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| 1. Description
of Business Orthodontic Centers of America, Inc. (the “Company”) provides integrated business services to orthodontic and pediatric dental practices throughout the United States and in Japan, Mexico, Spain and Puerto Rico. The Company provides business operations, financial, marketing and administrative services to orthodontic and pediatric dental practices. These services are provided under service agreements, business services agreements, management service agreements and consulting agreements (hereafter referred to as “Service Agreements”) with orthodontists or pediatric dentists and/or their wholly-owned professional entities (hereafter referred to as “Affiliated Practices”). Because the Company does not control the Affiliated Practices, it does not consolidate their financial results. The Company’s consolidated financial statements include service fees earned under the Service Agreements and the expenses of providing the Company’s services, which generally includes all expenses of the Affiliated Practices except for the practitioners’ compensation and certain expenses directly related to the Affiliated Practices, such as professional insurance coverage. 2. Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of Orthodontic Centers of America, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. 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. Accounting Change Effective January 1, 2000, the Company adopted a change in accounting for revenue in connection with Securities and Exchange Commission Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (SAB No. 101). The cumulative effect of this accounting change, calculated as of January 1, 2000, was $50.6 million, net of income tax benefit of $30.6 million. The effect of this accounting change in 2000 was to reduce fee revenue by $26.3 million. The Company recognized revenue of $23.9 million in 2001 and $57.3 million in 2000 that was included in the adjustment as a result of the cumulative effect of the accounting change. The pro forma amounts for 1999 presented in the consolidated statements of income were calculated assuming the accounting change was made retroactive to January 1, 1999. Effective January 1, 1999, the Company adopted Statement of Position 98-5, “Reporting the Costs of Start-Up Activities.” The cumulative effect of this accounting change, calculated as of January 1, 1999, was $678,000, net of income tax benefit. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, on January 1, 2000. Because the Company has no derivatives, there was no financial statement impact. Cash Equivalents The Company considers all liquid investments with a maturity within three months from the date of purchase to be cash equivalents. 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 amount 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. Service Fees Receivable, Service Fee Prepayments and Advances to Affiliated Entities: The carrying amounts reported on the balance sheets for service fees receivable, service fee prepayments and advances to affiliated entities approximate their fair values. 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 Fee revenue consists of service fees earned by the Company under the Service Agreements. Effective January 1, 2000, the Company changed its method of revenue recognition for service fees earned under its Service Agreements. Fee revenue is generally recognized as service fees are contractually due under the Company’s Service Agreements, except that recognition of a portion of the service fees is deferred because patient contract revenue is calculated on a straight-line basis over the term of the patient contracts (which, for orthodontic patients, average about 26 months), and are reduced by amounts retained or to be retained by Affiliated Entities. Amounts retained or to be retained by an Affiliated Practice equal the Affiliated Practice’s proportionate share of the portion of that straight-line allocation of patient contract revenue that is collected during the relevant period, and the patient receivables that represent the uncollected portion of that straight-line allocation of patient contract revenue. Amounts retained or to be retained are reduced by any operating losses, depreciation, interest on outstanding loans, bad debt or other expenses that the Company has incurred but for which it has not been reimbursed by the Affiliated Practice; however, these unreimbursed expenses reduce amounts retained by an Affiliated Practice only up to the amounts that would otherwise be retained by the Affiliated Practice. Any remaining unreimbursed expenses would reduce amounts retained or to be retained by the Affiliated Practice in subsequent periods. For the Company’s general form of Service Agreements (under which service fees are generally determined, at least in part, based upon a percentage of practice operating profit), the amounts retained or to be retained by an Affiliated Practice are estimated using the percentage of practice operating profits that may be retained by the Affiliated Practice under the Service Agreement. For OrthAlliance’s Service Agreements (under which service fees are generally determined, at least in part, based upon a percentage of practice revenue and reimbursement of practice related expenses), amounts retained or to be retained by an Affiliated Practice are estimated using the percentage of practice revenue that may be retained by the Affiliated Practice under the terms of the Service Agreement, minus the estimated amount of practice related expenses for which OrthAlliance may be reimbursed under the Service Agreement. Many of OrthAlliance’s Affiliated Practices require that their patients pay a down payment of approximately 25% of the total treatment fee at the commencement of treatment. This results in the Company receiving cash in advance of incurring certain practice related expenses and recognizing certain service fees as fee revenue, which are deferred and recorded as service fee prepayments. Service fee prepayments represent cash received in excess of service fees that have been recognized as fee revenue, less an estimate of the portion of that cash that the applicable Affiliated Practice is to retain and practice related expenses that have not yet been incurred. Prior to the change in method of revenue recognition, the Company recognized service fee revenues pursuant to the terms of the Company’s general form of Service Agreements. Such fees were recognized on a monthly basis at approximately 24% of new patient contract balances plus a portion of existing patient contract balances allocated equally over the remaining terms of the patient contracts, less amounts retained by the Affiliated Practices. This method was supported by proportional performance of business services provided under the Service Agreements. Most of the Affiliated Practices pledge their billed and unbilled patient fees receivable to the Company as collateral for the Company’s service fees. The Company is generally responsible for billing and collection of the patient fees receivable, which are conducted in the name of the applicable Affiliated Practice. Collections from patient fees receivable are generally deposited into depository bank accounts that the Company establishes and maintains. The Company generally collects its service fees receivable from funds that are collected from patient fees receivable and deposited into depository bank accounts. This results in deferral of collection of a portion of the Company’s service fees receivable until the related patient fees receivable that have been pledged to the Company are collected and