<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
----------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 000-22975
----------------
ORTHALLIANCE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4632134
(STATE OR JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
21535 HAWTHORNE BOULEVARD, SUITE 200
TORRANCE, CALIFORNIA 90503
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(310) 792-1300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
----------------
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 [ ]
<TABLE>
<CAPTION>
Issued and
Class Outstanding at November 12, 1999
----- --------------------------------
<S> <C>
Class A Common Stock, $.001 par value 12,884,235
Class B Common Stock, $.001 par value 249,292
</TABLE>
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<PAGE> 2
ORTHALLIANCE, INC.
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C> <C>
PART I. FINANCIAL INFORMATION .................................................................... 3
Item 1. Financial Statements...................................................................... 3
Condensed Consolidated Balance Sheets as of September 30, 1999 (unaudited) and
December 31, 1998......................................................................... 3
Unaudited Condensed Consolidated Statements of Income for the Three Month and
Nine Month Periods Ended September 30, 1999 and September 30, 1998........................ 4
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Month Periods
Ended September 30, 1999 and September 30, 1998........................................... 5
Notes to Unaudited Condensed Consolidated Financial Statements............................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..... 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................ 15
PART II. OTHER INFORMATION......................................................................... 16
Item 1. Legal Proceedings......................................................................... 16
Item 2. Changes in Securities and Use of Proceeds................................................. 16
Item 3. Defaults Upon Senior Securities........................................................... 16
Item 4. Submission of Matters to a Vote of Security Holders....................................... 16
Item 5. Other Information......................................................................... 16
Item 6. Exhibits and Reports on Form 8-K.......................................................... 16
Signatures................................................................................ 17
Exhibit Index............................................................................. 18
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------ -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................................ $ 6,272 $ 3,226
Patient receivables, net of allowances of $535 and $435 at
September 30, 1999 and December 31, 1998, respectively ................. 9,943 7,765
Unbilled patient receivables, net of
allowances of $403 and $385 at September 30, 1999 and
December 31, 1998, respectively ........................................ 3,629 3,462
Amounts due from Allied Practices ........................................ 10,955 9,880
Income taxes receivable .................................................. 245 1,102
Current deferred tax assets .............................................. 309 578
Other current assets ..................................................... 513 331
--------- --------
Total current assets .................................................... 31,866 26,344
Property and equipment, net ................................................. 6,229 4,585
Notes receivable ............................................................ 4,261 3,607
Non-current deferred tax assets ............................................. 1,851 2,918
Intangible assets, net ...................................................... 78,902 50,912
Other, net .................................................................. 554 214
--------- --------
Total assets ............................................................ $ 123,663 $ 88,580
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................................................... $ 2,030 $ 2,417
Accrued liabilities ...................................................... 1,966 2,368
Patient prepayments ...................................................... 5,797 4,777
Practice affiliations payable ............................................ 2,373 1,760
Amounts due to Allied Practices .......................................... 2,497 1,787
--------- --------
Total current liabilities ............................................... 14,663 13,109
--------- --------
Line of credit borrowings ................................................... 42,200 15,500
Non-current deferred tax liabilities ........................................ 798 715
Other non-current liabilities ............................................... 218 --
--------- --------
Total liabilities ....................................................... 57,879 29,324
--------- --------
Commitments and Contingencies
Stockholders' equity:
Class A Common Stock, $.001 par value, 70,000,000 shares
authorized, 13,197,961 shares issued and outstanding
at September 30, 1999 and December 31, 1998 ............................ 13 13
Class B Common Stock, $.001 par value, 250,000 shares
authorized, 249,292 shares issued and outstanding at
September 30, 1999 and December 31, 1998, respectively ............... -- --
Additional paid-in capital .................................................. 65,162 65,188
Retained earnings (accumulated deficit) ..................................... 2,947 (3,597)
Treasury stock, at cost, 248,142 shares at September 30, 1999
and 170,024 shares at December 31, 1998, respectively.................... (2,338) (2,348)
--------- --------
Total stockholders' equity .............................................. 65,784 59,256
--------- --------
Total liabilities and stockholders' equity .............................. $ 123,663 $ 88,580
========= ========
</TABLE>
The accompanying notes are an integral part
of these condensed consolidated balance sheets.
