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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported):
January 18, 2001 (January 18, 2001)
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ORTHODONTIC CENTERS OF AMERICA, INC.
(Exact Name of Registrant as Specified in Its Charter)
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DELAWARE 001-31457 72-1278948
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(State or Other Jurisdiction (Commission File Number) (I.R.S. Employer
of Incorporation) Identification Number)
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3850 N. CAUSEWAY BOULEVARD, SUITE 990
METAIRIE, LOUISIANA 70002
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(Address of Principal Executive Offices) (Zip Code)
(504) 834-4392
(Registrant's Telephone Number, Including Area Code)
NOT APPLICABLE
(Former Name or Former Address, if Changed from Last Report)
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ITEM 9. REGULATION FD DISCLOSURE.
Orthodontic Centers of America, Inc. ("OCA") has included the following
information pursuant to Regulation FD:
CAUTIONARY INFORMATION ABOUT FORWARD-LOOKING STATEMENTS
Certain portions of this document, including the answers to questions 1, 2, 3,
6, 7, 8, 9, 10, 11, 12 and 13, contain forward-looking statements which are
based on certain assumptions and expectations of future events that are subject
to risks and uncertainties. These statements generally include any of the words
"believe," "expect," "anticipate," "intend," "estimate," "should," "will,"
"plan" or similar expressions. Such statements are made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995.
Actual results could differ materially from those indicated in such
forward-looking statements because of a variety of risks and uncertainties.
These risks and uncertainties include failure of OCA's operating and expansion
strategy, failure to achieve anticipated operating results or to consummate
proposed affiliations, developments and acquisitions, regulatory constraints,
changes in laws regulating the practice of dentistry, competition from other
orthodontists and management companies, changes in accounting standards and
principles, changes in manner in which insiders determine to buy or sell OCA's
securities, OCA's ability to effectively provide services to an increasing
number of affiliated orthodontists and centers, the general economy of the
United States and the specific markets in which OCA operates or intends to
operate, and other factors as may be identified from time to time in OCA's
filings with the Securities and Exchange Commission or in other public
announcements by OCA. We undertake no obligation to update these forward-looking
statements to reflect events or circumstances that occur after the date of this
report.
OCA'S RESPONSES TO SELECTED INQUIRIES
1. With signs that the U.S. economy is slowing, will OCA's revenues decline?
In a sluggish economy, our experience has been that parents will generally not
postpone orthodontic treatment, but they will increasingly shop for value. In
that situation, the convenient, no down-payment, monthly payment plans offered
by our affiliated orthodontists become a more compelling alternative. Our
empirical analysis of the performance of our centers during the economic slump
of the early 1990's (when we were a privately-held company with a much smaller
number of centers) showed steady increases in patient case starts during that
period. Moreover, an analysis of the orthodontic industry during that period
(which was published in the Journal of Clinical Orthodontics) showed that the
average practice incomes of orthodontists during that period did not suffer, but
rather grew at rates commensurate with those of the late 1990's.
In addition, our information systems give us a clear, proactive tool to measure
downturns in the economic trends of our centers on an center-by-center basis in
virtually real-time. The majority of our centers are on a "data synchronization"
mode of reporting vital performance results to OCA's corporate office on a daily
basis - a tool we did not have during the early 1990's, and something we use
effectively today to proactively address trends. We currently enjoy a robust
business, and we have not seen signs of a downturn in our general business
trends.
2. A recent "short" report asserts that OCA's "accounting is neither proper nor
is it in accordance with GAAP." What is OCA's response to that?
We emphatically disagree with that assertion. The authors of that report either
misunderstood or misrepresented OCA's business, service fee arrangements,
financial statements and accounting policies, as well as relevant accounting
principles. The report even falsely claims that its authors were told
information by OCA's Chief Financial Officer, when, in fact, they have never
met or spoken with him. Clearly, the report was designed to undermine
investors' confidence in OCA, and further the publisher's goal of lowering
OCA's stock price to its targeted "short" position.
OCA's accounting is, in fact, proper, conservative and in compliance with
generally accepted accounting principles ("GAAP"). Our independent certified
public accountants, Ernst & Young LLP, audit our financial statements annually,
and have done so since our initial public offering in 1994. During our annual
audits, the auditors dedicate substantial time to the audit and heavily
scrutinize certain sensitive areas, including revenue recognition and equity
programs. Our financial statements have been consistently reported to
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conform with GAAP.
