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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
---------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 000-22975
---------------
ORTHALLIANCE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4632134
(STATE OR JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
23848 HAWTHORNE BOULEVARD, SUITE 200 90505
TORRANCE, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE): (310) 791-5656
---------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of Class A Common Stock and Class B Common Stock of the
Registrant outstanding at September 30, 1998 was 13,055,587 and 249,292,
respectively.
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ORTHALLIANCE, INC.
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
INDEX PAGE
----
<S> <C> <C>
PART I FINANCIAL INFORMATION............................................................................... 4
Item 1 Financial Statements and General Information........................................................ 4
Condensed Consolidated Balance Sheets as of December 31, 1997 and
September 30, 1998 (unaudited)...................................................................... 4
Condensed Consolidated Statements of Operations for the Nine Months Ended
September 30, 1997 and September 30, 1998 (unaudited)............................................... 5
Condensed Consolidated Statements of Operations for the Three Months Ended
September 30, 1997 and September 30, 1998 (unaudited)............................................... 6
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1997 and September 30, 1998 (unaudited)............................................... 7
Notes to Condensed Consolidated Financial Statements................................................ 8
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................................... 10
Item 3 Quantitative and Qualitative Disclosure about Market Risk........................................... 13
PART II OTHER INFORMATION................................................................................... 13
Item 1 Legal Proceedings................................................................................... 13
Item 2 Changes in Securities and Use of Proceeds........................................................... 13
Item 3 Defaults Upon Senior Securities..................................................................... 13
Item 4 Submission of Matters to a Vote of Security Holders................................................. 14
Item 5 Other Information................................................................................... 14
Item 6 Exhibits and Reports on Form 8-K.................................................................... 14
</TABLE>
2
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FORWARD-LOOKING STATEMENTS
Statements contained in this Report, which are not historical in nature, are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements include, without limitation, the
statements regarding efforts to determine Year 2000 exposure, the costs to bring
corporate and practice systems into Year 2000 compliance, funding of development
efforts, acquisitions and operations. Such forward-looking statements include
uncertainties and risks that could cause actual results to differ materially
from those documented in this report. These risks include the ability to grow
through affiliations with additional orthodontic or pediatric dental practices,
the ability to identify suitable affiliation candidates and to profitably manage
or successfully integrate new practices, the level of competition from other
orthodontic or dental practice management companies, the continued availability
of adequate insurance, the ability to secure capital to fund future growth,
regulatory developments and changes in the United States healthcare system, the
general economy of the United States and the specific markets in which
OrthAlliance operates orthodontic or pediatric dental offices, and other factors
as may be identified from time to time in future filings with the Securities and
Exchange Commission or in other public announcements, including those set forth
on Exhibit 99.1 to this report. The words "believe," "expect," "anticipate,"
"plan," and "intend" and similar expressions identify forward-looking
statements. Readers are cautioned not to place undue reliance on these forward-
looking statements, which speak only as of the date such statements are made.
3
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PART I
ITEM I. FINANCIAL STATEMENTS
ORTHALLIANCE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ........................................ $ 4,040,000 $ 12,647,000
Patient receivables, net of allowances of $381,000 and $242,000 .... 6,966,000 4,470,000
Unbilled patient receivables, net of
allowances of $400,000 and $293,000 ............................ 3,598,000 2,642,000
Amounts due from Allied Practices ................................ 6,584,000 2,489,000
Current deferred tax assets ...................................... 984,000 984,000
Other current assets ............................................. 283,000 67,000
------------ ------------
Total current assets ............................................ 22,455,000 23,299,000
Property and equipment, net ......................................... 5,054,000 3,214,000
Notes receivable from Allied Practices .............................. 3,324,000 2,010,000
Non-current deferred tax assets ..................................... 4,209,000 4,209,000
Intangible assets, net .............................................. 45,492,000 11,313,000
Other, net .......................................................... 236,000 318,000
------------ ------------
Total Assets .................................................... $ 80,770,000 $ 44,363,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accrued liabilities ................... $ 3,611,000 $ 3,024,000
Patient prepayments .............................................. 4,285,000 2,710,000
Liabilities assumed from Allied Practices ........................ 280,000 410,000
Income taxes payable ............................................. 843,000 1,308,000
Current deferred tax liabilities ................................. 1,672,000 1,672,000
Amounts due to Allied Practices .................................. 3,467,000 1,090,000
------------ ------------
Total current liabilities ....................................... 14,158,000 10,214,000
------------ ------------
Line of Credit borrowings ....................................... 8,500,000 --
Non-current deferred tax liabilities ............................ 121,000 121,000
------------ ------------
Total liabilities ............................................... 22,779,000 10,335,000
------------ ------------
Commitments and Contingencies
Stockholders' equity:
Class A Common Stock, $.001 par value, 20,000,000 shares
authorized, 13,055,587 shares and 11,486,761 shares issued and
outstanding at September 30, 1998 and December 31, 1997,
respectively.................................................... 13,000 11,000
Class B Common Stock, $.001 par value, 250,000 shares
authorized, 249,292 shares and 250,000 shares issued and
outstanding at September 30, 1998 and December 31, 1997,
respectively ................................................... -- --
Additional paid-in capital .......................................... 63,611,000 45,149,000
Accumulated deficit ................................................. (5,633,000) (11,132,000)
------------ ------------
Total stockholders' equity ...................................... 57,991,000 34,028,000
------------ ------------
Total liabilities and stockholders' equity ...................... $ 80,770,000 $ 44,363,000
============ ============
</TABLE>
The accompanying notes are an integral part
of these condensed consolidated balance sheets.
