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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM
--------------- TO
--------------- .
COMMISSION FILE NUMBER 000-22975
ORTHALLIANCE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4632134
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
21535 HAWTHORNE BOULEVARD, SUITE 200
TORRANCE, CALIFORNIA 90503
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(310) 792-1300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
CLASS A COMMON STOCK, PAR VALUE $.001 PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant as of March 27, 2001 (based on the last
reported closing price per share of Common Stock as reported on The Nasdaq
National Market on such date) was approximately $23,045,468. As of March 27,
2001, the registrant had 12,076,601 shares of Class A Common Stock outstanding
and 172,526 shares of Class B Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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ORTHALLIANCE, INC.
INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2000
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 9
Item 3. Legal Proceedings........................................... 9
Item 4. Submission of Matters to Vote of Security Holders........... 9
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters..................................................... 10
Item 6. Selected Financial Data..................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 12
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 21
Item 8. Consolidated Financial Statements and Supplementary Data.... 21
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 21
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 21
Item 11. Executive Compensation...................................... 24
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 28
Item 13. Certain Relationships and Related Party Transactions........ 29
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 34
Exhibit Index......................................................... 34
Signatures............................................................ 37
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This Form 10-K and documents incorporated by reference in this Form 10-K
contain certain forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of
1934 and such forward-looking statements are subject to the safe harbors created
thereby. Management cautions that any such forward-looking statements include
statements regarding the intent, belief or current expectations of the Company
and its management. For this purpose, any statements contained in this Form 10-K
except for historical information may be deemed to be forward-looking
statements. Without limiting the generality of the foregoing, words such as
"may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate,"
or "continue" or comparable terminology are intended to identify forward-
looking statements. In addition, any statements that refer to expectations,
projections or other characterizations of future events or circumstances are
forward-looking statements.
The business and operations of the Company are subject to risks that
increase the uncertainty inherent in the forward-looking statements, and the
inclusion of such information should not be regarded as a representation by the
Company or any other person that the objectives or plans of the Company will be
achieved. Such forward looking statements are not guarantees of future
performances and involve risks and uncertainties. Actual results may differ
materially from those contemplated by such forward-looking statements.
The Company believes that the following factors, among other things, could
cause actual results to differ materially from those in forward-looking
statements set forth in this Form 10-K: (a) the Company's ability to grow
through affiliations with additional orthodontic practices or other identified
means, including internal practice growth, additional satellite offices, and de
novo practices; (b) the Company's ability to identify suitable affiliation
candidates and to profitably manage or successfully integrate new Allied
Practices with the Company and its existing Allied Practices; (c) the Company's
ability to favorably resolve disputes concerning claims of alleged defaults by
the Company under agreements with its Allied Practices; (d) the Company's
dependence on the ability of its Allied Practices to recruit and employ
replacement orthodontists and pediatric dentists as current orthodontists and
pediatric dentists retire or terminate their employment agreements with the
Allied Practices; (e) challenges to the enforceability of the Company's
agreements with its Allied Practice and the cost of enforcing such agreements in
the event the Allied Practices enter into litigation with the Company; (f) the
level of competition in the practice management industries and the professions
of orthodontics and pediatric dentistry; (g) regulatory development and changes
in the United States healthcare system and dental and orthodontic professions,
including accounting standards applicable thereto, that may affect the
profitability of the Company or the enforceability of the Company's operative
agreements with its Allied Practices and Allied Practitioners; (h) the Company's
dependence on revenues generated by the Allied Practices and the Company's
ability to collect amounts owed by the Allied Practices; (i) the Company's
ability to secure capital, and the related cost of such capital, needed to fund
the future growth of the Company; (j) the Company's currently low stock price
may adversely affect its ability to raise capital, its relations with
stockholders, including orthodontists and pediatric dentists at the Allied
Practices, and its ability to retain a listing on a nationally recognized stock
exchange; (k) the Company's ability to retain key personnel and staff the Allied
Practices with appropriate qualified personnel; (l) the continued availability
to the Company of adequate insurance; and (m) the Allied Practices' reputation
for delivering high-quality patient care and their ability to attract and retain
patients. The foregoing factors should not be construed as exhaustive or as an
admission regarding the adequacy of disclosures previously made by the Company.
These and other factors that may affect future operating results are discussed
in more detail in "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and are set forth in the safe harbor compliance
statement included as Exhibit 99.1 to Form 10-K and are hereby included by
reference.
Assumptions relating to the foregoing involve judgments with respect to,
among other things, future economic, competitive and market conditions, and
future business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. In addition,
risks, uncertainties and assumptions change as events or circumstances change.
The Company disclaims any obligation to publicly release the results of any
revisions to these forward-looking statements which may be made to reflect
events or circumstances occurring subsequent to the filing of this Form 10-K
with the SEC or
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otherwise to revise or update any oral or written forward-looking statement that
may be made from time to time by or on behalf of the Company.
OrthAlliance(R), PedoAlliance(R) and certain of the Company's names,
protocols and other attributes referred to herein are trademarks of the Company.
This Annual Report on Form 10-K may also contain trademarks of other companies.
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PART I
ITEM 1. BUSINESS.
OVERVIEW
OrthAlliance, Inc., a Delaware corporation (together with its subsidiaries,
the "Company"), was incorporated on October 21, 1996 and provides practice
management and consulting services to orthodontic and pediatric dental practices
throughout the United States. The Company (i) manages or provides consulting
services with respect to certain business aspects of orthodontic and pediatric
dental practices affiliated (the "Allied Practices") with the Company and (ii)
provides capital for the development and growth of Allied Practices.
OrthAlliance's wholly-owned subsidiaries, incorporated in Delaware, include
PedoAlliance, Inc. ("PedoAlliance") and OrthAlliance Finance, Inc. ("OA
Finance") formed in December 1997, PedoAlliance Properties, Inc., a wholly-owned
subsidiary of PedoAlliance, OrthAlliance Properties and OrthAlliance Services,
Inc. were incorporated in California and were formed in April 1999, OrthAlliance
Holdings, Inc., a Texas subsidiary, 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. "New Image," which was effective March 1,
2000. OrthAlliance, Inc. and its subsidiaries are collectively referred to as
"OrthAlliance" or the "Company".
On August 26, 1997, the Company affiliated with 55 Allied Practices
including 81 orthodontists and 1 pediatric dentist operating 147 offices in 16
states pursuant to long-term management service and consulting agreements, and
commenced its initial operations. From August 26, 1997 to December 31, 2000, the
Company increased the number of Allied Practices, including pediatric dental
practices, to a net total of 175, with 225 orthodontists and pediatric dentists
(collectively, "Allied Orthodontists or Allied Practitioners") operating 394
offices in 32 states. From May 1, 1998 through December 31, 2000, PedoAlliance
entered into management and consulting agreements with 20 pediatric dental
practices, with 29 allied pediatric dentists ("Allied Dentists") operating 24
offices in 8 states, all of which are included in the Company information set
forth above. Unless the context indicates otherwise, certain references herein
to Allied Orthodontists or Allied Practitioners also include Allied Dentists. OA
Finance was formed in December 1997 to offer financing alternatives to the
patients of the Allied Practices. During 2000, OA Finance funded 289 loans to
patients for a total value of $.8 million and had $1.4 million of loans
outstanding as of December 31, 2000.
The Company intends to continue to expand its network of Allied Practices
and to target orthodontic and pediatric dental practices that management
believes are leading practices in their markets based upon a variety of factors,
including size, profitability, historical growth and reputation for high quality
care among local consumers of orthodontic and pediatric dental services and
within the orthodontic and pediatric dental services industry.
The Company provides fee-based management or consulting services to its
Allied Practices thereby allowing Allied Orthodontists or Pediatric Dentists to
concentrate on providing cost effective, quality patient care. The Company does
not practice orthodontics or dentistry, but generally acquires certain operating
assets of an orthodontic and pediatric dental practice, employs the practice
staff and administrative employees (except orthodontists and dentists, and where
applicable law requires, hygienists and dental assistants), and enters into
service or consulting agreements with the Allied Practices whereby the Company
also provides management or consulting services to the Allied Practices,
including billing and collections, cash management, purchasing, inventory
management, payroll processing, advertising and marketing, financial reporting
and analysis, productivity reporting and analysis, training, associate
orthodontist recruiting and capital for satellite office development and
acquisitions. Where state law allows and upon request by an Allied Practice, the
Company leases equipment or office space to the Allied Practices. Unless
otherwise indicated by the context, references herein to practice management
services, agreements or rights include consulting or similar
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arrangements that the Company has or will enter into with certain Allied
Practices in order to comply with applicable regulations in certain states
regarding practice management.
For the year ended December 31, 2000, the Company generated an operating
profit of $23.7 million on $142.0 million in net revenue.
THE ORTHODONTIC INDUSTRY
Orthodontics, the art and science of correcting the misalignment of teeth,
has historically been one of the most profitable specialties in dentistry.
Orthodontic research and education have aided the development of new materials
and techniques of orthodontic treatment, including the use of computers to help
solve complex cases. In 1998, orthodontists in the United States conducted
examinations of nearly 2.7 million potential new patients and initiated
treatment for approximately 1.8 million patients. The typical orthodontist
initiated treatment for approximately 200 patients in 1998 and maintained
approximately 450 active cases. Unless otherwise indicated, industry information
is derived from the 1999 Journal of Clinical Orthodontists Orthodontic Practice
Study (the "JCO Study") and relates to 1998. The information compiled in the JCO
Study relates to orthodontists who have completed accredited graduate
orthodontic training programs and does not include general dentists who also
perform certain orthodontic services.
The primary target market for orthodontic treatment is children ages 8 to
18. In 1998, approximately 85% of all patients treated were children. The U.S.
Census Bureau estimates that as of November 1, 1999, there were approximately
39.5 million children and adolescents between the ages of 10 and 19. Management
believes that as many as 80% of these children and adolescents could benefit
from orthodontic treatment. In addition to the traditional juvenile market, the
adult market has been a growing market for orthodontic services. Based on
statistics obtained from the JCO Study, management believes that the adult
market for orthodontic services remains largely untapped, as the number of
adults who need or want orthodontic treatment substantially exceeds the number
of patients currently seeking treatment. In 1996, standard case fees averaged
approximately $3,900 for children and $4,300 for adults.
There are approximately 9,000 practicing orthodontists in the United
States, nearly all of whom have graduated from accredited graduate programs of
orthodontics. The industry is highly fragmented, with approximately 90% of the
practicing orthodontists acting as sole practitioners and the balance practicing
in multiple-doctor practices (generally two orthodontists). The training and
qualification of an orthodontist is extremely rigorous. Generally, a dentist
must graduate in the top 10% of his or her class at an accredited graduate
school of dentistry, pass national and state board examinations, and complete an
accredited graduate orthodontic program to become an orthodontist. These
programs typically are structured as two- or three-year programs. Each year
about 200 new orthodontists graduate from accredited orthodontic programs.
THE PEDIATRIC DENTAL INDUSTRY
Pediatric dentistry is an age-defined specialty that provides both primary
and comprehensive preventative and therapeutic oral health care for infants and
children through adolescence, including those with special health care needs.
Pediatric dentists provide primary and specialty care in offices as well as in
hospital and other institutional sites and, when indicated, in conjunction with
other dental and medical disciplines. There are approximately 3,600 professional
active pediatric dentists in the United States. Pediatric dentists must complete
a specialty degree program which is typically two to three years in length.
Approximately 160 students are admitted each year to pediatric dental specialty
training programs.
The U.S. Bureau of the Census projects that between 1998 and 2025 there
will be an increase of 8.9 million children under the age of 15. Furthermore,
the number of practicing pediatric dentists has decreased from approximately
3,900 in 1990 to approximately 3,600 in 2000. The number of spaces available in
pediatric dental training programs has decreased from approximately 200 in 1990
to 160 in 2000. Accordingly, the Company believes that there will be an
increased demand for the services of pediatric dentists.
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OPERATING STRATEGY
The Company's operating strategy focuses on enabling the Allied Practices
to compete more effectively and realize greater profitability than other
practices, thereby providing an inducement for additional practices to affiliate
with the Company. Key elements of the Company's operating strategy include:
Emphasizing Quality Patient Care. Management believes that the services and
support it provides the Allied Orthodontists impact the level of patient care
positively by increasing the Allied Orthodontists' time available to concentrate
on patient care. The qualifications of providers of orthodontic and pediatric
dental services vary from general dentists who have taken weekend courses to
graduates of accredited three-year programs. Nearly all Allied Orthodontists
affiliated with the Allied Practices are graduates of accredited orthodontic or
pediatric dental programs. The Company established two clinical care advisory
committees, one consisting of Allied Orthodontists and the other consisting of
Allied Dentists, to formulate educational and training programs and to consult
with each other on current treatments, techniques and issues.
Capitalizing on the Best Demonstrated Practices of Allied
Orthodontists. The Company identifies practice-level strategies that have proven
successful for individual Allied Practices and shares this information among
other Allied Practices. The Company provides Allied Orthodontists with
comparative operating and financial data to enable Allied Orthodontists to
detect areas of their practices that could be improved. The Company provides its
own analysis of such operating and financial data and recommends changes to
improve performance. The Company consults with Allied Practices that have
demonstrated success in a certain area and generally seeks to facilitate
communication among Allied Practices through periodic conferences and meetings
and through the internet.
Achieving Operating Efficiencies and Economies of Scale. The Company
implements a variety of operating procedures and systems to improve the
productivity and profitability of each Allied Practice and to achieve economies
of scale including, without limitation, centralized payroll processing and
national group purchasing contracts. Operating efficiencies and economies are
instituted with the Allied Orthodontist's consent on a per Allied Practice need
basis.
Increasing the Affordability of Professional Care through Flexible Payment
Plans. The Company assists Allied Practices in developing and implementing
payment plans designed to make orthodontic and pediatric dental services more
affordable to prospective patients. Many of the Allied Practices historically
receive a down payment of approximately 25% of the total treatment plan fee at
the early stages of the procedure. Recognizing that orthodontic services are
largely discretionary and that a significant down payment is often a deterrent
to prospective patients, the Company believes that flexible payment plans or
financing opportunities are an effective means of increasing patient volume.
Payment plans are tailored to respond to the various market demands and
opportunities. The Company makes general recommendations to all Allied Practices
with respect to instituting flexible payment plans and develops and implements
market-tailored plans at the request of individual Allied Practices. In
addition, the Company provides access to working capital necessary for the
Allied Practices to implement flexible payment plans which may result in the
reduction or elimination of down payments.
Stimulating Demand in Local Markets through Marketing. In consultation with
and upon approval of the Allied Practices, the Company develops and implements
marketing plans to augment each Allied Practice's referral and other marketing
systems. Certain Allied Practices have developed referral systems with local
dentists. Upon the request of an Allied Practice and in appropriate markets, the
Company attempts to assist such Allied Practice in reaching potential patients
through print, local television and radio advertising.
GROWTH STRATEGY
The Company's growth strategy includes affiliation with existing practices
in both new and existing markets, the development of satellite offices for
existing Allied Practices and internal growth through improved operating
efficiencies.
Internal Growth through Improved Operating Efficiencies. The Company offers
a variety of operating procedures and systems to improve the productivity and
profitability of the Allied Practices. The Company
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implemented payroll processing, financial reporting and analysis, national group
purchasing discounted contracts and assists with appropriate credit and
collection policies which accommodate specific needs of each Allied Practice.
Operating efficiencies and economies are instituted on a per Allied Practice
need basis.
Development of Satellite Offices. If management determines market demand
supports practice expansion, the Company assists Allied Orthodontists in
developing satellite offices to be integrated into Allied Practices. The Company
provides a certain amount of capital for practice expansion, market research,
site selection, office design and marketing support for satellite office
development.
Affiliations with Existing Practices. The Company targets for affiliations
a market that includes approximately half of the orthodontic and pediatric
dental practices in the United States (approximately 4,500 orthodontic practices
and 1,500 pediatric dental practices), which practices fit the Company model of
quality and opportunity for revenue and earnings growth. The Company believes
that affiliation will be an attractive option for existing practices, because
the Company (i) provides access to capital to open and integrate new offices
into existing Allied Practices, (ii) makes available best practice ideas from
other Allied Practices, (iii) designs and offers business and clinical systems
for Allied Practices, (iv) with the approval of the Allied Orthodontist, employs
the necessary business and non-professional personnel for Allied Practices, (v)
helps Allied Practices by recommending marketing and advertising strategies, and
(vi) assists Allied Orthodontists with administrative and business related
tasks. The Company has reduced the number of affiliations with existing
practices in order to conserve capital resources. This is partially due to the
Company's low stock price, which has made it difficult for the Company to raise
capital and affiliate with practices. See, Item 5, Other Consequences of the
Company's Historically Low Stock Price.
De Novo Practice Development. In addition to traditional affiliations, the
Company believes that a complementary element to the Company's growth strategy
includes the development of De Novo Practices. De Novo practice development
represents an opportunity for the Company to build practices from the ground up
in key strategic markets. By drawing on the experiences of its existing members,
the Company can help to identify and implement the "best practices" for De Novo
operations. The Company has, to date, established two De Novo Practices.
PAYMENT PLAN AND CASE FEES
In the Allied Practitioners offices, at the initial orthodontic treatment,
generally the patient signs a contract outlining the terms of the treatment,
including the anticipated length of treatment, total fees and payment terms.
Each Allied Orthodontist determines the appropriate fee to charge for services
to patients based upon market conditions in the area served by that Allied
Orthodontist. Generally, the amount charged by the Allied Orthodontists is
independent of the patient's source of payment. The number of required monthly
payments is estimated at the beginning of the case and generally corresponds to
the anticipated number of months of treatment. Generally, the Allied Practices
require approximately 25% of the treatment contract to be paid upon installation
of the braces, and the remaining 75% evenly over the remainder of the treatment
term.
If the treatment period exceeds the period originally estimated by the
Allied Orthodontist, the patient and the Allied Orthodontist will determine
whether payment for additional treatment will be required. If the treatment is
completed prior to the scheduled completion date, the patient is required to pay
the remaining balance of the contract. If a patient terminates the treatment
prior to the completion of the treatment period, the patient is required to pay
the balance due for services rendered to date.
Other payment plans with lower monthly payments are available for patients
who have insurance coverage for the treatment. Payments from patients with
insurance may be lower, depending upon the amount of the fee paid on behalf of
the patient by insurance policies. For patients with insurance coverage, the
portion of the fee not covered by insurance is paid by the patient.
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LOCATION
As of December 31, 2000, the Company provided management services to Allied
Practices at the following locations:
NUMBER OF NUMBER OF NUMBER OF
STATE PRACTITIONERS OFFICES CITIES
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Alabama........................................... 4 9 5
Arkansas.......................................... 3 2 5
Arizona........................................... 11 15 2
California........................................ 37 64 54
Colorado.......................................... 7 5 3
Florida........................................... 24 49 38
Georgia........................................... 31 59 40
Hawaii............................................ 2 6 5
Idaho............................................. 1 2 1
Illinois.......................................... 3 8 7
Indiana........................................... 15 26 17
Kansas............................................ 1 2 1
Kentucky.......................................... 2 7 6
Massachusetts..................................... 1 1 6
Maryland.......................................... 9 8 1
Michigan.......................................... 2 2 2
Minnesota......................................... 2 4 3
Mississippi....................................... 2 6 8
North Carolina.................................... 1 2 1
New Mexico........................................ 1 1 1
New York.......................................... 1 1 1
Ohio.............................................. 3 6 5
Oregon............................................ 2 3 3
Pennsylvania...................................... 4 7 3
South Carolina.................................... 5 9 9
South Dakota...................................... 2 7 6
Tennessee......................................... 9 10 8
Texas............................................. 27 49 36
Utah.............................................. 6 12 9
Virginia.......................................... 2 2 2
Washington........................................ 5 9 8
Wyoming........................................... 1 1
--- --- ---
Total................................... 225 394 297
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AGREEMENTS WITH ALLIED PRACTICES AND ALLIED PRACTITIONERS
Each Allied Practice has entered or enters into the following three
material agreements: (i) an acquisition agreement, which may be in the form of a
purchase and sale agreement whereby the Company acquires certain of the assets,
or stock of an entity holding certain assets, of the Allied Practice, or an
agreement and plan of reorganization, whereby the Allied Practice transfers
certain assets to the Company; (ii) either a service agreement or a consulting
agreement (depending upon the applicable state regulatory requirements or a
management service agreement for OA New Image practices), whereby the Company
provides management or consulting services to the Allied Practice (collectively,
"Management Agreements"); and (iii) an employment agreement between the Allied
Practice and each related Allied Practitioner
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who is an equity holder in the Allied Practice or who provides orthodontic or
pediatric dental services through such practice for more than ten days each
month.
Acquisition Agreements. Each acquisition agreement generally results in the
sale by the Allied Practice of its equipment, licenses (to the extent assignable
by law), inventory, accounts receivable, furniture and other personal property,
or some combination thereof based on applicable state laws or regulations, in
exchange for consideration based on the Allied Practice's adjusted patient
revenue. The aggregate purchase price paid by the Company is generally payable
in cash, shares of Class A Common Stock, or a promissory note as determined by
each Allied Practice and the Company. The aggregate consideration, including
acquisition costs, paid by the Company in connection with the affiliation of the
175 Allied Practices net of consolidation from August 26, 1997 to December 31,
2000 was approximately $217.0 million, comprised of approximately $90.3 million
in cash, 8.2 million shares of Class A Common Stock and promissory notes of
$29.2 million.
