time to time, as the Company’s management deems appropriate.
 
ITEM 5. OTHER INFORMATION
 
On April 30, 2007, the Company amended its Credit Facility. The amended Credit Facility decreases the LIBOR rate margin from 1.50% to 1.25% and extends the expiration date of the credit agreement from May 31, 2008 to May 31, 2009.

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ITEM 6. EXHIBITS
 

Exhibit
Number
Description of Document
   3.1  
Amended and Restated Articles of Incorporation, incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement of Form S-1 (SEC File No. 333-36391), as filed with the Securities and Exchange Commission on September 25, 1997.
   
   3.2 
Amended and Restated Bylaws, incorporated herein by reference to Exhibit 3.3 to the Company’s Registration Statement on Form S-1 (SEC File No. 333-36391), as filed with the Securities and Exchange Commission on September 25, 1997.
   
   4.1 
Reference is made to Exhibits 3.1 through 3.2.
   
   4.2 
Specimen Stock Certificate, incorporated herein by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1 (SEC File No. 333-36391), as filed with the Securities and Exchange Commission on September 25, 1997.
   
   10.49 
Fifth Amendment of Second Amended and Restated Credit Agreement dated April 30, 2007 between the Registrant and Key Bank of Colorado.
   
   31.1 
Rule 13a-14(a) Certification of the Chief Executive Officer.
    
   31.2  
31.3  Rule 13a-14(a) Certification of the Chief Financial Officer.
   
   32.1 
Section 1350 Certifications of the Chief Executive Officer and the Chief Financial Officer.


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SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
BIRNER DENTAL MANAGEMENT SERVICES, INC.
 
 Date: May 15, 2007    
   By:  /s/ Frederic W.J. Birner 
   Name:  Frederic W.J. Birner
   Title:  Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
 
 
 Date: May 15, 2007    
   By:  /s/ Dennis N. Genty  
   Name: Dennis N. Genty
   Title: Chief Financial Officer, Secretary, and Treasurer
(Principal Financial and Accounting Officer)
 
 
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