4
<PAGE> 5
ORTHALLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------ ------------
<S> <C> <C>
Net revenues ..................................... $ 53,404,000 $ 4,054,000
------------ ------------
Direct expenses:
Salaries and benefits ............................ 16,641,000 1,383,000
Orthodontic supplies ............................. 5,215,000 319,000
Rent ............................................. 4,557,000 390,000
------------ ------------
Total Direct Expenses ............................ 26,413,000 2,092,000
Depreciation and amortization .................... 1,708,000 53,000
General and administrative expenses .............. 15,472,000 946,000
Non-recurring organizer compensation expense ..... -- 3,392,000
------------ ------------
Total expenses ................................... 43,593,000 6,483,000
------------ ------------
Net operating income (loss) ...................... 9,811,000 (2,429,000)
Interest expense ................................. (233,000) --
Interest income .................................. 272,000 --
------------ ------------
Income (loss) before income taxes ................ 9,850,000 (2,429,000)
Provision for (benefit from) for income taxes .... 4,297,000 (199,000)
------------ ------------
Net income (loss) ................................ $ 5,553,000 $ (2,230,000)
============ ============
Basic and diluted net
income (loss) per share .......................... $ 0.43 $ (1.30)
============ ============
Number of shares used in
calculating basic net
income (loss) per share .......................... 12,929,098 1,714,751
============ ============
Number of shares used in
Calculating diluted net
income (loss) per share .......................... 12,983,471 1,714,751
============ ============
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
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ORTHALLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------ ------------
<S> <C> <C>
Net revenues ..................................... $ 20,042,000 $ 4,054,000
------------ ------------
Direct expenses:
Salaries and benefits ............................ 6,291,000 1,383,000
Orthodontic supplies ............................. 2,031,000 319,000
Rent ............................................. 1,598,000 390,000
------------ ------------
Total Direct Expenses ............................ 9,920,000 2,092,000
Depreciation and amortization .................... 634,000 53,000
General and administrative expenses .............. 5,727,000 946,000
Non-recurring organizer compensation expense ..... -- 916,000
------------ ------------
Total expenses ................................... 16,281,000 4,007,000
------------ ------------
Net operating income (loss) ...................... 3,761,000 47,000
Interest expense ................................. (138,000) --
Interest income .................................. 76,000 --
------------ ------------
Income before income taxes ....................... 3,699,000 47,000
Provision for income taxes ....................... 1,627,000 424,000
------------ ------------
Net income (loss) ................................ $ 2,072,000 $ (377,000)
============ ============
Basic and diluted net
income (loss) per share .......................... $ 0.16 $ (0.08)
============ ============
Number of shares used in
Calculating basic net
income (loss) per share .......................... 13,268,784 4,607,995
============ ============
Number of shares used in
Calculating diluted net
income (loss) per share .......................... 13,276,739 4,607,995
============ ============
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
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<PAGE> 7
ORTHALLIANCE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------ ------------------
<S> <C> <C>
Cash flows from operating activities:
Net income ............................................. $ 5,553,000 $ (2,230,000)
Adjustments to reconcile net income to net cash
Provided by operating activities:
Depreciation and amortization ......................... 1,708,000 53,000
Non-recurring organizer compensation expense .......... -- 2,435,000
Changes in assets and liabilities, excluding
Effects of acquisitions:
(Increase) decrease in patient receivables ............ (658,000) 340,000
(Increase) decrease in due from Allied Practices ...... (4,094,000) 1,048,000
(Increase) decrease in other current assets ........... (216,000) 8,000
Decrease in other intangible assets, net .............. 19,000 --
Increase (decrease) in accounts payable and
accrued liabilities .................................. 550,000 (340,000)
Increase in due to Allied Practices ................... 2,378,000 --
Increase in patient prepayments ....................... 937,000 --
(Decrease) increase in income taxes payable ........... (465,000) (197,000)
------------ ------------
Net cash provided by operating activities .............. 5,712,000 1,117,000
