U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________________ to _______________________
Commission file number: 000-23673
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GENTLE DENTAL SERVICE CORPORATION
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(Exact name of small business issuer as specified in its charter)
Washington 91-1577891
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
222 No. Sepulveda Blvd., Suite 740, El Segundo, CA 90245
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(Address of principal executive offices)
Issuer's telephone number (310) 765-2400
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22800 Savi Ranch Parkway, Suite 206, Yorba Linda, CA 92887
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(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
As of May 14, 1998, 7,808,978 shares of the issuer's Common Stock were
outstanding.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited, in thousands, except share amounts)
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December 31, March 31,
Assets 1997 1998
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<S> <C> <C>
Current assets:
Cash and cash equivalents $ 302 $ 70
Accounts receivable, net 6,331 6,995
Receivables from affiliates 1,731 157
Supplies 1,109 1,411
Prepaid and other current assets 1,726 2,381
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Total current assets 11,199 11,014
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Property and equipment, net 10,084 12,195
Intangible assets, net 22,843 33,885
Other assets 282 338
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Total assets $ 44,408 $ 57,432
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Liabilities, Redeemable Common Stock and
Shareholders' Equity
Current liabilities:
Accounts payable $ 2,452 $ 1,768
Accrued payroll and payroll related costs 2,084 3,376
Other current liabilities 3,174 3,499
Current portion of long-term debt and capital lease obligations 651 678
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Total current liabilities 8,361 9,321
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Long-term liabilities:
Obligations under capital leases, net of current portion 581 511
Long-term debt, net of current portion 13,842 24,530
Other long-term liabilities 115 118
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Total long-term liabilities 14,538 25,159
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Total liabilities 22,899 34,480
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Redeemable common stock, no par value, 183,686 shares issued and outstanding
in 1997 and 1998, respectively 2,130 2,137
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Shareholders' equity:
Preferred stock, 30,000,000 shares authorized, no shares issued and - -
outstanding
Common stock, no par value, 50,000,000 shares authorized, 7,530,781 and
7,590,241 shares issued and outstanding in 1997 and 1998, respectively 21,784 22,325
Additional paid-in capital 3,165 4,255
Shareholder notes receivable (304) (308)
Accumulated deficit (5,266) (5,457)
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Total shareholders' equity 19,379 20,815
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Total liabilities, redeemable common stock
and shareholders' equity $ 44,408 $ 57,432
============== ==============
See accompanying notes to consolidated financial statements.
</TABLE>
2
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<TABLE>
<CAPTION>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited, in thousands, except per share amounts)
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Three Months Ended March 31,
1997 1998
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<S> <C> <C>
Dental practice net patient service revenue $ 4,953 $ 17,859
Net management fees 2,945 484
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Net revenues 7,898 18,343
Cost and expenses:
Clinical salaries and benefits 2,361 8,214
Practice nonclinical salaries and benefits 1,516 2,831
Dental supplies and lab expenses 1,205 2,084
Practice occupancy expenses 660 1,084
Practice selling, general and administrative expenses 851 1,868
Corporate selling, general and administrative expenses 1,231 1,407
Depreciation and amortization 396 725
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Operating income (loss) (322) 130
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Nonoperating income (expense):
Interest expense, net (122) (423)
Other expense, net (8) (18)
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Nonoperating expense, net (130) (441)
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Loss before income taxes (452) (311)
Income tax benefit - (125)
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Net loss (452) (186)
Dividends on redeemable convertible preferred stock - Series B (270) -
Accretion of redeemable common stock (10) (7)
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Net loss attributable to common stock $ (732) $ (193)
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Loss per share attributable to common stock - basic and diluted $ (.24) $ (.02)
============== ==============
See accompanying notes to consolidated financial statements.
