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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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: (281) 698-2500
------------------------
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 [_] No [X]*
*The Registrant became subject to the reporting requirements of Section 13
of the Securities Exchange Act of 1934 on May 22, 1997.
The number of shares of Class A Common Stock and Class B Common Stock of
the Registrant, par value $.001 per share, outstanding at May 22, 1997 was
6,376,483 and 3,347,084, respectively.
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<PAGE>
APPLE ORTHODONTIX, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1997
INDEX
PAGE
----
Part I -- Financial Information ........................................... 1
Item 1 -- Financial Statements and General Information ............... 1
Balance Sheets as of December 31, 1996 and March 31, 1997
(unaudited) ..................................................... 2
Statement of Operations for the Three Months Ended March
31, 1997 (unaudited) ............................................ 3
Statement of Cash Flows for the Three Months Ended March
31, 1997 (unaudited) ............................................ 4
Notes to Financial Statements ................................... 5
Item 2 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations ................................. 12
Part II -- Other Information .............................................. 14
Item 1 -- Legal Proceedings .......................................... 14
Item 4 -- Submission of Matters to a Vote of Security Holders ........ 14
Item 6 -- Exhibits and Reports on Form 8-K ........................... 14
Signature ................................................................. 17
( i )
<PAGE>
APPLE ORTHODONTIX, INC.
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GENERAL INFORMATION
On May 29, 1997, Apple Orthodontix, Inc. ("Apple" or the "Company")
acquired (the "Acquisitions") simultaneously with the closing of its initial
public offering (the "Offering"or "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"). The consideration for
acquisitions of the Founding Affiliated Practices consisted of a combination of
cash and Common Stock. The acquisitions of the Founding Affiliated Practices are
being accounted for in accordance with the Securities and Exchange Commission's
Staff Accounting Bulletin No. 48.
The consolidated financial statements 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, and 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
March 31, 1997.
Operating results for interim periods are not necessarily indicative of the
results for full years. It is suggested that these consolidated financial
statements be read in conjunction with the Financial Statements of Apple and
related notes thereto, and management's discussion and analysis related thereto,
all of which are included in the Company's Registration Statement on Form S-1
(No. 333-22785), as amended (the "Registration Statement"), filed with the SEC
in connection with the Offering.
1
<PAGE>
APPLE ORTHODONTIX, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1996 1997
--------------- ---------------
(UNAUDITED)
<S> <C> <C>
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
=============== ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
APPLE ORTHODONTIX, INC.
STATEMENT OF OPERATIONS
THREE MONTHS
ENDED
MARCH 31, 1997
--------------
(UNAUDITED)
REVENUES................................ $ --
COSTS AND EXPENSES:
Salaries and benefits.............. 234,070
Rent............................... 42,194
Depreciation and amortization...... 4,635
General and administrative......... 194,423
--------------
Total costs and expenses...... 475,322
PROVISION FOR INCOME TAXES.............. --
--------------
NET LOSS................................ $ (475,322)
==============
NET LOSS PER SHARE...................... $ (0.14)
==============
NUMBER OF SHARES USED IN CALCULATING NET
LOSS PER SHARE.......................... 3,358,513
==============
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
APPLE ORTHODONTIX, INC.
STATEMENT OF CASH FLOWS
THREE MONTHS
ENDED
MARCH 31, 1997
--------------
(UNAUDITED)
CASH FLOWS USED IN OPERATING
ACTIVITIES:
Net loss........................ $ (475,322)
Depreciation and amortization... 4,635
Increase (decrease) in accounts
payable and accrued liabilities
not related to issuance
costs.......................... (87,873)
--------------
Net cash used in operating
activities................ (558,560)
--------------
CASH FLOWS PROVIDED BY FINANCING
ACTIVITIES:
Cash paid related to issuance
costs.......................... (1,100,900)
Advances from a related party... 1,638,206
--------------
Net cash provided by
financing activities...... $ 537,306
--------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS................... $ (21,254)
==============
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
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.