Service Agreements. Each service agreement generally requires or permits
the Company to perform certain services for the Allied Practices, including
provide and maintain specified furnishings and equipment; provide necessary
employees (except practitioners and, where applicable law requires, hygienists
and dental assistants); establish appropriate business systems; purchase and
maintain inventory; perform payroll and accounting functions; provide billing
and collection services with respect to patients, insurance companies, and
third-party payors; arrange certain legal services not related to malpractice
litigation; design and execute a marketing plan; advise with respect to new
office locations; and manage and organize the Allied Practice's files and
records, including patient records where permitted by applicable law. If the
Allied Practice lacks sufficient funds to pay its current expenses, the Company
is required to advance funds to the Allied Practice for the purpose of paying
such expenses, subject to terms to be agreed upon. In exchange for performing
the services described above, the Company receives a management fee based on one
of the three fee structures described in Management's Discussion and Analysis of
Financial Condition and Results of Operations. The Company has entered into
agreements with certain Allied Practices to make the payment of such management
fees after the first two years contingent on various factors, including practice
profitability compared to acquisition consideration, timely reporting of
information, participation in practice improvement programs and orthodontist
hours worked. Prior patient revenue is not necessarily indicative of the level
of revenue that these practices may be expected to generate in the future.
The term of each service agreement is for 20 or 25 years, subject to prior
termination by either party in the event the other party becomes subject to
voluntary or involuntary bankruptcy proceedings or materially breaches the
agreement, subject to a cure period. In addition, the Allied Practices may
terminate the service agreements upon the occurrence of a change of control of
the Company (as defined therein, which does not include a transaction approved
by the Company's Board of Directors). Upon the expiration or termination of the
service agreement, the Allied Practice may, and in certain circumstances must,
repurchase for cash (at book value) certain assets, including all equipment, and
assume certain liabilities of the Company related to the Allied Practice.
Each service agreement is generally not assignable by either party thereto
without the written consent of the other party; however, the Company may assign
the service agreement without the Allied Practice's consent to any entity under
common control with the Company. The Company and the Allied Practice indemnify
each other for costs and expenses incurred by the other party that are caused
directly or indirectly by, as the case may be, the Company's or the Allied
Practice's intentional or negligent acts or omissions. In the case of the Allied
Practice's obligation to indemnify the Company, such obligation also applies to
intentional or negligent acts and omissions occurring prior to the date of the
service agreement. As of December 31, 2000, the Company had entered into service
agreements with 76 Allied Practices.
Consulting Agreements. Certain provisions of the consulting agreement are
substantially similar to the service agreement, including provisions relating to
the Company's obligation to loan funds to the Allied Practice in the event the
Allied Practice is unable to pay its current expenses, termination of the
consulting agreement, repurchase of assets and assumption of liabilities by the
Allied Practice upon expiration or termination, assignment, and indemnification.
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The services available to the Allied Practice under each consulting
agreement generally include consulting with respect to equipment and office
needs; preparing staffing models appropriate for an Allied Practice; advising
and training with respect to business systems; purchasing and maintaining
inventory; advising with respect to and providing or arranging accounting and
bookkeeping services; advising with respect to developing a marketing plan;
assessing the financial feasibility of establishing new offices; providing
billing and collection services; and assisting the Allied Practice in organizing
and developing filing and recording systems. In exchange for such services, the
Company receives a consulting fee based on one of the three fee structures
described in Management's Discussion and Analysis of Financial Condition and
Results of Operations. As of December 31, 2000, the Company had entered into
consulting agreements with 68 Allied Practices.
Pursuant to both the service agreements and consulting agreements, Allied
Practitioners maintain professional control over and ownership of their
practices, determine which personnel will be allied with the Allied Practices
and set their own standards of practice. The Company does not engage in the
practice of orthodontics or dentistry. Each Allied Practitioner is responsible
for compliance of his or her Allied Practice with state and local regulations
applicable to the practice of orthodontics and dentistry and with licensing or
certification requirements. Each Allied Practice, in its sole discretion,
determines the fees to be charged for services provided to patients based upon
market conditions in the service area and other factors deemed appropriate by
the Allied Practice. Each Allied Practice executes payor contracts and acquires
and pays for its own malpractice insurance coverage.
Management Service Agreements. In March 2000, the Company and OA New Image
assumed the obligations of New Image under the various Management Service
Agreements ("MSA") between New Image and the orthodontic practices with whom it
had entered into MSAs. The form of MSA provides for a variation of the service
fee calculation compared to the traditional Company form defined in the service
or consulting agreement. Under the MSAs, the service fee amount varies monthly
depending on the Allied Practices financial performance and represents the
residual amount after the payment of practice expenses and contractually
determined practice distributions. The service fee is affected by two variables,
(1) total Allied Practice gross revenue, less refunds, and (2) overhead. Service
fees are calculated based on two separate standardized grids set forth in the
MSA that determine (i) the percent of practice revenue that is distributed to
the Allied Practice based on that Allied Practice's gross revenue, less refunds,
("Gross Revenue Grid") and (ii) any additional or offsetting percentage of gross
revenue, less refunds, that is distributed to the Allied Practice based upon
that Allied's Practice's overhead ("Overhead Grid"). Pursuant to the Gross
Revenue Grid, in general, the Company's retained service fees increase if the
Allied Practice's gross revenue increases and decrease if the Allied Practice's
gross revenue decreases. Pursuant to the Overhead Grid, in general the Company's
retained service fees decrease if the Allied Practice's overhead expenses
increase and the retained service fees increase if the Allied Practice's
overhead decreases. The maximum retained service fee percentage is 20.0%. The
average service fee percentage for the OA New Image Allied Practices is
approximately 16.1%. In addition, a few OA New Image MSAs provide for a fixed
percentage service fee.
Employment Agreements. Each Allied Practitioner who is or becomes an equity
holder in an Allied Practice or who provides orthodontic or dental services
through an Allied Practice for more than 10 days a month is required to execute
an employment agreement with the Allied Practice. Each employment agreement
generally provides that the Allied Practitioner will perform professional
services for the Allied Practice for a period of five years, subject to prior
termination (i) for cause by the Allied Practice (which generally means death,
incapacity, willful misconduct, conviction for a felony, or chronic alcoholism
or drug addiction) and (ii) by the Allied Practitioner in the event of a
material breach by the Allied Practice. The Allied Practitioner agrees that
following termination or expiration of the employment agreement, he or she will
not compete for a period of two years in the market in which the Allied Practice
operates an office and will limit the methods of advertising in the area in
which an Allied Practice is located.
GOVERNMENT REGULATION
General. The field of dentistry, including orthodontics, is highly
regulated, and there can be no assurance that the regulatory environment in
which the Company operates will not change significantly in the future. In
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general, regulation of healthcare companies is increasing. Every state imposes
licensing requirements on individual practitioners and on facilities operated by
and services rendered by practitioners. In addition, federal and state laws
regulate health maintenance organizations and other managed care organizations
for which practitioners may be providers. The Company, Allied Practices and
Allied Practitioners may become subject to compliance with additional
regulations.
The operations of the Allied Practices must meet federal, state and local
regulatory standards in the areas of safety and health. Historically, compliance
with those standards has not had any material adverse effect on the operations
of the Allied Practices. Based on its familiarity with the historical operations
of the Allied Practices and the activities of the Allied Practitioners,
management believes that the Allied Practices are in compliance in all material
respects with all applicable federal, state and local laws and regulations
relating to safety and health.
State Legislation. The laws of several states prohibit practitioners from
splitting fees with non-practitioners. Furthermore, many states prohibit
non-professional entities from practicing dentistry, including orthodontics,
employing practitioners, or in some circumstances, employing hygienists and
dental assistants. The laws of some states prohibit advertising professional
services under a trade or corporate name and require that all advertising be in
the name of the practitioner. A number of states also regulate the content of
advertisement of professional services and the use of promotional gift items. A
number of states limit the ability of a non-licensed dentist or non-orthodontist
to own equipment or offices used in a practice. Some of these states allow
leasing of equipment and office space to an orthodontic or dental practice,
under a bona-fide lease, if the equipment and office remain in the complete care
and custody of the practitioner. Management believes, based on its familiarity
with the historical operations of the Allied Practices, that the activities of
the Allied Practitioners and applicable regulations, that the Company's current
and planned activities do not constitute the prohibited practices contemplated
by these statutes and regulations. There can be no assurance, however, that
future interpretations of such laws, or the enactment of more stringent laws,
will not require structural and organizational modifications of the Company's
existing contractual relationships with its Allied Practitioners or the
operation of the Allied Practices. In addition, statutes in some states could
restrict expansion of Company operations in those jurisdictions. The Company
enters into either a service agreement or consulting agreement depending upon
applicable state regulations.
Regulatory Compliance. The Company monitors developments in laws and
regulations relating to the practice of orthodontics and dentistry. The Company
may be required to modify its agreements, operations and marketing strategies
from time to time in response to changes in the regulatory environment. The
Company structures all of its agreements, operations and marketing in accordance
with applicable law, although there can be no assurance that its arrangements
will not be successfully challenged or that required changes may not materially
affect the Company's business, financial condition and results of operations.
COMPETITION
The business of providing orthodontic and pediatric dental services is
highly competitive in each market in which the Allied Practices operate. Allied
Practices compete with practitioners who maintain single offices or operate a
single satellite office, as well as with practitioners who maintain group
practices or operate in multiple offices. Allied Practices also compete with
general dentists and pediatric dentists who provide certain orthodontic and
pediatric dental services, some of whom have more established practices. The
provision of orthodontic and pediatric dental services by such dentists and
pediatric dentists has increased in recent years.
The Company faces substantial competition from other entities as the
Company seeks to affiliate with additional practices. The Company is aware of
several practice management companies that are focused in the area of
orthodontics and dental specialties. Additional entities may enter this market
and compete with the Company. Certain of these competitors have greater
financial or other resources than the Company.
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EMPLOYEES
As of December 31, 2000, the Company employed approximately 1,604 persons,
including 1,200 full-time employees. None of the Company's employees is
represented by a collective bargaining agreement. The Company considers its
relationship with its employees to be good.
INTELLECTUAL PROPERTY
The Company has obtained trademark registrations from the U.S. Patent and
Trademark Office for its service marks "OrthAlliance" and "PedoAlliance."
Management intends to continue to utilize the service marks, as allowed by
applicable law, in the Company's marketing and advertising campaigns and in
connection with the Company's services.
INSURANCE
The Company maintains general liability insurance for itself and on behalf
of the Allied Practices and, where permitted by applicable law and insurers, the
Company is named as an additional insured under the policies of the Allied
Practices. There can be no assurance that any claims against the Company or any
of the Allied Practices will not be successful, or if successful, will not
exceed the limits of available insurance coverage or that such coverage will
continue to be available at acceptable rates. The Allied Practitioners purchase
and maintain their own malpractice liability insurance coverage.
ITEM 2. PROPERTIES.
The Company leases approximately 12,465 square feet of office space in
Torrance, California for its headquarters. In addition, the Company leases
office space for certain Allied Practices. The Company's annual lease or rent
payments were approximately $11.8 million for the year ended December 31, 2000.
See note 14 to the Company's financial statements.
ITEM 3. 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.
From time to time, the Company has been, and can expect to be, involved in
litigation with certain of its Allied Practices. Such litigation has involved
claims that the Company failed to provide certain services under the Management
Agreements with the Allied Practices and that certain provisions of the
Management Agreements may be unenforceable, among other claims. The Company
vigorously defends against such claims and believes that such claims are without
merit. As of December 31, 2000, the Company did not have any pending legal
proceedings that separately, or in the aggregate, if adversely determined, would
have a material adverse effect on the Company. See also Item 5, Other
Consequences of the Company's Historically Low Stock Price.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's stockholders during
the fourth quarter of the fiscal year covered by this report.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
The Company's Class A Common Stock is traded on The NASDAQ Stock Market's
National Market System under the symbol "ORAL." There is no established public
trading market for the Company's Class B Common Stock. No transfers are
permitted of Class B Common Stock, except to the Class B stockholder's spouse,
parents, siblings, lineal descendants, trusts for the benefit of any such
individual or as determined by laws of descent or wills. The high and low prices
of the Company's Class A Common Stock as reported on The NASDAQ Stock Market
during each quarter from January 1, 1999 are shown below:
HIGH LOW
---- ---
1999
First Quarter............................................... 11 7/8 7
Second Quarter.............................................. 8 1/ 7
Third Quarter............................................... 7 7/1 6 1/16
Fourth Quarter.............................................. 9 5/1 6 1/16
2000
First Quarter............................................... 8 1/ 5
Second Quarter.............................................. 7 5 1/2
Third Quarter............................................... 7 9/3 5 14/32
Fourth Quarter.............................................. 6 2 14/32
At March 23, 2001, the last reported sale price of the Class A Common Stock
was $2.00 per share and there were approximately 97 record holders of Class A
Common Stock and 49 record holders of Class B Common Stock.
CONTINUED LISTING ON THE NASDAQ NATIONAL MARKET
The Company's Common Stock is currently quoted on the NASDAQ National
Market under the symbol "ORAL". For continued inclusion on the NASDAQ National
Market, a company must meet certain tests, including compliance with the NASDAQ
National Market Rule 4450(b)(4) concerning minimum bid price which requires
among other things, a minimum bid price of $1.00 and tangible net assets of at
least $4 million. As of December 31, 2000, the Company was not in compliance
with that requirement. The continued listing of the Company's Common Stock was
recently reviewed by the NASDAQ Staff and on February 28, 2001 the Company was
notified by the National Market that the Company's stock was not in compliance
with Rule 4450(b)(4) and that the stock may be subject to removal from the
National Market.
The Company has requested a hearing before the NASDAQ Listing
Qualifications Panel which has been scheduled for April 6, 2001. There can be no
assurance that the Company will satisfy the NASDAQ National Market conditions or
that the Company will be able to maintain the continued listing requirements in
the future. If the Company's Common Stock is delisted from the NASDAQ National
Market, and if trading of the Company's Common Stock is to continue, such
trading could be conducted on the NASDAQ Small Cap Market, in the
over-the-counter market on the so called "pink sheets" or, if available, on the
NASD's Electronic Bulletin Board. In such event, investors could find it more
difficult to dispose of, or to obtain accurate quotations as to the value of,
the Company's Common Stock. The trading price per share of the Company's Common
Stock could be reduced as a result.
OTHER CONSEQUENCES OF THE COMPANY'S HISTORICALLY LOW STOCK PRICE
In addition to the consequences of a possible de-listing from the NASDAQ
National Market discussed above, the Company's historically low stock price has
also had adverse consequences on its relations with certain of its Allied
Practitioners and its ability to affiliate with new orthodontic and pediatric
dental practices. Many of the Company's Allied Practitioners received shares of
the Company's common stock in consideration for their affiliation with the
Company. The significant decline in the price of the Company's stock has
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adversely affected these Allied Practitioners and, the Company believes, has
harmed the Company's relationship with certain of its Allied Practitioners. The
Company believes that this has led some Allied Practices to send notices to the
Company or institute's litigation against the Company alleging that the Company
has failed to provide certain services to the Allied Practice. See also Item 3,
Legal Proceedings.
On February 22, 2001, the Company announced the formation of a Special
Committee of the Board of Directors to explore strategic alternatives to
increase shareholder value. The Special Committee was formed as a result of the
Company's belief that the Company's stock remains undervalued despite meeting
certain financial objectives. The Committee's goal is to identify alternatives
to increase shareholder value.
Except for the payment in August 1997 of $13.8 million cash consideration
paid to the initial 55 Allied Practices which was recorded as a cash dividend,
the Company has never declared and paid any dividends on either its Class A
Common Stock or its Class B Common Stock. The Company expects that future
earnings, if any, will be retained for the growth and development of the
Company's business and, accordingly, the Company does not anticipate that any
dividends will be declared or paid on the Class A Common Stock or Class B Common
Stock for the foreseeable future. The declaration, payment and amount of future
dividends, if any, will depend upon the future earnings, results of operations,
financial position and capital requirements of the Company, among other factors,
and are limited by the Company's credit agreement.
Unregistered Securities
On August 26, 1997, simultaneously with the closing of the Company's
initial public offering of its Class A Common Stock pursuant to a Registration
Statement on Form S-1, the 55 initial Allied Practices received 5,882,985 shares
of unregistered Class A Common Stock as partial consideration for certain assets
or stock of such Allied Practices pursuant to the exemption set forth in Section
4(2) of the 1933 Act regarding non-public offerings.
On August 26, 1997, pursuant to that certain Agreement and Plan of Merger
between the Company, US Orthodontic Care, Inc. ("USOC") and Premier Orthodontic
Group, Inc. ("POG"), the Company issued 1,750,000 shares of unregistered Class A
Common Stock and 250,000 shares of unregistered Class B Common Stock as merger
consideration to the shareholders of USOC and POG in reliance on the exemption
set forth in Section 4(2) of the 1933 Act regarding non-public offerings.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated statements of income data for the years ended
December 31, 2000, 1999 and 1998 and the selected balance sheet data as of
December 31, 2000 and 1999 are derived from the Company's audited consolidated
financial statements included elsewhere in this Form 10-K. The Company's
historical results are not necessarily indicative of the results that may be
achieved for any other period. The following data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements included in this Form
10-K.
YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- ------- -------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
STATEMENT OF OPERATIONS DATA:
Net revenues................................................ $142,014 $95,703 $74,387
Income before income taxes.................................. 17,046 16,887 13,658
Net income.................................................. 9,535 9,583 7,535
Basic and diluted net income per share...................... 0.74 0.72 0.58
Weighted average number of common shares outstanding
(diluted) (in thousands).................................. 12,906 13,283 13,044
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YEARS ENDED DECEMBER 31,
----------------------------------------------------------
AT IPO 1997(2) 1998 1999 2000 TOTAL
------- ------- ------- ------- ------- --------
(DOLLARS IN THOUSANDS EXCEPT NON-REVENUE DATA)
SUPPLEMENTAL OPERATING DATA INCLUDES THE
FOLLOWING:
Annual Affiliations Data:
Annual patient revenues at
affiliation, net(1)................ $60,400 $10,826 $38,761 $36,008 $44,812 $190,807
Number of Allied Practitioners, net... 82 17 38 40 48 225
Number of offices, net................ 147 31 67 73 76 394
Additional states represented......... 16 2 11 3 -- 32
- ---------------
(1) Excludes internal same-store growth.
(2) Represents period subsequent to IPO, 8/26/97 to 12/31/97.
AS OF DECEMBER 31,
----------------------
2000 1999
--------- ---------
(DOLLARS IN THOUSANDS)
BALANCE SHEET DATA:
Working capital............................................. $ 11,525 $ 21,530
Total assets................................................ 184,906 135,259
Non-current liabilities..................................... 79,026 50,579
Stockholders' equity........................................ 74,060 67,812
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in conjunction with
the accompanying Consolidated Financial Statements and Notes thereto for the
years ended December 31, 2000, 1999 and 1998.
GENERAL
The Company began providing practice management and consulting services to
Allied Practices in the United States on August 26, 1997. The initial 55 Allied
Practices included 82 Allied Orthodontists operating 147 offices in 16 states.
By the end of 1997, the Company had affiliated with 11 new practices, including
17 additional orthodontists operating out of 31 new locations. In 1998, the
Company affiliated with 30 new practices, including 38 additional orthodontists
and pediatric dentists operating out of 67 locations. In 1999, the Company
affiliated with 36 new practices, including 40 additional orthodontists and
pediatric dentists operating out of 73 locations. In 2000, the Company
affiliated with 43 new practices, including 48 additional orthodontists and
pediatric dentists operating out of 76 locations. Of the 43 new Allied
Practices, 31 were affiliated on March 1, 2000 when the Company, through
OrthAlliance New Image, Inc., a wholly owned subsidiary, acquired substantially
all the assets of New Image Orthodontic Group, Inc., a provider of business
operations, financial and marketing and administrative services to orthodontic
practices across the United States.
The Company derives net revenues by providing services pursuant to
long-term 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
Practitioners 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
accounting principles generally accepted in the United States, including certain
accrual adjustments, including those related to patient
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prepayments, and adjustments for contractual allowances and other discounts,
plus an adjustment for uncollectible accounts.
Patient revenue is recognized as services are performed. For orthodontic
services, approximately 20% of the orthodontic contract revenues are recognized
at the time of initial treatment and generally approximates 25% of the total
treatment plan revenues collected by the Allied Practice. The balance of the
contract revenue is realized evenly over the remaining treatment period. The 20%
estimated revenue at the initial treatment date is based on the estimated costs
incurred by the Company 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 OrthAlliance employees at the Allied
Practices, orthodontic supplies, and associated administrative services.
The service fee is earned and paid monthly to the Company by each Allied
Practice using one of three different fee structures set forth in the Management
Agreements:
(i) a designated percentage ranging from 13.5% to 20% of Adjusted
Patient Revenue. The average designated percentage is 17% for the Allied
Practices subject to this fee structure. In some cases, the Allied Practice
must guarantee a minimum level of management fees to be paid by the Allied
Practice for a portion of the agreement ranging from one to 25 years.
(ii) a designated percentage of Adjusted Patient Revenue, ranging from
14% to 17%, subject to an annual adjustment based upon improvements in the
Allied Practice's operating margin in the most recent calendar year as
compared with the immediately preceding calendar year. No annual adjustment
will be made which would result in reducing the designated percentage below
the percentage applicable during the first year of the Management
Agreement. Operating margin is defined as the percentage determined by
dividing operating profit by Adjusted Patient Revenue. Operating profit is
equal to Adjusted Patient Revenue less operating expenses, excluding the
management fee and such expenses associated with the Allied Practices which
the Company is prohibited from incurring, primarily consisting of
orthodontist compensation. The average designated percentage is 16.2% for
the Allied Practices subject to this fee structure.
(iii) a fixed dollar fee with annual fixed dollar increases for each
year of the term of the Management Agreement.
The Company has entered into agreements with certain Allied Practices to
make the payment of service fees after the first two years contingent on various
factors, including practice profitability compared to acquisition consideration,
timely reporting of information, participation in practice improvement programs
and orthodontist hours worked.