</TABLE>
3
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<TABLE>
<CAPTION>
GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited, in thousands)
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Three Months Ended March 31,
1997 1998
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<S> <C> <C>
Cash flows from operating activities:
Net loss $ (452) $ (186)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 396 725
Loss on disposal of assets 5 -
Loss on investment in joint venture 18 4
Stock options granted to nonemployees 14 14
Interest accrued on shareholder notes receivables (4) (4)
Deferred income taxes - (125)
Change in assets and liabilities, net of the
effect of acquisitions:
Accounts receivable, net 283 173
Receivables from affiliates (77) (145)
Income taxes receivable - 105
Supplies (19) (154)
Prepaid expenses and other current assets (198) (575)
Other assets (33) (42)
Accounts payable (830) (1,097)
Accrued payroll and payroll related costs 221 (488)
Other liabilities 21 (37)
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Net cash used in operating activities (655) (1,832)
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Cash flows from investing activities:
Purchase of property and equipment (595) (757)
Cash paid for acquisitions, including other direct
costs, net of cash acquired (2,026) (7,899)
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Net cash used in investing activities (2,621) (8,656)
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Cash flows from financing activities:
Net payments on short-term borrowings (2,097) -
Proceeds from issuance of long-term debt - 10,400
Payments on long-term debt and obligations under capital leases (2,399) (183)
Payments of deferred financing costs - (13)
Proceeds from issuance of common and preferred stock 7,500 28
Common and preferred stock issuance costs (765) (1)
Exercise of stock options - 25
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Net cash provided by financing activities 2,239 10,256
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Decrease in cash and cash equivalents (1,037) (232)
Cash and cash equivalents, beginning of period 2,220 302
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Cash and cash equivalents, end of period $ 1,183 $ 70
============== ==============
See accompanying notes to consolidated financial statements.
</TABLE>
4
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GENTLE DENTAL SERVICE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited, in thousands, except per share and share amounts)
(1) Organization
Gentle Dental Service Corporation ("GDS" or the "Company"), incorporated on
December 14, 1992, is a Washington corporation headquartered in Yorba Linda,
California. The Company is one of the largest providers of dental practice
management services to multi-specialty dental practices in the United States.
Following the previously announced Dedicated Dental Affiliation and including
affiliations completed through May 14, 1998, the Company will provide management
services to dental practices at 70 dental offices with 260 dentists, including
65 specialists, and 653 operatories in selected markets in California,
Washington, Oregon, Idaho and Hawaii.
As part of a multi-specialty dental care delivery network, the Company provides
management services to dental practices (the "Affiliated Dental Practices" or
"DPs") under long-term management service agreements. Under the terms of the
management service agreements, the Company, among other things, bills and
collects patient receivables and provides all administrative support services to
the DPs. The dentists employed through the Company's network of Affiliated
Dental Practices provide comprehensive general dentistry services and offer
specialty dental services, which include orthodontics, periodontics,
endodontics, pedodontics, prosthodontics, oral surgery and oral pathology. The
Company's practice management services facilitate the delivery of convenient,
high quality, comprehensive and affordable dental care to patients in a
comfortable environment. The Company seeks to build geographically dense dental
practice networks in selected markets through a combination of affiliating with
existing dental practices and selectively developing de novo offices.
On February 13, 1997, the Company completed its initial public offering of
1,500,000 shares of no par value common stock (the "Offering"). The price per
share in the Offering was $5.00, resulting in gross offering proceeds of $7,500.
The Company received net proceeds of approximately $6,125 net of underwriters'
discount and offering expenses.
(2) Basis of Presentation and Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of GDS and its
subsidiaries. All significant intercompany transactions and accounts have been
eliminated. On November 4, 1997, GMS Dental Group, Inc. ("GMS") was merged with
and into the Company, with former stockholders of GMS owning 59% of the combined
company upon completion of the merger. These consolidated financial statements
have been prepared following the pooling-of-interests method of accounting and
reflect the combined financial position and operating results of GDS and GMS
(and certain affiliated DPs as discussed below) for all periods presented.
The Emerging Issues Task Force ("EITF") of the Financial Accounting Standards
Board recently evaluated certain matters relating to the physician practice
management industry (EITF issue number 97-2) and reached a consensus on the
accounting for transactions between physician practice management companies and
physician practices and the financial reporting of such entities. For financial
reporting purposes, EITF 97-2 mandates the consolidation of physician practice
activities with the practice management company when certain conditions have
been met, even though the practice management company does not have an equity
investment in the physician practice. The accompanying financial statements are
prepared in conformity with the consensus reached in EITF 97-2.
Corporate practice of medicine laws in the states in which the Company currently
operates prohibit the Company from owning dental practices. In response to these
laws the Company has executed management services agreements ("MSAs") with
various DPs. Based upon the terms of MSAs with certain of the DPs, the Company
has met the criteria for consolidation of those DPs with the Company. In these
circumstances, all the accounts of 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.
