Rule 424(b)(1)
Final Prospectus
Registration No. 333-13529
PROSPECTUS
[LOGO]
1,500,000 Shares
GENTLE DENTAL SERVICE CORPORATION
COMMON STOCK
All of the shares of Common Stock offered hereby are being sold by Gentle
Dental Service Corporation (the "Company"). Before this offering, there has been
no public market for the Common Stock of the Company. See "Underwriting" for a
discussion of the factors considered in determining the initial public offering
price. The Common Stock has been approved for quotation on the Nasdaq SmallCap
Market under the symbol "GNTL."
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SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK.
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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
PUBLIC DISCOUNT (1) COMPANY (2)
- --------------------------------------------------------------------------------
Per Share.......................... $ 5.00 $ 0.35 $ 4.65
- --------------------------------------------------------------------------------
Total (3).......................... $7,500,000 $ 525,000 $6,975,000
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(1) Excludes a nonaccountable expense allowance, payable by the Company to
Black & Company, Inc. and Wedbush Morgan Securities, the
representatives of the Underwriters (the "Representatives"), equal to
0.5% of the total Price to Public. The Company has also agreed to sell
to the Representatives, for nominal consideration, warrants to
purchase up to 150,000 shares of Common Stock for a price equal to
120% of the initial public offering price (the "Representatives'
Warrants") and to indemnify the underwriters against certain
liabilities, including liabilities under the Securities Act of 1933.
See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at
$550,000, including the Representatives' nonaccountable expense
allowance.
(3) The Company has granted to the Underwriters a 30-day option to
purchase up to 225,000 additional shares of Common Stock solely to
cover overallotments, if any. If the Underwriters exercise this option
in full, the Price to Public, the Underwriting Discount, and Proceeds
to Company will be $8,625,000, $603,750, and $8,021,250, respectively.
See "Underwriting."
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The shares of Common Stock are offered by the several Underwriters named
herein, subject to prior sale, when, as and if delivered to and accepted by the
Underwriters, and subject to certain other conditions. The Underwriters reserve
the right to reject any order in whole or in part and to withdraw, cancel, or
modify the offering without notice. It is expected that delivery of certificates
representing the Common Stock will be made against payment therefor at the
offices of the agent of Black & Company, Inc. in New York, New York on or about
February 19, 1997.
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BLACK & COMPANY, INC. WEDBUSH MORGAN SECURITIES
The date of this Prospectus is February 13, 1997.
<PAGE>
[Inside front cover graphic setting forth the following information:
(on background of enlarged Gentle Dental Network logo:)
The Gentle Dental Network
Providing families with all of their dental care needs
Comfortable, gentle dental care for the entire family
Customer Friendly Service:
- -- Convenient locations
- -- Extended hours
- -- Flexible payment options
Complete Range of Dental Care Including:
- -- Routine teeth cleaning
- -- Orthodontia
- -- Cosmetic dentistry
- -- Oral surgery
Established Dental Practices:
- -- Experienced professionals
- -- Focused on high quality dentistry]
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IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVERALLOT OR
EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF
THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT
OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED,
MAY BE DISCONTINUED AT ANY TIME.
--------------------
<PAGE>
[Two-page fold-out inside front cover
flaps with a montage of photographs
depicting Gentle Dental Network dental
offices, Gentle Dental Service
Corporation personnel, dentists with patients.]
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more
detailed information and financial statements appearing elsewhere in this
Prospectus. Investors should carefully consider the information set forth
under "Risk Factors." Except as otherwise noted, all information in this
Prospectus (i) assumes no exercise of the Underwriters' overallotment
option and (ii) gives retroactive effect to a one-for-two reverse split of
the Common Stock and other amendments to the Company's Articles of
Incorporation effected on October 23, 1996.
THE COMPANY
Gentle Dental Service Corporation (the "Company") provides dental
practice management support services to two professional corporations that
employ 62 dentists, orthodontists, and other specialists at 20 locations in
the Portland, Oregon and Seattle, Washington metropolitan areas. The
Company provides facilities, equipment, staffing, management support and
other ancillary services to the multi-specialty dental practices that
constitute the Company's network of affiliated dental service providers
(the "Gentle Dental Network"). The Company intends to rapidly expand the
Gentle Dental Network through acquisitions in both its existing markets as
well as new geographic markets. During 1995 and 1996, the Company acquired
11 dental practices.
Dental spending in the United States is expected to total $40.8
billion in 1996 according to the American Dental Association ("ADA") and is
projected to reach $83 billion by the year 2003 according to the
Congressional Budget Office. The aging of the U.S. population, a widely
recognized demographic trend, is expected to increase the demand for dental
services. Demand for dentists' new services, such as cosmetic dentistry,
also is expected to contribute to market growth.
Dentistry has traditionally been and continues to be a highly
fragmented industry dominated by solo practitioners. According to the ADA's
1995 Survey of Dental Practice, 67% of dentists were solo practitioners and
only 12% practiced in groups of three or more dentists. The Company
believes traditional practices have high operating costs, little purchasing
power with suppliers and must spread overhead over a relatively small
revenue base. In addition, these practices often have insufficient capital
to purchase new technologies and lack the systems necessary to develop
economies of scale. As a result, the Company believes that dentists
increasingly will find it attractive to affiliate with larger
organizations, such as the Gentle Dental Network, and that there are
significant opportunities to consolidate dental practices.
The Company's objective is to become a leading provider of dental
practice management support services through its growing network of
affiliated dentists and specialists. The Company's strategy to achieve this
objective is to enter selected geographic markets and develop locally
prominent, multi-specialty dental care delivery networks that provide high
quality, cost-effective dental care. In pursuing this strategy, the Company
will seek to replicate the dental service network it has developed and
supports in the Portland, Oregon area. From its base of operations in
Portland, the Company began its geographic expansion into the Seattle,
Washington area in 1995. The Company intends to enter additional geographic
markets by acquiring established dental practices, and will initially
target a significant group practice in each market. Upon entering a new
geographic market, the Company intends to acquire additional individual or
group practices as quickly as possible to realize the economies of scale in
administration and marketing that come from achieving critical mass in a
market. The Company will then recruit specialists, extend office hours, and
add locations in the geographic area as appropriate to provide patients a
comprehensive range of dental care at convenient times and locations
throughout the area. In the past,
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the Company has targeted for acquisition practices that derive all or a
high percentage of their revenue from fee-for-service sources, as opposed
to managed care sources. In the near term, the Company plans to continue
this approach as fee-for-service care is generally more profitable than
managed care.
The Company's operating strategy provides solutions for long standing
problems faced by dentists and patients while simultaneously yielding
economic efficiencies. Upon joining the Gentle Dental Network, dentists are
freed from administrative burdens, allowing them to focus on the practice
of dentistry and increase their productivity. The extended office hours
offered by Gentle Dental Network offices give patients the convenience of
expanded scheduling opportunities and allow the Company to spread fixed
costs over more hours of operation. The Gentle Dental Network's full
service approach, which includes on-staff specialists such as
orthodontists, pedodontists, periodontists, and oral surgeons, enables
patients to receive comprehensive dental care while capturing incremental
revenue for the Company. Flexible payment options and convenient locations
are among the other amenities the Gentle Dental Network offers to its
customers.
The Company was organized as a Washington corporation in December 1992
under the name of Mutual Health Systems, Inc. to provide dental practice
management support services to Tse, Saiget, Watanabe & McClure, Inc., P.S.,
a Washington professional corporation, and Gentle Dental of Oregon, P.C.,
an Oregon professional corporation (together, the "Professional
Corporations"), and to facilitate the development and expansion of the
Gentle Dental Network. The Company changed its name to Gentle Dental
Service Corporation in October 1996. The address of the Company's executive
offices is 900 Washington Street, Suite 1100, Vancouver, Washington, 98660
and its telephone number is (360) 750- 7975.
THE OFFERING
Common Stock offered................................. 1,500,000 shares
Common Stock to be outstanding after the offering.... 3,041,881 shares (1)
Use of proceeds...................................... to repay bank debt and
for acquisitions of
dental practices, capital
improvements, working
capital and general
corporate purposes
Nasdaq SmallCap Market symbol........................ GNTL
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(1) Excludes 582,950 shares of Common Stock subject to options outstanding
as of the date of this Prospectus, 150,000 shares subject to the
Representatives' Warrants, and 219,333 shares subject to other
outstanding warrants.
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<TABLE>
<CAPTION>
SUMMARY FINANCIAL DATA
(in thousands, except per share amounts and number of dental offices)
NINE MONTHS
YEARS ENDED DECEMBER 31, ENDED SEPTEMBER 30,
------------------------------------------- ----------------------------
1993 1994 1995 1995 1996
------------- ------------- ------------- ------------ --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Support services revenue (1).................... $ 1,541 $ 2,731 $ 9,781 $ 7,173 $ 7,866
Branch costs.................................... - - 4,701 3,394 5,234
Operating expenses.............................. 1,168 2,100 4,208 3,160 3,010
------------- ------------- ------------- ------------ --------------
Operating income (loss)......................... 373 631 872 619 (378)
Nonoperating income (expense)................... (3) (16) (382) (77) (550)
------------- ------------- ------------- ----------- --------------
Income (loss) before income taxes............... 370 615 490 542 (928)
Provision (benefit) for income taxes - - 233 258 (228)
------------- ------------- ------------- ------------ --------------
Net income (loss)............................... $ 370 $ 615 $ 257 $ 284 $ (700)
============= ============= ============= ============ ==============
Net income (loss) per share..................... $ 0.19 $ 0.21 $ (0.53)
============= ============ ==============
Unaudited pro forma data (2):
Net income................................... $ 243 $ 404
============= =============
Net income per share......................... $ 0.24 $ 0.35
============= =============
Weighted average shares outstanding............. 1,030 1,154 1,380 1,366 1,485
OTHER DATA:
Net revenue of Professional Corporations........ $ 10,270 $ 12,135 $ 16,029 $ 11,759 $ 15,731
Number of dental offices at period end.......... 10 11 17 15 20
SEPTEMBER 30, 1996
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ACTUAL AS ADJUSTED(3)
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BALANCE SHEET DATA:
Cash and cash equivalents....................................................... $ 630 $ 2,406
Working capital................................................................. 898 5,416
Total assets.................................................................... 13,013 14,789
Long-term debt and capital lease
obligations, net of current portion.......................................... 2,572 665
Redeemable common stock......................................................... 2,188 2,188
Nonredeemable shareholders' equity.............................................. 3,445 9,870
- -------------------
(1) The Company's revenue in 1995 and 1996 has been significantly affected
by changes in the services provided to and level of fees received from
the Professional Corporations. Under the support services agreements
in effect in the respective periods, support services revenue was 61%
of the net revenue of the Professional Corporations in 1995 and 50% of
such revenue in 1996. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Overview."
(2) Before 1995, the Company was a subchapter S corporation whose taxable
income was passed through to its shareholders. Effective January 1,
1995, the Company terminated its subchapter S status. The unaudited
pro forma data shows what net income and net income per share would
have been if the Company had been a C corporation during 1993 and
1994.
(3) As adjusted to give effect to the sale of the 1,500,000 shares of
Common Stock offered hereby and the application of the estimated net
proceeds therefrom.
</TABLE>
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RISK FACTORS
The information set forth in "Management's Discussion and Analysis of
Financial Condition and Results of Operations," "Use of Proceeds,"
"Business," and elsewhere in this Prospectus includes certain
forward-looking statements. Actual results could differ materially from
those projected in the forward-looking statements as a result of certain of
the risk factors set forth below and information appearing elsewhere in
this Prospectus. In addition to the other information contained in this
Prospectus, the following factors should be considered carefully in
evaluating the Company and its business before purchasing any shares of
Common Stock offered hereby.
EXPANSION PROGRAM
Much of the Company's future success is predicated on the entrance
into new markets in which the Company has no previous presence or
experience. The Company has had limited expansion experience to date. No
assurances can be given that the Company will be able to complete the
acquisitions necessary for its expansion plans, that such acquisitions will
be on terms favorable to the Company or that the Company will be able to
successfully integrate its business with acquired dental practices. Even
though the Company has completed a number of acquisitions in the past,
there can be no assurance that unforeseen problems with future acquisitions
and expansion will not adversely affect the Company. See "Proposed
Acquisition." In addition, the Company's acquisition model and past
experience reflect initial periods in which the dental practices within a
new geographic market will contribute minimally, if at all, to the
Company's earnings. Initial profitability at the regional level is expected
to be low because of the time and capital required to develop a network of
offices and practitioners that is large enough to permit full
implementation of the Gentle Dental business strategy. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations
- --Overview -- Acquisitions" and "Business -- The Gentle Dental Strategy"
and "-- Acquisitions." Moreover, delays in completing acquisitions could
cause fluctuations in quarterly earnings and corresponding fluctuations in
the market price of the Common Stock. The Company intends to use its Common
Stock as part of the purchase price of acquisitions. 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
acquisitions.
CURRENT LACK OF PROFITABILITY
Although the Company reported net income for 1993, 1994 and 1995, the
Company incurred a net loss of $699,661 for the nine months ended September
30, 1996 and expects a net loss for all of 1996. Moreover, the Company
would have incurred a pre-tax loss of approximately $1.3 million for 1995
if the service fees paid by the Professional Corporations had been 50% of
the Professional Corporations' revenues rather than the one-time 1995 level
of 61% of such revenues. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Overview." These losses
resulted primarily from a buildup in executive and general management staff
that the Company began in 1995 to support its expansion plans. There can be
no assurance that the Company will be profitable in the future.
DEPENDENCE ON AFFILIATED PROFESSIONAL CORPORATIONS
The Company receives fees for services provided to dental practices
under support services agreements, but does not employ dentists or control
the practices of its affiliated dentists. The Company's revenue is
dependent on revenue generated by the Company's affiliated Professional
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<PAGE>
Corporations and, therefore, performance of the Professional Corporations
is essential to the Company's success. The agreements with the Professional
Corporations are for 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 by the Professional
Corporations would have a material adverse effect on the Company. In
addition, the Company makes unsecured operating advances to the related
Professional Corporations. The failure of these entities to repay such
advances could have a material adverse effect on the Company.
ADDITIONAL FINANCING
The Company's expansion strategy will require substantial additional
funding. Moreover, the operation of the Gentle Dental Network's dental
offices requires ongoing capital expenditures. These expenditures will be
used for renovation, expansion and the addition of increasingly costly
dental equipment and technology used to provide ancillary services. These
requirements will 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. 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.
INTEGRATION OF AFFILIATED DENTAL PRACTICES AND MANAGEMENT INFORMATION SYSTEMS
The Company has limited experience in providing management support
services to affiliated dental practices outside of the Portland, Oregon
area. 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 the acquired practices
to the Company's systems. Significant delays or expenses of such
conversions could have a material adverse effect on the integration of
acquired practices. 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.
GOVERNMENT REGULATION
The health and dental care industry is subject to extensive federal,
state and local laws, rules and regulations. The Company believes that its
operations are in material compliance with applicable laws. Nevertheless,
because of the special nature of the Company's relationship with the
Professional Corporations, many aspects of the Company's business
operations have not been the subject of state or federal regulatory
interpretation. There can be no assurance that a review of the Company's or
the Professional Corporations' business by courts or regulatory authorities
will not result in a determination that could adversely affect the
operations of the Company or the Professional Corporations. In addition,
the standards of practice of dental care and related federal and state
regulations are subject to change. The Company cannot predict what changes
may be enacted which may affect its business or the manner in which its
business would be affected by such changes.
The laws of many states prohibit business corporations such as the
Company from practicing dentistry or employing dentists to practice
dentistry. In addition, the laws of many states prohibit dentists from
splitting fees with non-dentists. The laws regarding the corporate practice
of dentistry and fee splitting vary from state to state and are enforced by
the courts and by regulatory authorities with broad discretion. In most
states, these laws have been subjected to limited judicial and regulatory
interpretation and the Company has not obtained, or applied for, any
opinion of any regulatory or judicial authority that
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its business operations are in compliance with these laws. Therefore, no
assurances can be given that the Company's activities will be found to be
in compliance if scrutinized by such authorities. In addition, the
regulatory framework of certain jurisdictions may limit the Company's
expansion into such jurisdictions if the Company is unable to modify its
operational structure to conform with such regulatory framework.
A small percentage of the revenues of the Professional Corporations
comes from the Medicare and Medicaid programs. 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 Medicare or
Medicaid patient, (ii) the furnishing or arranging for the furnishing of
items or services reimbursable under Medicare or Medicaid programs or (iii)
the purchase, lease or order of any item or service reimbursable under
Medicare or Medicaid. Pursuant to this anti-kickback law, the federal
government has announced a policy of increased scrutiny of joint ventures
and other transactions among health care providers in an effort to reduce
potential fraud and abuse relating to Medicare and Medicaid costs. The
applicability of these provisions to many business transactions in the
health care industry has been subject to only limited judicial and
regulatory interpretation. Noncompliance with the federal anti-kickback
legislation can result in exclusion from Medicare and Medicaid programs and
civil and criminal penalties.
Congress has 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 could have
a material adverse effect on the operations of the Company.
MANAGED CARE
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.
COMPETITION
The market for dental services is highly fragmented and is
characterized by large numbers of solo practitioners and small group
practices competing for individual patients. The Company believes that
cost, location, hours of operation and quality of dental services are the
principal factors affecting competition for patients. 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 Professional Corporations
will be able to compete effectively in the markets they serve, and an
inability to do so would adversely affect the Company.
In pursuing its growth strategy, the Company also faces competitive
pressures for the acquisition of dental practices to be added to the Gentle
Dental Network. In each geographic market it enters, the Company will need
to be competitive with the existing market for dental practices among
dentists. In addition, although the dental practice service industry is
much less developed than the medical practice service industry, the Company
has experienced competition from other dental practice service companies
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for the acquisition of and provision of support services to dental
practices. The Company is aware of several other dental practice service
companies that are in various stages of formation and operation. There can
be no assurance that the Company will be able to compete effectively with
such competitors, that additional competitors with greater resources than
the Company will not enter the market, or that such competition will not
make it more difficult to acquire dental practices on terms beneficial to
the Company.
DEPENDENCE UPON KEY PERSONNEL
In large part, the success of the Company depends on the continued
availability of its executive officers and senior staff members. The
unavailability of certain of these people, or the Company's inability to
attract and retain other key employees, could severely affect the Company's
ability to carry on its business. There is no assurance that these officers
or employees will remain with the Company or that the Company will be able
to attract and retain other key employees. Successful expansion and
marketing of the Company's services and the development of its business
will depend to a large extent on the abilities and continued participation
of its key employees. The loss of any of these employees could have a
material adverse effect on the Company's business. There are no employment
agreements between the Company and any of its key employees.
DEPENDENCE UPON THIRD-PARTY PAYMENTS
A significant portion of the payment for services rendered by the
Professional Corporations is paid by private insurance programs. There is,
and has been in recent years, an ongoing effort to contain and reduce
health care and dental care costs, and in the event that third-party payors
are successful in obtaining lower payments for specified services, the
Company's results of operations may be materially adversely affected.
POTENTIAL LIABILITY AND INSURANCE
Due to the nature of its business, the Company may from time to time
become involved as a defendant in medical malpractice lawsuits brought
against affiliated Professional Corporations or dentists employed by those
Professional Corporations. 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 support services 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.
NO PRIOR PUBLIC MARKET; VOLATILITY; DILUTION
Before this offering, there has been no public market for the
Company's Common Stock. There is no assurance that an active trading market
will be sustained after completion of this offering or that the market
price of the Common Stock will not decline below the initial public
offering price. The initial public offering price of the Common Stock will
be determined through negotiations between the Company
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and the Representatives. See "Underwriting." The market for securities of
early stage, small business companies has been highly volatile in recent
years, often as a result of factors unrelated to a company's operations.
The Common Stock will be traded on the Nasdaq SmallCap Market, which market
has experienced and is likely to experience in the future significant price
and volume fluctuations, which could adversely affect the price of the
Common Stock without regard to the operating performance of the Company.
These factors, as well as general economic conditions such as recessions or
high interest rates, may adversely affect the market price of the Common
Stock. This offering involves immediate, substantial dilution to new
investors. See "Dilution."
OVERLAPPING OWNERSHIP OF COMPANY AND PROFESSIONAL CORPORATIONS
All of the outstanding stock of the Professional Corporations is owned
by Dany Y. Tse (Chairman, President and Chief Executive Officer, and
principal shareholder of the Company), Craig W. Wong (a director and
principal shareholder of the Company), William J. K. Saiget, Scott T.
McClure , Alvin S. Watanabe (principal shareholders of the Company) , and
Edward V. Conzatti (a shareholder of the Company). Accordingly, the same
group of individuals has the power to influence the composition of and
decisions made by the boards of directors of both the Professional
Corporations and the Company. The Company's Board of Directors has adopted
a policy that applies to all future transactions between the Company and
the Professional Corporations. 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. See "Certain Transactions."
CONCENTRATION OF STOCK OWNERSHIP
Following this offering, the executive officers and directors of the
Company, together with three other founding shareholders, will beneficially
own or have control over approximately 37% of the Common Stock.
Accordingly, these individuals will have the ability to influence the
election of the Company's directors and effectively control most corporate
actions. This concentration of ownership may also have the effect of
delaying, deterring, or preventing a change of control of the Company. See
"Principal Shareholders."
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 3,041,881 shares of Common Stock that will be outstanding
following this offering, the 1,500,000 shares of Common Stock offered
hereby will be freely tradable under federal securities law to the extent
they are not held by affiliates of the Company. An additional 40,500 shares
of Common Stock will be freely tradeable without restriction pursuant to
Rule 144(k) under the Securities Act of 1933 (the "Securities Act"), and,
beginning 90 days after the date of this Prospectus, an additional
1,296,189 shares will be eligible for resale subject to compliance with
Rule 144 or Rule 701 under the Securities Act. Holders of 1,033,450 of the
restricted shares eligible for resale beginning 90 days after the date of
this Prospectus have agreed that they will not, without the written consent
of Black & Company, Inc., offer to sell, contract to sell or otherwise sell
or dispose of their shares for one year following this offering. Holders of
100,000 shares of the Company's Common Stock and of warrants to purchase an
additional 104,333 shares are entitled to certain rights with respect to
the registration of such shares under the Securities Act. See "Description
of Capital Stock--
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Registration Rights." The Company also intends to register shares reserved
for past or future option grants under the Securities Act after this
offering. See "Description of Capital Stock," "Shares Eligible for Future
Sale," and "Underwriting."
