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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 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
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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 1.8% 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 lend additional credibility to 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
1.8% 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
10
<PAGE>
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.
11
<PAGE>
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.
12
<PAGE>
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.
13
<PAGE>
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.
ITEM 2. PROPERTIES
-------------------
The Company leases an average of between 2,200 and 2,500 square feet of
office space for each Orthodontic Center. The typical lease for office space
is for a term of approximately five years, and generally provides for renewal
options for additional years. The average rental payment is approximately
$3,500 per month. As demand for orthodontic services has increased in a
particular market, the Company has leased and developed new Orthodontic
Centers in that market rather than expand its existing Orthodontic Centers,
because the size of each Orthodontic Center, particularly those located in
shopping malls, has been limited.
14
<PAGE>
The Company leases approximately 5,354 and 2,420 square feet of office
space in Ponte Vedra Beach, Florida for its headquarters under two separate
leases which expire in January 2000 and February 2002, respectively. The
Company also maintains an office in approximately 5,300 square feet of office
space in Metairie, Louisiana under a lease which expires in October 1998.
ITEM 3. LEGAL PROCEEDINGS
------- -----------------
The Company does not have pending any litigation that, separately or in
the aggregate, if adversely determined, would have a material adverse effect
on the Company. The Company and its affiliated orthodontists may, from time
to time, be a party to litigation or administrative proceedings which arise in
the normal course of its business. The Company's affiliated orthodontists
have not performed, and will not in the future perform, in Orthodontic Centers
temporal mandibular joint dysfunction (or "TMJ") procedures, with which
substantial litigation has been associated.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
------- ---------------------------------------------------
Not applicable.
15
<PAGE>
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
------- ---------------------------------------------------------------------
The Company's Common Stock ("Common Stock") is quoted on the Nasdaq
Stock Market National Market under the symbol "OCAI". The following table
sets forth, for the periods indicated, the range of high and low sales prices
per share of Common Stock, as reported on the Nasdaq Stock Market National
Market:
<TABLE>
<CAPTION>
HIGH(1) LOW(1)
-------- ------
1994
----
<S> <C> <C>
Fourth Quarter (beginning December 20, 1994).. $ 3 1/8 $2 3/4
1995
----
First Quarter................................. $ 4 25/32 $2 29/32
Second Quarter................................ $ 6 3/8 $3 7/8
Third Quarter................................. $ 8 3/16 $5 15/16
Fourth Quarter................................ $12 1/16 $7
1996
----
First Quarter................................. $15 3/8 $10 3/8
Second Quarter................................ $20 3/4 $12 5/8
Third Quarter................................. $22 5/8 $11 3/8
Fourth Quarter................................ $21 3/8 $11
1997
----
First Quarter (through March 17, 1997)........ $17 3/4 $13 3/8
</TABLE>
______________
(1) All share prices have been adjusted to reflect two two-for-one stock
splits of the Common Stock effected in the form of a 100% stock dividend
as of December 29, 1995 and September 5, 1996, respectively.
At March 17, 1997, the last reported sale price of the Common Stock was
$15 1/8 per share, and the number of holders of record of the Common Stock was
approximately 283.
The Company has never declared or paid cash dividends on the Common
Stock. Prior to the October 18, 1994 combination (the "Combination
Transaction") of the operations of 32 orthodontic practice entities and two
orthodontic management entities that were previously under common ownership
and management, and substantially all of which were general partnerships,
limited liability companies and S corporations (the "Predecessor Entities"),
the Predecessor Entities made distributions of their earnings to their
respective partners, members and stockholders.
The Company expects that future earnings, if any, will be retained for
the growth and development of the Company's business and accordingly, the
Company does not anticipate that any cash dividends will be declared or paid
on the Common Stock for the foreseeable future. The declaration, payment and
amount of future dividends, if any, will depend upon the future earnings,
results of operations, financial position
16
<PAGE>
and capital requirements of the Company, among other factors. The Company's
$5.0 million revolving line of credit with First Union National Bank of
Florida limits the ability of the Company to pay dividends from other than
current year earnings, and additional financial covenants contained in such
line of credit, including the requirement to maintain a minimum tangible net
worth of not less than $8.2 million, may limit the amount or payment of
dividends.
During 1996, the following equity securities were sold by the Company
without registration under the Securities Act of 1933 (the "Securities Act"):
In January 1996, the Company granted options to purchase (i) an
aggregate of 4,800 shares of Common Stock under the Company's Non-Qualified
Stock Option Plan for Non-Employee Directors to two non-employee directors of
the Company, (ii) an aggregate of 44,314 shares of Common Stock under the
Company's Incentive Stock Plan to 14 employees of the Company, and (iii) 3,000
shares of Common Stock under the Company's Restricted Stock Plan to an
Affiliated Orthodontist. The exercise price under each of such options was
equal to the market price of the Common Stock on the date of grant, as
reported on the Nasdaq Stock Market National Market. The Company did not
receive any payment in exchange for granting any of such options. The options
were granted in reliance upon an exemption from registration under the
Securities Act contained in Section 4(2) of the Securities Act.
In February 1996, the Company issued and sold an aggregate of 15,108
shares of Common Stock, in reliance upon an exemption from registration under
the Securities Act contained in Section 4(2) of the Securities Act, to an
Affiliated Orthodontist in exchange for such Affiliated Orthodontist's
ownership interests in a corporation which owned certain operating assets used
in connection with the Affiliated Orthodontist's practice. No underwriters
were used in accomplishing this transaction.
In March 1996, the Company granted options to purchase 1,724 shares of
Common Stock under the Company's Restricted Stock Plan to an Affiliated
Orthodontist, in reliance upon an exemption from registration under the
Securities Act contained in Section 4(2) of the Securities Act. The exercise
price under such options was equal to the market price of the Common Stock on
the date of grant as reported on the Nasdaq Stock Market National Market. The
Company did not receive any payment in exchange for granting such options.
In May 1996, the Company sold 69,017 shares of Common Stock, in reliance
upon an exemption from registration under the Securities Act contained in
Section 4(2) of the Securities Act, to an Affiliated Orthodontist in exchange
for such Affiliated Orthodontist's ownership interests in a corporation which
owned certain operating assets used in connection with the Affiliated
Orthodontist's practice. No underwriters were used in accomplishing this
transaction.
In June 1996, the Company issued and sold 18,591 shares of Common Stock,
in reliance upon an exemption from registration under the Securities Act
contained in Section 4(2) of the Securities Act, to an Affiliated Orthodontist
in exchange for such Affiliated Orthodontist's ownership interests in a
corporation which owned certain operating assets used in connection with the
Affiliated Orthodontist's practice. No underwriters were used in
accomplishing this transaction.
17
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
------- -----------------------
The following table sets forth selected financial data of the Company.
The selected financial data in the table are derived from the Company's
consolidated financial statements. The data should be read in conjunction with
the consolidated financial statements and notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Report.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1992 1993 1994 1995 1996
-------- -------- ------------- ---------- -----------
STATEMENT OF INCOME DATA: (in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net revenue......................... $14,470 $18,807 $ 25,357 $41,556 $ 71,273
Direct expenses:....................
Employee costs.................... 3,082 4,835 6,842 11,784 19,895
Orthodontic supplies.............. 1,025 1,528 1,908 3,167 5,428
Rent.............................. 1,449 1,586 2,050 3,504 6,114
Advertising and marketing......... 1,036 1,239 2,147 4,323 6,644
------- ------- ---------- ------- --------
Total direct expenses.......... 6,592 9,188 12,947 22,778 38,081
General and administrative.......... 1,457 1,869 2,730 5,108 8,703
Depreciation and amortization....... 1,199 1,089 920 1,448 2,814
------- ------- ---------- ------- --------
Operating profit.................... 5,222 6,661 8,760 12,222 21,675
Interest (expense) income, net...... (160) (224) (266) 1,995 1,935
Nonrecurring litigation expense..... --- --- (3,750)(1) --- ---
------- ------- ---------- ------- --------
Income before income taxes.......... 5,062 6,437 4,744 14,217 23,610
Provision for income taxes(2)....... 560 331 2,715(3) 5,182 9,208
------- ------- ---------- ------- --------
Net income.......................... $ 4,502 $ 6,106 $ 2,029 $ 9,035 $ 14,402
======= ======= ========== ======= ========
Net income per share(4)............. $0.23 $0.33
======= ========
Weighted average shares 39,630 43,708
outstanding(4)..................... ======= ========
DECEMBER 31,
----------------------------------------------------------
1992 1993 1994 1995 1996
------- ------- ---------- ------- --------
(in thousands)
BALANCE SHEET DATA:
Working capital..................... $ 3,126 $ 5,893 $ 20,896 $43,778 $ 40,219
Total assets........................ 7,189 12,470 37,491 92,573 145,099
Total debt.......................... 1,696 2,354 4,968 4,490 3,397
Total equity........................ 3,405 7,602 25,735 77,313 114,887
</TABLE>
- ------------------------------
(1) Nonrecurring charge incurred in connection with settlement of litigation
unrelated to the operating activities of the Predecessor Entities and
therefore excluded from operating profit. See Note 6 to the Company's
consolidated financial statements.
(2) Prior to October 18, 1994, substantially all of the Predecessor Entities
were S corporations, general partnerships or limited liability companies
and their taxable income was taxed directly to their respective
stockholders, partners or members during such periods.
(3) Includes a one-time, non-cash charge of $2,606,000 for deferred income
taxes relating to the difference between the tax basis and the basis for
financial reporting purposes of assets and liabilities of the
Predecessor Entities acquired by the Company in the Combination
Transaction. See Note 9 to the Company's consolidated financial
statements.
(4) Amounts represent the full dilutive effect of the exercise of common
equivalent shares (stock options) outstanding during the year. Assuming
no dilution, net income per share for the year ended December 31, 1996
was $0.34, based upon weighted average shares outstanding of
approximately 42,388,000, and for the year ended December 31, 1995 was
$0.24, based upon weighted average shares outstanding of approximately
38,235,000.
18
<PAGE>
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 75
Number of centers developed during period..... 4 9 5 4 22 44 48
Number of centers acquired during period...... 3 5 17 5 1 29 73
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
19
<PAGE>
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.
20
<PAGE>
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
21
<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.
22
<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.
23
<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.
24
<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.
25
<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.
26
<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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Appendix A hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
27
<PAGE>
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------------------------------
Information relating to the directors and executive officers of the
Company is incorporated herein by reference to the section captioned "Election
of Directors" in the Company's definitive Proxy Statement relating to the
Annual Meeting of Stockholders of the Company to be held during 1997.
ITEM 11. EXECUTIVE COMPENSATION
--------------------------------
Information relating to executive compensation is incorporated herein by
reference to the section captioned "Executive Compensation" in the Company's
definitive Proxy Statement relating to the Annual Meeting of Stockholders of
the Company to be held during 1997. The sections captioned "Comparative
Performance Graph" and "Compensation Committee Report on Executive
Compensation" included in such Proxy Statement are expressly not incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------
Information relating to the security ownership of certain beneficial
stockholders and management of the Company is incorporated herein by reference
to the section captioned "Security Ownership of Certain Beneficial Owners and
Management" in the Company's definitive Proxy Statement relating to the Annual
Meeting of Stockholders of the Company to be held during 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------
Information relating to certain relationships and related transactions
with respect to the Company is incorporated herein by reference to the section
captioned "Certain Relationships and Related Transactions" in the Company's
definitive Proxy Statement relating to the Annual Meeting of Stockholders of
the Company to be held during 1997.