In March 2000, the Company and OA New Image assumed the obligations of New
Image under the various Management Service Agreements ("MSA") between New Image
and the orthodontic practices with whom it had entered into MSAs. The form of
MSA provides for a variation of the service fee calculation compared to the
traditional Company form defined in the service or consulting agreement. Under
the MSAs, the service fee amount varies monthly depending on the Allied
Practices financial performance and represents the residual amount after the
payment of practice expenses and contractually determined practice
distributions. The service fee is affected by two variables, (1) total Allied
Practice gross revenue, less refunds, and (2) overhead. Service fees are
calculated based on two separate standardized grids set forth in the MSA that
determine (i) the percent of practice revenue that is distributed to the Allied
Practice based on that Allied Practice's gross revenue, less refunds, ("Gross
Revenue Grid") and (ii) any additional or offsetting percentage of gross
revenue, less refunds, that is distributed to the Allied Practice based upon
that Allied's Practice's overhead ("Overhead Grid"). Pursuant to the Gross
Revenue Grid, in general, the Company's retained service fees increase if the
Allied Practice's gross revenue increases and decrease if the Allied Practice's
gross revenue decreases. Pursuant to the Overhead Grid, in general the Company's
retained service fees decrease if the Allied Practice's overhead expenses
increase and the retained service fees increase if the Allied Practice's
overhead decreases. The maximum retained service fee percentage is 20.0%. The
average
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service fee percentage for the OA New Image Allied Practices is approximately
16.1%. In addition, a few OA New Image MSAs provide for a fixed percentage
service fee.
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 join
the Company. Practice supplies include only those expenses required by the
Allied Practitioners to provide treatment to patients.
From time to time the Company may receive notices of alleged defaults of
certain Management Agreements. To date, the Company believes that such claims of
alleged default are without merit and vigorously defends the Company's position.
However, there is no assurance that such present or future disputes will be
resolved favorably for the Company.
RESULTS OF OPERATIONS
The consolidated income statement of the Company for the years ended
December 31, 2000, 1999 and 1998, include net income of $9.5 million on revenues
of $142.0 million, net income of $9.6 million on revenues of $95.7 million, and
net income of $7.5 million on revenues of $74.4 million, respectively. For the
years 2000, 1999, and 1998, the Company had income before taxes of $17.0
million, $16.9 million, and $13.7 million, respectively. Direct expenses for the
fourth quarter of 2000 included approximately $800,000 in expenses incurred in
the separation of its former Chief Executive Officer and certain charges.
The following table sets forth certain selected condensed consolidated
income statement data for the periods indicated in thousands of dollars and as a
percentage of total net revenues:
YEAR ENDED DECEMBER 31,
------------------------------------------------------
2000 1999 1998
---------------- --------------- ---------------
Net revenues:............................. $142,014 100.0% $95,703 100.0% $74,387 100.0%
Costs and expenses:
Salaries and benefits................... 42,461 29.9% 28,423 29.7% 22,880 30.8%
Orthodontic supplies.................... 13,903 9.8% 9,438 9.9% 7,436 10.0%
Rent.................................... 11,761 8.3% 8,252 8.6% 6,327 8.5%
-------- ----- ------- ----- ------- -----
Total direct expense............ 68,125 48.0% 46,113 48.2% 36,643 49.3%
General and administrative................ 43,410 30.6% 26,686 27.9% 21,456 28.8%
Depreciation and amortization............. 6,737 4.7% 3,983 4.1% 2,426 3.3%
-------- ----- ------- ----- ------- -----
Total operating expense......... 118,272 83.3% 76,782 80.2% 60,525 81.4%
Operating income.......................... 23,742 16.7% 18,921 19.8% 13,862 18.6%
Interest expense.......................... 7,371 5.2% 2,450 2.6% 555 0.8%
Interest income........................... 675 0.5% 416 0.4% 351 0.5%
-------- ----- ------- ----- ------- -----
Income before income taxes................ 17,046 12.0% 16,887 17.6% 13,658 18.3%
Provision for income taxes................ 7,511 5.3% 7,304 7.6% 6,123 8.2%
-------- ----- ------- ----- ------- -----
Net income...................... $ 9,535 6.7% $ 9,583 10.0% $ 7,535 10.1%
======== ===== ======= ===== ======= =====
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Net Income and Operating Income
Net income for the year ended December 31, 2000 of $9.5 million remained at
approximately the same level as net income in 1999. Operating income for the
year ended December 31, 2000 increased 25.4% to
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$23.7 million from $18.9 million in 1999. The increase in operating income for
the year ended December 31, 2000 is attributable to an overall increase in net
revenues related primarily to the acquisition of New Image and other Allied
Practices and internal same store growth. Despite achieving higher operating
income, net income remained flat due to the severance of the Company's former
President and Chief Executive Officer, higher than expected interest rates,
higher taxes, and other increased expenses.
Net Revenues
Net revenues for the year ended December 31, 2000 increased 48.4% to $142.0
million from $95.7 million in 1999. The increase in net revenues is due
primarily to an increase in affiliations of Allied Practices, the acquisition of
New Image, as well as internal store to store growth for the year approximating
8% compared to 9% in 1999. New Image contributed approximately $20.7 million of
the total year 2000 revenues. Net revenues as reported by the Company include
the Company's contractual service or consulting fee based in part on adjusted
patient revenues, as well as reimbursed expenses of the Allied Practices.
Operating Expenses
Total operating expenses increased 54.0% to $118.3 million, or 83.3% of net
revenues, for the year ended December 31, 2000 from $76.8 million, or 80.2% of
net revenues, from the prior year.
Direct expenses including salaries and benefits, orthodontic and dental
supplies and rent increased 47.7% to $68.1 million, or 48.0% of net revenues,
for the year ended December 31, 2000 from $46.1 million, or 48.2% of net
revenues, from the prior year. Direct expenses have increased in absolute
dollars as a result of the acquisition of New Image and other Allied Practices,
the expansion and growth of existing Allied Practices, as well as expenses
relating to the resignation of the Company's former President and Chief
Executive Officer. The amount of severance paid to the Company's former
President and Chief Executive Officer totaled approximately $600,000. The
decrease in direct expenses as a percentage of 1999 net revenues is primarily
attributable to economies of scale related to salaries and benefits and other
direct expenses.
Salaries and benefits increased 49.4% to $42.5 million, or 29.9% of net
revenues, for the year ended December 31, 2000 from $28.4 million, or 29.7% of
net revenues from the prior year. Salaries and benefits have increased in
absolute dollars as a result of the acquisition of New Image and Allied
Practices, the expansion and growth of existing Allied Practices, as well as
expenses relating to the resignation of the Company's former President and Chief
Executive Officer.
General and administrative expenses, consisting primarily of administrative
operating costs, non-rent facility costs, professional fees and overhead costs,
increased 62.7% to $43.4 million, or 30.6% of net revenues, for the year ended
December 31, 2000 from $26.6 million, or 27.9% of net revenues, from the prior
year. General and administrative expenses have shown an increase in absolute
dollars and as a percentage of revenue relating primarily to the acquisition of
New Image and other Allied Practices, expansion and growth of previously
existing Allied Practices, and higher laboratory cost.
Depreciation and Amortization
Depreciation and amortization expense increased approximately 69.1% to $6.7
million, or 4.7% of net revenues, for the year ended December 31, 2000 from $4.0
million, or 4.1% of net revenues from the prior year. This increase was
attributable to the increase in intangible assets associated with the
acquisition of New Image and other Allied Practices in 2000. Intangible assets
increased from $83.6 million in 1999 to $124.2 million in 2000. Depreciation and
amortization expense primarily relates to the depreciation of capital assets and
the amortization of excess cost over the fair value of net assets acquired
(goodwill) and certain other intangibles. The Company's policy has been to
amortize goodwill over the expected period to be benefited, not to exceed the
term of the Management Agreements.
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Interest Expense
For the years ended December 31, 2000 and 1999, interest expense was
approximately $7.4 million and $2.5 million, respectively and represents
interest charges on the Company's borrowings on its revolving line of credit and
notes payable. The increase was primarily due to increased borrowings under the
revolving line of credit in support of the acquisition of New Image and other
Allied Practices affiliated during the period. Company borrowings under the line
of credit increased from $47.5 million at December 31, 1999 to $62.0 million as
of December 31, 2000 (See "Liquidity and Capital Resources").
Provision for Income Taxes
Provision for income taxes for 2000 and 1999 approximates $7.5 million and
$7.3 million, respectively. A reconciliation of the provision for income taxes
for the years ending December 31, 2000, 1999 and 1998 to the amount computed at
the Federal statutory rate is included in Note 15 of Notes to Consolidated
Financial Statements. The Company's effective income tax rates for the years
ended December 31, 2000 and 1999 were higher than the statutory tax rate
primarily due to the amortization of certain intangible assets which were not
deductible for income tax purposes. The effective tax rate was 44% for the year
ended December 31, 2000 compared to 43% for the comparable period in 1999.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Net Income and Operating Income
Net income for the year ended December 31, 1999 increased 27.2% to $9.6
million from $7.5 million from 1998. Operating income for the year ended
December 31, 1999 increased 36.5% to $18.9 million from $13.9 million from 1998.
The increase in net income and operating income for the year ended December 31,
1999 is attributable to an overall increase in net revenues related to Allied
Practice acquisitions, internal same store growth and a reduction of expenses as
a percentage of net revenues.
Net Revenues
Net revenues increased 28.7% from 1998 to 1999, from $74.4 million to $95.7
million. The increase in net revenues is primarily due to an increase in
affiliations of Allied Practices together with an increase of approximately 9%
attributed to internal growth of comparable existing practices. Net revenues as
reported by the Company include the Company's contractual service or consulting
fee based in part on adjusted patient revenues, as well as reimbursed expenses
of the Allied Practices.
Operating Expenses
Total operating expenses increased 26.9% to $76.8 million, or 80.2% of net
revenues, for the year ended December 31, 1999 from $60.5 million, or 81.4% of
net revenues, from the prior year.
Direct expenses including salaries and benefits, orthodontic and dental
supplies and rent increased 25.8% to $46.1 million, or 48.2% of net revenues,
for the year ended December 31, 1999 from $36.6 million, or 49.3% of net
revenues from the prior year. Direct expenses have increased in absolute dollars
as a result of the affiliation of additional Allied Practices during the period
as well as the expansion and growth of previously existing Allied Practices. The
decrease in direct expenses as a percentage of 1999 net revenues is primarily
attributable to economies of scale related to salaries and benefits and other
direct expenses.
Salaries and benefits increased 24.2% to $28.4 million, or 29.7% of net
revenues, for the year ended December 31, 1999 from $22.9 million, or 30.8% of
net revenues from the prior year. The decrease in salaries and benefits as a
percentage of revenues is a result of a significant number of current year
practice affiliations whereby their employees remained employees of the Allied
Practice's professional corporations. Accordingly, for these practices, salary
and benefit expenses are not reported by the Company. The Company expects that
in future periods salaries and benefits will increase in absolute dollars, but
may vary as a percentage of net revenues.
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General and administrative expenses, consisting primarily of administrative
operating costs, non-rent facility costs, professional fees and overhead costs,
increased 24.4% to $26.7 million, or 27.9% of net revenues, for the year ended
December 31, 1999 from $21.5 million, or 28.8% of net revenues, from the prior
year. General and administrative expenses have shown an increase in absolute
dollars primarily related to the acquisition of additional Allied Practices
during the period as well as the expansion and growth of previously existing
Allied Practices offset by reductions in marketing, advertising and other costs.
Depreciation and Amortization
Depreciation and amortization expense increased approximately $1.6 million
in 1999 from 3.3% to 4.1% of net revenues from the prior year. This increase was
attributable to the increase in intangible assets associated with the
affiliation of Allied Practices in 1999. Intangible assets increased from $50.9
million to $83.6 million from 1998 to 1999. Depreciation and amortization
expense primarily relates to the depreciation of capital assets and the
amortization of excess cost over the fair value of net assets acquired
(goodwill) and certain other intangibles. The Company's policy is to amortize
goodwill over the expected period to be benefited, not to exceed the term of the
Management Agreements. For the years ended December 31, 1999 and 1998,
depreciation and amortization expense approximates $4.0 million and $2.4
million, respectively.
Interest Expense
For the years ended December 31, 1999 and 1998, interest expense was
approximately $2.5 million and $0.6 million, respectively and represents
interest charges on the Company's borrowings on its revolving line of credit.
The increase was primarily due to increased borrowings under the revolving line
of credit in support of Allied Practices affiliated during the period. Company
borrowings under the line of credit increased from $15.5 million at December 31,
1998 to $47.5 million as of December 31, 1999 (See "Liquidity and Capital
Resources").
Provision for Income Taxes
Provision for income taxes for 1999 and 1998 approximates $7.3 million and
$6.1 million, respectively. A reconciliation of the provision for income taxes
for the years ending December 31, 1999, 1998 and 1997 to the amount computed at
the Federal statutory rate is included in Note 15 of Notes to Consolidated
Financial Statements. The Company's effective income tax rates for the years
ended December 31, 1999 and 1998 were higher than the statutory tax rate
primarily due to the amortization of certain intangible assets which were not
deductible for income tax purposes. The effective tax rate was 43% for the year
ended December 31, 1999 compared to 45% for the comparable period in 1998.
QUARTERLY OPERATING RESULTS
The Company's unaudited quarterly operating information (amounts in
thousands, except per share amounts) for 2000, 1999 and 1998 is shown in the
following table.
QUARTERS ENDED
----------------------------------------------------------
MARCH 2000 JUNE 2000 SEPTEMBER 2000 DECEMBER 2000
---------- --------- -------------- -------------
Net revenues............................. $30,145 $36,056 $37,049 $38,764
Operating income......................... 5,652 6,629 6,905 4,556
Provision for income taxes............... 2,011 2,109 2,155 1,236
Net income............................... 2,560 2,703 2,840 1,432
Basic and diluted net income per share... 0.20 0.21 0.22 0.11
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QUARTERS ENDED
----------------------------------------------------------
MARCH 1999 JUNE 1999 SEPTEMBER 1999 DECEMBER 1999
---------- --------- -------------- -------------
Net revenues............................. $21,302 $23,860 $24,286 $26,255
Operating income......................... 4,128 4,737 5,049 5,007
Provision for income taxes............... 1,687 1,997 1,877 1,743
Net income............................... 2,134 2,356 2,581 2,512
Basic and diluted net income per share... 0.16 0.18 0.19 0.19
QUARTERS ENDED
----------------------------------------------------------
MARCH 1998 JUNE 1998 SEPTEMBER 1998 DECEMBER 1998
---------- --------- -------------- -------------
Net revenues............................. $14,650 $18,712 $20,042 $20,983
Operating income......................... 2,795 3,254 3,795 4,018
Provision for income taxes............... 1,271 1,399 1,627 1,826
Net income............................... 1,621 1,859 2,072 1,983
Basic and diluted net income per share... 0.13 0.14 0.16 0.15
SEASONALITY
Most patients who seek orthodontic treatment are children and young adults,
although the number of adults seeking treatment has been increasing in recent
years particularly with the introduction of new products such as Invisalign.
Based upon information provided by the Allied Practices, and based upon the
results of operations in 2000, 1999 and 1998, the Company generally experiences
an increase in new patient volume during the summer months when children are not
in school. The Company also expects the lowest volume of patient starts during
the Thanksgiving and Christmas holiday season when children are on vacation and
when many of the Allied Practices are closed. As a consequence, the Company
expects higher patient revenue in the third quarter and lower patient revenue in
the fourth quarter. Accordingly, the Company generally expects a stronger third
quarter.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash from
operations, the Company's line of credit and other available capital sources.
This capital is used for affiliations with new Allied Practices, development of
Allied Practice enhancements, development of Allied Practice satellite offices,
capital asset additions, and general working capital. The Company's working
capital decreased 46% to $11.5 million at December 31, 2000 from $21.5 million
at December 31, 1999. Stockholders' equity increased 9.2% to $74 million at
December 31, 2000 from $67.8 million on December 31, 1999.
The Company's operating activities generated cash of 12.7 million during
the year ended December 31, 2000, primarily attributed to net income during the
period, increased patient prepayments and other factors which were offset by
increases in patient and other receivables, compared to $15.2 million during the
year ended December 31, 1999. Net cash used in financing activities approximated
$1.2 million in the year ended December 31, 2000. Cash used in financing
activities consisted of debt repayment and the repurchase of the Company's Class
A Common Stock. For the year ended December 31, 2000, the Company borrowed
approximately $83 million and repaid $81.5 million. Repurchase of the Company's
Class A Common Stock totaled approximately $3.8 million. For the year ended
December 31, 1999, $28.1 million was provided by financing activities and
resulted primarily from borrowings under the revolving credit facility. Cash
used in investing activities of $17.8 million in the year ended December 31,
2000 consisted of payments in connection with the acquisition of New Image and
other Allied Practices affiliated and capital expenditures, primarily for office
and computer equipment used in Company operations. Cash used in investing
activities was $35.3 million in the year ended December 31, 1999 and consisted
of payments in connection with the affiliation of Allied Practices and capital
expenditures, primarily for office and computer equipment used in Company
operations. The Company does not currently have any material commitments with
respect to any capital expenditures.
On December 30, 1997, the Company entered into a credit agreement with
First Union National Bank to provide a $25 million revolving line of credit. The
interest on borrowings accrues at either the bank's prime
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rate or LIBOR, plus a margin. Amounts borrowed are secured by security interests
in substantially all of the Company's assets, which include accounts receivable,
Management Agreements and the capital stock of the Company's wholly-owned
subsidiaries. The Company expanded the credit facility ("the Revolving Credit
Facility") on March 26, 1999 from $25 million to $55 million and from $55
million to $75 million on April 14, 2000. Outstanding amounts under the April
14, 2000 agreement are repayable in full on April 13, 2003. As of December 31,
2000 and 1999, the outstanding balance under this credit facility was $62
million and $47.5 million, respectively. There can be no assurance that the
Company will be able to renew or replace its Revolving Credit Facility or obtain
alternate financing on reasonable terms, if at all. As of December 31, 2000, the
Company was in compliance with the terms and covenants of the Revolving Credit
Facility.
In 1997, after the completion of the IPO and the affiliation of the
founding 55 Allied Practices, the Company acquired certain operating assets of,
or the stock in entities that held certain operating assets of, 11 additional
orthodontic practices. The total consideration paid for these Allied Practices
was $12.4 million, of which $2.1 million was paid in cash and the balance
through the issuance of 863,775 shares of Class A Common Stock, pursuant to a
Registration Statement on Form S-4 (No. 333-29435).
For the year ended December 31, 1998, the Company acquired certain
operating assets of, or the stock in entities that held certain operating assets
of, 36 additional Allied Practices. The total consideration paid for these
Allied Practices was $46.8 million, of which $24.5 million was paid in cash,
$2.5 million issued in short-term notes payable and the balance through the
issuance of 1,640,492 shares of Class A Common Stock, pursuant to a Registration
Statement on Form S-4 (No. 333-29435).
For the year ended December 31, 1999, the Company acquired certain
operating assets of, or the stock in entities that held certain operating assets
of, 36 additional Allied Practices. The total consideration paid for these
Allied Practices was $39.5 million, of which $33.0 million was paid in cash,
$5.7 million in long term notes payable and the balance through the issuance of
93,584 shares of Class A Common Stock, pursuant to a Registration Statement on
Form S-4 (No. 333-53415).
For the year ended December 31, 2000, the Company acquired certain
operating assets of, or the stock in entities that held certain operating assets
of 43 additional Allied Practices. Of the 43 Allied Practices, 31 practices were
acquired on March 1, 2000, by acquiring 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 $32.1 million. The acquisition price
included a cash payment of $5.6 million; an estimated $0.3 million in
acquisition costs; promissory notes issued of approximately $12.9 million, with
interest rates ranging from 6% to 10%, repayable over a one to five year period;
the assumption of approximately $13.4 million of existing debt due to New
Image's former orthodontic practices, repayable over the next five years at
interest rates approximating 9%; and the issuance of approximately 273,000 stock
options. See note 3 to the Company's financial statements.
Capital resources needed to continue acquisition and development efforts
will be funded through a combination of cash flows provided by ongoing
operations, the Revolving Credit Facility, the possible issuance of equity and
debt securities, as described in the Company's Form S-4 registration statement
which became effective on August 6, 1999, and other sources. Management believes
that these sources of capital will be sufficient to meet the Company's capital
requirements for the next twelve months. The Company may choose to issue debt or
equity to meet its future long-term capital needs, as management deems
appropriate. There can be no assurance that the Company will be able to raise
such additional working capital on acceptable terms, if at all. (See Item 5,
Market for Registrant's Common Stock and Related Stockholder Matters.) In the
event the Company is unable to raise additional working capital, further
measures would be necessary including, without limitation, the delay, or scale
back of its operations, Allied Practice affiliations and development efforts,
marketing programs and other actions. Certain of such measures may require third
party consents or approvals, including the Company's bankers, and there can be
no such assurance that such consents or approvals can be obtained. The Company
has reduced the number of new affiliations with existing practices, in order to
conserve capital resources.
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
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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. From time to time the Company may enter into short-term loan
agreements with Allied Practices for office expansion or satellite office
programs. Loans are provided generally at an interest rate of prime plus 1 1/2%
with monthly payments through maturity.
ACQUISITION OF NEW IMAGE ORTHODONTIC GROUP, INC.
On March 1, 2000 the Company, through OA New Image, a wholly owned
subsidiary, closed a purchase and sale agreement with New Image. The Company
acquired substantially all the assets of New Image.
New Image was founded in February 1997 and provides business operations,
financial and marketing and administrative services to orthodontic practices
across the United States in accordance with long term service agreements. The
transaction was accounted for as a purchase and includes practice management
agreements with 36 orthodontic practitioners operating in 50 locations with over
$33 million in annualized revenues.
