U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ________ to ________
Commission File No. 000-27836
ORTHODONTIX, INC.
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(Name of Small Business Issuer in Its Charter)
Florida 65-0643773
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2222 Ponce de Leon Boulevard, Suite 300
Coral Gables, Florida 33134
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(Address of principal executive offices)
(305) 446-8661
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(Issuer's Telephone Number)
Securities registered under Section 12(b) of the Exchange Act: None Securities
registered under Section 12(g) of the Exchange Act:
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Title of each class Name of each exchange on which registered
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Common Stock, par value $.0001 per share Nasdaq Small Cap Market
</TABLE>
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB.[X]
State issuer's revenues for its most recent fiscal year: $8,035,839.
The aggregate market value of the voting stock held by non-affiliates of the
Company based on the closing sales price of $1.3125 of such common stock, as of
March 19, 1999, is $5,413,387 based upon 4,124,485 shares of the Company's
common stock outstanding as of March 19, 1999 held by non-affiliates.
As of March 31, 1999, the Company had a total of 5,881,721 shares of common
stock, par value $.0001 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: None.
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ORTHODONTIX, INC.
FORM 10-KSB
FISCAL YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
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PART I .........................................................................................................1
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Item 1. Description of Business.........................................................................1
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Item 2. Description of Property.........................................................................6
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Item 3. Legal Proceedings...............................................................................6
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Item 4. Submission of Matters to a Vote of Security Holders.............................................6
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PART II .........................................................................................................7
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Item 5. Market for Common Equity and Related Stockholder Matters........................................7
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Item 6. Management's Discussion and Analysis or Plan of Operation.......................................7
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Item 7. Financial Statements...........................................................................13
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Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...........................................................................13
PART III ........................................................................................................14
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of The Exchange Act .............................................14
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Item 10. Executive Compensation.........................................................................17
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Item 11. Security Ownership of Certain Beneficial Owners and Management.................................20
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Item 12. Certain Relationships and Related Transactions.................................................21
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Item 13. Exhibits And Reports on Form 8-K...............................................................21
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SIGNATURES.......................................................................................................22
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PART I
Item 1. Description of Business
OVERVIEW
Embassy Acquisition Corp. (now known as Orthodontix, Inc. (the
"Company")) was formed in November 1995 to seek to effect a merger, exchange of
capital stock, asset acquisition or similar business combination with an
acquired business. On April 16, 1998, the Company consummated a merger with
Orthodontix Subsidiary, Inc. (formerly known as Orthodontix, Inc. ("Ortho
Sub")), resulting in Ortho Sub becoming a wholly owned subsidiary corporation of
the Company (the "Merger"). Ortho Sub was an orthodontic practice management
company formed to affiliate with orthodontic practices and manage the business
aspects of such practices, including billing, collections, cash management,
payroll processing, financial reporting and analysis and productivity reporting
and analysis, in exchange for a management fee. Under the terms of the Merger,
the Company, among other things, issued a total of 3,341,721 shares of its
common stock, par value $.0001 (the "Common Stock") (representing approximately
56.8% of its Common Stock subsequent to the Merger) in exchange for all of the
outstanding shares of Common Stock of Ortho Sub, the acquisition of certain
assets and the assumption of certain liabilities of 26 orthodontic practices
(the "Founding Practices") and the entering into of long-term administrative
services agreements. In connection with the closing of the Merger, the Company
changed its name to Orthodontix, Inc. and began providing practice management
services to the Founding Practices. The Merger resulted in both a change in the
majority equity ownership and management of the Company and the cessation of the
Company's business operations as previously conducted. The Merger was accounted
for as a capital transaction equivalent to the issuance of stock for the net
monetary assets of the Company accompanied by a recapitalization of Ortho Sub.
As further discussed in Note 1 to the Company's Consolidated Financial
Statements for the fiscal year ended December 31, 1998, the acquisition of
certain assets and the assumption of certain liabilities of the Founding
Practices was accounted for in accordance with Securities and Exchange
Commission's Staff Accounting Bulletin No. 48 "Transfers of Nonmonetary Assets
by Promoters or Shareholders."
The Founding Practices included 27 orthodontists operating 48 offices
in 11 states. Unless the context otherwise requires, references to
(i)"Affiliated Practices" include the Founding Practices, and any orthodontic
practice which may enter into a similar arrangement with the Company whereby it
is provided practice management services by the Company, with orthodontic
services provided by the Affiliated Orthodontists; and (ii)"Affiliated
Orthodontists" include orthodontists directly employed by the PA Contractors or
the Practitioner PAs, as hereinafter defined.
BUSINESS OF THE COMPANY
The Company provides practice management services to the Affiliated
Practices pursuant to long-term Administrative Services Agreements with
separately organized affiliated professional associations (collectively, the "PA
Contractors"). Under the Administrative Services Agreements, the Company has
control over all non-orthodontic functions of the PA Contractors, including
administrative, management, billing and support functions. Pursuant to the
Administrative Services Agreements, from an accounting perspective, the Company
incurs the expenses necessary to manage and administer each Affiliated Practice.
Such expenses include, but are not limited to, salaries, wages and benefits of
Affiliated Practice non-professional personnel (excluding orthodontists and, in
some cases, certain clinical personnel) and the office (general and
administrative) expenses of the Affiliated Practices. The Company also incurs
personnel and administrative expenses in connection with maintaining corporate
offices, from which the Company provides the management services. The PA
Contractors pay the Company a management fee for its services. In certain
states, the fee is equal to a percentage of the gross revenue generated by the
underlying Affiliated Practices contracting with the PA Contractors as well as a
percentage of the income of such underlying Affiliated Practices. In other
states, the management fee consists of a flat base fee, which is determined on
an annual basis. Each of the Administrative Services Agreements has a term of 40
years and is subject to renegotiation at the end of such term.
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The PA Contractors directly employ Affiliated Orthodontists pursuant to
Employment Agreements or affiliate with other separately formed professional
associations owned by Affiliated Orthodontists pursuant to Service Agreements
(the "Practitioner PAs"), where such Practitioner PAs directly employ the
Affiliated Orthodontists to provide orthodontic services. The Employment
Agreements and Service Agreements have terms ranging from two to ten years. The
Affiliated Orthodontists generally receive a percentage of the gross revenue
generated at the Affiliated Practice as well as a percentage of the income
derived from the Affiliated Practice. The Affiliated Orthodontists are required
to hold a valid license to practice orthodontics in the jurisdiction in which
the Affiliated Orthodontist practices. The Company administers the billing of
patients and third party payors for services rendered by the Affiliated
Orthodontist. All of the Affiliated Orthodontists have agreed, for a period of
one to two years after the termination of employment or affiliation, not to
compete with the Company or the PA Contractor within a defined geographic area
and not to solicit Affiliated Orthodontists, other employees or patients of the
Affiliated Practices. In all cases, the Company directly employs all
non-orthodontic personnel and subject to applicable law directly owns the
tangible equipment and other assets used in the practices.
SERVICES OF THE COMPANY
The Company provides practice management services to the Affiliated
Practices. The Company does not practice orthodontics or dentistry, but
generally acquires certain tangible and intangible assets of an orthodontic
practice, employs the non-orthodontic employees, and causes the PA Contractors
to enter into Service Agreements or PA Contractor Employment Agreements with the
Affiliated Practices or the Affiliated Orthodontists, as the case may be. Each
Affiliated 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 Affiliated Practice.
The Company generates revenues by providing practice management
services to the Affiliated Practices, including billing and collections, cash
management, payroll processing, financial reporting and productivity reporting.
OPERATIONS
The Company commenced operations upon the closing of the Merger and is
continuing to develop and refine many elements of its operations. Management's
plan is to continue to offer certain management services to the Affiliated
Practices which do not terminate their affiliation and to continue to refine its
ability to deliver these services. In this way, the Company believes the
Affiliated Practices may be positioned to enable the Affiliated Practices to
compete more effectively with other orthodontic practices. Key elements of the
Company's operating plan, all of which elements have yet to be employed, are
anticipated to include:
Emphasizing Patient Care. Management believes that the services and
support which the Company can provide to Affiliated Orthodontists may positively
impact the level of patient care by increasing the Affiliated Orthodontists'
time to concentrate on patient care. Management believes that the primary
hindrances to consistent delivery of quality patient care are (i) the
discrepancy in qualifications among practicing orthodontists and (ii) the amount
of time each orthodontist spends on patient care. The qualifications of
providers of orthodontic services vary from general dentists who have taken
certain courses in orthodontics to graduates of accredited three-year programs.
Observing Effective Demonstrated Practices of Affiliated Orthodontists.
The Company believes that it will be positioned to identify practice-level
strategies that have proven successful for individual Affiliated Practices and
share this information among other Affiliated Practices. No assurances can be
given that the Company will be able to identify such strategies or if identified
that the Company will employ them at other Affiliated Practices. Management has
begun to evaluate the policies and procedures of the Affiliated Practices,
including such areas as practice-building, marketing, and expense control. The
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Company believes that a primary means of identifying and implementing solutions
to particular practice issues is to consult with Affiliated Practices that have
had demonstrated success in a certain area. The Company generally seeks to
facilitate communication among Affiliated Practices through a private website
accessible only to the Affiliated Orthodontists and the Company. In addition,
the Company has established an Advisory Board whose members are licensed
orthodontists designated by the Company and the PA Contractors and who
periodically meet to review, evaluate and make recommendations concerning
management issues. The Advisory Board has authority to review and resolve issues
regarding the type and levels of healthcare services to be provided, fee
schedules, any orthodontic or dental related functions and any other decisions
required by applicable law to be made solely by dentists and orthodontists. In
addition, the Advisory Board has made certain suggestions to the Company
regarding the management of the Affiliated Practices.
Striving to Achieve Operating Efficiencies and Economies of Scale. The
Company is currently refining its system of centralized payroll processing, and
is developing systems of inventory control and national group purchasing
contracts. In addition, the Company intends to develop, with the assistance of
the Affiliated Practices, appropriate credit and collection policies which
accommodate specific needs of the target market of each Affiliated Practice. In
many cases, management believes that patient flow and work flow at the
Affiliated Practices may be enhanced by physical improvements in designs to
facilities, which should result in an increase in the number of patients seen
and an increase in employee and orthodontist productivity. If such physical
improvement in design is supported by an adequate return on investment, the
Affiliated Practice and the Company may undertake such design changes.
Stimulating Demand in Local Markets Through Marketing. In consultation
with and upon approval of the Affiliated Practices, the Company may implement
marketing plans to augment each Affiliated Practice's referral and other
marketing systems. Management believes that the orthodontic industry has not
taken advantage of the gains that can be achieved through strategic direct
marketing and, upon request of an Affiliated Practice may implement direct
marketing campaigns. Upon the request of an Affiliated Practice and in
appropriate markets, the Company attempts to reach potential patients currently
through print advertising.
GROWTH STRATEGY
Management believes the growth of the Affiliated Practices and the
affiliation of new Affiliated Practices are key components of the future success
of the Company. To increase the Company's revenues and profits and gain market
share, management has attempted to initiate a growth strategy designed to
increase the number of Affiliated Practices and Affiliated Orthodontists over
time. Since the closing of the Merger, the Company has not added any Affiliated
Practices. There can be no assurances that the Company will affiliate with any
other orthodontic practices.
