-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QO11w4I2qNzmnk+nTFb0qvGtCHTyHPqhz8UIShs1oOl9xhJfD4bX5y+E3zL7rUyp FaC+2bx/+PEBE62W5CFsog== 0000890566-00-000864.txt : 20000523 0000890566-00-000864.hdr.sgml : 20000523 ACCESSION NUMBER: 0000890566-00-000864 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000522 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CASTLE DENTAL CENTERS INC CENTRAL INDEX KEY: 0001018152 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-NURSING & PERSONAL CARE FACILITIES [8050] IRS NUMBER: 760486898 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-13263 FILM NUMBER: 640693 BUSINESS ADDRESS: STREET 1: 1360 POST OAK BLVD STREET 2: STE 1300 CITY: HOUSTON STATE: TX ZIP: 77056 BUSINESS PHONE: 7134798000 10-K405 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER: 1-13263 CASTLE DENTAL CENTERS, INC. DELAWARE (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) 76-0486898 (I.R.S. EMPLOYER IDENTIFICATION NO.) 1360 POST OAK BOULEVARD, SUITE 1300 HOUSTON, TEXAS (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) 77056 (ZIP CODE) (713) 479-8000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.001 PAR VALUE (TITLE OF CLASS) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes. [X] No. [ ] Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K ( 229.405 under the Securities Exchange Act of 1934) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of May 16, 2000, there were 6,417,206 shares of Castle Dental Centers, Inc. Common Stock, $.001 par value, issued and outstanding, of which 3,293,363, having an aggregate market value of approximately $8.2 million, were held by non-affiliates of the registrant. ================================================================================ TABLE OF CONTENTS PAGE Item 1. Business.................................................... 1 The Company ................................................ 1 The Dental Industry......................................... 2 Business Strategy .......................................... 3 Dental Network Development.................................. 3 Management Services Agreement............................... 5 Dentist Employment Agreements............................... 5 Services.................................................... 6 Operations.................................................. 6 Sales and Marketing ........................................ 7 Managed Care Contracts...................................... 8 Competition................................................. 8 Management Information Systems.............................. 9 Regulation.................................................. 9 Employees................................................... 11 Corporate Liability and Insurance........................... 11 Item 2. Properties.................................................. 11 Item 3. Legal Proceedings........................................... 12 Item 4. Submission of Matters to a Vote of Security Holders......... 12 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....................................... 13 Recent Sales of Unregistered Securities..................... 13 Item 6. Selected Financial Data..................................... 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 16 Introduction................................................ 16 Components of Revenues and Expenses......................... 17 Results of Operations....................................... 17 Liquidity and Capital Resources............................. 21 Year 2000................................................... 23 Inflation................................................... 23 Item 7A.Quantitative And Qualitative Disclosures About Market Risk.. 23 Item 8. Financial Statements and Supplementary Data................. 24 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....................... 24 Item 10. Directors and Executive Officers of the Registrant......... 25 Item 11. Executive Compensation..................................... 27 Item 12. Security Ownership of Certain Beneficial Owners and Management........................................... 29 Item 13. Certain Relationships and Related Transactions............. 31 Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................................. 33 i NOTE ON FORWARD-LOOKING STATEMENTS This Form 10-K contains "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. All statements other than statements of historical facts included in this Form 10-K are forward-looking statements. When used in this document, the words, "anticipate," "believe," "estimate" and "expect" and similar expressions are intended to identify such forward-looking statements. Such statements reflect the Company's current views with respect to future events and are subject to certain uncertainties and assumptions. Important factors that could cause actual results to differ materially from expectations ("Cautionary Statements") are disclosed in this Form 10-K, including without limitation in conjunction with the forward-looking statements included in this Form 10-K. Should one or more of these uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from expectations. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the Cautionary Statements. ii ITEM 1. BUSINESS THE COMPANY The Company develops, manages and operates integrated dental networks through contractual affiliations with general, orthodontic and multi-specialty dental practices in the United States. The Company currently conducts operations in the states of Texas, Florida, Tennessee and California. The Company does not engage in the practice of dentistry but rather establishes integrated dental networks by entering into management services agreements with affiliated dental practices to provide, on an exclusive basis, management and administrative services to affiliated dental practices. The Company's strategy is to provide high-quality care in selected markets with a view to achieving broad geographic coverage within those markets. The Company seeks to achieve operating efficiencies by consolidating and integrating affiliated practices into regional networks, realizing economies of scale in such areas as marketing, administration and purchasing and enhancing the revenues of its affiliated dental practices by increasing both patient visits and the range of specialty services offered. As of December 31, 1999, the Company provided management services to 102 dental centers with approximately 250 affiliated dentists, orthodontists and other dental specialists. The Company's objective is to make each of its dental networks the leading group dental care provider in each market it serves. Since its formation, the Company has applied traditional retail principles of business and marketing techniques to the practice of dentistry, including locating practices in high-profile locations, offering more affordable fees and payment plans, expanding the range of services offered, increasing market share through targeted advertising and offering extended office hours. By using the Castle Dental Centers' approach to managing affiliated dental practices, the Company believes it will enable affiliated dentists, orthodontists and other dental specialists to focus on delivering quality patient care and to realize significantly greater productivity than traditional individual and small-group dental practices. The Company believes that the provision of a full range of dental services through an integrated network is attractive to managed care payers and intends to continue to pursue managed care contracts. The Company negotiates capitated managed care contracts on behalf of its affiliated dental practices, which maintained an aggregate of 70 capitated managed care contracts covering approximately 110,000 members at December 31, 1999. The Company believes that the continued development of its networks will assist it in negotiating national and regional capitated arrangements with managed care payors on behalf of the affiliated practices. The Company intends to establish a consistent national identity for its business by implementing common practice management policies and procedures in all of its dental centers and affiliated dental practices nationwide. Moreover, the Company believes that its experience and expertise in managing multi-specialty dental group practices, as well as the development of name recognition associated with the name "Castle Dental Centers," will provide its affiliated dental practices with a competitive advantage in attracting and retaining patients and realizing practice efficiencies. The Company was formed in 1981 by Jack H. Castle, D.D.S. and Jack H. Castle, Jr., as a single location, multi-specialty dental practice in Houston, Texas. From 1982 through 1996, the Company expanded to a total of 10 locations with 39 dentists in the Houston metropolitan area. During this period the Company developed, implemented and refined the integrated dental network approach that it utilized as a basis for its national expansion. Since the end of 1996, the Company has expanded to a total of 25 dental centers in Houston through the development of nine DE NOVO dental centers and the March 1998 acquisition of six dental centers owned by Dental World, Inc. In May 1996, the Company acquired the assets of and entered into long-term management services agreements with 1st Dental Care, a dental practice with 11 locations in the Tampa/Clearwater, Florida area, and Mid-South Dental Centers, a dental practice with six dental centers in various locations in Tennessee. In August 1996, the Company increased its dental practices under management in Texas by acquiring the assets of Horizon Dental Centers, a dental practice with four dental centers in Fort Worth, Texas and four dental centers in Austin, Texas. In September 1997, the Company acquired SW Dental Associates, LC, a dental practice with four dental centers in the Austin, Texas metropolitan area. In December 1997, the Company acquired substantially all the assets of two individual practices in Ft. Worth, Texas and Nashville, 1 Tennessee. In March 1998, the Company expanded into the southern California market through the acquisition of an 80% interest in ("Castle West") a company formed to acquire Dental Consulting Services LLC, a dental management company affiliated with five dental centers in the Los Angeles area. Subsequent to March 1998, Castle West acquired three additional dental practices with four dental offices in the Los Angeles area increasing the number of dental centers managed by the Company to nine in that market. In July 1998, the Company acquired a dental management company and five related dental practices in Florida. In December 1998, the Company completed the acquisition of the assets of Dental Centers of America and its affiliated dental practices. Dental Centers of America operated 16 dental centers in San Antonio, Austin, Waco and the Dallas/Fort Worth metroplex. (All of the acquisitions are collectively referred to as the "Completed Acquisitions"). THE DENTAL INDUSTRY Dental care services in the United States are generally delivered through a fragmented system of local providers, primarily sole practitioners, or small groups of dentists, orthodontists or other dental specialists, practicing at a single location with a limited number of professional assistants and business office personnel. According to the American Dental Association 1996 Survey of Dental Practice ("ADA Survey"), there were approximately 152,000 actively practicing dental professionals in the U.S., of which approximately 8,900 were practicing orthodontists. Nearly 88% of the nation's private practitioners work either as sole practitioners or in a practice with one other dentist. The balance of these dentists practice in about 4700 groups of three or more dentists. However, dental, orthodontic and other specialty practices have followed the trend of the health care industry generally and are increasingly forming larger group practices. The annual aggregate domestic market for dental services was estimated by the Health Care Financing Administration, Health Care Financing Review (1999) to be approximately $53.8 billion for 1998, representing approximately 4.7% of total health care expenditures in the United States, and is projected to reach $93.1 billion by 2008. Within the total market for dental services in the United States, there are, in addition to general dentistry, a number of specialties, including orthodontics (the straightening of teeth and remedy of occlusion), periodontics (gum care), endodontics (root canal therapy), oral surgery (tooth extraction) and pedodontics (care of children's teeth). The dental services market has grown at a compound annual growth rate of approximately 8.0% from 1980 to 1998, and is projected to grow at a compound annual growth rate of approximately 6.0% through the year 2008. In contrast to other health care expenditures, dental services are primarily paid for by the patient. According to the U.S. Department of Health and Human Services, in 1998, consumer out-of-pocket expenditures accounted for 48% of the payment for dental services, compared to 16% for other medical services. Management believes that the growth in the dental industry has largely been driven by four factors: (i) an increase in the availability and types of dental insurance; (ii) an increasing demand for dental services from an aging population; (iii) the evolution of technology which makes dental care less traumatic; and (iv) an increased focus on preventive and cosmetic dentistry. Concerns over the accelerating cost of health care have resulted in the increasing importance of managed care in the dental industry. Managed care typically involves a third party (frequently the payer) assuming responsibility for ensuring that health care is provided in a high quality, cost-effective manner. According to industry sources, approximately 18% of the estimated 147 million people covered by dental benefits in 1997 were enrolled in managed care programs. Enrollment in managed dental care plans, according to the National Association of Dental Plans, is estimated to have grown from 7.8 million patients in 1990 to 22.8 million patients in 1995. The Company believes that the provision of dental, orthodontic and other specialty care will follow the pattern set by other segments of the health care industry, moving away from the sole practitioner model to a group practice environment in which a separate professional management team handles personnel, management, billing, marketing and other business functions. The trends which are leading dentists to affiliate with dental practice management companies include; (i) the increasingly capital intensive nature of acquiring and maintaining state-of-the-art dental equipment, laboratory and clinical facilities; (ii) the growing need to develop and maintain specialized management information and billing systems to meet the increasing demands of payers; and (iii) the increasingly more complicated, competitive and regulated business environment for 2 dentists. BUSINESS STRATEGY The Company's strategy is to develop integrated networks for the provision of a broad range of dental services through practice affiliations and development of DE NOVO dental centers that provide high-quality, cost-effective dental care in target markets. Key elements of this strategy are to: PROVIDE HIGH-QUALITY, COMPREHENSIVE, ONE-STOP FAMILY DENTAL HEALTH CARE. The prototypical Castle Dental Center provides general dentistry as well as a full range of dental specialties (including orthodontics, pedodontics, periodontics, endodontics, oral surgery and implantology), thereby allowing the majority of specialty referrals to remain in-house within the Company's network of facilities. By bringing together multi-specialty dental services within a single practice, the Company is able to realize operating efficiencies and economies of scale and to promote increased productivity, higher utilization of professionals and facilities, and the sharing of dental specialists among multiple locations. The Company's practice model also incorporates quality assurance and quality control programs, including peer review and continuing education and technique enhancement. The Company believes that its multi-specialty strategy significantly differentiates it from both individual and multi-center practices that typically offer only general dentistry, orthodontics or other single specialty dental services. DEVELOP COMPREHENSIVE DENTAL NETWORKS IN TARGET MARKETS. The Company intends to build its networks through DE NOVO development of additional practices within target markets. The Company seeks to consolidate and integrate its affiliated practices to establish regional dental care networks. The Company believes this network system will enable it to reduce the operating costs of its affiliated practices by centralizing certain functions such as telemarketing and advertising, billing and collections, payroll and accounting and by negotiating regional and national contracts for supplies, equipment, services and insurance. Once practice affiliations are established in a market, the Company seeks to assist the affiliated practices in expanding their range of services to make available specialty dental services not previously offered. APPLY TRADITIONAL RETAIL PRINCIPLES OF BUSINESS TO DENTAL CARE. The Company believes it can enhance revenues and profitability by applying traditional retail principles of business to the provision of dental services in its target markets. These principles include professionally produced broadcast and print advertisements targeting specific audiences, and extended hours of operation which are convenient for patients, including weekend and evening hours. As part of its retail-oriented strategy, the Company seeks to establish or, where appropriate, relocate each Castle Dental Center in a convenient location in or near a high-profile neighborhood retail area and utilizes innovative sales and marketing programs designed to create strong name recognition and increase patient visits. In addition, the Company stresses the breadth and affordability of its services and works closely with patients to establish treatment schedules and affordable payment plans tailored to the patients' needs. MARKET ITS NETWORKS TO MANAGED CARE ENTITIES. The Company believes that managed care will play an increasing role in the provision of dental services and therefore intends to market the services of its dental practice networks to the managed care community. The Company believes that contracting with managed care entities will facilitate entry into new markets and the expansion of existing networks, as well as improve the utilization of existing facilities by providing a source of patients to dentists with whom the Company is affiliated. In addition, such contracts, including capitated contracts, enable the Company to leverage its infrastructure and marketing efforts by increasing patient visits. DENTAL NETWORK DEVELOPMENT The Company seeks to build its dental networks through the DE NOVO development of dental practices in retail environments. Prior to 1999, the Company has expanded into new markets through the acquisition of multi-location group dental practices. Once the market entry acquisition has been made, the Company has expanded within its target markets primarily through the DE NOVO development of new dental centers. In 1999, the Company entered the Corpus Christi, Texas market by opening two DE NOVO centers. During 1999, the Company expanded solely through the development of DE NOVO centers and did not complete any acquisitions of dental practices. 3 DE NOVO DEVELOPMENT The Company opened 20 newly developed dental centers in 1999; three in Houston, two in Austin, three in Dallas/Fort Worth, four in San Antonio, two in Corpus Christi, Texas and four in Nashville, Tennessee. All of the new centers were located in leased facilities in neighborhood retail shopping centers areas. The two DE NOVO centers opened in Corpus Christi, Texas represent the Company's first venture into a new market other than by acquisition of existing dental centers. Development of each DE NOVO dental center costs approximately $300,000 in leasehold improvements, signage, and dental and office equipment, depending primarily on the size of the dental facility. All new dental centers in the Company's existing markets utilize the Castle Dental Centers name and logo. At December 31, 1999, the Company had four DE NOVO dental centers under various stages of development in Dallas, Nashville and Florida. The Company also had two centers under development for the purpose of relocating existing centers in the Houston area. The Company is expanding its development of DE novo dental centers in existing markets because management believes that opening of new dental centers that conform to the Company's operating model is more effective in creating brand awareness and increasing market share in existing markets than acquiring dental practices that have different operating characteristics. ACQUISITION CRITERIA The Company's acquisition strategy has been to identify successful dental management companies and dental practices in its target markets, acquire certain assets of the identified practices, enter into long-term management services agreements, and utilize these core practices as a base from which to expand within the target markets. Prior to entering any market, the Company considers such factors as population, demographics, market potential, competitive environment, supply of available dentists, dental regulatory environment, patient-provider ratios, advertising costs and the economic condition of the local market. Core acquisition candidates are successful group dental practices that the Company believes are leaders in their regional markets. In considering acquisitions, the Company evaluates qualitative issues such as the dental professionals' qualifications, experience and reputation in the local marketplace and their operating histories, as well as the ability to demonstrate potential for revenue growth and continued profitability. The contractual arrangements pursuant to which the Completed Acquisitions were made include representations and warranties from the sellers regarding the assets or stock being acquired, and management services agreements with the affiliated practices containing non-competition provisions with the former owners of such practices. Additionally, the Company typically has entered into option agreements with the owners of its affiliated dental practices that entitles the Company to select successor owners of the affiliated dental practice. In some acquisitions, the Company has acquired the assets or stock of the practice management company and either entered into new management services agreements with the affiliated dental practices or assigned the dentist employment agreements and other contractual obligations to an affiliated dental practice with which the Company has an existing management services agreement. AFFILIATION AND INTEGRATION OF DENTAL CENTERS In acquiring dental practice management companies and affiliating with dental practices, the Company typically: (i) acquires certain assets of the practice, and, in certain situations, laboratory or other ancillary facilities that are either owned by or affiliated with such practice as allowable by federal and state law; (ii) enters into a long-term management services agreement with such dental practice pursuant to which the Company provides comprehensive management services to the affiliated practice; (iii) requires that the affiliated dentists enter into employment agreements with the affiliated practices containing non-compete and liquidated damages provisions; and (iv) assumes the principal administrative, financial, marketing and general management functions of the affiliated practice, including employment of most administrative personnel. As soon as practicable following the acquisition of an affiliated dental practice, the Company initiates the process of converting the affiliated practice into a Castle Dental Center. This conversion process, the implementation and timing of which will vary from market to market, typically includes the addition of specialty dental services not previously offered by the practice, implementation of retail business concepts applied by the Company, and the implementation of operating procedures employed by the Company, including standardization of dental practice management, accounting and financial software. During 1999, the Company 4 completed the integration of all acquired dental practices and each of the Company's dental centers operate under the Castle Dental Centers name, utilize the same practice management software and follow the Company's standard operating procedures. MANAGEMENT SERVICES AGREEMENT The Company has entered into a management services agreement with each of its affiliated dental practices pursuant to which the Company becomes the exclusive manager and administrator of all non-dental services relating to the operation of the practice. The amount of the management fee charged by the Company to an affiliated dental practice is intended to reflect and is based on the fair value of the management services rendered by the Company to the affiliated dental practice. Subject to applicable law, the Company is paid a monthly management fee comprised of three components: (i) the costs incurred by it on behalf of the affiliated practice; (ii) a base management fee in an amount ranging from 12.5% to 20.0% of adjusted gross revenues; and (iii) a performance fee equal to the patient revenues of the affiliated dental practice less (a) the expenses of the affiliated dental practice and (b) the sum of (i) and (ii), as described in each agreement. In California, the Company is paid a monthly management fee comprised of two components: (i) the costs incurred by it on behalf of the affiliated practice and (ii) a management fee in an amount ranging from 15.0% to 30.0% of net patient revenues. With respect to the three California professional corporations that own dental practices formerly managed by DCS, the Company is paid a bonus equal to 30% of patient revenues in excess average monthly patient revenues over the prior two-year period. The amount of the management fee is reviewed by the Company and the affiliated dental practice not less frequently than annually in order to determine whether such fee should be adjusted, up or down, to continue to reflect the fair value of the management services rendered by the Company. The obligations of the Company under its management services agreements include assuming financial and other responsibility, either on its own or with the input and participation of the policy board of the affiliated practice, for the following (subject to limitations imposed by applicable state law): facilities, equipment and supplies; advertising, marketing and sales; training and development; operations management; provision of support services; risk management and utilization review; application and maintenance of applicable local licenses and permits; negotiation of contracts between the affiliated dental practice and third parties, including third-party payors, alternative delivery systems and purchasers of group health care services; establishing and maintaining billing and collection policies and procedures; fiscal matters, such as annual budgeting, maintaining financial and accounting records, and arranging for the preparation of tax returns; and maintaining insurance. The Company does not assume any authority, responsibility, supervision or control over the provision of dental services to patients or for diagnosis, treatment, procedure or other health care services, or the administration of any drugs used in connection with any dental practice. The typical management services agreement is for an initial term of 25 to 40 years, and is automatically renewed for successive five-year terms unless terminated at least 90 days before the end of the initial term or any renewal term. As part of the management services agreement, the Company requires that the majority shareholder of the affiliated dental practice execute an option agreement that grants the Company's designee the right to acquire all the shareholder's interest in the practice at a nominal cost. The Company can exercise the option at any time on 10 days written notice. The Company may nominate without restriction any licensed dentist as its designee and may transfer the option at any time to any qualified person, subject to applicable state regulations governing the practice of dentistry. The management services agreement does not limit the number of times that the option may be exercised. At December 31, 1999, all of the Company's affiliated dental practices were wholly-owned by an individual dentist. Additionally, the management services agreement may be terminated by the Company or the affiliated dental practice only in the event of the bankruptcy or default in the performance of the material duties of the non-terminating party. DENTIST EMPLOYMENT AGREEMENTS Each affiliated dental practice has entered into employment agreements with substantially all of its full-time dentists, orthodontists and other dental specialists. Although the form of contract varies somewhat among practices and among dentists with different specialties, the typical contract for a full-time dentist provides for a defined compensation arrangement, including performance-based compensation and, where market conditions permit and to the extent deemed enforceable under applicable law, a covenant not to compete. Each full-time 5 dentist, whether or not a party to a dentist employment agreement, is required to maintain professional liability insurance, and mandated coverage limits are generally at least $1.0 million per claim and $3.0 million in the aggregate. In addition, many affiliated dental practices employ part-time dentists. Not all part-time dentists have employment agreements, but all part-time dentists are required to carry professional liability insurance in specified amounts. Certain part-time dentists retained by some of the affiliated dental practices are independent contractors and have entered into independent contractor agreements. SERVICES The Company provides management expertise, marketing, information systems, capital resources and acquisition services to its affiliated dental practices. As a result, the Company is involved in the financial and administrative management of the affiliated dental practices, including legal, financial reporting, cash management, human resources and insurance assistance. The Company's goals in providing such services are (i) to allow the dentists associated with affiliated dental practices to dedicate their time and efforts more fully to patient care and professional practice activities; (ii) to improve the performance of affiliated dental practices in these administrative and sales activities; and (iii) to enhance the financial return to the Company. Aside from the centralization of functions mentioned above, the affiliated dental practices are encouraged to administer their practices in accordance with the needs of their specific patient populations. The practice of dentistry at each affiliated dental practice is under the exclusive control of the dentists who practice at those locations. The majority of services provided by the Company's affiliated dental centers are classified as general dentistry. General dentistry includes diagnostics, treatment planning, preventive care, removal of infection, fillings, crowns, bridges, partials, dentures, and extractions, all of which are currently being provided by the affiliated dental practices. Within its networks, the Company provides a wide range of specialty dental services. The Company seeks to expand the services offered by affiliated practices beyond general dentistry to include other dental specialty services and to improve efficiency by improving appointment availability, increasing practice visibility and assisting the practices in adding complementary services. These complementary services include orthodontics, periodontics (the diagnosis, treatment and prevention of infection of the gums and supporting bone around the teeth), endodontics (the diagnosis, treatment and prevention of infection of the oral tissues), oral surgery and implantology (the placement of abutments (implants) in the jaw bones to support tooth replacement). By adding these complementary services to the practice, the affiliated dental practices will retain the majority of specialty service referrals in-house, thereby increasing patient revenues. OPERATIONS CENTER DESIGN AND LOCATION The Company's dental centers are generally located in retail environments. Many of the dental centers include semi-private general dentistry treatment rooms, private treatment rooms and orthodontic bays. Currently, the Company's dental centers include from four to 22 treatment rooms and range in size from approximately 1,000 square feet to approximately 6,000 square feet. New dental centers, developed by the Company, range in size from 1,600 square feet to 4,000 square feet, and have from five to fourteen operatories. Since its formation, the Company has adapted its locations to accommodate the full range of dental specialties. The Company believes the application of its method of designing and locating dental centers will facilitate the expansion of services offered by the acquired practices. Where a dental center is not able, due to limitations of floor space, zoning or other reasons, to accommodate new services or specialists, the Company may seek to relocate such dental center to a more desirable retail location as soon as practicable. STAFFING AND SCHEDULING The Company believes that making its facilities available at times which are convenient to its patients is an important element of its strategy. As a result, the affiliated dental practices maintain extended hours of operation, with many dental centers opening as early as 7:00 a.m. and closing as late as 9:00 p.m. on weekdays and 5:00 p.m. on Saturdays and Sundays. The dental centers are staffed with dentists and dental assistants every day they are open, with orthodontists and other specialists rotating among several centers in order to 6 utilize their time optimally. Each patient typically is assigned to and sees the same dentist or specialist on all visits to the center. Each dental center is also regularly staffed with an office manager, front office staff and other support staff. FEES AND PAYMENT PLANS The Company believes that fees charged by its affiliated practices are typically lower than usual and customary fees within their respective markets. The affiliated practices generally provide a wide range of payment options, including cash, checks, credit cards, third party insurance and various forms of credit. In general, most general dentistry and specialty services, other than orthodontics, are paid for by the patient, or billed to the patient's insurance carrier, on the date the service is rendered. In some instances, the Company will extend credit in accordance with its established credit policies. The Company believes that its lower fees and ability to assist patients in obtaining financing provides it with a competitive advantage compared to sole practitioners and small group practices. The Company's typical orthodontic payment plan consists of no initial down payment and equal monthly payments during the term of treatment ranging from $88 to $98 per month, with an average contract period of approximately 24 months. After consultation with the orthodontic staff at the initial visit, the patient signs a contract outlining the terms of the treatment, including the anticipated length of treatment and the total fees. The number of required monthly payments is fixed at the beginning of the case and corresponds to the anticipated number of monthly treatments. During 1999 the Company adopted a payment policy requiring that new orthodontic patients arrange for an automatic monthly bank draft. Previously existing patients are billed in advance by the Company on a monthly basis. QUALITY ASSURANCE Affiliated dental practices are solely responsible for all aspects of the practice of dentistry. The Company has responsibility for the business and administrative aspects of the practices and exercises no control over the provision of dental services. The Company's management structure is designed to bring to its affiliated dental practices improvements in their recruiting and professional training. The Company expects that the increased visibility of the Company, the ability to offer career paths previously unavailable to dentists and the ability to recruit for multiple markets will give it an advantage in recruiting and retaining dentists. In addition, the Company believes that the ability to offer dentists in private practice the chance to practice in an environment where they do not assume capital risks and administrative burdens normally associated with private practice will make joining the Company an attractive choice for private practitioners. Most affiliated dental practices have policy boards comprised of representatives of both the Company and the affiliated dental practice. The policy boards are responsible for developing and implementing management and administrative policies for the overall operation of the affiliated dental practice. Specifically, the policy board has the authority to review and approve capital improvements and expansion, marketing and advertising, collection policies, provider and payer relationships, strategic planning and capital expenditures. However, in recognition of the laws and regulations applicable to the licensure and practice of dentistry, the policy board does not make clinical decisions, recommendations or other decisions that are required to be made by a licensed dentist. SALES AND MARKETING The Company intends to establish a consistent national identity for its business and to utilize the "Castle Dental Centers" name and logo at all its dental centers. As of December 31, 1999, the Castle Dental Centers name had been implemented at all affiliated locations. The Company applies traditional retail principles of business to the provision of dental care. These principles include network development, extended hours of operation, location optimization, signage, customized treatment schedules, affordable fees and payment plans. The Company uses both print advertising and professionally produced broadcast advertising to market its dental services to potential patients its existing markets and intends to use the same marketing techniques in newly acquired markets. The Company has also established a national telemarketing system in Houston, Texas to field calls generated by advertising, to confirm upcoming scheduled patient visits and to encourage patients to return for 7 follow-up visits and regularly scheduled six-month periodic exams. The national telemarketing system is based on a national 800 number (1-800-TO SMILE) and utilizes state-of-the-art software to identify patients and direct them to the nearest Company operated dental center. This system is presently utilized in all of the Company's markets. The telemarketers can enter all relevant information into the Company's management information system for patients making appointments for an initial visit, including pre-screening patients for insurance and other credit information. MANAGED CARE CONTRACTS The Company negotiates, on behalf of its affiliated dental practices, contracts with dental healthcare maintenance organizations, insurance companies, self insurance plans and other third-party payers pursuant to which services are provided on some type of discounted fee-for-service or capitated basis. Under capitated contracts the affiliated dental practice receives a predetermined amount per patient per month in exchange for providing certain necessary covered services to members of the plan. Usually, the capitated plans also provide for supplemental payments and/or co-payments by members for certain higher cost procedures such as crowns, root canal therapy and dentures. These contracts typically result in lower average fees for services than the usual and customary fees charges by the Company's affiliated dental practices and may, in certain instances, expose the Company to losses on contracts where the total revenues received are less than the costs of providing such dental care. The Company generally bears the risk of such loss because it consolidates the financial results of its affiliated dental practices. However, most of these contracts are cancelable by either party on 30 to 90 days written notice thereby reducing the risk of long-term adverse impact on the Company. At December 31, 1999, the Company and its affiliated dental practices maintained an aggregate of 70 capitated managed care contracts covering approximately 110,000 members. Capitation fees, excluding supplemental fees and co-payments by members, totaled $7.4 million, or approximately 7.4% of total patient revenues in 1999. No single contract amounted to a significant portion of the Company's revenues, as each of the Company's regional operations contracts separately with managed care providers. The Company periodically evaluates its capitated managed care contracts by comparing the average reimbursement per procedure plus the total capitation fees per contract to the usual and customary fees charged by the affiliated dental practice. If the aggregate reimbursement percentage for the capitated contract exceeds 55% of the usual and customary fees, the Company believes that the incremental costs of providing covered services are being recovered. Management believes that capitated managed care contracts, in the aggregate, are profitable and will continue to increase as a percentage of total patient revenues in the future. A component of the Company's strategy is to seek long-term relationships with insurance companies on a regional and national basis. The development of new dental centers and expanded networks of dentists and dental specialists in the Company's markets makes the Company's dental networks attractive to insurance companies and other third-party payers. Management believes that negotiating with major dental healthcare providers on a national basis will result in better coordination and improved financial results from its managed care contracts. COMPETITION The dental care industry is highly fragmented, comprised principally of sole practitioners and group practices of dental and orthodontic services. The dental practice management industry is subject to continuing changes in the provision of services and the selection and compensation of providers. The Company is aware of several dental practice management companies, both publicly-traded and privately owned, that are acquiring and managing dental practices. Publicly traded dental practice management companies that compete with the Company include Monarch Dental Corporation, American Dental Partners, Inc., Interdent, Inc., and Coast Dental Services, Inc., as well as others. Certain of the Company's competitors are larger and better capitalized, may provide a wider variety of services, may have greater experience in providing dental care management services and may have longer established relationships with buyers of such services. The existence of other dental practice management companies may also increase competition for acquisition candidates, thereby increasing amounts that must be paid for acquired practice management businesses. In certain markets, the demand for dental care professional personnel presently exceeds the supply of qualified personnel. As a result, the Company experiences competitive pressures for the recruitment and 8 retention of qualified dentists to deliver their services. The Company's future success depends in part on its ability to continue to recruit and retain qualified dentists to serve as employees or independent contractors of the affiliated dental practices. There can be no assurance that the Company will be able to recruit or retain a sufficient number of competent dentists to continue to expand its operations. MANAGEMENT INFORMATION SYSTEMS During the first quarter of 1999, the Company completed the integration of the dental practice management systems in all its offices into a single practice management system that is centralized in Houston. This system monitors and controls patient treatment, scheduling, invoicing of patients and insurance companies, productivity of clinical staffs and other practice related activities. During the third quarter of 1999 the Company implemented a web-based purchase order system to enable management to monitor and control dental and office supplies purchasing. The Company also utilizes centralized financial information and accounting systems. These systems are linked to the practice management systems allowing for automatic transfer of data between the practice management and financial information systems. REGULATION GENERAL The practice of dentistry is highly regulated, and there can be no assurance that the regulatory environment in which the affiliated dental practices and the Company operate will not change significantly in the future. In general, regulation of health care related companies also is increasing. Every state imposes licensing and other requirements on individual dentists and dental facilities and services. In addition, federal and state laws regulate health maintenance organizations and other managed care organizations for which dentists may be providers. In connection with its operations in existing markets and expansion into new markets, the Company may become subject to compliance with additional laws, regulations and interpretations or enforcement thereof. The ability of the Company to operate profitably will depend in part upon the Company and its affiliated dental practices obtaining and maintaining all necessary licenses, certifications and other approvals and operating in compliance with applicable health care regulations. Dental practices must meet federal, state and local regulatory standards in the areas of safety and health. Historically, those standards have not had any material adverse effect on the operations of the dental practices managed by the Company. Based on its familiarity with the operations of the dental practices managed by the Company, management believes that it, and the practices it manages, are in compliance in all material respects with all applicable federal, state and local laws and regulations relating to safety and health. MEDICARE AND MEDICAID FRAUD AND ABUSE Federal law prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for, or in order to induce, (i) the referral of a person for services, (ii) the furnishing or arranging for the furnishing of items or services or (iii) the purchase, lease or order or arranging or recommending purchasing, leasing or ordering of any item or service, in each case, reimbursable under Medicare or Medicaid. Because dental services are covered under various government programs, including Medicare, Medicaid or other federal and state programs, the law applies to dentists and the provision of dental services. Pursuant to this anti-kickback law, the federal government announced a policy of increased scrutiny of joint ventures and other transactions among health care providers in an effort to reduce potential fraud and abuse related to Medicare and Medicaid costs. Many states have similar anti-kickback laws, and in many cases these laws apply to all types of patients, not just Medicare and Medicaid beneficiaries. The applicability of these federal and state laws to many business transactions in the health care industry, including the Company's operations, has not yet been subject to judicial interpretation. Significant prohibitions against physician self-referrals, including those by dentists, for services covered by Medicare and Medicaid programs were enacted, subject to certain exceptions, by Congress in the Omnibus Budget Reconciliation Act of 1993. These prohibitions, commonly known as "Stark II," amended prior physician and dentist self-referral legislation known as "Stark I" (which applied only to clinical laboratory 9 referrals) by dramatically enlarging the list of services and investment interests to which the referral prohibitions apply. Effective January 1, 1995 and subject to certain exceptions, Stark II prohibits a physician or dentist or a member of his immediate family from referring Medicare or Medicaid patients to any entity providing "designated health services" in which the physician or dentist has an ownership or investment interest, or with which the physician or dentist has entered into a compensation arrangement, including the physician's or dentist's own group practice unless such practice satisfies the "group practice" exception. The designated health services include the provision of clinical laboratory services, radiology and other diagnostic services (including ultrasound services), radiation therapy services, physical and occupational therapy services, durable medical equipment, parenteral and enteral nutrients, certain equipment and supplies, prosthetics, orthotics, outpatient prescription drugs, home health services and inpatient and outpatient hospital services. A number of states also have laws that prohibit referrals for certain services such as x-rays by dentists if the dentist has certain enumerated financial relationships with the entity receiving the referral, unless an exception applies. Noncompliance with, or violation of, the federal anti-kickback legislation or Stark II can result in exclusion from Medicare and Medicaid as well as civil and criminal penalties. Similar penalties are provided for violation of state anti-kickback and self-referral laws. To the extent that the Company or any affiliated dental practice is deemed to be subject to these federal or similar state laws, the Company believes its intended activities will comply in all material respects with such statutes and regulations. STATE LEGISLATION In addition to the anti-kickback laws and anti-referral laws noted above, the laws of many states prohibit dentists from splitting fees with non-dentists and prohibit non-dental entities such as the Company from engaging in the practice of dentistry and from employing dentists to practice dentistry. The specific restrictions against the corporate practice of dentistry, as well as the interpretation of those restrictions by state regulatory authorities, vary from state to state. However, the restrictions are generally designed to prohibit a non-dental entity from controlling the professional assets of a dental practice (such as patient records, payer contracts and, in certain states, dental equipment), employing dentists to practice dentistry (or, in certain states, employing dental hygienists or dental assistants), controlling the content of a dentist's advertising or professional practice or sharing professional fees. The laws of many states also prohibit dental practitioners from paying any portion of fees received for dental services in consideration for the referral of a patient. In addition, many states impose limits on the tasks that may be delegated by dentists to dental assistants. State dental boards do not generally interpret these prohibitions as preventing a non-dental entity from owning non-professional assets used by a dentist in a dental practice or providing management services to a dentist provided that the following conditions are met: a licensed dentist has complete control and custody over the professional assets; the non-dental entity does not employ or control the dentists (or, in some states, dental hygienists or dental assistants); all dental services are provided by a licensed dentist; licensed dentists have control over the manner in which dental care is provided and all decisions affecting the provision of dental care. State laws generally require that the amount of a management fee be reflective of the fair market value of the services provided by the management company and certain states require that any management fee be a flat fee or cost-plus fee based on the cost of services performed by the Company. In general, the state dental practice acts do not address or provide any restrictions concerning the manner in which companies account for revenues from a dental practice subject to the above-noted restrictions relating to control over the professional activities of the dental practice, ownership of the professional assets of a dental practice and payments for management services. The Company does not control the practice of dentistry or employ dentists to practice dentistry. Moreover, in states in which it is prohibited the Company does not employ dental hygienists or dental assistants. The Company provides management services to its affiliated practices, and the management fees the Company charges for those services are consistent with the laws and regulations of the jurisdictions in which it operates. In addition, there are certain regulatory risks associated with the Company's role in negotiating and administering managed care and capitation contracts. The application of state insurance laws to reimbursement arrangements other than various types of fee-for-service arrangements is an unsettled area of law and is subject to interpretation by regulators with broad discretion. As the Company or its affiliated practices contract with 10 third-party payors, including self-insured plans, for certain non-fee-for-service basis arrangements, the Company or the affiliated dental practices may become subject to state insurance laws. In the event that the Company or the affiliated practices are determined to be engaged in the business of insurance, these parties could be required either to seek licensure as an insurance company or to change the form of their relationships with third-party payors, and may become subject to regulatory enforcement actions. In such events, the Company's revenues may be adversely affected. REGULATORY COMPLIANCE The Company regularly monitors developments in laws and regulations relating to dentistry. The Company may be required to modify its agreements, operations or marketing from time to time in response to changes in the business, statutory and regulatory environments. The Company plans to structure all of its agreements, operations and marketing in compliance with applicable law, although there can be no assurance that its arrangements will not be successfully challenged or that required changes may not have a material adverse effect on operations or profitability. EMPLOYEES As of December 31, 1999, the Company and its affiliated dental practices employed approximately 980 administrative and dental office personnel on a full-time or part-time basis, and the affiliated dental practices employed approximately 215 general dentists and 35 specialists on a full-time or part-time basis. As a component of its acquisition strategy, the Company frequently enters into employment or consulting agreements for ongoing management and administrative services with the dentists from whom it acquires affiliated practices. The Company believes that its relations with its employees are good. The Company believes that it may need to hire additional personnel to accommodate the demands prompted by the provision of services to each of the affiliated practices under the management services agreements, as well as to pursue its growth strategies. CORPORATE LIABILITY AND INSURANCE The provision of dental services entails an inherent risk of professional malpractice and other similar claims. Although the Company does not influence or control the practice of dentistry by dentists or have responsibility for compliance with certain regulatory and other requirements directly applicable to dentists and dental groups, the contractual relationship between the Company and the affiliated dental practices may subject the Company to some medical malpractice actions under various theories, including successor liability. There can be no assurance that claims, suits or complaints relating to services and products provided by managed practices will not be asserted against the Company in the future. The availability and cost of professional liability insurance has been affected by various factors, many of which are beyond the control of the Company. Significant increases in the cost of such insurance to the Company and its affiliated dental practices may have an adverse effect on the Company's operations. The Company requires each affiliated dental practice to maintain comprehensive general liability and professional liability coverage covering the practice and each dentist retained or employed by the affiliated dental practice, which normally provide for comprehensive general liability coverage of $1.0 million for each occurrence and $3.0 million annual aggregate, and professional liability coverage of not less than $1.0 million for each occurrence and $3.0 million annual aggregate. The Company maintains other insurance coverage including general liability, property, business interruption and workers' compensation, which management considers to be adequate for the size of the Company and the nature of its business. ITEM 2. PROPERTIES The Company leases approximately 12,000 square feet of space for executive, administrative, sales and marketing and operations offices in Houston, Texas. The Company's initial lease term, which expired in May 2000, has been extended at the Company's option for an additional 12 months. All of the Company's existing centers are leased. Four of the centers are owned by affiliates of the companies from whom the Company acquired affiliated dental practices and one dental center is owned by an 11 officer of the Company. The Company intends to lease centers or enter into build-to-suit arrangements with third parties for dental centers to be leased by the Company. Certain leases provide for fixed minimum rentals and provide for additional rental payments for common area maintenance, insurance and taxes. The leases carry varying terms expiring between 2000 and 2009 excluding options to renew. The majority of the centers are located in retail locations. The Company believes that its leased facilities are well maintained, in good condition and adequate for its current needs. Furthermore, the Company believes that suitable additional or replacement space will be available when required. ITEM 3. LEGAL PROCEEDINGS In August 1998, the former owner of certain dental practices acquired by the Company in August 1996, filed a lawsuit against the Company in the 190th District Court of Harris Count, Texas. The lawsuit alleged that the Company committed various acts of fraud, securities fraud, conspiracy, breach of contract and misrepresentation concerning the value of the Company's common stock issued in the acquisition of the dental practices. In August 1999, the Company settled the lawsuit and recorded a one-time charge of $1.4 million. In December 1998, a dentist with whom the Company had entered into an agreement to acquire his dental practice filed a demand for arbitration alleging that the Company is liable for damages resulting from the failure to complete the transaction. The transaction was not completed because at least one of the contingencies required for closing was not met. The dentist is claiming damages equal to the difference between the purchase price provided for in the agreement of $8.1 million and the fair market value of the practice. The Company believes that the asserted claims are without merit and that it is not liable for damages resulting from these allegations. At May 10, 2000, the arbitration proceeding was underway. The Company and certain of its subsidiaries are parties to a number of legal proceedings that have arisen in the ordinary course of business. While the outcome of these proceedings cannot be predicted with certainty, management does not expect these matters to have a material adverse effect on the Company. The Company carries insurance with coverage and coverage limits that it believes to be customary in the dental industry. Although there can be no assurance that such insurance will be sufficient to protect the Company against all contingencies, management believes that its insurance protection is reasonable in view of the nature and scope of the Company's operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded in the over-the-counter market and quoted on the Nasdaq National Market under the symbol "CASL." The following table presents the quarterly high and low sale prices as reported by the Nasdaq National Market for the quarters indicated. These quotations reflect the inter-dealer prices, without retail mark-up, markdown or commission and may not necessarily represent actual transactions. HIGH LOW ---- --- 1998: First Quarter.......................... 12.13 6.63 Second Quarter......................... 13.44 9.25 Third Quarter.......................... 11.50 4.00 Fourth Quarter......................... 9.25 4.00 1999: First Quarter.......................... 7.00 5.31 Second Quarter......................... 8.25 6.25 Third Quarter.......................... 6.56 2.50 Fourth Quarter......................... 4.09 2.13 As of May 16, 2000, there were 6,417,206 shares of the Company's Common Stock outstanding held by approximately 42 stockholders of record. The Company believes there are approximately 1,200 beneficial owners of the Common Stock. The Company has never paid a cash dividend on its Common Stock. The Company currently intends to retain earnings to finance the growth and development of its business and does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. In addition, the Company's bank credit facility permits the payment of dividends only to the extent the Company maintains a specified minimum net worth. The Company's net worth as of December 31, 1999 was approximately $37.2 million. Any future change in the Company's dividend policy will be made at the discretion of the Company's Board of Directors in light of the financial condition, capital requirements, earnings and prospects of the Company and any restrictions under credit agreements, as well as other factors the Board of Directors may deem relevant. RECENT SALES OF UNREGISTERED SECURITIES On March 24, 1998, in connection with the acquisition by the Company of all of the outstanding capital stock of Dental World, Inc. ("Dental World"), the Company issued 23,342 shares of common stock to Reality, Ltd., the sole shareholder of Dental World. On March 30, 1998, the Company, through its wholly owned subsidiary CDC of California, Inc. ("CDC"), formed Castle Dental Centers of California, L.L.C. ("Castle West") for the purpose of acquiring the business of Dental Consulting Services, LLC ("DCS"). In connection with this acquisition, the Company issued an aggregate of $2,689,151 in its 8% subordinated promissory notes due March 30, 2001 to the five members of DCS ("DCS Members"). Following Castle West's formation: (i) CDC owned the Class A Membership Interest and the Class D Membership Interest in Castle West; (ii) sole-purpose corporations owned by the DCS Members ("Corporate B Members") collectively owned 100% of DCS, which owned the Class B Membership Interest in Castle West; and (iii) sole-purpose corporations (the "Corporate C Members") owned by the DCS Members plus one additional person collectively owned 100% of Castle West Holdings, L.L.C. ("Holdings"), which owned the Class C Membership Interest in Castle West. The Corporate B Members as a group were granted the one-time right (the "B Merger Option"), beginning March 30, 1999, to merge all of the Corporate B Members into CDC in exchange for the issuance of shares of the Company's common stock. The number of shares of common stock issuable upon exercise of the B Merger Option ("B Merger Consideration") was 13 initially set at 407,452 shares of common stock, subject to an adjustment based upon the purchase price of practices acquired by Castle West between the closing of such transaction and the one-year anniversary thereof. Each Corporate C Member was granted the one-time right (the "C Merger Option"), beginning March 30, 2000, to merge into CDC in exchange for cash, notes and common stock. The consideration to be received upon the exercise of the C Merger Option ("C Merger Consideration") is based upon the economic performance of Castle West following the closing date of the DCS acquisition. At least 50% of the C Merger Consideration was payable by CDC in common stock (based upon its trading price) and, if a Corporate C Member elects to receive more than 25% of the C Merger Consideration in cash, CDC would have the option of delivering a promissory note of Castle for the amount by which such cash payment would otherwise exceed 25% of the C Merger Consideration. On January 28, 2000, CDC acquired the Class B Membership Interest and the Class C Membership Interest in Castle West from DCS and Holdings, respectively, and the B Merger Option and the C Merger Option were cancelled. CDC now owns all of the outstanding membership interests in Castle West. On July 9, 1998, in connection with the Company's acquisition of the assets of Jared Woolf, D.D.S. & Associates of Palmetto, P.A., Jared Woolf, D.D.S. & Associates of Venice, P.A. and Woolf Dentistry, P.A. ("Woolf Dentistry"), the Company issued 15,424 shares of common stock to Woolf Dentistry. In connection with this acquisition, the Company issued an aggregate of $370,000 in its 9% subordinated promissory notes due July 9, 2001 to Woolf Dentistry. On that same date, in connection with the Company's acquisition of the stock of Dentcor, Inc., the Company issued an aggregate of 20,566 shares to the two shareholders of Dentcor, Inc. On August 1, 1998, in connection with the acquisition by the Company of all of the outstanding capital stock of NA Dental Management, Inc., the Company issued 3,635 shares of common stock and $32,580 in its 8% subordinated promissory notes due June 30, 2000 to the sole shareholder of NA Dental Management, Inc. In September 1997, the Company issued 119,231 shares of Series B Convertible Preferred Stock (the "Series B Stock") in connection with the acquisition of SW Dental. The number of shares issued were equivalent to $1,550,000 divided by the initial public offering price of the Company's common stock of $13.00 per share. The Series B Stock was convertible at the holder's option, for a thirty-day period beginning one year after its issuance into an equivalent number of shares of the Company's common stock. On October 1, 1998, the holder of the 119,231 shares of Series B Preferred Stock exercised the right to redeem the shares into an 8% subordinated note, due June 2002, in the original principal amount of $1,550,000, payable in quarterly installments of $114,000 in principal and interest. On December 30, 1998, in connection with the Company's acquisition of the assets of DCA Limited Partnership, L.L.P. ("DCA") and Dental Administrators of Texas Limited Partnership, L.L.P. ("DAI") and 16 related dental practices, the Company issued 79,352 and 45,648 shares of common stock to DCA and DAI, respectively. In addition, in connection with such acquisition, the Company issued to DCA and DAI an aggregate of $1,250,000 in 6% Subordinated Promissory Notes due December 30, 2001. Each of the foregoing transactions was exempt from registration under Section 4(2) of the Securities Act, no public offering being involved. 14 ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31, ------------------------------------------------------------ 1995 1996 1997 1998 1999 -------- -------- -------- -------- -------- (in thousands, except per share date) STATEMENT OF OPERATIONS DATA: Net patient revenues .......................... $ 18,257 $ 29,601 $ 46,225 $ 74,823 $102,701 Expenses: Dentist salaries and other professional costs 3,345 7,454 11,325 18,516 26,984 Clinical salaries ........................... 1,879 6,760 10,248 16,612 21,408 Dental supplies and laboratory fees ......... 2,185 3,120 4,335 7,197 9,641 Rental and lease expense .................... 836 1,592 2,590 4,091 6,203 Advertising and marketing ................... 959 1,522 2,033 2,763 3,650 Depreciation and amortization ............... 336 1,088 2,132 3,615 5,941 Other operating expenses .................... 2,260 2,913 4,314 6,976 10,314 General and administrative (1) .............. 9,109 4,292 5,929 8,145 10,909 -------- -------- -------- -------- -------- Total expenses .......................... 20,909 28,741 42,906 67,915 95,050 -------- -------- -------- -------- -------- Operating income (loss) ....................... (2,652) 860 3,319 6,908 7,651 Litigation settlement ......................... -- -- -- -- 1,366 Interest expense .............................. 87 2,596 2,792 1,889 4,220 Other (income) expense ........................ -- (89) (84) (57) 34 -------- -------- -------- -------- -------- Income (loss) before income taxes and extraordinary loss ...................... (2,739) (1,647) 611 5,076 2,031 Provision (benefit) for income taxes (2) ...... (325) (561) 200 1,490 835 -------- -------- -------- -------- -------- Income (loss) before extraordinary loss ....... (2,414) (1,086) 411 3,586 1,196 Extraordinary loss ............................ -- -- (3,195) -- -- -------- -------- -------- -------- -------- Net income (loss)(2) .......................... (2,414) (1,086) (2,784) 3,586 1,196 Preferred stock dividends(3) .................. -- -- (1,930) -- -- -------- -------- -------- -------- -------- Net income (loss) attributable to common stock $ (2,414) $ (1,086) $ (4,714) $ 3,586 $ 1,196 ======== ======== ======== ======== ======== Income (loss) per common share: Basic and diluted: Income (loss) before extraordinary loss ... $ (0.34) $ 0.10 $ 0.54 $ 0.18 Extraordinary loss ........................ -- (0.78) -- -- -------- -------- -------- -------- Net income (loss) ......................... $ (0.34) $ (0.68) $ 0.54 $ 0.18 ======== ======== ======== ======== Weighted average number of common and common equivalent shares outstanding Basic .................................. 3,191 4,100 6,586 6,825 ======== ======== ======== ======== Diluted ................................ 3,191 4,132 6,608 6,850 ======== ======== ======== ========
15
YEAR ENDED DECEMBER 31, ---------------------------------------------------------- 1995 1996 1997 1998 1999 -------- -------- -------- -------- -------- (in thousands) BALANCE SHEET DATA: Cash and cash equivalents ........... $ 6,439 $ 119 $ 2,908 695 $ 59 Working capital (deficit) ........... 6,208 (3,244) 3,917 10,345 15,768 Total assets ........................ 12,677 29,098 44,513 100,035 114,982 Long-term debt, less current portion 9,462 20,529 3,659 44,937 53,996 Redeemable preferred stock .......... 2,928 2,928 1,550 -- -- Total stockholders' equity (deficit) (5,743) (3,509) 31,113 36,397 37,163
(1) In 1995, the Company expensed $2.6 million of deferred compensation in connection with an acquisition. (2) Prior to 1996, the significant operations of the Company were conducted through a Subchapter S corporation and accordingly were not subject to federal and state income taxes. If all the Company's operations had been subject to income taxes, net loss would have been $1.7 million for the year ended December 31, 1995. (3) The Company recorded a $1.9 million non-cash dividend to accrete the Series A Convertible Preferred Stock and Series C Convertible Preferred Stock to their estimated fair value. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The Company develops, manages and operates integrated dental networks through contractual affiliations with general, orthodontic and multi-specialty dental practices in Texas, Florida, Tennessee and California. The Company does not engage in the practice of dentistry but rather establishes integrated dental networks by entering into management services agreements with affiliated dental practices to provide on an exclusive basis management and administrative services to affiliated dental practices. The Company's strategy is to provide high-quality care in selected markets with a view to achieving broad geographic coverage within those markets. The Company seeks to achieve operating efficiencies by consolidating and integrating affiliated practices into regional networks, realizing economies of scale in such areas as marketing, administration and purchasing and enhancing the revenues of its affiliated dental practices by increasing both patient visits and the range of specialty services offered. As of December 31, 1999, the Company provided management services to 102 dental centers with approximately 250 affiliated dentists, orthodontists and other dental specialists. The Company's objective is to make each of its dental networks the leading group dental care provider in each market it serves. The Company applies traditional retail principles of business to the practice of dentistry, including situating practices in high-profile locations, offering affordable fees and payment plans, expanding the range of services offered, increasing market share through targeted advertising and offering extended office hours. By using the Castle Dental Centers' approach to managing affiliated dental practices, the Company believes it will enable affiliated dentists, orthodontists and other dental specialists to focus on delivering quality patient care and to realize greater productivity than traditional retail and small group dental practices. Certain of the affiliated dental practices derive a significant portion of their revenues from managed care contracts, preferred provider arrangements and other negotiated price agreements. While the Company generally negotiates the terms and conditions of managed care contracts, preferred provider arrangements and other negotiated price agreements, the affiliated dental practices are the contracting parties for all such relationships, and the Company is dependent on its affiliated dental practices for the success of such relationships. The Company generally bears the risk of loss resulting from any such arrangements because it consolidates the financial results of its affiliated dental practices. However, most of these contracts are cancelable by either party on 30 to 90 days written notice thereby reducing the risk of long-term adverse impact on the Company. At December 31, 1999, the Company and its affiliated dental practices maintained an aggregate of 70 capitated managed care contracts covering approximately 110,000 members. Capitation fees, excluding supplemental fees and co-payments by members, totaled $7.4 million, or approximately 7.4% of total patient 16 revenues in 1999. No single contract amounted to a significant portion of the Company's revenues, as each of the Company's regional operations contracts separately with managed care providers. The Company periodically evaluates its capitated managed care contracts by comparing the average reimbursement per procedure plus the total capitation fees per contract to the usual and customary fees charged by the affiliated dental practice. If the aggregate reimbursement percentage for the capitated contract exceeds 55% of the usual and customary fees, the Company believes that the incremental costs of providing covered services are being recovered. Management believes that capitated managed care contracts, in the aggregate, are profitable and will continue to contract with capitated managed care providers on a case-by-case basis. COMPONENTS OF REVENUES AND EXPENSES Net patient revenues represent amounts billed by the affiliated dental practices to patients and third-party payors for dental services rendered. Such amounts also include monthly capitation payments received from third-party payors pursuant to managed care contracts. Net revenues are reported at established rates reduced by contractual amounts based on agreements with patients, third party payers and others obligated to pay for services rendered. Under the terms of the typical management services agreement with an affiliated dental practice, the Company becomes the exclusive manager and administrator of all non-dental services relating to the operation of the practice. While actual terms of the various management agreements may vary from practice to practice, material aspects of all the management service agreements, including the ability of the Company to nominate the majority shareholder and the calculation of the management fees, are consistent. The obligations of the Company include assuming responsibility for the operating expenses incurred in connection with managing the dental centers. These expenses include salaries, wages and related costs of non-dental personnel, dental supplies and laboratory fees, rental and lease expenses, advertising and marketing costs, management information systems, and other operating expenses incurred at the dental centers. In addition to these expenses, the Company incurs general and administrative expenses related to the billing and collection of accounts receivable, financial management and control of the dental operations, insurance, training and development, and other general corporate expenditures. RESULTS OF OPERATIONS The following table sets forth the percentages of patient revenues represented by certain items reflected in the Company's Statements of Operations. The information that follows represents historical results of the Company and does not include pre-acquisition results of the dental practices that the Company has acquired. The Company acquired Southwest Dental Associates ("SW Dental") of Austin, Texas in September 1997, and two individual practices located in Fort Worth, Texas and Nashville, Tennessee in December 1997. In March 1998, the Company acquired Dental World, Inc. a dental practice management company located in Houston, Texas. In March 1998, the Company acquired an 80.0% interest in Castle West, which was formed to acquire Dental Consulting Services, LLC, a California-based dental practice management company. In July 1998, the Company acquired Dentcor, Inc., a dental management company, and five related dental practices in Florida. In August 1998, the Company acquired all the outstanding stock of two dental practices in the Los Angeles area and purchased the assets of a dental office in Houston. In December 1998, the Company acquired the assets of Dental Centers of America, Inc., which managed 16 dental centers in San Antonio, Austin and Dallas/Fort Worth, Texas, and Crenshaw Family Dental in Los Angeles. (All of the acquisitions in 1997 and 1998 are collectively referred to as the "Completed Acquisitions"). 17 YEAR ENDED DECEMBER 31, ------------------------- 1997 1998 1999 ----- ----- ----- Net patient revenues .......................... 100.0% 100.0% 100.0% Expenses: Dentist salaries and other professional costs 24.5% 24.7% 26.3% Clinical salaries ........................... 22.2% 22.2% 20.8% Dental supplies and laboratory fees ......... 9.4% 9.6% 9.4% Rental and lease expense .................... 5.6% 5.5% 6.0% Advertising and marketing ................... 4.4% 3.7% 3.6% Depreciation and amortization ............... 4.6% 4.8% 5.8% Other operating expenses .................... 9.3% 9.3% 10.0% General and administrative .................. 12.8% 10.9% 10.6% ----- ----- ----- Total expenses .......................... 92.8% 90.8% 92.6% ----- ----- ----- Operating income .............................. 7.2% 9.2% 7.4% Litigation settlement ......................... -- -- 1.3% Interest expense .............................. 6.0% 2.5% 4.1% Other (income) expense ........................ -0.2% -0.1% 0.0% ----- ----- ----- Income before income taxes and extraordinary loss ...................... 1.3% 6.8% 2.0% Provision for income taxes .................... 0.4% 2.0% 0.8% ----- ----- ----- Income before extraordinary loss .............. 0.9% 4.8% 1.2% Extraordinary loss ............................ -6.9% -- -- ----- ----- ----- Net income (loss) ............................. -6.0% 4.8% 1.2% Preferred stock dividends ..................... -4.2% -- -- ----- ----- ----- Net income (loss) attributable to common stock -10.2% 4.8% 1.2% ===== ===== ===== YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998 NET PATIENT REVENUES - Net patient revenues increased from $74.8 million for the year ended December 31, 1998 to $102.7 million for the year ended December 31, 1999, an increase of $27.9 million or 37.3%. Approximately $21.2 million of the increase was attributable to the acquisitions completed in 1998. Revenues from DE NOVO dental centers opened in 1998 and 1999 contributed $7.3 million of the increase, accounting for 26.2% of the revenue increase from 1998. Patient revenues from dental centers open for more than one year decreased from 1998. DENTIST SALARIES AND OTHER PROFESSIONAL COSTS -- Dentist salaries and other professional costs increased from $18.5 million for the year ended December 31, 1998 to $27.0 million for the year ended December 31, 1999, an increase of $8.5 million or 45.7%. Expressed as a percentage of net patient revenues, dentist salaries increased from 24.7% to 26.3% for the years ended December 31, 1997 and 1998, respectively, reflecting higher compensation paid to dentists and the impact of new dental center openings in 1998 and 1999. CLINICAL SALARIES -- Clinical salaries increased from $16.6 million for the year ended December 31, 1998 to $21.4 million for the year ended December 31, 1999, an increase of $4.8 million or 28.9%. The Completed Acquisitions accounted for $4.3 million of the increase and the DE NOVO centers accounted for $1.4 million. Clinical salaries in dental centers open for more than one year decreased by $0.9 million. Expressed as a percentage of patient revenues, clinical salaries decreased from 22.2% to 20.8% for the years ended December 31, 1998 and 1999, respectively, primarily due to productivity improvements. 18 DENTAL SUPPLIES AND LABORATORY FEES -- Dental supplies and laboratory fees increased from $7.2 million for the year ended December 31, 1998 to $9.6 million for the year ended December 31, 1999, an increase of $2.4 million or 33.3%. This increase resulted primarily from the Completed Acquisitions, which incurred $2.1 million in dental supplies and laboratory expenses. Expressed as a percentage of patient revenues, dental supplies and laboratory fees decreased from 9.6% in 1998 to 9.4% in 1999. RENTAL AND LEASE EXPENSE -- Rental and lease expense increased from $4.1 million for the year ended December 31, 1998 to $6.2 million for the year ended December 31, 1999, an increase of $2.1 million or 51.6%. Rental expense from the 29 dental centers opened in 1998 and 1999 accounted for $0.8 million of the increase and the Completed Acquisitions in Florida, California, and Texas accounted for $1.1. Expressed as a percentage of patient revenues, rental and lease expense increased from 5.5% in 1998 to 6.0% in 1999 due primarily to higher relative lease expense at the DE NOVO centers. ADVERTISING AND MARKETING -- Advertising and marketing expense increased from $2.8 million for the year ended December 31, 1998 to $3.7 million for the year ended December 31, 1999, an increase of 32.1%. Expressed as a percentage of patient revenues, advertising and marketing costs decreased from 3.7% in 1998 to 3.6% in 1999, as advertising expenses in established markets were favorably leveraged over additional dental centers opened in 1998 and 1999. DEPRECIATION AND AMORTIZATION -- Depreciation and amortization increased from $3.6 million for the year ended December 31, 1998 to $5.9 million for the year ended December 31, 1999, an increase of $2.3 million or 64.3%, primarily resulting from higher depreciation and amortization of management services agreements and other intangibles related to the Completed Acquisitions. As a percentage of patient revenues, depreciation and amortization increased from 4.8% to 5.8% for the years ended December 31, 1998 and 1999, respectively. OTHER OPERATING EXPENSES -- Other operating expenses increased from $7.0 million for the year ended December 31, 1998 to $10.3 million for the year ended December 31, 1999, an increase of approximately $3.3 million or 47.8%. Other operating expenses include expenses related to the operation of the Company's dental centers, such as utilities, taxes and management information systems, and bad debt expense incurred in the financing of patient receivables at the affiliated dental practices. The increase from 1998 to 1999 resulted from higher bad debt expense and operating expenses at the DE NOVO dental centers and the Completed Acquisitions. The increase in bad debt expense from $2.5 million, or 3.4% of revenues, in 1998 to $4.2 million, or 4.1% of revenues, in 1999 resulted from higher levels of patient receivables. Expressed as a percentage of revenues, other operating expenses increased from 9.3% in 1998 to 10.0% in 1999, primarily due to the higher provision for bad debts. GENERAL & ADMINISTRATIVE EXPENSE -- General and administrative expenses increased from $8.1 million for the year ended December 31, 1998 to $10.9 million for the year ended December 31, 1999, an increase of $2.8 million or 33.9%. The increase resulted from the addition of general and administrative expenses of the Completed Acquisitions, the centralization of certain functions formerly performed at a clinical level, and increased personnel and general corporate expenses at the Company's headquarters in Houston. Expressed as a percentage of patient revenues, general and administrative expense, however, decreased from 10.9% to 10.6% for years ended December 31, 1998 and 1999, respectively, due to relatively greater percentage increase in the Company's patient revenues. LITIGATION SETTLEMENT -- In August 1998, the former owner of certain dental practices acquired by the Company in August 1996, filed a lawsuit against the Company. The lawsuit alleged that the Company committed various acts of fraud, securities fraud, conspiracy, breach of contract and misrepresentation concerning the value of the Company's common stock issued in the acquisition of the dental practices. In August 1999, the Company settled the lawsuit and recorded a charge of $1.4 million. INTEREST EXPENSE -- Interest expense increased from $1.9 million for the year ended December 31, 1998 to $4.2 million for the year ended December 31, 1999, primarily resulting from higher bank borrowings. Bank borrowings increased from $39.4 million at December 31, 1998 to $50.9 million at December 31, 1999. 19 INCOME TAXES -- For the year ended December 31, 1998, the Company recorded a provision for income taxes of $1.5 million resulting from income before income taxes of $5.1 million. For the year ended December 31, 1999, the Company recorded a provision for income taxes of $0.8 million resulting from the income before income taxes of $2.0 million. The Company's average tax rate for 1998 was 29.4%, compared to an average tax rate of 41.1% in 1999. A portion of the litigation settlement was non-deductible for income tax purposes, resulting in the higher average rate. In addition, during 1998, the Company continued to realize benefits from net operating loss carry forwards and other tax deductions not recognized in prior years. Management expects that the average tax rate in future periods will be similar to the 1999 tax rate. YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 NET PATIENT REVENUES - Net patient revenues increased from $46.2 million for the year ended December 31, 1997 to $74.8 million for the year ended December 31, 1998, an increase of $28.6 million or 61.9%. Approximately $19.7 million of the increase was attributable to the Completed Acquisitions. Revenues from twelve DE NOVO stores opened in 1997 and 1998 contributed patient revenues of $5.0 million, or a 10.8% increase from 1997, while patient revenues from dental centers open for more than one year increased $4.1 million, or 9.0%, in 1998. DENTIST SALARIES AND OTHER PROFESSIONAL COSTS -- Dentist salaries and other professional costs increased from $11.3 million for the year ended December 31, 1997 to $18.5 million for the year ended December 31, 1998, an increase of $7.2 million or 63.5%. The Completed Acquisitions accounted for $4.9 million of the increase in dentist salaries. Expressed as a percentage of net patient revenues, dentist salaries increased from 24.5% to 24.7% for the years ended December 31, 1997 and 1998, respectively. CLINICAL SALARIES -- Clinical salaries increased from $10.2 million for the year ended December 31, 1997 to $16.6 million for the year ended December 31, 1998, an increase of $6.4 million or 62.1%. The Completed Acquisitions accounted for the increase in clinical salaries. Expressed as a percentage of patient revenues, clinical salaries remained unchanged at 22.2% for the years ended December 31, 1997 and 1998. DENTAL SUPPLIES AND LABORATORY FEES -- Dental supplies and laboratory fees increased from $4.3 million for the year ended December 31, 1997 to $7.2 million for the year ended December 31, 1998, an increase of $2.9 million or 66.0%. This increase resulted primarily from the Completed Acquisitions, which incurred $2.2 million in dental supplies and laboratory expenses. Expressed as a percentage of patient revenues, dental supplies and laboratory fees increased from 9.4% in 1997 to 9.6% in 1998. RENTAL AND LEASE EXPENSE -- Rental and lease expense increased from $2.6 million for the year ended December 31, 1997 to $4.1 million for the year ended December 31, 1998, an increase of $1.5 million or 57.9%. Rental expense from the Completed Acquisitions in Florida, California, and Texas accounted for $1.2 million of the increase with the balance resulting from the opening of ten new dental centers in 1997 and 1998. Expressed as a percentage of patient revenues, rental and lease expense decreased from 5.6% in 1997 to 5.5% in 1998. ADVERTISING AND MARKETING -- Advertising and marketing expense increased from $2.0 million for the year ended December 31, 1997 to $2.8 million for the year ended December 31, 1997, an increase of 35.9%. Expressed as a percentage of patient revenues, advertising and marketing costs decreased, primarily due to economies of scale, from 4.4% in 1997 to 3.7% in 1998. DEPRECIATION AND AMORTIZATION -- Depreciation and amortization increased from $2.1 million for the year ended December 31, 1997 to $3.6 million for the year ended December 31, 1998, an increase of $1.5 million or 69.6%, primarily resulting from higher depreciation and amortization of management services agreements and other intangibles related to the Completed Acquisitions. As a percentage of patient revenues, depreciation and amortization increased from 4.6% to 4.8% for the years ended December 31, 1997 and 1998, respectively. OTHER OPERATING EXPENSES -- Other operating expenses increased from $4.3 million for the year ended December 31, 1997 to $7.0 million for the year ended December 31, 1998, an increase of approximately $2.7 million or 61.7%. Other operating expenses include expenses related to the operation of the Company's dental centers, such as utilities, taxes and management information systems, and bad debt expense incurred in the financing of patient receivables at the affiliated dental practices. The increase from 1997 to 1998 resulted from 20 the Completed Acquisitions and the new dental centers opened during 1997 and 1998. Expressed as a percentage of revenues, however, other operating expenses remained at 9.3%, for the years ended December 31, 1997 and 1998. GENERAL & ADMINISTRATIVE EXPENSE -- General and administrative expenses increased from $5.9 million for the year ended December 31, 1997 to $8.1 million for the year ended December 31, 1998, an increase of $2.2 million or 35.4%. The increase resulted from the addition of general and administrative expenses of the Completed Acquisitions and increased personnel and general corporate expenses at the Company's headquarters in Houston. Expressed as a percentage of patient revenues, general and administrative expense, however, decreased from 12.8% to 10.9% for the years ended December 31, 1997 and 1998, respectively, due to relatively greater percentage increase in the Company's patient revenues. INTEREST EXPENSE -- Interest expense decreased from $2.8 million for the year ended December 31, 1997 to $1.9 million for the year ended December 31, 1998. In September and October 1997, the Company repaid approximately $23.9 million of its outstanding debt with the net proceeds of the initial public offering of the Company's common stock. Bank borrowings and the issuance of subordinated seller notes increased from $5.2 million to $42.2 million, for the years ended December 31, 1997 and 1998, respectively. INCOME TAXES -- For the year ended December 31, 1998, the Company recorded a provision for income taxes of $1.5 million resulting from income before income taxes of $5.1 million. For the year ended December 31, 1997, the Company recorded a provision for income taxes of $200,000 resulting from the income before income taxes and extraordinary loss of $611,000. The Company's average tax rate for 1998 was 29.4%, compared to an average tax rate of 30.3% in 1997. During 1998, the Company continued to realize benefits from net operating loss carry forwards and other tax deductions not recognized in prior years. Management expects that the average tax rate will be higher in future periods. PREFERRED STOCK DIVIDENDS -- Coincident with the completion of the initial public offering in September 1997, the holders of the Company's Series A and Series C Preferred Stock converted such shares into an aggregate of 948,243 shares of Company Common Stock. As a result, the Company recorded $1.9 million in non-cash dividends in the third quarter 1997, representing the accretion of the difference between the recorded value of the Preferred Stock and its redemption value. No such expense was recorded in 1998. LIQUIDITY AND CAPITAL RESOURCES Since 1996, the Company has relied on cash flow from operations and third party borrowings to finance its operations, and on a combination of third party borrowings, the issuance of Company common stock and subordinated seller notes, and the assumption of certain debt and lease obligations to finance its acquisitions. At December 31, 1999, the Company had net working capital of $15.8 million, representing an increase of $5.5 million from net working capital of $10.3 million at December 31, 1998. Current assets at December 31, 1999 consisted of cash of $59,000, billed and unbilled accounts receivable of $21.6 million, deferred income taxes of $2.5 million, and prepaid expenses and other current assets of $4.2 million. These were partially offset by current liabilities of $12.6 million at December 31, 1999, consisting primarily of $9.9 million in accounts payable and accrued liabilities, $2.2 million in current maturities of long-term debt, and $526,000 in accrued deferred compensation payments. For the year ended December 31, 1999, net cash used in operating activities was approximately $0.9 million, 2.8 million lower than net cash provided by operating activities of $1.9 million for the prior year resulting from lower net income of $2.4 million and changes in working capital, primarily accounts receivable. During 1999, increases in accounts receivable of $7.7 million, net of increased provision for bad debts, were partially offset by net income of $1.2 million, deferred income taxes of $0.8 million and depreciation and amortization of $6.0 million. Cash used in investing activities in 1999 totaled approximately $10.4 million, primarily consisting of capital expenditures to build new dental centers. Net cash provided by financing activities in 1999 amounted to approximately $10.6 million, primarily reflecting proceeds from bank borrowings of $11.5 million utilized to fund capital expenditures and operating activities during the year. The Company made principal payments of $1.5 million on subordinated seller notes and other third-party debt in 1999. For the year ended December 31, 1998, net cash provided by operating activities was approximately $1.9 million, compared to net cash used by operating activities of $502,000 for the prior year, primarily as a result 21 of higher net income offset by increased working capital requirements. Cash used in investing activities in 1998 totaled approximately $37.5 million, primarily for the acquisition of dental practices and capital expenditures to build new dental centers. Significant components of cash used in investing activities included $30.8 million to complete the acquisitions of Dental Consulting Services in Los Angeles, Dental World, Inc. in Houston, Dentcor Inc./Woolf & Associates P.A. in Florida, Dental Centers of America in San Antonio, and three individual practices in Los Angeles and $6.7 million in capital expenditures for new dental centers and computer systems and software. Cash provided by financing activities in 1998 amounted to approximately $33.4 million. Significant components of cash provided by financing activities included bank borrowings of $37.0 million utilized to finance the acquisitions completed in 1998. During 1998, the Company made principal payments of $3.3 million on its bank credit facility, subordinated seller notes and other third-party debt. The Company's principal sources of liquidity as of December 31, 1999 consisted primarily of cash and net accounts receivable. At year-end, there was less than $500,000 available to borrow under the Company's bank credit facility. In January 2000, the Company amended its bank credit agreement ("Credit Agreement") with its existing bank and entered into a senior subordinated note agreement (Subordinated Note Agreement) and a subordinated convertible note agreement (Convertible Note Agreement) with two lenders. In March 2000, the Company advised its lenders under the bank credit facility that it was in violation of certain financial covenants of the Credit Agreement. Accordingly, in May 2000, the Company again amended its credit facility to cure its covenant violations and to provide additional availability for the Company to complete the DE NOVO dental centers that are under development for 2000. The Credit Agreement provides for borrowings up to $55.0 million and matures November 2002. Advances under the bank credit facility require quarterly interest payments through March 2001 at which time principal becomes payable quarterly based on a five-year amortization with final payment at maturity. Borrowings under the bank credit facility may at no time exceed a specified borrowing base, which is calculated as a multiple of the Company's earnings before interest, income taxes, depreciation and amortization ("EBITDA"), as adjusted. The bank credit facility bears interest at variable rates, which are based upon either the bank's base rate or LIBOR, plus, in either case, a margin which varies according to the ratio of the Company's funded debt to the EBITDA, each as defined in the bank credit facility. A commitment fee is payable quarterly at rates ranging from 0.125 percent to 0.5 percent of the unused amounts for such quarter. The bank credit facility contains affirmative and negative covenants that require that Company to maintain certain financial ratios, limit the amount of additional indebtedness, limit the creation or existence of liens, set certain restrictions on acquisitions, mergers and sales of assets and restrict the payment of dividends. In addition, under the May 2000 amended Credit Agreement, capital expenditures for 2000 are limited to no more than $3.5 million, acquisitions are not permitted in 2000, and the payment of any litigation settlement is restricted to no more than $100,000, without consent of the lenders. At September 30, 1999, the Company received waivers concerning violations of certain financial covenants under the Credit Agreement. At December 31, 1999, $50.9 million was outstanding under the bank credit facility and the average interest rate on the Company's bank borrowings was 9.8%. At May 10, 2000, bank borrowings were $43.5 million and the average interest rate had increased to 11.2%. The Subordinated Note Agreement and Convertible Note Agreement provided borrowings of $13.7 and $1.3 million, respectively. Proceeds from these notes were used to reduce borrowings under the bank credit facility, to acquire the 20% minority interest in Castle West and to reduce other accrued liabilities and accounts payable. Loans under the Subordinated Note Agreement bear interest at the 90-day LIBOR rate plus five and one-half percent, payable quarterly, and are due in eight quarterly installments beginning in the sixty-third month following the closing date. Loans under the Convertible Note Agreement bear interest at the same rate as loans under the Subordinated Note Agreement and are due on demand beginning seven years after the closing date with a final maturity date of January 30, 2009. The convertible note is convertible at any time into 442,880 shares of Company common stock at the request of the holders at a fixed conversion price of $3.1125 per share. The Subordinated Note Agreement and Convertible Note Agreement contain affirmative and negative covenants that require that Company to maintain certain financial ratios, limit the amount of additional indebtedness, limit the creation or existence of liens, set certain restrictions on acquisitions, mergers and sales of assets and restrict the payment of dividends. 22 During 1999, the Company did not acquire any significant dental practices as development was concentrated on the addition of 20 de novo dental centers. During 1998, the Company acquired dental management companies and dental practices operating 36 dental centers in Texas, Florida and California. Total purchase consideration for the acquisitions amounted to $41.7 million, including related acquisition expenses and excluding assumed liabilities, consisting of $30.8 million in cash, $4.5 million in subordinated seller notes and 595,421 shares of Company stock and common stock equivalents (see "Recent Sales of Unregistered Securities"). The Company does not anticipate making any acquisitions in 2000 due to its emphasis on DE NOVO development of dental centers and limitations under its bank credit facility. At December 31, 1999 the Company had four dental centers under construction with leases committed on an additional seven locations. Development of eight centers is anticipated to be completed during the first seven months of 2000 subject to the availability of funds generated by cash flow from operations or from the bank credit facility. The Company has deferred construction of three new dental centers until 2001 and will be required to incur lease expenses for these facilities unless subleases are obtained. Capital expenditures in 2000 are expected to be approximately $3.5 million. Management believes that cash flow from operations and borrowings available under the bank credit facility should be sufficient to meet its anticipated capital expenditures and other operating requirements for the next 12 months. However, because future cash flows and the availability of financing are subject to a number of variables, such as the level of capital spending, the Company's financial performance and other factors, there can be no assurance that the Company's capital resources will be sufficient to maintain currently planned levels of capital expenditures or to fund future acquisitions. Additional debt and equity financing may be required for the Company to fund its DE NOVO development plans and to support operations. The availability of these capital sources will depend on prevailing market conditions and interest rates and the then-existing financial condition of the Company. YEAR 2000 The year 2000 issue is the result of computer programs using two digits to define the applicable year instead of four. Any programs that have time sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. A computer system that is not year 2000 compliant would not be able to correctly process certain data, or in extreme situations, system failure could result. During 1998 and 1999, as part of the Company's continuing program to upgrade its information systems in anticipation of future growth, the Company installed year 2000 compliant software for its corporate and regional operations. This installation was completed prior to December 31, 1999 and the Company has not experienced, nor does it anticipate, any significant disruptions in any of its computer systems or its operations as a result of the Y2K problem. To date, the incremental costs incurred by the Company that relate solely to the year 2000 compliance problem have not been and are not expected to be material. These costs are exclusive of upgrades made to the Company's systems in the ordinary course of business and consist primarily of internal employee time. The Company did not separately track the internal costs incurred for the Year 2000 project, which consisted primarily of payroll and related costs associated with employee time. Based upon the Company's current assessments, the costs of the Company's year 2000 compliance program did not have a material effect on the Company's financial condition, results of operations or cash flows. INFLATION Inflation has not had a significant impact on the results of operations of the Company during the last three years. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's only financial instruments with market risk exposure are revolving credit borrowings under its Credit Agreement which total $50.9 million at December 31, 1999. Based on this balance, a change of one percent in the interest rate would cause a change in interest expense of approximately $509,000, or $0.04 per share, on an annual basis. The bank credit facility was not entered into for trading purposes and carries interest at a pre-agreed upon percentage point spread from either the prime interest rate or Eurodollar 23 interest rate. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements required by this Item 8 are incorporated under Item 14 in Part IV of this Annual Report on Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 24 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following sets forth information as to the current directors and executive officers of the Company, including their ages, present principal occupations, other business experience during the last five years, memberships on committees of the Board of Directors and directorships in other publicly-held companies. DIRECTOR NAME AGE POSITION WITH THE COMPANY SINCE - ------------------------------------------------------------------------------- Jack H. Castle, Jr. 45 Chairman of the Board and Chief Executive Officer 1995 Jack H. Castle, D.D.S. 78 Director 1995 Robert J. Cresci (1)(2) 56 Director 1995 G. Kent Kahle (1) 48 Director 1995 Elizabeth A. Tilney(2) 42 Director 1996 Emmett E. Moore(1) 58 Director 1997 G. Daniel Siewert III 56 President and Chief Operating Officer John M. Slack 52 Vice President and Chief Financial Officer ------------------------ (1) Member of the Audit Committee. (2) Member of the Compensation Committee. Jack H. Castle, Jr. became a director in December 1995. He was a co-founder of the Company in 1981 and has served as Chief Executive Officer since 1990. He became the Company's Chairman in August 1996. Mr. Castle received a B.A. from Rollins College and a Masters of Business Administration from Wake Forest University. Mr. Castle is the son of Jack H. Castle, D.D.S. Jack H. Castle, D.D.S. became a director in December 1995 and served as Chairman of the Company from 1981 until August 1996. He is also the sole owner of Jack H. Castle, D.D.S., P.C., a dental practice managed by the Company (the "Texas PC"). Prior to co-founding the Company, Dr. Castle operated a single location dental practice. Dr. Castle graduated from the University of Houston in 1943 and received a Doctorate of Dental Surgery from the University of Texas Health Science Center in Houston in 1945. He served in the United States Navy from 1947 to 1949. Dr. Castle is the father of Jack H. Castle, Jr. Robert J. Cresci became a director in December 1995. Mr. Cresci has been a Managing Director of Pecks Management Partners Ltd., an investment management firm, since September 1990. Mr. Cresci currently serves on the boards of Sepracor, Inc., Aviva Petroleum Ltd., Film Roman, Inc., Quest Educational Corporation, Jfax.Com, Inc., Candlewood Hotel Co., Inc., SeraCare, Inc., E-Stamp Corporation and several private companies. G. Kent Kahle became a director in December 1995. He has been a Managing Director of The GulfStar Group, Inc., an investment banking firm, since 1990. From 1982 to 1990 Mr. Kahle held various positions with Rotan Mosle, Inc., most recently as Senior Vice President and Director. Mr. Kahle has a Masters of Business Administration from The Wharton School of the University of Pennsylvania and an A.B. from Brown University. He currently serves on the board of Total Safety Corporation, U.S. Legal Support, Inc., Plassein Packaging Corp. and De-Ro Products, Inc. Elizabeth A. Tilney became a director in August 1996. Ms. Tilney is Senior Vice President, Marketing, Communications and Human Resources of Enron Energy Services, having joined Enron in March 1996. From 1987 to 1996, Ms. Tilney held various positions with Russell Reynolds Associates, an executive search firm, 25 and was most recently an Executive Director. Ms. Tilney was an account manager associated with Ogilvy & Mather Advertising in New York and Houston from 1983 to 1987. Ms. Tilney has a Masters of Business Administration from The Amos Tuck School of Business Administration of Dartmouth College and a B.A. from the University of Virginia. Emmett E. Moore became a director in September 1997. Since June 1999, Mr. Moore has been Chairman of the Board and Chief Executive Officer of MedEvolve, Inc., a provider of internet-based information technology solutions to physicians' offices. From November 1997 until joining MedEvolve, he was engaged in private consulting and investments related to healthcare. From April 1995 until November 1997, Mr. Moore was the Chairman of the Board and Chief Executive Officer of Physicians Resource Group, Inc., a publicly-traded ophthalmology practice management company. Mr. Moore received B.B.A., J.D. and M.P.A. degrees from the University of Texas, and is a certified public accountant. G. Daniel Siewert III joined the Company in August 1997 as President and Chief Operating Officer. From January 1995 through June 1997, he served as Chief Operating Officer for Family Dental Center, Inc., a large group dental practice with locations in Sears Roebuck & Company stores. From November 1993 to December 1994, Mr. Siewert provided business management consulting for a major retail eye care company. Prior to that, from September 1990 until August 1993, he was Chief Executive Officer of National Vision Associates, Inc. John M. Slack joined the Company in December 1995 as Vice President and Chief Financial Officer. From November 1994 through November 1995, he served as Vice President and Chief Financial Officer of Team, Inc., a publicly-held environmental services company. From 1985 through August 1994, Mr. Slack was Vice President and Chief Financial Officer of Serv-Tech, Inc., a publicly-held industrial services company. Mr. Slack received a B.S. in international economics from Georgetown University in 1969. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors, officers and persons holding more than ten percent of a registered class of the Company's equity securities to file with the Securities and Exchange Commission ("SEC") and any stock exchange or automated quotation system on which the Common Stock may then be listed or quoted (i) initial reports of ownership, (ii) reports of changes in ownership and (iii) annual reports of ownership of Common Stock and other equity securities of the Company. Such directors, officers and ten-percent stockholders are also required to furnish the Company with copies of all such filed reports. Based solely upon review of the copies of such reports furnished to the Company and written representations that no other reports were required during 1999, the Company believes that all of the Company's executive officers and directors complied with Section 16(a) reporting requirements during 1999. 26 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table provides certain summary information concerning compensation earned by the Company's Chief Executive Officer and each of the other executive officers of the Company (the "Named Executive Officers") whose compensation exceeded $100,000 during the year ended December 31, 1999.
