UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
(AMENDMENT NO. 1)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
Commission file number: 001-12977
APPLE ORTHODONTIX, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 74-2795193
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -------------------
Class A Common Stock, American Stock Exchange
$.001 Par Value Per Share
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
At April 14, 1999, the aggregate market value of the registrant's Common Stock
held by non-affiliates of the registrant was approximately $36,688,746 based on
the closing price of such stock on such date of $3.25.
At April 14, 1999, the number of shares outstanding of registrant's Class A
Common Stock was 11,760,904.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
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Apple Orthodontix, Inc., a Delaware corporation, (the "Company"), hereby amends
its Annual Report on Form 10-K originally filed with the Securities and Exchange
Commission on April 15, 1999, pursuant to Instruction G(3) to Form 10-K by
completing Items 10 through 13 of Part III thereof. In addition to this
information, the Annual Report on Form 10-K/A (Amendment No. 1) includes all
information required by Parts I, II and IV of Form 10-K that the Company
included in its original Form 10-K filed on April 15, 1999.
TABLE OF CONTENTS
Page
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PART I
Items 1
and 2. Business and Properties 4
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 13
PART II
Market for Registrant's Common Stock and Related Shareholder
Item 5. Matters 14
Item 6. Selected Financial Data 14
Management's Discussion and Analysis of Financial Condition and
Item 7. Results of Operations 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 20
Item 8. Financial Statements and Supplementary Data 21
Changes In and Disagreements With Accountants on Accounting and
Item 9. Financial Disclosure 39
PART III
Item 10. Directors and Executive Officers of the Registrant 39
Item 11. Executive Compensation 41
Item 12. Security Ownership of Certain Beneficial Owners and Management 49
Item 13. Certain Relationships and Related Party Transactions 49
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 51
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FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K includes certain statements that may be deemed
to be "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All
statements, other than statements of historical facts, included in this Annual
Report on Form 10-K that address activities, events or developments that the
Company expects, projects, believes or anticipates will or may occur in the
future, including such matters as business strategy, plans and objectives of
management of the Company for future operations and future industry conditions
are forward-looking statements. These statements are based on certain
assumptions and analyses made by management of the Company in light of its
experience and its perception of historical trends, current conditions, expected
future developments and other factors it believes are appropriate in the
circumstances. Such statements are subject to a number of assumptions, risks and
uncertainties, including the risk factors discussed herein, general economic and
business conditions, changes in laws or regulations and other factors, many of
which are beyond the control of the Company. Prospective investors are cautioned
that any such statements are not guarantees of future performance and that
actual results or developments may differ materially from those projected in the
forward-looking statements.
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PART I
ITEMS 1 AND 2. BUSINESS AND PROPERTIES
OVERVIEW
Apple Orthodontix, Inc., a Delaware corporation (the "Company"), provides
practice management services (which exclude the management and delivery of
orthodontic services) to orthodontic practices in the United States and Canada.
The Company offers the orthodontic practices with which it has affiliated (the
"Affiliated Practices") a full range of services designed to facilitate the
delivery of high-quality, affordable orthodontic treatment to consumers. The
Company's Affiliated Practices benefit from the Company's practice operating
approach designed to (i) stimulate demand in their local markets by increasing
consumer awareness of the benefits, availability and affordability of
orthodontic treatment, (ii) improve the productivity and profitability of their
practices and (iii) leverage the benefits of orthodontist affiliation by
providing basic services that include clinical and financial information
management, access to capital and technology, group purchasing and comprehensive
marketing techniques. The Company earns revenue by providing these management,
administrative, development and other services to its Affiliated Practices.
In connection with its initial public offering ("IPO") in May 1997, the Company
acquired substantially all the tangible and intangible assets and assumed
certain liabilities of, and began providing long-term management services to, 31
orthodontists operating in 58 offices located in 13 states in the United States
and in Alberta, Canada (the "Founding Affiliated Practices"). Since its IPO and
through April 14, 1999, the Company has affiliated with an additional 36
practices. During that time, the Company has also merged three practices into
existing practices and has terminated its affiliation with two practices. As of
April 14, 1999, the Company provided services to 62 orthodontic practices
representing 88 orthodontists operating in 17 states in the United States and
three provinces in Canada.
Affiliated Practices are selected based on a variety of factors, including
competitive and financial strengths and historical growth of their practices and
the potential for future growth in their markets. The Company also considers the
local and national reputations of the Affiliated Practices within the
orthodontic services industry, their ability to manage multi-location practices
providing high levels of quality care and their desire to grow and improve the
operating efficiency of their respective practices. The Company selects its
Affiliated Practices based on the recommendations of its affiliated
orthodontists and management's experience with orthodontic practices in the
United States and Canada.
INDUSTRY
OVERVIEW. The orthodontic services industry is highly fragmented, with over 90%
of the approximately 9,000 orthodontists in the United States operating as sole
practitioners. The industry currently generates approximately $3.8 billion in
annual gross revenues. Seventy percent of orthodontic services are performed on
a private pay, fee-for-service basis, 25% are covered by traditional dental
insurance (generally with a 50% or greater copayment by the patient), and less
than 5% are reimbursed from managed care payor sources due to the elective
nature of the service. According to the most recent statistics available from
studies by the Journal of Clinical Orthodontists ("JCO"), the median orthodontic
practice in the United States generated $518,800 in revenues, started 180 new
cases and experienced a case acceptance rate of 67% in 1996.
Orthodontic treatments are principally provided by orthodontists who have
completed two years of post-graduate studies following graduation from dental
school. The number of orthodontists in the United States has grown slowly since
1990, which the Company believes can be attributed to the limited number of
schools offering post-graduate orthodontic programs and the small class size at
each of those schools. In addition to orthodontists, a number of general
dentists provide various orthodontic services. The industry information set
forth herein does not include orthodontic treatments provided by general
dentists.
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The table below summarizes certain information from the 1997 JCO Orthodontic
Practice Study (the "1997 JCO Study") (the most recent available with respect to
average fee per case) concerning the United States orthodontic services industry
for each of the years presented:
NUMBER OF AVERAGE
--------------------------- FEE
YEAR ORTHODONTISTS NEW CASES PER CASE
------------------- ------------ ------------ ------------
1990 8,720 1,308,000 $3,050
1991 8,760 1,314,000 3,221
1992 8,856 1,416,690 3,401
1993 8,958 1,478,070 3,447
1994 9,060 1,540,200 3,492
1995 9,098 1,592,150 3,649
1996 9,115 1,640,700 3,703
THE TRADITIONAL ORTHODONTIC PRACTICE. The traditional orthodontic practice
typically involves a single orthodontist, practicing at one primary location or
with an average of less than one satellite office, with a small number of
orthodontic assistants and business office personnel and, in some cases, an
orthodontic associate. On an individual practice basis, the 1997 JCO Study
reported median annual revenues of $518,800 and median operating income of
$224,000 in 1996. Median overhead as a percentage of revenues was 55%, resulting
in a 42% median operating margin before orthodontist compensation, interest and
taxes. Median down payments were equal to approximately 25% of the total
treatment cost. In 1996, median case starts and active treatment cases were 180
and 400 per practice, respectively, and the median case acceptance rate was 67%.
In the traditional practice, the orthodontist manages all business aspects of
the practice; the use of third-party management services is not typical.
The 1997 JCO Study reports that individual practices, on average, generated over
one-half of their referrals from dentists and less than 8% of the practices
utilized commercial advertising (and 1.8% utilized television advertising).
According to the 1997 JCO Study, orthodontists believed they had the ability to
increase case starts by 28%, but the median case starts have not increased
significantly since 1981, the first year of data presented in the study.
THE APPLE ORTHODONTIX APPROACH
The Company believes the traditional orthodontic practice is inefficient and
administratively burdensome to orthodontists and can be financially burdensome
to patients, who traditionally pay approximately 25% of the total contract
amount as a down payment.
The Company has developed a comprehensive operating strategy designed to improve
efficiency, increase the number of new case starts and active cases handled by
each orthodontist and relieve orthodontists associated with Affiliated Practices
of time-consuming administrative responsibilities. As part of its practice
operating approach, the Company assists its Affiliated Practices in developing
and implementing payment programs designed to make orthodontic services more
affordable to prospective patients, thereby making their services available to a
larger segment of the population in their respective markets. The Company also
assists the Affiliated Practices in developing satellite offices to expand the
scope of the geographic areas they serve.
The Company believes its approach provides benefits to orthodontists who choose
to affiliate with it by providing opportunities to: (i) drive internal growth by
implementing the Company's operating strategy; (ii) share in the increased
profitability resulting from internal growth; (iii) lower costs through
economies of scale; (iv) participate in a cost-effective national advertising
program; (v) focus on patient care; and (vi) enhance liquidity and
diversification.
OPERATING STRATEGY
Through its practice operating approach, the Company seeks to stimulate
increased productivity and internal growth in its Affiliated Practices. To
accomplish this objective, the Company has developed an operating approach
consisting primarily of (i) implementing practice-building and external
marketing programs designed to generate new case starts through increased
referrals from existing and former patients and the use of multimedia
advertising to stimulate demand for treatment services, (ii) offering more
affordable payment plans to patients to broaden the market for orthodontic
services, (iii) increasing the operating efficiency of the Affiliated Practices
by relieving the orthodontists from various time-consuming administrative
responsibilities and realizing economies of scale, (iv) providing a
systems-oriented approach to training and education of clinic personnel to
improve communications with patients and prospective patients and increase
productivity, (v) developing satellite offices to expand the geographic markets
served by Affiliated Practices and (vi) utilizing customized management
information systems to provide detailed financial and operating data and
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related analyses to Affiliated Practices and management. The Company believes
that its approach has resulted in local market expansion, increased new case
starts and practice profitability, increased orthodontist productivity and
heightened patient satisfaction in certain of its existing Affiliated Practices.
EXPANSION STRATEGY
The Company pursued an aggressive expansion strategy upon the completion of the
IPO through June 1998. Since September 1998, the Company has attempted to raise
additional capital to fund its expansion strategy. This effort has been
unsuccessful to date. Consequently, the Company has discontinued its strategy of
expansion through acquisitions in order to devote its limited resources to the
integration of existing Affiliated Practices.
Another element of the Company's expansion strategy is the development of new
offices within selected markets served by the existing Affiliated Practices. The
Company believes that the new offices will increase the geographic area served
by the existing Affiliated Practices, thereby increasing the potential market
and leveraging the advertising budget of the existing Affiliated Practices. The
Company expects that these offices generally will be located in high traffic
areas. The Company has curtailed the development of new offices to be served by
existing Affiliated Practices due to funding constraints.
The Company was incorporated in July 1996 and conducted no operations before its
IPO in May 1997 other than in connection with the IPO and affiliation with the
Founding Affiliated Practices. Although each of the existing Affiliated
Practices operated independently before affiliation with the Company, the
Company has a limited combined operating history. As a result, there can be no
assurance that the process of integrating the management and administrative
functions of the Affiliated Practices will be successful or that the Company's
management will be able to effectively or profitably manage these operations or
successfully implement the Company's operating or expansion strategies. Failure
by the Company to successfully implement its operating or expansion strategies
would have a material adverse effect on the Company's business, financial
condition and results of operations. There can be no assurance that the
Company's expansion strategy will be successful, that modifications to the
Company's strategy will not be required, that the Company will be able to
provide services effectively and enhance the profitability of additional
Affiliated Practices or that the Company will be able to obtain adequate
financing on reasonable terms to support its expansion program.
SERVICES AND OPERATIONS
The Company generally provides services with respect to all aspects of the
operations of its Affiliated Practices other than the provision of orthodontic
treatment. Except in Canada, the Company employs all business personnel at the
offices of the Affiliated Practices and, where permitted by applicable law and
governmental regulations, also employs the orthodontic assistants.
ADMINISTRATIVE. The Company earns revenue by providing services to the
Affiliated Practices, including staffing, education and training, billing and
collections, cash management, group purchasing, inventory management, payroll
processing, employee benefits administration, advertising production and other
marketing support, patient scheduling, financial reporting and analysis,
productivity reporting and analysis, associate recruiting and support for
acquisitions, new site development and other capital requirements. The Company
believes the orthodontists at the Affiliated Practices benefit from the support
provided by the Company and that these services substantially reduce the amount
of time the orthodontists are required to spend on administrative matters,
thereby enabling them to dedicate more time to the growth of their professional
practices. Through economies of scale, the Company seeks to provide these
services at a lower cost than could be obtained by any of the Affiliated
Practices individually. In addition, because of its size and purchasing power,
the Company has been able to negotiate discounts on, among other things,
orthodontic and office supplies, health and malpractice insurance and equipment.
The Company does not employ orthodontists or control the practice of
orthodontics by the orthodontists employed by the Affiliated Practices, and its
services revenue generally depends on revenue generated by the Affiliated
Practices. In some cases, the fees are based on the costs and expenses the
Company incurs in connection with providing services. The profitability of the
Affiliated Practices, as well as the performance of the individual orthodontists
employed by the Affiliated Practices, affect the Company's profitability.
PRACTICE-BUILDING PROGRAM. The Company believes patient satisfaction levels,
practice productivity and profitability can be substantially enhanced through a
consistent training program emphasizing practice-building techniques. The
Company implements programs designed to generate growth in case starts by
increasing (i) referrals from existing and former patients and (ii) case
acceptance rates. These programs include a full complement of training,
operating and monitoring techniques emphasizing improvements in communications
with patients and patient satisfaction levels in all facets of operations,
including initial telephone contacts with prospective patients, initial
consultations and case presentations and written or telephonic follow-ups after
office visits. The Company's programs are designed to result in clear, concise
and consistent communications between the patient and the orthodontist and his
or her staff. The Company believes that these programs have a positive effect on
the patients' experience and therefore positively affect the number of patient
referrals
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and case acceptance rates of Affiliated Practices.
EXTERNAL MARKETING. The Company and its Affiliated Practices utilize multimedia
advertising in certain local markets to stimulate demand for treatment and
promote name recognition for the Company and the Affiliated Practices. The
general public traditionally has had little information about the availability
of orthodontic services or orthodontic fees prior to an initial consultation
with an orthodontist. The advertisements address the two primary barriers to
receiving orthodontic treatment, availability and affordability, by focusing on
the availability of orthodontic services and the more affordable payment plans
offered by the Affiliated Practices. The advertisements also stress the quality
of care available at the Affiliated Practices and the advantages of receiving
orthodontic treatment from a professionally trained orthodontist as opposed to a
general dentist. The advertisements also promote a toll-free number for ease of
scheduling an appointment with the local Affiliated Practice.
Generally, it is anticipated that an Affiliated Practice will spend an amount
equal to between 5% and 7% of its net revenues for advertising and marketing,
which the Company believes is significantly higher than the industry average for
traditional orthodontic practices. The Company is responsible for subcontracting
the production of all broadcast advertising, which is tailored to meet local
requirements. The frequency and airing times for any television advertisements
are determined by regional media consultants retained by the Company and the
Affiliated Practice in order to optimize penetration to target market segments.
AFFORDABLE PAYMENT PLANS. Orthodontic services primarily involve private pay,
fee-for-service treatments. As part of its overall marketing strategy for the
Affiliated Practices, the Company encourages the Affiliated Practices to make
orthodontic services available to a larger portion of the population in their
respective markets by offering more affordable payment plans. Many of the
existing Affiliated Practices have historically received a down payment equal to
25% of the total cost of services, with the remaining amount paid equally over
the term of treatment. The typical payment plan recommended by the Company
consists of a modest initial down payment and monthly payments thereafter for
the duration of the treatment period, generally between 26 and 34 months.
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. The Company believes that offering more
affordable payment plans combined with the use of advertising has resulted in an
increase in the number of patients inquiring about orthodontic treatment. The
Company also believes that this increase, combined with the use of its internal
marketing programs, has resulted in an increase in the number of patients
receiving orthodontic treatment at the existing Affiliated Practices.
TRAINING AND EDUCATION. Staff and practice development programs are an integral
part of the Company's operating strategy. The Company believes its programs (i)
increase the motivation and overall performance of the staff, (ii) improve the
level of patient satisfaction achieved by the Affiliated Practices and (iii)
improve the Company's ability to attract and retain qualified personnel, which
collectively result in increased referrals from existing and former patients and
increased case acceptance rates for the Affiliated Practices. The Company
provides each Affiliated Practice with consulting and educational services.
These services include a full training program covering all non-orthodontic
aspects of the practice and specific training designed for the efficient and
effective use of the Company's management information system.
Specifically, the Company's training program provides each member of the
Affiliated Practice, from the receptionist to the orthodontist, with guidelines
for addressing questions and concerns of prospective and existing patients,
techniques for explaining treatment procedures and length of treatment,
parameters for establishing appropriate financial arrangements with each patient
and a systematic approach to monitoring the success of each area of training.
Training is conducted both at individual clinics and in group sessions and
includes proprietary manuals, tapes and role playing activities.
MANAGEMENT INFORMATION SYSTEM.
The Company believes that access to accurate, relevant and timely financial and
operating information is a key element to providing practice management services
to orthodontic practices. The Company offers a choice between several financial
reporting, productivity measurement and patient management systems to each
existing Affiliated Practice. These systems are designed to increase the
productivity of the Affiliated Practices by enabling the Company and the
Affiliated Practices to cost-effectively monitor the productivity of the
Affiliated Practices, identify problem areas and opportunities for improvement
and take corrective action in a timely manner. Productivity measures that are
monitored include case acceptance rates, treatment times and case starts. In
addition, the management information system facilitates optimization of the
orthodontists' time through computerized scheduling and diagnostic and treatment
recordkeeping systems.
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LOCATIONS
As of December 31, 1998, the Company provided management services in the
following locations:
NUMBER OF
----------------------------------------
STATE/PROVINCE PRACTICES OFFICES ORTHODONTISTS
--------------------- ------------ ------------ ------------
Alberta 5 6 5
Arizona 3 9 3
British Columbia 2 3 2
California 12 17 14
Colorado 7 15 8
Connecticut 5 7 6
Florida 1 1 2
Georgia 1 3 1
Kentucky 2 2 2
Massachusetts 1 2 1
Michigan 1 6 7
Montana 1 3 1
Nevada 1 2 1
New Mexico 1 2 1
New York 1 2 1
Ontario 3 4 7
Pennsylvania 2 4 2
South Carolina 1 2 1
Texas 8 24 17
Utah 3 7 4
Virginia 2 3 3
------------ ------------ ------------
63 124 89
============ ============ ============
SERVICE AGREEMENTS
The Company enters into a long-term service agreement ("Service Agreement") with
each Affiliated Practice and such practice's orthodontist employees under which
the Company is the exclusive administrator of non-orthodontic services relating
to the operation of the Affiliated Practice. The following is intended to be a
brief summary of the typical form of Service Agreement the Company has entered
into and expects to enter into with Affiliated Practices. The actual terms of
the various Service Agreements may vary from the description below on a
case-by-case basis, depending on negotiations with the individual Affiliated
Practices and the requirements of applicable law and governmental regulations.
The service fees payable to the Company by the Affiliated Practices under the
Service Agreements are calculated in accordance with the Company's 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 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 Company retains 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 the Company 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 are reflective of
the fair market value of the service provided and are comparable to the fees
earned by other management service companies in the respective jurisdictions
where these arrangements exist. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Overview".
Pursuant to each Service Agreement, the Company, among other matters, (i) acts
as the exclusive manager and administrator of non-orthodontist services relating
to the operation of the Affiliated Practice, subject to matters reserved to the
Affiliated Practice, (ii) administers the billing of patients, insurance
companies and other third-party payors and collects on behalf of the Affiliated
Practice the fees for professional orthodontic and other services and products
rendered or sold by the Affiliated Practice, (iii) provides, as necessary,
clerical, accounting, payroll, legal, bookkeeping and computer services and
personnel, information management, tax return information, printing, postage and
duplication services and transcribing services, (iv) supervises and maintains
custody of substantially all files and records, (v) provides
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facilities, equipment and furnishings for the Affiliated Practice, (vi)
prepares, in consultation with the Affiliated Practice, all annual capital and
operating budgets, (vii) orders and purchases inventory and supplies as
reasonably requested by the Affiliated Practice and (viii) implements, in
consultation with the Affiliated Practice, advertising programs.
Under each Service Agreement, the applicable Affiliated Practice retains the
responsibility for, among other things, (i) hiring, compensating and supervising
orthodontist employees and other licensed dental professionals, (ii) ensuring
that orthodontists have the required licenses, credentials, approvals and other
certifications appropriate to the performance of their duties and (iii)
complying with federal and state laws, regulations and ethical standards
applicable to the practice of orthodontics. In addition, the Affiliated are
exclusively in control of all aspects of the practice of orthodontics and the
provision of orthodontic services.
During the term of the Service Agreement (generally 20 to 40 years) and, subject
to certain exceptions and limitations, for a period of two years thereafter, the
existing Affiliated Practices have agreed not to compete with the Company or the
other Affiliated Practices within a specified geographic area. In addition, each
orthodontist employee has agreed, subject to certain exceptions and limitations,
not to compete with the Company or the other Affiliated Practices within a
specified geographic area until the later of (i) the fifth anniversary date of
the Service Agreement or (ii) five years from the date the employee becomes a
stockholder of the Affiliated Practice, and for a period of two years after the
earlier of his or her termination of employment with the Affiliated Practice or
termination of the applicable Service Agreement. The existing Affiliated
Practices also have agreed not to disclose certain confidential and proprietary
information relating to the Company and the Affiliated Practices.
Each Affiliated Practice is responsible for obtaining professional liability
insurance for the employees of the Affiliated Practice (which names the Company
as an additional insured).
ORTHODONTIST EMPLOYMENT AGREEMENTS
The revenues of the Affiliated Practices (and, therefore, the success of the
Company) are dependent on fees generated by the orthodontists the Affiliated
Practices employ. Each Affiliated Practice is a party to an employment agreement
with each orthodontist associated with its practice (the "Orthodontist
Employment Agreements"). The Orthodontist Employment Agreements are generally
for an initial term ranging from five to seven years and continue thereafter on
a year-to-year basis until terminated under the terms of the agreements. The
Orthodontist Employment Agreements generally provide that the orthodontist will
not compete with the Company within a specified geographic area for a period of
two years following termination of the agreement. The Company does not employ
orthodontists and, where prohibited by applicable law, does not employ
orthodontic hygienists or orthodontic assistants. A substantial reduction in the
number of orthodontists employed by or associated with the Affiliated Practices
could have a material adverse effect on the financial performance of the
Company. The ability of the Affiliated Practices to replace existing
orthodontists by attracting new orthodontists may be constrained by the limited
number of new orthodontists completing post-graduate orthodontic programs each
year. In addition, a shortage of available orthodontists with the skills and
experience sought by the Company would have a material adverse effect on the
Company's expansion opportunities. Failure by the Affiliated Practices to employ
a sufficient number of orthodontists (whether by renewals of existing employment
agreements or otherwise) would have a material adverse effect on the Company's
business, financial condition and results of operations.