Collectively, the consideration totaled approximately $32.1 million. Of
this amount, $5.6 million was paid in cash, an estimated $0.3 million in
acquisition costs, 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 6% to 10%, and approximately 273,000 stock options with an
aggregate fair value of approximately $0.6 million.
During 2000, the Company integrated New Image into its business operations.
Management continues to believe that the Company will benefit from the economies
of scale and synergies resulting from the acquisition.
Internal Revenue Service Examination
The Internal Revenue Service (the "Service") has completed its examination
of the Company's federal income tax return for the year ended December 31, 1998.
The Company has agreed with the Service's proposed adjustment of approximately
$583,000 of additional tax payments for the years ended 1998 and 1999 which was
paid in March 2001. The adjustment related to timing differences between book
and tax with regard to certain capitalized practice acquisition costs. The
Company adequately provided reserves in prior years and the additional tax
payments did not result in additional income tax expense in fiscal 2000.
STOCK REPURCHASE PLAN
On December 1, 2000, the Company announced the extension of its Common
Stock Repurchase Program to repurchase up to $6.8 million of its Class A Common
Stock. The Company had initially announced the program on October 22, 1998. The
Company is authorized to purchase shares on the NASDAQ National Market at
prevailing prices through December 31, 2001. During 2000, the Company had
repurchased 0.9 million shares amounting to $3.8 million under this program.
Share repurchases are financed by a combination of operating cash flow and
borrowings under the Revolving Credit Facility. The timing and the amount of
shares to be purchased will be determined based on the evaluation of working
capital needs and stock market conditions. Subsequent to December 31, 2000 the
Company has acquired 4,300 shares of its Common Stock at a cost of approximately
$13,000. As of March 26, 2001, the Company's total purchase of Class A Common
Stock totaled approximately $6.7 million.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities", as amended by SFAS 137 and SFAS 138. 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 on the balance sheet and measure those instruments
at fair value. Management anticipates that the adoption of SFAS 133 will not
have a material effect on the Company's results of operations or financial
position.
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The SEC issued Staff Accounting Bulletin Number 101, Revenue Recognition in
Financial Statements, on December 3, 1999 ("SAB 101"). This pronouncement
clarifies existing revenue recognition principles and states that revenue is
generally realized or realizable and earned when all of the following criteria
are met: i) persuasive 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. Management believes
the Company is in compliance with SAB 101.
INFLATION
The Company does not believe that inflation has had a material effect on
the results of operations during the past three years. There can be no assurance
that the Company's business will not be affected by inflation in the future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company does not have any derivative financial instruments as of
December 31, 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
holdings of its financial instruments is not material.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's Consolidated Financial Statements, together with the
Independent Public Accountant's Report thereon of Arthur Andersen LLP, dated
March 7, 2001 begin on page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following sets forth information with respect to individuals who served
as executive officers and directors as of December 31, 2000.
EXECUTIVE OFFICERS
W. Dennis Summers (age 52) -- Interim President and Chief Executive
Officer -- Mr. Summers has been employed by the Company since November 2000. In
addition to his current position, W. Dennis Summers has been a director of the
Company since completion of the Company's initial public offering ("Offering")
in August 1997. Effective after the 1999 Annual Meeting of Stockholders, Mr.
Summers has been serving as Chairman of the Board. Mr. Summers has been a
principal in the Atlanta, Georgia office of McGuireWoods, L.L.P.
("McGuireWoods"), a national law firm, since August 1999, when he moved from his
previous firm, Roberts, Isaf & Summers. There, Mr. Summers served as a principal
of the law firm since 1984. Mr. Summers specializes in corporate and business
matters. Mr. Summers is currently on leave of absence from McGuireWoods.
James C. Wilson (age 51) -- Senior Vice President, Chief Financial
Officer -- Jim Wilson has been with OrthAlliance since July 1999. Mr. Wilson
came from Interplay Entertainment Corp., a leading developer, publisher and
distributor of interactive entertainment software. He was CFO of Interplay
Entertainment and previously held similar positions at Cloud 9 Interactive and
Applause Enterprises. Earlier in his career, Mr. Wilson was a senior finance
officer with Sega of America, the California Angels baseball team and Mattel
Electronics, and he was an audit manager with Arthur Young & Company, a major
public accounting firm.
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Paul H. Hayase (age 46) -- Senior Vice President, Human Resources, General
Counsel and Secretary -- Mr. Hayase has been with OrthAlliance since its
inception in October 1996. Prior to joining OrthAlliance, Mr. Hayase served as
VP of Human Resources, General Counsel, and Secretary for Systemed, Inc., a
pharmacy benefit management company. From 1983 to 1985 he served as Senior Vice
President -- Human Resources and General Counsel for Knapp Communications
Corporations, publisher of Architectural Digest, Bon Appetit and HOME Magazines.
Mr. Hayase also served as Senior Counsel for Ralphs Grocery Company from 1993 to
1995.
Stephen M. Toon (age 53)-- Senior Vice President, Chief Development
Officer -- Mr. Toon has served as Senior Vice President and Chief Development
Officer of OrthAlliance since August 1998. From 1995 until 1998, Mr. Toon served
as Chief Development Officer of Team Health Group, a division of MedPartners.
From 1991 until 1995, Mr. Toon served as Senior Vice President of Operations
with Coastal Health Care. Prior to joining Coastal, Mr. Toon served as President
of the Southern Division with MEDSEARCH International, a position to which he
was named in 1986.
BOARD MEMBERS
Stephen G. Tracey, D.D.S., M.S. (age 42) has practiced orthodontics in the
Upland, California area since 1986. Dr. Tracey graduated from Loma Linda
University in 1986 with a M.S. degree in orthodontics and in 1983 with a D.D.S.
degree. He is an Assistant Professor of Orthodontics at Loma Linda University
School of Dentistry and a past Director of the California Association of
Orthodontists.
Larry D. Dormois, D.D.S., M.S. (age 49) has practiced pediatric dentistry
in Memphis since 1987. Before that he was director of the Graduate Pediatric
Dental Residency Program and interim Chairman of the Department of Pediatric
Dentistry at the University of Tennessee College of Dentistry. He graduated from
the University of Tennessee College of Dentistry in 1975 with a DDS degree and
the Pediatric Dental Graduate Program in 1981 with a Master of Sciences in
Pediatric Dentistry. He has been a member of the executive committee for
LeBonheur Children's Medical Center since 1990.
Craig L. McKnight (age 50) has been a director of the Company since
completion of the initial public offering of Class A Common Stock (the
"Offering") in August 1997. Since June, 1999, Mr. McKnight has served as
Executive Vice President and Chief Financial Officer of Hillcrest Healthcare
System, a not-for-profit healthcare system with inpatient facilities and
clinics, including teaching hospitals. Previously, Mr. McKnight served from
March 1995 to May, 1999, as Executive Vice President of Magellan Health Services
("Magellan"), a specialty managed care company, which was previously known as
Charter Medical Corporation. Mr. McKnight practiced public accounting with
Coopers & Lybrand, LLP from 1985 through 1995. From June 1994 to March 1995, Mr.
McKnight was responsible for the Health Care Practice of Coopers & Lybrand,
L.L.P. in California and Philadelphia, Pennsylvania.
Douglas D. Durbin, D.M.D., M.S.D. (age 46) has been a director of the
Company since the completion of the Offering in August 1997. Dr. Durbin has
served as President of The Kentucky Center for Orthodontics, P.S.C. and its
predecessors since 1983. Dr. Durbin is a member of the American Association of
Orthodontics, the American Dental Association and the Kentucky Association of
Orthodontists, a Diplomate of the American Board of Orthodontics and has served
as President, Treasurer, and Secretary of the Bluegrass Dental Society. Dr.
Durbin graduated from the University of Kentucky College of Dentistry with a
D.M.D. degree in 1978 and received his M.S.D. and Certificate in Orthodontics
from the University of Kentucky College of Dentistry in 1983.
Randall K. Bennett, D.D.S., M.S. (age 45) has served as a Director of the
Company since its inception in October 1996. Dr. Bennett has practiced
orthodontics in Salt Lake City, Utah since 1989 and he practiced in Beverly
Hills, California from 1988 to 1989. Dr. Bennett graduated from Loma Linda
University in 1988 with a M.S. degree in orthodontics and from the University of
Alberta in 1981 with a D.D.S. degree.
G. Harry Durity (age 54) has served as a Director of the Company since
December 1998. Since August 1994, Mr. Durity has served as Corporate Vice
President/Worldwide Business Development for Automatic Data Processing, Inc., a
payroll service company. From 1992 to August 1994, Mr. Durity was Senior Vice
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President/Corporate Development for Revlon Consumer Products Company, a personal
care products company, and prior thereto was Vice President/Corporate
Development for RJR Nabisco, Inc., a consumer products company.
Raymond G.W. Kubisch, D.D.S., M.S.D. (age 56) has served as a Director of
the Company since June 1999. Dr. Kubisch has practiced orthodontics in the
Seattle, Washington area since 1976. Dr. Kubisch graduated from Indiana
University in 1968 with a Bachelor of Science in Marketing, and in 1974
graduated with a D.D.S. degree from Indiana University as Valedictorian. In
1976, Dr. Kubisch received his M.S.D. and Certificate in Orthodontics from the
University of Washington. From 1986 to 1993, Dr. Kubisch was an Assistant
Clinical Professor for the University of Washington.
Robert W. Miller (age 60) has served as a director of the Company since
January 2001. Mr. Miller graduated from the University of Georgia in 1964 with a
Bachelor of Arts in History, and in 1967 graduated with a law degree from Yale
Law School. From 1967 - 1997, Mr. Miller served as partner in a number of law
firms including Alston, Miller, & Gaines, Bondurant, Miller, Hishon &
Stephenson, and King & Spalding. In addition, Mr. Miller serves on a variety of
boards including Chairman of the Board at Magellan Health Services and
Paracelsus Healthcare Corporation.
With the exception of Mr. Summers, none of the directors are, or have been,
employed by any parent, subsidiary or other affiliate of the Company; provided,
however, that Dr. Bennett entered into a part-time employment arrangement with
the Company effective February 20, 1998. There are no family relationships
between any directors or executive officers.
COMPENSATION OF DIRECTORS
Commencing with the November 2000 Board of Directors meeting, the following
non-employee directors of the Company (the "Outside Directors") received
compensation at the rate of $12,500 per meeting for their services as directors,
Dr. Larry Dormois, Dr. Douglas Durbin, Dr. Stephen Tracey, Dr. Raymond Kubisch,
Dr. Randall K. Bennett and Dr. Harry G. Durity. W. Dennis Summers received
$15,000 prior to his assuming the responsibilities of interim President and
Chief Executive Officer. In addition, pursuant to the 1997 Non-Employee Director
Stock Plan, the Company made the following grants of options during 2000 to
directors: Craig McKnight, Dr. Douglas Durbin, Dr. Harry G. Durity, Dr. Randall
Bennett and Dr. Raymond Kubisch each received options to acquire 15,000 shares
of Class A Common Stock, Dr. Larry Dormois and Dr. Stephen Tracey each received
10,000 options to acquire shares of Class A Common Stock. W. Dennis Summers
received options to acquire 25,000 shares prior to assuming his responsibilities
as interim President and Chief Executive Officer. Finally, directors are
entitled to be reimbursed for expenses incurred in connection with their
services as directors.
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ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table sets forth certain information concerning the
compensation paid to the Company's Chief Executive Officer and each of the Named
Executive Officers whose salary and bonus compensation for the year ended
December 31, 2000 exceeded $100,000.
ANNUAL COMPENSATION LONG TERM COMPENSATION
------------------------------------------------ -----------------------------
OTHER SECURITIES
NAME AND ANNUAL UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY($)(1) BONUS($)(2) COMPENSATION OPTIONS(#) COMPENSATION($)
------------------ ---- ------------ ----------- ------------ ---------- ---------------
W. Dennis Summers........... 2000 $ 38,462(7) $ -- $ -- 200,000(5) --
Interim President and 1999 -- -- -- 10,000(6) --
Chief Executive Officer 1998 -- -- -- 10,000(6) --
and Chairman
Sam Westover................ 2000 268,830 -- 596,756(3) 150,000 --
President and Chief 1999 257,500 103,000 -- 100,000 --
Executive Officer 1998 250,000 117,857 -- 100,000 --
Paul H. Hayase.............. 2000 170,695 -- 150,000 --
Senior Vice President -- 1999 169,950 67,980 -- 100,000 --
Human Resources, General 1998 165,000 77,786 -- 75,000 --
Counsel and Secretary
James C. Wilson............. 2000 177,524 -- -- 50,000 --
Senior Vice President -- 1999 174,996 32,083 -- 75,000 --
Chief Financial Officer 1998 -- -- -- -- --
Stephen M. Toon............. 2000 190,382 -- 38,698(4) 22,544 --
Senior Vice President -- 1999 186,850 74,740 115,948(4) 72,015 --
Chief Development Officer 1998 63,327 92,500 -- 75,000 --
- ---------------
(1) Represents annual salary, except where noted.
(2) Represents annual bonus earned for the periods indicated.
(3) Represents severance salary paid upon resignation.
(4) Represents commission payments for practice affiliations paid during 2000
and 1999.
(5) 25,000 of the 200,000 options were acquired under the OrthAlliance 1997
Director Stock Option Plan ("Director Plan").
(6) Represents options acquired under the Director Plan.
(7) Represents salary paid for the months of November and December 2000.
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OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock option grants
for the year ended December 31, 2000 to the Chief Executive Officer and each of
the Named Executive Officers:
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
---------------------------------------------------------------------- ANNUAL RATES OF STOCK
PERCENT OF TOTAL PRICE APPRECIATION FOR
NUMBER OF OPTIONS GRANTED OPTION TERM(1)
SECURITIES UNDERLYING TO EMPLOYEES IN EXERCISE PRICE EXPIRATION -----------------------
OPTIONS GRANTED FISCAL 2000 PER SHARE DATE 5% 10%
--------------------- ---------------- -------------- ---------- ---------- ----------
W. Dennis Summers.... 175,000 20.30% $3.25 11/27/10 926,431 1,475,190
Sam Westover......... 150,000 17.41% $6.00 04/07/10 1,466,001 2,334,366
Paul H. Hayase....... 150,000 17.41% $6.00 04/07/10 1,466,001 2,334,366
James C. Wilson...... 50,000 5.80% $6.00 04/07/10 488,667 778,122
Stephen M. Toon...... 555 0.06% $7.75 03/11/10 7,006 11,156
Stephen M. Toon...... 1,615 0.19% $5.94 04/17/10 15,626 24,882
Stephen M. Toon...... 1,165 0.14% $6.06 05/26/10 11,500 18,312
Stephen M. Toon...... 830 0.10% $6.00 05/30/10 8,112 12,917
Stephen M. Toon...... 826 0.10% $5.69 06/09/10 7,656 12,190
Stephen M. Toon...... 2,724 0.32% $6.00 06/30/10 26,623 42,392
Stephen M. Toon...... 939 0.11% $6.00 07/15/10 9,942 15,831
Stephen M. Toon...... 1,921 0.22% $7.13 08/28/10 22,310 35,526
Stephen M. Toon...... 1,454 0.17% $6.13 09/29/10 14,518 23,118
Stephen M. Toon...... 665 0.08% $6.13 09/30/10 6,640 10,573
Stephen M. Toon...... 1,413 0.16% $6.13 09/30/10 14,109 22,466
Stephen M. Toon...... 969 0.11% $3.94 10/24/10 6,219 9,903
Stephen M. Toon...... 1,287 0.15% $3.63 11/02/10 7,610 12,117
Stephen M. Toon...... 1,433 0.17% $3.53 11/06/10 8,240 13,120
Stephen M. Toon...... 2,457 0.29% $3.38 11/22/10 13,527 21,540
Stephen M. Toon...... 2,291 0.27% $3.44 12/01/10 12,837 20,441
-------
547,544
- ---------------
(1) There can be no assurance provided to any executive officer or any other
holder of the Company's securities that the actual stock price appreciation
over the term will be at the assumed 5% and 10% levels or at any other
defined level. Unless the market price of the Class A Common Stock
appreciates over the option term, no value will be realized from the option
grants made to the Chief Executive Officer or the Named Executive Officers.
The following table sets forth certain information with respect to the
value of unexercised in-the-money options held by the Named Executive Officers
of the Company at December 31, 2000. No options were exercised by the Named
Executive Officers of the Company during 2000.
SECURITIES UNDERLYING VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#) AT FY-END($)(1)
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
W. Dennis Summers.......................... 150,000 75,000 $ 0 $ 0
Sam Westover............................... 320,000 330,000 0 0
Paul H. Hayase............................. 137,500 262,500 0 0
James C. Wilson............................ 40,000 85,000 0 0
Stephen M. Toon............................ 73,406 83,880 0 0
- ---------------
(1) Based on a closing price of $2.6875 per share of Class A Common Stock on
December 31, 2000.
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30
NONCOMPETITION AND EMPLOYMENT CONTRACTS
The Company entered into employment agreements, each dated May 13, 1997,
with Messrs. Westover and Hayase providing for annual base salaries of $250,000
and $165,000, respectively, with each person being eligible for a cash bonus of
up to 30% of his base salary (the "Employment Agreements"). Additionally, the
Employment Agreements provided for the grant of options for the purchase of
Class A Common Stock to each of Messrs. Westover and Hayase for 300,000 and
75,000 shares, respectively, which such options (i) vested 20% on August 21,
1997 and (ii) will vest 20% per year on the first through the fourth anniversary
dates thereof. These options expire ten years from the date of grant and are
exercisable at $12.00 per share. In the event of employment termination, these
options terminate 90 days from the date of such termination of employment.
Mr. Westover's employment agreement was terminated in December 2000. Mr.
Hayase's Employment Agreement is for an initial term of five years with an
automatic renewal for successive 1 year terms unless prior notice of termination
is provided. The Company may terminate Mr. Hayase's Employment Agreement (i) for
cause, (ii) without cause upon 30 days prior notice, or (iii) upon death or
disability of Mr. Hayase. Mr. Hayase may terminate the Employment Agreement
within 120 days after a constructive termination (as defined therein). If Mr.
Hayase is terminated by the Company without cause or Mr. Hayase terminates the
Employment Agreement within 120 days following a constructive termination, the
Company is required to pay Mr. Hayase a lump sum severance equal to 2 times the
applicable annual base salary. Mr. Hayase's Employment Agreement provides that
if Mr. Hayase is terminated within a twelve-month period following a change in
control of the Company (as defined therein), the Company will pay him three
times the sum of (i) his annual base compensation, plus (ii) the maximum
possible cash bonus for such year. In addition, upon a change in control, the
Company will pay Mr. Hayase any accrued salary, benefits or reimbursements and
his options will fully vest and become immediately exercisable for the longer of
(i) 90 days from the change in control or (ii) the time period specified in the
stock plan. Mr. Hayase's Employment Agreement prohibits Mr. Hayase from
competing with the Company for a period of 2 years following termination of
employment.
The Company entered into a letter agreement with Mr. Wilson on June 16,
1999 providing for an annual base salary of $174,996, and a cash bonus of up to
40% of his annualized base salary. Subject to the approval of the Board of
Directors and the achievement of certain financial goals of the Company
established by the Board of Directors and Management. Additionally, the Company
granted Mr. Wilson an option to purchase 75,000 shares of Class A Common Stock,
with a vesting schedule consistent with the vesting schedule described above for
the Employment Agreements.
The Company entered into a letter agreement with Mr. Toon on May 22, 1998
providing for an initial base salary of $185,000 with a guaranteed management
bonus in the amount of $92,500, and such bonus was paid in February of 1999.
Thereafter, Mr. Toon is eligible to receive a bonus of up to 40% of his base
salary, subject to the approval of the Board of Directors and the achievement of
certain financial goals of the Company established by the Board of Directors and
management. Additionally, the Company granted Mr. Toon an option to purchase
75,000 shares of Class A Common Stock, 20% of which vested on the date of grant,
and 20% of which vests on each anniversary of the grant date. The letter
agreement term is for a two year period and was extended for an additional two
year term by amendment on May 22, 2000.
On November 29, 2000, the Company and Sam Westover ("Westover"), entered
into a Severance Agreement and General Release dated November 29, 2000 (the
"Westover Settlement Agreement") pursuant to which Westover agreed to resign as
CEO and President of the Company. As part of the settlement, the Company and
Westover agreed to a lump sum pay out of approximately $597,000 payable upon
resignation. The Westover Severance Agreement also provided that Westover
released the Company from any claims relating to his employment with the
Company. Furthermore, to ensure an orderly transition, the Company and Westover
agreed to a 1 year consulting agreement. The consulting agreement with Westover
requires payment of approximately $12,000 per month beginning January 2001 and
ending December 2001.
On December 15, 2000, the Company entered into letter agreements with each
of Messrs. Hayase, Toon and Wilson. In the event each employee remains as a full
time employee through September 15, 2001, Messrs. Hayase, Toon and Wilson will
receive a one time bonus payment of $100,000, $75,000, and $75,000,
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respectively. In the event that the Company terminates Messrs. Hayase, Toon, or
Wilson's employment before September 15, 2001, other than for cause, then such
named executive shall receive payment in full.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The current members of the Compensation Committee are Dr. Dormois, Messrs.