28
<PAGE>
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
-------------------------------------------------------------------------
(a) Index to Consolidated Financial Statements, Financial Statement Schedules
and Exhibits
The following consolidated financial statements of the Company are
included in Appendix A hereto.
<TABLE>
<CAPTION>
(1) FINANCIAL STATEMENTS:
<S> <C>
Report of Independent Auditors........................................... A-1
Consolidated Balance Sheets - December 31, 1996 and 1995................. A-2
Consolidated Statements of Income - Years Ended December 31, 1996,
1995 and 1994............................................................ A-4
Consolidated Statements of Equity - Years Ended December 31, 1996,
1995 and 1994............................................................ A-5
Consolidated Statements of Cash Flows - Years Ended December 31, 1996,
1995 and 1994............................................................ A-6
Notes to Consolidated Financial Statements - December 31, 1996........... A-7
</TABLE>
(2) FINANCIAL STATEMENT SCHEDULE:
----------------------------
All schedules are omitted, because they are not applicable or not
required, or because the required information is included in the Company's
consolidated financial statements or notes thereto.
(3) EXHIBITS
--------
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------ -----------------------
3.1 -- Bylaws of the Registrant (1)
3.2 -- Restated Certificate of Incorporation of the Registrant (1)
4.1 -- Specimen Stock Certificate (1)
9.1 -- Voting Trust Agreement, dated as of October 18, 1994, between
John R. Anderson, D.D.S., P.A., Neal A. Stubbs, D.D.S., P.A.,
and Gasper Lazzara, Jr., D.D.S. (1)
10.1 -- Form of Service Agreement (confidential treatment granted as to
a portion of the agreement) (1)
10.2 -- Form of Management Agreement (confidential treatment granted as
to a portion of the agreement) (1)
10.3 -- Form of Consulting Agreement (1)
10.4 -- Employment Agreement between the Registrant and Gasper Lazzara,
Jr., D.D.S. (1)
10.5 -- Employment Agreement between the Registrant and Bartholomew F.
Palmisano, Sr. (1)
10.6 -- Orthodontic Centers of America, Inc. 1994 Incentive Stock Plan
(1)
29
<PAGE>
10.7 -- Orthodontic Centers of America, Inc. 1994 Non-Qualified Stock
Option Plan for Non-Employee Directors (1)
10.8 -- First Union National Bank Defined Contribution Master Plan and
Trust Agreement, and Adoption Agreement relating thereto,
between the Registrant and First Union National Bank (1)
10.9 -- Settlement and Purchase Agreement, dated as of October 10, 1994,
between John R. Anderson, D.D.S., P.A. and Neal A. Stubbs,
D.D.S., P.A., and Gasper Lazzara, Jr., D.D.S., P.A., Gasper
Lazzara, Jr., D.D.S., Bartholomew F. Palmisano, Sr., Palmisano &
Associates, A Corporation of Certified Public Accountants,
Orthodontic Centers of America, Inc., a Florida corporation,
Orthodontic Centers of America, Inc., a Louisiana corporation,
and the Registrant (1)
10.10 -- Non-Assignable Promissory Note, dated October 18, 1994, by the
Registrant in favor of John R. Anderson, D.D.S., P.A. (1)
10.11 -- Non-Assignable Promissory Note, dated October 18, 1994, by the
Registrant in favor of Neal A. Stubbs, D.D.S., P.A. (1)
10.12 -- Security Agreement, dated October 18, 1994, between John R.
Anderson, D.D.S., P.A. and Neal A. Stubbs, D.D.S., P.A. (1)
10.13 -- Stock Escrow and Pledge Agreement, dated October 18, 1994,
between Gasper Lazzara, Jr., D.D.S. and Bartholomew F.
Palmisano, Sr., and John R. Anderson, D.D.S., P.A., and Neal A.
Stubbs, D.D.S., P.A. (1)
10.14 -- Stock Escrow and Pledge Agreement, dated October 18, 1994,
between John R. Anderson, D.D.S., John R. Anderson, D.D.S.,
P.A., Neal A. Stubbs, D.D.S., Neal A. Stubbs, D.D.S., P.A. and
Gasper Lazzara, Jr., D.D.S., the Registrant and the Escrow Agent
(1)
10.15 -- Revolving Credit and Security Agreement, dated October 18, 1994,
between the Registrant and First Union National Bank of Florida
(1)
10.16 -- Letter of Credit issued to the Registrant by First Union
National Bank of Florida with John R. Anderson, D.D.S., P.A., as
beneficiary (1)
10.17 -- Letter of Credit issued to the Registrant by First Union
National Bank of Florida with Neal A. Stubbs, D.D.S., P.A., as
beneficiary (1)
10.18 -- Form of Exchange Agreement (1)
10.19 -- Form of Dissolution Agreement (1)
10.20 -- Form of Redemption Agreement (1)
10.21 -- Agreement, dated as of October 18, 1994, between the Registrant
and Dr. Gasper Lazzara, Jr. and Bartholomew F. Palmisano, Sr.
(1)
10.22 -- Exchange Agreement, dated as of October 18, 1994, between each
of the partners of Anderson, Lazzara, and Stubbs Partnership and
the Registrant (1)
10.23 -- Orthodontic Centers of America, Inc. 1995 Restricted Stock
Option Plan (2)
10.24 -- Orthodontic Centers of America, Inc. 1996 Employee Stock
Purchase Plan (3)
10.25 -- Employment Agreement between the Registrant and Geoffrey L. Faux
(filed herewith)
21.1 -- List of subsidiaries of the Registrant (filed herewith)
23.1 -- Consent of Ernst & Young LLP (filed herewith)
27.1 -- Financial Data Schedule (filed herewith)
- -------------------
(1) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-1, Registration Statement No. 33-
85326.
(2) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1994.
(3) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1995.
30
<PAGE>
The following is a list of all executive compensation plans and
arrangements filed as exhibits to this Annual Report on Form 10-K:
1. Employment Agreement between the Registrant and Gasper Lazzara, Jr.,
D.D.S. (Exhibit 10.4)
2. Employment Agreement between the Registrant and Bartholomew F.
Palmisano, Sr. (Exhibit 10.5)
3. Orthodontic Centers of America, Inc. 1994 Incentive Stock Plan
(Exhibit 10.6)
4. First Union National Bank Defined Contribution Master Plan and Trust
Agreement, and Adoption Agreement relating thereto, between the
Registrant and First Union National Bank (Exhibit 10.8)
5. Orthodontic Centers of America, Inc. 1996 Employee Stock Purchase
Plan (Exhibit 10.24)
6. Employment Agreement between the Registrant and Geoffrey L. Faux
(Exhibit 10.25)
(b) Reports on Form 8-K
No current reports on Form 8-K were filed during the fourth quarter
of 1996.
31
<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 March 30, 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
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Gasper Lazzara, Jr., D.D.S. Chairman of the Board, March 30, 1997
- -------------------------------------- President, Chief Executive
Gasper Lazzara, Jr., D.D.S. Officer and Director
(principal executive officer)
/s/ Bartholomew F. Palmisano, Jr. Chief Financial Officer, March 30, 1997
- -------------------------------------- Senior Vice President,
Bartholomew F. Palmisano, Sr. Treasurer, Director
(principal financial and
accounting officer)
/s/ Geoffrey L. Faux Executive Vice President, March 30, 1997
- -------------------------------------- Chief Administrative Officer,
Geoffrey L. Faux Director
/s/ Michael C. Johnsen Vice President of March 30, 1997
- -------------------------------------- Operations, Director
Michael C. Johnsen
/s/ Edward J. Walters, Jr. Director March 30, 1997
- --------------------------------------
Edward J. Walters, Jr.
/s/ A. Gordon Tunstall Director March 30, 1997
- --------------------------------------
A. Gordon Tunstall
/s/ Ashton J. Ryan, Jr. Director March 30, 1997
- --------------------------------------
Ashton J. Ryan, Jr.
</TABLE>
32
<PAGE>
CONSOLIDATED FINANCIAL STATEMENTS
ORTHODONTIC CENTERS OF AMERICA, INC.
YEARS ENDED DECEMBER 31, 1996, 1995 and 1994
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1996 and 1995
CONTENTS
Report of Independent Auditors.........................................A-1
Audited Consolidated Financial Statements
Consolidated Balance Sheets............................................A-2
Consolidated Statements of Income......................................A-4
Consolidated Statements of Equity......................................A-5
Consolidated Statements of Cash Flows..................................A-6
Notes to Consolidated Financial Statements.............................A-7
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Orthodontic Centers of America, Inc.
We have audited the accompanying consolidated balance sheets of Orthodontic
Centers of America, Inc. as of December 31, 1996 and 1995, and the related
consolidated statements of income, equity, and cash flows for each of the three
years in the period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Orthodontic Centers of America, Inc. at December 31, 1996 and 1995, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
Ernst & Young LLP
New Orleans, Louisiana
February 13, 1997
A-1
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
DECEMBER 31
1996 1995
---------------------
ASSETS
Current assets:
Cash and cash equivalents $ 11,827 $ 18,779
Investments 12,621 14,804
Patient receivables, net of allowance for
uncollectible billings of $2,590 and
$1,281 in 1996 and 1995, respectively 7,422 3,860
Unbilled patient receivables, net of allowance
for uncollectible amounts of $829 and $521
in 1996 and 1995, respectively 18,398 12,265
Amounts receivable from orthodontic entities 2,191 2,260
Supplies inventory, prepaid expenses and other
assets 3,670 2,476
-------------------
Total current assets 56,129 54,444
Property, equipment and improvements, net 24,201 14,014
Investments 6,482 13,089
Amounts receivable from orthodontic centers, less
current portion 5,369 4,903
Intangible assets 52,682 5,928
Other assets 236 195
-------------------
Total assets $145,099 $92,573
===================
A-2
<PAGE>
DECEMBER 31
1996 1995
------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 312 $ 313
Accrued salaries and other accrued liabilities 1,507 1,081
Patient prepayments 2,639 2,367
Income taxes payable 2,730 2,645
Amounts payable to orthodontic entities 5,662 650
Deferred income taxes 2,162 2,468
Current portion of long-term debt 898 1,142
------------------
Total current liabilities 15,910 10,666
Long-term debt, less current portion 2,499 3,348
Deferred income taxes 11,803 1,246
Shareholders' equity:
Preferred stock, $.01 par value; 10,000,000 shares
authorized, no shares outstanding -- --
Common stock, $.01 par value per share; 80,000,000
shares authorized, 43,888,722 and 41,779,528
shares issued and outstanding at December 31,
1996 and 1995, respectively 439 209
Additional paid-in capital 92,294 69,352
Retained earnings 22,154 7,752
------------------
Total shareholders' equity 114,887 77,313
------------------
Total liabilities and shareholders' equity $145,099 $92,573
==================
See accompanying notes.
