================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
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): July 5, 2002 (July 5, 2002)
-----------
ORTHODONTIC CENTERS OF AMERICA, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 1-13457 72-1278948
------------------------------ ------------------------ ----------------------
(State or Other Jurisdiction (Commission File Number) (I.R.S. Employer
of Incorporation) Identification Number)
3850 N. CAUSEWAY BOULEVARD, SUITE 800
METAIRIE, LOUISIANA 70002
---------------------------------------------- ----------------------
(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)
================================================================================
ITEM 9. REGULATION FD DISCLOSURE
The following information was compiled from recent questions received from
investors. We are providing these questions and answers in written form to
furnish the investment community with more information that we hope will help
investors to better understand OCA from a financial point of view. This also
reflects our attempt to comply with disclosure guidelines contained in the
Securities and Exchange Commission's Regulation FD.
o When will you conduct your earnings conference call for the second
quarter of 2002?
Thursday, August 8, 2002 at 2:00 p.m. (Eastern Time). The dial-in
number for the call will be released soon, or you can listen to the
webcast at www.ccbn.com, which will be archived for at least 30 days
following the webcast.
o What is management's earnings expectations for the year and quarter?
We affirm our prior estimate of net income per share of approximately
$1.54 for fiscal year 2002. We are still closing our books for the
second quarter, and at this time we do not have any reason to change
our previous estimate of $0.39 for the second quarter. We can't assure
you that our actual earnings will turn out to be those amounts. There
are a number of factors that could affect our ability to achieve these
estimates, many of which are beyond our control. Examples of these
factors are included in the section of this document captioned
"Cautionary Statement About Forward-Looking Statements."
o What are cash flow expectations?
As we stated in our last Form 8-K filed on May 9, 2002, we expect cash
flow from operating activities for fiscal year 2002 to be at least $60
million. Again, this is only our current estimate of this amount, which
could change and might be wrong. The risks described in "Cautionary
Statement About Forward-Looking Statements" and other factors could
prevent us from achieving this estimate.
o The company's stock price has been under considerable pressure over the
past two weeks. Can you explain why?
We believe that present investor sentiment in the broader markets is
one of caution and that many publicly-traded companies' reported
financial statements are receiving greater scrutiny. OCA is no
exception. We are sensitive to investors' concerns and we have a
history of being responsive to investors' concerns.
The responses that follow in this document are an attempt to answer
many of the questions we've received lately. To be clear, we prepare
our financial statements in accordance with generally accepted
accounting principles and we stand by the appropriateness of our
accounting treatment.
o What is the nature of the intangible assets on your balance sheet and
how are those intangible assets amortized?
We generally affiliate with an existing practice by acquiring
substantially all of the non-professional assets of the practice,
either directly or indirectly through a stock purchase, and entering
into a service agreement with the practice owner and his or her
professional corporation. The terms of the service agreements range
from 20 to 40 years, with most
2
ranging from 20 to 25 years. The acquired assets generally consist of
equipment, furniture, fixtures, supplies and leasehold interests. We
record these acquired tangible assets at their fair value as of the
date of acquisition (which typically represents about 5% to 10% of the
purchase price), and depreciate or amortize the acquired assets using
the straight-line method over their useful lives. The remainder of the
purchase price is allocated to an intangible asset, which represents
the costs of obtaining the service agreement, pursuant to which we
obtain the exclusive right to provide business operations, financial,
marketing and administrative services to the practice during the term
of the service agreement. We amortize that intangible asset over the
useful life of the service agreement (up to 25 years).
From time to time, we have provided consideration to existing
affiliated practices in return for the practices amending their service
agreements with us to provide material long-term value to us, with a
corresponding increase in the amount of the related intangible asset.
For example, on occasion we may agree to amend a given service
agreement as part of an affiliated practice's acquisition of another
existing practice, center or patient base, which in turn becomes part
of the acquiring practice. In cases when one of our affiliated
practices acquires another practice and it potentially provides
earnings leverage to us, we may therefore be willing to help fund the
acquisition by way of incremental consideration to the affiliated
practice.
