<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB/A
AMENDMENT NO. 2
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
For the fiscal year ended December 31, 1997
Commission file number 000-23673
---------
GENTLE DENTAL SERVICE CORPORATION
(Exact name of small business issuer as specified in its charter)
Washington 91-1577891
---------- ------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
222 North Sepulvada Boulevard, Suite 740, El Segundo, California 90245
- ---------------------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (310) 765-2400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [_]
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained in this form, and no disclosure will be contained, to the best
of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
Issuer's revenues for its most recent fiscal year: $43,403,000
Aggregate market value of Common Stock held by nonaffiliates of the registrant
at February 28, 1998: $39,500,000. For purposes of this calculation, officers
and directors are considered affiliates.
Number of shares of Common Stock outstanding at February 28, 1998: 7,769,925.
Documents Incorporated by Reference
-----------------------------------
Part of Form 10-KSB into
Document which incorporated
-------- ----------------------
Proxy Statement for 1998 Annual
Meeting of Shareholders Part III
Transitional Small Business Disclosure Format: Yes [_] No [X]
<PAGE>
PART II
Item 7. Financial Statements
In accordance with the rules and regulations of the Securities and
Exchange Commission (the "Commission"), Gentle Dental Service Corporation, a
Washington corporation, is refiling its financial statements to restate: (i) the
loss per share attributable to Common Stock - basic and diluted from $(1.17), as
reported in the Form 10-KSB filed with the Commission on March 31, 1998 (the
"Form 10-KSB"), to $(.91) per share, as reported in the Restated Financial
Statements set forth below (the "Restated Financial Statements"); (ii) the
weighted average common shares utilized for the year ended December 31, 1997
from 3,544,149 shares, as reported in the Form 10-KSB, to 4,559,140 shares, as
reported in the Restated Financial Statements; (iii) the per share amount of
restructuring plan charge recorded in the fourth quarter of 1997 from $.32 per
share, as reported in the Form 10-KSB, to $.25 per share, as reported in the
Restated Financial Statements; (iv) the pro forma net loss per common and common
equivalent share, as reported - basic and diluted from $(1.17) per share, as
reported in the Form 10-KSB, to $(.91) per share, as reported in the Restated
Financial Statements; and (v) the pro forma net loss per common and common
equivalent share, pro forma - basic and diluted from $(1.28) per share, as
reported in the Form 10-KSB, to $(.99) per share, as reported in the Restated
Financial Statements.
INDEX TO RESTATED FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report ........................................ 3
Report of Independent Accountants ................................... 4
Consolidated Balance Sheets at December 31, 1996 and 1997 ........... 5
Consolidated Statements of Operations for the years ended
December 31, 1996 and 1997 ......................................... 7
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1996 and 1997 ................................... 8
Consolidated Statements of Cash Flows for the years ended
December 31, 1996 and 1997 ......................................... 10
Notes to Consolidated Financial Statements .......................... 13
2
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Gentle Dental Service Corporation:
We have audited the accompanying consolidated balance sheet of Gentle Dental
Service Corporation and subsidiaries as of December 31, 1997 and the related
consolidated statements of operations and shareholders' equity and cash flows
for the year ended December 31, 1997 (as restated, see note 15). These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Gentle Dental
Service Corporation and subsidiaries as of December 31, 1997 and the results of
their operations and their cash flows for the year ended December 31, 1997, in
conformity with generally accepted accounting principles.
We previously audited and reported on the consolidated balance sheet of GMS
Dental Group, Inc. and subsidiaries as of December 31, 1996 and the related
consolidated statements of operations and shareholders' equity and cash flows
for the year ended December 31, 1996, prior to their restatement for the 1997
pooling of interests between Gentle Dental Service Corporation and subsidiaries
and GMS Dental Group, Inc. and subsidiaries. The contribution of GMS Dental
Group, Inc. and subsidiaries to total assets, revenues and net loss represented
50 percent, 26 percent and 42 percent of the respective restated totals.
Separate financial statements of Gentle Dental Service Corporation included in
the 1996 restated consolidated balance sheet and statements of operations and
cash flows were audited and reported on separately by other auditors. We also
audited the combination of the accompanying consolidated balance sheet as of
December 31, 1996 and the related consolidated statements of operations and cash
flows for the year ended December 31, 1996, after restatement for the pooling of
interests; in our opinion, such consolidated statements have been properly
combined on the basis described in note 3 of the notes to the consolidated
financial statements.
/s/ KPMG PEAT MARWICK LLP
Orange County, California
February 20, 1998, except as to
note 14 which is as of March 16, 1998
3
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of
Gentle Dental Service Corporation
In our opinion, the balance sheet and the related statements of operations, of
redeemable common stock and nonredeemable shareholders' equity and of cash
flows, not presented separately herein, present fairly, in all material
respects, the financial position of Gentle Dental Service Corporation at
December 31, 1996, and the results of its operations and its cash flows for the
year then ended, in conformity with generally accepted accounting principles.
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 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 disclosed in Note 10 to the financial statements, the Company has certain
related party transactions.
/s/ PRICE WATERHOUSE LLP
Portland, Oregon
February 28, 1997
4
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1996 and 1997
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Assets 1996 1997
---------- ----------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 2,220 $ 302
Accounts receivable, net of allowances of approximately $1,706 and
$4,159 in 1996 and 1997, respectively 4,826 6,331
Receivables from affiliates 1,197 1,731
Income taxes receivable 169 115
Supplies 554 1,109
Prepaid and other current assets 877 1,611
------- -------
Total current assets 9,843 11,199
------- -------
Property and equipment, net (notes 4 and 6) 5,766 10,084
Intangible assets, net of accumulated amortization (note 5) 10,330 22,843
Other assets 457 282
------- -------
Total assets $26,396 $44,408
======= =======
Liabilities, Redeemable Convertible Preferred and Common Stock and
Shareholders' Equity
Current liabilities:
Accounts payable $ 1,650 $ 2,452
Accrued payroll and payroll related costs 1,033 2,084
Other current liabilities 1,667 3,174
Current portion of long-term debt and capital lease
obligations (notes 6 and 10) 1,124 651
Short-term borrowings (note 6) 2,097 -
------- -------
Total current liabilities 7,571 8,361
------- -------
Long-term liabilities:
Obligations under capital leases, net of current portion (note 13) 572 581
Long-term debt, net of current portion (note 6) 1,822 13,842
Other long-term liabilities 91 115
------- -------
Total long-term liabilities 2,485 14,538
------- -------
Total liabilities $10,056 $22,899
------- -------
</TABLE>
(Continued)
5
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets, Continued
December 31, 1996 and 1997
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
1996 1997
-------- -------
<S> <C> <C>
Redeemable convertible preferred stock - Series B, $.001 par value,
9,270,000 shares authorized; 6,180,000 and zero shares issued and
outstanding in 1996 and 1997, respectively (note 8) $ 11,055 $ -
-------- -------
Redeemable common stock, no par value, 190,302 and 183,686 shares
issued and outstanding in 1996 and 1997, respectively (note 8)
2,199 2,130
-------- -------
Shareholders' equity (notes 7 and 9):
Preferred stock, 30,000,000 shares authorized, no shares issued and
outstanding - -
Convertible preferred stock - Series A, $.001 par value; 395,000
shares authorized; 395,000 and zero shares issued and outstanding
in 1996 and 1997, respectively 1 -
Convertible preferred stock - Series C, $.001 par value; 5,000
shares authorized; 1,777 and zero shares issued and outstanding in
1996 and 1997, respectively 1 -
Common stock, no par value, 50,000,000 shares authorized, 2,181,622
and 7,530,781 shares issued and outstanding in 1996 and 1997,
respectively 2,890 21,784
Additional paid-in capital 1,443 3,165
Shareholder notes receivable (136) (304)
Accumulated deficit (1,113) (5,266)
------- -------
Total shareholders' equity 3,086 19,379
------- -------
Commitments and contingencies (notes 13 and 14)
Total liabilities, redeemable convertible preferred and common
stock and shareholders' equity $26,396 $44,408
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1996 and 1997
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Dental practice net patient service revenue - consolidated (note 2) $ 3,701 $29,327
Net management fees (notes 2 and 10) 10,712 14,076