Durity and McKnight. Dr. Dormois, Messrs. Durity, and McKnight are not and have
not been officers or employees of the Company or any of its subsidiaries. A
predecessor of the Company, U.S. Orthodontic Care, Inc. ("USOC"), entered into a
consulting agreement with Newfound Capital Associates ("Newfound") and
Newfound's president, Mr. Wilfong. The Company succeeded to the rights and
obligations of USOC with respect to this agreement upon the merger of USOC with
and into the Company and Mr. Wilfong entered into a separate consulting
agreement with the Company whereby Mr. Wilfong agreed to provide financial and
general business services to the Company in return for consulting fees of
$300,000. In addition to the consulting fees, the Company granted Mr. Wilfong a
warrant to purchase 150,000 shares of Class A Common Stock at an exercise price
of $12.00 per share. A warrant granted to Mr. Wilfong to purchase 168,750 shares
of USOC's common stock was converted in such merger to a warrant to purchase
168,750 shares of Class A Common Stock at $11.16 a share. Both warrants are
exercisable for five (5) years from August 21, 1997.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
COMMON STOCK OWNERSHIP BY MANAGEMENT
AND PRINCIPAL STOCKHOLDERS
The following table sets forth the beneficial ownership of shares of Class
A Common Stock and Class B Common Stock as of March 13, 2001 for (i) directors
of the Company, (ii) the Chief Executive Officer and each of the three most
highly compensated executive officers of the Company (collectively the "Named
Executive Officers"), (iii) the directors and executive officers of the Company
as a group and (iv) each person who is a stockholder of the Company holding more
than a five percent (5%) interest in the Company.
NUMBER OF
NUMBER OF SHARES OF PERCENT OF
SHARES OF PERCENT OF CLASS CLASS B CLASS B
CLASS A A COMMON COMMON COMMON
COMMON STOCK STOCK STOCK
BENEFICIALLY BENEFICIALLY BENEFICIALLY BENEFICIALLY
NAME OF BENEFICIAL OWNER OWNED(1) OWNED OWNED(1) OWNED
------------------------ ------------ ---------------- ------------ ------------
Goldman Sachs Asset Management,
a separate operating division of
Goldman Sachs & Co. ................... 1,541,000(2) 12.8% -- --
1 New York Plaza
New York, NY 10004
Wasatch Advisors, Inc. .................. 922,350(3) 7.6% -- --
150 Social Hall Avenue
Salt Lake City, UT 84111
W. Dennis Summers........................ 130,000(4) 1.1% -- --
Sam Westover............................. 340,001(5) 2.8% -- --
James C. Wilson.......................... 50,000(6) *
Paul H. Hayase........................... 230,704(7) 1.9% 6,000 3.5%
Stephen M. Toon.......................... 84,371(8) *
Randall K. Bennett, D.D.S., M.S. ........ 378,396(9) 3.1% 24,000 13.9%
Douglas D. Durbin, D.M.D., M.S.D. ....... 132,502(10) 1.1% 1,062 0.6%
G. Harry Durity.......................... 20,000(11) * -- --
Raymond G.W. Kubisch, D.D.S., M.S.D. .... 15,000(12) * -- --
Larry D. Dormois, D.D.S., M.S. .......... 9,293 * -- --
Stephen G. Tracey, D.D.S., M.S. ......... 14,359(13) * -- --
Craig L. McKnight........................ 30,000(14) * -- --
Robert W. Miller......................... 0 * -- --
Robert N. Pickron, D.D.S. ............... 852,004(15) 7.1% 73,644 42.7%
All executive officers and directors as a
group (13 persons)..................... 1,434,626 11.9% 31,062 18%
- ---------------
* Less than 1%.
(1) Based on an aggregate of 12,076,601 shares of Class A Common Stock and
172,526 shares of Class B Common Stock issued and outstanding as of March
13, 2001. Includes shares of Class A Common Stock that may be acquired upon
the exercise of stock options and warrants exercisable within 60 days. Each
share of Class B Common Stock automatically converts into 8 shares of Class
A Common Stock upon the attainment of certain average closing price
calculations for the Class A Common Stock in 5 increments of 20% each. If
not converted on or before August 21, 2003, each share of Class B Common
Stock automatically converts into 1 share of Class A Common Stock. Each
person named above has sole voting and dispositive power with respect to
all shares listed opposite such person's name, except as otherwise noted.
The address of all persons listed, except Goldman Sachs Asset Management,
Wasatch Advisors, Inc. and Dr. Pickron, is 21535 Hawthorne Boulevard, Suite
200, Torrance, California 90503.
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33
(2) The business address of Goldman Sachs Asset Management ("GSAM") is 1 New
York Plaza, New York, New York 10004. Share ownership for GSAM, a separate
operating division of Goldman, Sachs & Co. is as of December 31, 2000 and
was obtained from a Schedule 13G/A, dated February 14, 2001, filed with the
Securities and Exchange Commission February 13, 2001. GSAM has sole voting
power with respect to 1,208,800 shares and sole dispositive power with
respect to 1,541,000 shares.
(3) The business address of Wasatch Advisors, Inc. ("Wasatch") is 150 Social
Hall Avenue, Salt Lake City, UT 84111. Share ownership Wasatch is as of
December 31, 2000 and was obtained from a Schedule 13G/A, dated February
14, 2001, filed with the Securities and Exchange Commission February 15,
2001.
(4) Includes 30,000 shares of Class A Common Stock purchasable upon exercise of
stock options that are currently exercisable or exercisable within 60 days
pursuant to the OrthAlliance 1997 Director Stock Option Plan, as amended
("Director Plan") and 100,000 shares of Class A Common Stock purchasable
under exercise of stock options that are currently exercisable or
exercisable within 60 days pursuant to the OrthAlliance, Inc. Amended and
Restated 1997 Employee Stock Option Plan ("Employee Plan").
(5) Includes 340,000 shares of Class A Common Stock purchasable upon exercise
of stock options that are currently exercisable or exercisable within 60
days pursuant to the Employee Plan. Mr. Westover resigned effective
December 27, 2000.
(6) Consists of 50,000 shares of Class A Common Stock purchasable upon exercise
of stock options that are currently exercisable or exercisable within 60
days pursuant to the Employee Plan.
(7) Includes 210,000 shares of Class A Common Stock purchasable upon exercise
of stock options that are currently exercisable or exercisable within 60
days pursuant to the Employee Plan.
(8) Includes 82,371 shares of Class A Common Stock purchasable upon exercise of
stock options that are currently exercisable or exercisable within 60 days
pursuant to the Employee Plan.
(9) Includes 50,000 shares of Class A Common Stock purchasable upon exercise of
stock options that are currently exercisable or exercisable within 60 days
pursuant to the Director Plan.
(10) Includes 30,000 shares of Class A Common Stock purchasable upon exercise of
stock options that are currently exercisable or exercisable within 60 days
pursuant to the Director Plan. This amount also includes 1,600 shares of
Class A Common Stock that are indirectly owned.
(11) Consists of 20,000 shares of Class A Common Stock purchasable upon exercise
of stock options that are currently exercisable or exercisable within 60
days pursuant to the Director Plan.
(12) Consists of 15,000 shares of Class A Common Stock purchasable upon exercise
of stock options that are currently exercisable or exercisable within 60
days pursuant to the Director Plan.
(13) Consists of 14,359 shares of Class A Common Stock purchasable upon exercise
of stock options that are currently exercisable or exercisable within 60
days pursuant to the OrthAlliance, Inc. 1999 Orthodontist Stock Option
Plan.
(14) Consists of 30,000 shares of Class A Common Stock purchasable upon exercise
of stock options that are currently exercisable or exercisable within 60
days pursuant to the Director Plan.
(15) The business address of Dr. Pickron is 3294 Medlock Bridge Road, Building
A, Norcross, Georgia 30092. Class A Common Stock share ownership of Dr.
Pickron is as of December 31, 1998 and was obtained from a Schedule 13G/A,
dated December 31, 1999, filed with the Securities and Exchange Commission
June 20, 2000. Class B Common Stock share ownership of Dr. Pickron is as of
December 31, 1998 and was obtained from a Schedule 13G/A, dated December
31, 1999, filed with the Securities and Exchange Commission June 20, 2000.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.
Dr. Randall Bennett, a director and shareholder, serves as Chairman of the
OrthAlliance Clinical Advisory Committee as an independent contractor at the
rate of $2,000 per month. In addition, Dr. Bennett assists in the development
and improvement of OrthAlliance's orthodontic programs, procedures and training
materials as a part-time employee of OrthAlliance Properties, Inc. for a salary
of $2,000 per month. On
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April 7, 1998, the Company loaned $49,885 to Randall K. Bennett, D.D.S., M.S.,
P.C. of which Dr. Bennett, a director of the Company, is the 100% owner to
purchase office equipment. Interest in the loan accrues at the prime rate plus
10% and the term of the loan is thirty-six months. At March 31, 2001, principal
in the amount of $1,500 was outstanding.
W. Dennis Summers, Esq., Interim President and Chief Executive Officer and
Chairman of the Board of Directors, is a partner of the law firm McGuire Woods,
L.L.P. ("McGuire Woods"). OrthAlliance has retained McGuire Woods to assist with
certain transactions, including, but not limited to, the Purchase and Sale
Agreement dated February 29, 2000 by and among OrthAlliance, New Image
Orthodontic Group, Inc. and OrthAlliance New Image, Inc. During 2000,
approximately $51,000 was paid to this firm.
Effective March 1, 2000, OrthAlliance acquired substantially all of the
assets of New Image. The consideration paid to New Image included approximately
$5.6 million in cash, an estimated $0.3 million in acquisition costs, the
issuance of approximately $12.9 million in promissory notes to New Image and the
assumption of approximately $13.4 million in indebtedness from New Image. At the
time of the sale, New Image was controlled by certain entities which
OrthAlliance believes are affiliated with Goldman Sachs Asset Management.
Goldman Sachs Asset Management has reported beneficially owning 12.8% of
OrthAlliance's Class A Common Stock. See "Common Stock Ownership by Management
and Principal Stockholders." The purchase price in the New Image acquisition was
determined in arms'-length negotiations between officers and directors of
OrthAlliance, on one hand, and officers and directors of New Image, on the other
hand. OrthAlliance believes the purchase price is within the range of purchase
prices generally paid by OrthAlliance and similar companies for similar assets
and rights related to orthodontic practices.
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REPORT ON EXECUTIVE COMPENSATION
The Compensation Committee is responsible for ensuring that a proper system
of short and long-term compensation is in place to provide performance-oriented
incentives to management. Its report on compensation is as follows:
The Compensation Committee (the "Committee") of the Board of Directors is
responsible for administering the Company's executive compensation program. None
of the members of the Committee are officers or employees of the Company.
EXECUTIVE COMPENSATION PROGRAM
The Committee believes that a portion of the compensation paid to executive
officers should relate to both the short-term and long-term profitability of the
Company. Therefore, the executive officers' compensation program is composed of
base salary, bonus and long-term incentive compensation.
Base Salary and Bonus. Base salaries for Messrs. Westover and Hayase are
paid pursuant to the Employment Agreements and the base salary for Messrs. Toon
and Wilson is paid pursuant to Letter Agreements. Base salary for Mr. Summers is
paid pursuant to an oral agreement.
Each of Messrs. Hayase, Wilson and Toon is eligible for an annual cash
bonus of up to forty percent (40%) of his annualized base salary. Until his
resignation from the Company on December 27, 2000, Mr. Westover was eligible for
an annual cash bonus of up to forty percent (40%) of his annualized base salary.
The individual bonus percentages for 2000 were established by the Committee
based upon each officer's level of responsibility within the Company and his
contributions toward improving operating performance and profitability. The
bonus percentages will be reviewed annually by the Committee and may be adjusted
in accordance with these factors or others that the Committee determines to be
relevant at the time.
The Committee believes that the bonus portion of the executive compensation
program is effective in motivating the executive officers of the Company to
improve the current profitability of the Company. The Committee also believes
that an adequate base salary is necessary to retain effective executive officers
and to discourage management decisions which might improve short-term
profitability but may not always be in the long-term best interest of the
Company.
Long-Term Incentives. The Committee believes that, in addition to the
annual cash bonus arrangements, it is appropriate for the Company to provide
long-term incentive awards to motivate the executive officers to improve
long-term profitability of the Company and create value for the stockholders.
COMPENSATION OF THE CHIEF EXECUTIVE OFFICER
Compensation arrangements for Mr. Summers as President and Chief Executive
Officer consisting of base salary and stock options were based on consideration
of various factors, including his prior experience with the Company as Chairman
and a Director, his compensation at his law firm from which he is on leave of
absence and his willingness to serve on an interim basis until a replacement is
identified.
Mr. Westover served as President and Chief Executive Officer of the Company
until his resignation as such on November 29, 2000. Compensation arrangements
for Mr. Westover were determined based on his Employment Agreement with respect
to base salary and long-term compensation and based on consideration of the
factors described above with respect to the bonus amounts. The Committee noted
the growth of the Company, attainment of financial objectives and the increase
in Mr. Westover's responsibilities related thereto.
SECTION 162(m) OF THE INTERNAL REVENUE CODE
Section 162(m) of the Internal Revenue Code, added as part of the Omnibus
Budget Reconciliation Act of 1993, imposes a limitation on deductions that can
be taken by a publicly held corporation for compensation paid to certain of its
executives. Under Section 162(m), a deduction is denied for compensation paid in
a tax year beginning on or after January 1, 1994, to a corporation's chief
executive officer or any of its other four
31
36
most highly compensated officers to the extent that such compensation exceeds $1
million. Certain performance-based compensation, however, is specifically exempt
from the deduction limit.
The Committee's current policy with respect to the Section 162(m)
limitations is to preserve the federal income tax deductibility of executive
compensation payments when it is appropriate and in the best interests of the
Company and its stockholders. For the foreseeable future, the Committee does not
expect Section 162(m) to have any practical effect on the Company's compensation
program. However, the Committee reserves the right to approve the payment of
nondeductible compensation in the future if it deems such payment to be
appropriate.
COMPENSATION COMMITTEE
Craig L. McKnight
Larry Dormois
G. Harry Durity
THE FOREGOING REPORT SHOULD NOT BE DEEMED INCORPORATED BY REFERENCE BY ANY
GENERAL STATEMENT INCORPORATING BY REFERENCE THIS FORM 10-K INTO ANY FILING
UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR UNDER THE EXCHANGE ACT
(TOGETHER, THE "ACTS"), EXCEPT TO THE EXTENT THAT THE COMPANY SPECIFICALLY
INCORPORATES THIS INFORMATION BY REFERENCE, AND SHALL NOT OTHERWISE BE DEEMED
FILED UNDER SUCH ACTS.
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STOCK PRICE PERFORMANCE GRAPH
The following line graph compares the yearly percentage change in
cumulative stockholder return on the Common Stock with (a) the performance of a
broad equity market indicator, and (b) the performance of a published industry
index. The graph compares the percentage change in the return on the Common
Stock since August 21, 1997 with the cumulative total return on the Nasdaq Stock
Market Index and Nasdaq Health Services Stock Index. The stock price performance
graph assumes an investment of $100 in the Company on August 21, 1997 and an
investment of $100 in the two (2) indexes on August 21, 1997 and further assumes
the reinvestment of all dividends. Stock price performance, presented monthly
for the period from August 21, 1997 through December 31, 2000 is not necessarily
indicative of future results.
COMPARISON OF 40 MONTH CUMULATIVE TOTAL RETURN*
AMONG ORTHALLIANCE, INC., THE NASDAQ STOCK MARKET (U.S.) INDEX
AND THE NASDAQ HEALTH SERVICES INDEX
NASDAQ STOCK NASDAQ HEALTH
ORTHALLIANCE, INC. MARKET (U.S.) SERVICES
------------------ ------------- -------------
8/21/97 100.00 100.00 100.00
8/97 115.63 98.98 100.25
9/97 122.92 104.85 108.71
10/97 112.50 99.38 101.61
11/97 92.71 99.91 97.17
12/97 76.04 98.16 97.73
1/98 90.63 101.27 95.12
2/98 107.29 110.78 103.84
3/98 116.67 114.88 107.22
4/98 130.21 116.82 107.05
5/98 120.31 110.33 97.50
6/98 120.83 118.04 97.36
7/98 95.83 116.65 83.11
8/98 75.00 93.53 64.93
9/98 67.71 106.50 73.13
10/98 87.50 111.18 79.02
11/98 94.79 122.49 76.57
12/98 91.67 138.40 82.84
1/99 91.67 158.49 79.41
2/99 75.00 144.30 71.99
3/99 64.58 155.21 74.17
4/99 60.42 160.21 77.69
5/99 62.50 155.78 83.27
6/99 61.46 169.79 91.62
7/99 61.46 166.73 79.55
8/99 52.60 173.78 71.15
9/99 60.42 174.02 67.68
10/99 53.13 187.96 56.66
11/99 72.92 210.82 59.88
12/99 52.08 257.19 66.64
1/00 47.40 247.68 68.35
2/00 51.04 294.76 71.32
3/00 58.33 288.69 69.31
4/00 51.04 242.82 63.53
5/00 48.44 213.53 65.09
6/00 50.00 251.00 70.72
7/00 46.88 237.40 73.11
8/00 59.90 265.45 75.37
9/00 51.04 230.95 78.51
10/00 31.78 211.93 79.69
11/00 24.48 163.39 75.93
12/00 22.40 154.63 91.48
* $100 INVESTED ON 8/21/97 IN STOCK OR INDEX-
INCLUDING REINVESTMENT OF DIVIDENDS.
FISCAL YEAR ENDING DECEMBER 31.
THE STOCK PRICE PERFORMANCE GRAPH SHALL NOT BE DEEMED INCORPORATED BY
REFERENCE BY ANY GENERAL STATEMENT INCORPORATING BY REFERENCE THIS FORM 10-K
INTO ANY FILING UNDER THE ACTS EXCEPT TO THE EXTENT THAT THE COMPANY
SPECIFICALLY INCORPORATES THIS INFORMATION BY REFERENCE, AND SHALL NOT OTHERWISE
BE DEEMED FILED UNDER SUCH ACT.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents as filed as part of this registrant:
(1) Financial Statements
The list of consolidated financial statements contained in the
accompanying Index to Consolidated Financial Statements covered by the
Report of Independent Public Accountants is herein incorporated by
reference.
(2) Financial Statement Schedules
The list of financial statement schedules contained in the
accompanying Index to Consolidated Financial Statements is incorporated by
reference. All other schedules are omitted because they are not applicable
or the required format is included in the Consolidated Financial Statements
and Notes thereto.
(3) Exhibits
The list of exhibits on the accompanying Exhibit Index is herein
incorporated by reference.
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
2.1 Agreement and Plan of Merger between the Company, USOC and
POG (incorporated by reference to Exhibit 2.1 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
3.1 Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
3.2 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement on Form S-1 Registration No. 333-27143, as
amended).
4.1 Specimen Class A Common Stock Certificate (incorporated by
reference to Exhibit 4.1 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
4.2 Amended and Restated Certificate of Incorporation of the
Company, including, without limitation Section 4
(incorporated by reference to Exhibit 3.1 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
4.3 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement on Form S-1 Registration No. 333-27143, as
amended).
10.1 Form of Purchase and Sale Agreement between the Company and
Allied Practices (incorporated by reference to Exhibit 2.2
of the Company's Registration Statement on Form S-1,
Registration No. 333-27143, as amended).
10.2 Form of Stock Purchase and Sale Agreement between the
Company and Stockholders of the initial Allied Practices
(incorporated by reference to Exhibit 2.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.3 Form of Stock Purchase and Sale Agreement between the
Company and the Stockholders of the Allied Practices
(incorporated by reference to Exhibit 10.4 of the Company's
Annual Report on Form 10-K for the fiscal Year ended
December 31, 1997).
10.4 Form of Agreement and Plan of Reorganization between the
Company, Allied Practices and the Stockholders of the Allied
Practices (incorporated by reference to Exhibit 2.3 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
10.5 Form of Service Agreement between the Company and Allied
Practices (Fixed Percentage Fee) (incorporated by reference
to Exhibit 10.1 of the Company's Registration Statement on
Form S-1, Registration No. 333-27143, as amended).
34
39
EXHIBIT DESCRIPTION
- ------- -----------
10.6 Form of Service Agreement between Company and Allied
Practices (Variable Percentage Fee) (incorporated by
reference to Exhibit 10.2 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
10.7 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Variable Percentage Fee)
(incorporated by reference to Exhibit 10.3 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.8 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Fixed Percentage Fee)
(incorporated by reference to Exhibit 10.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.9 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Fixed Dollar Fee)
(incorporated by reference to Exhibit 10.5 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.10 1997 Non-Employee Director Stock Plan (incorporated by
reference to Exhibit 4.3 of Post-Effective Amendment No. 1
to the Company's Registration Statement on Form S-8,
Registration No. 333-48833).
10.11 Amended and Restated 1997 Employee Stock Option Plan
(incorporated by reference to Exhibit 4.3 of Post-Effective
Amendment No. 1 to the Company's Registration Statement on
Form S-8, Registration No. 333-48831).
10.12 1997 Orthodontist Stock Option Plan (incorporated by
reference to Exhibit 4.3 of Post-Effective Amendment No. 1
to the Company's Registration Statement on Form S-8,
Registration No. 333-61461.
10.13 Employment Agreement between the Company and Sam Westover
(incorporated by reference to Exhibit 10.8 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.14 Letter Agreement between the Company and Stephen M. Toon
(incorporated by reference to Exhibit 10.14 of the Company's
Annual Report on Form 10-K for fiscal year ended December
31, 1998), as amended by that Amendment (Incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report
on Form 10-Q for fiscal quarter ended June 30, 2000).
10.16 Form of Company Practice Improvement Program Guarantee
(incorporated by reference to Exhibit 10.17 of the Company's
Annual Report on Form 10-K for fiscal year ended December
31, 1997).
10.18 Letter Agreement between the Company and James C. Wilson
(incorporated by reference to Exhibit 10.18 of the Company's
Registration Statement on Form S-4, Registration No.
333-84197).
10.19 1999 Orthodontist Stock Option Plan (incorporated by
reference to Exhibit 4.3 of the Registration Statement on
Form S-8, Registration No. 333-32392).
10.20 Purchase and Sale Agreement dated as of February 1, 2000
between the Company and New Image Orthodontic Group, Inc.
