U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
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[ ] 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: 000-23673
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GENTLE DENTAL SERVICE CORPORATION
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(Exact name of small business issuer as specified in its charter)
Washington 91-1577891
- ---------------------------------- ------------------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
222 No. Sepulveda Blvd., Suite 740, El Segundo, CA 90245
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(Address of principal executive offices)
Issuer's telephone number (310) 765-2400
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No Change
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(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [ ]
As of November 13, 1998, 9,027,960 shares of the issuer's common stock were
outstanding.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited, in thousands, except share amounts)
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December 31, September 30,
Assets 1997 1998
---------------- ----------------
Current assets:
Cash and cash equivalents $ 302 $ 1,817
Accounts receivable, net 6,331 9,376
Receivables from affiliates 1,731 193
Supplies 1,109 2,281
Prepaid and other current assets 1,726 2,358
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Total current assets 11,199 16,025
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Property and equipment, net 10,084 14,850
Intangible assets, net 22,843 72,840
Other assets 282 1,209
---------------- ----------------
Total assets $ 44,408 $ 104,924
================ ================
Liabilities, Redeemable Common Stock and Shareholders' Equity
Current liabilities:
Accounts payable $ 2,452 $ 2,157
Accrued payroll and payroll related costs 2,084 4,207
Other current liabilities 3,174 6,024
Current portion of long-term debt and capital lease obligations 651 1,415
---------------- ----------------
Total current liabilities 8,361 13,803
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Long-term liabilities:
Obligations under capital leases, net of current portion 581 824
Long-term debt, net of current portion 13,842 15,031
Convertible senior subordinated debt - 30,000
Other long-term liabilities 115 132
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Total long-term liabilities 14,538 45,987
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Total liabilities 22,899 59,790
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Redeemable common stock, no par value, 183,686 shares issued and
outstanding in 1997 and 180,712 in 1998, respectively 2,130 2,095
---------------- ----------------
Shareholders' equity:
Preferred stock, 30,000,000 shares authorized:
Preferred stock - Series A, no par value, 100 shares authorized,
zero and 100 shares issued and outstanding in 1997 and 1998,
respectively - 1
Convertible Preferred stock - Series B, no par value, 70,000
shares authorized, zero shares issued and outstanding in 1997
and 1998 - -
Preferred stock - Series C, no par value, 100 shares authorized,
zero and 100 shares issued and outstanding in 1997 and 1998,
respectively - 1
Convertible Preferred stock - Series D, no par value, 2,000,000
shares authorized, zero and 1,628,663 shares issued and
outstanding in 1997 and 1998, respectively - 12,286
Common stock, no par value, 50,000,000 shares authorized, 7,530,781
and 8,798,963 shares issued and outstanding in 1997 and 1998,
respectively 21,784 32,184
Additional paid-in capital 3,165 3,520
Shareholder notes receivable (304) (318)
Accumulated deficit (5,266) (4,635)
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Total shareholders' equity 19,379 43,039
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Total liabilities, redeemable common stock and shareholders' equity $ 44,408 $ 104,924
================ ================
See accompanying notes to consolidated financial statements.
2
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited, in thousands, except per share amounts)
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Three Months Ended Nine Months Ended
September 30, September 30,
1997 1998 1997 1998
----------- ----------- ----------- -----------
Dental practice net patient service revenue $ 8,740 $ 29,031 $ 19,810 $ 67,534
Net management fees 3,791 473 10,148 1,408
----------- ----------- ----------- -----------
Net revenues 12,531 29,504 29,958 68,942
Cost and expenses:
Clinical salaries and benefits 4,099 13,098 9,246 30,762
Practice nonclinical salaries and benefits 2,321 4,143 5,764 10,028
Dental supplies and lab expenses 1,856 3,451 4,545 8,000
Practice occupancy expenses 913 1,552 2,395 3,814
Practice selling, general and administrative expenses 1,129 2,614 3,169 6,434
Corporate selling, general and administrative expenses 1,635 1,746 3,868 4,531
Depreciation and amortization 466 1,293 1,282 2,877
----------- ----------- ----------- -----------
Operating income (loss) 112 1,607 (311) 2,496
----------- ----------- ----------- -----------
Nonoperating income (expense):
Interest expense, net (169) (777) (362) (1,820)
Other income (expense), net 28 (4) 19 (11)
----------- ----------- ----------- -----------
Nonoperating expense, net (141) (781) (343) (1,831)
----------- ----------- ----------- -----------
Income (loss) before income taxes (29) 826 (654) 665
Provision for income taxes - 84 - 19
----------- ----------- ----------- -----------
Net income (loss) (29) 742 (654) 646
Dividends on redeemable convertible preferred stock - Series B (288) - (829) -
Accretion of redeemable common stock (8) (3) (27) (15)
----------- ----------- ----------- -----------
Net income (loss) attributable to common stock $ (325) $ 739 $ (1,510) $ 631
=========== =========== =========== ===========
Income (loss) per share attributable to common stock - basic $ (.08) $ .08 $ (.38) $ .08
=========== =========== =========== ===========
Income (loss) per share attributable to common stock - diluted $ (.08) $ .07 $ (.38) $ .07
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
3
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited, in thousands)
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Nine Months Ended
September 30,
1997 1998
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Cash flows from operating activities:
Net income (loss) $ (654) $ 646
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 1,282 2,877
Loss on disposal of assets 36 4
Loss on investment in joint venture 68 4
Stock options granted to nonemployees 42 41
Interest accrued on shareholder notes receivables - (14)
Deferred income taxes 127 -
Change in assets and liabilities, net of the effect of
acquisitions:
Accounts receivable, net 733 325
Receivables from affiliates (493) (181)
Supplies 13 (322)
Prepaid expenses and other current assets (646) (995)
Other assets (110) 38
Accounts payable (524) (1,958)
Accrued payroll and payroll related costs 822 480
Other liabilities 206 (771)
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Net cash provided by operating activities 902 174
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Cash flows from investing activities:
Purchase of property and equipment (1,337) (2,431)
Proceeds from sale of property and equipment 22 -
Cash paid for acquisitions, including direct costs,
net of cash acquired (7,661) (40,178)
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Net cash used in investing activities (8,976) (42,609)
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Cash flows from financing activities:
Net payments on short-term borrowings (2,097) -
Net proceeds from credit facility - 1,400
Proceeds from issuance of long-term debt 4,300 30,000
Payments on long-term debt and obligations under capital leases (2,925) (717)
Payments of deferred financing costs - (368)
Proceeds from issuance of common and preferred stock 7,694 15,122
Payments for common and preferred stock issuance costs (918) (1,465)
Exercise of put rights (103) (50)
Exercise of stock options 50 28
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Net cash provided by financing activities 6,001 43,950
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Increase (decrease) in cash and cash equivalents (2,073) 1,515
Cash and cash equivalents, beginning of period 2,220 302
------------ ------------
Cash and cash equivalents, end of period $ 147 $ 1,817
============ ============
See accompanying notes to consolidated financial statements.
