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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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 other jurisdiction of (I.R.S. employer
Incorporation or organization) identification no.)
21535 HAWTHORNE BOULEVARD, SUITE 200 90503
TORRANCE, CALIFORNIA 90503 (Zip code)
(Address of principal executive offices)
Registrant's telephone number, including area code:
(310) 792-1300
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Class A Common Stock, par value $.001 per share
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. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 11, 1999 (based on the last reported closing price
per share of Common Stock as reported on The Nasdaq National Market on such
date) was approximately $102,741,000. As of March 11, 1999, the registrant had
13,039,205 shares of Class A Common Stock outstanding and 249,292 shares of
Class B Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held on June 3, 1999 are incorporated by reference in Part III.
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Certain statements in this Form 10-K under the captions "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and in certain documents incorporated by reference herein constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended (the "1933 Act"), and Section 21E of the Securities
Exchange Act of 1934, as amended (the "1934 Act"). Those statements include
statements regarding the intent, belief or current expectations of OrthAlliance,
Inc. and its wholly owned subsidiaries (collectively referred to as the
"Company") and members of its management team. Management cautions that any such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties, and that actual results may differ materially from
those contemplated by such forward-looking statements. Important factors
currently known to management that could cause actual results to differ
materially from those in forward-looking statements are set forth in the Safe
Harbor Compliance Statements included as Exhibit 99.1 to this Form 10-K, and are
hereby incorporated herein by reference. The Company undertakes no obligation to
update or revise forward-looking statements to reflect changed assumptions, the
occurrence of unanticipated events or changes to future operating results over
time.
PART I
ITEM 1. BUSINESS.
GENERAL
The Company was incorporated on October 21, 1996 and provides practice
management or consulting services to orthodontic practices throughout the United
States. The Company (i) manages or provides consulting services with respect to
certain business aspects of orthodontic and pediatric dental practices
affiliated with the Company (the "Allied Practices"), and (ii) provides capital
for the development and growth of Allied Practices. On August 26, 1997, the
Company affiliated with 55 Allied Practices with 81 orthodontists and 1
pediatric dentist at the Allied Practices (the "Allied Orthodontists") operating
147 offices in 16 states pursuant to long-term management service or consulting
agreements, and commenced its initial operations. From August 26, 1997 to
December 31, 1998, the Company increased the number of Allied Practices to a net
total of 96, with 137 Allied Orthodontists operating 245 offices in 29 states.
The Company intends to continue to expand its network of Allied Practices and to
target orthodontic and pediatric dental practices that management believes are
leading practices in their markets based upon a variety of factors, including
size, profitability, historical growth and reputation for high quality care,
among local consumers of orthodontic services and within the orthodontic and
pediatric dental services industry. The Company believes that affiliations with
orthodontists will continue to represent the majority of any additional
affiliations.
The Company provides fee-based management or consulting services to its
Allied Practices thereby allowing Allied Orthodontists to concentrate on
providing cost effective, quality patient care. The Company does not practice
orthodontics or dentistry, but generally acquires certain operating assets of an
orthodontic and pediatric dental practice, employs the employees (except
orthodontists and dentists, and where applicable law requires, hygienists and
dental assistants), and enters into service or consulting agreements with the
Allied Practices whereby the Company provides management or consulting services
to the Allied Practices, including billing and collections, cash management,
purchasing, inventory management, payroll processing, advertising and marketing,
financial reporting and analysis, productivity reporting and analysis, training,
associate orthodontist recruiting and capital for satellite office development
and acquisitions. Where state law allows and upon request by an Allied Practice,
the Company leases equipment or office space to the Allied Practices. Unless
otherwise indicated by the context, references herein to practice management
services, agreements or rights include consulting or similar arrangements that
the Company has or will enter into with certain Allied Practices in order to
comply with applicable regulations in certain states regarding practice
management.
The Company has two wholly-owned subsidiaries, PedoAlliance, Inc.
("PedoAlliance") and OrthAlliance Finance, Inc. ("OA Finance"). PedoAlliance was
formed in December 1997 to provide practice management or consulting services to
pediatric dental practices. Commencing from May 1, 1998 through December 31,
1998, PedoAlliance entered into management or consulting agreements with seven
pediatric dental practices, with 12 pediatric dentists ("Allied Dentists")
operating eight offices in seven states, all of which are included in the
Company information set forth above. Unless the context indicates otherwise,
certain references herein to Allied Orthodontists or Allied Practitioners also
include Allied Dentists. OA Finance was formed in October 1997 to offer
financing alternatives to the patients of the Allied Practices. During 1998, OA
Finance funded 153 loans to patients for a total value of $508,000 of which
$445,000 was outstanding as of December 31, 1998.
For the year ended December 31, 1998, the Company generated an operating
profit of $13,755,000 on $74,387,000 in net revenue.
THE ORTHODONTIC INDUSTRY
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Orthodontics, the art and science of correcting the misalignment of teeth,
has historically been one of the most profitable specialties in dentistry.
Orthodontic research and education have aided the development of new materials
and techniques of orthodontic treatment, including the use of computers to help
solve complex cases. In 1996, orthodontists in the United States conducted
examinations of nearly 2.5 million potential new patients and initiated
treatment for approximately 1.6 million patients. The typical orthodontist
initiated treatment for approximately 180 patients in 1996 and maintained
approximately 400 active cases. Unless otherwise indicated, industry information
is derived from the 1997 Journal of Clinical Orthodontists Orthodontic Practice
Study (the "JCO Study") and relates to 1996. The information compiled in the JCO
Study relates to orthodontists who have completed accredited graduate
orthodontic training programs and does not include general dentists who also
perform certain orthodontic services.
The primary target market for orthodontic treatment is children ages 8 to
18. In 1996, approximately 81%, or 1.3 million, of all patients treated were
children. The U.S. Census Bureau estimates that as of July 1, 1996, there were
approximately 37.6 million children and adolescents between the ages of 10 and
19. Management believes that as many as 80% of these children and adolescents
could benefit from orthodontic treatment. In addition to the traditional
juvenile market, the adult market has been a growing market for orthodontic
services. Based on statistics obtained from the JCO Study, management believes
that the adult market for orthodontic services remains largely untapped, as the
number of adults who need or want orthodontic treatment substantially exceeds
the number of patients currently seeking treatment. In 1996, standard case fees
averaged approximately $3,600 for children and $3,900 for adults.
There are approximately 9,000 practicing orthodontists in the United
States, nearly all of whom have graduated from accredited graduate programs of
orthodontics. The industry is highly fragmented, with approximately 90% of the
practicing orthodontists acting as sole practitioners and the balance practicing
in multiple-doctor practices (generally two orthodontists). The training and
qualification of an orthodontist is extremely rigorous. Generally, a dentist
must graduate in the top 10% of his or her class at an accredited graduate
school of dentistry, pass national and state board examinations, and complete an
accredited graduate orthodontic program to become an orthodontist. These
programs typically are structured as two- or three-year programs. Each year
about 200 new orthodontists graduate from accredited orthodontic programs.
THE PEDIATRIC DENTAL INDUSTRY
Pediatric dentistry is an age-defined specialty that provides both primary
and comprehensive preventative and therapeutic oral health care for infants and
children through adolescence, including those with special health care needs.
Pediatric dentists provide primary and specialty care in offices as well as in
hospital and other institutional sites and, when indicated, in conjunction with
other dental and medical disciplines. There are approximately 3,600 professional
active pediatric dentists in the United States. Pediatric dentists must complete
a specialty degree program which is typically two to three years in length.
Approximately 160 students are admitted each year to pediatric dental specialty
training programs.
The U.S. Bureau of the Census projects that between 1993 and 2020 there
will be an increase of 8.1 million children under the age of 15. Furthermore,
the number of practicing pediatric dentists has decreased from approximately
3,900 in 1990 to approximately 3,600 in 1997. The number of spaces available in
pediatric dental training programs has decreased from approximately 200 in 1990
to 160 in 1997. Accordingly, the Company believes that there will be an
increased demand for the services of pediatric dentists.
OPERATING STRATEGY
The Company's operating strategy focuses on enabling the Allied Practices
to compete more effectively and realize greater profitability than other
practices, thereby providing an inducement for additional practices to affiliate
with the Company. Key elements of the Company's operating strategy include:
EMPHASIZING QUALITY PATIENT CARE. Management believes that the services and
support it provides the Allied Orthodontists impact the level of patient care
positively by increasing the Allied Orthodontists' time available to concentrate
on patient care. The qualifications of providers of orthodontic and pediatric
dental services vary from general dentists who have taken weekend courses to
graduates of accredited three-year programs. Nearly all Allied Orthodontists
affiliated with the Allied Practices are graduates of accredited orthodontic or
pediatric dental programs. The Company established two clinical care advisory
committees, one consisting of Allied Orthodontists and the other consisting of
Allied Dentists, to formulate educational and training programs and to consult
with each other on current treatments, techniques and issues. Furthermore,
orthodontic and pediatric dental graduates recruited by the Company will be
required (in most cases) to complete a mentoring program pursuant to which such
graduates will provide treatment under the supervision and guidance of an
experienced Allied Orthodontist.
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CAPITALIZING ON THE BEST DEMONSTRATED PRACTICES OF ALLIED ORTHODONTISTS.
The Company identifies practice-level strategies that have proven successful for
individual Allied Practices and shares this information among other Allied
Practices. The Company provides Allied Orthodontists with comparative operating
and financial data to enable Allied Orthodontists to detect areas of their
practices that could be improved. The Company provides its own analysis of such
operating and financial data and recommends changes to improve performance. The
Company consults with Allied Practices that have had demonstrated success in a
certain area and generally seeks to facilitate communication among Allied
Practices through periodic conferences and meetings and, ultimately, through a
proprietary intranet system.
ACHIEVING OPERATING EFFICIENCIES AND ECONOMIES OF SCALE. The Company
implements a variety of operating procedures and systems to improve the
productivity and profitability of each Allied Practice and to achieve economies
of scale including, without limitation, centralized payroll processing and
national group purchasing contracts. The Company implements, with the practice's
consent, appropriate credit and collection policies which accommodate specific
needs of the target market of each Allied Practice. Operating efficiencies and
economies are instituted with the Allied Orthodontist's consent on a per market
or per Allied Practice need basis after analysis of work flow, patient flow,
aged accounts receivable history, facilities, employee work load and
productivity, and patient satisfaction.
INCREASING THE AFFORDABILITY OF PROFESSIONAL CARE THROUGH FLEXIBLE PAYMENT
PLANS. The Company assists Allied Practices in developing and implementing
payment plans designed to make orthodontic and pediatric dental services more
affordable to prospective patients. Many of the Allied Practices historically
received a down payment of approximately 20% of the total cost of orthodontic
services. Recognizing that orthodontic services are largely discretionary and
that a significant down payment is often a deterrent to prospective patients,
the Company believes that flexible payment plans are an effective means of
increasing patient volume. Payment plans are tailored to respond to the various
market demands and opportunities. The Company makes general recommendations to
all Allied Practices with respect to instituting flexible payment plans and
develops and implements market-tailored plans at the request of individual
Allied Practices. In addition, the Company provides the working capital
necessary for the Allied Practices to implement flexible payment plans which may
result in the reduction or elimination of down payments.
STIMULATING DEMAND IN LOCAL MARKETS THROUGH AGGRESSIVE MARKETING. In
consultation with and upon approval of the Allied Practices, the Company
develops and implements aggressive and innovative marketing plans to augment
each Allied Practice's referral and other marketing systems. Certain Allied
Practices have developed referral systems with local dentists. Upon the request
of an Allied Practice and in appropriate markets, the Company attempts to assist
such Allied Practice in reaching potential patients through print, local
television and radio advertising.
GROWTH STRATEGY
The Company's growth strategy includes affiliation with existing practices
in both new and existing markets, the development of satellite offices for
existing Allied Practices and internal growth through improved operating
efficiencies.
INTERNAL GROWTH THROUGH IMPROVED OPERATING EFFICIENCIES. The Company offers
a variety of operating procedures and systems to improve the productivity and
profitability of the Allied Practices. The Company implemented payroll
processing, financial reporting and analysis and national group purchasing
discounted contracts and implements appropriate credit and collection policies
which accommodate specific needs of each Allied Practice. Operating efficiencies
and economies are instituted on a per market or per Allied Practice need basis.
DEVELOPMENT OF SATELLITE OFFICES. If management determines market demand
supports practice expansion, the Company assists Allied Orthodontists in
developing satellite offices to be integrated into Allied Practices. The Company
provides a certain amount of capital for practice expansion, market research,
site selection, office design and marketing support for satellite office
development.
AFFILIATIONS WITH EXISTING PRACTICES. The Company targets for affiliations
a market that includes approximately half of the orthodontic and pediatric
dental practices in the United States (approximately 4,500 orthodontic practices
and 1,500 pediatric dental practices), which practices fit the Company model of
quality and opportunity for revenue and earnings growth. The Company believes
that affiliation will be an attractive option for existing practices, because
the Company (i) provides the capital to open and integrate new offices into
existing Allied Practices, (ii) identifies and recruits qualified associate
practitioners for the Allied Practices, (iii) designs and offers business and
clinical systems for each Allied Practice, (iv) with the approval of the Allied
Orthodontist, hires the necessary business and non-professional personnel for
each new Allied Practice, (v) helps increase each Allied Practice's market share
and the number of new patients seen by recommending marketing and advertising
strategies, and (vi) reduces the time Allied Orthodontists spend on
administrative and business related tasks, allowing them to focus on delivering
quality patient care.
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PAYMENT PLAN AND CASE FEES
PAYMENT PLAN; CASE FEES. At the initial orthodontic treatment, generally
the patient signs a contract outlining the terms of the treatment, including the
anticipated length of treatment and the total fees. Each Allied Orthodontist
determines the appropriate fee to charge for services to patients based upon
market conditions in the area served by that Allied Orthodontist. Generally, the
amount charged by the Allied Orthodontists is independent of the patient's
source of payment. The number of required monthly payments is estimated at the
beginning of the case and generally corresponds to the anticipated number of
months of treatment. Depending on the patient's credit history, the down payment
ranges from a substantial down payment to no down payment. Patients are
typically required to pay equal monthly installments, although each Allied
Practice offers a payment plan tailored to its market and patients.
If the treatment period exceeds the period originally estimated by the
Allied Orthodontist, the patient and the Allied Orthodontist will determine
whether payment for additional treatment will be required. If the treatment is
completed prior to the scheduled completion date, the patient is required to pay
the remaining balance of the contract. If a patient terminates the treatment
prior to the completion of the treatment period, the patient is required to pay
the balance due for services rendered to date.
Other payment plans with lower monthly payments are available for patients
who have insurance coverage for the treatment. Payments from patients with
insurance may be lower, depending upon the amount of the fee paid on behalf of
the patient by insurance policies. For patients with insurance coverage, the
portion of the fee not covered by insurance is paid by the patient and is
generally not waived or discounted by the Allied Practice.
LOCATION
As of December 31, 1998, the Company provided management services to Allied
Practices at the following locations:
<TABLE>
<CAPTION>
NUMBER OF NUMBER OF NUMBER OF
STATE PRACTITIONERS(1) OFFICES CITIES
- ----- ---------------- --------- ---------
<S> <C> <C> <C>
Alabama............................. 4 7 5
Arizona............................. 9 9 5
Arkansas............................ 1 1 1
California.......................... 23 36 32
Colorado............................ 6 4 3
Florida............................. 19 37 27
Georgia............................. 27 55 38
Hawaii.............................. 2 5 5
Illinois............................ 1 1 1
Indiana............................. 7 16 15
Kansas.............................. 1 2 2
Kentucky............................ 2 6 6
Maryland............................ 3 1 1
Massachusetts....................... 1 1 1
Michigan............................ 1 1 1
Minnesota........................... 3 4 4
Mississippi......................... 2 7 7
New York............................ 1 1 1
Ohio................................ 2 5 5
Oregon.............................. 1 3 3
Pennsylvania........................ 2 3 3
South Carolina...................... 3 5 5
South Dakota........................ 2 7 6
Tennessee........................... 5 6 6
Texas............................... 4 10 10
Utah................................ 2 2 2
Virginia............................ 1 2 2
Washington.......................... 2 7 7
Wyoming............................. -- 1 1
-- - -
Total.......................... 137 245 205
=== === ===
</TABLE>
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(1) Ten Allied Practitioners operate in two states.