COMMON STOCK PUT RIGHTS
A total of 190,302 shares of Common Stock issued by the Company (as
well as 100,000 shares of Common Stock subject to a warrant granted to an
outside investor) are subject to "put" rights. As of December 31, 1996, put
rights issued in connection with dental practice acquisitions ("Dentist Put
Rights") cover a total of 90,302 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 18,435 shares that can be exercised in varying amounts in
1997, 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.
The Company has also granted ServiceMaster Venture Fund, L.L.C.
("ServiceMaster") the right to require the Company to repurchase the
100,000 shares held by ServiceMaster and 100,000 shares ServiceMaster may
acquire upon exercise of an outstanding 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
$10,000,000 (a "Qualified Offering"). ServiceMaster's 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.
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. The Company's use of cash to honor
outstanding put rights would reduce funds otherwise available to the
Company for operations or acquisitions.
POSSIBLE ADVERSE EFFECT OF ISSUANCE OF PREFERRED STOCK; POTENTIAL
ANTITAKEOVER EFFECT OF WASHINGTON LAW
The Company is authorized to issue up to 30,000,000 shares of
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 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."
11
<PAGE>
PROPOSED ACQUISITION
The Company has entered into a non-binding letter of intent to acquire
substantially all of the assets of the Blue Oak Dental Group ("Blue Oak"),
a seven-dentist group practice located in the Sacramento, California area.
According to information supplied by Blue Oak to the Company, Blue Oak had
patient revenues of approximately $3.0 million in 1995 and approximately
$2.2 million for the nine months ended September 30, 1996. The letter of
intent contemplates a purchase price of $775,000 in cash, $1,075,000 in
shares of Company Common Stock valued at the initial public offering price
in this offering, and the assumption of debt and capital lease obligations
of up to a maximum of $550,000. The Company has commenced negotiation of a
definitive asset purchase agreement for this transaction. The agreement
will be subject to a number of closing conditions, including, but not
limited to, completion of this offering, receipt of required third-party
consents, and legal compliance. There can be no assurance that the Company
will be able to negotiate a definitive asset purchase agreement with Blue
Oak, that the terms of the definitive agreement will not change
substantially from the terms set forth in the letter of intent, or that the
conditions to closing of the transaction will be satisfied. Moreover, the
Company has not completed its analysis of the legal and regulatory issues
applicable to conducting its business in California, and there can be no
assurance that all such issues will be satisfactorily resolved. There can
be no assurance that the proposed acquisition of Blue Oak will be completed
or that it will be completed without significant delay.
USE OF PROCEEDS
The net proceeds to the Company from the sale of the shares of Common
Stock offered hereby are estimated to be $6.4 million ($7.5 million if the
Underwriters' overallotment option is exercised in full). The Company intends to
use approximately $4.65 million of the net proceeds to repay all
outstanding indebtedness under the Company's bank loan agreement. Of the
outstanding amount, $1.8 million was borrowed in 1995 and 1996 to fund
dental practice acquisitions and equipment purchases; this amount matures
on August 30, 2000 and carries an interest rate of 1.50% over prime (or
9.75% at September 30, 1996). Another $0.75 million of the outstanding
amount matures on August 30, 1999 and carries an interest rate of 1.25%
over prime (or 9.50% at September 30, 1996). The remaining outstanding
amount is borrowed pursuant to two lines of credit. One of the two lines of
credit provides a maximum of $1.85 million, carries an interest rate of
1.00% over prime (or 9.25% at September 30, 1996), and matures on October
31, 1997. The other line provides a maximum of $0.65 million, carries an
interest rate of 2.50% over prime (or 10.75% at September 30, 1996), and
matures on February 28, 1997, or 10 days after the consummation of this
public offering, if earlier. Upon repayment of the outstanding indebtedness
as described above, all personal guarantees provided by certain officers,
directors, and shareholders of the Company with respect to the Company's
current credit arrangements will be canceled. See "Certain Transactions."
If the proposed acquisition of Blue Oak is completed, $775,000 of the
net proceeds is expected to be used to fund the cash portion of the
purchase price. See "Proposed Acquisition." The balance of the net
proceeds, together with the borrowing capacity resulting from the repayment
of outstanding indebtedness, is expected to be used to fund acquisitions of
dental practices, improvements in existing and acquired practices, working
capital and other general corporate purposes. Although an integral part of
the Company's strategy is to grow through acquisitions, and the Company is
currently in discussions with several dental practices in both its current
and potential future geographic markets, no acquisition other than the
proposed acquisition of Blue Oak is the subject of any letter of intent or
definitive agreement.
12
<PAGE>
DIVIDEND POLICY
The payment of dividends is within the discretion of the Company's
Board of Directors. The Company paid cash dividends to its shareholders in
1994 and 1995 in the aggregate amounts of $223,680 and $86,943,
respectively, principally for the payment of the shareholders' income tax
liabilities associated with the Company's status as a subchapter S
corporation. The Company elected to terminate its subchapter S corporation
status on January 1, 1995. 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. The
Company's existing credit agreement prohibits the payment of cash
dividends.
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
September 30, 1996 and as adjusted to give effect to the sale of the
1,500,000 shares of Common Stock offered hereby and the application of the
estimated net proceeds therefrom.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
------------------------
ACTUAL AS ADJUSTED
---------- -----------
(IN THOUSANDS)
<S> <C> <C>
Long-term debt and capital lease obligations,
net of current portion.............................................. $ 2,572 $ 665
Redeemable common stock, 190,302 shares issued
and outstanding..................................................... 2,188 2,188
Nonredeemable shareholders' equity:
Preferred stock, 30,000,000 shares authorized,
no shares issued and outstanding..................................
Common stock, 50,000,000 shares authorized,
1,373,579 shares issued and outstanding,
2,873,579 shares issued and outstanding
as adjusted (1)(2)................................................ 2,888 9,313
Additional paid-in capital.......................................... 432 432
Retained earnings................................................... 125 125
---------- ---------
Total nonredeemable shareholders' equity........................ 3,445 9,870
---------- ---------
Total capitalization.................................................... $ 8,205 $ 12,723
========== =========
- -----------------
(1) Does not include 350,250 shares of Common Stock subject to outstanding
options at September 30, 1996 at a weighted average exercise price of
$10.20 per share, 150,000 shares subject to the Representatives'
Warrants, and 219,333 shares subject to other outstanding warrants at
an exercise price of $7.50 per share. All outstanding options with
exercise prices higher than the initial public offering price will be
repriced to the initial public offering price, except for options held
by Dr. Tse, which will be repriced to 110% of the initial public
offering price.
(2) Does not reflect the repurchase in December 1996 of 22,000 shares of
Common Stock at $0.02 per share from a former employee.
</TABLE>
13
<PAGE>
DILUTION
The net tangible book value of the Company at September 30, 1996 was
$166,127, or $0.12 per share of Common Stock. Net tangible book value per
share represents the tangible assets of the Company less its total
liabilities and redeemable common stock, divided by the number of
nonredeemable shares outstanding at September 30, 1996. Without taking into
account any changes in net tangible book value after September 30, 1996,
other than to give effect to the sale of the 1,500,000 shares of Common
Stock offered hereby and the deduction of the underwriting discount and
other estimated offering expenses, the net tangible book value of the
Company at September 30, 1996 would have been $2.29 per share of Common
Stock, representing an increase in net tangible book value of $2.17 per
share to existing shareholders and dilution of $2.71 per share to new
investors. Dilution is determined by subtracting net tangible book value
per share after the offering from the amount of cash paid by a new investor
for a share of Common Stock in the offering. The following table
illustrates per share dilution.
Assumed initial public offering price per share....... $ 5.00
Net tangible book value before the offering...... $ 0.12
Increase attributable to new investors........... 2.17
------
Net tangible book value per share after offering...... 2.29
--------
Dilution per share to new investors.............. $ 2.71
========
The following table summarizes, as of September 30, 1996, the relative
investments of all existing shareholders and new investors, giving pro
forma effect to the sale by the Company of the shares offered hereby.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
----------------------- ----------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
----------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C>
Existing Shareholders......................... 1,563,881 51.0% $4,996,979 40.0% $ 3.20
New Investors................................. 1,500,000 49.0% 7,500,000 60.0% 5.00
----------- ------- ----------- -------
Total................................ 3,063,881 100.0% $12,496,979 100.0%
=========== ======= =========== =======
</TABLE>
The foregoing computations do not include (i) an aggregate of
1,000,000 shares reserved for issuance under the Company's 1993 Stock
Incentive Plan, of which 350,250 shares were subject to outstanding options
at September 30, 1996 at a weighted average exercise price of $10.20 per
share, (ii) 150,000 shares subject to the Representatives' Warrants, and
(iii) 219,333 shares subject to other outstanding warrants at an exercise
price of $7.50 per share. All outstanding options with exercise prices
higher than the initial public offering price will be repriced to the
initial public offering price, except for options held by Dr. Tse, which
will be repriced to 110% of the initial public offering price. In addition,
the foregoing calculations do not reflect the repurchase in December 1996
of 22,000 shares of Common Stock at $0.02 per share from a former employee.
14
<PAGE>
SELECTED FINANCIAL DATA
The selected financial data presented below for the year ended
December 31, 1993 have been derived from unaudited financial statements of
the Company. The selected financial data presented below for the years
ended December 31, 1994 and 1995 and for the nine months ended September
30, 1996 have been derived from the audited financial statements of the
Company included elsewhere in this Prospectus. The selected financial data
presented below for the nine months ended September 30, 1995 have been
derived from the unaudited financial statements of the Company included
elsewhere in this Prospectus. In the opinion of management of the Company,
the unaudited financial statements have been prepared on the same basis as
the audited financial statements referred to above and include all
adjustments, consisting only of normal recurring accruals, necessary for a
fair presentation of the financial position of the Company and its results
of operations for the periods indicated. Operating results for the nine
months ended September 30, 1996 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1996. The
selected financial data should be read in conjunction with the financial
statements and notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS
YEARS ENDED DECEMBER 31, ENDED SEPTEMBER 30,
------------------------------------------- ----------------------------
1993 1994 1995 1995 1996
------------- ------------- ------------- ------------ --------------
(UNAUDITED) (UNAUDITED)
(in thousands, except per share amounts
and number of dental offices)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Support services revenue (1).................... $ 1,541 $ 2,731 $ 9,781 $ 7,173 $ 7,866
Branch costs.................................... - - 4,701 3,394 5,234
Operating expenses.............................. 1,168 2,100 4,208 3,160 3,010
------------- ------------- ------------- ------------ --------------
Operating income (loss)......................... 373 631 872 619 (378)
Nonoperating income (expense)................... (3) (16) (382) (77) (550)
------------- ------------- ------------- ----------- --------------
Income (loss) before income taxes............... 370 615 490 542 (928)
Provision (benefit) for income taxes - - 233 258 (228)
------------- ------------- ------------- ------------ --------------
Net income (loss)............................... $ 370 $ 615 $ 257 $ 284 $ (700)
============= ============= ============= ============ ==============
Net income (loss) per share..................... $ 0.19 $ 0.21 $ (0.53)
============= ============ ==============
Unaudited pro forma data (2):
Net income................................... $ 243 $ 404
============= =============
Net income per share......................... $ 0.24 $ 0.35
============= =============
Weighted average shares outstanding............. 1,030 1,154 1,380 1,366 1,485
OTHER DATA:
Net revenue of Professional Corporations........ $ 10,270 $ 12,135 $ 16,029 $ 11,759 $ 15,731
Number of dental offices at period end.......... 10 11 17 15 20
DECEMBER 31, SEPTEMBER 30,
------------------------------------------- -------------
1993 1994 1995 1996
------------- ------------- ------------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA: (in thousands)
Cash and cash equivalents....................... $ 522 $ 30 $ 689 $ 630
Working capital................................. 598 (120) 1,386 898
Total assets.................................... 976 2,763 10,214 13,013
Long-term debt and capital lease
obligations, net of current portion.......... - 847 2,734 2,572
Redeemable common stock......................... - - 711 2,188
Nonredeemable shareholders' equity.............. 858 1,268 3,812 3,445
- -------------------
(1) The Company's revenue in 1995 and 1996 has been significantly affected
by changes in the services provided to and level of fees received from
the Professional Corporations. Under the support services agreements
in effect in the respective periods, support services revenue was 61%
of the net revenue of the Professional Corporations in 1995 and 50% of
such revenue in 1996. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Overview."
(2) Before 1995, the Company was a subchapter S corporation whose taxable
income was passed through to its shareholders. Effective January 1, 1995,
the Company terminated its subchapter S status. The unaudited pro forma
data shows what net income and net income per share would have been if the
Company had been a C corporation during 1993 and 1994.
</TABLE>
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company provides facilities, equipment, staffing, management
support and other ancillary services to the Professional Corporations that
employ the dental service providers of the Gentle Dental Network. The
Company intends to rapidly expand the Gentle Dental Network through
acquisitions in both its existing markets as well as new geographic
markets. The Professional Corporations are exclusively in control of all
aspects of the practice of dentistry and the delivery of dental services.
The Company's revenues consist of fees received for services provided
under two Support Services Agreements between the Company and the
Professional Corporations (the "Support Services Agreements"). See
"Business -- Support Services Agreements." The Company's support services
revenue ("Support Services Revenue") is equal to a percentage of the net
revenue of the Professional Corporations ("Net PC Revenue"). Net PC Revenue
equals the gross billings of the Professional Corporations less contractual
discounts and bad debt allowances. Under the current Support Services
Agreement between Gentle Dental of Oregon, P.C. (the "Oregon Professional
Corporation") and the Company (the "Oregon Support Services Agreement"),
which went into effect as of January 1, 1996, Support Services Revenue is
equal to 50% of Net PC Revenue for 1996, 53% of Net PC Revenue for 1997,
54% of Net PC Revenue for 1998, and 55% of Net PC Revenue for 1999 and each
year thereafter. Under the current Support Services Agreement between Tse,
Saiget, Watanabe & McClure, Inc., P.S. (the "Washington Professional
Corporation") and the Company (the "Washington Support Services
Agreement"), which went into effect as of January 1, 1996, Support Services
Revenue is equal to 50% of Net PC Revenue for 1996, and increases 1% each
year thereafter until the fees reach 55% of Net PC Revenue. The Company
anticipates that, subject to applicable state law, future support services
agreements with professional corporations in new states will be similar to
the Washington Support Services Agreement and will provide for an initial
support services revenue percentage of 50%, increasing annually to 55%.
CHANGES IN SUPPORT SERVICES AGREEMENTS. The Company's operating
results for 1995 and 1996 have been significantly affected by changes in
its relationship with the Professional Corporations as reflected in the
Support Services Agreements. The major changes to the relationship effected
as of January 1, 1995 were designed to give the Company a fee and service
structure similar to other practice management support services companies
and to consolidate non-dental functions to facilitate efficient
administration.
Effective January 1, 1995, the Company entered into revised Support
Services Agreements with the Professional Corporations. These agreements
provided for expanded services in exchange for increased fees. The major
changes in the Support Services Agreements were to (i) change the personnel
to be provided by the Company to include all staff at the dental facilities
other than dentists, specialists, hygienists, nurses and dental assistants;
(ii) change the required services to include the provision of dental
equipment and facilities and financing services in addition to the
previously provided management, administrative, and development services;
(iii) change the method of calculating the Company's fee to a flat
percentage of Net PC Revenue; (iv) require an ongoing assignment of all
patient accounts receivable to the Company at the time patient services are
provided; and (v) allow the Company to collect its service fees by
deducting them from collections and remitting the balance to the
Professional Corporations. As a result of these changes, a number of
expenses incurred directly by the Professional Corporations in
16
<PAGE>
1994 and prior years have been incurred by the Company since January 1,
1995, and a corresponding increase has been made in the Support Services
Revenue received by the Company.
To position the Company to perform its obligations under the new
Support Services Agreements, a number of transactions between the Company
and the Professional Corporations were executed as of the last day of 1994
or the first day of 1995. See "Certain Transactions." In these
transactions, the Company purchased all of the Professional Corporations'
dental equipment and supplies which the Company now provides to the
Professional Corporations under the Support Services Agreements, and the
Company purchased the Professional Corporations' accounts receivable.
Equipment leases pursuant to which the Company previously provided certain
dental equipment to the Professional Corporations were terminated. In
addition, the Company directly assumed all of the leases of existing dental
service locations.
NON-RECURRING INCREASE IN SUPPORT SERVICES REVENUE. For 1995, the
Support Services Revenue percentage under the Support Services Agreements
was temporarily established at 61% of Net PC Revenue. This one-time
non-recurring increase was negotiated among the parties to provide
additional compensation to the Company during a transition year in which
the Company significantly increased its staff to support the accelerated
expansion program.
ACQUISITIONS. During 1995 and 1996, the Company acquired four dental
practices in the Portland, Oregon metropolitan area and seven dental
practices in the Seattle, Washington metropolitan area. The total purchase
price for these practices was $3.8 million, consisting of $1.9 million in
cash, $0.2 million in promissory notes, and 129,933 shares of Common Stock
valued at an aggregate of $1.7 million. The Company has also signed a
letter of intent for the proposed acquisition of the Blue Oak dental
practice for a purchase price consisting of $0.78 million in cash, $1.08
million in shares of Company Common Stock valued at the initial public
offering price in this offering, and the assumption of debt and capital
lease obligations of up to a maximum of $0.55 million. See "Proposed
Acquisition."
The Company's acquisition model and past experience reflect initial
periods in which a new geographic market will contribute minimally, if at
all, to the Company's earnings. Initial profitability at the regional level
is expected to be low because of the time and capital required to develop a
network of offices and practitioners that is large enough to permit full
implementation of the Gentle Dental strategy. This strategy requires that
the Company achieve a critical mass that enables it to economically add
longer office hours and higher-margin specialists to the area's general
dentistry practices, to develop customer awareness, and to position the
Company to enter into significant agreements for large groups of customers,
such as service contracts with health plans and self-insured employers. As
this strategy is implemented, the Company expects earnings contribution
from new regions to steadily improve. In the interim, operating income as a
percentage of revenues will be adversely affected by the lower
profitability of new regions.
The Company's recent expansion into the Seattle area has been
consistent with this initial low profitability expectation at the regional
level. Capital constraints delayed planned acquisitions in the Seattle area
and extended the start-up period. The Company plans to use a portion of the
proceeds from this offering or borrowing capacity resulting from the
repayment of outstanding indebtedness to make additional acquisitions in
the Seattle area.
In connection with the acquisition of dental practices, the Company
capitalizes a portion of the purchase price as intangible assets relating
to patient lists, noncompetition covenants, and the cost of
17
<PAGE>
purchasing the right to provide management support services to the acquired
practices under the Support Services Agreements. These intangible assets
are amortized on a straight-line basis over 25 years. The resulting
amortization expense reduces net income, but not cash flow, and the size of
this expense will increase as the Company completes acquisitions.
RESULTS OF OPERATIONS
The following table shows the derivation of the Company's revenues
from the net revenues of the Professional Corporations for the periods
indicated.
<TABLE>
<CAPTION>
NINE MONTHS
YEARS ENDED DECEMBER 31, ENDED SEPTEMBER 30,
------------------------------------------- ----------------------------
1993 1994 1995 1995 1996
------------- ------------- ------------- ------------ --------------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net revenues of Professional Corporations.......... $ 10,270 $ 12,135 $ 16,029 $ 11,759 $ 15,731
Amounts retained by Professional Corporations...... 8,729 9,404 6,248 4,586 7,865
------------- ------------- ------------- ------------ --------------
Support services revenue........................... $ 1,541 $ 2,731 $ 9,781 $ 7,173 $ 7,866
============= ============= ============= ============ ==============
</TABLE>
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1996 TO THE NINE MONTHS
ENDED SEPTEMBER 30, 1995
Many of the relationships between the nine month periods are affected
by the reduction in support service fees charged to the Professional
Corporations from 61% of Net PC Revenue in 1995 to 50% of Net PC Revenue in
1996. See "Overview -- Non-Recurring Increase in Support Services Revenue."
REVENUE. Net PC Revenue increased 33.8% from $11.8 million for the
nine months ended September 30, 1995 to $15.7 million for the nine months
ended September 30, 1996. Increased revenues from branch offices in
operation during both periods accounted for one-fifth of this increase
while the remainder was the net result of nine practice acquisitions, one
new branch opening, and one branch closure during the period of July 1,
1995 to September 30, 1996.
Support Services Revenue increased 9.7% from $7.2 million for the nine
months ended September 30, 1995 to $7.9 million for the nine months ended
September 30, 1996. This lower rate of growth was the result of the
reduction in the percentage of Net PC Revenue payable under the Support
Services Agreements from 61% in 1995 to 50% in 1996. If the Support
Services Revenue percentage had been 50% in 1995, Support Services Revenue
would have been $5.9 million for the nine months ended September 30, 1995.
BRANCH COSTS. Branch costs include all staff compensation and related
payroll costs at the dental facilities, other than dentists, hygienists,
and dental assistants, and all dental supplies, facilities, equipment
depreciation, and general branch administrative expense. Branch costs
increased 54.2% from $3.4 million for the nine months ended September 30,
1995 to $5.2 million for the nine months ended September 30, 1996. If 1995
Support Services Revenue is adjusted to 50% of Net PC Revenue, as in 1996,
then the branch costs increased as a percentage of Support Services Revenue
from 57.7% for the nine months ended September 30, 1995 to 66.6% for the
nine months ended September 30, 1996. In the Portland area, branch costs as
a percentage of Support Services Revenue (if adjusted to 50% of Net PC
Revenue) increased from 55.4% for the first nine months of 1995 to 64.9%
for the first nine months of 1996. This increase primarily resulted from
the start-up costs that the Company incurred in opening its
18
<PAGE>
new flagship dental office in downtown Portland during November 1995.
