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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 JUNE 30, 1998
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
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ORTHALLIANCE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4632134
(STATE OR JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
23848 HAWTHORNE BOULEVARD, SUITE 200
TORRANCE, CALIFORNIA 90505
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE): (310) 791-5656
----------------
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 [ ]
The number of shares of Class A Common Stock and Class B Common Stock of
the Registrant outstanding at June 30, 1998 was 12,996,304 and 250,000,
respectively.
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ORTHALLIANCE, INC.
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1998
INDEX PAGE
----
PART I FINANCIAL INFORMATION ............................................................. 4
Item 1 Financial Statements and General Information ...................................... 4
Condensed Consolidated Balance Sheets as of December 31, 1997 and
June 30, 1998 (unaudited) ......................................................... 4
Condensed Consolidated Statement of Operations for the Six Months Ended
June 30, 1997 and June 30, 1998 (unaudited) ....................................... 5
Condensed Consolidated Statement of Operations for the Three Months Ended
June 30, 1997 and June 30, 1998 (unaudited) ....................................... 6
Condensed Consolidated Statement of Cash Flows for the Three Months Ended
June 30, 1997 and June 30, 1998 (unaudited) ....................................... 7
Notes to Condensed Consolidated Financial Statements .............................. 8
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations ............................................................. 10
Item 3 Quantitative and Qualitative Disclosure about Market Risk ......................... 13
PART II OTHER INFORMATION ................................................................ 13
Item 1 Legal Proceedings ................................................................. 13
Item 2 Changes in Securities and Use of Proceeds ......................................... 13
Item 3 Defaults Upon Senior Securities ................................................... 13
Item 4 Submission of Matters to a Vote of Security Holders ............................... 14
Item 5 Other Information ................................................................. 15
Item 6 Exhibits and Reports on Form 8-K .................................................. 15
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FORWARD-LOOKING STATEMENTS
Statements contained in this Report, which are not historical in nature,
are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements include the
statements regarding efforts to determine Year 2000 exposure, the costs to bring
corporate and practice systems into Year 2000 compliance, funding of development
efforts, acquisitions and operations. Such forward-looking statements include
uncertainties that could cause actual results to differ materially from those
documented in this report. These risks include the ability to grow through
affiliations with additional orthodontic or pediatric dental practices, the
ability to identify suitable affiliation candidates and to profitably manage or
successfully integrate new practices, the level of competition from other
orthodontic or dental practice management companies, the continued availability
of adequate insurance, the ability to secure capital to fund future growth,
regulatory developments and changes in the United States healthcare system, the
general economy of the United States and the specific markets in which
OrthAlliance operates orthodontic or pediatric dental offices, and other factors
as may be identified from time to time in future filings with the Security and
Exchange Commission or in other public announcements.
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PART I
ITEM I. FINANCIAL STATEMENTS
ORTHALLIANCE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
AS OF AS OF
JUNE 30, DECEMBER 31,
1998 1997
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents .......................................... $ 5,362,000 $ 12,647,000
Patient receivables, net of allowances of $348,000 and $242,000 ....... 6,376,000 4,470,000
Unbilled patient receivables, net of
allowances of $307,000 and $293,000 .............................. 2,763,000 2,642,000
Amounts due from Allied Practices .................................. 4,434,000 2,489,000
Current deferred tax assets ........................................ 984,000 984,000
Other current assets ............................................... 233,000 67,000
------------- -------------
Total current assets .............................................. 20,152,000 23,299,000
Property and equipment, net ........................................... 4,820,000 3,214,000
Notes receivable from Allied Practices ................................ 2,877,000 2,010,000
Non-current deferred tax assets ....................................... 4,209,000 4,209,000
Intangible assets, net ................................................ 41,408,000 11,313,000
Other, net ............................................................ 259,000 318,000
------------- -------------
Total Assets ...................................................... $ 73,725,000 $ 44,363,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accrued liabilities ..................... $ 2,229,000 $ 3,024,000
Patient prepayments ................................................ 3,138,000 2,710,000
Liabilities assumed from Allied Practices .......................... 283,000 410,000
Line of Credit borrowings .......................................... 8,000,000 --
Income taxes payable ............................................... 799,000 1,308,000
Current deferred tax liabilities ................................... 1,672,000 1,672,000
Amounts due to Allied Practices .................................... 2,113,000 1,090,000
------------- -------------
Total current liabilities ......................................... 18,234,000 10,214,000
------------- -------------
Non-current deferred tax liabilities .................................. 121,000 121,000
------------- -------------
Total liabilities ................................................. 18,355,000 10,335,000
------------- -------------
Commitments and Contingencies
Stockholders' equity:
Class A Common Stock, $.001 par value, 20,000,000 shares authorized,
12,996,304 shares and 11,486,761 shares issued and outstanding at
June 30, 1998 and December 31, 1997, respectively ................. 13,000 11,000
Class B Common Stock, $.001 par value, 250,000 shares
Authorized, 250,000 shares issued and outstanding at
June 30, 1998 and December 31, 1997 .............................. -- --
Additional paid-in capital ............................................ 63,062,000 45,149,000
Accumulated deficit ................................................... (7,705,000) (11,132,000)
------------- -------------
Total stockholders' equity ........................................ 55,370,000 34,028,000
------------- -------------
Total liabilities and stockholders' equity ........................ $ 73,725,000 $ 44,363,000
============= =============
The accompanying notes are an integral part
of these condensed consolidated balance sheets.
