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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NUMBER 000-22975
ORTHALLIANCE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4632134
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
21535 HAWTHORNE BOULEVARD, SUITE 200
TORRANCE, CALIFORNIA 90503
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(310) 792-1300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
CLASS A COMMON STOCK, PAR VALUE $.001 PER SHARE
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant as of March 23, 2000 (based on the last
reported closing price per share of Common Stock as reported on The Nasdaq
National Market on such date) was approximately $85,597,670. As of March 23,
2000, the registrant had 12,610,235 shares of Class A Common Stock outstanding
and 249,292 shares of Class B Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held on June 1, 2000 are incorporated by reference in Part III.
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ORTHALLIANCE, INC.
INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999
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PART I
Item 1. Business.................................................... 4
Item 2. Properties.................................................. 12
Item 3. Legal Proceedings........................................... 12
Item 4. Submission of Matters to Vote of Security Holders........... 12
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters................................................... 13
Item 6. Selected Financial Data..................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 14
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk...................................................... 23
Item 8. Consolidated Financial Statements and Supplementary Data.... 23
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 23
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 23
Item 11. Executive Compensation...................................... 23
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 23
Item 13. Certain Relationships and Related Transactions.............. 23
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K....................................................... 24
Signatures.............................................................. 27
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This Form 10-K and documents incorporated by reference contain certain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 and such
forward-looking statements are subject to the safe harbors created thereby.
Management cautions that any such forward-looking statements include statements
regarding the intent, belief or current expectations of the Company and its
management. For this purpose, any statements contained in this Form 10-K except
for historical information may be deemed to be forward-looking statements.
Without limiting the generality of the foregoing, words such as "may," "will,"
"expect," "believe," "anticipate," "intend," "could," "estimate," or "continue"
or comparable terminology are intended to identify forward-looking statements.
In addition, any statements that refer to expectations, projections or other
characterizations of future events or circumstances are forward-looking
statements.
The business and operations of the Company are subject to risks that
increase the uncertainty inherent in the forward-looking statements, and the
inclusion of such information should not be regarded as a representation by the
Company or any other person that the objectives or plans of the Company will be
achieved. Such forward looking statements are not guarantees of future
performances and involve risks and uncertainties. Actual results may differ
materially from those contemplated by such forward-looking statements.
Some factors that may cause results to differ materially from those
contemplated by such forward looking statement include, among other things (a)
changes in governmental or professional regulations that may effect
profitability of the Company or the enforceability of its contracts with its
practices; (b) increasing competition in the practices services industry; (c)
the Company's ability to continue to make successful acquisitions and integrate
and grow its business; (d) the Company's dependence on revenue generated by its
Allied Practices and (e) general economic conditions including impacts on
liquidity and availability of capital as needed. These and other factors that
may affect future operating results are discussed in more detail in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors Affecting Future Performance" and are set forth in the
safe harbor compliance statements included as Exhibit 99.1 to Form 10-K and are
hereby included by reference.
Assumptions relating to the foregoing involve judgments with respect to,
among other things, future economic, competitive and market conditions, and
future business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. In addition,
risks, uncertainties and assumptions change as events or circumstances change.
The Company disclaims any obligation to publicly release the results of any
revisions to these forward-looking statements which may be made to reflect
events or circumstances occurring subsequent to the filing of this Form 10-K
with the SEC or otherwise to revise or update any oral or written
forward-looking statement that may be made from time to time by or on behalf of
the Company.
OrthAlliance(R), PedoAlliance(R) and certain of the Company's names,
protocols and other attributes referred to herein are trademarks of the Company.
This Annual Report on Form 10-K may also contain trademarks of other companies.
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PART I
ITEM 1. BUSINESS.
OVERVIEW
OrthAlliance, Inc., a Delaware corporation (together with its subsidiaries,
the "Company"), was incorporated on October 21, 1996 and provides practice
management and consulting services to orthodontic and pediatric dental practices
throughout the United States. The Company (i) manages or provides consulting
services with respect to certain business aspects of orthodontic and pediatric
dental practices affiliated (the "Allied Practices") with the Company and (ii)
provides capital for the development and growth of Allied Practices.
OrthAlliance's wholly-owned subsidiaries include the following:
PedoAlliance, Inc. ("PedoAlliance") and OrthAlliance Finance, Inc. ("OA
Finance") formed in December 1997; and OrthAlliance New Image, Inc. ("OA New
Image") formed in January 2000. The subsidiaries were formed to provide practice
management, patient financing, consulting and other services to the Allied
Practices or their patients. OA New Image was formed specifically in connection
with the Company's acquisition of substantially all of the assets of New Image
Orthodontic Group, Inc., which was effective March 1, 2000. OrthAlliance, Inc.
and its subsidiaries are collectively referred to as "OrthAlliance" or the
"Company".
On August 26, 1997, the Company affiliated with 55 Allied Practices
including 81 orthodontists and 1 pediatric dentist operating 147 offices in 16
states pursuant to long-term management service and consulting agreements, and
commenced its initial operations. From August 26, 1997 to December 31, 1999, the
Company increased the number of Allied Practices, including pediatric dental
practices, to a net total of 132, with 177 orthodontists and pediatric dentists
(collectively, "Allied Orthodontists or Allied Practices") operating 318 offices
in 32 states. From May 1, 1998 through December 31, 1999, PedoAlliance entered
into management and consulting agreements with 18 pediatric dental practices,
with 27 allied pediatric dentists ("Allied Dentists") operating 22 offices in 8
states, all of which are included in the Company information set forth above.
Unless the context indicates otherwise, certain references herein to Allied
Orthodontists or Allied Practitioners also include Allied Dentists. OA Finance
was formed in October 1997 to offer financing alternatives to the patients of
the Allied Practices. During 1999, OA Finance funded 253 loans to patients for a
total value of $0.9 million and had $1.0 million of loans outstanding as of
December 31, 1999.
The Company intends to continue to expand its network of Allied Practices
and to target orthodontic and pediatric dental practices that management
believes are leading practices in their markets based upon a variety of factors,
including size, profitability, historical growth and reputation for high quality
care among local consumers of orthodontic services and within the orthodontic
and pediatric dental services industry. The Company believes that affiliations
with orthodontists will continue to represent the majority of any additional
affiliations.
The Company provides fee-based management or consulting services to its
Allied Practices thereby allowing Allied Orthodontists or Dentists to
concentrate on providing cost effective, quality patient care. The Company does
not practice orthodontics or dentistry, but generally acquires certain operating
assets of an orthodontic and pediatric dental practice, employs the employees
(except orthodontists and dentists, and where applicable law requires,
hygienists and dental assistants), and enters into service or consulting
agreements with the Allied Practices whereby the Company provides management or
consulting services to the Allied Practices, including billing and collections,
cash management, purchasing, inventory management, payroll processing,
advertising and marketing, financial reporting and analysis, productivity
reporting and analysis, training, associate orthodontist recruiting and capital
for satellite office development and acquisitions. Where state law allows and
upon request by an Allied Practice, the Company leases equipment or office space
to the Allied Practices. Unless otherwise indicated by the context, references
herein to practice management services, agreements or rights include consulting
or similar arrangements that the Company has or will enter into with certain
Allied Practices in order to comply with applicable regulations in certain
states regarding practice management.
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For the year ended December 31, 1999, the Company generated an operating
profit of $18.9 million on $95.7 million in net revenue.
THE ORTHODONTIC INDUSTRY
Orthodontics, the art and science of correcting the misalignment of teeth,
has historically been one of the most profitable specialties in dentistry.
Orthodontic research and education have aided the development of new materials
and techniques of orthodontic treatment, including the use of computers to help
solve complex cases. In 1998, orthodontists in the United States conducted
examinations of nearly 2.7 million potential new patients and initiated
treatment for approximately 1.8 million patients. The typical orthodontist
initiated treatment for approximately 200 patients in 1998 and maintained
approximately 450 active cases. Unless otherwise indicated, industry information
is derived from the 1999 Journal of Clinical Orthodontists Orthodontic Practice
Study (the "JCO Study") and relates to 1998. The information compiled in the JCO
Study relates to orthodontists who have completed accredited graduate
orthodontic training programs and does not include general dentists who also
perform certain orthodontic services.
The primary target market for orthodontic treatment is children ages 8 to
18. In 1998, approximately 85% of all patients treated were children. The U.S.
Census Bureau estimates that as of November 1, 1999, there were approximately
39.5 million children and adolescents between the ages of 10 and 19. Management
believes that as many as 80% of these children and adolescents could benefit
from orthodontic treatment. In addition to the traditional juvenile market, the
adult market has been a growing market for orthodontic services. Based on
statistics obtained from the JCO Study, management believes that the adult
market for orthodontic services remains largely untapped, as the number of
adults who need or want orthodontic treatment substantially exceeds the number
of patients currently seeking treatment. In 1996, standard case fees averaged
approximately $3,900 for children and $4,300 for adults.
There are approximately 9,000 practicing orthodontists in the United
States, nearly all of whom have graduated from accredited graduate programs of
orthodontics. The industry is highly fragmented, with approximately 90% of the
practicing orthodontists acting as sole practitioners and the balance practicing
in multiple-doctor practices (generally two orthodontists). The training and
qualification of an orthodontist is extremely rigorous. Generally, a dentist
must graduate in the top 10% of his or her class at an accredited graduate
school of dentistry, pass national and state board examinations, and complete an
accredited graduate orthodontic program to become an orthodontist. These
programs typically are structured as two- or three-year programs. Each year
about 200 new orthodontists graduate from accredited orthodontic programs.
THE PEDIATRIC DENTAL INDUSTRY
Pediatric dentistry is an age-defined specialty that provides both primary
and comprehensive preventative and therapeutic oral health care for infants and
children through adolescence, including those with special health care needs.
Pediatric dentists provide primary and specialty care in offices as well as in
hospital and other institutional sites and, when indicated, in conjunction with
other dental and medical disciplines. There are approximately 3,600 professional
active pediatric dentists in the United States. Pediatric dentists must complete
a specialty degree program which is typically two to three years in length.
Approximately 160 students are admitted each year to pediatric dental specialty
training programs.
The U.S. Bureau of the Census projects that between 1998 and 2025 there
will be an increase of 8.9 million children under the age of 15. Furthermore,
the number of practicing pediatric dentists has decreased from approximately
3,900 in 1990 to approximately 3,600 in 2000. The number of spaces available in
pediatric dental training programs has decreased from approximately 200 in 1990
to 160 in 2000. Accordingly, the Company believes that there will be an
increased demand for the services of pediatric dentists.
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OPERATING STRATEGY
The Company's operating strategy focuses on enabling the Allied Practices
to compete more effectively and realize greater profitability than other
practices, thereby providing an inducement for additional practices to affiliate
with the Company. Key elements of the Company's operating strategy include:
Emphasizing Quality Patient Care. Management believes that the services and
support it provides the Allied Orthodontists impact the level of patient care
positively by increasing the Allied Orthodontists' time available to concentrate
on patient care. The qualifications of providers of orthodontic and pediatric
dental services vary from general dentists who have taken weekend courses to
graduates of accredited three-year programs. Nearly all Allied Orthodontists
affiliated with the Allied Practices are graduates of accredited orthodontic or
pediatric dental programs. The Company established two clinical care advisory
committees, one consisting of Allied Orthodontists and the other consisting of
Allied Dentists, to formulate educational and training programs and to consult
with each other on current treatments, techniques and issues.
Capitalizing on the Best Demonstrated Practices of Allied
Orthodontists. The Company identifies practice-level strategies that have proven
successful for individual Allied Practices and shares this information among
other Allied Practices. The Company provides Allied Orthodontists with
comparative operating and financial data to enable Allied Orthodontists to
detect areas of their practices that could be improved. The Company provides its
own analysis of such operating and financial data and recommends changes to
improve performance. The Company consults with Allied Practices that have had
demonstrated success in a certain area and generally seeks to facilitate
communication among Allied Practices through periodic conferences and meetings
and, ultimately, through a proprietary web-based system.
Achieving Operating Efficiencies and Economies of Scale. The Company
implements a variety of operating procedures and systems to improve the
productivity and profitability of each Allied Practice and to achieve economies
of scale including, without limitation, centralized payroll processing and
national group purchasing contracts. Operating efficiencies and economies are
instituted with the Allied Orthodontist's consent on a per Allied Practice need
basis.
Increasing the Affordability of Professional Care through Flexible Payment
Plans. The Company assists Allied Practices in developing and implementing
payment plans designed to make orthodontic and pediatric dental services more
affordable to prospective patients. Many of the Allied Practices historically
received a down payment of approximately 20% of the total cost of orthodontic
services. Recognizing that orthodontic services are largely discretionary and
that a significant down payment is often a deterrent to prospective patients,
the Company believes that flexible payment plans are an effective means of
increasing patient volume. Payment plans are tailored to respond to the various
market demands and opportunities. The Company makes general recommendations to
all Allied Practices with respect to instituting flexible payment plans and
develops and implements market-tailored plans at the request of individual
Allied Practices. In addition, the Company provides access to working capital
necessary for the Allied Practices to implement flexible payment plans which may
result in the reduction or elimination of down payments.
Stimulating Demand in Local Markets through Aggressive Marketing. In
consultation with and upon approval of the Allied Practices, the Company
develops and implements aggressive and innovative marketing plans to augment
each Allied Practice's referral and other marketing systems. Certain Allied
Practices have developed referral systems with local dentists. Upon the request
of an Allied Practice and in appropriate markets, the Company attempts to assist
such Allied Practice in reaching potential patients through print, local
television and radio advertising.
GROWTH STRATEGY
The Company's growth strategy includes affiliation with existing practices
in both new and existing markets, the development of satellite offices for
existing Allied Practices and internal growth through improved operating
efficiencies.
Internal Growth through Improved Operating Efficiencies. The Company offers
a variety of operating procedures and systems to improve the productivity and
profitability of the Allied Practices. The Company
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implemented payroll processing, financial reporting and analysis, national group
purchasing discounted contracts and implements appropriate credit and collection
policies which accommodate specific needs of each Allied Practice. Operating
efficiencies and economies are instituted on a per Allied Practice need basis.
Development of Satellite Offices. If management determines market demand
supports practice expansion, the Company assists Allied Orthodontists in
developing satellite offices to be integrated into Allied Practices. The Company
provides a certain amount of capital for practice expansion, market research,
site selection, office design and marketing support for satellite office
development.
Affiliations with Existing Practices. The Company targets for affiliations
a market that includes approximately half of the orthodontic and pediatric
dental practices in the United States (approximately 4,500 orthodontic practices
and 1,500 pediatric dental practices), which practices fit the Company model of
quality and opportunity for revenue and earnings growth. The Company believes
that affiliation will be an attractive option for existing practices, because
the Company (i) provides access to capital to open and integrate new offices
into existing Allied Practices, (ii) makes available best practice ideas from
other Allied Practices, (iii) designs and offers business and clinical systems
for Allied Practices, (iv) with the approval of the Allied Orthodontist, employs
the necessary business and non-professional personnel for Allied Practices, (v)
helps Allied Practices by recommending marketing and advertising strategies, and
(vi) assists Allied Orthodontists with administrative and business related
tasks.
PAYMENT PLAN AND CASE FEES
At the initial orthodontic treatment, generally the patient signs a
contract outlining the terms of the treatment, including the anticipated length
of treatment and the total fees. Each Allied Orthodontist determines the
appropriate fee to charge for services to patients based upon market conditions
in the area served by that Allied Orthodontist. Generally, the amount charged by
the Allied Orthodontists is independent of the patient's source of payment. The
number of required monthly payments is estimated at the beginning of the case
and generally corresponds to the anticipated number of months of treatment.
