1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
----------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
------------- -------------
COMMISSION FILE NUMBER 000-22975
----------------
ORTHALLIANCE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4632134
(STATE OR 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)
----------------
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 [ ]
Class Outstanding at May 15, 2000
----- ---------------------------
Class A Common Stock, $.001 par value 12,610,235
Class B Common Stock, $.001 par value 249,292
================================================================================
2
ORTHALLIANCE, INC. AND SUBSIDIARIES
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2000
INDEX
PAGE
NUMBER
------
PART I. FINANCIAL INFORMATION .................................................................... 3
Item 1. Financial Statements...................................................................... 3
Condensed Consolidated Balance Sheets as of March 31, 2000 (unaudited) and December
31, 1999.................................................................................. 3
Unaudited Condensed Consolidated Statements of Income for the Three Month
Periods Ended March 31, 2000 and March 31, 1999........................................... 4
Unaudited Condensed Consolidated Statements of Cash Flows for the Three Month Periods
Ended March 31, 2000 and March 31, 1999................................................... 5
Notes to Unaudited Condensed Consolidated Financial Statements............................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.....10
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................15
PART II. OTHER INFORMATION.........................................................................16
Item 1. Legal Proceedings.........................................................................16
Item 2. Changes in Securities and Use of Proceeds.................................................16
Item 3. Defaults Upon Senior Securities...........................................................16
Item 4. Submission of Matters to a Vote of Security Holders.......................................16
Item 5. Other Information.........................................................................16
Item 6. Exhibits and Reports on Form 8-K..........................................................17
Signatures................................................................................18
Exhibit Index.............................................................................19
2
3
PART I - FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
MARCH 31, DECEMBER 31,
2000 1999
------------- -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents ....................................... $ 10,744 $ 11,189
Patient receivables, net of allowances of $1,091 and $563 at
March 31, 2000 and December 31, 1999, respectively ............ 11,005 10,520
Unbilled patient receivables, net of
allowances of $375 and $382 at March 31, 2000 and
December 31, 1999, respectively ............................... 3,458 3,436
Amounts due from Allied Practices ............................... 14,180 10,630
Income taxes receivable ......................................... -- 509
Current deferred tax assets ..................................... 104 104
Other current assets ............................................ 642 2,010
------------- -------------
Total current assets ........................................... 40,133 38,398
Property and equipment, net ........................................ 8,573 6,333
Notes receivable ................................................... 5,105 4,920
Non-current deferred tax assets .................................... 1,229 1,486
Intangible assets, net ............................................. 118,073 83,620
Other, net ......................................................... 505 502
------------- -------------
Total assets ................................................... $ 173,618 $ 135,259
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable ................................ $ 9,719 $ --
Accounts payable ................................................ 2,599 2,549
Accrued liabilities ............................................. 4,159 2,299
Patient prepayments ............................................. 12,875 6,240
Practice affiliations payable ................................... 51 3,610
Income taxes payable ............................................ 800 --
Current deferred tax liabilities ................................ 182 182
Amounts due to Allied Practices ................................. 3,362 1,988
------------- -------------
Total current liabilities ...................................... 33,747 16,868
Line of credit borrowings .......................................... 51,000 47,500
Non-current deferred tax liabilities ............................... 932 2,144
Notes payable ...................................................... 18,902 935
------------- -------------
Total liabilities .............................................. 104,581 67,447
Commitments and Contingencies
Stockholders' equity:
Class A Common Stock, $.001 par value,
70,000,000 shares authorized, 13,197,961
shares issued and outstanding
at March 31, 2000 and December 31, 1999 ....................... 13 13
Class B Common Stock, $.001 par value, 250,000 shares
authorized, 249,292 shares issued and outstanding at
March 31, 2000 and December 31, 1999, respectively .......... -- --
Additional paid-in capital ......................................... 65,700 65,145
Retained earnings .................................................. 8,017 5,457
Treasury stock, at cost, 587,726 shares at March 31, 2000 and
318,726 shares at December 31, 1999 ............................ (4,693) (2,803)
------------- -------------
Total stockholders' equity ..................................... 69,037 67,812
------------- -------------
Total liabilities and stockholders' equity ..................... $ 173,618 $ 135,259
============= =============
The accompanying notes are an integral part of these condensed consolidated
balance sheets.