AFFILIATED PRACTICE OPERATIONS AND LOCATIONS
Payment Plan; Case Fees. At the initial orthodontic treatment, the
patient signs a contract outlining the terms of the treatment, including the
anticipated length of treatment and the total fees. Each Affiliated Orthodontist
determines the appropriate fee to charge for services to patients based upon
market conditions in the area served by that Affiliated Orthodontist. Generally,
the amount of fees charged by the Affiliated Orthodontists are 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. The down payment typically ranges
from a substantial down payment to no down payment.
If the treatment period exceeds the period originally estimated by the
orthodontist, the patient and the Affiliated Orthodontist will determine whether
payment for additional treatment will be required. Payments for patients with
insurance may be lower, depending upon the amount of the fee paid on behalf of
the patient by insurance policies. For patients with insurance coverage, the
portion of the fee not covered by insurance is paid by the patient and is not
generally waived or discounted by the Affiliated Practice.
Information Systems ("IS"). Although not currently in the developmental
stage, the Company plans to implement a comprehensive IS strategy over the next
several years. The Company may implement a communications and data transmission
program utilizing an intranet system and commercially available integration
technology. Typically, an orthodontic practice utilizes an
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accounting and general ledger system as well as a production system. The Company
currently maintains a general ledger system on behalf of the Affiliated
Practices. The Company believes that the production system, which provides
patient and practice management functions, will take more time to implement and
will not be implemented in the foreseeable future. Since the closing of the
Merger, the Company has experienced difficulties with the electronic
transmission of data from certain of the Affiliated Practices.
Purchasing. Although not in place as of the date hereof, the Company is
striving towards developing a system which coordinates quantity discounts of
equipment, office furniture, inventory and supplies for the Affiliated Practices
in order to reduce per unit costs. In addition, the Company may negotiate
arrangements with other suppliers, such as casualty insurance carriers, that
should provide cost savings to the Affiliated Practices.
Locations. The Company provides management services to the following
locations:
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Number of Number Number
State Orthodontists (1) of Offices of Cities
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California 1 1 1
Florida(2) 13 23 21
Georgia 1 1 1
Illinois 4 7 6
Kentucky 1 2 2
Louisiana 1 1 1
Maryland 1 2 2
Massachusetts 1 3 3
Ohio 1 2 2
Texas 1 2 1
Virginia 1 2 2
--------- ----- ----- ----
Total 26 46 42
</TABLE>
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(1) The 25 Affiliated Practices include an aggregate of 26 Affiliated
Orthodontists, operating in 11 states.
(2) As of April 5, 1999, the Company and one Affiliated Orthodontist located
in Miami, Florida terminated their affiliation. In connection with this
termination the Affiliated Orthodontist delivered to the Company $66,000
cash and 61,564 shares of the Company's Common Stock in exchange for the
repurchase by the Affiliated Orthodontist of certain practice assets. The
Company is currently in negotiation with six additional Affiliated
Orthodontists (representing annual practice revenue of approximately $4.5
million ) to terminate their affiliation with the Company. See
"Management's Discussion and Analysis or Plan of Operation -Results of
Operations."
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CONTRACTUAL RELATIONSHIPS
The Company contracts with the PA Contractors who in turn employ
Affiliated Orthodontists pursuant to PA Contractor Employment Agreements, or
affiliate with Affiliated Orthodontists pursuant to Service Agreements to
provide orthodontic services. The PA Contractor Employment Agreements and
Service Agreements typically have terms ranging from two to ten years. The
Affiliated Orthodontists are required to hold a valid license to practice
orthodontics in the jurisdiction in which the Affiliated Orthodontist practices.
The Company bills patients and third party payors for services rendered by the
Affiliated Orthodontist. All of the Affiliated Orthodontists have agreed, during
the term of their affiliation and for a period of one to two years after the
termination of employment or affiliation, not to compete with the Company or the
PA Contractor within a defined geographic area and not to solicit Affiliated
Orthodontists, other employees or patients of the Affiliated Practices.
The Company has Administrative Services Agreements with the PA
Contractors. Under the Administrative Services Agreements, the Company has
control over non-orthodontic functions of the PA Contractors, including
administrative, management, billing and support functions. The PA Contractors
pay the Company a management fee for its services. In certain states, the fee is
equal to a percentage of the adjusted accrual based practice revenue generated
by the underlying Affiliated Practices contracting with the PA Contractor. In
other states, the management fee consists of a flat base fee, which is
determined on an annual basis. Each of the Administrative Services Agreements
has a term of 40 years and is subject to renegotiation at the end of such term.
GOVERNMENT REGULATION
General. The business of the Company is subject to a variety of
governmental and regulatory requirements relating to healthcare matters as well
as laws and regulations which relate to business corporations in general. In
general, regulation of healthcare companies is increasing. Every state imposes
licensing requirements on individual orthodontists and on facilities operated by
and services rendered by orthodontists. In addition, federal and state laws
regulate health maintenance organizations and other managed care organizations
for which orthodontists may be providers. In connection with the possible entry
into new markets, the Company, the Affiliated Practices and the Affiliated
Orthodontists may become subject to compliance with additional regulations.
The operations of the Affiliated 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 Affiliated Practices. Based on its familiarity with the
historical operations of the Affiliated Practices and the activities of the
Affiliated Orthodontists, management believes that the Affiliated 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 orthodontists
from splitting fees with non-orthodontists. Furthermore, many states prohibit
non-orthodontic entities from practicing orthodontics, employing orthodontists,
or in some circumstances, employing orthodontic assistants. The laws of some
states prohibit advertising orthodontic services under a trade or corporate name
and require that all advertising be in the name of the orthodontist. A number of
states also regulate the content of advertisement of orthodontic 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 an
orthodontic practice. Some of these states allow leasing of equipment and office
space to an orthodontic practice, under a bona-fide lease, if the equipment and
office remain in the complete care and custody of the orthodontist. Management
believes, based on its familiarity with the historical operations of the
Affiliated Practices, the activities of Affiliated Orthodontists and applicable
regulations, that the Company's 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 other laws, will not require structural and organizational
modifications of the Company's initial relationships with its Affiliated
Orthodontists or the operation of the Affiliated Practices. In addition,
statutes in some states could restrict expansion of the Company operations in
those jurisdictions.
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Regulatory Compliance. The Company may be required to modify its
agreements, operations and marketing strategies from time to time in response to
changes in the business and regulatory environment. The Company intends to
structure 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 Company faces substantial competition from other entities operating
in the orthodontic practice management industry. Additional entities may enter
this market and compete with the Company. Certain of these competitors have
greater financial or other resources than the Company.
The business of providing orthodontic services is highly competitive in
each market in which the Affiliated Practices and other practices operate. The
Affiliated Practices compete with orthodontists who maintain single offices or
operate a single satellite office, as well as with orthodontists that maintain
group practices or operate in multiple offices. The Affiliated Practices also
compete with general dentists and pedodontists who provide certain orthodontic
services, some of whom have more established practices. The provision of
orthodontic services by such dentists and pedodontists has increased in recent
years. There can be no assurance that the Company or the Affiliated Practices
will be able to compete effectively within their markets.
EMPLOYEES
The Company employs an aggregate of approximately 220 full-time
employees. None of the Company's employees are represented by a collective
bargaining agreement.
Item 2. Description of Property
The Company currently leases, on a month to month basis, approximately
5,000 square feet of office space in Coral Gables, Florida from an unaffiliated
third party for a monthly rental amount of approximately $7,700. In addition,
the Company is obligated under 25 separate noncancelable operating leases
relating to the Affiliated Practices for office facilities, certain furniture
and equipment which expire at various dates.
Item 3. Legal Proceedings
In February 1999, the Company received from two Affiliated
Orthodontists, written demands for damages arising out of their allegations that
the Company has breached its obligations under lease agreements and Service
Agreements. One Affiliated Orthodontist has alleged damages in the amount of
$1,655,324.86 and the other Affiliated Orthodontist has alleged damages in the
amount of $588,993.52. The Company believes the allegations contained in the
written demands from these Affiliated Orthodontists are without merit. To the
extent these Affiliated Orthodontists or either of them pursue their alleged
claims, the Company intends to vigorously defend itself.
Subsequent to December 31, 1998, the Company received from seven
Affiliated Orthodontists notice that the Affiliated Orthodontists believed that
the Company had delivered less than should have been delivered to the Affiliated
Orthodontists for compensation amounts owing under agreements the Affiliated
Orthodontists are party to. In the aggregate, the amounts in question total
approximately $60,000. If the Affiliated Orthodontists pursue their beliefs
further, the Company intends to vigorously defend itself. Certain of the
Affiliated Orthodontists who have delivered notice regarding the amounts in
question are in discussions with the Company regarding termination of their
affiliation.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of the fiscal year ended December 31, 1998, no
matters were submitted to a vote of security holders of the Company.
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PART II
Item 5. Market for Common Equity and Related Stockholder Matters
The Company's Common Stock is listed on The Nasdaq SmallCap Market and is
traded under the symbol "OTIX." From April 2, 1996, when the Common Stock
commenced trading, through May 28, 1998, the Common Stock was traded in the
over-the-counter market under the symbol "MBCA." On May 29, 1998 the Common
Stock commenced trading on The Nasdaq SmallCap Market. The following table shows
the (i) reported high and low bid quotations for the Common Stock obtained from
the OTC Bulletin Board (for quotes from January 1, 1997 through May 28, 1998);
and (ii) reported high and low sales prices on The Nasdaq SmallCap Market (for
quotes commencing on May 29, 1998). The high and low bid prices for the periods
indicated are interdealer prices, without retail mark-up, mark-down or
commissions and may not represent actual transactions.
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OTC Bulletin Board Low Bid High Bid
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1997
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First Quarter...............................................................$6.00 $8.375
Second Quarter.............................................................$7.125 $9.25
Third Quarter...............................................................$8.00 $8.00
Fourth Quarter..............................................................$5.25 $8.75
1998
First Quarter...............................................................$8.00 $9.00
Second Quarter through May 28, 1998.........................................$8.50 $10.25
Nasdaq SmallCap Market Low High
- ---------------------- --- ----
1998
May 29 through June 30, 1998................................................$6.25 $7.875
Third Quarter...............................................................$2.50 $6.125
Fourth Quarter..............................................................$1.00 $2.75
1999
First Quarter...............................................................$1.25 $2.625
</TABLE>
The approximate number of holders of record of the Company's Common
Stock, as of March 18, 1999, amounts to 87, inclusive of those brokerage firms
and/or clearing houses holding the Company's shares of Common Stock for their
clientele (with each such brokerage house and/or clearing house being considered
as one holder).
The Company has not paid or declared any dividends upon its Common
Stock since its inception and, by reason of its present financial status and its
contemplated financial requirements, does not contemplate or anticipate paying
any dividends upon its Common Stock in the foreseeable future.
Item 6. Management's Discussion and Analysis or Plan of Operation
The following discussion of the financial condition or plan of
operation of the Company should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto included elsewhere in this
Report. Results of operations for the year ended 1997 and for the period from
January 1 through April 16, 1998, the date of the Merger, (the "1998
Administrative Period") reflect the organizational efforts of the Company prior
to the date of the Merger and therefore, in the Company's opinion, are not
comparable to the corresponding period in the current year.