Depending on the patient's credit history, the down payment ranges from a
substantial down payment to no down payment. Patients are typically required to
pay equal monthly installments, although each Allied Practice offers a payment
plan tailored to its market and patients.
If the treatment period exceeds the period originally estimated by the
Allied Orthodontist, the patient and the Allied Orthodontist will determine
whether payment for additional treatment will be required. If the treatment is
completed prior to the scheduled completion date, the patient is required to pay
the remaining balance of the contract. If a patient terminates the treatment
prior to the completion of the treatment period, the patient is required to pay
the balance due for services rendered to date.
Other payment plans with lower monthly payments are available for patients
who have insurance coverage for the treatment. Payments from patients with
insurance may be lower, depending upon the amount of the fee paid on behalf of
the patient by insurance policies. For patients with insurance coverage, the
portion of the fee not covered by insurance is paid by the patient and is
generally not waived or discounted by the Allied Practice.
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LOCATION
As of December 31, 1999, the Company provided management services to Allied
Practices at the following locations:
NUMBER OF NUMBER OF NUMBER OF
STATE PRACTITIONERS OFFICES CITIES
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Alabama........................................... 5 8 5
Arizona........................................... 8 11 5
Arkansas.......................................... 3 2 2
California........................................ 33 54 48
Colorado.......................................... 6 4 3
Florida........................................... 21 45 28
Georgia........................................... 25 57 37
Hawaii............................................ 2 6 5
Idaho............................................. 1 2 1
Illinois.......................................... 2 7 7
Indiana........................................... 9 17 15
Kansas............................................ 1 2 1
Kentucky.......................................... 2 6 6
Maryland.......................................... 6 3 3
Massachusetts..................................... 1 1 1
Michigan.......................................... 1 1 1
Minnesota......................................... 3 4 3
Mississippi....................................... 3 10 10
New Mexico........................................ 1 1 1
New York.......................................... 1 1 1
North Carolina.................................... 1 2 1
Ohio.............................................. 3 6 4
Oregon............................................ 2 3 3
Pennsylvania...................................... 1 3 3
South Carolina.................................... 4 7 7
South Dakota...................................... 2 7 6
Tennessee......................................... 9 10 8
Texas............................................. 12 22 20
Utah.............................................. 4 6 6
Virginia.......................................... 1 1 2
Washington........................................ 4 8 8
Wyoming........................................... -- 1 1
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Total................................... 177 318 252
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AGREEMENTS WITH ALLIED PRACTICES AND ALLIED PRACTITIONERS
Each Allied Practice has entered or enters into the following three
material agreements: (i) an acquisition agreement, which may be in the form of a
purchase and sale agreement whereby the Company acquires certain of the assets,
or stock of an entity holding certain assets, of the Allied Practice, or an
agreement and plan of reorganization, whereby the Allied Practice transfers
certain assets to the Company; (ii) either a service agreement or a consulting
agreement (depending upon the applicable state regulatory requirements), whereby
the Company provides management or consulting services to the Allied Practice;
and (iii) an employment agreement between the Allied Practice and each related
Allied Orthodontist who is an
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equity holder in the Allied Practice or who provides orthodontic or pediatric
dental services through such practice for more than ten days each month.
Acquisition Agreements. Each acquisition agreement generally results in the
sale by the Allied Practice of its equipment, licenses (to the extent assignable
by law), inventory, accounts receivable, furniture and other personal property,
or some combination thereof based on applicable state laws or regulations, in
exchange for consideration based on the Allied Practice's adjusted patient
revenue. The aggregate purchase price paid by the Company is generally payable
in cash, shares of Class A Common Stock, or a promissory note as determined by
each Allied Practice and the Company. The aggregate consideration, excluding
acquisition costs, paid by the Company in connection with the affiliation of the
132 Allied Practices net of consolidation from August 26, 1997 to December 31,
1999 was approximately $177.2 million, comprised of approximately $75.8 million
in cash, 8.3 million shares of Class A Common Stock and promissory notes with an
initial principal amount of $2.1 million.
Service Agreements. Each service agreement generally requires the Company
to perform the following services for the Allied Practices: provide and maintain
specified furnishings and equipment; provide necessary employees (except
practitioners and, where applicable law requires, hygienists and dental
assistants); establish appropriate business systems; purchase and maintain
inventory; perform payroll and accounting functions; provide billing and
collection services with respect to patients, insurance companies, and
third-party payors; arrange certain legal services not related to malpractice
litigation; design and execute a marketing plan; advise with respect to new
office locations; and manage and organize the Allied Practice's files and
records, including patient records where permitted by applicable law. If the
Allied Practice lacks sufficient funds to pay its current expenses, the Company
is required to advance funds to the Allied Practice for the purpose of paying
such expenses, subject to terms to be agreed upon. In exchange for performing
the services described above, the Company receives a management fee based on one
of the three fee structures described in Management's Discussion and Analysis of
Financial Condition and Results of Operations. The Company has entered into
agreements with certain Allied Practices to make the payment of such management
fees after the first two years contingent on various factors, including practice
profitability compared to acquisition consideration, timely reporting of
information, participation in practice improvement programs and orthodontist
hours worked. Prior patient revenue is not necessarily indicative of the level
of revenue that these practices may be expected to generate in the future.
The term of each service agreement is for 20 or 25 years, subject to prior
termination by either party in the event the other party becomes subject to
voluntary or involuntary bankruptcy proceedings or materially breaches the
agreement, subject to a cure period. In addition, the Allied Practices may
terminate the service agreements upon the occurrence of a change of control of
the Company (as defined therein, which does not include a transaction approved
by the Company's Board of Directors). Upon the expiration or termination of the
service agreement, the Allied Practice may, and in certain circumstances must,
repurchase for cash (at book value) certain assets, including all equipment, and
assume certain liabilities of the Company related to the Allied Practice.
Each service agreement is generally not assignable by either party thereto
without the written consent of the other party; however, the Company may assign
the service agreement without the Allied Practice's consent to any entity under
common control with the Company. The Company and the Allied Practice indemnify
each other for costs and expenses incurred by the other party that are caused
directly or indirectly by, as the case may be, the Company's or the Allied
Practice's intentional or negligent acts or omissions. In the case of the Allied
Practice's obligation to indemnify the Company, such obligation also applies to
intentional or negligent acts and omissions occurring prior to the date of the
service agreement. As of December 31, 1999, the Company had entered into service
agreements with 70 Allied Practices.
Consulting Agreements. Certain provisions of the consulting agreement are
substantially similar to the service agreement, including provisions relating to
the Company's obligation to loan funds to the Allied Practice in the event the
Allied Practice is unable to pay its current expenses, termination of the
consulting agreement, repurchase of assets and assumption of liabilities by the
Allied Practice upon expiration or termination, assignment, and indemnification.
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The services provided by the Company to the Allied Practice under each
consulting agreement generally include consulting with respect to equipment and
office needs; preparing staffing models appropriate for an Allied Practice;
advising and training with respect to business systems; purchasing and
maintaining inventory; advising with respect to and providing or arranging
accounting and bookkeeping services; advising with respect to developing a
marketing plan; assessing the financial feasibility of establishing new offices;
providing billing and collection services; and assisting the Allied Practice in
organizing and developing filing and recording systems. In exchange for such
services, the Company receives a consulting fee based on one of the three fee
structures described in Management's Discussion and Analysis of Financial
Condition and Results of Operations. As of December 31, 1999, the Company had
entered into consulting agreements with 62 Allied Practices.
Pursuant to both the service agreements and consulting agreements, Allied
Orthodontists maintain professional control over and ownership of their
practices, determine which personnel will be allied with the Allied Practices
and set their own standards of practice. The Company does not engage in the
practice of orthodontics or dentistry. Each Allied Orthodontist is responsible
for compliance of his or her Allied Practice with state and local regulations
applicable to the practice of orthodontics and dentistry and with licensing or
certification requirements. Each Allied Practice, in its sole discretion,
determines the fees to be charged for services provided to patients based upon
market conditions in the service area and other factors deemed appropriate by
the Allied Practice. Each Allied Practice executes payor contracts and acquires
and pays for its own malpractice insurance coverage.
Employment Agreements. Each Allied Orthodontist who is or becomes an equity
holder in an Allied Practice or who provides orthodontic or dental services
through an Allied Practice for more than 10 days a month is required to execute
an employment agreement with the Allied Practice. Each employment agreement
generally provides that the Allied Orthodontist will perform professional
services for the Allied Practice for a period of five years, subject to prior
termination (i) for cause by the Allied Practice (which generally means death,
incapacity, willful misconduct, conviction for a felony, or chronic alcoholism
or drug addiction) and (ii) by the Allied Orthodontist in the event of a
material breach by the Allied Practice. The Allied Orthodontist agrees that
following termination or expiration of the employment agreement, he or she will
not compete for a period of two years in the market in which the Allied Practice
operates an office and will limit the methods of advertising in the area in
which an Allied Practice is located.
GOVERNMENT REGULATION
General. The field of dentistry, including orthodontics, is highly
regulated, and there can be no assurance that the regulatory environment in
which the Company operates will not change significantly in the future. In
general, regulation of healthcare companies is increasing. Every state imposes
licensing requirements on individual practitioners and on facilities operated by
and services rendered by practitioners. In addition, federal and state laws
regulate health maintenance organizations and other managed care organizations
for which practitioners may be providers. The Company, Allied Practices and
Allied Orthodontists may become subject to compliance with additional
regulations.
The operations of the Allied Practices must meet federal, state and local
regulatory standards in the areas of safety and health. Historically, compliance
with those standards has not had any material adverse effect on the operations
of the Allied Practices. Based on its familiarity with the historical operations
of the Allied Practices and the activities of the Allied Orthodontists,
management believes that the Allied Practices are in compliance in all material
respects with all applicable federal, state and local laws and regulations
relating to safety and health.
State Legislation. The laws of several states prohibit practitioners from
splitting fees with non-practitioners. Furthermore, many states prohibit
non-professional entities from practicing dentistry, including orthodontics,
employing practitioners, or in some circumstances, employing hygienists and
dental assistants. The laws of some states prohibit advertising professional
services under a trade or corporate name and require that all advertising be in
the name of the practitioner. A number of states also regulate the content of
advertisement of professional services and the use of promotional gift items. A
number of states limit the
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ability of a non-licensed dentist or non-orthodontist to own equipment or
offices used in a practice. Some of these states allow leasing of equipment and
office space to an orthodontic or dental practice, under a bona-fide lease, if
the equipment and office remain in the complete care and custody of the
practitioner. Management believes, based on its familiarity with the historical
operations of the Allied Practices, the activities of the Allied Orthodontists
and applicable regulations, that the Company's current and planned activities do
not constitute the prohibited practices contemplated by these statutes and
regulations. There can be no assurance, however, that future interpretations of
such laws, or the enactment of more stringent laws, will not require structural
and organizational modifications of the Company's existing contractual
relationships with its Allied Orthodontists or the operation of the Allied
Practices. In addition, statutes in some states could restrict expansion of
Company operations in those jurisdictions. The Company enters into either a
service agreement or consulting agreement depending upon applicable state
regulations.
Regulatory Compliance. The Company monitors developments in laws and
regulations relating to the practice of orthodontics and dentistry. The Company
may be required to modify its agreements, operations and marketing strategies
from time to time in response to changes in the regulatory environment. The
Company structures all of its agreements, operations and marketing in accordance
with applicable law, although there can be no assurance that its arrangements
will not be successfully challenged or that required changes may not materially
affect the Company's business, financial condition and results of operations.
COMPETITION
The business of providing orthodontic and pediatric dental services is
highly competitive in each market in which the Allied Practices operate. Allied
Practices compete with practitioners who maintain single offices or operate a
single satellite office, as well as with practitioners who maintain group
practices or operate in multiple offices. Allied Practices also compete with
general dentists and pediatric dentists who provide certain orthodontic
services, some of whom have more established practices. The provision of
orthodontic services by such dentists and pediatric dentists has increased in
recent years.
The Company faces substantial competition from other entities as the
Company seeks to affiliate with additional practices. The Company is aware of
several practice management companies that are focused in the area of
orthodontics and dental specialists. Additional entities may enter this market
and compete with the Company. Certain of these competitors have greater
financial or other resources than the Company.
EMPLOYEES
As of December 31, 1999, the Company employed approximately 1,070 persons,
including 960 full-time employees. None of the Company's employees is
represented by a collective bargaining agreement. The Company considers its
relationship with its employees to be good.
INTELLECTUAL PROPERTY
The Company has obtained trademark registrations from the U.S. Patent and
Trademark Office for its service marks "OrthAlliance" and "PedoAlliance."
Management intends to continue to utilize the service marks, as allowed by
applicable law, in the Company's marketing and advertising campaigns and in
connection with the Company's services.
INSURANCE
The Company maintains general liability insurance for itself and on behalf
of the Allied Practices and, where permitted by applicable law and insurers, the
Company is named as an additional insured under the policies of the Allied
Practices. There can be no assurance that any claims against the Company or any
of the Allied Practices will not be successful, or if successful, will not
exceed the limits of available insurance coverage or that such coverage will
continue to be available at acceptable rates. The Allied Orthodontists purchase
and maintain their own malpractice liability insurance coverage.
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ITEM 2. PROPERTIES.
The Company leases approximately 8,978 square feet of office space in
Torrance, California for its headquarters. In addition, the Company leases
office space for certain Allied Practices. The Company's aggregate monthly lease
or rent payments was approximately $0.7 million as of December 31, 1999. See
note 13 to the Company's financial statements.
ITEM 3. LEGAL PROCEEDINGS.
As of December 31, 1999, the Company did not have any pending legal
proceedings that separately, or in the aggregate, if adversely determined, would
have a material adverse effect on the Company. The Company and its Allied
Practitioners may, from time to time, be involved in litigation or
administrative proceedings arising in the normal course of business. Management
believes that the final outcome of all legal matters pending and in prospect
will not have a material adverse affect on the Company's financial position or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's stockholders during
the fourth quarter of the fiscal year covered by this report.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
The Company's Class A Common Stock is traded on The Nasdaq Stock Market's
National Market System under the symbol "ORAL." There is no established public
trading market for the Company's Class B Common Stock. No transfers are
permitted of Class B Common Stock, except to the Class B stockholder's spouse,
parents, siblings, lineal descendants, trusts for the benefit of any such
individual or as determined by laws of descent or wills. The high and low prices
of the Company's Class A Common Stock as reported on The Nasdaq Stock Market
during each quarter from January 1, 1998 are shown below:
HIGH LOW
---- ---
1998
First Quarter............................................... 14 1/8 9 1/8
Second Quarter.............................................. 17 1/4 13 7/8
Third Quarter............................................... 14 1/8 7 1/2
Fourth Quarter.............................................. 13 7/8 7
1999
First Quarter............................................... 11 7/8 7
Second Quarter.............................................. 8 1/8 7
Third Quarter............................................... 7 7/16 6 1/16
Fourth Quarter.............................................. 9 5/16 6 1/16
At March 23, 2000, the last reported sale price of the Class A Common Stock
was $7.19 per share and there were approximately 112 record holders of Class A
Common Stock and 61 record holders of Class B Common Stock.
Except for the payment in August 1997 of $13.8 million cash consideration
paid to the initial 55 Allied Practices which was recorded as a cash dividend,
the Company has never declared and paid any dividends on either its Class A
Common Stock or its Class B Common Stock. The Company expects that future
earnings, if any, will be retained for the growth and development of the
Company's business and, accordingly, the Company does not anticipate that any
dividends will be declared or paid on the Class A Common Stock or Class B Common
Stock for the foreseeable future. The declaration, payment and amount of future
dividends, if any, will depend upon the future earnings, results of operations,
financial position and capital requirements of the Company, among other factors,
and are limited by the Company's credit agreement.