We view our investment in service agreements, whether it be in a new
affiliation or with an existing affiliated practice, as an investment
in what we characterize as an ongoing "stream of cash flow" from
providing business services to the affiliated practices. Accordingly,
impairment tests for such assets dictate that we examine our service
agreements relative to possible future cash flows. As a more immediate
check of future service fees, we also look to the existing patient
contract balances of our affiliated practices, which serve as a form of
"litmus" test for the intangible balances recorded on our balance sheet
(approximately $229.1 million as of March 31, 2002). As of March 31,
2002, these patient contract balances totaled approximately $743
million. While these patient contract balances of our affiliated
practices are not recorded on our balance sheet, we look at a
percentage of these patient contract balances as a predictor of service
fee revenue that we may realize during the following two year period.
In accordance with FASB Statement No. 144 ("Accounting for Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"), we
systematically evaluate on a routine basis whether events and
circumstances have occurred that indicate that all or a portion of the
carrying amount of these intangible assets may no longer be
recoverable, and is therefore impaired. Any future determination that
impairment has occurred would require us to write off the impaired
portion of unamortized intangible assets, resulting in a charge to our
earnings.
By way of information, during 2001, the composition of our investment
in intangibles, excluding the effect of the OrthAlliance merger, was
approximately 77% related to new affiliations and 23% related to
existing affiliated practices. Of the amount invested in new
affiliations during 2001, a portion was related to orthodontists who
signed definitive agreements in 2000, but to whom we did not ultimately
exchange consideration for the affiliation until 2001. For fiscal year
2000, our total acquisition costs for affiliations was $34.2 million,
and we estimate that the proportional investment in new affiliations
versus investment in existing affiliates was not materially different
than in 2001. Another noteworthy statistic is that the gross intangible
investment per practice declined to approximately $711,000 at year end
2001 from $748,000 at year end 1998. On a per-practice basis, our gross
investments in intangibles imply that we have not deviated from our
consistent investment behavior. While we have long preferred to target
our affiliations with practices having gross patient-based revenue of
$500,000 or less, we have affiliated with many practices that are
larger. Industry statistics will attest that the average size of
orthodontic practices has increased substantially over the last decade,
and we have been
3
forced to consider affiliating with larger practices in order to expand
our pool of prospective affiliations.
We amortize our investment in service agreements over the terms of our
service agreements, with a maximum amortization period of 25 years, in
accordance with generally accepted accounting principles. We view the
life of the practice as independent of the given practice owner at the
time. In the normal course of business, changes in practice ownership
are reasonably common within OCA's network of affiliates. In such
cases, the practice transfers to a successor practitioner who assumes
the transferring practitioner's obligations under the service
agreement. In fact, since 1994 we have facilitated over 100 successful
practice or center transitions within our system. While approximately
14 of those practice or center successions resulted from
non-performance or under-performance by the affiliated practitioner, or
because of the death of the practitioner, the vast majority of such
transitions have been to facilitate practice growth, transfer
individual centers from one affiliated practice to another, or
accommodate practitioners who desired to move, purchase another
practitioner's office or patient base, or retire, etc. As with many
"businesses," existing management may retire or sell to another owner,
but the "business" or practice itself continues on. For example, one of
our affiliated practices in Florida has had three separate practice
owners, and each successive practitioner has grown the practice. In
summary, we've proven, time and time again, that while the practitioner
may change, the business of the practice, and our stream of service
fees, generally remains unchanged.
A common misconception is that once a practitioner's initial commitment
period has expired, the practitioner can simply exit his or her
association with OCA and operate the affiliated practice independent of
any obligation to us. However, most of our service agreements require
that, before a practitioner may retire or exit from the affiliated
practice, his or her obligations under the service agreement must be
assumed by a successor practitioner, either through the retiring
practitioner selling the practice to a successor practitioner or
transferring the practice for nominal consideration to a successor
practitioner that we designate. In addition, practice owners are
generally subject to a covenant not to compete, which limits their
ability to practice within a designated area for a specified period of
time (generally two years). These provisions help to insure that there
is continuity in the practice.