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RESULTS OF OPERATIONS
Fiscal Years Ended December 31, 1998 and December 31, 1997.
Management Service Fee Revenue. For the fiscal year ended December 31,
1998, management service fee revenue reported by the Company was derived by
principally applying the appropriate management fee percentage to the adjusted
accrual based patient revenue, and adding the reimbursement from the Affiliated
Practices of practice expenses paid by the Company. Management service fee
revenue for the year ended December 31, 1998, which related only to amounts
earned during the period from April 17, 1998 through December 31, 1998 (the
"Operational Period") was approximately $8.04 million. The Company did not have
any management service fee revenue during the year ended December 31, 1997
because the Company had not yet commenced practice management operations.
During the period subsequent to the consummation of the Merger, the
Company, from time to time, advanced funds for the benefit of the Affiliated
Practices to cover expenses and for working capital purposes of the Affiliated
Practices (the "Working Capital Advances"). In addition, during the two week
period following the consummation of the Merger, certain amounts were collected
and disbursed by the Affiliated Practices in order to facilitate the transition
to the Company's centralized cash collection and disbursement procedures. To the
extent the net amounts (the difference between the collections and disbursements
during this initial period) have not been remitted by the Affiliated Practices
to the Company, the Company has recorded such net amounts as an advance to
Affiliated Practices (the "Transition Advances" and together with the "Working
Capital Advances", the "Advances"). As of December 31, 1998, the Advances
totaled approximately $1,750,000. The Company believes that these amounts will
be repaid by the Affiliated Practices over varying periods of time as adequate
funds are generated by the Affiliated Practices. Due to the ongoing efforts of
the Company to (i) pursue amended management arrangements with certain
Affiliated Practices and/or (ii) terminate its affiliation with certain
Affiliated Practices, the Company recorded an allowance related to the
collectability of the Advances of $800,000. (the "Allowance").
Direct Practice and Corporate Expenses. Direct practice expenses
include clinical and other practice expenses. Corporate expenses include
corporate general and administrative expenses. The Company incurred direct
practice expenses of approximately $6.3 million for the fiscal year ended
December 31, 1998 which related only to amounts incurred during the Operational
Period. The Company's direct practice expenses consist primarily of salaries and
benefits, orthodontic supplies, rent, advertising and marketing, general and
administrative and depreciation. The Company also incurred corporate general and
administrative expenses of approximately $2.9 million during the year ended
December 31, 1998 ($2.7 million during the Operational Period and $200,000
during the 1998 Adminstrative Period). For the year ended December 31, 1997, the
Company incurred corporate general and administrative expenses of approximately
$627,000, which represented corporate organizational costs.
Interest Income. Interest income represents interest earned on excess
cash balances invested primarily in short-term money market accounts and
overnight repurchase agreements as well as loans to certain of the Affiliated
Orthodontists. During the year ended December 31, 1998, the Company's interest
income was approximately $79,000 compared to $42 for the year ended December 31,
1997.
Net Loss. For the year ended December 31, 1998, the Company recorded a
net loss of approximately $1.1 million or approximately $.25 per share.
Included in the expenses for the year ended December 31, 1998 are
expenses of approximately $200,000 incurred during the 1998 Administrative
Period, non-cash expense items of approximately $398,000 principally related to
the issuance of stock options to employees and Affiliated Orthodontists and
depreciation and $800,000 related to the Allowance. During the
8
<PAGE>
Operational Period, the Company's net loss, excluding non-cash expense items
(other than the Allowance), was approximately $502,000. Net loss excluding
non-cash expense items is not presented as an alternative to operating results
or cash flow from operations as determined by generally accepted accounting
principles (GAAP) but rather to provide additional information related to the
ability of the Company to meet its cash flow needs. This information should not
be considered in isolation from, or construed as having greater importance than
GAAP operating income/loss or cash flows from operations as a measure of an
entity's performance.
For the year ended December 31, 1997, the Company generated a net loss
of approximately $634,000.
The following table sets forth the percentage of certain items in
relation to revenues for the year ended December 31, 1998.
<TABLE>
<CAPTION>
<S> <C>
Management service fee revenue.............................100.0 %
-------
Direct practice expenses
Salaries and benefits ..................................35.6 %
Orthodontic supplies....................................14.6 %
Rent....................................................13.1 %
Depreciation and amortization............................2.3 %
Other...................................................12.9 %
-------
Total direct practice expenses .............................78.5 %
Corporate general and administrative....................26.1 %
Provisions for advances to Founding
Practices............................................10.0 %
Corporate depreciation and
amortization ........................................ -
-------
Total expenses.............................................114.6 %
-------
Net operating income.......................................(14.6)%
-------
Other income (expense)
Interest income..........................................1.0 %
Interest expense.........................................(.7)%
-------
Total other income.............................................3 %
-------
Net income.................................................(14.3)%
=======
</TABLE>
9
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES/PLAN OF OPERATION
As of December 31, 1998, the Company had a working capital balance of
approximately $1,216,286. The Company continues to anticipate the primary uses
of capital will include costs related to the development of operational
efficiencies and funding the working capital needs of the Company and the
Affiliated Practices. The Advances totaled approximately $1,750,000 as of
December 31, 1998, which has been classified as a long term asset at December
31, 1998.
As of December 31, 1998 and December 31, 1997, the Company had cash and
cash equivalents of $1,289,481 and $84,920, respectively. As of December 31,
1998 and December 31, 1997, the Company had total liabilities of $1,418,122 and
$851,290, respectively. As of the closing of the Merger, the Company had cash
and cash equivalents of approximately $2.5 million. The significant decrease in
the Company's working capital balances since the closing of the Merger has
resulted from the Company's corporate overhead expenses and the Advances. The
Company's cash is currently invested in money market accounts and overnight
repurchase agreements. The Company believes that its operating funds will be
sufficient for its cash expenses for at least the next twelve months. The
Company intends to seek debt financing and other sources of financing for
working capital purposes. There can be no assurance that such additional sources
of financing will be found.
YEAR 2000 COMPLIANCE
The Year 2000 ("Year 2000") computer issue is the result of computer
programs using a two-digit format, as opposed to a four-digit format to indicate
the year. Such computer programs will be unable to recognize date information
correctly when the year changes to 2000. The Year 2000 issue poses risks for the
Company's information technology systems, including those used by the Company in
providing its practice management and marketing services to its Affiliated
Practices.
The Company's information technology systems are based upon software
licenses and software maintenance agreements with third party software
companies. Based upon the Company's internal assessments and communications with
its software vendors, the Company believes the costs involved with causing the
Company's corporate software to become Year 2000 Compliant will not be material.
The Company will continue to monitor its Year 2000 readiness.
Each of the Affiliated Practices has its own information technology
systems (including systems for billing and collecting patient fees) based on
third party software licenses and maintenance agreements with various vendors.
The Company believes that a significant number of its Affiliated Practices
information technology systems currently are not Year 2000 compliant and the
costs which may be incurred to cause the systems at the Affiliated Practices to
become Year 2000 Compliant may be material to the Company, provided, however,
over time the Company believes it will recover such costs from the Affiliated
Practices.
There is no assurance the Affiliated Practices' systems, upon which the
Company relies, will be timely converted to be Year 2000 compliant.
Consequently, there is no assurance that a material adverse effect on the
Company's operations and cash flows will not occur.
10
<PAGE>
FORWARD LOOKING INFORMATION MAY PROVE INACCURATE
This Annual Report on Form 10-KSB contains certain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. These statements are based on current plans and expectations of the
Company and involve risks and uncertainties that could cause actual future
activities and results of operations to be materially different from those set
forth in the forward-looking statements. Important factors that could cause
actual results to differ include, among others, inability to consummate
additional affiliations due to lack of cash and fluctuations in the market price
of the Company's shares, fluctuations in operating results because of the high
costs associated with the development of operations, the ability of the Company
to be repaid the Advances, the ability of the Affiliated Practices to generate
sufficient revenues to cover operating expenses, uncertainty in costs related to
Year 2000 compliance, changes in government regulations, the timing and ability
of the Company to decrease the fees it pays to professionals, risks of
operations and growth of affiliated orthodontic practices, and risks detailed in
the Company's filings with the Securities and Exchange Commission.
The forward-looking statements included herein are based on current
expectations that involve numerous risks and uncertainties. The Company's plans
and objectives are based on assumptions that the Affiliated Practices will be
profitable, that the orthodontic industry will not change materially or
adversely, and that there will be no unanticipated material adverse change in
the Company's operations or business. Assumptions relating to the foregoing
involve judgments with respect to, among other things, future economic,
competitive and market conditions and future business decisions, all of which
are difficult or impossible to predict accurately and many of which are beyond
the control of the Company. Although the Company believes that its assumptions
underlying the forward-looking statements are reasonable, any of the assumptions
could prove inaccurate and, therefore, there can be no assurance that the
forward-looking statements included in the following will prove to be accurate.
In light of the significant uncertainties inherent in the forward-looking
statements included herein, particularly in view of the Company's early stage of
operations, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved. Important factors that could cause actual
results to differ include, among others, risks associated with lack of new
affiliations, fluctuations in operating results, the ability of the Company to
be repaid certain cash advances made for the benefit of the Affiliated
Practices, changes in government regulations, competition, and risks of
operations and growth of existing and newly affiliated orthodontic practices.
This report should be read in conjunction with the financial statements and
notes appearing elsewhere herein and the Company's prior filings with the
Securities and Exchange Commission.
OUTLOOK AND UNCERTAINTIES
The Company's financial condition and results are subject to
substantial risks and uncertainties, certain of which are summarized below:
Restructure/Possible Unwinding of the Company's Arrangements with its
Affiliated Practices. The Company is contemporaneously exploring plans to (i)
restructure its arrangements with the Affiliated Practices; and (ii) allow
certain of the Affiliated Orthodontists to discontinue their affiliation with
the Company and to repurchase practice assets in exchange for cash and the
Company's Common Stock.
11
<PAGE>
The Company's existing agreements provide for the Company's management
fees as well as the amounts payable to the Affiliated Orthodontists pursuant to
the Services Agreements to be calculated using the accrual basis of accounting.
The Company has requested that each of the Affiliated Orthodontists restructure
their arrangements with the Company to provide for the Company's management fees
as well as the amounts payable to the Affiliated Orthodontists under the Service
Agreements to be calculated on a cash basis of accounting.
In the course of its communication with the Affiliated Orthodontists
regarding the proposed amended arrangements, several of the Affiliated
Orthodontists have expressed a desire to discontinue their affiliation with the
Company and to repurchase from the Company practice assets in exchange for cash
and the Company's Common Stock. As of April 5, 1999, the Company terminated its
affiliation with one Affiliated Orthodontist, and sold to this Affiliated
Orthodontist practice assets in exchange for cash and shares of the Company's
Common Stock. The Company is currently in negotiation with six other Affiliated
Orthodontists to unwind their affiliation and to sell back to the Affiliated
Orthodontists practice assets in exchange for cash and the Company's Common
Stock. There can be no assurances that the Company will consummate the unwinding
of these or any other affiliations on terms favorable to the Company, if at all.