COMPETITION
The Company faces substantial competition from other companies to establish
affiliations with additional orthodontic practices. A number of other public and
private practice management companies focus on orthodontics, and several
companies are pursuing similar strategies in dentistry and other segments of the
health care industry. The Company is aware that general dental practice
management companies have provided, or intend to provide, orthodontic services
and have sought, or intend to seek, to affiliate with or employ orthodontists.
Certain of these competitors have greater financial and other resources than the
Company. Additional companies with similar objectives may enter the Company's
markets and compete with the Company. In addition, the business of providing
orthodontic services is highly competitive in each market in which the Company
operates. The Affiliated Practices face local competition from other
orthodontists, general dentists and pedodontists (dentists specializing in the
care of children's teeth), some of whom have more established practices.
Dentists are not restricted by law or any governmental authority from providing
orthodontic services. The Company believes the increase in recent years in
dentists providing orthodontic services has limited the growth of patient case
starts performed by orthodontists. There can be no assurance that the Company or
the Affiliated Practices will be able to compete effectively, that additional
competitors will not enter their markets or that additional competition will not
have a material adverse effect on the Company.
EMPLOYEES
As of December 31, 1998, the Company had 698 employees, of which 46 were
employed at the Company's headquarters
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and 652 were employed at the locations of the existing Affiliated Practices.
None of the Company's employees is represented by collective bargaining
agreements. The Company has not experienced any work stoppages as a result of
labor disputes and the Company considers its employee relations to be good.
The Company's future performance depends in significant part on the continued
service of its senior management and other key personnel. In May 1998, the
Company replaced its president and its vice president of business development.
In August 1998, the Company replaced its chief executive officer and chief
financial officer. There can be no assurance that the Company's senior
management and other key employees will continue to work for the Company. Loss
of services of those employees could have a material adverse effect on the
Company's business, results of operations and financial condition. The success
of the Company's growth strategy also depends on the Company's ability to
attract and retain additional high-quality personnel.
INSURANCE
The Affiliated Practices provide orthodontic services to the public and are
exposed to the risks of professional liability and other claims. Such claims, if
successful, could result in substantial damage awards to the claimants that may
exceed the limits of any applicable insurance coverage. Although the Company
does not control the practice of orthodontics by the Affiliated Practices, it
could be asserted that the Company should be held liable for malpractice of an
orthodontist employed by an Affiliated Practice. Each of the existing Affiliated
Practices has undertaken to comply with all applicable regulations and legal
requirements, and the Company maintains liability insurance for itself and is
named as an additional insured party on the liability insurance policies of the
existing Affiliated Practices. The existing Affiliated Practices maintain
comprehensive professional liability insurance, generally with limits of not
less than $1.0 million per claim and with aggregate policy limits of not less
than $3.0 million per orthodontist. The Company expects that it will require
future Affiliated Practices to maintain comparable insurance coverage. In the
event an Affiliated Practice employs more than one orthodontist, that practice
will maintain insurance with a separate limit for claims against that practice
in an amount acceptable to the Company. There can be no assurance that a future
claim or claims will not be successful or, if successful, will not exceed the
limits of available insurance coverage or that such coverage will continue to be
available at acceptable costs.
The Company and the existing Affiliated Practices maintain professional
liability insurance coverage on a claims-made basis. Such insurance provides
coverage for claims asserted when the policy is in effect regardless of when the
events that caused the claim occurred.
GOVERNMENT REGULATION
The orthodontic services industry in the U.S. and Canada is regulated
extensively at both the state, provincial and federal levels. Regulatory
oversight includes, but is not limited to, considerations of fee-splitting,
corporate practice of orthodontics and state insurance regulation.
CORPORATE PRACTICE OF ORTHODONTICS; FEE-SPLITTING
The laws of many states in the U.S. and provinces of Canada prohibit business
corporations such as the Company from engaging in the practice of orthodontics
or employing orthodontists to practice orthodontics. The specific restrictions
against the corporate practice of orthodontics, as well as the interpretation of
those restrictions by state regulatory authorities, vary from jurisdiction to
jurisdiction. The restrictions are generally designed to prohibit an entity not
wholly owned by orthodontists (such as the Company) from controlling the
professional assets of an orthodontic practice (such as patient records and
payor contracts), employing orthodontists to practice orthodontics (or, in
certain jurisdictions, employing dental hygienists or orthodontic assistants),
or controlling the content of an orthodontist's advertising or professional
practice. The Company does not acquire any professional assets and, as provided
in the Service Agreements, does not control the practice of orthodontics or
employ orthodontists to practice orthodontics at any of the Affiliated
Practices' locations. Moreover, in jurisdictions in which it is prohibited, the
Company does not employ orthodontic hygienists or orthodontic assistants. The
Company provides management services to the Affiliated Practices, and believes
that the fees the Company charges for those services are consistent with the
laws and regulations of the jurisdictions in which it operates. Therefore, the
Company believes it would not be regarded as "owner," "operator" or "manager" of
the Affiliated Practices within the meaning of those terms under applicable
orthodontic practice acts and believes that its operations comply with the
above-described laws to which it is subject. The laws of many jurisdictions also
prohibit orthodontists from sharing professional fees with non-orthodontic
entities.
Dental boards do not generally interpret these prohibitions as preventing a
non-orthodontic entity from owning non-professional assets used by an
orthodontist in an orthodontic practice or providing management services to an
orthodontist for a fee provided that the following conditions are met: (i) a
licensed dentist or orthodontist has complete control and custody over the
professional assets; (ii) the non-orthodontic entity does not employ or control
the orthodontists (or, in
10
<PAGE>
some states, orthodontic hygienists or orthodontic assistants); (iii) all
orthodontic services are provided by a licensed dentist or orthodontist; and
(iv) licensed dentists or orthodontists have control over the manner in which
orthodontic care is provided and all decisions affecting the provision of
orthodontic care. Applicable laws generally require that the amount of a
management fee be reflective of the fair market value of the services provided
by the management company and in certain states require that any management fee
be a flat fee or cost-plus fee based on the cost of services performed by the
Company. In general, the orthodontic practice acts do not address or provide any
restrictions concerning the manner in which companies account for revenues from
an orthodontic practice, subject to the above-noted restrictions relating to
control over the professional activities of the orthodontic practice, ownership
of the professional assets of an orthodontic practice and payments for
management services.
There can be no assurance that a review of the Company's business relationships
by courts or regulatory authorities will not result in determinations that could
prohibit or otherwise adversely affect the operations of the Company or that the
regulatory environment will not change, requiring the Company to reorganize or
restrict its existing or future operations. The laws regarding fee-splitting and
the corporate practice of orthodontics and their interpretation are enforced by
regulatory authorities with broad discretion. There can be no assurance that the
legality of the Company's business or its relationship with the Affiliated
Practices will not be successfully challenged or that the enforceability of the
provisions of any Service Agreement will not be limited.
STATE INSURANCE REGULATION
Although the Company does not anticipate entering into managed care contracts,
there are certain regulatory risks associated with the Company's role in
negotiating and administering managed care contracts. The application of state
insurance laws to other than various types of fee-for-service arrangements is an
unsettled area of law and is subject to interpretation by regulators with broad
discretion. As the Company or the Affiliated Practices contract with third-party
payors, including self-insured plans, for certain non-fee-for-service basis
arrangements, the Company may become subject to state insurance laws.
Specifically, in some states, state insurance regulators may determine that the
Company or an Affiliated Practice is engaged in the business of insurance
because some of the managed care contracts to which an Affiliated Practice may
become a party may contain capitation features. In the event that the Company or
an Affiliated Practice is determined to be engaged in the business of insurance,
it could be required either to seek licensure as an insurance company or to
change the form of the relationships with third-party payors and, as a result,
the Company's revenues may be adversely affected.
HEALTH CARE REFORM PROPOSALS
The U.S. Congress has considered various types of health care reform, including
comprehensive revisions to the current health care system. It is uncertain what,
if any, legislative proposals will be adopted in the future or what actions
federal or state legislatures or third-party payors may take in anticipation of
or in response to any health care reform proposals or legislation. Health care
reform legislation could have a material adverse effect the operations of the
Company, and changes in the health care industry, such as the growth of managed
care organizations and provider networks, may result in lower payment levels for
the services of orthodontic practitioners and lower profitability for Affiliated
Practices, which would reduce the service fees payable to the Company.
CANADIAN MATTERS
The Alberta Dental Association ("ADA"), after receiving a complaint (the
"Alberta Complaint") filed by certain orthodontists who compete against the
orthodontists affiliated with Apple in Calgary, Alberta, determined (after
conducting a preliminary investigation) that a disciplinary hearing with respect
to the agreements between Apple and its Affiliated Practices in that Province
was required. An orthodontist affiliated with Apple then applied to the ADA for
its approval of his affiliation with Apple, which caused the postponement of the
disciplinary hearing relating to the Alberta Complaint. In October 1998, the ADA
refused to grant its approval of that orthodontist's affiliation with Apple. An
application has been filed for judicial review of that ADA decision. On review,
the Alberta court will have the power to confirm the decision, set the ADA's
decision aside, or find that the legislation on which the decision is based void
on either constitutional or administrative law grounds.
The ADA attempted to cause the disciplinary hearing relating to the Alberta
Complaint to proceed in advance of the judicial review. The Alberta court
granted an injunction which prevented the ADA from dealing with the Alberta
Complaint until the application for judicial review of the ADA's decision is
heard or the Alberta court orders otherwise. The judicial review is scheduled
for April 20 and 21, 1999. There can be no assurance that the judicial review or
any ADA disciplinary hearing with respect to the Alberta Complaint will not
limit the enforceability of the Service Agreements between Apple and its
Affiliated Practices in Alberta. In addition, a similar complaint has been filed
with the Ontario Dental Association, with respect to which no substantive action
has been taken as of April 14, 1999.
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<PAGE>
EXTENT OF PROTECTION OF PROPRIETARY RIGHTS
The Company relies in part on trademark, service mark, trade dress, trade
secret, unfair competition and copyright laws to protect its intellectual
property rights. There can be no assurance that actions taken by the Company
will be adequate to protect its intellectual property rights from
misappropriation by others, that the Company's proprietary information will not
become known to competitors, that others will not independently develop
substantially equivalent or better intellectual properties that do not infringe
on the Company's intellectual property rights or that others will not assert
rights in, and ownership of, proprietary rights of the Company. Furthermore, the
Company's rights to its "APPLE ORTHODONTIX" common law service mark may be
limited in market areas where a similar trademark or service mark may already be
in use. The Company has not applied for or obtained any registrations of its
trademarks or service marks. The Company is aware of several other businesses
that utilize an "APPLE" service mark in connection with the provision of general
dental services, some of which have obtained federal or state trademark
registrations. The Company is aware of one other orthodontic practice in the
United States that utilizes a service mark similar to the Company's, which
practice is not located in a market where any of the existing Affiliated
Practices' offices are located.
ITEM 3. 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 the Company, Dr. Vondrak, John G. Vondrak, P.C. and John G.
Vondrak Apple Orthodontix, Inc. ("JGVAOI"), alleging, among other things,
misappropriation of trade secrets and certain breaches of a confidentiality
agreement executed by Dr. Vondrak, on behalf of John G. Vondrak, P.C., in favor
of OCA. While the Company 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 the Company (specifically, OCA alleged that
Dr. Vondrak and Apple are alter egos and, alternatively, that Dr. Vondrak was
acting as the Company'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, the Company filed a declaratory judgment action in the District
Court of Harris County, Texas (164th Judicial District) seeking a finding by the
court that neither the Company nor Dr. Vondrak has violated the terms of the
confidentiality agreement, otherwise used confidential information supplied by
OCA or unfairly competed against OCA. In October 1997, OCA filed an answer
generally denying the Company's allegations, as well as asserting a counterclaim
against the Company, JGVAOI, Apple Orthodontix of Texas, Inc., Apple Acquisition
of Texas, Inc., Dr. Vondrak, John G. Vondrak, P.C., one of the Founding
Affiliated Practices and the orthodontist associated with such practice. OCA's
counterclaim alleges, among other things, unfair competition, misappropriation
of trade secrets, tortious interference with prospective contractual
arrangements and certain breaches of confidentiality agreements executed by each
of Dr. Vondrak, on behalf of John G. Vondrak, P.C., and the affiliated
orthodontist, on behalf of the Founding Affiliated Practice referred to above,
in favor of OCA. While the Company is not a party to these confidentiality
agreements, OCA alleged that the Company should be bound by their terms as a
result of the relationships between Dr. Vondrak, the affiliated orthodontist and
the Company (specifically, OCA alleged that Dr. Vondrak and the Company are
alter egos and that the Company and abetted or conspired with Dr. Vondrak and
the affiliated orthodontist in their wrongful conduct). OCA's complaint states
that it is seeking monetary damages in excess of the minimum jurisdictional
limits of the court, punitive damages, injunctive relief, prejudgment interest
and attorneys' fees. The Company intends to vigorously defend the claims made by
OCA, which the Company believes are without merit. This lawsuit is still
pending, and the Company 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 the Company.
On February 11, 1999, the Company filed a complaint in the United States
District Court for the Southern District of Texas against David V. Young,
D.D.S., M.D.S., and David V. Young, D.D.S., M.D.S., L.C. (collectively, the
"Young Parties") alleging, among other things, breach by the Young Parties of
the Services Agreement dated December 1, 1997 among the Young Parties and the
Company (the "Young Services Agreement"), tortious interference by the Young
Parties of the relationships of the Company with its employees resident in the
State of Utah and fraud by the Young Parties in connection with the repayment by
the Company of certain debts of Dr. Young. The complaint seeks a declaratory
judgement that the Young Services Agreement is in full force and effect
notwithstanding the purported termination of the Young Services Agreement by the
Young Parties on January 14, 1999.
On April 7, 1999, J. Darwin King, D.D.S., M.D.S. ("King") filed a motion for
judgment (the "Motion") in the Circuit Court of the County of Henrico, Virginia
against the Company alleging, among other things, actual and constructive fraud
and violations of the Virginia Securities Act. The Motion states that King is
seeking compensatory damages of at least $1.0 million and punitive damages of
$1.0 million, plus a return of the consideration King paid for his stock in the
Company, interest, reasonable attorney's fees, costs and all other relief as the
case may require. The Company intends to
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<PAGE>
vigorously defend the claims made by King, which the Company believes are
without merit. This lawsuit is still pending, and the Company cannot predict
whether it will succeed or, if not successful, what effect this may have on the
Company.
The Company is not currently a party to any material claims, suits or complaints
relating to services and products provided by the Company or the existing
Affiliated Practices, although there can be no assurance that such claims will
not be asserted against the Company in the future. The Company is subject to
certain pending claims as a result of successor liability in connection with its
affiliations with existing Affiliated Practices; however, the Company believes
that the ultimate resolution of those claims will not have a material adverse
effect on the financial position or operating results of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the fourth quarter of
1998.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
(a) The Company's authorized common stock consists of 25,000,000 shares of
Common Stock and 4,106,852 shares of Class B Stock.
The Company's Common Stock has been publicly traded on the American Stock
Exchange under the symbol AOI since the Company's IPO offering on May 22, 1997.
The following table sets forth the range of high and low sales prices for the
common stock from May 22, 1997 though April 14, 1999:
HIGH LOW
--------------- -------------
1999
Second quarter through April 14, 1999 3 3/8 2
First quarter ended March 31, 1999 4 7/8 2 3/8
1998
Fourth quarter ended December 31, 1998 6 2 1/4
Third quarter ended September 30, 1998 5 15/16 2 5/8
Second quarter ended June 30, 1998 16 1/2 4 1/8
First quarter ended March 31, 1998 14 1/4 10 7/16
1997
Fourth quarter ended December 31, 1997 16 1/16 10
Third quarter ended September 30, 1997 16 1/4 9
May 22, 1997 through June 30, 1997 12 15/16 7 3/8
The Company's Class B Stock is not publicly traded.
There were approximately 190 shareholders of record (including brokerage firms
and other nominees) of the Company's Common Stock as of April 14, 1999. The
number of record holders does not bear any relationship to the number of
beneficial owners of Common Stock.
The Company has never paid any cash dividends and does not anticipate paying
cash dividends on its Common Stock or Class B Stock in the foreseeable future.
The Company currently intends to retain earnings to support operations and
finance expansion. In addition, the Company's existing credit facility prohibits
the payment of dividends.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The Selected Consolidated Financial Data set forth below is derived from the
audited consolidated financial statements of the Company included elsewhere in
this Report. The Company believes that comparison of results for 1998 periods to
those for 1997 and 1996 periods is not meaningful because the Company was
effectively not in operation for the first five months of 1997 or for any of
1996.
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<PAGE>
The Selected Consolidated Financial Data should be read in conjunction with the
accompanying Consolidated Financial Statements of Apple Orthodontix, Inc. and
subsidiaries and the related notes thereto and "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
-------------------------------- DECEMBER 31,
1998 1997 1996
------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Management service fee revenues (1) ....................................... $ 47,517 $ 19,186 $ --
Costs and expenses (2):
Salaries and benefits ................................................... 18,288 8,411 627
Orthodontic supplies .................................................... 6,312 2,352 --
Rent .................................................................... 4,907 2,156 20
Advertising and marketing ............................................... 2,067 484 --
General and administrative .............................................. 7,717 3,617 232
Depreciation and amortization ........................................... 3,009 943 5
Special compensation expense related to
issuance of stock (3) ................................................. -- -- 13,812
Special consulting expense related to
issuance of stock (3) ................................................. -- -- 9,613
Special charges ......................................................... 21,726 -- --
------------- ------------- -------------
Total costs and expenses .............................................. 64,026 17,963 24,309
------------- ------------- -------------
Operating income (loss) ............................................... (16,509) 1,223 (24,309)
Interest expense, net of capitalized interest ............................. 810 274 --
Interest income ........................................................... (416) (191) --
Other income, net ......................................................... (77) (16) --
------------- ------------- -------------
Income (loss) before income taxes .................................... (16,826) 1,156 (24,309)
Income tax provision (benefit) ............................................ (6,496) 439 --
------------- ------------- -------------
Net income (loss) ..................................................... $ (10,330) $ 717 $ (24,309)
============= ============= =============
Income (loss) per common and common
equivalent share:
Basic .................................................................. $ (0.75) $ 0.09 $ (7.24)
============= ============= =============
Diluted ................................................................ $ (0.75) $ 0.09 $ (7.24)
============= ============= =============
Number of shares used in calculating
income (loss) per common and common
equivalent share:
Basic .................................................................. 13,783 8,132 3,359
============= ============= =============
Diluted ................................................................ 13,783 8,344 3,359
============= ============= =============
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1998 1997 1996
------------- ------------- -------------
BALANCE SHEET DATA:
Working capital (deficit) ................................................. $ 2,613 $ 2,538 $ (2,324)
Total assets .............................................................. 71,462 54,799 1,461
Long-term debt, net of current portion .................................... 23,654 248 --
Stockholders' equity (deficit) ............................................ 29,688 35,112 (884)
</TABLE>
(1) Reflects management service fees for the Founding Affiliated Practices
since June 1, 1997. Management service fees related to affiliations
subsequent to the IPO are included from the date of such affiliation.
(2) Corporate office expenses are included for all periods presented.
(3) Reflects non-recurring charges related to shares issued to management and
advisors of the Company in October and December 1996, at $7.00 per share.
15
<PAGE>
ITEM 7. 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, risks associated with affiliations,
fluctuations in operating results because of affiliations and variations in
stock price, changes in government regulations, competition, risks of operations
and growth of existing and new affiliated orthodontic practices, and risks
detailed in the Company's SEC filings. 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 accompanying Consolidated
Financial Statements of Apple Orthodontix, Inc. and subsidiaries and the related
notes thereto.
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 and through August 12, 1998, the Company has affiliated with an
additional 35 practices and 59 orthodontists operating in 64 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 management
service fees. The management 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 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 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 subject to adjustment on an annual
basis. It is used when local jurisdictions do not allow use of the Standard
Contract or 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.
The expenses incurred by the Company in fulfilling its obligations under the
Service Agreements are generally of the same nature as the operating costs and
expenses that would have otherwise been incurred by the Affiliated Practices,
including salaries, wages and benefits of practice personnel (excluding
orthodontists and, in some cases, orthodontic assistants and other professional
personnel), orthodontic supplies and office supplies used in administering their
clinic practices, the office (general and administrative) expenses of the
practices and depreciation and amortization of assets acquired from the Founding
Affiliated Practices. In addition to the operating costs and expenses discussed
above, the Company incurs personnel and administrative expenses in connection
with establishing and maintaining a corporate office, which provides management,
administrative, marketing and business development services.
In accordance with SAB No. 48, 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 the Initial Affiliations 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
effected by the Company after the IPO. The subsequent affiliations resulted in
substantial intangible assets being recorded and will continue to result in
substantial annual noncash amortization charges for intangible assets in the
Company's statements of operations. In this connection, the Company changed,
effective April 1, 1998, its estimate of the remaining useful life of its
intangible assets in light of recent trends in the practice management industry.
From that date, it will use a maximum 25-year useful life for amortizing
intangible assets attributable to Affiliations. Prior to that date, these costs
were being amortized over a period of 30 to 40 years to match the term of the
related Service Agreement.
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RECENT EVENTS
Since the third quarter of 1998, the Company has negotiated the termination of
its service agreements with two Affiliated Practices (the "Terminated
Practices"). The 1998 management service fee revenues related to the Terminated
Practices were $897,130. Two additional Affiliated Practices have alleged
breaches of their service agreements by the Company and sought to have the
service agreements terminated (the "Threatened Practices"). The Company
vigorously denies any breach of the service agreements with the Threatened
Practices and intends to strenuously seek enforcement of those service
agreements. The 1998 management service fee revenues related to the Threatened
Practices were $3.1 million. In addition, the Company is in the process of
negotiating the termination of additional service agreements with Affiliated
Practices with 1998 management service fee revenues of approximately $1.0
million.
On April 23, 1999, the Company executed an assignment agreement with one of the
Threatened Practices discussed above (the "Assignment Agreement"). The
Assignment Agreement provides for the Company to issue 181,818 shares of Common
Stock in return for the assignment of the ownership of the practice to the
Company. The Company intends to seek a new orthodontist to whom it will sell
this ownership interest. The 1998 management service fee revenues associated
with this practice were $2.4 million. Additionally, since April 14, 1999, one
additional Affiliated Practice has alleged breaches of its service agreement by
the Company and sought to have the service agreement terminated (the "Additional
Threatened Practice"). The Company vigorously denies any breach of the service
agreement with the Additional Threatened Practice and intends to strenuously
seek enforcement of this service agreement. The 1998 management service fee
revenues related to the Additional Threatened Practice were $138,499.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND THE
PERIOD FROM INCEPTION (JULY 15, 1996) THROUGH DECEMBER 31, 1996
MANAGEMENT SERVICE FEE REVENUES
The Company generated management service fee revenues of $47.5 million for the
year ended December 31, 1998, as compared with $19.2 million for the year ended
December 31, 1997. The Company conducted no significant operations from July 15,
1996 through the date of the IPO. Following completion of the IPO on May 29,
1997, the Company began operations effective June 1, 1997. Therefore, management
service fee revenues reflect only seven months of operations during the year
ended December 31, 1997 and there were no management service fee revenues during
the year ended December 31, 1996.