------- -------
Net revenues 14,413 43,403
Cost and expenses:
Clinical salaries and benefits 1,493 13,701
Practice nonclinical salaries and benefits 4,279 8,177
Dental supplies and lab expenses 2,830 6,271
Practice occupancy expenses 1,563 3,527
Practice selling, general and administrative expenses 1,805 4,912
Corporate selling, general and administrative expenses 2,998 5,700
Corporate restructure and merger costs (note 3) - 1,809
Depreciation and amortization 990 1,847
------- -------
Operating loss (1,545) (2,541)
------- -------
Nonoperating income (expense):
Interest expense, net (749) (653)
Other expense, net (48) (74)
------- -------
(797) (727)
------- -------
Loss before income taxes (2,342) (3,268)
Income tax benefit (note 11) (655) (81)
------- -------
Net loss (1,687) (3,187)
Dividends on redeemable convertible preferred stock - Series B (note 8) (240) (932)
Accretion of redeemable common stock (note 8) (91) (34)
------- -------
Net loss attributable to common stock $(2,018) $(4,153)
======= =======
Loss per share attributable to common stock - basic and diluted -
as restated (note 15) $ (1.18) $ (.91)
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Years ended December 31, 1996 and 1997
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Convertible preferred Convertible preferred Share-
stock -- Series A stock -- Series C Common stock Additional holder Accumu-
--------------------- --------------------- --------------------- paid-in notes lated
Shares Amount Shares Amount Shares Amount capital receivable deficit
--------- --------- --------- --------- --------- --------- ---------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance December 31, 1995... -- $ -- -- $ -- 1,366,145 $ 2,795 $ 152 $ (40) $ 905
Redeemable convertible
preferred stock -- Series B
initial issuance and
issuance costs............ -- -- -- -- -- -- (1,266) -- --
Convertible preferred stock
-- Series A issued for
acquisitions............. 395,000 1 -- -- -- -- 295 -- --
Convertible preferred stock
-- Series C issued for
acquisitions.............. -- -- 1,777 1 -- -- 1,733 -- --
Issuance of common stock in
connection with:
Exchange for shareholder
notes receivable.......... -- -- -- -- 608,524 1 136 (136) --
Acquisitions............... -- -- -- -- 226,453 68 99 -- --
Stock warrants issued
related to debt financing.. -- -- -- -- -- -- 9 -- --
Exercise of stock options... -- -- -- -- 2,000 2 -- -- --
Stock options granted to
nonemployees............... -- -- -- -- -- -- 52 -- --
Stock warrants issued
related to line of credit
guarantees................. -- -- -- -- -- -- 233 -- --
Accretion of put rights..... -- -- -- -- -- -- -- -- (91)
Repurchase of common stock.. -- -- -- -- (24,000) (1) -- -- --
Common stock granted to
nonemployees............... -- -- -- -- 2,500 25 -- -- --
Payments on shareholder
notes receivable........... -- -- -- -- -- -- -- 40 --
Dividends on redeemable
convertible preferred
stock -- Series B......... -- -- -- -- -- -- -- -- (240)
Net loss.................... -- -- -- -- -- -- -- -- (1,687)
------- ------- ----- ------- --------- --------- -------- ---------- -------
Balance, December 31, 1996.. 395,000 1 1,777 1 2,181,622 2,890 1,443 (136) (1,113)
------- ------- ----- ------- --------- --------- -------- ---------- -------
</TABLE>
(Continued)
8
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity, Continued
Years ended December 31, 1996 and 1997
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Convertible Convertible
preferred preferred
stock - Series A stock - Series C Common stock Additional Shareholder
---------------- ---------------- ----------------- paid-in notes Accumulated
Shares Amount Shares Amount Shares Amount capital receivable deficit
--------- ------ ------- ------ --------- ------ ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 395,000 1 1,777 1 2,181,622 2,890 1,443 (136) (1,113)
Convertible preferred stock -
Series C issued for acquisitions -- -- 1,156 -- -- -- 1,156 -- --
Common stock issued in connection
with:
Acquisitions -- -- -- -- 109,039 475 -- -- --
Initial public offering,
net of issuance costs -- -- -- -- 1,500,000 6,125 -- -- --
Employee purchase plan -- -- -- -- 1,902 17 -- -- --
Pursuant to options for share-
holder notes receivable -- -- -- -- 333,816 1 150 (150) --
Exercise of stock options -- -- -- -- 20,100 100 -- -- --
Stock options granted to
nonemployees -- -- -- -- -- -- 56 -- --
Accretion of put rights -- -- -- -- -- -- -- -- (34)
Interest accrued on shareholder
notes receivable -- -- -- -- -- -- -- (18) --
Dividends on redeemable convertible
preferred stock - Series B -- -- -- -- -- -- -- -- (932)
Issuance of common stock warrants
for acquisitions -- -- -- -- -- -- 4 -- --
Shares reserved for earnout -- -- -- -- -- -- 356 -- --
Conversion of convertible
preferred stock - Series A, B, and
C into common stock (395,000) (1) (2,933) (1) 3,384,302 12,176 -- -- --
Net loss -- -- -- -- -- -- -- -- (3,187)
-------- ------ ------- ------ --------- ------- ---------- ----------- -----------
Balance, December 31, 1997 -- $ -- -- $ -- 7,530,781 $21,784 $ 3,165 $ (304) $ (5,266)
======== ====== ======= ====== ========= ======= ========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
9
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1996 and 1997
(in thousands, except share amounts)
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (1,687) $ (3,187)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 990 1,847
Loss on disposal of assets 63 31
Loss on investment in joint venture 87 135
Stock options granted to nonemployees 52 56
Stock issued for fees and compensation 25 -
Interest accrued on shareholder notes receivables - (18)
Amortization of warrants 242 -
Deferred income taxes (146) 14
Change in assets and liabilities, net of the effect of acquisitions:
Accounts receivable, net (997) 47
Receivables from affiliates (562) (621)
Income taxes receivable 5 54
Supplies (48) (269)
Prepaid expenses and other current assets 52 (1,209)
Other assets 46 65
Accounts payable 346 268
Accrued payroll and payroll related costs 1,145 1,956
Other liabilities 5 (144)
-------- --------
Net cash used in operating activities (382) (975)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (873) (2,822)
Proceeds from sale of property and equipment - 22
Cash paid for investment in joint venture (75) -
Cash paid for organizations costs (5) -
Cash paid for acquisitions, including other direct costs, net of
cash acquired (7,268) (9,706)
-------- --------
Net cash used in investing activities $ (8,221) $(12,506)
-------- --------
</TABLE>
(Continued)
10
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Years ended December 31, 1996 and 1997
(in thousands, except share amounts)
<TABLE>
<CAPTION>
1996 1997
--------- --------
<S> <C> <C>
Cash flows from financing activities:
Net proceeds (payments) on short-term borrowings $ 1,048 $ (2,097)
Proceeds from issuance of long-term debt 466 10,000
Payments on long-term debt and obligations under capital leases (1,231) (3,122)
Payments of deferred financing costs (150) -
Proceeds from issuance of common stock and preferred stock 10,551 7,703
Common stock issuance costs (500) (918)
Payments of shareholder notes receivable 40 -
Exercise of put rights (90) (103)
Exercise of stock options - 100
-------- --------
Net cash provided by financing activities 10,134 11,563
-------- --------
Increase (decrease) in cash and cash equivalents 1,531 (1,918)
Cash and cash equivalents, beginning of year 689 2,220
-------- --------
Cash and cash equivalents, end of year 2,220 302
======== ========
Supplemental disclosure of cash flow information:
Cash paid during period:
Interest paid 489 601
Income taxes paid (received) $ (159) $ 1
======== ========
Supplemental schedule of noncash investing and financing activities:
Purchases of property and equipment under capital lease agreements $ 825 $ 278
Issuance of shareholder notes receivable for purchase of common
stock 136 150
Interest accrued on shareholder notes receivable - 18
Accretion of put rights 91 34
Issuance of common stock to founders and to purchase the
predecessor companies 530 -
Issuance of redeemable convertible preferred stock - Series B to
investment bankers for services 314 -
Conversion of convertible preferred stock series A, B and C into
7,603,677 shares of GMS common stock - 12,176
Conversion of 10,218,578 shares of GMS common stock into 4,548,161
shares of the Company's common stock - -
</TABLE>
(Continued)
11
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Years ended December 31, 1996 and 1997
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
1996 1997
---------- ----------
Acquisition of clinics:
<S> <C> <C>
Intangible assets acquired $ 8,501 $13,213
Liabilities assumed or issued 2,921 5,762
Common and convertible preferred stock and warrants issued 2,725 1,635
Tangible assets acquired 4,413 4,246
Shares reserved for earnout agreements - 356
Dental clinic prepayments $ 309 $ -
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
12
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years ended December 31, 1996 and 1997
(in thousands, except share and per share amounts)
(1) Organization
Gentle Dental Service Corporation ("GDS" or the "Company"), incorporated on
December 14, 1992, is a Washington corporation headquartered in Yorba
Linda, California. The Company, as part of a multi-specialty dental care
delivery network, provides management services to dental practices ("DPs")
under long-term management service agreements. Under the terms of the
management service agreements, the Company, among other things, bills and
collects patient receivables and provides all administrative support
services to the DPs.