We review our accounting policies on a regular basis, comply with changes
recommended by our independent auditors, and comply with proposed and enacted
accounting regulations (e.g., our adoption of SOP 98-5 in 1999). Our accounting
policies have also been reviewed from time to time by various analysts and other
third parties. In many cases, our accounting policies have been characterized as
excessively conservative given the environment in which we operate.
In sum, we are extremely confident that our accounting policies are appropriate
and that our financial statements comply with GAAP in every circumstance.
3. What is the impact, if any, on OCA of the new accounting rules proposed by
FASB with regard to SAB 101 and revenue recognition policies?
In light of the SEC's issuance of Staff Accounting Bulletin No. 101 ("SAB 101")
regarding revenue recognition, we have reviewed our revenue recognition policies
internally and with our independent auditors, Ernst & Young LLP. Based on that
review, we believe that our existing revenue recognition policies comply with
SAB 101, and that SAB 101 will not have a material impact on our results of
operations.
We recognize revenue according to the following:
- In proportion to completion of the services provided. The
approximately 24% of new patient contract balances recognized by OCA
during the first month of the term of a patient contract is correlated
to the approximately 24% of orthodontic services performed for a
patient during the first month of treatment, which includes the
relatively time-consuming preparation and installation of braces, as
determined through OCA's studies.
- Consistent with the terms of OCA's service agreements. OCA's service
agreements specify how patient contract balances are considered in
calculating OCA's fee from its affiliated orthodontists, which in turn
affects the timing of OCA's revenue recognition.
- Consistent with patients' acknowledgement of orthodontic services
performed. In the patient contract between an affiliated orthodontist
and an orthodontic patient (or parent or other responsible party), the
patient generally acknowledges the specific value of the orthodontic
services provided during the first month of treatment and agrees to
remit the unpaid portion of those services in the event the patient
terminates treatment, even if not yet billed. Under OCA's service
agreements, the affiliated orthodontists assign their patient fee
receivables to OCA in payment of service fees. OCA has a history of
collecting these amounts.
4. What are "amounts retained by affiliated orthodontists"?
Under our service agreements, we earn a monthly fee equal to (A) the amount of
patient revenue recognized during that month under the terms of the service
agreement (generally 24% of new patient contract balances in the first month of
treatment plus the balance ratably over the remainder of the patient contract,
which averages 26 months), minus (B) amounts retained by the affiliated
orthodontist.
The amount retained by a particular affiliated orthodontist is based upon the
terms of the orthodontist's service agreement, and generally equals 60% of the
difference of (A) the orthodontist's cash collections during the applicable
period, minus (B) expenses incurred by OCA with respect to the orthodontist's
practice for the applicable period (which generally include all of the expenses
related to operation of the practice other than doctor compensation, malpractice
insurance premiums and continuing education, licensure and similar professional
expenses).
Amounts retained by the orthodontists represent the portion of patient revenue
that is recognized during a particular period in accordance with the service
agreement which is not earned by OCA as a service fee. Accordingly, these
amounts are not reflected in OCA's statements of income. Rather, the top line of
our statements of income reflects "net revenue," which does not include any
amounts that are retained by our affiliated orthodontists.
5. How do you record amounts retained by affiliated orthodontists?
We recognize a liability for amounts retained by affiliated orthodontists during
the period in which the amounts arise pursuant to the terms of our service
agreements, on an accrual basis in conformity with GAAP. These amounts are
reflected in our balance sheets as amounts payable to orthodontic entities.
These essentially represent the portion of cash collections that were not
included in OCA's service fees.
Amounts retained by affiliated orthodontists are not recorded in our statements
of income. OCA does not employ its affiliated orthodontists. As a
non-professional corporation, OCA is prohibited from employing orthodontists by
state laws, which permit only licensed dentists or orthodontists and their
professional entities to employ an orthodontist.
6. Why is there a difference in magnitude in a given quarter between OCA's EBIT
(earnings before interest and taxes) and "amounts retained by
orthodontists"? In particular, why would the amounts retained by
orthodontists be less than OCA's EBIT if, in fact, the economic relationship
between OCA and its affiliated orthodontists is balanced in favor of the
orthodontists, i.e., shouldn't the amount retained be more than EBIT for a
given period?
