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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended March 31, 1999.
[ ] Transaction report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from _________ to_________.
Commission file number 1-13725
Pentegra Dental Group, Inc.
(exact name of Registrant as specified in its charter)
Delaware 76-0545043
(State or other jurisdiction (I.R.S. Employer
Of incorporation or organization) Identification No.)
2999 N. 44th Street, Suite 650, Phoenix, Arizona 85018
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (602) 952-1200
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act 1934
during the preceding 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 [ ]
The number of shares of Common Stock of the Registrant, par value $.001 per
share, outstanding at June 15, 1999 was 9,102,503.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy of information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the shares of the Registrant's Common
Stock held by non-affiliates of the Registrant June 15, 1999 was approximately
$7,678,000 based upon the closing price per share of the Registrant's Common
Stock as reported on the American Stock Exchange of $2.0625. As of June 15,
1999, there were 9,102,503 outstanding shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement relating to the
Annual Meeting of Stockholders of the Registrant to be held on July 30, 1999 are
incorporated by reference into Part III of this Report.
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FORM 10-K REPORT INDEX
PART I
Items 1. and 2 Business and Properties.................................................................. 3
Item 3. Legal Proceedings........................................................................ 12
Item 4. Submission of Matters to a Vote of Security Holders...................................... 12
PART II
Item 5. Market for Registrant's Common Stock and Related Shareholder Matters..................... 13
Item 6. Selected Financial Data.................................................................. 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 16
Item 7A Quantitative and Qualitative Disclosures about Market Risk............................... 20
Item 8. Financial Statements and Supplementary Data.............................................. 21
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure..... 40
PART III
Item 10 Directors and Executive Officers of the Registrant....................................... 40
Item 11 Executive Compensation .................................................................. 41
Item 12 Security Ownership of Certain Beneficial Owners and Management .......................... 41
Item 13 Certain Relationships and Related Party Transactions..................................... 41
PART IV
Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8 - K
FORWARD - LOOKING STATEMENTS
Statements contained in this Report, which are not historical in nature,
are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements include
statements in Item 1. "Business", Item 5. "Market for Registrant's Common
Stock and Related Shareholder Matters" and Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations" regarding the
development and acquisition of additional dental practice management companies
and affiliation with additional dental practices, recruitment of additional
affiliated dental practice management companies not shared with a general
dentist, projections of the Company's future earnings, funding of the
Company's expansion, operations and capital expenditures, payment or
nonpayment of dividends and cash outlays for income taxes."
Such forward - looking statements involve certain risks and uncertainties
that could cause actual results to differ materially from anticipated results.
These risks and uncertainties include regulatory constraints, changes in laws
regulating the practice of dentistry or the interpretation of such laws,
competition from other dentists or practice management companies, the
availability of suitable new markets and suitable locations within such
markets, changes in the Company's operating or expansion strategy, failure to
consummate proposed developments or acquisitions of dental practices, the
ability of the Company to effectively manage an increasing number of markets
in which the dental practices are located or are proposed to be located, and
other factors as may be identified from time to time in the Company's filings
with the Securities and Exchange Commission or in the Company's press
releases.
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PART I
ITEMS 1. AND 2. BUSINESS AND PROPERTIES
Overview
Pentegra Dental Group, Inc. (the "Company" or "Pentegra") provides
management, administrative, development and other services to dental practices
throughout the United States. Pentegra's approach to dental practice management
is designed to increase revenues and lower costs at a affiliated dental
practices ("Affiliated Practices") while freeing the practicing dentists to
focus on the delivery of high-quality care. Pentegra earns management service
fees under long-term service agreements with Affiliated Practices. In most
cases, service fees payable to Pentegra under the service agreements it has with
its Affiliated Practices represent a share of the Affiliated Practices'
operating profits, thereby providing incentives for Pentegra and the Affiliated
Practices to work together to maximize practice profitability. In other cases,
service fees are a percentage of dental practice collections. Pentegra will also
seek to grow by acquiring practice management companies and affiliating with
additional dental practices.
As of March 31, 1999, Pentegra has entered into service agreements with 85
Affiliated Practices, which include approximately 120 dentists and 99 dental
offices located in 27 states (the "Affiliates"). In addition, Pentegra acquired
from Dr. Reed the assets of a consulting firm, Pentegra, Ltd., which was founded
in 1988, and a seminar company, Napili International ("Napili"), which was
founded in 1963. The clinical, administrative and marketing training developed
and provided by these companies to practicing dentists and their teams are the
foundation for the Company's approach to dental practice management ("the
Pentegra Dental Program".) The Pentegra Dental Program is available exclusively
to Affiliated Practices.
Pentegra believes it has several advantages that would lead dental practices
to seek to affiliate with Pentegra: (i) Pentegra and the Affiliated Practices
focus on providing traditional fee-for-service dental care, which Pentegra
believes is highly profitable and professionally rewarding for dentists; (ii)
the Pentegra Dental Program offers proven techniques to increase practice
profitability substantially; (iii) both Pentegra and the Affiliated Practices
have incentives to work together to maximize practice profitability; and (iv)
affiliation with Pentegra enables Affiliated Practices to benefit from
professional management techniques, economies of scale in administrative and
other functions, and enable affiliated dentists to dedicate more time and effort
towards the growth of their practices.
Industry Overview
According to the U.S. Health Care Financing Administration ("HCFA"), dental
expenditures in the United States. increased from $31.6 billion in 1990 to $50.6
billion in 1997. HCFA also projects that dental expenditures will reach
approximately $95.2 billion by 2007, representing an increase of approximately
88% over 1997 dental expenditures. The Company believes there are several
factors that will drive growth in dental expenditures in the United States,
including (i) the aging of the population, which increases the demand for
restorative and maintenance procedures (e.g. crowns, bridges and implants) that
tend to be more profitable than routine procedures (e.g. cleanings and
fillings); (ii) the increasing attention to dental health and wellness, with
greater emphasis on personal appearance, which increases the demand for general
dentistry services and, in particular, cosmetic dental procedures (e.g..,
porcelain bonding and bleaching), which also tend to be more profitable than
routine procedures; and (iii) the increasing percentage of the population
covered by some form of dental insurance, which, according to the National
Center for Health Statistics, makes patients more likely to seek treatment from
their dentist. Payments for dental services are made either directly by patients
or by third-party payors. Third-party payors primarily consist of private
insurance indemnity plans, preferred provider organizations ("PPOs") and dental
health maintenance organizations and other managed care programs ("DHMOs").
Private indemnity insurance companies typically pay for a patient's dental care
on a fee-for-service basis, while PPO plans pay on a discounted fee-for-service
basis. DHMO plans typically pay on a per-person, per month basis regardless of
the level of service provided to the patient. In the case of both PPOs and
DHMOs, patients typically must pay on a fee-for-service basis for any services
outside the limited range of dental procedures covered. According to the 1997
Mercer Consulting Group survey of Employer-Sponsored Health Plans, approximately
86% of the respondents in that survey reported that they offer their employees
dental
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plans that pay for dental services on a fee-for-service basis, while
approximately 22% of the plans surveyed are PPO and DHMO plans (i.e., discounted
fee-for-service payments or capitated payments). According to HCFA, only
approximately four percent of all payments for dental care are made under the
Medicaid program (which provides limited coverage for indigent children), with
no coverage being provided by the Medicare program. In a 1995 survey, the
American Dental Association ("ADA") reported that there were approximately
153,000 active dentists in the United States, approximately 88% of who were
practicing either alone or with only one other dentist. In recent years,
dentists have begun to consolidate into affiliated groups and with practice
management organizations. Dentists who affiliate with practice management
companies gain several benefits, such as opportunities to achieve economies of
scale, to implement cost management techniques and to gain access to capital for
new equipment and other working capital needs.
Business Strategy
Pentegra's objective is to become a leader in providing dental practice
management services. In order to achieve this objective, Pentegra's strategy
includes the following elements:
- - Focus on Traditional Fee-for-Service Dental Care. According to the 1997
Mercer Consulting Group Survey of Employer-Sponsored Health Plans,
approximately 86% of the respondents in that survey reported that they
offer their employees dental plans that pay for dental services on a
fee-for-service basis. Pentegra believes that fee-for-service care is
high-quality, highly profitable and professionally rewarding for dentists.
- - Increase Productivity and Profitability of Affiliated Practices by
Implementing the Pentegra Dental Program. The Pentegra Dental Program
involves implementing techniques designed to increase revenues and lower
costs, as well as methods to make the dentist and his or her practice team
more efficient in the delivery of dental care.
- - Lower Operating Costs by Achieving Economies of Scale. Pentegra believes
that, as a result of its size and resources, it will be able to provide
Affiliated Practices with certain management functions at lower cost than
if the Affiliated Practices were to perform the services by themselves.
- - Free the Dentist to Focus More Time on the Practice of Dentistry. Pentegra
will relieve practicing dentists of administrative tasks. Pentegra believes
its management and administrative support will substantially reduce the
amount of time affiliated dentists are required to spend on administrative
matters and enable them to dedicate more time and effort toward the growth
of their professional practices.
- - Grow Through Acquisitions and Affiliations of Additional Dental Practices.
Pentegra will generally seek to affiliate with practices that have high
potential for future growth, particularly through implementation of the
Pentegra Dental Program, an established reputation for high-quality care
and a strategic fit either in an existing market or as an entry into a new
market.
The Pentegra Dental Program
Pentegra is continually implementing the Pentegra Dental Program at its
Affiliated Practices. The Pentegra Dental Program was originally developed by
Dr. Reed through Pentegra, Ltd. and Napili. Napili was founded in 1963 and has
conducted technical and management seminars for over 15,000 practicing dentists,
including many who have attended these seminars more than once. As a result of
demand by attendees of Napili seminars, Dr. Reed established Pentegra, Ltd. in
1988 to provide hands-on, on-site training and services to small groups of
dentists. Pentegra, Ltd. and Napili are wholly owned by Pentegra and their
services are available exclusively to Affiliated Practices.
Pentegra focuses on traditional fee-for-service practices, which generate
revenue by providing care to their established patient bases and typically grow
through patient referrals. Pentegra believes that the average dentist has the
skills necessary to diagnose and provide appropriate care to patients, but many
of them have not developed the skills needed to obtain patient acceptances of,
and commitments to, the treatment plans. As a result, a significant amount of
recommended care may not be completed, with correspondingly lower revenues to
the dentists.
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The Pentegra Dental Program is a cooperative approach that emphasizes
patient wellness and involves the dentist and his or her patient mutually
agreeing on a program to achieve and maintain optimal oral health. In addition
to technical seminars on the current clinical thinking in dentistry, Pentegra
provides seminars and on-site training and support to assist affiliated dentists
(who will control the practice of dentistry at Affiliated Practices) and their
teams to communicate effectively with each patient regarding the type and value
of care needed, obtain the patient's commitment to a treatment plan and then
implement the agreed-upon treatment plan. An initial on-site consulting and
training session is provided to Affiliated Practices lasting from one to three
days, with subsequent sessions as necessary. At each initial session, Pentegra
performs an analysis that includes on-site observation of the dental practice,
monitoring of the clinical staff and patient flow, as well as a review of the
charting and record documentation of the care provided. This process identifies
areas where improvements might be made in the day-to-day operations of the
dental practice, including changes in personnel and facility utilization,
patient scheduling and communication (both between the dentist and his or her
staff and between all dental practice personnel and its patients). In addition,
the dental practice's personnel, including its dentists, are introduced to
techniques designed to (i) improve communication among them and (ii) sensitize
them to becoming more confident and consistent in their communications with
patients to ensure that each patient is fully informed and agrees with the
dentist on a mutually acceptable treatment plan. Pentegra and the Affiliated
Practices monitor the patients' treatment plans by using active recall systems
to ensure that scheduled treatments are actually performed. The Pentegra Dental
Program stresses quality of care and personal attention, both of which Pentegra
believes are highly valued by patients and help achieve treatment plan
acceptance. Pentegra is developing a statistical database for each Affiliated
Practice to define and measure the standard of care and assure that the desired
standards are being achieved.
The Pentegra Dental Program also analyzes and rationalizes fee structures to
increase profitability. Pentegra believes that typical fee structures do not
accurately reflect all direct and indirect costs of various procedures. In order
to address this, Pentegra assists the Affiliated Practices by utilizing
time-related cost allocation models to compare cost and fee relationships for
Affiliated Practices that are designed to reflect the true cost of procedures
and, hence, increase profitability.
In addition, the Pentegra Dental Program focuses on increasing the
productivity of the dentist and his or her team. Pentegra consults with
Affiliated Practices with efforts to increase the use of hygienists and
production. A number of dental services can be provided by hygiene teams with
only limited involvement by the dentist, thereby enabling dentists to use their
extra time on higher margin procedures requiring greater expertise and skill.
Pentegra monitors the Affiliated Practices' patient scheduling and time spent
with patients.
SERVICES AND OPERATIONS
Service Agreements
Pentegra has entered into a service agreement with each Affiliated Practice
under which Pentegra is the exclusive manager and administrator of non-dental
services relating to the operation of the Affiliated Practices. The following is
intended to be a brief summary of the typical form of service agreement Pentegra
entered into with each Affiliated Practice. Pentegra expects to enter into
similar agreements with Affiliated Practices in the future. The actual terms of
the various service agreements vary from the description below on a case-by-case
basis, depending on negotiations with the individual Affiliated Practices and
the requirements of applicable law and governmental regulations.