On February 13, 1997, the Company completed its initial public offering of
1,500,000 shares of no par value common stock (the "Offering"). The price
per share in the Offering was $5.00, resulting in gross offering proceeds
of $7,500. The Company received net proceeds of approximately $6,125 net of
underwriters' discount and offering expenses. Concurrent with the receipt
of the net proceeds, the company utilized $4,426 to repay certain
outstanding principal under the Company's various bank loan arrangements
(see note 6).
(2) Basis of Presentation and Significant Accounting Policies
The consolidated financial statements include the accounts of GDS and its
subsidiaries. All significant intercompany transactions and accounts have
been eliminated. As described more fully in Note 3, on November 4, 1997,
GMS Dental Group, Inc. ("GMS") was merged with and into the Company, with
former stockholders of GMS owning 59% of the combined company upon
completion of the merger. These consolidated financial statements have been
prepared following the pooling-of-interests method of accounting and
reflect the combined financial position and operating results of GDS and
GMS (and certain affiliated DPs as discussed below) for all periods
presented. GMS commenced operations on October 11, 1996. Accordingly, its
results of operations for 1996 included only approximately 2-2/3 months.
The Emerging Issues Task Force ("EITF") of the Financial Accounting
Standards Board recently evaluated certain matters relating to the
physician practice management industry (EITF issue number 97-2) and reached
a consensus on the accounting for transactions between physician practice
management companies and physician practices and the financial reporting of
such entities. For financial reporting purposes, EITF 97-2 mandates the
consolidation of physician practice activities with the practice management
company when certain conditions have been met, even though the practice
management company does not have an equity investment in the physician
practice. The accompanying financial statements are prepared in conformity
with the consensus reached in EITF 97-2.
Corporate practice of medicine laws in the states in which the Company
currently operates prohibit the Company from owning dental practices. In
response to these laws the Company has executed management services
agreements ("MSAs") with various DPs. Based upon the terms of MSAs with
certain of the DPs,
13
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
the Company has met the criteria for consolidation of those DPs with the
Company. In these circumstances, all the accounts of the DPs are included
in the accompanying consolidated financial statements. Accordingly, the
consolidated statements of operations include the net patient revenues and
related expenses of the DPs.
In addition to the MSAs discussed above, the Company has entered into MSAs
with certain DPs where the Company has not met the criteria for
consolidation of the DPs activities. In these circumstances, the Company
does not consolidate the accounts of the DPs. Accordingly, the consolidated
statements of operations exclude the net patient revenues and expenses of
the DPs. Rather, the statements of operations include only the Company's
net management fees revenue generated from those MSAs and the Company's
expenses associated with those MSAs. Subsequent to December 31, 1997, the
Company entered into new MSAs with the Oregon and Washington DPs. Effective
January 1, 1998 the criteria has been met for consolidation of these DPs
financial statements with the Company (see note 14).
The Company has a 50% equity investment in Celebration Dental Services
L.L.C., a Florida limited liability company, which is accounted for on the
equity basis of accounting and is included in other expense, net.
Net Revenues
Revenues consist primarily of DP net patient service revenue (net patient
revenue) and Company net management fees. Net patient revenue represents
the consolidated revenue of the DPs reported at the estimated net
realizable amounts from patients, third party payors and others for
services rendered, net of contractual adjustments. Net management fees
represent amounts charged to the unconsolidated DPs on an agreed-upon
percentage of the DPs net patient service revenue under MSAs, net of
provisions for contractual adjustments and doubtful accounts. The
components of net revenues are as follow:
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
DP net patient service revenue--unconsolidated $ 21,424 $ 26,289
Less amounts retained by the DPs (10,712) (12,583)
Retail sales and other - 370
-------- --------
Net management fees 10,712 14,076
DP net patient service revenue--consolidated 3,701 29,327
-------- --------
Net revenues $ 14,413 $ 43,403
======== ========
</TABLE>
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
14
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
Accounts Receivable
Accounts receivable principally represent receivables from patients and
insurance carriers for dental services provided by the related DPs and are
recorded net of contractual adjustments and allowance for doubtful
accounts. 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.
An allowance for doubtful accounts is provided based upon historical
collection experience.
Receivables from Affiliates
Receivables from affiliates consist primarily of amounts owed to the
Company from unconsolidated DPs to reimburse the Company for payment of the
DPs payroll and other direct costs, net of amounts due to the DPs related
to the acquisitions and the DPs share of revenues (see notes 10 and 14)
Supplies
Supplies consist primarily of disposable dental supplies and instruments
stored at the clinics. Supplies are stated at the lower of cost (first-in,
first-out basis) or market (net realizable value).
Property and Equipment
Property and equipment are stated at cost net of accumulated depreciation
and amortization. Expenditures for maintenance and repairs are charged to
expense as incurred and expenditures for additions and betterments are
capitalized. Equipment held under capital leases is stated at the present
value of minimum lease payments at the inception of the lease. Depreciation
of property and equipment is recorded using the straight-line method over
the shorter of the related lease term or the estimated useful lives which
generally range from 3 to 15 years.
Intangible Assets
Intangible assets result primarily from the excess of cost over the fair
value of net tangible assets purchased. Such intangibles relate primarily
to noncompetition covenants and management services agreements. Intangibles
relating to management service agreements consist of the costs of
purchasing the rights to provide management support services to DPs over
the initial noncancelable 40-year terms of the related agreements. Under
these agreements, the DPs 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 DPs, providing facilities,
equipment, support staffing, management and other ancillary services. The
agreements are noncancelable except for performance defaults.
