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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A-1
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 1996, 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 NO.: 0-25256
ORTHODONTIC CENTERS OF AMERICA, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 72-1278948
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5000 SAWGRASS VILLAGE CIRCLE, SUITE 25
PONTE VEDRA BEACH, FLORIDA 32082
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (904) 280-4500
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
- ------------------------------------ ---------------------
NONE NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE PER SHARE
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(Title of Class)
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
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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 the 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 shares of the Registrant's Common Stock held
by non-affiliates of the Registrant on March 17, 1997 was approximately
$535,110,000 based upon the closing price per share of the Registrant's Common
Stock as reported on the Nasdaq Stock Market on March 17, 1997. As of March 17,
1997, there were 43,626,951 outstanding shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement relating to the
Annual Meeting of Stockholders of the Registrant to be held during 1997 are
incorporated by reference into Part III of this Report.
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FORWARD-LOOKING STATEMENTS
Statements contained in this Report which are not historical in nature
are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements include
statements in "Item 1. Business", "Item 3. Market for Registrant's Common
Equity and Related Stockholder Matters" and "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations" regarding the
development and acquisition of additional Orthodontic Centers and affiliation
with additional orthodontic practices, recruitment of additional Affiliated
Orthodontists, advancement of funds to Affiliated Orthodontists, location of
Orthodontic Centers in facilities not shared with a general dentist,
projections of the Company's future earnings, funding of the Company's
expansion, operations and capital expenditures, payment or nonpayment of
dividends and cash outlays for income taxes.
Such forward-looking statements involve certain risks and uncertainties
that could cause actual results to differ materially from anticipated results.
These risks and uncertainties include regulatory constraints, changes in laws
regulating the practice of dentistry or the interpretation of such laws,
competition from other orthodontists or practice management companies, the
availability of suitable new markets and suitable locations within such
markets, changes in the Company's operating or expansion strategy, failure to
consummate proposed developments or acquisitions of Orthodontic Centers, the
ability of the Company to effectively manage an increasing number of
Orthodontic Centers, the general economy of the United States and the specific
markets in which the Orthodontic Centers are located or are proposed to be
located, and other factors as may be identified from time to time in the
Company's filings with the Securities and Exchange Commission or in the
Company's press releases.
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PART I
ITEM 1. BUSINESS
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GENERAL
Orthodontic Centers of America, Inc. and its subsidiaries (the
"Company") develop and manage orthodontic practices on a national basis
pursuant to long-term agreements in the approximately $3.6 billion orthodontic
industry. The Company has grown from managing 11 orthodontic centers
affiliated with the Company (the "Orthodontic Centers") in 1989 to managing
247 Orthodontic Centers located in 28 states and staffed by 133 orthodontists
who provide orthodontic services at the Orthodontic Centers ("Affiliated
Orthodontists") at December 31, 1996. Of the 247 Orthodontic Centers at
December 31, 1996, 134 were developed by the Company and 113 were existing
orthodontic practices whose assets were acquired by the Company.
The Company provides capital for the development and growth of
Orthodontic Centers and manages the business and marketing aspects of the
Affiliated Orthodontists' practices, thereby allowing Affiliated Orthodontists
to focus on delivering quality patient care. Management believes that the
Company's operating strategy has allowed the Affiliated Orthodontists to
realize significantly greater productivity and profitability than traditional
orthodontic practices, thereby presenting an attractive opportunity to
orthodontists and allowing the Affiliated Orthodontists to compete more
effectively than traditional local practices.
The Orthodontic Centers' office design (which permits an Affiliated
Orthodontist to treat patients without moving from room to room), scheduling
system (which groups appointments by the type of procedure and dedicates
certain days exclusively to new patients), and efficient use of an average of
five orthodontic assistants per Orthodontic Center have enabled Affiliated
Orthodontists practicing in Orthodontic Centers open throughout 1995 to treat
an average of 77 patients per nine-hour patient treatment day during 1996.
Orthodontists in the United States treated an average of 41.5 patients per
operating day in 1994.
The Company develops and implements aggressive and innovative marketing
plans for the Orthodontic Centers, utilizing local television, radio and print
advertising and internal marketing promotions. During 1996, the Company spent
an average of approximately $70,491 per Affiliated Orthodontist on direct
marketing costs and advertising. In contrast, the traditional orthodontist,
who relies primarily on referrals from dentists and other patients, spent an
average of approximately $4,400 on marketing and advertising in 1992. As a
result of this marketing strategy, during 1996, each Affiliated Orthodontist
who had practiced orthodontics for at least one year generated an average of
512 new case starts as compared to the 1994 national average of approximately
170 new case starts per orthodontist.
The Company has implemented an aggressive growth strategy to develop new
Orthodontic Centers in conjunction with current and newly recruited Affiliated
Orthodontists and to acquire the assets of, and enter into long-term
agreements with, existing orthodontic practices in both new and existing
markets. The United States orthodontic industry is highly fragmented, with
approximately 90% of the approximately 9,060 practicing orthodontists acting
as sole practitioners. Because Affiliated Orthodontists have generally
experienced better financial performance than in their prior traditional
practices, management believes that affiliating with the Company offers
practicing orthodontists and recent graduates an attractive and profitable
opportunity.
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THE ORTHODONTIC INDUSTRY
Industry Overview
In 1994, orthodontists in the United States initiated treatment for
approximately 1.5 million patients. Of these patients, approximately 1.1
million were between the ages of nine and 18 and the remaining patients were
primarily adults between the ages of 25 and 35. The number of adults seeking
treatment has increased in recent years from 332,000 case starts in 1989 to
approximately 400,000 case starts in 1994. Based upon the results of a 1994
study conducted by members of the Department of Orthodontics of the University
of Florida and based upon management's experience in the orthodontic industry,
management believes that the total market for orthodontic services
substantially exceeds the number of patients currently seeking treatment.
According to the 1995 Journal of Clinical Orthodontists Orthodontic
Practice Study (the "1995 JCO Study"), the number of orthodontists practicing
in the United States has remained at approximately the same level since 1989.
The United States orthodontic industry includes approximately 9,060
orthodontists and is currently highly fragmented, with approximately 90% of
the practicing orthodontists acting as sole practitioners. Orthodontists must
complete up to three years of post graduate studies following completion of
dental programs. Many dentists who are not orthodontists also perform certain
orthodontic services. Data relating to these individuals are not included in
the 1995 JCO Study.
The table below presents certain information included in the 1995 JCO
Study concerning the United States orthodontic industry in each of the years
presented:
<TABLE>
<CAPTION>
1990 1991 1992 1993 1994
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<S> <C> <C> <C> <C> <C>
Number of practicing orthodontists.. 8,720 8,760 8,856 8,958 9,060
Number of new patient cases......... 1,308,000 1,314,000 1,416,960 1,478,070 1,540,200
Average fee per case................ $ 3,050 $ 3,221 $ 3,401 $ 3,447 $ 3,492
</TABLE>
Management believes, based upon the 1995 JCO Study, that the total
number of new patient cases has increased only moderately because of the
reliance of orthodontists in traditional orthodontic practices on referrals
from general dentists or existing patients for new patients. Orthodontists in
the United States spent an average of approximately $4,400 on marketing and
advertising in 1992. Therefore, to increase revenue many orthodontists have
raised the fees they charge for their services.
Traditional Orthodontic Practice
The traditional orthodontic practice typically includes a sole
orthodontist, who practices at a single primary location or at an average of
less than one satellite office, with an average of approximately three
orthodontic assistants and two business office personnel. At a typical
orthodontic office, chairs are arranged in an open room in a somewhat circular
pattern. Both the orthodontist and orthodontic assistant must complete
treatment on a particular patient before treating the next patient. The
traditional orthodontic office is structured so that the orthodontist rotates
from one patient to another, as an orthodontic assistant completes the
orthodontic work. In the traditional practice, the orthodontist manages all
business aspects of the practice, as the use of third party management
services is not typical.