BASIS OF PRESENTATION
In the opinion of Company management, the accompanying consolidated
financial statements include the accounts of the Company and all adjustments
necessary to present fairly the Company's financial position at December 31,
1996 and March 31, 1997, and its results of operations and cash flows for the
three months ended March 31, 1997. Although the Company believes that the
disclosures are adequate to make the information presented not misleading,
certain information and footnote disclosures normally included in annual
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission. These financial statements should be
read in conjunction with the Company's financial statements, and related notes
thereto, included in the Company's Registration Statement filed with the
5
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Securities and Exchange Commission. The results of operations for the three
months ended March 31, 1997 may not be indicative of the results for the full
year.
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.
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.
6
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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.
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 three month period ended March 31,
1997. 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. 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.
7
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
8
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
COMBINED OPERATING DATA OF THE FOUNDING AFFILIATED PRACTICES
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 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
MARCH 31,
1997
--------------
(UNAUDITED)
Patient receivables, net of
allowances of $597,000............. $ 794,000
Unbilled patient receivables, net of
allowances of $70,000.............. 3,701,000
Patient prepayments.................. (3,147,000)
--------------
Patient receivables net of
allowances and prepayments.... $ 1,348,000
==============
9
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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
ENDED
MARCH 31, 1997
--------------
(UNAUDITED)
Salaries, wages and benefits of
employees, excluding the
orthodontists...................... $1,557,000
Orthodontic supplies................. 581,000
Rent................................. 513,000
Advertising and marketing............ 107,000
General and administrative
expenses........................... 711,000
--------------
Total operating expenses........ $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 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 three month period ended March 31, 1997.
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
10
<PAGE>
APPLE ORTHODONTIX, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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
ENDED
MARCH 31,
1997
----------
Practices participating under the Standard Contract ............ $3,739,000
Practices participating under the Alternative Contract ......... 879,000
Practices participating under flat fee arrangements ............ 384,000
----------
Total pro forma management service revenues .......... $5,002,000
==========
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.
THREE MONTHS ENDED
MARCH 31, 1997
-----------------------------
HISTORICAL PRO FORMA
PATIENT MANAGEMENT
REGION REVENUES SERVICE FEES
- ------------------------------------- ----------- -------------
California........................... $ 1,350,000 $ 879,000
Western.............................. 2,736,000 2,080,000
East Coast........................... 1,475,000 1,036,000
Central.............................. 1,235,000 1,007,000
----------- -------------
$ 6,796,000 $ 5,002,000
=========== =============
4. SUBSEQUENT EVENT:
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.
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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 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 for accounting purposes, the Company acquired the
tangible and intangible assets and liabilities of, and entered 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 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 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.
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 will be incurring 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 are accounted for by the Company at the
transferors' historical cost basis, with
12
<PAGE>
the shares of common stock to be 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 will be
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 acquisitions made by the Company subsequent to the IPO. It is currently
anticipated that the Company's future acquisitions of certain of the assets and
liabilities of Affiliated Practices may result in substantial annual noncash
amortization charges for intangible assets in the Company's statements of
operations.
RESULTS OF OPERATIONS (UNAUDITED)
The Company has conducted no significant operations through March 31, 1997.
Following completion of the IPO and the Acquisitions on May 29, 1997, the
Company will begin operations effective June 1, 1997. General and administrative
expenses were incurred during the period from inception (July 15, 1996) through
March 31, 1997 in connection with the Offering. 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.
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 Offering 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 planned acquisition program. The
Company has agreed to refinance certain indebtedness of the Founding Affiliated
Practices totalling approximately $1.0 million.
13
<PAGE>
APPLE ORTHODONTIX, INC.
PART II -- OTHER INFORMATION
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 John G. Vondrak
Apple Orthodontix, Inc. ("JGVAOI"), one of the Founding Affiliated Practices,
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 are without merit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Prior to the closing of the Offering, the stockholders of the Company
approved a number of matters during the period covered by this Quarterly Report
on Form 10-Q. On April 24, 1997, the stockholders approved by written consent
(i) the amendment and restatement of the Company's Certificate of Incorporation
to, among other things, (A) increase the number of authorized shares of capital
stock to 39,106,852 shares, consisting of 25,000,000 shares of Class A Common
Stock, 4,106,852 shares of Class B Common Stock and 10,000,000 shares of
Preferred Stock, (B) change the par value of Common Stock to $.001 per share and
(C) reclassify each outstanding share of Common Stock into 4,012.556913 shares
of Class B Common Stock; and (ii) the adoption of the Company's 1996 Stock
Option Plan. On May 18, 1997, the stockholders approved by written consent a
certificate of amendment to the Company's Restated Certificate of Incorporation
providing for the reclassification of each issued and outstanding share of Class
B Common Stock into 0.815 shares of Class B Common Stock. The Company's first
Annual Meeting of the Stockholders as a public company will be held in 1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
EXHIBIT NO. DESCRIPTION
- ---------- -----------------------------------------------------------------
2.1(1) -- Form of Agreement and Plan of Reorganization
2.2(1) -- Form of Uniform Provisions relating to Agreement and Plan of
Reorganization
2.3(1) -- Form of Uniform Provisions relating to Contribution Agreement
with Sole Proprietorships
2.4(1) -- Form of Uniform Provisions relating to Contribution Agreement
with Professional Corporations or Professional Associations
2.5(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Orthodontics Exclusively, Ltd. and Paul Bonham, D.D.S.