3
<PAGE> 4
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues ................................................... $ 24,286 $ 20,042 $ 69,449 $ 53,404
-------- -------- -------- --------
Costs and expenses:
Salaries and benefits .......................................... 6,679 6,291 20,545 16,641
Orthodontic and dental supplies ................................ 2,423 2,031 6,693 5,215
Rent ........................................................... 2,169 1,598 5,939 4,557
-------- -------- -------- --------
Total direct expenses ..................................... 11,271 9,920 33,177 26,413
General and administrative ..................................... 6,944 5,715 19,525 15,433
Depreciation and amortization .................................. 1,022 612 2,832 1,671
-------- -------- -------- --------
Total operating expenses .................................. 19,237 16,247 55,534 43,517
-------- -------- -------- --------
Operating income ............................................... 5,049 3,795 13,915 9,887
Interest expense ............................................... (698) (172) (1,580) (309)
Interest income ................................................ 107 76 299 272
-------- -------- -------- --------
Income before income taxes ..................................... 4,458 3,699 12,634 9,850
Provision for income taxes ..................................... 1,877 1,627 5,561 4,297
-------- -------- -------- --------
Net income ..................................................... $ 2,581 $ 2,072 $ 7,073 $ 5,553
======== ======== ======== ========
Net income per share- basic and diluted ........................ $ 0.19 $ 0.16 $ 0.53 $ 0.43
======== ======== ======== ========
Weighted average number of
common shares outstanding (in thousands):
Basic ........................................................ 13,318 13,269 13,313 12,929
======== ======== ======== ========
Diluted ...................................................... 13,319 13,277 13,334 12,983
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
<PAGE> 5
ORTHALLIANCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income ............................................................. $ 7,073 $ 5,553
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ......................................... 2,832 1,671
Deferred taxes ........................................................ 479 --
Changes in assets and liabilities, excluding effects of
Acquisitions:
Increase in patient receivables, net ................................ (845) (658)
Increase in amounts due from Allied Practices ....................... (1,075) (4,094)
Increase in other current assets .................................... (175) (216)
Decrease in income taxes receivable ................................. 1,493 --
(Increase) decrease in other, net ................................... (11) 56
(Decrease) increase in accounts payable
and accrued liabilities .......................................... (144) 550
Increase in amounts due to Allied Practices ......................... 264 2,378
Increase in patient prepayments ..................................... 727 937
Decrease in income taxes payable .................................... -- (465)
-------- --------
Net cash provided by operating activities .............................. 10,618 5,712
-------- --------
Cash flows from investing activities:
Payments for new practice affiliations .............................. (24,068) (20,266)
Increase in notes receivable ........................................ (1,611) (1,718)
Principal payments on notes receivables ............................. 924 348
Capital expenditures ................................................ (834) (550)
-------- --------
Net cash used in investing activities .................................. (25,589) (22,186)
-------- --------
Cash flows from financing activities:
(Increase) decrease in bank overdraft ............................... (515) 22
Proceeds from exercise of stock options ............................. -- 255
Treasury shares purchased ........................................... (1,278) --
Increase in line of credit borrowings ............................... 27,200 9,500
Line of credit refinancing fees ..................................... (473) --
Repayment of debt ................................................... (6,917) (1,910)
-------- --------
Net cash provided by financing activities ........................... 18,017 7,867
-------- --------
Net increase (decrease) in cash and cash equivalents ................... 3,046 (8,607)
Cash and cash equivalents at beginning of period ....................... 3,226 12,647
-------- --------
Cash and cash equivalents at end of period ............................. $ 6,272 $ 4,040
======== ========
Supplemental cash flow information:
Cash paid during the period for:
Interest ............................................................ $ 1,713 $ 180
Income taxes ........................................................ 4,459 4,806
Non-cash investing and financing activities:
Acquisition of intangible assets:
Fair value of assets acquired ....................................... $ 32,040 $ 39,270
Less: Issuance of common stock ...................................... (760) (18,225)
Less: Practice affiliations payable ................................. (2,373) --
Less: Cash paid ..................................................... (28,689) (20,265)
-------- --------
Notes payable or liabilities assumed ................................ $ 218 $ 780
======== ========
</TABLE>
The accompanying notes are an integral part
of these condensed consolidated financial statements.
