ANNUAL REPORT 2020 Our true purpose is to improve the oral health of ALL Australians to world’s best. 2020 Performance Highlights PATIENT FEES – UP 0.6% $186.3m SAME CENTRE GROWTH (4.5%) DENTAL CENTRES – UP 5.6% 94 UNDERLYING EBITDA – UP 2.9% $23.5m UNDERLYING NPAT – DOWN 9.7% $8.1m Table of Contents 2020 Performance Highlights 1 2020 Operational Snapshot 2 4 Chairperson’s Letter 7 Managing Director’s Report 16 Dental Centre Locations 20 Directors’ Report 25 Remuneration Report 33 Auditor’s Independence Declaration 34 Financial Statements 38 Notes to the Financial Statements 68 Directors’ Declaration 69 77 Shareholder Information IBC Corporate Information Independent Auditor’s Report 1 ANNUAL REPORT 2020 | PACIFIC SMILES 2020 Operational Snapshot DENTAL CENTRES 5 new DENTISTS >600 DENTAL CENTRES 94 NEW DENTAL CHAIRS 32 DENTIST AND GRADUATE DEVELOPMENT 20 PATIENT NET PROMOTER SCORE >80 EMPLOYEE RETENTION >80% 2 We’re Here When You Need Us Pacific Smiles is committed to caring for the health and well-being of our patients, dentists and employees in all our local communities. Operating 90+ Dental Centres Pacific Smiles provides dentists with fully serviced and equipped facilities including support staff, materials, marketing and administrative services. Over 600 Dentists Assisted by more than 1,400 support staff, attend to over 767,000 patient appointments at Pacific Smiles centres each year. ANNUAL REPORT 2020 | PACIFIC SMILES Pacific Smiles – founded by dentists for dentists. 3 ANNUAL REPORT 2020 | PACIFIC SMILES Chairperson’s Letter I am extremely proud to chair the Board of this financially successful and culturally strong company that always remains focused on the professional support of the dentists who choose to practice with us, the wellbeing of our employees and the oral health of our patients. This financial year I accepted the role of Chairperson of Pacific Smiles Group, following Robert (Bob) Cameron’s retirement after 17 years as Chairman. Robert (Bob) Cameron stepped down as Chair in February 2020 and on behalf of the Board I would like to thank Bob for his immense contribution to the company since its inception to growth to 93 centres in his tenure. Mark Bloom joined the Board as a non-executive director this year adding his extensive experience in running global and local finance and information technology teams. Mark most recently held the position of CFO at ASX 20 listed Scentre Group Limited (owner and operator of Westfield in AU and NZ). In the year 2020, we must acknowledge the challenges COVID-19 has brought us as we operate this business with an agile mindset to ensure the best management of the virus and the safety of practitioners, employees and patients. In April, Pacific Smiles Group reverted to emergency services with only 16 centres remaining open. Despite these challenges Pacific Smiles Groups delivered $186.3 million in patient fees and $23.5 million in underlying EBITDA in no small part due to the unified commitment of practitioners, employees and our patients. The Board has focused on empowering the organisation and facilitating capital investment to drive Pacific Smiles Group’s growth. In FY20, we opened 5 new centres with only 1 new centre in the second half of the year. While COVID-19 has caused a near-term disruption in new openings we remain very excited by the long-term opportunity to open more than 250 centres throughout Australia. Additionally, we have enabled key leadership opportunities and are delighted that almost 90% of key leadership roles are held by women. This is a continuation of Pacific Smiles Group’s focus on cultivating culture as a competitive advantage. At Pacific Smiles Group, we strive to improve, adapt and refuse to be satisfied with the status quo, always developing our offering to better suit all key stakeholder groups. We are proud to support the Australian Dental Health Foundation who continue to improve the oral health of disadvantaged Australians. The Foundation coordinates life changing treatment, positively impacting the quality of life and smiles of many Australians. FY21 has commenced with the announcement of Pacific Smiles Group signing an initial 10-year base term Management Services Agreement with Western Australian health fund market leader HBF. This relationship consolidates Pacific Smiles’ position as the leading organic growth focused dental service organisation in Australia. At the same time, we continue our successful agreement with nib health funds as the owner and operator of nib Dental Care centres. The new financial year also marked the retirement of our co-founder Dr Alex Abrahams as a Non-Executive Director. His passion and drive to create a better work environment for dentists and better oral health outcomes for patients led to the group’s success. The Board thanks Alex for his significant contribution. I would like to thank the dentists who choose to practice at our centres and who ensure leading standards in patient care. Thanks also to the employees, my fellow Directors and the members of the Executive Leadership Team for their hard work and adaptability this year, particularly enabling the business to stand back up so quickly and safely in quarter four. Phil McKenzie, in his second year as Managing Director, led this strong and focused performance; making decisions with speed and conviction and proactively adapting during uncertain times. On behalf of the Board I would like to thank Phil for his energetic