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AGREEMENTS WITH ALLIED PRACTICES AND ALLIED PRACTITIONERS
Each Allied Practice has entered or enters into the following three
material agreements: (i) an acquisition agreement, which may be in the form of a
purchase and sale agreement whereby the Company acquires certain of the assets,
or stock of an entity holding certain assets, of the Allied Practice, or an
agreement and plan of reorganization, whereby the Allied Practice transfers
certain assets to the Company; (ii) either a service agreement or a consulting
agreement (depending upon the applicable state regulatory requirements), whereby
the Company provides management or consulting services to the Allied Practice;
and (iii) an employment agreement between the Allied Practice and each related
Allied Orthodontist who is an equity holder in the Allied Practice or who
provides orthodontic or pediatric dental services through such practice for more
than ten days each month.
ACQUISITION AGREEMENTS. Each acquisition agreement generally results in the
sale by the Allied Practice of its equipment, licenses (to the extent assignable
by law), inventory, accounts receivable, furniture and other personal property,
or some combination thereof based on applicable state laws or regulations, in
exchange for consideration based on the Allied Practice's adjusted patient
revenue. The aggregate purchase price paid by the Company is generally payable
in cash and shares of Class A Common Stock, as determined by each Allied
Practice and the Company. The aggregate consideration, excluding acquisition
costs, paid by the Company in connection with the affiliation of the 41 Allied
Practices net of consolidation from August 26, 1997 to December 31, 1998 was
approximately $56 million, comprised of approximately $28 million in cash and
2,504,268 shares of Class A Common Stock.
SERVICE AGREEMENTS. Each service agreement generally requires the Company
to perform the following services for the Allied Practices: provide and maintain
specified furnishings and equipment; provide necessary employees (except
practitioners and, where applicable law requires, hygienists and dental
assistants); establish appropriate business systems; purchase and maintain
inventory; perform payroll and accounting functions; provide billing and
collection services with respect to patients, insurance companies, and
third-party payors; arrange certain legal services not related to malpractice
litigation; design and execute a marketing plan; advise with respect to new
office locations; and manage and organize the Allied Practice's files and
records, including patient records where permitted by applicable law. If the
Allied Practice lacks sufficient funds to pay its current expenses, the Company
is required to advance funds to the Allied Practice for the purpose of paying
such expenses, subject to terms to be agreed upon. In exchange for performing
the services described above, the Company receives a management fee based on one
of the three fee structures described in Management's Discussion and Analysis of
Financial Condition and Results of Operations. The Company has entered into
agreements with certain Allied Practices to make the payment of such management
fees after the first two years contingent on various factors, including practice
profitability compared to acquisition consideration, timely reporting of
information, participation in practice improvement programs and orthodontist
hours worked. Prior patient revenue is not necessarily indicative of the level
of revenue that these practices may be expected to generate in the future.
The term of each service agreement is for 20 or 25 years, subject to prior
termination by either party in the event the other party becomes subject to
voluntary or involuntary bankruptcy proceedings or materially breaches the
agreement, subject to a cure period. In addition, the Allied Practices may
terminate the service agreements upon the occurrence of a change of control of
the Company (as defined therein, which does not include a transaction approved
by the Company's Board of Directors). Upon the expiration or termination of the
service agreement, the Allied Practice may, and in certain circumstances must,
repurchase for cash (at book value) certain assets, including all equipment, and
assume certain liabilities of the Company related to the Allied Practice.
Each service agreement is generally not assignable by either party thereto
without the written consent of the other party; however, the Company may assign
the service agreement without the Allied Practice's consent to any entity under
common control with the Company. The Company and the Allied Practice indemnify
each other for costs and expenses incurred by the other party that are caused
directly or indirectly by, as the case may be, the Company's or the Allied
Practice's intentional or negligent acts or omissions. In the case of the Allied
Practice's obligation to indemnify the Company, such obligation also applies to
intentional or negligent acts and omissions occurring prior to the date of the
service agreement. As of December 31, 1998, the Company had entered into service
agreements with 56 Allied Practices.
CONSULTING AGREEMENTS. Certain provisions of the consulting agreement are
substantially similar to the service agreement, including provisions relating to
the Company's obligation to loan funds to the Allied Practice in the event the
Allied Practice is unable to pay its current expenses, termination of the
consulting agreement, repurchase of assets and assumption of liabilities by the
Allied Practice upon expiration or termination, assignment, and indemnification.
The services provided by the Company to the Allied Practice under each
consulting agreement generally include consulting with respect to equipment and
office needs; preparing staffing models appropriate for an Allied Practice;
advising and training with respect to business systems; purchasing and
maintaining inventory; advising with respect to and providing or arranging
accounting and
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bookkeeping services; advising with respect to developing a marketing plan;
assessing the financial feasibility of establishing new offices; providing
billing and collection services; and assisting the Allied Practice in organizing
and developing filing and recording systems. In exchange for such services, the
Company receives a consulting fee based on one of the three fee structures
described in Management's Discussion and Analysis of Financial Condition and
Results of Operations. As of December 31, 1998, the Company had entered into
consulting agreements with 40 Allied Practices.
Pursuant to both the service agreements and consulting agreements, Allied
Orthodontists maintain professional control over and ownership of their
practices, determine which personnel will be allied with the Allied Practices
and set their own standards of practice. The Company does not engage in the
practice of orthodontics or dentistry. Each Allied Orthodontist is responsible
for compliance of his or her Allied Practice with state and local regulations
applicable to the practice of orthodontics and dentistry and with licensing or
certification requirements. Each Allied Practice, in its sole discretion,
determines the fees to be charged for services provided to patients based upon
market conditions in the service area and other factors deemed appropriate by
the Allied Practice. Each Allied Practice executes payor contracts and acquires
and pays for its own malpractice insurance coverage.
Employment Agreements. Each Allied Orthodontist who is or becomes an equity
holder in an Allied Practice or who provides orthodontic or dental services
through an Allied Practice for more than 10 days a month is required to execute
an employment agreement with the Allied Practice. Each employment agreement
generally provides that the Allied Orthodontist will perform professional
services for the Allied Practice for a period of five years, subject to prior
termination (i) for cause by the Allied Practice (which generally means death,
incapacity, willful misconduct, conviction for a felony, or chronic alcoholism
or drug addiction) and (ii) by the Allied Orthodontist in the event of a
material breach by the Allied Practice. The Allied Orthodontist agrees that
following termination or expiration of the employment agreement, he or she will
not compete for a period of two years in the market in which the Allied Practice
operates an office and will limit the methods of advertising in the area in
which an Allied Practice is located.
GOVERNMENT REGULATION
General. The field of dentistry, including orthodontics, is highly
regulated, and there can be no assurance that the regulatory environment in
which the Company operates will not change significantly in the future. In
general, regulation of healthcare companies is increasing. Every state imposes
licensing requirements on individual practitioners and on facilities operated by
and services rendered by practitioners. In addition, federal and state laws
regulate health maintenance organizations and other managed care organizations
for which practitioners may be providers. In connection with the entry into new
markets, the Company, Allied Practices and Allied Orthodontists may become
subject to compliance with additional regulations.
The operations of the Allied Practices must meet federal, state and local
regulatory standards in the areas of safety and health. Historically, compliance
with those standards has not had any material adverse effect on the operations
of the Allied Practices. Based on its familiarity with the historical operations
of the Allied Practices and the activities of the Allied Orthodontists,
management believes that the Allied Practices are in compliance in all material
respects with all applicable federal, state and local laws and regulations
relating to safety and health.
State Legislation. The laws of several states prohibit practitioners from
splitting fees with non-practitioners. Furthermore, many states prohibit
non-professional entities from practicing dentistry, including orthodontics,
employing practitioners, or in some circumstances, employing hygienists and
dental assistants. The laws of some states prohibit advertising professional
services under a trade or corporate name and require that all advertising be in
the name of the practitioner. A number of states also regulate the content of
advertisement of professional services and the use of promotional gift items. A
number of states limit the ability of a non-licensed dentist or non-orthodontist
to own equipment or offices used in a practice. Some of these states allow
leasing of equipment and office space to an orthodontic or dental practice,
under a bona-fide lease, if the equipment and office remain in the complete care
and custody of the practitioner. Management believes, based on its familiarity
with the historical operations of the Allied Practices, the activities of the
Allied Orthodontists and applicable regulations, that the Company's current and
planned activities do not constitute the prohibited practices contemplated by
these statutes and regulations. There can be no assurance, however, that future
interpretations of such laws, or the enactment of more stringent laws, will not
require structural and organizational modifications of the Company's existing
contractual relationships with its Allied Orthodontists or the operation of the
Allied Practices. In addition, statutes in some states could restrict expansion
of Company operations in those jurisdictions. The Company enters into either a
service agreement or consulting agreement depending upon applicable state
regulations.
Regulatory Compliance. The Company monitors developments in laws and
regulations relating to the practice of orthodontics and dentistry. The Company
may be required to modify its agreements, operations and marketing strategies
from time to time in response to changes in the regulatory environment. The
Company structures all of its agreements, operations and
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marketing in accordance with applicable law, although there can be no assurance
that its arrangements will not be successfully challenged or that required
changes may not materially affect the Company's business, financial condition
and results of operations.
COMPETITION
The business of providing orthodontic and pediatric dental services is
highly competitive in each market in which the Allied Practices operate. Allied
Practices compete with practitioners who maintain single offices or operate a
single satellite office, as well as with practitioners who maintain group
practices or operate in multiple offices. Allied Practices also compete with
general dentists and pediatric dentists who provide certain orthodontic
services, some of whom have more established practices. The provision of
orthodontic services by such dentists and pediatric dentists has increased in
recent years.
The Company faces substantial competition from other entities as the
Company seeks to affiliate with additional orthodontic practices. The Company is
aware of several practice management companies that are focused in the area of
orthodontics. Additional entities may enter this market and compete with the
Company. Certain of these competitors have greater financial or other resources
than the Company.
EMPLOYEES
As of December 31, 1998, the Company employed approximately 1,020 persons,
including 864 full-time employees. None of the Company's employees is
represented by a collective bargaining agreement. The Company considers its
relationship with its employees to be good.
INTELLECTUAL PROPERTY
The Company has obtained a trademark registration from the U.S. Patent and
Trademark Office for its service mark "OrthAlliance." Management intends to
continue to utilize the service mark, as allowed by applicable law, in the
Company's marketing and advertising campaigns and in connection with the
Company's services.
INSURANCE
The Company maintains general liability insurance for itself and on behalf
of the Allied Practices and, where permitted by applicable law and insurers, the
Company is named as an additional insured under the policies of the Allied
Practices. There can be no assurance that any claims against the Company or any
of the Allied Practices 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 rates. The Allied Orthodontists purchase
and maintain their own malpractice liability insurance coverage.
ITEM 2. PROPERTIES.
The Company leases approximately 8,978 square feet of office space in
Torrance, California for its headquarters. In addition, the Company leases
office space for certain Allied Practices (see note 11 to the Company's
financial statements) with aggregate monthly payments of $527,000 as of December
31, 1998.
ITEM 3. LEGAL PROCEEDINGS.
As of December 31, 1998, the Company did not have any pending legal
proceedings that separately, or in the aggregate, if adversely determined, would
have a material adverse effect on the Company. The Company and its Allied
Practitioners may, from time to time, be a party to litigation or administrative
proceedings which arise in the normal course of business.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
The Company's executive officers and key employees are as follows:
8
<PAGE> 9
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
<S> <C> <C>
Jonathan Wilfong(1) 50 Chairman of the Board of Directors
Sam Westover 43 President, Chief Executive Officer and Director
Robert S. Chilton(2) 40 Chief Financial Officer
Paul H. Hayase 44 Senior Vice President - Human Resources, General
Counsel and Secretary
Stephen M. Toon 50 Chief Development Officer
</TABLE>
- ------------
(1) Effective June 3, 1999, Mr. Wilfong's term as Chairman of the Board of
Directors will expire and Mr. W. Dennis Summers has been elected as
Chairman of the Board of Directors from June 3, 1999.
(2) Effective February 18, 1999, Mr. Westover assumed the position of Chief
Financial Officer.
Jonathan E. Wilfong served as Chairman of the Board of Directors of the
Company from May 1997. Mr. Wilfong served as an executive consultant to the
Company from its inception until September 1997. Mr. Wilfong is the founder and
a principal of Newfound Capital Associates, an investment banking advisory firm
founded in 1996 that specializes in advising high growth businesses on capital
formation strategies and acquisition transactions. Mr. Wilfong is a Certified
Public Accountant, and from 1983 to 1996 was a partner with Price Waterhouse LLP
in Atlanta, Georgia and Greenville, South Carolina.
Sam Westover has served as Director, President and Chief Executive Officer
of the Company since October 1996. From August 1993 until July 1996, Mr.
Westover served as President and Chief Executive Officer of SysteMed Inc., a
pharmacy benefit management company, where he also served as Director from July
1992 until February 1997. From January 1993 until August 1993, Mr. Westover
served as Senior Vice President, Chief Financial Officer and Treasurer of
Wellpoint Health Networks, Inc., a health insurance company. Prior to joining
Wellpoint, Mr. Westover served as Chief Financial Officer and Senior Vice
President, Corporate Financial Services of Blue Cross of California, a position
to which he was named in May 1990.
Robert S. Chilton served as Chief Financial Officer of the Company from May
1997 until February 18, 1999. From April 1994 until May 1997, Mr. Chilton served
as Vice President/Controller of E&S Ring Management Corporation, a real estate
management firm. Mr. Chilton was Controller of Karl Storz Endoscopy-America,
Inc., a medical device manufacturer and distributor, from October 1987 until
April 1994. Mr. Chilton is a Certified Public Accountant, and from February 1985
to October 1987 was employed by KPMG Peat Marwick.
Paul H. Hayase has served as Senior Vice President - Human Resources,
General Counsel and Secretary of the Company since October 1996. From August
1995 until January 1997, Mr. Hayase served as Vice President - Human Resources,
General Counsel and Secretary of Systemed, Inc. Mr. Hayase served as Senior
Counsel of Ralphs Grocery Company, a supermarket chain in California, from
November 1993 to August 1995. From January 1985 to November 1993, Mr. Hayase
served as Senior Vice President, General Counsel for Knapp Communications
Corporation, a magazine publishing company.
Stephen M. Toon has served as Senior Vice President - Chief Development
Officer of the Company since August 1998. From July 1995 until July 1998, Mr.
Toon served as Chief Development Officer of Team Health Group, a hospital based
division of MedPartners/Mulliken, Inc. Mr. Toon served as Senior Vice President
of Operations of Coastal Healthcare Group, a public physician practice
management company, from July 1991 to July 1995.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
(a) The Company's Class A Common Stock is traded on The Nasdaq Stock
Market's National Market System under the symbol "ORAL." There is no established
public trading market for the Company's Class B Common Stock. No transfers are
permitted of Class B Common Stock, except to the Class B stockholder's spouse,
parents, siblings, lineal descendants, trusts for the benefit of any such
individual or as determined by laws of descent or wills. The high and low prices
of the Company's Class A Common Stock as reported on The Nasdaq Stock Market
during each quarter from August 21, 1997 are shown below:
<TABLE>
<CAPTION>
1997 HIGH LOW
- ---- ----- -----
<S> <C> <C>
Third Quarter 15 3/8 13 1/2
Fourth Quarter 15 1/2 8 1/2
</TABLE>
9
<PAGE> 10
<TABLE>
1998
<S> <C> <C>
First Quarter 14 1/8 9 1/8
Second Quarter 17 1/4 13 7/8
Third Quarter 14 1/8 7 1/2
Fourth Quarter 13 7/8 7
1999
First Quarter
(through March 30, 1999) 11 7/8 7
</TABLE>
At March 30, 1999, the last reported sale price of the Class A Common Stock
was $7.50 per share and there were approximately 202 record holders of Class A
Common Stock and 67 record holders of Class B Common Stock.
Except for the payment in August 1997 of $13.8 million cash consideration
paid to the initial 55 Allied Practices which was recorded as a cash dividend,
the Company has not declared any dividends on either its Class A Common Stock or
its Class B Common Stock. The Company expects that future earnings, if any, will
be retained for the growth and development of the Company's business and,
accordingly, the Company does not anticipate that any dividends will be declared
or paid on the Class A Common Stock or Class B Common Stock for the foreseeable
future. The declaration, payment and amount of future dividends, if any, will
depend upon the future earnings, results of operations, financial position and
capital requirements of the Company, among other factors, and are limited by the
Company's Credit Agreement.
Recent Sales of Unregistered Securities.
On August 26, 1997, simultaneously with the closing of the Company's
initial public offering of its Class A Common Stock pursuant to a Registration
Statement on Form S-1, the 55 initial Allied Practices received 5,882,985 shares
of unregistered Class A Common Stock as partial consideration for certain assets
or stock of such Allied Practices pursuant to the exemption set forth in Section
4(2) of the 1933 Act regarding non-public offerings.