During the second half of 1995 and the first nine months of 1996 the
Company acquired practices in Seattle which experienced branch costs during
the first nine months of 1996 that were 87.0% of Support Services Revenue.
The Company's business strategy has not yet been fully implemented in
Seattle resulting in higher Seattle branch costs as a percentage of
revenue.
OPERATING EXPENSES. The Company's operating expenses decreased 4.7%
from $3.2 million for the nine months ended September 30, 1995 to $3.0
million for the nine months ended September 30, 1996. If 1995 Support
Services Revenue is adjusted to 50% of Net PC Revenue, as in 1996, then the
operating expenses decreased from 53.7% of Support Services Revenue for the
nine months ended September 30, 1995 to 38.3% of Support Services Revenue
in 1996. In 1995, the Company significantly increased its executive and
general management staff to support its expansion plans. In the first nine
months of 1996, operating expenses declined as a result of cost reduction
measures implemented by the Company. These cost reduction measures included
staff reductions and combining responsibilities from two executive
positions into one position, voluntary salary reductions by Company
executive personnel, and cutbacks in travel, entertainment, and office
expenses. Although the Company expects some increase in operating expenses,
the Company expects further reductions in operating expenses as a
percentage of revenue as the Company continues to experience economies of
scale in administration.
OPERATING INCOME (LOSS). The Company's operating income decreased from
$0.6 million for the nine months ended September 30, 1995 to an operating
loss of $0.4 million for the nine months ended September 30, 1996. This
decrease is attributable to the non-recurring increase in the Support
Services Revenue percentage in 1995. The Company would have incurred an
operating loss of $0.7 million for the nine months ended September 30, 1995
if the Support Services Revenue percentage had been 50% in 1995.
NONOPERATING INCOME (EXPENSE). Nonoperating expense increased from
$77,455 for the nine months ended September 30, 1995 to $0.5 million for
the nine months ended September 30, 1996. The increase for the nine months
ended September 30, 1996 partially reflects additional interest expense
related to additional borrowings. In addition, in May 1996, in
consideration for guaranteeing the Company's line of credit, the Company
issued to certain officers, directors, and shareholders of the Company
warrants to purchase 115,000 shares of the Company's common stock. The
estimated fair market value of the warrants was $232,978, which has been
amortized over the initial six-month term of the line of credit. As of
September 30, 1996, $194,148 of interest expense had been recorded related
to the warrants.
PROVISION (BENEFIT) FOR INCOME TAXES. For the nine months ended
September 30, 1995, the Company's effective tax rate was approximately 48%.
For the nine months ended September 30, 1996, the Company recognized a tax
benefit resulting from its taxable loss for the period. Because the Company
has in the past used and expects most future practice acquisitions to use a
tax-free merger structure, the amortization of intangible assets will
reduce earnings but will not be deductible for tax purposes. Accordingly,
the Company expects that in profitable years, the effective tax rate will
be higher than the applicable statutory tax rate.
19
<PAGE>
COMPARISON OF YEAR ENDED DECEMBER 31, 1995 TO YEAR ENDED DECEMBER 31, 1994
As discussed above under "Overview -- Changes in Support Services
Agreements," as a result of the changes to the services provided under the
Support Services Agreements effective January 1, 1995, a number of expenses
incurred directly by the Professional Corporations before 1995 are now
being incurred by the Company and a corresponding increase has been made in
the service fees paid by the Professional Corporations to the Company. Many
of the fluctuations between historical 1995 and 1994 operating results are
due to this expansion in the services provided by the Company to the
Professional Corporations. In addition, 1995 operating results were
affected by the temporary establishment of the Support Services Revenue
percentage at 61% of Net PC Revenue for 1995.
REVENUE. Net PC Revenue increased 32.1% from $12.1 million in 1994 to
$16.0 million in 1995. Increased revenues from branch offices in operation
during both periods accounted for 37.8% of this increase, while the
remainder was the result of the acquisition of seven dental practices, the
closure of one branch and the opening of one new branch. Support Services
Revenue increased from $2.7 million in 1994 to $9.8 million in 1995. This
increase was primarily attributable to (1) the increase in services
provided and fees paid under the Support Services Agreements from 1994 to
1995 and (2) the 32.1% increase in Net PC Revenue from 1994 to 1995.
Approximately $1.8 million of the increase would not have occurred if the
Support Services Revenue percentage had been 50%, as in 1996.
BRANCH COSTS. Branch costs did not exist in 1994 at the Company level
based on the structure of the Support Services Agreements. Before January
1, 1995, branch costs were incurred directly by the Professional
Corporations and the related support services were not provided under the
Support Services Agreements.
OPERATING EXPENSES. Operating expenses increased 100.4% from $2.1
million in 1994 to $4.2 million in 1995. This increase includes $0.8
million in additional executive and general management staff salaries and
benefits due to a buildup in executive and general management staff
required to support the Company's expansion plans. Additionally, there were
increases of $0.4 million in advertising and marketing costs and $0.4
million in depreciation expense related to the expansion of the Company's
corporate and regional operations.
OPERATING INCOME (LOSS). Operating income increased 38.2% from $0.6
million in 1994 to $0.9 million in 1995. The increase is attributable to
the non-recurring increase in the Support Services Revenue percentage. The
Company would have incurred an operating loss of $0.9 million for 1995 if
the Support Services Revenue percentage had been 50% in 1995.
NONOPERATING INCOME (EXPENSE). Nonoperating expense increased from
$16,217 in 1994 to $0.4 million in 1995. The 1995 increase primarily
relates to higher interest expense related to additional borrowings. In
addition, other expense for 1995 includes the recognition of an $86,187
loss on disposal of computer equipment as a result of a 1995 computer
upgrade and conversion.
20
<PAGE>
QUARTERLY RESULTS
The following table sets forth selected financial data by quarter for
the Company's 1995 fiscal year and the first three quarters of fiscal 1996.
The quarterly information is derived from the Company's unaudited financial
statements. In the opinion of management, the unaudited financial
statements have been prepared on the same basis as the audited financial
statements and include all adjustments of a normal and recurring nature
which are necessary for a fair presentation. The operating results for any
quarter are not necessarily indicative of the results for any future
period.
<TABLE>
<CAPTION>
FISCAL 1995 QUARTERS ENDED FISCAL 1996 QUARTERS ENDED
------------------------------------------ ----------------------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30 SEPT. 30
------- ------- -------- ------- ------- ------- --------
(in thousands, except per share data amounts and number of dental offices)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA: (unaudited)
Support services revenue................. $2,363 $ 2,474 $ 2,336 $ 2,608 $ 2,480 (1) $ 2,677 (1) $ 2,709 (1)
Branch costs............................. 1,211 1,110 1,072 1,308 1,751 1,725 1,758
Operating expenses....................... 977 1,043 1,140 1,048 901 1,011 1,098
------- ------- ------- ------- ------- ------- -------
Operating income......................... 175 321 124 252 (172) (59) (147)
Income (loss) before income taxes........ 161 295 86 (52) (261) (189) (478)
Net income (loss)........................ 84 154 46 (27) (199) (204) (297)
Net income (loss) per share.............. $ 0.07 $ 0.11 $ 0.03 $ (0.02) $ (0.19) $ (0.14) $ (0.20)
Weighted average shares outstanding...... 1,236 1,388 1,475 1,420 1,384 1,510 1,560
OTHER DATA:
Net revenue of Professional $ 3,874 $ 4,056 $ 3,830 $ 4,269 $ 4,960 $ 5,353 $ 5,418
Corporations...........................
Number of dental offices at period end 13 13 15 17 19 20 20
- -------------------
(1) Support Services Revenue for 1996 reflects the reduction of the
Support Services Revenue percentage from 61% of Net PC Revenue in 1995
to 50% of Net PC Revenue in 1996.
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
From January 1, 1995 to September 30, 1996, the Company has financed
its operations and expansion with bank borrowings and cash from operations
as well as $2.6 million in net proceeds from private sales of Common Stock
and warrants. At September 30, 1996, the Company had working capital of
$0.9 million.
The Company has a credit facility with its principal bank that
provides access to up to $5.1 million. Of this maximum amount, $4.65
million was outstanding as of September 30, 1996. Approximately $0.75
million of the outstanding amount is pursuant to a term loan that matures
on August 30, 1999 and carries an interest rate of 1.25% over prime.
Approximately $1.8 million of the outstanding amount is pursuant to a term
loan that matures on August 30, 2000 and carries an interest rate of 1.50%
over prime. The remaining outstanding amount is pursuant to two lines of
credit. One of the two lines of credit provides a maximum of $1.85 million,
carries an interest rate of 1.00% over prime, and matures on October 31,
1997. The other line provides a maximum of $0.65 million, carries an
interest rate of 2.50% over prime and matures on February 28, 1997, or 10
days after the consummation of this offering, if earlier. The Company
intends to repay all amounts owed to the Company's principal bank from the
proceeds of this offering. After completion of this offering, the Company
expects to negotiate for a new credit facility. Although the Company
expects to obtain improved terms based on its improved balance sheet, there
can be no assurance as to the credit terms the Company will be able to
secure.
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<PAGE>
The Company believes that its existing cash balances, amounts
available under renegotiated credit facilities and cash from operations,
together with the proceeds of this offering, will be sufficient to fund its
operations and acquisitions for at least the next 12 months. However, to
execute its long-term business strategy, the Company will require
substantial additional funding to acquire new practices and to expand and
maintain practices within the Gentle Dental Network. The Company will seek
to obtain needed funds through additional long-term or short-term borrowing
arrangements or through the public or private issuance of additional debt
or equity securities. 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.
22
<PAGE>
BUSINESS
OVERVIEW
The Company provides dental practice management support services to
two Professional Corporations that employ 62 dentists, orthodontists, and
other specialists at 20 locations in the Portland, Oregon and Seattle,
Washington metropolitan areas. The Company provides facilities, equipment,
staffing, management support and other ancillary services to the
multi-specialty dental practices that constitute the Gentle Dental Network.
The Company intends to rapidly expand the Gentle Dental Network through
acquisitions in both its existing markets as well as new geographic
markets. During 1995 and 1996, the Company acquired 11 dental practices.
All of the Gentle Dental Network's dentists, specialists, dental
hygienists, and other professional personnel are employed by one of the two
Professional Corporations. When a new dental practice is acquired, the
professionals associated with that practice become employees of the
Professional Corporation in the state where the practice is located. Branch
management and support personnel are employed by the Company. The dentists
maintain full control over all clinical aspects of their dental practices
and all Gentle Dental Network customers are patients of the Professional
Corporations. The Company is not engaged in the practice of dentistry and
does not have any direct relationship with the patients served by the
Professional Corporations.
The Company was organized in December 1992 to provide support services
to the Professional Corporations and to facilitate the development and
expansion of the Gentle Dental Network. The dental practices composing the
Professional Corporations originated with a single office dental practice
established in 1979 in Vancouver, Washington by Dr. Dany Tse, the Chairman,
President and Chief Executive Officer of the Company. Over the years, Dr.
Tse expanded the practice by adding new dentists and dental offices in
customer-convenient locations throughout the Portland, Oregon metropolitan
area. In 1995, the Company began the expansion of the Gentle Dental Network
into the Seattle, Washington metropolitan area, and has acquired the
practices of seven dentists in the Seattle area to date.
INDUSTRY BACKGROUND
Dental spending in the United States is expected to total $40.8
billion in 1996 according to the ADA (June 1996 report) and is projected by
the Congressional Budget Office to reach $83 billion by the year 2003
(Congressional Budget Office Memorandum, "Projections of National Health
Expenditures: 1993 Update" (October 1993)). The aging of the U.S.
population, a widely recognized demographic trend, is expected to increase
the demand for dental services. Due to the success of preventive dentistry
in reducing the incidence of oral disease, older Americans are expected to
retain their teeth longer and to be more aware of the importance of regular
dental care. Demand for dentists' newer services, such as cosmetic
dentistry, also is expected to contribute to market growth. In addition,
the Company believes that some individuals use dental services infrequently
because of fear, and that demand for dental services can be increased by
marketing and treatment approaches designed to alleviate that fear.
Dentistry has traditionally been and continues to be a highly
fragmented industry dominated by solo practitioners. According to the ADA's
1995 Survey of Dental Practice, 67% of dentists were solo practitioners and
only 12% practiced in groups of three or more dentists. The Company
believes traditional practices have high operating costs, wield little
purchasing power with suppliers and must spread overhead over a relatively
small revenue base. In addition, these practices often have insufficient
23
<PAGE>
capital to purchase new technologies and lack the systems necessary to
develop economies of scale. As a result, the Company believes that dentists
increasingly will find it attractive to affiliate with larger
organizations, such as the Gentle Dental Network, and that there are
significant opportunities to consolidate dental practices.
Another factor driving the trend towards consolidation of dental
practices is managed care. As managed dental care becomes more common,
dentists will have an even greater need for the information resources,
management expertise, economies of scale, and access to managed care group
contracts that larger organizations such as the Gentle Dental Network may
be better able to provide. Despite this shift toward managed care, dentists
have traditionally provided dental services on a fee-for-service basis and
this payment method is expected to predominate the dental market for the
next several years. According to the ADA's 1995 Survey of Dental Practices,
less than 6% of the patients surveyed were participating in managed dental
care systems. In addition, fee-for-service care is generally more
profitable than managed care.
THE GENTLE DENTAL STRATEGY
The Company's objective is to become a leading provider of dental
practice management support services through its growing network of
affiliated dentists and specialists. The Company's strategy to achieve this
objective is to enter selected geographic markets and develop locally
prominent, multi-specialty dental care delivery networks that provide high
quality, cost-effective dental care. In pursuing this strategy, the Company
will seek to replicate the dental service network it has developed and
supports in the Portland, Oregon area. The key elements of the Gentle
Dental strategy are as follows:
PROVIDE CONVENIENT, GENTLE, COMPREHENSIVE DENTAL CARE. The Gentle
Dental Network offers its patients gentle, customer-friendly,
comprehensive, and cost-effective dental care at convenient times and
locations. Because the network includes both general practitioners and
on-staff specialists who can provide a full range of services such as
orthodontics, pedodontics, prosthodontics, and oral surgery, patients can
rely on the Gentle Dental Network to serve all of their families' dental
care needs. Extended office hours and conveniently located offices make it
easier to schedule and keep appointments, while the Gentle Dental Network's
flexible payment options help reduce patients' financial burdens.
ATTRACT HIGH QUALITY, PRODUCTIVE DENTISTS AND SPECIALISTS. The Gentle
Dental Network seeks dentists and specialists who are committed to
delivering gentle, high quality dental care with the needs of patients as
their paramount concern. Dentists and specialists selected to join the
Gentle Dental Network also must be dedicated to expanding and enhancing
their practices. The Professional Corporations' quality assurance programs
are designed to ensure that providers in the Gentle Dental Network maintain
the high standards for quality, gentleness, and customer service that are
central to the Company's philosophy. See "Business -- Quality Assurance
Programs." The Company believes that it can offer significant benefits to
dentists and specialists whose practices and service philosophies meet the
Gentle Dental Network's selection criteria. Practitioners who join the
Gentle Dental Network are freed from administrative burdens associated with
operating a business, allowing them to focus on the practice of dentistry
and increase their productivity. The Company's size and structure also
enable it to offer financial resources for practice development and
enhancement that solo and small group practitioners could not obtain
independently. In addition, joining the Gentle Dental Network offers
established practitioners the opportunity to sell their practices for cash
and Common Stock of the Company while permitting them to continue
practicing dentistry.
24
<PAGE>
EXPAND THE GENTLE DENTAL NETWORK THROUGH ACQUISITIONS. The Company
intends to enter new geographic markets by acquiring established dental
practices and will initially target a significant group practice in each
market. Upon entering a new geographic market, the Company intends to
acquire additional individual or group practices as quickly as possible to
realize the economies of scale in management and marketing that come from
achieving critical mass in a market. The Company will then recruit
specialists, extend office hours, and add locations in the geographic area
as appropriate to provide patients a comprehensive range of dental care at
convenient times and locations throughout the area. The addition of
specialists such as orthodontists and oral surgeons who serve multiple
clinics within the Gentle Dental Network allows the Company to capture
incremental revenue from the higher fees commanded by specialty services.
ACHIEVE ECONOMIES OF SCALE. The Company intends to build a large
network of multi-specialty dental practices that will allow it to realize
economies of scale and reduce several key operating costs. For example,
economies of scale are experienced through centralization of several
management and administrative functions such as marketing, billing,
collections, human resources, payroll, and general accounting services for
the affiliated practices. In addition, the Company believes that the
network configuration will give it leverage to negotiate with third-party
payors and dental supply vendors to receive rates and contract terms that
are more favorable than those typically available to solo and small group
practitioners. The Company is also developing management information
systems to collect and analyze clinical and administrative data designed to
allow the Company to effectively control overhead expenses, maximize
reimbursement, and provide effective resource management.
PURSUE LARGE GROUP FEE-FOR-SERVICE AND MANAGED CARE CONTRACTS. The
Company intends to continue to aggressively pursue fee-for-service business
because it is generally more profitable than managed care business. The
Company believes that by providing comprehensive geographic coverage in
each market, the Gentle Dental Network will be strongly positioned to offer
group dental health packages to self-insured employers and dental health
plans in the area, which may allow it to rapidly expand its patient base.
In addition, as managed care penetration in the dental market increases,
the Company plans to develop information systems to improve productivity,
manage complex reimbursement methodologies, measure patient satisfaction
and outcomes of care, and integrate information from multiple sources. As
the Company continues to grow both internally and through acquisitions,
management believes that the Company's network will be positioned to
compete effectively for large group fee-for-service and managed care
business.
ACQUISITIONS
The Company intends to enter new geographic markets by acquiring
dental practices with established patient bases. The Company will initially
target a significant group practice in each new market to secure a solid
foundation upon which to build its regional network of dental practices.
The Company will then seek to acquire additional individual or group
practices as quickly as possible to realize the economies of scale in
management and marketing that come from achieving critical mass in a
market. The Company's growth plan emphasizes the affiliation of practices,
both primary and specialty care, to meet the needs of patients and payors,
adjusted according to the dynamics of individual markets. The Company will
focus on developing and maintaining a comprehensive network of dentists and
specialists in each market it enters. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Overview --
Acquisitions."
25
<PAGE>
The Company's criteria for entering new geographic markets include:
(i) population size and distribution, (ii) dental practice density,
specialty composition, saturation and average group size, (iii) local
competitors in the dental support services business, (iv) level of managed
care penetration, and (v) local industry and economy. In the past, the
Company has targeted dental practices that derive all or a high percentage
of their revenue from fee-for-service sources as opposed to managed care
sources. In the near term, the Company plans to continue this approach as
it develops its network of practices as fee-for-service care is generally
more profitable than managed care.
The Company generally uses a combination of Common Stock, cash and/or
notes to fund acquisitions. The amount paid for each practice will vary on
a case-by-case basis according to historical revenues, projected earnings
contribution after addition to the Gentle Dental Network, and transaction
structure. In connection with each acquisition, the Company acquires
substantially all of the assets of the practice, including its dental
equipment and supplies, office lease and improvements, receivables and
patient charts. After the acquisition of a dental practice, the patient
charts are transferred to a professional corporation with which the Company
has entered into a support services agreement, the dentist becomes an
employee of that professional corporation, and the patients are thereafter
served by that professional corporation. The employment agreements between
the Professional Corporations and the individual dentists typically have an
initial two-year term with annual renewals thereafter and typically include
a two-year noncompete provision following termination of employment. The
Company anticipates that, subject to applicable state law, it will enter
into a support services agreement with one professional corporation in each
state into which it expands the Gentle Dental Network.
Although an integral part of the Company's strategy is to grow through
acquisitions, and the Company is currently in discussions with several
dental practices in both its current and potential geographic markets, no
acquisition other than the proposed acquisition of Blue Oak is the subject
of any letter of intent or definitive agreement. See "Proposed
Acquisition."
26
<PAGE>
THE GENTLE DENTAL NETWORK
The Gentle Dental Network currently includes two affiliated
Professional Corporations that employ 36 general practitioners and 16
specialists in the Portland area and 10 general practitioners in the
Seattle area. There are 114 treatment rooms in the Gentle Dental Network's
Portland area offices and 27 treatment rooms in the Seattle area offices.
The following table provides certain other information about the dental
offices included in the Gentle Dental Network.
<TABLE>
<CAPTION>
GROSS BILLINGS
DATE OPENED NINE MONTHS
OR YEAR ENDED ENDED
LOCATION ACQUIRED DECEMBER 31, 1995 SEPT. 30, 1996
-------- -------------- ----------------- --------------
(IN THOUSANDS)
<S> <C> <C> <C>
PORTLAND AREA
Cascade Park August 1989 $ 1,841 $ 1,539
Cedar Hills January 1996 -- 791
Clackamas Town Center December 1986 1,715 1,315
Cornell Center August 1990 1,187 1,139
Downtown September 1995 61 391
Eastside September 1986 1,400 855
Eastside 2 January 1995 360 205
Gresham Village December 1994 792 676
Hazel Dell December 1986 2,030 1,743
Hillsboro December 1988 1,141 795
Lake Oswego November 1994 913 756
Lloyd Center April 1993 1,314 1,103
Tigard January 1990 1,458 1,161
Vancouver Mall April 1985 1,950 1,582
-------- --------
Subtotal 16,162 14,051
SEATTLE AREA
Ballard June 1996 -- 121
Everett October 1995 50 193
Pinehurst August 1995 311 614
Redmond October 1995 189 603
Tacoma October 1995 138 510
Totem Lake January 1996 -- 552
--------- ---------
Subtotal 688 2,593
--------- ---------
Total $ 16,850 $ 16,644
========= =========
</TABLE>
The Company believes the Gentle Dental Network is differentiated in
the marketplace by its patient-friendly approach to business. In a style
atypical of traditional dental practices, services are provided under the
Gentle Dental name in multi-specialty group practices with
customer-convenient locations and hours. Services are generally available
from 7:00 A.M. until 9:00 P.M. on weekdays and from 8:00 A.M. until 4:00
P.M. on Saturdays. Emergency care is available 24 hours a day, seven days a
week. The Company's extended hours offer patients expanded scheduling
opportunities, providing more convenience to patients and less disruption
for employers.