Intangible assets are amortized on the straight-line method over their
estimated useful lives, 5 years for organizational costs, 25 years for
management services agreements and other acquired intangibles, and 40 years
for trademarks.
15
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
LONG-LIVED ASSETS
The Company reviews its assets balances for impairment at the end of each
quarter or more frequently when events or changes in circumstances indicate
that the carrying amount of assets may not be recoverable. To perform that
review, the Company estimates the sum of expected future undiscounted net
cash flows from assets. If the estimated net cash flows are less than the
carrying amount of the asset, the Company recognizes an impairment loss in an
amount necessary to write-down the asset to a fair value as determined from
expected future discounted cash flows. No write-down of assets was recorded
for the years ended December 31, 1996 and 1997.
FAIR VALUE OF FINANCIAL ASSETS, LIABILITIES AND REDEEMABLE COMMON STOCK
The Company estimates the fair value of its monetary assets, liabilities and
redeemable common stock based upon the existing interest rates related to
such assets, liabilities and redeemable common stock 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, liabilities and redeemable common stock approximates fair value as of
December 31, 1996 and 1997.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
NET LOSS PER SHARE
Net loss per share is computed based on the weighted average number of shares
of common stock and dilutive 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 have
been excluded from the computation of loss per share as their effect is anti-
dilutive. The weighted average common shares utilized for the years ended
December 31, 1996 and 1997 were 1,707,095 and 4,559,140 (as restated - see
note 15), respectively.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 Earnings Per Share. In accordance with this pronouncement, the Company
adopted the new standard for the years ended December 31, 1996 and 1997. The
adoption of this pronouncement did not have an effect on reported loss per
share information.
16
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 ("SFAS 123"), Accounting for
Stock-Based Compensation. Under SFAS 123, the Company may elect to recognize
stock-based compensation expense based on the fair value of the awards or
continue to account for stock-based compensation under Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees' and disclose
in the financial statements the effects of SFAS 123 as if the recognition
provisions were adopted. The Company has elected to account for stock-based
compensation under Accounting Principles Board Opinion No. 25 ("APB 25").
(3) BUSINESS COMBINATIONS AND DENTAL PRACTICE ACQUISITIONS
BUSINESS COMBINATIONS
On November 4, 1997, GMS merged into GDS. In connection with the merger
transaction, all of the issued and outstanding shares of GMS common stock
were converted into 4,548,161 shares of common stock of the Company.
The merger has been accounted for using the pooling-of-interests method of
accounting. Accordingly, the historical financial statements for the periods
prior to the completion of the combination have been restated as though the
companies had been combined. The restated financial statements have been
adjusted to conform the lives in computing depreciation of equipment and
amortization of intangible assets. Such adjustments resulted in no change in
amortization expense in 1996 and in a decrease in depreciation expense of
$24 in 1996. Additionally, such adjustments resulted in a decrease in the
1996 income tax benefit of $10.
The results of operations of GMS and GDS for 1997 through the date of the
merger are as follows:
<TABLE>
<CAPTION>
GMS GDS
---------- ----------
<S> <C> <C>
DP net patient service revenue $ 22,683 $ -
Net management fees - 11,841
---------- ----------
Net income (loss) $ (1,087) $ 308
========== ==========
</TABLE>
As a result of the merger, the Company recorded direct merger expenses of
$677. These expenses consist primarily of accounting, legal and other
advisory fees. Also, the Company recorded a restructuring charge of
$1,132, or $.25 per share (as restated, see note 15), in the fourth quarter
of 1997. The charge included $289 for employee related costs, $311 for
facility consolidation and related leasehold and fixed asset write-offs and
$532 for the redirection of certain duplicative operations and programs and
other costs. These charges are scheduled to be substantially completed in
1998. At December 31, 1997, the Company's remaining obligation related to the
restructuring charges was $853 and is included in other current liabilities
in the accompanying financial statements.
17
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
DENTAL PRACTICE ACQUISITIONS
In 1996, the Company acquired substantially all of the assets of 15 dental
office locations, including cash, accounts receivable, supplies and fixed
assets. The total price for the fair value of the assets acquired, including
intangible assets was $12,914. Approximately $8,501 of the purchase price
has been allocated to intangible assets. The total purchase consideration
included $7,268 in cash, $2,725 in redeemable and nonredeemable preferred and
common stock and $2,921 in liabilities issued or assumed.
In 1997, the Company acquired substantially all of the assets of 15 dental
office locations, including cash, accounts receivable, supplies and fixed
assets. The total price for the fair value of the assets acquired, including
intangible assets was $17,459. Approximately $13,213 of the purchase price
has been allocated to intangible assets. The total purchase consideration
included $9,706 in cash, $1,991 in nonredeemable preferred and common stock
and warrants and $5,762 in liabilities issued or assumed.
In connection with the affiliation of certain dental practices, the Company
is obligated to pay additional consideration, depending upon the achievement
of certain financial results, as defined by the purchase agreements. During
1997, the Company accrued $356 for the portion of 1997 earnouts which the
Company expects to pay in common stock. Additional consideration may be
payable in cash or stock depending upon the performance of certain affiliated
practices. The additional consideration to be paid under these agreements is
not presently determinable. However, such additional consideration, if any,
is not expected to have a material impact on the financial condition or on
the results of operations of the Company.
The above asset purchases in 1996 and 1997 have been accounted for using the
purchase method of accounting. The excess of the total purchase price over
the fair value of the net tangible and identifiable intangible assets
acquired representing the estimated future value of the management services
agreements are being amortized over the lesser of the term of the related
management service agreements or 25 years using the straight-line method.
The results of operations for these practices have been included in the
consolidated financial statements of the Company since the dates of their
affiliation.
The following unaudited pro forma information presents the condensed
consolidated results of operations as if the 1996 and 1997 affiliations
discussed above had occurred as of January 1, 1996. The pro forma results
have been prepared for comparative purposes only and are not necessarily
indicative of what the actual results of operations would have been had the
practices been affiliated as of that date, nor does it purport to represent
future operations of the Company:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Pro forma:
DP net patient service revenue - consolidated $ 31,006 $ 14,076
Net management fees 13,182 35,242
Net loss (1,084) (1,918)
-------- --------
Net loss per share $ (.40) $ (.41)
======== ========
</TABLE>
18
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
(4) PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Dental equipment $ 3,328 $ 5,697
Computer equipment 1,098 1,941
Furniture, fixtures and equipment 728 1,053
Leasehold improvements 1,681 3,576
Vehicles 22 32
Buildings 48 48
Land 10 10
--------- ---------
Total property and equipment 6,915 12,357
Less accumulated depreciation and
amortization (1,149) (2,273)
--------- ---------
Property and equipment, net $ 5,766 $ 10,084
========= =========
</TABLE>
At December 31, 1996 and 1997, property and equipment include assets under
capital leases with an original cost of $1,262 and $1,524, respectively and
accumulated amortization of $235 and $456, respectively.
(5) INTANGIBLE ASSETS
Intangible assets consists of the following:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Management services agreements $ 10,430 $ 23,338
Trademarks 50 44
Organizational costs 75 5
Other 56 -
--------- ---------
10,611 23,387
Less accumulated amortization (281) (544)
--------- ---------
$ 10,330 $ 22,843
========= =========
</TABLE>
19
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
(6) DEBT
SHORT-TERM BORROWINGS
At December 31, 1996, the Company had a total of $2,097 outstanding under
two bank operating lines of credit with a bank secured by substantially all
assets of the Company. In February 1997, the entire outstanding amount was
fully repaid from the net proceeds from the Offering (see note 1).