The service fees payable under the service agreements to Pentegra by the
professional corporations or associations formed by the dentist-owners of the
Affiliated Practices were determined in arm's-length negotiations among the
parties. Those Affiliated Practices that have revenues greater than the average
amount of revenues generated by the Affiliated Practices will typically require
more administrative and other services from Pentegra than those Affiliated
Practices with lower than average revenues. Such fees, together with
reimbursement for operating and non-operating expenses of each Affiliated
Practice paid by Pentegra pursuant to the service agreements, are payable
monthly and consist of various combinations of the following: (i) a percentage
(ranging from 30% to 40%) of the Affiliated Practice's revenues related to
dental services less operating expenses associated with the operation of the
Affiliated Practice; (ii) a percentage (16%) of the Affiliated Practice's dental
service revenues, not to exceed a percentage (35%) of the difference between
those revenues and operating expenses associated with the operation of the
Affiliated Practice; (iii) the greater of (a) a percentage (not to exceed 35%)
of the Affiliated Practice's revenues related to dental services less operating
expenses associated with the operation of
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the Affiliated Practice or (b) a specified fixed fee or (iv) a percentage (15%)
of the Affiliated Practice's net collected revenues. In addition, with respect
to four of the Affiliated Practices, the Service Fees are based on fixed fees
that are subject to renegotiations on an annual basis. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Pursuant to each service agreement, Pentegra, among other things, (i) acts
as the exclusive manager and administrator of non-dental services relating to
the operation of the Affiliated Practice, subject to certain matters reserved to
the Affiliated Practice, (ii) administers the billing of patients, insurance
companies and other third-party payors and collects on behalf of the Affiliated
Practice the fees for professional dental and other services and products
rendered or sold by the Affiliated Practice, (iii) provides, as necessary,
clerical and postage, accounting, payroll, legal, bookkeeping and computer
services and personnel, information management, printing, (iv) supervises and
maintains custody of substantially all files and records (other than patient
records if prohibited by applicable law), (v) provides facilities, equipment and
furnishings for the Affiliated Practice, (vi) orders and purchases inventory and
supplies as reasonably requested by the Affiliated Practice and (vii)
implements, in consultation with the Affiliated Practice, public relations or
advertising programs.
Pursuant to each service agreement, the respective Affiliated Practice
retains the decision-making power and responsibility for, among other things,
(i) hiring, compensating and supervising dentist-employees and other licensed
dental professionals, (ii) ensuring that dentists have the required licenses,
credentials, approvals and other certifications appropriate for the performance
of their duties and (iii) complying with federal and state laws, regulations and
ethical standards applicable to the practice of dentistry. In addition, the
Affiliated Practice will be exclusively in control of all aspects of the
practice of dentistry and the provision of dental services.
Each service agreement is for an initial term of 30 to 40 years, with
automatic extensions (unless specified notice is given) of five years. The
service agreement may be terminated by either party if the other party (i) files
a petition in bankruptcy or other similar events occur or (ii) defaults on the
performance of a material duty or obligation, which default continues for a
specified term after notice. In addition, the service agreement may be
terminated by Pentegra (i) if the Affiliated Practice or a dental employee
engages in conduct for which the dental employee's license to practice dentistry
is revoked or suspended or is the subject of any restrictions or limitations by
any governmental authority to such an extent that he, she or it cannot engage in
the practice of dentistry or (ii) upon a breach by the dentist of the employment
agreement between the Affiliated Practice and the dentist.
The service agreement requires the Affiliated Practice to enforce the
employment agreements between the Affiliated Practice and the dentists
associated with the Affiliated Practice (the "Dentist Employment Agreements").
If the Affiliated Practice does not enforce such employment agreement, Pentegra
may, at its option, require the Affiliated Practice to either assign (i) such
employment agreement or (ii) the rights to enforce the covenant not to compete
set forth therein to Pentegra or its designee. The Affiliated Practice is
responsible for obtaining professional liability insurance for the employees of
the Affiliated Practice and Pentegra has obtained general liability and property
insurance for the Affiliated Practice.
Upon termination of a service agreement, the Affiliated Practice has the
option to purchase and assume, and Pentegra has the option to require the
Affiliated Practice to purchase and assume, the assets and liabilities related
to the Affiliated Practice at the fair market value thereof, except in certain
circumstances where the Affiliated Practice or Pentegra, as applicable, was in
breach of the service agreement.
Dentist Agreement
Substantially all of the dentist-owners of the Affiliated Practices entered
into a dentist agreement, which provides Pentegra such dentist's guarantee (for
the initial five years and for so long thereafter as he or she owns any interest
in the Affiliated Practice) of the Affiliated Practice's obligations under the
applicable service agreement. In addition, such agreement provides that the
dentist may not sell his or her ownership interest during the dentist's
five-year employment term without Pentegra's prior written consent. In the event
of a default under the Service agreement by the Affiliated Practice, the dentist
agreement provides that Pentegra may, at its option, require the Affiliated
Practice to convey its patient records and the capital stock of the Affiliated
Practice to Pentegra's authorized
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designee, who, in any such case, Pentegra anticipates will be a dentist
affiliated with an Affiliated Practice.
Management Information Systems
The Company utilizes an integrated server-based information system to track
important operational and financial data related to each Affiliated Practice's
performance. The Company's management information system enables the Company to
collect from each Affiliated Practice, on a daily basis, data on patients seen,
number and type of procedures performed, billing and collections, and other data
needed for financial reporting and analysis. The Company compiles and analyzes
this data in order to promote efficiency and assure high quality care at
Affiliated Practices, as well as maintain necessary financial controls. The
Company's management information system also enables the Company to centralize
certain functions, such as elements of purchasing, accounts payable and payroll
processing, and achieve economies of scale. Financial reporting to the
Affiliated Practices is performed automatically, through a nationally known
financial software that interfaces with and delivers electronic reports via the
internet.
Expansion Strategy
The Company's growth strategy is to affiliate with new dental practices in
both new and existing markets. Based upon the Company's experience in
negotiating with dentists, management believes that dentists choose to affiliate
with the Company because the Company provides (i) the capital required to open a
dental practice, (ii) the business and clinical systems and staffing required to
operate a new dental practice, (iii) the opportunity to substantially increase
practice income derived by the dentists, and (iv) the opportunity to increase
the dentists' focus on patient care rather than administrative services.
Locations
As of May 31, 1999, Pentegra provided management services to Affiliated
Practices with offices in the following states:
NUMBER OF
STATE PRACTICES OFFICES DENTISTS
-------------- ---------- --------- --------
Alaska........ 1 1 1
Arizona....... 6 6 7
Arkansas...... 1 2 1
California.... 2 2 3
Colorado...... 5 6 6
Florida....... 4 4 5
Illinois...... 1 1 1
Kansas........ 1 1 2
Louisiana..... 4 4 5
Maine......... 1 1 1
Maryland...... 1 1 1
Massachusetts. 1 1 2
Michigan...... 1 1 1
Missouri...... 1 1 1
Nebraska...... 1 2 4
New Mexico.... 1 1 2
New York...... 5 5 5
North Dakota.. 2 2 2
Ohio.......... 2 3 3
Oklahoma...... 6 7 8
Oregon........ 1 1 1
South Carolina 1 1 1
Tennessee..... 4 7 7
Texas......... 28 33 45
Virginia...... 1 2 2
Washington.... 2 2 2
Wisconsin..... 1 1 1
-- -- ---
Totals........ 85 99 120
== == ===
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OTHER PRACTICE MANAGEMENT SERVICES
The Company provides other practice management services to the Affiliated
Practices, including staffing, general business and professional dental
education and training to affiliated dentists, dental hygienists and office
staff, employee benefits administration, advertising and other marketing support
and, where permitted by applicable law, dentist recruiting. This management and
administrative supports is designed to substantially reduce the amount of time
affiliated dentists are required to spend on administrative matters and enable
them to dedicate more time and effort toward the growth of their professional
practices. In addition, the Company seeks to negotiate, on behalf of Affiliated
Practices, discounts on, among other things, dental and office supplies, health
and malpractice insurance and equipment. The Company does not enter into any
agreements with third-party payors.
SUMMARY OF TERMS OF AFFILIATIONS
Pentegra acquires all the assets necessary to operate the business of each
of the Affiliated Practices, except as limited by applicable restrictions on the
corporate practice of dentistry. The assets acquired include furniture,
fixtures, computer equipment, dental chairs, lights, autoclaves, mixers, vacuum
and suction systems, cabinets, hand instruments and hand pieces of each
Affiliated Practice. Pentegra also acquires the intangible assets of each
Affiliated Practice employs the non-professional staff of each Affiliated
Practice and, on occasion, assumes certain indebtedness of an Affiliated
Practice. The Company owns no interest in the professional corporations or
associations. In the event of a breach of the service agreement by an Affiliated
Practice, the Company has the right to designate a dentist to purchase the
ownership interests of the applicable professional corporation or association
owned by the dentists that are a party to a service agreement with the Company.
The consideration paid by Pentegra for each Affiliated Practice is determined by
negotiations between executive officers of Pentegra using valuation methods
based on the Affiliated Practice's gross revenue net of certain operating
expenses, and the Company's assessment of growth potential. The closing of each
affiliation is subject to customary conditions. These conditions include, among
others, the accuracy, on the closing date of the representations and warranties
made by the Affiliated Practices and their stockholders and by the Company; the
performance of each of their respective covenants included in the agreements
relating to the affiliations; and the absence of any material adverse change in
the results of operations, financial condition or business of each Affiliated
Practice.
Dentist Employment Agreements
Each Affiliated Practice is a party to a dentist employment agreement with
each dentist owner of the professional entity that is party to a service
agreement with Pentegra. The dentist employment agreements are generally for an
initial term of five years and continue thereafter on a year-to-year basis until
terminated under the terms of the agreements. The dentist employment agreements
provide that the employee dentist will not compete with the Affiliated Practice
during the term of the agreement and following the termination of the agreement
for a term of two years in a specified geographical area (usually a 25 mile
radius) around the location of the relevant dental office. If employment of a
dentist is terminated during the initial five-year term without the consent of
Pentegra for any reason other than the dentist's death or disability or the
occurrence of certain events outside the dentist's control, an event of default
will occur under the related service agreement. In certain jurisdictions a
covenant not to compete may not be enforceable under certain circumstances.
Competition
Pentegra anticipates facing substantial competition from other companies to
establish affiliations with additional dental practices. Pentegra is aware of
several publicly traded dental practice management companies that have
operations in jurisdictions where one or more Affiliated Practices conduct
business and several companies pursuing similar strategies in other segments of
the health care industry. Certain of these competitors have greater financial
and other resources than Pentegra and have operations in areas where Pentegra
may seek to expand in the future. Additional companies with similar objectives
are expected to enter Pentegra's markets and compete with Pentegra. In addition,
the business of providing dental services is highly competitive in each market
in which Pentegra operates. Each of the Affiliated Practices faces local
competition from other dentists, some of whom have more established practices.
There can be no assurance that Pentegra or the Affiliated Practices will be able
to compete effectively with their respective competitors, that additional
competitors will not enter their markets or that additional competition
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will not have a material adverse effect on Pentegra or the Affiliated Practices.
Employees
As of March 31, 1999, Pentegra employed 34 persons at its corporate office
and 602 persons at the offices of its Affiliated Practices. None of Pentegra's
employees is represented by collective bargaining agreements.
Pentegra considers its employee relations to be good.
Litigation and Insurance
The Affiliated Practices provide dental services to the public and are
exposed to the risk of professional liability and other claims. In recent years,
dentists have become subject to an increasing number of lawsuits alleging
malpractice and related legal theories. Some of these lawsuits involve large
claims and significant defense costs. Any suits or claims involving Pentegra or
dentists at the Affiliated Practices, if successful, could result in substantial
damage awards to the claimants that may exceed the limits of any applicable
insurance coverage. Although Pentegra does not control the practice of dentistry
by the Affiliated Practices, it could be asserted that Pentegra should be held
liable for malpractice of a dentist employed by an Affiliated Practice. Each
Affiliated Practice has undertaken to comply with all applicable regulations and
legal requirements, and Pentegra maintains liability insurance for itself. There
can be no assurance, however, that a future claim or claims will not be
successful or, if successful, will not exceed the limits of available insurance
coverage or that such coverage will continue to be available at acceptable
costs.
Pentegra is currently not a party to any claims, suits or complaints.
Pentegra may become subject to certain pending claims (each of which is an
ordinary routine proceeding incidental to the business of the applicable
Affiliated Practice) as the result of successor liability in connection with the
transactions in which Pentegra acquires assets from an Affiliated Practice;
however, it is management's opinion that the ultimate resolution of those claims
will not have a material adverse effect on the financial position, operating
results or cash flows of Pentegra.
The Affiliated Practices have maintained professional liability insurance
coverage, generally on a claims-made basis. Such insurance provides coverage for
claims asserted when the policy is in effect regardless of when the events that
caused the claim occurred. Pentegra has acquired similar coverage in the event
Pentegra succeeds to the liabilities of the Affiliated Practices.
Government Regulation
The dental services industry is regulated extensively at both the state and
federal levels. Regulatory oversight includes, but is not limited to,
considerations of fee-splitting, corporate practice of dentistry, prohibitions
on fraud and abuse, restrictions on referrals and self-referrals, advertising
restrictions, restrictions on delegation and state insurance regulation.
Corporate Practice of Dentistry and Fee-splitting Restrictions
The laws of many states permit a dentist to conduct a dental practice only
as an individual, a member of a partnership or an employee of a professional
corporation, professional association, limited liability company or limited
liability partnership. These laws prohibit business corporations such as
Pentegra from engaging in the practice of dentistry or employing dentists to
practice dentistry. The specific restrictions against the corporate practice of
dentistry, as well as the interpretation of those restrictions by state
regulatory authorities, vary from state to state. The restrictions are generally
designed to prohibit a non-dental entity (such as Pentegra) from controlling the
professional assets of a dental practice (such as patient records and payor
contracts), employing dentists to practice dentistry (or, in certain states,
employing dental hygienists or dental assistants) or controlling the content of
a dentist's advertising or professional practice. The laws of many states also
prohibit dentists from sharing professional fees with non-dental entities. State
dental boards do not generally interpret these prohibitions as preventing a
non-dental entity from owning non-professional assets used by a dentist in a
dental practice or providing management services to a dentist for a fee,
provided certain conditions are met. Pentegra believes that its operations will
not contravene any restriction on the corporate practice of dentistry. There can
be no assurance, however, that a review
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of Pentegra's business relationships by courts or regulatory authorities will
not result in determinations that could prohibit or otherwise adversely affect
the operations of Pentegra or that the regulatory environment will not change,
requiring Pentegra to reorganize or restrict its existing or future operations.
The laws regarding fee-splitting and the corporate practice of dentistry and
their interpretation are enforced by regulatory authorities with broad
discretion. There can be no assurance that the legality of Pentegra's business
or its relationship with the Affiliated Practices will not be successfully
challenged or that the enforceability of the provisions of any Service agreement
will not be limited.
