CASTLE DENTAL CENTERS INC, 10-K405, 1999-03-31

CASTLE DENTAL CENTERS INC
10-K405, 1999-03-31
NURSING & PERSONAL CARE FACILITIES

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 1-13263

CASTLE DENTAL CENTERS, INC.

DELAWARE
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)

76-0486898
(I.R.S. EMPLOYER IDENTIFICATION NO.)

1360 POST OAK BOULEVARD, SUITE 1300
HOUSTON, TEXAS
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

77056
(ZIP CODE)

(713) 479-8000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes. [X] No. [ ]

Indicate by check mark if the disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K ( 229.405 under the Securities Exchange Act of 1934)
is not contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

As of March 26, 1999, there were 6,417,206 shares of Castle Dental
Centers, Inc. Common Stock, $.001 par value, issued and outstanding, 3,533,784
of which having an aggregate market value of approximately $22.5 million were
held by non-affiliates of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement related to the registrant's 1999 annual
meeting of stockholders, which proxy statement will be filed under the
Securities Exchange Act of 1934 within 120 days of the end of the registrant's
fiscal year ended December 31, 1998, are incorporated by reference into Part III
of this Form 10-K.

<PAGE>
TABLE OF CONTENTS
PAGE
Item 1. Business.................................................... 1
The Company ................................................ 1
The Dental Industry......................................... 2
Business Strategy .......................................... 3
Dental Network Development.................................. 3
Management Services Agreement............................... 5
Dentist Employment Agreements............................... 6
Services.................................................... 6
Operations.................................................. 7
Sales and Marketing ........................................ 8
Managed Care Contracts...................................... 8
Competition................................................. 9
Management Information Systems.............................. 9
Regulation.................................................. 9
Employees................................................... 11
Corporate Liability and Insurance........................... 12
Item 2. Properties.................................................. 12
Item 3. Legal Proceedings........................................... 12
Item 4. Submission of Matters to a Vote of Security Holders......... 13
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 14
Recent Sales of Unregistered Securities..................... 14
Item 6 Selected Financial Data..................................... 16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................... 17
Introduction................................................ 17
Components of Revenues and Expenses......................... 18
Results of Operations....................................... 18
Liquidity and Capital Resources............................. 22
Year 2000................................................... 24
Inflation................................................... 24
Recently Issued Pronouncements.............................. 24
Item 7A Quantitative And Qualitative Disclosures About
Market Risk................................................. 25
Item 8. Financial Statements and Supplementary Data................. 25
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure......................... 25
Item 10. Directors and Executive Officers of the Registrant.......... 26
Item 11. xecutive Compensation....................................... 26
Item 12. Security Ownership of Certain Beneficial Owners
and Management.............................................. 26
Item 13. Certain Relationships and Related Transactions.............. 26
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K......................................... 27

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NOTE ON FORWARD-LOOKING STATEMENTS

This Form 10-K contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended. All statements other than
statements of historical facts included in this Form 10-K are forward-looking
statements. When used in this document, the words, "anticipate," "believe,"
"estimate" and "expect" and similar expressions are intended to identify such
forward-looking statements. Such statements reflect the Company's current views
with respect to future events and are subject to certain uncertainties and
assumptions. Important factors that could cause actual results to differ
materially from expectations ("Cautionary Statements") are disclosed in this
Form 10-K, including without limitation in conjunction with the forward-looking
statements included in this Form 10-K. Should one or more of these uncertainties
materialize, or should underlying assumptions prove incorrect, actual results
may vary materially from expectations. All subsequent written and oral
forward-looking statements attributable to the Company or persons acting on its
behalf are expressly qualified in their entirety by the Cautionary Statements.

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ITEM 1. BUSINESS

THE COMPANY

The Company develops, manages and operates integrated dental networks through
contractual affiliations with general, orthodontic and multi-specialty dental
practices in the United States. The Company currently conducts operations in the
states of Texas, Florida, Tennessee and California. The Company does not engage
in the practice of dentistry but rather establishes integrated dental networks
by entering into management services agreements with affiliated dental practices
to provide, on an exclusive basis, management and administrative services to
affiliated dental practices. The Company's strategy is to provide high-quality
care in selected markets with a view to achieving broad geographic coverage
within those markets. The Company seeks to achieve operating efficiencies by
consolidating and integrating affiliated practices into regional networks,
realizing economies of scale in such areas as marketing, administration and
purchasing and enhancing the revenues of its affiliated dental practices by
increasing both patient visits and the range of specialty services offered. As
of December 31, 1998, the Company provided management services to 86 dental
centers with approximately 220 affiliated dentists, orthodontists and other
dental specialists.

The Company's objective is to make each of its dental networks the leading
group dental care provider in each market it serves. Since its formation, the
Company has applied traditional retail principles of business and marketing
techniques to the practice of dentistry, including locating practices in
high-profile locations, offering more affordable fees and payment plans,
expanding the range of services offered, increasing market share through
targeted advertising and offering extended office hours. By using the Castle
Dental Centers' approach to managing affiliated dental practices, the Company
believes it will enable affiliated dentists, orthodontists and other dental
specialists to focus on delivering quality patient care and to realize
significantly greater productivity than traditional individual and small-group
dental practices.

The Company believes that the provision of a full range of dental services
through an integrated network is attractive to managed care payers and intends
to continue to pursue managed care contracts. The Company negotiates capitated
managed care contracts on behalf of its affiliated dental practices, which
maintained an aggregate of 72 capitated managed care contracts covering
approximately 115,000 members at December 31, 1998. The Company believes that
the continued development of its networks will assist it in negotiating national
and regional capitated arrangements with managed care payors on behalf of the
affiliated practices.

The Company intends to establish a consistent national identity for its
business by implementing common practice management policies and procedures in
all of its dental centers and affiliated dental practices nationwide. Moreover,
the Company believes that its experience and expertise in managing
multi-specialty dental group practices, as well as the development of name
recognition associated with the name "Castle Dental Centers," will provide its
affiliated dental practices with a competitive advantage in attracting and
retaining patients and realizing practice efficiencies.

The Company was formed in 1981 by Jack H. Castle, D.D.S. and Jack H. Castle,
Jr., as a single location, multi-specialty dental practice in Houston, Texas.
From 1982 through 1996, the Company expanded to a total of 10 locations with 39
dentists in the Houston metropolitan area. During this period the Company
developed, implemented and refined the integrated dental network approach that
it utilized as a basis for its national expansion.

Since the end of 1996, the Company has expanded to a total of 24 dental
centers in Houston through the development of 8 DE NOVO dental centers and the
March 1998 acquisition of six dental centers owned by Dental World, Inc. In May
1996, the Company acquired the assets of and entered into long-term management
services agreements with 1st Dental Care, a dental practice with 11 locations in
the Tampa/Clearwater, Florida area, and Mid-South Dental Centers, a dental
practice with six dental centers in various locations in Tennessee. In August
1996, the Company increased its dental practices under management in Texas by
acquiring the assets of Horizon Dental Centers, a dental practice with four
dental centers in Fort Worth, Texas and four dental centers in Austin, Texas. In
September 1997, the Company acquired SW Dental Associates, LC, a dental practice
with four dental centers in the Austin, Texas metropolitan area. In December
1997, the Company

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acquired substantially all the assets of two individual practices in Ft. Worth,
Texas and Nashville, Tennessee. In March 1998, the Company expanded into the
southern California market through the acquisition of an 80% interest in a
company ("Castle West") formed to acquire Dental Consulting Services LLC, a
dental management company affiliated with five dental centers in the Los Angeles
area. Subsequent to March 1998, Castle West acquired three additional dental
practices with four dental offices in the Los Angeles area increasing the number
of dental centers managed by the Company to nine in that market. In July 1998,
the Company acquired a dental management company and five related dental
practices in Florida. In December 1998, the Company completed the acquisition of
the assets of Dental Centers of America and its affiliated dental practices.
Dental Centers of America operated 16 dental centers in San Antonio, Austin,
Waco and the Dallas/Fort Worth metroplex. (All of the acquisitions are
collectively referred to as the "Completed Acquisitions").

THE DENTAL INDUSTRY

Dental care services in the United States are generally delivered through a
fragmented system of local providers, primarily sole practitioners, or small
groups of dentists, orthodontists or other dental specialists, practicing at a
single location with a limited number of professional assistants and business
office personnel. According to the American Dental Association 1995 Survey of
Dental Practice ("ADA Survey"), there were approximately 150,800 actively
practicing dental professionals in the U.S., of which approximately 8,900 were
practicing orthodontists. Nearly 81% of the nation's private practitioners work
either as sole practitioners or in a practice with one other dentist. The
balance of these dentists practice in about 4,700 groups of three or more
dentists. However, dental, orthodontic and other specialty practices have
followed the trend of the health care industry generally and are increasingly
forming larger group practices.

The annual aggregate domestic market for dental services was estimated by the
Health Care Financing Administration, Health Care Financing Review (1998) to be
approximately $50.6 billion for 1997, representing approximately 4.6% of total
health care expenditures in the United States, and is projected to reach $79.1
billion by 2005. Within the total market for dental services in the United
States, there are, in addition to general dentistry, a number of specialties,
including orthodontics (the straightening of teeth and remedy of occlusion),
periodontics (gum care), endodontics (root canal therapy), oral surgery (tooth
extraction) and pedodontics (care of children's teeth). The dental services
market has grown at a compound annual growth rate of approximately 8.0% from
1980 to 1997, and is projected to grow at a compound annual growth rate of
approximately 6.0% through the year 2005. In contrast to other health care
expenditures, dental services are primarily paid for by the patient. According
to the U.S. Department of Health and Human Services, in 1997, consumer
out-of-pocket expenditures accounted for 47% of the payment for dental services,
compared to 16% for other medical services.

The Company believes that the growth in the dental industry has largely been
driven by four factors: (i) an increase in the availability and types of dental
insurance; (ii) an increasing demand for dental services from an aging
population; (iii) the evolution of technology which makes dental care less
traumatic; and (iv) an increased focus on preventive and cosmetic dentistry.

Concerns over the accelerating cost of health care have resulted in the
increasing importance of managed care in the dental industry. Managed care
typically involves a third party (frequently the payer) assuming responsibility
for ensuring that health care is provided in a high quality, cost-effective
manner. According to industry sources, approximately 18.6% of the estimated
118.5 million people covered by dental benefits in 1995 were enrolled in managed
care programs. It is estimated that managed care's penetration of this group
will increase to 35% of the 131 million people expected to be covered by dental
benefits in the year 2000. Enrollment in managed dental care plans, according to
the National Association of Dental Plans, is estimated to have grown from 7.8
million patients in 1990 to 22.8 million patients in 1995.

The Company believes that the provision of dental, orthodontic and other
specialty care will follow the pattern set by other segments of the health care
industry, moving away from the sole practitioner model to a group practice
environment in which a separate professional management team handles personnel,
management, billing, marketing and other business functions. The trends which
are leading dentists to affiliate with dental practice management companies
include; (i) the increasingly capital intensive nature of acquiring

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and maintaining state-of-the-art dental equipment, laboratory and clinical
facilities; (ii) the growing need to develop and maintain specialized management
information and billing systems to meet the increasing demands of payers; and
(iii) the increasingly more complicated, competitive and regulated business
environment for dentists.

BUSINESS STRATEGY

The Company's strategy is to develop integrated networks for the provision of
a broad range of dental services through practice affiliations and development
of DE NOVO dental centers that provide high-quality, cost-effective dental care
in target markets. Key elements of this strategy are to:

PROVIDE HIGH-QUALITY, COMPREHENSIVE, ONE-STOP FAMILY DENTAL HEALTH CARE. The
prototypical Castle Dental Center provides general dentistry as well as a full
range of dental specialties (including orthodontics, pedodontics, periodontics,
endodontics, oral surgery and implantology), thereby allowing the majority of
specialty referrals to remain in-house within the Company's network of
facilities. By bringing together multi-specialty dental services within a single
practice, the Company is able to realize operating efficiencies and economies of
scale and to promote increased productivity, higher utilization of professionals
and facilities, and the sharing of dental specialists among multiple locations.
The Company's practice model also incorporates quality assurance and quality
control programs, including peer review and continuing education and technique
enhancement. The Company believes that its multi-specialty strategy
significantly differentiates it from both individual and multi-center practices
that typically offer only general dentistry, orthodontics or other single
specialty dental services.

DEVELOP COMPREHENSIVE DENTAL NETWORKS IN TARGET MARKETS. The Company intends
to build its networks through acquisition of existing practices and DE NOVO
development of additional practices within target markets. The Company seeks to
consolidate and integrate its affiliated practices to establish regional dental
care networks. The Company believes this network system will enable it to reduce
the operating costs of its affiliated practices by centralizing certain
functions such as telemarketing and advertising, billing and collections,
payroll and accounting and by negotiating regional and national contracts for
supplies, equipment, services and insurance. Once practice affiliations are
established in a market, the Company seeks to assist the affiliated practices in
expanding their range of services to make available specialty dental services
not previously offered.

APPLY TRADITIONAL RETAIL PRINCIPLES OF BUSINESS TO DENTAL CARE. The Company
believes it can enhance revenues and profitability by applying traditional
retail principles of business to the provision of dental services in its target
markets. These principles include professionally produced broadcast and print
advertisements targeting specific audiences, and extended hours of operation
which are convenient for patients, including weekend and evening hours. As part
of its retail-oriented strategy, the Company seeks to establish or, where
appropriate, relocate each Castle Dental Center in a convenient location in or
near a high-profile neighborhood retail area and utilizes innovative sales and
marketing programs designed to create strong name recognition and increase
patient visits. In addition, the Company stresses the breadth and affordability
of its services and works closely with patients to establish treatment schedules
and affordable payment plans tailored to the patients' needs.

MARKET ITS NETWORKS TO MANAGED CARE ENTITIES. The Company believes that
managed care will play an increasing role in the provision of dental services
and therefore intends to market the services of its dental practice networks to
the managed care community. The Company believes that contracting with managed
care entities will facilitate entry into new markets and the expansion of
existing networks, as well as improve the utilization of existing facilities by
providing a source of patients to dentists with whom the Company is affiliated.
In addition, such contracts, including capitated contracts, enable the Company
to leverage its infrastructure and marketing efforts by increasing patient
visits.

DENTAL NETWORK DEVELOPMENT

The Company seeks to build its dental networks through the acquisition of
existing dental practices and the DE NOVO development of dental practices in
retail environments. The Company typically has expanded into new markets through
the acquisition of multi-location group dental practices. Once the market entry

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acquisition has been made, the Company intends to expand within its target
markets primarily through the DE NOVO development of new dental centers.

ACQUISITION CRITERIA

The Company's acquisition strategy is to identify successful dental
management companies and dental practices in its target markets, acquire certain
assets of the identified practices, enter into long-term management services
agreements, and utilize these core practices as a base from which to expand
within the target markets. Prior to entering any market, the Company considers
such factors as population, demographics, market potential, competitive
environment, supply of available dentists, dental regulatory environment,
patient-provider ratios, advertising costs and the economic condition of the
local market. Core acquisition candidates are successful group dental practices
that the Company believes are leaders in their regional markets. Subsequent
acquisitions target practices that strategically complement the core practices
within a market. In considering acquisitions, the Company evaluates qualitative
issues such as the dental professionals' qualifications, experience and
reputation in the local marketplace and their operating histories, as well as
the ability to demonstrate potential for revenue growth and continued
profitability.

1998 ACQUISITIONS

The following table describes acquisitions completed during the year ended
December 31, 1998:
<TABLE>
<CAPTION>

NUMBER
NUMBER OF
OF AFFILIATED
ACQUIRED ENTITY PRINCIPAL LOCATIONS CENTERS DENTISTS*
--------------- ------------------- ------- ----------
<S> <C> <C>
Dental World, Inc....................... Houston, Texas 6 12
Dental Consulting Services LLC.......... Los Angeles, California 5 25
Dentcor, Inc./ Woolf & Associates P.A... Sarasota and Ft. Lauderdale, Florida 5 12
SMF Dental Management, Inc.............. Torrance, California 2 2
NA Dental Management, Inc............... Canoga Park, California 1 1
Dental Centers of America, Inc.......... San Antonio, Austin, 16 35
Dallas/Ft. Worth, Texas
Crenshaw Family Dental Center.......... Los Angeles, California 1 2
</TABLE>

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* Includes full-time and part-time dentists.

The contractual arrangements pursuant to which the Completed Acquisitions
were made include representations and warranties from the sellers regarding the
assets or stock being acquired, and management services agreements with the
affiliated practices containing non-competition provisions with the former
owners of such practices. Additionally, where applicable, the Company typically
enters into an option agreement with the owner of the affiliated dental practice
that entitles the Company to select successor owners of the affiliated dental
practice. Dental World, Inc., Dental Consulting Services LLC, Dentcor, Inc. and
Dental Centers of America, Inc. were practice management companies affiliated
with one or more dental practices. In these acquisitions, the Company acquired
the assets or stock of the practice management company and either entered into
new management services agreements with the affiliated dental practices or
assigned the dentist employment agreements and other contractual obligations to
an affiliated dental practice with which the Company has an existing management
services agreement.

AFFILIATION AND INTEGRATION OF DENTAL CENTERS

In acquiring dental practice management companies and affiliating with dental
practices, the Company typically: (i) acquires certain assets of the practice,
and, in certain situations, laboratory or other ancillary facilities that are
either owned by or affiliated with such practice as allowable by federal and
state law; (ii) enters into a long-term management services agreement with such
dental practice pursuant to which the Company provides comprehensive management
services to the affiliated practice; (iii) requires that the affiliated dentists
enter into employment agreements with the affiliated practices containing
non-compete and liquidated damages provisions; and (iv) assumes the principal
administrative, financial, marketing and general

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management functions of the affiliated practice, including employment of most
administrative personnel. As soon as practicable following the acquisition of an
affiliated dental practice, when market conditions permit, the Company initiates
the process of converting the affiliated practice into a Castle Dental Center.
This conversion process, the implementation and timing of which will vary from
market to market, typically includes the addition of specialty dental services
not previously offered by the practice, implementation of retail business
concepts applied by the Company, and the implementation of operating procedures
employed by the Company, including standardization of dental practice
management, accounting and financial software.

DE NOVO DEVELOPMENT

During 1998, the Company opened nine newly developed dental centers, four in
Houston, two in Austin, two in Dallas/Fort Worth and one in Nashville,
Tennessee. Also, during the year, the Company closed one facility in Fort Worth
and moved its patients to a nearby Company-owned dental center and relocated one
dental center in Houston. All of the new centers were located in leased
facilities in neighborhood retail shopping centers areas. Development of DE NOVO
dental centers costs approximately $300,000 in leasehold improvements, signage,
and dental and office equipment, depending primarily on the size of the dental
facility. All new dental centers in the Company's existing markets utilize the
Castle Dental Centers name and logo.

At December 31, 1998, the Company had seven DE NOVO dental centers under
various stages of development in all of the Company's existing markets, except
for California. In addition, several potential leases were under active
negotiation and, if successfully concluded, will result in additional dental
center openings in 1999. The Company is expanding its development of DE NOVO
dental centers in existing markets because management believes that opening of
new dental centers that conform to the Company's operating model is more
effective in creating brand awareness and increasing market share in existing
markets than acquiring dental practices that have different operating
characteristics.