ANNUAL COMPENSATION LONG-TERM COMPENSATION OTHER ANNUAL RESTRICTED NUMBER OF ALL OTHER SALARY BONUS COMPENSATION STOCK OPTIONS COMPENSATION NAME AND PRINCIPAL POSITION YEAR ($) ($) $ AWARDS GRANTED ($)(1) - --------------------------- ------ ------- ----- ------------ ------ ------- ------------ Jack H. Castle, Jr. 1999 249,925 -- -- -- 75,000 3,504 Chief Executive Officer 1998 243,663 -- -- -- 75,000 12,388 1997 254,167 -- -- -- 100,000 -- G. Daniel Siewert III 1999 199,929 -- -- -- 75,000 12,000 President & Chief Operating 1998 199,320 -- -- -- 75,000 12,000 Officer 1997 61,698(2) -- -- -- 110,000 -- John M. Slack 1999 144,231 -- -- -- 50,000 7,407 Vice President, Chief Financial 1998 142,026 -- -- -- 50,000 -- Officer, Treasurer 1997 120,001 -- -- -- 30,000 -- and Secretary
(1) Other compensation paid to Mr. Castle, Mr. Siewert and Mr. Slack in 1999 and 1998 consisted of automobile allowances. (2) Represents less than one full year's compensation; pursuant to agreement between the officer and the Company, such officer's employment began on August 4, 1997. STOCK OPTIONS The following table reflects certain information regarding stock options granted to the Named Executive Officers during 1999. OPTION GRANTS IN 1999
INDIVIDUAL GRANTS -------------------------------------------- POTENTIAL REALIZABLE VALUE AT NUMBER OF ASSUMED ANNUAL RATES OF SECURITIES STOCK PRICE APPRECIATION UNDERLYING PERCENT OF TOTAL FOR OPTION TERM OPTIONS OPTIONS GRANTED TO EXERCISE EXPIRATION ----------------------------- NAME GRANTED EMPLOYEES IN 1999 PRICE DATE 5%($) 10%($) ---- ------- ------------------ ------- ---------- -------- -------- Jack H. Castle, Jr. 75,000 29.7% $2.3125 11/07/08 $109,074 $276,415 G. Daniel Siewert III 75,000 29.7% $2.3125 11/07/08 $109,074 $267,415 John M. Slack 50,000 19.8% $2.3125 11/07/08 $ 72,716 $184,276
27 AGGREGATE OPTION EXERCISES IN 1999 AND YEAR-END 1999 OPTION VALUES The following table reflects certain information concerning the number of unexercised options held by the Named Executive Officers and the value of such officers' unexercised options as of December 31, 1999. No options were exercised by the Named Executive Officers during the year ended December 31, 1999.
NUMBER OF VALUE OF UNEXERCISED UNEXERCISED OPTIONS "IN THE MONEY" OPTIONS SHARES AT DECEMBER 31, 1999 (#) AT DECEMBER 31, 1999(1) ACQUIRED ON --------------------------- ---------------------------- NAME EXERCISE VALUE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- -------- -------------- ----------- ------------- ----------- ------------- Jack H. Castle, Jr. - - 58,750 191,250 - $51,563 G. Daniel Siewert III - - 68,750 191,250 - $51,563 John M. Slack - - 36,500 113,500 - $34,375
(1) Options are "in-the-money" if the closing market price of the Company's Common Stock exceeds the exercise price of the options. The exercise price of the options granted to the Named Executive Officers ranges from $2.3125 to $10.00 per share. The value of unexercised options for each of the Named Executive Officers represents the difference between the exercise price of such options and the closing price of the Company's Common Stock on December 31, 1999 ($3.00 per share). None of the "in-the-money" options granted to the Named Executive Officers were exercisable at December 31, 1999. 28 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information as of March 31, 2000 with respect to beneficial ownership of the Company's Common Stock by (i) each director, (ii) each executive officer, (iii) the executive officers and directors as a group, and (iv) each person known to the Company who beneficially owns 5% or more of the outstanding shares of its voting securities. Unless otherwise indicated, each of the stockholders has sole voting and investment power with respect to the shares beneficially owned.
NUMBER OF PERCENTAGE SHARES OF SHARES NAME AND ADDRESS OF BENEFICIALLY BENEFICIALLY BENEFICIAL OWNER OWNED OWNED ---------------- ----- ----- Jack H. Castle, Jr. (1)(2)......................... 1,386,75 22.4% Jack H. Castle, D.D.S. (2)(3)...................... 974,000 15.2% Loretta Castle (2)(3).............................. 974,000 15.2% Castle Interests, Ltd. (2) 1360 Post Oak Boulevard, Suite 1300, Houston, Texas 77056................... 514,000 8.0% Pecks Management Partners, Ltd. (4) One Rockefeller Plaza, Suite 900 New York, New York 10020........................... 913,243 14.2 Robert J. Cresci (5)............................... 923,243 14.4 The Capital Group Companies, Inc. 333 South Hope Street Los Angeles, California 90071..................... 625,000 9.7 Benson Associates, LLC 111 S.W. Fifth Avenue, Suite 2130 Portland, Oregon 97204............................. 542,900 8.5 G. Kent Kahle (6).................................. 75,329 1.2 G. Daniel Siewert III (7).......................... 110,600 1.7 John M. Slack (8).................................. 51,000 * Elizabeth A. Tilney (9)............................ 13,000 * Emmett E. Moore (9)................................ 10,000 * All directors and executive officers as a group (8 persons) (10).................................... 3,029,922 45.4%
* Less than 1% (1) Includes 714,000 shares held by the Castle 1995 Gift Trust f/b/o Jack H. Castle, Jr., of which Mr. Castle is Trustee. Includes options to acquire 58,750 shares of Common Stock issued under the Castle Dental Centers, Inc. Omnibus Stock and Incentive Plan (the "Plan") which are exercisable within 60 days. Excludes options to acquire 191,250 shares of Common Stock which are not exercisable within 60 days. (2) Includes 514,000 shares of Common Stock owned of record by Castle Interest, Ltd., a Texas limited partnership of which Jack H. Castle, D.D.S., Loretta Castle and Jack H. Castle, Jr. are the three general partners. The general partners of Castle Interests, Ltd. cannot act to vote or dispose of shares of Common Stock held by Castle Interests, Ltd. without the unanimous vote of all of the general partners. Loretta Castle is the wife of Jack H. Castle, D.D.S. and the mother of Jack H. Castle, Jr. 29 (3) Includes 103,000 shares of Common Stock owned jointly by Jack H. Castle, D.D.S. and Loretta Castle. (4) Includes 615,033, 121,708, and 176,502 shares of Common Stock owned of record by Delaware State Employees' Retirement Fund, Declaration of Trust for Defined Benefit Plans of ICI American Holdings Inc. and Declaration of Trust for Defined Benefit Plans of Zeneca Holdings Inc., respectively (the "Pecks Investors"). Pecks Management Partners Ltd. ("Pecks"), as investment manager for the Pecks Investors, has sole investment and voting power with respect to such shares. Mr. Cresci, a director of the Company, is a Managing Director of Pecks. Pecks disclaims beneficial ownership of such shares. (5) Includes all shares deemed to be beneficially owned by Pecks, of which Mr. Cresci is a Managing Director. As a result, Mr. Cresci may be deemed to share voting and investment power with respect to such shares. Mr. Cresci disclaims beneficial ownership of such shares. See note 4 above. Also includes options to acquire 10,000 shares of Common Stock under the Directors' Plan which are exercisable within 60 days. Excludes options to acquire 15,000 shares of Common Stock which are not exercisable within 60 days. (6) Includes 56,579 shares of Common Stock issuable on exercise of the GulfStar Warrant and options to acquire 12,500 shares of Common Stock under the Directors' Plan which are exercisable within 60 days. Mr. Kahle is a Managing Director of The GulfStar Group, Inc., an affiliate of GulfStar Investments, Ltd., the holder of the GulfStar Warrant. Excludes options to acquire 22,500 shares of Common Stock which are not exercisable within 60 days. (7) Includes options to acquire 68,750 shares of Common Stock issued under the Plan which are exercisable within 60 days. Excludes options to acquire 191,250 shares of Common Stock which are not exercisable within 60 days. (8) Includes options to acquire 36,500 shares of Common Stock issued under the Plan which are exercisable within 60 days. Excludes options to acquire 113,500 shares of Common Stock which are not exercisable within 60 days. (9) Includes options to acquire 10,000 shares of Common Stock issued under the Plan which are exercisable within 60 days. Excludes options to acquire 15,000 shares of Common Stock which are not exercisable within 60 days. (10) Includes (i) 714,000 shares of Common Stock held by the Castle 1995 Gift Trust f/b/o Jack H. Castle, Jr., (ii) 514,000 shares of Common Stock held by Castle Interests, Ltd., (iii) 913,243 shares of Common Stock beneficially owned by the Pecks Investors, and (iv) 56,579 shares of Common Stock issuable to GulfStar Investments, Ltd. on exercise of the GulfStar Warrant. 30 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Mr. Kahle, a director of the Company, is a Managing Director of The GulfStar Group, Inc., which has provided investment banking and advisory services to the Company. In 1995, the Company paid $540,000 in investment banking fees to The GulfStar Group, Inc. and issued a warrant to purchase 56,579 shares of Common Stock to GulfStar Investments, Ltd. The Company has paid The GulfStar Group, Inc. for investment banking and financial advisory services provided to the Company in connection with certain acquisitions. The GulfStar Group, Inc. received approximately $198,000 in investment banking and financial advisory fees from the Company in 1996. In 1998, The GulfStar Group, Inc. received a $183,332 advisory fee in connection with the acquisition of Dental Consulting Services, LLC. The directors of the Company other than Mr. Kahle approve the payments made to The GulfStar Group, Inc. by the Company. At December 31,1999, Jack H. Castle, Jr., the Company's Chief Executive Officer, G. Daniel Siewert, the Company's President and Chief Operating Officer, and John M. Slack, Vice-President and Chief Financial Officer, had outstanding loans in the aggregate amount of $307,000 from the Company. These loans are repayable over varying periods ranging from one to five years and bear interest at rates ranging from zero to six percent. Mr. Cresci, a director of the Company, is a Managing Director of Pecks Management Partners Ltd., the investment advisor to the Pecks Investors, which owns 948,243 shares of Common Stock. Pursuant to the provisions of the Stockholders Agreement (as defined below), for so long as certain ownership thresholds with respect to the Common Stock are maintained, the Signatory Stockholders (as defined below) are obligated to vote their shares of Common Stock in favor of the designee of the Pecks Investors to be a member of the Company's board of directors and Mr. Cresci is currently such nominee. In December 1995, the Company acquired all of the stock of Jack H. Castle, D.D.S., Inc., a professional corporation of which Jack H. Castle, D.D.S., a director of the Company, was the sole owner. In connection with that transaction, the Company paid Jack H. Castle, D.D.S. $6.0 million in cash and entered into a Deferred Compensation Agreement with Jack H. Castle, D.D.S. pursuant to which the Company has agreed to pay Jack H. Castle, D.D.S. $2.6 million in 20 quarterly installments of $131,500 beginning March 1996 and ending in December 2000. In connection with the purchase of the stock of Jack H. Castle, D.D.S., Inc., the Company also entered into a management services agreement with Jack H. Castle, D.D.S., P.C., a professional corporation of which Jack H. Castle, D.D.S. is the sole owner. Pursuant to the management services agreement, Jack H. Castle, D.D.S., P.C. receives an annual payment of $100,000 for services performed in connection therewith. The professional corporation employs or contracts with all of the dental professionals practicing at the Company's dental offices in Texas under the Management Agreement. The Company provides the professional corporation with, among other things, equipment, supplies, support services, non-dental personnel, office space, management, administration, financial record keeping and reporting services. The Management Agreement is for a term of 25 years, with automatic renewal thereafter. The Company receives a management fee under the Management Agreement with Jack H. Castle, D.D.S., P.C. equal to the Company's costs plus a base management fee and a performance fee. The base management fee is equal to 12.5% of adjusted gross revenues and the performance fee is equal to the professional corporation's net income after payment of all other fees and expenses. The Company's costs include all direct and indirect costs, overhead and expenses relating to the Company's provision of services to the professional corporation under the Management Agreement. In addition to the Management Agreement with Jack H. Castle, D.D.S., P.C., the Company has a contractual right to designate or approve the licensed dentist or dentists who own the professional corporation's capital stock in the event Jack H. Castle, D.D.S. ceases to be affiliated with the Company for any reason. The Company is party to a lease agreement with Goforth, Inc., a company owned by Jack H. Castle, Jr., the Company's Chairman and Chief Executive Officer. The lease agreement relates to the Castle Dental Center located at 2101 West Loop South in Houston, Texas, a 6,781 square foot free-standing building. The 31 Company has agreed to pay Goforth, Inc. a minimum guaranteed rental of $12,000 per month through January 2001 and $13,200 per month from January 2001 through January 2006. The Company has also agreed to pay additional rent of approximately $1,600 per month for insurance, taxes and common area maintenance. The Company believes that this lease agreement is on terms no less favorable to the Company than could have been obtained with an independent third party. Pursuant to a Registration Rights Agreement dated as of December 18, 1995, as amended, the Pecks Investors, GulfStar Investments, Ltd. and certain members of Jack H. Castle, Jr.'s family have been granted certain registration rights by the Company with respect to the shares of Common Stock owned by them or acquired upon exercise of the warrant issued to GulfStar Investments, Ltd. 32 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) (1) FINANCIAL STATEMENTS The following financial statements and the Report of Independent Accountants are filed as a part of this report on the pages indicated: PAGE ---- Report of Independent Accountants.............................. F-2 Consolidated Balance Sheets as of December 31, 1998 and 1999... F-3 Consolidated Statements of Operations for the Years Ended December 31, 1997, 1998 and 1999...................... F-4 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1997, 1998 and 1999........ F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1998 and 1999............................ F-6 Notes to Financial Statements.................................. F-7 (a)(2) FINANCIAL STATEMENT SCHEDULES The following Financial Statement Schedule and the Report of Independent Accountants on Financial Statement Schedule are included in this report on the pages indicated: PAGE ---- Report of Independent Accountants on Financial Statement Schedule.......................................... S-1 Financial Statement Schedule II -- Valuation and Qualifying Accounts..................... S-2 All other schedules are omitted because the required information is inapplicable or the information is presented in the consolidated financial statements or related notes. (a)(3) EXHIBITS The exhibits to this report have been included only with the copies of this report filed with the Commission. Copies of individual exhibits will be furnished to stockholders upon written request to the Company and payment of a reasonable fee. (b) REPORTS ON FORM 8-K NONE 33 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas on May 19, 2000. CASTLE DENTAL CENTERS, INC. By: /s/ JACK H. CASTLE, JR. ---------------------------- JACK H. CASTLE, JR. CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER POWER OF ATTORNEY We, the undersigned, directors and officers of Castle Dental Centers, Inc. (the "Company"), do hereby severally constitute and appoint Jack H. Castle, Jr. and John M. Slack and each or any of them, our true and lawful attorneys and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999, and to file the same with all exhibits thereto, and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys and agents, and each or any of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys and agents, and each of them, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE --------- ------- ---- /s/ JACK H. CASTLE, JR. Chairman of the Board, Chief May 19, 2000 --------------------------------- Executive Officer (Principal JACK H. CASTLE, JR. Executive Officer) /s/ G. DANIEL SIEWERT President, Chief Operating Officer May 19, 2000 --------------------------------- G. DANIEL SIEWERT /s/ JOHN M. SLACK Vice President -- Chief Financial May 19, 2000 --------------------------------- JOHN M. SLACK Officer (Principal Financial and May 19, 2000 Accounting Officer) /s/ JACK H. CASTLE, D.D.S. Director May 19, 2000 --------------------------------- JACK H. CASTLE, D.D.S. /s/ G. KENT KAHLE Director May 19, 2000 --------------------------------- G. KENT KAHLE /s/ ROBERT J. CRESCI Director May 19, 2000 --------------------------------- ROBERT J. CRESCI /s/ ELIZABETH A. TILNEY Director May 19, 2000 --------------------------------- ELIZABETH A. TILNEY /s/ EMMETT E. MOORE Director May 19, 2000 --------------------------------- EMMETT E. MOORE
34 CASTLE DENTAL CENTERS, INC. INDEX TO FINANCIAL STATEMENTS PAGE ---- AUDITED FINANCIAL STATEMENTS Report of Independent Accountants......................................F-2 Consolidated Balance Sheets as of December 31, 1998 and 1999...........F-3 Consolidated Statements of Operations for the years ended December 31, 1997, 1998 and 1999.....................................F-4 Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the years ended December 31, 1997, 1998 and 1999.......F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999.....................................F-6 Notes to Financial Statements..........................................F-7 F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Castle Dental Centers, Inc.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, changes in stockholders' equity (deficit) and cash flows present fairly, in all material respects, the financial position of Castle Dental Centers, Inc. at December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. April 26, 2000, except for the second paragraph of Note 4, as to which the date is May 19, 2000. Houston, Texas F-2 CASTLE DENTAL CENTERS, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share data)
DECEMBER 31, ----------------------- 1998 1999 --------- --------- ASSETS Current assets: Cash and cash equivalents .................................................. $ 695 $ 59 Patient receivables, net of allowance for uncollectible accounts of $8,508 and $13,588 in 1998 and 1999, respectively ........................ 10,700 16,928 Unbilled patient receivables, net of allowance for uncollectible accounts of $658 and $904 in 1998 and 1999, respectively ............................. 3,251 4,667 Prepaid expenses and other current assets .................................. 2,887 4,199 Deferred income taxes ...................................................... 1,809 2,488 --------- --------- Total current assets ........................................... 19,342 28,341 --------- --------- Property and equipment, net ................................................ 13,861 20,361 Intangibles, net ........................................................... 65,956 64,020 Other assets ............................................................... 876 2,260 --------- --------- Total assets ................................................... $ 100,035 $ 114,982 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt .......................................... $ 1,795 $ 2,192 Accounts payable and accrued liabilities ................................... 6,676 9,855 Deferred compensation payable, related party ............................... 526 526 --------- --------- Total current liabilities ...................................... 8,997 12,573 --------- --------- Long-term debt, net of current portion ....................................... 44,411 53,996 Other long-term liabilities, related party ................................... 526 -- Deferred income taxes ........................................................ 5,401 6,896 Minority interest ............................................................ 4,303 4,354 Commitments and contingencies Stockholders' equity: Common stock, $.001 par value, 30,000,000 shares authorized, 6,417,206 shares issued and outstanding in 1998 and 1999 ................... 6 6 Additional paid-in capital ................................................. 42,516 42,086 Accumulated deficit ........................................................ (6,125) (4,929) --------- --------- Total stockholders' equity ..................................... 36,397 37,163 --------- --------- Total liabilities and stockholders' equity ..................... $ 100,035 $ 114,982 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. F-3 CASTLE DENTAL CENTERS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1998 1999 -------- -------- -------- Net patient revenues .......................... $ 46,225 $ 74,823 $102,701 Expenses: Dentist salaries and other professional costs 11,325 18,516 26,984 Clinical salaries ........................... 10,248 16,612 21,408 Dental supplies and laboratory fees ......... 4,335 7,197 9,641 Rental and lease expense .................... 2,590 4,091 6,203 Advertising and marketing ................... 2,033 2,763 3,650 Depreciation and amortization ............... 2,132 3,615 5,941 Other operating expenses .................... 4,314 6,976 10,314 General and administrative .................. 5,929 8,145 10,909 -------- -------- -------- Total expenses .......................... 42,906 67,915 95,050 -------- -------- -------- Operating income .............................. 3,319 6,908 7,651 Litigation settlement ......................... -- -- 1,366 Interest expense .............................. 2,792 1,889 4,220 Other (income) expense ........................ (84) (57) 34 -------- -------- -------- Income before income taxes and extraordinary loss ...................... 611 5,076 2,031 Provision for income taxes .................... 200 1,490 835 -------- -------- -------- Income before extraordinary loss .............. 411 3,586 1,196 Extraordinary loss ............................ (3,195) -- -- -------- -------- -------- Net income (loss) ............................. (2,784) 3,586 1,196 Preferred stock dividends ..................... (1,930) -- -- -------- -------- -------- Net income (loss) attributable to common stock $ (4,714) $ 3,586 $ 1,196 ======== ======== ======== Income (loss) per common share: Basic and diluted: Income before extraordinary loss .......... $ 0.10 $ 0.54 $ 0.18 Extraordinary loss ........................ (0.78) -- -- -------- -------- -------- Net income (loss) ....................... $ (0.68) $ 0.54 $ 0.18 ======== ======== ======== Weighted average number of common and common equivalent shares outstanding Basic ....................................... 4,100 6,586 6,825 ======== ======== ======== Diluted ..................................... 4,132 6,608 6,850 ======== ======== ========
The accompanying notes are an integral part of the consolidated financial statements. F-4 CASTLE DENTAL CENTERS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) (in thousands, except share data)
ADDITIONAL STOCKHOLDERS' COMMON STOCK PAID-IN ACCUMULATED EQUITY SHARES AMOUNT CAPITAL DEFICIT (DEFICIT) --------- --------- --------- --------- --------- Balance, January 1, 1997 ............... 2,331,996 $ 2 $ 3,416 $ (6,927) $ (3,509) Issuance of common stock - Initial Public Offering ................. 2,784,000 3 31,743 -- 31,746 Conversion of Series A Preferred Stock ........................... 705,552 1 3,228 -- 3,229 Conversion of Series C Preferred Stock ........................... 242,691 -- 2,670 -- 2,670 Issuance of common stock in connection with an acquisition .. 165,000 -- 1,691 -- 1,691 Accretion of discount on preferred stock ................. -- -- (1,930) -- (1,930) Net loss ........................... -- -- -- (2,784) (2,784) --------- --------- --------- --------- --------- Balance, December 31, 1997 ............. 6,229,239 6 40,818 (9,711) 31,113 Issuance of common stock in connection with acquisitions .... 187,967 -- 1,698 -- 1,698 Net income ......................... -- -- -- 3,586 3,586 --------- --------- --------- --------- --------- Balance, December 31, 1998 ............. 6,417,206 6 42,516 (6,125) 36,397 Exchange of consideration for acquisition ...................... -- -- (430) -- (430) Net income ......................... -- -- -- 1,196 1,196 --------- --------- --------- --------- --------- Balance, December 31, 1999 ............. 6,417,206 $ 6 $ 42,086 $ (4,929) $ 37,163 ========= ========= ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements. F-5 CASTLE DENTAL CENTERS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1998 1999 -------- -------- -------- Cash flows from operating activities: Net income (loss) ................................................ $ (2,784) $ 3,586 $ 1,196 Adjustments: Provisions for bad debts ..................................... 1,897 2,545 4,160 Depreciation and amortization ................................ 2,132 3,615 5,960 Amortization of debt discount ................................ 712 -- -- Minority interest ............................................ -- -- 51 Deferred income taxes ........................................ 100 1,568 816 Extraordinary loss ........................................... 3,195 -- -- Changes in operating assets and liabilities: Patient receivables ........................................ (3,654) (5,864) (10,142) Unbilled patient receivables ............................... (1,046) (615) (1,662) Prepaid expenses and other current assets .................. (651) (1,957) (1,312) Other assets ............................................... (18) (45) (1,372) Accounts payable and accrued liabilities ................... 272 (278) 1,931 Deferred compensation payments to related party ............ (657) (657) (526) -------- -------- -------- Net cash provided by (used in) operating activities .... (502) 1,898 (900) -------- -------- -------- Cash flows used in investing activities: Capital expenditures ........................................... (1,515) (6,660) (9,503) Acquisition of affiliated dental practices, net of cash acquired (5,015) (30,818) (667) Non-competition agreements ..................................... -- -- (205) -------- -------- -------- Net cash used in investing activities .................. (6,530) (37,478) (10,375) -------- -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock ......................... 33,659 -- -- Proceeds from debt ............................................. 2,074 37,000 11,460 Repayment of debt .............................................. (24,376) (3,341) (1,478) Bank overdraft ................................................. -- -- 818 Offering costs ................................................. (1,263) -- -- Debt and preferred stock issuance costs ........................ (273) (292) (161) -------- -------- -------- Net cash provided by financing activities .............. 9,821 33,367 10,639 -------- -------- -------- Net change in cash and cash equivalents .......................... 2,789 (2,213) (636) Cash and cash equivalents, beginning of period ................... 119 2,908 695 -------- -------- -------- Cash and cash equivalents, end of period ......................... $ 2,908 $ 695 $ 59 ======== ======== ========
The accompanying notes are an integral part of the consolidated financial statements. F-6 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS 1. CORPORATE ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: CORPORATE ORGANIZATION AND BASIS OF PRESENTATION Castle Dental Centers, Inc. and subsidiaries (the "Company") provide administrative and management services, non-healthcare personnel, facilities and equipment to certain professional corporations in Texas, Florida, California and Tennessee ("affiliated dental practices") under long-term management services agreements. The consolidated financial statements include the accounts of the Company and all wholly-owned and beneficially-owned subsidiaries and the accounts of affiliated dental practices in which the Company has a long-term controlling financial interest. Because of corporate practice of medicine laws in the states in which the Company operates, the Company does not own dental practices but instead enters into exclusive long-term management services agreements ("Management Services Agreements") with professional corporations that operate the dental practices. In addition, the Company has the contractual right to designate, in its sole discretion and at any time, the licensed dentist who is the majority shareholder of the capital stock of the professional corporation at a nominal cost ("nominee arrangements"). At December 31, 1999, all of the affiliated dental practices were wholly-owned by dentists with whom the Company had a nominee arrangement. Under the Management Services Agreements, the Company establishes annual operating and capital budgets for the professional corporations and compensation guidelines for the licensed dental professionals. The Management Services Agreements have initial terms of twenty-five to forty years. The management fee charged by the Company to an affiliated dental practice is intended to reflect and is based on the fair value of the management services rendered by the Company to the affiliated dental practice. Subject to applicable law, the management fee earned by the Company, except professional corporations located in California, is generally comprised of three components: (i) the costs incurred by it on behalf of the affiliated dental practice; (ii) a base management fee ranging from 12.5% to 20.0% of patient revenues; and, (iii) a performance fee equal to the patient revenues of the affiliated dental practice less (a) the expenses of the affiliated dental practice and (b) the sum of (i) and (ii), as described in the agreements. In California, the Company is paid a monthly management fee comprised of two components: (i) the costs incurred by it on behalf of the affiliated practice and (ii) a management fee in an amount ranging from 15.0% to 30.0% of net patient revenues. With respect to certain professional corporations in California, the Company is paid a bonus equal to 30% of patient revenues in excess average monthly patient revenues over the prior two-year period. The amount of the management fee is reviewed by the Company and the affiliated dental practice at least annually in order to determine whether such fee should be adjusted to continue to reflect the fair value of the management services rendered by the Company. Through the management services agreements and the nominee arrangements, the Company has a significant long-term controlling financial interest in the affiliated dental practices and, therefore, according to Emerging Issues Task Force Issue No. 97-2, "Application of FASB Statement No. 94, CONSOLIDATION OF ALL MAJORITY-OWNED SUBSIDIARIES, and APB No. 16, BUSINESS COMBINATIONS, to Physician Practice Management Entities and Certain Other Entities with Contractual Management Agreements," must consolidate the results of the affiliated practices with those of the Company. Net patient revenues are presented in the accompanying statement of operations because the Company must present consolidated financial statements. All significant intercompany accounts and transactions, including management fees, have been eliminated in consolidation. REVENUE RECOGNITION Net patient revenues represent the estimated realizable amounts to be received from patients, third-party payors and others for services rendered by affiliated dentists. They are reported at established rates reduced by contracted amounts based on agreements with patients, third party payers and others obligated to pay for service rendered. Patient revenues from general dentistry are recognized as the services are performed. Patient revenues from orthodontic services are recognized in accordance with the proportional performance method. Under this method, revenue is recognized as services are performed under the terms of contractual agreements with each patient. Approximately 25% of the services are performed in the first month with the remaining F-7 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) services recognized ratably over the remainder of the contract. Billings under each contract, which average approximately 24 months, are made equally throughout the term of the contract, with final payment at the completion of the treatment. Net patient revenues include amounts received from capitated managed care contracts that the Company negotiates on behalf of its affiliated dental practices. Under capitated contracts the affiliated dental practice receives a predetermined amount per patient per month in exchange for providing certain necessary covered services to members of the plan. Usually, the capitated plans also provide for supplemental payments and/or co-payments by members for certain higher cost procedures. These contracts typically result in lower average fees for services than the usual and customary fees charges by the Company's affiliated dental practices and may, in certain instances, expose the Company to losses on contracts where the total revenues received are less than the costs of providing such dental care. The Company generally bears the risk of such loss because it consolidates the financial results of its affiliated dental practices. However, most of these contracts are cancelable by either party on 30 to 90 days written notice thereby reducing the risk of long-term adverse impact on the Company. Fees from capitated contracts totaled $5.1 million and $7.4 million in 1998 and 1999, respectively, excluding supplemental payments and co-payments by members. No single contract amounted to a significant portion of the Company's revenues, as each of the Company's regional operations contracts separately with managed care providers. The Company periodically evaluates its capitated managed care contracts by comparing the average reimbursement per procedure plus the total capitation fees per contract to the usual and customary fees charged by the affiliated dental practice. Accounts receivable consist primarily of receivables from patients, insurers, government programs and contracts between the affiliated dental practices and third-party payors for dental services provided by dentists. The Company does not believe that change in the reimbursement arrangements for its affiliated dental practice contracts with third-party payors would have a material impact on revenues. An allowance for doubtful accounts is recorded by the Company based on historical experience. CASH AND CASH EQUIVALENTS The Company considers all highly liquid debt investments with original maturities of three months or less at the date of acquisition to be cash equivalents. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Interest is capitalized on the construction of new centers. Depreciation is provided using the straight-line method over the estimated useful lives of the various classes of depreciable assets. Fully depreciated assets are retained in property and equipment until they are removed from service. Maintenance and repairs are charged to expense whereas renewals and major replacements are capitalized. Gains and losses from dispositions are included in operations. Useful lives for property and equipment are as follows: Equipment .......................... 3 - 7 years Leasehold improvements ............. 5 - 10 years Furniture and fixtures ............. 5 - 7 years Vehicles ........................... 3 - 5 years INTANGIBLE ASSETS The Company's acquisitions involve the purchase of tangible and intangible assets and the assumption of certain liabilities of the affiliated dental practices. As part of the purchase allocation, the Company allocates the purchase price to the tangible assets acquired and liabilities assumed, based on estimated fair market values. In connection with each acquisition, the Company enters into a long-term management services agreement with each affiliated dental practice, which cannot be terminated by either party without cause. The cost of the management services agreement is amortized on a straight line basis over its term, or such shorter period as may be indicated by the facts and circumstances, as described below. Amortization periods of the F-8 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) management services agreements acquired through December 31, 1999 are 25 years. In connection with the allocation of the purchase price to identifiable intangible assets, the Company analyzes the nature of the group with which a management services agreement is entered into, including the number of dentists in each group, number of dental centers and ability to recruit additional dentists, the affiliated dental practice's relative market position, the length of time each affiliated dental practice has been in existence, and the term and enforceability of the management services agreement. Because the Company does not practice dentistry, maintain patient relationships, hire dentists, enter into employment and noncompete agreements with the dentist, or directly contract with payors, the intangible asset created in the purchase allocation process is associated primarily with the management services agreement with the affiliated dental practice. The Company reviews intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If this review indicates that the carrying amount of the asset may not be recoverable, as determined based on the undiscounted cash flows of the related operations over the remaining amortization period, the carrying value of the asset is reduced to estimated fair value. Among the factors that the Company will continually evaluate are unfavorable changes in each affiliated dental practice's relative market share and local market competitive environment, current period and forecasted operating results and cash flows of the affiliated dental practice and its impact on the management fee earned by the Company, and legal factors governing the practice of dentistry. OTHER ASSETS Other assets consist primarily of debt issuance costs and other receivables. The costs related to the issuance of debt are capitalized and amortized using the effective interest method over the lives of the related debt. Other receivables include $339,000 and $238,000 at December 31, 1998 and 1999, respectively, in loans made to executive officers (see Note 12). INCOME TAXES The Company accounts for income taxes under the liability method. Under this method, deferred taxes are determined based on the differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted marginal tax rates currently in effect. ADVERTISING Costs incurred for advertising are expensed when incurred. PRE-OPENING COSTS Facility costs incurred prior to opening a dental center are capitalized and amortized over the life of the lease. All other costs, primarily salaries, are expensed when incurred. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during the reporting periods. Actual results could differ from those estimates. F-9 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 2. SELECTED BALANCE SHEET INFORMATION: The details of certain balance sheet accounts were as follows: DECEMBER 31, ---------------------- 1998 1999 ------- ------- (in thousands) Property and equipment: Equipment .................................... $ 9,334 $13,644 Leasehold improvements ....................... 6,529 9,265 Furniture and fixtures ....................... 1,553 2,009 Vehicles ..................................... 130 132 Construction-in-progress ..................... 1,213 3,213 ------- ------- Total property and equipment ......... 18,759 28,263 Less accumulated depreciation ................ 4,898 7,902 ------- ------- Property and equipment, net .......... $13,861 $20,361 ======= ======= Depreciation expense was approximately $1.2 million, $1.8 million and $3.0 million for the years ended December 31, 1997, 1998 and 1999, respectively. Capitalized interest cost was $329,000 for the year ended December 31, 1999. There were no amounts capitalized during 1997 and 1998. Fully depreciated assets in use as of December 31, 1998 and 1999 were approximately $1.2 million and $1.3 million, respectively. DECEMBER 31, ----------------------- 1998 1999 ------- ------- (in thousands) Intangible assets: Management services agreements ............. $68,584 $69,251 Other ...................................... 150 355 ------- ------- Total intangilbe assets ................ 68,734 69,606 Less accumulated amortization .................. 2,778 5,586 ------- ------- Intangible assets, net ................. $65,956 $64,020 ======= ======= Amortization expense was approximately $900,000, $1.8 million and $2.8 million for the years ended December 31, 1997, 1998 and 1999, respectively. DECEMBER 31, ----------------- 1998 1999 ------ ------ (in thousands) Accounts payable and accrued liabilities: Bank overdraft ......................................... $ -- $ 818 Trade .................................................. 3,083 3,792 Salaries, wages and payroll taxes ...................... 1,959 2,021 Due to patients ........................................ 1,420 1,772 Legal .................................................. -- 991 Other .................................................. 214 461 ------ ------ Total accounts payable and accrued liabilities . $6,676 $9,855 ====== ====== F-10 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 3. ACQUISITIONS: In March 1998, the Company acquired all the outstanding capital stock of Dental World, Inc., a dental practice management company, and the assets of Dental Delivery Services, P.C., a dental professional corporation, both located in Houston, Texas. The purchase price of $2.5 million, including related acquisition expenses, consisted of $2.2 million in cash and 23,342 shares of Company common stock. In March 1998, the Company acquired an 80.0% interest in Castle Dental Centers of California L.L.C. ("Castle West"), a company formed to acquire the assets of Dental Consulting Services LLC ("DCS"), a dental practice management company with headquarters in Los Angeles, California. The purchase price of $18.1 million included cash of $10.8 million, $2.7 million in 8% subordinated seller notes payable and an option granted to the sellers to convert a portion of their ownership interests into 407,454 shares of Company common stock (the "conversion right"). The conversion right may be exercised beginning twelve months after the closing date. This convertible ownership interest has been recorded at fair market value. The difference between the estimated fair value of the convertible ownership interest at the acquisition date and the Company's common stock into which it may be converted is being amortized over the period to the earliest conversion date. In connection with these acquisitions, the Company entered into management and consulting agreements with certain employees and former owners of the businesses acquired and into long-term management services agreements with each of the affiliated dental practices. In addition, the former owners of DCS have the right to put all or a portion of their 20% minority ownership in Castle West to the Company, beginning twenty-four months after the closing date, for a combination of cash and common stock. In January 2000, the Company and the former owners of DCS entered into a settlement agreement under which the Company acquired the 20% minority interest and the conversion right. The total consideration paid by the Company was $5.3 million of which $300,000 was paid in November 1999 as a deposit. The amount paid by the Company will be accounted for as additional consideration at the date of the settlement. In July 1998, the Company acquired all the outstanding capital stock of Dentcor, Inc, a dental practice management company, located in Florida. The purchase price of $1.0 million, including related acquisition expenses, consisted of $800,000 in cash and 20,566 shares of Company common. In July 1998, the Company acquired the assets of Jared Woolf, D.D.S. & Associates of Palmetto, P.A., Jared Woolf, D.D.S. & Associates of Venice, P.A. and Woolf Dentistry, P.A. ("Woolf Dentistry"), all dental professional associates, located in Sarasota, Florida. The purchase price of $2.6 million, including related acquisition expenses, consisted of $2.1 million in cash, $370,000 in 9% Subordinated Promissory Notes due July 9, 2001 and 15,424 shares of Company common stock. In December 1998, the Company acquired the assets of DCA Limited Partnership, L.L.P. ("DCA") and Dental Administrators of Texas Limited Partnership, L.L.P. ("DAI") and 16 related dental practices, located in San Antonio, Texas. The purchase price of $15.8 million, including related acquisition expenses, consisted of $13.2 million in cash, $1.3 million in 6% Subordinated Promissory Notes due December 30, 2001 and 125,000 shares of Company common stock. In addition, the Company entered into non-competition agreements with the shareholders' of DCA and DAI and paid $130,000 in connection therewith in January 1999. As provided for in the Asset Purchase Agreement, $430,000 was payable in December 1999 in connection with a guaranteed amount of the 125,000 shares of Company common stock issued upon the close of the acquisition. In January 2000, the Company paid the $430,000, which was accrued at December 31, 1999 and recorded as a reduction of additional paid-in capital. In addition, during 1998, the Company acquired the assets and stock of four additional dental practices. Three of the dental practices were located in California and one was located in Texas. The aggregate purchase price of $1.7 million, including related acquisition expenses, consisted of $1.4 million in cash, $229,000 in 8% and 8.5% Subordinated Promissory Notes due June 30, 2000 and October 1, 2001, respectively, and 3,635 shares of Company common stock. The purchase price allocations were originally calculated on a preliminary basis, subject to adjustment should new or additional facts about the business become known. During 1999, the purchase price allocations were adjusted by approximately $667,000 to reflect additional information that became available throughout F-11 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) the year. The assets and liabilities have been recorded at their estimated fair values at the date of acquisition. The aggregate purchase price and related expenses exceeded the fair market value of net assets, which has been assigned to management services agreements, included in intangible assets. Patient revenues, management fees and related costs are included in the consolidated financial statements from their acquisition dates. The estimated fair value of assets acquired and liabilities assumed are summarized as follows:
DECEMBER 31, ------------------------------------------ 1997 1998 1999 -------- -------- -------- (in thousands) Patient receivables, net ................................................ $ 236 $ 1,470 $ -- Unbilled patient receivables, net ....................................... 37 188 -- Prepaid expenses and other current assets ............................... 31 92 -- Property and equipment, net ............................................. 554 3,866 -- Other assets ............................................................ 3 93 -- Management services agreements .......................................... 9,934 42,072 667 Accounts payable and accrued liabilities ................................ (452) (2,019) -- Deferred taxes .......................................................... -- (3,149) -- Long-term debt, assumed ................................................. (138) (1,254) -- Minority interest ....................................................... -- (4,305) -- -------- -------- -------- 10,205 37,054 667 Less: fair value of common stock issued and other equity instruments .... 3,241 1,698 -- Less: issuance of notes payable ......................................... 1,449 4,538 -- Less: escrow deposit .................................................... 500 -- -- -------- -------- -------- Cash purchase price, net of cash acquired ........................... $ 5,015 $ 30,818 $ 667 ======== ======== ========
Unaudited pro forma combined results of operations, assuming all of the acquisitions occurred at the beginning of the year, are as follows: YEAR ENDED DECEMBER 31, -------------------------- 1997 1998 -------- -------- Net patient revenues .................... $ 63,414 $ 93,473 Net income (loss) ....................... (1,933) 3,918 Income (loss) per common share: Basic ................................... (0.42) 0.58 Diluted ................................. (0.41) 0.57 The unaudited pro forma summary is not necessarily indicative either of results of operations, that would have occurred had the acquisitions been made at the beginning of the periods presented, or of future results of operations of the combined companies. F-12 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 4. LONG-TERM DEBT: Long-term debt consisted of the following: DECEMBER 31, ------------------------- 1998 1999 ------- ------- (in thousands) Revolving credit loans ..................... $39,400 $50,860 Subordinated Seller Notes .................. 5,442 4,393 Other notes payable ........................ 1,364 935 ------- ------- Total debt ............................. 46,206 56,188 Less current portion ....................... 1,795 2,192 ------- ------- Long-term debt ......................... $44,411 $53,996 ======= ======= In December 1998, the Company entered into a credit agreement with a bank group (the "Credit Agreement") that provides for borrowings up to $55.0 million and matures in November 2002. Advances under the Credit Agreement require quarterly interest payments through March 2001 at which time principal becomes payable quarterly based on a five-year amortization with final payment at maturity. Borrowings under the Credit Agreement may at no time exceed a specified borrowing base, which is calculated as a multiple of the Company's earnings before interest, income taxes, depreciation and amortization ("EBITDA"), as adjusted. The bank credit facility bears interest at variable rates, which are based upon either the bank's base rate or LIBOR, plus, in either case, a margin which varies according to the ratio of the Company's funded debt to the EBITDA, each as defined in the Credit Agreement. A commitment fee is payable quarterly at rates ranging from 0.125 percent to 0.5 percent of the unused amounts for such quarter. The Credit Agreement contains affirmative and negative covenants that require the Company to maintain certain financial ratios, limit the amount of additional indebtedness, limit the creation or existence of liens, set certain restrictions on acquisitions, mergers and sales of assets and restrict the payment of dividends. At December 31, 1999, $50.9 million was outstanding under the Credit Agreement and the average interest rate on the Company's bank borrowings was 9.8%. In January 2000, the Company amended the Credit Agreement and entered into a senior subordinated note agreement (Subordinated Note Agreement) and a subordinated convertible note agreement (Convertible Note Agreement) with two lenders (Note 15). In March 2000, the Company advised its lenders under the bank credit facility that it was in violation of certain financial covenants of the Credit Agreement. Accordingly, in May 2000, the Company amended the credit facility to cure the covenant violations and to provide additional borrowing availability. In addition, under the May 2000 amended Credit Agreement, capital expenditures for 2000 are limited to no more than $3.5 million, acquisitions are not permitted in 2000, and the payment of any litigation settlement is restricted to no more than $100,000, without consent of the lenders. At September 30, 1999, the Company received waivers concerning violations of certain financial covenants under the Credit Agreement. At May 10, 2000, borrowings under the Credit Agreement were $43.5 million and the average interest rate had increased to 11.2%. In 1997, the Company retired approximately $23.9 million of long-term debt with proceeds of an initial public offering. The retirement of debt consisted of $10.4 million of senior subordinated notes, $9.1 million of Bank Credit Facility debt and $4.4 million of promissory notes in connection with certain acquisitions. In connection with the repayment of $9.5 million in 12% Senior Subordinated Debt in September 1997, the Company recognized a $3.2 million extraordinary loss associated with the early retirement of such debt. At December 31, 1999, approximately $484,000 (net of accumulated amortization of approximately $238,000) of debt issuance costs had been capitalized in connection with the issuance of the Credit Agreement. F-13 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) The Company has issued various subordinated seller notes payable in connection with certain acquisitions ("Subordinated Seller Notes"). These notes bear interest at varying rates ranging from 6.0% to 9.0%, require quarterly payments of interest and principal, and mature at varying dates ranging from June 2000 through June 2002. The aggregate maturities of long-term debt for each of the next five years subsequent to December 31, 1999 were as follows (in thousands): 2000..................................... $ 2,192 2001..................................... 13,081 2002..................................... 40,915 ------- $56,188 5. COMMITMENTS AND CONTINGENCIES: LEASE COMMITMENTS Future minimum lease payments under noncancelable operating leases with remaining terms of one or more years consisted of the following at December 31, 1999 (in thousands): 2000..................................... $ 5,163 2001..................................... 4,526 2002..................................... 3,755 2003..................................... 3,110 2004..................................... 2,251 Thereafter............................... 3,884 ------- Total minimum lease obligation........... $22,689 ======= The Company has entered into operating leases for various types of office equipment and for its building facilities. Certain building facility leases include rent escalation clauses. Most leases contain purchase and renewal options at fair market rental values. LITIGATION In August 1998, the former owner of certain dental practices acquired by the Company in August 1996, filed a lawsuit against the Company in the 190th District Court of Harris County, Texas. The lawsuit alleged that the Company committed various acts of fraud, securities fraud, conspiracy, breach of contract and misrepresentation concerning the value of the Company's common stock issued in the acquisition of the dental practices. In August 1999, the Company settled the lawsuit for $1.4 million. In December 1998, a dentist with whom the Company had entered into an agreement to acquire his dental practice filed a demand for arbitration alleging that the Company is liable for damages resulting from the failure to complete the transaction. The transaction was not completed because at least one of the conditions required for closing was not met. The dentist is claiming damages equal to the difference between the purchase price provided for in the agreement of $8.1 million and the fair market value of the practice. The Company believes that the asserted claims are without merit and that it is not liable for damages resulting from these allegations. The Company carries insurance with coverage and coverage limits that it believes to be customary in the dental industry. Although there can be no assurance that such insurance will be sufficient to protect the Company against all contingencies, management believes that its insurance protection is reasonable in view of the nature and scope of the Company's operations. The Company is from time to time subject to claims and suits arising in the ordinary course of operations. In the opinion of management, the ultimate resolution of such pending legal proceedings will not have a material adverse effect on the Company's financial position, results of operations or liquidity. F-14 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 6. INCOME TAXES Significant components of the Company's deferred tax assets (liabilities) were as follows: DECEMBER 31, ------------------------ 1998 1999 ------- ------- (in thousands) Deferred tax assets: Net operating loss carryforward ......... $ 756 $ 543 Deferred compensation .................... 400 200 Allowance for bad debts .................. 1,232 2,018 Other .................................... 24 114 ------- ------- Total deferred assets .............. 2,412 2,875 ------- ------- Deferred tax liabilities: Unbilled receivables ..................... (1,236) (1,778) Loss of Subchapter S status .............. (211) (4) Management services agreement ............ (4,047) (4,428) Property and equipment ................... (400) (1,057) Other .................................... (110) (16) ------- ------- (6,004) (7,283) ------- ------- Net deferred tax liabilities ................. (3,592) (4,408) Less current portion ......................... 1,809 2,488 ------- ------- Non-current liabilities .................. $(5,401) $(6,896) ======= ======= Significant components of the provision for income taxes on continuing operations were as follows: YEAR ENDED DECEMBER 31, -------------------------------- 1997 1998 1999 ------- ------- ------- (in thousands) Current tax provision (benefit): Federal ......................... $ - $ (70) $ 17 State ........................... 100 (8) 2 ------- ------- ------- Total current .............. 100 (78) 19 ------- ------- ------- Deferred tax provision (benefit): Federal ......................... 90 1,403 730 State ........................... 10 165 86 ------- ------- ------- Total deferred ............. 100 1,568 816 ------- ------- ------- Provision (benefit) for income taxes ...... $ 200 $ 1,490 $ 835 ======= ======= ======= F-15 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) The differences between the statutory federal tax rate and the Company's effective tax rate on continuing operations were as follows: YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1998 1999 ------- ------- ------- (in thousands) Tax at U.S. statutory rate (34%) ........ $ 208 $ 1,726 $ 691 State income taxes, net of federal tax .. 24 203 81 Nondeductible expenses and other ........ (32) 26 63 Change in estimate of net operating loss carryforward .................... -- (465) -- ------- ------- ------- $ 200 $ 1,490 $ 835 ======= ======= ======= At December 31, 1999, the Company had net operating loss carryforwards available to reduce future taxable income of approximately $2.5 million, expiring in 2016. The Company has not recorded a valuation allowance for the potential inability to realize its net deferred tax assets because, after consideration of the affiliated dental practices' historical operating results and the Company's planned operations, management believes that it is more likely than not that the Company will realize those assets. 7. STOCK OPTION PLANS: The Company grants stock options under the Castle Dental Centers, Inc. Omnibus Stock and Incentive Plan, a stock-based incentive compensation plan (the "Employees' Plan"), and the Non-employee Directors' Stock Option Plan (the "Directors' Plan," together the "Plans") which are described below. The Company recognizes stock-based compensation issued to employees at the intrinsic value between the exercise price of options granted and the fair value of stock for which the options may be exercised. However, pro forma disclosures as if the Company recognized stock-based compensation at the fair-value of the options themselves are presented below. Under the Employees' Plan, the Company is authorized to issue 1,050,000 shares of Common Stock pursuant to "Awards" granted to officers and key employees in the form of stock options and restricted stock. Under the Directors' Plan, the Company is authorized to issue 150,000 shares of Common Stock to non-employee directors of the Company. There are 930,100 and 100,000 options granted under the Employees' Plan and the Directors' Plan, respectively, at December 31, 1999. The Compensation Committee administers the Plans. These stock options have contractual terms of 10 years and have an exercise price no less than the fair market value of the stock at grant date. The options vest at varying rates over a four or five-year period, beginning on the first anniversary of the date of grant. F-16 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) Following is a summary of the status of the Company's stock options as of December 31, 1999 and the changes during the three-year period then ended: NUMBER OF WEIGHTED SHARES OF AVERAGE UNDERLYING EXERCISE OPTIONS PRICE ---------- --------- Outstanding at January 1, 1997 ........... 91,750 $10.00 Granted .................................. 562,500 10.67 Excercised ............................... -- -- Forfeited ................................ (20,000) 10.00 Expired .................................. -- -- ---------- ------ Outstanding at December 31, 1997 ......... 634,250 $10.59 ========== ====== Excercisable at December 31, 1997 ........ 14,350 $10.00 ========== ====== Granted .................................. 281,750 $ 5.31 Excercised ............................... -- -- Forfeited ................................ (72,600) 11.03 Expired .................................. -- -- ---------- ------ Outstanding at December 31, 1998 ......... 843,400 $ 8.79 ========== ====== Excercisable at December 31, 1998 ........ 126,680 $10.47 ========== ====== Granted .................................. 252,650 $ 2.57 Excercised ............................... -- -- Forfeited ................................ (52,223) 6.23 Expired .................................. (13,727) 8.93 ---------- ------ Outstanding at December 31, 1999 ......... 1,030,100 $ 7.27 ========== ====== Excercisable at December 31, 1999 ........ 287,682 $ 9.34 ========== ====== Weighted-average fair value of options granted during the year: 1997 ..................................... $ 5.06 1998 ..................................... 2.85 1999 ..................................... 1.58 The fair value of each stock option granted by the Company is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: dividend yield of 0% for each year; expected volatility of 45.0% for 1997, 56.9% for 1998, and 67.9% for 1999; risk-free interest rates are 5.9% for 1997, 4.7% for 1998 and 6.1% for 1999; and the expected lives of the options average five years. F-17 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) The following table summarizes information about stock options outstanding at December 31, 1999: OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------- ---------------------- WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED NUMBER REMAINING AVERAGE EXERCISABLE AVERAGE OUTSTANDING CONTRACT EXERCISE AT EXERCISE RANGE OF EXERCISE PRICE AT 12/31/99 LIFE PRICE 12/31/99 PRICE - ----------------------- ----------- --------- -------- ----------- --------- $2.00 to $8.00 ........ 499,650 9.25 $ 3.77 61,752 $ 5.00 $8.00 to $13.00 ....... 530,450 7.65 $10.57 225,930 $10.53 --------- ----------- 1,030,100 8.43 $ 7.27 287,682 $ 9.34 ========= =========== Had the compensation cost for the Company's stock-based compensation plans been determined using the fair value rather than the intrinsic value of the options, the net loss and basic and diluted net loss per common share for 1997 would approximate $2.9 million or $0.71 per share; the Company's net income and diluted net income per share for 1998 would approximate $3.5 million, or $0.54 per share; the Company's net income and diluted net income per share for 1999 would approximate $796,000, or $0.12 per share. The effects of applying fair value accounting in this pro forma disclosure are not indicative of future amounts. 8. EARNINGS PER SHARE: A reconciliation of the numerators and denominators of the basic and diluted per-share computations for net income follows: DECEMBER 31, ---------------------------------- 1997 1998 1999 ------- ------- ------- (in thousands) Net income (loss) attributable to common stock (1) .................... $(4,714) $ 3,586 $ 1,196 Preferred stock accretion .............. 1,930 -- -- ------- ------- ------- Net income (loss) ...................... (2,784) 3,586 1,196 Less extraordinary loss ................ 3,195 -- -- ------- ------- ------- Income before extraordinary loss ....... $ 411 $ 3,586 $ 1,196 ======= ======= ======= Shares (denominator) Shares - basic (2) ................ 4,100 6,586 6,825 Options and warrants .............. 32 22 25 ------- ------- ------- Shares - diluted .................. 4,132 6,608 6,850 ======= ======= ======= (1) The effect of the preferred stock accretion is excluded from earnings per share. The preferred stock was converted to common stock at a nominal value and those common shares were included in the calculation of Basic shares outstanding for all periods. (2) Includes the weighted average of 407,544 shares of common stock issuable upon the exercise of the conversion right. Options to purchase an aggregate 125,000 shares of common stock at exercise prices of $13.00 per share were excluded from the calculation of diluted earnings per share for 1997 because their effect would have been antidilutive. The options, which expire in 2007, were still outstanding at December 31, 1997. Options to purchase an aggregate 616,000 shares of common stock at exercise prices of $10.00 to $13.00 per share were F-18 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) excluded from the calculation of diluted earnings per share for 1998 because their effect would have been antidilutive. The options, which expire in 2007, were still outstanding at December 31, 1998. Options to purchase an aggregate 604,000 shares of common stock at exercise prices of $6.00 to $13.00 per share were excluded from the calculation of diluted earnings per share for 1999 because their effect would have been antidilutive. The options, 588,300 expiring 2007 and 15,700 expiring 2009, were still outstanding at December 31, 1999. A warrant to purchase 56,579 shares of common stock at $11.00 per share was excluded from the calculation of diluted earnings per share for 1997, 1998, and 1999 because its effect would have been antidilutive. The warrant, which expires in December 2000, was still outstanding at December 31, 1999. 9. DEFINED CONTRIBUTION PLANS: In August 1996, the Company adopted a defined contribution plan qualified under Section 401(k) of the Internal Revenue Code of 1986 (the "401(k) Plan"). All permanent employees of the Company are eligible to participate in the 401(k) Plan upon the completion of three months of service. The Company may match contributions made by participants under the Plan each year in an amount determined by the Company on a year-to-year basis. The Company did not make any contributions to the Plan in 1997, 1998, or 1999. 10. SUPPLEMENTAL CASH FLOW INFORMATION: DECEMBER 31, -------------------------- 1997 1998 1999 ------ ------ ------ (in thousands) Cash paid during the period for: Interest ...................................... $1,707 $1,803 $3,997 Income taxes .................................. 44 222 595 Supplemental disclosure of noncash investing and financing activities: Acquisition stock guarantee payment accrual ... -- -- 430 Issuance of notes payable for accrued interest and purchase of property and equipment .............................. 450 -- -- Issuance of capital lease obligation for property and equipment ................. 416 -- -- Issuance of Series B Preferred Stock in connection with an acquisition .......... 1,550 -- -- Issuance of Preferred Stock in connection with related party financing ............... 1,144 -- -- Conversion to common stock of Series A and Series C Preferred Stock ............... 5,898 -- -- Conversion of Series B Preferred Stock to subordinated notes ...................... -- 1,550 -- 11. CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTS: CREDIT RISK The Company grants customers credit in the normal course of business. The Company does not require collateral on the extension of credit. Procedures are in effect to monitor the creditworthiness of customers and appropriate allowances are made to reduce accounts to their net realizable values. The Company maintains cash balances at various financial institutions. Accounts at each institution are insured up to $100,000 by the Federal Deposit Insurance Corporation. The Company's accounts at these institutions may, at times, exceed the federally insured limits. The Company has not experienced any losses in F-19 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) such accounts. FAIR VALUE OF FINANCIAL INSTRUMENTS The following estimated fair values of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and the revolving line of credit approximate fair values due to the short-term maturities of these instruments. The carrying amounts of the Company's long-term borrowings as of December 31, 1998 and 1999, respectively, approximate their fair value based on the Company's current incremental borrowing rates for similar type of borrowing arrangements. 12. RELATED PARTY TRANSACTIONS: The Company maintains a management services agreement with one of the Company's affiliated dental practices in Texas pursuant to which the sole shareholder of the affiliated dental practice, a member of the Board of Directors of the Company, receives an annual salary of $100,000 to take actions necessary to maintain the dental license for the affiliated dental practice in the state of Texas, for as long as he holds such license and is the sole shareholder of the practice. Such compensation arrangement was negotiated between the shareholder and previously unaffiliated investors in the Company. In 1995, in connection with the Company's acquisition of the assets of the shareholder's dental practice, the Company entered into a deferred compensation agreement with the shareholder pursuant to which the Company agreed to pay the shareholder $2.6 million in 20 quarterly installments of $131,500, beginning March 1996. As of December 31, 1999, there was $526,000 payable to the shareholder under the terms of the deferred compensation agreement. At December 31, 1998 and 1999, three executive officers of the Company had outstanding loans in the aggregate amount of $339,000 and $307,000 from the Company. These loans are repayable over varying periods ranging from one to five years and bear interest at rates ranging from zero to six percent. A director of the Company is a Managing Director of The GulfStar Group, Inc. ("GulfStar"), which has provided investment banking and advisory services to the Company. The Company paid $183,000 during 1998 in investment banking fees to GulfStar. The Company made no payments to Gulfstar during 1997 and 1999. A director of the Company is a Managing Director of Pecks Management Partners Ltd., the investment advisor to investors in the Company owning an aggregate of 913,243 shares of Company common stock. Pursuant to the provisions of the Securities Purchase Agreement dated December 18, 1995, for so long as certain ownership thresholds are maintained with respect to the common stock, the investors have the contractual right to nominate one member of the Company's Board of Directors. The Company entered into a lease agreement with Goforth, Inc., a company owned by the Company's chairman and chief executive officer (the "Affiliate"). The Company has agreed to pay the Affiliate a minimum guaranteed rental of $12,000 per month through January 2001 and $13,200 per month from January 2001 through January 2006 for rental of a dental center. The Company has also agreed to pay additional rent of approximately $1,600 per month for insurance, taxes and common area maintenance. The Company paid $174,000 under this agreement during 1997, 1998 and 1999. F-20 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 13. QUARTERLY FINANCIAL DATA (UNAUDITED): FIRST SECOND THIRD FOURTH -------- -------- -------- -------- (in thousands, except per share data) 1998 Net patient revenues ...... $ 14,541 $ 19,679 $ 20,175 $ 20,427 Operating income .......... 1,076 1,713 1,973 2,146 Net income ................ 662 781 1,021 1,122 Basic and diluted earnings per share (1) . $ 0.11 $ 0.12 $ 0.15 $ 0.17 1999 Net patient revenues ...... $ 25,167 $ 25,661 $ 26,092 $ 25,781 Operating income .......... 2,639 2,565 2,033 414 Net income (loss) ......... 1,003 107 507 (421) Basic and diluted earnings per share (1) . $ 0.15 $ 0.02 $ 0.07 $ (0.06) (1) Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share does not equal the total computed for the year due to stock transactions that occurred. The Company has restated its previously issued financial statements on Form 10-Q for the third quarter of 1999. The restatement is attributable to an increase in the Company's bad debt expense and allowance for doubtful accounts, and capitalization of interest on construction of dental centers. The net impact of these adjustments on the third quarter of 1999 is as follows: PREVIOUSLY REPORTED RESTATED ---------- ---------- (in thousands) Net patient revenues ......................... $26,092 $26,092 Operating income ............................. 2,625 2,033 Net income ................................... 856 507 Basic and diluted earnings per share ................................. $ 0.13 $ 0.07 F-21 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 14. OPERATING SEGMENTS: Financial information is provided below for each of the Company's operating regions. The Company measures the performance of its regional operations primarily based on net patient revenues and operating income. There are no inter-regional revenues. The Company's primary measure of profit by which it formulates decisions and communicates to investors and analysts is net income and earnings per share. Financial information internally reported for the Company for the years ended December 31, 1997, 1998 and 1999 is as follows: YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1998 1999 --------- --------- --------- (in thousands) Net patient revenues: Texas ......................... $ 29,631 $ 47,464 $ 68,362 Florida ....................... 9,650 11,951 12,142 Tennessee ..................... 6,944 7,853 10,236 California .................... -- 7,555 11,961 --------- --------- --------- Total revenue .................. 46,225 74,823 102,701 --------- --------- --------- Operating expenses: Texas ......................... $ 25,460 $ 39,865 $ 59,406 Florida ....................... 8,708 10,351 11,607 Tennessee ..................... 6,552 7,419 9,276 California .................... -- 6,289 10,387 Corporate, general and administrative expenses ..... 2,186 3,991 4,374 --------- --------- --------- Total operating expenses ....... 42,906 67,915 95,050 --------- --------- --------- Operating income (loss): Texas ......................... 4,171 7,599 8,956 Florida ....................... 942 1,600 535 Tennessee ..................... 392 434 960 California .................... -- 1,266 1,574 Corporate, general and administrative expenses ..... (2,186) (3,991) (4,374) --------- --------- --------- Total operating income .... 3,319 6,908 7,651 Litigation settlement ................ -- -- 1,366 Interest expense ..................... 2,792 1,889 4,220 Other (income) expense ............... (84) (57) 34 --------- --------- --------- Income (loss) before income taxes and extraordinary loss ...... $ 611 $ 5,076 $ 2,031 ========= ========= ========= Assets: Texas ....................................... $ 37,953 $ 32,201 Florida ..................................... 12,203 11,928 Tennessee ................................... 6,276 9,320 California .................................. 20,259 22,302 -------- -------- Total assets for reportable segments .................. 76,691 75,751 Other unallocated amounts ................... 23,344 39,231 -------- -------- Total assets ............................ $100,035 $114,982 ======== ======== F-22 CASTLE DENTAL CENTERS, INC. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 15. SUBSEQUENT EVENTS In January 2000, the Company amended its Credit Agreement and entered into a senior subordinated note agreement (Subordinated Note Agreement) and a subordinated convertible note agreement (Convertible Note Agreement) with two lenders. The Subordinated Note Agreement and Convertible Note Agreement provide for borrowings of $13.7 million and $1.3 million, respectively. Loans under the Subordinated Note Agreement bear interest at the 90-day LIBOR rate plus five and one-half percent, payable quarterly, and are due in eight quarterly installments beginning in the sixty-third month following the closing date. Loans under the Convertible Note Agreement bear interest at the same rate as loans under the Subordinated Note Agreement and are due on demand beginning seven years after the closing date with a final maturity date of January 30, 2009. The convertible note is convertible at any time into 442,880 shares of Company common stock at the request of the holders at a fixed conversion price of $3.1125 per share. The Subordinated Note Agreement and Convertible Note Agreement contain affirmative and negative covenants that require that the Company maintain certain financial ratios, limit the amount of additional indebtedness, limit the creation or existence of liens, set certain restrictions on acquisitions, mergers and sales of assets and restrict the payment of dividends. In January 2000, the Company paid $5.0 million to the former owners of DCS as consideration for entering into a settlement agreement. Under the terms of the settlement agreement, the Company acquired the 20% minority interest and the conversion right held by the former owners of DCS (Note 3). In January 2000, the Company paid the former owners of DCA and DCI approximately $430,000 pursuant to the terms of the Asset Purchase Agreement (Note 3). F-23 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Castle Dental Centers, Inc.: Our report on the financial statements of Castle Dental Centers, Inc. is included on page F-2 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in item 14(a) in this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included herein. PricewaterhouseCoopers LLP Houston, Texas April 26, 2000 S-1 CASTLE DENTAL CENTERS, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSAND)