In many states in which the Affiliated Practices are located, there is no
case law or other authority interpreting the foregoing provisions. There are,
however, interpretations in some states of analogous medical provisions. One
recent example is in the State of Florida, where the Florida Board of Medicine
recently considered the issue of whether a physician practice is permitted to
enter into a management agreement pursuant to which the managing entity earns a
management fee which includes a percentage of the practice's net income as
consideration for providing certain management and operational services. The
Florida Board of Medicine issued an opinion indicating that such a management
agreement is prohibited by applicable fee-splitting statutes. However, that
order has been stayed pending its appeal to the Florida courts. Although the
Florida Board of Medicine's decision did not apply to dental practices, the
court considering the appeal of the Board of Medicine's order could reach
conclusions or make statements that affect the application of fee-splitting
provisions applicable to dental management agreements. Pursuant to the terms of
the Service agreements, in the event such a Service agreement were determined to
be in violation of applicable law, the agreement would have to be amended in a
manner that complies with applicable law and preserves, to the greatest extent
possible, the economic interests of the parties thereto.
Fraud and Abuse Laws and Restrictions on Referrals and Self-Referrals
Many states in which the Affiliated Practices are located have fraud and
abuse laws that, in many cases, apply to referrals for items or services
reimbursable by any insurer, not just by Medicare and Medicaid. A number of
states, including many of the states in which the Affiliated Practices are
located, also impose significant penalties for submitting false claims for
dental services. In addition, most states in which the Affiliated Practices are
located have laws prohibiting paying or receiving any remuneration, direct or
indirect, that is intended to induce referrals for health care items or
services, including dental items and services. Many states in which the
Affiliated Practices are located either prohibit or require disclosure of
self-referral arrangements and impose penalties for the violation of these laws.
Many states limit the ability of a person other than a licensed dentist to own
or control equipment or offices used in a dental practice. Some of these states
allow leasing of equipment and office space to a dental practice under a bona
fide lease, if the equipment and office remain under the control of the dentist.
The service agreements that will be entered into by Pentegra with respect to
Affiliated Practices in these states will provide that equipment and offices
owned or leased by Pentegra and used at an Affiliated Practice will remain under
the exclusive control of the dentists employed by that Affiliated Practice.
Federal laws regulating the provision of dental care apply only to dental
services which are reimbursed under certain federally funded programs. Because
none of the Affiliated Practices receive any revenue under these programs, the
impact of these laws on Pentegra is anticipated to be negligible.
There can be no assurance, however, that Affiliated Practices will not have
patients in the future covered by these laws, or that the scope of these laws
will not be expanded in the future, and if expanded, such laws or
interpretations thereunder could have a material adverse effect on Pentegra.
The federal fraud and abuse statute prohibits, subject to certain safe
harbors, the payment, offer, solicitation or receipt of any form of remuneration
in return for, or in order to induce: (i) the referral of a person for service,
(ii) the furnishing or arranging to furnish items or services or (iii) the
purchase, lease or order or the arrangement or recommendation of a purchase,
lease or order of any item or service which is, in each case, reimbursable under
Medicare or Medicaid. The statute reflects the federal government's policy of
increased scrutiny of joint ventures and other transactions among healthcare
providers in an effort to reduce potential fraud and abuse related to Medicare
and Medicaid costs. Because dental services are covered under various government
programs, including Medicare and Medicaid, this federal law applies to dentists
and the provision of dental services under those programs.
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Significant prohibitions against dentist self-referrals for services covered
by Medicare and Medicaid programs were enacted, subject to certain exceptions,
by Congress in the Omnibus Budget Reconciliation Act of 1993. These
prohibitions, commonly known as Stark II, amended prior physician and dentist
self-referral legislation known as Stark I (which applied only to clinical
laboratory referrals) by dramatically enlarging the list of services and
investment interests to which the self-referral prohibitions apply. Stark II
prohibits a physician or dentist, or a member of his or her immediate family,
from making referrals for certain "designated health services" to entities in
which the physician or dentist has an ownership or investment interest, or with
which the physician or dentist has a compensation arrangement. "Designated
health services" include, among other things, clinical laboratory services,
radiology and other diagnostic services, radiation therapy services, durable
medical equipment, prosthetics, outpatient prescription drugs, home health
services and inpatient and outpatient hospital services. Stark II prohibitions
include referrals within the physician's or dentist's own group practice (unless
such practice satisfies the "group practice" exception) and referrals in
connection with the physician's or dentist's employment arrangements with the
practice (unless the arrangement satisfies the employment exception). Stark II
also prohibits billing the Medicare or Medicaid programs for services rendered
following prohibited referrals. Noncompliance with, or violation of, Stark II
can result in exclusion from the Medicare and Medicaid programs and civil and
criminal penalties. Pentegra believes that its operations as presently conducted
do not pose a material risk under Stark II, primarily because Pentegra does not
provide "designated health services." Nevertheless, there can be no assurance
that Stark II will not be interpreted or hereafter amended in a manner that has
a material adverse effect on Pentegra's operations.
Other Federal Regulations
Federal regulations also allow state licensing boards to revoke or restrict
a dentist's license in the event such dentist defaults in the payment of a
government-guaranteed student loan, and further allow the Medicare program to
offset such overdue loan payments against Medicare income due to the defaulting
dentist's employer. Pentegra cannot assure compliance by dentists with the
payment terms of their student loans, if any.
The operations of the Affiliated Practices are also subject to compliance
with regulations promulgated by the Occupational Safety and Health
Administration ("OSHA"), relating to such matters as heat sterilization of
dental instruments and the use of barrier techniques such as masks, goggles and
gloves.
Licensure, Advertising Restrictions and Limitations on Delegation
The dentists associated with the Affiliated Practices must possess a license
from the applicable state Board of Dental Examiners and a permit from the U.S.
Drug Enforcement Agency. Additionally, to the extent required by applicable
state laws, dentists associated with the Affiliated Practices must also possess
a state controlled substance permit or certificate from their respective states.
Some states prohibit the advertising of dental services under a trade or
corporate name. Some states require all advertisements to be in the name of the
dentist. A number of states also regulate the content of advertisements of
dental services and the use of promotional gift items. In addition, many states
impose limits on the tasks that may be delegated by dentists to hygienists and
dental assistants. These laws and their interpretations vary from state to state
and are enforced by the courts and by regulatory authorities with broad
discretion.
Insurance Regulation
There are certain state insurance regulatory risks associated with
Pentegra's anticipated role in negotiating and administering managed care
contracts on behalf of the Affiliated Practices. The application of state
insurance laws to third-party payor arrangements, other than fee-for-service
arrangements, is an unsettled area of law with little guidance available. State
insurance laws are subject to broad interpretation by regulators and, in some
states, state insurance regulators may determine that Pentegra or the Affiliated
Practices are engaged in the business of insurance because of the capitation
features (or similar features under which an Affiliated Practice assumes
financial risk) that may be contained in managed care contracts. In the event
that Pentegra or an Affiliated Practice is determined to be engaged in the
business of insurance, Pentegra or the Affiliated Practice could be required to
either seek licensure as an insurance company or change the form of its
relationships with the third-party payors. There can be no assurance
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that Pentegra's operations would not be adversely affected if Pentegra or any of
the Affiliated Practices were to become subject to state insurance regulations.
Health Care Reform
The United States Congress has considered various types of health care
reform, including comprehensive revisions to the current health care system. It
is uncertain what legislative proposals, if any, will be adopted in the future
or what actions federal or state legislatures or third-party payors may take in
anticipation of or in response to any health care reform proposals or
legislation. There can be no assurance that applicable federal or state laws and
regulations will not change or be interpreted in the future either to restrict
or adversely affect Pentegra's relationships with dentists or the operation of
Affiliated Practices.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is subject to litigation incidental to its
business. The Company is not presently a party to any material litigation. Such
claims, if successful, could result in damage awards exceeding, perhaps
substantially, applicable insurance coverage.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the fourth
quarter of fiscal 1999.
Item S-K 401(b). Executive Officers of the Registrant
Pursuant to Instruction 3 to Item 401(6) of Regulation S-K and General
Instruction G(3) to Form 10K, the following information is included in Part I of
this Form 10K. The following table sets forth certain information concerning the
executive officers of Pentegra (ages are as of March 31, 1999):
NAME AGE POSITION
James M. Powers, Jr., D.D.S .............. 43 Chairman, President and
Chief Executive Officer
Omer K. Reed, D.D.S....................... 67 Clinical Officer and
Director
Sam H. Carr............................... 42 Senior Vice President,
Chief Financial Officer,
Secretary and Director
James L. Dunn, Jr......................... 37 Senior Vice President and
Chief Development Officer
John G. Thayer............................ 46 Senior Vice President and
Chief Operating Officer
JAMES M. POWERS, JR., D.D.S. has served as Pentegra's Chairman of the Board
and Chief Executive Officer since November 1998. Dr. Powers served as Chairman
of the Board and President of Liberty Dental Alliance, Inc. from September 1997,
until November 1998, when Pentegra agreed to acquire Liberty Dental Alliance,
Inc. Liberty Dental Alliance, Inc. was a Nashville, Tennessee based dental
practice management company in its formative stages which had letters of intent
to purchase the assets of 75 independent dental practices. Dr. Powers also has
served as the Chairman of the Board of Directors of Clearridge, Inc., a
Nashville based bottled water company since May 1993. He served as President of
Clearridge, Inc., from May 1993 to January 1997. Dr. Powers was a co-founder and
member of the Board of Directors of Barnhill's Country Buffet, Inc., a Memphis,
Tennessee based 23 unit restaurant chain. Since his graduation from the
University of Tennessee College of Dentistry in 1979 until November 1998, Dr.
Powers practiced dentistry in a private practice in Waverly, Tennessee. He also
received a MBA from Vanderbilt University.
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OMER K. REED, D.D.S. has served as Clinical Officer since May 1997 and
served as Pentegra's Chairman of the Board from May 1997 to November 1998. He
founded Pentegra, Ltd. in 1988 and Napili International in 1963, and is a
practicing dentist with one of the Pentegra's affiliated practices. Since
inception, Pentegra, Ltd. and Napili have provided comprehensive management and
consulting services to dental practices around the nation. In 1965, Dr. Reed
founded the CeramDent Laboratory and he has maintained a private dental practice
in Phoenix since 1959. He has held associate professorships in the Departments
of Ecological Dentistry at the University of North Carolina, Chapel Hill
(1978-1988) and the University of Minnesota (1982-1991), and has lectured
extensively around the world on various subjects related to the practice of
dentistry. Dr. Reed also serves on the Board of Directors of Century Companies
of America, CUNA Mutual Insurance Group and the American Volunteer Medical Team.
SAM H. CARR has served as Pentegra's Senior Vice President and Chief
Financial Officer since September 1997. From September 1996 until August of
1997, Mr. Carr served as Vice President -- Finance and Corporate Development of
Ankle & Foot Centers of America, LLP, a podiatry practice management company.
From February 1995 until July 1996, Mr. Carr was a Senior Manager with Arthur
Andersen LLP. Prior thereto, Mr. Carr was Chief Financial Officer of
Columbia/HCA's Bellaire Hospital in Houston, Texas from January 1994 until
January 1995, and Vice President of Finance of St. Vincent Hospital in Santa Fe,
New Mexico from 1990 until 1994. From 1978 to 1990, Mr. Carr was an accountant
with Arthur Andersen L.L.P. Mr. Carr is a certified public accountant. Mr. Carr
received his BBA in accounting from the University of Texas in 1977 and received
an Executive MBA from the University of New Mexico in 1994.
JAMES L. DUNN, JR. has served as Pentegra's Senior Vice President and Chief
Development Officer since July 1997 and served as a Director from March 1997 to
March 1998. From 1987 through March 1998, Mr. Dunn was an attorney practicing as
a sole practitioner in Houston, Texas. His legal practice focused on providing
services to members of the dental community. He has been actively involved in
the valuation and sale of dental practices over the past five years. In 1995,
Mr. Dunn was appointed to the Texas Medical Disclosure Panel, the body that
determines which dental procedures require informed consent. Mr. Dunn is a
member of the American Society of Pension Actuaries and is a certified public
accountant.
JOHN G. THAYER has served as Pentegra's Senior Vice President and Chief
Operating Officer since March 1997. Prior thereto, Mr. Thayer was Managing
General Partner of England and Company, a public accounting firm he co-founded
in 1983, which provides accounting and practice management counseling to health
care professionals in the Texas Gulf Coast area. In 1994, he co-founded Medtek
Management, Inc., a privately held management information company specializing
in the data processing needs of health care professionals.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
MARKET INFORMATION, HOLDERS AND DIVIDEND
The Company's Common Stock has been traded on the American Stock Exchange
system under the symbol "PEN" since March 30, 1998. The following table sets
forth the range of the reported high and low sales prices of the Company's
Common Stock for the year ended March 31, 1999:
1999 High Low
1st Quarter (beginning April 1, 1998) $9.00 $6.25
2nd Quarter ......................... $8.69 $3.87
3rd Quarter ......................... $3.81 $1.75
4th Quarter ......................... $2.81 $1.38
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As of June 15, 1999, there were approximately 163 holders of record of
Common Stock, as shown on the records of the transfer agent and registrar of
Common Stock. The number of record holders does not bear any relationship to the
number of beneficial owners of the Common Stock. The last reported sale price of
the Common Stock on the American Stock Exchange as of June 15, 1999 was $2.0625
per share.
The Company has not paid any cash dividends on its Common Stock in the past
and does not plan to pay any cash dividend on its Common Stock in the
foreseeable future. In addition, the terms of the Company's revolving credit
facility prohibit it from paying dividends or making other payments with respect
to its Common Stock without the lenders' consent. The Company's Board of
Directors intends, for the foreseeable future, to retain earnings to finance the
continued operation and expansion of the Company's business.
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ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth-selected financial data of the Company. The
selected financial data in the table are derived from the Company's consolidated
financial statements. The data should be read in conjunction with the
consolidated financial statements and notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this Report.