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ORTHALLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1998 JUNE 30, 1997
---------------- ----------------
Net revenues ..................................... $ 33,362,000 $--
------------- -------------
Direct expenses:
Salaries and benefits ............................ 10,350,000 --
Orthodontic supplies ............................. 3,183,000 --
Rent ............................................. 2,959,000 --
------------- -------------
Total Direct Expenses ............................ 16,492,000 --
Depreciation and amortization .................... 1,074,000 --
General and administrative expenses .............. 9,745,000 --
Non-recurring organizer compensation expense ..... -- 2,271,000
------------- -------------
Total expenses ................................... 27,311,000 2,271,000
------------- -------------
Net operating income (loss) ...................... 6,051,000 (2,271,000)
Interest expense ................................. (94,000) --
Interest income .................................. 196,000 --
------------- -------------
Income (loss) before income taxes ................ 6,153,000 (2,271,000)
Provision for income taxes ....................... 2,670,000 --
------------- -------------
Net income (loss) ................................ $ 3,483,000 $ (2,271,000)
============= =============
Basic and diluted net
income (loss) per share .......................... $ 0.27 N/A
============= -------------
Number of shares used in
calculating basic net
Income (loss) per share .......................... 12,756,440 N/A
============= -------------
Number of shares used in
calculating diluted net
income (loss) per share .......................... 12,841,330 N/A
============= =============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
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ORTHALLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, 1998 JUNE 30, 1997
------------------ ------------------
Net revenues ..................................... $ 18,712,000 $--
--------------- ---------------
Direct expenses:
Salaries and benefits ............................ 5,855,000 --
Orthodontic supplies ............................. 1,850,000 --
Rent ............................................. 1,647,000 --
--------------- ---------------
Total Direct Expenses ............................ 9,352,000 --
Depreciation and amortization .................... 588,000 --
General and administrative expenses .............. 5,518,000 --
Non-recurring organizer compensation expense ..... -- 2,271,000
--------------- ---------------
Total expenses ................................... 15,458,000 2,271,000
--------------- ---------------
Net operating income (loss) ...................... 3,254,000 (2,271,000)
Interest expense ................................. (87,000) --
Interest income .................................. 92,000 --
--------------- ---------------
Income (loss) before income taxes ................ 3,259,000 (2,271,000)
Provision for (benefit from) income taxes ........ 1,400,000 --
--------------- ---------------
Net income (loss) ................................ $ 1,859,000 $ (2,271,000)
=============== ===============
Basic and diluted net
income (loss) per share .......................... $ 0.14 N/A
=============== ===============
Number of shares used in
calculating basic net
Income (loss) per share .......................... 13,037,235 N/A
=============== ===============
Number of shares used in
calculating diluted net
Income (loss) per share .......................... 13,191,143 N/A
=============== ===============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
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ORTHALLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1998 JUNE 30, 1997
--------------- ---------------
Cash flows from operating activities:
Net income ............................................. $ 3,483,000 $ (2,271,000)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ......................... 1,074,000 --
Non-recurring organizer compensation expense .......... -- 2,271,000
Changes in assets and liabilities, excluding
effects of acquisitions:
Increase in patient receivables ....................... (324,000) --
Increase in due from Allied Practices ................. (1,945,000) --
Increase in other current assets ...................... (166,000) --
Decrease in other intangible assets, net .............. 19,000 --
Decrease in accounts payable and accrued liabilities .. (281,000) --
Increase in due to Allied Practices ................... 1,023,000 --
Increase in patient prepayments ....................... 428,000 --
