================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________________ TO ____________________
COMMISSION FILE NUMBER 1-12977
------------------------
APPLE ORTHODONTIX, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 74-2795193
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
2777 ALLEN PARKWAY, SUITE 700
HOUSTON, TEXAS 77019
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 852-2500
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of Class A Common Stock and Class B Common Stock of
the Registrant, par value $.001 per share, outstanding at October 24, 1997 was
8,090,382 and 3,347,084, respectively.
================================================================================
<PAGE>
APPLE ORTHODONTIX, INC.
FORM 10-Q REPORT INDEX
Part I--Financial Information
Item 1 -- Financial Statements
Item 2 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations
Part II--Other Information
Item 1 -- Legal Proceedings
Item 6 -- Exhibits and Reports on Form 8-K
Signature
( i )
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents....... $ 3,321,583 $ 21,254
Restricted cash................. 2,134,002 --
Receivable from orthodontic
practices, net of allowances of
$34,111 and $0, respectively... 993,269 --
Prepaid expenses................ 200,048 --
Deferred income taxes........... 409,594 --
Other current assets............ 60,859 --
------------- ------------
Total current assets....... 7,119,355 21,254
Property and equipment, net of
accumulated depreciation of
$252,163 and $0, respectively...... 4,817,500 --
Receivable from orthodontic
practices, net of current
portion............................ 1,357,040 --
Deferred issuance costs.............. 22,868 1,395,350
Intangibles assets, net of
accumulated amortization of
$164,135 and $4,510,
respectively....................... 26,714,562 44,687
Other assets......................... 751,447 --
------------- ------------
Total assets............... $ 40,782,772 $ 1,461,291
============= ============
LIABILITIES AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current maturities of long-term
debt........................... $ 122,157 $ --
Accounts payable and accrued
expenses....................... 3,008,456 1,830,009
Payable to orthodontic
practices...................... 583,266 --
Payable to owners of new
affiliated practices........... 2,712,184 --
Amounts due to venture capital
investors...................... -- 515,000
------------- ------------
Total current
liabilities............ 6,426,063 2,345,009
------------- ------------
Long-term debt, net of current
maturities......................... 9,410,482 --
Deferred income taxes................ 8,805,227 --
Other long-term obligations.......... 9,229 --
------------- ------------
Total liabilities.......... 24,651,001 2,345,009
------------- ------------
Stockholders' equity (deficit)
Class A common stock, $0.001 par
value, 25,000,000 shares
authorized, 7,930,799 and 0
shares issued and
outstanding.................... 7,931 --
Class B common stock, $0.001 par
value, 4,106,852 shares
authorized, 3,347,084 and
3,347,084 shares issued and
outstanding.................... 3,347 3,347
Additional paid-in capital...... 39,808,286 23,422,313
Warrants........................ 777,106 --
Retained deficit................ (24,464,899) (24,309,378)
------------- ------------
Total stockholders' equity
(deficit).............. 16,131,771 (883,718)
------------- ------------
Total liabilities and
stockholders' equity
(deficit).............. $ 40,782,772 $ 1,461,291
============= ============
The accompanying notes are an integral part of these financial statements.