STATEMENT OF OPERATIONS DATA
For the period
from inception,
February 21, 1997
Year ended Three months ended through
March 31, March 31, December 31,
1999 1998 1997
---------- ------------------ -----------------
Net Revenue $ 38,824 $ -- $ --
Operating Expenses 36,940 1,800 1,354
-------- -------- -------
Earnings from operations 1,884 (1,800) (1,354)
-------- -------- -------
Income (loss) before income taxes 1,717 (1,960) (1,354)
Income tax benefit (525) -- --
-------- -------- -------
Net income (loss) 2,242 (1,960) (1,354)
Preferred stock dividend -- (1,070) --
======== ======== =======
Income (loss) attributable to common stock 2,242 (3,030) (1,354)
======== ======== =======
Basic and diluted earnings per share: $ 0.29
=======
BALANCE SHEET DATA
Cash and cash equivalents $ 1,047 $ 6,708 --
Working capital 4,224 3,640 --
Total assets 37,127 10,633 --
Long-term debt, less current maturities 13,134 368 --
Total shareholders' equity 20,760 6,996 --
OPERATING DATA
Number of dental practices 85 51 --
Number of dentists 120 77 --
Total net revenue per dental office $ 457 $ --
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. THESE STATEMENTS ARE BASED ON CURRENT PLANS AND EXPECTATIONS OF PENTEGRA
AND INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL FUTURE ACTIVITIES
AND RESULTS OF OPERATIONS TO BE MATERIALLY DIFFERENT FROM THAT SET FORTH IN THE
FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO
DIFFER INCLUDE, AMONG OTHERS, RISKS ASSOCIATED WITH AFFILIATIONS, FLUCTUATIONS
IN OPERATING RESULTS BECAUSE OF AFFILIATIONS AND VARIATIONS IN STOCK PRICE,
CHANGES IN GOVERNMENT REGULATIONS, COMPETITION, RISKS OF OPERATIONS AND GROWTH
OF EXISTING AND NEW AFFILIATED DENTAL PRACTICES, AND RISKS DETAILED IN
PENTEGRA'S SEC FILINGS.
Overview
Pentegra provides practice management services to fee-for-service dental
practices in the United States. On March 30, 1998, Pentegra acquired
simultaneously with the closing of its initial public offering ("IPO"),
substantially all of the tangible and intangible assets, and assumed the
liabilities, of 50 Affiliated Practices. Pentegra also began to provide practice
management services to professional corporations or associations owned by the
dentist-owners of those Affiliated Practices (one of which split into two
separate dental practices immediately after the IPO) pursuant to long-term
management service agreements entered into at the time of the IPO. Throughout
fiscal 1999, Pentegra added 34 Affiliate Practices.
The expenses incurred by Pentegra in fulfilling its obligations under the
management service agreements are generally of the same nature as the operating
costs and expenses that are otherwise incurred by the affiliated practices,
including salaries, wages and benefits of practice personnel (excluding dentists
and certain other licensed dental care professionals), dental supplies and
office supplies used in administering their practices and the office (general
and administrative) expenses of their practices. In addition to the operating
costs and expenses discussed above, Pentegra incurs personnel and administrative
expenses in connection with maintaining a corporate office, which provides
management, practice enhancements, administrative and business development
services.
Results of Operations
Following completion of the IPO, Pentegra began operations effective April
1, 1998. In May 1998, Pentegra changed its fiscal year end from December 31 to
March 31, effective for the year beginning April 1, 1998. Management service fee
recognition and related expenses began April 1, 1998, and Pentegra began
managing 50 dental practices in 18 states. At March 31, 1999, Pentegra managed
85 practices in 99 offices in 27 states.
Components of Revenues and Expenses
Under the terms of the typical management services agreement with an
Affiliated Practice, Pentegra serves as the exclusive manager and administrator
of all non-dental services relating to the operation of an Affiliated Practice.
The obligations of Pentegra include assuming responsibility for the operating
expenses incurred in connection with managing the dental centers. These expenses
include salaries, wages and related costs of non-dental personnel, dental
supplies and laboratory fees, rental and lease expenses, promotion and marketing
costs, management information systems and other operating expenses incurred at
the Affiliated Practices. In addition, Pentegra incurs general and
administrative expenses related to the financial and administrative management
of dental operations, insurance, training and development and other typical
corporate expenditures. As compensation for its services under the typical
services agreement and subject to applicable law, Pentegra is paid a management
fee comprised of two components: (1) a management fee that is fixed in amount,
an amount usually approximating 35% of the Affiliated Practice's operating
profit, before dentist compensation, or 15% of the Affiliated Practice's
collected gross revenue ("Service Fee") and, (2) the costs incurred by Pentegra
on behalf of the Affiliated Practice. Therefore, net revenues represent amounts
earned by Pentegra under the terms of its management services agreements with
the Affiliated
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Practices, which generally equate to the sum of the Service Fees and the
operating expenses that the affiliated practices paid to Pentegra under the
service agreements.
Net Revenue
For the year ended March 31, 1999, net revenue generated was $38.8 million
and dental center patient revenues aggregated to approximately $51.6 million.
During this period, Pentegra affiliated with 34 additional dental practices.
Operating Expenses
Pentegra incurred operating expenses of approximately $36.9 million for the
year ended March 31, 1999. Operating expenses consisted primarily of salaries,
wages and benefits, dental supplies and laboratory fees, rent, advertising and
marketing, and general and administrative expenses.
General and administrative represent the corporate expenses of Pentegra.
These corporate expenses include salaries, wages and benefits, rent, consulting
fees, travel (primarily related to practice development and practice
enhancement), office costs and other general corporate expenses. For the year
ended March 31, 1999, general and administrative expenses were approximately
$4.5 million, which represented 11.6% of net revenue. Included in general and
administrative expenses for that year is a one time severance payment of
$350,000 to the former Chief Executive Officer of Pentegra.
Income Tax Expense
Pentegra recognized a tax benefit of $525,000 during the year ended March
31, 1999. The benefit was recognized because management concluded it was more
likely than not it would realize certain tax assets in future years.
Liquidity and Capital Resources
At March 31, 1999, Pentegra had a working capital balance of approximately
$4.2 million. Current assets included approximately $1.0 million in cash and
$5.7 million in accounts receivable, due entirely from Affiliated Practices.
Current liabilities consisted of approximately $1.8 million in accounts payable
and accrued liabilities, mostly related to expenses of the Affiliated Practices
and $537,000 million in short term notes payable used in the acquisition of
certain Affiliated Practices. Pentegra believes that cash on hand, together with
the availability under the revolving line of credit will be sufficient to
continue execution of its affiliation strategy through 2000.
On June 1, 1998, Pentegra closed a revolving bank credit facility with Bank
One, Texas, N.A., which provides Pentegra with a revolving line of credit of up
to $15.0 million, to be used for general corporate purposes including financing
of acquisitions, capital expenditures and working capital. The credit facility
is collateralized by liens on certain of Pentegra's assets, including its rights
under the management service agreements and accounts receivable. The credit
facility contains restrictions on the incurrence of additional indebtedness and
payment of dividends on Pentegra's common stock. Additionally, compliance with
certain financial covenants is required and the lender has approval rights with
respect with acquisitions exceeding certain limits. At March 31, 1999, $8.0
million was outstanding under the revolving line of credit.
Cash used in investing activities for the year ended March 31, 1999 included
$1.4 million for purchases of capital equipment, mostly for assets acquired in
new practice affiliations, and $10.3 million for the purchase of intangibles
associated with those new practice affiliations.
Cash generated from financing activities for the year ended March 31, 1999,
included draws on the revolving line of credit of approximately $8.0 million and
the issuance of 375,000 shares of stock in connection with the exercise of the
underwriters' over-allotment option after the IPO, which provided net proceeds
to Pentegra of approximately $2.9 million. Uses of cash include the issuance of
notes receivable to Affiliated Practices at $1.3 million.
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On April 17, 1998, the Company filed a registration statement on Form S-4
for 1,500,000 shares of Common Stock, which the Company may issue from time to
time in connection with the direct and indirect acquisitions of other
businesses, properties or securities in business combination transactions. On
September 29, 1998, the Company filed a registration statement on Form S-4 for
1,500,000 shares of Common Stock, and $50,000,000 in Convertible Subordinated
Debt Securities, which the Company may issue from time to time in connection
with the direct and indirect acquisitions of other businesses, properties or
securities in business combination transactions. The terms upon which it issues
the shares and convertible subordinated debt securities are determined through
negotiations of the businesses whose securities or assets are to be acquired.
The shares of Common Stock that are issued are valued at market prices. Persons
receiving Common Stock in connection with such acquisitions may be contractually
required to hold all or some portion of the Common Stock for varying periods of
time. The convertible subordinated debt securities will be convertible in whole
or in part into shares of Common Stock, at any time on or after their
convertibility commencement date, and at or before maturity, unless previously
redeemed at their conversion price. The convertible subordinated debt securities
will be (i) unsecured and (ii) subordinate to all present and future senior
indebtedness of Pentegra and (iii) effectively subordinated to all indebtedness
and other liabilities of subsidiaries of Pentegra. The convertible subordinated
debt securities issued will be valued at prices reasonably related to their
principal amount.
As of March 31, 1999, 2,286,000 shares and $4,566,000 aggregate principal
amount or convertible subordinated notes registered under these filings had been
issued.
Year 2000 Issue
A number of computer programs and other equipment with embedded chips or
processors ("Systems") use two digits rather than four digits to define the
applicable year. Any Systems that are date sensitive may recognize a date of
"00" as the year 1900 rather than the year 2000. This could result in
miscalculations or System failures causing disruptions of operations, as well as
potentially exposing Pentegra to third party liability. This issue is commonly
referred to as the year 2000 problem ("Y2K").
Pentegra has initiated a Y2K compliance program to ensure that all of the
critical Systems and processes that are under its direct control remain
functional. Pentegra completed the installation of year 2000 compliant software
for its operations prior to the IPO. Accordingly Pentegra does not expect the
year 2000 issue to have a material adverse effect on its financial position,
results of operations or cash flows.
Although Pentegra's Y2K compliance program will attempt to determine the Y2K
readiness of key third parties, there may be certain Systems or processes relied
on by Pentegra that are outside of its control, and there can be no assurance
that these Systems or processes will remain functional. Non-compliance by key
third parties could have a material adverse effect on the operations of
Pentegra. To date, the costs incurred by Pentegra that relate solely to the Y2K
compliance program have been minimal. In the opinion of management, the costs to
complete Pentegra's Y2K compliance program will not have a material adverse
effect on Pentegra's consolidated financial position, results of operations or
cash flows.
Pentegra has received assurance that the systems implemented prior to the
IPO are Y2K compliant. In addition, Pentegra has inventoried all hardware and
software at the Affiliated Practices that process information related to
practice management. Pentegra has estimated it will incur approximately $250,000
in computer upgrades for Y2K compliance. These upgrades are estimated to be
completed by September 1999.
The failure to correct a material year 2000 problem could possibly result in
an interruption in or failure of, certain normal business activities operations.
Such failure would materially and adversely affect Pentegra's financial
position, results of operations and cash flows. Due to the general uncertainty
inherent in the year 2000 problem, including uncertainty regarding the year 2000
readiness of third party suppliers and potential future acquisitions, Pentegra
is unable to determine at this time whether the consequences of any possible
year 2000 failures will have a material adverse impact on Pentegra's financial
position, results or operations and cash flows. Pentegra believes that, with the
scheduled completion of its computer system upgrades, the possibility of any
material interruption to normal operations should be significantly reduced.
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Pentegra's plans to comply with year 2000 requirements and completion dates
are based on management's best estimates, which were derived utilizing numerous
assumptions of future events including the continued availability of certain
resources and other factors. There can be no assurances, however, that the
estimates will be achieved and actual results could differ from those estimates.
Specific factors that might cause such material difference include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to identify and correct potential problems and similar uncertainties.
Contingency Plans
If during the course of the Company's assessments of its critical Systems
if it is determined that the risk of Y2K disruptions is significant, contingency
plans will be developed as appropriate. Such plans might include the use of
alternative service providers or product suppliers should they incur significant
Y2K issues. Currently, the Company does not have any contingency plans in place
based on current Y2K readiness assessments.
Acquisition of Liberty Dental Alliance
On November 13, 1998 Pentegra and Liberty Dental Alliance, Inc. ("Liberty")
entered into an Agreement and Plan of Merger (the "Liberty Merger Agreement"),
pursuant to which Liberty will become a wholly owned subsidiary of Pentegra, and
James M. Powers, Jr., D.D.S. was named President of Pentegra, replacing Gary S.
Glatter. The Liberty Merger Agreement provides Pentegra will pay (a) $0.01 per
share for each outstanding share of Liberty common stock, par value $0.01 per
share at closing and (b) up to $3.99 per share and options to purchase up to
0.25 shares of common stock of Pentegra with an exercise price of $6.125 per
share for each share of Liberty common stock (collectively, the "Additional
Common Merger Consideration") in accordance with the following:
(i) One-third of the Additional Common Merger Consideration is payable upon
completion of affiliations with dental practices under a letter of
intent with Liberty ("Liberty Affiliations") that had collected
revenues for the year ended December 31, 1997 ("1997 Practice
Revenues") aggregating to at least $10,000,000;
(ii) One-third of the Additional Common Merger Consideration is payable upon
completion of additional Liberty Affiliations that had aggregate 1997
Practice Revenues of at least $15,000,000; and
(iii)One-third of the Additional Common Merger Consideration is payable upon
completion of additional Liberty Affiliations that had aggregate 1997
Practice Revenues of at least $15,000,000.
The holders of shares of Liberty common stock will forfeit any right to receive
Additional Common Merger Consideration related to Liberty Affiliations not
consummated by July 31, 1999. As of March 31, 1999, there were 315,750 shares of
Liberty common stock outstanding, which would result in Pentegra paying an
aggregate of up to $1,263,000 cash and issuing options to acquire up to 78,938
shares of Pentegra common stock.
The Liberty Merger Agreement also provides that Pentegra pay (a) $0.01 per
share for each outstanding share of Liberty Class B common stock, par value
$0.01 per share at closing and (b) up to one share of common stock for each
outstanding share of Liberty class B common stock (the "Additional Class B
Merger Consideration") in accordance with the following:
(i) One-fifth of the Additional Class B Merger Consideration is payable
upon completion of Liberty Affiliations that had aggregate 1997
Practice Revenues of at least $10,000,000;
(ii) Three-tenths of the Additional Class B Merger Consideration is payable
upon completion of additional Liberty Affiliations that had aggregate
1997 Practice Revenues of at least $10,000,000;
(iii)Two-fifths of the Additional Class B Merger Consideration is payable
upon completion of additional Liberty Affiliations that had aggregate
1997 Practice Revenues of at least $20,000,000; and
(iv) One-tenth of the Additional Class B Merger Consideration is payable
upon completion of additional Liberty Affiliations that had aggregate
1997 Practice Revenues of at least $10,000,000.
19
20
The holders of shares of Liberty class B common stock will forfeit any
right to receive Additional Class B Merger Consideration related to Liberty
Affiliations not consummated by July 31, 1999. As of March 31, 1999, there were
545,000 shares of Liberty class B common stock outstanding, which would result
in Pentegra paying an aggregate of up to $5,450 cash and up to 545,000 shares of
Pentegra common stock. Consummation of the Liberty Merger Agreement, which is
anticipated to occur prior to July 31, 1999, is subject to, among other things,
Pentegra obtaining the consent of its lenders.