MANAGEMENT SERVICES AGREEMENT

The Company has entered into a management services agreement with each of its
affiliated dental practices pursuant to which the Company becomes the exclusive
manager and administrator of all non-dental services relating to the operation
of the practice. The Company anticipates that it will enter into a similar
management services agreement with each new affiliated dental practice. The
amount of the management fee charged by the Company to an affiliated dental
practice is intended to reflect and is based on the fair value of the management
services rendered by the Company to the affiliated dental practice. Subject to
applicable law, the Company is paid a monthly management fee comprised of three
components: (i) the costs incurred by it on behalf of the affiliated practice;
(ii) a base management fee in an amount ranging from 12.5% to 15.0% of adjusted
gross revenues; and (iii) a performance fee equal to the patient revenues of the
affiliated dental practice less (a) the expenses of the affiliated dental
practice and (b) the sum of (i) and (ii), as described in each agreement. In
California, the Company is paid a monthly management fee comprised of two
components: (i) the costs incurred by it on behalf of the affiliated practice
and (ii) a management fee in an amount ranging from 15.0% to 30.0% of net
patient revenues. With respect to the three California professional corporations
that own dental practices formerly managed by DCS, (i) the first $2,500 per
month of patient revenues is excluded from the calculation of the management fee
and (ii) Company is paid a bonus equal to 30% of patient revenues in excess
average monthly patient revenues over the prior two-year period. The amount of
the management fee is reviewed by the Company and the affiliated dental practice
not less frequently than annually in order to determine whether such fee should
be adjusted, up or down, to continue to reflect the fair value of the management
services rendered by the Company.

The obligations of the Company under its management services agreements
include assuming financial and other responsibility, either on its own or with
the input and participation of the policy board of the affiliated practice, for
the following (subject to limitations imposed by applicable state law):
facilities, equipment and supplies; advertising, marketing and sales; training
and development; operations management; provision of support services; risk
management and utilization review; application and maintenance of applicable
local licenses and permits; negotiation of contracts between the affiliated
dental practice and third parties, including third-party payors, alternative
delivery systems and purchasers of group health care services; establishing and
maintaining billing and collection policies and procedures; fiscal matters, such
as annual
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budgeting, maintaining financial and accounting records, and arranging for the
preparation of tax returns; and maintaining insurance. The Company does not
assume any authority, responsibility, supervision or control over the provision
of dental services to patients or for diagnosis, treatment, procedure or other
health care services, or the administration of any drugs used in connection with
any dental practice.

The typical management services agreement is for an initial term of 25 to 40
years, and is automatically renewed for successive five-year terms unless
terminated at least 90 days before the end of the initial term or any renewal
term. As part of the management services agreement, the Company requires that
the majority shareholder of the affiliated dental practice execute an option
agreement that grants the Company's designee the right to acquire all the
shareholder's interest in the practice at a nominal cost. The Company can
exercise the option at any time on 10 days written notice. The Company may
nominate without restriction any licensed dentist as its designee and may
transfer the option at any time to any qualified person, subject to applicable
state regulations governing the practice of dentistry. The management services
agreement does not limit the number of times that the option may be exercised.
At December 31, 1998, all of the Company's affiliated dental practices were
wholly-owned by an individual dentist. Additionally, the management services
agreement may be terminated by the Company or the affiliated dental practice
only in the event of the bankruptcy or default in the performance of the
material duties of the non-terminating party.

DENTIST EMPLOYMENT AGREEMENTS

As a part of the process of converting an affiliated dental practice into a
Castle Dental Center, each affiliated dental practice has entered into
employment agreements with substantially all of its full-time dentists,
orthodontists and other dental specialists. Although the form of contract varies
somewhat among practices and among dentists with different specialties, the
typical contract for a full-time dentist provides for a defined compensation
arrangement, including performance-based compensation and, where market
conditions permit and to the extent deemed enforceable under applicable law, a
covenant not to compete. Each full-time dentist, whether or not a party to a
dentist employment agreement, is required to maintain professional liability
insurance, and mandated coverage limits are generally at least $1.0 million per
claim and $3.0 million in the aggregate. In addition, many affiliated dental
practices employ part-time dentists. Not all part-time dentists have employment
agreements, but all part-time dentists are required to carry professional
liability insurance in specified amounts. Certain part-time dentists retained by
some of the affiliated dental practices are independent contractors and have
entered into independent contractor agreements.

SERVICES

The Company provides management expertise, marketing, information systems,
capital resources and acquisition services to its affiliated dental practices.
As a result, the Company is involved in the financial and administrative
management of the affiliated dental practices, including legal, financial
reporting, cash management, human resources and insurance assistance. The
Company's goals in providing such services are (i) to allow the dentists
associated with affiliated dental practices to dedicate their time and efforts
more fully to patient care and professional practice activities; (ii) to improve
the performance of affiliated dental practices in these administrative and sales
activities; and (iii) to enhance the financial return to the Company.

Aside from the centralization of functions mentioned above, the affiliated
dental practices are encouraged to administer their practices in accordance with
the needs of their specific patient populations. The practice of dentistry at
each affiliated dental practice is under the exclusive control of the dentists
who practice at such location.

The majority of services provided by the Company affiliated dental services
are classified as general dentistry. General dentistry includes diagnostics,
treatment planning, preventive care, removal of infection, fillings, crowns,
bridges, partials, dentures, and extractions, all of which are currently being
provided by the affiliated dental practices. Within its networks, the Company
provides a wide range of specialty dental services. The Company seeks to expand
the services offered by affiliated practices beyond general dentistry to include
other dental specialty services and to improve efficiency by improving
appointment availability, increasing practice visibility and assisting the
practices in adding complementary services. These complementary services include
orthodontics, periodontics (the diagnosis, treatment and prevention of infection
of the gums and supporting bone around the teeth), endodontics (the diagnosis,
treatment and
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prevention of infection of the oral tissues), oral surgery and implantology (the
placement of abutments (implants) in the jaw bones to support tooth
replacement). By adding these complementary services to the practice, the
affiliated dental practices will retain the majority of specialty service
referrals in-house, thereby increasing patient revenues.

OPERATIONS

CENTER DESIGN AND LOCATION

The Company's dental centers are generally located in retail environments.
Many of the dental centers include semi-private general dentistry treatment
rooms, private treatment rooms and orthodontic bays. Currently, the Company's
dental centers include from four to 22 treatment rooms and range in size from
approximately 1,000 square feet to approximately 6,000 square feet. New dental
centers, developed by the Company, range in size from 1,600 square feet to 4,000
square feet, and have from five to fourteen operatories.

Since its formation, the Company has adapted its locations to accommodate
the full range of dental specialties. The Company believes the application of
its method of designing and locating dental centers will facilitate the
expansion of services offered by the acquired practices. Where a dental center
is not able, due to limitations of floor space, zoning or other reasons, to
accommodate new services or specialists, the Company may seek to relocate such
dental center to a more desirable retail location as soon as practicable.

STAFFING AND SCHEDULING

The Company believes that making its facilities available at times which are
convenient to its patients is an important element of its strategy. As a result,
the affiliated dental practices maintain extended hours of operation, with many
dental centers opening as early as 7:00 a.m. and closing as late as 9:00 p.m. on
weekdays and 5:00 p.m. on Saturdays and Sundays. The dental centers are staffed
with dentists and dental assistants every day they are open, with orthodontists
and other specialists rotating among several centers in order to utilize their
time optimally. Each patient typically is assigned to and sees the same dentist
or specialist on all visits to the center. Each dental center is also regularly
staffed with an office manager, front office staff and other support staff.

FEES AND PAYMENT PLANS

The Company believes that fees charged by its affiliated practices are
typically lower than usual and customary fees within their respective markets.
The affiliated practices generally provide a wide range of payment options,
including cash, checks, credit cards, third party insurance and various forms of
credit. In general, most general dentistry and specialty services, other than
orthodontics, are paid for by the patient, or billed to the patient's insurance
carrier, on the date the service is rendered. In some instances, the Company
will extend credit in accordance with its established credit policies. The
Company believes that its lower fees and ability to assist patients in obtaining
financing provides it with a competitive advantage compared to sole
practitioners and small group practices.

The Company's typical orthodontic payment plan consists of no initial down
payment and equal monthly payments during the term of treatment ranging from $88
to $98 per month, with an average contract period of approximately 24 months.
After consultation with the orthodontic staff at the initial visit, the patient
signs a contract outlining the terms of the treatment, including the anticipated
length of treatment and the total fees. The number of required monthly payments
is fixed at the beginning of the case and corresponds to the anticipated number
of monthly treatments. Patients are billed in advance by the Company on a
monthly basis.

QUALITY ASSURANCE

Affiliated dental practices are solely responsible for all aspects of the
practice of dentistry. The Company has responsibility for the business and
administrative aspects of the practices and exercises no control over the
provision of dental services. The Company's management structure is designed to
bring to its affiliated dental practices improvements in their recruiting and
professional training. The Company expects that the increased visibility of the
Company, the ability to offer career paths previously unavailable to dentists
and the ability to recruit for multiple markets will give it an advantage in
recruiting and retaining dentists. In addition, the Company believes that the
ability to offer dentists in private practice the chance to practice in an
environment
7

<PAGE>
where they do not assume capital risks and administrative burdens normally
associated with private practice will make joining the Company an attractive
choice for private practitioners.

Most affiliated dental practices have policy boards comprised of
representatives of both the Company and the affiliated dental practice. The
policy boards are responsible for developing and implementing management and
administrative policies for the overall operation of the affiliated dental
practice. Specifically, the policy board has the authority to review and approve
capital improvements and expansion, marketing and advertising, collection
policies, provider and payer relationships, strategic planning and capital
expenditures. However, in recognition of the laws and regulations applicable to
the licensure and practice of dentistry, the policy board does not make clinical
decisions, recommendations or other decisions that are required to be made by a
licensed dentist.

SALES AND MARKETING

The Company intends to establish a consistent national identity for its
business and to utilize the "Castle Dental Centers" name and logo. When acquired
practices already have high existing name recognition within their local
markets, the Company may seek to capitalize on that name recognition and
implement the Castle Dental Centers name over an extended period of time. The
Company intends to change the name of all its presently affiliated dental
practices to a common name subject to applicable laws and regulations of the
jurisdictions in which they are located. The Company applies traditional retail
principles of business to the provision of dental care. These principles include
network development, extended hours of operation, location optimization,
signage, customized treatment schedules, affordable fees and payment plans. The
Company uses both print advertising and professionally produced broadcast
advertising to market its dental services to potential patients its existing
markets and intends to use the same marketing techniques in newly acquired
markets.

The Company has also established a national telemarketing system in Houston,
Texas to field calls generated by advertising, to confirm upcoming scheduled
patient visits and to encourage patients to return for follow-up visits and
regularly scheduled six-month periodic exams. The national telemarketing system
is based on a national 800 number (1-800-TO SMILE) and utilizes state-of-the-art
software to identify patients and direct them to the nearest Company operated
dental center. This system, presently utilized in Houston, Austin, Dallas/Fort
Worth, Tennessee and Florida, will be in use in all of the Company's markets by
July 1999. The telemarketers can enter all relevant information into the
Company's management information system for patients making appointments for an
initial visit, including pre-screening patients for insurance and other credit
information.

MANAGED CARE CONTRACTS

The Company negotiates, on behalf of its affiliated dental practices,
contracts with dental healthcare maintenance organizations, insurance companies,
self insurance plans and other third-party payers pursuant to which services are
provided on some type of discounted fee-for-service or capitated basis. Under
capitated contracts the affiliated dental practice receives a predetermined
amount per patient per month in exchange for providing certain necessary covered
services to members of the plan. Usually, the capitated plans also provide for
supplemental payments and/or co-payments by members for certain higher cost
procedures such as crowns, root canal therapy and dentures. These contracts
typically result in lower average fees for services than the usual and customary
fees charges by the Company's affiliated dental practices and may, in certain
instances, expose the Company to losses on contracts where the total revenues
received are less than the costs of providing such dental care. The Company
generally bears the risk of such loss because it consolidates the financial
results of its affiliated dental practices. However, most of these contracts are
cancelable by either party on 30 to 90 days written notice thereby reducing the
risk of long-term adverse impact on the Company.

8
<PAGE>
periodically evaluates its capitated managed care contracts by comparing the
average reimbursement per procedure plus the total capitation fees per contract
to the usual and customary fees charged by the affiliated dental practice. If
the aggregate reimbursement percentage for the capitated contract exceeds 55% of
the usual and customary fees, the Company believes that the incremental costs of
providing covered services are being recovered. Management believes that
capitated managed care contracts, in the aggregate, are profitable and will
continue to increase as a percentage of total patient revenues in the future.

A component of the Company's strategy is to seek long-term relationships
with insurance companies on a regional and national basis. The development of
new dental centers and expanded networks of dentists and dental specialists in
the Company's markets makes the Company's dental networks attractive to
insurance companies and other third-party payers. Management believes that
negotiating with major dental healthcare providers on a national basis will
result in better coordination and improved financial results from its managed
care contracts.

COMPETITION

The dental care industry is highly fragmented, comprised principally of sole
practitioners and group practices of dental and orthodontic services. The dental
practice management industry is subject to continuing changes in the provision
of services and the selection and compensation of providers. The Company is
aware of several dental practice management companies, both publicly-traded and
privately owned, that are acquiring and managing dental practices. Publicly
Traded dental practice management companies that compete with the Company
include Monarch Dental Corporation, American Dental Partners, Inc., Interdent,
Inc., and Coast Dental Services, Inc., as well as others. Certain of the
Company's competitors are larger and better capitalized, may provide a wider
variety of services, may have greater experience in providing dental care
management services and may have longer established relationships with buyers of
such services. The existence of other dental practice management companies may
also increase competition for acquisition candidates, thereby increasing amounts
that must be paid for acquired practice management businesses.

In certain markets, the demand for dental care professional personnel
presently exceeds the supply of qualified personnel. As a result, the Company
experiences competitive pressures for the recruitment and retention of qualified
dentists to deliver their services. The Company's future success depends in part
on its ability to continue to recruit and retain qualified dentists to serve as
employees or independent contractors of the affiliated dental practices. There
can be no assurance that the Company will be able to recruit or retain a
sufficient number of competent dentists to continue to expand its operations.

MANAGEMENT INFORMATION SYSTEMS

At December 31, 1998, the Company and its affiliated dental practices
utilized two dental practice management software systems to monitor and control
patient treatment, scheduling, invoicing of patients and insurance companies,
productivity of clinical staffs and other practice related activities. The
Company is integrating the dental practice management systems in all of its
offices into a single practice management system that is centralized in Houston.
This system will permit the standardization of practice management policies and
procedures in all of the Company's dental centers and affiliated dental
practices. During 1998, the Company implemented common client-server based
financial management and payroll systems throughout all of its dental centers
and regional offices designed to enable the Company to compare financial
performance of its affiliated dental practices, to track and control costs, and
to facilitate the accounting and financial reporting process. The Company
intends to standardize its financial information and practice management systems
in all of its existing and newly acquired dental practices as soon as is
feasible.

REGULATION GENERAL

The practice of dentistry is highly regulated, and there can be no assurance
that the regulatory environment in which the affiliated dental practices and the
Company operate will not change significantly in the future. In general,
regulation of health care related companies also is increasing.

Every state imposes licensing and other requirements on individual dentists and
dental facilities and
9

<PAGE>
services. In addition, federal and state laws regulate health maintenance
organizations and other managed care organizations for which dentists may be
providers. In connection with its operations in existing markets and expansion
into new markets, the Company may become subject to compliance with additional
laws, regulations and interpretations or enforcement thereof. The ability of the
Company to operate profitably will depend in part upon the Company and its
affiliated dental practices obtaining and maintaining all necessary licenses,
certifications and other approvals and operating in compliance with applicable
health care regulations.

Dental practices must meet federal, state and local regulatory standards in
the areas of safety and health. Historically, those standards have not had any
material adverse effect on the operations of the dental practices managed by the
Company. Based on its familiarity with the operations of the dental practices
managed by the Company, management believes that it, and the practices it
manages, are in compliance in all material respects with all applicable federal,
state and local laws and regulations relating to safety and health.

MEDICARE AND MEDICAID FRAUD AND ABUSE

Federal law prohibits the offer, payment, solicitation or receipt of any
form of remuneration in return for, or in order to induce, (i) the referral of a
person for services, (ii) the furnishing or arranging for the furnishing of
items or services or (iii) the purchase, lease or order or arranging or
recommending purchasing, leasing or ordering of any item or service, in each
case, reimbursable under Medicare or Medicaid. Because dental services are
covered under various government programs, including Medicare, Medicaid or other
federal and state programs, the law applies to dentists and the provision of
dental services. Pursuant to this anti-kickback law, the federal government
announced a policy of increased scrutiny of joint ventures and other
transactions among health care providers in an effort to reduce potential fraud
and abuse related to Medicare and Medicaid costs. Many states have similar
anti-kickback laws, and in many cases these laws apply to all types of patients,
not just Medicare and Medicaid beneficiaries. The applicability of these federal
and state laws to many business transactions in the health care industry,
including the Company's operations, has not yet been subject to judicial
interpretation.

Significant prohibitions against physician self-referrals, including those
by dentists, for services covered by Medicare and Medicaid programs were
enacted, subject to certain exceptions, by Congress in the Omnibus Budget
Reconciliation Act of 1993. These prohibitions, commonly known as "Stark II,"
amended prior physician and dentist self-referral legislation known as "Stark I"
(which applied only to clinical laboratory referrals) by dramatically enlarging
the list of services and investment interests to which the referral prohibitions
apply. Effective January 1, 1995 and subject to certain exceptions, Stark II
prohibits a physician or dentist or a member of his immediate family from
referring Medicare or Medicaid patients to any entity providing "designated
health services" in which the physician or dentist has an ownership or
investment interest, or with which the physician or dentist has entered into a
compensation arrangement, including the physician's or dentist's own group
practice unless such practice satisfies the "group practice" exception. The
designated health services include the provision of clinical laboratory
services, radiology and other diagnostic services (including ultrasound
services), radiation therapy services, physical and occupational therapy
services, durable medical equipment, parenteral and enteral nutrients, certain
equipment and supplies, prosthetics, orthotics, outpatient prescription drugs,
home health services and inpatient and outpatient hospital services. A number of
states also have laws that prohibit referrals for certain services such as
x-rays by dentists if the dentist has certain enumerated financial relationships
with the entity receiving the referral, unless an exception applies.

Noncompliance with, or violation of, the federal anti-kickback legislation
or Stark II can result in exclusion from Medicare and Medicaid as well as civil
and criminal penalties. Similar penalties are provided for violation of state
anti-kickback and self-referral laws. To the extent that the Company or any
affiliated dental practice is deemed to be subject to these federal or similar
state laws, the Company believes its intended activities will comply in all
material respects with such statutes and regulations.

STATE LEGISLATION

In addition to the anti-kickback laws and anti-referral laws noted above,
the laws of many states prohibit dentists from splitting fees with non-dentists
and prohibit non-dental entities such as the Company from engaging in the
practice of dentistry and from employing dentists to practice dentistry. The
specific restrictions
10
<PAGE>
against the corporate practice of dentistry, as well as the interpretation of
those restrictions by state regulatory authorities, vary from state to state.
However, the restrictions are generally designed to prohibit a non-dental entity
from controlling the professional assets of a dental practice (such as patient
records, payer contracts and, in certain states, dental equipment), employing
dentists to practice dentistry (or, in certain states, employing dental
hygienists or dental assistants), controlling the content of a dentist's
advertising or professional practice or sharing professional fees. The laws of
many states also prohibit dental practitioners from paying any portion of fees
received for dental services in consideration for the referral of a patient. In
addition, many states impose limits on the tasks that may be delegated by
dentists to dental assistants.