COSTS AND EXPENSES
The Company incurred costs and expenses of $64.0 million and $18.0 million for
the years ended December 31, 1998 and 1997, respectively. As described more
fully under the caption MANAGEMENT SERVICE FEE REVENUES above, costs and
expenses for the year ended December 31, 1997 reflect only seven months of
operations. Costs and expenses for the 1997 period do, however, reflect
corporate office expenses (consisting primarily of various legal, accounting,
travel, personnel and marketing costs incurred in connection with the IPO and
the Initial Affiliations) for the entire period presented.
Costs and expenses for 1998 included two special charges. The Company recorded a
$3.7 million special charge in the second quarter which reflected severance
costs associated with a series of management changes ($3.3 million), costs of
terminated transaction negotiations ($382,344) and certain other items
($84,490). The severance costs related to three executive officers of the
Company. As of December 31, 1998, the Company had paid $2.7 million in cash and
$537,952 in stock related to the second quarter special charge.
In the fourth quarter of 1998, the Company recorded an additional special charge
of $18.0 million on a pre-tax basis. This special charge, which was primarily
noncash in nature, reflected valuation reserves related to the Company's service
fee intangibles ($7.0 million), receivables from certain of the Affiliated
Practices ($4.9 million), property and equipment ($1.8 million), the
discontinuation of the Company's business development program ($1.3 million),
lawsuit settlements ($831,000) and the writedown of certain other assets ($2.2
million).
Exclusive of the special charges, costs and expenses for 1998 were $42.3 million
(89.0% of management service fee revenues).
Costs and expenses of $24.3 million for 1996 represented corporate office
expenses for the period from inception (July 15, 1996) through December 31,
1996. Of the $24.3 million of costs and expenses for the period ended December
31, 1996, $23.4 million related to the valuing of stock issued to founders,
management and advisors of the Company in October and December 1996 at the
initial public offering price of $7.00 per share. This valuation resulted in
special compensation expense of $13.8 million and special consulting expense of
$9.6 million, with a corresponding increase in additional paid-in capital of
$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.
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<PAGE>
OPERATING INCOME (LOSS)
The Company generated operating income (loss) of $(16.8) million, $1.2 million
and $(24.3) million for the years ended December 31, 1998 and 1997 and the
period from inception (July 15, 1996) through December 31, 1996, respectively.
As discussed more fully above, the operating loss for 1998 was primarily
attributable to two special charges totaling $21.7 million. The operating income
for 1997 reflects only seven months of operations. The operating loss for 1996
was primarily attributable to the compensation and consulting charges totaling
$23.4 million.
INTEREST EXPENSE
Interest expense is summarized as follows (in thousands):
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
------------------------------ DECEMBER 31,
1998 1997 1996
------------- ------------- -------------
Gross interest ............... $ 976 $ 283 $ --
Less: capitalized interest .. (166) (9) --
------------- ------------- -------------
Interest expense ............. $ 810 $ 274 $ --
============= ============= =============
Interest expense increased $536,000 (196%) from 1997 to 1998. This increase was
due primarily to higher average debt levels, partially offset by increased
capitalized interest on development projects.
INTEREST INCOME
Interest income of $416,000 for the year ended December 31, 1998 reflected
interest earned on notes receivable from certain of the Affiliated Practices.
Interest income of $190,669 for the year ended December 31, 1997 reflected
interest earned on the Company's net proceeds from the IPO and on notes
receivable from certain of the Affiliated Practices. There was no interest
income generated during the year ended December 31, 1996.
INCOME TAX PROVISION (BENEFIT)
The Company generated an income tax benefit of $6.5 million for the year ended
December 31, 1998, representing an effective tax rate of 38.6%. The Company
incurred an income tax provision of $439,282 for the year ended December 31,
1997, representing an effective tax rate of 38.0%. The Company incurred no
income taxes for the period ended December 31, 1996. The benefit of the net
operating loss generated during 1996 was fully reserved.
NET INCOME (LOSS)
As a result of the foregoing factors, the Company generated a net loss of $10.3
million for the year ended December 31, 1998, or a loss per share of $0.75.
Excluding the effect of the special charges, the Company generated net income of
$3.0 million for the year ended December 31, 1998, or earnings per share of
$0.22. This net income amount comprised 6.3% of service fee revenues for the
period.
The Company generated net income of $716,725 for the year ended December 31,
1997, or earnings per share of $0.09. This net income amount comprised 3.7% of
service fee revenues for the period.
The net loss of $24.3 million for 1996 represented a loss per share of $7.24.
YEAR 2000 IMPACT ON INFORMATION TECHNOLOGY INFRASTRUCTURE
The Company is in the process of upgrading the practice management systems at
its Affiliated Practices (the "Affiliated Practice Systems"). The purpose of
this upgrade includes enhancement of the diagnostic, imaging, scheduling and
financial features of the Affiliated Practice Systems. The Company has also
conducted an evaluation of its information technology infrastructure, including
information technology systems in the Company's corporate office (the "Corporate
Systems") and the Affiliated Practice Systems, to analyze the impact of the
technical problems anticipated for the year 2000 (the "Year 2000 Issue"). The
Year 2000 Issue concerns computer programs written using two digits rather than
four to define the applicable year. As a result, any of the Company's computer
applications that have date-sensitive programs may recognize a date using "00"
as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculation causing disruptions including but not limited to a
temporary inability to process transactions, issue invoices, communicate with
customers and financial institutions and update internal accounting systems. If
not corrected, such disruptions could have a significant impact on the Company's
operations. Following its evaluation, the Company
18
<PAGE>
determined that substantially all its Corporate Systems would be unaffected by
such problems. Certain of the Affiliated Practice Systems, however, could be
affected by the Year 2000 Issue.
The Company has initiated a Company-wide program to prepare the Company's
computer systems and applications for the year 2000. Based on present
information, the Company believes that it will be able to achieve year 2000
compliance through the replacement of current programs with new programs that
are already year 2000 compliant. The Company will utilize both internal and
external resources to replace and test software for year 2000 compliance. The
Company plans to complete the year 2000 conversion project by June 1999. The
total project costs are presently estimated not to exceed $250,000 and will be
expensed as incurred. Costs relating to the purchase of new software will be
capitalized.
The Company is taking steps to resolve year 2000 compliance issues that may be
created by customers, suppliers and financial institutions with whom the Company
does business. However, there can be no guarantee that the systems of other
entities will be converted timely. A failure to convert by another entity could
have a significant adverse effect on the Company.
The costs of the year 2000 conversion project and the date on which the Company
plans to complete the project are based on management's best estimates, which
were derived using numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. There can be no guarantee that these estimates will be achieved and
actual results could vary significantly from current estimates.
The Company does not have a written contingency plan to address the issues that
could arise should the Company or any of its suppliers or customers not be
prepared to accommodate year 2000 issues timely. The Company believes that in an
emergency it could revert to the use of manual systems that do not rely on
computers and could perform the minimum functions required to maintain the
performance of its services and provide information reporting to maintain
satisfactory control of the business. Should the Company have to utilize manual
systems, it is uncertain that it could maintain the same level of operations and
this could have a material adverse impact on the business. The Company intends
to maintain constant surveillance on this situation and will develop such
contingency plans as are required by the changing environment.
LIQUIDITY AND CAPITAL RESOURCES
FINANCING ACTIVITIES
As a result of the $18.0 million special charge, at December 31, 1998, the
Company was no longer in compliance with certain of the covenants of its $25
million unsecured bank credit facility with Chase Bank of Texas, N.A. (the
"Chase Facility"). On April 14, 1999, the Company amended the Chase Facility
(the "Amended Chase Facility") with respect to certain of the covenants. The
Amended Chase Facility provides for the revolving credit period to expire on May
31, 2001 and for a security interest in substantially all the Company's assets.
The Company is now in compliance with all covenants of the Amended Chase
Facility.
At December 31, 1998, the Company had borrowed $23.5 million under the Chase
Facility. The Company requires substantial capital to pursue its operating
strategy. To date, the Company has relied upon net cash provided by financing
activities to fund its capital requirements. The Company's operations have
historically been a use of funds. For the years ended December 31, 1998 and
1997, the Company's operations used $4.3 million and $2.6 million, respectively,
of cash. Excluding the payment of special charges of $2.7 million during 1998,
the Company's operations used $1.6 million of cash for 1998.
On April 27, 1999, the Company announced that it had signed a non-binding letter
of intent with an investor group in connection with the consideration of a
potential investment in the Company. The investment would be in the form of a
private placement of $20 million of convertible preferred shares, convertible on
a one-for-one basis into shares of the Company's Class A Common Stock. The
convertible preferred shares would be issued at a price of $3.00 per share
(subject to completion of due diligence satisfactory to the investor group) and
would represent, on an as-converted basis, approximately a 32% ownership
interest in the Company at that price. The Company anticipates that the net
proceeds would be used to repay a substantial portion of the Chase Facility. The
proposed investment by the investor group remains subject to further negotiation
of applicable terms and conditions (including price), the negotiation of
definitive documents, the completion of due diligence satisfactory to the
investor group, and the receipt of any necessary approvals and third-party
consents.
In order to increase its liquidity, the Company has developed the following
strategies: (i) suspension of its new practice affiliation program, (ii)
substantial curtailment of its new office development program, (iii)
implementation of tighter credit policies with its Affiliated Practices, (iv)
consideration of terminating the service agreements of selected underperforming
Affiliated Practices, (v) reducing costs in the Company's corporate office, (vi)
raising additional capital and (vii) the consideration of strategic alternatives
which could include, but are not limited to, a sale of the Company or a business
combination with another physician practice management company or financial
sponsor.
Based on its current strategy to enhance cash collections and reduce costs, the
Company expects its operations to be a sufficient source of funds to meet its
operating capital requirements over the next twelve months. However, there can
be no assurance that the Company's strategies will be achieved. In addition, the
Company's capital expenditure and other
19
<PAGE>
liquidity needs are dependent upon access to additional capital. Any limitation
on the Company's ability to obtain additional financing could have a material
adverse effect on the Company's business, financial condition and results of
operations. As a result of the above factors, there is substantial doubt as to
the Company's ability to continue as a going concern. The accompanying financial
statements do not reflect any adjustments related to the recoverability and
classification of recorded assets or other adjustments which might be required
should the Company be unable to continue as a going concern.
During 1998, the Company amended the Chase Facility to increase its size from
$15 million to $25 million and to increase its bank group from one to two banks.
The Chase Facility provides for a revolving credit period expiring on May 31,
2002. Availability under the Chase Facility is tied to the Company's cash flow
and liquidity. Advances bear interest, at the Company's option, at a prime rate
or LIBOR, in each case plus a margin which is calculated based upon the
Company's ratio of indebtedness to cash flow. The Company is required to
maintain certain financial covenants regarding net worth, coverage ratios and
additional indebtedness. Upon the execution of the Amended Chase Facility, the
Company had borrowing availability of $1.5 million and $1.0 million, as of
December 31, 1998 and March 31, 1999, respectively.
In May 1997, the Company issued and sold 2,702,500 shares of Common Stock in the
IPO. The IPO provided the Company with net proceeds of $12.1 million, which it
used to fund cash paid for the Initial Affiliations ($6.6 million) and
subsequent affiliations ($5.5 million). In November 1997, the Company issued and
sold 1,490,014 shares of Common Stock in a public offering (the "Offering"). The
Company has used the net proceeds of the Offering ($15.3 million) to repay $12.2
million under the Chase Facility, to affiliate with additional orthodontists, to
develop new offices, for capital expenditures and for general corporate
purposes.
Total long-term debt increased from $247,624 at December 31, 1997, to $23.7
million at December 31, 1998. The increase is attributable to borrowings for the
affiliation of new orthodontic practices, the purchase of property and equipment
and general working capital needs. The Company's weighted average cost of
indebtedness was 7.0% and 8.7% for 1998 and 1997, respectively.
CAPITAL EXPENDITURES
The Company made capital expenditures for the Affiliated Practices of $3.2
million and $3.6 million for 1998 and 1997, respectively, to fund, among other
things, the development of new offices. With the exception of one stand alone de
novo office opened during the second quarter of 1998, which cost $1.3 million to
develop, the Company incurred an average cost of developing the one de novo and
seven satellite offices opened to date of approximately $400,000 each. 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 $4.1 million at
December 31, 1998.
During 1998, total consideration related to the New Orthodontist Affiliations
consisted of 455,604 shares of common stock and $7.1 million of cash, assumed
debt and deferred purchase price.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company does not utilize financial instruments for trading purposes and
holds no derivative financial instruments which could expose the Company to
significant market risk. The Company's exposure to market risk for changes in
interest rates relates primarily to its long-term debt obligations discussed in
Note 6 to the consolidated financial statements. At December 31, 1998, the
Company had outstanding $23.5 million of floating rate debt under the Chase
Facility. The detrimental effect on the Company's pre-tax earnings of a
hypothetical 100 basis point increase in the interest rate under the Chase
Facility would be $235,000. This sensitivity analysis does not consider any
actions the Company might take to mitigate its exposure to such a change in the
Chase Facility rate. The hypothetical change used in this analysis may be
different from what actually occurs in the future. The Company's remaining
long-term debt obligations of $154,000 were primarily at fixed rates of
interest.
20
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Apple Orthodontix, Inc.:
We have audited the accompanying consolidated balance sheets of Apple
Orthodontix, Inc., a Delaware corporation, and subsidiaries as of December 31,
1998 and 1997, and the related consolidated statements of operations and
comprehensive income, changes in stockholders' equity (deficit) and cash flows
for the years ended December 31, 1998 and 1997 and the period from inception
(July 15, 1996) through December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Apple Orthodontix,
Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the years ended December 31, 1998 and 1997
and the period from inception (July 15, 1996) through December 31, 1996, in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has a constrained access to capital and a net
capital deficiency that raises substantial doubt about its ability to continue
as a going concern. Management's plans in regard to these matters are also
described in Note 1. The accompanying consolidated financial statements do not
reflect any adjustments related to the recoverability and classification of the
recorded assets or other adjustments which might be required should the Company
be unable to continue as a going concern.
ARTHUR ANDERSEN LLP
Houston, Texas
April 14, 1999
21
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
---------------------
1998 1997
-------- --------
ASSETS
Current assets:
Cash and cash equivalents ............................. $ 755 $ 2,114
Restricted cash ....................................... 2,140 2,140
Receivable from orthodontic practices, net of
allowances of $5,785 and $69, respectively .... 5,521 2,362
Prepaid expenses ...................................... 464 250
Other current assets .................................. 455 538
-------- --------
Total current assets .................................. 9,335 7,404
-------- --------
Property and equipment, net ............................ 6,649 6,002
Intangible assets, net ................................. 49,347 38,788
Receivable from orthodontic practices, net of current
portion ................................................ 3,890 1,642
Notes receivable ....................................... 1,451 600
Receivable from related party .......................... 634 --
Other assets ........................................... 156 363
-------- --------
Total assets .......................................... $ 71,462 $ 54,799
======== ========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities:
Consideration payable to orthodontic practices ........ $ 2,098 $ 833
Accounts payable ...................................... 934 1,826
Accrued severance ..................................... 514 --
Payable to orthodontic practices ...................... 454 250
Accrued legal fees .................................... 396 --
Accrued commissions ................................... 333 --
Current maturities of long-term debt .................. 105 1,023
Income tax payable .................................... -- 351
Other accrued expenses ................................ 1,888 583
-------- --------
Total current liabilities ............................. 6,722 4,866
-------- --------
Long-term debt, net of current maturities .............. 23,654 248
Deferred income taxes .................................. 11,394 14,544
Other long-term obligations ............................ 4 29
-------- --------
Total liabilities ..................................... 41,774 19,687
-------- --------
Commitments and contingencies
Stockholders' equity:
Class A common stock, $0.001 par value,
25,000 shares authorized, 11,699 and
9,980 shares issued and outstanding,
respectively ..................................... 12 10
Class B common stock, $0.001 par value,
4,107 shares authorized, 2,325 and
3,177 shares issued and outstanding,
respectively ..................................... 2 3
Additional paid-in capital .......................... 64,310 58,295
Warrants ............................................ 1,086 777
Retained deficit .................................... (33,922) (23,592)
Foreign currency translation adjustment ............. (1,800) (381)
-------- --------
Total stockholders' equity ............................ 29,688 35,112
-------- --------
Total liabilities and stockholders' equity ............ $ 71,462 $ 54,799
======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
22
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
------------------------------ DECEMBER 31,
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS
Management service fee revenues ............ $ 47,517 $ 19,186 $ --
Costs and expenses:
Salaries and benefits ................... 18,288 8,411 627
Orthodontic supplies .................... 6,312 2,352 --
Rent .................................... 4,907 2,156 20
Advertising and marketing ............... 2,067 484 --
General and administrative .............. 7,717 3,617 232
Depreciation and amortization ........... 3,009 943 5
Special compensation expense
related to issuance of stock ............ -- -- 13,812
Special consulting expense
related to issuance of stock ............ -- -- 9,613
Special charges ......................... 21,726 -- --
------------- ------------- -------------
Total costs and expenses ............. 64,026 17,963 24,309
------------- ------------- -------------
Operating income (loss) .............. (16,509) 1,223 (24,309)
Interest expense, net of
capitalized interest ..................... 810 274 --
Interest income ............................ (416) (191) --
Other income, net .......................... (77) (16) --
------------- ------------- -------------
Income (loss) before
income taxes ....................... (16,826) 1,156 (24,309)
Income tax provision (benefit) ............. (6,496) 439 --
------------- ------------- -------------
Net income (loss) .................... $ (10,330) $ 717 $ (24,309)
============= ============= =============
Income (loss) per common and
common equivalent share:
Basic ................................... $ (0.75) $ 0.09 $ (7.24)
============= ============= =============
Diluted ................................. $ (0.75) $ 0.09 $ (7.24)
============= ============= =============
Number of shares used in calculating
income (loss) per common and common
equivalent share:
Basic ................................... 13,783 8,132 3,359
============= ============= =============
Diluted ................................. 13,783 8,344 3,359
============= ============= =============
STATEMENT OF COMPREHENSIVE
INCOME (LOSS)
Net income (loss) .......................... $ (10,330) $ 717 $ (24,309)
Foreign currency translation
adjustment ............................... (1,419) (381) --
------------- ------------- -------------
Comprehensive income (loss) ................ $ (11,749) $ 336 $ (24,309)
============= ============= =============
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
23
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
CLASS A AND B FOREIGN
COMMON STOCK ADDITIONAL CURRENCY STOCKHOLDERS'
------------------- PAID-IN RETAINED TRANSLATION EQUITY
SHARES AMOUNT CAPITAL WARRANTS DEFICIT ADJUSTMENT (DEFICIT)
-------- -------- ---------- -------- -------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, July 15, 1996 ........................ -- $ -- $ -- $ -- $ -- $ -- $ --
Issuance of common stock ................. 3,347 3 23,422 -- -- -- 23,425
Net loss ................................. -- -- -- -- (24,309) -- (24,309)
-------- -------- ---------- -------- -------- ----------- -------------
BALANCE, December 31, 1996 .................... 3,347 3 23,422 -- (24,309) -- (884)
Issuances of common stock ................ 4,197 4 27,429 -- -- -- 27,433
Transfers of certain assets and
liabilities by founders ............. 3,683 4 495 -- -- -- 499
Special dividend to founders ............. -- -- (6,592) -- -- -- (6,592)
Issuance of warrants ..................... -- -- (777) 777 -- -- --
Issuances of stock to new affiliated
practices ........................... 1,930 2 14,113 -- -- -- 14,115
Issuances of options to non-employees .... -- -- 205 -- -- -- 205
Net income ............................... -- -- -- -- 717 -- 717
Foreign currency translation adjustment .. -- -- -- -- -- (381) (381)
-------- -------- ---------- -------- -------- ----------- -------------
BALANCE, December 31, 1997 .................... 13,157 13 58,295 777 (23,592) (381) 35,112
Issuance of warrants .................... -- -- -- 309 -- -- 309
Issuances of stock to new affiliated
practices ........................... 456 1 3,469 -- -- -- 3,470
Issuances of common stock for
settlement of contingent
obligations related to new
affiliated practices from prior
years ............................... 314 -- 1,492 -- -- -- 1,492
Issuances of common stock under
employee stock option plan,
including income tax benefit ........ 20 -- 79 -- -- -- 79
Issuances of options to non-employees ... -- -- 437 -- -- -- 437
Issuances of common stock for
compensation expense ................ 77 -- 538 -- -- -- 538
Net loss ................................ -- -- -- -- (10,330) -- (10,330)
Foreign currency translation adjustment . -- -- -- -- -- (1,419) (1,419)
-------- -------- ---------- -------- -------- ----------- -------------
BALANCE, December 31, 1998 .................... 14,024 $ 14 $ 64,310 $ 1,086 $(33,922) $ (1,800) $ 29,688
======== ======== ========== ======== ======== =========== =============
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
24
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
------------------------------ DECEMBER 31,
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ....................................... $ (10,330) $ 717 $ (24,309)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization ........................... 3,009 943 5
Deferred income tax provision (benefit) ................. (7,082) 88 --
Special compensation and consulting expense paid in stock 538 -- 23,425
Portion of special charge not requiring cash ............ 17,959 -- --
Provision for doubtful accounts ......................... 777 69 --
Changes in assets and liabilities, excluding effects of
acquisitions:
Receivable from orthodontic practices ................... (7,342) (2,323) --
Prepaid expenses ........................................ (214) (286) --
Other assets ............................................ (731) (83) --
Payables and other accrued liabilities .................. (904) (1,766) 404
------------- ------------- -------------
Net cash used in operating activities ................... (4,320) (2,641) (475)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .................................... (2,856) (3,632) --
Payments for new affiliated practices ................... (10,142) (8,318) --
Payment into escrow for a new affiliated practice ....... -- (2,140) --
Advances to third parties ............................... (2,101) (600) --
Advances to related party ............................... (634) -- --
Advances to affiliates .................................. (4,017) (1,868) --
Repayment of advances by affiliates ..................... 236 123 --
------------- ------------- -------------
Net cash used in investing activities ................... (19,514) (16,435) --
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt ............................ 23,500 14,934 798
Repayments of long-term debt ............................ (1,012) (15,354) (253)
Proceeds from issuances of common stock ................. 79 33,724 --
Cash paid related to common stock issuance costs ........ -- (5,496) (49)
Special dividend to founders ............................ -- (6,592) --
------------- ------------- -------------
Net cash provided by financing activities ............... 22,567 21,216 496
------------- ------------- -------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH ................... (92) (47) --
------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ...... (1,359) 2,093 21
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .......... 2,114 21 --
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................ $ 755 $ 2,114 $ 21
============= ============= =============
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
25
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND ORGANIZATION
GENERAL
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 substantially all of the
tangible and intangible assets and assumed certain of the liabilities of 31
orthodontic practices (collectively, the "Founding Affiliated Practices") in
exchange for 3.7 million shares of its class A common stock, par value $.001 per
share (the "Common Stock"), and $6.6 million (the "Acquisitions"). Simultaneous
with the Acquisitions, Apple closed its initial public offering (the "IPO") of
2.7 million shares of Common Stock. The net proceeds of the Common Stock issued
in the IPO (after deducting the underwriting discounts and commissions) were
$17.6 million. Total related offering costs were $5.5 million.