In connection with the Liberty Merger Agreement, Pentegra has agreed to pay
investment banking fees of up to $600,000 to SunTrust Equitable Securities
Corporation, $166,667 of which is payable upon completion of Liberty
Affiliations that had aggregate 1997 Practice Revenues of at least $10,000,000,
$166,667 of which is payable upon completion of additional Liberty Affiliations
that had aggregate 1997 Practice Revenues of at least $15,000,000 and $266,666
of which is payable upon completion of additional Liberty Affiliations that had
aggregate 1997 Practice Revenues of at least $15,000,000. Pentegra also agreed
to issue an aggregate of 145,000 options to acquire Pentegra common stock to
certain consultants of Pentegra with an exercise price of $6.125 per share, in
the same proportions and upon completion of Liberty Affiliations as the
Additional Common Merger Consideration is payable.
As of March 31, 1999, Pentegra had completed Liberty Affiliations with 17
dental practices. These dental practices generated aggregate annual patient
revenue of approximately $13 million during their most recently completed fiscal
year, and include dentists treating patients in 17 dental offices. The aggregate
consideration paid by Pentegra for these practices consisted of approximately
$5.6 million in cash, 1,295,268 shares of Pentegra common stock and
approximately $3.6 million aggregate principal amount of 6% Series A convertible
subordinated notes, one-half payable November 2002 and one-half payable November
2003, and $160,000 aggregate principal amount of 6% of Series B convertible
subordinated notes one-half payable April 2003 and one-half payable April 2004.
The consideration to be paid based on the Liberty affiliations as of March 31,
1999 consisted of approximately $585,000 in cash, 109,000 shares of Pentegra
common stock, and 74,000 options to purchase Pentegra common stock.
Dr. Powers entered into an employment agreement with Pentegra, effective
November 13, 1998, pursuant to which he became Pentegra's Chairman, President
and Chief Executive Officer. Dr. Powers's two year employment agreement also
provides for a base annual salary of $200,000, bonus payments of up to 25% of
the base salary upon achievement of certain earnings per share targets and the
issuance of options to acquire 150,000 shares of Pentegra common stock with an
exercise price of $6.125 per share and an additional 150,000 shares with an
exercise price of $2.625 per share (the closing sale price on November 13,
1998).
Acquisition of Omega Orthodontics
During March 1999, the Company executed a definitive merger agreement with
Omega Orthodontics, Inc. ("Omega"). Pursuant to the merger agreement, each of
the approximately 5.1 million shares of Omega will be exchanged for 0.356 shares
of the Company (approximately 1.8 million shares). Approximately $1.4 million of
Omega debt will be assumed by Pentegra. The merger is subject to the
satisfaction of several closing conditions, and is expected to close by August
1999. The merger will be accounted for under the purchase method of accounting.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates on
borrowed funds, which could affect its results of operations and financial
condition. At March 31, 1999, the Company has $8.0 million in variable rate debt
outstanding and, as such, the risk is immaterial based upon a 10% increase or
decrease in interest rates from their March 31, 1999 levels.
20
21
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors and Shareholders of
Pentegra Dental Group, Inc. and Subsidiary
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, changes in shareholders' equity and cash
flows present fairly, in all material respects, the financial position of
Pentegra Dental Group, Inc. and Subsidiary at March 31, 1999 and 1998, and the
results of their operations and their cash flows for the year ended March 31,
1999, the three months ended March 31, 1998, and the period from inception,
February 21, 1997 through December 31, 1997, in conformity with generally
accepted accounting principles. These financials statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Phoenix, Arizona
May 20, 1999
21
22
PENTEGRA DENTAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, March 31,
1999 1998
-------- --------
Assets
Current assets:
Cash and cash equivalents $ 1,047 $ 6,708
Receivables from affiliated practices, net of
allowance for doubtful accounts of $125 for 1999 5,659 --
Prepaid and other current assets 465 101
Notes receivable from affiliated practices - current 286 --
-------- --------
Total current assets 7,457 6,809
Property and equipment, net 6,171 3,577
Intangible assets, net 21,848 247
Notes receivable from affiliated practices 971 --
Deferred tax asset 680 --
-------- --------
Total assets $ 37,127 $ 10,633
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $ 1,756 $ 1,819
Accrued employment agreement 940 1,250
Current portion of long term debt 537 100
-------- --------
Total current liabilities 3,233 3,169
Line of credit 8,000
Convertible subordinated notes 4,566
Shareholders' notes 568 468
Commitments and contingencies
Shareholders' equity
Common stock, $.001 par value 40,000,000 shares authorized, 9,102,503 and
6,441,898 issued and outstanding in 1999 and 1998, respectively 9 6
Additional paid-in capital 21,823 10,304
Accumulated deficit (1,072) (3,314)
-------- --------
Total shareholders' equity 20,760 6,996
-------- --------
Total liabilities and shareholders' equity $ 37,127 $ 10,633
======== ========
The accompanying notes are an integral part of the financial statements
22
23
PENTEGRA DENTAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
FOR THE PERIOD
FROM INCEPTION,
FEBRUARY 21, 1997
YEAR ENDED THREE MONTHS THROUGH DECEMBER
MARCH 31, ENDED MARCH 31, 31,
1999 1998 1997
---------- --------------- -----------------
Net revenue $ 38,824 $ -- $ --
Operating expenses:
Clinical salaries, wages and benefits 14,735 -- --
Dental supplies and lab fees 7,133 -- --
Rent 2,963 -- --
Advertising and marketing 785 -- --
General and administrative 4,497 550 709
Other operating expenses 5,627 -- --
Depreciation and amortization 1,200 -- --
Employment agreement 1,250 --
Compensation expense in connection
with issuance of stock -- -- 645
-------- ------- -------
Total operating expenses 36,940 1,800 1,354
-------- ------- -------
Earnings from operations 1,884 (1,800) (1,354)
Interest expense 399 -- --
Interest income (188) (160) --
Other income (44) -- --
-------- ------- -------
Income (loss) before income taxes 1,717 (1,960) (1,354)
Income tax benefit (525) -- --
-------- ------- -------
Net income (loss) 2,242 (1,960) (1,354)
Preferred stock dividend -- (1,070)
-------- ------- -------
Income (loss) attributable to common stock $ 2,242 $(3,030) $(1,354)
======== ======= =======
Basic and diluted earnings per share $ 0.29
=======
Weighted average number of shares
outstanding - basic and diluted 7,803
=======
The accompanying notes are an integral part of the financial statements
23
24
PENTEGRA DENTAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
Additional Total
Common Stock Paid In Accumulated Shareholders'
Shares Amount Capital Deficit Equity
------------------- ---------- ----------- -------------
Balances at February 21, 1997
Issuances of common stock 1,844 $ 19 $ 1,194 -- $ 1,213
Purchases of common stock (87) (1) (1)
Net loss from inception through December 31, 1997 -- -- (1,354) (1,354)
------ ---- -------- ------- --------
Balances, December 31, 1997 1,757 18 1,194 (1,354) (142)
Issuance of common stock 2,500 3 16,357 -- 16,360
Transfers of certain assets
and liabilities to founders 3,094 3 (6,180) -- (6,177)
Dividend to shareholders of founding
affiliated practices -- -- (1,070) -- (1,070)
Repurchase of common stock
Share exchange (909) (18) 3 -- (15)
Net loss -- -- (1,960) (1,960)
------ ---- -------- ------- --------
Balances, March 31, 1998 6,442 6 10,304 (3,314) 6,996
Issuance of common stock 375 1 2,870 -- 2,871
Issuance of common stock to affiliated practices 2,286 2 8,494 -- 8,496
Tax benefit related to assets acquired in affiliations -- -- 155 -- 155
Net income -- -- -- 2,242 2,242
------ ---- -------- ------- --------
Balances, March 31, 1999 9,103 $ 9 $ 21,823 $(1,072) $ 20,760
====== ==== ======== ======= ========
The accompanying notes are an integral part of the financial statements
24
25
PENTEGRA DENTAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the period
from
inception,
For the year Three months February 21,
ended ended 1997 through
March 31, 1999 March 31, 1998 December 31, 1997
---------------- ---------------- -----------------
Cash flows from operating activities
Net income (loss) $ 2,242 $ (1,960) $(1,354)
Adjustments to net income (loss) -- -- --
Provision for bad debts 125 -- --
Depreciation and amortization 1,200 -- --
Amortization of loan discount -- 135 45
Deferred income taxes (benefit) (525) -- --
Compensation associated with issuance of common stock -- -- 645
Changes in operating assets and liabilities -- -- --
Receivables from affiliated practices (5,784) -- --
Prepaid expenses and other current assets (364) (49) --
Accounts payable and accrued liabilities (63) 1,476 57
Accrued employment agreement (310) -- --
-------- -------- -------
Net cash used in operating activities (3,479) (398) (607)
-------- -------- -------
Cash flows from investing activities
Capital expenditures (1,424) (310) (166)
Acquisitions of affiliated dental practices net of cash acquired (10,326) (100) --
Dividend to founding affiliated practices -- (6,492) --
Issuance of notes receivable (1,257) -- --
Organizational costs -- (59) (5)
Net cash used in investing activities (13,007) (6,961) (171)
-------- -------- -------
Cash flows from financing activities
Proceeds from issuance of common and redeemable preferred stock 2,930 19,762 1,476
Proceeds from issuance of notes payable -- 486 350
Proceeds from line of credit 8,000 -- --
Redemption of common stock -- (1,691) --
Repurchase of common stock -- (14) --
Repayment of long-term debt -- (3,129) --
Offering and financing costs (105) (1,447) (948)
-------- -------- -------
Net cash provided by financing activities 10,825 13,967 878
-------- -------- -------
Net change in cash and cash equivalents (5,661) 6,608 100
Cash and cash equivalents, beginning of period 6,708 100 --
-------- -------- -------
Cash and cash equivalents, end of period $ 1,047 $ 6,708 $ 100
======== ======== =======
The accompanying notes are an integral part of the financial statements
25
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Organization and Basis of Presentation
Pentegra Dental Group, Inc. (the "Company") together with its wholly owned
subsidiary, Pentegra Investments, Inc. ("PII"), provides practice management
services to dental practices throughout the United States. In July 1997,
Pentegra Dental Group, Inc., changed its name to Pentegra Investments, Inc. and
formed a new wholly owned subsidiary named Pentegra Dental Group, Inc.
("Pentegra Dental" or "the Company"). On March 30, 1998, simultaneously with the
Company's initial public offering, PII repurchased (the "Share Repurchase") from
the stockholders of PII, on a pro rata basis, at a purchase price of $0.015 per
share, that number of shares as was necessary so that the aggregate number of
shares of Pentegra Dental common stock, par value $.001 per share (the "Common
Stock"), issued in connection with the Affiliations (as defined below) and the
Share Exchange (as defined below) would not exceed 3,941,898 shares. Pursuant to
that agreement, PII repurchased 909,237 shares for $14,000 and exchanged on a
share-for-share basis, shares of PII common stock, par value $0.015 per share,
for 1,756,667 shares of Common Stock (the "Share Exchange"). On March 30, 1998,
Pentegra Dental acquired (the "Affiliations") simultaneously with the closing of
its initial public offering (the "Offering" or "IPO"), substantially all of the
tangible and intangible assets, and assumed the liabilities, of 50 dental
practices (collectively, the "Founding Affiliated Practices") in exchange for
3.1 million shares of Common Stock, $6.5 million in cash and net assets assumed
of approximately $300,000. The net proceeds of the 2.5 million shares of Common
Stock issued in the IPO (after deducting the underwriting discounts and
commissions) were $19.8 million. Total related offering costs were $3.4 million.
The acquisitions of the Founding Affiliated Practices have been accounted
for in accordance with the Securities and Exchange Commission's Staff Accounting
Bulletin ("SAB") No. 48, "Transfers of Non-monetary Assets by Promoters or
Shareholders". In accordance with SAB No. 48, the acquisition of the assets and
assumption of certain liabilities for all of the Founding Affiliated Practices
pursuant to the Affiliations has been accounted for by the Company at the
transferors' historical cost basis, with the shares of Common Stock issued in
those transactions being valued at the historical cost of the non-monetary
assets acquired net of liabilities assumed. The cash consideration of
approximately $6.5 million, paid at closing on March 30, 1998, less net assets
acquired of approximately $300,000, is reflected as a dividend by the Company to
the owners of the Founding Affiliated Practices in the quarter ended March 31,
1998. SAB No. 48 is not applicable to any acquisitions made by the Company
subsequent to the IPO. Acquisitions of certain of the assets and liabilities of
practices that affiliate with the Company after the IPO have been accounted for
as purchases, and resulted in substantial annual non-cash amortization charges
for intangible assets in the Company's statements of operations.
In April 1998, the over allotment option to sell 375,000 shares of Common
Stock was exercised at a price of $8.50 per share, yielding additional net
proceeds to the Company of approximately $2.9 million.
On April 17, 1998, the Company filed a registration statement on Form S-4
for 1,500,000 shares of Common Stock, which the Company may issue from time to
time in connection with the direct and indirect acquisitions of other
businesses, properties or securities in business combination transactions. On
September 29, 1998, the Company filed a registration statement on Form S-4 for
1,500,000 shares of Common Stock, and $50,000,000 in Convertible Subordinated
Debt Securities, which the Company may issue from time to time in connection
with the direct and indirect acquisitions of other businesses, properties or
securities in business combination transactions. The terms upon which it issues
the shares and convertible subordinated debt securities are determined through
negotiations with the businesses whose securities or assets are to be acquired.