LONG-TERM DEBT
At December 31, 1997, the Company had a credit facility from a bank in the
amount of $10,000 (which was increased to a $25,000 credit facility on
January 7, 1998, see note 14). The proceeds of the credit facility are
available for working capital needs and to finance dental practice asset
acquisitions. Principal amounts owed under the credit facility through
December 31, 1997 bear interest up to 1% above the prime rate or up to 3.25%
above LIBOR, at the Company's option, dependent on the Company's leverage
ratio. The outstanding balance on this facility as of December 31, 1997 was
$10,000. The obligations under this credit agreement are secured by
substantially all assets of the Company and its subsidiaries.
20
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
Long term debt is summarized as follows:
<TABLE>
<CAPTION>
1996 1997
---------- -------------
<S> <C> <C>
Note payable to bank due in monthly installments of principal and
interest at prime plus 1.25%, paid during 1997 $ 667 $ -
Notes payable to bank with interest-only payments for the first 12
months at prime plus 1.5%, paid during 1997 1,699 -
Secured notes payable, bearing interest at rates ranging from 9.75%
to 9.99%; monthly principal and interest payments of $5; maturing
at various dates through June 2000; secured by mortgage 70 -
Credit facility, bearing interest at 3.25% in excess of LIBOR rate
(9.1% at December 31, 1997), unpaid balance due in equal quarterly
installments of principal and interest commencing October, 1998
through October 2001 48 10,000
Subordinated note payable, bearing interest at 8%, interest payable
annually beginning December 31, 1997 through January 2002;
principal due 2002 - 742
Senior subordinated note payable, bearing interest at 8%; due in 60
monthly installments of principal and interest of $14, beginning
August 1, 1997 through July 2002 - 637
Subordinated note payable bearing interest at 8%; payable in 36
monthly installments of $5, beginning December 1, 1997 through
December 2001 - 155
Senior subordinated note payable, face value of $500 discounted at
8%; due in July 1999 - 441
Senior subordinated note payable, face value of $2,083 discounted
at 8%; due in July 2002 - 1,448
Various unsecured notes payable, due in monthly installments of
principal and interest at rates ranging from 8.25% to 10.75%,
maturing through November 2003 210 702
-------- -------------
2,694 14,125
Less current portion (872) (283)
-------- -------------
$ 1,822 $ 13,842
======== =============
</TABLE>
21
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statement, Continued
(in thousands, except share and per share amounts)
At December 31, 1997, the aggregate maturities of long-term debt for each of
the next five years are as follows:
<TABLE>
<S> <C>
1998 $ 283
1999 1,381
2000 3,061
2001 3,815
2002 5,564
Thereafter 21
---------
$ 14,125
=========
</TABLE>
(7) SHAREHOLDERS' EQUITY
As of December 31, 1996, the Company had only common stock outstanding and
GMS had two classes of stock outstanding: common stock and preferred stock.
GMS preferred stock outstanding consisted of convertible preferred stock -
Series A, redeemable convertible preferred stock - Series B and convertible
preferred stock - Series C. The redeemable convertible preferred stock -
Series B, including dividends and the convertible preferred stock - Series A
and C, were converted into 7,603,677 shares (3,384,302 shares of GDS common
stock) of GMS common stock on November 4, 1997 prior to the GMS merger. Upon
closing of the merger between GMS and the Company, all 10,218,578
outstanding GMS common shares were converted into 4,548,161 shares of the
Company's common stock.
COMMON STOCK
An aggregate of 608,524 shares of common stock were issued in 1997 at a
purchase price of $.225 per share to the founders of GMS. 269,278 of these
shares are subject to a four-year vesting schedule whereby one-quarter of
the shares vested upon issuance and one-quarter of the shares vested in
October 1997. The remaining shares vest on a monthly basis during the
remaining thirty-six months.
An aggregate of 254,901 shares issued to certain other shareholders, which
were issued at a price of $.45 per share, and 339,246 shares out of the
608,524 shares issued to GMS founders, are subject to, in certain events, a
right of repurchase by the Company, at cost. One half of the shares are
currently subject to repurchase because the Company's EBITDA (excluding CEO
salary and related expenses) for 1997 did not exceed $4,724. The second half
of the shares will be subject to repurchase if, among other things, the
Company's EBITDA (excluding CEO salary and related expenses) for 1998 does
not exceed $12,683, and a portion of the second half will be subject to
repurchase if such EBITDA does not exceed $16,911.
PREFERRED STOCK
Preferred stock may be issued by the Board of Directors with preferences to
be determined at the time of issuance. Through December 31, 1997, none of
the 30,000,000 authorized shares of the Company's preferred stock has been
issued or is outstanding.
22
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
STOCK WARRANTS ISSUED IN CONJUNCTION WITH DEBT ISSUANCE AND ACQUISITIONS
In May 1996 the Company issued warrants to purchase 4,333 shares of the
Company's common stock at $7.50 per share to a lender in connection with a
line of credit agreement. The stock warrants were valued at $9 and have been
recorded as debt issuance costs and additional paid-in capital. The
estimated fair value of the stock warrants was amortized over the six-month
term of the line of credit. Such amortization expense has been included in
interest expense in the statement of operations. The stock warrants expire
on May 31, 2001 and carry certain piggyback registration rights. The stock
warrants have not been exercised to date.
In addition, in May 1996, the Company issued to certain directors, officers
and shareholders of the Company warrants to purchase 115,000 shares of the
Company's common stock at $7.50 per share in consideration for guaranteeing a
total of $1,000 of a line-of-credit which is no longer available and has been
fully repaid. The fair value of the stock warrants of $233 was amortized
over the six-month term of the line of credit. Such amortization expense has
been included in interest expense in the statement of operations. All stock
warrants expire in May 2001 and no such stock warrants have been exercised to
date.
In connection with the Company's $10 million credit facility, warrants were
issued in 1996 entitling the bank to purchase up to 81,942 shares of the
Company's common stock at a price of $3.93 per share. The warrants were
recorded at their estimated fair market value of $1 which is included in
interest expense in the accompanying financial statements. These warrants
expire in October 2001.
In connection with the Company's initial public offering, warrants were
issued in 1997 entitling representatives of the underwriters to purchase up
to 150,000 shares of the Company's common stock at a price of $6.00 per
share. These warrants were recorded at their estimated fair value of $1.
In connection with the acquisition of the net assets of dental practices in
1997, the Company issued warrants to purchase approximately 189,160 shares of
common stock at $7.86 per share. The warrants expire in 2004; no such stock
warrants have been exercised to date. Warrants for 22,254 shares become
exercisable only if certain performance conditions are met by the acquired
dental practices. The estimated fair value of $4 was recorded as part of the
consideration for the acquisition.
