PROSPECTUS
2,000,000 SHARES
[LOGO -- APPLE ORTHODONTIX, INC.]
CLASS A COMMON STOCK
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This Prospectus covers the offer and sale of up to 2,000,000 shares of
Class A Common Stock, par value $.001 per share ("Common Stock"), of Apple
Orthodontix, Inc. ("Apple" or the "Company"), which Apple may issue from
time to time in connection with the future affiliations with orthodontic
practices ("Practices"), direct and indirect acquisitions of other businesses,
properties or securities in business combination transactions (collectively,
"Affiliations") in accordance with Rule 415(a)(1)(viii) of Regulation C under
the Securities Act of 1933, as amended (the "Securities Act"), or as otherwise
permitted under the Securities Act. The Common Stock is entitled to one vote per
share while the Class B Common Stock is entitled to three-tenths (3/10ths) of a
vote per share.
Apple expects that the terms upon which it may issue the shares in
Affiliations will be determined through negotiations. It is expected that the
shares that are issued will be valued at prices reasonably related to market
prices for the Common Stock prevailing either at the time an Affiliation
agreement is executed or at the time an Affiliation is consummated.
This Prospectus will be furnished to securityholders of Practices or of the
business, properties or securities to be acquired. This Prospectus will only be
used in connection with Affiliations that would be exempt from registration but
for the possibility of integration with other transactions. If an Affiliation is
not exempt from registration even if integration is not taken into account, then
the offerees of Common Stock in such Affiliation will be furnished with copies
of this Prospectus as amended by a post-effective amendment to the Registration
Statement on Form S-4 of which this Prospectus is a part.
Persons receiving Common Stock in connection with Affiliations may be
contractually required to hold all or some portion of the Common Stock for
varying periods of time. In addition, pursuant to the provisions of Rule 145
under the Securities Act, the volume limitations and certain other requirements
of Rule 144 under the Securities Act will apply to resales of those shares by
affiliates of the businesses the Company acquires for a period of two years. See
"Plan of Distribution."
If an Affiliation has a material financial effect upon Apple, a current
report on Form 8-K, or if Apple is not eligible to incorporate such a report by
reference a post-effective amendment to the registration statement of which this
Prospectus forms a part, will be filed subsequent to the Affiliation, and prior
to the consummation of additional Affiliations utilizing this Prospectus,
containing financial and other information about the Affiliation that would be
material to subsequent acquirors of Common Stock offered hereby, including pro
forma information for Apple and historical financial information about
Affiliating Practices and Companies. A current report on Form 8-K, or if Apple
is not eligible to incorporate such a report by reference a post-effective
amendment to the registration statement of which this Prospectus forms a part,
will also be filed when an Affiliation does not per se have a material effect
upon Apple, but if aggregated with other Affiliations (for which such
information has not been filed) since the date of Apple's most recent audited
financial statements, would have such a material effect.
As of May 29, 1997, 6,376,483 shares of Common Stock were issued and
outstanding, of which 2,702,500 are registered and available for unrestricted
trading in public markets unless owned by affiliates of Apple. The Common Stock
is listed on The American Stock Exchange, under the symbol "AOI." Application
will be made to list the shares offered hereby on The American Stock Exchange.
On July 17, 1997, the last reported sales price of the Common Stock on The
American Stock Exchange was $11.00 per share.
All expenses of this offering (this "Offering") will be paid by Apple. No
underwriting discounts or commissions will be paid in connection with the
issuance of shares by Apple in Affiliations.
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THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" COMMENCING ON PAGE 7.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The date of this Prospectus is July 21, 1997
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PROSPECTUS SUMMARY
CONCURRENTLY WITH APPLE'S INITIAL PUBLIC OFFERING (THE "IPO"), APPLE
ACQUIRED, IN SEPARATE TRANSACTIONS (THE "ACQUISITIONS"), SUBSTANTIALLY ALL THE
TANGIBLE AND INTANGIBLE ASSETS, AND ASSUMED CERTAIN LIABILITIES, OF 31
ORTHODONTIC PRACTICES (COLLECTIVELY, THE "FOUNDING AFFILIATED PRACTICES") IN
EXCHANGE FOR CASH AND SHARES OF CLASS A COMMON STOCK, PAR VALUE $.001 PER SHARE,
OF APPLE ("COMMON STOCK"). UNLESS OTHERWISE INDICATED BY THE CONTEXT,
REFERENCES HEREIN TO (I) "APPLE" OR THE "COMPANY" MEAN APPLE ORTHODONTIX,
INC., (II) "AFFILIATED PRACTICES" MEAN THE FOUNDING AFFILIATED PRACTICES AND
ANY ORTHODONTIC PRACTICES WITH WHICH THE COMPANY MAY ENTER INTO SIMILAR
RELATIONSHIPS IN THE FUTURE, (III) "NEW CASE STARTS" MEAN THE NUMBER OF NEW
PATIENTS BEGINNING TREATMENT DURING A PERIOD OF TIME AND (IV) "CASE ACCEPTANCE
RATE" MEAN, FOR ANY SPECIFIED PERIOD OF TIME, THE PERCENTAGE OF POTENTIAL
PATIENTS WHO UNDERGO AN INITIAL EXAMINATION AT AN ORTHODONTIC PRACTICE WHO IN
FACT ELECT TO BEGIN TREATMENT WITH SUCH EXAMINING ORTHODONTIST.
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, APPEARING
ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, THE INFORMATION IN
THIS PROSPECTUS (I) GIVES EFFECT TO THE ACQUISITIONS AND (II) GIVES EFFECT TO
CERTAIN STOCK SPLITS OF THE OUTSTANDING SHARES OF CLASS B COMMON STOCK, PAR
VALUE $.001 PER SHARE ("CLASS B STOCK") EFFECTED IN CONNECTION WITH THE
OFFERING.
THE COMPANY
Apple was founded in July 1996 to provide practice management services to
orthodontic practices in the United States and Canada. The Company's objective
is to provide a full complement of practice management services designed to
drive internal growth by enhancing the ability of Affiliated Practices to: (i)
deliver quality, affordable orthodontic treatment primarily on a fee-for-service
basis; (ii) stimulate demand in their local markets by increasing consumer
awareness of the benefits, availability and affordability of orthodontic
treatment; and (iii) improve the productivity and profitability of their
practices. The Company will also seek to grow through the Affiliation with
additional Practices and the development of satellite offices that complement
geographic areas served by existing and future Affiliated Practices. The Company
will earn revenue by providing management, administrative, development and other
services to Affiliated Practices.
The Company has acquired substantially all the tangible and intangible
assets and assumed certain liabilities of, and provide long-term management
services to, the Founding Affiliated Practices. The Founding Affiliated
Practices include 31 orthodontists and 58 offices located in 13 states in the
United States and in Calgary, Alberta. The Founding Affiliated Practices were
selected based on a variety of factors, including the competitive and financial
strengths and historical growth of their practices and the potential for future
growth in their markets. Apple also considered the local and national
reputations of the Founding Affiliated Practices within the orthodontic services
industry, their ability to manage multi-location practices providing high levels
of quality care and their desire to grow and improve the operating efficiency of
their respective practices. For the year ended December 31, 1996, the Founding
Affiliated Practices had median patient revenues per practice of approximately
$700,000 and average (mean) patient revenues per practice of approximately
$800,000.
The orthodontic services industry is highly fragmented, with over 90% of
the approximately 9,000 orthodontists in the United States operating as sole
practitioners and less than 2% being affiliated with the only existing public
practice management company specializing in orthodontics. The industry currently
generates approximately $3.5 billion in annual gross revenues, which have grown
steadily at an average rate of 7.5% per year in recent years. Industry data and
management's experience indicate that the need for orthodontics significantly
exceeds the current demand.
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The Company's business strategy emphasizes (i) implementing a comprehensive
operating strategy designed to drive internal growth of the Affiliated Practices
and (ii) expanding the Company's network of Affiliated Practices through an
aggressive Affiliation program.
The primary elements of the Company's operating strategy are (i)
implementing practice-building and external marketing programs designed to
generate new patient starts through increased referrals from existing and former
patients and the use of multimedia advertising to stimulate demand for treatment
services, (ii) offering more affordable payment plans to patients to broaden the
market for orthodontic services, (iii) increasing the operating efficiency of
the Affiliated Practices by relieving the orthodontists from various
time-consuming administrative responsibilities and realizing economies of scale,
(iv) providing a systems-oriented approach to training and education of clinic
personnel to improve their communications with patients and potential patients
and increase their productivity, (v) developing satellite offices to expand the
geographic markets served by Affiliated Practices and (vi) utilizing customized
management information systems to provide detailed financial and operating data
and related analysis to Affiliated Practices and management. Each of these
elements is intended to drive the internal growth of the Affiliated Practices
while allowing them to maintain high levels of quality care.
The Company has implemented its operating strategy at a prototype practice
owned and, until June 1996, operated by the Company's Chairman and CEO, John G.
Vondrak, D.D.S. This practice has grown substantially since 1989, when Dr.
Vondrak acquired it, to approximately $1.9 million of revenues in 1996, which
management believes places it among the largest sole-practitioner orthodontic
practices in the United States. Among the factors contributing to this growth
have been the Company's practice-building program (consisting of a complete
training and operating program designed to maximize patient satisfaction levels,
generate referrals from existing and former patients and increase case
acceptance rates) and external marketing efforts, including television
advertising focusing on affordable payment programs offered by that practice.
This prototype practice had a case acceptance rate of approximately 71% in 1996.
Management believes that the results of this practice demonstrate the
effectiveness of the Company's operating strategy. In July 1996, Dr. Vondrak
delegated the operating responsibilities of this practice to a newly hired
orthodontist who recently completed her education, so that he could devote his
time fully to the formation of the Company. Since this transfer, the continued
application of the Company's operating strategy has resulted in a comparable
number of case starts based on a comparison of the six-month period ended
December 31, 1996 to the corresponding period in the prior year.
The Company also intends to pursue an aggressive expansion program designed
to strengthen its position in its current markets and expand its network of
Affiliated Practices into markets it does not currently serve. The Company
believes that, because of the highly fragmented nature of the industry, there
are numerous orthodontic practices that are attractive candidates to become
Affiliated Practices. Additionally, the Company plans to focus on candidates who
have strong reputations in their local markets and the desire to implement the
Company's operating strategy. The Company intends to leverage the reputations
and relationships of the orthodontists affiliated with the Founding Affiliated
Practices to identify and develop growth opportunities with candidates to become
future Affiliated Practices. Many of these orthodontists hold, or have
previously held, leadership roles in various state, regional and national
associations or are affiliated with or teach at graduate orthodontic programs at
dental schools. The Company believes the visibility and reputation of these
individuals, combined with the acquisition experience of management, will
provide the Company with certain advantages in identifying, negotiating and
consummating future Affiliations.
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THE OFFERING
Common Stock offered by the
Company............................ 2,000,000 shares of Common Stock to be
issued by Apple in connection with the
Affiliations.
Common Stock to be outstanding after
the Offering....................... 8,376,483 shares(1)
Class B Stock to be outstanding after
the Offering....................... 3,347,084 shares
Voting Rights........................ Holders of Common Stock are entitled to
one vote per share. The holders of Class
B Stock are entitled to three-tenths (
3/10ths) of a vote per share. In
addition, holders of the Class B Stock
are entitled currently to elect as a
class one member of the Board of
Directors and the holders of the Common
Stock are entitled to elect as a class
all other members of the Board of
Directors. The Common Stock and Class B
Stock possess ordinary voting rights and
vote together as a single class in
respect of other corporate matters. See
"Description of Capital Stock."
Transfer of Common Stock............. Persons acquiring shares of Common Stock
in Affiliations pursuant to this Offering
may be contractually required to hold all
or some portion of such shares for
varying periods of time.
American Stock Exchange symbol....... AOI
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(1) Includes 3,673,983 shares of Common Stock issued in connection with the
Acquisitions and 2,702,500 shares of Common Stock issued in connection with
the IPO and excludes (i) an aggregate of approximately 743,000 shares of
Common Stock issuable upon exercise of stock options outstanding at a
weighted average exercise price of $6.89 per share under Apple's 1996 Stock
Option Plan (the "1996 Stock Option Plan"), (iii) approximately 257,000
shares reserved for future issuance under the 1996 Stock Option Plan and
(iv) 180,000 shares of Common Stock issuable upon the exercise of a warrant
issued to TriCap Partners, L.L.C. ("TriCap Partners"), with an exercise
price per share of $7.00. See "Management -- 1996 Stock Option Plan."
EXCEPT WHERE OTHERWISE SPECIFIED, INDUSTRY INFORMATION USED IN THIS
PROSPECTUS IS DERIVED FROM THE 1995 JOURNAL OF CLINICAL ORTHODONTISTS
ORTHODONTIC PRACTICE STUDY ("1995 JCO STUDY"), A BIENNIAL STUDY, AND RELATES
TO 1994 UNLESS OTHERWISE INDICATED. COMPARABLE INFORMATION FOR 1995 AND 1996 IS
NOT EXPECTED TO BE AVAILABLE UNTIL THE RELEASE OF THE 1997 JCO STUDY IN LATE
1997. THE INFORMATION COMPILED IN THE 1995 JCO STUDY RELATES TO ORTHODONTISTS
WHO HAVE COMPLETED ACCREDITED GRADUATE ORTHODONTIC TRAINING PROGRAMS AND NEITHER
THAT INFORMATION NOR ANY OTHER INDUSTRY INFORMATION SET FORTH IN THIS PROSPECTUS
INCLUDES GENERAL DENTISTS WHO ALSO PERFORM ORTHODONTIC SERVICES.
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SUMMARY FINANCIAL DATA
(IN THOUSANDS)
The following information is derived from the financial statements of Apple
included elsewhere in this Prospectus. Except as otherwise indicated, this
information does not reflect the effects of the Acquisitions or the IPO. For
certain information concerning the Founding Affiliated Practices, see Note 6 of
Notes to Financial Statements. Apple was formed on July 15, 1996, and
effectively began its operations on June 1, 1997 following completion of the
IPO.
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1996 MARCH 31, 1997
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(UNAUDITED)
STATEMENT OF OPERATIONS DATA:
Revenues............................. $ -- $ --
Costs and expenses:
Salaries, wages and benefits.... 627 234
Rent............................ 20 42
Depreciation and amortization... 5 5
General and administrative
expenses...................... 232 194
Special compensation expense
related to issuance of
stock(1)...................... 13,812 --
Special consulting expense
related to issuance of
stock(1)...................... 9,613 --
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Total costs and expenses........ 24,309 475
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Income (loss) before income taxes.... (24,309) (475)
Provision for income taxes........... -- --
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Net income (loss).................... $ (24,309) $ (475)
================= ==============
DECEMBER 31,
1996 MARCH 31, 1997
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(UNAUDITED)
BALANCE SHEET DATA:
Working capital...................... $(2,324) $ 4,922
Total assets......................... 1,461 3,610
Stockholders' equity................. (884) (1,359)
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(1) These amounts reflect the value of shares issued to founders, management and
advisors of the Company, in October and December 1996, at $7.00 per share.
See Note 1 of the Notes to the Financial Statements included elsewhere in
this Prospectus.
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RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS,
PROSPECTIVE INVESTORS SHOULD CONSIDER THE FOLLOWING FACTORS IN EVALUATING THE
COMPANY AND ITS BUSINESS BEFORE PURCHASING ANY OF THE SHARES OF THE COMMON STOCK
OFFERED HEREBY. THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE
RISKS AND UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER FROM THOSE DISCUSSED IN THE
FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET
FORTH BELOW AND ELSEWHERE IN THIS PROSPECTUS.
ABSENCE OF COMBINED OPERATING HISTORY
The Company was incorporated in July 1996 and conducted no operations
before May 29, 1997 other than in connection with the IPO and the Acquisitions.
There can be no assurance that the process of integrating the management and
administrative functions of Affiliated Practices will be successful or that the
recently assembled management group will be able to manage effectively or
profitably these operations and successfully implement the Company's operating
or expansion strategies. Failure by the Company to successfully implement its
operating and expansion strategies would have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Business Strategy" and "-- Service Agreements."
RELIANCE ON AFFILIATED PRACTICES AND ORTHODONTISTS
The Company will receive fees for management services provided to the
Affiliated Practices under the Service Agreements. It will not employ
orthodontists or control the practice of orthodontics by the orthodontists
employed by the Affiliated Practices, and its management services revenue
generally will depend on revenue generated by the Affiliated Practices. In some
cases, the management fees will be based on the costs and expenses the Company
incurs in connection with providing management services. The profitability of
the Affiliated Practices, as well as the performance of the individual
orthodontists employed by the Affiliated Practices, will affect the Company's
profitability. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Overview" and "Business -- Service Agreements."
The revenue of the Affiliated Practices (and, therefore, the success of the
Company) is dependent on fees generated by the orthodontists employed by the
Affiliated Practices. In connection with the Service Agreements, each
orthodontist affiliated with a Founding Affiliated Practice will enter into an
employment agreement with the professional corporation or association in which
that orthodontist owns an equity interest (and which is a party to a Service
Agreement). A substantial reduction in the number of orthodontists employed by
or associated with the Affiliated Practices could have a material adverse effect
on the financial performance of the Company. The ability of the Affiliated
Practices to replace existing orthodontists by attracting new orthodontists may
be constrained by the limited number of new orthodontists completing
post-graduate orthodontic programs each year. Failure by the Affiliated
Practices to employ a sufficient number of orthodontists (whether by renewals of
existing employment agreements or otherwise) would have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Business -- Industry" and "-- Orthodontist Employment Agreements."
RISKS ASSOCIATED WITH EXPANSION STRATEGY
The success of the Company's expansion strategy will depend on a number of
factors, including the Company's ability to (i) identify attractive and willing
candidates to become Affiliated Practices, (ii) affiliate with acceptable
Affiliated Practices on favorable terms, (iii) adapt the Company's structure to
comply with present or future legal requirements affecting the Company's
arrangements with Affiliated Practices and comply with regulatory and licensing
requirements applicable to orthodontists and facilities operated and services
offered by orthodontists, (iv) obtain suitable financing to facilitate its
expansion program and (v) expand the Company's infrastructure and management to
accommodate expansion. Identifying candidates to become Affiliated Practices and
proposing, negotiating and implementing economically feasible affiliations with
such groups can be a lengthy, complex and costly process. A shortage of
available orthodontists with the skills and experience sought by the Company
would have a
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material adverse effect on the Company's expansion opportunities. Furthermore,
the Company anticipates facing substantial competition from other companies to
establish affiliations with additional orthodontic practices. There can be no
assurance that the Company's expansion strategy will be successful, that
modifications to the Company's strategy will not be required, that the Company
will be able to effectively manage and enhance the profitability of additional
Affiliated Practices or that the Company will be able to obtain adequate
financing on reasonable terms to support its expansion program. In addition,
future acquisitions accounted for as purchases may result in substantial annual
noncash amortization charges for intangible assets in the Company's statements
of operations. See " -- Competition," " -- Substantial Dilution and Absence
of Dividends," "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Overview" and "Business -- Business Strategy."