The shares of Common Stock that are issued are valued at market prices for the
Common Stock. Persons receiving Common Stock in connection with such
acquisitions may be contractually required to hold all or some portion of the
Common Stock for varying periods of time. The convertible subordinated debt
securities will be convertible in whole or in part into shares of Common Stock,
at any time on or after their convertibility commencement date, and at or before
maturity, unless previously redeemed at their conversion price. The convertible
subordinated debt securities will be (i) unsecured and (ii) subordinate to all
26
27
present and future senior indebtedness of Pentegra and (iii) effectively
subordinated to all indebtedness and other liabilities of subsidiaries of
Pentegra. The convertible subordinated debt securities issued are valued at
prices reasonably related to their principal amount. As of March 31, 1999,
2,286,000 shares and $4,566,000 aggregate principal amount of Convertible
Subordinated Notes registered under these filings had been issued.
Principles of Consolidation
The consolidated financial statements of the Company include the accounts
of the Company and its subsidiary. All significant intercompany accounts and
transactions are eliminated consolidation.
Fiscal Year Change
In May 1998, the Company changed its fiscal year from December 31 to March
31, effective for the year beginning April 1, 1998. The three-month transition
period from January 1, 1998 through March 31, 1998 (the "Transition Period")
preceded the start of the new fiscal year. The period ended December 31, 1997
has not been recast to conform to the new fiscal year ended March 31, 1999.
2. SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
The Company considers all highly liquid debt investments with original
maturities of three months or less at the date of acquisition to be cash
equivalents.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the various classes
of depreciable assets, ranging from three to seven years. Maintenance and
repairs are charged to expense whereas renewals and major replacements are
capitalized. Gains and losses from dispositions are included in operations.
Intangible Assets
The Company's acquisitions involve the purchase of tangible and intangible
assets and the assumption of certain liabilities of the affiliated dental
practices. As part of the purchase allocation, the Company allocates the
purchase price to the tangible assets acquired and liabilities assumed, based on
estimated fair market values. In connection with each acquisition, the Company
enters into a long-term management services agreement with each affiliated
dental practice, which cannot be terminated by either party without cause. The
cost of the management services agreement is amortized on a straight-line basis
over its term, or such shorter period as may be indicated by the facts and
circumstances, as described below. Amortization periods of the management
services agreements acquired through March 31, 1999 are 25 years.
In connection with the allocation of the purchase price to identifiable
intangible assets, the Company analyzes the nature of the group with which a
management services agreement is entered into, including the number of dentists
in each group, number of dental centers and ability to recruit additional
dentists, the affiliated dental practice's relative market position, the length
of time each affiliated dental practice has been in existence, and the term and
enforceability of the management services agreement. Because the Company does
not practice dentistry, maintain patient relationships, hire dentists, enter
into employment and non-compete agreements with the dentist, or directly
contract with payors, the intangible asset created in the purchase allocation
process is associated primarily with the management services agreement with the
affiliated dental practice.
The Company reviews intangible assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the asset may not
be recoverable. If this review indicates that the carrying amount of the asset
may not be recoverable, as determined based on the undiscounted cash flows of
the related operations over the remaining amortization period, the carrying
value of the asset is reduced to estimate fair value. Among the factors
27
28
that the Company will continually evaluate are unfavorable changes in each
affiliated dental practice's relative market share and local market competitive
environment, current period and forecasted operating results and cash flows of
the affiliated dental practice and its impact on the management fee earned by
the Company, and legal factors governing the practice of dentistry.
Notes Receivable from Affiliated Practices
Notes receivable consisted of the following as March 31, 1999 (in thousands):
Notes receivable $ 1,257
Amounts due within one year (286)
-------
$ 971
=======
Notes receivables are with affiliated practices and are uncollateralized,
ranging in length from one to fourteen years. The notes bear interest at March
31, 1999 at rates ranging from 0% to 9% with interest and principal payments due
monthly.
Revenue Recognition
Under the terms of the typical management services agreement with an
Affiliated Practice, Pentegra serves as the exclusive manager and administrator
of all non-dental services relating to the operation of an Affiliated Practice.
The obligations of Pentegra include assuming responsibility for the operating
expenses incurred in connection with managing the dental centers. These expenses
include salaries, wages and related costs of non-dental personnel, dental
supplies and laboratory fees, rental and lease expenses, promotion and marketing
costs, management information systems and other operating expenses incurred at
the Affiliated Practices. In addition, Pentegra incurs general and
administrative expenses related to the financial and administrative management
of dental operations, insurance, training and development and other typical
corporate expenditures. As compensation for its services under the typical
services agreement and subject to applicable law, Pentegra is paid a management
fee comprised of two components: (1) a management fee that is fixed in amount,
an amount usually approximating 35% of the Affiliated Practice's operating
profit, before dentist compensation, or 15% of the Affiliated Practice's
collected gross revenue ("Service Fee") and, (2) the costs incurred by Pentegra
on behalf of the Affiliated Practice. Therefore, net revenues represent amounts
earned by Pentegra under the terms of its management services agreements with
the Affiliated Practices, which generally equate to the sum of the Service Fees
and the operating expenses that the affiliated practices paid to Pentegra under
the service agreements.
Income Taxes
The Company utilizes the liability method of accounting for income taxes.
Under this method, deferred taxes are determined based on differences between
the financial reporting and tax basis of assets and liabilities and are measured
using the enacted marginal tax rates currently in effect when the differences
reverse.
Earnings Per Share
Basic earnings per share are computed based upon the weighted average number
of shares of common stock and common stock equivalents outstanding during each
period. Diluted earnings per share are not separately presented because such
amounts would be the same as amounts computed for basic earnings per share.
Outstanding options to purchase 596,666 shares of Common Stock at exercise
prices above the market value of Common Stock were excluded from the calculation
of earnings per share because their effect would have been antidilutive.
Earnings per share for the periods prior to the year ended March 31, 1999 are
not reported because the Company had no significant operations.
28
29
Segment Reporting
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" that establishes standards for reporting
information about operating segments in annual and interim financial statements.
SFAS 131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. SFAS 131 is effective for fiscal
years beginning after December 15, 1997 and was adopted by the Company.
The Company operates in one business segment, which is to manage dental
practices. The Company currently manages offices across the United States. All
aspects of the Company's business are structured on a practice-by-practice
basis. Financial analysis and operational decisions are made at the office
level. The Company does not evaluate performance criteria based upon geographic
location, type of service offered or sources of revenue.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of estimates and assumptions by
management in determining the reported amounts of liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of expenses during the reporting period. Actual results
could differ from those estimates.
Reclassifications
Certain reclassifications have been made in the 1998 consolidated balance
sheet in order to be comparable with the 1999 presentation.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
March 31,
---------------------------
1999 1998
------ ------
(in thousands)
Furniture & Fixtures $2,959 $2,918
Equipment 2,381 4
Computer Equipment 1,330 655
Leasehold Improvements 287
------ ------
Total property and equipment 6,957 3,577
Less: accumulated depreciation 786
====== ======
Property and equipment, net $6,171 $3,577
====== ======
Depreciation expense for the year ended March 31, 1999 was $786,000.
29
30
4. INTANGIBLE ASSETS
Intangible assets consisted of the following:
March 31,
---------------------------
1999 1998
------- -----
(in thousands)
Management service agreements $21,970 $ --
Other 292 247
------- ----
22,262 247
Less: accumulated amortization 414
------- ----
Intangible assets, net $21,848 $247
======= ====
Amortization expense for the year ended March 31, 1999 was $414,000.
5. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consisted of the following:
March 31,
----------------------------
1999 1998
------ ------
(in thousands)
Accounts payable trade $1,066 $ 895
Accrued interest 334 --
Other 356 924
------ ------
Total accounts payable and
accrued liabilities $1,756 $1,819
====== ======
6. AFFILIATIONS
For the year ended March 31, 1999, the Company completed new dentist
affiliations with 34 practices. Total consideration paid by the Company for the
new affiliations consisted of 2,286,000 shares of Common Stock, $4.6 million
aggregate principal amount of Convertible Subordinated Debt Securities, $537,000
in shareholder notes and $10.3 million of cash.
30
31
The assets and liabilities have been recorded at their estimated fair values
at the date of acquisition. The aggregate purchase price and related expenses
that exceeded the fair market value of net assets, have been assigned to
management services agreements. Management fees and related costs are included
in the financial statements from their acquisition dates, The allocations were
as follows (in thousands):
Property and equipment, net $ 1,955
Management services agreements 21,970
-------
23,926
Less: Common stock issued 8,496
Less: Notes payable and convertible
subordinated notes issued 5,103
-------
Cash purchase price $10,326
=======
In November 1998 the Company and Liberty Dental Alliance, Inc. ("Liberty")
entered into an Agreement and Plan of Merger (the "Liberty Merger Agreement"),
pursuant to which Liberty will become a wholly owned subsidiary of Pentegra, and
James M. Powers, Jr., D.D.S. was named President of Pentegra, replacing Gary S.
Glatter. The Liberty Merger Agreement provides that Pentegra pay (a) $0.01 per
share for each outstanding share of Liberty common stock, par value $0.01 per
share at closing and (b) up to $3.99 per share and options to purchase up to
0.25 shares of common stock of Pentegra with an exercise price of $6.125 per
share for each share of Liberty common stock (collectively, the "Additional
Common Merger Consideration") in accordance with the following:
(i) One-third of the Additional Common Merger Consideration is payable upon
completion of affiliations with dental practices under a letter of
intent with Liberty ("Liberty Affiliations") that had collected
revenues for the year ended December 31, 1997 ("1997 Practice
Revenues") aggregating to at least $10,000,000;
(ii) One-third of the Additional Common Merger Consideration is payable upon
completion of additional Liberty Affiliations that had aggregate 1997
Practice Revenues of at least $15,000,000; and
(iii)One-third of the Additional Common Merger Consideration is payable upon
completion of additional Liberty Affiliations that had aggregate 1997
Practice Revenues of at least $15,000,000.
The holders of shares of Liberty common stock will forfeit any right to
receive Additional Common Merger Consideration related to Liberty Affiliations
not consummated by July 31, 1999. As of March 31, 1999, there are 315,750 shares
of Liberty common stock outstanding, which would result in Pentegra paying an
aggregate of up to $1,263,000 cash and issuing options to acquire up to 78,938
shares of Pentegra common stock.
The Liberty Merger Agreement also provides that Pentegra pay (a) $0.01 per
share for each outstanding share of Liberty Class B common stock, par value
$0.01 per share at closing and (b) up to one share of common stock for each
outstanding share of Liberty class B common stock (the "Additional Class B
Merger Consideration") in accordance with the following:
(i) One-fifth of the Additional Class B Merger Consideration is payable
upon completion of Liberty Affiliations that had aggregate 1997
Practice Revenues of at least $10,000,000;
(ii) Three-tenths of the Additional Class B Merger Consideration is payable
upon completion of additional Liberty Affiliations that had aggregate
1997 Practice Revenues of at least $10,000,000;
(iii)Two-fifths of the Additional Class B Merger Consideration is payable
upon completion of additional Liberty Affiliations that had aggregate
1997 Practice Revenues of at least $20,000,000; and
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32
(iv) One-tenth of the Additional Class B Merger Consideration is payable
upon completion of additional Liberty Affiliations that had aggregate
1997 Practice Revenues of at least $10,000,000.
The holders of shares of Liberty class B common stock will forfeit any
right to receive Additional Class B Merger Consideration related to Liberty
Affiliations not consummated by July 31, 1999. As of March 31, 1999, there are
545,000 shares of Liberty class B common stock outstanding, which would result
in Pentegra paying an aggregate of up to $5,450 cash and up to 545,000 shares of
Pentegra common stock. Consummation of the Liberty Merger Agreement, which is
anticipated to occur prior to July 31, 1999, is subject to, among other things,
Pentegra obtaining the consent of its lenders.
In connection with the Liberty Merger Agreement, Pentegra has agreed to pay
investment banking fees of up to $600,000 to SunTrust Equitable Securities
Corporation, $166,667 of which is payable upon completion of Liberty
Affiliations that had aggregate 1997 Practice Revenues of at least $10,000,000,
$166,667 of which is payable upon completion of additional Liberty Affiliations
that had aggregate 1997 Practice Revenues of at least $15,000,000 and $266,666
of which is payable upon completion of additional Liberty Affiliations that had
aggregate 1997 Practice Revenues of at least $15,000,000. Pentegra also agreed
to issue an aggregate of 145,000 options to acquire Pentegra common stock to
certain consultants of Pentegra with an exercise price of $6.125 per share, in
the same proportions and upon completion of Liberty Affiliations as the
Additional Common Merger Consideration is payable.
As of March 31, 1999, the Company had completed Liberty Affiliations with 17
dental practices. These dental practices generated aggregate annual patient
revenue of approximately $13 million during their most recently completed fiscal
year, and include dentists treating patients in 17 dental offices. The aggregate
consideration paid by Pentegra for these practices consisted of approximately
$5.6 million in cash, 1,295,268 shares of Pentegra common stock and
approximately $3.6 million aggregate principal amount of 6% Series A convertible
subordinated notes, one-half payable November 2002 and one-half payable November
2003, and $160,000 aggregate principal amount of 6% of Series B convertible
subordinated notes one-half payable April 1, 2003 and one-half payable April 1,
2004.
The Company expects the Liberty merger to close in the second quarter of
fiscal 2000. The consideration to be paid based on the Liberty affiliations as
of March 31, 1999 consisted of approximately $585,000 in cash, 109,000 shares of
Pentegra common stock, and 74,000 options to purchase Pentegra common stock.
During March 1999, the Company executed a definitive agreement with Omega
Orthodontics, Inc. ("Omega"). Pursuant to the merger agreement, each of the
approximately 5.1 million shares of Omega will be exchanged for 0.356 shares of
the Company (approximately 1.8 million shares). Approximately 1.4 million of
Omega debt will remain outstanding. The merger, which has received the necessary
approvals, is subject to the satisfaction of several closing conditions, and is
expected to close by August 1999. The merger will be accounted for under the
purchase method of accounting.