Unregistered Securities.
On August 26, 1997, simultaneously with the closing of the Company's
initial public offering of its Class A Common Stock pursuant to a Registration
Statement on Form S-1, the 55 initial Allied Practices received 5,882,985 shares
of unregistered Class A Common Stock as partial consideration for certain assets
or stock of such Allied Practices pursuant to the exemption set forth in Section
4(2) of the 1933 Act regarding non-public offerings.
On August 26, 1997, pursuant to that certain Agreement and Plan of Merger
between the Company, US Orthodontic Care, Inc. ("USOC") and Premier Orthodontic
Group, Inc. ("POG"), the Company issued 1,750,000 shares of unregistered Class A
Common Stock and 250,000 shares of unregistered Class B Common Stock as merger
consideration to the shareholders of USOC and POG in reliance on the exemption
set forth in Section 4(2) of the 1933 Act regarding non-public offerings.
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ITEM 6. SELECTED FINANCIAL DATA.
The selected statement of operations data for the years ended December 31,
1999, 1998 and 1997 and the selected balance sheet data as of December 31, 1999,
1998 and 1997 are derived from the Company's audited consolidated financial
statements included elsewhere in this Form 10-K. The Company's historical
results are not necessarily indicative of the results that maybe achieved for
any other period. The following data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements included in this Form
10-K.
YEARS ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
Statement of Operations Data:
Net revenues................................................ $95,703 $74,387 $18,081
Income before income taxes.................................. 16,887 13,658 105 (1)
Net income (loss)........................................... 9,583 7,535 (736)(1)
Basic and diluted net income (loss) per share............... 0.72 0.58 (0.18)
Weighted average number of common stock shares outstanding
(diluted)................................................. 13,283 13,044 4,026
- ---------------
(1) Includes non-recurring compensation expense.
YEARS ENDED DECEMBER 31,
-------------------------------------------------
AT IPO 1997(3) 1998 1999 TOTAL
------- --------- --------- --------- ----------
(DOLLARS IN THOUSANDS EXCEPT NON-REVENUES DATA)
Supplemental operating data since the IPO
includes the following:
Operating Data:
Annual patient revenues at affiliation,
net(2)................................. $60,400 $10,826 $38,761 $36,008 $145,995
Number of practitioners, net............. 82 17 38 40 177
Number of offices, net................... 147 31 67 73 318
Additional states represented............ 16 2 11 3 32
- ---------------
(2) Excludes same-store growth.
(3) Represents period subsequent to IPO, 8/26/97 to 12/31/97.
AS OF DECEMBER 31,
-----------------------
1999 1998
---------- ---------
(DOLLARS IN THOUSANDS)
Balance Sheet Data:
Working capital............................................. $ 21,530 $13,235
Total assets................................................ 135,259 88,580
Non-current liabilities..................................... 50,579 16,215
Stockholders' Equity........................................ 67,812 59,256
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with the
accompanying Consolidated Financial Statements and Notes thereto for the years
ended December 31, 1999, 1998 and 1997.
GENERAL
The Company began providing practice management services to Allied
Practices in the United States on August 26, 1997. The initial 55 Allied
Practices included 82 Allied Orthodontists operating 147 offices in 16 states.
By the end of 1997, the Company had affiliated with 11 new practices, including
17 additional orthodontists operating out of 31 new locations. In 1998, the
Company affiliated with 30 new practices,
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including 38 additional orthodontists and pediatric dentists operating out of 67
locations. In 1999, the Company affiliated with 36 new practices, including 40
additional orthodontists and pediatric dentists operating out of 73 locations.
The Company anticipates that future growth will come from new affiliations,
satellite expansion of Allied Practices, development of new orthodontic
practices and through improved operating efficiencies.
The Company derives net revenues by providing services pursuant to
long-term service agreements or consulting agreements (collectively, "Management
Agreements") with Allied Practices. The Company provides management or
consulting services to each Allied Practice and assumes substantially all
operating expenses except for compensation to the Allied Orthodontists and other
employees that the Company cannot employ according to applicable state laws. In
exchange for assuming these expenses and providing services, the Company records
revenues in amounts equal to the assumed expenses plus a service fee or
consulting fee, as described below. In general, the Management Agreements
provide for the recognition of fees to the Company based on a negotiated
percentage of the "Adjusted Patient Revenue" of Allied Practices. The timing of
the payment of such service fees is based upon cash collected. Adjusted Patient
Revenue is net patient revenue, as determined under generally accepted
accounting principles, including certain accrual adjustments, including those
related to patient prepayments, and adjustments for contractual allowances and
other discounts, plus an adjustment for uncollectible accounts.
Patient revenue is recognized as services are performed. For orthodontic
services, approximately 20% of the orthodontic contract revenues are recognized
at the time of initial treatment. The balance of the contract revenue is
realized evenly over the remaining treatment period. The 20% estimated revenue
at the initial treatment date is based on the estimated costs incurred by the
practice at that time as compared to the total costs of providing the contracted
services and is consistent with industry standards. The percentage includes the
estimated costs of diagnosis and treatment plan development, initial treatment
by orthodontic personnel, orthodontic supplies, and associated administrative
services. Net revenues also include the amortization of patient prepayments that
were originally recorded at the affiliation date of the respective Allied
Practice.
The service fee is earned and paid monthly to the Company by each Allied
Practice using one of three different fee structures set forth in the Management
Agreements:
(i) a designated percentage ranging from 13.5% to 20% of Adjusted
Patient Revenue. The average designated percentage is 17% for the Allied
Practices subject to this fee structure. In some cases, the Allied Practice
must guarantee a minimum level of management fees to be paid by the Allied
Practice for a portion of the agreement ranging from one to 25 years.
(ii) a designated percentage of Adjusted Patient Revenue, ranging from
14% to 17%, subject to an annual adjustment based upon improvements in the
Allied Practice's operating margin in the most recent calendar year as
compared with the immediately preceding calendar year. No annual adjustment
will be made which would result in reducing the designated percentage below
the percentage applicable during the first year of the Management
Agreement. Operating margin is defined as the percentage determined by
dividing operating profit by Adjusted Patient Revenue. Operating profit is
equal to Adjusted Patient Revenue less operating expenses, excluding the
management fee and such expenses associated with the Allied Practices which
the Company is prohibited from incurring, primarily consisting of
orthodontist compensation. The average designated percentage is 16.2% for
the Allied Practices subject to this fee structure.
(iii) a fixed dollar fee with annual fixed dollar increases for each
year of the term of the Management Agreement.
The Company has entered into agreements with certain Allied Practices to
make the payment of service fees after the first two years contingent on various
factors, including practice profitability compared to acquisition consideration,
timely reporting of information, participation in practice improvement programs
and orthodontist hours worked.
Expenses reported by the Company include certain of the expenses to operate
the orthodontic or pediatric dental offices and all of the expenses of any
corporate offices, facilities or functions. Therefore, salaries and
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benefits include the wages, benefits, taxes or other employment costs for all
employees of the Company, including practice office staff, business office staff
and management personnel. Rent includes facility expenses for both practice
offices and corporate offices. General and administrative expenses include
professional services, such as legal and accounting, utilities, advertising,
marketing, insurance, telephone, license fees, office supplies and shipping
expenses. Advertising and marketing costs, which are included in general and
administration costs, includes practice activities to attract new patients and
corporate activities to attract new orthodontists or pediatric dentists to join
the Company. Practice supplies include only those expenses required by the
Allied Orthodontists to provide treatment to patients.
RESULTS OF OPERATIONS
The consolidated results of operations of the Company for the years ended
December 31, 1999, 1998 and 1997, include net income of $9.6 million on revenues
of $95.7 million, net income of $7.5 million on revenues of $74.4 million and a
net loss of $0.7 million on revenues of $18.1 million, respectively. For the
years 1999, 1998 and 1997, the Company had income before taxes of $16.9 million,
$13.7 million and $0.1 million, respectively. Because the year ended December
31, 1997 reflects the results of operations for the period August 26, 1997 to
December 31, 1997 and includes non-recurring compensation expense in the amount
of $3.4 million, direct year-to-year comparisons to 1997 may not be meaningful.
The following table sets forth certain selected condensed consolidated
income statement data for the periods indicated in thousands of dollars and as a
percentage of total net revenues:
YEARS ENDED DECEMBER 31,
--------------------------------------------------------
1999 1998 1997
---------------- ---------------- ----------------
Net Revenues......................... $95,703 100.0% $74,387 100.0% $18,081 100.0%
------- ----- ------- ----- ------- -----
Costs and expenses:
Salaries and benefits................ 28,423 29.7 22,880 30.8 5,771 31.9
Orthodontic and dental supplies...... 9,438 9.9 7,436 10.0 1,684 9.3
Rent................................. 8,252 8.6 6,327 8.5 1,751 9.7
------- ----- ------- ----- ------- -----
Total direct expenses...... 46,113 48.2 36,643 49.3 9,206 50.9
General and administrative........... 26,686 27.9 21,456 28.8 5,403 29.9
Depreciation and amortization........ 3,983 4.1 2,426 3.3 245 1.4
Non-recurring organizer Compensation
expense............................ -- -- -- -- 3,392 18.8
------- ----- ------- ----- ------- -----
Total operating expenses... 76,782 80.2 60,525 81.4 18,246 101.0
------- ----- ------- ----- ------- -----
Operating income (loss).............. 18,921 19.8 13,862 18.6 (165) (1.0)
Interest expense..................... (2,450) (2.6) (555) (0.8) -- --
Interest income...................... 416 0.4 351 0.5 270 1.5
------- ----- ------- ----- ------- -----
Income before income taxes........... 16,887 17.6 13,658 18.3 105 0.5
Provision for income taxes........... 7,304 7.6 6,123 8.2 841 4.6
------- ----- ------- ----- ------- -----
Net income (loss).................... $ 9,583 10.0 $ 7,535 10.1 $ (736) (4.1)
======= ===== ======= ===== ======= =====
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Net Income and Operating Income
Net income for the year ended December 31, 1999 increased 27.2% to $9.6
million from $7.5 million from 1998. Operating income for the year ended
December 31, 1999 increased 36.5% to $18.9 million from $13.9 million from 1998.
The increase in net income and operating income for the year ended December 31,
1999 is attributable to an overall increase in net revenues related to Allied
Practice acquisitions, internal same store growth and a reduction of expenses as
a percentage of net revenues.
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Net Revenues
Net revenues increased 28.7% from 1998 to 1999, from $74.4 million to $95.7
million. The increase in net revenues is primarily due to an increase in
affiliations of Allied Practices together with an increase of approximately 9%
attributed to internal growth of comparable existing practices. Net revenues as
reported by the Company include the Company's contractual service or consulting
fee based in part on adjusted patient revenues, as well as reimbursed expenses
of the Allied Practices.
Operating Expenses
Total operating expenses increased 26.9% to $76.8 million, or 80.2% of net
revenues, for the year ended December 31, 1999 from $60.5 million, or 81.4% of
net revenues, from the prior year.
Direct expenses including salaries and benefits, orthodontic and dental
supplies and rent increased 25.8% to $46.1 million, or 48.2% of net revenues,
for the year ended December 31, 1999 from $36.6 million, or 49.3% of net
revenues from the prior year. Direct expenses have increased in absolute dollars
as a result of the affiliation of additional Allied Practices during the periods
as well as the expansion and growth of previously existing Allied Practices. The
decrease in direct expenses as a percentage of 1999 net revenues is primarily
attributable to economies of scale related to salaries and benefits and other
direct expenses.
Salaries and benefits increased 24.2% to $28.4 million, or 29.7% of net
revenues, for the year ended December 31, 1999 from $22.9 million, or 30.8% of
net revenues from the prior year. The decrease in salaries and benefits as a
percentage of revenues is a result of a significant number of current year
practice affiliations whereby their employees remained employees of the Allied
Practice's professional corporations. Accordingly, for these practices, salary
and benefit expenses are not reported by the Company. The Company expects that
in future periods salaries and benefits will increase in absolute dollars, but
may vary as a percentage of net revenues.
General and administrative expenses, consisting primarily of administrative
operating costs, non-rent facility costs, professional fees and overhead costs,
increased 24.4% to $26.7 million, or 27.9% of net revenues, for the year ended
December 31, 1999 from $21.5 million, or 28.8% of net revenues, from the prior
year. General and administrative expenses have shown an increase in absolute
dollars primarily related to the acquisition of additional Allied Practices
during the period as well as the expansion and growth of previously existing
Allied Practices offset by reductions in marketing, advertising and other costs.
Depreciation and Amortization
Depreciation and amortization expense increased approximately $1.6 million
in 1999 from 3.3% to 4.1% of net revenues from the prior year. This increase was
attributable to the increase in intangible assets associated with the
affiliation of Allied Practices in 1999. Intangible assets increased from $50.9
million to $83.6 million from 1998 to 1999. Depreciation and amortization
expense primarily relates to the depreciation of capital assets and the
amortization of excess cost over the fair value of net assets acquired
(goodwill) and certain other intangibles. The Company's policy is to amortize
goodwill over the expected period to be benefited, not to exceed the term of the
Management Agreements. For the years ended December 31, 1999 and 1998,
depreciation and amortization expense approximates $4.0 million and $2.4
million, respectively.
Interest Expense
For the years ended December 31, 1999 and 1998, interest expense was
approximately $2.5 million and $0.6 million, respectively and represents
interest charges on the Company's borrowings on its revolving line of credit.
The increase was primarily due to increased borrowings under the revolving line
of credit in support of Allied Practices affiliated during the period. Company
borrowings under the line of credit increased from $15.5 million at December 31,
1998 to $47.5 million as of December 31, 1999 (See "Liquidity and Capital
Resources").
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Provision for Income Taxes
Provision for income taxes for 1999 and 1998 approximates $7.3 million and
$6.1 million, respectively. A reconciliation of the provision for income taxes
for the years ending December 31, 1999, 1998 and 1997 to the amount computed at
the Federal statutory rate is included in Note 14 of Notes to Consolidated
Financial Statements. The Company's effective income tax rates for the years
ended December 31, 1999 and 1998 were higher than the statutory tax rate
primarily due to the amortization of certain intangible assets which were not
deductible for income tax purposes. The effective tax rate was 43% for the year
ended December 31, 1999 compared to 45% for the comparable period in 1998.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Because the year ended December 31, 1997 reflects the results of operations
for the period August 26, 1997 to December 31, 1997 and includes non-recurring
compensation expense in the amount of $3.4 million, direct year-to-year
comparisons to 1997 may not be meaningful.
Net Revenues
Revenues increased 311% from 1997 to 1998, due to 1997 being a partial
year. A comparison of net revenues for the first full quarter of operations from
year-to-year (4th quarter 1997 to 4th quarter 1998) shows a 50% increase in net
revenues. This was attributable to the new affiliations of Allied Practices
during 1998 and to an increase in internal growth. Net revenues reported by the
Company is derived by applying the appropriate management fee percentage against
adjusted patient revenues and includes reimbursed operating expenses.
Direct and General & Administrative Expenses
From 1997 to 1998, direct and general & administrative expenses as a
percentage of net revenue, remained at a fairly constant level as a percentage
of net revenues. The operating expense categories are consistent with
management's expectations.
Depreciation and Amortization
Depreciation and amortization expense in 1998 increased approximately $2.2
million from 1.4% of net revenues to 3.3% of net revenue from the prior year.