Decrease in income taxes payable ...................... (509,000) --
--------------- ---------------
Net cash provided by operating activities .............. 2,802,000 --
--------------- ---------------
Cash flows from investing activities:
Payment for new practice affiliations ................. (15,578,000) --
Loans to Allied Orthodontists ......................... (919,000) --
Purchase of loans from Allied Practices ............... (201,000) --
Principal payments on loans ........................... 197,000 --
Capital expenditures .................................. (405,000) --
--------------- ---------------
Net cash used in investing activities ................. (16,906,000) --
--------------- ---------------
Cash flows from financing activities:
Reduction in bank overdraft ........................... (529,000) --
Proceeds from exercise of stock options ............... 255,000 --
Borrowing on line of credit ........................... 8,000,000 --
Reduction in assumed liabilities ...................... (907,000) --
--------------- ---------------
Net cash provided by financing activities ............. 6,819,000 --
--------------- ---------------
Net decrease in cash and cash equivalents ............. $ (7,285,000) $--
=============== ===============
Cash and cash equivalents at beginning of period ....... $ 12,647,000 $--
Cash and cash equivalents at end of period ............. $ 5,362,000 $--
=============== ---------------
Supplemental cash flow information:
Interest paid ......................................... $ 48,000 $--
Income taxes paid ..................................... $ 3,179,000 $--
Noncash investing and financing activities
Acquisition of businesses:
Fair value of assets acquired ........................ $ 34,033,000 --
Less: Issuance of common stock ....................... (17,675,000) --
Less: Cash paid ...................................... (15,578,000) --
--------------- ---------------
Liabilities assumed .................................. $ 780,000 $--
=============== ===============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
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ORTHALLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
1. BUSINESS AND ORGANIZATION
Organization
OrthAlliance, Inc. ("OrthAlliance" or the "Company") (formerly known as
Premier Orthodontic Holdings, Inc.), a Delaware corporation, was founded in
October, 1996 to provide practice management and consulting services
(collectively "management services") to orthodontic practices in the United
States.
On August 26, 1997, OrthAlliance acquired (the "Acquisitions")
simultaneously with the closing of the initial public offering (the "Offering"
or "IPO") of its Class A Common Stock ("Common Stock"), certain operating assets
of or the stock of entities holding certain tangible and intangible assets, and
assumed certain liabilities of 55 orthodontic practices (collectively, the
"Founding Practices") in exchange for 5,882,984 shares of Common Stock and
$13,800,000 in cash. The underwriters exercised an overallotment option to
purchase an additional 390,000 shares of Common Stock, thereby increasing the
number of shares of Common Stock offered in the IPO from 2,600,000 to 2,990,000.
The net proceeds of the shares of Common Stock issued in the IPO (after
deducting the underwriting discounts and commission) were $33,368,400. The
Acquisitions have been accounted for in accordance with the Securities and
Exchange Commission's Staff Accounting Bulletin No. 48.
Effective prior to the closing of the 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 an aggregate of 1,750,000 shares of Common Stock and 250,000
shares of Class B Common Stock ("Class B Common Stock"). Each share of USOC
common stock converted into 0.496 shares of Common Stock and 0.071 shares of
Class B Common Stock. Each share of Premier common stock converted into 5,250
shares of Common Stock and 750 shares of Class B Common Stock. The USOC and
Premier stockholders received an aggregate of 1,225,000 and 525,000 shares of
Common Stock and 175,000 and 75,000 shares of Class B Common Stock,
respectively. Premier and USOC incurred certain expenses related to the Offering
prior to the merger totaling approximately $2,200,000.
OrthAlliance began to conduct the business of providing management and
consulting services to the Founding Practices on August 26, 1997. Subsequent to
the IPO, the Company has entered into agreements for management services with
additional orthodontic and pediatric dental practices. These new practices along
with the Founding Practices collectively shall be referred to as "Allied
Practices".
