AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 9, 1998
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
GENTLE DENTAL SERVICE CORPORATION
(NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
WASHINGTON 8099 91-1577891
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION INDUSTRIAL IDENTIFICATION NO.)
OF INCORPORATION OR CLASSIFICATION CODE
ORGANIZATION) NUMBER)
22800 SAVI RANCH PARKWAY, SUITE 206
YORBA LINDA, CALIFORNIA 92887
(714) 998-0587
(ADDRESS, TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES AND PRINCIPAL PLACE
OF BUSINESS)
---------------
MICHAEL T. FIORE
PRESIDENT AND CHIEF EXECUTIVE OFFICER
GENTLE DENTAL SERVICE CORPORATION
22800 SAVI RANCH PARKWAY, SUITE 206
YORBA LINDA, CALIFORNIA 92887
(714) 998-0587
(NAME, ADDRESS AND TELEPHONE NUMBER OF AGENT FOR SERVICE)
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COPIES TO:
RICHARD J. BABCOCK, ESQ. ERIC H. SCHUNK, ESQ.
GREGORY W. PRESTON, ESQ. MILBANK, TWEED, HADLEY & MCCLOY
MCDERMOTT, WILL & EMERY 601 SOUTH FIGUEROA, 30TH FLOOR
1301 DOVE STREET, SUITE 500 LOS ANGELES, CALIFORNIA 90017
NEWPORT BEACH, CALIFORNIA 92660 (213) 892-4000
(714) 851-0633
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APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
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If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
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CALCULATION OF REGISTRATION FEE
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PROPOSED MAXIMUM
TITLE OF EACH CLASS OF PROPOSED MAXIMUM AGGREGATE
SECURITIES AMOUNT TO BE OFFERING PRICE OFFERING AMOUNT OF
TO BE REGISTERED REGISTERED(1) PER UNIT(2) PRICE(2) REGISTRATION FEE
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Common Stock............ 4,125,000 shares $9.00 $37,125,000 $10,952
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(1) Includes up to 525,000 shares of Common Stock which may be sold pursuant
to the over-allotment option granted by the Registrant to the
Underwriters.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) of the Securities Act of 1933, as amended.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
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++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED JANUARY 9, 1998
PROSPECTUS
[LOGO]
3,600,000 SHARES
GENTLE DENTAL SERVICE CORPORATION
COMMON STOCK
Of the 3,600,000 shares of Common Stock (the "Common Stock") of Gentle Dental
Service Corporation (the "Company") offered hereby, 3,500,000 shares are being
offered by the Company and 100,000 shares are being offered by certain
shareholders of the Company (the "Selling Shareholders"). See "Principal and
Selling Shareholders." The Company will not receive any of the proceeds from
the sale of the Common Stock offered by the Selling Shareholders. The Common
Stock is quoted on the NASDAQ SmallCap Market under the symbol "GNTL" and the
Company has applied to have the Common Stock quoted under that symbol on the
NASDAQ Stock Market's National Market (the "NASDAQ National Market") upon
completion of this Offering ("Offering"). On January 7, 1998, the last reported
sale price of the Common Stock on the NASDAQ SmallCap Market was $9.42 per
share. See "Price Range of Common Stock."
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SEE "RISK FACTORS" BEGINNING ON PAGE EIGHT FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CAREFULLY CONSIDERED BY PROSPECTIVE PURCHASERS OF THE
COMMON STOCK OFFERED HEREBY.
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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PRICE TO UNDERWRITING PROCEEDS TO PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) SHAREHOLDERS
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Per Share..... $ $ $ $
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Total(3)...... $ $ $ $
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(1) The Company and the Selling Shareholders have agreed to indemnify the
underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended (the "Securities Act"). See
"Underwriting."
(2) Before deducting expenses payable by the Company estimated at $ .
(3) The Company has granted to the Underwriters a 30-day option to purchase up
to 525,000 additional shares of Common Stock solely to cover over-
allotments, if any. If such option is exercised in full, the Price to
Public, the Underwriting Discount, and Proceeds to Company will be
$ , $ , and $ , respectively. See
"Underwriting."
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The shares of Common Stock are being offered severally by the Underwriters,
subject to prior sale, when, as and if issued and accepted by the Underwriters
and subject to certain conditions, including their rights to reject orders in
whole or in part. It is expected that delivery of the shares of Common Stock
will be made at the offices of Bear, Stearns & Co. Inc., 245 Park Avenue, New
York, New York 10167, on or about , 1998.
BEAR, STEARNS & CO. INC.
SALOMON SMITH BARNEY
WESSELS, ARNOLD & HENDERSON
BLACK & COMPANY, INC.
The date of this Prospectus is , 1998.
[Inside front cover graphic setting forth the following information:]
THE GENTLE DENTAL NETWORK
[Map of Western U.S. with illustration of Company
headquarters and dental practices, including those
relating to the Dedicated Dental Affiliation]
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CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT COVERING TRANSACTIONS. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET
MAKING TRANSACTIONS IN THE COMMON STOCK OF THE COMPANY ON NASDAQ IN ACCORDANCE
WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING."
----------------
2
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements, including the notes thereto, appearing
elsewhere in this Prospectus. Gentle Dental Service Corporation, a Washington
corporation ("Gentle Dental"), is a dental practice management company which
provides office space, equipment, non-clinical support personnel, information
systems and management services to general dentists and specialists. Except in
compliance with applicable law, Gentle Dental does not employ any dentists to
practice dentistry nor does it otherwise control the practice of dentistry.
Gentle Dental has entered into management agreements with numerous dental
practices including those controlled by various professional corporations (the
"Professional Corporations") which employ all dentists and other professionals
with respect to the practice of dentistry. As used in this Prospectus, the term
"Affiliated Dental Practices" means the dental practices with respect to which
Gentle Dental has (i) acquired the non-professional assets (i.e., the assets
other than patient records, payor contracts and provider contracts); and (ii)
entered into long-term contracts for the provision of comprehensive management
and administrative services. In November 1997, Gentle Dental was merged with
GMS Dental Group, Inc. ("GMS"), a California-based dental practice management
company, which resulted in the former shareholders of GMS owning approximately
59% of the then outstanding shares of the combined company (the "GMS Merger").
Gentle Dental has entered into definitive agreements to acquire all of the
outstanding capital stock of Dedicated Dental Systems, Inc. ("Dedicated
Dental") and to affiliate with certain related dental practices (such
acquisition and affiliations hereinafter collectively referred to as the
"Dedicated Dental Affiliation"). Prior to completion of this Offering, Gentle
Dental expects to affiliate with an additional dental practice (collectively
with the Dedicated Dental Affiliation, the "Pending Affiliations"). See "Recent
and Pending Affiliations." As used in this Prospectus, unless the context
otherwise requires, the "Company" shall mean (a) the combined operations of
Gentle Dental and the Affiliated Dental Practices, when used with respect to
historical information contained herein; or (b) the combined operations of
Gentle Dental, the Affiliated Dental Practices and the Pending Affiliations,
when used with respect to the current business description and information
about events that will occur after completion of this Offering. All references
herein to industry financial and statistical information are based on trade
articles and industry reports that the Company believes to be reliable,
although there can be no assurance in that regard. An investment in the Common
Stock offered hereby involves a high degree of risk, and investors should
carefully consider the information set forth under "Risk Factors."
THE COMPANY
The Company is one of the largest providers of dental practice management
services to multi-specialty dental practices in the United States. Following
the Pending Affiliations, the Company will provide management services to
dental practices at 59 locations with 205 dentists, including 49 specialists
and 581 operatories, in California, Washington, Oregon, Idaho and Hawaii. The
dentists employed by the Company's 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.
The Health Care Financing Administration ("HCFA") estimates that the annual
aggregate domestic market for dental services was approximately $45.8 billion
for 1995, representing 4.6% of total health care expenditures in the United
States. Dental services expenditures grew at a compound annual growth rate of
approximately 8.6% from 1980 to 1995. According to HCFA, the size of the dental
services industry is projected to reach $79.1 billion by 2005. The Company
believes that the anticipated growth in the dental industry will be driven by
several factors including: (i) an increase in the availability and types of
dental insurance; (ii) an increasing
3
demand for dental services from an aging population; (iii) the evolution of
technology which makes dental care less traumatic and, therefore, more
attractive to patients; (iv) an increased focus on preventive and cosmetic
dentistry; and (v) the growth of managed care organizations that offer dental
coverage to their members.
The U.S. general and specialty dentistry industries are highly fragmented.
The American Dental Association estimates that at December 1995, there were
approximately 150,000 dentists in 113,000 general dental practices, with single
dentist practices accounting for approximately 70% of all practices. The
Company estimates that approximately 2% of all dentists are currently
affiliated with practice management companies. Since January 1997, the number
of dentists contracting or otherwise associated with practice management
organizations has grown significantly. The Company believes that the trend
toward consolidation in the dental services industry will continue as dentists
seek to affiliate with group practice managers such as the Company due to (i)
the desire of dentists to focus on clinical aspects rather than on
administrative and regulatory aspects of their practices; (ii) the increasing
patient demands for more flexible evening and weekend hours; (iii) the
increasing demand for competitively-priced, high quality dental care at
multiple locations; (iv) the increasing desire of recent dental school
graduates to pursue alternatives to the traditional solo practice of dentistry;
and (v) the need for certifiable standards of care for patients. In order to
capitalize on these consolidation opportunities, the Company utilizes the
extensive dental industry experience of its senior management and its
significant relationships with numerous practitioners and other industry
leaders throughout the United States. The Company believes that these extensive
relationships provide a competitive advantage to the Company as it seeks
additional affiliation opportunities to further the growth of the Company's
network of Affiliated Dental Practices.
The Company's operating strategy is to provide value to Affiliated Dental
Practices through the introduction of a variety of practice enhancements. The
Company assists the Affiliated Dental Practices by providing general
administrative services and implementing Company procedures designed to
optimize staffing ratios and patient scheduling. The Company also assists the
Affiliated Dental Practices by developing and implementing targeted advertising
and marketing programs and attracting additional dentists and dental practices.
To the extent applicable, the Company provides significant managed care
expertise to the Affiliated Dental Practices. The Company believes the
implementation of these enhancements has resulted in significant revenue growth
at the Affiliated Dental Practices.
The Company's strategic objective is to maintain and expand its leadership
position in the dental practice management services industry. To achieve this
objective, the Company seeks to enter selected geographic markets and develop
locally-prominent, multi-specialty dental delivery networks that provide
gentle, high-quality, cost-effective dental care. The key elements of the
Company's strategy are to: (i) provide convenient, comprehensive dental care;
(ii) focus on quality of patient care; (iii) establish a comprehensive dental
care network through affiliations and de novo offices; (iv) achieve operational
efficiencies and enhance revenue; (v) integrate and leverage management
information systems; (vi) expand patient volume through proactive marketing;
and (vii) capitalize on managed care expertise.
The Company has recently completed a major merger and is in the process of
completing a major affiliation. On November 4, 1997, Gentle Dental was merged
with GMS, a California-based dental practice management company, which provided
management services to dental practices at 22 locations consisting of 102
dentists, including 30 specialists. Upon completion of the GMS Merger, the
former shareholders of GMS received approximately 59% of the outstanding shares
of the Company. On September 21, 1997, the Company executed definitive
agreements for the pending Dedicated Dental Affiliation, which will add
California based dental practices at 15 locations consisting of 33 dentists,
including three specialists. See "Recent and Pending Affiliations." The
Company's principal executive offices are located at 22800 Savi Ranch Parkway,
Suite 206, Yorba Linda, California, 92887, telephone number (714) 998-0587.
4
THE OFFERING
Common Stock offered by the
Company.................... 3,500,000 shares
Common Stock offered by the
Selling Shareholders....... 100,000 shares
Common Stock to be
outstanding after the
Offering................... 11,178,683 shares (1)
Use of proceeds............. Net proceeds to the Company from this Offering
will be used (i) to repay existing Company debt,
of which approximately $10.0 million was
outstanding at December 31, 1997; (ii) to repay
approximately $10.1 million of debt to be
incurred in connection with the Pending
Affiliations; and (iii) for future affiliations
of dental practices, capital improvements,
working capital and general corporate purposes.
See "Use of Proceeds" and "Recent and Pending
Affiliations."
NASDAQ symbol............... GNTL
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(1) Excludes an aggregate of 1,562,180 shares of Common Stock issuable upon
closing of the Pending Affiliations (subject to closing adjustments),
shares that may be issued under earn-out agreements entered into in
connection with the Company's affiliation of certain Affiliated Dental
Practices, 1,298,710 shares subject to options and warrants outstanding as
of the date of this Prospectus, and 525,000 shares that may be sold by the
Company pursuant to the Underwriters over-allotment option. See
"Underwriting." Includes 297,074 shares of Common Stock subject to
repurchase by the Company in early 1998 at an average price of $0.32 per
share if certain performance targets are not met. See "Certain
Transactions."
5
SUMMARY CONSOLIDATED AND PRO FORMA FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND NUMBER OF OFFICES)
The following consolidated financial data presents the combined results of
Gentle Dental and GMS, which were merged on November 4, 1997 in a transaction
which the Company anticipates will be accounted for as a pooling of interests.
The consolidated financial data has been derived from the Gentle Dental
Supplemental Consolidated Financial Statements and should be read in
conjunction with such statements, the notes related thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere in this Prospectus.
The following selected pro forma financial data for the year ended December
31, 1996 and the nine month period ended September 30, 1997 are unaudited and
were prepared by management of the Company on the same basis as the audited
financial statements included elsewhere herein and, in the opinion of
management of the Company, include all adjustments necessary to present fairly
the information set forth herein and give effect to the following as if they
had occurred at the beginning of the respective periods: (i) the GMS Merger;
(ii) the conversion of all shares of preferred stock of GMS into Common Stock;
(iii) completed affiliations and the Pending Affiliations (including the effect
of all cash, Common Stock and debt issued or expected to be issued in
connection therewith); (iv) the Company's February 1997 initial public offering
(the "Initial Public Offering"); (v) this Offering; and (vi) the effect of the
amended Management Agreements with the Oregon and Washington Professional
Corporations. The summary pro forma financial data is not necessarily
indicative of the actual results of operations or financial position that would
have been achieved had such transactions been completed at the dates specified,
nor are the statements necessarily indicative of the Company's future results
of operations or financial position. The summary pro forma financial data
should be read in conjunction with the "Use of Proceeds," "Selected Pro Forma
Consolidated Financial Data," and notes related thereto, and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere in this Prospectus.
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------- -----------------------------
SUPPLEMENTAL SUPPLEMENTAL
CONSOLIDATED PRO FORMA CONSOLIDATED PRO FORMA
---------------- 1996 ---------------- 1997
1995 1996 (UNAUDITED) 1996 1997 (UNAUDITED)
------- ------- ----------- ------- ------- -----------
Consolidated Statement
of Operations Data:
Dental group net
patient service
revenue............... $ -- $ 3,701 $69,402 $ -- $19,348 $58,774
Net management fees
(support services
revenue) ............. 9,781 10,712 5,975 7,866 10,269 3,995
------- ------- ------- ------- ------- -------
Net revenues....... 9,781 14,413 75,377 7,866 29,617 62,769
Clinical salaries and
benefits.............. -- 1,493 27,552 -- 6,571 22,312
Practice non clinical
salaries and
benefits.............. 2,418 4,279 13,862 2,373 8,122 11,743
Dental supplies and
lab expenses.......... 1,633 2,830 9,254 1,648 4,424 7,709
Practice occupancy
expenses.............. 911 1,563 4,318 976 2,450 3,563
Practice selling,
general and
administrative
expenses.............. 1,311 1,805 10,563 986 3,199 8,157
Corporate selling,
general and
administrative
expenses.............. 2,153 2,998 5,134 1,562 3,845 3,845
Depreciation and
amortization.......... 482 990 3,457 700 1,295 2,422
------- ------- ------- ------- ------- -------
Total operating
expenses.......... 8,908 15,958 74,140 8,245 29,906 59,751
------- ------- ------- ------- ------- -------
Operating income
(loss)................ 873 (1,545) 1,237 (379) (289) 3,018
Interest expense,
net................... (290) (749) (726) (572) (362) (110)
Other income
(expense)............. (92) (48) 17 23 (16) (77)
------- ------- ------- ------- ------- -------
Income (loss) before
income taxes.......... 491 (2,342) 528 (928) (667) 2,831
Provision (benefit)
for income taxes...... 234 (655) 211 (228) 80 1,132
------- ------- ------- ------- ------- -------
Net income (loss)...... 257 (1,687) 317 (700) (747) 1,699
Dividends on
redeemable
convertible
preferred stock--
Series B.............. -- (240) -- -- (829) --
Accretion of
redeemable common
stock................. -- (91) (91) (80) (27) (27)
------- ------- ------- ------- ------- -------
Net income (loss)
attributable to
common stock.......... $ 257 $(2,018) $ 226 $ (780) $(1,603) $ 1,672
======= ======= ======= ======= ======= =======
Net income (loss) per
share:
Primary.............. $ 0.19 $ (0.86) $ 0.02 $ (0.53) $ (0.40) $ 0.13
Fully diluted........ 0.19 (0.86) 0.02 (0.53) (0.40) 0.13
Shares outstanding:
Primary.............. 1,380 2,355 12,877 1,485 4,005 12,877
Fully diluted........ 1,380 2,355 13,321 1,485 4,005 13,321
Selected Operating Data:
Net revenue of
Professional
Corporations.......... $16,029 $25,125 $79,626 $15,731 $38,720 $65,769
6
SEPTEMBER 30, 1997
------------------------------------
PRO FORMA
AS ADJUSTED
SUPPLEMENTAL PRO FORMA (UNAUDITED)
CONSOLIDATED (UNAUDITED) (1)
------------ ----------- -----------
Selected Consolidated Balance Sheet Data:
Cash and cash equivalents............... $ 147 $ 147 $ 9,006
Working capital......................... 4,023 834 9,693
Total assets............................ 38,634 67,345 76,204
Long-term debt and capital lease
obligations, net of current portion.... 8,612 22,442 3,756
Redeemable convertible preferred stock.. 12,072 -- --
Redeemable common stock................. 2,123 2,123 1,391
Shareholders' equity.................... $ 9,458 $33,183 $61,460
- --------
(1) Reflects the issuance and sale of 3,500,000 shares of Common Stock at $8.75
per share, less related offering expenses and the reclassification on the
balance sheet of 100,000 shares of Common Stock subject to redemption to
shares of Common Stock not subject to redemption in connection with the
sale of such shares in the Offering by a Selling Shareholder.
7
RISK FACTORS
An investment in the Common Stock offered hereby involves a high degree of
risk. Prospective investors should carefully consider the following risk
factors, in addition to the other information contained in this Prospectus,
before purchasing the securities offered hereby. This Prospectus contains
forward-looking statements. Discussions containing such forward-looking
statements may be found in the material set forth hereunder, and under
"Prospectus Summary," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Use of Proceeds," and "Business," as
well as in this Prospectus generally. These statements are based on certain
assumptions and analyses made by the Company in light of its experience and
its perception of historical trends, current conditions, expected future
developments and other factors that the Company believes are important under
the circumstances. The words "expect," "believe," "goal," "plan," "intend,"
"estimate" and similar expressions and variations thereof used in this
Prospectus are intended to specifically identify forward-looking statements.
Prospective investors are cautioned that any such forward-looking statements
are not guarantees of future performance and involve risks and uncertainties
that actual events or results may differ materially from those discussed in
the forward-looking statements as a result of various factors, including,
without limitation, the risk factors set forth below and the matters set forth
in this Prospectus generally, many of which are beyond the control of the
Company.
EXPANSION PROGRAM
One of the Company's primary business strategies is to increase revenue and
expand the markets it serves by acquiring certain operating assets and
entering into long-term management service agreements with additional dental
practices. The Company's strategy includes growth through continued
affiliation with dental practices in areas where the Company operates and in
new markets. The success of the Company's affiliation strategy will depend on
a number of factors, including (i) regulatory requirements, (ii) the
availability of financing to fund the affiliation strategy on terms acceptable
to the Company, (iii) the ability to successfully integrate additional
dentists and dental sites, (iv) the ability to affiliate with dentists to open
new dental sites and the ability to obtain locations in suitable markets, and
(v) the ability to identify and affiliate with suitable existing dental
practices on favorable terms. Competition for such affiliations has increased
significantly in recent years and may increase further in the future due to
ongoing consolidation in the dental practice management services industry. As
a result of such competition, there may be fewer attractive affiliation
opportunities than the Company has encountered in the past, or the price of
affiliations may increase significantly. In implementing its affiliation
strategy, the Company will compete with other dental practice management
companies, some of which may have greater financial resources than the
Company. No assurances can be given that the Company will be able to complete
the affiliations necessary for its expansion plans, that such affiliations
will be on terms favorable to the Company, or that the Company will be able to
successfully integrate its business with dental practices affiliated with the
Company. Failure to complete future affiliations or to integrate dental
practices affiliated with the Company could have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Recent and Pending Affiliations."
The Company may in the future enter new markets in which the Company will
have limited or no previous presence or experience. The Company's past
experience reflects initial periods in which certain dental practices within
new geographic markets contribute minimally to the Company's operating
results. Initial profitability, if any, at the regional level may be low
because of the time and capital required to develop a network of offices and
practitioners in accordance with the Company's business strategy.
The Company will devote substantial time and resources to identifying
potential affiliation targets, negotiating terms of affiliations and
integrating Affiliated Dental Practices into the Company's network, all of
which may distract management resources from the day-to-day operations of the
Company. Delays in completing affiliations could cause fluctuations in
quarterly earnings and corresponding fluctuations in the market price of the
Common Stock. Further, the Company's financial results and the market value of
the Common Stock in the
8
fiscal quarters immediately following an affiliation may be adversely affected
during the period in which the Company is implementing its operating model at
new Affiliated Dental Practices. The Company intends to use its Common Stock
as part of the consideration for affiliations with additional dental
practices. There can be no assurance that fluctuations in the market price of
the Common Stock will not adversely affect the Company's ability to use its
Common Stock for affiliations. In addition, the issuance of Common Stock as
part of the purchase price of affiliations will result in dilution of the
beneficial ownership interests and voting power of the holders of Common Stock
prior to the completion of such affiliations.
LIMITED OPERATING HISTORY; OPERATING LOSSES
Gentle Dental was organized in December 1992. As of November 4, 1997, the
date of the GMS Merger, Gentle Dental provided management services to dental
practices at 21 locations. GMS began operations in October 1996 and acquired
assets and liabilities of, and entered into long-term management agreements
with, dental practices operating at 22 locations prior to the GMS Merger. The
Company, including Gentle Dental and GMS, has a limited operating history. The
Company has reported consolidated losses for the year ended December 31, 1996
and the nine months ended September 30, 1997 of $1.7 million and $747,000,
respectively. There can be no assurance that the Company will not incur losses
in future periods. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
MANAGEMENT OF GROWTH AND INTEGRATION
The Company is experiencing a period of rapid growth with a substantial
increase in the number of its Affiliated Dental Practices resulting from the
GMS Merger, the Pending Affiliations, and other identified or targeted dental
practices. See "Recent and Pending Affiliations." The Company's strategy calls
for future growth, substantially through affiliations with additional dental
practices, including through the completion of the Pending Affiliations. The
recently completed affiliations have placed, and future affiliations will
place, strains on the Company's management, operations and systems. Therefore,
the Company's ability to manage its growth and compete effectively will depend
upon its ability to hire, train and assimilate additional management and other
employees and to expand, improve and effectively utilize its operating,
management, marketing, information and financial systems to accommodate its
expanded operations. Any failure by the Company's management to anticipate,
implement and manage effectively the changes required to sustain its growth
may have a material adverse effect on its business, financial condition and
results of operations. In addition, while the Company believes that the
operations of GMS and Dedicated Dental can be effectively integrated into the
Company, failure by the Company to successfully integrate the management teams
and the operations of these companies may adversely affect its business,
financial condition and results of operations.
The Company's expansion into new markets will require the Company to
maintain and establish payor and customer relationships and to convert the
patient tracking and financial reporting systems of new Affiliated Dental
Practices to the Company's systems. Significant delays or expenses with regard
to this process could have a material adverse effect on the integration of
Affiliated Dental Practices and on the Company's business, financial condition
and results of operations. There can be no assurance that the Company will be
able to maintain or establish payor and customer relationships, convert
management information systems or integrate new practices into its existing
network.
The integration of Affiliated Dental Practices typically requires the
implementation and centralization of purchasing, accounting, human resources,
management information systems, cash management and other systems, which may
be difficult, costly and time-consuming. There can be no assurance that the
Company will be successful in managing its combined operations as they
currently exist or upon completion of the Pending Affiliations or other
subsequent affiliations or that any additional dental practices will be
effectively and profitably integrated into the Company's network of Affiliated
Dental Practices. The Company's operating results in fiscal quarters
immediately following an affiliation may be adversely affected while the
Company attempts to complete the integration process. The Company may
encounter significant unanticipated costs or other problems associated with
the Company's integration of future affiliations into the Company's network of
Affiliated Dental
9
Practices. There can be no assurance that future affiliations will not have a
material adverse effect on the Company's business, financial condition and
results of operations, particularly during the period immediately following
such affiliations.
RISKS ASSOCIATED WITH EXPANSION WITHIN EXISTING MARKETS
The Company seeks to increase revenue and profitability in existing markets
by expanding the operations of the Affiliated Dental Practices by adding more
general dentists, specialists and hygienists, by establishing dental practices
on a de novo basis, and by improving the efficiency of the Affiliated Dental
Practices. The Company's success will be dependent, in part, upon increasing
the revenue from the Affiliated Dental Practices and successfully establishing
de novo dental practices. The Company is subject to risks associated with this
growth strategy, including the risk that the Company will be unable to
successfully expand the operations of the Affiliated Dental Practices or
establish de novo dental practices or increase efficiency through its
management of Affiliated Dental Practices. In addition, establishment of de
novo offices will require significant capital expenditures by the Company to
furnish the offices with appropriate equipment materials and supplies and such
offices may be staffed with one or more dentists who have no existing patient
base and, as a result, may require the Company to make significant advertising
and marketing expenditures to attract patients on behalf of such offices.
COMPLETION OF DEDICATED DENTAL AFFILIATION
On September 21, 1997, the Company entered into definitive agreements to
acquire all of the outstanding capital stock of Dedicated Dental and to
affiliate with certain related dental practices. Dedicated Dental and its
related dental practices consist of 33 dentists employed by dental practices
in 15 locations in and around Bakersfield, California. For the year ended
December 31, 1996 and the nine months ended September 30, 1997, Dedicated
Dental and its related dental practices, on a combined basis, had dental group
net patient service revenues of approximately $15.2 million and $13.5 million,
respectively, and net income of approximately $2.7 million and $1.9 million,
respectively. Accordingly, for the year ended December 31, 1996 and the nine
months ended September 30, 1997, Dedicated Dental and its related dental
practices contributed approximately 19% and 21%, respectively, of the
Company's pro forma patient revenues during such periods, after giving effect
to the GMS Merger and the Dedicated Dental Affiliation. After giving pro forma
effect to the GMS Merger, the Dedicated Dental Affiliation, all other
completed affiliations and the Pending Affiliations the Company had net income
of $226,000 and net income of approximately $1.7 million for the year ended
December 31, 1996 and the nine months ended September 30, 1997, respectively,
whereas the Company would have incurred losses of approximately $2.6 million
and $315,000 for such periods, if the operating results of Dedicated Dental
and its related dental practices were excluded from the pro forma
calculations. The completion of the Dedicated Dental Affiliation, expected to
occur in the first quarter of 1998, is subject to the satisfaction of certain
conditions, some of which are beyond the Company's control, including the
receipt of all necessary consents and approvals of the California Department
of Corporations (the "DOC") pursuant to the California Knox-Keene Health Care
Service Plan Act of 1975 (the "Knox-Keene Act"). There can be no assurance
that such consents and approvals will be obtained or, if obtained, that the
proposed Dedicated Dental Affiliation will be completed. Failure to complete
the Dedicated Dental Affiliation could have a material adverse effect on the
Company's business, financial condition and results of operations as presented
in the pro forma financial information set forth in this Prospectus.
ADDITIONAL MANAGEMENT AND STAFFING OF DENTAL PRACTICES
A key component of the Company's operating strategy is to increase
profitability by maximizing Affiliated Dental Practice utilization through
extended hours of operation and the addition of general dentists, specialists,
hygienists, and dental assistants. Accordingly, the Company's financial
success will be dependent, in part, upon its ability to attract and retain for
the Affiliated Dental Practices a sufficient number of qualified dentists,
specialists, hygienists, and dental assistants. See "Business--Operating
Strategy." No assurance can be given that the Company will, on behalf of the
Affiliated Dental Practices, continue to be able to attract qualified
dentists, specialists and clinical staff at acceptable compensation levels, or
at all. Failure to appropriately staff
10
Affiliated Dental Practices could have an adverse effect on the Company's
revenues and results of operations. The Company believes that its future
success will also depend in part upon its ability to attract and retain
qualified management personnel. Competition for such personnel is intense and
the Company competes with numerous other employers, some of which have greater
financial and other resources than the Company. There can be no assurance that
the Company will be successful in attracting and retaining such personnel.
AVAILABILITY OF FINANCING
The Company's expansion strategy has required and is expected to continue to
require substantial funding to affiliate with or establish additional dental
facilities. Moreover, the operation of the Company's network of Affiliated
Dental Practice offices requires ongoing working capital and capital
expenditures for renovation, expansion and the addition of dental equipment
and technology used to provide dental services. These requirements may result
in the Company incurring long-term and short-term indebtedness and in the
public or private issuance, from time to time, of additional equity or debt
securities. The Company has entered into an amended, secured credit facility
with Imperial Bank and other lenders (the "Credit Facility"). The Credit
Facility provides the Company with up to $25 million in borrowing capacity and
may be increased at the option of the Company to $30 million following
completion of an equity offering by the Company in which the Company receives
more than $20 million in net cash proceeds. The Credit Facility provides that
the aggregate amount borrowed under the Credit Facility for working capital
purposes and letter of credit obligations may not exceed $4 million, and that
remaining amounts available under the Credit Facility may be used by the
Company for permitted acquisitions and capital expenditures. The ability of
the Company to incur indebtedness under the Credit Facility is subject to
delivery of customary opinions, certificates and closing documents by the
Company. The Credit Facility contains numerous covenants including
(i) restrictions on the ability of the Company to incur indebtedness and
repurchase, or make dividends with respect to, its capital stock; and
(ii) requirements relating to maintenance of a specified net worth and
specified ratios of current assets to current liabilities, debt to cash flow
and earnings before interest expense, income taxes, depreciation, amortization
and operating lease rentals ("EBITDAR") to fixed charges. In addition, the
Credit Facility requires the Company to notify the lenders prior to making any
acquisition and to obtain the consent of the lenders prior to making (i)
certain acquisitions with purchase prices exceeding $3 million, (ii) all
acquisitions with purchase prices exceeding $5 million and (iii) capital
expenditures exceeding $5 million in any fiscal year. The Credit Facility also
requires the Company to convert to a holding company that owns no assets other
than the stock of its operating subsidiaries on or before May 31, 1998. If the
Company does not attain holding company status before May 31, 1998, the
interest rate applicable to amounts borrowed under the Credit Facility would
be increased by 0.5% and if holding company status is not attained on or
before July 31, 1998 an event of default would exist under the terms of the
Credit Facility. Prior to the completion of the GMS Merger, GMS was not in
compliance with the ratio of current assets to current liabilities set forth
in the Credit Facility; however, the Company obtained a waiver with respect to
such noncompliance and believes that, following the GMS Merger, the Company is
in compliance with such covenant. There can be no assurance that the Company
will remain in compliance with the covenants contained in the Credit Facility
and any failure to comply with such covenants could have a material adverse
effect on the Company's liquidity, business, results of operations and
financial condition. The Company expects that capital requirements over the
next several years will substantially exceed cash flow generated from
operations, the net proceeds of this Offering and borrowings available under
the Credit Facility. Additional debt or equity financing could be required to
fund the Company's growth and operations. In addition, offerings of equity
securities other than Common Stock could be required to the extent that the
Common Stock fails to maintain a market value sufficient to warrant its use
for future financing needs. There can be no assurance that the Company will be
able to obtain additional required capital on satisfactory terms, if at all.
The failure to raise the funds necessary to finance its future cash
requirements could materially adversely affect the Company's ability to pursue
its expansion strategy and its business, financial condition and results of
operations for future periods. If additional funds are raised through the
issuance of equity securities, dilution to the Company's existing stockholders
may result. If additional funds are raised through the incurrence of debt,
such debt instruments will likely contain restrictive financial, maintenance
and security covenants. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
DEPENDENCE ON AFFILIATED DENTAL PRACTICES
The Company receives fees for services provided to Affiliated Dental
Practices under management and similar agreements (the "Management
Agreements"), but does not employ dentists or control the practices of its
affiliated dentists. The Company's profitability is dependent on the revenue
and expenses of the Affiliated Dental Practices and, therefore, performance of
the Affiliated Dental Practices is essential to the Company's success. Revenue
and expenses of the Affiliated Dental Practices are
11
affected by a number of factors, including the ability to attract and retain
high quality dental practitioners and other personnel, marketing, pricing,
patient visits, compensation expenses and other expenses of the Affiliated
Dental Practices. From time to time, the Company enters into or amends
Management Agreements and employment agreements, which have a material impact
on certain of these factors. The Management Agreements with the Affiliated
Dental Practices generally have terms of 40 years and may be terminated by
either party for "cause," which includes a material default by, or bankruptcy
of, the other party. Any material loss of revenue or increase in the expenses
of the Affiliated Dental Practices would have a material adverse effect on the
Company. Effective January 1, 1998, the Company amended Management Agreements
with the Oregon and Washington Professional Corporations to more closely
conform such Management Agreements to the form of management agreement used by
GMS in affiliating with dental practices. The Company believes, consistent with
the Company's accounting for the Affiliated Dental Practices historically
associated with GMS, that the amendment of these Management Agreements will
require the Company to consolidate the financial results of the Oregon and
Washington Professional Corporations on a prospective basis. For a discussion
of the financial impact of the amendments to the Management Agreements with the
Oregon and Washington Professional Corporations, see "Condensed Pro Forma
Consolidated Financial Data and notes related thereto, including note (b)."
GOVERNMENT REGULATION
The dental industry is regulated extensively at both the state and federal
levels. Regulatory oversight includes, but is not limited to, considerations of
fee-splitting, corporate practice of dentistry, anti-kickback and anti-referral
legislation and state insurance regulation. See "Business--Government
Regulation."
CORPORATE PRACTICE OF DENTISTRY; FEE SPLITTING. 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 or
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. The
restrictions are generally designed to prohibit a non-dental entity from
controlling the professional practice of a dentist, employing dentists to
practice dentistry (or, in certain states, employing dental hygienists or
dental assistants), controlling the content of a dentist's advertising or
sharing professional fees. A number of states limit the ability of a person
other than a licensed dentist to own equipment or offices used in a dental
practice. Some of these states allow leasing of equipment and office space to a
dental practice under a bona fide lease. Some states also limit the number of
offices that may be operated by a single dentist or dental practice. The laws
of many states also prohibit dental practitioners from paying any portion of
fees received from 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.
Although the Company believes that its operations comply in all material
respects with the above-described laws to which it is subject, there can be no
assurance that a review of the Company's business relationships by courts or
other regulatory authorities would not result in determinations that could
prohibit or otherwise adversely affect the operations of the Company or that
the regulatory environment will not change, requiring the Company to
reorganize, change its method of reporting revenues and other financial results
or restrict its existing or future operations. Any such change could have a
material adverse effect on the business and results of operations of the
Company. The laws regarding fee-splitting and the corporate practice of
dentistry and their interpretation vary from state to state and are enforced by
regulatory authorities with broad discretion. There can be no assurance that
the legality of the Company's business or its relationships with dentists or
Affiliated Dental Practices will not be successfully challenged or that the
enforceability of the provisions of any Management Agreement will not be
limited.
STATE AND FEDERAL FRAUD AND ABUSE, ANTI-KICKBACK AND ANTI-REFERRAL
LAWS. 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, in each case,
reimbursable under Medicare, Medicaid or other federal and state health care
programs. These provisions apply to dental services covered under the Medicaid
program in which the Company participates. The federal government has 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.
12
The applicability of these federal and state laws to transactions in the
health care industry such as those to which the Company is or may be a party
has not been the subject of judicial interpretation. There can be no assurance
that judicial or administrative authorities will not find these provisions
applicable to the Company's operations, which could have a material adverse
effect on the Company's business, financial condition or results of operations.
Under current federal law, a physician or dentist or member of his or her
immediate family is prohibited 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, including the physician's or
dentist's own group practice, unless an applicable exception is available. 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. Any future expansion of these prohibitions to other health services
could restrict the Company's ability to integrate Affiliated Dental Practices
and carry out the development of its network of Affiliated Dental Practices.
Noncompliance with, or violation of, either the anti-kickback provisions or
restrictions on referrals can result in exclusion from the Medicare and
Medicaid programs as well as civil and criminal penalties. Similar penalties
apply for violations of state law. While the Company makes every effort to
comply with the anti-kickback and anti-referral laws, a determination of
violation under these laws by the Company or its Affiliated Dental Practices
could have a material adverse effect on the Company's business, financial
condition and results of operations.
STATE INSURANCE LAWS AND REGULATIONS. 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 the
Affiliated Dental Practices contract with third-party payors, including self-
insured plans, for certain non-fee-for-service arrangements, the Company or the
Affiliated Dental Practices may become subject to state insurance laws. In the
event that the Company or the dental practices are determined to be engaged in
the business of insurance, the Company or the affected practice 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 event, the Company's revenues may be
adversely affected.
Dedicated Dental operates under a license issued by the DOC under the Knox-
Keene Act, which is expected to be maintained by Dedicated Dental after it
becomes a wholly-owned subsidiary of the Company following receipt of all
necessary and required consents and approvals of the DOC. See "Recent and
Pending Affiliations." The Knox-Keene Act and the regulations promulgated
thereunder subject entities which are licensed as healthcare service plans in
California to substantial regulation by the DOC. In addition, licensees under
the Knox-Keene Act are required to file periodic financial data and other
information (which generally become available to the public), maintain
substantial tangible net equity on their balance sheets and maintain adequate
levels of medical, financial and operating personnel dedicated to fulfilling
the licensee's statutory and regulatory requirements. The DOC is empowered by
law to take enforcement actions against licensees that fail to comply with such
requirements. Any significant delay in obtaining such consents and approvals or
any material non-compliance with the Knox-Keene Act and the regulations
promulgated thereunder, could have a material adverse effect on the Company's
business, financial condition and results of operations.
REFORM INITIATIVES. The United States Congress and state legislatures have
considered various types of health care reform, including comprehensive
revisions to the current health care system. It is uncertain what legislative
proposals will be adopted in the future, if any, or what actions federal or
state legislatures or third-party payors may take in anticipation of or in
response to any health care reform proposals or legislation. Health
13
care reform legislation adopted by Congress or the legislatures of states in
which the Company does business, as well as changes in federal and state
regulations could have a material adverse effect on the operations of the
Company, and changes in the health care industry, such as the growth of managed
care organizations and provider networks, may result in lower payment levels
for the services of dentists within the Company's network of Affiliated Dental
Practices and lower profitability for such Affiliated Dental Practices. See
"Business--Government Regulation."
DEPENDENCE ON THIRD-PARTY PAYORS; RISKS ASSOCIATED WITH MANAGED CARE
A significant portion of the payment for services rendered by the Affiliated
Dental Practices is paid by private insurance programs. There is, and has been
in recent years, an ongoing effort by third-party and government payors to
contain and reduce health care and dental care costs, and impose lower
reimbursement rates on health care providers. Such initiatives may result in a
reduction in per-patient and per-procedure revenue from historic levels. In the
event that third-party payors are successful in obtaining lower payments for
specified services, the Company's business, financial condition and results of
operations may be materially adversely affected.
Managed care arrangements typically shift some of the economic risk of
providing patient care from the person who pays for the care to the provider of
the care by capping fees, requiring reduced fees, or paying a set fee per
patient irrespective of the amount of care delivered. There can be no assurance
that managed care arrangements will not become more prevalent in the dental
care field in the future, that the downward pressures on fees associated with
managed care will not increase, or that the Company will not be adversely
affected by growth in managed dental care.
Under capitated managed dental care contracts, the dentist is typically paid
a predetermined monthly capitation payment amount per patient, per month, from
the payor in exchange for providing all necessary covered services to the
patients covered under the arrangement. This arrangement shifts the risks of
utilization of such services to the dental group practice that provides the
dental services. These types of contracts pass most of the financial risk of
providing dental care, including the risk of over-utilization, from the payor
to the dentist. The Company's success will, in part, be dependent upon its
ability to negotiate contracts on behalf of the Affiliated Dental Practices,
with health maintenance organizations ("HMOs"), employer groups and other third
party payors, pursuant to which services will be provided on a risk-sharing or
capitated basis by some or all of the Affiliated Dental Practices managed by
the Company. There can be no assurance that the Company will be able to
negotiate, on behalf of the Affiliated Dental Practices, satisfactory
arrangements on a capitated or other risk-sharing basis. In addition, to the
extent that patients or enrollees covered by such arrangements require more
frequent or extensive care than is anticipated, the combined entity would incur
unanticipated costs not offset by additional revenue, which would reduce
operating margins. Health care reforms being considered at the federal and
state levels could result in a mandate that managed care patients receive
certain benefits, and no assurance can be given that the Company will be
successful in negotiating adjustments to capitation rates that will adequately
compensate the Affiliated Dental Practices for performing such procedures. Any
such reduction or elimination of earnings could have an adverse effect on the
Company's business, financial condition and operating results.
ACCOUNTING TREATMENT FOR PROFESSIONAL PRACTICE MANAGEMENT COMPANIES AND GMS
MERGER
The Emerging Issues Task Force ("EITF"), an advisory committee of the
Financial Accounting Standards Board, has recently evaluated certain matters
relating to accounting practices for professional practice management
companies, including consolidation of the financial statements of professional
practice management companies and professional associations with which such
companies have management agreements. The EITF recently reached consensus
regarding consolidation of professional associations that are controlled
through contractual agreement. Gentle Dental has not historically consolidated
the financial results of its Affiliated Dental Practices, whereas GMS has
historically consolidated the financial results of its Affiliated Dental
Practices. The Company believes its Management Agreements with the Affiliated
Dental Practices historically affiliated with
14
GMS contain provisions that require the Company to report such operations on a
consolidated basis. The Company recently amended the Management Agreements
with the Oregon and Washington Professional Corporations to more closely
conform such Management Agreements to the forms of management agreement used
by GMS in affiliating with dental practices and to provide the Company with a
controlling financial interest in such Professional Corporations. The Company
believes such amended Management Agreements and increased control will require
the Company, consistent with the Company's accounting for the Affiliated
Dental Practices historically affiliated with GMS, to consolidate the
financial results of the Oregon and Washington Professional Corporations under
the EITF consensus. However, there can be no assurance that interpretations of
the EITF consensus will not require the Company to change its reporting in the
future. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--GMS Merger and Restructuring." For a discussion of the
financial impact of the amendments to the Management Agreements with the
Oregon and Washington Professional Corporations, see "Condensed Pro Forma
Consolidated Financial Data" and the notes related thereto including note (b).
The GMS Merger is expected to be accounted for by the Company by the pooling
of interests method of accounting. Under this method of accounting, the
recorded assets and liabilities of the Company and GMS will be carried forward
at the book values to the Company. Although the Company believes that the GMS
Merger will qualify for pooling-of-interests accounting treatment, there can
be no assurance that the Securities and Exchange Commission will not
successfully assert a contrary position. In such case, the purchase method of
accounting would be applicable and GMS would be the acquiror for accounting
purposes under purchase accounting. The book value of the Company's assets
would be increased to their fair values. While there would be no impact on the
Company's cash flow, this would result in higher goodwill amortization as the
excess of the purchase price over the fair value of the Company's assets would
be amortized over a period of years, which would adversely affect the
Company's future earnings and the amounts provided in the Company's
Supplemental Consolidated Financial Statements and certain pro forma data
included in this Prospectus.
COMPETITION
The Company competes with other dental practice management companies seeking
to affiliate with dental practices in the highly competitive dental practice
management industry. The Company is aware of a number of competitors
specializing in the business of providing comprehensive management services to
dental practices and there are other companies with substantial resources that
may decide to enter the industry. The market for general and specialty dental
services is highly fragmented and is characterized by large numbers of
individual practitioners and small group practices competing for individual
patients. Competition for providing dental services is highly competitive in
the markets in which the Company's network of Affiliated Dental Practices
operates and often includes practitioners who have established practices and
reputations. The Company believes that cost, location, hours of operation and
quality of dental services are the principal factors affecting competition for
patients and the Company believes that its marketing strategy is tailored to
address such competitive factors. The Company expects that the ability to meet
the needs of managed care payors will increasingly be a factor in competing
for patients covered by managed care reimbursement arrangements. There can be
no assurance that the Company's network of Affiliated Dental Practices will be
able to compete effectively in the markets they serve, and an inability to do
so would materially adversely affect the Company's business, financial
condition and results of operations. See "Business--Competition."
DEPENDENCE UPON KEY PERSONNEL
The success of the Company is dependent upon the continued services of
certain of the Company's senior management team, including the Company's Co-
Chairman of the Board, Chief Executive Officer and President, Michael Fiore,
and its Co-Chairman of the Board and President of Clinical Services, Dany Tse.
The loss of services of one or both of these individuals could have a material
adverse effect on the Company's business, financial condition and results of
operations. There can be no assurance that these officers will remain with the
Company or that the Company will be able to attract and retain other key
management personnel. The Company's expansion strategy requires significant
management resources to identify, negotiate and integrate Affiliated Dental
Practices. Accordingly, successful expansion and marketing of the Company's
services and the development of
15
its business will depend to a large extent on the Company's ability to attract
and retain qualified management personnel and on the abilities and continued
participation of the Company's key employees. See "Management."
AVAILABILITY OF DENTAL PROFESSIONALS
The Company's business is dependent on the recruitment and retention of
general dentists, specialists, hygienists and dental assistants to join the
Affiliated Dental Practices. While the Company has been successful in
assisting in recruiting and retaining such professionals for its network of
Affiliated Dental Practices, no assurances can be given that the Company will
be able to continue to do so on terms similar to its current arrangements or
on terms that are satisfactory to the Company. Substantially all dentists
practicing within the Company's network of Affiliated Dental Practices have
entered into employment or similar agreements, or independent contractor
agreements with their respective Affiliated Dental Practices. Such agreements
typically contain a noncompetition agreement following termination of the
agreement within a specified geographic area, usually a specified number of
miles from the offices of the relevant Affiliated Dental Practices. Although
the Company, in conjunction with the Affiliated Dental Practices, endeavors to
maintain and renew agreements with affiliated dentists, in the event that a
significant number of such dentists terminate or do not renew such agreements
or in the event the non-competition agreements are determined to be
unenforceable or more limited in scope than their terms, the Company's
business, financial condition and results of operations could be materially
and adversely affected.
RISKS ASSOCIATED WITH MANAGEMENT AGREEMENTS AND OTHER INTANGIBLE ASSETS
A substantial portion of the Company's assets consists of the Management
Agreements and other intangible assets. At September 30, 1997, the Company's
Supplemental Consolidated Balance Sheet reflected $38.6 million of total
assets (of which approximately $19.8 million were intangible assets) and
approximately $9.5 million in total stockholders' equity at such date.
Intangible assets will increase to approximately $46.2 million upon completion
of the Pending Affiliations, and the Company expects such amount to increase
further in the future in connection with additional dental practice
affiliations. This increase will have an adverse impact on earnings as the
intangible assets are amortized. In the event of any sale or liquidation of
the Company or a portion of its assets, there can be no assurance that the
value of the Management Agreements will be realized. In addition, the Company
continually evaluates whether events and circumstances have occurred which
indicate that any portion of the remaining amounts allocable to one or more of
the Management Agreements or other intangible assets may not be recoverable.
When factors indicate that the amount allocable to one or more of the
Management Agreements or other intangible assets should be evaluated for
possible impairment, the Company may be required to reduce the carrying value
of such Management Agreements or other intangible assets, which could have a
material adverse effect on the results of operations of the Company during the
periods in which such reduction is recognized.
The Company owns all or substantially all of the operating assets of the
Affiliated Dental Practices it manages but, except as permitted by law, does
not employ or contract with dentists, or control the provision of dental care.
Therefore, effective and continued performance of dentists providing services
for the Affiliated Dental Practices is essential to the Company's long-term
success. Because the Company derives its revenues through the Management
Agreements, any material decline in revenue by one or more Affiliated Dental
Practices could have a material adverse effect on the Company's business,
financial condition and results of operations, and any termination by one of
the Affiliated Dental Practices of a Management Agreement (which is permitted
in the event of a bankruptcy of the Company or material breach without cure by
the Company), could have such a material adverse effect. In the event of a
breach of a Management Agreement by any of the Affiliated Dental Practices,
there can be no assurance that the legal remedies available to the Company
will be adequate to compensate the Company or cover its damages resulting from
such breach. See "Business--Management Agreements."
POTENTIAL LIABILITY AND INSURANCE
In recent years, dentists have become subject to an increasing number of
lawsuits alleging malpractice and related legal theories. Due to the nature of
its business, the Company may from time to time become involved as
16
a defendant in medical malpractice lawsuits brought against the Affiliated
Dental Practices or dentists employed by the Affiliated Dental Practices. In
addition, the Company could be involved in litigation in which it is alleged
that the Company has been negligent in performing its duties under the
Management Agreements. The Company maintains professional and general
liability insurance in amounts deemed appropriate by management based upon its
assessment of historical claims and the nature and risks of its business.
There can be no assurance, however, that an existing or future claim or claims
will not exceed the limits of available insurance coverage, that any insurer
will remain solvent and able to meet its obligations to provide coverage for
any such claim or claims, or that such coverage will continue to be available
or available with sufficient limits and at a reasonable cost to insure
adequately and economically the Company's operations in the future. A judgment
against the Company that exceeds its insurance coverage could have a material
adverse effect on the Company's business, financial condition and results of
operations.
GEOGRAPHIC CONCENTRATION
The Company's growth strategy contemplates affiliation with or development
of dental practices in selected geographic markets. The Company's strategy of
focused expansion within selected markets increases the risk to the Company
that adverse economic or regulatory developments in one or more of these
markets may have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company and
the Affiliated Dental Practices with which it has Management Agreements are
subject to a broad range of antitrust laws that prohibit anti-competitive
conduct, including price fixing, concerted refusals to deal and divisions of
markets. Among other things, these laws may limit the ability of the Company
to enter into Management Agreements with separate practice groups that compete
with one another in the same geographic market. In addition, these laws
prevent affiliations or acquisitions of practices that would be integrated
into existing professional groups if such affiliations or acquisitions
substantially lessen competition or tend to create a monopoly.
PUBLIC MARKET VOLATILITY
The trading price of the Company's Common Stock has in the past been and
could in the future be subject to wide fluctuations in response to quarter-to-
quarter variations in the Company's operating results, material announcements
by the Company or its competitors, governmental regulatory action, conditions
in the health care industry generally or in the dental services industry
specifically, or other events or factors, many of which are beyond the
Company's control. In addition, the stock market has experienced extreme price
and volume fluctuations which have particularly affected the market prices of
many health care services companies and which often have been unrelated to the
operating performance of such companies. The Company's operating results in
future quarters may be below the expectations of securities analysts and
investors. In such event, the price of the Common Stock would likely decline,
perhaps substantially. See "Price Range of Common Stock."
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of Common Stock in the public market following
this Offering could adversely affect the price of the Common Stock. Of the
11,178,683 shares of Common Stock that will be outstanding following this
Offering, the 4,548,161 shares issued in the GMS Merger on November 4, 1997,
the 109,039 shares issued in the affiliation with Blue Oak Dental Group on
March 31, 1997, and the shares issuable in connection with Pending
Affiliations are or will be "restricted securities" as defined in Rule 144
promulgated under the Securities Act. All other shares are or will be freely
tradable under federal securities laws to the extent they are not held by
affiliates of the Company. Holders of of the shares eligible for
resale have agreed that they will not, without the written consent of Bear,
Stearns & Co. Inc., offer to sell, contract to sell or otherwise sell or
dispose of their shares for 180 days following this Offering. Holders of
100,000 shares of the Company's Common Stock and of warrants to purchase an
additional 336,275 shares are entitled to certain rights with respect to the
registration of such shares under the Securities Act. In addition, the Company
has agreed to file a registration statement on or prior to March 31, 1998 to
register the resale of an aggregate of 1,519,103 shares of Common Stock to be
issued upon completion of the Dedicated Dental Affiliation. The holders of
these shares
17
are entitled to sell a number of shares with an aggregate market value of up to
$4 million in an underwritten public offering prior to March 31, 1998. The
Company anticipates that these shares will be issued prior to completion of
this Offering and will be sold pursuant thereto. See "Principal and Selling
Shareholders." Such holders have agreed that they will not sell, offer to sell
or otherwise transfer any of their remaining shares of Common Stock prior to
March 31, 1999. Commencing on March 31, 1999 and continuing on the last day of
each of the nine months thereafter, one-tenth of the shares registered by the
Company on behalf of such holders will be released from the foregoing
restriction and will be eligible for sale. See "Description of Capital Stock--
Registration Rights." The Company has also registered an aggregate of 934,638
shares reserved for past or future option grants under the Securities Act. See
"Description of Capital Stock" and "Shares Eligible for Future Sale."
COMMON STOCK PUT RIGHTS
A total of 183,686 shares of Common Stock issued by the Company (as well as
100,000 shares of Common Stock subject to a warrant granted to ServiceMaster
Venture Fund, L.L.C. ("ServiceMaster")) are subject to "put" rights. As of
September 30, 1997, put rights issued in connection with affiliations ("Dentist
Put Rights") cover a total of 83,686 shares of Common Stock and give the
holders the right to require the Company to repurchase the shares at prices
ranging from $13.38 to $19.62 per share. One such holder has put rights with
respect to 11,820 shares that can be exercised in varying amounts in 1998,
1999, and 2000. All other Dentist Put Rights become exercisable between January
2000 and January 2003 and expire if not exercised within 60 days of the
exercise date. The Dentist Put Rights with respect to all but 20,000 shares
will terminate if the Company completes a public offering of Common Stock at a
price greater than $20.00 per share. Pursuant to the terms of the Dentist Put
Rights, the Company could be required to repurchase 2,974 shares of Common
Stock at an aggregate purchase price of approximately $50,000 in 1998, 2,754
shares of Common Stock at an aggregate purchase price of approximately $50,000
in 1999, 40,849 shares of Common Stock at an aggregate purchase price of
approximately $576,000 in 2000, 29,681 shares of Common Stock at an aggregate
purchase price of approximately $438,000 in the year 2001, and 3,714 shares of
Common Stock at an aggregate purchase price of approximately $51,000 in each of
2002 and 2003. The Company has also granted ServiceMaster the right to require
the Company to repurchase the 100,000 shares held by ServiceMaster and the
100,000 shares ServiceMaster may acquire upon exercise of its warrant, if by
June 21, 2001, the Company has not made a public offering of its Common Stock
with a per share price of at least $22.00 and net proceeds to the Company of at
least $10 million (a "Qualified Offering"). The put right may not be exercised
before June 21, 2001, and will expire upon the earlier of the completion of a
Qualified Offering or June 21, 2003. The per share price applicable to
ServiceMaster's put right is 20 times the Company's average adjusted net income
per share for the two most recent fiscal years preceding ServiceMaster's
exercise of the right. ServiceMaster's put right with respect to 100,000 shares
will be extinguished upon the sale of such shares in the Offering. See
"Description of Capital Stock."