NEED FOR ADDITIONAL FINANCING
The Company's expansion strategy will require substantial capital
resources. Capital is needed not only for the acquisition of the assets of
additional Affiliated Practices, but also for the effective integration,
operation and expansion of the Affiliated Practices. In addition, the Affiliated
Practices may from time to time require capital for renovation and expansion and
for the addition of equipment and technology. The Service Agreements provide for
advances by the Company to Affiliated Practices under various circumstances.
Such loans will generally bear interest and will be repayable over varying
periods of time not to exceed five years. The extent to which the Company will
be able or willing to use shares of Common Stock to consummate Affiliations or
provide future financing will depend on its market value from time to time and,
in the case of Affiliations, the willingness of owners of potential Affiliated
Practices to accept Common Stock as full or partial payment of consideration.
Using shares of Common Stock for these purposes may result in significant
dilution to then-existing stockholders. The Company will require additional
capital from outside financing sources in order to continue its expansion
program. Although the Company currently believes it will be able to secure
additional financing, there can be no assurance that the Company will be able to
obtain additional funds when needed on satisfactory terms. Any limitation on the
Company's ability to obtain additional financing could have a material adverse
effect on the Company's business, financial condition and results of operations.
See " -- Substantial Dilution and Absence of Dividends" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
GOVERNMENT REGULATION
Various federal and state laws regulate the orthodontic services industry.
Regulatory oversight includes, but is not limited to, considerations of
fee-splitting and corporate practice of orthodontics.
The laws of many states prohibit business corporations such as the Company
from engaging in the practice of orthodontics or employing orthodontists to
practice orthodontics and prohibit orthodontists from splitting fees with
non-orthodontists. The specific restrictions against the corporate practice of
orthodontics, as well as the interpretation of those restrictions by state
regulatory authorities, vary from state to state. The restrictions are generally
designed to prohibit a non-orthodontic entity (such as the Company) from
controlling the professional assets of an orthodontic practice (such as patient
records and payor contracts), employing orthodontists to practice orthodontics
(or, in certain states, employing dental hygienists or orthodontic assistants),
or controlling the content of an orthodontist's advertising or professional
practice. The laws of many states also prohibit orthodontists from sharing
professional fees with non-orthodontic entities. State orthodontic boards do not
generally interpret these prohibitions as preventing a non-orthodontic entity
from owning non-professional assets used by an orthodontist in an orthodontic
practice or providing management services to an orthodontist for a fee provided
certain conditions are met. There can be no assurance that a review of the
Company's business relationships by courts or regulatory authorities will not
result in determinations that could prohibit or otherwise adversely affect the
operations of the Company or that the regulatory environment will not change,
requiring the Company to reorganize or restrict its existing or future
operations. The laws regarding fee-splitting and the corporate practice of
orthodontics and their interpretation are enforced by regulatory authorities
with broad discretion. There can
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be no assurance that the legality of the Company's business or its relationship
with the Affiliated Practices will not be successfully challenged or that the
enforceability of the provisions of any Service Agreement will not be limited.
CONTROL BY EXISTING MANAGEMENT AND STOCKHOLDERS; POTENTIAL CONFLICTS OF INTEREST
Dr. John G. Vondrak, the Company's Chairman and Chief Executive Officer,
the other executive officers and directors of the Company as a group, and TriCap
will beneficially own approximately 38.6%, 11.3% and 41.0%, respectively, of the
outstanding shares of Class B Stock (or an aggregate of approximately 91.0%) and
5.4%, 4.6% and 6.3%, respectively, of the outstanding shares of Common Stock (or
an aggregate of approximately 15.7%). These persons, if acting in concert, will
be able to exercise significant influence over the Company's affairs, elect the
entire Board of Directors and (subject to Section 203 of the Delaware General
Corporation Law ("DGCL")) control the outcome of any matter submitted to a
vote of stockholders. See "Security Ownership of Certain Beneficial Owners and
Management."
DEPENDENCE ON KEY PERSONNEL
The Company's future performance depends in significant part on the
continued service of its senior management, including John G. Vondrak, D.D.S.
and other key personnel, including LeeAnn Peniche. There can be no assurance
that Dr. Vondrak, the Company's senior management and other key employees will
continue to work for the Company. Loss of services of those employees could have
a material adverse effect on the Company's business, results of operations and
financial condition. The success of the Company's growth strategy will also
depend on the Company's ability to attract and retain additional high quality
personnel. See "Business -- Employees" and "Management."
COMPETITION
The Company anticipates facing substantial competition from other companies
to establish affiliations with additional orthodontic practices. The Company is
aware of one public and two private practice management companies focused on
orthodontics and several companies pursuing similar strategies in other segments
of the health care industry (including dentistry). Certain of these competitors
have greater financial and other resources than the Company (including more
established trading histories for their shares of common stock, which may be
used as currency in making acquisitions). Additional companies with similar
objectives may enter the Company's markets and compete with the Company. In
addition, the business of providing orthodontic services is highly competitive
in each market in which the Company will operate. Affiliated Practices face
local competition from other orthodontists, general dentists and pedodontists
(dentists specializing in the care of children's teeth), some of whom have more
established practices. Dentists are not restricted by law or any governmental
authority from providing orthodontic services. Management believes the increase
in recent years in dentists providing orthodontic services has limited the
growth of patient case starts performed by orthodontists. There can be no
assurance that the Company or the Affiliated Practices will be able to compete
effectively with their respective competitors, that additional competitors will
not enter their markets or that additional competition will not have a material
adverse effect on the Company. See "Business -- Competition."
RISK OF PROVIDING ORTHODONTIC SERVICES; ADEQUACY OF INSURANCE COVERAGE
The Affiliated Practices provide orthodontic services to the public and are
exposed to the risks of professional liability and other claims. Such claims, if
successful, could result in substantial damage awards to the claimants that may
exceed the limits of any applicable insurance coverage. Although the Company
will not control the practice of orthodontics by the Affiliated Practices, it
could be asserted that the Company should be held liable for malpractice of an
orthodontist employed by an Affiliated Practice. Each Affiliated Practice has
undertaken to comply with all applicable regulations and legal requirements, and
the Company maintains liability insurance for itself and it is anticipated that
the Company will be named as an additional insured party on the liability
insurance policies of the Affiliated Practices. The Founding Affiliated
Practices have agreed to maintain comprehensive professional liability
insurance, generally with limits of not less than $1.0 million per claim and
with aggregate policy limits of not less than $3.0 million
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per orthodontist and, in the event a Founding Affiliated Practice employs more
than one orthodontist, that Founding Affiliated Practices will maintain such
insurance with a separate limit for claims against that Founding Affiliated
Practice in an amount acceptable to Apple. There can be no assurance, however,
that a future claim or claims will not be successful or, if successful, will not
exceed the limits of available insurance coverage or that such coverage will
continue to be available at acceptable costs. See "Business -- Litigation and
Insurance."
LITIGATION WITH ORTHODONTIC CENTERS OF AMERICA
On December 10, 1996, Orthodontic Centers of America, Inc. ("OCA") filed
a complaint in the United States District Court for the Eastern District of
Louisiana against Apple, Dr. Vondrak, John G. Vondrak, P.C. and JGVAOI alleging,
among other things, misappropriation of trade secrets and certain breaches of a
confidentiality agreement executed by Dr. Vondrak, on behalf of John Vondrak,
P.C., in favor of OCA. While Apple is not a party to the confidentiality
agreement, OCA has alleged that Apple should be bound by its terms as a result
of the relationship between Dr. Vondrak and Apple (specifically, OCA has alleged
that Dr. Vondrak and Apple are alter egos and, alternatively, that Dr. Vondrak
was acting as Apple's agent when he executed the confidentiality agreement). The
Company intends to vigorously defend against the claims made by OCA, which,
based on the advice of legal counsel, the Company believes are without merit.
See "Business -- Litigation and Insurance."
POTENTIAL EFFECT OF SHARES ELIGIBLE FOR FUTURE SALE ON PRICE OF COMMON STOCK
The market price of the Common Stock of the Company could be adversely
affected by the sale of substantial amounts of the Common Stock in the public
market following the IPO. The shares being sold in the IPO will be freely
tradable unless acquired by affiliates of the Company.
Concurrently with the closing of the IPO, security holders of the Founding
Affiliated Practices received, in the aggregate, 3,673,983 shares of Common
Stock as a portion of the consideration for the assets of their practices.
Certain other stockholders of the Company hold, in the aggregate, an additional
3,347,084 shares of Class B Stock. Those shares are not being offered and sold
pursuant to this Prospectus. None of those 7,021,067 shares were acquired in the
transactions registered under the Securities Act, and, accordingly, such shares
may not be sold except in transactions registered under the Securities Act or
pursuant to an exemption from registration. In addition, the holders of
3,673,983 of those shares have agreed not to sell any shares of Common Stock
owned by them immediately after the consummation of the Acquisitions for a
one-year period following the IPO, subject to their right to exercise certain
registration rights. After the expiration of such restricted period, all of
those shares may be sold in accordance with Rule 144 under the Securities Act,
subject to the applicable volume limitations, holding period and other
requirements of Rule 144. Substantially all of the outstanding shares of Class B
Stock will become eligible for resale pursuant to Rule 144 in October 1997,
although such shares will remain subject to a contractual resale restriction
during the 180-day period described in the following paragraph.
The Company, its directors and executive officers, TriCap and all persons
acquiring shares of Common Stock in connection with the Acquisitions have agreed
not to offer or sell any shares of Common Stock for a period of 180 days (the
"180-Day Lockup Period") following May 22, 1997 without the prior written
consent of Bear, Stearns & Co. Inc., except that the Company may issue, subject
to certain conditions, Common Stock in connection with acquisitions and awards
under the 1996 Stock Option Plan. These restrictions will be applicable to any
shares acquired by any of those persons in the Offering or otherwise during the
180-Day Lockup Period.
The 2,000,000 shares of Common Stock issuable pursuant to this Offering
will generally be freely tradable by nonaffiliates after their issuance, unless
the sale is contractually restricted. The Company anticipates that the
agreements entered into in connection with its future Affiliations will restrict
the resale of all or a portion of the shares issued in those transactions for
varying periods of time.
The Company has outstanding under the 1996 Stock Option Plan options to
purchase approximately 743,000 shares of Common Stock. The Company intends to
register the shares issuable upon exercise of
10
<PAGE>
options granted under the 1996 Stock Option Plan. See "Management -- 1996 Stock
Option Plan" and "Shares Eligible for Future Sale."
POSSIBLE VOLATILITY OF STOCK PRICE
The securities markets have, from time to time, experienced significant
price and volume fluctuations that may be unrelated to the operating performance
of particular companies. These fluctuations often substantially affect the
market price of a company's common stock. The market prices for securities of
physician practice management companies have in the past been, and can in the
future be expected to be, particularly volatile. The market price of the Common
Stock may be subject to volatility from quarter to quarter depending on
announcements regarding the Affiliated Practices and their ability to open new
satellite offices, acquisitions by the Company or its competitors, government
relations, developments or disputes concerning proprietary rights, changes in
reimbursement levels, changes in health care policy in the United States and
internationally, the issuance of stock market analyst reports and
recommendations, and economic and other external factors, as well as operating
results of the Company and fluctuations in the Company's financial results. See
"-- Fluctuations in Operating Results."
FLUCTUATIONS IN OPERATING RESULTS
The Company's results of operations may fluctuate significantly from
quarter to quarter or year to year. Results may fluctuate due to a number of
factors, including the timing of future acquisitions and satellite office
openings, seasonal fluctuations in the demand for orthodontic services and
competitive factors. Accordingly, quarterly comparisons of the Company's
revenues and operating results should not be relied on as an indication of
future performance, and the results of any quarterly period may not be
indicative of results to be expected for a full year. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
CERTAIN ANTI-TAKEOVER PROVISIONS
Certain provisions of the Company's Restated Certificate of Incorporation
(the "Certificate of Incorporation") and Bylaws and of Delaware law could,
together or separately, discourage potential acquisition proposals, delay or
prevent a change in control of the Company or limit the price that certain
investors might be willing to pay in the future for shares of the Common Stock.
The Certificate of Incorporation provides for "blank check" preferred stock,
which may be issued without stockholder approval, provides for a "staggered"
Board of Directors and provides that stockholders may act only at an annual or
special meeting of stockholders and may not act by written consent. In addition,
certain provisions of the Company's Bylaws restrict the right of the
stockholders to call a special meeting of stockholders, to nominate directors,
to submit proposals to be considered at stockholders' meetings and to adopt
amendments to the Bylaws. The Company also is subject to Section 203 of the
DGCL, which, subject to certain exceptions, prohibits a Delaware corporation
from engaging in any of a broad range of business acquisitions with an
"interested stockholder" for a period of three years following the date such
stockholder became an interested stockholder. See "Description of Capital
Stock."
ABSENCE OF DIVIDENDS
The Company has never paid any cash dividends and does not anticipate
paying cash dividends on its Common Stock or Class B Stock in the foreseeable
future. See "Dividend Policy."
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<PAGE>
THE COMPANY
The Company was incorporated in July 1996 and conducted no operations prior
to May 29, 1997 other than in connection with the IPO and the Acquisitions. The
Company has acquired substantially all the assets and assumed certain
liabilities of the Founding Affiliated Practices concurrently with the closing
of the IPO. The Company's principal executive offices are located at 2777 Allen
Parkway, Suite 880, Houston, Texas 77019, and its telephone number is (281)
698-2500.
PRICE RANGE OF COMMON STOCK
The following table sets forth the range of high and low sale prices for
the Common Stock on the American Stock Exchange for the periods indicated:
LOW HIGH
--------- ---------
Year ending December 31, 1997:
2nd quarter (beginning May 22
through July 17, 1997)............. $ 7.25 $ 12.94
As of May 22, 1997 there were approximately 35 holders of record of Common
Stock, as shown on the records of the transfer agent and registrar for the
Common Stock. The number of record holders does not bear any relationship to the
number of beneficial owners of the Common Stock.
DIVIDEND POLICY
It is the Company's current intention to retain earnings for the
foreseeable future to support operations and finance expansion. The payment of
any future dividends will be at the discretion of the Company's Board of
Directors and will depend upon, among other things, the Company's earnings,
financial condition, cash flow from operations, capital requirements, expansion
plans, the income tax laws then in effect, the requirements of Delaware law and
restrictions that may be imposed in the Company's future financing arrangements.
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<PAGE>
SELECTED FINANCIAL DATA
(IN THOUSANDS)
The following information is derived from the financial statements of Apple
included elsewhere in this Prospectus. This information does not reflect the
effect of the Acquisitions or the IPO. Apple was formed on July 15, 1996, and
effectively began its operations on June 1, 1997 following completion of the
IPO.
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1996 MARCH 31, 1997
----------------- ---------------
(UNAUDITED)
STATEMENT OF OPERATIONS DATA:
Revenues............................. $ -- $ --
Costs and expenses:
Salaries, wages and benefits.... 627 234
Rent............................ 20 42
Depreciation and amortization... 5 5
General and administrative
expenses...................... 232 194
Special compensation expense
related to issuance of
stock(1)...................... 13,812 --
Special consulting expense
related to issuance of
stock(1)...................... 9,613 --
----------------- ---------------
Total costs and expenses........ 24,309 475
----------------- ---------------
Income (loss) before income taxes.... (24,309) (475)
Provision for income taxes........... -- --
----------------- ---------------
Net income (loss).................... $ (24,309) $ (475)
================= ===============
DECEMBER 31, 1996 MARCH 31, 1997
----------------- ---------------
(UNAUDITED)
BALANCE SHEET DATA:
Working capital...................... $(2,324) $(4,922)
Total assets......................... 1,461 3,610
Stockholders' equity................. (884) (1,359)
- ------------
(1) These amounts reflect the value of shares issued to founders, management and
advisors of the Company, in October and December 1996, at $7.00 per share.
See Note 1 of the Notes to the Financial Statements included elsewhere in
this Prospectus.
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS CONTAINS CERTAIN STATEMENTS OF A
FORWARD-LOOKING NATURE RELATING TO FUTURE EVENTS OR THE FUTURE FINANCIAL
PERFORMANCE OF THE COMPANY. SUCH STATEMENTS ARE ONLY PREDICTIONS AND THE ACTUAL
EVENTS OR RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE
FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "RISK
FACTORS," AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS PROSPECTUS. THE
HISTORICAL RESULTS SET FORTH IN THIS DISCUSSION AND ANALYSIS ARE NOT INDICATIVE
OF TRENDS WITH RESPECT TO ANY ACTUAL OR PROJECTED FUTURE FINANCIAL PERFORMANCE
OF THE COMPANY. THIS DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
THE FINANCIAL STATEMENTS AND THE RELATED NOTES THERETO INCLUDED ELSEWHERE IN
THIS PROSPECTUS.
OVERVIEW
The Company has conducted no significant operations through March 31, 1997.
Effective June 1, 1997, the Company acquired the tangible and intangible assets
and liabilities of, and enter into Service Agreements with, the Founding
Affiliated Practices. The Company expects that its future growth will come from
(i) implementing a comprehensive operating strategy designed to drive internal
growth of the Affiliated Practices and (ii) entering into Service Agreements
with new Affiliated Practices and developing new orthodontic centers (including
satellite offices) with existing and future Affiliated Practices.
Through its Service Agreements, the Company provides a full complement of
practice management services to Affiliated Practices in return for management
service fees. Except with respect to two Service Agreements providing for the
payment of flat fees, the management service fees earned by the Company are in
accordance with two general types of Service Agreements -- the standard form of
the Service Agreement ("Standard Contract") and the alternative form of the
Service Agreement ("Alternative Contract"). The Standard Contract calls for a
calculation of the monthly service fee based on the total revenues earned by the
Affiliated Practices, which is defined by the agreement to represent 24% of the
total contract value in the initial month of a patient's treatment with the
remainder of the contract balance earned evenly over the balance of the contract
term. From total revenues, the practices retain a percentage of the Affiliated
Practices' cash collections.