In a typical orthodontic practice, before braces are applied a patient
is required to complete as many as four preliminary appointments, consisting
of an initial examination and sessions for making impressions of the patient's
teeth, taking x-rays and placing spacers between the patient's teeth. The
patient returns for monthly adjustments before the braces are removed and a
retainer is made to maintain the orthodontic
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treatment. In 1994, standard case fees in traditional orthodontic practices
averaged approximately $3,450 for children and approximately $3,700 for
adults. The charges for preliminary appointments, including a required down
payment, averaged approximately $875 to $925, or approximately 25% of the
total fee. Fees are paid each month by the patient for services performed at
that visit.
According to the 1995 JCO Study, the average orthodontist initiated
treatment of approximately 170 patients in 1994, treated approximately 41.5
patients per operating date and maintained approximately 380 active cases. In
addition, the average orthodontic practice consisted of one or two offices and
generated gross fees of $475,000, with the orthodontists realizing net
practice income of approximately $191,000.
OPERATING STRATEGY
The Company's operating strategy focuses on facilitating the provision
of quality and affordable orthodontic care by Affiliated Orthodontists,
attracting new patients through marketing and advertising, increasing the
productivity and profitability of Affiliated Orthodontists, achieving
economies of scale in marketing, administration and purchasing and
capitalizing on the experience of the Company's senior management.
Emphasizing Quality Patient Care. All Affiliated Orthodontists are
graduates of accredited orthodontic training programs and participate in
advisory committees that meet twice a year to perform peer review studies and
to consult with the Affiliated Orthodontists. In addition, the Company
provides operating systems and support that enhance the ability of Affiliated
Orthodontists to provide quality patient care. Senior clinical technicians
and the clinical staff receive training in procedures which enhance the level
of patient service.
Stimulating Demand in Local Markets Through Aggressive Marketing. The
Company develops and implements aggressive and innovative marketing plans for
each Orthodontic Center, utilizing local television, radio and print
advertising and internal marketing promotions. During 1996, the Company spent
on average approximately $70,491 per Affiliated Orthodontist on direct
marketing costs and advertising. In contrast, the traditional orthodontist,
who relies primarily on referrals from dentists and other patients, spent an
average of approximately $4,400 on marketing and advertising in 1992. During
1996, each Affiliated Orthodontist who had been affiliated with the Company
for at least one year generated an average of 512 new case starts as compared
to the 1994 national average of approximately 170 new case starts per
orthodontist.
Achieving Operating Efficiencies and Economies of Scale. The Company
implements a variety of operating procedures and systems to improve the
productivity and profitability of the Orthodontic Centers and to achieve
economies of scale. These include Orthodontic Center office designs which
have increased the number of patients treated and enhanced patient comfort and
privacy, a scheduling system which has increased capacity utilization,
efficient use of orthodontic assistants and centralized purchasing and
distribution systems. During 1996, Affiliated Orthodontists practicing in
Orthodontic Centers open throughout 1995 treated an average of 77 patients per
nine-hour patient treatment day. Orthodontists in the United States treated
an average of 41.5 patients per operating day in 1994.
Increasing Market Penetration with Affordable Payment Plans. The
Orthodontic Centers generally provide a payment plan recommended by the
Company which consists of no down payment, equal monthly payments of $98 per
month over the term of the treatment and a final payment of $398 at completion
of the treatment. In the event a patient has dental insurance, which, during
1996, covered approximately 21% of the patients treated at the Orthodontic
Centers, patients may co-pay from $49 to $79 per month. Based upon
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the success of the Orthodontic Centers in attracting new patients, management
believes that this payment plan and the Company's marketing activities have
resulted in many patients receiving treatment who otherwise may not have
sought orthodontic services. For a standard case in which treatment continues
for between 26 and 32 months, the total fees charged by the Affiliated
Orthodontists averaged approximately $3,100 in 1996, which was below the 1994
national average of $3,450 to $3,700 for the same period of treatment. Since
1991, approximately 1.3% of the Company's net revenue has been uncollectible.
Management believes that the Orthodontic Centers are able to charge lower fees
because of the operating efficiencies resulting from the office designs of
Orthodontic Centers, the patient scheduling systems, efficient use of
orthodontic assistants and centralized purchasing and distribution systems.
Capitalizing on Management Expertise. The members of the Company's
senior management have over 41 years combined experience in the orthodontic
industry. In addition to providing marketing and operating expertise, the
Company provides Affiliated Orthodontists with monthly operating data and
quarterly financial statements for each Orthodontic Center, including
management's analysis of the financial results and recommended changes to
improve financial and operating performance. The Company assists Affiliated
Orthodontists in the selection of new sites for Orthodontic Centers and
provides trained staff personnel to operate the Orthodontic Centers.
EXPANSION STRATEGY
The Company has implemented a growth strategy to develop new Orthodontic
Centers and to affiliate with existing practices in both new and existing
markets. Based upon the Company's experience in negotiating with
orthodontists, management believes that orthodontists choose to affiliate with
the Company because the Company provides (i) the capital required to open an
Orthodontic Center, (ii) the business and clinical systems and staffing
required to operate a new Orthodontic Center, (iii) the opportunity to
substantially increase practice income derived by the orthodontists, and (iv)
the opportunity to increase the orthodontists' focus on patient care rather
than administration.
Development of New Orthodontic Centers. The Company actively markets
itself to orthodontists interested in opening new practices by targeting
orthodontic students and military orthodontists and by advertising in
professional journals. The average cost of developing a new Orthodontic
Center is approximately $230,000, including the cost of equipment, leasehold
improvements, working capital and losses associated with the initial
operations of the Orthodontic Center. The costs of developing a new
Orthodontic Center are shared by the Company and the particular Affiliated
Orthodontist. The Company assists Affiliated Orthodontists in obtaining
financing of their share of such costs through the Company's primary lender.
For new developments, the Company has discontinued financing Affiliated
Orthodontists' share of losses associated with the initial operations of the
Orthodontic Center, which were historically financed by the Company as an
unsecured advance repayable by the Affiliated Orthodontist over a five-year
period and bearing interest at 1.5% per annum above the prime rate, with
repayment beginning upon the attainment of positive cash flow by the
Orthodontic Center (which generally occurs approximately 12 months after an
Orthodontic Center commences operations). The Company intends, however, to
continue to make advances of approximately $20,000 to newly-affiliated
Affiliated Orthodontists during the first year of an Orthodontic Center's
operations, which advances bear no interest and typically are repaid during
the second year of the Orthodontic Center's operations. The Company is
assisting Affiliated Orthodontists in obtaining financing from the Company's
primary lender to replace the Company's financing of such Affiliated
Orthodontists' share of the costs of previously completed developments.
At December 31, 1996, the Company had entered into agreements with 22
orthodontists pursuant to which 48 Orthodontic Centers would be developed
during 1997, many of which would be opened in states
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in which the Company does not currently manage an Orthodontic Center. The
development of an Orthodontic Center typically takes six to eight months
following execution of such agreement. The Company also intends to develop
additional Orthodontic Centers with current Affiliated Orthodontists in 1997.
There can be no assurance that any such proposed developments will be
completed or that any such Orthodontic Centers will operate successfully.
Acquisition of the Assets of Existing Orthodontic Practices. During the
period January 1, 1989 through December 31, 1996, the Company acquired the
assets of, and affiliated with, 113 existing orthodontic practices, following
which such practices have experienced increased average quarterly gross
revenue and operating income per center. The Company continues to evaluate
additional potential acquisitions.
Affiliation with Non-Advertising Practices. The Company recently
commenced operations of a new division within the Company that will focus on
affiliations with traditional, non-advertising orthodontic practices that
generate a relatively large amount of revenue. The Company has engaged the
services of Dr. Ronald M. Roncone, who operates a successful non-advertising
orthodontic practice in California, to assist the Company in developing this
new division. Dr. Roncone is considered one of the country's leading
orthodontists and lectures internationally on methods of expanding orthodontic
practices. Management expects that the terms of the service or consulting
agreements between non-advertising orthodontists and the Company will be
similar to those currently used by the Company. According to the 1995 JCO
Study, most orthodontists practicing in the United States do not advertise
through mass media. Management believes that affiliating with selected non-
advertising orthodontic practices will provide the Company with additional
opportunities for growth. In addition, management believes that its
association with Dr. Roncone will enhance the reputation of the Company
within the orthodontic industry.