4
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
September 30, 1998
Notes to Condensed Consolidated Financial Statements
(Unaudited, in thousands, except per share and share amounts)
(1) Organization
Gentle Dental Service Corporation ("GDS" or the "Company"), incorporated on
December 14, 1992, is a Washington corporation headquartered in El Segundo,
California. The Company is one of the largest providers of dental practice
management services to multi-specialty dental practices in the United States.
Including affiliations completed through November 13, 1998, the Company provides
management services to dental practices at 92 dental offices with 352 dentists,
including 103 specialists, and 915 operatories in selected markets in
California, Washington, Oregon, Idaho and Hawaii.
As part of a multi-specialty dental care delivery network, the Company provides
management services to dental practices (the "Affiliated Dental Practices" or
"DPs") under long-term management service agreements. Under the terms of the
management service agreements, the Company, among other things, bills and
collects patient receivables and provides all administrative support services to
the DPs. The dentists employed through the Company's network of Affiliated
Dental Practices provide comprehensive general dentistry services and offer
specialty dental services, which include orthodontics, periodontics,
endodontics, pedodontics, prosthodontics, oral surgery and oral pathology. The
Company's practice management services facilitate the delivery of convenient,
high quality, comprehensive and affordable dental care to patients in a
comfortable environment. The Company seeks to build geographically dense dental
practice networks in selected markets through a combination of affiliating with
existing dental practices and selectively developing de novo offices.
On February 13, 1997, the Company completed its initial public offering of
1,500,000 shares of no par value common stock (the "Offering"). The price per
share in the Offering was $5.00, resulting in gross offering proceeds of $7,500.
The Company received net proceeds of approximately $6,125 net of underwriters'
discount and offering expenses.
(2) Basis of Presentation and Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of GDS and its
subsidiaries. All significant intercompany transactions and accounts have been
eliminated. On November 4, 1997, GMS Dental Group, Inc. ("GMS") was merged with
and into the Company, with former stockholders of GMS owning 59% of the combined
company upon completion of the merger. These consolidated financial statements
have been prepared following the pooling-of-interests method of accounting and
reflect the combined financial position and operating results of GDS and GMS
(and certain affiliated DPs as discussed below) for all periods presented.
The Emerging Issues Task Force ("EITF") of the Financial Accounting Standards
Board recently evaluated certain matters relating to the physician practice
management industry (EITF issue number 97-2) and reached a consensus on the
accounting for transactions between physician practice management companies and
physician practices and the financial reporting of such entities. For financial
reporting purposes, EITF 97-2 mandates the consolidation of physician practice
activities with the practice management company when certain conditions have
been met, even though the practice management company does not have an equity
investment in the physician practice. The accompanying financial statements are
prepared in conformity with the consensus reached in EITF 97-2.
Corporate practice of medicine laws in the states in which the Company currently
operates generally prohibit the Company from owning dental practices. In
response to these laws the Company has executed management services agreements
("MSAs") with various DPs. Based upon the terms of MSAs with certain of the DPs,
the Company has met the criteria for consolidation of those DPs with the
Company. In these circumstances, all the accounts of those DPs are included in
the accompanying consolidated financial statements. Accordingly, the
consolidated statements of operations include the net patient revenues and
related expenses of those DPs.
5
In addition to the MSAs discussed above, the Company has entered into MSAs with
certain DPs where the Company has not met the criteria for consolidation of the
DPs' activities. In these circumstances, the Company does not consolidate the
accounts of the DPs. Accordingly, the consolidated statements of operations
exclude the net patient revenues and expenses of these DPs. Rather, the
statements of operations include only the Company's net management fees revenue
generated from those MSAs and the Company's expenses associated with those MSAs.
Effective January 1, 1998, the Company entered into new MSAs with certain DPs
located in Oregon and Washington (the "Oregon and Washington DPs"), thereby
meeting the criteria for consolidation of these DPs' financial statements with
the Company. As a result of the new MSAs entered into with the Oregon and
Washington DPs, as of January 1, 1998 all of the DPs within the Gentle Dental
Network except one are accounted for under the consolidation method of
accounting as outlined in EITF 97-2. Prior to January 1, 1998, the Oregon and
Washington DPs were not consolidated.
The Company has a 50% investment in Celebration Dental Services L.L.C., a
Florida limited liability company, which is accounted for on the equity basis of
accounting and included in other expense, net.
Interim Reporting
The accompanying unaudited interim consolidated financial statements of the
Company have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). Certain information and note
disclosures normally included in annual consolidated financial statements have
been condensed or omitted pursuant to those rules and regulations. In the
opinion of management, all adjustments, consisting only of normal, recurring
adjustments considered necessary for a fair presentation, have been included.
Although management believes that the disclosures made are adequate to insure
that the information presented is not misleading, it is suggested that these
financial statements be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's annual report on Form
10-KSB for the fiscal year ended December 31, 1997. The results for the three
and nine months ended September 30, 1998 are not necessarily indicative of the
results of operations for the entire year.
Net Revenues
Revenues consist primarily of DP net patient service revenue (net patient
revenue) and Company net management fees. Net patient revenue represents the
consolidated revenue of the DPs reported at the estimated net realizable amounts
from patients, third party payors and others for services rendered, net of
contractual adjustments. Net management fees represent amounts charged under
MSAs to the unconsolidated DPs on an agreed-upon percentage of the DPs net
patient service revenue, net of provisions for contractual adjustments and
doubtful accounts.
Net Income (Loss) Per Share
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") in the fourth quarter of 1997. SFAS 128
simplifies the computation of earnings per share ("EPS") previously required by
Accounting Principles Board (APB) Opinion No.15, "Earnings Per Share" by
replacing primary and fully diluted EPS with basic and diluted EPS. Dilutive
potential common shares represent shares issuable using the treasury stock
method. Dilutive potential common shares have been excluded from the computation
of loss per share for the three and nine months ended September 30, 1997as their
effect is anti-dilutive. Shares issuable upon conversion of the subordinated
notes payable and exercise of certain options and warrants have been excluded
from the computation of diluted income per share for the three and nine months
ended September 30, 1998 as their effect is anti-dilutive. Such excluded
issuable shares were 4,394,883 and 3,453,044, respectively for three and nine
months ended September 30, 1998. Loss per share for the three and nine-month
periods ended September 30, 1997 have been restated in accordance with SFAS 128.