------------ ------------
Cash flows from investing activities:
Payment for new practice affiliations ................. (20,266,000) (831,000)
Loans to Allied Orthodontists ......................... (1,332,000) --
Purchase of loans from Allied Practices ............... (386,000) --
Principal payments on loans ........................... 348,000 --
Capital expenditures .................................. (550,000) (8,000)
------------ ------------
Net cash used in investing activities ................. (22,186,000) (839,000)
------------ ------------
Cash flows from financing activities:
Increase in bank overdraft ............................ 22,000 --
Proceeds from exercise of stock options ............... 255,000 --
Borrowing on line of credit ........................... 9,500,000 --
Proceeds from issuance of common stock ................ -- 33,368,000
Proceeds from issuance of warrants .................... -- 2,000
Dividends paid to shareholders of founding
affiliated practices ................................. -- (13,759,000)
Payment of liabilities ................................ (1,910,000) (2,417,000)
------------ ------------
Net cash provided by financing activities ............. 7,867,000 17,194,000
------------ ------------
Net (decrease) increase in cash and cash equivalents .. $ (8,607,000) $ 17,472,000
============ ============
Cash and cash equivalents at beginning of period ....... $ 12,647,000 $ --
Cash and cash equivalents at end of period ............. $ 4,040,000 $ 17,472,000
============ ============
Supplemental cash flow information:
Interest paid ......................................... $ 107,000 $ 64,000
Income taxes paid ..................................... 4,806,000 --
Noncash investing and financing activities
Acquisition of businesses:
Fair value of assets acquired ......................... $ 39,270,000 $ 19,254,000
Less: Issuance of common stock ........................ (18,225,000) (7,735,000)
Less: Cash paid ....................................... (20,265,000) (831,000)
------------ ------------
Liabilities assumed ................................... $ 780,000 $ 10,688,000
============ ============
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
7
<PAGE> 8
ORTHALLIANCE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
1. DESCRIPTION OF ORGANIZATION AND BASIS OF PRESENTATION
Organization
OrthAlliance, Inc. ("OrthAlliance" or the "Company") (formerly known as
Premier Orthodontic Holdings, Inc.), a Delaware corporation, was founded in
October, 1996 to provide practice management and consulting services
(collectively "management services") to orthodontic practices in the United
States.
On August 26, 1997, OrthAlliance acquired (the "Acquisitions")
simultaneously with the closing of the initial public offering (the "Offering"
or "IPO") of its Class A Common Stock ("Common Stock"), certain operating assets
of or the stock of entities holding certain tangible and intangible assets, and
assumed certain liabilities of 55 orthodontic practices (collectively, the
"Founding Practices") in exchange for 5,882,985 shares of Common Stock and
$13,800,000 in cash. The underwriters exercised an overallotment option to
purchase an additional 390,000 shares of Common Stock, thereby increasing the
number of shares of Common Stock offered in the IPO from 2,600,000 to 2,990,000.
The net proceeds of the shares of Common Stock issued in the IPO (after
deducting the underwriting discounts and commission) were $33,368,400. The
Acquisitions have been accounted for in accordance with the Securities and
Exchange Commission's Staff Accounting Bulletin No. 48.
Effective prior to the closing of the IPO, Premier Orthodontic Group, Inc.
("Premier") and US Orthodontic Care, Inc. ("USOC") merged with and into
OrthAlliance. In the merger, the outstanding common stock of USOC and Premier
converted into an aggregate of 1,750,000 shares of Common Stock and 250,000
shares of Class B Common Stock ("Class B Common Stock"). Each share of USOC
common stock converted into 0.496 shares of Common Stock and 0.071 shares of
Class B Common Stock. Each share of Premier common stock converted into 5,250
shares of Common Stock and 750 shares of Class B Common Stock. The USOC and
Premier stockholders received an aggregate of 1,225,000 and 525,000 shares of
Common Stock and 175,000 and 75,000 shares of Class B Common Stock,
respectively. Premier and USOC incurred certain expenses related to the Offering
prior to the merger totaling approximately $2,200,000.
OrthAlliance began to conduct the business of providing management services
to the Founding Practices on August 26, 1997. Subsequent to the IPO, the Company
has entered into agreements for management services with additional orthodontic
and pediatric dental practices. These new practices along with the Founding
Practices collectively shall be referred to as "Allied Practices".