ORTHODONTIC CENTERS
Location
At December 31, 1996 there were 247 Orthodontic Centers located in 28
states. The following table sets forth information regarding these 247
Orthodontic Centers:
Number of
State ADI(1) Centers
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Alabama Birmingham.................... 2
Montgomery.................... 1
Arizona Lake Havasu................... 1
Phoenix....................... 5
Tucson........................ 2
California Fresno........................ 2
Palm Desert................... 1
San Diego..................... 9
San Jose...................... 1
Colorado Colorado Springs.............. 2
Denver........................ 4
Fort Collins.................. 1
Grand Junction................ 1
Connecticut Hartford...................... 5
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Number of
State ADI(1) Centers
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Florida Fort Lauderdale/Miami......... 11
Fort Myers.................... 2
Gainesville................... 3
Jacksonville.................. 4
Orlando....................... 7
Panama City................... 1
Pensacola..................... 1
Tallahassee................... 1
Tampa......................... 10
West Palm Beach............... 4
Georgia Albany........................ 3
Atlanta....................... 9
Augusta....................... 1
Columbus...................... 1
Savannah...................... 2
Illinois Chicago....................... 3
Rockford...................... 1
Indiana Indianapolis.................. 3
Louisville, KY................ 1
Kentucky Louisville.................... 2
Louisiana Alexandria.................... 1
Baton Rouge................... 1
Lafayette..................... 1
Monroe........................ 1
New Orleans................... 8
Shreveport.................... 1
Maryland Baltimore..................... 6
Rockville/Washington, D.C..... 5
Massachusetts Providence, RI................ 2
Springfield................... 3
Minnesota Minneapolis................... 5
Mississippi Gulfport...................... 4
Hattiesburg................... 1
Jackson....................... 1
Meridian...................... 1
New Orleans, LA............... 1
New Jersey Philadelphia, PA.............. 1
North Carolina Charlotte..................... 3
Greenville.................... 4
Greenville, SC................ 1
Raleigh-Durham................ 4
Winston-Salem................. 4
Nevada Reno.......................... 1
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Number of
State ADI(1) Centers
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Ohio Charleston, WV................ 1
Wheeling,WV................... 1
Cincinnati.................... 3
Cleveland..................... 2
Columbus...................... 2
Youngstown.................... 2
Oregon Bend.......................... 3
Portland...................... 2
Pennsylvania Baltimore, MD................. 1
Hershey....................... 2
Johnstown-Altoona............. 2
Philadelphia.................. 4
Pittsburgh.................... 1
Rhode Island Providence.................... 1
South Carolina Charleston.................... 3
Columbia...................... 2
Greenville.................... 1
Tennessee Chattanooga................... 2
Johnson City/Bristol/Kingsport 3
Knoxville..................... 2
Nashville..................... 3
Texas Austin........................ 2
Dallas/Ft. Worth.............. 3
El Paso....................... 2
Houston....................... 2
San Antonio................... 3
Waco.......................... 2
Virginia Norfolk....................... 4
Richmond...................... 3
Arlington/Washington, D.C..... 4
Washington Portland, OR.................. 1
Seattle....................... 7
West Virginia Charleston.................... 2
Wheeling...................... 2
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Total
247
===
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(1) "ADI" refers to an "area of dominant influence" (as defined by Arbitron
Ratings Company) and is the broadcast coverage area of television and
radio stations in a given market area.
Design
The Orthodontic Centers are generally located either in shopping centers
or professional office buildings. Substantially all of the Orthodontic Centers
include private treatment rooms and large patient waiting areas (rather than one
large treatment area). This allows the Orthodontic Centers to locate in a
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broader range of office space than a traditional orthodontic practice. The
Orthodontic Centers typically include up to six treatment rooms.
Of the 247 Orthodontic Centers at December 31, 1996, 244 are located in
offices used only by the Affiliated Orthodontists and three are located in
space shared with a general dentist. The Company intends to relocate these
three Orthodontic Centers to free-standing locations as soon as practicable.
In its development of additional Orthodontic Centers, the Company intends to
establish only free-standing Orthodontic Centers and does not intend to share
office space with general dentists.
The Company has opened three Orthodontic Centers with approximately
twice the number of square feet as the other Orthodontic Centers. This new
larger configuration is intended to improve operating efficiency and is being
evaluated for additional markets.
Staffing and Scheduling
For days on which patients are scheduled, an Orthodontic Center is
generally open for business from 8:30 a.m. to 6:30 p.m., and at least one
Saturday every month. In markets in which there are two or more Orthodontic
Centers, each Orthodontic Center in that market is fully staffed only for days
on which the Affiliated Orthodontist is scheduled to work, ranging from two to
20 days per month. Staff members dedicated to the Orthodontic Centers in that
market, including the business personnel and the orthodontic assistants,
rotate with the Affiliated Orthodontist among the Orthodontic Centers in the
market. On all other days, the Orthodontic Center is staffed only with a
receptionist who answers the telephone and books appointments.
Patients are scheduled based upon this rotation schedule, if applicable.
Therefore, a particular Orthodontic Center will have appointments available
only for pre-established days each month. To promote efficiency, appointments
for particular types of procedures are grouped together on designated days,
with each Orthodontic Center scheduling specified days on which new patients
are treated and other days each month during which current patients are
treated. This system permits utilization of an Orthodontic Center by a
greater number of patients each day patients are treated.
New patient days. Certain days each month are dedicated solely to
seeing new patients. Longer appointments are scheduled for new patient days
to allow for the initial consultation, preliminary procedures (including teeth
impressions and x-rays) and the placing of spacers between the patient's teeth
in anticipation of the application of the braces at the next appointment. If
orthodontic treatment is recommended by the Affiliated Orthodontist, the
patient then signs a contract for the treatment. The grouping of new patient
appointments separately from the monthly appointments for existing patients
avoids certain inefficiencies which might be created by the longer
appointments required for new patients.
Regular treatment days. Within two weeks after a patient's initial
visit, a patient typically returns to an Orthodontic Center for application of
braces and returns each month thereafter for adjustments to the braces. The
patient makes a monthly payment prior to receiving his or her chart and
proceeding to an inner waiting room. The Affiliated Orthodontist then reviews
the status of the treatment and prescribes any necessary adjustments to the
braces. The patient then proceeds to a private treatment room, where an
orthodontic assistant makes the prescribed adjustments. The patient then
returns to the Affiliated Orthodontist for final examination and adjustments
that must be made by an orthodontist. Before leaving the Orthodontic Center,
the patient makes an appointment for the next month and receives appropriate
written information or instructions regarding his or her activities during the
interim period.
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Payment Plan; Case Fees
The Orthodontic Centers generally provide a payment plan recommended by
the Company, which consists of no initial down payment, equal monthly payments
of $98 per month during the term of the treatment and a final payment of $398
at the completion of treatment. At the initial treatment, the patient signs a
contract outlining the terms of the treatment, including the anticipated
length of treatment and the total fees. The number of required monthly
payments is fixed at the beginning of the case and corresponds to the
anticipated term of treatment, which averages 26 months. Payment is required
from patients at the beginning of each month.
In the event the treatment period exceeds the period originally
estimated by the orthodontist, the patient is not required to pay for the
additional months of treatment. In the event the treatment is completed prior
to the scheduled completion date, the patient is required to pay 75% of 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 all services rendered to date pursuant to the
contract. Patients may transfer to another Orthodontic Center for the
completion of the treatments. In such an event the patient would continue to
pay the required monthly fees under the contract. Since 1991, approximately
1.3% of the Company's net revenue have proven to be uncollectible.
The Orthodontic Centers do not accept payment by Medicare or Medicaid
for services provided. Other payment plans with lower total payments by the
patient are available for patients who have insurance coverage for the
treatment. During 1996, approximately 21% of the patients treated at the
Orthodontic Centers had some form of insurance coverage and approximately 14%
of the patient revenue of the Affiliated Orthodontists was paid by a third
party payor. The portion of the fee not covered by insurance is the
responsibility of the patient.