The Alternative Contract is a cost-plus fee arrangement, whereby the
service fee includes the reimbursement of defined expenses incurred by Apple in
the course of providing services to the Affilated Practice plus a percentage of
revenues. The Company believes the fees to be generated by each of these
formulas are reflective of the fair market value of the services provided and
will be comparable to the fees earned by other management service companies in
the respective jurisdictions where these arrangements will exist. In addition,
with respect to two of the Founding Affiliated Practices, the service fees will
be based on flat fees that are subject to adjustment on an annual basis. See
"Business -- Service Agreements."
The expenses incurred by the Company in fulfilling its obligations under
the Service Agreements are generally of the same nature as the operating costs
and expenses that would have otherwise been incurred by the Affiliated
Practices, including salaries, wages and benefits of practice personnel
(excluding orthodontists and, in some cases, orthodontic assistants and other
professional personnel), orthodontic supplies and office supplies used in
administering their clinic practices, the office (general and administrative)
expenses of the practices and depreciation and amortization of assets acquired
from the Founding Affiliated Practices. In addition to the operating costs and
expenses discussed above, the Company incurs personnel and administrative
expenses in connection with establishing and maintaining a corporate office,
which will provide management, administrative, marketing and development and
acquisition services.
In accordance with Staff Accounting Bulletin ("SAB") No. 48, "Transfers
of Nonmonetary Assets by Promoters or Shareholders," published by the
Securities and Exchange Commission (the "Commission"), the acquisition of the
assets and assumption of certain liabilities for all of the Founding Affiliated
Practices pursuant to the Acquisitions were accounted for by the Company at the
transferors' historical cost basis, with the shares of common stock issued in
those transactions valued at the historical cost of the nonmonetary assets
acquired net of liabilities assumed. The cash consideration paid at closing on
May 29,
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<PAGE>
1997 was reflected as a dividend by Apple to the owners of the Founding
Affiliated Practices in the quarter ended June 30, 1997. SAB No. 48 will not be
applicable to any new Affiliations. It is currently anticipated that the
Company's future Affiliations may result in substantial annual noncash
amortization charges for intangible assets in the Company's statements of
operations.
RESULTS OF OPERATIONS
The Company began operations effective June 1, 1997. As discussed in Notes
1 and 2 in the accompanying financial statements, the shares issued in October
and December 1996 have been valued at the assumed offering price. Special
compensation and consulting expense related to issuance of stock has been
recorded for the difference between the amount paid for the stock and the
offering price of $7.00 per share. General and administrative expenses were
incurred during the year ended December 31, 1996 and the three months ended
March 31, 1997 in connection with the IPO. Of these expenses, $2.6 million was
funded through the issuance of Convertible Notes to TriCap and $0.4 million was
funded by other advances from TriCap. The Convertible Notes have been repaid
from the proceeds of the Offering. The unaudited financial statements of the
Company for the three-month period ended March 31, 1997 reflect a net loss of
approximately $475,000, a corresponding increase in stockholders' deficit and a
decrease in net current assets of approximately $2.6 million resulting from
continued operating and offering costs incurred prior to completion of the IPO.
LIQUIDITY AND CAPITAL RESOURCES
A part of the Company's business strategy is to encourage Affilated
Practices to offer more affordable payment plans to patients. The Company does
not expect the affordable payment plans, or any potential increase in bad debt
expense resulting from these plans, to have any significant negative impact on
the working capital or liquidity of the Affiliated Practices. Moreover, the
Company believes the Founding Affiliated Practices have the financial
wherewithal to sustain any negative impact that may result from these payment
plans. Therefore, Apple does not anticipate that the offering by the Affiliated
Practices of more affordable payment plans will impair the Company's ability to
collect management service revenues from the Affiliated Practices. See
"Business -- Services and Operations -- Affordable Payment Plans."
The Company anticipates making routine capital expenditures for the
Founding Affiliated Practices during the remainder of 1997 of approximately $2.0
million to fund, among other things, the development of satellite offices. The
average cost of developing a satellite office (which may vary by geographic
market) is estimated to be approximately $250,000, including initial working
capital requirements. The Service Agreements provide for advances by the Company
to the Founding Affiliated Practices for working capital requirements (including
any deficits in cash flows of Founding Affiliated Practices resulting from,
among other things, development of satellite offices) and other purposes. Such
loans will generally bear interest at prime plus one percent and will be
repayable over varying periods of time not to exceed five years. It is
anticipated that the foregoing capital expenditures will be funded from the
Company's cash flow from operations. The Company also expects to make
acquisitions of additional orthodontic practices during 1997 that will involve
the use of cash and Common Stock.
Management believes that the cash proceeds of the IPO combined with its
cash flow from operations will be sufficient to fund planned capital
expenditures and ongoing operations of the Company through the end of 1998. The
Company is also seeking to establish a revolving bank credit facility which,
when combined with the shares of Common Stock offered hereby and the Company's
cash resources, will be used in the Company's Affiliation program. The Company
has agreed to refinance certain indebtedness of the Founding Affiliated
Practices totalling approximately $1.0 million.
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<PAGE>
BUSINESS
OVERVIEW
Apple was founded in July 1996 to provide practice management services to
orthodontic practices in the United States and Canada. The Company's objective
is to provide a full complement of practice management services designed to
drive internal growth by enhancing the ability of Affiliated Practices to: (i)
deliver quality, affordable orthodontic treatment primarily on a fee-for-service
basis; (ii) stimulate demand in their local markets by increasing consumer
awareness of the benefits, availability and affordability of orthodontic
treatment; and (iii) improve the productivity and profitability of their
practices. The Company will also seek to grow through the acquisition of
additional Affiliated Practices and the development of satellite offices that
complement existing geographic areas served by existing and future Affiliated
Practices. The Company will earn revenue by providing management,
administrative, development and other services to Affiliated Practices.
The Company has acquired substantially all the tangible and intangible
assets and assumed certain liabilities of, and provides long-term management
services to, the Founding Affiliated Practices. The aggregate consideration paid
by Apple to acquire the Founding Affiliated Practices was (i) approximately $6.4
million in cash and (ii) 3,673,983 shares of Common Stock.
The Founding Affiliated Practices include 31 orthodontists and 58 offices
located in 13 states in the United States and in Calgary, Alberta. The Founding
Affiliated Practices were selected based on a variety of factors, including the
competitive and financial strengths and historical growth of their practices and
the potential for future growth in their markets. Apple also considered the
local and national reputations of the Founding Affiliated Practices within the
orthodontic services industry, their ability to manage multi-location practices
providing high levels of quality care and their desire to grow and improve the
operating efficiency of their respective practices. The Founding Affiliated
Practices were selected by Apple based on its management's extensive experience
with orthodontic practices in the United States and Canada. Of the 31 Founding
Affiliated Practices, nine are corporations (of which the orthodontist is a
stockholder and employee), 16 are professional corporations or professional
associations (of which the orthodontist is a stockholder and employee) and six
are sole proprietorships (owned and operated by the orthodontist). In connection
with the Acquisitions, each Founding Affiliated Practice has agreed to operate
through a professional corporation, which will employ, and will be owned by, the
orthodontist or orthodontists affiliated with such Founding Affiliated Practice.
For the year ended December 31, 1996, the Founding Affiliated Practices had
revenues ranging from approximately $200,000 to $1.9 million and had average
patient revenues of approximately $800,000. See "-- Summary of Terms of
Acquisitions."
INDUSTRY
INDUSTRY OVERVIEW. The orthodontic services industry is highly fragmented,
with over 90% of the approximately 9,000 orthodontists in the United States
operating as sole practitioners and less than 2% being affiliated with the only
existing public practice management company specializing in orthodontics. The
industry currently generates approximately $3.5 billion in annual gross
revenues, which have grown steadily at an average rate of 7.5% per year in
recent years. Based on published industry data, over 70% of orthodontic
treatments are performed on a private pay, fee-for-service basis, 25% of
treatments are covered by traditional forms of dental insurance (generally with
a 50% or greater co-payment by the patient) and the remaining 5% of treatments
involve other payment methods, including managed care networks. Managed care
represents only a small portion of the payor sources due to the elective nature
of most orthodontic treatments. Most orthodontic practices (including all the
Founding Affiliated Practices) do not accept payment by Medicare or Medicaid.
Orthodontic treatments are principally provided by orthodontists who have
completed two years of post-graduate studies following graduation from dental
school. The number of orthodontists in the United States has grown slowly since
1990, which management believes can be attributed to the limited number of
schools offering post-graduate orthodontic programs and the small class size at
each of those schools. In
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<PAGE>
addition to orthodontists, a number of dentists provide various orthodontic
services. The industry information set forth in this Prospectus does not include
orthodontic treatments provided by dentists.
The table below summarizes certain information from the 1995 JCO Study
concerning the United States orthodontic services industry for each of the years
presented:
<TABLE>
<CAPTION>
1990 1991 1992 1993 1994
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Number of orthodontists.............. 8,720 8,760 8,856 8,958 9,060
Number of new cases.................. 1,308,000 1,314,000 1,416,690 1,478,070 1,540,200
Average fee per case................. $ 3,050 $ 3,221 $ 3,401 $ 3,447 $ 3,492
</TABLE>
Based on a 1994 study performed by the Department of Orthodontics,
University of Florida College of Dentistry (the "University of Florida Study")
and management's experience, the Company believes the need for orthodontics
significantly exceeds the current demand. The University of Florida Study, which
was funded by a grant from the National Institute of Dental Research and
involved a statistical sample of approximately 3,700 children in Florida,
concluded that only approximately one out of every five children who need
orthodontics receives treatment. The University of Florida Study also indicated
that cost was a barrier to orthodontics. Children in higher socioeconomic groups
received treatment approximately six times more often than children in lower
groups despite no measurable difference in need among the groups. The University
of Florida Study did not address the market potential for adult patients, which
management believes is significant. The Company believes there is significant
opportunity to expand the orthodontic treatment population through improved
public awareness of the benefits, availability and affordability of orthodontic
treatment.
THE TRADITIONAL ORTHODONTIC PRACTICE. The traditional orthodontic practice
typically involves a single orthodontist, practicing at one primary location or
with an average of less than one satellite office, with a small number of
orthodontic assistants and business office personnel and, in some cases, an
orthodontic associate. According to the 1995 JCO Study, the average orthodontist
initiated treatment of 170 new patients in 1994 and maintained approximately 380
active patients. In addition, the 1995 JCO Study reports that only 1.3% of
orthodontists use television advertising to promote their practices. In the
traditional practice, the orthodontist manages all business aspects of the
practice. The use of third-party management services is not typical.
On an individual practice basis, the 1995 JCO Study reported median annual
revenues of $475,000 and median operating income of $191,000 in 1994. The median
overhead as a percentage of revenues was 55%, resulting in a 40% median
operating margin before orthodontist compensation, interest and taxes. Median
down payments were equal to approximately 25% of the total treatment cost.
Median case starts and active treatment cases were 170 and 380 per practice,
respectively, and the median case acceptance rate was 60%. Individual practices
on average generated over one-half of their referrals from dentists and less
than 7% of the practices utilized commercial advertising as a referral source.
Orthodontists believed they had the ability to increase case starts by 30%, yet
the median case starts have not increased significantly since 1981, the first
year of data presented in the study.
THE APPLE ORTHODONTIX APPROACH
The Company believes the traditional orthodontic practice is inefficient
and administratively burdensome to orthodontists, and can be financially
burdensome to patients, who traditionally pay approximately 25% of the total
contract amount as a down payment ($875 when applied to the average fee per case
in 1994, according to the 1995 JCO Study). The Company has developed a
comprehensive operating strategy designed to improve efficiency, increase the
number of new case starts and active cases handled by each orthodontist and
relieve orthodontists associated with Affiliated Practices of time-consuming
administrative responsibilities. As part of its operating strategy, the Company
will assist its Affiliated Practices in developing satellite offices to expand
the scope of the geographic areas they serve. The Company will also assist
Affiliated Practices in developing and implementing payment programs designed to
make orthodontic services more affordable to prospective patients, thereby
making their services available to a larger segment of the population in their
respective markets.
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<PAGE>
The Company has implemented its operating strategy at a prototype practice
owned and, until June 1996, operated by the Company's Chairman and CEO, John G.
Vondrak, D.D.S. This practice has grown substantially since 1989, when Dr.
Vondrak acquired it, to approximately $1.9 million of revenues in 1996, which
management believes places it among the largest sole-practitioner orthodontic
practices in the United States. Among the factors contributing to this growth
have been the Company's practice-building program (consisting of a complete
training and operating program emphasizing clear, concise and consistent
communications to existing and prospective patients in order to maximize
satisfaction levels, generate referrals and increase new case acceptance rates)
and external marketing efforts, including television advertising focusing on
affordable payment plans offered by that practice. This prototype practice had a
case acceptance rate of approximately 71% in 1996.
The Company believes its approach provides unique benefits to orthodontists
who choose to affiliate with it by providing opportunities for the orthodontist
to: (i) drive internal growth by implementing the Company's operating strategy;
(ii) share in the increased profitability resulting from internal growth; (iii)
lower costs through economies of scale; (iv) participate in a cost-effective
national advertising program; (v) focus on patient care; and (vi) enhance
liquidity and diversification.
BUSINESS STRATEGY
The Company's business strategy emphasizes (i) implementing a comprehensive
operating strategy designed to drive internal growth of the Affiliated Practices
and (ii) expanding the Company's network of Affiliated Practices through an
aggressive acquisition program.
OPERATING STRATEGY. The primary elements of the Company's operating
strategy are (i) implementing practice-building and external marketing programs
designed to generate new patient starts through increased referrals from
existing and former patients and the use of multimedia advertising to stimulate
demand for treatment services, (ii) offering more affordable payment plans to
patients to broaden the market for orthodontic services, (iii) increasing the
operating efficiency of the Affiliated Practices by relieving the orthodontists
from various time-consuming administrative responsibilities and realizing
economies of scale, (iv) providing a systems-oriented approach to training and
education of clinic personnel to improve their communications with patients and
potential patients and increase their productivity, (v) developing satellite
offices to expand the geographic markets served by Affiliated Practices and (vi)
utilizing customized management information systems to provide detailed
financial and operating data and related analysis to Affiliated Practices and
management. Each of these elements is intended to drive the internal growth of
the Affiliated Practices while allowing them to maintain high levels of quality
care. However, operating results at each Affiliated Practice will be largely
dependent upon the skills and personality of the orthodontists employed by that
Affiliated Practice.
Management believes that the results of the prototype practice owned by Dr.
Vondrak demonstrate the effectiveness of the Company's operating strategy. In
July 1996, Dr. Vondrak delegated the operating responsibilities of this practice
to a newly hired orthodontist who recently completed her education, so that he
could devote his time fully to the formation of the Company. Since this
transfer, the continued application of the Company's operating strategy has
resulted in a comparable number of case starts based on a comparison of the
six-month period ended December 31, 1996 to the corresponding period in the
prior year.
Over time, the Company plans to implement a regional management structure
aligned with the locations of its Affiliated Practices. Management believes a
regional structure will allow it to respond to the management and operational
issues within a particular region in a more timely and focused manner. In
addition, a regional structure will allow management to compare the operating
results of its Affiliated Practices to regularly published regional industry
statistics.
EXPANSION STRATEGY. The Company intends to pursue an aggressive expansion
strategy designed to strengthen its position in its current markets and expand
its network of Affiliated Practices into markets it does not currently serve.
The Company believes that, due to the highly fragmented nature of the industry,
there are numerous orthodontic practices that are attractive candidates to
become Affiliated Practices.
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<PAGE>
Additionally, the Company plans to focus on candidates who have strong
reputations in their local markets and the desire to implement the Company's
operating strategy. The Company intends to leverage the reputations and
relationships of the orthodontists affiliated with the Founding Affiliated
Practices to identify and develop growth opportunities with candidates to become
future Affiliated Practices. Many of these orthodontists hold, or have
previously held, leadership roles in various state, regional and national
associations or are affiliated with or teach at graduate orthodontic programs at
dental schools. The Company believes the visibility and reputation of these
individuals, combined with the acquisition experience of management, will
provide the Company with certain advantages in identifying, negotiating and
consummating future Affiliations.
As consideration for future Affiliations, the Company intends to use
various combinations of its Common Stock, cash and notes.
SERVICES AND OPERATIONS
The Company will generally manage all aspects of the Affiliated Practices
operations other than the provision of orthodontic treatment. The Company will
employ all business personnel at the offices of the Affiliated Practices and,
where permitted by applicable law and governmental regulations, also will employ
the orthodontic assistants.
ADMINISTRATIVE. The Company will earn revenue by providing management and
other services to the Affiliated Practices, including staffing, education and
training, billing and collections, cash management, purchasing, inventory
management, payroll processing, employee benefits administration, advertising
production and other marketing support, patient scheduling, financial reporting
and analysis, productivity reporting and analysis, associate recruiting and
support for acquisitions, new site development and other capital requirements.
The Company believes the orthodontists at the Affiliated Practices will benefit
from the administrative and management support provided by Apple and that these
services will substantially reduce the amount of time the orthodontists are
required to spend on administrative matters and will enable them to dedicate
more time to the growth of their professional practices. Management believes
that through economies of scale the Company will be able to provide these
services at a lower cost than could be obtained by each of the Affiliated
Practices individually. In addition, the Company believes that, due to its size
and purchasing power, it will be able to negotiate discounts on, among other
things, orthodontic and office supplies, health and malpractice insurance and
equipment.
PRACTICE-BUILDING PROGRAM. Management believes patient satisfaction
levels, practice productivity and profitability can be substantially enhanced
through a consistent training program emphasizing practice-building techniques.
The Company will implement programs designed to generate growth in case starts
by increasing (i) referrals from existing and former patients and (ii) case
acceptance rates. These programs include a full complement of training,
operating and monitoring techniques emphasizing improvements in communications
with patients and patient satisfaction levels in all facets of operations,
including initial telephone contacts with prospective patients, initial
consultations and case presentations and written or telephonic follow-ups after
office visits. The Company's programs are designed to result in clear, concise
and consistent communications between the patient and the orthodontist and his
or her staff. It is management's belief that these programs will have a positive
effect on the patients' experience and therefore positively impact the number of
patient referrals and case acceptance rates of Affiliated Practices.
EXTERNAL MARKETING. The Company and the Affiliated Practices may utilize
multimedia advertising in local markets to stimulate demand for orthodontic
treatment and promote name recognition for Apple and the Affiliated Practices.