5
<PAGE> 6
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. BUSINESS AND ORGANIZATION
OrthAlliance, Inc. ("OrthAlliance" or the "Company"), a Delaware
corporation, was founded in October 1996 to provide practice management and
consulting services (collectively "management services") to orthodontic and
pediatric dental practices in the United States. Effective prior to the closing
of the initial public offering of shares of OrthAlliance's Class A Common Stock
(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 shares
of Class A Common Stock ("Common Stock") and shares of Class B Common Stock
("Class B Common Stock"). On August 26, 1997, OrthAlliance acquired (the
"Acquisitions") simultaneously with the closing of the IPO certain operating
assets of or the stock of entities holding certain tangible and intangible
assets and assumed certain liabilities of 55 orthodontic practices in exchange
for shares of Common Stock and cash. The Acquisitions have been accounted for in
accordance with the Securities and Exchange Commission's Staff Accounting
Bulletin No. 48.
OrthAlliance has five wholly-owned subsidiaries including PedoAlliance,
Inc, and OrthAlliance Finance, Inc. formed in December 1997, and PedoAlliance
Properties Inc., OrthAlliance Properties, Inc., and OrthAlliance Services Inc.,
formed in April 1999. The subsidiaries were formed to provide practice
management, patient financing, consulting and other services to OrthAlliance or
OrthAlliance's allied orthodontic and pediatric dental practices (the "Allied
Practices") or their patients. OrthAlliance, Inc. and its subsidiaries are
collectively referred to as "OrthAlliance" or the "Company".
NOTE 2. BASIS OF PRESENTATION
The accompanying interim condensed consolidated financial statements of
OrthAlliance are unaudited and reflect all adjustments that, in the opinion of
management, are necessary for a fair presentation of the results for the interim
period in accordance with Securities and Exchange Commission instructions for
Form 10-Q. Accordingly, they do not include all information and footnotes
required by generally accepted accounting principles for complete financial
statements. The condensed consolidated statements of income for the current
interim period are not necessarily indicative of results to be expected for the
current year or any other period.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes thereto
as well as other information included in the Company's Annual Report on Form
10-K for the year ended December 31, 1998 and other Company filings with the
Securities and Exchange Commission.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect 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 reported
period. Actual results could differ from those estimates.
Consolidation
The Company does not consolidate the operations of the Allied Practices
which it manages as the Company's arrangements with its Allied Practices does
not meet the requirements for consolidation as set forth in EITF 97-2.
Reclassifications
Certain prior year reclassifications have been made to conform to
classifications used in the current period.
6
<PAGE> 7
ORTHALLIANCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 3. NEW AFFILIATIONS
During the nine months ended September 30, 1999 the Company entered into
practice affiliation agreements with 35 practitioners, including 22
orthodontists and 13 pediatric dentists to provide management services and
acquire certain operating assets for a total consideration (including
acquisition costs) of $30.5 million. This consideration consisted of 93,584
shares of Common Stock, with an aggregated value at various acquisition dates of
$0.8 million, and cash, notes or affiliations payable totaling $29.7 million.
These Allied Practices operate 60 locations and generated patient revenue of
approximately $30.5 million during the 12-month period prior to the date of
affiliation. Prior patient revenue is not necessarily indicative of the level of
revenue these practices may be expected to generate in the future.
NOTE 4. PRACTICE AFFILIATION PAYABLE
As of September 30, 1999 and December 31, 1998, practice affiliation
payables approximated $2.4 million and $1.8 million related to the acquisition
of management agreements executed prior to September 30, 1999 and December 31,
1998, respectively. The amounts are unsecured and do not bear interest. These
amounts were paid in full in October 1999 and January 1999, respectively.
NOTE 5. BANK LINE OF CREDIT
On December 30, 1997, the Company entered into a $25 million Revolving
Credit Facility with First Union N.A., which had an expiration date of December
30, 2000. The Revolving Credit Facility bears interest on borrowings at variable
rates including the bank's prime lending rate plus up to 0.5% or LIBOR plus up
to 1.5% as determined by certain factors defined in the Revolving Credit
Agreement. Amounts borrowed are secured by the Company's assets including
accounts receivable, management and service agreements and the capital stock of
the Company's wholly owned subsidiaries.
Effective March 26, 1999, the Company executed an amended Revolving Credit
Facility for borrowings of up to $55 million with First Union National Bank, US
Bank National Association, and Union Bank of California N.A. (due March 2002)
under substantially the same terms and conditions as the previous Revolving
Credit Facility which was repaid in full at the closing. As of September 30,
1999 and December 31, 1998, the outstanding borrowings under the Revolving
Credit Facilities were $42.2 million and $15.5 million, respectively. As of
September 30, 1999 the Company was in compliance with the terms and covenants of
the Revolving Credit Facility.