the funds are deposited into a depository bank account. This deferral is generally for a period that averages less than 90 days, as patient fees receivable are generally collected within that period of time. The Company does not generally charge Affiliated Practices any interest on these deferred balances of service fees receivable. For newly-developed centers (which typically generate operating losses during their first 12 months of operations), the Company generally defers payment of a portion of its service fees relating to unreimbursed expenses over a five-year period that generally commences in the second year of the center’s operations, and charges the Affiliated Practices interest on those deferred amounts at market rates. Under the Company’s revenue recognition policy, those unreimbursed expenses are not recognized as revenue or recorded as service fees receivable until such revenue is collateralized by patient fees receivable pledged by Affiliated Practices. Pledged patient fees receivable which prove to be uncollectible have the effect of reducing the amount of service fees receivable collected by the Company. In some cases, the Company assists Affiliated Practices in obtaining financing for their share of operating expenses by providing a guaranty of loans from a third-party lender. Information about amounts guaranteed by the Company is provided in Note 4. Receivables Service fees receivable represents the uncollected portion of the Company’s fee revenue as calculated under the Company’s revenue recognition policy. Under the terms of the Company’s general form of Service Agreements, the Affiliated Practices pledge their patient fees receivable to the Company as collateral for the Company’s service fees. The Company is generally responsible for billing and collection of the patient fees receivable, which are conducted in the name of the applicable Affiliated Practice. Collections are generally deposited into a depository bank account that the Company establishes and maintains. Service fees receivable does not include any service fees receivable relating to certain OrthAlliance affiliated practices that are parties to litigation pending against OrthAlliance and who have ceased remitting service fees to OrthAlliance. See Note 3 for additional information about these practices. The Company is exposed to credit risks of nonpayment of the Company’s service fees by Affiliated Practices. The Company is also exposed to credit risks of nonpayment of patient fees receivable pledged as collateral for the Company’s service fees, in that nonpayment of patient fees receivable may result in adjustment to the Company’s service fees receivable if the Company does not seek recourse against the applicable Affiliated Practice for payment of the related service fees. The Company generally may seek recourse against an Affiliated Practice, and their assets, for nonpayment of the Company’s service fees. However, for business reasons, the Company generally has not sought recourse against Affiliated Practices for nonpayment of service fees relating to uncollectible patient fees receivable unless their Service Agreement has terminated or been alleged to have terminated. The Company manages such credit risks by regularly reviewing the accounts and contracts, and providing appropriate allowances. Provisions are made currently for all known or anticipated losses for service fees receivable. Such provisions totaled approximately $701,000 for 2001, $373,000 for 2000 and $2.1 million for 1999, and have been within management’s expectations. Collection of advances to Affiliated Practices is highly dependent on the Affiliated Practices’ 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 Affiliated Practices. Management evaluates the collectibility of these advances based upon a number of factors relevant to the Affiliated Practices, including recent new patient contract performance, active patient base and center cost structure. The Company has a history of collecting amounts due from Affiliated Practices. Supplies Inventory Supplies inventory is valued at the lower of cost or market determined on the first-in, first-out basis and represents the market value of supplies owned by the Company. 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 range from 5 to 10 years. Leasehold improvements are amortized over the original lease terms, which are generally 5 to 10 years. The related depreciation and amortization expense was $10.9 million in 2001, $8.2 million in 2000 and $6.5 million in 1999. Intangible Assets The Company generally affiliates with an existing orthodontic or pediatric dental 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 orthodontist or pediatric dentist and/or his or her professional corporation or other entity. The terms of the Service Agreements range from 20 to 40 years, with most ranging from 20 to 25 years. The acquired assets generally consist of equipment, furniture, fixtures and leasehold interests. The Company records these acquired tangible assets at their fair value as of the date of acquisition, and depreciates or amortizes 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. In the event the Service Agreement is terminated, the related Affiliated Practice is generally required to purchase all of the related assets, including the unamortized portion of intangible assets, at the current book value. The Company may issue shares of its common stock as consideration when it acquires the assets of, and enters into Service Agreements with, existing practices. The Company values the shares of stock issued in these transactions at the average closing market price during a few days prior to the date on which the particular transaction is closed. Service Agreements are amortized over the shorter of their term or 25 years. Amortization expense was $9.0 million in 2001, $7.0 million in 2000 and $5.7 million in 1999. Accumulated amortization was $29.7 million, $20.7 million and $13.7 million as of December 31, 2001, 2000 and 1999, respectively. Intangible assets and the related accumulated amortization are written off when fully amortized. Impairment of Long-Lived Assets The Company assessed long-lived assets for impairment under SFAS No. 121, “Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” during 2001. Under those rules, Service Agreements are included in impairment evaluations when events or circumstances exist that indicate the carrying amounts of those assets may not be recoverable. The recoverability of Service Agreements is assessed periodically and takes into account whether the Service Agreements should be completely or partially written off or the amortization period accelerated based on management’s estimate of future operating income over the remaining term of the Service Agreement. If a Service Agreement is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the Service Agreement exceeds its fair value using estimated cash flows on a discounted basis. See “New Accounting Pronouncements” below on the issuance of SFAS No. 144. Goodwill Goodwill represents the excess of purchase price over fair value of net assets acquired or arising from the OrthAlliance merger on November 9, 2001. See Note 3 for a description of the OrthAlliance merger. Goodwill is not amortized but will be tested for impairment by applying a fair value concept. See “New Accounting Pronouncements” below on the issuance of SFAS No. 142. Marketing and Advertising Costs Marketing and advertising costs are expensed as incurred. Income Taxes Income taxes are determined by the liability method in accordance with SFAS No. 109, “Accounting for Income Taxes.” Deferred income tax assets and liabilities are recognized for the expected future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. Stock Compensation Arrangements As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), the Company accounts for its stock compensation arrangements with employees under the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” The Company accounts for stock options granted to non-employees, primarily orthodontists, at fair value determined according to SFAS No. 123. The Company accounts for the incentive plans implemented in connection with the OrthAlliance merger in accordance with Emerging Issues Task Force Issue No. 96-18 and Issue No. 00-18. Earnings Per Share The calculation of earnings per share is performed using the treasury stock method. Reclassifications Certain reclassifications have been made to the prior year’s financial statements in order to conform to the current year’s presentation. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, “Business Combinations,” and No. 142, “Goodwill and Other Intangible Assets,” effective for fiscal years beginning after December 15, 2001. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, and prohibits the use of the pooling-of-interests method for such transactions. SFAS 142 requires that goodwill and intangible assets with indefinite lives, including such assets recorded in past business combinations, no longer be amortized, but instead be tested for impairment by measuring the reporting unit at fair value with the initial impairment test performed within six months from the beginning of the year in which the standard is adopted. SFAS 142 also requires that the impairment test be performed at least annually thereafter, with interim testing required if circumstances warrant. Intangible assets with finite lives will continue to be amortized over their useful lives and reviewed for impairment. The Company applied provisions of SFAS No. 141 and No. 142 in recording its business combination with OrthAlliance on November 9, 2001, and did not amortize goodwill arising from the combination in accordance with SFAS No. 142. On January 1, 2002, the Company will adopt SFAS No. 141 and No. 142, except for the provisions in SFAS 141 related to the business combination with OrthAlliance which was adopted on November 9, 2001. The Company has not completed its initial evaluation of goodwill impairment that is required with the adoption of SFAS No. 142. However, based on a preliminary evaluation, the Company does not believe that its existing goodwill balance is currently impaired under the new standard. However, no assurances can be given regarding future impairment. The Company anticipates completing the initial evaluation by June 30, 2002, which is within the six month transition period allowed by the new standard upon adoption. In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which addresses the financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” and provisions of APB Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” for the disposal of a segment of a business. The Company will adopt SFAS No. 144 on January 1, 2002, which management expects will not have a material impact on the Company’s financial position or results of operations. 3. Business Combination with OrthAlliance On November 9, 2001, a newly-formed subsidiary of the Company merged with and into OrthAlliance, Inc. (“OrthAlliance”). As a result of the merger, OrthAlliance became a wholly-owned subsidiary of the Company. OrthAlliance provides management and consulting services to orthodontic and pediatric dental practices throughout the United States. In the merger, each share of OrthAlliance Class A and Class B common stock was exchanged for 0.10135 shares of the Company’s common stock, with cash paid for fractional shares of the Company’s common stock. The Company issued approximately 1.2 million shares of common stock with a total value of $32.3 million, based on the last sale price of the Company’s common stock on the New York Stock Exchange on the day immediately preceding the merger ($26.05 on November 8, 2001). The Company also incurred approximately $4.2 million in merger-related expenses and assumed approximately $119.8 million of liabilities. The Company believes that the OrthAlliance merger provided a unique opportunity for the Company to expand and affiliate with a large number of quality orthodontic and pediatric dental practices at a single time. The acquisition was accounted for using the purchase method of accounting. The results of operations of OrthAlliance subsequent to November 9, 2001 have been included in the Company’s consolidated statements of income. The results of OrthAlliance do not include results of operations relating to Service Agreements with certain affiliated practices that are parties to litigation pending against OrthAlliance and have ceased remitting service fees to OrthAlliance (the “Excluded OrthAlliance Affiliated Practices”). See Note 12 for further discussion of litigation relating to OrthAlliance. The purchase price has been allocated to the acquired assets, including identifiable intangible assets, and liabilities assumed based on their estimated fair values. These allocations are preliminary and, therefore, subject to change as the Company obtains more information and as certain pre-acquisition contingencies, particularly those related to litigation, are resolved. The purchase price allocation as of November 9, 2001 is as follows (in thousands):
Following the announcement of the merger agreement with OrthAlliance, a number of OrthAlliance’s affiliated practices commenced litigation against OrthAlliance, alleging, among other things, that OrthAlliance breached the terms of their Service Agreements by failing to provide certain services and/or that certain provisions of their Service Agreements may be unenforceable. In determining the purchase price allocation, the Company has assigned no value to advances to affiliated practices, property, equipment and improvements, notes receivable, and Service Agreements relating to certain OrthAlliance affiliated practices that are parties to such pending litigation and have ceased paying service fees to OrthAlliance, because of the inherent uncertainties of the litigation process, the relatively early stages of these lawsuits and the recentness of the merger, all of which create uncertainties with respect to the recoverability of these assets. Also, the allocation does not reflect any proceeds that may be received by OrthAlliance from these affiliated practices in consideration for certain assets or termination of their Service Agreements. Therefore, the above estimated values are preliminary and may change as more facts become known. The assignment of no value to assets related to these affiliated practices does not reflect a belief by management that these lawsuits have merit or that the plaintiffs will ultimately prevail in these actions. In connection with the OrthAlliance merger, the Company acquired a liability for certain estimated additional merger-related costs that may be incurred by the Company, including estimated attorneys fees and legal expenses anticipated to be incurred in connection with these lawsuits. See Note 12 for further discussion of legal proceedings. Intangible assets represent the costs of obtaining Service Agreements, pursuant to which the Company obtains the exclusive right to provide business operations, financial, marketing and administrative services to the Affiliated Practices during the term of the Service Agreements. The intangible assets are being amortized on a straight-line basis over the lives of the Service Agreements (up to 25 years), with a weighted-average life of 20 years. Part of the