The general public traditionally has had little information about the
availability of orthodontic services or orthodontic fees prior to an initial
consultation with an orthodontist. The advertisements will address the two
primary barriers to receiving orthodontic treatment, availability and
affordability, by focusing on the availability of orthodontic services and the
more affordable payment plans offered by the Affiliated Practices. The
advertisements will also stress the quality of care available at the Affiliated
Practices and the advantage of receiving orthodontic treatment from a
professionally trained
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orthodontist as opposed to a general dentist, and will promote a toll-free
number for ease of scheduling an appointment with the local Affiliated Practice.
Generally, it is anticipated that an Affiliated Practice will spend an
amount equal to between 5% and 7% of its net revenues for advertising and
marketing, which the Company believes is significantly higher than the industry
average for traditional orthodontic practices. The Company will be responsible
for subcontracting the production of all broadcast advertising, which will be
tailored to meet local requirements. The frequency and airing times for these
television ads will be determined by regional media consultants retained by
Apple and the Affiliated Practice in order to optimize penetration to target
market segments.
AFFORDABLE PAYMENT PLANS. Orthodontic services primarily involve private
pay, fee-for-service treatments. As part of its overall marketing strategy for
the Affiliated Practices, the Company intends to encourage the Affiliated
Practices to make orthodontic services available to a larger portion of the
population in their respective markets by offering more affordable payment
plans. Many of the Founding Affiliated Practices have historically received a
down payment equal to 25% of the total cost of services, with the remaining
amount paid equally over the term of treatment. It is contemplated that the
typical payment plan utilized after the IPO would consist of a modest initial
down payment and monthly payments thereafter for the duration of the treatment
period, generally between 26 and 34 months. Those Affiliated Practices that
offer the affordable payment plans will experience an initial decrease in
working capital. However, the Company believes the decrease in working capital
caused by the change in payment plans will be offset by an increase in the
number of patients receiving orthodontic treatment due to the combined effect of
advertising, offering more affordable payment plans and the use of its
practice-building program. The Company believes that offering more affordable
payment plans combined with the use of advertising will result in an increase in
the number of patients inquiring about orthodontic treatment. The Company also
believes that this anticipated increase combined with the use of its internal
marketing programs will result in an increase in the number of patients
receiving orthodontic treatment at the Affiliated Practices.
SATELLITE OFFICES. The Company intends to develop additional satellite
offices (or branch locations) within selected markets served by the Affiliated
Practices. The Company believes that the satellite offices will increase the
geographic area served by the Affiliated Practices, thereby (i) increasing the
potential market, (ii) leveraging the advertising budget of the Affiliated
Practices and (iii) achieving critical mass within its existing markets. It is
anticipated that the satellite offices will generally be located in high
traffic, retail-oriented areas.
Satellite offices developed by the Company will be staffed either on a
part-time basis by an orthodontist from an Affiliated Practice or on a full-time
basis by a newly recruited orthodontist, depending on the potential for
additional patients. The average cost of developing a satellite office (which
may vary by geographic market) is estimated to be approximately $250,000,
including initial working capital requirements. The Company will provide
management services and a portion of the capital to develop satellite offices.
The Company will be responsible for selecting the site, negotiating the lease,
designing the office layout and furnishing the satellite office. The Company
will also assist the Affiliated Practices in recruiting orthodontists and
support staff for those satellite offices, which will be open full-time.
TRAINING AND EDUCATION. Staff and practice development programs are an
integral part of the Company's operating strategy. The Company believes its
programs will (i) increase the motivation and overall performance of the staff,
(ii) improve the level of patient satisfaction achieved by the Affiliated
Practices and (iii) improve the Company's ability to attract and retain
qualified personnel, which will collectively result in increased referrals from
existing and former patients and increased case acceptance rates for the
Affiliated Practices. The Company will provide each Affiliated Practice with
consulting and educational services. These services include a full training
program covering all non-orthodontic aspects of the practice and specific
training designed for the efficient and effective use of the Company's
management information system.
Specifically, the Company's training program will provide each member of
the practice, from the receptionist to the orthodontist, with guidelines for
addressing questions and concerns of prospective and
20
<PAGE>
existing patients, techniques for explaining treatment procedures and length of
treatment, parameters for establishing appropriate financial arrangements with
each patient and a systematic approach to monitoring the success of each area of
training. Training will be conducted both at individual clinics and in group
sessions and will include proprietary manuals, tapes and role playing
activities.
MANAGEMENT INFORMATION SYSTEMS. The Company believes access to accurate,
relevant and timely financial and operating information is a key element to
providing practice management services to orthodontic practices. The Company
will offer a fully integrated financial reporting, productivity management and
patient management system at each Affiliated Practice. These systems are
designed to increase the productivity of the Affiliated Practices by enabling
the Company and the Affiliated Practices to cost-effectively monitor the
productivity of the Affiliated Practices, identify problem areas and
opportunities for improvement and advise on corrective action in a timely
manner. Productivity measures to be monitored will include case acceptance
rates, treatment times and case starts. In addition, the management information
systems will facilitate optimization of the orthodontists' time through
computerized scheduling and diagnostic and treatment recordkeeping systems. The
Company believes these systems will also improve the productivity of the
Affiliated Practices through benchmarking programs that identify and help
establish the most efficient operational procedures.
SERVICE AGREEMENTS
The Company will enter into a Service Agreement with each Affiliated
Practice and its orthodontist employees under which the Company is the exclusive
manager and administrator of non-orthodontic services relating to the operation
of the Affiliated Practice. The following is intended to be a brief summary of
the typical form of Service Agreement the Company expects to enter into with
each Affiliated Practice. The actual terms of the various Service Agreements
will vary from the description below on a case-by-case basis, depending on
negotiations with the individual Founding Affiliated Practices and the
requirements of applicable law and governmental regulations.
The service fees (the "Service Fees") payable to the Company by the
Affiliated Practices under the Service Agreements will be in accordance with the
Company's two general types of Service Agreements. The Standard Contract calls
for a calculation of the monthly Service Fee based on the total revenues earned
by the Affiliated Practices, which is defined by the agreement to represent 24%
of the total contract value in the initial month of a patient's treatment with
the remainder of the contract balance earned evenly over the balance of the
contract term. From total revenues, the practices retain a percentage of the
Affiliated Practices' cash collections. The Alternative Contract is a cost plus
fee arrangement, whereby the service fee includes the reimbursement of defined
expenses incurred by Apple in the course of providing services to the Affiliated
Practice plus a percentage of revenues. The Company believes the fees to be
generated by each of these formulas will be reflective of the fair market value
of the service provided and will be comparable to the fees earned by other
management service companies in the respective jurisdictions where these
arrangements will exist.
Pursuant to each Service Agreement, the Company will, among other things,
(i) act as the exclusive manager and administrator of non-orthodontist services
relating to the operation of the Affiliated Practice, subject to matters
reserved to the Affiliated Practice, (ii) administer the billing of patients,
insurance companies and other third-party payors and collect on behalf of the
Affiliated Practice the fees for professional orthodontic and other services and
products rendered or sold by the Affiliated Practice, (iii) provide, as
necessary, clerical, accounting, payroll, legal, bookkeeping and computer
services and personnel, information management, tax return information,
printing, postage and duplication services and transcribing services, (iv)
supervise and maintain custody of substantially all files and records, (v)
provide facilities, equipment and furnishings for the Affiliated Practice, (vi)
prepare, in consultation with the Affiliated Practice, all annual capital and
operating budgets, (vii) order and purchase inventory and supplies as reasonably
requested by the Affiliated Practice and (viii) implement, in consultation with
the Affiliated Practice, advertising programs.
21
<PAGE>
Under each Service Agreement, the applicable Affiliated Practice retains
the responsibility for, among other things, (i) hiring, compensating and
supervising orthodontist employees and other licensed dental professionals, (ii)
ensuring that orthodontists have the required licenses, credentials, approvals
and other certifications appropriate to the performance of their duties and
(iii) complying with federal and state laws, regulations and ethical standards
applicable to the practice of orthodontics. In addition, the Affiliated Practice
will be exclusively in control of all aspects of the practice of orthodontics
and the provision of orthodontic services.
During the term of the Service Agreement and, subject to certain exceptions
and limitations, for a period thereafter, the Affiliated Practice and each of
its orthodontist employees agrees not to compete with the Company or the other
practices for which the Company provides management services within a specified
geographic area. The Affiliated Practice also agrees not to disclose certain
confidential and proprietary information relating to the Company and the
Affiliated Practices.
The Affiliated Practice is responsible for obtaining professional liability
insurance for the employees of the Affiliated Practice (and which will name the
Company as an additional insured).
COMPETITION
The Company anticipates facing substantial competition from other companies
to establish affiliations with additional orthodontic practices. The Company is
aware of one public and two private practice management companies focused on
orthodontics and several companies pursuing similar strategies in other segments
of the health care industry (including dentistry). Certain of these competitors
have greater financial and other resources than the Company (including more
established trading histories for their shares of common stock, which may be
used as currency in making acquisitions). Additional companies with similar
objectives may enter the Company's markets and compete with the Company. In
addition, the business of providing orthodontic services is highly competitive
in each market in which the Company will operate. Each of the Founding
Affiliated Practices faces local competition from other orthodontists, general
dentists and pedodontists (dentists specializing in the care of children's
teeth), some of whom have more established practices. Dentists are not
restricted by law or any other governmental authority from providing orthodontic
services. Management believes the increase in recent years of dentists providing
orthodontic services has limited the growth of patient case starts performed by
orthodontists. There can be no assurance that the Company or the Affiliated
Practices will be able to compete effectively with their respective competitors,
that additional competitors will not enter their markets or that additional
competition will not have a material adverse effect on the Company.
EMPLOYEES
As of June 30, 1997, the Company employs approximately 300 employees, of
which approximately 20 are employed at the Company's headquarters and
approximately 280 are employed at the locations of the Affiliated Practices.
None of the Company's employees are represented by collective bargaining
agreements. The Company has not experienced any work stoppages as a result of
labor disputes and the Company considers its employee relations to be good.
LITIGATION AND INSURANCE
The Affiliated Practices provide orthodontic services to the public and are
exposed to the risk of professional liability and other claims. Such claims, if
successful, could result in substantial damage awards to the claimants that may
exceed the limits of any applicable insurance coverage. Although the Company
does not control the practice of orthodontics by the Affiliated Practices, it
could be asserted that the Company should be held liable for malpractice of an
orthodontist employed by an Affiliated Practice. Each Affiliated Practice has
undertaken to comply with all applicable regulations and legal requirements, and
the Company maintains liability insurance for itself and it is anticipated that
the Company will be named as an additional insured party on the liability
insurance policies of the Affiliated Practices. The Founding Affiliated
Practices have agreed to maintain comprehensive professional liability
insurance, generally with limits of not less than $1.0 million per claim and
with aggregate policy limits of not less than $3.0 million
22
<PAGE>
per orthodontist and, in the event a Founding Affiliated Practice employs more
than one orthodontist, the Founding Affiliated Practices will maintain such
insurance with a separate limit for claims against that Founding Affiliated
Practice in an amount acceptable to Apple. There can be no assurance, however,
that a future claim or claims will not be successful or, if successful, will not
exceed the limits of available insurance coverage or that such coverage will
continue to be available at acceptable costs.
On December 10, 1996, OCA filed a complaint in the United States District
Court for the Eastern District of Louisiana against Apple, Dr. Vondrak, John G.
Vondrak, P.C. and JGVAOI, alleging, among other things, misappropriation of
trade secrets and certain breaches of a confidentiality agreement executed by
Dr. Vondrak, on behalf of John Vondrak, P.C., in favor of OCA. While Apple is
not a party to the confidentiality agreement, OCA has alleged that the Company
should be bound by its terms as a result of the relationship between Dr. Vondrak
and Apple (specifically, OCA has alleged that Dr. Vondrak and Apple are alter
egos and, alternatively, that Dr. Vondrak was acting as Apple's agent when he
executed the confidentiality agreement). OCA's complaint states that OCA is
seeking monetary damages in excess of $75,000. The Company intends to vigorously
defend against the claims made by OCA, which the Company believes, based on
advice of counsel, are without merit.
The Company is not currently a party to any other claims, suits or
complaints relating to services and products provided by the Company or the
Founding Affiliated Practices, although there can be no assurances that such
claims will not be asserted against the Company in the future. The Company will
become subject to certain pending claims as the result of successor liability in
connection with the Acquisitions; however, it is the opinion of management that
the ultimate resolution of those claims will not have a material adverse effect
on the financial position or operating results of the Company.
The Founding Affiliated Practices have maintained professional liability
insurance coverage on a claims-made basis. Such insurance provides coverage for
claims asserted when the policy is in effect regardless of when the events that
caused the claim occurred. The Company intends to acquire similar coverage after
the closing of the Acquisitions, since the Company, as a result of the
Acquisitions, will in some cases succeed to the liabilities of the Founding
Affiliated Practices. Therefore, claims may be asserted after the Acquisitions
against the Company for events that occurred prior to the Acquisitions.
GOVERNMENT REGULATION
The orthodontic services industry is regulated extensively at both the
state and federal levels. Regulatory oversight includes, but is not limited to,
considerations of fee-splitting, corporate practice of orthodontics and state
insurance regulation.
FEE-SPLITTING; CORPORATE PRACTICE OF ORTHODONTICS
The laws of many states prohibit business corporations such as the Company
from engaging in the practice of orthodontics or employing orthodontists to
practice orthodontics and prohibit orthodontists from splitting fees with
non-orthodontists. The specific restrictions against the corporate practice of
orthodontics, as well as the interpretation of those restrictions by state
regulatory authorities, vary from state to state. The restrictions are generally
designed to prohibit a non-orthodontic entity (such as the Company) from
controlling the professional assets of an orthodontic practice (such as patient
records and payor contracts), employing orthodontists to practice orthodontics
(or, in certain states, employing dental hygienists or orthodontic assistants),
or controlling the content of an orthodontist's advertising or professional
practice. Apple will neither acquire any professional assets nor employ any
orthodontists who will provide orthodontic services at any of the Affiliated
Practices' locations. As provided in the Service Agreements, the Company does
not and will not control the practice of orthodontics or employ orthodontists to
practice orthodontics. Moreover, in states in which it is prohibited, the
Company does not employ orthodontic hygienists or orthodontic assistants. The
Company provides management services to the Affiliated Practices, and believes
that the management fees the Company charges for those services are consistent
with the laws and regulations of the jurisdictions in which it operates.
Therefore, the Company believes it would not be regarded as "owner,"
"operator" or "manager" of the Affiliated Practices within the meaning of
those
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<PAGE>
terms under the state orthodontic practice acts and believes that its operations
comply with the above-described laws to which it is subject.
The laws of many states also prohibit orthodontists from sharing
professional fees with non-orthodontic entities. There can be no assurance that
a review of the Company's business relationships by courts or regulatory
authorities will not result in determinations that could prohibit or otherwise
adversely affect the operations of the Company or that the regulatory
environment will not change, requiring the Company to reorganize or restrict its
existing or future operations. The laws regarding fee-splitting and the
corporate practice of orthodontics and their interpretation are enforced by
regulatory authorities with broad discretion. There can be no assurance that the
legality of the Company's business or its relationship with the Affiliated
Practices will not be successfully challenged or that the enforceability of the
provisions of any Service Agreement will not be limited.
State dental boards do not generally interpret these prohibitions as
preventing a non-orthodontic entity from owning non-professional assets used by
an orthodontist in an orthodontic practice or providing management services to
an orthodontist for a fee provided that the following conditions are met: a
licensed dentist has complete control and custody over the professional assets;
the non-orthodontic entity does not employ or control the orthodontists (or, in
some states, orthodontic hygienists or orthodontic assistants); all orthodontic
services are provided by a licensed dentist; licensed dentists have control over
the manner in which orthodontic care is provided and all decisions affecting the
provision of orthodontic 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 in 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 orthodontic practice acts do not address or
provide any restrictions concerning the manner in which companies account for
revenues from an orthodontic practice subject to the above-noted restrictions
relating to control over the professional activities of the orthodontic
practice, ownership of the professional assets of an orthodontic practice and
payments for management services. See "Risk Factors -- Government Regulation."
STATE INSURANCE REGULATION
Although the Company does not anticipate entering into managed care
contracts, there are certain regulatory risks associated with the Company's role
in negotiating and administering managed care contracts. The application of
state insurance laws to 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 the Affiliated Practices contract with
third-party payors, including self-insured plans, for certain non-fee for
service basis arrangements, the Company may become subject to state insurance
laws. Specifically, in some states, state insurance regulators may determine
that the Company or an Affiliated Practice is engaged in the business of
insurance because some of the managed care contracts to which an Affiliated
Practice may become a party may contain capitation features. The Company is
reviewing, and where appropriate modifying, the terms of certain of its
capitation contracts to reduce the likelihood that they could be characterized
as insurance contracts. In the event that the Company or an Affiliated Practice
is determined to be engaged in the business of insurance, it could be required
either to seek licensure as an insurance company or to change the form of the
relationships with third-party payors and, as a result the Company's revenues
may be adversely affected.
HEALTH CARE REFORM PROPOSALS
The United States Congress has considered various types of health care
reform, including comprehensive revisions to the current health care system. It
is uncertain what, if any, legislative proposals will be adopted in the future
or what actions federal or state legislatures or third-party payors may take in
anticipation of or in response to any health care reform proposals or
legislation. Health care reform legislation could have a material adverse effect
on the operations of the Company, and changes in the health care industry, such
as the growth of managed care organizations and provider networks, may result in
lower payment levels for the services of orthodontic practitioners and lower
profitability for Affiliated Practices.
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<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth certain information concerning the Company's
directors, the executive officers and key employees of the Company (ages are as
of March 31, 1997):
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------- --- ---------------------------------------------------
<S> <C> <C>
John G. Vondrak, D.D.S......................... 56 Chairman of the Board and Chief Executive Officer
Robert J. Syverson............................. 48 President and Chief Operating Officer
Michael W. Harlan.............................. 36 Vice President and Chief Financial Officer
H. Steven Walton............................... 39 Vice President of Business Development
and General Counsel
W. Daniel Cook................................. 41 Chief Administrative Officer and a Director
LeeAnn Peniche*................................ 36 Vice President of Marketing and Training
William W. Sherrill............................ 70 Director
Wm. Randol Womack, D.D.S.*..................... 58 Director of Business Development
Charles W. Sommer*............................. 32 Controller
</TABLE>
- ------------
* Key Employee
The executive officers of the Company are elected annually by the Board of
Directors of the Company and serve at the discretion of the Board.