On August 26, 1997, pursuant to that certain Agreement and Plan of Merger
between the Company, US Orthodontic Care, Inc. ("USOC") and Premier Orthodontic
Group, Inc. ("POG"), the Company issued 1,750,000 shares of unregistered Class A
Common Stock and 250,000 shares of unregistered Class B Common Stock as merger
consideration to the shareholders of USOC and POG in reliance on the exemption
set forth in Section 4(2) of the 1933 Act regarding non-public offerings.
10
<PAGE> 11
ITEM 6. SELECTED FINANCIAL DATA.
<TABLE>
<CAPTION>
FOR THE PERIOD SINCE
INCEPTION (10/21/96)
FOR THE YEAR ENDED TO DECEMBER 31, 1996
DECEMBER 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
STATEMENT OF OPERATIONS
(in thousands, except per share data):
Net revenues.................................................... $74,387 $18,081 $ --
Income before taxes............................................. 13,658 105(a) --
Net income (loss)............................................... 7,535 (736)(a) --
Basic and diluted net income (loss) per share................... 0.58 (0.18) --
Weighted average number of common stock shares
outstanding (diluted) ........................................ 13,044 4,026 --
</TABLE>
(a) Includes non-recurring compensation expense.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------
1998 1997 1996
------- ------- ----
BALANCE SHEET DATA
(in thousands):
<S> <C> <C> <C>
Working capital .......................... $13,235 $13,329 $ --
Total assets ............................. 88,580 44,363 --
Long term liabilities .................... 16,215 121 --
Redeemable common stock, common stock,
additional paid-in-capital, accumulated
deficit and treasury stock ............ 59,256 34,028 --
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with the accompanying
Consolidated Statements of Operations and notes thereto for the years ended
December 31, 1998 and 1997 and for the period from inception (October 21, 1996)
to December 31, 1996.
General
The Company began providing practice management services to Allied
Practices in the United States on August 26, 1997. The initial 55 Allied
Practices included 82 Allied Orthodontists operating 147 offices in 16 states.
By the end of 1997, the Company had affiliated with 11 new practices, including
17 additional orthodontists operating out of 31 new locations. In 1998, the
Company affiliated with 36 new practices, including 45 additional orthodontists
and pediatric dentists operating out of 70 locations. The Company anticipates
that future growth will come from new affiliations, satellite expansion of
Allied Practices, development of new orthodontic practices and through improved
operating efficiencies.
The Company earns revenue by providing services pursuant to long-term
service agreements or consulting agreements (collectively, "Management
Agreements") with Allied Practices. The Company provides management or
consulting services to each Allied Practice and assumes substantially all
operating expenses except for compensation to Allied Orthodontists and other
employees that the Company cannot employ according to applicable state laws. In
exchange for assuming these expenses and providing services, the Company records
revenues in amounts equal to the assumed expenses plus a service fee or
consulting fee, as described below. In general, the Management Agreements
provide for the recognition of fees to the Company based on a negotiated
percentage of the "Adjusted Patient Revenue" of Allied Practices. The timing of
the payment of such service fees is based upon cash collected. 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. Patient revenue
is recognized as services are performed. For orthodontic services, approximately
20% of the orthodontic contract revenue is recognized at the time of initial
treatment. The balance of the contract revenue is realized evenly over the
remaining treatment period. The 20% estimated revenue 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. The percentage includes the estimated costs
of diagnosis and treatment plan development, initial treatment by orthodontic
personnel, orthodontic supplies, and associated administrative services.
11
<PAGE> 12
The service fee is earned and paid monthly to the Company by each Allied
Practice using one of three different fee structures set forth in the Management
Agreements:
(i) a designated percentage of Adjusted Patient Revenue, ranging from
13.5% to 20%, subject to an annual adjustment based upon improvements in
the Allied Practice's operating margin in the most recent calendar year as
compared with the immediately preceding calendar year. No annual adjustment
shall be made which would result in reducing the designated percentage
below the percentage applicable during the first year of the Management
Agreement. Operating margin is defined as the percentage determined by
dividing operating profit by Adjusted Patient Revenue. Operating profit is
equal to Adjusted Patient Revenue less operating expenses, excluding the
management fee and such expenses associated with the Allied Practices which
the Company is prohibited from incurring, primarily consisting of
orthodontist compensation. The average designated percentage is 16.9% for
the Allied Practices subject to this fee structure.
(ii) a designated percentage ranging from 13.5% to 20% of Adjusted
Patient Revenue with a potential annual adjustment of 25% of the increase
in operating margin (as defined in subparagraph (i) above) in a calendar
year as compared to the preceding calendar year multiplied by the Adjusted
Patient Revenue for the current calendar year. The supplemental fee for
improvement in operating margin, if applicable, is paid in a lump sum
payment upon final determination of the Allied Practice's operating margin
for the calendar year. The average designated percentage is 16.7% for the
Allied Practices subject to this fee structure. In some cases, the Allied
Orthodonist must guarantee a minimum level of management fees to be paid by
the Allied Practice for a portion of the agreement ranging from one to 25
years.
(iii) a fixed dollar fee with annual fixed dollar increases for each
year of the term of the Management Agreement.
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 practice profitability compared to acquisition
consideration, timely reporting of information, participation in practice
improvement programs and orthodontist hours worked.
Expenses reported by the Company include certain of the expenses to operate
the orthodontic offices and all of the expenses of any corporate offices,
facilities or functions. Therefore, salaries and benefits include the wages,
benefits, taxes or other employment costs for all employees of the Company,
including practice office staff, business office staff and management personnel.
Rent includes facility expenses for both practice offices and corporate offices.
Advertising and marketing includes practice activities to attract new patients
and corporate activities to attract new orthodontists to join the Company.
General and administrative expenses include professional services, such as legal
and accounting, utilities, advertising, marketing, insurance, telephone, license
fees, office supplies and shipping expenses. Practice supplies include only
those expenses required by the Allied Orthodontist to provide treatment to
patients.
RESULTS OF OPERATIONS
The audited financial statements of the Company for the years ended
December 31, 1998 and 1997 and from the period from inception (October 21, 1996
to December 31, 1996, report a net income of $7,535,000 on revenues of
$74,387,000, a net loss of $736,000 on revenues $18,081,000 and no net income or
revenues, respectively. For the years 1998 and 1997 and from the period from
inception (October 21, 1996) to December 31, 1996, the Company had income before
taxes of $13,658,000, $105,000 and $0, respectively. Because the year ended
December 31, 1997 reflects the results of operations for the period August 26,
1997 to December 31, 1997 and includes non-recurring compensation expense in the
amount of $3,392,000, direct year-to-year comparisons may not be meaningful. The
Company did not have any operations in 1996.
The following table sets forth the percentage of certain items in relation to
net revenues.
<TABLE>
<CAPTION>
FROM THE PERIOD
FROM INCEPTION
YEAR ENDED YEAR ENDED (OCTOBER 31, 1996)
DECEMBER 31, 1998 DECEMBER 31, 1997 TO DECEMBER 31, 1996
----------------- ----------------- --------------------
<S> <C> <C> <C>
Net Revenue........................ 100.0% 100.0% 0%
Direct Expenses:
Employee costs................. 30.8 31.9 --
Practice supplies.............. 10.0 9.3 --
Rent........................... 8.5 9.7 --
Depreciation and amortization.. 3.3 1.4 --
General and administrative..... 28.9 29.9 --
---- ---- ---
</TABLE>
12
<PAGE> 13
<TABLE>
<S> <C> <C> <C>
Total operating expenses ................... 81.5 82.2 --
---- ---- ---
Operating profit ............................... 18.5 17.8 --
Non-recurring organizer compensation expense ... -- (18.8) --
Interest (expense) income, net ................. (0.1) 1.5 --
---- ---- ---
Income before income taxes ..................... 18.3 0.5 --
Provision for income taxes ..................... 8.2 4.6 --
---- ---- ---
Net income (loss) .............................. 10.1% (4.1%) 0%
==== ==== ---
</TABLE>
Net Revenue. Revenues increased 311% from 1997 to 1998, due to 1997 being a
partial year. A comparison of net revenue for the first full quarter of
operations from year-to-year (4th quarter 1997 to 4th quarter 1998) shows a 50%
increase in net revenue. This was attributable to the new affiliations of Allied
Practices during 1998 and to an increase in internal growth. Net Revenue
reported by the Company is derived by applying the appropriate management fee
percentage against adjusted patient revenue and includes reimbursed operating
expenses.
Operating Expenses. From 1997 to 1998, total operating expenses as a
percentage of net revenue, remained at a fairly constant level as a percentage
of net revenue. The operating expense categories are consistent with
management's expectations.
Depreciation and Amortization. Depreciation and amortization expense
increased approximately $2.2 million from 1.4 % of net revenue to 3.3% of net
revenue from the prior year. This increase was attributable to the increase in
intangible assets associated with the affiliation of Allied Practices in 1998.
Intangible assets increased from $11.3 million to $50.9 million from 1997 to
1998. Depreciation and amortization expense primarily relates to the
depreciation of capital assets and the amortization of excess cost over the fair
value of net assets acquired (goodwill) and certain other intangibles. The
Company's policy is to amortize goodwill over the expected period to be
benefited, not to exceed the term of the Management Agreements. For the years
ended December 31, 1998 and 1997, depreciation and amortization were $2,485,000
and $245,000, respectively.
Non-recurring Organizer Compensation Expense. Prior to the completion of
the IPO, USOC and POG merged with and into the Company, and the Company
succeeded to the rights and obligations of both USOC and POG. Certain
compensation expenses were incurred by USOC and POG during the period from
inception (October 21, 1996) through August 26, 1997 in connection with the IPO.
In the second quarter of 1997, the Company issued warrants to owners of certain
Allied Practices, and certain officers and consultants for their assistance in
recruiting orthodontists to the Company and in completing the IPO. In addition,
pursuant to the merger between USOC, POG and the Company, warrants held by
Jonathan Wilfong and Robert Garces to purchase a total of 225,000 shares of USOC
stock converted into warrants to purchase an equal number of shares of the
Company's Class A Common Stock. The Company recorded compensation expense of
$3,392,000 related to warrants during 1997.
Interest Income. For the years ended December 31, 1998 and 1997, interest
income was $351,000 and $270,000, respectively, and represents interest earned
on excess cash balances invested primarily in short-term money market accounts.
Interest Expense. For the years ended December 31, 1998 and 1997, interest
expense was $448,000 and $0, respectively and represents interest charges
accrued on amounts of the Company's borrowings on its revolving line of credit.
The outstanding balance of this line of credit was $15,500,000 at December 31,
1998. See further discussion in the Liquidity and Capital Resources section
below.
Provision for Income Taxes. Provision for income taxes for 1998 and 1997
were $6,123,000 and $841,000, respectively. A reconciliation of the provision
for income taxes for the years ending December 31, 1998, 1997 and 1996 to the
amount computed at the Federal statutory rate is included in Note 12 of Notes to
Consolidated Financial Statements. The Company's effective income tax rate for
the year was higher than the statutory rate primarily due to the
non-deductibility for income tax purposes of the organizer compensation expense
in 1997 and the amortization of goodwill in 1998.
QUARTERLY OPERATING RESULTS
The Company's unaudited quarterly operating information for 1998 and 1997
is shown in the following table. The Company began operations in the third
quarter of 1997, but the Company recognized non-recurring organizer expense
related to warrants, described
13
<PAGE> 14
above, in the second and third quarters. The fourth quarter of 1997 represents
the only quarter presented for 1997 when the Company was fully operational.
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------------------------
MARCH 1998 JUNE 1998 SEPTEMBER 1998 DECEMBER 1998
----------- ----------- --------------- -------------
<S> <C> <C> <C> <C>
Net revenues $14,650,000 $18,712,000 $20,042,000 $20,983,000
Net operating income 2,795,000 3,254,000 3,761,000 3,945,000
Net income 1,621,000 1,859,000 2,072,000 1,983,000
Basic earnings per share $ 0.13 $ 0.14 $ 0.16 $ 0.15
Diluted earnings per share 0.13 0.14 0.16 0.15
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------------------
MARCH 1997 JUNE 1997 SEPTEMBER 1997 DECEMBER 1997
---------- ------------ --------------- -------------
<S> <C> <C> <C> <C>
Net revenues $ -- $ -- $4,054,000 $14,027,000
Net operating income (loss) $ -- $(2,271,000) $ 47,000 2,346,000
Net income (loss) $ -- $(2,271,000) $ (377,000) 1,521,000
Basic earnings (loss) per share $ -- $ N/A $ (0.08) $ 0.13
Diluted earnings (loss) per share -- N/A (0.08) 0.13
</TABLE>
SEASONALITY
Most patients who seek orthodontic treatment are children, although the
number of adults seeking treatment has been increasing in recent years. Based
upon information provided by the Allied Practices, and based upon the results of
operations in 1998 and 1997, the Company expects an increase in new patient
volume during the summer months when children are not in school. The Company
also expects the lowest volume of patient starts during the Christmas holiday
season when children are on vacation and when many of the Allied Practices are
closed. Since the Company recognizes 20% of all patients contracts as revenue in
the month treatment begins, the Company expects higher patient revenue in the
third quarter and lower patient revenue in the fourth quarter. Accordingly, the
Company should see an increase or decrease in service fee revenue during these
periods.
LIQUIDITY AND CAPITAL RESOURCES
Pursuant to the Company's Registration Statement on Form S-1, as amended
(No. 333-27143), that became effective on August 21, 1997, the Company offered
and sold 2,600,000 shares of Class A Common Stock at $12.00 per share.
Concurrently, the underwriters exercised their over-allotment option for an
additional 390,000 shares of Class A Common Stock. The IPO and exercise of the
over-allotment option generated, net of underwriting discounts and commissions,
approximately $31.1 million in cash for the Company. The Company has used these
funds for the following: payment of certain expenses related to the IPO, payment
of a dividend to the owners of the 55 Allied Practices that affiliated with the
Company in August 1997 ($13.8 million), funding of the acquisitions of certain
operating assets of, or the stock of entities holding certain operating assets
of newly affiliated practices, payment of debt assumed from Allied Practices as
part of the affiliation process, and for working capital requirements.
As of December 31, 1998 and 1997, the Company had a working capital balance
of approximately $13.2 million and $13.3 million, respectively. The Company
anticipates the primary uses of capital will include additional affiliations
with orthodontic and pediatric dental practices, certain costs related to the
development of satellite offices, and funding the working capital needs of the
Company and Allied Practices.
On December 30, 1997, the Company entered into a credit agreement with
First Union National Bank to provide a $25 million revolving line of credit. The
interest on borrowings accrues at either the bank's prime rate or LIBOR, plus a
margin. Amounts borrowed are secured by security interests in the Company's
assets, which include accounts receivable, Management Agreements and the capital
stock of the Company's wholly-owned subsidiaries. As of December 31, 1998 and
1997, the outstanding balance under this credit facility was $15,500,000 and $0,
respectively. As of December 31, 1998, the Company was in compliance with all
applicable covenants. Management expanded the credit facility on March 26, 1999
from $25 million to $55 million. The agreement terminates on March 26, 2002.
The working capital requirements and capital resources needed to continue
acquisition and development efforts will be funded through a combination of cash
flows provided by ongoing operations and funding from the Company's revolving
line of credit. Management believes that these sources of capital will be
sufficient to meet the Company's
14
<PAGE> 15
funding requirements for the next twelve months. The Company may choose to issue
debt or equity to meet its future long-term capital needs as management deems
appropriate.
In 1997, after the completion of the IPO and the affiliation of the founding
55 Allied Practices, the Company acquired certain operating assets of, or the
stock in entities that held certain operating assets of, 11 additional
orthodontic practices. The total consideration paid for these Allied Practices
was $12.4 million, of which $2.1 million was paid in cash and the balance
through the issuance of 863,775 shares of Class A Common Stock, pursuant to a
Registration Statement on Form S-4 (No. 333-29435).
For the year ended December 31, 1998, the Company acquired certain
operating assets of, or the stock in entities that held certain operating assets
of, 36 additional Allied Practices. The total consideration paid for these
Allied Practices was $46.8 million, of which $24.5 million was paid in cash,
$2.5 million issued in short-term notes payable and the balance through the
issuance of 1,640,492 shares of Class A Common Stock, pursuant to a Registration
Statement on Form S-4 (No. 333-29435).
The Management Agreements provide for short-term advances by the Company to
the Allied Practices for working capital requirements and other purposes on
terms to be mutually agreed upon. These items are advanced and repaid in a
revolving manner. Generally, advances are repaid when Allied Practices deposit
patient revenue into their depository accounts. Advances occur when the Allied
Practice operating expenses paid exceed patient revenue earned.