State dental boards do not generally interpret these prohibitions as
preventing a non-dental entity from owning non-professional assets used by a
dentist in a dental practice or providing management services to a dentist
provided that the following conditions are met: a licensed dentist has complete
control and custody over the professional assets; the non-dental entity does not
employ or control the dentists (or, in some states, dental hygienists or dental
assistants); all dental services are provided by a licensed dentist; licensed
dentists have control over the manner in which dental care is provided and all
decisions affecting the provision of dental care. State laws generally require
that the amount of a management fee be reflective of the fair market value of
the services provided by the management company and certain states require that
any management fee be a flat fee or cost-plus fee based on the cost of services
performed by the Company. In general, the state dental practice acts do not
address or provide any restrictions concerning the manner in which companies
account for revenues from a dental practice subject to the above-noted
restrictions relating to control over the professional activities of the dental
practice, ownership of the professional assets of a dental practice and payments
for management services.

The Company does not control the practice of dentistry or employ dentists to
practice dentistry. Moreover, in states in which it is prohibited the Company
does not employ dental hygienists or dental assistants. The Company provides
management services to its affiliated practices, and the management fees the
Company charges for those services are consistent with the laws and regulations
of the jurisdictions in which it operates.

In addition, there are certain regulatory risks associated with the
Company's role in negotiating and administering managed care and capitation
contracts. The application of state insurance laws to reimbursement arrangements
other than various types of fee-for-service arrangements is an unsettled area of
law and is subject to interpretation by regulators with broad discretion. As the
Company or its affiliated practices contract with third-party payors, including
self-insured plans, for certain non-fee-for-service basis arrangements, the
Company or the affiliated dental practices may become subject to state insurance
laws. In the event that the Company or the affiliated practices are determined
to be engaged in the business of insurance, these parties could be required
either to seek licensure as an insurance company or to change the form of their
relationships with third-party payors, and may become subject to regulatory
enforcement actions. In such events, the Company's revenues may be adversely
affected.

REGULATORY COMPLIANCE

The Company regularly monitors developments in laws and regulations relating
to dentistry. The Company may be required to modify its agreements, operations
or marketing from time to time in response to changes in the business, statutory
and regulatory environments. The Company plans to structure all of its
agreements, operations and marketing in compliance with applicable law, although
there can be no assurance that its arrangements will not be successfully
challenged or that required changes may not have a material adverse effect on
operations or profitability.

EMPLOYEES

As of December 31, 1998, the Company and its affiliated dental practices
employed approximately 1,220 administrative and dental office personnel on a
full-time or part-time basis, and the affiliated dental practices employed
approximately 190 general dentists and 30 specialists on a full-time or
part-time basis. As a component of its acquisition strategy, the Company
frequently enters into employment or consulting agreements for ongoing
management and administrative services with the dentists from whom it acquires
affiliated practices. The Company believes that its relations with its employees
are good. The Company believes that it may need to hire additional personnel to
accommodate the demands prompted by the provision

11
<PAGE>
of services to each of the affiliated practices under the management services
agreements, as well as to pursue its growth strategies.

CORPORATE LIABILITY AND INSURANCE

The provision of dental services entails an inherent risk of professional
malpractice and other similar claims. Although the Company does not influence or
control the practice of dentistry by dentists or have responsibility for
compliance with certain regulatory and other requirements directly applicable to
dentists and dental groups, the contractual relationship between the Company and
the affiliated dental practices may subject the Company to some medical
malpractice actions under various theories, including successor liability. There
can be no assurance that claims, suits or complaints relating to services and
products provided by managed practices will not be asserted against the Company
in the future. The availability and cost of professional liability insurance has
been affected by various factors, many of which are beyond the control of the
Company. Significant increases in the cost of such insurance to the Company and
its affiliated dental practices may have an adverse effect on the Company's
operations.

The Company requires each affiliated dental practice to maintain
comprehensive general liability and professional liability coverage covering the
practice and each dentist retained or employed by the affiliated dental
practice, which normally provide for comprehensive general liability coverage of
$1.0 million for each occurrence and $3.0 million annual aggregate, and
professional liability coverage of not less than $1.0 million for each
occurrence and $3.0 million annual aggregate.

The Company maintains other insurance coverages including general liability,
property, business interruption and workers' compensation, which management
considers to be adequate for the size of the Company and the nature of its
business.

ITEM 2. PROPERTIES

The Company leases approximately 12,000 square feet of space for executive,
administrative, sales and marketing and operations offices in Houston, Texas.
The Company's initial lease term expires May 2000, which may be extended at the
Company's option for an additional 60 months.

All of the Company's existing centers are leased. Five of the centers are
owned by affiliates of the companies from whom the Company acquired affiliated
dental practices and one dental center is owned by an officer of the Company.

The Company intends to lease centers or enter into build-to-suit
arrangements with third parties for dental centers to be leased by the Company.
Certain leases provide for fixed minimum rentals and provide for additional
rental payments for common area maintenance, insurance and taxes. The leases
carry varying terms expiring between 1999 and 2009 excluding options to renew.

The majority of the centers are located in retail locations. The Company
believes that its leased facilities are well maintained, in good condition and
adequate for its current needs. Furthermore, the Company believes that suitable
additional or replacement space will be available when required.

ITEM 3. LEGAL PROCEEDINGS

In August 1998, the former owner of certain dental practices acquired by the
Company in August 1996, filed a lawsuit against the Company in the 190th
District Court of Harris Count, Texas. The lawsuit alleges that the Company
committed various acts of fraud, securities fraud, conspiracy, breach of
contract and misrepresentation concerning the value of the Company's common
stock issued in the acquisition of the dental practices. The lawsuit seeks
damages and exemplary damages in the amount of $11 million. The Company believes
that the asserted claims are without merit and intends to defend itself
vigorously. In the opinion of management, resolution of these claims will not
have a material adverse effect on the Company's financial position, results of
operations or cash flows.

12
<PAGE>
contingencies required for closing was not met. The dentist is claiming damages
equal to the difference between the purchase price provided for in the agreement
of $6.5 million and the fair market value of the practice. The Company believes
that the asserted claims are without merit and that it is not liable for damages
resulting from these allegations. In the opinion of management, resolution of
these claims will not have a material adverse effect on the Company's financial
position, results of operations or cash flows.

The Company and certain of its subsidiaries are parties to a number of legal
proceedings that have arisen in the ordinary course of business. While the
outcome of these proceedings cannot be predicted with certainty, management does
not expect these matters to have a material adverse effect on the Company.

The Company carries insurance with coverage and coverage limits that it
believes to be customary in the dental industry. Although there can be no
assurance that such insurance will be sufficient to protect the Company against
all contingencies, management believes that its insurance protection is
reasonable in view of the nature and scope of the Company's operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

13
<PAGE>
PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock is traded in the over-the-counter market and
quoted on the Nasdaq National Market under the symbol "CASL." The following
table presents the quarterly high and low sale prices as reported by the Nasdaq
National Market since the shares became publicly traded on September 12, 1997.
These quotations reflect the inter-dealer prices, without retail mark-up,
markdown or commission and may not necessarily represent actual transactions.

1997: HIGH LOW

Third Quarter (beginning September 12, 1997)....... 14.75 13.00
Fourth Quarter..................................... 14.25 7.31

1998:

First Quarter..................................... 12.13 6.63
Second Quarter.................................... 13.44 9.25
Third Quarter..................................... 11.50 4.00
Fourth Quarter.................................... 9.25 4.00

As of March 15, 1999, there were 6,417,206 shares of the Company's Common
Stock outstanding held by approximately 42 stockholders of record. The Company
believes there are approximately 1,800 beneficial owners of the Common Stock.

The Company has never paid a cash dividend on its Common Stock. The Company
currently intends to retain earnings to finance the growth and development of
its business and does not anticipate paying any cash dividends on the Common
Stock in the foreseeable future. In addition, the Company's bank credit facility
permits the payment of dividends only to the extent the Company maintains a
specified minimum net worth. The Company's net worth as of December 31, 1998 was
approximately $36.4 million. Any future change in the Company's dividend policy
will be made at the discretion of the Company's Board of Directors in light of
the financial condition, capital requirements, earnings and prospects of the
Company and any restrictions under credit agreements, as well as other factors
the Board of Directors may deem relevant.

RECENT SALES OF UNREGISTERED SECURITIES

On March 24, 1998, in connection with the acquisition by the Company of all
of the outstanding capital stock of Dental World, Inc. ("Dental World"), the
Company issued 23,342 shares of common stock to Reality, Ltd., the sole
shareholder of Dental World.

On March 30, 1998, the Company, through its wholly owned subsidiary CDC of
California, Inc. ("CDC"), formed Castle Dental Centers of California, L.L.C.
("Castle West") for the purpose of acquiring the business of Dental Consulting
Services, LLC ("DCS"). In connection with this acquisition, the Company issued
an aggregate of $2,689,151 in its 8% subordinated promissory notes due March 30,
2001 to the five members of DCS ("DCS Members"). Following Castle West's
formation: (i) CDC owns the Class A Membership Interest and the Class D
Membership Interest in Castle West; (ii) sole-purpose corporations owned by the
DCS Members ("Corporate B Members") collectively own 100% of DCS, which owns the
Class B Membership Interest in Castle West; and (iii) sole-purpose corporations
(the "Corporate C Members") owned by the DCS Members plus one additional person
collectively own 100% of Castle West Holdings, L.L.C. ("Holdings"), which owns
the Class C Membership Interest in Castle West. The Corporate B Members as a
group were granted the one-time right (the "B Merger Option"), beginning March
30, 1999, to merge all of the Corporate B Members into CDC in exchange for the
issuance of shares of the Company's common stock. The number of shares of common
stock issuable upon exercise of the B Merger Option ("B Merger Consideration")
was initially set at 407,452 shares of common stock, subject to an adjustment
based upon the purchase price of
14
<PAGE>
practices acquired by Castle West between the closing of such transaction and
the one-year anniversary thereof. The Company estimates that 452,058 shares of
common stock are currently issuable as B Merger Consideration. Each Corporate C
Member was granted the one-time right (the "C Merger Option"), beginning March
30, 2000, to merge into CDC in exchange for cash, notes and common stock. The
consideration to be received upon the exercise of the C Merger Option ("C Merger
Consideration") is based upon the economic performance of Castle West following
the closing date of the DCS acquisition. At least 50% of the C Merger
Consideration is payable by CDC in common stock (based upon its trading price)
and, if a Corporate C Member elects to receive more than 25% of the C Merger
Consideration in cash, CDC will have the option of delivering a promissory note
of Castle for the amount by which such cash payment would otherwise exceed 25%
of the C Merger Consideration.

On July 9, 1998, in connection with the Company's acquisition of the assets
of Jared Woolf, D.D.S. & Associates of Palmetto, P.A., Jared Woolf, D.D.S. &
Associates of Venice, P.A. and Woolf Dentistry, P.A. ("Woolf Dentistry"), the
Company issued 15,424 shares of common stock to Woolf Dentistry. In connection
with this acquisition, the Company issued an aggregate of $370,000 in its 9%
subordinated promissory notes due July 9, 2001 to Woolf Dentistry. On that same
date, in connection with the Company's acquisition of the stock of Dentcor,
Inc., the Company issued an aggregate of 20,566 shares to the two shareholders
of Dentcor, Inc.

On August 1, 1998, in connection with the acquisition by the Company of all
of the outstanding capital stock of NA Dental Management, Inc., the Company
issued 3,635 shares of common stock and $32,580 in its 8% subordinated
promissory notes due June 30, 2000 to the sole shareholder of NA Dental
Management, Inc.

In September 1997, the Company issued 119,231 shares of Series B Convertible
Preferred Stock (the "Series B Stock") in connection with the acquisition of SW
Dental. The number of shares issued were equivalent to $1,550,000 divided by the
initial public offering price of the Company's common stock of $13.00 per share.
The Series B Stock was convertible at the holder's option, for a thirty-day
period beginning one year after its issuance into an equivalent number of shares
of the Company's common stock. On October 1, 1998, the holder of the 119,231
shares of Series B Preferred Stock exercised the right to redeem the shares into
an 8% subordinated note, due June 2002, in the original principal amount of
$1,550,000, payable in quarterly installments of $114,000 in principal and
interest.

On December 30, 1998, in connection with the Company's acquisition of the
assets of DCA Limited Partnership, L.L.P. ("DCA") and Dental Administrators of
Texas Limited Partnership, L.L.P. ("DAI") and 16 related dental practices, the
Company issued 79,352 and 45,648 shares of common stock to DCA and DAI,
respectively. In addition, in connection with such acquisition, the Company
issued to DCA and DAI an aggregate of $1,250,000 in 6% Subordinated Promissory
Notes due December 30, 2001.

Each of the foregoing transactions was exempt from registration under
Section 4(2) of the Securities Act, no public offering being involved.

15
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA

The selected financial data of the Company should be read in conjunction
with the related financial statements, notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere herein.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net patient revenues ......................... $ 17,083 $ 18,257 $29,601 $ 46,225 $ 74,823
Expenses:

Dentist salaries and other

professional costs .................... 2,853 3,345 7,454 11,325 18,516
Clinical salaries ......................... 1,811 1,879 6,760 10,248 16,612
Dental supplies and laboratory fees ....... 1,907 2,185 3,120 4,335 7,197
Rental and lease expense .................. 681 836 1,592 2,590 4,091
Advertising and marketing ................. 1,062 959 1,522 2,033 2,763
Depreciation and amortization ............. 309 336 1,088 2,132 3,615
Other operating expenses .................. 2,205 2,260 2,913 4,314 6,976
General and administrative(1) ............. 5,319 9,109 4,292 5,929 8,145
-------- -------- -------- -------- --------
Total expenses ......................... 16,147 20,909 28,741 42,906 67,915
-------- -------- -------- -------- --------
Operating income (loss) ...................... 936 (2,652) 860 3,319 6,908
Interest expense ............................. 112 87 2,596 2,792 1,889
Other income ................................. -- -- (89) (84) (57)
-------- -------- -------- -------- --------
Income (loss) before income taxes and ........

extraordinary loss ....................... 824 (2,739) (1,647) 611 5,076
Provision (benefit) for income taxes(2) ...... 43 (325) (561) 200 1,490
-------- -------- -------- --------
Income (loss) before extraordinary loss ...... 781 (2,414) (1,086) 411 3,586

Extraordinary loss ........................... -- -- -- (3,195) --
-------- -------- -------- --------
Net income (loss)(2) ......................... 781 (2,414) (1,086) (2,784) 3,586

Preferred stock dividends(3) ................. -- -- -- (1,930) --
-------- -------- -------- -------- --------
Net income (loss) attributable to
common stock ............................. $ 781 $ (2,414) $ (1,086) $ (4,714) $ 3,586
======== ======== ======== ======== ========

Income (loss) per common share:
Basic and diluted:

Income (loss) before extraordinary loss ... $ (0.34) $ 0.10 $ 0.54
Extraordinary loss ........................ -- (0.78) --
-------- -------- --------
Net income (loss) ......................... $ (0.34) $ (0.68) $ 0.54
======== ======== ========
Weighted average number of common and
common equivalent shares outstanding

Basic .................................. 3,191 4,100 6,586
======== ======== ========
Diluted ................................ 3,191 4,132 6,608
======== ======== ========
</TABLE>

16
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents .......... $ 22 $ 6,439 $ 119 $ 2,908 $ 695
Working capital (deficit) .......... 1,212 6,208 (3,244) 3,917 10,345

Total assets ....................... 4,711 12,677 29,098 44,513 100,035
Long-term debt, less current portion 162 9,462 20,529 3,659 44,937

Redeemable preferred stock ......... -- 2,928 2,928 1,550 --
Total stockholders' equity (deficit) 2,577 (5,743) (3509) 31,113 36,397
</TABLE>
------------
(1)In 1995, the Company expensed $2.6 million of deferred compensation in
connection with an acquisition.
(2)Prior to 1996, significant operations of the Company were conducted through
a subchapter S corporation and accordingly were not subject to federal and
state income taxes. If all of the Company's operations had been subject to
income taxes, net income (loss) would have been $515,000 and ($1.7 million)
for the years ended December 31, 1994 and 1995, respectively.
(3)The Company recorded a $1,930,000 non-cash dividend to accrete the Series A
Convertible Preferred Stock and the Series C Convertible Preferred Stock to
their estimated fair value.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

INTRODUCTION

The Company develops, manages and operates integrated dental networks through
contractual affiliations with general, orthodontic and multi-specialty dental
practices in Texas, Florida, Tennessee and California. The Company does not
engage in the practice of dentistry but rather establishes integrated dental
networks by entering into management services agreements with affiliated dental
practices to provide on an exclusive basis management and administrative
services to affiliated dental practices. The Company's strategy is to provide
high-quality care in selected markets with a view to achieving broad geographic
coverage within those markets. The Company seeks to achieve operating
efficiencies by consolidating and integrating affiliated practices into regional
networks, realizing economies of scale in such areas as marketing,
administration and purchasing and enhancing the revenues of its affiliated
dental practices by increasing both patient visits and the range of specialty
services offered. As of December 31, 1998, the Company provided management
services to 86 dental centers with approximately 220 affiliated dentists,
orthodontists and other dental specialists.

The Company's objective is to make each of its dental networks the leading
group dental care provider in each market it serves. The Company applies
traditional retail principles of business to the practice of dentistry,
including situating practices in high-profile locations, offering affordable
fees and payment plans, expanding the range of services offered, increasing
market share through targeted advertising and offering extended office hours. By
using the Castle Dental Centers' approach to managing affiliated dental
practices, the Company believes it will enable affiliated dentists,
orthodontists and other dental specialists to focus on delivering quality
patient care and to realize greater productivity than traditional retail and
small group dental practices.

Certain of the affiliated dental practices derive a significant portion of
their revenues from managed care contracts, preferred provider arrangements and
other negotiated price agreements. While the Company generally negotiates the
terms and conditions of managed care contracts, preferred provider arrangements
and other negotiated price agreements, the affiliated dental practices are the
contracting parties for all such relationships, and the Company is dependent on
its affiliated dental practices for the success of such relationships. The
Company generally bears the risk of such loss because it consolidates the
financial results of its affiliated dental practices. However, most of these
contracts are cancelable by either party on 30 to 90 days written notice thereby
reducing the risk of long-term adverse impact on the Company.

At December 31, 1998, the Company and its affiliated dental practices
maintained an aggregate of 72 capitated managed care contracts covering
approximately 115,000 members. Capitation fees, excluding supplemental fees and
co-payments by members, totaled $5.1 million, or approximately 6.9% of total
patient
17
<PAGE>
revenues in 1998. No single contract amounted to a significant portion of the
Company's revenues, as each of the Company's regional operations contract
separately with managed care providers. The Company periodically evaluates its
capitated managed care contracts by comparing the average reimbursement per
procedure plus the total capitation fees per contract to the usual and customary
fees charged by the affiliated dental practice. If the aggregate reimbursement
percentage for the capitated contract exceeds 55% of the usual and customary
fees, the Company believes that the incremental costs of providing covered
services are being recovered. Management believes that capitated managed care
contracts, in the aggregate, are profitable and will continue to contract with
capitated managed care providers on a case-by-case basis.

COMPONENTS OF REVENUES AND EXPENSES

Net patient revenues represent amounts billed by the affiliated dental
practices to patients and third-party payors for dental services rendered. Such
amounts also include monthly capitation payments received from third-party
payors pursuant to managed care contracts. Net revenues are reported at
established rates reduced by contractual amounts based on agreements with
patients, third party payers and others obligated to pay for services rendered.