JOHN G. VONDRAK, D.D.S. has been Chairman of the Board of Directors and
Chief Executive Officer of the Company since October 1996 and has served as a
director of the Company since July 1996. Dr. Vondrak has been the President and
sole shareholder of JGVAOI, one of the Founding Affiliated Practices, for more
than the past five years. Dr. Vondrak is a licensed dentist, a graduate of an
American Dental Association accredited orthodontic program and has maintained a
private orthodontic practice for over 24 years. He is a member of the American
Association of Orthodontists and the Southwest Society of Orthodontists and has
served as President of the New Mexico Orthodontic Society (1979).
ROBERT J. SYVERSON has been President of the Company since November 1996
and Chief Operating Officer of the Company since October 1996. From July 1996
through October 1996, Mr. Syverson served as a consultant to the Company on
operational and financial matters. From February 1979 through April 1996, Mr.
Syverson held various executive positions in the finance operations and sales
departments of "A" Company Orthodontics, a manufacturer and supplier of
orthodontic materials. Positions included Vice President of Finance, Vice
President of Operations, Vice President International Sales and most recently,
Executive Vice President Sales. "A" Company Orthodontics was an affiliate of
Johnson & Johnson from April 1982 through June 1994. Prior thereto, Mr. Syverson
held various positions with Coopers & Lybrand as a certified public accountant,
where he was a manager from July 1977 through January 1979.
MICHAEL W. HARLAN has been Vice President and Chief Financial Officer of
the Company since March 1997. From December 1996 to February 1997, Mr. Harlan
served as a consultant to the Company on financial and accounting matters. From
April 1991 through December 1996, Mr. Harlan held various positions in the
finance and acquisition departments of Sanifill, Inc., an international
environmental services company, where he had been the Treasurer since September
1993. While at Sanifill, Inc., Mr. Harlan participated in over 100 acquisitions
and was actively involved in raising in excess of $500 million of public and
private capital. From May 1982 through April 1991, Mr. Harlan held various
positions in the tax and corporate financial consulting services division of
Arthur Andersen LLP, where he had been a manager since July 1986. Mr. Harlan is
a certified public accountant.
H. STEVEN WALTON is Vice President of Business Development and General
Counsel. Mr. Walton served as Vice President -- Government Affairs and General
Counsel of Sanifill, Inc., an international environmental services company, from
June 1994 to August 1996. Sanifill was acquired by USA Waste Services, Inc. in
August 1996, and Mr. Walton served as Vice President -- Business Development for
USA Waste
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<PAGE>
from August 1996 to March 1997. Before joining Sanifill, Mr. Walton was Senior
Vice President and General Counsel of Catalyst Energy Corporation, an
independent power company, and Of Counsel to the law firm Blackwell, Sanders,
Matheny, Weary & Lombardi, Kansas City, Missouri.
W. DANIEL COOK has served as a director of the Company since October 1996
and as Chief Administrative Officer since February 1997. From December 1996 to
January 1997 Mr. Cook served as a consultant to the Company on various legal
matters. Prior thereto he was a partner at the law firm of Breard, Raines &
Cook, P.L.L.C. (1996 to 1997) and was associated with the law firm of Page,
Mannio, Peresich, Dickinson & McDermott, P.L.L.C. (1991 to 1995).
LEEANN PENICHE is Vice President of Marketing and Training of the Company.
From September 1996 to February 1997, Ms. Peniche served as a consultant to the
Company on various practice development matters. In July 1989, Ms. Peniche
founded Peniche & Associates, Inc., a consulting firm specializing in the
development and implementation of practice development techniques for
orthodontic practices throughout North America, where she has served as its
President from inception to the date of this Prospectus. Ms. Peniche has entered
into a three-year employment agreement with the Company. From June 1978 until
July 1989, Ms. Peniche held various positions within several orthodontic
clinics, including dental assistant and office manager. From January 1985 until
September 1991, Ms. Peniche was on the faculty of Paradigm Practice Management
Company, where she specialized in training orthodontists and their staff in
practice development activities. Ms. Peniche is a frequent lecturer with the
American Association of Orthodontics, the Pacific Coast Orthodontic Society and
numerous other private orthodontic societies. Ms. Peniche is a Registered Dental
Assistant, specializing in orthodontics.
WILLIAM W. SHERRILL has served as a director of the Company since October
1996. He is an Executive Professor at the University of Houston College of
Business Administration and is the Director for the University of Houston's Conn
Center for Entrepreneurship & Innovation. Mr. Sherrill was formerly the
principal of William W. Sherrill, Financial Consultants from 1974 to 1981. From
1971 to 1974, Mr. Sherrill served as the President of Associates Corporation of
North America and was a director of Gulf and Western Industries, Inc. Before
joining Associates Corporation, he was appointed by the President of the United
States in 1967, and confirmed by the U.S. Senate, to fill an unexpired term as
Governor of the Federal Reserve Board in Washington D.C. Mr. Sherrill was
reappointed by the President, and again confirmed by the Senate, to a full
14-year term on the Board of Governors. Prior to his Federal Reserve
appointment, he was the Director of the Federal Deposit Insurance Corporation,
being appointed by the President, and confirmed by the Senate, to the FDIC's
three-member Board of Directors. Before joining the FDIC, he was President and
Chief Operating Officer of the Homestead Bank, Houston, Texas, from 1963 to
1966. Mr. Sherrill is being appointed to the Company's Board of Directors
pursuant to the provisions of a funding agreement between Apple and TriCap. This
funding agreement terminated pursuant to its terms upon completion of the IPO.
See "Certain Transactions -- Agreements with TriCap."
WM. RANDOL WOMACK, D.D.S., has been Director of Business Development since
March 1997. From December 1996 to February 1997, Dr. Womack has served as a
consultant to the Company. Prior thereto, Dr. Womack practiced orthodontics
beginning in 1966 in Clovis, New Mexico, with a satellite practice in Tucumari,
New Mexico, and subsequently established a practice in Phoenix, Arizona, where
he has practiced orthodontics since 1972.
CHARLES W. SOMMER has been Controller of the Company since March 1997. From
January 1997 to February 1997, Mr. Sommer served as a consultant to the Company
on various accounting matters. From February 1996 through January 1997, Mr.
Sommer was the Corporate Controller of COREStaff, Inc., a publicly traded,
national provider of temporary services, which has grown through acquisitions
since its inception. From November 1993 through February 1996, Mr. Sommer was
assistant corporate controller of Sanifill, Inc., where he was responsible for
Commission reporting and financial due diligence on acquisitions. From July 1986
through November 1993, Mr. Sommer held various positions in the audit division
of Arthur Andersen LLP, where he had been a manager since July 1990. Mr. Sommer
is a certified public accountant.
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<PAGE>
BOARD OF DIRECTORS
The Board of Directors of the Company currently is composed of three
directors. The Company intends to expand the Board of Directors shortly after
the IPO to add two additional directors, neither of whom will be affiliated with
the Company or its affiliates. The Board of Directors will be divided into three
classes with two directors in each class, with the term of one class expiring at
the annual meeting of stockholders in each year, commencing 1998. At each annual
meeting of stockholders, directors of the class the term of which then expires
will be elected by the holders of the Common Stock to succeed those directors
whose terms are expiring.
There are three committees of the Board: Audit, Compensation and Executive.
The members of the Audit and Compensation Committees are not employees of the
Company.
Directors who are employees of the Company do not receive additional
compensation for serving as directors. Each director who is not an employee of
the Company will receive a fee of $2,000 for attendance at each Board of
Directors meeting and $1,000 for each committee meeting (unless held on the same
day as a Board of Directors meeting) and an initial grant of nonqualified
options to purchase 10,000 shares of Common Stock. See " -- 1996 Stock Option
Plan." All directors of the Company are reimbursed for out-of-pocket expenses
incurred in attending meetings of the Board of Directors or committees thereof,
and for other expenses incurred in their capacity as directors of the Company.
EXECUTIVE COMPENSATION
The following table sets forth the total compensation paid by the Company
during the fiscal year 1996 for its Chairman of the Board and Chief Executive
Officer.
ANNUAL
COMPENSATION
NAME SALARY
- ------------------------------------- -------------
John G. Vondrak, D.D.S. ............. $75,000(1)
- ------------
(1) Dr. Vondrak received no cash bonus or other form of annual compensation
other than salary during 1996.
Apple was incorporated in July 1996 and has not conducted any operations
prior to May 29, 1997 other than in connection with the IPO and the
Acquisitions. The Company anticipates that during 1997 its most highly
compensated executive officers will be Dr. Vondrak and Messrs. Syverson, Harlan,
Walton and Cook (the "Named Executive Officers"), each of whom has entered
into an employment agreement providing for an annual salary of $180,000,
$150,000, $130,000, $130,000 and $120,000, respectively, and providing that they
be full-time employees of Apple. See " -- Employment Agreements."
In addition to base salary, the Named Executive Officers through their
employment agreements are eligible for bonuses based on earnings performance of
the Company, and Mr. Walton is entitled to receive certain commissions upon the
consummation of future acquisitions.
In April 1997, the Company granted options to purchase 135,000 shares,
100,000 shares, 90,000 shares, 161,850 shares and 70,000 shares of Common Stock
to Dr. Vondrak, Mr. Syverson, Mr. Harlan, Mr. Walton and Mr. Cook, respectively,
under the Company's 1996 Stock Option Plan, exercisable at the initial public
offering price per share set forth on the cover page of this Prospectus. Such
options will expire in April 2007 and will vest, with respect to all but one
option to acquire 76,850 shares granted to Mr. Walton, as to 25% of the
underlying shares on the date the Offering is consummated and with respect to
the remaining underlying shares on the next three anniversaries of such date in
25% increments. With respect to the option to acquire 76,850 shares granted to
Mr. Walton, such option vests as to 50% of the underlying shares on the date the
Offering is consummated and as to the remaining underlying shares on the first
anniversary of such date. See "-- 1996 Stock Option Plan."
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<PAGE>
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with Dr. Vondrak and
Messrs. Syverson, Harlan, Walton and Cook. The following summary of these
agreements does not purport to be complete and is qualified by reference to such
agreements, copies of which have been filed as exhibits to the Registration
Statement of which this Prospectus is a part. Each of these agreements provides
for an annual base salary in an amount not less than the initial specified
amount and entitles the employee to participate in all the Company's
compensation plans (as defined) in which other executive officers of the Company
participate. Each of these agreements also has a continuous three-year term
subject to the right of the Company and the employee to terminate the employee's
employment at any time. If the employee's employment is terminated by the
Company without cause (as defined) or by the employee with good reason (as
defined), the employee will be entitled, during each of the years in the
three-year period beginning on the termination date, to (i) periodic payments
equal to his average annual cash compensation (as defined) from the Company,
including bonuses, if any, during the two years (or such shorter period of
employment) preceding the termination date, and (ii) continued participation in
all the Company's compensation plans (other than the granting of new awards
under the 1996 Stock Option Plan or any other performance-based plan). Except in
the case of a termination for cause, any stock options previously granted to the
employee under the Incentive Plan that have not been exercised and are
outstanding as of the time immediately prior to the date of his termination will
remain outstanding (and continue to become exercisable pursuant to their
respective terms) until exercised or the expiration of their term, whichever is
earlier. If a change of control (as defined) of the Company occurs, the employee
will be entitled to terminate his employment at any time during the 365-day
period following that change of control and receive a lump-sum payment equal to
three times his highest annual base salary under the agreement (plus such
amounts as may be necessary to hold the employee harmless from the consequences
of any resulting excise or other similar purpose tax relating to "parachute
payments" under the Internal Revenue Code of 1986, as amended (the "Code")).
Each employment agreement contains a covenant limiting the employee's right to
compete against the Company for a period of one year following termination of
employment.
Each Founding Affiliated Practice will enter into an employment agreement
with its orthodontist employees. See "Business -- Orthodontist Employment
Agreements."
1996 STOCK OPTION PLAN
In December 1996, the Board of Directors adopted, and the stockholders of
the Company approved, the 1996 Stock Option Plan. The purpose of the 1996 Stock
Option Plan is to provide employees, non-employee directors, advisors and
orthodontists with practice management contracts with the Company or a
subsidiary with additional incentives by increasing their proprietary interest
in the Company. The Company has reserved 1,000,000 shares of Common Stock for
use in connection with the 1996 Stock Option Plan (which includes 743,000 shares
subject to options previously granted). Beginning with the Company's first
fiscal quarter after the closing of the IPO and continuing each fiscal quarter
thereafter, the number of shares available for use in connection with the 1996
Stock Option Plan will be the greater of 1,000,000 or 12% of the number of
shares of Common Stock outstanding on the last day of the preceding calendar
quarter.
The 1996 Stock Option Plan provides for the grant of incentive stock
options ("ISOs"), as defined in Section 422 of the Code, and nonqualified
stock options (collectively, "Awards"). Following the consummation of the IPO,
the 1996 Stock Option Plan will be administered by the Compensation Committee of
the Board of Directors, which will be comprised of not less than two members of
the Board of Directors (the "Committee"). Prior to the consummation of the
IPO, the 1996 Stock Option Plan had been administered by the Company's full
Board of Directors. The Committee has, subject to the terms of the 1996 Stock
Option Plan, the sole authority to grant Awards under the 1996 Stock Option
Plan, to interpret the 1996 Stock Option Plan and to make all other
determinations necessary or advisable for the administration of the 1996 Stock
Option Plan.
All of the Company's employees, non-employee directors, advisors and
orthodontists with practice management contracts with the Company or a
subsidiary are eligible to receive Awards under the 1996 Stock Option Plan, but
only employees of the Company are eligible to receive ISOs. Awards will be
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<PAGE>
exercisable during the period specified in each option agreement and will
generally be exercisable in installments pursuant to a vesting schedule to be
designated by the Committee. Notwithstanding the provisions of any option
agreement, options will become immediately exercisable in the event of certain
events including certain merger or consolidation transactions and changes in
control of the Company. No option will remain exercisable later than ten years
after the date of grant (or five years from the date of grant in the case of
ISOs granted to holders of more than 10% of Common Stock).
The exercise price for ISOs granted under the 1996 Stock Option Plan may be
no less than the fair market value of the Common Stock on the date of grant (or
110% of the fair market value in the case of ISOs granted to employees owning
more than 10% of the Common Stock). The per share exercise price for
nonqualified options granted under the 1996 Stock Option Plan will be in the
discretion of the Committee, but may not be less than the fair market value of a
share of Common Stock on the date of grant.
There are generally no federal income tax consequences upon the grant of an
option under the 1996 Stock Option Plan. Upon exercise of a nonqualified option,
the optionee generally will recognize ordinary income in the amount equal to the
difference between the fair market value of the option shares at the time of
exercise and the exercise price, and the Company is generally entitled to a
corresponding tax deduction. When an optionee sells shares issued upon the
exercise of a non-qualified stock option, the optionee realizes short-term or
long-term capital gain or loss, depending on the length of the holding period,
but the Company is not entitled to any tax deduction in connection with such
sale.
An optionee will not be subject to federal income taxation upon the
exercise of ISOs granted under the 1996 Stock Option Plan, and the Company will
not be entitled to a federal income tax deduction by reason of such exercise. A
sale of shares of Common Stock acquired upon exercise of an ISO that does not
occur within one year after the date of exercise or within two years after the
date of grant of the option generally will result in the recognition of
long-term capital gain or loss by the optionee in an amount equal to the
difference between the amount realized on the sale and the exercise price, and
the Company is not entitled to any tax deduction in connection therewith. If a
sale of shares of Common Stock acquired upon exercise of an ISO occurs within
one year from the date of exercise of the option or within two years from the
date of the option grant (a "disqualifying disposition"), the optionee
generally will recognize ordinary income equal to the lesser of (i) the excess
of the fair market value of the shares on the date of exercise of the options
over the exercise price or (ii) the excess of the amount realized on the sale of
the shares over the exercise price. Any amount realized on a disqualifying
disposition in excess of the amount treated as ordinary income will be long-term
or short-term capital gain, depending upon the length of time the shares were
held. The Company generally will be entitled to a tax deduction on a
disqualifying disposition corresponding to the amount of ordinary income
recognized by the optionee.
The Company has (i) outstanding options to purchase a total of
approximately 743,000 shares of Common Stock under the 1996 Stock Option Plan
and (ii) options to purchase 257,000 additional shares available for grant under
the 1996 Stock Option Plan.
Each nonemployee director automatically will be granted nonqualified stock
options ("NSOs") to purchase 10,000 shares of Common Stock. In addition, on
the first business day of the month following the date on which each annual
meeting of the Company's stockholders is held (each an "Annual Director Award
Date"), each nonemployee director automatically will be granted NSOs to
purchase 5,000 shares of Common Stock. Any person who first becomes a
nonemployee director after the date the Offering closes otherwise than by
election at an annual meeting of stockholders automatically will be granted, on
the date of his or her election, NSOs to purchase 10,000 shares of Common Stock.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to December 1996, the Company did not have a Compensation Committee,
and executive compensation has been set by the Company's Board of Directors.
29
<PAGE>
CERTAIN TRANSACTIONS
ORGANIZATION OF THE COMPANY
The following table provides certain information concerning the issuance of
the outstanding shares of Class B Stock, which the Company issued on October 11,
and December 9, 1996:
DATE OF NUMBER OF PURCHASE PRICE
NAME ISSUANCE SHARES PER SHARE
- ---------------------------------- --------- ----------- ---------------
John G. Vondrak, D.D.S. .......... 10-11-96 1,358,782 $.001
TriCap Funding I, L.L.C. ......... 10-11-96 1,373,498 $.001
Robert J. Syverson................ 10-11-96 130,809 $.001
W. Daniel Cook.................... 10-11-96 171,687 $.001
Michael W. Harlan................. 12- 9-96 76,850 $.001
All outstanding shares of Class B Stock are convertible into shares of
Common Stock under certain circumstances. See "Description of Capital
Stock -- Common Stock and Class B Stock." The purchase prices paid for the
foregoing shares of capital stock were the fair market value on the date of
issuance as determined by the Board of Directors.
Apple entered into agreements with Messrs. Syverson, Harlan and Cook
pursuant to which the Company sold to such officers 130,809 shares, 76,850
shares and 171,687 shares of Class B Stock, respectively, at the purchase price
per share set forth in the foregoing table. Each holder of such shares is
entitled to all rights of ownership of Common Stock, including the right to vote
and receive dividends, subject to certain restrictions set forth in a
subscription agreement entered into by the Company and each such holder (each a
"Subscription Agreement"). Each Subscription Agreement provides that, until
the restrictions affecting such shares lapse, the holder may not sell, transfer,
pledge or otherwise dispose of the shares subject to the agreement. Each
Subscription Agreement also provides that, in the event of the termination of
the employment of such holder (other than as a result of termination without
cause, death, disability or a change in control of the Company), the Company
shall have the right to repurchase any shares with respect to which the
restrictions imposed by the Subscription Agreement have not lapsed at the price
per share paid by the executive officer.