A-3
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
YEAR ENDED DECEMBER 31
1996 1995 1994
------------------------------
Net revenue $71,273 $41,556 $25,357
Direct expenses:
Employee costs 19,895 11,784 6,842
Orthodontic supplies 5,428 3,167 1,908
Rent 6,114 3,504 2,050
Advertising and marketing 6,644 4,323 2,147
------- ------- -------
Total direct expenses 38,081 22,778 12,947
General and administrative 8,703 5,108 2,730
Depreciation and amortization 2,814 1,448 920
------- ------- -------
Operating profit 21,675 12,222 8,760
Interest expense (424) (471) (266)
Interest income 2,359 2,466 --
Nonrecurring litigation
expense -- -- (3,750)
------- ------- -------
Income before income taxes 23,610 14,217 4,744
Provision for income taxes 9,208 5,182 2,715
------- ------- -------
Net income $14,402 $ 9,035 $ 2,029
======= ======= =======
Net income per share:
Assuming no dilution $ .34 $ .24
======= =======
Assuming full dilution $ .33 $ .23
======= =======
If all of the Company's
operations had been subject
to income taxes, net income
would be as follows
(unaudited):
Historical income before
income taxes $ 4,744
Provision for income taxes 1,803
Net income -------
$ 2,941
=======
See accompanying notes.
A-4
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(In thousands, except share data)
<TABLE>
<CAPTION>
ADDITIONAL RETAINED
OWNERS' COMMON PAID-IN EARNINGS TOTAL
EQUITY STOCK CAPITAL (DEFICIT) EQUITY
------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1994 $ 7,602 $ -- $ -- $ -- $ 7,602
Contributions of capital 104 -- -- -- 104
Net income from January 1, 1994 to October 17,
1994 3,312 -- -- -- 3,312
Distributions to owners (2,350) -- -- -- (2,350)
------- -------- --------- ------- --------
Balance at October 18, 1994 8,668 -- -- -- 8,668
Exchange of common stock for net assets
(25,379,648 shares) (8,668) 63 8,925 -- 320
Initial public offering (7,600,000 shares) -- 19 18,011 -- 18,030
Deferred income taxes recorded due to change in
tax status of Predecessor Entities in
connection with Combination Transaction -- -- -- (2,606) (2,606)
Net income from October 18, 1994 to
December 31, 1994 -- -- -- 1,323 1,323
------- -------- --------- ------- --------
Balance at December 31, 1994 -- 82 26,936 (1,283) 25,735
Over-allotment option of initial public offering
(1,140,000 shares) -- 3 2,552 -- 2,555
Public offering of common stock (7,200,000 shares) -- 18 38,679 -- 38,697
Issuance of shares of common stock to obtain
management agreements (460,000 shares) -- 2 1,289 -- 1,291
Two-for-one stock split -- 104 (104) -- --
Net income -- -- -- 9,035 9,035
------- -------- --------- ------- --------
Balance at December 31, 1995 -- 209 69,352 7,752 77,313
Issuance of shares under Incentive Option Plan
(391,000 shares) -- 2 691 -- 693
Tax benefit associated with exercise of options -- -- 1,705 -- 1,705
Issuance of shares of common stock to obtain
management agreements (1,718,000 shares) -- 15 20,759 -- 20,774
Two-for-one stock split -- 213 (213) -- --
Net income -- -- -- 14,402 14,402
------- -------- --------- ------- --------
Balance at December 31, 1996 $ -- $ 439 $ 92,294 $22,154 $114,887
======= ======== ========= ======= ========
</TABLE>
See accompanying notes.
A-5
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except share data)
YEARS ENDED DECEMBER 31
1996 1995 1994
------------------------------
OPERATING ACTIVITIES
Net income $ 14,402 $ 9,035 $ 2,029
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for bad debt expense 1,617 958 342
Depreciation and amortization 2,814 1,448 920
Deferred income taxes (3,031) 823 2,145
Nonrecurring litigation expense -- -- 3,356
Change in operating assets and liabilities:
Patient receivables (4,871) (3,233) (259)
Unbilled patient receivables and patient
prepayments (6,169) (2,236) (2,637)
Supplies inventory, prepaid expenses and
other (1,235) (1,403) (705)
Amounts receivable from/payable to
orthodontic entities 1,074 (3,350) (208)
Accounts payable and other current
liabilities 2,215 1,978 1,222
-------- -------- -------
Net cash provided by operating activities 6,816 4,020 6,205
INVESTING ACTIVITIES
Purchase of property, equipment and
improvements (12,333) (8,230) (4,655)
Purchase of available-for-sale investments (30,000) (95,465) --
Proceeds from sales or maturities of
available-for-sale investments 38,790 67,572 --
Intangible assets acquired (6,870) (3,998) (80)
Advances to orthodontic entities (6,160) (2,832) (385)
Payments from orthodontic entities 3,325 582 --
-------- -------- -------
Net cash used in investing activities (13,248) (42,371) (5,120)
FINANCING ACTIVITIES
Proceeds from long-term debt -- -- 138
Repayment of long-term debt (1,213) (1,230) (1,105)
Issuance of common stock 693 41,252 18,030
Capital contributions -- -- 104
Distributions to owners -- -- (2,611)
-------- -------- -------
Net cash provided by (used in) financing
activities (520) 40,022 14,556
-------- -------- -------
Increase (decrease) in cash and cash
equivalents (6,952) 1,671 15,641
Cash and cash equivalents at beginning of year 18,779 17,108 1,467
-------- -------- -------
Cash and cash equivalents at end of year $ 11,827 $ 18,779 $17,108
======== ======== =======
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 424 $ 471 $ 266
======== ======== =======
Income taxes $ 10,449 $ 2,345 $ 137
======== ======== =======
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Long-term debt and common stock issued to
obtain management agreements $ 20,894 $ 2,043 $ --
======== ======== =======
Long-term debt issued to acquire property,
equipment and improvements $ -- $ -- $ 225
======== ======== =======
Long-term debt issued related to litigation
settlement $ -- $ -- $ 3,356
======== ======== =======
See accompanying notes.
A-6
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Orthodontic Centers of America, Inc. (the "Company") manages orthodontic centers
on a national basis. The Company managed 247, 145 and 75 orthodontic centers as
of December 31, 1996, 1995 and 1994, respectively. As of December 31, 1996, such
centers were located in 28 states.
Prior to October 18, 1994, under the terms of contractual agreements with 32
entities which operated the orthodontic centers, two predecessor management
entities provided business operations, financial, marketing and administrative
services to these 32 operating entities. The predecessor management entities or
their owners had an ownership interest in each of the entities which operated an
orthodontic center (collectively, the "Predecessor Entities"). Subsequent to
October 17, 1994, these same services are provided under service, management and
consulting agreements with the orthodontic entities (hereafter referred to as
"management agreements"). These management agreements are generally for a term
of 20-40 years. The practicing orthodontists own the orthodontic entities.
Effective October 18, 1994, the Company acquired all of the common stock
outstanding related to the two predecessor management entities and acquired the
assets and liabilities of predecessor operating entities in exchange for
25,379,648 shares of the Company's common stock (the "Combination Transaction").
The consolidated financial statements reflect the accounts of the Company and
the Predecessor Entities accounted for in a manner similar to the pooling-of-
interests method. Substantially all of the Predecessor Entities were dissolved
following the Combination Transaction. Significant intercompany accounts and
transactions have been eliminated.
Unaudited Pro Forma Net Income Per Share
Net income per share for the year ended December 31, 1994 has been omitted from
the consolidated statements of income because the Company was not a single
entity with its own capital structure during that period. The computation of pro
forma net income and
A-7
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION (CONTINUED)
net income per share for the year ended December 31, 1994 computed as if the
Combination Transaction had occurred at the beginning of the year ended December
31, 1994, and as if the Company had been a C corporation for the entire year is
as follows (in thousands, except per share data):
Historical income before income taxes $ 4,744
Reclassify distributions to practicing orthodontists as a
reduction to net revenue (1,158)
Changes to the calculation of net revenue under the
management agreements 998
Reduction of expenses due to employment agreements (70)
-------
Pro forma income before income taxes 4,514
Provision for income taxes 1,715
-------
Pro forma net income $ 2,799
=======
Weighted average shares outstanding 25,464
=======
Pro forma net income per share:
Assuming no dilution $ .11
=======
Assuming full dilution $ .11
=======
The weighted average shares outstanding include the 25,379,648 shares of common
stock issued in the Combination Transaction as if they were outstanding since
January 1, 1994. In addition, the Company issued 7,600,000 shares of its common
stock on December 28, 1994 in an initial public offering (see Note 7). The
effect of outstanding stock options was immaterial.
A-8
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
INVESTMENTS
Management determines the appropriate classification of debt securities at the
time of purchase and re-evaluates such designation as of each balance sheet
date. All investments held at December 31, 1996 and 1995 are classified as
available-for-sale because management does not have positive intent to hold
until maturity. Available-for-sale investments are carried at fair value.
Investments included in current assets are debt securities with a maturity of
greater than three months when purchased and a remaining maturity of less than
one year, and which management expects to use in its current operations. All
other investments are considered long-term assets and have maturities of less
than five years. At December 31, 1996 and 1995, the Company's amortized cost of
investments held consisted of $10,060,000 and $19,353,000, respectively, of U.
S. Treasury and U. S. Government Agency obligations, and $9,043,000 and
$8,531,000, respectively, of corporate and municipal bonds. The unrealized gains
and losses on these investments at December 31, 1996 and 1995 were not
significant. The amortized cost of debt securities is adjusted for amortization
of premiums and accretion of discounts to maturity and included in interest
income. The cost of investments sold is based on the specific identification
method. Interest on investments classified as available-for-sale is included in
interest income.
A-9
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the balance sheets
for cash and cash equivalents approximates their fair value.
INVESTMENTS: The fair values for marketable debt securities are based on
quoted market prices.
AMOUNTS RECEIVABLE FROM ORTHODONTIC ENTITIES: The carrying amounts reported on
the balance sheets for amounts receivable from orthodontic entities
approximate fair value.
LONG-TERM DEBT: The fair values of the Company's long-term debt are estimated
using discounted cash flow analyses, based on the Company's current
incremental borrowing rates for similar types of borrowing arrangements, and
approximate their carrying values.
REVENUE RECOGNITION
The following represent amounts included in the determination of net revenue (in
thousands):
YEAR ENDED DECEMBER 31
1996 1995 1994
------------------------------
Subsequent to October 17, 1994:
Management fees earned $71,273 $41,556 $ 6,662
Prior to October 18, 1994:
Gross center revenue -- -- 21,797
Less base service fees -- -- (3,102)
------- ------- -------
$71,273 $41,556 $25,357
======= ======= =======
A-10
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Subsequent to October 17, 1994, revenue is earned by the Company under the
management agreements with orthodontic entities equal to approximately 24% of
new patient contract balances in the first month of new contracts plus a portion
of existing contract balances, less amounts retained by the orthodontic
entities. The orthodontic entities retain all orthodontic center revenue not
paid to the Company as the management fee. The amounts retained by the
orthodontic entities are dependent on their financial performance, based in
significant part on the orthodontic entities cash receipts and disbursements.
Under the terms of the management agreements, the orthodontic entities assign
their receivables (billed and unbilled) to the Company in payment of their
management fees. The Company is responsible for collection. Unbilled patient
receivables represent the earned revenue in excess of billings to patients as of
the end of each period. There are no unbilled receivables which will not be
billed. The Company is exposed to certain credit risks. The Company manages such
risks by regularly reviewing the accounts and contracts, and providing
appropriate allowances. Provisions are made currently for all known or
anticipated losses for billed and unbilled patient receivables and for loss
contracts. Such deductions totaled $1,617,000, $958,000 and $342,000 for the
years ended December 31, 1996, 1995 and 1994, respectively, and have been within
management's expectations. At December 31, 1996, and 1995 there were
approximately 83,000 and 53,000, respectively, active patient contracts with
balances outstanding. Patient prepayments represent collections from patients
or their insurance companies which are received in advance of the performance
of the related services.