Basis of Presentation
The condensed consolidated financial statements included herein have
been prepared by the Company without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (the "SEC"). Pursuant to
such regulations, certain information and footnote disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. The Company believes the
presentation and disclosure herein are adequate to make the information not
misleading. The financial statements reflect all elimination entries and
normal adjustments that are necessary for a fair presentation of the results
for the interim period ended June 30, 1998.
Operating results for interim periods are not necessarily indicative of
the results for full years. These condensed consolidated financial statements
should be read in conjunction with the Financial Statements of OrthAlliance and
related notes thereto, and management's discussion and analysis related thereto,
all of which are included in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997, (the "Annual Report").
In the opinion of Company management, the accompanying condensed
consolidated financial statements include the accounts of the Company and all
adjustments necessary to present fairly the Company's financial position at June
30, 1998 and December 31, 1997, and its results of operations and cash flows for
the six months and the three months ended June 30, 1998 and June 30, 1997.
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2. PEDOALLIANCE, INC.
On December 19, 1997, the Company created a new wholly owned subsidiary,
PedoAlliance, Inc., a Delaware Corporation ("PedoAlliance"). PedoAlliance was
formed to provide practice management or consulting services to pediatric dental
practices ("Allied Pediatric Practices") located throughout the United States.
PedoAlliance intends to manage the business aspects of or consult with, Allied
Pediatric Practices, thereby allowing the pediatric dentist ("Allied Pediatric
Dentist") to focus on delivering cost-effective, high quality patient care, and
to provide capital for the development and growth of such pediatric dental
practices. As of June 30, 1998, PedoAlliance had affiliated with three Allied
Pediatric Practices that included six Allied Pediatric Dentists operating out of
four offices. These practices generated $3.5 million in annual patient revenues
for the 12 month period immediately prior to affiliating with PedoAlliance.
Prior patient revenue is not necessarily indicative of the level of revenue
these practices may be expected to generate in the future. The total
consideration paid for these practices, excluding acquisition costs, was
$3,651,800. This consideration consisted of 85,493 shares of Common Stock with
an aggregated value at various stock prices of $1,286,800 and payment of
$2,364,900 cash.
3. NEW AFFILIATIONS
From January 1, 1998 to June 30, 1998, the Company entered into
agreements with 20 orthodontic practices which included 25 additional
orthodontists ("Allied Orthodontic Dentists") for a total consideration
(excluding acquisition costs) of $29,667,800. This consideration consisted of
1,358,689 shares of Common Stock with an aggregated value at various share
prices of $16,388,300 and payment of $13,279,500 in cash. These orthodontists
operated out of 45 locations and generated patient revenue of approximately
$24.7 million during a 12 month period immediately preceding the date of
affiliation. Prior patient revenue is not necessarily indicative of the level of
revenue these practices may be expected to generate in the future. The Company
has entered into agreements with certain Allied Practices to make the payment of
management fees after the first two years contingent on various factors,
including relative practice profitability, acquisition consideration, timely
reporting of information, participation in practice improvement programs and
orthodontist hours worked.
During the period April 1, 1998 to June 30, 1998, four orthodontists
ended their affiliation with certain Allied Practices. It is anticipated that
these orthodontists will be replaced with new associates once appropriate
candidates are recruited and affiliated. Some associate positions have been
eliminated due to enhanced practice efficiencies that made it possible for
Allied Practices to continue their businesses without the associates.
Considering these terminations, as of June 30, 1998, the Company was affiliated
with 126 Allied Pediatric Dentists and Allied Orthodontic Dentists
(collectively, "Allied Orthodontists").
4. ORTHALLIANCE FINANCE, INC.
On October 7, 1997, the Company created a wholly owned subsidiary,
OrthAlliance Finance, Inc., a Delaware corporation ("OA Finance"). OA Finance
has established a patient financing program for approved patients of Allied
Practices and non-affiliated practices, and purchases loans made by these
practices to their patients. OA Finance pays these practices approximately 20%
of the total discounted consideration that OA Finance is paying for the loan,
upon receipt of the appropriate loan documentation, and pays the balance, with
interest, over approximately 24 months. Alternatively, OA Finance pays 100% of
the discounted consideration at the option of the practice. As of June 30, 1998,
OA Finance had purchased 66 loans for a total value of $201,000.