With respect to Messrs. Syverson and Harlan, the Subscription Agreements
provide that the restrictions lapsed with respect to 50% of each holder's shares
upon consummation of the IPO and that the restrictions on such holder's
remaining shares will lapse on May 29, 1998. The Subscription Agreement between
Apple and Mr. Cook provides that the restrictions lapsed immediately upon
issuance with respect to approximately 24% of his shares and with respect to
approximately 38% of his shares on May 29, 1997, and that the restrictions on
his remaining shares will lapse on May 29, 1998.
In connection with the Acquisition of JGVAOI, Dr. Vondrak received
approximately 259,981 shares of Common Stock and $455,000, and entered into a
Service Agreement providing for service fee payments to the Company. See
"Business -- Service Agreements." Additionally, TriCap incurred $400,000 of
expenses in connection with the Acquisitions and the IPO, and advanced to the
Company $2.6 million to fund transaction costs in exchange for the reimbursement
of such expenses and the repayment of such advances plus accrued interest (at
the prime rate announced by NationsBank of Texas, N.A. plus .25%) from the
proceeds of the IPO. The Company has used $230,000 of the funds advanced to it
by TriCap to reimburse JGVAOI for a portion of the organizational expenses of
Apple incurred by JGVAOI. The Company has reimbursed JGVAOI an additional
$70,000 from the proceeds of the IPO to repay the remainder of such expenses.
See "Risk Factors -- Control By Existing Management and Stockholders; Potential
Conflicts of Interest" and "Use of Proceeds."
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<PAGE>
AGREEMENTS WITH TRICAP AND TRICAP PARTNERS
TriCap Partners, an affiliate of TriCap co-owned by Mr. Sherrill, was the
exclusive financial advisor to Apple pursuant to a consulting agreement with a
term that extended through May 29, 1997. Pursuant to the consulting agreement
Apple paid TriCap Partners (i) $500,000 upon consummation of the IPO and (ii) a
warrant to purchase 180,000 shares of Common Stock with an exercise price per
share of $7.00. In connection with the warrant, the Company granted TriCap
Partners certain demand and piggyback registration rights. See "Shares Eligible
for Future Sale."
Pursuant to a funding agreement between TriCap and Apple, TriCap advanced
to Apple approximately $2.6 million to fund transaction costs in connection with
the Acquisitions and the IPO. These advances together with expenses of
approximately $400,000 incurred by TriCap on behalf of the Company were repaid
with proceeds from the IPO. The funding agreement terminated pursuant to its
terms on May 29, 1997. See "Use of Proceeds." In connection with this
agreement, Apple granted TriCap and Dr. Vondrak certain piggyback registration
rights. See "Shares Eligible For Future Sale."
TriCap purchased 400,000 shares of Common Stock in IPO. See "Security
Ownership of Certain Beneficial Owners and Management."
COMPANY POLICY
It is anticipated that future transactions with affiliates of the Company
will be minimal, will be approved by a majority of the disinterested members of
the Board of Directors and will be made on terms no less favorable to the
Company than could be obtained from unaffiliated third parties. The Company does
not intend to incur any further indebtedness to, or make any loans to, any of
its executive officers, directors or other affiliates.
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<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table shows, as of June 1, 1997, information respecting the
"beneficial owners" (as defined by the Commission) of more than 5% of the
Common Stock and Class B Stock, each director, each executive officer, and all
executive officers and directors of the Company as a group.
<TABLE>
<CAPTION>
NUMBER OF SHARES BENEFICIALLY OWNED(1)
---------------------------------------------------
COMMON PERCENT OF CLASS B PERCENT OF
NAME STOCK CLASS STOCK CLASS
- ------------------------------------- ------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
TriCap Funding I, L.L.C. ............ 400,000 6.3% 1,373,498 41.0%
One West Loop South, Suite 100
Houston, Texas 77027
John G. Vondrak, D.D.S............... 343,731(2)(3) 5.4% 1,293,377 38.6%
W. Daniel Cook....................... 17,500(3) * 171,687 5.1%
Robert J. Syverson................... 25,000(3) * 130,809 3.9%
Michael W. Harlan.................... 22,500(3) * 76,850 2.3%
H. Steven Walton..................... 61,175(3) *
William W. Sherrill.................. 183,125(3)(4) 2.8% -- --
All executive officers and directors
as a group
(6 persons)........................ 653,031(3)(4) 9.0% 1,672,723 50.0%
</TABLE>
- ------------
* less than 1%.
(1) Shares shown in the above table do not include shares that could be acquired
upon exercise of currently outstanding stock options which do not vest
within 60 days of June 1, 1997.
(2) Includes 259,981 shares issued in connection with the acquisition of JGVAOI.
(3) Includes shares that may be acquired pursuant to outstanding options within
60 days of June 1, 1997: 33,750 shares in the case of Dr. Vondrak; 17,500
shares in the case of Mr. Cook; 25,000 shares in the case of Mr. Syverson;
22,500 shares in the case of Mr. Harlan; 3,125 shares in the case of Mr.
Sherrill; 59,675 shares in the case of Mr. Walton; and 161,550 shares in the
case of all executive officers and directors as a group.
(4) Includes 180,000 shares that may be acquired pursuant to an outstanding
warrant within 60 days of June 1, 1997 held of record by TriCap Partners,
which Mr. Sherrill co-owns.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock consists of 25,000,000 shares of
Class A Common Stock, par value $0.001 per share, 4,106,852 shares of Class B
Common Stock, par value $0.001 per share, and 10,000,000 shares of preferred
stock, par value $0.001 per share (the "Preferred Stock"). At June 1, 1997,
3,347,084 shares of Class B Stock were issued and outstanding, 6,376,483 shares
of Common Stock were issued and outstanding, and no shares of preferred stock of
the Company were issued and outstanding. The following summary is qualified in
its entirety by reference to the Certificate of Incorporation, which is included
as an exhibit to the Registration Statement of which this Prospectus is a part.
COMMON STOCK AND CLASS B COMMON STOCK
Holders of the Class B Stock have the ability to elect as a class one
member of the Board of Directors and the holders of the Common Stock will have
the ability to elect as a class all other members of the Board of Directors. In
the event of a change in the number of directors, holders of Class A Common
Stock have the ability to elect at least 80% of the Board of Directors (rounded
up to the nearest whole number) elected by the holders of Common Stock and,
subject to the rights of the holders of any series of preferred stock, the
holders of the Class B Common Stock will have the right to elect the remaining
directors. The Common Stock and Class B Stock possess ordinary voting rights and
vote together as a single class in respect of all other corporate matters, and,
in connection therewith, holders of shares of Common Stock are entitled to one
vote per share and holders of shares of Class B Stock are entitled to
three-tenths ( 3/10ths) of a vote per share. The Common Stock and Class B Stock
afford no cumulative voting rights, and the holders of a majority of the shares
voting for the election of directors can elect all the directors if they choose
to do so. The Common Stock and Class B Stock carry no preemptive rights, are not
convertible, redeemable, assessable or entitled to the benefits of any sinking
fund. The holders of Common Stock and Class B Stock are entitled to dividends in
such amounts and at such times as may be declared by the Board of Directors out
of funds legally available therefor. The Company intends that all future
dividends, if any, declared on, or distributions with respect to, its shares of
Common Stock and Class B Stock will be paid on a pro rata basis to the holders
of such shares. See "Dividend Policy" for information regarding the Company's
dividend policy.
Directors may be removed, with or without cause, by the holders of the
class or classes of stock that elected them. Directors may be removed by the
Board of Directors only for cause. Vacancies in a directorship may be filled by
the vote of the class or classes of shares that had previously filled that
vacancy, or by the remaining directors or director elected by such class or
classes; however, if there are no such directors, the vacancy may be filled by
the other directors.
Each share of Class B Stock will automatically convert to Common Stock on a
share-for-share basis (i) in the event of a disposition of such share of Class B
Stock by the holder thereof (excluding dispositions to such holder's
affiliates), (ii) in the event any person not affiliated with Apple acquires
beneficial ownership of 15% or more of the outstanding shares of capital stock
of the Company, (iii) in the event any person not affiliated with Apple offers
to acquire 15% or more of the outstanding shares of capital stock of the
Company, (iv) in the event the holder of such share elects to so convert at any
time after the second anniversary of the date of this Prospectus, (v) on the
fifth anniversary of the date of this Prospectus or (vi) in the event the
holders of a majority of the outstanding shares of Common Stock approve such
conversion. In addition, the Company may elect to convert any outstanding shares
of Class B Stock into shares of Common Stock in the event 80% or more of the
outstanding shares of Class B Stock as of the date of this Prospectus have
previously been converted into shares of Common Stock.
PREFERRED STOCK
The Preferred Stock may be issued from time to time by the Board of
Directors as shares of one or more classes or series. Subject to the provisions
of the Certificate of Incorporation and limitations prescribed by law, the Board
of Directors is expressly authorized to adopt resolutions to issue the shares,
to fix the number of shares and to change the number of shares constituting any
series and to provide for or change the voting powers, designations, preferences
and relative, participating, optional or other special rights, qualifications,
limitations or restrictions thereof, including dividend rights (including
whether dividends are cumulative), dividend rates, terms of redemption
(including sinking fund provisions),
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<PAGE>
redemption prices, conversion rights and liquidation preferences of the shares
constituting any class or series of the Preferred Stock, in each case without
any further action or vote by the holders of Common Stock.
Although the Company has no present intention to issue shares of Preferred
Stock, the issuance of shares of Preferred Stock, or the issuance of rights to
purchase such shares, could be used to discourage an unsolicited acquisition
proposal. For example, the issuance of a series of Preferred Stock might impede
a business combination by including class voting rights that would enable the
holders to block such a transaction; or such issuance might facilitate a
business combination by including voting rights that would provide a required
percentage vote of the stockholders. In addition, under certain circumstances,
the issuance of Preferred Stock could adversely affect the voting power of the
holders of the Common Stock. Although the Board of Directors is required to make
any determination to issue such stock based on its judgment as to the best
interests of the stockholders of the Company, the Board of Directors could act
in a manner that would discourage an acquisition attempt or other transaction
that some or a majority of the stockholders might believe to be in their best
interests or in which stockholders might receive a premium for their stock over
the then-market price of such stock. The Board of Directors does not at present
intend to seek stockholder approval prior to any issuance of currently
authorized stock, unless otherwise required by law or the rules of any market on
which the Company's securities are traded.
STATUTORY BUSINESS COMBINATION PROVISION
The Company is a Delaware corporation and is subject to Section 203 of the
DGCL. In general, Section 203 prevents an "interested stockholder" (defined
generally as a person owning 15% or more of a corporation's outstanding voting
stock) from engaging in a "business combination" (as defined) with a Delaware
corporation for three years following the time such person became an interested
stockholder unless (i) before such person became an interested stockholder, the
board of directors of the corporation approved the transaction in which the
interested stockholder became an interested stockholder or approved the business
combination, (ii) upon consummation of the transaction that resulted in the
stockholder's becoming an interested stockholder, the interested stockholder
owned at least 85% of the voting stock of the corporation outstanding at the
time the transaction commenced (excluding stock held by directors who are also
officers of the corporation and by employee stock plans that do not provide
employees with the rights to determine confidentially whether shares held
subject to the plan will be tendered in a tender or exchange offer) or (iii)
following the transaction in which such person became an interested stockholder,
the business combination was approved by the board of directors of the
corporation and authorized at a meeting of stockholders by the affirmative vote
of the holders of two thirds of the outstanding voting stock of the corporation
not owned by the interested stockholder. Under Section 203, the restrictions
described above also do not apply to certain business combinations proposed by
an interested stockholder following the announcement or notification of one of
certain extraordinary transactions involving the corporation and a person who
had not been an interested stockholder during the previous three years or who
became an interested stockholder with the approval of a majority of the
corporation's directors, if such extraordinary transaction is approved or not
opposed by a majority of the directors who were directors prior to any person's
becoming an interested stockholder during the previous three years or were
recommended for election or elected to succeed such directors by a majority of
such directors.
OTHER MATTERS
Delaware law authorizes corporations to limit or eliminate the personal
liability of directors to corporations and their stockholders for monetary
damages for breach of a director's fiduciary duty of care. The duty of care
requires that, when acting on behalf of the corporation, directors must exercise
an informed business judgment based on all material information reasonably
available to them. Absent the limitations authorized by Delaware law, directors
are accountable to corporations and their stockholders for monetary damages for
conduct constituting gross negligence in the exercise of their duty of care.
Delaware law enables corporations to limit available relief to equitable
remedies such as injunction or rescission. The Certificate of Incorporation
limits the liability of directors of the Company to the Company or its
stockholders to the fullest extent permitted by Delaware law. Specifically,
directors of the Company will not be personally liable for monetary damages for
breach of a director's fiduciary duty as a director, except for liability (i)
for any breach of the director's duty of loyalty to the Company or its
stockholders, (ii) for acts or
34
<PAGE>
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) for unlawful payments of dividends or unlawful stock
repurchases or redemptions as provided in Section 174 of the DGCL or (iv) for
any transaction from which the director derived an improper personal benefit.
The inclusion of this provision in the Certificate of Incorporation may
have the effect of reducing the likelihood of derivative litigation against
directors and may discourage or deter stockholders or management from bringing a
lawsuit against directors for breach of their duty of care, even though such an
action, if successful, might otherwise have benefited the Company and its
stockholders. The Company's Bylaws provide indemnification to the Company's
officers and directors and certain other persons with respect to certain
matters, and the Company has entered into agreements with each of its directors
and executive officers providing for indemnification with respect to certain
matters.
The Certificate of Incorporation provides that stockholders may act only at
an annual or special meeting of stockholders and may not act by written consent.
The Certificate of Incorporation and Bylaws provide that special meetings of the
stockholders can be called only by the Chairman of the Board, the President or a
majority of the Board of Directors.
The Certificate of Incorporation provides that the Board of Directors shall
consist of three classes of directors serving for staggered terms. As a result,
it is currently contemplated that approximately one-third of the Company's Board
of Directors will be elected each year. The classified board provision could
prevent a party who acquires control of a majority of the outstanding voting
stock of the Company from obtaining control of the Board of Directors until the
second annual stockholders' meeting following the date the acquiror obtains the
controlling interest. See "Management -- Directors, Executive Officers and Key
Employees."
The Certificate of Incorporation provides that the number of directors
shall be as determined by the Board of Directors from time to time, but shall
not be less than three. It also provides that directors may be removed only for
cause, and then only by the affirmative vote of the holders of at least a
majority of all outstanding voting stock entitled to vote. This provision, in
conjunction with the provisions of the Certificate of Incorporation authorizing
the Board of Directors to fill vacant directorships, will prevent stockholders
from removing incumbent directors without cause and filling the resulting
vacancies with their own nominees.
STOCKHOLDER PROPOSALS
The Company's Bylaws contain provisions (i) requiring that advance notice
be delivered to the Company of any business to be brought by a stockholder
before an annual meeting of stockholders and (ii) establishing certain
procedures to be followed by stockholders in nominating persons for election to
the Board of Directors. Generally, such advance notice provisions provide that
written notice must be given to the Secretary of the Company by a stockholder
(i) in the event of business to be brought by a stockholder before an annual
meeting, not less than 90 days prior to the anniversary date of the immediately
preceding annual meeting of stockholders (with certain exceptions if the date of
the annual meeting is different by more than specified amounts from the
anniversary date), and (ii) in the event of nominations of persons for election
to the Board of Directors by any stockholder, (a) with respect to an election to
be held at the annual meeting of stockholders, not less than 90 days prior to
the anniversary date of the immediately preceding annual meeting of stockholders
(with certain exceptions if the date of the annual meeting is different by more
than specified amounts from the anniversary date), and (b) with respect to an
election to be held at a special meeting of stockholders for the election of
directors, not later than the close of business on the seventh day following the
day on which notice of the date of the special meeting was mailed to
stockholders or public disclosure of the date of the special meeting was made,
whichever first occurs. Such notice must set forth specific information
regarding such stockholder and such business or director nominee, as described
in the Company's Bylaws. The foregoing summary is qualified in its entirety by
reference to the Company's Bylaws, which are included as an exhibit to the
Registration Statement of which this Prospectus is a part.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services, L.L.C.
35
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
The Company has outstanding (i) 6,376,483 shares of Common Stock of which
the 2,702,500 shares sold in the IPO are freely tradeable without restriction or
further registration under the Securities Act, except for those held by
"affiliates" (as defined in the Securities Act) of the Company, which shares
will be subject to the resale limitations of Rule 144 under the Securities Act,
and (ii) 3,347,084 shares of Class B Stock. The remaining shares of Common Stock
and all of the outstanding shares of Class B Stock are deemed "restricted
securities" under Rule 144 in that they were originally issued and sold by the
Company in private transactions in reliance upon exemptions under the Securities
Act, and may be publicly sold only if registered under the Securities Act or
sold in accordance with an applicable exemption from registration, such as those
provided by Rule 144 promulgated under the Securities Act as described below.
In general, under Rule 144 as amended effective April 29, 1997, if a
minimum of one year has elapsed since the later of the date of acquisition of
restricted securities from the issuer or from an affiliate of the issuer, the
acquirer or subsequent holder would be entitled to sell within any three-month
period a number of those shares that does not exceed the greater of one percent
of the number of shares of such class of stock then outstanding or the average
weekly trading volume of the shares of such class of stock during the four
calendar weeks preceding the filing of a Form 144 with respect to such sale.
Sales under Rule 144 are also subject to certain manner of sale provisions and
notice requirements and to the availability of current public information about
the issuer. In addition, if a period of at least two years has elapsed since the
later of the date of acquisition of restricted securities from the issuer or
from any affiliate of the issuer, and the acquirer or subsequent holder thereof
is deemed not to have been an affiliate of the issuer of such restricted
securities at any time during the 90 days preceding a sale, such person would be
entitled to sell such restricted securities under Rule 144(k) without regard to
the requirements described above. Rule 144 does not require the same person to
have held the securities for the applicable periods. The foregoing summary of
Rule 144 is not intended to be a complete description thereof. The Commission
has proposed certain amendments to Rule 144 that would, among other things,
eliminate the manner of sale requirements and revise the notice provisions of
that rule. The SEC has also solicited comments on other possible changes to Rule
144, including possible revisions to the one- and two-year holding periods and
the volume limitations referred to above.