1
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS THREE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------- ---------------------------
1997 1996 1997 1996
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Service fee revenues................. $ 9,165,610 $ -- $ 7,479,653 $ --
Costs and expenses:
Salaries and benefits........... 4,543,875 160,566 3,093,490 160,566
Orthodontic supplies............ 1,197,506 -- 997,513 --
Rent............................ 1,213,714 -- 786,418 --
Advertising and marketing....... 153,421 -- 145,716 --
General and administrative...... 1,856,154 9,319 1,241,039 9,319
Depreciation and amortization... 411,788 2,510 341,482 2,510
------------ ------------ ------------- ------------
Total costs and expenses... 9,376,458 172,395 6,605,658 172,395
------------ ------------ ------------- ------------
Operating income (loss).... (210,848) (172,395) 873,995 (172,395)
Interest expense..................... 147,995 -- 141,312 --
Interest income...................... (104,844) -- (91,252) --
Other expense (income), net.......... (3,158) -- (3,102) --
------------ ------------ ------------- ------------
Income (loss) before income
taxes.................... (250,841) (172,395) 827,037 (172,395)
Income tax (benefit)................. (95,320) -- 314,274 --
------------ ------------ ------------- ------------
Net income (loss).......... $ (155,521) $ (172,395) $ 512,763 $ (172,395)
============ ============ ============= ============
Net income (loss) per common and
common equivalent share............ $ (0.02) $ (0.05) $ 0.05 $ (0.05)
============ ============ ============= ============
Number of shares used in calculating
net loss per common and common
equivalent share................... 6,965,078 3,347,084 11,205,045 3,347,084
============ ============ ============= ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN
STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
<TABLE>
<CAPTION>
CLASS A AND B TOTAL
COMMON STOCK ADDITIONAL STOCKHOLDERS'
------------------------ PAID-IN RETAINED EQUITY
SHARES AMOUNT CAPITAL WARRANTS DEFICIT (DEFICIT)
------------- --------- ------------- ---------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1996........... 3,347,084 $ 3,347 $ 23,422,313 $ -- $ (24,309,378) $ (883,718)
Issuance of common stock to
public........................ 2,702,500 2,703 12,304,756 -- -- 12,307,459
Transfers of certain assets and
liabilities by founders....... 3,682,554 3,683 476,134 -- 479,817
Special dividend to founders.... -- -- (6,544,424) -- -- (6,544,424)
Issuance of warrant............. -- -- (777,106) 777,106 -- --
Issuance of stock to new
affiliated practices.......... 1,541,459 1,541 10,691,717 -- -- 10,693,258
Issuances of options to non-
employees..................... -- -- 204,899 -- -- 204,899
Net loss........................ -- -- -- -- (155,521) (155,521)
Other........................... 4,286 4 29,997 -- -- 30,001
------------- --------- ------------- ---------- -------------- -------------
BALANCE, September 30, 1997.......... 11,277,883 $ 11,278 $ 39,808,286 $ 777,106 $ (24,464,899) $ 16,131,771
============= ========= ============= ========== ============== =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
1997 1996
------------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................ $ (155,521) $ (172,395)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and
amortization............. 411,788 2,510
Deferred income tax
benefit.................. (95,320) --
Provision for doubtful
accounts................. 34,111 --
Changes in assets and
liabilities, excluding effects
of affiliations:
Receivable from orthodontic
practices................ (930,584) --
Prepaid expenses........... (190,061) --
Other assets............... 70,469 --
Payables and other accrued
liabilities.............. (1,183,120) 84,370
------------- -----------
Net cash used in
operating
activities......... (2,038,238) (85,515)
------------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and
equipment...................... (2,327,047) --
Payments for new affiliated
practices...................... (3,689,055) --
Payment into escrow for a new
affiliated practice............ (2,134,002) --
Advances to affiliates.......... (1,493,793) --
Repayment of advances by
affiliates..................... 48,985 --
------------- -----------
Net cash used in
investing
activities......... (9,594,912) --
------------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuances of
common stock................... 17,623,276 --
Cash paid related to common
stock issuance costs........... (4,951,928) (94,903)
Special dividend to founders.... (6,544,424) --
Proceeds from borrowings........ 11,434,130 180,418
Repayments of borrowings........ (2,627,575) --
------------- -----------
Net cash provided by
financing
activities......... 14,933,479 85,515
------------- -----------
NET INCREASE IN CASH AND CASH
EQUIVALENTS........................ 3,300,329 --
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD................ 21,254 --
------------- -----------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD............................. $ 3,321,583 $ --
============= ===========
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF PRESENTATION
Apple Orthodontix, Inc. ("Apple" or the "Company") was founded in July
1996 to provide practice management services to orthodontic practices in the
United States and Canada. On May 29, 1997, Apple acquired simultaneously with
the closing of its initial public offering (the "IPO") of its class A common
stock, par value $.001 per share (the "Common Stock"), substantially all of
the tangible and intangible assets, and assumed the liabilities, of 31
orthodontic practices (collectively, the "Founding Affiliated Practices") in
exchange for 3,682,554 shares of Common Stock and $6.5 million in cash. The net
proceeds of the 2,702,500 shares of Common Stock issued in the IPO (after
deducting the underwriting discounts and commissions) were $17.6 million. Total
related offering costs were $5.3 million. The acquisitions of the Founding
Affiliated Practices have been accounted for in accordance with the Securities
and Exchange Commission's Staff Accounting Bulletin No. 48. Accordingly, the
assets acquired and liabilities assumed were recorded at their historical
values.