The unwinding of affiliations between the Company and the Affiliated
Orthodontists as well as the sale back of practice assets is contingent upon the
negotiation of definitive agreements between the Company and the Affiliated
Orthodontists. No assurances can be given that the Company will be able to enter
into the amended arrangements with the Affiliated Orthodontists or consummate
any unwinding of affiliations, or if done that such amendments or unwindings
will take place in a timely manner. If the Company is not able to timely and
successfully implement its plan to amend its existing arrangements or unwind
affiliations as well as satisfactorily resolve certain disputes with its
Affiliated Orthodontists , its operating business, financial condition, cash
flows and results of operations will be materially and adversely affected.
Limited Operating History: Anticipation of Losses: Negative Cash Flow.
The Company commenced providing practice management services in April 1998
contemporaneous with the consummation of the Merger. Accordingly, the Company
has an extremely limited operating history upon which an evaluation of the
Company and its business can be based. The Company's business must be considered
in light of the risks, expenses and difficulties frequently encountered by
companies in their early state of development. Specifically, such risks include
the failure of the Company to anticipate and adapt to the needs of the
Affiliated Orthodontists and the difficulty faced by the Company in introducing
new systems and procedures to mature orthodontic practices. In addition, the
Company has attempted to monitor the practice expenses and to work with the
Affiliated Orthodontists to control such expense levels.
To date, operating costs have exceeded management fee revenues. The
Company's ability to increase management fee revenues and achieve positive cash
flow will largely depend upon the Company's ability to enter into amended
arrangements with the Affiliated Orthodontists, or the Company's ability to
reduce certain practice operating expenses, neither of which can be assured.
12
<PAGE>
The Company's sole source of cash is derived from operations. The
Company has no credit line or other sources of cash. In addition, the Company's
liquidity is affected by the amounts and timing of collections at the Affiliated
Practices and the timing and collections of the Advances. No assurances can be
given that the collections will be received on a timely basis or in amounts
sufficient to meet the short term liquidity needs of the Company.
Dependence on Affiliated Orthodontists: Allowance for
Non-Collectability of Advances to Affiliated Practices. The Company receives
fees for practice management services provided to the Affiliated Practices under
Administrative Services Agreements, but does not employ orthodontists or control
the practices of the Affiliated Practices. The Company's revenue is completely
dependent on revenue generated by the Affiliated Practices, which in turn is
largely dependent on the efforts of the Affiliated Orthodontists and, therefore,
the performance of the Affiliated Orthodontists is essential to the Company's
success. During the period subsequent to the consummation of the Merger, the
Company, from time to time, advanced funds for the benefit of the Affiliated
Practices to cover expenses and for working capital purposes of the Affiliated
Practices (the "Working Capital Advances"). In addition, during the two week
period following the consummation of the Merger, certain amounts were collected
and disbursed by the Affiliated Practices in order to facilitate the transition
to the Company's centralized cash collection and disbursement procedures. To the
extent the net amounts (the difference between the collections and disbursements
during this initial period) have not been remitted by the Affiliated Practices
to the Company, the Company has recorded such net amounts as an advance to
Affiliated Practices (the "Transition Advances" and together with the "Working
Capital Advances", the "Advances"). As of December 31, 1998, the Advances
totaled approximately $1,750,000. The Company believes that these amounts will
be repaid by the Affiliated Practices over varying periods of time as adequate
funds are generated by the Affiliated Practices. Due to the ongoing efforts of
the Company to (i) pursue amended management arrangements with certain
Affiliated Practices and/or (ii) terminate its affiliation with certain
Affiliated Practices, the Company recorded an allowance related to the
collectability of the Advances of $ 800,000. (the "Allowance"). There can be no
assurances that the Advances will be repaid, or if repaid that they will be
repaid timely. Certain of the Affiliated Orthodontists currently in negotiation
with the Company to discontinue their affiliation with the Company have received
Advances.
Item 7. Financial Statements
The financial statements included herein, commencing at page F-1, have
been prepared in accordance with the requirements of Regulation S-B and
supplementary financial information included herein, if any, has been prepared
in accordance with Item 310(a) of Regulation S-B.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
13
<PAGE>
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act
DIRECTORS AND EXECUTIVE OFFICERS
The current directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C>
Stephen Grussmark, DDS, MSD 58 Chief Executive Officer and Chief
Clinical Officer, Director
F.W. Mort Guilford 70 President, Chief Operating Officer,
Secretary, Treasurer, Director
Edward Strongin 49 Acting Chief Financial Officer
Stephen J. Dresnick, MD 49 Chairman of the Board of Directors
Glenn L. Halpryn 38 Director
William Thompson, DDS 66 Director
Gary Gerson 65 Director
Stephen H. Bittel 42 Director
</TABLE>
Stephen Grussmark, DDS, MSD became the Chief Executive Officer and
Chief Clinical Officer and a director of the Company in April 1998 upon the
closing of the Merger. From August 1996 until the Merger, Dr. Grussmark was
Chief Executive Officer, Chief Clinical Officer and a director of Ortho Sub.
Since 1968, Dr. Grussmark has been a practicing orthodontist in the Miami,
Florida area. Since 1990, Dr. Grussmark has been an Assistant Clinical Professor
of Graduate Orthodontics at the University of Florida Dental School and has been
a staff member at Miami Children's Hospital since 1969. Dr. Grussmark is a
member of the Dade County Dental Research Group, the American Dental
Association, the American Association of Orthodontists, the Southern Association
of Orthodontists, and is Past President of both the Florida Cleft Palate
Association and the South Florida Academy of Orthodontists.
F.W. Mort Guilford became the President, Chief Operating Officer and a
director of the Company in April 1998 upon the closing of the Merger. From
August 1996 until the Merger, Mr. Guilford was President, Chief Operating
Officer and a director of Ortho Sub. From 1956 through the closing of the
Merger, Mr. Guilford practiced business, real estate and land use law in the
Miami, Florida area and has been an investor in numerous business ventures,
including real estate, banking and food franchises. Since 1984, Mr. Guilford has
served as Chairman of The Alma Jennings Foundation, a charitable foundation, and
from 1989 through 1994, he served on the Florida Public Service Nominating
Committee, which makes recommendations to the Governor of Florida for appointees
to the Florida Public Service Commission. In addition, Mr. Guilford has served
on the State of Florida Finance and Bond Council, was a member of the University
of Miami Board of Trustees, and was Chairman of the Economic Development
Committee and Code Enforcement Board for the City of Coral Gables, Florida.
Since 1995, Mr. Guilford has been a member of the Coral Gables Foundation.
14
<PAGE>
Stephen J. Dresnick, MD has been a member of the Board of Directors of
the Company since its inception and the Chairman of the Board of Directors since
April 1998. Since March, 1998, Dr. Dresnick has been the Chief Executive
Officer, President and Chairman of the Board of Directors of FPA Medical
Management, Inc., a physician practice management company ("FPA"). From November
1996 through February 1998, Dr. Dresnick served as the Vice Chairman of the
Board of FPA. On July 19, 1998, FPA and 89 of its subsidiaries and affiliates
(collectively, the "Debtors") filed for protection under Chapter 11 in the
United States District Court for the District of Delaware (the "Bankruptcy
Court"). The cases have been consolidated for the purpose of joint
administration and have been assigned to Chief United States Bankruptcy Judge
Peter J. Walsh. The consolidated caption is: In re FPA Medical Management, Inc.,
et. al., Debtors, Case Nos. 98-1596 through 98-1685. From 1987 through March
1998, Dr. Dresnick has served as President, Chief Executive Officer and Chairman
of the Board of Directors of Sterling Healthcare Group, Inc., a company engaged
in providing physician practice management to hospital-based emergency
departments. Dr. Dresnick is a Diplomate of the National Board of Medical
Examiners and is certified by the American Board of Emergency Medicine. Dr.
Dresnick is licensed to practice medicine in 12 states. Dr. Dresnick currently
holds an appointment as Assistant Professor at University of Miami, School of
Nursing; is on the Dean's Advisory Committee at University of Miami, School of
Business; is an Advisory Board Member at the Center for the Advancement of
Service Management, University of Florida, College of Business Administration;
is a Clinical Associate Professor for the Department of Surgery, University of
Florida, School of Medicine; and is a member of the Board of Trustees of Florida
International University.
Glenn L. Halpryn has been a member of the Board of Directors since its
inception, and was President of the Company from inception through the closing
of the Merger in April 1998. Since 1985, Mr. Halpryn has been engaged in real
estate investment and development activities, including the management, finance
and leasing of commercial real estate. From April 1988 through June 1998, Mr.
Halpryn was Vice Chairman of Central Bank, a Florida state-chartered bank. Since
June 1987, Mr. Halpryn has been the President of and beneficial holder of stock
of United Security Corporation, a broker-dealer registered with the NASD. From
June 1992 through May 1994, Mr. Halpryn served as the Vice President,
Secretary-Treasurer of Frost Hanna Halpryn Capital Group, Inc., a "blank check"
company whose business combination was effected in May 1994 with Sterling
Healthcare Group, Inc. From June 1995 through October 1996, Mr. Halpryn served
as a member of the Board of Directors of Sterling Healthcare Group, Inc.
William Thompson, DDS became a director of the Company upon the closing
of the Merger in April 1998. Dr. Thompson had been a consultant to Ortho Sub
since its inception. Since 1960, Dr. Thompson has been a practicing orthodontist
in the Bradenton, Florida area. He is a member of the Council on Orthodontic
Education of the American Association of Orthodontics. From 1985 through 1992,
Dr. Thompson was a Director and from 1991 through 1992 was the President of the
American Board of Orthodontics. Dr. Thompson has received numerous professional
appointments as well as published numerous articles concerning orthodontics. Dr.
Thompson has been a member of the Board of Directors of the First National Bank
of Manatee since 1989.
15
<PAGE>
Gary Gerson, CPA became a director of the Company upon the closing of
the Merger in April 1998. Mr. Gerson is a founding partner, shareholder of and
practicing accountant with Gerson Preston & Co., an accounting firm
headquartered in Miami Beach, Florida since 1958, with offices in Boca Raton and
Tampa. Mr. Gerson was former President and Chairman of the Board of Trustees of
Mount Sinai Medical Center in Miami Beach, Florida, General Chairman of the
Israel Bonds Organization for Florida, Member of the Board of Directors of the
Greater Miami Jewish Federation, University of Florida Foundation and the
Concert Association of Florida. Mr. Gerson was the recipient of an Honorary
Doctorate of Laws Degree from St. Thomas University, the Distinguished Alumnus
Award from the University of Florida and the 1996 Man of the Year award from the
City of Miami Beach Chamber of Commerce.
Stephen H. Bittel became a director of the Company in October 1998.
Since 1980, Mr. Bittel has been the President and Chief Executive Officer of
Terranova Corporation, a Miami- based full-service real estate organization
founded in 1980.
Edward Strongin. Mr. Strongin became the Company's acting Chief
Financial Officer in August 1998 upon the resignation of Robert Leahy, the
former Chief Financial Officer of the Company. Since 1986, Mr. Strongin has been
a partner in the accounting firm of Pinchasik Strongin Muskat Stein & Co.,
Miami, Florida.