STOCK REPURCHASE PLAN
On October 22, 1998 the Company announced that the Board of Directors
approved the repurchase of shares of its Common Stock up to $5 million. The
Company is authorized to purchase shares over a 12 month period on Nasdaq Stock
Market's National Market at prices prevailing on that market. As of December 31,
1998, no shares were repurchased under this Stock Repurchase Plan.
YEAR 2000 COMPLIANCE
The Year 2000 issue arose as a result of certain computer hardware and
software using two digits rather than four digits to define the applicable
year. As a result, some of the Company's hardware and software systems have
date-sensitive software or embedded chips which may incorrectly recognize a
date using "00" rather than the year 2000 or not recognize the year at all.
This could result in system failures or miscalculations leading to disruptions
in the Company's activities and operations.
Corporate Office
The Company has performed a comprehensive Year 2000 evaluation of the
hardware and software systems utilized by the corporate office in all areas of
office automation, including payroll, payables, general ledger and data
management. As far as can be determined, all computer network systems are in
full compliance. Necessary certificates of compliance have been obtained from
hardware and software vendors.
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 backup 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 has requested Year 2000 compliance certificates from its
material third parties. The Company received compliance certificates from
approximately 60% of such requests. The Company will verify the status of the
remaining material third parties through follow-up requests. The Company is
uncertain whether the risks of non-Year 2000 compliance by material third
parties will materially affect the Company's operations or financial position.
The Company has determined it is not substantially reliant on any one vendor
and expects to use alternate resources in order to continue daily operations.
There can be no assurance that material third parties will not suffer a Year
2000 business disruptions which could have an adverse effect on the Company's
results of operations or financial position.
The corporate office does not have any "Non-IT" systems that might 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 micro-controllers. Therefore, the Company does not believe that
it is at risk from any failure associated with these kinds of devices.
Because the Company started operations in August 1997, most of the
corporate office systems were already Year 2000 compliant. Accordingly, any
costs associated with Year 2000 upgrades, including fiscal year 1998 and
year-to-date as of March 26, 1999 have not been significant. Additionally, the
Company does not expect to incur any significant costs in the future.
Allied Practice Locations
The Company has completed a survey of all practice hardware and software to
identify non-compliant systems and to make the necessary recommendations for
achieving compliance. The Company is currently advising the Allied Practices to
install upgrades and replace hardware and software as necessary. The Allied
Practices are contractually responsible to reimburse the Company for any costs
the Company incurs to upgrade its hardware and software, whether owned by
themselves or the Company.
The Company believes that the significant systems that may impact the
Allied Practice's operations are the practice management and billing system and
the accounts payable system. In the event that the Allied Practices have not
upgraded or replaced their hardware, software or non-IT devices, the Company
believes that the impact on Allied Practice operations would be minimal.
In the event that these systems are not Year 2000 compliant, certain
procedures can be utilized to minimize the affect on practice operations. These
procedures may include the following: manual billings, manual posting of
payments to patient records and 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.
Additionally, the Company plans to advise the Allied Practice to have a
contingency plan, including a complete backup of all systems and data prior to
December 31, 1999. If the Allied Practices determine that a system has failed
after operations commence in the year 2000, they can reset all system clocks to
a date prior to January 1, 2000 and restore the affected systems from the
backup. This will provide the Allied Practice with more time to repair the
affected systems.
The Company has advised the Allied Practices to request Year 2000
compliance certificates from their key material third parties. The Company is
uncertain whether the risks of non-Year 2000 compliance by third parties of the
Allied Practices will materially affect the Company's operations or financial
position. The Company has determined that the Allied Practices are not
substantially reliant on any one third party and expects them to use alternate
resources if necessary to continue daily operations.
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 has advised each Allied Practice
to evaluate all equipment to determine if any such devices exist. In the event
that some of the Allied Practices have not upgraded their significant non-IT
systems, such as x-ray and imaging machines, the Allied Practices can outsource
the procedures in order to continue its daily operations. The Allied Practices
are contractually responsible to reimburse the Company for any costs the
Company incurs to repair or replace any non-compliant devices, whether owned by
themselves or the Company.
15
<PAGE> 16
NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted SFAS 130, "Reporting
Comprehensive Income." This statement establishes disclosure requirements
related to the reporting of comprehensive income and its components. The Company
did not have any comprehensive income for the years ended December 31, 1998 and
1997 and for the period from October 31, 1996 to December 31, 1996.
Effective January 1, 1998, the Company implemented SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information." This standard establishes
disclosure requirements related to the reporting of the Company's operating
segments. As of December 31, 1998, the Company does not have any reportable
segments.
The Emerging Issues Task Force of the Financial Accounting Standards Board
issued its Consensus Opinion 97-2 ("EITF 97-2"), which addresses certain
specific matters pertaining to the physician, dentistry and veterinary practice
management industries. EITF 97-2 became effective for the Company for its year
ending 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 practices that it manages. The guidance in
EITF 97-2 did not change the Company's accounting method because the Company's
arrangements with its Allied Practices do not meet the requirements for
consolidation as set forth in EITF 97-2.
In 1999, the Company will implement SOP 98-5 "Reporting on Costs of Start-up
Activities." The SOP requires net costs of start-up activities, including
organizational costs, to be expensed as incurred. In addition, the SOP requires
that previously capitalized start-up costs be expensed upon the effective date.
The Company does not have any start-up costs capitalized as of December 31,
1998.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's Financial Statements, together with the report thereon of
Arthur Andersen LLP, dated February 19, 1999 begin on page F-1 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information contained under the heading "Information Concerning
Directors" in the Company's definitive proxy statement for its annual meeting of
stockholders to be held on June 3, 1998 (the "1999 Proxy Statement") is
incorporated herein by reference. Information regarding the Company's executive
officers is set forth in Item 4A of Part I hereof.
ITEM 11. EXECUTIVE COMPENSATION.
The information contained under the heading "Executive Compensation" in the
1999 Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information contained under the headings "Information Concerning
Directors" and "Principal Stockholders" in the 1999 Proxy Statement is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information contained under the heading "Certain Transactions" in the
1999 Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements
Listed on the Index to the Financial Statements and Schedules on page F-1
of this Report.
(2) Financial Statement Schedules
16
<PAGE> 17
Listed on the Index to the Financial Statements and Schedules on page F-1
of this Report.
(3) Exhibits
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<S> <C>
2.1 Agreement and Plan of Merger between the Company, USOC and POG
(incorporated by reference to Exhibit 2.1 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
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 Specimen Class A Common Stock Certificate (incorporated by
reference to Exhibit 4.1 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
4.2 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).
4.3 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).
4.4 Incidental Registration Rights for certain Allied
Orthodontists as set forth in the Form of Purchase and Sale
Agreement, the Form of Stock Purchase
and Sale Agreement and the Form of
Agreement and Plan of Reorganization (incorporated by reference
to Exhibit 10.2, 10.3 and 10.5, respectively, of the Company's
Annual Report on Form 10-K for the year ended December 31, 1997).
10.1 Form of Purchase and Sale Agreement between the Company and
Allied Practices (incorporated by reference to Exhibit 2.2 of
the Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
10.2 Form of Stock Purchase and Sale Agreement between the Company
and Stockholders of the initial Allied Practices (incorporated
by reference to Exhibit 2.4 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
10.3 Form of Stock Purchase and Sale Agreement between the Company
and the Stockholders of the Allied Practices (incorporated by reference to
Exhibit 10.4 of the Company's Annual Report on Form 10-K for the fiscal
Year ended December 31, 1997).
</TABLE>
17
<PAGE> 18
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<S> <C>
10.4 Form of Agreement and Plan of Reorganization between the
Company, Allied Practices and the Stockholders of the Allied
Practices (incorporated by reference to Exhibit 2.3 of the
Company's Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.5 Form of Service Agreement between the Company and Allied
Practices (Fixed Percentage Fee) (incorporated by reference to
Exhibit 10.1 of the Company's Registration Statement on Form
S-1, Registration No. 333-27143, as amended).
10.6 Form of Service Agreement between Company and Allied Practices
(Variable Percentage Fee) (incorporated by reference to
Exhibit 10.2 of the Company's Registration Statement on Form
S-1, Registration No. 333-27143, as amended).
10.7 Form of Consulting and Business Services Agreement between the
Company and Allied Practices (Variable Percentage Fee)
(incorporated by reference to Exhibit 10.3 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.8 Form of Consulting and Business Services Agreement between the
Company and Allied Practices (Fixed Percentage Fee)
(incorporated by reference to Exhibit 10.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.9 Form of Consulting and Business Services Agreement between the
Company and Allied Practices (Fixed Dollar Fee) (incorporated
by reference to Exhibit 10.5 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
10.10 1997 Non-Employee Director Stock Plan (incorporated by
reference to Exhibit 10.6 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143).
10.11 Amended and Restated 1997 Employee Stock Option Plan
(incorporated by reference to Exhibit 10.7 of the Company's
Registration Statement on Form S-1, Registration No. 333-27143).
10.12 1997 Orthodontist Stock Option Plan (incorporated by reference to
Exhibit 10.13 of the Company's Annual Report on Form 10-K for
fiscal year ended December 31, 1997).
10.13 Employment Agreement between the Company and Sam Westover
(incorporated by reference to Exhibit 10.8 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.14 Letter Agreement between the Company and Stephen M. Toon.
10.15 Credit Agreement dated December 30, 1997 between the Company
and First Union National Bank (incorporated by reference to
Exhibit 10.16 of the Company's Annual Report on Form 10-K for
fiscal year ended December 31, 1997).
10.16 Form of Company Practice Improvement Program Guarantee (incorporated by
</TABLE>
18
<PAGE> 19
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<S> <C>
reference to Exhibit 10.17 of the Company's Annual Report on
Form 10-K for Fiscal year ended December 31, 1997).
21.1 Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule.
99.1 Safe Harbor Compliance Statement (incorporated by reference to
Exhibit 99.1 of the Company's Annual Report on Form 10-K for
fiscal year ended December 31, 1997).
</TABLE>
(b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K during the fourth quarter
of 1998.
19
<PAGE> 20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the 1934 Act, the
Company has duly caused this Form 10-K to be signed on behalf of the
undersigned, thereunto duly authorized, on March 31, 1999.
ORTHALLIANCE, INC.
By: /s/
----------------------------------------
Sam Westover
President, Chief Executive Officer
and Chief Financial Officer
20
<PAGE> 21
SIGNATURES
Pursuant to the Requirements of the 1934 Act, this Form 10-K has been
signed below by the following persons in the capacities indicated on March 31,
1999.
<TABLE>
<S> <C>
/s/ President, Chief Executive Officer,
- ------------------------------------ Chief Financial Officer and Director
SAM WESTOVER
/s/ Director
- ------------------------------------
RANDALL K. BENNETT
/s/ Director
- ------------------------------------
DOUGLAS D. DURBIN
/s/ Director
- ------------------------------------
G. HARRY DURITY
/s/ Director
- ------------------------------------
CRAIG L. MCKNIGHT
/s/ Director
- ------------------------------------
RANDALL A. SCHMIDT
/s/ Director
- ------------------------------------
W. DENNIS SUMMERS
/s/ Chairman of the Board and Director
- ------------------------------------
JONATHAN E. WILFONG
</TABLE>
21
<PAGE> 22
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
OrthAlliance, Inc.
Report of Independent Public Accountants................................... F-2
Balance Sheets as of December 31, 1998 and December 31, 1997............... F-3
Statements of Operations For the Years Ended December 31, 1998,
December 31, 1997 and From the Period from Inception
(October 21, 1996) to December 31, 1996.................................. F-4
Statements of Cash Flows For the Years Ended December 31, 1998,
December 31, 1997 and From the Period from Inception
(October 21, 1996) to December 31, 1996.................................. F-5
Statements of Changes in Stockholder's Equity For the Period From
Inception (October 21, 1996) to December 31, 1996 and for the
years ended December 31, 1997 and 1998................................... F-6
Notes to Consolidated Financial Statements................................. F-7
</TABLE>
22
<PAGE> 23
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of OrthAlliance, Inc.:
We have audited the accompanying consolidated balance sheets of OrthAlliance,
Inc. (a Delaware Corporation) and subsidiaries as of December 31, 1998 and 1997,
and the related consolidated statements of operations, stockholders' equity and
cash flows for the years then ended and for the period from inception (October
21, 1996) to 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 the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of OrthAlliance, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended and for the period from
inception (October 21, 1996) to December 31, 1996 in conformity with generally
accepted accounting principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Los Angeles, California
February 19, 1999
23
<PAGE> 24
ORTHALLIANCE, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF AS OF
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .......................................... $ 3,226,000 $ 12,647,000
Patient receivables, net of allowances of $435,000 and $242,000 .... 7,765,000 4,470,000
Unbilled patient receivables, net of allowances
of $385,000 and $293,000 ......................................... 3,462,000 2,642,000
Amounts due from Allied Practices .................................. 9,880,000 2,489,000
Income tax receivable .............................................. 1,102,000 --
Current deferred tax assets ........................................ 578,000 1,228,000
Other current assets ............................................... 331,000 67,000
------------ ------------
Total current assets ............................................... 26,344,000 23,543,000
Property and equipment, net ........................................... 4,585,000 3,214,000
Notes receivable ...................................................... 3,607,000 2,010,000
Non-current deferred tax assets ....................................... 2,918,000 3,965,000
Intangible assets, net ................................................ 50,912,000 11,313,000
Other, net ............................................................ 214,000 318,000
------------ ------------
Total assets ....................................................... $ 88,580,000 $ 44,363,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accrued liabilities ..................... $ 4,785,000 $ 3,024,000
Patient prepayments ................................................ 4,777,000 2,710,000
Notes payable to Allied Practices .................................. 2,032,000 410,000
Income taxes payable ............................................... -- 1,308,000
Current deferred tax liabilities ................................... -- 1,672,000
Amounts due to Allied Practices .................................... 1,515,000 1,090,000
------------ ------------
Total current liabilities ....................................... 13,109,000 10,214,000
------------ ------------
Line of credit borrowings ............................................. 15,500,000 --
Non-current deferred tax liabilities .................................. 715,000 121,000
------------ ------------
Total liabilities .................................................. 29,324,000 10,335,000
------------ ------------
Commitments and Contingencies (Note 11)
Stockholders' equity:
Class A Common Stock, $.001 par value, 70,000,000 shares authorized,
13,197,961 and 11,486,761 shares
issued and outstanding at December 31, 1998
and 1997, respectively ........................................... 13,000 11,000
Class B Common Stock, $.001 par value, 250,000
Authorized, 249,292 and 250,000 shares issued and
Outstanding at December 31, 1998 and
1997, respectively ............................................... -- --
Additional paid-in capital ............................................ 65,188,000 45,149,000
Accumulated deficit ................................................... (3,597,000) (11,132,000)
Treasury stock, at cost, 170,024 and zero shares at December 31, 1998
and 1997, respectively ............................................. (2,348,000) --
------------ ------------
Total stockholders' equity ....................................... 59,256,000 34,028,000
------------ ------------
Total liabilities and stockholders' equity ....................... $ 88,580,000 $ 44,363,000
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
24
<PAGE> 25
ORTHALLIANCE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
INCEPTION (OCTOBER 21,
FOR THE YEAR ENDED FOR THE YEAR ENDED 1996) TO
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
------------------ ----------------- ----------------------
<S> <C> <C> <C>
Net revenues ....................................... $ 74,387,000 $ 18,081,000 $ --
------------ ------------ ------------
Costs and expenses:
Salaries and benefits ............................ 22,880,000 5,771,000 --
Orthodontic and dental supplies .................. 7,436,000 1,684,000 --
Rent ............................................. 6,327,000 1,751,000 --
------------ ------------ ------------
Total direct expenses ......................... 36,643,000 9,206,000 --
Depreciation and amortization .................... 2,485,000 245,000 --
General and administrative ....................... 21,504,000 5,403,000 --
Non-recurring organizer compensation expense ..... -- 3,392,000 --
------------ ------------ ------------
Total operating expenses ...................... 60,632,000 18,246,000 --
------------ ------------ ------------
Net operating income (loss) ...................... 13,755,000 (165,000) --
Interest income .................................. 351,000 270,000 --
Interest expense ................................. (448,000) -- --
------------ ------------ ------------