amortization generated by these intangible assets is not deductible for income tax purposes. OrthAlliance’s Service Agreements are with a professional corporation or other entity owned by an orthodontist or pediatric dentist. OrthAlliance’s Service Agreements generally provide that the professional corporation or other entity is responsible for providing orthodontic or pediatric dental services and for hiring orthodontists or pediatric dentists. These Service Agreements also generally provide that OrthAlliance services are feasible only if the professional entity operates an active orthodontic or pediatric dental practice to which it and each orthodontist associated with the professional entity devotes their full time and attention. These Service Agreements also generally require that the professional entity enter into an employment agreement with the owner of the professional entity and other practitioners providing services in the respective practice. These employment agreements are generally for a term of five years, which generally automatically renew for one year terms unless earlier terminated. The weighted-average remaining life of the terms of the existing employment agreements is approximately 3 years. Under these employment agreements, the orthodontist or pediatric dentist may generally terminate their employment (subject to a covenant not to compete) following the initial term of the agreement by giving at least one year’s prior written notice. Approximately five of OrthAlliance’s affiliated practitioners formerly affiliated with New Image (not including nine of the Excluded OrthAlliance Affiliated Practices) may terminate their employment agreement prior to expiration of their term by giving at least one year’s prior written notice and by paying a termination fee ranging from $300,000 to $1,000,000. In connection with the OrthAlliance merger, the Company implemented seven incentive programs under which the Company offered shares of its common stock to orthodontists and pediatric dentists who were owners and employees of Affiliated Practices that are parties to Service Agreements with OrthAlliance. Participation in each of these programs was conditioned upon execution of either a participation agreement or an amendment to the Affiliated Practices’ respective Service Agreement and employment agreement. See Note 9 for further discussion on these incentive programs. In connection with the OrthAlliance merger, the Company acquired liabilities for estimated employee severance and for operating lease agreements expected to be terminated. The severance accrual relates to approximately 30 OrthAlliance corporate employees. The operating lease payment accrual relates to facility leases assumed by the Company for facilities that have been vacated. Amounts accrued represent management’s estimates of the cost to exit these leases. Components and activity in 2001 for the liabilities assumed are as follows:
At December 31, 2001, the balance of these accrued liabilities for severance and operating facility leases of approximately $3.8 million is included in “accrued salaries and other accrued liabilities” on the Company’s Consolidated Balance Sheets. The following summarized unaudited pro forma income statement data reflects the impact that the OrthAlliance merger would have had on 2001 and 2000, had the acquisition taken place at January 1, 2000 (in thousands, except per share data):
The pro forma results include changes in amortization of the intangibles, property, equipment and improvements resulting from the purchase price allocation, and interest expense on debt assumed to finance the purchase. The pro forma results are not necessarily indicative of what actually would have occurred if the OrthAlliance merger had been completed as of January 1, 2000, nor are they necessarily indicative of future consolidated results. 4. Transactions and Affiliated Practices The following table summarizes the Company’s finalized agreements with Affiliated Practices to obtain Service Agreements and to acquire other assets for the years ended December 31, 2001, 2000 and 1999:
Advances to Affiliated Practices totaled $31.7 million and $16.7 million at December 31, 2001, and 2000, respectively. Of the advances at December 31, 2001, approximately $3.8 million was to Affiliated Practices that generated operating losses during the three months ended December 31, 2001 and $9.4 million was to Affiliated Practices in international locations. Of the advances to Affiliated Practices at December 31, 2000, approximately $1.2 million was to Affiliated Practices that generated operating losses during the three months ended December 31, 2000 and $6.2 million was to Affiliated Practices in international locations. As of December 31, 2001, the Company had established an allowance for uncollectible amounts of $9.0 million for advances to the Excluded OrthAlliance Affiliated Practices, which are parties to pending litigation and have ceased paying service fees to OrthAlliance, because of the inherent uncertainties of the litigation process, the relatively early stages of these lawsuits and the recentness of the merger, all of which create uncertainties with respect to the recoverability of these assets. Orthodontic centers that have been newly developed by the Company have typically generated initial operating losses as the practices in the centers begin to build a patient base. These newly developed centers have typically begun to generate operating profits after approximately 12 months of operations. To assist Affiliated Practices in obtaining financing for their portion of initial operating losses and capital improvements for newly developed orthodontic centers, the Company has entered into an agreement with a financial institution under which (i) the financial institution finances these operating losses and capital improvements directly to the Affiliated Practice, subject to the financial institution’s credit approval of the Affiliated Practice, and (ii) the Company remains a guarantor of the related debt. At December 31, 2001 and 2000 the Company was a guarantor for approximately $1.9 million and $2.5 million, respectively, of loans under this arrangement. Of these amounts, approximately $0.1 million and $0.2 million related to Affiliated Practices that generated operating losses during the three months ended December 31, 2001 and 2000, respectively. In connection with the merger with OrthAlliance, the Company acquired promissory notes from certain of OrthAlliance’s Affiliated Practices that are payable to OrthAlliance. Generally, principal and accrued interest under these promissory notes are payable in monthly installments, with interest accruing at prime plus 1% per year. Generally, these notes have maturity dates ranging from three to five years, are unsecured and are personally guaranteed by the respective practitioners. As of December 31, 2001, the amount due from these Affiliated Practices was $2.5 million. 5. Other Assets and Current Liabilities
6. Property, Equipment and Improvements Property, equipment and improvements consisted of the following (in thousands):
Depreciation expense was $10.9 million and $8.2 million for the years ended December 31, 2001 and 2000, respectively. 7. Long-Term Debt and Notes Payable Long-term debt consisted of the following (in thousands):