PATIENT RECEIVABLES: BALANCE BALANCE BEGINNING CHARGED TO AT END OF YEAR EXPENSES DEDUCTIONS OTHER(1) OF YEAR ------- ------- ------- ------- ------- Year ended December 31, 1997: Allowance for uncollectible accounts - patient receivables ........................... $ 2,425 $ 1,698 $ 451 $ 257(1) $ 3,929 ======= ======= ======= ======= ======= Year ended December 31, 1998: Allowance for uncollectible accounts - patient receivables ........................... $ 3,929 $ 2,474 $ 1,092 $ 3,197(1) $ 8,508 ======= ======= ======= ======= ======= Year ended December 31, 1999: Allowance for uncollectible accounts - patient receivables ........................... $ 8,508 $ 3,914 $ -- $ 1,166(1)(2) $13,588 ======= ======= ======= ======= ======= BALANCE BALANCE UNBILLED PATIENT RECEIVABLES BEGINNING CHARGED TO AT END OF YEAR EXPENSES DEDUCTIONS OTHER(1) OF YEAR ------- ------- ------- ------- ------- Year ended December 31, 1997: Allowance for uncollectible accounts - unbilled patient receivables .................. $ 361 $ 199 $ -- $ 8 $ 568 ======= ======= ======= ======= ======= Year ended December 31, 1998: Allowance for uncollectible accounts - unbilled patient receivables .................. $ 568 $ 71 $ 30 $ 49 $ 658 ======= ======= ======= ======= ======= Year ended December 31, 1999: Allowance for uncollectible accounts - unbilled patient receivables .................. $ 658 $ 246 $ -- $ -- $ 904 ======= ======= ======= ======= =======
(1) Acquired allowances for uncollectible accounts of affiliated dental practices. (2) Adjustments to patient accounts that are charged to the allowance for doubtful accounts. S-2 (a)(3) EXHIBITS EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------- ---------------------- *3.1 -- Certificate of Incorporation of Castle Dental Centers, Inc., as amended. *3.2 -- Certificate of Amendment to Certificate of Incorporation of Castle Dental Centers, Inc., dated August 28, 1996. *3.3 -- Certificate of Amendment of Certificate of Incorporation of Castle Dental Centers, Inc., dated June 16, 1997. *3.4 -- Bylaws of Castle Dental Centers, Inc. *3.5 -- Amendment to Bylaws of Castle Dental Centers, Inc. dated August 16, 1996. *4.1 -- Form of Certificate representing the Common Stock, par value $.001 per share, of Castle Dental Centers, Inc. *4.2 -- Registration Rights Agreement dated December 18, 1995, among Castle Dental Centers, Inc. and Delaware State Employees' Retirement Fund, Declaration of Trust for Defined Benefit Plan of ICI American Holdings, Inc., Declaration of Trust for Defined Benefit Plan of Zeneca Holdings, Inc. and certain stockholders and investors in the Company. 4.3 -- Stockholders Agreement dated as of January 31, 2000, by and among Castle Dental Centers, Inc., Heller Financial, Inc., Midwest Mezzanine Fund II, L.P., and certain stockholders and investors in the Company. 4.4 -- Registration Rights Agreement dated as of January 31, 2000, by and among Castle Dental Centers, Inc., Heller Financial, Inc., Midwest Mezzanine Fund II, L.P., and certain stockholders and investors in the Company. *10.1 -- Management Services Agreement effective December 18, 1995 by and between Castle Dental Centers of Texas, Inc. and Jack H. Castle, D.D.S., P.C. *10.2 -- Amendment to Management Services Agreement between Castle Dental Centers of Texas, Inc. and Jack H. Castle, D.D.S., P.C., dated as of August 15, 1996. *10.3 -- Indemnity Agreement dated December 18, 1995 by and between Castle Dental Centers, Inc. and G. Kent Kahle. *10.4 -- Indemnity Agreement dated December 18, 1995, by and between Castle Dental Centers, Inc. and Jack H. Castle, D.D.S. *10.5 -- Indemnity Agreement dated December 18, 1995 by and between Castle Dental Centers, Inc. and Jack H. Castle, Jr. *10.6 -- Indemnity Agreement dated December 18, 1995 by and between Castle Dental Centers, Inc. and Robert J. Cresci. *10.7 -- Indemnity Agreement dated August 16, 1996 by and between Castle Dental Centers, Inc. and Elizabeth A. Tilney. *10.8 -- Management Services Agreement effective May 19, 1996 by and between Castle Dental Centers of Florida, Inc. and Castle 1st Dental Care, P.A. *10.9 -- Amendment to Management Services Agreement between Castle Dental Centers of Florida, Inc. and Castle 1st Dental Care, P.A., dated as of August 16, 1996. *10.10 -- Management Services Agreement effective May 31, 1996 by and between Castle Dental Centers of Tennessee, Inc. and Castle Mid-South Dental Center, P.C. *10.11 -- Amendment to Management Services Agreement between Castle Dental Centers of Tennessee, Inc. and Castle Mid-South Dental Center, P.C., dated as of August 16, 1996. *10.12 -- 1996 Castle Dental Centers, Inc. Omnibus Stock and Incentive Plan, as amended. *10.13 -- 1996 Castle Dental Centers, Inc. Non-Employee Directors' Plan, as amended. *10.14 -- Lease dated January 1, 1996 by and between Goforth, Inc. and Family Dental Services of Texas, Inc. 10.15 -- Form of Subordinated Promissory Note issued to former members of Dental Consulting Services, LLC ("DCS"). (Incorporated by reference from the Company's Form 8-K dated as of March 30, 1998.) 10.16 -- Form of Subordination Agreement entered into between each former member of DCS, Castle and NationsBank of Texas, N.A., as Agent. (Incorporated by reference from the Company's Form 8-K dated as of March 30, 1998.) 10.17 -- Asset Purchase Agreement dated as of December 30, 1998, by and among Castle Dental Centers of Texas, Inc., Castle Dental Centers, Inc., and Jack H. Castle, D.D.S., P.C., and DCA Limited Partnership, L.L.P. ("DCA, Ltd."), Dental Administrators of Texas Limited Partnership, L.L.P. ("DAI, Ltd."), Dental Centers of America Paymaster P.C. ("Paymaster"), Bandera Road Dental Center, P.C. ("Bandera"), Ingram Park Family Dental Center, P.C. ("Ingram"), Northeast Family Dental Center, P.C. ("Northeast"), Dental Centers of America at Rolling Oaks Mall, PLLC ("Rolling Oaks"), San Pedro Family Dental Center, P.C. ("San Pedro"), Southpark Family Dental Center, P.C. ("Southpark"), Windsor Park Family Dental Center, P.C. ("Windsor"), Dental Centers of America at Barton Creek Square Mall, PLLC ("Barton Creek"), Dental Centers of America at Lakeline Mall, PLLC ("Lakeline"), Dental Centers of America at Hurst Northeast Mall, PLLC ("Hurst"), Dental Centers of America at Irving Mall, PLLC ("Irving"), Dental Centers of America at Six Flags Mall, PLLC ("Six Flags"), Dental Centers of America at Waco, P.C. ("Waco"), Dental Centers of America at Mesquite, P.C. ("Mesquite"), Dental Centers of America at Sherman, P.C. ("Sherman"), Dental Centers of America at Richardson Square Mall, P.C. ("Richardson" and, collectively with DCA, Ltd., DAI, Ltd., Paymaster, Bandera, Ingram, Northeast, Rolling Oaks, San Pedro, Southpark, Windsor, Barton Creek, Lakeline, Hurst, Irving, Six Flags, Waco, Mesquite and Sherman, the "DCA Sellers"), Barry E. Solomon, D.D.S., an individual living in San Antonio, Texas ("B. Solomon"), Marc A. Solomon, an individual living in San Antonio, Texas ("M. Solomon"), Hebron D. Cutrer, an individual living in San Antonio, Texas ("Cutrer"), Stan E. Faye, an individual living in San Antonio, Texas ("Faye"), and Robert B. Grau, an individual living in San Antonio, Texas ("Grau", and together with B. Solomon, M. Solomon, Cutrer and Faye, the "DCA Shareholders"). (Incorporated by reference from the Company's Form 8-K dated as of December 30, 1998.) 10.18 -- Form of Subordinated Promissory Note issued to DCA Sellers and/or DCA shareholders. (Incorporated by reference from the Company's Form 8-K dated as of December 30, 1998.) 10.19 -- Form of Subordination Agreement entered into between each DCA Seller and/or DCA Shareholder receiving a Subordinated Promissory Note, Castle Dental and NationsBank, N.A., as Agent. (Incorporated by reference from the Company's Form 8-K dated as of December 30, 1998.) 10.20 -- Amended and Restated Credit Agreement dated as of December 18, 1998, by and among Castle Dental, NationsBank, N.A., as agent, and the lenders thereunder. (Incorporated by reference from the Company's Form 8-K dated as of December 30, 1998.) 10.21 -- Third Amendment to Amended and Restated Credit Agreement dated as of January 31, 2000, by and among Castle Dental Centers, Inc., Bank of America, N.A., as agent, and the lenders thereunder. 10.22 -- Settlement Agreement dated January 28, 2000, between Castle Dental Centers, Inc., Castle Dental Centers of California, L.LC., CDC of California, Inc. and the former owners of DCS. 10.23 -- Senior Subordinated Note Purchase Agreement dated as of January 31, 2000, is among Castle Dental Centers, Inc., Heller Financial, Inc., and Midwest Mezzanine Fund II, L.P. 10.24 -- Form of Subordinated Note issued pursuant to Senior Subordinated Note Purchase Agreement dated January 31, 2000. 10.25 -- Form of Convertible Subordinated Note issued pursuant to Senior Subordinated Note Purchase Agreement dated January 31, 2000. 10.26 -- Fourth Amendment to Amended and Restated Credit Agreement dated effective as of December 31, 1999, by and among Castle Dental Centers, Inc., Bank of America, N.A., as agent, and the lenders thereunder. 10.27 -- First Amendment to Senior Subordinated Note Purchase Agreement dated as of May 19, 2000, by and among Castle Dental Centers, Inc., Heller Financial, Inc., and Midwest Mezzanine Fund II, L.P. 21 -- Subsidiaries of the Registrant. 27.1 -- Financial Data Schedule as of December 31, 1999. ------------- * Incorporated herein by reference to the Company's Registration Statement on Form S-1 (registration number 333-1335) EX-4.3 2 EXHIBIT 4.3 STOCKHOLDERS AGREEMENT Stockholders Agreement (this "AGREEMENT") dated as of January 31, 2000, by and among Castle Dental Centers, Inc., a Delaware corporation (the "COMPANY"), Heller Financial, Inc., a Delaware corporation ("HELLER"), Midwest Mezzanine Fund II, L.P., a Delaware limited partnership ("MIDWEST"), and each Person whose name appears on SCHEDULE I hereto (collectively, the "CURRENT STOCKHOLDERS"). Capitalized terms used and not otherwise defined herein have the respective meanings ascribed thereto in Article I. RECITALS WHEREAS, contemporaneously with the execution and delivery of this Agreement, Heller, Midwest and the Company will enter into a Senior Subordinated Note Purchase Agreement (the "PURCHASE AGREEMENT"); WHEREAS, pursuant to the Purchase Agreement, Heller and Midwest will purchase notes convertible into shares of Common Stock of the Company; and WHEREAS, each of the Current Stockholders, Heller, Midwest and the Company desire to enter into this Agreement to regulate certain aspects of their relationship and to provide for, among other things, restrictions on the transfer or other disposition of securities of the Company. NOW, THEREFORE, the parties hereto hereby agree as follows: ARTICLE I CERTAIN DEFINITIONS 1.1. DEFINED TERMS. (a) The following capitalized terms, when used in this Agreement, have the respective meanings set forth below: "ACQUISITION" means the acquisition of another Person by the Company, directly or indirectly, by merger, purchase of shares of capital stock or purchase of all or substantially all of such other Person's assets. "AFFILIATE" means, as applied to any Person, (i) any other Person directly or indirectly controlling, controlled by or under common control with, that Person, (ii) any other Person that owns or controls 5% or more of any class of equity securities (including any equity securities issuable upon the exercise of any option or convertible security) of that Person or any of its Affiliates, or (iii) any director, partner, officer, agent, employee -1- or relative of such Person. For the purposes of this definition, "control" (including with correlative meanings, the terms "controlling", "controlled by", and "under common control with") as applied to any Person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of that Person whether through ownership of voting securities, by contract or otherwise. "BUSINESS DAY" shall mean any day other than a Saturday, Sunday or a day on which commercial banks in the State of Illinois are authorized or required by law or executive order to remain closed. "CALL PRICE" shall mean 150.00% of the Conversion Amount of the Convertible Notes called. "CHANGE OF CONTROL" shall mean (i) the direct or indirect sale, lease, exchange or other transfer of all or substantially all of the assets of the Company to any Person or entity or group of Persons or entities acting in concert as a partnership or other group within the meaning of Rule 13d-5 under the Exchange Act (a "GROUP OF PERSONS"), (ii) the merger or consolidation of the Company with or into another corporation, in which transaction the Company's shares of capital stock outstanding immediately prior to such transaction would entitle the holders thereof immediately after such transaction to ownership of less than a majority of the equity securities of the surviving corporation or its parent, (iii) the replacement of a majority of the Board of Directors of the Company, over a two-year period, from the directors who constituted the Board of Directors at the beginning of such period, except to the extent any such replacement shall have been approved by the Board of Directors of the Company as constituted at the beginning of such period, (iv) a Person or Group of Persons (other than any of the Current Stockholders, Investor Stockholders or their respective Affiliates) shall, as a result of a tender or exchange offer, open market purchases, privately negotiated purchases or otherwise, have become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act) of securities of the Company representing a majority of the combined voting power of the then outstanding securities of the Company ordinarily (and apart from rights accruing under special circumstances) having the right to vote in the election of directors. "CLOSING DATE" means the date on which the transaction contemplated by the Purchase Agreement shall have been consummated. "COMMISSION" means the Securities and Exchange Commission or any other federal agency at the time administering the Securities Act. "COMMON STOCK" means the common stock of the Company, par value $.001 per share, any securities into which such Common Stock shall have been changed or any securities resulting from any reclassification or recapitalization of such Common Stock and all other securities of any class or classes (however designated) of the Company the holders -2- of which have the right, without limitation as to amount, after payment on any securities entitled to a preference on dividends or other distributions upon any dissolution, liquidation or winding up, either to all or to a share of the balance of payments upon such dissolution, liquidation or winding up, including without limitation, any non-voting common stock issuable pursuant to Section 3.2 of this Agreement. "COMPANY" means Castle Dental Centers, Inc., a Delaware corporation. "CONVERSION AMOUNT" has the meaning ascribed to it in the Convertible Notes. "CONVERTIBLE NOTES" means the notes dated the date hereof initially convertible for an aggregate of 442,880 shares of Common Stock, issued to Heller and Midwest, and any securities issued upon subdivision or combination, or in substitution, thereof. "CURRENT MARKET PRICE" means, with respect to each share of Common Stock as of any date, the dollar volume-weighted average trading price per share of Common Stock (as reported by Bloomberg through its "Volume at Price" function) for the ten (10) consecutive trading days prior to such date; provided that if on any such date the shares of Common Stock are not listed or admitted for trading on any national securities exchange or quoted by NASDAQ or a similar service, the Current Market Price for a share of Common Stock shall be the fair market value of such share as determined in good faith by the Board of Directors of the Company. If the Board of Directors is unable to determine the fair market value, or if the Majority Holders disagree with the Board's determination of fair market value by written notice delivered to the Company within five Business Days after the Board's determination thereof is communicated in writing to the holders of Convertible Notes, then the Company and the Majority Holders shall select an Independent Financial Expert which shall determine such fair market value. If the Company and the Majority Holders are unable to agree upon an Independent Financial Expert within fifteen Business Days after the notice by the Majority Holders, each of the Company and the Majority Holders shall select an Independent Financial Expert within five Business Days following the expiration of such fifteen Business Day period, and these Independent Financial Experts shall select a third Independent Financial Expert, and the third Independent Financial Expert shall determine such fair market value. The determination of fair market value by such Independent Financial Expert shall be final, binding and conclusive on all parties. All costs and fees of any of this Independent Financial Expert(s) retained in accordance with the foregoing shall be borne by the Company. "CURRENT STOCKHOLDER" means each Person whose name appears on SCHEDULE I hereto and each of their Permitted Transferees and any other Person who becomes a "Current Stockholder" by execution and delivery of a Joinder Agreement. The parties acknowledge and agree that no Investor Stockholder shall be included in the definition of the term "Current Stockholder" for purposes of this Agreement. -3- "EXEMPTED SECURITIES" means the 100,000 shares of Common Stock acquired by Jack H. Castle, Jr. in September 1998 and the 103,000 shares of Common Stock acquired by Jack H. Castle, D.D.S. and Loretta Castle, jointly in September 1998. "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. "FULLY DILUTED BASIS" means, with respect to the calculation of the number of shares of Common Stock, (i) all shares of Common Stock outstanding at the time of determination, and (ii) all shares of Common Stock issuable upon the conversion, exchange or exercise of all securities (including the Convertible Notes) convertible, exchangeable or exercisable for or into shares of Common Stock regardless of whether such securities are then convertible, exchangeable or exercisable. "GAAP" means generally accepted accounting principles, consistently applied. "INDEPENDENT FINANCIAL EXPERT" means an independent nationally recognized investment banking firm. "INVESTOR STOCKHOLDERS" means, so long as any such Person shall hold Restricted Securities, Heller, Midwest and any Person to whom Heller or Midwest shall Transfer any Restricted Securities other than pursuant to an Open Market Sale. "JOINDER AGREEMENT" means a Joinder Agreement substantially in the form attached hereto as EXHIBIT A. "LIEN" means any lien, claim, charge, encumbrance, security interest or other adverse claim of any kind, other than any restrictions imposed under this Agreement or under federal or state securities laws. "MAJORITY HOLDERS" means, as of any particular date, the holders of a majority of the outstanding Redeemable Securities based upon the sum of the total number of Redeemable Shares then outstanding and the total number of shares of Common Stock issuable with respect to any Convertible Notes then outstanding. "OPEN MARKET SALE" means a sale of shares of Common Stock pursuant to a "brokers' transaction" within the meaning of Section 4(4) of the Securities Act or in a transaction directly with a "market maker", as that term is defined in Section 3(1) (38) of the Exchange Act. "OPEN MARKET SALES THRESHOLD" means, as of any particular date, a number of shares of Restricted Securities equal to the lesser of (i) 1% of the total number of shares of Common Stock then outstanding, without giving effect to the conversion, exchange or exercise of any securities, and (ii) 50% of the average weekly trading volume of the -4- Company's Common Stock for the four consecutive calendar weeks immediately prior to the week in which such date occurs. "PERMITTED TRANSFEREE" means (i) the spouse or lineal descendants of any Current Stockholder, (ii) any trust for the benefit of such Current Stockholder or the benefit of the spouse or lineal descendants of such Current Stockholder, any corporation or partnership in which such Current Stockholder, the spouse and the lineal descendants of such Current Stockholder are the direct and beneficial owners of all of the equity interests (provided such Current Stockholder, spouse and lineal descendants agree in writing to remain the direct and beneficial owners of all of the equity interests thereof), (iii) the personal representative of such Current Stockholder upon such Current Stockholder's death for purposes of administration of such Current Stockholder's estate or upon such Current Stockholder's incompetency for purposes of the protection and management of the assets of such Current Stockholder, or (iv) with respect to a Current Stockholder that is a partnership, trust, or other entity, any partner, beneficiary, or individual that is a beneficial owner of such entity as of the date hereof; PROVIDED, HOWEVER, in each case, that such transferee must agree to be bound by the terms of this Agreement by executing a Joinder Agreement. "PERSON" means an individual, partnership, corporation, trust, unincorporated organization, joint venture, government (or agency or political subdivision thereof) or any other entity of any kind. "REDEEMABLE SECURITIES" means the Convertible Notes and the Redeemable Shares. "REDEEMABLE SHARES" means, as of any given date of determination, any shares of Common Stock beneficially owned by an Investor Stockholder that have been issued on or prior to such date upon conversion of the Convertible Notes and any securities issued with respect thereto as a result of any stock dividend, stock split, reclassification, recapitalization, reorganization, merger, consolidation or similar event or upon the conversion, exchange or exercise thereof. "REDEMPTION PRICE" means: (i) with respect to any Conversion Amount of the Convertible Notes tendered for redemption, an aggregate amount equal to the greater of (A)(I) the number of shares of Common Stock issuable upon conversion of such Conversion Amount as of the date of the Redemption Notice, multiplied by (II) the Current Market Price, or (B) the Conversion Amount of the Convertible Notes tendered for redemption, and (ii) with respect to any Redeemable Shares tendered for redemption, an aggregate amount equal to (A) the number of Redeemable Shares tendered for redemption, multiplied by (B) the Current Market Price, provided, however, that in the case of an event described in clause (i)(A) of the definition of "Triggering Event", the Redemption Price shall equal the Conversion Amount of the Convertible Notes tendered for redemption. -5- "REGISTRATION RIGHTS AGREEMENT" means the Registration Rights Agreement, dated as of the date hereof, among the Company, Heller and Midwest as the same may be amended from time to time. "REGULATORY PROBLEM" means any set of facts or circumstances wherein any Investor Stockholder reasonably believes it is not entitled to hold, or exercise any significant right with respect to, the Common Stock. "RESTRICTED SECURITIES" means the Common Stock, Convertible Notes, the Common Stock issued or issuable upon conversion of the Convertible Notes, and any securities issued with respect thereto as a result of any stock dividend, stock split, reclassification, recapitalization, reorganization, merger, consolidation or similar event or upon the conversion, exchange or exercise thereof. "SECURITIES ACT" means the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. "SUBSIDIARY" means, with respect to any Person, any corporation of which an aggregate of 50% or more of the outstanding capital stock having ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether, at the time, capital stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time, directly or indirectly, owned by such Person and/or one or more Subsidiaries of such Person. "TRANSFER" means, directly or indirectly, any sale, transfer, assignment, hypothecation, pledge or other disposition of any Restricted Securities or any interests therein. "TRIGGERING EVENT" means the occurrence of any of the following: (i) with respect to the Convertible Notes and Redeemable Shares: (A) January 31, 2007; (B) any prepayment of principal pursuant to any of the Subordinated Notes (as defined in the Purchase Agreement); or (C) the occurrence of an Event of Default (as such term is defined in the Purchase Agreement); or (ii) with respect to the Redeemable Shares only: (A) a Change of Control; -6- (B) the Common Stock failing to be traded or listed for quotation on The New York Stock Exchange, American Stock Exchange, Nasdaq National Market or Nasdaq Smallcap Market; or (C) after January 31, 2003 and prior to January 31, 2004, the average weekly trading volume of the Company's Common Stock for four consecutive calendar weeks falling below 25,000 shares, or after January 31, 2004, the average weekly trading volume of the Company's Common Stock for four consecutive calendar weeks falling below 50,000 shares (in both cases, subject to equitable adjustment with respect to any stock split, stock dividend, recapitalization or other similar event). (b) Unless otherwise provided herein, all accounting terms used in this Agreement shall be interpreted in accordance GAAP as in effect from time to time. ARTICLE II TRANSFERS OF RESTRICTED SECURITIES 2.1. RESTRICTIONS GENERALLY; SECURITIES ACT. (a) Each Current Stockholder agrees that it will not, directly or indirectly, Transfer any Restricted Securities except in accordance with the terms of this Agreement. Each Investor Stockholder agrees that it will not, directly or indirectly, Transfer any Restricted Securities except in accordance with Section 2.1(b) of this Agreement. Any attempt to Transfer any Restricted Securities not in accordance with the terms of this Agreement shall be null and void and neither the issuer of such securities nor any transfer agent of such securities shall give any effect to such attempted Transfer in its stock records. (b) Each Current Stockholder and Investor Stockholder agrees that, in addition to the other requirements herein relating to Transfer, it will not Transfer any Restricted Securities except pursuant to an effective registration statement under the Securities Act, or upon receipt by the Company of an opinion of counsel to the Current Stockholder or Investor Stockholder, as the case may be, reasonably satisfactory to the Company or counsel to the Company, or a no-action letter from the Commission addressed to the Company, to the effect that no registration statement is required because of the availability of an exemption from registration under the Securities Act. 2.2. LEGEND. (a) Each certificate representing Restricted Securities other than Exempted Securities shall be endorsed with the following legends and such other legends as may be required by applicable state securities laws: THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS -7- AMENDED, OR ANY STATE SECURITIES LAWS. THE SECURITIES REPRESENTED BY THIS CERTIFICATE AND ANY INTEREST THEREIN MAY NOT BE SOLD, TRANSFERRED, PLEDGED, HYPOTHECATED OR OTHERWISE DISPOSED OF, EXCEPT PURSUANT TO (i) AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND APPLICABLE STATE SECURITIES LAWS OR (ii) AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT. THE SHARES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO CERTAIN RESTRICTIONS SET FORTH IN A STOCKHOLDERS AGREEMENT, DATED AS OF JANUARY 31, 2000. A COPY OF SUCH AGREEMENT MAY BE OBTAINED BY THE HOLDER HEREOF AT THE COMPANY'S PRINCIPAL PLACE OF BUSINESS WITHOUT CHARGE. (b) The legends set forth above shall be removed and the Company shall issue a certificate without such legends to the holder of the Restricted Securities upon which it is stamped, if, unless otherwise required by state securities laws, (i) a registration statement with respect to such Restricted Securities shall have become effective under the Securities Act, and such Restricted Securities shall have been disposed of in accordance with such registration statement, (ii) in connection with a Transfer permitted under or made in compliance with this Agreement, such holder provides the Company, at the Company's expense, with an opinion of counsel, in a generally acceptable form, to the effect that a public sale, assignment or transfer of the Restricted Securities may be made without registration under the Securities Act, or (iii) the Restricted Securities are not subject to restrictions on Transfer under this Agreement and can be sold pursuant to Rule 144 without any restriction as to the number of securities acquired as of a particular date that can then be immediately sold. 2.3. TAG-ALONG RIGHTS. (a) If any Current Stockholder (the "TRANSFEROR") proposes to Transfer any Restricted Securities ("TRANSFEROR SHARES") to any Person (the "BUYER"), other than to a Permitted Transferee or pursuant to an Open Market Sale, then, as a condition to such Transfer, the Transferor shall cause the Buyer to include an offer (the "TAG-ALONG OFFER") to each of the Investor Stockholders (collectively, the "OFFEREES"), to purchase from each Offeree, at the option of each Offeree, up to a number of shares of Restricted Securities determined in accordance with Section 2.3(b), on the same terms and conditions as are applicable to the Transferor Shares. The Transferor shall provide a written notice (the "TAG-ALONG NOTICE") of the Tag-Along Offer to each Offeree, which may accept the Tag-Along Offer by providing a written notice of acceptance of the Tag-Along Offer to the Transferor within thirty days of delivery of the Tag-Along Notice. (b) Each Offeree shall have the right (a "TAG-ALONG RIGHT") to sell pursuant to the Tag-Along Offer up to a number of shares of Restricted Securities equal to: (i) the number of shares of Restricted Securities that the Buyer is willing to purchase from the Transferor and the Offerees, in the aggregate, multiplied by (ii) a fraction, the numerator of which is the number of -8- Restricted Securities owned by such Offeree and the denominator of which is the number of Restricted Securities owned by the Transferor and all of the Offerees exercising their respective Tag-Along Rights; PROVIDED, HOWEVER, that, if all Common Stock beneficially owned by all Offerees is permitted to be sold to the Buyer, the Transferor shall be entitled to sell the number of shares set forth in the Tag-Along Offer which any Offeree has chosen not to sell without providing additional notice to the Offerees. (c) Upon exercise of a Tag-Along Right, at the closing of the proposed Transfer (which date, place and time shall be designated by the Transferor and provided to the Offerees in writing at least five Business Days prior thereto), each Offeree shall deliver to the Buyer a certificate or certificates representing the shares of Common Stock to be sold or otherwise disposed of pursuant to the Tag-Along Offer by such Offeree, free and clear of all Liens, against delivery of the purchase price therefor; PROVIDED that neither the Transferor nor any Offeree shall sell any Restricted Securities to any Buyer if such Buyer does not purchase, simultaneously and pursuant to the same terms, all of the Restricted Securities which the Offerees are entitled to sell to such Buyer pursuant to Section 2.3(b). In the event that, following delivery of a Tag-Along Notice, the 30-day period set forth in Section 2.3(a) shall have expired and the Transferor shall not have received a written notice from any Offeree pursuant to Section 2.3(a), the Transferor shall have the right, during the remainder of the 120-day period following the expiration of such 30-day period, to sell the Transferor Shares to the proposed Buyer, at a price not less than the price within the Tag-Along Offer and on terms no more favorable to such proposed Buyer than the terms of the Tag-Along Offer. (d) Promptly after the consummation of the sale or other disposition of the Transferor Shares and shares of Common Stock of the Offerees to the Buyer pursuant to the Tag- Along Offer, the Transferor shall notify the Offerees thereof, and the Buyer shall pay to the Transferor and each of the Offerees their respective portions of the sales price of the shares of Common Stock sold or otherwise disposed of pursuant thereto, and shall furnish such other evidence of the completion of such sale or other disposition and the terms thereof as may be reasonably requested by the Offerees. (e) The Exempted Securities shall not be subject to the provisions of Section 2.3 hereof. 2.4. NOTICE OF OPEN MARKET SALES. In any ninety-day period, a Current Stockholder may not sell a number of shares of Restricted Securities in excess of the Open Market Sales Threshold then in effect unless and until all of the following criteria shall have been met: (a) all of the Restricted Securities then held by the Investor Stockholders either are (i) then registered for resale under the Securities Act on a Form S-2 or S-3 (or any successor or similar short-form registration statement) that remains effective as of the date of such sale and during the ten Business Days prior thereto, or (ii) freely transferable in Open Market Sales, other than restrictions with respect to the number of securities that can be sold pursuant to Rule 144; and (b) no less than ten Business Days prior to the placing with a broker of an order to execute such sale or the execution -9- directly with a market maker of such sale, such Current Stockholder shall have filed with the Commission a notice of proposed sale on Form 144 with respect to such sale and shall have delivered a copy thereof to each of the Investor Stockholders; provided, however, that the Exempted Securities shall not be subject to Section 2.4 hereof. ARTICLE III COMPANY OBLIGATIONS 3.1. REDEMPTION RIGHT. From the date hereof until January 31, 2009, each Investor Stockholder shall have the following redemption rights: (a) In addition to all other rights of any Investor Stockholder contained herein, within 60 days following a Triggering Event any Investor Stockholder may notify the Company in writing (the "REDEMPTION NOTICE") of such Investor Stockholder's desire to cause the Company to redeem all or any portion of the Redeemable Securities held by such Investor Stockholder for their Redemption Price. Furthermore, following an event described in clause (ii) of the definition of a "Triggering Event", but prior to an event described in clause (i) of the definition of a "Triggering Event", an Investor Stockholder may convert all or any portion of the Conversion Amount of any Convertible Note for the purpose of tendering for redemption any shares of Common Stock issuance upon such exercise pursuant to this Section 3.1. (b) If the Company receives a Redemption Notice pursuant to Section 3.1(a), it shall deliver to the tendering Investor Stockholders in writing within thirty days of the receipt by the Company of the Redemption Notice, a notice stating: (i) the date as of which such redemption shall occur which date (the "REDEMPTION CLOSING") shall be not less than ten days nor more than thirty days following the date of such notice, but in any event prior to January __, 2009; (ii) the Redeemable Securities to be redeemed from the such Investor Stockholders and the Redemption Price (which shall be calculated as of the date of the Redemption Notice) and (iii) the place or places where the Redeemable Securities are to be surrendered for payment, subject to Section 3.1(e) below with respect to any Convertible Notes. (c) If the Company fails to pay the Redemption Price on the date fixed for redemption, in addition to any other remedies available to the Investor Stockholders, the Company shall also pay interest thereon at the rate of 1.5% per month (prorated for partial months) until such Redemption Price, any interest thereon and all accrued and unpaid interest on the Convertible Notes shall have been paid in full. (d) At the Redemption Closing, the tendering Investor Stockholders shall deliver to the Company any Redeemable Shares being tendered for redemption, in each case, duly endorsed for transfer to the Company, and subject to Section 3.1(e), any Convertible Notes being tendered for redemption, and the Company shall deliver to each tendering Investor Stockholder a cashier's or certified check payable to such Investor Stockholder in an amount equal to the Redemption Price payable thereto plus all accrued and unpaid interest on the Convertible Notes held by such Investor Stockholder being tendered for redemption. -10- (e) Notwithstanding anything to the contrary set forth herein, upon redemption of any portion of the Convertible Notes in accordance with the terms hereof, the Investor Stockholders shall not be required to physically surrender any of the Convertible Notes to the Company unless the full Conversion Amount then outstanding with respect thereto is being redeemed. The Company shall maintain records showing the Conversion Amount so redeemed and the dates of such redemptions or shall use such other method, reasonably satisfactory to the Investor Stockholders, so as not to require physical surrender of any Convertible Note upon any such partial redemption. Notwithstanding the foregoing, if any portion of a Convertible Note is redeemed as aforesaid, thereafter, the holder thereof may not transfer a Convertible Note unless such Investor Stockholder first physically surrenders such Convertible Note to the Company, whereupon the Company will forthwith issue and deliver upon the order of such Investor Stockholder a new Convertible Note (a "NEW CONVERTIBLE NOTE") of like tenor, registered as such Investor Stockholder may request, representing in the aggregate the remaining Conversion Amount represented by the Convertible Note. The Investor Stockholders and any assignees, by acceptance of the Convertible Notes or any New Convertible Note, acknowledge and agree that, by reason of the provisions of this paragraph, following redemption of any portion of any Convertible Note, the Conversion Amount represented by a New Convertible Note may be less than the principal amount set forth on the face of the corresponding Convertible Note dated January 31, 2000. (f) The Company shall not (and shall not permit any Affiliate of the Company to) hereafter enter into any contract or other consensual arrangement that by its terms restricts the Company's ability to redeem any of the Redeemable Securities, except as provided in the Senior Credit Agreement and the Subordination Agreement (as defined in the Purchase Agreement). 3.2. REGULATORY PROBLEM. In the event an Investor Stockholder determines that it has a Regulatory Problem, such Investor Stockholder shall have the right to transfer its entire interest in the Company without regard to any restriction on transfer set forth in this Agreement (other than securities laws restrictions), and the Company agrees to take all such actions as are reasonably requested by such Investor Stockholder in order to (i) effectuate and facilitate any transfer by such Investor Stockholder of its interests to any person designated by such Investor Stockholder (subject to compliance with applicable federal and state securities) or (ii) permit such Investor Stockholder (or any Affiliate thereof) to exchange all or any portion of the Common Stock then held by, or issuable to, it on a "share-for-share" basis for interests of a class of non- voting common stock of the Company, which non-voting common stock shall be identical in all respects to such Common Stock, except such stock shall be non-voting common stock and shall be convertible into voting common stock on such terms as are requested by such Investor Stockholder in light of regulatory considerations then prevailing. Company and each Current Stockholder and each Investor Stockholder agree to enter into such additional agreements, adopt such amendments hereto and to the Certificate of Incorporation of the Company and to take such additional actions as are reasonably requested by such Investor Stockholder in order to effectuate the intent of the foregoing. 3.3. APPROVAL OF ACQUISITIONS. During the term of this Agreement, any Acquisition by the Company of another Person shall require the approval of at least two-thirds of the members of the board of directors then in office. -11- ARTICLE IV OTHER AGREEMENTS 4.1. TERMINATION OF SECURITYHOLDERS AGREEMENT. Each of the Company and the Current Stockholders hereby agrees that the Amended and Restated Securityholders Agreement, dated as of June 16, 1997, and as amended to date, among the Company, Jack H. Castle, D.D.S., P.C. and the Current Stockholders, is hereby terminated and shall be of no further force and effect. 4.2. CONSENT TO REGISTRATION RIGHTS AGREEMENT. Each of the Current Stockholders hereby acknowledges that the Company is entering into the Registration Rights Agreement with the Investor Stockholders and that the Registration Rights Agreement conflicts with the terms of the Amended and Restated Registration Rights Agreement, dated as of June 16, 1997, and as amended to date, among the Company and the Current Stockholders (the "EXISTING REGISTRATION AGREEMENT") and grants preferential registration rights to the Investor Stockholders over those registration rights previously granted to the Current Stockholders pursuant to the Existing Registration Rights Agreement. Each of the Current Stockholders hereby consents to the Company entering into the Registration Rights Agreement and to the granting by the Company thereunder of such preferential registration rights and agrees that all registration rights held by such Current Stockholder shall be subject to the terms of the Registration Rights Agreement. 4.3. VOTING AGREEMENTS. (a) Each of the Current Stockholders hereby agrees that as long as Delaware State Employees' Retirement Fund, Declaration of Trust for Defined Benefit Plans of ICI American Holdings Inc. and Declaration of Trust for Defined Benefit Plans of Zeneca Holdings Inc. (collectively, the "PECKS INVESTORS") beneficially own in the aggregate at least 4.4 percent of the fully diluted outstanding shares of Common Stock, the Current Stockholders shall take all action within their respective power, including without limitation, the voting of capital stock of the Company, required to cause the Board of Directors of the Company to at all times consist of at least 4 and no more than 7 members, one of whom shall be designated by the Pecks Investors (the "DESIGNEE"). Each of the Current Stockholders agrees to vote all of its shares of Common Stock which are outstanding at all meetings of stockholders of the Company (or any written consents in lieu thereof) in which directors are elected in favor of the Designee. (b) The Company agrees to place on the agenda for its next annual meeting of stockholders, which will take place on or before June 1, 2000 (the "ANNUAL MEETING"), a proposal (the "PROPOSAL") to amend its certificate of incorporation (the "AMENDMENT") to authorize a class of no less than 500,000 shares of non-voting Common Stock of the Company which will be reserved for issuance to the Investor Stockholders in accordance with Section 2(c) of the Convertible Note or Section 3.2 of this Agreement. Furthermore, the Company agrees to recommend to its stockholders that they vote in favor of, and to solicit proxies for the purpose of -12- voting in favor of, the Proposal at the Annual Meeting. In furtherance of the foregoing, each of the Current Stockholders agrees to take all actions within their respective power, including without limitation, the voting of all capital stock of the Company, required to approve the Proposal, and following such approval, the Company shall cause the Amendment to be promptly filed with the Secretary of State of the State of Delaware, and the Company will promptly deliver to each Investor Stockholder a copy of the Amendment, certified by the Secretary of State of the State of Delaware, following its filing therewith. (c) Each of the Current Stockholders hereby agrees that upon the request of Jack H. Castle, D.D.S. or Loretta Castle, the Current Stockholders shall take all action within their respective power, including without limitation, the voting of capital stock of the Company, required to cause the Company to exercise its right under Section 2.2 of the Registration Rights Agreement to cause the registration of the Registrable Securities (as defined in the Registration Agreement). ARTICLE V CALL RIGHT 5.1. CALL RIGHT. From the date hereof until January 31, 2009, the Company shall have the following call rights: (a) At any time within 30 days after the consummation of a Change of Control of the type described in any of clauses (i), (ii) or (iv) of the definition of Change of Control, the Company may notify each Investor Stockholder in writing (the "CALL NOTICE") of the Company's desire to call for redemption all and not any lesser portion of the Convertible Notes held by such Investor Stockholder for their Call Price. Following the Call Notice, an Investor Stockholder shall retain the right to convert all or any portion of the Conversion Amount of any Convertible Note into shares of Common Stock, or tender all or any portion of the Conversion Amount of any Convertible Note or the resulting Redeemable Shares of Common Stock for redemption pursuant to Section 3.1 of this Agreement, at any time prior to the Call Closing (defined below). (b) The Call Notice shall state: (i) the date as of which such call shall occur (the "CALL CLOSING"), which date shall not be earlier than the sixtieth (60th) day following the Call Notice; (ii) the Convertible Notes to be called from each Investor Stockholder and the Call Price (which shall be calculated as of the date of the Call Notice) and (iii) the place or places where the Convertible Notes are to be surrendered for payment. (c) At the Call Closing, the tendering Investor Stockholders shall deliver to the Company all Convertible Notes called for redemption and which have not been converted into shares of Common Stock or tendered for redemption pursuant to Section 2.1 of this Agreement, in each case, duly endorsed for transfer to the Company and the Company shall deliver to each tendering Investor Stockholder a cashier's or certified check payable to such Investor Stockholder in an amount equal to the Call Price payable thereto plus all accrued and unpaid interest on the -13- Convertible Notes held by such Investor Stockholder being tendered for redemption pursuant to this Section 5.1. ARTICLE VI MISCELLANEOUS 6.1. GOVERNING LAW; SUBMISSION TO JURISDICTION. (a) This Agreement shall be governed by, and construed in accordance with, the laws of the State of Illinois. (b) Any legal action or proceeding with respect to this agreement shall be brought in the courts of the State of Illinois or of the United States of America for the northern district of Illinois, and, by execution and delivery of this agreement, each of the Company and each Stockholder and Investor Stockholder hereby accepts for itself and (to the extent permitted by law) in respect of its property, generally and unconditionally, the jurisdiction of the aforesaid courts. Each of the Company and each Current Stockholder and Investor Stockholder hereby irrevocably waives any objection, including, without limitation, any objection to the laying of venue or based on the grounds of FORUM NON CONVENIENS, which it may now or hereafter have to the bringing of any such action or proceeding in such respective jurisdictions. (c) Nothing herein shall affect the right of any holder to serve process in any other manner permitted by law. (d) The Company and each Current Stockholder and Investor Stockholder hereby (i) irrevocably and unconditionally waive, to the fullest extent permitted by law, trial by jury in any legal action or proceeding relating to this agreement and for any counterclaim therein; (ii) irrevocably waive, to the maximum extent not prohibited by law, any right it may have to claim or recover in any such litigation any special, exemplary, punitive or consequential damages, or damages other than, or in addition to, actual damages; (iii) certify that no party hereto nor any representative or agent of counsel for any party hereto has represented, expressly or otherwise, or implied that such party would not, in the event of litigation, seek to enforce the foregoing waivers, and (iv) acknowledge that it has been induced to enter into this agreement and the transactions contemplated hereby among other things, the mutual waivers and certifications contained in this Section 5.1. 6.2. ENTIRE AGREEMENT; AMENDMENTS. This Agreement constitutes the entire agreement of the parties with respect to the subject matter hereof and supersedes any and all previous oral or written communications, representations or agreements. This Agreement may be amended, modified or supplemented only by a written instrument duly executed by the Company, the Current Stockholders and the Investor Stockholders. -14- 6.3. TERM. Sections 2.3 and 2.4, Article III, Section 4.3(b) and Article V of this Agreement will terminate ("Partial Termination") at the earlier to occur of (a) such time as the Restricted Securities owned by the Investor Stockholders, in the aggregate, represent less than both (i) 1% of the Company's outstanding shares of Common Stock on a Fully Diluted Basis, and (ii) the average weekly trading volume of the Company's Common Stock for four consecutive calendar weeks and (b) immediately following the consummation of the Call Closing or its scheduled date if all Convertible Notes are converted prior to such date. Following a Partial Termination, the remaining provisions of this Agreement will terminate when the Pecks Investors beneficially own in the aggregate less than 4.4 percent of the fully diluted outstanding shares of Common Stock. 6.4. INSPECTION. For so long as this Agreement shall remain in effect, this Agreement shall be made available for inspection by any Current Stockholder or Investor Stockholder at the principal executive offices of the Company. 6.5. RECAPITALIZATION, EXCHANGES, ETC., AFFECTING RESTRICTED SECURITIES. The provisions of this Agreement shall apply, to the full extent set forth herein with respect to the Restricted Securities, to any and all shares of the Company capital stock or any successor or assign of the Company (whether by merger, consolidation, sale of assets, or otherwise, including shares issued by a parent corporation in connection with a triangular merger) which may be issued in respect of, in exchange for, or in substitution of, Restricted Securities and shall be appropriately adjusted for any stock dividends, splits, reverse splits, combinations, reclassifications and the like occurring after the date hereof. 6.6. WAIVER. No waiver by any party of any term or condition of this Agreement, in one or more instances, shall be valid unless in writing, and no such waiver shall be deemed to be construed as a waiver of any subsequent breach or default of the same or similar nature. Any rights of the Investor Stockholders hereunder may be waived by the affirmative vote of the Majority Holders and each of Heller and Midwest so long as such Investor Stockholders own any Restricted Securities. 6.7. SUCCESSORS AND ASSIGNS. Except as otherwise expressly provided herein, this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and permitted assigns, as the case may be; PROVIDED, HOWEVER, that nothing contained herein shall be construed as granting any Current Stockholder the right to transfer any of its Restricted Securities except in accordance with this Agreement. 6.8. REMEDIES. In the event of a breach by any party to this Agreement of its obligations under this Agreement, the loss of any right as provided in this Agreement as a result of such breach shall not be the sole and exclusive remedy of any party injured by such breach. Any such injured party will be entitled to specific performance of its rights under this Agreement, in addition to being entitled to exercise all rights granted by law, including recovery of damages. The parties agree that the provisions of this Agreement shall be specifically enforceable, it being -15- agreed by the parties that the remedy at law, including monetary damages, for breach of any such provision will be inadequate compensation for any loss and that any defense in any action for specific performance that a remedy at law would be adequate is waived. 6.9. INVALID PROVISIONS. If any provision of this Agreement is held to be illegal, invalid or unenforceable under any present or future law, and if the rights or obligations of any party hereto under this Agreement will not be materially and adversely affected thereby, (i) such provision will be fully severable, (ii) this Agreement will be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof, (iii) the remaining provisions of this Agreement will remain in full force and effect and will not be affected by the illegal, invalid or unenforceable provision or by its severance herefrom and (iv) in lieu of such illegal, invalid or unenforceable provision, there will be added automatically as a part of this Agreement a legal, valid and enforceable provision as similar in terms to such illegal, invalid or unenforceable provision as may be possible. 6.10. HEADINGS. The headings used in this Agreement have been inserted for convenience of reference only and do not define or limit the provisions hereof. 6.11. FURTHER ASSURANCES. Each party hereto shall cooperate and shall take such further action and shall execute and deliver such further documents as may be reasonably requested by any other party in order to carry out the provisions and purposes of this Agreement. 6.12. GENDER. Whenever the pronouns "he" or "his" are used herein they shall also be deemed to mean "she" or "hers" or "it" or "its" whenever applicable words in the singular shall be read and construed as though in the plural and words in the plural shall be construed as though in the singular in all cases where they would so apply. 6.13. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which will be deemed an original, but all of which together will constitute one and the same instrument. 6.14. NOTICES. All notices and other communications provided for herein (including, without limitation, any modifications of, or waivers or consents under, this Agreement) shall be given or made by telex, telecopy, courier or U.S. Mail or in writing and telexed, telecopied, mailed or delivered to the intended recipient at the address specified below; or, as to any party, at such other address as shall be designated by such party in a notice to each other party: -16- If to the Company or the Current Stockholders: Castle Dental Centers, Inc. 1360 Post Oak Boulevard Suite 1300 Houston, Texas 77056 Attention: Jack H. Castle, Jr. Telecopy: (713) 513-1401 If to Heller: Heller Financial, Inc. 500 West Monroe Street Chicago, Illinois 60661 Attention: Account Manager Corporate Finance Telecopy: (312) 441-7367 with a copy to: Heller Financial, Inc. 500 West Monroe Street Chicago, Illinois 60661 Attention: Legal Services Corporate Finance Group Telecopy: (312) 441-6876 If to Midwest: Midwest Mezzanine Fund II, L.P. 208 South LaSalle Street, 10th floor Chicago, Illinois 60604-1003 Attention: J. Allan Kayler Telecopy: (312) 553-6647 Except as otherwise provided in this Agreement, all such communications shall be deemed to have been duly given when transmitted, if transmitted before 1:00 p.m. local time on a Business Day (otherwise on the next succeeding Business Day) by telex or telecopier and evidence or confirmation of receipt is obtained, or personally delivered or, in the case of a mailed notice, three (3) Business Days after the date deposited in the mails, postage prepaid, in each case given or addressed as aforesaid. -17- IN WITNESS WHEREOF, the parties hereto have executed and delivered this Stockholders Agreement as of the date first above written. HELLER FINANCIAL, INC., A DELAWARE CORPORATION By :_________________________________ MIDWEST MEZZANINE FUND II, L.P., A DELAWARE LIMITED PARTNERSHIP By: ABN AMRO Mezzanine Management II, L.P., its general partner By: ABN AMRO Mezzanine Management II, Inc., its general partner By :_________________________________ J. Allan Kayler Senior Vice President CASTLE DENTAL CENTERS, INC., A DELAWARE CORPORATION By :_________________________________ Jack H. Castle, Jr. Chairman and Chief Executive Officer STOCKHOLDERS [SEE FOLLOWING PAGE] -18- Exhibit A FORM OF JOINDER AGREEMENT Castle Dental Centers, Inc. 1360 Post Oak Blvd., Suite 1300 Houston, Texas 77056 Gentlemen: In consideration of the transfer to the undersigned of ________ shares of Common Stock, par value $.001 per share, [DESCRIBE ANY OTHER SECURITY BEING TRANSFERRED] of Castle Dental Center, Inc., a Delaware corporation (the "Company"), the undersigned represents that it is a Permitted Transferee of [INSERT NAME OF TRANSFEROR] and agrees that, as of the date written below, [HE] [SHE] [IT] shall become a party to, and a Permitted Transferee as defined in, that certain Stockholders Agreement dated as of January 31, 2000, as such agreement may have been amended from time to time (the "Agreement"), among the Company and the persons named therein, and as a Permitted Transferee shall be fully bound by, and subject to, all of the covenants, terms and conditions of the Agreement that were applicable to the undersigned's transferor, as though an original party thereto and shall be deemed a Current Stockholder for purposes thereof. Executed as of the _________ day of __________________________________. TRANSFEREE: Address: ACKNOWLEDGED AND ACCEPTED: CASTLE DENTAL CENTERS, INC. By:___________________________________________ Name:___________________________________ Title:__________________________________ -19- EX-4.4 3 Exhibit 4.4 REGISTRATION RIGHTS AGREEMENT REGISTRATION RIGHTS AGREEMENT (this "AGREEMENT"), dated as of January 31, 2000, by and between CASTLE DENTAL CENTERS, INC., a Delaware corporation (the "COMPANY"), HELLER FINANCIAL, INC., a Delaware corporation ("HELLER") and MIDWEST MEZZANINE FUND II, L.P., a Delaware limited partnership ("MIDWEST") (Heller and Midwest are sometimes referred to individually as a "HOLDER" and together, as the "HOLDERS"). Capitalized terms used and not other defined herein have the respective meanings ascribed thereto in Article I. RECITALS WHEREAS, contemporaneously with the execution and delivery of this Agreement, the Holders and the Company will enter into a Subordinated Note Purchase Agreement (the "PURCHASE AGREEMENT"); WHEREAS, pursuant to the Purchase Agreement, the each Holder will purchase a note or notes convertible into shares of Common Stock of the Company; and WHEREAS, each of the Holders and the Company desire to enter into this Agreement to provide the Holders with certain rights with respect to their ownership of the Company's Common Stock issuable upon conversion of the Convertible Note. NOW, THEREFORE, the parties hereto hereby agree as follows: ARTICLE I CERTAIN DEFINITIONS 1.1 DEFINED TERMS. The following capitalized terms, when used in this Agreement, have the respective meanings set forth below: "COMMISSION" means the Securities and Exchange Commission or any other federal agency at the time administering the Securities Act. "COMMON STOCK" means the common stock of the Company, par value $.001 per share, any securities into which such Common Stock shall have been changed or any securities resulting from any reclassification or recapitalization of such Common Stock and all other securities of any class or classes (however designated) of the Company the holders of which have the right, without limitation as to amount, after payment on any securities entitled to a preference on dividends or other distributions upon any dissolution, liquidation Registration Rights Agreement -1- or winding up, either to all or to a share of the balance of payments upon such dissolution, liquidation or winding up. "CONVERTIBLE NOTES" means the notes dated the date hereof initially convertible for an aggregate of 442,880 shares of Common Stock, issued to the Holders, and any securities issued upon subdivision or combination, or in substitution, thereof. "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. "EXISTING REGISTRABLE SECURITIES" means the 2,969,822 shares of Common Stock defined as "Registrable Securities" and "Registrable inside Shareholder Securities" pursuant to that certain Amended and Restated Registration Rights Agreement, dated as of June 16, 1997, among the Company and those Persons whose names appear thereon, as such agreement exists as of the date hereof, without giving effect to any further amendment or modifications thereto, so long as such shares remain "Registrable Securities" or "Registrable inside Shareholder Securities" thereunder. "FULLY DILUTED BASIS" means, with respect to the calculation of the number of shares of Common Stock, (i) all shares of Common Stock outstanding at the time of determination, and (ii) all shares of Common Stock issuable upon the conversion, exchange or exercise of all securities (including the Convertible Notes) convertible, exchangeable or exercisable for or into shares of Common Stock regardless of whether such securities are then convertible, exchangeable or exercisable. "HOLDERS" means the Holders and any permitted successors or assigns, so long as such Persons are the owners of record of any Registrable Securities or any Convertible Notes pursuant to which any Registrable Securities may be issued. "MAJORITY HOLDERS" means, as of any particular date, the holders of a majority of the outstanding Registrable Securities based upon the sum of the total number of shares of Registrable Securities then outstanding and the total number of shares of Registrable Securities issuable with respect to any Convertible Notes then outstanding. "PERSON" means an individual, partnership, corporation, trust, unincorporated organization, joint venture, government (or agency or political subdivision thereof) or any other entity of any kind. "REGISTRABLE SECURITIES" means any shares of Common Stock issuable upon conversion of the Convertible Note or securities issued or issuable with respect to such Convertible Note or Common Stock by way of stock dividend or stock split or in connection with a combination of shares, recapitalization, merger, consolidation or other reorganization or otherwise upon any required adjustments. As to any particular Registrable Securities, such securities shall cease to be Registrable Securities when (a) Registration Rights Agreement -2- a registration statement with respect to the sale of such securities shall have become effective under the Securities Act and such securities shall have been disposed of in accordance with such registration statement, or (b) they shall have been distributed to the public pursuant to Rule 144 (or any successor provision) under the Securities Act. "REGISTRATION EXPENSES" means all expenses incident to the Company's performance of or compliance with SECTION 2, including, without limitation, all registration, filing and National Association of Securities Dealers, Inc. fees, all fees and expenses of complying with securities or blue sky laws, all word processing, duplicating and printing expenses, messenger and delivery expenses, the fees and disbursements of counsel for the Company and of its independent public accountants, including the expenses of any special audits or "comfort" letters required by or incident to such performance and compliance, the reasonable fees and disbursements of one counsel (except in the event of a conflict of interest, then such number of counsel as is appropriate to resolve such conflict) retained by the holder or holders of a majority of the Registrable Securities being registered, premiums and other costs of policies of insurance, if any, obtained by the Company against liabilities arising out of the public offering of the Registrable Securities being registered and any fees and disbursements of underwriters customarily paid by issuers or sellers of securities, including reasonable fees of underwriters counsel including qualification of securities under blue sky laws, but excluding all agency fees and commissions, underwriting discounts and commissions and transfer taxes, if any. "SECURITIES ACT" means the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. ARTICLE II REGISTRATION UNDER SECURITIES ACT 2.1 REGISTRATION OF REGISTRABLE SECURITIES ON REQUEST. (a) REQUEST. The Majority Holders shall have the right to request in writing that the Company effect one registration under the Securities Act of 1933, as amended (the "SECURITIES ACT") of all or part of such Holders' Registrable Securities pursuant to this SECTION 2.1. Within ten days after receipt of any such request, the Company will give written notice of such requested registration to all other Holders of Registrable Securities, which Holders shall be entitled to include their Registrable Securities in such registration subject to SECTION 2.1(F). Thereupon the Company will use its best efforts to effect, as expeditiously as possible, the registrations under the Securities Act on the form requested by the Holders of Registrable Securities requesting registration of the following securities, subject to SECTIONS 2.1(F): Registration Rights Agreement -3- (i) the Registrable Securities which the Company has been so requested to register by the Majority Holders; and (ii) all other Registrable Securities which the Company has been requested to register by the Holders thereof by written request given to the Company within thirty (30) days after the giving of such written notice by the Company (which request shall specify the intended method of disposition of such Registrable Securities). The Holders of a majority of the Registrable Securities requesting a registration under this ARTICLE II may, at any time prior to the effective date of the registration statement relating to such registration, revoke, without liability, such request by providing written notice to the Company. The Company will pay all Registration Expenses in connection with any registration pursuant to this SECTION 2.1. (b) REGISTRATION OF OTHER SECURITIES. Whenever the Company shall effect a registration pursuant to this SECTION 2.1, no securities other than Registrable Securities shall be included among the securities covered by such registration unless (i) the managing underwriter of such offering shall have advised each Holder of Registrable Securities to be covered by such registration in writing that the inclusion of such other securities would not in the underwriter's reasonable judgment adversely affect such offering or (ii) the Holders of a majority of Registrable Securities to be covered by such registration shall have consented in writing to the inclusion of such other securities. The Company has not granted, and the Company will not grant to any person at any time on or after the date hereof, the right to be included among the securities registered pursuant to this SECTION 2.1 that is inconsistent with the provisions of this SECTION 2.1(B). (c) REGISTRATION STATEMENT FORM. Registrations under this SECTION 2.1 shall be on such appropriate registration form of the Commission (i) as shall be selected by the Holders of a majority of the Registrable Securities so to be registered and (ii) as shall permit the disposition of such Registrable Securities in accordance with the intended method or methods of disposition specified in their request for such registration. The Company agrees to include in any such registration statement all information which Holders of Registrable Securities being registered shall reasonably request. (d) EFFECTIVE REGISTRATION STATEMENT. A registration requested pursuant to this SECTION 2.1 shall not be deemed to have been effected and shall not count as a requested registration pursuant to SECTION 2.1(A) hereof (i) unless a registration statement with respect thereto has become effective under the Securities Act and has remained effective for a period of at least 180 days (or such shorter period in which all Registrable Securities included in such registration have actually been sold thereunder, but subject to extension pursuant to SECTION 2.4(B)), (ii) if after it has become effective, such registration is interfered with by any stop order, injunction or other order or requirement of the Commission or other governmental agency or court for any reason not the fault of a Holder of Registrable Securities covered thereby have not been sold, or (iii) if the conditions to closing specified in the selling agreement or Registration Rights Agreement -4- underwriting agreement entered into in connection with such registration are not satisfied or waived by the parties thereto other than a Holder of Registrable Securities. Notwithstanding the foregoing, the Company will pay all Registration Expenses in connection with any registration that is not deemed to have been effected pursuant to SECTION 2.1(A) as a result of the terms of this SECTION 2.1(D). (e) UNDERWRITERS. Any registration effected pursuant to this SECTION 2.1 shall, at the election of the Holders of a majority of the Registrable Securities to be so registered, be an underwritten public offering on a firm commitment basis or a best efforts basis. The managing underwriter or underwriters thereof shall be selected by the Company, subject to the approval of such selection by the Holders of a majority of the Registrable Securities to be so registered, and the price, terms and provisions of the offering shall be subject to the approval of the Company and the Holders of a majority of the Registrable Securities to be so registered. (f) APPORTIONMENT IN REGISTRATIONS REQUESTED. If, in connection with a registration requested pursuant to this SECTION 2.1, the managing underwriter shall advise the Company in writing (with a copy to each Holder of Registrable Securities requesting registration) that, in its opinion, the number of securities requested to be included in such registration exceeds the number which can be sold in such offering within a price range acceptable to the Holders of a majority of the Registrable Securities requested to be included in such registration, the number of securities that are otherwise entitled to be included in such registration shall be allocated in the following manner: the Registrable Securities requested to be included in such registration shall be reduced, on a pro rata basis among the Holders thereof requesting such registration on the basis of the percentage of the Registrable Securities held by the Holders of Registrable Securities which have requested that such Registrable Securities be included. 2.2 REGISTRATIONS ON FORM S-3. Anything contained in SECTION 2.1 to the contrary notwithstanding, the Holder or Holders of the Registrable Securities shall have the right to request in writing an unlimited number of registrations on Form S-3 (or any successor or similar short- form registration statement), of Registrable Securities, which request or requests shall (i) specify the number of Registrable Securities intended to be sold or disposed of and the Holders thereof, and (ii) state the intended method of disposition of such Registrable Securities. A requested registration in compliance with this SECTION 2.2 shall not count as a registration statement initiated pursuant to SECTION 2.1 but shall otherwise be treated as a registration initiated pursuant to, and shall, except as otherwise expressly provided in this SECTION 2.2, be subject to SECTION 2.1. In addition, the Company may at any time initiate a registration on Form S-3 (or any successor or similar short-form registration statement) of the Registrable Securities. The Holder or Holders of such Registrable Securities shall cooperate with such registration, including providing the information regarding such Holder or Holders required to be included in the Prospectus by the Securities Act. The Company will pay all Registration Expenses in connection with any registration on Form S-3 (or any successor or similar short-form registration statement). Registration Rights Agreement -5- 2.3 "PIGGYBACK" REGISTRATIONS. (a) RIGHT TO INCLUDE REGISTRABLE SECURITIES. If the Company at any time proposes to register any Common Stock under the Securities Act (other than by a registration on Form S-4, Form S-8 or any successor or similar form, or in connection with a tender offer, merger, or other acquisition, and other than pursuant to SECTION 2.1 or SECTION 2.2), whether or not for sale for its own account, and the registration form to be used may be used for the registration of Registrable Securities, the Company will give prompt written notice (in any event within ten (10) business days after its receipt of any notice of exercise of other demand registration rights and at least thirty (30) days prior to the anticipated filing date of the registration statement relating to such registration) to all Holders of Registrable Securities of its intention to do so and of such Holders' rights under this SECTION 2.3. Upon the written request of any such Holder made within twenty (20) days after the date of any such notice, the Company will include in such registration all Registrable Securities which the Company has been so requested to register by the Holders thereof, PROVIDED that if, at any time after giving written notice of its intention to register its Common Stock and prior to the effective date of the registration statement filed in connection with such registration, the Company shall determine for any reason not to register or to delay registration of its Common Stock, the Company may, at its election, give written notice of such determination to each Holder of Registrable Securities and, thereupon, (i) in the case of a determination not to register, shall be relieved of its obligation to register any Registrable Securities in connection with such registration (but not from its obligation to pay the Registration Expenses in connection therewith or to include any Registrable Securities in subsequent registrations), without prejudice, however, to the rights of any Holder of Registrable Securities entitled to do so to request that such registration be effected as a registration under SECTION 2.1 or SECTION 2.2, and (ii) in the case of a determination to delay registering, shall be permitted to delay registering any Registrable Securities for the same period as the delay in registering its Common Stock. No registration effected under this SECTION 2.3 shall relieve the Company of its obligation to effect any registration upon request under SECTION 2.1 or SECTION 2.2. The Company will pay all Registration Expenses in connection with each registration of Registrable Securities requested pursuant to this SECTION 2.3. (b) APPORTIONMENT IN "PIGGYBACK" REGISTRATIONS. (i) If a registration under this SECTION 2.3 is an underwritten primary registration on behalf of the Company and the managing underwriter of such underwritten offering advises the Company in writing of its belief that the aggregate number of shares of Common Stock requested to be included in such registration exceeds the number which can be sold in such offering, then the Company will include in such registration, (A) first, the securities proposed by the Company to be sold for its own account, (B) second, the Registrable Securities and Existing Registrable Securities requested to be included in such registration; PROVIDED, THAT if the managing underwriter advises the Company in writing of its belief that a lower number of Registrable Securities and Existing Registrable Securities should be included, then the Company shall be required to include in the underwriting only that lower number of Registrable Securities and Existing Registrable Securities, and the holders of Registrable Securities and Existing Registrable Securities Registration Rights Agreement -6- who have requested registration shall participate in the underwriting in accordance with the terms of SECTION 2.3(B)(III) below, and (C) third, if all of the Registrable Securities and Existing Registrable Securities requested to be included in such registration have been included therein, then any other securities requested to be included in such registration. (ii) If a registration under this SECTION 2.3 is an underwritten secondary registration on behalf of holders of the Company's Securities, and the managing underwriter advises the Company in writing of its belief that the aggregate number of shares of Common Stock requested to be included in such registration exceeds the number which can be sold in such offering, then the Company will include in such registration (A) first, the securities requested to be included therein by the holders requesting such registration, (B) second, the Registrable Securities and Existing Registrable Securities requested to be included in such registration; PROVIDED, THAT if the managing underwriter advises the Company in writing of its belief that a lower number of Registrable Securities and Existing Registrable Securities should be included, then the Company shall be required to include in the underwriting only that lower number of Registrable Securities and Existing Registrable Securities, and the holders of Registrable Securities and Existing Registrable Securities who have requested registration shall participate in the underwriting in accordance with the terms of SECTION 2.3(B)(III) below, and (C) third, if all of the Registrable Securities and Existing Registrable Securities requested to be included in such registration have been included therein, then any other securities requested to be included in such registration. (iii) If the number of Registrable Securities and Existing Registrable Securities to be included in a registration are to be reduced pursuant to either SECTION 2.3(B)(I)(B) or SECTION 2.3(B)(II)(B), the maximum number of Registrable Securities and Existing Registrable Securities that are entitled to be included in such registration (other than Registrable Securities included pursuant to SECTION 2.3(B)(II)(A), which shall not be reduced) (the "MAXIMUM NUMBER OF SHARES") shall be allocated among the holders of Registrable Securities and Existing Registrable Securities in the following manner: (A) first, each Holder of Registrable Securities shall be entitled to include in such registration a number of shares of Registrable Securities determined in accordance with the following formula: 1 degree = 2 x (H/R x M) Where: 1 degree = the number of shares of Registrable Securities that such Holder shall be entitled to include in such registration pursuant to this clause (A). H = the number of shares of Registrable Securities owned by such Holder. Registration Rights Agreement -7- R = the total number of shares of Registrable Securities and Existing Registrable Securities for which registration has been requested. M = the Maximum Number of Shares. (B) second, each Holder of Registrable Securities and each holder of Existing Registrable Securities shall be entitled to include in such registration a portion of the remaining Maximum Number of Shares determined in accordance with the following formula: 2 degree = H/R x (M-I) Where: 2 degree = the number of shares of Registrable Securities or Existing Registrable Securities that such Holder shall be entitled to include in such registration pursuant to this clause (B). H = the number of shares of Registrable Securities and Existing Registrable Securities owned by such Holder. R = the aggregate number of shares of Registrable Securities and Existing Registrable Securities for which registration has been requested. M = the Maximum Number of Shares. I = the aggregate number of shares of Registrable Securities to be included in such registration pursuant to clause (A) above. 