2.6(1) -- Contribution Agreement among Apple Orthodontix, Inc., Duncan Y.
Brown P.C. and Dr. Duncan Y. Brown.
2.7(1) -- Contribution Agreement among Apple Orthodontix, Inc., Roger L.
Bumgarner, D.D.S., P.C., Roger Bumgarner, D.D.S., P.C. and Roger
L. Bumgarner, D.D.S.
2.8(1) -- Contribution Agreement between Apple Orthodontix, Inc. and Thomas
K. Chubb, D.D.S.
2.9(1) -- Contribution Agreement among Apple Orthodontix, Inc., Stanley D.
Crawford, D.D.S., P.C. and Stanley D. Crawford, D.D.S.
14
<PAGE>
EXHIBIT NO. DESCRIPTION
- ---------- -----------------------------------------------------------------
2.10(1) -- Contribution Agreement among Apple Orthodontix, Inc., Western New
York Orthodontic Care, P.C. and Anthony G. Deluke, D.D.S.
2.11(1) -- Contribution Agreement between Apple Orthodontix, Inc. and Robert
J. Dennington, D.D.S., M.S.D.
2.12(1) -- Contribution Agreement between Apple Orthodontix, Inc. and Philip
DePasquale, D.D.S.
2.13(1) -- Contribution Agreement among Apple Orthodontix, Inc., Robert S.
Fields, D.M.D., P.C. and Robert S. Fields, D.M.D.
2.14(1) -- Contribution Agreement among Apple Orthodontix, Inc. and Robert
C. Frantz, D.D.S., P.C. and Robert C. Frantz, D.D.S.
2.15(1) -- Contribution Agreement among Apple Orthodontix, Inc., Andrew
Girardot, Jr., D.D.S., P.C. and Andrew Girardot, Jr., D.D.S.
2.16(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Bruce S. Harris, D.D.S., Inc. and Bruce S. Harris, D.D.S.
2.17(1) -- Contribution Agreement among Apple Orthodontix, Inc., James H.
Jennings, D.D.S., P.A. and James H. Jennings, D.D.S.
2.18(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Phillip Milanovich, D.D.S., M.S., P.C. and Phillip
Milanovich, D.D.S., M.S.
2.19(1) -- Contribution Agreement between Apple Orthodontix, Inc. and Bowen
D. Miles, D.M.D.
2.20(1) -- Contribution Agreement among Apple Orthodontix, Inc., Mark J.
Mills, D.D.S., P.C. and Mark J. Mills, D.D.S.
2.21(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Carlos F. Navarro, D.D.S., M.S.D., P.C. and Carlos F.
Navarro, D.D.S., M.S.D.
2.22(1) -- Contribution Agreement among Apple Orthodontix, Inc., Paul
Rigali, D.D.S., P.C. and Paul Rigali, D.D.S.
2.23(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Carl P. Roy, D.D.S., M.S., P.C. and Carl P. Roy, D.D.S.,
M.S.
2.24(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Budd Rubin, D.D.S., M.S., Inc. and Budd Rubin, D.D.S., M.S.
2.25(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., John Dell Sauter, D.D.S., M.D.S., P.C. and John Dell
Sauter, D.D.S., M.D.S.
2.26(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Donald D. Schmitz, D.D.S., M.S., Ltd. and Donald D.
Schmitz, D.D.S., M.S.
2.27(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Dr. Charles L. Schnibben, Ltd. and Charles L. Schnibben,
D.D.S.