3
4
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
---------------------------
2000 1999
---------- ----------
Net revenues .......................................... $ 30,145 $ 21,302
---------- ----------
Costs and expenses:
Salaries and benefits ................................. 8,610 6,755
Orthodontic and dental supplies ....................... 2,680 2,029
Rent .................................................. 2,511 1,734
---------- ----------
Total direct expenses .......................... 13,801 10,518
General and administrative ............................ 9,282 5,829
Depreciation and amortization ......................... 1,410 798
---------- ----------
Total operating expenses ....................... 24,493 17,145
Operating income ...................................... 5,652 4,157
Interest income ....................................... 171 87
Interest expense ...................................... (1,252) (423)
---------- ----------
Income before income taxes ............................ 4,571 3,821
Provision for income taxes ............................ 2,011 1,687
---------- ----------
Net income ............................................ $ 2,560 $ 2,134
========== ==========
Net income per share- basic and diluted ............... $ 0.20 $ 0.16
========== ==========
Weighted average number of
Common shares outstanding (in thousands):
Basic ............................................. 13,038 13,273
========== ==========
Diluted ........................................... 13,042 13,280
========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
5
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
-----------------------
2000 1999
-------- --------
Cash flows from operating activities:
Net income ............................................... $ 2,560 $ 2,134
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ........................... 1,410 798
Deferred taxes .......................................... 246 479
Changes in assets and liabilities, excluding
effects of Acquisitions:
Patient receivables, net ............................. 95 368
Amounts due from Allied Practices .................... (77) 1,185
Other current assets ................................. 1,555 (12)
Income taxes receivable .............................. 1,332 931
Other, net ........................................... 50 (44)
Accounts payable and accrued liabilities ............. (971) 247
Amounts due to Allied Practices ...................... 1,374 1,302
Patient prepayments .................................. 1,230 (130)
-------- --------
Net cash provided by operating activities ................ 8,804 7,258
-------- --------
Cash flows from investing activities:
Payments for new practice affiliations ............... (377) (10,095)
Payments for acquisition of New Image ................ (5,500) --
Increase in notes receivable ......................... (560) (499)
Principal payments on notes receivables .............. 354 223
Capital expenditures ................................. (84) (400)
-------- --------
Net cash used in investing activities .................... (6,167) (10,771)
-------- --------
Cash flows from financing activities:
Decrease in bank overdraft ........................... (1,195) (862)
Treasury shares purchased ............................ (1,890) (260)
Increase in line of credit borrowings ................ 8,000 11,000
Line of credit refinancing fees ...................... (53) (473)
Repayment on line of credit and notes payable ........ (7,944) (2,260)
-------- --------
Net cash provided by financing activities ............ (3,082) 7,145
-------- --------
Net (decrease) increase in cash and cash equivalents ..... (445) 3,632
Cash and cash equivalents at beginning of period ......... 11,189 3,226
-------- --------
Cash and cash equivalents at end of period ............... $ 10,744 $ 6,858
======== ========
Supplemental cash flow information: Cash paid
during the period for:
Interest ............................................. $ 1,138 $ 436
Income taxes ......................................... 702 756
Non-cash investing and financing activities:
Acquisition of intangible assets:
Fair value of assets acquired ........................ $ 33,087 $ 10,854
Less: Issuance of common stock or stock options ...... (555) (759)
Less: Cash paid ...................................... (5,877) (10,095)
-------- --------
Notes payable or liabilities assumed ................. $ 26,655 $ --
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
6
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
NOTE 1. BUSINESS AND 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; 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
(collectively "Management Services") to allied orthodontic and pediatric dental
practices (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".