(incorporated by reference to Exhibit 2.1 of the Current
Report on Form 8-K, dated March 1, 2000).
10.21 Credit Agreement dated April 14, 2000 between the Company
and First Union National Bank, as agent (incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report
on Form 10-Q for the quarter ending March 31, 2000).
10.22 Employment Agreement between the Company and Paul H. Hayase
(incorporated by reference to Exhibit 10.8 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.23 Severance Agreement and General Release between the Company
and Sam Westover, dated November 29, 2000.
10.24 Consulting Agreement between the Company and Sam Westover,
dated December 27, 2000.
10.25 Letter Agreement by and between the Company and Stephen M.
Toon dated December 15, 2000.
10.26 Letter Agreement by and between the Company and Paul H.
Hayase dated December 15, 2000 (incorporated by reference to
Exhibit 10.25 of the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2000).
35
40
EXHIBIT DESCRIPTION
- ------- -----------
10.27 Letter Agreement by and between the Company and James C.
Wilson dated December 15, 2000 (incorporated by reference to
Exhibit 10.25 of the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2000).
21.1 Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP.
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 fourth quarter
of 2000.
36
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the 1934 Act, the
Company has duly caused this Form 10-K to be signed on behalf of the
undersigned, thereunto duly authorized, on March 31, 2001.
ORTHALLIANCE, INC.
By: /s/ W. DENNIS SUMMERS
------------------------------------
W. Dennis Summers
President, Chief Executive Officer
and Chairman of the Board
(Principal Executive Officer)
By: /s/ JAMES C. WILSON
------------------------------------
James C. Wilson
Chief Financial Officer
(Principal Financial and Accounting
Officer)
Pursuant to the Requirements of the 1934 Act, this Form 10-K has been
signed below by the following persons in the capacities indicated on March 31,
2001.
/s/ W. DENNIS SUMMERS Chief Executive Officer
- --------------------------------------------- and Chairman
W. Dennis Summers
Director
- ---------------------------------------------
Randall K. Bennett
/s/ DOUGLAS D. DURBIN Director
- ---------------------------------------------
Douglas D. Durbin
/s/ G. HARRY DURITY Director
- ---------------------------------------------
G. Harry Durity
Director
- ---------------------------------------------
Craig L. McKnight
/s/ LARRY DORMOIS Director
- ---------------------------------------------
Larry Dormois
Director
- ---------------------------------------------
Raymond G.W. Kubisch
/s/ ROBERT W. MILLER Director
- ---------------------------------------------
Robert W. Miller
/s/ STEPHEN G. TRACEY Director
- ---------------------------------------------
Stephen G. Tracey
37
42
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants.................... F-2
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2000 and
December 31, 1999...................................... F-3
Consolidated Statements of Income For the Years Ended
December 31, 2000, December 31, 1999 and December 31,
1998................................................... F-4
Consolidated Statements of Cash Flows For the Years Ended
December 31, 2000, December 31, 1999 and December 31,
1998................................................... F-5
Consolidated Statements of Stockholders' Equity For the
Years Ended December 31, 2000, December 31, 1999 and
December 31, 1998...................................... F-6
Notes to Consolidated Financial Statements................ F-7
Report of Independent Public Accountants.................... F-27
Schedule II -- Valuation and Qualifying Accounts For the
Years Ended December 31, 2000, 1999 and 1998.............. F-28
F-1
43
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of OrthAlliance, Inc.:
We have audited the accompanying consolidated balance sheets of
OrthAlliance, Inc. (a Delaware Corporation) and subsidiaries as of December 31,
2000 and 1999, and the related consolidated statements of income, stockholders'
equity and cash flows for each of the three years ended December 31, 2000. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of OrthAlliance, Inc. and
subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years ended December 31,
2000, in conformity with accounting principles generally accepted in the United
States.
/s/ ARTHUR ANDERSEN LLP
Arthur Andersen LLP
Los Angeles, California
March 7, 2001
F-2
44
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ASSETS
DECEMBER 31,
-------------------
2000 1999
-------- --------
Current assets:
Cash and cash equivalents................................. $ 5,075 $ 11,189
Patient receivables, net of allowances of $401 and $563... 18,935 10,520
Unbilled patient receivables, net of allowances of $100
and $382............................................... 3,897 3,436
Amounts due from Allied Practices......................... 14,203 10,630
Income tax receivable..................................... 512 509
Current deferred income tax assets........................ 168 104
Other current assets...................................... 555 2,010
-------- --------
Total current assets.............................. 43,345 38,398
Property and equipment, net................................. 8,426 6,333
Notes receivable, net of allowances of $53 and $38.......... 6,849 4,920
Non-current deferred tax assets............................. 1,042 1,486
Intangible assets, net...................................... 124,198 83,620
Other, net.................................................. 1,046 502
-------- --------
Total assets...................................... $184,906 $135,259
======== ========
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities:
Accounts payable.......................................... $ 4,609 $ 2,549
Accrued liabilities....................................... 5,237 2,299
Patient prepayments....................................... 13,137 6,240
Practice affiliation payable.............................. 988 3,610
Deferred income tax liabilities........................... 23 182
Amounts due to Allied Practices........................... 2,474 1,988
Current portion of long-term debt......................... $ 5,352 --
-------- --------
Total current liabilities......................... 31,820 16,868
Line of credit borrowings................................... 62,000 47,500
Long-term debt.............................................. 15,658 2,144
Non-current deferred tax liabilities........................ 1,368 935
-------- --------
Total non-current liabilities..................... 79,026 50,579
-------- --------
Total liabilities................................. 110,846 67,447
-------- --------
Commitments and contingencies
Stockholders' equity (shares in thousands)
Class A Common Stock, $.001 par value, 70,000 shares
authorized,
13,262 and 13,198 shares issued and outstanding at
December 31, 2000 and 1999, respectively............... 13 13
Class B Common Stock, $.001 par value, 250 shares
authorized, 185 and 249 shares issued and outstanding
at
December 31, 2000 and 1999, respectively............... -- --
Additional paid in capital.................................. 65,700 65,145
Retained earnings........................................... 14,992 5,457
Treasury Stock, at cost, 1,194 and 318 shares at December
31, 2000 and
1999, respectively........................................ (6,645) (2,803)
-------- --------
Total stockholders' equity........................ 74,060 67,812
-------- --------
Total liabilities and stockholders' equity........ $184,906 $135,259
======== ========
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
45
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2000 1999 1998
--------- -------- --------
Net revenues................................................ $142,014 $95,703 $74,387
Costs and expenses:
Salaries and benefits..................................... 42,461 28,423 22,880
Orthodontic supplies...................................... 13,903 9,438 7,436
Rent...................................................... 11,761 8,252 6,327
-------- ------- -------
Total direct expenses............................. 68,125 46,113 36,643
General and administrative.................................. 43,410 26,686 21,456
Depreciation and amortization............................... 6,737 3,983 2,426
-------- ------- -------
Total operating expenses.......................... 118,272 76,782 60,525
-------- ------- -------
Operating income............................................ 23,742 18,921 13,862
Interest expense............................................ (7,371) (2,450) (555)
Interest income............................................. 675 416 351
-------- ------- -------
Income before income taxes.................................. 17,046 16,887 13,658
Provision for income taxes.................................. 7,511 7,304 6,123
-------- ------- -------
Net income.................................................. $ 9,535 $ 9,583 $ 7,535
======== ======= =======
Basic and diluted net income per share...................... $ 0.74 $ 0.72 $ 0.58
Weighted average number of common shares outstanding
(in thousands):
Basic.................................................. 12,858 13,271 13,006
Diluted................................................ 12,906 13,283 13,044
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
46
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
-------- -------- --------
Cash flows from operating activities:
Net income............................................... $ 9,535 $ 9,583 $ 7,535
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization......................... 6,737 3,983 2,426
Deferred income tax expense (benefit)................. 1,149 1,544 (226)
Changes in assets and liabilities, excluding effects of
acquisitions:
Increase in patient receivables.......................... (7,796) (1,149) (549)
Increase in due from Allied Practices.................... (3,573) (461) (7,543)
(Increase) decrease in income tax receivable............. (491) 1,020 (2,409)
Decrease (increase) in other assets...................... 1,660 (211) (247)
(Decrease) increase in accounts payable and accrued
liabilities........................................... (579) 174 427
Increase in patient prepayments.......................... 5,645 1,170 1,366
Increase (decrease) in due to Allied Practices........... 463 (470) 425
-------- -------- --------
Net cash provided by operating activities........ 12,750 15,183 1,205
-------- -------- --------
Cash flows from investing activities:
Payment for practice affiliations........................ (14,784) (33,019) (24,477)
Increase in notes receivables............................ (3,402) (2,400) (2,184)
Principal payments on notes receivable................... 1,650 1,087 534
Capital expenditures..................................... (1,165) (952) (683)
-------- -------- --------
Net cash used in investing activities............ (17,701) (35,284) (26,810)
-------- -------- --------
Cash flows from financing activities:
Increase in bank overdraft............................... 2,076 20 1,363
Borrowings on line of credit............................. 83,000 50,300 16,500
Repayment of line of credit borrowings and long term
debt.................................................. (81,473) (20,094) (1,919)
Proceeds from exercise of stock options.................. -- -- 240
Treasury shares purchased................................ (3,846) (1,743) --
Payment of deferred financing costs...................... (920) (419) --
-------- -------- --------
Net cash (used in) provided by financing
activities..................................... (1,163) 28,064 16,184
-------- -------- --------
Net (decrease) increase in cash and cash equivalents....... (6,114) 7,963 (9,421)
Cash and cash equivalents at beginning of period........... 11,189 3,226 12,647
-------- -------- --------
Cash and cash equivalents at end of period................. 5,075 11,189 3,226
Supplemental cash flow information:
Cash paid during the year for:
Interest.............................................. 5,643 2,575 280
Income taxes.......................................... 6,316 6,711 8,774
Non-cash investing and financing activities:
Acquisition of management agreements:
Fair value of assets acquired....................... 42,555 39,532 46,819
Less: issuance of common stock...................... (555) (759) (19,801)
Less: cash paid for practice affiliations........... (14,784) (33,019) (24,477)
-------- -------- --------
Notes payable, affiliation payables and liabilities
assumed.......................................... $ 27,216 $ 5,754 $ 2,541
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
47
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
(DOLLARS AND SHARE AMOUNTS IN THOUSANDS)
COMMON STOCK
--------------------------------- (ACCUMULATED
CLASS A CLASS B DEFICIT) TREASURY STOCK TOTAL
--------------- --------------- PAID-IN RETAINED ----------------- STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT EQUITY
------ ------ ------ ------ ------- ------------ ------- ------- -------------
BALANCES, DECEMBER 31, 1997...... 11,487 $11 250 $ $45,149 $(11,132) -- $ -- $34,028
Issuance of common stock for
intangible assets.............. 1,640 2 -- -- 19,799 -- -- -- 19,801
Stock options exercised.......... 70 -- -- -- 240 -- -- -- 240
Conversions to Class A common
stock.......................... 1 -- (1) -- -- -- -- -- --
Repurchase of common stock....... -- -- -- -- -- -- (170) (2,348) (2,348)
Net income....................... -- -- -- -- -- 7,535 -- -- 7,535
------ --- --- --- ------- -------- ------- ------- -------
BALANCES, DECEMBER 31, 1998...... 13,198 13 249 -- 65,188 (3,597) (170) (2,348) 59,256
------ --- --- --- ------- -------- ------- ------- -------
Issuance of common stock from
Treasury, for intangible
assets......................... -- -- -- -- -- (529) 93 1,288 759
Repurchase of common stock....... -- -- -- -- -- -- (241) (1,743) (1,743)
Registration costs............... -- -- -- -- (43) -- -- -- (43)
Net income....................... -- -- -- -- -- 9,583 -- -- 9,583
------ --- --- --- ------- -------- ------- ------- -------
BALANCES, DECEMBER 31, 1999...... 13,198 13 249 -- 65,145 5,457 (318) (2,803) 67,812
------ --- --- --- ------- -------- ------- ------- -------
Stock options New Image.......... -- -- -- -- 555 -- -- -- 555
Repurchase of common stock....... -- -- -- -- -- -- (876) (3,842) (3,842)
Conversions to Class A common
stock.......................... 64 -- (64) -- -- -- -- -- --
Net income....................... -- -- -- -- -- 9,535 -- -- 9,535
------ --- --- --- ------- -------- ------- ------- -------
BALANCES, DECEMBER 31, 2000...... 13,262 $13 185 $-- $65,700 $ 14,992 (1,194) $(6,645) $74,060
====== === === === ======= ======== ======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
48
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. BUSINESS AND ORGANIZATION
a. ORGANIZATION
OrthAlliance, Inc. ("OrthAlliance"), a Delaware corporation, was
incorporated on October 21, 1996 and provides practice management and consulting
services to orthodontic and pediatric dental practices throughout the United
States. Effective prior to the closing of the initial public offering of shares
of OrthAlliance's Class A Common Stock (the "Offering" or "IPO"), Premier
Orthodontic Group, Inc. ("Premier") and US Orthodontic Care, Inc. ("USOC")
merged with and into OrthAlliance. In the merger, the outstanding common stock
of USOC and Premier converted into shares of Class A Common Stock ("Common
Stock") and shares of Class B Common Stock ("Class B Common Stock"). On August
26, 1997, OrthAlliance acquired (the "Acquisitions") simultaneously with the
closing of the IPO certain operating assets of or the stock of entities holding
certain tangible and intangible assets and assumed certain liabilities of 55
orthodontic practices in exchange for shares of Common Stock and cash. The
Acquisitions were accounted for in accordance with the Securities and Exchange
Commission's Staff Accounting Bulletin No. 48.
OrthAlliance's wholly-owned subsidiaries, incorporated in Delaware, include
PedoAlliance, Inc. ("PedoAlliance") and OrthAlliance Finance, Inc. ("OA
Finance") were formed in December 1997. PedoAlliance Properties Inc., a
wholly-owned subsidiary of PedoAlliance, OrthAlliance Properties, Inc. and
OrthAlliance Services, Inc. were incorporated in California in April 1999.
OrthAlliance Holdings, Inc., incorporated in Texas, and OrthAlliance New Image,
Inc. ("OA New Image") were formed in January 2000. These subsidiaries were
formed to provide practice management, patient financing, consulting and other
services (collectively "Management Services") to allied orthodontic and
pediatric dental practices (the "Allied Practices") or their patients.
OrthAlliance, Inc. and its subsidiaries are collectively referred to as
"OrthAlliance" or the "Company".
b. AGREEMENTS WITH ALLIED PRACTICES
The Company is party to management service agreements with the Allied
Practices. These are either "Service Agreements", "Consulting Agreements", or
"Management Service Agreements", collectively "Management Agreements." The type
of Management Agreements are determined by the Company and each Allied Practice
based primarily on applicable state laws and regulations and are as follows:
Service Agreements
The parties to each Service Agreement include the Company and the Allied
Practice, which typically is a professional corporation or association owned by
the related Orthodontist or Pediatric Dentist. Each Service Agreement generally
requires the Company to perform the following services for the Allied Practices:
provide and maintain specified furnishings and equipment; provide necessary
employees (except Orthodontists and Pediatric Dentists, and where applicable law
requires, hygienists and dental assistants); establish appropriate business
systems; purchase and maintain inventory; perform payroll and accounting
functions; provide billing and collection services with respect to patients,
insurance companies, and third-party payors; arrange certain legal services not
related to malpractice litigation; design and execute a marketing plan; advise
with respect to new office locations; and manage and organize the Allied
Practices' files and records, including patient records where permitted by
applicable law. If the Allied Practice lacks sufficient funds to pay its current
operating expenses, the Company is also required to advance funds to the Allied
Practice for the purpose of paying such expenses. In exchange for performing the
services described above, the Company receives a management fee based on one of
the three fee structures described in section c. below.
F-7
49
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The term of each Service Agreement is 20 to 25 years, subject to prior
termination by either party in the event the other party becomes subject to
voluntary or involuntary bankruptcy proceedings or materially breaches the
agreement, subject to a cure period. In addition, the Allied Practices may
terminate the Service Agreements upon the occurrence of a change of control of
OrthAlliance (as defined therein, which does not include a transaction approved
by the Company's Board of Directors). Upon the expiration or termination of the
Service Agreement, the Allied Practice may, and in certain circumstances must,
repurchase for cash (at book value) certain assets, including all equipment, and
assume certain liabilities of the Company related to the Allied Practice.
Service Agreements are generally not assignable by either party thereto
without the written consent of the other party; however, the Company may assign
the Service Agreement without the Allied Practice's consent to any entity under
common control of the Company. The Company and the Allied Practice agree to
indemnify each other for costs and expenses incurred by such other party that
are caused directly or indirectly by, as the case may be, the Company's or the
Allied Practice's intentional or negligent acts or omissions. In the case of the
Allied Practice's obligation to indemnify the Company, such obligation also
applies to intentional or negligent acts and omissions occurring prior to the
date of the Service Agreement.
Consulting Agreements
The parties to each Consulting Agreement include the Company and the Allied
Practice. Certain provisions of the Consulting Agreement are substantially
similar to the Service Agreement, including provisions relating to the Company's
obligation to loan funds to the Allied Practice in the event the Allied Practice
is unable to pay its current operating expenses; termination of the Consulting
Agreement; repurchase of assets and assumption of liabilities by the Allied
Practice upon expiration or termination; assignment; and indemnification.
The services provided by the Company to the Allied Practice under each
Consulting Agreement generally include consulting with respect to equipment and
office needs; preparing staffing models appropriate for an Allied Practice;
advising and training with respect to business systems; purchasing and
maintaining inventory; advising with respect to and providing or arranging
accounting and bookkeeping services; advising with respect to developing a
marketing plan; assessing the financial feasibility of establishing new offices;
providing billing and collection services; and assisting the Allied Practice in
organizing and developing filing and recording systems. In exchange for such
services, the Company receives a consulting fee based on one of the three fee
structures described below.
Management Service Agreements.
In March 2000, the Company and OA New Image assumed the obligations of New
Image under the various Management Service Agreements ("MSA") between New Image
and the orthodontic practices with whom it had entered into MSAs. The form of
MSA provides for a variation of the service fee calculation compared to the
traditional Company form defined in the service or consulting agreement. Under
the MSAs, the service fee amount varies monthly depending on the Allied
Practices financial performance and represents the residual amount after the
payment of practice expenses and contractually determined practice
distributions. The service fee is affected by two variables, (1) total Allied
Practice gross revenue, less refunds, and (2) overhead. Service fees are
calculated based on two separate standardized grids set forth in the MSA that
determine (i) the percent of practice revenue that is distributed to the Allied
Practice based on that Allied Practice's gross revenue, less refunds, ("Gross
Revenue Grid") and (ii) any additional or offsetting percentage of gross
revenue, less refunds, that is distributed to the Allied Practice based upon
that Allied's Practice's overhead ("Overhead Grid"). Pursuant to the Gross
Revenue Grid, in general, the Company's
F-8
50
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
retained service fees increase if the Allied Practice's gross revenue increases
and decrease if the Allied Practice's gross revenue decreases. Pursuant to the
Overhead Grid, in general, the Company's retained service fees decrease if the
Allied Practice's overhead expenses increase and the retained service fees
increase if the Allied Practice's overhead decreases. The maximum retained
service fee percentage is 20.0%. The average service fee percentage for the OA
New Image Allied Practices is approximately 16.1%. In addition, a few OA New
Image MSAs provide for a fixed percentage service fee.
c. CALCULATION OF MANAGEMENT FEES
Management fees are calculated pursuant to the Management Agreements based
upon the Allied Practice's Adjusted Patient Revenue calculated on the accrual
basis. There are three economic models by which the management fee may be
calculated under the Management Agreements discussed above which are as follows:
(i) a designated percentage ranging from 13.5% to 20% of Adjusted
Patient Revenue. The average designated percentage is 17% for the Allied
Practices subject to this fee structure. In some cases, the Allied Practice
must guarantee a minimum level of management fees to be paid by the Allied
Practice for a portion of the agreement ranging from one to 25 years.
(ii) a designated percentage of Adjusted Patient Revenue, ranging from
14% to 17%, subject to an annual adjustment based upon improvements in the
Allied Practice's operating margin in the most recent calendar year as
compared with the immediately preceding calendar year. No annual adjustment
will be made which would result in reducing the designated percentage below
the percentage applicable during the first year of the Management
Agreement. Operating margin is defined as the percentage determined by
dividing operating profit by Adjusted Patient Revenue. Operating profit is
equal to Adjusted Patient Revenue less operating expenses, excluding the
management fee and such expenses associated with the Allied Practices which
the Company is prohibited from incurring, primarily consisting of
orthodontist compensation. The average designated percentage is 16.2% for
the Allied Practices subject to this fee structure.
(iii) a fixed dollar fee with annual established fixed increases for
each year of the Management Agreement.
The Company has entered into agreements with certain Allied Practices to
make the payment of service fees after the first two years contingent on various
factors, including practice profitability compared to acquisition consideration,
timely reporting of information, participation in practice improvement programs
and orthodontist hours worked.
The Company earns revenue by providing services pursuant to Management
Agreements with Allied Practices. The Company provides management or consulting
services to each Allied Practice and assumes substantially all operating
expenses except for compensation to the allied orthodontists and pediatric
dentists ("Allied Practitioners") and other employees that the Company may not
employ according to applicable state laws. In exchange for assuming these
expenses and providing services, the Company records revenues in amounts equal
to the assumed expenses plus a service fee or consulting fee, as described
below.
Patient revenue is recognized as services are performed. For orthodontic
services, approximately 20% of the orthodontic patient contract revenues are
recognized at the time of initial treatment. The balance of the contract revenue
is recognized evenly over the remaining treatment period. The 25% estimated
revenue at the initial treatment date is based on the estimated costs incurred
by the Company at that time as compared to the total costs of providing the
contracted services. The percentage includes the estimated costs of diagnosis
and
F-9
51
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
treatment plan development, initial treatment by Company personnel, orthodontic
supplies, and associated administrative services.