The following table summarizes the computation of EPS:
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1998 1997 1998
------------ ------------- ------------ ------------
Net income (loss) attributable to common stock - basic
and diluted $ (325) $ 739 $ (1,510) $ 631
============ ============= ============ ============
Basic Shares Reconciliation:
Weighted average common shares outstanding 4,309,687 8,702,362 3,930,621 8,104,687
Contingently issuable common shares - 57,564 - 91,396
------------ ------------- ------------ -------------
Basic shares 4,309,687 8,759,926 3,930,621 8,196,083
============ ============= ============ ============
Income (loss) per share attributable to common stock
- basic $ (.08) $ .08 $ (.38) $ .08
============ ============= ============ ============
6
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1998 1997 1998
------------ ------------- ------------ ------------
Diluted Shares Reconciliation:
Basic shares 4,309,687 8,759,926 3,930,621 8,196,083
Effects of dilutive potential common shares:
Convertible preferred stock - 1,628,664 - 813,139
Warrants - 68,123 - 134,901
Stock options - 242,209 - 297,601
Put rights - 79,965 - 58,044
------------ ------------- ------------ ------------
Diluted shares 4,309,687 10,779,087 3,930,621 9,499,768
============ ============= ============ ============
Income (loss) per share attributable to common stock -
diluted $ (.08) $ .07 $ (.38) $ .07
============ ============= ============ ============
Comprehensive Income
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" ("SFAS 130") in the first quarter of 1998. SFAS
130 establishes standards for reporting and display of comprehensive income. The
adoption of SFAS 130 did not have an effect on the Company's financial position
or results of operations.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Reclassifications
Certain reclassifications have been made to the 1997 financial statements to
conform to the presentation as of September 30, 1998. Such reclassifications
had no effect on the Company's previously reported results of operations or
financial position.
(3) Dental Practice Acquisitions
The Company and its related Washington and Oregon DPs entered into asset
purchase and management service agreements (collectively, the "Agreements") on
January 1, 1998. The new MSA's meet the criteria for consolidation of the DP
accounts with the Company for financial reporting purposes as outlined in EITF
97-2.
Under the terms of the Agreements, the Company acquired all of the fixed assets
and assumed certain liabilities of the DPs. In exchange, the Company paid
consideration of $1,674 in addition to the assumption of certain liabilities,
which was offset by the Company's $1,674 receivable from the DPs. In addition,
the Company will pay $575 in cash over 18 equal monthly installments and may pay
future consideration, to be determined upon the achievement of certain financial
results, as described in the Agreements.
During the nine months ended September 30, 1998, the Company acquired
substantially all of the assets of 27 dental office locations, including cash,
accounts receivable, supplies and fixed assets. Additionally, the Company
acquired all of the outstanding capital stock of Managed Dental Care of Oregon,
Inc., a dental care entity that contracts with the Oregon Health Plan, and all
of the outstanding capital stock of Dedicated Dental Systems, Inc. ("Dedicated
Dental"), a Bakersfield, California company which owns and operates eleven staff
model dental offices pursuant to a license granted under the California
Knox-Keene Health Care Service Plan Act of 1975.
The aggregate dental practice acquisition purchase price recorded during the
nine months ended September 30, 1998, representing the fair value of the assets
acquired, including intangible assets was $58,004. Approximately $51,389 of the
purchase price has been allocated to intangible assets. The total purchase
consideration included $40,178 in cash, $10,251 in common stock issued
(1,223,741 shares), $6,141 in liabilities incurred and assumed, and $1,434 in
accrued earnout from transactions completed in current and prior periods.
The Company has agreed to make future cash and stock earnout payments as set
forth in various purchase agreements based upon the achievement of financial
targets of the applicable related dental practices. The Company accrues for
earn-out
7
payments with respect to prior practice acquisitions when such amounts are
probable and reasonably estimable. As of September 30, 1998, the Company has
accrued $1,789 for future earn-out payments, of which $578 is included in
additional paid-in capital for anticipated stock issuances while the remaining
accrual for anticipated cash payments is included in other current liabilities.
Earnouts are based upon future operating results. Accordingly, the calculation
of accrued earnout liabilities is not precisely estimable. However, management
believes the estimated total maximum earn-out to be paid, including amounts
already accrued, is between $15,000 and $20,000 over the next four years, of
which up to $15,000 is expected to be paid in cash.
The above acquisitions have been accounted for using the purchase method of
accounting. The excess of the total purchase price over the fair value of the
net tangible and identifiable intangible assets acquired generally represents
the estimated future value of the management services agreements and are being
amortized over the lesser of the term of the related management service
agreements or 25 years using the straight-line method. The results of operations
for the acquired businesses have been included in the consolidated financial
statements of the Company from the dates of their acquisitions.
The following unaudited pro forma information presents the condensed
consolidated results of operations for the nine months ended September 30, 1997
and 1998 as if certain affiliations completed during the nine months ended
September 30, 1998 had occurred as of January 1, 1997. The pro forma results
have been prepared for comparative purposes and include only those significant
affiliations for which a Form 8-K was filed during the nine months ended
September 30, 1998. These pro forma results have been prepared for comparable
purposes only and are not necessarily indicative of what the actual results of
operations would have been had the practices been affiliated as of that date,
nor does it purport to represent future operations of the Company:
Nine Months ended
September 30,
1997 1998
-------------- --------------
Pro forma:
Dental practice net patient service revenue $ 46,861 $ 85,850
Net management fees 10,148 1,408
Net income attributable to common stock 745 2,255
Income per share attributable to common stock - basic .15 .25
Income per share attributable to common stock - diluted .14 .22
(4) Debt
On June 3, 1998, in connection with the private placement as discussed in note
5, the Company issued $30,000 of convertible subordinated notes (the
"Subordinated Notes"). The Subordinated Notes bear interest at an annual rate of
7.0% and mature in May 2006. The Company utilized the proceeds for working
capital requirements, to fund the purchase of dental practices assets and to
repay all outstanding amounts due under the Company's current credit facility.
Under certain circumstances, the Subordinated Notes are convertible into common
and preferred stock (see note 6).
At September 30, 1998 the Company's credit facility provided for borrowing of up
to $25,000. The credit facility provided that aggregate amounts borrowed under
the credit facility for working capital purposes and letter of credit
obligations may not exceed $4,000, and that remaining amounts available under
the credit facility may be used by the Company for permitted acquisitions and
capital expenditures. Subsequent to September 30, 1998, the credit facility was
terminated at the option of the Company as the Company received funding under a
new credit facility in the amount of $45,000 (see note 6).
(5) Shareholders' Equity
As of January 1, 1997, GDS had only common stock outstanding and GMS had two
classes of stock outstanding: common stock and preferred stock. GMS preferred
stock outstanding consisted of convertible preferred stock - Series A,
redeemable convertible preferred stock - Series B and convertible preferred
stock - Series C. The redeemable convertible preferred stock - Series B,
including dividends, and the convertible preferred stock - Series A and C, were
converted into 7,603,677 shares (3,384,302 shares of GDS common stock) of GMS
common stock on November 4, 1997 prior to the merger. Upon closing of the merger
between GMS and the Company, all 10,218,578 outstanding GMS common shares were
converted into 4,548,161 shares of the Company's common stock.