Each director serves until the next annual meeting of shareholders and
until his successor is elected and qualified. Each officer is appointed to serve
until the next annual meeting of the Board of Directors and until his successor
has been appointed and qualified.
BOARD COMMITTEES
The Board currently has four standing committees: an Executive
Committee, a Nominating Committee, an Audit Committee, and a Compensation and
Stock Option Committee. Messrs. Bittel, Halpryn and Drs. Dresnick and Thompson
serve on the Executive Committee. Messrs. Guilford and Halpryn and Dr. Grussmark
serve on the Nominating Committee. Messrs. Bittel and Gerson serve on the Audit
Committee and Messrs. Bittel and Gerson and Dr. Dresnick serve on the
Compensation and Stock Option Committee. The Executive Committee is authorized
by the Board of Directors to review and advise senior management of the Company
regarding issues concerning strategic planning, significant transactions,
policies and procedures and to make recommendations to senior management
generally on issues such as budgetary items and to otherwise take all other
action which may be delegated by the Board of Directors under the Florida
Business Corporation Act. The Nominating Committee recommends candidates for
election to the Company's Board of Directors, examines the performance of
incumbent Directors and makes recommendations concerning the retention of such
Directors. The Audit Committee recommends the annual appointment of the
Company's auditors, with whom the Audit Committee reviews the scope of audit and
non-audit assignments and related fees, accounting principles used by the
Company in financial reporting and the adequacy of the Company's internal
control procedures. The Compensation and Stock Option Committee administers the
1997 Orthodontix, Inc. Stock Option Plan (the "Stock Option Plan"). The
Compensation and Stock Option Committee also has the responsibility for
reviewing and approving salaries, bonuses, and other compensation and benefits
of executive officers, and advising management regarding benefits and other
terms and conditions of compensation.
16
<PAGE>
CONFLICTS OF INTEREST
None.
SIGNIFICANT EMPLOYEES
None.
FAMILY RELATIONSHIPS
William Thompson's son, Jeffrey Thompson, DDS, M.S. is an Affiliated
Orthodontist.
INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS
As discussed above, Dr. Dresnick is the Chief Executive Officer,
President and Chairman of the Board of Directors of FPA, which filed for
protection under Chapter 11 of the Federal Bankruptcy Code in the Bankruptcy
Court on July 19, 1998, along with certain of its subsidiaries and affiliates.
Except for the FPA Bankruptcy, to the Company's knowledge based on information
received from each officer and director, there have been no events under any
bankruptcy act, no criminal proceedings and no judgments or injunctions material
to the evaluation of the ability and integrity of any executive officer during
the past five years.
COMPLIANCE WITH SECTION 16(a)
To the Company's knowledge, based solely upon the Company's review of
Forms 3, 4 and 5 furnished to the Company, for the fiscal year ended December
31, 1998, and for the period ended March 15, 1999, no person who was a director,
officer or beneficial owner of more than ten percent of the Company's
outstanding Common Stock or any other person subject to Section 16 of the
Securities Exchange Act of 1934 (the "Exchange Act") failed to file on a timely
basis, reports required by Section 16(a) of the Exchange Act.
Item 10. Executive Compensation
DIRECTOR COMPENSATION
Since the Merger, non-employee directors of Orthodontix have received
$500 for each Board meeting attended as well as accountable reimbursement for
any reasonable business expenses incurred in connection with their activities on
behalf of Orthodontix. In addition, they are entitled to receive stock options
under the 1997 Orthodontix, Inc. Stock Option Plan. The Board of Directors met
six times and took action by written consent once during the fiscal year ended
December 31, 1998. As of March 1999, the Company granted to each non-employee
director of the Company, other than Mr. Bittel, the option for a period of two
years to acquire 20,000 shares of the Company's Common Stock at a purchase price
of $1.75 per share in lieu of any future cash payments to be made to such
persons for attendance at Board meetings. As of March 1999, the Company granted
to Mr. Bittel, the option for a period of two years to acquire 100,000 shares of
the Company's Common Stock at a purchase price of $1.75 per share.
17
<PAGE>
EXECUTIVE COMPENSATION
No executive officer of the Company earned more than $100,000 during
the fiscal year ended December 31, 1998. The following table sets forth the
compensation earned for services rendered to the Company in all capacities for
the fiscal years ended December 31, 1998, 1997 and 1996 by the Company's Chief
Executive Officer and President (the "Named Executive Officers"):
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Long Term
Annual Compensation Compensation Awards
- ---------------------------------------------------------------------------------------------------------------------------
Securities
Name and Principal Other Annual Underlying All Other
Position (1) Year Salary Bonus Compensation(2) Options/SARs Compensation
===========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Stephen Grussmark, 1998 $0 $0 $0 0 $0
DDS, MSD, Chief
Executive Officer, Chief 1997 - - - - -
Clinical Officer and 1996 - - - - -
director since April
1998
- ---------------------------------------------------------------------------------------------------------------------------
F.W. Mort Guilford, 1998 $0 $0 $9,440 150,000 $0
President, Chief
Operating Officer and 1997 - - - - -
director since April 1996 - - - - -
1998
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Edward Strongin, the Company's Acting Chief Financial Officer, is a partner
of Pinchasik Strongin Muskat Stein & Co., which firm was paid $192,045 by
the Company during the year ended December 31, 1998.
(2) Other Annual Compensation represents an automobile allowance for Mr.
Guilford.
STOCK OPTION GRANTS IN FISCAL YEAR 1998
No stock options were granted to Dr. Grussmark during the fiscal year ended
December 31, 1998. No exercised or unexercised options to purchase the Company's
Common Stock were held by Dr. Grussmark as of December 31, 1998. Options to
acquire 150,000 shares of the Company's Common Stock at any time and from time
to time for a period of five years, commencing April 16, 1998 were granted to
Mr. Guilford in connection with the closing of the Merger (the "Guilford
Options"). The Guilford Options remained unexercised and outstanding as of
December 31, 1998.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Number of
Securities Percent of Total Market
Underlying Options Granted to Price on Exercise or
Options Employees Date of Base Price Expiration
Name Granted(1) In Fiscal Year Grant ($) ($) Date
===========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Stephen Grussmark, DDS - - - - -
- ---------------------------------------------------------------------------------------------------------------------------
F.W. Mort Guilford 150,000 26.32% 9.11 9.11 April 15, 2003
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) All options are non-qualified options.
18
<PAGE>
STOCK OPTION EXERCISES IN FISCAL YEAR 1998
AND FISCAL YEAR END OPTION VALUES
The following table sets forth certain summary information concerning
exercised and unexercised options to purchase the Company's Common Stock as of
December 31, 1998 held by Dr. Grussmark and Mr. Guilford. Neither Dr. Grussmark
nor Mr. Guilford exercised any options during the year ended December 31, 1998.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Value of Unexercised
Shares Number of Unexercised In-the-money Options
Acquired Value Options at FY-end at FY-end
Name on Exercise Realized (1) Exercisable/Unexercisable Exercisable/Unexercisable (2)(3)
===========================================================================================================================
<S> <C> <C> <C> <C> <C>
Stephen Grussmark, DDS -- -- 0 / 0 n/a
F.W. Mort Guilford -- -- 150,000 / 0 $0 / $0
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) The difference between the average of the high and low sales prices per
share of the Common Stock as reported on Nasdaq on the date of exercise,
and the exercise or base price.
(2) The difference between the average of the high and low sales prices per
share of the Common Stock as quoted on Nasdaq on December 31, 1998, $2.25,
and the exercise or base price.
(3) As of December 31, 1997, Mr. Guilford held options to purchase 150,000
shares of Common Stock at $9.11 per share, all of which are currently
exercisable.
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-
CONTROL ARRANGEMENTS
Dr. Grussmark, an Affiliated Orthodontist has no employment agreement
with the Company and does not receive a salary in his capacity as the Company's
Chief Executive Officer and Chief Clinical Officer. Dr. Grussmark's
responsibilities include business development and acting as a liaison between
the Company and the Affiliated Practices. Mr. Guilford has no employment
agreement with the Company and does not receive a salary in his capacity as
President and Chief Operating Officer, but does receive an automobile allowance
of $1,180 monthly.
19
<PAGE>
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information known to the Company with
respect to the beneficial ownership of its Common Stock as of March 31, 1999 by
(i) each stockholder known by the Company to own beneficially more than 5% of
the outstanding Common Stock, (ii) each of Mr. Guilford and Dr. Grussmark, the
only persons named in the Summary Compensation Table, (iii) each director of the
Company, and (iv) all directors and executive officers as a group. As of March
31, 1999, there were 5,881,721 shares of Common Stock outstanding.
<TABLE>
<CAPTION>
PRINCIPAL SHAREHOLDERS
Name and Address Shares of Common Stock Percent
of Beneficial Owner Beneficially Owned(1) Owned
- ------------------- --------------------- -----
<S> <C> <C> <C>
Stephen Grussmark, DDS, MSD 896,956 (2) 15.25%
2222 Ponce de Leon Blvd., 3rd Floor
Coral Gables, FL 33134
F.W. Mort Guilford 500,180 (4) 8.29%
2222 Ponce de Leon Blvd., 3rd Floor
Coral Gables, FL 33134
Stephen J. Dresnick 380,000 (3)(4) 6.23%
2222 Ponce de Leon Blvd., 3rd Floor
Coral Gables, FL 33134
Glenn L. Halpryn 357,300 (4) 6.05%
2222 Ponce de Leon Blvd., 3rd Floor
Coral Gables, FL 33134
Stephen Bittel 103,000 (4) 1.72%
2222 Ponce de Leon Blvd., 3rd Floor
Coral Gables, FL 33134
William Thompson, DDS 69,500 (4)(5) 1.17%
2222 Ponce de Leon Blvd., 3rd Floor
Coral Gables, FL 33134
Gary Gerson 20,000 (4) 0.34%
2222 Ponce de Leon Blvd., 3rd Floor
Coral Gables, FL 33134
All Officers and Directors 2,337,236 36.17%
as a Group
Total Shares Outstanding 5,881,721
as of March 31, 1999
</TABLE>
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of Common Stock subject to options or warrants held by that person that
are currently exercisable or will become exercisable within 60 days after March
31, 1999 are deemed outstanding, while such shares are not deemed outstanding
for purposes of computing percentage ownership of any other person. Unless
otherwise indicated in the footnotes below, the persons and entities named in
the table have sole voting and investment power with respect to all shares
beneficially owned, subject to community property laws where applicable.
(2) Includes 891,956 shares of Common Stock held in various trusts for which Dr.
Grussmark or his spouse is the sole trustee and the beneficiaries of which are
Dr. Grussmark, his spouse or his children.
(3) Includes 160,000 shares of Common Stock held by a limited partnership of
which Dr. Dresnick is both a limited partner and the owner of the corporate
general partner.
(4) Includes shares of Common Stock issuable upon the exercise by Mr.
Guilford (150,000), Dr. Dresnick (220,000), Dr. Thompson (60,000), Mr. Bittel
(100,000), Mr. Halpryn (20,000), and Mr. Gerson (20,000) of currently
exercisable stock options.
(5) Includes 2,000 shares of Common Stock held in a trust for which Dr.