NOTE 6. SUBSEQUENT EVENTS
Treasury Stock Transactions
Subsequent to September 30, 1999, pursuant to the Common Stock Repurchase
Program, the Company repurchased 65,584 shares at an average price of $6.67 per
share.
7
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Cautionary Statement
The information contained in this Form 10-Q is intended to update the
information contained in the Company's Annual Report on Form 10-K for the year
ended December 31, 1998 and presumes that readers have access to, and will have
read, the "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other information contained in such Form 10-K and
other Company filings with the Securities and Exchange Commission ("SEC").
This Form 10-Q contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities and Exchange Act of 1934 and such forward-looking statements are
subject to the safe harbors created thereby. For this purpose, any statements
contained in this Form 10-Q except for historical information may be deemed to
be forward-looking statements. Without limiting the generality of the foregoing,
words such as "may," "will," "expect," "believe," "anticipate," "intend,"
"could," "estimate" or "continue" or the negative or other variations thereof or
comparable terminology are intended to identify forward-looking statements. In
addition, any statements that refer to expectations, projections or other
characterizations of future events or circumstances are forward-looking
statements.
The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties, as well as on
certain assumptions that could cause actual future activities and results of
operations to be materially different from those set forth in the
forward-looking statements. Important factors that could cause actual results to
differ include, among other things, risks associated with Allied Practice
affiliations, availability of capital or that the Company will remain in
compliance with its credit facilities, fluctuations in operating results because
of affiliations and variations in stock price, dependence upon revenues
generated by Allied Practices, continued compliance with the listing
requirements for the Nasdaq national market listing, changes in government
regulations, competitive conditions, risks of operations and growth of existing
and newly affiliated practices, ability to staff the Allied Practices with
qualified personnel, the continued availability of adequate insurance, ability
of Allied Practices to attract and retain patients and other risks.
Additional factors that may affect future operating results are discussed
in more detail in the Exhibit 99.1 of the Company's Annual Report on Form 10-K.
Assumptions relating to the foregoing involve judgments with respect to, among
other things, future economic, competitive and market conditions, and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. Although the
Company believes that the assumptions underlying the forward-looking statements
are reasonable, the business and operations of the Company are subject to risks
that increase the uncertainty inherent in the forward-looking statements, and
the inclusion of such information should not be regarded as a representation by
the Company or any other person that the objectives or plans of the Company will
be achieved. In addition, risks, uncertainties and assumptions change as events
or circumstances change. The Company disclaims any obligation to publicly
release the results of any revisions to these forward-looking statements which
may be made to reflect events or circumstances occurring subsequent to the
filing of this Form 10-Q with the SEC or otherwise to revise or update any oral
or written forward-looking statement that may be made from time to time by or on
behalf of the Company.
The information contained in this Form 10-Q is not a complete description
of the Company's business or the risks associated with an investment in the
Company. Readers are urged to carefully review and consider the various
disclosures made by the Company in this Report and in the Company's other
filings with the SEC, that attempt to advise interested parties of certain
risks, uncertainties and other factors that may affect the Company's business.
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 practitioners operating 147 offices in 16 states. By the end of
1997, the Company had affiliated with 11 new practices, including 17 additional
practitioners 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. During the nine month period ended
September 30, 1999, the Company affiliated with 32 new practices, including 35
practitioners operating out of 60 locations. The Company anticipates that future
growth will come from new affiliations, satellite expansion of Allied Practices,
the development of new orthodontic practices and improved operating
efficiencies.
8
<PAGE> 9
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 the allied orthodontists and
pediatric dentists ("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 certain
accrual adjustments, including those related to patient prepayments, and
adjustments for contractual allowances and other discounts, plus an adjustment
for uncollectible accounts. The Company recognizes a normal management fee
related to the amortization of patient prepayments, which were originally
recorded at the affiliation date of the respective Allied Practices. Patient
revenue is recognized as services are performed. For orthodontic services,
approximately 20% of the orthodontic contract revenues are 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.
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 ranging from 13.5% to 20% of Adjusted
Patient Revenue. The average designated percentage is 17.0% for the Allied
Practices subject to this fee structure. In some cases, the Allied Practice
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.
(ii) a designated percentage of Adjusted Patient Revenue, ranging from
14.0% to 17%, 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
will 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 16.2% for the Allied
Practices subject to this fee structure.