As of February 28, 1997, options to purchase an aggregate of approximately
743,000 shares of Common Stock were outstanding under the Company's 1996 Stock
Option Plan. See " Management -- 1996 Stock Option Plan." In general, pursuant
to Rule 701 under the Securities Act, any employee, officer or director of, or
consultant to, the Company who purchased his or her shares pursuant to a written
compensatory plan or contract is entitled to rely on the resale provisions of
Rule 701, which permit non-affiliates to sell such shares without compliance
with the public information, holding period, volume limitation or notice
provisions of Rule 144, and permit affiliates to sell such shares without
compliance with the holding period provisions of Rule 144, in each case
commencing 90 days after the date of this Prospectus. A total of 20,000 shares
of Common Stock will be eligible for resale pursuant to Rule 701 (upon exercise
of options) 90 days following the date of this Prospectus (although the holders
of those shares have agreed not to offer or sell any of those shares during the
180-Day Lockup Period). In addition, the Company intends to file a registration
statement covering the 980,000 additional shares issuable upon exercise of stock
options that may be granted in the future under the 1996 Stock Option Plan, in
which case such shares of Common Stock generally will be freely tradable by
non-affiliates in the public market without restriction under the Securities
Act.
The Company, its executive officers and directors, TriCap and the persons
who acquired shares of Common Stock in connection with the Acquisitions have
agreed not to offer, sell, contract to sell, grant any option or other right for
the sale of, or otherwise dispose of any shares of Common Stock or any
securities, indebtedness or other rights exercisable for or convertible or
exchangeable into Common Stock owned or acquired in the future in any manner
prior to the expiration of 180 days after May 22, 1997 (the "180-Day Lockup
Period") without the prior written consent of Bear, Stearns & Co. Inc., except
that the Company may issue, subject to certain conditions, Common Stock in
connection with acquisitions and may grant
36
<PAGE>
Awards (or Common Stock upon exercise of Awards) under the 1996 Stock Option
Plan. These restrictions will be applicable to any shares acquired by any of
those persons in the Offering or otherwise during the 180-Day Lockup Period. In
addition, the holders of the shares of Common Stock acquired in connection with
the Acquisitions have agreed with the Company that they generally will not sell,
transfer or otherwise dispose of any of their shares for one year following May
29, 1997. Substantially all the outstanding shares of Class B Stock will become
eligible for resale pursuant to Rule 144 in October 1997.
In connection with the Acquisitions, the Company entered into a
registration rights agreement with former stockholders of the Founding
Affiliated Practices (the "Registration Rights Agreement"), which provide
certain registration rights with respect to the Common Stock issued to such
stockholders in the Acquisitions. The Registration Rights Agreement provides the
holders of Common Stock subject to the agreement with the right in the event the
Company proposes to register under the Securities Act any Common Stock for its
own account or for the account of others at any time through November 2001,
subject to certain exceptions, to require the Company to include shares owned by
them in the registration. In addition, pursuant to separate registration rights
agreements with TriCap, Dr. Vondrak and TriCap Partners, TriCap, Dr. Vondrak and
TriCap Partners have the right, in the event the Company proposes to register
under the Securities Act any Common Stock for its own account or for the account
of others at any time through November 2001, subject to certain exceptions, to
require the Company to include shares owned by them in the registration.
Furthermore, the registration rights agreement to which TriCap Partners is a
party provides for a single demand registration right pursuant to which Apple
will file a registration statement under the Securities Act to register the sale
of the shares issuable to TriCap Partners on exercise of the warrant described
under "Certain Transactions -- Agreements with TriCap." The demand request may
be made at any time before May 31, 2002, subject to certain conditions and
limitations.
In the case of each registration rights agreement described above, the
Company is generally required to pay the costs associated with such an offering
other than underwriting discounts and commissions and transfer taxes
attributable to the shares sold on behalf of the selling stockholders. Each
registration rights agreement provides that the number of shares of Common Stock
that must be registered on behalf of the selling stockholders is subject to
limitation if the managing underwriter determines that market conditions require
a limitation. Under each agreement, the Company will indemnify the selling
stockholders thereunder, and such stockholders will indemnify the Company,
against certain liabilities in respect of any registration statement or offering
covered by the registration rights agreement.
Before the IPO, there was no established public market for the Common
Stock. No prediction can be made of the effect, if any, that sales of shares
under Rule 144, or otherwise, or the availability of shares for sale will have
on the market price of the Common Stock prevailing from time to time after the
IPO. The Company is unable to estimate the number of shares that may be sold in
the public market under Rule 144, or otherwise, because such amount will depend
on the trading volume in, and market price for, the Common Stock and other
factors. Nevertheless, sales of substantial amounts of shares in the public
market, or the perception that such sales could occur, could adversely affect
the market price of the Common Stock of the Company. See "Underwriting."
The 2,000,000 shares of Common Stock issuable pursuant to this Offering
generally will be freely tradable after their issuance by persons not affiliated
with the Company unless the Company contractually restricts their sale. The
Company anticipates that the agreements entered into in connection with its
future Affiliations will restrict the resale of all or a portion of the shares
issued in those transactions for varying periods of time.
37
<PAGE>
PLAN OF DISTRIBUTION
THE COMPANY
This Prospectus covers the offer and sale of up to 2,000,000 shares of
Common Stock, which the Company may issue from time to time in connection with
the future direct and indirect acquisitions of other businesses, properties or
securities in business combination transactions in accordance with Rule
415(a)(1)(viii) of Regulation C under the Securities Act or as otherwise
permitted under the Securities Act.
The Company expects that the terms upon which it may issue the shares will
be determined through negotiations with the securityholders or principal owners
of the businesses whose securities or assets are acquired. It is expected that
the shares that are issued will be valued at prices reasonably related to market
prices for the Common Stock prevailing either at the time an acquisition
agreement is executed or at the time an acquisition is consummated.
GENERAL
All expenses of this Offering will be paid by the Company. No underwriting
discounts or commissions will be paid in connection with the issuance of shares
by the Company in business combination transactions, although finder's fees may
be paid with respect to specific acquisitions. Any person receiving a finder's
fee may be deemed to be an Underwriter within the meaning of the Securities Act.
The shares of Common Stock offered hereunder will be included on The
American Stock Exchange, but may be subject to certain contractual holding
period restrictions.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by H. Steven Walton, General Counsel of the Company.
EXPERTS
The financial statements of Apple Orthodontix, Inc. as of December 31, 1996
and for the period from inception, July 15, 1996, through December 31, 1996
included in this Prospectus and appearing elsewhere in the Registration
Statement have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their report with respect thereto, which is
included herein in reliance upon the authority of said firm as experts in giving
said report.
38
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 (together with all exhibits, schedules and amendments relating thereto, the
"Registration Statement") with respect to the Common Stock offered hereby.
This Prospectus, filed as part of the Registration Statement, does not contain
all the information contained in the Registration Statement, certain portions of
which have been omitted in accordance with the rules and regulations of the
Commission. For further information with respect to the Company and the Common
Stock offered hereby, reference is made to the Registration Statement including
the exhibits and schedules thereto. Statements contained in this Prospectus as
to the contents of any contract or other document filed as an exhibit to the
Registration Statement accurately describe the material provisions of such
document and are qualified in their entirety by reference to such exhibits for
complete statements of their provisions.
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended, and in accordance therewith files reports,
proxy statements and other information with the Commission. All of these
documents may be inspected without charge at the Public Reference Section of the
Commission at Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington,
D.C. 20549, and at the following regional offices of the Commission: Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661; and 7
World Trade Center, 13th Floor, New York, New York 10048. Copies can also be
obtained from the Commission at prescribed rates. The Commission maintains a Web
site (http://www.sec.gov) that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission. In addition, shares of the Common Stock of the Company are
traded on The American Stock Exchange and such reports, proxy statements and
other information may be inspected at 86 Trinity Place, New York, New York
10006-1881.
39
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Page
----
FINANCIAL STATEMENTS OF APPLE ORTHODONTIX, INC.
Report of Independent Public Accountants ........................... F-2
Balance Sheets ..................................................... F-3
Statements of Operations ........................................... F-4
Statements of Changes in Stockholders' Equity (Deficit) ............ F-5
Statements of Cash Flows ........................................... F-6
Notes to Financial Statements ...................................... F-7
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Apple Orthodontix, Inc.:
We have audited the accompanying balance sheet of Apple Orthodontix, Inc.,
a Delaware corporation, as of December 31, 1996, and the related statements of
operations, changes in stockholders' equity (deficit) and cash flows for the
period from inception, July 15, 1996, through December 31, 1996, as restated,
see Note 1. 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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Apple Orthodontix, Inc., as
of December 31, 1996, and the results of its operations and its cash flows for
the period from inception, July 15, 1996, through December 31, 1996, in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Houston, Texas
February 28, 1997
(except as discussed in Notes 1 and 2,
as to which the date is May 22, 1997)
F-2
<PAGE>
APPLE ORTHODONTIX, INC.
BALANCE SHEETS
DECEMBER 31, MARCH 31,
1996 1997
--------------- ---------------
(UNAUDITED)
ASSETS
Cash and cash equivalents............... $ 21,254 $ --
Long-term assets:
Property and equipment............. -- 165,358
Deferred issuance costs............ 1,395,350 3,402,795
Organization costs, net of
accumulated amortization of
$4,510 and $6,970................ 44,687 42,227
--------------- ---------------
Total long-term assets........ 1,440,037 3,610,380
--------------- ---------------
Total assets.................. $ 1,461,291 $ 3,610,380
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable................... $ 1,439,565 $ 2,377,995
Accrued bonuses.................... 325,000 325,000
Other accrued liabilities.......... 35,000 35,000
Amounts due to a founding
affiliated practice.............. 30,444 30,444
Amounts due to venture capital
investors........................ 515,000 2,153,206
--------------- ---------------
Total current liabilities..... 2,345,009 4,921,645
Long term liabilities:
Amounts due under capital lease
obligations...................... -- 47,775
--------------- ---------------
Total long term liabilities... -- 47,775
--------------- ---------------
Total liabilities............. 2,345,009 4,969,420
Stockholders' equity (deficit):
Class A Common Stock, $.001 par
value, no shares authorized,
issued and outstanding........... -- --
Class B Common Stock, $.001 par
value, 4,106,852 shares
authorized,
3,347,084 shares issued and
outstanding...................... 3,347 3,347
Additional paid-in capital......... 23,422,313 23,422,313
Retained deficit................... (24,309,378) (24,784,700)
--------------- ---------------
Total stockholders' equity
(deficit).................. (883,718) (1,359,040)
--------------- ---------------
Total liabilities and
stockholders' equity
(deficit).................. $ 1,461,291 $ 3,610,380
=============== ===============
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
APPLE ORTHODONTIX, INC.
STATEMENTS OF OPERATIONS
INCEPTION
(JULY 15, 1996) THREE MONTHS
THROUGH ENDED
DECEMBER 31, 1996 MARCH 31, 1997
----------------- --------------
(UNAUDITED)
REVENUES................................ $ -- $ --
COSTS AND EXPENSES:
Salaries and benefits.............. 627,476 234,070
Rent............................... 19,676 42,194
Depreciation and amortization...... 4,510 4,635
General and administrative......... 232,232 194,423
Special compensation expense
related to issuance of stock..... 13,812,681 --
Special consulting expense related
to issuance of stock............. 9,612,803 --
----------------- --------------
Total costs and expenses...... 24,309,378 475,322
PROVISION FOR INCOME TAXES.............. -- --
----------------- --------------
NET LOSS................................ $ (24,309,378) $ (475,322)
================= ==============
NET LOSS PER SHARE...................... $ (7.24) $ (0.14)
================= ==============
NUMBER OF SHARES USED IN CALCULATING NET
LOSS PER SHARE.......................... 3,358,513 3,358,513
================= ==============
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
APPLE ORTHODONTIX, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
-------------------- PAID-IN RETAINED STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT EQUITY (DEFICIT)
----------- ------ ----------- --------------- ----------------
<S> <C> <C> <C> <C> <C>
BALANCE, July 15, 1996............... -- $ -- $ -- $ -- $ --
Issuance of stock............... 3,347,084 3,347 23,422,313 -- 23,425,660
Net loss........................ -- -- -- (24,309,378) (24,309,378)
----------- ------ ----------- --------------- ----------------
BALANCE, December 31, 1996........... 3,347,084 3,347 23,422,313 (24,309,378) (883,718)
Net loss (unaudited)............ -- -- -- (475,322) (475,322)
----------- ------ ----------- --------------- ----------------
BALANCE, March 31, 1997
(unaudited)........................ 3,347,084 $3,347 $23,422,313 $ (24,784,700) $ (1,359,040)
=========== ====== =========== =============== ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
APPLE ORTHODONTIX, INC.
STATEMENTS OF CASH FLOWS
INCEPTION
(JULY 15, 1996) THREE MONTHS
THROUGH ENDED
DECEMBER 31, 1996 MARCH 31, 1997
----------------- --------------
(UNAUDITED)
CASH FLOWS USED IN OPERATING
ACTIVITIES:
Net loss........................ $ (24,309,378) $ (475,322)
Depreciation and amortization... 4,510 4,635
Special compensation and
consulting expense paid in
stock......................... 23,425,484 --
Increase (decrease) in accounts
payable and accrued
liabilities not related to
issuance costs................ 404,215 (87,873)
----------------- --------------
Net cash used in operating
activities.............. (475,169) (558,560)
----------------- --------------
CASH FLOWS PROVIDED BY FINANCING
ACTIVITIES:
Cash paid for organization
costs......................... (49,197) --
Cash paid related to issuance
costs......................... -- (1,100,900)
Advances from a related party... 515,000 1,638,206
Advances from a founding
practice........................ 283,744 --
Repayment of advances from a
founding practice............. (253,300) --
Proceeds from issuance of common
stock......................... 176 --
----------------- --------------
Net cash provided by
financing activities.... 496,423 $ 537,306
----------------- --------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS................... $ 21,254 $ (21,254)
================= ==============
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS AND ORGANIZATION:
Apple Orthodontix, Inc. (Apple or the Company), was established as a
Delaware corporation on July 15, 1996, for the purpose of creating an
orthodontic practice management company which will own the assets of and provide
management services to orthodontic practices (see Note 6). The Company's
operations to date have consisted primarily of seeking affiliations with
orthodontists, negotiating to acquire the assets of those professionals'
practices and negotiating agreements to provide management services to those
practices (Acquisitions). Apple plans to complete an initial public offering of
its Class A common stock and simultaneously exchange cash and shares of its
Class A common stock for selected assets and liabilities associated with 31
orthodontic practices (the Founding Affiliated Practices). The completion of the
Acquisitions, public offering and entry by Apple into service agreements with
the owners of the orthodontic practices will mark the beginning of Apple's
operations. The financial statements have been prepared on the basis that the
proposed transactions will occur although no assurance can be made that the
proposed transaction will be completed. For further discussion of the various
risks associated with Apple's operations and the proposed transaction, including
the absence of a combined operating history, reliance on Affiliated Practices
and orthodontists, the need for additional financing, government regulation,
dependence on key personnel, competition, and other risks, please refer to the
discussion of risk factors in the Company's registration statement.
RESTATEMENT
In connection with the initial public offering process, the Company
restated its previous financial statements as of December 31, 1996 and for the
period from inception, July 15, 1996, through December 31, 1996. The restatement
involves valuing stock issued to founders, management and advisors of the
Company, in October and December 1996, at the initial public offering price. The
impact of this adjustment is to increase special compensation expense related to
issuance of stock by $13,812,681 and to increase special consulting expense
related to issuance of stock by $9,612,803. The overall impact of the
restatement on the Company's Balance Sheet as of December 31, 1996 was to
increase the Class A and B Stock and related additional paid-in capital by a
total of $23,422,132 and, after giving effect to previously recorded negative
paid-in-capital of $3,350, to increase the retained deficit by $23,422,132.
There was no net effect on stockholders' equity (deficit).
Further revisions and restatements were made to reflect (i) a reverse stock
split which reduced the effective split from 4,013-for-one to 3,270-for-one;
(ii) the cancellation of a warrant previously issued to TriCap Partners, which
was valued at $1,700,000 with the number of shares to be determined based on the
final offering price to the public utilizing the Black-Scholes option-pricing
model, and the issuance of a new warrant for the purchase of 180,000 shares at
$7.00 per share, which has been valued at $777,106, and (iii) the actual
offering price to the public of $7.00 per share.
INTERIM FINANCIAL INFORMATION
The interim financial statements as of March 31, 1997, and for the three
months ended March 31, 1997, are unaudited, and certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles, have been omitted. In the opinion
of management, all adjustments, consisting only of normal recurring adjustments,
necessary to fairly present the financial position, results of operations and
cash flows with respect to the consolidated interim financial statements, have
been included. The results of operations for the interim period are not
necessarily indicative of results for the entire fiscal year.
F-7
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Equipment under capital leases
is stated at the net present value of future minimum lease payments at the
inception of related leases. Depreciation of property and equipment is
calculated using the straight line method over the estimated useful lives of the
assets. Routine maintenance and repairs are charged to expense as incurred,
while costs of betterments and renewals are capitalized.
DEFERRED ISSUANCE COSTS
Salaries and general and administrative expenses and other internal costs
associated with seeking and negotiating with orthodontists to enter into the
transaction have been expensed. Various external costs resulting from the
provision of legal, accounting and other professional services and other costs
incurred for the transactions are a requirement of the Offering and accordingly
have been recorded as deferred issuance costs. All deferred issuance costs will
be charged against the proceeds of the initial public offering upon its
successful completion. As of December 31, 1996, no deferred issuance costs
associated with the Offering have been paid.
ORGANIZATION COSTS
Organization costs incurred in the formation of the Company are amortized
on a straight-line basis over a five-year period.