Thompson's spouse is the sole trustee and beneficiary.
20
<PAGE>
Item 12. Certain Relationships and Related Transactions
Edward Strongin, the Company's Acting Chief Financial Officer, is a
partner of Pinchasik Strongin Muskat Stein & Co., which firm was paid $192,045
by the Company during the fiscal year ended December 31, 1998. Until a suitable
replacement is retained by the Company, the Company presently intends to
continue to engage the services of Mr. Strongin as Acting Chief Financial
Officer.
Item 13. Exhibits And Reports on Form 8-K
(a) Documents filed as part of this report
1. Financial Statements
See page F-1.
2. Exhibits:
See Exhibit Index. The Exhibits listed in the accompanying
Exhibits Index are filed or incorporated by reference as part of this report.
(b) Reports on Form 8-K:
None
21
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
By: /s/ F.W. Mort Guilford
--------------------------
F.W. Mort Guilford, President
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the Registrant in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Stephen Grussmark, DDS, MSD Chief Executive Officer, Chief April 14, 1999
- ------------------------------- Clinical Officer, Director
Stephen Grussmark, DDS, MSD
/s/ F.W. Mort Guilford President, Chief Operating Officer, April 14, 1999
- -------------------------------------------------- Secretary, Treasurer, Director
F.W. Mort Guilford
/s/ Edward Strongin Acting Chief Financial Officer April 14, 1999
- ----------------------------------------------------
Edward Strongin
/s/ Stephen J. Dresnick, MD Director April 14, 1999
- ---------------------------------------------
Stephen J. Dresnick, MD
Director April 14, 1999
- ----------------------------------------------------
Glenn L. Halpryn
/s/ William Thompson, DDS Director April 14, 1999
- -----------------------------------------
William Thompson, DDS
/s/ Stephen H. Bittel Director April 14, 1999
- -----------------------------------------------------
Stephen H. Bittel
/s/ Gary Gerson, CPA Director April 14, 1999
- -----------------------------------------------
Gary Gerson, CPA
</TABLE>
22
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------ -------------------
<S> <C>
2.1* Agreement and Plan of Merger and Reorganization, dated October 30, 1997, between
Embassy Acquisition Corp. (now known as Orthodontix, Inc. (the "Company")) and
Orthodontix, Inc. (now known as Orthodontix Subsidiary, Inc.).
3.1* Amended and Restated Articles of Incorporation of the Company.
3.2* Bylaws of the Company as amended.
4.1* Form of certificate representing shares of Common Stock of the Company.
10.1* 1997 Orthodontix, Inc. Stock Option Plan
10.2* Form of Administrative Services Agreement of the Company.
10.3* Forms of Services Agreement of the Company.
10.4* Form of Agreement and Plan of Reorganization of the Company.
10.5* Forms of Lock-Up Agreement.
21.1+ Subsidiaries of the Company.
27.1+ Financial Data Schedule for the Company as of and for the Year Ended December
31, 1998.
</TABLE>
- ------------
* Incorporated by reference to the Company's Registration Statement on Form
S-4 declared effective on March 26, 1998 by the Securities and Exchange
Commission, SEC File No. 333-48677.
+ Filed herewith.
23
<PAGE>
LIST OF EXHIBITS
Exhibit
Number Exhibit Description
21.1 Subsidiaries of the Company.
27.1 Financial Data Schedule for the Company as of and for the Year
Ended December 31, 1998.
<PAGE>
<TABLE>
<CAPTION>
INDEX TO FINANCIAL STATEMENTS
Pages
<S> <C>
Report of Independent Certified Public Accountants F-2
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-3
Consolidated Statements of Operations for the years ended
December 31, 1998 and 1997 F-4
Consolidated Statements of Changes in Stockholders' (Deficiency) Equity
for the years ended December 31, 1998 and 1997 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998 and 1997 F-6
Notes to the Consolidated Financial Statements F-7
</TABLE>
F-1
<PAGE>
Report of Independent Certified Public Accountants
April 11, 1999
To the Board of Directors and
Shareholders of Orthodontix, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in stockholders' (deficiency)
equity and of cash flows present fairly, in all material respects, the financial
position of Orthodontix, Inc. (the "Company") at December 31, 1998 and 1997, and
the results of their operations and their cash flows for each of the two
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 1, subsequent to year-end, the Company terminated or is
negotiating to terminate its affiliation with seven Founding Practices. In
addition, management is exploring various ways to restructure agreements with
Founding Practices. If management is not able to successfully restructure the
agreements and negotiate to terminate certain affiliations, additional
alternatives with respect to its operations may be pursued.
PricewaterhouseCoopers, LLP
F-2
<PAGE>
ORTHODONTIX, INC.
CONSOLIDATED BALANCE SHEETS
as of December 31, 1998 and 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
------ ---- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,289,481 $ 84,920
Patient receivables and unbilled patient receivables, net of allowance
of $267,000 at December 31, 1998 1,113,254 --
Prepaid expenses and other current assets 183,736 130
----------- -----------
Total current assets 2,586,471 85,050
Property and equipment, net 839,193 3,400
Advances to Founding Practices, net of allowance of $800,000 950,328 --
Notes and other receivables 303,040 50,000
Deferred tax asset 73,825 --
Other assets 20,094 5,215
----------- -----------
Total assets $ 4,772,951 $ 143,665
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
-------------------------------------------------
Current liabilities:
Accounts payable and accrued liabilities $ 705,525 $ 57,502
Amounts payable to Founding Practices 466,626 --
Patient prepayments 108,009 --
Bank line of credit -- 496,283
Lease payable - current portion 16,200 --
Deferred tax liability 73,825 --
----------- -----------
Total current liabilities 1,370,185 553,785
Lease payable 47,937 --
Due to stockholders -- 297,505
----------- -----------
Total liabilities 1,418,122 851,290
----------- -----------
Commitments and contingencies (Notes 6 and 10)
Stockholders' equity (deficiency):
Preferred stock, $.0001 par value, 100,000,000 and 1,000,000 shares
authorized at December 31, 1998 and 1997, respectively,
no shares issued and outstanding -- --
Common stock, $.0001 par value, 100,000,000 shares authorized,
5,881,721 and 1,300,000 shares issued and outstanding at
December 31, 1998 and 1997, respectively 588 130
Additional paid-in capital 5,607,261 --
Accumulated deficit (1,854,557) (707,755)
Less: deferred compensation - stock options (398,463) --
----------- -----------
Total stockholders' equity (deficiency) 3,354,829 (707,625)
----------- -----------
Total liabilities and stockholders' equity (deficiency) $ 4,772,951 $ 143,665
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
ORTHODONTIX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
for the years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Management service fee revenue $ 8,035,839 $ --
----------- -----------
Direct practice expenses:
Salaries and benefits 2,861,318 --
Orthodontic supplies 1,169,323 --
Rent 1,051,671 --
Depreciation and amortization 184,278 --
Other 1,039,066 --
----------- -----------
Total direct practice expenses 6,305,656 --
General and administrative 2,086,328 626,937
Provision for losses on advances to Founding Practices 800,000 --
Depreciation and amortization 17,927 377
----------- -----------
Total expenses 9,209,911 627,314
----------- -----------
Net operating loss (1,174,072) (627,314)
----------- -----------
Other income (expense):
Interest income 78,836 42
Interest expense (51,566) (6,308)
----------- -----------
Total other income (expense) 27,270 (6,266)
----------- -----------
Net loss $(1,146,802) $ (633,580)
=========== ===========
Loss per common and common
equivalent share:
Basic $ (0.25) $ (0.49)
=========== ===========
Diluted $ (0.25) $ (0.49)
=========== ===========
Weighted average number of common and
common equivalent shares outstanding -
basic and diluted 4,563,691 1,300,000
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
ORTHODONTIX, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (DEFICIENCY) EQUITY
for the years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
Additional
Common Stock Paid-in Accumulated Deferred
Shares Amount Capital Deficit Subtotal Compensation Total
------ ------ ------- ------- -------- ------------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 1,300,000 $ 130 $ - $ (74,175) $ (74,045) $ - $ (74,045)
Net loss for the year ended December 31, 1997 - - - (633,580) (633,580) - (633,580)
----------- ------- ----------- ------------ ----------- ---------- ----------
Balance, December 31, 1997 1,300,000 130 - (707,755) (707,625) - (707,625)
Issuance of stock to public stockholders
in connection with the Merger and
to Founding Practices 4,581,721 458 5,607,261 - 5,607,719 - 5,607,719
Net loss for the year ended December 31, 1998 - - - (1,146,802) (1,146,802) - (1,146,802)
Deferred compensation for stock options - - - - - (521,625) (521,625)
Amortization of deferred compensation - - - - - 123,162 123,162
----------- ------- ----------- ------------ ----------- ---------- ----------
Balance, December 31, 1998 5,881,721 $ 588 $ 5,607,261 $ (1,854,557) $3,753,292 $ (398,463) $3,354,829
=========== ======= =========== ============ =========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
ORTHODONTIX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss $(1,146,802) $ (633,580)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 202,205 377
Bad debt expense 237,187 -
Noncash compensation expense 195,312 --
Provision for advances to Founding Practices 800,000 --
Changes in assets and liabilities (net of practice assets acquired):
Patient receivables and unbilled patient receivables (568,393) --
Advances to Founding Practices (1,750,328) --
Prepaid expenses and other current assets (86,483) --
Other assets (14,879) (5,215)
Accounts payable and accrued liabilities 648,023 29,243
Amounts payable to Founding Practices 466,626 --
Patient prepayments 108,009 --
----------- -----------
Net cash used in operating activities (909,523) (609,175)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (139,987) (3,777)
Purchase of practice assets (3,362,593) --
Payment of notes receivable 59,393 --
Investment in notes receivable to stockholders (409,556) (50,000)
----------- -----------
Net cash used in investing activities (3,852,743) (53,777)
----------- -----------
Cash flows from financing activities:
Payment of lease obligation (20,745) --
(Repayment to) proceeds from bank line of credit, net (496,283) 496,283
Proceeds from merger, net of costs 6,781,360 --
(Repayments to) advances from stockholders, net (297,505) 248,907
----------- -----------
Net cash provided by financing activities 5,966,827 745,190
----------- -----------
Net increase in cash and cash equivalents 1,204,561 82,238
Cash and cash equivalents, beginning of year 84,920 2,682
----------- -----------
Cash and cash equivalents, end of year $ 1,289,481 $ 84,920
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Interest paid $ 51,566 $ 6,308
=========== ===========
Supplemental Disclosure of Non-Cash Items from Investing Activities:
Assets acquired under lease agreement $ 84,882 $ --
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business:
On April 16, 1998, Orthodontix, Inc. ("Orthodontix" or the "Company")
consummated a merger ("Merger") with Embassy Acquisition Corp.
("Embassy"), a publicly held Florida corporation. As a result of the
Merger, each outstanding share of common stock of Orthodontix converted
into one share of Embassy common stock. Embassy's outstanding common
stock and Embassy's articles of incorporation were amended to change
Embassy's name to Orthodontix. Additionally, the Company authorized a
class of Preferred Stock consisting of 100,000,000 shares, par value
$.0001. The Merger has been treated as a capital transaction equivalent
to the issuance of 2,540,000 shares of common stock by the Company for
the net monetary assets of Embassy of approximately $7.4 million at the
closing accompanied by a recapitalization of Orthodontix. The Company
incurred merger costs of approximately $649,000 in connection with the
Merger.