Apple has subsequently acquired the assets and assumed the liabilities of
additional practices (the "New Orthodontist Affiliations"). The New
Orthodontist Affiliations together with the Founding Affiliated Practices are
collectively referred to as the "Affiliated Practices." The acquisitions of
assets and liabilities of the New Orthodontist Affiliations are accounted for by
allocating the value of the consideration paid by Apple to the assets acquired,
net of liabilities assumed, including intangible assets. As a result of this
allocation process, the Company records a significant portion of the
consideration as a service fee intangible.
The condensed consolidated financial statements included herein have been
prepared by the Company without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission (the "SEC"). Pursuant to such
regulations, certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. The Company believes the presentation
and disclosures herein are adequate to make the information not misleading. The
financial statements reflect all elimination entries and normal adjustments that
are necessary for a fair presentation of the results for the interim period
ended September 30, 1997.
Operating results for interim periods are not necessarily indicative of the
results for full years. Operating results for the nine- and three-month periods
ended September 30, 1996 represent results for the period from inception (July
15, 1996) through September 30, 1996. It is suggested that these consolidated
financial statements be read in conjunction with the financial statements of
Apple and management's discussion and analysis related thereto.
2. SIGNIFICANT ACCOUNTING POLICIES
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Equipment under capital leases is
stated at the net present value of the future minimum lease payments at the
inception of the 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 betterment and renewals are capitalized.
INTANGIBLE ASSETS, NET
Intangible assets consist primarily of service fee intangibles which are
amortized over the life of the service agreement (ranging from 20 to 40 years)
with the respective Affiliated Practice. The Company's management periodically
evaluates the realizability of the intangible assets on a practice by practice
basis considering such factors as profitability and net cash flow. Should this
evaluation result in an assessment
5
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
that the value of the intangible asset is overstated, an adjustment will be made
in the period that the adjustment is identified. If it is determined that the
estimated remaining service period requires revision, that revision will be made
on a prospective basis.
REVENUE RECOGNITION
The service fees (the "Service Fees") payable to the Company by the
Founding Affiliated Practices under their Service Agreements with the Company
(the "Service Agreements") vary based on the fair market value, as determined
in arm's-length negotiations, for the nature and amount of services provided.
Except with respect to Service Agreements providing for the payment of flat
fees, the Service Fees earned by the Company are 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 Founding 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 Founding Affiliated Practices' 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 practices
on a monthly basis. The Alternative Contract is used 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
Founding Affiliated Practice plus a percentage of revenues.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income
Taxes,"which requires recognition of deferred tax assets and liabilities for
expected future tax consequences of events that have been recognized in the
financial statements or tax returns. Under this method, deferred tax assets and
liabilities are determined based on the differences between the financial
statement carrying amounts and the tax bases of assets and liabilities using
enacted tax rates and laws in effect in the years in which the differences are
expected to reverse. The deferred tax asset at September 30, 1997 related to net
operating losses of the Company for the nine months ended September 30, 1997.
NEW ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings Per Share." This statement establishes new standards for
computing and presenting earnings per share requiring the presentation of
"basic" and "diluted" earnings per share as compared to "primary" and
"fully diluted" earnings per share. The Company is required to adopt SFAS No.
128 for all fiscal periods ending after December 15, 1997. Earlier adoption is
not permitted and restatement of all prior period earnings per share data is
required.