5
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In addition to the MSAs discussed above, the Company has entered into MSAs with
certain DPs where the Company has not met the criteria for consolidation of the
DPs activities. In these circumstances, the Company does not consolidate the
accounts of the DPs. Accordingly, the consolidated statements of operations
exclude the net patient revenues and expenses of these DPs. Rather, the
statements of operations include only the Company's net management fees revenue
generated from those MSAs and the Company's expenses associated with those MSAs.
Effective January 1, 1998, the Company entered into new MSAs with the Oregon and
Washington DPs, thereby meeting the criteria for consolidation of these DPs'
financial statements with the Company. As a result of the new MSAs entered into
with the Oregon and Washington DPs, as of January 1, 1998 all of the DPs within
the Gentle Dental Network except one are accounted for under the consolidation
method of accounting as outlined in EITF 97-2. Prior to January 1, 1998, the
Oregon and Washington DPs were not consolidated. The remaining DP that has not
met the criteria for consolidation has annualized net patient revenues of
approximately $3,500.
The Company has a 50% investment in Celebration Dental Services L.L.C., a
Florida limited liability company, which is accounted for on the equity basis of
accounting and included in other expense, net.
Interim Reporting
The accompanying unaudited interim consolidated financial statements of the
Company have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). Certain information and note
disclosures normally included in annual consolidated financial statements have
been condensed or omitted pursuant to those rules and regulations. In the
opinion of management, all adjustments, consisting only of normal, recurring
adjustments considered necessary for a fair presentation, have been included.
Although management believes that the disclosures made are adequate to insure
that the information presented is not misleading, it is suggested that these
financial statements be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's annual report on Form
10-KSB for the fiscal year ended December 31, 1997. The results for the three
months ended March 31, 1998 are not necessarily indicative of the results of
operations for the entire year.
Net Revenues
Revenues consist primarily of DP net patient service revenue (net patient
revenue) and Company net management fees. Net patient revenue represents the
consolidated revenue of the DPs reported at the estimated net realizable amounts
from patients, third party payors and others for services rendered, net of
contractual adjustments. Net management fees represent amounts charged under
MSAs to the unconsolidated DPs on an agreed-upon percentage of the DPs net
patient service revenue, net of provisions for contractual adjustments and
doubtful accounts.
Net 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 three months ended March 31,
1997 and 1998 were 3,066,474 and 7,754,936, respectively.
Reclassifications
Certain reclassifications have been made to the 1997 financial statements to
conform to the presentations as of March 31, 1998. Such reclassifications had no
effect on the Company's previously reported results of operations or financial
position.
(3) Dental Practice Acquisitions
The Company and its related Washington and Oregon DPs entered into asset
purchase and management service agreements (collectively, the Agreements) on
January 1, 1998. The new 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 in addition to the assumption of certain liabilities,
which was offset by the Company's $1,674 receivable from the DPs. In addition,
the Company will pay $575 in cash over 18 equal monthly installments and may pay
future consideration, determined upon the achievement of certain financial
results, as defined in the Agreements.
6
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During the three months ended March 31, 1998, the Company acquired substantially
all of the assets of 10 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 $8,829. Approximately $7,435 of
the purchase price has been allocated to intangible assets. The total purchase
consideration included $7,899 in cash, $490 in common stock (51,418 shares) and
$440 in liabilities assumed. Also, the Company may pay future consideration in
cash to be determined upon the achievement of certain financial results. The
Company accrues for earn-out payments with respect to prior practice
acquisitions when such amounts are probable and reasonably estimable. As of
March 31, 1998, the Company has accrued $1.8 million for future earn-out
payments, of which $1.4 million is included in additional paid-in capital for
anticipated stock issuances while the remaining accrual for anticipated cash
payments is included in other current liabilities.
The above asset purchases 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 from the dates of their acquisitions.