2.4 REGISTRATION PROCEDURES. Whenever the holders of Registrable Securities have requested that any Registrable Securities be registered pursuant to this Agreement, the Company will use its best efforts to effect the registration and the sale of such Registrable Securities in accordance with the intended method of disposition thereof, and pursuant thereto the Company will as expeditiously as possible: (a) prepare and file with the Commission within 90 days, and use its best efforts to prepare and so file within 45 days, after receipt of a request for registration with respect to such Registrable Securities, a registration statement with respect to such Registrable Securities (such registration statement to include all information which the holders of the Registrable Securities to be registered thereby shall reasonably request) and use its best efforts to cause such registration statement to become and remain effective; PROVIDED, THAT at least five days before filing a registration statement or prospectus or any amendments or supplements thereto, the Company will (i) furnish to counsel selected by the holders of a majority of the Registrable Securities covered by such registration statement copies of all such documents proposed to be filed, and the Company Registration Rights Agreement -8- shall not file any thereof to which such counsel shall have reasonably objected on the grounds that such document does not comply in all material respects with the requirements of the Securities Act or of the rules or regulations thereunder, and (ii) notify each holder of Registrable Securities covered by such registration statement of (x) any request by the Commission to amend such registration statement or amend or supplement any prospectus, or (y) any stop order issued or threatened by the Commission, and take all reasonable actions required to prevent the entry of such stop order or to remove it if entered; (b) (i) prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective for a period of not less than 180 days (except that such 180 day period shall be extended (x) by the length of any period that a stop order or similar proceeding is in effect which prohibits the distribution of the Registrable Securities, and (y) by the number of days during the period from and including the date on which each seller of Registrable Securities shall have received a notice delivered pursuant to clause (g) below until the date when such seller shall have received a copy of the supplemented or amended prospectus contemplated by clause (g) below), and (ii) comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement during such period in accordance with the intended methods of disposition by the sellers thereof set forth in such registration statement; (c) furnish to each seller and each underwriter, if any, of Registrable Securities, without charge, such number of conformed copies of such registration statement, each amendment and supplement thereto, the prospectus included in such registration statement (including each preliminary prospectus and, in each case including all exhibits) and such other documents as such seller may reasonably request in order to facilitate the disposition of the Registrable Securities owned by such seller; (d) use its best efforts to register or qualify such Registrable Securities under such other securities or blue sky laws of such jurisdictions as any seller thereof shall reasonably request, to keep such registration or qualification in effect for so long as such registration statement remains in effect and do any and all other acts and things which may be reasonably necessary or advisable to enable such seller to consummate the disposition in such jurisdictions of the Registrable Securities owned by such Seller; PROVIDED, HOWEVER, that the Company will not be required to (i) qualify generally to do business in any jurisdiction where it would not otherwise be required to qualify but for this clause (d), (ii) subject itself to taxation in any such jurisdiction or (iii) consent to general service of process in any such jurisdiction; (e) furnish to each seller of Registrable Securities a signed copy, addressed to such seller (and the underwriters, if any) of an opinion of counsel for the Company, dated the effective date of such registration statement (and, if such registration statement includes an underwritten public offering, dated the date of the closing under the underwriting agreement), reasonably satisfactory in form and substance to such seller, covering substantially the same matters with respect to such registration statement (and the prospectus included therein) as are customarily Registration Rights Agreement -9- covered in opinions of issuer's counsel delivered to the underwriters in underwritten public offerings, and such other legal matters as the seller (or the underwriters, if any) may reasonably request; (f) furnish to each seller of Registrable Securities a signed copy, addressed to such seller (and the underwriters, if any) of a "comfort" letter, dated the effective date of such registration statement signed by the independent public accountants who have certified the Company's financial statements, covering substantially the same matters with respect to such registration statement (and the prospectus included therein) and with respect to events subsequent to the date of such financial statements, as are customarily covered in accountants' letters delivered to the underwriters in underwritten public offerings of securities and such other financial matters as the underwriters may reasonably request; (g) immediately notify the managing underwriter, if any, and each seller of Registrable Securities, at a time when a prospectus relating thereto is required to be delivered under the Securities Act, of the happening of any event known to the Company as a result of which the prospectus included in such registration statement, as then in effect, contains an untrue statement of a material fact or omits to state any fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances under which they were made, and, at the request of any such seller, the Company will prepare and furnish such seller, as soon as practicable, a reasonable number of copies of a supplement to or an amendment of such prospectus as may be necessary so that, as thereafter delivered to the purchasers of such Registrable Securities, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances under which they were made; PROVIDED THAT, if (i) the providing of copies of such supplement or amendment would require the Company to publicly disclose information sooner than it otherwise would be required to disclose such information and (ii) the Board of Directors of the Company determines, in its reasonable business judgment, that the disclosure of such information would interfere with any material financing, acquisition, corporate reorganization or other material transaction or development involving the Company, then the Company may postpone providing copies of such supplement or amendment until the earlier of (x) the date 30 days after the occurrence of the event necessitating such supplement or amendment and (y) a date as soon as practicable after the date on which the Board of Directors determines, in its reasonable business judgment, that the disclosure of such information would not interfere with any material financing, acquisition, corporate reorganization or other material transaction or development involving the Company; (h) cause all such Registrable Securities to be listed on each securities exchange on which similar securities issued by the Company are then listed and on any Securities Exchange or National Automated Quotation System requested by the holders of a majority (by number of shares) of such Registrable Securities, provided that the Company then meets or is reasonably capable of meeting the eligibility requirements for such exchange or system and such exchange or system is reasonably satisfactory to the managing underwriters, and to enter into such Registration Rights Agreement -10- customary agreements as may be required in furtherance thereof, including, without limitation, listing applications and indemnification agreements in customary form; (i) retain a transfer agent and registrar for all such Registrable Securities not later than the effective date of such registration statement; (j) make available for inspection by any seller of Registrable Securities, any underwriter participating in any disposition pursuant to such registration statement and any attorney, accountant or other agent retained by any such seller or underwriter, all financial and other records, pertinent corporate documents and properties of the Company and its subsidiaries, if any, and cause the Company's and its affiliates' and subsidiaries' officers, directors, employees and independent accountants to supply all information reasonably requested by any such seller, underwriter, attorney, accountant or agent in connection with such registration statement to enable them to conduct a reasonable investigation within the meaning of the Securities Act; (k) subject to other provisions hereof, use its best efforts to cause such Registrable Securities covered by such registration statement to be registered with or approved by such other governmental agencies or authorities or self-regulatory organizations as may be necessary to enable the sellers thereof to consummate the disposition of such Registrable Securities; (l) otherwise use its best efforts to comply with all applicable rules and regulations of the Commission and make available to its security holders, in each case as soon as practicable, an earnings statement covering a period of at least twelve months, beginning with the first month after the effective date (as the term "effective date" is defined in Rule 158(c) under the Securities Act) of the registration statement, which earnings statement shall satisfy the provisions of SECTION 11(A) of the Securities Act and Rule 158 thereunder; (m) permit any holder of Registrable Securities, which holder, in the sole judgment, exercised in good faith, of such holder might be deemed to be a controlling person of the Company (within the meaning of the Securities Act or the Exchange Act) to participate in the preparation of any registration statement covering such holder's Registrable Securities and to include therein material, furnished to the Company in writing, which in the reasonable judgment of such holder should be included and which is reasonably acceptable to the Company; and (n) use every reasonable effort to obtain the lifting at the earliest possible time of any stop order suspending the effectiveness of any registration statement or of any order preventing or suspending the use of any preliminary prospectus. 2.5 REGISTRATION EXPENSES. All expenses incident to the Company's performance of or compliance with this Agreement, including without limitation, all Registration Expenses will be borne by the Company. Registration Rights Agreement -11- ARTICLE III INDEMNIFICATION 3.1 INDEMNIFICATION BY THE COMPANY. In the event of any registration of any securities by the Company under the Securities Act, the Company agrees to indemnify and hold harmless, to the fullest extent permitted by law, each of the holders of any Registrable Securities covered by such registration statement, each other Person, if any, who controls such holder within the meaning of the Securities Act or the Exchange Act, and each of their respective directors, officers, general partners, limited partners and managing directors and each other person who participates as an underwriter in the offering or sale of such securities as follows: (a) against any and all loss, liability, claim, damage or expense arising out of or based upon an untrue statement or alleged untrue statement of a material fact contained in any registration statement (or any amendment or supplement thereto), including all documents incorporated therein by reference, or in any preliminary prospectus or prospectus (or any amendment or supplement thereto) or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, or any violation by the Company of any federal, state or common law rule or regulation applicable to the Company and relating to action required of or inaction by the Company in connection with any such registration; (b) against any and all loss, liability, claim, damage and expense to the extent of the aggregate amount paid in settlement of any litigation, investigation or proceeding by any governmental agency or body, commenced or threatened, or of any claim whatsoever based upon any such untrue statement or omission or any such alleged untrue statement or omission, or any violation by the Company of any federal, state or common law rule or regulation applicable to the Company and relating to action required of or inaction by the Company in connection with any such registration, if such settlement is effected with the written consent of the Company, which consent shall not be unreasonably withheld; and (c) against any and all expense incurred by them in connection with investigating, preparing or defending against any litigation, or investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue statement or omission or any such alleged untrue statement or omission, or any violation by the Company of any federal, state or common law rule or regulation applicable to the Company and relating to action required of or inaction by the Company in connection with any such registration, to the extent that any such expense is not paid under SECTION 3.1 (A) or (B) above; PROVIDED, THAT this indemnity does not apply with respect to any particular holder, to any loss, liability, claim, damage or expense to the extent arising out of an untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in conformity with written information furnished to the Company by or on behalf of that holder expressly for use in the preparation of any registration statement (or any amendment or supplement thereto), including all documents incorporated therein by reference, or in any preliminary prospectus or prospectus Registration Rights Agreement -12- (or any amendment or supplement thereto); PROVIDED, FURTHER, that the Company will not be liable to any holder or any person who participates as an underwriter in the offer or sale of Registrable Securities, if any, under the indemnity agreement in this SECTION 3.1, with respect to any preliminary prospectus or the final prospectus or the final prospectus as amended or supplemented, as the case may be, to the extent that any such loss, liability, claim, damage or expense of such underwriter, controlling Person or holder results from the fact that such underwriter sold Registrable Securities to a Person to whom there was not sent or given, at or prior to the written confirmation of such sale, a copy of the final prospectus or of the final prospectus as then amended or supplemented, whichever is most recent, if the Company has previously and timely furnished copies thereof to such underwriter and such final prospectus, as then amended or supplemented, has corrected any such misstatement or omission. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of such holder or any such director, officer, general partner, underwriter or other controlling person and shall survive the transfer of such securities by such seller. 3.2 INDEMNIFICATION BY HOLDERS OF REGISTRABLE SECURITIES. In connection with any registration statement in which a holder of Registrable Securities is participating, each such holder agrees to indemnify and hold harmless (in the same manner and to the same extent as set forth in SECTION 3.1 of this Agreement), to the extent permitted by law, the Company and its directors, officers and controlling Persons, and their respective directors, officers and general partners, with respect to any statement or alleged statement in or omission or alleged omission from such registration statement, any preliminary, final or summary prospectus contained therein, or any amendment or supplement thereto, if such statement or alleged statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by or on behalf of such holder, specifically stating that it is for use in the preparation of such registration statement, preliminary, final or summary prospectus or amendment or supplement. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of the Company, or such holder, as the case may be, or any of their respective directors, officers, controlling Persons or general partners and shall survive the transfer of such securities by such holder; PROVIDED that no such holder shall be liable under SECTION 3.2 for any amounts exceeding the product of the purchase price per Registrable Security and the number of Registrable Securities being sold pursuant to such registration statement or prospectus by such holder. 3.3 WRITTEN NOTICE. Promptly after receipt by an indemnified party hereunder of written notice of the commencement of any action or proceeding involving a claim referred to in SECTION 3.1 or SECTION 3.2 of this Agreement, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party, give written notice to the latter of the commencement of such action; PROVIDED, THAT the failure of any indemnified party to give notice as provided herein shall not relieve the indemnifying party of its obligations under SECTION 3.1 or SECTION 3.2 of this Agreement except to the extent that the indemnifying party is actually materially prejudiced by such failure to give notice. In case any such action is brought against an indemnified party, the indemnifying party will be entitled to participate in and to assume the defense thereof, jointly with any other indemnifying party similarly notified, to the extent that it Registration Rights Agreement -13- may wish, with counsel reasonably satisfactory to such indemnified party, and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party will not be liable to such indemnified party for any legal or other expenses subsequently incurred by the latter in connection with the defense thereof, unless in such indemnified party's reasonable judgment a conflict of interest between such indemnified and indemnifying parties may exist in respect of such claim, in which case the indemnifying party shall not be liable for the fees and expenses of (i) more than one counsel for all holders of Registrable Securities, selected by a majority (by number of shares) of the holders of Registrable Securities (which choice shall be reasonably satisfactory to the Company), or (ii) more than one counsel for the Company in connection with any one action or separate but similar or related actions. An indemnifying party who is not entitled to, or elects not to, assume the defense of a claim will not be obligated to pay the fees and expenses of more than one counsel for all parties indemnified by such indemnifying party with respect to such claim, unless in the reasonable judgment of any indemnified party a conflict of interest may exist between such indemnified party and any other of such indemnified parties with respect to such claim, in which event the indemnifying party shall be obligated to pay the fees and expenses of such additional counsel or counsels. The indemnifying party will not, without the prior written consent of each indemnified party, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not such indemnified party or any Person who controls such indemnified party is a party to such claim, action, suit or proceeding), unless such settlement, compromise or consent includes an unconditional release of such indemnified party from all liability arising out of such claim, action, suit or proceeding. Notwithstanding anything to the contrary set forth herein, and without limiting any of the rights set forth above, in any event any party will have the right to retain, at its own expense, counsel with respect to the defense of a claim. 3.4 UNDERWRITING AGREEMENT. The Company and each holder of Registrable Securities requesting registration shall provide for the foregoing indemnity (with appropriate modifications) in any underwriting agreement with respect to any required registration or other qualification of securities under any Federal or state law or regulation of any governmental authority other than the Securities Act. 3.5 CONTRIBUTIONS. If the indemnification provided for in SECTIONS 3.1 and 3.2 of this Agreement is unavailable or insufficient to hold harmless an indemnified party under such Sections, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of the losses, claims, damages or liabilities referred to in SECTION 3.1 or SECTION 3.2 of this Agreement in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand, and the indemnified party on the other, in connection with statements or omissions which resulted in such losses, liabilities, claims, damages or expenses, as well as any other relevant equitable considerations, including, without limitation, the relative benefits received by each party from the offering of the securities covered by such registration statement, the parties' relative knowledge and access to information concerning the matter with respect to which the claim was asserted and the opportunity to correct and prevent any statement or omission. The relative fault shall be determined by reference to, Registration Rights Agreement -14- among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the indemnifying party or the indemnified party and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such untrue statements or omission. The parties hereto agree that it would not be just and equitable if contributions pursuant to this SECTION 3.5 were to be determined by pro rata or per capita allocation (even if the underwriters, if any, were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to in the first sentence of this SECTION 3.5. The amount paid by an indemnified party as a result of the losses, claims, damages or liabilities referred to in the first sentence of this SECTION 3.5 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any action or claim (which shall be limited as provided in SECTION 3.3 of this Agreement if the indemnifying party has assumed the defense of any such action in accordance with the provisions thereof) which is the subject of this SECTION 3.5. Promptly after receipt by an indemnified party under this SECTION 3.5 of notice of the commencement of any action against such party in respect of which a claim for contribution may be made against an indemnifying party under this SECTION 3.5, such indemnified party shall notify the indemnifying party in writing of the commencement thereof if the notice specified in SECTION 3.3 of this Agreement has not been given with respect to such action; PROVIDED, THAT the omission to so notify the indemnifying party shall not relieve the indemnifying party from any liability which it may otherwise have to any indemnified party under this SECTION 3.5, except to the extent that the indemnifying party is actually materially prejudiced by such failure to give notice. The Company and each holder of Registrable Securities agrees with each other and the underwriters of the Registrable Securities, if requested by such underwriters, that (i) the underwriters' portion of such contribution shall not exceed the underwriting discount and (ii) that the amount of such contribution shall not exceed an amount equal to the net proceeds actually received by such indemnifying party from the sale of Registrable Securities in the offering to which the losses, liabilities, claims, damages or expenses of the indemnified parties relate. No Person guilty of fraudulent misrepresentation (within the meaning of SECTION 11(F) of the Securities Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation. 3.6 PERIODIC PAYMENTS. The indemnification required by this Article III shall be made by periodic payments of the amount thereof during the course of the investigation or defense, as and when bills are received or expense, loss, damage or liability is incurred. ARTICLE IV OTHER AGREEMENTS 4.1 HOLDBACK AGREEMENTS. (a) HOLDERS OF REGISTRABLE SECURITIES. Each holder of Registrable Securities agrees not to sell, make any short sale of, loan, grant any option for the purchase of, effect any public sale or distribution of or otherwise dispose of any securities of the Company, during the seven days Registration Rights Agreement -15- prior to, and the 90-day period beginning on, the effective date of any underwritten registration pursuant to Article II hereof (except as part of such underwritten registration), unless the managing underwriters of the registered public offering otherwise agree. (b) THE COMPANY. The Company agrees (i) not to sell, make any short sale of, loan, grant any option for the purchase of, effect any public sale or distribution of its securities, during the seven days prior to, and during the 90-day period beginning on, the effective date of any underwritten registration pursuant to Article II hereof in which holders of Registrable Securities are selling stockholders (except as part of such underwritten registration or pursuant to registrations on Form S-4 or Form S-8 or any successor form), unless the managing underwriters of the registered public offering otherwise agree, and (ii) to use all reasonable efforts to cause each holder of at least 5% (on a fully-diluted basis) of its equity securities, or any securities convertible, exchangeable or exercisable for or into such securities, to agree not to sell, make any short sale of, loan, grant any option for the purchase of, or effect any public sale or distribution of any such securities during such period (except as part of such underwritten registration, if otherwise permitted), unless the managing underwriters of the registered public offering otherwise agree. 4.2 UNDERWRITTEN OFFERINGS. (a) DEMAND UNDERWRITTEN OFFERINGS. If requested by the managing underwriter for any underwritten offering of Registrable Securities pursuant to a registration pursuant to SECTION 2.1 or 2.2 above, the Company will enter into an underwriting agreement with such underwriters for such offering, such agreement to be reasonably satisfactory in substance and form to the Company, and to contain such representations and warranties by the Company and such other terms as are generally included in agreements of this type, including, without limitation, indemnities customarily included in such agreements. The holders of the Registrable Securities will cooperate with the Company in the negotiation of the underwriting agreement. The holders of Registrable Securities to be distributed by such underwriters shall be parties to such underwriting agreement. The Company shall cooperate with any such holder of Registrable Securities in order to limit any representations or warranties to, or agreements with, the Company or the underwriters to be made by such holder only to those representations, warranties or agreements regarding such holder, such holder's Registrable Securities and such holder's intended method of distribution and any other representation required by law. (b) INCIDENTAL UNDERWRITTEN OFFERINGS. If the Company at any time proposes to register any of its securities under the Securities Act as contemplated by SECTION 2.3 of this Agreement and such securities are to be distributed by or through one or more underwriters, the Company will, if requested by any holder of Registrable Securities as provided in SECTION 2.3 of this Agreement, arrange for such underwriters to include all the Registrable Securities to be offered and sold by such holder, subject to the limitations set forth in SECTION 2.3 hereof, among the securities to be distributed by such underwriters. The holders of Registrable Securities to be distributed by such underwriters shall be parties to the underwriting agreement between the Company and such underwriters. The Company shall cooperate with any such holder of Registration Rights Agreement -16- Registrable Securities in order to limit any representations or warranties to, or agreements with, the Company or the underwriters to be made by such holder only to those representations, warranties or agreements regarding such holder, such holder's Registrable Securities and such holder's intended method of distribution and any other representation required by law. 4.3 ADJUSTMENTS AFFECTING REGISTRABLE SECURITIES. The Company will not take any action, or fail to take any action which it may properly take, with respect to its securities which would adversely affect the ability of the holders of Registrable Securities to include such Registrable Securities in any registration of its securities contemplated by this Agreement or the marketability of such Registrable Securities under any such registration (including, without limitation, effecting a stock split or a combination of shares). 4.4 RULE 144. The Company covenants that it will file the reports required to be filed by it under the Securities Act and the Exchange Act and the rules and regulations adopted by the Commission thereunder (or, if the Company is not required to file such reports, it will, upon the request of any holder of Registrable Securities, make publicly available other information), and it will take such further action as any holder of Registrable Securities may reasonably request, all to the extent required from time to time to enable such holder to sell shares of Registrable Securities without registration under the Securities Act within the limitation of the exemption provided by (i) Rule 144 under the Securities Act, as such Rule may be amended from time to time, or (ii) any similar rule or regulation hereafter adopted by the Commission. Upon the request of any holder of Registrable Securities, the Company will deliver to such holder a written statement as to whether it has complied with such requirements. ARTICLE V MISCELLANEOUS 5.1 NOMINEES FOR BENEFICIAL OWNERS. In the event that any Registrable Securities are held by a nominee for the beneficial owner thereof, the beneficial owner thereof may upon the giving of written notice to the Company, at its election, be treated as the Holder of such Registrable Securities for purposes of any request or other action by any Holder or Holders of Registrable Securities pursuant to this Agreement or any determination of any number or percentage of shares of Registrable Securities held by any Holder or Holders of Registrable Securities contemplated by this Agreement. The Company may require assurances reasonably satisfactory to it of such owner's beneficial ownership of such Registrable Securities. 5.2 GOVERNING LAW; SUBMISSION TO JURISDICTION. (a) This Agreement shall be governed by, and construed in accordance with, the laws of the State of Illinois. (b) Any legal action or proceeding with respect to this agreement shall be brought in the courts of the State of Illinois or of the United States of America for the northern district of Illinois, Registration Rights Agreement -17- and, by execution and delivery of this agreement, each of the Company and the Holder hereby accepts for itself and (to the extent permitted by law) in respect of its property, generally and unconditionally, the jurisdiction of the aforesaid courts. Each of the Company and the Holder hereby irrevocably waives any objection, including, without limitation, any objection to the laying of venue or based on the grounds of FORUM NON CONVENIENS, which it may now or hereafter have to the bringing of any such action or proceeding in such respective jurisdictions. (c) Nothing herein shall affect the right of any holder to serve process in any other manner permitted by law. (d) The Company and the Holder hereby (i) irrevocably and unconditionally waive, to the fullest extent permitted by law, trial by jury in any legal action or proceeding relating to this agreement and for any counterclaim therein; (ii) irrevocably waive, to the maximum extent not prohibited by law, any right it may have to claim or recover in any such litigation any special, exemplary, punitive or consequential damages, or damages other than, or in addition to, actual damages; (iii) certify that no party hereto nor any representative or agent of counsel for any party hereto has represented, expressly or otherwise, or implied that such party would not, in the event of litigation, seek to enforce the foregoing waivers, and (iv) acknowledge that it has been induced to enter into this agreement and the transactions contemplated hereby among other things, the mutual waivers and certifications contained in this SECTION 5.2. 5.3 ENTIRE AGREEMENT; AMENDMENTS. This Agreement constitutes the entire agreement of the parties with respect to the subject matter hereof and supersedes any and all previous oral or written communications, representations or agreements. This Agreement may be amended, modified or supplemented only by a written instrument duly executed by the Company, the Holders of a majority of the outstanding Registrable Securities, and each of Heller and Midwest so long as such Holders own any Registrable Securities. 5.4 TERM. This Agreement will terminate at such time as the Registrable Securities, in the aggregate, represent less than both (i) 1% of the Company's outstanding shares of Common Stock on a fully diluted basis, and (ii) the average weekly trading volume of the Company's Common Stock for four consecutive calendar weeks. 5.5 WAIVER. No waiver by any party of any term or condition of this Agreement, in one or more instances, shall be valid unless in writing, and no such waiver shall be deemed to be construed as a waiver of any subsequent breach or default of the same or similar nature. 5.6 SUCCESSORS AND ASSIGNS. Except as otherwise expressly provided herein, this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and permitted assigns, as the case may be. 5.7 REMEDIES. In the event of a breach by any party to this Agreement of its obligations under this Agreement, the loss of any right as provided in this Agreement as a result of such breach shall not be the sole and exclusive remedy of any party injured by such breach. Any such injured Registration Rights Agreement -18- party will be entitled to specific performance of its rights under this Agreement, in addition to being entitled to exercise all rights granted by law, including recovery of damages. The parties agree that the provisions of this Agreement shall be specifically enforceable, it being agreed by the parties that the remedy at law, including monetary damages, for breach of any such provision will be inadequate compensation for any loss and that any defense in any action for specific performance that a remedy at law would be adequate is waived. 5.8 INVALID PROVISIONS. If any provision of this Agreement is held to be illegal, invalid or unenforceable under any present or future law, and if the rights or obligations of any party hereto under this Agreement will not be materially and adversely affected thereby, (i) such provision will be fully severable, (ii) this Agreement will be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof, (iii) the remaining provisions of this Agreement will remain in full force and effect and will not be affected by the illegal, invalid or unenforceable provision or by its severance herefrom and (iv) in lieu of such illegal, invalid or unenforceable provision, there will be added automatically as a part of this Agreement a legal, valid and enforceable provision as similar in terms to such illegal, invalid or unenforceable provision as may be possible. 5.9 HEADINGS. The headings used in this Agreement have been inserted for convenience of reference only and do not define or limit the provisions hereof. 5.10 FURTHER ASSURANCES. Each party hereto shall cooperate and shall take such further action and shall execute and deliver such further documents as may be reasonably requested by any other party in order to carry out the provisions and purposes of this Agreement. 5.11 GENDER. Whenever the pronouns "he" or "his" are used herein they shall also be deemed to mean "she" or "hers" or "it" or "its" whenever applicable words in the singular shall be read and construed as though in the plural and words in the plural shall be construed as though in the singular in all cases where they would so apply. 5.12 COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which will be deemed an original, but all of which together will constitute one and the same instrument. 5.13 NOTICES. All notices and other communications provided for herein (including, without limitation, any modifications of, or waivers or consents under, this Agreement) shall be given or made by telex, telecopy, courier or U.S. Mail or in writing and telexed, telecopied, mailed or delivered to the intended recipient at the address specified below; or, as to any party, at such other address as shall be designated by such party in a notice to each other party: Registration Rights Agreement -19- If to the Company: Castle Dental Centers, Inc. 1360 Post Oak Boulevard Suite 1300 Houston, Texas 77056 Attention: Jack H. Castle, Jr. Telecopy: (713) 513-1401 If to Heller: Heller Financial, Inc. 500 West Monroe Street Chicago, Illinois 60661 Attention: Account Manager Corporate Finance Telecopy: (312) 441-7367 with a copy to: Heller Financial, Inc. 500 West Monroe Street Chicago, Illinois 60661 Attention: Legal Services Corporate Finance Group Telecopy: (312) 441-6876 If to Midwest: Midwest Mezzanine Fund II, L.P. 208 South LaSalle Street, 10th floor Chicago, Illinois 60604-1003 Attention: J. Allan Kayler Telecopy: (312) 553-6647 Except as otherwise provided in this Agreement, all such communications shall be deemed to have been duly given when transmitted, if transmitted before 1:00 p.m. local time on a business day (otherwise on the next succeeding business day) by telex or telecopier and evidence or confirmation of receipt is obtained, or personally delivered or, in the case of a mailed notice, three (3) business days after the date deposited in the mails, postage prepaid, in each case given or addressed as aforesaid. Registration Rights Agreement -20- IN WITNESS WHEREOF, the parties have executed and delivered this Registration Rights Agreement as of the date first above written. HELLER FINANCIAL, INC., CASTLE DENTAL CENTERS, INC., A DELAWARE CORPORATION A DELAWARE CORPORATION By_________________________________ By_________________________________ Jack H. Castle, Jr. Chairman and Chief Executive MIDWEST MEZZANINE FUND II, L.P. Officer By: ABN AMRO Mezzanine Management II, L.P., its general partner By: ABN AMRO Mezzanine Management II, Inc., its general partner By_________________________________ J. Allan Kayler, Senior Vice President Registration Rights Agreement EX-10.21 4 EXHIBIT 10.21 THIRD AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT This THIRD AMENDMENT to AMENDED AND RESTATED CREDIT AGREEMENT (this "THIRD Amendment") executed effective as of January 31, 2000 (the "EFFECTIVE DATE"), is by and among CASTLE DENTAL CENTERS, INC., a Delaware corporation ("BORROWER"), and BANK OF AMERICA, N.A. (formerly known as NationsBank, N.A.), a national banking association (in its individual capacity, "BANK OF AMERICA"), as agent (in such capacity, "AGENT") for each of the lenders that is a signatory hereto (individually, together with its successors and assigns, "LENDER" and collectively, "LENDERS") and such Lenders. W I T N E S S E T H: WHEREAS, the Borrower, the Agent and the Lenders are parties to that certain Amended and Restated Credit Agreement dated as of December 18, 1998, as amended by First Amendment to Amended and Restated Credit Agreement dated as of July 20, 1999, as amended by Second Amendment to Amended and Restated Credit Agreement dated as of September 30, 1999 (such Amended and Restated Credit Agreement as amended and as the same may be further amended from time to time, the "CREDIT AGREEMENT"), pursuant to which the Lenders agreed to make loans to and extensions of credit on behalf of the Borrower; and WHEREAS, the Borrower has requested that the Agent and the Lenders amend the Credit Agreement, and the Agent and the Lenders have agreed to amend the Credit Agreement in the particulars hereinafter provided. NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the parties hereto agree as follows: 1. TERMS DEFINED ABOVE. As used in this Third Amendment, each of the terms "Agent," "Bank of America," "Borrower," "Credit Agreement," "Effective Date," "Lenders," and "Third Amendment" shall have the meaning assigned to such term herein above. 2. TERMS DEFINED IN CREDIT AGREEMENT. Each term defined in the Credit Agreement and used herein without definition shall have the meaning assigned to such term in the Credit Agreement, unless expressly provided to the contrary. 3. OTHER DEFINITIONAL PROVISIONS. The words "hereby," "herein," "hereinafter," "hereof," "hereto," and "hereunder" when used in this Third Amendment shall refer to this Third Amendment as a whole and not to any particular paragraph or provision of this Third Amendment. 4. AMENDMENTS AND SUPPLEMENTS TO DEFINITIONS. (1) The following terms, which are defined in Section 1.02 of the Credit Agreement, are hereby amended in their entirety to read as follows: 1 "AGREEMENT" shall mean this Amended and Restated Credit Agreement, as amended and supplemented by the First Amendment, the Second Amendment, and the Third Amendment and as the same may from time to time be further amended or supplemented. "SUBORDINATED DEBT" shall mean the Debt of the Borrower or any Subsidiary that is subordinated to the Indebtedness pursuant to a subordination agreement substantially in the form of Exhibit H or otherwise on terms satisfactory to the Majority Lenders. (2) Section 1.02 of the Credit Agreement is hereby further amended and supplemented by adding the following new definitions where alphabetically appropriate, which read in their entirety as follows: "EFFECTIVE DATE" shall mean the Effective Date of this Third Amendment. "THIRD AMENDMENT" shall mean that certain Third Amendment to Amended and Restated Credit Agreement dated as of the Effective Date, by and among the Borrower, the Agent and Lenders. "NEW MEZZANINE FINANCING" shall mean Subordinated Debt issued by the Borrower pursuant to which net cash proceeds to the Borrower shall be up to but not to exceed $20,000,000, provided such New Mezzanine Financing is upon terms satisfactory to the Majority Lenders. "SETTLEMENT AGREEMENT" shall mean that certain letter agreement dated as of January 28, 2000 among the Company, Castle Dental Centers of California, Inc. and the Persons referred to therein as the "DCS Parties". 5. AMENDMENT TO SECTION 2.03(A). Section 2.03(a) of the Credit Agreement is hereby amended in its entirety to read as follows: "The Aggregate Commitments shall at all times be equal to the lesser of (i) the Aggregate Maximum Credit Amounts after adjustments resulting from reductions pursuant to Section 2.03(b) or increases pursuant to Section 2.03(d) or (ii) the Borrowing Base as determined from time to time." 6. AMENDMENT TO SECTION 8.01(H). Section 8.01(h) of the Credit Agreement is hereby amended by adding the following sentence at the end thereof: "Borrower shall issue an additional borrowing base report as of September 30, 1999 on January 20, 2000 which shall reflect on a pro forma basis all Debt outstanding on January 20, 2000 and include, without limitation, the effects of the New Mezzanine Financing." 2 7. AMENDMENT TO SECTION 8.11. Section 8.11 of the Credit Agreement is hereby amended in its entirety to read as follows: "The Borrower hereby covenants and agrees that, beginning 20 Business Days after the Effective Date, Borrower shall maintain at all times Hedging Agreements with one of the Lenders, or with another party reasonably acceptable to the Majority Lenders, whereby the Borrower will swap the floating interest rate relating to 50% of Borrower's Total Funded Debt for a fixed rate relating to such amount." 8. AMENDMENT TO SECTION 9.11. Section 9.11 of the Credit Agreement is hereby amended in its entirety to read as follows: "Section 9.11 RATIO OF TOTAL FUNDED DEBT TO CAPITALIZATION. For the four fiscal quarters ending on December 31, 1999, March 31, 2000, June 30, 2000, and September 30, 2000, the Borrower will not permit its ratio of Total Funded Debt to Capitalization to be greater than .65 to 1.0. For the one fiscal quarter ending on December 31, 2000, the Borrower will not permit its ratio of Total Funded Debt to Capitalization to be greater than .625 to 1.0. For each fiscal quarter thereafter, the Borrower will not permit its ratio of Total Funded Debt to Capitalization as of the end of any fiscal quarter to be greater than .60 to 1.0." 9. AMENDMENT TO SECTION 9.14. Section 9.14 of the Credit Agreement is hereby amended by deleting the chart contained therein in its entirety and replacing it with the following: ------------- --------------------------------- RATIO PERIOD ------------- --------------------------------- 1.10 to 1.00 from the Effective Date through and including 3/31/2001 ------------- --------------------------------- 1.15 to 1.00 from 6/30/2001 and thereafter ------------- --------------------------------- 10. AMENDMENT TO SECTION 9.16. Section 9.16 of the Credit Agreement is hereby amended in its entirety to hereafter read as follows: "Section 9.16 CAPITAL EXPENDITURES. Without the prior written consent of the Majority Lenders, the Borrower will not make any expenditures for fixed or capital assets if, after giving effect thereto, the aggregate of all such expenditures would, in the case of the 12 month periods ending at the end of the fiscal quarters ending on December 31, 1999, March 31, 2000 and June 30, 2000 respectively, exceed $11,000,000, and in the case of each 12 month period ending at the end of each fiscal quarter thereafter, exceed $10,000,000." 11. AMENDMENT - NEW SECTION 9.24. A new Section 9.24 to Article IX is hereby added to read as follows: 3 "Section 9.24 PRE-PAYMENT OF NEW MEZZANINE FINANCING. Neither the Borrower nor any Subsidiary will directly or indirectly prepay any sums outstanding on the New Mezzanine Financing whether voluntarily, mandatorily or through any redemption pursuant to the Stockholders Agreement dated January 31, 2000, between the Borrower, Heller Financial, Inc. and Midwest Mezzanine Fund II, L.P. (the "STOCKHOLDERS AGREEMENT") or otherwise without the express written consent of the Majority Lenders. In furtherance hereof and in addition, the Borrower will not redeem any "Redeemable Securities" (as defined in the Stockholders Agreement) without the express written consent of the Majority Lenders." 12. AMENDMENT TO EXHIBIT H. Exhibit H to the Credit Agreement is hereby amended to read as Exhibit H attached hereto. 13. LIMITED WAIVER. Borrower's Default with respect to Section 8.11 of the Credit Agreement as it existed prior to the Effective Date is hereby waived. This waiver is effective as of the Effective Date and does not apply to compliance with Section 8.11 after the Effective Date. This limited waiver shall not be deemed to be a consent to, or waiver or modification of, any other term or condition of the Credit Agreement, the Security Agreement, the Guaranty Agreement, or any other Loan Document and shall not prejudice any right or rights which the Lenders may now have or may have in the future under the Credit Agreement, Security Agreement, Guarantee Agreement, or any other Loan Document. 14. CONDITIONS. The effectiveness of this Third Amendment against the Agent and the Lenders is subject to the following conditions precedent: (1) the New Mezzanine Financing in an amount of at least $15,000,000 shall have been closed and funded; (2) the Agent's receipt of multiple original counterparts, as requested by the Agent, of this Third Amendment, executed and delivered by a duly authorized officer of the Borrower, the Agent, and each Lender, as applicable and ratified by the Guarantors; (3) the Agent's receipt of a copy of the Subordinated Note and a fully executed Subordination Agreement in connection therewith; (4) the Agent's receipt of such other instruments or documents as the Agent may reasonably request; and (5) the "Closing" (as defined in the Settlement Agreement) shall have occurred and payment of the "Full Settlement Amount" (as defined in the Settlement Agreement) shall occur concurrently herewith. 15. REPRESENTATIONS AND WARRANTIES. Except as affected by the transactions contemplated in the Credit Agreement and this Third Amendment, each of the representations and warranties made by the Borrower in or pursuant to the Credit Agreement and the Security Instruments shall be true and 4 correct in all material respects as of the Effective Date, as if made on and as of such date (except to the extent such representations and warranties are expressly limited to an earlier date). 16. ADOPTION, RATIFICATION AND CONFIRMATION OF CREDIT AGREEMENT. Each of the Borrower, the Agent, and the Lenders does hereby adopt, ratify and confirm the Credit Agreement, as amended hereby, and acknowledges and agrees that the Credit Agreement, as amended hereby, is and remains in full force and effect. 17. SUCCESSORS AND ASSIGNS. This Third Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns permitted pursuant to the Credit Agreement. 18. COUNTERPARTS. This Third Amendment may be executed by one or more of the parties hereto in any number of separate counterparts, and all of such counterparts taken together shall be deemed to constitute one and the same instrument and shall be enforceable as of the Effective Date upon the execution of one or more counterparts hereof by the Borrower, the Agent and the Lenders. In this regard, each of the parties hereto acknowledges that a counterpart of this Third Amendment containing a set of counterpart execution pages reflecting the execution of each party hereto shall be sufficient to reflect the execution of this Third Amendment by each necessary party hereto and shall constitute one instrument. 19. ENTIRE AGREEMENT. This Third Amendment constitutes the entire agreement among the parties hereto with respect to the subject hereof. All prior understandings, statements and agreements, whether written or oral, relating to the subject hereof are superseded by this Third Amendment. 20. GOVERNING LAW. This Third Amendment shall be deemed to be a contract made under and shall be governed by and construed in accordance with the internal laws of the State of Texas. THIS THIRD AMENDMENT, THE CREDIT AGREEMENT, AS SUPPLEMENTED AND AMENDED HEREBY, THE NOTES, AND THE OTHER SECURITY INSTRUMENTS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. [SIGNATURES BEGIN ON NEXT PAGE] 5 IN WITNESS WHEREOF, the parties hereto have caused this Third Amendment to be duly executed and delivered by their proper and duly authorized officers as of the Effective Date. BORROWER: CASTLE DENTAL CENTERS, INC. By: ________________________________________ Name: ______________________________________ Title: _____________________________________ LENDER AND AGENT: BANK OF AMERICA, N.A. (formerly known as NationsBank, N.A.) By _________________________________________ Matt Bryant, Vice President LENDERS: BANKBOSTON, N.A. By: ________________________________________ Name: ______________________________________ Title: _____________________________________ AMSOUTH BANK By: ________________________________________ Name: ______________________________________ Title: _____________________________________ HELLER FINANCIAL, INC. By: ________________________________________ Name: ______________________________________ Title: _____________________________________ 6 RATIFICATION Each of the Guarantors hereby expressly (i) acknowledges the terms of this Third Amendment, (ii) ratifies and affirms its obligations under its Guaranty Agreement, in favor of the Agent and the Lenders, as amended, supplemented or otherwise modified, (iii) acknowledges, renews and extends its continued liability under its Guaranty Agreement and agrees that said Guaranty Agreement remains in full force and effect; and (iv) guarantees to the Agent and each Lender to promptly pay when due all amounts owing or to be owing by it under its Guaranty Agreement pursuant to the terms and conditions thereof. GUARANTORS: CASTLE DENTAL CENTERS OF FLORIDA, INC. By: ________________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer CASTLE DENTAL CENTERS OF TENNESSEE, INC. By: ________________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer CASTLE DENTAL CENTERS OF TEXAS, INC. By: ________________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer CDC OF CALIFORNIA, INC. By: ________________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer 7 CASTLE DENTAL CENTERS OF CALIFORNIA, L.L.C. By: ________________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer DENTAL WORLD, INC. By: ________________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer CASTLE DENTAL CENTERS OF AUSTIN, INC. By: ________________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer DENTCOR, INC. By: ________________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer 8 EXHIBIT H FORM OF SUBORDINATION AGREEMENT This Subordination Agreement dated as of _____________ ("AGREEMENT"), is made by ____________________________ ("SUBORDINATED CREDITOR"), and CASTLE DENTAL CENTERS, INC., a Delaware corporation ("DEBTOR"), in favor of NATIONSBANK, N.A., as agent for the senior creditors defined below ("AGENT"). INTRODUCTION Reference is made to the Amended and Restated Credit Agreement dated as of December 18, 1998 (as modified from time to time, the "CREDIT AGREEMENT"), among the Debtor, the Agent and the banks party thereto ("SENIOR CREDITORS"). It is a condition precedent to the Senior Creditors' permitting the Debtor to incur the indebtedness represented by the Subordinated Note that the Subordinated Creditor enter into this Agreement. In consideration of the foregoing and for other good and valuable consideration, the Subordinated Creditor, the Debtor, and the Senior Creditors hereby agree as follows: Section 1. DEFINITIONS. The following terms shall have the following meanings: "EVENT OF DEFAULT" means any "Default" or "Event of Default" as defined in, and which may occur under, the Credit Agreement. "LOAN DOCUMENTS" shall have the meaning specified by the Credit Agreement. "SENIOR DEBT" means (a) all principal, interest (including interest accruing after the commencement of a Bankruptcy Event, without regard to whether or not such interest is an allowed claim), fees, reimbursements, indemnifications, and other amounts now or hereafter owed by the Debtor and its Subsidiaries to Senior Creditors under the Credit Agreement, the Loan Documents, and any other instrument or agreement related thereto and (b) any increases, extensions, and rearrangements of the foregoing obligations under any amendments, supplements, and other modifications of the documents and agreements creating the foregoing obligations. "SUBORDINATED DEBT" means all present and future indebtedness, liabilities, and obligations of any kind owed by the Debtor to the Subordinated Creditor, including debt obligations, equity obligations, and other contractual obligations requiring payments of any kind to be made to the Subordinated Creditor, whether such indebtedness, liabilities, and obligations are absolute or contingent, joint, several, or independent, arising by operation of law or contract, created directly with the Subordinated Creditor or acquired by assignment, participation, or otherwise, or direct or indirect (including indebtedness, liabilities, and obligations of the Debtor to the Subordinated Creditor as a result of either's membership in any partnership, syndicate, association, or other group, and whether incurred by the Debtor as principal, guarantor, surety, endorser, accommodation party, or otherwise). Subordinated Debt specifically includes the Subordinated Note. Exhibit H-1 "SUBORDINATED NOTE" means the $___________ Note dated as of _______________, made by the Debtor and payable to the order of the Subordinated Creditor, as the same may be increased, extended, rearranged, amended, supplemented, and otherwise modified from time to time in accordance with this Agreement. Section 2. TERMS OF SUBORDINATION. Unless and until the Senior Debt shall have been irrevocably paid in full in cash, and the Senior Creditors shall have no commitment to extend further Senior Debt, the payment and performance of the Subordinated Debt is hereby made expressly subordinate and junior in right of payment and performance to the prior payment in cash and performance of all obligations and liabilities under the Senior Debt to the extent and in the manner set forth in this Section 2: 2.1 LIMITATION ON PAYMENTS. (a) No payment or prepayment of any sum on the Subordinated Debt, whether by acceleration or otherwise, shall be made, if at the time of such payment, prepayment, or immediately after giving effect thereto there shall exist a default in the payment or prepayment with respect to any of the Senior Debt, or immediately after giving effect thereto (i) there shall exist a default in the payment or prepayment of the principal or interest with respect to any of the Senior Debt or (ii) there shall have occurred, or after giving effect to such payment there shall occur, an Event of Default (other than an Event of Default in the payment of prepayment of principal or interest with respect to any of the Senior Debt) permitting the Senior Creditors to accelerate the maturity thereof (with notice, lapse of time, or both) and such Event of Default shall not have been cured or waived to the satisfaction of the Senior Creditors. (b) If at any time there shall occur an Event of Default, the Subordinated Creditor shall not be entitled to receive any payment on the Subordinated Debt before the earlier of (i) cure of the Event of Default to the satisfaction of the Senior Creditors or (ii) the irrevocable payment in full in cash of the Senior Debt and the termination of all commitments to extend Senior Debt. (c) In the event that any Subordinated Debt is declared due and payable before their expressed maturity because of the occurrence of an event of default (under circumstances when the provisions of the foregoing paragraphs (a) or (b) are not applicable), the Senior Creditors shall be entitled to receive payment in full of all principal, interest, and other sums outstanding in connection with the Senior Debt before the Subordinated Creditor is entitled to receive any payment on account of such Subordinated Debt. (d) Any payments received by the Subordinated Creditor in violation of this Agreement shall be held by the Subordinated Creditor in trust for the benefit of the Senior Creditors and shall be immediately turned over to the Agent in the form received (together with any necessary endorsements) for application to the Senior Debt until all outstanding Senior Debt has been irrevocably paid in full. 2.2 SUBORDINATION ON LIQUIDATION. Upon any receivership, insolvency proceeding, bankruptcy proceeding, assignment for the benefit of creditors, reorganization, arrangement with creditors, sale of assets for creditors, dissolution, liquidation, or marshalling of the assets of the Debtor or any of its Subsidiaries (each, a "BANKRUPTCY EVENT"), all amounts due with respect to the Exhibit H-2 Senior Debt shall be irrevocably paid in full in cash before the Subordinated Creditor shall be entitled to collect or receive any payment with respect to the Subordinated Debt. Any payments received by the Subordinated Creditor in such proceedings shall be held by the Subordinated Creditor in trust for the benefit of the Senior Creditors and shall be immediately turned over to the Agent in the form received (together with any necessary endorsements) for application to the Senior Debt until all outstanding Senior Debt has been irrevocably paid in full in cash. 2.3 SUBORDINATION OF LIENS. The Subordinated Creditor will not create, assume, or suffer to exist any lien, security interest, or assignment of collateral securing the repayment of the Subordinated Debt. Any such judgment lien, and any other lien, security interest, or assignment existing in violation of the foregoing shall be fully subordinate to any lien, security interest, or assignment in favor of the Senior Creditors which secures any of the Senior Debt. At the request of the Senior Creditors, the Subordinated Creditor and the Debtor will take any and all steps necessary to fully effect the release of any such lien, security interest, assignment, or collateral. 2.4 LIMITATION OF ACTION. Until the Senior Debt is paid in full in cash, Subordinated Creditor shall not, without the prior written consent of Senior Creditors, initiate or participate with others in any suit, action or proceeding against Debtor or any of its Subsidiaries to enforce payment of or to collect all or any part of the Subordinated Debt or commence judicial enforcement of any of its rights or remedies with respect to the Subordinated Debt. 2.5 FURTHER ASSURANCES. The Subordinated Creditor and the Debtor agree to execute any and all other instruments requested by the Senior Creditors to further evidence the subordination of the Subordinated Debt to the Senior Debt as herein provided. Section 3. SUBORDINATION ABSOLUTE. This is an irrevocable agreement of subordination and the Senior Creditors may, without notice to any of the parties hereto and without impairing or releasing the obligations of the Debtor and the Subordinated Creditor hereunder, (a) create Senior Debt by extending credit under the Credit Agreement; (b) change the terms of or increase the amount of the Senior Debt by increasing, extending, rearranging, amending, supplementing, or otherwise modifying any of the Loan Documents or other instruments or agreements creating Senior Debt; (c) sell, exchange, release, or otherwise deal with any collateral securing any Senior Debt; (d) release anyone, including the Debtor or any guarantor, liable in any manner for the payment or collection of any Senior Debt; (e) exercise or refrain from exercising any rights against the Debtor or any other Person; and (f) apply any sums received by any of the Senior Creditors, from whatever source, to the payment of the Senior Debt. Section 4. PROVISIONS REGARDING SUBORDINATED DEBT. 4.1 There may be no increases, extensions, rearrangements, amendments, supplements, or other modifications to the Subordinated Note which increase the principal amount of, increase the interest rate payable on, or accelerate the scheduled principal and interest payments on the Subordinated Note, or add or make more restrictive any default or covenant, without the prior written permission of the Senior Creditors. 4.2 The Subordinated Creditor will cause all Subordinated Debt to be evidenced by a note, debenture, instrument, or other writing evidencing the Subordinated Debt and will inscribe Exhibit H-3 a statement or legend thereon to the effect that such note, debenture, instrument, or other writing is subordinated to the Senior Debt in favor of the Senior Creditors in the manner and to the extent set forth in this Agreement. 4.3 The Subordinated Creditor shall mark the books of Subordinated Creditor to show that the Subordinated Debt is subordinated to the Senior Debt in the manner and to the extent set forth in this Agreement and cause all financial statements of the Subordinated Creditor hereafter prepared for delivery to any person to make specific reference to the provisions of this Agreement. 4.4 The Subordinated Creditor shall not assign or otherwise transfer to any other person any interest in the Subordinated Debt unless the Subordinated Creditor causes the assignee or other transferee to execute and deliver to the Senior Creditors a subordination agreement in substantially the form of this Agreement or otherwise acknowledges to the reasonable satisfaction of the Senior Creditors the subordination of the Subordinated Debt in accordance with this Agreement. Section 5. MISCELLANEOUS. 5.1 To the extent not paid by the Debtor, the Subordinated Creditor shall reimburse the Senior Creditors for all reasonable expenses of the Senior Creditors, including reasonable charges and disbursements of legal counsel for the Senior Creditors, in connection with the execution, amendment, modification, waiver, and interpretation of this Agreement, and the administration, preservation, and enforcement of any rights of the Senior Creditors under this Agreement. To the extent not paid by the Debtor, the Subordinated Creditor shall indemnify the Senior Creditors against all claims, liabilities, damages, and expenses in connection with any litigation or proceeding relating to this Agreement, INCLUDING CLAIMS CAUSED BY THE SENIOR CREDITORS' OWN NEGLIGENCE, EXCEPT AS A RESULT OF THE SENIOR CREDITORS' GROSS NEGLIGENCE OR WILLFUL MISCONDUCT. The Senior Creditors are hereby authorized to setoff and apply any obligations owed by the Senior Creditors to the Debtor against any obligations of the Debtor under this Agreement. The provisions of this paragraph shall survive termination of this Agreement. 5.2 This Agreement shall be governed by the laws of the State of Texas. If any provision in this Agreement is held to be unenforceable, such provision shall be severed and the remaining provisions shall remain in full force and effect. The Senior Creditors' remedies under this Agreement shall be cumulative, and no delay in enforcing this Agreement shall act as a waiver of the Senior Creditors' rights hereunder. The provisions of this Agreement may be waived or amended only in a writing signed by all of the parties hereto. This Agreement shall bind the Subordinated Creditor and the Debtor and their successors and assigns and shall inure to the benefit of the Senior Creditors and their successors and assigns. This Agreement may be executed in multiple counterparts which together shall constitute one and the same agreement. Unless otherwise specified, all notices provided for in this Agreement shall be in writing, delivered to the following addresses: If to the Subordinated Creditor: ______________________________ Exhibit H_4 ______________________________ Telephone: ___________________ Telecopier: __________________ If to the Debtor: Castle Dental Centers, Inc. Attn: Jack H. Castle, Jr. 1360 Post Oak Boulevard Houston, Texas 77056 Telephone: (713) 513-1401 Telecopier: (713) 513-1400 If to the Senior Creditors: Bank of America, N.A. Attn: Matt Bryant 700 Louisiana, 7th Floor Houston, Texas 77002 Telephone: 713-247-6056 Telecopier: 713-247-7748 or to such other address as shall be designated by one party in writing to the other parties. Notice sent by telecopy shall be deemed to be given and received when receipt of such transmission is acknowledged, and delivered notice shall be deemed to be given and received when receipted for by, or actually received by, an authorized officer of the receiving party. THIS WRITTEN AGREEMENT AND THE RELATED CREDIT DOCUMENTS REPRESENT THE FINAL AGREEMENT AMONG THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. Exhibit H-5 EXECUTED as of the date first above written. BANK OF AMERICA, N.A. (formerly NationsBank, N.A.) By: ________________________________________ Name: ______________________________________ Title: _____________________________________ CASTLE DENTAL CENTERS, INC. By: ________________________________________ Name: ______________________________________ Title: _____________________________________ [SUBORDINATED CREDITOR] By: ________________________________________ Name: ______________________________________ Title: _____________________________________ Exhibit H-6 EX-10.22 5 EXHIBIT 10.22 January 28, 2000 To the Parties on the Signature Page Re: Castle Dental Centers of California, L.L.C. Ladies & Gentlemen: The purpose of this letter is to set forth certain agreements among Castle Dental Centers of California, L.L.C., a Delaware limited liability company ("Castle West"), CDC of California, Inc., a Delaware corporation ("CDC"), Castle Dental Centers, Inc., a Delaware corporation ("Castle Dental," and together with Castle West and CDC, the "Castle Parties"), and each of the other parties listed on the signature page hereto (the "DCS Parties" and, collectively with the Castle Parties, the "Parties"). (A) The Parties hereto have previously entered into the following agreements (hereinafter, the "Castle West Transaction Documents"): 1. The Master Contribution and Combination Agreement, dated as of January 30, 1998, among the Castle Parties and the DCS Parties, as amended by the First Amendment to Master Contribution and Combination Agreement dated as of February 27, 1998, the Second Amendment to Master Contribution and Combination Agreement dated as of March 16, 1998, and the Third Amendment to Master Contribution and Combination Agreement dated as of March 30, 1998 (as so amended, the "Combination Agreement"); 2. The letter agreement dated as of May 29, 1998, among the Castle Parties and the DCS Parties (the "Letter Agreement"); 3. The Limited Liability Company Agreement of Castle West dated as of March 30, 1998 ("Limited Liability Company Agreement"), among Castle Dental, CDC, Castle West Holdings, LLC, a California limited liability company ("Holdings"), and Dental Consulting Services, LLC, a California limited liability company ("DCS"); 4. The Management Agreement between Castle West and Holdings dated as of March 30, 1998 ("Management Agreement"); 5. The Shareholders' Agreement between the Castle Parties and the DCS Parties dated as of March 30, 1998 ("Shareholders' Agreement"); 6. The Registration Rights Agreement between Castle Dental and Jeffrey D. Schechter, D.D.S. ("J. Schechter"), S. Alexander Soleimani, D.M.D. ("Soleimani"), Martin Schechter, D.D.S. ("M. Schechter"), Elliot Schlang, D.D.S. ("Schlang"), Dental Advisory Group, LLC, a California limited liability company ("DAG"), and Julie D'Aguanno ("D'Aguanno"), dated March 30, 1998 (the "Registration Rights Agreement"); 7. Confidentiality and Noncompetition Agreements each dated as of March 30, 1998 (the "Noncompetition Agreements") between Castle Dental and each of J. Schechter, Soleimani, M. Schechter, Schlang and DAG; 8. Operating Agreement dated as of March 30, 1998 for Holdings among J. Schechter, Soleimani, M. Schechter, Schlang, D'Aguanno and DAG ("Holdings Operating Agreement"); 9. Consulting Agreement dated as of March 30, 1998 between Holdings and DAG ("Consulting Agreement"); 10. 8% Subordinated Notes of Castle Dental each dated March 30, 1998 issued to each of J. Schechter, Soleimani, M. Schechter, Schlang and DAG in the aggregate original principal amount of $2,689,151 (the "Original Notes"); 11. Subordination Agreements dated as of March 30, 1998 ("Subordination Agreements"), by and among Castle Dental, Nationsbank of Texas, N.A. and each of J. Schechter, Soleimani, M. Schechter, Schlang and DAG; and 12. Assumption Agreement, dated March 30, 1998, by Castle West and DCS ("Assumption Agreement"). As a result of the consummation of the transactions contemplated by the Castle West Transaction Documents, CDC acquired the Class A and Class D Membership Interests in Castle West, DCS acquired the Class B Membership Interest in Castle West and Holdings acquired the Class C Membership Interest in Castle West. J. Schechter and Schlang currently serve as directors of Castle West, and J. Schechter serves as President, and M. Schechter, Schlang and Soleimani each serve as a Vice President of Castle West. (B) In addition, in connection with the foregoing, the following documents were executed by Castle West in connection with Castle Dental's bank facility (hereinafter, the "Castle Bank Documents"): 2 1. Guarantee, dated as of March 30, 1998, by Castle West in favor of Nationsbank of Texas, N.A., as amended or supplemented to date; 2. Security Agreement, dated as of March 30, 1998, by Castle West in favor of Nationsbank of Texas, N.A., as amended or supplemented to date; 3. Financing Statement, dated as of March 30, 1998, by Castle West in favor of Nationsbank of Texas, N.A., as amended or supplemented to date; and 4. Certain other documents evidencing Castle West's liabilities, if any, with respect to Castle Dental's senior creditors. (C) In addition, in connection with the foregoing, the following documents were executed by the DCS Parties and never delivered to the Castle Parties (collectively, the "Undelivered Documents"): 1. Asset Purchase Agreement between Martin Schechter, D.D.S., Inc. ("Schechter, Inc.") and DCS (the "Schechter Agreement"). 2. Asset Purchase Agreement between Elliot Schlang, D.D.S., Inc. ("Schlang, Inc.") and DCS (the "Schlang Agreement"). 3. Asset Purchase Agreement between S.A. Soleimani, D.M.D., Inc. ("Soleimani, Inc.") and DCS (the "Soleimani Agreement" and, together with the Schechter Agreement and the Schlang Agreement, the "Asset Purchase Agreements"). 4. Management Services Agreement between Castle West and Schechter, Inc. ("Schechter MSO"). 5. Stock Put/Call Option and Successor Designation Agreement between Castle West, Schechter, Inc. and M. Schechter regarding the outstanding capital stock of Schechter, Inc. ("Schechter Buy/Sell"). 6. Management Services Agreement between Castle West and Schlang, Inc. ("Schlang MSO"). 7. Stock Put/Call Option and Successor Designation Agreement between Castle West, Schlang, Inc. and Schlang regarding the outstanding capital stock of Schlang, Inc. ("Schlang Buy/Sell"). 3 8. Management Services Agreement between Castle West and Soleimani, Inc. ("Soleimani MSO" and collectively with the Schechter MSO and the Schlang MSO, the "MSO Agreements"). 