Under the terms of the typical management services agreement with an
affiliated dental practice, the Company becomes the exclusive manager and
administrator of all non-dental services relating to the operation of the
practice. While actual terms of the various management agreements may vary from
practice to practice, material aspects of all the management service agreements,
including the ability of the Company to nominate the majority shareholder and
the calculation of the management fees, are consistent. The obligations of the
Company include assuming responsibility for the operating expenses incurred in
connection with managing the dental centers. These expenses include salaries,
wages and related costs of non-dental personnel, dental supplies and laboratory
fees, rental and lease expenses, advertising and marketing costs, management
information systems, and other operating expenses incurred at the dental
centers. In addition to these expenses, the Company incurs general and
administrative expenses related to the billing and collection of accounts
receivable, financial management and control of the dental operations,
insurance, training and development, and other general corporate expenditures.

RESULTS OF OPERATION

The following table sets forth the percentages of patient revenues
represented by certain items reflected in the Company's Statements of
Operations. The information that follows represents historical results of the
Company and does not include pre-acquisition results of the dental practices
that the Company has acquired. The Company acquired Southwest Dental Associates
("SW Dental") of Austin, Texas in September 1997, and two individual practices
located in Fort Worth, Texas and Nashville, Tennessee in December 1997. In March
1998, the Company acquired Dental World, Inc. a dental practice management
company located in Houston, Texas. In March 1998, the Company acquired an 80.0%
interest in Castle West, which was formed to acquire Dental Consulting Services,
LLC, a California-based dental practice management company. In July 1998, the
Company acquired Dentcor, Inc., a dental management company, and five related
dental practices in Florida. In August 1998, the Company acquired all the
outstanding stock of two dental practices in the Los Angeles area and purchased
the assets of a dental office in Houston. In December 1998, the Company acquired
the assets of Dental Centers of America, Inc., which managed 16 dental centers
in San Antonio, Austin and Dallas/Fort Worth, Texas, and Crenshaw Family Dental
in Los Angeles. (All of the acquisitions in 1997 and 1998 are collectively
referred to as the "Completed Acquisitions").

18
<PAGE>

YEAR ENDED DECEMBER 31,
--------------------------
1996 1997 1998
------- -------- -------

Net patient revenues........................... 100.0% 100.0% 100.0%
Expenses:
Dentist salaries and other professional costs 25.2 24.5 24.7
Clinical salaries........................... 22.8 22.2 22.2
Dental supplies and laboratory fees......... 10.5 9.4 9.6
Rental and lease expense.................... 5.4 5.6 5.5
Advertising and marketing................... 5.1 4.4 3.7
Depreciation and amortization............... 3.7 4.6 4.8
Other operating expenses.................... 9.8 9.3 9.3
General and administrative.................. 14.6 12.8 10.9
---- ---- ----
Total expenses.............................. 97.1 92.8 90.8
---- ---- ----
Operating income............................... 2.9 7.2 9.2
Interest expense............................... 8.8 6.0 2.5
Other income................................... (0.3) (0.2) (0.1)
----- ----- -----
Income (loss) before income taxes and
extraordinary loss. (5.6) 1.3 6.8

Provision (benefit) for income taxes........... (1.9) 0.4 2.0
----- --- ---
Income (loss) before extraordinary loss........ (3.7) 0.9 4.8
Extraordinary loss............................. -- (6.9) --
-- ----- --
Net income (loss).............................. (3.7) (6.0) 4.8
Preferred stock dividends...................... -- (4.2) --
-- ----- --
Net income (loss) attributable to common stock. (3.7)% (10.2)% 4.8%
====== ===== =====

YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

NET PATIENT REVENUES - Net patient revenues increased from $46.2 million for
the year ended December 31, 1997 to $74.8 million for the year ended December
31, 1998, an increase of $28.6 million or 61.9%. Approximately $19.7 million of
the increase was attributable to the Completed Acquisitions. Revenues from
twelve DE NOVO stores opened in 1997 and 1998 contributed patient revenues of
$5.0 million, or 10.8% increase from 1997, while patient revenues from dental
centers open for more than one year increased $4.1 million, or 9.0%, in 1998.

DENTIST SALARIES AND OTHER PROFESSIONAL COSTS -- Dentist salaries and other
professional costs increased from $11.3 million for the year ended December 31,
1997 to $18.5 million for the year ended December 31, 1998, an increase of $7.2
million or 63.5%. The Completed Acquisitions accounted for $4.9 million of the
increase in dentist salaries. Expressed as a percentage of net patient revenues,
dentist salaries increased from 24.5% to 24.7% for the years ended December 31,
1997 and 1998, respectively.

CLINICAL SALARIES -- Clinical salaries increased from $10.2 million for the
year ended December 31, 1997 to $16.6 million for the year ended December 31,
1998, an increase of $6.4 million or 62.1%. The Completed Acquisitions accounted
for the increase in clinical salaries. Expressed as a percentage of patient
revenues, clinical salaries remained unchanged at 22.2% for the years ended
December 31, 1997 and 1998.

DENTAL SUPPLIES AND LABORATORY FEES -- Dental supplies and laboratory fees
increased from $4.3 million for the year ended December 31, 1997 to $7.2 million
for the year ended December 31, 1998, an increase of $2.9 million or 66.0%. This
increase resulted primarily from the Completed Acquisitions, which incurred $2.2
million in dental supplies and laboratory expenses. Expressed as a percentage of
patient revenues, dental supplies and laboratory fees increased from 9.4% in
1997 to 9.6% in 1998.

19
<PAGE>
RENTAL AND LEASE EXPENSE -- Rental and lease expense increased from $2.6
million for the year ended December 31, 1997 to $4.1 million for the year ended
December 31, 1998, an increase of $1.5 million or 57.9%. Rental expense from the
Completed Acquisitions in Florida, California, and Texas accounted for $1.2
million of the increase with the balance resulting from the opening of ten new
dental centers in 1997 and 1998. Expressed as a percentage of patient revenues,
rental and lease expense decreased from 5.6% in 1997 to 5.5% in 1998.

ADVERTISING AND MARKETING -- Advertising and marketing expense increased
from $2.0 million for the year ended December 31, 1997 to $2.8 million for the
year ended December 31, 1997, an increase of 35.9%. Expressed as a percentage of
patient revenues, advertising and marketing costs decreased, primarily due to
economies of scale, from 4.4% in 1997 to 3.7% in 1998.

DEPRECIATION AND AMORTIZATION -- Depreciation and amortization increased
from $2.1 million for the year ended December 31, 1997 to $3.6 million for the
year ended December 31, 1998, an increase of $1.5 million or 69.6%, primarily
resulting from higher depreciation and amortization of management services
agreements and other intangibles related to the Completed Acquisitions. As a
percentage of patient revenues, depreciation and amortization increased from
4.6% to 4.8% for the years ended December 31, 1997 and 1998, respectively.

OTHER OPERATING EXPENSES -- Other operating expenses increased from $4.3
million for the year ended December 31, 1997 to $7.0 million for the year ended
December 31, 1998, an increase of approximately $2.7 million or 61.7%. Other
operating expenses include certain expenses related to the operation of the
Company's dental centers and bad debt expense incurred in the financing of
patient receivables at the affiliated dental practices. The increase from 1997
to 1998 resulted from the Completed Acquisitions and the new dental centers
opened during 1997 and 1998. Expressed as a percentage of revenues, however,
other operating expenses remained at 9.3%, for the years ended December 31, 1997
and 1998.

GENERAL & ADMINISTRATIVE EXPENSE -- General and administrative expenses
increased from $5.9 million for the year ended December 31, 1997 to $8.1 million
for the year ended December 31, 1998, an increase of $2.2 million or 35.4%. The
increase resulted from the addition of general and administrative expenses of
the Completed Acquisitions and increased personnel and general corporate
expenses at the Company's headquarters in Houston. Expressed as a percentage of
patient revenues, general and administrative expense, however, decreased from
12.8% to 10.9% for years ended December 31, 1997 and 1998, respectively, due to
relatively greater percentage increase in the Company's patient revenues.

INTEREST EXPENSE -- Interest expense decreased from $2.8 million for the
year ended December 31, 1997 to $1.9 million for the year ended December 31,
1998. In September and October 1997, the Company repaid approximately $23.9
million of its outstanding debt with the net proceeds of the initial public
offering of the Company's common stock. Bank borrowings and the issuance of
subordinated seller notes increased from $5.2 million to $42.2 million, for the
years ended December 31, 1997 and 1998, respectively.

INCOME TAXES -- For the year ended December 31, 1998, the Company recorded a
provision for income taxes of $1.5 million resulting from income before income
taxes of $5.1 million. For the year ended December 31, 1997, the Company
recorded a provision for income taxes of $200,000 resulting from the income
before income taxes and extraordinary loss of $611,000. The Company's average
tax rate for 1998 was 29.4%, compared to an average tax rate of 30.3% in 1997.
During 1998, the Company continued to realize benefits from net operating loss
carry forwards and other tax deductions not recognized in prior years.
Management expects that the average tax rate will be higher in future periods.

PREFERRED STOCK DIVIDENDS -- Coincident with the completion of the initial
public offering in September 1997, the holders of the Company's Series A and
Series C Preferred Stock converted such shares into an aggregate of 948,243
shares of Company Common Stock. As a result, the Company recorded $1.9 million
in non-cash dividends in the third quarter 1997, representing the accretion of
the difference between the recorded value of the Preferred Stock and its
redemption value. No such expense was recorded in 1998.

YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

NET PATIENT REVENUES - Net patient revenues increased from $29.6 million for
the year ended December 31, 1996 to $46.2 million for the year ended December
31, 1997, an increase of $16.6 million or 56%. Approximately $12.6 million of
the increase was attributable to the acquisitions of 1st Dental Care in

20
<PAGE>
Clearwater, Florida, Mid-South Dental Centers in Nashville, Tennessee, and
Horizon Dental Centers in Ft. Worth and Austin, Texas, completed during 1996,
and SW Dental Associates in Austin, Texas, completed in September 1997.
(Collectively referred to as the "1996/97 Acquisitions"). Patient revenues in
Houston increased from $18.6 million in 1996 to $20.5 million in 1997, primarily
the result of the opening of three new dental centers in Houston during 1997.

DENTIST SALARIES AND OTHER PROFESSIONAL COSTS - Dentist salaries and other
professional costs increased from $7.5 million for the year ended December 31,
1996 to $11.3 million for the year ended December 31, 1997, an increase of $3.8
million or 52.0%. This increase resulted primarily from the 1996/97
Acquisitions. Expressed as a percentage of net patient revenues, dentist
salaries and other professional costs decreased from 25.2% in 1996 to 24.5% in
1997.

CLINICAL SALARIES -- Clinical salaries increased from $6.8 million for the
year ended December 31, 1996 to $10.2 million for the year ended December 31,
1997, an increase of $3.4 million or 51.6%. The 1996/97 Acquisitions accounted
for the increase in clinic employee salaries. Expressed as a percentage of
patient revenues, clinical salaries decreased from 22.8% to 22.2% for the years
ended December 31, 1996 and 1997, respectively.

DENTAL SUPPLIES AND LABORATORY FEES -- Dental supplies and laboratory fees
increased from $3.1 million for the year ended December 31, 1996 to $4.3 million
for the year ended December 31, 1997, an increase of $1.2 million or 39.0%. This
increase resulted primarily from the 1996/97 Acquisitions, which incurred $1.2
million in dental supplies and laboratory expenses. Expressed as a percentage of
patient revenues, dental supplies and laboratory fees decreased from 10.5% in
1996 to 9.4% in 1997, primarily resulting from the centralization of the
Company's purchasing function and the institution of national supply agreements
with certain vendors of dental supplies and laboratory work.

RENTAL AND LEASE EXPENSE -- Rental and lease expense increased from $1.6
million for the year ended December 31, 1996 to $2.6 million for the year ended
December 31, 1997, an increase of $1.0 million or 62.7%. Rental expense from the
acquisitions in Florida, Tennessee and Texas accounted for $765,000 of the
increase with the balance resulting from the opening of four new dental centers
in Houston in 1996 and 1997. Expressed as a percentage of patient revenues,
rental and lease expense increased from 5.4% in 1996 to 5.6% in 1997.

ADVERTISING AND MARKETING -- Advertising and marketing expense increased
from $1.5 million for the year ended December 31, 1996 to $2.0 million for the
year ended December 31, 1997, an increase of 33.6%. The 1996/97 Acquisitions
accounted for all of the increase. Expressed as a percentage of patient
revenues, however, advertising and marketing costs decreased from 5.1% in 1996
to 4.4% in 1997 as the 1996/97 Acquisitions generally had lower advertising and
marketing costs than the Company's operations in Houston.

DEPRECIATION AND AMORTIZATION -- Depreciation and amortization increased
from $1.1 million for the year ended December 31, 1996 to $2.1 million for the
year ended December 31, 1997, an increase of $1.0 million or 96.0%, primarily
resulting from higher depreciation and amortization of goodwill related to the
1996/97 Acquisitions. As a percentage of patient revenues, depreciation and
amortization increased from 3.7% to 4.6% for the years ended December 31, 1996
and 1997, respectively.

OTHER OPERATING EXPENSES -- Other operating expenses increased from $2.9
million for the year ended December 31, 1996 to $4.3 million for the year ended
December 31, 1997, an increase of approximately $1.4 million or 48.1%. Other
operating expenses include certain expenses related to the operation of the
Company's dental centers and bad debt expense incurred in the financing of
patient receivables at the affiliated dental practices. The increase from 1996
to 1997 resulted from the 1996/97 Acquisitions and the new dental centers opened
in Houston during 1997. Expressed as a percentage of revenues, however, other
operating expenses decreased from 9.8% to 9.3%, for the years ended December 31,
1996 and 1997, respectively.

GENERAL & ADMINISTRATIVE EXPENSE -- General and administrative expenses
increased from $4.3 million for the year ended December 31, 1996 to $5.9 million
for the year ended December 31, 1997, an increase of $1.6 million or 38.2%. The
increase resulted from the addition of general and administrative expenses of
the 1996/97 Acquisitions and increased personnel and general corporate expenses
at the Company's headquarters

21
<PAGE>
in Houston. Expressed as a percentage of patient revenues, general and
administrative expense, however, decreased from 14.6% to 12.8% for years ended
December 31, 1996 and 1997, respectively, due to relatively higher percentage
increase in the Company's patient revenues.

INTEREST EXPENSE -- Interest expense increased from $2.6 million for the year
ended December 31, 1996 to $2.8 million for the year ended December 31, 1997, as
a result of higher average borrowing levels and increased interest rates in
1997. In September and October 1997, the Company repaid approximately $23.9
million of its outstanding debt with the net proceeds of the initial public
offering of the Company's common stock.

INCOME TAXES -- For the year ended December 31, 1997, the Company recorded a
provision for income taxes of $200,000 resulting from income before income taxes
and extraordinary loss of $611,000. For the year ended December 31, 1996, the
Company recorded a benefit for income taxes of $561,000 resulting from the loss
before income taxes of $1.6 million. The Company's average tax rate for 1997 was
30.3% as it realized a portion of the available benefit from its net operating
loss carry forwards.

EXTRAORDINARY LOSS -- During 1997, the Company recorded an extraordinary loss
of $3.2 million, net of income tax benefit of $490,000, to record the write off
of deferred loan costs and unamortized discounts associated with early
retirement of the Company's 12% Senior Subordinated Notes in the aggregate
amount of $10.4 million, including accrued interest. The Senior Subordinated
Notes had been issued in December 1995 and in June 1997 in original principal
amounts of $7.5 million and $2.0 million, respectively, and were retired
utilizing a portion of the proceeds of the Company's initial public offering.

LIQUIDITY AND CAPITAL RESOURCES

Since 1996, the Company has relied on cash flow from operations and third
party borrowings to finance its operations, and on a combination of third party
borrowings, the issuance of Company common stock and subordinated seller notes,
and the assumption of certain debt and lease obligations to finance its
acquisitions.

At December 31, 1998, the Company had net working capital of $10.3 million,
representing an increase of $6.4 million from net working capital of $3.9
million at December 31, 1997. Current assets at December 31, 1998 consisted of
cash of $695,000, billed and unbilled accounts receivable of $14.0 million,
deferred income taxes of $1.8 million, and prepaid expenses and other current
assets of $2.9 million. These were partially offset by current liabilities of
$9.0 million at December 31, 1998, consisting primarily of $6.7 million in
accounts payable and accrued liabilities, $1.8 million in current maturities of
long-term debt, and $526,000 in accrued deferred compensation payments.

For the year ended December 31, 1998, net cash provided by operating
activities was approximately $1.9 million, compared to net cash used by
operating activities of $502,000 for the prior year, primarily as a result of
higher net income offset by increased working capital requirements. Cash used in
investing activities in 1998 totaled approximately $37.5 million, primarily for
the acquisition of dental practices and capital expenditures to build new dental
centers. Significant components of cash used in investing activities included
$30.8 million to complete the acquisitions of Dental Consulting Services in Los
Angeles, Dental World, Inc. in Houston, Dentcor Inc./Woolf & Associates P.A. in
Florida, Dental Centers of America in San Antonio, and three individual
practices in Los Angeles and $6.7 million in capital expenditures for new dental
centers and computer systems and software. Cash provided by financing activities
in 1998 amounted to approximately $33.4 million. Significant components of cash
provided by financing activities included bank borrowings of $37.0 million
utilized to finance the acquisitions completed in 1998. During 1998, the Company
made principal payments of $3.3 million on its bank credit facility,
subordinated seller notes and other third-party debt.

For the year ended December 31, 1997, net cash used in operating activities
was approximately $502,000.

22
<PAGE>
Cash used in investing activities in 1997 totaled approximately $6.5 million.
Cash provided by financing activities amounted to approximately $9.8 million.
Significant components of cash used in operations included net income before
extraordinary item and other non-cash adjustments of $5.3 million offset by
increased patient and unbilled patient receivables of $4.7 million and decreased
liabilities of $385,000. These changes resulted primarily from the addition of
new dental centers, increased orthodontic revenues and a reduction in accounts
payable. Significant components of cash used in investing activities included
$5.0 million to complete the acquisition of SW Dental Associates located in
Austin, Texas and $1.5 million in capital expenditures used primarily to develop
three DE NOVO dental centers in Houston, Texas and to upgrade the Company's
practice management software. Significant components of cash provided by
financing activities included net proceeds of $33.7 million from the initial
public offering of the Company's common stock in September 1997 and $2.0 million
in additional subordinated debt partially offset by debt reductions totaling
$24.4 million. Significant debt reductions included $10.4 million in Senior
Subordinated Debt, $9.1 million due under the Company's bank credit facility and
$4.4 million in subordinated seller notes. In connection with the repayment of
$10.4 million of 12% Senior Subordinated Notes, the Company recognized a $3.2
million extraordinary loss, net of income tax benefit, associated with the early
retirement of such debt.