On June 3, 1998, the Company completed a $45,000 private placement, consisting
of $30,000 of Subordinated Notes and $15,000 of convertible preferred stock of
the Company. The Subordinated Notes have an eight-year term and are convertible
into shares of the Company's common stock at $9.21 for each share of common
stock issuable upon conversion of outstanding principal and accrued but unpaid
interest on such Subordinated Notes. If certain events of default occur
8
under the Company's credit facility, the Subordinated Notes then outstanding
will automatically convert into shares of Convertible Preferred Stock - Series B
("Preferred Stock - Series B") at a rate of one share of Preferred Stock Series
B for each thousand dollars in outstanding principal and accrued but unpaid
interest on the Subordinated Notes, subject to adjustment for stock splits,
reverse splits, stock dividends, reorganizations and the like. The Subordinated
Notes and all outstanding shares of Preferred Stock shall be automatically
converted into common stock (or, in the case of the Preferred Stock - Series A
and Preferred Stock - Series C, redeemed at nominal cost) if the rolling 21-day
average closing market price of the common stock on 20 out of any 30 consecutive
trading days is more than $15.73 on or prior to May 18, 1999, more than $16.85
on or prior to May 18, 2000, or more than $17.98 at any time thereafter.
The Preferred Stock includes the following series: 100 shares of Preferred Stock
- - Series A, all of which is issued and outstanding; 70,000 shares of Preferred
Stock - Series B, none of which is presently outstanding but which will be
issued automatically upon conversion of the then outstanding Subordinated Notes,
as described above; 100 shares of Preferred Stock - C, all of which is issued
and outstanding; and 2,000,000 shares of Convertible Preferred Stock - Series D
("Preferred Stock - Series D"), of which 1,628,663 shares are issued and
outstanding. The shares of Preferred Stock - Series B are convertible into
shares of the Company's common stock at the rate of 108.58 shares of common
stock for each share of Preferred Stock - Series B, and the shares of Preferred
Stock - Series D are convertible into shares of the Company's common stock on a
share for share basis, in each case subject to adjustment for stock splits,
reverse splits, stock dividends, reorganizations and the like. The Preferred
Stock of Series A and C are not convertible and have limited voting rights, but
the holders of outstanding shares of Preferred Stock - Series A have, and upon
the occurrence of certain events the holders of outstanding shares of Preferred
Stock - Series C will have, the right to elect one member of Company's Board of
Directors.
(6) Subsequent Events
On October 2, 1998, the Company received funding under a new senior revolving
credit facility syndication led by The Chase Manhattan Bank. Union Bank of
California, U.S. Bank, and Fleet Capital are also participating lenders. The new
credit facility provides for a maximum borrowing of $45,000. The Company intends
to use the credit facility for working capital requirements, to purchase
non-professional dental practice assets of additional dental practices, and to
purchase operating assets for existing affiliated dental practices. The
revolving feature of the credit facility expires on September 30, 2001, at which
time it will convert into a four year term loan to be repaid in 16 equal
quarterly installments. Principal amounts owed under the credit facility bear
interest, at varying amounts over either LIBOR or the prime rate, at the
Company's option, based on the level of the Company's leverage ratio. The credit
facility requires the Company to pay an unused commitment fee in an amount
ranging from 0.375% to 0.750% per annum of the average daily amount by which the
bank commitment under the credit facility exceeds the aggregate amount of all
loans then outstanding. The credit facility also contains provisions requiring
the maintenance of certain financial ratios and compliance with restrictive
covenants, including consent of the lenders prior to making acquisitions over a
specified purchase price. Furthermore, the obligations under this credit
agreement are secured by substantially all assets of the Company and its
subsidiaries.
On October 15, 1998, the Company and Dental Care Alliance, Inc. signed a
definitive agreement to merge in a transaction expected to be accounted for as a
pooling-of-interests. The proposed transaction will create one of the largest
dental practice management companies in the nation. The new company will be
affiliated with dental practices in California, Florida, Georgia, Hawaii, Idaho,
Indiana, Michigan, Oregon, and Washington. Michael Fiore, Co-Chairman, President
and Chief Executive Officer of Gentle Dental Service Corporation will become
Co-Chairman and Chief Executive Officer of the new company. Steven Matzkin, DDS,
Chairman and Chief Executive Officer of Dental Care Alliance, Inc. will become
Co-Chairman, President and Chief Dental Officer of the new company.
In the proposed combination, the Company and Dental Care Alliance, Inc. each
will become a wholly-owned subsidiary of a new Delaware corporation to be
headquartered in El Segundo, California. In the merger, each share of Company
common stock will be automatically converted into the right to receive one share
of common stock of the new company. Each share of Company preferred stock will
be converted into the right to receive one share of preferred stock of the new
company with the same rights, preferences, and privileges as to the new company
as the share of preferred stock had with the Company. Each share of Dental Care
Alliance, Inc. common stock will be automatically converted into the right to
receive 1.67 shares of common stock of the new company. The transaction is
subject to various shareholder and regulatory approvals. In connection with the
transaction, the new company filed a registration statement on Form S-4 with the
Securities and Exchange Commission on October 30, 1998.
On October 30, 1998, the Company acquired all of the issued and outstanding
shares of stock of Capitol Dental Care, Inc., an Oregon corporation, and
purchased substantially all the assets of Dental Maintenance of Oregon, P.C., an
Oregon professional corporation. As consideration for purchase of the capital
stock of Capitol Dental Care, Inc., the Company issued a promissory note in the
amount of $738. As consideration for purchase of the assets of Dental
Maintenance of Oregon, P.C., the Company paid $6,088 in cash, and issued or
assumed long-term notes of $1,613. Dental Management of Oregon, PC. can earn
additional cash consideration based on the EBITDA of the acquired businesses for
the first three years following the
9
acquisition. Capitol Dental Care, Inc. provides capitated dental services under
the Oregon Health Plan pursuant to a contract with the State of Oregon Office of
Medical Assistance Programs. Dental Maintenance of Oregon, PC, is a dental
practice with nine offices which provides professional dental care to patients
and also subcontracts with Capitol Dental Care, Inc. to provide professional
dental services to beneficiaries under the Oregon Health Plan. This affiliation
was accounted for using the purchase method of accounting.
On October 30, 1998, the Company also completed the acquisition of a DP,
representing one clinical office location. The purchase price for this
affiliation totaled $1,200. The total purchase price is comprised of capital
stock of $360 and a promissory note of $840 bearing interest at an annual rate
of 8%, plus contingent payments to be made based on future performance. This
affiliation was accounted for using the purchase method of accounting.
Item 2. Management's Discussion and Analysis or Plan of Operations
Overview
Gentle Dental Service Corporation is one of the largest providers of dental
practice management services to multi-specialty dental practices in the United
States. Including the affiliations completed through November 13, 1998, the
Company provides management services to dental practices at 92 dental offices
with 352 dentists, including 103 specialists, and 915 operatories in selected
markets in California, Washington, Oregon, Idaho and Hawaii.
As part of a multi-specialty dental care delivery network, the Company provides
management services to affiliated dental practices under long-term management
service agreements. Under the terms of the management service agreements, the
Company, among other things, bills and collects patient receivables and provides
all administrative support services to the dental practices. The dentists
employed through the Company's network of affiliated dental practices provide
comprehensive general dentistry services and offer specialty dental services,
which include orthodontics, periodontics, endodontics, pedodontics,
prosthodontics, oral surgery and oral pathology. The Company's practice
management services facilitate the delivery of convenient, high quality,
comprehensive and affordable dental care to patients in a comfortable
environment. The Company seeks to build geographically dense dental practice
networks in selected markets through a combination of affiliating with existing
dental practices and selectively developing new dental offices.