The following unaudited pro forma information presents the condensed
consolidated results of operations for the three months ended March 31, 1997 and
1998 as if certain affiliations completed during the three months ended March
31, 1998 had occurred as of January 1, 1997. The pro forma results have been
prepared for comparative purposes and include only those affiliations for which
a Form 8-K was filed. These pro forma results 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:
1997 1998
--------- ---------
Pro forma:
DP net patient service revenue $ 7,335 $ 19,215
Net management fees 2,945 484
Net income (loss) (321) (11)
Net income (loss) per share attributed
to common stock $ (.10) $ (.00)
========= =========
(4) Shareholders' Equity
As of January 1, 1997, GDS had only common stock outstanding and GMS had two
classes of stock outstanding: common stock and preferred stock. GMS preferred
stock outstanding consisted of convertible preferred stock - Series A,
redeemable convertible preferred stock - Series B and convertible preferred
stock - Series C. The redeemable convertible preferred stock - Series B,
including dividends and the convertible preferred stock - Series A and C, were
converted into 7,603,677 shares (3,384,302 shares of GDS common stock) of GMS
common stock on November 4, 1997 prior to the 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.
(5) Subsequent Events
On April 1, 1998, the Company completed the acquisition of one DP located in
southern California, representing one clinical office location. The purchase
price for this affiliation totaled $744 and included cash and 28,535 shares of
common stock valued at $246,000. This affiliation will be accounted for using
the purchase method of accounting.
On May 12, 1998, the Company entered into definitive agreements to privately
place $30 million of convertible subordinated notes (the "Subordinated Notes").
The Subordinated Notes bear interest at an annual rate of 7.0% and mature in May
2006. The Company intends to use the proceeds for working capital requirements,
to fund the purchase of dental practices assets and to repay all outstanding
amounts due under the Company's current credit facility. Under the terms of the
definitive agreements, the Subordinated Notes will convert into common stock of
the Company at a conversion price of $9.21. The holders of the Subordinated
Notes may convert such notes to common stock at any time subject to compliance
with certain terms of the definitive agreements. During the first year of the
agreement, the Company can mandate the conversion of the Subordinated Notes to
common stock when the average of the bid and ask price of the Company's stock
for 20 of the last 30 trading days is 175% of the Company's common stock market
price of $8.98, which was the market price at the date the definitive agreements
were signed, increasing to 187.5% in year two, and 200% thereafter.
In addition, pursuant to the definitive agreements and concurrent with the
placement of the Subordinated Notes, the Company agreed to privately place 1.6
million shares of convertible preferred stock in exchange for $15 million with
the same investors
7
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who are purchasing the Subordinated Notes. The number of shares was determined
using the same conversion price of the Subordinated Notes. The preferred stock
is convertible to common stock on a one-for-one basis. Funding under the
definitive agreements and issuance of the Subordinated Notes and preferred stock
is subject to certain closing conditions.
Item 2. Management's Discussion and Analysis or Plan of Operations
Overview
Gentle Dental Service Corporation is one of the largest providers of dental
practice management services to multi-specialty dental practices in the United
States. Following the previously announced Dedicated Dental Affiliation and
including affiliations completed through May 14, 1998, the Company will provide
management services to dental practices at 70 dental offices with 260 dentists,
including 65 specialists, and 653 operatories in selected markets in California,
Washington, Oregon, Idaho and Hawaii.
As part of a multi-specialty dental care delivery network, the Company provides
management services to dental practices (the "Affiliated Dental Practices" or
"DPs") under long-term management service agreements. Under the terms of the
management service agreements, the Company, among other things, bills and
collects patient receivables and provides all administrative support services to
the DPs. The dentists employed through the Company's network of Affiliated
Dental Practices provide comprehensive general dentistry services and offer
specialty dental services, which include orthodontics, periodontics,
endodontics, pedodontics, prosthodontics, oral surgery and oral pathology. The
Company's practice management services facilitate the delivery of convenient,
high quality, comprehensive and affordable dental care to patients in a
comfortable environment. The Company seeks to build geographically dense dental
practice networks in selected markets through a combination of affiliating with
existing dental practices and selectively developing de novo offices.
The following discussion of the results of operations and financial condition of
the Company should be read in conjunction with the unaudited consolidated
financial statements and the notes thereto included elsewhere in this Report.
The following discussion contains forward-looking statements. The Company's
results may differ significantly from those projected in the forward-looking
statements. Factors that might cause future results to differ materially from
the Company's recent results or those projected in the forward-looking
statements include, without limitation, the Company's ability to complete
affiliations necessary for its expansion plans, to integrate dental practices
and to attract and retain a sufficient number of qualified dental care
professionals, the availability of financing to fund the Company's growth and
operations, the enforceability of the provisions of the Company's Management
Agreements and the legality of its business and relationships with Affiliated
Dental Practices.