The Company's principal sources of liquidity as of December 31, 1998
consisted of cash and cash equivalents, net accounts receivable and borrowing
availability under the Company's bank credit facility. In December 1998, the
Company entered into a new bank credit agreement ("Credit Agreement") with its
existing bank and refinanced the outstanding balance due under the previous bank
credit facility. The Credit Agreement provides for borrowings up to $47.5
million and matures November 2002. Advances under the bank credit facility
require quarterly interest payments through December 2000 at which time
principal becomes payable quarterly based on a five-year amortization and a
final payment at maturity. Borrowings under the bank credit facility may at no
time exceed a specified borrowing base, which is calculated as a multiple of the
Company's earnings before interest, income taxes, depreciation and amortization
("EBITDA"), as adjusted. The bank credit facility bears interest at variable
rates, which are based upon either the bank's base rate or LIBOR, plus, in
either case, a margin which varies according to the ratio of the Company's
funded debt to the EBITDA, each as defined in the bank credit facility. A
commitment fee is payable quarterly at rates ranging from 0.125 percent to 0.5
percent of the unused amounts for such quarter. The bank credit facility
contains affirmative and negative covenants that require that Company to
maintain certain financial ratios, limit the amount of additional indebtedness,
limit the creation or existence of liens, set certain restrictions on
acquisitions, mergers and sales of assets and restrict the payment of dividends.
At December 31, 1998, $39.4 million was outstanding under the bank credit
facility and the average interest rate on the Company's bank borrowings was
8.5%.

During 1998, the Company acquired dental management companies and dental
practices operating 36 dental centers in Texas, Florida and California. Total
purchase consideration for the acquisitions amounted to $41.7 million, including
related acquisition expenses and excluding assumed liabilities, consisting of
$30.8 million in cash, $4.5 million in subordinated seller notes and 595,421
shares of Company stock and common stock equivalents (see "Recent Sales of
Unregistered Securities"). The Company anticipates that the number of
acquisitions in 1999 will be less than in 1998 due to limitations on future
borrowings available under its bank credit facility. In addition, the Company
plans to increase the number of DE NOVO dental centers added in its existing
markets from nine new centers in 1998 to approximately 25 new centers in 1999.
Accordingly, management anticipates that 1999 capital expenditures will increase
to approximately $10.0 million.

Management believes that cash flow from operations and borrowings available
under the bank credit facility should be sufficient to meet its anticipated
capital expenditures and other operating requirements and to fund anticipated
acquisitions for the next 12 months. However, because future cash flows and the
availability of financing are subject to a number of variables, such as the
level of capital spending, the number and size of acquisitions made by the
Company, the Company's financial performance and other factors, there can be no
assurance that the Company's capital resources will be sufficient to maintain
currently planned levels of capital expenditures or to fund future acquisitions.
Additional debt and equity financing may be required in connection with future
acquisitions. The availability of these capital sources will depend on
prevailing market conditions and interest rates and the then-existing financial
condition of the Company.

23
<PAGE>
YEAR 2000

The year 2000 issue is the result of computer programs using two digits to
define the applicable year instead of four. Any programs that have time
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. A computer system that is not year 2000 compliant would not be
able to correctly process certain data, or in extreme situations, system failure
could result.

As part of the Company's continuing program to upgrade its information
systems in anticipation of future growth, the Company is currently involved in
the installation of year 2000 compliant software for its corporate and regional
operations. This installation is currently expected to be complete by the second
quarter of 1999. The Company presently believes that, with such upgrades, the
year 2000 problem will not pose significant operational problems for the
Company's computer systems. The estimated costs of these efforts are not
expected to be material to the Company's financial position or any year's
results of operations.

The Company is currently making inquires of certain of its vendors and banks
to determine what impact, if any, their year 2000 compliance exposure might have
on the company's operations. The Company expects to receive assurances that
those vendors' systems are or will be year 2000 compliant in a timely manner.

The failure to correct a material year 2000 problem could possibly result in
an interruption in or failure of, certain normal business activities or
operations. Such failure can materially and adversely affect the Company's
financial position, results of operation sand cash flows. Due to the general
uncertainty inherent in the year 2000 problem, including uncertainty regarding
the year 2000 readiness of third party suppliers and potential future
acquisitions, the Company is unable to determine at this time whether the
consequences of any possible year 2000 failures will have a material impact on
the Company's financial position, results of operations and cash flows. The
Company believes that, with the scheduled completion of its computer system
upgrades, the possibly of any material interruption to normal operations should
be significantly reduced.

The Company's plans to comply with year 2000 requirements and completion
dates are based on management's best estimates, which were derived utilizing
numerous assumptions of future events including the continued availability of
certain resources and other factors. There can no assurance, however, that these
estimates will be achieved and actual results could differ materially from those
estimates. Specific factors that might cause such material differences include,
but are not limited to, the availability and cost of personnel trained in this
area, the ability to identify and correct potential problems, and similar
uncertainties.

To date, the incremental costs incurred by the Company that relate solely to
the year 2000 compliance problem have not been and are not expected to be
material. These costs are exclusive of upgrades made to the Company's systems in
the ordinary course of business and consist primarily of internal employee time.
The Company does not separately track the internal costs incurred for the Year
2000 project, which consists primarily of payroll and related costs associated
with employee time. Based upon the Company's current assessments, the costs to
complete the Company's year 2000 compliance program will not have a material
effect on the Company's financial condition, results of operations or cash
flows. All the current and future costs related to the Company's year 2000
compliance program have been and are expected to be funded with cash generated
from the Company's operations.

If during the course of the company's assessment of its critical systems, it
is determined that the risk of year 2000 disruptions is significant, contingency
plans will be developed as appropriate. Such plans might include the use of
alternative service providers or product suppliers. Currently, the Company does
not have any contingency plans in place based on current year 2000 readiness
assessments.

INFLATION

Inflation has not had a significant impact on the results of operations of
the Company during the last three years.

RECENTLY ISSUED PRONOUNCEMENTS

In February 1998, the FASB issued Statement of Financial Accounting Standard
No. 132, Employers' Disclosure about Pensions and Other Post retirement Benefits
("SFAS 132"). SFAS 132, which is effective for fiscal years beginning after
December 15, 1997, establishes standard disclosure requirements for pensions and

24
<PAGE>
other post retirement benefits. Adopting of SFAS 132 will not effect the
reporting requirements because the Company does not have any pensions or post
retirements benefits.

In June 1998, the FASB issued Statement of Financial Accounting Standard No.
133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133").
SFAS 133, which is effective for fiscal years beginning after June 15, 1999,
establishes accounting and reporting standards of derivative instruments and
hedging activities. It requires that entities recognize all derivatives as
either assets or liabilities in the statement of financial position, and measure
those instruments at fair value. Adoption of SFAS 133 will not effect the
reporting requirements because the Company does not have derivative instruments
and hedging activities.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's only financial instruments with market risk exposure are
revolving credit borrowings under its Credit Agreement which total $39,400,000
at December 31, 1998. Based on this balance, a change of one percent in the
interest rate would cause a change in interest expense of approximately
$394,000, or $0.04 per share, on an annual basis. The bank credit facility was
not entered into for trading purposes and carries interest at a pre-agreed upon
percentage point spread from either the prime interest rate or Eurodollar
interest rate.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements required by this Item 8 are incorporated under Item
14 in Part IV of this Annual Report on Form 10-K. ITEM 9. CHANGES IN AND
DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

25
<PAGE>
PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item as to the directors and executive
officers of the Company is hereby incorporated by reference from the information
appearing under the captions "-- Election of Directors -- Directors and Nominees
for Director," "-- Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive proxy statement which involves
the election of directors and is to be filed with the Securities and Exchange
Commission (the "Commission") pursuant to the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), within 120 days of the end of the Company's
fiscal year ended December 31, 1998.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item as to the management of the Company is
hereby incorporated by reference from the information appearing under the
captions "Executive Compensation" and "Election of Directors -- Director
Compensation" in the Company's definitive proxy statement which involves the
election of directors and is to be filed with the Commission pursuant to the
Exchange Act within 120 days of the end of the Company's fiscal year ended
December 31, 1998.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item as to the ownership by management and
others of securities of the Company is hereby incorporated by reference from the
information appearing under the caption "Voting Securities and Principal
Stockholders" in the Company's definitive proxy statement which involves the
election of directors and is to be filed with the Commission pursuant to the
Exchange Act within 120 days of the end of the Company's fiscal year ended
December 31, 1998.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item as to the ownership by management and
others of securities of the Company is hereby incorporated by reference from the
information appearing under the caption "Certain Relationships And Related
Transactions" in the Company's definitive proxy statement which involves the
election of directors and is to be filed with the Commission pursuant to the
Exchange Act within 120 days of the end of the Company's fiscal year ended
December 31, 1998.

26
<PAGE>
PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) (1) FINANCIAL STATEMENTS

The following financial statements and the Report of Independent Accountants
are filed as a part of this report on the pages indicated:

PAGE
----
Report of Independent Accountants.................................... F-2
Balance Sheets as of December 31, 1997 and 1998...................... F-3
Statements of Operations for the Years Ended
December 31, 1996, 1997 and 1998................................. F-4
Statements of Changes in Stockholders' Equity for the Years Ended
December 31, 1996, 1997 and 1998.................................. F-5
Statements of Cash Flows for the Years Ended
December 31, 1996, 1997 and 1998............................... F-6

Notes to Financial Statements........................................ F-7

(a)(2) FINANCIAL STATEMENT SCHEDULES

The following Financial Statement Schedule and the Report of Independent
Accountants on Financial Statement Schedule are included in this report on the
pages indicated:

PAGE
----
Report of Independent Accountants on Financial Statement Schedule..... S-1

Financial Statement Schedule

II -- Valuation and Qualifying Accounts........................... S-2

All other schedules are omitted because the required information is
inapplicable or the information is presented in the consolidated financial
statements or related notes.

(a) (3) EXHIBITS

The exhibits to this report have been included only with the copies of
this report filed with the Commission. Copies of individual exhibits will
be furnished to stockholders upon written request to the Company and
payment of a reasonable fee.

(b) REPORTS ON FORM 8-K

(1) On January 14, 1999, the Company filed a Current Report on Form 8-K
(the "December 30 8-K") regarding the Company's December 30, 1998
acquisition ("DCA Acquisition") of the assets of DCA Limited
Partnership, L.L.P., Dental Administrators of Texas Limited
Partnership, L.L.P. and 16 related dental practices (collectively,
the "DCA Entities"). This Current Report on Form 8-K included the
historical financial statements of the DCA Entities.

(2) On March 30, 1999, the Company filed a Current Report on Form 8-K/A
amending the December 30 8-K and the Company's Current Report on
Form 8-K filed April 14, 1998 regarding the Company's March 30,
1998 acquisition ("DCS Acquisition") of an 80% interest in Castle
Dental Centers of California, L.L.C., an entity formed to acquire
all of the assets of Dental Consulting Services, LLC ("DCS"). This
Current Report on Form 8-K included the historical financial
statements of DCS and dental practices it managed as well as Pro
Forma Consolidated Statements of Operations of the Company for the
years ended December 31, 1997 and 1998 reflecting the DCA
Acquisition and the DCS Acquisition.

27
<PAGE>
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Houston, State of Texas on March 31, 1999.

CASTLE DENTAL CENTERS, INC.

By: /S/ JACK H. CASTLE, JR.
------------------------
JACK H. CASTLE, JR.
CHAIRMAN OF THE BOARD AND
CHIEF EXECUTIVE OFFICER

POWER OF ATTORNEY

We, the undersigned, directors and officers of Castle Dental Centers, Inc.
(the "Company"), do hereby severally constitute and appoint Jack H. Castle, Jr.
and John M. Slack and each or any of them, our true and lawful attorneys and
agents, with full power of substitution and resubstitution, for him and in his
name, place and stead, in any and all capacities, to sign any and all amendments
to the Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1998, and to file the same with all exhibits thereto, and all other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys and agents, and each or any of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys and agents, and
each of them, or his substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.

SIGNATURE TITLE DATE
--------- ----- ----
/S/ JACK H. CASTLE, JR. Chairman of the Board, Chief March 31, 1999
JACK H. CASTLE, JR. Executive Officer (Principal
Executive Officer)

/S/ G. DANIEL SIEWERT President, Chief Operating Officer March 31, 1999
G. DANIEL SIEWERT

/S/ JOHN M. SLACK Vice President -- Chief Financial March 31, 1999
JOHN M. SLACK Officer (Principal Financial and
Accounting Officer)

/S/ JACK H CASTLE, D.D.S. Director March 31, 1999
JACK H. CASTLE, D.D.S.

/S/ G. KENT KAHLE Director March 31, 1999
G. KENT KAHLE

/S/ ROBERT J. CRESCI Director March 31, 1999
ROBERT J. CRESCI

/S/ ELIZABETH A. TILNEY Director March 31, 1999
ELIZABETH A. TILNEY

/S/ EMMETT E. MOORE Director March 31, 1999
EMMETT E. MOORE

/S/ JOHN J. ROBERTS Director March 31, 1999
JOHN J. ROBERTS

28
<PAGE>

CASTLE DENTAL CENTERS, INC.
INDEX TO FINANCIAL STATEMENTS

PAGE

AUDITED FINANCIAL STATEMENTS

Report of Independent Accountants...................................F-2
Balance Sheets as of December 31, 1997 and 1998.....................F-3
Statements of Operations for the years ended
December 31, 1996, 1997 and 1998 ...............................F-4
Statements of Changes in Stockholders' Equity (Deficit)
for the years ended December 31, 1996, 1997 and 1998..............F-5
Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998 ...............................F-6
Notes to Financial Statements.......................................F-7

F-1
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Castle Dental Centers, Inc.:

In our opinion, the accompanying balance sheets and the related statements
of operations, changes in stockholders' equity (deficit) and cash flows
presently fairly, in all material respects, the financial position of Castle
Dental Centers, Inc. and subsidiaries at December 31, 1997 and 1998, and the
results of their operations and their cash flows for each of the three 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.

PricewaterhouseCoopers LLP

Houston, Texas
March 5, 1999

<PAGE>

CASTLE DENTAL CENTERS, INC.
BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE DATA)

DECEMBER 31,
1997 1998
------ ------
ASSETS

Current assets:

Cash and cash equivalents................................ $2,908 $ 695
Patient receivables, net of allowance for uncollectible
accounts of $3,929 and $8,508 in 1997 and 1998,
respectively.......................................... 5,841 10,700
Unbilled patient receivables, net of allowance for
uncollectible accounts of $568 and $658 in 1997
and 1998, respectively................................ 2,521 3,251

Prepaid expenses and other current assets................ 838 2,887
Deferred income taxes.................................... -- 1,809
------ ------
Total current assets............................... 12,108 19,342
------ ------
Property and equipment, net................................. 5,189 13,861
Intangibles, net............................................ 25,565 65,956
Deferred income taxes....................................... 1,125 --
Other assets................................................ 526 876
------ ------
Total assets....................................... $44,513 $100,035
======= ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt........................ $2,598 $1,795
Accounts payable and accrued liabilities................. 4,935 6,676
Deferred compensation payable, related party............. 658 526
Total current liabilities............................. 8,191 8,997
Long-term debt, net of current portion...................... 2,607 44,411
Other long-term liabilities, related party.................. 1,052 526
Deferred income taxes....................................... -- 5,401
Commitments and contingencies
Minority interest........................................... -- 4,303
Redeemable preferred stock, $.001 par value,
5,000,000 shares authorized; 119,231 shares Series B
issued and outstanding at December 31, 1997 1,550 --
Stockholders' equity:
Common stock, $.001 par value, 30,000,000 shares authorized,
6,229,239 and 6,417,206 shares issued and outstanding in
1997 and 1998, respectively........................... 6 6
Additional paid-in capital............................... 40,818 42,516
Accumulated deficit...................................... (9,711) (6,125)
-------- ----------
Total stockholders' equity............................ 31,113 36,397
-------- ----------
Total liabilities and stockholders' equity............ $44,513 $100,035
======= ========

The accompanying notes are an integral part of the financial statements.

F-3
<PAGE>
CASTLE DENTAL CENTERS, INC.
STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

YEAR ENDED DECEMBER 31,
-----------------------
1996 1997 1998
---- ---- ----
Net patient revenues............................. $29,601 $46,225 $74,823
Expenses:
Dentist salaries and other professional costs. 7,454 11,325 18,516
Clinical salaries............................. 6,760 10,248 16,612
Dental supplies and laboratory fees........... 3,120 4,335 7,197
Rental and lease expense...................... 1,592 2,590 4,091
Advertising and marketing..................... 1,522 2,033 2,763
Depreciation and amortization................. 1,088 2,132 3,615
Other operating expenses...................... 2,913 4,314 6,976
General and administrative.................... 4,292 5,929 8,145
------- ------- -------
Total expenses............................. 28,741 42,906 67,915
------- ------- -------
Operating income........................... 860 3,319 6,908
Interest expense................................. 2,596 2,792 1,889
Other income..................................... (89) (84) (57)
-------- -------- --------
Income (loss) before income taxes and
extraordinary loss............................ (1,647) 611 5,076
Provision (benefit) for income taxes............. (561) 200 1,490
-------- ------- -------
Income (loss) before extraordinary loss.......... (1,086) 411 3,586
Extraordinary loss............................... -- (3,195) --
------- -------- -------
Net income (loss)................................ (1,086) (2,784) 3,586
Preferred stock dividends........................ -- (1,930) --
------- -------- -------
Net income (loss) attributable to common stock... $(1,086) $(4,714) $ 3,586
======== ======== =======
Income (loss) per common share:
Basic and diluted:
Income (loss) before extraordinary loss..... $(0.34) $0.10 $0.54
Extraordinary loss.......................... -- (0.78) --
------- ------ -------
Net income (loss)........................ $(0.34) $(0.68) $0.54
======= ======= =====
Weighted average number of common and
common equivalent shares outstanding
Basic ...................................... 3,191 4,100 6,586
======= ======= =======
Diluted ...................................... 3,191 4,132 6,608
======= ======= =======

The accompanying notes are an integral part of the financial statements.

F-4
<PAGE>
CASTLE DENTAL CENTERS, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

(IN THOUSANDS EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
ADDITIONAL STOCKHOLDERS'
COMMON STOCK PAID-IN ACCUMULATED EQUITY
SHARES AMOUNT CAPITAL DEFICIT (DEFICIT)
------ ------ ------- ------- ---------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1996 ............ 2,000,000 $ 2 $ 96 $ (5,841) $ (5,743)
Issuance of common stock ......... 331,996 -- 3,320 -- 3,320
Net loss ......................... -- -- -- (1,086) (1,086)
--------- --------- --------- --------- ---------
Balance, December 31, 1996 .......... 2,331,996 2 3,416 (6,927) (3,509)
Issuance of common stock - Initial
Public Offering ............... 2,784,000 3 31,743 -- 31,746
Conversion of Series A Preferred
Stock ......................... 705,552 1 3,228 -- 3,229
Conversion of Series C Preferred
Stock .......................... 242,691 -- 2,670 -- 2,670
Issuance of common stock in
connection with an acquisition 165,000 -- 1,691 -- 1,691
Accretion of discount on
preferred stock ............... -- -- (1,930) -- (1,930)
Net loss ......................... -- -- -- (2,784) (2,784)
--------- --------- --------- --------- ---------
Balance, December 31, 1997 .......... 6,229,239 6 40,818 (9,711) 31,113
Issuance of common stock in
connection with acquisitions .. 187,967 -- 1,698 -- 1,698
Net income ....................... -- -- -- 3,586 3,586
--------- --------- --------- --------- ---------
Balance, December 31, 1998 .......... 6,417,206 $ 6 $ 42,516 $ (6,125) $ 36,397
========= ========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of the financial statements.