9. Stock Put/Call Option and Successor Designation Agreement between Castle West, Soleimani, Inc. and Soleimani regarding the outstanding capital stock of Soleimani, Inc. ("Soleimani Buy/Sell" and collectively with the Schechter Buy/Sell and the Schlang Buy/Sell, the "Buy/Sell Agreements"). (D) The following forms of consideration have not yet been paid or delivered by the Castle Parties to the DCS Parties pursuant to the Castle West Transaction Documents and the MSO Agreements (collectively, the "Outstanding Castle Obligations"): 1. The "Acquisition Purchase Price Adjustment" as defined in Section 3.4 of the Combination Agreement; 2. The "B Merger Consideration" as defined in Section 7.1 of the Combination Agreement; 3. The "C Merger Consideration" as defined in Section 8.1 of the Combination Agreement, as well as any Incentive Payment payable pursuant to the provisions of Section 8.1(c) of the Combination Agreement; 4. Certain distributions of cash payable pursuant to Article 8 of the Limited Liability Company Agreement; 5. Certain management fees payable pursuant to Section 3 of the Management Agreement (including any amounts which Holdings was to use to pay the Consulting Fee to DAG pursuant to Section 4 of the Consulting Agreement); and 6. Certain Gross Practice Revenues (as defined in the MSO Agreements) excluded from MSO compensation under the MSO Agreements. On July 22, 1999, the DCS Members appropriately gave notice to the Castle Parties of their exercise of their right to cause the B Merger (as defined in the Contribution Agreement). On September 30, 1999, Castle West gave notice to Holdings of Castle West's intention not to extend the term of the Management Agreement beyond its initial term and consequently the Management Agreement will terminate by its terms on March 30, 2000. On November 17, the Castle Parties delivered to counsel for the DCS Parties for the benefit and on behalf of the DCS Parties a wire 4 transfer payable to the trust account of Kaye, Scholer, Fierman, Hays & Handler, LLP in the amount of $300,000. The character of such payment, which is non-refundable, shall be determined in accordance with Section (E)18 below. Certain differences and disagreements have arisen between the Parties hereto with regard to the foregoing transactions (the "Castle West Transaction") and the Parties hereto desire to settle all of their differences in the manner stated below: (E) NOW, THEREFORE, in consideration of the foregoing, the Parties hereto agree as follows: 1. Other than as specifically stated to the contrary in this Agreement below, following the Payment Date (as defined below), if any, the Parties hereto shall have no further obligations under the Castle West Transaction Documents and the Undelivered Documents (collectively, the "Existing Documents"), and such agreements shall be terminated and be of no further force or effect. The Castle Bank Documents shall remain in full force and effect following the Closing. However, each of the Castle Parties, jointly and severally, shall indemnify and hold each of the DCS Parties, and any affiliate or related person thereof (other than Castle West), harmless from and against any and all Damages (as defined in the Combination Agreement) suffered by any DCS Party, and any affiliate or related person thereof (other than Castle West), following the Payment Date as a result of, caused by, arising out of, or in any way relating to the Castle Bank Documents. 2. The closing of the transactions contemplated hereby ("Closing") shall occur when all documents required to be signed are signed by all Parties hereto and delivered at the law offices of Kaye, Scholer, Fierman, Hays & Handler, LLP in Los Angeles, California on or before January 28, 2000. At the Closing, the Parties hereto shall deliver the items as stated below. The Parties agree that for purposes of holding and delivering documents under this Agreement, counsel for the DCS Parties is Kaye, Scholer, Fierman, Hays & Handler, LLP and counsel for the Castle Parties is Boyer, Ewing & Harris Incorporated. All items shall be exchanged and delivered to the respective legal counsel for the Parties. If the Closing does not occur on or before January 28, 2000, the provisions of this Agreement shall be terminated and be of no further force and effect. (a) The respective DCS Parties shall deliver to counsel for the Castle Parties executed copies of the Undelivered Documentation. 5 (b) The DCS Parties shall deliver to counsel for the DCS Parties the following: (i) DCS shall deliver membership certificates and a membership power transferring the Class B Membership Interest in Castle West to CDC free and clear of all liens other than those that may exist under any of the Castle West Transaction Documents in favor of the Castle Parties, effective only after the occurrence of the Payment Date; (ii) Holdings shall deliver membership certificates and a membership power transferring the Class C Membership Interest in Castle West to CDC free and clear of all liens other than those that may exist under any of the Castle West Transaction Documents in favor of the Castle Parties, effective only after the occurrence of the Payment Date; and (iii) J & K Partnership, a California general partnership ("J&K"), and M. Schechter and Schlang, as the respective landlords under the following leases: (x) lease agreement dated August 1, 1996, by and between J&K", as the landlord, and Schechter, Inc. as the tenant, regarding the premises located at 13220 Hawthorne Blvd., Hawthorne, California (as amended by First Amendment to Lease Agreement dated effective as of November 1, 1996), which lease has been assigned by Schechter, Inc. to DCS and has been further assigned by DCS to Castle West such that Castle West is currently the tenant thereunder (the "Hawthorne Lease"); and (y) lease agreement dated August 1, 1996, by and between M. Schechter and Schlang, as the landlord, and Elliot Schlang, Inc. as the tenant, regarding the premises located at 4433 Tweedy Blvd., South Gate, California (as amended by First Amendment to Lease Agreement dated effective as of November 1, 1996), which lease has been assigned by Elliot Schlang, Inc. to DCS and has been further assigned by DCS to Castle West such that Castle West is currently the tenant thereunder (the "South Gate Lease"); 6 shall enter into new lease agreements (the "New Leases") with Castle West replacing the Hawthorne Lease and the South Gate Lease. The New Leases shall be in the forms of Exhibits A-1 and A-2 attached hereto; and (iv) The side letter agreement between the DCS Parties and the Castle Parties (the "Side Letter Agreement"), which shall supercede the provisions of this Agreement. (c) The Castle Parties shall deliver to counsel for the DCS Parties: (i) three original executed copies of this Letter; (ii) the New Leases; (iii) guaranties by Castle Dental of the obligations of Castle West under the New Leases and the month-to-month lease by and between Schlang, as the landlord, and Castle West as the tenant, regarding the premises located at 140 North Victory Boulevard, Burbank, California (the "Burbank Lease"); (iv) a check in the amount of $3,000.00 made payable to Carol Perrin in payment of services rendered in dissolving corporations owned by J. Schechter and Soleimani; and (v) the Side Letter Agreement. Counsel for the DCS Parties shall hold copies of the executed documents described in Section (E)2(b) and Section (E)2(c) (the "Remaining Documents") in escrow pending the occurrence of the Payment Date. If the Payment Date occurs, Counsel for the DCS Parties shall deliver the Remaining Documents to the Castle Parties. If the Payment Date does not occur, Counsel for the DCS Parties shall deliver the Remaining Documents to the DCS Parties, upon which time they shall be cancelled and of no effect and shall be null and void. 3. On or prior to February 1, 2000, Castle Dental shall (a) wire transfer to the trust account of Kaye, Scholer, Fierman, Hays & Handler, LLP, $5,000,000 as a final payment in settlement of, and in lieu of, all amounts owed by the Castle Parties to the DCS Parties as Outstanding Castle Obligations or otherwise in connection with the Castle West Transaction, (b) delivery of checks to Kaye, Scholer, Fierman, Hays & Handler, LLP made payable to the DCS Members equal the past-due interest and principal payments on the 7 Current Notes and (c) delivery of a check in the amount of $9,493 payable to Kaye, Scholer, Fierman, Hays & Handler, LLP to be held in trust for payment of the amounts payable under Sections (E)12(d) and (E)12(g) hereunder (collectively, the "Full Settlement Amount"). If the Castle Parties pay the Full Settlement Amount on or prior to February 1, 2000, then the date that such payment is received shall be the "Payment Date". If the Castle Parties do not pay the Full Settlement Amount by February 1, 2000, there shall be no Payment Date hereunder and all transactions and/or amendments contemplated hereby that are predicated on the occurrence of the Payment Date shall be of no force and effect. Notwithstanding anything herein to the contrary, the Castle Parties shall remain obligated to pay to the DCS Parties distributions of cash payable pursuant to Article 8 of the Limited Liability Company Agreement that accrue during the three-month period ending December 31, 1999 ("Fourth Quarter Earnings"), such amount to be payable on March 15, 2000. 4. If the Payment Date does not occur, the Existing Documents shall remain in full force and effect except for those Existing Documents that are specifically amended herein effective as of the Closing, which Existing Documents shall remain amended as described herein following the Closing regardless of the occurrence or nonoccurrence of the Payment Date. If the Payment Date does not occur, on February 1, 2000, the Castle Parties shall: (a) wire transfer to the trust account of Kaye, Scholer, Fierman, Hays & Handler, LLP $336,530; (b) file the B Merger Certificate (as defined in the Combination Agreement) with the Delaware Secretary of State and (c) deliver 421,116 shares of Castle Dental Common Stock to the DCS Parties as payment in full of the B Merger Consideration (collectively, the "Partial Settlement Amount"). The shares of Castle Dental Common Stock deliverable pursuant to item (c) of this Section (E)4 shall be dated as of July 22, 1999, the date the B Merger Notice was provided to Castle Dental, and such shares shall be deemed for all purposes to have been outstanding since such date. Following payment of the Partial Settlement Amount, if made on or before February 1, 2000, the Castle Parties shall be relieved of any obligation to pay any further amounts regarding (i) the Acquisition Purchase Price Adjustment applicable to the purchase of the Class A Membership Interest and the Class B Membership Interest, (ii) any payments due and owing by the Castle Parties or otherwise accrued through December 31, 1999 or which should otherwise have been paid by the Castle Parties on or prior to such date as (x) management fees payable pursuant to Section 3 of the Management Agreement (including any amounts which Holdings was to use to pay the Consulting Fee to DAG pursuant to Section 4 of the Consulting Agreement); or (y) Gross Practice Revenues excluded from MSO compensation under the MSO Agreements, (iii) any payments due and owing by the Castle Parties or otherwise accrued through September 30, 1999 or which should otherwise have been paid by the Castle Parties on or prior to such date as distributions of cash payable pursuant to Article 8 of the Limited Liability Company Agreement and (iv) the B Merger Consideration (collectively, the 8 "Adjustment Obligations"). Notwithstanding anything herein to the contrary, the Castle Parties shall remain obligated to pay to the DCS Parties the Fourth Quarter Earnings, such amount to be payable on March 15, 2000. 5. If the Payment Date does not occur, in addition to payment and delivery of the Partial Settlement Amount and the Fourth Quarter Earnings, the Castle Parties shall immediately resume making all payments due under the Existing Documents to the extent the obligation to make such payments accrues on or after January 1, 2000 in accordance with the terms of the Existing Documents, the Management Agreement shall be terminated as of March 30, 2000, and the DCS Parties shall be entitled to receive the C Merger Consideration upon delivery of the C Merger Notice (as defined in the Contribution Agreement). The Parties agree that time is strictly of the essence regarding the obligations of the Parties under this agreement. In addition, if the Partial Settlement Amount is not timely paid and delivered on or before February 1, 2000, the Castle Parties shall not be relieved of any obligations under any agreement giving rise to the Adjustment Obligations and shall be obligated to pay the full amount thereof including, without limitation, the Adjustment Obligations. 6. The Asset Purchase Agreements and all documents transferring ownership of the assets of DCS's business to Castle West as described therein shall remain in full force and effect in order to effect the transfer of such assets of Schechter, Inc., Schlang, Inc. and Soleimani, Inc. to DCS, and the subsequent transfer of DCS's assets (with the exception of any interest in or assets of the Canoga Park office which was not, and shall not be deemed to have been, transferred) to Castle West. The Parties hereto hereby ratify the transfers of all of such assets to Castle West and agree that, following the Closing, Castle West shall continue to own and operate the assets and business it acquired from DCS in connection with the Castle West Transaction, subject to the terms and provisions of the New Leases and the Burbank Lease. The Parties further agree that following the Payment Date Castle West shall be owned solely by CDC. 7. The Parties hereto hereby ratify the assumption of the obligations, liabilities and responsibilities under the Assumption Agreement and related documents and agree that Castle West shall continue to pay such obligations and liabilities and to perform such responsibilities in accordance with their respective terms. 8. The consideration previously received by the DCS Parties, regardless of the form thereof, shall be retained by the DCS Parties and the Original Notes and the Subordination Agreements shall remain in full force and effect following the Closing. 9 9. Following the earlier of March 30, 2000 or the Payment Date, other than as set forth in Sections (E)11 and (E)12 hereof, no DCS Party shall be obligated to provide any services to any Castle Party pursuant to any Existing Document, oral employment agreement or otherwise. Following the Closing, the Castle Parties shall be free to contract with D'Aguanno in any capacity. Effective as of the Payment Date, J. Schechter, M. Schechter, Schlang and Soleimani hereby resign from all of their positions as officers and/or directors of Castle West. 10. Following the Closing, the Noncompetition Agreements shall be and are hereby amended and restated as set forth in Exhibit B attached hereto and incorporated herein by this reference, with such agreement remaining in full force and effect following the Closing as so amended. 11. Following the Closing, the MSO Agreements shall remain in full force and effect provided that the MSO Agreements (other than the Schechter MSO Agreement) shall be and hereby are amended as of the Payment Date to delete the $2,500 per month exclusion of Gross Practice Revenues from the compensation payable to the MSO thereunder (the "Ownership Fee"). Following the Closing, the $2,500 per month Ownership Fee shall remain payable to Schechter, Inc. until such time as the Capital Stock of Schechter, Inc. is transferred to a qualified transferee pursuant to Section (E)12(d) below. 12. Following the Closing, the Buy/Sell Agreements shall remain in full force and effect provided that as of the Payment Date they shall be and hereby are amended as follows: (a) The Put Option and the Call Option currently set forth in Sections 2 and 3 are deleted in their entirety. (b) The MSO may exercise the Successor Designation Option set forth in Section 5 upon its determination that it has located a qualified successor to purchase all of the outstanding Capital Stock of the applicable PC. The dentist owning the Capital Stock of each PC hereby agrees that he will not attempt to transfer such Capital Stock to any person other than the qualified successor to be designated by the Castle Parties. (c) The Purchase Price of the Capital Stock of the PC (as defined in Section 10) shall be $100.00 in cash. (d) The dentist owning the Capital Stock in the applicable PC (other than M. Schechter) hereby agrees to continue to serve as the dentist of record for such PC 10 at all of its current locations until the later to occur of (i) the date Castle West designates a successor and the Capital Stock of the applicable PC is transferred to such successor and (ii) March 30, 2000. M. Schechter hereby agrees to continue to serve as the dentist of record for Schechter, Inc. at its current location at 13220 Hawthorne Blvd., Hawthorne, California, until the earlier to occur of (1) the date 90 days following the date he gives notice that he desires that Castle West designate a successor owner of Schechter, Inc., (2) the occurrence of any "Transfer Event" (as defined in Section 5(a) of the Schechter Buy/Sell), (3) the date 30 days following the date that Castle West gives notice that it desires to designate a successor owner of Schechter, Inc. and (4) the second anniversary of the Payment Date. In the event that Castle West elects to cause M. Schechter to transfer the Capital Stock of Schechter, Inc. pursuant to the provisions of section (3) of the previous sentence, Castle West shall be obligated to pay, as a condition of closing of such transfer of such Capital Stock, the Ownership Fees that would have been paid to Schechter, Inc. between the date of such transfer and the second anniversary of the Payment Date. Upon the transfer of the Capital Stock of Schechter, Inc., M. Schechter shall be reimbursed for any pension administration fees for termination of his PC Pension/Profit Sharing Plan, in an amount not to exceed $5,000 upon submission of invoices therefor to Kaye, Scholer, Fierman, Hays & Handler, LLP which Kaye, Scholer, Fierman, Hays & Handler, LLP shall be entitled to pay at its sole discretion out of the funds delivered to Kaye, Scholer, Fierman, Hays & Handler, LLP by Castle Dental pursuant to Section (E)3(c) above. M. Schechter hereby agrees to indemnify and hold harmless the Castle Parties from any and all Damages that they may incur as a result of any violation of ERISA by Schechter, Inc. or M. Schechter in the administration or termination of such PC Pension/Profit Sharing Plan. (e) The Castle Parties hereby agree to locate a qualified successor to purchase all of the outstanding Capital Stock of each PC (other than Schechter, Inc.) subject to a Buy/Sell Agreement and to cause such purchaser to purchase the Capital Stock of each PC (other than Schechter, Inc.) as soon a practicable but no later than March 30, 2000, after which date the dentist owning such PC shall have no further obligation to provide any further services to such PC or to any Castle Party. The Castle Parties hereby agree to locate a qualified successor to purchase all of the outstanding Capital Stock of Schechter, Inc. and to cause such purchaser to purchase the Capital Stock of Schechter, Inc. no later than the date M. Schechter's obligation to serve as dentist of record for Schechter, Inc. expires in accordance with the provisions of the last sentence of Section (E)12(d) above, after which date M. Schechter shall have no further obligation to provide any further services to Schechter, Inc. or to any Castle Party. Following such date, the purchaser of such 11 Capital Stock shall become the dentist of record for all locations of such PC. If M. Schechter so requests, following the purchase of the Capital Stock of Schechter, Inc., he may, but shall not be required to, continue to practice dentistry at the Hawthorne location for a period ending on the third anniversary of the Closing Date (unless such period is extended at the discretion of Castle West), subject to the reasonable supervision of the dentist then owning Schechter, Inc. (f) If an existing patient requests to consult with a DCS Member, the Castle Parties shall use good faith efforts to give such information to the applicable DCS Party by telephonic and/or voice message at a number designated by the applicable DCS Member with such action to occur within 24 hours of the time such patient request is received by a Castle Party or its representative or employee. If such DCS Party cannot be reached to provide such information, the Castle Parties shall reasonably attempt to provide such patient with professional quality care and treatment by another dentist. The Castle Parties hereby agree, that if a DCS Party who is a dentist requests to see an existing patient of such DCS Party at one of the offices managed by Castle West and reasonably asserts that the reason for his request to provide services to such patient is that he is required to provide such services under applicable law, such DCS Party shall be allowed to provide such services to such patient at such Castle West office but shall be entitled to no remuneration for such services from such office. (g) The Castle Parties agree to pay for and maintain malpractice insurance coverage for dentists who are DCS members in a manner which is substantially similar to such insurance presently in effect, and further agree to pay for and maintain after the Payment Date such malpractice insurance commonly referred to as a "tail" for the dentists who are DCS Members covering the period they served as dentists at a PC so that such dentists are continuously covered by malpractice insurance without any gap in malpractice insurance coverage. Such malpractice insurance coverage will be purchased for each owner of a PC on or prior to the date the Capital Stock of such PC is transferred to a qualified successor and the purchase of such insurance will be a condition precedent to the closing of the sale of such Capital Stock. J. Schechter shall purchase his own malpractice insurance and shall submit an invoice therefor to Kaye, Scholer, Fierman, Hays & Handler, LLP in an amount not to exceed $4,493 which Kaye, Scholer, Fierman, Hays & Handler, LLP shall be entitled to pay at its sole discretion out of the funds delivered to Kaye, Scholer, Fierman, Hays & Handler, LLP by Castle Dental pursuant to Section (E)3(c) above. Prior to such dates, the Castle Parties agree to keep the malpractice insurance currently in force at the PCs in effect. 12 (h) Upon the closing of a transaction designating a successor dentist for a PC, the name of the PC shall be changed so that its new name is not substantially similar to its then existing name and does not use the name of any DCS Party and the dentist transferring the PC shall have the right to use his name in any other business or entity. The Castle Parties shall reimburse such dentist for reasonable legal and accounting fees incurred in connection with such transfer in an amount not to exceed $5,000 for each such transfer limited to one per PC. Payment of such reasonable legal and accounting fees shall be payable at the closing of the transfer of the Capital Stock of the PC, upon presentment of an invoice itemizing such amounts. (i) For 18 months following the Payment Date, J. Schechter and M. Schechter shall be permitted to practice one day per month at their choosing at either the Hawthorne or South Gate locations, on any patients they choose. In addition, for a period of 24 months following the Payment Date, J. Schechter and M. Schechter shall be permitted to treat their family members at either the Hawthorne or South Gate locations. In connection with dental services provided pursuant to this subsection: (w) neither J. Schechter nor M. Schechter will receive any compensation for dental services provided or be charged for use of the Castle Parties' facilities; (x) J. Schechter and M. Schechter shall not be entitled to the assistance of any of the Castle Parties' staff; (y) J. Schechter and M. Schechter shall reimburse the Castle Parties for any supplies used or third-party costs incurred; and (z) J. Schechter and M. Schechter shall indemnify and hold harmless the Castle Indemnitees for any Damages they may incur as a result of any malpractice claims brought in connection with such dental services. If M. Schechter provides dental services to patients who are obligated to pay in accordance with Castle West's then existing fee structure, M. Schechter shall be compensated for such services in accordance with past practices and, with respect to such services provided, he shall not be subject to the provisions of the immediately preceding sentence. (j) The Castle Parties acknowledge that Schechter, Inc. is currently sponsoring four doctors in its office for U.S. citizenship. The Castle Parties hereby agree, to the full extent permitted by law, to continue sponsoring such individuals for U.S. citizenship, provided that their continued employment with Schechter, Inc. shall be dependent upon their job performance. (k) Lane Schechter and Danny Gersh shall be entitled to continue to receive orthodontic treatment at the Hawthorne office at no cost or expense to them. 13 (l) For a period of eighteen months following the Payment Date, the Castle Parties shall provide COBRA health insurance coverage to the DCS Members and their families who are currently covered by health insurance through any Castle Party, at such DCS Member's expense. In addition, each of the Castle Parties, jointly and severally, shall indemnify and hold each of the DCS Parties, and any affiliate or related person thereof, harmless from and against any and all Damages suffered by any DCS Party, and any affiliate or related person thereof, as a result of, caused by, arising out of, or in any way relating to the ownership, operation or conduct of a PC (other than a DCS Party's liability for his own malpractice or for any violations of ERISA in connection with the administration or termination of the PC Pension/Profit Sharing Plan in place at Schechter, Inc.) or the operation of the business of any Castle Party. Each owner of a PC hereby represents and warrants to the Castle Parties that (i) the only business that is currently being conducted by his PC (except as requested by a Castle Party or its affiliate) or that will be conducted by his PC as long as he is the owner thereof and the applicable Buy/Sell Agreement remains in effect is the provision of dental services consistent with the terms of the applicable MSO Agreement, (ii) other than the MSO Agreement with Castle West and employment agreements with dentists employed by his PC, his PC is not a party to any material agreement or contract other than those disclosed in or contemplated by the Castle West Transaction Documents or any replacement, renewal or similar substitution or extension thereof and (iii) his PC has no debt obligations outstanding and will not incur any debt as long as the applicable Buy/Sell Agreement remains in effect. The Castle Parties hereby represent and warrant that all payments owed to the PCs to date have been paid in full. The Castle Parties agree to indemnify and hold harmless the owners of the PCs from any and all Damages any of them may incur resulting from any obligation that any Castle Party causes such PC to incur, directly or indirectly, which is not otherwise paid. 13. Following the Closing, the Limited Liability Agreement shall remain in full force and effect provided that as of the Payment Date CDC shall be the only party thereto; provided, however, that the provisions of Articles 11 (with respect to any period as to which any DCS Party was a Member of Castle West), 12 and 13 thereof shall continue for the benefit of, and shall be enforceable by, each DCS Party as if each such DCS Party was set forth in such agreement as a party thereto entitled to the benefits thereof. 14. Following the Payment Date, the terms and provisions of the Combination Agreement shall terminate other than the terms and provisions of: 14 (a) Section 15.2, (which shall also be deemed to refer to any Books and Records (as defined in the Combination Agreement) of Castle West related to the operation of Castle West and its predecessors whether or not such Books and Records were transferred to Castle West in connection with the consummation of the transactions contemplated by the Castle West Transaction Documents) which shall continue for a period of no less than six years from the date of the Payment Date; and (b) Section 17.1 items (b) and (c) and the other applicable procedural provisions set forth in Article 17, which will survive until the end of the statute of limitation with respect to any applicable possible claim thereunder. The Parties agree that the transactions contemplated hereby are being entered into and consummated at the Payment Date in lieu of consummating the B Mergers and the C Mergers contemplated by the Combination Agreement and otherwise requiring the Castle Parties to pay the Outstanding Castle Obligations. 15. Other than the obligations of the respective Parties under this Agreement and those provisions of the Existing Documents specifically preserved by this Agreement (including, without limitation, the obligations of the Castle Parties to pay or deliver certain amounts and securities to the DCS Parties with respect to the Outstanding Castle Obligations), all of which shall remain for all purposes in full force and effect in accordance with their respective terms and provision (as modified, as applicable, by this Agreement), for and in consideration of the releases and indemnities set forth herein and entry into this Agreement and the delivery of the documents required hereby, effective as of the Closing, each of the Castle Parties does hereby release, remise and forever discharge each of the DCS Parties and their respective heirs, successors, assigns, legal and personal representatives, estates, devisees, legatees, past or present officers, directors, employees, shareholders, stockholders, parent and subsidiary corporations, agents, affiliates and their attorneys, and each of them, separately and collectively ("DCS Indemnitees"), of and from any and all manner of claims, demands, actions, causes of action, suits, proceedings, controversies, rights, obligations, liabilities, disputes, amounts due, debts, contracts, judgments, damages, counterclaims, defenses, set-offs, credits, known or unknown, asserted or not asserted, of any nature whatsoever, in law or in equity, whether pursuant to federal or state securities laws or otherwise (herein collectively referred to as "Claims") which it ever had, now has or which it or its heirs, representatives, devisees, legatees, successors or assigns can, shall or may have for or by any reason of any matter, cause or thing whatsoever relating to or in any way connected with the Existing Documents, any transaction contemplated by the Existing Documents or any breach thereof by any DCS Indemnitee prior to the Closing, including, but not limited to, any services or employment rendered or not rendered to the Castle Parties. For 15 avoidance of doubt, following the Closing, the Castle Parties acknowledge that they have no defenses, claims, or other offsets against payment of the Original Notes, the Partial Settlement Amount, the Full Settlement Amount, the C Merger Consideration or other amounts owing to the DCS Parties under the Existing Documents (all of which shall be calculated and paid in accordance with the terms of the Existing Documents or this document, as applicable) arising from events occurring prior to the Closing and agree that they shall not assert any such defense, claim or offset; provided that the Original Notes remain subject to the Subordination Agreements. Following the Payment Date, monies owed to, or incurred in connection with, Dr. Leon Roisman (or his affiliates), if any, shall be the sole obligation of the Castle Parties; provided, that expenses incurred in connection with the foregoing during the fourth quarter of 1999 will reduce, pro rata in accordance with their ownership percentage in Castle West, the amount of Fourth Quarter Earnings payable to the DCS Parties. 16. Other than the obligations of the respective Parties under this Agreement and those provisions of the Existing Documents specifically preserved by this Agreement, all of which shall remain for all purposes in full force and effect in accordance with their respective terms and provision (as modified, as applicable, by this Agreement), for and in consideration of the releases and indemnities set forth herein and entry into this Agreement and the delivery of the documents required hereby, effective as of the Closing, each of the DCS Parties does hereby release, remise and forever discharge each of the Castle Parties and their respective heirs, successors, assigns, legal and personal representatives, estates, devisees, legatees, past or present officers, directors, employees, shareholders, stockholders, parent and subsidiary corporations, agents, affiliates and their attorneys, and each of them, separately and collectively ("Castle Indemnitees"), of and from any and all Claims which it ever had, now has or which it or its heirs, representatives, devisees, legatees, successors or assigns can, shall or may have for or by any reason of any matter, cause or thing whatsoever relating to or in any way connected with the Existing Documents, any transaction contemplated by the Existing Documents or any breach thereof by any Castle Indemnitee prior to the Closing. Effective as of the Payment Date, except as otherwise specifically provided herein to the contrary, each of the DCS Parties does hereby release, remise and forever discharge each of the Castle Indemnities of and from any and all Claims which it ever had, now has or which it or its heirs, representatives, devisees, legatees, successors or assigns can, shall or may have for or by any reason of any matter, cause or thing whatsoever relating to or in any way connected with any obligation to pay the Acquisition Purchase Price Adjustment, the B Merger Consideration, the C Merger Consideration or any other amounts payable under the Combination Agreement, the Letter Agreement, the Limited Liability Company Agreement (other than Fourth Quarter Earnings, which shall remain payable), the Management 16 Agreement, the Holdings Operating Agreement, the Consulting Agreement or the Adjustment Obligations. 17. The DCS Parties hereby agree, jointly and severally, to indemnify and hold harmless the Castle Indemnitees from any and all Damages suffered by any Castle Indemnitee as a result of, caused by, arising out of, or in any way relating to any allegations by D'Aguanno, JUL-C Corporation or their respective heirs, representatives, devisees, legatees, successors or assigns (the "D'Aguanno Affiliates") to the effect that (a) any of the DCS Parties breached, misrepresented the contents of, or violated any duty owed to any D'Aguanno Affiliate under any Existing Document or applicable law or (b) any Castle Indemnitee acted in concert with any DCS Party (in consummating the transactions contemplated by this Agreement or otherwise) to deprive any D'Aguanno Affiliate of any rights or value that she or it was entitled to receive under the Existing Documents. 18. The Parties agree that the transactions contemplated herein shall be treated for federal, state and local tax purposes as follows, and agree to report to all tax authorities consistent with this Section 18: (a) If the Payment Date occurs: (i) The $300,000 payment made by the Castle Parties on November 17, 1999 and the Full Settlement Amount shall be considered payments (x) first, in consideration of the cash and note portion of the Acquisition Purchase Price Adjustment applicable to the sale of the Class A Membership Interest in an amount equal to $336,530; (y) second, in consideration of the sale of the Class B Membership Interest by DCS to CDC in an amount equal to $3,663,470; and (z) third, in consideration of the sale of the Class C Membership interest by Holdings to CDC in an amount equal to $1,300,000. No amount shall be considered a payment in connection with amounts described in Section (D)5 or (D)6 or any other amounts that may otherwise be due and owing to the DCS Parties under any of the Outstanding Castle Obligations. (ii) The amount of Castle West's taxable income allocable to Holdings for the taxable period ending December 31, 1999 shall be an amount equal to the lesser of (x) twenty percent of the total amount of Castle West's taxable income or (y) $200,000. The amount of Castle West's taxable income allocable to Holdings for the taxable period ending on the Payment Date shall be zero. No other allocation of taxable profits, losses or gains of 17 Castle West shall be allocated to Holdings, DCS or any other DCS Party for either taxable year. To the extent necessary to give effect to this Section (E)18(a)(ii), this Section (E)18(a)(ii) shall be considered an amendment to the Limited Liability Company Agreement. (iii) The payment of the Fourth Quarter Earnings shall be treated as a distribution from Castle West to Holdings under Article 8 of the Limited Liability Company Agreement. Should the distribution occur after the transfer of the B Membership Interests and C Membership interests, the parties shall treat the payment as a payment pursuant to Section 736(b) of the Internal Revenue Code of 1986, as amended (the "Code"). (b) If the Payment Date does not occur, and the Partial Settlement Amount is paid on or before February 1, 2000: (i) The $300,000 payment made by the Castle Parties on November 17, 1999 and the cash portion of the Partial Settlement Amount shall be considered a partial payment in consideration of the cash and note portion of the Acquisition Purchase Price Adjustment applicable to the sale of the Class A Membership Interest. No amount shall be considered a payment in connection with amounts described in Section (D)5 or (D)6 or any other amounts that may otherwise be due and owing to the DCS Parties under any of the Outstanding Castle Obligations. (ii) The amount of Castle West's taxable income allocable to Holdings for the taxable period ending December 31, 1999 shall be an amount equal to the lesser of (i) twenty percent of the total amount of Castle West's taxable income or (ii) $200,000 plus Fourth Quarter Earnings. No other allocation of taxable profits, losses or gains of Castle West shall be allocated to Holdings, DCS or any other DCS Party for the taxable year ending on December 31, 1999. To the extent necessary to give effect to this Section (E)18(b)(ii), this Section(E)18(b)(ii) shall be considered an amendment to the Limited Liability Company Agreement. (iii) The payment of the Fourth Quarter Earnings shall be treated as a distribution from Castle West to Holdings under Article 8 of the Limited Liability Agreement. 18 (c) If the Payment Date does not occur, and the Partial Settlement Amount is not paid on or before February 1, 2000: (i) The $300,000 payment made by the Castle Parties on November 17, 1999 shall be considered a partial payment in consideration of the cash and note portion of the Acquisition Purchase Price Adjustment applicable to the sale of the Class A Membership Interest. All other payments shall be characterized in accordance with the Castle West Transaction Documents. (ii) The amount of Castle West's taxable income allocable to Holdings for the taxable period ending December 31, 1999 shall be calculated in accordance with the Limited Liability Company Agreement. Similarly, distributions shall be calculated and timely made in accordance with the Limited Liability Company Agreement. (d) In all events: (i) Castle West shall be responsible for all filings required under Code Section 6050K (dealing with filing in connection with the transfer of a partnership interest). Castle Dental shall be responsible for the timely filing of all of the Castle Parties' tax returns consistent with the terms of this Agreement. Castle Dental shall ensure that the DCS Parties are notified of any audit of the Castle West tax returns and are treated as "notice partners" under Code Section 6231 and Castle Dental shall supply such information to the Internal Revenue Service as is necessary to assure notice is given to the DCS Parties pursuant to Code Section 6223 et seq. (ii) The Parties agree that Castle Dental shall not be obligated to comply strictly with the tax positions required by Section (E)18(a) or (b) above in the event that it is advised by its auditors that such positions are inconsistent with the positions that Castle Dental is required to make under the Code; provided that Castle Dental shall take positions as nearly identical as possible to those required above that are consistent with its reporting obligations under the Code and will give the DCS Parties notice of such determination prior to the filing thereof. 19. Each Party to the Hawthorne Lease and the South Gate Lease hereby agrees that following the Closing, the New Leases shall remain in full force and effect as written 19 and as further guaranteed by Castle Dental in accordance with Section (E)2(c)(ii) above. Each Party to the Burbank Lease hereby agrees that following the Closing, the Burbank Lease shall remain in full force and effect as guaranteed by Castle Dental in accordance with Section (E)2(c)(ii) above. Schlang and the Castle Parties agree to enter into a new lease in due course on mutually acceptable terms replacing the Burbank Lease. 20. Each Party hereto specifically waives the benefit of the provisions of Section 1542 of the Civil Code of the State of California, as follows: "A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor." 21. All Parties hereto expressly understand and acknowledge that it is possible that unknown losses or claims exist or that present losses may have been underestimated in amount or severity or that losses or claims may arise in the future, and such Parties explicitly took that into account and assumed that risk in determining the amount of consideration to be paid in connection with the execution of this Agreement, and a portion of said consideration, having been bargained for between the Parties with the knowledge of the possibility of such unknown claims, was given in exchange for a full accord, satisfaction, discharge and release of all such claims, whether asserted or not, and whether or not now known or knowable. 22. Each Party hereto represents and warrants to the others that it has full power and authority to enter into this Agreement on behalf of itself, its members, managers, officers, directors, employees, shareholders, stockholders, parent and subsidiary corporations, agents and affiliates and to perform this Agreement and those provisions of the Existing Documents specifically preserved by this Agreement in accordance with their respective provisions, that the representatives executing this Agreement are duly authorized to execute and deliver this Agreement, and further represents and warrants that the claims subject to this Agreement have not been assigned to any person not a Party hereto. 23. Each Party hereto represents and warrants to the others that this Agreement and those provisions of the Existing Documents specifically preserved by this Agreement each constitutes a valid and binding agreement of such Party enforceable against such Party in accordance with its respective terms, except to the extent that its enforceability may be subject to applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting the enforcement of creditors' rights generally and by general equitable principles. 20 24. It is understood and agreed that this Agreement involves the settlement and compromise of disputed claims, and that the consideration exchanged is not to be deemed or construed as an admission of liability on the part of any Party hereto herein released, all of whom deny all liability and intend merely to avoid further legal action and to buy their peace. 25. From time to time, whether at or after execution hereof, as and when requested, the Parties hereto agree to execute, acknowledge and deliver all such instruments or documents and take such other action as may be reasonably necessary to effectuate the terms, conditions and purposes of this Agreement. In addition, at the sole expense of the Castle Parties, each DCS Party agrees to cooperate and render such assistance as the Castle Parties reasonably request in connection with the Roisman litigation and any other claims that may be made against any Castle Party in connection with Castle West's business and operations occurring prior to the Payment Date, including providing testimony where appropriate. 26. This Agreement shall be binding upon and inure to the benefit of the Parties hereto and their respective agents, employees, representatives, members, officers, directors, divisions, subsidiaries, affiliates, successors in interest, assigns, heirs, shareholders and stockholders. 27. This Agreement may be executed in any number of counterparts, which taken together shall constitute one and the same instrument and each of which shall be considered an original for all purposes. This Agreement shall not be effective against any Party hereto unless and until all of the Parties listed on the signature page hereof have executed and delivered a copy of this Agreement. 28. Each Party hereto agrees to accept the facsimile signature of the other Parties to this Agreement as evidence of the execution and delivery of this Agreement. Such facsimile signature will be deemed to be binding upon the Party sending such facsimile signature. 29. All Parties hereto represent and warrant that no promise, inducement, representation, warranty or agreement not expressed herein has been made to them in connection with this Agreement and that this Agreement and the agreements contemplated hereby constitute the entire agreement between the Parties hereto pertaining to the subject matter hereof and supersede all prior agreements, understandings, negotiations and discussions, whether oral or written, of the Parties pertaining to the subject matter hereof. No supplement, amendment, alteration, modification, waiver or termination of this Agreement 21 shall be binding unless executed in writing by the Party against whom such change is being enforced. The Parties hereto agree that they will make no claim that this Agreement has been orally altered or modified or otherwise changed by oral communication of any kind or character. 30. The DCS Parties acknowledge that Castle Dental's existing credit facilities may not be sufficient to finance Castle Dental's currently planned level of expenditures for operations and growth and that Castle Dental is currently in the process of attempting to secure up to an additional $20 million in subordinated debt financing. In addition, the DCS Parties acknowledge that management is committed to maximizing Castle Dental's future shareholder value through whatever appropriate alternatives may become known to them, including, without limitation, in connection with the debt placement or otherwise. 31. In the case any one or more of the provisions contained in this Agreement shall be invalid, illegal, or unenforceable, in any respect, the validity, legality, and enforceability of the remaining provisions contained herein and therein or any subsequent application of such provision shall not in any way be affected thereby. In lieu of any such invalid, illegal or unenforceable provision, the Parties intend that there shall be added as part of this Agreement a provision as similar in terms to such invalid, illegal or unenforceable provision as may be possible and be valid, legal and enforceable. 32. This Agreement shall be deemed to have been executed and delivered within California and shall be construed and enforced pursuant to the laws of the State of California, without giving effect to the conflicts of laws principles thereof. Any action to enforce, modify or construe this Agreement shall be brought only in the State or Federal Courts located in the County of Los Angeles, California and each Party hereto hereby consents to the personal jurisdiction of such courts for the purpose of any such action, and agrees that the service of process in any such action may be made by certified mail to such Party's last known address, or as otherwise authorized by law or by applicable court rule. 33. The Parties hereto have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by the Parties and no presumption or burden of proof shall arise favoring or disfavoring any Party hereto by virtue of the authorship of any of the provisions of this Agreement. Time is strictly of the essence in the requirement of notice, performance and any other provision of this Agreement. 22 34. Each Party hereto has made such investigation of the facts pertaining to this settlement and to this Agreement and all of the matters pertaining thereto as it deems necessary. 35. All Parties hereto shall preserve the confidentiality of this Agreement and shall not disclose the existence or terms hereof to anyone not a Party to this Agreement, an attorney for such a Party or a Party's accountants and lenders to the extent necessary to inform them of its financial condition or to prepare tax returns, except to the extent that such disclosure is required by law or court order. 36. This Agreement is entered into by all Parties hereto freely and voluntarily, and with and upon the advice of counsel. All Parties hereto represent and warrant that they have been fully advised by their attorneys with respect to the advisability of executing this Agreement and with respect to the meaning of California Civil Code Section 1542. 37. Each term of Section (E) of this Agreement is contractual and not merely a recital. 38. In the event of any litigation relating to this Agreement, the prevailing Party shall be entitled to reasonable attorneys' fees and costs. 39. This Agreement is made and entered into as of the day first above written in Los Angeles, California. [THE REMAINDER OF THE PAGE LEFT BLANK] 23 If the foregoing accurately reflects your understanding of the agreement among the Parties hereto, please execute this letter in the space so provided below, upon which execution this letter shall become a binding and enforceable agreement of each of the signatories hereto. CDC OF CALIFORNIA, INC. By:______________________________________ John M. Slack, Vice President and Chief Financial Officer CASTLE DENTAL CENTERS OF CALIFORNIA, L.L.C. By:______________________________________ John M. Slack, Vice President and Chief Financial Officer CASTLE DENTAL CENTERS, INC. By:______________________________________ John M. Slack, Vice President and Chief Financial Officer CASTLE WEST HOLDINGS, LLC By:_______________________________________ Jeffrey D. Schechter, D.D.S., a Manager DENTAL CONSULTING SERVICES, LLC By:_______________________________________ Jeffrey D. Schechter, D.D.S., a Manager 24 DENTAL ADVISORY GROUP, LLC a Delaware limited liability company By:______________________________________ Barry Brief, Managing Member __________________________________________ Jeffrey D. Schechter, D.D.S., Individually __________________________________________ S. Alexander Soleimani, D.M.D., Individually __________________________________________ Martin Schechter, D.D.S., Individually __________________________________________ Elliot Schlang, D.D.S., Individually JDS-B CORPORATION By:_______________________________________ Jeffrey D. Schechter, D.D.S., President SAS-B CORPORATION By:_______________________________________ S. Alexander Soleimani, D.M.D., President MART-B CORPORATION By:_______________________________________ Martin Schechter, D.D.S., President 25 ES-B CORPORATION By:_______________________________________ Elliot Schlang, D.D.S., President DAG-B CORPORATION By:_______________________________________ Barry Brief, President JDS-C CORPORATION By:_______________________________________ Jeffrey D. Schechter, D.D.S., President SAS-C CORPORATION By:_______________________________________ S. Alexander Soleimani, D.M.D., President MART-C CORPORATION By:_______________________________________ Martin Schechter, D.D.S., President EL-S-C CORPORATION By:_______________________________________ Elliot Schlang, D.D.S., President 26 DAG-C CORPORATION By:______________________________________ Barry Brief, President S.A. SOLEIMANI, D.M.D., INC. By:_______________________________________ S. Alexander Soleimani, D.M.D., President MARTIN SCHECHTER, D.D.S., INC. By:_______________________________________ Martin Schechter, D.D.S., President ELLIOT SCHLANG, D.D.S., INC. By:_______________________________________ Elliot Schlang, D.D.S., President J & K PARTNERSHIP, a California general partnership By:_______________________________________ Jeffrey D. Schechter, D.D.S., Partner By:_______________________________________ S. Alexander Soleimani, D.M.D., Partner 27 EX-10.23 6 EXHIBIT 10.23 CASTLE DENTAL CENTERS, INC. AND HELLER FINANCIAL, INC. AND MIDWEST MEZZANINE FUND II, L.P. ----------------------------------------------- SENIOR SUBORDINATED NOTE PURCHASE AGREEMENT ----------------------------------------------- TABLE OF CONTENTS Page ARTICLE I Definitions and Accounting Matters.....................................1 Section 1.01 TERMS DEFINED ABOVE.......................................1 Section 1.02 CERTAIN DEFINED TERMS.....................................1 Section 1.03 ACCOUNTING TERMS AND DETERMINATIONS......................12 ARTICLE II Purchase and Sale of Notes............................................12 Section 2.01 PURCHASE AND SALE OF NOTES...............................12 Section 2.02 FEES.....................................................13 Section 2.03 PREPAYMENTS..............................................13 ARTICLE III Payments of Principal and Interest....................................14 Section 3.01 PAYMENT OF NOTES.........................................14 Section 3.02 INTEREST.................................................15 ARTICLE IV Payments; Computations; Etc...........................................15 Section 4.01 PAYMENTS.................................................15 Section 4.02 COMPUTATIONS.............................................16 Section 4.03 INTENTIONALLY OMITTED....................................16 Section 4.04 TAXES....................................................16 ARTICLE V Capital Adequacy......................................................17 Section 5.01 CAPITAL ADEQUACY; ADDITIONAL COSTS.......................17 Section 5.02 LIMITATION ON EURODOLLAR RATE............................18 Section 5.03 ILLEGALITY...............................................19 Section 5.04 INTEREST ON THE NOTES AT THE BASE RATE PURSUANT TO SECTIONS 5.01, 5.02 AND 5.03.............................19 Section 5.05 COMPENSATION.............................................19 ARTICLE VI Conditions Precedent..................................................20 Section 6.01 INITIAL PURCHASE.........................................20 Section 6.02 NO WAIVER................................................22 ARTICLE VII Representations and Warranties........................................22 Section 7.01 CORPORATE EXISTENCE......................................22 Section 7.02 FINANCIAL CONDITION......................................22 Section 7.03 LITIGATION...............................................23 Section 7.04 NO BREACH................................................23 Section 7.05 AUTHORITY................................................23 Section 7.06 APPROVALS................................................23 Section 7.07 USE OF NOTE PROCEEDS.....................................23 Section 7.08 ERISA....................................................24 Section 7.09 TAXES....................................................25 Section 7.10 TITLES, ETC..............................................25 Section 7.11 NO MATERIAL MISSTATEMENTS................................25 Section 7.12 INVESTMENT COMPANY ACT...................................26 Section 7.13 PUBLIC UTILITY HOLDING COMPANY ACT.......................26 Section 7.14 SUBSIDIARIES.............................................26 Section 7.15 LOCATION OF BUSINESS AND OFFICES.........................26 Section 7.16 DEFAULTS.................................................26 Section 7.17 ENVIRONMENTAL MATTERS....................................26 Section 7.18 COMPLIANCE WITH THE LAW..................................26 Section 7.19 INSURANCE................................................26 Section 7.20 MANAGEMENT SERVICES AGREEMENTS AND ACCOUNTS RECEIVABLE PURCHASE AGREEMENTS..................27 Section 7.21 RESTRICTION ON LIENS.....................................27 Section 7.22 MATERIAL AGREEMENTS......................................27 Section 7.23 HEDGING AGREEMENTS.......................................28 Section 7.24 YEAR 2000................................................28 Section 7.25 CAPITALIZATION...........................................28 ARTICLE VIII Affirmative Covenants.................................................29 Section 8.01 REPORTING REQUIREMENTS...................................29 Section 8.02 LITIGATION...............................................31 Section 8.03 MAINTENANCE, ETC.........................................31 Section 8.04 ENVIRONMENTAL MATTERS....................................32 Section 8.05 FURTHER ASSURANCES.......................................32 Section 8.06 PERFORMANCE OF OBLIGATIONS...............................33 Section 8.07 ERISA INFORMATION AND COMPLIANCE.........................33 Section 8.08 MANAGEMENT SERVICES AGREEMENTS AND ACCOUNTS RECEIVABLE PURCHASE AGREEMENTS..................33 Section 8.09 GUARANTEE BY ACQUIRED ENTITIES...........................33 Section 8.10 YEAR 2000................................................34 Section 8.11 BOARD OBSERVATION........................................34 Section 8.12 CORRESPONDING AMENDMENT..................................34 ARTICLE IX Negative Covenants....................................................35 Section 9.01 DEBT.....................................................35 Section 9.02 LIENS....................................................35 Section 9.03 INVESTMENTS, LOANS AND ADVANCES..........................36 Section 9.04 DIVIDENDS, DISTRIBUTIONS AND REDEMPTIONS.................38 Section 9.05 SALES AND LEASEBACKS.....................................38 Section 9.06 NATURE OF BUSINESS.......................................38 Section 9.07 MERGERS, ETC.............................................38 Section 9.08 PROCEEDS OF NOTES........................................38 Section 9.09 ERISA COMPLIANCE.........................................38 Section 9.10 SALE OR DISCOUNT OF RECEIVABLES..........................40 Section 9.11 RATIO OF TOTAL FUNDED DEBT TO CAPITALIZATION.............40 Section 9.12 NET WORTH................................................40 Section 9.13 LEVERAGE RATIO...........................................40 Section 9.14 FIXED CHARGE COVERAGE RATIO..............................40 Section 9.15 RATIO OF TOTAL FUNDED DEBT TO EBITDA.....................41 Section 9.16 CAPITAL EXPENDITURES.....................................41 Section 9.17 ENVIRONMENTAL MATTERS....................................41 Section 9.18 TRANSACTIONS WITH AFFILIATES.............................41 Section 9.19 SUBSIDIARIES.............................................42 Section 9.20 NEGATIVE PLEDGE AGREEMENTS...............................42 Section 9.21 OTHER AGREEMENTS.........................................42 Section 9.22 ACQUIRED ENTITIES........................................42 Section 9.23 AMENDMENT OF CASTLE WEST LLC AGREEMENT...................42 Section 9.24 JUNIOR SUBORDINATION DEBT................................43 Section 9.25 RESTRICTION ON FUNDAMENTAL CHANGES.......................43 Section 9.26 DISPOSAL OF ASSETS OR SUBSIDIARY STOCK...................43 ARTICLE X Events of Default; Remedies...........................................43 Section 10.01 EVENTS OF DEFAULT.......................................43 Section 10.02 REMEDIES................................................45 ARTICLE XI Holder Representations and Warranties.................................46 Section 11.01 ACCREDITED INVESTOR.....................................46 ARTICLE XII Miscellaneous.........................................................46 Section 12.01 WAIVER..................................................46 Section 12.02 NOTICES.................................................47 Section 12.03 PAYMENT OF EXPENSES, INDEMNITIES, ETC...................47 Section 12.04 AMENDMENTS, ETC.........................................49 Section 12.05 SUCCESSORS AND ASSIGNS..................................49 Section 12.06 ASSIGNMENTS.............................................49 Section 12.07 INVALIDITY..............................................50 Section 12.08 COUNTERPARTS............................................50 Section 12.09 REFERENCES..............................................50 Section 12.10 SURVIVAL................................................50 Section 12.11 CAPTIONS................................................51 Section 12.12 NO ORAL AGREEMENTS......................................51 Section 12.13 GOVERNING LAW; SUBMISSION TO JURISDICTION...............51 Section 12.14 INTEREST................................................52 Section 12.15 CONFIDENTIALITY.........................................52 Section 12.16 EFFECTIVENESS...........................................53 Section 12.17 EXCULPATION PROVISIONS..................................53 Section 12.18 SUBORDINATION...........................................54 EXHIBITS AND SCHEDULES Exhibit A - Form of Subordinated Note Exhibit B - Form of Convertible Note Exhibit C - Form of Compliance Certificate Exhibit D - Form of Officer's Certificate Exhibit E - Due Diligence Items Exhibit F - Form of Subordination Agreement for Junior Subordinated Debt Schedule 1.1 - Acquired Entities Schedule 7.02 - Liabilities Schedule 7.03 - Litigation Schedule 7.14 - Subsidiaries Schedule 7.19 - Insurance Schedule 7.20 - Management Services Agreements and Accounts Receivable Purchase Agreements Schedule 7.22 - Material Agreements Schedule 7.23 - Hedging Agreements Schedule 7.25 - Capitalization Schedule 9.01 - Debt Schedule 9.02 - Liens Schedule 9.03 - Investments, Loans and Advances THIS SENIOR SUBORDINATED NOTE PURCHASE AGREEMENT, dated as of January 31, 2000, is among CASTLE DENTAL CENTERS, INC., a corporation formed under the laws of the State of Delaware (the "COMPANY"), HELLER FINANCIAL, INC., a Delaware corporation ("HELLER") and MIDWEST MEZZANINE FUND II, L.P., a Delaware limited partnership ("MIDWEST") (Heller and Midwest are sometimes referred to individually as a "HOLDER" and together, as the "HOLDERS"). R E C I T A L S A. The Company wishes to sell to Holders, and Holders wish to purchase from the Company, senior subordinated promissory notes (collectively, the "SUBORDINATED NOTES") due January 31, 2007, in the aggregate principal amount of $13,621,536 and senior subordinated convertible promissory notes in the aggregate principal amount of $1,378,464, convertible into 6% of the fully diluted common equity ownership of the Company (collectively, the "CONVERTIBLE NOTES") (the Convertible Notes and Subordinated Notes are collectively referred to as the "NOTES"), upon the terms and subject to the conditions hereinafter set forth; B. In consideration of the mutual covenants and agreements herein contained and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto agree as follows: ARTICLE I DEFINITIONS AND ACCOUNTING MATTERS Section 1.01 TERMS DEFINED ABOVE. As used in this Agreement, the terms "COMPANY", "HELLER" , "MIDWEST" and "HOLDER" shall have the meanings indicated above. Section 1.02 CERTAIN DEFINED TERMS. As used herein, the following terms shall have the following meanings (all terms defined in this Article I or in other provisions of this Agreement in the singular to have the same meanings when used in the plural and VICE VERSA): "ACCOUNTS RECEIVABLE PURCHASE AGREEMENTS" shall mean the Accounts Receivable Purchase Agreements either previously or, if applicable, hereafter entered into between an Acquired Entity, as seller, and Company or any Subsidiary, as buyer, in form and substance satisfactory to Holders. "ACQUIRED ENTITY" shall mean the entities identified on SCHEDULE 1.1 hereto and all entities (of whatever form) whose assets are acquired by the Company or any Subsidiary in connection with New Acquisitions, and all new professional corporations, professional associations or other Persons which become a party to future Management Services Agreements and Accounts Receivable Purchase Agreements with Company or any Subsidiary pursuant to New Acquisitions. "ADDITIONAL COSTS" shall have the meaning assigned such term in Section 5.01(a). 1 "AFFECTED NOTES" shall have the meaning assigned such term in Section 5.04. "AFFILIATE" of any Person shall mean (i) any Person directly or indirectly controlled by, controlling or under common control with such first Person, (ii) any director or officer of such first Person or of any Person referred to in clause (i) above and (iii) if any Person in clause (i) above is an individual, any member of the immediate family (including parents, spouse and children) of such individual and any trust whose principal beneficiary is such individual or one or more members of such immediate family and any Person who is controlled by any such member or trust. For purposes of this definition, any Person which owns directly or indirectly 10% or more of the securities having ordinary voting power for the election of directors or other governing body of a corporation or 10% or more of the partnership or other ownership interests of any other Person (other than as a limited partner of such other Person) will be deemed to "CONTROL" (including, with its correlative meanings, "CONTROLLED BY" and "UNDER COMMON CONTROL WITH") such corporation or other Person. "AGREEMENT" shall mean this Agreement, as the same may from time to time be amended, restated, supplemented or otherwise modified from time to time. "APPLICABLE MARGIN" shall mean (a) with respect to interest calculated by reference to the Eurodollar Rate, four percent (4%) and (b) with respect to interest calculated by reference to the Base Rate, two and three quarters percent (2.75%). "ASSET PURCHASE" shall mean the acquisition of all or substantially all of the assets of any Acquired Entity by Company or any Subsidiary pursuant to an Asset Purchase Agreement. "ASSET PURCHASE AGREEMENTS" shall mean Asset Purchase Agreements entered into by Company or any Subsidiary in form and substance satisfactory to Holders in connection with New Acquisitions. "BASE RATE" means a variable rate of interest per annum equal to the rate of interest from time to time published by the Board of Governors of the Federal Reserve System in Federal Reserve statistical release H.15 (519) entitled "Selected Interest Rates" as the Bank prime loan rate. Base Rate also includes rates published in any successor publications of the Federal Reserve System reporting the Bank prime loan rate or its equivalent. The statistical release generally sets forth a Bank prime loan rate for each business day. The applicable Bank prime loan rate for any date not set forth shall be the rate set forth for the last preceding date. In the event the Board of Governors of the Federal Reserve System ceases to publish a Bank prime loan rate or equivalent, the term "Base Rate" shall mean a variable rate of interest per annum equal to the highest of the "prime rate," "reference rate," "base rate" or other similar rate as determined by Agent announced from time to time by any of Bankers Trust Company, The Chase Manhattan Bank or Citibank, N.A. (with the understanding that any such rate may merely be a reference rate and may not necessarily represent the lowest or best rate actually charged to any customer by such bank). 2 "BUSINESS DAY" shall mean any day other than a day on which commercial banks are authorized or required to close in Chicago, Illinois or in the Commonwealth of Pennsylvania and, where such term is used in the definition of "Quarterly Date" or if such day relates to a payment or prepayment of principal of or interest on a Note, any day which is also a day on which dealings in Dollar deposits are carried out in the London interbank market. "CAPITALIZATION" shall mean shareholder's equity plus Total Funded Debt. "CHANGE OF CONTROL" shall mean at any time, as a result of one or more transactions after the date of this Agreement, any "person" or "group" of persons acting in concert (other than persons owning common stock of the Company on the Closing Date) shall have "beneficial ownership" of more than 51% of the outstanding common stock of the Company (within the meaning of Section 13(d) or 14 (d) of the Securities Exchange Act of 1934, as amended, and the applicable rules and regulations thereunder), PROVIDED that the relationships among the respective shareholders of the Company on the date of this Agreement shall not be deemed to constitute all or any combination of them as a "group". "CLOSING DATE" shall mean January 31, 2000. "CODE" shall mean the Internal Revenue Code of 1986, as amended from time to time and any successor statute. "COMMON STOCK" shall mean the common stock, $.001 par value, of the Company. "CONSOLIDATED NET INCOME" shall mean with respect to the Company and its Consolidated Subsidiaries, for any period, the aggregate of the net income (or loss) of the Company and its Consolidated Subsidiaries after allowances for taxes for such period, determined on a consolidated basis in accordance with GAAP; PROVIDED that there shall be excluded from such net income (to the extent otherwise included therein) the following: (i) the net income of any Person in which the Company or any Consolidated Subsidiary has an interest (which interest does not cause the net income of such other Person to be consolidated with the net income of the Company and its Consolidated Subsidiaries in accordance with GAAP), except to the extent of the amount of dividends or distributions actually paid in such period by such other Person to the Company or to a Consolidated Subsidiary, as the case may be; (ii) the net income (but not loss) of any Consolidated Subsidiary to the extent that the declaration or payment of dividends or similar distributions or transfers or loans by that Consolidated Subsidiary is not at the time permitted by operation of the terms of its charter or any agreement, instrument or Governmental Requirement applicable to such Consolidated Subsidiary, or is otherwise restricted or prohibited in each case determined in accordance with GAAP; (iii) the net income (or loss) of any Person acquired in a pooling-of-interests transaction for any period prior to the date of such transaction; (iv) any nonrecurring gains or losses acceptable to Holders and any extraordinary gains or losses, including gains or losses attributable to Property sales not in the ordinary course of business; and (v) the 3 cumulative effect of a change in accounting principles and any gains or losses attributable to writeups or write downs of assets. "CONSOLIDATED SUBSIDIARIES" shall mean each Subsidiary of the Company (whether now existing or hereafter created or acquired) the financial statements of which shall be (or should have been) consolidated with the financial statements of the Company in accordance with GAAP. "DEBT" shall mean, for any Person the sum of the following (without duplication): (i) all obligations of such Person for borrowed money or evidenced by bonds, debentures, notes or other similar instruments (including principal, interest, fees and charges); (ii) all obligations of such Person (whether contingent or otherwise) in respect of bankers' acceptances, letters of credit, surety or other bonds and similar instruments; (iii) all obligations of such Person to pay the deferred purchase price of Property or services (other than for borrowed money); (iv) all obligations under leases which shall have been, or should have been, in accordance with GAAP, recorded as capital leases in respect of which such Person is liable (whether contingent or otherwise); (v) all obligations under leases which require such Person or its Affiliate to make payments over the term of such lease, including payments at termination, which are substantially equal to at least eighty percent (80%) of the purchase price of the Property subject to such lease plus interest as an imputed rate of interest; (vi) all Debt (as described in the other clauses of this definition) and other obligations of others secured by a Lien on any asset of such Person, whether or not such Debt is assumed by such Person; (vii) all Debt (as described in the other clauses of this definition) and other obligations of others guaranteed by such Person or in which such Person otherwise assures a creditor against loss of the debtor or obligations of others; (viii) all obligations or undertakings of such Person to maintain or cause to be maintained the financial position or covenants of others or to purchase the Debt or Property of others; (ix) obligations to deliver goods or services in consideration of advance payments; and (x) all obligations of such Person under Hedging Agreements. "DEFAULT" shall mean an Event of Default or an event which with notice or lapse of time or both would become an Event of Default. "DOLLARS" and "$" shall mean lawful money of the United States of America. "EBITDA" shall mean, for any period, the sum of Consolidated Net Income for such period plus the following expenses or charges to the extent deducted from Consolidated Net Income in such period: interest, taxes, depreciation, depletion, amortization and the amount of the settlement of the lawsuit with Joseph Bonola, D.D.S. up to but not to exceed $1,372,743 as reflected on Schedule 1 to the Second Amendment to the Senior Credit Agreement, dated as of September 30, 1999. "ENVIRONMENTAL LAWS" shall mean any and all Governmental Requirements pertaining to health or the environment in effect in any and all jurisdictions in which the Company or any Subsidiary is conducting or at any time has conducted business, or where any Property of the Company or any Subsidiary is located, including without limitation, the Oil Pollution Act of 1990 ("OPA"), the Clean Air Act, as amended, the Comprehensive Environmental, Response, 4 Compensation, and Liability Act of 1980 ("CERCLA"), as amended, the Federal Water Pollution Control Act, as amended, the Occupational Safety and Health Act of 1970, as amended, the Resource Conservation and Recovery Act of 1976 ("RCRA"), as amended, the Safe Drinking Water Act, as amended, the Toxic Substances Control Act, as amended, the Superfund Amendments and Reauthorization Act of 1986, as amended, the Hazardous Materials Transportation Act, as amended, and other environmental conservation or protection laws. The term "oil" shall have the meaning specified in OPA, the terms "hazardous substance" and "release" (or "threatened release") have the meanings specified in CERCLA, and the terms "solid waste" and "disposal" (or "disposed") have the meanings specified in RCRA; PROVIDED, HOWEVER, that (i) in the event either OPA, CERCLA or RCRA is amended so as to broaden the meaning of any term defined thereby, such broader meaning shall apply subsequent to the effective date of such amendment and (ii) to the extent the laws of the state in which any Property of the Company or any Subsidiary is located establish a meaning for "oil," "hazardous substance," "release," "solid waste" or "disposal" which is broader than that specified in either OPA, CERCLA or RCRA, such broader meaning shall apply. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time and any successor statute. "ERISA AFFILIATE" shall mean each trade or business (whether or not incorporated) which together with the Company or any Subsidiary would be deemed to be a "single employer" within the meaning of section 4001(b)(1) of ERISA or subsections (b), (c), (m) or (o) of section 414 of the Code. "ERISA EVENT" shall mean (i) a "Reportable Event" described in Section 4043 of ERISA and the regulations issued thereunder, (ii) the withdrawal of the Company, any Subsidiary or any ERISA Affiliate from a Plan during a plan year in which it was a "substantial employer" as defined in Section 4001(a)(2) of ERISA, (iii) the filing of a notice of intent to terminate a Plan or the treatment of a Plan amendment as a termination under Section 4041 of ERISA, (iv) the institution of proceedings to terminate a Plan by the PBGC or (v) any other event or condition which might constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Plan. "EURODOLLAR RATE" shall mean, for each Interest Period, a rate per annum equal to: (a) the offered rate for deposits in U.S. dollars in an amount comparable to the amount of the applicable Note in the London interbank market which is published by the British Bankers' Association, and that currently appears on Telerate Page 3750, as of 11:00 a.m. (London time) on the day which is two (2) Business Days prior to the first day of such Interest Period for a term comparable to such Interest Period; or if, for any reason, such a rate is not published by the British Bankers' Association on Telerate or any other source approved by Heller, the rate per annum equal to the average rate (rounded upwards, if necessary, to the nearest 1/100 of 1%) at which Heller determines that U.S. dollars in an amount comparable to the amount of the applicable Note is being offered to prime banks at approximately 11:00 a.m. (London time) on the day which is two (2) Business Days prior to the first day of such Interest Period for a term comparable to such 5 Interest Period for settlement in immediately available funds by leading banks in the London interbank market selected by Heller; DIVIDED BY (b) a number equal to 1.0 MINUS the aggregate (but without duplication) of the rates (expressed as a decimal fraction) of reserve requirements in effect on the day which is two (2) Business Days prior to the beginning of such Interest Period (including, without limitation, basic, supplemental, marginal and emergency reserves under any regulations of the Board of Governors of the Federal Reserve System or other governmental authority having jurisdiction with respect thereto, as now and from time to time in effect) for Eurocurrency funding (currently referred to as "Eurocurrency Liabilities" in Regulation D of such Board) which are required to be maintained by a member bank of the Federal Reserve System; such rate to be rounded upward to the next whole multiple of one-sixteenth of one percent (.0625%). "EVENT OF DEFAULT" shall have the meaning assigned such term in Section 10.01. "EXCEPTED LIENS" shall mean: (i) Liens for taxes, assessments or other governmental charges or levies not yet due or which are being contested in good faith by appropriate action and for which adequate reserves have been maintained; (ii) Liens in connection with workmen's compensation, unemployment insurance or other social security, old age pension or public liability obligations not yet due or which are being contested in good faith by appropriate action and for which adequate reserves have been maintained in accordance with GAAP; (iii) operators', vendors', carriers', warehousemen's, repairmen's, mechanics', workmen's, materialmen's, construction or other like Liens arising by operation of law in the ordinary course of business or statutory landlord's liens, each of which is in respect of obligations that have not been outstanding more than 90 days or which are being contested in good faith by appropriate proceedings and for which adequate reserves have been maintained in accordance with GAAP; (iv) any Liens reserved in leases for rent and for compliance with the terms of leases in the case of leasehold estates, to the extent that any such Lien referred to in this clause does not materially impair the use of the Property covered by such Lien for the purposes for which such Property is held by the Company or any Subsidiary or materially impair the value of such Property subject thereto; (v) encumbrances (other than to secure the payment of borrowed money or the deferred purchase price of Property or services), easements, restrictions, servitudes, permits, conditions, covenants, exceptions or reservations in any rights of way or other Property of the Company or any Subsidiary for the purpose of roads, pipelines, transmission lines, transportation lines, distribution lines for the removal of gas, oil, coal or other minerals or timber, and other like purposes, or for the joint or common use of real estate, rights of way, facilities and equipment, and defects, irregularities, zoning restrictions and deficiencies in title of any rights of way or other Property which in the aggregate do not materially impair the use of such rights of way or other Property for the purposes of which such rights of way and other Property are held by the Company or any Subsidiary or materially impair the value of such Property subject thereto; (vi) deposits of cash or securities to secure the performance of bids, trade contracts, leases, statutory obligations and other obligations of a like nature incurred in the ordinary course of business; and (vii) Liens permitted by the Senior Credit Documents. 6 "FINANCIAL STATEMENTS" shall mean the financial statement or statements of the Company and its Consolidated Subsidiaries described or referred to in Section 7.02. "GAAP" shall mean generally accepted accounting principles in the United States of America in effect from time to time. "GOVERNMENTAL AUTHORITY" shall include the country, the state, county, city and political subdivisions in which any Person or such Person's Property is located or which exercises valid jurisdiction over any such Person or such Person's Property, and any court, agency, department, commission, board, bureau or instrumentality of any of them including monetary authorities which exercises valid jurisdiction over any such Person or such Person's Property. Unless otherwise specified, all references to Governmental Authority herein shall mean a Governmental Authority having jurisdiction over, where applicable, the Company, its Subsidiaries or any of their Property or any Holder. "GOVERNMENTAL REQUIREMENT" shall mean any law, statute, code, ordinance, order, determination, rule, regulation, judgment, decree, injunction, franchise, permit, certificate, license, authorization or other directive or requirement (whether or not having the force of law), including, without limitation, Environmental Laws, energy regulations and occupational, safety and health standards or controls, of any Governmental Authority. "GUARANTORS" shall mean each Subsidiary which may, or is required to, execute a Subordinated Guaranty Agreement pursuant to Section 9.19. "HEDGING AGREEMENTS" shall mean any interest rate swap, cap, floor, collar, forward agreement or other protection agreements or any option with respect to any such transaction. "HIGHEST LAWFUL RATE" shall mean the maximum nonusurious interest rate, if any, that at any time or from time to time may be contracted for, taken, reserved, charged or received on the Notes or on other Indebtedness under laws applicable to Holders which are presently in effect or, to the extent allowed by law, under such applicable laws which may hereafter be in effect and which allow a higher maximum nonusurious interest rate than applicable laws now allow. "INDEBTEDNESS" shall mean any and all amounts owing or to be owing by the Company or any Subsidiary to Holders in connection with the Subordinated Note Documents, now or hereafter entered into between or among the Company, any of its Subsidiaries and any Holder, and all renewals, extensions and/or rearrangements of any of the above. "INDEMNIFIED PARTIES" shall have the meaning assigned such term in Section 12.03(a)(ii). "INDEMNITY MATTERS" shall mean any and all actions, suits, proceedings (including any investigations, litigation or inquiries), claims, demands and causes of action made or threatened against a Person and, in connection therewith, all losses, liabilities, damages (including, without 7 limitation, consequential damages) or reasonable costs and expenses of any kind or nature whatsoever incurred by such Person whether caused by the sole or concurrent negligence of such Person seeking indemnification. "INITIAL PURCHASE" shall mean the initial purchase of the Notes upon satisfaction of the conditions set forth in Sections 6.01 and 6.02. "INTEREST PERIOD" shall mean each three-month period, with the first period commencing on the Closing Date and ending on the numerically corresponding day in the third calendar month thereafter, except that each Interest Period which commences on the last Business Day of a calendar month (or on any day for which there is no numerically corresponding day in the appropriate subsequent calendar month) shall end on the last Business Day of the appropriate subsequent calendar month. Notwithstanding the foregoing, each Interest Period which would otherwise end on a day which is not a Business Day shall end on the next succeeding Business Day (or, if such next succeeding Business Day falls in the next succeeding calendar month, on the next preceding Business Day). "JUNIOR SUBORDINATED DEBT" shall mean Debt of the Company or any Subsidiary that is subordinated to the Indebtedness pursuant to a subordination agreement substantially in the form of EXHIBIT F and otherwise on terms and conditions acceptable to Holders. "LIEN" shall mean any interest in Property securing an obligation owed to, or a claim by, a Person other than the owner of the Property, whether such interest is based on the common law, statute or contract, and whether such obligation or claim is fixed or contingent, and including but not limited to the lien or security interest arising from a mortgage, encumbrance, pledge, security agreement, conditional sale or trust receipt or a lease, consignment or bailment for security purposes. The term "LIEN" shall include reservations, exceptions, encroachments, easements, rights of way, covenants, conditions, restrictions, leases and other title exceptions and encumbrances affecting Property. For the purposes of this Agreement, the Company or any Subsidiary shall be deemed to be the owner of any Property which it has acquired or holds subject to a conditional sale agreement, or leases under a financing lease or other arrangement pursuant to which title to the Property has been retained by or vested in some other Person in a transaction intended to create a financing. "MAJORITY LENDERS" shall mean the "Majority Lenders" as defined in the Senior Credit Agreement. "MANAGEMENT SERVICES AGREEMENTS" shall mean Management Service Agreements previously or hereafter entered into between an Acquired Entity and Company or any Subsidiary, in form and substance satisfactory to Holders. 8 "MATERIAL ADVERSE EFFECT" shall mean any material and adverse effect on (i) the assets, liabilities, financial condition, business, operations or affairs of the Company and its Subsidiaries taken as a whole different from those reflected in the Financial Statements or from the facts represented or warranted in any Subordinated Note Document, or (ii) the ability of the Company and its Subsidiaries taken as a whole to carry out their business as at the Closing Date or as proposed as of the Closing Date to be conducted or meet their obligations under the Subordinated Note Documents on a timely basis. "MULTIEMPLOYER PLAN" shall mean a Plan defined as such in Section 3(37) or 4001(a)(3) of ERISA. "NET WORTH" shall mean, as at any date, the sum of the following for the Company and its Consolidated Subsidiaries determined (without duplication) in accordance with GAAP: (i) the amount of preferred stock and common stock at par plus the amount of surplus of the Company, PLUS (ii) the retained earnings (or, in the case of retained earnings deficit, MINUS the amount of such deficit). "NEW ACQUISITION" shall mean the acquisition of dental practices and/or management service organizations as permitted by this Agreement. "NOTES" shall mean the Notes provided for by Section 2.01, together with any and all renewals, extensions for any period, increases, rearrangements, substitutions or modifications thereof. "OTHER TAXES" shall have the meaning assigned such term in Section 4.04(b). "PBGC" shall mean the Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions. "PERSON" shall mean any individual, corporation, company, voluntary association, partnership, joint venture, trust, unincorporated organization or government or any agency, instrumentality or political subdivision thereof, or any other form of entity. "PLAN" shall mean any employee pension benefit plan, as defined in Section 3(2) of ERISA, which (i) is currently or hereafter sponsored, maintained or contributed to by the Company, any Subsidiary or an ERISA Affiliate or (ii) was at any time during the preceding six calendar years sponsored, maintained or contributed to, by the Company, any Subsidiary or an ERISA Affiliate. "POST-DEFAULT RATE" shall mean, in respect of any principal of any Note or any other amount payable by the Company under this Agreement or any other Subordinated Note Document, a rate 9 per annum during the period commencing on the date of occurrence of an Event of Default until such amount is paid in full or all Events of Default are cured or waived equal to 2% per annum above the Eurodollar Rate or the Base Rate, as the case may be, as in effect from time to time plus the Applicable Margin. "PROPERTY" shall mean any interest in any kind of property or asset, whether real, personal or mixed, or tangible or intangible. "QUARTERLY DATE" shall mean the 15th day of each January, April, July and October, commencing April 15, 2000; PROVIDED, HOWEVER, that if any such day is not a Business Day, such Quarterly Date shall be the next succeeding Business Day. "REGISTRATION RIGHTS AGREEMENT" shall mean that certain Registration Rights Agreement, dated as of January 31, 2000, by and among the Company and the stockholders party thereto. "REGULATION D" shall mean Regulation D of the Board of Governors of the Federal Reserve System (or any successor), as the same may be amended or supplemented from time to time. "REGULATORY CHANGE" shall mean any change after the Closing Date in any Governmental Requirement (including Regulation D) or the adoption or making after such date of any interpretations, directives or requests applying to a class of lenders of or under any Governmental Requirement (whether or not having the force of law) by any Governmental Authority charged with the interpretation or administration thereof. "RESPONSIBLE OFFICER" shall mean, as to any Person, the Chief Executive Officer, the President or any Vice President of such Person and, with respect to financial matters, the term "Responsible Officer" shall include the Chief Financial Officer of such Person. Unless otherwise specified, all references to a Responsible Officer herein shall mean a Responsible Officer of the Company. "SEC" shall mean the Securities and Exchange Commission or any successor Governmental Authority. "SENIOR AGENT" shall mean Bank of America, N.A. (formerly known as NationsBank of Texas, N.A.) (together with any duly appointed successor) for the Senior Lenders. "SENIOR CREDIT AGREEMENT" shall mean that certain Amended and Restated Credit Agreement dated as of December 18, 1998, as amended by First Amendment to Amended and Restated Credit Agreement dated as of July 20, 1999, Second Amendment to Amended and Restated Credit Agreement dated as of September 30, 1999 and Third Amendment to Amended and Restated Credit Agreement dated as of January 31, 2000, as the same may hereafter be amended, restated, supplemented or otherwise modified from time to time as permitted herein and in the Subordination Agreement. 10 "SENIOR CREDIT DOCUMENTS" shall mean the Senior Credit Agreement and the "Loan Documents" (as defined in the Senior Credit Agreement) in each instance as in effect on the date hereof and as the same may be amended, modified or supplemented from time to time as permitted herein. "SENIOR INDEBTEDNESS" shall mean "Senior Debt" as such term is defined in the Subordination Agreement. "SENIOR FUNDED DEBT" shall mean, at any date and with respect to the Company and its Subsidiaries, all Debt for borrowed money (excluding the Indebtedness and other Debt expressly subordinated to the Indebtedness in form and substance satisfactory to the Holders), any capital lease obligations and any guaranty with respect to Senior Funded Debt of another person. "SENIOR LENDERS" shall mean each Person that is or shall become a lender under the Senior Credit Agreement for so long as such Person shall be a party to that Agreement. "SETTLEMENT AGREEMENT" shall mean that certain letter agreement dated January 28, 2000 among the Company, Castle Dental Centers of California, L.L.C., CDC of California, Inc. and the Persons referred to therein as the "DCS Parties". "SHARES" shall mean the Common Stock issued and/or issuable upon conversion of all or any part of the Convertible Notes. "SPECIAL ENTITY" shall mean any joint venture, limited liability company or partnership, general or limited partnership or any other type of partnership or company other than a corporation in which the Company or one or more of its other Subsidiaries is a member, owner, partner or joint venturer and owns, directly or indirectly, at least a majority of the equity of such entity or controls such entity, but excluding any tax partnerships that are not classified as partnerships under state law. For purposes of this definition, any Person which owns directly or indirectly an equity investment in another Person which allows the first Person to manage or elect managers who manage the normal activities of such second Person will be deemed to "control" such second Person (E.G. a sole general partner controls a limited partnership). "STOCKHOLDERS AGREEMENT" shall mean that certain Stockholders Agreement, dated as of January __, 2000, by and among the Company and the stockholders party thereto. "STOCK PURCHASE" shall mean any acquisition of all capital stock of any Acquired Entity by Company or a Subsidiary pursuant to a Stock Purchase Agreement. "STOCK PURCHASE AGREEMENTS" shall mean each stock purchase agreement entered into by Company or any Subsidiary in connection with New Acquisitions. 11 "SUBORDINATED GUARANTY AGREEMENT" shall mean an agreement executed by the Guarantors subordinated on terms substantially as provided in the Subordination Agreement and otherwise in form and substance satisfactory to Holders guaranteeing, unconditionally, payment of the Indebtedness, as the same may be amended, modified or supplemented from time to time. "SUBORDINATED NOTE DOCUMENTS" shall mean this Agreement, the Notes, the Subordinated Guaranty Agreement, the Stockholders Agreement and the Registration Rights Agreement. "SUBORDINATION AGREEMENT" shall mean that certain Subordination and Intercreditor Agreement of even date herewith among the Company, Holders, Guarantors and the Senior Agent, as such Agreement may be amended from time to time as provided therein. "SUBSIDIARY" shall mean (i) any corporation of which at least a majority of the outstanding shares of stock having by the terms thereof ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether or not at the time stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time directly or indirectly owned or controlled by the Company or one or more of its Subsidiaries or by the Company and one or more of its Subsidiaries and (ii) any Special Entity. Unless otherwise indicated herein, each reference to the term "Subsidiary" shall mean a Subsidiary of the Company. "TAXES" shall have the meaning assigned such term in Section 4.06(a). "TOTAL FUNDED DEBT" shall mean Senior Funded Debt, the Indebtedness plus all other debt expressly subordinated to the Senior Indebtedness, including without limitation, any contingent Debt resulting from the guaranty of a future stock price of capital stock issued by the Company or an Affiliate of the Company to a seller in consideration for an acquisition, all in form and substance satisfactory to Holders. "WHOLLY-OWNED SUBSIDIARY" shall mean, as to the Company, any Subsidiary of which all of the outstanding shares of capital stock or other equity interests, on a fully-diluted basis, are owned by the Company or one or more of the Wholly-Owned Subsidiaries or by the Company and one or more of the Wholly-Owned Subsidiaries. Section 1.03 ACCOUNTING TERMS AND DETERMINATIONS. Unless otherwise specified herein, all accounting terms used herein shall be interpreted, all determinations with respect to accounting matters hereunder shall be made, and all financial statements and certificates and reports as to financial matters required to be furnished to Holders hereunder shall be prepared, in accordance with GAAP, applied on a basis consistent with the audited financial statements of the Company referred to in Section 7.02 (except for changes concurred with by the Company's independent public accountants). ARTICLE II 12 PURCHASE AND SALE OF NOTES Section 2.01 PURCHASE AND SALE OF NOTES. (a) Subject to the terms and conditions herein set forth, the Company agrees that it will issue and sell to each of Heller and Midwest, and each of Heller and Midwest agrees that it will acquire from the Company on the Closing Date, the Subordinated Notes in an original principal amount of $9,081,024 and $4,540,512, respectively, in substantially the form attached hereto as EXHIBIT A, appropriated completed in conformity herewith, the purchase price of which shall be $9,081,024 and $4,540,512, respectively. (b) Subject to the terms and conditions herein set forth, the Company agrees that it will issue and sell to each of Heller and Midwest, and each of Heller and Midwest agrees that it will acquire from the Company, on the Closing Date, for the purchase price of $918,976 and $459,488, respectively, the Convertible Notes in an original principal amount of $918,976 and $459,488, respectively, in substantially the form attached hereto as EXHIBIT B, which Convertible Notes shall be convertible into 295,253.33 and 147,626.67 shares of Common Stock of the Company, respectively, constituting an aggregate of 6% of the sum of the fully diluted Common Stock of the Company as of the date hereof. The holders of Convertible Notes will be entitled to the benefits of the Stockholders Agreement and the Registration Rights Agreement. (c) The Company and each Holder acknowledge that the purchase prices set forth above for each of the Notes represent their relative fair market values and agree to be bound by this allocation for all tax purposes pursuant to Treasury Regulation ss.1.1273-2(h). Section 2.02 FEES. (a) COMMITMENT FEE. The Company shall pay to each of Heller and Midwest on the Closing Date the fees set forth in separate letter agreements executed concurrently herewith. Section 2.03 PREPAYMENTS. (a) VOLUNTARY PREPAYMENTS. Subject to the terms of the Subordination Agreement, the Company may prepay the outstanding principal of (together with accrued interest on and, if applicable, the prepayment fee described below) the Subordinated Notes in full or in part (in minimum amounts of $1,000,000), at any time and from time to time on any Quarterly Date as applicable, upon not less than three (3) Business Days' prior notice to Holders. The Company shall not be permitted to prepay voluntarily the Convertible Notes. (b) MANDATORY PREPAYMENTS. Subject to the terms of the Subordination Agreement: 13 (i) if the Company raises any cash proceeds by the offering of equity, 20% of the net cash proceeds obtained from such equity offering shall be used to prepay the outstanding principal of the Subordinated Notes; and (ii) concurrently with the consummation of a Change in Control, Company shall pay the outstanding principal of the Subordinated Notes (together with accrued interest and, if applicable, the prepayment fee described below). (c) PREPAYMENT FEES. If the Company should voluntarily prepay the Subordinated Notes in their entirety, or shall prepay the Subordinated Notes in their entirety due to a Change in Control, Company shall pay to Holders a prepayment fee of 2.00% of the principal amount of the Subordinated Notes prepaid if such prepayment occurs on or prior to the first anniversary of the Closing Date and 1.00% of the principal amount of the Subordinated Notes prepaid if such prepayment occurs after the first anniversary of the Closing Date but prior to the second anniversary of the Closing Date. (d) CONVERTIBLE NOTES. Subject to the terms of the Subordination Agreement, the Convertible Notes may be subject to prepayment prior to their maturity date pursuant to the terms and provisions of the Stockholders Agreement. (e) ALLOCATION. Any partial prepayment of Subordinated Notes shall be allocated among the Subordinated Notes pro rata in accordance with the respective outstanding principal balances thereof. ARTICLE III PAYMENTS OF PRINCIPAL AND INTEREST Section 3.01 PAYMENT OF NOTES. (a) Commencing on March 31, 2005, the aggregate principal amount of the Subordinated Notes outstanding shall be payable in eight (8) equal consecutive quarterly installments in the amounts and at the times described below: DATE AMOUNT ---- ------ March 31, 2005 $1,702,692 June 30, 2005 $1,702,692 September 30, 2005 $1,702,692 December 31, 2005 $1,702,692 March 31, 2006 $1,702,692 June 30, 2006 $1,702,692 September 30, 2006 $1,702,692 14 December 31, 2006 $1,702,692 plus all remaining accrued interest (b) The aggregate outstanding principal balance of the Convertible Notes shall be payable on January 31, 2009. Section 3.02 INTEREST. (a) INTEREST RATES. The Company will pay to Holders, interest on the unpaid principal amount of the Notes for the period commencing on the Closing Date to, but excluding, the date such Notes shall be paid in full, at the Eurodollar Rate plus the Applicable Margin, except as provided in Section 5.04. (b) POST-DEFAULT RATE. Notwithstanding the foregoing, the Company will pay to Holders, interest at the applicable Post-Default Rate on any principal of any Note, and (to the fullest extent permitted by law) on any other amount payable by the Company hereunder or under any Subordinated Note Document, for the period commencing on the date of an Event of Default until the same is paid in full or all Events of Default are cured or waived. (c) DUE DATES. Accrued interest on the Notes shall be payable on each Quarterly Date, except that interest payable at the Post-Default Rate shall be payable from time to time on demand. In addition, accrued interest on Convertible Notes shall be payable on the date of conversion of all or any part of such Convertible Note. (d) DETERMINATION OF RATES. Promptly after the determination of any interest rate provided for herein or any change therein, the Company shall promptly notify in writing each Holder thereof. ARTICLE IV PAYMENTS; COMPUTATIONS; ETC. Section 4.01 PAYMENTS. Except to the extent otherwise provided herein, all payments of principal, interest and other amounts to be made by the Company under this Agreement and the Notes shall be made in Dollars, in immediately available funds, to each Holder at such account as such Holder shall specify by notice to the Company from time to time, not later than 11:00 a.m. Chicago time on the date on which such payments shall become due (each such payment made after such time on such due date to be deemed to have been made on the next succeeding Business Day). Such payments shall be made without (to the fullest extent permitted by applicable law) defense, set-off or counterclaim. Except as otherwise provided in the definition of "Interest Period", if the due date of any payment under this Agreement or any Note would otherwise fall on a day which is 15 not a Business Day such date shall be extended to the next succeeding Business Day and interest shall be payable for any principal so extended for the period of such extension. Section 4.02 COMPUTATIONS. Interest shall be computed on the basis of a year of 360 days and actual days elapsed (including the first day but excluding the last day) occurring in the period for which such interest is payable, unless such calculation would exceed the Highest Lawful Rate, in which case interest shall be calculated on the per annum basis of a year of 365 or 366 days, as the case may be. Interest calculated at the Base Rate shall be computed on the basis of a year or 365 days or 366 days, as the case may be, and actual days elapsed (including the first day, but excluding the last day) occurring in the period for which such interest is payable. Section 4.03 INTENTIONALLY OMITTED. Section 4.04 TAXES. (a) PAYMENTS FREE AND CLEAR. Any and all payments by the Company hereunder shall be made, in accordance with Section 4.01, free and clear of and without deduction for any and all present or future taxes, levies, imposts, deductions, charges or withholdings, and all liabilities with respect thereto, EXCLUDING, in the case of any Holder, taxes imposed on its income, and franchise or similar taxes imposed on it, by (i) any jurisdiction (or political subdivision thereof) of which such Holder is a citizen or resident, (ii) the jurisdiction (or any political subdivision thereof) in which such Holder is organized, or (iii) any jurisdiction (or political subdivision thereof) in which such Holder is presently doing business which taxes are imposed solely as a result of doing business in such jurisdiction (all such non-excluded taxes, levies, imposts, deductions, charges, withholdings and liabilities being hereinafter referred to as "TAXES"). If the Company shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to any Holder (i) the sum payable shall be increased by the amount necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 4.04) such Holder shall receive an amount equal to the sum it would have received had no such deductions been made, (ii) the Company shall make such deductions and (iii) the Company shall pay the full amount deducted to the relevant taxing authority or other Governmental Authority in accordance with applicable law and provide such Holder with a receipt thereof. (b) OTHER TAXES. In addition, to the fullest extent permitted by applicable law, the Company agrees to pay any present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies that arise from any payment made hereunder or from the execution, delivery or registration of, or otherwise with respect to, this Agreement, any assignment of the Notes or Shares, or the Subordinated Guaranty Agreement (hereinafter referred to as "OTHER TAXES"). (C) INDEMNIFICATION. TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, THE COMPANY WILL INDEMNIFY EACH HOLDER FOR THE FULL AMOUNT OF TAXES AND OTHER TAXES (INCLUDING, BUT NOT LIMITED 16 TO, ANY TAXES OR OTHER TAXES IMPOSED BY ANY GOVERNMENTAL AUTHORITY ON AMOUNTS PAYABLE UNDER THIS SECTION 4.04) PAID BY SUCH HOLDER AND ANY LIABILITY (INCLUDING PENALTIES, INTEREST AND EXPENSES) ARISING THEREFROM OR WITH RESPECT THERETO, WHETHER OR NOT SUCH TAXES OR OTHER TAXES WERE CORRECTLY OR LEGALLY ASSERTED UNLESS THE PAYMENT OF SUCH TAXES WAS NOT CORRECTLY OR LEGALLY ASSERTED AND SUCH HOLDER'S PAYMENT OF SUCH TAXES OR OTHER TAXES WAS THE RESULT OF ITS GROSS NEGLIGENCE OR WILLFUL MISCONDUCT. ANY PAYMENT PURSUANT TO SUCH INDEMNIFICATION SHALL BE MADE WITHIN THIRTY (30) DAYS AFTER THE DATE A HOLDER MAKES WRITTEN DEMAND THEREFOR. IF A HOLDER RECEIVES A REFUND OR CREDIT IN RESPECT OF ANY TAXES OR OTHER TAXES FOR WHICH SUCH HOLDER HAS RECEIVED PAYMENT FROM THE COMPANY IT SHALL PROMPTLY NOTIFY THE COMPANY OF SUCH REFUND OR CREDIT AND SHALL, IF NO DEFAULT HAS OCCURRED AND IS CONTINUING, WITHIN THIRTY (30) DAYS AFTER RECEIPT OF A REQUEST BY THE COMPANY (OR PROMPTLY UPON RECEIPT, IF THE COMPANY HAS REQUESTED APPLICATION FOR SUCH REFUND OR CREDIT PURSUANT HERETO), PAY AN AMOUNT EQUAL TO SUCH REFUND OR CREDIT TO THE COMPANY WITHOUT INTEREST (BUT WITH ANY INTEREST SO REFUNDED OR CREDITED), PROVIDED THAT THE COMPANY, UPON THE REQUEST OF A HOLDER, AGREES TO RETURN SUCH REFUND OR CREDIT (PLUS PENALTIES, INTEREST OR OTHER CHARGES) TO SUCH HOLDER IN THE EVENT SUCH HOLDER IS REQUIRED TO REPAY SUCH REFUND OR CREDIT. ARTICLE V CAPITAL ADEQUACY Section 5.01 CAPITAL ADEQUACY; ADDITIONAL COSTS. (a) EURODOLLAR REGULATIONS, ETC. The Company shall pay directly to each affected Holder from time to time such amounts as such Holder may determine to be necessary to compensate itself for any costs which it determines are attributable to its purchasing or maintaining of any Notes at the Eurodollar Rate or any reduction in any amount receivable by such Holder hereunder in respect of any Notes at the Eurodollar Rate (such increases in costs and reductions in amounts receivable being herein called "ADDITIONAL COSTS"), resulting from any Regulatory Change which: (i) changes the basis of taxation of any amounts payable to such Holder under this Agreement or any Note in respect of any of such Notes at the Eurodollar Rate (other than taxes imposed on the overall net income of such Holder for any of such Notes at the Eurodollar Rate by the jurisdiction in which such Holder has its principal office); or (ii) imposes or modifies any reserve, special deposit, minimum capital, capital ratio or similar requirements relating to any extensions of credit or other 17 assets of, or any deposits with or other liabilities of such Holder or the Eurodollar interbank market; or (iii) imposes any other condition affecting this Agreement or any Notes (or any of such extensions of credit or liabilities). The affected Holder will notify the Company of any event occurring after the Closing Date which will entitle it to compensation pursuant to this Section 5.01(a) as promptly as practicable after it obtains knowledge thereof and determines to request such compensation. (b) REGULATORY CHANGE. Without limiting the effect of the provisions of Section 5.01(a), in the event that at any time (by reason of any Regulatory Change or any other circumstances arising after the Closing Date affecting (A) any Holder, (B) the Eurodollar interbank market or (C) such Holders position in such market), the Eurodollar Rate, as determined in good faith by such Holder, will not adequately and fairly reflect the cost to such Holder of funding at the Eurodollar Rate, then, if such Holder so elects, by notice to the Company, the obligation of such Holder to continue calculating interest on the Notes at the Eurodollar Rate shall be suspended until such Regulatory Change or other circumstances ceases to be in effect (in which case the provisions of Section 5.04 shall be applicable). (c) CAPITAL ADEQUACY. Without limiting the effect of the foregoing provisions of this Section 5.01 (but without duplication), the Company shall pay directly to each affected Holder from time to time on request such amounts as such Holder may reasonably determine to be necessary to compensate itself or its parent or holding company for any costs which it determines are attributable to the maintenance by such Holder or its parent or holding company, pursuant to any Governmental Requirement following any Regulatory Change, of capital in respect of the Notes, such compensation to include, without limitation, an amount equal to any reduction of the rate of return on assets or equity of such Holder or its parent or holding company to a level below that which such Holder or its parent or holding company could have achieved but for such Governmental Requirement. Each affected Holder will notify the Company that it is entitled to compensation pursuant to this Section 5.01(c) as promptly as practicable after it determines to request such compensation. (d) COMPENSATION PROCEDURE. Upon notifying the Company of the incurrence of additional costs under this Section 5.01, the affected Holder shall in such notice to the Company set forth in reasonable detail the basis and amount of its request for compensation. Determinations and allocations by such Holder for purposes of this Section 5.01 of the effect of any Regulatory Change pursuant to Section 5.01(a) or (b), or of the effect of capital maintained pursuant to Section 5.01(c), on its costs or rate of return of maintaining Notes at the Eurodollar Rate and of the amounts required to compensate such Holder under this Section 5.01, shall be conclusive and binding for all purposes, provided that such determinations and allocations are made on a reasonable basis. Any request for additional compensation under this Section 5.01 shall be paid by the Company within thirty (30) days of the receipt by the Company of the notice described in this Section 5.01(d). Section 5.02 LIMITATION ON EURODOLLAR RATE. Anything herein to the contrary notwithstanding, if, on or prior to the determination of any Eurodollar Rate for any Interest Period: 18 (i) a Holder determines (which determination shall be conclusive, absent manifest error) that quotations of interest rates for the relevant deposits referred to in the definition of "Eurodollar Rate" in Section 1.02 are not being provided in the relevant amounts or for the relevant maturities for purposes of determining rates of interest at the Eurodollar Rate as provided herein; or (ii) a Holder determines (which determination shall be conclusive, absent manifest error) that the relevant rates of interest referred to in the definition of "Eurodollar Rate" in Section 1.02 upon the basis of which the rate of interest at the Eurodollar Rate for such Interest Period is to be determined are not sufficient to adequately cover the cost to such Holder of maintaining Notes at the Eurodollar Rate; then such Holder shall give the Company prompt notice thereof, and so long as such condition remains in effect, such Holder shall be under no obligation to continue calculating interest on the Notes at the Eurodollar Rate. Section 5.03 ILLEGALITY. Notwithstanding any other provision of this Agreement, in the event that it becomes unlawful for any Holder to continue to maintain Notes at the Eurodollar Rate hereunder, then such Holder shall promptly notify the Company thereof and such Holder's obligation to continue to calculate interest on the Notes at the Eurodollar Rate shall be suspended until such time as such Holder may again maintain the Notes at the Eurodollar Rate (in which case the provisions of Section 5.04 shall be applicable). Section 5.04 INTEREST ON THE NOTES AT THE BASE RATE PURSUANT TO SECTIONS 5.01, 5.02 AND 5.03. If the obligation of any Holder to calculate interest on its Notes at the Eurodollar Rate shall be suspended pursuant to Sections 5.01, 5.02 or 5.03 ("AFFECTED NOTES"), interest on all Affected Notes which would otherwise be calculated at the Eurodollar Rate shall be calculated instead at the Base Rate (and, if an event referred to in Section 5.01(b) or Section 5.03 has occurred and the affected Holder so requests by notice to the Company, all Affected Notes then outstanding shall be calculated at the Base Rate commencing on the date specified by such Holder in such notice). Section 5.05 COMPENSATION. The Company shall pay to each affected Holder within thirty (30) days of receipt of written request of such Holder (which request shall set forth, in reasonable detail, the basis for requesting such amounts and which shall be conclusive and binding for all purposes provided that such determinations are made on a reasonable basis), such amount or amounts as shall compensate it for any loss, cost, expense or liability which such Holder determines are attributable to any payment, prepayment or conversion from a Eurodollar Rate properly made by such Holder or the Company for any reason (including, without limitation, the acceleration of the Notes pursuant to Section 10.01) on a date other than the last day of the Interest Period; or Without limiting the effect of the preceding sentence, such compensation shall include an amount equal to the excess, if any, of (i) the amount of interest which would have accrued on the principal amount so paid for the period from the date of such payment to the last day of the Interest Period 19 at the applicable rate of interest for such Note provided for herein over (ii) the interest component of the amount such Holder would have bid in the London interbank market for Dollar deposits of leading banks in amounts comparable to such principal amount and with maturities comparable to such period (as reasonably determined by such Holder). ARTICLE VI CONDITIONS PRECEDENT Section 6.01 INITIAL PURCHASE. The obligation of Holders to purchase the Notes is subject to the receipt by Holders of all fees payable pursuant to Section 2.02 on or before the Closing Date and the receipt by Holders of the following documents and satisfaction of the other conditions provided in this Section 6.01, each of which shall be reasonably satisfactory to Holders in form and substance: (a) A certificate of the Secretary or an Assistant Secretary of the Company setting forth (i) resolutions of its board of directors with respect to the authorization of the Company to execute and deliver the Subordinated Note Documents to which it is a party and to enter into the transactions contemplated in those documents, (ii) the officers of the Company (y) who are authorized to sign the Subordinated Note Documents to which Company is a party and (z) who will, until replaced by another officer or officers duly authorized for that purpose, act as its representative for the purposes of signing documents and giving notices and other communications in connection with this Agreement and the transactions contemplated hereby, (iii) specimen signatures of the authorized officers, and (iv) the articles or certificate of incorporation and bylaws of the Company, certified as being true and complete. Holders may conclusively rely on such certificate until it receives notice in writing from the Company to the contrary. (b) A certificate of the Secretary or an Assistant Secretary of each Guarantor setting forth (i) resolutions of its board of directors with respect to the authorization of such Guarantor to execute and deliver the Subordinated Note Documents to which it is a party and to enter into the transactions contemplated in those documents, (ii) the officers of such Guarantor (y) who are authorized to sign the Subordinated Note Documents to which such Guarantor is a party and (z) who will, until replaced by another officer or officers duly authorized for that purpose, act as its representative for the purposes of signing documents and giving notices and other communications in connection with this Agreement and the transactions contemplated hereby, (iii) specimen signatures of the authorized officers, and (iv) the articles or certificate of incorporation and bylaws of such Guarantor, certified as being true and complete. Holders may conclusively rely on such certificate until they receive notice in writing from such Guarantor to the contrary. (c) Certificates of the appropriate state agencies with respect to the existence, qualification and good standing of the Company and its Subsidiaries. 20 (d) A compliance certificate which shall be substantially in the form of EXHIBIT C, duly and properly executed by a Responsible Officer and dated as of the date of the Initial Purchase. (e) The Notes, duly completed, executed and delivered to each Holder, as applicable. (f) The Subordinated Guaranty Agreement duly completed, executed and delivered to each Holder. (g) Opinions of Boyer Ewing and Harris, counsel to the Company and Guarantors, in form and substance satisfactory to Holders, as to such matters incident to the transactions herein contemplated as Holders may reasonably request. (h) A certificate of insurance coverage of the Company evidencing that the Company is carrying insurance in accordance with Section 7.19. (i) Unaudited pro forma projected consolidated balance sheet of the Company and its Consolidated Subsidiaries at the Closing Date (which pro forma shall be based on the consolidated balance sheet of the Company and its Consolidated Subsidiaries as of September 30, 1999), and the unaudited pro forma projected consolidated statements of income of the Company and its Consolidated Subsidiaries for five (5) years commencing as of the Closing Date, which represent the Company's good faith estimate of the pro forma projected consolidated financial condition of the Company and its Consolidated Subsidiaries as at the Closing Date, after giving effect to the transactions contemplated herein provided projections as to future performance should not be construed as a guarantee of future performance. (j) Certified copies of the Senior Debt Documents, the promissory notes evidencing the Debt described on Schedule 9.01 and the subordination agreements executed in connection therewith. (k) Stockholder's Agreement and Registration Rights Agreement duly completed, executed and delivered to Holders. (l) the "Closing" (as defined in the Settlement Agreement) shall have occurred and payment of the "Full Settlement Amount" (as defined in the Settlement Agreement) shall occur concurrently herewith. (m) evidence that the Company has authorized and reserved a sufficient number of shares of common stock with respect to the conversion of the Convertible Notes. (n) payment of all legal fees of counsel to Holders. (o) with respect to Midwest, duly executed and completed (i) SBA Form 480 (Size Status Declaration) and SBA Form 652 (Assurance of Compliance), (ii) SBA Form 1031 (Portfolio 21 Finance Report), Part A and B, and (iii) letter regarding SBA matters in form and substance acceptable to Midwest. (p) Such other documents as Holders or special counsel to Holders may reasonably request. Section 6.02 NO WAIVER. No waiver of any condition precedent shall preclude Holders from thereafter declaring that the failure of the Company to satisfy such condition precedent constitutes a Default. ARTICLE VII REPRESENTATIONS AND WARRANTIES The Company represents and warrants to each Holder: Section 7.01 CORPORATE EXISTENCE. Each of the Company and each Subsidiary: (i) is a corporation duly organized, legally existing and in good standing under the laws of the jurisdiction of its incorporation; (ii) has all requisite corporate power, and has all material governmental licenses, authorizations, consents and approvals necessary to own its assets and carry on its business as now being or as proposed to be conducted; and (iii) is qualified to do business in all jurisdictions in which the nature of the business conducted by it makes such qualification necessary and where failure so to qualify would have a Material Adverse Effect. Section 7.02 FINANCIAL CONDITION. The audited consolidated balance sheet of the Company and its Consolidated Subsidiaries as at December 31, 1998 and the related consolidated statement of income, stockholders' equity and cash flow of the Company and its Consolidated Subsidiaries for the fiscal year ended on said date, with the opinion thereon of Pricewaterhouse Coopers L.L.P. heretofore furnished to Holders and the unaudited consolidated balance sheet of the Company and its Consolidated Subsidiaries as at September 30, 1999 and their related consolidated statements of income, stockholders' equity and cash flow of the Company and its Consolidated Subsidiaries for the nine month period ended on such date heretofore furnished to Holders, are complete and correct and fairly present the consolidated financial condition of the Company and its Consolidated Subsidiaries as at said dates and the results of its operations for the fiscal year and the nine month period on said dates, all in accordance with GAAP, as applied on a consistent basis (subject, in the case of the interim financial statements, to normal year-end adjustments). Neither the Company nor any Subsidiary has on the Closing Date any material Debt, contingent liabilities, liabilities for taxes, unusual forward or long-term commitments or unrealized or anticipated losses from any unfavorable commitments, except as referred to or reflected or provided for in the Financial Statements or in SCHEDULE 7.02. Since December 31, 1998, there has been no change or event having a Material Adverse Effect. Since the date of the Financial Statements, neither the business nor the Properties of the Company or any Subsidiary have been materially and adversely affected as a result of any fire, explosion, earthquake, flood, drought, windstorm, accident, strike or other labor disturbance, 22 embargo, requisition or taking of Property or cancellation of contracts, permits or concessions by any Governmental Authority, riot, activities of armed forces or acts of God or of any public enemy. The unaudited pro forma projected consolidated balance sheet of the Company and its Consolidated Subsidiaries at the Closing Date (which proforma shall be based on the consolidated balance sheet of the Company and its Consolidated Subsidiaries as of September 30, 1999, adjusted to reflect the transactions contemplated herein), and the unaudited pro forma projected consolidated statement of income of the Company and its Consolidated Subsidiaries as of the Closing Date, heretofore furnished to Holders, represent Company's best estimate of the pro forma projected consolidated financial condition of the Company and its Consolidated Subsidiaries as at the Closing Date after giving effect to the transactions contemplated herein provided projections as to future performance should not be construed as a guarantee of future performance. Section 7.03 LITIGATION. Except as set forth on Schedule 7.03, at the Closing Date there is no litigation, legal, administrative or arbitral proceeding, investigation or other action of any nature pending or, to the knowledge of the Company threatened against or affecting the Company or any Subsidiary which could reasonably be expected to have a Material Adverse Effect. Section 7.04 NO BREACH. Neither the execution and delivery of the Subordinated Note Documents, nor compliance with the terms and provisions hereof or thereof will conflict with or result in a breach of, or require any consent which has not been obtained as of the Closing Date under, the respective charter or by-laws of the Company or any Subsidiary, or any Governmental Requirement or any material agreement or instrument to which the Company or any Subsidiary is a party or by which it is bound or to which it or its Properties are subject, or constitute a default under any such material agreement or instrument, or result in the creation or imposition of any Lien upon any of the revenues or assets of the Company or any Subsidiary pursuant to the terms of any such material agreement or instrument other than the Liens created by the Senior Credit Documents. Section 7.05 AUTHORITY. The Company and each Subsidiary have all necessary corporate power and authority to execute, deliver and perform its respective obligations under the Subordinated Note Documents to which it is a party. The execution, delivery and performance by the Company and each Subsidiary of the Subordinated Note Documents to which it is a party, have been duly authorized by all necessary corporate action on its part. The Subordinated Note Documents constitute the legal, valid and binding obligations of the Company and each Subsidiary, enforceable in accordance with their terms. Section 7.06 APPROVALS. No authorizations, approvals or consents of, and no filings or registrations with, any Governmental Authority are necessary for the execution, delivery or performance by the Company or any Subsidiary of the Subordinated Note Documents to which it is a party or for the validity or enforceability thereof. Section 7.07 USE OF NOTE PROCEEDS. The proceeds of the Notes shall be used to provide financing for (i) New Acquisitions or new store openings, (ii) repayment of existing indebtedness, (iii) payment of costs and expenses associated with this transaction, (iv) payment of the "Full 23 Settlement Amount" (as defined in the Settlement Agreement) contemplated by the Settlement Agreement and (v) payment of approximately $430,000 to DCA Limited Partnership, LLP and related persons. The Company is not engaged principally, or as one of its important activities, in the business of extending credit for the purpose, whether immediate, incidental or ultimate, of buying or carrying margin stock (within the meaning of Regulation T, U or X of the Board of Governors of the Federal Reserve System) and no part of the proceeds of the Notes will be used to buy or carry any margin stock. Section 7.08 ERISA. (a) The Company, each Subsidiary and each ERISA Affiliate have complied in all material respects with ERISA and, where applicable, the Code regarding each Plan. (b) Each Plan is, and has been, maintained in substantial compliance with ERISA and, where applicable, the Code. (c) No act, omission or transaction has occurred which could result in imposition on the Company, any Subsidiary or any ERISA Affiliate (whether directly or indirectly) of (i) either a civil penalty assessed pursuant to section 502(c), (i) or (l) of ERISA or a tax imposed pursuant to Chapter 43 of Subtitle D of the Code or (ii) breach of fiduciary duty liability damages under section 409 of ERISA. (d) No liability to the PBGC (other than for the payment of current premiums which are not past due) by the Company, any Subsidiary or any ERISA Affiliate has been or is expected by the Company, any Subsidiary or any ERISA Affiliate to be incurred with respect to any Plan. No ERISA Event with respect to any Plan has occurred. (e) Full payment when due has been made of all amounts which the Company, any Subsidiary or any ERISA Affiliate is required under the terms of each Plan or applicable law to have paid as contributions to such Plan, and no accumulated funding deficiency (as defined in section 302 of ERISA and section 412 of the Code), whether or not waived, exists with respect to any Plan. (f) The actuarial present value of the benefit liabilities under each Plan which is subject to Title IV of ERISA does not, as of the end of the Company's most recently ended fiscal year, exceed the current value of the assets (computed on a plan termination basis in accordance with Title IV of ERISA) of such Plan allocable to such benefit liabilities. The term "actuarial present value of the benefit liabilities" shall have the meaning specified in section 4041 of ERISA. (g) None of the Company, any Subsidiary or any ERISA Affiliate sponsors, maintains, or contributes to an employee welfare benefit plan, as defined in section 3(1) of ERISA, including, without limitation, any such plan maintained to provide benefits to former employees of such entities, that may not be terminated by the Company, a Subsidiary or any ERISA Affiliate in its sole discretion at any time without any material liability. 24 (h) None of the Company, any Subsidiary or any ERISA Affiliate sponsors, maintains or contributes to, or has at any time in the preceding six calendar years, sponsored, maintained or contributed to, any Multiemployer Plan. (i) None of the Company, any Subsidiary or any ERISA Affiliate is required to provide security under section 401(a)(29) of the Code due to a Plan amendment that results in an increase in current liability for the Plan. Section 7.09 TAXES. Each of the Company and its Subsidiaries has filed all United States Federal income tax returns and all other tax returns which are required to be filed by them and have paid all material taxes due pursuant to such returns or pursuant to any assessment received by the Company or any Subsidiary. The charges, accruals and reserves on the books of the Company and its Subsidiaries in respect of taxes and other governmental charges are, in the opinion of the Company, adequate. No tax lien has been filed and, to the knowledge of the Company, no claim is being asserted with respect to any such tax, fee or other charge. Section 7.10 TITLES, ETC. (a) Each of the Company and its Subsidiaries and each Acquired Entity has good and defensible title to its material (individually or in the aggregate) Properties, free and clear of all Liens, except Liens permitted by Section 9.02. (b) All leases and agreements necessary for the conduct of the business of the Company and its Subsidiaries and each Acquired Entity are valid and subsisting, in full force and effect and there exists no default or event or circumstance which with the giving of notice or the passage of time or both would give rise to a default under any such lease or leases, which would affect in any material respect the conduct of the business of the Company and its Subsidiaries. (c) The licenses, rights, Properties and other assets presently owned, leased or licensed by the Company and its Subsidiaries and each Acquired Entity, include all rights, Properties and other assets necessary to permit the Company and its Subsidiaries and each Acquired Entity to conduct their business in all material respects in the same manner as its business has been conducted prior to the Closing Date. (d) All of the assets and Properties of the Company and its Subsidiaries and each Acquired Entity which are reasonably necessary for the operation of its business are in good working condition and are maintained in accordance with prudent business standards. Section 7.11 NO MATERIAL MISSTATEMENTS. No written information, statement, exhibit, certificate, document or report furnished to Holders by the Company or any Subsidiary in connection with the negotiation of this Agreement contained any material misstatement of fact or omitted to state a material fact or any fact necessary to make the statement contained therein not 25 materially misleading in the light of the circumstances in which made and with respect to the Company and its Subsidiaries taken as a whole. Section 7.12 INVESTMENT COMPANY ACT. Neither the Company nor any Subsidiary is an "investment company" or a company "controlled" by an "investment company," within the meaning of the Investment Company Act of 1940, as amended. Section 7.13 PUBLIC UTILITY HOLDING COMPANY ACT. Neither the Company nor any Subsidiary is a "holding company," or a "subsidiary company" of a "holding company," or an "affiliate" of a "holding company" or of a "subsidiary company" of a "holding company," or a "public utility" within the meaning of the Public Utility Holding Company Act of 1935, as amended. Section 7.14 SUBSIDIARIES. Except as set forth on SCHEDULE 7.14, the Company has no Subsidiaries. In the event that a new Subsidiary is formed or acquired, Company will provide Holders with a new, updated SCHEDULE 7.14. Section 7.15 LOCATION OF BUSINESS AND OFFICES. The Company's principal place of business and chief executive offices are located at the address stated on the signature page of this Agreement. The principal place of business and chief executive office of each Subsidiary are located at the addresses stated on SCHEDULE 7.14. Section 7.16 DEFAULTS. Neither the Company nor any Subsidiary is in default nor has any event or circumstance occurred which, but for the expiration of any applicable grace period or the giving of notice, or both, would constitute a default under any agreement or instrument to which the Company or any Subsidiary is a party or by which the Company or any Subsidiary is bound which default would have a Material Adverse Effect. No Default hereunder or under the Senior Credit Documents has occurred and is continuing. Section 7.17 ENVIRONMENTAL MATTERS. Except as would not have a Material Adverse Effect, neither any Property of the Company nor any Subsidiary nor the operations conducted thereon violate any law, order or requirement of any court or Governmental Authority or any Environmental Laws. Section 7.18 COMPLIANCE WITH THE LAW. Neither the Company nor any Subsidiary has violated any Governmental Requirement or failed to obtain any license, permit, franchise or other governmental authorization necessary for the ownership of any of its Properties or the conduct of its business, which violation or failure would have (in the event such violation or failure were asserted by any Person through appropriate action) a Material Adverse Effect. Section 7.19 INSURANCE. SCHEDULE 7.19 attached hereto contains an accurate and complete description of all material policies of fire, liability, workmen's compensation and other forms of insurance owned or held by the Company and each Subsidiary. All such policies are in full force and effect, all premiums with respect thereto covering all periods up to and including the date of the 26 closing have been paid, and no notice of cancellation or termination has been received with respect to any such policy. Such policies are sufficient for compliance with all requirements of law and of all agreements to which the Company or any Subsidiary is a party; are valid, outstanding and enforceable policies; provide adequate insurance coverage in at least such amounts and against at least such risks (but including in any event public liability) as are usually insured against in the same general area by companies engaged in the same or a similar business for the assets and operations of the Company and each Subsidiary; will remain in full force and effect through the respective dates set forth in SCHEDULE 7.19 without the payment of additional premiums; and will not in any way be affected by, or terminate or lapse by reason of, the transactions contemplated by this Agreement. SCHEDULE 7.19 identifies all material risks, if any, which the Company and its Subsidiaries and their respective Board of Directors or officers have designated as being self insured. Neither the Company nor any Subsidiary has been refused any insurance with respect to its assets or operations, nor has its coverage been limited below usual and customary policy limits, by an insurance carrier to which it has applied for any such insurance or with which it has carried insurance during the last three years. In the event that a new Subsidiary is formed or acquired, Company will provide Holders with a new, updated SCHEDULE 7.19. Section 7.20 MANAGEMENT SERVICES AGREEMENTS AND ACCOUNTS RECEIVABLE PURCHASE AGREEMENTS. The copies of Management Services Agreements and Account Receivable Purchase Agreements listed on Schedule 7.20 hereto constitute all of such agreements to which the Company or any of its Subsidiaries are a party. The above Management Services Agreements and the Accounts Receivable Purchase Agreements are valid, binding and enforceable against the parties thereto. The Company and its Subsidiaries have obtained all consents from Governmental Authorities necessary to perform under the Management Services Agreements, the failure of which to obtain could have a Material Adverse Effect. In the event that a new Subsidiary is formed or acquired, any Management Services Agreements and Accounts Receivable Purchase Agreements binding such Subsidiary shall be included within the terms of this representation and warranty. Section 7.21 RESTRICTION ON LIENS. Neither the Company nor any of its Subsidiaries is a party to any agreement or arrangement (other than the Senior Credit Agreement and the Senior Credit Documents), or subject to any order, judgment, writ or decree, which either restricts or purports to restrict its ability to grant Liens to other Persons on or in respect of their respective assets or Properties, except for Property subject to Liens permitted under Section 9.02. Section 7.22 MATERIAL AGREEMENTS. Set forth on SCHEDULE 7.22 hereto is a complete and correct list of all material credit agreements, indentures, purchase agreements, obligations in respect of letters of credit, guarantees, joint venture agreements, and other instruments in effect or to be in effect as of the Closing Date (other than Hedging Agreements) providing for, evidencing, securing or otherwise relating to any Debt of the Company or any of its Subsidiaries in excess of $250,000, and all obligations of the Company or any of its Subsidiaries to issuers of surety or appeal bonds issued for account of the Company or any such Subsidiary in excess of $250,000, and such list correctly sets forth the names of the debtor or lessee and creditor or lessor with respect to the Debt or lease obligations outstanding or to be outstanding and the Property subject to any Lien securing 27 such Debt or lease obligation. In the event that a new Subsidiary is formed or acquired, Company will provide each Holder with a new, updated SCHEDULE 7.22. Section 7.23 HEDGING AGREEMENTS. SCHEDULE 7.23 sets forth, as of the Closing Date, a true and complete list of all Hedging Agreements of the Company, the material terms thereof (including the type, term, effective date, termination date and notional amounts or volumes), the net mark to market value thereof, all credit support agreements relating thereto (including any margin required or supplied), and the counterparty to each such agreement. Section 7.24 YEAR 2000. (a) The Company has analyzed the operations of the Company and its Subsidiaries and Affiliates that could be adversely affected by failure to become Year 2000 compliant (that is, that computer applications, imbedded microchips and other systems will be able to perform date-sensitive functions prior to and after December 31, 1999). The Company reasonably believes that it is Year 2000 compliant for its operations and those of its Subsidiaries and Affiliates except to the extent that a failure to do so could not reasonably be expected to have a Material Adverse Effect upon the financial condition of the Company. (b) The Company reasonably believes any suppliers and vendors that are material to the operations of Company or its Subsidiaries and Affiliates are Year 2000 compliant for their own computer applications except to the extent that a failure to do so could not reasonably be expected to have a Material Adverse Effect upon the financial condition of the Company. Section 7.25 CAPITALIZATION. The authorized capital stock and other equity securities of each of the Company and each of its Subsidiaries is as set forth on Schedule 7.25. All issued and outstanding shares of capital stock and other equity securities of each of the Company and each of its Subsidiaries are duly authorized and validly issued, fully paid, non-assessable, free and clear of all Liens other than those in favor of Senior Agent, and such shares were issued in compliance with all applicable state and federal laws concerning the issuance of securities. No shares of the capital stock of Company or any of its Subsidiaries, other than those described above, are issued and outstanding. Except as set forth on Schedule 7.25, all of the issued and outstanding capital stock and other equity securities of Subsidiaries of the Company are owned by the Company. Except as provided in the Stockholders Agreement and as set forth on Schedule 7.25, there are no preemptive or other outstanding rights, options, warrants, conversion rights or similar agreements or understandings for the purchase or acquisition from Company or any of its Subsidiaries, of any shares of capital stock or other securities of any such entity. 28 ARTICLE VIII AFFIRMATIVE COVENANTS The Company covenants and agrees that, so long as any of the Subordinated Notes are outstanding and, with respect to Sections 8.01(a), 8.01(b), 8.01(c), 8.03 and 8.11, so long as any of the Convertible Notes, or Common Stock issued upon conversion of all or any portion of the Convertible Notes are outstanding: Section 8.01 REPORTING REQUIREMENTS. The Company shall deliver, or shall cause to be delivered, to each Holder: (a) ANNUAL FINANCIAL STATEMENTS. As soon as available and in any event within 120 days after the end of each fiscal year of the Company, the audited consolidated and unaudited consolidating statements of operations, changes in stockholders' equity, changes in financial position and cash flow of the Company and its Consolidated Subsidiaries for such fiscal year, and the related consolidated and consolidating balance sheets of the Company and its Consolidated Subsidiaries as at the end of such fiscal year, and setting forth in each case in comparative form the corresponding figures for the preceding fiscal year, and accompanied by the related opinion of independent public accountants of recognized national standing acceptable to Holders which opinion shall state that said financial statements fairly present the consolidated financial condition and results of operations of the Company and its Consolidated Subsidiaries as at the end of, and for, such fiscal year and that such financial statements have been prepared in accordance with GAAP, except for such changes in such principles with which the independent public accountants shall have concurred and such opinion shall not contain a "going concern" or like qualification or exception, and a certificate of such accountants stating that, in making the examination necessary for their opinion, they obtained no knowledge, except as specifically stated, of any Default. (b) QUARTERLY FINANCIAL STATEMENTS. As soon as available and in any event within 45 days after the end of each of the first three fiscal quarterly periods of each fiscal year of the Company, consolidated and consolidating statements of income, stockholders' equity, changes in financial position and cash flow of the Company and its Consolidated Subsidiaries for such period and for the period from the beginning of the respective fiscal year to the end of such period, and the related consolidated and consolidating balance sheets as at the end of such period, and setting forth in each case in comparative form the corresponding figures for the corresponding period in the preceding fiscal year, accompanied by the certificate of a Responsible Officer, which certificate shall state that said financial statements fairly present the consolidated and consolidating financial condition and results of operations of the Company and its Consolidated Subsidiaries in accordance with GAAP, as at the end of, and for, such period (subject to normal year-end audit adjustments). (c) BUDGET. As soon as available and in any event within thirty (30) days after the end of each fiscal year of the Company, a budget for the Company and its Consolidated Subsidiaries, as approved by the board of directors of the Company, for the following fiscal year setting forth in 29 comparative form corresponding figures from the preceding fiscal year, in reasonable detail and certified as to its good-faith preparation by a Responsible Officer. (d) NOTICE OF DEFAULT, ETC. Promptly after the Company knows that any Default or any Material Adverse Effect has occurred hereunder or under the Senior Credit Documents, a notice of such Default or Material Adverse Effect, describing the same in reasonable detail and the action the Company proposes to take with respect thereto. (e) OTHER ACCOUNTING REPORTS. Promptly upon receipt thereof, a copy of each other report or letter submitted to the Company or any Subsidiary by independent accountants in connection with any annual, interim or special audit made by them of the books of the Company and its Subsidiaries, and a copy of any response by the Company or any Subsidiary of the Company, or the Board of Directors of the Company or any Subsidiary of the Company, to such letter or report. (f) SEC FILINGS, ETC. Promptly upon its becoming available, each financial statement, report, notice or proxy statement sent by the Company to stockholders generally and each regular or periodic report and any registration statement, prospectus or written communication (other than transmittal letters) in respect thereof filed by the Company with or received by the Company in connection therewith from any securities exchange or the SEC or any successor agency. (g) NOTICES UNDER OTHER AGREEMENTS. Promptly after the furnishing thereof, copies of any material statement, report or notice furnished to or any Person pursuant to the terms of any indenture, loan or credit or other similar agreement, including without limitation the Senior Credit Documents, other than this Agreement and not otherwise required to be furnished to Holders pursuant to any other provision of this Section 8.01. (h) ANNUAL REVENUE REPORTS. As soon as available and in any event within 120 days after the end of each fiscal year of the Company, a report prepared by the Company for each dental center setting forth the revenues, expenses and contributions to profit of such dental center in form and substance acceptable to Holders. (i) QUARTERLY REVENUE REPORTS. As soon as available and in any event within 45 days after the end of each of the first three fiscal quarterly periods of each fiscal year of the Company, a report by the Company for each dental center setting forth the revenues, expenses and contributions to profit of such dental center in form and substance acceptable to Holders. (j) PLAN REPORT. From time to time such other information regarding the business, affairs or financial condition of the Company or any Subsidiary (including, without limitation, any Plan or Multiemployer Plan and any reports or other information required to be filed under ERISA) as any Holder may reasonably request. (k) HEDGING AGREEMENT REPORT. As soon as available and in any event within ten (10) Business Days after the last day of each calendar quarter, a report, in form and substance satisfactory 30 to Holders, setting forth as of the last Business Day of such calendar quarter a true and complete list of all Hedging Agreements of the Company, the material terms thereof (including the type, term, effective date, termination date and notional amounts or volumes), the net mark to market value therefor, any new credit support agreements relating thereto not listed on SCHEDULE 7.23, any margin required or supplied under any credit support document, and the counterparty to each such agreement. (l) CAPITAL EXPENDITURES BUDGET. Promptly upon becoming available and in any event within 30 days after the end of each fiscal year of the Company, a capital expenditure budget for the next fiscal year setting forth all proposed capital expenditures to be incurred during such fiscal year. (m) MODIFICATIONS OF MANAGEMENT SERVICES AGREEMENTS, ETC. Promptly upon the execution thereof, executed copies of any modification or amendment of any Management Services Agreement, Accounts Receivable Purchase Agreement or Senior Credit Document. The Company shall furnish to each Holder, at the time it furnishes each set of financial statements pursuant to paragraph (a) or (b) above, a certificate substantially in the form of EXHIBIT C hereto executed by a Responsible Officer (i) certifying as to the matters set forth therein and stating that no Default has occurred and is continuing (or, if any Default has occurred and is continuing, describing the same in reasonable detail), and (ii) setting forth in reasonable detail the computations necessary to determine the Company's Total Funded Debt, Senior Funded Debt and EBITDA and whether the Company is in compliance with Sections 9.11, 9.12, 9.13, 9.14, 9.15 and 9.16 as of the end of the respective fiscal quarter or fiscal year. Section 8.02 LITIGATION. The Company shall promptly give to each Holder notice of: (i) all legal or arbitral proceedings, and of all proceedings before any Governmental Authority affecting the Company, any Acquired Entity or any Subsidiary, except proceedings which, if adversely determined, would not have a Material Adverse Effect, and (ii) of any litigation or proceeding against or adversely affecting the Company, any Acquired Entity or any Subsidiary in which the amount involved is not covered in full by insurance (subject to normal and customary deductibles and for which the insurer has not assumed the defense), or in which injunctive or similar relief is sought. The Company will, and will cause each of its Subsidiaries to, promptly notify each Holder of any claim, judgment, Lien or other encumbrance affecting any Property of the Company, any Acquired Entity or any Subsidiary if the value of the claim, judgment, Lien, or other encumbrance affecting such Property shall exceed $250,000. Section 8.03 MAINTENANCE, ETC. (a) GENERALLY. The Company shall and shall cause each Subsidiary to: preserve and maintain its corporate existence and all of its material rights, privileges and franchises; keep books of record and account in which full, true and correct entries will be made of all dealings or transactions in relation to its business and activities; comply with all Governmental Requirements 31 if failure to comply with such requirements, individually or in the aggregate, will have a Material Adverse Effect; pay and discharge all taxes, assessments and governmental charges or levies imposed on it or on its income or profits or on any of its Property prior to the date on which penalties attach thereto, except for any such tax, assessment, charge or levy the payment of which is being contested in good faith and by proper proceedings and against which adequate reserves are being maintained; upon reasonable notice, permit representatives of each Holder, during normal business hours, to examine, copy and make extracts from its books and records, to inspect its Properties, and to discuss its business and affairs with its officers, all to the extent reasonably requested by such Holder; and keep, or cause to be kept, insured by financially sound and reputable insurers all Property of a character usually insured by Persons engaged in the same or similar business similarly situated against loss or damage of the kinds and in the amounts customarily insured against by such Persons and carry such other insurance as is usually carried by such Persons including, without limitation, environmental risk insurance to the extent reasonably available. (b) PROOF OF INSURANCE. Contemporaneously with the delivery of the financial statements required by Section 8.01(a) to be delivered for each year, the Company will furnish or cause to be furnished to each Holder a certificate of insurance coverage from the insurer in form and substance satisfactory to Holders and, if requested, will furnish Holders copies of the applicable policies. (c) OPERATION OF PROPERTIES. The Company will and will cause each Subsidiary to operate its Properties or cause such Properties to be operated in a careful and efficient manner in accordance with the practices of the industry and in compliance with all applicable contracts and agreements and in compliance in all material respects with all Governmental Requirements. Section 8.04 ENVIRONMENTAL MATTERS. (a) ESTABLISHMENT OF PROCEDURES. The Company will and will cause each Subsidiary to establish and implement such procedures as may be reasonably necessary to continuously determine and assure that (i) all Property of the Company and its Subsidiaries and the operations conducted thereon and other activities of the Company and its Subsidiaries are, in all material respects, in compliance with and do not violate the requirements of any Environmental Laws, and (ii) no oil, hazardous substances or solid wastes are disposed of or otherwise released on or to any Property owned by any such party except in compliance with Environmental Laws. (b) NOTICE OF ACTION. The Company will promptly notify each Holder in writing of any threatened action, investigation or inquiry by any Governmental Authority of which the Company has knowledge in connection with any Environmental Laws, excluding routine testing and corrective action. Section 8.05 FURTHER ASSURANCES. The Company will and will cause each Subsidiary to cure promptly any defects in the creation and issuance of the Notes and the execution and delivery of the Subordinated Guaranty Agreement and this Agreement. The Company at its expense will and will cause each Subsidiary to promptly execute and deliver to each Holder upon request all such 32 other documents, agreements and instruments to comply with or accomplish the covenants and agreements of the Company or any Subsidiary, as the case may be, in any of the Subordinated Note Documents, or to correct any omissions in any of the Subordinated Note Documents, or to state more fully the security obligations set out herein or in any of the other Subordinated Note Documents, or to make any recordings, to file any notices or obtain any consents, all as may be necessary or appropriate in connection therewith. Section 8.06 PERFORMANCE OF OBLIGATIONS. The Company will pay the Notes according to the reading, tenor and effect thereof; and the Company will and will cause each Subsidiary to do and perform every act and discharge all of the obligations to be performed and discharged by them under the Subordinated Guaranty Agreement and this Agreement, at the time or times and in the manner specified. Section 8.07 ERISA INFORMATION AND COMPLIANCE. The Company will promptly furnish and will cause the Subsidiaries and any ERISA Affiliate to promptly furnish to each Holder (i) promptly after the filing thereof with the United States Secretary of Labor, the Internal Revenue Service or the PBGC, copies of each annual and other report with respect to each Plan or any trust created thereunder, (ii) immediately upon becoming aware of the occurrence of any ERISA Event or of any "prohibited transaction," as described in section 406 of ERISA or in section 4975 of the Code, in connection with any Plan or any trust created thereunder, a written notice signed by a Responsible Officer specifying the nature thereof, what action the Company, the Subsidiary or the ERISA Affiliate is taking or proposes to take with respect thereto, and, when known, any action taken or proposed by the Internal Revenue Service, the Department of Labor or the PBGC with respect thereto, and (iii) immediately upon receipt thereof, copies of any notice of the PBGC's intention to terminate or to have a trustee appointed to administer any Plan. With respect to each Plan (other than a Multiemployer Plan), the Company will, and will cause each Subsidiary and ERISA Affiliate to, (i) satisfy in full and in a timely manner, without incurring any late payment or underpayment charge or penalty and without giving rise to any lien, all of the contribution and funding requirements of section 412 of the Code (determined without regard to subsections (d), (e), (f) and (k) thereof) and of section 302 of ERISA (determined without regard to sections 303, 304 and 306 of ERISA), and (ii) pay, or cause to be paid, to the PBGC in a timely manner, without incurring any late payment or underpayment charge or penalty, all premiums required pursuant to sections 4006 and 4007 of ERISA. Section 8.08 MANAGEMENT SERVICES AGREEMENTS AND ACCOUNTS RECEIVABLE PURCHASE AGREEMENTS. The Company will and will cause each Subsidiary to do all things necessary to maintain and keep in full force and effect and to enforce compliance with the Management Services Agreements and the Accounts Receivable Purchase Agreements. In the event that a new Subsidiary is formed, any Management Services Agreements and Accounts Receivable Purchase Agreements binding such Subsidiary shall be included within the terms of this affirmative covenant. Section 8.09 GUARANTEE BY ACQUIRED ENTITIES. In connection with Company's or any Subsidiary's purchase of all the outstanding stock of any Acquired Entity pursuant to any Stock 33 Purchase Agreement, upon the request of any Holder at any time thereafter, the Company will cause such Acquired Entity to guarantee the Indebtedness upon terms satisfactory to Holders, which guarantee shall be subordinated to the Senior Indebtedness on terms substantially similar to the Subordinated Guaranty Agreement. Section 8.10 YEAR 2000. The Company will promptly notify each Holder in the event the Company determines that any computer application which is material to the operations of the Company, its Subsidiaries or any of its material vendors or suppliers will not be fully Year 2000 compliant on a timely basis, except to the extent that such failure could not reasonably be expected to have a Material Adverse Effect upon the financial condition of the Company. Section 8.11 BOARD OBSERVATION. Each Holder shall have the right to have one individual (an "OBSERVER") attend any meeting of the Board of Directors of the Company (the "BOARD") or any committee thereof. Each Observer shall not have the right to vote on any matter presented to the Board or any committee thereof. The Company shall give each Observer written notice of each meeting thereof at the same time and in the same manner as the members of the Board or such committee receive notice of such meetings, and the Company shall permit each Observer to attend as an observer at all meetings thereof. Each Observer shall be entitled to receive all written materials and other information given to the directors in connection with such meetings at the same time such materials and information are given to the directors, and each Observer shall keep such materials and information confidential. If the Company proposes to take any action by written consent in lieu of a meeting of the Board, the Company shall give written notice thereof to each Observer prior to the effective date of such consent describing the nature and substance of such action or including the proposed text of such written consent. If an issue is to be discussed or otherwise arises at any Board meeting which, in the reasonable judgment of the Board, cannot be discussed in the presence of the Observers in order to avoid a conflict of interest on the part of the Observers or to preserve an attorney-client or accountant-client privilege, then such issue may be discussed without the Observers being present and may be deleted from any materials being distributed in connection with any meeting at which such issues are to be discussed, so long as each Observer is given notice of the occurrence of such meeting and the deletion of such materials. Section 8.12 CORRESPONDING AMENDMENT. Company agrees that, in the event any change or amendment is made to the Senior Credit Documents in consideration of a waiver of an actual or contemplated default or event of default thereunder, a corresponding change or amendment shall automatically and simultaneously be deemed to have been made to this Agreement without further action; provided Company agrees to execute such documents as any Holder may reasonably request to further memorialize such change or amendments. 