We work with practice owners who are seeking to retire to find a
successor owner-practitioner to operate the practice. In addition to
the contractual requirements under most of our service agreements and
the potential proceeds from selling the practice to a successor, a
practical inducement for a retiring practice owner to locate a
successor for their practice is the potentially costly process of
winding down a practice (as facilities' leases and other fixed costs
continue to be incurred while the patient base diminishes) and ethical
and legal limitations on abandonment of patients.
o What do you believe are the relevant units of economic analysis for
your business?
Our service fees are largely a function of our affiliated practices'
patient activity. Therefore, new patient case starts and new patient
contract dollars continue to provide the fundamental building blocks
and visibility for financial performance going forward.
As we discussed above, our business has changed a lot over the years
since we were founded in 1985. The units that many analysts and
shareholders use to analyze and forecast our business are the number of
practitioners and centers. During the late 1980's and into the 1990's,
the majority of our initial practice affiliations consisted of one
doctor and one center, and therefore for many years we described our
business using practitioners and centers. However, our affiliated
practices, on average, have grown into multi-location businesses and
often include multiple practitioners. We are also serving a growing
number of pediatric dental practices, which have their own unique
financial characteristics.
4
As a related matter, the composition of our doctor base is becoming
less uniform over time with more associates and general practitioners
operating in our centers. These auxiliary practitioners greatly vary in
terms of their compensation and their time commitment to our affiliated
practices. Some work only a few hours a week while others work a full
schedule.
We suggest that the appropriate lens to view our business is the entity
with which we are directly affiliated and the means by which we derive
our service fees - the practice. On a relative scale, the economic
results among practices are more uniform than the economic results of
individual practitioners and the economic results of centers. As a
practical matter, we manage our business using the practice as a profit
center, rather than using the individual center or practitioner as
profit centers. The overriding source of value among our affiliated
orthodontic practices is new patient contract volume, and we have
learned that new patient contract volume is managed at the practice
level, regardless of the method employed to increase patient contract
volume. Whether increased patient volume is derived from adding new
centers, adopting affordable pricing plans, adding more practitioners,
improving operational efficiency, expanding patient intervals or other
factors, we focus on facilitating greater patient volume at the
practice level.
We have had several requests for historical practice count data. The
following table provides information about the growth in the number of
our affiliated practices for the periods shown:
NUMBER OF AFFILIATED PRACTICES
December 31,
-------------------------------------------------------------------------
1994 1995 1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ---- ---- ----
Number of Affiliated Practices... 28 60 96 168 210 225 241 364
o What are the advances to affiliated entities on your balance sheet and
how are those advances repaid?
Newly-developed affiliated orthodontic practices and existing
affiliated practices expanding their capacity by adding additional
centers or practitioners typically experience cash flow needs until
they begin generating sufficient operating profits at the
newly-developed or newly-expanded centers. We may advance funds to
affiliated practitioners to assist affiliated practitioners with
maintaining a reasonable standard of living during the start up or
expansion phase of their practices. According to the terms of most of
our service agreements, the practitioner retains a percentage of the
cash operating profits of the practice (excluding the doctor's
compensation). If the practice does not produce a cash operating
profit, the doctor does not retain funds to pay himself. Therefore, we
may lend the practice as an advance against future service fees some
cash to fund the practice owner's compensation. Part of our role is to
facilitate growth of our affiliated practices, while reducing the
financial stress associated with that growth, so that our affiliated
practitioners can focus on patient care. We should also mention that
these advances are not to be confused with "startup losses". We fund
startup losses separately, and those losses are generated independent
of the practitioner's compensation. We do not record fundings for
startup losses of centers on our balance sheet because of our revenue
recognition policy in accordance with Staff Accounting Bulletin No.
101.
5
These advances to affiliated entities are interest free, unsecured
loans to the affiliated practices. The affiliated practice generally
begins to repay the advances once the practice becomes profitable,
generally at the beginning of the second year that the practice is
open.