F-5
<PAGE>
CASTLE DENTAL CENTERS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1997 1998
------- ------ ------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income (loss) ................................................................ $ (1,086) $ (2,784) $ 3,586
Adjustments:

Provisions for bad debts ...................................................... 1,227 1,897 2,545
Depreciation and amortization ................................................. 1,088 2,132 3,615
Gain on sale of property and equipment ........................................ (16) -- --
Amortization of debt discount ................................................. 522 712 --
Deferred income taxes (benefit) .............................................. (561) 100 1,568
Extraordinary loss ............................................................ -- 3,195 --
Changes in operating assets and liabilities:

Patient receivables ........................................................ (1,514) (3,654) (5,864)
Unbilled patient receivables ............................................... (748) (1,046) (615)
Prepaid expenses and other current assets .................................. (246) (651) (1,957)
Other assets ............................................................... (283) (18) (45)
Accounts payable and accrued liabilities ................................... 2,326 272 (278)
Deferred compensation payments to shareholder .............................. (263) (657) (657)
-------- -------- --------

Net cash provided by (used in) operating activities ..................... 446 (502) 1,898

Cash flows used in investing activities:

Capital expenditures .......................................................... (1,337) (1,515) (6,660)
Proceeds from sale of property, plant and equipment ........................... 607 -- --
Acquisition of affiliated dental practices, net of cash acquird (10,335) (5,015) (30,818)

Escrow deposit ............................................................. (500) -- --
-------- -------- --------

Net cash used in investing activities ................................... (11,565) (6,530) (37,478)

Cash flows from financing activities:

Proceeds from issuance of common stock ........................................ -- 33,659 --
Proceeds from debt ............................................................ 7,250 2,074 37,000
Repayment of debt ............................................................. (1,543) (24,376) (3,341)

Offering costs ................................................................ (650) (1,263) --
Debt and preferred stock issuance costs ....................................... (258) (273) (292)
-------- -------- --------

Net cash provided by financing activities ............................... 4,799 9,821 33,367
-------- -------- --------

Net change in cash and cash equivalents .......................................... (6,320) 2,789 (2,213)
Cash and cash equivalents, beginning of period ................................... 6,439 119 2,908
-------- -------- --------
Cash and cash equivalents, end of period ......................................... $ 119 $ 2,908 $ 695
======== ======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.

F-6
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

1. CORPORATE ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

CORPORATE ORGANIZATION AND BASIS OF PRESENTATION

Castle Dental Centers, Inc. and subsidiaries (the "Company") provide
administrative and management services, non-healthcare personnel, facilities and
equipment to certain professional corporations in Texas, Florida, California and
Tennessee ("affiliated dental practices") under long-term management services
agreements.

The consolidated financial statements include the accounts of the Company
and all wholly-owned and beneficially-owned subsidiaries and the accounts of
affiliated dental practices in which the Company has a long-term controlling
financial interest. Because of corporate practice of medicine laws in the states
in which the Company operates, the Company does not own dental practices but
instead enters into exclusive long-term management services agreements
("Management Services Agreements) with professional corporations that operate
the dental practices. In addition, the Company has the contractual right to
designate, in its sole discretion and at any time, the licensed dentist who is
the majority shareholder of the capital stock of the professional corporation at
a nominal cost ("nominee arrangements"). At December 31, 1998, all of the
affiliated dental practices were wholly-owned by dentists with whom the Company
had a nominee arrangement. Under the Management Services Agreements, the Company
establishes annual operating and capital budgets for the professional
corporations and compensation guidelines for the licensed dental professionals.
The Management Services Agreements have initial terms of twenty-five to forty
years. The management fee charged by the Company to an affiliated dental
practice is intended to reflect and is based on the fair value of the management
services rendered by the Company to the affiliated dental practice. Subject to
applicable law, the management fee earned by the Company, except professional
corporations located in California, is generally comprised of three components:
(i) the costs incurred by it on behalf of the affiliated dental practice; (ii) a
base management fee ranging from 12.5% to 20.0% of patient revenues; and, (iii)
a performance fee equal to the patient revenues of the affiliated dental
practice less (a) the expenses of the affiliated dental practice and (b) the sum
of (i) and (ii), as described in the agreements.

In California, the Company is paid a monthly management fee comprised of two
components: (i) the costs incurred by it on behalf of the affiliated practice
and (ii) a management fee in an amount ranging from 15.0% to 30.0% of net
patient revenues. With respect to certain professional corporations in
California (i) the first $2,500 per month of patient revenues is excluded from
the calculation of the management fee and (ii) Company is paid a bonus equal to
30% of patient revenues in excess average monthly patient revenues over the
prior two-year period. The amount of the management fee is reviewed by the
Company and the affiliated dental practice at least annually in order to
determine whether such fee should be adjusted to continue to reflect the fair
value of the management services rendered by the Company.

Through the management services agreements and the nominee arrangements, the
Company has a significant long-term controlling financial interest in the
affiliated dental practices and, therefore, according to Emerging Issues Task
Force Issue No. 97-2, "Application of FASB Statement No. 94, CONSOLIDATION OF
ALL MAJORITY-OWNED SUBSIDIARIES, and APB No. 16, BUSINESS COMBINATIONS, to
Physician Practice Management Entities and Certain Other Entities with
Contractual Management Agreements," must consolidate the results of the
affiliated practices with those of the Company. Net patient revenues are
presented in the accompanying statement of operations because the Company must
present consolidated financial statements. All significant intercompany accounts
and transactions, including management fees, have been eliminated in
consolidation.

At December 31, 1997 and 1998, and for each of the three years ended
December 31, 1998, the consolidated financial statements include Castle Dental
Centers, Inc., and its management company subsidiaries and the affiliated
professional corporations.

Reclassifications of certain prior year amounts have been made to conform to
current period classifications.

F-7
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

REVENUE RECOGNITION

Net patient revenues represent the estimated realizable amounts to be
received from patients, third-party payors and others for services rendered by
affiliated dentists. They are reported at established rates reduced by
contractual amounts based on agreements with patients, third party payers and
others obligated to pay for services rendered. Patient revenues from general
dentistry are recognized as the services are performed. Patient revenues from
orthodontic services are recognized in accordance with the proportional
performance method. Under this method, revenue is recognized as services are
performed under the terms of contractual agreements with each patient.
Approximately 25% of the services are performed in the first month with the
remaining services recognized ratably over the remainder of the contract.
Billings under each contract, which average approximately 24 months, are made
equally throughout the term of the contract, with final payment at the
completion of the treatment.

Net patient revenues include amounts received from capitated managed care
contracts that the Company negotiates on behalf of its affiliated dental
practices. Under capitated contracts the affiliated dental practice receives a
predetermined amount per patient per month in exchange for providing certain
necessary covered services to members of the plan. Usually, the capitated plans
also provide for supplemental payments and/or co-payments by members for certain
higher cost procedures. These contracts typically result in lower average fees
for services than the usual and customary fees charges by the Company's
affiliated dental practices and may, in certain instances, expose the Company to
losses on contracts where the total revenues received are less than the costs of
providing such dental care. The Company generally bears the risk of such loss
because it consolidates the financial results of its affiliated dental
practices. However, most of these contracts are cancelable by either party on 30
to 90 days written notice thereby reducing the risk of long-term adverse impact
on the Company. Fees from capitated contracts totaled $5.1 million in 1998,
excluding supplemental payments and co-payments by members. No single contract
amounted to a significant portion of the Company's revenues, as each of the
Company's regional operations contracts separately with managed care providers.
The Company periodically evaluates its capitated managed care contracts by
comparing the average reimbursement per procedure plus the total capitation fees
per contract to the usual and customary fees charged by the affiliated dental
practice.

Accounts receivable consist primarily of receivables from patients,
insurers, government programs and contracts between the affiliated dental
practices and third-party payors for dental services provided by dentists. The
Company does not believe that change in the reimbursement arrangements for its
affiliated dental practice contracts with third-party payors would have a
material impact on revenues. An allowance for doubtful accounts is recorded by
the Company based on historical experience.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid debt investments with original
maturities of three months or less at the date of acquisition to be cash
equivalents.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the various classes
of depreciable assets, ranging from five to ten years. Fully depreciated assets
are retained in property and equipment until they are removed from service.
Fully depreciated assets in use as of December 31, 1997 and 1998 were
approximately $1.1 million and $1.2 million, respectively. Maintenance and
repairs are charged to expense whereas renewals and major replacements are
capitalized. Gains and losses from dispositions are included in operations.

INTANGIBLE ASSETS

The Company's acquisitions involve the purchase of tangible and intangible
assets and the assumption of certain liabilities of the affiliated dental
practices. As part of the purchase allocation, the Company allocates the
purchase price to the tangible assets acquired and liabilities assumed, based on
estimated fair market values. In connection with each acquisition, the Company
enters into a long-term management services agreement with each affiliated
dental practice, which cannot be terminated by either party without cause. The
cost of the management services agreement is amortized on a straight line basis
over its term, or such shorter

F-8
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

period as may be indicated by the facts and circumstances, as described below.
Amortization periods of the management services agreements acquired through
December 31, 1998 are 25 years.

In connection with the allocation of the purchase price to identifiable
intangible assets, the Company analyzes the nature of the group with which a
management services agreement is entered into, including the number of dentists
in each group, number of dental centers and ability to recruit additional
dentists, the affiliated dental practice's relative market position, the length
of time each affiliated dental practice has been in existence, and the term and
enforceability of the management services agreement. Because the Company does
not practice dentistry, maintain patient relationships, hire dentists, enter
into employment and noncompete agreements with the dentist, or directly contract
with payors, the intangible asset created in the purchase allocation process is
associated primarily with the management services agreement with the affiliated
dental practice.

The Company reviews intangible assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the asset may not
be recoverable. If this review indicates that the carrying amount of the asset
may not be recoverable, as determined based on the undiscounted cash flows of
the related operations over the remaining amortization period, the carrying
value of the asset is reduced to estimated fair value. Among the factors that
the Company will continually evaluate are unfavorable changes in each affiliated
dental practice's relative market share and local market competitive
environment, current period and forecasted operating results and cash flows of
the affiliated dental practice and its impact on the management fee earned by
the Company, and legal factors governing the practice of dentistry.

OTHER ASSETS

Other assets consist primarily of debt issuance costs and other receivables.
The costs related to the issuance of debt are capitalized and amortized using
the effective interest method over the lives of the related debt. Other
receivables include $339,000 in loans made to executive officers (see Note 13).

INCOME TAXES

The Company accounts for income taxes under the liability method. Under this
method, deferred taxes are determined based on the differences between the
financial reporting and tax basis of assets and liabilities and are measured
using the enacted marginal tax rates currently in effect.

EARNINGS PER SHARE

In June 1997, the Company's Board of Directors declared and the stockholders
approved a 1-for-2 reverse split of the Company's common stock. All share and
per share information in the accompanying financial statements has been
retroactively restated to reflect the effects of the reverse stock split.

ADVERTISING

Costs incurred for advertising are expensed when incurred.

PRE-OPENING COSTS

Costs incurred prior to opening a dental center, primarily salaries and
lease expense, are expensed when incurred.

USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of net revenue and expenses during the
reporting periods. Actual results could differ from those estimates.

F-9
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

2. SELECTED BALANCE SHEET INFORMATION:

The details of certain balance sheet accounts were as follows:
DECEMBER 31,
---------------
1997 1998
---- ----
(IN THOUSANDS)
Property and equipment:
Equipment...................................... $ 5,249 $ 9,334
Leasehold improvements......................... 2,820 7,742
Furniture and fixtures......................... 653 1,553
Vehicles....................................... 75 130
------- -------
Total property and equipment................ 8,797 18,759
Less accumulated depreciation.................. 3,608 4,898
------- -------
Property and equipment, net................. $ 5,189 $13,861
======= =======

Depreciation expense was approximately $678,000, $1.2 million and $1.8
million for the years ended December 31, 1996, 1997 and 1998, respectively.

DECEMBER 31,
---------------
1997 1998
---- ----
(IN THOUSANDS)
Intangible assets:
Management services agreements................. $26,447 $68,519
Other.......................................... 150 150
------- -------
Total intangible assets..................... 26,597 68,669
Less accumulated amortization..................... 1,032 2,713
------- -------
Intangible assets, net...................... $25,565 $65,956
======= =======

Amortization expense was approximately $410,000, $900,000 and $1.8 million
for the years ended December 31, 1996, 1997 and 1998, respectively.

DECEMBER 31,
---------------
1997 1998
---- ----
(IN THOUSANDS)

Accounts payable and accrued liabilities:
Trade.......................................... $ 2,023 $ 3,083
Salaries, wages and payroll taxes.............. 1,577 1,959
Due to patients................................ 914 1,420
Other.......................................... 421 214
------- -------
Total accounts payable and accrued liabilities $ 4,935 $ 6,676
======= =======

3. ACQUISITIONS:

In June 1997, the Company entered into a management services agreement and
option agreement to acquire all of the membership interest in SW Dental, a group
dental practice located in Austin, Texas. In September 1997, the Company
completed the acquisition. The purchase price of $7.0 million, including related
acquisition expenses, consisted of $5.2 million in cash and 119,231 shares of
Company series B preferred stock.

In December 1997, the Company acquired substantially all the assets of two
individual practices in Ft. Worth, Texas and Nashville, Tennessee and entered
into employment agreements with the dentists. The aggregate purchase price of
$3.2 million, including related acquisition expenses, consisted of $300,000 in
cash, and 165,000 shares of Company common stock.

In March 1998, the Company acquired all the outstanding capital stock of
Dental World, Inc., a dental practice management company, and the assets of
Dental Delivery Services, P.C., a dental professional corporation, both located
in Houston, Texas. The purchase price of $2.5 million, including related
acquisition

F-10
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

expenses, consisted of $2.2 million in cash and 23,342 shares of Company common
stock.

In March 1998, the Company acquired an 80.0% interest in Castle Dental
Centers of California L.L.C. ("Castle West"), a company formed to acquire the
assets of Dental Consulting Services LLC ("DCS"), a dental practice management
company with headquarters in Los Angeles, California. The purchase price of
$18.1 million included cash of $10.8 million, $2.7 million in 8% subordinated
seller notes payable and an option granted to the sellers to convert a portion
of their ownership interests into 407,454 shares of Company common stock (the
"conversion right"). The conversion right may be exercised beginning twelve
months after the closing date. This convertible ownership interest has been
recorded at fair market value. The difference between the estimated fair value
of the convertible ownership interest at the acquisition date and the Company's
common stock into which it may be converted is being amortized over the period
to the earliest conversion date. In connection with these acquisitions, the
Company entered into management and consulting agreements with certain employees
and former owners of the businesses acquired and into long-term management
services agreements with each of the affiliated dental practices. In addition,
the former owners of DCS have the right to put all or a portion of their 20%
minority ownership in Castle West to the Company, beginning twenty-four months
after the closing date, for a combination of cash and common stock. The
consideration to be paid will be determined based on the earnings before
interest, income taxes, depreciation and amortization ("EBITDA"), as defined in
the purchase agreement, as adjusted, for Castle West's business, and will be
accounted for as additional purchase consideration at its fair value at the date
of the exchange. The Company will also pay additional consideration to the
former owners of DCS related to the acquisition of certain additional dental
practices in the Los Angeles area. The amount of such additional consideration
related to the acquisition of the assets of three dental practices is estimated
to be approximately $505,000 in cash and 8% subordinated notes, and 44,600
shares of Company common stock, and will be included in the purchase price of
the dental practices acquired.

In July 1998, the Company acquired all the outstanding capital stock of
Dentcor, Inc, a dental practice management company, located in Florida. The
purchase price of $1.0 million, including related acquisition expenses,
consisted of $800,000 in cash and 20,566 shares of Company common.

In July 1998, the Company acquired the assets of Jared Woolf, D.D.S. &
Associates of Palmetto, P.A., Jared Woolf, D.D.S. & Associates of Venice, P.A.
and Woolf Dentistry, P.A. ("Woolf Dentistry"), all dental professional
associates, located in Sarasota, Florida. The purchase price of $2.6 million,
including related acquisition expenses, consisted of $2.1 million in cash,
$370,000 in 9% Subordinated Promissory Notes due July 9, 2001 and 15,424 shares
of Company common stock.

In December 1998, the Company acquired the assets of DCA Limited
Partnership, L.L.P. ("DCA") and Dental Administrators of Texas Limited
Partnership, L.L.P. ("DAI") and 16 related dental practices, located in San
Antonio, Texas. The purchase price of $15.8 million, including related
acquisition expenses, consisted of $13.2 million in cash, $1.3 million in 6%
Subordinated Promissory Notes due December 30, 2001 and 125,000 shares of
Company common stock.

In addition, during 1998, the Company acquired the assets and stock of four
additional dental practices. Three of the dental practices were located in
California and one was located in Texas. The aggregate purchase price of $1.7
million, including related acquisition expenses, consisted of $1.4 million in
cash, $229,000 in 8% and 8.5% Subordinated Promissory Notes due June 30, 2000
and October 1, 2001, respectively, and 3,635 shares of Company common stock.

The assets and liabilities have been recorded at their estimated fair values
at the date of acquisition. The aggregate purchase price and related expenses
exceeded the fair market value of net assets, which has been assigned to
management services agreements, included in intangible assets. Patient Revenues,
management fees and related costs are included in the consolidated financial
statements from their acquisition dates.

F-11
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

The estimated fair value of assets acquired and liabilities assumed are
summarized as follows:

DECEMBER 31,
---------------
1997 1998
---- ----
(IN THOUSANDS)

Patient receivables, net.............................. $ 236 $ 1,470
Unbilled patient receivables, net..................... 37 188
Prepaid expenses and other current assets............. 31 92
Property and equipment, net........................... 554 3,866
Other assets.......................................... 3 93
Management services agreements........................ 9,934 42,072
Accounts payable and accrued liabilities.............. (452) (2,019)
Deferred taxes........................................ -- (3,149)
Long-term debt, assumed............................... (138) (1,254)
Minority interest..................................... -- (4,305)
------- --------
10,205 37,054

Less: fair value of common stock issued and other
equity instruments.................................. 3,241 1,698
Less: issuance of notes payable....................... 1,449 4,538
Less: escrow deposit................................. 500 --
------- -------
Cash purchase price, net of cash acquired.......... $ 5,015 $30,818
======= =======

Unaudited pro forma combined results of operations, assuming all of the
acquisitions occurred at the beginning of each year, are as follows:

DECEMBER 31,
---------------
1997 1998
---- ----
(IN THOUSANDS EXCEPT
FOR SHARE DATA)

Net patient revenues.............................. $63,414 $93,473
Net income (loss)................................. (1,933) 3,918
Income (loss) per common share:
Basic ............................................ (0.42) 0.58
Diluted........................................... (0.41) 0.57

The unaudited pro forma summary is not necessarily indicative either of
results of operations, that would have occurred had the acquisitions been made
at the beginning of the periods presented, or of future results of operations of
the combined companies.