Shares subject to put rights are classified as "Redeemable Common Stock" on
the Company's balance sheet. If holders of Common Stock subject to put rights
elect to exercise those rights, the Company will have to pay those holders the
applicable repurchase price in cash in exchange for the delivery of the
holders' Common Stock, and such an election could have a material adverse
effect on the Company's business, financial condition and operating results.
There can be no assurance that the Company will have sufficient capital
resources to honor the outstanding put rights and the Company's use of cash to
honor outstanding put rights would also reduce funds otherwise available to the
Company for operations or obtaining Affiliated Dental Practices.
POTENTIAL ANTITAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS AND WASHINGTON LAW
The Company is authorized to issue up to 30 million shares of Preferred Stock
(the "Preferred Stock"), and the Board of Directors may fix the preferences,
limitations and relative rights of those shares without any vote or action by
the shareholders. The potential issuance of Preferred Stock may delay, deter,
or prevent a change in control of the Company, may discourage bids for the
Common Stock at a premium over the market price of the Common Stock, and may
adversely affect the market price of, and the voting and other rights of the
holders of, Common Stock. The Company has no current plans to issue shares of
Preferred Stock. In addition, certain provisions of Washington law could have
the effect of delaying, deterring, or preventing a change in control of the
Company. See "Description of Capital Stock."
18
RECENT AND PENDING AFFILIATIONS
GMS MERGER
On November 4, 1997, the Company was merged with GMS, a California-based
dental practice management company, which provided management services to
dental practices at 22 locations consisting of 102 dentists, including
specialists. Under the terms of the GMS Merger, the Company issued to the
shareholders of GMS 4,512,377 shares of Common Stock, representing
approximately 59% of the then outstanding shares of the Company following
completion of the GMS Merger. Upon completion of the GMS Merger, the Board of
Directors and senior management of the Company were reconstituted. See
"Management."
RECENT AFFILIATIONS
Between January 1, 1995 and the completion of the GMS Merger, Gentle Dental
entered into affiliations with and acquired the non-professional assets and
certain liabilities of, and entered into long-term management agreements with,
dental practices operating at 14 locations. GMS began operations in October
1996. Prior to completion of the GMS Merger, GMS acquired assets and certain
liabilities of, and entered into long-term management agreements with, dental
practices operating at 22 locations.
DEDICATED DENTAL AFFILIATION AND OTHER PENDING AFFILIATIONS
On September 21, 1997, the Company entered into a definitive agreement
pursuant to which it has agreed to acquire all of the stock of Dedicated
Dental, which is based in Bakersfield, California and owns and operates 11
staff model dental offices pursuant to a license issued by the DOC under the
Knox-Keene Act. Under this license, Dedicated Dental is permitted to own the
dental practices and employ dentists, hygienists and other professionals as
corporate employees. The Company has also entered into three asset purchase
agreements to acquire the nonprofessional assets of related dental practices
operating at four locations in southern California. The aggregate purchase
price under these agreements is $22,750,000, consisting of $9,771,000 in cash
(reduced by any outstanding debt of Dedicated Dental at closing), $12,429,000
in shares of Common Stock (1,519,103 shares valued at $8.1818 per share, which
was the average closing price of the Common Stock for the 30 trading days
prior to the execution of the agreements), and $550,000 in estimated future
earnout payments under two of the asset purchase agreements, all subject to
certain adjustments provided for in the agreements. The Dedicated Dental
Affiliation is subject to the satisfaction of certain other conditions, some
of which are beyond the control of the Company, including approval of the DOC
under the Knox-Keene Act, and is expected to close during the first quarter of
1998. There can be no assurance that the conditions to the closing of the
Dedicated Dental Affiliation, including receipt of approval of the DOC will be
satisfied or that the affiliation will ultimately be completed. Failure to
complete the Dedicated Dental Affiliation could have a material adverse effect
on the Company's business, financial condition and results of operations as
presented in the pro forma financial data set forth in this Prospectus.
The Company has agreed that Arthur G. Kaiser, DDS, the principal shareholder
of Dedicated Dental, will be made a director of the Company effective as of
the closing of the Dedicated Dental Affiliation. Holders of shares issued in
the Dedicated Dental Affiliation will have certain registration rights and
will be subject to certain lock-up provisions. See "Description of Capital
Stock--Registration Rights."
On September 29, 1997, the Company entered into an agreement for the
acquisition of the nonprofessional assets of a dental practice located in
Sacramento, California. The purchase price is $810,000, consisting of $320,000
in cash and $490,000 in shares of Common Stock (43,077 shares valued at
$11.375 per share, which was the average closing price of Common Stock for the
10 trading days prior to the execution of the agreement). The acquisition is
expected to close in January 1998. As consideration for future affiliations,
the Company may use a combination of cash, stock, debt, seller financing and
earn-outs.
19
The following table summarizes the relative contributions to the Company's
network of Affiliated Dental Practices by Gentle Dental, GMS, Dedicated Dental
and related practices, and the other Pending Affiliation described above.
DEDICATED OTHER
GENTLE DENTAL PENDING
DENTAL GMS AFFILIATION AFFILIATION TOTAL
------ --- ----------- ----------- -------
Dental professionals:
General dentists.............. 53 72 30 1 156
Specialists................... 16 30 3 0 49
--- --- --- --- -------
Total dental professionals...... 69 102 33 1 205
=== === === === =======
Locations:
Dental offices................ 21 22 15 1 59
Operatories................... 185 266 124 6 581
States........................ 3 3 1 1 5
Pro forma patient level revenues
for nine months ended September
30, 1997 (in thousands)(1)..... $65,769
- --------
(1) Pro forma assuming completion on January 1, 1997 of all Pending
Affiliations and all other affiliations completed by either Gentle Dental
or GMS in 1997.
20
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of the shares
of Common Stock offered by the Company hereby are estimated to be $27,545,000
million ($32,138,750 million if the Underwriters' overallotment option is
exercised in full). The Company intends to use the net proceeds from this
Offering (i) to repay existing Company debt, of which approximately $10.0
million was outstanding at December 31, 1997; (ii) to repay approximately
$10.1 million of debt to be incurred in connection with the Pending
Affiliations; and (iii) for future affiliations of dental practices, capital
improvements, working capital and general corporate purposes. See "Recent and
Pending Affiliations." The Company will not receive any proceeds from the sale
of the 100,000 shares of Common Stock by the Selling Shareholder. See
"Principal and Selling Shareholders." Outstanding amounts under the Company's
Credit Facility are subject to repayment in twelve equal consecutive quarterly
installments commencing on September 30, 1999 and amounts outstanding
thereunder bear interest at rates ranging from approximately 9.1% to 9.5% as
of December 31, 1997. The Company debt, that will be repaid with the proceeds
of the Offering was incurred to finance acquisitions made by the Company in
1997.
Although an integral part of the Company's strategy is to grow through
affiliations, and the Company is currently in discussions with several dental
practices in both its current and potential future geographic markets, no
affiliation other than the Pending Affiliations discussed above are the
subject of any definitive agreement.
PRICE RANGE OF COMMON STOCK
The Common Stock is traded on the NASDAQ SmallCap Market under the symbol
GNTL. The Company has applied to have the Common Stock traded on the NASDAQ
National Market upon completion of this Offering. The following table sets
forth the high and low closing sales prices of the Common Stock, as reported
by the NASDAQ SmallCap Market, for the periods indicated:
PRICE RANGE
OF COMMON
STOCK
-------------
HIGH LOW
------ ------
Fiscal Year Ended December 31, 1997:
First Quarter(1)............................................ $ 5.25 $ 4.00
Second Quarter.............................................. 5.50 3.63
Third Quarter............................................... 16.50 5.13
Fourth Quarter.............................................. 16.00 8.00
Fiscal Year Ending December 31, 1998:
First Quarter (2)........................................... 10.00 9.00
- --------
(1) Commencing February 13, 1997, the first day of trading of the Common
Stock.
(2) Through January 7, 1998
On January 7, 1998, the closing sale price of the Common Stock, as reported
by the NASDAQ SmallCap Market, was $9.42 per share. As of January 7, the
Company had approximately 96 holders of record of its Common Stock.
DIVIDEND POLICY
The payment of dividends is within the discretion of the Company's Board of
Directors; however, the Company intends to retain earnings from operations for
use in the operation and expansion of its business and does not expect to pay
cash dividends in the foreseeable future. Any future decision with respect to
dividends will depend on future earnings, operations, capital requirements and
availability, restrictions in future financing agreements and other business
and financial considerations. In addition, the Company's Credit Facility
prohibits the payment of cash dividends.
21
CAPITALIZATION
The following table sets forth the capitalization of the Company at
September 30, 1997. Pro forma reflects (i) the GMS Merger (including the
associated restructuring and merger charge); (ii) the conversion of all shares
of preferred stock of GMS into Common Stock; (iii) completed affiliations and
the Pending Affiliations (including the effect of all cash, Common Stock and
debt issued or expected to be issued in connection therewith); (iv) the
Initial Public Offering; and (v) the effect of the amended Management
Agreements with the Oregon and Washington Professional Corporations. Pro forma
as adjusted reflects items (i) through (v) and this Offering. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--GMS Merger and Restructuring." This table should be read in
conjunction with Gentle Dental's Supplemental Consolidated Financial
Statements and related notes thereto and pro forma data appearing elsewhere in
this Prospectus.
SEPTEMBER 30, 1997
----------------------------------
SUPPLEMENTAL PRO FORMA
CONSOLIDATED PRO FORMA AS ADJUSTED
------------ --------- -----------
(IN THOUSANDS, EXCEPT SHARE
AMOUNTS)
Current portion of debt and capital lease
obligations................................ $ 687 $ 1,051 $ 1,051
Long-term debt including capital lease
obligations less current portion........... 8,612 22,443 3,756
Redeemable Covertible Preferred Stock--
Series B................................... 12,072 -- --
Redeemable common stock 183,686 shares
issued and outstanding and 83,686 issued
and outstanding pro forma as adjusted...... 2,123 2,123 1,391
Shareholders' equity:
Preferred stock, 30,000,000 shares
authorized; no shares issued and
outstanding.............................. -- -- --
Convertible preferred stock--Series A,
395,000 shares authorized; 395,000 shares
issued and outstanding as of December 31,
1996 and September 30, 1997.............. 1 -- --
Convertible preferred stock--Series C,
5,000 shares authorized; 1,777 and 2,753
shares issued and outstanding as of
December 31, 1996 and September 30,
1997..................................... 1 -- --
Common stock, 50,000,000 shares
authorized; 7,694,711 shares issued and
outstanding actual; 9,276,649 shares
issued and outstanding pro forma; and
12,876,649 shares issued and outstanding
pro forma as adjusted(1)................. 9,546 34,751 63,028
Additional paid in capital................ 2,926 2,926 2,926
Notes receivable from shareholders........ (300) (300) (300)
Accumulated deficit....................... (2,716) (4,194) (4,194)
------- ------- -------
Total shareholders' equity................ 9,458 33,183 61,460
------- ------- -------
Total capitalization.................... $32,952 $58,800 $67,658
======= ======= =======
- --------
(1) Does not include 1,255,652 shares of Common Stock subject to outstanding
options and warrants at September 30, 1997 at a weighted average exercise
price of $5.68 per share.
22
CONDENSED PRO FORMA CONSOLIDATED FINANCIAL DATA
The Condensed Pro Forma Consolidated Balance Sheet and Pro Forma
Consolidated Statement of Operations Data have been prepared by the Company
based on Gentle Dental's Supplemental Consolidated Financial Statements for
the year ended December 31, 1996 and the nine month period ended September 30,
1997 and the financial statements of the entities involved in affiliations
completed during 1996 and 1997, and the Pending Affiliations. The Condensed
Pro Forma Consolidated Financial Data is based on certain assumptions and
adjustments described in the notes hereto and should be read in conjunction
therewith and in conjunction with the complete Gentle Dental Supplemental
Consolidated Financial Statements and the notes thereto, the Gentle Dental
Financial Statements and the notes thereto, the GMS Consolidated Financial
Statements and the notes thereto, the Dedicated Dental Financial Statements,
the California Dental Practice Management Company and Related Dental Offices
Financial Statements and the notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere
in this Prospectus. The following Condensed Pro Forma Consolidated Financial
Data for the year ended December 31, 1996 and the nine month period ended
September 30, 1997 are unaudited and were prepared by management of the
Company on the same basis as the audited financial statements included
elsewhere herein and, in the opinion of management of the Company, include all
adjustments necessary to present fairly the information set forth herein.
The Condensed Pro Forma Consolidated Statement of Operations Data for the
years ended December 31, 1996 and the nine month period ended September 30,
1997 give effect to the following, as if each had occurred on January 1, 1996:
(i) the GMS Merger; (ii) the conversion of all shares of preferred stock of
GMS into Common Stock; (iii) completed affiliations and the Pending
Affiliations (including the effect of all cash, common stock and debt issued
or expected to be issued in connection therewith); (iv) the Initial Public
Offering; (v) this Offering; and (vi) the effect of the amended Management
Agreements with the Oregon and Washington Professional Corporations. The
Condensed Pro Forma Consolidated Balance Sheet as of September 30, 1997 gives
effect to items (i) through (vi) and the restructuring and merger charge
recorded in connection with the GMS Merger. The Condensed Pro Forma
Consolidated Financial Data does not purport to be indicative of the combined
results of operations that actually would have occurred if the transactions
described above had been effected at the dates indicated or to project future
results of operations for any period.
23
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ADJUSTMENTS
FOR AMENDED COMPLETED COMPLETED
SUPPLEMENTAL MANAGEMENT 1996 1997 PENDING
CONSOLIDATED AGREEMENTS AFFILIATIONS AFFILIATIONS AFFILIATIONS PRO FORMA OFFERING
(a) (b) SUBTOTAL (c) (d) (e) ADJUSTMENTS ADJUSTMENTS
------------ ----------- -------- ------------ ------------ ------------ ----------- -----------
Dental group net
patient service
revenue.............. $ 3,701 $21,424 (v) $25,125 $13,520 $21,894 $ 8,863 $ --
Net management fees
(support service
revenue)............. 10,712 (10,712)(w) -- -- 1,464 4,511 -- --
------- ------- ------- ------- ------- ------- ------- ------
Net revenues.... 14,413 10,712 25,125 13,520 23,358 13,374 -- --
Clinical salaries and
benefits............. 1,493 9,642 (x) 11,135 5,005 9,046 2,975 (609)(f)
Practice nonclinical
salaries and
benefits............. 4,279 -- 4,279 3,571 5,275 1,214 (477)(g)
Dental supplies and
lab expenses......... 2,830 -- 2,830 1,611 3,297 1,497 19 (g)
Practice occupancy
expenses............. 1,563 -- 1,563 906 1,124 563 162 (h)
Practice selling,
general and
administrative
expenses............. 1,805 844 (y) 2,649 1,859 2,881 3,959 (785)(g)
Corporate selling,
general and
administrative
expenses............. 2,998 -- 2,998 -- -- -- 2,136 (i)
Depreciation and
amortization......... 990 79 (aa) 1,069 329 493 300 1,266 (j)
------- ------- ------- ------- ------- ------- ------- ------
Total operating
expenses............ 15,958 10,565 26,523 13,281 22,116 10,508 1,712 --
------- ------- ------- ------- ------- ------- ------- ------
Operating income
(loss).............. (1,545) 147 (1,398) 239 1,242 2,866 (1,712) --
Interest expense,
net.................. (749) -- (749) (164) (332) (94) (1,413)(k) 420(m)
1,606(n)
Other income
(expense)............ (48) -- (48) 9 (15) 149 (78)(g)
------- ------- ------- ------- ------- ------- ------- ------
Income (loss)
before income
taxes............... (2,342) 147 (2,195) 84 895 2,921 (3,203) 2,026
Provision (benefit)
for income taxes..... (655) 59 (596) 32 358 20 (413) 810(l)
------- ------- ------- ------- ------- ------- ------- ------
Net income (loss)... (1,687) 88 (1,599) 52 537 2,901 (2,790) 1,216
Dividends on
redeemable
convertible preferred
stock--Series B...... (240) -- (240) -- -- -- 240 (p) --
Accretion of
redeemable common
stock................ (91) -- (91) -- -- -- -- --
------- ------- ------- ------- ------- ------- ------- ------
Net income (loss)
attributable to
common stock........ $(2,018) $ 88 $(1,930) $ 52 $ 537 $ 2,901 $(2,550) $1,216
======= ======= ======= ======= ======= ======= ======= ======
Net income (loss) per
share:
Primary............. $ (0.86)
Fully diluted....... $ (0.86)
Shares outstanding:
Primary............. 2,355
Fully diluted....... 2,355
PRO FORMA
AS ADJUSTED
-----------
Dental group net
patient service
revenue.............. $69,402
Net management fees
(support service
revenue)............. 5,975
---------
Net revenues.... 75,377
Clinical salaries and
benefits............. 27,552
Practice nonclinical
salaries and
benefits............. 13,862
Dental supplies and
lab expenses......... 9,254
Practice occupancy
expenses............. 4,318
Practice selling,
general and
administrative
expenses............. 10,563
Corporate selling,
general and
administrative
expenses............. 5,134
Depreciation and
amortization......... 3,457
---------
Total operating
expenses............ 74,140
---------
Operating income
(loss).............. 1,237
Interest expense,
net.................. (726)
Other income
(expense)............ 17
---------
Income (loss)
before income
taxes............... 528
Provision (benefit)
for income taxes..... 211
---------
Net income (loss)... 317
Dividends on
redeemable
convertible preferred
stock--Series B...... --
Accretion of
redeemable common
stock................ (91)
---------
Net income (loss)
attributable to
common stock........ $ 226
=========
Net income (loss) per
share:
Primary............. $ 0.02
Fully diluted....... $ 0.02
Shares outstanding:
Primary............. 12,877
Fully diluted....... 13,321
24
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ADJUSTMENTS
FOR AMENDED COMPLETED
SUPPLEMENTAL MANAGEMENT 1997 PENDING
CONSOLIDATED AGREEMENTS AFFILIATIONS AFFILIATIONS PRO FORMA OFFERING PRO FORMA
(A) (B) SUBTOTAL (O) (O) ADJUSTMENTS ADJUSTMENTS AS ADJUSTED
------------ ----------- -------- ------------ ------------ ----------- ----------- -----------
Dental group net
patient service
revenue................ $19,348 $ 17,721 (v) $37,069 $11,942 $ 9,763 $ $ $58,774
Net management fees
(support service
revenue) .............. 10,269 (9,470)(w) 799 441 2,755 -- 3,995
------- -------- ------- ------- ------- ----- ------ -------
Net revenues.......... 29,617 8,251 37,868 12,383 12,518 -- -- 62,769
Clinical salaries and
benefits............... 6,571 7,757 (x) 14,328 4,928 3,403 (347)(f) 22,312
Practice nonclinical
salaries and benefits.. 8,122 -- 8,122 2,618 1,004 (1)(g) 11,743
Dental supplies and
lab.................... 4,424 -- 4,424 1,753 1,532 7,709
Practice occupancy
expenses............... 2,450 -- 2,450 608 505 3,563
Practice selling,
general and
administrative
expenses............... 3,199 494 (y) 3,693 1,398 3,789 (723)(g) 8,157
Corporate selling,
general and
administrative
expenses............... 3,845 -- 3,845 3,845
Depreciation and
amortization........... 1,295 59 (aa) 1,354 208 268 592 (j) 2,422
------- -------- ------- ------- ------- ----- ------ -------
Total operating
expenses.............. 29,906 8,310 38,216 11,513 10,501 (479) -- 59,751
------- -------- ------- ------- ------- ----- ------ -------
Operating income
(loss)................ (289) (59) (348) 870 2,017 479 -- 3,018
Interest expense, net.. (362) -- (362) (450) (102) (736)(k) 53(m) (110)
1,487(n)
Other income
(expense).............. (16) -- (16) 4 121 (186)(g) (77)
------- -------- ------- ------- ------- ----- ------ -------
Income (loss) before
income taxes.......... (667) (59) (726) 424 2,036 (443) 1,540 2,831
Provision (benefit) for
income taxes........... 80 -- 80 165 22 249 (l) 616(l) 1,132
------- -------- ------- ------- ------- ----- ------ -------
Net income (loss)..... (747) (59) (806) 259 2,014 (692) 924 1,699
Dividends on redeemable
convertible preferred
stock--Series B........ (829) -- (829) -- -- 829 (p) -- --
Accretion of redeemable
common stock........... (27) -- (27) -- -- -- -- (27)
------- -------- ------- ------- ------- ----- ------ -------
Net income (loss)
attributable to common
stock................. $(1,603) $ (59) $(1,662) $ 259 $ 2,014 $ 137 $ 924 $ 1,672
======= ======== ======= ======= ======= ===== ====== =======
Net income (loss) per
share:
Primary............... $ (0.40) $ 0.13
Fully diluted......... (0.40) $ 0.13
Weighted average shares
outstanding:
Primary............... 4,005 12,877
Fully diluted......... 4,005 13,321
25
CONDENSED PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1997
(IN THOUSANDS)
ADJUSTMENTS
FOR
AMENDED COMPLETED
SUPPLEMENTAL MANAGEMENT 1997 PENDING PRO FORMA OFFERING
CONSOLIDATED AGREEMENTS AFFILIATIONS AFFILIATIONS ADJUSTMENTS ADJUSTMENTS PRO FORMA
(a) (bb) SUBTOTAL (q) (q) (r) (s) AS ADJUSTED
------------ ----------- -------- ------------ ------------ ----------- ----------- -----------
Cash and cash
equivalents............ $ 147 $ -- $ 147 $ 31 $ 726 $ (757) $ 8,859 $ 9,006
Accounts receivable..... 7,589 (1,800)(z) 5,789 292 1,554 (374) -- 7,261
Other current assets.... 2,126 -- 2,126 50 127 190 -- 2,493
------- ------- ------- ---- ------ ------- -------- -------
Total current assets.... 9,862 (1,800) 8,062 373 2,407 (941) 8,859 18,760
Property and equipment.. 8,424 900 9,324 486 3,154 (2,222) 10,742
Intangible assets....... 19,845 1,969 21,814 -- 94 24,290 46,198
Other long-term assets.. 503 -- 503 1 52 (52) -- 504
------- ------- ------- ---- ------ ------- -------- -------
Total assets............ $38,634 $ 1,069 $39,703 $860 $5,707 $21,075 $ 8,859 $76,204
======= ======= ======= ==== ====== ======= ======== =======
Current liabilities..... $ 5,839 $ 509 $ 6,348 $152 $2,138 $429 $ -- $ 9,067
Long-term debt and
capital lease
obligations, net of
current portion........ 8,612 560 9,172 290 1,785 11,195 (18,686) 3,756
Other long-term
liabilities............ 530 -- 530 -- -- -- -- 530
Redeemable common
stock.................. 2,123 -- 2,123 -- -- -- (732) 1,391
Redeemable preferred
stock--Series B........ 12,072 -- 12,072 -- -- (12,072)(t) --
Shareholders' equity.... 9,458 -- 9,458 418 1,784 12,072 (t) 732 61,460
(1,478)(u) 27,545
10,929
------- ------- ------- ---- ------ ------- -------- -------
Total liabilities,
redeemable stock and
shareholders' equity... $38,634 $ 1,069 $39,703 $860 $5,707 $21,075 $ 8,859 $76,204
======= ======= ======= ==== ====== ======= ======== =======
26
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL DATA
The accompanying pro forma consolidated financial data presents the pro
forma financial position of the Company as of September 30, 1997 and the pro
forma results of operations for the year ended December 31, 1996 and the nine
month period ended September 30, 1997.
From January 1, 1996 through September 30, 1997, the Company acquired 16
dental practices. The accompanying Condensed Pro Forma Consolidated Balance
Sheet includes the acquired non-professional dental practice assets and
liabilities and payment of cash, issuance of Common Stock and borrowings in
connection with completed affiliations and the Pending Affiliations, as if
they had been completed on January 1, 1996.
The pro forma adjustments reflected in the Condensed Pro Forma Consolidated
Balance Sheet and Consolidated Statement of Operations are as follows:
(a) Reflects the supplemental consolidated financial position and results of
operations of Gentle Dental and GMS, adjusted to conform the accounting
methodologies of GMS to those of Gentle Dental as if the combination
occurred on January 1, 1996. Such adjustments resulted in no change in
amortization expense in 1996 and an increase of $148,000 in 1997 and in
decreases in depreciation expense of $24,000 in 1996 and $135,000 in 1997.
Additionally, such adjustments resulted in a decrease in the 1996 income
tax benefit of $10,000 and a decrease in the 1997 income tax expense of
$5,000.
(b) Reflects the net impact of: (i) adjustments to consolidate certain
previously unconsolidated financial results of the Oregon and Washington
Professional Corporations with the results of the Company, including the
impact of aggregate pre-tax losses of $576,000 and $816,000 incurred by
the Oregon and Washington Professional Corporations for the year ended
December 31, 1996 and the nine months ended September 30, 1997,
respectively, offset by (ii) reductions in clinical salaries and benefits
to give pro forma effect to the revised compensation formula included in
the amended Management Agreements. The table below summarizes the impact
of the two components on pro forma operating income:
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
Consolidation of Oregon and Washington
Professional Corporations ................. $(576,000) $(816,000)
Impact of Amended Management Agreements..... 802,000 816,000
Impact of Amended Management Agreement
Intangible Amortization.................... (79,000) (59,000)
--------- ---------
Net pro forma adjustment to operating income
(loss)..................................... $147,000 $ (59,000)
========= =========
(c) Reflects the results of operations for Affiliated Dental Practices that
affiliated with the Company during 1996 for the period January 1, 1996
through the date of affiliation.
(d) Reflects the results of operations for Affiliated Dental Practices that
affiliated with the Company during 1997 for the period January 1, 1996
through December 31, 1996.
(e) Reflects the results of operations for dental practices to be affiliated
with the Company upon completion of the Pending Affiliations for the
period January 1, 1996 through December 31, 1996.
(f) Reflects the effect of changes in compensation paid to former dentist
owners pursuant to employment agreements that are entered into as part of
completed and pending acquisitions of non-professional dental practice net
assets and the execution of Management Agreements in connection therewith.
(g) Reflects the effect of certain expenses which are expected to be
nonrecurring and will be adjusted or eliminated in connection with
completed and pending acquisitions of non-professional dental practice net
assets and execution of Management Agreements in connection therewith.
(h) Reflects the effect of increased rents that resulted or will result upon
the execution of new lease agreements with the Company.
27
(i) Reflects the effect of additional corporate office salaries, rent and
other expenses that would have been incurred by GMS had GMS been in
existence at January 1, 1996.
(j) Reflects changes in depreciation and amortization expenses associated with
the following: (i) conforming the accounting methodologies of dental
practices affiliated or to be affiliated with the Company to the Company's
accounting methodologies, and (ii) the expected amortization expense
related to the estimated intangible assets resulting from the purchase
price allocations of the Pending Affiliations.
(k) Reflects the estimated increase in interest expense that would have
resulted from borrowings under the Company's Credit Facility and from the
issuance of debt to certain of the former dentist owners in connection
with completed and pending acquisitions of certain non-professional dental
practice net assets and execution of Management Agreements in connection
therewith. The interest rate assumed was 9.2%.
(l) Reflects the change in income tax expense or income tax benefit resulting
from Completed Affiliations, the Pending Affiliations, the pro forma
affiliation adjustments, and the Offering adjustments to reflect pro forma
tax expense based upon an effective tax rate of 40% for affiliations in
accordance with staff Accounting Bulletin Topic 1-02.
(m) Reflects the estimated reduction in interest expense resulting from the
repayment of outstanding debt with a portion of the proceeds of the
Initial Public Offering.
(n) Reflects the expected reduction in interest expense resulting from the
repayment of certain outstanding debt with a portion of the proceeds of
this Offering based on the issuance of 3,500,000 shares of common stock
offered by the Company hereby at an assumed offering price of $8.75 per
share and the application of the estimated proceeds therefrom, as follows:
Estimated proceeds, net of related issuance costs.......... $ 27,545,000
Repayment of Credit Facility............................... (18,686,000)
------------
Net proceeds to the Company after payment of the Credit
Facility................................................ $ 8,859,000
============
(o) Reflects the results of operations for Affiliated Dental Practices that
affiliated with the Company between January 1, 1997 and September 30, 1997
for the period January 1, 1997 through the date of affiliation and the
results of operations for Affiliated Dental Practices that affiliated with
the Company after September 30, 1997 and Pending Affiliations for the
period January 1, 1997 through September 30, 1997.
(p) Reflects the elimination of the dividends on shares of redeemable
preferred stock of GMS in connection with the conversion of such shares
into Common Stock as a result of the GMS Merger.
(q) Reflects certain balance sheet items for Affiliated Dental Practices that
affiliated with the Company between January 1, 1997 and December 31, 1997
and Affiliated Dental Practices that will affiliate after December 31,
1997.
(r) Reflects changes in certain balance sheet items for assets and liabilities
not acquired or assumed and debt and Common Stock issued to acquire the
remaining net assets of the dental practices affiliated or to be
affiliated after September 30, 1997.
(s) Reflects the increase in cash, the reduction of debt and the increase in
shareholders' equity resulting from this Offering.
(t) Reflects the conversion of all GMS preferred stock into Common Stock.
(u) Reflects the GMS restructuring and merger charge occurring in 1997.
(v) Reflects the consolidation of the historical patient service revenue of
the Oregon and Washington Professional Corporations with the Company.
(w) Represents the adjustment to consolidate the historical results of the
Oregon and Washington Professional Corporations with the Company. Reflects
the elimination of the net management fees historically paid by the Oregon
and Washington Professional Corporations to the Company.
28
(x) Reflects the net impact of: (i) the adjustment to consolidate the
historical clinical salaries and benefits of the Oregon and Washington
Professional Corporations with the Company, and (ii) adjustments to such
clinical salaries and benefits to give pro forma effect to the revised
compensation formula included in the amended Management Agreements. The
table below summarizes the financial impact of the two components:
NINE MONTHS
ENDED
SEPTEMBER 30,
1996 1997
----------- -------------
Consolidation of Oregon and Washington
Professional Corporations.................. $10,444,000 $8,573,000
Impact of Amended Management Agreements..... (802,000) (816,000)
----------- ----------
Net pro forma adjustment to clinical
salaries and benefits...................... $ 9,642,000 $7,757,000
=========== ==========
(y) Reflects the consolidation of the historical practice selling, general and
administrative expenses of the Oregon and Washington Professional
Corporations with the Company.
(z) Reflects the elimination of the $1.8 million receivable due from the
Oregon and Washington Professional Corporations which has been offset by
consideration paid under the amended Management Agreements.
(aa) Reflects the amortization expense related to the additional intangibles
recorded as a result of the purchase of certain assets of the Oregon and
Washington Professional Corporation.
(bb) Reflects the assets and liabilities of the Washington and Oregon
Professional Corporations.
29
SELECTED HISTORICAL FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND NUMBER OF OFFICES)
The following consolidated financial data presents the combined results of
Gentle Dental and GMS, which were merged on November 4, 1997 in a transaction
the Company anticipates will be accounted for as a pooling of interests. The
consolidated financial data has been derived from the Gentle Dental
Supplemental Consolidated Financial Statements and should be read in
conjunction with such statements, the notes related thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere in this Prospectus.
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
---------------- ----------------------
1995 1996 1996 1997
------- ------- ------- -------------
Consolidated Statement of Operations
Data:
Dental group net patient service
revenue............................. $ -- $ 3,701 $ -- $19,348
Net management fees (support
services revenue) .................. 9,781 10,712 7,866 10,269
------- ------- ------- -------
Net revenues..................... 9,781 14,413 7,866 29,617
Clinical salaries and benefits....... -- 1,493 -- 6,571
Practice non clinical salaries and
benefits............................ 2,418 4,279 2,373 8,122
Dental supplies and lab expenses..... 1,633 2,830 1,648 4,424
Practice occupancy expenses.......... 911 1,563 976 2,450
Practice selling, general and
administrative expenses............. 1,311 1,805 986 3,199
Corporate selling, general and
administrative expenses............. 2,153 2,998 1,562 3,845
Depreciation and amortization........ 482 990 700 1,295
------- ------- ------- -------
Total operating expenses......... 8,908 15,958 8,245 29,906
------- ------- ------- -------
Operating income (loss).............. 873 (1,545) (379) (289)
Interest expense, net................ (290) (749) (572) (362)
Other income (expense)............... (92) (48) 23 (16)
------- ------- ------- -------
Income (loss) before income taxes.... 491 (2,342) (928) (667)
Provision (benefit) for income
taxes............................... 234 (655) (228) 80
------- ------- ------- -------
Net income (loss).................... 257 (1,687) (700) (747)
Dividends on redeemable convertible
preferred stock--Series B........... -- (240) -- (829)
Accretion of redeemable common
stock............................... -- (91) (80) (27)
------- ------- ------- -------
Net income (loss) attributable to
common stock........................ $ 257 $(2,018) $ (780) $(1,603)
======= ======= ======= =======
Net income (loss) per share:
Primary and fully diluted.......... $ 0.19 $ (0.86) $ (0.53) $ (0.40)
Weighted average shares outstanding:
Primary and fully diluted.......... 1,380 2,355 1,485 4,005
Selected Data:
Net revenue of Professional
Corporations........................ $16,029 $25,125 $15,731 $38,720
SEPTEMBER 30,
1997
-------------
Selected Consolidated Balance Sheet
Data:
Cash and cash equivalents.................................... $ 147
Working capital.............................................. 4,023
Total assets................................................. 38,634
Long-term debt and capital lease obligations, net of current
portion..................................................... 8,612
Redeemable convertible preferred stock....................... 12,072
Redeemable common stock...................................... 2,123
Shareholders' equity......................................... $ 9,458
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of the results of operations and financial
condition of the Company should be read in conjunction with the Condensed Pro
Forma Consolidated Financial Data and the Audited Financial Statements and the
notes thereto included elsewhere in this Prospectus. The following discussion
contains certain forward-looking statements. The Company's results may differ
significantly from those projected in the forward-looking statements. Factors
that might cause future actual results to differ materially from the Company's
recent results or those projected in the forward-looking statements include,
but are not limited to, those discussed in the "Risk Factors" and below.
OVERVIEW
The Company manages dental practices in California, Hawaii, Idaho, Oregon
and Washington and is one of the largest providers of dental group management
services to multi-specialty dental groups in the United States. Following
completion of the Pending Affiliations, the Company will provide management
services to 59 dental offices with 205 dentists, including 49 specialists and
581 operatories.
Gentle Dental is a Washington corporation incorporated on December 14, 1992.
As of September 30, 1997, Gentle Dental provided management support services
to 21 dental offices with 69 dentists. On November 4, 1997, Gentle Dental
completed its merger with GMS, a California-based dental practice management
company, which provides management services to 22 locations consisting of 102
dentists. On September 21, 1997, the Company entered into an agreement to
acquire Dedicated Dental, a California-based company which owns and operates
11 staff model dental offices in the Bakersfield, California area. The Company
has also entered into three asset purchase agreements to acquire the assets of
four related dental practices in Southern California and one unrelated dental
practice in Northern California.
As a part of its strategy, the Company is pursuing an aggressive network
expansion plan. Prior to the GMS Merger and subsequent to its formation in
October 1996, GMS successfully affiliated with all of its Affiliated Dental
Practices, completed through 11 separate transactions including 22 locations.
The Company's integration process is intended to improve the operations of
newly-affiliated dental practices and to position them for increased patient
revenue and profit growth. The Company's objective is to affiliate with dental
practices that have a significant market position or, when combined with
existing Affiliated Dental Practices, would result in a significant market
position.
GMS MERGER AND RESTRUCTURING
As a result of the GMS Merger, which is expected to be accounted for as a
pooling of interests, the Company expects to incur costs totaling
approximately $1.8 million, most of which was expensed in the fourth quarter
of 1997. Additionally, effective January 1, 1998 the Company entered into
amended Management Agreements and related agreements with the Oregon and
Washington Professional Corporations and their respective shareholders
(collectively the "Amended Management Agreements") which restructured the
Management Agreements between the Company and such Professional Corporations
in order to conform to the structure of the management agreements used by GMS
in affiliations with dental practices.
The Company believes that the Amended Management Agreements more closely
align the incentives of the Oregon and Washington Professional Corporations
with the Company's objectives. The Amended Management Agreements, among other
things (i) in exchange for certain cash payments, stock options and earn out
consideration as described below, reduce dental practitioners' compensation
which is calculated as a percentage of net patient service revenue;
(ii) provide for a management fee payable to the Company which includes
reimbursement of expenses incurred by the Company in performance of its
obligations, a fixed fee equal to 15% of net revenue and an additional fee
which is calculated under a formula based on a percentage of the adjusted
revenues of the Oregon and Washington Professional Corporations; and
(iii) transfer ownership interests in certain tangible and intangible assets
of the Oregon and Washington Professional Corporations to the Company.
31
Under current accounting pronouncements and standards, the Company believes
that the Amended Management Agreements provide the Company with a controlling
financial interest in the Oregon and Washington Professional Corporations and
require the Company to consolidate the financial results of these Professional
Corporations on a prospective basis.
As consideration for entering into the Amended Management Agreements, the
Company has agreed to pay to the Oregon and one of the Washington Professional
Corporations or certain of their respective designated dental practitioners,
in the aggregate, the following: (i) approximately $1.8 million in cash offset
by approximately $1.8 million of Company receivables previously due from such
Oregon and Washington Professional Corporations; (ii) the right to receive an
aggregate of either $575,000 cash in 18 equal monthly installments or options
to acquire 230,000 shares of Common Stock at an exercise price of $8.375 per
share, subject to five year vesting plus options to acquire an aggregate of
110,000 shares of Common Stock exercisable at $8.375 per share, subject to
five year vesting; and (iii) future cash or options subject to five year
vesting in amounts to be determined according to a formula based upon the
operating revenues of such Oregon and Washington Professional Corporations for
fiscal years ending December 31, 1998 and 1999. The Company has recorded
intangible assets of approximately $2.0 million in the fourth quarter of 1997,
which resulted from the Amended Management Agreements.
Gentle Dental has not historically consolidated the financial results of its
Affiliated Dental Practices, whereas GMS has historically consolidated the
financial results of its Affiliated Dental Practices. The Oregon and
Washington Professional Corporations incurred pre-tax losses of $576,000 and
$816,000 for the twelve months ended December 31, 1996 and the nine months
ended September 30, 1997, respectively. The preceding Condensed Pro Forma
Consolidated Financial Data reflects the effect of the Amended Management
Agreements, including consolidating the operating results of the Oregon and
Washington Professional Corporations. However, had the Amended Management
Agreements been in effect, the pre-tax income for the Oregon and Washington
Professional Corporations would have been $226,000 and $0 for the twelve
months ended December 31, 1996 and the nine months ended September 30, 1997,
respectively. Accordingly, the Company's net income for such periods, on a pro
forma basis adjusted for the effects of the Amended Management Agreements, is
not materially different from the historic results for such periods. See note
(b) to the "Condensed Pro Forma Consolidated Financial Data" for a more
detailed discussion of the impact of the Amended Management Agreements on the
net income of the Company for such periods.
PRO FORMA RESULTS OF OPERATIONS
The following discussion of pro forma results of operations is provided for
comparison of the Company's Pro Forma Consolidated Statement of Operations for
the year ended December 31, 1996 and the nine months ended September 30, 1997,
giving effect to the following, as if each had occurred on January 1, 1996:
(i) the GMS Merger, including the restructuring and merger charge related
thereto; (ii) the conversion of all shares of preferred stock of GMS into
Common Stock; (iii) completed affiliations and the Pending Affiliations,
including the effect of all cash, Common Stock and debt issued or expected to
be issued in connection therewith; (iv) the Initial Public Offering; (v) this
Offering; and (vi) the effect of the Amended Management Agreements. The pro
forma consolidated financial data is intended for informational purposes only
and is not necessarily indicative of the Company's future financial position,
future results of operations or what would have occurred had the events
described in the pro forma consolidated financial data occurred at the
beginning of the respective periods presented below.
32
The following table of summary pro forma consolidated financial data is
intended for informational purposes only. The following information should be
read in conjunction with the Condensed Pro Forma Consolidated Financial Data,
the financial statements and supplemental financial statements and notes
thereto found elsewhere in this Prospectus.
PRO FORMA
NINE MONTHS
ENDED
PRO FORMA SEPTEMBER 30,
1996 1997
------------- -------------
(IN THOUSANDS, EXCEPT
PERCENTAGES)
Net revenues.................................... $75,377 100.0% $62,769 100.0%
Practice operating expenses..................... 65,549 87.0 53,484 85.2
Corporate selling, general and administrative
expenses....................................... 5,134 6.8 3,845 6.1
Depreciation and amortization................... 3,457 4.6 2,422 3.9
Operating income................................ 1,237 1.6 3,018 4.8
Net income attributable to common stock......... 226 0.3 $ 1,672 2.7
Practice Operating Expenses. Practice operating expenses decreased from
87.0% of net revenues for the year ended December 31, 1996 to 85.2% of net
revenues for the nine months ended September 30, 1997. The decrease in
practice operating expenses as a percent of revenues is due to a lower cost
structure of dental practices to be affiliated with the Company pursuant to
the Pending Affiliations.
Corporate Selling, General and Administrative Expenses. Corporate selling,
general and administrative expenses decreased from 6.8% of net revenues to
6.1% of net revenues. This decrease was the result of economies of scale
realized through the centralization of dental practice management.
Depreciation and Amortization. Depreciation and amortization decreased from
4.6% of net revenues to 3.9% of net revenues. This decrease was primarily
attributable to the Affiliated Dental Practices that affiliated with the
Company in 1996 and 1997 having lower depreciation as a percentage of net
revenue.
Net Income Attributable to Common Stock. Net income increased from 0.3% of
net revenues for the year ended December 31, 1996 to 2.7% for the nine months
ended September 30, 1997. This increase in net income is attributable to
economies of scale realized through the centralization of dental practice
management and a decrease in interest expense associated with the net
repayment of outstanding debt.
SUPPLEMENTAL CONSOLIDATED RESULTS OF OPERATIONS
The following discussion of supplemented consolidated results of operations
is provided for comparison of the Company's Supplemental Consolidated
Statement of Operations for certain historical periods. The Company reports
dental group net patient revenue and associated clinical salaries and benefits
in those instances where the Company meets certain specific EITF consolidation
requirements. In those instances where the specific requirements are not met,
the Company reports net management fees revenue, and does not record any
associated clinical salaries and benefits expense. To provide a more
meaningful comparison, the following discussion compares expenses to the total
of dental group net patient service revenue of consolidated and unconsolidated
dental practices.
NINE MONTHS ENDED SEPTEMBER 30, 1997 SUPPLEMENTAL STATEMENT OF OPERATIONS
COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1996 STATEMENT OF OPERATIONS
Dental Group Net Patient Service Revenue and Net Management Fees (Support
Service Revenue). Dental group net patient revenue increased from zero for the
nine months ended September 30, 1996 to $19.3 million for the nine months
ended September 30, 1997. This growth is directly attributable to five
affiliations completed
33
during the three months ended December 31, 1996 and four affiliations
completed during the nine months ended September 30, 1997, representing a
total of twenty clinical locations. These affiliations have Management
Agreements that meet the requirements for consolidation of the related
Affiliated Dental Practices' with the Company's revenues and expenses.
Net management fee revenue represents management services to certain
unconsolidated Affiliated Dental Practices, covering twenty-one clinical
locations as of September 30, 1997. Support service revenue increased 30.5%
from $7.9 million for the nine months ended September 30, 1996 to $10.3
million for the nine months ended September 30, 1997. This growth was
primarily a result of three affiliations completed in 1997. Also,
approximately 15.0% of the increase in support services revenue is
attributable to increases in the percentages of patient revenue payable under
the Management Agreements with the Washington and Oregon Professional
Corporations from 50.0% to 51.0% and 50.0% to 53.0%, respectively.
Clinical Salaries and Benefits. Clinical salaries and benefits costs include
all patient service provider staff compensation and related payroll costs at
the dental facilities, including dentists and hygienists with the consolidated
Affiliated Dental Practices. Clinical salaries and benefits increased from
zero for the nine months ended September 30, 1996 to $6.6 million for the nine
months ended September 30, 1997, representing 34.0% of dental group net
patient revenue. The increase is due to the inclusion of salaries and benefits
attributable to the seven affiliations completed during 1997 that were
accounted for on a consolidated basis.
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 and hygienists. Total nonclinical
salary costs increased 242% from $2.4 million for the nine months ended
September 30, 1996 to $8.1 million for the nine months ended September 30,
1997. This increase was primarily attributable to the addition of Affiliated
Dental Practices in affiliations completed during the three months ended
December 31, 1996 and the nine months ended September 30, 1997. If all Company
revenue had been reported at the dental group net patient revenue level,
practice nonclinical salaries and benefits as a percentage of total revenue
for the nine months ended September 30, 1996 and 1997 would have been 15.1%
and 21.0%, respectively. The increase is attributable to the consolidated
Affiliated Dental Practices that affiliated with the Company in late 1996 and
1997. For consolidated Affiliated Dental Practices, practice nonclinical
salaries and benefits includes dental assistant personnel. For non-
consolidated Affiliated Dental Practices, dental assistant costs are excluded
from this cost category, as those costs are the responsibility of the
Professional Corporations.
Dental Supplies and Lab Costs. Total dental supplies and lab costs increased
168% from $1.6 million for the nine months ended September 30, 1996 to $4.4
million for the nine months ended September 30, 1997. If all Company revenue
had been recorded at the dental group net patient service revenue, dental
supplies and lab costs as a percentage of total revenue for the nine months
ended September 30, 1996 and 1997 would have been 10.5% and 11.4%,
respectively. The increase of 0.9% is attributed to the new practices added in
late 1996 and 1997 which had a higher dental supply usage and lab costs than
the Company's base operations.
Practice Occupancy. Practice occupancy expenses increased 151% from $976,000
for the nine months ended September 30, 1996 to $2.5 million for the nine
months ended September 30, 1997. This increase in occupancy expenses is
primarily attributable to the addition of Affiliated Dental Practices in
affiliations completed during the three months ended December 31, 1996 and the
nine months ended September 30, 1997. If all Company revenue had been recorded
at the dental group net patient service revenue level, practice occupancy cost
as a percentage of total revenue for the nine months ended September 30, 1996
and 1997 would have been 6.2% and 6.3%, respectively. The slight increase in
comparable costs was due to higher rent at these Affiliated Dental Practices
as a percentage of revenue.
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
34
224% from $986,000 for the nine months ended September 30, 1996 to $3.2 million
for the nine months ended September 30, 1997. If all Company revenue had been
recorded at the dental group net patient service revenue level, practice
selling, general and administrative expenses as a percentage of total revenue
for the nine months ended September 30, 1996 and 1997 would have been 6.3% and
8.3%, respectively. The Affiliated Dental Practices that affiliated with the
Company in late 1996 and 1997 contributed to the increase in this percentage.
Corporate Selling, General and Administrative Expenses. Total corporate
selling, general and administrative expenses increased 146% from $1.6 million
for the nine months ended September 30, 1996 to $3.8 million for the nine
months ended September 30, 1997. If all Company revenue had been recorded at
the dental group net patient service revenue level, corporate selling, general
and administrative expenses as a percentage of total revenue for the nine
months ended September 30, 1996 and 1997 would have been 9.9% and 9.9%,
respectively.
Depreciation and Amortization. Total depreciation and amortization expense
for the nine months ended September 30, 1996 and 1997 were $700,000 and
$1.3 million, respectively. The increase was primarily due to the Affiliated
Dental Practices that affiliated with the Company in late 1996 and 1997.
Interest Expense. Total interest expense decreased 36.7% from $572,000 for
the nine months ended September 30, 1996 to $362,000 for the nine months ended
September 30, 1997. This decrease in interest expense resulted from the
repayment by the Company of $4.4 million under its various bank loan
arrangements with the proceeds from the Initial Public Offering partly offset
by additional debt incurred to complete additional affiliations in 1997.
Provision (Benefit) for Income Taxes. For the nine months ended September 30,
1996, the Company recognized a tax benefit resulting from its taxable loss for
the period. For the nine months ended September 30, 1997, prior to the pooling
of interests, Gentle Dental reported tax expense of $219,000 on $448,000 of
pretax income. The effective tax rate of 48.9% was higher than the statutory
rate due to Gentle Dental utilizing a tax-free merger structure for certain
dental practice affiliations. As a result, the amortization of certain
intangible assets reduced earnings but was not deductible for tax purposes.
This reported tax expense was offset by a tax benefit of $139,000 reported by
GMS for the same period. Accordingly, on a consolidated basis, the Company
incurred a tax expense of $80,000 on a net loss before taxes of $667,000 for
the nine months ended September 30, 1997.
YEAR ENDED DECEMBER 31, 1996 STATEMENT OF OPERATIONS COMPARED TO YEAR ENDED
DECEMBER 31, 1995 STATEMENT OF OPERATIONS
Dental Group Net Patient Service Revenue and Net Management Fees (Support
Services Revenue). Dental group net patient revenue increased from zero for the
year ended December 31, 1995 to $3.7 million for the year ended December 31,
1996. This growth was directly attributed to five affiliations completed during
the three months ended December 31, 1996, representing eleven clinical
locations. These affiliations have Management Agreements that meet the
requirements for consolidation of the revenues and expenses of the Affiliated
Dental Practices and the Company.
Support services revenue represents management services to certain
unconsolidated Affiliated Dental Practices. Support services revenues increased
9.5% from $9.8 million for the year ended December 31, 1995 to $10.7 million
for the year ended December 31, 1996. This increase is attributable to a 33.7%
increase in total patient level revenue recognized at the Professional
Corporations, which was partially offset by the reduction in the percentage of
revenue payable to the Company under the support services agreements from 61%
of patient revenue in 1995 to 50% of patient revenue in 1996.
Total patient level revenue increased from $16 million for the year ended
December 31, 1995 to $25.1 million for the year ended December 31, 1996. The
increase is primarily due to the Affiliated Dental Practices that affiliated
with the Company in 1996.
35
Clinical Salaries and Benefits. Clinical salaries and benefits costs include
all patient service provider staff compensation and related payroll costs at
the dental facilities, including dentists, and hygienists associated with the
consolidated Affiliated Dental Practices. Clinical salaries and benefits
increased from zero for the year ended December 31, 1995 to $1.5 million for
the year ended December 31, 1996, representing 40.3% of dental group net
patient revenue. The increase is due to the addition of five Affiliated Dental
Practices that are accounted for on a consolidated basis.
Practice Nonclinical Salaries and Benefits. Practice nonclinical salaries
and benefits costs include all staff compensation and related payroll costs at
the dental office other than dentists and hygienists. Total nonclinical salary
costs increased 76.9% from $2.4 million for the year ended December 31, 1995
to $4.3 million for the year ended December 31, 1996. If all Company revenue
had been reported at the dental group net patient revenue level, practice
nonclinical salaries and benefits as a percentage of total revenue for the
year ended December 31, 1995 and 1996 would have been 15.1% and 17.1%,
respectively. The increase is attributable to the consolidated Affiliated
Dental Practices that affiliated with the Company in 1996. For consolidated
Affiliated Dental Practices, practice nonclinical salaries and benefits
includes dental assistant personnel. For non-consolidated Affiliated Dental
Practices, dental assistant costs are excluded from this cost category, as
those costs are the responsibility of the Affiliated Dental Practices.
Dental Supplies and Lab Costs. Total dental supplies and lab costs increased
73.3% from $1.6 million for the year ended December 31, 1995 to $2.8 million
for the year ended December 31, 1996. This increase is primarily attributable
to the addition of Affiliated Dental Practices in affiliations completed
during 1996. If all Company revenue had been recorded at the dental group net
patient service revenue level, dental supplies and lab costs as a percentage
of total revenue for the years ended December 31, 1995 and 1996 would have
been 10.2% and 11.3%, respectively. The increase was due to a higher cost
ratio of the Affiliated Dental Practices that affiliated with the Company in
1996 relative to the historic cost ratio of the Company.
Practice Occupancy. Practice occupancy expenses increased 71.2% from
$911,000 for the year ended December 31, 1995 to $1.6 million for the year
ended December 31, 1996. This increase in occupancy expenses is also
attributable to the addition of new Affiliated Dental Practices from
affiliations completed during 1996. If all Company revenue had been recorded
at the dental group net patient service revenue level, practice occupancy cost
as a percentage total revenue for the years ended December 31, 1995 and 1996
would have been 5.7% and 6.2%, respectively.
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 branch level. Practice selling, general and
administrative expenses increased 37.7% from $1.3 million for the year ended
December 31, 1995 to $1.8 million for the year ended December 31, 1996. If all
Company revenue had been recorded at the dental group net patient service
revenue level, practice selling, general and administrative cost as a
percentage of total revenue for the years ended December 31, 1995 and 1996
would have been 8.2% and 6.2%, respectively.
Corporate Selling, General and Administrative Expenses. Total corporate
selling, general and administrative expenses increased 39.2% from $2.2 million
for the year ended December 31, 1995 to $3.0 million for the year ended
December 31, 1996. If all Company revenue had been recorded at the dental
group net patient service revenue level, practice selling, general and
administrative cost as a percentage of total revenue for the years ended
December 31, 1995 and 1996 would have been 13.4% and 11.9%, respectively. The
decline as a percentage of revenue was attributable to economies of scale
resulting from the addition of Affiliated Dental Practices.
Depreciation and Amortization. Total depreciation and amortization expense
for the years ended December 31, 1995 and 1996 were $482,000 and $990,000,
respectively. The increase was primarily due to the Affiliated Dental
Practices that affiliated with the Company in 1996.
36
Interest Expense. The increase in interest expense from $290,000 for the
year ended December 31, 1995 to $749,000 for the year ended December 31, 1996
partially reflects the increase in additional short-term and long-term
borrowings as a result of several purchases of dental practice assets.
Additionally, in consideration for guaranteeing the Company's line of credit,
the Company issued to certain of its officers, directors, and shareholders
warrants to purchase 115,000 shares of the Common Stock. The estimated fair
value of the warrants was $232,000 and was fully amortized as interest expense
during 1996.
Provision (Benefit) for Income Taxes. For the year ended December 31, 1995,
the Company's effective tax rate was 47.7%. For the year ended December 31,
1996, prior to the pooling of interests, Gentle Dental reported a tax benefit
of $345,000 on a pretax loss of $1.3 million. This reported tax benefit was
increased by a tax benefit of $310,000 reported by GMS for the same period.
Accordingly on a pooled basis, the Company reported a tax benefit of $655,000
on a net loss before taxes of $2.3 million for the year ended December 31,
1996.
LIQUIDITY AND CAPITAL RESOURCES
On November 4, 1997, Gentle Dental merged with GMS in a transaction intended
to be accounted for as a pooling of interests. Gentle Dental issued 4,512,377
shares of Common Stock in exchange for substantially all outstanding capital
stock of GMS. Of the Common Stock issued, 297,074 shares are subject to
repurchase by the Company at an average price of $0.32 per share if the
Company does not achieve specified performance targets for 1997. The Company
does not expect to meet the 1997 targets and anticipates that the shares will
be repurchased during 1998. After giving effect to the Pending Affiliations
described below, the Company expects that the GMS shareholders will hold
approximately 47.5% of the outstanding shares of the Company.