The following discussion of the results of operations and financial condition of
the Company should be read in conjunction with the unaudited consolidated
financial statements and the notes thereto included elsewhere in this Report on
Form 10-QSB. The following discussion contains forward-looking statements. The
Company's results may differ significantly from those projected in the
forward-looking statements. Factors that might cause future results to differ
materially from the Company's recent results or those projected in the
forward-looking statements include, without limitation, the Company's ability to
complete affiliations necessary for its expansion plans, to integrate dental
practices, attract and retain a sufficient number of qualified dental care
professionals, the availability of financing to fund the Company's growth and
operations, the enforceability of the provisions of the Company's Management
Agreements and the legality of its business and relationships with Affiliated
Dental Practices.
Results of Operations
To provide a more meaningful comparison, the following discussion generally
compares (i) expenses to (ii) the total of dental practice net patient revenue
of consolidated and unconsolidated affiliated dental practices. The Company
reports dental practice net patient revenue and associated clinical salaries and
benefits costs in those instances where the Company meets certain specific
consolidation requirements established by the Emerging Issues Task Force (the
"EITF") of the Financial Accounting Standards Board. In those instances where
such consolidation requirements are not met, the Company (i) reports net
management fee revenue and (ii) does not record any associated clinical salaries
and benefits costs. Through December 31, 1997, net patient service revenue of
certain affiliations in Oregon and Washington (representing a significant
portion of overall net patient revenues) were not included within the Company's
consolidated financial statements, as the EITF consolidation requirements were
not met. As of January 1, 1998, the Company entered into new management services
agreements with such affiliates. Consequently, all of the dental practices
affiliated with the Company, except one, are now accounted for under the EITF
consolidation requirements. The remaining dental practice, acquired April 1,
1997, has not met EITF consolidation requirements.
10
Three Months Ended September 30, 1997 Statement of Operations Compared to Three
Months Ended September 30, 1998 Statement of Operations
Dental Practice Net Patient Service Revenue. Total revenues increased from $12.5
million for the three months ended September 30, 1997 to $29.5 million for the
three months ended September 30, 1998, an increase of 136%. This increase is
primarily attributable to the new management services agreements with certain
Oregon and Washington affiliated dental practices, as discussed above, in
addition to five affiliations completed during the second half of 1997 and ten
affiliations completed during the nine months ended September 30, 1998,
representing forty-nine current clinical locations.
If all the affiliated dental practices met the EITF consolidation requirements,
total dental practice net patient revenue reported would have been $15.8 million
for the three months ended September 30, 1997 and $29.9 million for the three
months ended September 30, 1998, representing a 90% increase.
Clinical Salaries and Benefits. Clinical salaries and benefits costs include all
patient service provider staff compensation and related payroll costs at the
consolidated dental practices, including dentists, hygienists and dental
assistants. Clinical salaries and benefits increased from $4.1 million for the
three months ended September 30,1997 to $13.1 million for the three months ended
September 30, 1998, an increase of 220%. This increase is attributed to the new
management services agreements and affiliations as discussed above.
If all the dental practices met the EITF consolidation requirements, clinical
salaries and benefits would have been $7.5 million for the three months ended
September 30, 1997 and $13.5 million for the three months ended September 30,
1998. Practice clinical salaries and benefits as a percentage of dental practice
net patient revenue for the three months ended September 30, 1997 and 1998 would
have been 47.4% and 45.2%, respectively. This decrease as a percentage of
revenues is the result of the new management services agreements entered into
with the Oregon and Washington dental practices as discussed above. The
affiliation of dental practices with the Company during the second half of 1997
and the nine months ended September 30, 1998 also contributed to the overall
percentage decrease.
Practice Nonclinical Salaries and Benefits. Practice nonclinical salaries and
benefits costs include all staff compensation and related payroll costs at the
dental facilities other than dentists, hygienists and dental assistants. Total
nonclinical salary costs increased 78% from $2.3 million for the three months
ended September 30, 1997 to $4.1 million for the three months ended September
30, 1998. This increase was primarily attributable to the addition of costs from
affiliations completed during the second half of 1997 and the nine months ended
September 30, 1998.
If all the dental practices met the EITF consolidation requirements, practice
nonclinical salaries and benefits as a percentage of total revenue for the three
months ended September 30, 1997 and 1998 would have been 14.7% and 13.8%,
respectively. The expense mix of the dental practices affiliated with the
Company during the second half of 1997 and the nine months ended September 30,
1998 contributed to the percentage decrease.
Dental Supplies and Lab Expenses. Total dental supplies and lab costs increased
86% from $1.9 million for the three months ended September 30, 1997 to $3.5
million for the three months ended September 30, 1998. This increase was
primarily attributable to the addition of costs from affiliations completed
during the second half of 1997 and the nine months ended September 30, 1998.
If all the dental practices met the EITF consolidation requirements, dental
supplies and lab costs as a percentage of total revenue for the three months
ended September 30, 1997 and 1998 would have been 11.8% and 11.5%, respectively.
Practice Occupancy Expenses. Practice occupancy expenses increased 70% from
$913,000 for the three months ended September 30, 1997 to $1.6 million for the
three months ended September 30, 1998. This increase is primarily attributed to
the addition of costs from affiliations completed during the second half of 1997
and the nine months ended September 30, 1998.
If all the dental practices met the EITF consolidation requirements, practice
occupancy cost as a percentage of total revenue for the three months ended
September 30, 1997 and 1998 would have been 5.8% and 5.2%, respectively. The
expense mix of the dental practices affiliated with the Company during the
second half of 1997 and the nine months ended September 30, 1998 contributed to
the percentage decrease.
Practice Selling, General and Administrative Expenses. These costs include
general office, advertising, professional services (excluding dentistry), travel
and entertainment, local taxes, insurance, and other miscellaneous costs at the
clinical office level. Practice selling, general and administrative expenses
increased 132% from $1.1 million for the three months ended September 30, 1997
to $2.6 million for the three months ended September 30, 1998. This increase is
attributed to the new management services agreements and affiliations as
discussed above.
11
If all the dental practices met the EITF consolidation requirements, practice
selling, general and administrative expenses as a percentage of total revenue
for the three months ended September 30, 1997 and 1998 would have been 7.7% and
8.9%, respectively. These costs for the three months ended September 30, 1997
were lower due to favorable collections on accounts receivable resulting in a
lower bad debt provision. Excluding the favorable impact of the favorable bad
debt provision, practice selling, general and administrative expenses as a
percentage of total revenue for the three months ended September 30, 1997 would
have been 9.2%.
Corporate Selling, General and Administrative Expenses. Total corporate selling,
general and administrative expenses increased 6.8% from $1.6 million for the
three months ended September 30, 1997 to $1.7 million for the three months ended
September 30, 1998. The increase in these expenses is the result of the Company
implementing infrastructure required to accommodate expected future growth, a
substantial part of which occurred in 1997.