6
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. NEW ORTHODONTIST AFFILIATIONS
During the period from commencement of operations (June 1, 1997) through
September 30, 1997, the Company completed New Orthodontist Affiliations with 12
practices representing 18 orthodontists and 23 office locations. In addition,
four orthodontists joined existing Affiliated Practices.
Total consideration related to the New Orthodontist Affiliations is
summarized as follows:
Cash................................. $ 3,689,055
Deferred payments.................... 2,712,184
Common stock......................... 10,693,258
-------------
Total consideration............. $ 17,094,497
=============
In addition to the above consideration, the Company placed $2.1 million
into an escrow account pending the resolution of certain contingencies related
to one of the New Orthodontist Affiliations closed during the third quarter of
1997. A favorable resolution of these post-closing contingencies would result in
payment of the $2.1 million to the sellers in January 1999. The Company has the
right to post a letter of credit in order to have the $2.1 million refunded from
escrow to the Company prior to January 1999. The Company expects to post the
letter of credit during the fourth quarter of 1997. Upon resolution of these
contingencies beyond a reasonable doubt, the Company will record a liability for
the consideration and allocate the consideration to the assets to be acquired,
primarily intangibles.
The cost of each of the above New Orthodontist Affiliations has been
allocated on the basis of the estimated fair market value of the assets acquired
and liabilities assumed, resulting in service fee intangibles of $26.2 million.
These allocations may be adjusted to the extent that management becomes aware of
additional information within one reporting year of the affiliation date which
results in a material change in the amount of any contingency or changes in the
estimated fair market value of assets acquired and liabilities assumed.
Financial data for the year ended December 31, 1996 or their most recently
completed fiscal year related to the New Orthodontist Affiliations are
summarized as follows:
PATIENT CASH OPERATING
REVENUES COLLECTIONS EXPENSES
---------- ------------ ----------
Practices participating under the
Standard Contract................. $ 4,805,000 $ 4,000,000 $ 3,313,000
Practices participating under the
Alternative Contract.............. 6,882,000 6,757,000 4,160,000
Practices participating under the
flat fee agreements............... 4,612,000 4,612,000 2,592,000
----------- ----------- -----------
$16,299,000 $15,369,000 $10,065,000
=========== =========== ===========
7
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. LONG-TERM DEBT
Long-term debt consisted of the following at September 30, 1997 and
December 31, 1996:
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
Unsecured revolving credit
facility........................... $9,200,000 $ --
Note payable, maturing in June 1999,
with interest at 9.25%............. 135,106 --
Capitalized lease obligations, due in
monthly installments through April
2001, with interest ranging from
11.8% to 24.7%..................... 197,533 --
------------- ------------
9,532,639 --
------------- ------------
Less: current maturities........ 122,157 --
------------- ------------
Long-term debt, net of current
maturities...................... $9,410,482 $ --
============= ============
On July 28, 1997, the Company entered into a three-year, $15.0 million
revolving credit facility with Texas Commerce Bank. Advances under this facility
bear interest, at the Company's option, at prime rate or LIBOR, in each case
plus a margin which is calculated based upon the Company's ratio of indebtedness
to cashflow.
The notes payable relate to debts of the Affiliated Practices that were
assumed by the Company.