This increase was attributable to the increase in intangible assets associated
with the affiliation of Allied Practices in 1998. Intangible assets increased
from $11.3 million to $50.9 million from 1997 to 1998. Depreciation and
amortization expense primarily relates to the depreciation of capital assets and
the amortization of excess cost over the fair value of net assets acquired
(goodwill) and certain other intangibles. The Company's policy is to amortize
goodwill over the expected period to be benefited, not to exceed the term of the
Management Agreements. For the years ended December 31, 1998 and 1997,
depreciation and amortization were $2.4 million and $0.2 million, respectively.
Non-recurring Organizer Compensation Expense
Effective prior to the closing of the initial public offering of shares of
OrthAlliance's Class A Common Stock ("IPO"), Premier Orthodontic Group, Inc.
("POG") and US Orthodontic Care, Inc. ("USOC") merged with and into
OrthAlliance, and the Company succeeded to the rights and obligations of both
USOC and POG. In connection with the IPO, compensation expenses were incurred by
USOC and POG during the period from inception (October 21, 1996) through August
26, 1997. In the second quarter of 1997, the Company issued warrants to owners
of certain Allied Practices, and certain officers and consultants for their
assistance in recruiting orthodontists to the Company and in completing the IPO.
In addition, warrants held by a director and a consultant to purchase a total of
225,000 shares of USOC stock converted into warrants to purchase an equal number
of shares of the Company's Class A Common Stock. Accordingly, the Company
recorded compensation expense of $3.4 million related to warrants during 1997.
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Interest Expense
For the years ended December 31, 1998 and 1997, interest expense was $0.6
million and $0, respectively and represents interest charges on the Company's
borrowings on its revolving line of credit. The outstanding balance of this line
of credit was $15.5 million at December 31, 1998. See further discussion in the
Liquidity and Capital Resources section below.
Provision for Income Taxes
Provision for income taxes for 1998 and 1997 were $6.1 million and $0.8
million, respectively. A reconciliation of the provision for income taxes for
the years ending December 31, 1998 and 1997 to the amount computed at the
Federal statutory rate is included in Note 14 of Notes to Consolidated Financial
Statements. The Company's effective income tax rate for 1998 and 1997 was higher
than the statutory rate primarily due to the non-deductibility for income tax
purposes of the organizer compensation expense in 1997 and the amortization of
goodwill in 1998.
QUARTERLY OPERATING RESULTS
The Company's unaudited quarterly operating information (amounts in
thousands, except per share amounts) for 1999, 1998 and 1997 is shown in the
following table. The Company began operations in the third quarter of 1997, but
the Company recognized non-recurring organizer expense related to warrants,
described above, in the second and third quarters. The fourth quarter of 1997
represents the only quarter of 1997 when the Company was fully operational.
QUARTERS ENDED
-------------------------------------------------------------
MARCH 1999 JUNE 1999 SEPTEMBER 1999 DECEMBER 1999
---------- --------- -------------- ----------------
Net revenues............................ $21,302 $23,860 $24,286 $26,255
Operating income........................ 4,128 4,737 5,049 5,007
Provision for income taxes.............. 1,687 1,997 1,877 1,743
Net income.............................. 2,134 2,356 2,581 2,512
Basic and diluted net income per
share................................. $ 0.16 $ 0.18 $ 0.19 $ 0.19
QUARTERS ENDED
----------------------------------------------------------
MARCH 1998 JUNE 1998 SEPTEMBER 1998 DECEMBER 1998
---------- --------- -------------- -------------
Net revenues.............................. $14,650 $18,712 $20,042 $20,983
Operating income.......................... 2,795 3,254 3,795 4,018
Provision for income taxes................ 1,271 1,399 1,627 1,826
Net income................................ 1,621 1,859 2,072 1,983
Basic and diluted net income per share.... $ 0.13 $ 0.14 $ 0.16 $ 0.15
QUARTERS ENDED
----------------------------------------------------------
MARCH 1997 JUNE 1997 SEPTEMBER 1997 DECEMBER 1997
---------- --------- -------------- -------------
Net revenues.............................. $-- $ -- $4,054 $14,027
Operating income (loss)................... -- (2,271) 47 2,346
Provision for income taxes................ (199) 1,040
Net income (loss)......................... -- (2,271) (377) 1,521
Basic and diluted net income (loss) per
share................................... $-- $ N/A $(0.08) $ 0.13
SEASONALITY
Most patients who seek orthodontic treatment are children and young adults,
although the number of adults seeking treatment has been increasing in recent
years. Based upon information provided by the Allied Practices, and based upon
the results of operations in 1999, 1998 and 1997, the Company generally
experiences an increase in new patient volume during the summer months when
children are not in school. The Company also expects the lowest volume of
patient starts during the Christmas holiday season when children are on vacation
and when many of the Allied Practices are closed. Since the Company recognizes
20% of all patients contracts as revenue in the month treatment begins, the
Company expects higher patient
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revenue in the third quarter and lower patient revenue in the fourth quarter.
Accordingly, the Company may see an increase or decrease in service fee revenues
during these periods.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash from
operations, the Company's line of credit and other available capital sources.
This capital is used for affiliations with new Allied Practices, development of
Allied Practice enhancements, development of Allied Practice satellite offices,
capital asset additions, and general working capital. The Company's financial
position remains strong with working capital increasing 62.7% to $21.5 million
at December 31, 1999 from $13.2 million at December 31, 1998. Stockholders'
equity increased 14.4% to $67.8 million at December 31, 1999 from $59.3 million
on December 31, 1998.
The Company's operating activities generated cash of $15.2 million during
the year ended December 31, 1999 primarily attributed to net income during the
period, increased patient prepayments and other factors which were offset in
part by increases in patient and other receivables compared to and $1.2 million
during the year ended December 31, 1998. Net cash provided by financing
activities approximated $28.1 million in the year ended December 31, 1999 and
$16.2 million in the year ended December 31, 1998 and resulted primarily from
the proceeds from borrowings under the revolving credit facility. Cash used in
investing activities of $35.3 million in the year ended December 31, 1999
consisted of payments in connection with Allied Practices affiliated and capital
expenditures, primarily for office and computer equipment used in Company
operations. Cash used in investing activities was $26.8 million in the year
ended December 31, 1998 and consisted of payments in connection with the
affiliation of Allied Practices and capital expenditures, primarily for office
and computer equipment used in Company operations. The Company does not
currently have any material commitments with respect to any capital
expenditures.
On December 30, 1997, the Company entered into a credit agreement with
First Union National Bank to provide a $25 million revolving line of credit. The
interest on borrowings accrues at either the bank's prime rate or LIBOR, plus a
margin. Amounts borrowed are secured by security interests in the Company's
assets, which include accounts receivable, Management Agreements and the capital
stock of the Company's wholly-owned subsidiaries. The Company expanded the
credit facility ("the Revolving Credit Facility") on March 26, 1999 from $25
million to $55 million. The agreement terminates on March 26, 2002. As of
December 31, 1999 and 1998, the outstanding balance under this credit facility
was $47.5 million and $15.5 million, respectively. The Company believes that it
will be able to renew its Revolving Credit Facility or obtain alternate
financing on reasonable terms. However, there can be no assurance that the
Company will be able to renew or replace its Revolving Credit Facility or obtain
alternate financing on reasonable terms, if at all. The Company is currently in
compliance or has received proper lender consents with all terms of this
facility.
In 1997, after the completion of the IPO and the affiliation of the
founding 55 Allied Practices, the Company acquired certain operating assets of,
or the stock in entities that held certain operating assets of, 11 additional
orthodontic practices. The total consideration paid for these Allied Practices
was $12.4 million, of which $2.1 million was paid in cash and the balance
through the issuance of 863,775 shares of Class A Common Stock, pursuant to a
Registration Statement on Form S-4 (No. 333-29435).
For the year ended December 31, 1998, the Company acquired certain
operating assets of, or the stock in entities that held certain operating assets
of, 36 additional Allied Practices. The total consideration paid for these
Allied Practices was $46.8 million, of which $24.5 million was paid in cash,
$2.5 million issued in short-term notes payable and the balance through the
issuance of 1,640,492 shares of Class A Common Stock, pursuant to a Registration
Statement on Form S-4 (No. 333-29435).
For the year ended December 31, 1999, the Company acquired certain
operating assets of, or the stock in entities that held certain operating assets
of, 36 additional Allied Practices. The total consideration paid for these
Allied Practices was $39.5 million, of which $33.0 million was paid in cash,
$5.7 million in long term notes payable and the balance through the issuance of
93,584 shares of Class A Common Stock, pursuant to a Registration Statement on
Form S-4 (No. 333-53415).
20
21
Subsequent to December 31, 1999 the Company used $5.5 million of its
available revolving credit facility to acquire substantially all of the assets
of New Image Orthodontic Group, Inc. ("New Image") a Georgia Corporation based
in Atlanta, Georgia. In connection with the transaction the Company also issued
approximately $12.9 million in promissory notes, with interest rates ranging
from 9% to 10%, repayable over a one to five year period and the assumption of
approximately $13.4 million of existing debt due to former New Image orthodontic
practices, repayable over the next five years at interest rates approximating
9%. The Company will transition New Image into its business operations. Although
management is confident that the transition will be successful, there are no
assurances that certain matters outside management's control will not occur,
delaying successful integration of the New Image business operation, and having
an unfavorable impact on operations and working capital. The Company believes
that funds available to the Company will be sufficient to satisfy the Company's
projected working capital and debt obligation needs in the normal course of
business through March 2002. However, there are no assurances that actual
results will not differ materially from those contemplated or that adequate
capital will be available to the Company in the future at reasonable cost. See
"Acquisition of New Image Orthodontic Group, Inc." and "Footnote 19, Notes to
Consolidated Financial Statements".
Capital resources needed to continue acquisition and development efforts
will be funded through a combination of cash flows provided by ongoing
operations, expansion of the Revolving Credit Facility, the issuance of equity
and debt securities, as described in the Company's Form S-4 registration
statement which became effective on August 6, 1999, and other sources.
Management believes that these sources of capital will be sufficient to meet the
Company's capital requirements for the next twelve months. The Company may
choose to issue debt or equity to meet its future long-term capital needs, as
management deems appropriate. There can be no assurance that the Company will be
able to raise such additional working capital on acceptable terms, if at all. In
the event the Company is unable to raise additional working capital, further
measures would be necessary including, without limitation, the delay, or scale
back of its operations, Allied Practice affiliations and development efforts,
marketing programs and other actions. Certain of such measures may require third
party consents or approvals, including the Company's bank, and there can be no
such assurance that such consents or approvals can be obtained.
The Management Agreements provide for short-term advances by the Company to
the Allied Practices for working capital requirements and other purposes on
terms to be mutually agreed upon. These items are advanced and repaid in a
revolving manner. Generally, advances are repaid when Allied Practices deposit
patient revenue into their depository accounts. Advances occur when the Allied
Practice operating expenses paid exceed patient revenue earned.
ACQUISITION OF NEW IMAGE ORTHODONTIC GROUP, INC.
On March 1, 2000 the Company, through OrthAlliance New Image, Inc., a
wholly owned subsidiary, closed a purchase and sale agreement with New Image .
The Company acquired substantially all the assets of New Image.
New Image was founded in February 1997 and provides business operations,
financial and marketing and administrative services to orthodontic practices
across the United States in accordance with long term service agreements. The
transaction will be accounted for as a purchase and includes practice management
agreements with 36 orthodontic practitioners operating in 50 locations with over
$33 million in annualized revenues.
Collectively, the consideration and transaction costs associated with this
transaction totaled approximately $34.4 million. Of this amount, $5.5 million
was paid in cash, approximately $13.4 million of debt was assumed and $12.9
million in promissory notes were issued to the sellers, with interest rates
ranging from 9% to 10%.
The Company will transition New Image into its business operations.
Although management is confident that the transition will be successful, there
are no assurances that certain matters outside of management's control will not
occur, delaying successful integration of the New Image business operation, and
having an unfavorable impact on operations and working capital. The Company
believes that funds available to the
21
22
Company will be sufficient to satisfy the Company's projected working capital
and debt obligation needs in the normal course of business through March 2002.
However, there are no assurances that actual results will not differ materially
from those contemplated or that adequate capital will be available to the
Company in the future at reasonable cost.
STOCK REPURCHASE PLAN
On September 8, 1999 the Company announced the extension of its Common
Stock Repurchase Program to repurchase up to $5 million of its Class A Common
Stock. The Company had previously announced the program on October 22, 1998. The
Company is authorized to purchase shares on the NASDAQ National Market at
prevailing prices through December 2000. During 1999, the Company had
repurchased 0.2 million shares amounting to $1.7 million under this program.
Payments for such share repurchases come from operating cash flow and/or
borrowings under the Revolving Credit Facility. The timing and the amount of
shares to be purchased will be determined based on the evaluation of working
capital needs and stock market conditions. Subsequent to December 31, 1999 the
Company has acquired 0.3 million shares of its Common Stock at a cost of
approximately $1.9 million.
YEAR 2000
The Company did not experience any system failures or any material effects
that would impact the Company's financial condition or results of operations as
a result of any Year 2000 issues. Because the Company started operations in
August 1997, most of the corporate office systems were already Year 2000
compliant. Accordingly, any costs associated with Year 2000 upgrade were not
significant. Currently, the Company has assessed its Year 2000 position and does
not expect any future problems relating to any Year 2000 issues that would have
a material impact on the Company's operations or financial condition.
NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
issued a Statement of Position 98-1 "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"), which is
effective for the fiscal years beginning after December 15, 1998. The adoption
of SOP 98-1 did not have a material effect on the Company's financial position
or its results of operations.
In January 1999 the Company implemented Statement of Position 98-5 ("SOP
98-5") "Reporting on Costs of Start-up Activities." The SOP requires net costs
of start-up activities, including organizational costs, to be expensed as
incurred. In addition, the SOP requires that previously capitalized start-up
costs be expensed upon the effective date. The Company does not have any
start-up costs capitalized as of December 31, 1999.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"), which is effective for all fiscal quarters
of fiscal years beginning after June 15, 2000. SFAS 133 establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. It requires
that entities recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
The Company has adopted Staff Accounting Bulletin Number 101, Revenue
Recognition Issues, issued December 3, 1999 ("SAB 101"). This pronouncement
states that revenue is generally realized or realizable and earned when all of
the following criteria are met: i) pervasive evidence of an arrangement exists,
ii) delivery has occurred or services rendered, iii) the seller's price to the
buyer is fixed or determinable and iv) collectibility is reasonably assured. The
adoption of SAB 101 did not have a material impact on the Company's financial
position or the results of its operations.
22
23
INFLATION
The Company does not believe that inflation has had a material effect on
the results of operations and during the past three years. There can be no
assurance that the Company's business will not be affected by inflation in the
future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company does not have any derivative financial instruments as of
December 31, 1999. Further, the Company is not exposed to interest rate risk as
the Company's revolving line of credit agreement has a variable interest rate.
Therefore, the fair value of these instruments is not affected by change in
market interest rates. The Company believes that the market risk arising from
holdings of its financial instruments is not material.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's Consolidated Financial Statements, together with the
independent public accountant's report thereon of Arthur Andersen LLP, dated
February 17, 2000 begin on page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information contained under the heading "Information Concerning
Directors" in the Company's definitive proxy statement for its annual meeting of
stockholders to be held on June 1, 2000 (the "2000 Proxy Statement"), to be
filed with the commission not later than 120 days after the end of the
registrant's fiscal year, is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
The information contained under the heading "Executive Compensation" in the
2000 Proxy Statement, to be filed with the commission not later than 120 days
after the end of the registrant's fiscal year, is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information contained under the headings "Information Concerning
Directors" and "Principal Stockholders" in the 2000 Proxy Statement, to be filed
with the commission not later than 120 days after the end of the registrant's
fiscal year, is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information contained under the heading "Certain Transactions" in the
2000 Proxy Statement, to be filed with the commission not later than 120 days
after the end of the registrant's fiscal year, is incorporated herein by
reference.