Income before income taxes ......................... 13,658,000 105,000 --
Provision for income taxes ......................... 6,123,000 841,000 --
------------ ------------ ------------
Net income (loss) .................................. $ 7,535,000 $ (736,000) $ --
============ ============ ============
Basic and diluted net income (loss)
per share ........................................ $ 0.58 $ (0.18) $ --
============ ============ ============
Number of shares used in calculating basic net
income (loss) per share .......................... 13,005,664 4,026,313 1
============ ============ ============
Number of shares used in calculating diluted net
income (loss) per share .......................... 13,043,713 4,026,313 1
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
25
<PAGE> 26
ORTHALLIANCE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
INCEPTION
FOR THE YEAR ENDED FOR THE YEAR ENDED (OCTOBER 21, 1996) TO
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
------------------ ------------------ ---------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) ................................................... $ 7,535,000 $ (736,000) $ --
Adjustments to reconcile net income (loss) to net cash
Provided by operating activities:
Depreciation and amortization .................................... 2,485,000 245,000 --
Deferred tax expense (benefit) ................................... (226,000) (467,000) --
Organizer compensation warrants .................................. -- 2,435,000 --
Changes in assets and liabilities, excluding effects of acquisitions:
Increase in patient receivables .................................. (549,000) (261,000) --
Increase in due from Allied Practices ............................ (7,543,000) (2,489,000) --
Increase in income tax receivable ................................ (1,102,000) -- --
Increase in other assets ......................................... (306,000) (37,000) --
Increase in accounts payable and accrued liabilities ............. 427,000 126,000 --
Increase in due to Allied Practices .............................. 425,000 1,090,000 --
Increase in patient prepayments .................................. 1,366,000 243,000 --
Decrease (increase) in income taxes payable ...................... (1,307,000) 1,307,000 --
------------ ------------ ----
Net cash provided by operating activities ........................ 1,205,000 1,456,000 --
------------ ------------ ----
Cash flows from investing activities:
Payment for new practice affiliations ............................ (24,477,000) (2,063,000) --
Increase in notes receivables .................................... (2,184,000) -- --
Principal payments on notes receivable ........................... 534,000 -- --
Capital expenditures ............................................. (683,000) (69,000) --
Acquisition of other assets ...................................... -- (30,000) --
------------ ------------ ----
Net cash used in investing activities ............................ (26,810,000) (2,162,000) --
------------ ------------ ----
Cash flows from financing activities:
Increase in bank overdraft ....................................... 1,363,000 859,000 --
Increase in line of credit borrowings ............................ 16,500,000 -- --
Proceeds from exercise of stock options .......................... 240,000 -- --
Proceeds from issuance of common stock ........................... -- 31,137,000 --
Proceeds from issuance of warrants ............................... -- 1,000 --
Dividend paid to shareholders of founding
Allied Practices .............................................. -- (13,759,000) --
Payment of deferred financing costs .............................. -- (288,000) --
Repayment of debt ................................................ (1,919,000) (4,597,000) --
------------ ------------ ----
Net cash provided by financing activities ........................ 16,184,000 13,353,000 --
------------ ------------ ----
Net (decrease) increase in cash and cash equivalents ................ $ (9,421,000) $ 12,647,000 $ --
============ ============ ====
Cash and cash equivalents at beginning of period .................... $ 12,647,000 $ -- $ --
Cash and cash equivalents at end of period .......................... $ 3,226,000 $ 12,647,000 $ --
============ ============ ====
Supplemental cash flow information:
Interest paid .................................................... $ 280,000 $ 42,000 $ --
Income taxes paid ................................................ 8,774,000 -- --
Non-cash investing and financing activities
Acquisition of management agreements:
Fair value of assets acquired ................................. 46,819,000 25,370,000 --
Less: Issuance of common stock ................................ (19,801,000) (14,720,000) --
Elimination of predecessor's accumulated deficit .............. -- 2,945,000 --
Less: Cash paid ............................................... (24,477,000) (2,063,000) --
------------ ------------ ----
Notes payable issued and liabilities assumed .................. $ 2,541,000 $ 11,532,000 $ --
============ ============ ====
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
26
<PAGE> 27
ORTHALLIANCE, INC.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE PERIOD FROM INCEPTION (OCTOBER 21, 1996) TO DECEMBER 31, 1996
<TABLE>
<CAPTION>
CLASS A CLASS B RETAINED
COMMON STOCK COMMON STOCK ADDITIONAL EARNINGS
-------------------------- --------------------------- PAID-IN (ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT)
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balances at
October 21, 1996 ...... -- $ -- -- $ $ -- $ --
------------ ------------ ------------ ------------ ------------ ------------
Balances at
December 31, 1996 ..... -- -- -- -- --
Initial public
offering
of common stock ....... 2,990,000 3,000 -- -- 30,398,000 --
Transfers of certain
assets and
liabilities
by founders ........... 7,632,984 7,000 250,000 -- 1,435,000 3,363,000
Dividend to
Shareholders of
Founding Allied
Practices ............. -- -- -- -- -- (13,759,000)
Issuance of common
stock for intangible
assets ................ 863,776 1,000 -- -- 10,278,000 --
Issuance of warrants .. -- -- -- -- 3,038,000 --
Net loss .............. -- -- -- -- -- (736,000)
------------ ------------ ------------ ------------ ------------ ------------
Balances at
December 31, 1997 ..... 11,486,761 11,000 250,000 -- 45,149,000 (11,132,000)
------------ ------------ ------------ ------------ ------------ ------------
Issuance of common
stock for intangible
assets ................ 1,640,492 2,000 -- -- 19,799,000 --
Stock options
exercised ............. 70,000 -- -- -- 240,000 --
Conversion to Class A
common stock .......... 708 -- (708) -- -- --
Treasury stock ........ -- -- -- -- -- --
Net Income ............ -- -- -- -- -- 7,535,000
------------ ------------ ------------ ------------ ------------ ------------
Balances at
December 31, 1998 ..... 13,197,961 $ 13,000 249,292 $ -- $ 65,188,000 $ (3,597,000)
============ ============ ============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
TOTAL
TREASURY STOCK SHAREHOLDERS'
SHARES AMOUNT EQUITY
------------ ------------ ------------
<S> <C> <C>
Balances at
October 21, 1996 ...... -- $ -- $ --
------------ ------------ ------------
Balances at
December 31, 1996 ..... -- $ -- $ --
Initial public
offering
of common stock ....... -- -- 30,401,000
Transfers of certain
assets and
liabilities
by founders ........... -- -- 4,805,000
Dividend to
Shareholders of
Founding Allied
Practices ............. -- -- (13,759,000)
Issuance of common
stock for intangible
assets ................ -- -- 10,279,000
Issuance of warrants .. -- -- 3,038,000
Net loss .............. -- -- (736,000)
------------ ------------ ------------
Balances at
December 31, 1997 ..... -- -- 34,028,000
------------ ------------ ------------
Issuance of common
stock for intangible
assets ................ -- -- 19,801,000
Stock options
exercised ............. -- -- 240,000
Conversion to Class A
common stock .......... -- -- --
Treasury stock ........ 170,024 (2,348,000) (2,348,000)
Net Income ............ -- -- 7,535,000
------------ ------------ ------------
Balances at
December 31, 1998 ..... 170,024 $ 2,348,000 $ 59,256,000
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
27
<PAGE> 28
ORTHALLIANCE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. BUSINESS AND ORGANIZATION
a. ORGANIZATION
OrthAlliance, Inc. ("OrthAlliance") (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.
Effective prior to the closing of the initial public offering (the "Offering" or
"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 Class A Common Stock ("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.
On August 26, 1997, OrthAlliance acquired (the "Acquisitions") simultaneously
with the closing of the IPO of its Class A 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 5,882,984 shares of
Common Stock and $13,759,000 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 were $31,137,000. Other expenses incurred by the Company related to the
Offering totalled approximately $2,200,000 and these were recognized by Premier
and USOC prior to the merger. The Acquisitions have been accounted for in
accordance with the Securities and Exchange Commission's Staff Accounting
Bulletin No. 48.
OrthAlliance has two wholly-owned subsidiaries, PedoAlliance, Inc.
("PedoAlliance") and OrthAlliance Finance, Inc. ("OA Finance"). PedoAlliance was
formed in December 1997 to provide practice management or consulting services to
pediatric dental practices. From May 1, 1998 to December 31, 1998, PedoAlliance
entered into management or consulting agreements with seven pediatric dental
practices, that have 12 pediatric dentists ("Allied Dentists") operating eight
offices in seven states. Unless otherwise indicated, certain references herein
to "Orthodontists" also include Allied Dentists. OA Finance was formed in
October 1997 to offer financing alternatives to the patients of the Allied
Practices. During 1998, OA Finance funded 153 loans to patients for a total
value of $508,000 of which $445,000 was outstanding as of December 31, 1998.
OrthAlliance, PedoAlliance and OA Finance are sometimes collectively referred to
as the "Company."
b. AGREEMENTS WITH ALLIED PRACTICES
The Company is party to management service agreements with orthodontic and
pediatric dentistry practices which include the Founding Practices as well as
practices that have become affiliated with the Company subsequent to the IPO
("Allied Practices"). These are either "Service Agreements" or "Consulting
Agreements". The type of management service agreement is determined by the
Company and each Allied Practice based primarily on applicable state laws and
regulations. The types of management service agreements are as follows:
Service Agreements
The parties to each Service Agreement include the Company and the Allied
Practice, which typically is a professional corporation or association owned by
the related Orthodontist. Each Service Agreement generally requires the Company
to perform the following services for the Allied Practices: provide and maintain
specified furnishings and equipment; provide necessary employees (except
Orthodontists and where applicable law requires, hygienists and dental
assistants); establish appropriate business systems; purchase and maintain
inventory; perform payroll and accounting functions; provide billing and
collection services with respect to patients,
28
<PAGE> 29
insurance companies, and third-party payors; arrange certain legal services not
related to malpractice litigation; design and execute a marketing plan; advise
with respect to new office locations; and manage and organize the Allied
Practices' files and records, including patient records where permitted by
applicable law. If the Allied Practice lacks sufficient funds to pay its current
expenses, the Company is also required to advance funds to the Allied Practice
for the purpose of paying such expenses. In exchange for performing the services
described above, the Company receives a management fee based on one of the three
fee structures described in section c. below.
The term of each Service Agreement is 20 to 25 years, subject to prior
termination by either party in the event the other party becomes subject to
voluntary or involuntary bankruptcy proceedings or materially breaches the
agreement, subject to a cure period. In addition, the Allied Practices may
terminate the Service Agreements upon the occurrence of a change of control of
OrthAlliance (as defined therein, which does not include a transaction approved
by the Company's Board of Directors). Upon the expiration or termination of the
Service Agreement, the Allied Practice may, and in certain circumstances must,
repurchase for cash (at book value) certain assets, including all equipment, and
assume certain liabilities of the Company related to the Allied Practice.
Service Agreements are generally not assignable by either party thereto without
the written consent of the other party; however, the Company may assign the
Service Agreement without the Allied Practice's consent to any entity under
common control with the Company. The Company and the Allied Practice agree to
indemnify each other for costs and expenses incurred by such other party that
are caused directly or indirectly by, as the case may be, the Company's or the
Allied Practice's intentional or negligent acts or omissions. In the case of the
Allied Practice's obligation to indemnify the Company, such obligation also
applies to intentional or negligent acts and omissions occurring prior to the
date of the Service Agreement.
Consulting Agreements
The parties to each Consulting Agreement include the Company and the Allied
Practice. Certain provisions of the Consulting Agreement are substantially
similar to the Service Agreement, including provisions relating to the Company's
obligation to loan funds to the Allied Practice in the event the Allied Practice
is unable to pay its current expenses, termination of the Consulting Agreement,
repurchase of assets and assumption of liabilities by the Allied Practice upon
expiration or termination, assignment, and indemnification.
The services provided by the Company to the Allied Practice under each
Consulting Agreement generally include consulting with respect to equipment and
office needs; preparing staffing models appropriate for an Allied Practice;
advising and training with respect to business systems; purchasing and
maintaining inventory; advising with respect to and providing or arranging
accounting and bookkeeping services; advising with respect to developing a
marketing plan; assessing the financial feasibility of establishing new offices;
providing billing and collection services; and assisting the Allied Practice in
organizing and developing filing and recording systems. In exchange for such
services, the Company receives a consulting fee based on one of the three fee
structures described below.
c. CALCULATION OF MANAGEMENT FEES
The management fee is calculated pursuant to the Service or Consulting
Agreements based upon the practice's adjusted patient revenue calculated on the
accrual basis. There are three economic models by which the management fee may
be calculated under the two management service agreements discussed above which
are as follows:
(i) a designated percentage of adjusted patient revenue, ranging from 13.5% to
20%, subject to an annual adjustment based upon improvements in the Allied
Practice's operating margin in the most recent fiscal period as compared
with the immediately preceding fiscal period. No annual adjustment shall be
made which would result in reducing the designated percentage applicable
during the first year of the management agreement. Operating margin is
defined as the percentage determined by dividing operating profit by
adjusted patient revenue. Adjusted patient revenue under the agreement 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. Operating profit
is equal to adjusted patient revenue less operating expenses, excluding the
management fee and such expenses associated with the Allied Practices which
the Company is prohibited from incurring, primarily consisting of
orthodontist compensation.
(ii) a designated percentage ranging from 13.5% to 20% of adjusted patient
revenue with a potential annual adjustment of 25% of the increase in
operating margin (as defined above) in a fiscal year as compared to the
preceding fiscal year multiplied by the adjusted
29
<PAGE> 30
patient revenue for the current fiscal year. The supplemental fee, if
applicable, is paid as a lump sum payment upon final determination of the
improvement in the Allied Practice's operating margin as compared to the
prior fiscal year period.
(iii) a fixed dollar fee with annual established fixed increases for each year
of the management agreement.
d. PATIENT RECEIVABLES AND PATIENT PREPAYMENTS
The difference in the timing of the recognition of adjusted patient revenue and
the collection of cash related thereto results in unbilled receivables or
patient prepayments. Unbilled patient receivables represent the earned revenue
in excess of billings to patients as of the end of each period. Patient
prepayments represent collections from patients or their insurance companies
which are received in advance of the performance of the related services.
After the transfer of certain assets and certain liabilities of an Allied
Practice to the Company, the Company continues to purchase patient accounts
receivable generated by the Allied Practice and records these receivables on the
balance sheet of OrthAlliance. The receivable is recorded at net realizable
value on the date of purchase. Any subsequent uncollectible account is written
off by OrthAlliance and the Allied Practice revenue is reduced accordingly. The
impact on the Company from such write offs is the loss of management revenue
because practice revenue is reduced. All of the accounts receivable are assigned
to the Company, which generates the funds required for (i) the expenses incurred
by the Company to manage and administer the Allied Practice, (ii) the management
fees, and (iii) salaries for other employees of the Allied Practices with the
balance due the affiliated Orthodontist.
e. AMOUNTS DUE FROM ALLIED PRACTICES
Amounts due from Allied Practices include short-term advances for operating
capital and short-term receivables related to a timing difference between when
the services fees are paid from the Allied Practice's accounts and when the
service fees are deposited by the Company. These items are advanced and repaid
in a revolving manner. Generally, advances are repaid when Allied Practices
deposit patient revenue into their depository accounts. Advances occur when the
Allied Practice operating expenses paid exceed patient revenue earned. Service
fees outstanding are generally paid within 30 days.
f. OPERATING EXPENSES OF ALLIED PRACTICES
Certain operating expenses of the Allied Practices are the responsibility of
OrthAlliance. The Company is responsible for the payment of all operating
expenses incurred by the practice, except for compensation to affiliated
Orthodontists and other expenses of the Allied Practices that the Company is
prohibited from paying.
These expenses include the following:
- - Salaries, benefits, payroll taxes, workers compensation, health insurance
and other benefit plans, and other direct expenses of all employees of
OrthAlliance at each practice office, excluding those costs associated with
orthodontists and any other classification of employee which OrthAlliance
is prohibited from employing by applicable state laws or regulations,
- - Direct costs of all employees or consultants that provide services to each
practice office except for Affiliated Orthodontists and other employees of
the Allied Practices that the Company is prohibited from employing,
- - Dental and office supplies as permitted by applicable state laws or
regulations,
- - Lease or rent payments as permitted by state laws or regulations,
utilities, telephone and maintenance expenses for practice facilities,
- - Property taxes on OrthAlliance assets located at Allied Practice offices,
- - Property, casualty, liability and malpractice insurance premiums,
- - Orthodontists recruiting expenses,
- - Interest on advances to practice bank accounts and
30
<PAGE> 31
- - Advertising and other marketing expenses attributable to the promotion of
practice offices.
All of the above expenses are paid directly to the third party provider of the
goods or services indicated. All of the above items are incurred by
OrthAlliance. Such expenses are classified together with similar expenses of the
Company in the consolidated statement of operations. In exchange for incurring
these expenses and providing management services, the Company records revenue in
amounts equal to those incurred expenses plus a management fee based on varying
percentages of the adjusted patient revenues of the Allied Practices.