(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 service 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 or pediatric dental 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. General and administrative expenses include professional
services, such as legal and accounting, utilities, advertising, marketing,
insurance, telephone, license fees, office supplies and shipping expenses.
Advertising and marketing costs, which are included in general and
administration costs, includes practice activities to attract new patients and
corporate activities to attract new orthodontists or pediatric dentists to join
the Company. Practice supplies include only those expenses required by the
Allied Orthodontists to provide treatment to patients.
9
<PAGE> 10
RESULTS OF OPERATIONS
The following table sets forth certain selected condensed consolidated income
statement data for the periods indicated in thousands of dollars and as a
percentage of total net revenues:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------------------ ---------------------------------------
1999 1998 1999 1998
------------------- ------------------ ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Revenues ............................... $ 24,286 100.0% $ 20,042 100.0% $ 69,449 100.0% $ 53,404 100.0%
-------- ------- -------- ----- -------- ----- -------- -----
Costs and expenses:
Salaries and benefits ...................... 6,679 27.5 6,291 31.4 20,545 29.6 16,641 31.2
Orthodontic and dental supplies ............ 2,423 10.0 2,031 10.1 6,693 9.6 5,215 9.8
Rent ....................................... 2,169 8.9 1,598 8.0 5,939 8.6 4,557 8.5
-------- ------- -------- ----- -------- ----- -------- -----
Total direct expenses ................. 11,271 46.4 9,920 49.5 33,177 47.8 26,413 49.5
General and administrative ................. 6,944 28.6 5,715 28.5 19,525 28.1 15,433 28.9
Depreciation and amortization .............. 1,022 4.2 612 3.1 2,832 4.1 1,671 3.1
-------- ------- -------- ----- -------- ----- -------- -----
Total operating expenses .............. 19,237 79.2 16,247 81.1 55,534 80.0 43,517 81.5
-------- ------- -------- ----- -------- ----- -------- -----
Operating income ........................... 5,049 20.8 3,795 18.9 13,915 20.0 9,887 18.5
Interest expense ........................... (698) (2.9) (172) (0.9) (1,580) (2.2) (309) (0.6)
Interest income ............................ 107 0.4 76 0.4 299 0.4 272 0.5
-------- ------- -------- ----- -------- ----- -------- -----
Income before income taxes ................. 4,458 18.3 3,699 18.4 12,634 18.2 9,850 18.4
Provision for income taxes ................. 1,877 7.7 1,627 8.1 5,561 8.0 4,297 8.0
-------- ------- -------- ----- -------- ----- -------- -----
Net income.................................. $ 2,581 10.6 $ 2,072 10.3 $ 7,073 10.2 $ 5,553 10.4
======== ======= ======== ===== ======== ===== ======== =====
</TABLE>
Net Income and Operating Income
Net income for the three months ended September 30, 1999 increased 24.6% to
$2.6 million from $2.1 million in the comparable 1998 quarter. Net income for
the nine months ended September 30, 1999 increased 27.4% to $7.1 million from
$5.6 million in the comparable 1998 period. Operating income for the for the
three months ended September 30, 1999 increased 33.0% to $5.0 million from $3.8
million in the comparable 1998 quarter. Operating income for the nine months
ended September 30, 1999 increased 40.7% to $13.9 million from $9.9 million in
the comparable 1998 period. The increase in net income and operating income for
the three months ended and the nine months ended September 30, 1999 is
attributable to an overall increase in net revenues and a reduction of direct
expenses as a percentage of net revenues.
Net Revenues
Net revenues for the three months ended September 30, 1999 increased 21.2%
to $24.3 million from $20.0 million in the comparable 1998 quarter. Net revenues
for the nine months ended September 30, 1999 increased 30.0% to $69.4 million
from $53.4 million in the comparable 1998 period.
The increase in net revenues for the three months and the nine months ended
September 30, 1999 is primarily due to an increase in affiliations of Allied
Practices and an increase in the internal growth of comparative same-store
collections of more than ten percent. Net revenues as reported by the Company
generally include the Company's contractual service or consulting fee based in
part on patient revenues, as well as reimbursed expenses of the Allied
Practices.
Operating Expenses
Total operating expenses increased 18.4% to $19.2 million, or 79.2% of net
revenues, in the three months ended September 30, 1999 from $16.2 million, or
81.1% of net revenues, for the comparable 1998 quarter. Total operating expenses
increased 27.6% to
10
<PAGE> 11
$55.5 million, or 80.0% of net revenues, in the nine months ended September 30,
1999 from $43.5 million, or 81.5% of net revenues, for the comparable 1998
period.