The fundamental reason for the difference is that we report our results of
operations on an accrual basis in accordance with GAAP, while the amounts
retained by our affiliated orthodontists are determined based on the difference
between cash collections and practice related expenses (other than doctor
compensation, malpractice insurance premiums and continuing education, licensure
and similar professional expenses). As a result, in newly developed centers,
which typically experience
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initial operating losses on a cash basis as a patient base is established, the
amounts retained by the affiliated orthodontists operating in those centers are
reduced, while the orthodontists' portion of the operating losses are added to
our fee.
To assist affiliated orthodontists in obtaining financing for their portion of
initial operating losses, we guarantee loans to the orthodontists from a third
party lender. Previously, we financed the orthodontists' portion of initial
operating losses through unsecured advances.
As a center establishes a patient base and matures, operating profits on a cash
basis typically increase, as the negative cash flow from patients starting
treatment is offset by the positive cash flow from existing patients and
patients ending treatment. As the cash-basis operating profits of a center
increase, the amounts retained by the affiliated orthodontist likewise increase.
Our service fee arrangements are fundamentally structured to benefit the
orthodontist for increases in the center's operating profits on a cash basis,
and we believe that these arrangements have proven to be the backbone of our
business and one of the cornerstones of our continued success. This has been the
system by which our affiliated orthodontists retain compensation since before
our initial public offering in 1994.
We believe that it is incorrect to use a single patient contract model as the
basis for the evaluating amounts retained by orthodontists. A proper analysis
would include the entire mix of patients in a center - those starting treatment
as well as existing patients, who typically contribute the bulk of a given
center's cash collections and therefore are the chief contributors to cash
profitability calculations for purposes of amounts retained by affiliated
orthodontists.
7. If the amount of new patient contracts declines significantly, what effect
would that have on OCA's earnings?
We believe that new patient contracts are the best predictor of our future
revenue. If new patient contracts were to decline significantly, we expect that
it would have a gradual, negative impact on our earnings. We believe that the
impact on our earnings would be gradual, rather than immediate, because of the
large number of patients who are already in active treatment by our affiliated
orthodontists, for terms that average about 26 months. This large existing
patient base generates large amounts of revenue each month as compared to the
relatively small number of new patients who initiate treatment each month.
In addition, the impact of such a decline in new patient contracts on our
earnings would also be tempered by the fact that a new patient contract results
in a significant amount of costs being incurred, and orthodontist time being
utilized, during the first month of the patient's treatment, as the patient is
diagnosed, records are taken and braces are applied. Therefore, if new patient
case starts were to decline, staff costs, supply costs and other variable
expenses would also likely decline commensurately.
To illustrate, if new patient case starts were to decline to a level that is
equal to the number of patients completing treatment, i.e., a zero-growth
"equilibrium" scenario, we would expect operating margins to improve and EPS to
climb beyond present consensus estimates, based primarily upon the cost
"savings" that would result from fewer case starts. Such a scenario is neither
desired nor expected but serves to highlight the impact of patient case starts
on our financial statements.
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8. If the amount of new patient contracts declines significantly, how would
amounts retained by orthodontists be affected as existing patients pay a
completion fee, which is about four times the amount of their monthly fee,
upon completion of their treatment?
We expect that amounts retained by orthodontists would increase only moderately
in that case.
Since our inception, our affiliated orthodontists have generally used a payment
plan for their patients that involves equal monthly installments during the
patient's course of treatment and a completion fee upon completion of treatment.
The completion fee is generally $436 or $476, and the monthly fee is generally
$109 or $119.
About 20% of patients have historically paid their completion fee in equal
monthly payments over the term of their treatment. As a result, the effect of
these completion payments on the amounts retained by the orthodontists (by
increasing the centers' cash-basis operating profits) is spread over the term of
treatment, rather than solely in the last month.
In addition, about 5% of patients have paid their completion fee over the four
months after the end of their treatment. Therefore, the effect of the completion
payment on the amounts retained by orthodontists is spread over a four month
period, rather than one month.