Apple effectively began operations with the Founding Affiliated Practices on
June 1, 1997. Apple has subsequently acquired the assets and assumed the
liabilities of 36 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 the Founding Affiliated Practices have been accounted for in
accordance with the Securities and Exchange Commission's Staff Accounting
Bulletin ("SAB") No. 48. In accordance with SAB No. 48, 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 the Company 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 acquisitions of assets and liabilities of the New Orthodontist Affiliations
are accounted for by allocating the fair market 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
service fee intangible has resulted and will continue to result in substantial
noncash amortization charges for intangible assets in the Company's consolidated
statements of operations.
RECENT EVENTS
In August 1998, the Company's board of directors elected A. Stone Douglass to
the office of president and chief executive officer. Mr. Douglass' election came
at a time when the Company's rapid growth had placed strains on its management
and operations, resulting in the resignation of four of its executive officers
during the period from May 1998 through August 1998. The resignation of three of
these executive officers contributed to the recording of a special charge in the
second quarter of 1998 of $3.7 million on a pre-tax basis.
Since August 1998, Mr. Douglass has completed a comprehensive review of the
Company's operations. As a result of this review, in the fourth quarter of 1998,
the Company recorded an additional special charge of $18.0 million on a pre-tax
basis. This special charge, which was primarily noncash in nature, reflected
valuation reserves related to the Company's service fee intangibles ($7.0
million), receivables from certain of the Affiliated Practices ($4.9 million),
property and equipment ($1.8 million), the discontinuation of the Company's
business development program ($1.3 million), lawsuit settlements ($831,000) and
the writedown of certain other assets ($2.2 million).
As a result of the $18.0 million special charge, at December 31, 1998, the
Company was no longer in compliance with certain of the covenants of its $25
million unsecured bank credit facility with Chase Bank of Texas, N.A. (the
"Chase Facility"). On April 14, 1999, the Company amended the Chase Facility
(the "Amended Chase Facility") with respect to certain of the covenants. The
Company is now in compliance with all covenants of the Amended Chase Facility.
At December 31, 1998, the Company had borrowed $23.5 million under the Chase
Facility. The Company requires substantial capital to pursue its operating
strategy. To date, the Company has relied upon net cash provided by financing
activities to fund its capital requirements. The Company's operations have
historically been a use of funds. For the years ended December 31, 1998 and
1997, the Company's operations used $4.3 million and $2.6 million, respectively,
of cash. Excluding the payment of special charges of $2.7 million during 1998,
the Company's operations used $1.6 million of cash for 1998.
In order to increase its liquidity, the Company has developed the following
strategies: (i) suspension of its new practice affiliation program, (ii)
substantial curtailment of its new office development program, (iii)
implementation of tighter credit policies with its Affiliated Practices, (iv)
consideration of terminating the service agreements of selected underperforming
Affiliated Practices, (v) reducing costs in the Company's corporate office, (vi)
raising additional capital
26
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
and (vii) the consideration of strategic alternatives which could include, but
are not limited to, a sale of the Company or a business combination with another
physician practice management company or financial sponsor.
Based on its current strategy to enhance cash collections and reduce costs, the
Company expects its operations to be a sufficient source of funds to meet its
operating capital requirements over the next twelve months. However, there can
be no assurance that the Company's strategies will be achieved. In addition, the
Company's capital expenditure and other liquidity needs are dependent upon
access to additional capital. Any limitation on the Company's ability to obtain
additional financing could have a material adverse effect on the Company's
business, financial condition and results of operations. As a result of the
above factors, there is substantial doubt as to the Company's ability to
continue as a going concern. The accompanying financial statements do not
reflect any adjustments related to the recoverability and classification of
recorded assets or other adjustments which might be required should the Company
be unable to continue as a going concern.
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All intercompany transactions and balances have
been eliminated.
CASH AND CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company considers
all time deposits and certificates of deposit with original maturities of three
months or less to be cash equivalents.
RESTRICTED CASH
In June 1997, the Company placed $2.1 million into an escrow account pending the
resolution of certain post-closing contingencies related to one of the New
Orthodontist Affiliations closed during the third quarter of 1997. The amount in
escrow is considered restricted cash. In January 1999, the Company disbursed
$1.9 million in full settlement of this contingent obligation. The remainder of
the balance in the escrow account was returned to the Company.
RECEIVABLE FROM ORTHODONTIC PRACTICES, NET
The Company grants credit to its customers (i.e. the Affiliated Practices),
which are located in various geographic regions throughout the United States and
Canada. The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. The Company maintains an allowance for
doubtful accounts at a level which management believes is sufficient to cover
potential credit losses.
PROPERTY AND EQUIPMENT, NET
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.
Prior to January 1, 1998, property and equipment were depreciated over the
estimated useful life of the asset (ranging from three to seven years). In order
to conform with standards in the practice management industry, the Company
changed its estimate of the remaining useful lives of its property and equipment
to five to ten years effective January 1, 1998 on a prospective basis. If it is
determined that the estimated remaining lives require further revision, such
revisions would similarly be made on a prospective basis.
INTANGIBLE ASSETS, NET
Intangible assets consist primarily of service fee intangibles. Prior to April
1, 1998, these intangibles were amortized over the life of the related service
agreement (ranging from 20 to 40 years) with the respective Affiliated Practice.
In reaction to recent trends in the practice management industry, the Company
changed its estimate of the remaining useful life of its intangible assets to a
maximum of 25 years effective April 1, 1998 on a prospective basis. If it is
determined that the estimated remaining service period requires further
revision, such revisions would similarly be made on a prospective basis.
27
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Service fee intangibles represent the excess of the costs of affiliation over
the fair value of the net assets acquired. The costs of affiliation include the
consideration paid to the owners of the Affiliated Practices, the incremental
out-of-pocket costs incurred in connection with the affiliation and the direct
costs related to the Apple employees who identify, evaluate, negotiate and close
the affiliation. Such costs are recorded as other noncurrent assets until
consummation of the affiliation. If an affiliation is not consummated, all such
costs are expensed in the period in which the affiliation is abandoned. The
Company expensed such costs of $1.7 million during 1998. 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. This evaluation was performed as of December 31, 1998 and resulted in
a writedown of service fee intangibles of $7.0 million.
REVENUE RECOGNITION
The management service fee revenues (the "Service Fees") payable to the Company
by the 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, of the nature and amount of services provided. Except
with respect to Service Agreements providing for the payment of flat fees (the
"Flat Fee Contract"), the Service Fees earned by the Company are in accordance
with the Company's two general types of Service Agreements. The standard
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. 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 (the "Alternative Contract"). 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 based on revenues.
GENERAL AND ADMINISTRATIVE COSTS
General and administrative costs include office expenses, professional fees,
clerical and other administrative overhead.
INCOME TAXES
The Company recognizes deferred tax assets and liabilities for expected future
tax consequences of events that have been recognized in the financial statements
or tax returns. 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.
COMPREHENSIVE INCOME
Statement of Financial Accounting Standards ("SFAS") No. 130 - "Reporting
Comprehensive Income," requires the reporting of comprehensive income in
addition to net income from operations. Comprehensive income is a more inclusive
financial methodology that includes disclosure of certain financial information
that historically has not been recognized in the calculation of net income from
operations. The Company adopted SFAS No. 130 effective January 1, 1998.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist primarily of cash and cash
equivalents, trade receivables, trade payables and debt instruments. The book
values of each of these items are considered to be representative of their
respective fair values.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject the Company to concentrations
of credit risk, consist principally of cash deposits, trade accounts and notes
receivable. The Company maintains cash balances at financial institutions, which
may at times be in excess of federally insured levels. The Company has not
incurred losses related to these balances to date.
28
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NEW ACCOUNTING STANDARDS
The Emerging Issues Task Force of the Financial Accounting Standards Board (the
"FASB") recently issued its Consensus Opinion 97-2 ("EITF 97-2"). EITF 97-2
addresses certain specific matters pertaining to the physician, dentistry and
veterinary practice management industries. EITF 97-2 is effective for the
Company for the year ended December 31, 1998. EITF 97-2 addresses the ability of
certain practice management companies to consolidate the results of certain
practices with which it has an existing contractual relationship. The Company
currently does not consolidate the operations of the orthodontic practices that
it manages. The guidance in EITF 97-2 does not change the Company's accounting
method because the Company's arrangements with its Affiliated Practices do not
meet the requirements for consolidation as set forth in EITF 97-2.
In June 1997, the FASB issued SFAS No. 131 - "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 is effective for the
Company for the year ended December 31, 1998. SFAS No. 131 did not have a
material effect on its financial position or results of operations.
In March 1998, the American Institute of Certified Public Accountants ("AICPA")
issued Statement of Position ("SOP") 98-1 providing guidance on accounting for
the costs of computer software developed or obtained for internal use. SOP 98-1
requires expenditures to be expensed as incurred. The effective date of SOP 98-1
is for fiscal years beginning after December 15, 1998. The Company believes its
current policies are materially consistent with SOP 98-1 and the impact on the
Company's future results of operations will not be material.
In April 1998, SOP 98-5, "Reporting on the Costs of Start-Up Activities," was
issued by the AICPA. SOP 98-5 requires that all non-governmental entities
expense the costs of start-up activities as those costs are incurred. The
Company is required to adopt SOP 98-5 as of January 1, 1999. The Company does
not expect the adoption of SOP 98-5 to have a material effect on its financial
position or results of operations.
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.
FOREIGN CURRENCY TRANSLATION
The Canadian dollar has been determined to be the functional currency for the
Company's operations in Canada. Translation gains and losses from operations in
Canada are reported as a component of comprehensive income. Translation losses
from operations in Canada were $1.4 million and $381,000 for 1998 and 1997,
respectively.
RECLASSIFICATIONS
Certain reclassifications have been made to amounts in prior period financial
statements to conform with current period presentation.
3. NEW ORTHODONTIST AFFILIATIONS
During 1998, the Company completed New Orthodontist Affiliations with 15
practices representing 21 orthodontists and 23 office locations. In addition,
four orthodontists joined existing Affiliated Practices. Total consideration
related to the 1998 New Orthodontist Affiliations consisted of 455,604 shares of
common stock and $7.1 million of cash, assumed debt and deferred purchase price.
During the period from commencement of operations (June 1, 1997) through
December 31, 1997, the Company completed New Orthodontist Affiliations with 21
practices representing 27 orthodontists and 37 office locations. In addition,
eight orthodontists joined existing Affiliated Practices. Total consideration
related to the 1997 New Orthodontist Affiliations consisted of 1.9 million
shares of common stock and $9.9 million of cash, assumed debt and deferred
purchase price.
29
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The cost of each of the above New Orthodontist Affiliations was allocated on the
basis of the estimated fair market value of the assets acquired and liabilities
assumed, resulting in gross service fee intangibles of $55.7 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. Such
adjustments resulted in an increase in service fee intangibles of $4.8 million
with respect to the 21 practices with which the Company affiliated in 1997.
The 1998 New Orthodontist Affiliations generated patient revenue of $9.9 million
during their most recently completed fiscal years prior to affiliation. The 1997
New Orthodontist Affiliations generated patient revenue of $23.2 million during
their most recently completed fiscal years prior to affiliation. Prior patient
revenue is not necessarily indicative of the level of patient revenue that these
practices may be expected to generate in the future and is not necessarily
indicative of the future service fees that the Company will receive in
conjunction with these affiliations.
Since the third quarter of 1998, the Company has negotiated the termination of
its service agreements with two Affiliated Practices (the "Terminated
Practices"). The 1998 management service fee revenues related to the Terminated
Practices were $897,130. Two additional Affiliated Practices have alleged
breaches of their service agreements by the Company and sought to have the
service agreements terminated (the "Threatened Practices"). The Company
vigorously denies any breach of the service agreements with the Threatened
Practices and intends to strenuously seek enforcement of those service
agreements. The 1998 management service fee revenues related to the Threatened
Practices were $3.1 million. In addition, the Company is in the process of
negotiating the termination of additional service agreements with Affiliated
Practices with 1998 management service fee revenues of approximately $1.0
million.
4. RECEIVABLE FROM ORTHODONTIC PRACTICES
The activity in the allowance for doubtful accounts with respect to the
receivable from orthodontic practices is as follows (in thousands):
YEAR ENDED
DECEMBER 31,
--------------------
1998 1997
-------- --------
Balance at beginning of period ......................... $ 69 $ --
Bad debt provision .................................. 777 69
Special charge ...................................... 4,939 --
-------- --------
Balance at end of period ............................... $ 5,785 $ 69
======== ========
5. PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows (dollar amounts in thousands):
USEFUL DECEMBER 31,
LIVES IN --------------------
YEARS 1998 1997
-------- -------- --------
Equipment ................................... 10 $ 1,867 $ 1,435
Furniture and fixtures ...................... 10 1,438 1,366
Computer software ........................... 5 854 1,306
Leasehold improvements ...................... 5 2,646 1,069
Computer hardware ........................... 5 925 485
Construction in progress .................... -- 289 828
-------- --------
8,019 6,489
Less: accumulated depreciation ............. (1,370) (487)
-------- --------
$ 6,649 $ 6,002
======== ========
Property and equipment at December 31, 1998 is net of a 1998 writedown for
impairment of $1.8 million.
30
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
6. INTANGIBLE ASSETS
A summary of intangible assets is as follows (in thousands):
DECEMBER 31,
-------------------------
1998 1997
-------- --------
Service fee intangible ....................... $ 51,563 $ 39,121
Other ........................................ 46 121
-------- --------
51,609 39,242
Less: accumulated amortization .............. (2,262) (454)
-------- --------
$ 49,347 $ 38,788
======== ========
Intangible assets at December 31, 1998 are net of a 1998 writedown for
impairment of $7.0 million.
7. LONG-TERM DEBT
A summary of long-term debt is as follows (dollar amounts in thousands):
DECEMBER 31,
----------------------
1998 1997
-------- --------
Unsecured bank credit facility ..................... $ 23,500 $ --
Notes payable, maturing in varying amounts
through October 2002, with interest rates
ranging from 7.5% to 9.25% ...................... 121 1,076
Capitalized lease obligations, due in monthly
installments through April 2001, with
interest rates ranging from 9.5% to 24.66% ...... 138 195
-------- --------
23,759 1,271
Less: current maturities ..................... (105) (1,023)
-------- --------
$ 23,654 $ 248
======== ========
In July 1997, the Company entered into a three-year, $15 million unsecured bank
credit facility with Chase Bank of Texas, N.A. (the "Chase Facility"). During
1998, the Company amended the Chase Facility to increase its size from $15
million to $25 million and to increase its bank group from one to two banks. The
Chase Facility provides for a revolving credit period expiring on May 31, 2002.
Availability under the Chase Facility is dependent upon the Company's cash flow
and liquidity. Advances bear interest, at the Company's option, at a prime rate
or LIBOR, in each case plus a margin which is calculated based upon the
Company's ratio of indebtedness to cash flow. The Company is required to
maintain certain financial covenants regarding net worth, coverage ratios and
additional indebtedness. As of December 31, 1998, the Company had $23.5 million
drawn under the Chase Facility.
As a result of the special charge, at December 31, 1998, the Company was no
longer in compliance with certain of the covenants of the Chase Facility. On
April 14, 1999, the Company amended the Chase Facility (the "Amended Chase
Facility") with respect to certain of the covenants. The Amended Chase Facility
provides for the revolving credit period to expire on May 31, 2001 and for a
security interest in substantially all the Company's assets. The Company is now
in compliance with all covenants of the Amended Chase Facility and had borrowing
availability of $1.5 million as of December 31, 1998.
The notes payable primarily relate to debts of the Affiliated Practices that
were assumed by the Company.
Total assets recorded under capital leases and the accumulated depreciation
thereon were $263,436 and $138,712 as of December 31, 1998 and $263,436 and
$76,052 as of December 31, 1997, respectively.
31
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Aggregate maturities of the Chase Facility, the notes payable and the future
minimum payments under capital leases are as follows (in thousands):
Year Ended December 31,
-----------------------
1999................... $ 105
2000................... 77
2001................... 23,542
2002................... 18
2003................... 17
----------
$ 23,759
==========
8. STOCKHOLDERS' EQUITY
COMMON STOCK
Holders of the Common Stock are entitled to one vote per share. Holders of the
Company's Class B common stock (the "Class B Stock") are entitled to
three-tenths (3/10ths) of a vote per share. The Class B Stock is convertible
into Common Stock in certain circumstances, including the disposition of shares
of Class B Stock by the holder thereof (excluding dispositions to such holder's
affiliates). During the years ended December 31, 1998 and 1997, 839,281 and
170,310 shares of Class B Stock, respectively, were converted into Common Stock.
DIVIDENDS
With the exception of a special dividend paid to the Founding Affiliated
Practices in connection with the Acquisitions (see Note 1), the Company has
never paid cash dividends on its common stock and has no present intention to
pay cash dividends. In addition, the Chase Facility prohibits the payment of
cash dividends on its common stock.
WARRANTS
In May 1997, the Company granted stock purchase warrants that entitled certain
venture capital investors to purchase 180,000 shares of the Common Stock at a
price of $7.00 per share through May 2002. At December 31, 1997, all of these
warrants were vested. These warrants were recorded at their estimated fair value
of $777,106 by applying the Black-Scholes option pricing model at the date of
grant.
In November 1998, the Company granted stock purchase warrants that entitled one
of its practice management software vendors to purchase 70,000 shares of the
Company's common stock at a price of $2.50 per share through November 2003.
These warrants were issued in settlement of a breach of contract claim. At
December 31, 1998, none of these warrants were vested. These warrants were
recorded at their estimated fair value of $308,766 by applying the Black-Scholes
option pricing model at the date of grant.
STOCK OPTION PLAN
The Company maintains incentive compensation plans which provide the ability to
grant non-qualified options, restricted stock, deferred stock, incentive stock
options, stock appreciation rights and other long-term incentive awards. Stock
options are typically granted under these plans at an exercise price which
equals the fair market value of the stock on the date of the grant. The number
of shares available for issuance under the Company's 1996 Stock Compensation
Incentive Plan at any time is limited to the greater of 1.0 million shares of
common stock or 12% of the number of shares of common stock outstanding on the
last day of the preceding calendar quarter, although the board of directors of
the Company may, in its discretion, grant additional awards or establish other
compensation plans.
32
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following table summarizes the activity relating to the Company's stock
option plans (in thousands, except per share amounts):
<TABLE>
<CAPTION>
1998 1997
------------------------ -----------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
------------ -------- ------------ --------
<S> <C> <C>
Options outstanding at January 1 .... 923 7.55 -- --
Granted .......................... 696 4.00 923 7.55
Exercised ........................ (97) 6.17 -- --
Forfeited ........................ (31) 7.80 -- --
------------ -------- ------------ --------
Options outstanding at December 31 .. 1,491 5.98 923 7.55
============ ======== ============ ========
Options exercisable at December 31 .. 354 7.41 203 6.80
============ ======== ============ ========
Option exercise price range
at December 31 ..................... $3.00-$15.25 $3.00-$15.25
</TABLE>
As allowed by SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company accounts for awards under its Incentive Plan in accordance with
Accounting Principles Board Opinion No. 25, under which no compensation cost is
recognized for stock options issued with exercise prices greater than or equal
to the fair market value of the Common Stock at the date of grant. Had
compensation cost for these plans been determined consistent with SFAS No. 123,
the Company's net income (loss) and income (loss) per share would have been
changed to the following pro forma amounts (in thousands, except per share
amounts):
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
---------------------- DECEMBER 31,
1998 1997 1996
--------- --------- -------------
Net income (loss)
As reported ....................... $ (10,330) $ 717 $ (24,309)
========= ========= =============
Pro forma ......................... $ (10,521) $ 592 $ (24,309)
========= ========= =============
Income (loss) per share
As reported ....................... $ (0.75) $ 0.09 $ (7.24)
========= ========= =============
Pro forma ......................... $ (0.76) $ 0.07 $ (7.24)
========= ========= =============
The effects of applying SFAS No. 123 in the pro forma disclosure may not be
indicative of future amounts as additional awards in future years are
anticipated. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following
assumptions:
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
---------------------- DECEMBER 31,
1998 1997 1996
--------- --------- -------------
Expected dividend yield ............... 0.0% 0.0% 0.0%
Expected stock price volatility ....... 67.5% 67.5% 67.5%
Risk free interest rate ............... 5.7% 6.2% 6.2%
Expected life of options .............. 10 years 10 years 10 years
During 1998 and 1997, the Company issued options to purchase 35,000 and 28,000
shares, respectively, to individuals other than employees and directors of the
Company as consideration for the closing of New Orthodontist Affiliations. The
fair value of these options was determined using the Black-Scholes option
pricing model at the date of grant and capitalized as a cost of affiliation.
33
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
PROFIT SHARING PLAN
In 1997, the Company established a defined contribution 401(k) profit sharing
plan for employees meeting certain employment requirements. Eligible employees
may contribute amounts up to the lesser of 15% of their annual compensation or
the maximum amount permitted under IRS regulations to their 401(k) account. The
Company does not match any portion of employee contributions.
9. INCOME TAXES
The Company and its subsidiaries are required to file a consolidated income tax
return in the United States and Canada. Affiliated Practices file "short-period"
federal returns through their respective acquisition dates and thereafter are
included in the Company's consolidated return. The new practices established by
the affiliating orthodontists file separate income tax returns and are solely
responsible for their tax liabilities on an ongoing basis.