Direct expenses including salaries and benefits, orthodontic and dental
supplies, and rent increased 13.6% to $11.3 million, or 46.4% of net revenues,
in the three months ended September 30, 1999 from $9.9 million, or 49.5% of net
revenues, for the comparable 1998 quarter. Direct expenses increased 25.6% to
$33.2 million, or 47.8% of net revenues, in the nine months ended September 30,
1999 from $26.4 million, or 49.5% of net revenues, for the comparable 1998
period. Direct expenses have increased in absolute terms as a result of the
acquisition of additional Allied Practices during the periods as well as the
expansion and growth of previously existing Allied Practices. The decrease in
direct expenses as a percentage of net revenues in the three months and nine
months ended September 30, 1999 is primarily attributable to the reduction of
salaries and benefits and economies of scale as a percentage of revenue for both
periods.
Salaries and benefits increased 6.2% to $6.7 million, or 27.5% of revenues,
in the three months ended September 30, 1999 from $6.3 million, or 31.4% of net
revenues for the comparable 1998 quarter. Salaries and benefits increased 23.5%
to $20.5 million, or 29.6% of revenues, in the nine months ended September 30,
1999 from $16.6 million, or 31.2% of net revenues for the comparable 1998
period. The decrease in salaries and benefits as a percentage of revenues is a
result of a significant number of current year practice affiliations of which
their employees remained employees of the Allied Practice's professional
corporations. Accordingly, for these practices, salary and benefit expenses are
not reported by the Company. The Company expects that in future periods salaries
and benefits will increase in absolute dollars, but may vary as a percentage of
net revenues.
General and administrative expenses increased 21.5% to $6.9 million, or
28.6% of net revenues, in the three months ended September 30, 1999 from $5.7
million, or 28.5% of net revenues, for the comparable 1998 quarter. General and
administrative expenses increased 26.5% to $19.5 million, or 28.1% of net
revenues, in the nine months ended September 30, 1999 from $15.4 million, or
28.9% of net revenues, for the comparable 1998 period. General and
administrative expenses have shown an increase in absolute dollars primarily
related to the acquisition of additional Allied Practices during the periods as
well as the expansion and growth of previously existing Allied Practices
offsetting reductions in marketing and advertising and other costs.
Depreciation and amortization expenses increased approximately $0.4 million
or 67.0% to $1.0 million for the three months ended September 30, 1999 and $1.1
million or 69.5% to $2.8 million for the nine months ended September 30, 1999 as
compared to the same periods in 1998. This increase is attributable to the
increase in intangible assets associated with the affiliations of Allied
Practices. Intangible assets, net, increased $28.0 million to $78.9 million at
September 30, 1999 from $50.9 million at December 31, 1998. Depreciation and
amortization expenses primarily relate to the depreciation of capital assets and
the amortization of excess cost over the fair value of net assets acquired 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 or other related agreements.
Interest Expense
Interest expense increased to $0.7 million for the three months ended
September 30, 1999 from $0.2 in the comparable period in 1998 and increased to
$1.6 million for the nine month period ended September 30, 1999 from interest
expense of $0.3 million for the comparable period in 1998. The increase was
primarily due to increased borrowings under the Company's Revolving Credit
Facility in support of Allied Practices affiliated during the period. Company
borrowings under the Revolving Credit Facilities increased from $15.5 million at
December 31, 1998 to $42.2 million as of September 30, 1999.
Provision for Income Taxes
The provision for income taxes increased 15.4% to $1.9 million for the three
month period ended September 30, 1999 from $1.6 million for the comparable 1998
period. For the nine months ended September 30, 1999 and 1998, the provision for
income taxes was $5.6 million and $4.3 million, respectively. The Company's
effective income tax rates for the periods ended September 30, 1999 and 1998,
were higher than the statutory tax rate primarily due to the amortization of
certain intangible assets not being deductible for income tax purposes. The
effective tax rate was 44.0% for the nine month period ended September 30, 1999
as compared to 43.6% for the comparable period in 1998. The current year
effective tax rate is slightly higher due to an increase in the Company's
federal rate from 34% to 35% which was off-set by a partial year tax savings
resulting from a restructuring plan the Company completed during the current
year.