Prior to October 18, 1994, center revenue was recognized in accordance with the
proportional performance method of accounting for service contracts. Under this
method, revenue was recognized as services were performed and the costs
associated therewith were incurred, under the terms of contractual agreements
with each patient. A significant portion, approximately 24%, of the services
were performed in the initial month of the contract. Billings under each
contract, which averaged 26 months, were made equally throughout the term of the
contract, with a final payment at the completion of the treatment. The base
service fees retained by the orthodontist were based on actual hours worked. The
Company did not pay any salaries to the orthodontists. In addition, prior to
October 18, 1994, certain orthodontists also had an ownership interest in one or
more of the Predecessor Entities. The orthodontists, excluding Dr. Lazzara, who
were owners of the Predecessor Entities, received distributions totaling
approximately $1,343,000 for the period from January 1, 1994 to October 17,
1994. Such distributions are included as distributions to owners in the
consolidated statements of equity.
A-11
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SUPPLIES INVENTORY
Supplies inventory is valued at the lower of cost or market determined on the
first-in, first-out basis.
PROPERTY, EQUIPMENT AND IMPROVEMENTS
Property, equipment and improvements are stated at cost. Depreciation expense is
provided using the straight-line method over the estimated useful lives of the
assets, which are five to 10 years. Leasehold improvements are amortized over
the original lease term which is generally five to 10 years. The related
depreciation and amortization expense for the years ended December 31, 1996,
1995 and 1994 was $2,146,000, $1,256,000 and $426,000, respectively.
INTANGIBLE ASSETS
Amortization expense for the years ended December 31, 1996, 1995 and 1994, was
$668,000, $192,000 and $494,000, respectively. Accumulated amortization was
$1,353,000 and $686,000, as of December 31, 1996 and 1995, respectively.
Intangible assets and the related accumulated amortization are written off when
fully amortized.
Intangible assets include the costs of obtaining management agreements, which
are amortized over the life of the agreements which is generally 20 to 40 years.
Such management agreements represent the exclusive right to provide business
operations, financial, marketing and administrative service to an orthodontic
entity during the term of the management agreement. In the event the management
agreement is terminated, the related orthodontic entity is required to purchase
all of the related assets, including the unamortized portion of intangible
assets, at the current book value.
A-12
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING AND MARKETING COSTS
Advertising and marketing costs are expensed as incurred.
INCOME TAXES
Income taxes for the Company and Predecessor Entities organized as C
corporations are determined by the liability method in accordance with Statement
of Financial Accounting Standards 109, Accounting for Income Taxes. The Company
maintains a fiscal year end of September 30 for income tax reporting purposes.
Income taxes for Predecessor Entities which were organized as partnerships,
limited liability companies or S corporations were the responsibility of the
individual owners and no provision for income taxes has been made in the
consolidated financial statements for these entities.
NET INCOME PER SHARE
Net income per share is based upon the weighted average of common and common
equivalent shares (stock options) outstanding during the year. The number of
common and common equivalent shares utilized in the per share computations for
1996 and 1995 were 42,388,005 and 38,234,662, respectively, for net income per
share assuming no dilution, and 43,708,301 and 39,630,028, respectively,
assuming full dilution.
STOCK COMPENSATION ARRANGEMENTS
The Company accounts for its stock compensation arrangements under the
provisions of APB 25, Accounting for Stock Issued to Employees.
A-13
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. TRANSACTIONS WITH ORTHODONTIC ENTITIES
Under the terms of the management agreements, the Company has historically
funded the operating losses and capital improvements of orthodontic entities.
Amounts advanced to an orthodontic entity to fund operating losses were required
to be repaid to the Company over five years once the orthodontic entity
generated operating profits. During December 1996, the Company entered into an
agreement with its financial institution whereby the financial institution
finances the operating losses and capital improvements directly to the
orthodontic entity, subject to the financial institution's credit approval of
the orthodontic entity, but where the Company remains a guarantor of the related
debt. At December 31, 1996, the Company was a guarantor for $2,819,000 under
this agreement.
Amounts receivable from orthodontic entities are classified on the consolidated
balance sheets based upon the expected date of collection. Collection of amounts
due from orthodontic entities is highly dependent on the entities' financial
performance. Therefore, the Company is exposed to certain credit risk. However,
management believes such risk is minimized by the Company's involvement in
certain business aspects of the orthodontic entity.
Amounts payable to orthodontic entities represents the extent that the patient
receivables assigned to the Company exceed the management fee earned and other
amounts currently due the Company.
A-14
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. PROPERTY, EQUIPMENT AND IMPROVEMENTS
Property, equipment and improvements consisted of the following (in thousands):
DECEMBER 31
1996 1995
--------------------
Leasehold improvements $15,020 $ 8,251
Furniture and fixtures 12,782 7,424
Other equipment 72 92
Centers in progress 748 536
--------------------
28,622 16,303
Less accumulated depreciation and
amortization 4,421 2,289
--------------------
$24,201 $14,014
====================
5. LONG-TERM DEBT AND LINE OF CREDIT
Long-term debt consisted of the following (in thousands):
DECEMBER 31
1996 1995
--------------------
Notes payable to affiliated
orthodontists, interest rates ranging
from 8% to 10%, with maturity dates ranging
from 1997 to 2000, unsecured. $ 922 $ 1,604
Notes payable related to litigation settlement,
interest rate of 8%, payable in 84 monthly
installments of approximately $52,000
including interest through 2001, secured
by the Company's assets 2,475 2,886
-----------------
3,397 4,490
Less current portion 898 1,142
-----------------
$ 2,499 $ 3,348
=================
A-15
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. LONG-TERM DEBT AND LINE OF CREDIT (CONTINUED)
The aggregate maturities of long-term debt as of December 31, 1996 for each of
the next five years are as follows (in thousands):
1997 $ 898
1998 735
1999 717
2000 591
2001 456
At December 31, 1996, the Company has an outstanding line of credit of
$5,000,000 with a financial institution, all of which is available for general
working capital needs, the development of new orthodontic centers and the
acquisition of assets from existing orthodontic centers. The Company is required
to maintain certain financial covenants under the terms of this line of credit.
The line of credit agreement also restricts certain activities of the Company,
including limiting the declaration of dividends to current earnings. At December
31, 1996, the Company was in compliance with the covenants and restrictions of
the agreement.
6. NONRECURRING LITIGATION EXPENSE
In April 1994, two orthodontists previously affiliated with certain of the
Predecessor Entities filed an action against the Company and its stockholders,
Dr. Lazzara and Mr. Palmisano, alleging among other matters, an interest in all
of the Predecessor Entities and alleging breach of fiduciary duties by Dr.
Lazzara and Mr. Palmisano. On October 10, 1994, the parties to the litigation
entered into a definitive agreement of settlement terms pursuant to which the
two orthodontists agreed to withdraw their allegations and dismiss their lawsuit
with prejudice.
Under the terms of the agreement, the Company paid to the two orthodontists
$318,000 in cash and issued notes payable in the aggregate amount of $3,356,000
(see Note 5). In addition, the Company issued to the two orthodontists an
aggregate of 1,186,144 shares of its common stock in connection with the
Combination Transaction. The two orthodontists also agreed to enter into a five-
year non-competition agreement restricting the orthodontists' ability to own or
provide orthodontic services except in limited circumstances. The two
orthodontists have not practiced in affiliated centers since March 1994.
A-16
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. NONRECURRING LITIGATION EXPENSE (CONTINUED)
The excess of the consideration over the net assets acquired represents the cost
to settle the litigation and was estimated to be $3,750,000. The amount was
recorded as a nonrecurring litigation expense and is classified below operating
profit in the consolidated statement of income because the litigation was
unrelated to the operating activities of the Company.
7. ISSUANCE OF COMMON STOCK
On December 28, 1994, the Company completed an initial public offering of
7,600,000 shares of its common stock at $2.75 per share. This offering resulted
in net proceeds (after deducting issuance costs) of $18,030,000. In connection
with the public offering, the Company granted an over-allotment option to the
underwriters for an additional 1,140,000 shares of the Company's common stock.
This option was exercised by the underwriters on January 25, 1995, resulting in
net proceeds of $2,555,000.
On June 19, 1995, the Company completed a public offering of 7,200,000 shares of
its common stock at $5.75 per share. This offering resulted in net proceeds to
the Company (after deducting issuance costs) of $38,697,000.
On August 15, 1996, the board of directors of the Company declared a two-for-one
stock split of the Company's common stock. This was paid in the form of a 100%
stock distribution on September 5, 1996, to shareholders of record as of August
28, 1996. Accordingly, all share and per share data for all periods presented
reflect the effects of this split. The par value for the additional shares
issued was transferred from additional paid-in capital to common stock.
A-17
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LEASES
Facilities for the orthodontic centers and administrative offices are rented
under long-term leases accounted for as operating leases. The original lease
terms are generally five to 10 years with options to renew the leases for
specified periods subsequent to their original terms. The leases have other
various provisions, including sharing of certain executory costs and scheduled
rent increases. Minimum rent expense is recorded on a straight-line basis over
the life of the lease. Minimum future commitments as of December 31, 1996 are as
follows (in thousands):
1997 $ 6,477
1998 5,972
1999 5,377
2000 4,110
2001 3,383
Thereafter 3,769
-------
$29,088
=======
Many of the lease agreements provide for payments comprised of a minimum rental
payment plus a contingent rental payment based on a percentage of cash
collections and other additional amounts. Rent expense attributable to minimum
and additional rentals along with sublease income was as follows (in thousands):
YEARS ENDED DECEMBER 31
1996 1995 1994
-----------------------------
Minimum rentals $ 5,096 $ 2,869 $ 1,388
Additional rentals 1,124 710 723
Sublease income (106) (75) (61)
------- ------- -------
$ 6,114 $ 3,504 $ 2,050
======= ======= =======
9. INCOME TAXES
Prior to October 18, 1994, much of the income of the Predecessor Entities
related to entities which were organized as partnerships, limited liability
companies or S-corporations. Since taxes for these entities were the
responsibility of the individual owners, no provision
A-18
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES (CONTINUED)
for income taxes has been made in the consolidated financial statements related
to the income for these entities. As part of the Combination Transaction, the
Company received assets and liabilities from the entities which had not been
subject to income taxes. The basis of these assets and liabilities for financial
reporting purposes exceeded the basis for income tax purposes by $6,858,000 as
of October 18, 1994. The tax effect of this difference, $2,606,000, was recorded
in 1994 in the provision for income taxes as required by FAS 109. A separate
presentation on the accompanying consolidated statements of income shows a
provision for income taxes and net income for the year ended December 31, 1994
as if all of the Company's operations had been subject to income taxes for the
entire period, and assuming an effective tax rate of 38%.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the consolidated deferred tax liabilities and assets were as follows (in
thousands):
DECEMBER 31
1996 1995
------------------
Deferred tax liabilities:
Conversion to accrual basis of accounting for income
tax purposes $ 2,311 $ 5,255
Intangible assets 13,443 20
Other 634 370
------- -------
Total deferred tax liabilities 16,388 5,645
Deferred tax assets:
Property and equipment 124 149
Allowance for uncollectible billings and amounts 1,334 685
Litigation settlement costs 965 1,097
------- -------
Total deferred tax assets 2,423 1,931
------- -------
Net deferred tax liabilities $13,965 $ 3,714
======= =======
A-19
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES (CONTINUED)
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
ending September 30, 1996, because of its level of cash receipts, 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 as of October 1, 1995 have been
reclassified in the table above to a single amount. The related deferred tax
liability of $2,311,000 as of December 31, 1996 will reverse over the period
ending September 30, 1997.