Results of Operations
The Company reports dental practice net patient revenue and associated clinical
salaries and benefits in those instances where the Company meets certain
specific consolidation requirements established by the Emerging Issues Task
Force ("EITF"), an advisory committee of the Financial Accounting Standards
Board. In those instances where the specific requirements are not met, the
Company reports net management fees revenue, and does not record any associated
clinical salaries and benefits expense. Through December 31, 1997, the Oregon
and Washington DPs (representing a significant portion of overall net patient
revenues) were not included within the Company's consolidated financial
statements, as the criteria for their consolidation were not met. Following the
new MSAs entered into on January 1, 1998 with the Oregon and Washington DPs, all
of the DPs affiliated with the Company except one are accounted for under the
consolidation method of accounting as outlined in EITF 97-2. The remaining DP
that has not met the criteria for consolidation has annualized patient revenues
of approximately $3.5 million. This DP's operations were acquired effective
April 1, 1997.
To provide a more meaningful comparison, the following discussion generally
compares expenses to the total of dental practice net patient service revenue of
consolidated and unconsolidated Affiliated Dental Practices.
Three Months Ended March 31, 1997 Statement of Operations Compared to Three
Months Ended March 31, 1998 Statement of Operations
Dental Practice Net Patient Service Revenue. If all the affiliated dental
practices were accounted for on the consolidated basis for financial reporting
purposes, total dental practice net patient revenue reported would have been
$10.7 million for the three months ended March 31, 1997 and $18.8 million for
the three months ended March 31, 1998, representing a 75.1% increase. This
growth in patient level revenues is directly attributed to nine affiliations
completed during the year ended December 31, 1997 and two affiliations completed
during the three months ended March 31, 1998, representing twenty-five clinical
locations.
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Clinical Salaries and Benefits. Clinical salaries and benefits costs include all
patient service provider staff compensation and related payroll costs at the
consolidated DPs, including dentists, hygienists and dental assistants. If all
the DPs were accounted for on the consolidated basis for financial reporting
purposes, clinical salaries and benefits would have been $5.2 million for the
three months ended March 31, 1997 and $8.7 million for the three months ended
March 31, 1998. Practice clinical salaries and benefits as a percentage of
dental practice net patient revenue for the three months ended March 31, 1997
and 1998 were 48.7% and 46.1%, respectively. This decrease as a percentage of
revenues is the result of the new MSAs entered into with the Oregon and
Washington DPs as of January 1, 1998. Also, the addition of Affiliated Dental
Practices with the Company during the year ended December 31, 1997 and the three
months ended March 31, 1998 contributed to the overall percentage decrease.
Practice Nonclinical Salaries and Benefits. Practice nonclinical salaries and
benefits costs include all staff compensation and related payroll costs at the
dental facilities other than dentists, hygienists and dental assistants. Total
nonclinical salary costs increased 86.8% from $1.5 million for the three months
ended March 31, 1997 to $2.8 million for the three months ended March 31, 1998.
This increase was primarily attributable to the addition of costs from
affiliations completed during the year ended December 31, 1997 and the three
months ended March 31, 1998. If all Company revenue had been reported at the
dental practice net patient revenue level, practice nonclinical salaries and
benefits as a percentage of total revenue for the three months ended March 31,
1997 and 1998 would have been 14.1% and 15.1%, respectively.
Dental Supplies and Lab Costs. Total dental supplies and lab costs increased
73.0% from $1.2 million for the three months ended March 31, 1997 to $2.1
million for the three months ended March 31, 1998. The addition of Affiliated
Dental Practices with the Company in 1997 and 1998 contributed to the increase.
If all Company revenue had been recorded at the dental group net patient service
revenue level, dental supplies and lab costs as a percentage of total revenue
for the three months ended March 31, 1997 and 1998 would have been 11.2% and
11.1%, respectively.