Basis of Presentation
The condensed consolidated financial statements included herein have been
prepared by the Company without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission (the "SEC"). Pursuant to such
regulations, certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. The Company believes the presentation
and disclosure herein are adequate to make the information not misleading. The
financial statements reflect all elimination entries and normal adjustments that
are necessary for a fair presentation of the results for the interim period
ended September 30, 1998.
Operating results for interim periods are not necessarily indicative of the
results for full years. These condensed consolidated financial statements should
be read in conjunction with the Financial Statements of OrthAlliance and related
notes thereto, and management's discussion and analysis related thereto, all of
which are included in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1997 (the "Annual Report").
In the opinion of Company management, the accompanying condensed
consolidated financial statements include the accounts of the Company and all
adjustments necessary to present fairly the Company's financial position at
September 30, 1998 and December 31, 1997, and its results of operations and cash
flows for the nine months and the three months ended September 30, 1998 and
September 30, 1997.
Certain prior year amounts have been reclassified to conform to the 1998
presentation.
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2. PEDOALLIANCE, INC.
On December 19, 1997, the Company created a new wholly owned subsidiary,
PedoAlliance, Inc., a Delaware Corporation ("PedoAlliance"). PedoAlliance was
formed to provide practice management or consulting services to pediatric dental
practices ("Allied Pediatric Practices") located throughout the United States.
PedoAlliance intends to manage the business aspects of or consult with, Allied
Pediatric Practices, thereby allowing the pediatric dentist ("Allied Pediatric
Dentist") to focus on delivering cost-effective, high quality patient care, and
to provide capital for the development and growth of such pediatric dental
practices. As of September 30, 1998, PedoAlliance had affiliated with five
Allied Pediatric Practices that included ten Allied Pediatric Dentists operating
out of six offices. These practices generated $5.9 million in annual patient
revenues for the 12 month period immediately prior to affiliating with
PedoAlliance. Prior patient revenue is not necessarily indicative of the level
of revenue these practices may be expected to generate in the future. The total
consideration paid for these practices, excluding acquisition costs, was
$5,979,348. This consideration consisted of 85,493 shares of Common Stock with
an aggregated value at various stock prices of $1,286,882 and payment of
$4,692,466 cash and assumed debt.
3. NEW AFFILIATIONS
From January 1, 1998 to September 30, 1998, the Company affiliated with 24
orthodontic practices which included 30 additional orthodontists ("Allied
Orthodontic Dentists") for a total consideration, excluding acquisition costs,
of $32,530,565. This consideration consisted of 1,417,263 shares of Common Stock
with an aggregated value at various share prices of $16,938,266 and payment of
$15,592,299 in cash and assumed debt. These orthodontists operated out of 55
locations and generated patient revenue of approximately $29.6 million during a
12 month period immediately preceding the date of affiliation. Prior patient
revenue is not necessarily indicative of the level of revenue these practices
may be expected to generate in the future. The Company has entered into
agreements with certain Allied Practices to make the payment of management fees
after the first two years contingent on various factors, including relative
practice profitability, acquisition consideration, timely reporting of
information, participation in practice improvement programs and orthodontist
hours worked.
During the period July 1, 1998 to September 30, 1998, two orthodontists
ended their affiliation with certain Allied Practices. It is anticipated that
these orthodontists will be replaced with new associates once appropriate
candidates are recruited and affiliated. Some associate positions have been
eliminated due to enhanced practice efficiencies that made it possible for
Allied Practices to continue their businesses without the associates.
Considering these terminations, as of September 30, 1998, the Company was
affiliated with 131 Allied Pediatric Dentists and Allied Orthodontic Dentists
(collectively, "Allied Practitioners").
4. ORTHALLIANCE FINANCE, INC.
On October 7, 1997, the Company created a wholly owned subsidiary,
OrthAlliance Finance, Inc., a Delaware corporation ("OrthAlliance Finance").
OrthAlliance Finance has established a patient financing program for approved
patients of Allied Practices and non-affiliated practices, and purchases loans
made by these practices to their patients. OrthAlliance Finance usually pays
100% of the discounted consideration for these loans, upon receipt of the
appropriate loan documentation. Alternatively, OrthAlliance Finance pays these
practices approximately 20% of the total discounted consideration and pays the
balance, with interest, over approximately 24 months at the option of the
practice. As of September 30, 1998, OrthAlliance Finance had purchased 115 loans
for a total value of $386,000.