Components of the 1996, 1995 and 1994 provision (benefit) for income taxes are
as follows (in thousands):
<TABLE>
<CAPTION>
SUBSEQUENT
PRIOR TO TO
YEAR ENDED DECEMBER 31, OCTOBER 18, OCTOBER 17, TOTAL
1996 1995 1994 1994 1994
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Current $12,239 $ 4,359 $ 29 $ 541 $ 570
Deferred (3,031) 823 (714) 253 (461)
Provision due to change in tax status of
predecessor Entities in connection
with Combination Tranaction -- -- -- 2,606 2,606
------- ------- ------- ------- ------
Total $ 9,208 $ 5,182 $ (685) $ 3,400 $2,715
======= ======= ======= ======= ======
</TABLE>
The reconciliation of income tax computed at the federal statutory rates to
income tax expense (benefit) for 1996, 1995 and 1994 is (in thousands):
<TABLE>
<CAPTION>
SUBSEQUENT
PRIOR TO TO
YEAR ENDED DECEMBER 31, OCTOBER 18, OCTOBER 17, TOTAL
1996 1995 1994 1994 1994
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Tax at federal statutory rates $ 8,164 $ 4,876 $ 893 $ 720 $ 1,613
Income of entities not subject to tax -- -- (1,606) -- (1,606)
Other, primarily state income taxes 1,044 306 28 74 102
Provision due to change in tax status
Predecessor Entities in connection
with Combination Transaction -- -- -- 2,606 2,606
------- ------- ------- ------- -------
Total $ 9,208 $ 5,182 $ (685) $ 3,400 $ 2,715
======= ======= ======= ======= =======
</TABLE>
A-20
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. BENEFIT PLANS
The Company has reserved 3,400,000 of the authorized shares of common stock for
issuance pursuant to options granted and restricted stock awarded under the
Orthodontic Centers of America, Inc. 1994 Incentive Stock Plan (the "Incentive
Option Plan"). Options may be granted to officers, directors and employees of
the Company, for terms not longer than 10 years at prices not less than fair
market value of the common stock on the date of grant. Granted options generally
become exercisable in four equal annual installments beginning two years after
the grant date, and expire 10 years after the grant date.
The Company has reserved 600,000 of the authorized shares of common
stock for issuance pursuant to options granted and restricted stock awarded
under the Orthodontic Centers of America, Inc. Non-Qualified Stock Option Plan
for Non-Employee Directors (the "Director Option Plan"). The Director Option
Plan provides for the grant of options to purchase 2,400 shares of common stock
on the first trading date each year to each non-employee director serving the
Company on such date, at prices equal to the fair market value of the common
stock on the date of grant. Granted options generally become exercisable in four
equal annual installments beginning two years after the grant date, and expire
10 years after the grant date, unless canceled sooner due to termination of
service or death.
A-21
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. BENEFIT PLANS (CONTINUED)
The Company has reserved 2,000,000 of the authorized shares of common stock for
issuance pursuant to options granted under the Orthodontic Centers of America,
Inc. 1995 Restricted Stock Plan (the "Orthodontist Plan"). Options may be
granted to orthodontists who own an orthodontic entity which has a service,
management or consulting agreement with the Company, at prices not less than
100% of the fair market value of the common stock on the date of grant. Granted
options generally become exercisable in four equal annual installments beginning
two years after grant date, and expire 10 years after the grant date.
The Company has reserved 200,000 of the authorized shares of common stock for
issuance under the 1996 Employee Stock Purchase Plan (the "Employee Purchase
Plan"), which allows participating employees of the Company to purchase shares
of common stock from the Company through a regular payroll deduction of up to
10% of their respective normal monthly pay. Deducted amounts are accumulated for
each participating employee and used to purchase the maximum number of whole
shares of Common Stock at a price per share equal to 85% of the closing price of
the Common Stock, as reported on the Nasdaq National Market, on the applicable
purchase date or the first trading date of year, whichever is lower.
Additionally, the Company has reserved 2,000,000 shares of common stock for
issuance to affiliated orthodontists through a stock purchase program that
allows participating affiliated orthodontists to acquire shares of common stock
from the Company. At December 31, 1996, no shares have been issued under either
of these stock purchase plans.
FASB Statement No. 123, Accounting for Stock-Based Compensation, requires the
Company to disclose pro forma information regarding net income and earnings per
share as if the Company had accounted for its employee stock options under the
fair value method. The fair value was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1996 and 1995, respectively: risk-free interest rates of 6.3%
and 7.1%; a dividend yield of 0% for both years, volatility factors of the
expected market price of the Company's common stock of .45 and .612, and a
weighted-average expected life of the option of 6.7 and 6.9 years.
A-22
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. BENEFIT PLANS (CONTINUED)
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Had the Company's stock based compensation plan been determined based on the
fair value at the grant dates, the Company's net income and earnings per share
would not have been materially different from the amounts reported in the
consolidated statement of income.
A-23
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. BENEFIT PLANS (CONTINUED)
A summary of the Company's stock option activity, and related information for
the plans described above for the years ended December 31 follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding-beginning of 1,858,496 $ 2.75 938,628 $ 2.75 -- $ --
year
Granted 237,095 12.83 952,476 3.55 938,628 2.75
Exercised (390,868) 2.95 -- -- --
Forfeited (42,970) 3.24 (32,608) 2.75 --
---------- --------- -------
Outstanding-end of year 1,661,753 $ 3.65 1,858,496 $ 3.24 938,628 $ 2.75
========== ========= =======
Exercisable at end of
year 6,592 $ 2.75 -- --
========== ========= =======
Weighted-average fair
value of options
granted during the
year $ 8.58 $ 2.40
========== =========
</TABLE>
Of the options outstanding at December 31, 1996, approximately 1,500,000 were
issued near the Company's initial public offering (see note 7) and have exercise
prices which range from $2.75 to $3.25, a weighted-average exercise price of
$3.06 and a weighted average remaining contractual life of 8 years. The
remaining options outstanding at December 31, 1996 have exercise prices which
range from $4.25 to $20.19, a weighted average exercise price of $9.85 and a
weighted average remaining contractual life of 8.8 years.
A-24
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. BENEFIT PLANS (CONTINUED)
The Company sponsors a 401(k) Plan for all employees who have satisfied minimum
service and age requirements. Employees may contribute up to 15% of their
earnings to the plan. The Company matches 40% of an employee's contribution to
the plan, up to a maximum of $600 per year. Plan expense totaled $49,000,
$36,000 and $24,000 for the years ended December 31, 1996, 1995 and 1994,
respectively.
11. ACQUISITION OF MANAGEMENT CONTRACTS
In 1996, the Company finalized agreements with 40 orthodontic entities to obtain
management agreements and acquire other assets for approximately $32.4 million.
These orthodontic entities operate 54 centers (net of consolidations). The
consideration to these orthodontic entities included approximately $120,000 in
notes payable, and the issuance of 1,718,000 shares of the Company's common
stock at an average price of approximately $12.09 per share, with the remainder
paid in cash.
In 1995, the Company finalized agreements with 10 orthodontic entities to obtain
management agreements and acquire other assets for approximately $5,900,000.
These orthodontic entities operate 29 centers. The consideration to these
orthodontic entities included approximately $752,000 in notes payable, and the
issuance of 460,000 shares of the Company's common stock at an average price of
approximately $2.81 per share, with the remainder paid in cash.
12. CONTINGENCIES
In the normal course of business, the Company becomes a defendant or plaintiff
in various lawsuits. Although a successful claim for which the Company is not
fully insured could have a material effect on the Company's financial condition,
management is of the opinion that it maintains insurance at levels sufficient to
insure itself against the normal risk of operations.
A-25
<PAGE>
ORTHODONTIC CENTERS OF AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the unaudited quarterly results of operations
for the year ended December 31, 1996 and 1995 (in thousands, except per share
data):
QUARTER ENDED
-----------------------------------------
MARCH JUNE SEPTEMBER DECEMBER
1996 1996 1996 1996
-----------------------------------------
Net revenue $13,719 $15,517 $18,881 $23,156
Operating profit 3,914 4,592 6,185 6,984
Net income 2,734 3,111 4,075 4,482
Net income per share:
Assuming no dilution $ .07 $ .08 $ .10 $ .10
Assuming full dilution .07 .07 .09 .10
QUARTER ENDED
-----------------------------------------
MARCH JUNE SEPTEMBER DECEMBER
1995 1995 1995 1995
-----------------------------------------
Net revenue $ 8,465 $ 9,236 $11,490 $12,365
Operating profit 2,718 2,577 3,318 3,609
Net income 1,790 1,743 2,534 2,968
Net income per share:
Assuming no dilution $ .05 $ .05 $ .06 $ .08
Assuming full dilution .05 .05 .06 .07
A-26
<PAGE>
EXHIBIT INDEX
EXHIBIT PAGE
NUMBER DESCRIPTION OF EXHIBITS NUMBER
------ ----------------------- ------
3.1 Bylaws of the Registrant (1)
3.2 Restated Certificate of Incorporation of the Registrant (1)
4.1 Specimen Stock Certificate (1)
9.1 Voting Trust Agreement, dated as of October 18, 1994,
between John R. Anderson, D.D.S., P.A., Neal A. Stubbs,
D.D.S., P.A., and Gasper Lazzara, Jr., D.D.S. (1)
10.1 Form of Service Agreement (confidential treatment granted as
to a portion of the agreement) (1)
10.2 Form of Management Agreement (confidential treatment
granted as to a portion of the agreement) (1)
10.3 Form of Consulting Agreement (1)
10.4 Employment Agreement between the Registrant and Gasper
Lazzara, Jr., D.D.S. (1)
10.5 Employment Agreement between the Registrant and Bartholomew
F. Palmisano, Sr. (1)
10.6 Orthodontic Centers of America, Inc. 1994 Incentive Stock Plan (1)
10.7 Orthodontic Centers of America, Inc. 1994 Non-Qualified Stock
Option Plan for Non-Employee Directors (1)
10.8 First Union National Bank Defined Contribution Master Plan and
Trust Agreement, and Adoption Agreement relating thereto, between
the Registrant and First Union National Bank (1)
10.9 Settlement and Purchase Agreement, dated as of October 10, 1994,
between John R. Anderson, D.D.S., P.A. and Neal A. Stubbs, D.D.S.,
P.A., and Gasper Lazzara, Jr., D.D.S., P.A., Gasper Lazzara, Jr.,
D.D.S., Bartholomew F. Palmisano, Sr., Palmisano & Associates, A
Corporation of Certified Public Accountants, Orthodontic Centers of
America, Inc., a Florida corporation, Orthodontic Centers of
America, Inc., a Louisiana corporation, and the Registrant (1)
10.10 Non-Assignable Promissory Note, dated October 18, 1994, by the
Registrant in favor of John R. Anderson, D.D.S., P.A. (1)
10.11 Non-Assignable Promissory Note, dated October 18, 1994, by the
Registrant in favor of Neal A. Stubbs, D.D.S., P.A. (1)
10.12 Security Agreement, dated October 18, 1994, between John R.
Anderson, D.D.S., P.A. and Neal A. Stubbs, D.D.S., P.A. (1)
10.13 Stock Escrow and Pledge Agreement, dated October 18, 1994, between
Gasper Lazzara, Jr., D.D.S. and Bartholomew F. Palmisano, Sr., and
John R. Anderson, D.D.S., P.A., and Neal A. Stubbs, D.D.S., P.A.