5. SUBSEQUENT EVENTS
Lock-up Agreements
The Company issued 7,632,985 shares ("Initial Shares") of unregistered
Common Stock to its initial shareholders ("Initial Shareholders") immediately
prior to or concurrent with the closing of its IPO in August 1997. Of those
Initial Shares, 7,126,537 shares were subject to a one-year lock-up agreement
with J. C. Bradford & Co. ("Representative") as representative for the
underwriters for the IPO, under which agreement the shareholders agreed not to
sell, transfer, give, pledge, assign, irrevocably hypothecate or otherwise
dispose of such Initial Shares during the one year period ending August 21, 1998
without the prior written approval of the Representative, except in certain
limited circumstances. Since June 30, 1998, certain of the Initial Shareholders
owning approximately six million shares of the unregistered Common Stock have
entered into new lock-up agreements with the Representative, pursuant to which
the Initial Shareholders agreed not to sell, transfer, give, pledge, assign,
irrevocably hypothecate or otherwise dispose of such shares during a new one
year period without the prior written consent of the Representative, except that
the
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Initial Shareholders may: (i) give or pledge any Initial Shares without the
prior written approval of the Representative if the donee or pledgee agrees in
writing prior to such gift or pledge to be bound by the terms of the lock-up
agreement, (ii) sell up to fifteen percent (15%) of the Initial Shares during a
thirty (30) day period starting in approximately six months and (iii) margin up
to fifteen percent (15%) of the Initial Shares with the Initial Shareholder's
stock broker.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
The Company began providing management services to Allied Practices in
the United States on August 26, 1997 and therefore, comparisons with the first
half or second quarter of 1997 are not meaningful. The initial 55 Allied
Practices included 82 Allied Orthodontists operating 147 offices in 16 states.
By June 30, 1998, the Company had affiliated with 48 additional Allied
Orthodontic Dentists and Allied Pediatric Dentists operating out of 82 new
locations.
The Company has entered into either a service agreement ("Service
Agreement") or a consulting and business services agreement ("Consulting
Agreement") with each Allied Practice (the Service Agreements and Consulting
Agreements are sometimes referred to herein collectively as "Management
Agreements"). Under the Service Agreements, the Company provides practice
management services to Allied Practices in exchange for certain management fees.
Under the Consulting Agreements, which allow the Company and the Allied
Practices to comply with certain state law restrictions on practice management,
the Company provides consulting services in exchange for consulting fees. From
time to time the Company has entered into and may enter into agreements with
certain Allied Practices to make the payment of such management fees after a
certain period of time contingent on various factors, including relative
practice profitability, acquisition consideration, timely reporting of
information, participation in practice improvement programs and dentist hours
worked. Except with respect to five Service Agreements providing for the payment
of flat fees, the management fees earned by the Company are based on a
negotiated percentage of the "Adjusted Patient Revenue" of the Allied Practices.
Adjusted Patient Revenue is net patient revenue, as determined under generally
accepted accounting principles, including adjustments for contractual allowances
and other discounts, plus an adjustment for uncollectible accounts. For
orthodontic practices patient revenue is recognized as orthodontic services are
performed. If a patient enters into a long-term orthodontic services contract,
approximately 20% of the contract value is recognized at the time of initial
treatment. The balance of the contract revenue is realized evenly over the
remaining treatment period. The 20% revenue recognized 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. For pediatric dental practices patient
revenue is recognized as dental services are provided. Pursuant to the
Management Agreements, the Company incurs the expenses necessary to manage and
administer each Allied Practice and such expenses are paid from funds generated
by such Allied Practice. Such expenses include, but are not limited to,
salaries, wages and benefits of Allied Practice personnel (excluding
practitioners and, in some cases, certain clinical personnel), the office
(general and administrative) expenses of the Allied Practices and depreciation
and amortization of assets acquired from the Allied Practices. The Company also
incurs personnel and administrative expenses in connection with maintaining
corporate offices, from which the Company provides the management services.
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Results Of Operations (Unaudited)
The following table sets forth the percentage of certain items in
relation to net revenues in the Company's condensed consolidated statements of
income.