34 ARTICLE IX NEGATIVE COVENANTS The Company covenants and agrees that, so long as any of the Subordinated Notes are outstanding and, with respect to Section 9.25, so long as any of the Convertible Notes are outstanding: Section 9.01 DEBT. Neither the Company nor any Subsidiary will incur, create, assume or permit to exist any Debt, except: (a) the Notes, the Indebtedness or any guaranty of or suretyship arrangement for the Notes or the Indebtedness; (b) accounts payable (for the deferred purchase price of Property or services) from time to time incurred in the ordinary course of business which, if greater than 90 days past the invoice or billing date, are being contested in good faith by appropriate proceedings and reserves adequate under GAAP shall have been established therefor; (c) Debt under capital leases (as required to be reported on the financial statements of the Company pursuant to GAAP) not to exceed $2,500,000 in the aggregate; (d) Debt of the Company under Hedging Agreements with a Senior Lender or otherwise approved by Holders; (e) purchase money Debt not to exceed $2,500,000 in the aggregate; (f) Debt described on SCHEDULE 9.01; (g) Junior Subordinated Debt in connection with New Acquisitions; and (h) Senior Indebtedness. Section 9.02 LIENS. Neither the Company nor any Subsidiary will create, incur, assume or permit to exist any Lien on any of its Properties (now owned or hereafter acquired), except: (a) Liens securing the payment of any Senior Indebtedness; (b) Excepted Liens; (c) Liens disclosed on SCHEDULE 9.02. 35 (d) Liens securing capital leases allowed under Section 9.01(c), but only on the Property leased with such capital leases. (e) Liens originally created to secure purchase money Debt permitted under Section 9.01(e), which in each case shall not exceed 100% of the lesser of the total purchase price and the fair market value of the Property acquired as determined at the time of acquisition; PROVIDED, THAT, (i) the Property to be purchased with the proceeds of such Debt shall be purchased not more than sixty (60) days prior to the date of the creation of such Lien and (ii) such Lien encumbers only the Property so acquired. Section 9.03 INVESTMENTS, LOANS AND ADVANCES. Neither the Company nor any Subsidiary will make or permit to remain outstanding any loans or advances to or investments in any Person, except that the foregoing restriction shall not apply to: (a) investments, loans or advances reflected in the Financial Statements or which are disclosed in SCHEDULE 9.03; (b) accounts receivable arising in the ordinary course of business; (c) direct obligations of the United States or any agency thereof, or obligations guaranteed by the United States or any agency thereof, in each case maturing within one year from the date of creation thereof; (d) commercial paper maturing within one year from the date of creation thereof rated in the highest grade by Standard & Poor's Corporation or Moody's Investors Service, Inc.; (e) deposits maturing within one year from the date of creation thereof with, including certificates of deposit issued by, any Senior Lender or any office located in the United States of any other bank or trust company which is organized under the laws of the United States or any state thereof, has capital, surplus and undivided profits aggregating at least $100,000,000.00 (as of the date of such Senior Lender's or bank or trust company's most recent financial reports) and has a short term deposit rating of no lower than A2 or P2, as such rating is set forth from time to time, by Standard & Poor's Corporation or Moody's Investors Service, Inc., respectively; (f) deposits in money market funds investing exclusively in investments described in Section 9.03(c), 9.03(d) or 9.03(e); (g) investments in, or purchases of, dental practices, provided that Company delivers to each Holder a duly completed Officer's Certificate substantially in the form of EXHIBIT D and further provided that: 36 (i) such purchase is an Asset Purchase or Stock Purchase and, if such purchase is a Stock Purchase, such Acquired Entity shall be merged with and into Company or a Subsidiary, and such Subsidiary (if the surviving entity) shall have executed a Guaranty Agreement pursuant to Section 9.19 hereof in favor of Holders in form and substance satisfactory to Holders; (ii) (A) any investment of $5,000,000.00 or more in any one dental practice, (B) any investment in any dental practice which has incurred a net income loss calculated after adding back any adjustments for any owner's compensation as though the dental practice had been owned by the Company throughout the relevant pre- purchase period, for any of its last three fiscal years, or (C) any investment in any dental practice which has a total purchase price in excess of eight (8) times the EBITDA of such dental practice, shall require the prior written approval of Holders; provided, however, so long as the Senior Credit Agreement is in effect, Holders shall have no approval rights with respect to such investment or purchase provided (I) the Majority Lenders have approved such investment or purchase, (II) no Default or Event of Default has occurred and is continuing and (III) such investment and purchase complies with the terms and conditions set forth in the Senior Credit Agreement as in effect on the date hereof. The Company shall deliver to each Holder at least ten (10) Business Days prior to closing the purchase of any such dental practice (1) pro forma financial statements demonstrating continued compliance with all covenants in this Agreement following the inclusion of the target in Company's consolidated enterprise, (2) completed due diligence consisting of the information listed on EXHIBIT E, as approved by Holders, (3) due diligence review conducted by Claymore Partners, Ltd. if such dental practice is in a region in which neither the Company nor any Subsidiary owns a dental practice as of the date hereof and the investment in such practice exceeds $5,000,000.00, (4) audited or reviewed financial statements of the dental practice to be acquired for the last three (3) years and interim period or, in lieu thereof, confirmation of profits, cash flows and accounts receivable of such dental practice by a third party acceptable to Holders, (5) any additional information and/or documentation reasonably requested by any Holder; (iii) for any investment of $2,000,000 or more but less than $5,000,000, and which is not a dental practice described in clause (ii)(B) or (ii)(C) above, the Company shall deliver to each Holder within ten (10) Business Days after closing the purchase of any such dental practice (1) pro forma financial statements demonstrating continued compliance with all covenants in this Agreement following the inclusion of the target in Company's consolidated enterprise, (2) completed due diligence consisting of the information listed on EXHIBIT E, as approved by Holders, (3) compiled financial statements of the dental practice to be acquired for the last three (3) years and interim period or, in lieu thereof, confirmation of profits, cash flows and accounts receivable of such dental practice by a third party acceptable to 37 Holders, and (4) any additional information and/or documentation reasonably requested by any Holder. (iv) for any investment of less than $2,000,000, and which is not a dental practice described in clause (ii)(B) or (ii)(C) above, the Company shall deliver to each Holder within ten (10) Business Days after closing the purchase of any such dental practice, copies of the tax returns of the target dental practice for the last three years. Section 9.04 DIVIDENDS, DISTRIBUTIONS AND REDEMPTIONS. The Company will not declare or pay any dividend, purchase, redeem or otherwise acquire for value any of its stock, or options or warrants to acquire such stock, now or hereafter outstanding, return any capital to its stockholders or make any distribution of its assets to its stockholders, other than the repurchase and/or redemption of the Convertible Note as permitted or required herein or therein or of the Shares. Section 9.05 SALES AND LEASEBACKS. Neither the Company nor any Subsidiary will enter into any arrangement, directly or indirectly, with any Person whereby the Company or any Subsidiary shall sell or transfer any of its Property, whether now owned or hereafter acquired, and whereby the Company or any Subsidiary shall then or thereafter rent or lease as lessee such Property or any part thereof or other Property which the Company or any Subsidiary intends to use for substantially the same purpose or purposes as the Property sold or transferred; provided, however, so long as the Senior Credit Agreement is in effect, this provision shall not prohibit any such transaction to the extent approved by the Majority Lenders and provided no Default or Event of Default exists. Section 9.06 NATURE OF BUSINESS. Neither the Company nor any Subsidiary will allow any material change to be made in the character of its business. Section 9.07 MERGERS, ETC. Neither the Company nor any Subsidiary will merge into or with or consolidate with any other Person, or sell, lease or otherwise dispose of (whether in one transaction or in a series of transactions) all or substantially all of its Property or assets to any other Person, another Subsidiary or in connection with Section 9.03(g), except that any Subsidiary may merge into the Company or into any Wholly-Owned Subsidiary so long as the surviving Wholly- Owned Subsidiary is a Guarantor. Section 9.08 PROCEEDS OF NOTES. The Company will not permit the proceeds of the Notes to be used for any purpose other than those permitted by Section 7.07. Neither the Company nor any Person acting on behalf of the Company has taken or will take any action which might cause any of the Subordinated Note Documents to violate Regulation T, U or X or any other regulation of the Board of Governors of the Federal Reserve System or to violate Section 7 of the Securities Exchange Act of 1934 or any rule or regulation thereunder, in each case as now in effect or as the same may hereinafter be in effect. Section 9.09 ERISA COMPLIANCE. The Company will not at any time: 38 (a) Engage in, or permit any Subsidiary or ERISA Affiliate to engage in, any transaction in connection with which the Company, any Subsidiary or any ERISA Affiliate could be subjected to either a civil penalty assessed pursuant to section 502(c), (i) or (l) of ERISA or a tax imposed by Chapter 43 of Subtitle D of the Code; (b) Terminate, or permit any Subsidiary or ERISA Affiliate to terminate, any Plan in a manner, or take any other action with respect to any Plan, which could result in any material liability to the Company, any Subsidiary or any ERISA Affiliate to the PBGC; (c) Fail to make, or permit any Subsidiary or ERISA Affiliate to fail to make, full payment when due of all amounts which, under the provisions of any Plan, agreement relating thereto or applicable law, the Company, a Subsidiary or any ERISA Affiliate is required to pay as contributions thereto; (d) Permit to exist, or allow any Subsidiary or ERISA Affiliate to permit to exist, any accumulated funding deficiency within the meaning of Section 302 of ERISA or section 412 of the Code, whether or not waived, with respect to any Plan; (e) Permit, or allow any Subsidiary or ERISA Affiliate to permit, the actuarial present value of the benefit liabilities under any Plan maintained by the Company, any Subsidiary or any ERISA Affiliate which is regulated under Title IV of ERISA to exceed the current value of the assets (computed on a plan termination basis in accordance with Title IV of ERISA) of such Plan allocable to such benefit liabilities. The term "actuarial present value of the benefit liabilities" shall have the meaning specified in section 4041 of ERISA; (f) Contribute to or assume an obligation to contribute to, or permit any Subsidiary or ERISA Affiliate to contribute to or assume an obligation to contribute to, any Multiemployer Plan; (g) Acquire, or permit any Subsidiary or ERISA Affiliate to acquire, an interest in any Person that causes such Person to become an ERISA Affiliate with respect to the Company, any Subsidiary or any ERISA Affiliate if such Person sponsors, maintains or contributes to, or at any time in the six-year period preceding such acquisition has sponsored, maintained, or contributed to, (1) any Multiemployer Plan, or (2) any other Plan that is subject to Title IV of ERISA under which the actuarial present value of the benefit liabilities under such Plan exceeds the current value of the assets (computed on a plan termination basis in accordance with Title IV of ERISA) of such Plan allocable to such benefit liabilities; (h) Incur, or permit any Subsidiary or ERISA Affiliate to incur, a liability to or on account of a Plan under sections 515, 4062, 4063, 4064, 4201 or 4204 of ERISA; (i) Contribute to or assume an obligation to contribute to, or permit any Subsidiary or ERISA Affiliate to contribute to or assume an obligation to contribute to, any employee welfare benefit plan, as defined in section 3(1) of ERISA, including, without limitation, any such plan 39 maintained to provide benefits to former employees of such entities, that may not be terminated by such entities in their sole discretion at any time without any material liability; or (j) Amend or permit any Subsidiary or ERISA Affiliate to amend, a Plan resulting in an increase in current liability such that the Company, any Subsidiary or any ERISA Affiliate is required to provide security to such Plan under section 401(a)(29) of the Code. Section 9.10 SALE OR DISCOUNT OF RECEIVABLES. Neither the Company nor any Subsidiary will discount or sell (with or without recourse) any of its notes receivable or accounts receivable; provided, however, so long as the Senior Credit Agreement is in effect, this provision shall not prohibit any such transaction to the extent approved by the Majority Lenders and provided no Default or Event of Default exists. Section 9.11 RATIO OF TOTAL FUNDED DEBT TO CAPITALIZATION. The Company will not permit its ratio of Total Funded Debt to Capitalization as of the end of any fiscal quarter to be greater than .65 to 1.0. Section 9.12 NET WORTH. The Company will not permit its Net Worth to be less than $33,049,000 at any time, with such minimum amount being permanently increased by an amount equal to 67.5% of positive net income of the Company during each fiscal quarter beginning with the fiscal quarter ended September 30, 1999, and 100% of equity capital raised by the Company after the Closing Date, provided, such minimum amount shall not be decreased as a result of any losses or negative earnings. Section 9.13 LEVERAGE RATIO. The Company will not permit its Leverage Ratio as of the end of any fiscal quarter (calculated on a rolling four quarter basis) to be greater than 3.25 to 1.0. For any calculation period which would include one or more quarters prior to any Stock Purchase or any Asset Purchase or any other future acquisition of an entity, the "rolling four quarters" shall include the "pro forma" EBITDA of the applicable Acquired Entity for such prior periods, as approved by Holders, adjusted to reflect costs and expenses which such Acquired Entity would have included had the Management Services Agreements between Company and/or any Subsidiary and such Acquired Entity been in effect (adding back appropriate executive salaries and non-cash charge offs relating to this transaction), in each instance, as approved by Holders. As used in this Section 9.13, "LEVERAGE RATIO" shall mean the ratio of (i) Senior Funded Debt to (ii) EBITDA. Section 9.14 FIXED CHARGE COVERAGE RATIO. The Company will not permit its Fixed Charge Coverage Ratio as of the end of any fiscal quarter (calculated on a rolling four quarter basis) to be less than the ratio for the relevant periods set forth below. RATIO PERIOD --------------------- ----------------------------- 1.00 to 1.00 from the Closing Date through and including 3/31/2001 --------------------- ----------------------------- 1.05 to 1.00 from 4/1/2001 and thereafter --------------------- ----------------------------- For purposes of this Section 9.14, "FIXED CHARGE COVERAGE RATIO" shall mean the ratio for the relevant period of (i) EBITDA, LESS taxes payable in cash, PLUS lease and rental expense to the extent deducted in computing net income to (ii) lease and rental expense, PLUS interest, PLUS, during the Revolving Credit Period (as defined in the Senior Credit Agreement), one-seventh (1/7) of the then- outstanding principal balance of the Senior Loans, PLUS, without duplication, current maturities of long-term debt, PLUS capital leases PLUS, from and after Revolving Credit Period scheduled payments of principal on Debt of the Company and its Subsidiaries. For any calculation period which would include one or more quarters prior to any Stock Purchase or any Asset Purchase or any other future acquisition of an entity, the "rolling four quarters" shall include the "pro forma" EBITDA of the applicable Acquired Entity for such prior periods as approved by Holders, adjusted to reflect costs and expenses which such Acquired Entity would have included had the Management Services Agreements between Company and/or any Subsidiary and such Acquired Entity been in effect (adding back appropriate executive salaries and non-cash charge offs relating to this transaction), in each instance, as approved by Holders. Section 9.15 RATIO OF TOTAL FUNDED DEBT TO EBITDA. The Company will not permit its ratio of Total Funded Debt as of the end of any fiscal quarter to EBITDA for the four fiscal quarters ending on such date to be greater than 4.25 to 1.0. For purposes hereof, EBITDA shall be calculated as provided in Section 9.13 above. Section 9.16 CAPITAL EXPENDITURES. The Company will not make any expenditures for fixed or capital assets if, after giving effect thereto, the aggregate of all such expenditures would, in the case of the 12 month periods ending on the last day of the fiscal quarters ending on December 31, 1999, March 31, 2000 and June 30, 2000, respectively, exceed $11,000,000, and in the case of each 12 month period ending on the last day of each fiscal quarter thereafter, exceed $10,000,000. Section 9.17 ENVIRONMENTAL MATTERS. Neither the Company nor any Subsidiary will cause or permit any of its Property to be in violation of, or do anything or permit anything to be done which will subject any such Property to any remedial obligations under any Environmental Laws, assuming disclosure to the applicable Governmental Authority of all relevant facts, conditions and circumstances, if any, pertaining to such Property where such violations or remedial obligations would have a Material Adverse Effect. Section 9.18 TRANSACTIONS WITH AFFILIATES. Except pursuant to Management Services Agreements and the Accounts Receivable Purchase Agreements, neither the Company nor any Subsidiary will enter into any transaction, including, without limitation, any purchase, sale, lease or exchange of Property or the rendering of any service, with any Affiliate unless such transactions are otherwise permitted under this Agreement, are in the ordinary course of its business and are upon fair and reasonable terms no less favorable to it than it would obtain in a comparable arm's length transaction with a Person not an Affiliate. 40 Section 9.19 SUBSIDIARIES. In each case in which the Company or any of its Subsidiaries creates or acquires any additional Subsidiaries, each new Subsidiary shall forthwith execute and deliver a Subordinated Guaranty Agreement in favor of Holders. The Company shall not and shall not permit any Subsidiary to sell or to issue any stock of a Subsidiary or any interest in a Special Entity. The Company shall not permit any Subsidiary to issue any stock except to the Company or any Guarantors and except in compliance with Section 9.03. Section 9.20 NEGATIVE PLEDGE AGREEMENTS. Neither the Company nor any Subsidiary will create, incur, assume or suffer to exist any contract, agreement or understanding (other than the Senior Credit Documents and the Subordinated Note Documents) which in any way prohibits or restricts the granting, conveying, creation or imposition of any Lien on any of its Property or restricts any Subsidiary from paying dividends to the Company, or which requires the consent of or notice to other Persons in connection therewith. Section 9.21 OTHER AGREEMENTS. Neither the Company nor any Subsidiary shall make or permit any material amendment or modification of the Management Services Agreements or the Accounts Receivables Purchase Agreements, except for (i) those amendments or modifications required to comply with Government Requirements and (ii) those amendments or modifications which would not have an adverse effect on Borrower or any of its Subsidiaries. The Company will not and will not permit any of its Subsidiaries directly or indirectly to change or amend the terms of any of the Senior Credit Documents if the effect of such amendment is to: (a) increase the principal amount of Senior Indebtedness to an amount in excess of that permitted in the definition of "Senior Debt" in the Subordination Agreement or increase the interest rate on such Senior Indebtedness by more than 200 basis points of the maximum rate of interest set forth in the Senior Credit Agreement; (b) extend the final maturity of the Senior Indebtedness by more than two (2) years; (c) shorten the final maturity of the Senior Indebtedness by more than one (1) year; (d) except as permitted in clause (c), shorten the dates upon which scheduled payments of principal or interest are due on such Senior Indebtedness; or (e) change in any manner adverse to the Company or add any event of default or add or make more restrictive any covenant with respect to such Senior Indebtedness other than in consideration for a waiver of an actual or contemplated default or event of default under the Senior Credit Documents. Section 9.22 ACQUIRED ENTITIES. Notwithstanding anything to the contrary contained herein, the Company will not permit any Acquired Entity to create, incur, assume or permit to exist any Debt (other than the Senior Indebtedness and the Indebtedness) or Lien, make any loans, advances or investments in any persons, or sell or transfer any of its property, whether now owned or hereafter acquired except for Debt and Liens in favor of the Company and Liens permitted by Section 9.02. Section 9.23 AMENDMENT OF CASTLE WEST LLC AGREEMENT. Neither the Company nor any Subsidiary shall make or permit any material amendment or modification of the Limited Liability Company Agreement of Castle Dental Centers of California, L.L.C., a Delaware limited liability company, without the prior written consent of Holders. 41 Section 9.24 JUNIOR SUBORDINATION DEBT. The Company will not, and will not permit any of is Subsidiaries, to make any payment of principal or interest on Junior Subordinated Debt except to the extent permitted under, and subject to the terms and conditions set forth in, the subordination agreement or other such agreement executed in connection therewith. Section 9.25 RESTRICTION ON FUNDAMENTAL CHANGES. The Company will not and will not permit any of its Subsidiaries directly or indirectly to amend, modify or waive any term or provision of its organizational documents, including without limitation its articles of incorporation, certificates of designations pertaining to preferred stock, by-laws, partnership agreement or members' agreement. Section 9.26 DISPOSAL OF ASSETS OR SUBSIDIARY STOCK. The Company will not and will not permit any of its Subsidiaries directly or indirectly to: convey, sell, lease, sublease, transfer or otherwise dispose of, or grant any Person an option to acquire, in one transaction or a series of transactions, any of its property, business or assets, or the capital stock of or other equity interests in any of its Subsidiaries, whether now owned or hereafter acquired, except for (a) bona fide sales of inventory to customers for fair value in the ordinary course of business and dispositions of obsolete equipment not used or useful in the business and (b) asset dispositions if all of the following conditions are met: (i) the market value of assets sold or otherwise disposed of in any fiscal year of the Company does not exceed $2,500,000; (ii) the consideration received is at least equal to the fair market value of such assets; and (iii) no Default or Event of Default then exists or shall result from such asset disposition. ARTICLE X EVENTS OF DEFAULT; REMEDIES Section 10.01 EVENTS OF DEFAULT. One or more of the following events shall constitute an "EVENT OF DEFAULT": (a) the Company shall default in the payment or prepayment when due of any principal of or interest on any Note, or any fees or other amount payable by it hereunder or under the Subordinated Guaranty Agreement; provided, however, if such default is a default in the payment of fees (other than fees under Section 2.03(c)), such default shall continue unremedied for a period of 30 days; or (b) the Company or any Subsidiary shall default in the payment when due of any principal of or interest on any of its other Debt (other than Senior Debt) aggregating $250,000 or more, or any event specified in any note, agreement, indenture or other document evidencing or relating to any such Debt shall occur if the effect of such event is to cause, or (with the giving of any notice or the lapse of time or both) to permit the holder or holders of such Debt (or a trustee or 42 an agent on behalf of such holder or holders) to cause, such Debt to become due prior to its stated maturity; or (c) any representation, warranty or certification made or deemed made herein or in any of the other Subordinated Note Documents by the Company or any Subsidiary, or any certificate furnished to any Holder pursuant to the provisions hereof or the other Subordinated Note Documents, shall prove to have been materially false or misleading as of the time made or furnished in any material respect; or (d) the Company shall default in the performance of any of its obligations under Article IX or any other Article of this Agreement other than under Article VIII; or the Company shall default in the performance of any of its obligations under Article VIII or the Subordinated Guaranty Agreement (other than the payment of amounts due which shall be governed by Section 10.01(a)) and such default shall continue unremedied for a period of thirty (30) days after the earlier to occur of (i) notice thereof to the Company by any Holder or (ii) the Company otherwise becoming aware of such default; or (e) the Company shall admit in writing its inability to, or be generally unable to, pay its debts as such debts become due; or (f) the Company shall (i) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee or liquidator of itself or of all or a substantial part of its property, (ii) make a general assignment for the benefit of its creditors, (iii) commence a voluntary case under the Federal Bankruptcy Code (as now or hereafter in effect), (iv) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, winding-up, liquidation or composition or readjustment of debts, (v) fail to controvert in a timely and appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case under the Federal Bankruptcy Code, or (vi) take any corporate action for the purpose of effecting any of the foregoing; or (g) a proceeding or case shall be commenced, without the application or consent of the Company, in any court of competent jurisdiction, seeking (i) its liquidation, reorganization, dissolution or winding-up, or the composition or readjustment of its debts, (ii) the appointment of a trustee, receiver, custodian, liquidator or the like of the Company of all or any substantial part of its assets, or (iii) similar relief in respect of the Company under any law relating to bankruptcy, insolvency, reorganization, winding-up, or composition or adjustment of debts, and such proceeding or case shall continue undismissed, or an order, judgment or decree approving or ordering any of the foregoing shall be entered and continue unstayed and in effect, for a period of 60 days; or (iv) an order for relief against the Company shall be entered in an involuntary case under the Federal Bankruptcy Code; or (h) a judgment or judgments for the payment of money in excess of $250,000 in the aggregate shall be rendered by a court against the Company or any Subsidiary and the same shall 43 not be discharged (or provision shall not be made for such discharge), or a stay of execution thereof shall not be (i) fully covered by insurance owned or held by the Company or such Subsidiary, as applicable, under a policy or policies which are in full force and effect, or (ii) procured, within thirty (30) days from the date of entry thereof and the Company or such Subsidiary shall not, within said period of 30 days, or such longer period during which execution of the same shall have been stayed, appeal therefrom and cause the execution thereof to be stayed during such appeal; or (i) the Subordinated Guaranty Agreement after delivery thereof shall for any reason, except to the extent permitted by the terms thereof, cease to be in full force and effect and valid, binding and enforceable in accordance with their terms, except to the extent permitted by the terms of this Agreement, or the Company shall so state in writing; or (j) the Company discontinues its usual business; or (k) any Guarantor takes, suffers or permits to exist any of the events or conditions referred to in paragraphs (e), (f), (g) or (h) hereof or if any provision of any guaranty agreement related thereto shall for any reason cease to be valid and binding on any Guarantor or if any Guarantor shall so state in writing; or (l) any Acquired Entity or any Subsidiary takes, suffers or permits to exist any of the events or conditions referred to in paragraphs (e), (f), (g) or (h) hereof; or (m) any Management Services Agreement (other than the Management Services Agreement with Ner H. Azaula, D.D.S.) or any Accounts Receivable Purchase Agreement terminates or a default by the Company occurs thereunder; or (n) any modification or amendment of any Management Services Agreement (other than the Management Services Agreement with Ner H. Azaula, D.D.S.) or any Accounts Receivable Purchase Agreement is made that could result in a monetary impact to the Company without the prior written consent of Holders; or (o) a Change of Control occurs; or (p) the Company shall default in the payment or performance of any obligations in the Senior Credit Documents after any applicable cure period provided for in the such document and as a result any Senior Lender causes the Senior Indebtedness to be accelerated or the Company shall default in the repayment of such Senior Indebtedness at final maturity. Section 10.02 REMEDIES. (a) In the case of an Event of Default other than one referred to in clauses (e), (f) or (g) of Section 10.01 or in clauses (k) and (l) to the extent they relates to clauses (e), (f) or (g), each Holder may, by notice to the Company, declare the principal amount then outstanding of, and the 44 accrued interest on, the Subordinated Notes and/or Convertible Notes held by it and all other amounts payable to it by the Company hereunder and under the Subordinated Notes and Convertible Notes to be forthwith due and payable, whereupon such amounts shall be immediately due and payable without presentment, demand, protest, notice of intent to accelerate, notice of acceleration or other formalities of any kind, all of which are hereby expressly waived by the Company. (b) In the case of the occurrence of an Event of Default referred to in clauses (e), (f) or (g) of Section 10.01 or in clauses (k) and (l) to the extent they relate to clauses (e), (f) or (g), the principal amount then outstanding of, and the accrued interest on, the Notes and all other amounts payable by the Company hereunder and under the Notes shall become automatically immediately due and payable without presentment, demand, protest, notice of intent to accelerate, notice of acceleration or other formalities of any kind, all of which are hereby expressly waived by the Company. (c) All proceeds received after maturity of the Notes, whether by acceleration or otherwise shall be applied first to reimbursement of expenses and indemnities provided for in this Agreement and the Subordinated Guaranty Agreement; second to accrued interest on the Notes; third to fees; fourth pro rata to principal outstanding on the Notes and other Indebtedness; and any excess shall be paid to the Company or as otherwise required by any Governmental Requirement. (d) Upon the occurrence and during the continuance of any one or more Events of Default, any Holder may proceed to protect and enforce its rights hereunder by suit in equity, action at law or by other appropriate proceeding, whether for the specific performance of any covenant or agreement contained in this Agreements, the Notes or the other Subordinated Note Documents or in aid of the exercise of any power granted in this Agreement or the Notes, or may proceed to enforce the payment of the Notes, or to enforce any other of its legal or equitable rights. ARTICLE XI HOLDER REPRESENTATIONS AND WARRANTIES Section 11.0 ACCREDITED INVESTOR. Each Holder represents, as to itself, that it is an "accredited investor" within the meaning of Regulation D promulgated under the Securities Act. ARTICLE XII MISCELLANEOUS Section 12.01 WAIVER. No failure on the part of a Holder to exercise and no delay in exercising, and no course of dealing with respect to, any right, power or privilege under any of the Subordinated Note Documents shall operate as a waiver thereof, nor shall any single or partial 45 exercise of any right, power or privilege under any of the Subordinated Note Documents preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The remedies provided herein are cumulative and not exclusive of any remedies provided by law. Section 12.02 NOTICES. All notices and other communications provided for herein and in the other Subordinated Note Documents (including, without limitation, any modifications of, or waivers or consents under, this Agreement or the other Subordinated Note Documents) shall be given or made by telex, telecopy, courier or U.S. Mail or in writing and telexed, telecopied, mailed or delivered to the intended recipient at the "Address for Notices" specified below its name on the signature pages hereof or in the Subordinated Note Documents; or, as to any party, at such other address as shall be designated by such party in a notice to each other party. Except as otherwise provided in this Agreement or in the other Subordinated Note Documents, all such communications shall be deemed to have been duly given when transmitted, if transmitted before 1:00 p.m. local time on a Business Day (otherwise on the next succeeding Business Day) by telex or telecopier and evidence or confirmation of receipt is obtained, or personally delivered or, in the case of a mailed notice, three (3) Business Days after the date deposited in the mails, postage prepaid, in each case given or addressed as aforesaid. Section 12.03 PAYMENT OF EXPENSES, INDEMNITIES, ETC. (a) The Company agrees: (i) whether or not the transactions hereby contemplated are consummated, to pay all reasonable expenses of Holders in the administration (both before and after the execution hereof and including advice of counsel as to the rights and duties of a Holder with respect thereto) of, and in connection with the negotiation, syndication, investigation, preparation, execution and delivery of, recording or filing of, preservation of rights under, enforcement of, and refinancing, renegotiation or restructuring of, the Subordinated Note Documents and any amendment, waiver or consent relating thereto (including, without limitation, travel, photocopy, mailing, courier, telephone and other similar expenses of Holders, the cost of environmental audits, surveys and appraisals at reasonable intervals, the reasonable fees and disbursements of counsel and other outside consultants for Holders and, in the case of enforcement (including, without limitation, bankruptcy and workout matters), the reasonable fees and disbursements of counsel for Holders; and promptly reimburse a Holder for all amounts expended, advanced or incurred by such Holder to satisfy any obligation of the Company under this Agreement or the Subordinated Guaranty Agreement; (II) TO INDEMNIFY EACH HOLDER AND EACH OF ITS AFFILIATES AND EACH OF ITS OFFICERS, DIRECTORS, EMPLOYEES, REPRESENTATIVES, AGENTS, ATTORNEYS, ACCOUNTANTS AND EXPERTS ("INDEMNIFIED PARTIES") FROM, HOLD EACH OF THEM HARMLESS AGAINST AND PROMPTLY UPON DEMAND PAY OR REIMBURSE EACH OF THEM FOR, THE INDEMNITY MATTERS WHICH MAY BE INCURRED BY OR ASSERTED AGAINST OR INVOLVE ANY OF THEM (WHETHER OR NOT ANY OF THEM IS DESIGNATED A PARTY 46 THERETO) AS A RESULT OF, ARISING OUT OF OR IN ANY WAY RELATED TO (I) ANY ACTUAL OR PROPOSED USE BY THE COMPANY OF THE PROCEEDS OF ANY OF THE NOTES, (II) THE EXECUTION, DELIVERY AND PERFORMANCE OF THE SUBORDINATED NOTE DOCUMENTS, (III) THE OPERATIONS OF THE BUSINESS OF THE COMPANY AND ITS SUBSIDIARIES, (IV) THE FAILURE OF THE COMPANY OR ANY SUBSIDIARY TO COMPLY WITH THE TERMS OF THE SUBORDINATED GUARANTY AGREEMENT OR THIS AGREEMENT, OR WITH ANY GOVERNMENTAL REQUIREMENT, (V) ANY INACCURACY OF ANY REPRESENTATION OR ANY BREACH OF ANY WARRANTY OF THE COMPANY OR ANY GUARANTOR SET FORTH IN ANY OF THE SUBORDINATED NOTE DOCUMENTS, (VI) ANY ASSERTION THAT ANY HOLDER WAS NOT ENTITLED TO RECEIVE THE PROCEEDS RECEIVED PURSUANT TO THE SUBORDINATED GUARANTY AGREEMENT OR (VII) ANY OTHER ASPECT OF THE SUBORDINATED NOTE DOCUMENTS, INCLUDING, WITHOUT LIMITATION, THE REASONABLE FEES AND DISBURSEMENTS OF COUNSEL AND ALL OTHER EXPENSES INCURRED IN CONNECTION WITH INVESTIGATING, DEFENDING OR PREPARING TO DEFEND ANY SUCH ACTION, SUIT, PROCEEDING (INCLUDING ANY INVESTIGATIONS, LITIGATION OR INQUIRIES) OR CLAIM AND INCLUDING ALL INDEMNITY MATTERS ARISING BY REASON OF THE ORDINARY NEGLIGENCE OF ANY INDEMNIFIED PARTY, BUT EXCLUDING ALL INDEMNITY MATTERS ARISING SOLELY BY REASON OF THE GROSS NEGLIGENCE OR WILLFUL MISCONDUCT ON THE PART OF THE INDEMNIFIED PARTY; AND (III) TO INDEMNIFY AND HOLD HARMLESS FROM TIME TO TIME THE INDEMNIFIED PARTIES FROM AND AGAINST ANY AND ALL LOSSES, CLAIMS, COST RECOVERY ACTIONS, ADMINISTRATIVE ORDERS OR PROCEEDINGS, DAMAGES AND LIABILITIES TO WHICH ANY SUCH PERSON MAY BECOME SUBJECT (I) UNDER ANY ENVIRONMENTAL LAW APPLICABLE TO THE COMPANY OR ANY SUBSIDIARY OR ANY OF THEIR PROPERTIES, INCLUDING WITHOUT LIMITATION, THE TREATMENT OR DISPOSAL OF HAZARDOUS SUBSTANCES ON ANY OF THEIR PROPERTIES, (II) AS A RESULT OF THE BREACH OR NON-COMPLIANCE BY THE COMPANY OR ANY SUBSIDIARY WITH ANY ENVIRONMENTAL LAW APPLICABLE TO THE COMPANY OR ANY SUBSIDIARY, (III) DUE TO PAST OWNERSHIP BY THE COMPANY OR ANY SUBSIDIARY OF ANY OF THEIR PROPERTIES OR PAST ACTIVITY ON ANY OF THEIR PROPERTIES WHICH, THOUGH LAWFUL AND FULLY PERMISSIBLE AT THE TIME, COULD RESULT IN PRESENT LIABILITY, (IV) THE PRESENCE, USE, RELEASE, STORAGE, TREATMENT OR DISPOSAL OF HAZARDOUS SUBSTANCES ON OR AT ANY OF THE PROPERTIES OWNED OR OPERATED BY THE COMPANY OR ANY SUBSIDIARY, OR (V) ANY OTHER ENVIRONMENTAL, HEALTH OR SAFETY CONDITION IN CONNECTION WITH THE SUBORDINATED NOTE DOCUMENTS. (b) No Indemnified Party may settle any claim to be indemnified without the consent of the indemnitor, such consent not to be unreasonably withheld. (c) In the case of any indemnification hereunder, the Indemnified Party shall give notice to the Company of any such claim or demand being made against the Indemnified Party and the Company shall have the non-exclusive right to join in the defense against any such claim or demand 47 provided that if the Company provides a defense, the Indemnified Party shall bear its own cost of defense unless there is a conflict between the Company and such Indemnified Party. (D) THE FOREGOING INDEMNITIES SHALL EXTEND TO THE INDEMNIFIED PARTIES NOTWITHSTANDING THE SOLE OR CONCURRENT NEGLIGENCE OF EVERY KIND OR CHARACTER WHATSOEVER, WHETHER ACTIVE OR PASSIVE, WHETHER AN AFFIRMATIVE ACT OR AN OMISSION, INCLUDING WITHOUT LIMITATION, ALL TYPES OF NEGLIGENT CONDUCT IDENTIFIED IN THE RESTATEMENT (SECOND) OF TORTS OF ONE OR MORE OF THE INDEMNIFIED PARTIES OR BY REASON OF STRICT LIABILITY IMPOSED WITHOUT FAULT ON ANY ONE OR MORE OF THE INDEMNIFIED PARTIES. TO THE EXTENT THAT AN INDEMNIFIED PARTY IS FOUND TO HAVE COMMITTED AN ACT OF GROSS NEGLIGENCE OR WILLFUL MISCONDUCT, THIS CONTRACTUAL OBLIGATION OF INDEMNIFICATION SHALL CONTINUE BUT SHALL ONLY EXTEND TO THE PORTION OF THE CLAIM THAT IS DEEMED TO HAVE OCCURRED BY REASON OF EVENTS OTHER THAN THE GROSS NEGLIGENCE OR WILLFUL MISCONDUCT OF THE INDEMNIFIED PARTY. (e) The Company's obligations under this Section 12.03 shall survive any termination of this Agreement, conversion of the Convertible Notes and the payment of the Notes and shall continue thereafter in full force and effect. (f) The Company shall pay any amounts due under this Section 12.03 within thirty (30) days of the receipt by the Company of notice of the amount due. Section 12.04 AMENDMENTS, ETC. Any provision of this Agreement or the Subordinated Guaranty Agreement may be amended, modified or waived with the Company's and Holders' prior written consent. Section 12.05 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. Section 12.06 ASSIGNMENTS. (a) The Company may not assign its rights or obligations hereunder or under the Notes without the prior consent of Holders. (b) Subject to applicable securities laws, in the case of the Notes, and to the terms and conditions of the Stockholders Agreement, in the case of the Convertible Notes, Holders (and its permitted assigns) may assign to one or more assignees all or a portion of its rights and obligations under this Agreement and the other Subordinated Note Documents to any Person, and any such assignee may further assign such rights and obligations to any Person. Any such assignment will become effective upon the execution and delivery to the assigning Holder of the assignment. Upon the assigning Holder's request, the Company, will, at its own expense, execute and deliver new Notes to the assignor and/or assignee, as appropriate, in accordance with their respective interests as they appear. Upon the effectiveness of any assignment pursuant to this Section 12.06(b), all 48 references to "Holders" or a "Holder" in this Agreement, the Notes and the other Subordinated Note Documents shall mean and include each such assignee, each such assignee shall be deemed a party to this Agreement and bound by all the agreements and covenants of Holders (other than the covenant to purchase a Note) contained herein and all actions which are to be taken, and all consents or waivers to be granted or consents, amendments, waivers and other writings required to be signed by Holders or a party (other than the Company) to this Agreement shall be, in each case, effective only if taken or executed or delivered by Holders and all such assignees. (c) A Holder may furnish any information concerning the Company in its possession from time to time to assignees (including prospective assignees); provided that, such Persons agree to be bound by the provisions of Section 12.15. (d) Notwithstanding any other provisions of this Section 12.06, no transfer or assignment of the interests or obligations of a Holder or any grant of participations therein shall be permitted if such transfer, assignment or grant would require the Company to file a registration statement with the SEC or to qualify the Notes under the "Blue Sky" laws of any state. Section 12.07 INVALIDITY. In the event that any one or more of the provisions contained in any of the Subordinated Note Documents shall, for any reason, be held invalid, illegal or unenforceable in any respect, such invalidity, illegality or unenforceability shall not affect any other provision of the Notes, this Agreement or the Subordinated Guaranty Agreement. Section 12.08 COUNTERPARTS. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument and any of the parties hereto may execute this Agreement by signing any such counterpart. Section 12.09 REFERENCES. The words "herein," "hereof," "hereunder" and other words of similar import when used in this Agreement refer to this Agreement as a whole, and not to any particular article, section or subsection. Any reference herein to a Section shall be deemed to refer to the applicable Section of this Agreement unless otherwise stated herein. Any reference herein to an exhibit or schedule shall be deemed to refer to the applicable exhibit or schedule attached hereto unless otherwise stated herein. Section 12.10 SURVIVAL. The obligations of the parties, other than under, but subject to the introductory statement to, Article VIII and Article IX, shall survive the repayment of the Notes and the conversion of the Convertible Notes. To the extent that any payments on the Indebtedness are subsequently invalidated, declared to be fraudulent or preferential, set aside or required to be repaid to a trustee, debtor in possession, receiver or other Person under any bankruptcy law, common law or equitable cause, then to such extent, the Indebtedness so satisfied shall be revived and continue as if such payment or proceeds had not been received and Holders' rights, powers and remedies under this Agreement and the Subordinated Guaranty Agreement shall continue in full force and effect. In such event, the Subordinated Guaranty Agreement shall be automatically reinstated and 49 the Company shall take such action as may be reasonably requested by Holder to effect such reinstatement. Section 12.11 CAPTIONS. Captions and section headings appearing herein are included solely for convenience of reference and are not intended to affect the interpretation of any provision of this Agreement. Section 12.12 NO ORAL AGREEMENTS. THE SUBORDINATED NOTE DOCUMENTS EMBODY THE ENTIRE AGREEMENT AND UNDERSTANDING BETWEEN THE PARTIES AND SUPERSEDE ALL OTHER AGREEMENTS AND UNDERSTANDINGS BETWEEN SUCH PARTIES RELATING TO THE SUBJECT MATTER HEREOF AND THEREOF. THE SUBORDINATED NOTE DOCUMENTS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. Section 12.13 GOVERNING LAW; SUBMISSION TO JURISDICTION. (A) THIS AGREEMENT AND THE NOTES SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF ILLINOIS. (B) SUBJECT TO SECTION 12.17, ANY LEGAL ACTION OR PROCEEDING WITH RESPECT TO THE SUBORDINATED NOTE DOCUMENTS SHALL BE BROUGHT IN THE COURTS OF THE STATE OF ILLINOIS OR OF THE UNITED STATES OF AMERICA FOR THE NORTHERN DISTRICT OF ILLINOIS, AND, BY EXECUTION AND DELIVERY OF THIS AGREEMENT, EACH OF THE COMPANY AND EACH HOLDER HEREBY ACCEPTS FOR ITSELF AND (TO THE EXTENT PERMITTED BY LAW) IN RESPECT OF ITS PROPERTY, GENERALLY AND UNCONDITIONALLY, THE JURISDICTION OF THE AFORESAID COURTS. EACH OF THE COMPANY AND EACH HOLDER HEREBY IRREVOCABLY WAIVES ANY OBJECTION, INCLUDING, WITHOUT LIMITATION, ANY OBJECTION TO THE LAYING OF VENUE OR BASED ON THE GROUNDS OF FORUM NON CONVENIENS, WHICH IT MAY NOW OR HEREAFTER HAVE TO THE BRINGING OF ANY SUCH ACTION OR PROCEEDING IN SUCH RESPECTIVE JURISDICTIONS. (C) NOTHING HEREIN SHALL AFFECT THE RIGHT OF ANY HOLDER TO SERVE PROCESS IN ANY OTHER MANNER PERMITTED BY LAW. (D) THE COMPANY AND EACH HOLDER HEREBY (I) IRREVOCABLY AND UNCONDITIONALLY WAIVE, TO THE FULLEST EXTENT PERMITTED BY LAW, TRIAL BY JURY IN ANY LEGAL ACTION OR PROCEEDING RELATING TO THIS AGREEMENT OR THE SUBORDINATED GUARANTY AGREEMENT AND FOR ANY COUNTERCLAIM THEREIN; (II) IRREVOCABLY WAIVE, TO THE MAXIMUM EXTENT NOT PROHIBITED BY LAW, ANY RIGHT IT MAY HAVE TO CLAIM OR RECOVER IN ANY SUCH LITIGATION ANY SPECIAL, EXEMPLARY, PUNITIVE OR CONSEQUENTIAL DAMAGES, OR DAMAGES OTHER THAN, OR IN ADDITION TO, ACTUAL DAMAGES; (III) CERTIFY THAT NO PARTY HERETO NOR ANY REPRESENTATIVE OR AGENT OF COUNSEL FOR ANY PARTY 50 HERETO HAS REPRESENTED, EXPRESSLY OR OTHERWISE, OR IMPLIED THAT SUCH PARTY WOULD NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVERS, AND (IV) ACKNOWLEDGE THAT IT HAS BEEN INDUCED TO ENTER INTO THIS AGREEMENT, THE SUBORDINATED GUARANTY AGREEMENT AND THE TRANSACTIONS CONTEMPLATED HEREBY AND THEREBY BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS CONTAINED IN THIS SECTION 12.13. Section 12.14 INTEREST. It is the intention of the parties hereto that Holders shall conform strictly to usury laws applicable to it. Accordingly, if the transactions contemplated hereby would be usurious as to Holders under laws applicable to it (including the laws of the United States of America and the State of Illinois or any other jurisdiction whose laws may be mandatorily applicable to Holders notwithstanding the other provisions of this Agreement), then, in that event, notwithstanding anything to the contrary in any of the Subordinated Note Documents or any agreement entered into in connection with or as security for the Notes, it is agreed as follows: (i) the aggregate of all consideration which constitutes interest under law applicable to Holders that is contracted for, taken, reserved, charged or received by Holders under any of the Subordinated Note Documents or agreements or otherwise in connection with the Notes shall under no circumstances exceed the maximum amount allowed by such applicable law, and any excess shall be canceled automatically and if theretofore paid shall be credited by Holders on the principal amount of the Indebtedness (or, to the extent that the principal amount of the Indebtedness shall have been or would thereby be paid in full, refunded by Holders to the Company); and (ii) in the event that the maturity of the Notes is accelerated by reason of an election of the holder thereof resulting from any Event of Default under this Agreement or otherwise, or in the event of any required or permitted prepayment, then such consideration that constitutes interest under law applicable to Holders may never include more than the maximum amount allowed by such applicable law, and excess interest, if any, provided for in this Agreement or otherwise shall be canceled automatically by Holders as of the date of such acceleration or prepayment and, if theretofore paid, shall be credited by Holders on the principal amount of the Indebtedness (or, to the extent that the principal amount of the Indebtedness shall have been or would thereby be paid in full, refunded by Holders to the Company). All sums paid or agreed to be paid to Holders for the use, forbearance or detention of sums due hereunder shall, to the extent permitted by law applicable to Holders, be amortized, prorated, allocated and spread throughout the full term of the Notes until payment in full so that the rate or amount of interest on account of any Notes hereunder does not exceed the maximum amount allowed by such applicable law. If at any time and from time to time (i) the amount of interest payable to Holders on any date shall be computed at the Highest Lawful Rate applicable to Holders pursuant to this Section 12.14 and (ii) in respect of any subsequent interest computation period the amount of interest otherwise payable to Holders would be less than the amount of interest payable to Holders computed at the Highest Lawful Rate applicable to Holders, then the amount of interest payable to Holders in respect of such subsequent interest computation period shall continue to be computed at the Highest Lawful Rate applicable to Holders until the total amount of interest payable to Holders shall equal the total amount of interest which would have been payable to Holders if the total amount of interest had been computed without giving effect to this Section 12.14. 51 Section 12.15 CONFIDENTIALITY. In the event that the Company provides to a Holder written confidential information belonging to the Company, if the Company shall denominate such information in writing as "confidential", such Holder shall thereafter maintain such information in confidence in accordance with the standards of care and diligence that each utilizes in maintaining its own confidential information. This obligation of confidence shall not apply to such portions of the information which (i) are in the public domain, (ii) hereafter become part of the public domain without a Holder breaching its obligation of confidence to the Company, (iii) are previously known by a Holder from some source other than the Company, (iv) are hereafter developed by a Holder without using the Company's information, (v) are hereafter obtained by or available to a Holder from a third party who owes no obligation of confidence to the Company with respect to such information or through any other means other than through disclosure by the Company, (vi) are disclosed with the Company's consent, (vii) must be disclosed either pursuant to any Governmental Requirement or to Persons regulating the activities of a Holder, or (viii) as may be required by law or regulation or order of any Governmental Authority in any judicial, arbitration or governmental proceeding. Further, a Holder may disclose any such information to any independent consultants, any independent certified public accountants, any legal counsel employed by such Person in connection with this Agreement or the Subordinated Guaranty Agreement, including without limitation, the enforcement or exercise of all rights and remedies thereunder, or any assignee (including prospective assignees) in the Notes; PROVIDED, HOWEVER, that such Holder shall receive a confidentiality agreement from the Person to whom such information is disclosed such that said Person shall have the same obligation to maintain the confidentiality of such information as is imposed upon such Holder hereunder. Notwithstanding anything to the contrary provided herein, this obligation of confidence shall cease three (3) years from the date the information was furnished, unless the Company requests in writing at least thirty (30) days prior to the expiration of such three year period, to maintain the confidentiality of such information for an additional three year period. The Company waives any and all other rights it may have to confidentiality as against a Holder arising by contract, agreement, statute or law except as expressly stated in this Section 12.15. Section 12.16 EFFECTIVENESS. This Agreement shall be effective on the Closing Date. Section 12.17 EXCULPATION PROVISIONS. EACH OF THE PARTIES HERETO SPECIFICALLY AGREES THAT IT HAS A DUTY TO READ THIS AGREEMENT AND THE SUBORDINATED GUARANTY AGREEMENT AND AGREES THAT IT IS CHARGED WITH NOTICE AND KNOWLEDGE OF THE TERMS OF THIS AGREEMENT AND THE SUBORDINATED GUARANTY AGREEMENT; THAT IT HAS IN FACT READ THIS AGREEMENT AND IS FULLY INFORMED AND HAS FULL NOTICE AND KNOWLEDGE OF THE TERMS, CONDITIONS AND EFFECTS OF THIS AGREEMENT; THAT IT HAS BEEN REPRESENTED BY INDEPENDENT LEGAL COUNSEL OF ITS CHOICE THROUGHOUT THE NEGOTIATIONS PRECEDING ITS EXECUTION OF THIS AGREEMENT AND THE SUBORDINATED GUARANTY AGREEMENT; AND HAS RECEIVED THE ADVICE OF ITS ATTORNEY IN ENTERING INTO THIS AGREEMENT AND THE SUBORDINATED GUARANTY AGREEMENT; AND THAT IT RECOGNIZES THAT CERTAIN OF THE TERMS OF THIS AGREEMENT AND THE SUBORDINATED GUARANTY AGREEMENT RESULT IN ONE PARTY ASSUMING THE LIABILITY INHERENT IN SOME ASPECTS OF THE TRANSACTION AND RELIEVING THE OTHER PARTY OF ITS RESPONSIBILITY FOR SUCH LIABILITY. EACH PARTY 52 HERETO AGREES AND COVENANTS THAT IT WILL NOT CONTEST THE VALIDITY OR ENFORCEABILITY OF ANY EXCULPATORY PROVISION OF THIS AGREEMENT AND THE SUBORDINATED GUARANTY AGREEMENT ON THE BASIS THAT THE PARTY HAD NO NOTICE OR KNOWLEDGE OF SUCH PROVISION OR THAT THE PROVISION IS NOT "CONSPICUOUS." Section 12.18 SUBORDINATION. Each of the Company, the Guarantors and Holders, by their acceptance of this Agreement, agree that all of the Indebtedness, all payments in respect thereof (prior to the payment in full of the Senior Indebtedness) and any renewals, refinancings or extensions thereof shall be subordinate and junior in right to all Senior Indebtedness as set forth and subject to the terms of the Subordination Agreement. [SIGNATURES BEGIN ON NEXT PAGE] 53 The parties hereto have caused this Agreement to be duly executed as of the day and year first above written. Company: CASTLE DENTAL CENTERS, INC. By:_________________________________ Name: Jack H. Castle, Jr. Title: Chairman and Chief Executive Officer Address for Notices: 1360 Post Oak Boulevard Suite 1300 Houston, Texas 77056 Telecopier No: (713) 513-1401 Telephone No: (713) 513-1400 Attention: Jack H. Castle, Jr. Senior Subordinated Note Purchase Agreement The parties hereto have caused this Agreement to be duly executed as of the day and year first above written. Heller: HELLER FINANCIAL, INC. By: _______________________________ Name: _______________________________ Title:_______________________________ If to Heller: HELLER FINANCIAL, INC. 500 West Monroe Street Chicago, Illinois 60661 ATTN: Account Manager Corporate Finance Telecopy: (312) 441-7367 with a copy to: HELLER FINANCIAL, INC. 500 West Monroe Street Chicago, Illinois 60661 ATTN: Legal Services Corporate Finance Telecopy: (312) 441-6876 Senior Subordinated Note Purchase Agreement The parties hereto have caused this Agreement to be duly executed as of the day and year first above written. Midwest: MIDWEST MEZZANINE FUND II, L.P. By: ABN AMRO Mezzanine Management II, L.P., its general partner By: ABN AMRO Mezzanine Management II, Inc., its general partner By:__________________________________ J. Allan Kayler, Senior Vice President Notices to: Midwest Mezzanine Fund II, L.P. 208 South LaSalle Street, 10th floor Chicago, Illinois 60604-1003 ATTN: J. Allan Kayler Telecopy: (312) 553-6647 Senior Subordinated Note Purchase Agreement EX-10.24 7 EXHIBIT 10.24 THIS NOTE HAS NOT BEEN REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED, NOR THE SECURITIES LAWS OF ANY STATE. THIS NOTE MAY NOT BE SOLD, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED AT ANY TIME, EXCEPT UPON (1) SUCH REGISTRATION, OR (2) DELIVERY TO THE ISSUER OF THIS NOTE OF AN OPINION OF COUNSEL REASONABLY ACCEPTABLE TO THE ISSUER THAT REGISTRATION IS NOT REQUIRED FOR SUCH TRANSFER, OR (3) THE SUBMISSION TO THE ISSUER OF THIS NOTE OF OTHER EVIDENCE, REASONABLY ACCEPTABLE TO THE ISSUER, TO THE EFFECT THAT ANY SUCH SALE, PLEDGE, HYPOTHECATION OR TRANSFER WILL NOT BE IN VIOLATION OF THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED, OR OTHER APPLICABLE SECURITIES LAWS OF ANY STATE, OR ANY RULES OR REGULATIONS PROMULGATED THEREUNDER. THE PAYMENT OF THE PRINCIPAL OF, AND INTEREST ON, AND ALL OTHER AMOUNTS OWING IN RESPECT OF THE INDEBTEDNESS EVIDENCED BY, THIS NOTE, IS AND SHALL BE EXPRESSLY SUBORDINATED, TO THE EXTENT AND IN THE MANNER SET FORTH HEREIN AND, IF APPLICABLE, IN THAT CERTAIN SUBORDINATION AGREEMENT, OR ANY OTHER SUBORDINATION AGREEMENT NOW OR HEREAFTER EXECUTED, AMONG THE ISSUER OF THE NOTE, THE HOLDER, BANK OF AMERICA, N.A., FORMERLY KNOWN AS NATIONSBANK OF TEXAS, N.A., ITS SUCCESSORS OR ASSIGNS, OR ANY OTHER HOLDER OF SENIOR DEBT (COLLECTIVELY, "SENIOR CREDITOR"), (IN ANY SUCH EVENT, THE "SUBORDINATION AGREEMENT"). SENIOR SUBORDINATED PROMISSORY NOTE $13,621,536.00 JANUARY 31, 2000 CHICAGO, ILLINOIS FOR VALUE RECEIVED, the undersigned, CASTLE DENTAL CENTERS, INC., a Delaware corporation ("Company"), hereby unconditionally promises to pay to the order of ________________________________ ("Holder"), at Holder's office at _____________________ or at such other place as Holder may from time to time designate in writing, in lawful money of the United States of America and in immediately available funds, the principal sum of THIRTEEN MILLION SIX HUNDRED TWENTY ONE THOUSAND FIVE HUNDRED THIRTY SIX AND NO/100 DOLLARS ($13,621,536.00), or, if less, the aggregate unpaid principal amount hereof, at such times as are specified in, and in accordance with the provisions of, the Senior Note Purchase Agreement (or hereinafter defined). This Senior Subordinated Promissory Note is referred to in and was executed and delivered pursuant to that certain Senior Subordinated Note Purchase Agreement of even date herewith (the "Note Purchase Agreement") among the Company, Holder and ________________________________, to which reference is hereby made for a statement of the terms and conditions under which the senior subordinated loan evidenced hereby was made and is to be repaid. All terms which are capitalized and used herein (which are not otherwise specifically defined herein) and which are defined in the Note Purchase Agreement shall be used in this Senior Subordinated Promissory Note as defined in the Note Purchase Agreement. The Company further promises to pay interest on the outstanding unpaid principal amount hereof, as provided in the Note Purchase Agreement, from the date hereof until payment in full hereof at the applicable rate specified in subsection 3.02(a) of the Note Purchase Agreement; provided, however, that if Holder so elects, following the occurrence and during the continuance of an Event of Default, the Company promises to pay to Holder interest on the unpaid principal amount hereof at the applicable rate specified in subsection 3.02(b) of the Note Purchase Agreement. Interest shall be payable in accordance with the provisions specified in subsection 3.02(c) of the Note Purchase Agreement, which specifies that accrued interest on the subordinated Notes shall be payable on each Quarterly Date, except that interest payable at the Post-Default Rate shall be payable from time to time on demand. If a payment hereunder becomes due and payable on a day that is not a Business Day, the payment may be made on the next succeeding Business Day, and such extension of time shall be included in the computation of the amount of interest due on such succeeding Business Day. Checks, drafts or similar items of payment received by Holder shall not constitute payment, but credit therefor shall, solely for the purpose of computing interest earned by Holder, be given in accordance with the Note Purchase Agreement. In no contingency or event whatsoever shall interest charged hereunder, however such interest may be characterized or computed, exceed the highest rate permissible under any law which a court of competent jurisdiction determines is applicable hereto. In the event of any such determination, the provisions of subsection 5.03 of the Note Purchase Agreement shall govern and control. If any suit or action is instituted or attorneys are employed to collect this Senior Subordinated Promissory Note or any part thereof, the Company hereby promises and agrees to pay all costs of collection, including attorneys' fees and court costs. The Company and each endorser, guarantor and surety of this Senior Subordinated Promissory Note hereby waives presentment for payment, protest and demand, and notice of demand, protest, dishonor and nonpayment of this Senior Subordinated Promissory Note. THIS SENIOR SUBORDINATED PROMISSORY NOTE HAS BEEN DELIVERED AT AND SHALL BE DEEMED TO HAVE BEEN MADE AT CHICAGO, ILLINOIS AND SHALL BE INTERPRETED AND THE RIGHTS AND LIABILITIES OF THE PARTIES HERETO SHALL BE DETERMINED IN ACCORDANCE WITH THE INTERNAL LAWS AND DECISIONS OF THE STATE OF ILLINOIS WITHOUT REGARD TO CONFLICTS OF LAW PROVISIONS. Whenever possible each provision of this Senior Subordinated Promissory Note shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Senior Subordinated Promissory Note shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Senior Subordinated Promissory Note. Whenever in this Senior Subordinated Promissory Note reference is made to Holder or the Company, such reference shall be deemed to include, as applicable, a reference to their respective successors and assigns. The provisions of this Senior Subordinated Promissory Note shall be binding upon and shall inure to the benefit of such successors and assigns. The Company's successors and assigns shall include, without limitation, a receiver, trustee or debtor in possession of or for the Company. - REMAINDER OF PAGE INTENTIONALLY LEFT BLANK - [SIGNATURE PAGE FOLLOWS] IN WITNESS WHEREOF, the Company has executed this Senior Subordinated Promissory Note as of the day and year first written above. CASTLE DENTAL CENTERS, INC., a Delaware corporation By: _______________________________ Name: Jack H. Castle, Jr. Title: Chairman and Chief Executive Officer EX-10.25 8 Exhibit 10.25 THIS NOTE AND THE SECURITIES ISSUABLE UPON CONVERSION OF THIS NOTE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAWS. THIS NOTE, THE SECURITIES ISSUABLE UPON CONVERSION OF THIS NOTE AND ANY INTEREST THEREIN MAY NOT BE SOLD, TRANSFERRED, PLEDGED, HYPOTHECATED OR OTHERWISE DISPOSED OF, EXCEPT PURSUANT TO (i) AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND APPLICABLE STATE SECURITIES LAWS OR (ii) AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT. THIS NOTE AND THE SECURITIES ISSUABLE UPON CONVERSION OF THIS NOTE ARE SUBJECT TO CERTAIN RESTRICTIONS SET FORTH IN A STOCKHOLDERS AGREEMENT, DATED AS OF JANUARY 31, 2000 (THE "STOCKHOLDERS AGREEMENT"). A COPY OF SUCH AGREEMENT MAY BE OBTAINED BY THE HOLDER HEREOF AT THE COMPANY'S PRINCIPAL PLACE OF BUSINESS WITHOUT CHARGE. THE PAYMENT OF THE PRINCIPAL OF, AND INTEREST ON, AND ALL OTHER AMOUNTS OWING IN RESPECT OF THE INDEBTEDNESS EVIDENCED BY, THIS NOTE, IS AND SHALL BE EXPRESSLY SUBORDINATED, TO THE EXTENT AND IN THE MANNER SET FORTH HEREIN AND, IF APPLICABLE, IN THAT CERTAIN SUBORDINATION AGREEMENT, OR ANY OTHER SUBORDINATION AGREEMENT NOW OR HEREAFTER EXECUTED, AMONG THE COMPANY, THE HOLDER, BANK OF AMERICA, N.A., FORMERLY KNOWN AS NATIONSBANK OF TEXAS, N.A., ITS SUCCESSORS OR ASSIGNS, OR ANY OTHER HOLDER OF SENIOR DEBT (COLLECTIVELY, "SENIOR CREDITOR"), (IN ANY SUCH EVENT, THE "SUBORDINATION AGREEMENT"). CONVERTIBLE SUBORDINATED NOTE JANUARY 31, 2000 $1,378,464 FOR VALUE RECEIVED, CASTLE DENTAL CENTERS, INC., a Delaware corporation (the "COMPANY"), hereby promises to pay to the order of ________________________________________or registered assigns ("HOLDER") the principal amount of ONE MILLION THREE HUNDRED SEVENTY EIGHT THOUSAND FOUR HUNDRED SIXTY FOUR AND NO/00 DOLLARS ($1,378,464.00), on January 31, 2009 (the "MATURITY DATE"). The Company further promises to pay interest on the outstanding unpaid principal amount hereof, as provided in the Purchase Agreement (as defined below), from the date hereof until payment in full hereof at the applicable rate specified in subsection 3.02(a) of the Purchase Agreement; provided, however, that if Holder so elects, following the occurrence and during the continuance of an Event of Default, the Company promises to pay to Holder interest on the unpaid principal amount hereof at the applicable rate specified in subsection 3.02(b) of the Purchase Agreement. Interest shall be payable in accordance with the provisions specified in subsection 3.02(c) of the Purchase Agreement. This Convertible Subordinated Note (hereinafter referred to as the "NOTE") is being issued by the Company pursuant to the terms of the Senior Subordinated Note Purchase Agreement, dated January 31, 2000 (the "PURCHASE AGREEMENT"), executed by and among the Company, the Holder and certain other parties thereto. All terms which are capitalized and used herein (which are not otherwise specifically defined herein) and which are defined in the Purchase Agreement shall have the meanings set forth in the Purchase Agreement. 1. PAYMENTS OF PRINCIPAL AND INTEREST. The principal amount hereof, to the extent that it has not been converted into shares of Common Stock pursuant to Section 2 hereof, shall be payable in full on the Maturity Date. All payments of principal and interest on this Note shall be made in lawful money of the United States of America by wire transfer of immediately available funds to such account as the Holder may from time to time designate by written notice in accordance with the provisions of this Note. If a payment hereunder becomes due and payable on a day that is not a Business Day, the payment may be made on the next succeeding Business Day, and such extension of time shall be included in the computation of the amount of interest due on such succeeding Business Day. Checks, drafts or similar items of payment received by Holder shall not constitute payment, but credit therefor shall, solely for the purpose of computing interest earned by Holder, be given in accordance with the Purchase Agreement. In no contingency or event whatsoever shall interest charged hereunder, however such interest may be characterized or computed, exceed the highest rate permissible under any law which a court of competent jurisdiction determines is applicable hereto. In the event of any such determination, the provisions of subsection 5.03 of the Purchase Agreement shall govern and control. 