The aggregate maturities of long-term debt, excluding the credit facilities, as of December 31, 2001 for each of the next five years are as follows (in thousands): 2002—$4,036; 2003—$6,783; 2004—$3,740; 2005—$1,041, and 2006—$0. On November 9, 2001, the Company amended its syndicated $100.0 million revolving line of credit (the “Senior Credit Facility”) to allow for the OrthAlliance merger. Borrowings under the Senior Credit Facility were used to refinance certain existing indebtedness, finance certain acquisitions of assets of existing Affiliated Practices, provide working capital, and repay a portion of OrthAlliance’s revolving line of credit, as further discussed below. These borrowings are secured by security interests in the Company’s ownership interests in its operating subsidiaries. As of December 31, 2001, outstanding borrowings under the Senior Credit Facility were $69.0 million, comprised of $54.0 million in U.S. dollars and $15.0 million in Japanese yen (converted to U.S. dollars). The Senior Credit Facility provides for an interest rate based on LIBOR, plus the Applicable Margin, as defined in the Senior Credit Facility. The weighted-average interest rate outstanding on the Senior Credit Facility as of December 31, 2001 and 2000 was 4.0% and 6.27%, respectively. The Company also pays a quarterly commitment fee ranging from 0.25% to 0.375% per annum of the unused portion of available credit under the Senior Credit Facility. Also on November 9, 2001, the Company obtained a $50.0 million bridge credit facility (the “Bridge Credit Facility”), under which $50.0 million was immediately borrowed and was still outstanding as of December 31, 2001. Proceeds from the Bridge Credit Facility and certain of the proceeds from the Senior Credit Facility were used to repay the total outstanding balance under OrthAlliance’s revolving line of credit of $59.5 million at the completion of the merger. Upon repayment of the outstanding balance, OrthAlliance’s revolving line of credit was terminated. The Company has the right, upon written notice at least 30 days prior to November 9, 2002, to extend the Bridge Credit Facility to October 7, 2003. The Company anticipates that it will either repay a portion of the Bridge Credit Facility through cash flow from operations, enter into a new long-term financing arrangement to replace the Bridge Credit Facility, or extend the term on the Bridge Credit Facility to October 2003. If the Company exercises its right to extend the facility until October 2003, the interest rates shall accrue as follows:
The Company is presently reviewing its projections for cash needs and the possibility of obtaining a new long-term financing arrangement providing more favorable interest rates and terms. The Bridge Credit Facility presently provides for an interest rate based on LIBOR, plus the Applicable Margin, as defined in the Bridge Credit Facility. The interest rate on this facility was 4.15% as of December 31, 2001. The Senior Credit Facility and the Bridge Credit Facility require the Company to maintain certain financial and nonfinancial covenants under the terms of the agreements, including a maximum leverage ratio, minimum fixed charge coverage ratio and minimum consolidated net worth ratio. The Senior Credit Facility and the Bridge Credit Facility also restricts certain activities of the Company, including the payment of any cash dividends. At December 31, 2001, the Company was in compliance with the covenants and restrictions of the Senior Credit Facility and the Bridge Credit Facility. At December 31, 2001, the Company also had a $3,000,000 line of credit with a financial institution, of which none was outstanding. The line of credit 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, 2001, the Company was in compliance with the covenants and restrictions of the agreement. As part of the merger with OrthAlliance, the Company assumed notes payable to certain Affiliated Practices and to affiliates of Goldman Sachs. Total notes payable assumed from OrthAlliance was $14.4 million at December 31, 2001. 8. Leases Facilities for the Company’s Affiliated Practices and administrative offices are generally rented under long-term leases accounted for as operating leases. The original lease terms are generally 5 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 rental commitments as of December 31, 2001 are as follows (in thousands):
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 amounts. Rent expense attributable to minimum and additional rentals along with sublease income was as follows (in thousands):
9. Benefit Plans Employee and Director Stock Option Plans and Warrants 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 installments beginning two years after the grant date and expire 10 years after the grant date. At December 31, 2001, 451,944 shares were available for issuance under the Incentive Option Plan. 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. 1994 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. At December 31, 2001, 564,065 shares were available for issuance under the Director Option Plan. As a result of the merger with OrthAlliance, holders of stock options granted under OrthAlliance’s stock option plans and holders of warrants to purchase shares of OrthAlliance’s common stock became eligible to exercise those options and warrants for shares of the Company’s common stock. The number of shares subject to those options and warrants, and their exercise price, were adjusted based on the exchange ratio in the merger of 0.10135. At December 31, 2001, options to purchase 116,640 shares of the Company’s common stock, based on the exchange ratio in the OrthAlliance merger, were outstanding under OrthAlliance’s Amended and Restated 1997 Employee Stock Option Plan (“OrthAlliance 1997 Employee Plan”), and options to purchase 14,189 shares of the Company’s common stock, based on the exchange ratio in the OrthAlliance merger, were outstanding under OrthAlliance’s 2000 Employee Stock Option Plan (“OrthAlliance 2000 Employee Plan”). Options granted under the OrthAlliance 1997 Employee Plan and the OrthAlliance 2000 Employee Plan vest after being held for one to five years, are exercisable in whole or in installments and expire ten years from date of grant. As a result of the merger with OrthAlliance, holders of stock options granted under the OrthAlliance 2000 Employee Plan and the OrthAlliance 1997 Employee Plan became eligible to exercise those options for shares of the Company’s common stock upon the receipt of written notice of the right to such options. Any option not exercised within 90 days from such notice will terminate unless sooner terminated by such plan or applicable option agreement. These stock options are expected to terminate, unless earlier exercised, by the end of the second quarter of 2002. The options were issued with exercise prices equal to the market price of OrthAlliance’s common stock price at the date of grant. The Company does not intend to grant any additional options under the OrthAlliance 1997 Employee Plan or OrthAlliance 2000 Employee Plan. At December 31, 2001, options to purchase 29,898 shares of the Company’s common stock, based on the exchange ratio in the OrthAlliance merger, were outstanding under OrthAlliance’s 1997 Director Stock Option Plan (“OrthAlliance Director Plan”). Options granted under the OrthAlliance Director Plan vest after being held for one year, are exercisable in whole or in installments, and expire ten years from the date of grant. As a result of the merger with OrthAlliance, holders of stock options granted under the OrthAlliance Director Plan became eligible to exercise those options for shares of the Company’s common stock upon the receipt of written notice of the right to such options. Any option not exercised within 90 days from such notice will terminate unless sooner terminated by such plan or applicable option agreement. These stock options are expected to terminate, unless earlier exercised, by the end of the second quarter of 2002. The options were issued with exercise prices equal to the market price of OrthAlliance’s common stock at the date of grant. The Company does not intend to grant any additional options under the OrthAlliance Director Plan. In connection with OrthAlliance’s initial public offering in 1997, OrthAlliance granted warrants to purchase shares of OrthAlliance’s common stock. The vesting periods for those warrants ranged from immediate to one year and expire five years from the date of grant. Certain of these warrants have incidental registration rights pursuant to which the Company is obligated to use reasonable efforts to register the shares of common stock issued upon their exercise if the Company initiates a public offering and files a registration statement in connection therewith, excluding the registration of shares issued pursuant to an employee stock purchase or option plan or an acquisition or proposed acquisition by the Company. At December 31, 2001, warrants to purchase 55,096 shares of the Company’s common stock, based on the exchange ratio in the OrthAlliance merger, were outstanding. SFAS 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.