The amounts of consolidated federal, state and foreign income tax provision
(benefit) are as follows (in thousands):
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
------------------------------ DECEMBER 31,
1998 1997 1996
------------- ------------- -------------
Current:
Federal $ (298) $ 298 $ --
State (53) 53
Foreign 937 -- --
------------- ------------- -------------
586 351 --
------------- ------------- -------------
Deferred:
Federal (6,087) 80 --
State (716) 8
Foreign (279) -- --
------------- ------------- -------------
(7,082) 88 --
------------- ------------- -------------
$ (6,496) $ 439 $ --
============= ============= =============
A reconciliation of the Company's income tax provision (benefit) to the amounts
calculated by applying the federal statutory tax rate is as follows (in
thousands):
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
----------------------- DECEMBER 31,
1998 1997 1996
---------- --------- -------------
Tax at statutory rate $ (5,721) $ 393 $ (301)
Add (deduct):
State income taxes (664) 46 (26)
Foreign income tax
provision in
excess of U.S.
federal rates (320) -- --
Nondeductible expenses 39 27 --
Valuation allowance 170 (27) 327
---------- --------- -------------
Income tax provision (benefit) $ (6,496) $ 439 $ --
========== ========= =============
34
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The components of deferred income tax liabilities and assets are as follows (in
thousands):
YEAR ENDED DECEMBER 31,
-------------------------
1998 1997
---------- ----------
Deferred income tax liabilities:
Property and equipment, net $ (32) $ (38)
Intangible assets, net (15,211) (14,718)
Federal effect of deferred state
taxes (390) --
---------- ----------
Total deferred income tax
liabilities (15,633) (14,756)
---------- ----------
Deferred income tax assets:
Estimated tax basis resulting
from affiliation with founding
practices 1,022 1,022
Bad debt reserves 330 26
Accrued expenses 207 186
Reserves relating to special
charge 3,702 --
Net operating loss 170 --
Less: valuation allowance (1,192) (1,022)
---------- ----------
Total deferred income tax
assets 4,239 212
---------- ----------
Net deferred income tax
liabilities $ (11,394) $ (14,544)
========== ==========
Certain reclassifications have been made to the December 31, 1997 disclosures in
order to reflect the refining of estimates during 1998.
10. INCOME (LOSS) PER SHARE
Income (loss) per common and common equivalent share have been computed based on
the weighted average number of shares outstanding. The following table
reconciles the number of common shares outstanding with the number of common
shares used in computing income (loss) per share (in thousands):
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
----------------------- DECEMBER 31,
1998 1997 1996
--------- --------- -------------
Common shares outstanding 14,024 13,157 3,347
Effect of using weighted
average common shares
outstanding during the
period (241) (5,025) 12
--------- --------- -------------
Shares used in calculating
basic income (loss) per
share 13,783 8,132 3,359
Effect of shares issuable
under stock option
plans based on the
treasury stock method -- 212 --
--------- --------- -------------
Shares used in calculating
diluted income (loss)
per share 13,783 8,344 3,359
========= ========= =============
11. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures of cash flow information are as follows (in thousands):
PERIOD FROM
INCEPTION
(JULY 15,
YEAR ENDED DECEMBER 31, 1996) THROUGH
---------------------- DECEMBER 31,
1998 1997 1996
--------- --------- -------------
Interest paid during the
period $ 824 $ 288 $ --
Income taxes paid during
the period 1,045 -- --
The Company acquired assets in capital lease transactions $263,781 in 1997.
There have been no other acquisitions of assets in capital lease transactions
since inception.
35
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES
The Company has entered into various non-cancelable operating lease agreements,
primarily for facilities and equipment utilized for operations. Certain of these
agreements were negotiated between the Company and its affiliated practices.
Rental expense under operating leases was $4.2 million, $1.8 million and $19,676
in 1998, 1997 and 1996, respectively. Minimum future annual lease payments under
these agreements are as follows (in thousands):
Year Ended December 31,
----------------------
1999 $ 3,657
2000 3,258
2001 2,872
2002 2,395
2003 1,752
Thereafter 6,012
------------
$ 19,946
============
The Company has secured employment agreements with various officers and certain
key employees of the Company. The agreements generally provide for the
employee's annual base salary and bonus participation. The agreements also
generally provide for one year non-competition agreements and severance payments
of between one and three year's salary in the event the employee is terminated
without cause or if there is a change in control of the Company. The amount of
severance payments that would be payable upon a change in control of the Company
were $3.3 million as of December 31, 1998.
The Company has committed to certain of its practices to build additional
satellite offices for those practices. The amount expected to be expended during
1999 related to those additional offices is approximately $1.2 million.
The Company has five and three Affiliated Practices in Alberta and Ontario,
Canada, respectively. Complaints have been filed with the Alberta Dental
Association and the Ontario Dental Association by certain orthodontists who
compete with orthodontists affiliated with Apple. Although there can be no
assurance that the result of hearings with these dental associations will not
limit the enforceability of the Service Agreements between Apple and its
Affiliated Practices, management believes that the Company will ultimately
prevail. The recorded net assets associated with the Alberta and Ontario
Affiliated Practices were $13.2 million as of December 31, 1998. Management
service fee revenues from these Affiliated Practices were $10.1 million and $4.3
million for the years ended December 31, 1998 and 1997, respectively.
The Company is from time to time party to litigation in the ordinary course of
business. There are currently no pending legal proceedings that, in management's
opinion, would have a material adverse effect on the Company's operating results
or financial condition. The Company maintains various insurance coverages in
order to minimize the financial risk associated with certain claims. The Company
has provided accruals for probable losses and legal fees associated with certain
of these actions in the accompanying financial statements.
The Company carries a broad range of insurance coverage, including general
liability, comprehensive property damage, workers' compensation, employers'
liability, directors' and officers' liability and other coverage customary in
the industry. The Company and the existing Affiliated Practices maintain
professional liability insurance coverage on a claims-made basis. Such insurance
provides coverage for claims asserted when the policy is in effect, regardless
of when the events that caused the claim occurred.
13. RELATED PARTY TRANSACTIONS
On September 8, 1998, the Company loaned $500,000 to Dr. John G. Vondrak, the
Company's Chairman of the Board, pursuant to a promissory note that bears
interest at 8.5% per annum and is payable in full on September 9, 2000 (the
"Promissory Note"). The Promissory Note is secured by a security interest in
250,000 shares of Class A or B common stock of the Company pursuant to a stock
pledge agreement. On September 10, 1998, the Company and Dr. Vondrak executed an
amendment to Dr. Vondrak's employment agreement to recognize Dr. Vondrak's
change in title and responsibilities with the Company as well as to modify
certain of the terms of compensation in the event Dr. Vondrak's employment with
the Company is terminated. The Company has also advanced $134,000 to Dr. Vondrak
for payment of legal fees. These advances bear interest at the prime rate minus
200 basis points. The amount advanced to Dr. Vondrak for legal fees was $134,000
and $0 as of December 31, 1998 and 1997, respectively.
36
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Mr. Douglass has a financial interest in and is the business partner of the
Chairman of the Board of Directors of one of Apple's primary practice management
software vendors (the "Software Vendor"). Prior to hiring Mr. Douglass, Apple
had entered into a software development, license and support agreement (the
"License Agreement") with the Software Vendor. The License Agreement provided
for, among other things, the scheduled payment by Apple of $2.5 million in
license fees through January 2001. As of December 31, 1998, Apple owed $375,000
under the License Agreement plus a termination fee of $175,000 had it chosen to
terminate the License agreement. As of March 1999, Apple owed $666,000 under the
License Agreement plus a termination fee of $125,000 had it chosen to terminate
the License Agreement. Mr. Douglass has negotiated an oral amendment to the
License Agreement to limit the total license fees to $500,000 (of which $250,000
had been paid at December 31, 1998) in return for nine licenses (the "License
Agreement Amendment"). As of April 14, 1999, the License Agreement Amendment had
not been executed.
In 1996, the Company entered into an agreement with TriCap Funding I, L.L.C.
("TriCap"), which is co-owned by a director of the Company, whereby TriCap
agreed to provide $3 million to finance costs related to the IPO. The $3
million, to the extent expended, was repaid out of proceeds from the IPO,
including interest at a rate of prime plus 25 basis points. The Company also
entered into an agreement with TriCap during 1996 that provided for the payment
to TriCap of a $500,000 financial advisory fee and the issuance to TriCap of
warrants to purchase 180,000 shares of common stock with an exercise price of
$7.00 per share, each upon the consummation of the IPO.
The practice of a founding stockholder of the Company (the "Founding
Stockholder") paid for certain costs and expenses on behalf of the Company prior
to the consummation of the IPO. The amount payable to the Founding Stockholder's
practice at December 31, 1996 was $30,444 and was included in accounts payable
and accrued expenses in the accompanying balance sheet. This amount was repaid
with the proceeds from the IPO.
14. CONCENTRATIONS OF SERVICE FEE REVENUE
For 1998 and 1997, 15% and 14%, respectively, of the Company's revenues were
derived from one Affiliated Practice, which was the only Affiliated Practice
that provided 10% or more of revenues.
15. COMBINED PATIENT DATA
Combined operating data for the Affiliated Practices for the period from their
affiliation date through the end of the applicable year is as follows (in
thousands):
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1998 1997
---------------------- ----------------------
PATIENT CASH PATIENT CASH
REVENUES COLLECTIONS REVENUES COLLECTIONS
-------- ----------- -------- -----------
Practices participating
under the Standard Contract $ 36,084 $ 34,101 $ 14,892 $ 13,617
Practices participating
under the Alternative
Contract 12,058 11,853 4,096 3,982
Practices participating
under the Flat Fee Contract 14,522 14,522 6,055 6,055
-------- ----------- -------- -----------
$ 62,664 $ 60,476 $ 25,043 $ 23,654
======== =========== ======== ===========
Combined patient receivables, net of the Affiliated Practices, is as follows (in
thousands):
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997
-------- --------
Patient receivables $ 5,123 $ 3,471
Unbilled patient receivables 6,903 3,444
Patient prepayments (3,433) (2,410)
-------- --------
Patient receivables, net of
prepayments $ 8,593 $ 4,505
======== ========
37
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
16. OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA
In July 1997, SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information," was issued. SFAS No. 131 requires certain financial
and supplementary information to be disclosed on an annual and interim basis
for each reportable segment of an enterprise. SFAS No. 131 is effective for
the Company for the year ended December 31, 1998.
The Company has only one line of business, which provides practice management
services to orthodontic practices. The Company has operations in two geographic
areas. The following is a breakdown of revenues and long-lived assets by
geographic area (in thousands):
UNITED STATES CANADA TOTAL
------------- ------- -------
AS OF AND FOR YEAR ENDED
DECEMBER 31, 1998
Management service fee
revenues $36,275 $11,242 $47,517
Long-lived assets 37,236 18,760 55,996
AS OF AND FOR YEAR ENDED
DECEMBER 31, 1997
Management service fee
revenues $14,348 $ 4,838 $19,186
Long-lived assets 27,411 17,379 44,790
17. EVENTS SUBSEQUENT TO THE DATE OF REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
(UNAUDITED)
On April 23, 1999, the Company executed an assignment agreement with one of the
Threatened Practices discussed in Note 3 (the "Assignment Agreement"). The
Assignment Agreement provides for the Company to issue 181,818 shares of Common
Stock in return for the assignment of the ownership of the practice to the
Company. The Company intends to seek a new orthodontist to whom it will sell
this ownership interest. The 1998 management service fee revenues associated
with this practice were $2.4 million. Additionally, since April 14, 1999, one
additional Affiliated Practice has alleged breaches of its service agreement by
the Company and sought to have the service agreement terminated (the "Additional
Threatened Practice"). The Company vigorously denies any breach of the service
agreement with the Additional Threatened Practice and intends to strenuously
seek enforcement of this service agreement. The 1998 management service fee
revenues related to the Additional Threatened Practice were $138,499.
On April 27, 1999, the Company announced that it had signed a non-binding letter
of intent with an investor group in connection with the consideration of a
potential investment in the Company. The investment would be in the form of a
private placement of $20 million of convertible preferred shares, convertible on
a one-for-one basis into shares of Common Stock. The convertible preferred
shares would be issued at a price of $3.00 per share (subject to completion of
due diligence satisfactory to the investor group) and would represent, on an
as-converted basis, approximately a 32% ownership interest in the Company at
that price. The Company anticipates that the net proceeds would be used to repay
a substantial portion of the Chase Facility. The proposed investment by the
investor group remains subject to further negotiation of applicable terms and
conditions (including price), the negotiation of definitive documents, the
completion of due diligence satisfactory to the investor group, and the receipt
of any necessary approvals and third-party consents.
38
<PAGE>
APPLE ORTHODONTIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages (as of April 1, 1999) and
positions of the Company's executive officers:
NAME AGE POSITION
- --------------------------- ------ -----------------------------------------
A. Stone Douglass 51 Chief Executive Officer, President and
Director
W. Daniel Cook 44 Senior Vice President of Practice
Affiliations and Director
James E. Bobbitt 54 Vice President and Chief Financial Officer
Stephen T. Yavorsky 48 Vice President of Business Development
Lee Ann Peniche 38 Vice President of Training and Marketing
The executive officers of the Company are elected annually by the Board of
Directors of the Company and serve at the discretion of the Board.
A. STONE DOUGLASS has been Chief Executive Officer, President and a director of
the Company since August 1998. From May 1997 until July 1998, he was Chairman
and Chief Executive Officer of Aria Wireless Systems. He has been a managing
director of Compass Partners LLC, a merchant bank, since September 1995. From
March 1992 until July 1995, he was Chairman and Chief Executive Officer of Piper
Aircraft Corporation, a manufacturer of general aviation aircraft.
W. DANIEL COOK has served as a director of the Company since October 1996 and as
Chief Administrative Officer from February 1997 to May 1998. He has served as
Senior Vice President of Practice Affiliations since May 1998. From December
1996 to May 1997, Mr. Cook served as a consultant to the Company on various
legal matters. Prior thereto he was a partner at the law firm of Breard, Raines
& Cook, P.L.L.C. from March 1996 to May 1997 and was associated with the law
firm of Page, Mannio, Peresich, Dickinson & McDermott, P.L.L.C. from 1991 to
1995.
JAMES E. BOBBITT has been Vice President and Chief Financial Officer of Company
since August 1998. From April 1993 to August 1998, he was President of Tristar
Web Graphics, Inc. a commercial printing company. From June 1984 to April 1993,
Mr. Bobbitt was Executive Vice President and Chief Financial Officer of Shelton
Ranch Corporation, which had operations in energy, real estate and agriculture.
Prior thereto he was President of WellSource Corporation, a land based contract
drilling company from May 1980 to June 1984. From October 1975 to May 1980 Mr.
Bobbitt was Vice President and Chief Financial Officer of Petrochem
Manufacturing Company, a company engaged in manufacturing and distribution of
metal products. Mr. Bobbitt was with Arthur Young & Company, an international
accounting firm, from June 1968 to October 1975. Mr. Bobbitt has a BBA and MBA
from the University of Texas at Austin and is a Certified Public Accountant.
STEPHEN T. YAVORSKY has served as Vice President of Business Development since
May 1998. From December 1997 to May 1998, he was an employee of the Company who
developed new offices. From March 1995 to December 1997, Mr. Yavorsky served as
Executive Vice President of The Walters Group, a real estate development
company. From 1988 to 1995, Mr. Yavorsky served as Chairman, Chief Executive
Officer and President of Union Land Title Company. Mr. Yavorsky is the brother
of Lee Ann Peniche.
LEE ANN PENICHE has been Vice President of Training and Marketing since June
1997. Prior to that time, she served as Director of Training of the Company
beginning in March 1997. From September 1996 to February 1997, Ms. Peniche
served as a consultant to the Company on various practice development matters.
In July 1989, Ms. Peniche founded Peniche & Associates, Inc., a consulting firm
specializing in the development and implementation of
39
<PAGE>
practice development techniques for orthodontic practices throughout North
America, where she has served as its President from inception to the date of the
IPO. From January 1985 until September 1991, Ms. Peniche was on the faculty of
Paradigm Practice Management Company, where she specialized in training
orthodontists and their staff in practice development activities. Ms. Peniche is
a frequent lecturer with the American Association of Orthodontics, the Pacific
Coast Orthodontic Society and numerous other private orthodontic societies. Ms.
Peniche is a Registered Dental Assistant, specializing in orthodontics. Ms.
Peniche is the sister of Stephen T. Yavorsky.
DIRECTORS OF THE REGISTRANT
The following sets forth information concerning the Class I, Class II and Class
III directors of the Company whose present terms of office will expire at the
2001, 1999 or 2000 annual meetings of stockholders, respectively, including each
director's age as of April 13, 1999, position with the Company, if any, and
business experience during the past five years.
CLASS I
A. STONE DOUGLASS. See "-- Executive Officers of the Registrant."
ROD L. CROSBY, JR., age 60, has served as a director of the Company since
July 1997. Mr. Crosby has served as the Senior Vice President of Business
Development of Corporate Express, a supplier of office products and services,
since 1995. From 1994 to 1995, Mr. Crosby served as a director of U.S.
Delivery Systems, Inc., a delivery service company formed as a result of a
combination in November 1993 of a number of delivery companies, including
ViaNet, Inc., a company founded by Mr. Crosby. Prior to that time, Mr. Crosby
served as Chairman and Chief Executive Officer of ViaNet, Inc. from 1986
until 1993. Mr. Crosby serves on the board of directors of e-CommLink, a
software company serving the banking and medical industries.
RICHARD J. MARXEN, age 52, has served as a director of the Company since
February 1998. Mr. Marxen is the founder of Connective Technologies, Inc., a
privately-held business solutions provider for systems integration, and has
served as its chairman, president and chief executive officer since 1990. Prior
to that time, Mr. Marxen founded a business consulting firm and a management
systems consulting firm.
CLASS II
W. DANIEL COOK. See "-- Executive Officers of the Registrant."
WILLIAM W. SHERRILL, age 72, has served as a director of the Company since
October 1996. He is an Executive Professor at the University of Houston College
of Business Administration and is the Director for the University of Houston's
Center for Entrepreneurship & Innovation. Mr. Sherrill was formerly the
principal of William W. Sherrill, Financial Consultants from 1974 to 1981. From
1971 to 1974, Mr. Sherrill served as the President of Associates Corporation of
North America and was a director of Gulf and Western Industries, Inc. Before
joining Associates Corporation, he was appointed by the President of the United
States in 1967 to fill an unexpired term as Governor of the Federal Reserve
Board in Washington, D.C. and was reappointed to a full 14-year term on the
Board of Governors. Prior to his Federal Reserve appointment, he was the
Director of the Federal Deposit Insurance Corporation. Mr. Sherrill initially
was appointed to the Company's Board of Directors pursuant to the provisions of
a funding agreement between the Company and TriCap Funding I, L.L.C. ("TriCap").
See "Certain Relationships and Related Party Transactions" under Item 13.
ROBERT L. BREWTON, age 46, has served as a director of the Company since
February 1998. Since January 1996, Mr. Brewton has served as the Chief
Investment Officer of Residential Company of America, Ltd., a privately-held
real estate investment and management company. From 1987 until January 1996, Mr.
Brewton served as President of the multifamily division of the Transwestern
Property Company, the predecessor of Residential Company of America, Ltd.
40
<PAGE>
CLASS III
JOHN G. VONDRAK, D.D.S., age 58, has served as Chairman of the Board of
Directors since October 1996 and as a Director of the Company since July 1996.
Dr. Vondrak is a founder of the Company and served as Chief Executive Officer of
the Company from October 1996 to August 1998 and as President and Chief
Operating Officer from May 1998 to August 1998. He was the President and sole
shareholder of JGVAOI, one of the Founding Affiliated Practices, for more than
the past five years. Dr. Vondrak is a licensed dentist, a graduate of an
American Dental Association accredited orthodontic program and has maintained a
private orthodontic practice for over 24 years. He is a member of the American
Association of Orthodontists and the Southwest Society of Orthodontists and
served as President of the New Mexico Orthodontic Society in 1979.
CLYDE C WADDELL, JR., age 57, has served as a director of the Company since
July 1997. Mr. Waddell is the owner, President and Chief Executive Officer of
Hester's Office Center, Inc., an office supply company, and has served in
such capacity for more than the past five years. Mr. Waddell is a certified
public accountant.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Section 16(a) of the Exchange Act requires the Company's directors and executive
officers and persons who own more than 10% of a registered class of the
Company's equity securities, to file with the Commission and the American Stock
Exchange initial reports of ownership and reports of changes in ownership of
Common Stock. Officers, directors and greater than 10% stockholders are required
by SEC regulation to furnish the Company with copies of all such forms they
file.
Due to inadvertence in connection with several transactions involving the
Company's Common Stock, Dr. Vondrak, the Chairman of the Board and former Chief
Executive Officer, and Mr. Sherrill, a director, did not timely file reports on
Form 4 to reflect changes in their beneficial ownership during 1998. Upon
discovery of such inadvertent omission, all such transactions have been reported
to the SEC. Based solely on a review of the copies of such reports furnished to
the Company and written representations that no other reports were required, the
Company believes that all other filings required under Section 16(a) of the
Exchange Act have been made.
ITEM 11. EXECUTIVE COMPENSATION
DIRECTOR COMPENSATION
Each director who is not an employee of the Company receives a fee of $2,000 for
attendance at each Board of Directors meeting and $1,000 for each committee
meeting (unless held on the same day as a Board of Directors meeting). All
directors are reimbursed for their out-of-pocket expenses and other expenses
incurred in attending meetings of the Board or committees thereof and for other
expenses incurred in their capacity as directors. In addition, under the
Company's 1997 Stock Compensation Plan, each current nonemployee director has
been granted nonqualified options to purchase 10,000 shares of Common Stock. In
addition, each newly elected nonemployee director automatically will be granted
nonqualified options to purchase 10,000 shares of Common Stock on the date that
person first becomes a nonemployee director of the Company. Thereafter, each
nonemployee director automatically will be granted nonqualified options to
purchase 5,000 shares of Common Stock on the date of the Company's annual
meeting of stockholders. Each option will have an exercise price per share equal
to the fair market value of the Company's Common Stock on the date of grant. On
completion of the Company's IPO in May 1997, Mr. Sherrill was granted an option
to purchase 12,500 shares of Common Stock at an exercise price per share equal
to the initial public offering price to the public. Each of Messrs. Crosby,
Waddell, Brewton and Marxen received an option to purchase 10,000 shares of
Common Stock on his appointment to the Board of Directors (July 1997 for Messrs.
Crosby and Waddell and February 1998 for Messrs. Brewton and Marxen) at an
exercise price per share equal to the fair market value of the Common Stock on
the date of grant. All the options granted to the nonemployee directors have a
term of ten years, and become exercisable as to one-quarter of the shares on the
date of grant, and thereafter in cumulative annual installments of one-quarter
beginning on the first anniversary of the date of grant.