The remaining 75% of patients, who pay the completion fee during the last month,
represent about 15 patients in an average center, as compared to about 500
patients that continue treatment and payment of monthly fees, and about 20 new
patients starting treatment. In a given month, the amount of cash collected from
patients who are completing treatment (including payments of the completion fee)
is less than 10% of cash collected from all patients, including new patients and
patients that continue in active treatment.
9. How is the doctors' restricted stock program accounted for in OCA's
financial statements?
Some of our affiliated orthodontists participate in a program that enables them
to purchase restricted shares of OCA common stock, which they elect to do upon
affiliation with OCA. We record the proceeds from such program as a debit to
cash and a credit to equity, which is reflected in our balance sheets and
statements of shareholders' equity and is included within shares issued to
obtain management agreements. The dollar amount and number of shares related to
this program are relatively insignificant, and we do not expect them to have a
material impact on our financial condition.
None of the proceeds from the program or the sale of the shares is recorded as
revenue. Any assertion that proceeds from this program are somehow run through
our income statements in some manner is categorically false and misleading.
10. Can you comment on an insider transaction that was recently disclosed?
In a Form 4 filed January 10, 2001 with the SEC, Dr. Gasper Lazzara, Jr., OCA's
Chairman of the Board, reported that, on December 18, 2000, several trusts of
which Dr. Lazzara's children are the beneficiaries exchanged a total of 156,865
shares of OCA common stock for interests in an exchange fund, in a privately
negotiated transaction.
That exchange transaction is consistent with Dr. Lazzara's statements during
OCA's third quarter 2000 earnings conference call on October 26, 2000 (an
archived recording of which is currently accessible on OCA's website,
www.4braces.com) regarding his intention, commensurate with his role as Chairman
and his longer term retirement, estate planning and diversification goals, to
sell approximately 40% of his equity stake in OCA in an orderly manner over the
next four years. If Dr.
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Lazzara were to sell that amount of shares, he would still retain a sizeable
interest in OCA (over 2 million shares, based on his current direct and indirect
beneficial ownership) and remain one of OCA's leading shareholders.
11. Is management comfortable with consensus earnings estimates for OCA for the
fourth quarter of 2000 and year-end 2000?
Yes, management is comfortable with consensus earnings estimates for the fourth
quarter of 2000 and year-end 2000.
12. What do you see as OCA's chief strengths, and what do you think explains
OCA's sustained success in an environment where so many others have had
difficulty?
The chief reasons for our continued success can be boiled down to a number of
key factors:
- Superior execution of a proven growth strategy. We have been
delivering high value services to orthodontists since 1985, long
before we went public in 1994, and we continue to apply time-tested
principles and innovative approaches to enhancing the productivity and
profitability of our affiliated orthodontists' practices. We have a
proven ability to successfully operate our company and to add value to
our affiliated orthodontists' practices.
- Sound discipline. We operate according to sound business principles.
We apply a disciplined approach to affiliations with new
orthodontists, and avoid over-paying for those affiliations. We devote
our corporate resources to growth and concentrate on initiatives
designed to grow small practices into successful, larger ones.
- Singular focus. We concentrate solely on orthodontics and have not
been distracted by trendy ideas or capricious acquisitions.
- A winning economic model. Our service agreements with our affiliated
orthodontists are bottom-line focused and are a key to our success.
Many of the companies that have tried to copy our success have
employed a top-line, revenue oriented model, which we believe to be
inherently unsustainable and flawed in the long run. Most importantly,
our affiliated orthodontists are generally happy, successful
practitioners. Numerous independent due diligence efforts undertaken
by investors have confirmed this. It likely would not be the case if
we weren't getting our job done.
- Superior revenue and earnings visibility. Our business is highly
predictable, with relatively high margins. There has generally been
little deviation among various analysts' estimates of our revenue.
13. What are OCA's greatest challenges going forward?
Our challenges going forward remain what they've always been:
- Continuing to provide superior and innovative execution and delivery
of value-added services to our affiliated orthodontists.
- Continuing to enable our affiliated orthodontists to grow their
practices and to maintain the solid internal growth performance we
have established together.
- Continuing to affiliate with the highest caliber orthodontic
professionals.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
ORTHODONTIC CENTERS OF AMERICA, INC.
By: /s/ Bartholomew F. Palmisano, Sr.
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Bartholomew F. Palmisano, Sr.
President and Chief Executive Officer
Date: January 18, 2001
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