2. CONVERSION OF NOTES. This Note shall be convertible into shares of the Company's common stock, $.001 par value per share (the "COMMON STOCK"), on the terms and conditions set forth in this Section 2. (a) HOLDER'S CONVERSION RIGHT; MANDATORY CONVERSION. Subject to the provisions of Section 2(c), at any time or times on or after the Issuance Date, the Holder shall be entitled to convert all or any part of the outstanding and unpaid principal of this Note (in each case, the "CONVERSION AMOUNT") into fully paid and nonassessable shares of Common Stock in accordance with Section 2(d), at the Conversion Rate (as defined below). (b) CONVERSION RATE. The number of shares of Common Stock issuable upon conversion of a Conversion Amount of this Note pursuant to Section 2(a) shall be determined according to the following formula (the "CONVERSION RATE"): CONVERSION AMOUNT Conversion Price (c) REGULATORY PROBLEM. In the event Holder determines that it has a Regulatory Problem (as defined below), Holder shall have the right to transfer its entire interest in the Company without regard to any restriction on transfer set forth in this Note (other than securities laws restrictions) and the Company agrees to take all such actions as are reasonably requested by Holder in order to (i) effectuate and facilitate any transfer by Holder of its -2- interests to any person designated by Holder (subject to compliance with applicable federal and state securities) or (ii) to permit Holder (or any affiliate thereof) to exchange all or any portion of the Common Stock then held by, or issuable to, it on a "share-for-share" basis for interests of a class of non-voting stock of the Company, which non-voting stock shall be identical in all respects to such Common Stock, except such stock shall be non-voting and shall be convertible into voting stock on such terms as are requested by such holder in light of regulatory considerations then prevailing. Company agrees to enter into such additional agreements, adopt such amendments hereto and to the Certificate of Incorporation of the Company and to take such additional actions as are reasonably requested by Holder in order to effectuate the intent of the foregoing. For purposes hereof, a "Regulatory Problem" means any set of facts or circumstances wherein Holder reasonably believes it is not entitled to hold, or exercise any significant right with respect to, the Common Stock. (d) MECHANICS OF CONVERSION. Any conversion of this Note at the option of the Holder shall be conducted in the following manner: (i) HOLDER'S DELIVERY REQUIREMENTS. To convert this Note into shares of Common Stock on any date set forth in the Conversion Notice by the Holder (the "CONVERSION DATE"), the Holder hereof shall (A) transmit by facsimile (or otherwise deliver), for receipt on such date, a fully executed notice of conversion in the form attached hereto as Exhibit A (the "CONVERSION NOTICE") to the Company with a copy thereof to the Company's designated transfer agent (the "TRANSFER AGENT") and (B) if required by Section 2(d)(vi), surrender to a common carrier for delivery to the Company as soon as practicable following such date the original Note being converted (or an indemnification undertaking with respect to such Note in the case of its loss, theft or destruction). (ii) COMPANY'S RESPONSE. Upon receipt by the Company of a Conversion Notice, the Company shall (A) promptly, and in no event later than one business day after receipt, immediately send, via facsimile, a confirmation of receipt of such Conversion Notice to such Holder and the Transfer Agent, which confirmation shall constitute an instruction to the Transfer Agent to process such Conversion Notice in accordance with the terms herein, and (B) on or before the second Business Day following the date of receipt by the Company of such Conversion Notice (the "SHARE DELIVERY DATE"): (i) issue and deliver to the address as specified in the Conversion Notice, a certificate, registered in the name of the Holder or its designee, for the number of shares of Common Stock to which the Holder shall be entitled, or (ii) provided the Transfer Agent is participating in The Depository Trust Company ("DTC") Fast Automated Securities Transfer Program, upon the request of the Holder, credit such aggregate number of shares of Common Stock to which the Holder shall be entitled to the Holder's or its designee's balance account with DTC through its Deposit Withdrawal Agent Commission system. Subject to Section 2(d)(vi), if less than all of the Conversion Amount of this Note is submitted for conversion, then the Company shall, as soon as practicable and in no event later than three Business Days -3- after receipt of the Note (the "NOTE DELIVERY DATE") and at its own expense, issue and deliver to the Holder a new Note for the outstanding principal amount not converted. (iii) DISPUTE RESOLUTION. In the case of a dispute as to the determination of the Current Market Price or the arithmetic calculation of the Conversion Rate, the Company shall instruct the Transfer Agent to issue to the Holder the number of shares of Common Stock that is not disputed and shall submit the disputed determinations or arithmetic calculations to the Holder via facsimile within five Business Days of receipt of such Holder's Conversion Notice. (iv) RECORD HOLDER. The person or persons entitled to receive the shares of Common Stock issuable upon a conversion of this Note shall be treated for all purposes as the record holder or holders of such shares of Common Stock on the Conversion Date. (v) COMPANY'S FAILURE TO TIMELY CONVERT. (A) CASH DAMAGES. If within ten Business Days after the Company's receipt of the Conversion Notice the Company shall fail to issue a certificate to the Holder or its designee or credit the Holder's or its designee's balance account with DTC for the number of shares of Common Stock to which such Holder or its designee is entitled upon such Holder's conversion of this Note or, subject to Section 2(d)(vi), the Company shall fail to issue a new Note representing the principal amount to which such Holder is entitled, if any, pursuant to Section 2(d)(ii), in addition to all other available remedies which such Holder may pursue hereunder and under the Purchase Agreement (including indemnification thereunder), the Company shall pay additional damages to such Holder for each date after the Share Delivery Date such conversion is not timely effected and/or each date after the Note Delivery Date such new Note is not delivered in an amount equal to 0.5% of the product of (I) the sum of the number of shares of Common Stock not issued to the Holder or its designee on or prior to the Share Delivery Date and to which such Holder or its designee is entitled and, in the event the Company has failed to deliver a new Note to the Holder on or prior to the Note Delivery Date, the number of shares of Common Stock issuable upon conversion of the Conversion Amount represented by new Note, as of the Note Delivery Date and (II) the Current Market Price of the Common Stock on the Share Delivery Date, in the case of the failure to deliver Common Stock, or the Note Delivery Date, in the case of failure to deliver a new Note. If the Company fails to pay the additional damages set forth in this Section 2(d)(v) within five Business Days of the date incurred, then the Holder entitled to such payments shall have the right at any time, so long as the Company continues to fail to make such payments, to require the Company, upon written notice, to immediately issue, in lieu of such cash damages, the number of shares of Common Stock equal to the quotient of (X) the aggregate amount of the damages payments described -4- herein divided by (Y) the Conversion Price in effect on such Conversion Date as specified by the Holder in the Conversion Notice. (B) VOID CONVERSION NOTICE; ADJUSTMENT TO CONVERSION PRICE. If for any reason the Holder has not received all of the shares of Common Stock prior to the tenth Business Day after the expiration of the Share Delivery Date with respect to a conversion of this Note, then the Holder, upon written notice to the Company, may void its Conversion Notice with respect to, and retain or have returned or restored as of the Conversion Date, as the case may be, any principal amount of this Note that has not been converted pursuant to such Holder's Conversion Notice; PROVIDED that the voiding of a Holder's Conversion Notice shall not effect the Company's obligations to make any payments which have accrued prior to the date of such notice pursuant to Section 2(d)(v)(A) or otherwise. Thereafter, the Conversion Price of the principal amount of this Note retained by, or returned or restored in favor of, the Holder for failure to timely convert shall be adjusted to the lesser of (I) the Conversion Price as in effect on the date on which the Holder voided the Conversion Notice and (II) the lowest Closing Sale Price during the period beginning on the Conversion Date and ending on the date such Holder voided the Conversion Notice, subject to further adjustment as provided in this Note. (vi) BOOK-ENTRY. Notwithstanding anything to the contrary set forth herein, upon conversion of any portion of this Note in accordance with the terms hereof, the Holder thereof shall not be required to physically surrender this Note to the Company unless the full Conversion Amount then outstanding is being converted. The Company shall maintain records showing the Conversion Amount so converted and the dates of such conversions or shall use such other method, reasonably satisfactory to the Holder, so as not to require physical surrender of this Note upon each such conversion. Notwithstanding the foregoing, if any portion of this Note is converted as aforesaid, thereafter, the Holder may not transfer this Note unless the Holder first physically surrenders this Note to the Company, whereupon the Company will forthwith issue and deliver upon the order of the Holder a new Note of like tenor, registered as the Holder may request, representing in the aggregate the remaining Conversion Amount represented by this Note. The Holder and any assignee, by acceptance of this Note or such new Note, acknowledge and agree that, by reason of the provisions of this paragraph, following conversion of any portion of this Note, the Conversion Amount represented by this Note may be less than the principal amount set forth on the face hereof. (vii) FRACTIONAL SHARES. No fractional shares of Common Stock or scrip shall be issued to any Holder in connection with the conversion of this Note. Instead of any fractional shares of Common Stock that would otherwise be issuable to such Holder, the Company will pay to such Holder a cash adjustment in respect of such fractional interest in an amount equal to that fractional interest of the then Current Market Price per share of Common Stock. -5- (e) TAXES. The Company shall pay any and all taxes that may be payable with respect to the issuance and delivery of Common Stock upon the conversion of Notes; provided, however, that the Holder shall be required to pay any and all taxes that may be payable in respect of any transfer involved in the issuance and delivery of Common Stock in a name other than that of the then Holder as reflected upon the books of the Company. (f) CERTAIN ADJUSTMENTS. In addition to any other adjustments provided herein, the terms of this Note will be subject to adjustment from time to time as provided in this Section 2(f). (i) STOCK DIVIDENDS, SUBDIVISION, COMBINATION OR RECLASSIFICATION OF COMMON STOCK. If at any time after the Issuance Date the Company shall (A) declare a stock dividend on the Common Stock payable in shares of its capital stock (including Common Stock), (B) increase the number of shares of Common Stock outstanding by a subdivision or split-up of shares of Common Stock, (C) decrease the number of shares of Common Stock outstanding by a combination of shares of Common Stock or (D) issue any shares of its capital stock in a reclassification of the Common Stock, then, on the record date for such dividend or the effective date of such subdivision or split-up, combination or reclassification, as the case may be, the Conversion Price will be adjusted so that the Holder will be entitled to receive the number and kind of shares of Common Stock that such Holder would have owned or been entitled to receive upon or by reason of such event had this Note been converted immediately prior thereto, and the Conversion Price will be adjusted as provided below in paragraph (vii) in this Section 2(f). (ii) REORGANIZATION, ETC. If at any time after the Issuance Date any consolidation of the Company with or merger of the Company with or into any other Person (other than a merger or consolidation in which the Company, is the surviving or continuing corporation and which does not result in any reclassification of, or change (other than a change in par value or from par value to no par value or from no par value to par value, or as a result of a subdivision or combination) in, outstanding shares of Common Stock) or any sale, lease or other transfer of all or substantially all of the assets of the Company to any other person (each, a "REORGANIZATION EVENT"), shall be effected in such a way that the holders of Common Stock shall be entitled to receive cash, stock, other securities or assets (whether such cash, stock, other securities or assets are issued or distributed by the Company or another Person) with respect to or in exchange for Common Stock, then, upon conversion of this Note, the Holder shall have the right to receive the kind and amount of cash, stock, other securities or assets receivable upon such Reorganization Event by a holder of the number of shares of Common Stock that such Holder would have been entitled to receive upon conversion of this Note had this Note been converted immediately before such Reorganization Event, subject to adjustments that shall be as nearly equivalent as may be practicable to the adjustments provided for in this Section 2(f). -6- (iii) CERTAIN ISSUANCES OF COMMON STOCK. If at any time after the Issuance Date the Company shall issue or sell, or fix a record date for the issuance of, (A) Common Stock (or securities convertible into or exchangeable or exercisable for Common Stock) (other than Excluded Securities) or (B) rights, options or warrants entitling the holders thereof to subscribe for or purchase Common Stock (or securities convertible into or exchangeable or exercisable for Common Stock) (other than Excluded Securities), in any such case, at a price per share (treating the price per share of the securities convertible into or exchangeable or exercisable for Common Stock as equal to (x) the sum of (i) the price for a unit of the security convertible into or exchangeable or exercisable for Common Stock, plus (ii) any additional consideration initially payable upon the conversion of such security into Common Stock or the exchange or exercise of such security for Common Stock divided by (y) the number of shares of Common Stock initially underlying such convertible, exchangeable or exercisable security) that is less than the Measuring Price on the date of such issuance or such record date, then, immediately after the date of such issuance or sale or on such record date, the number of shares of Common Stock to be delivered upon conversion of this Note shall be increased so that the Holder thereafter shall be entitled to receive the number of shares of Common Stock determined by multiplying the number of shares of Common Stock such Holder would have been entitled to receive immediately before the date of such issuance or sale or such record date by a fraction, the denominator of which shall be the number of shares of Common Stock outstanding (calculated to include the shares of Common Stock underlying the Note and all then currently convertible and exchangeable securities that are "in the money") on such date plus the number of shares of Common Stock that the aggregate offering price of the total number of shares so offered for subscription or purchase (or the aggregate purchase price of the convertible, exchangeable or exercisable securities so offered plus the aggregate of amount of any additional consideration initially payable upon conversion into Common Stock or exchange or exercise for Common Stock) would purchase at the Measuring Price and the numerator of which shall be the number of shares of Common Stock outstanding (calculated to include the shares of Common Stock underlying the Notes and all then currently exercisable, convertible and exchangeable securities that are "in the money") on such date plus the number of additional shares of Common Stock offered for subscription or purchase (or into or for which the convertible or exchangeable securities or rights, options or warrants so offered are initially convertible or exchangeable or exercisable, as the case may be), and the Conversion Price shall be adjusted as provided below in paragraph (vii) in this Section 2(f). For purposes of this Section 2(f)(iii), any shares of Common Stock issued as consideration in any Acquisition shall be deemed to have been issued at a "price per share" equal to the Current Market Value thereof on the date of such issuance. (iv) EXTRAORDINARY DISTRIBUTIONS. If at any time after the Issuance Date, the Company shall distribute to all holders of its Common Stock (including any such distribution made in connection with a consolidation or merger in which the Company is the continuing or surviving corporation and the Common Stock is not changed or -7- exchanged) cash, evidences of indebtedness, securities or other assets (excluding (A) ordinary course cash dividends to the extent such dividends exceed the Company's retained earnings and (B) dividends payable in shares of capital stock for which adjustment is made under Section 2(f)(i)) or rights, options or warrants to subscribe for or purchase securities of the Company (excluding those for which adjustment is made under Section 2(f)(iii)), then the number of shares of Common Stock to be delivered to such Holder upon conversion of this Note shall be increased so that the Holder thereafter shall be entitled to receive the number of shares of Common Stock determined by multiplying the number of shares such Holder would have been entitled to receive immediately before such record date by a fraction, the denominator of which shall be the Current Market Price per share of Common Stock on such record date minus the then fair market value (as reasonably determined by the Board of Directors of the Company in good faith) of the portion of the cash, evidences of indebtedness, securities or other assets so distributed or of such rights or warrants applicable to one share of Common Stock (provided that such denominator shall in no event be less than $.0l) and the numerator of which shall be the Current Market Price per share of the Common Stock, and the Conversion Price shall be adjusted as provided below in paragraph (vii) in this Section 2(f). (v) PRO RATA REPURCHASES. If at any time after the Issuance Date, the Company or any subsidiary thereof shall make a Pro Rata Repurchase, then the number of shares of Common Stock to be delivered to such Holder upon conversion of this Note shall be increased so that the Holder thereafter shall be entitled to receive the number of shares of Common Stock determined by multiplying the number of shares of Common Stock such Holder would have been entitled to receive immediately before such Pro Rata Repurchase by a fraction (which in no event shall be less than one) the denominator of which shall be (i) the product of (x) the number of shares of Common Stock outstanding immediately before such Pro Rata Repurchase and (y) the Current Market Price of the Common Stock as of the day immediately preceding the first public announcement by the Company of the intent to effect such Pro Rata Repurchase minus (ii) the aggregate purchase price of the Pro Rata Repurchase (provided that such denominator shall never be less than $.0l), and the numerator of which shall be the product of (i) the number of shares of Common Stock outstanding immediately before such Pro Rata Repurchase minus the number of shares of Common Stock repurchased in such Pro Rata Repurchase and (ii) the Current Market Price of the Common Stock as of the day immediately preceding the first public announcement by the Company of the intent to effect such Pro Rata Repurchase. (vi) CARRYOVER. Notwithstanding any other provision of this Section 2(f), no adjustment shall be made to the number of shares of Common Stock to be delivered to the Holder (or to the Conversion Price) if such adjustment represents less than .05% of the number of shares to be so delivered, but any lesser adjustment shall be carried forward and shall be made at the time and together with the next subsequent adjustment that together with any adjustments so carried forward shall amount to .05% or more of the number of shares to be so delivered. -8- (vii) CONVERSION PRICE ADJUSTMENT. Whenever the number of shares of Common Stock purchasable upon the conversion of the Note is adjusted as provided pursuant to this Section 2(f), the Conversion Price per share payable upon the conversion of this Note shall be adjusted by multiplying such Conversion Price immediately prior to such adjustment by a fraction, of which the numerator shall be the number of shares of Common Stock purchasable upon the conversion of the Note immediately prior to such adjustment, and of which the denominator shall be the number of shares of Common Stock purchasable immediately thereafter; PROVIDED, HOWEVER, that the Conversion Price for each share of Common Stock shall in no event be less than the par value of such share. (viii) MULTIPLE ADJUSTMENTS. If any action or transaction would require adjustment of the number of shares of Common Stock to be delivered to the Holder upon conversion of this Note pursuant to more than one paragraph of this Section 2(f), only one adjustment shall be made and each such adjustment shall be the amount of adjustment that has the highest absolute value. (g) NOTICE OF ADJUSTMENT. Whenever the number of shares of Common Stock or the Conversion Price of such shares of Common Stock is adjusted, as herein provided, the Company shall deliver to the Holder in writing a notice of such adjustment or adjustments and a certificate of a firm of independent public accountants of recognized national standing selected by the Board of Directors of the Company (who shall be appointed at the Company's expense and who may be the independent public accountants regularly employed by the Company) setting forth the number of shares of Common Stock and the Conversion Price of such shares after such adjustment, setting forth a brief statement of the facts requiring such adjustment and setting forth the computation by which such adjustment was made. 3. RESERVATION OF SHARES. The Company covenants and agrees as follows: (a) All shares of Common Stock that are issued upon the conversion of this Note will, upon issuance, be validly issued, fully paid and nonassessable, not subject to any preemptive rights, and free from all taxes, liens, security interests, charges, and other encumbrances with respect to the issuance thereof, other than taxes in respect of any transfer occurring contemporaneously with such issue. (b) During the period within which this Note may be converted, the Company will at all times have authorized and reserved, and keep available free from preemptive rights, a sufficient number of shares of Common Stock to provide for the exercise of the rights represented by this Note. 4. VOTING RIGHTS. Prior to conversion of all or any portion of this Note, Holders shall have no voting rights, except as required by law, including but not limited to the General Corporation Law of the State of Delaware, and as expressly provided in this Note. -9- 5. NOTICE OF CORPORATE ACTION. So long as this Note has not been converted or redeemed in full, in the event of: (a) any consolidation or merger involving the Company and any other party or any transfer of all or substantially all the assets of the Company to any other party, or (b) any voluntary or involuntary dissolution, liquidation or winding-up of the Company, the Company will notify the Holder in writing of the date or expected date on which a reorganization, reclassification, recapitalization, consolidation, merger, transfer, dissolution, liquidation or winding- up is to take place and the time, if any such time is to be fixed, as of which the holders of record of Common Stock (or other securities) shall be entitled to exchange their shares of Common Stock (or other securities) for the securities or other property deliverable upon such reorganization, reclassification, recapitalization, consolidation, merger, transfer, dissolution, liquidation or winding- up. Such notice shall be delivered as soon as practicable and if possible at least twenty days prior to the date therein specified in the case of any date referred to in the foregoing sentence. Failure to give the notice specified hereunder shall have no effect on the status or effectiveness of the action to which the required notice relates. 6. REISSUANCE OF NOTES. Subject to Section 2(d)(vi), in the event of a conversion or redemption pursuant to this Note of less than all of the Conversion Amount represented by this Note, the Company shall promptly cause to be issued and delivered to the Holder, upon tender by the Holder of the Note converted or redeemed, a new note of like tenor representing the remaining principal amount of this Note which has not been so converted or redeemed. 7. DEFINITIONS. As used herein, unless the context otherwise requires, the following terms have the following meanings: "ACQUISITION" means any acquisition of another Person by the Company by merger, purchase of shares of capital stock or purchase of all or substantially all of such other Person's assets. "AFFILIATE" means, as applied to any Person, (i) any other Person directly or indirectly controlling, controlled by or under common control with, that Person, (ii) any other Person that owns or controls 5% or more of any class of equity securities (including any equity securities issuable upon the exercise of any option or convertible security) of that Person or any of its Affiliates, or (iii) any director, partner, officer, agent, employee or relative of such Person. For the purposes of this definition, "control" (including with correlative meanings, the terms "controlling", "controlled by", and "under common control with") as applied to any Person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of that Person whether through ownership of voting securities or by contract or otherwise. -10- "CONVERSION PRICE" means THREE AND 11.25/00 DOLLARS ($3.1125), subject to adjustment as provided herein. "CURRENT MARKET PRICE" means, with respect to each share of Common Stock as of any date, the dollar volume-weighted average trading price per share of Common Stock (as reported by Bloomberg through its "Volume at Price" function) for the ten consecutive trading days prior to such date; provided that if on any such date the shares of Common Stock are not listed or admitted for trading on any national securities exchange or quoted by NASDAQ or a similar service, the Current Market Price for a share of Common Stock shall be the fair market value of such share as determined in good faith by the Board of Directors of the Company. If the Board of Directors is unable to determine the fair market value, or if the holders of a majority of the Notes issued pursuant to the Purchase Agreement disagree with the Board's determination of fair market value by written notice delivered to the Company within five Business Days after the Board's determination thereof is communicated in writing to such holders, then the Company and a majority-in-interest of such holders shall select an Independent Financial Expert which shall determine such fair market value. If the Company and such holders are unable to agree upon an Independent Financial Expert within fifteen Business Days after the notice by such holders, each of the Company and such holders shall select an Independent Financial Expert within five Business Days following the expiration of such fifteen Business Day period, and these Independent Financial Experts shall select a third Independent Financial Expert, and the third Independent Financial Expert shall determine such fair market value. The determination of fair market value by such Independent Financial Expert shall be final, binding and conclusive on the Company and all Holders. All costs and fees of any of this Independent Financial Expert(s) retained in accordance with the foregoing shall be borne by the Company. "EXCLUDED SECURITIES" means (i) shares of Common Stock issued upon conversion or exercise of convertible securities, warrants and options of the Company, outstanding on the Issuance Date, (ii) shares of Common Stock, and options to purchase such shares, issued to officers, directors, employees or former employees of, or consultants to, the Company or any of its subsidiaries pursuant to any equity incentive plan, agreement or other arrangement which has been approved by a vote of at least two-thirds of the Board of Directors of the Company, provided that the total number of shares of Common Stock which may be Excluded Securities under this clause (ii) shall not exceed 1,250,000 shares (subject to equitable adjustment with respect to any stock split, stock dividend, reclassification or other similar event described in Section 2(f)(i) hereof), and (iii) shares of Common Stock issued upon conversion of the Note. "GAAP" means generally accepted accounting principles, consistently applied. "INDEPENDENT FINANCIAL EXPERT" means an independent nationally recognized investment banking firm. "ISSUANCE DATE" means the date of issuance of the Note. -11- "MEASURING PRICE" means, as of any date of determination, (i) with respect to any issuance of securities as consideration for any Acquisition by the Company, the Conversion Price as of such date, and (ii) with respect to any other issuance of securities by the Company, the greater of the Current Market Price of the Common Stock and the Conversion Price as of such date. "PERSON" means any individual, limited liability company, partnership, joint venture, association, joint-stock company, corporation, trust, unincorporated organization, estate and other entity or government or any department or agency thereof. "PRO RATA REPURCHASE" means any purchase of shares of Common Stock by the Company or by any of its subsidiaries whether for cash, shares of capital stock of the Company, other securities of the Company, evidences of indebtedness of the Company or any other Person or any other property (including, without limitation, shares of capital stock, other securities or evidences of indebtedness of a subsidiary of the Company), or any combination thereof, which purchase is subject to Section 13(e) of the Securities Exchange Act of 1934, as amended, or is made pursuant to an offer made available to all holders of Common Stock. 8. LOST OR STOLEN NOTES. Promptly upon receipt by the Company of evidence satisfactory to the Company of the loss, theft, destruction or mutilation of any Note, and, in the case of loss, theft or destruction, of an indemnification undertaking by the Holder to the Company in a form reasonably acceptable to the Company and, in the case of mutilation, upon surrender and cancellation of the Notes, the Company shall execute and deliver new notes of like tenor and date; provided, however, the Company shall not be obligated to re-issue notes if the Holder contemporaneously requests the Company to convert such remaining principal amount into Common Stock. 9. PAYMENT OF COLLECTION, ENFORCEMENT AND OTHER COSTS. If any suit or action is instituted or attorneys are employed to collect or enforce this Note or any part thereof, the Company hereby promises and agrees to pay all costs of collection, including attorneys' fees and court costs. 10. CANCELLATION. After all principal and accrued interest at any time owed on this Note has been paid in full, this Note shall automatically be deemed canceled, shall be surrendered to the Company for cancellation and shall not be reissued. 11. WAIVER OF NOTICE. To the extent permitted by law, the Company hereby waives demand, notice, protest and all other demands and notices in connection with the delivery, acceptance, performance, default or enforcement of this Note and the Purchase Agreement. 12. GOVERNING LAW. This Note shall be construed and enforced in accordance with, and all questions concerning the construction, validity, interpretation and performance of this Note shall be governed by, the laws of the State of Illinois, without giving effect to provisions thereof regarding conflict of laws. -12- 13. REMEDIES, CHARACTERIZATIONS, OTHER OBLIGATIONS, BREACHES AND INJUNCTIVE RELIEF. The remedies provided in this Note shall be cumulative and in addition to all other remedies available under this Note, at law or in equity (including a decree of specific performance and/or other injunctive relief), no remedy contained herein shall be deemed a waiver of compliance with the provisions giving rise to such remedy and nothing herein shall limit a holder's right to pursue actual damages for any failure by the Company to comply with the terms of this Note. The Company covenants to each Holder of Notes that there shall be no characterization concerning this instrument other than as expressly provided herein. Amounts set forth or provided for herein with respect to payments, conversion and the like (and the computation thereof) shall be the amounts to be received by the Holder thereof and shall not, except as expressly provided herein, be subject to any other obligation of the Company (or the performance thereof). The Company acknowledges that a breach by it of its obligations hereunder will cause irreparable harm to the holders of the Notes and that the remedy at law for any such breach may be inadequate. The Company therefore agrees that, in the event of any such breach or threatened breach, the holders of the Notes shall be entitled, in addition to all other available remedies, to an injunction restraining any breach, without the necessity of showing economic loss and without any bond or other security being required. 14. SPECIFIC SHALL NOT LIMIT GENERAL; CONSTRUCTION. No specific provision contained in this Note shall limit or modify any more general provision contained herein. This Note shall be deemed to be jointly drafted by the Company and all holders and shall not be construed against any person as the drafter hereof. 15. FAILURE OR INDULGENCE NOT WAIVER. No failure or delay on the part of this Note in the exercise of any power, right or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such power, right or privilege preclude other or further exercise thereof or of any other right, power or privilege. 16. NOTICES. Whenever notice is required to be given under this Note, unless otherwise provided herein, such notice shall be given in accordance with the notice provisions in the Purchase Agreement. Any party may by notice given in accordance with this Section 17 designate another address or person for receipt of notices hereunder. -13- IN WITNESS WHEREOF, the Company has caused this Note to be signed by Jack H. Castle, Jr., its Chairman and Chief Executive Officer, as of day and year first written above. CASTLE DENTAL CENTERS, INC. By: __________________________________ Name: Jack H. Castle, Jr. Its: Chairman and Chief Executive Officer Senior Subordinated Convertible Note -14- EXHIBIT A CASTLE DENTAL CENTERS, INC. CONVERSION NOTICE Reference is made to the Note issued by Castle Dental Centers, Inc. (the "COMPANY"). In accordance with and pursuant to the Note, the undersigned hereby elects to convert the Conversion Amount (as defined in the Note) of the Note, indicated below into shares of Common Stock, par value $.001 per share (the "COMMON STOCK"), of the Company as of the date specified below. Date of Conversion:_______________________________________________________ Aggregate Conversion Amount to be converted:______________________________ Note no(s). of Note to be converted:______________________________________ Please confirm the following information:_______________________________________ Conversion Price:_________________________________________________________ Number of shares of Common Stock to be issued:____________________________ Please issue the Common Stock into which the Note is being converted and, if applicable, any check drawn on an account of the Company in the following name and to the following address: Issue to:_________________________________________________________________ _________________________________________________________________ _________________________________________________________________ Facsimile Number:_________________________________________________________ Authorization:____________________________________________________________ By:_________________________________________ Title:______________________________________ Dated:____________________________________________________________________ Account Number: (if electronic book-entry transfer):____________________________________ Transaction Code Number (if electronic book-entry transfer):____________________________________ Senior Subordinated Convertible Note -15- ACKNOWLEDGMENT The Company hereby acknowledges this Conversion Notice and hereby directs [TRANSFER AGENT] to issue the above indicated number of shares of Common Stock in accordance with the Transfer Agent Instructions dated ___________ ___, _____ from the Company and acknowledged and agreed to by [TRANSFER AGENT]. CASTLE DENTAL CENTERS, INC. By:_________________________________________ Name:_______________________________________ Title:______________________________________ Senior Subordinated Convertible Note -16- EX-10.26 9 EXHIBIT 10.26 FOURTH AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT This FOURTH AMENDMENT to AMENDED AND RESTATED CREDIT AGREEMENT (this "FOURTH AMENDMENT") effective as of December 31, 1999 (the "EFFECTIVE DATE" and to continue to be effective to and including December 31, 2000 as provided in Section 15 below), is by and among CASTLE DENTAL CENTERS, INC., a Delaware corporation ("BORROWER"), and BANK OF AMERICA, N.A. (formerly known as NationsBank, N.A.), a national banking association (in its individual capacity, "BANK OF AMERICA"), as agent (in such capacity, "AGENT") for each of the lenders that is a signatory hereto (individually, together with its successors and assigns, "LENDER" and collectively, "LENDERS") and such Lenders. W I T N E S S E T H: WHEREAS, the Borrower, the Agent and the Lenders are parties to that certain Amended and Restated Credit Agreement dated as of December 18, 1998, as amended by First Amendment to Amended and Restated Credit Agreement dated as of July 20, 1999, as amended by Second Amendment to Amended and Restated Credit Agreement dated as of September 30, 1999, as Amended by Third Amendment to Amended and Restated Credit Agreement dated as of January 31, 2000 (such Amended and Restated Credit Agreement as amended and as the same may be further amended from time to time, the "AGREEMENT"), pursuant to which the Lenders agreed to make loans to and extensions of credit on behalf of the Borrower; and WHEREAS, the Borrower has requested that the Agent and the Lenders amend the Agreement, and the Agent and the Lenders have agreed to amend the Agreement in the particulars hereinafter provided. NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the parties hereto agree as follows: 1. TERMS DEFINED ABOVE. As used in this Fourth Amendment, each of the terms "Agent," "Bank of America," "Borrower," "Agreement," "Effective Date," "Lenders," and "Fourth Amendment" shall have the meaning assigned to such term herein above. 2. TERMS DEFINED IN AGREEMENT. Each term defined in the Agreement and used herein without definition shall have the meaning assigned to such term in the Agreement, unless expressly provided to the contrary. 3. OTHER DEFINITIONAL PROVISIONS. The words "hereby," "herein," "hereinafter," "hereof," "hereto," and "hereunder" when used in this Fourth Amendment shall refer to this Fourth Amendment as a whole and not to any particular paragraph or provision of this Fourth Amendment. 4. AMENDMENTS AND SUPPLEMENTS TO DEFINITIONS. Page 1 (1) The following terms, which are defined in Section 1.02 of the Agreement, are hereby amended in their entirety to read as follows: "APPLICABLE MARGIN" effective as of April 1, 2000, the applicable per annum percentage set forth at the appropriate intersection in the table shown below, based on the ratio of Total Funded Debt to EBITDA, determined as of the end of the most recent fiscal quarter (beginning with the fiscal quarter ended March 31, 2000) of the Borrower: ------------------------------------------------------------ APPLICABLE APPLICABLE MARGIN TOTAL FUNDED DEBT TO MARGIN ALTERNATE BASE EBITDA EURODOLLAR RATE ------------------------------------------------------------ Less than 1.0 2.25% 0.00% ------------------------------------------------------------ Greater than or equal to 1.0 but less than 1.5 2.5% .25% ------------------------------------------------------------ Greater than or equal to 1.5 but less than 2.0 2.75% .25% ------------------------------------------------------------ Greater than or equal to 2.0 but less than 2.5 3.0% .50% ------------------------------------------------------------ Greater than or equal to 2.5 but less than 4.0 3.5% 1.00% ------------------------------------------------------------ Greater than or equal to 4.0 4.5% 2.00% ------------------------------------------------------------ Each change in the Applicable Margin resulting from a change in the ratio of Total Funded Debt to EBITDA shall take effect as of the date of determination of the ratio of Total Funded Debt to EBITDA. For clarity purposes it is understood and agreed that Total Funded Debt includes, without limitation, any and all deferred interest under any Subordinated Debt. "BORROWING BASE" shall mean (i) for the period from December 31, 1999 through January 31, 2000, the amount equal to three and three quarters (3.75) times EBITDA as of the end of the most recent fiscal quarter of the Borrower (calculated on a rolling four quarter basis), (ii) for the period from February 1, 2000 through December 30, 2000, the amount equal to three and four tenths (3.40) times EBITDA as of the end of the most recent fiscal quarter of the Borrower (calculated on a rolling four quarter basis), (iii) and (iii) on December 31, 2000, three (3.00) times EBITDA as of the end of the most recent fiscal quarter of the Borrower (calculated on a rolling four quarter basis). For any calculation period which would include one or more quarters prior to any Stock Purchase or any Asset Purchase or any other future acquisition of an entity occurring during the quarter, the "rolling four quarters" shall include the "pro forma" EBITDA of the applicable Acquired Entity for such prior periods adjusted to reflect the costs and expenses which such Acquired Entity would have incurred had the Management Services Agreements between the Borrower and/or any Subsidiary and such Acquired Entity been in effect (adding back appropriate executive salaries and non-cash charge offs relating to this transaction). "CLOSING DATE" shall mean the date that this Fourth Amendment shall be executed by the Lenders and the Borrower. Page 2 "EBITDA" shall mean, for any period, the sum of Consolidated Net Income for such period plus the following expenses or charges to the extent deducted from Consolidated Net Income in such period: interest, taxes, depreciation, depletion, amortization, the amount of the settlement of the lawsuit with Joseph Bonola, D.D.S. up but not to exceed $1,372,743 as reflected on Schedule 1 to the Second Amendment, and the amount of legal fees and expenses related to the arbitration with Dr. Leon Roisman, D.M.D. that was expensed in Fiscal year 1999, up to but not to exceed $541,000. (2) Section 1.02 of the Agreement is hereby further amended and supplemented by adding the following new definitions where alphabetically appropriate, which read in their entirety as follows: "FOURTH AMENDMENT" shall mean that certain Fourth Amendment to Amended and Restated Credit Agreement dated effective as of the December 31, 1999, by and among the Borrower, the Agent and Lenders. 5. AMENDMENT TO SECTION 8.01. Section 8.01 of the Agreement is hereby amended by adding the following to the end of Section 8.01(a): "As soon as available, and in any event on or before two weeks after the Closing Date, Borrower shall deliver to the Agent the audited annual financial statements for fiscal year 1999 prepared in accordance with this Section 8.01(a) accompanied by the related opinion of independent public accountants as called for in this Section 8.01(a)." 6. AMENDMENT TO SECTION 8.01. Section 8.01 of the Agreement is hereby amended by deleting the paragraph after Section 8.01(o) in its entirety and replacing it with the following: The Borrower shall furnish to the Lenders, at the time it furnishes financial statements pursuant to paragraph (a) above and within 45 days of the end of each of the first three fiscal quarters of the Borrower, a certificate substantially in the form of EXHIBIT C hereto executed by a Responsible Officer (i) certifying as to the matters set forth therein and stating that no Default has occurred and is continuing (or, if any Default has occurred and is continuing, describing the same is reasonable detail), and (ii) setting forth in reasonable detail the computations necessary to determine the Borrower's Total Funded Debt, Senior Funded Debt and EBITDA and whether the Borrower is in compliance with Sections 9.11, 9.12, 9.13, 9.14, 9.15, 9.16, and 9.24 as of the end of the respective fiscal quarter or fiscal year. 7. AMENDMENT TO SECTION 8.01. Section 8.01 of the Agreement is hereby amended by adding the following new subsections: (p) MONTHLY FINANCIAL STATEMENTS. As soon as available and in any event within 45 days after the end of each calendar month, the Borrower-prepared consolidated and consolidating statements of income, cash flow of the Borrower and its Consolidated Subsidiaries for such period and for the period from the beginning Page 3 of the respective fiscal year to the end of such period, and the related consolidated and consolidating balance sheets as at the end of such period, and setting forth in each case in comparative form the corresponding figures for the corresponding period in the preceding fiscal year, accompanied by the certificate of a Responsible Officer, which certificate shall state that said financial statements fairly present the consolidated and consolidating financial condition and results of operations of the Borrower and its Consolidated Subsidiaries in accordance with GAAP, as at the end of, and for, such period (subject to normal year-end audit adjustments). (q) MANAGEMENT LETTER. As soon as available and in any event by no later than two weeks after the Closing Date, an auditor-prepared Fiscal 1999 management letter. (r) ACCOUNTS RECEIVABLE. As soon as available and in any event within 45 days after the end of each calendar month, (i) a report in form reasonably satisfactory to the Agent reflecting the aging and collection of the receivables of the Borrower and its Subsidiaries, each such aging report to show in reasonable detail, calculations reflecting compliance with Section 9.24 and (ii) such other reports as deemed necessary by the Agent. 8. AMENDMENT TO SECTION 8. Section 8 of the Agreement is hereby amended by adding a new Section 8.13 to read as follows: Section 8.13 FIELD EXAM. The Borrower and its Subsidiaries shall permit the Agent and its representatives to have access, during normal business hours, to their records of accounts and appropriate personnel for purpose of conducting an examination of accounts receivable. Such field exam shall be completed and a report provided to the Agent within 45 days after the Closing Date. 9. AMENDMENT TO SECTION 9.13. Section 9.13 of the Agreement is hereby amended in its entirety to read as follows: 9.13 LEVERAGE RATIO. The Borrower will not permit its Leverage Ratio as of the end of any fiscal quarter (calculated on a rolling four quarter basis) to be greater than the ratio indicated in the chart below. For any calculation period which would include one or more quarters prior to any Stock Purchase or any Asset Purchase or any other future acquisition of an entity, the "rolling four quarters" shall include the "pro forma" EBITDA of the applicable Acquired Entity for such prior periods adjusted to reflect costs and expenses which such Acquired Entity would have included had the Management Services Agreements between Borrower and/or any Subsidiary and such Acquired Entity been in effect (adding back appropriate executive salaries and non-cash charge offs relating to this transaction). As used in this Section 9.13, "Leverage Ratio" shall mean the ratio of (i) Senior Funded Debt to (ii) EBITDA. Page 4 ------------------------------------------------- PERIOD (QUARTER END DATE) RATIO ------------------------------------------------- December 31, 1999 3.75 to 1.0 ------------------------------------------------- March 31, 2000 3.40 to 1.0 ------------------------------------------------- ------------------------------------------------- June 30, 2000 3.40 to 1.0 ------------------------------------------------- ------------------------------------------------- September 30, 2000 3.40 to 1.0 ------------------------------------------------- ------------------------------------------------- 3.00 to December 31, 2000 1.0 ------------------------------------------------- 10. AMENDMENT TO SECTION 9.14. Section 9.14 of the Agreement is hereby amended in its entirety to read as follows: Section 9.14. FIXED CHARGE COVERAGE RATIO. The Borrower will not permit its Fixed Charge Coverage Ratio as of the end of any fiscal quarter (calculated on a rolling four quarter basis) to be less than the ratio for the relevant periods set forth below. ------------------------------------------------- PERIOD RATIO ------------------------------------------------- December 31, 1999 through December 31, 2000 1.30 to 1.0 ------------------------------------------------- For purposes of this Section 9.14, "Fixed Charge Coverage Ratio" shall mean the ratio for the relevant period of (i) EBITDA, less taxes payable in cash, plus lease and rental expense to (ii) lease and rental expense, plus cash and deferred interest, plus senior and subordinate principal payments scheduled during the period, plus actual capital lease payments. The ratio will be determined quarterly on a rolling twelve-month basis. For any calculation period which would include one or more quarters prior to any Stock Purchase or any Asset Purchase or any other future acquisition of an entity, the "rolling four quarters" shall include the "pro forma" EBITDA of the applicable Acquired Entity for such prior periods adjusted to reflect costs and expenses which such Acquired Entity would have included had the Management Services Agreements between Borrower and/or any Subsidiary and such Acquired Entity been in effect (adding back appropriate executive salaries and non-cash charge offs relating to this transaction). 11. AMENDMENT TO SECTION 9.15. Section 9.15 of the Agreement is hereby amended in its entirety to read as follows: Section 9.15. RATIO OF TOTAL FUNDED DEBT TO EBITDA. The Borrower will not permit its ratio of Total Funded Debt as of the end of any fiscal quarter to EBITDA for the four fiscal quarters ending on such date to be greater than the ratio indicated in the chart below. For purposes hereof, EBITDA shall be calculated as provided in Section 9.13 above. For clarity purposes it is understood and agreed that Total Funded Debt includes, without limitation, any and all deferred interest under any Subordinated Debt. ------------------------------------------------- PERIOD (QUARTER END DATE) RATIO ------------------------------------------------- December 31, 1999 4.25 to 1.0 ------------------------------------------------- March 31, 2000 4.75 to 1.0 ------------------------------------------------- June 30, 2000 4.75 to 1.0 ------------------------------------------------- September 30, 2000 4.60 to 1.0 ------------------------------------------------- December 31, 2000 4.15 to 1.0 ------------------------------------------------- Page 5 12. AMENDMENT TO SECTION 9.16. Section 9.16 of the Agreement is hereby amended in its entirety to read as follows: Section 9.16. CAPITAL EXPENDITURES. Without the prior written consent of the Majority Lenders, the Borrower will not make any expenditures for fixed or capital assets if, after giving effect thereto, the aggregate of all such expenditures would exceed $3,500,000 during fiscal year 2000 (January 1, 2000 through December 31, 2000), as outlined in SCHEDULE 9.16. 13. AMENDMENT TO SECTION 9. Section 9 of the Agreement is hereby amended by adding the following new Sections: Section 9.24 ACCOUNTS RECEIVABLE. Neither the Borrower nor any Subsidiary will permit its Average Accounts Receivable Days [at the end of any calendar month] to exceed 80 days. For purposes of this Section 9.24, "Average Accounts Receivable Days" shall mean the (i) net patient receivables plus net unbilled patient receivables, divided by (ii) net patient revenues for the 12-month period ending on such date, multiplied by (iii) 365 days. Section 9.25 ACQUISITIONS. Neither the Borrower nor any Subsidiary will, during fiscal year 2000, make any New Acquisition (whether or not proceeds of any Loans are utilized therefor), unless such New Acquisition is approved of in advance by all of the Lenders. Section 9.26 ADVANCES. Unless the Borrower or its Subsidiary receives prior written consent from all of the Lenders, neither the Borrower nor any Subsidiary will, during fiscal year 2000, use the proceeds of any Loan to settle any lawsuit or arbitration if any such settlement exceeds $100,000, or the aggregate of all settlements for fiscal year 2000 exceeds $250,000. 14. AMENDMENT TO SECTION 10.01. The period at the end of clause (o) in Section 10.01 is changed to "; or" and a new clause (p) is hereby added to Section 10.01 to read as follows: "(p) the field exam conducted pursuant to Section 8.13 is determined by the Majority Lenders in their sole reasonable discretion to be less than satisfactory. 15. EFFECTIVENESS OF THIS FOURTH AMENDMENT. Except for the definition of "Applicable Margin", which shall be effective as of December 31, 1999 and continuing until the Final Maturity Date, this Fourth Amendment shall be effective as of December 31, 1999 through December 31, 2000. Thereafter, the terms and conditions of the Agreement as in effect prior to the execution of this Fourth Amendment shall govern as if this Fourth Amendment had not been executed. 16. TEMPORARY WAIVER. Borrower's covenant in Section 8.11 is hereby temporarily waived. This temporary waiver shall terminate 30 days after the Closing Date and shall not be deemed to be a consent to, or waiver or modification or, any other term or condition of the Agreement, the Security Agreement, the Guarantee Agreement, or any other Loan Document. Page 6 17. AMENDMENT FEE. The Borrower shall pay to the Agent for the account of each Lender an amendment fee equal to .5% of the Aggregate Maximum Commitment Amounts (the "AMENDMENT FEE"). Borrower shall pay (i) 33.34 % of the Amendment Fee on Borrower's execution hereof, (ii) 33.33% of the Amendment Fee on September 29, 2000, and (iii) 33.33% of the Amendment Fee on December 29, 2000. If the Loans are completely paid prior to December 29, 2000, then the balance of the Amendment Fee shall be due and payable at such time the loans are completely paid. 18. CONDITIONS. The effectiveness of this Fourth Amendment against the Agent and the Lenders is subject to the following conditions precedent: (1) the Agent's receipt of Borrower-prepared financial statements (in form of the financial statements called for in Section 8.01(b)), at least two days prior to the Closing Date, for the period ending March 31, 2000; (2) the Agent's receipt of the reports reflecting compliance (as waived by the letter dated May 19, 2000 from Agent to Borower) with all financial covenants as of September 30, 1999, December 31, 1999 and March 31, 2000 applying the terms and conditions of the Agreement as amended by this Fourth Amendment; (3) the Agent's receipt of multiple original counterparts, as requested by the Agent, of this Fourth Amendment, executed and delivered by a duly authorized officer of the Borrower, the Agent, and each Lender, as applicable and ratified by the Guarantors; and, (4) the Agent's receipt of such other instruments or documents as the Agent may reasonably request. 19. REPRESENTATIONS AND WARRANTIES. Except as affected by the transactions contemplated in the Agreement and this Fourth Amendment, each of the representations and warranties made by the Borrower in or pursuant to the Agreement and the Security Instruments shall be true and correct in all material respects as of the Effective Date, as if made on and as of such date (except to the extent such representations and warranties are expressly limited to an earlier date). 20. ADOPTION, RATIFICATION AND CONFIRMATION OF AGREEMENT. Each of the Borrower, the Agent, and the Lenders does hereby adopt, ratify and confirm the Agreement, as amended hereby, and acknowledges and agrees that the Agreement, as amended hereby, is and remains in full force and effect. 21. SUCCESSORS AND ASSIGNS. This Fourth Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns permitted pursuant to the Agreement. 22. COUNTERPARTS. This Fourth Amendment may be executed by one or more of the parties hereto in any number of separate counterparts, and all of such counterparts taken together shall be deemed to constitute one and the same instrument and shall be enforceable as of the Effective Date upon the execution of one or more counterparts hereof by the Borrower, the Agent and the Lenders. In this regard, each of the parties hereto acknowledges that a counterpart of this Fourth Amendment containing a set of counterpart execution pages reflecting the execution of each party hereto shall be Page 7 sufficient to reflect the execution of this Fourth Amendment by each necessary party hereto and shall constitute one instrument. 23. ENTIRE AGREEMENT. This Fourth Amendment constitutes the entire agreement among the parties hereto with respect to the subject hereof. All prior understandings, statements and agreements, whether written or oral, relating to the subject hereof are superseded by this Fourth Amendment. 24. GOVERNING LAW. This Fourth Amendment shall be deemed to be a contract made under and shall be governed by and construed in accordance with the internal laws of the State of Texas. THIS FOURTH AMENDMENT, THE AGREEMENT, AS SUPPLEMENTED AND AMENDED HEREBY, THE NOTES, AND THE OTHER SECURITY INSTRUMENTS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. [SIGNATURES BEGIN ON NEXT PAGE] Page 8 IN WITNESS WHEREOF, the parties hereto have caused this Fourth Amendment to be duly executed and delivered by their proper and duly authorized officers as of the Effective Date. BORROWER: CASTLE DENTAL CENTERS, INC. By: ________________________________________ Name: ______________________________________ Title: _____________________________________ LENDER AND AGENT: BANK OF AMERICA, N.A. (FORMERLY KNOWN AS NATIONSBANK, N.A.) By: ________________________________________ Name: ______________________________________ Title: _____________________________________ LENDERS: FLEET NATIONAL BANK (FORMERLY KNOWN AS BANK BOSTON, N.A.) By: ________________________________________ Name: ______________________________________ Title: _____________________________________ AMSOUTH BANK By: ________________________________________ Name: ______________________________________ Title: _____________________________________ HELLER FINANCIAL, INC. By: ________________________________________ Name: ______________________________________ Title: _____________________________________ Page 9 RATIFICATION Each of the Guarantors hereby expressly (i) acknowledges the terms of this Fourth Amendment, (ii) ratifies and affirms its obligations under its Guaranty Agreement, in favor of the Agent and the Lenders, as amended, supplemented or otherwise modified, (iii) acknowledges, renews and extends its continued liability under its Guaranty Agreement and agrees that said Guaranty Agreement remains in full force and effect; and (iv) guarantees to the Agent and each Lender to promptly pay when due all amounts owing or to be owing by it under its Guaranty Agreement pursuant to the terms and conditions thereof. GUARANTORS: CASTLE DENTAL CENTERS OF FLORIDA, INC. By: ______________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer CASTLE DENTAL CENTERS OF TENNESSEE, INC. By: ______________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer CASTLE DENTAL CENTERS OF TEXAS, INC. By: ______________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer CDC OF CALIFORNIA, INC. By: _____________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer Page 10 CASTLE DENTAL CENTERS OF CALIFORNIA, L.L.C. By: ______________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer DENTAL WORLD, INC. By: ______________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer CASTLE DENTAL CENTERS OF AUSTIN, INC. By: ______________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer DENTCOR, INC. By: ______________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer CASTLE TEXAS HOLDINGS, INC. By: ______________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer ACADEMY FOR DENTAL ASSISTANTS, INC. By: ______________________________________ Jack H. Castle, Jr. Chairman & Chief Executive Officer Page 11 SCHEDULE 9.16 Schedule 9.16, Page 1 EX-10.27 10 EXHIBIT 10.27 FIRST AMENDMENT TO SENIOR SUBORDINATED NOTE PURCHASE AGREEMENT This FIRST AMENDMENT TO SENIOR SUBORDINATED NOTE PURCHASE AGREEMENT ("AMENDMENT") is dated as of May 19, 2000, and is entered into by and among CASTLE DENTAL CENTERS, INC., a corporation formed under the laws of Delaware (the "COMPANY"), HELLER FINANCIAL, INC., a Delaware corporation ("HELLER") and MIDWEST MEZZANINE FUND II, L.P., a Delaware limited partnership ("Midwest") (Heller and Midwest are sometimes referred to individually as a "HOLDER" and together as the "HOLDERS"). WHEREAS, the Company and the Holders are parties to a certain Senior Subordinated Note Purchase Agreement dated January 31, 2000 (as such agreement has from time to time been amended, supplemented or otherwise modified, the "AGREEMENT"); and WHEREAS, the parties desire to amend the Agreement as hereinafter set forth. NOW THEREFORE, in consideration of the mutual conditions and agreements set forth in the Agreement and this Amendment, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. DEFINITIONS. Capitalized terms used in this Amendment, unless otherwise defined herein, shall have the meaning ascribed to such terms in the Agreement. 2. AMENDMENTS. Subject to the conditions set forth below, the Agreement is hereby amended as follows: (a) Subsection 1.02 is amended by deleting the definition of "Applicable Margin" in its entirety and inserting the following in lieu thereof: "APPLICABLE MARGIN" shall mean (a) with respect to interest calculated by reference to the Eurodollar Rate, (i) from January 31, 2000 through April 30, 2000, four percent (4.0%) and (ii) from May 1, 2000 and thereafter, five and one half percent (5.5%) and (b) with respect to interest calculated by reference to the Base Rate, (i) from January 31, 2000 through April 30, 2000, two and three quarters percent (2.75%) and (ii) from May 1, 2000 and thereafter, four and one quarter percent (4.25%). (b) Subsection 1.02 is further amended by deleting the definition of "EBITDA" in its entirety and inserting the following in lieu thereof: "EBITDA" shall mean, for any period, the sum of Consolidated Net Income for such period plus the following expenses or charges to the extent deducted from Consolidated Net Income in such period: interest, taxes, depreciation, depletion, amortization, the amount of the settlement of the lawsuit with Joseph Bonola, D.D.S. up to but not to exceed $1,372,743 as reflected on Schedule 1 to the Second Amendment to the Senior Credit Agreement, dated as of September 30, 1999 and the amount of the unreimbursed (whether by insurance or otherwise) legal feesand expenses related to the arbitration with Dr. Leon Roisman, D.M.D. that was expensed in Fiscal year 1999, up to but not to exceed $541,000. (c) Subsection 1.02 is further amended by inserting the definition of "Payment Rate" in its entirety and in the proper alphabetical order: "PAYMENT RATE" shall mean the Eurodollar or Base Rate, as applicable, PLUS appropriate Applicable Margin in effect from time to time, LESS, in any case, from May 1, 2000 through December 31, 2000, one and one half percent (1.5%). (d) Subsection 1.02 is further amended by inserting the definition of "PIK Interest" in its entirety and in the proper alphabetical order: "PIK INTEREST" shall mean that interest computed on the unpaid principal amount of the Notes at one and one-half percent (1.5%) from May 1, 2000 through December 31, 2000. (e) Subsection 2.03(a) is hereby amended in its entirety to hereafter read as follows: " (a) VOLUNTARY PREPAYMENTS. Subject to the terms of the Subordination Agreement, the Company may prepay the outstanding principal of (together with accrued interest on and, if applicable, the prepayment fee described below) the Subordinated Notes in full or in part (in minimum amounts of $1,000,000), at any time and from time to time on any Quarterly Date as applicable, upon not less than three (3) Business Days' prior notice to Holders. The Company shall not be permitted to prepay voluntarily the Convertible Notes. Any prepayment in full of the Subordinated Notes shall be accompanied by all PIK Interest accrued to date." (f) Subsection 2.03(b)(ii) is hereby amended in its entirety to hereafter read as follows: " (ii) concurrently with the consummation of a Change in Control, Company shall pay the outstanding principal of the Subordinated Notes (together with accrued interest and, if applicable, the prepayment fee described below). Any prepayment in full of the subordinated Notes shall be accompanied by all PIK Interest accrued to date." (g) Subsection 3.02(c) is hereby amended in its entirety to hereafter read as follows: " DUE DATES. Accrued interest on the Notes shall be payable at the Payment Rate on each Quarterly Date, except that interest payable at the Post-Default Rate shall be payable from time to time on demand. The PIK Interest shall accrue from 2 May 1, 2000 through December 31, 2000 and shall be payable in full on the first Quarterly Date in the year 2001 and shall also be payable on demand upon the occurrence of an Event of Default. In addition, accrued interest on Convertible Notes shall be payable on the date of conversion of all or any part of such Convertible Note." (h) Section 9.13 is amended by deleting the first sentence thereof and inserting the following in lieu thereof: "The Company will not permit its Leverage Ratio as of the end of any fiscal quarter (calculated on a rolling four quarter basis) to be greater than the ratio on the relevant dates set forth below: DATE RATIO ------------------------------------------------------------ March 31, 2000 3.65 to 1.00 June 30, 2000 3.65 to 1.00 September 30, 2000 3.50 to 1.00 December 31, 2000 and thereafter 3.25 to 1.00." (i) Section 9.14 is amended in its entirety to hereafter read as follows: "Section 9.14 FIXED CHARGE COVERAGE RATIO . The Company will not permit its Fixed Charge Coverage Ratio as of the end of any fiscal quarter (calculated on a rolling four quarter basis) to be less than the ratio on the relevant dates set forth below. DATE RATIO ------------------------------------------------------------ March 31, 2000 1.15 to 1.00 June 30, 2000 1.15 to 1.00 September 30, 2000 1.15 to 1.00 December 31, 2000 1.15 to 1.00 March 31, 2001 1.00 to 1.00 June 30, 2001 and thereafter 1.05 to 1.00 For purposes of this Section 9.14, "FIXED CHARGE COVERAGE RATIO" shall mean (a) with respect to all calculations of Fixed Charge Coverage Ratio through and including December 31, 2000, the ratio for the relevant period of (i) EBITDA, LESS taxes payable in cash, PLUS lease and rental expense to the extent deducted in computing net income to (ii) lease and rental expense, PLUS interest expense, PLUS, scheduled senior and subordinate principal payments including Senior Funded Debt, capital leases, the Indebtedness, Junior Subordinated Debt, Debt described on Schedule 9.01 and other Debt subordinated or required to be subordinated to the Indebtedness and (b) with respect to all calculations of Fixed Charge Coverage Ratio on January 1, 2001 and thereafter, the ratio for the relevant period 3 of (i) EBITDA, LESS taxes payable in cash, PLUS lease and rental expense to the extent deducted in computing net income to (ii) lease and rental expense, PLUS interest, PLUS, during the Revolving Credit Period (as defined in the Senior Credit Agreement), one-seventh (1/7) of the then-outstanding principal balance of the Senior Loans, PLUS, without duplication, current maturities of long-term debt, PLUS capital leases PLUS, from and after Revolving Credit Period scheduled payments of principal on Debt of the Company and its Subsidiaries. For any calculation period which would include one or more quarters prior to any Stock Purchase or any Asset Purchase or any other future acquisition of an entity, the "rolling four quarters" shall include the "pro forma" EBITDA of the applicable Acquired Entity for such prior periods as approved by Holders, adjusted to reflect costs and expenses which such Acquired Entity would have included had the Management Services Agreements between Company and/or any Subsidiary and such Acquired Entity been in effect (adding back appropriate executive salaries and non-cash charge offs relating to this transaction), in each instance, as approved by Holders." (j) Section 9.15 is amended in its entirety to hereafter read as follows: "9.15 RATIO OF TOTAL FUNDED DEBT TO EBITDA. The Company will not permit its ratio of Total Funded Debt as of the end of any fiscal quarter to EBITDA for the four fiscal quarters ending on such date to be greater than the ratio for the relevant periods set forth below: PERIOD ENDING RATIO -------------------------------------------------------------- March 31, 2000 5.00 to 1.00 June 30, 2000 5.00 to 1.00 September 30, 2000 4.75 to 1.00 December 31, 2000 and thereafter 4.25 to 1.00. For purposes hereof, EBITDA shall be calculated as provided in section 9.13. For clarity purposes, it is understood and agreed that Total Funded Debt includes, without limitation, any and all deferred interest under all Total Funded Indebtedness." 3. AMENDMENT FEES. In connection with the execution of this Amendment, the Company shall pay to Holders, for their ratable benefit, a fee of $37,500 ("AMENDMENT FEE"), which Amendment Fee shall be deemed to be earned on the Effective Date and shall be due and payable on the following dates in the following amounts: DATE AMOUNT ---------------------------------------- Effective Date $12,502.50 September 29, 2000 $12,498.75 December 29, 2000 $12,498.75 4 ;provided, however, in the event the Company pays to Holders the entire principal balance of the Subordinated Notes prior to December 29, 2000, the entire unpaid amount of the Amendment Fee shall become immediately due and payable. 4. CONDITIONS. The effectiveness of this Amendment (the date on which this Amendment becomes effective shall referred to as the "EFFECTIVE DATE") is subject to the following conditions precedent (unless specifically waived in writing by the Holders): (a) The Company shall have executed and delivered this Amendment, and such other documents and instruments as the Holders may reasonably require shall have been executed and/or delivered to the Holders; (b) All proceedings taken in connection with the transactions contemplated by this Amendment and all documents, instruments and other legal matters incident thereto shall be satisfactory to the Holders and their legal counsel; (c) Holders shall have received all deliquent payments due under the Agreement; (d) After giving effect to this Amendment, no Default or Event of Default shall have occurred and be continuing; (e) Each of the Holders shall have received (and the Company covenants and agrees to deliver to Holders), by May __, 2000 [TWO WEEKS FROM EFFECTIVE DATE], the documents referred to in Section 8.01(a) of the Agreement for the fiscal year ended December 31, 1999 and Section 8.01(b) for the fiscal quarter ended March 31, 2000; (f) Each of the Holders shall have received consolidated and consolidating statements of income, stockholders' equity, changes in financial position and cash flow of the Company and its Consolidated Subsidiaries for the months ending January 31, 2000 and February 29, 2000, in each case prepared by the Company and accompanied by the certificate of a Responsible Officer stating that such financial statements fairly present the consolidated and consolidating financial condition of the Company and its Consolidated Subsidiaries in accordance with GAAP, as at the end of, and for, each such month; (g) Each of the Holders shall have received evidence that the requisite number of Senior Lenders have consented to the execution of this Amendment; and (h) The Senior Credit Documents shall have been amended in a manner satisfactory to Holders and such amendment shall have become effective. 5. REPRESENTATIONS AND WARRANTIES. To induce Holders to enter into this Amendment, the Company represents and warrants to Holders: 5 (a) that the execution, delivery and performance of this Amendment has been duly authorized by all requisite corporate action on the part of the Company and that this Amendment has been duly executed and delivered by the Company; (b) that each of the representations and warranties set forth in Article VII of the Agreement (other than those which, by their terms, specifically are made as of certain date prior to the date hereof) are true and correct in all material respects as of the date hereof; and 6. SEVERABILITY. Any provision of this Amendment held by a court of competent jurisdiction to be invalid or unenforceable shall not impair or invalidate the remainder of this Amendment and the effect thereof shall be confined to the provision so held to be invalid or unenforceable. 7. REFERENCES. Any reference to the Agreement contained in any document, instrument or agreement executed in connection with the Agreement shall be deemed to be a reference to the Agreement as modified by this Amendment. 8. COUNTERPARTS. This Amendment may be executed in one or more counterparts, each of which shall constitute an original, but all of which taken together shall be one and the same instrument. 9. RATIFICATION. The terms and provisions set forth in this Amendment shall modify and supersede all inconsistent terms and provisions of the Agreement and shall not be deemed to be a consent to the modification or waiver of any other term or condition of the Agreement. Except as expressly modified and superseded by this Amendment, the terms and provisions of the Agreement are ratified and confirmed and shall continue in full force and effect. 10. WAIVER. The Company and the Holders hereby acknowledge and agree that prior to the effectiveness hereof, the Company was in default for the months of January, February, March, April and May 2000 under Sections 3.02, 8.01(a) and (b), 9.13, 9.14 and 9.15 of the Agreement. Provided that no other defaults by the Company currently exist and are continuing under the Agreement, and provided further, the conditions precedent set forth in Section 4 hereof are satisfied, then the defaults listed above which occurred on or before the date hereof are hereby waived by the Holders and the Holders' remedies with respect thereto are hereby waived. Notwithstanding the foregoing, or any other election by the Holders to date in forgiving any default by the Company or in waiving any remedies with respect thereto, no such forgiveness or waiver shall affect or be deemed to affect any default by the Company or any remedy by the Holders existing after the date hereof, and the Holders shall not be obligated in any manner to forgive any such defaults, or waive any such remedies. The Holders hereby reserve, and the Company hereby acknowledges and agrees that the Holders have effectively preserved, all of their rights, remedies and recourses with respect to any default under the Agreement except with respect to the defaults expressly set forth above. 6 IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed under seal and delivered by their respective duly authorized officers on the date first written above. HELLER FINANCIAL, INC., CASTLE DENTAL CENTERS, INC., a Delaware corporation a Delaware corporation By: ________________________ By: ________________________ Name: ________________________ Name: Jack H. Castle, Jr. Title:________________________ Title: Chief Executive Officer ATTEST: MIDWEST MEZZANINE FUND II, L.P., ______________________________ a Delaware limited partnership [ASSISTANT] SECRETARY [CORPORATE SEAL] By: ________________________ Name: ________________________ Title:________________________ 7 CONSENT AND REAFFIRMATION Each of the undersigned (each a "GUARANTOR", collectively the "GUARANTORS") hereby (i) acknowledges receipt of a copy of the foregoing First Amendment to Senior Subordinated Note Purchase Agreement; (ii) consents to the Company's execution and delivery thereof; (iii) agrees to be bound thereby; and (iv) affirms that nothing contained therein shall modify in any respect whatsoever its guaranty of the obligations of Company to Heller and Midwest pursuant to the terms of that certain Subordinated Guaranty Agreement dated January 31, 2000 (the "GUARANTY") and reaffirms that the Guaranty is and shall continue to remain in full force and effect. Although each Guarantor has been informed of the matters set forth herein and has acknowledged and agreed to same, each Guarantor understands that the Holders have no obligation to inform any Guarantor of such matters in the future or to seek any Guarantor's acknowledgment or agreement to future amendments or waivers, and nothing herein shall create such a duty. IN WITNESS WHEREOF, each of the undersigned has executed this Consent and Reaffirmation on and as of the date of such Amendment. ACADEMY FOR DENTAL ASSISTANTS, INC. CASTLE TEXAS HOLDINGS, INC. CASTLE DENTAL CENTERS OF CALIFORNIA, L.L.C. CASTLE DENTAL CENTERS OF TEXAS, INC. DENTAL WORLD, INC. CDC OF CALIFORNIA, INC. CASTLE DENTAL CENTERS OF AUSTIN, INC. CASTLE DENTAL CENTERS OF FLORIDA, INC. CASTLE DENTAL CENTERS OF TENNESSEE, INC., AND DENTCOR, INC. By: ________________________________ Name: Jack H. Castle, Jr. Title: Chief Executive Officer 8 EX-21 11 EXHIBIT 21 SCHEDULE 21 SUBSIDIARIES SUBSIDIARY PCT. OWNERSHIP STATE OF INCORPORATION Castle Dental Centers of Texas, Inc. 100% Texas Castle Texas Holdings, Inc. 100% Delaware Castle Dental Centers of Austin, Inc. 100% Texas Dental World, Inc. (of Castle Dental 100% Texas of Texas, Inc.) Castle Dental Centers of Tennessee, Inc. 100% Tennessee Castle Dental Centers of Florida, Inc. 100% Florida Dentcor, Inc. (of Castle Dental Centers 100% Florida of Florida, Inc.) CDC of California, Inc. 100% Delaware Castle Dental Centers of California, L.L.C. 80% Delaware (of CDC of California, Inc.) EX-27.1 12
5 THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1999 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS, FOR THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 12-MOS DEC-31-1999 DEC-31-1999 59 0 36,087 14,492 0 28,341 28,263 7,902 114,982 12,573 53,996 0 0 6 37,157 114,982 102,701 102,701 0 95,050 1,400 0 4,220 2,031 835 1,196 0 0 0 1,196 0.18 0.18
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