In November 1997, the Company entered into an agreement to acquire Dedicated
Dental and to affiliate with certain related dental practices. Consideration
for the Dedicated Dental Affiliation consists of $9.8 million in cash and
1,519,103 shares of Common Stock valued at approximately $13.0 million. The
closing of the Dedicated Dental Affiliation is subject to satisfaction of
certain conditions, including receipt of the approval of the DOC. There can be
no assurance that these conditions will be satisfied or that the Dedicated
Dental Affiliation will be completed. Additionally, the Company has announced
a pending affiliation of a dental practice in Sacramento, California. The
aggregate consideration for such affiliation is $810,000, consisting of
$320,000 in cash and 43,077 shares of Common Stock. These affiliations will be
accounted for as purchases.
On October 31, 1997, GMS purchased the assets of two additional dental
practices for $2.9 million in cash, a $160,000 promissory note, 180 shares of
its preferred stock, warrants to purchase 125,000 shares of its common stock,
of which 50,000 are subject to earnout provisions, and the assumption of
$245,000 of debt. Immediately prior to the consummation of the GMS Merger,
shares of preferred stock were converted into shares of GMS common stock and
upon consummation of the GMS Merger the warrants were converted into warrants
to purchase 55,636 shares of Common Stock. The aggregate purchase price for
such acquisitions was approximately $3.6 million and will be allocated to the
fair value of assets acquired, including the management agreements.
The Company's Credit Facility provides for a maximum credit line of $25
million, which may be increased at the option of the Company to $30 million
following completion of an equity offering by the Company in which the Company
receives at least $20 million in net cash proceeds.The Company intends to use
the Credit Facility for working capital requirements, to purchase non-
professional dental practice assets of additional dental practices that the
Company may seek to affiliate with, and to purchase operating assets for
existing Affiliated Dental Practices. The Credit Facility provides that
aggregate amounts borrowed under the Credit Facility for working capital
purposes and letter of credit obligations may not exceed $4 million, and that
remaining amounts available under the Credit Facility may be used by the
Company for permitted acquisitions and capital expenditures. The ability of
the Company to incur indebtedness under the Credit Facility is subject to
delivery of customary opinions, certificates and closing documents by the
Company. The revolving feature of the Credit Facility expires on September 30,
1999, at which time it will convert into a three year term loan to be repaid
in 12 equal quarterly installments. Principal amounts owed under the Credit
Facility bear interest, at the Company's option and dependent upon the
Company's leverage ratio, of (i) up to 1.0% over prime or (ii) up to 3.25%
above LIBOR. The Credit Facility requires the Company to pay an unused
commitment fee in the amount of 0.50% per annum or 0.375% per annum, depending
on the Company's leverage ratio, on the average daily amount by
37
which the bank commitment under the Credit Facility exceeds the aggregate
amount of all loans then outstanding. The Credit Facility contains several
covenants including (i) restrictions on the ability of the Company to incur
indebtedness and repurchase, or make dividends with respect to, its capital
stock; and (ii) requirements relating to maintenance of a specified net worth
and specified ratios of current assets to current liabilities, debt to cash
flow and EBITDAR to fixed charges. In addition, the Credit Facility requires
the Company to notify the lenders prior to making any acquisition and to
obtain the consent of the lenders prior to making (i) certain acquisitions
with purchase prices exceeding $3 million, (ii) all acquisitions with purchase
prices exceeding $5 million and (iii) capital expenditures exceeding $5
million in any fiscal year. The Credit Facility also requires the Company to
convert to a holding company that owns no assets other than the stock of its
operating subsidiaries on or before May 31, 1998. If the Company does not
attain holding company status on or before May 31, 1998, the interest rate
applicable to amounts borrowed under the Credit Facility would be increased by
0.5% and if holding company status is not attained on or before July 31, 1998
an event of default would exist under the terms of the Credit Facility. The
Company's obligations under the Credit Facility are guaranteed by each of the
subsidiaries of the Company. The obligations of the Company under the Credit
Facility and the subsidiaries under the guarantees are secured by a security
interest in the equipment, fixtures, inventory, receivables, subsidiary stock,
certain debt instruments, accounts and general intangibles of each of such
entities.
Assuming the GMS Merger had occurred at September 30, 1997, the outstanding
balance under the Credit Facility would have been $4.3 million. Assuming that
the GMS Merger, the Dedicated Dental Affiliation, the other Pending
Affiliation and two affiliations completed after September 30, 1997 had been
completed at September 30, 1997, the pro forma outstanding balance under the
Credit Facility would have been $18.7 million. Upon the completion of this
Offering, the Company intends to apply $18.7 million of the net proceeds to
the repayment of outstanding indebtedness of the Company under the Credit
Facility.
On June 21, 1996, ServiceMaster purchased 100,000 shares of the Common Stock
and a warrant to purchase an additional 100,000 shares at $7.50 per share for
total consideration of $1 million. ServiceMaster has the right to require the
Company to repurchase any or all of the 100,000 shares initially purchased and
any or all shares acquired upon exercise of the warrant if by June 21, 2001,
the Company has not made a public offering of its Common Stock with a per
share price of at least $22 with net proceeds to Company of at least
$10 million. The purchase price under the put right is equal to 20 times the
Company's average adjusted net income per share for the two most recent fiscal
years preceding ServiceMaster's exercise of the put.
The holders of the Dentist Put Rights issued by the Company in connection
with affiliations with dental practices have the right to require the Company
to repurchase an aggregate of 83,686 shares of Common Stock for an aggregate
of $1,216,000. Such rights are exercisable by the holders thereof at various
dates between 1998 and 2003. The rights as to all but 20,000 of the shares of
Common Stock will terminate if the Company completes a public offering of
Common Stock with a price that is greater than $20 per share. See "Risk
Factors--Common Stock Put Rights" and note (9) to the Gentle Dental
Supplemental Consolidated Financial Statements.
The Company funded capital expenditures of $1.2 million, $873,000 and $1.3
million for the years ended December 31, 1995, December 31, 1996 and the nine
months ended September 30, 1997, respectively. Such expenditures were
primarily related to the purchase of furniture and equipment, certain
information systems and tenant improvements. Cash paid for acquisitions was
$1.1 million, $7.3 million and $7.7 million for the years ended December 31,
1995, December 31, 1996 and the nine months ended September 30, 1997,
respectively. Such expenditures consisted primarily of cash paid in connection
with affiliation transactions, when completed, as well as cash paid pursuant
to related earn outs. In connection with certain completed affiliation
transactions the Company has agreed to pay to the sellers certain future
consideration in the form of cash and stock. The amount of future
consideration payable by the Company under earn outs is generally computed
based upon financial performance of the Affiliated Dental Practices during
certain specified periods.
The Company has in the past, and may in the future, issue promissory notes
to sellers of dental practice assets in connection with the affiliation
transactions with dental practices. At September 30, 1997, the Company had
approximately $3,710,000 in aggregate principal amount of such promissory
notes outstanding. Such notes generally require the Company to make quarterly
or monthly installments of principal. Certain of such notes require the
Company to make periodic balloon payments of principal amounts thereof. One
such note requires the Company to make a $500,000 lump sum payment in July
1999, a $2,083,179 lump sum payment in July 2002, and, in the event that
specified performance targets are attained by certain dental practices, a
payment of up to $2,800,000 in October 2002 (or such earlier date on which the
performance targets are achieved).
The Company plans to fund working capital requirements, acquisition of the
non-professional assets of additional dental practices the Company may seek to
affiliate with, and purchase of additional operating assets for the existing
practices with a combination of borrowings under the Credit Facility, issuance
of Common Stock and notes to purchase nonprofessional assets of Affiliated
Dental Practices, cash flow from operations and proceeds, if any, from future
offerings of Common Stock. 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.
38
BUSINESS
OVERVIEW
The Company is one of the largest providers of dental practice management
services to multi-specialty dental practices in the United States. Following
the Pending Affiliations, the Company will provide management services to
dental practices at 59 dental offices with 205 dentists, including 49
specialists, and 581 operatories in selected markets in California,
Washington, Oregon, Idaho and Hawaii. 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.
The Company is pursuing an aggressive expansion strategy. The Company's
operating strategy is to provide value to Affiliated Dental Practices through
the introduction of a variety of practice enhancements. The Company assists
the Affiliated Dental Practices by providing general administrative services
and implementing established Company procedures designed to optimize staffing
ratios and patient scheduling. The Company also assists the Affiliated Dental
Practices by increasing utilization of specialists through effective cross-
referral programs among the Affiliated Dental Practices which capture
specialty dental service revenues previously referred to outside practices,
developing and implementing targeted advertising and marketing programs, and
attracting additional dentists and dental practices. To the extent applicable,
the Company provides significant managed care expertise to the Affiliated
Dental Practices. The Company believes the implementation of these
enhancements has resulted in significant revenue growth at the Affiliated
Dental Practices.
The Company has recently established a clinical services council (the
"Clinical Services Council") comprised of leading dental practitioners within
the Company's network of Affiliated Dental Practice. The Clinical Services
Council will work with Affiliated Dental Practices to establish and implement
procedures and protocols for the purpose of maintaining high quality dental
care. The Company provides educational services and a training program
covering non-clinical aspects of the dental practices. The Company also
provides a management information system that combines commercially available
software with customized, proprietary software of the Company. The Company
believes that its enhanced system provides a competitive advantage by allowing
the Company to effectively manage a large geographically diverse network of
dental practices from a centralized base. As of December 31, 1997, the
Company's basic management information system was in place at approximately
91% of the locations within the Affiliated Dental Practices network. The
Company intends to install its basic management information system at
Dedicated Dental and at each dental practice with which it affiliates.
The Company has recently completed a major merger and is in the process of
completing a major affiliation. On November 4, 1997, Gentle Dental merged with
GMS, a California-based dental practice management company, which provided
management services to dental practices at 22 locations consisting of 102
dentists, including 30 specialists. Upon completion of the GMS Merger, the
former shareholders of GMS received approximately 59% of the then outstanding
shares of the Company. On September 21, 1997, the Company executed definitive
agreements for the pending Dedicated Dental Affiliation, which will add
management services affiliations with respect to California based dental
practices at 15 locations consisting of 33 dentists, including three
specialists. See "Recent and Pending Affiliations."
DENTAL SERVICES INDUSTRY
HCFA estimates that the annual aggregate domestic market for dental services
was approximately $45.8 billion for 1995, representing 4.6% of total health
care expenditures in the United States. Dental services expenditures grew at a
compound annual growth rate of approximately 8.6% from 1980 to 1995. According
to HCFA, the size of the dental services industry is projected to reach $79.1
billion by 2005. The Company
39
believes that the anticipated growth in the dental industry will be driven by
several factors including: (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, therefore, more attractive to patients; (iv) an increased focus
on preventive and cosmetic dentistry; and (v) the growth of managed care
organizations that offer dental coverage to their members.
The market for dental services in the United States consists of both general
and specialty dentistry services. General dentistry services include
preventive and diagnostic procedures such as cleanings, examinations and
x-rays and restorative treatments such as fillings of cavities, gum therapy
and crowns. Specialty dentistry services include orthodontics, periodontics,
endodontics, pedodontics, prosthodontics, oral surgery, and oral pathology.
Dental care services in the United States are generally delivered through a
fragmented system of local providers, primarily individual or small group
practices. According to the American Dental Association 1995 Survey of Dental
Practice there were approximately 150,000 actively practicing dental
professionals in the United States, approximately 70% of whom practiced alone.
The Company estimates that approximately 2% of general and specialty
practitioners are affiliated with practice management companies.
According to industry sources, approximately 30% of the estimated 117
million people covered by dental benefits in 1995 were enrolled in managed
dental care programs, including preferred provider organizations ("PPO") and
dental HMOs. Enrollment in dental HMOs, according to the National Association
of Dental Plans, is estimated to have grown from 7.8 million in 1990 to 23.8
million in 1995.
The Company believes that the trend toward consolidation in the dental
services industry will continue as dentists seek to affiliate with group
practice managers such as the Company due to (i) the desire of dentists to
focus on clinical aspects rather than on administrative and regulatory aspects
of their practices; (ii) the increasing patient demands for more flexible
evening and weekend hours; (iii) the increasing demand for competitively-
priced, high quality dental care at multiple locations; (iv) the increasing
desire of recent dental school graduates to pursue alternatives to the
traditional solo practice of dentistry and (v) the need for certifiable
standards of care for patients.
OPERATING STRATEGY
The Company's strategic objective is to maintain and expand its leadership
position in the dental practice management industry. To achieve this
objective, the Company seeks to enter selected geographic markets and develop
locally prominent, multi-specialty dental delivery networks that provide
gentle, high quality, cost-effective dental care. The key elements of the
Company's strategy are as follows:
PROVIDE CONVENIENT, COMPREHENSIVE DENTAL CARE. The Affiliated Dental
Practices within the Company's network provide patients with customer-
friendly, comprehensive and cost-effective dental care which is made available
at convenient times and locations. Because the Company's Affiliated Dental
Practices generally include both general practitioners and on-staff
specialists who can provide dental services such as orthodontics,
periodontics, endodontics, pedodontics, prosthodontics, oral pathology and
oral surgery, patients can rely on the Company's network of Affiliated Dental
Practices that are generally structured to serve comprehensive dental care
needs. By offering extended office hours and conveniently located offices,
patients are offered a dental care environment that makes it easier to
schedule and keep appointments. The Company also provides flexible payment
options in an effort to reduce patient financial burdens.
FOCUS ON QUALITY OF PATIENT CARE. The Company has and continues to refine
procedures, training and systems designed to ensure optimum patient care. The
Company seeks to improve clinical outcomes through its Clinical Services
Council which works directly with the affiliated network dentists to: (i)
institute quality assurance and utilization review programs, (ii) develop and
implement continuing education and training
40
programs for dental professionals, (iii) design and implement treatment
protocols, developed in cooperation with dental practitioners, (iv) evaluate
new techniques and technologies, (v) monitor treatment outcomes, and
(vi) reduce patient fear of dental procedures. Additionally, the Company seeks
to affiliate with dentists and specialists who are committed to delivering
high quality dental care.
ESTABLISH A COMPREHENSIVE DENTAL CARE NETWORK. The Company's strategy is to
increase the number of Affiliated Dental Practices by entering into management
contracts with and acquiring the non-professional assets of dental groups and
practices in selected markets. The Company's objective is to affiliate with
dental groups and practices that have a significant market position or, when
combined with existing Affiliated Dental Practices, would result in a
significant market position. The Company also intends to selectively establish
de novo dental offices in the markets in which the Company operates, in order
to augment its market presence. The Company believes that the establishment of
significant positions in the markets it serves will result in economies of
scale. Following each new affiliation with a dental practice, the Company
works closely with the professionals and staff in order to achieve network
integration and provide patients with convenient dental treatment.
ACHIEVE OPERATIONAL EFFICIENCIES AND ENHANCE REVENUE. The Company believes
it achieves operating efficiencies through the establishment of (i)
centralized management and administrative functions, such as marketing,
payroll, accounts payable, general accounting and human resources services for
the Affiliated Dental Practices; and (ii) on-site functions such as patient
scheduling and billing and collections at each dental office or on a regional
basis. The Company also enhances dental practice revenues by providing
services and establishing procedures designed to optimize staff ratios and
patient scheduling, capture specialty revenue, develop and implement targeted
advertising and marketing programs, attract new dentists to join the
affiliated practices, and utilize its management information system to more
effectively support the Company's network of Affiliated Dental Practices. The
Company believes that its network configuration provides leverage in
negotiating with third-party payors and dental supply vendors to receive
structured payments and contract terms that are more favorable than those
typically available to individual and small group practitioners. The addition
of specialists such as orthodontists and oral surgeons who serve multiple
offices within the Company's affiliated network generally allows the Company
to capture incremental revenue from the higher fees commanded by specialty
services.
INTEGRATE AND LEVERAGE MANAGEMENT INFORMATION SYSTEMS. The Company's
management information system utilizes commercially available software, which
has been enhanced by proprietary software of the Company. This management
information system allows the Company to more effectively enhance the
Affiliated Dental Practices. The system is designed to assist each Affiliated
Dental Practice in optimizing staffing ratios, patient scheduling, identifying
and reducing unfinished patient treatment programs, maximizing billing and
collection efforts, and actively monitoring the performance of managed care
and other third party contracts. The Company believes that its management
information system provides a distinct competitive advantage by allowing the
Company to effectively service a diverse network of dental practices from a
centralized base. As of December 31, 1997, the Company's basic management
information system was in place at approximately 91% of the locations within
the Affiliated Dental Practices network.
EXPAND PATIENT VOLUME THROUGH PROACTIVE MARKETING. The Company seeks to
assist the Affiliated Dental Practices to increase patient volume by focusing
on patient satisfaction and targeting existing and new patients through radio,
direct mail, print advertising and other retail marketing programs. The
Company tailors its advertising to local markets, based upon demographic
characteristics of each market and the brand name recognition of the
Affiliated Dental Practices in the respective markets. The Affiliated Dental
Practices support this marketing program by offering convenient hours and
locations for the dental practices, providing comprehensive dental care
services such as same-day emergency care, introducing or expanding specialty
services at the dental practices, and utilizing the Company's management
information system to identify and reduce incomplete patient treatments. The
Company's objective is to leverage its existing advertising programs to
generate revenue as it expands within its selected markets.
41
CAPITALIZE ON MANAGED CARE EXPERTISE. The Company assists the Affiliated
Dental Practices by supplementing their fee-for-service business with selected
managed care contracts. The Company believes that selected managed care
contracts offer an attractive and profitable source of incremental revenue for
the Affiliated Dental Practices and the Company. The Company believes that the
financial and clinical data generated by the Company's management information
system enables the Company to negotiate managed care contracts under terms
favorable to the Company and its dental practice network. Additionally, the
Company utilizes its management information system to actively monitor
utilization of patient groups covered by the managed care plans. The Company
believes that its expertise in managed care represents a competitive
advantage, given the increasing market share of managed care payors in the
dental care sector.
DENTAL PRACTICE NETWORK
Following completion of the Pending Affiliations, the Company will provide
comprehensive management services to a dental practice network which employs
205 dentists, including 49 specialists, practicing out of 59 dental offices
and 581 operatories located in the geographic markets set forth below.
LOCATION DENTISTS(1) OFFICES OPERATORIES
-------- ----------- ------- -----------
Northern California............................ 74 15 175
Southern California(2)......................... 40 16 137
Portland, Oregon Area.......................... 50 13 109
Seattle, Washington Area....................... 13 7 64
Hawaii......................................... 14 6 55
Idaho.......................................... 14 2 41
--- --- ---
Total...................................... 205 59 581
=== === ===
- --------
(1) Includes 46 specialists at current dental practices and three additional
specialists after giving effect to the Pending Affiliations. See "Recent
and Pending Affiliations."
(2) Includes the 15 dental offices that will be affiliated upon completion of
the Dedicated Dental Affiliation.
EXPANSION STRATEGY
As a part of its strategy, the Company is pursuing an aggressive network
expansion plan. The Company believes that it has significant opportunities to
affiliate with additional dental practices resulting from (i) favorable
industry characteristics, (ii) the professional and business relationships of
the Company's senior management, and (iii) the Company's strong name
recognition.
The U.S. general and specialty dentistry industries are highly fragmented.
The American Dental Association estimates that at December 1995, there were
approximately 150,000 dentists in 113,000 general dental practices, with
single dentist practices accounting for approximately 70% of all practices.
The Company estimates that approximately 2% of all dentists are currently
affiliated with practice management companies. Since January 1997, the number
of dentists contracting or otherwise associated with practice management
organizations has grown significantly. The Company believes that the use of
dental practice management companies will continue to grow rapidly, resulting
in significant consolidation opportunities for the Company and other practice
management organizations. In order to capitalize on these consolidation
opportunities, the Company utilizes the extensive dental industry experience
of its senior management and its significant relationships with numerous
practitioners and other industry leaders throughout the United States. The
Company believes that these extensive relationships provide a competitive
advantage to the Company as it seeks additional affiliation opportunities to
further the growth of the Company's network of Affiliated Dental Practices.
The Company intends to continue to offer numerous significant benefits and
value-added services to attract dentists and specialty practitioners to its
affiliated provider network. Specific value-added services provided by
42
the Company include billing, reimbursement and collections services, payroll
and staffing, patient scheduling, advertising and marketing, product supply
management and equipment maintenance, dentists recruitment and capital
resources. Additional benefits to practitioners include clinical leadership
and excellence, quality of care standards and continuing education, and
financial benefits including equity compensation, earn-outs and performance
bonuses. The Company believes that it will continue to be successful in
attracting dentists for the Affiliated Dental Practices by providing these
services and benefits. Furthermore, the Company believes that its name
recognition is and will continue to be attractive to practitioners from an
affiliation standpoint. As a result, the Company believes it will have greater
consolidation opportunities.
The Company uses a range of evaluation criteria in selecting affiliation
candidates, including (i) number of practitioners and compensation; (ii)
patient base; (iii) quality of care; (iv) operating statistics, including
number of operatories, patient visits and revenue per chair; (v) historical
operating results and financial condition; (vi) general versus specialty
revenue mix; (vii) payor mix; (viii) location; (ix) market demographics and
competition; (x) advertising expenditures; (xi) reputation within the local
community; (xii) non-professional staffing requirements; and (xiii) condition
of facilities and equipment including information systems. The Company intends
to target individual and group practitioners, as well as local and regional
consolidators. As consideration for future affiliations, the Company may use a
combination of cash, stock, seller financing and earn-outs.
Upon a new affiliation with a dental practice, the Company's integration
process may include (i) centralization of certain management and
administrative functions, (ii) access to the expertise of regional management
personnel, (iii) integration of management information systems, (iv)
initiation of quality assurance and peer review programs, (v) development of
advertising and marketing programs, (vi) managing payroll and staffing, (vii)
reviewing quality of care and staff utilization, and (viii) modification of
scheduling procedures. Such integration is intended to improve the operations
of the dental practices and to position them for increased patient revenue and
profit growth. The Company will also continue its strategy of establishing de
novo dental offices in selected markets to augment existing market presence.
SERVICES AND OPERATIONS
The Company provides comprehensive management services with respect to all
of the operations of its network of Affiliated Dental Practices, other than
the provision of dental treatment. The Company employs all non-clinical
personnel at the dental practices.
ADMINISTRATIVE. The Company provides administrative services to the
Affiliated Dental Practices, including staffing, education and training,
billing and collections, patient scheduling, patient treatment follow-up,
financial reporting and analysis, productivity reporting and analysis, cash
management, group purchasing, inventory management, payroll processing,
employee benefits administration, advertising production and other marketing
support. The Company also assists in professional recruiting and provides
support for dental practice affiliations, new site development and other
capital requirements. The Company believes the dentists at the Affiliated
Dental Practices benefit from the support provided by the Company and that
these services substantially reduce the amount of time they are otherwise
required to devote to administrative matters, thereby enabling network
dentists to dedicate more time to the growth of their professional practices.
Through economies of scale, the Company is able to provide these services at a
lower cost than could be obtained by any of the Affiliated Dental Practices
individually. In addition, because of its size and purchasing power, the
Company has been able to negotiate discounts on, among other things, dental
and office supplies, health and malpractice insurance and equipment.
STAFFING AND SCHEDULING. The Company provides management services that are
designed to optimize staffing ratios and patient scheduling at the dental
practices within the Company's network. The Company provides analysis and
advice with respect to the optimal number of general dentists, specialist
dentists, dental assistants and hygienists at each dental practice in an
effort to provide high levels of quality care and patient confidence while
practicing at a heightened level of efficiency. In addition, the Company
assists dental practices
43
with their scheduling in order to maximize efficiency and minimize delays in
treatment. The Company also assists each Affiliated Dental Practice, to the
extent necessary, with respect to expanding office hours, optimizing the flow
of patients through the offices and assisting dentists in the more efficient
use of dental assistants and hygienists.
ADVERTISING AND MARKETING. The Company assists the Affiliated Dental
Practices in developing and implementing targeted advertising and marketing
programs. The Company's marketing programs, which include patient educational
and patient recall prevention programs at selected dental practices, are
focused on the retention and reactivation of existing patients. In addition,
the Company also uses external marketing programs such as direct mail and
yellow page advertising that are designed to identify the convenience of
individual locations, payment plans and service hours, and the high standards
of care at the practices in an attempt to attract new patients.
DENTIST AFFILIATION. In order to continue the Company's growth, the Company
seeks to enter into Management Agreements with dental practices that employ
dentists who become affiliated with the Company. The Company believes that its
affiliation structure allows many dentists to reduce the financial constraints
associated with having a significant portion of their net worth invested in
their practices. Further, the Company believes that the practice of dentistry
within its network allows dentists to focus almost exclusively on practicing
dentistry by avoiding the burden of non-clinical administrative and management
responsibilities. An affiliation with the Company offers dentists the
additional advantages of employee benefits such as health insurance and
continuing education.
QUALITY ASSURANCE. The clinical management procedures and treatment
protocols for the Affiliated Dental Practices within the Company's network
vary from region to region. Under the guidance of the Company's recently
formed Clinical Services Council, key dentists in each region will review and
determine these procedures and treatment protocols. The Company intends to
work closely with the dentists and hygienists at the Affiliated Dental
Practices to develop and implement these procedures and protocols, as well as
business and administrative standards under which dental services are provided
in order to create a heightened clinical environment for the Affiliated Dental
Practices to enhance patient care and clinical outcomes. Included among the
procedures and protocols to be determined by the Clinical Services Council are
treatment planning, diagnostic screening, radiographic records, record
keeping, specialty referrals and dental hygiene protocols. As part of the
Affiliated Dental Practices' clinical enhancement program, the Company intends
to assist in providing quality assurance, peer review and utilization review
programs.
TRAINING AND EDUCATION. Staff and practice development programs are an
integral part of the Company's operating strategy. The Company's programs are
designed to (i) motivate the staff to achieve optimum performance goals, (ii)
improve the level of patient satisfaction, and (iii) improve the Company's
ability to attract and retain qualified personnel. The Company believes that
its programs collectively have increased referrals from patients, and have
increased treatment acceptance rates. The Company provides the Affiliated
Dental Practices with consulting and educational services. These services
include a training program covering non-clinical aspects of the practice,
together with specific training designed for the efficient and effective use
of the Company's management information system. Specifically, the Company's
training programs provide professionals and Company employees at the dental
practices with access to guidelines for addressing questions and concerns of
prospective and existing patients, techniques for explaining treatment
procedures and length of treatment, parameters for establishing appropriate
financial arrangements with patients, and a systematic approach to monitoring
the success of each area of training.
MANAGEMENT INFORMATION SYSTEM. Management believes that access to accurate,
relevant and timely financial and operating information is a key element of
its practice management services. The Company's management information system
is a combination of commercially available software with proprietary
44
enhancements, and is designed to increase the efficiency and productivity of
dental practices by enabling the Company and the dental practices to cost-
effectively monitor the key business and professional operating aspects. The
Company's basic management system is in place at approximately 91% of the
locations within the Affiliated Dental Practice network. The Company intends
to implement its basic management system at Dedicated Dental and at each
dental practice with which it affiliates. The system allows the dental
practices to identify, track and schedule the patient treatment process,
thereby reducing unfinished patient treatment programs which correspondingly
increases practice revenues. The system also contains features designed to
maximize billing and collection efforts, and to actively monitor the
performance of managed care contracts. The management information system
functions to optimize the practitioner's time through computerized scheduling.
The Company believes that its enhanced management information system provides
a critical competitive advantage, in that it allows the Company to more
effectively manage a geographically diverse network of dental practices from a
centralized base. The current proprietary software enhancements, together with
its capacity to develop future enhancements, uniquely positions the Company
for future expansion of its Affiliated Dental Practice management network. The
Company believes this system has increased the productivity of the existing
Affiliated Dental Practices that have implemented it.
MANAGEMENT AGREEMENTS
The Company has entered into Management Agreements with the Affiliated
Dental Practices under which the Company is the exclusive administrator of all
non-clinical aspects of the dental practices conducted by the Affiliated
Dental Practices, providing facilities, equipment, staffing, management
support and other ancillary services. Under the Management Agreements the
Company (i) provides all facilities and equipment used by the Affiliated
Dental Practices; (ii) bills and collects all receivables on behalf of the
Affiliated Dental Practices; (iii) purchases and provides all supplies; (iv)
provides all clerical, accounting, payroll, human resources, computer and
other non-dental support services and personnel; (v) supervises and maintains
custody of all business records; (vi) provides management information reports;
(vii) provides market research and plans and implements marketing and
advertising programs; (viii) negotiates contracts on behalf of the Affiliated
Dental Practices with managed care payors or other third parties; and (ix)
assists in the recruitment of dentists.
Under the Management Agreements, the Affiliated Dental Practices retain the
responsibility for, among other things, (i) hiring and compensating dentists
and other dental professionals, (ii) purchasing and maintaining malpractice
insurance, (iii) maintaining patient records, and (iv) ensuring that dentists
have the required licenses and other certifications needed to perform their
duties. In addition, the Affiliated Dental Practices are exclusively in
control of all aspects of the practice of dentistry and the delivery of dental
services.
As compensation for all services provided under the Management Agreements,
the Company receives service fees from the Affiliated Dental Practices. Under
a typical Management Agreement, the Company will receive a service fee equal
to reimbursement of expenses incurred by the Company in the performance of its
obligations under the Management Agreement, plus an additional fee equal to a
percentage ranging from 15% to 30% of the net revenues of each Affiliated
Dental Practice, after allowances for contractual adjustments and bad debts.
Under certain of the Management Agreements, the Company is also entitled to
receive a bonus based upon achieving certain performance objectives.
Additionally, one Management Agreement provides for a flat fee of 53% of the
net revenues of the Affiliated Dental Practice. The fees under this Management
Agreement increase annually at the rate of 1% to a maximum of 55%. In
addition, Management Agreements to be entered into with dental practices
related to Dedicated Dental provide for flat fees ranging from 57% to 71% of
the net revenues of the practices. The service fees are collected by the
Company on an ongoing basis out of the cash collections of the Affiliated
Dental Practices, or under certain Management Agreements, out of receivables
assigned to the Company by the Affiliated Dental Practices.
The Management Agreements each have an initial term of 40 years with
automatic extensions ranging from five years to ten years thereafter, unless
either party gives notice before the end of the term. The Management
Agreements are not subject to early termination by the Affiliated Dental
Practices unless (i) the Company is the
45
subject of bankruptcy proceedings, or (ii) the Company materially breaches the
Management Agreement and does not cure the breach following notice. Certain of
the Management Agreements have additional termination events, including: (i)
refusal to comply with the decisions of the joint operating committee, (ii)
failure to pay the management fee, and (iii) a material change in the law.
GOVERNMENT REGULATION
GENERAL. The practice of dentistry is regulated extensively at both the
state and federal level. Regulatory oversight includes, but is not limited to,
considerations of fee-splitting, corporate practice of dentistry, anti-
kickback and anti-referral legislation and state insurance regulation.
Every state imposes licensing and other requirements on individual dentists
and dental facilities and services. In addition, federal and state laws
regulate HMOs 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 enforcements 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, these standards have not had any
material adverse effect on the operations of the Affiliated Dental Practices.
The Company believes that the Company and the Affiliated Dental Practices are
in compliance in all material respects with all applicable federal, state and
local laws and regulations relating to safety and health.
CORPORATE PRACTICE OF DENTISTRY; FEE SPLITTING. The laws of many states
prohibit by statute or under common law dentists from splitting fees with non-
dentists and prohibit non-dental entities such as the Company from engaging in
the practice of dentistry or 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. The restrictions are generally designed to prohibit a
non-dental entity from controlling the professional practice of a dentist,
employing dentists to practice dentistry (or, in certain states, employing
dental hygienists or dental assistants), controlling the content of a
dentist's advertising or sharing professional fees. A number of states limit
the ability of a person other than a licensed dentist to own equipment or
offices used in a dental practice. Some of these states allow leasing of
equipment and office space to a dental practice under a bona fide lease. Some
states also prohibit a dentist from operating more than two dental offices.
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.
The Company provides management and administration services to dental
practices, and believes that the fees the Company charges for those services
are consistent with the laws and regulations of the jurisdictions in which it
operates.The Company does not control the clinical aspects of the practice of
dentistry or, employ dentists to practice dentistry, except as permitted by
law. Moreover, in states in which it is prohibited, the Company does not
employ dental hygienists or dental assistants. Although the Company believes
that its operations comply in all material respects with the above-described
laws to which it is subject, there can be no assurance that a review of the
Company's business relationships by courts or other regulatory authorities
would not result in determinations that could prohibit or otherwise adversely
affect the operations of the Company or that the regulatory environment will
not change, requiring the Company to reorganize or restrict its existing or
future operations.
The laws regarding fee-splitting and the corporate practice of dentistry and
their interpretation vary from state to state and are enforced by regulatory
authorities with broad discretion. There can be no assurance that the legality
of the Company's business or its relationships with dentists or Affiliated
Dental Practices will not be successfully challenged or that the
enforceability of the provisions of any Management Agreement will not be
46
limited. The laws and regulations of certain states in which the Company may
seek to expand may require the Company to change the form of the Company's
relationships with Affiliated Dental Practices in such states in a manner
which may restrict the Company's operations or the way in which providers may
be paid or may prevent the Company from acquiring the non-dental assets of
such practices or managing dental practices in such states. Similarly, there
can be no assurance that the laws and regulations of the states in which the
Company presently maintains operations will not change or be interpreted in
the future either to restrict or adversely affect the Company's existing or
future relationships with the Company's Affiliated Dental Practices. Any
change in the Company's relationships with its Affiliated Dental Practices
resulting from the interpretation of corporate practice of dentistry and fee-
splitting statutes and regulations could have a material adverse effect on the
Company's business and results of operations.
ANTI-KICKBACK AND ANTI-REFERRAL LEGISLATION. Federal and many states laws
prohibit 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, in each case, reimbursable under
Medicare, Medicaid or other federal and state health care programs. These
provisions apply to dental services covered under the Medicaid program in
which the Company participates. The federal government has 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 transactions in the
health care industry such as those to which the Company is or may be a party
has not been the subject of judicial interpretation. There can be no assurance
that judicial or administrative authorities will not find these provisions
applicable to the Company's operations, which could have a material adverse
effect on the Company's business. Under current federal law, a physician or
dentist or member of his or her immediate family is prohibited 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, including the physician's or dentist's own group practice, unless
such an applicable exception is available. 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,
prosthesis, 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. Any future expansion of
these prohibitions to other health services could restrict the Company's
ability to integrate dental practices and carry out the development of the
Company's network of Affiliated Dental Practices.
Noncompliance with, or violation of, either the anti-kickback provisions or
restrictions on referrals can result in exclusion from the Medicare and
Medicaid programs as well as civil and criminal penalties. Similar penalties
apply for violations of state law. While the Company makes every effort to
comply with the anti-kickback and anti-referral laws a determination of
violation of these laws by the Company or its Affiliated Dental Practices
could have a material adverse effect on the Company's business, financial
condition and results of operations.
STATE INSURANCE REGULATION. 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 Dental
Practices contract with third-party payors, including self-insured plans, for
certain non-fee-for-service arrangements, the Company or the Affiliated Dental
Practice may become subject to state insurance laws. In the event that the
Company or the Affiliated Dental Practices are determined to be engaged in the
business of
47
insurance, such 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
event, the Company's revenues may be adversely affected.
Dedicated Dental operates under a license issued by the DOC under the Knox-
Keene Act, which is expected to be maintained by Dedicated Dental after it
becomes a wholly-owned subsidiary of the Company. See "Recent and Pending
Affiliations." The Knox-Keene Act and the regulations promulgated thereunder
subject entities which are licensed as healthcare service plans in California
to substantial regulation by the DOC. In addition, licensees under the Knox-
Keene Act are required to file periodic financial data and other information
(which generally become available to the public), maintain substantial
tangible net equity on their balance sheets and maintain adequate levels of
medical, financial and operating personnel dedicated to fulfilling the
licensee's statutory and regulatory requirements. The DOC is empowered by law
to take enforcement actions against licensees that fail to comply with such
requirements. Any material non-compliance with the Knox-Keene Act and the
regulations promulgated thereunder could have a material adverse effect on the
Company's business, financial condition and results of operations.
HEALTH CARE REFORM PROPOSALS. The United States Congress and state
legislatures have considered various types of health care reform, including
comprehensive revisions to the current health care system. It is uncertain
what legislative proposals will be adopted in the future, if any, or what
actions federal or state legislatures or third-party payors may take in
anticipation of or in response to any health care reform proposals or
legislation. Health care reform legislation adopted by Congress or the
legislatures of states in which the Company does business, as well as changes
in federal and state regulations could have a material adverse effect on the
operations of the Company, and changes in the health care industry, such as
the growth of managed care organizations and provider networks, may result in
lower payment levels for the services of dentists within the Company's network
of Affiliated Dental Practices and lower profitability of such affiliated
practices.
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
accordance with applicable law, although there can be no assurance that its
arrangements will not be successfully challenged or that the required changes
may not have a material adverse effect on operations or profitability.
COMPETITION
The Company competes with other dental practice management companies seeking
to affiliate with dental practices in the highly competitive dental practice
management industry. The Company believes that the industry will become more
competitive as it continues to develop. Key factors of competition between
dental practice management companies currently include acquisition methods and
models, the reputations of the dental practices within dental care networks,
the scope of services provided by dental care networks, management experience
and expertise, the sophistication of management information, accounting,
finance and other systems, and network operating methods. The Company believes
that it effectively competes in each of these areas. See "Risk Factors--
Competition."
INSURANCE
The Company carries comprehensive liability, fire, and extended coverage
insurance. The Affiliated Dental Practices carry professional liability and
general liability insurance. Such insurance coverages are expanded to include
all additional practices that the Company develops or affiliates, with policy
specifications, insured limits, and deductibles customarily carried for
similar dental practices.
SERVICE MARK
The Company's network of Affiliated Dental Practices in Oregon and
Washington is operated and marketed under the name Gentle Dental. Other
affiliated practices may or may not use the Gentle Dental name depending
48
upon each affiliated practice's name recognition and other local market
conditions. Gentle Dental is a federally registered service mark owned by the
Company. On April 19, 1989, the Company's predecessor acquired title to the
federal registration of this service mark as originally issued on October 26,
1982. As part of the purchase, the seller was granted an exclusive personal
license ("License") to use the mark for the sale of dental services in
practices owned or controlled by the seller in the Boston, Massachusetts,
Baltimore, Maryland, and Washington, D.C. metropolitan areas for a period
equal to the lesser of the seller's "natural life" or the 10 year period
ending April 19, 1999. As a result, the Company cannot use the mark in those
markets until expiration of the License. The Company also recognizes that
there are numerous other practices across the country using the name Gentle
Dental. Any entity that commenced use of the Gentle Dental mark before October
26, 1982, may have rights to the mark in its geographic market superior to the
Company's rights. The Company has been advised by counsel that, subject to the
License, it should have the right to prevent use of the Gentle Dental mark in
geographic markets the Company enters where the competing use commenced after
October 26, 1982, provided that the Company asserts its rights in a timely
manner and has not otherwise acquiesced to the use of the conflicting mark.
Given the costs and inherent uncertainties of service mark litigation, there
can be no assurance that the Company can successfully enforce its service mark
rights in any particular market.
LEGAL PROCEEDINGS
Neither the Company nor the Affiliated Dental Practices are currently
subject to any material litigation nor, to the Company's knowledge, is any
material litigation threatened against the Company or the Affiliated Dental
Practices other than routine litigation arising in the ordinary course of
business, some of which are expected to be covered by liability insurance and
all of which collectively are not expected to have a material adverse effect
on the Company's business, financial condition or results of operations.
EMPLOYEES
At December 31, 1997, the Company had 606 full-time employees, including 237
dental assistants directly employed by the Company, and 100 part-time
employees and the Affiliated Dental Practices had a total of 404 employees,
including 125 general dentistry practitioners, 46 specialists, 117 dental
hygienists, and 116 dental assistants. Approximately 36 clerical personnel and
dental assistants employed by one of the Professional Corporations are subject
to a collective bargaining agreement that expires in January 1999. Management
believes it maintains good relationships with its employees.
PROPERTIES
The dental practice and business offices in the Company's network are
generally leased from various parties pursuant to leases with remaining terms
ranging from one to 17 years. One dental office, in Everett, Washington, is
leased on a month-to-month basis; however, the Company believes that
alternative space is readily available in this area at comparable rates and on
comparable terms. Several of the leases have options to renew, and the Company
expects to renew or replace leases as they expire. The Company's corporate
headquarters are located in leased office space in Yorba Linda, California and
the Company also maintains executive offices in leased office space in
Vancouver, Washington. In connection with the amendment of the Management
Agreements with Oregon and Washington Professional Corporations, the Company
acquired an office building located in Hazeleale, Washington. Such office
building is occupied by one of the Company's Affiliated Dental Practices.
49
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Information with respect to the executive officers and directors of the
Company is set forth below.
NAME AGE POSITION
---- --- --------
Michael T. Fiore........ 43 Co-Chairman of the Board, Chief Executive Officer and President
Dany Y. Tse, DMD........ 47 Co-Chairman of the Board and President of Clinical Services Council
Grant M. Sadler......... 51 Vice Chairman of the Board
L. Theodore Van Eerden.. 42 Executive Vice President, Chief Development Officer and Director
Norman R. Huffaker...... 51 Chief Financial Officer
Gerald R. Aaron, DDS.... 51 Director
Kenneth D. Hooten....... 34 Director
Paul H. Keckley......... 48 Director
Craig W. Wong, DMD...... 42 Director
Steven R. Bull, DDS..... 47 Director
Robert Finzi............ 44 Director
Kathleen D. La Porte.... 36 Director
H. Wayne Posey.......... 59 Director
Arthur G. Kaiser, DDS... 53 Director designee
Michael T. Fiore. Mr. Fiore has served as Co-Chairman of the Board, Chief
Executive Officer and President of the Company since November 1997. Before
joining the Company in November 1997, Mr. Fiore was the Chief Executive
Officer, President and a director of GMS from April 1997 to October 1997. From
1986 to March 1996, Mr. Fiore served in various management positions at Salick
Health Care, Inc., a provider of diagnostic and therapeutic services to
patients with catastrophic illness, principally in the areas of cancer and
kidney failure, including serving as a director, Executive Vice President and
Chief Operating Officer, and as President of its principal subsidiary,
Comprehensive Cancer Centers, Inc.
Dany Y. Tse, DMD. Dr. Tse has served as Co-Chairman of the Board and
President of Clinical Services Council since November 1997. Dr. Tse served as
Chairman of the Board since December 1996 and, as President and Chief
Executive Officer of the Company from March 1996 until November 1997. He
previously served as Chairman of the Board from inception in December 1992 to
March 1996. Dr. Tse is a licensed dentist in Oregon and Washington.
Grant M. Sadler. Mr. Sadler has been Vice-Chairman of the Board since
November 1997. Prior to joining the Company in November 1997, Mr. Sadler
founded and served as the Chief Executive Officer, President and Secretary of
GMS from its inception in October 1996 to April 1997, at which time he vacated
those positions and assumed the position of Chairman of the Board and served
in that capacity until November 1997. Prior to GMS, Mr. Sadler served as
President of Group Management Services, Inc., a dental group consulting
practice formed by Mr. Sadler in 1991.
L. Theodore Van Eerden. Mr. Van Eerden has served as Executive Vice
President, Chief Development Officer and as a director since November 1997. He
served as Chief Financial Officer from March 1996 until November 1997. Before
joining the Company as Chief Financial Officer in March 1996, Mr. Van Eerden
was Vice President--Administration for HOSTS Corporation, a Vancouver,
Washington company that provides proprietary educational software products and
instructional delivery systems to schools throughout the United States. From
April 1993 to April 1994, Mr. Van Eerden was Director of Development for The
ServiceMaster Company where he focused on mergers and acquisitions and new
business development. Before that, Mr. Van Eerden was Vice President and Chief
Financial Officer of Medical SafeTec, Inc., a manufacturer of medical waste
destruction equipment. Prior to Medical SafeTec, Inc., Mr. Van Eerden served
in various positions with ServiceMaster focusing on mergers and acquisitions.
50
Norman R. Huffaker. Mr. Huffaker has served as Chief Financial Officer of
the Company since November 1997. Prior to joining the Company in November
1997, Mr. Huffaker served as Chief Financial Officer of GMS from December 1996
to November 1997. Mr. Huffaker previously served as Vice President of Finance
for Community Dental Services, Inc. (SmileCare Dental Group), an Irvine,
California based dental HMO and staff model practice company.
Gerald R. Aaron, DDS. Dr. Aaron has been a director of the Company since
December 1996. He has been certified as a pediatric dentist since 1976 and has
been employed since 1991 by the Professional Corporation in Washington.
Kenneth D. Hooten. Mr. Hooten has been a director of the Company since June
1996. Since 1995, Mr. Hooten has been Vice President of The ServiceMaster
Company responsible for managing the ServiceMaster Ventures Group, an internal
venture capital firm. From 1990 to 1995, Mr. Hooten served as Vice President
of Lasalle Partners Ltd., a real estate company. Following the sale of shares
of Common Stock by ServiceMaster pursuant to this Offering, director Hooten
has indicated his intent to resign from the Board of Directors.
Paul H. Keckley. Mr. Keckley has been a director of the Company since
December 1996. Since 1994, he has been Vice President Strategic Development at
PhyCor, Inc. Mr. Keckley previously served as a director of PhyCor, Inc., and
from 1985 to 1994 he was President of The Keckley Group, a market research and
strategic planning firm for hospitals, health systems, medical practices, and
health maintenance organizations.
Craig W. Wong, DMD. Dr. Wong has been a director of the Company since March
1995. Dr. Wong has been an oral and maxillofacial surgeon licensed to practice
in the states of Washington and Oregon since 1986. Dr. Wong serves as the
Chief of the Department of Oral and Maxillofacial Surgery for the Affiliated
Dental Practices in Oregon and Washington. Dr. Wong also serves as Section
Chief of Oral and Maxillofacial Surgery for the Veterans Administration
Medical Center in Portland, Oregon.
Steven R. Bull, DDS. Dr. Bull has been a director of the Company since
November 1997 and served as a director of GMS from December 1996 until the GMS
Merger. Since 1994, Dr. Bull has served as Senior Vice President of Public and
Professional Services for Delta Dental Plan of California. In this capacity,
Dr. Bull is responsible for coordinating the implementation of dental policy,
providing professional liaison with the dental provider community, and
recommending dental policy to the Delta California Dental Policy Committee and
Board of Directors. Dr. Bull has previously served as Senior Vice President of
PMI Dental Health Plan, and as Dental Director of Safeguard Health Plans.
Robert Finzi. Mr. Finzi has been a director of the Company since November
1997 and served as a director of GMS from October 1996 until the GMS Merger.
Since May 1991, Mr. Finzi has been a Vice President of the Sprout Group, a
division of DLJ Capital Corporation, which is the managing general partner of
Sprout Capital VII, L.P. and Sprout Growth II, L.P., and an affiliate of
Donaldson, Lufkin & Jenrette Securities Corporation. Mr. Finzi is also a
general partner of the general partner of a series of investment funds managed
by the Sprout Group and a limited partner of the general partner of ML Venture
Partners II, L.P. From 1984 to 1991, Mr. Finzi was a Vice President of Merrill
Lynch Venture Capital. Mr. Finzi serves on the board of directors of The
Cerplex Group and six privately held companies.
Kathleen D. La Porte. Ms. La Porte has been a director of the Company since
November 1997 and served as a director of GMS from October 1996 until the GMS
Merger. From January 1993 to the present, Ms. La Porte has been affiliated
with the Sprout Group, a division of DLJ Capital Corporation, which is the
managing general partner of Sprout Capital VII, L.P. and Sprout Growth II,
L.P. and an affiliate of Donaldson, Lufkin & Jenrette Securities Corporation.
Ms. La Porte has served as a general partner of the Sprout Group since
December 1993. From August 1987 to January 1993, Ms. La Porte was a principal
at Asset Management Company, a venture capital firm focused on early stage
health care and technology investments. Ms. La Porte currently serves on the
board of directors of FemRx, Hall Kinion, Onyx Pharmaceuticals and Lynx
Therapeutics and two privately held companies.
51
H. Wayne Posey. Mr. Posey has been a director of the Company since November
1997 and served as a director of GMS from December 1996 until the GMS Merger.
Since its inception in 1994, Mr. Posey has served as President, Chief
Executive Officer, director, and a member of the executive committee of
ProMedCo. Mr. Posey was a healthcare consultant from 1975 until 1994, most
recently as the principal in charge of the healthcare services division of
McCaslin & Company, P.C., a public accounting and consulting company in Fort
Worth, Texas.
Arthur G. Kaiser, DDS. The Company has agreed that Dr. Kaiser will be made a
director of the Company effective as of the closing of the Dedicated Dental
Affiliation. Dr. Kaiser has been the President and a director of Dedicated
Dental since December of 1986. Dr. Kaiser is a licensed dentist in California.
CLASSIFIED BOARD
The Company's Restated Articles of Incorporation provide for three classes
of directors. Directors Fiore, Finzi, Posey and Bull have been appointed to
Class II and will serve until the meeting of shareholders in 1998; directors
Sadler and Van Eerden have been appointed to serve with directors Tse and
Aaron in Class III until the meeting of shareholders in 1999; and director La
Porte has been appointed to serve with directors Hooten, Keckley, and Wong in
Class I until the annual meeting of shareholders in 2000. After these
directors' initial terms expire, newly elected directors shall serve for a
three year term or until their successors are duly elected and qualified.
While directors Sadler and Van Eerden have been appointed to Class III and
director La Porte has been appointed to Class I, their service for the
remaining one and two years of their terms must be approved at the Company's
1998 Annual Shareholder's Meeting because they were appointed by the Board of
Directors to fill vacancies. Following the completion of the Dedicated Dental
Affiliation, director designee Kaiser will be appointed to serve on the Board
of Directors. Director Hooten has indicated his intention to resign from the
Board of Directors following the sale of shares of Common Stock by
ServiceMaster pursuant to this Offering.
BOARD COMMITTEES
The Board of Directors maintains an Executive Committee, an Audit Committee
and a Compensation Committee. The Executive Committee, consisting of directors
Finzi, Fiore, La Porte, Van Eerden and Tse, has all of the authority of the
Board of Directors except as limited by applicable law. The Audit Committee,
consisting of directors Bull, La Porte and Posey, oversees actions taken by
the Company's independent auditors, and reviews the Company's internal audit
controls. The Compensation Committee, consisting of directors Finzi, Keckley
and Posey, reviews the compensation levels of the Company's employees and
makes recommendations to the Company's board regarding compensation.
DIRECTOR COMPENSATION
The members of the Company's Board of Directors are reimbursed for out-of-
pocket and travel expenses incurred in attending Board meetings. In January
1997, Mr. Keckley was granted a 10-year stock option for 2,000 shares with an
exercise price of $5.00 per share and in August 1997, Mr. Keckley was granted
a 10-year stock option for 5,000 shares with an exercise price of $8.02 per
share. In the GMS Merger, 10-year stock options previously granted by GMS to
each of Dr. Bull and Mr. Posey in December 1996 were converted into options
for 11,127 shares of Common Stock each at an exercise price of $0.45 per
share.
52
COMPENSATION OF EXECUTIVE OFFICERS
SUMMARY COMPENSATION TABLE. The following table sets forth compensation
information for each person who served as chief executive officer of the
Company in 1997 and all other current executive officers of the Company,
(collectively, the "Named Officers").
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
--------------------- ------------
OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS GRANTED COMPENSATION
--------------------------- ---- -------- ------- ------------ ------------
Michael T. Fiore............ 1997 $ 37,500 $50,000 -- $2,000(1)
Co-Chairman of the Board, 1996 $ -- $ -- -- $ --
Chief Executive Officer and
President (2)(3)
Dany Y. Tse, DMD............ 1997 $212,887 $83,000 125,000(5) $ --
Co-Chairman of the Board, 1996 $187,313 $ -- -- $3,339(6)
President of Clinical
Services Council (4)
Grant M. Sadler............. 1997 $ 29,166 $15,000 -- $ --
Vice Chairman of the
Board(2)(7) 1996 $ -- $ -- -- $ --
L. Theodore Van Eerden...... 1997 $122,994 $60,000 101,000(8) $ --
Executive Vice President 1996 $ 77,500 $ -- 37,500 $ --
Chief Development Officer
Norman R. Huffaker.......... 1997 $ 23,334 $25,000 44,508(10) $ --
Chief Financial Officer
(2)(9) 1996 $ -- $ -- -- $ --
- --------
(1) Consists of auto allowances from November 4, 1997 (the effective date of
the GMS Merger).
(2) Amounts shown reflect compensation earned from November 4, 1997 (the
effective date of the GMS Merger) through December 31, 1997.
(3) Mr. Fiore's annual base compensation is currently $225,000. At December
31, 1997, Mr. Fiore held 333,818 shares of Common Stock as unvested
restricted stock. At December 31, 1997, the value of these shares, net of
the amount paid for the shares, was $2,770,908. See "Certain
Transactions."
(4) Dr. Tse served as President and Chief Executive Officer of the Company
until November 4, 1997.
(5) Includes options for 50,000 shares repriced at the time of the Initial
Public Offering in February 1997.
(6) Consists of matching contributions made by the Company to the Company's
401(k) Plan.
(7) Mr. Sadler's annual base compensation is currently $175,000. At December
31, 1997, Mr. Sadler held 303,162 shares of unvested restricted stock. At
December 31, 1997, the value of these shares, net of the amount paid for
the shares, was $2,622,630. See "Certain Transactions."
(8) Includes options for 37,500 shares originally granted in 1996 and repriced
at the time of the Initial Public Offering.
(9) Mr. Huffaker's annual base compensation is currently $140,000.
(10) Consists of options to purchase 100,000 shares of GMS Common Stock
granted to Mr. Huffaker by GMS on December 4, 1996, which were converted
into options to purchase 44,508 shares of Common Stock in connection with
the GMS Merger on November 4, 1997.
53
STOCK OPTIONS GRANTED IN FISCAL 1997. The following table sets forth
information concerning stock options granted to the Named Officers during
1997:
PERCENTAGE OF
NUMBER OF OPTIONS
SHARES GRANTED TO
UNDERLYING EMPLOYEES
OPTIONS DURING EXERCISE PRICE EXPIRATION
NAME GRANTED FISCAL YEAR PER SHARE DATE
---- ---------- ------------- -------------- ----------
Michael T. Fiore(1)..... -- -- -- --
Dany Y. Tse, DMD........ 31,000(2) 6.1% $ 5.50 1/29/02
50,000(2)(3) 9.8% $ 5.50 7/26/05
44,000(4) 8.6% $4.125 4/9/02
Grant M. Sadler......... -- -- -- --
L. Theodore Van Eerden.. 63,500(5) 12.5% $ 5.00 1/29/07
25,000(3)(5) 4.9% $ 5.00 3/19/06
12,500(3)(5) 2.5% $ 5.00 5/31/06
Norman R. Huffaker...... 22,254(6) 4.4% $ 0.45 12/4/06
22,254(7) 4.4% $ 0.45 12/4/06
- --------
(1) Does not include options for 333,816 shares of Common Stock (on a post-GMS
Merger basis) granted to Mr. Fiore by GMS and exercised on April 1, 1997,
prior to the GMS Merger. See "Certain Transactions."