STOCKHOLDERS' EQUITY (DEFICIT)
On October 11, 1996, 3,165,586 shares of Class B common stock were issued
at a total price of $9.68. On December 9, 1996, 181,498 additional shares were
issued in exchange for $166 of consideration. The shares issued through December
31, 1996 have been restated to reflect the effect of an aggregate 3,270-for-one
stock split approved on May 18, 1997. After considering the effects of the stock
split, the effective per share consideration paid was $.000003 per share on
October 11, 1996 and $.0009 per share on December 9, 1996. In conjunction with
the stock split approved on April 24, 1997, additional amounts were contributed
to bring the aggregate purchase price per share up to the par value of $.001 per
share. The Class B common stock will be entitled to a three-tenths ( 3/10ths) of
a vote per share. The Class B common stock automatically converts to one vote
per share in the event of the disposition of the stock by the stockholder
(excluding dispositions to the holder's affiliates), any person offers to or
acquires 15% or more of the outstanding capital stock of the Company, any person
acquires beneficial ownership of 15% or more of the outstanding shares of
capital stock of the Company, the stockholder elects to convert at any time
after the second anniversary of the effective date of this Offering, the holders
of that number of shares of Class A common stock and Class B common stock,
voting together as a single class, with a majority of the outstanding voting
power approve conversion, or on the fifth anniversary of the effective date of
the Offering. In the event that 80 percent or more of the currently outstanding
shares of Class B common stock have been converted into shares of Class A common
stock, the Company may elect to convert the remaining outstanding shares of
Class B common shares into shares of Class A common stock. The Class A common
stock to be issued to the Founding Affiliated Practices and in the Offering will
be entitled to one vote per share. As discussed in Note 1, the shares issued on
October 11, 1996 and December 9, 1996, have been valued at the assumed offering
price. Special compensation and consulting expense related to issuance of stock
has been recorded for the difference between the amount paid for the stock and
the offering price of $7.00 per share.
Approximately 724,267 of the issued and outstanding shares were subject to
subscription agreements that include a put option provision in the event of a
change in control of the Company. On May 15, 1997, the parties to the
subscription agreements irrevocably waived the provision effective December 31,
1996.
F-8
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The shares used in calculating net loss per share include all shares of
capital stock outstanding as of May 22, 1997 and the additional shares that
would be outstanding if all options that were issued prior to the Offering were
exercised and the proceeds used to repurchase shares at the offering price of
$7.00 per share.
STOCK OPTION PLAN
In December 1996 the board of directors of the Company adopted the 1996
Stock Option Plan (Plan). Employees, non-employee directors and advisors are
eligible to receive awards under the Plan; only employees of the Company are
eligible to receive incentive stock options. The aggregate number of options to
purchase shares of common stock that may granted under the Plan is the greater
of 1,000,000 or 12% of the number of shares of Class A common stock outstanding
on the last day of the preceding calendar quarter. As of December 31, 1996, no
options had been granted under the Plan. The Company anticipates that upon or
shortly after the consummation of its Offering that it will grant options to
purchase approximately 743,000 shares of common stock under the Plan. All of
these options will be at the Offering price except for 20,000 options that were
granted in January 1997 at $3.00 per option, which equaled the fair value of the
common stock of the Company at that date. The Company will account for options
issued to employees and non-employee directors under the Plan in accordance with
APB Opinion No. 25, and accordingly no compensation cost will be recognized. The
Company will provide the pro forma disclosure of net earnings per share in the
notes to the financial statements as if the fair value-based method of
accounting had been applied to awards as required by Statement of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation."
INCOME TAXES
As reflected in the accompanying statement of operations, the Company
incurred a loss from operations during the period from inception, July 15, 1996,
through December 31, 1996. Due to the limited operations of the Company since
its inception and the pending Offering, a valuation allowance has been recorded
to fully reserve for the deferred tax benefits generated by these net operating
losses. There is no significant difference in the tax and book bases of the
Company's assets or liabilities that would give rise to deferred tax balances.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of estimates and assumptions by
management in determining the reported amounts of liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of expenses during the reporting period. Actual results
could differ from those estimates.
3. FINANCING PROVIDED BY VENTURE CAPITAL INVESTORS:
On November 14, 1996, the Company entered into an agreement with TriCap
Funding I, L.L.C. (TriCap), whereby TriCap agreed to provide $3,000,000 to
finance costs related to the Offering. As of December 31, 1996, the Company had
borrowed $515,000 under this agreement. The $3,000,000, to the extent expended,
will be repaid out of proceeds from the Offering, including interest at a rate
of prime plus .25 percent. The Company also entered into an agreement on such
date with TriCap Partners, L.L.C. (TriCap Partners) that extends through the
date of the consummation of the first public offering of Common Stock (or a
security convertible or exchangeable for Common Stock) by the Company following
the Offering. This agreement provides for (a) the payment by Apple to TriCap
Partners of approximately $500,000 upon consummation of the Offering and (b) the
issuance to TriCap Partners of a warrant with an estimated value of $777,106 to
purchase 180,000 shares of Common Stock, with an exercise price per share of
$7.00. The $777,106 value of the warrant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions: (i)
expected dividend yield -- 0.0%; (ii) expected
F-9
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
stock price volatility -- 67.5%; (iii) risk-free interest -- 6.2%; and (iv)
expected life of the warrant -- 5 years.
4. RELATED PARTY:
The practice of a founding stockholder of the Company, John G. Vondrak,
D.D.S., has paid for certain costs and expenses on behalf of the Company. Such
payments, net of reimbursement in conjunction with the financing, have been
reflected as amounts due to a Founding Affiliated Practice in the accompanying
balance sheet and will be repaid with proceeds from the planned Offering.
5. LITIGATION:
On December 10, 1996, Orthodontic Centers of America (OCA) filed a
complaint against Apple, Dr. Vondrak and his practice, alleging misappropriation
of trade secrets and breach of a confidentiality agreement executed by Dr.
Vondrak with OCA. The Company plans to vigorously defend itself in this matter
and does not believe that the results of these proceedings will have a material
adverse effect on the Company's operating results or financial position.
6. PLANNED ACQUISITIONS OF FOUNDING AFFILIATED PRACTICES:
Apple plans to complete, through a series of mergers and asset transfers,
the acquisition of certain assets and assumption of certain liabilities of the
Founding Affiliated Practices (the Acquisitions) concurrently with an initial
public offering of shares of its Class A common stock. The Founding Affiliated
Practices will receive Class A common stock and cash as consideration in the
Acquisitions. In connection with the Acquisitions, the selling orthodontists
will create new professional corporations, professional associations or other
entities (collectively, the New PCs) that will enter into 20-year service
agreements with Apple. Additionally, those orthodontists will enter into
employment and noncompete agreements with the New PCs.
The Company will not employ orthodontists or control the practice of
orthodontics by the orthodontists employed by the New PCs. As Apple will not be
acquiring the future patient revenues earned by the New PCs, the Acquisitions
are not deemed to be business combinations. In accordance with the Securities
and Exchange Commission's Staff Accounting Bulletin (SAB) No. 48, "Transfers of
Nonmonetary Assets by Promoters or Shareholders," the transferred nonmonetary
assets and assumed liabilities will be accounted for at the historical cost
basis of the Founding Affiliated Practices. Each of the Founding Affiliated
Practices is a promoter of the Offering. Any monetary assets included in the
Acquisitions will be recorded at fair value. The resulting value of the net
assets acquired by Apple will be recorded as the value of the stock
consideration tendered. Cash consideration paid to selling orthodontists in
conjunction with the Acquisitions will be reflected as a dividend paid by Apple.
The selling orthodontists will generally retain the long-term debt
obligations of their respective practices. Capital lease obligations will be
assumed by the Company. In certain cases, Apple has agreed to refinance debt
retained by the selling orthodontists.
F-10
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The combined detail of the Founding Affiliated Practices' assets to be
transferred and liabilities to be assumed is as follows:
COMBINED PRESENTATION OF ASSETS TO BE TRANSFERRED AND LIABILITIES ASSUMED FROM
THE
FOUNDING AFFILIATED PRACTICES
DECEMBER 31, 1996 MARCH 31, 1997
----------------- --------------
(UNAUDITED)
Cash and cash equivalents............ $ 1,177,000 $1,442,000
Patient receivables, net of
allowances and patient
prepayments........................ 866,000 1,348,000
Prepaid expenses and other current
assets............................. 137,000 253,000
Property, equipment and improvements,
net................................ 2,087,000 1,911,000
Intangible and other long-term
assets, net........................ 431,000 500,000
----------------- --------------
Assets transferred................... 4,698,000 5,454,000
Accounts payable and accrued
liabilities........................ (1,627,000) (1,501,000)
Current portion of capital lease
obligations........................ (121,000) (88,000)
Long-term portion of capital lease
obligations........................ (312,000) (282,000)
----------------- --------------
Assets transferred, net of
liabilities assumed................ $ 2,638,000 $3,583,000
================= ==============
The management service revenues that will be earned by Apple subsequent to
the Acquisitions and execution of the service agreements are based on various
arrangements. In general, the resulting fee will be substantially based on the
patient revenues and cash collections of the New PCs and the operating expenses
assumed by Apple. Apple's standard form of service agreement (the Standard
Contract) will be applied to all practices operating in locations where it is
not prohibited by law or governmental regulation. In those instances where the
standard contract may not be permitted, an alternative form of agreement (the
Alternative Contract) will be used. In addition, with respect to two of the New
PCs, the service fees are based on flat fees that are subject to adjustment on
an annual basis.
COMBINED OPERATING DATA OF THE FOUNDING AFFILIATED PRACTICES
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
PATIENT REVENUES CASH COLLECTIONS OPERATING EXPENSES
---------------- ---------------- ------------------
<S> <C> <C> <C>
Practices participating under the
Standard Contract.................. $ 17,490,000 $ 17,521,000 $ 10,809,000
Practices participating under the
Alternative Contract............... 5,358,000 5,519,000 2,935,000
Practices participating under flat
fee agreements..................... 2,209,000 2,365,000 1,226,000
---------------- ---------------- ------------------
Totals for Founding Affiliated
Practices.......................... $ 25,057,000 $ 25,405,000 $ 14,970,000
================ ================ ==================
</TABLE>
FOR THE THREE MONTHS ENDED MARCH 31, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
PATIENT REVENUES CASH COLLECTIONS OPERATING EXPENSES
---------------- ---------------- ------------------
<S> <C> <C> <C>
Practices participating under the
Standard Contract.................... $ 4,912,000 $ 4,537,000 $ 2,499,000
Practices participating under the
Alternative Contract............... 1,350,000 1,307,000 658,000
Practices participating under flat
fee agreements..................... 534,000 534,000 312,000
---------------- ---------------- ------------------
Totals for Founding Affiliated
Practices.......................... $ 6,796,000 $ 6,378,000 $ 3,469,000
================ ================ ==================
</TABLE>
Patient revenues are derived from orthodontic care provided to patients
under contract terms agreed to by the patient or other responsible parties. The
contracts vary by practice and by patient, and service often extends over an
eighteen month to six-year period. Revenue is recognized based on the estimated
costs incurred as compared to the total estimated treatment cost, with
approximately 24 percent being recognized at the time of initial treatment which
is related to the costs incurred at the time of initial treatment. The
F-11
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
balance of the contract revenue is realized pro rata each month over the
remaining contract period. The 24 percent estimated cost at the initial
treatment date is consistent with industry standards and includes the estimated
costs of diagnosis, treatment plan development, initial treatment by orthodontic
personnel, orthodontic supplies and associated administrative services.
The difference in the timing of the recognition of patient revenues and
cash collections results in (i) unbilled receivables in instances where
recognition of revenues precedes the patient's payment plan and (ii) patient
prepayments when payments are made on a more accelerated basis than revenues are
earned. The following table presents the combined uncollected patient
receivables unbilled patient receivables and patient prepayments of the Founding
Affiliated Practices. These amounts are not receivables of the Company, but the
net position of these receivables will be acquired as part of the Acquisitions
and in future periods each New PC will provide the Company with a security
interest in the receivables of the New PC.
COMBINED PATIENT RECEIVABLES, NET, OF THE FOUNDING AFFILIATED PRACTICES
DECEMBER 31, MARCH 31,
1996 1997
-------------- --------------
(UNAUDITED)
Patient receivables, net of
allowances of $631,000 and
$597,000, respectively............. $ 918,000 $ 794,000
Unbilled patient receivables, net of
allowances of $70,000.............. 3,361,000 3,701,000
Patient prepayments.................. (3,413,000) (3,147,000)
-------------- --------------
Patient receivables net of
allowances and prepayments.... $ 866,000 $ 1,348,000
============== ==============
Subsequent to the Acquisitions, the operating expenses of the Founding
Affiliated Practices will be the responsibility of Apple. The Company will have
discretion to control the level of those expenses in conjunction with providing
the related services to the New PCs. The combined historical expenses of the
Founding Affiliated Practices that will be assumed by the Company in the future
were:
COMBINED DETAIL OF THE FOUNDING AFFILIATED PRACTICES' EXPENSES
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1996 MARCH 31, 1997
----------------- --------------
(UNAUDITED)
Salaries, wages and benefits of
employees, excluding the
orthodontists...................... $ 6,381,000 $1,557,000
Orthodontic supplies................. 2,548,000 581,000
Rent................................. 1,923,000 513,000
Advertising and marketing............ 438,000 107,000
General and administrative
expenses........................... 3,680,000 711,000
----------------- --------------
Total operating expenses........ $14,970,000 $3,469,000
================= ==============
The combined historical financial information of the Founding Affiliated
Practices presented herein is not related to the financial position or results
of operations of Apple. This information is presented solely for the purpose of
providing disclosures to potential investors regarding the group of entities
with which Apple will be contracting to provide future services due to the
significant relationships between Apple and the Founding Affiliated Practices.
The Founding Affiliated Practices' financial information is presented on
F-12
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
a combined basis to assist in an understanding of their relationship to the pro
forma financial statements included elsewhere in the Company's registration
statement and due to the fact that their service agreements with the Company
will be signed contingent on the single common event of the completion of the
Offering. The Founding Affiliated Practices were not operated under common
control or management during the fiscal year ended December 31, 1996.
UNAUDITED PRO FORMA MANAGEMENT SERVICES FEES
Except with respect to service agreements providing for the payment of flat
fees, the management service fees earned by the Company will be in accordance
with two general types of service agreements -- the standard form of the service
agreement (Standard Contract) and the alternative form of the service agreement
(the Alternative Contract). The determination of which service agreement will be
used for a practice has been based on (i) the historical arrangements utilized
by medical and dental professionals in that jurisdiction to contract for
management services and (ii) the laws relating to the corporate practice of
dentistry and fee splitting in the state or states in which that practice
operates. The Standard Contract calls for a calculation of the monthly service
fee based on the total revenues earned by the New PCs, which is defined by the
agreement to represent 24% of the total contract value in the initial month of a
patient's treatment with the remainder of the contract balance earned evenly
over the balance of the contract term. From total revenues, the orthodontists
retain a percentage of the New PC's cash collections. There are adjustments to
the service fee designed to both provide incentives for the orthodontists to
provide efficient patient treatment and to increase the number of patients
treated, as well as to ensure that the orthodontists retain a minimum amount for
payment of their compensation from their respective New PCs on a monthly basis.
The Alternative Contract is currently offered in California. It is a cost plus
fee arrangement, whereby the service fee includes the reimbursement of defined
expenses incurred by Apple in the course of providing services to the New PC
plus a percentage of revenues. The Company believes the fees to be generated by
each of these formulas will be reflective of the fair market value of the
services provided and will be comparable to the fees earned by other management
service companies in the respective jurisdictions where these arrangements will
exist. In addition, with respect to two of the New PCs, the service fees are
based on flat fees that are subject to adjustment on an annual basis.
The pro forma management service fee for practices that have agreed to the
Standard Contract is based on the accrual basis revenues of the Founding
Affiliated Practices less a percentage of the cash collections of the practices
appropriately adjusted for various provisions of the service fee agreement. The
pro forma management service fee for practices that have agreed to the
Alternative Contract represents a percentage of revenues and reimbursement of
the operating expenses of those practices. The total pro forma management
service revenues would have been:
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
1996 1997
-------------- ------------
Practices participating under the
Standard Contract.................... $ 12,897,000 $3,739,000
Practices participating under the
Alternative Contract................. 3,659,000 879,000
Practices participating under flat
fee arrangements..................... 1,582,000 384,000
-------------- ------------
Total pro forma management
service revenues........... $ 18,138,000 $5,002,000
============== ============
F-13
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Apple will be managed on a regional basis. The following information on the
pro forma management service fee is provided on a regional basis as supplemental
information.
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, 1996 MARCH 31, 1997
---------------------------- ----------------------------
HISTORICAL PRO FORMA HISTORICAL PRO FORMA
PATIENT MANAGEMENT PATIENT MANAGEMENT
REGION REVENUES SERVICE FEES REVENUES SERVICE FEES
- ------------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
California........................... $ 5,358,000 $ 3,659,000 $ 1,350,000 $ 879,000
Western.............................. 10,709,000 7,640,000 2,736,000 2,080,000
East Coast........................... 5,392,000 4,094,000 1,475,000 1,036,000
Central.............................. 3,598,000 2,745,000 1,235,000 1,007,000
----------- ------------- ----------- -------------
$25,057,000 $ 18,138,000 $ 6,796,000 $ 5,002,000
=========== ============= =========== =============
</TABLE>
7. SUBSEQUENT EVENT (UNAUDITED):
On May 29, 1997, the Company consummated the Offering and simultaneously
exchanged cash and shares of its common stock for certain assets and liabilities
of the Founding Affiliated Practices. The Company will begin to manage the
administrative functions of the Founding Affiliated Practices under the terms of
the service agreements effective June 1, 1997.
F-14
<PAGE>
================================================================================
NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THE OFFERING
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
OF ANY SECURITIES OTHER THAN THE SECURITIES TO WHICH IT RELATES OR AN OFFER TO
SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN
WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR TO ANY PERSON TO WHOM IT
IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF
ANY TIME SUBSEQUENT TO THE DATE HEREOF.
---------------------
TABLE OF CONTENTS
Page
----
Prospectus Summary .................................................... 3
Risk Factors .......................................................... 7
The Company ........................................................... 12
Price Range of Common Stock ........................................... 12
Dividend Policy ....................................................... 12
Selected Financial Data ............................................... 13
Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 14
Business .............................................................. 16
Management ............................................................ 25
Certain Transactions .................................................. 30
Security Ownership of Certain Beneficial Owners and Management ........ 32
Description of Capital Stock .......................................... 33
Shares Eligible for Future Sale ....................................... 36
Plan of Distribution .................................................. 38
Legal Matters ......................................................... 38
Experts ............................................................... 38
Available Information ................................................. 39
Index to Financial Statements ......................................... F-1
================================================================================
================================================================================
2,000,000 SHARES
[LOGO APPLE ORTHODONTIX]
COMMON STOCK
---------------------
PROSPECTUS
---------------------
JULY 21, 1997
================================================================================