NOTE 2. BASIS OF PRESENTATION
The accompanying interim condensed consolidated financial statements of
OrthAlliance are unaudited and reflect all adjustments that, in the opinion of
management, are necessary for a fair presentation of the results for the interim
period in accordance with Securities and Exchange Commission instructions for
Form 10-Q. Accordingly, they do not include all information and footnotes
required by generally accepted accounting principles for complete financial
statements. The condensed consolidated statements of income for the current
interim period are not necessarily indicative of results to be expected for the
current year or any other period.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes thereto
as well as other information included in the Company's Annual Report on Form
10-K for the year ended December 31, 1999 and other Company filings with the
Securities and Exchange Commission.
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 reported period. Actual
results could differ from those estimates.
Consolidation
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 EITF 97-2.
Reclassifications
Certain prior period reclassifications have been made to conform to
classifications used in the current period.
6
7
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
NOTE 3. ACQUISITION OF NEW IMAGE
Effective March 1, 2000, the Company acquired substantially all of the assets
of New Image Orthodontic Group, Inc. ("New Image"), a privately held Georgia
corporation based in Atlanta, Georgia, for a total consideration (including
acquisition costs) of approximately $33.8 million. New Image was founded in
February 1997 and provided business operations, financial, marketing and
administrative services to orthodontic practices in nine states in accordance
with long term service and employment agreements and had practice management
agreements with 36 orthodontists operating in 50 locations.
The acquisition price included a cash payment of $5.5 million, an estimated
$1.5 million in acquisition costs, promissory notes issued of approximately
$12.9 million, the assumption of approximately $13.4 million of existing debt
due to New Image's former orthodontic practices, and the issuance of
approximately 273,000 stock options. The promissory notes issued and assumed
have interest rates ranging from 9% to 10% and are repayable over a one to five
year period. The Company will utilize substantially all the acquired assets in
the continued operation of the business. The acquisition has been accounted for
as a purchase. Intangible assets of approximately $34.2 million resulted from
the acquisition. The results of operations of New Image are 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.
The following pro forma results of operations are presented to illustrate
the effect of the acquisition on the historical operating results of
OrthAlliance and New Image for the three month periods ended March 31, 2000 and
March 31, 1999. These pro forma results of operation gives effect to the
acquisition as if it occurred as of January 1, 2000 and January 1, 1999,
respectively. The pro forma results of operations are based on management's
current estimates and may not be indicative of the results of operations that
actually would have occurred if the transaction had been effective at the dates
indicated or to project future results of operations for any period.
THREE MONTHS ENDED MARCH 31, 2000
-------------------------------------------------------------
PRO FORMA
ORTHALLIANCE NEW IMAGE (a) ADJUSTMENTS (a) PRO FORMA
------------ ------------- --------------- ------------
Net revenues ............................................... $ 30,145 $ 3,803 $ -- $ 33,948
Operating income (loss) .................................... 5,652 (84) 323 5,891
Net income (loss) .......................................... 2,560 (448) 440 2,552
Basic and diluted net income per share .................... $ .20 $ .20
============ ============
Weighted average number of
Common shares outstanding (in thousands):
Basic ............................................. 13,038 13,038
============ ============
Diluted ........................................... 13,042 13,042
============ ============
(a) As the transaction with New Image was effective March 1, 2000, the
results of operations for New Image and the pro forma adjustments are for
the two month period ended February 29, 2000.
THREE MONTHS ENDED MARCH 31, 1999
-------------------------------------------------------------
PRO FORMA
ORTHALLIANCE NEW IMAGE ADJUSTMENTS PRO FORMA
------------ ------------- --------------- ------------
Net revenues ............................................... $ 21,302 $ 5,502 $ -- $ 26,804
Operating income (loss) .................................... 4,157 (191) 722 4,688
Net income (loss) .......................................... 2,134 (875) 884 2,143
Basic and diluted net income per share .................... $ 0.16 $ .16
============ ============
Weighted average number of
Common shares outstanding (in thousands):
Basic ............................................. 13,273 13,273
============ ============
Diluted ........................................... 13,280 13,280
============ ============
7
8
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
NOTE 4. BANK LINE OF CREDIT
On December 30, 1997, the Company entered into a $25 million Revolving Credit
Facility with First Union N.A., which had an expiration date of December 30,
2000. The Revolving Credit Facility bears interest on borrowings at variable
rates including the bank's prime lending rate plus a percentage or LIBOR plus a
percentage as determined by certain factors defined in the Revolving Credit
Agreement. Amounts borrowed are secured by the Company's assets including
accounts receivable, management and service agreements and the capital stock of
the Company's wholly owned subsidiaries.