23
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
(8) Redeemable Convertible Preferred and Common Stock
The following summary presents the changes in the redeemable convertible
preferred stock - Series B and redeemable common stock:
<TABLE>
<CAPTION>
Shares of
Redeemable Redeemable
Convertible Convertible Shares of Redeemable
Preferred Stock- Preferred Stock- Redeemable Common Common
Series B Series B Stock Stock
-------------------- -------------------- -------------------- -------------
<S> <C> <C> <C> <C>
Balance, December 31, 1995 - $ - 57,551 $ 711
Issued in connection with
private placement 6,180,000 10,815 100,000 957
Issued in connection with
acquisitions - - 38,994 530
Accretion of put rights - - - 91
Exercise of put rights - - (6,243) (90)
Dividends on redeemable
convertible preferred stock
- Series B - 240 - -
-------------------- -------------------- -------------------- ----------
Balance, December 31, 1996 6,180,000 11,055 190,302 2,199
-------------------- -------------------- -------------------- ----------
Issued in connection with
private placement 107,142 188 - -
Dividends on redeemable
convertible preferred stock
- Series B - 932 - -
Accretion of put rights - - - 34
Exercise of put rights - - (6,616) (103)
Conversion into common stock (6,287,142) (12,175) - -
-------------------- -------------------- -------------------- ----------
Balance, December 31, 1997 - $ - 183,686 $ 2,130
==================== ==================== ==================== ==========
</TABLE>
REDEEMABLE COMMON STOCK
In connection with certain acquisitions, the Company granted put rights to
certain shareholders that may require the Company to redeem up to 96,545
shares of its common stock, at a redemption price ranging from $13.38 to
$19.62 per share. If all shareholders with such put rights exercise their
options, the Company would be required to repurchase the above shares of
common stock for $1,409. The redemption periods began April 1, 1996 and
continue through January 4, 2003. If the shareholder does not place a
redemption request during the redemption period, the put right will expire
on the stated expiration date. Put rights for all but 20,000 shares
terminate in the event of the Company successfully completing a public
offering at a price of at least $20.00 per share. The Company redeemed 6,243
shares of redeemable common stock for $90 during 1996 and 6,616 shares for
$103 during 1997.
24
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
The shares of common stock subject to the put rights are reported on the
balance sheet as redeemable common stock. Such shares have been recorded at
their fair value as of date of acquisition, inclusive of accretion during
each of the two years in the period ended December 31, 1997. The Company
records accretion on a ratable basis over the redemption period of the
respective stock. Such accretion for the years ended December 31, 1996 and
1997 was $91 and $34, respectively.
Such common stock at December 31, 1997 is redeemable as follows:
<TABLE>
<CAPTION>
Shares Amount Price range
------- ------- -----------------
<S> <C> <C> <C>
1998 2,974 $ 50 $ 16.82
1999 2,754 50 13.38 - 18.16
2000 40,849 576 13.60 - 19.62
2001 29,681 438 13.60 - 18.80
2002 3,714 51 13.60
Thereafter 3,714 51 13.60
------ -------
83,686 $ 1,216
====== =======
</TABLE>
PRIVATE PLACEMENT OF REDEEMABLE COMMON STOCK AND WARRANTS
In June 1996, the Company completed a private placement offering (the
"Placement Offering") of 100,000 shares Company's redeemable 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 Placement Offering (net of Placement Offering costs of $43) were $957.
The net proceeds allocated to common stock aggregated $732. The stock
warrants were recorded at their estimated fair value of $225 and are entitled
to certain piggyback registration rights. The stock warrants expire on
December 14, 2001; no stock warrants have been exercised to date.
In connection with the private placement, the shareholder received certain
put rights which are exercisable after June 21, 2001 but not later than June
21, 2003 if the Company has not completed a public offering of its common
stock by June 21, 2001 at a price of at least $22.00 per share and with net
proceeds to the Company of at least $10,000. The per share price applicable
to the put rights is 20 times the Company's average adjusted net income per
share for the two most recent fiscal years preceding the exercise of the
rights. As of December 31, 1997, the Company has not recorded any accretion
related to the above put rights.
25
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
(9) Stock Options
The Company has adopted a Stock Incentive Plan (the "Plan"). The Plan
provides for issuance of up to 1,000,000 shares of common stock in
connection with various stock grants, awards and sales granted under such
plan to employees and non-employees (primarily key dental group 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 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.
On February 13, 1997 (the offering date), the Company repriced all employee
stock options than outstanding to the offering price of $5.00 per share
(except for certain stock options held by a principal shareholder, which
were repriced at 110% of the offering price). All other terms with respect
to such options were maintained. The Company did not recognize compensation
expense related to the repricing of the employee stock options as the
adjusted exercise price was not below the fair value of the common stock as
of the repricing date.
Prior to the merger, GMS had two stock-based option plans ("Former Plans")
which offered essentially the same awards and stock option terms as the
Plan. Upon consummation of the merger of GMS with the Company, the Former
Plans were frozen to allow no additional option grants under those plans.
The number of options and option price for the options granted under the
Former Plans were converted to the Company share and share price equivalent
utilizing the same conversion ratio of GMS common stock to Company common
stock.
Stock options issued to non-employees have been recorded at their estimated
fair market value and are being expensed over their respective vesting
lives of up to five years. Total compensation expense recorded for the
years ended December 31, 1996 and 1997 was $52 and $56, respectively.
Statement of Financial Accounting Standards No. 123 ("SFAS 123")
The Financial Accounting Standards Board has issued SFAS 123, Accounting
for Stock Based Compensation, which defines a fair value based method of
accounting for employee stock option or similar compensation plans.
However, it also allows an entity to continue to measure compensation cost
related to stock options issued to employees under these plans using the
method of accounting prescribed by the Accounting Principles Board Opinion
No. 25 ("APB 25"), Accounting for Stock Issued to Employees. Entities
electing to remain with the accounting in APB 25 must make pro forma
disclosures of net income and earnings per share, as if the fair value
based method of accounting defined in this Statement had been applied.
26
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
The Company has elected to account for its stock-based compensation plans
under APB 25; however, the Company has computed for pro forma disclosure
purposes the value of all options granted during the years ended December
31, 1996 and 1997. The 1996 options were valued using the minimum value
pricing model as prescribed by SFAS 123 for nonpublic companies. The
options issued subsequent to the Company's 1997 initial public offering
have been valued using the Black-Scholes pricing model as prescribed by
SFAS 123. The following weighted average assumptions have been used for
grants of stock options:
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
Risk free interest rate 6.5% 6.4%
Expected dividend yield - -
Expected lives 5 years 5 years
Expected volatility - 60%
</TABLE>
Options were assumed to be exercised over the five-year expected life for
the purpose of this valuation. Adjustments are made for options forfeited
prior to vesting. The total value of options granted was computed as the
following approximate amounts, which would be amortized on the straight-
line basis over the vesting period of the options:
<TABLE>
<S> <C>
Year ended December 31, 1996 $ 705
Year ended December 31, 1997 1,175
</TABLE>
If the Company had accounted for stock options issued to employees in
accordance with SFAS 123, the Company's net loss attributable to common
stock and pro forma net loss per share would have been reported as follows:
Net loss attributable to common stock:
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
As reported $(2,018) $(4,153)
Pro forma (2,133) (4,523)
</TABLE>
Pro forma net loss per common and common equivalent share:
<TABLE>
<CAPTION>
1997
(as restated -
1996 see note 15)
-------- --------------
<S> <C> <C>
As reported - basic $(1.18) $ (.91)
Pro forma - basic (1.25) (.99)
As reported - diluted (1.18) (.91)
Pro forma - diluted (1.25) (.99)
</TABLE>
The effects of applying SFAS 123 for providing pro forma disclosures for
1996 and 1997 are not likely to be representative of the effects on
reported net loss and net loss per common equivalent share for future
years, because options vest over several years and additional awards
generally are made each year.