The Allied Practices retain the responsibility for the payment of any and all
direct employment expenses, including benefits, for any Orthodontist or other
employee that OrthAlliance is prohibited from employing by applicable state laws
or regulations. In addition, the Allied Practices retain the responsibility for
the payment of continuing education expenses, seminars, professional licenses,
professional membership dues and all other expenses of any Orthodontist.
g. NEW AFFILIATIONS
For the year ended December 31, 1998, the Company entered into agreements with
36 Allied Practices, of which seven related to pediatric dentists, to provide
management services and acquire certain operating assets for a total
consideration (including acquisition costs) of $46,819,000. This consideration
consisted of 1,640,492 shares of Common Stock with an aggregate value at various
acquisition dates of $19,801,000 and payment of $24,477,000 in cash and issuance
of notes payable of $2,541,000. These Allied Practices operate 70 locations in
22 states.
From August 26, 1997 to December 31, 1997, the Company entered into agreements
with 11 Allied Practices to provide management services and acquire certain
operating assets for a total consideration (including acquisition costs) of
$12,396,000. This consideration consisted of 863,776 shares of Common Stock with
an aggregate value at various acquisition dates of $10,279,000 and payment of
$2,063,000 in cash. The Company also assumed $1,390,000 in debt related to the
assets acquired. These Allied Practices operate 31 locations in seven states.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
b. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include OrthAlliance, Inc. and its wholly
owned subsidiaries. Significant intercompany accounts and transactions have been
eliminated in consolidation.
c. CASH AND CASH EQUIVALENTS
The Company considers all highly-liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents. All cash
equivalents are recorded at cost, which approximates fair value.
d. PROPERTY AND EQUIPMENT, NET
Property and equipment is recorded at cost. Routine maintenance and repairs are
expensed when incurred, while costs of improvements and renewals are
capitalized. Depreciation of property and equipment and amortization of
leasehold improvements are calculated using the straight-line method over the
estimated useful lives of the assets as follows:
Furniture and equipment 5- 7 years
Leasehold improvements shorter of 3-10 years
or the related lease term
31
<PAGE> 32
Depreciation expense for the years ended December 31, 1998 and 1997 and for the
period from inception (October 21, 1996) to December 31, 1996 was $874,000,
$140,000 and $0, respectively.
e. INTANGIBLE ASSETS, NET
The Company's acquisition of management agreements involve the purchase of
tangible and intangible assets and the assumption of certain liabilities of the
Allied Practices. The Company allocates the purchase price to the tangible
assets acquired and liabilities assumed based on estimated fair values. In
connection with each acquisition, the Company enters into long-term service
agreements with the Allied Practices. The service agreements are for terms of 20
to 25 years and can be terminated by either party only with cause, which is
primarily bankruptcy or material default. Each management agreement intangible
is being amortized using the straight-line method over its term. The Company
continually evaluates whether events and circumstances have occurred that
indicate the remaining useful life of the intangible assets may warrant revision
or that the remaining balance of the intangible assets may not be recoverable.
As of December 31, 1998 and 1997, there were no events or circumstances to
indicate that any portion of the recorded net intangible assets may not be
recoverable.
Amortization expense related to these intangible assets for the years ended
December 31, 1998 and 1997 and for the period from inception (October 21, 1996)
to December 31, 1996 was $1,526,000, $105,000 and $0, respectively.
f. OTHER, NET
Other, net consists mainly of deferred costs. These costs are amortized using
the straight-line method over the expected period to be benefited (three to 25
years). Amortization expense related to these costs for the years ended December
31, 1998 and 1997 and for the period from inception (October 21, 1996) to
December 31, 1996 was $85,000, $0 and $0, respectively.
g. NET REVENUES
Net revenues primarily consist of management fee income and reimbursed practice
operating expenses. Such expenses amounted to $54,391,000, $13,753,000 and $0
for the years ended December 31, 1998 and 1997 and for the period from inception
(October 21, 1996) to December 31, 1996, respectively.
h. INCOME TAXES
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," which
requires recognition of deferred tax assets and liabilities for expected future
tax consequences of events that have been recognized in the financial statements
or tax returns. Under this method, deferred tax assets and liabilities are
determined based on the differences between the financial statement carrying
amounts and the tax bases of such assets and liabilities using enacted tax rates
and laws in effect in the years in which the differences are expected to
reverse.
i. FAIR VALUE OF FINANCIAL INSTRUMENTS
As of December 31, 1998 and 1997, the carrying amounts of the Company's
financial instruments, which include cash and cash equivalents, notes
receivable, accounts payable and other accrued liabilities, notes payable to
Allied Practices and line of credit borrowings are recorded at cost, which
approximates fair value.
j. NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted SFAS 130, "Reporting
Comprehensive Income." This statement establishes disclosure requirements
related to the reporting of comprehensive income and its components. The Company
did not have any comprehensive income for the years ended December 31, 1998 and
1997 and for the period from October 31, 1996 to December 31, 1996.
Effective January 1, 1998, the Company implemented SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information." This standard establishes
disclosure requirements related to the reporting of the Company's operating
segments. As of December 31, 1998, the Company does not have any reportable
segments.
32
<PAGE> 33
Effective January 1, 1998, the Company adopted SFAS 132, "Employer's Disclosure
about Pensions and Other Postretirement Benefits." This statement revises
employers' disclosures related to pension and other postretirement benefit
plans. This statement does not have any effect on the Company since it does not
have any pensions or any postretirement benefit plans as of December 31, 1998.
The Emerging Issues Task Force of the Financial Accounting Standards Board
issued its Consensus Opinion 97-2 ("EITF 97-2"), which addresses certain
specific matters pertaining to the physician, dentistry and veterinary practice
management industries. EITF 97-2 became effective for the Company for its year
ending 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 did not change the Company's accounting method because the
Company's arrangements with its Allied Practices do not meet the requirements
for consolidation as set forth in EITF 97-2.
In 1999, the company will implement SOP 98-5 "Reporting on Costs of Start-up
Activities." The SOP requires net costs of start-up activities, including
organizational costs, to be expensed as incurred. In addition, the SOP requires
that previously capitalized start-up costs be expensed upon the effective date.
The Company does not have any start-up costs capitalized as of December 31,
1998.
3. PROPERTY AND EQUIPMENT, NET
Property and equipment, net, consisted of the following as of December 31:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Furniture and fixtures ...... $ 3,524,000 $ 3,361,000
Equipment ................... 3,846,000 2,565,000
Leasehold improvements ...... 1,710,000 1,174,000
Construction in progress .... 273,000 --
----------- -----------
9,353,000 7,100,000
Less accumulated depreciation (4,768,000) (3,886,000)
----------- -----------
$ 4,585,000 $ 3,214,000
=========== ===========
</TABLE>
4. NOTES RECEIVABLE
Notes receivable consisted of the following as of December 31:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Notes receivable from Allied Practices $3,162,000 $2,010,000
Patient notes receivable ............. 445,000 --
---------- ----------
$3,607,000 $2,010,000
========== ==========
</TABLE>
Certain Allied Practices have signed promissory notes due to the Company.
Generally, principal and interest payments are due monthly, with interest
accruing at prime plus 1%. Generally, these notes are unsecured but have been
personally guaranteed by the respective Orthodontists. The terms of these notes
range from three to five years. As of December 31, 1998 and 1997, the prime
interest rate was 7.75% and 8.50%, respectively.
During 1998, the Company acquired approximately $508,000 of patient loans from
certain Allied Practices. These loans outstanding are generally without
recourse. Principal and interest are due monthly, with interest rates, varying
between 9.9% and 16.9 %, depending on the credit risk of the borrower.
The terms of these loans range from one to five years.
5. ACCOUNTS PAYABLE AND OTHER ACCRUED LIABILITIES
Accounts payable and other accrued liabilities consisted of the following as of
December 31:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Bank overdrafts ........................ $2,222,000 $ 859,000
Accounts payable and accrued liabilities 1,963,000 1,565,000
Litigation reserve ..................... 600,000 600,000
---------- ----------
$4,785,000 $3,024,000
========== ==========
</TABLE>
33
<PAGE> 34
The litigation reserve was established by the Company as a result of the
increased possibility for legal action by one or more state governments
challenging the compliance of the Management Agreements with state and local law
or regulations. Management believes the reserve is adequate to cover any
potential costs to defend such legal actions.
6. LINE OF CREDIT BORROWINGS
On December 30, 1997, the Company entered into a $25.0 million revolving credit
facility (the "Revolving Credit Facility") with First Union, N.A. The Revolving
Credit Facility expires in December 2000, although it is subject to two,
one-year renewals upon the mutual acceptance of the Company and the bank.
The Company's receivables and its service agreements with the Allied Practices
collateralize the Revolving Credit Facility. Under the terms of the Revolving
Credit Facility, the Company is required to maintain certain consolidated
financial ratios and minimum consolidated net worth amounts. The Revolving
Credit Facility also prohibits the Company from incurring certain additional
indebtedness, limits certain future acquisitions to $2,000,000 per practice and
to $75,000,000 in total during the term without lender approval, and restricts
capital expenditures and cash dividends. At December 31, 1998 and 1997, the
Company was in compliance with all financial covenants of the Revolving Credit
Facility.
The Revolving Credit Facility requires payment of interest at variable rates
(bank's prime rate plus up to 0.5% or LIBOR plus up to 1.5%) depending upon the
Company's Leverage Ratio as defined in the Revolving Credit Facility. In
addition, the Company is charged a commitment fee of up to 0.375% of the unused
balance.
The outstanding balance under the Revolving Credit Facility as of December 31,
1998 and 1997, were $15,500,000 and $-0-, respectively.
7. CLASS B COMMON STOCK
Each share of Class B Common Stock will automatically convert into eight shares
of Class A Common Stock upon the attainment of certain conversion prices. Twenty
percent of the Class B Common Stock shares will convert at each of the following
conversion prices: $18.00, $21.60, $25.92, $31.10, and $37.32. The conversion
will be effected when the average Class A Common Stock closing price for 20
consecutive trading days exceeds the threshold. Class B Common Stock is also
convertible to an equal number of Class A Common Stock shares at any time at the
option of the holder. Any Class B Common Stock shares not converted to Class A
Common Stock, because the necessary conversion prices were not attained, will
automatically convert to one share of Common Stock upon the sixth anniversary of
the IPO. Class B Common Stock shares are not transferable, except to a holder's
direct relatives or as determined by will or the laws of descent. The holders of
Class B Common Stock enjoy the same share-for-share voting rights with holders
of the Class A Common Stock, with whom they vote as a single class.
8. PREFERRED STOCK
The Company is authorized to issue up to 20 million shares of preferred stock.
The Board of Directors, from time to time and without any stockholder action or
approval, may fix the relative rights and preferences of the preferred shares,
including voting powers, dividend rights, liquidation preferences, redemption
rights and conversion privileges. No preferred stock was outstanding as of
December 31, 1998 and 1997, respectively.
9. TREASURY STOCK
On October 22, 1998 the Company announced that the Board of Directors approved
the repurchase of shares of its Common Stock with a cost to the Company of up to
$5 million ("Stock Repurchase Plan"). The Company is authorized to purchase
shares over a 12 month period on Nasdaq Stock Market's National Market at prices
prevailing on that market. The Company uses the cost method to account for
treasury stock. As of December 31, 1998, no shares were repurchased under this
Stock Repurchase Plan.
During 1998, the Company acquired 170,024 shares of its common stock in
transactions with certain Allied Practices, with a market valuation at the date
of the transactions of $2,348,000. These transactions included a mutual
rescission agreement, which resulted in the Company incurring approximately
$32,000 in after tax expenses, and forgiveness of a note receivable, with a
value equal to the shares acquired.
10. STOCK OPTIONS AND WARRANTS
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<PAGE> 35
The Company has three stock option plans, the Amended and Restated 1997 Employee
Stock Option Plan ("Employee Plan"), the 1997 Non-Employee Director Stock Plan
("Non-Employee Plan") and the 1997 Orthodontist Stock Option Plan ("Orthodontist
Plan"). In addition, the Company issued warrants to certain executives in 1997.
Options may be granted as incentive or nonqualified stock options. The Company
accounts for the Employee Plan and the Non-Employee Plan under APB Opinion No.
25, under which no cost has been recognized.
The Company may grant options to purchase up to 1,500,000 shares of Common Stock
under the Employee Plan, 200,000 shares of Common Stock under the Non-Employee
Plan and 100,000 shares of Common Stock under the Orthodontist Plan. The options
are issued with exercise prices equal to the Company's stock price at the date
of grant. Options granted under the Employee Plan vest over one to five years;
are exercisable in whole or in installments; and expire ten years from date of
grant. Options granted under the Non-Employee Plan vest over one year; are
exercisable in whole or in installments; and also expire ten years from date of
grant. Options granted under the Orthodontist Plan vest at grant; are
exercisable in whole or in installments; and expire five years from the grant
date.
In connection with the IPO, the Company issued warrants to purchase 593,622
shares of Common Stock with exercise prices ranging from $0.01 to $14.38. The
weighted average fair value of the warrants granted was $4.74. The vesting
period for those warrants range from immediate to one year. These warrants
expire five years from date of grant and their weighted average exercise price
is $11.01 per warrant. Certain of these warrants have incidental registration
rights pursuant to which the Company is obligated to use reasonable efforts to
register the shares of Common Stock issued upon their exercise if the Company
initiates a public offering and files a registration statement in connection
therewith, excluding the registration of shares issued pursuant to an employee
stock purchase or option plan or an acquisition or proposed acquisition by the
Company.
The following summarizes stock option and warrant activity of the plans for the
years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------ ----------------------- -----------------------
WTD. AVG WTD. AVG NO. SHARES WTD. AVG NO. SHARES
EXERCISE NO. SHARES EXERCISE UNDER EXERCISE UNDER
PRICE UNDER OPTION PRICE OPTION PRICE OPTION
-------- ------------ -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Options and warrants outstanding,
beginning of year ......................... $11.72 1,243,332 $ -- -- $ -- --
Granted ..................................... 13.10 664,882 11.72 1,243,332 -- --
Exercised ................................... 3.44 70,000 -- -- -- --
Forfeited ................................... 12.24 96,000 -- -- -- --
------ --------- ------ --------- ------ ------
Options warrants outstanding, end of year ... $12.55 1,742,154 $11.72 1,243,332 $ -- --
====== ========= ====== ========= ====== ======
Options warrants exercisable, end of year ... $12.50 1,043,514 $11.46 739,732 $ -- --
====== ========= ====== ========= ====== ======
</TABLE>
The shares under option and warrants at December 31, 1998, were in the following
exercise price ranges:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ ----------------------------------
WTD. AVG
NO. SHARES CONTRACTUAL WTD. AVG NO. SHARES WTD. AVG
UNDER OPTION LIFE (YEARS) EXERCISE PRICE UNDER OPTION EXERCISE PRICE
------------ -------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
$ 8 - 9.99 ........ 104,585 8 $ 8.89 36,985 $ 8.71
10 - 11.99 ....... 30,108 8 11.12 22,618 11.20
12 - 13.99 ....... 1,124,213 7 12.03 741,563 12.03
14 - 15.99 ....... 483,248 8 14.67 242,348 14.64
--------- ---------
1,742,154 1,043,514
========= =========
</TABLE>
In accordance with Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" ("SFAS 123"), the fair value of option
grants is estimated using the Black-Scholes option pricing model for pro forma
footnote purposes. The following weighted average assumptions were used for
grants:
<TABLE>
<CAPTION>
1998 1997 1996
--------------- ------------- --------------
<S> <C> <C> <C>
Risk-free interest rate.............. 4.35-5.73% 5.7-6.5% 0%
Dividend yield....................... 0% 0% 0%
Expected volatility.................. 60% 44% 0%
Expected option life (years)......... 9 6 -
</TABLE>
As permitted by SFAS 123, the Company has chosen to continue accounting for
stock options at their intrinsic value. Accordingly, no compensation expense has
been recognized for its stock option compensation plans. Had the fair value
method of accounting been applied to the Company's stock option plans, the
tax-effected impact would be as follow:
35
<PAGE> 36
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------- -------------------------------- -----------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
--------------- -------------- -------------- --------------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Net income (loss)........ $7,535,000 $6,548,000 $(736,000) $(1,558,000) $ -- $ --
Basic EPS................ $ 0.58 $0.50 $(0.18) (0.39) $ -- --
Diluted EPS.............. $ 0.58 $0.50 $(0.18) (0.39) $ -- --
</TABLE>
11. COMMITMENTS AND CONTINGENCIES
The Company leases office space for the use of the Allied Practices and
corporate offices under operating leases, which have current expiration terms at
various dates through 2015. Certain of these leases have renewal options for
specified periods subsequent to their current terms. The annual lease payments
under the lease agreements have provisions for annual increases based on the
Consumer Price Index or other amounts specified within the lease agreements.