23
24
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents as filed as part of this registrant:
(1) Financial Statements
The list of consolidated financial statements contained in the accompanying
Index to Consolidated Financial Statements covered by the Report of
Independent Public Accountants is herein incorporated by reference.
(2) Financial Statement Schedules
The list of financial statement schedules contained in the accompanying
Index to Consolidated Financial Statements is incorporated by reference.
All other schedules are omitted because they are not applicable or the
required format is included in the Consolidated Financial Statements and
Notes thereto.
(3) Exhibits
The list of exhibits on the accompanying Exhibit Index is herein
incorporated by reference.
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
2.1 Agreement and Plan of Merger between the Company, USOC and
POG (incorporated by reference to Exhibit 2.1 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
3.1 Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
3.2 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement on Form S-1 Registration No. 333-27143, as
amended).
4.1 Specimen Class A Common Stock Certificate (incorporated by
reference to Exhibit 4.1 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
4.2 Amended and Restated Certificate of Incorporation of the
Company, including, without limitation Section 4
(incorporated by reference to Exhibit 3.1 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
4.3 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement on Form S-1 Registration No. 333-27143, as
amended).
10.1 Form of Purchase and Sale Agreement between the Company and
Allied Practices (incorporated by reference to Exhibit 2.2
of the Company's Registration Statement on Form S-1,
Registration No. 333-27143, as amended).
10.2 Form of Stock Purchase and Sale Agreement between the
Company and Stockholders of the initial Allied Practices
(incorporated by reference to Exhibit 2.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.3 Form of Stock Purchase and Sale Agreement between the
Company and the Stockholders of the Allied Practices
(incorporated by reference to Exhibit 10.4 of the Company's
Annual Report on Form 10-K for the fiscal Year ended
December 31, 1997).
10.4 Form of Agreement and Plan of Reorganization between the
Company, Allied Practices and the Stockholders of the Allied
Practices (incorporated by reference to Exhibit 2.3 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
10.5 Form of Service Agreement between the Company and Allied
Practices (Fixed Percentage Fee) (incorporated by reference
to Exhibit 10.1 of the Company's Registration Statement on
Form S-1, Registration No. 333-27143, as amended).
24
25
EXHIBIT DESCRIPTION
- ------- -----------
10.6 Form of Service Agreement between Company and Allied
Practices (Variable Percentage Fee) (incorporated by
reference to Exhibit 10.2 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
10.7 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Variable Percentage Fee)
(incorporated by reference to Exhibit 10.3 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.8 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Fixed Percentage Fee)
(incorporated by reference to Exhibit 10.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.9 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Fixed Dollar Fee)
(incorporated by reference to Exhibit 10.5 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.10 1997 Non-Employee Director Stock Plan (incorporated by
reference to Exhibit 10.6 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143).
10.11 Amended and Restated 1997 Employee Stock Option Plan
(incorporated by reference to Exhibit 10.7 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.12 1997 Orthodontist Stock Option Plan (incorporated by
reference to Exhibit 10.13 of the Company's Annual Report on
Form 10-K for fiscal year ended December 31, 1997).
10.13 Employment Agreement between the Company and Sam Westover
(incorporated by reference to Exhibit 10.8 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.14 Letter Agreement between the Company and Stephen M. Toon
(incorporated by reference to Exhibit 10.14 of the Company's
Annual Report on Form 10-K for fiscal year ended December
31, 1998).
10.15 Credit Agreement dated December 30, 1997 between the Company
and First Union National Bank (incorporated by reference to
Exhibit 10.16 of the Company's Annual Report on Form 10-K
for fiscal year ended December 31, 1997).
10.16 Form of Company Practice Improvement Program Guarantee
(incorporated by reference to Exhibit 10.17 of the Company's
Annual Report on Form 10-K for fiscal year ended December
31, 1997).
10.17 Credit Agreement dated March 26, 1999 between the Company
and First Union National Bank, as Agent (incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report
on Form 10-Q for quarter ended March 31, 1999).
10.18 Letter Agreement between the Company and James C. Wilson
(incorporated by reference to Exhibit 10.18 of the Company's
Registration Statement on Form S-4, Registration No.
333-84197).
10.19 1999 Orthodontist Stock Option Plan (incorporated by
reference to Exhibit 4.3 of the Registration Statement on
Form S-8, Registration No. 333-32392).
10.20 Purchase and Sale Agreement dated as of February 1, 2000
between the Company and New Image Orthodontic Group, Inc.
(incorporated by reference to Exhibit 2.1 of the Current
Report on Form 8-K, dated March 1, 2000).
21.1 Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule.
99.1 Safe Harbor Compliance Statement (incorporated by reference
to Exhibit 99.1 of the Company's Annual Report on Form 10-K
for fiscal year ended December 31, 1997).
25
26
(b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K during the fourth quarter
of 1999. The Company filed a Report on Form 8-K on March 15, 2000, which
reported that the Company has completed the acquisition of substantially all the
assets of New Image Orthodontic Group, Inc., a Georgia corporation based in
Atlanta, Georgia. The transaction will be accounted for as a purchase and was
effective on March 1, 2000.
26
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the 1934 Act, the
Company has duly caused this Form 10-K to be signed on behalf of the
undersigned, thereunto duly authorized, on March 30, 2000.
ORTHALLIANCE, INC.
By: /s/ SAM WESTOVER
------------------------------------
Sam Westover
President and Chief Executive
Officer
(Principal Executive Officer)
By: /s/ JAMES C. WILSON
------------------------------------
James C. Wilson
Chief Financial Officer
(Principal Financial and Accounting
Officer)
Pursuant to the Requirements of the 1934 Act, this Form 10-K has been
signed below by the following persons in the capacities indicated on March 30,
2000.
/s/ SAM WESTOVER President,
- --------------------------------------------- Chief Executive Officer
Sam Westover and Director
/s/ RANDALL K. BENNETT Director
- ---------------------------------------------
Randall K. Bennett
/s/ DOUGLAS D. DURBIN Director
- ---------------------------------------------
Douglas D. Durbin
/s/ G. HARRY DURITY Director
- ---------------------------------------------
G. Harry Durity
/s/ CRAIG L. MCKNIGHT Director
- ---------------------------------------------
Craig L. McKnight
/s/ JONATHAN WILFONG Director
- ---------------------------------------------
Jonathan Wilfong
Director
- ---------------------------------------------
Raymond G.W. Kubisch
/s/ W. DENNIS SUMMERS Chairman of the Board
- --------------------------------------------- and Director
W. Dennis Summers
27
28
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants.................... F-2
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1999 and
December 31, 1998...................................... F-3
Consolidated Statements of Operations For the Years Ended
December 31, 1999, December 31, 1998 and December 31,
1997................................................... F-4
Consolidated Statements of Cash Flows For the Years Ended
December 31, 1999, December 31, 1998 and December 31,
1997................................................... F-5
Consolidated Statements of Stockholders' Equity For the
Years Ended December 31, 1999, December 31, 1998 and
December 31, 1997...................................... F-6
Notes to Consolidated Financial Statements................ F-7
F-1
29
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of OrthAlliance, Inc.:
We have audited the accompanying consolidated balance sheets of
OrthAlliance, Inc. (a Delaware Corporation) and subsidiaries as of December 31,
1999 and 1998, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years ended December
31, 1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of OrthAlliance, Inc. and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years ended December 31,
1999, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Los Angeles, California
February 17, 2000
F-2
30
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ASSETS
DECEMBER 31,
-------------------
1999 1998
-------- -------
Current assets:
Cash and cash equivalents................................. $ 11,189 $ 3,226
Patient receivables, net of allowances of $563 and $435... 10,520 7,765
Unbilled patient receivables, net of allowances of $382
and $385............................................... 3,436 3,462
Amounts due from Allied Practices......................... 10,630 9,880
Income tax receivable..................................... 509 1,102
Current deferred tax assets............................... 104 578
Other current assets...................................... 2,010 331
-------- -------
Total current assets.............................. 38,398 26,344
Property and equipment, net................................. 6,333 4,585
Notes receivable, net of allowances of $38 and $0........... 4,920 3,607
Non-current deferred tax assets............................. 1,486 2,918
Intangible assets, net...................................... 83,620 50,912
Other, net.................................................. 502 214
-------- -------
Total assets...................................... $135,259 $88,580
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,549 $ 2,417
Accrued liabilities....................................... 2,299 2,368
Patient prepayments....................................... 6,240 4,777
Practice affiliations payable............................. 3,610 1,760
Deferred tax liabilities.................................. 182 --
Amounts due to Allied Practices........................... 1,988 1,787
-------- -------
Total current liabilities......................... 16,868 13,109
Line of credit borrowings................................... 47,500 15,500
Notes payable............................................... 2,144 --
Non-current deferred tax liabilities........................ 935 715
-------- -------
Total non-current liabilities..................... 50,579 16,215
-------- -------
Total liabilities................................. 67,447 29,324
-------- -------
Commitments and Contingencies
Stockholders' equity (shares in thousands):
Class A Common Stock, $.001 par value, 70,000 shares
authorized, 13,198 shares issued and outstanding at
December 31, 1999 and 1998, respectively............... 13 13
Class B Common Stock, $.001 par value, 250 shares
authorized, 249 shares issued and outstanding at
December 31, 1999 and 1998, respectively............... -- --
Additional paid-in capital.................................. 65,145 65,188
Retained earnings (deficit)................................. 5,457 (3,597)
Treasury stock, at cost, 318 and 170 shares at December 31,
1999 and 1998, respectively............................... (2,803) (2,348)
-------- -------
Total stockholders' equity........................ 67,812 59,256
-------- -------
Total liabilities and stockholders' equity........ $135,259 $88,580
======== =======
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
31
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
-------- -------- --------
Net revenues................................................ $95,703 $74,387 $18,081
------- ------- -------
Costs and expenses:
Salaries and benefits..................................... 28,423 22,880 5,771
Orthodontic and dental supplies........................... 9,438 7,436 1,684
Rent...................................................... 8,252 6,327 1,751
------- ------- -------
Total direct expenses............................. 46,113 36,643 9,206
General and administrative................................ 26,686 21,456 5,403
Depreciation and amortization............................. 3,983 2,426 245
Non-recurring organizer compensation expense.............. -- -- 3,392
------- ------- -------
Total operating expenses.......................... 76,782 60,525 18,246
------- ------- -------
Operating income (loss)................................... 18,921 13,862 (165)
Interest income........................................... 416 351 270
Interest expense.......................................... (2,450) (555) --
------- ------- -------
Income before income taxes.................................. 16,887 13,658 105
Provision for income taxes.................................. 7,304 6,123 841
------- ------- -------
Net income (loss)........................................... $ 9,583 $ 7,535 $ (736)
======= ======= =======
Basic and diluted net income (loss) per share............... $ 0.72 $ 0.58 $ (0.18)
======= ======= =======
Weighted average number of common shares outstanding (in
thousands):
Basic.................................................. 13,271 13,006 4,026
======= ======= =======
Diluted................................................ 13,283 13,044 4,026
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
32
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
-------- -------- --------
Cash flows from operating activities:
Net income (loss)......................................... $ 9,583 $ 7,535 $ (736)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization........................... 3,983 2,426 245
Deferred income tax expense (benefit)................... 1,544 (226) (467)
Organizer compensation warrants......................... -- -- 2,435
Changes in assets and liabilities, excluding effects of
acquisitions:
Increase in patient receivables........................... (1,149) (549) (261)
Increase in due from Allied Practices..................... (461) (7,543) (2,489)
Decrease (increase) in income tax receivable.............. 1,020 (1,102) --
Increase in other assets.................................. (211) (247) (37)
Increase in accounts payable and accrued liabilities...... 174 427 126
(Decrease) increase in due to Allied Practices............ (470) 425 1,090
Increase in patient prepayments........................... 1,170 1,366 243
(Decrease) increase in income taxes payable............... -- (1,307) 1,307
-------- -------- --------
Net cash provided by operating activities........... 15,183 1,205 1,456
-------- -------- --------
Cash flows from investing activities:
Payment for practice affiliations......................... (33,019) (24,477) (2,063)
Increase in notes receivables............................. (2,400) (2,184) --
Principal payments on notes receivable.................... 1,087 534 --
Capital expenditures...................................... (952) (683) (69)
Acquisition of other assets............................... -- -- (30)
-------- -------- --------
Net cash used in investing activities............... (35,284) (26,810) (2,162)
-------- -------- --------
Cash flows from financing activities:
Increase in bank overdraft................................ 20 1,363 859
Borrowings on line of credit.............................. 50,300 16,500 --
Repayment of line of credit borrowings and other debt..... (20,094) (1,919) (4,597)
Proceeds from exercise of stock options................... -- 240 --
Proceeds from issuance of common stock.................... -- -- 31,138
Treasury shares purchased................................. (1,743) -- --
Dividend paid to shareholders of founding Allied
Practices............................................... -- -- (13,759)
Payment of deferred financing costs....................... (419) -- (288)
-------- -------- --------
Net cash provided by financing activities........... 28,064 16,184 13,353
-------- -------- --------
Net increase (decrease) in cash and cash equivalents........ 7,963 (9,421) 12,647
Cash and cash equivalents at beginning of period............ 3,226 12,647 --
-------- -------- --------
Cash and cash equivalents at end of period.................. $ 11,189 $ 3,226 $ 12,647
======== ======== ========
Supplemental cash flow information:
Cash paid during the year for:
Interest................................................ $ 2,575 $ 280 $ 42
Income taxes............................................ 6,711 8,774 --
Non-cash investing and financing activities
Acquisition of management agreements:
Fair value of assets acquired......................... 39,532 46,819 25,370
Less: Issuance of common stock........................ (759) (19,801) (14,720)
Less: Cash paid for practice affiliations............. (33,019) (24,477) (2,063)
Elimination of predecessor's accumulated deficit...... -- -- 2,945
-------- -------- --------
Notes payable, affiliation payable and liabilities
assumed.............................................. $ 5,754 $ 2,541 $ 11,532
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
33
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
(DOLLARS AND SHARE AMOUNTS IN THOUSANDS)
COMMON STOCK
---------------------------------
CLASS A CLASS B RETAINED TREASURY STOCK TOTAL
--------------- --------------- PAID-IN EARNINGS ---------------- STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) SHARES AMOUNT EQUITY
------ ------ ------ ------ ------- --------- ------ ------- --------------
Balances, December 31, 1996....... -- $ -- -- $ -- $ -- $ -- -- $ -- $ --
Initial public offering of common
stock........................... 2,990 3 -- -- 30,398 -- -- -- 30,401
Transfers of certain assets and
liabilities by founders......... 7,633 7 250 -- 1,435 3,363 -- -- 4,805
Dividend to Shareholders of
Founding Allied Practices....... -- -- -- -- -- (13,759) -- -- (13,759)
Issuance of common stock for
intangible assets............... 864 1 -- -- 10,278 -- -- -- 10,279
Issuance of warrants.............. -- -- -- -- 3,038 -- -- -- 3,038
Net loss.......................... -- -- -- -- -- (736) -- -- (736)
------ ----- --- ----- ------- -------- ---- ------- --------
Balances, December 31, 1997....... 11,487 11 250 -- 45,149 (11,132) -- -- 34,028
------ ----- --- ----- ------- -------- ---- ------- --------
Issuance of common stock for
intangible assets............... 1,640 2 -- -- 19,799 -- -- -- 19,801
Stock options exercised........... 70 -- -- -- 240 -- -- -- 240
Conversion to Class A common
stock........................... 1 -- (1) -- -- -- -- -- --
Repurchase of common stock........ -- -- -- -- -- -- (170) (2,348) (2,348)
Net Income........................ -- -- -- -- -- 7,535 -- -- 7,535
------ ----- --- ----- ------- -------- ---- ------- --------
Balances, December 31, 1998....... 13,198 13 249 -- 65,188 (3,597) (170) (2,348) 59,256
------ ----- --- ----- ------- -------- ---- ------- --------
Issuance of common stock from
Treasury, for intangible
assets.......................... -- -- -- -- -- (529) 93 1,288 759
Repurchase of common stock........ -- -- -- -- -- -- (241) (1,743) (1,743)
Registration costs................ -- -- -- -- (43) -- -- -- (43)
Net Income........................ -- -- -- -- -- 9,583 -- -- 9,583
------ ----- --- ----- ------- -------- ---- ------- --------
Balances, December 31, 1999....... 13,198 $ 13 249 $ -- $65,145 $ 5,457 (318) $(2,803) $ 67,812
------ ----- --- ----- ------- -------- ---- ------- --------
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
34
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. BUSINESS AND ORGANIZATION
a. ORGANIZATION
OrthAlliance, Inc. ("OrthAlliance"), a Delaware corporation, was
incorporated on October 21, 1996 and provides practice management and consulting
services to orthodontic and pediatric dental practices throughout the United
States. Effective prior to the closing of the initial public offering of shares
of OrthAlliance's Class A Common Stock (the "Offering" or "IPO"), Premier
Orthodontic Group, Inc. ("Premier") and US Orthodontic Care, Inc. ("USOC")
merged with and into OrthAlliance. In the merger, the outstanding common stock
of USOC and Premier converted into shares of Class A Common Stock ("Common
Stock") and shares of Class B Common Stock ("Class B Common Stock"). On August
26, 1997, OrthAlliance acquired (the "Acquisitions") simultaneously with the
closing of the IPO certain operating assets of or the stock of entities holding
certain tangible and intangible assets and assumed certain liabilities of 55
orthodontic practices in exchange for shares of Common Stock and cash. The
Acquisitions were accounted for in accordance with the Securities and Exchange
Commission's Staff Accounting Bulletin No. 48.