Practice Occupancy. Practice occupancy expenses increased 64.3% from $660,000
for the three months ended March 31, 1997 to $1.1 million for the three months
ended March 31, 1998. This increase in occupancy expenses is primarily
attributable to the addition of costs from affiliations completed during the
year ended December 31, 1997 and the three months ended March 31, 1998. If all
Company revenue had been recorded at the dental practice net patient service
revenue level, practice occupancy cost as a percentage of total revenue for the
three months ended March 31, 1997 and 1998 would have been 6.1% and 5.8%,
respectively.
Practice Selling, General and Administrative Expenses. These costs include
general office, advertising, professional services (excluding dentistry), travel
and entertainment, local taxes, insurance, and other miscellaneous costs at the
clinical office level. Practice selling, general and administrative expenses
increased 120% from $851,000 for the three months ended March 31, 1997 to $1.8
million for the three months ended March 31, 1998. If all Company revenue had
been recorded at the dental group net patient service revenue level, practice
selling, general and administrative expenses as a percentage of total revenue
for the three months ended March 31, 1997 and 1998 would have been 10.7% and
10.3%, respectively. The expense mix of Affiliated Dental Practices affiliating
with the Company in 1997 and 1998 contributed to the slight decrease in this
percentage.
Corporate Selling, General and Administrative Expenses. Total corporate selling,
general and administrative expenses increased 14.3% from $1.2 million for the
three months ended March 31, 1997 to $1.5 million for the three months ended
March 31, 1998. If all Company revenue had been recorded at the dental practice
net patient service revenue level, corporate selling, general and administrative
expenses as a percentage of total revenue for the three months ended March 31,
1997 and 1998 would have been 11.5% and 7.5%, respectively.
Depreciation and Amortization. Total depreciation and amortization expense for
the three months ended March 31, 1997 and 1998 was $396,000 and $725,000,
respectively. The increase was primarily due to the addition of Affiliated
Dental Practices with the Company in 1997 and 1998.
Interest Expense. Total interest expense increased 247% from $122,000 for the
three months ended March 31, 1997 to $423,000 for the three months ended March
31, 1998. This increase in interest expense was due to additional debt incurred
to complete certain dental practice affiliations in 1997 and 1998.
Provision (Benefit) for Income Taxes. For the three months ended March 31, 1997
the Company recognized no tax benefit resulting from its taxable loss as the
probable utilization of any loss carryforwards was uncertain. For the three
months ended March 31, 1998, the Company recognized a tax benefit resulting from
its taxable loss. Based upon recent results of operations, management believes
that the Company will be able to fully utilize its tax loss carryforwards. The
effective tax rate for the tax benefit was lower than the statutory rate due to
the Company's use of a tax-free merger structure for certain dental practice
affiliations. This occurred because the amortization of certain intangible
assets reduced earnings but was not deductible for tax purposes.
9
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Liquidity and Capital Resources
At March 31, 1998, the Company's cash and cash equivalents were $70,000 and
working capital was $1.7 million. Net cash used in operations was $655,000 and
$1.9 million for the three-month periods ending March 31, 1997 and 1998,
respectively. Net cash used in investing activities, principally dental practice
affiliations, was $2.6 million and $8.6 million for the three-month periods
ending March 31, 1997 and 1998, respectively. Net cash provided from financing
activities was $2.2 million and $10.3 million for the three-month periods ending
December 31, 1997 and 1998, respectively.
On January 1, 1998, the Company and its Washington and Oregon Affiliated Dental
Practices entered into asset purchase and management service agreements
(collectively, the "Agreements"). Under the terms of the agreements, the Company
acquired all of the fixed assets and assumed certain liabilities of these
Affiliated Dental Practices. In exchange, the Company paid consideration of $1.7
million in addition to the assumption of certain liabilities, which was offset
by the Company's $1.7 million receivable from these Affiliated Dental Practices.
In addition, the Company will pay $575,000 in cash over 18 monthly installments.
The new management services agreements meet the criteria for consolidation of
the Affiliated Dental Practice accounts with the Company for financial reporting
purposes.
Through April 1, 1998, the Company has completed three affiliations in which the
Company purchased the assets of three dental practices representing eleven
clinical locations for $8.3 million in cash, 79,953 shares of Common Stock,
liabilities assumed of $440,000, and additional future consideration based upon
financial performance targets.
On February 28, 1998, the Company entered into an agreement to purchase the
assets of a dental care organization for $950,000 in cash. The affiliation is
subject to Oregon State regulatory approval. The affiliation is expected to
close in 1998 and will be accounted for using the purchase method of accounting.