From time to time, affiliated practitioners will approach us to request
our assistance in the acquisition of additional assets, centers or
practices that will have a material benefit to OCA over the long term.
We accommodate such investments by our affiliated practices by
advancing funds to our affiliated practices if we determine that is in
the best interest of our business.
o What is the nature of your capital expenditures during the past few
years?
As you would expect for a business with over 800 locations and
double-digit historical internal growth, we invest a lot of money in
our physical infrastructure and our equipment. Generally, we own all
the leasehold improvements, furniture and equipment in our affiliated
centers.
Our capital expenditures have historically fallen into four categories:
(1) expenditures to facilitate growth and development of existing
centers, (2) maintenance expenditures to sustain current levels of
business activity at existing centers, (3) acquisitions of the fixed
assets of newly affiliated practices, and (4) development of de novo
centers in the United States and abroad.
During the stages of rapid growth in the number of our affiliated
practices in the 1990's, we expended a disproportionately high amount
of our capital investment on de novo centers relative to expenditures
on our existing centers. During recent years, however, our investment
has increasingly included capital expenditures directed toward
remodeling and improving our existing fixed asset base to facilitate
internal growth. Given our heavy reliance on computer systems, we also
invested heavily during recent years in our computer systems
infrastructure. Our extensive network of affiliated centers requires a
consistent level of "field" investment in technology, such as advanced
digital cameras or DSL data delivery capability. In addition, we
continue to invest in the foundational infrastructure of our
international operations.
Therefore, a comprehensive understanding of our overall capital
expenditure needs to include amounts which are required to grow both
internally and "externally" (de novo growth and acquisitions) as well
as the capital investment required to service and maintain the existing
practice base of our affiliated practices. Merely multiplying the
number of centers added during a given period by our per-center
build-out costs to reconcile overall capital-related investment is an
incomplete analysis.
The following table provides information about the estimated
composition of our changes in fixed assets for 2001:
FY 2001 SUMMARY OF CHANGES IN FIXED ASSETS
($ in millions)
Beginning property, equipment
and improvements, net ................... $76.7
Center additions ........................... 8.4
Remodeling of existing centers ............. 6.9
Maintenance capital expenditures ........... 4.8
International development .................. 1.7
OrthAlliance acquisition ................... 3.9
Corporate .................................. 0.2
-----
Total gross capital expenditures ........... 25.9
Less depreciation .......................... 10.8
-----
Ending property, equipment
and improvements, net ................... $91.8
=====
6
o What is the status of OrthAlliance affiliated practitioners who are
litigating with OrthAlliance?
To our knowledge, there are currently 54 of these litigating
practitioners. We continue to be confident in the strength of our
position with respect to these lawsuits. As we stated last quarter,
based on our prior experience and discussions with some of these
litigating practitioners or their representatives, we currently believe
that some of these practitioners will settle their lawsuits by paying
us an amount of cash in exchange for termination or modification of
their service, management service or consulting agreements with
OrthAlliance, depending upon the parties' ability to reach an agreement
as to the amount to be paid. As some indication of value we may receive
when a practitioner seeks to exit his agreement with OrthAlliance, we
recently received approximately $1.8 million in consideration for
terminating one OrthAlliance practitioner's service agreement, which
equated to a transaction multiple of nearly 6 times the practice's
EBITDA to OrthAlliance during the prior 12 months. We cannot assure you
that such an agreement or settlement will be reached in any of these
lawsuits. We also cannot, at this time, predict the outcome of these
lawsuits or assure you that we will prevail in any of them, nor can we
estimate at this time the amount of damages that we might incur or
receive in these actions. In summary, we are working on resolving these
lawsuits, and are currently involved in settlement discussions with
many of these practitioners.
o What do you plan to do about the future retiring affiliated
practitioners? What is the average age of your affiliated
practitioners?