Future minimum lease payments on operating leases at December 31, 1998 are as
follows:
<TABLE>
<S> <C>
1999 $ 3,034,000
2000 2,750,000
2001 2,179,000
2002 1,501,000
2003 1,228,000
Thereafter 3,706,000
------------
$ 14,398,000
============
</TABLE>
The Company may be subject to certain government regulation at the federal and
state levels. To comply with certain regulatory requirements, the Company does
not control the practice of the Orthodontists, or control or employ the
Orthodontists. There can be no assurance that the legality of any long-term
management services agreements that have been entered into will not be
successfully challenged. There also can be no assurance that the laws and
regulations of states in which the Company maintains operations will not change
or be interpreted in the future to restrict or further restrict the Company's
relationship with the Orthodontists.
Orthodontists may be subject to legal liability suits while under management or
consulting services agreements with the Company. The Company may also, in the
normal course of business, become a defendant or plaintiff in various lawsuits.
Although a successful claim for which the Company is not fully insured could
have a material effect on the Company's financial condition, management is of
the opinion that it maintains insurance at levels sufficient to insure itself
against the normal risk of operations.
12. INCOME TAXES
The provision for income taxes is comprised of the following:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Current:
Federal $ 5,276,000 $ 1,086,000 $ --
State 1,073,000 222,000 --
----------- ----------- -----------
6,349,000 1,308,000 --
----------- ----------- -----------
Deferred:
Federal (114,000) (386,000) --
State (112,000) (81,000) --
----------- ----------- -----------
(226,000) (467,000) --
----------- ----------- -----------
$ 6,123,000 $ 841,000 $ --
=========== =========== ===========
</TABLE>
A reconciliation of the provision for income taxes to the amount computed at the
Federal statutory rate is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Federal income tax at statutory rate 34% 34% 0%
Effect of disallowed expense ........ -- 2 --
Effect of amortization of goodwill .. 4 34 --
Non-deductible warrant expense ...... -- 615 --
State taxes, net of Federal benefit . 5 88 --
Other ............................... 2 3 --
------- ------- -------
45% 806% 0%
======= ======= =======
</TABLE>
36
<PAGE> 37
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 31 are as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Current deferred tax assets:
Warrant expense ................... $ -- $ 211,000 $ --
Litigation reserve ................ 244,000 244,000 --
Patient prepayments ............... 230,000 773,000 --
Other ............................. 104,000 -- --
----------- ----------- -----------
578,000 1,228,000 --
----------- ----------- -----------
Non-current deferred tax assets:
Benefit of IRC Section 351 Gain
on transferred assets .......... 1,889,000 2,510,000 --
Start-up costs amortization ....... 960,000 1,281,000 --
Other ............................. 69,000 174,000 --
----------- ----------- -----------
Total non-current deferred tax
assets ............................ 2,918,000 3,965,000 --
----------- ----------- -----------
Total deferred tax assets, net ........ $ 3,496,000 $ 5,193,000 $ --
=========== =========== ===========
Current deferred tax liabilities:
Patient receivables ............... $ -- $(1,672,000) $ --
----------- ----------- -----------
Non-current deferred tax liabilities:
Depreciation ...................... (159,000) -- --
State Taxes ....................... (184,000) -- --
Other ............................. (372,000) (121,000) --
----------- ----------- -----------
(715,000) (121,000) --
----------- ----------- -----------
Total deferred tax liabilities ........ $ (715,000) $(1,793,000) $ --
=========== =========== ===========
</TABLE>
As a result of the acquisitions of the Allied Practices, temporary differences
were created for the differences between the financial statement carrying
amounts and the tax basis of assets acquired. Such temporary differences
predominantly relate to property and equipment and related depreciation and
were properly recorded.
13. EARNINGS PER SHARE
The Company adopted SFAS No. 128, Earnings per Share ("SFAS 128") effective
December 15, 1997. Basic earnings per share of Common Stock is computed by
dividing the net income (loss) for the year by the weighted average number of
shares of Common Stock outstanding during the year.
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Net income (loss) ........................... $ 7,535,000 $ (736,000) $ --
Determination of shares:
Weighted average number of common stock
shares outstanding ..................... 13,005,664 4,026,313 --
Assumed conversion of stock options ....... 38,049 -- --
----------- ----------- -----------
Diluted common stock shares outstanding ..... 13,043,713 4,026,313 --
=========== =========== ===========
Basic and diluted net income (loss) per share $ 0.58 $ (0.18) $ --
=========== =========== ===========
</TABLE>
37
<PAGE> 38
Securities, including those issuable pursuant to the conversion of Class B
Common Stock to Class A Common Stock, which could potentially dilute EPS in the
future have not been included in the computation of diluted EPS because of its
anti-dilutive effect or its conversion contingencies were not met. As of
December 31, potential dilutive shares were the following:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- -----------
<S> <C> <C> <C>
Common Stock shares issuable in the future
Pursuant to options and warrants outstanding 506,251 1,243,332 --
Common Stock shares issuable in the future for
Conversion of Class B Common Stock shares ... 1,745,044 1,750,000 --
--------- --------- -----------
2,251,295 2,993,332 --
========= ========= ===========
</TABLE>
14. RELATED PARTY TRANSACTIONS
For the year ended December 31, 1998, the Company entered into the following
related party transactions:
i) The company had short-term employee advances of $108,000 outstanding as of
December 31, 1998.
ii) Referral Commissions for recruiting new Allied Practices of $158,000 and
options to purchase 82,042 shares of Common Stock were paid and granted to
an Allied Orthodontist who is also a director.
iii) Referral Commissions for recruiting new Allied Practices of approximately
$310,000 were paid in cash to certain Allied Orthodontists.
For the year ended December 31, 1997, the Company entered into the following
related party transactions:
i) Paid a $300,000 consulting fee to a director, who provided financial and
general business services in connection with the IPO pursuant to a
consulting agreement. Pursuant to this consulting agreement and in addition
to the consulting fee, the Company granted the director a warrant to
purchase 150,000 shares of its Common Stock exercisable at $12.00 per
share.
Pursuant to the merger with USOC, a warrant granted to a director by USOC
to purchase 168,750 shares of USOC's common stock was converted to a
warrant to purchase an equal number of shares of OrthAlliance's Common
Stock at an exercise price of $11.16 per share.
The Company recorded a non-recurring organizer compensation expense of
$1,297,000 during the year ended December 31, 1997 related to these
warrants.
ii) In connection with the IPO, certain Allied Orthodontists were instrumental
in recruiting new Allied Practices and received warrants to purchase an
aggregate of 90,000 shares of OrthAlliance Common Stock. Of these, 31,600
were granted to an Allied Orthodontist who is also a director. All of these
warrants have an exercise price of $12.00 per share.
The Company recorded a non-recurring organizer compensation expense of
$366,000 during the year ended December 31, 1997 related to these warrants.
iii) Referral Commissions for recruiting new Allied Practices of approximately
$106,000 were paid to an Allied Orthodontist who is also a director. These
consisted of approximately $41,000 in cash and options to purchase 5,210
shares of Common Stock valued at approximately $65,000.
iv) Referral Commissions for recruiting new Allied Practices of approximately
$91,000 were paid in cash to certain Allied Orthodontists.
15. SUBSEQUENT EVENTS (unaudited)
Subsequent to December 31, 1998, 10 practices affiliated with the Company which
included 12 Allied Orthodontists. The Company entered into agreements with these
practices to provide management services and to acquire certain operating assets
for a total consideration (including acquisition costs) of $9,270,000. This
consideration consisted of 93,583 shares of Common Stock with an aggregate value
at various acquisition dates of $680,000 and payment of $8,590,000 in cash.
38
<PAGE> 39
Subsequent to December 31, 1998, pursuant to the Stock Repurchase Plan, the
Company repurchased 22,500 of its shares of Common Stock at a total cost of
$259,000.
On March 26, 1999, the Company closed an agreement to extend the existing line
of credit from $25 million to $55 million.
39
<PAGE> 40
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of OrthAlliance, Inc.:
We have audited in accordance with generally accepted auditing standards, the
consolidated financial statements of OrthAlliance, Inc. and subsidiaries
included in this Form 10-K and have issued our report thereon dated February 19,
1999. Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule identified as "Schedule II -
Valuation and Qualifying Accounts" is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures applied
in the audits of the basic consolidated financial statements and, in our
opinion, fairly states in all material respects the financial data to be set
forth therein in relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Los Angeles, California
February 19, 1999
40
<PAGE> 41
ORTHALLIANCE, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND FOR THE PERIOD FROM INCEPTION
TO DECEMBER 31, 1996
<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND END OF
PERIOD EXPENSE WRITE-OFFS OTHER (A) PERIOD
------------ ---------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1998
Allowance for uncollectible accounts .... $535,000 $123,000 $ -- $162,000 $820,000
Year ended December 31, 1997
Allowance for uncollectible accounts .... $ -- $ 18,000 $ -- $517,000 $535,000
Year ended December 31, 1996
Allowance for uncollectible accounts .... $ -- $ -- $ -- $ -- $ --
</TABLE>
(A) Amount was recognized at the time that the Allied Practices transferred
certain of their assets and liabilities to the Company.
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<S> <C>
2.1 Agreement and Plan of Merger between the Company, USOC and POG
(incorporated by reference to Exhibit 2.1 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
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 Specimen Class A Common Stock Certificate (incorporated by
reference to Exhibit 4.1 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
4.2 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).
4.3 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).
4.4 Incidental Registration Rights for certain Allied
Orthodontists as set forth in the Form of Purchase and Sale
Agreement, the Form of Stock Purchase
and Sale Agreement and the Form of
Agreement and Plan of Reorganization (incorporated by reference
to Exhibit 10.2, 10.3 and 10.5, respectively, of the Company's
Annual Report on Form 10-K for the year ended December 31, 1997).
10.1 Form of Purchase and Sale Agreement between the Company and
Allied Practices (incorporated by reference to Exhibit 2.2 of
the Company's Registration Statement on Form S-1, Registration
No. 333-27143, as amended).
</TABLE>
41
<PAGE> 42
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<S> <C>
10.2 Form of Stock Purchase and Sale Agreement between the Company
and Stockholders of the initial Allied Practices (incorporated
by reference to Exhibit 2.4 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
10.3 Form of Stock Purchase and Sale Agreement between the Company
and the Stockholders of the Allied Practices (incorporated by reference to
Exhibit 10.4 of the Company's Annual Report on Form 10-K for the fiscal
Year ended December 31, 1997).
10.4 Form of Agreement and Plan of Reorganization between the
Company, Allied Practices and the Stockholders of the Allied
Practices (incorporated by reference to Exhibit 2.3 of the
Company's Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.5 Form of Service Agreement between the Company and Allied
Practices (Fixed Percentage Fee) (incorporated by reference to
Exhibit 10.1 of the Company's Registration Statement on Form
S-1, Registration No. 333-27143, as amended).
10.6 Form of Service Agreement between Company and Allied Practices
(Variable Percentage Fee) (incorporated by reference to
Exhibit 10.2 of the Company's Registration Statement on Form
S-1, Registration No. 333-27143, as amended).
10.7 Form of Consulting and Business Services Agreement between the
Company and Allied Practices (Variable Percentage Fee)
(incorporated by reference to Exhibit 10.3 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.8 Form of Consulting and Business Services Agreement between the
Company and Allied Practices (Fixed Percentage Fee)
(incorporated by reference to Exhibit 10.4 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143, as amended).
10.9 Form of Consulting and Business Services Agreement between the
Company and Allied Practices (Fixed Dollar Fee) (incorporated
by reference to Exhibit 10.5 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143, as
amended).
10.10 1997 Non-Employee Director Stock Plan (incorporated by
reference to Exhibit 10.6 of the Company's Registration
Statement on Form S-1, Registration No. 333-27143).
10.11 Amended and Restated 1997 Employee Stock Option Plan
(incorporated by reference to Exhibit 10.7 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.12 1997 Orthodontist Stock Option Plan (incorporated by reference to
Exhibit 10.13 of the Company's Annual Report on Form 10-K for
fiscal year ended December 31, 1997).
</TABLE>
42
<PAGE> 43
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<S> <C>
10.13 Employment Agreement between the Company and Sam Westover
(incorporated by reference to Exhibit 10.8 of the Company's
Registration Statement on Form S-1, Registration No.
333-27143).
10.14 Letter Agreement between the Company and Stephen M. Toon.
10.15 Credit Agreement dated December 30, 1997 between the Company
and First Union National Bank (incorporated by reference to
Exhibit 10.16 of the Company's Annual Report on Form 10-K for
fiscal year ended December 31, 1997).
10.16 Form of Company Practice Improvement Program Guarantee (incorporated by
reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for
Fiscal year ended December 31, 1997).
21.1 Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule.
99.1 Safe Harbor Compliance Statement (incorporated by reference to
Exhibit 99.1 of the Company's Annual Report on Form 10-K for
fiscal year ended December 31, 1997).
</TABLE>
43
<PAGE> 1
[ORTHALLIANCE LETTERHEAD]
May 22, 1998
Via Federal Express and Facsimile to 423-675-9692
Mr. Steve Toon
12864 Pecos Road
Knoxville, TN 37922
Dear Steve:
I am pleased to formalize and present the following employment offer for the
position of Senior Vice President - Chief Development Officer of OrthAlliance,
Inc. ("Company") reporting to me:
COMPENSATION:
o Initial Base Salary of $15,416.67 per month. You will be eligible for a
salary review in January 1999.
o You will receive a guaranteed management bonus in February 1999 of $92,500
for your efforts in 1998. Thereafter, subject to the approval of the
Compensation Committee of the Board of Directors, you will be eligible to
receive a bonus of up to 50% of your base salary based upon the achievement
of Company targets established by the Board of Directors and Management of
the Company.
o You are eligible for recruitment commissions in accordance with Exhibit A
attached to this letter and incorporated by this reference.
TERM:
o Two years from your first date of employment
STOCK OPTIONS:
o A stock option grant for 75,000 shares of common stock of Company will be
granted on the first date of your employment. You will be eligible for
additional options on an annual basis. Vesting will be 20% on such date of
grant and 20% on each anniversary of such date.
COMPANY BENEFITS:
o Participation in all benefits made generally available to Company employees
from time to time. The Company currently provides medical insurance and free
parking to employees.
o Four (4) weeks vacation per year.
o Moving Allowance of $40,000 will be paid to you upon signing your employment
agreement
1
<PAGE> 2
Steve Toon
May 22, 1998
Page 2
for you to move to Southern California this summer. To the extent that you
do not submit appropriate receipts and documentation, the Moving Allowance
will be added to your taxable income. In the event you do not commence
employment with the Company, you will repay the Moving Allowance.
START DATE:
o August 31, 1998 or sooner ("Commencement Date").
SEVERANCE; CONFIDENTIALITY AND NON-COMPETITION:
o See Exhibit B attached to this letter and incorporated by this reference.
It is the policy of the Company that all employment may be discontinued at will
by you or the Company, at any time and for any reason, with or without cause. If
these terms are acceptable, please sign in the space provided below and return
one copy of this letter to me.
I am excited about the opportunity to work with you. Please feel free to call me
with any questions.
Sincerely,
/s/ Sam Westover
- ----------------------
Sam Westover
President and CEO
Agreed: /s/ Stephen M. Toon Date: May 22, 1998
------------------------- ------------------------
2
<PAGE> 3
Exhibit A
Steve Toon ("Employee") is eligible to receive recruitment for his
solicitation and enrollment of new orthodontic practices ("Prospect Practices")
that affiliate with the Company pursuant to the following terms:
1. Acceptance of Prospect Practices.
In order to affiliate with the Company, Prospect Practices must
provide such information and documentation and execute such agreements and
documentation as the Company may require from time to time. The acceptance of
such information, agreements and documentation from all Prospect Practices shall
be subject to the approval of Company and Company, in its sole discretion, may
withhold such approval.
2. Terms of Affiliation.
Company shall have the right, in its sole discretion, to
determine the terms and conditions for the Prospect Practices to affiliate with
the Company and Company may change such terms and conditions in any respect at
any time without prior notice to Employee.
3. Computation of Commissions.
3.1 If Employee solicits and recruits a Prospect Practice that
affiliates with the Company and is not an Excluded
Practice (as defined in Section 3.2 below), Employee shall
be paid a commission, as a percentage of combined Adjusted
Gross Revenue for all such practices recruited by Employee
during the term of this Agreement, of:
(i) One and One-Half percent (1-1/2%) of Adjusted Gross
Revenue for such Prospect Practices that affiliate
with the Company for the first $5 million of such
practices' combined Adjusted Gross Revenue.