If all the dental practices met the EITF consolidation requirements, corporate
selling, general and administrative expenses as a percentage of total revenue
for the three months ended September 30, 1997 and 1998 would have been 10.4% and
5.8%, respectively. The decrease as a percentage of revenue is consistent with
the Company's strategy to leverage the corporate support costs on total company
revenue growth.
Depreciation and Amortization. Total depreciation and amortization expense for
the three months ended September 30, 1997 and 1998 was $466,000 and $1.3
million, respectively. This increase is primarily due to the addition of
intangible and fixed assets resulting from the affiliation of dental practices
with the Company during the second half of 1997 and the nine months ended
September 30, 1998.
Interest Expense. Total interest expense increased from $169,000 for the three
months ended September 30, 1997 to $777,000 for the three months ended September
30, 1998. This increase in interest expense was due to additional debt incurred
under the Company's credit facility and the completion of a private placement to
continue the Company's strategy of growth through additional practice
affiliations.
Provision for income taxes. For the three months ended September 30, 1997 the
Company recognized no tax benefit resulting from its taxable loss as the
probable utilization of any loss carryforwards was uncertain. For the three
months ended September 30, 1998, the Company recognized a tax expense resulting
from its taxable income to offset the tax benefit recorded during the three
months ended March 31, 1998, as the Company recognized a tax benefit resulting
from its taxable loss for that period. Additional expense at statutory rates was
not recorded during the three months ended September 30, 1998, as management
believes that the Company will be able to utilize available federal and state
loss carryforwards.
Nine Months Ended September 30, 1997 Statement of Operations Compared to Nine
Months Ended September 30, 1998 Statement of Operations
Dental Practice Net Patient Service Revenue and Net Management fees. Total
revenues increased from $30.0 million for the nine months ended September 30,
1997 to $68.9 million for the nine months ended September 30, 1998, an increase
of 130%. This increase is primarily attributable to the new management service
agreements with certain Oregon and Washington affiliated dental practices, as
discussed above, in addition to five affiliations completed during the second
half of 1997 and ten affiliations completed during the nine months ended
September 30, 1998, representing forty-nine current clinical locations.
If all the dental practices met the EITF consolidation requirements, total
dental practice net patient revenue reported would have been $39.4 million for
the nine months ended September 30, 1997 and $70.3 million for the nine months
ended September 30, 1998, representing a 78% increase.
Clinical Salaries and Benefits. Clinical salaries and benefits costs include all
patient service provider staff compensation and related payroll costs at the
consolidated dental practices, including dentists, hygienists and dental
assistants. Clinical salaries and benefits increased from $9.2 million for the
nine months ended September 30, 1997 to $30.8 million for the nine months ended
September 30, 1998, an increase of 233%. This increase is attributed to the new
management services agreements and affiliations as discussed above.
If all the dental practices met the EITF consolidation requirements, clinical
salaries and benefits would have been $18.8 million for the nine months ended
September 30, 1997 and $32.1 million for the nine months ended September 30,
1998. Practice clinical salaries and benefits as a percentage of dental practice
net patient revenue for the nine months ended September 30, 1997 and 1998 were
47.7% and 45.6%, respectively. This decrease as a percentage of revenues is the
result of the new management services agreements entered into with the Oregon
and Washington dental practices as discussed above. The expense mix of
12
the dental practices affiliated with the Company during the second half of 1997
and the nine months ended September 30, 1998 also contributed to the overall
percentage decrease.
Practice Nonclinical Salaries and Benefits. Practice nonclinical salaries and
benefits costs include all staff compensation and related payroll costs at the
dental facilities other than dentists, hygienists and dental assistants. Total
nonclinical salary costs increased 74% from $5.8 million for the nine months
ended September 30, 1997 to $10.0 million for the nine months ended September
30, 1998. This increase was primarily attributable to the addition of costs from
affiliations completed during the second half of 1997 and the nine months ended
September 30, 1998.
If all the dental practices met the EITF consolidation requirements, practice
nonclinical salaries and benefits as a percentage of total revenue for the nine
months ended September 30, 1997 and 1998 would have been 14.6% and 14.3%,
respectively. The expense mix of the dental practices affiliated with the
Company during the second half of 1997 and the nine months ended September 30,
1998 contributed to the percentage decrease.
Dental Supplies and Lab Expenses. Total dental supplies and lab costs increased
76% from $4.5 million for the nine months ended September 30, 1997 to $8.0
million for the nine months ended September 30, 1998. This increase was
primarily attributable to the addition of costs from affiliations completed
during the second half of 1997 and the nine months ended September 30, 1998.
If all the dental practices met the EITF consolidation requirements, dental
supplies and lab costs as a percentage of total revenue for the nine months
ended September 30, 1997 and 1998 would have been 11.5% and 11.4%, respectively.
Practice Occupancy Expenses. Practice occupancy expenses increased 59% from $2.4
million for the nine months ended September 30, 1997 to $3.8 million for the
nine months ended September 30, 1998. This increase is primarily attributed to
the addition of costs from affiliations completed during the second half of 1997
and the nine months ended September 30, 1998.
If all the dental practices met the EITF consolidation requirements, practice
occupancy cost as a percentage of total revenue for the nine months ended
September 30, 1997 and 1998 would have been 6.1% and 5.4%, respectively. The
expense mix of the dental practices affiliated with the Company during the
second half of 1997and the nine months ended September 30, 1998 contributed to
the percentage decrease.
Practice Selling, General and Administrative Expenses. These costs include
general office, advertising, professional services (excluding dentistry), travel
and entertainment, local taxes, insurance, and other miscellaneous costs at the
clinical office level. Practice selling, general and administrative expenses
increased 103% from $3.2 million for the nine months ended September 30, 1997 to
$6.4 million for the nine months ended September 30, 1998. This increase is
attributed to the new management services agreements and affiliations as
discussed above.
If all the dental practices met the EITF consolidation requirements, practice
selling, general and administrative expenses as a percentage of total revenue
for the nine months ended September 30, 1997 and 1998 would have been 10.0% and
9.3%, respectively. The expense mix of the dental practices affiliated with the
Company during the second half of 1997and the nine months ended September 30,
1998 contributed to the percentage decrease
Corporate Selling, General and Administrative Expenses. Total corporate selling,
general and administrative expenses increased 17% from $3.9 million for the nine
months ended September 30, 1997 to $4.5 million for the nine months ended
September 30, 1998. The increase in these expenses is the result of the Company
implementing infrastructure required to accommodate expected future growth, a
substantial part of which occurred in 1997.
If all the dental practices met the EITF consolidation requirements, corporate
selling, general and administrative expenses as a percentage of total revenue
for the nine months ended September 30, 1997 and 1998 would have been 9.8% and
6.4%, respectively. The decrease as a percentage of revenue is consistent with
the Company's strategy to leverage the corporate support costs on total company
revenue growth.