Six Months Ended Three Months Ended
June 30, 1998 June 30, 1998
---------------- ------------------
Net Revenue ....................... 100.0% 100.0%
Direct Expenses
Employee costs .................... 31.0 31.3
Practice supplies ................. 9.6 9.9
Rent .............................. 8.9 8.8
--------------- ---------------
Total direct expenses ............. 49.5 50.0
Depreciation and amortization ..... 3.2 3.1
General and Administrative ........ 29.2 29.5
--------------- ---------------
Net operating income .............. 18.1 17.4
Interest expense .................. (0.3) (0.5)
Interest income ................... 0.6 0.5
--------------- ---------------
Income before income taxes ........ 18.4 17.4
Provision for income taxes ........ 8.0 7.5
--------------- ---------------
Net income ........................ 10.4 9.9
Net Revenue. Net revenue was $33,362,000 and $18,712,000 for the six
month and three month periods ending June 30 ,1998 respectively. Net revenue for
the second quarter of 1998 increased 27.7% from the prior quarter. This increase
was caused primarily by the addition of new Allied Practices. The Company began
operations on August 26, 1997, therefore there is no comparison of net revenue
with the same period in the prior year. Net revenue reported by the Company is
derived by applying the appropriate management fee percentage against Adjusted
Patient Revenue, and adding the reimbursement from the Allied Practices of
practice expenses paid by the Company. In addition, the Company does include in
revenue the amortization of certain prepaid revenue balances that were acquired
from the Allied Practices. Prepaid revenue is recognized as the orthodontist
provides the services that were prepaid by patients before the practice
affiliated with the Company.
Direct Expenses. Direct expenses include clinical expenses paid and
corporate expenses incurred during the quarter. All expense categories in the
second quarter of 1998 compared to the first quarter increased due to the
addition of new Allied Practices in the second quarter. All direct expense
categories are consistent with management's expectations based upon expense
information provided by the Allied Practices prior to affiliation with the
Company. Direct expenses as a percentage to net revenue are consistent with
levels seen within the industry.
Depreciation and Amortization. Depreciation and amortization expense
relates to the depreciation of capital assets and the amortization of intangible
assets acquired resulting from new practice affiliations. Service agreement
intangibles are amortized over the expected period benefited, not to exceed the
term of the Management Agreements, which range from 20 to 25 years. Depreciation
and amortization expense increased in the second quarter of 1998 compared with
the first quarter due to the additional service agreement intangible assets
amortization associated with recent practice affiliations. Total depreciation
and amortization expense is consistent with management's expectations based upon
the number and size of the affiliations completed.
General and Administrative Expenses. General and administrative expenses
include practice administration expenses and corporate expenses pertaining to
accounting, legal, marketing and advertising. General and administrative
expenses increased by 30.5% during the second quarter of 1998 when compared with
the first quarter of 1998. This increase is primarily due to additional practice
administration expenses associated with new practices that recently affiliated
with the Company. In addition, increased corporate marketing expenses directed
toward generating additional patients for the Allied Practices caused a portion
of the increase in general and administrative expense for the second quarter.
Non-recurring Organizer Compensation. In the second quarter of 1997, the
Company issued warrants to owners of certain Founding Practices and Jonathan
Wilfong and Craig Hethcox for their assistance in the Offering. The Company
recorded compensation expense of approximately $2.3 million for the fair value
of these warrants. The Company began operations on August
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26, 1997, therefore the expense recognized in the second quarter of 1997 did not
include any practice administration expenses or other corporate administrative
expenses.
Interest Income. Represents interest earned on excess cash balances
invested primarily in short-term money market accounts, loans to affiliated
practices and loans to patients through OA Finance. Earnings on invested excess
cash declined during the quarter as excess cash balances were used to pay the
consideration for practice affiliations.
Interest Expense. Represents interest incurred on borrowings against the
Company's $25 million revolving credit facility. The increase in the outstanding
balance of the credit facility caused interest expense to increase during the
quarter.
Liquidity and Capital Resources
The patient receivables of the Allied Practices are recorded at net
realizable value on the date of purchase by the Company. Any subsequent
uncollectable amount is written off by OrthAlliance and is funded by the Allied
Practice. These accounts receivable should generate funds required for (i) the
expenses incurred by the Company to manage and administer the Allied Practices,
(ii) the management fees, and (iii) salaries for other employees of the Allied
Practices, with the balance due to the owning orthodontists of the Allied
Practices.