OrthAlliance's wholly-owned subsidiaries, incorporated in Delaware, include
the following: PedoAlliance, Inc. ("PedoAlliance") and OrthAlliance Finance,
Inc. ("OA Finance") formed in December 1997. The subsidiaries were formed to
provide practice management, patient financing, consulting and other services
(collectively "Management Services") to allied orthodontic and pediatric dental
practices (the "Allied Practices") or their patients. OrthAlliance, Inc. and its
subsidiaries are collectively referred to as "OrthAlliance" or the "Company".
b. AGREEMENTS WITH ALLIED PRACTICES
The Company is party to management service agreements with the Allied
Practices. These are either "Service Agreements" or "Consulting Agreements,"
collectively "Management Agreements." The type of Management Agreements are
determined by the Company and each Allied Practice based primarily on applicable
state laws and regulations and are as follows:
Service Agreements
The parties to each Service Agreement include the Company and the Allied
Practice, which typically is a professional corporation or association owned by
the related Orthodontist or Pediatric Dentist. Each Service Agreement generally
requires the Company to perform the following services for the Allied Practices:
provide and maintain specified furnishings and equipment; provide necessary
employees (except Orthodontists and where applicable law requires, hygienists
and dental assistants); establish appropriate business systems; purchase and
maintain inventory; perform payroll and accounting functions; provide billing
and collection services with respect to patients, insurance companies, and
third-party payors; arrange certain legal services not related to malpractice
litigation; design and execute a marketing plan; advise with respect to new
office locations; and manage and organize the Allied Practices' files and
records, including patient records where permitted by applicable law. If the
Allied Practice lacks sufficient funds to pay its current operating expenses,
the Company is also required to advance funds to the Allied Practice for the
purpose of paying such expenses. In exchange for performing the services
described above, the Company receives a management fee based on one of the three
fee structures described in section c. below.
The term of each Service Agreement is 20 to 25 years, subject to prior
termination by either party in the event the other party becomes subject to
voluntary or involuntary bankruptcy proceedings or materially breaches the
agreement, subject to a cure period. In addition, the Allied Practices may
terminate the Service Agreements upon the occurrence of a change of control of
OrthAlliance (as defined therein, which does not
F-7
35
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
include a transaction approved by the Company's Board of Directors). Upon the
expiration or termination of the Service Agreement, the Allied Practice may, and
in certain circumstances must, repurchase for cash (at book value) certain
assets, including all equipment, and assume certain liabilities of the Company
related to the Allied Practice.
Service Agreements are generally not assignable by either party thereto
without the written consent of the other party; however, the Company may assign
the Service Agreement without the Allied Practice's consent to any entity under
common control of the Company. The Company and the Allied Practice agree to
indemnify each other for costs and expenses incurred by such other party that
are caused directly or indirectly by, as the case may be, the Company's or the
Allied Practice's intentional or negligent acts or omissions. In the case of the
Allied Practice's obligation to indemnify the Company, such obligation also
applies to intentional or negligent acts and omissions occurring prior to the
date of the Service Agreement.
Consulting Agreements
The parties to each Consulting Agreement include the Company and the Allied
Practice. Certain provisions of the Consulting Agreement are substantially
similar to the Service Agreement, including provisions relating to the Company's
obligation to loan funds to the Allied Practice in the event the Allied Practice
is unable to pay its current operating expenses, termination of the Consulting
Agreement, repurchase of assets and assumption of liabilities by the Allied
Practice upon expiration or termination, assignment, and indemnification.
The services provided by the Company to the Allied Practice under each
Consulting Agreement generally include consulting with respect to equipment and
office needs; preparing staffing models appropriate for an Allied Practice;
advising and training with respect to business systems; purchasing and
maintaining inventory; advising with respect to and providing or arranging
accounting and bookkeeping services; advising with respect to developing a
marketing plan; assessing the financial feasibility of establishing new offices;
providing billing and collection services; and assisting the Allied Practice in
organizing and developing filing and recording systems. In exchange for such
services, the Company receives a consulting fee based on one of the three fee
structures described below.
c. CALCULATION OF MANAGEMENT FEES
Management fees are calculated pursuant to the Management Agreements based
upon the Allied Practice's adjusted patient revenue calculated on the accrual
basis. There are three economic models by which the management fee may be
calculated under the two Management Agreements discussed above which are as
follows:
(i) a designated percentage ranging from 13.5% to 20% of Adjusted
Patient Revenue. The average designated percentage is 17% for the Allied
Practices subject to this fee structure. In some cases, the Allied Practice
must guarantee a minimum level of management fees to be paid by the Allied
Practice for a portion of the agreement ranging from one to 25 years.
(ii) a designated percentage of Adjusted Patient Revenue, ranging from
14% to 17%, subject to an annual adjustment based upon improvements in the
Allied Practice's operating margin in the most recent calendar year as
compared with the immediately preceding calendar year. No annual adjustment
will be made which would result in reducing the designated percentage below
the percentage applicable during the first year of the Management
Agreement. Operating margin is defined as the percentage determined by
dividing operating profit by Adjusted Patient Revenue. Operating profit is
equal to Adjusted Patient Revenue less operating expenses, excluding the
management fee and such expenses associated with the
F-8
36
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Allied Practices which the Company is prohibited from incurring, primarily
consisting of orthodontist compensation. The average designated percentage
is 16.2% for the Allied Practices subject to this fee structure.
(iii) a fixed dollar fee with annual established fixed increases for
each year of the management agreement.
The Company has entered into agreements with certain Allied Practices to
make the payment of service fees after the first two years contingent on various
factors, including practice profitability compared to acquisition consideration,
timely reporting of information, participation in practice improvement programs
and orthodontist hours worked.
The Company earns revenue by providing services pursuant to Management
Agreements with Allied Practices. The Company provides management or consulting
services to each Allied Practice and assumes substantially all operating
expenses except for compensation to the allied orthodontists and pediatric
dentists ("Allied Orthodontists") and other employees that the Company may not
employ according to applicable state laws. In exchange for assuming these
expenses and providing services, the Company records revenues in amounts equal
to the assumed expenses plus a service fee or consulting fee, as described
below.
Patient revenue is recognized as services are performed. For orthodontic
services, approximately 20% of the orthodontic contract revenues are recognized
at the time of initial treatment. The balance of the contract revenue is
realized evenly over the remaining treatment period. The 20% estimated revenue
at the initial treatment date is based on the estimated costs incurred by the
practice at that time as compared to the total costs of providing the contracted
services and is consistent with industry standards. The percentage includes the
estimated costs of diagnosis and treatment plan development, initial treatment
by orthodontic personnel, orthodontic supplies, and associated administrative
services. Net revenues also include the amortization of patient prepayments that
were originally recorded at the affiliation date of the respective Allied
Practice. The Company recognizes a normal operating margin related to the
amortization of the patient prepayments.
Expenses reported by the Company include certain of the expenses to operate
the orthodontic or pediatric dental offices and all of the expenses of any
corporate offices, facilities or functions.
d. PATIENT RECEIVABLES AND PATIENT PREPAYMENTS
The difference in the timing of the recognition of adjusted patient revenue
and the collection of cash related thereto results in unbilled receivables or
patient prepayments. Unbilled patient receivables represent the earned revenue
in excess of billings to patients as of the end of each period. Patient
prepayments represent collections from patients or their insurance companies
which are received in advance of the performance of the related services.
Patient receivables are recorded at net realizable value on the date of
purchase and subsequent collections are used to pay Allied Practice operating
expenses, the Company's management fee, and payments to the Affiliated
Practices. Generally, any subsequent uncollectible accounts are recorded as a
reduction of net revenues, which reduces the Company's management fees at the
applicable fee percentage.
e. AMOUNTS DUE FROM ALLIED PRACTICES
Amounts due from Allied Practices include short-term advances for operating
capital and short-term receivables related to a timing difference between when
the services fees are paid from the Allied Practice's accounts and when the
service fees are deposited by the Company. These items are advanced and repaid
in a revolving manner. Generally, advances are repaid when Allied Practices
deposit patient revenue into their
F-9
37
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
depository accounts. Advances occur when the Allied Practice operating expenses
paid exceed patient revenue earned. Service fees outstanding are generally paid
within 30 days.
f. OPERATING EXPENSES OF ALLIED PRACTICES
The Company is responsible for the payment of all operating expenses
incurred by the Allied Practice, except for compensation to affiliated
Orthodontists and other expenses of the Allied Practices that the Company is
prohibited from paying. Expenses that are the responsibility of the Company
include the following: (i) salaries, benefits, payroll taxes, workers
compensation, health insurance and other benefit plans, and other direct
expenses of all employees of OrthAlliance at each practice office, excluding
those costs associated with orthodontists and any other classification of
employee which OrthAlliance is prohibited from employing by applicable state
laws or regulations; (ii) direct costs of all employees or consultants that
provide services to each practice office except for Affiliated Orthodontists and
other employees of the Allied Practices that the Company is prohibited from
employing, (iii) dental and office supplies as permitted by applicable state
laws or regulations, (iv) lease or rent payments as permitted by state laws or
regulations, utilities, telephone and maintenance expenses for practice
facilities, (v) property taxes on OrthAlliance assets located at Allied Practice
offices, (vi) property, casualty, and liability insurance premiums, (vii)
orthodontists recruiting expenses, and (viii) advertising and other marketing
expenses attributable to the promotion of practice offices.
All of the above expenses are paid directly to the third party provider of
the goods or services indicated. All of the above expenses are incurred by
OrthAlliance. Such expenses are classified together with similar expenses of the
Company in the consolidated statement of operations. In exchange for incurring
these expenses and providing management services, the Company records revenue in
amounts equal to those incurred expenses.
The Allied Practices retain the responsibility for the payment of any and
all direct employment expenses, including benefits, for any Orthodontist or
other employee that OrthAlliance is prohibited from employing by applicable
state laws or regulations. In addition, the Allied Practices retain the
responsibility for the payment of continuing education expenses, seminars,
professional licenses, professional membership dues and all other expenses of
any Orthodontist.
g. NEW AFFILIATIONS
For the year ended December 31, 1999, the Company entered into agreements
with 36 Allied Practices, 11 of which were pediatric dental practices, to
provide management services and acquire certain operating assets for a total
consideration (including acquisition costs) of $39.5 million. This consideration
consisted of 93,584 shares of Common Stock, from the Treasury, with an aggregate
value at various acquisition dates of $0.8 million, payment of $33.0 million in
cash, $5.7 million in affiliation and notes payables. These Allied Practices
operate 73 locations.
For the year ended December 31, 1998, the Company entered into agreements
with 36 Allied Practices, seven of which were related to pediatric dental
practices, to provide management services and acquire certain operating assets
for a total consideration (including acquisition costs) of $46.8 million. This
consideration consisted of 1,640,492 shares of Common Stock with an aggregate
value at various acquisition dates of $19.8 million and payment of $24.5 million
in cash and issuance of notes payable of $2.5 million. These Allied Practices
operate 70 locations.
From August 26, 1997 to December 31, 1997, the Company entered into
agreements with 11 Allied Practices to provide management services and acquire
certain operating assets for a total consideration
F-10
38
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(including acquisition costs) of $12.4 million. This consideration consisted of
863,775 shares of Common Stock with an aggregate value at various acquisition
dates of $10.3 million and payment of $2.1 million in cash. The Company also
assumed $1.4 million in debt related to the assets acquired. These Allied
Practices operate 31 locations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include OrthAlliance, Inc. and its
wholly owned subsidiaries. The Company does not consolidate the operations of
the Allied Practices which it manages as the Company's arrangements with its
Allied Practices do not meet the requirements for consolidation as set forth in
Emerging Issues Task Force consensus opinion 97-2 ("EITF 97-2"). All significant
intercompany accounts and transactions have been eliminated in consolidation.
b. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
c. CASH AND CASH EQUIVALENTS
The Company considers all highly-liquid investments with a maturity of
three months or less at the date of purchase to be cash equivalents. All cash
equivalents are recorded at cost, which approximates fair value.
d. PROPERTY AND EQUIPMENT, NET
Property and equipment are stated at cost or fair value at acquisition date
if acquired upon affiliation with an Allied Practice. Routine maintenance and
repairs are expensed when incurred, while costs of improvements and renewals are
capitalized. Depreciation of property and equipment is calculated using the
straight-line method over the estimated useful lives of the assets or remaining
lease terms as follows:
Furniture, fixtures and equipment.................. 5 years
Leasehold improvements............................. Shorter of 3 - 10 years or
the related lease term
Depreciation expense for the years ended December 31, 1999, 1998 and 1997
was approximately $1.2 million, $0.9 million and $0.1 million, respectively.
e. INTANGIBLE ASSETS, NET
The Management Agreements with Allied Practices include the acquisition of
certain tangible and intangible assets and the assumption of certain liabilities
of the Allied Practices. The Company allocates the purchase price to the
tangible assets acquired and liabilities assumed based on their estimated fair
values. Intangible assets related to the Management Agreements are being
amortized using the straight-line method over their respective terms. The
Company periodically evaluates whether events and circumstances have occurred
that indicate the remaining useful life of the intangible assets may warrant
revision or that the remaining balance of the intangible assets may not be
recoverable. As of December 31, 1999 and 1998, there
F-11
39
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
were no events or circumstances to indicate that any portion of the recorded net
intangible assets may not be recoverable.