On April 16, 1998, the Company acquired, simultaneously with the closing
of the Merger, certain assets and assumed certain liabilities of 26
orthodontic practices (the "Founding Practices") (collectively referred
to as the "Affiliated Acquisitions"), with the net book value of
approximately $1.3 million, in exchange for 2,041,721 shares of common
stock and approximately $3.4 million in cash. The Company does not employ
orthodontists or control the practice of orthodontics by the
orthodontists employed by professional corporations (collectively
referred to as the "Affiliated Practices"). The Company executed
Administrative Service Agreements with separately formed professional
associations (the "PCs") and does not hold any equity ownership interest
in the PCs, therefore, the Affiliated Acquisitions were not deemed to be
business combinations. Because each of the owners of the Founding
Practices was a Promoter of the transaction, in accordance with the
Securities and Exchange Commission's Staff Accounting Bulletin No. 48,
"Transfers of Nonmonetary Assets by Promoters or Shareholders",
transferred nonmonetary assets and assumed liabilities are accounted for
at the historical cost basis of the Founding Practices and any monetary
assets assumed and any monetary liabilities included in the Affiliated
Acquisitions were recorded at fair value. The cash consideration paid in
excess of net assets transferred is reflected as a dividend paid by the
Company.
Under the Administrative Services Agreement, the Company provides
management services which include consultation and other activities
regarding the suitability of facilities and equipment, nonprofessional
staffing, regulatory compliance, productivity improvements, inventory and
supplies management, information systems management, and, subject to
applicable law, other services as the Company deems necessary to meet the
day-to-day requirements of the Founding Practices. The Company is paid a
management fee for its services under the Administrative Service
Agreements which have terms of 40 years and are subject to renegotiations
at the end of such terms. The Company manages 46 offices in 11 states at
December 31, 1998.
F-7
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. Summary of Significant Accounting Policies:
The Company has suffered losses from operations of $1,146,802 and
$633,580 for the years ended December 31, 1998 and 1997, respectively,
and has an accumulated deficit of $1,854,557 at December 31, 1998.
Subsequent to year-end, as a result of such losses, management is
exploring plans to amend the agreements with the Founding Practices with
respect to the Company's management fees as well as amounts payable to
the orthodontists. This will result in the Company not needing to advance
amounts to the Founding Practices. In addition, in the course of
discussions with certain orthodontists, several have expressed an
interest in terminating their affiliation with the Company. Management is
negotiating with certain Founding Practices to terminate their
affiliation with the Company and to buy back certain practice assets
originally purchased from the Founding Practices (see Notes 6 and 10).
Management is also exploring possible ways in which to control corporate
general and administrative costs while continuing to provide services
required under various agreements. Such plans are designed to reduce the
losses from operations that the Company has incurred to date. There are
no assurances that such measures will be successful. Management believes
that to the extent such measures are not successful that the Company will
have to explore additional alternatives with respect to its operations.
Basis of Presentation
The accompanying consolidated financial statements include the accounts
of Orthodontix and its wholly-owned subsidiaries. All significant
intercompany transactions have been eliminated in the preparation of the
consolidated financial statements.
The consolidated financial statements are prepared in accordance with the
consensus reached by the Financial Accounting Standards Board's Emerging
Issues Task Force with respect to physician practice management
companies. The Company does not meet the conditions and, therefore, does
not consolidate the results of operations of the Founding Practices into
its consolidated statements of operations.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid financial instruments with
maturities of 90 days or less at the date of purchase to be cash
equivalents.
F-8
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. Summary of Significant Accounting Policies, Continued:
Cash and Cash Equivalents, Continued
The Company maintains its cash and cash equivalents, which consist
principally of demand deposit accounts, money market accounts and
overnight repurchase agreements with financial institutions. The balance
in demand deposit accounts, at times, may exceed FDIC insurance limits.
Patient Receivables and Unbilled Patient Receivables
After the Affiliated Acquisitions by the Company, the Company continues
to purchase patient accounts receivable generated by the Founding
Practices and records these receivables on the balance sheet of the
Company. The receivables are recorded at net realizable value on the date
of purchase. Any subsequent uncollectible account is written off by the
Company and the Founding Practice revenue is reduced accordingly. The
impact on the Company from such write-offs is a loss of management fees
revenue because practice revenue is reduced.
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.
Concentration of credit risk relating to patient receivables is limited
by the number, diversity and geographic dispersion of the business units
managed by the Company, as well as by the large number of patients and
payors.
Advances to/Amounts Payable to Founding Practices
From time to time, certain funds have been advanced to the Founding
Practices to cover expenses and for working capital purposes. In addition
at the time of the Merger, certain amounts were collected and disbursed
by the Founding Practices in connection with the Company's transition to
centralized cash collection and disbursement procedures. To the extent
the net amounts (the difference between collections and disbursements
during this initial period) have not been remitted by the Founding
Practices, such amounts have been recorded as advances to Founding
Practices. Such amounts are due to the Company on demand. The Company is
currently negotiating repayment terms with the orthodontists. Although
the Company anticipates collection of certain amounts in 1999, such
amounts are not determinable. Therefore, the balance of advances to
Founding Practices have been classified as a long-term asset at December
31, 1998. The Company has recorded an allowance related to the
collectibility of such amounts at December 31, 1998 of $800,000. Such
allowance was recorded principally in the fourth quarter of 1999.
Amounts payable to Founding Practices represents amounts earned and
accrued under their agreements with the PCs and due to Founding Practices
but not remitted at year-end.
F-9
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. Summary of Significant Accounting Policies, Continued:
Property and Equipment, net
Property and equipment is stated at historical cost. Depreciation of
property and equipment is calculated using the straight-line method over
the estimated useful lives of the assets of three to five years. Upon the
sale or retirement of property and equipment, the cost and related
accumulated depreciation are eliminated from the respective accounts and
the resulting gain or loss is included in earnings. Routine maintenance
and repairs are charged to expense as incurred, while costs of
betterments and renewals are capitalized.
Management Fee Revenue
Revenue from managing the practices is recognized on a monthly basis as
the services are provided. The revenue of the Company consists of the sum
of the management service fees and such amounts equal to the operating
expenses of orthodontic practices incurred by the Company under such
Administrative Service Agreements.
In general, the Administrative Service Agreements provide for the payment
of fees to the Company based on a negotiated percentage of the accrued
patient revenue of each Founding Practice. Patient revenue is recognized
by the Founding Practice as orthodontic services are performed. If the
patient enters into a long-term orthodontic contract, approximately 24%
of the contract value is recognized at the initial treatment date and the
remaining amounts are recognized on an estimated average contract period
of 24 months. The 24% estimated revenue is based on the estimated costs
incurred by each Founding Practice at that time as compared to the total
costs of providing the contracted services and is consistent with
industry standards. The percentage includes the estimated costs of
diagnosis and treatment plan development, initial treatment by
orthodontic personnel, orthodontic supplies, and associated
administrative services. Expenses not required to be paid by the Company
pursuant to the Administrative Service Agreements primarily consist of
professional expenses of the orthodontists.
Advertising Costs
The Company expenses all advertising costs the first time the advertising
takes place. For the years ended December 31, 1998 and 1997, the Company
expensed advertising costs of approximately $239,000 and $157,000,
respectively.
Income Taxes
The Company utilizes the liability method of accounting for income taxes.
The liability method requires recognition of deferred tax assets and
liabilities based on the differences between the financial statement and
the tax bases of assets and liabilities using enacted tax rates and laws
in effect in the years in which the differences are expected to reverse.
Deferred tax assets are also established for the future tax benefits of
loss and credit carryovers.
F-10
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. Summary of Significant Accounting Policies, Continued:
Earnings Per Share
In 1997, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings per Share", which requires the presentation
of both basic and diluted earnings per share. Basic earnings per share is
calculated by dividing the net income or loss by the weighted average
number of common shares outstanding during the period. Diluted earnings
per share is calculated by dividing the net income or loss by the
weighted average number of common and potential common equivalent shares
outstanding during the period. Potential common shares consist of the
dilutive effect of outstanding options calculated using the treasury
stock method. Potential common shares for 1998 are antidilutive and,
thus, are excluded from the calculation of earnings per share.
Stock Options
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but
does not require, companies to recognize compensation expense for grants
of stock, stock options and other equity instruments based on fair value
accounting rules. The Company has chosen not to apply the fair value
accounting rules in the statements of operations for employee stock-based
compensation. But such treatment is required for non-employee stock-based
compensation, including options granted to the orthodontists. The Company
has chosen the SFAS No. 123 alternative to disclose pro forma net income
and earnings per share as if the fair value based method was used.
Recent Accounting Pronouncements
AICPA Statement of Position ("SOP") No. 98-5, "Reporting on the Costs of
Start-Up Activities", requires certain costs related to start-up
activities to be charged to expense as incurred. SOP No. 98-5 is
effective for fiscal years beginning after December 31, 1998.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded
in other contracts, and for hedging activities. The statement requires
that an entity recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those instruments at
fair value. SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999.
It is currently anticipated that the adoption of SOP No. 98-5 and
SFAS No. 133 will not have a significant financial statement impact
when adopted.
F-11
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
3. Property and Equipment:
Property and equipment consist of the following at December 31, 1998 and
1997:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Furniture and fixtures $ 347,364 $ 3,777
Dental and office equipment 542,335 -
Leasehold improvement 152,076 -
----------------- ------------------
1,041,775 3,777
Less accumulated depreciation
and amortization (202,582) (377)
----------------- ------------------
$ 839,193 $ 3,400
================= ==================
</TABLE>
The Company leases certain equipment under a capital lease. Included in
the above amounts at December 31, 1998 is certain leased equipment and
accumulated amortization of $84,882 and $15,458, respectively.
4. Accounts Payable and Accrued Expenses:
Accounts payable and accrued expenses consists of the following at
December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Accounts payable $ 430,027 $ 54,279
Accrued salaries and benefits 188,084 3,223
Other accrued expenses 87,414 -
---------------- -----------------
$ 705,525 $ 57,502
================ =================
</TABLE>
5. Bank Line of Credit:
In July 1997, the Company entered into a loan agreement with a bank for a
$500,000 line of credit to fund the Company's working capital needs. All
amounts outstanding were due and payable on demand. The line of credit
accrued interest at the LIBOR market index rate plus 2% (approximately
7.69% at December 31, 1997). A limited partnership, whose sole limited
partner is the Chairman of the Company, collateralized the Company's
repayment obligation under the line of credit. The outstanding balance
was repaid with proceeds from the Merger.
F-12
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
6. Commitments and Contingencies:
The Company leases certain orthodontic centers and furniture and
equipment under noncancelable operating leases which expire at various
dates. Additionally, the Company leases equipment under a capital lease,
which expires in 2002.