41
<PAGE>
COMPENSATION OF EXECUTIVE OFFICERS
The following table sets forth information regarding the compensation of the
Company's chief executive officer and other executive officers who were serving
as such at December 31, 1998 (together with the Chief Executive Officer, the
"Named Executive Officers") for the years ended December 31, 1998, December 31,
1997 and the period from the Company's inception (July 15, 1996) through
December 31, 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL LONG-TERM
COMPENSATION (1) COMPENSATION AWARDS
--------------------------------------------- ----------------------
Restricted Shares
Other Annual Stock Underlying
Name and Principal Position Year Salary(2) Bonus Compensation Awards Options
- --------------------------- ---- -------- -------- ------------ ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
A. Stone Douglass
Chief Executive Officer,
President and Director 1998 $ 60,154 $ -- $ 25,000(3) $-- 450,000
W. Daniel Cook
Senior Vice President of 1998 120,000 -- -- -- --
Practice Affiliations and 1997 117,564 -- -- -- 70,000
Director 1996 10,000 48,000 -- (4) --
Steven T. Yavorsky (5)
Vice President of Business 1998 116,308 -- -- --
Development 1997 10,000 -- 41,917(3) -- 60,000
LeeAnn Peniche (6)
Vice President of 1998 133,154 -- 58,906(3) -- --
Training and Marketing 1997 109,541 -- -- -- 60,000
John G. Vondrak, D.D.S.(7)
Chairman of the Board, 1998 180,000 -- -- -- --
Former President and Chief 1997 176,763 -- 2,054(8) -- 135,000
Executive Officer 1996 75,000 52,000 -- -- --
Robert J. Syverson (7) 1998 55,962 -- 775,000(9) -- --
Former President and Chief 1997 159,455 -- -- -- 100,000
Operating Officer 1996 56,000 48,000 -- (4) --
H. Steven Walton (7) 1998 45,000 -- 2,387,952(10) -- --
Former Vice President of 1997 404,447(11) 37,000 -- -- 161,850
Business Development 1996 -- -- -- -- --
</TABLE>
- -----------
(1) Excludes any perquisites and other benefits that do not exceed the lesser
of $50,000 or 10% of the total of annual salary and bonus reported for any
Named Executive Officer.
(2) Amounts shown for 1996 consist of fees earned as a consultant to the
Company. Amounts shown for 1997 include fees earned as a consultant to the
Company from January 1997 to April 1997 of $62,500, $62,500 and $40,000 for
Dr. Vondrak, Mr. Syverson and Mr. Cook, respectively, and in December 1997
of $10,000 for Mr. Yavorsky.
(3) Consists of moving expenses reimbursed by the Company in 1998.
(4) Does not include amounts for shares of restricted stock purchased by
Messrs. Syverson and Cook in October 1996. For federal income tax purposes,
the Company valued the shares purchased in October 1996 at their purchase
price ($1,030 for Mr. Syverson and $1,202 for Mr. Cook). For financial
statement purposes, the Company recorded special compensation expense for
1996 of $1,029,980 (Mr. Syverson) and $1,201,637 (Mr. Cook).
(5) Joined the Company in December 1997 and became an executive officer in May
1998.
(6) Joined the Company in March 1997 and became an executive officer in June
1997.
42
<PAGE>
(7) No longer an executive officer of the Company. In May 1998, the Company
undertook a management reorganization, as follows: Dr. Vondrak was given
added responsibilities as President and the chief operating officer,
replacing Robert J. Syverson; Mr. Yavorsky, formerly head of real estate
operations, replaced H. Steven Walton as a vice president of business
development; and Mr. Cook was elected to the new position of Senior Vice
President of Practice Affiliations. In August 1998, Mr. Douglass replaced
Dr. Vondrak as Chief Executive Officer and President and Mr. Bobbitt
replaced Michael Harlan as Vice President and Chief Financial Officer.
(8) Consists of moving expenses reimbursed by the Company in 1997. Does not
include amounts for shares of stock purchased by Dr. Vondrak in October
1996 in respect of which the Company recorded a special compensation
expense of $9,052,346 in 1996.
(9) Consists of a severance cash benefit paid to Mr. Syverson in lieu of the
benefits which were otherwise payable pursuant to his employment agreement
with the Company, which was terminated.
(10) Consists of a severance cash benefit of $1,600,000 paid to Mr. Walton in
lieu of the benefits which were otherwise payable pursuant to his
employment agreement with the Company, which was terminated, $250,000 that
was paid to reimburse certain tax liabilities and the forgiveness of a
promissory note receivable in the amount of $537,952. The Company paid
$1,316,667 of this amount in 1998 and the remainder is payable in 1999.
(11) Includes performance-based payment for the completion of new affiliations
of orthodontists with the Company pursuant to Mr. Walton's employment
agreement with the Company, which was terminated in 1998.
OPTION GRANTS
The following table sets forth certain information on grants of stock options
during 1998 to the Named Executive Officers reflected in the Summary
Compensation Table.
STOCK OPTIONS GRANTED IN 1998
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATES OF
STOCK PRICE APPRECIATION
INDIVIDUAL GRANTS FOR OPTION TERM (1)
-------------------------------------------------------------------------- ----------------------------
Percent of Total
Number of Shares Options Granted Exercise
underlying options to Employees in Price (per Expiration
granted in 1998 1998 share) (2) Date 5% 10%
--------------------- ------------------- --------------- ---------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
A. Stone Douglass (3) 100,000 17.4% $ 3.00 08/06/2008 $188,667 $478,122
(4) 150,000 26.1 3.00 08/06/2008 283,001 717,183
(5) 200,000 34.8 3.00 08/06/2008 377,334 956,244
</TABLE>
- ------------
(1) The potential realizable value through the expiration date of the options
has been determined on the basis of the per share market price at the time
the options were granted, compounded annually over 10 years, net of the
exercise price. These values have been determined based on assumed rates of
appreciation and are not intended to forecast the possible future
appreciation, if any, of the price or value of the Company's Common Stock.
(2) The exercise price of the options granted was equal to the fair market
value of the Common Stock on the date of grant.
(3) These options were granted in August 1998 and become exercisable with
respect to 33 1/3% of the subject shares one year after the date on which
the closing price of the Company's Common Stock has equaled or exceeded
$12.00 per share for 90 consecutive trading days (the "$12.00 Trigger
Date"). The options are
43
<PAGE>
exercisable in additional 33 1/3% increments on each subsequent anniversary
of the $12.00 Trigger Date. With respect to any shares that have not vested
pursuant to the clause described in the preceding sentences, the option may
be exercised as to 33 1/3% of the subject shares on each of the eighth and
ninth anniversaries of the date of grant and, as to the remaining 33 1/3%,
nine years and eleven months after the date of grant.
(4) These options were granted in August 1998 and become exercisable with
respect to 33 1/3% of the subject shares on August 6, 1999. They become
exercisable in additional 33 1/3% increments on August 6, 2000 and August
6, 2001.
(5) These options were granted in August 1998 and, as to 100,000 of the subject
shares, become exercisable with respect to 33 1/3% of those shares one year
after the date on which the closing price of the Company's Common Stock
equals or exceeds $7.00 per share for 90 consecutive trading days (the
"$7.00 Trigger Date"). The options are exercisable in additional 33 1/3
increments on each subsequent anniversary of the $7.00 Trigger Date. With
respect to the remaining 100,000 subject shares, the options are
exercisable with respect to 33 1/3% of those shares one year after the date
on which the closing price of the Company's Common Stock equals or exceeds
$10.00 per share for 90 consecutive trading days (the "$10.00 Trigger
Date"). The options are exercisable in additional 33 1/3% increments on
each subsequent anniversary of the $10.00 Trigger Date. With respect to any
shares that have not vested pursuant to the clauses described in the
preceding sentences, the options may be exercised as to 33 1/3% of the
subject shares on each of the eighth and ninth anniversaries of the date of
the grant and, as to the remaining 33 1/3%, nine years and eleven months
after the date of grant.
OPTION EXERCISES AND 1998 YEAR-END OPTION VALUES
The following table sets forth certain information with respect to unexercised
options to purchase Common Stock held by the Named Executive Officers at
December 31, 1998. None of the Named Executive Officers exercised options in
1998.
YEAR-END 1998 OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES UNDERLYING VALUE OF UNEXERCISED IN-THE-
UNEXERCISED OPTIONS HELD AT MONEY OPTIONS AT
DECEMBER 31, 1998 DECEMBER 31, 1998 (1)
-------------------------------------- -------------------------------------
EXERCISABLE UNEXERCISABLE (2) EXERCISABLE UNEXERCISABLE (2)
----------- ----------------- ----------- -----------------
<S> <C> <C> <C> <C>
A. Stone Douglass -- 450,000 $ -- $112,500
W. Daniel Cook 35,000 35,000 -- --
Steven T. Yavorsky 20,000 40,000 -- --
LeeAnn Peniche 30,000 30,000 -- --
John G. Vondrak 67,500 67,500 -- --
Robert J. Syverson 50,000 50,000 -- --
H. Steven Walton 42,500 42,500 -- --
</TABLE>
- ---------
(1) Value of unexercised in-the-money options is calculated based upon the
difference between the option price and the closing price of the Common
Stock at year end, multiplied by the number of shares underlying the
options. The closing price of the Common Stock as reported on the American
Stock Exchange on December 31, 1998 was $3.25.
(2) All these options become immediately exercisable on a change in control of
the Company.
EMPLOYMENT AGREEMENTS
The Company has employment agreements with Dr. Vondrak and Messrs. Douglass,
Cook, Yavorsky and Ms. Peniche. Each of these agreements provides for an annual
base salary in an amount not less than $180,000, $170,000, $120,000, $120,000
and $138,000 for Dr. Vondrak, Mr. Douglass, Mr. Cook, Mr. Yavorsky and Ms.
Peniche, respectively, and entitles the employee to participate in all the
Company's compensation plans (as defined in the agreements) in which other
executive officers of the Company participate. Each of these agreements also has
a
44
<PAGE>
continuous three-year term, subject to the right of the Company and the employee
to terminate the employee's employment at any time. With regard to the
employment agreement with Mr. Douglass, if his employment is terminated by the
Company without cause (as defined in the agreement) or he elects to terminate
upon a material breach by the Company pursuant to a change of control (as
defined in the agreement), he will be entitled to: (a) all salary and bonus
amounts accrued through the termination date, and (b) payment of 100% of the
remaining period of time in the initial three-year term or the current renewal
term, as the case may be, of his base salary as of the termination date. The
employment agreement for Mr. Douglass contains a covenant limiting his right to
compete against the Company for a period of two years following termination of
employment for cause or for a period of six months following termination of
employment without cause.
With regard to the employment agreement with Mr. Cook, if his employment is
terminated by the Company without cause (as defined in the agreement) or by him
with good reason (as defined in the agreement), he will be entitled, during each
of the years in the three-year period beginning on the termination date, to (i)
periodic payments equal to his average annual cash compensation (as defined in
the agreement) from the Company, including bonuses, if any, during the two years
(or the period of employment, if shorter) preceding the termination date, and
(ii) continued participation in all the Company's compensation plans (other than
the granting of new awards under the 1997 Stock Compensation Plan or any other
performance-based plan). Except in the case of a termination for cause, any
stock options previously granted to the employee under the 1997 Stock
Compensation Plan that have not been exercised and are outstanding as of the
time immediately prior to the date of his termination will remain outstanding
(and continue to become exercisable pursuant to their respective terms) until
exercised or the expiration of their term, whichever is earlier. If a change of
control (as defined in the agreement) of the Company occurs, the employee will
be entitled to terminate his employment at any time during the 365-day period
following that change of control and receive a lump-sum payment equal to three
times his highest annual base salary under the agreement (plus such amounts as
may be necessary to hold the employee harmless from the consequences of any
resulting excise or other similar purpose tax relating to "parachute payments"
under the Internal Revenue Code of 1986, as amended). The employment agreement
for Mr. Cook contains a covenant limiting his right to compete against the
Company for a period of one year following termination of employment.
With respect to the employment agreement with Mr. Yavorsky, if his employment is
terminated by the Company without cause (as defined in the agreement), he will
be entitled to six months base compensation and he shall be deemed fully vested
as to the stock options for 60,000 shares of the Company's Common Stock that he
was granted pursuant to the agreement. The stock options also vest upon a change
in control (as defined in the agreement). Mr. Yavorsky's employment agreement
contains a covenant limiting his right to compete against the Company for a
period of one year following termination of employment.
With respect to the employment agreement with Ms. Peniche, if her employment is
terminated by the Company without cause (as defined in the agreement), she will
be entitled to $50,000 as well as employee benefits for a period of one year
following termination. Ms. Peniche's employment agreement contains a covenant
limiting her right to compete against the Company for a period of three years
following termination of employment.
During 1998 Dr. Vondrak's employment agreement was amended to provide that, in
the event his employment is terminated by the Company other than for cause (as
defined in his employment agreement), the Company and Dr. Vondrak intend to
enter into a consulting arrangement whereby Dr. Vondrak will provide requested
business development services to the Company for a period of three years for
which he will be paid an amount commensurate with the value of the services
rendered. The aggregate amount of consulting fees payable is $865,000. The
Company will use its best efforts to provide Dr. Vondrak with transaction
opportunities during each quarter during the term of this consulting agreement
that will generate a minimum consulting fee of $72,081 per quarter. If Dr.
Vondrak's employment is terminated by him with good reason (as defined in the
agreement), he will be entitled during each of the years in the three-year
period beginning on the termination date, to continued participation in all the
Company's compensation plans (other than the granting of new awards under the
1997 Stock Compensation Plan or any other performance-based plan) and any stock
options previously granted to Dr. Vondrak under the 1997 Stock Compensation Plan
that have not been exercised and are outstanding as of the time immediately
prior to the date of his termination will remain outstanding (and continue to
become exercisable pursuant to their respective terms) until exercised or the
expiration of their term, whichever is earlier. Upon a change of control (as
defined in his employment agreement), the Company or its successor will pay Dr.
Vondrak an amount equal to the difference between $865,000 and all amounts
previously paid pursuant to the consulting agreement, if such agreement is
45
<PAGE>
then effective. The employment agreement for Dr. Vondrak contains a covenant
limiting his right to compete against the Company for a period of one year
following termination of employment. The Company also agreed to loan Dr. Vondrak
$500,000 pursuant to a promissory note and stock pledge agreement. See "--
Certain Relationships and Related Party Transactions."
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
In September 1997, the Company established a Compensation Committee to make
recommendations with respect to salaries and bonuses to be paid to officers and
other employees of the Company. The current members of the Compensation
Committee of the Board are Messrs. Brewton, Crosby, Marxen, Waddell and Sherrill
(chairman), each of whom is a nonemployee director. Prior to completion of the
Company's IPO, matters with respect to the compensation of executive officers
and other employees of the Company were determined by the members of the Board
of Directors as a whole. Messrs. Vondrak and Cook, who were members of the Board
of Directors, participated in deliberations concerning compensation.
REPORT OF COMMITTEE ON EXECUTIVE COMPENSATION
OVERVIEW
The Compensation Committee of the Board of Directors of the Company (the
"Compensation Committee") is responsible for establishing a general compensation
policy for officers and employees of the Company, preparing any reports that may
be required relating to officer compensation and approving any increases in
director's fees. The Compensation Committee consists of Messrs. Brewton, Crosby,
Marxen, Waddell and Sherrill. The Compensation Committee approves, or in some
cases recommends to the Board, remuneration arrangements and compensation plans
involving the Company's directors, executive officers and certain other
employees whose compensation exceeds specified levels. The Compensation
Committee also acts on the granting of stock options to executive officers under
the Company's Stock Plan. To assist the Compensation Committee in carrying out
its responsibilities, the Company has retained an executive compensation
consulting firm to review the compensation paid to the Chief Executive Officer
and its other executive officers, and to provide a competitive assessment as to
how the components of the Company's compensation program compare to those of
companies that compete with the Company for executive employees.
The Company's executive compensation program has been designed to assist the
Company in attracting, motivating and retaining the executive talent necessary
for the Company to maximize its return to stockholders. To this end, this
program provides competitive compensation levels and incentive pay levels that
vary based on corporate and individual performance.
The Company's compensation program for executives consists of three key
elements: a base salary; a performance-based annual bonus; and periodic grants
of stock options.
The Compensation Committee believes that this three-part approach best serves
the interests of the Company and its stockholders. It enables the Company to
meet the requirements of the highly competitive environment in which the Company
operates while ensuring that executive officers are compensated in a way that
advances both the short-term and long-term interests of its stockholders. Under
this approach, compensation for these officers involves a high proportion of pay
that is dependent on maximizing long-term returns to stockholders.
BASE SALARY
Base Pay is designed to be competitive with salary levels for comparable
executive positions at other companies and the Compensation Committee reviews
such comparable salary information as one factor to be considered in determining
the base pay for the Company's executive officers. Other factors the
Compensation Committee considers in determining base pay for each of the
executive officers are that officer's responsibilities, experience, leadership,
potential future contribution and demonstrated individual performance. The
Company has employment agreements with its Chief Executive Officer, its former
Chief Executive Officer, Dr. Vondrak, the other three current executive officers
named in the Summary Compensation Table and certain of its other officers. These
agreements provide for minimum base annual salaries the Company may increase,
but cannot decrease. Any
46
<PAGE>
increases in these base salaries, the base salaries of the Company's other
executive officers and any changes in those salaries will be based on
recommendations by the Company's Chief Executive Officer, taking into account
such factors as competitive industry salaries, a subjective assessment of the
nature of the position and the contribution and experience of the officer.
Performance for base salary purposes will be assessed on a qualitative, rather
than a quantitative, basis. No specific performance formula or weighting of
factors will be used in determining base salary levels.
ANNUAL BONUS
For 1998, the Company determined that, for 1998, it was their preference to
compensate the executive officers primarily in the form of long-term,
equity-based compensation, and accordingly, made awards of stock options rather
than cash bonuses. The Compensation Committee expects to base future annual
bonuses on the Company's financial performance and the individual performance of
the awardees, and intends to use qualitative, rather than quantitative, factors
for this purpose.
STOCK PLAN
Prior to the IPO, the stockholders and the Board of Directors of the Company
approved the Stock Plan. The objectives of the Stock Plan are to (i) attract and
retain superior personnel for positions of substantial responsibility and (ii)
provide employees, nonemployee directors, advisors and orthodontists with an
additional incentive to contribute to the success of the Company.
In August 1998, the Company granted to Mr. Douglass options to purchase 450,000
shares of Common Stock at a per-share exercise price of $3.00.
Stock options align the interests of employees and stockholders by providing
value to option holders through stock price appreciation only. The Compensation
Committee expects that it will make future stock option or other long-term
equity-based incentive awards periodically at its discretion based on
recommendations of the Chief Executive Officer. Stock option grant sizes, in
general, will be evaluated by regularly assessing competitive market practices,
the overall performance of the Company the, size of previous grants and the
number of options held. In addition, the Compensation Committee may consider
factors including that executive's current ownership stake in the Company, the
degree to which increasing that ownership stake would provide the executive with
additional incentives for future performance, the likelihood that the grant of
those options would encourage the executive to remain with the Company and the
value of the executive's service to the Company. This posture with regard to
stock options is intended to focus management's efforts on maximizing
stockholder returns. The number of options granted to a particular participant
will also be based on the Company's historical financial success, its future
business plans and the individual's position and level of responsibility within
the Company, but these factors will be assessed subjectively and not weighted.
1998 CHIEF EXECUTIVE OFFICER PAY
As described above, the Compensation Committee will consider several factors in
developing an executive compensation package. For the Chief Executive Officer,
these factors will include competitive market pay practices, performance level,
experience, contributions toward achievement of strategic goals and the overall
financial and operations success of the Company.
The Company entered into an Executive Employment Agreement (the "Agreement")
with Mr. Douglass, the Company's Chief Executive Officer, on August 6, 1998. The
initial term of the Agreement is for three years at an initial rate of $170,000
per year. Mr. Douglass is eligible to receive an annual discretionary cash bonus
in an amount up to 50% of his base salary. In addition, Mr. Douglass was granted
options to purchase 450,000 shares of Common Stock at an exercise price of $3.00
per share. The Compensation Committee believes the terms of the Agreement and
this initial option award was appropriate.
From the date of the IPO until August 1998, the Compensation Committee took no
action respecting Dr. Vondrak's compensation for 1998. The Company's
compensation consultant advised the Compensation Committee that Dr. Vondrak's
total compensation (base salary and bonus) paid for that portion of 1998 that he
served the Company as
47
<PAGE>
Chief Executive Officer was within an acceptable range of competitive market
levels for compensation paid to the executive officers of comparable companies
surveyed by the consultant.
Executive compensation is an evolving field. The Compensation Committee monitors
trends in this area, as well as changes in law, regulation and accounting
practices, that may affect either its compensation practices or its philosophy.
Accordingly, the Committee reserves the right to alter its approach in response
to changing conditions.
This report will not be deemed incorporated by reference by any general
statement incorporating this Annual Report on Form 10K by reference into any
filing under the Securities Act or under the Exchange Act and will not be deemed
filed under either of such statutes except to the extent that the Company
specifically incorporates this information by reference.
The Compensation Committee
Robert L. Brewton
Rod L. Crosby
Richard J. Marxen
Clyde C. Waddell
William W. Sherrill
PERFORMANCE GRAPH
The following performance graph compares the cumulative total stockholder
return on the Common Stock to the cumulative total return on the Standard &
Poor's 500 Stock Index ("S&P 500") and a peer group, selected in good faith,
comprised of Castle Dental Centers, Inc., Coast Dental Services, Inc., Gentle
Dental Service Corp., Monarch Dental Corp., Omega Orthodontics, Inc.,
Orthalliance, Inc. and Orthodontic Centers of America, Inc. (the "Peer Group"),
over the period from May 22, 1997, the date of the Company's IPO, to December
31, 1998. The graph assumes that $100 was invested on May 22, 1997 in the Common
Stock at its IPO price of $7.00 per share and in each of the other two indices
and the reinvestment of all dividends, if any.
[LINEAR GRAPH PLOTTED FROM DATA IN TABLE BELOW]
5/22/97 12/31/97 12/31/98
------- -------- --------
The Company $100 $170 $ 43
S&P 500 $100 $116 $149
Peer Group $100 $115(1) $109
- ----------
(1) The amount reflected for the Peer Group as of December 31, 1997 in the
Schedule 14A information filed on June 24, 1998 was $107 rather than $115,
as reflected above, due to the exclusion of Omega Orthodontics, Inc. in the
prior year Peer Group calculation.
The graph is presented in accordance with SEC requirements. Stockholders are
cautioned against drawing any conclusions from the data contained therein, as
past results are not necessarily indicative of future financial performance. The
total return on investment for the period shown for the Company, the S&P 500 and
the Peer Group is based on the stock price or composite index at May 22, 1997.
The performance graph appearing above will not be deemed incorporated by
reference by any general statement incorporating this Annual Report on Form 10-K
by reference into any filing under the Securities Act of 1933, as amended (the
"Securities Act"), or under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and will not be deemed filed under either of those Acts except
to the extent that the Company specifically incorporates this information by
reference.
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<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the shares of Common Stock and the Class B
Stock beneficially owned directly or indirectly as of April 23, 1999 (i) by each
person who is known to the Company to own beneficially more than 5% of the
Common Stock and the Class B Stock, (ii) each of the Company's directors and
Named Executive Officers and (iii) all executive officers and directors as a
group.