As the Gentle Dental name suggests, the Gentle Dental Network stresses
comfortable and gentle customer-friendly dentistry. In the Portland, Oregon
metropolitan area, a complete range of family dental
27
<PAGE>
health care services is offered in each location with on-staff dental
specialists and value-added amenities such as flexible payment options.
Gentle Dental dentists provide comprehensive dental care for the entire
family, ranging from routine teeth cleaning and diagnosis to oral surgery,
cosmetic bonding, orthodontia and major rehabilitation. The Professional
Corporations employ family dentists and hygienists along with specialists
in endodontics, oral pathology, oral surgery, orthodontics, pedodontics,
periodontics and prosthodontics. The Company's comprehensive approach
allows the Company to capture incremental revenue generated by on-staff
specialists and ancillary services. The Gentle Dental Network in the
Seattle, Washington area is at an earlier stage of development and does not
yet include specialists.
QUALITY ASSURANCE PROGRAMS
By taking advantage of the Gentle Dental Network's group practice
structure, the Company has assisted the Professional Corporations in
developing quality assurance programs to help implement the Gentle Dental
service philosophy. In addition to encouraging Gentle Dental customers to
provide feedback to the Company about the care they receive, the
Professional Corporations have formal peer-review procedures in place.
These procedures are designed to ensure that high-quality,
customer-oriented dental care is consistently delivered to all Gentle
Dental customers, and include formal evaluations of all dental care
providers at least annually and a system of tracking and responding to all
customer complaints. In addition, because the Gentle Dental Network offers
speciality services and extended hours, there is a greater likelihood that
more than one practitioner will see a given customer and will therefore
have the opportunity to evaluate the work done by other service providers
within the network. This permits direct monitoring of the quality of dental
care delivered through the network. Furthermore, the aggregation of
practitioners within the Gentle Dental Network makes its possible for the
Company to organize in-house training in up-to-date practice techniques for
those practitioners.
MARKETING
The Company's marketing program is designed to help the Professional
Corporations achieve three central objectives: retaining existing customers
and expanding the services they receive, attracting new individual
customers, and developing contracts to serve large groups of customers.
The Company believes that customer satisfaction is the key to enabling
the Professional Corporations to retain and expand services to their
existing customers. The Gentle Dental Network strives to deliver
comfortable, high quality dental care at times and locations that are
convenient for the customer, and believes that these features will motivate
customers to return to Gentle Dental offices for their future dental care
needs. Encouraging customers to complete treatment plans, ensuring that
each customer leaves a Gentle Dental clinic with a future visit already
scheduled, and offering specialty services such as cosmetic bonding,
endodontics, oral surgery, orthodontics, pedodontics, periodontics, and
prosthodontics on site also enhance the Professional Corporations' ability
to build customer loyalty and patronage. In addition, the support services
provided by the Company enable the Gentle Dental Network to offer flexible
payment alternatives and sophisticated record-keeping and administrative
services to help customers manage the expense of dental care and the
complexity of health plan or insurance rules.
The Company believes that the same aspects of the Gentle Dental
Network's approach that earn the loyalty of the Professional Corporations'
current customers will also generate new customers. The Company's new
customer marketing programs have two primary goals: helping the Gentle
Dental Network generate referrals from its existing customers and
increasing the Gentle Dental Network's
28
<PAGE>
visibility in the community. The Company seeks to foster visibility by
developing marketing materials and information sources (such as yellow page
advertisements) that communicate the Gentle Dental Network's philosophy of
high quality customer-oriented dental care.
The Company's large customer group marketing strategy is designed to
enable the Gentle Dental Network to develop contracts with self-insured
employers and health plans in the metropolitan areas that it serves. The
Company's large group marketing approach emphasizes the convenience,
quality of care, and large range of services that the Gentle Dental Network
has to offer. The size and economies of scale inherent in the Company's
business strategy also may allow health plans and self-insured employers
served by the Gentle Dental Network to reduce administrative burdens they
might otherwise face. The Company believes that the Gentle Dental Network
is well positioned to respond to managed care opportunities as they arise.
The Gentle Dental Network has also begun to implement a program that
guarantees, for the patient's lifetime, the materials used in restorative
dental work (such as fillings, crowns, and fixed bridges) performed by a
Gentle Dental Network dentist. The guarantee is conditioned upon the
patient completing on schedule all recommended treatments and receiving
regular preventive dental care at Gentle Dental Network offices. The
guarantee program is designed to encourage patients to complete and
maintain recommended oral health programs and return consistently to the
Gentle Dental Network for their dental care. The guarantee program was
introduced in the Seattle area in October 1996 and in the Portland area in
December 1996.
SUPPORT SERVICES AGREEMENTS
The Company has entered into a Support Services Agreement with each of
the Professional Corporations under which the Company is the exclusive
administrator of all non-dental aspects of the dental practices conducted
by the Professional Corporations, providing facilities, equipment,
staffing, management support and other ancillary services. Specifically,
under the Support Services Agreements, the Company, among other things, (i)
provides all facilities and equipment used by the Professional
Corporations, (ii) licenses the use of the Gentle Dental service mark,
(iii) receives an assignment of all accounts receivable generated by the
Professional Corporations and bills and collects the receivables in the
name of the Professional Corporations, (iv) purchases and provides all
supplies, (v) provides all clerical, accounting, payroll, computer and
other non-dental support services and personnel, (vi) supervises and
maintains custody of all business records, (vii) provides management
information reports, (viii) provides market research and plans and
implements marketing and advertising programs, (ix) negotiates contracts on
behalf of the Professional Corporations with managed care payors or other
third parties, and (x) assists in the recruitment of dentists.
Under the Support Services Agreements, the Professional Corporations
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
Professional Corporations are exclusively in control of all aspects of the
practice of dentistry and the delivery of dental services, including final
authority over fees charged and practice locations and equipment.
As compensation for all services provided under the Support Services
Agreements, the Company receives fees based on a percentage of the net
revenues of the Professional Corporations, after allowances
29
<PAGE>
for contractual discounts and bad debts. The current Oregon Support
Services Agreement provides for service fees equal to 50% of the Oregon
Professional Corporation's net revenue for 1996, 53% of net revenue for
1997, 54% of net revenue for 1998, and 55% of net revenue for 1999 and each
year thereafter. The current Washington Support Services Agreement provides
for service fees equal to 50% of the Washington Professional Corporation's
net revenue for 1996, increasing 1% each year thereafter until the fees
reach 55% of net revenue. The service fees are collected by the Company on
an ongoing basis out of the receivables assigned to the Company by the
Professional Corporations. Cash representing the portion of net revenue not
payable to the Company as service fees is advanced to the Professional
Corporations as necessary to meet their financial obligations such as
payroll, malpractice insurance, continuing education costs, and taxes. The
Company anticipates that, subject to applicable state law, future support
services agreements with professional corporations in new states will be
similar to the Washington Support Services Agreement and provide for an
initial support services revenue percentage of 50%, increasing annually to
55%.
The Support Services Agreements each have an initial term of 40 years
commencing January 1, 1996, with automatic 10-year extensions thereafter
unless either party gives notice before the end of the term. The Support
Services Agreements are not terminable earlier by the Professional
Corporations unless (i) the Company is the subject of bankruptcy
proceedings or (ii) the Company materially breaches the Agreement and does
not cure the breach following notice.
SUPPLIERS AND SUPPORT STAFF
The Company selects its supply vendors based upon criteria that
include quality, price, and service. The Company continually evaluates
vendors with respect to these criteria. The Company currently purchases the
majority of the consumable dental supplies used by the Gentle Dental
Network (such as impression material, x-ray film, operatory instruments,
gloves, amalgam, and hypodermic needles) from one supplier, but these
supplies are widely available from other sources. The Company currently
purchases prosthetic devices (such as bridges, crowns, and dentures) from
one of several other suppliers, but these products are also widely
available from other sources.
The Company's workforce includes full-time collection personnel and
staff with full-time responsibility for maintaining the Gentle Dental
Network's facilities. The Company also has a full-time Management
Information Systems (MIS) department.
GOVERNMENT REGULATION
GENERAL. The health and dental care industry is subject to extensive
federal, state, and local laws, rules, and regulations. The Company
believes that its operations are in material compliance with applicable
laws. Nevertheless, because of the special nature of the Company's
relationship with the Professional Corporations, many aspects of the
Company's business operations have not been the subject of state or federal
regulatory interpretation and there can be no assurance that a review of
the Company's or the Professional Corporations' business by courts or
regulatory authorities will not result in a determination that could
adversely affect the operations of the Company or the Professional
Corporations. In addition, the standards of practice of dental care and
related federal and state regulations are subject to change. The Company
cannot predict what changes may be enacted that may affect its business or
the manner in which its business would be affected by such changes.
30
<PAGE>
CORPORATE PRACTICE OF DENTISTRY; FEE SPLITTING. The laws of many
states prohibit business corporations such as the Company from practicing
dentistry or employing dentists to practice dentistry. The Company performs
only non-dental administrative services, does not represent to the public
or its clients that it offers dental services, and does not exercise
influence or control over the practice of dentistry by the Professional
Corporations with which it contracts. Accordingly, the Company believes
that it is not in violation of applicable state laws relating to the
practice of dentistry. In addition, the laws of many states prohibit
dentists from splitting fees with non-dentists. The Company believes that
its receipt of compensation from the Professional Corporations for
providing non-dental management services does not constitute illegal fee
splitting. The laws regarding the corporate practice of dentistry and fee
splitting vary from state to state and are enforced by the courts and by
regulatory authorities with broad discretion. In most states, these laws
have been subjected to limited judicial and regulatory interpretation, and
the Company has not obtained, or applied for, any opinion of any regulatory
or judicial authority that its business operations are in compliance with
these laws. Therefore, no assurances can be given that the Company's
activities will be found to be in compliance if scrutinized by such
authorities. In addition, the regulatory framework of certain jurisdictions
may limit the Company's expansion into such jurisdictions if the Company is
unable to modify its operational structure to conform with such regulatory
framework.
MEDICARE AND MEDICAID FRAUD AND ABUSE. A small percentage of the
revenues of the Professional Corporations comes from the Medicare and
Medicaid programs. For the year ended December 31, 1995, Medicare and
Medicaid revenues combined represented less than 5% of the gross revenue of
the Professional Corporations.
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 Medicare or Medicaid patient, (ii) the furnishing or
arranging for the furnishing of items or services reimbursable under
Medicare or Medicaid programs, or (iii) the purchase, lease or order of any
item or service reimbursable under Medicare or Medicaid. Pursuant to this
anti-kickback law, the federal government has announced a policy of
increased scrutiny of joint ventures and other transactions among health
care providers in an effort to reduce potential fraud and abuse relating to
Medicare and Medicaid costs. The applicability of these provisions to many
business transactions in the health care industry has been subject to only
limited judicial and regulatory interpretation. Noncompliance with the
federal anti-kickback legislation can result in exclusion from Medicare and
Medicaid programs and civil and criminal penalties.
The Company believes that, although it receives fees under the Support
Services Agreements for administrative services, the Support Services
Agreements do not place the Company in a position to make or influence
referrals of patients for services reimbursed under Medicare or Medicaid
programs to the Professional Corporations, or to receive such referrals.
The Company also does not believe that the activities of the Company or the
Professional Corporations under the Support Services Agreements constitute
furnishing, arranging, purchasing, ordering, or recommending Medicare or
Medicaid items or services under the anti-kickback law. If the Company is
deemed to be in a position to make, influence, or receive referrals from or
to dentists, or the Company is deemed to be a provider under the Medicare
or Medicaid programs, the operations of the Company could be subject to
scrutiny under federal and state anti-kickback and anti-referral laws.
Significant prohibitions against physician referrals have been enacted
by Congress. These prohibitions, commonly known as "Stark II," amended
prior physician self-referral legislation known as "Stark I" by
dramatically enlarging the field of physician-owned or physician-interested
entities to which
31
<PAGE>
the referral prohibitions apply. Stark II prohibits a physician from
referring Medicare or Medicaid patients to an entity providing "designated
health services" in which the physician has an ownership or investment
interest, or with which the physician has entered into a compensation
agreement. Although dentists are "physicians" under Stark II, dental
services generally are not designated health services under the law.
Certain services provided by dentists, such as radiology and outpatient
prescription drugs, are designated health services. The Company does not
provide such services, but the Professional Corporations do. The penalties
for violating Stark II include a prohibition on payment by these government
programs and civil penalties of as much as $15,000 for each impermissible
referral and $100,000 for participation in a "circumvention scheme." To the
extent that the Company or either Professional Corporation is deemed to be
subject to Stark II, the Company believes its activities and the activities
of the Professional Corporations fall within the permissible activities
defined in Stark II, including, but not limited to, the provision of
in-office ancillary services.
In addition, the Company also believes that the methods it uses to
acquire existing dental practices do not violate anti-kickback and
anti-referral laws and regulations. Specifically, the Company believes the
consideration paid by the Company to dentists to acquire the tangible and
intangible assets associated with their practices is consistent with fair
market value in arm's length transactions and not intended to induce the
referral of patients. Moreover, the Company does not believe that the
Company or dentists whose practices are acquired by the Company are in a
position to refer, recommend, or arrange Medicare or Medicaid business for
each other. Should the acquisition of dental practices by the Company be
deemed to constitute an arrangement designed to induce the referral of
Medicare or Medicaid patients, then such acquisitions could be viewed as
possibly violating anti-kickback or anti-referral laws and regulations.
POSSIBLE HEALTH CARE REFORM. Congress has 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 could have a material adverse effect on the operations
of the Company.
COMPETITION
The market for dental services is highly fragmented and is
characterized by large numbers of solo practitioners and small group
practices competing for individual patients. The Company believes that
cost, location, hours of operation, and quality of dental services are the
principal factors affecting competition for patients. 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 Professional Corporations
will be able to compete effectively in the markets they serve, and an
inability to do so would adversely affect the Company.
In pursuing its growth strategy, the Company faces competitive
pressures for the acquisition of dental practices to be added to the Gentle
Dental Network. In each geographic market it enters, the Company will need
to be competitive with the existing market for dental practices. In
addition, although the dental practice service industry is much less
developed than the medical practice service industry, the Company has
experienced competition from other dental practice service companies for
the acquisition and provision of support services to dental practices. The
Company is aware of other dental practice service companies that are in
various stages of formation and operation. There can be no assurance that
32
<PAGE>
the Company will be able to compete effectively with such competitors,
that additional competitors with greater resources than the Company will
not enter the market, or that such competition will not make it more
difficult to acquire dental practices on terms beneficial to the Company.
INSURANCE
The Company carries comprehensive liability, fire, and extended
coverage insurance. The Professional Corporations carry professional
liability, general liability, products hazard/completed operations and loss
of practice income insurance. Such insurance coverages are expanded to
include all additional practices that the Company develops or acquires,
with policy specifications, insured limits, and deductibles customarily
carried for similar dental practices.
SERVICE MARK
Other than newly acquired practices, the Company's affiliated dental
practices are operated and marketed under the name Gentle Dental. Newly
acquired practices may or may not immediately use the Gentle Dental name
depending upon each acquired 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 acquired title to the
federal registration of this service mark as originally issued on October
26, 1982. As part of the purchase, the Company granted an exclusive license
("License") to the seller 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 of 10 years, or through 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 of those
practices that commenced use of the Gentle Dental mark before October 26,
1982 will have rights to the mark in their geographic markets 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. However, until the Company actually
begins doing business in a new market where another practice is using the
Gentle Dental name, the Company generally cannot, and therefore will not,
seek to prevent use of its registered service mark in that market. Given
the costs and inherent uncertainties of service mark litigation, there can
be no assurance that the Company will be able to or will choose to enforce
its service mark rights in any particular market.
LEGAL PROCEEDINGS
On June 26, 1996, Donald E. Janoff, D.D.S., a former employee of the
Oregon Professional Corporation, filed a complaint in the circuit court of
the state of Oregon for the county of Multnomah against Gentle Dental, P.C.
for breach of contract. The complaint alleges that Gentle Dental, P.C.
breached Dr. Janoff's employment contract by wrongfully terminating the
contract. The complaint seeks damages of $375,000.
Other than the proceeding described above, neither the Company nor the
Professional Corporations are currently subject to any material litigation
nor, to the Company's knowledge, is any material litigation threatened
against the Company or the Professional Corporations other than routine
litigation arising in the ordinary course of business, some of which are
expected to be covered by liability
33
<PAGE>
insurance and all of which collectively are not expected to have a material
adverse effect on the business, financial condition or results of
operations of the Company.
EMPLOYEES
At December 31, 1996, the Company had 137 full-time and 30 part-time
employees and the Professional Corporations had a total of 187 employees,
including 46 general dentistry practitioners, 16 specialists, 36 dental
hygienists, and 89 dental assistants. None of the Company's employees are
represented by a labor union. Management believes it maintains good
relationships with its employees.
PROPERTIES
The clinics in the Gentle Dental Network are leased from various
parties pursuant to leases with terms ranging from three to fifteen years,
except that two clinics, one on the east side of Portland and the other in
Everett, Washington, are leased month-to-month. 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 downtown Vancouver, Washington.
34
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Information with respect to the executive officers and directors of
the Company is set forth below.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Dany Y. Tse, DMD 46 Chairman of the Board, President
and Chief Executive Officer
Lawrence S. Wasserman 43 Chief Operating Officer
L. Theodore Van Eerden 41 Chief Financial Officer - Corporate
Secretary
William W. Westrate 36 Vice President - Information Technology
Steven M. Wolfe 48 Vice President - Human Resources
Gerald R. Aaron, DDS 50 Director
Richard A. Armstrong 61 Director
Kenneth D. Hooten 33 Director
Daniel P. Hunt 59 Director
Paul H. Keckley 47 Director
Jerald L. Willbur 49 Director
Craig W. Wong, DMD 40 Director
</TABLE>
Dany Y. Tse, DMD. Dr. Tse has served as President and Chief Executive
Officer of the Company since March 1996, and as Chairman of the Board since
December 1996. He previously served as Chairman of the Board from inception
in December 1992 to March 1996. As the founder of the Gentle Dental
Network, Dr. Tse opened a solo dental practice in Vancouver, Washington in
August 1979, and established a group practice by opening additional Gentle
Dental locations in the greater Portland/Vancouver metropolitan area. Dr.
Tse is a licensed dentist in Oregon and Washington and continues to
practice dentistry on a part-time basis.
Lawrence S. Wasserman. Mr. Wasserman joined the Company in June 1995
as Chief Financial Officer and became Chief Operating Officer in March
1996. Before joining the Company, Mr. Wasserman provided consulting
services to entrepreneurial companies, specializing in financial and
management functions. From June 1992 to November 1992, he was the Chief
Operating and Financial Officer for LifePort, Inc., a company that provides
aeromedical transportation equipment for air ambulance providers. Before
joining LifePort, Mr. Wasserman spent seven years at TriCare, Inc. as Chief
Financial Officer.
35
<PAGE>
L. Theodore Van Eerden. 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.
William W. Westrate. Before joining the Company in September 1996, Mr.
Westrate was Vice President, Data Center Services of Van Kampen American
Capital from December 1990 to July 1996.
Steven M. Wolfe. Mr. Wolfe joined the Company as Vice President of
Human resources in October 1994. From August 1988 to October 1994, Mr.
Wolfe owned and operated a training and consulting company specializing in
helping clients acquire and maintain customers. Services included training
in sales, marketing, distribution, customer service, and all aspects of
human resource management and development.
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 by the Washington Professional Corporation since
1991.
Richard A. Armstrong. Mr. Armstrong has been a director of the Company
since July 1995. Mr. Armstrong has served in various positions at The
ServiceMaster Company since 1964. From July 1991 to March 1994, he was
Senior Vice President of People Services. Since March 1994, he has been
Senior Vice President and Advisor to the Chairman.
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.
Daniel P. Hunt. Mr. Hunt has been a director of the Company since
December 1992. Mr. Hunt has been employed since June 1988 as Chief
Financial Officer for HOSTS Corporation, a Vancouver, Washington company
which provides proprietary educational software products and instructional
delivery systems to schools throughout the United States.
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.
Jerald L. Willbur. Dr. Willbur has been a director of the Company
since December 1992. Dr. Willbur has been the Global Director of
Organizational Effectiveness of S.C. Johnson and Sons since July 1996. He
is responsible for strategic planning, human resources, and organization
effectiveness and reports directly to the President. Dr. Willbur was
President and Chief Operating Officer of HOSTS Corporation from June 1988
until January 1996.
36
<PAGE>
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 1982. Dr. Wong serves
as the Chief of the Department of Oral and Maxillofacial Surgery for the
Professional Corporations 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.
The Company's Restated Articles of Incorporation provide for three
classes of directors. Directors Hooten, Keckley, and Wong have been
appointed to Class I and will serve until the annual meeting of
shareholders in 1997; Directors Armstrong, Hunt, and Willbur have been
appointed to Class II and will serve until the meeting of shareholders in
1998; and Director Tse has been appointed to Class III and will serve until
the meeting of shareholders in 1999. 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. Director Aaron has also
been appointed to Class III, but because he was appointed by the Board of
Directors to fill a vacancy, his service for the remaining two years of his
term must be approved at the Company's 1997 annual shareholders' meeting.
BOARD COMMITTEES
The Board of Directors maintains an Audit Committee and a Compensation
Committee. The Audit Committee, consisting of Directors Armstrong , Hunt,
and Willbur, oversees actions taken by the Company's independent auditors,
and reviews the Company's internal audit controls. The Compensation
Committee, consisting of Directors Armstrong, Hunt, and Willbur, reviews
the compensation levels of the Company's employees and makes
recommendations to the Board regarding changes in 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
connection with his initial election as a director in July 1995, Mr.