(1)
10.14 Stock Escrow and Pledge Agreement, dated October 18, 1994, between
John R. Anderson, D.D.S., John R. Anderson, D.D.S., P.A., Neal A.
Stubbs, D.D.S., Neal A. Stubbs, D.D.S., P.A. and Gasper Lazzara,
Jr., D.D.S., the Registrant and the Escrow Agent (1)
10.15 Revolving Credit and Security Agreement, dated October 18, 1994,
between the Registrant and First Union National Bank of Florida (1)
10.16 Letter of Credit issued to the Registrant by First Union National
Bank of Florida with John R. Anderson, D.D.S., P.A., as beneficiary
(1)
10.17 Letter of Credit issued to the Registrant by First Union National
Bank
<PAGE>
of Florida with Neal A. Stubbs, D.D.S., P.A., as beneficiary (1)
10.18 Form of Exchange Agreement (1)
10.19 Form of Dissolution Agreement (1)
10.20 Form of Redemption Agreement (1)
10.21 Agreement, dated as of October 18, 1994, between the Registrant
and Dr. Gasper Lazzara, Jr. and Bartholomew F. Palmisano, Sr. (1)
10.22 Exchange Agreement, dated as of October 18, 1994, between each
of the partners of Anderson, Lazzara, and Stubbs Partnership and
the Registrant (1)
10.23 Orthodontic Centers of America, Inc. 1995 Restricted Stock Option
Plan (2)
10.24 Orthodontic Centers of America, Inc. 1996 Employee Stock Purchase
Plan (3)
10.25 Employment Agreement between the Registrant and Geoffrey L. Faux
(filed herewith)
21.1 List of subsidiaries of the Registrant (filed herewith)
23.1 Consent of Ernst & Young LLP (filed herewith)
27.1 Financial Data Schedule (filed herewith)
_______________
(1) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-1, Registration Statement
No. 33-85326.
(2) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1994.
(3) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1995.
<PAGE>
EXHIBIT 10.25
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT ("Agreement"), dated as of August 1, 1996,
between ORTHODONTIC CENTERS OF AMERICA, INC., a Delaware corporation (the
"Company"), and GEOFFREY L. FAUX, a resident of the State of Georgia
("Executive").
W I T N E S S E T H:
-------------------
WHEREAS, the Company and its subsidiaries are engaged in providing
management services to orthodontic practices throughout the United States;
WHEREAS, the Company desires to avail itself of Executive's talents and
expertise, and to employ him as Executive Vice President and Chief
Administrative Officer of the Company and certain of its subsidiaries, and
Executive is willing to accept such employment, all on the terms and conditions
set forth herein;
NOW, THEREFORE, in consideration of the premises, and other mutual
promises and covenants hereinafter contained, the Company and Executive do
hereby agree, for their mutual benefit, as follows:
SECTION 1. EMPLOYMENT.
----------
Executive shall be employed by the Company under this Agreement, effective
as of September 1, 1996, and Executive accepts such employment upon the terms
and conditions hereinafter set forth.
SECTION 2. TERM.
----
The term of employment provided for in this Agreement shall commence on
September 1, 1996, and shall remain in full force and effect for a period of
three (3) years thereafter; provided, however, that such term shall be
automatically extended for an additional two (2) year period unless, no later
than six (6) months prior to the expiration of the initial three (3) year
period, either party hereto shall provide written notice of its or his desire to
not extend the term hereof to the other party hereto.
SECTION 3. POSITIONS, POWERS AND DUTIES.
----------------------------
Executive shall be employed by the Company during the term of his
employment under this Agreement to serve as Executive Vice President and Chief
Administrative Officer of the Company, with such other positions and titles as
may be assigned to him from time to time by the Chairman of the Board and Chief
Executive Officer and the Board of Directors (the "Board of Directors") of the
Company. Executive shall report directly to the Chairman of the Board and Chief
Executive Officer of the Company and the Board of Directors. In addition, the
<PAGE>
Company shall use its reasonable best efforts to cause Executive to be nominated
and elected as a Director of the Company within a year following the date
hereof.
In carrying out his duties under this Agreement, Executive shall have such
powers, responsibilities and duties usually incident to an Executive Vice
President and Chief Administrative Officer, together with such other powers,
responsibilities and duties, commensurate with Executive's position as an
Executive Vice President and Chief Administrative Officer, which may be assigned
to him from time to time by the Chairman of the Board and Chief Executive
Officer of the Company and/or the Board of Directors. Executive's initial
responsibilities and duties shall include general responsibility for
orthodontist recruiting, marketing and investor relations for the Company and
its subsidiaries. The performance by Executive of any duties assigned to him
which are not of the type provided for herein shall not constitute a waiver of
his rights hereunder or an abrogation, abandonment or termination of this
Agreement.
Executive shall devote all of his working time and best efforts in the
best interest of and on behalf of the Company throughout the term of this
Agreement in a manner appropriate for an executive having Executive's position,
duties, responsibilities and status. Executive shall not be restricted from
engaging in a business which is noncompetitive with the Company and its
subsidiaries and affiliates after normal working hours or on weekends or from
investing his assets in such form or manner as will not require any services on
his part in the operation of the affairs of the companies in which such
investments are made.
SECTION 4. PLACE OF PERFORMANCE.
--------------------
The headquarters for the performance of Executive's duties shall be
located in Ponte Vedra Beach, Florida, but from time to time Executive shall be
required to travel to the Company's other locations in the proper conduct of his
responsibilities under this Agreement. Due to the national scope of the
Company's business, the Company may require Executive to spend a reasonable
amount of time traveling, as his duties and the business of the Company and its
subsidiaries and affiliates may require.
SECTION 5. COMPENSATION.
------------
For all services rendered by Executive pursuant to this Agreement, the
Company shall pay Executive the following compensation:
(a) A base salary at the annual rate of $200,000 for the period September
1, 1996 through September 1, 1997, such salary to be paid in accordance with the
regular payroll practices of the Company, as such may exist from time to time.
Such salary shall be reviewed annually by the Chairman of the Board and Chief
Executive Officer and the Compensation Committee (the "Compensation Committee")
of the Board of Directors.
(b) (i) In addition to the above base salary, for each fiscal year or
portion thereof (on a pro-rata basis) during the term hereof,
Executive shall be paid a target
2
<PAGE>
incentive bonus (the "Base Bonus") in the amount of forty percent
(40%) of Executive's base salary per annum during such year, which
Base Bonus shall be payable only if the Company meets or exceeds the
annual performance standard (the "Annual Performance Standard")
established from time to time by the Compensation Committee.
(ii) In the event, however, that during such year or portion
thereof (on a pro-rata basis) the Company exceeds the Annual
Performance Standard by (i) fifteen percent (15%) or more, Executive
shall, in lieu of the Base Bonus, be paid a target incentive bonus in
the amount of sixty percent (60%) of Executive's base salary per
annum during such year, or (ii) twenty-two and one-half percent
(22.5%) or more, Executive shall, in lieu of the Base Bonus, be paid
a target incentive bonus in the amount of eighty percent (80%) of
Executive's base salary per annum during such year (each, a "Premium
Bonus").
(iii) The Annual Performance Standard will be established for each
fiscal year during the term of this Agreement by the Compensation
Committee. The Annual Performance Standard may be changed prior to
the beginning of any fiscal year (or portion thereof) during the term
of this Agreement, and the Compensation Committee may, in its
discretion, so change the Annual Standard for the purposes of this
paragraph. The Compensation Committee or the Company shall give
notice to Executive of any such change in the Annual Performance
Standard.
(iv) The Base Bonus or Premium Bonus, as applicable, shall be paid
on an annual basis and shall be payable within ten (10) days
following the date on which the Compensation Committee determines the
amount of the Base Bonus or the Premium Bonus, as applicable.
(c) (i) In addition to the above cash compensation, on October 25,
1996, September 1, 1997 and September 1, 1998, Executive shall be
granted incentive stock options under the Company's 1994 Stock
Incentive Plan (the "Option Plan") to purchase 50,000, 15,000 and
20,000 shares, respectively, of Common Stock, $.01 par value per
share (the "Common Stock"), of the Company, and, if the term of this
Agreement shall be extended pursuant to Section 2 hereof, on
September 1, 1999 and September 1, 2000, Executive shall be granted
incentive stock options under the Option Plan to purchase 25,000 and
30,000 shares, respectively, of Common Stock.
(ii) Further, if, during any two-year cycle during the term hereof
(beginning with the two-year cycle during fiscal years 1997 and
1998), the Company exceeds by at least 15%, 20% or 25% the
performance standard for long-term performance (the "Long-Term
Performance Standard") established by the Compensation Committee for
such two-year cycle, Executive shall receive additional grants of
incentive stock options under the Option Plan to purchase
3
<PAGE>
10,000, 17,500 or 25,000 shares of Common Stock, respectively. For
purposes of this Agreement the Long-Term Performance Standard will be
determined, initially, based upon the expected number of openings of
new orthodontic centers, affiliations with orthodontists, revenues
and/or earnings per share of the Company. If, during the term of
this Agreement, the Compensation Committee shall determine that the
Long-Term Performance Standard shall be changed to a different
performance measure, i.e., total shareholder return, relative
shareholder value, stock price appreciation or other criteria, the
Long-Term Performance Standard may be changed, with prior
notification and discussion with Executive.
(c) Executive shall be entitled to participate in any other bonus plan or
long-term incentive plan approved by the Board of Directors for the Company's
management and shall be eligible for other discretionary bonuses approved by the
Board of Directors.
(d) For purposes of administration, the terms of this Agreement shall be
given effect on a pro-rata basis for partial fiscal years and otherwise
administered on a fiscal year basis.
(e) Options granted to Executive hereunder shall vest in a manner
consistent with the vesting schedule of options granted under the Option Plan to
other members of senior management of the Company, and the number thereof shall
be adjusted proportionally to reflect any stock split or stock dividend of the
Common Stock following the date hereof.
SECTION 6. EMPLOYEE BENEFITS.
-----------------
Subject to eligibility requirements, Executive will be entitled to
participate during the term hereof in any employee retirement, benefit or
welfare plans provided by the Company to its employees and/or to its senior
executives, such as life insurance, health and dental, retirement, savings and
disability plans which the Company has in effect or may adopt from time to time.
Without limiting the generality of the foregoing, the Company shall provide
Executive the following during the term of this Agreement:
(a) a reasonable paid vacation during each year of this Agreement of up to
three (3) weeks per annum;
(b) mileage reimbursement for use of Executive's personal vehicle in
connection with the performance of Executive's duties hereunder, in accordance
with the Company's expense reimbursement policy;
(c) a one-time "signing" bonus of $15,000, to be paid in cash within
thirty (30) days following the date hereof; and
(d) consideration, at least annually, by the Compensation Committee for
the grant to Executive of options to purchase Common Stock subsequent to the
grants outlined in Section 5(c) hereof.
4
<PAGE>
SECTION 7. EXPENSES.
--------
Executive is authorized to incur reasonable expenses in promoting the
business of the Company and its subsidiaries, including expenses, to the extent
used for business purposes, for entertainment, travel and similar items. The
Company will reimburse Executive for all such expenses, upon the presentation by
him of an itemized account of such expenditures in accordance with the Company's
expense reimbursement procedures.