Expenses reported by the Company include certain of the expenses to operate
the orthodontic or pediatric dental offices and all of the expenses of any
corporate offices, facilities or functions.
d. PATIENT RECEIVABLES AND PATIENT PREPAYMENTS
The difference in the timing of the recognition of adjusted patient revenue
and the collection of cash related thereto results in unbilled receivables or
patient prepayments. Unbilled patient receivables represent the earned revenue
in excess of billings to patients as of the end of each period. Patient
prepayments represent collections from patients or their insurance companies
which are received in advance of the performance of the related services.
Patient receivables are recorded at net realizable value on the date of
affiliation and subsequent collections are used to pay Allied Practice operating
expenses, the Company's management fee, and payments to the Allied Practices.
Generally, any subsequent uncollectible accounts are recorded as a reduction of
net revenues, which reduces the Company's management fees at the applicable
service fee percentage.
Generally, the Allied Practices require approximately 25% of the treatment
contract to be paid upon installation of the braces, and the remaining 75%
evenly over the remainder of the treatment term.
e. AMOUNTS DUE FROM ALLIED PRACTICES
Amounts due from Allied Practices include short-term advances for operating
capital and short-term receivables related to a timing difference between when
the service fees are paid from the Allied Practice's accounts and when the
service fees are deposited by the Company. These items are advanced and repaid
in a revolving manner. Generally, advances are repaid when Allied Practices
deposit patient revenue into their depository accounts. Advances occur when the
Allied Practice operating expenses paid exceed patient revenue earned. Service
fees outstanding are generally paid within 30 days.
f. OPERATING EXPENSES OF ALLIED PRACTICES
The Company is responsible for the payment of all operating expenses
incurred by the Allied Practice, except for compensation to Allied Practitioners
and other expenses of the Allied Practices that the Company is prohibited from
paying. Expenses that are the responsibility of the Company include the
following: (i) salaries, benefits, payroll taxes, workers compensation, health
insurance and other benefit plans, and other direct expenses of all employees of
OrthAlliance at each practice office, excluding those costs associated with
orthodontists and any other classification of employee which OrthAlliance is
prohibited from employing by applicable state laws or regulations; (ii) direct
costs of all employees or consultants that provide services to each practice
office except for Affiliated Orthodontists and other employees of the Allied
Practices that the Company is prohibited from employing, (iii) dental and office
supplies as permitted by applicable state laws or regulations, (iv) lease or
rent payments as permitted by state laws or regulations, utilities, telephone
and maintenance expenses for practice facilities, (v) property taxes on
OrthAlliance assets located at Allied Practice offices, (vi) property, casualty,
and liability insurance premiums, (vii) orthodontists recruiting expenses, and
(viii) advertising and other marketing expenses attributable to the promotion of
practice offices.
All of the above expenses are paid directly to the third party provider of
the goods or services indicated. All of the above expenses are incurred by
OrthAlliance. Such expenses are classified together with similar expenses of the
Company in the consolidated statements of income. In exchange for incurring
these expenses
F-10
52
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
and providing management services, the Company records revenue in amounts equal
to those incurred expenses.
The Allied Practices retain the responsibility for the payment of any and
all direct employment expenses, including benefits, for any Orthodontist or
other employee that OrthAlliance is prohibited from employing by applicable
state laws or regulations. In addition, the Allied Practices retain the
responsibility for the payment of continuing education expenses, seminars,
professional licenses, professional membership dues and all other expenses of
any Orthodontist.
g. NEW AFFILIATIONS
For the year ended December 31, 2000, the Company entered into or assumed
agreements with 43 Allied Practices. Included were 31 practices acquired from
New Image on March 1, 2000, as well as 2 pediatric dental practices, to provide
management and consulting services and acquire certain operating assets for a
total consideration (including acquisition costs) of $42.6 million. This
consideration consisted of options to acquire Class A Common Stock with a fair
value of $0.6 million, $14.8 million in cash, $27.2 million in affiliation and
notes payables. These Allied Practices operate 76 locations.
For the year ended December 31, 1999, the Company entered into agreements
with 36 Allied Practices, 11 of which were pediatric dental practices, to
provide management services and acquire certain operating assets for a total
consideration (including acquisition costs) of $39.5 million. This consideration
consisted of 93,584 shares of Common Stock, from the Treasury, with an aggregate
value at various acquisition dates of $0.8 million, payment of $33.0 million in
cash, $5.7 million in affiliation and notes payable. These Allied Practices
operate 73 locations.
For the year ended December 31, 1998, the Company entered into agreements
with 36 Allied Practices, seven of which were related to pediatric dental
practices, to provide management services and acquire certain operating assets
for a total consideration (including acquisition costs) of $46.8 million. This
consideration consisted of 1,640,492 shares of Common Stock with an aggregate
value at various acquisition dates of $19.8 million and payment of $24.5 million
in cash and issuance of notes payable of $2.5 million. These Allied Practices
operate 70 locations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include OrthAlliance, Inc. and its
wholly owned subsidiaries. The Company does not consolidate the operations of
the Allied Practices which it manages as the Company's arrangements with its
Allied Practices do not meet the requirements for consolidation as set forth in
Emerging Issues Task Force consensus opinion 97-2 ("EITF 97-2"). All significant
intercompany accounts and transactions have been eliminated in consolidation.
b. USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
F-11
53
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
c. CASH AND CASH EQUIVALENTS
The Company considers all highly-liquid investments with a maturity of
three months or less at the date of purchase to be cash equivalents. All cash
equivalents are recorded at cost, which approximates fair value.
d. PROPERTY AND EQUIPMENT, NET
Property and equipment are stated at cost or fair value at acquisition date
if acquired upon affiliation with an Allied Practice. Routine maintenance and
repairs are expensed when incurred, while costs of improvements and renewals are
capitalized. Depreciation of property and equipment is calculated using the
straight-line method over the estimated useful lives of the assets or remaining
lease terms as follows:
Furniture, fixtures and equipment............ 5 years
Leasehold improvements....................... Shorter of 3 - 10 years
or the related lease term
Depreciation expense for the years ended December 31, 2000, 1999 and 1998
was approximately $1.8 million, $1.2 million, and $0.9 million, respectively.
e. INTANGIBLE ASSETS, NET
The Management Agreements with Allied Practices include the acquisition of
certain tangible and intangible assets and the assumption of certain liabilities
of the Allied Practices. The Company allocates the purchase price to the
tangible assets acquired and liabilities assumed based on their estimated fair
values. Intangible assets related to the Management Agreements are being
amortized using the straight-line method over their respective terms. The
Company periodically evaluates whether events and circumstances have occurred
that indicate the remaining useful life of the intangible assets may warrant
revision or that the remaining balance of the intangible assets may not be
recoverable. As of December 31, 2000 and 1999, there were no events or
circumstances to indicate that any portion of the recorded net intangible assets
may not be recoverable.
Amortization expense related to these intangible assets for the years ended
December 31, 2000, 1999 and 1998 was $4.9 million, $2.8 million, and $1.5
million, respectively.
f. OTHER, NET
Other, net consists primarily of deferred costs related to the Company's
bank credit facility. These costs are amortized using the straight-line method
over the expected period to be benefited. The amortization of deferred costs
related to the line of credit borrowings is included in interest expense.
g. NET REVENUES
Net revenues primarily consist of management fee income and reimbursed
practice operating expenses (See Note 1). Such reimbursed practice operating
expenses amounted to $106.1 million, $68.9 million, and $54.4 million for the
years ended December 31, 2000, 1999, and 1998, respectively.
h. INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
The statement requires recognition of deferred tax assets and liabilities for
expected future tax consequences of events that have been recognized in the
financial statements or tax returns. Deferred income taxes are provided for
temporary differences in the
F-12
54
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
recognition of certain income and expense items for financial reporting and tax
purposes given the provisions of the enacted tax laws.
i. FAIR VALUE OF FINANCIAL INSTRUMENTS
As of December 31, 2000 and 1999 the carrying amounts of the Company's
financial instruments, which include cash and cash equivalents, notes
receivable, accounts payable and accrued liabilities, notes payable and line of
credit borrowings, approximates fair value.
j. RECENT ACCOUNTING PRONOUNCEMENTS
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"), as amended by SFAS 137 and SFAS 138. 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 on the balance sheet and measure those instruments
at fair value. Management anticipates that the adoption of SFAS 133 will not
have a material affect on the Company's results of operations or financial
position.
The SEC issued Staff Accounting Bulletin Number 101, Revenue Recognition in
Financial Statements, on December 3, 1999 ("SAB 101"). This pronouncement
clarifies existing revenue recognition principles and states that revenue is
generally realized or realizable and earned when all of the following criteria
are met: i) persuasive 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. Management believes
the Company is in compliance with SAB 101.
k. RECLASSIFICATIONS
Certain prior year reclassifications have been made to conform to
classifications used in the current period.
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 9 states in accordance
with long term service and employment agreements and had practice management
agreements with 36 orthodontists operating in 50 locations.
Total consideration (including acquisition costs) consisted of $5.6 million
paid in cash, an estimated $0.3 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 with an aggregate fair value
of $0.6 million. The promissory notes issued and assumed have interest rates
ranging from 6% - 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 using the
purchase method of accounting. Intangible assets of approximately $32.9 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 obtained the appropriate consents from its lenders with regard to this
transaction.
F-13
55
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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 twelve month periods ended December 31, 1999
and December 31, 2000. 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 at the dates indicated.
DECEMBER 31, 2000 (UNAUDITED)
-----------------------------------------------------------
PRO FORMA
ORTHALLIANCE NEW IMAGE(A) ADJUSTMENTS(A) PRO FORMA
------------ ------------ -------------- ---------
Net revenues............................. $142,014 3,803 -- $145,817
Operating income (loss).................. 23,742 (84) 323 23,981
Net income (loss)........................ 9,535 (448) 440 9,527
Basic and diluted net income per share... $ 0.74 $ 0.74
======== ========
Weighted average number of common shares
outstanding (in thousands):
Basic.................................. 12,858 12,858
======== ========
Diluted................................ 12,906 12,906
======== ========
DECEMBER 31, 1999 (UNAUDITED)
-----------------------------------------------------------
PRO FORMA
ORTHALLIANCE NEW IMAGE ADJUSTMENTS PRO FORMA
------------ ------------ -------------- ---------
Net revenues............................. $ 95,703 $22,796 -- $118,499
Operating income (loss).................. 18,921 (2,085) $4,436 21,272
Net income (loss)........................ 9,583 (4,834) 4,750 9,499
Basic and diluted net income per share... $ 0.72 $ 0.72
======== ========
Weighted average number of common shares
outstanding (in thousands):
Basic.................................. 13,271 13,271
======== ========
Diluted................................ 13,283 13,283
======== ========
- ---------------
(a) Because the transaction with New Image was effective March 1, 2000, the
results of operations for New Image and the proforma adjustments are for the
two months period ended February 29, 2000.
(b) Proforma adjustments are presented to illustrate the effect of the
acquisition on the historical operating results of OrthAlliance and New
Image, as if the acquisition occurred as of that date. The proforma
adjustments include the effect of increased amortization of goodwill and
interest expense, due to the additional goodwill acquired and increased debt
levels relating to the financing of the acquisition. Other proforma
adjustments reflect cost savings relating to the elimination of duplicate
general and administrative expenses included in the New Image and
OrthAlliance corporate overhead structures.
F-14
56
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
4. OTHER CURRENT ASSETS
Other current assets consist of the following:
DECEMBER 31,
--------------
2000 1999
---- ------
Short term receivable....................................... $ 51 $1,566
Prepaid expenses and other current assets................... 504 444
---- ------
$555 $2,010
==== ======
5. PROPERTY AND EQUIPMENT, NET
Property and equipment, net consist of the following:
DECEMBER 31,
------------------
2000 1999
------- -------
Furniture and fixtures................................... $ 4,262 $ 4,007
Equipment................................................ 7,882 5,504
Leasehold improvements................................... 3,577 2,420
Construction in progress................................. 538 392
------- -------
16,259 12,323
Less: accumulated depreciation........................... (7,833) (5,990)
------- -------
$ 8,426 $ 6,333
======= =======
6. NOTES RECEIVABLE, NET
Notes receivable consist of the following:
DECEMBER 31,
----------------
2000 1999
------ ------
Notes receivable from Allied Practices..................... $5,488 $3,934
Patient loans.............................................. 1,414 1,024
------ ------
6,902 4,958
Allowance for doubtful accounts............................ (53) (38)
------ ------
$6,849 $4,920
====== ======
Certain Allied Practices have signed promissory notes due to the Company.
Generally, principal and interest payments are due monthly, with interest
accruing at prime plus 1%. Generally, these notes have maturity dates ranging
from three to five years, are unsecured and are personally guaranteed by the
respective practitioners. As of December 31, 2000 and 1999, the prime interest
rate was 9.0% and 8.50%, respectively.
During 2000 and 1999, OA Finance financed approximately $0.8 million and
$1.0 million, respectively, of patient loans from certain Allied Practices. OA
Finance was formed to provide patient financing options to all Allied Practices.
The loans outstanding are generally without recourse and principal and interest
are due monthly, with interest rates, varying between 9.9% and 16.9 %, depending
on the credit risk of the borrower. The terms of these loans range from one to
five years.
F-15
57
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
7. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following:
DECEMBER 31,
----------------
2000 1999
------ ------
Bank overdrafts............................................ $4,318 $2,242
Accounts payable........................................... 291 307
------ ------
$4,609 $2,549
====== ======
DECEMBER 31,
----------------
2000 1999
------ ------
Accrued wages.............................................. $1,706 $1,055
Accrued interest........................................... 1,771 43
Other accrued liabilities.................................. 1,760 1,201
------ ------
$5,237 $2,299
====== ======
8. LINE OF CREDIT BORROWINGS
On December 30 1997, the Company entered into a credit agreement with First
Union National Bank to provide a $25 million revolving line of credit. The
interest on borrowings accrues at either the bank's prime rate or LIBOR, plus a
margin. Amounts borrowed are secured by security interests in the Company's
assets, which include accounts receivable, Management Agreements and the capital
stock of the Company's wholly-owned subsidiaries. The Company expanded the
credit facility ("the Revolving Credit Facility") with on March 26, 1999 from
$25 million to $55 million and from $55 million to $75 million on April 14,
2000. Outstanding amounts under the April 14, 2000 agreement are repayable in
full on April 13, 2003. As of December 31, 2000 and 1999, the outstanding
balance under this credit facility was $62 million and $47.5 million,
respectively. As of December 31, 2000 the Company was in compliance with the
terms and covenants of the Revolving Credit Facility.
F-16
58
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. NOTES PAYABLE
Notes payable as of December 31, 2000 and 1999 are summarized in the
following table:
2000 1999
------- ------
Fixed-rate secured notes payable to New Image orthodontists:
9% notes payable, payable in annual installments ranging
from $93 to $110, due in 2005, secured by practice
assets................................................. $ 904 $ --
6% note payable, payable in annual installments of $71,
due in 2006, secured by practice assets................ 393 --
Fixed-rate unsecured notes payable to New Image
orthodontists:
9% note payable, payable in monthly installments of $10,
due in 2001............................................ 127 --
9% notes payable, principal maturing in varying monthly
amounts, due in 2002................................... 53 --
9% notes payable, principal maturing in varying monthly
amounts, due in 2003................................... 180 --
9% notes payable, payable in annual installments ranging
from $2 to $295, including interest, due in 2004....... 4,070 --
10% notes payable, principal maturing in varying quarterly
amounts, due in 2004................................... 412 --
9% notes payable, payable in annual installments ranging
from $75 to $212, due in 2005.......................... 3,900 --
9% notes payable, principal maturing in varying monthly
amounts, due in 2006................................... 174 --
9% notes payable, payable in annual installments of $59,
due in 2006............................................ 353 --
9% note payable, payable in monthly installments of $57,
including interest, due in 2007........................ 402 --
Fixed-rate unsecured bonds payable to OrthAlliance
orthodontists:
8% note payable, due in 2002.............................. 218 218
7% notes payable, due in 2003............................. 2,691 1,926
9% Goldman Sachs Series A Notes, payable in quarterly
installments ranging from $1 to $34, due in 2004.......... 2,007 --
9% Goldman Sachs Series B Notes, payable in quarterly
installments ranging from $44 to $132, due in 2004........ 3,626 --
10% Goldman Sachs Series C Notes, due on February 28,
2001...................................................... 1,500 --
------- ------
21,010 2,144
Less current portion of long-term debt...................... (5,352) --
------- ------
$15,658 $2,144
======= ======
Future maturities of notes payable are as follows as of December 31, 2000:
YEAR ENDING
DECEMBER 31, AMOUNT
- ------------------------------------------------------ ----------------
2001.................................................. $ 5,352
2002.................................................. 4,023
2003.................................................. 6,125
2004.................................................. 3,952
2005.................................................. 1,558
Thereafter............................................ --
-------
$21,010
=======
F-17
59
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. CLASS B COMMON STOCK
Each share of Class B Common Stock will automatically convert into eight
shares of Class A Common Stock upon the attainment of certain conversion prices.
Twenty percent of the Class B Common Stock shares will convert at each of the
following conversion prices: $18.00, $21.60, $25.92, $31.10, and $37.32. The
conversion will be effected when the average Class A Common Stock closing price
for 20 consecutive trading days exceeds the threshold. Class B Common Stock is
also convertible to an equal number of Class A Common Stock shares at any time
at the option of the holder. Any Class B Common Stock shares not converted to
Class A Common Stock, because the necessary conversion prices were not attained,
will automatically convert to one share of Common Stock upon the sixth
anniversary of the IPO. Class B Common Stock shares are not transferable, except
to a holder's direct relatives or as determined by will or the laws of descent.
The holders of Class B Common Stock enjoy the same share-for-share voting rights
with holders of the Class A Common Stock, with whom they vote as a single class.
11. PREFERRED STOCK
The Company is authorized to issue up to 20.0 million shares of preferred
stock. The Board of Directors, from time to time and without stockholder action
or approval, may fix the relative rights and preferences of the preferred
shares, including voting powers, dividend rights, liquidation preferences,
redemption rights and conversion privileges. No preferred stock was outstanding
as of December 31, 2000 and 1999, respectively.
12. TREASURY STOCK
On December 1, 2000, the Company announced that its common stock repurchase
program ("Stock Repurchase Program"), instituted in October 1998, would be
extended through December 2001. In connection with the program, the Company is
authorized to purchase up to $6.8 million in shares at prices prevailing on the
market. The Company uses the cost method to account for treasury stock. During
2000 and 1999, the Company repurchased 876,100 and 241,286 shares of its Common
Stock, respectively under the Stock Repurchase Program. As of December 31, 2000,
the Company's aggregate purchase price of Common Stock shares held in treasury
was $6.6 million.
During 1998, the Company acquired 170,024 shares of its common stock in
transactions with certain Allied Practices, with a market valuation at the date
of the transactions of $2.3 million. These transactions included a mutual
rescission and forgiveness of a note receivable, with a value equal to the
shares acquired.
13. STOCK OPTIONS AND WARRANTS
The Company has five stock option plans, the Amended and Restated 1997
Employee Stock Option Plan ("1997 Employee Plan"), the 1997 Director Stock
Option Plan ("Director Plan") the 1997 Orthodontist Stock Option Plan ("1997
Orthodontist Plan") the 1999 Orthodontist Stock Option Plan ("1999 Orthodontist
Plan") and 2000 Employee Stock Option Plan ("2000 Employee Plan"). In addition,
the Company issued warrants to certain executives in 1997. Options may be
granted as incentive or nonqualified stock options. The Company accounts for the
1997 Employee Plan and the Director Plan under APB Opinion No. 25, under which
no expense has been recognized.
The Company may grant options to purchase up to 2.0 million shares of
Common Stock under the 1997 Employee Plan, 500,000 shares of Common Stock under
the Director Plan, 300,000 shares of Common Stock under the 1997 Orthodontist
Plan, 280,000 shares of Common Stock under the 1999 Orthodontist Plan and
500,000 shares of Common Stock under the 2000 Employee Plan. The options are
issued with exercise prices equal to the Company's stock price at the date of
grant. Options granted under the 1997 Employee Plan and
F-18
60
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2000 Employee Plan vest over one to five years; are exercisable in whole or in
installments; and expire ten years from date of grant. Options granted under the
Director Plan vest over one year; are exercisable in whole or in installments;
and also expire ten years from date of grant. Options granted under the 1997
Orthodontist Plan and 1999 Orthodontist Plan vest at grant; are exercisable in
whole or in installments; and expire five years and three years, respectively,
from the grant date.
In connection with the IPO, the Company issued warrants to purchase 593,622
shares of Common Stock with exercise prices ranging from $0.01 to $14.38. The
weighted average fair value of the warrants granted was $4.74. The vesting
period for those warrants ranged from immediate to one year. These warrants
expire five years from date of grant and their weighted average exercise price
is $11.01 per warrant. Certain of these warrants have incidental registration
rights pursuant to which the Company is obligated to use reasonable efforts to
register the shares of Common Stock issued upon their exercise if the Company
initiates a public offering and files a registration statement in connection
therewith, excluding the registration of shares issued pursuant to an employee
stock purchase or option plan or an acquisition or proposed acquisition by the
Company.