Depreciation and Amortization. Total depreciation and amortization expense for
the nine months ended September 30, 1997 and 1998 was $1.3 million and $2.9
million, respectively. This increase is primarily due to the addition of
intangible and fixed assets resulting from the affiliation of dental practices
with the Company during the second half of 1997 and the nine months ended
September 30, 1998.
Interest Expense. Total interest expense increased from $362,000 for the nine
months ended September 30, 1997 to $1.8 million for the nine months ended
September 30, 1998. This increase in interest expense was due to additional debt
incurred under the Company's credit facility and private placement to complete
certain dental practice affiliations.
13
Provision for income taxes. For the nine months ended September 30, 1997 the
Company recognized no tax benefit resulting from its taxable loss as the
probable utilization of any loss carryforwards was uncertain. For the nine
months ended September 30, 1998, the Company did not accrue a provision for
income taxes as management believes that the Company will be able to utilize
available federal and state tax loss carryforwards. The income tax expense
recorded during the nine months ended September 30, 1998 represents incidental
filing fees for various federal and state income tax returns.
Liquidity and Capital Resources
At September 30, 1998, the Company's cash and cash equivalents were $1.8 million
and working capital was $2.2 million. Net cash provided by operations was
$902,000 and $174,000 for the nine-month periods ending September 30, 1997 and
1998, respectively. The reduction of net cash provided by operations during the
nine-months ended September 30, 1998 was directly attributed to the reduction of
accounts payable and accrued liabilities outstanding at December 31, 1997. The
significant level of such liabilities at December 31, 1997 was attributed to
merger and restructure related costs between the Company and GMS Dental Group,
Inc. as a result of the merger effective in November 1997. Net cash used in
investing activities, principally dental practice affiliations, was $9.0 million
and $42.6 million for the nine-month periods ending September 30, 1997 and 1998,
respectively. Net cash provided from financing activities was $6.0 million and
$40.0 million for the nine-month periods ending September 30, 1997 and 1998,
respectively. The increase in net cash provided by financing activities during
the nine-months ended September 30, 1998 was primarily attributed to the $45
million private placement completed during 1998 as further discussed below.
On January 1, 1998, the Company and certain Washington and Oregon affiliated
dental practices entered into asset purchase and management service agreements
(collectively, the "Agreements"). Under the terms of the Agreements, the Company
acquired all of the fixed assets and assumed certain liabilities of these
affiliated dental practices. In exchange, the Company gave consideration of $1.7
million in addition to the assumption of certain liabilities, which was offset
by the Company's $1.7 million receivable from these affiliated dental practices.
In addition, the Company will pay $575,000 in cash over 18 monthly installments.
The transaction meets the criteria for consolidation of the affiliated dental
practice accounts with the Company for financial reporting purposes.
During the nine months ended September 30, 1998, the Company acquired
substantially all of the assets of 27 dental office locations, including cash,
accounts receivable, supplies and fixed assets. Additionally, the Company
acquired all of the outstanding capital stock of Managed Dental Care of Oregon,
Inc., a dental care entity that contracts with the Oregon Health Plan, and all
of the outstanding capital stock of Dedicated Dental Systems, Inc. ("Dedicated
Dental"), a Bakersfield, California company which owns and operates eleven staff
model dental offices pursuant to a license granted under the California
Knox-Keene Health Care Service Plan Act of 1975.
The aggregate dental practice acquisition purchase price recorded during the
nine months ended September 30, 1998, representing the fair value of the assets
acquired, including intangible assets was $58,004. Approximately $51,389 of the
purchase price has been allocated to intangible assets. The total purchase
consideration included $40,178 in cash, $10,251 in common stock issued
(1,223,741 shares), $6,141 in liabilities incurred and assumed, and $1,434 in
accrued earnout from transactions completed in current and prior periods.
The Company has agreed to make future cash and stock earnout payments as set
forth in various purchase agreements based upon the achievement of financial
targets of the applicable related dental practices. The Company accrues for
earn-out payments with respect to prior practice acquisitions when such amounts
are probable and reasonably estimable. As of September 30, 1998, the Company has
accrued $1,789 for future earn-out payments, of which $578 is included in
additional paid-in capital for anticipated stock issuances while the remaining
accrual for anticipated cash payments is included in other current liabilities.
The Company estimates the total maximum earn-out to be paid, including amounts
already accrued, is between $15 and $20 million over the next four years, of
which up to $15 million is expected to be paid in cash.
A total of 254,901 outstanding shares of common stock issued at a price of $.45
per share and 339,246 outstanding shares of common stock issued at a price of
$.225 per share are subject to, under certain events, repurchase by the Company
at cost. One half of these shares are currently subject to repurchase as a
result of the Company's failure to achieve certain specified performance targets
during 1997.
On October 2, 1998, the Company received funding under a new senior revolving
credit facility syndication led by The Chase Manhattan Bank. Union Bank of
California, U.S. Bank, and Fleet Capital are also participating lenders. The new
credit facility provides for a maximum borrowing of $45 million. The Company
intends to use the credit facility for working capital requirements, to purchase
non-professional dental practice assets of additional dental practices, and to
purchase operating assets for existing affiliated dental practices. The
revolving feature of the credit facility expires on September 30,
14
2001, at which time it will convert into a four year term loan to be repaid in
16 equal quarterly installments. Principal amounts owed under the credit
facility bear interest, at varying amounts over either LIBOR or the prime rate,
at the Company's option, based on the level of the Company's leverage ratio. The
credit facility requires the Company to pay an unused commitment fee in an
amount ranging from 0.375% to 0.750% per annum of the average daily amount by
which the bank commitment under the credit facility exceeds the aggregate amount
of all loans then outstanding. . The credit facility also contains provisions
requiring the maintenance of certain financial ratios and compliance with
restrictive covenants, including consent of the lenders prior to making
acquisitions over a specified purchase price. Furthermore, the obligations under
this credit agreement are secured by substantially all assets of the Company and
its subsidiaries.
On June 3, 1998, the Company completed a $45 million private placement with
Chase Capital and existing venture capital investors, consisting of $30 million
of subordinated notes ("Subordinated Notes") and $15 million of convertible
preferred stock of the Company. The Subordinated Notes have an eight-year term
and are convertible into shares of the Company's common stock at $9.21 for each
share of common stock issuable upon conversion of outstanding principal and
accrued but unpaid interest on such Subordinated Notes. If certain events of
default occur, the Subordinated Notes then outstanding will automatically
convert into shares of Convertible Preferred Stock - Series B ("Preferred Stock
- - Series B") at a rate of one share of Preferred Stock - Series B for each
thousand dollars in outstanding principal and accrued but unpaid interest on the
Subordinated Notes, subject to adjustment for stock splits, reverse splits,
stock dividends, reorganizations and the like. The Subordinated Notes and all
outstanding shares of Preferred Stock shall be automatically converted into
common stock (or, in the case of the Preferred Stock - Series A and Preferred
Stock - Series C, redeemed at nominal cost) if the rolling 21-day average
closing market price of the common stock on 20 out of any 30 consecutive trading
days is more than $15.73 on or prior to May 18, 1999, more than $16.85 on or
prior to May 18, 2000, or more than $17.98 at any time thereafter.