For the six months ended June 30, 1998, the Company generated $2.8
million in cash. During the six months ended June 30, 1998, $16.9 million in
cash was used in investing activities mostly due to the consideration paid
for new affiliations during the quarter. Financing activities provided $6.8
million in cash during the first half of 1998 composed principally of the draws
from the Company's credit facility with First Union National Bank.
As of June 30, 1998, the Company had a working capital balance of
approximately $1.9 million, a decrease of $11.2 million from December 31, 1997.
The decline in working capital is primarily attributable to investments in new
practice affiliations. The Company continues to anticipate that the primary uses
of its capital will include additional affiliation with orthodontic and
pediatric dental practices, expenditures related to the development of satellite
offices and funding the working capital needs of the Company and the Allied
Practices. The Management Agreements provide for advances by the Company to the
Allied Practices for working capital requirements and other purposes. Such loans
generally bear interest at prime plus one percent and are repayable over varying
periods not to exceed five years. It is anticipated that the foregoing capital
expenditures will be funded from the Company's cash flow from operations,
existing working capital and borrowings under the revolving credit facility.
Year 2000 Compliance
The Company has reviewed the systems utilized by the corporate office in
all areas of office automation, including payroll, payables, general ledger and
data management. In all cases the systems are already in compliance with Year
2000 requirements or the developers of the systems have a Year 2000 compliant
version available. The Company intends to upgrade the remaining systems at the
corporate office that are not already in compliance with a compliant version
before the end of 1998. The cost to upgrade these systems is minimal since the
upgrades are provided by the developers under the maintenance agreements already
in place.
In the event the Company fails to identify all of the systems at risk
for possible failure due to the Year 2000 issue, the Company plans to retain a
complete copy of the systems and data in use prior to December 31, 1999. If
after the Company begins operations in the Year 2000 it is determined that a
system has failed, the Company can reset all system clocks to a date prior to
January 1, 2000 and restore the affected systems from the copy. This will
provide the Company with more time to repair the affected systems.
The Company does not own any "Non-IT" systems at the corporate office
that might also be affected by the Year 2000 issue. As an example, the Company
does not own any automated machinery, elevators, telephone switches, or other
equipment that might contain microcontrollers. Therefore, the Company does not
believe that it is at risk from any failure associated with these kinds of
devices. The Company may own some "Non-IT" systems in practice offices that
might be affected by the Year 2000 issue. The Company has not yet determined
which offices may contain such devices. The Company plans to evaluate all
equipment owned by the Company in each Allied Practice office to determine if
any such devices exist. The cost to repair any devices found would be reimbursed
to the Company by the affected Allied Practices.
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The Company has not performed an evaluation of any of the systems
installed in each of its Allied Practice offices. Therefore, the Company is not
aware of which systems are currently Year 2000 compliant. The Company does have
a plan to evaluate the Allied Practice office systems for Year 2000 compliance
before the end of 1998. The Company plans to work with those practice offices
that are found to possess systems that are not Year 2000 compliant to either
upgrade, replace or modify non-compliant systems with compliant systems. The
Company will develop a timetable for completing this effort for each Allied
Practice office once it is determined which offices and which systems are
affected. Since the Company is not aware of which systems are currently Year
2000 compliant, the Company is not aware of the costs associated with upgrading
these systems to Year 2000 compliance; however, any costs incurred by the
Company to complete a systems upgrade would be reimbursed to the Company by each
Allied Practice. The Company has not performed a detailed analysis of each
system to determine the impact on the Company in the event any Allied Practice
failed to upgrade any one of their office systems prior to the end of 1999;
however, the Company believes that the only two office systems that might have a
direct impact on its operations are the practice management systems and accounts
payable systems. In some instances, Allied Practice offices have installed a
network of computers that rely upon a central database server for multiple user
access to information. In these instances, failure by these Allied Practice
offices to upgrade the network system to be Year 2000 compliant, could affect
the practice management and accounts payable systems, even if these later two
systems are themselves Year 2000 compliant. The Company believes that the impact
on Company operations from a failure of the practice management or accounts
payable systems would be minimal. Failure of the practice management systems can
be mitigated by manual posting of payments to client records. Failure of the
accounts payable system can be mitigated by manual preparation of vendor
payments. Although additional staffing may be necessary to perform these tasks
without the benefit of the affected automated systems, these functions are not
critical to providing orthodontic or pediatric dental services. Therefore, the
Company believes that operations can continue relatively unaffected by a failure
of an Allied Practice office to upgrade their system to Year 2000 compliance.