5. LOCK-UP AGREEMENTS
The Company issued 7,632,985 shares ("Initial Shares") of unregistered
Common Stock to its initial shareholders ("Initial Shareholders") immediately
prior to or concurrent with the closing of its IPO in August 1997. Of those
Initial Shares, 7,126,537 shares were subject to a one-year lock-up agreement
with J. C. Bradford & Co. ("Representative") as representative for the
underwriters for the IPO, under which agreement the shareholders agreed not to
sell, transfer, give, pledge, assign, irrevocably hypothecate or otherwise
dispose of such Initial Shares during the one year period ending August 21, 1998
without the prior written approval of the Representative, except in certain
limited circumstances. On or about August 21, 1998, certain of the Initial
Shareholders owning approximately six million shares of the unregistered Common
Stock entered into new lock-up agreements with the Representative, pursuant to
which certain of the Initial Shareholders agreed not to sell, transfer, give,
pledge, assign, irrevocably hypothecate or otherwise dispose of such shares
during a new one year period without the prior written consent of the
Representative,
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<PAGE> 10
except that these Initial Shareholders may: (i) give or pledge any Initial
Shares without the prior written approval of the Representative if the donee or
pledgee agrees in writing prior to such gift or pledge to be bound by the terms
of the lock-up agreement, (ii) sell up to fifteen percent (15%) of the Initial
Shares during a thirty (30) day period starting in approximately six months from
the execution of the agreement and (iii) margin up to fifteen percent (15%) of
the Initial Shares with an Initial Shareholder's stock broker.
6. SUBSEQUENT EVENTS
Stock Repurchase
On October 22, 1998 the Company announced that the Board of Directors
approved the repurchase of up to $5 million of the Company's Common Stock. The
Company was authorized to purchase shares from time to time over a 12 month
period on Nasdaq Stock Market's National Market at prices prevailing on that
market. Based upon the price of the Company's Common Stock at the time of the
announcement, which was $8 5/8, the Company could purchase as much as 580,000
shares. The Company will use cash generated from operations or from the line of
credit with First Union National Bank to finance any purchases under this
program.
Contract Revision
The Management Service and Consulting Agreements ("Management Agreements")
between OrthAlliance and the Allied Practices state that OrthAlliance will
provide practice management services to the practices in exchange for certain
monthly management or consulting fees. Most of the contracts executed through
September 30, 1998 provided that in addition to the regular monthly fees,
OrthAlliance was entitled to collect a potential annual adjustment of 25% of the
increase in operating margin in a fiscal year the preceding fiscal year
multiplied by the patient revenue for the current fiscal year. Operating margin
was defined as the percentage determined by dividing operating profit by patient
revenue. For all contracts executed after September 30, 1998, the 25% annual
adjustment has been removed.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
The Company began providing management services to Allied Practices in the
United States on August 26, 1997 and therefore, comparisons with the first nine
months or third quarter of 1997 are not meaningful. The initial 55 Allied
Practices included 82 Allied Orthodontists operating 147 offices in 16 states.
By September 30, 1998, the Company had affiliated with 51 additional Allied
Orthodontic Dentists and Allied Pediatric Dentists operating out of 88 new
locations.
The Company has entered into either a service agreement ("Service
Agreement") or a consulting and business services agreement ("Consulting
Agreement") with each Allied Practice. Under the Service Agreements, the Company
provides practice management services to Allied Practices in exchange for
certain management fees. Under the Consulting Agreements, the Company provides
consulting services in exchange for consulting fees. From time to time the
Company has entered into and may enter into agreements with certain Allied
Practices to make the payment of such management fees after a certain period of
time contingent on various factors, including relative practice profitability,
acquisition consideration, timely reporting of information, participation in
practice improvement programs and dentist hours worked. Except with respect to
six Service Agreements providing for the payment of flat fees, the management
fees earned by the Company are based on a negotiated percentage of the Adjusted
Patient Revenue of the Allied Practices. Adjusted Patient Revenue is net patient
revenue, as determined under generally accepted accounting principles, including
adjustments for contractual allowances and other discounts, plus an adjustment
for uncollectible accounts. For orthodontic practices, patient revenue is
recognized as orthodontic services are performed. If a patient enters into a
long-term orthodontic services contract, approximately 20% of the contract value
is recognized at the time of initial treatment. The balance of the contract
revenue is realized evenly over the remaining treatment period. The 20% revenue
recognized at the initial treatment date is based on the estimated costs
incurred by the practice at that time as compared to the total costs of
providing the contracted services and is consistent with industry standards. For
pediatric dental practices patient revenue is recognized as dental services are
provided. Pursuant to the Management Agreements, the Company incurs the expenses
necessary to manage and administer each Allied Practice and such expenses are
paid from funds generated by such Allied Practice. Such expenses include, but
are not limited to, salaries, wages and benefits of Allied
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<PAGE> 11
Practice personnel (excluding practitioners and, in some cases, certain clinical
personnel), the office (general and administrative) expenses of the Allied
Practices and depreciation and amortization of assets acquired from the Allied
Practices. The Company also incurs personnel and administrative expenses in
connection with maintaining corporate offices, from which the Company provides
the management services.