(2) This option was fully exercisable at the time of grant.
(3) Although this option was originally granted prior to 1997, it was repriced
at the time of the Initial Public Offering in February 1997.
(4) This option becomes exercisable for 20 percent of the shares on each of
the first five anniversaries of April 9, 1997, the grant date.
(5) This option becomes exercisable for 20 percent of the shares on each of
the first five anniversaries of the grant date, which is ten years prior
to the expiration date shown in the table.
(6) This option becomes exercisable for 25 percent of the shares on each of
the first four anniversaries of December 4, 1996, the date of original
grant by GMS.
(7) This option will become exercisable for one-half of the shares if, among
other things, the Company's EBITDA (excluding CEO salary and related
expense) for 1997 exceeds $6,298,000, and will become exercisable for a
portion of that half of the shares if such EBITDA exceeds $4,723,500. This
option will become exercisable for the second half of the shares if, among
other things, the Company's EBITDA (excluding CEO salary and related
expense) for 1998 exceeds $16,911,000, and will become exercisable for a
portion of that half of the shares if such EBITDA exceeds $12,683,250. To
the extent the performance targets are not met, this option will be
forfeited.
54
AGGREGATED OPTION EXERCISES. No options were exercised by the Named Officers
during 1997. The following table sets forth certain information concerning the
number of shares covered by both exercisable and unexercisable stock options
as of December 31, 1997. Also reported are values of "in-the-money" options
that represent the positive spread between the respective exercise prices of
outstanding stock options and the fair market value of the Company's Common
Stock as of December 31, 1997.
FISCAL YEAR-END OPTION VALUES
NUMBER OF SHARES VALUE OF
SUBJECT TO UNEXERCISED IN-THE-MONEY OPTIONS
NAME OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END(1)
---- -------------------------- -------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
Michael T. Fiore(2)........ -- -- -- --
Dany Y. Tse, DMD........... 81,000 44,000 $708,750 $385,000
Grant M. Sadler............ -- -- -- --
L. Theodore Van Eerden..... 7,500 93,500 $ 65,625 $818,125
Norman R. Huffaker......... 5,563 38,945 -- $340,769
- --------
(1) Based on price of $8.75 per share on December 31, 1997.
(2) Does not include options for 333,816 shares of Common Stock (on a post-GMS
Merger basis) granted to Mr. Fiore by GMS and exercised on April 1, 1997,
prior to the GMS Merger. See "Certain Transactions."
1993 STOCK INCENTIVE PLAN. In January 1993 the Board of Directors adopted,
and in March 1993 the shareholders of the Company approved, the 1993 Stock
Incentive Plan (the "Plan"). The Plan provides for the award of incentive
stock options to the Company's key employees and the award of nonqualified
stock options, stock appreciation rights, bonus rights, and other incentive
grants to the Company's directors, officers, employees, and other key
contributors, including key employees of the Affiliated Dental Practices. The
total number of shares of Common Stock that may be issued under the Plan will
not exceed 1,000,000. At December 31, 1997, 87,962 shares had been issued
under the Plan, options for 559,050 shares were outstanding under the Plan,
and 352,488 shares remained available for future grants under the Plan. At
December 31, 1997, options granted under GMS stock option plans covering
110,600 shares of Common Stock were also outstanding.
The Plan is administered by the Compensation Committee of the Board of
Directors, which has the authority, subject to the terms of the Plan, to
determine the persons to whom options or rights may be granted, the exercise
price and number of shares subject to each option or right, the character of
the grant, the time or times at which all or a portion of each option or right
may be exercised and certain other provisions of each option or right. The
Board of Directors may also delegate authority to administer the Plan to
another committee of the Board of Directors or to a senior executive officer
of the Company, or both.
The purchase price of Common Stock issued upon exercise of stock options
granted under the Plan must not be less than 85% of the fair market value of
the Common Stock at the date of the grant or, in the case of stock options
issued to holders of more than 10% of the Company's outstanding Common Stock,
110% of fair market value. The purchase price of Common Stock issued upon
exercise of incentive stock options granted under the Plan must not be less
than 100% of the fair market value of the Common Stock at the date of the
grant. The maximum term of any stock option is 10 years or five years in the
case of 10% shareholders. The aggregate fair market value, on the date of the
grant, of the stock for which incentive stock options are exercisable for the
first time by an employee during any calendar year may not exceed $100,000.
Options are exercisable over a period of time in accordance with the terms of
option agreements entered into at the time of the grant, but may not become
exercisable at a rate of less than 20% per year over the first five years of
the option's terms. Generally, options become exercisable over a five-year
period. Options granted under the Plan are generally nontransferable by the
optionee and, unless otherwise determined by the Board of Directors, must be
exercised by the optionee during the period of the optionee's employment or
service with the Company or within a specified period following termination of
employment or service.
55
EMPLOYMENT AGREEMENTS
The Company has entered into certain employment agreements with its
executive officers under which the annual base salaries of Mr. Fiore, Dr. Tse,
Mr. Sadler, Mr. Van Eerden, and Mr. Huffaker for the fiscal year 1998 are
$225,000, $243,000, $175,000, $140,000, and $140,000, respectively. The
executive officers are also entitled to participate in bonus plans maintained
or established by the Company. The employment agreements for Dr. Tse and Mr.
Van Eerden provide for terms through April 30, 2002, and the employment
agreement for Mr. Fiore provides for a term through July 31, 1999, during
which they may not be terminated without cause. Mr. Fiore, Dr. Tse, Mr.
Sadler, Mr. Van Eerden and Mr. Huffaker are entitled to continuation of their
base salaries (for Mr. Fiore and Dr. Tse in part under consulting
arrangements) for 18 months, three years, nine months, 12 months and nine
months, respectively, if their employment is terminated by the Company without
cause or if they voluntarily terminate their employment for good reason. In
addition, if Mr. Fiore's employment is terminated by the Company without cause
before April 1, 2001, he is entitled to be retained by the Company as a
consultant for a number of months equal to one-half of the number of months
between the termination date and April 1, 2001.
CERTAIN TRANSACTIONS
Outstanding stock of the Oregon and Washington Professional Corporations is
owned in whole or in part by Dany Y. Tse, Craig W. Wong and Gerald R. Aaron.
The Company is a party to Management Agreements with these Professional
Corporations pursuant to which the Company earns a significant portion of its
revenues. Effective January 1, 1998, the Company entered into agreements to
amend these Management Agreements to conform them to the existing management
agreements of Affiliated Dental Practices historically affiliated with GMS and
to increase the Company's control over the Oregon and Washington Professional
Corporations. As consideration for entering into the amended Management
Agreements, the Company has agreed to pay to the Oregon and one of the
Washington Professional Corporations or certain of their respective designated
dental practitioners, in the aggregate, the following: (i) approximately $1.8
million in cash offset by approximately $1.8 million of Company receivables
due from such Oregon and Washington Professional Corporations; (ii) the right
to receive an aggregate of either $575,000 in cash in 18 equal monthly
installments or options to acquire 230,000 shares of Common Stock at an
exercise price of $8.375 per share, subject to five year vesting, plus options
to acquire an aggregate of 110,000 shares of Common Stock exercisable at
$8.375 per share, subject to five year vesting; and (iii) future cash or
options subject to five year vesting in amounts to be determined according to
a formula based upon the operating revenues of such Oregon and Washington
Professional Corporations for fiscal years ending December 31, 1998 and 1999.
The Company has recorded intangible assets of approximately $2.0 million in
the fourth quarter of 1997, which resulted from the Amended Management
Agreements. The Company believes that these amendments will require the
Company to consolidate the financial results of the Oregon and Washington
Professional Corporations. See "Business--Management Agreements" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--GMS Merger and Restructuring."
On May 31, 1996, the Company executed a modification of its former loan and
security agreement with Silicon Valley Bank (the "Modification"). In
connection with the Modification, 14 officers, directors, and shareholders of
the Company including Dr. Tse, Dr. Wong and Mr. Van Eerden, provided
continuing personal guarantees on $1,000,000 of the Company's indebtedness to
Silicon Valley Bank in connection with a $1,000,000 increase in availability
under such credit facility. In consideration for the personal guarantees, the
Company issued warrants to purchase an aggregate total of 115,000 shares of
the Company's Common Stock at $7.50 per share. Each guarantor received
warrants to purchase 1,150 shares for each $10,000 of indebtedness guaranteed.
All of these guarantees terminated in February 1997 upon the repayment of the
loan.
The above-described transactions with related parties were on terms the
Company's Board of Directors believed to be fair to the Company and no less
favorable to the Company than terms that could have been
56
obtained from an unrelated party. Future transactions between the Company and
Affiliated Dental Practices controlled by officers, directors, and principal
shareholders of the Company will be carried out pursuant to a related party
transaction policy adopted by the Company's Board of Directors. The policy
provides that any transaction between the Company and (i) an officer,
director, or principal shareholder of the Company or (ii) any entity that is
controlled by officers, directors, or principal shareholders of the Company
must be approved by at least a majority of the Company's directors who do not
have an interest in the transaction. The terms of such transactions must be no
less favorable to the Company than those that are generally available from
unaffiliated third parties.
On April 1, 1997, Mr. Fiore was granted stock options by GMS exercisable for
750,000 shares of GMS Common Stock at an aggregate exercise price of $150,000.
On the same date, Mr. Fiore exercised the options for all such shares. The
exercise price was paid in the form of a secured promissory note in the
principal amount of $150,000 which bears annual interest at the rate of 6.84%
compounded annually. All unpaid principal and accrued interest becomes due and
payable to the Company on March 31, 2001. In the GMS Merger, the shares
purchased on exercise of Mr. Fiore's options were converted into 333,816
shares of Common Stock. Of these shares, 300,434 shares are subject to a four
year vesting schedule under which 25% of the shares vest on April 1, 1998 and
the remaining shares vest in equal amounts over the next 36 months. All
unvested shares are subject to repurchase by the Company at $0.45 per share
upon termination of Mr. Fiore's service to the Company for any reason. Of the
remaining 33,382 shares of Common Stock held by Mr. Fiore, one half are
subject to repurchase by the Company at $0.45 per share if, among other
things, the Company's EBITDA (excluding CEO salary and related expense) for
1997 does not exceed $4,723,500, and a portion of that one half will be
subject to repurchase if such EBITDA does not exceed $6,298,000. The second
half of the remaining shares are subject to repurchase by the Company at the
same price if, among other things, the Company's EBITDA (excluding CEO salary
and related expense) for 1998 does not exceed $12,683,250, and a portion of
the second half will be subject to repurchase if such EBITDA does not exceed
$16,911,000.
In 1996, Mr. Sadler purchased from GMS 888,681 shares of GMS Common Stock
for $88,868. The purchase price was paid in part in the form of secured
promissory note in the principal amount of $87,911, which bears interest at
the rate of 6.84%, compounded annually. All unpaid principal and accrued
interest on such promissory note becomes due and payable on August 31, 2000.
In the GMS Merger, the foregoing shares were converted into 395,541 shares of
Common Stock. Of these shares, 175,031 shares are subject to a four year
vesting schedule under which one fourth of the shares vested immediately upon
issuance another one fourth on October 11, 1997 and the remaining shares vest
in equal amounts over the next 36 months thereafter. All unvested shares are
subject to repurchase by the Company at $0.225 per share upon termination of
Mr. Sadler's service to the Company for any reason. In addition, 110,255
shares of Common Stock held by Mr. Sadler are subject to repurchase by the
Company at $0.225 per share if, among other things, the Company's EBITDA
(excluding CEO salary and related expense) for 1997 does not exceed
$4,723,500, and a portion of those shares will be subject to repurchase if
such EBITDA does not exceed $6,298,000. Another 110,255 shares are subject to
repurchase by the Company at the same price if, among other things, the
Company's EBITDA (excluding CEO salary and related expense) for 1998 does not
exceed $12,683,250, and a portion of those shares will be subject to
repurchase if such EBITDA does not exceed $16,911,000.
An additional 340,255 shares of Common Stock held by certain other former
GMS shareholders (including 42,060 shares held by Sprout Capital VII and
certain related entities are also subject to repurchase by the Company at an
average price of $0.37 per share ($.45 per share for Sprout Capital VII and
certain related entities). One half of the shares are subject to repurchase
if, among other things, the Company's EBITDA (excluding CEO salary and related
expense) for 1997 does not exceed $4,723,500, and a portion of that half will
be subject to repurchase if such EBITDA does not exceed $6,298,000. The second
half of the shares are subject to repurchase if, among other things, the
Company's EBITDA (excluding CEO salary and related expense) for 1998 does not
exceed $12,683,250, and a portion of the second half will be subject to
repurchase if such EBITDA does not exceed $16,911,000.
57
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership, as of December 31, 1997, and as adjusted to reflect the sale of the
Common Stock offered by this Prospectus, of the Common Stock by (i) each
person known by the Company to own beneficially more than 5% of the Common
Stock, (ii) each director of the Company, (iii) the Chief Executive Officer
and each other Named Officer, (iv) all directors and executive officers as a
group, and (v) the Selling Shareholders. Except as otherwise noted, the
Company believes the persons listed below have sole investment and voting
power with respect to the Common Stock owned by them.
PERCENTAGE OF
COMMON STOCK
SHARES SHARES -----------------
BENEFICIALLY TO BE BEFORE AFTER
NAME AND ADDRESS(1) OWNED SOLD(2) OFFERING OFFERING
------------------- ------------ ------- -------- --------
Sprout Capital VII L.P. and certain
related entities (3).................. 1,649,562 -- 21.5% 14.8%
3000 Sand Hill Road
Bldg. 3, Suite 170
Menlo Park, CA 94025
Accel V L.P. and certain related
entities (4).......................... 524,708 -- 6.8% 4.7%
c/o Accel Partners
428 University Avenue
Palo Alto, CA 94301
Bessemer Venture Partners GMS.......... 393,530 -- 5.1% 3.5%
83 Walnut Street
Wellesley Hills, MA 02181
ServiceMaster Venture Fund L.L.C. (5).. 200,000 100,000 2.6% *%
One ServiceMaster Way
Downers Grove, IL 60515
Michael T. Fiore (6)................... 356,772 -- 4.7% 3.2%
Dany Y. Tse, DMD (7)................... 620,500 -- 8.1% 5.6%
Grant M. Sadler (8).................... 395,541 -- 5.2% 3.5%
L. Theodore Van Eerden (9)............. 23,075 -- *% *%
Norman R. Huffaker (10)................ 5,564 -- *% *%
Gerald R. Aaron, DDS (11).............. 9,584 -- *% *%
Kenneth D. Hooten (12)................. 200,000 -- 2.6% *%
Paul H. Keckley (13)................... 400 -- *% *%
Craig W. Wong, DMD (14)................ 89,500 -- 1.2% *%
Steven R. Bull, DDS (15)............... 2,782 -- *% *%
Wayne Posey (15)....................... 29,017 -- *% *%
Robert Finzi (16)...................... 1,649,562 -- 21.5% 14.8%
Kathleen D. La Porte (16).............. 1,649,562 -- 21.5% 14.8%
All directors and officers as a group
(13 persons) (16)(17)................. 3,382,297 -- 42.6% 29.6%
- --------
* Less than one percent
(1) Unless otherwise indicated the address of each of the shareholders listed
in the table is: c/o Gentle Dental Service Corporation, 22800 Savi Ranch
Parkway, Suite 206, Yorba Linda, California, 92887.
(2) Following completion of the Dedicated Dental Acquisition, which is
expected to occur prior to completion of this Offering, Dr. Kaiser and
Robert Newman will acquire 1,519,103 shares of Common Stock (subject to
final closing adjustments). A portion of these shares with an aggregate
market value of up to $4 million will be included in and sold pursuant to
this Offering.
(3) Consists of the following shares: 793,600 shares held by Sprout Capital
VII L.P. ("Sprout"); 164,956 held by DLJ First ESC L.L.C. ("DLJ First");
648,797 shares held by Sprout Growth II, L.P. ("Sprout
58
Growth"), 9,218 shares held by the Sprout CEO Fund, L.P. ("Sprout CEO");
and 32,991 shares held byDLJ Capital Corporation ("DLJ Capital"). DLJ
Capital is the managing of each of Sprout CEO, Sprout Growth and Sprout
Capital VII and has voting and investment control over the shares held by
each of those three shareholders. DLJ LBO Plans Management Corporation is
the manager of DLJ First and has voting and investment control over the
shares held by DLJ First.
(4) Consists of the following shares: 422,914 shares held by Accel V L.P.
("A5"); 56,669 shares held by Accel Internet/Strategic Technology Fund
L.P. ("AISTF"); 25,186 shares held by Accel Investors '96 L.P. ("AI96");
11,544 shares held by Ellmore C. Patterson Partners ("ECPP"); and 8,395
shares held by Accel Keiretsu V L.P. ("AK5") (A5, AISTF, AI96, ECPP, AK5
and A5A collectively, the "Accel Entities"). Arthur C. Patterson, ACP
Family Partnership L.P., James R. Swartz, James W. Breyer, The Breyer
1995 Trust dated 10/4/95, Eugene D. Hill, Swartz Family Partnership L.P.,
Luke B. Evnin, and G. Carter Sednaoui share control of the Accel Entities
and disclaim beneficial ownership except to the extent of their
respective pecuniary interests.
(5) Includes 100,000 shares subject to an exercisable warrant. ServiceMaster
Venture Fund L.L.C. is a subsidiary of the ServiceMaster Company Limited
Partnership, which in turn is a subsidiary of ServiceMaster Limited
Partnership, a NYSE-listed limited partnership.
(6) Includes 16,691 shares subject to repurchase by the Company in January
1998 and 16,691 shares subject to repurchase by the Company in January
1999, all at $0.45 per share, if certain performance targets are not met.
See "Certain Transactions."
(7) Includes 81,000 shares subject to exercisable options, 34,500 shares
subject to an exercisable warrant and 3,500 shares held by Dr. Tse's
wife.
(8) Includes 110,255 shares subject to repurchase by the Company in January
1998 and 110,255 shares subject to repurchase by the Company in January
1999, all at $0.225 per share, if certain performance targets are not
met. Also includes 170,169 shares subject to repurchase by the Company at
a price of $0.225 per share, which rights lapse at a rate of 2,431 shares
per month until October 31, 2000, at which time the Company's rights will
have lapsed as to all such 170,169 shares. See "Certain Transactions."
(9) Includes 20,200 shares subject to options exercisable within 60 days
after December 31, 1997 and 2,875 shares subject to an exercisable
warrant.
(10) Includes 5,564 shares subject to an option exercisable within 60 days
after December 31, 1997.
(11) Includes 7,334 shares subject to options exercisable within 60 days after
December 31, 1997.
(12) Includes 200,000 shares beneficially owned by ServiceMaster Venture Fund
L.L.C. ("ServiceMaster Venture Fund"). Mr. Hooten, as a Vice President of
The ServiceMaster Company, which manages ServiceMaster Venture Fund, may
be deemed to share voting and dispositive power with respect to such
shares. Mr. Hooten disclaims beneficial ownership of these shares.
(13) Includes 400 shares subject to an option exercisable within 60 days after
December 31, 1997.
(14) Includes 1,600 shares subject to an exercisable option and 6,900 shares
subject to an exercisable warrant.
(15) Includes 2,782 shares subject to options exercisable within 60 days after
December 31, 1997.
(16) Includes 1,649,562 shares beneficially owned by Sprout Capital VII, L.P.
and certain related entities. Mr. Finzi and Ms. La Porte, as members,
partners or as general or limited partners of such partners of entities
within this group, may be deemed to share voting and dispositive power
with respect to such shares. Mr. Finzi and Ms. La Porte each disclaims
beneficial ownership of these shares.
(17) Includes 121,662 shares subject to options exercisable within 60 days
after December 31, 1997, 144,275 shares subject to exercisable warrants
and 253,892 shares subject to repurchase by the Company if certain
performance targets are not met.
59
DESCRIPTION OF CAPITAL STOCK
AUTHORIZED SECURITIES
The authorized capital stock of the Company consists of 50,000,000 shares of
Common Stock and 30,000,000 shares of Preferred Stock.
COMMON STOCK. The Company is authorized to issue 50,000,000 shares of Common
Stock. As of December 31, 1997, 7,678,683 shares of Common Stock were
outstanding, held of record by approximately 96 shareholders. After this
Offering, 11,178,683 shares will be outstanding. Holders of Common Stock are
entitled to receive dividends as may from time to time be declared by the
Board of Directors of the Company out of funds legally available therefor.
Holders of Common Stock are entitled to one vote per share on all matters on
which the holders of Common Stock are entitled to vote and do not have any
cumulative voting rights. Holders of Common Stock have no preemptive,
conversion, redemption, or sinking fund rights. In the event of a liquidation,
dissolution, or winding up of the Company, holders of Common Stock, along with
holders of any Preferred Stock with a right of participation, are entitled to
share equally and ratably in the assets of the Company, if any, remaining
after the payment of all liabilities of the Company and the liquidation
preference of any outstanding class or series of Preferred Stock. The
outstanding shares of Common Stock are, and the shares of Common Stock offered
by the Company hereby when issued will be, fully paid and nonassessable. The
rights, preferences, and privileges of holders of Common Stock are subject to
any series of Preferred Stock that the Company may issue in the future, as
described below.
PREFERRED STOCK. The Company is authorized to issue up to 30,000,000 shares
of Preferred Stock. As of December 31, 1997, no shares of Preferred Stock were
outstanding. The Board of Directors has the authority to issue Preferred Stock
in one or more series and to fix the number of shares constituting any such
series and the preferences, limitations, and relative rights, including
dividend rights, dividend rate, voting rights, terms of redemption, redemption
price or prices, conversion rights, and liquidation preferences of the shares
constituting any series, without any further vote or action by the
shareholders of the Company. The issuance of Preferred Stock by the Board of
Directors could adversely affect the rights of holders of Common Stock.
The potential issuance of Preferred Stock may have the effect of delaying,
deterring, or preventing a change in control of the Company, may discourage
bids for the Common Stock at a premium over the market price of the Common
Stock and may adversely affect the market price of, and the voting and other
rights of the holders of, Common Stock. The Company has no plans to issue
shares of Preferred Stock.
WARRANTS
As of December 31, 1997, there were warrants outstanding to purchase an
aggregate of 640,435 shares of Common Stock, 189,160 of which have an exercise
price of $7.86 per share, 219,333 of which have an exercise price of $7.50 per
share, 150,000 of which have an exercise price of $6.00 per share, and 81,942
of which have an exercise price of $3.93 per share. Warrants to purchase
119,333 shares expire in May 2001, warrants to purchase 100,000 shares expire
in December 2001, warrants to purchase 150,000 shares expire in February 2002,
warrants to purchase 133,524 expire on the later of (i) July 2004 or (ii) 90
days after the closing of the first public offering by the Company after
October 31, 1997, warrants to purchase 55,636 expire on the later of
(i) October 2004 or (ii) 90 days after the closing of the first public
offering by the Company after October 31, 1997, and warrants to purchase
81,942 shares expire in October 2001. Warrants for 150,000 shares issued to
the underwriters in the Company's initial public offering do not become
exercisable until February 12, 1998. Warrants for 22,254 shares at $7.86 per
share become exercisable only if certain performance conditions are met by one
Affiliated Dental Practice.
PUT RIGHTS
In connection with dental practice affiliations during 1995 and 1996, the
Company granted "put" rights to certain sellers with respect to some of the
shares of Common Stock issued in the affiliations. As of December 31,
60
1997, these put rights cover a total of 83,686 shares of Common Stock and give
the holders the right to require the Company to repurchase the shares at
prices ranging from $13.38 to $19.62 per share. One holder has put rights with
respect to 11,820 shares that can be exercised in varying amounts in 1998,
1999 and 2000. All other put rights become exercisable between January 2000
and January 2003 and expire if not exercised within 60 days of the exercise
date. The put rights with respect to all but 20,000 shares will terminate if
the Company completes a public offering of Common Stock at a price greater
than $20.00 per share. The Company has also granted ServiceMaster the right to
require the Company to repurchase the 100,000 shares held by ServiceMaster and
the 100,000 shares ServiceMaster may acquire upon exercise of its warrant, if
by June 21, 2001, the Company has not made a public offering of its Common
Stock with a per share price of at least $22.00 and net proceeds to the
Company of at least $10 million ("Qualified Offering"). The put right may not
be exercised before June 21, 2001, and will expire upon the earlier of the
completion of a Qualified Offering or June 21, 2003. The per share price
applicable to ServiceMaster's put right is 20 times the Company's average
adjusted net income per share for the two most recent fiscal years preceding
ServiceMaster's exercise of the right. ServiceMaster's put right with respect
to 100,000 shares will be extinguished upon the sale of such shares in the
Offering. Shares subject to put rights are classified as Redeemable Common
Stock on the Company's Balance Sheet.
REGISTRATION RIGHTS
Certain holders of 100,000 shares of the Company's Common Stock and warrants
to purchase an additional 336,275 shares of the Company's Common Stock (the
"Rights Holders") are entitled to certain rights with respect to the
registration of such shares under the Securities Act. The shares subject to
registration rights include 95,000 shares to be sold in this offering by
ServiceMaster. Under the terms of agreements between the Company and these
holders, if the Company proposes to register any of its Common Stock under the
Securities Act for its own account or for the account of other security
holders (other than pursuant to certain excluded registration forms), the
Rights Holders are entitled to notice of such registration and to include in
such registration shares of Common Stock that they hold, subject to cutback
limitations that may be imposed by the underwriter of any underwritten public
offering of the Company's Common Stock. The Rights Holders are not required to
bear any expenses incurred by the Company in connection with registering the
Rights Holders' shares, but underwriting fees, discounts, or commissions
relating to the sale of each Rights Holder's shares are borne by the
applicable Rights Holder.
The holders of the 1,519,103 shares of Company Common Stock (subject to
final closing adjustments) to be issued upon completion of the Dedicated
Dental Affiliation (the "Dedicated Rights Holders") will also have certain
registration rights. If the Company proposes to register any of its Common
Stock under the Securities Act for its own account or for the account of other
security holders (other than pursuant to certain excluded registration forms),
the Dedicated Rights Holders will be entitled to notice of such registration
and to include in such registration shares of Common Stock that they hold,
subject to cutback limitations that may be imposed by the underwriter of any
underwritten public offering of the Company's Common Stock. In the Dedicated
Dental merger agreement, the Company agreed that Dr. Kaiser and the other
shareholder of Dedicated Dental would be able to sell a number of shares of
Common Stock with an aggregate market value of up to $4 million in an
underwritten offering prior to March 31, 1998. The Company anticipates that
these shares will be issued prior to completion of this Offering and will be
sold pursuant thereto. See "Principal and Selling Shareholders." In addition,
the Company has agreed to file a registration statement by March 31, 1998 to
register all of the shares held by the Dedicated Rights Holders for resale in
ordinary market transactions and to maintain that registration statement until
March 31, 2000. The Dedicated Rights Holders are not required to bear any
expenses incurred by the Company in connection with registering their shares,
other than payment of their respective underwriting fees, discounts, and
brokerage commissions relating to the sale of their shares.
Except for the $4 million of Common Stock described in the foregoing
paragraph, the Dedicated Rights Holders have agreed that they will not sell,
offer to sell or otherwise transfer any of the shares discussed in the
foregoing paragraph until March 31, 1999. On March 31, 1999, and on the last
day of each of the next nine months, one-tenth of these shares will be
released from the lock-up restriction and will be eligible for sale.
61
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article VIII of the Company's Restated Articles of Incorporation, as amended
(the "Articles"), authorizes indemnification of directors of the Company to
the fullest extent permitted by the Washington Business Corporation Act (the
"Act"). In addition, Section 10 the Company's Bylaws requires the Company to
indemnify directors and former directors of the Company to the fullest extent
permitted by applicable law, and permits the Company to indemnify officers,
employees, and agents of the Company. The effects of the Articles, Bylaws and
the Act (the "Indemnification Provisions") are summarized as follows:
(a) The Indemnification Provisions grant a right of indemnification in
respect of any action, suit or proceeding (other than an action by or in
the right of the Company) against expenses (including attorney fees),
judgments, fines and amounts paid in settlement actually and reasonably
incurred, if the director or former director concerned (i) acted in good
faith and in a manner the director or former director reasonably believed
to be, in the case of conduct in the director's or former director's
official capacity, in the best interests of the Company or, in all other
cases, not opposed to the best interests of the Company, (ii) was not
adjudged liable on the basis of receipt of an improper personal benefit and
(iii) with respect to any criminal action or proceeding, had no reasonable
cause to believe the conduct was unlawful. The termination of an action,
suit or proceeding by judgment, order, settlement, conviction or plea of
nolo contendere does not, of itself, create a presumption that the director
or former director did not meet the required standards of conduct.
(b) The Indemnification Provisions grant a right of indemnification in
respect of any action or suit by or in the right of the Company against the
expenses (including attorney fees) actually and reasonably incurred if the
director or former director concerned acted in good faith and in a manner
the director or former director reasonably believed to be, in the case of
conduct in the director's or former director's official capacity, in the
best interests of the Company, or in all other cases, not opposed to the
best interests of the Company; except that no right of indemnification will
be granted if the director or former director is adjudged to be liable to
the Company.
(c) Every director and officer who has been wholly successful on the
merits or otherwise of a controversy described in (a) or (b) above is
entitled to indemnification for reasonable expenses as a matter of right.
(d) Because the limits of permissible indemnification under Washington
law are not clearly defined, the Indemnification Provisions may provide
indemnification broader than that described in (a) and (b).
(e) The Company shall advance to a director or former director the
expenses incurred in defending any action, suit or proceeding in advance of
its final disposition if the director or former director affirms in good
faith that he or she has met the standard of conduct to be entitled to
indemnification as described in (a) or (b) above and undertakes to repay
any amount advanced if it is determined that the director or former
director did not meet the required standard of conduct.
(f) The Company may, by action of the Board of Directors from time to
time, provide indemnification and pay expenses in advance of the final
disposition of a proceeding to officers, employees, and agents of the
Company on the same terms and with the same scope as described above.
The Company may obtain insurance for the protection of its directors and
officers against any liability asserted against them in their official
capacities. The rights of indemnification described above are not exclusive of
any other rights of indemnification to which the persons indemnified may be
entitled under any bylaw, agreement, vote of shareholders or directors or
otherwise.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to the foregoing provisions or otherwise, the Company has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act
and is therefore unenforceable.
62
WASHINGTON ANTITAKEOVER STATUTE
Washington law contains provisions relating to "significant business
transactions" that may have the effect of delaying or discouraging a hostile
takeover of the Company. Chapter 23B.19 of the Washington Business Corporation
Act (the "Statute") applies to all Washington corporations that have a class
of voting stock registered under section 12 or section 15 of the Exchange Act.
The Statute prohibits, subject to certain exceptions, a corporation from
entering into any "significant business transactions" with an "Acquiring
Person" (defined generally as a person or affiliated group who acquires 10% or
more of the outstanding voting securities of a corporation without the prior
approval of the corporation's board of directors) for a period of five years
after such person or affiliated group becomes an Acquiring Person. The
prohibited transactions include, among others, a merger with, disposition of
assets to, or issuance or redemption of stock to or from, the Acquiring
Person, or allowing the Acquiring Person to receive any disproportionate
benefit as a shareholder.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is TranSecurities
International, Inc., Spokane, Washington.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this Offering, there will be 11,178,683 shares of Common
Stock outstanding. Of these shares, the 4,548,161 shares issued in the GMS
Merger on November 4, 1997, the 109,039 shares issued in the affiliation with
Blue Oak Dental Group on March 31, 1997, and the shares issuable in connection
with the Pending Affiliations are or will be "restricted securities" as
defined in Rule 144 promulgated under the Securities Act. All other shares are
or will be eligible for sale to the public without restriction under the
Securities Act, except for any shares held by affiliates of the Company, which
will be subject to certain resale limitations of Rule 144. However, certain
directors, executive officers and shareholders of the Company have agreed with
the Underwriters not to offer to sell, contract to sell or otherwise sell or
dispose of shares of Common Stock owned by them for a period of 180 days after
the date of this Prospectus without the prior written consent of Bear, Stearns
& Co. Inc. These persons hold shares of Common Stock that are otherwise
eligible for resale.
In general, under Rule 144 as currently in effect, any person (or persons
whose shares are aggregated) who has beneficially owned restricted securities
for at least one year is entitled to sell, within any three-month period, a
number of shares that does not exceed the greater of (i) 1% of the then
outstanding shares of issuer's common stock (approximately 112,145 shares
immediately after the Offering) and (ii) the average weekly trading volume
during the four calendar weeks preceding such sale, provided that certain
public information about the issuer as required by Rule 144 is then available
and the seller complies with certain other requirements. A person who is not
an affiliate, has not been an affiliate within three months preceding the sale
and has beneficially owned the restricted securities for at least two years is
entitled to sell such shares under Rule 144 without regard to any of the
limitations described above.
Sales of substantial amounts of Common Stock in the public market, or the
perception that such sales could occur, could adversely affect prevailing
market prices of the Common Stock and could impair the Company's future
ability to raise capital through an offering of its equity securities.
63
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement among the
Company, the Selling Shareholders, Bear, Stearns & Co. Inc., Smith Barney
Inc., Wessels, Arnold & Henderson, L.L.C. and Black & Company, Inc. as
Representatives, each of the Underwriters named below has severally agreed to
purchase from the Company and the Selling Shareholders, and the Company and
the Selling Shareholders have agreed to sell to the Underwriters, the
respective number of shares of Common Stock set forth opposite its respective
name.
NUMBER OF
UNDERWRITER SHARES
- ----------- ---------
Bear, Stearns & Co. Inc...............................................
Smith Barney Inc. ....................................................
Wessels, Arnold & Henderson, L.L.C. ..................................
Black & Company, Inc. ................................................
---
Total...............................................................
===
The Underwriters propose to offer the shares of Common Stock directly to the
public at the public offering price set forth on the cover page of this
Prospectus, and at such price less a concession not in excess of $ per
share of Common Stock to certain other dealers who are members of the National
Association of Securities Dealers, Inc. The Underwriters may allow, and such
dealers may reallow concessions not in excess of $ per share to certain
other dealers. After the public offering, the offering price and other selling
terms may be changed by the Underwriters.
The Underwriters have been granted a 30-day allotment option to purchase
from the Company up to 525,000 additional shares of Common Stock at the public
offering price less the underwriting discount. If the Underwriters exercise
such over-allotment option, then each of the Underwriters will have a firm
commitment, subject to certain conditions, to purchase approximately the same
percentage thereof as the number of shares of Common Stock to be purchased by
it as shown in the above table bears to the 3,600,000 shares of Common Stock
offered hereby. The Underwriters may exercise such option only to cover over-
allotments made in connection with the sale of the shares of Common Stock
offered hereby.
The Company, its directors, officers, and certain shareholders have agreed
that, without the prior written consent of Bear, Stearns & Co. Inc., they will
not directly or indirectly offer to sell, sell, transfer, assign or otherwise
dispose of shares of Common Stock or any securities convertible or
exchangeable therefor, for a period of 180 days after the date of this
Prospectus. These restrictions will be applicable to any shares acquired by
any of those persons in this Offering or otherwise during the 180 day lockup
period.
The Underwriting Agreement provides that the Company and the Selling
Shareholders will indemnify the Underwriters and controlling persons, if any,
against certain civil liabilities, including liabilities under the Securities
Act, or will contribute to payments that the Underwriters or any such
controlling persons may be required to make in respect thereof.
In order to facilitate the Offering, certain persons participating in the
Offering may engage in transactions that stabilize, maintain or otherwise
affect the price of the Common Stock during and after the Offering.
64
Specifically, the Underwriters may over-allot or otherwise create a short
position in the Common Stock for their own account by selling more shares of
Common Stock than have been sold to them by the Company and the Selling
Shareholders. The Underwriters may elect to cover any such short position by
purchasing shares of Common Stock in the open market or by exercising the
over-allotment option granted to the Underwriters. In addition, such persons
may stabilize or maintain the price of the Common Stock by bidding for or
purchasing shares of Common Stock in the open market and may impose penalty
bids, under which selling concessions allowed to syndicate members or other
broker-dealers participating in the Offering are reclaimed if shares of Common
Stock previously distributed in the Offering are repurchased in connection
with stabilizing transactions or otherwise. The effect of these transactions
may be to stabilize or maintain the market price of the Common Stock at a
level above that which might otherwise prevail in the open market. The
imposition of a penalty bid may also affect the price of the Common Stock to
the extent that it discourages resales thereof. No representation is made as
to the magnitude or effect of any such stabilization or other transactions.
Such transactions may be effected on the NASDAQ National Market and, if
commenced, may be discontinued at any time.
In connection with this Offering, certain Underwriters and selling group
members or their respective affiliates who are qualified market makers on the
Nasdaq National Market may engage in passive market making transactions in the
Common Stock of the Company on the Nasdaq National Market in accordance with
Rule 103 of Regulation M under the Exchange Act. Passive market makers must
comply with applicable volume and price limitations and must be identified as
such. In general, a passive market maker must display its bid at a price in
excess of the highest independent bid for such security; if all independent
bids are lowered below the passive market maker's bid, however, such bid must
then be lowered when certain purchase limits are exceeded.
Black & Company, Inc. acted as one of the representatives of the
underwriters in the Initial Public Offering and, as partial consideration for
services provided in connection therewith, the Company issued a warrant to
Black & Company, Inc. to purchase up to 82,500 shares of Common Stock at an
exercise price of $6.00 per share. This warrant is exercisable for a period of
four years commencing in February 1998. In addition, Black & Company, Inc.
received a nonaccountable expense allowance in the amount of $37,500.
LEGAL MATTERS
The validity of the issuance of the Common Stock offered hereby will be
passed upon for the Company by McDermott, Will & Emery, Newport Beach,
California. Certain legal matters in connection with this Offering will be
passed upon for the Underwriters by Milbank, Tweed, Hadley & McCloy, Los
Angeles, California. McDermott, Will & Emery has from time to time represented
certain of the Underwriters in connection with unrelated legal matters.
EXPERTS
The financial statements of Gentle Dental Service Corporation as of
September 30, 1997 and December 31, 1996 and December 31, 1995, and for the
nine-month period ended September 30, 1997 and for the years ended December
31, 1996 and 1995 included in this Prospectus and Registration Statement have
been so included in reliance on the report of Price Waterhouse LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
The financial statements of GMS Dental Group, Inc. as of December 31, 1996
and September 30, 1997, and for the periods from October 11, 1996 (inception)
to December 31, 1996 and the nine months ended September 30, 1997 have been
included herein and in the Registration Statement in reliance upon the reports
of KPMG Peat Marwick LLP, independent certified public accountants, appearing
elsewhere herein, and upon the authority of said firms as experts in
accounting and auditing.
The financial statements of Dedicated Dental Systems, Inc. as of September
30, 1997 and December 31, 1995, and for the nine-month period ended September
30, 1997 and for the year ended December 31, 1995
65
included in this Prospectus and Registration Statement have been so included
in reliance on the report of Price Waterhouse LLP, independent accountants,
given on the authority of said firm as experts in auditing and accounting.
The financial statements of Dedicated Dental Systems, Inc. as of and for the
year ended December 31, 1996 appearing in this Prospectus and Registration
Statement and have been audited by Ernst & Young LLP, independent auditors, as
set forth in their report thereon appearing elsewhere herein, and are included
in reliance upon such report given upon the authority of such firm as experts
in accounting and auditing.
The financial statements of California Dental Practice Management Company
and Related Dental Offices as of September 30, 1997 and December 31, 1996 and
1995, and for the nine-month period ended September 30, 1997 and for the years
ended December 31, 1996 and 1995 included in this Prospectus and Registration
Statement have been so included in reliance on the report of Price Waterhouse
LLP, independent accountants, given on the authority of said firm as experts
in auditing and accounting.
The Supplemental Consolidated Financial Statements of Gentle Dental Service
Corporation as of December 31, 1996 and September 30, 1997 and for the years
ended December 31, 1995 and 1996 and the nine months ended September 30, 1997
have been included herein and in the Registration Statement in reliance upon
the report of KPMG Peat Marwick LLP, independent certified public accountants,
appearing elsewhere herein, and upon the authority of said firm as experts in
accounting and auditing.
On November 14, 1997, the Company dismissed Price Waterhouse LLP as its
principal accountants and engaged KPMG Peat Marwick LLP as its new principal
accountants. The decision to change accounting firms was approved by the
Company's Board of Directors. There were no adverse opinions, disclaimers of
opinion or qualifications as to uncertainty, audit scope or accounting
principles in the reports of Price Waterhouse LLP on the Company's financial
statements for the two most recent fiscal years preceding their dismissal.
Through the date of the change in accountants, there were no disagreements
with Price Waterhouse LLP on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of such accountants, would
have caused them to make reference to the subject matter of the disagreements
in connection with their reports.
Prior to the Merger, KPMG Peat Marwick LLP served as the principal
accountants for GMS. Other than in connection with the Merger, before engaging
KPMG Peat Marwick LLP as its new independent accountants, the Company did not
previously consult with them regarding any matters related to the application
of accounting principles or the type of audit opinion that might be rendered
on the Company's financial statements.
ADDITIONAL INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports and other information with the Securities and Exchange
Commission (the "Commission"). The Registration Statement, of which this
Prospectus is a part, as well as such reports and other information can be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and at
the Commission's Regional Offices located at 7 World Trade Center, New York,
New York 10048 and Northwest Atrium, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. Copies of such materials can be obtained from the
Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. The Commission also maintains a
Worldwide Web site (address: http://www.sec.gov) that contains reports, proxy
and information statements and other information regarding registrants that
file electronically with the Commission.
The Company has filed with the Commission a Registration Statement on Form
SB-2, including amendments thereto, under the Securities Act with respect to
the Common Stock offered hereby. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules
66
thereto. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and in
each instance, reference is made to the copy of such contract or other document
filed as an exhibit or incorporated by reference to the Registration Statement
of which this Prospectus forms a part, each such statement being qualified in
all respects by such reference. For further information with respect to the
Company and the Common Stock offered hereby, reference is made to the
Registration Statement and the exhibits and schedules thereto. Copies of the
Registration Statement and the exhibits and schedules thereto may be inspected,
without charge, at the offices of the Commission, or obtained at prescribed
rates from the Public Reference Section of the Commission at 450 Fifth Street,
N.W., Washington, D.C. 20549.
67
INDEX TO FINANCIAL STATEMENTS
PAGE
----
GENTLE DENTAL SERVICE CORPORATION
Report of Price Waterhouse LLP........................................... F-2
Balance Sheet as of December 31, 1995 and 1996, and September 30, 1997... F-3
Statement of Operations for the years ended December 31, 1995 and 1996
and for the nine month periods ended September 30, 1996 and 1997........ F-4
Statement of Changes in Redeemable Common Stock and Nonredeemable
Shareholders' Equity for the years ended December 31, 1995 and 1996, and
for the nine month period ended September 30, 1997...................... F-5
Statement of Cash Flows for the years ended December 31, 1995 and 1996,
and for the nine month periods ended September 30, 1996 and 1997........ F-6
Notes to Financial Statements............................................ F-7
GMS DENTAL GROUP, INC.
Report of KPMG Peat Marwick LLP.......................................... F-24
Consolidated Balance Sheets as of December 31, 1996 and September 30,
1997.................................................................... F-25
Consolidated Statements of Operations for the periods from October 11,
1996 (inception) to December 31, 1996 and the nine months ended
September 30, 1997...................................................... F-26
Consolidated Statements of Stockholders' Deficit for the periods from
October 11, 1996 (inception) to December 31, 1996 and the nine months
ended September 30, 1997................................................ F-27
Consolidated Statements of Cash Flows for the periods from October 11,
1996 (inception) to December 31, 1996 and the nine months ended
September 30, 1997...................................................... F-28
Notes to Consolidated Financial Statements............................... F-29
DEDICATED DENTAL SYSTEMS, INC.
Report of Price Waterhouse LLP........................................... F-43
Report of Ernst & Young LLP.............................................. F-44
Balance Sheet as of December 31, 1995 and 1996, and September 30, 1997... F-45
Statement of Income and Retained Earnings for the years ended December
31, 1995 and 1996 and for the nine months ended September 30, 1997...... F-46
Statement of Cash Flows for the years ended December 31, 1995 and 1996,
and for the nine months ended
September 30, 1997...................................................... F-47
CALIFORNIA DENTAL PRACTICE MANAGEMENT AND RELATED OFFICES
Report of Price Waterhouse LLP........................................... F-55
Balance Sheet as of December 31, 1995 and 1996, and September 30, 1997... F-56
Statement of Operations for the years ended December 31, 1995 and 1996
and for the nine months ended
September 30, 1997...................................................... F-57
Statement of Changes in Capital for the years ended December 31, 1995 and
1996, and for the nine months ended September 30, 1997.................. F-58
Statement of Cash Flows for the years ended December 31, 1995 and 1996,
and for the nine months ended
September 30, 1997...................................................... F-59
GENTLE DENTAL SERVICE CORPORATION SUPPLEMENTAL CONSOLIDATED FINANCIAL
STATEMENTS
Report of KPMG Peat Marwick LLP.......................................... F-66
Supplemental Consolidated Balance Sheets as of December 31, 1996 and
September 30, 1997...................................................... F-67
Supplemental Consolidated Statements of Operations for the years ended
December 31, 1995 and 1996 and for the nine month period ended September
30, 1997................................................................ F-68
Supplemental Consolidated Statement of Shareholders' Equity for the years
ended December 31, 1995 and 1996 and the nine months ended September 30,
1997.................................................................... F-69
Supplemental Consolidated Statements of Cash Flows for the years ended
December 31, 1995 and 1996 and for the nine month period ending
September 30, 1997...................................................... F-71
Notes to Supplemental Consolidated Financial Statements.................. F-74
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Gentle Dental Service
Corporation
In our opinion, the accompanying balance sheet and the related statements of
operations, of redeemable common stock and nonredeemable shareholders' equity
and of cash flows present fairly, in all material respects, the financial
position of Gentle Dental Service Corporation at December 31, 1995 and 1996
and September 30, 1997, and the results of its operations and its cash flows
for the years ended December 31, 1995 and 1996 and for the nine month periods
ended September 30, 1996 and 1997, in conformity with generally accepted
accounting principles. 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 generally accepted auditing standards 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.
As disclosed in Note 10 to the financial statements, the Company has certain
related party transactions.
Price Waterhouse LLP
Portland, Oregon
October 21, 1997 except for the
first paragraph of Note 12 which
is as of November 6, 1997 and
the last paragraph of Note 12
which is as of December 7, 1997
F-2
GENTLE DENTAL SERVICE CORPORATION
BALANCE SHEET
DECEMBER 31, 1995 AND 1996, AND SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------- ------- -------------
ASSETS
Current assets:
Cash and cash equivalents.................... $ 689 $ 229 $ 79
Accounts receivable, net..................... 2,247 3,007 2,742
Receivables from affiliates.................. 597 1,197 1,603
Income taxes receivable...................... 174 169 134
Supplies..................................... 286 363 476
Prepaid expenses and other current assets.... 291 734 520
------- ------- -------
Total current assets....................... 4,284 5,699 5,554
Property and equipment, net.................... 3,654 4,164 4,911
Intangible assets, net......................... 2,058 3,225 5,549
Other assets................................... 428 68 54
------- ------- -------
Total assets............................... $10,424 $13,156 $16,068
======= ======= =======
LIABILITIES, REDEEMABLE COMMON STOCK AND
NONREDEEMABLE SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................. $ 271 $ 1,256 $ 787
Accrued payroll and payroll related
obligations................................. 432 364 785
Other accrued liabilities.................... 673 806 630
Short-term borrowings........................ 1,049 2,097 --
Current portion of long-term debt and capital
lease obligations........................... 473 917 441
------- ------- -------
Total current liabilities.................. 2,898 5,440 2,643
Deferred rent.................................. 83 88 112
Deferred income taxes.......................... 187 3 237
Long-term debt, less current portion........... 2,310 1,822 577
Capital lease obligations, less current
portion....................................... 423 441 314
------- ------- -------
Total liabilities.......................... 5,901 7,794 3,883
------- ------- -------
Commitments and contingencies..................
Redeemable common stock, no par value, 57,551,
190,302 and 183,686 shares issued and
outstanding, respectively..................... 711 2,199 2,123
------- ------- -------
Nonredeemable shareholders' equity:
Preferred stock, 30,000,000 shares
authorized, no shares issued and
outstanding................................. -- -- --
Common stock, no par value, 50,000,000 shares
authorized, 1,366,145, 1,351,579 and
2,971,772 shares issued and outstanding,
respectively................................ 2,795 2,888 9,543
Shareholder note receivable.................. (40) -- --
Additional paid-in capital................... 152 446 488
Retained earnings (deficit).................. 905 (171) 31
------- ------- -------
Total nonredeemable shareholders' equity... 3,812 3,163 10,062
------- ------- -------
Total liabilities, redeemable common stock
and nonredeemable shareholders' equity.... $10,424 $13,156 $16,068
======= ======= =======
The accompanying notes are an integral part of this statement.
F-3
GENTLE DENTAL SERVICE CORPORATION
STATEMENT OF OPERATIONS
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS EXCEPT PER SHARE AND SHARE AMOUNTS)
DECEMBER 31, SEPTEMBER 30,
1995 1996 1996 1997
--------- --------- --------- ---------
Support services revenue from
affiliates....................... $ 9,781 $ 10,712 $ 7,866 $ 10,269
Operating expenses:
Practice nonclinical salaries
and benefits................... 2,418 3,148 2,373 2,712
Dental supplies and lab
expenses....................... 1,633 2,332 1,648 2,219
Practice occupancy expenses..... 911 1,298 976 1,248
Practice selling, general and
administrative expenses........ 1,311 1,336 986 1,040
Corporate selling, general and
administrative expenses........ 2,153 2,372 1,562 1,820
Depreciation and amortization... 482 853 700 699
--------- --------- --------- ---------
Total operating expenses...... 8,908 11,339 8,245 9,738
--------- --------- --------- ---------
Operating income (loss)....... 873 (627) (379) 531
--------- --------- --------- ---------
Nonoperating income (expenses):
Interest expense................ (290) (742) (572) (135)
Other income (expense), net..... (92) 39 23 52
--------- --------- --------- ---------
Nonoperating expense, net....... (382) (703) (550) (83)
--------- --------- --------- ---------
Income (loss) before income
taxes............................ 491 (1,330) (928) 448
Provision (benefit) for income
taxes............................ 234 (345) (228) 219
--------- --------- --------- ---------
Net income (loss)................. 257 (985) (700) 229
Accretion of redeemable common
stock............................ -- (91) (80) (27)
--------- --------- --------- ---------
Net income (loss) attributable to
common stock..................... $ 257 $ (1,076) $ (780) $ 202
========= ========= ========= =========
Primary earnings (loss) per
share............................ $ .19 $ (.71) $ (.53) $ .07
========= ========= ========= =========
Weighted average common and common
equivalent shares outstanding.... 1,379,960 1,524,484 1,484,498 3,287,874
========= ========= ========= =========
Fully diluted earnings (loss) per
share............................ $ .19 $ (.71) $ (.53) $ .06
========= ========= ========= =========
Weighted average fully diluted
shares outstanding............... 1,379,960 1,524,484 1,484,498 2,951,139
========= ========= ========= =========
The accompanying notes are an integral part of this statement.
F-4
GENTLE DENTAL SERVICE CORPORATION
STATEMENT OF CHANGES IN REDEEMABLE COMMON STOCK AND
NONREDEEMABLE SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIOD ENDED SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
NONREDEEMABLE SHAREHOLDERS' EQUITY
REDEEMABLE SHAREHOLDER ADDITIONAL RETAINED
COMMON STOCK COMMON STOCK NOTE PAID-IN EARNINGS
SHARES AMOUNT SHARES AMOUNT RECEIVABLE CAPITAL (DEFICIT)
------- ------ --------- ------ ----------- ---------- ---------
Balance, December 31,
1994................... -- $ -- 1,154,250 $ 533 $-- $-- $ 735
Issuance of stock
pursuant to Stock
Incentive Plan......... -- -- 20,112 201 -- -- --
Common stock issued in
connection with:
Clinic Acquisitions.... 57,551 711 28,456 387 -- -- --
Private placement, net
of offering costs..... -- -- 169,327 1,634 -- -- --
Promissory note from
shareholder........... -- -- 4,000 40 (40) -- --
Stock options granted to
non-employees.......... -- -- -- -- -- 152 --
Repurchase of common
stock.................. -- -- (10,000) -- -- -- --
Distributions to
shareholders........... -- -- -- -- -- -- (87)
Net income.............. -- -- -- -- -- -- 257
------- ------ --------- ------ ---- ---- -----
Balance, December 31,
1995................... 57,551 711 1,366,145 2,795 (40) 152 905
Common stock and
warrants issued in
connection with:
Clinic acquisitions.... 38,994 530 4,934 67 -- -- --
Private placement, net
of offering costs..... 100,000 957 -- -- -- -- --
Exercise of put rights.. (6,243) (90) -- -- -- -- --
Stock warrants issued
related to debt
financing.............. -- -- -- -- -- 9 --
Exercise of stock
options................ -- -- 2,000 2 -- -- --
Stock options granted to
non-employees.......... -- -- -- -- -- 52 --
Stock warrants issued
related to line of
credit guarantees...... -- -- -- -- -- 233 --
Accretion of put
rights................. -- 91 -- -- -- -- (91)
Repurchase of common
stock.................. -- -- (24,000) (1) -- -- --
Common stock granted to
non-employees.......... -- -- 2,500 25 -- -- --
Proceeds from note
receivable............. -- -- -- -- 40 -- --
Net loss................ -- -- -- -- -- -- (985)
------- ------ --------- ------ ---- ---- -----
Balance, December 31,
1996................... 190,302 2,199 1,351,579 2,888 -- 446 (171)
Common stock issued in
connection with:
Clinic acquisitions.... -- -- 109,039 475 -- -- --
Public offering, net of
offering costs........ -- -- 1,500,000 6,125 -- -- --
Employee purchase
plan.................. -- -- 1,054 5 -- -- --
Exercise of put rights.. (6,616) (103) -- -- -- -- --
Exercise of stock
options................ -- -- 10,100 50 -- -- --
Stock options granted to
non-employees.......... -- -- -- -- -- 42 --
Accretion of put
rights................. -- 27 -- -- -- -- (27)
Net income.............. -- -- -- -- -- -- 229
------- ------ --------- ------ ---- ---- -----
Balance, September 30,
1997................... 183,686 $2,123 2,971,772 $9,543 $-- $488 $ 31
======= ====== ========= ====== ==== ==== =====
The accompanying notes are an integral part of this statement.