5. STOCK OPTION PLAN
As allowed by SFAS No. 123, "Accounting for Stock-Based Compensation,"
the Company accounts for awards under its 1997 Stock Compensation Plan under
Accounting Principles Board Opinion No. 25, under which no compensation cost has
been recognized for stock options issued with exercise prices greater than or
equal to the fair market value at the date of grant. Had compensation cost for
these plans been determined consistent with SFAS No. 123, the Company's net loss
and loss per share would have been reduced to the following pro forma amounts:
NINE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1997
------------- -------------
Net income (loss)
As reported..................... $(155,521) $ 512,763
============= =============
Pro forma....................... $(249,336) $ 481,491
============= =============
Income (loss) per share
As reported..................... $ (0.02) $ 0.05
============= =============
Pro forma....................... $ (0.04) $ 0.04
============= =============
6. COMBINED PATIENT DATA
Combined operating data for the Affiliated Practices for the period from
commencement of operations (June 1, 1997) through September 30, 1997 is as
follows:
PATIENT CASH
REVENUES COLLECTIONS
---------- -------------
Practices participating under the
Standard Contract.................... $ 7,806,542 $ 7,058,368
Practices participating under the
Alternative Contract................. 3,412,403 3,093,277
Practices participating under flat
fee agreements....................... 1,552,348 1,552,348
----------- -------------
$12,771,293 $ 11,703,993
=========== =============
8
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Combined patient receivables of the Affiliated Practices as of September
30, 1997 is as follows:
Patient receivables.................. $ 3,099,449
Unbilled patient receivables......... 9,897,645
Patient prepayments.................. (3,720,262)
-------------
Patient receivables, net of
prepayments................. $ 9,276,832
=============
7. PRO FORMA SERVICE FEES
The pro forma Service Fees for the Company for the twelve months ended
December 31, 1996, assuming the service agreements with all Affiliated Practices
(including the Founding Affiliated Practices and New Orthodontist Affiliations)
had been consummated as of January 1, 1996, are summarized as follows:
Practices participating under the
Standard Contract.................... $ 16,295,000
Practices participating under the
Alternative Contract................. 8,901,000
Practices participating under flat
fee agreements....................... 5,123,000
-------------
Total pro forma Service
Fees......................... $ 30,319,000
=============
The following information on the pro forma Service Fees for the year ended
December 31, 1996 is provided on a regional basis as supplemental information:
HISTORICAL PRO FORMA
PATIENT SERVICE
REGION REVENUES FEES
- ------------------------------------- ------------ -----------
California........................... $ 6,200,000 $ 4,382,000
Western.............................. 9,174,000 6,735,000
East Coast........................... 5,392,000 4,094,000
Central.............................. 8,403,000 6,143,000
Canada............................... 12,187,000 8,965,000
------------ -----------
$41,356,000 $30,319,000
============ ===========
8. SUBSEQUENT EVENTS
NEW ORTHODONTIST AFFILIATIONS
Since September 30, 1997 through October 24, 1997, eight additional
orthodontists affiliated with the Company. Five of these orthodontists had
established practices, and three agreed to join existing Affiliated Practices.
The additional orthodontists in established practices operate seven locations
and generated historical patient revenue over the prior twelve months of
approximately $2.4 million. Prior patient revenue is not necessarily indicative
of the level of revenue that these practices may be expected to generate in the
future. Historical patient revenue for the Founding Affiliated Practices was
$25.1 million for the twelve months ended December 31, 1996. Total consideration
to these new orthodontists consisted of approximately $1.8 million of common
stock and $901,769 of cash, assumed debt and deferred purchase price.
STOCK OFFERING
On October 27, 1997, the Company announced that it had filed a registration
statement with the SEC for a public offering of 3,404,000 shares (including
444,000 shares issuable upon exercise of the Underwriter's over-allotment
option) of its Common Stock. Of the total offering, 2,944,000 shares (including
the shares subject to the over-allotment option) are being sold by the Company
and 460,000 are being sold by certain selling stockholders of the Company
("Selling Stockholders"). The net proceeds to the Company from the offering
will be used to repay bank debt, for future affiliations, the development of new
offices, future capital expenditures and general corporate purposes. The Company
will not receive any of the proceeds from the sale of shares by the Selling
Stockholders.
9
<PAGE>
ITEM 2. 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 OF THE COMPANY AND THE RELATED NOTES THERETO INCLUDED
ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
The Company conducted no significant operations before its IPO in May 1997
when the Company acquired the tangible and intangible assets and liabilities of,
and entered into Service Agreements with, the 31 Founding Affiliated Practices.