Results Of Operations (Unaudited)
The following table sets forth the percentage of certain items in relation
to net revenues in the Company's condensed consolidated statements of income.
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
------------------ ------------------
<S> <C> <C>
Net Revenue ...................... 100.0% 100.0%
Direct Expenses
Employee costs ................... 31.2 31.4
Practice supplies ................ 9.8 10.1
Rent ............................. 8.5 8.0
----- -----
Total direct expenses ............ 49.5 49.5
Depreciation and amortization .... 3.2 3.2
General and Administrative ....... 29.0 28.6
----- -----
Net operating income ............. 18.3 18.7
Interest expense ................. (0.4) (0.7)
Interest income .................. 0.5 0.4
----- -----
Income before income taxes ....... 18.4 18.4
Provision for income taxes ....... 8.0 8.1
----- -----
Net income ....................... 10.4 10.3
</TABLE>
Net Revenue. Net revenue was $53,404,000 and $20,042,000 for the nine month
and three month periods ending September 30, 1998 respectively. Net revenue for
the third quarter of 1998 increased 7.1% from the prior quarter. This increase
was caused primarily by an increase in new patient starts at existing
orthodontic practices. The Company began operations on August 26, 1997, and only
reported one month of operations for the third quarter of 1997. Therefore there
is no meaningful comparison of net revenue in the third quarter of 1998 with the
same period in the prior year. Net revenue reported by the Company is derived by
applying the appropriate management fee percentage against Adjusted Patient
Revenue, and adding the reimbursement from the Allied Practices of practice
expenses paid by the Company. In addition, the Company includes in revenue the
amortization of certain deferred revenue balances that were acquired from the
Allied Practices. Deferred revenue is recognized as the orthodontist provides
the services that were prepaid by patients before the practice affiliated with
the Company.
Direct Expenses. Direct expenses include clinical expenses paid and
corporate expenses incurred during the quarter. Most expense categories in the
third quarter of 1998 compared to the second quarter increased due to the
addition of new Allied Practices in the third quarter. All direct expense
categories are consistent with management's expectations based upon expense
information provided by the Allied Practices prior to affiliation with the
Company. Direct expenses as a percent of net revenue in the third quarter are
consistent with similar percentages for the first nine months of 1998.
Depreciation and Amortization. Depreciation and amortization expense
relates to the depreciation of capital assets and the amortization of intangible
assets acquired from new practice affiliations. Service agreement intangibles
are amortized over the period expected to benefit from the existence of the
agreement, not to exceed the term of the Management Agreements, which range from
20 to 25 years. Depreciation and amortization expense increased in the third
quarter of 1998 compared with the second quarter due to additional service
agreement intangible asset amortization associated with recent practice
affiliations. Total depreciation and amortization expense is consistent with
management's expectations based upon the number and size of the affiliations
completed.
General and Administrative Expenses. General and administrative expenses
include practice administration expenses and corporate expenses pertaining to
accounting, legal, marketing and advertising. General and administrative
expenses increased during the third quarter of 1998 compared with the second
quarter of 1998, primarily due to additional practice administration expenses
associated with new practice affiliations.
Non-recurring Organizer Compensation. In the third quarter of 1997, the
Company issued warrants to owners of certain Founding Practices and Jonathan
Wilfong and Robert D. Garces for their assistance in the Offering. The Company
recorded compensation expense of approximately $0.9 million for the fair value
of these warrants.
11
<PAGE> 12
Interest Income. Represents interest earned on excess cash balances
invested primarily in short-term money market accounts, loans to affiliated
practices and loans to patients through OrthAlliance Finance. Earnings on
invested excess cash declined during the quarter as excess cash balances were
used as consideration for practice affiliations.
Interest Expense. Represents interest incurred on borrowings against the
Company's $25 million revolving credit facility. The increase in the outstanding
balance of the credit facility caused interest expense to increase during the
quarter.
Liquidity and Capital Resources
The patient receivables of the Allied Practices are recorded at net
realizable value on the date of purchase by the Company. Any subsequent
uncollectable amount is written off by OrthAlliance and is funded by the Allied
Practice. These accounts receivable should generate funds required for (i) the
expenses incurred by the Company to manage and administer the Allied Practices,
(ii) the management fees, and (iii) salaries for other employees of the Allied
Practices, with the balance due to the Allied Practitioners.