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7. LONG-TERM DEBT
Long-term debt consisted of the following:
March 31,
--------------------------
1999 1998
------- ----
(in thousands)
Line of credit $ 8,000 $ --
Convertible subordinated notes, Series A 4,211 --
Convertible subordinated notes, Series B 355 --
Shareholders' notes payable 1,105 568
------- ----
13,671 568
Less: current portion of long-term debt 537 100
------- ----
Long-term debt $13,134 $468
======= ====
The Line of Credit provides the Company with a revolving line of credit of
up to $15.0 million, to be used for general corporate purposes including
financing of acquisitions, capital expenditures and working capital. The credit
facility bears interest at an adjustable rate based on LIBOR. At March 31, 1999
the interest rate on outstanding amounts was 7.58%. The credit facility is
collateralized by liens on certain of the Company's assets, including its rights
under the management service agreements and accounts receivable. The credit
facility contains restrictions on the incurrence of additional indebtedness and
payment of dividends on the Common Stock.
The Convertible Subordinated Notes, Series A Securities (Series A
Securities) were issued in connection with the acquisition of certain affiliated
practices. The Series A Securities bear interest at 6% and can be converted to
Common Stock of the Company at conversion prices ranging from $6.75 to $7.00 per
share. The conversion period begins on November 1, 1999 and ends on November 1,
2003. The principal amount of the Series A Securities, if not converted, are
payable one-half on November 1, 2002 and one-half on November 1, 2003.
The Convertible Subordinated Notes, Series B Securities (Series B
Securities) were issued in connection with the acquisition of certain affiliated
practices. The Series B Securities bear interest at 6% and can be converted to
Common Stock of the Company at a conversion price of $6.75 per share. The
conversion period begins on April 1, 2000 and ends on April 1, 2004. The
principal amount of the Series B Securities, if not converted, are payable
one-half on April 1, 2003 and one-half on April 1, 2004.
In connection with the IPO, the Company issued $468,000 of notes payable to
certain shareholders formerly owning preferred stock (See Note 8). The notes
bear 6% interest and are payable on the earlier of the fifth anniversary of the
IPO, or the date upon which the Company offers and sells an amount of equity
securities equal or greater to the gross proceeds of the IPO.
In March 1999, the Company issued $537,000 of notes payable to owners of
affiliated dental practices. These notes were paid in April 1999.
The Company entered into an agreement with an officer to purchase
substantially all the assets and the operations of Pentegra, Ltd. and Napili,
International for total consideration of $200,000, consisting of an aggregate of
$100,000 in cash and a $100,000 principal amount 9.0% promissory note due April
2000.
In February 1998, the Company issued $486,000 of 15% promissory notes due
on the earlier of three days after the closing of the IPO or eight months from
the date the notes were issued. The notes and interest were repaid on March 30,
1998.
In November 1997, the Company issued an additional $50,000 of 9.5%
promissory notes due on the earlier of 30 days after the closing of the IPO or
July 1998. The notes and interest were repaid in March 1998.
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34
In October 1997, the Company repurchased an additional 20,000 shares of its
common stock from a director at a purchase price per share of $0.015, and issued
(i) 20,000 shares of common stock and (ii) $300,000 of 9.5 % promissory notes
due on the earlier of 30 days after the closing of the IPO or October 1998. The
Company allocated the $300,000 proceeds between the promissory notes and the
common stock based on their relative fair market values, with the value of the
shares based on $8.50 per share. The amount of the proceeds allocated to those
shares of common stock was recorded as a discount on the promissory notes of
approximately $180,000. The notes and interest were repaid in March 1998. The
Company recognized the remaining unamortized discount of $135,000 in interest
expense during the transition period.
The aggregate maturities of long-term debt for each of the next five years
subsequent to March 31, 1999 were as follows (in thousands):
2000 ............... $ 537
2001 ............... 100
2002 ............... 8,000
2003 ............... 468
2004 ............... 4,211
Thereafter ......... 355
-------
$13,671
=======
8. REDEEMABLE PREFERRED STOCK
Prior to the IPO, certain officers and directors agreed to permit PII to
repurchase their shares of Class B Preferred Stock at the subscription price.
Accordingly, the Company used a portion of the net proceeds of the IPO to
repurchase 245,835 shares of PII Class B Preferred Stock held by those officers
and directors at repurchase prices equal to the subscription prices, which
ranged from $0.01 to $1.00 per share. The remaining 1,337,500 shares of Class A
and B preferred stock outstanding were redeemed at a price of $1.50 per share,
of which $1.15 per share was paid in cash and $0.35 per share was paid in the
form of 6.0% promissory note (See Note 7) that becomes due and payable by the
Company on the earlier of the fifth anniversary of the date of the closing of
the IPO or the date on which the Company offers and sells an amount of equity
securities with gross proceeds equal to or greater than the gross proceeds of
the IPO. The Company recognized a dividend on the preferred stock for the
difference between the redemption amount and the recorded value at the date of
the IPO of approximately $1,070,000 during the transition period.
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9. INCOME TAXES
Significant components of the Company's deferred tax assets (liabilities)
were as follows (in thousands):
March 31,
------------------------------
1999 1998
------- -------
Deferred tax assets:
Net operating loss carryforward $ 2,083 $ 126
Organizational costs 477 607
Accrued liabilities and other -- 595
------- -------
Total deferred tax assets 2,560 1,328
Deferred tax liabilities:
Excess book basis over tax basis of
accrued revenues and expenses (1,311) --
Property and equipment (512) (19)
Management services agreement (57) --
------- -------
Total deferred tax liabilities (1,880) (19)
Net deferred tax asset 680 1,309
Less valuation allowance -- (1,309)
------- -------
Net deferred tax asset $ 680 $ --
------- -------
Less current portion -- --
------- -------
Noncurrent assets $ 680 $ --
======= =======
Significant components of the provision for income taxes were as follows:
For the period
from inception
Three months February 21, 1997
Year ended ended March 31, through December
March 31, 1999 1998 31, 1997
-------------- --------------- ------------------
Current tax
Federal $ -- $-- $--
State -- -- --
---- --- ---
Total current -- -- --
---- --- ---
Deferred tax benefit:
Federal 462
State 63 -- --
---- --- ---
Total deferred 525 -- --
---- --- ---
Benefit for income taxes $525 $-- $--
==== === ===
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The differences between the statutory federal tax rate and the
Company's effective tax rate on continuing operations were as follows (in
thousands):
For the period
from inception
Year ended Three months February 21, 1997
March 31, ended March 31, through December
1999 1998 31, 1997
---------- --------------- -----------------
(in thousands)
Tax at U.S. Statutory rate (34%) ..... 584 (666) (460)
State income taxes, net of federal tax 82 (93) (64)
Nondeductible expenses and other ..... 118 (14) (12)
Change in valuation allowance ........ (1,309) 773 536
------- ------- -------
Total tax benefit ............... $ (525) $ -- $ --
======= ======= =======
At March 31, 1999, the Company had net operating loss carry-forwards
available to reduce future taxable income of approximately $5.0 million,
expiring in 2017. The Company has not recorded a valuation allowance for the
potential inability to realize its net deferred tax assets because, after
consideration of the Company's planned operations and historical results
management believes that is more likely than not that the Company will realize
those assets.
In addition, the Company has $4.9 million of available deductions related
to the increase in tax basis of the assets acquired in the Affiliations. The tax
benefits will be recognized over a period of seven to fifteen years. For the
year ended March 31, 1999, the Company recognized a tax benefit of $155,000 as
an increase to additional paid-in capital.
10. STOCK OPTION PLANS
The Company grants stock options under the 1997 Stock Compensation Plan, a
stock-based incentive compensation plan (the "Plan".) The Company recognizes
stock-based compensation issued to employees at the intrinsic value between the
exercise price of options granted and the fair value of stock for which the
options may be exercised. However, pro forma disclosures as if the Company
recognized stock-based compensation at the fair value of the options themselves
are presented below.
Under the Plan, the Company is authorized to issue 2,000,000 shares of
Common Stock pursuant to "Awards" granted to officers and key employees in the
form of stock options.
There are 596,666 options granted under the Plan, at March 31, 1999. The
Compensation Committee administers the Plans. These stock options have
contractual terms of 10 years and have an exercise price no less than the fair
market value of the stock at grant date. The options vest at varying rates over
a one to five year period, beginning on the first anniversary of the date of
grant.
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37
Following is a summary of the status of the Company's stock options as of
March 31, 1999 and the changes from inception:
Number of Shares of Weighted Average
Underlying Options Exercise Prices
------------------- -----------------
Outstanding at December 31, 1997 ..... -- --
-------- ----
Exercisable at December 31, 1997 ..... -- --
-------- ----
Granted .............................. 671,666 8.50
Exercised ............................ -- --
Forfeited ............................ -- --
Expired .............................. -- --
-------- ----
Outstanding at March 31, 1998 ........ 671,666 8.50
-------- ----
Exercisable at March 31, 1998 ........ -- --
-------- ----
Granted .............................. 358,000 4.94
Exercised ............................ -- --
Forfeited ............................ (433,000) 8.46
Expired .............................. -- --
-------- ----
Outstanding at March 31, 1999 ........ 596,666 6.40
-------- ----
Exercisable at March 31, 1999 ........ 136,333 6.69
-------- ----
Weighted average fair value of options
granted during the period: ..................
For the three months ended March 31, 1998 5.63
Fiscal 1999 2.77
The fair value of each stock option granted by the Company is estimated on
the date of grant using the Black-Scholes option pricing model for 1997, the
Transition Period, and the year ended March 31, 1999, with the following
weighted-average assumptions: dividend yield of 0% for each year; expected
volatility of 0% for 1997, and 61.4% for the Transition Period and for the year
ended March 31, 1999; risk-free interest rates are 5.9% for 1997 and 4.7% for
Transition period and the year ended March 31, 1999 and the expected lives of
the options average ten years.
The following table summarizes information about stock options outstanding
at March 31, 1999:
Weighted Average Weighted Average
Weighted Exercise Price Exercise Price
Number Average Of options Number Of Exercisable
Range of Outstanding at Remaining outstanding Exercisable Options
Exercise Prices 3/31/99 Contract Life at 3/31/99
--------------- -------------- ------------- ---------------- ----------- ------------------
$2.63 - $8.50 596,666 9.1 years $6.40 136,333 $6.69
Had the compensation cost for the company's stock based compensation plans
been determined using the fair value rather than the intrinsic value of the
options, the Company's net income and diluted net income per share for 1999
would approximate $1.9 million, or $0.25 per share. The pro forma effect for the
periods prior to the year ended March 31, 1999 are excluded because the Company
had insignificant historical operating results. The effects of applying fair
value accounting in this pro forma disclosure are not indicative of future
amounts.
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11. COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company has entered into operating leases for various types of office
equipment and for its building facilities. Certain building facility leases
include rent escalation clauses. Most leases contain purchase and renewal
options at fair market rental values.
Future minimum lease payments under noncancelable operating leases with
remaining terms of one or more years consisted of the following at March 31,
1999 (in thousands):
2000 ......................... $ 253
2001 ......................... 260
2002 ......................... 263
2003 ......................... 249
2004 ......................... 145
Thereafter ................... --
------
Total minimum lease obligation $1,170
======
12. RELATED PARTY TRANSACTIONS
During the Transition Period, an employment bonus of $1,250,000 to an
officer of the Company was recorded. Payments of the bonus have been and will
continue to be made in increments of $10,000 on the closing of each future
dental practice affiliation until the bonus has been paid in full. Pursuant to
the terms of the Company's employment agreement with the officer, the employment
bonus must be paid in full within three years of the IPO.
At March 31,1999, a bonus payable of $940,000 remained outstanding.
During the year ended March 31, 1999 the Company made a one time severance
payment of $350,000 to the former Chief Executive Officer.
The Company has a note receivable from a Director of the Company of
$109,000 as of March 31,1999. This amount is included in Notes Receivable from
Affiliated Practices on the Balance Sheet.
13. CREDIT RISK
The Company maintains cash balances at various financial institutions.
Accounts at each institution are insured by the Federal Deposit Insurance
Corporation up to $100,000. The Company's accounts at these institutions may, at
times, exceed the federally insured limits.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, receivables from
affiliated practices, and accounts payable approximate fair values due to the
short-term maturities of these instruments. The carrying amounts of the
Company's long-term borrowings, and revolving line of credit and notes
receivables from affiliated practices as of March 31, 1999 and 1998, approximate
their fair value based on the Company's current incremental borrowing rates for
similar type of borrowing arrangements.
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14. SUPPLEMENTAL CASH FLOW INFORMATION
For the period from
inception February
Year ended Three months ended 21, 1997 through
March 31, March 31, December,
1999 1998 1997
------------------ ---------------------- ---------------------
(in thousands)
Cash paid during the period for:
Interest $ 55 $ 24 $ --
Income taxes 85 -- --
Supplemental disclosure of non-cash
investing and financing activities:
Issuance of common stock
in connection with practice
affiliations: 8,496 -- --
Issuance of Convertible Subordinated
Notes in connection with practice
affiliations: 4,566 -- --
Issuance and notes payable in
connection with practice affiliations: 537 -- --
Share exchange -- 18 --
Issuance of notes payable for prepaid
assets and acquisitions: -- 373 --
Issuance of notes payable for
redemption of preferred stock -- 468 --
Offering costs accrued -- 1,008 1,795
Acquisition of property and
equipment accrued -- -- 243
Discount on notes payable -- -- 180
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15. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth summary quarterly results of operations for
the Company for the year ended March 31, 1999, and for the period from
inception, February 21, 1997 through December 31, 1997 (in thousands):
1999
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- -------- -------- --------
Net revenue $ 7,412 $ 8,761 $ 9,851 $ 12,800
Operating expenses 6,515 8,394 9,888 12,143
Earnings from operations 897 367 (37) 657
Earnings before income taxes 937 406 (115) 489
Income taxes 263 112 (885) (15)
Net earnings $ 674 $ 294 $ 770 $ 504
Net earnings per share (1)
Basic and diluted $ .10 $ .04 $ .10 $ .06
Weighted average common shares outstanding:
Basic and diluted 6,886 7,526 7,961 8,841
1997(2)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- -------- -------- --------
Net revenue -- -- -- --
Operating expenses 11 228 511 604
Earnings from operations (11) (228) (511) (604)
Earnings before income taxes (11) (228) (511) (604)
Income taxes -- -- -- --
Net earnings/(loss) (11) (228) (511) (604)
(1) Earnings per share are computed independently for each of the quarters
presented. Therefore, the sum of the quarterly earnings per share dues not
equal the total computed for the year due in stock transactions that
occurred.