SERVICES AND OPERATIONS
The Company generally manages all of the operations of an Orthodontic
Center other than the provision of orthodontic services. The Company provides
financial, accounting, billing and collection services for an Orthodontic
Center and employs the Orthodontic Center's business personnel. Where
permitted by applicable statutes or regulations, the Company also employs the
orthodontic assistants.
Advertising and Marketing
The Company advertises and markets the services of Orthodontic Centers
through television, radio and print media advertising. The Company produces
internally all broadcast advertising and tailors such advertising to the
particular local market. The names of the Orthodontic Center and the
Affiliated Orthodontist are prominently featured in each advertisement.
Advertising and direct marketing expenditures averaged approximately $70,491
per Affiliated Orthodontist in 1996 as compared to a national average of
approximately $4,400 per orthodontist for traditional practices in 1992.
The general public traditionally has had little information about
orthodontic fees prior to consultations with an orthodontist. The advertising
produced by the Company stresses an Orthodontic Center's affordable payment
plan and that the Affiliated Orthodontists are specialists in the field of
orthodontics (not general dentists practicing orthodontics). The
advertisements also emphasize the importance of utilizing a specialist for
orthodontic care and that the Orthodontic Centers are conveniently located in
each market and operate for extended hours and on some weekend days to
accommodate working parents. The advertisements include a toll free national
800 number which routes incoming calls to an
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Orthodontic Center located in the caller's area. The Orthodontic Centers
typically receive increased inquiries from prospective patients following a
broadcast of the advertisements. Accordingly, the scheduling of television
and radio advertisements is coordinated to achieve optimal use of
advertisement expenditures, with the level of advertising coordinated with
available Orthodontic Center capacity to achieve desired demand levels at a
particular Orthodontic Center.
Recruiting and Training
The Company actively markets its services to the approximately 200
orthodontists who graduate each year from accredited United States orthodontic
programs, and to experienced orthodontists who may consider affiliating with
the Company. Orthodontists who select the Company for affiliation are
generally given their choice of markets in the United States in which to
locate where the Company does not have another Orthodontic Center. The
Company also performs market studies to determine the advantages of locating
Orthodontic Centers in new markets.
Affiliated Orthodontists receive initial training regarding the
Company's operating systems at the Company's training offices in Orlando and
Jacksonville, Florida and in Denver, Colorado to enable an Affiliated
Orthodontist to take advantage of the efficiencies created by the Company's
systems. The Company also employs training teams which travel to each new
Orthodontic Center to train the Orthodontic Center's clinical and business
staff with respect to the Company's operating systems. Follow-up visits by
the training team are conducted six months following the opening of an
Orthodontic Center to maintain operating efficiencies.
The Affiliated Orthodontists maintain full control over their
orthodontic practices, determine which personnel, including orthodontic
assistants, to hire or terminate and set their own standards of practice in
order to promote quality orthodontic care. The Company is not engaged in the
practice of orthodontics. The Affiliated Orthodontists are responsible for
compliance with state and local regulations governing the practice of
orthodontics and with licensure or certification requirements. In addition,
each Affiliated Orthodontist acquires and pays for malpractice insurance, and
is required to use reasonable efforts to have the Company named as an
additional insured party. Quality of care is monitored through internal peer
review procedures administered by the Affiliated Orthodontists through their
advisory committee.
The Company maintains an incentive-based compensation program for its
employees which rewards employees based upon their performance and the
operating results of the Orthodontic Centers, including increased collections
and case starts and cost containment efforts.
The Company has engaged the services of three former practicing dentists
to assist the Company in recruiting orthodontists to affiliate with the
Company. The Company intends to maintain its recruiting efforts internally,
rather than through outside recruitment services.
Management Information Systems
The Company provides Affiliated Orthodontists with management and
financial information systems which have improved Orthodontic Center
efficiencies and have provided cost savings for Orthodontic Center operations.
These systems have also maintained greater uniformity in the manner in which
services have been provided at the Orthodontic Centers. The Company utilizes
information systems which track important data related to the Orthodontic
Centers' operations and financial performance. The Company monitors all
expenditures on advertising and reallocates resources between markets where
advertising expenditures need to be increased or decreased. The Company's
systems also track new patient cases for each of the
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Orthodontic Centers to allow programs to be initiated to better ensure that
new patient cases at the Orthodontic Centers are within projected levels.
Billing and collection information is sent daily by the Orthodontic Centers to
the Company for processing.
The Company also provides Affiliated Orthodontists with monthly
operating data and quarterly financial statements. With the quarterly
financial statements, the Company provides an analysis of the financial
results and recommends changes to improve financial performance of the
Orthodontic Center. This analysis allows the Affiliated Orthodontist and the
Company to make periodic adjustments in marketing and operating the
Orthodontic Center.
Purchasing and Distribution
Because of the number of Orthodontic Centers, the Company is able to
make bulk purchases of equipment, office furniture, inventory and supplies in
order to reduce per unit costs. The Company negotiates arrangements with
suppliers that provide cost savings to each of the Orthodontic Centers.
Inventory and supplies are purchased by the Company and distributed on a just-
in-time basis to each Orthodontic Center, thereby limiting storage of unused
inventory and supplies.
AGREEMENTS WITH AFFILIATED ORTHODONTISTS
The Company provides comprehensive management and marketing services to
Affiliated Orthodontists pursuant to a service agreement or, in very limited
circumstances, a consulting agreement. The selection of either the service
agreement or consulting agreement structure is based upon regulatory
provisions of the particular state in which an Orthodontic Center is located.
Service Agreement
Service agreements are between the Company and an Affiliated
Orthodontist and the Affiliated Orthodontist's professional corporation or
other entity. Pursuant to the service agreement, the Company manages the
business and marketing aspects of Orthodontic Centers, provides capital,
facilities and equipment (including utilities, maintenance and rental),
implements a marketing program, prepares budgets and financial statements,
orders and purchases inventory and supplies, provides a patient scheduling
system and staff, bills and collects patient fees, maintains files and records
and arranges for certain legal and accounting services. The Affiliated
Orthodontist subleases from the Company the facility occupied by the
Orthodontic Center and leases the equipment used at the Orthodontic Center
from the Company. Service agreements are generally for a term of 40 years.
Under a service agreement, the Affiliated Orthodontist pays the Company
a fee equal to approximately 24% of new patient contract balances in the first
month of treatment plus the balance ratably over the remainder of the patient
contracts, less amounts retained by the Affiliated Orthodontist. In addition,
a $25,000 annual fee is earned by the Company for 42 free-standing Orthodontic
Centers with respect to which long-term service agreements were entered into
with the Company in connection with the combination of the Company's
predecessor entities. Operating expenses of the Orthodontic Centers are
expenses of the Company and are recognized as incurred. The amounts retained
by an Affiliated Orthodontist are dependent on the Affiliated Orthodontist's
financial performance, based in significant part on the Affiliated
Orthodontist's profitability on a cash basis, as provided in the service
agreements.
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Consulting Agreements
The terms of consulting agreements differ significantly from the terms
of service agreements and will vary depending upon the regulatory requirements
of the particular state in which an Orthodontic Center is located. Currently,
in one state, the Company may only provide consulting services to the
Affiliated Orthodontists and may not manage the Affiliated Orthodontist's
practice. The consulting fee payable to the Company is determined at the time
of affiliation, is limited to the consulting services performed and is based
on criteria such as the number of hours of operations of the applicable
Orthodontic Centers.
GOVERNMENT REGULATION
General
The field of 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 health care
companies is increasing. Every state imposes licensing and other requirements
on individual orthodontists, and orthodontic facilities and services. In
addition, federal and state laws regulate health maintenance organizations and
other managed care organizations for which orthodontists may be providers. In
connection with its entry into new markets, the Company may become subject to
compliance with additional regulations.