(ii) One percent (1%) of the next combined $5 million of
such practices' Adjusted Gross Revenue.
(iii) One-Half percent (1/2%) of any additional Adjusted
Gross Revenue of such practices.
As used herein, Adjusted Gross Revenue shall mean the Prospect
Practice's annual adjusted gross revenue used by the Company for valuation
purposes. Provided, however, the foregoing commission percentages assume that
the Purchase Price Multiple is 5.88 or less for each Prospect Practice. As used
herein, the Purchase Price Multiple is defined as the consideration paid by
OrthAlliance to the Prospect Practice divided by such practice's Adjusted
1
<PAGE> 4
Gross Revenue. Prospect Practices that are acquired by OrthAlliance at a
Purchase Price Multiple of 7.06 or more shall not be eligible for any
commission, but Prospect Practices that affiliate with OrthAlliance at a
Purchase Price Multiple greater than 5.88 and less than 7.06 shall be
interpolated and given partial credit for Pro Forma Adjusted Gross Revenue as
follows: Multiply the Pro Forma Adjusted Gross Revenue for the applicable
Prospect Practice by a fraction, (a) the denominator of which is 1.18 (7.06
minus 5.88) and (b) the numerator of which is 7.06 minus the Purchase Price
Multiple for the applicable Prospect Practice.
As used herein, a Prospect Practice will not be deemed to have
affiliated with the Company unless and until all of the information, contracts
and documentation required by the Company have been accepted by the Company and
all necessary government filings and approvals have been completed and obtained.
3.2 The Company shall have the right to recruit Prospect
Practices through any and all avenues, including but not limited to the efforts
of its affiliated practices to recruit Prospect Practices and the use of other
employees and recruitment representatives. Notwithstanding anything contained
herein to the contrary, in the event that the Company is required to pay any
recruiting commissions, fees, stock options or other amounts (collectively
"Recruiting Commission") to any other persons or entities in connection with the
solicitation and recruitment of any Prospect Practice ("Excluded Practice"),
Employee shall not be eligible to receive any commission for such Excluded
Practice; provided, however, referral commissions (up to 1% of Adjusted Gross
Revenue) paid to affiliated practices or orthodontists who referred a Prospect
Practice to the Company ("Referral Commission") shall not be considered to be a
Recruiting Commission and shall not cause a Prospect Practice to become an
Excluded Practice. Affiliated Practices and Orthodontists may, however, also
recruit Prospect Practices and qualify for a Recruiting Commission in addition
to the Referral Commission. If the Company pays a Recruiting Commission to any
affiliated practice or orthodontist in connection with the affiliation of a
Prospect Practice, then such Prospect Practice shall be deemed to be an Excluded
Practice. The President and CEO of the Company shall determine in his sole
discretion whether any Recruiting Commission is owed to any other person or
entity, including an affiliated practice or orthodontist.
2
<PAGE> 5
EXHIBIT B
1.TERMINATION. In the event that Steve Toon's ("Employee") employment
with the Company (i) is terminated by the Company without "Cause" during the
term or (ii) is terminated by Employee within 120 days following a Constructive
Termination during the term, in exchange for a general release of any and all
claims that the Employee may have against the Company, the Company will pay
Employee, as Employee's sole remedy in connection with such termination, (a)
severance pay in the amount of Employee's monthly base salary at the rate in
effect immediately preceding the termination of Employee's employment multiplied
by 24 months (the "Separation Payment"), which Separation Payment will be paid
by the Company in a lump sum on the date of termination, (b) the portion of his
base salary accrued but unpaid from the last monthly payment date to the date of
termination, (c) expense reimbursements for expenses incurred in the performance
of his duties prior to termination and (d) any unpaid bonus for any year that
was completed prior to the termination and a pro-rata portion of the annual
maximum bonus for the year in which the termination occurs.
Employee will not be entitled to any severance pay or other compensation
upon termination of his employment (i) pursuant to Employee's death or
disability, (ii) in the event that Employee voluntarily leaves the employment of
the Company, or (iii) for Cause, except for any portion of his base salary
accrued but unpaid from the last monthly payment date to the date of termination
and expense reimbursements hereof for expenses incurred in the performance of
his duties hereunder prior to termination.
(a) Disability. Employee will be deemed disabled if, as a result of
Employee's incapacity due to physical or mental illness, Employee shall have
been absent from his duties with the Company on a full-time basis for 120
consecutive business days.
(b) Cause. For purposes of this Agreement, a termination will be for
Cause if (i) Employee continuously fails to perform his duties with the Company
(other than any such failure resulting from incapacity due to physical or mental
illness), (ii) Employee engages in misconduct materially and demonstrably
injurious to the Company or (iii) Employee has been convicted of a felony or a
crime involving moral turpitude.
(c) Constructive Termination. As used herein, the term "Constructive
Termination" means (i) a change in Employee's title without Employee's consent,
(ii) a material reduction in Employee's duties and responsibilities without
Employee's consent, (iii) a reduction in Employee's base compensation or maximum
eligible bonus from the immediately preceding year without Employee's consent or
(iv) the relocation of the Company's principal executive offices outside a 20
mile radius from the location of the Company's principal executive offices at
the Commencement Date without Employee's consent.
Section 2. CHANGE IN CONTROL TERMINATION PAYMENT.
(a) Termination Payment.
(i) Amount. Notwithstanding anything to the contrary contained in
Section 1 hereof, in the event Employee's employment with the Company
terminates for any reason (other than death) within the twelve month
period following a Change In Control (as defined in subsection 2(b)
hereof), the Company will pay Employee a lump sum payment (the
"Termination Payment") in cash equal to three (3) times the sum of the
items in the following subsections (I) and (II):
1
<PAGE> 6
(I) Employee's annual base compensation determined by
reference to his base salary in effect immediately prior to the
Change In Control; and
(II) the maximum bonus that Employee could receive under
any management incentive bonus plan of the Company for the year
in which the Change In Control occurs.
The Termination Payment will also include the following:
(III) Employee's base salary accrued but unpaid from the
last payment date to the date of termination;
(IV) expense reimbursement for expenses incurred in the
performance of his duties hereunder prior to the termination of
his employment with the Company;
(V) any other benefit accrued but unpaid as of the date of
such termination; and
(VI) the estimated cost to Employee of obtaining medical
insurance coverage for a period of eighteen months; provided that
such coverage will be substantially similar to the coverage
provided to Employee by Company immediately prior to the Change
In Control; and provided further that this subsection 2(a)(i)(VI)
will be applied without regard to, and the amount payable under
this subsection 2(a)(i)(VI) is in addition to, any continuation
(COBRA) rights or conversion rights under any plan provided by
Company, which rights are not affected by any provision hereof.
(ii) Time for Payment; Interest. The Company will pay the
Termination Payment to Employee concurrent with Employee's termination
of employment. Company's obligation to pay to Employee any amounts under
this Section 2, including without limitation the Termination Payment and
any Gross Up Payment due under subsection (c), will bear interest at the
maximum rate allowed by law until paid by Company, and all accrued and
unpaid interest will bear interest at the same rate, all of which
interest will be compounded daily.
(iii) Termination. The Company's obligation to pay the
Termination Payment will not be affected by the manner in which
Employee's employment with the Company is terminated. Without limiting
the generality of the foregoing, the Company will be obligated to pay
the Termination Payment and any Gross Up Payment regardless of whether
Employee's termination of employment is voluntary, involuntary, for
cause, without cause, in violation of any employment agreement or other
agreement in effect at the time of the Change In Control, or due to
Employee's retirement or disability. Employee's notice of his
termination of employment in connection with a Change In Control may be
made by any means. If Employee receives the Termination Payment, the
Employee shall not be entitled to receive the Separation Payment under
Section 1 above.
(b) Change In Control. A Change In Control will be deemed to have
occurred for purposes hereof (i) when a change of stock ownership of the Company
of a nature that would be required to be reported in response to Item 6(e) of
Schedule 14A promulgated under the
2
<PAGE> 7
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and any
successor Item of a similar nature has occurred; or (ii) upon the acquisition of
beneficial ownership, directly or indirectly, by any person (as such term is
used in Section 14(d)(2) of the Exchange Act) of securities of the Company
representing 33 % or more of the combined voting power of the Company's then
outstanding securities; or (iii) a change during any period of two consecutive
years of a majority of the members of the Board of Directors of the Company for
any reason, unless the election, or the nomination for election by the Company's
shareholders, of each director was approved by a vote of a majority of the
directors then still in office who were directors at the beginning of the
period; provided that a Change In Control will not be deemed to have occurred
for purposes hereof with respect to any person meeting the requirements of
clauses (i) and (ii) of Rule 13d-l(b)(1) promulgated under the Securities
Exchange Act of 1934, as amended.
(c) Gross Up Payment.
(i) Excess Parachute Payment. If Employee incurs the tax (the "Excise
Tax") imposed by Section 4999 of the Internal Revenue Code of 1986 (the "Code")
on "excess parachute payments" within the meaning of Section 280G(b)(1) of the
Code, the Company will pay to Employee an amount (the "Gross Up Payment") such
that the net amount retained by Employee, after deduction of any Excise Tax on
the excess parachute payment and any federal, state and local income tax
(together with penalties and interest) and Excise Tax upon the payment provided
for by this subsection (c)(i), will be equal to the amount of the excess
parachute payment.
(ii) Applicable Rates. For purposes of determining the amount of the
Gross Up Payment, Employee will be deemed to pay federal income taxes at the
highest marginal rate of federal income taxation in the calendar year in which
the Gross Up Payment is to be made and state and local income taxes at the
highest marginal rates of taxation in the state and locality of Employee's
residence on the date of his termination of employment, net of the maximum
reduction in federal income taxes that could be obtained from deduction of such
state and local taxes.
(iii) Determination of Gross Up Payment Amount. The determination of
whether the Excise Tax is payable and the amount thereof will be based upon the
opinion of tax counsel selected by Employee. If such opinion is not finally
accepted by the Internal Revenue Service (or state and local taxing
authorities), then appropriate adjustments to the Excise Tax will be computed
and additional Gross Up Payments will be made in the manner provided by this
subsection (c).
(iv) Time For Payment. The Company will pay the estimated amount of the
Gross Up Payment in cash to Employee concurrent with Employee's termination of
employment. Employee and the Company agree to reasonably cooperate in the
determination of the actual amount of the Gross Up Payment. Further, Employee
and the Company agree to make such adjustments to the estimated amount of the
Gross Up Payment as may be necessary to equal the actual amount of the Gross Up
Payment, which in the case of Employee will refer to refunds of prior
overpayments and in the case of the Company will refer to makeup of prior
underpayments.
(d) Arbitration. Any controversy or claim arising out of or relating to
this Section 2, or the breach thereof, will be settled exclusively by
arbitration in Los Angeles, California, in accordance with the Commercial
Arbitration Rules of the American Arbitration Association then
3
<PAGE> 8
in effect. Judgment upon the award rendered by the arbitrator(s) may be entered
in, and enforced by, any court having jurisdiction thereof.
(e) No Right To Continued Employment. This Exhibit A will not give
Employee any right of continued employment or any right to compensation or
benefits from the Company except the rights specifically stated herein.
(f) Exercise of Stock Options. Employee's options to purchase the
Company's Common Stock will vest completely and become immediately exercisable
upon a Change In Control and will remain exercisable for the greater of 90 days
or the time period specified in the applicable option plan or option agreement.
Section 3. CONFIDENTIAL INFORMATION. Employee recognizes and
acknowledges that certain assets of the Company and its affiliates, including
without limitation information regarding customers, pricing policies, methods of
operation, proprietary computer programs, sales, products, profits, costs,
markets, key personnel, formulae, product applications, technical processes, and
trade secrets (hereinafter called "Confidential Information") are valuable,
special and unique assets of Company and its affiliates. Employee will not,
during or after his term of employment, disclose any of the Confidential
Information to any person, firm, corporation, association, or any other entity
for any reason or purpose whatsoever, directly or indirectly, except as may be
required pursuant to his employment hereunder, unless and until such
Confidential Information becomes publicly available other than as a consequence
of the breach by Employee of his confidentiality obligations hereunder. In the
event of the termination of his employment, whether voluntary or involuntary and
whether by the Company or Employee, Employee will deliver to the Company all
documents and data pertaining to the Confidential Information and will not take
with him any documents or data of any kind or any reproductions (in whole or in
part) of any items relating to the Confidential Information.
Section 4. NONCOMPETITION. Until two years after termination of
Employee's employment hereunder, Employee will not (i) engage directly or
indirectly, alone or as a shareholder, partner, officer, director, employee or
consultant of any other business organization, in any business activities which
(A) relate to the acquisition, consolidation or management of orthodontic and
pediatric practices (the "Designated Industry") and (B) were either conducted by
the Company prior to Employee's termination or proposed to be conducted by the
Company at the time of such termination, (ii) divert to any competitor of the
Company in the Designated Industry any customer of the Company, or (iii) solicit
or encourage any officer, employee, or consultant of the Company to leave its
employ for employment by or with any competitor of the Company in the Designated
Industry. The parties hereto acknowledge that Employee's noncompetition
obligations hereunder will not preclude Employee from owning less than 2 % of
the common stock of any publicly traded corporation conducting business
activities in the Designated Industry. Employee will continue to be bound by the
provisions of this Section 4 until their expiration and will not be entitled to
any compensation from the Company with respect thereto. If at any time the
provisions of this Section 4 are determined to be invalid or unenforceable, by
reason of being vague or unreasonable as to area, duration or scope of activity,
this Section 4 will be considered divisible and will become and be immediately
amended to only such area, duration and scope of activity as will be determined
to be reasonable and enforceable by the court or other body having jurisdiction
over the matter; and Employee agrees that this Section 4 as so amended will be
valid and binding as though any invalid or unenforceable provision had not been
included herein.
4
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF
ORTHALLIANCE, INC.
<TABLE>
<CAPTION>
State of
Name Incorporation
- ---- -------------
<S> <C>
Amley Asset Subsidiary, Inc. FL
Arkle Assets Subsidiary, Inc. NC
Asset Subsidiary, Inc. WA
Bevans Asset Subsidiary, Inc. AR
Brenkert Asset Subsidiary, Inc. CO
Burckhardt Asset Subsidiary, Inc. MN
Crawford Asset Subsidiary, Inc. GA
Crum Asset Subsidiary, Inc. AZ
Dormois Asset Subsidiary, Inc. TN
Engst Asset Subsidiary, Inc. WA
Halliburton Asset Subsidiary, Inc. TN
Horvath Asset Subsidiary, Inc. GA
Jayne Asset Subsidiary, Inc. AL
Lam Asset Subsidiary, Inc. AZ
Loeffler Asset Subsidiary, Inc. CA
Lorentz Asset Subsidiary, Inc. MS
Mitchell Asset Subsidiary, Inc. GA
OA Equipment, Inc. IN
Only Orthodontics of South Miami, Inc. FL
Pence Asset Subsidiary, Inc. IN
Pickron Asset Subsidiary, Inc. GA
Robson Asset Subsidiary, Inc. CA
Sharp Asset Subsidiary, Inc. CA
Silver Asset Subsidiary, Inc. GA
Smernoff Asset Subsidiary, Inc. VA
Starr Asset Subsidiary, Inc. MD
Yaffey Asset Subsidiary, Inc. FL
Yurfest Asset Subsidiary, Inc. GA
OrthAlliance Finance, Inc. DE
PedoAlliance, Inc. DE
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation by reference in this Form 10-K of our reports included in the
Company's previously filed S-1 Registration Statement File No. 333-27143, S-4
Registration Statements File No. 333-29435 and 333-53415, S-8 Registration
Statements File No. 333-48831, 333-48833 and 333-61461.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Los Angeles, California
March 26, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 3,226,000
<SECURITIES> 0
<RECEIVABLES> 12,047,000
<ALLOWANCES> (820,000)
<INVENTORY> 0
<CURRENT-ASSETS> 26,344,000
<PP&E> 9,353,000
<DEPRECIATION> (4,768,000)
<TOTAL-ASSETS> 88,580,000
<CURRENT-LIABILITIES> 13,109,000
<BONDS> 0
0
0
<COMMON> 13,000
<OTHER-SE> 59,243,000
<TOTAL-LIABILITY-AND-EQUITY> 88,580,000
<SALES> 0
<TOTAL-REVENUES> 74,387,000
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 60,281,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 448,000
<INCOME-PRETAX> 13,658,000
<INCOME-TAX> 6,123,000
<INCOME-CONTINUING> 7,535,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,535,000
<EPS-PRIMARY> 0.58
<EPS-DILUTED> 0.58
</TABLE>