Effective March 26, 1999, the Company executed an amended Revolving Credit
Facility for borrowings of up to $55 million with First Union National Bank, US
Bank National Association, and Union Bank of California N.A. (due March 2002)
under substantially the same terms and conditions as the previous Revolving
Credit Facility which was repaid in full at the closing. As of March 31, 2000
and December 31, 1999, the outstanding borrowings under the Revolving Credit
Facilities were $51.0 million and $47.5 million, respectively. As of March 31,
2000 the Company was in compliance with the terms and covenants of the Revolving
Credit Facility.
5. OPERATING SEGMENTS
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: "Orthodontic Practices" which include the OrthAlliance Allied
Orthodontists (includes New Image orthodontists) and "Pediatric Practices" which
include the 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 following is a summary of certain financial data for each of the
segments:
ORTHODONTIC PEDIATRIC
PRACTICES PRACTICES ALL OTHERS TOTAL
----------- ---------- ---------- ----------
THREE MONTHS ENDED MARCH 31, 2000:
Net revenues $ 26,921 $ 3,224 $ -- $ 30,145
Operating income (loss) 4,855 868 (71) 5,652
Depreciation and amortization 1,352 58 -- 1,410
THREE MONTHS ENDED MARCH 31, 1999:
Net revenues $ 20,095 $ 1,207 $ -- $ 21,302
Operating income (loss) 3,849 368 (60) 4,157
Depreciation and amortization 747 51 -- 798
8
9
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 total segment operating income and consolidated net
income or loss is set forth below:
THREE MONTHS ENDED
MARCH 31,
-----------------------
2000 1999
-------- --------
Segment operating income $ 5,652 $ 4,157
Interest income 171 87
Interest expense (1,252) (423)
Provision for income taxes (2,011) (1,687)
-------- --------
Net income $ 2,560 $ 2,134
======== ========
NOTE 6. TREASURY STOCK TRANSACTIONS
In February 2000, the Company acquired 270,000 shares of its common stock at
a cost of approximately $1.9 million.
NOTE 7. SUBSEQUENT EVENTS
Credit Facility
Effective April 14, 2000, the Company entered into a new Revolving Credit
Facility, which expanded the previous facility providing for borrowings of up to
$75 million with First Union National Bank, City National Bank, US Bank National
Association, Union Bank of California N.A. and Wells Fargo Bank, N.A., under
substantially the same terms and conditions as the original agreement. The
Revolving Credit Facility is repayable in full on April 13, 2003.
New Affiliations
The Company entered into an agreement with an orthodontic practice which
affiliated with the Company in April 2000 to provide management services and to
acquire certain operating assets for a total consideration (including
acquisition costs) of $0.8 million, of which $0.6 million was paid in cash and
$0.2 million was issued in debt. This Allied Practice operates three locations
and generated historical patient revenue over the prior 12 months of
approximately $0.8 million. Prior patient revenue is not necessarily indicative
of the level of revenue that this practices may be expected to generate in the
future.
9
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Cautionary Statement
The information contained in this Form 10-Q and documents incorporated by
reference are intended to update the information contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 1999 and presumes
that readers have access to, and will have read, the "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and other
information contained in such Form 10-K and other Company filings with the
Securities and Exchange Commission ("SEC").