Amortization expense related to these intangible assets for the years ended
December 31, 1999, 1998 and 1997 was $2.8 million, $1.5 million and $0.1
million, respectively.
f. OTHER, NET
Other, net consists primarily of deferred costs related to the Company's
bank credit facility. These costs are amortized using the straight-line method
over the expected period to be benefited. The amortization of deferred costs
related to the line of credit borrowings is included in interest expense.
g. NET REVENUES
Net revenues primarily consist of management fee income and reimbursed
practice operating expenses. Such reimbursed practice operating expenses
amounted to $68.9 million, $54.4 million and $13.8 million for the years ended
December 31, 1999, 1998 and 1997, respectively.
h. INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
The statement requires recognition of deferred tax assets and liabilities for
expected future tax consequences of events that have been recognized in the
financial statements or tax returns. Deferred income taxes are provided for
temporary differences in the recognition of certain income and expense items for
financial reporting and tax purposes given the provisions of the enacted tax
laws.
i. FAIR VALUE OF FINANCIAL INSTRUMENTS
As of December 31, 1999 and 1998 the carrying amounts of the Company's
financial instruments, which include cash and cash equivalents, notes
receivable, accounts payable and other accrued liabilities, notes payable to
Allied Practices and line of credit borrowings, approximates fair value.
j. NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
issued a Statement of Position 98-1 "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"), which is
effective for the fiscal years beginning after December 15, 1998. The adoption
of SOP 98-1 did not have a material effect on the Company's financial position
or its results of operations.
In January 1999 the Company implemented Statement of Position 98-5 ("SOP
98-5") "Reporting on Costs of Start-up Activities." The SOP requires net costs
of start-up activities, including organizational costs, to be expensed as
incurred. In addition, the SOP requires that previously capitalized start-up
costs be expensed upon the effective date. The Company does not have any
start-up costs capitalized as of December 31, 1999.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"), which is effective for all fiscal quarters
of fiscal years beginning after June 15, 2000. SFAS 133 establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. It requires
that entities recognize all derivatives as either assets or
F-12
40
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
liabilities in the statement of financial position and measure those instruments
at fair value. The Company does not have any derivative instruments as of
December 31, 1999.
The Company has adopted Staff Accounting Bulletin Number 101, Revenue
Recognition Issues, issued December 3, 1999 ("SAB 101"). This pronouncement
states that revenue is generally realized or realizable and earned when all of
the following criteria are met: i) pervasive evidence of an arrangement exists,
ii) delivery has occurred or services rendered, iii) the seller's price to the
buyer is fixed or determinable and iv) collectibility is reasonably assured. The
adoption of SAB 101 did not have a material impact on the Company's financial
position or the results of its operations.
k. RECLASSIFICATIONS
Certain prior year reclassifications have been made to conform to
classifications used in the current period.
3. OTHER CURRENT ASSETS
Other current assets consist of the following:
DECEMBER 31,
--------------
1999 1998
------ ----
Short term receivable....................................... $1,566 $ --
Prepaid expenses and other current assets................... 444 331
------ ----
$2,010 $331
====== ====
4. PROPERTY AND EQUIPMENT, NET
Property and equipment, net consist of the following:
DECEMBER 31,
------------------
1999 1998
------- -------
Furniture and fixtures................................... $ 4,007 $ 3,524
Equipment................................................ 5,504 3,846
Leasehold improvements................................... 2,420 1,710
Construction in progress................................. 392 273
------- -------
12,323 9,353
Less accumulated depreciation............................ (5,990) (4,768)
------- -------
$ 6,333 $ 4,585
======= =======
F-13
41
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
5. NOTES RECEIVABLE, NET
Notes receivable consist of the following:
DECEMBER 31,
----------------
1999 1998
------ ------
Notes receivable from Allied Practices..................... $3,934 $3,162
Patient loans.............................................. 1,024 445
------ ------
4,958 3,607
Allowance for doubtful accounts............................ (38) --
------ ------
$4,920 $3,607
====== ======
Certain Allied Practices have signed promissory notes due to the Company.
Generally, principal and interest payments are due monthly, with interest
accruing at prime plus 1%. Generally, these notes have maturity dates ranging
from three to five years, are unsecured and are personally guaranteed by the
respective practitioners. As of December 31, 1999 and 1998, the prime interest
rate was 8.50% and 7.75%, respectively.
During 1999 and 1998, the Company's wholly-owned subsidiary, OrthAlliance
Finance, financed approximately $1.0 million and $0.5 million, respectively, of
patient loans from certain Allied Practices. OrthAlliance Finance was formed to
provide patient financing options to all Allied Practices. The loans outstanding
are generally without recourse and principal and interest are due monthly, with
interest rates, varying between 9.9% and 16.9 %, depending on the credit risk of
the borrower. The terms of these loans range from one to five years.
6. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following:
DECEMBER 31,
----------------
1999 1998
------ ------
Bank overdrafts............................................ $2,242 $2,222
Accounts payable........................................... 307 195
------ ------
$2,549 $2,417
====== ======
DECEMBER 31,
----------------
1999 1998
------ ------
Accrued wages.............................................. $1,055 $ 644
Other accrued liabilities.................................. 1,244 1,724
------ ------
$2,299 $2,368
====== ======
7. LINE OF CREDIT BORROWINGS
In December 1997, the Company entered into a $25 million revolving credit
facility (the "Revolving Credit Facility") with First Union N.A., that had an
expiration date of December 30, 2000. The Company's receivables and its service
agreements with the Allied Practices collateralize the Revolving Credit
Facility. Under the terms of the Revolving Credit Facility, the Company is
required to maintain certain consolidated financial ratios and minimum
consolidated net worth amounts. The Revolving Credit Facility also prohibits the
Company from incurring certain additional indebtedness, limits certain future
acquisitions to $2.0 million per practice and to $50.0 million in any
twelve-month period without lender approval, and restricts capital
F-14
42
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
expenditures and cash dividends. The Revolving Credit Facility requires payment
of interest at variable rates (bank's prime rate plus up to 1.5% or LIBOR plus
up to 2.5%) depending upon the Company's leverage ratio as defined in the Credit
Facility. In addition, the Company is charged a commitment fee of up to 0.5% of
the unused balance. Effective March 26, 1999, the Company amended the Revolving
Credit Facility providing for borrowings of up to $55 million with First Union
National Bank, US Bank National Association, and Union Bank of California N.A.,
under substantially the same terms and conditions as the original agreement. The
Revolving Credit Facility is repayable in full on March 26, 2002.
As of December 31, 1999 and December 31, 1998, the outstanding borrowings
under the Revolving Credit Facility was $47.5 million and $15.5 million,
respectively. The Company is in compliance with the terms and covenants of the
Revolving Credit Facility.
8. NOTES PAYABLE
During 1999, the Company issued notes payable to certain Allied Practices
in connection with their affiliations. The unsecured note terms range from three
to four years with interest rates of 7.0% to 8.0%. Principal payments are due as
follows: $0.2 million due in 2002 and $1.9 million in 2003.
9. CLASS B COMMON STOCK
Each share of Class B Common Stock will automatically convert into eight
shares of Class A Common Stock upon the attainment of certain conversion prices.
Twenty percent of the Class B Common Stock shares will convert at each of the
following conversion prices: $18.00, $21.60, $25.92, $31.10, and $37.32. The
conversion will be effected when the average Class A Common Stock closing price
for 20 consecutive trading days exceeds the threshold. Class B Common Stock is
also convertible to an equal number of Class A Common Stock shares at any time
at the option of the holder. Any Class B Common Stock shares not converted to
Class A Common Stock, because the necessary conversion prices were not attained,
will automatically convert to one share of Common Stock upon the sixth
anniversary of the IPO. Class B Common Stock shares are not transferable, except
to a holder's direct relatives or as determined by will or the laws of descent.
The holders of Class B Common Stock enjoy the same share-for-share voting rights
with holders of the Class A Common Stock, with whom they vote as a single class.
10. PREFERRED STOCK
The Company is authorized to issue up to 20.0 million shares of preferred
stock. The Board of Directors, from time to time and without stockholder action
or approval, may fix the relative rights and preferences of the preferred
shares, including voting powers, dividend rights, liquidation preferences,
redemption rights and conversion privileges. No preferred stock was outstanding
as of December 31, 1999 and 1998, respectively.
11. TREASURY STOCK
During 1999 the Company's common stock repurchase program ("Stock
Repurchase Program"), instituted in October 1998, was extended through December
2000. In connection with the program, the Company is authorized to purchase up
to $5.0 million in shares on Nasdaq Stock Market's National Market at prices
prevailing on that market. The Company uses the cost method to account for
treasury stock. During 1999, the Company repurchased 241,286 shares under this
Stock Repurchase Plan and none during 1998.
During 1998, the Company acquired 170,024 shares of its common stock in
transactions with certain Allied Practices, with a market valuation at the date
of the transactions of $2.3 million. These transactions included a mutual
rescission and forgiveness of a note receivable, with a value equal to the
shares acquired.
F-15
43
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
12. STOCK OPTIONS AND WARRANTS
The Company has three stock option plans, the Amended and Restated 1997
Employee Stock Option Plan ("Employee Plan"), the 1997 Non-Employee Director
Stock Option Plan ("Non-Employee Plan") and the 1997 Orthodontist Stock Option
Plan ("Orthodontist Plan"). In addition, the Company issued warrants to certain
executives in 1997. Options may be granted as incentive or nonqualified stock
options. The Company accounts for the Employee Plan and the Non-Employee Plan
under APB Opinion No. 25, under which no expense has been recognized.
The Company may grant options to purchase up to 2.0 million shares of
Common Stock under the Employee Plan, 200,000 shares of Common Stock under the
Non-Employee Plan and 300,000 shares of Common Stock under the Orthodontist
Plan. The options are issued with exercise prices equal to the Company's stock
price at the date of grant. Options granted under the Employee Plan vest over
one to five years; are exercisable in whole or in installments; and expire ten
years from date of grant. Options granted under the Non-Employee Plan vest over
one year; are exercisable in whole or in installments; and also expire ten years
from date of grant. Options granted under the Orthodontist Plan vest at grant;
are exercisable in whole or in installments; and expire five years from the
grant date.
In connection with the IPO, the Company issued warrants to purchase 593,622
shares of Common Stock with exercise prices ranging from $0.01 to $14.38. The
weighted average fair value of the warrants granted was $4.74. The vesting
period for those warrants ranged from immediate to one year. These warrants
expire five years from date of grant and their weighted average exercise price
is $11.01 per warrant. Certain of these warrants have incidental registration
rights pursuant to which the Company is obligated to use reasonable efforts to
register the shares of Common Stock issued upon their exercise if the Company
initiates a public offering and files a registration statement in connection
therewith, excluding the registration of shares issued pursuant to an employee
stock purchase or option plan or an acquisition or proposed acquisition by the
Company.
The following summarizes stock option and warrant activity of the plans:
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
1999 1998 1997
--------------------- --------------------- ---------------------
WEIGHTED NUMBER WEIGHTED NUMBER WEIGHTED NUMBER
AVERAGE SHARES AVERAGE SHARES AVERAGE SHARES
EXERCISE UNDER EXERCISE UNDER EXERCISE UNDER
PRICE OPTION PRICE OPTION PRICE OPTION
-------- --------- -------- --------- -------- ---------
Options and warrants outstanding, Beginning
of year................................... $12.55 1,742,154 $11.72 1,243,332 $ -- --
Granted..................................... 7.54 616,642 13.10 664,882 11.72 1,243,332
Exercised................................... -- -- 3.44 70,000 -- --
Forfeited................................... 12.79 168,132 12.24 96,000 -- --
------ --------- ------ --------- ------ ---------
Options warrants outstanding, end of year... $11.12 2,190,664 $12.55 1,742,214 $11.72 1,243,332
====== ========= ====== ========= ====== =========
Options warrants exercisable, end of year... $10.84 1,515,470 $12.50 1,043,514 $11.46 739,732
====== ========= ====== ========= ====== =========
F-16
44
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The shares under option and warrants at December 31, 1999, were in the
following exercise price ranges:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- -----------------------------
NUMBER WEIGHTED NUMBER WEIGHTED
SHARES CONTRACTUAL AVERAGE SHARES AVERAGE
EXERCISE PRICE UNDER OPTION LIFE (YEARS) EXERCISE PRICE UNDER OPTION EXERCISE PRICE
- -------------- ------------ ------------ -------------- ------------ --------------
$ 6.00 - 8.49 569,379 7 $ 7.36 312,585 $ 6.21
8.50 - 10.99 120,214 4 9.04 61,414 9.18
11.00 - 13.49 1,090,229 5 12.00 888,729 11.66
13.50 - 15.99 410,842 7 14.63 252,742 14.06
--------- ---------
2,190,664 11.12 1,515,470 10.84
========= =========
In accordance with Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" ("SFAS 123"), the fair value of option
grants is estimated using the Black-Scholes option pricing model for pro forma
footnote purposes. The following weighted average assumptions were used for
grants:
DECEMBER 31,
------------------------------------------
1999 1998 1997
------------ ------------ ----------
Risk-free interest rate................... 4.62 - 6.92% 4.35 - 5.73% 5.7 - 6.5%
Dividend yield............................ 0% 0% 0%
Expected volatility....................... 43% 60% 44%
Expected option life (years).............. 8 9 6
As permitted by SFAS 123, the Company has chosen to continue accounting for
stock options at their intrinsic value. Accordingly, no compensation expense has
been recognized for its stock option compensation plans. Had the fair value
method of accounting been applied to the Company's stock option plans, the tax-
effected impact follows:
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------
1999 1998 1997
----------------------- ----------------------- -----------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- --------- ----------- ---------
Net income (loss)............... $9,583 $7,560 $7,535 $6,548 $ (736) $(1,558)
Basic EPS....................... $ 0.72 $ 0.57 $ 0.58 $ 0.50 $(0.18) $ (0.39)
Diluted EPS..................... $ 0.72 $ 0.57 $ 0.58 $ 0.50 $(0.18) $ (0.39)
13. COMMITMENTS AND CONTINGENCIES
The Company leases office space for the use of the Allied Practices and
corporate offices under operating leases, which have current expiration terms at
various dates through 2015. Certain of these leases have renewal options for
specified periods subsequent to their current terms. The annual lease payments
under the lease agreements have provisions for annual increases based on the
Consumer Price Index or other amounts specified within the lease agreements.
F-17
45
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Future minimum lease payments on operating leases as of December 31, 1999
are as follows:
2000....................................................... $ 3,511
2001....................................................... 2,859
2002....................................................... 2,169
2003....................................................... 2,097
2004....................................................... 1,327
Thereafter................................................. 3,181
-------
$15,144
=======
Rent expense for the years ended December 31, 1999, 1998 and 1997
approximated $8.3 million, $6.3 million and $1.8 million, respectively.
The Company may be subject to certain government regulation at the federal
and state levels. To comply with certain regulatory requirements, the Company
does not control the practice of the Orthodontists, or control or employ the
Orthodontists. There can be no assurance that the legality of any long-term
management services agreements that have been entered into will not be
successfully challenged. There also can be no assurance that the laws and
regulations of states in which the Company maintains operations will not change
or be interpreted in the future to restrict or further restrict the Company's
relationship with the Orthodontists.