For the nine months ended September 30, 1998, the Company used $8.6 million
in cash. The decline in cash during this period was caused by continuing
investment of cash in new practice affiliations. During the first nine months of
1998, $22.2 million in cash was used in investing activities mostly due to the
consideration paid for new affiliations during the quarter. Financing activities
provided $7.9 million in cash composed principally of the draws from the
Company's credit facility with First Union National Bank. Operations provided
$5.7 million for the first three quarters of 1998.
As of September 30, 1998, the Company had a working capital balance of
approximately $8.3 million, a decrease of $4.8 million from December 31, 1997.
The decline in working capital is primarily attributable to investments in new
practice affiliations. The Company continues to anticipate that the primary uses
of its capital will include additional affiliation with orthodontic and
pediatric dental practices, expenditures related to the development of satellite
offices and funding the working capital needs of the Company and the Allied
Practices. The Management Agreements provide for advances by the Company to the
Allied Practices for working capital requirements and other purposes. Such loans
generally bear interest at prime plus one percent and are repayable over varying
periods not to exceed five years. It is anticipated that the foregoing capital
expenditures will be funded from the Company's cash flow from operations,
existing working capital and borrowings under the revolving credit facility.
Year 2000 Compliance
The Company has reviewed the systems utilized by the corporate office in
all areas of office automation, including payroll, payables, general ledger and
data management. In all cases the systems are already in compliance with Year
2000 requirements or the developers of the systems have a Year 2000 compliant
version available. The Company intends to upgrade the remaining systems at the
corporate office that are not already in compliance with a compliant version
before the end of 1998. The cost to upgrade these systems is minimal since the
upgrades are provided by the developers under the maintenance agreements already
in place.
In the event the Company fails to identify all of the systems at risk for
possible failure due to the Year 2000 issue, the Company plans to retain a
complete copy of the systems and data in use prior to December 31, 1999. If
after the Company begins operations in the Year 2000 it is determined that a
system has failed, the Company can reset all system clocks to a date prior to
January 1, 2000 and restore the affected systems from the copy. This will
provide the Company with more time to repair the affected systems.
The Company does not own any "Non-IT" systems at the corporate office that
might also be affected by the Year 2000 issue. As an example, the Company does
not own any automated machinery, elevators, telephone switches, or other
equipment that might contain microcontrollers. Therefore, the Company does not
believe that it is at risk from any failure associated with these kinds of
devices. The Company may own some "Non-IT" systems in practice offices that
might be affected by the Year 2000 issue. The Company has not yet determined
which offices may contain such devices. The Company plans to evaluate all
equipment owned by the Company in each Allied Practice office to determine if
any such devices exist. The cost to repair any devices found would be reimbursed
to the Company by the affected Allied Practices.
The Company has not performed an evaluation of any of the systems installed
in each of its Allied Practice offices. Therefore, the Company is not aware of
which systems are currently Year 2000 compliant. The Company aims to evaluate
the Allied Practice office systems for Year 2000 compliance before the end of
1998, and plans to work with those practice offices where Year 2000 issues
12
<PAGE> 13
are identified to either upgrade, replace or modify non-compliant systems with
compliant systems. The Company will develop a timetable for completing this
effort for each Allied Practice office once it is determined which offices and
which systems are affected. Since the Company is not aware of which systems are
currently Year 2000 compliant, the Company is not aware of the costs associated
with upgrading these systems to Year 2000 compliance; however, any costs
incurred by the Company to complete a systems upgrade would be reimbursed to the
Company by each Allied Practice. The Company has not performed a detailed
analysis of each system to determine the impact on the Company in the event any
Allied Practice failed to upgrade any one of their office systems prior to the
end of 1999; however, the Company believes that the only two office systems that
might have a direct impact on its operations are the practice management systems
and accounts payable systems. In some instances, Allied Practice offices have
installed a network of computers that rely upon a central database server for
multiple user access to information. In these instances, failure by these Allied
Practice offices to upgrade the network system to be Year 2000 compliant, could
affect the practice management and accounts payable systems, even if these later
two systems are themselves Year 2000 compliant. The Company believes that the
impact on Company operations from a failure of the practice management or
accounts payable systems would be minimal. Failure of the practice management
systems can be mitigated by manual posting of payments to client records.