The Company has not performed an evaluation of all of the significant
third party entities to determine if a failure by any one of them to upgrade
their systems to Year 2000 compliance could have an adverse impact on the
Company. Some of the significant third party entities that the Company currently
has a material relationship, include General Telephone, MCI, Automated Data
Processing, Edison International and all of the various financial institutions
with which the Company currently has banking relationships. The Company has not
yet assessed the risks associated with a failure by any of the systems utilized
by these entities and what steps can be taken to mitigate these risks.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Applicable.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) None
(b) None
(c) None
(d) None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
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(a) None
(b) None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) The annual meeting of stockholders of the Company was held on Friday,
June 5, 1998. At this meeting, the following matters were voted upon by the
Company's stockholders.
(b) Election of Class I Directors
Douglas D. Durbin, D.M.D., M.S.D. and W. Dennis Summers were elected to
serve as Class I directors of the Company until the 2001 Annual Meeting
of Stockholders or until their successors are elected and qualified. The
vote was as follows:
Name Votes Cast in Votes Cast Against Abstentions
Favor or Withheld Non Votes
---------------- --------------------- -----------------
Douglas D. Durbin, D.M.D., M.S.D. 9,893,469 108,013
W. Dennis Summers 9,894,469 107,013
The following directors continued in office following the meeting:
Name Term Expires
- ---- ------------
Randall K. Bennett, D.D.S., M.S. 1999
U. Bertram Ellis, Jr. 1999
Randall A. Schmidt, D.D.S., M.S.D. 1999
Craig L. McKnight 2000
Sam Westover 2000
Jonathan E. Wilfong 2000
(c)(i) Approval of Amendment to the 1997 Employee Stock Option Plan
The stockholders of the Company approved an increase in the number of
shares of Common stock which may be issued subject to options granted under the
1997 Employee Stock Option Plan from 1,000,000 to 1,500,000 shares, subject to
certain anti-dilution provisions set forth in the plan. The vote was as follows:
Votes Cast in Votes Cast Against Abstentions
Favor or Withheld Non Votes
--------------- --------------------- ---------------------
9,323,354 314,724 363,404
(c)(ii) Approval of Amendments to the 1997 Non-Employee Director Stock Plan
The stockholders of the Company approved amendments to the 1997
Non-Employee Director Stock Plan ("Director Plan") to change the class of
persons eligible to participate in the Director Plan from non-employee directors
to all directors of the Company and to give the Compensation Committee of the
Board of Directors authority and discretion to administer the Director Plan
rather than providing for automatic formula grants. The vote was as follows:
Votes Cast in Votes Cast Against Abstentions
Favor or Withheld Non Votes
----------------- ---------------------- ------------------
9,063,512 445,775 492,195
(c)(iii) Approval of the 1997 Orthodontist Stock Option Plan
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The stockholders of the Company approved the 1997 Orthodontist Stock
Option Plan. The vote was as follows:
Votes Cast in Votes Cast Against or Abstentions
Favor Withheld Non Votes
---------------- -------------------------- --------------
8,855,950 625,758 519,774
(c)(vi) Selection of Independent Auditors
The stockholders of the Company ratified the appointment of Arthur
Andersen LLP as the Company's independent auditors for the fiscal year ending
December 31, 1998. The vote was as follows:
Votes Cast in Votes Cast Against or Abstentions
Favor Withheld Non Votes
----------------- ------------------------- --------------
9,993,107 1,100 7,275
(d) None
ITEM 5. OTHER INFORMATION.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
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 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).
4.2 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).
27.1 Financial Data Schedule.
99.1 Safe Harbor Compliance Statement.
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended
June 30, 1998.
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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: August 13, 1998 By: /s/ Sam Westover
----------------------------
Sam Westover,
President and
Chief Executive Officer
Date: August 13, 1998 By: /s/ Robert Chilton
----------------------------
Robert Chilton,
Chief Financial Officer
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