SECTION 8. DEFINITIONS.
-----------
As used in this Agreement, the following terms shall have the meanings set
forth below:
(a) "CAUSE" shall mean (i) violations by Executive of Executive's
obligations under this Agreement (other than as a result of incapacity due to
physical or mental illness) which violation (A) is willful and deliberate on
Executive's part, or committed in bad faith or without reasonable belief that
such violation is in the best interests of the Company, and (B) are not remedied
within thirty (30 days) after receipt of written notice from the Company
specifying such violations, (ii) the conviction of Executive of a felony or
other crime involving moral turpitude, or (iii) willful dishonesty towards,
fraud or embezzlement upon or deliberate injury or attempted injury to the
Company by Executive.
(b) "CHANGE IN CONTROL" shall mean:
(i) The acquisition by any individual, entity or group (within the
meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange
Act of 1934, as amended (the "Exchange Act") (a "Person"), of
beneficial ownership (within the meaning of Rule 13d-3 promulgated
under the Exchange Act) of 20% or more of either (A) the then
outstanding shares of Common Stock (the "Outstanding Company Common
Stock") or (B) the combined voting power of the then outstanding
voting securities of the Company entitled to vote generally in the
election of directors ("the Outstanding Company Voting Securities");
provided, however, that for purposes of this subsection (i), the
following acquisitions shall not constitute a Change of Control: (1)
any acquisition directly from the Company, (2) any acquisition by the
Company, (3) any acquisition by any employee benefit plan (or related
trust) sponsored or maintained by the Company or any Person
controlled by the Company or (4) any acquisition by any Person
pursuant to a transaction which complies with clauses (1), (2) and
(3) of subsection (iii) below;
(ii) Individuals who, as of the date of this Agreement, constitute
the Board of Directors (the "Incumbent Board") cease for any reason
to constitute at least a majority of the Board of Directors;
provided, however, that any individual becoming a director subsequent
to the date hereof whose election, or nomination for election by the
Company's stockholders, was approved by a vote of at least
5
<PAGE>
a majority of the directors then comprising the Incumbent Board shall
be considered as though such individual were a member of the
Incumbent Board, but excluding, for this purpose, any such individual
whose initial assumption of office occurs as a result of an actual or
threatened election contest with respect to the election or removal
of directors or other actual or threatened solicitation of proxies or
consents by or on behalf of a Person other than the Board of
Directors;
(iii) Consummation of a reorganization, merger or consolidation or
sale or other disposition of all or substantially all of the assets
of the Company (a "Business Combination"), in each case, unless,
following such Business Combination, (1) all or substantially all of
the individuals and entities who were the beneficial owners,
respectively, of the Outstanding Company Common Stock and Outstanding
Company Voting Securities immediately prior to such Business
Combination beneficially own, directly or indirectly, more than 50%
of, respectively, the then outstanding shares of common stock and the
combined voting power of the then outstanding voting securities
entitled to vote generally in the election of directors, as the case
may be, of the corporation resulting from such Business Combination
(including, without limitation, a corporation which as a result of
such transaction owns the Company or all or substantially all of the
Company's assets either directly or through one or more subsidiaries)
in substantially the same proportions as their ownership, immediately
prior to such Business Combination of the Outstanding Company Common
Stock and Outstanding Company Voting Securities, as the case may be,
(2) no party (excluding any corporation resulting from such Business
Combination or any employee benefit plan (or related trust) of the
Company or such corporation resulting from such Business Combination)
beneficially owns, directly or indirectly, twenty percent (20%) or
more of, respectively, the then outstanding shares of common stock of
the corporation resulting from such Business Combination or the
combined voting power of the then outstanding voting securities of
such corporation except to the extent that such ownership existed
prior to the Business Combination and (3) at least a majority of the
members of the board of directors of the corporation resulting from
such Business Combination were members of the Board of Directors of
the Company at the time of the execution of the initial agreement, or
of the action of the Board of Directors, providing for such Business
Combination; or
(iv) Approval by the stockholders of the Company of a complete
liquidation or dissolution of the Company.
(c) "CODE" shall mean the Internal Revenue Code of 1986 and all
regulations promulgated thereunder, as the same may be amended from time to
time.
(d) "DISABILITY" shall be deemed to have occurred if Executive makes
application for or is otherwise eligible for disability benefits under any
Company sponsored long-term
6
<PAGE>
disability program covering Executive, and Executive qualifies for such
benefits. In the absence of a Company-sponsored long-term disability program
covering Executive, Executive shall be presumed totally and permanently disabled
if so determined by the Board of Directors following reasonable review of a
medical opinion certifying that Executive will be unable to perform his duties
under this Agreement for at least one hundred twenty (120) substantially
consecutive days due to a physical or mental condition.
(e) "GOOD REASON" shall mean:
(i) The assignment to Executive, without Executive's prior written
consent, of any duties inconsistent with Executive's position,
duties, responsibilities and status with the Company as described in
this Agreement or an adverse change in Executive's titles or offices
or any removal of Executive from any of such positions, except in
connection with the termination of this Agreement under Sections
9(c), 9(d) or 9(e);
(ii) A reduction in Executive's base salary, as the same may be
increased from time to time;
(iii) A termination by the Company of any compensation, retirement,
benefit or welfare plan in which Executive is participating, without
substituting plans providing Executive with substantially similar
benefits, or the taking of any action by the Company which would
adversely affect Executive's participation in or materially reduce
Executive's benefits under any of such plans or deprive Executive of
any material fringe benefit enjoyed by Executive;
(iv) Any purported termination for Cause or Disability without
reasonable grounds therefor; or
(v) The relocation of Executive's primary work location to a location
that is more than thirty (30) miles from Executive's primary work
location without Executive's prior consent.
(f) "RETIREMENT DATE" shall mean the date Executive reaches age 70 1/2,
or the date Executive retires in accordance with the Company's retirement
arrangements established for Executive with Executive's consent.
SECTION 9. TERMINATION.
-----------
This Agreement shall terminate upon the occurrence of any of the following
termination events:
(a) Executive gives notice to the Company prior to the occurrence of a
Change in Control that Executive wishes to terminate this Agreement for any
reason other than Good
7
<PAGE>
Reason not less than one hundred eighty (180) days after such notice is given,
such termination to be effective on the date specified in such notice;
(b) Executive gives notice to the Company prior to the occurrence of a
Change in Control that Executive wishes to terminate this Agreement for Good
Reason not less than ninety (90) days after such notice is given, such
termination to be effective on the date specified in such notice;
(c) the Company gives notice to Executive that the Company wishes to
terminate this Agreement for Cause, such termination to be effective upon
receipt by Executive of such notice;
(d) Executive dies or Executive ceases to be able to perform his duties
hereunder due to death or a Disability, such termination to be effective
immediately upon such death or Disability;
(e) Executive reaches his Retirement Date, such termination to be
effective upon such Retirement Date;
(f) the Company gives notice to Executive that the Company wishes to
terminate this Agreement for any reason other than for Cause, such termination
to be effective upon receipt by Executive of such notice;
(g) the Company gives notice to Executive following the occurrence of a
Change in Control that the Company wishes to terminate this Agreement for any
reason other than for Cause or due to Executive's death, Disability or
Retirement Date, such termination to be effective upon receipt by Executive of
such notice; or
(h) Executive gives notice to the Company following the occurrence of a
Change in Control that Executive wishes to terminate this Agreement for Good
Reason, such termination to be effective upon receipt by the Company of such
notice.
SECTION 10. TERMINATION BENEFITS.
--------------------
(a) Upon the occurrence of an event of termination described in Section
9(a) or 9(c), Executive shall be entitled to receive the following as severance
compensation:
(i) payment of any previously unpaid base salary and earned annual
incentive through the date of termination;
(ii) payment of all vested deferred compensation; and
(iii) payment of any life insurance, disability or other benefits,
if any, for which Executive is then eligible under the terms of the
Company' employee retirement, benefit and welfare plans.
8
<PAGE>
(b) Upon the occurrence of an event of termination described in Section
9(d) or 9(e), Executive (or Executive's estate in the event of Executive's
death) shall be entitled to receive the following as severance compensation:
(i) payment of any previously unpaid base salary and earned annual
incentive through the date of termination or disability;
(ii) payment of all vested deferred compensation; and
(iii) continuation of any life insurance, disability or other
benefits, if any, for which Executive is then eligible under the
terms of the Company' employee retirement, benefit and welfare plans
for the remainder of the employment agreement term.
(c) Upon the occurrence of an event of termination described in Sections
9(b) or 9(f), Executive shall be entitled to receive the following as severance
compensation:
(i) payment of any previously unpaid base salary through the date of
termination;
(ii) continued payment of Executive's annual base salary at the time
of termination for the remaining term of this Agreement, but in no
event for a period of less than three (3) years; provided, however,
that if Executive accepts other employment or is engaged in his own
business during such period, the severance compensation payable to
Executive during such period will be reduced by the amount of
compensation that the Employee is receiving in respect of such other
employment or business.
(iii) payment of all vested deferred compensation;
(iv) payment of an amount equal to two (2) times Executive's average
annual incentive bonus during the preceding two (2) years;
(v) payment of any life insurance, disability or other benefits, if
any, for which Executive is then eligible under the terms of the
Company' employee retirement, benefit and welfare plans;
(vi) subject to the terms and eligibility requirements of any such
plan, continued coverage during the remainder of the term hereof
following the date of termination under any employee retirement,
benefit and welfare plans of the Company for which Executive is then
eligible; provided that, (A) if Executive's participation in any such
plan is not permitted under the terms thereof, the Company will use
reasonable best efforts to provide or arrange comparable coverage for
Executive, (B) the Company's obligation under this paragraph (vi)
will terminate with respect to any plan on the date Executive first
becomes
9
<PAGE>
eligible for the same type of coverage under another employer's plan,
and (C) to the extent applicable, upon termination of coverage under
any plan pursuant to this paragraph (vi), Executive shall have the
option to have assigned to him at no cost and with no apportionment
for prepaid premiums, any assignable insurance policy owned by the
Company and relating specifically to Executive;
(vii) a right to immediately vest in one hundred percent (100%) of
all options to purchase Common Stock that have been granted to
Executive by the Company and a period of at least ninety (90) days
following termination for Executive to exercise all such options in
accordance with the terms thereof; and
(viii) payment of the reasonable costs for outplacement services, in
an amount of up to $5,000, during the lesser of the period (A) until
Executive becomes employed on a full-time basis, or (B) six (6)
months following the date of termination of this Agreement.
(d) Upon the occurrence of an event of termination described in Section
9(g) or 9(h), Executive shall be entitled to receive the following as
severance compensation:
(i) payment of any previously unpaid base salary through the date of
termination;
(ii) continued payment of Executive's annual base salary at the time
of termination for the remaining term of this Agreement, but in no
event for a period of less than three (3) years;
(iii) payment of all vested deferred compensation;
(iv) payment of an amount equal to two (2) time Executive's average
annual incentive bonus during the preceding two (2) years; and
(v) subject to the terms and eligibility requirements of any such
plan, continued coverage during the remainder of the term hereof
following the date of termination under any employee retirement,
benefit and welfare plans of the Company for which Executive is then
eligible; provided that, (A) if Executive's participation in any such
plan is not permitted under the terms thereof, the Company will use
reasonable best efforts to provide or arrange comparable coverage for
Executive, (B) the Company's obligation under this paragraph (v) will
terminate with respect to any plan on the date Executive first
becomes eligible for the same type of coverage under another
employer's plan, and (C) to the extent applicable, upon termination
of coverage under any plan pursuant to this paragraph (v), Executive
shall have the option to have assigned to him at no cost and with no
apportionment for prepaid premiums, any assignable insurance policy
owned by the Company and relating specifically to Executive;
10
<PAGE>
(vi) a right to immediately vest in one hundred percent (100%) of
all options to purchase Common Stock that have been granted to
Executive by the Company and a period of at least ninety (90) days
following termination for Executive to exercise all such options in
accordance with the terms thereof; and
(vii) payment of the reasonable costs for outplacement services, in
an amount of up to $5,000, during the lesser of the period (A) until
Executive becomes employed on a full-time basis, or (B) six (6)
months following the date of termination of this Agreement.