(2) Earnings per share are not presented for the period from inception,
February 21, 1997 through December 31, 1997 because the Company did not
have significant operations.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is set forth under the captions
"Election of Directors' and "Section 16 Reports will be set forth in the
Company's definitive Proxy Statement (the "1999 Proxy Statement") for its 1999
annual meeting of stockholders, which sections are incorporated herein by
reference.
Pursuant to Item 401 (b) of Regulation S-K, the information required by
this item with respect to executive officers of the Company is set forth in Part
I of this Report.
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ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be set forth in the section
entitled "Executive Compensation" in the 1999 Proxy Statement, which section is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be set forth in the section
entitled "Security Ownership of Certain Beneficial Owners and Management" in the
1999 Proxy Statement, which section is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED THIRD PARTY TRANSACTIONS
The information required by this item will be set forth in the section
entitled "Certain Transactions" in the 1999 Proxy Statement, which section is
incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8 - K
(A) (1) FINANCIAL STATEMENTS
Report of Independent Accountants
Consolidated Balance Sheets as of March 31, 1999 and 1998
Consolidated Statements of Operations for the Year Ended March 31, 1999, the
three months ended March 31, 1998 and the period from inception (February 21,
1997) through March 31, 1997.
Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the
Year Ended March 31, 1999, the three months ended March 31, 1998 and the period
from inception (February 21, 1997) through March 31, 1997.
Consolidated Statements of Cash Flows for the Year Ended March 31, 1999, the
three months ended March 31, 1998, and the period from inception (February 21,
1997) through March 31, 1997.
Notes to the Consolidated Financial Statements
(a)(2) Financial Statement Schedules
All Schedules and other statements for which provision is made in the applicable
regulations of the Commission have been omitted because they are not required
under the relevant instructions or are inapplicable.
(a)(3)EXHIBITS
EXHIBITS
NUMBER DESCRIPTION OF EXHIBITS
- -------- -----------------------
3.1(1) Restated Certificate of Incorporation of Pentegra Dental Group, Inc.
3.2(1) Bylaws of Pentegra Dental Group, Inc.
4.1(1) Form of certificate evidencing ownership of Common Stock of Pentegra Dental Group,
Inc.
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4.2(1) Form of Registration Rights Agreement for Owners of Founding Affiliated Practices
4.3(1) Registration Rights Agreement dated September 30, 1997 between Pentegra Dental Group, Inc. and
the stockholders named therein
4.4(2) Form of Stockholders' Agreement for Owners of Affiliated Practices
4.5(3) Form of Indenture from Pentegra Dental Group, Inc. to U.S. Trust Company of Texas, N.A., as
Trustee relating to the Convertible Debt Securities
+10.1(1) Pentegra Dental Group, Inc. 1997 Stock Compensation Plan
+10.2(1) Employment Agreement dated July 31, 1997 between Pentegra Dental Group, Inc. and Omer K. Reed,
D.D.S.
+10.3(1) Employment Agreement dated July 1, 1997 between Pentegra Dental Group, Inc. and Gary S. Glatter
+10.4(1) Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and John Thayer
+10.5(1) Employment Agreement dated September 1, 1997 between Pentegra Dental Group, Inc. and Sam H.
Carr
+10.6(1) Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and James Dunn,
Jr.
+10.7(1) Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and Kimberlee K.
Rozman
+10.8(1) Form of Service Agreement
+10.9(1) Amendment to Employment Agreement dated July 31, 1997 between Pentegra Dental Group, Inc. and
Omer K. Reed, D.D.S.
+10.10(1) Second Amendment to Employment Agreement dated July 31, 1997 between Pentegra Dental Group,
Inc. and Omer K. Reed, D.D.S.
+10.11(1) Amendment to Employment Agreement dated May 1, 1997 between Pentegra Dental Group, Inc. and
Gary S. Glatter
+10.12(1) Amendment to Employment Agreement dated September 1, 1997 between Pentegra Dental Group, Inc.
and Sam H. Carr
+10.13(1) Amendment to Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and
James L. Dunn, Jr.
+10.14(1) Amendment to Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and John Thayer
+10.15(1) Amendment to Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and
Kimberlee Rozman
10.16(1) Second Amendment to Asset Contribution Agreement dated August 20, 1997 between Pentegra Dental Group, Inc.,
Pentegra, Ltd., Napili International, Inc. and the shareholders of Pentegra, Ltd. and Napili International, Inc.
10.17(4) Credit Agreement dated June 1, 1998 between Bank One, Texas, N.A. and Pentegra Dental Group,
Inc.
10.18(5) Modification to Credit Agreement between Pentegra Dental Group, Inc. and Bank One, Texas, N.A.
dated September 9, 1998
10.19(5) Second Amendment to Employment Agreement between Pentegra Dental Group, Inc. and James L. Dunn,
Jr. dated April 22, 1998
10.20(5) Separation and Mutual Release Agreement between Pentegra Dental Group, Inc. and Gary S. Glatter
dated November 13, 1998
10.21(5) Agreement and Plan of Merger among Pentegra Dental Group, Inc., Liberty Dental Alliance, Inc.,
Liberty Acquisition Corporation, James M. Powers, Jr., Sylvia H. McAlister and William Kelly
dated as of November 13, 1998
10.22(5) Employment Agreement between Pentegra Dental Group, Inc. and James M. Powers, Jr. dated
November 13, 1998
10.23(2) First Amendment to Credit Agreement by and among Pentegra Dental Group, Inc. and Bank One,
Texas, N.A. dated as of February 9, 1999
10.24(2) First Amendment to the Agreement and Plan of Merger by and among Pentegra Dental Group,
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Inc., Liberty Dental Alliance, Inc., Liberty Acquisition Corporation, James M. Powers, Jr.,
Sylvia H. McAlister and William Kelly dated as of January 29, 1999
10.25(2) Agreement and Plan of Merger dated as of March 15, 1999 among Pentegra, Omega, Merger Sub and the
stockholders of Omega named therein (included Annex A to the Proxy Statement/Prospectus)
21.1 Subsidiaries of the Registrant
23.1 Consent of PricewaterhouseCoopers LLP
27.1 Financial Data Schedule
(1) Previously filed as an exhibit to Pentegra's Registration Statement on Form
S-1 (No. 333-37633), and incorporated herein by reference.
(2) Previously filed as an exhibit to Pentegra's Registration Statement on Form
S-4 (No. 333-78535), and incorporated herein by reference.
(3) Previously filed as an exhibit to Pentegra's Registration Statement on Form
S-4 (No. 333-64665), and incorporated herein by reference.
(4) Previously filed as an exhibit to Pentegra's Quarterly Report on Form 10-Q
for the fiscal quarter ended June 30, 1998.
(5) Previously filed as an exhibit to Pentegra's Quarterly Report on Form 10-Q
for the fiscal quarter ended September 30, 1998.
+ Management contract or compensatory plan or arrangement required to be
filed as an exhibit pursuant to the requirements of Item 14(c) of Form
10-K.
(b) No current reports on Form 8-K were filed during the fourth quarter 1999.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Phoenix, State of Arizona, on June 28, 1999.
PENTEGRA DENTAL GROUP , INC.
By: /s/ James M. Powers, Jr., D.D.S.
---------------------------------
James M. Powers, Jr., D.D.S.
Chairman of the Board, President and
Chief Executive Officer
44
45
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the date indicated.
Name Capacity Date
- ---- -------- ----
/s/ James. M. Powers, Jr. D.D.S.
- ----------------------------------------
James M. Powers, Jr., D.D.S. Chairman of the Board, President and Chief June 28, 1999
Executive Officer (Principal Executive Officer)
/s/ Sam H. Carr
- ----------------------------------------
Sam H. Carr Senior Vice President, Chief Financial Officer, June 28, 1999
Secretary and Director (Principal Financial and
Accounting Officer)
/s/ Omer K. Reed, D.D.S.
- ----------------------------------------
Omer K. Reed, D.D.S. Director June 28, 1999
/s/ Ronnie L. Andress, D.D.S.
- ----------------------------------------
Ronnie L. Andress, D.D.S. Director June 28, 1999
/s/ James H. Clarke, Jr., D.D.S.
- ----------------------------------------
James H. Clarke, Jr., D.D.S. Director June 28, 1999
/s/ Ronald E. Geistfeld, D.D.S.
- ----------------------------------------
Ronald E. Geistfeld, D.D.S. Director June 28, 1999
/s/ Mack E. Greder, D.D.S.
- ----------------------------------------
Mack E. Greder, D.D.S. Director June 28, 1999
/s/ Roger Allen Kay, D.D.S.
- ----------------------------------------
Roger Allen Kay, D.D.S. Director June 28, 1999
/s/ Gerald F. Mahoney
- ----------------------------------------
Gerald F. Mahoney Director June 28, 1999
/s/ Anthony P. Maris
- ----------------------------------------
Anthony P. Maris Director June 28, 1999
/s/ George M. Siegel
- ----------------------------------------
George M. Siegel Director June 28, 1999
/s/ Ronald M. Yaros, D.D.S.
- ----------------------------------------
Ronald M. Yaros, D.D.S. Director June 28, 1999
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EXHIBIT INDEX
EXHIBITS
NUMBER DESCRIPTION OF EXHIBITS
- -------- -----------------------
3.1(1) Restated Certificate of Incorporation of Pentegra Dental Group, Inc.
3.2(1) Bylaws of Pentegra Dental Group, Inc.
4.1(1) Form of certificate evidencing ownership of Common Stock of Pentegra Dental Group,
Inc.
4.2(1) Form of Registration Rights Agreement for Owners of Founding Affiliated Practices
4.3(1) Registration Rights Agreement dated September 30, 1997 between Pentegra Dental Group, Inc. and
the stockholders named therein
4.4(2) Form of Stockholders' Agreement for Owners of Affiliated Practices
4.5(3) Form of Indenture from Pentegra Dental Group, Inc. to U.S. Trust Company of Texas, N.A., as
Trustee relating to the Convertible Debt Securities
+10.1(1) Pentegra Dental Group, Inc. 1997 Stock Compensation Plan
+10.2(1) Employment Agreement dated July 31, 1997 between Pentegra Dental Group, Inc. and Omer K. Reed,
D.D.S.
+10.3(1) Employment Agreement dated July 1, 1997 between Pentegra Dental Group, Inc. and Gary S. Glatter
+10.4(1) Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and John Thayer
+10.5(1) Employment Agreement dated September 1, 1997 between Pentegra Dental Group, Inc. and Sam H.
Carr
+10.6(1) Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and James Dunn,
Jr.
+10.7(1) Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and Kimberlee K.
Rozman
+10.8(1) Form of Service Agreement
+10.9(1) Amendment to Employment Agreement dated July 31, 1997 between Pentegra Dental Group, Inc. and
Omer K. Reed, D.D.S.
+10.10(1) Second Amendment to Employment Agreement dated July 31, 1997 between Pentegra Dental Group,
Inc. and Omer K. Reed, D.D.S.
+10.11(1) Amendment to Employment Agreement dated May 1, 1997 between Pentegra Dental Group, Inc. and
Gary S. Glatter
+10.12(1) Amendment to Employment Agreement dated September 1, 1997 between Pentegra Dental Group, Inc.
and Sam H. Carr
+10.13(1) Amendment to Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and
James L. Dunn, Jr.
+10.14(1) Amendment to Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and John Thayer
+10.15(1) Amendment to Employment Agreement dated July 12, 1997 between Pentegra Dental Group, Inc. and
Kimberlee Rozman
10.16(1) Second Amendment to Asset Contribution Agreement dated August 20, 1997 between Pentegra Dental Group, Inc.,
Pentegra, Ltd., Napili International, Inc. and the shareholders of Pentegra, Ltd.
and Napili International, Inc.
10.17(4) Credit Agreement dated June 1, 1998 between Bank One, Texas, N.A. and Pentegra Dental Group,
Inc.
10.18(5) Modification to Credit Agreement between Pentegra Dental Group, Inc. and Bank One, Texas, N.A.
dated September 9, 1998
10.19(5) Second Amendment to Employment Agreement between Pentegra Dental Group, Inc. and James L. Dunn,
Jr. dated April 22, 1998
10.20(5) Separation and Mutual Release Agreement between Pentegra Dental Group, Inc. and Gary S. Glatter
dated November 13, 1998
10.21(5) Agreement and Plan of Merger among Pentegra Dental Group, Inc., Liberty Dental Alliance, Inc.,
Liberty Acquisition Corporation, James M. Powers, Jr., Sylvia H. McAlister and William Kelly
dated as of November 13, 1998
10.22(5) Employment Agreement between Pentegra Dental Group, Inc. and James M. Powers, Jr. dated
November 13, 1998
10.23(2) First Amendment to Credit Agreement by and among Pentegra Dental Group, Inc. and Bank One,
Texas, N.A. dated as of February 9, 1999
10.24(2) First Amendment to the Agreement and Plan of Merger by and among Pentegra Dental Group,
Inc., Liberty Dental Alliance, Inc., Liberty Acquisition Corporation, James M. Powers, Jr.,
Sylvia H. McAlister and William Kelly dated as of January 29, 1999
10.25(2) Agreement and Plan of Merger dated as of March 15, 1999 among Pentegra, Omega, Merger Sub and the stockholders
of Omega named therein (included Annex A to the Proxy Statement/Prospectus)
21.1 Subsidiaries of the Registrant
23.1 Consent of PricewaterhouseCoopers LLP 23.2 -- Consent of Jackson Walker L.L.P. (contained in Exhibit
5.1)
27.1 Financial Data Schedule
(1) Previously filed as an exhibit to Pentegra's Registration Statement on Form
S-1 (No. 333-37633), and incorporated herein by reference.
(2) Previously filed as an exhibit to Pentegra's Registration Statement on Form
S-4 (No. 333-78535), and incorporated herein by reference.
(3) Previously filed as an exhibit to Pentegra's Registration Statement on Form
S-4 (No. 333-64665), and incorporated herein by reference.
(4) Previously filed as an exhibit to Pentegra's Quarterly Report on Form 10-Q
for the fiscal quarter ended June 30, 1998.
(5) Previously filed as an exhibit to Pentegra's Quarterly Report on Form 10-Q
for the fiscal quarter ended September 30, 1998.
+ Management contract or compensatory plan or arrangement required to be
filed as an exhibit pursuant to the requirements of Item 14(c) of Form
10-K.
(b) No current reports on Form 8-K were filed during the fourth quarter 1999.
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