On September 21, 1997, the Company entered into an agreement to acquire
Dedicated Dental and to affiliate with certain related dental practices. On
February 28, 1998, the Company and the other parties to the Dedicated Dental
Affiliation amended the respective agreements to (i) reduce the aggregate stock
consideration to be given by the Company from $12,429,000 to $5,769,000; (ii)
increase the aggregate cash consideration from $9,771,000 to $16,431,000
(reduced by any outstanding indebtedness of Dedicated Dental at closing); (iii)
add cash earn-out consideration in connection with the acquisition of the stock
of Dedicated Dental to the cash earn-out consideration provided in two of the
asset purchase agreements, in each case at a presently undeterminable amount to
be determined based upon future earnings before interest expense, income taxes,
depreciation and amortization of Dedicated Dental or the related dental
practices, as applicable; and (iv) to eliminate certain registration rights. The
aggregate cash and stock consideration to be paid by the Company at the closing
of the Dedicated Dental Affiliation was not changed by such amendments and
continues to be $22,200,000. The closing of the Dedicated Dental Affiliation is
subject to satisfaction of certain conditions, including receipt of the approval
of the Department of Corporations, a California state agency. There can be no
assurance that these conditions will be satisfied or that the Dedicated Dental
Affiliation will be completed. The new agreement has also changed the
transaction from a non-taxable to taxable structure, thereby allowing the
Company to deduct the amortization of goodwill for income tax purposes.
In connection with certain completed affiliation transactions, the Company has
agreed to pay to the sellers possible future consideration in the form of cash
and stock. The amount of future consideration payable by the Company under
earn-outs is generally computed based upon financial performance of the
Affiliated Dental Practices during certain specified periods. The Company
accrues for earn-out payments with respect to prior practice acquisitions when
such amounts are probable and reasonably estimable. As of March 31, 1998, the
Company has accrued $1.8 million for future earn-out payments, of which $1.4
million is included in additional paid-in capital for anticipated stock
issuances while the remaining accrual for anticipated cash payments is included
in other current liabilities. Based upon current operating results for those
acquisitions with earn-out provisions, the Company estimates the total earn-out
to be paid, including amounts already accrued, is between $12 and $14 million
over the next five years, of which up to $10 million is expected to be paid in
cash.
A total of 254,901 outstanding shares of common stock issued at a price of $.45
and 339,246 outstanding shares of Common Stock issued at a price of $.225 per
share are subject to, under certain events, repurchase by the Company at cost.
One half of these shares are currently subject to repurchase as a result of the
Company's failure to achieve certain specified performance targets during 1997
and are expected to be repurchased during 1998.
The Company's credit facility ("Credit Facility") provides for a maximum credit
line of $25 million, which will be increased to $30 million following completion
of an equity offering by the Company in which the Company receives at least $20
million in net cash proceeds. The Company intends to use the Credit Facility for
working capital requirements, to purchase non-professional dental practice
assets of additional dental practices that the Company may seek to affiliate
with, and to purchase operating assets for existing Affiliated Dental Practices.
The Credit Facility provides that aggregate amounts
10
<PAGE>
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 are dependent upon the Company's leverage ratio, of (i) up to 1.0% over
prime or (ii) up to 3.25% above LIBOR. The Company is currently in negotiations
to increase its senior Credit Facility to $45 million. There can be no assurance
as to the credit terms and the amount that the Company will ultimately be able
to secure.
On May 12, 1998, the Company entered into definitive agreements to privately
place $30 million of convertible subordinated notes (the "Subordinated Notes").
The Subordinated Notes bear interest at an annual rate of 7.0% and mature in May
2006. The Company intends to use the proceeds for working capital requirements,
to fund the purchase of dental practices assets and to repay all outstanding
amounts due under the Company's current credit facility. Under the terms of the
definitive agreements, the Subordinated Notes will convert into common stock of
the Company at a conversion price of $9.21. The holders of the Subordinated
Notes may convert such notes to common stock at any time subject to compliance
with certain terms of the definitive agreements. During the first year of the
agreement, the Company can mandate the conversion of the Subordinated Notes to
common stock when the average of the bid and ask price of the Company's stock
for 20 of the last 30 trading days is 175% of the Company's common stock market
price of $8.98, which was the market price at the date the definitive agreements
were signed, increasing to 187.5% in year two, and 200% thereafter.