11
<PAGE> 12
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash flow
from operations and use of its Revolving Credit Facility. As of September 30,
1999 and December 31, 1998 the Company had a working capital balance of $ 17.2
million and $13.2 million, respectively. As of September 30, 1999 the Company's
principal sources of liquidity included cash and short term investments of
approximately $6.3 million and the Revolving Credit Facility, which has a
balance of $42.2 million bearing interest at the prime interest rate plus a
margin or the LIBOR plus a margin. This facility expires on March 26, 2002. As
of September 30, 1999, the Company had $12.8 million available for additional
borrowings up to its borrowing limit of $55 million under the terms of the
Revolving Credit Facility (as in effect on March 26, 1999). The Company believes
that it will be able to renew its Revolving Credit Facility or obtain alternate
financing on reasonable terms. However, there can be no assurance that the
Company will be able to renew or replace its Revolving Credit Facility or obtain
alternate financing on reasonable terms, if at all. The Company is currently in
compliance with all terms of this facility.
The Company's primary capital requirements will be funded through cash from
operations, the Revolving Credit Facility and other available capital sources.
The use of this capital will be for affiliations with new Allied Practices,
development of Allied Practice enhancements, development of Allied Practice
satellite offices, capital asset additions, and general working capital. The
Company's operating activities generated cash of $10.6 million during the nine
month period ended September 30, 1999 and $5.7 million during the nine month
period ended September 30, 1998.
Net cash provided by financing activities approximated $18.0 million in the
nine month period ended September 30, 1999 and $7.9 million in the nine months
ended September 30, 1998 and resulted primarily from the proceeds from
borrowings under the Revolving Credit Facilities.
Cash used in investing activities of $25.6 million in the nine month period
ended September 30, 1999 consisted of payments in connection with Allied
Practices affiliated and capital expenditures, primarily for office and computer
equipment used in Company operations. Cash used in investing activities was
$22.2 million in the nine month period ended September 30, 1998 and consisted of
payments in connection with Allied Practices affiliated and capital
expenditures, primarily for office and computer equipment used in Company
operations. The Company does not currently have any material commitments with
respect to any capital expenditures.
The Company's capital resources needed to continue acquisition and
development efforts will be funded through a combination of cash flows provided
by ongoing operations, the Revolving Credit Facility, which the Company is in
the process of negotiating a further extension, the issuance of equity and debt
securities, as described in the Company's Form S-4 registration statement which
became effective on August 6, 1999, and other sources. Management believes that
these sources of capital will be sufficient to meet the Company's capital
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. There can be no assurance that the Company will be able to raise
such additional working capital on acceptable terms, if at all. In the event the
Company is unable to raise additional working capital, further measures would be
necessary including, without limitation, the delay, or scale back of its
operations, Allied Practice affiliations, marketing programs and other actions.
Certain of such measures may require third party consents or approvals,
including the Company's bank, and there can be no such assurance that such
consents or approvals can be obtained.
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.
On September 8, 1999 the Company announced the extension of its Common Stock
Repurchase Program to repurchase up to $5 million of its Class A Common Stock.
The Company had previously announced the program on October 22, 1998. The
Company is authorized to purchase shares on the NASDAQ National Market at
prevailing prices through December 2000. As of September 30, 1999, the Company
had repurchased 171,702 shares amounting to $1.3 million under this program.
Funding has and is expected to come from operating cash flow and/or borrowings
under the Revolving Credit Facilities. The timing and the amount of shares to be
purchased will be determined based on the evaluation of working capital needs
and stock market conditions.
12
<PAGE> 13
YEAR 2000 COMPLIANCE
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. Therefore, they do not
properly recognize a year that begins with "20" rather than "19". Others do not
correctly process "leap year" dates. As a result, such systems and applications
could fail or create erroneous results unless corrected so that they can
correctly process data related to the Year 2000 and beyond. The Company relies
on its systems and applications in operating and monitoring all major aspects of
its business, including financial systems (such as general ledger, accounts
payable and payroll modules), customer services, networks and telecommunications
systems equipment and end products. The Company also relies, directly and
indirectly, on external systems of suppliers for the management and control of
business enterprises such as customers, suppliers, creditors, financial
organizations, and governmental entities for accurate exchange of data. The
Company could be affected through disruptions in the operation of the
enterprises with which the Company interacts or from general widespread problems
or an economic crisis resulting from noncompliant Year 2000 systems. Despite the
Company's efforts to address the Year 2000 impact on its internal systems and
business operations, there can be no assurance that such impact will not result
in a material disruption of its business or have a material adverse effect on
the Company's business, operating results and financial condition.