Since that time, through October 24, 1997, the Company has affiliated with an
additional 17 practices and 30 orthodontists operating in 30 offices. The
Company expects that its future growth will come from (i) implementing a
comprehensive practice operating approach designed to drive internal growth of
the Affiliated Practices, (ii) entering into Service Agreements with new
Affiliated Practices and (iii) developing new orthodontic centers, including
satellite offices (branch locations of existing Affiliated Practices), 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 service fees.
The service fees earned by the Company are in accordance with three general
types of Service Agreements -- the standard form of the Service Agreement (the
"Standard Contract"), the alternative form of the Service Agreement (the
"Alternative Contract") and a Service Agreement based upon a flat fee (the
"Flat Fee Contract"). The Standard Contract calls for a calculation of the
monthly service fee based on the total patient revenues earned by the Affiliated
Practice, 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 patient revenues, the practices retain a percentage of the Affiliated
Practices' cash collections.
The Alternative Contract is used in certain jurisdictions where use of the
Standard Contract is not permitted. 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 Affiliated Practice plus a percentage
of revenues. The Flat Fee Contract is based on a flat fee that is subject to
adjustment on an annual basis. It is used when local jurisdictions do not allow
use of the Standard Contract or the Alternative Contract. The Company believes
the fees generated by each of these formulas reflect the fair market value of
the services provided and are comparable to the fees earned by other practice
management service companies in the respective jurisdictions where these
arrangements exist. 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 existing 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 provides management, administrative, marketing and business development
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
has been accounted for by the Company at the transferors' historical cost basis,
with the shares of Common Stock issued in those transactions being valued at the
historical cost of the nonmonetary assets acquired net of liabilities assumed.
The cash consideration paid at closing on May 29, 1997 is reflected as a
dividend by Apple to the owners of the Founding Affiliated Practices in the
quarter ended June 30, 1997. SAB No. 48 is not applicable to affiliations made
by the Company subsequent to the IPO. The Company's subsequent acquisitions of
certain of the assets and liabilities of Affiliated Practices has resulted and
will continue to result in substantial noncash amortization charges for
intangible assets in the Company's statements of operations.
RESULTS OF OPERATIONS FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 1997 AND 1996
(UNAUDITED)
SERVICE FEE REVENUES
The Company generated service fee revenues of $7.5 million and $9.2 million
for the three- and nine-month periods ended September 30, 1997, respectively.
The Company conducted no significant operations through the date of the IPO.
Following completion of the IPO and the affiliations with the Founding
Affiliated Practices on May 29, 1997, the Company began operations effective
June 1, 1997. Therefore, service fee revenues reflect only four months of
operations during the nine months ended September 30, 1997 and there were no
service fee revenues during the nine months ended September 30, 1996.
COSTS AND EXPENSES
The Company incurred costs and expenses of $6.6 million (88.3% of service
fee revenues) and $9.4 million (102.3% of service fee revenues) for the three-
and nine-month periods ended September 30, 1997, respectively. The Company's
costs and expenses consisted primarily of salaries and benefits, orthodontic
supplies, rent, advertising and marketing, general and administrative and
depreciation and amortization. Costs and expenses of $172,395 for each of the
three- and nine-month periods ended September 30, 1996 represented corporate
office expenses for the period from inception (July 15, 1996) through September
30, 1996.
OPERATING INCOME
The Company generated operating income (loss) of $873,995 and $(210,848)
for the three- and nine-month periods ended September 30, 1997, respectively.
These operating income (loss) amounts comprised 11.7% and (2.3)%, respectively,
of service fee revenues for such periods. The Company generated an operating
loss of $172,395 for each of the three- and nine-month periods ended September
30, 1996. As stated above, these results reflect the impact of the Company's
Service Agreements only for the period from June 1, 1997 through September 30,
1997 (I.E., the period subsequent to the IPO) for the Founding Affiliated
Practices and from the date of affiliation through September 30, 1997 for all
subsequent affiliations. General and administrative expenses were incurred
during the entire period from inception (July 15, 1996) through May 29, 1997 in
connection with the IPO and the affiliation with the Founding Affiliated
Practices.