NUMBER OF SHARES BENEFICIALLY OWNED (1)
-------------------------------------------------------
COMBINED
COMMON PERCENT OF CLASS B PERCENT OF VOTING
STOCK (2) CLASS STOCK CLASS POWER
-------------------------------------------------------
A. Stone Douglass -- *% -- *% *%
W. Daniel Cook 77,698 * 171,687 7.6 1.0
Steven T. Yavorsky 20,000 * -- * *
LeeAnn Peniche 81,308 * 80,120 3.5 *
John G. Vondrak, D.D.S. 511,231 4.3 1,293,377 57.2 7.2
Robert L. Brewton 6,250 * -- * *
Rod L. Crosby, Jr. 22,656 * 28,167 1.2 *
Richard J. Marxen 6,250 * -- * *
William W. Sherrill 70,625 * 112,400 5.0 *
Clyde C. Waddell, Jr. 6,250 * -- * *
Robert J. Syverson 75,000 * 130,809 5.8 *
H. Steven Walton 142,100 1.2 -- * 1.1
All executive
officers and
directors as a
group (12 persons) 1,019,368 8.3 1,816,560 80.3 12.1
- ------------
* less than 1%.
(1) The address of each person listed is 2777 Allen Parkway, Suite 700,
Houston, Texas 77019.
(2) Includes shares subject to outstanding options that are or will become
exercisable within 60 days of April 23, 1999, as follows: Mr. Cook - 52,500
shares; Mr. Yavorsky - 20,000 shares; Ms. Peniche - 45,000 shares; Dr.
Vondrak - 101,250 shares; Messrs. Brewton, Crosby, Marxen, and Waddell -
6,250 shares each; Mr. Sherrill - 10,625 shares; Mr. Syverson - 75,000
shares; and Mr. Walton - 63,750 shares. In addition, the shares shown for
Mr. Sherrill include 60,000 shares subject to an outstanding exercisable
warrant.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
INDEBTEDNESS OF MANAGEMENT
On September 8, 1998, the Company loaned $500,000 to Dr. John G. Vondrak, the
Company's Chairman of the Board, pursuant to a promissory note that bears
interest at 8.5% per annum and is payable in full on September 9, 2000 (the
"Promissory Note"). The Promissory Note is secured by a security interest in
250,000 shares of Class A or B common stock of the Company pursuant to a stock
pledge agreement. On September 10, 1998, the Company and Dr. Vondrak executed an
amendment to Dr. Vondrak's employment agreement to recognize Dr. Vondrak's
change in title and responsibilities with the Company as well as to modify
certain of the terms of compensation in the event Dr. Vondrak's employment with
the Company is terminated. The Company also advanced $134,000 to Dr. Vondrak for
payment of legal fees during 1998. These advances bear interest at the prime
rate minus 200 basis points.
AGREEMENT WITH INFOCURE
Mr. Douglass, the Company's Chief Executive Officer, President and a director,
has a financial interest in and is the business partner of the chairman of the
board of directors of one of the Company's primary practice management software
vendors ("Infocure"). Prior to hiring Mr. Douglass, the Company had entered into
a software development, license and support agreement (the "License Agreement")
with Infocure. The License Agreement provided for, among other things, the
scheduled payment by the Company of $2.5 million in license fees through January
2001. As of December 31, 1998, the Company owed $375,000 under the License
Agreement plus a termination fee of
49
<PAGE>
$175,000 had it chosen to terminate the License Agreement. As of March 1999, the
Company owed $666,000 under the License Agreement plus a termination fee of
$125,000 had it chosen to terminate the License Agreement. Mr. Douglass has
negotiated an oral amendment to the License Agreement to limit the total license
fees to $500,000 (of which $250,000 had been paid at December 31, 1998) in
return for nine licenses (the "License Agreement Amendment"). As of April 14,
1999, the License Agreement Amendment had not been executed.
50
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Operations for the Years Ended December 31, 1998 and
1997 and the period from inception (July 15, 1996) through December 31, 1996
Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the
Years Ended December 31, 1998 and 1997 and the period from inception (July 15,
1996) through December 31, 1996
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998 and
1997 and the period from inception (July 15, 1996) through December 31, 1996
Notes to Consolidated Financial Statements
(s)(2) FINANCIAL STATEMENT SCHEDULES
All schedules and other statements for which provision is made in the applicable
regulations of the Commission have been omitted because they are not required
under the relevant instructions or are inapplicable.
(A)(3) EXHIBITS
EXHIBIT DESCRIPTION
------- ----------------------------------------------------------------
*3.1 Restated Certificate of Incorporation (Incorporated herein by
reference to Exhibit 3.1 of the Company's Registration Statement
on Form S-1 (Registration No. 333-22785)).
*3.2 Bylaws (Incorporated herein by reference to Exhibit 3.2 of the
Company's Registration Statement on Form S-1 (Registration No.
333-22785)).
*4.1 Form of certificate evidencing ownership of Common Stock of
Apple Orthodontix, Inc. (Incorporated herein by reference to
Exhibit 4.1 of the Company's Registration Statement on Form S-1
(Registration No. 333-22785)).
*4.2 Form of Registration Rights Agreement (Incorporated herein by
reference to Exhibit 4.1 of the Company's Registration Statement
on Form S-1 (Registration No. 333-22785)).
*4.3 Registration Rights Agreement among Apple Orthodontix, Inc.,
John G. Vondrak, D.D.S. and TriCap Funding I, L.L.C.
(Incorporated herein by reference to Exhibit 4.3 of the
Company's Registration Statement on Form S-1 (Registration No.
333-22785)).
*4.4 Registration Rights Agreement between TriCap Partners, L.L.C.
and Apple Orthodontix, Inc. (Incorporated herein by reference to
Exhibit 4.4 of the Company's Registration Statement on Form S-1
(Registration No. 333-22785)).
*10.1 Revolving Credit Facility with Chase Bank of Texas, N.A.
(formerly named "Texas Commerce Bank, N.A.") (Incorporated
herein by reference to Exhibit 10.1 of the Company's
Registration Statement on Form S-1 (Registration
No. 333-38817)).
+*10.2 Apple Orthodontix, Inc. 1997 Stock Compensation Plan
(Incorporated herein by reference to Exhibit 10.2 of the
Company's Registration Statement on Form S-1 (Registration No.
333-38817)).
*10.3 Form of Option Agreement for the Apple Orthodontix, Inc. 1997
Stock Compensation Plan (Incorporated herein by reference to
Exhibit 10.3 of the Company's Registration Statement on Form S-1
(Registration No. 333-38817)).
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<PAGE>
EXHIBIT DESCRIPTION
-------- ------------------------------------------------------------------
+*10.4 Employment Agreement between Apple Orthodontix, Inc. and John G.
Vondrak, D.D.S. (Incorporated herein by reference to Exhibit
10.2 of the Company's Registration Statement on Form S-1
(Registration No. 333-22785)).
+*10.5 Employment Agreement between Apple Orthodontix, Inc. and Robert
J. Syverson (Incorporated herein by reference to Exhibit 10.3 of
the Company's Registration Statement on Form S-1 (Registration
No. 333-22785)).
+*10.6 Employment Agreement between Apple Orthodontix, Inc. and Michael
W. Harlan (Incorporated herein by reference to Exhibit 10.4 of
the Company's Registration Statement on Form S-1 (Registration
No. 333-22785)).
+*10.7 Employment Agreement between Apple Orthodontix, Inc. and W.
Daniel Cook (Incorporated herein by reference to Exhibit 10.5 of
the Company's Registration Statement on Form S-1 (Registration
No. 333-22785)).
+*10.8 Employment Agreement of H. Steven Walton (Incorporated herein by
reference to Exhibit 10.7 of the Company's Registration
Statement on Form S-1 (Registration No. 333-22785)).
+*10.9 Amendment to Employment Agreement of H. Steven Walton
(Incorporated herein by reference to Exhibit 10.9 of the
Company's Registration Statement on Form S-1 (Registration No.
333-38817)).
+*10.10 Second Amendment to Employment Agreement of H. Steven Walton
(Incorporated herein by reference to Exhibit 99.2 of the
Company's Current Report on Form 8-K dated February 24, 1998).
*10.11 Form of Service Agreement for Founding Affiliated Practices
(Incorporated herein by reference to Exhibit 10.8 of the Company's
Registration Statement on Form S-1 (Registration No.
333-22785)).
*10.12 Form of Alternative Service Agreement for Founding Affiliated
Practices (Incorporated herein by reference to Exhibit 10.6 of
the Company's Registration Statement on Form S-1 (Registration
No. 333-22785)).
*10.13 Form of Flat Fee Service Agreement for Founding Affiliated
Practices (Incorporated herein by reference to Exhibit 10.11 of
the Company's Registration Statement on Form S-1 (Registration
No. 333-22785)).
+*10.14 First Amendment to Employment Agreement of Robert J. Syverson
(Incorporated herein by reference to Exhibit 99.1 of the
Company's Current Report on Form 8-K dated February 24, 1998).
+*10.15 Employment Agreement between Apple Orthodontix, Inc. and A
Stone Douglass, dated August 6, 1998 (incorporated herein by
reference to Exhibit 10.1 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998).
+*10.16 Employment Agreement between Apple Orthodontix, Inc. and James
E. Bobbitt, dated August 11, 1998 (incorporated herein by
reference to Exhibit 10.2 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998).
+*10.17 Agreement Regarding Termination of Employment between Apple
Orthodontix, Inc. and Michael W. Harlan, dated August 11, 1998
(incorporated herein by reference to Exhibit 10.3 of the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998).
+*10.18 Agreement Regarding Termination of Employment and Severance
Benefits between Apple Orthodontix, Inc. and H. Steven Walton,
dated May 6, 1998 (incorporated herein by reference to Exhibit
10.4 of the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
+*10.19 Consulting Agreement between Apple Orthodontix, Inc. and
Michael W. Harlan, dated August 11, 1998 (incorporated herein by
reference to Exhibit 10.5 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998).
+*10.20 Promissory Note between Apple Orthodontix, Inc. and John G.
Vondrak, dated September 8, 1998 (incorporated herein by reference
to Exhibit 10.6 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998).
+*10.21 Stock Pledge Agreement between Apple Orthodontix, Inc. and John
G. Vondrak, dated September 9, 1998 (incorporated herein by
reference to Exhibit 10.7 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998).
+*10.22 Amendment to Employment Agreement of John G. Vondrak, dated
September 10, 1998 (incorporated herein by reference to Exhibit
10.9 of the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
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<PAGE>
+*10.23 Amendment to Employment Agreement of A. Stone Douglass, dated
November 23, 1998. (incorporated by reference to Exhibit 10.23 of
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.)
+*10.24 Amendment to Employment Agreement of James E. Bobbitt, dated
November 23, 1998. (incorporated by reference to Exhibit 10.24 of
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.)
*10.25 First Amendment to Credit Agreement with Chase Bank of Texas,
N.A., dated May 21, 1998. (incorporated by reference to Exhibit
10.25 of the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.)
+10.26 Agreement Regarding Termination of Employment and Severance
Benefits between Apple Orthodontix, Inc. and Robert J. Syverson,
dated May 20, 1998.
10.27 Second Amendment and Waiver to Credit Agreement with Chase Bank
of Texas, N.A., dated April 14, 1999.
*21.1 Subsidiaries of the Registrant (incorporated by reference to
Exhibit 21.1 of the Company's Annual Report on Form 10-K/A
(Amendment No. 2) for the year ended December 31, 1997).
23.1 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule.
- -------------
* Incorporated herein by reference as indicated.
+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.
(b) REPORTS ON FORM 8-K
None.
53
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS
BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
APPLE ORTHODONTIX, INC.
By: /s/ JAMES E. BOBBITT
James E. Bobbitt
Vice President and Chief Financial Officer
Date: April 29, 1999
54
AGREEMENT REGARDING
TERMINATION OF EMPLOYMENT
AND SEVERANCE BENEFITS
WHEREAS, Robert J. Syverson ("Syverson") and Apple Orthodontix, Inc.
("Apple") have heretofore entered into an agreement dated December 6, 1996
pursuant to which Apple employed Syverson and thereafter amended such employment
agreement in certain respects (the amended employment agreement being hereafter
referred to as the "Employment Agreement"); and
WHEREAS, Apple has terminated Syverson's employment effective as of May 4,
1998; and
WHEREAS, Syverson and Apple have agreed to certain commitments and
understandings regarding the severance benefits which he is owed as a result of
Apple's termination of his employment and desire to evidence such understandings
pursuant to this agreement;
NOW, THEREFORE, Syverson and Apple agree as follows:
1. Apple agrees that Syverson's termination of employment by Apple is
without Cause (as such term is defined in the Employment Agreement) for all
purposes of the Employment Agreement.
2. In lieu of the benefits which otherwise would be payable by Apple to
Syverson pursuant to Section 5(E)(i) and Section 5(E)(iv) of the Employment
Agreement, Syverson agrees to accept and Apple agrees to pay to Syverson a total
cash severance benefit payment in the amount of $775,000.00 payable by direct
deposit to Syverson's bank account in accordance with the direct deposit
instructions in effect on May 4, 1998 with Apple's payroll department as
follows: $387,500 no later than 5:00 p.m. Central Standard Time on May 20th,
1998 and $387,500 no later than 5:00 p.m. Central Standard Time on July 1, 1998.
3. Apple agrees that, in accordance with prior agreements, the forfeiture
restrictions upon all shares of Apple stock heretofore transferred to Syverson
shall lapse as of the date of this agreement and that a certificate evidencing
such shares shall be transferred to Syverson upon execution of this agreement.
<PAGE>
4. Upon the occurrence of a "Change of Control" of Apple, all payments
then remaining payable pursuant to paragraph 2 above of this agreement shall
become immediately due and payable. For purposes of this paragraph 4, "Change of
Control" means the occurrence of any of the following events: (a) any Person
becomes an Acquiring Person; (b) at any time the then Continuing Directors cease
to constitute a majority of the members of the Board; (c) a merger of Apple with
or into, or a sale by Apple of its properties and assets substantially as an
entirety to, another Person occurs and, immediately after that occurrence, any
Person, other than an Exempt Person, together with all Affiliates and Associates
of such Person, shall be the Beneficial Owner of twenty-five percent (25%) or
more of the total voting power of the then outstanding Voting Shares of the
Person surviving that transaction (in the case or a merger or consolidation) or
the Person acquiring those properties and assets substantially as an entirety.
For purposes of the preceding definition of "Change of Control", the following
terms shall have the following meanings:
(i) "Acquiring Person" means any Person who or which, together
with all Affiliates and Associates of such Person, is or are the
Beneficial Owner of twenty-five percent (25%) or more of the
shares of Common Stock then outstanding, but does not include any
Exempt Person; provided, however, that a Person shall not be or
become an Acquiring Person if such Person, together with its
Affiliates and Associates, shall become the Beneficial Owner of
twenty-five percent (25%) or more of the shares of Common Stock
then outstanding solely as a result of a reduction in the number
of shares of Common Stock outstanding due to the repurchase of
Common Stock by Apple, unless and until such time as such Person
or any Affiliate or Associate of such Person shall purchase or
otherwise become the Beneficial Owner of additional shares of
Common Stock constituting one percent (1%) or more of the then
outstanding shares of Common Stock or any other Person (or
Persons) who is (or collectively are) the Beneficial Owner of
shares of Common Stock constituting one percent (1%) or more of
the then outstanding shares of Common Stock shall become an
Affiliate or Associate of such Person, unless, in either such
case, such Person, together with all Affiliates and Associates of
such Person, is not then the Beneficial Owner of twenty-five
percent (25%) or more of the shares of Common Stock then
outstanding.
(ii) "Affiliate" has the meaning ascribed to that term in the
Securities Exchange Act of 1934 Rule 12b-2.
(iii) "Associate" means, with reference to any Person, (a) any
corporation, firm, partnership, association, unincorporated
organization or other entity (other than Apple or a subsidiary of
Apple) of which that Person is an officer or general partner (or
officer or general partner of a general partner) or is, directly
or indirectly, the Beneficial Owner of 10% or more of any class
of its equity securities, (b) any trust or other estate in which
that Person has a substantial beneficial interest or for or of
which that Person serves as trustee or in a similar fiduciary
capacity, (c) any relative or spouse of that Person, or any
relative of that spouse, who has the same home as that Person and
(d) any stockholder, partner or owner of any equity in such
Person.
<PAGE>
(iv) "Board" means the board of directors of Apple.
(v) "Common Stock" means the common stock of Apple.
(vi) "Continuing Director" means at any time any individual who then
(a) is a member of the Board and was a member of the Board as of May
4, 1998 or whose nomination for his first election, or that first
election, to the Board following that date was recommended or
approved by a majority of the then Continuing Directors (acting
separately or as a part of any action taken by the Board or any
committee thereof) and (b) is not an Acquiring Person, an Affiliate
or Associate of an Acquiring Person or a nominee or representative
of an Acquiring Person or of any such Affiliate or Associate.
(vii) "Exempt Person" means (a) (1) Apple, any subsidiary of Apple,
any employee benefit plan of Apple or of any subsidiary of Apple and
(2) any Person organized, appointed or established by Apple for or
pursuant to the terms of any such plan or for the purpose of funding
any such plan or funding other employee benefits for employees of
Apple or any subsidiary of Apple and (b) Syverson, any Affiliate or
Associate of Syverson or any group (as that term is used in the
Securities Exchange Act of 1934 Rule 13d-5(b)) of which Syverson or
any Affiliate or Associate of Syverson is a member.
(viii) "Person" means any natural person, sole proprietorship,
corporation, partnership of any kind having a separate legal status,
limited liability company, business trust, unincorporated
organization or association, mutual company, joint stock company,
joint venture, estate, trust, union or employee organization or
governmental authority.
(ix) "Voting Shares" means: (a) in the case of any corporation,
stock of that corporation of the class or classes having general
voting power under ordinary circumstances to elect a majority of
that corporation's board of directors; and (b) in the case of any
other entity, equity interests of the class or classes having
general voting power under ordinary circumstances equivalent to the
Voting Shares of a corporation.
<PAGE>
5. Should any payments made by Apple to Syverson pursuant to this
agreement or resulting from or in connection with his prior employment with
Apple, singly, in any combination or in the aggregate, to or for the benefit of
Syverson be determined or alleged to be subject to an excise or similar purpose
tax pursuant to Section 4999 of the Internal Revenue Code of 1986, as amended
(the "Code"), or any successor or other comparable federal, state or local tax
law by reason of being a "parachute payment" (within the meaning of Section 280G
of the Code), Apple shall pay to Syverson such additional compensation as is
necessary (after taking into account all federal, state and local taxes payable
by Syverson as a result of the receipt of such additional compensation) to place
Syverson in the same after-tax position (including federal, state and local
taxes) he would have been in had no such excise or similar purpose tax (or
interest or penalties thereon) been paid or incurred. Apple hereby agrees to pay
such additional compensation within the earlier to occur of (i) five (5)
business days after Syverson notifies Apple that Syverson intends to file a tax
return taking the position that such excise or similar purpose tax is due and
payable in reliance on a written opinion of Syverson's tax counsel (such tax
counsel to be chosen solely by Syverson) that it is more likely than not that
such excise tax is due and payable or (ii) twenty-four (24) hours of any notice
of or action by Apple that it intends to take the position that such excise tax
is due and payable. The costs of obtaining the tax counsel opinion referred to
in clause (i) of the preceding sentence shall be borne by Apple, and as long as
such tax counsel was chosen by Syverson in good faith, the conclusions reached
in such opinion shall not be challenged or disputed by Apple. If Syverson
intends to make any payment with respect to any such excise or similar purpose
tax as a result of an adjustment to Syverson's tax liability by any federal,
state or local tax authority, Apple will pay such additional compensation by
delivering its cashier's check payable in such amount to Syverson within five
(5) business days after Syverson notifies Apple of his intention to make such
payment. Without limiting the obligation of Apple hereunder, Syverson agrees, in
the event Syverson makes any payment pursuant to the preceding sentence, to
negotiate with Apple in good faith with respect to procedures reasonably
requested by Apple which would afford Apple the ability to contest the
imposition of such excise or similar purpose tax; provided, however, that
Syverson will not be required to afford Apple any right to contest the
applicability of any such excise or similar purpose tax to the extent that
Syverson reasonably determines (based upon the opinion of his tax counsel) that
such contest is inconsistent with the overall tax interests of Syverson.
6. In entering into this agreement Apple intends that Syverson receive
without reduction or delay all the intended benefits of this agreement and that
those benefits, and the terms and conditions hereof, be construed in a manner
most favorable to Syverson; Apple, therefore, agrees that it will strive
expeditiously and in good faith to construe and resolve in Syverson's favor and
to his benefit any ambiguities or uncertainties that may be created by the
express language hereof. If, however, at any time during the term hereof or
afterwards: (i) there should exist a dispute or conflict between Syverson and
Apple or another person or entity as to the validity, interpretation or
application of any term or condition hereof, or as to Syverson's entitlement to
any benefit intended to be bestowed hereby, which is not resolved to the
satisfaction of Syverson, (ii) Syverson must (a) defend the validity of this
agreement, (b) contest any determination by Apple concerning the amounts payable
(or reimbursable) by Apple to Syverson, or (c) determine in any tax year of
Syverson the tax consequences to Syverson of any amounts payable (or
reimbursable) under Paragraph 5, or (iii) Syverson must prepare responses to an
Internal Revenue Service ("IRS") audit of, or otherwise defend, his personal
income tax return for any year the subject of any such audit, or an adverse
determination, administrative proceedings or civil litigation arising therefrom
that is occasioned by or related to an audit by the IRS of Apple's income tax
returns, then Apple hereby unconditionally agrees:
<PAGE>
(a) On written demand of Apple by Syverson, to provide sums sufficient
to advance and pay on a current basis (either by paying directly or
by reimbursing Syverson) not less than thirty (30) days after a
written request therefor is submitted by Syverson, Syverson's out of
pocket costs and expenses (including attorney's fees, expenses of
investigation, travel, lodging, copying, delivery services and
disbursements for the fees and expenses of experts, etc.) incurred
by Syverson in connection with any such matter;
(b) Syverson shall be entitled, upon application to any court of
competent jurisdiction, to the entry of a mandatory injunction
without the necessity of posting any bond with respect thereto which
compels Apple to pay or advance such costs and expenses on a current
basis; and
(c) Apple's obligations under this Paragraph 6 will not be affected if
Syverson is not the prevailing party in the final resolution of any
such matter.
7. Apple agrees to pay all legal and other fees, costs and expenses
incurred by Syverson in connection with the termination of his employment with
Apple including fees, costs and expenses incurred by Syverson in connection with
and the negotiation and implementation of this agreement and certain other
proposed but ultimately not consummated agreements.