leadership. The last financial year’s investment in growth opportunities incorporating capital investment, network growth and leadership opportunities will lay a solid foundation for the future strength and success of the organisation in the coming year. Only the best professional services will excel in the current market that requires constant adaptability, and with ‘Adapt’ forming one of our key cultural values we will be able to continue to provide the public access to the world’s best oral healthcare. No final dividend was declared in relation to FY2020. Total dividends in relation to FY2020 represented 46% of underlying net profit after tax. Thank you to our shareholders for your continued support. Zita Peach Chairperson 4 I S E L M S C F C A P I I | 0 2 0 2 T R O P E R L A U N N A Pacific Smiles’ absolute commitment to outstanding patient care and customer service is reflected by our high Net Promoter Scores. 5 ANNUAL REPORT 2020 | PACIFIC SMILES 6 During the year we provided over 767,000 patient appointments ANNUAL REPORT 2020 | PACIFIC SMILES Managing Director’s Report In FY 2020, Pacific Smiles delivered over 767,000 patient appointments with a patient net promoter score of greater than 80%. We opened 5 new dental centres in Robina and Mitchelton in Queensland and Epping, Ocean Grove and Narre Warren in Victoria taking the network total to 94. In my second year as Managing Director, I couldn’t be more pleased with our results progression or more appreciative of the contribution of every person involved with this organisation. After 17 years as founding Chairman of the Board Robert Cameron AO has retired and we would like to thank him for his significant contribution to the business over the years; and from me personally for facilitating my successful transition in as Managing Director. Pacific Smiles congratulates Zita Peach stepping up to the role of Chairperson. Zita’s decades of relevant healthcare experience and positive focus since joining the board in 2017 has been to empower the management team to deliver on our organisational growth strategy. The Board and management are also pleased to welcome Mark Bloom to the Pacific Smiles Group Board adding to its caliber with a highly respected commercial financial skillset and deep retail property experience. To ensure our growth plans are met, we have invested by adding key leadership roles to the Executive Team for the Property and Technology functions. Attracting and investing in top tier talent will enable us to scale and not dilute our culture. The pride and diligent dedication shown by our people every day makes Pacific Smiles Group the company that it is. Number of Centres Patient Fees $m FY 20 19 18 17 16 15 14 13 12 11 94 89 80 70 58 49 41 34 31 28 FY 20 19 18 17 16 15 14 13 12 11 96 95 86 70 186 187 165 147 134 121 7 ANNUAL REPORT 2020 | PACIFIC SMILES 8 Australian Dental Health Foundation Sponsor for over 4 years delivering free dental treatment to disadvantaged Australians Child Dental Benefits We’ve helped approximately 40,000 kids smiles with the Child Dental Benefits Schedule ANNUAL REPORT 2020 | PACIFIC SMILES We are clear about our why, our way and our how. ‘Our why’ is our True Purpose; to improve the oral health of all Australians to world’s best. ‘Our way’ leverages our culture play book; Unifying, Adapting, and Playing to win. ‘Our how’ is our value propositions; dentists are respected, employees matter, and our patients trust in Pacific Smiles Group. We will continue to make decisions with a long-term view consistent with our known success factors and capitalising on technology innovations. The dedication and discipline of the entire team, focused equally on execution today and the long-term performance objectives of the business, will ensure prosperity. Operational Overview and Insights Statutory Results The first half of the financial year delivered strong underlying EBITDA growth of 15.0% and the opening of four new dental centres. Our Insight graduate program had a record number of applications and 20 new graduates began the program with Pacific Smiles Group this year, our biggest intake to date. We also launched the Pacific Smiles education experience node for University of Sydney final year dental students. This program was developed to broaden the student training program and provide experience in a private practice setting. The University of Sydney Dental School has been providing education and training in dentistry and oral health for over 100 years and we are proud to partner with the university to help shape the future of oral healthcare in Australia. The third quarter for 2020 delivered the Australian market unforeseen health and business challenges with the impact of COVID-19. Pacific Smiles’ proven business processes, system and protocols for servicing dentists and caring for patients and each other enabled us to successfully manage through the crisis and stand the business back up efficiently and effectively, once restrictions eased in May. Over 600 dentists were actively supported by Pacific Smiles’ during the peak of the COVID-19 pandemic in Australia. Restrictions on dental practices changed on multiple occasions and it was important for us to guide practitioners in complying with the guidelines put forward by the Australian Dental Association and enforced by Australian Health Protection Principle Committee (AHPPC). In doing so, practitioners were able to continue to assist patients needing care during