In addition, pursuant to the definitive agreements and concurrent with the
placement of the Subordinated Notes, the Company agreed to privately place 1.6
million shares of convertible preferred stock in exchange for $15 million with
the same investors who are purchasing the Subordinated Notes. The number of
shares was determined using the same conversion price of the Subordinated Notes.
The preferred stock is convertible to common stock on a one-for-one basis.
Funding under the definitive agreements and issuance of the Subordinated Notes
and preferred stock is subject to certain closing conditions.
The Company believes that proceeds from the expected expansion of the existing
Credit Facility, the agreement to place convertible debt and preferred stock,
and cash flow from operations, if any, will be sufficient to fund its operations
for the near future. The Company also believes that such funds will be
sufficient to complete the pending Dedicated Dental Affiliation, a number of
other future practice affiliations, and any possible future consideration from
existing affiliations. However, to execute its long term business strategy, the
Company will require substantial additional funding through additional long-term
or short-term borrowing arrangements or through the public or private issuance
of additional debt or equity securities to acquire new practices and to expand
and maintain existing affiliated practices. There can be no assurance that any
such financing will be available to the Company or will be available on terms
acceptable to the Company.
11
<PAGE>
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
On January 23, 1998, the Company issued 51,418 shares of Common Stock as part of
the purchase price for the acquisition of assets of a dental practice. The
issuance of the shares was exempt from registration under Section 4(2) of the
Securities Act of 1933 and Rule 506 of Regulation D thereunder because the
purchaser was an accredited investor within the meaning of Rule 501.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
27 Financial Data Schedule
(b) Reports on Form 8-K.
On January 20, 1998, the Company filed a Current Report on Form 8-K/A
Amendment No. 1 to amend its previously filed Form 8-K relating to the
merger of GMS Dental Group, Inc. with and into the Company on November
4, 1997. The amendment includes or incorporates by reference under Item
7 the financial statements of GMS Dental Group, Inc. as of and for the
periods ended September 30, 1997 and December 31, 1996, and proforma
financial information as of September 30, 1997 and for the periods
ended September 30, 1997 and December 31, 1996.
On March 16, 1998, the Company filed a Current Report on Form 8-K to
report under Item 2 the acquisition on February 28, 1998 of
substantially all of the assets of Affordable Dental Care, Inc. No
financial statements were included in the report.
12
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
GENTLE DENTAL SERVICE CORPORATION
---------------------------------
(Registrant)
Date: May 15, 1998 By: NORMAN R. HUFFAKER
------------------------ -------------------------------------
Norman R. Huffaker
Chief Financial Officer
13
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GENTLE
DENTAL SERVICE CORPORATION'S FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-END> MAR-31-1997 MAR-31-1998
<CASH> 0<F1> 70
<SECURITIES> 0<F1> 0
<RECEIVABLES> 0<F1> 6,995
<ALLOWANCES> 0<F1> 0
<INVENTORY> 0<F1> 0
<CURRENT-ASSETS> 0<F1> 11,014
<PP&E> 0<F1> 12,195
<DEPRECIATION> 0<F1> 0
<TOTAL-ASSETS> 0<F1> 57,432
<CURRENT-LIABILITIES> 0<F1> 9,321
<BONDS> 0<F1> 0
0<F1> 2,137
0<F1> 0
<COMMON> 0<F1> 22,325
<OTHER-SE> 0<F1> (1,510)
<TOTAL-LIABILITY-AND-EQUITY> 0<F1> 57,432
<SALES> 7,898 18,343
<TOTAL-REVENUES> 7,898 18,343
<CGS> 0 0
<TOTAL-COSTS> 8,220 18,213
<OTHER-EXPENSES> 8 18
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 122 423
<INCOME-PRETAX> (452) (311)
<INCOME-TAX> 0 (125)
<INCOME-CONTINUING> (452) (186)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (452) (186)
<EPS-PRIMARY> (.24) (.02)
<EPS-DILUTED> (.24) (.02)
<FN>
<F1> The restated balance sheet as of March 31, 1997 is not included in this
report.
</FN>
</TABLE>