4. REVOLVING LINE OF CREDIT AND LONG-TERM DEBT:

Long-term debt consisted of the following:

DECEMBER 31,
---------------
1997 1998
---- ----
(IN THOUSANDS)

Term loan.......................................... $ 3,000 $ --
Revolving credit loans............................. -- 39,400
Subordinated Seller Notes.......................... 1,499 5,442
Other notes payable................................ 706 1,364
------- -------
Total debt...................................... 5,205 46,206
Less current portion............................... 2,598 1,795
----- -------
Long-term debt.................................. $ 2,607 $44,411
======= =======

F-12
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

In December 1998, the Company entered into a new credit agreement with its
existing bank (the "Credit Agreement") and refinanced the outstanding term loan
of $3.0 million due under the previous bank credit facility. The Credit
Agreement provides for borrowings up to $47.5 million and matures November 2002.
Revolving credit advances under the Credit Agreement require quarterly interest
payments through December 2000 when principal becomes payable based on a
five-year quarterly amortization and a final payment at maturity. Borrowings
under the bank credit facility may at no time exceed a specified borrowing base,
which is calculated as a multiple of the Company's earnings before interest,
income taxes, depreciation and amortization ("EBITDA"), as adjusted. The Credit
Agreement bears interest at variable rates, which are based upon (a) either (i)
the bank's base rate or (ii) LIBOR plus (b) a margin which varies according to
the ratio of the Company's funded debt to EBITDA, each as defined in the Credit
Agreement. The bank's base rate at December 31, 1998 was 7.5%. A commitment fee
is payable quarterly at rates ranging from 0.125 percent to 0.5 percent of the
unused amounts for such quarter. The Credit Agreement is collateralized by
substantially all of the Company's assets and contains affirmative and negative
covenants that require the Company to maintain certain financial ratios, limit
the creation or existence of liens and set certain restrictions on acquisitions,
mergers, sale of assets and restrict the payment of dividends. During 1998, the
Company made $600,000 in principal payments on the term loan and borrowed $37.0
million under the revolving bank credit facility, primarily to fund acquisitions
and capital expenditures.

The Company retired approximately $23.9 million of long-term debt in 1997
with proceeds of its initial public offering. The retirement of debt consisted
of $10.4 million of senior subordinated notes, $9.1 million of senior bank debt
and $4.4 million of promissory notes in connection with certain acquisitions. In
connection with the repayment of $9.5 million in 12% Senior Subordinated Debt in
September 1997, the Company recognized a $3.2 million extraordinary loss
associated with the early retirement of such debt.

At December 31, 1998, approximately $472,000 (net of accumulated amortization
of approximately $89,000) of debt issuance costs had been capitalized in
connection with the issuance of the Credit Agreement.

The Company has issued various subordinated seller notes payable in
connection with certain acquisitions ("Subordinated Seller Notes"). These notes
bear interest at varying rates ranging from 6.0% to 9.0%, require quarterly
payments of interest and principal, and mature at varying dates ranging from
June 2000 through June 2002.

The aggregate maturities of long-term debt for each of the next five years
subsequent to December 31, 1998 were as follows (in thousands):

1999..................................... $ 1,795
2000..................................... 3,808
2001..................................... 10,581
2002..................................... 29,898
2003..................................... 124
-------
$46,206
=======
5. STOCK:

In September and October 1997, the Company completed an initial public
offering, of 2,784,000 shares of its common stock at $13.00 per share. Proceeds
of $31.7 million, net of underwriting commission and offering expenses of $1.9
million, were used primarily to retire debt and complete the SW Dental
Associates, LC ("SW Dental") acquisition.

In connection with the completion of the initial public offering, the
holders of 1,244,737 shares of Series A and 485,382 shares of Series C Preferred
Stock converted such shares into an aggregate of 948,243 shares of Company
common stock. During the year ended December 31, 1997, the Company recorded
approximately $1.9 million in non-cash dividends, which represents the accretion
of the difference between the recorded value of the Preferred Stock and the
value of the common stock into which it was converted. As of December 31, 1997,
there were no shares of the Series A Stock and Series C Convertible Preferred
Stock (the "Series C Stock") outstanding.

F-13
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

In September 1997, the Company issued 119,231 shares of Series B Convertible
Preferred Stock (the "Series B Stock") in connection with the acquisition of SW
Dental (Note 3). The number of shares issued were equivalent to $1,550,000
divided by the initial public offering price of the Company's common stock of
$13.00 per share. The Series B Stock was convertible at the holder's option, for
a thirty-day period beginning one year after its issuance (the "Conversion
Period"), into an equivalent number of shares of the Company's common stock. In
October 1998, the holder of the 119,231 shares of Series B Preferred Stock
exercised the right to exchange the shares for an 8% subordinated note, due June
2002, in the original principal amount of $1,550,000, payable in quarterly
installments of $114,000 in principal and interest.

6. COMMITMENTS AND CONTINGENCIES:

LEASE COMMITMENTS

Future minimum lease payments under noncancelable operating leases with
remaining terms of one or more years consisted of the following at December 31,
1998 (in thousands):

1999..................................... $ 4,582
2000..................................... 4,024
2001..................................... 3,375
2002..................................... 2,728
2003..................................... 2,079
Thereafter............................... 8,957
-----
Total minimum lease obligation........... $25,745
=======

The Company has entered into operating leases for various types of office
equipment and for its building facilities. Certain building facility leases
include rent escalation clauses. Most leases contain purchase and renewal
options at fair market rental values.

LITIGATION

In August 1998, the former owner of certain dental practices acquired by the
Company in August 1996, filed a lawsuit against the Company in the 190th
District Court of Harris County, Texas. The lawsuit alleges that the Company
committed various acts of fraud, securities fraud, conspiracy, breach of
contract and misrepresentation concerning the value of the Company's common
stock issued in the acquisition of the dental practices. The lawsuit seeks
damages and exemplary damages in the amount of $11 million. The Company believes
that the asserted claims are without merit and intends to defend itself
vigorously. In the opinion of management, resolution of these claims will not
have a material adverse effect on the Company's financial position, results of
operations or cash flows.

In December 1998, a dentist with whom the Company had entered into an
agreement to acquire his dental practice filed a demand for arbitration alleging
that the Company is liable for damages resulting from the failure to complete
the transaction. The transaction was not completed because at least one of the
conditions required for closing was not met. The dentist is claiming damages
equal to the difference between the purchase price provided for in the agreement
of $6.5 million and the fair market value of the practice. The Company believes
that the asserted claims are without merit and that it is not liable for damages
resulting from these allegations. In the opinion of management, resolution of
these claims will not have a material adverse effect on the Company's financial
position, results of operations or cash flows.

The Company is from time to time subject to claims and suits arising in the
ordinary course of operations. In the opinion of management, the ultimate
resolution of such pending legal proceedings will not have a

F-14
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

material adverse effect on the Company's financial position, results of
operations or liquidity.

7. INCOME TAXES:

Significant components of the Company's deferred tax assets (liabilities) were
as follows:

DECEMBER 31,
---------------
1997 1998
---- ----
(IN THOUSANDS)

Deferred tax assets:

Net operating loss carry-forward.................. $ 2,275 $ 756
Deferred compensation............................. 650 400
Allowances for bad debts.......................... -- 1,232
Other............................................. -- 24
------- -------
Total deferred assets.......................... 2,925 2,412
------- -------
Deferred tax liabilities:
Unbilled receivables.............................. (975) (1,236)
Loss of Subchapter S status in connection with
changes in corporate form....................... (375) (211)
Management services agreements.................... (250) (4,047)
Property and equipment............................ (125) (400)
Other............................................. (75) (110)
-------- -------
Total deferred tax liabilities................. (1,800) (6,004)
-------- --------
Net deferred tax assets (liabilities)................ 1,125 (3,592)
Less current portion................................. -- 1,809
------- -------
Non-current assets (liabilities).................. $ 1,125 $(5,401)
======== ========

Significant components of the provision for income taxes on continuing
operations were as follows:

DECEMBER 31,
----------------------
1996 1997 1998
------ ------ ------
(IN THOUSANDS)
Current tax provision (benefit):

Federal........................................ $ -- $ -- $ (70)
State.......................................... -- 100 (8)
------ ------ -------
Total current............................... -- 100 (78)
Deferred tax provision (benefit):
Federal........................................ (512) 90 1,403
State.......................................... (49) 10 165
------- ------ ------
Total deferred.............................. (561) 100 1,568
------- ------ ------
Provision (benefit) for income taxes................. $ (561) $ 200 $1,490
======= ====== ======

The differences between the statutory federal tax rate and the Company's
effective tax rate on continuing operations were as follows (in thousands):

DECEMBER 31,
----------------------
1996 1997 1998
------ ------ ------
(IN THOUSANDS)

Tax at U.S. statutory rate (34%).................. $ (560) $ 208 $1,726
State income taxes, net of federal tax............ (66) 24 203
Nondeductible expenses and other.................. 65 (32) 26
Change in estimate of net operating
loss carryforward............................... -- -- (465)
$ (561) $ 200 $1,490
======= ====== ======

F-15
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

At December 31, 1998, the Company had net operating loss carryforwards
available to reduce future taxable income of approximately $3.0 million,
expiring in 2017. The Company has not recorded a valuation allowance for the
potential inability to realize its net deferred tax assets because, after
consideration of the affiliated dental practices' historical operating results
and the Company's planned operations, management believes that it is more likely
than not that the Company will realize those assets.

8. STOCK OPTION PLANS:

The Company grants stock options under the Castle Dental Centers, Inc.
Omnibus Stock and Incentive Plan, a stock-based incentive compensation plan (the
"Employees' Plan"), and the Non-employee Directors' Stock Option Plan (the
"Directors' Plan," together the "Plans") which are described below. The Company
recognizes stock-based compensation issued to employees at the intrinsic value
between the exercise price of options granted and the fair value of stock for
which the options may be exercised However, pro forma disclosures as if the
Company recognized stock-based compensation at the fair-value of the options
themselves are presented below.

Under the Employees' Plan, the Company is authorized to issue 1,050,000
shares of Common Stock pursuant to "Awards" granted to officers and key
employees in the form of stock options and restricted stock. Under the
Directors' Plan, the Company is authorized to issue 150,000 shares of Common
Stock to non-employee directors of the Company.

There are 718,400 and 125,000 options granted under the Employees' Plan and
the Directors' Plan, respectively, at December 31, 1998. The Compensation
Committee administers the Plans. These stock options have contractual terms of
10 years and have an exercise price no less than the fair market value of the
stock at grant date. The options vest at varying rates over a four or five-year
period, beginning on the first anniversary of the date of grant.

Following is a summary of the status of the Company's stock options as of
December 31, 1998 and the changes during the three-year period then ended:

NUMBER OF WEIGHTED
SHARES OF AVERAGE
UNDERLYING EXERCISE
OPTIONS PRICES
--------- ---------
Outstanding at January 1, 1996... -- $ --

Granted.......................... 91,750 10.00
Exercised........................ -- --
Forfeited........................ -- --
Expired.......................... -- --
------- --------
Outstanding at December 31, 1996. 91,750 $ 10.00
======= ========
Exercisable at December 31, 1996. -- --
====== ========
Granted.......................... 562,500 10.67
Exercised........................ -- --
Forfeited........................ (20,000) --
Expired.......................... -- --
------- --------
Outstanding at December 31, 1997. 634,250 $ 10.59
======= ========
Exercisable at December 31, 1997. 14,350 $ 10.00
======= ========

Granted.......................... 281,750 5.31
Exercised........................ -- --
Forfeited........................ (72,600) 11.03
Expired.......................... -- --
------- --------
Outstanding at December 31, 1998. 843,400 $ 8.79
======= ========
Exercisable at December 31, 1998. 126,680 $ 10.47
======= ========

F-16
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

Weighted-average fair value of options granted during the year:

1996............................. $2.56
1997............................. 5.06
1998............................. 2.85

The fair value of each stock option granted by the Company is estimated on
the date of grant using the minimum value method for 1996 and Black-Scholes
option pricing model for 1997 and 1998 with the following weighted-average
assumptions: dividend yield of 0% for each year; expected volatility of 0% for
1996, 45.0% for 1997, and 56.9% for 1998; risk-free interest rates are 6.1% for
1996, 5.9% for 1997, and 4.7% for 1998; and the expected lives of the options
average five years.

The following table summarizes information about stock options outstanding at
December 31, 1998:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- ------------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
RANGE OF AT CONTRACT EXERCISE AT EXERCISE
EXERCISE PRICES 12/31/98 LIFE PRICE 12/31/97 PRICE
--------- --------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$5.00 to $9.99.............. 281,750 9.69 years $ 5.31 -- $ --
$10.00 to $13.00............ 561,650 8.65 years $ 10.53 126,680 $ 10.47
--------- --------- -------- ----------- --------
843,400 9.00 years $ 8.79 126,680 $ 10.47
========= ===========
</TABLE>
Had the compensation cost for the Company's stock-based compensation plans
been determined using the fair value rather than the intrinsic value of the
options, the Company's net income and diluted net income per share for 1998
would approximate $3.5 million, or $0.54 per share; the net loss and basic and
diluted net loss per common share for 1997 would approximate $2.9 million or
$0.71 per share. The pro forma effect for 1996 is immaterial.

The effects of applying fair value accounting in this pro forma disclosure
are not indicative of future amounts.

9. EARNINGS PER SHARE:

A reconciliation of the numerators and denominators of the basic and diluted
per-share computations for net income follows:

DECEMBER 31,
----------------------
1996 1997 1998
------ ------ ------
(IN THOUSANDS)

Net income (loss) attributable to
common stock (1)......................... (1,086) (4,714) 3,586
Preferred stock accretion................. -- 1,930 --
-------- -------- -------
Net (loss) income......................... (1,086) (2,784) 3,586
Less extraordinary loss................... -- 3,195 --
-------- -------- -------
Income before extraordinary loss.......... $ (1,086) $ 411 $ 3,586
========= ======== =======
Shares (denominator)
Shares - basic (2)..................... 3,191 4,100 6,586
Options and warrants................... -- 32 22
-------- -------- -------
Shares -- diluted...................... 3,191 4,132 6,608
======== ======== =======
----------
(1)The effect of the preferred stock accretion is excluded from earnings per
share. The preferred stock was converted to common stock at a nominal
value and those common shares were included in the calculation of Basic
shares outstanding for all periods.
(2)Includes the weighted average of 407,454 shares of common stock issuable
upon the exercise of the conversion right (See Note 3).

F-17
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

Options to purchase an aggregate 125,000 shares of common stock at exercise
prices of $13.00 per share were excluded from the calculation of diluted
earnings per share for 1997 because their effect would have been antidilutive.
The options, which expire in 2007, were still outstanding at December 31, 1997.
Options to purchase an aggregate 616,000 shares of common stock at exercise
prices of $10.00 to $13.00 per share were excluded from the calculation of
diluted earnings per share for 1998 because their effect would have been
antidilutive. The options, which expire in 2007, were still outstanding at
December 31, 1998.

A warrant to purchase 56,579 shares of common stock at $11.00 per share was
excluded from the calculation of diluted earnings per share for 1997 and 1998
because its effect would have been antidilutive. The warrant, which expires in
December 2000, was still outstanding at December 31, 1998.

10. DEFINED CONTRIBUTION PLANS:

In August 1996, the Company adopted a defined contribution plan qualified
under Section 401(k) of the Internal Revenue Code of 1986 (the "401(k) Plan").
All permanent employees of the Company, except those of the Tennessee
subsidiary, are eligible to participate in the 401(k) Plan upon the completion
of three months of service. The Company maintains a separate defined
contribution 401(k) plan for all permanent employees of the Company's Tennessee
subsidiary ("Tennessee 401(k) Plan"). Employees are eligible to participate in
the Tennessee 401(k) Plan upon the completion of four months of service. The
Company may match contributions made by participants under both Plans each year
in an amount determined by the Company on a year-to-year basis. The Company did
not make any contributions to either Plan in 1997 or 1998.

11. SUPPLEMENTAL CASH FLOW INFORMATION:

DECEMBER 31,
---------------------
1996 1997 1998
----- -------- -----
(IN THOUSANDS)
Cash paid during the period for:
Interest.................................. $1,358 $1,707 1,803
Income taxes.............................. -- 44 222
Supplemental disclosure of noncash investing and
financing activities:
Issuance of notes payable for accrued
interest and purchase of property and
equipment................................... 576 450 --
Issuance of capital lease obligation for
property and equipment...................... -- 416 --
Issuance of Series B Preferred Stock in connection
with an acquisition......................... -- 1,550 --
Issuance of Preferred Stock in connection with
related party financing..................... -- 1,144 --
Conversion to common stock of Series A and
Series C Preferred Stock.................... -- 5,898 --
Conversion of Series B Preferred Stock to
subordinated notes.......................... -- -- 1,550

12. CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTS:

CREDIT RISK

The Company grants customers credit in the normal course of business. The
Company does not require collateral on the extension of credit. Procedures are
in effect to monitor the creditworthiness of customers and appropriate
allowances are made to reduce accounts to their net realizable values.

The Company maintains cash balances at various financial institutions.
Accounts at each institution are

F-18
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

insured by the Federal Deposit Insurance Corporation up to $100,000. The
Company's accounts at these institutions may, at times, exceed the federally
insured limits. The Company has not experienced any losses in such accounts.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The following estimated fair values of financial instruments have been
determined by the Company using available market information and appropriate
valuation methodologies.

The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable and the revolving line of credit approximate fair values due to
the short-term maturities of these instruments. The carrying amounts of the
Company's long-term borrowings and preferred stock as of December 31, 1997 and
1998, respectively, approximate their fair value based on the Company's current
incremental borrowing rates for similar type of borrowing arrangements.

13. RELATED PARTY TRANSACTIONS:

The Company maintains a management services agreement with one of the
Company's affiliated dental practices in Texas pursuant to which the sole
shareholder of the affiliated dental practice, a member of the Board of
Directors of the Company, receives an annual salary of $100,000 to take actions
necessary to maintain the dental license for the affiliated dental practice in
the state of Texas, for as long as he holds such license and is the sole
shareholder of the practice. Such compensation arrangement was negotiated
between the shareholder and previously unaffiliated investors in the Company. In
1995, in connection with the Company's acquisition of the assets of the
shareholder's dental practice, the Company entered into a deferred compensation
agreement with the shareholder pursuant to which the Company agreed to pay the
shareholder $2.6 million in 20 quarterly installments of $131,500, beginning
March 1996. As of December 31, 1998, there was $1.1 million payable to the
shareholder under the terms of the deferred compensation agreement.

At December 31, 1998, two executive officers of the Company had outstanding
loans in the aggregate amount of $339,000 from the Company. These loans are
repayable over varying periods ranging from one to five years and bear interest
at rates ranging from zero to six percent.

A director of the Company is a Managing Director of The GulfStar Group, Inc.
("GulfStar"), which has provided investment banking and advisory services to the
Company. The Company paid $198,000 and $183,000 during 1996 and 1998,
respectively, in investment banking fees to GulfStar.

A director of the Company is a Managing Director of Pecks Management
Partners Ltd., the investment advisor to investors in the Company owning an
aggregate of 913,243 shares of Company common stock. Pursuant to the provisions
of the Securities Purchase Agreement dated December 18, 1995, for so long as
certain ownership thresholds are maintained with respect to the common stock,
the investors have the contractual right to nominate one member of the Company's
Board of Directors.

During 1995, the Company entered into a lease agreement with Goforth, Inc.,
a company owned by the Company's chairman and chief executive officer (the
"Affiliate"). The Company has agreed to pay the Affiliate a minimum guaranteed
rental of $12,000 per month through January 2001 and $13,200 per month from
January 2001 through January 2006 for rental of a dental center. The Company has
also agreed to pay additional rent of approximately $1,600 per month for
insurance, taxes and common area maintenance. The Company paid $235,000,
$174,000 and $174,000 under this agreement during 1996, 1997 and 1998,
respectively.