Armstrong was granted a 10-year stock option for 2,000 shares with an
exercise price of $10.00 per share. The Board of Directors has resolved
that the exercise price of Mr. Armstrong's option will be repriced to the
initial public offering price. In January 1997, Mr. Keckley was granted a
10-year stock option for 2,000 shares with an exercise price equal to the
initial public offering price. In prior years, Directors Hunt and Willbur
received awards of restricted stock as compensation for services as
directors, which awards are only partially vested.
37
<PAGE>
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 1996 and the only other executive officers of the
Company whose total annual salary and bonus exceeded $100,000 in fiscal
1996 (collectively, the "Named Officers").
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSAION ------------
---------------------- OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS GRANTED COMPENSATION(1)
- --------------------------- ---- --------- ----- ------- ---------------
<S> <C> <C> <C> <C> <C>
Dany Y. Tse, DMD 1996 $ 170,185 -- -- $3,339
Chairman of the Board,
President and Chief
Executive Officer
Lawrence S. Wasserman 1996 $ 105,412 -- 32,500 $2,933
Chief Operating Officer
John W. Castles 1996 $ 51,610 -- -- $1,811
Former President and
Chief Executive Officer (2)
Alan J. Resnik 1996 $ 108,772 -- -- --
Former Senior Vice
President - Marketing (3)
- -----------------
(1) Consists of matching contributions made by the Company to the
Company's 401(k) Plan.
(2) Mr. Castles served as President and Chief Executive Officer until
March 1996, and then served as Chairman of the Board and a part-time
employee until December 1996.
(3) Mr. Resnik ceased to be an employee of the Company in November 1996.
</TABLE>
STOCK OPTIONS GRANTED IN FISCAL 1996. The following table sets forth
information concerning stock options granted to the Named Officers during
1996:
<TABLE>
<CAPTION>
PERCENTAGE
OF OPTIONS
GRANTED TO
NUMBER OF SHARES EMPLOYEES
UNDERLYING OPTIONS DURING EXERCISE PRICE EXPIRATION
NAME GRANTED FISCAL YEAR PER SHARE DATE
- ---------------- ------- ----------- --------- ----
<S> <C> <C> <C> <C>
Dany Y. Tse, DMD -- -- -- --
Lawrence S. Wasserman 32,500 (1) 22% $13.60 (2) 4/19/06
John W. Castles -- -- -- --
Alan J. Resnik -- -- -- --
- ----------------
(1) This option becomes exercisable for 20 percent of the shares on each
of the first five anniversaries of April 4, 1996, the grant date.
(2) All outstanding options with exercise prices higher than the initial
public offering price, including this option, will be repriced to the
initial public offering price, except for options held by Dr. Tse,
which will be repriced to 110% of the initial public offering price.
</TABLE>
38
<PAGE>
AGGREGATED OPTION EXERCISES. No options were exercised by the Named
Officers during 1996. The following table sets forth certain information
concerning the number of shares covered by both exercisable and
unexercisable stock options as of December 31, 1996. 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, 1996.
<TABLE>
<CAPTION>
FISCAL YEAR-END OPTION VALUES
NUMBER OF SHARES SUBJECT TO VALUE OF IN-THE-MONEY OPTIONS AT
UNEXERCISED OPTIONS AT FISCAL FISCAL
YEAR-END (1) YEAR-END (2)
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Dany Y. Tse, DMD 50,000 0 $0 $0
Lawrence S. Wasserman 3,500 46,500 $0 $0
John W. Castles 6,000 0 $0 $0
Alan J. Resnik 5,200 0 $0 $0
- ------------------
(1) Does not reflect options granted in January 1997 to Dr. Tse for 31,000
shares at 110% of the initial public offering price and to Mr. Wasserman
for 60,000 shares at the initial public offering price.
(2) Based on estimated fair market value of $5.00 per share on December 31,
1996.
</TABLE>
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 Professional
Corporations. The total number of shares of Common Stock that may be issued
under the Plan will not exceed 1,000,000. At January 31, 1997, 63,362 shares
had been issued under the Plan, options for 582,950 shares were outstanding
under the Plan, and 353,688 shares remained available for future grants under
the Plan.
The Plan is administered by 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 a
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
39
<PAGE>
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.
CERTAIN TRANSACTIONS
All of the outstanding stock of the Professional Corporations is owned
by Dany Y. Tse (Chairman, President and Chief Executive Officer, and
principal shareholder of the Company), Craig W. Wong (a director and
principal shareholder of the Company), William J. K. Saiget, Scott T.
McClure , Alvin S. Watanabe (principal shareholders of the Company) , and
Edward V. Conzatti (a shareholder of the Company). The Company is a party
to Support Services Agreements with the Professional Corporations pursuant
to which the Company earns all of its revenues. See "Business -- Support
Services Agreements" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview."
Effective December 31, 1994, the Company executed asset purchase
agreements with the Professional Corporations for the purchase of certain
tangible assets of the Professional Corporations in exchange for the
forgiveness of certain liabilities and the assumption of other third-party
liabilities. The fair market value of the assets purchased, and the
consideration paid, was $1,354,913.
On January 2, 1995, the Company executed asset purchase agreements
with the Professional Corporations for purchase of the Professional
Corporations' accounts receivable in exchange for interest only promissory
notes payable on December 31, 1995. The fair market value of the assets
purchased, and the consideration paid, was $2,092,928.
On June 21, 1996, The ServiceMaster Company Limited Partnership
purchased 100,000 shares of the Company's Common Stock and a warrant to
purchase an additional 100,000 shares at $7.50 per share for total
consideration of $1,000,000. The ServiceMaster Company Limited Partnership
subsequently transferred the shares and warrants to its subsidiary,
ServiceMaster Venture Fund L.L.C. ("ServiceMaster"). ServiceMaster has the
right to require the Company to repurchase any or all of the 100,000 shares
initially purchased (the "Initial Shares"), and any or all shares acquired
upon exercise of the warrant (the "Warrant Shares"), 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
$10,000,000 (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. In connection with its investment,
ServiceMaster also was given the right to designate one person to serve as
a director of the Company. This designee is currently Kenneth D. Hooten. In
addition, ServiceMaster has "piggyback" registration rights with respect to
both the Initial Shares and the Warrant Shares. See "Description of Capital
Stock -- Registration Rights."
On May 31, 1996, the Company executed a modification of its existing
loan and security agreement with the Company's principal bank (the
"Modification"). In connection with the Modification, 14 officers,
directors, and shareholders of the Company provided continuing personal
guarantees on $1,000,000 of the Company's indebtedness to the Company's
principal bank in connection with a
40
<PAGE>
$1,000,000 increase in availability under the Company's operating line of
credit. 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. The
warrants expire on May 31, 2001. The individuals who provided guarantees
and the number of shares for which they received warrants are as follows:
Dany Y. Tse, 34,500 shares; Richard A. Armstrong, 23,000 shares; John W.
Castles, 11,500; Craig W. Wong, 6,900 shares; Jerald L. Willbur, 5,750
shares; Daniel P. Hunt, 5,750 shares; Scott T. McClure, 5,750 shares;
William J. K. Saiget, 5,750 shares; Anna M. Morrison, 4,600 shares;
Carleton G. Lindgren, 3,450 shares; L. Theodore Van Eerden, 2,875 shares;
Alan J. Resnik, 2,875 shares; David B. Hunt, son of director Daniel P.
Hunt, 1,150 shares; and Alvin S. Watanabe, 1,150 shares. The guarantors'
obligations with respect to the Company's indebtedness will cease if (i)
all amounts borrowed under the $1,000,000 increase in the line of credit
are repaid, and (ii) the Company is not in default under the loan and
security agreement with the Company's principal bank. All of the guarantees
will be released when the Company repays the Company's principal bank in
full from the proceeds of this offering.
From March to May 1995, the Company offered shares of its Common Stock
at $10.00 per share to accredited investors through a private offering. In
that offering, the Company sold an aggregate total of 173,327 shares. Of
those 173,327 shares, 68,100 were purchased by 11 executive officers,
directors, and principal shareholders of the Company together with members
of their immediate families and trusts for their benefit or the benefit of
their immediate family members. The number of shares purchased by each
executive officer, director, and principal shareholder (including shares
purchased by immediate family members and related trusts) are as follows:
Daniel P. Hunt, 19,800 shares; Dany Y. Tse, 10,000 shares; Richard A.
Armstrong, 10,000 shares; John W. Castles, 10,000; William J. K. Saiget,
5,700 shares; Jerald L. Willbur, 5,000 shares; Scott T. McClure, 4,000
shares; Carleton G. Lindgren, 2,500 shares; Craig W. Wong, 1,000 shares;
and Alvin S. Watanabe, 100 shares. Dr. Tse was permitted to pay for 4,000
shares with a three-year promissory note bearing interest at the applicable
federal rate. This note has been repaid in full.
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 obtained from
an unrelated party. Future transactions between the Company and
professional corporations 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.
TRANSACTIONS WITH PROMOTERS
The Company was formed by and initially capitalized by contributions
from the following persons: Dany Y. Tse, William J. K. Saiget, Alvin S.
Watanabe, Scott T. McClure, Craig W. Wong, and Edward V. Conzatti.
41
<PAGE>
PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding the
beneficial ownership, as of December 31, 1996, 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 and (iv) all directors and
executive officers as a group. 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.
<TABLE>
<CAPTION>
PERCENTAGE OF
COMMON STOCK
SHARES -------------------------
BENEFICIALLY BEFORE AFTER
OWNED OFFERING OFFERING
------------ -------- --------
<S> <C> <C> <C>
Dany Y. Tse, DMD (1)................................... 544,500 33.5% 17.4%
ServiceMaster Venture Fund L.L.C. (2).................. 200,000 12.2% 6.4%
William J. K. Saiget, DMD (3).......................... 166,450 10.8% 5.5%
Alvin S. Watanabe, DMD (4)............................. 156,250 10.1% 5.1%
Scott T. McClure, DDS (5)............................. 129,750 8.4% 4.3%
John W. Castles (6).................................... 123,000 7.9% 4.0%
Craig W. Wong, DMD (7)................................. 87,900 5.7% 2.9%
Richard A. Armstrong (8)............................... 33,400 2.1% 1.1%
Daniel P. Hunt (9)..................................... 33,050 2.1% 1.1%
Jerald L. Willbur (10)................................. 18,250 1.2% *
Alan J. Resnik (11).................................... 14,325 * *
Gerald R. Aaron (12)................................... 3,917 * *
Lawrence S. Wasserman (13)............................. 3,500 * *
Kenneth D. Hooten...................................... 0 - -
Paul H. Keckley........................................ 0 - -
All directors and officers as a group (12 persons) (14) 735,392 43.7% 23.1%
- ----------------
* Less than one percent
(1) Includes 50,000 shares subject to an exercisable option, 34,500 shares
subject to an exercisable warrant and 3,500 shares held by Dr. Tse's
wife.
(2) 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.
(3) Includes 5,750 shares subject to an exercisable warrant and 1,600
shares held by Dr. Saiget's wife.
(4) Includes 1,150 shares subject to an exercisable warrant.
(5) Includes 5,750 shares subject to an exercisable warrant.
(6) Includes 6,000 shares subject to an exercisable option and 11,500
shares subject to an exercisable warrant.
(7) Includes 6,900 shares subject to an exercisable warrant.
(8) Includes 400 shares subject to an exercisable option and 23,000 shares
subject to an exercisable warrant.
(9) Includes 5,750 shares subject to an exercisable warrant and 550 shares
held by Mr. Hunt's wife.
(10) Includes 5,750 shares subject to an exercisable warrant.
(11) Includes 5,200 shares subject to an exercisable option and 2,875
shares subject to an exercisable warrant.
(12) Includes 1,667 shares subject to an exercisable option.
(13) Includes 3,500 shares subject to exercisable options.
(14) Includes 63,567 shares subject to exercisable options and 78,775
shares subject to exercisable warrants.
</TABLE>
42
<PAGE>
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, 1996, 1,541,881 shares of Common Stock
were outstanding, held of record by 51 shareholders. After this offering,
3,041,881 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 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, 1996, 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, 1996, there were warrants outstanding to purchase
an aggregate of 219,333 shares of the Company's Common Stock, held of
record by 16 warrant holders. All outstanding warrants have an exercise
price of $7.50 per share. Warrants to purchase 119,333 shares expire in May
2001, and warrants to purchase 100,000 shares expire in December 2001.
43
<PAGE>
PUT RIGHTS
In connection with dental practice acquisitions 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 acquisitions. As of December 31,
1996, these put rights cover a total of 90,302 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 18,435 shares that can be exercised in varying
amounts in 1997, 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 $10,000,000 (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. 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 104,333 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. 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 Company is not required to include any of the shares
with registration rights in a registration if the holders of such shares
would be able to sell such shares without registration pursuant to Rule 144
of the Securities Act or otherwise. None of the Rights Holders will
participate in this offering.
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:
44
<PAGE>
(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 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.
45
<PAGE>
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. The Statute also
provides, however, that a corporation may enter into a "significant
business transaction" with an Acquiring Person if the per share
consideration paid to holders of outstanding shares of Common Stock and
other classes of stock of the corporation meet certain minimum "fair price"
criteria.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is
TranSecurities International, Inc., Spokane, Washington.
SHARES ELIGIBLE FOR FUTURE SALE
Before this offering, there has been no public market for the Common
Stock of the Company. Future sales of substantial amounts of Common Stock
in the public market could adversely affect prevailing market prices.
Upon completion of this offering, there will be 3,041,881 shares of
Common Stock outstanding. Of these shares, the 1,500,000 shares sold in
this offering will be eligible for sale to the public without restriction
under the Securities Act, except for any shares purchased by affiliates of
the Company, which will be subject to certain resale limitations of Rule
144 promulgated under the Securities Act. The remaining 1,541,881 shares
are "restricted securities" as defined in Rule 144. Of this amount,
approximately 40,500 shares of Common Stock will be eligible for immediate
sale in the public market without restriction pursuant to Rule 144(k).
Beginning 90 days after the date of this Prospectus, an additional
1,296,189 shares will be eligible for resale subject to compliance with
Rule 144 or Rule 701 under the Securities Act. However, all directors and
executive officers of the Company and certain shareholders 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 one year
after the date of this Prospectus without the prior written consent of
Black & Company, Inc. These persons hold 1,033,450 shares of Common Stock
that would otherwise be eligible for resale beginning 90 days after the
date of this Prospectus.
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 two years 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 30,418 shares immediately after this offering) and (ii) the
average weekly trading volume during the four calendar weeks preceding such
sale, provided
46
<PAGE>
that certain public information about the issuer as required by Rule 144 is
then available and the seller complies with certain other requirements. In
general, shares issued in compliance with Rule 701 promulgated under the
Securities Act may be sold by nonaffiliates subject to the manner of sale
requirements of Rule 144, but without compliance with the other
requirements of Rule 144. Affiliates may sell such shares issued under Rule
701 in compliance with Rule 144, other than the holding period requirement.
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 three 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.
UNDERWRITING
Under the terms and subject to the conditions of the Underwriting
Agreement, the Underwriters named below, for which Black & Company, Inc.
and Wedbush Morgan Securities are acting as Representatives, have severally
agreed to purchase from the Company, and the Company has agreed to sell to
each Underwriter, the aggregate number of shares of Common Stock set forth
opposite their respective names in the table below. The Underwriting
Agreement provides that the obligations of the Underwriters to pay for and
accept delivery of the shares of Common Stock are subject to certain
conditions precedent, and that the Underwriters are committed to purchase
and pay for all shares if any shares are purchased.
NUMBER OF
UNDERWRITER SHARES
----------- ---------
Black & Company, Inc. ................................... 412,500
Wedbush Morgan Securities. .............................. 412,500
Needham & Company, Inc. ................................. 100,000
Cruttenden Roth Incorporated............................. 100,000
Cohig & Associates, Inc. ................................ 75,000
Mesirow Financial, Inc. ................................. 40,000
L T Lawrence & Co., Inc. ................................ 40,000
Sands Brothers & Co., Ltd. .............................. 40,000
Paulson Investment Company, Inc. ........................ 40,000
National Securities Corporation.......................... 40,000
Commonwealth Associates.................................. 40,000
D. A. Davidson & Co. .................................... 40,000
Laidlaw Equities, Inc. .................................. 40,000
The Boston Group......................................... 40,000
Ladenburg, Thalmann & Co., Inc. ......................... 40,000
---------
Total................................................ 1,500,000
=========
The Company has been advised by the Representatives that the
Underwriters propose initially to offer the shares of Common Stock to the
public at the offering price set forth on the cover page of this Prospectus
and to certain dealers (who may include the Underwriters) at such price
less a concession of not more than $0.20 per share. The Underwriters may allow,
and such dealers may reallow, a concession to certain other dealers (who
may include the Underwriters) of not more than $0.10 per share. After the
initial offering to the public, the offering price and other selling terms
may be changed by the Representatives.
The Company has granted an option to the Underwriters, exercisable
during the 30-day period after the date of this Prospectus, to purchase up
to a maximum of 225,000 shares of Common Stock at
47
<PAGE>
the initial public offering price per share, less the underwriting
discounts and commissions, set forth on the cover page of this Prospectus.
The Underwriters may exercise such option only to cover over-allotments
made in connection with the sale of the Common Stock offered hereby. To the
extent the Underwriters exercise such option, each of the Underwriters will
be committed, subject to certain conditions, to purchase approximately the
same percentage of such additional shares as the number of shares of Common
Stock to be purchased by such underwriter as shown in the above table bears
to the total shown.
The Company has also agreed to sell to the Representatives, for
nominal consideration, the Representatives' Warrants to purchase up to
150,000 shares of Common Stock. The Representatives' Warrants are
exercisable for a period of four years beginning one year from the date of
this Prospectus. The Representatives' Warrants are exercisable at a price
of $6.00 per share (120% of the initial public offering price). The
Representatives' Warrants are nontransferable for a period of one year
following the date of this Prospectus, except (a) to any of the
Underwriters or to any individual who is either an officer or a partner of
an Underwriter or (b) by will or the laws of descent and distribution. The
holders of the Representatives' Warrants will have, in that capacity, no
voting, dividend, or other shareholder rights. Any profit realized by the
Representatives on the sale of securities issuable on exercise of the
Representatives' Warrants may be deemed to be additional underwriting
compensation.
The Representatives will also receive at closing a nonaccountable
expense allowance equal to 0.5% of the aggregate initial public offering
price of the shares of Common Stock sold in the Offering.
In the Underwriting Agreement, the Company has agreed to indemnify the
Underwriters against certain liabilities that may be incurred in connection
with this offering, including liabilities under the Securities Act, or to
contribute to payments that the Underwriters may be required to make in
respect thereof.
The Representatives have advised the Company that the Underwriters do
not intend to confirm sales to any accounts over which they exercise
discretionary authority.
The Company, its directors, officers, and certain shareholders have
agreed that, without the prior written consent of Black & Company, Inc.,
they will not directly or indirectly offer to sell, sell, or otherwise
dispose of shares of Common Stock or any securities convertible or
exchangeable therefor, for a period of one year after the date of this
Prospectus, subject to certain limited exceptions.
Before this offering, there has been no public market for the Common
Stock. Consequently, the initial public offering price was determined by
negotiations between the Company and the Representatives. Among the factors
considered in such negotiations were the history of and prospects for the
Company and the industry in which it competes, an assessment of the
Company's management, its past and present operations and financial
performance, the present state of the Company's development, the general
condition of the securities markets at the time of the offering and the
market prices of and demand for publicly traded common stock of comparable
companies in recent periods.
48
<PAGE>
LEGAL MATTERS
The validity of the issuance of the Common Stock offered hereby will
be passed upon for the Company by Stoel Rives LLP, Portland, Oregon.
Certain legal matters in connection with this offering will be passed upon
for the Underwriters by Tonkon, Torp, Galen, Marmaduke & Booth, Portland,
Oregon.
EXPERTS
The financial statements of the Company as of, and for the year ended,
December 31, 1994 included in this Prospectus have been so included in
reliance on the report of Moss Adams LLP, independent accountants, given on
the authority of said firm as experts in auditing and accounting.
The financial statements of the Company as of, and for the periods
ended, December 31, 1995 and September 30, 1996 included in this Prospectus
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 Scott Campbell DDS, P.S. as of and for the
periods ended December 31, 1994 and September 29, 1995 included in this
Prospectus 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 Peter A. Vermeulen, D.D.S., P.S. (dba
Pinehurst Dental Clinic) as of and for the periods ended December 31, 1994
and June 30, 1995 included in this Prospectus 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 Company replaced its previous auditors, Moss Adams LLP, with Price
Waterhouse LLP in November 1995. 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 Moss Adams LLP on the
Company's financial statements within the two most recent fiscal years
preceding their dismissal. There were no disagreements with Moss Adams 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. Before engaging Price Waterhouse LLP as its new
independent accountants, the Company did not previously consult with them
regarding any matters related to the application of accounting principles,
the type of audit opinion that might be rendered on the Company's financial
statements or any other such matters.
ADDITIONAL INFORMATION
A Registration Statement on Form SB-2, including amendments thereto,
relating to the shares offered hereby has been filed by the Company with
the Securities and Exchange Commission (the "Commission"). This Prospectus
does not contain all of the information set forth in the Registration
Statement and the exhibits thereto. For further information with respect to
the Company and the shares of Common Stock offered hereby, reference is
made to such Registration Statement and exhibits. A copy
49
<PAGE>
of the Registration Statement may be inspected and copied at the offices of
the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 and at
regional offices of the Commission located at 7 World Trade Center, 13th
Floor, New York, New York 10048 and 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. Copies of all or any part of the Registration
Statement may be obtained from the Public Reference Section of the
Commission, Washington, D.C., upon the payment of the fees prescribed by
the Commission. The Commission also maintains a site on the World Wide Web
that contains reports, proxy and information statements and other
information regarding registrants that file electronically with the
Commission. The address of such site is http://www.sec.gov.