27
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
The following summary presents the options granted and outstanding under
the Plan and Former Plans as of December 31, 1997:
<TABLE>
<CAPTION>
Weighted
Number of shares average
------------------------- Exercise
Employee Non-employee Total price
---------- ------------ --------- --------
<S> <C> <C> <C> <C>
Outstanding, December 31, 1995 215,000 67,750 282,750 $5.47
Granted 192,112 38,705 230,817 3.43
Exercised (2,000) - (2,000) -
Canceled (96,549) (5,833) (102,382) 8.19
-------- ------- -------- -----
Outstanding, December 31, 1996 308,563 100,622 409,185 3.66
Granted 746,306 1,200 747,506 3.03
Exercised (353,918) - (353,918) .71
Canceled (142,100) (1,200) (143,300) 4.78
-------- ------- -------- -----
Outstanding, December 31, 1997 558,851 100,622 659,473 $4.85
======== ======= ======== =====
</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 granted under the Plan and Former Plans at December
31, 1997:
<TABLE>
<CAPTION>
Weighted
average
Number of options contractual
Exercise ------------------------- life
price Outstanding Exercisable remaining
-------- ----------- ----------- -------------
<S> <C> <C> <C>
$ .20 15,250 15,250 7.57 years
.45 84,118 19,195 8.90
.67 15,355 - 9.63
4.13 45,500 - 6.76
5.00 305,250 48,170 8.45
5.50 81,000 81,000 5.83
8.02 68,000 1,000 9.64
10.00 45,000 27,672 7.35
------ ------- ------- ----
$ 4.85 659,473 192,287 8.02
====== ======= ======= ====
</TABLE>
As of December 31, 1997, there are 354,538 options available for future
grant under the Plan.
28
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
(10) Transactions with and Receivables from Related DP's
The Company currently derives a portion of its management fees from three
DPs with which it is related through common ownership of certain
shareholders.
The Company provides management support services to these related DPs under
management agreements with forty-year terms. In 1996 and 1997, the Company
earned management fees based on specified percentages of net dental
practice patient revenues as defined in the agreements. Such percentages
ranged from 51% to 53% and were negotiated with the DPs and have been
developed and revised as necessary based on the Company's services and
operating needs. Subsequent to December 31, 1997, the Company and the DPs
have entered into new management services agreements (see note 14).
Affiliate receivables consist primarily of amounts owed to the Company by
the unconsolidated DPs to reimburse the Company for payment of the
unconsolidated DPs payroll and other direct costs, net of amounts due to
the unconsolidated DPs related to the asset acquisitions and the
unconsolidated DPs share of revenues. The Company also transacts various
other business with the related DPs, including short-term operating
advances.
(11) Income Taxes
Income tax benefit consists of the following:
<TABLE>
<CAPTION>
1996
------------------------------
Current Deferred Total
------- -------- ---------
<S> <C> <C> <C>
U.S. Federal $(175) $(420) $(595)
State and local (6) (54) (60)
----- ----- -----
$(181) $(474) $(655)
===== ===== =====
<CAPTION>
1997
------------------------------
Current Deferred Total
------- -------- ---------
<S> <C> <C> <C>
U.S. Federal $(123) $ 34 $ (89)
State and local 8 - 8
----- ----- -----
$(115) $ 34 $ (81)
===== ===== =====
</TABLE>
29
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
The effective tax rate differed from the U.S. statutory Federal rate due to
the following:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Statutory federal rate $ (796) $(1,111)
Increase (reduction) in income taxes resulting from:
State income taxes, net of federal income tax benefit (90) 3
Amortization of nondeductible goodwill and other
nondeductible items 163 80
Valuation allowance for deferred tax assets allocated
to income tax expense 75 691
Prior year reconciliation - 189
Other (7) 67
------- -------
Effective tax rate $ (655) $ (81)
======= =======
</TABLE>
Deferred tax assets (liabilities) are comprised of the following
components:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward $ 647 $ 645
Accrued payroll/bonus related - 85
Allowance for doubtful accounts 618 1,663
Compensated absences, principally due to accrual for
financial reporting purposes 114 146
Intangible assets, principally due to differences in
amortization and capitalized cost - 164
Other 12 38
------- -------
Total gross deferred tax assets 1,391 2,741
Less valuation allowance (75) (766)
------- -------
Deferred tax assets, net of valuation allowance 1,316 1,975
------- -------
Deferred tax liabilities:
Accounts receivable (759) (1,410)
Plant and equipment, principally due to differences
in depreciation and capitalized cost (444) (525)
Intangible assets, principally due to accrual for
financial reporting purposes (11) -
Cash versus accrual reporting for tax purposes (68) (38)
Other - (2)
------- -------
Deferred tax liabilities (1,282) (1,975)
------- -------
Net deferred tax asset $ 34 $ -
======= =======
</TABLE>
30
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
(12) Malpractice Insurance
The dental group's dentists are insured with respect to dentistry
malpractice risks on a claims-made basis. There are known claims and
incidents that may result in the assertion of additional claims, as well as
claims from unknown incidents that may be asserted arising from services
provided to patients. Management is not aware of any claims against the
Company or its affiliated groups which might have a material impact on the
Company's financial position or results of operations.
(13) Commitments and Contingencies
Lease Commitments
The Company has primarily entered into operating leases of commercial
property. Commercial properties under operating leases mostly include space
required to perform dental services and space for administrative
facilities. Lease expense, including month-to-month rentals, for the years
ended December 31, 1996 and 1997 was $1,432 and $3,012, respectively.
The future minimum lease payments under capital leases and noncancelable
operating leases with remaining terms of one or more years consist of the
following at December 31, 1997:
<TABLE>
<CAPTION>
Capital Operating
--------- ---------
<S> <C> <C>
1998 $ 465 $ 3,246
1999 312 3,169
2000 232 2,838
2001 103 2,506
2002 36 2,029
Thereafter - 8,284
------ -------
Total minimum lease obligation 1,148 $22,072
=======
Less portion attributable to interest 199
------
Obligations under capital leases 949
Less current portion 368
------
$ 581
======
</TABLE>
31
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
Litigation
The Company is subject to various claims and legal actions which arise in
the ordinary course of business. In the opinion of management, the ultimate
resolution of such matters will not have a material adverse effect on the
Company's financial position or results of operations
(14) Subsequent Events
On January 7, 1998, the Company amended its $10 million credit facility
(the "Credit Facility") to provide for a maximum credit line of $25
million, which may be increased at the option of the Company to $30 million
following completion of an equity offering by the Company in which the
Company receives at least $20 million in net cash proceeds. The Company
intends to use the Credit Facility for working capital requirements, to
purchase non-professional dental practice assets of additional dental
practices that the Company may seek to affiliate with, and to purchase
operating assets for existing affiliated dental practices. The Credit
Facility provides that the aggregate amount borrowed under the Credit
Facility for working capital purposes and letter of credit obligations may
not exceed $4 million, and that remaining amounts available under the
Credit Facility may be used by the Company for permitted acquisitions and
capital expenditures. The revolving feature of the Credit Facility expires
on September 30, 1999, at which time it will convert into a three year term
loan to be repaid in 12 equal quarterly installments. Principal amounts
owed under the Credit Facility bear interest, at the Company's option and
dependent upon the Company's leverage ratio, of (i) up to 1.0% over prime
or (ii) up to 3.25% above LIBOR. The Credit Facility requires the Company
to pay an unused commitment fee based upon a range from .375 - .50% of the
amount by which the bank commitment under the Credit Facility exceeds the
aggregate amount of all loans then outstanding. The Credit Facility
contains several covenants including (i) restrictions on the ability of the
Company to incur indebtedness and repurchase, or pay dividends with respect
to, its capital stock; and (ii) requirements relating to maintenance of a
specific net worth and specified ratios of current assets to current
liabilities, debt to cash flow and EBITDAR (earnings before interest
expense, taxes, depreciation, amortization and operating lease rental
expense) to fixed charges. In addition, the Credit Facility requires the
Company to notify the lenders prior to making any acquisition and to obtain
the consent of the lenders prior to making (i) certain acquisitions with
purchase price exceeding $3 million, (ii) all acquisitions with purchase
prices exceeding $5 million and (iii) capital expenditures exceeding $5
million in any fiscal year. The Credit Facility also requires the Company
to convert to a holding company that owns no assets other than the stock of
its operating subsidiaries on or before May 31, 1998. If the Company does
not attain holding company status on or before May 31, 1998, the interest
rate applicable to amounts borrowed under the Credit Facility will be
increased by 0.5% and if holding company status is not obtained on or
before July 31, 1998 an event of default will exist under the terms of the
Credit Facility. The Company's obligations under the Credit Facility are
guaranteed by each of the subsidiaries of the Company. The obligations of
the Company under the Credit Facility and the subsidiaries under the
guarantees are secured by a security interest in the equipment, fixtures,
inventory, receivables, subsidiary stock, certain debt instruments,
accounts and general intangibles of each of such entities.