The Company may be involved in litigation arising from the normal course of
business. Management believes that the final outcome for all legal matters will
not have a material adverse effect on the Company's financial position or
results of operations
14. INCOME TAXES
The provision for income taxes is comprised of the following:
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998 1997
------ ------ ------
Current:
Federal................................................ $5,063 $5,276 $1,086
State.................................................. 697 1,073 222
------ ------ ------
5,760 6,349 1,308
------ ------ ------
Deferred:
Federal................................................ 1,357 (114) (386)
State.................................................. 187 (112) (81)
------ ------ ------
1,544 (226) (467)
------ ------ ------
$7,304 $6,123 $ 841
====== ====== ======
F-18
46
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
A reconciliation of the statutory federal income tax rate to the effective
tax rate as a percentage of income before income taxes follows:
YEARS ENDED
DECEMBER 31,
--------------------
1999 1998 1997
---- ---- ----
Federal income tax at statutory rate........................ 35% 34% 34%
Effect of disallowed expense................................ -- -- 2
Effect of amortization of goodwill.......................... 5 4 34
Non-deductible warrant expense.............................. -- -- 615
State taxes, net of Federal benefit......................... 3 5 88
Other....................................................... -- 2 3
-- -- ---
43% 45% 776%
== == ===
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are as follows:
AS OF DECEMBER 31,
-------------------
1999 1998
-------- -------
Current deferred tax assets:
Warrant expense......................................... $ -- $ --
Litigation reserve...................................... 87 244
Patient prepayments..................................... 12 230
Other................................................... 5 104
------- ------
104 578
------- ------
Non-current deferred tax assets:
Benefit of IRC Section 351 Gain on transferred assets... 1,334 1,889
Start-up costs amortization............................. 99 960
Other................................................... 53 69
------- ------
1,486 2,918
------- ------
Total deferred tax assets, net.................. $ 1,590 $3,496
======= ======
Current deferred tax liabilities:
Patient receivables..................................... $ (182) $ --
------- ------
Non-current deferred tax liabilities:
Depreciation............................................ (561) (159)
State taxes............................................. (106) (184)
Other................................................... (268) (372)
------- ------
(935) (715)
------- ------
Total deferred tax liabilities.................. $(1,117) $ (715)
======= ======
As a result of the acquisitions of the Allied Practices, temporary
differences were created for the differences between the financial statement
carrying amounts and the tax basis of assets acquired. Such temporary
differences predominantly relate to property and equipment and related
depreciation.
F-19
47
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
15. EARNINGS PER SHARE
The Company adopted SFAS No. 128, Earnings per Share ("SFAS 128") effective
December 15, 1997. Basic earnings (loss) per share of Common Stock is computed
by dividing the net income (loss) for the year by the weighted average number of
shares of Common Stock outstanding during the year.
The following table sets forth the computation of basic and diluted
earnings (loss) per share:
YEARS ENDED DECEMBER 31,
----------------------------
1999 1998 1997
------- ------- ------
Net income (loss)...................................... $ 9,583 $ 7,535 $ (736)
======= ======= ======
Determination of shares:
Weighted average number of common stock shares
outstanding....................................... 13,271 13,006 4,026
Assumed conversion of stock options.................. 12 38 --
------- ------- ------
Diluted common stock shares outstanding................ 13,283 13,044 4,026
======= ======= ======
Basic and diluted net income (loss) per share.......... $ 0.72 $ 0.58 $(0.18)
======= ======= ======
Securities, including those issuable pursuant to the conversion of Class B
Common Stock to Class A Common Stock, which could potentially dilute EPS in the
future were not included in the computation of diluted EPS because of its
anti-dilutive effect or its conversion contingencies were not met. Potential
dilutive shares (in thousands) include the following:
AS OF DECEMBER 31,
-----------------------
1999 1998 1997
----- ----- -----
Common Stock shares issuable in the future pursuant to
options and warrants outstanding.......................... 1,672 506 1,243
Common Stock shares issuable in the future for conversion of
Class B Common Stock shares............................... 1,745 1,745 1,750
----- ----- -----
3,417 2,251 2,993
===== ===== =====
16. 401(k) PLAN
During 1999, the Company established a voluntary retirement plan ("the
Plan") under section 401(k) of the Internal Revenue Code. The Plan covers all
eligible, non-highly compensated employees with at least twelve months of
employment with the Company. Currently, the Plan does not provide for Company
matching contributions.
17. RELATED PARTY TRANSACTIONS
For the year ended December 31, 1999, the Company entered into the
following related party transaction:
(i) Referral Commissions for recruiting new Allied Practices of
options to purchase 72,015 shares of Common Stock were granted to an Allied
Orthodontist who was also a director.
(ii) The Company incurred $68,100 of legal expenses with a law firm
that has a partner who also serves on the Company's Board of Directors.
F-20
48
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
For the year ended December 31, 1998, the Company entered into the
following related party transaction:
(i) Referral Commissions for recruiting new Allied Practices of $0.2
million and options to purchase 82,042 shares of Common Stock were paid and
granted to an Allied Orthodontist who was also a director.
For the year ended December 31, 1997, the Company entered into the
following related party transactions:
(i) Paid a $0.3 million consulting fee to a director, who provided
financial and general business services in connection with the IPO pursuant
to a consulting agreement. Pursuant to this consulting agreement and in
addition to the consulting fee, the Company granted the director a warrant
to purchase 150,000 shares of its Common Stock exercisable at $12.00 per
share.
Pursuant to the merger with USOC, a warrant granted to a director by
USOC to purchase 168,750 shares of USOC's common stock was converted to a
warrant to purchase an equal number of shares of OrthAlliance's Common
Stock at an exercise price of $11.16 per share.
The Company recorded a non-recurring organizer compensation expense of
$1.3 million during the year ended December 31, 1997 related to these
warrants.
(ii) In connection with the IPO, certain Allied Orthodontists were
instrumental in recruiting new Allied Practices and received warrants to
purchase an aggregate of 90,000 shares of OrthAlliance Common Stock. Of
these, 31,600 were granted to an Allied Orthodontist who is also a
director. All of these warrants have an exercise price of $12.00 per share.
The Company recorded a non-recurring organizer compensation expense of
$0.4 million during the year ended December 31, 1997 related to these
warrants.
18. OPERATING SEGMENTS AND RELATED INFORMATION
The Company adopted Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information" ("SFAS No.
131") in 1998. This statement establishes standards for the reporting of
information about operating segments and also requires disclosures about
products and services, geographic areas and major customers. The adoption of
SFAS No. 131 did not affect the Company's consolidated financial position or
results of operations. Because the Company did not have any significant segments
in the prior year, the adoption of SFAS No. 131 did not affect previous
disclosures of segment information.
The Company has two reportable segments organized as business units that
provide management or consulting services to the two distinct types of allied
practices: OrthAlliance Allied Orthodontists and PedoAlliance Allied Dentists.
Each business unit provides similar management and consulting services to the
respective Allied Practices and the Company does not manage the business units
separately. The remaining segments identified as "All Other" derive revenues
from interest income and primarily consist of patient contract financing
operations.
Management utilizes multiple views of data to measure segment performance
and to allocate resources to the segments. The accounting policies of the
segments are consistent with those described in the summary of significant
accounting policies, as discussed in Note 2.
F-21
49
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following is a summary of certain financial data for each of the
segments:
ORTHODONTIC PEDIATRIC
PRACTICE PRACTICE ALL OTHERS TOTAL
----------- --------- ---------- -------
Year ended December 31, 1999:
Net revenue............................. $86,421 $9,282 $ -- $95,703
Operating income (loss)................. 16,707 2,562 (348) 18,921
Depreciation and amortization........... 3,843 140 -- 3,983
Year ended December 31, 1998:
Net revenue............................. $72,704 $1,683 $ -- $74,387
Operating income (loss)................. 13,578 446 (162) 13,862
Depreciation and amortization........... 2,345 81 -- 2,426
Year ended December 31, 1997:
Net revenue............................. $18,081 $ -- $ -- $18,081
Operating loss.......................... (165) -- -- (165)
Depreciation and amortization........... 245 -- -- 245
Included in the operating income of the orthodontic practice segment are
certain corporate expenses that are not allocated to the pediatric practice
segment or to the "all others" category. Examples of these expenses are
corporate office salaries, rent, overhead expenses, and amortization expense.
A reconciliation between segment operating income and consolidated net
income or (loss) is set forth below:
YEARS ENDED DECEMBER 31,
---------------------------
1999 1998 1997
------- ------- -----
Segment operating income (loss)......................... $18,921 $13,862 $(165)
Interest income......................................... 416 351 270
Interest expense........................................ (2,450) (555) --
Provision for income taxes.............................. (7,304) (6,123) (841)
------- ------- -----
Net income (loss)....................................... $ 9,583 $ 7,535 $(736)
======= ======= =====
19. SUBSEQUENT EVENTS (UNAUDITED)
Acquisition of New Image
On February 1, 2000, OrthAlliance New Image, Inc., a wholly owned
subsidiary of the Company, executed a Purchase and Sale Agreement with New Image
Orthodontic Group, Inc. ("New Image"), a privately held Georgia corporation
based in Atlanta, Georgia, to purchase substantially all of the assets of New
Image. The transaction was effective March 1, 2000 and will be accounted for as
a purchase. New Image was founded in February 1997 and provides business
operations, financial, marketing and administrative services to orthodontic
practices across the United States in accordance with long term service and
employment agreements. New Image has practice management agreements with 36
orthodontists operating in 50 locations.
The acquisition price included approximately $5.5 million in cash, the
issuance of approximately $12.9 million in promissory notes, with interest rates
ranging from 9% to 10%, repayable over a one to five year period, and the
assumption of approximately $13.4 million of existing debt due to New Image's
former orthodontic practices, repayable over the next five years at interest
rates approximating 9%. The Company will utilize substantially all the acquired
assets in the continued operation of the business. Intangible assets of
approximately $35.8 million resulted from the acquisition. The results of
operations of New Image will be
F-22
50
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
included with the results of operations of the Company from March 1, 2000. The
Company has obtained the appropriate consents from its lenders regarding this
transaction.
In connection with the transaction and subsequent to December 31, 1999, the
Company established and filed a registration statement Form S-8 for a 1999
Orthodontist Stock Option Plan with attributes comparable to other plans of the
Company.
Treasury Stock
Subsequent to December 31, 1999 the Company has acquired 0.3 million shares
of its common stock at a cost approximating $1.9 million. The Company has
obtained the appropriate consents from its lenders regarding this transaction.
F-23
51
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of OrthAlliance, Inc.:
We have audited in accordance with generally accepted auditing standards,
the consolidated financial statements of OrthAlliance, Inc. and subsidiaries
included in this Form 10-K and have issued our report thereon dated February 17,
2000. Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule identified as "Schedule
II -- Valuation and Qualifying Accounts" is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures applied
in the audits of the basic consolidated financial statements and, in our
opinion, fairly states in all material respects the financial data to be set
forth therein in relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Los Angeles, California
February 17, 2000
F-24
52
ORTHALLIANCE, INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(DOLLARS IN THOUSANDS)
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND END OF
PERIOD EXPENSE WRITE-OFFS OTHER(A) PERIOD
------------ ---------- ---------- -------- ----------
Year ended December 31, 1999
Allowance for uncollectible accounts...... $820 $135 $(16) $ 44 $983
Year ended December 31, 1998
Allowance for uncollectible accounts...... $535 $123 $ -- $162 $820
Year ended December 31, 1997
Allowance for uncollectible accounts...... $ -- $ 18 $ -- $517 $535
- ---------------
(A) Amount was recognized at the time that the Allied Practices transferred
certain of their assets and liabilities to the Company.
F-25
53
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
2.1 Agreement and Plan of Merger between the Company, USOC and
POG (incorporated by reference to Exhibit 2.1 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
3.1 Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
3.2 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement on Form S-1 Registration No. 333-27143, as
amended).
4.1 Specimen Class A Common Stock Certificate (incorporated by
reference to Exhibit 4.1 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
4.2 Amended and Restated Certificate of Incorporation of the
Company, including, without limitation Section 4
(incorporated by reference to Exhibit 3.1 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
4.3 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement on Form S-1 Registration No. 333-27143, as
amended).
10.1 Form of Purchase and Sale Agreement between the Company and
Allied Practices (incorporated by reference to Exhibit 2.2
of the Company's Registration Statement on Form S-1,
Registration No. 333-27143, as amended).
10.2 Form of Stock Purchase and Sale Agreement between the
Company and Stockholders of the initial Allied Practices
(incorporated by reference to Exhibit 2.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.3 Form of Stock Purchase and Sale Agreement between the
Company and the Stockholders of the Allied Practices
(incorporated by reference to Exhibit 10.4 of the Company's
Annual Report on Form 10-K for the fiscal Year ended
December 31, 1997).
10.4 Form of Agreement and Plan of Reorganization between the
Company, Allied Practices and the Stockholders of the Allied
Practices (incorporated by reference to Exhibit 2.3 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
10.5 Form of Service Agreement between the Company and Allied
Practices (Fixed Percentage Fee) (incorporated by reference
to Exhibit 10.1 of the Company's Registration Statement on
Form S-1, Registration No. 333-27143, as amended).
10.6 Form of Service Agreement between Company and Allied
Practices (Variable Percentage Fee) (incorporated by
reference to Exhibit 10.2 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
10.7 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Variable Percentage Fee)
(incorporated by reference to Exhibit 10.3 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.8 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Fixed Percentage Fee)
(incorporated by reference to Exhibit 10.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.9 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Fixed Dollar Fee)
(incorporated by reference to Exhibit 10.5 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.10 1997 Non-Employee Director Stock Plan (incorporated by
reference to Exhibit 10.6 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143).
54
EXHIBIT DESCRIPTION
- ------- -----------
10.11 Amended and Restated 1997 Employee Stock Option Plan
(incorporated by reference to Exhibit 10.7 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.12 1997 Orthodontist Stock Option Plan (incorporated by
reference to Exhibit 10.13 of the Company's Annual Report on
Form 10-K for fiscal year ended December 31, 1997).
10.13 Employment Agreement between the Company and Sam Westover
(incorporated by reference to Exhibit 10.8 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.14 Letter Agreement between the Company and Stephen M. Toon.
(incorporated by reference to Exhibit 10.14 of the Company's
Annual Report on Form 10-K for fiscal year ended December
31, 1998).
10.15 Credit Agreement dated December 30, 1997 between the Company
and First Union National Bank (incorporated by reference to
Exhibit 10.16 of the Company's Annual Report on Form 10-K
for fiscal year ended December 31, 1997).
10.16 Form of Company Practice Improvement Program Guarantee
(incorporated by reference to Exhibit 10.17 of the Company's
Annual Report on Form 10-K for Fiscal year ended December
31, 1997).
10.17 Credit Agreement dated March 26, 1999 between the Company
and First Union National Bank, as Agent (incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report
on Form 10-Q for quarter ended March 31, 1999).
10.18 Letter Agreement between the Company and James C. Wilson
(incorporated by reference to Exhibit 10.18 of the Company's
Registration Statement on Form S-4, Registration No.
333-84197).
10.19 1999 Orthodontist Stock Option Plan (incorporated by
reference to Exhibit 4.3 of the Registration Statement on
Form S-8, Registration No. 333-32392).
10.20 Purchase and Sale Agreement dated as of February 1, 2000
between the Company and New Image Orthodontic Group, Inc.
(incorporated by reference to Exhibit 2.1 of the Current
Report on Form 8-K, dated March 1, 2000).
21.1 Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule.
99.1 Safe Harbor Compliance Statement (incorporated by reference
to Exhibit 99.1 of the Company's Annual Report on Form 10-K
for fiscal year ended December 31, 1997).