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that 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, management believes that the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the option is amortized to expense over the option’s vesting period. Had the Company’s stock-based compensation plans been determined based on the fair value at the grant dates, the Company’s net income and earnings per share would have been reduced to the pro forma amounts (before the effect of the change in accounting principle in 2000) indicated below (in thousands, except per share data):
Employee Stock Purchase Plans The Company has reserved 200,000 of the authorized shares of its common stock for issuance under the Company’s 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 New York Stock Exchange on the applicable purchase date or the first trading date of the year, whichever is lower. In 1997, the Company implemented the Orthodontic Centers of America, Inc. 1997 Key Employee Stock Purchase Plan (the “Key Employee Purchase Plan”) to encourage ownership of the Company’s common stock by executive officers and other key employees of the Company and thereby align their interests with those of the Company’s shareholders. In 1997, 295,000 shares of the Company’s common stock were purchased under the Key Employee Purchase Plan. In connection with the Key Employee Purchase Plan, the Company financed the purchase price of each participating employee who purchased shares of the Company’s common stock pursuant to the Key Employee Purchase Plan. The Company’s Co-Chief Executive Officers were to personally finance 50% of the purchase price for such shares on terms comparable to loans from the Company for 50% of the purchase price; however, the Company financed all of the purchase price. These loans were evidenced by promissory notes bearing interest at 6.01% per annum, and were full recourse obligations of the employees that were secured by a pledge of all of the shares of the Company’s common stock acquired by the employees in connection with the loans. These loans have been recorded as a capital contribution to the Company. At December 31, 2001, approximately $488,000 of these loans were outstanding to employees who were still participating in the Key Employee Purchase Plan. These loans were recorded as due from key employees, which is a contra-account that reduces shareholders’ equity. In addition, at December 31, 2001, $1.0 million of loans to a former employee under the Key Employee Purchase Plan, which were assumed in October 1999 by the Company’s then Co-Chief Executive Officers, remained outstanding. These loans were reclassified at December 31, 2001 to prepaid expenses and other assets from capital contributions receivable from shareholders as the amount are due in 2002. Orthodontist Stock Option Plans 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 Option Plan (the “Orthodontist Option Plan”). Options may be granted to orthodontists who own an orthodontic entity which has a service 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 grant date. At December 31, 2001, 1,016,909 shares were available for issuance under the Orthodontist Option Plan. Expense of approximately $593,000, $110,000 and $410,000 has been recognized for the Orthodontist Option Plan for the years ended December 31, 2001, 2000 and 1999, respectively. As a result of the merger with OrthAlliance, holders of stock options granted under OrthAlliance’s stock option plans and holders of warrants to purchase shares of OrthAlliance’s common stock became eligible to exercise those options and warrants for shares of the Company’s common stock. The number of shares subject to those options and warrants, and their exercise price, were adjusted based on the exchange ratio in the merger of 0.10135. OrthAlliance had two existing stock option plans available to its affiliated practitioners at the time of the OrthAlliance merger. At December 31, 2001, options to purchase 9,817 shares of the Company’s common stock, based on the exchange ratio in the OrthAlliance merger, were outstanding under OrthAlliance’s 1999 Orthodontist Stock Option Plan (“OrthAlliance 1999 Orthodontist Plan”), and options to purchase 8,849 shares of the Company’s common stock, based on the exchange ratio in the OrthAlliance merger, were outstanding under OrthAlliance’s 1997 Orthodontist Stock Option Plan (“OrthAlliance 1997 Orthodontist Plan”). Options granted under the OrthAlliance 1997 Orthodontist Plan and OrthAlliance 1999 Orthodontist Plan vest at grant, are exercisable in whole or in installments and expire five years and three years, respectively, from the grant date. The Company does not intend to grant any additional options under the OrthAlliance 1999 Orthodontist Plan or OrthAlliance 1997 Orthodontist Plan. In connection with the merger with OrthAlliance, the Company implemented seven incentive programs under which shares of the Company’s common stock could be granted to orthodontists and pediatric dentists who were owners and employees of professional entities that were parties to service, management service or consulting agreements with OrthAlliance and its subsidiaries. Participation in each of the programs was conditioned upon, among other things, execution of either a participation agreement or an amendment to the service, management service or consulting agreement and employment agreement and completion of the merger with OrthAlliance. None of the practitioners met the eligibility requirements to participate in the OrthAlliance Stockholder Bonus Program, High Participation Bonus Program, Conversion Incentive Program, or the Doctors Trust Program. The three programs for which certain eligible practitioners elected to participate are the Stock Pool Program, Target Stock Program and the OrthAlliance Stockholder Value Program. To be eligible to participate in the Stock Pool Program, the OrthAlliance affiliated practitioners must have entered into an amendment to their service, management service or consulting agreement or new business services agreement with the Company and amend their employment agreement by September 30, 2001. There were 62 participants at December 31, 2001 who were eligible to be granted a total of 141,874 shares of the Company’s common stock. The number of shares to be granted to each participant was based on the amount of service fees paid to OrthAlliance or its subsidiaries, the number of months that they had been a party to a service, management service or consulting agreement with OrthAlliance or its