INTEREST EXPENSE
Interest expense of $141,312 and $147,995 for the three- and nine-month
periods ended September 30, 1997, respectively, reflected the cost of borrowings
under the Company's revolving credit facility entered into on July 28, 1997,
certain indebtedness of the Founding Affiliated Practices that was assumed by
the Company and certain capital lease obligations for computer and office
equipment. There was no interest expense incurred during the nine months ended
September 30, 1996.
INTEREST AND OTHER INCOME
Interest income of $91,252 and $104,844 for the three- and nine-month
periods ended September 30, 1997, respectively, reflected interest earned on the
Company's net proceeds from the IPO and on notes receivable from certain of the
Founding Affiliated Practices. There was no interest income generated during the
nine months ended September 30, 1996.
INCOME TAXES
The Company generated an income tax provision (benefit) of $314,274 and
$(95,320) for the three-and nine-month periods ended September 30, 1997,
respectively. The income tax benefit for the nine-month period resulted from net
operating losses generated by the Company during the period from January 1, 1997
through May 29, 1997. The Company incurred no income taxes for the nine months
ended September 30, 1996.
NET INCOME (LOSS)
As a result of the foregoing factors, the Company generated net income
(loss) of $512,763 and $(155,521) for the three- and nine-month periods ended
September 30, 1997, respectively, or earnings (loss) per share of $0.05 and
$(0.02), respectively. These net income (loss) amounts comprised 6.9% and
(1.7)%, respectively, of service fee revenues for such periods.
RESULTS OF OPERATIONS FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1996
The Company conducted no significant operations during 1996. The Company's
retained deficit at December 31, 1996 was primarily attributable to compensation
and consulting charges totaling $23.4 million related to valuing stock issued to
management and advisors of the Company, in October and December of 1996, at the
IPO price of $7.00 per share. The overall impact of these charges was to
increase additional paid-in capital by a total of $23.4 million and to increase
the retained deficit by $23.4 million. There was no net effect on stockholders'
equity. The Company also incurred various legal, accounting, travel, personnel
and marketing costs during the period from inception (July 15, 1996) through
December 31, 1996 in connection with the IPO and the affiliations with the
Founding Affiliated Practices.
LIQUIDITY AND CAPITAL RESOURCES
FINANCING ACTIVITIES
The Company has financed its capital requirements to date with borrowings
from banks and issuances of equity securities. To date, the Company has been
able to obtain satisfactory financing for its operations and believes that it
will be able to obtain such financing as required in the future. On July 28,
1997, the Company entered into a three-year, $15.0 million revolving credit
facility with TCB. Availability under the TCB Facility is tied to the Company's
cash flow and liquidity. Advances under the TCB Facility bear interest, at the
Company's option, at prime rate or LIBOR, in each case plus a margin which is
calculated based upon the Company's ratio of indebtedness to cash flow. At
September 30, 1997, the Company had $9.2 million drawn under this facility,
bearing interest at the rate of 8.5% per annum.
Total long-term debt increased from zero at December 31, 1996, to $9.4
million at September 30, 1997. The increase is attributable to borrowings for
affiliations with new orthodontic practices, the purchase of property and
equipment and general working capital needs. The Company's weighted average cost
of indebtedness was 8.7% per annum for the third quarter of 1997.
WORKING CAPITAL MANAGEMENT
The Company's strategy in managing its working capital is to maintain
sufficient availability under its bank credit facility to finance short-term
capital needs in excess of internally generated funds and minimize excess cash
on its balance sheet.
The cash and cash equivalents balance of $3.3 million at September 30, 1997
primarily consisted of borrowings under the Company's revolving credit facility
for use as consideration for certain new affiliations completed during the third
quarter of 1997. These funds were placed into escrow pending the completion of
certain post-closing amendments to the definitive agreements for these
transactions. These amendments had not been completed as of September 30, 1997.
The Company expects these amendments to be completed and the funds disbursed
from the escrow account to the sellers during the fourth quarter of 1997.