8. Time is of the essence of this agreement. Overdue payments under this
agreement shall accrue interest at a rate of 18% per annum through the date of
full and complete payment. Any failure by Apple to pay any amounts due under
this agreement that continues for more than 10 business days shall constitute a
material breach by Apple of this agreement and all then remaining payable
pursuant to paragraph 2 of this agreement shall thereupon be accelerated and
shall be immediately due and payable.
9. Syverson shall be indemnified by Apple with respect to his prior
employment with Apple to the maximum extent permitted by the laws of Delaware,
the state of Apple's incorporation, and the laws of the state of incorporation
of any subsidiary of Apple of which Syverson is or at any time was a director,
officer, employee or consultant as same may be in effect from time to time.
<PAGE>
10. Syverson waives and releases all rights, claims, charges, demands and
causes of action against Apple, its predecessors, successors, parent companies,
subsidiaries and affiliates, and its officers, directors, employees, owners,
shareholders and agents, of any kind or character, both past and present, known
or unknown, including but not limited to those arising under the Age
Discrimination in Employment Act of 1967, Title VII of the Civil Rights Act of
1964, and the Employee Retirement Income Security Act of 1974, all as amended,
and any other state or federal statute, regulation or the common law (contract,
tort or other), which relate to Syverson's employment with Apple prior to May 4,
1998 or termination of such employment, including but not limited to any alleged
discriminatory or retaliatory employment practices, any matter relating to or
arising under the Employment Agreement or any other matter. Apple understands
and agrees that the foregoing waiver and release shall not serve to waive or
release any rights or claims that may arise after the date this agreement is
executed whether relating to this agreement or otherwise. Apple waives and
releases all rights, claims, charges, demands and causes of action against
Syverson of any kind or character, both past and present, known or unknown,
arising under any state or federal statute, regulation or the common law
(contract, tort or other), which relate to Syverson's employment or termination
of such employment any matter relating to or arising under the Employment
Agreement or any other matter. Syverson understands that the foregoing waiver
and release shall not serve to waive or release any rights or claims that may
arise after the date this agreement is executed whether relating to this
agreement or otherwise.
11. This agreement is entered into under and shall be governed for all
purposes by the laws of the State of Texas.
12. No failure by either party hereto at any time to give notice of any
breach by the other party of, or to require compliance with, any condition or
provision of this agreement shall be deemed a waiver of similar or dissimilar
provisions or conditions at the same time or at any prior or subsequent time.
13. If a court of competent jurisdiction determines that any provision of
this agreement is invalid or unenforceable, then the invalidity or
unenforceability of that provision shall not affect the validity or
enforceability of any other provision of this agreement, and all other
provisions shall remain in full force and effect.
14. This agreement and the rights and obligations of the parties hereunder
are personal, and neither this agreement nor any right, benefit, or obligation
of either party hereto shall be subject to voluntary or involuntary assignment,
alienation, or transfer, whether by operation of law or otherwise, without the
prior written consent of the other party.
15. This agreement represents the entire agreement between the parties
hereto with respect to the matters covered herein and may not be changed,
altered, or modified in any respect except by an instrument in writing signed by
both the parties hereto.
16. Except as specifically set forth in this agreement, Apple agrees that
any and all rights and benefits otherwise accruing to or benefitting Syverson
under the terms of the Employment Agreement continue to be in full force and
effect.
IN WITNESS WHEREOF, the parties hereto have caused these presents to be
executed this 20th day of May, 1998.
APPLE ORTHODONTIX, INC.
By: /s/ JOHN G. VONDRAK
John G. Vondrak, CEO
________________________________
Robert J. Syverson
SECOND AMENDMENT AND WAIVER
TO
CREDIT AGREEMENT
This SECOND AMENDMENT AND WAIVER TO CREDIT AGREEMENT is made and
entered into effective as of the 31st day of March, 1999 (this "AMENDMENT")
among, APPLE ORTHODONTIX, INC., a Delaware corporation (the "COMPANY"), the
Subsidiaries of the Company listed on the signature pages hereto as Guarantors
(together with each other person who subsequently becomes a Guarantor,
collectively the "Guarantors"), the banks and other financial institutions
listed on the signature pages hereto under the caption "Banks" (together with
each other person who becomes a Bank, collectively the "BANKS") and CHASE BANK
OF TEXAS, NATIONAL ASSOCIATION, f/k/a Texas Commerce Bank National Association
("TCB"), individually as a Bank "CHASE", and as agent for the other Banks (in
such capacity, together with any other Person who becomes the agent, the
"AGENT").
WHEREAS, the Company, the Guarantors, and TCB, both as a Bank and an
Agent, entered into that certain Credit Agreement dated as of July 28, 1997 (as
amended by that First Amendment to Credit Agreement dated May 21, 1998 and as
further amended or restated from time to time, the "CREDIT AGREEMENT"), which
Credit Agreement provides for a revolving credit facility pursuant to which TCB
and the Banks named therein committed to make loans of up to $25,000,000.00 upon
the terms and conditions as provided therein.
WHEREAS, TCB has changed its name to Chase, and Chase holds all
rights and obligations of TCB in, to and under the Credit Agreement.
WHEREAS, the Company has requested the Banks and the Agent to amend
the Credit Agreement to waive certain terms thereof and to modify other terms
and conditions thereof.
WHEREAS, said parties have agreed to do so to the extent reflected
in this Amendment, provided the Company and the Guarantors ratify and confirm
all of their obligations under the Credit Agreement and the Loan Documents, as
well as agree to make certain other amendments as set forth herein.
WHEREAS, the Company, the Guarantors, the Banks, and the Agent wish
to execute this document to evidence their agreement in regard thereto.
NOW, THEREFORE, in consideration of the premises and other good and
valuable consideration and the mutual benefits, covenants and agreements herein
expressed, the receipt and sufficiency of which are hereby acknowledged, the
parties hereto now agree as follows:
1. DEFINED TERMS. All capitalized terms used in this Amendment and
not otherwise defined herein shall have the meanings ascribed to such terms in
the Credit Agreement.
<PAGE>
2. AMENDMENT TO SECTION 1.01. (a) Section 1.01 of the Credit
Agreement is hereby amended by deleting and restating the following
definitions to read as follow:
(i) "'COLLATERAL' means all Collateral described in any of the Security
Documents and shall include substantially all of the assets of the
Company and each of its Subsidiaries, real and personal, tangible
and intangible."
(ii) "'DEFAULT RATE' means the lesser of (i) the Highest Lawful Rate and
(ii) the Alternate Base Rate plus 3%."
(iii) "'DESIGNATED PAYMENT DATE' means the last Business Day of each
month."
(iv) "'EBITDA' means, for any period, the consolidated pre-tax income for
such period, plus the aggregate amount which was deducted for such
period in determining such consolidated, pre-tax income in respect
of interest expense (including amortization of debt discount,
imputed interest and capitalized interest), plus depreciation and
amortization, excluding any income attributable to any minority
interest in any Person or any Foreign Subsidiaries of the Company
(other than Foreign Subsidiaries organized under the laws of Canada
or one of its provinces, which Canadian Subsidiaries' EBITDA shall
be included in EBITDA), unless remitted to the Company or any of its
Subsidiaries that is not a Foreign Subsidiary.
(v) "MARGIN" means with respect to any Advance, the percentage
determined in accordance with the following table as a function of
the Funded Indebtedness to EBITDA ratio:
FUNDED INDEBTEDNESS/ ALTERNATE BASE LIBOR RATE
EBITDA RATIO RATE MARGIN MARGIN
> 3.50 1.50% 3.00%
>=3.00 but < 3.50 1.25% 2.75%
>= 2.50 but < 3.00 1.00% 2.50%
>= 2.00 but < 2.50 0.75% 2.25%
>= 1.50 but < 2.00 0.50% 2.00%
>= 1.00 but < 1.50 0.25% 1.75%
< 1.00 0.00% 1.50%
If sufficient information does not exist to calculate the
Margin, the Alternate Base Rate Margin shall be 1.50% and the LIBOR
Rate Margin shall be 3.00%.
<PAGE>
(vi) "'MATURITY DATE' means May 31, 2001, or such earlier date determined
in accordance with ARTICLE IX hereof."
(vii) "'SECURITY DOCUMENTS' means all security agreements, pledge
agreements, mortgages, deeds of trust, guaranty agreements, and
similar items, and UCC financing statements giving notice thereof,
executed by the Company and its Subsidiaries in favor of the Agent
for the benefit of the Banks and covering substantially all of the
assets of said Persons."
(b) Section 1.01 is hereby further amended by adding the following
definition thereto in appropriate alphabetical order:
"'PRACTICE RECEIVABLE REPORT' has the meaning provided in SECTION
6.01(A)."
3. AMENDMENT TO SECTION 2.11. Section 2.11(a) is hereby amended by
deleting the reference to "one, two, three or six month" interest periods
contained therein and replacing same with a reference to "one month" interest
periods.
4. ADDITION OF SECTION 5.17. A new Section 5.17 is hereby added to
the Credit Agreement to read as follows:
"Section 5.17 GRANTING OF LIENS ON COLLATERAL. On or before May 15,
1999, the Company will, and will cause each of its Subsidiaries to take
such steps, to provide such information and execute such documents as the
Agent shall reasonably request to grant to the Agent, for the benefit of
the Banks, a first and prior lien and security interest in substantially
all of the assets of the Company and each of its Subsidiaries, real and
personal, tangible and intangible."
5. AMENDMENT TO SECTION 6.01. Section 6.01 of the Credit Agreement
is hereby amended by deleting subsection (a) thereof and replacing it with the
following:
"(a) As soon as available, and in any event within thirty (30) days
after the end of each month and forty-five (45) days after the close of
each quarter of each fiscal year, the unaudited consolidated balance sheet
of the Company and its Subsidiaries as of the end of such period and the
related consolidated statements of income and cash flow for such period,
and its practice receivable report, containing a listing of accounts
receivable by Practice (the "PRACTICE RECEIVABLE REPORT"), setting forth,
in each case, comparative consolidated figures for the related periods in
the prior fiscal year, all of which shall be certified by the chief
financial officer or chief executive officer of the Company as fairly
presenting in all material respects, the financial position of the Company
and its Subsidiaries as of the end of such period and the results of their
operations for the period then ended in accordance with GAAP, subject to
changes resulting from normal year-end audit adjustments and inclusion of
abbreviated footnotes; provided, however, that delivery
<PAGE>
of the Quarterly Report on Form 10-Q of the Company for such quarter
period filed with the Securities and Exchange Commission shall be deemed
to satisfy the requirements of this SECTION 6.01(A) with regard to the
delivery of said Financials."
6. AMENDMENT TO SECTION 7.03 Section 7.03 of the Credit Agreement is
hereby amended by adding the following provisions to the end of subsection (e)
thereof:
"provided, no additional new Indebtedness of more than $200,000.00
may be included from the date of the Second Amendment and thereafter."
7. AMENDMENT TO SECTION 7.04 Section 7.04 of the Credit Agreement is
hereby amended by redesignating subsection (d) as subsection (e) thereto and
adding a new subsection (d) thereto that reads as follows:
"(d) liens in favor of the Agent for the benefit of the Banks."
8. AMENDMENT TO SECTION 7.05 Section 7.05 of the Credit Agreement is
hereby amended by:
(i) deleting the reference to $750,000.00 in subsection (c) thereof
and replacing it with $50,000.00;
(ii) deleting subparagraph (d) thereof in its entirety and replacing
it with the following:
"(d) Investments in all or substantially all of the stock,
warrants, stock appreciation rights, other securities and/or other
assets of physician practice management entities in the field of
dentistry or assets of practicing orthodontists or dentists, (i) in
which, in the case of a Subsidiary, the Company directly or
indirectly owns a majority of the voting equity in such Person or is
the surviving entity, (ii) acquired at a time when no Default or
Event of Default exists hereunder and (iii) for which (y) the cash
and assumed Indebtedness consideration paid does not exceed
$500,000.00 in any one year and (z) total consideration paid,
including cash, notes, debt owed by the entity acquired (whether or
not assumed by the Company) and the value of stock given to any
selling entity for any one such Investment which does not exceed
$1,000,000.00 in any one year."
; and
(iii) deleting subsection (g) thereof in its entirety and replacing
it with the following:
<PAGE>
"(g) short term advances to Practicing Orthodontists or
Practices in the form of: (i) Uncollected Service Fees (as such term
is defined in the Practice Receivable Report) of not more than
$3,000,000.00 outstanding at any one time, and (ii) Cash Advances in
Excess of Cash Profit and Sweep Deficit Account balances (as such
terms are defined in the Practice receivable Report) of not more
than $4,000,000.00, collectively, outstanding at any one time."
9. AMENDMENT TO SECTION 7.10. Section 7.10 is hereby deleted in its
entirety and the following substituted therefor:
"Section 7.10 MINIMUM NET WORTH. The Company will not permit its
Consolidated Net Worth to be less than the greater of: (a) $29,000,000 or
(b) 90% of the actual net worth as of the December 31, 1998, plus, in all
cases: (i) 100% of the net proceeds resulting from the issuance of any
capital stock by the Company or any Subsidiary subsequent to the Execution
Date at any time during the term hereof and (ii) 75% of the consolidated
after tax income of the Company and its Subsidiaries (to be adjusted each
quarter) for each fiscal year during the term hereof (including any
Subsidiaries acquired subsequent hereto)."
10. AMENDMENT TO SECTION 7.11. Section 7.11 is hereby deleted in its
entirety and the following substituted therefor:
"SECTION 7.11 FUNDED INDEBTEDNESS TO EBITDA RATIO. The Company will
not permit the ratio of (i) its total Funded Indebtedness to (ii) EBITDA,
calculated for the preceding four (4) fiscal quarters on a rolling four
(4) quarter basis, PLUS, (A) during the four (4) fiscal quarters ending on
the last day of June, September and December of 1998 and March of 1999,
the special, non-recurring charges incurred during the quarter ending June
30, 1998 resulting from severance costs associated with management
changes, costs of terminated acquisitions and related items, up to a
maximum of $3,745,000, and (B) during the fourth fiscal quarter of 1998
and the first three fiscal quarters of 1999, the special non-recurring
charges, including adjustments, of up to $18,811,000 taken during the
fourth fiscal quarter of 1998, to be greater than that shown on the
following chart:
QUARTER ENDING RATIO
March 31, 1999 3.1 to 1.0
June 30, 1999 3.4 to 1.0
September 30, 1999 3.75 to 1.0
December 31, 1999 3.75 to 1.0
March 31, 2000 and thereafter 3.0 to 1.0"
<PAGE>
11. AMENDMENT TO SECTION 7.12. Section 7.12 is hereby deleted in its
entirety and the following substituted therefor:
"SECTION 7.12 FIXED CHARGE COVERAGE RATIO. The Company will not
permit the ratio of (a) EBITDA calculated for the preceding four (4)
quarters on a rolling four (4) quarter basis PLUS (A) during the four (4)
fiscal quarters ending on the last day of June, September and December of
1998 and March of 1999, the special, non-recurring charges incurred during
the quarter ending June 30, 1998 resulting from severance costs associated
with management changes, costs of terminated acquisitions and related
items, up to a maximum of $3,745,000, and (B) during the fourth fiscal
quarter of 1998 and the first three fiscal quarters of 1999, the special
non-recurring charges, including adjustments, of up to $18,811,000 taken
during the fourth fiscal quarter of 1998, LESS (C) taxes actually paid
during the four (4) most recent quarters, to (b) the sum of: (i) the
current portion of long-term debt for the upcoming four (4) fiscal
quarters, PLUS (ii) interest expense, PLUS (iii) cash Consolidated Capital
Expenditures up to a maximum of $2,000,000.00, both items (ii) and (iii)
calculated for the preceding four (4) quarters on a rolling four (4)
quarter basis, to be less than 2.0 to 1.0 at any time during the term
hereof."
12. AMENDMENT TO SECTION 7.13 Section 7.13 of the Credit Agreement
is hereby amended by deleting the reference to $10,000,000 contained therein and
replacing it with $2,000,000.00.
13. AMENDMENT OF SECTION 7.16. Section 7.16 is hereby amended by
deleting subsection (a) thereof in its entirety.
14. ADDITION OF SECTION 7.17. A new Section 7.17 is hereby added to
the Credit Agreement to read as follows:
"Section 7.17 MINIMUM QUARTERLY EBITDA. The Company shall not permit
EBITDA to be less than the amounts shown on the following chart for the
periods indicated:
Each Quarter Ending March 31 1,520,000
Each Six Month Period Ending June 30 3,045,000
Each Nine Month Period Ending September 30 4,815,000
Each Year Ending December 31 6,510,000"
15. WAIVER OF CERTAIN DEFAULTS OR EVENTS OF DEFAULT. The following
provisions of the Credit Agreement, to the extent they resulted in a Default or
an Event of Default thereunder or under any of the Loan Documents, are hereby
waived for the period indicated:
<PAGE>
(i) Sections 7.05(g), 7.10, 7.11 and 7.12 for the period ending
December 31, 1999.
(ii) Section 7.16 (a) for all periods from the Effective Date
through the date of the Second Amendment.
(iii) Any Default or Event of Default arising from a calculation of
EBITDA that included the results of any Subsidiary located in Canada, for
all periods from the Effective Date through the date of the Second
Amendment.
16. RATIFICATION. The Company and each Guarantor hereby ratify all
of their obligations under the Credit Agreement and the Loan Documents, and
agree and acknowledge that the Credit Agreement (including the Guaranty
contained therein) and each of the Loan Documents shall continue in full force
and effect as amended and modified by this Amendment. Nothing in this Amendment
extinguishes, novates or releases any right, claim, lien, security interest or
entitlement of any of the Banks created by or contained in any of such documents
nor is the Company released from any covenant, warranty or obligation created by
or contained therein except as expressly provided herein.
17. REPRESENTATIONS AND WARRANTIES. The Company hereby represents
and warrants to the Banks that (a) this Amendment has been duly executed and
delivered on behalf of the Company, (b) this Amendment constitutes a valid and
legally binding agreement enforceable against the Company in accordance with its
terms, (c) the representations and warranties contained in the Credit Agreement
and the Loan Documents are true and correct on as of the date hereof in all
material respects as though made as of the date hereof except as heretofore
otherwise disclosed in writing to the Agent (other than those of such
representations and warranties which by their express terms speak to a date on
or before the date hereof), (d) no Default exists under the Credit Agreement or
any of the Loan Documents and (e) the execution, delivery and performance of
this Amendment has been duly authorized by the Company. The Company will, upon
request by the Agent, provide satisfactory evidence of items (a) and (e) above.
18. MULTIPLE COUNTERPARTS. This Amendment may be signed in any
number of counterparts, each of which may be delivered in original or facsimile
form, and each shall be construed as an original, but all of which together
shall constitute one and the same instrument.
19. CONDITIONS TO EFFECTIVENESS. This Amendment shall be effective
upon (i) the execution hereof by all parties and delivery of signed copies to
the Agent, and (ii) receipt by the Agent, for the pro rata benefit of the Banks
of an amendment fee equal to .5% of the Total Commitment.
20. CHOICE OF LAW. THIS AMENDMENT SHALL BE DEEMED TO BE A CONTRACT
EXECUTED BY THE PARTIES UNDER, AND SHALL BE GOVERNED BY AND CONSTRUED IN
ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE
<PAGE>
OF TEXAS, EXCEPT TO THE EXTENT THAT THE LAWS OF THE UNITED STATES OF AMERICA AND
ANY RULES, REGULATIONS OR ORDERS ISSUED OR PROMULGATED THEREUNDER APPLICABLE TO
THE AFFAIRS AND TRANSACTIONS OF ANY BANK OTHERWISE PREEMPT TEXAS LAW, IN WHICH
EVENT SUCH FEDERAL LAW SHALL CONTROL.
21. ENTIRE AGREEMENT. THIS AMENDMENT AND THE CREDIT AGREEMENT AND
THE OTHER LOAN DOCUMENTS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND
MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL
AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL
AGREEMENTS BETWEEN THE PARTIES.
[SIGNATURES BEGIN ON NEXT PAGE]
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be executed by their respective officers thereunto duly authorized as of the
date first above written.
COMPANY:
APPLE ORTHODONTIX, INC.
By: /s/ JAMES E. BOBBITT
Name: James E. Bobbitt
Title: Vice President and
Chief Financial Officer
GUARANTORS:
APPLE ORTHODONTIX OF TEXAS, INC.
By: /s/ JAMES E BOBBITT
Name: James E. Bobbitt
Title: Vice President and
Chief Financial Officer
AGENT:
CHASE BANK OF TEXAS, NATIONAL
ASSOCIATION
By: /s/ MICHAEL E. ONDRUCH
Michael E. Ondruch
Vice President
<PAGE>
BANKS
Amount of Commitment: CHASE BANK OF TEXAS, NATIONAL
$15,000,000.00 ASSOCIATION
By: /s/ MICHAEL E. ONDRUCH
Michael E. Ondruch
Vice President
ADDRESS:
712 Main Street
Houston, Texas 77002
Telephone No.: (713) 216-5324
Telecopy No.: (713) 216-6004
Attention: Michael E. Ondruch
DOMESTIC LENDING OFFICE
See above
EURODOLLAR LENDING OFFICE
See above
<PAGE>
BANKS
Amount of Commitment: PARIBAS
$10,000,000.00
By: /s/ GLENN E. MEALEY
Name: Glenn E. Mealey
Title: Managing Director
By: /s/ ROSINE K. MATTHEWS
Name: Rosine K. Matthews
Title: Vice President
ADDRESS:
2 Allen Center, Suite 3100
Houston, Texas 77002
Telephone No.: (713) 659-4811
Telecopy No.: (713) 659-5234
Attention:
DOMESTIC LENDING OFFICE
See above
EURODOLLAR LENDING OFFICE
See above
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated April 14, 1999 included in this Form 10-K/A, into the Company's
previously filed Registration Statements on Form S-4, File No.
333-28937 and Form S-8, File No. 333-38077.
/s/ ARTHUR ANDERSEN LLP
Houston, Texas
April 29, 1999
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<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 755
<SECURITIES> 0
<RECEIVABLES> 11,306
<ALLOWANCES> (5,785)
<INVENTORY> 0
<CURRENT-ASSETS> 9,335
<PP&E> 8,019
<DEPRECIATION> (1,370)
<TOTAL-ASSETS> 71,462
<CURRENT-LIABILITIES> 6,722
<BONDS> 0
0
0
<COMMON> 14
<OTHER-SE> 29,674
<TOTAL-LIABILITY-AND-EQUITY> 71,462
<SALES> 0
<TOTAL-REVENUES> 53,302
<CGS> 0
<TOTAL-COSTS> 64,026
<OTHER-EXPENSES> 77
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 394
<INCOME-PRETAX> (16,826)
<INCOME-TAX> (6,496)
<INCOME-CONTINUING> (10,330)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,330)
<EPS-PRIMARY> (.75)
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