F-5
GENTLE DENTAL SERVICE CORPORATION
STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30,
1995 1996 1996 1997
------- ------ ------ -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................... $ 257 $ (985) $ (700) $ 229
Adjustments to reconcile change in net cash
provided by (used in) operating activities:
Depreciation and amortization............... 482 853 596 699
Loss on disposal of assets.................. 86 63 61 36
Stock options granted to non-employees...... 152 52 38 42
Stock issued for fees and compensation...... -- 25 25 --
Amortization of warrants.................... -- 242 201 --
Deferred income taxes....................... 71 (156) (56) 212
Deferred rent............................... -- 5 5 24
Changes in certain assets and liabilities,
net of acquisitions:
Accounts receivable, net.................... 349 (976) (255) 574
Receivables from affiliates................. (2,476) (562) (416) (493)
Income taxes receivable..................... (225) 5 (137) 35
Supplies.................................... (165) (49) (50) (113)
Prepaid expenses and other current assets... (11) (37) (337) (221)
Other assets................................ (79) 53 30 13
Accounts payable............................ 88 965 415 (469)
Accrued liabilities......................... 686 371 (54) (131)
------- ------ ------ -------
Net cash provided by (used in) operating
activities................................ (785) (131) (634) 699
------- ------ ------ -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment,
excluding acquisitions..................... (1,251) (748) (532) (1,199)
Proceeds from sale of property and
equipment.................................. -- -- -- 22
Cash paid for acquisitions, including other
direct costs, net of cash acquired......... (1,073) (667) (667) (1,483)
Dental clinic acquisitions prepayments...... (309) -- -- --
------- ------ ------ -------
Net cash used in investing activities...... (2,633) (1,415) (1,199) (2,660)
------- ------ ------ -------
CASH FLOWS FROM FINANCING ACTIVITIES,
EXCLUDING ACQUISITIONS:
Net proceeds from short-term borrowings..... 916 1,048 1,048 (2,097)
Proceeds from issuance of notes payable..... 2,703 466 465 --
Payments of notes payable................... (1,264) (602) (407) (2,444)
Payments of capital lease obligations....... (26) (277) (241) (182)
Proceeds from issuance of common stock...... 1,835 1,000 1,000 7,505
Common stock issuance costs................. -- (500) (43) (918)
Proceeds from note receivable............... -- 40 40 --
Exercise of put rights...................... -- (90) (90) (103)
Distribution to shareholders................ (87) -- -- --
Exercise of stock options................... -- -- -- 50
Other....................................... -- 1 2 --
------- ------ ------ -------
Net cash provided by financing activities.. 4,077 1,086 1,774 1,811
------- ------ ------ -------
Increase (decrease) in cash and cash
equivalents................................. 659 (460) (59) (150)
Cash and cash equivalents, beginning of
period...................................... 30 689 689 229
------- ------ ------ -------
Cash and cash equivalents, end of period..... $ 689 $ 229 $ 630 $ 79
======= ====== ====== =======
The accompanying notes are an integral part of this statement.
F-6
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS EXCEPT PER SHARE AND SHARE AMOUNTS)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Gentle Dental Service Corporation (the "Company"), incorporated on December
14, 1992, is a Washington corporation headquartered in Vancouver, Washington.
The Company, as part of a multi-specialty dental care delivery network,
provides support services to dental professional corporations in Oregon,
Washington, and California. The Company provides management support to four
professional corporations under long-term support services agreements: Gentle
Dental of Oregon, P.C.; Tse, Saiget, Watanabe & McClure, Inc., P.S., a.k.a.,
Gentle Dental of Washington, P.C.; Arena Dental Corporation, a California
Professional Corporation; and Dany Tse, P.C. (together, the "PCs"). Under the
terms of the service agreements, the Company, among other things, bills and
collects patient receivables and provides all administrative support services
to the PCs in exchange for support services fees.
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 total offering expenses. Concurrent with the
receipt of the net proceeds, the Company utilized $4,426 to repay all
outstanding principal under the Company's various bank loan arrangements (see
note 5). No significant gain or loss resulted in connection with the debt
extinguishment.
On February 13, 1997 (the offering date), the Company repriced all employee
stock options outstanding to the Offering price of $5 per share (except for
certain stock options held by the Company's chief executive officer, which
were repriced at 110% of the Offering price). All other terms with respect to
such options were maintained. The Company did not recognize compensation
expense related to the repricing of the employee stock options as the adjusted
exercise price was not below the fair value of the common stock as of the
repricing date.
Revenues
Revenues consist primarily of support services fees charged to the PCs based
on an agreed-upon percentage of PC revenues under support services agreements,
net of provisions for contractual adjustments and doubtful accounts. Such fees
are recognized when earned.
NINE MONTHS
YEARS ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996 1996 1997
------- -------- ------- -------
PC dental revenue, net of provisions for
contractual adjustments and
doubtful accounts........................ $16,029 $ 21,424 $15,731 $19,020
Less amounts retained by the PCs.......... (6,248) (10,712) (7,866) (9,103)
Adjustments to allowance for doubtful
accounts................................. -- -- -- 230
Retail sales.............................. -- -- -- 122
------- -------- ------- -------
Support services revenue from affiliates.. $ 9,781 $ 10,712 $ 7,865 $10,269
======= ======== ======= =======
F-7
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Statement of cash flows
Cash equivalents consist of liquid investments with maturities at the date
of purchase of 90 days or less.
Supplemental disclosure of cash flow information:
NINE MONTHS
YEARS ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996 1996 1997
------ ------ ------ ------
Interest paid................................... $ 290 $ 489 $ 180 $ 129
Income taxes paid (received).................... 350 (159) -- (28)
Supplemental schedule of noncash investing and
financing activities:
Capital lease obligations related to the
leasing of fixed assets...................... 534 275 275 --
Issuance of common stock in exchange for
shareholder note............................. 40 -- -- --
Accretion of put rights....................... -- 91 80 27
Acquisition of tangible assets from related
parties:
Liabilities assumed or issued................. 2,093 -- -- --
Tangible assets acquired...................... 2,093 -- -- --
Acquisition of clinics from unrelated parties:
Intangible assets............................. 2,012 1,335 1,335 2,480
Liabilities assumed or issued................. 453 148 148 893
Common stock issued in connection with
acquisitions................................. 1,098 597 597 475
Dental clinic acquisition prepayments......... -- 309 309 --
Tangible assets acquired, excluding cash...... 611 386 386 371
Accounts receivable and allowances for contractual adjustments and doubtful
accounts
Accounts receivable principally represent receivables from patients or
dental group insurance carriers for dental services provided by the related
PCs. The Company has recorded an allowance for contractual adjustments and
doubtful accounts of $782, $187, $963, and $701 at December 31, 1995 and 1996,
and September 30, 1996 and 1997, respectively. Contractual adjustments
represent an estimate of the difference between the amount billed by the
Company and the amount which the patient, third party payor or other is
contractually obligated to pay the Company. The allowance for doubtful
accounts and contractual adjustments are estimated based on past collection
performance.
Supplies
Supplies consist primarily of operatory dental supplies stored at the
clinics. Supplies are stated at the lower of cost (first-in, first-out basis)
or market.
Prepaid expenses and other current assets
Prepaid and other current assets primarily represent miscellaneous
receivables, prepaid rent, and deferred acquisition costs. Such deferred
acquisition costs were $64 and $178 as of December 31, 1996 and September 30,
1997, respectively. Such costs were not significant at December 31, 1995.
Also, at December 31, 1996, included within prepaid expenses was $457 in
deferred offering costs associated with the initial Public Offering completed
in February 1997.
F-8
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Property and equipment
Property and equipment are stated at cost. Expenditures for maintenance and
repairs are charged to expense as incurred and expenditures for additions and
betterments are capitalized. Depreciation of property and equipment is
calculated using the straight-line method over estimated useful lives which
range from 3 to 15 years.
Intangible assets
Intangible assets result primarily from the excess of cost over the fair
value of net tangible assets purchased in acquisitions. Such intangibles
relate primarily to noncompetition covenants and support services agreements.
Intangibles relating to support services agreements consist of the costs of
purchasing the rights to provide management support services to dental
practices over the initial noncancelable 40-year terms of the related support
services agreements. Under these agreements, the dental groups have agreed to
provide dental services on an exclusive basis only through facilities provided
by the Company. Pursuant to the terms of the agreements, the Company is the
exclusive administrator of all non-dental aspects of the acquired dental
practices, providing facilities, equipment, support staffing, management
support and other ancillary services. The support services agreements are
noncancelable except for performance defaults.
Intangible assets are amortized on the straight-line method over their
estimated useful lives, 5 years for organizational costs, 25 years for support
services agreements and other acquired intangibles, and 40 years for
trademarks (see note 4).
The Company reviews its asset balances for impairment at the end of each
quarter or more frequently when events or changes in circumstances indicate
that the carrying amount of intangible assets may not be recoverable. To
perform that review, the Company estimates the sum of expected future
undiscounted net cash flows from intangible assets. If the estimated net cash
flows are less than the carrying amount of the intangible asset, the Company
recognizes an impairment loss in an amount necessary to write-down the
intangible asset to a fair value as determined from expected future discounted
cash flows. No write-down for impairment loss was recorded for the years ended
December 31, 1995 and 1996, or for the nine months ended September 30, 1996
and 1997.
Income taxes
Prior to 1995, the Company elected to be treated as a Subchapter S
corporation under provisions of the Internal Revenue Code. As such, the income
or losses of the Company were attributable to its shareholders in their
individual tax returns. Effective January 1, 1995, the Company terminated its
Subchapter S corporation status and elected C corporation status under the
Internal Revenue Code for tax purposes, and for financial reporting purposes
adopted Statement of Accounting Standards No. 109, "Accounting for Income
Taxes." (see note 7).
Accounting for impairment of long-lived assets
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The
statement provides that impairments of long-lived assets (including property
and equipment and intangible assets) be measured and valued based on the
estimated future cash flows of the Company.
The Company adopted the statement in 1996; however, the adoption did not
have a significant impact on the Company's financial position or results of
operations.
F-9
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Fair value of financial assets and liabilities
The Company estimates the fair value of its monetary assets and liabilities
based upon the existing interest rates related to such assets and liabilities
compared to current market rates of interest for instruments with a similar
nature and degree of risk. The Company estimates that the carrying value of
all of its monetary assets and liabilities approximate fair value as of
December 31, 1995 and 1996, and September 30, 1997.
Accounting estimates
The preparation of the Company's 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 revenues and expenses during the
reported periods. Actual results may differ from these estimates.
Reclassifications
Certain reclassifications have been made to the 1995 and 1996 financial
statements to conform with the 1997 financial statement presentations. Such
reclassifications had no effect on the Company's previously reported results
of operations or financial position.
Primary and fully diluted earnings per share
Primary and fully diluted earnings per share are based on the weighted
average number of common and common equivalent shares outstanding during the
periods presented. The computation of fully diluted earnings per share assumes
the exercise of contingent stock warrants and options. The computation of
fully diluted earnings per share was anti-dilutive for the years ended
December 31, 1995 and 1996, and for the nine months ended September 30, 1996;
therefore, such fully diluted earnings per share amounts equal the primary
earnings per share amounts.
New accounting pronouncements
In February 1997, the Financial Accounting Standards Board issued SFAS 128
"Earnings Per Share." In accordance with this pronouncement, the Company will
adopt the new standard for periods ending after December 15, 1997. Management
does not expect the adoption of this pronouncement to have a significant
effect on reported earnings per share information.
The Emerging Issues Task Force of the Financial Accounting Standards Board
is currently evaluating certain matters relating to the physician practice
management industry, which the Company expects will include a review of the
consolidation of professional corporation revenues and the accounting for
business combinations. The Company is unable to predict the impact, if any,
that this review may have on the Company's acquisition strategy, allocation of
purchase price related to acquisitions, and amortization life assigned to
acquired intangible assets.
F-10
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS EXCEPT PER SHARE AND SHARE AMOUNTS)
(2) ACQUISITIONS
On January 2, 1995, the Company purchased from Gentle Dental of Oregon, P.C.
and Tse, Saiget, Watanabe & McClure, Inc., P.S., a.k.a., Gentle Dental of
Washington, P.C. the net accounts receivable of those PCs totaling $2,093 in
exchange for interest-only promissory notes payable on December 31, 1995. The
principal portion of the promissory notes issued to the PCs by the Company was
satisfied via reductions to the Company's receivables from those PCs.
During 1995, the Company acquired substantially all of the assets of seven
dental practices in Washington and Oregon including cash, accounts receivable,
supplies and fixed assets, net of the assumption of certain liabilities. The
total purchase price of $2,346 for the seven acquired clinics includes $982
paid in cash, $1,098 in redeemable and nonredeemable common stock, and
$175,000 in promissory notes. In addition, the Company paid $91 in cash for
closing costs which have been included in the total purchase price. The
Company issued a total of 86,007 shares of stock in conjunction with these
acquisitions. Of these shares, 20,000 were valued by management at $10.00 per
share for one acquisition in January 1995 and 66,007 were valued at $13.60 per
share for the remaining acquisitions. These common stock values reflect the
estimated fair market value at the dates of the acquisitions. Certain shares
of the common stock issued are subject to "put rights" from the shareholders
(see note 8).
In 1996, the Company acquired substantially all of the assets of four
clinics, including cash, accounts receivable, supplies and fixed assets, net
of the assumption of certain liabilities. The total purchase price of $1,601
for the four acquired clinics included $944 in cash, $597 in redeemable and
nonredeemable common stock and a promissory note for $28. In addition, the
Company paid for closing costs of $32 which have been included in the total
purchase price. The Company issued a total of 43,928 shares relating to those
acquisitions. Such shares were valued at $13.60 per share. Common stock values
reflect the estimated fair value on the date of acquisition.
In 1997, the Company acquired substantially all of the assets of three
clinics, including cash, accounts receivable, supplies and fixed assets, net
of the assumption of certain liabilities. The total purchase price of $2,738
for the three acquired clinics included $1,483 in cash, $475 in common stock,
$532 in promissory notes and the assumption of long-term liabilities for $248.
In addition, the Company paid for closing costs of $33 which have been
included in the total purchase price. The Company issued a total of 109,039
shares of stock in conjunction with these acquisitions. Such shares were
valued at $4.36 per share. The common stock values reflect the estimated fair
value on the dates of the acquisitions. Additionally, one acquisition during
1997 is subject to future possible earn-out payments in which the Company will
issue a maximum of 160,689 shares of common stock if certain operating results
are achieved as outlined in the purchase agreement.
The results of operations for these acquisitions have been included in the
financial statements of the Company since the dates of acquisitions. The
following pro forma information has been prepared assuming that the 1996 and
1997 acquisitions had occurred at the beginning of each period presented. The
pro forma information includes adjustments to give effect to amortization of
goodwill, interest expense on acquisition debt and certain other adjustments,
together with related income tax effects. The pro forma financial information
is not necessarily indicative of the results of operations as they would have
been had the transaction been effected on the assumed dates, nor are they
necessarily indicative of future operating results.
F-11
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
(2) ACQUISITIONS (CONTINUED)
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED) (UNAUDITED)
Support services revenue.......................... $13,182 $11,172
======= =======
Net income (loss)................................. $ (831) $ 289
======= =======
Fully Diluted earnings (loss) per share........... $ (.51) $ .09
======= =======
(3) PROPERTY AND EQUIPMENT
DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------ ------- -------------
Dental equipment............................ $2,319 $ 2,542 $ 2,805
Computer equipment.......................... 482 831 1,251
Office equipment, furniture and fixtures.... 503 540 640
Vehicles.................................... 20 20 32
Leasehold improvements...................... 762 1,313 1,785
------ ------- -------
4,086 5,246 6,513
Less accumulated depreciation and
amortization............................... (432) (1,082) (1,602)
------ ------- -------
$3,654 $ 4,164 $ 4,911
====== ======= =======
At December 31, 1995 and 1996, and September 30, 1997, property and equipment
include $553, $762 and $916, respectively, of equipment held under capital
leases with related accumulated amortization aggregating $56, $194, and $276,
respectively.
(4) INTANGIBLE ASSETS
Intangible assets consist of the following:
DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------ ------ -------------
Support services agreements.................... $2,013 $3,325 $5,805
Trademarks..................................... 50 50 50
Organizational costs........................... 70 70 70
------ ------ ------
2,133 3,445 5,925
Less accumulated amortization.................. (75) (220) (376)
------ ------ ------
$2,058 $3,225 $5,549
====== ====== ======
F-12
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS)
(5) BORROWINGS
Short-term borrowings
At December 31, 1996 the Company had a total of $2,097 outstanding under two
bank operating lines of credit with a bank secured by substantially all assets
of the Company. In February 1997, the entire outstanding amount was fully
repaid from the net proceeds from the Offering (see Note 1).
As of September 30, 1997 the Company has a line of credit secured by
substantially all of the Company's accounts receivable. Borrowings under the
line bear interest at prime plus 1% (9.5% at September 30, 1997). The Company
may borrow from the credit line a maximum of $1,850 and limited to a borrowing
base calculated at 75% of the Company's eligible accounts receivable. There
are no amounts outstanding under the credit line at September 30, 1997. The
Company must pay a commitment fee of 1/2% per annum of the average daily
portion of the $1,850 available. The credit line agreement includes provisions
for maintaining certain financial covenants including debt service coverage
ratio, current ratio, debt to tangible net worth ratio, minimum tangible net
worth, and restrictions on payment of cash dividends. The Company is in
compliance with these covenants at September 30, 1997.
DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------ ------ -------------
Long-term debt
Note payable to bank due in monthly instalments of
principal
and interest at prime plus 1.25%, paid during
1997............................................. $ 938 $ 667 $ --
Notes payable to bank with interest-only payments
for the
first 12 months at prime plus 1.5%, paid during
1997............................................. 1,684 1,699 --
Unsecured note payable, due in monthly instalments
of principal and
interest at 10.47% commencing on June 30, 1996,
maturing November 2003........................... -- 140 130
Note payable due in monthly instalments of
principal and interest at 9.99%, collateralized
by a vehicle, maturing June 2000................. 15 14 12
Unsecured note payable, due in monthly instalments
of principal and interest at 9.5% commencing on
March 31, 1997, maturing October 2001............ -- -- 116
Unsecured note payable, due in monthly instalments
of principal and interest at 10.5% commencing on
March 31, 1997, maturing December 2002........... -- -- 163
Unsecured note payable, due in quarterly
instalments of principal and
interest at 8.25% commencing on March 19, 1997,
maturing March 2002.............................. -- -- 117
Unsecured note payable, due in quarterly
instalments of principal and
interest at 8.5% commencing on July 31, 1997,
maturing June 2002............................... -- -- 100
Various unsecured notes payable, due in monthly
instalments of principal and interest varying
from 9.38% to 10.75%, maturing through March
1999............................................. 62 70 96
------ ------ -----
2,699 2,590 734
Less current portion.............................. 389 768 157
------ ------ -----
$2,310 $1,822 $ 577
====== ====== =====
F-13
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
(5) BORROWINGS (CONTINUED)
Scheduled maturities of long-term debt at September 30, 1997 are as follows:
1998................................................................. $157
1999................................................................. 175
2000................................................................. 131
2001................................................................. 137
2002................................................................. 97
Thereafter........................................................... 37
----
$734
====
Capital lease obligations
The Company has entered into certain capital lease obligations related to
the acquisition of dental and computer equipment. The leases, which are
secured by the equipment, bear interest at rates ranging from 7%- 15% and
require monthly payments of principal and interest.
Future minimum payments under the Company's capital lease obligations at
September 30, 1997 are summarized as follows:
1998................................................................ $346
1999................................................................ 178
2000................................................................ 160
2001................................................................ 18
----
702
Less portion representing interest.................................. 104
----
598
Less current portion................................................ 284
----
$314
====
(6) EMPLOYEE BENEFIT PLANS
The Company participates in a 401(k) profit sharing plan and trust covering
substantially all employees. Profit sharing contributions are made at the
discretion of management. No employer profit sharing contributions have been
made. The Company also provides a non-discretionary matching 401(k)
contribution equal to 3% of participants' eligible compensation. The Company's
401(k) contributions were $49, $55 and $45, for the years ended December 31,
1995 and 1996, and for the nine months ended September 30, 1996, respectively.
Effective January 1, 1997, the plan was amended to eliminate the
nondiscretionary contribution provisions.
Effective May 1, 1997, the Company also adopted the Employee Stock Purchase
Plan covering 200,000 shares of the Company's common stock. All full-time
employees of the Company can purchase common stock under the plan through
payroll withholding at a 10% discount of the market price of the stock on the
last day of each calendar quarter.
F-14
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS)
(7) INCOME TAXES
The provision (benefit) for income taxes is as follows:
NINE MONTHS
YEARS ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996 1996 1997
----- ------ ------- ------
Current:
Federal..................................... $ 147 $ (175) $ (173) $ 7
State....................................... 16 (14) 0
----- ------ ------- ------
163 (189) (173) 7
----- ------ ------- ------
Deferred:
Federal..................................... 65 (143) (35) 197
State....................................... 6 (13) (20) 15
----- ------ ------- ------
71 (156) (55) 212
----- ------ ------- ------
Total provision (benefit)..................... $ 234 $ (345) $ (228) $ 219
===== ====== ======= ======
The provision for income taxes for the year ended December 31, 1995 includes
the recognition of a cumulative net deferred tax liability of $25 associated
with the termination of the Company's Subchapter S corporation status on
January 1, 1995.
Deferred tax assets (liabilities) are comprised of the following components:
DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------ ------ -------------
Property and equipment.......................... $ (141) $ (379) $(380)
Intangibles..................................... (6) (12) (8)
Cash versus accrual reporting for tax purposes--
long-term...................................... (40) (38) (38)
Net operating loss carryforward................. -- 417 180
Other........................................... -- 9 9
------ ------ -----
Net long-term deferred tax liability............ $ (187) $ (3) $(237)
====== ====== =====
Cash versus accrual reporting for tax purposes--
current........................................ $ (20) $ (30) $ (28)
Accrued payroll related costs................... 75 57 48
Accrued bonus................................... -- -- 29
------ ------ -----
Net current deferred tax assets, included in
prepaid and other current assets............... $ 55 $ 27 $ 49
====== ====== =====
F-15
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
(7) INCOME TAXES (CONTINUED)
The effective tax rate differed from the U.S. statutory federal tax rate due
to the following:
NINE MONTHS
YEARS ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
------------- ----------------
1995 1996 1996 1997
------ ------ ------- ------
Statutory federal rate....................... 34.0% (34.0)% (34.0)% 34.0%
State taxes, net of federal benefit.......... 2.3 (3.2) (3.5) 2.2
Non-deductible intangible and other permanent
differences................................. 6.3 11.3 12.9 10.8
Other, including cumulative effect from the
termination of Subchapter S corporation
status in 1995.............................. 5.1 -- -- 1.9
----- ------ ------- ------
Effective tax rate........................... 47.7% (25.9)% (24.6)% 48.9%
===== ====== ======= ======
(8) REDEEMABLE COMMON STOCK AND NONREDEEMABLE SHAREHOLDERS' EQUITY
Redeemable common stock
In connection with certain acquisitions, the Company granted "put rights" to
certain shareholders that may require the Company to redeem up to 96,545
shares of its common stock at a redemption price ranging from $13.38 to $19.62
per share. If all shareholders with such "put rights" exercise their options,
the Company would be required to repurchase the above shares of common stock
for $1,409. The redemption periods began April 1, 1996 and continue through
January 4, 2003. If the shareholder does not place a redemption request during
the redemption period, the "put right" will expire on the stated expiration
date. "Put rights" for all but 20,000 shares terminate in the event of the
Company successfully completing a public offering at a price of at least
$20.00 per share. The Company redeemed 6,243 shares of redeemable common stock
for $90 during 1996 and redeemed 6,616 shares for $103 during 1997.
The shares of common stock subject to the "put rights" are reported on the
balance sheet as redeemable common stock. Such shares have been recorded at
their fair value as of the dates of acquisition, inclusive of accretion during
the year ended December 31, 1996 and nine months ended September 30, 1997. The
Company records accretion on a ratable basis over the redemption period of the
respective stock. Such accretion for the year ended December 31, 1996, and the
nine month periods ended September 30, 1996 and 1997 was $91, $80 and $27,
respectively. Accretion in prior years was insignificant.
Such common stock at September 30, 1997 is redeemable as follows:
NUMBER OF REDEMPTION REDEMPTION
SHARES AMOUNT PRICE RANGE
--------- ---------- ------------
1998....................................... 2,974 $ 50 $16.82
1999....................................... 2,754 50 13.38-18.16
2000....................................... 40,849 576 13.60-19.62
2001....................................... 29,681 438 13.60-18.80
2002....................................... 3,714 51 13.60
Thereafter................................. 3,714 51 13.60
------ ------
83,686 $1,216
====== ======
F-16
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997 (IN THOUSANDS EXCEPT
SHARE AND PER SHARE AMOUNTS)
(8) REDEEMABLE COMMON STOCK AND NONREDEEMABLE SHAREHOLDERS' EQUITY (CONTINUED)
Private placement of redeemable common stock and warrants
In May 1996, the Company completed a private placement offering ("the
offering") of 100,000 shares of the Company's common stock which include
warrants to purchase 100,000 additional shares of the Company's common stock
at an exercise price of $7.50 per share. Total proceeds from the offering (net
of offering costs of $43) were $957. The net proceeds allocated to common
stock aggregated $732. The stock warrants were recorded at their estimated
fair value of $225 and are entitled to certain "piggyback" registration
rights. The stock warrants expire on December 14, 2001; no stock warrants have
been exercised to date.
In connection with the private placement, the shareholder received certain
"put rights" which are exercisable after June 21, 2001 but no later than June
21, 2003 if the Company has not completed a public offering of its common
stock by June 21, 2001 at a price of at least $22.00 per share and with net
proceeds to the Company of at least $10,000. The per share price applicable to
the "put rights" is 20 times the Company's average adjusted net income per
share for the two most recent fiscal years preceding the exercise of the
rights. As of September 30, 1997, the Company has not recorded any accretion
related to the above "put rights."
Preferred stock
Preferred stock may be issued by the Board of Directors with preferences to
be determined at the time of issuance. Through September 30, 1997, none of the
30,000,000 authorized shares of the Company's preferred stock has been issued
or is outstanding.
Stock warrants issued in conjunction with debt issuance
In May 1996 the Company issued warrants to purchase 4,333 shares of the
Company's common stock at $7.50 per share to a lender in connection with a
line of credit. The stock warrants were valued at $9 and have been recorded as
debt issuance costs and additional paid-in-capital. The estimated fair value
of the stock warrants was amortized over the six-month term of the line of
credit. Such amortization expense has been included in interest expense in the
statement of operations. The stock warrants expire on May 31, 2001 and carry
certain "piggyback" registration rights. The stock warrants have not been
exercised to date.
In addition, in May 1996, the Company issued to certain directors, officers,
and shareholders of the Company warrants to purchase 115,000 shares of the
Company's common stock at $7.50 per share in consideration for guaranteeing a
total of $1,000 on a line-of-credit which is no longer available and has been
fully repaid. The estimated fair value of the stock warrants of $233 was
amortized over the six-month term of the line of credit. Such amortization
expense has been included in interest expense in the statement of operations.
All stock warrants expire in May 2001 and no such stock warrants have been
exercised to date.
F-17
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
(9) STOCK INCENTIVE PLAN
The Board of Directors adopted a Stock Incentive Plan ("the Plan"), as
amended during 1996. The Plan provides for issuance of up to 1,000,000 shares
of common stock in connection with various stock grants, awards and sales
granted under such plan to employees and nonemployees (primarily key PC
personnel). The Plan authorizes the grant of incentive stock options, non-
statutory stock options, stock appreciation rights or bonus rights; award of
stock bonuses; and/or sale of restricted stock. The exercise price for
incentive stock options may not be less than the fair market value of the
underlying shares on the date of grant. The Plan is administered by the
Company's Board of Directors. The Board has the authority to determine the
persons to whom awards will be made, the amounts, and other terms and
conditions of the awards. Shares issued under the Plan are generally subject
to a five-year vesting schedule from the date of grant and expire ten years
from the original grant date.
Stock options issued to nonemployees, including dental professionals
employed by the affiliated PC's, have been recorded at their estimated fair
market value and are being expensed over their respective vesting lives of up
to five years. Total compensation expense recorded for the years ended
December 31, 1995 and 1996, and the nine months ended September 30, 1996 and
1997 was $152, $52, $38 and $42, respectively.
Statement of Financial Accounting Standards No. 123 ("SFAS 123")
During 1995, the Financial Accounting Standards Board issued SFAS 123,
"Accounting for Stock Based Compensation," which defines a fair value based
method of accounting for an employee stock option or similar equity instrument
and encourages all entities to adopt that method of accounting for all of
their employee stock compensation plans. However, it also allows an entity to
continue to measure compensation cost related to stock options issued to
employees under these plans using the method of accounting prescribed by the
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock
Issued to Employees." Entities electing to remain with the accounting in APB
25 must make pro forma disclosures of net income and earnings per share, as if
the fair value based method of accounting defined in this Statement had been
applied.
The Company has elected to account for its stock-based compensation plans
under APB 25; however, the Company has computed for pro forma disclosure
purposes the value of all options granted during the years ended December 31,
1995 and 1996 and the nine months ended September 30, 1996 and 1997. The 1995
and 1996 options were valued using the minimum value pricing model as
prescribed by SFAS 123 for nonpublic companies. The options issued subsequent
to the Company's 1997 initial public offering have been valued using the
Black-Scholes pricing model as prescribed by SFAS 123. The following weighted
average assumptions have been used for grants of stock options:
NINE MONTHS
YEARS ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
---------------- ----------------
1995 1996 1996 1997
------- ------- ------- -------
Risk free interest rate.................. 6.5% 6.5% 6.5% 6.4%
Expected dividend yield.................. -- % -- % -- % -- %
Expected lives........................... 5 years 5 years 5 years 5 years
Expected volatility...................... N/A N/A N/A 60%
F-18
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997 (IN THOUSANDS EXCEPT
SHARE AND PER SHARE AMOUNTS)
(9) STOCK INCENTIVE PLAN (CONTINUED)
Options were assumed to be exercised over the five-year expected life for
the purpose of this valuation. Adjustments are made for options forfeited
prior to vesting. The total value of options granted was calculated in the
following amounts, which would be amortized on the straight-line basis over
the vesting period of the options:
Year ended December 31, 1995...................................... $ 334
Year ended December 31, 1996...................................... 301
Nine months ended September 30, 1996.............................. 301
Nine months ended September 30, 1997.............................. 1,219
If the Company had accounted for stock options issued to employees in
accordance with SFAS 123, the Company's net income attributable to common
stock and pro forma net income per share would have been reported as follows:
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCK
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996 1996 1997
---- ------- --------- --------
As reported................................... $257 $(1,076) $ (780) $ 229
Pro Forma..................................... 222 (1,156) (851) 18
PRO FORMA NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996 1996 1997
----- ------- --------- --------
As reported--primary......................... $0.19 $(0.71) $ (0.51) $ 0.07
Pro Forma--primary........................... 0.16 (0.76) (0.55) 0.01
As reported--fully diluted................... 0.19 (0.71) (0.51) 0.06
Pro Forma--fully diluted..................... 0.16 (0.76) (0.55) 0.01
The effects of applying SFAS 123 for providing pro forma disclosures for
1995 and 1996 and for the nine months ended September 30, 1996 and 1997 are
not likely to be representative of the effects on reported net income (loss)
and net income (loss) per common equivalent share for future years, because
options vest over several years and additional awards generally are made each
year.
F-19
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
(9) STOCK INCENTIVE PLAN (CONTINUED)
The following summary presents the options granted and outstanding as of
September 30, 1997:
WEIGHTED
AVERAGE
NUMBER OF SHARES EXERCISE
EMPLOYEE NONEMPLOYEE TOTAL PRICE
-------- ----------- -------- --------
Outstanding, December 31, 1994..... 110,000 -- 110,000 $4.52
Granted.......................... 136,000 72,750 208,750 5.91
Canceled......................... (31,000) (5,000) (36,000) 6.56
-------- ------- -------- -----
Outstanding, December 31, 1995..... 215,000 67,750 282,750 5.47
Granted.......................... 134,250 12,000 146,250 5.16
Exercised........................ (2,000) -- (2,000) .80
Canceled......................... (96,549) (5,833) (102,382) 8.19
-------- ------- -------- -----
Outstanding, December 31, 1996..... 250,701 73,917 324,618 5.52
Granted.......................... 382,000 -- 382,000 5.46
Exercised........................ (10,100) -- (10,100) 5.00
Canceled......................... (110,101) (13,667) (123,768) 5.17
-------- ------- -------- -----
Outstanding, September 30, 1997.... 512,500 60,250 572,750 $5.62
======== ======= ======== =====
The following table sets forth the exercise prices, the number of options
outstanding and exercisable, and the remaining contractual lives of the
Company's stock options at September 30, 1997:
NUMBER OF OPTIONS WEIGHTED AVERAGE
EXERCISE ------------------------------------- CONTRACTUAL LIFE
PRICE OUTSTANDING EXERCISABLE REMAINING
-------- ----------- ----------- ----------------
$ .20 15,250 15,250 7.82 years
4.13 45,500 -- 7.01
5.00 318,000 57,900 8.63
5.50 81,000 81,000 6.08
8.02 68,000 1,000 9.90
10.00 45,000 27,672 7.61
F-20
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS)
(10) TRANSACTIONS WITH AFFILIATES
Major customers
The Company currently derives substantially all of its revenue from the PCs,
with which it has support services agreements. The Company and three of the
PCs are related through common ownership of certain shareholders.
Support services agreements
The Company provides management support services to the PCs under support
services agreements with forty-year terms. The Company is currently earning
revenues under these agreements based on specified percentages of net dental
practice patient revenues as defined in the agreements. Such percentages are
negotiated with the PCs and have been developed and revised as necessary based
on the Company's services and operating needs. The support services agreements
were amended such that support services revenue is based upon the following
percentage of net PC revenue:
DANY TSE,
P.C. WASHINGTON OREGON CALIFORNIA
--------- ---------- ------ ----------
1997.................................. 53% 51% 53% 53%
1998.................................. 54% 52% 54% 54%
1999.................................. 55% 53% 55% 55%
2000.................................. 56% 54% 55% 55%
2001, and thereafter.................. 56% 55% 55% 55%
Office lease
The Company leases office space for $4 per month from Gentle Dental of
Washington, PC (see note 1) on a month-to-month basis. Lease expense
aggregated approximately $50 for each of the years ended December 31, 1995 and
1996, and $37 for each of the nine months ended September 30, 1996 and 1997.
Receivables from affiliates
Affiliate receivables consist primarily of amounts owed to the Company by
the PCs to reimburse the Company for payment of the PCs' payroll and other
direct costs, net of amounts due to the PCs related to the acquisitions and
the PCs' share of revenues. The Company also transacts various other business
with the PCs, including short-term operating advances.
F-21
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
(11) COMMITMENTS AND CONTINGENT LIABILITIES
Operating leases
The Company has entered into operating lease agreements for dental service
locations, office space and parking. Rental expense, including month-to-month
rentals, for the years ended December 31, 1995, 1996 and the nine months ended
September 30, 1996 and 1997 was $837, $1,256, $864 and $1,147, respectively.
Management expects to renew or replace leases as they expire. Following is a
summary of scheduled future minimum lease payments, including assumed leases:
1998.............................................................. $ 1,569
1999.............................................................. 1,522
2000.............................................................. 1,301
2001.............................................................. 1,029
2002.............................................................. 910
Thereafter........................................................ 4,316
-------
$10,647
=======
Pending acquisitions
On September 21, 1997, the Company entered into a merger agreement pursuant
to which it has agreed to acquire all of the stock of Dedicated Dental
Systems, Inc. ("DDS"), which is based in Bakersfield, California and owns and
operates 11 staff-model dental offices pursuant to a Knox-Keene license from
the state of California. At the same time, the Company entered into three
asset purchase agreements to acquire the non-professional assets of four
related dental offices in Southern California. The aggregate purchase price
under these agreements is $22,750, consisting of $9,771 in cash, $12,429 in
shares of Company common stock (1,519,103 shares valued at $8.1818 per share,
which was the average closing price of Company common stock for the 30 trading
days prior to the execution of the agreements), and $550 in estimated future
earnout payments under two of the asset purchase agreements, all subject to
certain adjustments provided for in the agreements. The acquisition is subject
to California Knox-Keene regulatory approval, among other contingencies, and
is expected to close in the first quarter of 1998.
On September 29, 1997, the Company entered into an agreement for the
acquisition of the nonprofessional assets of a dental practice located in
Sacramento, California. The purchase price is $810, consisting of $320 in cash
and $490 in shares of Company common stock (43,077 shares valued at $11.375
per share, which was the average closing price of Company common stock for the
10 trading days prior to the execution of the agreement). The acquisition is
expected to close in January 1998.
F-22
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
(IN THOUSANDS)
(12) SUBSEQUENT EVENT
On November 4, 1997, the Company completed its merger with GMS Dental Group,
Inc. ("GMS"), a privately held corporation, with the Company as the surviving
corporation. The merger is being accounted for as a pooling of interests.
Under the terms of the merger agreement, the Company issued 4,548,161 shares
of its Common stock representing approximately 59% of the outstanding stock of
the merged company, to the former shareholders of GMS. A total of 297,074 of
the shares issued in the merger are subject to repurchase by the Company at an
average price of $0.32 per share if certain performance targets for 1997 are
not achieved. These targets are not expected to be met and the shares are
anticipated to be purchased during 1998.
Upon completion of the DDS acquisition discussed in note 11, and after the
foregoing repurchase of the shares discussed above, the shares issued to GMS
shareholders will represent approximately 47.5% of the total outstanding
common stock. Prior to the merger, GMS was a dental practice management
company based in Yorba Linda, California providing management support services
to 22 dental offices with approximately 100 dentists in California, Idaho and
Hawaii.
The consolidated financial statements for the periods prior to the
combination will be restated to include the accounts and results of operations
of GMS when financial statements are prepared for the period including the
date of the merger.
The results of operations previously reported by the separate enterprises
and the combined amount are summarized below:
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996 1996 1997
------ ------- -------- ---------
Net Sales:
GMS--patient service................ $ -- $ 3,701 $ -- $ 19,348
The GDS--management fee............. 9,781 10,712 7,866 10,269
------ ------- -------- ---------
Combined sales........................ 9,781 $14,413 $ 7,866 $ 29,617
====== ======= ======== =========
Net income (loss) attributed to common
stock:
GMS................................. $ -- $ (957) $ -- $ (1,814)
The GDS............................. 257 (1,076) (780) 202
------ ------- -------- ---------
Combined net income (loss)............ $ 257 $(2,033) $ (780) $ (1,612)
====== ======= ======== =========
Adjustments to conform GMS's method of accounting for amortization of
intangible assets with that of the Company will reduce net income for the
years ended December 31, 1995 and 1996 and the nine months ended September 30,
1997 by approximately $0, $0, and $148.
There were no significant transactions between GMS and GDS prior to the
combination.
In December 1997, the Company and the Oregon and Washington professional
corporations signed letters of intent to restructure the management agreements
with those professional corporations. The Company will pay consideration of
$1.8 million, to be offset by its receivable from the professional
corporations for $1.8 million, cash of $575,000 to be paid over a term of 18
months, or options to acquire 230,000 shares of common stock at an exercise
price of $8.38 per share, and 1.5% of the increase in revenue in 1998 and
1999, in exchange for revised management agreements which provide the company
with a controlling financial interest in the operation of the practices.
F-23
INDEPENDENT AUDITORS' REPORT
The Board of Directors
GMS Dental Group, Inc.:
We have audited the accompanying consolidated balance sheets of GMS Dental
Group, Inc. and subsidiaries as of December 31, 1996 and September 30, 1997
and the related consolidated statements of operations, stockholders' deficit
and cash flows for the period from October 11, 1996 (inception) through
December 31, 1996 and the nine-month period ended September 30, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of GMS Dental
Group, Inc. and subsidiaries as of December 31, 1996 and September 30, 1997
and the results of their operations and their cash flows for the period from
October 11, 1996 through December 31, 1996 and for the nine months ended
September 30, 1997 in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Orange County, California
November 14, 1997
F-24
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
1996 1997
------- -------
ASSETS
Current assets:
Cash and cash equivalents.................................. $ 1,991 $ 68
Accounts receivable, net of allowances of approximately
$1,519 and $2,278 in
1996 and 1997, respectively (note 7)...................... 1,819 3,244
Dental supplies............................................ 191 359
Prepaid and other current assets........................... 143 637
------- -------
Total current assets..................................... 4,144 4,308
------- -------
Property and equipment, (notes 5 and 7)...................... 1,578 3,354
Intangible assets, net of accumulated amortization of $61 and
$227 in 1996 and 1997, respectively......................... 7,105 14,444
Other assets (note 6)........................................ 399 454
------- -------
Total assets............................................. $13,226 $22,560
======= =======
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable........................................... $ 394 $ 441
Accrued salaries, wages and benefits....................... 669 1,293
Accrued expenses and other current liabilities............. 861 1,216
Current maturities of notes payable and obligations under
capital leases (notes 7 and 12)........................... 207 246
------- -------
Total current liabilities................................ 2,131 3,196
------- -------
Long-term liabilities:
Obligations under capital leases, net of current portion
(note 12)................................................. 131 327
Long-term debt, net of current portion (note 7)............ -- 7,394
Other long-term liabilities................................ -- 181
------- -------
Total long-term liabilities.............................. 131 7,902
------- -------
Total liabilities........................................ 2,262 11,098
------- -------
Redeemable convertible preferred stock--Series B, $.001 par
value; authorized
9,270,000 shares; issued and outstanding 6,180,000 and
6,287,142 shares in 1996
and 1997, respectively...................................... 11,055 12,072
------- -------
Stockholders' deficit (notes 7, 8 and 9):
Convertible preferred stock--Series A, $.001 par value;
authorized 395,000
shares; issued and outstanding 395,000 shares in 1996 and
1997...................................................... 1 1
Convertible preferred stock--Series C, $.001 par value;
authorized 5,000 shares; issued and outstanding 1,777 and
2,753 shares in 1996 and 1997, respectively............... 1 1
Common stock, $.001 par value; authorized 14,500,000
shares; issued and outstanding 1,864,901 and 2,614,901
shares in 1996 and 1997, respectively..................... 2 3
Additional paid-in capital................................. 997 2,438
Notes receivable from stockholders......................... (136) (300)
Accumulated deficit........................................ (956) (2,753)
------- -------
Total stockholders' deficit.............................. (91) (610)
Commitments and contingencies (notes 8, 11 and 12)
Subsequent events (note 13)..................................
------- -------
Total liabilities, redeemable convertible preferred stock
and stockholders' deficit............................... $13,226 $22,560
======= =======
See accompanying notes to consolidated financial statements.
F-25
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
PERIODS FROM OCTOBER 11, 1996 (INCEPTION) THROUGH DECEMBER 31, 1996 AND THE
NINE-MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
1996 1997
--------- ---------
Dental group net patient service revenue (note 7)........ $ 3,701 $ 19,348
--------- ---------
Operating expenses:
Clinical salaries and benefits......................... 1,493 6,571
Practice nonclinical salaries and benefits............. 1,131 5,410
Dental supplies and lab expenses....................... 498 2,205
Practice occupancy expenses............................ 265 1,202
Practice selling, general and administrative expenses.. 469 2,159
Corporate selling, general and administrative
expenses.............................................. 626 2,025
Depreciation and amortization.......................... 161 583
--------- ---------
4,643 20,155
--------- ---------
Operating loss....................................... (942) (807)
Nonoperating expenses:
Interest expense, net.................................. (7) (227)
Loss on investment in joint venture.................... (87) (68)
--------- ---------
Loss before income tax benefit....................... (1,036) (1,102)
Income tax benefit....................................... 320 134
--------- ---------
Net loss............................................. (716) (968)
Dividends on redeemable convertible preferred stock...... (240) (829)
--------- ---------
Net loss attributable to common stockholders......... $ (956) $ (1,797)
========= =========
Net loss per common share................................ $ (.51) $ (.76)
========= =========
Weighted-average number of common shares outstanding..... 1,864,901 2,367,648
========= =========
See accompanying notes to consolidated financial statements.
F-26
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
PERIODS FROM OCTOBER 11, 1996 (INCEPTION) THROUGH DECEMBER 31, 1996
AND THE NINE-MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
SHARES OF SHARES OF
CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE NOTES
PREFERRED PREFERRED PREFERRED PREFERRED SHARES OF ADDITIONAL RECEIVABLE
STOCK-- STOCK-- STOCK-- STOCK-- COMMON COMMON PAID-IN FROM ACCUMULATED
SERIES A SERIES A SERIES C SERIES C STOCK STOCK CAPITAL STOCKHOLDERS DEFICIT
----------- ----------- ----------- ----------- --------- ------ ---------- ------------ -----------
Balance, October
11, 1996....... -- $-- -- $-- -- $-- $ -- $ -- $ --
Initial issuance
of common stock
in exchange for
note
receivable..... -- -- -- -- 1,367,201 1 136 (136) --
Common stock
issued for
acquisitions... -- -- -- -- 497,700 1 99 -- --
Convertible
preferred
stock-- Series
A issued for
acquisitions... 395,000 1 -- -- -- -- 295 -- --
Convertible
preferred
stock-- Series
C issued for
acquisitions... -- -- 1,777 1 -- -- 1,733 -- --
Issuance costs
for redeemable
convertible
preferred
stock--Series
B.............. -- -- -- -- -- -- (1,266) -- --
Dividends on
redeemable
convertible
preferred
stock--Series
B.............. -- -- -- -- -- -- -- -- (240)
Net loss........ -- -- -- -- -- -- -- -- (716)
------- ---- ----- ---- --------- ---- ------- ----- -------
Balance,
December 31,
1996........... 395,000 1 1,777 1 1,864,901 2 997 (136) (956)
Issuance of
common stock
upon exercise
of stock
options in
exchange for
note
receivable..... -- -- -- -- 750,000 1 150 (150) --
Interest accrued
on note
receivable..... -- -- -- -- -- -- -- (14) --
Shares reserved
under earnout
agreement...... -- -- -- -- -- -- 314 -- --
Issuance of
common stock
warrants for
acquisition.... -- -- -- -- -- -- 1 -- --
Convertible
preferred
stock-- Series
C issued for
acquisitions... -- -- 976 -- -- -- 976 -- --
Dividends on
redeemable
convertible
preferred
stock--Series
B.............. -- -- -- -- -- -- -- (829)
Net loss........ -- -- -- -- -- -- -- -- (968)
------- ---- ----- ---- --------- ---- ------- ----- -------
Balance,
September 30,
1997........... 395,000 $ 1 2,753 $ 1 2,614,901 $ 3 $ 2,438 $(300) $(2,753)
======= ==== ===== ==== ========= ==== ======= ===== =======
TOTAL
STOCKHOLDERS'
DEFICIT
-------------
Balance, October
11, 1996....... $ --
Initial issuance
of common stock
in exchange for
note
receivable..... 1
Common stock
issued for
acquisitions... 100
Convertible
preferred
stock-- Series
A issued for
acquisitions... 296
Convertible
preferred
stock-- Series
C issued for
acquisitions... 1,734
Issuance costs
for redeemable
convertible
preferred
stock--Series
B.............. (1,266)
Dividends on
redeemable
convertible
preferred
stock--Series
B.............. (240)
Net loss........ (716)
-------------
Balance,
December 31,
1996........... (91)
Issuance of
common stock
upon exercise
of stock
options in
exchange for
note
receivable..... 1
Interest accrued
on note
receivable..... (14)
Shares reserved
under earnout
agreement...... 314
Issuance of
common stock
warrants for
acquisition.... 1
Convertible
preferred
stock-- Series
C issued for
acquisitions... 976
Dividends on
redeemable
convertible
preferred
stock--Series
B.............. (829)
Net loss........ (968)
-------------
Balance,
September 30,
1997........... $ (610)
=============
See accompanying notes to consolidated financial statements.
F-27
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIODS FROM OCTOBER 11, 1996 (INCEPTION) THROUGH DECEMBER 31, 1996 AND THE
NINE-MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS)
1996 1997
------ ------
Cash flows from operating activities:
Net loss.................................................. $ (716) $ (968)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization............................. 161 583
Loss on investment in joint venture....................... 87 68
Change in assets and liabilities, net of the effect of
acquisitions:
Decrease (increase) in accounts receivable............... (21) 159
Decrease in dental supplies.............................. 1 126
(Increase) decrease in prepaid expenses and other
current assets.......................................... 89 (460)
Increase in other assets................................. (7) (123)
Decrease in accounts payable............................. (619) (55)
Increase in accrued salaries, wages and benefits......... 526 624
Increase in accrued expenses and other current
liabilities............................................. 576 67
Increase (decrease) in other liabilities................. (328) 182
------ ------
Net cash (used in) provided by operating activities..... (251) 203
------ ------
Cash flows from investing activities:
Purchases of property and equipment....................... (125) (138)
Cash paid for investment in joint venture................. (75) --
Cash paid for organization costs.......................... (5) --
Cash paid for acquisition of dental practices............. (6,601) (6,178)
------ ------
Net cash used in investing activities................... (6,806) (6,316)
------ ------
Cash flows from financing activities:
Payment of deferred financing costs....................... (150) --
Proceeds from the issuance of redeemable convertible
preferred stock--Series B, net of costs.................. 9,550 188
Proceeds from the issuance of common stock................ 1 1
Proceeds from issuance of debt............................ -- 4,300
Repayment of debt......................................... (353) (299)
------ ------
Net cash provided by financing activities............... 9,048 4,190
------ ------
Increase (decrease) in cash and cash equivalents........ 1,991 (1,923)
Cash and cash equivalents, beginning of period............. -- 1,991
------ ------
Cash and cash equivalents, end of period................... $1,991 $ 68
====== ======
Supplemental disclosure of cash flow information:
Cash paid during the period:
Interest ................................................. $ -- $ 212
Supplemental Schedule of Noncash Investing and Financing
Activities:
Issuance of convertible preferred stock--Series A to
founders and to purchase the predecessor companies....... $ 295 $ --
Issuance of redeemable convertible preferred stock--Series
B to investment banker for services...................... 314 --
Issuance of convertible preferred stock--Series C to
purchase dental practices................................ 1,733 976
Notes payable issued to purchase dental practice.......... -- 3,214
Shares reserved under earnout agreements.................. -- 315
Issuance of common stock warrants to purchase dental
practice................................................. -- 1
Issuance of common stock to founders and to purchase the
predecessor companies.................................... 235 --
Issuance of notes receivable to stockholders for purchase
of common stock.......................................... 136 150
Interest accrued on notes receivable from stockholders.... -- 14
Purchases of equipment under capital lease agreements..... 550 414
====== ======
See accompanying notes to consolidated financial statements.
F-28
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
(1) DESCRIPTION OF BUSINESS
GMS Dental Group, Inc. and subsidiaries (GMS or the Company), is a Delaware
corporation engaged in managing dental groups. The Company, through its wholly
owned subsidiaries, acquires the net assets of and manages dental groups under
long-term service agreements with the affiliated dental groups. The Company
was incorporated on March 19, 1996 and commenced operations on October 11,
1996 at which time the Company completed its first acquisitions. Therefore,
the Company has a limited operating history.
(2) SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation/Basis of Consolidation
The consolidated financial statements have been prepared on the accrual
basis of accounting and include the accounts of the Company and its wholly
owned subsidiaries and the affiliated professional dental group practices. The
Company's subsidiaries acquire the operating assets and assume certain
liabilities of the dental groups and account for the Company's management
activities with the dental groups under the Company's long-term service
agreements. 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 with
the dental groups. The Company designates a majority shareholder or other
owner of the dental group as its nominee. Additionally, advisory boards are
established which govern the activities of the dental practices. The Company
appoints a majority of the advisory board members. Through the management
services agreements and its control of the advisory board and nominee
shareholders of the dental practices, the Company has exclusive authority over
the decision making related to all major ongoing operations of the underlying
dental groups with the exception of the professional aspects of dentistry
practice as required by applicable state law. Under the management services
agreements, the Company establishes annual operating and capital budgets for
the dental groups and compensation guidelines for the licensed dental
professionals. The Company consolidates the operating results and accounts of
the dental groups since the Company has control over the operations of the
dental practices.
The Company has a 50% equity investment in Celebration Dental Services L.C.,
a Florida limited liability company, which is accounted for on the equity
basis of accounting.
Dental Group Net Patient Service Revenue
Dental group net patient service revenue represents the revenue of the
dental groups reported at the estimated realizable amounts from patients,
third-party payors and others for services rendered, net of contractual
adjustments.
Cash and Cash Equivalents
The Company considers all highly liquid investments in debt instruments with
an original maturity of three months or less to be cash equivalents.
Accounts Receivable
Accounts receivable principally represent receivables from patients and
other third-party payors for dental services provided by the dental groups.
Amounts are recorded net of contractual allowances.
F-29
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
Dental Supplies
Dental supplies represent disposable supplies and instruments used in
delivering dental services to patients. The supplies are recorded at the lower
of cost or market (net realizable value).
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is recorded using the straight-line method over five to seven years,
their estimated useful lives of the assets. Leasehold improvements are
amortized on the straight-line method over the shorter of the lease term or
the estimated useful life.
Equipment held under capital leases are stated at the present value of
minimum lease payments at the inception of the lease and is amortized on a
straight-line basis over the shorter of the lease term or the estimated useful
life of the asset. Amortization of assets subject to capital leases is
included in depreciation expense.
Intangible Assets
Intangible assets consist primarily of management service agreements and are
amortized on a straight-line basis over the period of the agreements, which is
40 years. Amortization expense for the periods ended December 31, 1996 and
September 30, 1997 was $61 and $166, respectively.
Long-Lived Assets
The Company requires that long-lived assets and certain identifiable
intangibles to be held and used or disposed of by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. An impairment charge is
recorded when the estimated undiscounted cash flows from such assets is
insufficient to recover the cost of the long-lived asset.
Income Taxes
The Company uses the asset and liability method of accounting for income
taxes, under which deferred tax assets and liabilities are recognized for the
estimated future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date.
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.
Reclassification
Certain prior years amounts have been reclassified to conform with the
current year presentation.
F-30
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
New Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings Per Share." In accordance with this pronouncement, the Company
will adopt the new standard for periods ending after December 15, 1997.
Management does not expect the adoption of this pronouncement to have a
significant effect on reported earnings (loss) per share information.
The Emerging Issues Task Force 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
criteria for establishing a controlling financial interest in a physician
practice, the appropriateness of accounting for a transaction between a
physician practice management company and a physician practice as a business
combination, and the appropriateness of accounting for such transactions using
the pooling-of-interests method of accounting. The accompanying financial
statements are prepared in conformity with the consensus reached in EITF 97-2.
The Company is unable to predict the impact, if any, that this review may have
on its future acquisition strategy.
Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-
Based Compensation." Under SFAS 123, the Company may elect to recognize stock-
based compensation expense based on the fair value of the awards or continue
to account for stock-based compensation under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and disclose in the
financial statements the effects of SFAS 123 as if the recognition provisions
were adopted. Effective October 11, 1996 (inception), GMS elected to account
for stock-based compensation under Accounting Principles Board Opinion No. 25
(APB 25).
(3) ACQUISITIONS
During the period ended December 31, 1996, the Company acquired Group
Management Service, Inc. which owned a 50% investment in Celebration Dental
Service, L.C. (Celebration), a Florida dental limited liability company. Group
Management Service, Inc. also owned the rights to purchase 100% of the net
assets of five dental practices. Subsequent to the purchase of Group
Management Service, Inc. GMS Dental Group, through its wholly owned
subsidiaries, acquired certain operating assets and assumed certain
liabilities of the five dental practices. During the period ended September
30, 1997, the Company acquired the net assets of four additional dental
practices. These acquisitions have been accounted for under the purchase
method of accounting and, accordingly, the assets and liabilities of the
acquired dental practices were recorded at their estimated fair values at the
dates of acquisition. The operating results of these acquisitions have been
included in the financial statements of the Company since the dates of
acquisition.