32
<PAGE>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Financial Statements, Continued
(in thousands, except share and per share amounts)
The Company and its related Washington and Oregon DPs entered into asset
purchase and management service agreements (collectively, the Agreements)
on January 1, 1998. The new management service agreements meet the criteria
for consolidation of the DP accounts with the Company for financial
reporting purposes as outlined in EITF 97-2.
Under the terms of the Agreements, the Company acquired all of the fixed
assets and assumed certain liabilities of the DPs. In exchange, the Company
paid consideration of $1,674, which was offset by the Company's $1,674
receivable from the DPs. In addition, the Company issued options to
purchase 110,000 shares of Company common stock at an exercise price of
$8.38 per share, subject to a five-year vesting schedule and will pay $575
in cash over 18 equal monthly installments. Also, the Company may pay
possible minimal future consideration in cash or options to be determined
upon the achievement of certain financial results, as defined in the
Agreements.
In 1998 the Company completed the acquisitions of two DPs located in
northern California and western Oregon, representing ten clinical office
locations. The purchase price for these affiliations totalled $8,410 and
included cash and 43,077 shares of common stock. These affiliations will be
accounted for using the purchase method of accounting.
On February 28, 1998 the Company signed a definitive agreement to acquire
Managed Dental Care of Oregon, Inc. (MDC). MDC is a dental care
organization that contracts with the state of Oregon to provide care under
the Oregon Health Plan. MDC in turn contracts with dental care providers to
provide dental care to Oregon Health Plan participants. The cash purchase
price is $950 and the acquisition is subject to Oregon state regulatory
approval. The acquisition is expected to close during 1998 and will be
accounted for using the purchase method of accounting.
During September 1997, the Company entered into definitive agreements to
acquire Dedicated Dental Systems, Inc. (DDS) and the assets of certain
related practices. The acquisition includes 15 dental offices located in
and around Bakersfield, CA. On February 28, 1998 the definitive agreements
were amended and now provide for a purchase price of $16,431 in cash and
705,101 shares of common stock valued at $5,769 plus potential future
amounts based on performance. The acquisition of DDS is expected to close
during 1998 and is subject to California state regulatory approval. The
acquisition will be accounted for using the purchase method of accounting.
During March 1998, the Company entered into an agreement to lease office
space for a period of sixty months commencing May 1998 at a monthly base
rent of $15.
(15) Restatement of Consolidated Financial Statements
The Company has restated its consolidated financial statements for the
correction of an error in the weighted average number of shares of common
stock outstanding for the year ended December 31, 1997. As a result of
this correction, the following amounts were restated as of and for the
year ended December 31, 1997:
<TABLE>
<CAPTION>
As Previously As
Reported Restated
----------------- -----------------
<S> <C> <C>
Loss per share attributable
to common stock - basic and
diluted $(1.17) $(.91)
Weighted average common shares
utilized for the year ended
December 31, 1997 (note 2) 3,544,149 4,559,140
Per share amount of re-
structuring plan charge
recorded in the fourth
quarter of 1997 (note 3) $ .32 $ .25
Pro forma net loss per common
and common equivalent share:
As reported - basic and diluted $(1.17) $(.91)
Pro forma - basic and diluted $(1.28) $(.99)
(note 9)
</TABLE>
33
<PAGE>
PART IV
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
23.1 Independent Auditors' Consent of KPMG Peat Marwick LLP.
23.2 Independent Auditors' Consent of PricewaterhouseCoopers
LLP.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
On November 19, 1997, the Company filed a Current Report on Form
8-K to report under Item 2 the merger of GMS Dental Group, Inc. with and into
the Company on November 4, 1997. On November 21, 1997, the Company filed a
Current Report on Form 8-K to report under Item 4 a change in the Company's
principal accountants that occurred on November 14, 1997. No financial
statements were included in either report.
34
<PAGE>
SIGNATURE
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on July 29, 1998.
GENTLE DENTAL SERVICE CORPORATION
By: /s/ NORMAN HUFFAKER
-----------------------
Norman Huffaker
Chief Financial Officer
35
<PAGE>
EXHIBIT INDEX
Exhibit
Number Document Description
- ------ --------------------
23.1 Independent Auditors' Consent of KPMG Peat Marwick LLP
23.2 Independent Auditors' Consent of PricewaterhouseCoopers LLP
27.1 Financial Data Schedule
<PAGE>
EXHIBIT 23.1
CONSENT OF ACCOUNTANTS
The Board of Directors and Shareholders
Gentle Dental Service Corporation:
We consent to incorporation by reference in the registration statements on Form
S-8 (Nos. 333-25315 and 333-25319) of Gentle Dental Services Corporation of our
report dated February 20, 1998, except as to note 14 which is as of March 16,
1998, relating to the consolidated balance sheets of Gentle Dental Service
Corporation and subsidiaries as of December 31, 1996 and 1997 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the years in the two year period ended December 31, 1997 (as restated),
which report appears in this amendment number 2 on Form 10-KSB of Gentle Dental
Service Corporation. Our report refers to the report of other auditors for the
separate financial statements of Gentle Dental Service Corporation included in
the 1996 financial statements restated for the 1997 pooling of interests between
Gentle Dental Service Corporation and GMS Dental Group, Inc. and subsidiaries.
/s/ KPMG PEAT MARWICK LLP
Orange County, California
August 3, 1998
<PAGE>
EXHIBIT 23.2
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 333-25315 and 333-25319) of Gentle Dental Service
Corporation of our report dated February 28, 1997 which appears in Gentle Dental
Service Corporation's amendment number 2 on Form 10-KSB for the year ended
December 31, 1997.
/s/ PricewaterhouseCoopers LLP
August 3, 1998
Portland, Oregon
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GENTLE
DENTAL SERVICE CORPORATION'S FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER
31, 1996 AND DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1997
<PERIOD-END> DEC-31-1996 DEC-31-1997
<CASH> 2,220 302
<SECURITIES> 0 0
<RECEIVABLES> 4,826 6,331
<ALLOWANCES> 1,706 4,159
<INVENTORY> 0 0
<CURRENT-ASSETS> 9,843 11,199
<PP&E> 5,766 10,084
<DEPRECIATION> 1,149 2,273
<TOTAL-ASSETS> 26,396 44,408
<CURRENT-LIABILITIES> 7,571 8,361
<BONDS> 0 0
13,254 2,130
2 0
<COMMON> 2,890 21,784
<OTHER-SE> 194 (2,405)
<TOTAL-LIABILITY-AND-EQUITY> 26,396 44,408
<SALES> 14,413 43,403
<TOTAL-REVENUES> 14,413 43,403
<CGS> 0 0
<TOTAL-COSTS> 15,958 45,944
<OTHER-EXPENSES> 48 74
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 749 653
<INCOME-PRETAX> (2,342) (3,268)
<INCOME-TAX> (655) (81)
<INCOME-CONTINUING> (1,687) (3,187)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,687) (3,187)
<EPS-PRIMARY> (1.18) (.91)
<EPS-DILUTED> (1.18) (.91)
</TABLE>