The operations of the Orthodontic Centers must meet federal, state and
local regulatory standards in the areas of safety and health. Historically,
those standards have not had any material adverse effect on the operations of
the Orthodontic Centers. Based on its familiarity with the operations of the
Orthodontic Centers and the activities of the Affiliated Orthodontists,
management believes that the Orthodontic Centers 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 many states prohibit orthodontists from splitting fees with
non-orthodontists and prohibit non-orthodontic entities (such as the Company)
from practicing dentistry, including orthodontics (which in certain states
includes managing or operating an orthodontic office), and from employing
orthodontists or, in certain circumstances, orthodontic assistants. The laws
of some states prohibit advertising of orthodontic services under a trade or
corporate name and require that all advertisements be in the name of the
orthodontist. A number of states also regulate the content of advertisements
of orthodontic 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
or control equipment or offices used in an orthodontic practice. Some of
these states allow leasing of equipment and office space to an orthodontic
practice, under a bona fide lease, if the equipment and office remain in the
complete care and custody of the orthodontist. Management believes, based on
its familiarity with the operations of the Orthodontic Centers and the
activities of the Affiliated Orthodontists, that the Company's current and
planned activities do not violate 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 the Affiliated Orthodontists or the operation of the
Orthodontic Centers. In addition, statutes in some states could restrict
expansion of Company operations in those jurisdictions. In response to
particular state regulatory provisions, the Company is required to utilize the
consulting agreement structure in at least one state. Management plans to use
a form of one of its operating agreements in each of the states in which a
development or acquisition proposal is pending.
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Regulatory Compliance
The Company regularly monitors developments in laws and regulations
relating to dentistry. The Company may be required to modify its agreements,
operations and marketing from time to time in response to changes in the
business and regulatory environment. The Company plans to structure all of
its agreements, operations and marketing in accordance with applicable law,
although there can be no assurance that its arrangement will not be
successfully challenged or that required changes may not have a material
adverse effect on operations or profitability.
COMPETITION
The business of providing orthodontic services is highly competitive in
each of the markets in which the Orthodontic Centers operate. Each Affiliated
Orthodontist competes with orthodontists who maintain single offices or
operate a single satellite office, as well as with orthodontists who maintain
group practices or operate in multiple offices. The Orthodontic Centers also
compete with dentists who provide certain orthodontic services. The provision
of orthodontic services by such persons has increased in recent years.
There are several companies pursuing similar strategies in the health
care industry, and companies with similar objectives and substantially greater
financial resources may enter the Company's markets and compete with the
Company.
EMPLOYEES
At December 31, 1996, the Company employed 1,287 persons, including 949
full-time employees and 49 employees in the Company's corporate offices. None
of the Company's employees are represented by a collective bargaining
agreement. The Company considers its relationship with its employees to be
good.
INSURANCE
The Company maintains general liability and property insurance. The
costs of insurance coverage varies, and the availability of certain coverage
has fluctuated in recent years. While management believes, based upon its
claims experience, that the Company's current insurance coverage is adequate
for its current operations, there can be no assurance that the coverage will
be sufficient for all future claims or will continue to be available in
adequate amounts or at reasonable rates. The Affiliated Orthodontists
purchase and maintain their own malpractice liability insurance coverage, and
are required to use reasonable efforts to have the Company named as an
additional insured party on their respective insurance policies.
TRADENAMES
The Company registered the tradenames "The Dentist Place" and
"Orthodontic Specialist Network" with the United States Patent and Trademarks
Office in 1990 and 1993, respectively. Of the 247 Orthodontic Centers at
December 31, 1996, 218 use a tradename which combines the state, region or
city in which the center is located and "Orthodontic Specialists", such as
"Middle Tennessee Orthodontic Specialists". The tradename "The Dentist Place"
is utilized in the four centers in the Jacksonville, Florida area.
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EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information with respect to the
executive officers of the Company:
NAME AGE POSITIONS WITH THE COMPANY
- ---- --- --------------------------
Dr. Gasper Lazzara, Jr......... 54 Chairman of the Board, President, Chief
Executive Officer, Director
Bartholomew F. Palmisano, Sr... 50 Chief Financial Officer, Senior Vice
President,
Secretary, Treasurer, Director
Geoffrey L. Faux............... 41 Executive Vice President, Chief
Administrative Officer, Director
Michael C. Johnsen............. 44 Vice President of Operations, Director
DR. GASPER LAZZARA, JR. Dr. Lazzara has served as Chairman of the
Board, President and Chief Executive Officer of the Company since its
inception in July 1994. From 1989 to 1994, Dr. Lazzara served as president or
managing partner of certain of the Company's predecessor entities. He is a
licensed orthodontist and, prior to founding the Company, maintained a private
orthodontic practice for over 25 years. He is a member of the American
Association of Orthodontists and is a Diplomat of the American Board of
Orthodontists.
BARTHOLOMEW F. PALMISANO, SR. Mr. Palmisano has served as Chief
Financial Officer, Senior Vice President, Secretary and Treasurer of the
Company since its inception in July 1994. From 1989 to 1994, Mr. Palmisano
served as the chief financial officer of certain of the Company's predecessor
entities. Mr. Palmisano is a licensed certified public accountant and
attorney. He was previously served as an accountant with the firm of
Palmisano & Vignes, Certified Public Accountants, in New Orleans, Louisiana
from 1977 to 1989, and with Main Lafrenz & Co. from 1969 to 1976.
GEOFFREY L. FAUX. Mr. Faux has served as Executive Vice President and
Chief Administrative Officer of the Company since September 1996. From 1992
to September 1996, Mr. Faux served as Director, Investment Banking Group for
Prudential Securities Incorporated.
MICHAEL C. JOHNSEN. Mr. Johnsen has served as Vice President of
Operations of the Company since its inception in July 1994. From 1988 to
1994, Mr. Johnsen served as Vice President of Operations of certain of the
Company's predecessor entities. Mr. Johnsen is Dr. Lazzara's brother-in-law.
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PART II
-------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company's business was established in 1989 by Dr. Gasper Lazzara,
Jr. and Mr. Bartholomew F. Palmisano, Sr., the Chief Executive Officer and
Chief Financial Officer, respectively, of the Company. There were 247
Orthodontic Centers in 28 states at December 31, 1996.
The following table sets forth certain information relating to the
growth in the number of Orthodontic Centers for the periods shown:
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------
1990 1991 1992 1993 1994 1995 1996
---- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Number of centers at beginning of period...... 11 18 31 47 55 75 145
Number of centers developed during period..... 4 9 5 4 22 44 53
Number of centers acquired during period...... 3 5 17 5 1 29 68
Number of centers consolidated during period.. -- (1) (6) (1) (3) (3) (19)
---- ---- ---- ---- ---- ---- ----
Number of centers at end of period............ 18 31 47 55 75 145 247
---- ---- ---- ---- ---- ---- ----
</TABLE>
At December 31, 1991, 26 of the 31 Orthodontic Centers at that time were
located in general dentists' offices. During 1992, the Company began pursuing
a strategy of relocating Orthodontic Centers to free-standing locations,
pursuant to which each of these 26 Orthodontic Centers was relocated to free-
standing locations. At December 31, 1996, only three of the 247 Orthodontic
Centers were located in a general dentist's office. The Company intends to
relocate these three remaining Orthodontic Centers to free-standing locations
as soon as practicable. In developing additional Orthodontic Centers, the
Company intends to locate the Orthodontic Centers only in free-standing
locations. By locating in free-standing locations, Orthodontic Centers have
been able to increase available operating days and thereby enhance their
revenue producing capability.
Of the 247 Orthodontic Centers at December 31, 1996, 134 were developed
by the Company and 113 were existing orthodontic practices whose assets were
acquired by the Company. The Company expects that future growth in
Orthodontic Centers will come from both developing Orthodontic Centers with
existing and newly-recruited Affiliated Orthodontists and acquiring the assets
of, and entering into long-term agreements with, existing practices.