Facilities for the orthodontic centers and administrative offices are
rented under long-term leases accounted for as operating leases. The
original lease terms are generally five to ten years with options to
renew the leases for specified periods subsequent to their original
terms. The leases have other various provisions, including sharing of
certain executory costs and scheduled rent increases. Minimum future
commitments as of December 31, 1998 are as follows:
1999 $ 1,177,156
2000 1,026,925
2001 901,054
2002 742,725
2003 519,896
Thereafter 2,534,812
----------------
$ 6,902,568
================
The Company incurred rental expense for noncancelable operating leases
and month-to-month leases of approximately $953,000 and $3,000 for the
years ended December 31, 1998 and 1997, respectively.
Certain of the leases for orthodontic centers are with the orthodontists
associated with the Founding Practices. Included in the future minimum
commitments, in the preceding table, are $4,337,000 in amounts due to
such parties. In addition, of the rent expense incurred by the Company
for the year ended December 31, 1998, $364,000 was paid to such parties.
Amounts due for equipment under a capital lease at December 31, 1998 is
as follows:
1999 $ 22,092
2000 22,092
2001 22,092
2002 11,482
---------------
77,758
Less amounts representing interest (13,621)
---------------
Amount due under capital lease $ 64,137
===============
Subsequent to year-end, the Company received written demands for damages
from two Founding Practices arising from their allegations that the
Company has breached its obligations under certain agreements including
lease agreements with the orthodontists associated with these Founding
Practices. Pursuant to the demand letter, these Founding Practices have
alleged damages, in aggregate, of approximately $2.2 million.
F-13
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
6. Commitments and Contingencies, Continued:
In addition, subsequent to year-end, the Company received notice from an
additional seven Founding Practices arising out of their allegations that
the Company delivered less than should be delivered to the orthodontists
for amounts owed under certain agreements. These Founding Practices have
alleged damages, in the aggregate, of approximately $60,000. The Company
is in negotiations with certain of these orthodontists associated with
the Founding Practices to terminate their affiliation with the Company.
The Company believes the matters described in the two preceding
paragraphs are without merit and intends to vigorously defend itself. The
Company does not believe such matters will have a material impact on the
Company's consolidated financial position, results of operations, or
liquidity.
7. Related Party Transactions:
In addition to transactions with related parties described elsewhere, the
Company has the following additional related party transactions:
During 1998, the Company advanced approximately $410,000 to stockholders
of the Company who are associated with the Founding Practices. At
December 31, 1998, the outstanding balance on such notes receivable,
including accrued interest, was approximately $405,000, of which
approximately $102,000 is included in prepaid expenses and other current
assets as these amounts are expected to be repaid in 1999. The interest
rate for these notes is 6% per annum. Such amounts are repayable in
monthly installments of approximately $3,000 with accrued interest. One
note receivable, in the amount of approximately $83,000 at December 31,
1998, is due in a balloon payment with accrued interest in April 1999.
The remaining principal balance is due in monthly installments through
May 2013.
Two of the Company's stockholders funded expenses of the Company from the
date of inception to the date of the Merger. Such amounts were classified
as a long-term liability at December 31, 1997, as the stockholders agreed
not to demand repayment of such amounts until the Company completed the
Merger at which time such amounts were repaid.
In addition, during 1997, the Company advanced $50,000 to an orthodontist
associated with one of the Founding Practices. The amount advanced had an
interest rate of 6% and was repaid at the time of the Merger.
Neither the individual who serves as the Company's Chief Executive
Officer and Chief Clinical Officer nor the individual who serves as the
Company's President and Chief Operating Officer have an employment
agreement with the Company. These individuals receive no compensation
except the individual that serves as the Company's President and Chief
Operating Officer receives an automobile allowance.
F-14
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
7. Related Party Transactions, Continued:
The Company shared office space and several support employees with the
Company's President and Chief Operating Officer. Such amounts charged to
the Company for its pro rata share of such costs amounted to
approximately $104,700 and $62,200 for the years ended December 31, 1998
and 1997, respectively, and have been included in general and
administrative expenses in the accompanying statements of operations.
8. Income Taxes:
The components of the income tax expense is as follows for the years
ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Current:
Federal $ (9,541) $ --
State (1,633) --
--------- ---------
(11,174) --
--------- ---------
Deferred:
Federal (607,822) (193,384)
State (104,047) (33,103)
Change in valuation allowance 723,043 226,487
--------- ---------
11,174 --
--------- ---------
Total $ -- $ --
========= =========
</TABLE>
The effective tax rate on income was 34% for the years ended December 31,
1998 and 1997. The differences between the effective rate and the U.S.
federal income tax statutory rates are as follows for the years ended
December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Tax at statutory rate $ (389,913) $ (215,417)
State income tax, net of federal benefit (41,191) (22,998)
Change in valuation allowance 427,743 226,487
Other, net 3,361 11,928
----------------- -----------------
Total $ - $ -
================= =================
</TABLE>
F-15
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
8. Income Taxes, Continued:
The significant components of deferred income tax assets and liabilities
are as follows at December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Deferred tax assets:
Start-up expenses $ 187,313 $ 225,970
Net operating loss carryforward 37,740 --
Allowance for receivables and advances 327,001 --
Nonqualified stock options 73,496 --
Other, net 4,612 376
--------- ---------
630,162 226,346
Valuation allowance (399,279) (226,346)
--------- ---------
$ 230,883 $ --
========= =========
Deferred tax liabilities:
Accounts receivable $ 221,475 $ --
Other 9,408 --
--------- ---------
Total $ 230,883 $ --
========= =========
</TABLE>
The long term deferred tax asset of $230,883 at December 31, 1998
is shown net of the long term deferred tax liability of $157,058.
The Company has recorded a valuation allowance at December 31, 1998 and
1997 with respect to the deferred tax assets to the extent that
management has determined that it is more likely than not that the
benefit of such amounts will not be realized.
The Company has net operating loss carryforwards for federal and state
tax purposes of approximately $100,300 at December 31, 1998 and $70,600
at December 31, 1997. Such net operating loss carryforwards expire at
various times commencing in 2012.
9. Stock Option Plan:
In conjunction with the Merger, the Company adopted an option plan (the
"Option Plan") that provides for granting up to 500,000 shares of common
stock by November 18, 2007. The Option Plan provides for the issuance of
incentive stock options and non-qualified stock options. Under the Option
Plan, options may be granted at not less than the fair market value of
the stock on the date of the grant. The term of each option generally may
not exceed ten years. At December 31, 1998, no options have been granted
under the Option Plan.
In connection with the Merger, certain directors, officers, employees and
non-employees of the Company were awarded 956,303 stock options outside
the Option Plan at exercise prices ranging from $7.29 to $9.11 per share.
The options generally vest over varying periods of time.
In addition, underwriter options, originally issued by Embassy in
connection with their initial public offering, to purchase 120,000 shares
of common stock at an exercise price of $7.80 per share, are outstanding.
Such options are exerciseable for a period of five years commencing April
2, 1996.
F-16
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
9. Stock Option Plan, Continued:
As part of the 956,303 stock options granted, the Company recognized
compensation expense of approximately $72,000 for the year ended December
31, 1998 related to 185,000 options granted to employees for which the
fair value of the stock on the date granted exceeded the exercise price.
In addition, the Company determined the fair value of the 97,500 options
granted to members of the Company's Advisory Board, who are
non-employees, to be approximately $522,000 based on the Black-Scholes
option-pricing model (the "Model"). Such amount was recorded as unearned
compensation and is being amortized over the three year period that these
options vest. At December 31, 1998, the unamortized unearned
compensation, which is included as a separate component of stockholder's
equity, was $398,463. The compensation expense related to such options
for the year ended December 31, 1998 was $123,162. The fair value of each
option granted to such nonemployee Advisory Board member was estimated on
the date of grant, using the Model, with the following weighted average
assumptions used: no dividend yield; expected volatility of the
underlying stock of 70%; risk-free interest rate of 5.57% covering the
related option periods; and expected lives of the options of 2 to 5 years
based on the related option periods.
As part of the 956,303 stock options granted, options to purchase up to
291,303 shares were granted to certain orthodontists. Such options are
not exercisable until the orthodontists' practices reach certain revenue
levels over a five year period. If such options were exercisable on the
date of the Merger, the Company would have recorded additional
compensation expense of $1.4 million over a five year period based on the
Model. Compensation expense, if any, will be recorded to the extent the
performance criteria are attained based on the value of the options using
the Model on the date such performance criteria are attained.
A summary of the Company's stock option activity and related information
is as follows:
<TABLE>
<CAPTION>
Weighted
Number Option Price Average Expiration
of Shares Per Share Exercise Price Date
-------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Outstanding at December 31, 1997 - - - -
Granted 785,000 $7.29 - $9.11 $8.49 2001 - 2004
Exercised - - - -
Forfeited 35,000 9.11 9.11 2001 - 2003
-------------- --------------- ---------------
Outstanding at December 31, 1998 750,000 $7.29 - $9.11 $8.46 2001 - 2004
============== =============== ===============
Exercisable at December 31, 1998 652,500 $7.29 - $9.11 $8.36 2001 - 2003
============== =============== ===============
</TABLE>
F-17
<PAGE>
ORTHODONTIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
9. Stock Option Plan, Continued:
The Company has chosen to disclose pro forma net income and earnings per
share as if the fair value based method was used. Had compensation
expense been determined based on fair value consistent with the
provisions of SFAS No. 123, the Company's net loss and net loss per share
- basic and diluted for the year ended December 31, 1998 would have been
$2,102,152 and $.46, respectively. The fair value of each option or share
to be issued, using the Model, with the following assumptions: no
dividend yield; expected volatility of the underlying stock of 70%,
risk-free interest rate ranging from 5.38% to 5.57% covering the related
option periods; and expected weighted average life of the options of 4.15
years based on the related option periods.
10. Subsequent Events:
In addition to subsequent events described elsewhere, the following
additional subsequent events have occurred:
In March 1999, the Company granted to each non-employee director, an
option for a period of two years to acquire 20,000 shares of the
Company's common stock at an option price of $1.75 per share. In
addition, the Company granted one of the non-employee directors an
additional option to acquire 80,000 shares of the Company's common stock
under the same terms.
On April 5, 1999, the Company terminated its affiliation with one of the
Founding Practices. In connection with the termination, the Company sold
certain practice assets including furniture and equipment and patient
receivables, to the Founding Practice in exchange for cash and shares of
the Company's common stock received in connection with the original
transaction.
F-18
List of Subsidiaries
1. Orthodontix Subsidiary, Inc.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 1,289,481
<SECURITIES> 0
<RECEIVABLES> 1,380,524
<ALLOWANCES> 267,000
<INVENTORY> 0
<CURRENT-ASSETS> 2,586,471
<PP&E> 1,041,775
<DEPRECIATION> 202,582
<TOTAL-ASSETS> 4,772,951
<CURRENT-LIABILITIES> 1,370,185
<BONDS> 0
0
0
<COMMON> 588
<OTHER-SE> 3,354,241
<TOTAL-LIABILITY-AND-EQUITY> 4,772,951
<SALES> 8,035,839
<TOTAL-REVENUES> 8,035,839
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 9,209,911
<LOSS-PROVISION> (1,174,072)
<INTEREST-EXPENSE> (51,566)
<INCOME-PRETAX> (1,146,802)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,146,802)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,146,802)
<EPS-PRIMARY> (0.25)
<EPS-DILUTED> (0.25)
</TABLE>