F-31
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
The cost of acquisitions in excess of the identified fair value of assets
and liabilities has been allocated primarily to management service agreements.
Summary information concerning the acquisitions during 1996 follow:
Accounts receivable, net.......................................... $ 1,798
Dental supplies................................................... 192
Prepaid expenses and other current assets......................... 232
Property and equipment............................................ 1,544
Other assets...................................................... 261
Liabilities assumed............................................... (2,005)
Deferred tax liability............................................ (320)
Management service agreements and other intangible assets......... 7,166
-------
8,868
Less fair value of common stock issued............................ 100
Less fair value of convertible preferred stock--Series A issued... 295
Less fair value of convertible preferred stock--Series C issued... 1,733
Less deferred purchase price (payable in cash).................... 139
-------
Cash purchase price, net of cash acquired....................... $ 6,601
=======
Summary information concerning the acquisitions during 1997 are as follows:
Accounts receivable, net.......................................... $ 1,584
Dental supplies................................................... 294
Prepaid expenses and other current assets......................... 34
Property and equipment............................................ 1,641
Liabilities assumed............................................... (239)
Deferred tax liability............................................ (134)
Management service agreements and other intangible assets......... 7,504
-------
10,684
Less notes payable to sellers..................................... 3,214
Less fair value of convertible preferred stock--Series C shares
issued and reserved for issuance................................. 1,291
Less common stock warrants issued................................. 1
-------
Cash purchase price, net of cash acquired....................... $ 6,178
=======
The following unaudited pro forma summary for the nine month period ended
September 30, 1997 presents the condensed consolidated results of operations
as if the 1997 acquisitions discussed above had occurred as of January 1,
1997. These pro forma results have been prepared for comparative purposes only
and are not necessarily indicative of what the actual results of operations
would have been had the acquisitions been made as of that date, nor does it
purport to represent future operations of the Company:
1997
-------
Pro forma:
Dental Group net patient service revenue......................... $27,582
Net loss......................................................... (766)
=======
Net loss per common share........................................ $ (.32)
=======
F-32
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
The fair value of the stock issued was determined by the Company based upon
an analysis of the value of the operating assets and liabilities being
acquired using projected discounted cash flows and the negotiation process
between the Company and the sellers. Under the purchase agreements, the
purchase price is adjustable by the Company for a period between six months
and one year after the closing of the transactions in order to finalize the
fair values of the assets acquired and liabilities assumed.
In connection with the acquisition of four of the dental groups, the Company
is contingently obligated to pay additional consideration, depending on the
achievement of certain financial results, as defined by the purchase
agreements. During 1997, the Company accrued $314 for the portion of 1997
earnouts which the Company expects to pay in common stock.
(4) RECEIVABLES SOLD WITH RECOURSE
Prior to October 11, 1996, one of the acquired practices sold certain of its
receivables to a financial institution with recourse. Under the terms of these
transactions, the practice received 97% of the face value of each receivable.
Additionally, as collateral for these receivables, the practice was required
to maintain a cash balance at the financial institution of approximately 10%
of the outstanding receivables. The recourse provisions require the Company to
repurchase any receivable which becomes more than 150 days delinquent.
The outstanding balance of receivables sold with recourse was approximately
$261 and are included in accounts receivable in the accompanying consolidated
balance sheets at December 31, 1996. As of September 30, 1997, the Company no
longer sells its receivables.
(5) PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
1996 1997
------ ------
Dental equipment............................................. $ 786 $2,100
Computer equipment........................................... 267 477
Furniture, fixtures, and equipment........................... 188 312
Leasehold improvements....................................... 370 915
Buildings.................................................... 48 48
Land......................................................... 10 10
------ ------
Total property and equipment............................... 1,669 3,862
Less accumulated depreciation................................ (91) (508)
------ ------
Property and equipment, net................................ $1,578 $3,354
====== ======
(6) INVESTMENT IN JOINT VENTURE
The Company is a 50% owner in a joint venture with Private Medical Care,
Inc., a subsidiary of Delta Dental, Inc., in a dental practice located in
Celebration, Florida. The initial investment by the Company consisted of $75
in cash and $150 of contributed assets.
F-33
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
(7) LONG-TERM DEBT AND LINE OF CREDIT
Long-term debt is summarized as follows:
1996 1997
---- ------
Term note, bearing interest at 9.75%; monthly principal and
interest payments of $5; due October 17, 1997 with a balloon
payment of $12; secured by mortgage.......................... $ 56 $ 12
Credit facility, bearing interest at 3.25% in excess of LIBOR
rate (9.1% at September 30, 1997)............................ 48 4,300
Subordinated note payable, discounted at 8% annual interest,
payable in annual installments of principle and interest
beginning December 31, 1997 through January 2002............. -- 696
Senior subordinated note payable, discounted at 8% annual
interest. Payable in 60 monthly installments of $14,
beginning August 1, 1997 through July 2002................... -- 667
Senior subordinated note payable, discounted at 8% annual
interest; balloon payment of $500 due July 1999.............. -- 432
Senior subordinated note payable, discounted at 8% annual
interest; balloon payment of $2,083 due July 2002............ -- 1,419
---- ------
104 7,526
Less current portion.......................................... 104 132
---- ------
$-- $7,394
==== ======
As of September 30, 1997, the aggregate maturities of long-term debt for
each of the next five years are as follows:
1998.................................. $ 132
1999.................................. 1,711
2000.................................. 1,574
2001.................................. 1,898
2002.................................. 2,211
Thereafter............................ --
------
$7,526
======
The Company has obtained a credit facility from a bank in the amount of
$10 million. The proceeds of the credit facility are available for working
capital needs and to finance acquisitions approved by the bank. Principal
amounts owed under the credit facility bear interest up to 1% above the prime
rate or up to 3.25% above LIBOR, dependent on the Company's leverage ratio.
The outstanding balance on this facility as of September 30, 1997 was $4.3
million. As of September 30, 1997, the Company was in violation of certain
covenants for which it obtained a waiver from the bank.
On October 11, 1998, the credit facility will convert from a revolving
facility to a three-year loan. The term loan will provide for 12 equal
quarterly payments of principal and interest. The obligations under this
credit agreement are secured by a first-priority security interest in favor of
the bank in all revenue of the Company and its subsidiaries. The Company must
meet certain ratios defined by the bank credit agreement.
In connection with this credit facility, the Company issued a warrant to the
bank to purchase up to 184,103 shares of the Company's common stock at a price
of $1.75 per share. The warrant expires in October 2001.
F-34
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
(8) STOCKHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK (NOTE 13)
The Company has two classes of stock: common stock and preferred stock. As
of September 30, 1997, preferred stock consists of three series: convertible
preferred stock--Series A, redeemable convertible preferred stock--Series B
and convertible preferred stock--Series C. The preferences, privileges and
restrictions granted or imposed on the preferred stock are as follows:
Common Stock
Upon formation of the Company, GMS Dental Group, Inc. issued an aggregate
1,367,201 shares of its common stock at a purchase price of $.10 per share to
the founders of the Company. 605,000 of these shares are subject to a three-
year vesting schedule whereby one-quarter of the shares vested upon issuance
and one-quarter of the shares will vest on October 11, 1997. The remaining
shares vest on a monthly basis during the remaining thirty-six months.
572,700 shares issued to certain other stockholders, which were issued at a
price of $.20 per share, and 762,201 shares out of the 1,367,201 shares issued
to the founders, are subject to a right of repurchase, at cost, in favor of
the Company that expires upon the earlier of (1) the achievement by the
Company of certain performance milestones over a two-year period or (2) nine
years and nine months from the date of issuance.
Dividends
The holders of the Series B convertible redeemable preferred stock will be
entitled to receive dividends in preference to any dividend on the Series A
convertible preferred stock, the Series C convertible preferred stock and the
common stock, at a rate of 10% per annum of the per share purchase price of
the Series B convertible redeemable preferred stock, which dividend rate will
be $.175 per share of Series B convertible redeemable preferred stock. The
dividends payable to the holders of the Series B convertible redeemable
preferred stock are cumulative and are payable upon the earlier of conversion
of such shares into common stock, the initial public offering of the Company's
securities, a liquidation of the Company or an acquisition of the Company or
substantially all of its assets. Accumulated undeclared dividends as of
September 30, 1997 totaled $1,069.
Liquidation Preference
In the event of any liquidation, dissolution or winding up of the Company,
the holders of the Series B convertible redeemable preferred stock are
entitled to receive $1.75 per share, plus all accrued but unpaid dividends on
such shares, prior to and in preference to any distributions made to holders
of the Series A convertible preferred stock, the Series C convertible
preferred stock or the common stock. The holders of Series A and Series C
convertible preferred stock are then entitled to $0.748 per share and $1,000
per share, respectively, plus an amount equal to all declared but unpaid
dividends on each such share. After payment of the preference amounts to the
holders of the Series A and Series C convertible preferred stock, any
remaining assets or property distributable upon such liquidation, dissolution
or winding up will be divided pro rata among the holders of the Series B
convertible redeemable preferred and the common stock on an as-converted
basis. At September 30, 1997, the Company has 6,287,142, 395,000 and 2,753
shares outstanding of Series B convertible redeemable preferred stock, Series
A convertible preferred stock and Series C convertible preferred stock,
respectively.
F-35
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
Redemption Rights
After October 11, 2001, any or all of the holders of the Series B
convertible redeemable preferred stock shall have the right to the extent
permitted by law and by the Company's Loan Agreement with Imperial Bank, to
require the Company to repurchase all or any part of such holder's shares of
such series of preferred stock by payment of an amount per share equal to the
liquidation preference amount, together with any accumulated but unpaid
dividends on such redeemed shares. The Series A and Series C convertible
preferred stock are not redeemable.
Conversion Rights
The holders of shares of Series A convertible preferred stock and Series B
convertible redeemable preferred stock have the right to convert such shares
at any time into common stock of the Company. The initial conversion rate will
be on a 1-to-1 basis and will be subject to adjustment for anti-dilution
(including, but not limited to, adjustments to the conversion rates in the
event the Company issues common stock or securities convertible into or
exercisable for common stock at a price per share less than the conversion
price for such series of preferred stock). Each share of Series A convertible
preferred stock and Series B convertible redeemable preferred stock
automatically will be converted into common stock, at the then applicable
conversion rate, upon the closing of a firm commitment underwritten public
offering of the Company's common stock at a price per share not less than $10
and for a total offering price of not less than $30 million or upon the
written consent of the holders of at least a majority of the Series A
convertible preferred stock and Series B convertible redeemable preferred
stock, voting together as a class.
Each share of Series C convertible preferred stock automatically shall be
converted into common stock, at a ratio equal to $1,000 divided by the Series
C conversion price (as defined below), upon earlier of (i) the closing of a
firm commitment underwritten public offering of the Company's common stock or
(ii) the acquisition of the Company (by merger, stock purchase, sale of assets
or otherwise) for a purchase price in excess of an amount equal to four times
the aggregate liquidation preferences of all the then outstanding shares of
preferred stock of the Company. For purposes of automatic conversion upon the
closing of a public offering as described above, the Series C conversion price
shall be 75% of the price per share of common stock at which such shares are
sold to the public in the public offering. For purposes of automatic
conversion upon the acquisition of the Company as described above, the Series
C conversion price shall be 75% of the price per share of common stock paid in
such acquisition. The price per share of common stock will be determined by
dividing the total consideration to be received by the Company's stockholders
as a result of such acquisition by the number of shares of common stock then
outstanding on an as-converted basis (including the approximate number of
shares of common stock issuable upon conversion of the Series C convertible
preferred stock upon such acquisition).
Voting Rights
The holders of the Series A and Series B preferred stock shall be entitled
to the number of votes equal to the number of shares of common stock then
issuable upon conversion of such shares. The holders of the Series C preferred
stock shall be entitled to a number of votes equal to 5% of the total voting
power of the outstanding voting securities.
Registration Rights
The Company has granted to the holders of shares of Series A and Series B
convertible preferred stock certain registration rights pursuant to an
Investor Rights Agreement. Pursuant to the Investor Rights Agreement,
F-36
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
holders of Series A and Series B convertible preferred stock will have the
right to demand one registration and will have an unlimited number of
"piggyback" registrations. In addition, the holders of the Series A and
Series B convertible preferred stock will be entitled to two demand
registrations per year on Form S-3, so long as such registrations are not less
than $500. The Company will bear registration expenses (exclusive of
underwriting discounts and commissions) of the one demand registration and all
"piggyback" registrations. Expenses of registration on Form S-3 will be borne
pro rata by the holders participating in such registration. Registration
rights will terminate on the earlier of (i) five years after an initial public
offering of the Company's common stock or (ii), with respect to a particular
holder of less than 200,000 shares, upon such a public offering if such holder
may sell all of such holders' registrable securities pursuant to Rule 144
during any 90-day period.
Rights of First Offer
Each purchaser of Series B convertible redeemable preferred stock who
continues to hold at least 25% of such purchaser's original investment or a
transferee who acquires at least 400,000 shares of the Series B convertible
redeemable preferred stock (a Major Investor) will have a right of first offer
to purchase its pro rata share of offerings of new securities of the Company
(other than (i) securities issued to certain employees, directors, consultants
and vendors of the Company, (ii) shares of the Company's capital stock issued
in connection with the acquisition of dental practices and (iii) securities
issued in connection with the Company's business relationships up to 1% of the
then outstanding common stock on an as-converted basis). The right of first
offer will terminate upon an initial public offering of the Company's common
stock.
Redeemable Preferred Stock Activity
The following summary presents the changes in the redeemable convertible
preferred stock--Series B:
SHARES AMOUNT
--------- -------
(in
000s)
Issued in connection with private placement............... 6,180,000 $10,815
Dividends accumulated..................................... -- 240
--------- -------
Balance, December 31, 1996................................ 6,180,000 11,055
Issued in connection with private placement............... 107,142 188
Dividends accumulated..................................... -- 829
--------- -------
Balance, September 30, 1997............................... 6,287,142 $12,072
========= =======
Warrants
In connection with the acquisition of the net assets of a dental practice in
1997, the Company issued warrants to purchase 300,000 shares of common stock
at $3.50 per share. The warrants were recorded at their estimated fair value
of $1 and expire in 2004.
As described in note 7, in 1996 the Company issued a warrant to the bank to
purchase up to 184,103 shares of common stock at a price of $1.75 per share.
The warrant expires in October 2001. None of the warrants have been exercised
to date.
(9) STOCK OPTIONS
As of December 31, 1996 and September 30, 1997, GMS had two stock-based
option plans, as described below and has elected to apply the opinion of APB
Opinion No. 25 and related interpretations in accounting for its plans.
Management believes that options have been issued at fair value at the date of
grant. Accordingly, no compensation expense has been recognized for those
plans in the consolidated statement of operations.
F-37
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
The 1996 stock plans, the Performance Stock Option Plan and the Stock Option
Plan, authorize the Board or one or more committees which the Board may
appoint from among its members (the Committee) to grant options and rights to
purchase common stock to employees only under the "Performance" plan and to
employees, directors and consultants under the stock option plan. Options
granted under the 1996 stock plans may be either "incentive stock options" as
defined in Section 422 of the Internal Revenue Code of 1986, as amended, or
nonstatutory stock options, as determined by the Board or the Committee. The
exercise price of options granted under the 1996 stock plans is to be equal to
the fair market value of GMS common stock on the date of grant. Options vest
at a minimum of 20% per year from the date of grant. Options are exercisable
for no longer than ten years. A total of 1,152,600 shares of common stock has
been reserved for issuance under the 1996 stock plans. As of September 30,
1997, options to purchase a total of 998,500 shares of the Company's common
stock have been granted under the 1996 stock plans.
The following tables summarize GMS' option activity:
PERIOD FROM OCTOBER
11, 1996
(INCEPTION) THROUGH NINE MONTHS ENDED
DECEMBER 31, 1996 SEPTEMBER 30, 1997
------------------- -------------------
EXERCISE EXERCISE
PRICE PRICE
RANGE RANGE
NUMBER PER NUMBER PER
OF OPTIONS OPTION OF OPTIONS OPTION
---------- -------- ---------- --------
Outstanding beginning of period........ -- $-- 190,000 $ .20
Granted during period.................. 190,000 .20 808,500 .20-.30
Exercised during period................ -- -- 750,000 .20
------- ---- ------- --------
Outstanding, end of period........... 190,000 $.20 248,500 $.20-.30
======= ==== ======= ========
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- -----------------------------------
WEIGHTED-AVERAGE
RANGE OF REMAINING
EXERCISE NUMBER OUTSTANDING CONTRACTUAL LIFE WEIGHTED-AVERAGE NUMBER EXERCISABLE WEIGHTED-AVERAGE
PRICES SEPTEMBER 30, 1997 (IN YEARS) EXERCISE PRICE SEPTEMBER 30, 1997 EXERCISE PRICE
- -------- ------------------ ---------------- ---------------- ------------------ ----------------
$.20-.30 248,500 9.15 $.21 2,500 $.20
======== =========== ========== ========== =========== ==========
The following table presents pro forma information as if GMS recorded
compensation cost using the fair value of the issued stock options using the
minimum value valuation model:
1996 1997
----- -----
Net loss:
As reported............................................... $(716) $(968)
Assumed stock compensation cost........................... (1) (1)
----- -----
Pro forma, adjusted..................................... $(717) $(969)
===== =====
The fair value of each option grant is estimated on the date of grant using
the minimum value method and the following assumptions:
1996 1997
------- -------
Risk-free interest rate.................................. 6.4% 6.4%
Option term in years..................................... 7 years 4 years
Stock dividend yield..................................... -- --
Volatility............................................... -- --
======= =======
F-38
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
(10) INCOME TAXES
Income tax expense (benefit) consists of:
1996
----------------------
CURRENT DEFERRED TOTAL
------- -------- -----
U.S. Federal......................................... $ -- $(287) $(287)
State and local...................................... 8 (41) (33)
----- ----- -----
$ 8 $(328) $(320)
===== ===== =====
1997
----------------------
CURRENT DEFERRED TOTAL
------- -------- -----
U.S. Federal......................................... $ -- $(121) $(121)
State and local...................................... 4 (17) (13)
----- ----- -----
$ 4 $(138) $(134)
===== ===== =====
Income tax benefit differed from the amount computed by applying the U.S.
Federal income tax rate of 35% to loss before income tax benefit as a result of
the following:
1996 1997
----- -----
Computed "expected" tax (benefit)............................ $(352) $(386)
Increase (reduction) in income taxes resulting from:
State income taxes, net of Federal income tax benefit...... (47) (46)
Amortization of nondeductible goodwill and other
nondeductible items....................................... 13 30
Valuation allowance for deferred tax assets allocated to
income tax expense........................................ 75 265
Other...................................................... (9) 3
----- -----
$(320) $(134)
===== =====
F-39
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
Deferred income taxes reflect the net tax effects of the temporary
differences between the carrying amount of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and liabilities
are as follows:
1996 1997
----- -------
Deferred tax assets:
Allowance for doubtful accounts.......................... $ 618 $ 857
Net operating loss carryforwards......................... 230 825
Compensated absences, principally due to accrual for
financial reporting purposes............................ 57 95
Intangible assets, principally due to differences in
amortization and capitalized cost....................... -- 239
State taxes.............................................. 3 5
----- -------
Total gross deferred tax assets........................ 908 2,021
Less valuation allowance................................. (75) (339)
----- -------
Deferred tax assets, net of valuation allowance........ 833 1,682
----- -------
Deferred tax liabilities:
Accounts receivable...................................... (759) (1,535)
Plant and equipment, principally due to differences in
depreciation and capitalized cost....................... (65) (81)
Intangible assets, principally due to accrual for
financial reporting purposes............................ (9) (64)
Other.................................................... -- (2)
----- -------
Deferred tax liabilities............................... (833) (1,682)
----- -------
Net deferred tax asset................................. $ -- $ --
===== =======
(11) MALPRACTICE INSURANCE
The dental groups' dentists are insured with respect to dentistry
malpractice risks on a claims-made basis. There are known claims and incidents
that may result in the assertion of additional claims, as well as claims from
unknown incidents that may be asserted arising from services provided to
patients. Management is not aware of any claims against the Company or its
affiliated groups which might have a material impact on the Company's
financial position or results of operations.
(12) COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company has primarily entered into operating leases of commercial
property. Commercial properties under operating leases mostly include space
required to perform dental services and space for administrative facilities.
Lease expense for dental office space and administrative office space for the
periods ended December 31, 1996 and September 30, 1997 was $175 and $1,255,
respectively.
F-40
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
The future minimum lease payments under capital leases and noncancelable
operating leases with remaining terms of one or more years consist of the
following at September 30, 1997:
CAPITAL OPERATING
------- ---------
1998....................................................... $ 168 $1,327
1999....................................................... 142 1,214
2000....................................................... 114 1,123
2001....................................................... 74 1,044
2002....................................................... 50 892
Thereafter................................................. -- 4,035
----- ------
Total minimum lease obligation........................... 548 $9,635
======
Less portion attributable to interest...................... (107)
-----
Obligations under capital leases......................... 441
Less current portion....................................... (114)
-----
$ 327
=====
Included in dental equipment and furniture, fixtures and equipment are
assets under capital lease with an original cost of $964 and accumulated
amortization of $151 at September 30, 1997.
Litigation
The Company is subject to various claims and legal actions which arise in
the ordinary course of business. In the opinion of management, the ultimate
resolution of such matters will not have a material adverse effect on the
Company's financial position or results of operations.
(13) SUBSEQUENT EVENTS
On November 4, 1997, the Company completed a merger with Gentle Dental
Service Corporation (GDSC) in a transaction that will be accounted for as a
pooling of interests. Immediately prior to the merger, substantially all
outstanding shares of the Series A, Series B and Series C convertible
preferred stock were converted into shares of GMS common stock. GMS
stockholders received 4,512,377 shares of GDSC common stock in exchange for
all of the then outstanding shares of GMS common stock. A total of 297,074 of
the shares issued in the merger are subject to repurchase by GDSC at an
average price of $0.32 per share if certain performance targets for 1997 are
not achieved. These targets are not expected to be met and the shares are
anticipated to be purchased during 1998.
F-41
GMS DENTAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
The results of operations previously reported by the separate enterprises
and the combined amount are summarized below:
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
-------------- -----------------
1995 1996 1997
------ ------- -----------------
Net revenue:
GMS--patient service................... $ -- $ 3,701 $19,348
GDSC--support services fee............. 9,781 10,712 10,269
------ ------- -------
Combined................................. 9,781 $14,413 $29,617
====== ======= =======
Net income (loss):
GMS.................................... $ -- $ (716) $ (968)
GDSC................................... 257 (985) 229
Adjustments to conform accounting
policies, net of tax.................. -- 14 (8)
------ ------- -------
Combined................................. $ 257 $(1,687) $ (747)
====== ======= =======
Adjustments to conform GMS's method of accounting for amortization of
intangible assets with that of GDSC will reduce net income for the years ended
December 31, 1995 and 1996 and the nine months ended September 30, 1997 by
approximately $0, $0, and $148, respectively, and adjustments to conform GMS's
method of accounting for depreciation of property and equipment with that of
GDSC, will increase net income for the years ended December 31, 1995 and 1996
and the nine months ended September 30, 1997 by approximately $0, $13, and
$124, respectively.
There were no significant transactions between GMS and GDSC prior to the
combination.
During October 1997, the Company acquired substantially all of the assets of
two dental practices, one located in Idaho Falls, Idaho and the other with two
offices in San Francisco and Daly City, California for a combined purchase
price of approximately $3,600. The purchase price consists of approximately
$2,920 in cash, $180 in convertible preferred stock--Series C, and warrants
valued at approximately $5. Additional consideration may be paid subject to
earn-out agreements.
F-42
REPORT OF INDEPENDENT ACCOUNTANTS
November 17, 1997
To the Shareholders and Board of Directors of
Dedicated Dental Systems, Inc.
In our opinion, the accompanying balance sheet and the related statements of
income and retained earnings and of cash flows present fairly, in all material
respects, the financial position of Dedicated Dental Systems, Inc. at December
31, 1995 and September 30, 1997, and the results of its operations and its
cash flows for the year ended December 31, 1995 and for the nine months ended
September 30, 1997, in conformity with generally accepted accounting
principles. 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 generally accepted auditing standards 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. The financial statements of Dedicated Dental
Systems, Inc. for the year ended December 31, 1996 were audited by other
independent accountants whose report dated April 25, 1997 expressed an
unqualified opinion on those statements.
As disclosed in Note 6 to the financial statements, the Company has certain
related party transactions.
As disclosed in Note 7 to the financial statements, during September 1997,
the Company signed a definitive merger agreement pursuant to which all of its
outstanding shares of common stock will be acquired by Gentle Dental Service
Corporation, a publicly-traded Washington corporation.
Price Waterhouse LLP
F-43
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Dedicated Dental Systems, Inc.
We have audited the accompanying balance sheet of Dedicated Dental Systems,
Inc. as of December 31, 1996, and the related statements of income and
retained earnings, and cash flows for the year then ended. 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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards 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. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Dedicated Dental Systems,
Inc. at December 31, 1996, and the results of its operations and its cash
flows for the year then ended in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Los Angeles, California
April 25, 1997
F-44
DEDICATED DENTAL SYSTEMS, INC.
BALANCE SHEET
DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
1995 1996 1997
--------- ---------- ----------
ASSETS
Current assets:
Cash and cash equivalents................. $ 21,213 $ 371,974 $ 680,176
Receivables, net.......................... 372,664 644,357 1,058,722
Prepaid expenses and other current
assets................................... 71,581 80,062 89,805
--------- ---------- ----------
Total current assets........................ 465,458 1,096,393 1,828,703
Equipment and leasehold improvements, net
(Note 2)................................... 385,014 836,299 1,114,691
Intangibles and other assets................ 15,144 43,504 94,935
Certificate of deposit--restricted (Note
1)......................................... 50,000 50,000 50,000
--------- ---------- ----------
Total assets................................ $ 915,616 $2,026,196 $3,088,329
========= ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................... $ 56,764 $ 129,649 $ 294,151
Accrued expenses.......................... 196,003 230,427 267,087
Unearned premium revenue (Note 1)......... 154,569 247,469 227,439
Current maturities of long-term debt...... 39,851 187,403 301,463
--------- ---------- ----------
Total current liabilities................... 447,187 794,948 1,090,140
--------- ---------- ----------
Long-term debt, less current maturities
(Note 4)................................... 104,612 149,564 635,876
--------- ---------- ----------
Commitments and contingencies (Notes 5 and
6)
Shareholders' equity:
Common stock, no par value:
Authorized, 1,000, 500,000 and 500,000
shares, respectively
Issued and outstanding, 100, 100,100 and
100,100 shares, respectively............. 104,903 104,903 104,903
Retained earnings......................... 715,282 1,661,333 1,800,629
--------- ---------- ----------
820,185 1,766,236 1,905,532
Receivable from related party (Note 6).... (456,368) (684,552) (543,219)
--------- ---------- ----------
Total shareholders' equity.................. 363,817 1,081,684 1,362,313
--------- ---------- ----------
Total liabilities and shareholders' equity.. $ 915,616 $2,026,196 $3,088,329
========= ========== ==========
The accompanying notes are an integral part of this statement.
F-45
DEDICATED DENTAL SYSTEMS, INC.
STATEMENT OF INCOME AND RETAINED EARNINGS
YEARS ENDED DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
1995 1996 1997
---------- ---------- -----------
Revenue:
Fee for service revenue................. $5,208,168 $6,703,555 $ 7,353,348
Premiums................................ 1,574,997 2,101,208 2,284,186
Other................................... 2,682 58,642 125,681
---------- ---------- -----------
Total operating revenue................... 6,785,847 8,863,405 9,763,215
---------- ---------- -----------
Expenses:
Practice Clinical salaries.............. 2,353,013 2,974,562 3,403,331
Practice non-clinical salaries and
benefits............................... 454,515 678,379 667,042
Dental Supplies and lab expenses........ 751,302 879,097 1,020,950
Practice occupancy expenses............. 240,160 319,701 364,132
Practice selling, general and
administrative expenses................ 998,423 1,055,269 1,054,784
Corporate--selling, general and
administrative expenses................ 1,063,572 1,469,323 1,597,852
Depreciation and amortization........... 75,898 122,814 171,546
---------- ---------- -----------
Total operating expenses.............. 5,936,883 7,499,145 8,279,637
---------- ---------- -----------
Operating income.......................... 848,964 1,364,260 1,483,578
Interest income........................... 6,975 14,266 20,315
Interest expense.......................... (9,415) (7,800) (46,740)
---------- ---------- -----------
Net income before state income taxes...... 846,524 1,370,726 1,457,153
Provision for state income taxes.......... 15,161 20,560 21,857
---------- ---------- -----------
Net income................................ 831,363 1,350,166 1,435,296
Retained earnings at beginning of period.. 413,919 715,282 1,661,333
Distribution to shareholders.............. (530,000) (404,115) (1,296,000)
---------- ---------- -----------
Retained earnings at end of period........ $ 715,282 $1,661,333 $ 1,800,629
========== ========== ===========
The accompanying notes are an integral part of this statement.
F-46
DEDICATED DENTAL SYSTEMS, INC.
STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
1995 1996 1997
--------- ---------- -----------
OPERATING ACTIVITIES:
Net income................................ $ 831,363 $1,350,166 $ 1,435,296
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization........... 75,898 122,814 171,546
Changes in assets and liabilities, net
of amounts purchased in acquisitions:
Receivables........................... (112,070) (191,693) (414,365)
Prepaid expenses and other assets..... (42,057) (2,137) (9,743)
Accounts payable...................... (14,105) 72,885 164,502
Accrued expenses and unearned premium
revenue.............................. 83,780 127,324 16,630
--------- ---------- -----------
Net cash provided by operating
activities............................... 822,809 1,479,359 1,363,866
--------- ---------- -----------
INVESTING ACTIVITIES:
Purchase of equipment and leasehold
improvements, net of amounts purchased in
acquisitions............................. (93,040) (378,865) (301,369)
Cash paid for acquisition................. (109,000) (60,000) (200,000)
--------- ---------- -----------
Net cash used in investing activities..... (202,040) (438,865) (501,369)
--------- ---------- -----------
FINANCING ACTIVITIES:
Proceeds from notes payable............... 100,000 -- 882,000
Principal payments on notes payable....... (40,640) (148,549) (281,628)
(Increase) decrease in receivable from
related party............................ (228,184) (228,184) 141,333
Cash distributions to shareholders........ (530,000) (313,000) (1,296,000)
--------- ---------- -----------
Net cash used in financing activities..... (698,824) (689,733) (554,295)
--------- ---------- -----------
Net increase (decrease) in cash and cash
equivalents.............................. (78,055) 350,761 308,202
Cash and cash equivalents at beginning of
period................................... 99,268 21,213 371,974
--------- ---------- -----------
Cash and cash equivalents at end of
period................................... $ 21,213 $ 371,974 $ 680,176
========= ========== ===========
The accompanying notes are an integral part of this statement.
F-47
DEDICATED DENTAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Dedicated Dental Systems, Inc. (the "Company") was formed in 1985 as a
California S-corporation licensed as a health maintenance organization ("HMO")
under the Knox-Keene Health Care Service Plan Act (the "Knox-Keene Act"). The
Company delivers managed dental care services through its dental practice
offices to enrolled individuals, subscriber groups, individuals covered by the
State of California Denti-Cal program, and individuals covered under fee for
service plans.
Business and regulatory environment
The Company is licensed by the Department of Corporations of the State of
California (the "DOC"). As of September 30, 1997 DOC regulations require the
Company to maintain a minimum tangible net equity of $888,599. In addition,
the Commissioner of Corporations requires the Company to maintain a deposit of
$50,000 pursuant to the Knox-Keene Act. The deposit is comprised of a
certificate of deposit held by a trustee and is included in certificate of
deposit--restricted in the accompanying balance sheet. Interest earned on the
funds accrues to the Company and is not restricted as to use.
Statement of cash flows
The Company considers short-term investments which are highly-liquid, are
readily converted into cash and have original maturities of fewer than three
months to be cash equivalents for purposes of cash flows. For the years ended
December 31, 1995 and 1996 and the nine months ended September 30, 1997, the
Company paid interest of $9,415, $7,800 and $46,740, respectively, and paid
state franchise taxes of $12,161, $10,826 and $13,900, respectively.
Concentrations of credit risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of premiums receivable.
Concentrations of credit risk with respect to receivables are limited due to
the large number of individuals and employer groups comprising the Company's
customer base.
Fair value of financial instruments
The Company's balance sheet includes the following financial instruments:
cash and cash equivalents, receivables, accounts payable and long-term
obligations. The Company considers the carrying amounts of current assets and
liabilities in the financial statements to approximate the fair value for
these financial instruments because of the relatively short period of time
between origination of the instruments and their expected realization. The
Company believes the carrying value of all the long-term obligations
approximates the fair value of such obligations.
Equipment and leasehold improvements
Equipment and leasehold improvements are stated at cost; replacements and
major improvements are capitalized, while repairs and maintenance are charged
to expense as incurred. Upon sale or retirement of equipment and leasehold
improvements, the cost and related accumulated depreciation and amortization
are eliminated from the accounts. Any resulting gains and losses are included
in the determination of net income. Equipment is depreciated using the
straight-line method for financial reporting purposes over five years.
F-48
DEDICATED DENTAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Leasehold improvements are amortized using the straight-line method over the
shorter of the useful life or the term of the lease.
Effective January 1, 1996, the Company changed its method of computing
depreciation for financial reporting purposes from an accelerated method to
the straight-line method. The change was made because management believes the
new method is a better method for matching costs with revenues. The effect of
such change has been retroactively applied to prior periods.
Other assets
Other assets consist primarily of capitalized loan fees incurred upon
issuing debt related to the purchase of property.
Intangibles
Intangibles represent the unamortized excess of the cost of acquiring dental
practices over the fair values of such dental practices' net tangible assets
at the dates of acquisition. Such intangibles are amortized on a straight-line
basis over 30 years.
Income taxes
The Company operates under Subchapter S of the Internal Revenue Code, and
consequently, is not subject to federal income tax. The shareholders include
the Company's income in their own income for federal income tax purposes. For
California franchise tax purposes, the Company is subject to taxes at a rate
of 1.5 percent of taxable income.
Shareholders' equity
In February 1996, the Company's Board of Directors approved an amendment to
the Company's Certificate of Incorporation increasing the number of authorized
shares of common stock from 1,000 to 500,000. In May 1996, the Company issued
an additional 100,000 shares to its two shareholders.
Accounting for impairment of long-lived assets and for long-lived assets to
be disposed of
The Company accounts for the impairment and disposition of long-lived assets
in accordance with Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of." In accordance with SFAS No. 121, long-lived assets to be
held are reviewed for events or changes in circumstances which indicate that
their carrying value may not be recoverable. The Company has determined that
no long-lived assets are impaired at September 30, 1997.
Revenue recognition and health care services
Prepaid dental care premiums from enrolled groups and individuals are
reported as revenue in the month in which enrollees are entitled to receive
dental care. Premiums received prior to such period are recorded as unearned
premium revenue. Fee for services and other revenues consist of professional
fees and are reported at the estimated realizable amounts from patients,
third-party payors and others for services rendered.
Dental care expenses are recorded as incurred. Substantially all of the
dental care services are provided at the dental practice offices. Dental care
expenses are comprised of dentist and dental staff salaries, supplies, and
other dental office related costs.
F-49
DEDICATED DENTAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Medical malpractice liability insurance
The Company maintains claims-made basis professional liability insurance
coverage of $1,000,000 per incident and $1,000,000 in the aggregate on an
annual basis. Claims-made coverage covers only those claims reported during
the policy period. The Company expects to renew its existing policies and to
be able to continue to obtain coverage in future years.
Use of estimates in 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 revenues and expenses during the
reporting period. Actual results could differ from these estimates. Principal
areas requiring the use of estimates include determination of allowances for
doubtful accounts receivable, dental claims and accruals, professional and
general liabilities, and certain other reserves.
Reclassifications
Certain reclassifications have been made to the December 31, 1996 financial
statements to conform with financial statement presentation for the nine
months ended September 30, 1997. These reclassifications have no effect on
previously reported results of operations or shareholders' equity.
(2) ACQUISITIONS
In August 1995, the Company purchased a dental practice, including
equipment, leasehold improvements, supplies and accounts receivable. The total
purchase price was $109,000, including $9,000 which was allocated to
intangibles. The practice was acquired for cash, and has been accounted for
using the purchase method of accounting. The results of operations of the
practice are included in the Company's financial statements from the date of
purchase.
On November 1, 1996, the Company purchased a dental practice, including
equipment and leasehold improvements, supplies and accounts receivable. The
total purchase price was $60,000, including $25,000 which was allocated to
intangibles. The acquisition was accounted for as a purchase transaction.
On November 15, 1996, the Company purchased a dental practice, including
equipment and leasehold improvements, supplies, and accounts receivable. The
total purchase price was $325,000, including $10,000 which was allocated to
intangibles. The acquisition was financed through the issuance of a note
payable to seller. The acquisition was accounted for as a purchase
transaction.
On March 1, 1997, the Company purchased a dental practice including
equipment and leasehold improvements, supplies, and accounts receivable for
$400,000. The purchase price included payment of $200,000 at closing, $50,000
due on April 15, 1997, $50,000 due on June 1, 1997, and $100,000 due on
January 1, 1998. Interest on the unpaid balance is payable at 6 percent per
annum. The acquisition was accounted for as a purchase transaction.
F-50
DEDICATED DENTAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
(2) ACQUISITIONS (CONTINUED)
The following unaudited pro forma information represents the results of the
Company as if all of the acquisitions had occurred at the beginning of each
period presented, after giving effect to amortization of intangibles acquired,
increased interest expense for notes issued related to the acquisitions and
increased state income taxes:
1996 1997
(UNAUDITED) (UNAUDITED)
----------- -----------
Operating revenue....................................... $10,557,488 $9,840,382
----------- ----------
Net income.............................................. $ 1,669,224 $1,427,971
----------- ----------
(3) EQUIPMENT AND LEASEHOLD IMPROVEMENTS
The following table summarizes the components of equipment and leasehold
improvements at December 31, 1995 and 1996 and nine months ended September 30,
1997:
DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
--------- ---------- -------------
Equipment................................ $ 691,496 $ 947,145 $1,282,224
Leasehold improvements................... 81,048 227,711 510,740
Construction in progress................. -- 170,235 --
--------- ---------- ----------
772,544 1,345,091 1,792,964
Less accumulated depreciation and
amortization............................ (387,530) (508,792) (678,273)
--------- ---------- ----------
$ 385,014 $ 836,299 $1,114,691
========= ========== ==========
F-51
DEDICATED DENTAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
(4) LONG-TERM DEBT
Long-term debt consists of the following:
DECEMBER 31, SEPTEMBER 30,
------------------- -------------
1995 1996 1997
-------- --------- -------------
Note payable to bank, principal and
interest payments of $2,108 due monthly
through July 5, 2000, interest at 9.65%... $ 96,283 $ -- $ --
Note payable to bank for various equipment
loans, principal and interest payments of
$7,290 due monthly through November 5,
1998, interest ranging from 7.6 percent to
10.95%.................................... 48,180 -- --
Note payable to seller (see Note 2),
principal and interest payments of $5,000
due monthly through July 1, 2000,
principal and interest payments of $75,000
due January 1, 1997 and April 1, 1997,
interest at 8.5%.......................... -- 321,211 145,459
Note payable to bank, principal and
interest payments of $376 due monthly
through December 1, 2000, interest at
9.5%...................................... -- 15,756 12,713
Note payable to seller (see Note 2), due
January 1, 1998, interest
at 6%..................................... -- -- 100,000
Note payable to bank, principal and
interest payments of $9,374 due monthly
through January 15, 2002, interest at
9.25%..................................... -- -- 346,667
Note payable to bank, principal and
interest payments of $8,505 due monthly
through June 15, 2002, interest at 9.5%... -- -- 332,500
-------- --------- ---------
144,463 336,967 937,339
Less current maturities.................... (39,851) (187,403) (301,463)
-------- --------- ---------
$104,612 $ 149,564 $ 635,876
======== ========= =========
F-52
DEDICATED DENTAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
Maturities of long-term debt at September 30, 1997 are summarized as
follows:
1997............................................................. $ 50,436
1998............................................................. 304,149
1999............................................................. 208,826
2000............................................................. 186,589
2001............................................................. 150,000
2002............................................................. 37,339
--------
$937,339
========
(5) COMMITMENTS AND CONTINGENCIES
The Company leases office space and equipment for its corporate and dental
practice offices under various noncancelable operating leases. See Note 6 for
related party leases. Future minimum lease payments due to unrelated parties
are summarized as follows:
1997............................................................. $ 31,143
1998............................................................. 102,133
1999............................................................. 90,574
2000............................................................. 86,976
2001............................................................. 50,484
Thereafter....................................................... 64,414
--------
$425,724
========
Rental expense totaled $91,881, $112,400 and $113,438 for the years ended
December 31, 1995 and 1996 and the nine months ended September 30, 1997,
respectively.
In September 1997, the Company signed a definitive merger agreement pursuant
to which all of its outstanding shares of common stock will be acquired by
Gentle Dental Service Corporation, a publicly-traded Washington Corporation.
This sale is part of a larger transaction entered into by the Company's
shareholders in which both the Company and DPM and related dental offices will
be sold for consideration of approximately $22,750,000, paid partially in cash
and partially in stock. The accompanying financial statements do not reflect
any effects of this transaction.
(6) RELATED PARTY TRANSACTIONS
California Dental Practice Management Company ("DPM"), an entity owned by
the shareholders of the Company, provides accounting, human resource and
dental office operations services to the Company for $8,000 per month under a
management agreement ("Management Agreement"). The agreement was amended
effective September 1, 1996 and the monthly allocation was reduced to $5,600
per month. The amended agreement expires December 31, 2001.
The Company paid certain operating expenses of DPM from 1994 through April
1997 aggregating $760,613. In 1997, DPM began repaying the amount due. The
receivable from related party relating to this transaction is included in the
balance sheet as a reduction of shareholders' equity.
F-53
DEDICATED DENTAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER 30, 1997
The Company leases the following dental practice offices from DPM: Rosedale
Dental Practice located in Bakersfield, California Dental Center located in
Bakersfield, San Dimas Orthodontic Center located in Bakersfield, Delano
Family Dentistry located in Delano, and Lake Isabella Family Dentistry located
in Lake Isabella. The leases require aggregate monthly payments of up to
$20,500 and expire at various dates through February 2007. Rental expense,
aggregating $256,753, $174,500 and $166,500 for the years ended
December 31, 1995 and 1996 and the nine months ended September 30, 1997,
respectively, and are included in dental care expenses.
Future minimum lease payments under lease agreements with DPM and the
shareholders at September 30, 1997 are summarized as follows:
1997........................................................... $ 61,500
1998........................................................... 246,000
1999........................................................... 210,000
2000........................................................... 210,000
2001........................................................... 210,000
Thereafter .................................................... 714,500
----------
$1,652,000
==========
F-54
REPORT OF INDEPENDENT ACCOUNTANTS
November 17, 1997
To the Partners of
California Dental Practice Management Company
and Related Dental Offices
In our opinion, the accompanying combined balance sheet and the related
combined statements of operations, of changes in capital and of cash flows
present fairly, in all material respects, the financial position of California
Dental Practice Management Company and Related Dental Offices ("the Company")
at December 31, 1995 and 1996 and September 30, 1997 and the results of their
operations and their cash flows for the years ended December 31, 1995 and 1996
and for the nine months ended September 30, 1997, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the management of California Dental Practice Management
Company and Related Dental Offices; 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 generally accepted auditing
standards 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.
As disclosed in Note 4 to the financial statements, California Dental
Practice Management Company and Related Dental Offices have certain related
party transactions.
As disclosed in Note 5 to the financial statements, California Dental
Practice Management and Related Dental Offices during September 1997 have
signed definitive agreements to sell most of their operating assets, except
land and buildings, to Gentle Dental Service Corporation, a publicly-traded
Washington Corporation.
Price Waterhouse LLP
F-55
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
BALANCE SHEET
DECEMBER 31, 1995 AND 1996, AND SEPTEMBER 30, 1997
1995 1996 1997
---------- ---------- ----------
ASSETS
Current assets:
Cash and cash equivalents.................... $ 33,360 $ 51,939 $ 46,236
Account receivable, net (Note 1)............. 382,868 281,665 277,043
Supplies..................................... -- 20,990 24,527
Prepaid expenses and other current assets
(Note 1).................................... 3,996 15,604 11,800
---------- ---------- ----------
Total current assets....................... 420,224 370,198 359,606
Property and equipment, net (Note 2)........... 2,126,360 2,058,867 1,931,839
Other assets (Note 1).......................... 16,836 5,121 2,576
---------- ---------- ----------
Total assets............................... $2,563,420 $2,434,186 $2,294,021
========== ========== ==========
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities:
Accounts payable............................. $ 97,434 $ 125,162 $ 89,200
Accrued liabilities.......................... 54,644 60,121 64,951
Due to affiliates (Note 4)................... 439,919 658,365 522,076
Unearned rental income (Note 4).............. -- 16,358 --
Current portion of long-term debt and capital
lease obligations (Note 3).................. 160,664 142,421 177,373
---------- ---------- ----------
Total current liabilities.................. 752,661 1,002,427 853,600
Long-term debt, less current portion (Note 3).. 997,500 855,082 1,089,575
---------- ---------- ----------
Total liabilities.......................... 1,750,161 1,857,509 1,943,175
Commitments and contingent liabilities (Note 5)
Capital........................................ 813,259 576,677 350,846
---------- ---------- ----------
Total liabilities and partners' capital.... $2,563,420 $2,434,186 $2,294,021
========== ========== ==========
The accompanying notes are an integral part of this statement.
F-56
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
STATEMENT OF OPERATIONS
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND NINE MONTHS ENDED SEPTEMBER 30,
1997
1995 1996 1997
---------- ---------- ----------
Dental practice revenue................... $5,667,309 $6,347,066 $3,725,292
Management services revenue from
affiliates............................... 108,872 163,187 133,140
---------- ---------- ----------
5,776,181 6,510,253 3,858,432
Practice clinical salaries and benefits... 2,163,387 2,395,454 1,405,286
Practice non-clinical salaries and
benefits................................. 453,444 459,436 277,967
Dental supplies and lab expenses.......... 469,934 514,649 427,576
Practice occupancy expense................ 212,581 200,974 109,348
Practice selling, general and
administrative expenses.................. 320,545 419,429 383,280
Corporate selling, general and
administrative expenses.................. 905,092 899,016 647,199
Depreciation and amortization............. 149,121 132,632 78,498
---------- ---------- ----------
Total operating expenses.................. 4,674,104 5,021,590 3,329,154
---------- ---------- ----------
Operating income.......................... 1,102,077 1,488,663 529,278
Nonoperating income (expense):
Interest expense, net................... (102,651) (86,769) (70,789)
Other income, net....................... 380,657 149,203 121,858
---------- ---------- ----------
278,006 62,434 51,069
---------- ---------- ----------
Net income................................ $1,380,083 $1,551,097 $ 580,347
========== ========== ==========
The accompanying notes are an integral part of this statement.
F-57
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
STATEMENT OF CHANGES IN CAPITAL
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND NINE MONTHS ENDED SEPTEMBER 30,
1997
CAPITAL
-----------
Balance at December 31, 1994....................................... $ 725,451
Net income....................................................... 1,452,083
Distributions to owners ......................................... (1,632,782)
Contributions from owners........................................ 268,507
-----------
Balance at December 31, 1995....................................... 813,259
Net income....................................................... 1,551,097
Distributions to owners.......................................... (1,924,125)
Contributions from owners........................................ 136,446
-----------
Balance at December 31, 1996....................................... 576,677
Net income....................................................... 580,347
Distributions to owners.......................................... (806,178)
-----------
Balance at September 30, 1997...................................... $ 350,846
===========
The accompanying notes are an integral part of this statement.
F-58
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995 AND 1996, AND NINE MONTHS ENDED SEPTEMBER 30,
1997
1995 1996 1997
----------- ----------- ---------
Cash flows from operating activities:
Net income.............................. $ 1,452,083 $ 1,551,097 $ 580,347
Adjustments to reconcile change in net
cash used in operating activities:
Depreciation and amortization......... 114,621 132,633 78,498
Loss on disposition of equipment...... -- 70,460 33,789
Changes in certain assets and
liabilities:
Accounts receivable, net.............. (27,347) 101,203 4,622
Supplies.............................. -- (20,990) (3,537)
Prepaid expenses and other current
assets............................... (3,996) (11,608) (15,696)
Other assets.......................... 33,251 11,715 2,545
Accounts payable...................... (2,087) 27,728 (35,962)
Accrued liabilities................... 4,644 5,477 4,830
Unearned rental income................ -- 16,358 (16,358)
Due to affiliates..................... 211,735 218,446 (136,289)
----------- ----------- ---------
Net cash used in operating
activities......................... 1,782,904 2,102,519 496,789
----------- ----------- ---------
Cash flows from investing activities:
Purchase of property and equipment...... (368,707) (44,485) (38,119)
----------- ----------- ---------
Net cash used in investing
activities......................... (368,707) (44,485) (38,119)
----------- ----------- ---------
Cash flows from financing activities:
Proceeds from notes payable............. 273,986 -- 657,750
Payments on notes payable............... (158,863) (160,661) (388,305)
Cash contributions by owners............ 157,665 45,331 --
Distributions to owners................. (1,632,782) (1,924,125) (733,818)
----------- ----------- ---------
Net cash provided by financing
activities......................... (1,359,994) (2,039,455) (464,373)
----------- ----------- ---------
Increase (decrease) in cash and cash
equivalents.............................. 54,203 18,579 (5,703)
Cash and cash equivalents, beginning of
year..................................... (20,843) 33,360 51,939
----------- ----------- ---------
Cash and cash equivalents, end of year.... $ 33,360 $ 51,939 $ 46,236
=========== =========== =========
The accompanying notes are an integral part of this statement.
F-59
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1996, AND SEPTEMBER 30, 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
California Dental Practice Management Company and Related Dental Offices
(the "Company") collectively include certain accounts of California Dental
Practice Management Company ("DPM") (a partnership which provides management
services to affiliated dental practices), Indio Dental Clinic (a dental office
wholly owned by the majority owner of DPM), and five dental offices (Ming & H,
Crosstown, Wasco, Rosedale, and Valley) owned by various practicing dentists.
As a combined entity, the Company provides dental services to patients, bills
and collects patient receivables related to the foregoing six dental offices,
and provides administrative support services to dental offices owned by an
affiliated company, Dedicated Dental Systems, Inc. (DDS). All of the Company's
operations are in Southern California.
The Company and DDS, a corporation which owns and operates dental offices
and provides managed healthcare insurance, are related through common
ownership. The Company and its affiliates structure their business enterprises
to comply with state regulatory mandates requiring dentistry practices to be
owned and operated by state-licensed dentists.
In November 1996 the Valley dental office was purchased by DDS. In February
1997 the Company opened a dental practice, Wasco, through a joint effort with
the owner of the Crosstown dental office. In March 1997 the Rosedale dental
office was purchased by DDS.
Principles of combination
The accompanying combined financial statements include certain accounts of
DPM and the dental offices noted above. The entities have been combined for
financial reporting purposes because DPM manages the dental practices and
receives 51% of the net profits therefrom in exchange for its management
services. In addition, DPM and each of the dental offices have entered into
agreements to sell most of their assets to Gentle Dental Service Corporation
(see Note 5). Intercompany transactions and balances including those related
to the management services have been eliminated.
Revenues
Revenues consist primarily of dental services charged to patients, net of
provisions for contractual adjustments and doubtful accounts. Management
services revenue consists of support services charged to affiliated dental
offices and laboratories. Such revenues are recognized when earned.
Statement of cash flows
Cash equivalents consist of highly liquid investments with maturities at the
date of purchase of ninety days or less. During 1995 and 1996, the Company
received non-cash capital contributions of land and buildings of $110,842 and
$91,115, respectively. During 1997, DPM distributed assets of $72,310 to its
owners. These transactions have been excluded from the accompanying statement
of cash flows. For the years ended December 31, 1995 and 1996 and the nine
months ended September 30, 1997, the Company paid interest of $102,672,
$86,769 and $77,115, respectively. As DPM is a partnership and the Related
Dental Offices are sole proprietorships, all income tax liabilities are
attributed to the individual owners.
F-60
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996, AND SEPTEMBER 30, 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Accounts receivable and allowances for contractual adjustments
Accounts receivable principally represent receivables from patients or
dental group insurance carriers for dental services provided by the dental
offices. The Company has recorded an allowance for contractual adjustments of
$195,835, $132,170 and $189,687 at December 31, 1995 and 1996 and September
30, 1997, respectively. Contractual adjustments represent an estimate of the
difference between the amount billed by the Company and the amount which the
patient, third party payor or other is contractually obligated to pay the
Company.
Supplies
Supplies consist primarily of operatory dental supplies stored at the DPM
office and at one of the dental offices. Supplies are stated at the lower of
cost (first-in, first-out basis) or market. Supplies are expensed when they
are delivered to the dental offices for consumption.
Prepaid expenses and other current assets
Prepaid expenses and other current assets consist primarily of prepaid
insurance premiums and prepaid property taxes.
Property and equipment
Property and equipment are stated at cost. Expenditures for maintenance and
repairs are charged to expense as incurred and expenditures for additions and
betterments are capitalized. Depreciation of property and equipment is
calculated using the straight-line method over estimated useful lives which
range from 5 to 25 years.
Other assets
Other assets primarily consist of capitalized loan fees incurred upon
issuing debt related to the purchase of property.
Affiliate payables
Affiliate payables consist primarily of amounts owed for payments made by
DDS since 1994 on behalf of the Company related to a consulting agreement. The
payable is partially offset by receivables from DDS related to services
provided to DDS by DPM.
Income taxes
DPM is a partnership under provisions of the Internal Revenue Code. The
Related Dental Offices are sole proprietorships, and as such, the income or
losses of DPM and the Related Dental Offices are attributable to their owners
in their individual tax returns.
Accounting for impairment of long-lived assets
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be
F-61
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996, AND SEPTEMBER 30, 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Disposed Of." The statement provides that impairments of long-lived assets
(including property and equipment and intangible assets) be measured and
valued based on the estimated future cash flows of the Company.
The Company adopted the statement in 1996; however, the adoption did not
have a significant impact on the Company's financial position or results of
operations.
Fair value of financial assets and liabilities
The Company estimates the fair value of its monetary assets and liabilities
based upon the existing interest rates related to such assets and liabilities
compared to current market rates of interest for instruments with a similar
nature and degree of risk. The Company estimates that the carrying value of
all of its monetary assets and liabilities approximates fair value as of
December 31, 1995, 1996 and September 30, 1997.
Accounting estimates
The preparation of the Company's 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 revenues and expenses during the
reported periods. Actual results may differ from these estimates.