The average cost of developing a new Orthodontic Center is approximately
$230,000, including the cost of equipment, leasehold improvements, working
capital and losses associated with the initial operations of the Orthodontic
Center. The costs of developing a new Orthodontic Center are shared by the
Company and the particular Affiliated Orthodontist. The Company assists
Affiliated Orthodontists in obtaining financing of their share of such costs
through the Company's primary lender. For new developments, the Company has
discontinued financing Affiliated Orthodontists' share of losses associated
with the initial operations of the Orthodontic Center, which were historically
financed by the Company as an unsecured advance repayable by the Affiliated
Orthodontist over a five-year period and bearing interest at 1.5% per annum
above the prime rate, with repayment beginning upon the attainment of positive
cash flow by the Orthodontic Center (which generally occurs approximately 12
months after an Orthodontic Center commences operations). The Company
intends, however, to continue to make advances of approximately $20,000 to
newly-affiliated Affiliated Orthodontists during the first year of an
Orthodontic Center's operations, which advances bear no interest and typically
are repaid during the second year of the Orthodontic Center's operations. The
Company is assisting Affiliated Orthodontists in obtaining financing from the
Company's primary lender to replace the Company's
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financing of such Affiliated Orthodontists' share of the costs of previously
completed developments.
Typically, when the Company develops a new Orthodontic Center, all
patients treated at the Orthodontic Center are new patients and, in the first
several months after commencing operations, the Orthodontic Center is open
only for a limited number of days each month as new patients are added. The
Orthodontic Centers have typically become increasingly more productive and
profitable as more new patients are added and existing patients return for
monthly follow-up visits. After 26 months of operations, the Orthodontic
Centers' growth in patient base has typically begun to stabilize as the
initial patients complete treatment. An Orthodontic Center can increase the
number of patients treated by improving the efficiency of its clinical staff
and by adding operating days or orthodontists. The Orthodontic Centers may
also increase revenue by implementing periodic price increases. Established
practices whose assets were acquired by the Company have typically increased
their revenue by applying the Company's operating strategies, including
increased advertising and efficient patient scheduling.
The financial statements of the Company prior to October 18, 1994
recognized revenue as services were performed and the associated costs were
incurred, in accordance with the proportional performance method of accounting
for service contracts. Approximately 24% of the orthodontic services were
performed and their associated costs incurred in the first month of treatment.
Accordingly, approximately 24% of the revenue associated with a patient
contract was historically recognized in the first month, with the remaining
revenue recognized in equal monthly installments over the balance of the
contract period, which averaged 26 months. Expenses were recognized as
incurred.
Since October 18, 1994, the Company earns its revenue from long-term
service or consulting agreements entered into with Affiliated Orthodontists.
Pursuant to the service agreement, an Affiliated Orthodontist pays a fee to
the Company equal to approximately 24% of new patient contract balances of the
Affiliated Orthodontist in the first month of treatment plus the balance
ratably over the remainder of the patient contract, less amounts retained by
the Affiliated Orthodontist. The amounts retained by an Affiliated
Orthodontist are dependent on his or her financial performance, based in
significant part on the Affiliated Orthodontist's profitability on a cash
basis, as provided in the service agreements. Amounts retained by an
Affiliated Orthodontist which operates a newly developed Orthodontic Center
are typically reduced by operating losses on a cash basis because of start-up
expenses. An Affiliated Orthodontist's share of these operating losses is
added to the Company's fee in the period during which the operating losses are
incurred, while the Affiliated Orthodontist's share of capital expenditures is
recovered through the Company's fee over a period which approximates the
useful life of the related capital assets. In addition, a $25,000 annual fee
is earned by the Company for 42 free-standing Orthodontic Centers with respect
to which long-term agreements were entered into with the Company in the
Combination Transaction. In exchange for its service fees, the Company
provides capital for the development and growth of Orthodontic Centers and
manages the business and marketing aspects of Orthodontic Centers, including
implementing advertising and marketing programs, preparing budgets, purchasing
inventory, providing patient scheduling systems, billing and collecting fees
and maintaining records. Operating expenses of the Orthodontic Centers are
expenses of the Company and are recognized as incurred.
The terms of consulting agreements differ significantly from the terms of
service agreements and vary depending upon the regulatory requirements of the
particular state in which an Orthodontic Center is located. Currently, in one
state, the Company may only provide consulting services to the orthodontists
and may not manage the orthodontist's practice. The consulting fee payable to
the Company is determined at the time of affiliation, is limited to
compensation for the specific consulting services performed and is based on
criteria such as the number of hours of operations of the applicable
Orthodontic Centers.
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Employee costs consist of wages, salaries and benefits paid to all
employees of the Company, including orthodontic assistants, business staff and
management personnel. General and administrative expenses consist of
provision for losses on patient contracts and receivables, professional
service fees, maintenance and utility costs, office supply expense, telephone
expense, taxes, license fees, and printing and shipping expense.
Patient contracts are for terms averaging 26 months and are payable in
equal monthly installments throughout the term of treatment, except for the
last month when a final payment is made. During 1996, the Orthodontic Centers
generally instituted a price increase recommended by the Company for
orthodontic services from $89 per month to $98 per month for new patients with
an increase in the final payment from $366 to $398.
RESULTS OF OPERATIONS
The following table sets forth the percentages of net revenue represented by
certain items in the Company's consolidated statements of income.
Year ended December 31,
--------------------------
1994 1995 1996
-------- ------- -------
Net Revenue...................... 100.0% 100.0% 100.0%
Direct expenses:
Employee costs................ 27.0 28.4 27.9
Orthodontic supplies.......... 7.5 7.6 7.6
Rent.......................... 8.1 8.4 8.6
Advertising and marketing..... 8.5 10.4 9.3
----- ----- -----
Total direct expenses......... 51.1 54.8 53.4
General and administrative....... 10.8 12.3 12.2
Depreciation and amortization.... 3.6 3.5 4.0
----- ----- -----
Operating profit................. 34.5 29.4 30.4
Interest (expense) income, net... (1.0) 4.8 2.7
Nonrecurring litigation expense.. (14.8) -- --
----- ----- -----
Income before income taxes....... 18.7 34.2 33.1
Provision for income taxes....... 10.7 12.5 12.9
----- ----- -----
Net income....................... 8.0% 21.7% 20.2%
===== ===== =====
1996 Compared to 1995
Net Revenue. Net revenue increased 71.5% from $41.6 million for 1995 to
$71.3 million for 1996. Approximately $6.9 million of this increase was
attributable to the growth in net revenue of the 74 Orthodontic Centers open
throughout both periods, $12.1 million was attributable to the 57 Orthodontic
Centers (net of consolidations) opened during 1995, $11.0 million was
attributable to the 116 Orthodontic Centers opened during 1996 and
approximately $546,000 was attributable to the Affiliated Orthodontists' share
of the operating losses of newly-developed Orthodontic Centers, which amounts
were advanced by the Company. The remaining difference resulted primarily
from the fact that revenue recognized from the sale of ownership interests in
Orthodontic Centers obtained by the Company in the Combination Transaction
were lower in 1996 than in 1995. The number of patient contracts increased
from approximately 53,000 at December 31, 1995 to approximately 83,000 at
December 31, 1996.
Employee Costs. Employee costs increased 68.8% from $11.8 million for
1995 to $19.9 million for 1996. This increase was caused by an increase in
the number of patient contracts, which resulted in additional
17
<PAGE>
employee time required to service these contracts. As a percentage of net
revenue, however, employee costs decreased from 28.4% for 1995 to 27.9% for
1996. The decrease in employee costs as a percentage of net revenue resulted
from increased efficiency in scheduling and monitoring employee productivity
for all patient days.
Orthodontic Supplies. Orthodontic supplies expense increased 71.4% from
$3.2 million for 1995 to $5.4 million for 1996. As a percentage of net
revenue, orthodontic supplies remained constant at 7.6%. Cost improvements
attained through bulk purchasing were offset by increased expense associated
with an increased percentage of new patient treatment days, which require
greater orthodontic supplies per patient, associated with the opening of
additional Orthodontic Centers.
Rent. Rent expense increased 74.5% from $3.5 million for 1995 to $6.1
million for 1996. As a percentage of net revenue, rent expense increased from
8.4% to 8.6%. The increase in this expense as a percentage of net revenue was
attributable to the relatively fixed nature of the expense in conjunction with
the opening of additional Orthodontic Centers, which typically generate less
net revenue during their initial operations.