(e) At the Executive's election, he may receive a lump sum amount equal to
the present value of such severance payments described above which may not be
greater than three (3) times the Executive's base salary. The present value will
be determined using a discount rate equal to the ninety (90) day treasury bill
interest rate in effect on the date of delivery of such notice. Notwithstanding
the foregoing, the Company is not required to pay the Executive any amount which
is not deductible for federal income purposes.
SECTION 11. NON-COMPETITION AND CONFIDENTIALITY.
-----------------------------------
(a) During the term of this Agreement and for a period of two (2) years
thereafter, Executive shall not, directly or indirectly, own, operate, be
employed by, be a director of, act as a consultant for, be associated with, or
be a partner or have a proprietary interest in, any enterprise, partnership,
association, corporation, joint venture or other entity, which is competitive
with the orthodontic practice management services business of the Company, or
any subsidiary or affiliate thereof, and Executive shall not solicit any
customer of client of the Company or solicit the services of individuals in the
Company's employ.
(b) Executive, except in connection with his employment hereunder, shall
not disclose to any person or entity or use, either during the term of this
Agreement or at any time thereafter, any information not in the public domain or
generally known in the industry, in any form, acquired by Executive while
employed by the Company or any predecessor to the Company's business, and
relating to the Company, its subsidiaries or affiliates, including but not
limited to information regarding customers, vendors, suppliers, trade secrets,
training programs, manuals or materials, technical information, contracts,
systems, procedures, mailing lists, know-how, trade names, improvements, price
lists, financial or other data (including the revenues, costs or profits
associated with any of the Company's services), business plans, code books,
invoices and other financial statements, computer programs, software systems,
databases, discs and printouts, plans (business, technical or otherwise),
customer and industry lists, correspondence, internal reports, personnel files,
sales and advertising material, telephone numbers, names, addresses or any other
compilation of information, written or unwritten, which is or was used in the
business of the Company or any subsidiaries or affiliates thereof. Executive
agrees and acknowledges that all of such information, in any form, and copies
and extracts thereof, are and shall remain the sole and exclusive property of
the Company, and upon termination of his employment with the Company, Executive
shall return to the Company the originals and all copies of any such information
provided to or acquired by Executive in
11
<PAGE>
connection with the performance of his duties for the Company, and shall return
to the Company all files, correspondence and/or other communications received,
maintained and/or originated by Executive during the course of his employment.
(c) The parties have entered into this Section 11 of this Agreement in
good faith and for the reasons set forth in the recitals hereto and assume that
this Agreement is legally binding. If for any reason, this Section 11 is not
binding because of its geographical scope or because of its term, then the
parties agreed that this Agreement shall be deemed effective to the widest
geographical area and/or the longest period of time as may be legally
enforceable.
(d) Executive acknowledges that the rights and privileges granted to the
Company in this Section 11 are of special and unique character, which gives them
a peculiar value, the loss of which may not be reasonably or adequately
compensated for by damages in an action of law, and that a breach thereof by
Executive of this Section 11 will cause the Company great and irreparable injury
and damage. Accordingly, Executive hereby agrees that the Company shall be
entitled to remedies of injunction, specific performance or other equitable
relief to prevent a breach of this Section 12 of this Agreement by Executive.
This provision shall not be construed as a waiver of any other rights or
remedies the Company may have for damages or otherwise.
SECTION 12. NON-ASSIGNABILITY.
-----------------
Executive shall not have the right to assign, transfer, pledge,
hypothecate or dispose of any right to receive payments hereunder or any rights,
privileges or interest hereunder, all of which are hereby expressly declared to
be non-assignable and non-transferable, except after termination of his
employment hereunder. In the event of a violation of the provisions of this
Section 12, no further sums shall hereafter become due or payable by the Company
or its subsidiaries and affiliates to Executive or his assignee, transferee,
pledgee or to any other person whatsoever, and the Company shall have no further
liability under this Agreement to Executive.
SECTION 13. CLAIMS; MEDIATION.
-----------------
(a) All claims by Executive for compensation and benefits under this
Agreement shall be directed to and determined by the Compensation Committee and
shall be in writing. Any denial by the Compensation Committee or the Board of
Directors of a claim for benefits under this Agreement shall be delivered to
Executive in writing and shall set forth the specific reasons for the denial and
specific provisions of this Agreement relied upon. The Board of Directors shall
afford a reasonable opportunity to Executive for a review of a decision denying
a claim and shall further allow Executive to appeal to the Board of Directors a
decision of the Compensation Committee or the Board of Directors within sixty
(60) days after notification by the Compensation Committee or the Board of
Directors, as applicable, that Executive's claim has been denied.
(b) In the event that the parties hereto fail to resolve any dispute or
controversy arising under or in connection with this Agreement within ninety
(90) following the date on
12
<PAGE>
which such dispute or controversy arose, upon written demand by either party
hereto to the other party hereto, such dispute or controversy shall be promptly
submitted to non-binding mediation by a mediator mutually agreeable to both
parties. Each party shall bear their respective expenses incurred in connection
with such mediation and shall evenly divide the fees and expenses of such
mediator.
SECTION 14. EMPLOYMENT TAXES.
----------------
All compensation paid pursuant to this Agreement, including compensation
paid pursuant to Section 5 and Section 10 of this Agreement, shall be subject to
reduction by all applicable withholding, social security and other federal,
state and local taxes and deductions.
SECTION 15. BINDING EFFECT.
--------------
The rights and obligations of the Company and its subsidiaries under this
Agreement shall inure to the benefit of and shall be binding upon the successors
and assigns of the Company. Executive shall not assign or alienate any interest
of his in this Agreement.
SECTION 16. WAIVER OF BREACH.
----------------
The waiver by either party to this Agreement of a breach of any provision
thereof by the other party shall not operate or be construed as a waiver of any
subsequent breach of such party.
SECTION 17. NOTICES.
-------
Any notice required or permitted to be given under this Agreement shall be
sufficient if in writing and if delivered by hand or by certified or registered
mail or by a nationally recognized overnight delivery service, postage or other
charges pre-paid, and addressed to: Geoffrey L. Faux, 840 Marseilles Drive,
Atlanta, Georgia 30327 (if such notice is addressed to Executive), or to
Orthodontic Centers of America, Inc., 13000 Sawgrass Village Circle, Suite 41,
Ponte Vedra Beach, Florida 32082, Attention: Chief Executive Officer (if such
notice is addressed to the Company), or such other address as may be designated
by a party hereto in written notice to the other party hereto. Such notice
shall be deemed to have been given or made on the date of delivery, if delivered
by hand, or on the next following date if sent by mail or overnight delivery
service.
SECTION 18. ENTIRE AGREEMENT.
----------------
This instrument shall be governed by the laws of the State of Florida and
contains the entire agreement of the parties with respect to the subject matter
hereof and supersedes any other agreements, whether written or oral, between the
parties. This Agreement may not be changed orally, but only by an instrument in
writing signed by the party against whom enforcement of any waiver, change,
modification, extension or discharge is sought.
13
<PAGE>
SECTION 19. COUNTERPARTS.
------------
This Agreement may be executed in two or more counterparts, each of which
shall for all purposes be deemed to be an original but each of which, when so
executed, shall constitute but one and the same instrument.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first above written.
ORTHODONTIC CENTERS OF AMERICA, INC.
By:/s/ Dr. Gasper Lazzara, Jr.
------------------------------
Dr. Gasper Lazzara, Jr.
Chairman of the Board and
Chief Executive Officer
/s/ Geoffrey L. Faux
---------------------------------
Geoffrey L. Faux
14
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE REGISTRANT
Name State of Incorporation
---- ----------------------
Orthodontic Centers of Alabama, Inc. Delaware
Orthodontic Centers of Arizona, Inc. Delaware
Orthodontic Centers of California, Inc. Delaware
Orthodontic Centers of Colorado, Inc. Delaware
Orthodontic Centers of Connecticut, Inc. Delaware
Orthodontic Centers of Florida, Inc. Delaware
Orthodontic Centers of Georgia, Inc. Delaware
Orthodontic Centers of Illinois, Inc. Delaware
Orthodontic Centers of Indiana, Inc. Delaware
Orthodontic Centers of Kentucky, Inc. Delaware
Orthodontic Centers of Louisiana, Inc. Delaware
Orthodontic Centers of Maryland, Inc. Delaware
Orthodontic Centers of Massachusetts, Inc. Delaware
Orthodontic Centers of Minnesota, Inc. Delaware
Orthodontic Centers of Mississippi, Inc. Delaware
Orthodontic Centers of Nevada, Inc. Nevada
Orthodontic Centers of New Jersey, Inc. Delaware
Orthodontic Centers of North Carolina, Inc. Delaware
Orthodontic Centers of Ohio, Inc. Delaware
Orthodontic Centers of Oregon, Inc. Delaware
Orthodontic Centers of Pennsylvania, Inc. Delaware
Orthodontic Centers of Rhode Island, Inc. Delaware
Orthodontic Centers of South Carolina, Inc. Delaware
Orthodontic Centers of Tennessee, Inc. Delaware
Orthodontic Centers of Texas, Inc. Delaware
Orthodontic Centers of Virginia, Inc. Delaware
Orthodontic Centers of Washington, Inc. Delaware
Orthodontic Centers of West Virginia, Inc. Delaware
Orthodontic Centers of Wisconsin, Inc. Delaware
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-4 No. 333-05977) of Orthodontic Centers of America, Inc. and in the related
Prospectus of our report dated February 13, 1997, with respect to the
consolidated financial statements of Orthodontic Centers of America, Inc.
included in this Annual Report (Form 10-K) for the year ended December 31, 1996.
Ernst & Young LLP
New Orleans, Louisiana
March 26, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from consolidated
financial statements and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 11,827
<SECURITIES> 19,103
<RECEIVABLES> 23,462
<ALLOWANCES> 3,419
<INVENTORY> 0
<CURRENT-ASSETS> 56,129
<PP&E> 28,622
<DEPRECIATION> 4,421
<TOTAL-ASSETS> 145,099
<CURRENT-LIABILITIES> 15,910
<BONDS> 0
0
0
<COMMON> 439
<OTHER-SE> 114,448
<TOTAL-LIABILITY-AND-EQUITY> 145,099
<SALES> 0
<TOTAL-REVENUES> 71,273
<CGS> 0
<TOTAL-COSTS> 49,598
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,617
<INTEREST-EXPENSE> (1,935)
<INCOME-PRETAX> 23,610
<INCOME-TAX> 9,208
<INCOME-CONTINUING> 14,402
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,402
<EPS-PRIMARY> .34
<EPS-DILUTED> .33
</TABLE>