The Company is not currently subject to the periodic reporting
requirement of the Securities Exchange Act of 1934. The Company intends to
furnish to its shareholders annual reports containing financial statements
audited by an independent public accounting firm.
50
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Page
----
GENTLE DENTAL SERVICE CORPORATION
Report of Price Waterhouse LLP...............................................F-2
Report of Moss Adams LLP.....................................................F-3
Balance Sheet as of December 31, 1995 and September 30, 1996.................F-4
Statement of Operations for the years ended December 31, 1994
and 1995, and for the nine months ended September 30, 1995
(unaudited) and 1996 .....................................................F-5
Statement of Redeemable Common Stock and Nonredeemable
Shareholders' Equity for the years ended December 31,
1994 and 1995, and for the nine months ended
September 30, 1996........................................................F-6
Statement of Cash Flows for the years ended December 31,
1994 and 1995, and for the nine months ended
September 30, 1995 (unaudited) and 1996...................................F-7
Notes to Financial Statements ...............................................F-8
SCOTT CAMPBELL DDS, P.S.
Report of Price Waterhouse LLP..............................................F-26
Balance Sheet as of December 31, 1994 and September 29, 1995................F-27
Statement of Operations and Retained Earnings for the year
ended December 31, 1994 and for the period ended
September 29, 1995 ......................................................F-28
Statement of Cash Flows for the year ended December 31, 1994
and for the period ended September 29, 1995 .............................F-29
Notes to Financial Statements ..............................................F-30
PETER A. VERMEULEN, D.D.S., P.S.
Report of Price Waterhouse LLP..............................................F-34
Balance Sheet as of December 31, 1994 and June 30, 1995.....................F-35
Statement of Operations and Owner's Deficit for the year
ended December 31, 1994 and for the six months ended
June 30, 1995 ...........................................................F-36
Statement of Cash Flows for the year ended December 31,
1994 and for the six months ended June 30, 1995 .........................F-37
Notes to Financial Statements ..............................................F-38
GENTLE DENTAL SERVICE CORPORATION
Pro Forma Combined Financial Information (unaudited)........................F-42
Pro Forma Combined Statement of Operations for the year ended
December 31, 1995 (unaudited)............................................F-43
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Gentle Dental Service
Corporation (formerly Mutual Health Systems, Inc.)
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 September 30, 1996, and the results of its operations and its cash
flows for the year ended December 31, 1995 and the nine months ended
September 30, 1996, 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 11 to the financial statements, the Company has
certain related party transactions.
PRICE WATERHOUSE LLP
Portland, Oregon
November 8, 1996
F-2
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders of Gentle Dental Service
Corporation (formerly Mutual Health Systems, Inc.)
We have audited the accompanying statements of operations, redeemable
common stock and nonredeemable shareholders' equity and of cash flows of
Gentle Dental Service Corporation (the Company) for the year ended December
31, 1994. 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
and also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe 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 results of operations and cash flows of the
Company for the year ended December 31, 1994, in conformity with generally
accepted accounting principles.
The Company is a member of a group of affiliated companies and, as
disclosed in Note 11 to the financial statements, has transactions with and
derives substantially all of its revenue from members of the group under
support services agreements. Such revenue is based on specified percentages
of net dental practice patient revenues as negotiated with members of the
group of affiliated companies. Because the parties to the support services
agreements are members of the group, it is possible that the terms of these
transactions may not be the same as those that would result from
transactions among wholly unrelated parties.
MOSS ADAMS LLP
February 14, 1995
Vancouver, Washington
F-3
<PAGE>
<TABLE>
<CAPTION>
GENTLE DENTAL SERVICE CORPORATION
BALANCE SHEET
- ----------------------------------------------------------------------------------------------------------------
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 688,518 $ 629,874
Accounts receivable, net (Note 1) 2,036,654 2,493,174
Receivables from affiliates and other receivables (Note 11) 711,862 1,151,802
Income taxes receivable (Note 8) 174,448 312,157
Supplies 286,000 363,750
Prepaid expenses and other current assets 176,256 541,828
------------- -------------
Total current assets 4,073,738 5,492,585
Property and equipment, net (Note 3) 3,654,101 4,150,362
Intangible assets, net (Note 4) 2,057,538 3,279,173
Other assets (Note 1) 428,317 91,139
------------- -------------
Total assets $ 10,213,694 $ 13,013,259
============= =============
LIABILITIES, REDEEMABLE COMMON STOCK AND
NONREDEEMABLE SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 270,909 $ 705,738
Accrued payroll and payroll related costs 431,199 454,696
Other accrued liabilities 463,437 498,362
Short-term borrowings (Note 5) 1,049,025 2,097,126
Current portion of long-term debt and capital lease obligations (Note 5) 473,370 838,169
------------- -------------
Total current liabilities 2,687,940 4,594,091
Deferred rent 82,446 87,280
Deferred tax liability (Note 8) 187,123 126,557
Long-term debt, less current portion (Note 5) 2,310,212 2,090,648
Capital lease obligations, less current portion (Note 5) 423,428 480,921
------------- -------------
Total liabilities 5,691,149 7,379,497
------------- -------------
Commitments and contingent liabilities (Notes 5, 6, 9 and 12) Redeemable
common stock, no par value, 57,551 and 190,302 shares
issued and outstanding, respectively (Note 9) 710,694 2,188,462
------------- -------------
Nonredeemable shareholders' equity (Note 9):
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
and 1,373,579 shares issued and outstanding, respectively 2,795,005 2,888,668
Shareholder note receivable (40,000) -
Additional paid-in capital 152,195 431,793
Retained earnings 904,651 124,839
------------- -------------
Total nonredeemable shareholders' equity 3,811,851 3,445,300
------------- -------------
Total liabilities, redeemable common stock and
nonredeemable shareholders' equity $ 10,213,694 $ 13,013,259
============= =============
The accompanying notes are an integral part of this statement.
</TABLE>
F-4
<PAGE>
<TABLE>
<CAPTION>
GENTLE DENTAL SERVICE CORPORATION
STATEMENT OF OPERATIONS
- -------------------------------------------------------------------------------------------------------------------
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1994 1995 1995 1996
------------- -------------- ------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Support services revenue from affiliates
(Notes 1 and 11) $ 2,731,403 $ 9,781,077 $ 7,173,242 $ 7,865,606
Branch costs - 4,700,695 3,393,691 5,234,378
Operating expenses 2,100,067 4,207,739 3,159,594 3,009,666
------------- -------------- ------------- --------------
Operating income (loss) 631,336 872,643 619,957 (378,438)
------------- -------------- ------------- --------------
Nonoperating income (expense):
Interest expense (23,046) (289,608) (130,196) (572,239)
Other income (expense) 6,829 (92,702) 52,741 22,760
------------- --------------- ------------- --------------
(16,217) (382,310) (77,455) (549,479)
------------- -------------- ------------- --------------
Income (loss) before income taxes 615,119 490,333 542,502 (927,917)
Provision (benefit) for income taxes (Note 8) - 233,826 258,719 (228,256)
------------- -------------- ------------- --------------
Net income (loss) $ 615,119 $ 256,507 $ 283,783 $ (699,661)
============= ============== ============= ==============
Accretion of redeemable
common stock (Note 9) (80,151)
--------------
Net income (loss) attributable to common stock $ (779,812)
==============
Net income (loss) per share of common stock $ .19 $ .21 $ (.53)
============== ============= =============
Unaudited pro forma information (Notes 1 and 8):
Income before income taxes $ 615,119
Provision for income taxes 210,678
-------------
Net income $ 404,441
=============
Net income per share $ .35
=============
Weighted average number of
shares outstanding 1,154,428 1,379,960 1,365,738 1,484,498
============= ============== ============= ==============
The accompanying notes are an integral part of this statement.
</TABLE>
F-5
<PAGE>
<TABLE>
<CAPTION>
GENTLE DENTAL SERVICE CORPORATION
STATEMENT OF REDEEMABLE COMMON STOCK AND NONREDEEMABLE SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1994 AND 1995 AND NINE MONTHS ENDED SEPTEMBER 30, 1996
- ------------------------------------------------------------------------------------------------------------------------------------
NONREDEEMABLE SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------
REDEEMABLE COMMON STOCK COMMON STOCK
COMMON STOCK CLASS A CLASS B
----------------- ----------------- -----------------
SHAREHOLDER ADDITIONAL
NOTE PAID-IN RETAINED
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT RECEIVABLE CAPITAL EARNINGS
------ ------ ------ ------ ------ ------ ----------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1993 - $ - 766,000 $ 359,900 385,000 $ 154,000 $ - $ - $ 343,648
Issuance of stock pursuant to
Stock Incentive Plan - - 3,250 19,500 - - - - -
Conversion (1:1) of Class B to
Class A - - 385,000 154,000 (385,000) (154,000) - - -
Distributions to shareholders - - - - - - - - (223,680)
Net income - - - - - - - - 615,119
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 1994 - - 1,154,250 533,400 - - - - 735,087
Issuance of stock pursuant to
Stock Incentive Plan - - 20,112 201,115 - - - - -
Common stock issued in
connection with clinic
acquisitions 57,551 710,694 28,456 387,003 - - - - -
Common stock issued in
connection with private
placement, net of offering
costs - - 169,327 1,633,687 - - - - -
Common stock issued for
promissory note from
shareholder - - 4,000 40,000 - - (40,000) - -
Stock options granted to
nonemployees - - - - - - - 152,195 -
Repurchase of common stock - - (10,000) (200) - - - - -
Distributions to shareholders - - - - - - - - (86,943)
Net income - - - - - - - 256,507
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 1995 57,551 710,694 1,366,145 2,795,005 - - (40,000) 152,195 904,651
Common stock issued in
connection with clinic
acquisitions 38,994 530,284 4,934 67,103 - - - - -
Common stock and warrants
issued in connection with
private placement, net of
offering costs 100,000 957,357 - - - - - - -
Exercise of put rights (6,243) (90,024) -
Stock warrants issued,
related to debt financing
(Note 5) - - - - - - - 8,778 -
Exercise of stock options - - 2,000 1,600 - - - - -
Stock options granted to
nonemployees - - - - - - - 37,842 -
Stock warrants issued related
to line of credit
guarantees (Notes 5 and 9) - - - - - - - 232,978 -
Accretion of put rights 80,151 (80,151)
Repurchase of common stock - - (2,000) (40) - - - - -
Common stock granted to
nonemployees - - 2,500 25,000 - - - - -
Proceeds from note receivable - - - - - - 40,000 - -
Net loss - - - - - - - - (699,661)
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Balance, September 30, 1996 190,302 $2,188,462 1,373,579 $2,888,668 - $ - $ - $ 431,793 $ 124,839
========= ========== ========= ========== ========= ========= ========= ========= ==========
The accompanying notes are an integral part of this statement.
</TABLE>
F-6
<PAGE>
<TABLE>
<CAPTION>
GENTLE DENTAL SERVICE CORPORATION
STATEMENT OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------------------
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1994 1995 1995 1996
-------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 615,119 $ 256,507 $ 283,783 $ (699,661)
Adjustments to reconcile change in net cash provided by
operating activities:
Depreciation and amortization 105,685 481,517 311,708 596,441
Loss on disposal of assets - 86,187 - 61,149
Stock options granted to nonemployees - 152,195 - 37,842
Stock issued for fees and compensation 19,500 - - 25,000
Amortization of warrants - - - 201,463
Deferred taxes - 71,470 39,250 (55,547)
Deferred rent - - - 87,280
Changes in certain assets and liabilities, net of acquisitions:
Accounts receivable, net - 348,596 209,583 (343,083)
Receivables from affiliates and other receivables (231,010) (2,476,343) (1,989,012) (427,510)
Income taxes receivable - (224,778) - (137,709)
Supplies (104,625) (164,375) (20,375) (50,250)
Prepaid expenses and other current assets (43,976) (11,195) (50,843) (327,979)
Other assets - (78,625) (85,906) 29,680
Accounts payable 80,606 87,896 206,949 415,144
Accrued liabilities 121,220 685,907 294,451 (45,938)
-------------- ------------- ------------- -------------
Net cash (used for) provided by operating activities 562,519 (785,041) (800,412) (633,678)
------------- ------------- ------------- -------------
Cash flows from investing activities:
Purchase of property and equipment, excluding acquisitions (783,266) (1,251,180) (117,806) (531,845)
Cash paid for acquisitions, including other direct costs, net of
cash acquired - (1,072,905) (796,240) (666,870)
Dental clinic acquisition pre-payments - (309,130) - -
-------------- ------------- ------------- -------------
Net cash used for investing activities (783,266) (2,633,215) (914,046) (1,198,715)
-------------- ------------- ------------- -------------
Cash flows from financing activities:
Net proceeds from short-term borrowings - 916,154 1,123,403 1,048,101
Proceeds from issuance of notes payable - 2,703,511 - 465,548
Payments of notes payable (48,242) (1,264,034) (392,463) (407,305)
Payments of capital lease obligations - (26,147) (21,328) (241,488)
Proceeds from issuance of common stock - 1,834,802 1,962,498 957,357
Proceeds from note receivable - - - 40,000
Exercise of put rights - - - (90,024)
Distributions to shareholders (223,680) (86,943) (86,943) -
Other - (200) - 1,560
-------------- ------------- ------------- -------------
Net cash provided by (used for) financing activities (271,922) 4,077,143 2,585,167 1,773,749
------------- ------------- ------------- -------------
Increase (decrease) in cash (492,669) 658,887 870,709 (58,644)
Cash and cash equivalents, beginning of period 522,300 29,631 29,631 688,518
-------------- ------------- ------------- -------------
Cash and cash equivalents, end of period $ 29,631 $ 688,518 $ 900,340 $ 629,874
============== ============= ============= =============
The accompanying notes are an integral part of this statement.
</TABLE>
F-7
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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 and Washington. As of September
30, 1996, the Company provided management support to two professional
corporations under long-term support services agreements: Gentle
Dental of Oregon, P.C. and Tse, Saiget, Watanabe & McClure, Inc.,
P.S., a.k.a., Gentle Dental of Washington, 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 (see Note 11).
The Company and the PCs are related through common ownership and a
common member on both the Company's and PC's Boards of Directors. The
Company and its affiliates structure their business enterprises to
comply with the state regulatory mandates requiring dentistry
practices to be owned and operated by state-licensed dentists (see
Note 11).
INTERIM PERIOD STATEMENTS
The interim financial data for the nine months ended September 30,
1996 and for the nine months ended September 30, 1995 (unaudited), in
the opinion of management, include all of the adjustments (consisting
of normal recurring adjustments) necessary for a fair statement of the
results of such periods. The results of operations for an interim
period are not necessarily indicative of the results of operations for
a full year.
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.
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1994 1995 1995 1996
------------ ------------ ------------ --------------
(UNAUDITED)
<S> <C> <C> <C> <C>
PC dental revenue, net of provisions
for contractual adjustments and
doubtful accounts $ 12,134,815 $ 16,028,535 $ 11,759,413 $ 15,731,212
Less amounts retained by the PCs 9,403,412 6,247,458 4,586,171 7,865,606
------------- -------------- ------------- --------------
Support services revenue from affiliates $ 2,731,403 $ 9,781,077 $ 7,173,242 $ 7,865,606
============= ============== ============= ==============
</TABLE>
F-8
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1994 1995 1995 1996
----------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Interest paid $ 23,046 $ 289,608 $ 117,418 $ 180,358
Income taxes paid - 350,000 245,000 -
Supplemental schedule of noncash investing
and financing activities:
Capital lease obligations related to the
lease of fixed assets - 534,366 214,737 274,517
Issuance of common stock in exchange for
shareholder note - 40,000 40,000 -
Accretion of put rights - - - 80,151
Acquisition of tangible assets from
related parties:
Liabilities assumed or issued 1,354,913 2,092,928 2,092,928 -
Tangible assets acquired 1,354,913 2,092,928 2,092,928 -
Acquisition of clinics from unrelated
parties:
Support services agreements - 2,012,409 1,472,623 1,335,032
Liabilities assumed or issued - 453,285 367,688 147,588
Common stock issued in connection
with acquisitions - 1,097,697 782,684 597,387
Dental clinic acquisition prepayments - - - 309,130
Tangible assets acquired in connection
with acquisitions, excluding cash - 611,478 473,989 385,943
Stock warrants related to line of credit
guarantee issued as compensation - - - 232,078
Stock warrants issued related to debt issuance - - - 8,778
</TABLE>
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 had an allowance for contractual adjustments
and doubtful accounts of $782,055 at December 31, 1995 and $962,764 at
September 30, 1996 (see Note 2). 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. To date, such changes in
estimated contractual adjustments have not been significant.
AFFILIATE RECEIVABLES
Affiliate receivables consist primarily of amounts owed to the Company
from the PCs in order to reimburse the Company for payment of the PC's
payroll and other direct costs net of amounts due to the PCs related
to the acquisitions and the collection of receivables.
F-9
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
During 1995, the Company implemented a conversion plan for certain
parts of its information systems. As a result, in 1995, the Company
recognized a writedown of $86,187 on the valuation of the computer
equipment and reclassified the computer equipment as equipment held
for resale which was included in prepaid expenses and other current
assets. At September 30, 1996, prepaid expenses and other current
assets include $20,000 of computer equipment held for resale, net of
an additional write-off of $34,569 recognized in the nine-months
period ended September 30, 1996.
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. The cost
of assets sold or otherwise disposed of and the related accumulated
depreciation are eliminated from the accounts, and any resulting gain
or loss is reflected in the statement of operations.
Depreciation of property and equipment is calculated using the
straight-line method over estimated useful lives which range from 3 to
10 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 patient lists, 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 a 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
F-10
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 cash flows. No
write-down for impairment loss was recorded for the years ended
December 31, 1994 and 1995, or for the nine months ended September 30,
1995 and 1996.
OTHER ASSETS
Other assets consist primarily of cash payments and deferred
acquisition costs incurred during the fiscal period related to dental
clinic acquisitions not consummated until the following period.
(see Note 2).
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. An
unaudited pro forma provision for income taxes that would have been
recorded if the Company had been a C corporation for the year ended
December 31, 1994 is provided for comparative purposes in the
statement of operations.
See Note 8.
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
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 and
September 30, 1996.
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.
F-11
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 and 1994
financial statements to conform with financial statement presentations
for the nine months ended September 30, 1996. Such reclassifications
had no effect on the Company's previously reported results of
operations or financial position.
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-dilutive. The unaudited pro forma net income per
share for the year ended December 31, 1994 has been calculated as if
the Company had been a C corporation for all periods presented.
2. ACQUISITIONS
On December 31, 1994, the Company purchased from the PCs certain
dental, office and computer equipment and supplies totaling $1,354,913
and assumed certain liabilities totaling $565,557. No cash was paid by
the Company for the net assets purchased. Instead, the Company
decreased its receivables from the PCs. The transaction was executed
at fair market value as determined by independent appraisal. The
equipment purchased was considered by management to be used equipment
and is being depreciated using the straight-line method over estimated
useful lives ranging from 3 to 7 years.
On January 2, 1995, the Company purchased from the PCs the net
accounts receivable of the PCs totaling $2,092,928 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 were 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 the assumption
of certain liabilities. The total purchase price of $2,345,774 for the
seven acquired clinics includes $982,400 paid in cash, $1,097,697 in
redeemable and nonredeemable common stock, and $174,872 in promissory
notes. In addition, the Company paid $90,805 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
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 as discussed in Note
9.
F-12
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. ACQUISITIONS (CONTINUED)
Outstanding promissory notes issued related to the acquisitions at
December 31, 1995 totaled $119,871, consisting of $57,371, included in
short-term borrowings and subsequently paid in January 1996 and
$62,500, included in long-term debt and due in monthly instalments 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 four
clinics in Oregon and Washington, including cash, accounts receivable,
supplies and fixed assets, net of the assumption of certain
liabilities. The total purchase price of $1,601,485 for the four
acquired clinics includes $943,890 in cash, $597,387 in redeemable and
nonredeemable common stock and a promissory note for $28,098. In
addition, to date the Company paid for closing costs of $32,110 which
have been included in the total purchase price.
The Company issued a total of 43,928 shares of stock in conjunction
with these acquisitions. Such shares were valued by management at
$13.60 per share. The common stock values reflect the estimated fair
value on 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.
The outstanding promissory note issued related to a 1996 acquisition,
included in long-term debt, is due in quarterly installments of
principal and interest at 9.0% commencing on May 31, 1996 and maturing
in July 1998.
The above acquisitions in 1995 and 1996 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 patient lists,
noncompetition covenants, and support services agreements, is being
amortized over 25 years using the straight-line method (see Note 4).
The results of operations for these acquisitions have been included in
the financial statements of the Company since the dates of
acquisitions.
F-13
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. ACQUISITIONS (CONTINUED)
The following unaudited pro forma information represents the results
of operations of the Company as if all of the acquisitions had
occurred as of January 1, 1995, after giving effect to amortization of
the cost of acquisition in excess of the fair value of net tangible
assets acquired, adjustments to reflect the difference in compensation
between historical amounts and amounts specified in the purchase
agreements, increased interest expense for borrowing, and for notes
issued related to the acquisitions and increased income taxes:
YEAR ENDED
DECEMBER 31,
1995
---------------
(UNAUDITED)
Support services revenue $ 11,983,208
===============
Net income $ 46,901
===============
Earnings per share $ .03
===============
The pro forma results for the nine months ended September 30, 1996
have not been presented because the effect of 1996 acquisitions on the
Company's operations is not significant.
The unaudited pro forma information does not purport to be indicative
of the results which would actually have been obtained had the
acquisitions occurred as of January 1, 1995 or which may be obtained
in the future.
3. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------- -------------
<S> <C> <C>
Dental equipment $ 2,318,955 $ 2,511,932
Computer equipment 481,867 815,020
Office equipment, furniture and fixtures 503,504 573,192
Vehicles 19,443 19,443
Leasehold improvements 761,906 1,150,769
------------- -------------
4,085,675 5,070,356
Less accumulated depreciation and amortization (431,574) (919,994)
------------- -------------
$ 3,654,101 $ 4,150,362
============= =============
</TABLE>
At December 31, 1995 and September 30, 1996, property and equipment
include $553,362 and $761,710, respectively, of equipment held under
capital leases with related accumulated amortization aggregating
$55,709 and $157,190, respectively.
F-14
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. INTANGIBLE ASSETS
Intangible assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------- -------------
<S> <C> <C>
Support services agreements and other acquired intangibles $ 2,012,409 $ 3,322,583
Service marks 50,000 50,000
Organizational costs 70,391 70,391
------------- -------------
2,132,800 3,442,974
Less accumulated amortization (75,262) (163,801)
------------- -------------
$ 2,057,538 $ 3,279,173
============= =============
</TABLE>
5. BORROWINGS
SHORT-TERM BORROWINGS
The Company had a total of $2,097,126 outstanding at September 30,
1996 under two operating lines of credit secured by substantially all
the assets of the Company.
Line of credit No. 1 bears interest at prime plus 1% (9.25% at
September 30, 1996) and the Company may borrow a maximum of
$1,850,000, limited to a borrowing base calculated as 75% of the
Company's net eligible accounts receivable. All unpaid principal and
interest is due and payable October 31, 1997. The Company must pay a
commitment fee of 1/2% per annum of the average daily unused portion
of the $1,850,000 available.
Line of credit No. 2 bears interest at prime plus 2.5% (10.75% at
September 30, 1996) and the Company may borrow up to a maximum of
$650,000. All unpaid principal and interest is due and payable
February 28, 1997 or 10 days after the consummation of a public
offering, if earlier.
In connection with a 1996 modification to line of credit No. 1 and the
issuance of line of credit No. 2, certain directors, officers and
shareholders personally guaranteed a total of $1,000,000 of the two
operating lines of credit. In exchange for the guarantees, the Company
issued 115,000 common stock warrants with an exercise price of $7.50
to those individuals. In connection with line of credit No. 2, the
Company issued 4,333 common stock warrants with an exercise price of
$7.50 to the lender (see Note 9).
The Company had $991,654 outstanding at December 31, 1995 under an
operating line of credit secured by substantially all of the assets of
the Company. The credit line bore interest at prime plus 1/2% (9.25%
at December 31, 1995) and the Company could borrow a maximum of
$1,500,000, limited to a borrowing base calculated as 75% of the
Company's net eligible accounts receivable. The Company paid a
commitment fee of 1/2% per annum of the average daily unused portion
of the $1,500,000 available. Additionally, at December 31, 1995, the
Company owed to an individual $57,371 related to receivables purchased
in acquiring a dental practice. These borrowings, as well as any
accrued and unpaid interest, were paid subsequent to December 31,
1995.
F-15
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
5. BORROWINGS (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------- -------------
<S> <C> <C>
LONG-TERM DEBT
Note payable due in monthly instalments of principal and interest
at prime plus 1.25% effective May 31, 1996 (9.5% at September
30, 1996) collateralized by accounts
receivable, inventory and equipment, maturing August 1999 $ 937,500 $ 750,000
Notes payable with interest-only payments for the first
12 months at prime plus 1.5% effective May 31, 1996 (9.75% at
September 30, 1996), due in monthly instalments of principal and
interest beginning in August 1996, maturing August 2000, secured
by accounts receivable,
inventory and equipment 1,684,064 1,801,751
Note payable due in monthly instalments of principal and
interest at 9.99%, collateralized by a vehicle, maturing
June 2000 14,727 12,243
Unsecured note payable, due in monthly instalments of
principal and interest at 10.25% commencing on January 1,
1996, maturing December 1998 (Note 2) 62,500 49,483
Unsecured note payable, due in quarterly instalments of
principal and interest at 9.0% commencing on May 31, 1996,
maturing July 1998 - 28,098
Unsecured note payable, due in monthly instalments of
principal and interest at 10.47% commencing on June 30,
1996, maturing November 2003 - 143,557
------------- -------------
2,698,791 2,785,132
Less current portion 388,579 694,484
------------- -------------
$ 2,310,212 $ 2,090,648
============= =============
</TABLE>
Scheduled maturities of long-term debt at September 30, 1996 are as
follows:
Remainder of 1996 $ 171,312
1997 706,636
1998 762,726
1999 712,189
2000 363,271
2001 22,988
Thereafter 46,010
-------------
$ 2,785,132
=============
F-16
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
5. BORROWINGS (CONTINUED)
The credit line agreements and notes include 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. At December 31, 1995, the Company obtained a waiver of
certain of these covenants. The credit line agreement was revised
during 1996 and the Company is in compliance with these covenants at
September 30, 1996.
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 12%
- 14% and require monthly payments of principal and interest.
Future minimum payments under the Company's capital lease obligations
at September 30, 1996 are summarized as follows:
Remainder of 1996 $ 54,237
1997 212,634
1998 206,928
1999 175,620
2000 126,495
2001 13,134
-------------
789,048
Less portion representing interest 164,442
-------------
624,606
Less current portion 143,685
-------------
$ 480,921
=============
6. BANK CREDIT COMMITMENTS
In 1994, the Company cross-guaranteed the borrowings of the PCs. At
December 31, 1994, the outstanding borrowings of the PCs aggregated
$427,907. These borrowings were refinanced without cross-guarantees
during 1995.
7. PROFIT SHARING PLAN
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 were made for the years ended December 31, 1994 and 1995
and for the nine months ended September 30, 1996. 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 $48,936 and $165,228, respectively, for the years
ended December 31, 1994 and 1995, and $35,039 and $44,996,
respectively, for the nine months ended September 30, 1995 (unaudited)
and 1996.
F-17
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
8. INCOME TAXES
On January 1, 1995, the Company elected to terminate its Subchapter S
corporation status. Accordingly, unaudited pro forma income tax
information is presented below for the year ended December 31, 1994,
which would have been recorded if the Company had been a C Corporation
during all periods presented, based on tax laws in effect during those
periods, as calculated under Statement of Financial Accounting
Standards No. 109 (SFAS 109), "Accounting for Income Taxes."
The provision (benefit) for income taxes is as follows:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1994 1995 1996
------------- ------------- --------------
(UNAUDITED
PRO FORMA)
<S> <C> <C> <C>
Current:
Federal $ 184,165 $ 147,134 $ (172,711)
State 1,538 15,222 -
------------- ------------- -------------
185,703 162,356 (172,711)
------------- ------------- -------------
Deferred:
Federal 24,696 64,951 (34,993)
State 279 6,519 (20,554)
------------- ------------- -------------
24,975 71,470 (55,547)
------------- ------------- -------------
Total provision (benefit) $ 210,678 $ 233,826 $ (228,258)
============= ============= =============
</TABLE>
The provision for income taxes for the year ended December 31, 1995
includes the recognition of a cumulative net deferred tax liability of
$24,975 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:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------- -------------
<S> <C> <C>
Property and equipment $ (140,983) $ (339,846)
Intangibles (5,642) (13,964)
Cash versus accrual reporting for tax purposes - long-term (40,498) (20,989)
Net operating loss carryforward - 261,028
Other - (12,786)
------------- -------------
Net long-term deferred tax liability $ (187,123) $ (126,557)
============= =============
Cash versus accrual reporting for tax purposes - current $ (20,250) $ (20,989)
Accrued payroll related costs 75,156 70,876
------------- -------------
Net current deferred tax assets, included in prepaid and
other current assets $ 54,906 $ 49,887
============= =============
</TABLE>
F-18
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
8. INCOME TAXES (CONTINUED)
The effective tax rate differed from the U.S. statutory federal tax rate
due to the following:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------- -------------
<S> <C> <C>
Statutory federal rate 34.0% (34.0)%
State taxes, net of federal benefit 2.3 (3.5)
Non-deductible intangibles and other permanent differences 6.3 12.9
Other, primarily cumulative effect from the termination
of Subchapter S corporation status in 1995 5.1
----------- --------
47.7% (24.6)%
=========== ========
</TABLE>
9. REDEEMABLE COMMON STOCK AND NONREDEEMABLE SHAREHOLDERS' EQUITY
REDEEMABLE COMMON STOCK
As part of the 1995 and 1996 acquisitions discussed in Note 2, the
Company granted "put rights" to certain shareholders that may require
the Company to redeem 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 $1,408,554. 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. During 1996,
the Company redeemed 6,243 shares of redeemable common stock for
$90,024.
The shares of common stock subject to the "put rights" are 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 nine months ended September 30, 1996. The
Company records accretion on a ratable basis over the redemption
period of the respective stock. Such accretion for the nine months
ended September 30, 1996 was $80,151. Accretion in prior years was
insignificant.
Such common stock at September 30, 1996 is redeemable as follows:
<TABLE>
<CAPTION>
NUMBER REDEMPTION REDEMPTION
OF SHARES AMOUNT PRICE RANGE
------------- ------------- -------------
<S> <C> <C> <C>
Remainder of 1996 - $ - $ -
1997 6,615 102,929 15.56
1998 2,974 50,023 16.82
1999 2,754 50,013 13.38-18.16
2000 40,849 576,479 13.60-19.62
2001 29,681 438,056 13.60-18.80
Thereafter 7,429 101,030 13.60
------------- -------------
90,302 $ 1,318,530
============= =============
</TABLE>
F-19
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. REDEEMABLE COMMON STOCK AND NONREDEEMABLE SHAREHOLDERS' EQUITY (CONTINUED)
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 $42,643) were
$957,357. The net proceeds allocated to common stock aggregated
$732,430. The stock warrants were recorded at an estimated fair value
of $224,927 and are entitled to certain "piggyback" registration
rights. The stock warrants expire on December 14, 2001 and 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 net proceeds to the Company of at least
$10,000,000. 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, 1996, 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, 1996, none of the 30,000,000 authorized shares of the
Company's preferred stock has been issued or is outstanding.
SHAREHOLDER NOTE RECEIVABLE
In 1995, the Company issued to a shareholder 4,000 shares of common
stock at $10.00 per share in exchange for a note from the shareholder.
The note bore interest at prime plus 0.5% (9.25% at December 31,
1995), collateralized by the common stock and was repaid on September
26, 1996.
STOCK WARRANTS ISSUED IN CONJUNCTION WITH DEBT ISSUANCE
As discussed in Note 5, 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. The stock warrants were valued at $8,778 and have been
recorded as debt issuance costs and additional paid-in-capital. The
estimated fair value of the stock warrants is being amortized over the
six-month term of the line of credit. As of September 30, 1996, $7,315
in amortization expense has been recorded. Such amortization expense
has been included in interest expense in the statement of operations.
The stock warrants expire on May 31, 2000 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 officers,
directors 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 the Company's line-of-credit (see Note
5). The estimated fair value of the stock warrants was $232,978 and is
being amortized over the six-month term of the line of credit. As of
September 30, 1996, $194,148 in amortization expense has been
recorded. 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-20
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
10. STOCK INCENTIVE PLAN
The Board of Directors adopted a Stock Incentive Plan ("the Plan") in
1993. The Plan was amended in 1994 and 1996, and provides for
issuance of up to 412,500 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.
In addition to the stock options granted, the Plan had issued 83,362
shares for $274,615 through stock bonuses and restricted stock sales
through September 30, 1996.
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 ("AFB 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 has 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 1995 and
the nine months ended September 30, 1996; using the minimum value
pricing model as prescribed by SFAS 123 and the following weighted
average assumptions used for grants:
Risk free interest rate 6.5%
Expected dividend yield 0%
Expected lives 7 years
Expected volatility N/A
Options were assumed to be exercised over the seven-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 to be 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 $ 333,763
Nine months ended September 30, 1996 $ 301,480
F-21
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
10. STOCK INCENTIVE PLAN (CONTINUED)
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123 (SFAS 123) (CONTINUED)
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
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------- ---------------
<S> <C> <C>
As reported $ 256,507 $ (779,812)
Pro Forma 221,596 (850,897)
</TABLE>
PRO FORMA NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------- --------------
<S> <C> <C>
As reported $ 0.19 $ (0.53)
Pro Forma 0.16 (0.57)
</TABLE>
The effects of applying SFAS 123 for providing pro forma disclosures
for 1995 and 1996 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.
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 year ended December 31, 1995 and the nine
months ended September 30, 1996 was $152,195 and $37,842,
respectively.
F-22
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
10. STOCK INCENTIVE PLAN (CONTINUED)
The following summary presents the options granted and outstanding as
of September 30, 1996:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF SHARES EXERCISE
EMPLOYEE NONEMPLOYEE TOTAL PRICE
------------- -------------- --------------- -----------
<S> <C> <C> <C> <C>
Outstanding, January 1, 1994 - - - $ -
Granted 110,000 - 110,000 5.76
Exercised - - - -
Canceled - - - -
------------- -------------- ---------------
Outstanding, December 31, 1994 110,000 - 110,000 5.76
Granted 136,000 72,750 208,750 10.23
Exercised - - - -
Canceled (31,000) (5,000) (36,000) 6.56
------------ ------------- ------------
Outstanding, December 31, 1995 215,000 67,750 282,750 8.96
Granted 129,250 12,000 141,250 10.83
Exercised (2,000) - (2,000) .80
Canceled (69,250) (2,500) (71,750) 6.64
------------ ------------- ------------
Outstanding, September 30, 1996 273,000 77,250 350,250 10.20
=========== =========== ===========
</TABLE>
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, 1996:
<TABLE>
<CAPTION>
NUMBER OF OPTIONS
EXERCISE -------------------------------- WEIGHTED AVERAGE
PRICE OUTSTANDING EXERCISABLE CONTRACTUAL LIFE REMAINING
------------- ----------- ----------- --------------------------
<S> <C> <C> <C>
$ 0.02 15,250 15,250 8.8 years
6.00 23,500 12,000 8.4
10.00 222,250 74,567 8.6
13.60 89,250 11,350 9.2
</TABLE>
11. TRANSACTIONS WITH AFFILIATES
MAJOR CUSTOMERS
The Company currently derives substantially all of its revenue from
the PCs, with which it has support services agreements. As described
in Note 1, the Company and the PCs are related through common
ownership and a common member on both the Company's and the PCs
Boards of Directors.
F-23
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
11. TRANSACTIONS WITH AFFILIATES (CONTINUED)
SUPPORT SERVICE 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. Under the support services agreements
for 1995, support services revenue is based upon 61% of net PC
revenue.
Effective January 1, 1996 the support services agreements were
amended such that support services revenue is based upon the
following percentage of net PC revenue:
Washington Oregon
---------- ------
1996 50% 50%
1997 51% 53%
1998 52% 54%
1999 53% 55%
2000 54% 55%
2001, and thereafter 55% 55%
OFFICE LEASE
The Company leases office space for $4,126 per month from Gentle
Dental of Washington, PC (see Note 1) on a month-to-month basis.
Lease expense aggregated approximately $49,512, for each of the years
ended December 31, 1994 and 1995, and $37,134 for the nine months
ended September 30, 1996.
RECEIVABLES FROM AFFILIATES
The Company transacts various other business with the PCs, including
short-term operating advances and miscellaneous asset purchases.
12. COMMITMENTS AND CONTINGENT LIABILITIES
Effective January 1, 1995, the Company assumed operating leases for
dental service locations. These leases range in term from 5 to 10
years with options to renew several of the leases. The Company has
entered into operating lease agreements for office space and parking.
Rent expense for the years ended December 31, 1994 and 1995 was
$10,820 and $837,487, respectively, and for the nine months ended
September 30, 1995 and 1996 was $506,145 (unaudited) and $863,979,
respectively.
F-24
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
12. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Management expects to renew or replace leases that expire. Following
is a summary of scheduled future minimum lease payments, including
assumed leases:
Remainder of 1996 $ 322,110
1997 1,067,699
1998 1,055,667
1999 983,924
2000 748,069
2001 534,557
Thereafter 1,089,808
-------------
$ 5,801,834
=============
13. SUBSEQUENT EVENTS
Each of the following actions was approved at a special meeting of
the Company's shareholders held in October 1996:
The Company effected a 1-for-2 reverse stock split of the Company's
common stock. All share and per share amounts in the accompanying
financial statements have been adjusted to retroactively reflect this
reverse stock split.
The Company eliminated Class B common stock, reclassified Class A
voting common stock to common stock and authorized an additional
42,500,000 shares of common stock.
The Company increased the number of shares available under the
Company's stock incentive plan to 1,000,000 shares.
The Company changed its name from Mutual Health Systems, Inc. to
Gentle Dental Service Corporation.
F-25
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Mutual Health Systems, Inc. (to be changed to
Gentle Dental Service Corporation):
In our opinion, the accompanying balance sheet and the related statements
of operations and retained earnings and of cash flows present fairly, in
all material respects, the financial position of Scott Campbell, DDS, P.S.
at December 31, 1994 and September 29, 1995 and the results of its
operations and its cash flows for the year ended December 31, 1994 and the
nine months ended September 29, 1995 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
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 audit provides a reasonable basis for the opinion expressed above.
As more fully described in Note 10, substantially all of the Company's
assets and operating business were sold to Gentle Dental Service
Corporation, effective September 29, 1995.
PRICE WATERHOUSE LLP
Portland, Oregon
September 17, 1996
F-26
<PAGE>
<TABLE>
<CAPTION>
SCOTT CAMPBELL DDS, P.S.
BALANCE SHEET
- ----------------------------------------------------------------------------------------------------------------
DECEMBER 31, SEPTEMBER 29,
1994 1995
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 300 $ 1,255
Patient accounts receivable, net (Note 2) 73,103 64,717
Income taxes receivable 5,067 10,462
------------- -------------
Total current assets 78,470 76,434
Furniture and equipment, net (Note 3) 11,085 5,647
------------- -------------
Total assets $ 89,555 $ 82,081
============= =============
LIABILITIES AND SHAREHOLDER'S EQUITY Current liabilities:
Accounts payable $ 13,262 $ 25,249
Accrued liabilities 11,133 8,131
Deferred income taxes 7,913 5,920
Current portion of notes payable (Note 5) 10,944 11,503
------------- -------------
Total current liabilities 43,252 50,803
Notes payable, less current portion (Note 5) 14,039 5,865
------------- -------------
Commitments and contingent liabilities (Note 9)
Shareholder's equity (Note 6):
Common stock 500 500
Retained earnings 31,764 24,913
------------- -------------
32,264 25,413
------------- -------------
Total liabilities and shareholder's equity $ 89,555 $ 82,081
============= =============
The accompanying notes are an integral part of this statement.
</TABLE>
F-27
<PAGE>
<TABLE>
<CAPTION>
SCOTT CAMPBELL DDS, P.S.
STATEMENT OF OPERATIONS AND RETAINED EARNINGS
- ----------------------------------------------------------------------------------------------------------------
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 29,
1994 1995
------------- -------------
<S> <C> <C>
Gross revenues $ 688,859 $ 554,365
Less contractual provisions (44,060) (51,851)
------------- -------------
Net revenues 644,799 502,514
------------- -------------
Clinic expenses 665,600 484,512
General and administrative support expenses 19,724 22,520
------------- -------------
685,324 507,032
------------- -------------
Operating income (loss) (40,525) (4,518)
Other expense:
Officer's life insurance (1,548) (1,161)
Interest expense, net (3,621) (2,377)
------------- -------------
Loss before income taxes (45,694) (8,056)
------------- -------------
Benefit from (provision for) income taxes:
Current (400) (788)
Deferred 7,254 1,993
------------- -------------
6,854 1,205
------------- -------------
Net loss (38,840) (6,851)
Retained earnings, beginning of period 70,604 31,764
------------- -------------
Retained earnings, end of period $ 31,764 $ 24,913
============= =============
The accompanying notes are an integral part of this statement.
</TABLE>
F-28
<PAGE>
<TABLE>
<CAPTION>
SCOTT CAMPBELL DDS, P.S.
STATEMENT OF CASH FLOWS
- -----------------------------------------------------------------------------------------------------------------
PERIOD
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 29,
1994 1995
------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (38,840) $ (6,851)
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 17,180 5,438
Deferred income tax benefit (7,254) (1,993)
Net change in current assets and liabilities:
Patient accounts receivable, net 54,410 8,386
Other receivables 401 -
Prepaid expenses 1,680 -
Income taxes (2,067) (5,395)
Accounts payable 7,558 11,987
Accrued liabilities (5,746) (3,002)
------------- -------------
Net cash provided by operating activities 27,322 8,570
------------- -------------
Cash flows from investing activities:
Additions to furniture and equipment (14,522) -
------------- -------------
Net cash used in investing activities (14,522) -
------------- -------------
Cash flows from financing activities:
Payment on note payable to stockholder (6,138) -
Payments on notes payable (11,558) (7,615)
Payment on capital lease obligation (3,784) -
------------- -------------
Net cash used in financing activities (21,480) (7,615)
------------- -------------
Net increase (decrease) in cash (8,680) 955
Cash at beginning of period 8,980 300
------------- -------------
Cash at end of period $ 300 $ 1,255
============= =============
The accompanying notes are an integral part of this statement.
</TABLE>
F-29
<PAGE>
SCOTT CAMPBELL DDS, P.S.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Scott Campbell DDS, P.S. (the Company) is a Washington corporation
that operates a dental clinic in Redmond, Washington.
SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
Revenues are recognized as services are rendered to patients. Revenues
are reported at the estimated amounts which the patients, third party
payers and others are contractually obligated to pay for services
rendered. See Note 2.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost and include those additions
and improvements that add to productive capacity or extend useful
life. When property or equipment are sold or otherwise retired, the
cost and related accumulated depreciation are removed from the
respective accounts and the resulting profit or loss is recorded in
operations. The costs of repairs and maintenance are charged to
expense as incurred.
Depreciation is computed using the double-declining balance method
over useful lives of five to seven years for computers, software,
furniture and operating equipment. Leasehold improvements are
amortized on the straight-line basis over the shorter of the asset
life or lease term.