subsidiaries and the date on which they entered into the amendments or new business services agreements. Shares are issuable in three annual installments, with one-third of the shares to be issued following each of the first, second and third anniversaries of the completion of the merger if the amount of service or consulting fees paid by the OrthAlliance affiliated practitioners and his or her professional entity to the Company during the twelve calendar months prior to that anniversary is at least 90% of the amount of service or consulting fees paid to OrthAlliance or its subsidiary during and for the twelve calendar months immediately preceding the completion of the merger. However, if that 90% minimum target is not achieved in a particular twelve calendar month period, but is achieved during one of the subsequent twelve calendar month periods prior to the third anniversary of the merger, then the installment of shares would be issuable at that time. To be eligible to participate in the Target Stock Program, the OrthAlliance affiliated practitioners must have entered into an amendment to their service, management service or consulting agreement or new business services agreement and amend their employment agreement prior to the merger. Under the Target Stock Program, the participants could be granted shares of the Company’s common stock, or a promissory note, with a value equal to three times 70% of the amount of service fees that their respective professional entities paid OrthAlliance or its subsidiaries during the 12 months prior to completion of the merger, provided that the amount of service fees they pay in the third year following completion of the merger is at least 70% greater than that amount. If the service fees increase by less than 70%, then the participant will receive a pro rata amount of shares of the Company’s common stock, or a promissory note. At December 31, 2001, there were 53 participants in the program. Under the program, the number of shares to which a participant may be entitled is based upon the market price of the Company’s common stock near the third anniversary of the OrthAlliance merger. The total potential dollar value of the Company’s common stock that may be issued under the program is approximately $20.6 million. Shares are issuable in four annual installments, with one-fourth of the shares to be issued following each of the fifth, sixth, seventh and eighth anniversaries of the completion of the merger if the amount of service or consulting fees paid by the OrthAlliance affiliated practitioners and his or her professional entity to the Company during the twelve calendar months prior to that anniversary is at least 90% of the amount of service or consulting fees paid to OrthAlliance or its subsidiary during and for the twelve calendar months immediately preceding the completion of the merger. However, if that 90% minimum target is not achieved in a particular twelve calendar month period, but is achieved during one of the subsequent twelve calendar month periods prior to the eighth anniversary of the merger, then the installment of shares would be issuable at that time. To be eligible to participate in the OrthAlliance Stockholder Value Program, the OrthAlliance affiliated practitioners must have entered an addendum to their service, management service or consulting agreements with OrthAlliance and its subsidiaries by December 31, 2001, in which they agreed to use the Company’s systems upon completion of the merger, or have entered into an amendment to their service, management service or consulting agreement or new business services agreements and an amendment to their employment agreements by September 30, 2001, and have received shares of OrthAlliance common stock as 50% or more of the consideration paid to them in connection with their initial affiliation with OrthAlliance or one of its subsidiaries. Under the OrthAlliance Stockholder Value Program, the participants were granted a base amount of 2,000 shares of the Company’s common stock and an additional number of shares of the Company’s common stock based on the amount of service fees paid to OrthAlliance or its subsidiary during the 12 months ended March 31, 2001 and the amount of consideration paid to such participant in connection with his or her original affiliation with OrthAlliance or its subsidiary. At December 31, 2001, there were 24 participants who were eligible to be granted a total of 220,094 shares of the Company’s common stock. Shares are issuable in four annual installments, with one-fourth of the shares to be issued following each of the second, third, fourth and fifth anniversaries of the completion of the merger if the amount of service or consulting fees paid by the OrthAlliance affiliated practitioners and his or her professional entity to the Company during the twelve calendar months prior to that anniversary is at least 90% of the amount of service or consulting fees paid to OrthAlliance or its subsidiary during and for the twelve calendar months immediately preceding the completion of the merger. However, if that 90% minimum target is not achieved in a particular twelve calendar month period, but is achieved during one of the subsequent twelve calendar month periods prior to the fifth anniversary of the merger, then the installment of shares would be issuable at that time. Stock Purchase Program 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. Under the program, a participating orthodontist contractually commits, generally at the time they enter into a Service Agreement, to purchase a certain amount of the Company’s common stock over a period of years. Shares under the program are purchased over a period of 12 years, with payments and issuance beginning two years after the participating orthodontist commits to purchase the shares. There are restrictions on transfer of shares purchased under this program, which lapse as to 2% of the shares in years 3, 4, and 5 following the commitment to purchase, as to 26% of the shares in year 6, as to 2% of the shares in years 7 and 8, as to 30% of the shares in year 9, as to 2% of the shares in years 10 and 11 and as to 30% of the shares in year 12. During the year ended December 31, 2001, 28,190 shares of the Company’s common stock were issued under the program, and participating orthodontists had committed to purchase a total of 1,828,742 shares of the Company’s common stock under the program at December 31, 2001. Summary of Outstanding Options and Warrants A summary of the Company’s stock option and warrant activity, and related information for the years ended December 31, 2001, 2000 and 1999 follows:
The shares of the Company’s common stock subject to options and warrants at December 31, 2001 were in the following exercise price ranges:
Defined Contribution Plan 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 $22,000, $45,000 and $59,000 for the years ended December 31, 2001, 2000 and 1999, respectively. At the date of the merger, OrthAlliance sponsored a 401(k) plan for all eligible, non-highly compensated employees with at least twelve months of employment with OrthAlliance. The plan does not provide for Company matching contributions. 10. Income Taxes 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:
Components
of the provision (benefit) for income taxes (before the tax effect of
the change in accounting in 2000) were as follows:
The reconciliation of income tax computed at the federal statutory rates to the provision for income taxes (before the tax effect of the change in accounting in 2000) is:
11. Earnings Per Share The following table sets forth the components of the basic and diluted net income (loss) per share calculations.