the pandemic, both face to face and via tele-dentistry, with the safety of the patients and the dental team top of mind. The fourth quarter was about leading out of the disruption and uncertainty with agility. Our commitment to expanding services to patients was demonstrated with the opening of a new dental centre in Narre Warren, Victoria. The long-term plan remains simple and focused on growing the core business through our unique greenfield centre expansion program; the goal of more than 250 centres and 800 chairs is unchanged. Statutory net profit after tax for the year was $6.4 million. This result is down on the 2019 statutory net profit after tax of $8.6 million, a decrease of 25.5%. The statutory results for the year were impacted by COVID-19 and Government mandated restrictions on dental services and several underlying adjustments as detailed in the table below. The new standard resulted in the Group recognising depreciation and interest costs, rather than operating lease expenses. During the year the Group recognised $9.2 million of depreciation charges, $2.8 million of interest costs from these leases payable and $0.03 million of interest income from leases receivable. AASB 16 had an impact of $0.1 million on net profit after tax (NPAT). The Operational overview and insights discussions will focus on the underlying results for 2020 and the comparative period and excluding the impacts of AASB 16 in 2020 given the standard does not require restatement of comparatives. Removing these impacts enhances the year on year performance comparisons. Underlying Results Underlying EBITDA, exclusive of the impacts of AASB 16, increased by 2.9% to $23.5 million compared with the previous financial year. For the 8 months to 29 February 2020, prior to COVID-19 restrictions, both patient fees and underlying EBITDA were tracking at approximately 14% growth on the prior corresponding period. On 30 March 2020, the Australian Health Protection Principle Committee (AHPPC) mandated Level 3 restrictions to dental services. This resulted in 76 dental centres closing for a period of 4 weeks, and a large proportion of our workforce being stood down during this time. The centres which remained open were selected due to the role they played as regional ‘hubs’ to continue to offer emergency care within their communities. 9 ANNUAL REPORT 2020 | PACIFIC SMILES Almost 90% of key leadership roles are held by women at Pacific Smiles Group. 10 ANNUAL REPORT 2020 | PACIFIC SMILES Restrictions were eased to Level 2 on 24 April and returned to normal dental services (with COVID-19 precautions) from 11 May. At this time all centres re-opened and employees were stood back up to support patient volumes. Our ability to be operationally agile throughout this period led to strong patient volumes in June with same centre patient fee growth for the month of 12.4%. Underlying NPAT decreased by 9.7% to $8.1 million compared to $8.9 million for the prior year. To reduce the cost base and preserve cash during the nationwide restrictions, the Chief Executive Officer and Executive Leadership team salaries and Non-executive Director fees were reduced for a period of time. Short-term incentive bonuses were not paid this year, notwithstanding that prior to COVID-19 management were on track to achieve the targets for 2020. Executive team salaries were reinstated in recognition of the workload required to support the business to rapidly scale at the conclusion of the restrictions. A cost reduction program was implemented in late March 2020 to review and negotiate savings with key suppliers and with landlords. We were able to negotiate approximately $1 million in abatements and deferrals with the vast majority of landlords. Pacific Smiles successfully applied for the Government’s JobKeeper scheme and was eligible from 1 April 2020. In FY 2020, the Company is entitled to $8.4 million for its eligible employees. Depreciation costs (excluding the impact of AASB 16) totalled $11.0 million an increase of $1.6 million on the prior period. Group revenue was $120.6 million, down 1.3% over the previous financial year. Revenue is the service fees charged to the dentists who practice from our centres. Pacific Smiles provides dentists with fully serviced and equipped facilities including support staff, materials, marketing and administrative services. Dentists are then free to focus on offering exceptional patient care. The Government mandated restrictions on dental services resulted in an estimated reduction in patient fees of $28.0 million. Up until the end of February, Pacific Smiles was tracking at achieving patient fee growth of 14.2% but ended the year down by 0.6% due to the restrictions. Revenue growth is achieved through the combination of our existing dental centres and our new dental centres opened in recent years. Patient fees decreased 0.6% over the previous year to $186.3 million due to the impact of COVID-19 on same centre patient fees which contracted by 4.5%. The new centres have performed in line with expectations prior to COVID-19 and will be strong contributors to long-term growth and profit margins over time. The Group’s underlying EBITDA to Patient fees margin increased in 2020 to 12.6%, supported by the JobKeeper Government scheme and operational capability to scale expenditure. The year saw a decline in top line growth across our network of centres with COVID-19 restrictions reducing appointment volumes. The increasing proportion