F-19
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

14. QUARTERLY FINANCIAL DATA (UNAUDITED):

FIRST SECOND THIRD FOURTH
----- ------ ----- ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1996

Net patient revenues............... $4,493 $ 6,214 $ 9,194 $ 9,700
Operating income (loss)............ 580 430 330 (480)
Net income (loss).................. 77 (46) (283) (835)
Earnings (loss) per share.......... 0.02 (0.02) (0.09) (0.25)

1997

Net patient revenues............... 10,464 10,863 11,727 13,171
Operating income................... 803 740 835 941
Income(loss)before extraordinary loss 21 (101) (30) 521
Extraordinary loss................. -- -- (3,195) --
Net income (loss).................. 21 (101) (3,225) 521
Basic and diluted earnings per share(1):
Income(loss)before extraordinary loss 0.01 (0.03) (0.01) 0.09
Extraordinary loss............... -- -- (0.85) --
------ ------- ------ ------
Net income (loss)................ 0.01 (0.03) (0.86) 0.09
===== ====== ====== ======

1998
Net patient revenues............... 14,541 19,679 20,175 20,427
Operating income................... 1,076 1,713 1,973 2,146
Net income......................... 662 781 1,021 1,122
Basic and diluted earnings per share(1) $0.11 $ 0.12 $ 0.15 $ 0.17

--------

(1)Earnings per share are computed independently for each of the quarters
presented. Therefore, the sum of the quarterly earnings per share does not
equal the total computed for the year due to stock transactions that
occurred.

F-20
<PAGE>
CASTLE DENTAL CENTERS, INC.
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

15. OPERATING SEGMENTS:

Financial information is provided below for each of the Company's operating
regions. The Company measures the performance of its regional operations
primarily based on net patient revenues and operating income. There are no
inter-regional revenues. The Company's primary measure of profit is that by
which it formulates decisions and communicates to investors and analysts is net
income and earnings per share. Financial information internally reported for the
Company for the years ended December 31, 1996, 1997 and 1998 is as follows:

DECEMBER 31,
---------------------
1996 1997 1998
----- -------- -----
(IN THOUSANDS)
Net patient revenue:

Texas.................................. $ 21,076 $ 29,631 $ 47,464
Florida................................ 4,920 9,650 11,951
Tennessee.............................. 3,605 6,944 7,853
California............................. -- -- 7,555
------- ----- ------
Total revenue.......................... 29,601 46,225 74,823

Operating expenses:
Texas.................................. 17,818 25,460 39,865
Florida................................ 4,775 8,708 10,351
Tennessee.............................. 3,683 6,502 7,419
California............................. -- -- 6,289
------- ----- ------
Total operating expenses............... 26,276 40,670 63,924

Operating income (loss):
Texas.................................. 3,258 4,171 7,599
Florida................................ 145 942 1,600
Tennessee.............................. (78) 442 434
California............................. -- -- 1,266
----- ----- ------
Total operating income.............. 3,325 5,555 10,899
Corporate, general and administrative expenses 2,465 2,236 3,991
Interest expense.......................... 2,596 2,792 1,889
Other income.............................. (89) (84) (57)
------ ----- -------
Income (loss) before income taxes and
extraordinary loss...................... $ (1,647) $ 611 $ 5,076
====== ===== =======

Assets:

Texas.................................. $ 24,818 $ 37,953
Florida................................ 8,626 12,203
Tennessee.............................. 6,996 6,276
California............................. -- 20,259
---- ------
Total assets for reportable segments 40,440 76,691
Other unallocated amounts.............. 4,073 23,344
----- ------
Total assets........................ $ 44,513 $100,035
====== ========

F-21
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Castle Dental Centers, Inc.:

Our report on the financial statements of Castle Dental Centers, Inc. is
included on page F-2 of this Form 10-K. In connection with our audits of such
financial statements, we have also audited the related financial statement
schedule listed in item 14(a) in this Form 10-K.

In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included herein.

PricewaterhouseCoopers LLP

Houston, Texas
March 5, 1999

S-1
<PAGE>

<TABLE>
<CAPTION>
CASTLE DENTAL CENTERS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

(IN THOUSANDS)

BALANCE BALANCE
BEGINNING CHARGED TO AT END
OF YEAR EXPENSES DEDUCTIONS OTHER (1) OF YEAR
------- ------ ---------- --------- --------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996:
Allowance for uncollectible accounts -
patient receivables...... $ 2,437 $1,137 $ 1,324 $ 175 $2,425
======= ====== ======= ===== ======
Year ended December 31, 1997:
Allowance for uncollectible accounts -
patient receivables...... $ 2,425 $1,698 $ 451 $ 257 $3,929
======= ====== ======= ===== ======
Year ended December 31, 1998
Allowance for uncollectible accounts -
patient receivables...... $ 3,929 $2,474 $ 1,092 $3,197 $8,508
======= ====== ======= ======= ======
</TABLE>
<TABLE>
<CAPTION>
BALANCE BALANCE
BEGINNING CHARGED TO AT END
OF YEAR EXPENSES DEDUCTIONS OTHER (1) OF YEAR
------- ------ ---------- --------- --------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996:
Allowance for uncollectible accounts -
unbilled patient receivables. $ 228 $ 90 $ -- $ 43 $ 361
======= ====== ====== ======= =======
Year ended December 31, 1997:
Allowance for uncollectible accounts -
unbilled patient receivables. $ 361 $ 199 $ -- $ 8 $ 568
======= ======= ====== ====== ======
Year ended December 31, 1998
Allowance for uncollectible accounts -
unbilled patient receivables $ 568 $ 71 $ 30 $ 49 $ 658
======= ====== ====== ======= =======
</TABLE>
------------

(1)Acquired allowances for uncollectible accounts of affiliated dental
practices.

S-2
<PAGE>
ITEM 14 (A)(3). EXHIBITS

EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
*3.1 -- Certificate of Incorporation of Castle Dental Centers, Inc.,
as amended.
*3.2 -- Certificate of Amendment to Certificate of Incorporation of
Castle Dental Centers, Inc. dated August 28, 1996.
*3.3 -- Bylaws of Castle Dental Centers, Inc.
*3.4 -- Amendment to Bylaws of Castle Dental Centers, Inc.
dated August 16, 1996.
*3.5 -- Certificate of Amendment of Certificate of Incorporation of
Castle Dental Centers, Inc. dated June 16, 1997.
*4.1 -- Form of Certificate representing the Common Stock, par value
$.001 per share, of Castle Dental Centers, Inc.
*4.2 -- Registration Rights Agreement dated December 18, 1995, among
Castle Dental Centers, Inc. and Delaware State Employees'
Retirement Fund, Declaration of Trust for Defined Benefit
Plan of ICI American Holdings, Inc., Declaration of Trust for
Defined Benefit Plan of Zeneca Holdings, Inc. and certain
stockholders and investors in the Company.
*4.3 -- Amended and Restated Securityholders Agreement dated June 16,
1997, among Castle Dental Centers, Inc., Jack H. Castle,
D.D.S., P.C., certain investors in the Company, certain
stockholders of Castle Dental Centers, Inc., and certain
shareholders of Jack H. Castle, D.D.S., P.C.
*10.1 -- Securities Purchase Agreement dated December 18, 1995 among
Castle Dental Centers, Inc., Jack H. Castle, D.D.S., P.C.,
JHCDDS, Inc. and certain investors.
*10.2 -- Amendment No. 1 to Securities Purchase Agreement dated June
16, 1997 among Castle Dental Centers, Inc., Jack H. Castle,
D.D.S., P.C., JHCDDS, Inc. and certain investors.
*10.3 -- Managemen Services Agreement effective December 18, 1995 by
and between Castle Dental Centers, Inc. and Jack H. Castle,
D.D.S., P.C. *10.4 -- Amendment to Management Services
Agreement between Castle Dental Centers, Inc. and Jack H.
Castle, D.D.S., P.C., dated as of August 15, 1996.
*10.5 -- Plan and Agreement of Merge of Family Dental Services of
Texas, Inc. with and into Castle Dental Centers, Inc. dated
December 18, 1995.
*10.6 -- Stock Purchase Agreement dated December 18, 1995 by and
between Jack H.Castle, D.D.S. and Castle Dental Centers, Inc.
*10.7 -- Amendment to Stock Purchase Agreement by and between Jack H.
Castle, D.D.S. and Castle Dental Centers, Inc., dated as of
August 15, 1996.
**10.8 -- Deferred Compensation Agreement effective December 18,1995 by
and between Castle Dental Centers, Inc. and Jack H. Castle,
D.D.S.
*10.9 -- Indemnity Agreement dated December 18, 1995 by and between
Castle Dental Centers, Inc. and G. Kent Kahle.
*10.10 -- Indemnity Agreement dated December 18, 1995, by and between
Castle Dental Centers, Inc. and Jack H. Castle, D.D.S.
*10.11 -- Indemnity Agreement dated December 18, 1995 by and between
Castle Dental Centers, Inc. and Jack H. Castle, Jr.
*10.12 -- Indemnity Agreement dated December 18, 1995 by and between
Castle Dental Centers, Inc. and Robert J. Cresci.
*10.13 -- Indemnity Agreement dated August 16, 1996 by and between
Castle Dental Centers, Inc. and Elizabeth A. Tilney.
*10.14 -- Asset Purchase Agreement dated May 19, 1996 by and among
Castle Dental Centers of Florida, Inc., and 1st Dental Care,
Inc., Hernando Dental Center-Lester B. Greenberg,
D.D.S., P.A., M&B Dental Lab, Inc., Lester B. Greenberg,
D.D.S. and Elisa Greenberg.
*10.15 -- Management Services Agreement effective May 19, 1996 by and
between Castle Dental Centers of Florida, Inc. and Castle 1st
Dental Care, P.A.
*10.16 -- Amendment to Management Services Agreement between Castle
Dental Centers of Florida, Inc. and Castle 1st Dental Care,
P.A., dated as of August 16, 1996.

<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT

*10.17 -- Asset Purchase Agreement dated April 29, 1996 by and among
Castle Dental Centers of Tennessee, Inc. and Mid-South Dental
Center, P.C. and G. Powell Bilyeu, D.D.S.

*10.18 -- Management Services Agreement effective May 31, 1996 by
and between Castle Dental Centers of Tennessee, Inc. and
Castle Mid-South Dental Center, P.C.

*10.19 -- Amendment to Management Services Agreement between Castle
Dental Centers of Tennessee, Inc. and Castle Mid-South
Dental Center, P.C., dated as of August 16, 1996.

*10.20 -- Asset Purchase Agreement dated August 9, 1996 by and among
Castle Dental Centers, Inc.; Castle Dental Centers of Texas,
Inc.; Consolidated Industries, Inc.; S.A. Dental Services,
P.C.; C.A. Dental Services, P.C.; S.C.A. Dental Services,
P.C.; Austin Periodontist Associates, Inc.; Joseph A.
Bonola, D.D.S.; and Kristen Bonola.

*10.21 -- Plan and Agreement of Reorganization dated August 9, 1996 by
and among Castle DentalCenters, Inc.; Castle Dental Centers
of Texas, Inc.; N.A. Dental Services, P.C.; EFWDental
Services, P.C.; HDC Dental Services, P.C.; Midcities Dental
Services, P.C.; NEFW Dental Services, P.C.; West Ft. Worth
Dental Services, P.C.; Joseph A. Bonola, D.D.S.; Kristen
Bonola; and Larry Charles Jackson.

**10.22 -- 1996 Castle Dental Centers, Inc. Omnibus Stock and Incentive
Plan, as amended.

**10.23 -- 1996 Castle Dental Centers, Inc. Non-Employee Directors'
Plan, as amended.

*10.24 -- Agreement and Plan of Merger dated as of December 8, 1997 by
and among Castle Dental Centers of Texas, Inc and Steve W.
Lebo, D.D.S., Inc. and Steve W. Lebo, D.D.S.

*10.25 -- Lease dated January 1, 1996 by and between Goforth, Inc. and
Family Dental Services of Texas, Inc.

*10.26 -- Member Interests Purchase Agreement dated as of June 1, 1997
by and among Castle Dental Centers of Texas, Inc., Castle
Dental Centers, Inc., Jack H. Castle, D.D.S., P.C., SW
Dental Associates, LC, John Goodman, D.D.S. and Harold
Simpson, Jr.

10.27 -- Master Contribution and Combination Agreement dated as of
January 30, 1998, by and among Castle, CDC of California,
Inc., a Delaware corporation ("CDC"), Dental Consulting
Services, LLC, a California limited liability company
("DCS"), Castle Dental Centers of California, L.L.C., a
Delaware limited liability company ("Castle West"), Castle
West Holdings, LLC, a California limited liability company
("Holdings"), and each of the "Members" who are parties
thereto. (Incorporated by reference from the Company's Form
8-K dated as of March 30, 1998.)

10.28 -- Limited Liability Company Agreement of Castle West.
(Incorporated by reference from the Company's Form 8-K dated
as of March 30, 1998.)

10.29 -- Management Agreement between Holdings and Castle West.
(Incorporated by reference from the Company's Form 8-K dated
as of March 30, 1998.)

10.30 -- Form of Subordinated Promissory Note issued to former
members of DCS. (Incorporated by reference from the Company's
Form 8-K dated as of March 30, 1998.)

10.31 -- Form of Subordination Agreement entered into between each
former member of DCS, Castle and NationsBank of Texas, N.A.,
as Agent. (Incorporated by reference from the Company's Form
8-K dated as of March 30, 1998.)

10.32 -- Registration Rights Agreement among Castle and each former
member of DCS. (Incorporated by reference from the Company's
Form 8-K dated as of March 30, 1998.)

10.33 -- Stockholders' Agreement among CDC, Castle West, DCS,
Holdings, each member of DCS ("Corporate B Member"), each
stockholder of each Corporate B Member ("B Stockholder"),
each member of Holdings ("Corporate C Member"), and each
stockholder of each Corporate C Member ("C Stockholder").
(Incorporated by reference from the Company's Form 8-K dated
as of March 30, 1998.)

10.34 -- Asset Purchase Agreement
dated as of December 30, 1998, by and among Castle Dental
Centers of Texas, Inc., Castle Dental Centers, Inc., and
Jack H. Castle, D.D.S., P.C., and DCA Limited Partnership,
L.L.P. ("DCA, Ltd."), Dental Administrators of Texas Limited
Partnership, L.L.P. ("DAI, Ltd."), Dental Centers of America
Paymaster P.C. ("Paymaster"), Bandera Road Dental Center,
P.C. ("Bandera"), Ingram Park Family Dental Center, P.C.
("Ingram"), Northeast Family Dental Center, P.C.
("Northeast"), Dental Centers of America at Rolling Oaks
Mall, PLLC ("Rolling Oaks"), San Pedro Family Dental Center,
P.C. ("San Pedro"), Southpark Family Dental

<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------

Center, P.C. ("Southpark"), Windsor Park Family Dental
Center, P.C. ("Windsor"), Dental Centers of America at Barton
Creek Square Mall, PLLC ("Barton Creek"), Dental Centers of
America at Lakeline Mall, PLLC ("Lakeline"), Dental Centers
of America at Hurst Northeast Mall, PLLC ("Hurst"), Dental
Centers of America at Irving Mall, PLLC ("Irving"), Dental
Centers of America at Six Flags Mall, PLLC ("Six Flags"),
Dental Centers of America at Waco, P.C. ("Waco"), Dental
Centers of America at Mesquite, P.C. ("Mesquite"), Dental
Centers of America at Sherman, P.C. ("Sherman"), Dental
Centers of America at Richardson Square Mall, P.C.
("Richardson" and, collectively with DCA, Ltd., DAI, Ltd.,
Paymaster, Bandera, Ingram, Northeast, Rolling Oaks, San
Pedro, Southpark, Windsor, Barton Creek, Lakeline, Hurst,
Irving, Six Flags, Waco, Mesquite and Sherman, the "DCA
Sellers"), Barry E. Solomon, D.D.S., an individual living in
San Antonio, Texas ("B. Solomon"), Marc A. Solomon, an
individual living in San Antonio, Texas ("M. Solomon"),
Hebron D. Cutrer, an individual living in San Antonio, Texas
("Cutrer"), Stan E. Faye, an individual living in San
Antonio, Texas ("Faye"), and Robert B. Grau, an individual
living in San Antonio, Texas ("Grau", and together with B.
Solomon, M. Solomon, Cutrer and Faye, the "DCA
Shareholders"). (Incorporated by reference from the Company's
Form 8-K dated as of December 30, 1998.)

10.35 -- Form of Subordinated Promissory Note issued to DCA Sellers
and/or DCA shareholders. (Incorporated by reference from the
Company's Form 8-K dated as of December 30, 1998.)

10.36 -- Form of Subordination Agreement entered into between each
DCA Seller and/or DCA Shareholder receiving a Subordinated
Promissory Note, Castle Dental and NationsBank, N.A., as
Agent. (Incorporated by reference from the Company's Form
8-K dated as of December 30, 1998.)

10.37 -- Registration Rights Agreement among Castle Dental and each
DCA Shareholder. (Incorporated by reference from the
Company's Form 8-K dated as of December 30, 1998.)

10.38 -- Amended and Restated Credit Agreement dated as of December
18, 1998, by and among Castle Dental, NationsBank, N.A., as
agent, and the lenders thereunder. (Incorporated by
reference from the Company's Form 8-K dated as of December
30, 1998.) 10.39 -- Amendment, dated May 29, 1998, to the
Master Contribution and Combination Agreement, dated as of
January 30, 1998, by and among Castle, CDC of California,
Inc., a Delaware corporation ("CDC"), Dental Consulting
Services, LLC, a California limited liability company
("DCS"), Castle Dental Centers of California, L.L.C., a
Delaware limited liability company ("Castle West"), Castle
West Holdings, LLC, a California limited liability company
("Holdings"), and each of the "Members" who are parties
thereto, and to the Management Agreement between Holdings
and Castle West.

21 -- Subsidiaries of the Registrant.

27.1 -- Financial Data Schedule as of December 31, 1998.

-------------

* Incorporated herein by reference to the Company's Registration Statement on
Form S-1 (registration number 333-1335)

EXHIBIT 21

SUBSIDIARIES

SUBSIDIARY PCT. OWNERSHIP STATE OF INCORPORATION

Castle Dental Centers of Texas, Inc. 100% Texas

Castle Dental Centers of Austin, Inc. 100% Texas

Dental World, Inc. (of Castle Dental 100% Texas
of Texas, Inc.)

JHCDDS, Inc. 100% Texas

Castle Dental Centers of Tennessee, Inc. 100% Tennessee

Castle Dental Centers of Florida, Inc. 100% Florida

Dentcor, Inc. (of Castle Dental Centers 100% Florida
of Florida, Inc.)

CDC of California, Inc. 100% Delaware

Castle Dental Centers of California, L.L.C. 80% Delaware
(of CDC of California, Inc.)

<ARTICLE> 5
<LEGEND>
THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION
EXTRACTED FROM THE DECEMBER 31, 1998 CONSOLIDATED BALANCE SHEET AS OF
DECEMBER 31, 1998 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS,
FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 695
<SECURITIES> 0
<RECEIVABLES> 23,117
<ALLOWANCES> 9,166
<INVENTORY> 0
<CURRENT-ASSETS> 19,342
<PP&E> 18,759
<DEPRECIATION> 4,898
<TOTAL-ASSETS> 100,035
<CURRENT-LIABILITIES> 8,997
<BONDS> 44,937
0
0
<COMMON> 6
<OTHER-SE> 36,397
<TOTAL-LIABILITY-AND-EQUITY> 100,035
<SALES> 74,823
<TOTAL-REVENUES> 74,823
<CGS> 0
<TOTAL-COSTS> 67,915
<OTHER-EXPENSES> (57)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,889
<INCOME-PRETAX> 5,076
<INCOME-TAX> 1,490
<INCOME-CONTINUING> 3,586
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,586
<EPS-PRIMARY> (0.54)
<EPS-DILUTED> (0.54)

</TABLE>