INCOME TAXES
The Company recognizes deferred tax liabilities and assets for the
expected future tax consequences relating to differences between the
recorded amounts of assets and liabilities for financial reporting,
and tax purposes, in accordance with Statement of Financial Accounting
Standards No. 109.
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 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 those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The recorded amounts of cash, accounts receivable, accounts payable,
and accrued liabilities as presented in the financial statements
approximate fair value because of the short-term maturity of these
instruments. The recorded amount of notes payable approximates fair
value as the actual interest rates are based on the prime rate set by
the lender.
CLINIC EXPENSES
Clinic expenses primarily represent all direct operating expenses such
as lease payments, professional and office payroll, supplies,
depreciation and utilities.
F-30
<PAGE>
SCOTT CAMPBELL DDS, P.S.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. PATIENT ACCOUNTS RECEIVABLE
Patient accounts receivable consist of:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 29,
1994 1995
------------- -------------
<S> <C> <C>
Patient accounts receivable $ 121,839 $ 106,700
Less allowances for doubtful accounts and
contractual allowance 48,736 41,983
------------- -------------
Patient accounts receivable, net $ 73,103 $ 64,717
============= =============
</TABLE>
During the year ended December 31, 1994 and the nine months ended
September 29, 1995, bad debt expense aggregated $22,614 and $15,861
and is included in clinic expenses in the accompanying statement of
operations. Contractual allowances 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. To date, such amounts have not been
significant.
3. FURNITURE AND EQUIPMENT
Furniture and equipment consist of:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 29,
1994 1995
------------- -------------
<S> <C> <C>
Dental equipment $ 149,371 $ 149,371
Furniture and operating equipment 17,171 17,171
Leasehold improvements 25,722 25,722
------------- -------------
Total fixed assets 192,264 192,264
Accumulated depreciation and amortization (181,179) (186,617)
------------- -------------
$ 11,085 $ 5,647
============= =============
</TABLE>
4. CAPITAL LEASES
The Company leased computer equipment under a capital lease agreement.
At December 31, 1994, the gross amount of equipment under capital
leases totaled $13,650, with accumulated amortization of $13,650.
F-31
<PAGE>
SCOTT CAMPBELL DDS, P.S.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
5. NOTES PAYABLE
Notes payable consist of:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 29,
1994 1995
------------- -------------
<S> <C> <C>
Note payable to U.S. Bank, due in monthly instalments,
plus interest rate at prime plus 1.5%, secured by
accounts receivable $ 24,983 $ 17,368
Less current portion 10,944 11,503
------------- -------------
$ 14,039 $ 5,865
============= =============
</TABLE>
6. COMMON STOCK
The Company has authorized 50,000 shares of common stock with no par
value. Five hundred shares were issued to the sole shareholder and
outstanding as of September 29, 1995 and December 31, 1994.
7. RELATED PARTY TRANSACTIONS
The Company leased office space from a company owned by the sole
shareholder of the Company. The rent payments made to this company
aggregated $28,000 in 1994 and $2,225 in 1995. In January 1995 the
building was sold by the related party lessor to a third party. The
Company continues to lease the office space (see Note 9).
8. INCOME TAXES
The Company's effective tax rate of 15% for the year ended December
31, 1994 and the nine months ended September 29, 1995 represents the
statutory federal tax rates in effect based upon the amount of the
Company's taxable losses.
Deferred tax liabilities (assets) are comprised of the following
components:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 29,
1994 1995
------------- -------------
<S> <C> <C>
Patient accounts receivable, net $ 11,573 $ 9,708
Accounts payable and accrued liabilities (3,660) (3,788)
------------- -------------
$ 7,913 $ 5,920
============= =============
</TABLE>
F-32
<PAGE>
SCOTT CAMPBELL DDS, P.S.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases its operating facilities and certain equipment
under agreements which require minimum annual lease payments as
follows:
1996 $ 9,600
1997 28,800
1998 28,800
1999 19,200
-------------
$ 86,400
=============
Rent expense totaled $28,000 and $21,600 for the year ended December
31, 1994 and nine months ended September 29, 1995, respectively.
10. SUBSEQUENT EVENT
Effective September 29, 1995, substantially all of the Company's
assets and operating business were sold to Gentle Dental Service
Corporation, a Vancouver, Washington corporation. The purchase price
included cash of $341,400 and shares of Gentle Dental Service
Corporation common stock valued at $247,064.
The accompanying financial statements do not reflect the effects of
the sale.
F-33
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Mutual Health Systems, Inc. (to be changed to
Gentle Dental Service Corporation):
In our opinion, the accompanying balance sheet and the related statements
of operations and owner' deficit and of cash flows present fairly, in all
material respects, the financial position of Peter A. Vermeulen, D.D.S.,
P.S. (dba Pinehurst Dental Clinic) at December 31, 1994 and June 30, 1995,
and the results of its operations and its cash flows for the year ended
December 31, 1994 and the six months ended June 30, 1995, in conformity
with generally accepted accounting principles. These financial statements
are the responsibility of 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 more fully described in Note 8, substantially all of the Dental Clinic's
assets and operating business were sold to Gentle Dental Service
Corporation, effective July 14, 1995.
PRICE WATERHOUSE LLP
Portland, Oregon
September 17, 1996
F-34
<PAGE>
<TABLE>
<CAPTION>
PETER A. VERMEULEN, D.D.S., P.S.
(DBA PINEHURST DENTAL CLINIC)
BALANCE SHEET
- --------------------------------------------------------------------------------
DECEMBER 31, JUNE 30,
1994 1995
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 1,023 $ 4,688
Patient accounts receivable, net (Note 2) 95,793 77,002
Other receivables 790 590
------------- -------------
Total current assets 97,606 82,280
Furniture and equipment, net (Note 3) 54,146 44,046
Other assets 2,428 -
------------- -------------
Total assets $ 154,180 $ 126,326
============= =============
LIABILITIES AND OWNER'S DEFICIT
Current liabilities:
Accounts payable $ 39,657 $ 37,828
Accrued liabilities 35,670 28,145
Current portion of notes payable (Note 5) 11,301 -
Current portion of obligations under capital lease (Note 4) 4,964 5,933
Line of credit (Note 5) 59,774 54,097
------------- -------------
Total current liabilities 151,366 126,003
Capital lease obligations, less current portion (Note 4) 11,132 7,376
Notes payable, less current portion (Note 5) 380,000 -
------------- -------------
Total long-term liabilities 391,132 7,376
------------- -------------
Commitments and contingent liabilities (Note 7)
Owner's deficit (Note 8) (388,318) (7,053)
------------- -------------
Total liabilities and owner's deficit $ 154,180 $ 126,326
============= =============
The accompanying notes are an integral part of this statement.
</TABLE>
F-35
<PAGE>
<TABLE>
<CAPTION>
PETER A. VERMEULEN, D.D.S., P.S.
(DBA PINEHURST DENTAL CLINIC)
STATEMENT OF OPERATIONS AND OWNER'S DEFICIT
- ----------------------------------------------------------------------------------------------------------------
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
1994 1995
------------- -------------
<S> <C> <C>
Net revenues $ 726,907 $ 365,425
------------- -------------
Clinic expenses 679,446 328,835
General and administrative support expenses 17,404 14,712
------------- -------------
696,850 343,547
------------- -------------
Operating income (loss) 30,057 21,878
Other income (expense):
Interest expense (51,264) (23,674)
Interest income 50 45
------------- -------------
Net loss (21,157) (1,751)
Owner's deficit, beginning of period (271,300) (388,318)
Cash distribution to shareholder (95,861) -
Loan assumed by shareholder (Note 5 and 6) - 380,000
Other liabilities assumed by shareholder (Note 6) - 3,016
------------- -------------
Owner's deficit, end of period $ (388,318) $ (7,053)
============= =============
The accompanying notes are an integral part of this statement.
</TABLE>
F-36
<PAGE>
<TABLE>
<CAPTION>
PETER A. VERMEULEN, D.D.S., P.S.
(DBA PINEHURST DENTAL CLINIC)
STATEMENT OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------------------
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
1994 1995
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (21,157) $ (1,751)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 55,484 14,922
Net change in current assets and liabilities:
Patient accounts receivable, net 36,167 18,791
Other receivables (200) 200
Accounts payable 10,931 (1,829)
Accrued liabilities, net of liabilities assumed by
shareholder in 1995 5,983 (4,509)
------------- --------------
Net cash provided (used in) by operating activities 87,208 25,824
------------- -------------
Cash flows from investing activities:
Additions to furniture and equipment - (2,394)
------------- -------------
Net cash used in investing activities - (2,394)
------------- -------------
Cash flows from financing activities:
Payments on capital lease obligation (7,460) (2,787)
Proceeds from borrowings 37,627 -
Payments on notes (20,491) (11,301)
Payment on line of credit (5,677)
Cash distributions to shareholder (95,861) -
------------- -------------
Net cash used in financing activities (86,185) (19,765)
------------- -------------
Net increase in cash 1,023 3,665
Cash at beginning of period - 1,023
------------- -------------
Cash at end of period $ 1,023 $ 4,688
============= =============
The accompanying notes are an integral part of this statement.
</TABLE>
F-37
<PAGE>
PETER A. VERMEULEN, D.D.S., P.S.
(DBA PINEHURST DENTAL CLINIC)
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Peter A. Vermeulen, D.D.S., P.S. dba Pinehurst Dental Clinic (the
Clinic) operates a dentist practice providing dental services. Prior
to May 16, 1995, the Clinic was a sole proprietorship. On May 16, 1995
the Clinic became a Washington corporation and elected to become an S
corporation.
SIGNIFICANT ACCOUNTING POLICIES
FAIR VALUE OF FINANCIAL INSTRUMENTS
The recorded amounts of cash, accounts receivable, accounts payable,
notes payable, and accrued liabilities as presented in the financial
statements approximate fair value because of the short-term maturity
of these instruments. The recorded amount of long-term debt
approximates fair value as the actual interest rates approximate
current competitive rates.
REVENUE RECOGNITION
Revenues are recognized as services are rendered to patients. Revenues
are reported at the estimated amounts which the patients, third party
payors and others are contractually obligated to pay for services
rendered.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost and include those additions
and improvements that add to productive capacity or extend useful
life. When property or equipment are sold or otherwise retired, the
cost and related accumulated depreciation are removed from the
respective accounts and the resulting profit or loss is recorded in
operations. The costs of repairs and maintenance are charged to
expense as incurred.
Depreciation is computed using the double-declining balance method
over useful lives of five to seven years for computers, software,
furniture and operating equipment. Leasehold improvements are
amortized on the straight-line basis over the shorter of the asset
life or lease term.
INCOME TAXES
As a sole proprietorship and as an S corporation, the Clinic's taxable
income or loss is attributed directly to its owner for inclusion in
his separate income tax returns. Accordingly, the accompanying
statements of operations do not include a provision or benefit for
income taxes.
STATEMENT OF CASH FLOWS
During the years ended December 31,1994 and 1995, the Clinic made cash
interest payments of approximately $54,570 and $25,236, respectively.
As described in Note 6, when the Clinic changed from a sole
proprietorship to an S Corporation, the Clinic's owner personally
assumed a note for $380,000. Further, the sole owner assumed accrued
liabilities aggregating $3,016. These noncash items have been excluded
from the accompanying statement of operations and owner's deficit.
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
F-38
<PAGE>
PETER A. VERMEULEN, D.D.S., P.S.
(DBA PINEHURST DENTAL CLINIC)
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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 those estimates.
CLINIC EXPENSES
Clinic expenses represent all direct operating expenses such as lease
payments, professional and office payroll, supplies, depreciation and
utilities.
2. PATIENT ACCOUNTS RECEIVABLE
Patient accounts receivable consist of:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1994 1995
------------- -------------
<S> <C> <C>
Gross patient accounts receivable $ 120,075 $ 96,252
Less allowances for doubtful accounts (24,282) (19,250)
------------- -------------
Patient accounts receivable, net $ 95,793 $ 77,002
============= =============
</TABLE>
During the year ended December 31, 1994 and the six months ended June
30, 1995, bad debt expense aggregated $49,925 and $12,830 ,
respectively, and is included in clinic expenses. There are no
contractual allowances as all services are billed at amounts which do
not vary significantly from actual cash receipts.
3. FURNITURE AND EQUIPMENT
Furniture and equipment consist of:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1994 1995
------------- -------------
<S> <C> <C>
Dental equipment $ 149,475 $ 150,927
Furniture and operating equipment 91,024 91,024
Leasehold improvements 6,361 6,361
------------- -------------
246,860 248,312
Accumulated depreciation and amortization (192,714) (204,266)
------------- -------------
Furniture and equipment, net $ 54,146 $ 44,046
============= =============
</TABLE>
4. CAPITAL LEASE OBLIGATIONS
The Clinic leases computer equipment under a capital lease agreement.
At December 31, 1994 and June 30, 1995, the cost of equipment under
capital leases totaled $24,865 and accumulated amortization aggregated
$11,183 and $16,156, respectively.
F-39
<PAGE>
PETER A. VERMEULEN, D.D.S., P.S.
(DBA PINEHURST DENTAL CLINIC)
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. CAPITAL LEASE OBLIGATIONS (CONTINUED)
Future minimum lease payments for equipment under these leases at
December 31, 1994 are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1995 $ 7,460
1996 7,460
1997 5,596
Thereafter -
-------------
20,516
Less amount representing interest 4,420
Present value of future minimum lease payments 16,096
Less current portion of obligations under capital lease 4,964
-------------
Capital lease obligation - long-term $ 11,132
=============
</TABLE>
5. NOTES PAYABLE AND LINE OF CREDIT
The Clinic has a $60,000 line of credit with SeaFirst Bank.
Outstanding borrowings under the line aggregated $59,774 and $54,097
at December 31, 1994 and June 30, 1995, respectively. Borrowings bear
interest at prime plus 2.25% (10.75% and 11.25% at December 31, 1994
and June 30, 1995).
This line of credit does not have any debt covenants.
Notes payable consists of:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1994 1995
------------- -------------
<S> <C> <C>
Note payable to father of sole owner, with interest
at 12% (See Note 6) $ 380,000 $ -
Note to SeaFirst Bank, secured by accounts receivable,
payable in monthly instalments of $1,889 11,301 -
------------- -------------
391,301 -
Less current portion 11,301 -
------------- -------------
$ 380,000 $ -
============= =============
</TABLE>
F-40
<PAGE>
PETER A. VERMEULEN, D.D.S., P.S.
(DBA PINEHURST DENTAL CLINIC)
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
6. RELATED PARTY TRANSACTIONS
On January 12, 1990 the father of the sole owner loaned the Clinic
$380,000 (See Note 5). The note did not have established maturity
dates, and interest at 12% was paid on a monthly basis. On May 16,
1995 when the Clinic changed from a sole proprietorship to an S
corporation, the Clinic's owner personally assumed all payment
responsibilities pursuant to this note. In addition, the sole owner
assumed accrued liabilities aggregating $3,016 on that date. Such
assumptions were recorded as decreases in owner's deficit.
7. COMMITMENTS AND CONTINGENT LIABILITIES
The Clinic leases its operating facilities and certain equipment under
agreements which require minimum annual lease payments at December 31,
1994 as follows:
1995 $ 30,300
1996 2,525
-------------
$ 32,825
=============
The Clinic leases operating space for its Seattle facility. Rent
expense related to this facility totaled $30,300 and $15,150 for the
year ended December 31, 1994 and the period ended June 30, 1995,
respectively.
8. SUBSEQUENT EVENT
Effective July 14, 1995 substantially all of the Clinic's assets and
operating business were sold to Gentle Dental Service Corporation, a
Vancouver, Washington corporation. The owner received cash of $262,000
and shares of Gentle Dental Service Corporation common stock valued at
$335,621. As part of the purchase agreement, Gentle Dental Service
Corporation granted the owner "put rights" that may require it to
redeem the shares of its common stock after the rights have been
exercised.
The accompanying financial statements do not reflect the effects of
the sale of the practice.
F-41
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
PRO FORMA COMBINED FINANCIAL INFORMATION
(UNAUDITED)
- --------------------------------------------------------------------------------
Effective July 14, 1995, Gentle Dental Service Corporation ("GDSC")
acquired substantially all of the assets of the dental practice of Peter A.
Vermeulen, D.D.S., P.S. ("Vermeulen").
Effective September 29, 1995, GDSC acquired substantially all of the assets
of the dental practice of Scott Campbell, D.D.S., P.S. ("Campbell").
Effective October 12, 1995, GDSC acquired substantially all of the assets
of the dental practice of Kristan K. Overby, D.D.S., P.S. ("Overby").
In addition, GDSC acquired substantially all of the assets of four other
dental practices in 1995 and four dental practices in 1996, each of which
is individually insignificant to the GDSC Pro Forma Combined Statement of
Operations.
The following unaudited pro forma combined statement of operations combines
the GDSC historical statement of operations for the year ended December 31,
1995 with the Vermeulen historical statement of operations for the six
months ended June 30, 1995, the Campbell historical statement of operations
for the period ended September 29, 1995, the Overby historical statement of
operations for the period ended September 30, 1995, and the historical
statements of operations for the year ended December 31, 1995 of the
individually insignificant dental practices acquired in 1995 and 1996. The
pro forma combined statement of operations includes adjustments resulting
from the acquisitions. Such acquisition adjustments include:
1. the elimination of the net dental revenue generated by the
acquired dental clinics and attributable to the Professional
Corporations;
2. the addition of $2,202,131 in support services revenue;
3. the elimination of $1,247,410 of historical professional salaries
and wages attributed to the Professional Corporations by whom the
dentists were employed after the respective acquisitions;
4. the incremental amortization of intangible assets acquired of
$62,001; and
5. the increase in interest of $113,594 on borrowings incurred in
conjunction with the acquisitions.
An unaudited pro forma combined statement of operations for the nine months
ended September 30, 1996 has not been presented as the dental practices
acquired in 1996 are insignificant, individually and in the aggregate, to
the historical results of operations.
The unaudited pro forma combined statement of operations is not necessarily
indicative of the operating results that would have been achieved had the
transactions been in effect as of the beginning of the period presented and
should not be construed as representative of future operations.
The historical financial statements of GDSC and the historical statements
of operations of Vermeulen and Campbell are included elsewhere in this
Prospectus and the unaudited pro forma combined statement of operations
presented herein should be read in conjunction with those financial
statements and related notes.
F-42
<PAGE>
<TABLE>
<CAPTION>
GENTLE DENTAL SERVICE CORPORATION
PRO FORMA COMBINED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1995 (UNAUDITED)
- --------------------------------------------------------------------------------
GENTLE 1995 1996
DENTAL INDIVIDUALLY INDIVIDUALLY
SERVICE INSIGNIFICANT INSIGNIFICANT
CORP. P. VERMEULEN S. CAMPBELL K. OVERBY ACQUISITIONS ACQUISITIONS ADJUSTMENTS COMBINED
---------- ------------- ----------- --------- ------------ ------------ ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Dental revenue, net $ - $ 365,425 $ 502,514 $ 339,162 $ 286,553 $ 2,116,397 $(3,610,051)(1) $ -
Support services
revenue from
affiliates 9,781,077 2,202,131(2) 11,983,208
Branch costs 4,700,695 342,297 489,764 304,724 314,396 2,043,762 (1,247,410)(3) 6,948,228
Operating expenses 4,207,739 1,250 19,086 34,330 10,833 86,545 62,001(4) 4,421,784
----------- ----------- ----------- --------- ----------- ------------ ----------
Operating income
(loss) 872,643 21,878 (6,336) 108 (38,676) (13,910) 613,196
Interest and other
expense, net 382,310 23,629 1,720 515 - 1,772 113,594(5) 523,540
----------- ----------- ----------- --------- ----------- ------------ ----------
Income (loss)
before income
taxes 490,333 (1,751) (8,056) (407) (38,676) (15,682) 89,656
Provision (benefit)
for income taxes 233,826 - - - - - (191,071) 42,755
----------- ----------- ----------- --------- ----------- ------------ ----------
Net income (loss) $ 256,507 $ (1,751) $ (8,056) $ (407) $ (38,676) $ (15,682) $ 46,901
=========== ========== =========== ========= =========== ============ ==========
Pro forma net
income per share $ .03
==========
Pro forma weighted
average common
shares and equivalents 1,420,365
==========
</TABLE>
F-43
<PAGE>
[Inside back cover graphic setting forth the following information:
The Gentle Dental Network
Gentle Dental Professional
Service Corporation Corporations
Support Services
Agreement
----------------------
-- Management support -- Complete, quality
-- Marketing dental care
-- Non-dental staffing -- Professional staffing
-- Facilities and of dentists and
equipment specialists
-- Growth capital -- Set standards and
-- Recruitment assess quality control]
<PAGE>
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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.
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TABLE OF CONTENTS
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Page
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Prospectus Summary............................................... 3
Risk Factors..................................................... 6
Proposed Acquisition............................................ 12
Use of Proceeds................................................. 12
Dividend Policy................................................. 13
Capitalization.................................................. 13
Dilution........................................................ 14
Selected Financial Data......................................... 15
Management's Discussion and Analysis
of Financial Condition and Results
of Operations................................................. 16
Business ....................................................... 23
Management...................................................... 35
Certain Transactions............................................ 40
Principal Shareholders.......................................... 42
Description of Capital Stock.................................... 43
Shares Eligible for Future Sale................................. 46
Underwriting.................................................... 47
Legal Matters................................................... 49
Experts......................................................... 49
Additional Information.......................................... 49
Index to Financial Statements...................................F-1
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Until March 10, 1997 (25 days after the date of this Prospectus), all
dealers effecting transactions in the Common Stock, whether or not
participating in this distribution, may be required to deliver a
Prospectus. This is in addition to the obligation of dealers to deliver a
Prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
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1,500,000 SHARES
GENTLE DENTAL SERVICE
CORPORATION
COMMON STOCK
--------------
PROSPECTUS
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BLACK & COMPANY, INC.
WEDBUSH MORGAN SECURITIES
February 13, 1997