This Form 10-Q contains 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. For this purpose, any statements contained in this
Form 10-Q 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 the negative or other variations thereof 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 forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties, as well as on
certain assumptions that could cause actual future activities and results of
operations to be materially different from those set forth in the
forward-looking statements. Important factors that could cause actual results to
differ include, among other things, risks associated with Allied Practice
affiliations, availability of capital or that the Company will remain in
compliance with its credit facilities, fluctuations in operating results because
of affiliations and variations in stock price, dependence upon revenues
generated by Allied Practices, continued compliance with the listing
requirements for the Nasdaq national market listing, changes in government
regulations, competitive conditions, risks of operations and growth of existing
and newly affiliated practices, ability to staff the Allied Practices with
qualified personnel, the continued availability of adequate insurance, ability
of Allied Practices to attract and retain patients and other risks.
Additional factors that may affect future operating results are discussed in
more detail in Exhibit 99.1 of the Company's Annual Report on Form 10-K.
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. Although the
Company believes that the assumptions underlying the forward-looking statements
are reasonable, 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. 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-Q 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.
The information contained in this Form 10-Q is not a complete description of
the Company's business or the risks associated with an investment in the
Company. Readers are urged to carefully review and consider the various
disclosures made by the Company in this Report and in the Company's other
filings with the SEC that attempt to advise interested parties of certain risks,
uncertainties and other factors that may affect the Company's business.
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 practitioners operating 147 offices in 16 states. By the end of
1997, the Company had affiliated with 11 new practices, including 17 additional
practitioners operating out of 31 new locations. In 1998, the Company affiliated
with 36 new practices, including 45 additional orthodontists and pediatric
dentists operating out of 70 locations. In 1999, the Company affiliated with 36
new practices, including 40 additional orthodontists and pediatric dentists
operating out of 73 locations. During the three month period ended March 31,
2000, the Company affiliated with 31 new practices, including 36 practitioners
operating out of 51 locations, primarily related to the New Image acquisition.
The Company anticipates that future growth will come from new affiliations,
satellite expansion of Allied Practices, and the development of new orthodontic
practices, increased internal growth and improved operating efficiencies.
10
11
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
pediatric dentists ("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% to 24% 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% to 24% 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.
The service fee is earned and paid monthly to the Company by each Allied
Practice using one of several 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.
(iv) the Company's management service fee related to the practices
affiliated in connection with the New Image transaction is generally based on
a designated percentage of patient revenues. The fee is determined by several
factors including the dollar amount of patient revenues during the
measurement period and the actual overhead expense of the practice expressed
as a percentage of patient revenues. Generally, the fee percentage for this
group of practice ranges up to 19.5% of patient revenues. In certain cases,
the New Image Allied Practice must guarantee a minimum management fee over
the term of the management agreement. The average management fee percentage
during 1999 was approximately 16.6% of patient revenues.
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 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
affiliate with the Company. Practice supplies include only those expenses
required by the Allied Orthodontists to provide treatment to patients.
11
12
RESULTS OF OPERATIONS
The following table sets forth certain selected unaudited condensed
consolidated income statement data for the periods indicated in thousands of
dollars and as a percentage of total net revenues:
THREE MONTHS ENDED MARCH 31,
------------------------------------------------
2000 1999
--------------------- ---------------------
Net revenues ........................ $ 30,145 100.0% $ 21,302 100.0%
-------- -------- -------- --------
Costs and expenses:
Salaries and benefits ............... 8,610 28.6 6,755 31.7
Orthodontic and dental supplies ..... 2,680 8.9 2,029 9.5
Rent ................................ 2,511 8.3 1,734 8.2
-------- -------- -------- --------
Total direct expenses ........ 13,801 45.8 10,518 49.4
General and administrative .......... 9,282 30.8 5,829 27.4
Depreciation and .................... 1,410 4.7 798 3.7
-------- -------- -------- --------
amortization
Total operating expenses ..... 24,493 81.3 17,145 80.5
Operating income .................... 5,652 18.7 4,157 19.5
Interest income ..................... 171 0.6 87 0.4
Interest expense .................... (1,252) (4.2) (423) (2.0)
-------- -------- -------- --------
Income before income taxes .......... 4,571 15.1 3,821 17.9
Provision for income taxes .......... 2,011 6.7 1,687 7.9
-------- -------- -------- --------
Net income .......................... $ 2,560 8.4 $ 2,134 10.0
======== ======== ======== ========
Operating Income and Net Income
Operating income for the three months ended March 31, 2000 increased 36% to
$5.7 million from $4.2 million in the comparable 1999 quarter. Net income for
the three months ended March 31, 2000 increased 20% to $2.6 million from $2.1
million in the comparable 1999 quarter.