Failure of the accounts payable system can be mitigated by manual preparation of
vendor payments. Although additional staffing may be necessary to perform these
tasks without the benefit of the affected automated systems, these functions are
not critical to providing orthodontic or pediatric dental services. Therefore,
the Company believes that operations can continue relatively unaffected by a
failure of an Allied Practice office to upgrade their system to Year 2000
compliance.
The Company has not performed an evaluation of all of the significant third
party entities to determine if a failure by any one of them to upgrade their
systems to Year 2000 compliance could have an adverse impact on the Company.
Some of the significant third party entities that the Company currently has a
material relationship, include General Telephone, MCI, Automated Data
Processing, Edison International and all of the various financial institutions
with which the Company currently has banking relationships. The Company has not
yet assessed the risks associated with a failure by any of the systems utilized
by these entities and what steps can be taken to mitigate these risks.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Applicable.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) None
(b) None
(c) None
(d) None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(a) None
(b) None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
13
<PAGE> 14
(a) None
(b) None
(c) None
(d) None
ITEM 5. OTHER INFORMATION.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 of the Company's
Registration Statement on Form S-1, Registration No. 333-27143, as
amended).
3.2 Amended and Restated Bylaws of the Company (incorporated by reference
to Exhibit 3.2 of the Company's Registration Statement on Form S-1
Registration No. 333-27143, as amended).
4.1 Amended and Restated Certificate of Incorporation of the Company,
including, without limitation Section 4 (incorporated by reference to
Exhibit 3.1 of the Company's Registration Statement on Form S-1,
Registration No. 333-27143, as amended).
4.2 Amended and Restated Bylaws of the Company (incorporated by reference
to Exhibit 3.2 of the Company's Registration Statement on Form S-1
Registration No. 333-27143, as amended).
27.1 Financial Data Schedule.
99.1 Safe Harbor Compliance Statement.
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended
September 30, 1998.
14
<PAGE> 15
SIGNATURES
Pursuant to the requirements 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.
ORTHALLIANCE, INC.
(Registrant)
Date: September 13, 1998 By: /s/ Sam Westover
----------------------------------
Sam Westover,
President and
Chief Executive Officer
Date: September 13, 1998 By: /s/ Robert Chilton
----------------------------------
Robert Chilton,
Chief Financial Officer
15
<PAGE> 16
Exhibit Describition
- ------- ------------
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 of the Company's
Registration Statement on Form S-1, Registration No. 333-27143, as
amended).
3.2 Amended and Restated Bylaws of the Company (incorporated by reference
to Exhibit 3.2 of the Company's Registration Statement on Form S-1
Registration No. 333-27143, as amended).
4.1 Amended and Restated Certificate of Incorporation of the Company,
including, without limitation Section 4 (incorporated by reference to
Exhibit 3.1 of the Company's Registration Statement on Form S-1,
Registration No. 333-27143, as amended).
4.2 Amended and Restated Bylaws of the Company (incorporated by reference
to Exhibit 3.2 of the Company's Registration Statement on Form S-1
Registration No. 333-27143, as amended).
27.1 Financial Data Schedule.
99.1 Safe Harbor Compliance Statement.
<PAGE> 1
EXHIBIT 99.1
SAFE HARBOR COMPLIANCE STATEMENT
The Company believes that the following factors could cause actual results
to differ materially from those in forward-looking statements set forth in this
Form 10-Q.
1. The Company's ability to grow through affiliations with additional
orthodontic and pediatric dental practices (collectively, the "Allied
Practices").
2. The Company's ability to identify suitable affiliation candidates and to
profitably manage or successfully integrate new Allied Practices with the
Company and its existing Allied Practices.
3. The level of competition in the orthodontic and pediatric dental practice
management industries.
4. Regulatory development and changes in the United States healthcare system
and dental and orthodontic professions that may affect the profitability of
the Company or the enforceability of the Company's operative agreements
with its Allied Practices and orthodontist and pediatric dentists
(collectively, the "Allied Orthodontists") affiliated with the Allied
Practices.
5. The Company's dependence on revenues generated by the Allied Orthodontists
of the Allied Practices.
6. The Company's ability to secure capital, and the related cost of such
capital, needed to fund the future growth of the Company through
affiliations with orthodontic and pediatric dental practices as well as
internal growth.
7. The Company's ability to staff the Allied Practices with appropriate
qualified personnel.
8. The continued availability to the Company of adequate insurance.
9. The Allied Practices' reputation for delivering high-quality patient care
and their ability to attract and retain patients.
10. Unexpected complications and costs arising from the Company's, Allied
Practices' and material third party entities efforts to make all systems
Year 2000 compliant.
The foregoing factors should not be construed as exhaustive or as an
admission regarding the adequacy of disclosures previously made by the
Company.
16
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