2.28(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Darrell G. Smith, D.D.S., P.C. and Darrell G. Smith, D.D.S.
2.29(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Ronald N. Spiegel, D.M.D., Inc. and Ronald N. Spiegel,
D.M.D.
2.30(1) -- Contribution Agreement between Apple Orthodontix, Inc. and
Michael C. Theurer, D.D.S.
2.31(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Thomas A. Tiller, D.D.S., Inc. and Thomas A. Tiller, D.D.S.
2.32(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Jack D. Utley, Jr., D.M.D., P.C. and Jack D. Utley, Jr.,
D.M.D.
2.33(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., John G. Vondrak Apple Orthodontix, Inc. and John G.
Vondrak, D.D.S.
2.34(1) -- Contribution Agreement between Apple Orthodontix, Inc. and Ira S.
Wiedman, D.D.S.
15
<PAGE>
EXHIBIT NO. DESCRIPTION
- ---------- -----------------------------------------------------------------
2.35(1) -- Agreement and Plan of Reorganization among Apple Orthodontix,
Inc., Ronald H. Roth, D.D.S. and Brian W. Wong, D.D.S., P.C. and
Brian W. Wong, D.D.S.
The schedules and exhibits to the foregoing acquisition
agreements have not been filed as exhibits to this Registration
Statement. Pursuant to Item 601(b)(2) of Regulation S-K, Apple
agrees to furnish a copy of such schedules and exhibits to the
Commission upon request.
3.1(1) -- Restated Certificate of Incorporation
3.2(1) -- Bylaws
3.3(2) -- Certificate of Amendment to Restated Certificate of Incorporation
4.1(1) -- Form of certificate evidencing ownership of Common Stock of Apple
Orthodontix, Inc.
4.2(1) -- Form of Registration Rights Agreement
4.3(1) -- Registration Rights Agreement among Apple Orthodontix, Inc., John
G. Vondrak, D.D.S. and TriCap Funding I, L.L.C.
4.4(1) -- Registration Rights Agreement between TriCap Partners, L.L.C. and
Apple Orthodontix, Inc.
10.1(1) -- Apple Orthodontix, Inc., 1996 Stock Option Plan
10.2(1) -- Employment Agreement between Apple Orthodontix, Inc. and John G.
Vondrak, D.D.S.
10.3(1) -- Employment Agreement between Apple Orthodontix, Inc. and Robert
J. Syverson
10.4(1) -- Employment Agreement between Apple Orthodontix, Inc. and Michael
W. Harlan
10.5(1) -- Employment Agreement between Apple Orthodontix, Inc. and W.
Daniel Cook
10.6(1) -- Form of California Service Agreement
10.7(1) -- Employment Agreement of H. Steven Walton
10.8(1) -- Form of Service Agreement
10.9(1) -- Consulting Agreement between TriCap Partners, L.L.C. and Apple
Orthodontix, Inc.
10.10(1) -- Amendment to Consulting Agreement between TriCap Partners and
Apple Orthodontix, Inc.
10.11(1) -- Form of Flat Fee Service Agreement
27.1 -- Financial Data Schedule.
- ------------
(1) Previously filed as an exhibit to the Company's Registration Statement on
Form S-1 (No. 333-22785), and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Registration Statement on
Form S-4, which has been filed immediately prior to this Form 10-Q and
incorporated herein by reference.
16
<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.
Dated: June 9, 1997 APPLE ORTHODONTIX, INC.
By: /s/ MICHAEL W. HARLAN
MICHAEL W. HARLAN
CHIEF FINANCIAL OFFICER
(CHIEF ACCOUNTING OFFICER)
17
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE COMPANIE'S FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> MAR-31-1997
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 167,533
<DEPRECIATION> 2,175
<TOTAL-ASSETS> 3,610,380
<CURRENT-LIABILITIES> 4,921,645
<BONDS> 47,775
0
0
<COMMON> 3,347
<OTHER-SE> (1,362,387)
<TOTAL-LIABILITY-AND-EQUITY> 3,610,380
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 475,322
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (475,322)
<INCOME-TAX> 0
<INCOME-CONTINUING> (475,322)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (475,322)
<EPS-PRIMARY> (0.14)
<EPS-DILUTED> (0.14)
</TABLE>