Net Revenues
Net revenues for the three months ended March 31, 2000 increased 42% to
$30.1 million from $21.3 million in the comparable 1999 quarter. The increase in
net revenues for the three months ended March 31, 2000 is primarily due to an
increase in affiliations of Allied Practices, the New Image acquisition and an
increase in the internal growth of comparative same-store collections of more
than twelve percent for the current period. Net revenues as reported by the
Company include the Company's contractual service or consulting fee based in
part on patient revenues, as well as reimbursed expenses of the Allied
Practices.
Operating Expenses
Total operating expenses increased 43% to $24.5 million, or 81% of net
revenues, in the three months ended March 31, 2000 from $17.1 million, or 80% of
net revenues, for the comparable 1999 quarter.
Direct expenses including salaries and benefits, orthodontic and dental
supplies, and rent increased 31% to $13.8 million, or 46% of net revenues, in
the three months ended March 31, 2000 from $10.5 million, or 49% of net
revenues, for the comparable 1999 quarter. Direct expenses have increased in
absolute dollars as a result of the acquisition of additional Allied Practices
during the periods as well as the expansion and growth of previously existing
Allied Practices.
12
13
Salaries and benefits increased 27% to $8.6 million, or 29% of revenues, in
the three months ended March 31, 2000 from $6.8 million, or 32% of net revenues
for the comparable 1999 quarter. The decrease in salaries and benefits as a
percentage of net revenues is a result of practice affiliations of which
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 increased 59% to $9.3 million, or 31% of
net revenues, in the three months ended March 31, 2000 from $5.8 million, or 27%
of net revenues, for the comparable 1999 quarter. 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 offsetting
reductions in marketing and advertising and other costs.
Depreciation and amortization expenses increased approximately $0.6 million
or 77% to $1.4 million for the three months ended March 31, 2000 as compared to
the same period in 1999. This increase is attributable to the increase in
intangible assets associated with the affiliations of Allied Practices and the
acquisition of New Image. The intangible assets, net balance was $118.1 million
and $83.6 million at March 31, 2000 and December 31, 1999, respectively.
Depreciation and amortization expenses primarily relate to the depreciation of
capital assets and the amortization of excess cost over the fair value of net
assets acquired and certain other intangibles. The Company's policy is to
amortize goodwill over the expected period to be benefited, not to exceed 25
years.
Interest Expense
Interest expense increased to $1.3 million for the three months ended March
31, 2000 from $0.4 in the comparable period in 1999. The increase was primarily
due to increased borrowings under the Company's Revolving Credit Facility in
support of Allied Practices affiliated and the New Image acquisition. Company
borrowings under the Revolving Credit Facilities were $51.0 million and $47.5
million at March 31, 2000 and December 31, 1999, respectively.
Provision for Income Taxes
The provision for income taxes increased 19% to $2.0 million for the three
month period ended March 31, 2000 from $1.7 million for the comparable 1999
period. The Company's effective income tax rates for the periods ended March 31,
2000 and 1999, respectively, were higher than the statutory tax rate primarily
due to the amortization of certain intangible assets not being deductible for
income tax purposes. The effective tax rate was 44% for the three month period
ended March 31, 2000 and for the comparable period in 1999.
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 resources.