(2) PROPERTY AND EQUIPMENT
DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
---------- ---------- -------------
Land and buildings...................... $1,895,430 $1,994,884 $1,994,700
Dental equipment, furniture and
fixtures............................... 533,529 525,662 387,895
Computer equipment...................... 87,845 87,845 87,845
Vehicles................................ 24,617 24,617 24,617
Leasehold improvements.................. 328,374 238,578 196,571
---------- ---------- ----------
2,869,795 2,871,586 2,691,628
Less accumulated depreciation and
amortization........................... (743,435) (812,719) (759,789)
---------- ---------- ----------
$2,126,360 $2,058,867 $1,931,839
========== ========== ==========
F-62
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996, AND SEPTEMBER 30, 1997
(3) LONG-TERM DEBT
The Company has obtained notes from various banks to finance the purchase of
property and equipment and to finance operations. In addition, the Company has
issued notes payable to individuals related to the purchase of dental offices
in prior years. Long-term debt balances are as follows:
DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
---------- --------- -------------
Note payable to bank with interest-only
payments until maturity at prime plus
1.25% (8.5% at December 31, 1996),
collateralized by real property,
maturing July 2000...................... $ 210,000 $ 174,000 $ 147,000
Note payable to bank due in monthly
instalments of principal and interest at
11%, secured by a vehicle, maturing
February 1998........................... 11,078 6,154 2,462
Note payable to bank due in equal monthly
instalments of principal and interest at
prime plus 2% (10.25% at December 31,
1996), maturing April 2000.............. 49,818 38,744 29,994
Note payable to bank due in monthly
instalments of $2,894 for principal and
interest at 8.65% through February 1998,
secured by real property with the
remainder due March 1998................ 248,415 234,637 223,496
Notes payable to bank due in monthly
instalments of principal and interest at
prime plus 1.25% (8.5% at December 31,
1996), maturing December 1996........... 25,000 -- --
Mortgage payable to bank due in monthly
instalments of principal and interest at
8.35%, secured by real property,
maturing June 1996 (see Note 4--Building
Partnership)............................ 248,121 232,807 220,786
Note payable to bank, due in monthly
instalments of principal and interest at
9.65%, secured by real property,
maturing September 2002................. -- -- 188,145
Various unsecured notes payable due in
monthly instalments of principal and
interest at interest rates ranging from
8% to 9%................................ 365,732 311,161 455,065
---------- --------- ----------
1,158,164 997,503 1,266,948
Less current portion..................... (160,664) (142,421) (177,373)
---------- --------- ----------
$ 997,500 $ 855,082 $1,089,575
========== ========= ==========
F-63
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996, AND SEPTEMBER 30, 1997
(3) LONG-TERM DEBT (CONTINUED)
Scheduled maturities of long-term debt at September 30, 1997 are as follows:
1997........................................................... $ 45,035
1998........................................................... 389,018
1999........................................................... 161,465
2000........................................................... 170,324
2001........................................................... 110,024
Thereafter..................................................... 391,082
----------
$1,266,948
==========
(4) TRANSACTIONS WITH AFFILIATES
Management services
DPM provides accounting, human resources and dental office operations
services to DDS under a management agreement. The amended management agreement
expires December 31, 2001. The revenue related to these services is included
in management services revenues. In addition, DPM purchases dental supplies in
bulk and sells these supplies to its affiliated dental offices at cost.
During 1995, 1996 and 1997, DPM leased the following dental practice offices
to DDS: California Dental Center, Rosedale Dental Practice and San Dimas
Orthodontic Center located in Bakersfield, California, Delano Family Dentistry
located in Delano, California, and Lake Isabella Family Dentistry located in
Lake Isabella, California. In addition, in 1996 the owners contributed a
dental practice office located in Arvin, California to the Company, which the
Company began leasing to DDS in 1997. The leases call for aggregate monthly
payments to DPM of up to $20,500 and expire at various dates through February
2007. Future minimum lease payments to be received from DDS under these
operating leases at September 30, 1997 are summarized as follows:
1997........................................................... $ 61,500
1998........................................................... 246,000
1999........................................................... 210,000
2000........................................................... 210,000
2001........................................................... 210,000
Thereafter..................................................... 714,500
----------
$1,652,000
==========
Rental income of $256,753, $174,500 and $166,500 is included in other income
for the years ended December 31, 1995 and 1996 and the nine months ended
September 30, 1997, respectively.
Payables to affiliates
DDS has paid certain operating expenses from 1994 through April 1997
aggregating $760,613 relating to a consulting agreement on behalf of DPM.
During 1997, the Company began repaying this balance. Accordingly, payables to
DDS of $456,368, $684,552 and $522,076 as of December 31, 1995 and 1996 and
September 30, 1997, respectively, are included on the balance sheet as a
component of the payable to affiliates. This balance is net of receivables
from affiliates for management services and dental supplies (See Note 6).
F-64
CALIFORNIA DENTAL PRACTICE MANAGEMENT COMPANY AND RELATED DENTAL OFFICES
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996, AND SEPTEMBER 30, 1997
(4) TRANSACTIONS WITH AFFILIATES (CONTINUED)
Building Partnership
The Company co-owns a building which houses San Dimas Orthodontic Clinic, an
orthodontic practice owned by DDS. The building was financed through the
issuance of a long-term loan from a bank to a partnership which includes the
owners of California Dental Practice Management Company. According to the
terms of the building partnership, the Company is responsible for 44.52% of
the mortgage payment and common area charges relating to the building. The
total mortgage balance was $557,325, $522,927 and $495,814 at December 31,
1995, 1996 and September 30, 1997, respectively; accordingly, the Company's
obligation for the mortgage aggregated $248,121, $232,807 and $220,786 at
December 31, 1995 and 1996 and September 30, 1997, respectively (see Note 3).
(5) COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases certain of its dental practice offices. These leases
range in terms from five to ten years. Rent expense, including month-to-month
rentals, for the years ended December 31, 1995 and 1996 and the nine months
ended September 30, 1997 aggregated $167,075, $154,304 and $52,428,
respectively.
Management expects to renew or replace leases that expire. Following is a
summary of scheduled future minimum lease payments:
1997............................................................. $ 20,061
1998............................................................. 80,904
1999............................................................. 85,128
2000............................................................. 86,088
2001............................................................. 49,344
Thereafter....................................................... 236,310
--------
$557,835
========
In September 1997 the Company signed definitive agreements to sell all of
its assets, except for its land and buildings with a net book value of
$1,724,700 and certain assets of DPM related to dental offices not included in
these combined financial statements, to Gentle Dental Service Corporation, a
publicly traded Washington Corporation. This sale is part of a larger
transaction entered into by the owners of the Company in which both DPM, the
dental offices and DDS will be sold for an aggregate consideration of
approximately $22,750,000, paid partially in cash and partially in common
stock of Gentle Dental Service Corporation. The accompanying financial
statements do not reflect the effects of this transaction.
F-65
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Gentle Dental Service Corporation:
We have audited the combination of the accompanying supplemental
consolidated balance sheets of Gentle Dental Service Corporation and
subsidiaries as of December 31, 1996 and September 30, 1997, and the related
supplemental consolidated statements of operations, shareholders' equity and
cash flows for each of the years in the two year period ended December 31,
1996 and for the nine-month period ended September 30, 1997. These
supplemental consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
supplemental consolidated financial statements based on our audits. We did not
audit the consolidated balance sheets of Gentle Dental Service Corporation as
of December 31, 1996 and September 30, 1997 and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
years in the two year period ended period December 31, 1996 and for the nine-
month period ended September 30, 1997, which statements reflect total assets
constituting 50% and 42% at December 31, 1996 and September 30, 1997,
respectively, of the related supplemental consolidated financial statement
totals, and which reflect net income constituting 100% of the related
supplemental consolidated financial statement totals for the year ended
December 31, 1995, net losses constituting approximately $985,000 of the
related supplemental consolidated financial statement totals for the year
ended December 31, 1996 and net income constituting $229,000 of the related
supplemental consolidated financial statement totals for the nine-month period
ended September 30, 1997. Those statements were audited by other auditors
whose report has been furnished to us, and our opinion, insofar as it relates
to data included for Gentle Dental Service Corporation, is based solely on the
report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
The supplemental consolidated financial statements give retroactive effect
to the merger of Gentle Dental Service Corporation and GMS Dental Group, Inc.
on November 4, 1997, which has been accounted for as a pooling-of-interests as
described in Note 3 to the supplemental consolidated financial statements.
Generally accepted accounting principles proscribe giving effect to a
completed business combination accounted for by the pooling-of-interests
method in financial statements that do not include the date of consummation.
These financial statements do not extend through the date of consummation.
However, they will become the historical consolidated financial statements of
Gentle Dental Service Corporation and subsidiaries after the financial
statements covering the date of consummation of the business combination are
issued.
In our opinion, the supplemental consolidated financial statements referred
to above present fairly, in all material respects, the financial position of
Gentle Dental Service Corporation and subsidiaries as of December 31, 1996 and
September 30, 1997 and the results of their operations and cash flows for each
of the years in the two year period ended December 31, 1996 and for the nine-
month period ended September 30, 1997 in conformity with generally accepted
accounting principles applicable after financial statements are issued for a
period which includes the date of consummation of the business combination.
KPMG Peat Marwick LLP
Orange County, California
November 14, 1997, except as to the second
paragraph of note 15, which is as of
January 7, 1998 and the fourth
paragraph of note 15, which is as of December 8, 1997
F-66
GENTLE DENTAL SERVICE CORPORATION
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1996 1997
------- -------
ASSETS
Current assets:
Cash and cash equivalents.................................. $ 2,220 $ 147
Accounts receivable, net of allowances of approximately
$1,706 and $2,979 in 1996 and 1997, respectively (note
8)........................................................ 4,826 5,986
Receivables from affiliates................................ 1,197 1,603
Income taxes receivable.................................... 169 134
Supplies................................................... 554 835
Prepaid and other current assets........................... 877 1,157
------- -------
Total current assets..................................... 9,843 9,862
------- -------
Property and equipment, net (notes 5 and 8).................. 5,766 8,424
Intangible assets, net of accumulated amortization (note 6).. 10,330 19,845
Other assets................................................. 457 503
------- -------
Total assets............................................. $26,396 $38,634
======= =======
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED AND COMMON
STOCK AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................... $ 1,650 $ 1,228
Accrued payroll and payroll related costs.................. 1,033 2,078
Other current liabilities.................................. 1,667 1,846
Current portion of long-term debt and capital lease
obligations............................................... 1,124 687
Short-term borrowings...................................... 2,097 --
------- -------
Total current liabilities................................ 7,571 5,839
------- -------
Long-term liabilities:
Obligations under capital leases, net of current portion... 572 641
Long-term debt, net of current portion..................... 1,822 7,971
Other long-term liabilities................................ 91 530
------- -------
Total long-term liabilities.............................. 2,485 9,142
------- -------
Total liabilities........................................ 10,056 14,981
------- -------
Redeemable convertible preferred stock--Series B, $.001 par
value, 9,270,000 shares authorized; 6,180,000 and 6,287,142
shares issued and outstanding in 1996 and 1997,
respectively................................................ 11,055 12,072
Redeemable common stock, no par value, 190,302 and 183,686
shares issued and outstanding in 1996 and 1997,
respectively................................................ 2,199 2,123
Shareholders' equity (notes 8, 9 and 10):
Preferred stock, 30,000,000 shares authorized, no shares
issued and outstanding.................................... -- --
Convertible preferred stock--Series A, $.001 par value;
395,000 shares authorized; 395,000 shares issued and
outstanding in 1996 and 1997.............................. 1 1
Convertible preferred stock--Series C, $.001 par value;
5,000 shares authorized; 1,777 and 2,753 shares issued and
outstanding in 1996 and 1997, respectively................ 1 1
Common stock, no par value, 50,000,000 shares authorized,
2,181,627 and 4,135,638 shares issued and outstanding in
1996 and 1997, respectively............................... 2,890 9,546
Additional paid-in capital................................. 1,443 2,926
Notes receivable from stockholders......................... (136) (300)
Accumulated deficit........................................ (1,113) (2,716)
------- -------
Total shareholders' equity............................... 3,086 9,458
Commitments and contingencies (notes 9, 13 and 14)...........
Subsequent events (note 15)..................................
------- -------
Total liabilities, redeemable convertible preferred and
common stock and shareholders' equity................... $26,396 $38,634
======= =======
See accompanying notes to supplemental consolidated financial statements.
F-67
GENTLE DENTAL SERVICE CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1995 AND 1996
AND THE NINE-MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1995 1996 1997
------ ------- -------
Dental group net patient service revenue............ $ -- $ 3,701 $19,348
Net management fees (support service revenue) ...... 9,781 10,712 10,269
------ ------- -------
Net revenues........................................ 9,781 14,413 29,617
Costs and expenses:
Clinical salaries and benefits.................... -- 1,493 6,571
Practice nonclinical salaries and benefits........ 2,418 4,279 8,122
Dental supplies and lab expenses.................. 1,633 2,830 4,424
Practice occupancy expenses....................... 911 1,563 2,450
Practice selling, general and administrative
expenses......................................... 1,311 1,805 3,199
Corporate selling, general and administrative
expenses......................................... 2,153 2,998 3,845
Depreciation and amortization..................... 482 990 1,295
------ ------- -------
Operating income (loss)......................... 873 (1,545) (289)
Nonoperating income (expense):
Interest expense, net............................. (290) (749) (362)
Other income (expense)............................ (92) (48) (16)
------ ------- -------
(382) (797) (378)
------ ------- -------
Income (loss) before income taxes............... 491 (2,342) (667)
Provision (benefit) for income taxes................ 234 (655) 80
------ ------- -------
Net income (loss)............................... 257 (1,687) (747)
Dividends on redeemable convertible preferred
stock--Series B.................................... -- (240) (829)
Accretion of redeemable common stock................ -- (91) (27)
------ ------- -------
Net income (loss) attributable to common stock.. $ 257 $(2,018) $(1,603)
====== ======= =======
Primary and fully diluted earnings (loss) per
share.............................................. $ .19 $ (.86) $ (.40)
====== ======= =======
See accompanying notes to supplemental consolidated financial statements.
F-68
GENTLE DENTAL SERVICE CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995 AND 1996 AND THE NINE-MONTHS ENDED SEPTEMBER 30,
1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
SHARES OF SHARES OF
CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE NOTES
PREFERRED PREFERRED PREFERRED PREFERRED SHARES OF ADDITIONAL RECEIVABLE ACCUMULATED
STOCK-- STOCK-- STOCK-- STOCK-- COMMON COMMON PAID-IN FROM EARNINGS
SERIES A SERIES A SERIES C SERIES C STOCK STOCK CAPITAL SHAREHOLDERS (DEFICIT)
----------- ----------- ----------- ----------- --------- ------ ---------- ------------ -----------
Balance December
31, 1994........ -- -- -- -- 1,154,250 $ 533 -- -- 735
Issuance of
common stock in
exchange for
note
receivable...... -- -- -- -- 4,000 40 -- (40) --
Issuance of
common stock
pursuant to
stock incentive
plan............ -- -- -- -- 20,112 201 -- -- --
Issuance of
common stock in
connection with
acquisitions.... -- -- -- -- 28,456 387 -- -- --
Issuance of
common stock in
connection with
private
placement, net
of offering
costs........... -- -- -- -- 169,327 1,634 -- -- --
Options granted
to non-
employees....... -- -- -- -- -- -- 152 -- --
Repurchases of
common stock.... -- -- -- -- (10,000) -- -- -- --
Distributions to
shareholders.... -- -- -- -- -- -- -- -- (87)
Net income...... -- -- -- -- -- -- -- -- 257
--- --- --- --- --------- ------ --- --- ---
Balance at
December 31,
1995............ -- -- -- -- 1,366,145 $2,795 152 (40) 905
=== === === === ========= ====== === === ===
TOTAL
SHAREHOLDERS'
EQUITY
-------------
Balance December
31, 1994........ 1,268
Issuance of
common stock in
exchange for
note
receivable...... --
Issuance of
common stock
pursuant to
stock incentive
plan............ 201
Issuance of
common stock in
connection with
acquisitions.... 387
Issuance of
common stock in
connection with
private
placement, net
of offering
costs........... 1,634
Options granted
to non-
employees....... 152
Repurchases of
common stock.... --
Distributions to
shareholders.... (87)
Net income...... 257
-----
Balance at
December 31,
1995............ 3,812
=====
See accompanying notes to supplemented consolidated financial statements.
F-69
GENTLE DENTAL SERVICE CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995 AND 1996 AND THE NINE-MONTHS ENDED SEPTEMBER 30,
1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
SHARES OF SHARES OF
CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE NOTES
PREFERRED PREFERRED PREFERRED PREFERRED SHARES OF ADDITIONAL RECEIVABLE ACCUMULATED
STOCK-- STOCK-- STOCK-- STOCK-- COMMON COMMON PAID-IN FROM EARNINGS
SERIES A SERIES A SERIES C SERIES C STOCK STOCK CAPITAL SHAREHOLDERS (DEFICIT)
----------- ----------- ----------- ----------- --------- ------ ---------- ------------ -----------
Balance December
31, 1995........ -- -- -- -- 1,366,145 2,795 152 (40) 905
Issuance of
common stock in
exchange for
notes
receivable...... -- -- -- -- 608,527 1 136 (136) --
Redeemable
convertible
preferred
stock--Series B
issuance costs.. -- -- -- -- -- -- (1,266) -- --
Stock warrants
issued related
to debt
financing....... -- -- -- -- -- -- 9 -- --
Exercise of
stock options... -- -- -- -- 2,000 2 -- -- --
Common stock
issued for
acquisitions.... -- -- -- -- 226,455 68 99 -- --
Convertible
preferred
stock--Series A
issued for
acquisitions.... 395 1 -- -- -- -- 295 -- --
Convertible
preferred
stock--Series C
issued for
acquisitions.... -- -- 1,777 1 -- -- 1,733 -- --
Stock options
granted to
nonemployees.... -- -- -- -- -- -- 52 -- --
Stock warrants
issued related
to line of
credit
guarantees...... -- -- -- -- -- -- 233 -- --
Accretion of put
rights.......... -- -- -- -- -- -- -- -- (91)
Repurchase of
common stock.... -- -- -- -- (24,000) (1) -- -- --
Common stock
granted to
nonemployees.... -- -- -- -- 2,500 25 -- -- --
Proceeds from
note
receivable...... -- -- -- -- -- -- -- 40 --
Dividends on
redeemable
convertible
preferred
stock--Series
B............... -- -- -- -- -- -- -- -- (240)
Net loss........ -- -- -- -- -- -- -- -- (1,687)
--- --- ----- --- --------- ----- ------ ---- ------
Balance December
31, 1996........ 395 1 1,777 1 2,181,627 2,890 1,443 (136) (1,113)
Common stock
issued for
Acquisitions.... -- -- -- -- 109,039 475 -- -- --
Convertible
preferred
stock--Series C
issued for
acquisitions.... -- -- 976 -- -- -- 976 -- --
Common stock
issued for
Public offering,
net of offering
costs........... -- -- -- -- 1,500,000 6,125 -- -- --
Common stock
issued for
Employee
purchase plan... -- -- -- -- 1,054 5 -- -- --
Common stock
issued for
Exercise of
stock options... -- -- -- -- 10,100 50 -- -- --
Common stock
issued for stock
options granted
to non-
employees....... -- -- -- -- -- -- 42 -- --
Accretion of put
rights.......... -- -- -- -- -- -- -- -- (27)
Common stock
issued pursuant
to options for
notes
receivable...... -- -- -- -- 333,818 1 150 (150) --
Interest accrued
on notes
receivable...... -- -- -- -- -- -- -- (14) --
Shares reserved
on earnout
agreement....... -- -- -- -- -- -- 314 -- --
Issuance of
common stock
warrants for
acquisition..... -- -- -- -- -- -- 1 -- --
Dividends on
redeemable
convertible
preferred
stock--Series
B............... -- -- -- -- -- -- -- -- (829)
Net loss........ -- -- -- -- -- -- -- -- (747)
--- --- ----- --- --------- ----- ------ ---- ------
Balance at
September 30,
1997............ 395 1 2,753 1 4,135,638 9,546 2,926 (300) (2,716)
=== === ===== === ========= ===== ====== ==== ======
TOTAL
SHAREHOLDERS'
EQUITY
-------------
Balance December
31, 1995........ 3,812
Issuance of
common stock in
exchange for
notes
receivable...... 1
Redeemable
convertible
preferred
stock--Series B
issuance costs.. (1,266)
Stock warrants
issued related
to debt
financing....... 9
Exercise of
stock options... 2
Common stock
issued for
acquisitions.... 167
Convertible
preferred
stock--Series A
issued for
acquisitions.... 296
Convertible
preferred
stock--Series C
issued for
acquisitions.... 1,734
Stock options
granted to
nonemployees.... 52
Stock warrants
issued related
to line of
credit
guarantees...... 233
Accretion of put
rights.......... (91)
Repurchase of
common stock.... (1)
Common stock
granted to
nonemployees.... 25
Proceeds from
note
receivable...... 40
Dividends on
redeemable
convertible
preferred
stock--Series
B............... (240)
Net loss........ (1,687)
------
Balance December
31, 1996........ 3,086
Common stock
issued for
Acquisitions.... 475
Convertible
preferred
stock--Series C
issued for
acquisitions.... 976
Common stock
issued for
Public offering,
net of offering
costs........... 6,125
Common stock
issued for
Employee
purchase plan... 5
Common stock
issued for
Exercise of
stock options... 50
Common stock
issued for stock
options granted
to non-
employees....... 42
Accretion of put
rights.......... (27)
Common stock
issued pursuant
to options for
notes
receivable...... 1
Interest accrued
on notes
receivable...... (14)
Shares reserved
on earnout
agreement....... 314
Issuance of
common stock
warrants for
acquisition..... 1
Dividends on
redeemable
convertible
preferred
stock--Series
B............... (829)
Net loss........ (747)
------
Balance at
September 30,
1997............ 9,458
======
See accompanying notes to supplemental consolidated financial statements.
F-70
GENTLE DENTAL SERVICE CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995 AND 1996
AND FOR THE NINE-MONTH PERIOD ENDING SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
1995 1996 1997
------- ------ ------
Cash flows from operating activities:
Net income (loss).................................... $ 257 (1,687) (747)
Adjustments to reconcile change in net cash (used in)
provided by operating activities:
Depreciation and amortization....................... 482 990 1,295
Loss on disposal of assets.......................... 86 63 36
Loss on investment in joint venture................. -- 87 68
Stock options granted to nonemployees............... 152 52 42
Stock issued for fees and compensation.............. -- 25 --
Amortization of warrants............................ -- 242 --
Deferred income taxes............................... 71 (146) 207
Deferred rent....................................... -- 5 24
Change in assets and liabilities, net of the effect
of acquisitions:
Accounts receivable, net........................... 349 (997) 733
Receivables from affiliates........................ (2,476) (562) (493)
Income taxes receivable............................ (225) 5 35
Supplies........................................... (165) (48) 13
Prepaid expenses and other current assets.......... (11) 52 (681)
Other assets....................................... (79) 46 (110)
Accounts payable................................... 88 346 (524)
Accrued liabilities................................ 686 1,145 1,004
------- ------ ------
Net cash (used in) provided by operating
activities........................................ (785) (382) 902
------- ------ ------
Cash flows from investing activities:
Purchase of property and equipment................... (1,251) (873) (1,337)
Proceeds from sale of property and equipment......... -- -- 22
Cash paid for investment in joint venture............ -- (75) --
Cash paid for organization costs..................... -- (5) --
Cash paid for acquisitions, including other direct
costs, net of cash acquired......................... (1,073) (7,268) (7,661)
Dental clinic acquisition prepayments................ (309) -- --
------- ------ ------
Net cash used in investing activities.............. (2,633) (8,221) (8,976)
------- ------ ------
See accompanying notes to supplemental consolidated financial statements.
F-71
GENTLE DENTAL SERVICES CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
1995 1996 1997
------- ------ ------
Cash flows from financing activities:
Net proceeds (payments) on short-term borrowings.... $ 916 1,048 (2,097)
Proceeds from issuance of long-term debt............ 2,703 466 4,300
Payments on long-term debt and obligations under
capital leases..................................... (1,290) (1,232) (2,925)
Payments of deferred financing costs................ -- (150) --
Proceeds from issuance of common stock and preferred
stock.............................................. 1,835 10,551 7,694
Common stock issuance costs......................... -- (500) (918)
Proceeds from note receivable....................... -- 40 --
Distributions to shareholders....................... (87) -- --
Exercise of put rights.............................. -- (90) (103)
Exercise of options................................. -- -- 50
Other............................................... -- 1 --
------- ------ ------
Net cash provided by financing activities......... 4,077 10,134 6,001
------- ------ ------
Increase (decrease) in cash and cash equivalents.. 659 1,531 (2,073)
Cash and cash equivalents, beginning of period........ 30 689 2,220
------- ------ ------
Cash and cash equivalents, end of period.............. $ 689 2,220 147
======= ====== ======
Supplemental disclosure of cash flow information:
Cash paid during period:
Interest paid..................................... $ 290 489 341
Income taxes paid (received)...................... 350 (159) (28)
======= ====== ======
See accompanying notes to supplemental consolidated financial statements.
F-72
GENTLE DENTAL SERVICE CORPORATION
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
1995 1996 1997
------ ------ ------
Supplemental schedule of noncash investing and financing
activities:
Purchases of property and equipment under capital lease
agreements............................................. $ 534 $ 825 $ 414
Issuance of notes receivable to shareholders for
purchase of common stock............................... 40 136 150
Interest accrued on notes receivable from shareholders.. -- -- 14
Accretion of put rights................................. -- 91 27
Issuance of common stock to founders and to purchase the
predecessor companies.................................. -- 530 --
Issuance of redeemable convertible preferred stock--
Series B to investment bankers for services............ -- 314 --
Issuance of convertible preferred stock--Series C to
purchase dental practices.............................. -- 1,734 976
Notes payable issued to purchase dental practices....... -- -- 3,214
Shares reserved for earnout agreements.................. -- -- 314
Issuance of notes receivable to shareholders for common
stock.................................................. -- 136 164
====== ====== ======
Acquisition of tangible assets from related parties:
Liabilities assumed or issued........................... $2,093 $ -- $ --
Tangible assets acquired................................ 2,093 -- --
====== ====== ======
Acquisition of clinics from unrelated parties:
Intangible assets....................................... $2,012 $1,335 $2,480
Liabilities assumed or issued........................... 453 148 893
Common stock issued in connection with acquisitions..... 1,098 597 475
Dental clinic acquisition prepayments................... -- 309 --
====== ====== ======
See accompanying notes to supplemental consolidated financial statements.
F-73
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1996 AND SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(1) ORGANIZATION
Gentle Dental Service Corporation (GDS or the Company), incorporated on
December 14, 1992, is a Washington corporation. The Company, as part of a
multi-specialty dental care delivery network, provides support services to
dental professional corporations (PC's) under long-term service agreements.
Under the terms of the service agreements, the Company, among other things,
bills and collects patient receivables and provides all administrative support
services to the PC's in exchange for support services fees.
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
$7,500,000. The Company received net proceeds of approximately $6,125,000, net
of underwriters' discount and total offering expenses. Concurrent with the
receipt of the net proceeds, the company utilized $4,426,000 to repay certain
outstanding principal under the Company's various bank loan arrangements (see
note 8). No significant gain or loss resulted in connection with the debt
extinguishment.
The Board of Directors granted certain officers of the Company the authority
to reprice employee stock options to the offering price at the date this price
was determinable. All other terms with respect to such options were
maintained. On February 12, 1997 (the offering date), the Company repriced all
employee stock options outstanding to the offering price of $5 per share
(except for certain stock options held by the Company's chief executive
officer, which were repriced at 110% of the offering price). The Company did
not recognize compensation expense related to the repricing of the employee
stock options as the adjusted exercise price was not below the Company's
quoted fair value as of the repricing date.
(2) SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation/Basis of Consolidation
The supplemental consolidated financial statements include the accounts of
GDS and its subsidiaries. All significant intercompany transactions and
accounts have been eliminated. As described more fully in Note 3, on November
4, 1997, GDS merged with GMS Dental Group, Inc. (GMS), with former
stockholders of GMS owning 59% of the combined company upon completion of the
merger. These supplemental 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 for all
periods presented. Upon issuance of financial statements covering the period
which includes the date of the merger, these supplemental consolidated
financial statements will become the historical financial statements of the
Company.
Corporate practice of medicine laws in the states in which the Company
operates prohibit the Company from owning dental practices, instead the
Company enters into exclusive long-term service agreements with the dental
groups. The Company has two primary types of contractual arrangements with the
dental groups. The first type of arrangement involves the provision of
management services to the dental groups under long-term service agreements
where the Company has no control over the activities of the dental groups, and
accordingly, does not consolidate the accounts of the dental groups. See
related discussion of the amended management agreements at note 15.
The second type of arrangement involves the purchase of the operating assets
and management services agreements and the assumption of certain liabilities
of dental groups where the Company has control of the dental groups
activities. The Company retains the right to designate a majority shareholder
or other owner of the dental group as its nominee and an advisory board is
established which governs the activities of the dental groups, of which the
Company retains the right to appoint a majority of the advisory board members.
Through the
F-74
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
management services agreement and its control of the advisory board and
nominee shareholders of the dental practices, the Company has exclusive
authority over the decision making related to all major ongoing operations of
the underlying dental group with the exception of the professional aspects of
the dentistry practice as required by applicable state law. Under the
management services agreement, the Company establishes annual operating and
capital budgets for the dental groups and compensation guidelines for the
licensed dental professionals. The Company consolidates the accounts of the
dental groups since the Company has control over the operations of the dental
practices.
The Company has a 50% equity investment in Celebration Dental Services
L.L.C., a Florida limited liability company, which is accounted for on the
equity basis of accounting.
Net Revenues
Revenues consist primarily of dental group net patient revenue and net
management fees. Dental group net patient revenue represents the revenue of
the dental groups reported at the estimated net realizable amounts from
patients, third party payors and others for services rendered, net of
contractual adjustments. Net management fees represents amounts charged to the
unconsolidated dental groups based on an agreed-upon percentage of dental
group revenues under management services agreements, net of provisions for
contractual adjustments and doubtful accounts. The components of net revenues
are as follow:
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
----------------- -----------------
1995 1996 1997
------- -------- -----------------
PC dental revenue, net of provisions for
contractual adjustments and doubtful
accounts................................. $16,029 $ 21,424 $19,020
Less amounts retained by the PCs.......... (6,248) (10,712) (9,103)
Adjustments to allowance for doubtful
accounts................................. -- -- 230
Retail sales.............................. -- -- 122
------- -------- -------
Support services revenue from affiliates.. 9,781 10,712 10,269
Dental group net patient service revenue.. -- 3,701 19,348
------- -------- -------
Net revenues............................. $ 9,781 $ 14,413 $29,617
======= ======== =======
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
Accounts Receivable and Allowances for Contractual Adjustments and Doubtful
Accounts
Accounts receivable principally represent receivables from patients and
dental group insurance carriers for dental services provided by the related
PC's and are recorded net of contractual allowances. Contractual adjustments
represent an estimate of the difference between the amount billed by the
Company and the amount which the patient, third party payor or other is
contractually obligated to pay the Company.
Affiliate Receivables
Affiliate receivables consist primarily of amounts owed to the Company from
the PCs to reimburse the Company for payment of the PCs' payroll and other
direct costs, net of amounts due to the PCs related to the acquisitions and
the PCs' share of revenues.
Supplies
Supplies consist primarily of disposable dental supplies and instruments
stored at the clinics. Supplies are stated at the lower of cost (first-in,
first-out basis) or market (net realizable value).
Property and Equipment
Property and equipment are stated at cost net of accumulated depreciation
and amortization. Expenditures for maintenance and repairs are charged to
expense as incurred and expenditures for additions and betterments are
capitalized. Depreciation of property and equipment is recorded using the
straight-line method over the shorter of the related lease term or the
estimated useful lives which range from 3 to 15 years.
F-75
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Equipment held under capital leases are stated at the present value of
minimum lease payments at the inception of the lease and is amortized on a
straight-line basis over the shorter of the lease term or the estimated useful
life of the asset. Amortization of assets subject to capital leases is
included in depreciation expense.
Intangible Assets
Intangible assets result primarily from the excess of cost over the fair
value of net tangible assets purchased in acquisitions. Such intangibles
relate primarily to noncompetition covenants, support services agreements and
management services agreements. Intangibles relating to support services
agreements and management agreements consist of the costs of purchasing the
rights to provide management support services to dental practices over the
initial noncancelable 40-year terms of the related agreements. Under these
agreements, the dental groups have agreed to provide dental services on an
exclusive basis only through facilities provided by the Company. Pursuant to
the terms of the agreements, the Company is the exclusive administrator of all
non-dental aspects of the acquired dental practices, providing facilities,
equipment, support staffing, management and other ancillary services. The
agreements are noncancelable except for performance defaults.
Intangible assets are amortized on the straight-line method over their
estimated useful lives, 5 years for organizational costs, 25 years for support
services agreements and management services agreements and other acquired
intangibles, and 40 years for trademarks.
The Company reviews its asset balances for impairment at the end of each
quarter or more frequently when events or changes in circumstances indicate
that the carrying amount of intangibles assets may not be recoverable. To
perform that review, the Company estimates the sum of expected future
undiscounted net cash flows from intangible assets. If the estimated net cash
flows are less than the carrying amount of the intangible asset, the Company
recognizes an impairment loss in an amount necessary to write-down the
intangible asset to a fair value as determined from expected future discounted
cash flows. No write-down for impairment loss was recorded for the years ended
December 31, 1995 and 1996 and the nine-month ended September 30, 1997.
Fair Value of Financial Assets and Liabilities
The Company estimates the fair value of its monetary assets and liabilities
compared to current market rates of interest for instruments with a similar
nature and degree of risk. The Company estimates that the carrying value of
all of its monetary assets and liabilities approximates fair value as of
December 31, 1996 and September 30, 1997.
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.
Net Income (Loss) Per Share
Net income (loss) per share is computed based on the weighted average number
of shares of common stock and common stock equivalents outstanding during the
periods. Common stock equivalents consist of the number of shares issuable
upon exercise of the outstanding common stock warrants and common stock
options (using the treasury stock method). Common stock equivalents are
excluded from the computation if their effect is anti-
F-76
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
dilutive. The number of primary and fully diluted weighted average common and
common equivalent shares utilized for the years ended December 31, 1995 and
1996 were 1,379,960 and 2,354,533, respectively. For the nine months ended
September 30, 1997, the number of primary and fully diluted weighted average
common and common equivalent shares utilized were 4,004,955.
New Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings Per Share." In accordance with this pronouncement, the Company
will adopt the new standard for periods ending after December 15, 1997. The
adoption of this pronouncement will not have an effect on reported earnings
(loss) per share information.
The Emerging Issues Task Force 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
criteria for establishing a controlling financial interest in a physician
practice, the appropriateness of accounting for a transaction between a
physician practice management company and a physician practice as a business
combination, and the appropriateness of accounting for such transactions using
the pooling-of-interests method of accounting. The accompanying financial
statements are prepared in conformity with the consensus reached in EITF 97-2.
Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-
Based Compensation." Under SFAS 123, the Company may elect to recognize stock-
based compensation expense based on the fair value of the awards or continue
to account for stock-based compensation under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and disclose in the
financial statements the effects of SFAS 123 as if the recognition provisions
were adopted. Effective October 11, 1996 (inception), GMS elected to account
for stock-based compensation under Accounting Principles Board Opinion No. 25
(APB 25).
(3) BUSINESS COMBINATIONS, ACQUISITIONS AND RESTRUCTURING
On November 4, 1997, GMS merged into GDS to form the Company. In connection
with the merger transaction, substantially all of the issued and outstanding
shares of GMS common stock were converted into 4,512,377 shares of common
stock of the Company. Immediately prior to the consummation of the merger,
substantially all of the issued and outstanding preferred stock of GMS was
converted to common stock pursuant to the merger. A holder of GMS preferred
stock has notified the Company of his intent to dissent with respect to the
conversion of such shares into 35,784 shares of Company Common Stock. If such
shareholder ultimately pursues his "dissenter rights" the Company will be
required to pay such shareholder cash consideration in an amount determined by
an independent appraisal, in lieu of Company Common Stock.
The merger has been accounted for using the pooling-of-interests method of
accounting. Accordingly, the historical financial statements for the periods
prior to the completion of the combination have been restated as though the
companies had been combined. The restated financial statements have been
adjusted to conform the differing accounting policies of the separate
companies. Such differences related primarily to the use of different lives in
computing depreciation of equipment and amortization of intangible assets.
Furthermore, the presentation of support services revenue (management fees)
has been revised to reflect the dental group net patient service revenue of
unconsolidated dental practices less amounts retained by the unconsolidated
dental groups. Management believes this presentation facilitates the
comparison with the operations of dental practices which are consolidated.
F-77
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
All fees and expenses associated with the merger and the estimated costs of
executing the Company's restructuring plan as a result of the Merger have not
been reflected in the supplemental consolidated statements of operations, but
will be reflected in the Company's consolidated statement of operations for the
quarter ended December 31, 1997. Such fees and expenses are currently estimated
to be approximately $1.8 million of which $264 represents direct transaction
costs, with the remainder representing estimated expenses related to activities
such as restructuring corporate functions and reducing personnel.
The calculation of net income per common and common equivalent share for each
period presented reflects the issuance of 0.44509 of a share of the Company's
common stock for each share of GMS common stock used in such calculation.
Separate and combined results of GDS and GMSC are as follows:
ADJUSTMENTS AND
GMS GDS RECLASSIFICATIONS TOTAL
------- ------- ----------------- -------
Year ended December 31, 1995:
Net patient revenues........... $ -- $ -- $ --
Management fees................ -- 9,781 9,781
------- ------- --- -------
$ -- $ 9,781 -- $ 9,781
======= ======= === =======
Net income..................... $ -- $ 257 -- $ 257
======= ======= === =======
Year ended December 31, 1996:
Net patient revenues........... $ 3,701 $ -- $ 3,701
Management fees................ -- 10,712 10,712
------- ------- --- -------
$ 3,701 $10,712 $14,413
======= ======= === =======
Net loss....................... $ (716) $ (985) $14 $(1,687)
======= ======= === =======
Nine-months ended September 30,
1997:
Net patient revenues........... $19,348 $ -- $19,348
Management fees................ -- 10,269 10,269
------- ------- --- -------
$19,348 $10,269 $29,617
======= ======= === =======
Net (loss) income.............. $ (968) $ 229 $(8) $ (747)
======= ======= === =======
On January 2, 1995, the Company purchased from the PCs the net accounts
receivable of PCs totaling $2,093 in exchange for interest-only promissory
notes payable on December 31, 1995. The principal portion of the promissory
notes issued to the Company was satisfied via reductions to the Company's
receivables from the PCs.
During 1995, the Company acquired substantially all of the assets of seven
dental practices in Washington and Oregon including cash, accounts receivable,
supplies and fixed assets, net of assumption of certain liabilities. The total
purchase price of $2,346 for the seven acquired clinics included $982 paid in
cash, $1,098 in redeemable and nonredeemable common stock, and $175 in
promissory notes. In addition, the Company paid $91 in cash for closing costs
which have been included in the total purchase price. The Company issued a
total of 86,007 shares of stock in conjunction with these acquisitions. 20,000
such shares were valued by management at $10.00 per share for one acquisition
in January 1995 and 66,007 shares were valued at $13.60 per share for the
remaining acquisitions. These common stock amounts reflect the estimated fair
market value at the dates of the acquisitions. Certain shares of the common
stock issued are subject to "put rights" from the shareholders as discussed in
note 9.
F-78
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Outstanding promissory notes issued related to the acquisitions at December
31, 1995 totaled $120, consisting of $57 included in short-term borrowings and
subsequently paid in January 1996 and $63 included in long-term and due in
monthly installments of principal and interest at 10.25% commencing in January
1996 and maturing in December 1998.
In 1996, the Company acquired substantially all of the assets of nine dental
practices, including cash, accounts receivable, supplies and fixed assets, net
of the assumption of certain liabilities. The total purchase price of $10,469
for the nine acquired dental practices included $7,684 in cash, $2,725 in
redeemable and nonredeemable preferred and common stock and a promissory note
for $28. In addition, the Company paid for closing costs of $32 which have
been included in the total purchase price. The Company issued a total of
43,928 shares relating to those acquisitions.
In 1997, the Company acquired substantially all of the assets of seven
dental practices, including cash, accounts receivable, supplies and fixed
assets, net of the assumption of certain liabilities. The total purchase price
of $13,455 for the seven acquired dental practices included $7,661 in cash,
$1,767 in redeemable and nonredeemable preferred and common stock, $3,746 in
promissory notes and the assumption of long-term liabilities for $248. In
addition, the Company paid for closing costs of $33 which have been included
in the total purchase price. The Company issued a total of 109,000 shares of
stock valued at $4.36 per share and 133,527 warrants to purchase common stock
at $7.86 per share in conjunction with these acquisitions. The stock and
warrants amounts reflect the estimated fair market value on the dates of the
acquisitions.
The above acquisitions in 1995, 1996 and 1997 have been accounted for using
the purchase method of accounting. The excess of the total acquisition cost
over the fair value of the net tangible assets acquired representing the
estimated future value of the support services and management services
agreements are being amortized over 25 years using the straight-line method.
The results of operations for these acquisitions have been included in the
financial statements of the Company since the dates of acquisitions.
The following unaudited pro forma summary presents the condensed
consolidated results of operations as if the 1996 and 1997 acquisitions
discussed above had occurred as of January 1, 1996. These pro forma results
have been prepared for comparative purposes only and are not necessarily
indicative of what the actual results of operations would have been had the
acquisitions been made as of those dates, nor does it purport to represent
future operations of the Company:
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -----------------
Pro forma:
Revenue, net.................................. $62,003 50,251
Net loss...................................... (1,010) (547)
------- ------
Net loss per share............................ $ (.25) (.14)
======= ======
The fair value of the stock issued by GMS was determined by GMS based upon
an analysis of the value of the operating assets and liabilities being
acquired using projected discounted cash flows and the negotiation process
between GMS and the sellers. Under certain purchase agreements, the purchase
price is adjustable by the Company for a period between six months and one
year after the closing of the transaction in order to finalize the fair values
of the assets acquired and liabilities assumed.
F-79
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
In connection with the acquisition of two of the dental groups, the Company
is contingently obligated to pay additional consideration, depending on the
achievement of certain financial results, as defined by the purchase
agreements. During 1997, the Company accrued $314 for the portion of 1997
earnouts which the Company expects to pay in shares of common stock.
(4) RECEIVABLES SOLD WITH RECOURSE
Prior to October 11, 1996, one of the acquired practices sold certain of its
receivables to a financial institution with recourse. Under the terms of these
transactions, the practice received 97% of the face value of each receivable.
Additionally, as collateral on these receivables, the practice was required to
maintain a cash balance at the financial institution of approximately 10% of
the outstanding receivables. The recourse provisions require the Company to
repurchase any receivable which becomes more than 150 days delinquent.
The outstanding balance of receivables sold with recourse was approximately
$261,000 at December 31, 1996. As of September 30, 1997, the Company no longer
sells its receivables.
(5) PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows:
1996 1997
------- ------
Dental equipment............................................ $ 3,328 4,905
Computer equipment.......................................... 1,098 1,728
Furniture, fixtures, and equipment.......................... 728 952
Leasehold improvements...................................... 1,681 2,700
Vehicles.................................................... 22 32
Buildings................................................... 48 48
Land........................................................ 10 10
------- ------
Total property and equipment.............................. 6,915 10,375
Less accumulated depreciation and amortization.............. (1,149) (1,951)
------- ------
Property and equipment, net............................... $ 5,766 8,424
======= ======
At December 31, 1996 and September 30, 1997, property and equipment include
assets under capital leases with an original cost of $1,262 and $1,880 and
accumulated amortization of $235 and $427, respectively.
(6) INTANGIBLE ASSETS
Intangible assets consist of the following:
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
Management services agreements.................... $ 7,105 14,671
Support services agreements....................... 3,325 5,805
Trademarks........................................ 50 50
Organizational costs.............................. 75 75
Other............................................. 56 143
------- ------
10,611 20,744
Less accumulated amortization..................... (281) (899)
------- ------
$10,330 19,845
======= ======
F-80
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(7) INVESTMENT IN JOINT VENTURE
The Company is a 50% owner in a joint venture with Private Medical Care,
Inc., a subsidiary of Delta Dental, Inc., in a dental practice located in
Celebration, Florida. The initial investment by the Company consisted of $75
in cash and $150 of contributed assets.
(8) DEBT
Short-Term Borrowings
At December 31, 1996, the Company had a total of $2,097 outstanding under
two bank operating lines of credit with a bank secured by substantially all
assets of the Company. In February 1997, the entire outstanding amount was
fully repaid from the net proceeds from the Offering (see Note 1).
As of September 30, 1997, the Company has a line of credit secured by
substantially all of GDS's accounts receivable. Borrowings under the line bear
interest at prime plus 1% (9.5% at September 30, 1997). The Company may borrow
from the credit line a maximum of $1,850 limited to a borrowing base
calculated at 75% of the Company's eligible accounts receivable. There are no
amounts outstanding under the credit line at September 30, 1997.
The Company must pay a commitment fee of .5% per annum of the average daily
portion of the $1,850 available. The credit line agreement includes provisions
for maintaining certain financial covenants including debt service coverage
ratio, current ratio, debt to intangible net worth ratio, minimum tangible net
worth, and restrictions on payment of cash dividends. The Company is in
compliance with these covenants at September 30, 1997.
The Company has obtained a credit facility from a bank in the amount of
$10,000. The proceeds of the credit facility are available for working capital
needs and to finance acquisitions approved by the bank. Principal amounts owed
under the credit facility bear interest up to 1% above the prime rate or up to
3.25% above LIBOR, at the Company's option, dependent on the Company's
leverage ratio. The outstanding balance on this facility as of September 30,
1997 was $4,300. As of September 30, 1997, the Company was in violation of
certain covenants for which it has obtained a waiver from the bank.
On October 11, 1998, the credit facility will convert from a revolving
facility to a three-year loan. The term loan will provide for 12 equal
quarterly payments of principal and interest. The obligations under this
credit agreement are secured by a security interest in favor of the bank in
all assets of the Company and its subsidiaries. The Company must meet certain
ratios defined by the bank credit agreement.
In connection with this credit facility, the Company issued a warrant to the
bank to purchase up to 81,942 shares of the Company's common stock at a price
of $3.93 per share. The warrant expires in October 2001.
F-81
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Long-term Debt
Long-term debt is summarized as follows:
1996 1997
------ ------
Secured notes payable, bearing interest at rates ranging from
9.75% to 9.99%; monthly principal and interest payments of $5;
maturing at various dates through June 2000; secured by
mortgage....................................................... $ 70 $ 24
Credit facility, bearing interest at 3.25% in excess of LIBOR
rate (9.1% at September 30, 1997).............................. 48 4,300
Subordinated note payable, bearing interest at 8%, payable in
annual installments beginning December 31, 1997 through January
2002........................................................... -- 696
Senior subordinated note payable, discounted at 8%; annual
interest payable in 60 monthly installments of $14, beginning
August 1, 1997 through July 2002............................... -- 667
Senior subordinated note payable, discounted at 8%; annual
interest; balloon payment of $500 due in July 1999............. -- 432
Senior subordinated note payable, discounted at 8%; annual
interest; balloon payment of $2,083 payable in July 2002....... -- 1,419
Note payable to bank due in monthly installments of principal
and interest at prime plus 1.25%, paid during 1997............. 667 --
Notes payable to bank with interest-only payments for the first
12 months at prime plus 1.5%, paid during 1997................. 1,699 --
Various unsecured notes payable, due in monthly installments of
principal and interest at rates ranging from 8.25% to 10.75%,
maturing through November 2003................................. 210 722
------ ------
2,694 8,260
Less current portion............................................ 872 289
------ ------
$1,822 $7,971
====== ======
At September 30, 1997, the aggregate maturities of long-term debt for each
of the next five years are as follows:
1998.................................................................. $ 289
1999.................................................................. 1,886
2000.................................................................. 1,705
2001.................................................................. 2,035
2002.................................................................. 2,308
Thereafter............................................................ 37
------
$8,260
======
F-82
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(9) REDEEMABLE CONVERTIBLE PREFERRED AND COMMON STOCK AND SHAREHOLDERS' EQUITY
The Company has two classes of stock: common stock and preferred stock. As
of September 30, 1997, Preferred stock consists of convertible preferred
stock--Series A, redeemable convertible preferred stock--Series B and
convertible preferred stock--Series C. Common stock consists of redeemable
common stock and non redeemable common stock. The redeemable convertible
preferred stock--Series B, including dividends, and the convertible preferred
stock--Series A and C, were converted to common stock on November 4, 1997
prior to the GMS merger.
Common Stock
Upon formation of the Company, GMS Dental Group, Inc. issued an aggregate
608,527 shares of its common stock at a purchase price of $.23 per share to
the founders of the Company. 269,279 of these shares are subject to a three-
year vesting schedule whereby one-quarter of the shares vested upon issuance
and one-quarter of the shares will vest on October 11, 1997. The remaining
shares vest on a monthly basis during the remaining thirty-six months.
254,903 shares issued to certain other stockholders, which were issued at a
price of $.45 per share, and 339,248 shares out of the 608,527 shares issued
to the founders, are subject to a right of repurchase, at cost, in favor of
the Company that expires upon the earlier of (1) the achievement by the
Company of certain performance milestones over a two-year period or (2) nine
years and nine months from the date of issuance.
Redeemable Preferred and Common Stock
The following summary presents the changes in the redeemable convertible
preferred stock--Series B and redeemable common stock:
SHARES OF
REDEEMABLE REDEEMABLE
CONVERTIBLE CONVERTIBLE SHARES OF
PREFERRED PREFERRED REDEEMABLE REDEEMABLE
STOCK-- STOCK-- COMMON COMMON
SERIES B SERIES B STOCK STOCK
----------- ----------- ---------- ----------
Balance, December 31, 1994... -- $ -- -- $ --
Issued in connection with
acquisitions................ -- -- 57,551 711
--------- ------- ------- ------
Balance, December 31, 1995... -- -- 57,551 711
Issued in connection with
private placement........... 6,180,000 10,815 100,000 957
Issued in connection with
acquisitions................ -- -- 38,994 530
Accretion of put rights...... -- -- -- 91
Exercise of put rights....... -- -- (6,243) (90)
Dividend on redeemable
convertible preferred
stock--Series B............. -- 240 -- --
--------- ------- ------- ------
Balance, December 31, 1996... 6,180,000 11,055 190,302 2,199
--------- ------- ------- ------
Issued in connection with
private placement........... 107,142 188 -- --
Dividend on redeemable
convertible preferred
stock--Series B............. -- 829 -- --
Accretion of put rights...... -- -- -- 27
Exercise of put rights....... -- -- (6,616) (103)
--------- ------- ------- ------
Balance, September 30, 1997.. 6,287,142 $12,072 183,686 $2,123
========= ======= ======= ======
F-83
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Dividends
The holders of the Series B redeemable convertible preferred stock will be
entitled to receive dividends in preference to any dividend on the Series A or
Series C convertible preferred stock and the common stock, at a rate of 10%
per annum of the per share purchase price of the Series B redeemable
convertible preferred stock, which dividend rate will be $.175 per share of
Series B redeemable convertible preferred stock. The dividends payable to the
holders of the Series B redeemable convertible preferred stock are cumulative
and are payable upon the earlier of conversion of such shares into common
stock, the initial public offering of the Company's securities, a liquidation
of the Company or an acquisition of the Company or substantially all of its
assets. Accumulated undeclared dividends as of September 30, 1997 totaled
$1,069.
Liquidation Preference
The holders of the Series B redeemable convertible preferred stock are
entitled to liquidation preferences followed by the holders of the Series A
and Series C convertible preferred stock.
Redemption Rights
After October 11, 2001, any or all of the holders of the Series B redeemable
convertible preferred stock shall have the right to the extent permitted by
law and by the Company's Loan Agreement with Imperial Bank, to require the
Company to repurchase all or any part of such holder's shares of such series
of preferred stock by payment of an amount per share equal to the liquidation
preference amount, together with any accumulated but unpaid dividends on such
redeemed shares. The Series A and Series C convertible preferred stock are not
redeemable.
Conversion Rights
The holders of shares of Series A convertible preferred stock and Series B
redeemable convertible preferred stock have the right to convert such shares
at any time into common stock of the Company. The initial conversion rate will
be on a 1-to-1 basis and will be subject to adjustment for anti-dilution
(including, but not limited to, adjustments to the conversion rates in the
event the Company issues common stock or securities convertible into or
exercisable for common stock at a price per share less than the conversion
price or such series of preferred stock). Each share of Series A convertible
preferred stock and Series B redeemable convertible preferred stock
automatically will be converted into common stock, at the then applicable
conversion rate, upon the written consent of the holders of at least a
majority of the Series A convertible preferred stock and Series B redeemable
convertible preferred stock, voting together as a class.
Each share of Series C convertible preferred stock automatically shall be
converted into common stock, at a ratio equal to $1,000 divided by the Series
C conversion price (as defined below), upon the earlier of (i) the closing of
a firm commitment underwritten public offering of the Company's common stock
or (ii) the acquisition of the Company (by merger, stock purchase, sale of
assets or otherwise) for a purchase price in excess of an amount equal to four
times the aggregate liquidation preferences of all the then outstanding shares
of preferred stock of the Company. For purposes of automatic conversion upon
the closing of a public offering as described above, the Series C conversion
price shall be 75% of the price per share of common stock at which such shares
are sold to the public in the public offering. For purposes of automatic
conversion upon the acquisition of the Company as described above, the Series
C conversion price shall be 75% of the price per share of common stock paid in
such acquisition. The price per share of common stock will be determined by
dividing the total consideration to be received by the Company's shareholders
as a result of such acquisition by the number of shares of common stock then
outstanding on an as-converted basis (including the approximate number
F-84
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
of shares of common stock issuable upon conversion of the Series C convertible
preferred stock upon such acquisition).
Voting Rights
The holders of the Series A and Series B preferred stock shall be entitled
to the number of votes equal to the number of shares of common stock then
issuable upon conversion of such shares. The holders of the Series C preferred
stock shall be entitled to a number of votes equal to 5% of the total voting
power of all outstanding voting securities.
Rights of First Offer
Each purchaser of Series B redeemable convertible preferred stock who
continues to hold at least 25% of such purchaser's original investment or a
transferee who acquires at least 400,000 shares of the Series B redeemable
convertible preferred stock (a Major Investor) will have a right of first
offer to purchase its pro rata share of offerings of new securities of the
Company (other than (i) securities issued to certain employees, directors,
consultants and vendors of the Company, (ii) shares of the Company's capital
stock issued in connection with the acquisition of dental practices and (iii)
securities issued in connection with the Company's business relationships up
to 1% of the then outstanding common stock on an as-converted basis). The
right of first offer will terminate upon an initial public offering of the
Company's common stock.
Redeemable Common Stock
In connection with certain acquisitions, the Company granted "put rights" to
certain shareholders that may require the Company to redeem up to 96,545
shares of its common stock at a redemption price ranging from $13.38 to $19.62
per share. If all shareholders with such "put rights" exercise their options,
the Company would be required to repurchase the above shares of common stock
for $1,409. The redemption periods began April 1, 1996 and continue through
January 4, 2003. If the shareholder does not place a redemption request during
the redemption period, the "put right" will expire on the stated expiration
date. "Put rights" for all but 20,000 shares terminate in the event of the
Company successfully completing a public offering at a price of at least
$20.00 per share. The Company redeemed 6,243 shares of redeemable common stock
for $90 during 1996 and 6,616 shares for $103 during 1997.