The Preferred Stock includes the following series: 100 shares of Preferred Stock
- - Series A, all of which is issued and outstanding; 70,000 shares of Preferred
Stock - Series B, none of which is presently outstanding but which will be
issued automatically upon conversion of the then outstanding Subordinated Notes,
as described above; 100 shares of Preferred Stock - C, all of which is issued
and outstanding; and 2,000,000 shares of Convertible Preferred Stock - Series D
("Preferred Stock - Series D"), of which 1,628,663 shares are issued and
outstanding. The shares of Preferred Stock - Series B are convertible into
shares of the Company's common stock at the rate of 108.58 shares of common
stock for each share of Preferred Stock - Series B, and the shares of Preferred
Stock - Series D are convertible into shares of the Company's common stock on a
share for share basis, in each case subject to adjustment for stock splits,
reverse splits, stock dividends, reorganizations and the like. The Preferred
Stock of Series A and C are not convertible.
The Company believes that proceeds from the credit facility and cash flow from
operations will be sufficient to fund its operations for the near future. The
Company also believes that such funds will be sufficient to complete a number of
other future practice affiliations and any possible future consideration from
existing affiliations. However, to execute its long term business strategy, the
Company will require substantial additional funding through additional long-term
or short-term borrowing arrangements or through the public or private issuance
of additional debt or equity securities to acquire new practices and to expand
and maintain existing affiliated practices. There can be no assurance that any
such financing will be available to the Company or will be available on terms
acceptable to the Company.
Year 2000 Compliance
Many existing computer programs use only two digits to identify a year in a data
field. These programs were designed and developed without considering the impact
of the upcoming change in the century. If not corrected, many computer
applications could fail or create erroneous results by or at the Year 2000 or
earlier. The Year 2000 issue affects us in that the dental practice management
business is dependent on computer applications, such as management information
systems and financial and accounting systems.
Based upon confirmations received from some of the significant management
information systems and financial and accounting systems software licensors,
certain of our significant systems are currently believed to be Year 2000
compliant or are expected to be Year 2000 compliant by April 1999. We are in the
process of verifying whether our other management information systems and
financial and accounting systems are or will be Year 2000 compliant. We expect
that we may have to incur internal staff costs as well as consulting and other
expenses related to Year 2000 and are currently developing an estimate of the
costs to be incurred as a result of the Year 2000 compliance effort.
As part of these preparations, we have contacted or intend to contact vendors,
third-party and governmental payors and other third parties upon whose services
we rely on to determine their Year 2000 compliance. We have contacted certain of
our significant vendors who have confirmed to us that they are or expect to be
Year 2000 compliant. Management believes that in the event that any of its major
suppliers are unable to provide the Company with supplies necessary to conduct
the Company's business, the Company will be able to find suitable alternative
suppliers. However, there can be no assurance
15
that the Company will be able to obtain such products at existing or comparable
prices. Also, we anticipate that many third-party and governmental payors may
not be Year 2000 compliant. Failure of third-party or governmental payors to
achieve Year 2000 compliance could have a material adverse effect on our
business, financial condition or results of operations.
Although we believe that the steps we are taking will be adequate to ensure that
we will not be materially affected by the Year 2000 problem, there can be no
assurance that these actions will protect us from the risks associated with the
Year 2000 problem. The analysis of, and preparation for, the Year 2000 and
related problems necessarily rely on a variety of assumptions about future
events, and there can be no assurance that we will accurately predict such
future events or that any remedial and contingency plans that may be adopted
will adequately address such future events.
16
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
On July 31, 1998, the Company completed the acquisition of all the stock of
Dedicated Dental Systems, Inc. ("Dedicated Dental"), a Bakersfield, California
company which owns and operates eleven staff model dental offices pursuant to a
license granted under the California Knox-Keene Health Care Service Plan Act of
1975. Also, pursuant to the terms of three asset purchase agreements, the
Company completed the acquisition of the non-professional assets of related
dental practices operating at four locations in southern California. The Company
issued 705,101 shares of common stock as part of the purchase price for these
acquisitions. The issuance of the shares was exempt from registration under
Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 of
Regulation D thereunder because all the purchasers were accredited investors
within the meaning of Rule 501 of Regulation D.
On August 31, 1998, the Company issued 88,235 shares of common stock in
connection with the acquisition of a dental practice. The issuance of the shares
was exempt from registration under Section 4(2) of the Securities Act of 1933
and Rule 506 of Regulation D thereunder because the purchaser was an accredited
investor within the meaning of Rule 501 of Regulation D.
On June 30, 1998, the Company issued warrants to purchase 50,000 shares of
common stock in connection with the acquisition of a dental practice. The
issuance of the warrants was exempt from registration under Section 4(2) of the
Securities Act of 1933 and Rule 506 of Regulation D thereunder because all
purchasers were accredited investors within the meaning of Rule 501 of
Regulation D.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
10.1 Credit Agreement, dated September 30, 1998, by and among Gentle
Dental Service Corporation, Gentle Dental Management, Inc., the
Guarantors (named therein), the Lenders (named therein), Union Bank
of California, N.A., as Administrative Agent, and The Chase
Manhattan Bank, as Syndication Agent. Incorporated by reference to
Exhibit 10.43 of the Registration Statement on Form S-4 filed by
Wisdom Holdings, Inc. on October 30, 1998 (Registration No.
333-66475).
27 Financial Data Schedule.
(b) Reports on Form 8-K.
On July 2, 1998, the Company filed a Current Report on Form 8-K to report
under Item 5 the completion of a $45 million private placement consisting
of $30 million in 7% convertible subordinated debt and $15 million in
shares of convertible preferred stock of the Company. No financial
statements were included in the report.
On July 15, 1998, the Company filed a Current Report on Form 8-K to report
under Item 2 the acquisition on June 30, 1998 of certain assets of Pacific
Dental Services, Inc. and related entities. No financial statements were
included in the report.
On August 14, 1998, the Company filed a Current Report on Form 8-K to
report under Item 2 the acquisition on July 31, 1998 of all of the
outstanding capital stock of Dedicated Dental Systems, Inc. and
substantially all of the assets of certain related dental practices. No
financial statements were included in the report.
On September 14, 1998, the Company filed a Current Report on Form 8-K/A
Amendment No. 1 to amend its previously filed Form 8-K relating to the
acquisition on June 30, 1998 of certain assets of Pacific Dental Services,
Inc. and related entities. The amendment includes under Item 7 the
consolidated financial statements of Pacific Dental Services, Inc. as of
and for the periods ended December 31, 1997 and March 31, 1998, financial
statements of TG3 Dental Services as of and for the periods ended December
31, 1997 and March 31, 1998, and pro forma financial information as of
March 31, 1998 and for the periods ended December 31, 1997 and March 31,
1998.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
GENTLE DENTAL SERVICE CORPORATION
---------------------------------
(Registrant)
Date: November 16, 1998 By: NORMAN R. HUFFAKER
--------------------------- -----------------------------------
Norman R. Huffaker
Chief Financial Officer
18