Advertising and Marketing. Advertising and marketing expense increased
53.7% from $4.3 million for 1995 to $6.6 million for 1996. The increase in
this expense resulted primarily from the addition of Orthodontic Centers in
new advertising markets after December 31, 1995. As a percentage of net
revenue, however, advertising and marketing decreased from 10.4% for 1995 to
9.3% for 1996. The decrease in this expense as a percentage of net revenue is
the result of cost improvements achieved through bulk media and production
purchases.
General and Administrative. General and administrative expense increased
70.4% from $5.1 million for 1995 to $8.7 million for 1996. This increase
resulted from the increase in Orthodontic Centers. As a percentage of net
revenue, however, general and administrative expense remained relatively
unchanged, at 12.3% in 1995 compared to 12.2% in 1996.
Depreciation and Amortization. Depreciation and amortization expense
increased 94.3% from $1.4 million for 1995 to $2.8 million for 1996. As a
percentage of net revenue, depreciation and amortization increased from 3.5%
to 4.0%. The increase in this expense is a result of the fixed assets
acquired for Orthodontic Centers developed or relocated after December 31,
1995 and amortization of service agreements acquired during 1996.
Operating Profit. Operating profit increased 77.3% from $12.2 million for
1995 to $21.7 million for 1996. As a percentage of net revenue, operating
profit increased from 29.4% to 30.4%, as a result of the factors discussed
above.
Interest. Net interest income decreased 3.0% from $2.0 million for 1995
to $1.9 million for 1995. The decrease resulted from a decrease in
the Company's average investment balances.
Provision for Income Taxes. Provision for income taxes increased 77.7%
from $5.2 million for 1995 compared to $9.2 million for 1996. The Company's
effective tax rate increased from 36.4% to 39.0% to reflect the Company's
higher income tax bracket for federal purposes and its blended state tax rate.
18
<PAGE>
1995 Compared to 1994
Net Revenue. Net revenue increased 63.9% from $25.4 million for 1994 to
$41.6 million for 1995. Approximately $3.9 million of this increase was
attributable to the growth in net revenue of the 53 Orthodontic Centers open
throughout both periods, $4.1 million was attributable to the 22 Orthodontic
Centers (net of consolidations) opened during 1994, $5.3 million was
attributable to the 70 Orthodontic Centers opened during 1995 and
approximately $1.7 million was attributable to the Affiliated Orthodontists'
share of the operating losses of newly-developed Orthodontic Centers, which
amounts were advanced by the Company. The remaining increase resulted
primarily from the sale of ownership interests in Orthodontic Centers obtained
by the Company in the Combination Transaction. The number of patient
contracts increased from approximately 33,000 at December 31, 1994 to
approximately 53,000 at December 31, 1995.
Employee Costs. Employee costs increased 72.2% from $6.8 million for 1994
to $11.8 million for 1995. As a percentage of net revenue, employee costs
increased from 27.0% for 1994 to 28.4% for 1995. This increase was caused
primarily by an increased percentage of new patient treatment days, which
require additional staff time per patient, associated with the opening of
additional Orthodontic Centers.
Orthodontic Supplies. Orthodontic supplies expense increased 66.0% from
$1.9 million for 1994 to $3.2 million for 1995. As a percentage of net
revenue, orthodontic supplies increased from 7.5% to 7.6%. Cost improvements
attained through bulk purchasing were offset by increased expense associated
with an increased percentage of new patient treatment days, which require
greater orthodontic supplies per patient, associated with the opening of
additional Orthodontic Centers.
Rent. Rent expense increased 70.9% from $2.1 million for 1994 to $3.5
million for 1995. As a percentage of net revenue, rent expense increased from
8.1% to 8.4%. The increase in this expense as a percentage of net revenue was
attributable to the relatively fixed nature of the expense in conjunction with
the opening of additional Orthodontic Centers, which typically generate less
net revenue during their initial operations.
Advertising and Marketing. Advertising and marketing expense increased
101.4% from $2.1 million for 1994 to $4.3 million for 1995. Advertising and
marketing expense increased as a percentage of net revenue from 8.5% to 10.4%.
The increase in this expense as a percentage of net revenue is the result of
advertising for Orthodontic Centers opened in new markets (including
metropolitan areas with relatively higher advertising rates), additional grand
opening promotions for Orthodontic Centers relocated in existing markets and
an overall increase in the quality of advertising.
General and Administrative. General and administrative expense increased
87.1% from $2.7 million for 1994 to $5.1 million for 1995. As a percentage of
net revenue, general and administrative expense increased from 10.8% to 12.3%
as a result of an increase in bad debt expense from $342,000 to $958,000,
expenses associated with being a publicly held company and administrative
expenses associated with the opening of additional Orthodontic Centers.
Depreciation and Amortization. Depreciation and amortization expense
increased 57.4% from $920,000 for 1994 to $1.4 million for 1995. The increase
in this expense is a result of the fixed assets acquired for Orthodontic
Centers developed or relocated after December 31, 1994. As a percentage of
net revenue, however, depreciation and amortization expense decreased from
3.6% to 3.5%. The decrease resulted from the full amortization in 1994 of the
patient contracts acquired in 1993.
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<PAGE>
Operating Profit. Operating profit increased 39.5% from $8.8 million for
1994 to $12.2 million for 1995. As a percentage of net revenue, however,
operating profit decreased from 34.5% to 29.4%, as a result of the factors
discussed above.
Interest. Net interest expense was $266,000 for 1994 compared to net
interest income of $2.0 million for 1995. The interest income resulted from
the investment of the unexpended proceeds from the Company's prior public
offerings.
Nonrecurring Litigation Expense. The Company incurred a nonrecurring
litigation expense of approximately $3.7 million during the second quarter of
1994 in connection with the acquisition by the Company of the practice assets
of two orthodontists as part of the Combination Transaction and as part of the
settlement of the litigation initiated by those orthodontists against the
Company. The $3.7 million consisted of approximately $300,000 in cash and
$3.4 million in promissory notes. In addition, the Company issued to the two
orthodontists an aggregate of 1,186,124 shares of Common Stock (after giving
effect to the Company's two subsequent two-for-one stock splits effected in
the form of a 100% stock dividend). The two previously affiliated
orthodontists alleged in the action, among other matters, that such
orthodontists had an interest in all of the Predecessor Entities and that Dr.
Lazzara and Mr. Palmisano had breached their fiduciary duties. The two
orthodontists claimed that the value offered to them in the Combination
Transaction was insufficient in view of their claim of ownership interest in
all of the Predecessor Entities. It is the Company's view, therefore, that
this litigation was unrelated to the operating activities of the Company,
which provides business operations and financial, marketing and administrative
services to Affiliated Orthodontists. Accordingly, the nonrecurring
litigation expense is not reflected in the Company's operating profit.
Provision for Income Taxes. Provision for income taxes increased 90.9%
from $2.7 million for 1994 compared to $5.2 million for 1995. The Company's
effective tax rate decreased from 57.2% to 36.4%. The 1994 provision
reflected a one-time, non-cash charge of $2.6 million for deferred income
taxes resulting from the change in tax status of the operations of the Company
upon completion of the Combination Transaction.
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<PAGE>
QUARTERLY OPERATING RESULTS
The following table sets forth certain unaudited quarterly operating
information of the Company for 1995 and 1996. The Company believes that the
following information includes all of the adjustments, consisting of normal
recurring accruals and adjustments necessary to convert cash basis accounting
records of the Company to an accrual basis, considered necessary for a fair
presentation of the Company's consolidated financial position and its
consolidated results of operations for these periods in accordance with
generally accepted accounting principles.