12. Commitments and Contingencies On May 12, 2000, two plaintiffs filed an action against the Company, in which they alleged that the Company breached an agreement to settle an earlier lawsuit by one of these plaintiffs regarding a proposed, but never completed, affiliation with that plaintiff, and that the Company fraudulently induced the plaintiff to settle the earlier lawsuit. The plaintiffs sought specific enforcement of the settlement agreement and unspecified compensatory and punitive damages and attorneys’ fees. A trial in this action was completed on March 13, 2002, and a judgment was rendered in favor of the plaintiffs, who were awarded compensatory and punitive damages and attorneys fees. The Company believes that it has meritorious grounds to support post-trial motions and an appeal challenging these results, and intends to file such motions and appeal. The Company also believes that it has adequately reserved for the estimated outcome of this lawsuit. The Company believes that the estimated outcome of this lawsuit will not have a material adverse effect on the Company’s financial position or results of operations. On October 17, 2000, the Company filed an action against a former employee whose employment was terminated for cause, in which the Company alleged that the former employee breached the terms of his employment agreement and failed to satisfy a condition to the Company’s performance under the employment agreement by failing and refusing to affiliate his orthodontic practice with the Company. In the action, the Company seeks a declaratory judgment that the former employee’s failure to satisfy this condition precedent relieves the Company of any obligations under the employment agreement, that the termination of employment for cause and the former employee’s failure to recruit a minimum number of affiliated orthodontists relieves the Company from any obligation to pay certain incentive compensation under the employment agreement and that, if the former employee is found to be entitled to incentive compensation, it should take the form of stock options rather than shares of the Company’s common stock. The Company also seeks repayment with interest of about $2.3 million that it loaned to the former employee, about $1.4 million that it paid to a lender as guarantor of a loan to the former employee and about $1.0 million that it advanced on the former employee’s behalf to lease, improve and equip a training center and orthodontic office. On November 1, 2000, the former employee filed a counterclaim against the Company, in which he alleged that the Company breached the terms of the employment agreement and an alleged oral agreement or modification to the employment agreement to convert about $3.0 million in loans to an interest-free basis and, at his option, compensation, and to waive his obligation to affiliate his practice with the Company. The former employee seeks an unspecified amount of damages or 940,000 shares of the Company’s common stock. A trial in this action has been scheduled to begin in April 2002. On April 9, 2001, an action was filed against the Company and Bartholomew F. Palmisano, Sr., our Chairman of the Board, President and Chief Executive Officer, Bartholomew F. Palmisano, Jr., our Chief Operating Officer, and Dr. Gasper Lazzara, Jr., our former Chairman of the Board, in which the plaintiff alleged that the Company and the other defendants violated Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder, by allegedly recognizing revenue in violation of generally accepted accounting principles and SEC disclosure requirements and by allegedly making false and misleading statements about the Company’s financial results and accounting. On May 17, 2001, May 17, 2001 and June 13, 2001, three similar actions were filed by other plaintiffs against the Company and the other defendants. Each of these actions purported to be filed as a class action on behalf of the plaintiff and other purchasers of shares of our common stock from April 27, 2000 through March 15, 2001. In each of these actions, the plaintiff sought unspecified compensatory damages, interest and attorneys’ fees. On June 27, 2001, the court consolidated these actions into one matter. On December 18, 2001, the court entered an order naming lead plaintiffs. On February 25, 2002, the lead plaintiffs filed a consolidated amended complaint that named W. Dennis Summers, one of the Company’s directors and former Interim President and Chief Executive Officer of OrthAlliance, as an additional defendant and purported to extend the class period for the action through February 7, 2002. In the amended complaint, the lead plaintiffs alleged, in addition to the prior allegations, that the Company and the other defendants violated Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder, by allegedly making false and misleading statements about the OrthAlliance merger and the status of litigation between OrthAlliance and certain of its affiliated practices. Approximately 56 of OrthAlliance’s affiliated practitioners and/or their professional corporations have filed actions against OrthAlliance that are currently pending in courts in a number of states. In these lawsuits, the plaintiffs have generally alleged that OrthAlliance breached their respective service, management service or consulting agreements with OrthAlliance, and that these agreements and the employment agreements between the practitioners and their professional corporations violate state laws prohibiting fee splitting and the corporate practice of dentistry. Certain of the plaintiffs have also alleged that OrthAlliance fraudulently induced the plaintiffs to enter into the service, management service or consulting agreements, that OrthAlliance breached a fiduciary duty allegedly owed to the plaintiffs and that OrthAlliance has been unjustly enriched under these agreements. The plaintiffs seek, among other things, actual or compensatory damages, an accounting of fees paid to OrthAlliance under their service, management service and consulting agreements and a recovery of amounts improperly paid, a declaratory judgement that their service, management service or consulting agreements and their employment agreements (including the covenants not to compete) are illegal or against public policy and therefore void and unenforceable, a declaratory judgment that the service, management service and consulting agreements are not assignable by OrthAlliance, rescission of those agreements, an award of attorneys fees and, in some cases, punitive damages. In one of the lawsuits, the plaintiffs also seek to revoke amendments to their respective employment agreements and service, management service or consulting agreements, which they executed in connection with the OrthAlliance merger, and to form a class of other OrthAlliance affiliated practices that entered into similar amendments in connection with the merger. The plaintiffs in this lawsuit also allege that they were wrongfully induced into signing the amendments based on misrepresentations about the Company’s business model and common stock and the benefits of being affiliated with the Company, and that the amendments were revocable until after the effective date of a registration statement relating to various incentive programs that the Company offered to OrthAlliance affiliated practices. OrthAlliance has filed counterclaims against the plaintiffs in these actions, in which OrthAlliance generally alleges that the plaintiffs have breached their service, management service and consulting agreements, that OrthAlliance detrimentally relied on the plaintiffs’ statements and actions in entering into these agreements, that the plaintiffs have been unjustly enriched under these agreements and that the individual plaintiffs have tortiously interfered with OrthAlliance’s contractual relations with the professional corporation plaintiffs. In these counterclaims, OrthAlliance generally seeks damages, specific performance of the agreements and attorneys fees. The Company intends to vigorously defend each of the actions described above, and believes that it has meritorious defenses in these cases. Litigation is, however, inherently uncertain, and the Company cannot assure you that it will prevail in any of these actions, nor can it estimate with reasonable certainty the amount of damages that it might incur. Regardless of the outcome of these lawsuits, they could be costly and time-consuming, and could divert the time and attention of management. The Company and its subsidiaries and Affiliated Practices are, and from time to time may become, party to other litigation or administrative proceedings which arise in the normal course of their business. 13. Quarterly Results of Operations (Unaudited) The following is a tabulation of the unaudited quarterly results of operations for the years ended December 31, 2001 and 2000. For the year ended December 31, 2000, the amounts include results previously reported by the Company and results restated to reflect the Company’s change in revenue recognition pursuant to SAB No. 101, “Revenue Recognition in Financial Statements” effective January 1, 2000.
A portion of the revenue that was included in the adjustment due to the cumulative effect of the accounting change as of January 1, 2000 was recognized as revenue in 2001. The amount of this recycled revenue was $9.5 million during the quarter ended March 31, 2001, $7.4 million during the quarter ended June 30, 2001, $5.2 million during the quarter ended September 30, 2001 and $1.8 million during the quarter ended December 31, 2001.
A portion of the revenue that was included in the adjustment due to the cumulative effect of the accounting change as of January 1, 2000 was recognized as revenue in 2000. The amount of this recycled revenue was $16.9 million during the quarter ended March 31, 2000, $15.3 million during the quarter ended June 30, 2000, $13.6 million during the quarter ended September 30, 2000 and $11.5 million during the quarter ended December 31, 2000. Back to top |
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