The average age of our affiliated "practice owners" (that is,
affiliated practitioners who have an ownership position in their
practice) is approximately 51 years of age. Assuming that the average
affiliated practitioner treats patients until he or she is 65 years
old, we believe that on average our affiliated practitioners have at
least fifteen years of active service in their practices before they
retire. Of note, the average age of the associate practitioners working
in our affiliated practices is substantially less than 51 years of age.
In the limited number of cases in which one of our affiliated practice
owners has retired, we have worked with the practice owner to
facilitate a sale of the doctor's interest in the practice to a
successor practitioner, which perpetuated our economic interest.
As for succession planning, we have placed great emphasis during recent
quarters on assisting our affiliated practices in recruiting associate
practitioners. An "associate practitioner" is an employee of a practice
owner and receives a salary from him. The associate will often
eventually succeed the practice owner as one of our affiliated
practitioners.
As a general matter, associates are, on the whole, easier to recruit
than an orthodontist who already owns and operates an existing
practice. During the fourth quarter of 2001 and the first quarter of
2002, for example, excluding our acquisition of OrthAlliance in
November 2001, our affiliated practices added a total of 13 associate
practitioners. These associate practitioners are prospective purchasers
of affiliated practices as time passes and the practice owners decide
to retire. Associate practitioners also provide short-term benefits
because they allow our affiliated practices to grow by increasing their
capacity to treat patients.
7
In their service agreements with us, our affiliated practice owners
have generally agreed to notify us in advance of their intent to retire
from their practice, and we work together with the affiliated
practitioners to find successors for them. The affiliated practitioners
have a significant economic interest in their practices, and, based on
our prior experience, we believe that before retiring, they will exert
considerable effort to identify someone to purchase their interest in
the practice.
We have a very successful track record in assisting practice owner
successions during the past decade, and we are confident in our ability
to facilitate such successions in the future. We have a doctor
relations team of ten individuals whose responsibilities include
succession management. We will continue to recruit for the purpose of
successions. Given our large network of affiliated practitioners, our
financial and recruiting resources and our suite of services, we
believe our affiliated practitioners are in a position of strength
relative to their industry peers with respect to attracting buyers of
their practices upon retirement.
CAUTIONARY STATEMENT ABOUT FORWARD LOOKING STATEMENTS
Certain statements contained in this Report may not be based on historical facts
and are "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. These forward-looking statements may be identified by
their reference to a future period or periods or by the use of forward-looking
terminology, such as "anticipate," "believe," "estimate," "project," "expect,"
"may," "might," "will," "would," "could" or "intend." These forward-looking
statements include, without limitation, those relating to earnings per share,
cash flow, recruiting orthodontic practices, legal proceedings and settlements,
succession planning and recruiting, termination of service agreements,
impairment of intangible assets, and advancement of funds to affiliated
practices.
We caution you not to place undue reliance on the forward-looking statements
contained in this Report in that actual results could differ materially from
those indicated in such forward-looking statements, due to a variety of factors.
Those factors include, but are not limited to, potential inability to
successfully integrate OrthAlliance and its affiliated centers and practices,
adverse changes in our financial results and conditions, adverse outcomes of
litigation pending against us and OrthAlliance, potential inability to
successfully achieve some or all of our proposed internal growth initiatives,
changes in general economic conditions and business conditions, changes in our
operating or expansion strategy, inability to attract and retain qualified
personnel and orthodontists, and inability to effectively market our services
and those of our affiliated practices, the impact of competition and existing
and future regulations affecting orthodontics and our business, legal
restrictions on the use or advertisement of general dentists in orthodontic
practices, legal restrictions on immigration and licensing foreign dentists, our
dependence on existing sources of funding, other factors generally understood to
affect the financial results of orthodontic practice management companies, and
other risks detailed from time to time in our press releases, Annual Report on
Form 10-K for the year ended December 31, 2001 and other filings with the
Securities and Exchange Commission. We undertake no obligation to update these
forward-looking statements to reflect events or circumstances that occur after
the date on which such statements were made.
8
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.
----------------------------------
Bartholomew F. Palmisano, Sr.
Chairman, President and
Chief Executive Officer
Date: July 5, 2002
9