This capital is used for affiliations with new Allied Practices, development of
Allied Practice satellite offices, capital additions and general working capital
needs. As of March 31, 2000 and December 31, 1999 the Company had a working
capital balance of $6.4 million and $21.5 million, respectively. As of March 31,
2000 the Company's principal sources of liquidity included cash and short term
investments of approximately $10.7 million and the Revolving Credit Facility,
which has a balance of $51.0 million bearing interest at the prime interest rate
plus a margin or the LIBOR plus a margin. As of March 31, 2000, the Company is
currently in compliance with all terms of its facility. On April 14, 2000, the
Company expanded its revolving credit facility to $75 million, which expires on
April 13, 2003 and has substantially similar terms to the previous facility.
The Company's operating activities generated cash of $8.8 million during the
three month period ended March 31, 2000. Net cash used in financing activities
approximated $3.1 million in the three month period ended March 31, 2000 and
consisted of borrowings net of repayments on the line of credit, notes payable
and treasury shares purchased. Cash used in investing activities of $6.2 million
in the three month period ended March 31, 2000 consisted of payments in
connection with the acquisition of New Image, Allied Practices affiliated 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.
The Company's capital resources needed to continue acquisition and
development efforts will be funded through a combination of cash flows provided
by ongoing operations, the Company's line of credit, 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
13
14
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, 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.
During the three months ended March 31, 2000, the Company acquired 0.3
million shares of its common stock at an approximate cost of $1.7 million.
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.
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
Orthodontic Group, Inc ("New Image"), a privately held Georgia corporation based
in Atlanta, Georgia. 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 in
nine states in accordance with long term service agreements. The transaction was
accounted for as a purchase and includes practice management agreements with 36
orthodontic practitioners operating in 50 locations with over $33.0 million in
annualized revenues. Collectively, the consideration and transaction costs
associated with this transaction totaled approximately $33.8 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 believes that the transition will be successful, there can be no
assurances that certain matters outside of management's control will not occur,
delaying the successful integration of the New Image business operation, and
having an unfavorable impact on operations and working capital.
YEAR 2000 COMPLIANCE
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 future problems relating to any Year 2000 issues that would have a
material impact on the Company's operations or financial condition.
RECENT 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 ("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 March 31, 2000.
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
14
15
beginning after June 15, 2000, as per the issuance of SFAS 137. 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.
INFLATION
The Company does not believe that inflation has had a material effect on the
results of operations. There can be no assurance that the Company's business
will not be affected by inflation in the future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not have any derivative financial instruments as of March
31, 2000. 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
not hedging its financial instruments is not material.
15
16
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time the Company is involved in various legal proceedings,
claims and litigation matters arising in the ordinary course of business,
including labor and personnel related issues. In the opinion of management, the
outcome of such routine matters will not have a material adverse effect on the
Company's business, financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) None
(b) None
(c) None
(d) None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(a) None
(b) None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) None
(b) None
(c) None
(d) None
ITEM 5. OTHER INFORMATION
None
16
17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Credit Agreement dated as of April 14, 2000 by and among
OrthAlliance, Inc., First Union National Bank as Agent, and the
Lenders named therein.
27.1 Financial Data Schedule for the three month period ended March
31, 2000.
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).
(b) Reports on Form 8-K
On March 15, 2000, the Company filed a Report on Form 8-K related to its
acquisition of substantially all of the assets of New Image Orthodontic Group,
Inc., which became effective March 1, 2000.
On May 15, 2000, the Company filed a Report on Form 8-K/A related to its
acquisition of substantially all of the assets of New Image Orthodontic Group,
Inc.
17
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ORTHALLIANCE, INC.
(Registrant)
Date: May 15, 2000 By: /s/ Sam Westover
---------------------------------
Sam Westover,
President and Chief Executive
Officer
(Principal Executive Officer)
Date: May 15, 2000 By: /s/ James C. Wilson
---------------------------------
James C. Wilson,
Chief Financial Officer
(Principal Financial and
Accounting Officer)
18
19
EXHIBIT INDEX
EXHIBIT DESCRIPTION
------- -----------
10.1 Credit Agreement dated as of April 14, 2000 by and among
OrthAlliance, Inc., First Union National Bank as Agent, and the
Lenders named therein.
27.1 Financial Data Schedule for the three month period ended March
31, 2000.
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).
19