<TABLE>
<CAPTION>
Quarters ended
--------------
1995 1996
---- ----
Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31
------- ------- -------- ------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(in thousands)
Net revenue....... $8,465 $9,236 $11,490 $12,365 $13,719 $15,517 $18,881 $23,156
Operating profit.. 2,719 2,577 3,318 3,609 3,914 4,592 6,185 6,984
</TABLE>
SEASONALITY
The Orthodontic Centers have experienced their highest volume of new cases
in the summer and certain other periods when schools are not typically in
session. During these periods, children have a greater opportunity to visit
an orthodontist to commence treatment. Consequently, the Orthodontic Centers
have experienced higher revenue during the first and third quarters of the
year as a result of increased patient starts. During the Thanksgiving and
Christmas seasons, the Orthodontic Centers have experienced reduced volume and
fourth quarter revenue for the Orthodontic Centers has been generally lower as
compared to other periods. Seasonality in recent periods has been mitigated
by the impact of additional Orthodontic Centers.
LIQUIDITY AND CAPITAL RESOURCES
Development and acquisition costs, capital expenditures and working
capital needs have been, and will continue to be, financed through a
combination of cash flow from operations, bank borrowings and the issuance of
notes and shares of Common Stock. The Company intends to continue to lease,
rather than purchase, facilities for the Orthodontic Centers, to maximize the
Company's available capital.
Net cash provided by operations for the year ended December 31, 1996 was
$6.8 million. Net cash used in the Company's investing activities was $13.2
million and included the purchases of property, equipment and improvements,
the acquisition of intangible assets and advances to orthodontic entities,
offset by the proceeds from sales and maturities of investments and payments
from orthodontic entities. Net cash used in the Company's financing activities
for the year ended December 31, 1996 was $520,000, and consisted of payments
of long-term debt, offset by proceeds from the exercise of certain stock
options under the Company's three stock option plans.
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<PAGE>
The Company completed an initial public offering of 7,600,000 shares of
Common Stock at a public offering price of $2.75 per share in December 1994,
resulting in net proceeds to the Company of approximately $18.0 million. In
January 1995, the underwriters of the Company's initial public offering
exercised their over-allotment option for an additional 1,140,000 shares of
Common Stock, which provided the Company with additional net proceeds of
approximately $2.6 million. In June 1995, the Company completed a public
offering of 7,200,000 shares of Common Stock at a public offering price of
$5.75 per share, resulting in net proceeds to the Company of approximately
$38.7 million. In April 1996, in connection with a public offering by certain
selling stockholders, the Company issued 390,868 shares of Common Stock upon
the exercise of stock options under the Company's three stock option plans,
resulting in aggregate net proceeds to the Company of $693,000 from the
exercise price of such options. At December 31, 1996, the Company had used
approximately $29.9 million of the aggregate of approximately $60.0 million in
net proceeds received by the Company in these public offerings, including
approximately $1.5 million used to repay bank indebtedness and promissory
notes to Affiliated Orthodontists. The Company intends to utilize the
remaining proceeds of approximately $30.1 million to fund the expansion of its
business through the development of new Orthodontic Centers and the
acquisition of assets of, and the entering into long-term agreements with,
existing orthodontic practices, and for working capital and general corporate
purposes.
The Company's revolving line of credit with First Union National Bank of
Florida, which was entered into on October 18, 1994, provides an aggregate of
$5.0 million for general working capital needs and expansion of the number of
Orthodontic Centers, all of which is currently available for borrowing. The
revolving line of credit bears interest at 0.5% per annum above First Union's
prime rate and amounts borrowed are secured by a security interest in all of
the Company's assets, including its accounts receivable and equipment, and are
to be repaid over a period of four years.
As of October 18, 1994, in connection with the acquisition of the
ownership interests of two orthodontists in the Combination Transaction and as
a part of the settlement of litigation filed by such orthodontists, the
Company paid $318,000 in cash and issued promissory notes in the aggregate
principal amount of approximately $3.4 million to the two orthodontists.
These notes are payable in 84 equal monthly installments, commencing November
1, 1994, bear interest at 8.0% per annum and mature on November 1, 2001. At
December 31, 1996, the outstanding principal balance of such notes was an
aggregate of approximately $2.5 million.
Of the 247 Orthodontic Centers at December 31, 1996, 113 were acquired
through the acquisition of the assets of and the affiliation with existing
orthodontic practices. During 1996, the Company acquired the assets of and
affiliated with 40 existing orthodontic practices operating at 64 locations
(net of consolidations) at a cost of approximately $32.4 million, of which the
cash portion was approximately $11.4 million (including $4.6 million which was
due to orthodontic entities at December 31, 1996 and paid shortly after year
end) and the balance consisted of promissory notes issued by the Company in an
aggregate principal amount of $120,000 and an aggregate of 1,718,236 shares of
Common Stock. Outstanding indebtedness at December 31, 1996 under promissory
notes issued by the Company to Affiliated Orthodontists to acquire the assets
of existing orthodontic practices was approximately $920,000, with maturities
ranging from one to five years and interest rates ranging from 8.0% to 10.0%
per annum.
22
<PAGE>
The Company intends to develop additional Orthodontic Centers in 1997.
The average cost of developing a new Orthodontic Center is approximately
$230,000, including the cost of equipment, leasehold improvements, working
capital and losses associated with the initial operations of the Orthodontic
Center. The costs of developing a new Orthodontic Center are shared by the
Company and the particular Affiliated Orthodontist. The Company assists
Affiliated Orthodontists in obtaining financing of their share of such costs
through the Company's primary lender. For new developments, the Company has
discontinued financing Affiliated Orthodontists' share of losses associated
with the initial operations of the Orthodontic Center, which were historically
financed by the Company as an unsecured advance repayable by the Affiliated
Orthodontist over a five-year period and bearing interest at 1.5% per annum
above the prime rate, with repayment beginning upon the attainment of positive
cash flow by the Orthodontic Center (which generally occurs approximately 12
months after an Orthodontic Center commences operations). The Company
intends, however, to continue to make advances of approximately $20,000 to
newly-affiliated Affiliated Orthodontists during the first year of an
Orthodontic Center's operations, which advances bear no interest and typically
are repaid during the second year of the Orthodontic Center's operations. The
Company is assisting Affiliated Orthodontists in obtaining financing from the
Company's primary lender to replace the Company's financing of such Affiliated
Orthodontists' share of the costs of previously completed developments. The
Company intends to fund such advances and any continued financing through a
combination of bank borrowings, cash from operations and the remaining net
proceeds from the Company's prior public offerings.
The level of these cash needs could significantly change depending upon
the Company's ability to recruit orthodontists, find appropriate sites, enter
into long-term service or consulting agreements, and acquire the assets of
existing orthodontic practices. Based upon the Company's anticipated capital
needs for 1997, management believes that the combination of the funds
available under the Company's revolving line of credit, cash flow from
operations, and the proceeds remaining from the Company's prior public
offerings will be sufficient to meet the Company's funding requirements for
the foreseeable future.
Unbilled patient receivables of Affiliated Orthodontists increased from
$12.3 million at December 31, 1995 to $18.4 million at December 31, 1996,
which increases are consistent with the increase in the number of patient
contracts. Property, equipment and leasehold improvements increased from
$14.0 million at December 31, 1995 to $24.2 million at December 31, 1996
primarily as a result of the development of 48 new Orthodontic Centers. Total
current liabilities increased from $10.7 million at December 31, 1995 to $16.0
million at December 31, 1996 primarily as a result of an increase in accounts
payable and other accrued liabilities of $5.3 million.
The Company was able to use the cash basis of accounting for income tax
purposes through its tax year ended September 30, 1995. Beginning with the
tax year ended September 30, 1996, the Company is required to use the accrual
basis of accounting for income tax purposes. All deferred tax liabilities and
assets related to differences between the cash and accrual basis of accounting
which existed on October 1, 1995 will reverse over the two-year period ending
September 30, 1997. As a result, the Company estimates that its cash outlays
for income taxes will exceed its provision for income taxes in 1997 by
approximately $2.3 million.
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<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Ponte Vedra Beach, State of Florida, on April 21, 1997.
ORTHODONTIC CENTERS OF AMERICA, INC.
By: /s/ Gasper Lazzara, Jr., D.D.S.
--------------------------------------
Gasper Lazzara, Jr., D.D.S.
Chairman of the Board, President
and Chief Executive Officer
24