The restricted cash balance of $2.1 million at September 30, 1997 consisted
of borrowings under the Company's revolving credit facility which were placed
into escrow pending the resolution of certain post-closing contingencies related
to a new affiliation completed during the third quarter of 1997. A favorable
resolution of these post-closing contingencies would result in payment of the
$2.1 million to the sellers in January 1999. The Company has the right to post a
letter of credit in order to have the $2.1 million released from escrow to the
Company prior to January 1999. The Company expects to post the letter of credit
during the fourth quarter of 1997.
CAPITAL EXPENDITURES
The Company anticipates making capital expenditures for the Affiliated
Practices during the remainder of 1997 of approximately $1.0 million to fund,
among other things, the development of new offices. The average cost of
developing a new office (which may vary by geographic market) is estimated to be
approximately $250,000 to $400,000, including initial working capital
requirements. The Service Agreements provide for advances by the Company to the
Affiliated Practices for working capital requirements (including any deficits in
cash flows of Affiliated Practices resulting from, among other things,
development of satellite offices) and other purposes. Such loans bear interest
at prime plus one percent and are repayable over varying periods of time not to
exceed five years. Total notes receivable from Affiliated Practices were $1.5
million at September 30, 1997. It is anticipated that capital expenditures will
be funded from the Company's cash flow from operations, the net proceeds from
this Offering and borrowings under the TCB Facility.
BUSINESS DEVELOPMENT
The Company's business development program also requires significant
amounts of capital. The amount of cash to be used in attracting the affiliation
of new Affiliated Practices, particularly the amount to be used in any given
period, depends on a number of factors, many of which are beyond the Company's
control. The Company anticipates the use of a combination of cash, notes and
shares of its Common Stock to fund the cost of additional affiliations. In order
to fund such additional affiliations, the Company will use cash flow from
operations, net proceeds from this Offering and borrowings under the TCB
Facility, and will seek to raise capital through additional bank borrowings and
public or private debt or equity issuances. The availability of these capital
sources will depend upon prevailing market conditions, interest rates and the
then existing financial condition of the Company. During the quarter ended
September 30, 1997, the Company spent $8.5 million of cash (including $2.7
million in deferred payments and $2.1 million that has been placed in escrow)
and issued 1,541,459 shares of Common Stock in connection with affiliations with
new Affiliated Practices.
AFFORDABLE PAYMENT PLANS
A part of the Company's business strategy is to encourage Affiliated
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. Existing
Affiliated Practices using such payment plans have experienced an initial
decrease in working capital; however, the Company believes that the decrease in
working capital generally will be offset by an increase in the number of
patients receiving orthodontic treatment because of the combined effect of
advertising, offering more affordable payment plans and the use of the Company's
practice-building program. Moreover, the Company believes the existing
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 service fees from the
Affiliated Practices.
PART II
ITEM 1. LEGAL PROCEEDINGS
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 alleged that the Company should be bound by its
terms as a result of the relationship between Dr. Vondrak and Apple
(specifically, OCA 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 stated that OCA was seeking monetary
damages in excess of $75,000. In August 1997, the court dismissed OCA's claims
without prejudice on the grounds that the court lacked jurisdiction. There can
be no assurance that OCA will not seek to overturn the court's decision or file
a similar suit in another jurisdiction.
In August 1997, Apple filed a declaratory judgment action in the District
Court of Harris County, Texas (164th Judicial District) seeking a finding by the
court that neither Apple nor Dr. Vondrak has violated the terms of the
confidentiality agreement, otherwise used confidential information supplied by
OCA or unfairly competed against OCA. This lawsuit is still pending, and Apple
cannot predict whether it will succeed in obtaining the declarations sought from
the court or, if it is not successful, what effect this may have on Apple.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
<PAGE>
SIGNATURE
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT, APPLE ORTHODONTIX, INC., HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
APPLE ORTHODONTIX, INC.
By /s/ MICHAEL W. HARLAN
Michael W. Harlan
Vice President -- Chief
Financial Officer
Dated: October 27, 1997
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