The following summarizes stock option and warrant activity of the plans:
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
2000 1999 1998
-------------------- -------------------- --------------------
WEIGHTED NUMBER WEIGHTED NUMBER WEIGHTED NUMBER
AVERAGE SHARES AVERAGE SHARES AVERAGE SHARES
EXERCISE UNDER EXERCISE UNDER EXERCISE UNDER
PRICE OPTION PRICE OPTION PRICE OPTION
-------- --------- -------- --------- -------- ---------
Options and warrants outstanding,
beginning of year................. $11.12 2,190,664 $12.55 1,742,154 $11.72 1,243,332
Granted............................. 5.50 1,009,088 7.54 616,642 13.10 664,882
Exercised........................... -- -- -- -- 3.44 70,000
Forfeited........................... 9.95 195,475 12.79 168,132 12.24 96,000
------ --------- ------ --------- ------ ---------
Options and warrants outstanding,
end of year....................... $ 9.31 3,004,277 $11.12 2,190,664 $12.55 1,742,214
------ --------- ------ --------- ------ ---------
Options and warrants exercisable,
end of year....................... $10.71 2,093,862 $10.84 1,515,470 $12.50 1,043,514
====== ========= ====== ========= ====== =========
The shares under option and warrants at December 31, 2000, were in the
following exercise price ranges:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- -----------------------------
NUMBER WEIGHTED NUMBER WEIGHTED
SHARES CONTRACTUAL AVERAGE SHARES AVERAGE
EXERCISE PRICE UNDER OPTION LIFE (YEARS) EXERCISE PRICE UNDER OPTION EXERCISE PRICE
-------------- ------------ ------------ -------------- ------------ --------------
$ 1.00 - 3.49 182,039 8 $ 3.25 153,241 $ 2.19
$ 3.50 - 5.99 58,380 8 $ 5.46 21,476 $ 5.14
$ 6.00 - 8.49 1,245,294 7 $ 6.53 599,270 $ 6.79
$ 8.50 - 10.99 114,328 6 $ 8.96 81,814 $ 9.12
$11.00 - 13.49 1,008,488 6 $12.01 980,019 $11.69
$13.50 - 15.99 395,748 7 $14.63 258,042 $14.07
--------- ---------
3,004,277 $ 9.31 2,093,862 $ 9.72
========= =========
F-19
61
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
In accordance with Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" ("SFAS 123"), the fair value of option
grants is estimated using the Black-Scholes option pricing model for pro forma
footnote purposes. The following weighted average assumptions were used for
grants:
DECEMBER 31,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
Risk-Free interest rate.................... 5.46 - 6.95% 4.62 - 6.92% 4.35 - 5.73%
Dividend yield............................. 0% 0% 0%
Expected volatility........................ 51% 43% 60%
Expected option life (years)............... 9 8 9
As permitted by SFAS 123, the Company has chosen to continue accounting for
employee and director stock options at their intrinsic value. Accordingly, no
compensation expense has been recognized for its stock option compensation
plans. Had the fair value method of accounting been applied to the Company's
stock option plans, the tax- effected impact follows (unaudited):
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------
2000 1999 1998
----------------------- ----------------------- -----------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- --------- ----------- ---------
Net income...................... $9,535 $7,173 $9,583 $7,560 $7,535 $6,548
Basic EPS....................... $ 0.74 $ 0.56 $ 0.72 $ 0.57 $ 0.58 $ 0.50
Diluted EPS..................... $ 0.74 $ 0.56 $ 0.72 $ 0.57 $ 0.58 $ 0.50
14. COMMITMENTS AND CONTINGENCIES
The Company leases office space for the use of the Allied Practices and
corporate offices under operating leases, which have current expiration terms at
various dates through 2015. Certain of these leases have renewal options for
specified periods subsequent to their current terms. The annual lease payments
under the lease agreements have provisions for annual increases based on the
Consumer Price Index or other amounts specified within the lease agreements.
Future minimum annual lease payments on operating leases as of December 31,
2000 are as follows:
2001....................................................... $ 3,267
2002....................................................... 2,432
2003....................................................... 2,240
2004....................................................... 1,583
2005....................................................... 1,181
Thereafter................................................. 2,361
-------
$13,064
=======
Rent expense for the years ended December 31, 2000, 1999 and 1998
approximated $11.8 million, $8.3 million, and $6.3 million, respectively.
The Company may be subject to certain government regulation at the federal
and state levels. To comply with certain regulatory requirements, the Company
does not control the practice of the Orthodontists, or control or employ the
Orthodontists. There can be no assurance that the legality of any long-term
management services agreements that have been entered into will not be
successfully challenged. There also
F-20
62
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
can be no assurance that the laws and regulations of states in which the Company
maintains operations will not change or be interpreted in the future to restrict
or further restrict the Company's relationship with the Orthodontists.
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.
From time to time the Company has been, and can expect to be, involved in
litigation with certain of its Allied Practices. Such litigation has involved
claims that the Company failed to provide required services under the Management
Agreements with the Allied Practices and that certain provisions of the
Management Agreements may be unenforceable, among other claims. The Company
vigorously defends against such claims and believes that such claims are without
merit. As of December 31, 2000, the Company did not have any pending legal
proceedings that separately, or in the aggregate, if adversely determined, would
have a material adverse effect on the Company.
15. INCOME TAXES
The provision for income taxes is comprised of the following:
YEARS ENDED DECEMBER 31,
--------------------------
2000 1999 1998
------ ------ ------
Current
Federal................................................ $5,586 $5,063 $5,276
State.................................................. 776 697 1,073
------ ------ ------
6,362 5,760 6,349
------ ------ ------
Deferred
Federal................................................ 1,010 1,357 (114)
State.................................................. 139 187 (112)
------ ------ ------
1,149 1,544 (226)
------ ------ ------
$7,511 $7,304 $6,123
====== ====== ======
A reconciliation of the statutory federal income tax rate to the effective
tax rate as a percentage of income before income taxes follows:
YEARS ENDED
DECEMBER 31,
--------------------
2000 1999 1998
---- ---- ----
Federal income tax at statutory rate........................ 35% 35% 34%
Effect of amortization of non-deductible goodwill........... 6 5 4
State taxes, net of federal benefit......................... 3 3 5
Other....................................................... -- -- 2
-- -- --
44% 43% 45%
== == ==
F-21
63
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are as follows:
YEARS ENDED
DECEMBER 31,
------------------
2000 1999
------- -------
Current deferred tax assets:
Litigation reserve........................................ $ 72 $ 87
Patient prepayments....................................... 76 12
Other..................................................... 20 5
------- -------
168 104
------- -------
Non-current deferred tax assets:
Benefit of IRC Section 351 Gain on transferred assets..... 970 1,334
Start-up costs amortization............................... 72 99
Other..................................................... 53
------- -------
1,042 1,486
------- -------
Total deferred tax assets, net.................... $ 1,210 $ 1,590
======= =======
Current deferred tax liabilities:
Patient receivables....................................... $ -- $ (182)
Consulting................................................ (12)
Legal..................................................... (6) --
Other..................................................... (5) --
------- -------
(23) (182)
Non-current deferred tax liabilities:
Depreciation.............................................. (538) (561)
Amortization.............................................. (669) (268)
State taxes............................................... (161) (106)
------- -------
(1,368) (935)
------- -------
Total deferred tax liabilities.................... $(1,391) $(1,117)
======= =======
As a result of the acquisitions of the Allied Practices, temporary
differences were created for the differences between the financial statement
carrying amounts and the tax basis of assets acquired. Such temporary
differences predominantly relate to property and equipment and related
depreciation.
F-22
64
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
16. EARNINGS PER SHARE
The Company adopted SFAS No. 128, Earnings per Share ("SFAS 128") effective
December 15, 1997. Basic earnings per share of Common Stock is computed by
dividing the net income for the year by the weighted average number of shares of
Common Stock outstanding during the year.
The following table sets forth the computation of basic and diluted
earnings per share:
YEARS ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
------- ------- -------
Net income............................................ $ 9,535 $ 9,583 $ 7,535
Determination of shares:
Weighted average number of common stock shares
outstanding...................................... 12,858 13,271 13,006
Assumed conversion of stock options................. 48 12 38
------- ------- -------
Diluted common stock shares outstanding............. 12,906 13,283 13,044
======= ======= =======
Basic and diluted net income per share.............. $ 0.74 $ 0.72 $ 0.58
======= ======= =======
Securities, including those issuable pursuant to the conversion of Class B
Common Stock to Class A Common Stock, which could potentially dilute EPS in the
future were not included in the computation of diluted EPS because of its
anti-dilutive effect or its conversion contingencies were not met. Potential
dilutive shares (in thousands) include the following:
YEARS ENDED DECEMBER 31,
--------------------------
2000 1999 1998
------ ------ ------
Common Stock shares issuable in the future pursuant to
options and warrants outstanding.......................... 2,812 1,672 506
Common Stock shares issuable in the future for conversion of
Class B Common Stock shares............................... 1,294 1,745 1,745
----- ----- -----
4,106 3,417 2,251
===== ===== =====
17. 401(K) PLAN
The Company administrates a voluntary retirement plan ("the Plan") under
section 401(k) of the Internal Revenue Code. The Plan covers all eligible,
non-highly compensated employees with at least twelve months of employment with
the Company. Currently, the Plan does not provide for Company matching
contributions.
18. RELATED PARTY TRANSACTIONS
FOR THE YEAR ENDED DECEMBER 31, 2000, the Company entered into the
following related party transactions:
(i) On December 27, 2000, the Company and its former President and
Chief Executive Officer Sam Westover ("Westover"), entered into a Severance
Agreement and General Release dated December 27, 2000 (the "Westover
Severance Agreement") pursuant to which Westover agreed to resign as
President and Chief Executive Officer of the Company. As part of the
severance, the Company and Westover agreed to a lump sum pay-out of
approximately $0.6 million payable upon separation. This expense is
reflected in salaries and benefits expenses in the accompanying
consolidated statements of income. Furthermore, to ensure an orderly
transition, the Company and Westover agreed to a one year consulting
F-23
65
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
agreement effective January 1, 2001. The consulting agreement with Westover
requires payment of approximately $12 per month.
(ii) The Company incurred $51 of legal expenses with a law firm that
has a partner who also serves on the Company's Board of Directors.
(iii) Dr. Randall Bennett, a director and shareholder, serves as
Chairman of the OrthAlliance Clinical Advisory Committee as an independent
contractor at the rate of $2 per month. In addition, Dr. Bennett assists in
the development and improvement of OrthAlliance's orthodontic programs,
procedures and training materials as a part-time employee of OrthAlliance
Properties, Inc. for a salary of $2 per month. On April 7, 1998, the
Company loaned $50 to Randall K. Bennett, D.D.S., M.S., P.C. of which Dr.
Bennett, a director of the Company, is the 100% owner to purchase office
equipment. Interest in the loan accrues at the prime rate plus 10% and the
term of the loan is thirty-six months. At March 31, 2001, principal in the
amount of $2 was outstanding.
FOR THE YEAR ENDED DECEMBER 31, 1999, the Company entered into the
following related party transactions:
(i) Referral Commissions for recruiting new Allied Practices of
options to purchase 72,015 shares of Common Stock were granted to an Allied
Orthodontist who was also a director.
(ii) The Company incurred $68 of legal expenses with a law firm that
has a partner who also serves on the Company's Board of Directors.
FOR THE YEAR ENDED DECEMBER 31, 1998, the Company entered into the
following related party transaction:
(i) Referral Commissions for recruiting new Allied Practices of $0.2
million and options to purchase 82,042 shares of Common Stock were paid and
granted to an Allied Orthodontist who was also a director.
19. OPERATING SEGMENTS AND RELATED INFORMATION
The Company adopted Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information" ("SFAS No.
131") in 1998. This statement establishes standards for the reporting of
information about operating segments and also requires disclosures about
products and services, geographic areas and major customers.
The Company has two reportable segments organized as business units that
provide management or consulting services to the two distinct types of allied
practices: OrthAlliance Allied Orthodontists and PedoAlliance Allied Dentists.
Each business unit provides similar management and consulting services to the
respective Allied Practices and the Company does not manage the business units
separately. The remaining segments identified as "All Other" derive revenues
from interest income and primarily consist of patient contract financing
operations.
Management utilizes multiple views of data to measure segment performance
and to allocate resources to the segments. The accounting policies of the
segments are consistent with those described in the summary of significant
accounting policies, as discussed in Note 2.
F-24
66
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following is a summary of certain financial data for each of the
segments:
ORTHODONTIC PEDIATRIC
PRACTICE PRACTICE ALL OTHERS TOTALS
----------- --------- ---------- --------
Year ended December 31, 2000
Net revenue................................... $127,681 $14,333 $ -- $142,014
Operating income (loss)....................... 21,578 3,933 (1,769) 23,742
Depreciation and amortization................. 6,555 159 23 6,737
Year ended December 31, 1999
Net revenue................................... $ 86,421 $ 9,282 $ -- $ 95,703
Operating income (loss)....................... 16,707 2,562 (348) 18,921
Depreciation and amortization................. 3,843 140 -- 3,983
Year ended December 31, 1998
Net revenue................................... $ 72,704 $ 1,683 $ -- $ 74,387
Operating income (loss)....................... 13,578 446 (162) 13,862
Depreciation and amortization................. 2,345 81 -- 2,426
Included in the operating income of the orthodontic practice segment are
certain corporate expenses that are not allocated to the pediatric practice
segment or to the "all others" category. Examples of these expenses are
corporate office salaries, rent, overhead expenses, and amortization expense.
A reconciliation between segment operating income and consolidated net
income is set forth below:
YEARS ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
------- ------- -------
Segment operating income.............................. $23,742 $18,921 $13,862
Interest income....................................... 675 416 351
Interest expense...................................... (7,371) (2,450) (555)
Provision for income taxes............................ (7,511) (7,304) (6,123)
------- ------- -------
Net income............................................ $ 9,535 $ 9,583 $ 7,535
======= ======= =======
20. SUBSEQUENT EVENTS (UNAUDITED)
NASDAQ Notification:
The Company's common stock is traded on the NASDAQ National Market and is
subject to certain continued listing requirements. As of December 31, 2000 the
Company was not in compliance with Rule 4450(b)(4) which requires among other
things a minimum bid price of $1.00 and tangible net assets of $4 million. On
February 28, 2001 the Company was notified by the National Market that the
Company's stock did not meet the compliance requirements of Rule 4450(b)(4) and
that the stock may be subject to removal from the NASDAQ National Market. The
Company has requested a hearing before the NASDAQ Listing Qualifications Panel,
which has been scheduled for April 6, 2001.
There can be no assurance that the Company will satisfy the NASDAQ National
Market conditions or be able to maintain the continued listing requirements in
the future. If the Company's Common stock is delisted from the NASDAQ National
Market trading of the Company's Common Stock, if any, would be conducted on the
NASDAQ Small Cap Market, in the over-the-counter market on the so called "pink
sheets" or, if available, the NASD's Electronic Bulletin Board." In any of those
cases, investors could find it more difficult to dispose of, or to obtain
accurate quotations as to the value of, its Common Stock. The trading price per
share of the Company's Common Stock could be reduced as a result.
F-25
67
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Internal Revenue Service Examination
The Internal Revenue Service (the "IRS") has completed its examination of
the Company's federal income tax return for the year ended December 31, 1998.
The Company has agreed with the IRS' proposed adjustment of approximately $0.6
million of additional tax payments for the years ended 1998 and 1999 which was
paid in March 2001. The adjustment related to timing differences between book
and tax with regard to certain capitalized practice acquisition costs. The
Company adequately provided reserves in prior years and the additional tax
payments did not result in additional income tax expense in fiscal 2000.
Practice Affiliations
Subsequent to December 31, 2000, the Company entered into a practice
affiliation agreement with a orthodontic practitioner to provide management
services and acquire certain operating assets for a total cash consideration of
$0.9 million. The acquired practice operates a single location and generated
historical patient revenue over the prior 12 months of approximately $1.0
million. Prior patient revenue is not necessarily indicative of the level of
revenue that these practices may be expected to generate in the future.
Treasury Stock
Subsequent to December 31, 2000 the Company acquired 4,300 shares of its
common stock at a cost approximating $13.
F-26
68
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of OrthAlliance, Inc.:
We have audited in accordance with auditing standards generally accepted in
the United States, the consolidated financial statements of OrthAlliance, Inc.
and subsidiaries included in this Form 10-K and have issued our report thereon
dated March 7, 2001. Our audits were made for the purpose of forming an opinion
on the basic financial statements taken as a whole. The schedule identified as
"Schedule II -- Valuation and Qualifying Accounts" is the responsibility of the
Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in the audits of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data to be set forth therein in relation to the basic financial
statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Arthur Andersen LLP
Los Angeles, California
March 7, 2001
F-27
69
ORTHALLIANCE, INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COST AND END OF
PERIOD EXPENSE WRITE-OFFS OTHER(A) PERIOD
------------ ---------- ---------- -------- ----------
Year ended December 31, 2000
Allowance for uncollectible
accounts....................... $983 $ 32 $(27) $(434) $554
Year ended December 31, 1999
Allowance for uncollectible
accounts....................... $820 $135 $(16) $ 44 $983
Year ended December 31, 1998
Allowance for uncollectible
accounts....................... $535 $123 $ -- $ 162 $820
(A) Represents a reduction of management's estimate of required allowance for
doubtful accounts based upon updated write-off studies.
F-28
70
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
2.1 Agreement and Plan of Merger between the Company, USOC and
POG (incorporated by reference to Exhibit 2.1 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
3.1 Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
3.2 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement on Form S-1 Registration No. 333-27143, as
amended).
4.1 Specimen Class A Common Stock Certificate (incorporated by
reference to Exhibit 4.1 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
4.2 Amended and Restated Certificate of Incorporation of the
Company, including, without limitation Section 4
(incorporated by reference to Exhibit 3.1 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
4.3 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement on Form S-1 Registration No. 333-27143, as
amended).
10.1 Form of Purchase and Sale Agreement between the Company and
Allied Practices (incorporated by reference to Exhibit 2.2
of the Company's Registration Statement on Form S-1,
Registration No. 333-27143, as amended).
10.2 Form of Stock Purchase and Sale Agreement between the
Company and Stockholders of the initial Allied Practices
(incorporated by reference to Exhibit 2.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.3 Form of Stock Purchase and Sale Agreement between the
Company and the Stockholders of the Allied Practices
(incorporated by reference to Exhibit 10.4 of the Company's
Annual Report on Form 10-K for the fiscal Year ended
December 31, 1997).
10.4 Form of Agreement and Plan of Reorganization between the
Company, Allied Practices and the Stockholders of the Allied
Practices (incorporated by reference to Exhibit 2.3 of the
Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
10.5 Form of Service Agreement between the Company and Allied
Practices (Fixed Percentage Fee) (incorporated by reference
to Exhibit 10.1 of the Company's Registration Statement on
Form S-1, Registration No. 333-27143, as amended).
10.6 Form of Service Agreement between Company and Allied
Practices (Variable Percentage Fee) (incorporated by
reference to Exhibit 10.2 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
10.7 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Variable Percentage Fee)
(incorporated by reference to Exhibit 10.3 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.8 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Fixed Percentage Fee)
(incorporated by reference to Exhibit 10.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.9 Form of Consulting and Business Services Agreement between
the Company and Allied Practices (Fixed Dollar Fee)
(incorporated by reference to Exhibit 10.5 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.10 1997 Non-Employee Director Stock Plan (incorporated by
reference to Exhibit 4.3 of Post-Effective Amendment No. 1
to the Company's Registration Statement on Form S-8,
Registration No. 333-48833).
10.11 Amended and Restated 1997 Employee Stock Option Plan
(incorporated by reference to Exhibit 4.3 of Post-Effective
Amendment No. 1 to the Company's Registration Statement on
Form S-8, Registration No. 333-48831).
71
EXHIBIT DESCRIPTION
- ------- -----------
10.12 1997 Orthodontist Stock Option Plan (incorporated by
reference to Exhibit 4.3 of Post-Effective Amendment No. 1
to the Company's Registration Statement on Form S-8,
Registration No. 333-61461.
10.13 Employment Agreement between the Company and Sam Westover
(incorporated by reference to Exhibit 10.8 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.14 Letter Agreement between the Company and Stephen M. Toon
(incorporated by reference to Exhibit 10.14 of the Company's
Annual Report on Form 10-K for fiscal year ended December
31, 1998), as amended by that Amendment (Incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report
on Form 10-Q for fiscal quarter ended June 30, 2000).
10.16 Form of Company Practice Improvement Program Guarantee
(incorporated by reference to Exhibit 10.17 of the Company's
Annual Report on Form 10-K for Fiscal year ended December
31, 1997).
10.18 Letter Agreement between the Company and James C. Wilson
(incorporated by reference to Exhibit 10.18 of the Company's
Registration Statement on Form S-4, Registration No.
333-84197).
10.19 1999 Orthodontist Stock Option Plan (incorporated by
reference to Exhibit 4.3 of the Registration Statement on
Form S-8, Registration No. 333-32392).
10.20 Purchase and Sale Agreement dated as of February 1, 2000
between the Company and New Image Orthodontic Group, Inc.
(incorporated by reference to Exhibit 2.1 of the Current
Report on Form 8-K, dated March 1, 2000).
10.21 Credit Agreement dated April 14, 2000 between the Company
and First Union National Bank, as Agent (incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 2000).
10.22 Employment Agreement between the Company and Paul H. Hayase
(incorporated by reference to Exhibit 10.8 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143.
10.23 Severance Agreement and General Release between the Company
and Sam Westover, dated December 27, 2000.
10.24 Consulting Agreement by and between the Company and Sam
Westover, dated December 27, 2000.
10.25 Letter Agreement by and between the Company and Stephen M.
Toon dated December 15, 2000.
10.26 Letter Agreement by and between the Company and Paul H.
Hayase dated December 15, 2000 (incorporated by reference to
Exhibit 10.25 of the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2000).
10.27 Letter Agreement by and between the Company and James C.
Wilson dated December 15, 2000 (incorporated by reference to
Exhibit 10.25 of the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2000).
21.1 Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP.
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 fourth quarter
of 2000.