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 party suppliers and vendors. The Company received compliance
certificates from approximately 70% of such parties. The Company will verify the
status of the remaining parties through follow-up requests. The Company is
uncertain whether the risks of non-Year 2000 compliance by such 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 these parties will not suffer a Year 2000 business disruption
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 November 12, 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 the Allied Practices' 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 effect on practice operations. These
procedures may include the following: manual billings, manual posting of
payments to patient records and manual
13
<PAGE> 14
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 has advised the Allied Practices to have
contingency plans, 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 party vendors and suppliers. The
Company is uncertain whether the risks of non-Year 2000 compliance by such third
parties will materially affect the Company's operations or financial position.
The Company has determined that the Allied Practices are not substantially
reliant on any individual 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 required 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.
Other
The Company has estimated that the total cost of Year 2000 compliance is
negligible and management's current estimate is that the costs associated with
the Year 2000 issue should not have a material adverse effect on the results of
operations or financial position of the Company in any given year. The Company
does not have a formal contingency plan as the impacts have not been deemed
significant.
The foregoing statements are based upon management's best estimates at the
present time, which were derived utilizing numerous assumptions of future
events, including the continued availability of certain resources, third party
modification plans and other factors. There can be no assurance that these
estimates will be achieved and actual results could differ materially from those
anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, the
nature and amount of programming required to upgrade or replace each of the
affected programs, the rate and magnitude of related labor and consulting costs
and the success of the Company's external suppliers and Allied Practices in
addressing the Year 2000 issue. The Company's evaluation is ongoing and it
expects that new and different information will become available to it as the
evaluation continues. Consequently, there can be no assurance that all material
elements will be Year 2000 compliant in time.
RECENT 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's comprehensive income for the year ended December 31, 1998 and for the
nine months ended September 30, 1999 was equal to its net income.
Effective January 1, 1998, the Company implemented SFAS 131, "Disclosures
about Segments of an Enterprise and Related Information." This standard
established disclosure requirements related to the reporting of the Company's
operating segments. As of September 30, 1999, 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.
14
<PAGE> 15
Effective January 1, 1999, the Company implemented SOP 98-5 "Reporting on
Costs of Start-up Activities." The SOP requires net costs of start-up
activities, including organizational costs, to be expenses as incurred. In
addition, the SOP requires that previously capitalized start-up costs be
expensed upon the effective date. The Company did not have any start-up costs
capitalized as of the implementation date.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Applicable.
15
<PAGE> 16
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time the Company is involved in various legal proceedings,
claims and litigation matters arising in the ordinary course of business,
including labor and personnel related issues. In the opinion of management, the
outcome of such routine matters will not have a material adverse effect on the
Company's business, financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) None
(b) None
(c) None
(d) None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(a) None
(b) None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) None
(b) None
(c) None
(d) None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule for the nine month period ended September
30, 1999.
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).
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended
September 30, 1999.
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ORTHALLIANCE, INC.
(Registrant)
Date: November 12, 1999 By: /s/ Sam Westover
--------------------------------------------
Sam Westover,
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 12, 1999 By: /s/ James C. Wilson
-------------------------------------------
James C. Wilson,
Chief Financial Officer
(Principal Financial and
Accounting Officer)
17
<PAGE> 18
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<S> <C>
27.1 Financial Data Schedule for the nine month period ended September
30, 1999.
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>
18
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 6,272,000
<SECURITIES> 0
<RECEIVABLES> 14,510,000
<ALLOWANCES> (938,000)
<INVENTORY> 0
<CURRENT-ASSETS> 31,866,000
<PP&E> 11,819,000
<DEPRECIATION> (5,590,000)
<TOTAL-ASSETS> 123,663,000
<CURRENT-LIABILITIES> 14,663,000
<BONDS> 42,200,000
0
0
<COMMON> 13,000
<OTHER-SE> 65,771,000
<TOTAL-LIABILITY-AND-EQUITY> 123,663,000
<SALES> 0
<TOTAL-REVENUES> 69,449,000
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 55,534,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,281,000
<INCOME-PRETAX> 12,634,000
<INCOME-TAX> 5,561,000
<INCOME-CONTINUING> 7,073,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,073,000
<EPS-BASIC> .53
<EPS-DILUTED> .53
</TABLE>