The shares of common stock subject to the "put rights" are reported on the
balance sheet as redeemable common stock. Such shares have been recorded at
their fair value as of the dates of acquisition, inclusive of accretion during
the year ended December 31, 1996 and nine months ended September 30, 1997. The
Company records accretion on a ratable basis over the redemption period of the
respective stock. Such accretion for the year ended December 31, 1996 and the
nine months ended September 30, 1997 was $91 and $27, respectively. Accretion
in prior years was insignificant.
Such common stock at September 30, 1997 is redeemable as follows:
NUMBER OF REDEMPTION REDEMPTION
SHARES AMOUNT PRICE RANGE
--------- ---------- ------------
1998....................................... 2,974 $ 50 $ 16.82
1999....................................... 2,754 50 13.38-18.16
2000....................................... 40,849 576 13.60-19.62
2001....................................... 29,681 438 13.60-18.80
2002....................................... 3,714 51 13.60
Thereafter................................. 3,714 51 13.60
------ ------
83,686 $1,216
====== ======
F-85
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Private Placement of Redeemable Common Stock and Warrants
In June 1996, the Company completed a private placement offering (the
offering) of 100,000 shares of the Company's common stock which include
warrants to purchase 100,000 additional shares of the Company's common stock
at an exercise price of $7.50 per share. Total proceeds from the offering (net
of offering costs of $43) were $957. The net proceeds allocated to common
stock aggregated $732. The stock warrants were recorded at their estimated
fair value of $225 and are entitled to certain "piggyback" registration
rights. The stock warrants expire on December 14, 2001; no stock warrants have
been exercised to date.
In connection with the private placement, the shareholder received certain
"put rights" which are exercisable after June 21, 2001 but no later than June
21, 2003 if the Company has not completed a public offering of its common
stock by June 21, 2001 at a price of at least $22.00 per share and with net
proceeds to the Company of at least $10,000. The per share price applicable to
the "put rights" is 20 times the Company's average adjusted net income per
share for the two most recent fiscal years preceding the exercise of the
rights. As of September 30, 1997, the Company has not recorded any accretion
related to the above "put rights."
Preferred Stock
Preferred stock may be issued by the Board of Directors with preferences to
be determined at the time of issuance. Through September 30, 1997, none of the
30,000,000 authorized shares of the Company's preferred stock has been issued
or is outstanding.
Stock Warrants Issued in Conjunction with Debt Issuance and Acquisitions
In May 1996 the Company issued warrants to purchase 4,333 shares of the
Company's common stock at $7.50 per share to a lender in connection with a
line of credit agreement. The stock warrants were valued at $9 and have been
recorded as debt issuance costs and additional paid-in capital. The estimated
fair value of the stock warrants was amortized over the six-month term of the
line of credit. Such amortization expense has been included in interest
expense in the statement of operations. The stock warrants expire on May 31,
2001 and carry certain "piggyback" registration rights. The stock warrants
have not been exercised to date.
In addition, in May 1996, the Company issued to certain directors, officers
and shareholders of the Company warrants to purchase 115,000 shares of the
Company's common stock at $7.50 per share in consideration for guaranteeing a
total of $1,000 on a line-of-credit which is no longer available and has been
fully repaid. The estimated fair value of the stock warrants of $233 was
amortized over the six-month term of the line of credit. Such amortization
expense has been included in interest expense in the statement of operations.
All stock warrants expire in May 2001 and no such stock warrants have been
exercised to date.
In connection with the Company's $10 million credit facility, a warrant was
issued entitling the bank to purchase up to 81,942 shares of the Company's
common stock at a price of $3.93 per share. The warrants were recorded at
their estimated fair market value of $1 and expire in October 2001.
In connection with the acquisition of the net assets of a dental practice,
the Company issued warrants to purchase 133,527 shares of common stock at
$7.86 per share. The warrants expire in 2004; no such stock warrants have been
exercised to date.
F-86
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(10) STOCK OPTIONS
The Board of Directors adopted a Stock Incentive Plan (the Plan), as amended
during 1996. The Plan provides for issuance of up to 1,000,000 shares of
common stock in connection with various stock grants, awards and sales granted
under such plan to employees and nonemployees (primarily key dental group
personnel). The Plan authorizes the grant of incentive stock options,
nonstatutory stock options, stock appreciation rights or bonus rights; award
of stock bonuses; and/or sale of restricted stock. The exercise price for
incentive stock options may not be less than the fair market value of the
underlying shares on the date of grant. The Plan is administered by the
Company's Board of Directors. The Board has the authority to determine the
persons to whom awards will be made, the amounts, and other terms and
conditions of the awards. Shares issued under the Plan are generally subject
to a five-year vesting schedule from the date of grant and expire ten years
from the original grant date.
Stock options issued to nonemployees have been recorded at their estimated
fair market value and are being expensed over their respective vesting lives
of up to five years. Total compensation expense recorded for the years ended
December 31, 1995 and 1996 and the nine-months ended September 30, 1997 was
$152, $52 and $42, respectively.
Statement of Financial Accounting Standards No. 123 (SFAS 123)
During 1995, the Financial Accounting Standards Board issued SFAS 123,
"Accounting for Stock Based Compensation," which defines a fair value based
method of accounting for an employee stock option or similar equity instrument
and encourages all entities to adopt that method of accounting for all of
their employee stock compensation plans. However, it also allows an entity to
continue to measure compensation cost related to stock options issued to
employees under these plans using the method of accounting prescribed by the
Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock
Issued to Employees." Entities electing to remain with the accounting in APB
25 must make pro forma disclosures of net income and earnings per share, as if
the fair value based method of accounting defined in this Statement had been
applied.
The Company has elected to account for its stock-based compensation plans
under APB 25; however, the Company has computed for pro forma disclosure
purposes the value of all options granted during the years ended December 31,
1995 and 1996 and the nine months ended September 30, 1997. The 1995 and 1996
options were valued using the minimum value pricing model as prescribed by
SFAS 123 for nonpublic companies. The options issued subsequent to the
Company's 1997 initial public offering have been valued using the Black-
Scholes pricing model as prescribed by SFAS 123. The following weighted
average assumptions have been used for grants of stock options:
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31 SEPTEMBER 30
---------------- -----------------
1995 1996 1997
------- ------- -----------------
Risk free interest rate.................. 6.5% 6.5% 6.4%
Expected dividend yield.................. -- -- --
Expected lives........................... 5 years 5 years 5 years
Expected volatility...................... N/A N/A 60%
======= ======= =======
F-87
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Options were assumed to be exercised over the five-year expected life for
the purpose of this valuation. Adjustments are made for options forfeited
prior to vesting. The total value of options granted was computed as the
following approximate amounts, which would be amortized on the straight-line
basis over the vesting period of the options:
Year ended December 31, 1995....................................... $ 334
Year ended December 31, 1996....................................... 301
Nine months ended September 30, 1997............................... 1,219
If the Company had accounted for stock options issued to employees in
accordance with SFAS 123, the Company's net income attributable to common
stock and pro forma net income per share would have been reported as follows:
Net income (loss) attributable to common stock:
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31 SEPTEMBER 30
----------- -----------------
1995 1996 1997
---- ------ -----------------
As reported................................. $257 (1,687) (747)
Pro forma................................... 222 (1,767) (817)
==== ====== ====
Pro forma net income (loss) per common and common equivalent share:
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31 SEPTEMBER 30
----------- -----------------
1995 1996 1997
----- ----- -----------------
As reported--primary........................ $ .19 (.86) (.40)
Pro forma--primary.......................... .16 (.91) (.44)
As reported--fully diluted.................. .19 (.86) (.40)
Pro forma--fully diluted.................... .16 (.91) (.44)
===== ===== ====
The effects of applying SFAS 123 for providing pro forma disclosures for
1995 and 1996 and for the nine-months ended September 30, 1997 are not likely
to be representative of the effects on reported net income (loss) and net
income (loss) per common equivalent share for future years, because options
vest over several years and additional awards generally are made each year.
F-88
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
The following summary presents the options granted and outstanding as of
September 30, 1997:
WEIGHTED
NUMBER OF SHARES AVERAGE
------------------------------ EXERCISE
EMPLOYEE NONEMPLOYEE TOTAL PRICE
-------- ----------- -------- --------
Outstanding, December 31, 1994........ 110,000 -- 110,000 $4.52
Granted............................. 136,000 72,750 208,750 5.91
Canceled............................ (31,000) (5,000) (36,000) 6.56
-------- ------- -------- -----
Outstanding, December 31, 1995........ 215,000 67,750 282,750 5.47
Granted............................. 192,112 38,705 230,817 3.43
Exercised........................... (2,000) -- (2,000) --
Canceled............................ (96,549) (5,833) (102,382) 8.19
-------- ------- -------- -----
Outstanding, December 31, 1996........ 308,563 100,622 409,185 3.66
Granted............................. 741,855 -- 741,855 3.03
Exercised........................... (343,918) -- (343,918) .58
Canceled............................ (110,101) (13,667) (123,768) 5.17
-------- ------- -------- -----
Outstanding, September 30, 1997....... 596,399 86,955 683,354 $4.26
======== ======= ======== =====
The following table sets forth the exercise prices, the number of options
outstanding and exercisable, and the remaining contractual lives of the
Company's stock options at September 30, 1997:
NUMBER OF OPTIONS WEIGHTED
------------------------------------- AVERAGE
EXERCISE CONTRACTUAL LIFE
PRICE OUTSTANDING EXERCISABLE REMAINING
-------- ----------- ----------- ----------------
$ .20 15,250 15,250 7.82 years
.21 110,604 46,734 9.15
4.13 45,500 -- 7.01
5.00 318,000 57,900 8.63
5.50 81,000 81,000 6.08
8.02 68,000 1,000 9.90
10.00 45,000 27,672 7.61
------ ------- ------- ----
4.72 683,354 229,556 9.02
====== ======= ======= ====
(11) TRANSACTIONS WITH AFFILIATES
Management Agreements
The Company currently derives substantially all of its management fee
revenue from three dental groups with which it is related through common
ownership of certain shareholders.
F-89
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
The Company provides management support services to these three related dental
groups under management agreements with forty-year terms. The Company is
currently earning revenues based on specified percentages of net dental
practice patient revenues as defined in the agreements. Such percentages are
negotiated with the dental groups and have been developed and revised as
necessary based on the Company's services and operating needs. The management
agreements provide that management fee revenue is based upon the following
percentage of net dental group revenue:
DANY TSE,
P.C. WASHINGTON OREGON
--------- ---------- ------
1997.......................................... 53% 51% 53%
1998.......................................... 54% 52% 54%
1999.......................................... 55% 53% 55%
2000.......................................... 56% 54% 55%
2001, and thereafter.......................... 56% 55% 55%
Office Lease
The Company leases office space for $4 per month from one of the related
dental groups (see note 1) on a month-to-month basis. Lease expense aggregated
approximately $50 for the years ended December 31, 1995 and 1996 and $37 for
the nine-months ended September 30, 1997.
Receivables from affiliates
Affiliate receivables consist primarily of amounts owed to the Company by
the unconsolidated dental groups to reimburse the Company for payment of the
unconsolidated dental groups' payroll and other direct costs, net of amounts
due to the unconsolidated dental groups related to the acquisitions and the
unconsolidated dental groups' share of revenues. The Company also transacts
various other business with the related dental groups, including short-term
operating advances.
(12) INCOME TAXES
Income tax expense (benefit) consists of:
1995
----------------------
CURRENT DEFERRED TOTAL
------- -------- -----
U.S. Federal......................................... $ 147 65 212
State and local...................................... 16 6 22
----- ---- ----
$ 163 71 234
===== ==== ====
1996
----------------------
CURRENT DEFERRED TOTAL
------- -------- -----
U.S. Federal......................................... $(175) (420) (595)
State and local...................................... (6) (54) (60)
----- ---- ----
$(181) (474) (655)
===== ==== ====
1997
----------------------
CURRENT DEFERRED TOTAL
------- -------- -----
U.S. Federal......................................... $ 7 71 78
State and local...................................... 4 (2) 2
----- ---- ----
$ 11 69 80
===== ==== ====
F-90
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Income tax benefit differed from the amount computed by applying the U.S.
Federal income tax rate to loss before income tax benefit as a result of the
following:
1995 1996 1997
---- ---- ----
Computed "expected" tax (benefit)............................. $167 (804) (234)
Increase (reduction) in income taxes resulting from:
State income taxes, net of Federal income tax benefit....... 11 (90) (36)
Amortization of nondeductible goodwill and other
nondeductible items........................................ 31 163 39
Valuation allowance for deferred tax assets allocated to
income tax expense......................................... -- 75 265
Other....................................................... 25 1 46
---- ---- ----
$234 (655) 80
==== ==== ====
Deferred income taxes reflect the net tax effects of the temporary
differences between the carrying amount of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and liabilities
are as follows:
1996 1997
------- ------
Deferred tax assets:
Net operating loss carryforward.............................. $ 647 1,005
Accrued payroll/bonus related................................ -- 29
Allowance for doubtful accounts.............................. 618 857
Compensated absences, principally due to accrual for
financial reporting purposes................................ 114 143
Intangible assets, principally due to differences in
amortization and capitalized cost........................... -- 239
Other........................................................ 12 14
------- ------
Total gross deferred tax assets........................... 1,391 2,287
Less valuation allowance..................................... (75) (339)
------- ------
Deferred tax assets, net of valuation allowance........... 1,316 1,948
------- ------
Deferred tax liabilities:
Accounts receivable.......................................... (759) (1,535)
Plant and equipment, principally due to differences in
depreciation and capitalized cost........................... (444) (461)
Intangible assets, principally due to accrual for financial
reporting purposes.......................................... (11) (67)
Cash versus accrual reporting for tax purposes............... (68) (66)
Other........................................................ -- (2)
------- ------
Deferred tax liabilities.................................. (1,282) (2,131)
------- ------
Net deferred tax asset (liability)........................ $ 34 (183)
======= ======
(13) MALPRACTICE INSURANCE
The dental groups' dentists are insured with respect to dentistry
malpractice risks on a claims-made basis. There are known claims and incidents
that may result in the assertion of additional claims, as well as claims from
unknown incidents that may be asserted arising from services provided to
patients. Management is not aware of any claims against the Company or its
affiliated groups which might have a material impact on the Company's
financial position or results of operations.
F-91
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(14) COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company has primarily entered into operating leases of commercial
property. Commercial properties under operating leases mostly include space
required to perform dental services and space for administrative facilities.
Lease expense for dental office space and administrative office space for the
years ended December 31, 1995 and 1996 and for the nine-months ended September
30, 1997 was $837, $1,432 and $2,402, respectively.
The future minimum lease payments under capital leases and noncancelable
operating leases with remaining terms of one or more years consist of the
following at September 30, 1997:
CAPITAL OPERATING
------- ---------
1998................................................... $ 514 2,896
1999................................................... 320 2,736
2000................................................... 274 2,424
2001................................................... 92 2,073
2002................................................... 50 1,730
Thereafter............................................. -- 8,083
------ -------
Total minimum lease obligation....................... 1,250 $19,942
=======
Less portion attributable to interest.................. (211)
------
Obligations under capital leases..................... 1,039
Less current portion................................... (398)
------
$ 641
======
Litigation
The Company is subject to various claims and legal actions which arise in
the ordinary course of business. In the opinion of management, the ultimate
resolution of such matters will not have a material adverse effect on the
Company's financial position or results of operations.
(15) SUBSEQUENT EVENTS
During October 1997, the Company acquired substantially all of the assets of
two dental practices, one located in Idaho Falls, ID, and the other with two
offices in Sacramento, CA and Daly City, CA for a combined purchase price of
approximately $3,600. The purchase price is payable in a combination of cash,
common stock and warrants to purchase common stock. Additional consideration
may be paid subject to earn-out agreements.
On October 31, 1997, the Company's $1,850 credit line expired. On January 7,
1998, the Company amended its $10 million credit facility (the "Credit
Facility") to provide for a maximum credit line of $25 million, which may be
increased at the option of the Company to $30 million following completion of
an equity offering by the Company in which the Company receives at least $20
million in net cash proceeds. The Company intends to use the Credit Facility
for working capital requirements, to purchase non-professional dental practice
assets of additional dental practices that the Company may seek to affiliate
with, and to purchase operating assets for existing Affiliated Dental
Practices. The Credit Facility provides that aggregate amount borrowed under
the Credit Facility for working capital purposes and letter of credit
obligations may not exceed $4 million, and that remaining amounts available
under the Credit Facility may be used by the Company for
F-92
GENTLE DENTAL SERVICE CORPORATION
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
permitted acquisitions and capital expenditures. The ability of the Company to
incur indebtedness under the Credit Facility is subject to delivery of
customary opinions, certificates and closing documents by the Company. The
revolving feature of the Credit Facility expires on September 30, 1999, at
which time it will convert into a three year term loan to be repaid in 12 equal
quarterly installments. Principal amounts owed under the Credit Facility bear
interest, at the Company's option and dependent upon the Company's leverage
ratio, of (i) up to 1.0% over prime or (ii) up to 3.25% above LIBOR. The Credit
Facility requires the Company to pay an unused commitment fee in the amount of
0.50% per annum or 0.375% per annum, depending on the Company's leverage ratio,
on 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 contains several covenants including (i) restrictions on the ability
of the Company to incur indebtedness and repurchase, or make dividends with
respect to, its capital stock; and (ii) requirements relating to maintenance of
a specified net worth and specified ratios of current assets to current
liabilities, debt to cash flow and EBITDAR to fixed charges. In addition, the
Credit Facility requires the Company to notify the lenders prior to making any
acquisition and to obtain the consent of the lenders prior to making (i)
certain acquisitions with purchase prices exceeding $3 million, (ii) all
acquisitions with purchase prices exceeding $5 million and (iii) capital
expenditures exceeding $5 million in any fiscal year. The Credit Facility also
requires the Company to convert to a holding company that owns no assets other
than the stock of its operating subsidiaries on or before May 31, 1998. If the
Company does not attain holding company status on or before May 31, 1998, the
interest rate applicable to amounts borrowed under the Credit Facility would be
increased by 0.5% and if holding company status is not obtained on or before
July 31, 1998 an event of default would exist under the terms of the Credit
Facility. The Company's obligations under the Credit Facility are guaranteed by
each of the subsidiaries of the Company. The obligations of the Company under
the Credit Facility and the subsidiaries under the guarantees are secured by a
security interest in the equipment, fixtures, inventory, receivables,
subsidiary stock, certain debt instruments, accounts and general intangibles of
each of such entities.
During November 1997, the Company entered into an agreement to acquire a
dental practice management company with dental practices located in and around
Bakersfield, CA for a purchase price of approximately $22,750. The purchase
price is payable in a combination of $9.8 million cash and 1,519,103 shares of
common stock. Of the $22,750 purchase price, approximately $550 is estimated to
be paid subject to an earn-out agreement.
In December 1997, the Company and the Oregon and Washington professional
corporations signed letters of intent to amend the management agreements with
those professional corporations. In exchange for amended management agreements
which provide the Company with a controlling financial interest in the
operation of the practices, the Company will pay consideration of $1.8 million,
to be offset by its receivable from the professional corporations for $1.8
million, the right to receive an aggregate of either $575,000 cash in 18 equal
monthly installments or options to acquire 230,000 shares of common stock at an
exercise price of $8.38 per share, subject to five year vesting plus options to
acquire an aggregate of 10,000 shares of common stock at an exercise price of
$8.38 per share, subject to five year vesting and future cash or options
subject to five year vesting in amounts to be determined according to a formula
based upon the operating revenues of such Oregon and Washington professional
corporations for the fiscal years ending December 31, 1998 and 1999.
F-93
[Inside back cover graphic setting forth the following information:]
[Description of content and format.]
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NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THIS OFFERING AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL, OR SOLICITATION OF AN OFFER TO BUY, ANY OF THE
SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS
OF THE COMPANY SINCE SUCH DATE.
-----------------
TABLE OF CONTENTS
PAGE
----
Prospectus Summary....................................................... 3
Risk Factors............................................................. 8
Recent and Pending Affiliations.......................................... 19
Use of Proceeds.......................................................... 21
Price Range of Common Stock.............................................. 21
Dividend Policy.......................................................... 21
Capitalization........................................................... 22
Selected Pro Forma Consolidated Financial Data........................... 23
Selected Historical Financial Data....................................... 30
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 31
Business................................................................. 39
Management............................................................... 50
Certain Transactions..................................................... 56
Principal and Selling Shareholders....................................... 58
Description of Capital Stock............................................. 60
Shares Eligible for Future Sale.......................................... 63
Underwriting............................................................. 64
Legal Matters............................................................ 65
Experts.................................................................. 65
Additional Information................................................... 66
Index to Financial Statements............................................ F-1
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3,600,000 SHARES
GENTLE DENTAL SERVICE CORPORATION
COMMON STOCK
-----------------
PROSPECTUS
-----------------
BEAR, STEARNS & CO. INC.
SALOMON SMITH BARNEY
WESSELS, ARNOLD & HENDERSON
BLACK & COMPANY, INC.
, 1998
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PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article VIII of the Registrant's Restated Articles of Incorporation, as
amended (the "Articles"), authorizes indemnification of directors of the
Registrant to the fullest extent permitted by the Washington Business
Corporation Act (the "Act"). In addition, Section 10 the Registrant's Bylaws
requires the Registrant to indemnify directors and former directors of the
Registrant to the fullest extent permitted by applicable law, and permits the
Registrant to indemnify officers, employees, and agents of the Registrant. The
effects of the Articles, Bylaws and the Act (the "Indemnification Provisions")
are summarized as follows:
(a) The Indemnification Provisions grant a right of indemnification in
respect of any action, suit or proceeding (other than an action by or in
the right of the Registrant) against expenses (including attorney fees),
judgments, fines and amounts paid in settlement actually and reasonably
incurred, if the director or former director concerned (i) acted in good
faith and in a manner the director or former director reasonably believed
to be, in the case of conduct in the director's or former director's
official capacity, in the best interests of the Registrant or, in all other
cases, not opposed to the best interests of the Registrant, (ii) was not
adjudged liable on the basis of receipt of an improper personal benefit and
(iii) with respect to any criminal action or proceeding, had no reasonable
cause to believe the conduct was unlawful. The termination of an action,
suit or proceeding by judgment, order, settlement, conviction or plea of
nolo contendere does not, of itself, create a presumption that the director
or former director did not meet the required standards of conduct.
(b) The Indemnification Provisions grant a right of indemnification in
respect of any action or suit by or in the right of the Registrant against
the expenses (including attorney fees) actually and reasonably incurred if
the director or former director concerned acted in good faith and in a
manner the director or former director reasonably believed to be, in the
case of conduct in the director's or former director's official capacity,
in the best interests of the Registrant, or in all other cases, not opposed
to the best interests of the Registrant; except that no right of
indemnification will be granted if the director or former director is
adjudged to be liable to the Registrant.
(c) Every director and officer who has been wholly successful on the
merits of a controversy described in (a) or (b) above is entitled to
indemnification for reasonable expenses as a matter of right.
(d) Because the limits of permissible indemnification under Washington
law are not clearly defined, the Indemnification Provisions may provide
indemnification broader than that described in (a) and (b).
(e) The Registrant shall advance to a director or former director the
expenses incurred in defending any action, suit or proceeding in advance of
its final disposition if the director or former director affirms in good
faith that he or she has met the standard of conduct to be entitled to
indemnification as described in (a) or (b) above and undertakes to repay
any amount advanced if it is determined that the director or former
director did not meet the required standard of conduct.
(f) The Registrant may, by action of the Board of Directors from time to
time, provide indemnification and pay expenses in advance of the final
disposition of a proceeding to officers, employees, and agents of the
Registrant on the same terms and with the same scope as described above.
The Registrant may obtain insurance for the protection of its directors and
officers against any liability asserted against them in their official
capacities. The rights of indemnification described above are not exclusive of
any other rights of indemnification to which the persons indemnified may be
entitled under any bylaw, agreement, vote of shareholders or directors or
otherwise.
II-1
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth an itemized statement of expenses of the
Registrant in connection with the sale of the Common Stock being registered
hereby. All of the expenses are estimated, except for the SEC registration
fee, the NASD filing fee and the NASDAQ listing fees.
SEC Registration fee............................................... $ 10,952
NASD filing fee.................................................... 4,213
Blue Sky fees...................................................... *
Printing and engraving expenses.................................... *
Legal fees and expenses............................................ *
Auditors' fees and expenses........................................ *
Transfer Agent and Registrar fees.................................. *
NASDAQ listing fees................................................
Miscellaneous expenses............................................. *
--------
Total.......................................................... $ *
========
- --------
* To be filed by amendment
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
Within the last three years the Registrant has sold securities without
registration under the Securities Act in the transactions and in reliance on
the exemptions described below. The numbers of shares stated under each item
give retroactive effect to the one-for-two reverse stock split of the
Registrant's Common Stock that was effected in October 1996.
1. Between January 1995 and January 1996 the Registrant issued an
aggregate total of 129,935 shares of its Common Stock to eight dentists in
connection with the affiliation of their dental practices. The sales of the
stock were exempt from registration under Section 4(2) of the Securities
Act because all of the purchasers, either alone or together with their
legal and other advisors, had the knowledge and experience in business and
financial matters to evaluate an investment in the Registrant, received
information about the Registrant and made appropriate investment
representations.
2. From March to May 1995, the Registrant sold an aggregate total of
173,327 shares of its Common Stock at $10.00 per share to 27 purchasers
through a private offering. The sales of the stock were exempt from
registration under Section 4(2) of the Securities Act and Rule 506 of
Regulation D thereunder because all purchasers were accredited investors
within the meaning of Rule 501.
3. On May 31, 1995 the Registrant sold an aggregate total of 20,112
shares of Common Stock at $9.00 per share to dentists employed by
Affiliated Dental Practices to which the Registrant provides management
support services. The sales of the stock were exempt from registration
under Rule 701 under the Securities Act because the shares were offered
pursuant to a written compensation plan of the Registrant.
4. On May 31, 1996 the Registrant issued warrants to purchase an
aggregate total of 115,000 shares of Common Stock at an exercise price of
$7.50 per share to 14 officers, directors, and shareholders of the
Registrant who provided personal guarantees to the Registrant's principal
bank. The issuance of the warrants was exempt from registration under
Section 4(2) of the Securities Act and Rule 506 of Regulation D thereunder
because the officers, directors, and shareholders of the Registrant who
received warrants were accredited investors within the meaning of Rule 501.
II-2
5. On May 31, 1996 the Registrant issued a warrant to purchase 4,333
shares of Common Stock at an exercise price of $7.50 per share to the
Registrant's principal bank in connection with modifying the Registrant's
existing loan and security agreement with that bank. The issuance of the
warrant was exempt from registration under Section 4(2) of the Securities
Act and Rule 506 of Regulation D thereunder because the Registrant's
principal bank is an accredited investor within the meaning of Rule 501.
6. On May 31, 1996 the Registrant sold 2,000 shares of Common Stock to a
departing employee upon exercise of the vested portion of a stock option
granted to the employee under the Registrant's 1993 Stock Incentive Plan.
The option's exercise price per share was $0.80. The sale of the stock was
exempt from registration under Rule 701 of the Securities Act because the
sale was made to an employee of the Registrant pursuant to a written
compensation plan.
7. On June 21, 1996 the Registrant sold 100,000 shares of its Common
Stock and a warrant to purchase an additional 100,000 shares at $7.50 per
share to The ServiceMaster Company Limited Partnership. The ServiceMaster
Company Limited Partnership subsequently transferred the shares and warrant
to its subsidiary, ServiceMaster Venture Fund, L.L.C. The total
consideration for the stock and warrant was $1,000,000. The sale of the
stock and the warrant was exempt from registration under Section 4(2) of
the Securities Act and Rule 506 of Regulation D thereunder because The
ServiceMaster Company Limited Partnership is an accredited investor within
the meaning of Rule 501.
8. On November 4, 1997, in connection with the GMS Merger, the Registrant
issued 4,548,163 shares of Common Stock in exchange for all outstanding
shares of the common stock of GMS. The issuance of the shares was exempt
from registration under Section 4(2) of the Securities Act and Rule 506 of
Regulation D thereunder because all purchasers were accredited investors
within the meaning of Rule 501.
ITEM 27. EXHIBITS
(a) Exhibits
*1.1 Form of Underwriting Agreement.
2.1 Agreement and Plan of Merger of Gentle Dental Service Corporation and GMS
Dental Group, Inc. dated October 30, 1997, incorporated by reference to
the Registrant's Report on Form 8-K, Accession No. 97-000678.
3.1 Restated Articles of Incorporation, incorporated by reference to the
Registrant's Registration Statement on Form SB-2, Registration No. 33-
13529.
3.2 Bylaws, as amended, incorporated by reference to the Registrant's
Registration Statement on Form SB-2, Registration No. 33-13529.
4.1 Restated Articles of Incorporation (filed as Exhibit 3.1).
4.2 Bylaws, as amended (filed as Exhibit 3.2).
*5.1 Legal Opinion of McDermott, Will & Emery with respect to the validity of
the securities being registered.
10.1 Support Services Agreement dated as of January 1, 1996 between the
Registrant and Tse, Saiget, Watanabe & McClure, Inc., P.S., incorporated
by reference to the Registrant's Registration Statement on Form SB-2,
Registration No. 33-13529.
10.2 Support Services Agreement dated as of January 1, 1996 between the
Registrant and Gentle Dental of Oregon, P.C., incorporated by reference
to the Registrant's Registration Statement on Form SB-2, Registration
No. 33-13529.
10.3 Asset Purchase Agreement dated as of December 31, 1994 between the
Registrant and Tse, Saiget, Watanabe & McClure, Inc., P.S., incorporated
by reference to the Registrant's Registration Statement on Form SB-2,
Registration No. 33-13529.
II-3
10.4 Asset Purchase Agreement dated as of December 31, 1994 between the
Registrant and Gentle Dental of Oregon, P.C., incorporated by reference
to the Registrant's Registration Statement on Form SB-2, Registration
No. 33-13529.
10.5 Asset Purchase Agreement dated as of January 2, 1995 between the
Registrant and Tse, Saiget, Watanabe & McClure, Inc., P.S.,
incorporated by reference to the Registrant's Registration Statement on
Form SB-2, Registration No. 33-13529.
10.6 Asset Purchase Agreement dated as of January 2, 1995 between the
Registrant and Gentle Dental of Oregon, P.C., incorporated by reference
to the Registrant's Registration Statement on Form SB-2, Registration
No. 33-13529.
10.7 1993 Stock Incentive Plan, incorporated by reference to the Registrant's
Registration Statement on Form SB-2, Registration No. 33-13529.
10.8 Stock Acquisition Agreement dated as of June 21, 1996 between the
Registrant and The ServiceMaster Company Limited Partnership,
incorporated by reference to the Registrant's Registration Statement on
Form SB-2, Registration No. 33-13529.
10.9 Form of Warrant Subscription and Guarantor Agreement dated as of May 31,
1996 between the Registrant and various officers, directors, and
shareholders of the Registrant, incorporated by reference to the
Registrant's Registration Statement on Form SB-2, Registration No. 33-
13529.
10.10 Employment Agreement dated November 3, 1997, by and between Dany Y. Tse,
DMD and the Registrant.
10.11 Employment Agreement dated November 3, 1997, by and between Michael T.
Fiore and the Registrant.
10.12 Employment Agreement dated November 3, 1997, by and between L. Theodore
Van Eerden and the Registrant.
10.13 Employment Agreement dated August 31, 1996, by and between Grant M.
Sadler and GMS Dental Group, Inc.
10.14 Employment Agreement dated November 7, 1996, by and between Norman
Huffaker and GMS Dental Group, Inc.
10.15 Employment Agreement dated August 31, 1996, by and between Kenneth J.
Davis and GMS Dental Group, Inc..
10.16 1996 Stock Option Plan of GMS Dental Group, Inc.
10.17 1996 Performance Stock Option Plan of GMS Dental Group, Inc.
10.18 Incentive Stock Option Agreement dated April 1, 1997, by and between
Michael T. Fiore and GMS Dental Group, Inc.
10.19 Stock Option Agreement dated April 1, 1997, by and between Michael T.
Fiore and GMS Dental Group, Inc.
*10.20 Promissory Note dated April 1, 1997, executed by Michael T. Fiore in
favor of GMS Dental Group, Inc.
10.21 Security Agreement dated April 1, 1997, by and between Michael T. Fiore
and GMS Dental Group, Inc.
10.22 Acknowledgment and Clarification of Repurchase Rights Agreement dated
October 31, 1997, by and between Michael T. Fiore and GMS Dental
Group, Inc.
10.23 Founder Stock Purchase Agreement dated August 31, 1996, by and between
Grant M. Sadler and GMS Dental Group, Inc.
10.24 Promissory Note dated August 31, 1996, executed by Grant M. Sadler in
favor of GMS Dental Group, Inc.
II-4
10.25 Security Agreement dated August 31, 1996, by and between Grant M.
Sadler and GMS Dental Group, Inc.
10.26 Common Stock Escrow Agreement dated October 11, 1996, by and among
Grant M. Sadler, Kenneth J. Davis and GMS Dental Group, Inc.
10.27 Acknowledgement and Clarification of Repurchase Rights Agreement, dated
October 31, 1997, by and among Grant M. Sadler, Kenneth J. Davis and
GMS Dental Group, Inc.
10.28 Founder Stock Purchase Agreement dated August 31, 1996, by and between
Kenneth J. Davis and GMS Dental Group, Inc.
10.29 Promissory Note dated August 31, 1996, executed by Kenneth J. Davis in
favor of GMS Dental Group, Inc.
10.30 Security Agreement dated August 31, 1996, by and between Kenneth J.
Davis and GMS Dental Group, Inc.
10.31 Incentive Stock Option Agreement dated December 4, 1996, by and between
Norman Huffaker and GMS Dental Group, Inc.
10.32 Stock Option Agreement dated December 4, 1996, by and between Norman
Huffaker and GMS Dental Group, Inc.
10.33 Acknowledgment and Clarification of Repurchase Rights Agreement dated
October 31, 1996, by and between Norman R. Huffaker and GMS Dental
Group, Inc.
+10.34 Dental Group Management Agreement dated October 11, 1996, by and
between Alan M. Slutsky, DMD, a Professional Corporation, and Slutsky
Dental Corporation.
+10.35 Dental Group Management Agreement dated October 11, 1996, by and
between GMS Dental Group Management of Hawaii, Inc. and Dental Care
Centers of Hawaii, Inc.
+10.36 Dental Group Management Agreement dated October 11, 1996, by and
between Henry J. Lerian, Trustee of the Henry J. Lerian and Jeanette
P. Lerian Irrevocable Marital Trust U/D/T 03/23/94, Henry J. Lerian,
Trustee of the Henry J. Lerian and Jeanette P. Lerian Revocable
Survivor's Trust U/D/T 03/23/04, Henry J. Lerian, DDS and Lerian
Dental Corporation.
+10.37 Dental Group Management Agreement dated June 30, 1997, by and between
Warren M. Francis, Jr. D.D.S., Inc. and Francis Dental Corporation.
+10.38 Dental Group Management Agreement dated June 30, 1997, by and between
Warren M. Francis, Jr. D.D.S., Inc. and Burrell Dental Corporation.
+10.39 Dental Group Management Agreement dated June 30, 1997, by and between
Warren M. Francis, Jr. D.D.S., Inc. and Ashrafi Dental Corporation.
+10.40 Dental Group Management Agreement dated October 11, 1996, by and
between GMS Dental Group Management of Hawaii, Inc. and Hualalai
Dental Services, Inc.
+10.41 Dental Group Management Agreement dated February 24, 1997, by and
between Naismith Dental Corporation and Yep Dental Corporation.
10.42 Dental Group Management Agreement dated October 11, 1996, by and
between GMS Dental Group Management, Inc. and Idaho Dental Group, P.A.
10.43 Dental Group Management Agreement dated July 24, 1997, by and between
GMS Dental Group Management, Inc. and Fremont Dental Group.
10.44 Dental Group Management Agreement dated July 24, 1997, by and between
GMS Dental Group Management, Inc. and Mark Armstrong, D.D.S. d/b/a
Concord Dental Care.
10.45 Dental Group Management Agreement dated October 31, 1997, by and
between GMS Dental Group Management, Inc. and Charles Murillo, D.D.S.
d/b/a Community Dental Group.
10.46 Dental Group Management Agreement dated July 24, 1997, by and between
GMS Dental Group Management, Inc. and Sam Samudio, D.D.S. d/b/a
Pleasanton Dental Care.
II-5
10.47 Dental Group Management Agreement dated October 31, 1997, by and
between Premier Dental Care, Inc. and SJL, P.A.
+10.48 Dental Group Management Agreement dated February 24, 1997, by and
between Naismith Dental Corporation and Burns Dental Corporation.
10.49 Credit Agreement dated October 10, 1996, as amended, by and among GMS
Dental Group Management, Inc., GMS California Acquisition Company, GMS
Hawaii Acquisition Company and Imperial Bank.
+10.50 Support Services Agreement dated March 31, 1997, between the Registrant
and Arena Dental Corporation.
10.51 Promissory Note dated July 24, 1997, executed by GMS Dental Group
Management in favor of Fremont Dental Group.
10.52 Guaranty dated July 24, 1997, by GMS Dental Group, Inc. in favor of
Fremont Dental Group.
10.53 Merger Agreement, dated as of September 21, 1997, between the Company,
Gentle Dental Merger Corporation, a wholly-owned subsidiary of the
Company, Dedicated Dental Systems, Inc., a California corporation,
Arthur G. Kaiser, D.D.S. and Robert J. Newman, incorporated by
reference to the Registrant's Report on Form 10-QSB, Accession No. 97-
000656.
10.54 Asset Purchase Agreement, dated as of September 21, 1997, between the
Company, California Dental Practice Management Company, a California
general partnership, Arthur G. Kaiser, D.D.S., Robert J. Newman and
Mark Thomas, D.D.S., incorporated by reference to the Registrant's
Report on Form 10-QSB, Accession No. 97-000656.
10.55 Asset Purchase Agreement, dated as of September 21, 1997, between the
Company, California Dental Practice Management Company, a California
general partnership, Arthur G. Kaiser, D.D.S., Robert J. Newman and
Clarence Au, D.D.S., incorporated by reference to the Registrant's
Report on Form 10-QSB, Accession No. 97-000656.
10.56 Asset Purchase Agreement, dated as of September 21, 1997, between the
Company and Arthur G. Kaiser, D.D.S., incorporated by reference to the
Registrant's Report on Form 10-QSB, Accession No. 97-000656.
*10.57 Dental Group Management Agreement dated as of January 1, 1998 between
the Registrant and Tse, Saiget, Watanabe & McClure, Inc., P.S.
*10.58 Dental Group Management Agreement dated as of January 1, 1998, between
the Registrant and Gentle Dental of Oregon, P.C.
*10.59 Dental Group Management Agreement dated as of January 1, 1998 between
the Registrant and Dany Tse, P.C.
*23.1 Consent of McDermott, Will & Emery (included in Exhibit 5.1).
23.2 Independent Auditors' Consent of Price Waterhouse.
23.3 Independent Auditors' Consent of KPMG Peat Marwick LLP.
23.4 Independent Auditors' Consent of Ernst & Young LLP.
23.5 Independent Auditors' Consent of KPMG Peat Marwick LLP.
24.1 Power of Attorney (included on page II-8 of the Registrant's
Registration Statement on Form SB-2 filed January 9, 1998).
27.1 Financial Data Schedule.
99.1 Consent of Arthur G. Kaiser, DDS to being named as a director designee.
- --------
*To be filed by Amendment.
+Confidential Treatment Requested.
II-6
(b) Schedules
No supporting schedules have been included because they are not required.
ITEM 28. UNDERTAKINGS
The Registrant will provide to the Underwriters at the closing specified in
the Underwriting Agreement certificates in such denominations and registered
in such names as required by the Underwriters to permit prompt delivery to
each purchaser.
The Registrant will:
(1) File, during any period in which it offers or sells securities, a
post-effective amendment to this registration statement to:
(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the
information in the registration statement. Notwithstanding the
foregoing, any increase or decrease in volume of securities offered (if
the total dollar value of the securities offered would not exceed that
which was registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) if, in the
aggregate, the changes in volume and price represent no more than a 20%
change in the maximum aggregate offering price set forth in the
"Calculation of Registration Fee" table in the effective registration
statement; and
(iii) Include any additional or changed material information on the
plan of distribution.
(2) For determining liability under the Securities Act, treat each post-
effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial
bona fide offering.
(3) File a post-effective amendment to remove from registration any of
the securities that remain unsold at the end of the offering.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
(the "Commission") such indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the Registrant of expenses incurred or paid by a
director, officer or controlling person of the Registrant in the successful
defense of any action, suit or proceeding) is asserted by such director,
officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
For determining any liability under the Securities Act, the Registrant
agrees to treat the information omitted from the form of prospectus filed as
part of this Registration Statement in reliance upon Rule 430A and contained
in a form of prospectus filed by the Registrant under Rule 424(b)(1) or (4) or
497(h) under the Securities Act as part of this Registration Statement as of
the time the Commission declared it effective.
For determining any liability under the Securities Act, the Registrant
agrees to treat each post-effective amendment that contains a form of
prospectus as a new registration statement for the securities offered in the
registration statement and the offering of the securities at that time as the
initial bona fide offering of those securities.
II-7
SIGNATURES
IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE
REGISTRANT CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS
ALL OF THE REQUIREMENTS FOR FILING ON FORM SB-2 AND AUTHORIZES THIS
REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, IN THE
CITY OF YORBA LINDA, STATE OF CALIFORNIA, ON JANUARY 8, 1998.
GENTLE DENTAL SERVICE CORPORATION
By: /s/ Michael T. Fiore
__________________________________
Michael T. Fiore
Co-Chairman, Chief Executive Officer
and President
POWER OF ATTORNEY
We, the undersigned officers and directors of Gentle Dental Service
Corporation, do hereby constitute and appoint Michael T. Fiore and Norman R.
Huffaker, and each of them, our true and unlawful attorneys-in-fact and agents,
each 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 this Registration Statement, and to file same, with exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and
thing requisite or necessary to be done in and about the premises, as fully to
all intents and purposes as he might or could do in person, hereby, ratifying
and confirming all that said attorneys-in-fact and agents, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement has been signed be by the following persons in the
capacities and on the dates stated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Michael T. Fiore Co-Chairman, Chief Executive January 8, 1998
____________________________________ Officer and President
Michael T. Fiore (Principal Executive
Officer)
/s/ Dany Y. Tse Co-Chairman and President of January 8, 1998
____________________________________ Clinical Services Council
Dany Y. Tse
/s/ Grant M. Sadler Vice Chairman of the Board January 8, 1998
____________________________________
Grant M. Sadler
/s/ L. Theodore Van Eerden Director, Executive Vice January 8, 1998
____________________________________ President and Chief
L. Theodore Van Eerden Development Officer
II-8
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Norman R. Huffaker Chief Financial Officer January 8, 1998
____________________________________ (Principal Financial and
Norman R. Huffaker Accounting Officer)
/s/ Steven R. Bull, DDS Director January 8, 1998
____________________________________
Steven R. Bull, DDS
/s/ Kenneth D. Hooten Director January 8, 1998
____________________________________
Kenneth D. Hooten
/s/ Robert Finzi Director January 8, 1998
____________________________________
Robert Finzi
/s/ Kathleen D. LaPorte Director January 8, 1998
____________________________________
Kathleen D. LaPorte
/s/ Craig W. Wong Director January 8, 1998
____________________________________
Craig W. Wong
/s/ Paul H. Keckley Director January 8, 1998
____________________________________
Paul H. Keckley
/s/ Gerald R. Aaron Director January 8, 1998
____________________________________
Gerald R. Aaron
/s/ H. Wayne Posey Director January 8, 1998
____________________________________
H. Wayne Posey
II-9
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DOCUMENT DESCRIPTION PAGE
------- -------------------- ------------
*1.1 Form of Underwriting Agreement.
2.1 Agreement and Plan of Merger of Gentle Dental Service
Corporation and GMS Dental Group, Inc. dated October
30, 1997, incorporated by reference to the
Registrant's Report on Form 8-K, Accession No. 97-
000678.
3.1 Restated Articles of Incorporation, incorporated by
reference to the Registrant's Registration Statement
on Form SB-2, Registration No. 33-13529.
3.2 Bylaws, as amended, incorporated by reference to the
Registrant's Registration Statement on Form SB-2,
Registration No. 33-13529.
4.1 Restated Articles of Incorporation (filed as Exhibit
3.1).
4.2 Bylaws, as amended (filed as Exhibit 3.2).
*5.1 Legal Opinion of McDermott, Will & Emery with respect
to the validity of the securities being registered.
10.1 Support Services Agreement dated as of January 1, 1996
between the Registrant and Tse, Saiget, Watanabe &
McClure, Inc., P.S., incorporated by reference to the
Registrant's Registration Statement on Form SB-2,
Registration No. 33-13529.
10.2 Support Services Agreement dated as of January 1, 1996
between the Registrant and Gentle Dental of Oregon,
P.C., incorporated by reference to the Registrant's
Registration Statement on Form SB-2, Registration No.
33-13529.
10.3 Asset Purchase Agreement dated as of December 31, 1994
between the Registrant and Tse, Saiget, Watanabe &
McClure, Inc., P.S., incorporated by reference to the
Registrant's Registration Statement on Form SB-2,
Registration No. 33-13529.
10.4 Asset Purchase Agreement dated as of December 31, 1994
between the Registrant and Gentle Dental of Oregon,
P.C., incorporated by reference to the Registrant's
Registration Statement on Form SB-2, Registration No.
33-13529.
10.5 Asset Purchase Agreement dated as of January 2, 1995
between the Registrant and Tse, Saiget, Watanabe &
McClure, Inc., P.S., incorporated by reference to the
Registrant's Registration Statement on Form SB-2,
Registration No. 33-13529.
10.6 Asset Purchase Agreement dated as of January 2, 1995
between the Registrant and Gentle Dental of Oregon,
P.C., incorporated by reference to the Registrant's
Registration Statement on Form SB-2, Registration No.
33-13529.
10.7 1993 Stock Incentive Plan, incorporated by reference to
the Registrant's Registration Statement on Form SB-2,
Registration No. 33-13529.
10.8 Stock Acquisition Agreement dated as of June 21, 1996
between the Registrant and The ServiceMaster Company
Limited Partnership, incorporated by reference to the
Registrant's Registration Statement on Form SB-2,
Registration No. 33-13529.
10.9 Form of Warrant Subscription and Guarantor Agreement
dated as of May 31, 1996 between the Registrant and
various officers, directors, and shareholders of the
Registrant, incorporated by reference to the
Registrant's Registration Statement on Form SB-2,
Registration No. 33-13529.
10.10 Employment Agreement dated November 3, 1997, by and
between Dany Y. Tse, DMD and the Registrant.
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DOCUMENT DESCRIPTION PAGE
------- -------------------- ------------
10.11 Employment Agreement dated November 3, 1997, by and
between Michael T. Fiore and the Registrant.
10.12 Employment Agreement dated November 3, 1997, by and
between L. Theodore Van Eerden and the Registrant.
10.13 Employment Agreement dated August 31, 1996, by and
between Grant M. Sadler and GMS Dental Group, Inc.
10.14 Employment Agreement dated November 7, 1996, by and
between Norman Huffaker and GMS Dental Group, Inc.
10.15 Employment Agreement dated August 31, 1996, by and
between Kenneth J. Davis and GMS Dental Group, Inc..
10.16 1996 Stock Option Plan of GMS Dental Group, Inc.
10.17 1996 Performance Stock Option Plan of GMS Dental Group,
Inc.
10.18 Incentive Stock Option Agreement dated April 1, 1997,
by and between Michael T. Fiore and GMS Dental Group,
Inc.
10.19 Stock Option Agreement dated April 1, 1997, by and
between Michael T. Fiore and GMS Dental Group, Inc.
*10.20 Promissory Note dated April 1, 1997, executed by
Michael T. Fiore in favor of GMS Dental Group, Inc.
10.21 Security Agreement dated April 1, 1997, by and between
Michael T. Fiore and GMS Dental Group, Inc.
10.22 Acknowledgment and Clarification of Repurchase Rights
Agreement dated October 31, 1997, by and between
Michael T. Fiore and GMS Dental Group, Inc.
10.23 Founder Stock Purchase Agreement dated August 31, 1996,
by and between Grant M. Sadler and GMS Dental Group,
Inc.
10.24 Promissory Note dated August 31, 1996, executed by
Grant M. Sadler in favor of GMS Dental Group, Inc.
10.25 Security Agreement dated August 31, 1996, by and
between Grant M. Sadler and GMS Dental Group, Inc.
10.26 Common Stock Escrow Agreement dated October 11, 1996,
by and among Grant M. Sadler, Kenneth J. Davis and GMS
Dental Group, Inc.
10.27 Acknowledgement and Clarification of Repurchase Rights
Agreement, dated October 31, 1997, by and among Grant
M. Sadler, Kenneth J. Davis and GMS Dental Group, Inc.
10.28 Founder Stock Purchase Agreement dated August 31, 1996,
by and between Kenneth J. Davis and GMS Dental Group,
Inc.
10.29 Promissory Note dated August 31, 1996, executed by
Kenneth J. Davis in favor of GMS Dental Group, Inc.
10.30 Security Agreement dated August 31, 1996, by and
between Kenneth J. Davis and GMS Dental Group, Inc.
10.31 Incentive Stock Option Agreement dated December 4,
1996, by and between Norman Huffaker and GMS Dental
Group, Inc.
10.32 Stock Option Agreement dated December 4, 1996, by and
between Norman Huffaker and GMS Dental Group, Inc.
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DOCUMENT DESCRIPTION PAGE
------- -------------------- ------------
10.33 Acknowledgment and Clarification of Repurchase Rights
Agreement dated October 31, 1996, by and between
Norman R. Huffaker and GMS Dental Group, Inc.
+10.34 Dental Group Management Agreement dated October 11,
1996, by and between Alan M. Slutsky, DMD, a
Professional Corporation, and Slutsky Dental
Corporation.
+10.35 Dental Group Management Agreement dated October 11,
1996, by and between GMS Dental Group Management of
Hawaii, Inc. and Dental Care Centers of Hawaii, Inc.
+10.36 Dental Group Management Agreement dated October 11,
1996, by and between Henry J. Lerian, Trustee of the
Henry J. Lerian and Jeanette P. Lerian Irrevocable
Marital Trust U/D/T 03/23/94, Henry J. Lerian, Trustee
of the Henry J. Lerian and Jeanette P. Lerian
Revocable Survivor's Trust U/D/T 03/23/04, Henry J.
Lerian, DDS and Lerian Dental Corporation.
+10.37 Dental Group Management Agreement dated June 30, 1997,
by and between Warren M. Francis, Jr. D.D.S., Inc. and
Francis Dental Corporation.
+10.38 Dental Group Management Agreement dated June 30, 1997,
by and between Warren M. Francis, Jr. D.D.S., Inc. and
Burrell Dental Corporation.
+10.39 Dental Group Management Agreement dated June 30, 1997,
by and between Warren M. Francis, Jr. D.D.S., Inc. and
Ashrafi Dental Corporation.
+10.40 Dental Group Management Agreement dated October 11,
1996, by and between GMS Dental Group Management of
Hawaii, Inc. and Hualalai Dental Services, Inc.
+10.41 Dental Group Management Agreement dated February 24,
1997, by and between Naismith Dental Corporation and
Yep Dental Corporation.
10.42 Dental Group Management Agreement dated October 11,
1996, by and between GMS Dental Group Management, Inc.
and Idaho Dental Group, P.A.
10.43 Dental Group Management Agreement dated July 24, 1997,
by and between GMS Dental Group Management, Inc. and
Fremont Dental Group.
10.44 Dental Group Management Agreement dated July 24, 1997,
by and between GMS Dental Group Management, Inc. and
Mark Armstrong, D.D.S. d/b/a Concord Dental Care.
10.45 Dental Group Management Agreement dated October 31,
1997, by and between GMS Dental Group Management, Inc.
and Charles Murillo, D.D.S. d/b/a Community Dental
Group.
10.46 Dental Group Management Agreement dated July 24, 1997,
by and between GMS Dental Group Management, Inc. and
Sam Samudio, D.D.S. d/b/a Pleasanton Dental Care.
10.47 Dental Group Management Agreement dated October 31,
1997, by and between Premier Dental Care, Inc. and
SJL, P.A.
+10.48 Dental Group Management Agreement dated February 24,
1997, by and between Naismith Dental Corporation and
Burns Dental Corporation.
10.49 Credit Agreement dated October 10, 1996, as amended, by
and among GMS Dental Group Management, Inc., GMS
California Acquisition Company, GMS Hawaii Acquisition
Company and Imperial Bank.
+10.50 Support Services Agreement dated March 31, 1997,
between the Registrant and Arena Dental Corporation.
10.51 Promissory Note dated July 24, 1997, executed by GMS
Dental Group Management in favor of Fremont Dental
Group.
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DOCUMENT DESCRIPTION PAGE
------- -------------------- ------------
10.52 Guaranty dated July 24, 1997, by GMS Dental Group, Inc.
in favor of Fremont Dental Group.
10.53 Merger Agreement, dated as of September 21, 1997,
between the Company, Gentle Dental Merger Corporation,
a wholly-owned subsidiary of the Company, Dedicated
Dental Systems, Inc., a California corporation, Arthur
G. Kaiser, D.D.S. and Robert J. Newman, incorporated
by reference to the Registrant's Report on Form 10-
QSB, Accession No. 97-000656.
10.54 Asset Purchase Agreement, dated as of September 21,
1997, between the Company, California Dental Practice
Management Company, a California general partnership,
Arthur G. Kaiser, D.D.S., Robert J. Newman and Mark
Thomas, D.D.S., incorporated by reference to the
Registrant's Report on Form 10-QSB, Accession No. 97-
000656.
10.55 Asset Purchase Agreement, dated as of September 21,
1997, between the Company, California Dental Practice
Management Company, a California general partnership,
Arthur G. Kaiser, D.D.S., Robert J. Newman and
Clarence Au, D.D.S., incorporated by reference to the
Registrant's Report on Form 10-QSB, Accession No. 97-
000656.
10.56 Asset Purchase Agreement, dated as of September 21,
1997, between the Company and Arthur G. Kaiser,
D.D.S., incorporated by reference to the Registrant's
Report on Form 10-QSB, Accession No. 97-000656.
*10.57 Dental Group Management Agreement dated as of January
1, 1998 between the Registrant and Tse, Saiget,
Watanabe & McClure, Inc., P.S.
*10.58 Dental Group Management Agreement dated as of January
1, 1998, between the Registrant and Gentle Dental of
Oregon, P.C.
*10.59 Dental Group Management Agreement dated as of January
1, 1998 between the Registrant and Dany Tse, P.C.
*23.1 Consent of McDermott, Will & Emery (included in Exhibit
5.1).
23.2 Independent Auditors' Consent of Price Waterhouse.
23.3 Independent Auditors' Consent of KPMG Peat Marwick LLP.
23.4 Independent Auditors' Consent of Ernst & Young LLP.
23.5 Independent Auditors' Consent of KPMG Peat Marwick LLP.
24.1 Power of Attorney (included on page II-8 of the
Registrant's Registration Statement on Form SB-2 filed
January 9, 1998).
27.1 Financial Data Schedule.
99.1 Consent of Arthur G. Kaiser, DDS to being named as a
director designee.
- --------
*To be filed by Amendment.
+Confidential Treatment Requested.