of fees coming from centres opened in the last 3 years unfavourably impacted the EBITDA to Patient fees margin given that the less mature Pacific Smiles’ dental centres typically generate lower margins. This means the accelerated dental centre rollout strategy also affects Group profitability, and therefore margins, in the short term. Adjustments to the Statutory Income Statement Statutory net profit after tax Severance and HR consultancy expense Executive LTI plan expense/(write-back) Lease adjustments Non-scheduled IT outage Asset impairment Restructuring Income tax effect of adjustments Underlying statutory net profit after tax Net tax impacts of AASB 16 Underlying statutory net profit after tax excluding the impacts of AASB 16 2020 $ million 2019 $ million 6.4 0.2 0.5 – 0.5 0.8 0.3 (0.7) 8.0 0.1 8.1 11 8.6 0.6 (0.1) (0.0) – – – (0.2) 8.9 – 8.9 ANNUAL REPORT 2020 | PACIFIC SMILES Financial Position Pacific Smiles’ strong focus on cash management resulted in net debt of $6.7 million as at 30 June 2020. In order to maximise financial flexibility in the current environment, the Group secured an additional debt facility of $10.0 million in August 2020. This takes the overall debt facility to $40.0 million and gives Pacific Smiles significant capacity should there be future COVID-19 mandated restriction periods in 2021, as well as focusing on the long-term growth strategy of dental centre rollouts. Capital expenditure for the year was lower at $10.0 million (FY2019: $16.5 million), reflecting a spending pause during March to May 2020. It includes 5 new centres, additional chairs in existing centres, automated sterilisation systems and the bulk purchase of dental chairs. Borrowings increased by $5.0 million to $22.0 million in the current year to support the expansion of the dental centre network and upgrades of existing facilities, equipment and systems. The Group implemented a Dividend Reinvestment Plan for the fully franked interim dividend of 2.40 cents per share this year. This action gave existing shareholders the flexibility to reinvest in the business, while allowing the Company to retain additional cash of $1.7 million as a buffer for the period of shutdowns. With shareholders electing to receive $1.7 million as ordinary shares, a further $7.3 million cash dividend was paid to shareholders this financial year. In total, ordinary dividends of $9.0 million were paid to shareholders in 2020, compared with $9.3 million in the prior year. No final dividend was declared for FY2020. The dividend payout ratio is 46.3% of underlying Net Profit After Tax, exclusive of AASB 16 (2019 was 98.8% of underlying Net Profit After Tax). The Market The market for dental services in Australia is approximately $10 billion to $11 billion per annum and continues to grow steadily over the long term. Funding for dental services is predominantly from individuals; however private health insurance participation supports dental attendances and spending through co-payment arrangements. The Australian Health Practitioner Regulation Agency’s (APRHA) latest dental service data reported that more than 44 million dental services per annum were funded by health funds as at March 2020, with health funds paying more than $2.0 billion per annum in dental benefits. The proportions of total expenditure on dental services by health funds and by Government are trending in opposite directions. Health funds have increased their proportion from 14.0% in 2009-10 to 19.1% in 2017-18, according to Australian Institute of Health and Welfare. The proportion Group Financial Performance $ millions Revenue Gross profit EBITDA EBIT Net profit after tax Operating metrics 12 Number of Dental Centres Commissioned Dental Chairs Patient Fees ($ millions) Same Centre Patient Fees growth Financial metrics Earnings per share (cents) EBITDA margin EBITDA to Patient Fees margin EBIT margin * Excludes the impacts of AASB 16. Underlying 2020* Underlying 2019 Change (1.3%) (0.4%) 2.9% (7.1%) (9.7%) 5.6% 9.1% (0.6%) (9.9%) 120.6 109.9 23.5 12.5 8.1 94 383 186.3 (4.5%) 5.3 19.5% 12.6% 10.3% 122.2 110.3 22.8 13.4 8.9 89 351 187.4 8.6% 5.9 18.7% 12.2% 11.0% ANNUAL REPORT 2020 | PACIFIC SMILES Managing Director’s Report by the Australian Government has decreased from 16.3% in 2009-10 to 15.0% in 2017-18, with expenditure by State and Local Governments maintained at 8.2% in 2009- 10 and in 2017-18. The Child Dental Benefit Schedule and some partnership arrangements with the States and Territories, continue to be the main funding programs of the Commonwealth Government, whereas the various States and Territories operate systems to overflow patients from public clinics to the private sector. The industry continues to be highly fragmented with the majority of providers operating from small scale single locations, although corporate activity in the sector is increasing. There are more branded networks, including some owned and operated by private health insurance organisations, who market to their own members to encourage attendance. The other major feature of the market is the continued growth in the number of registered dentists. The increase in recent years has been the combined impact of overseas trained dentists and local graduates. The number of registered dentists was 18,157 in March 2020, up 2.8% on the prior year. The demographic shift in the dental workforce continues with females making up 53% of registered dentists, increasing 1% on the year earlier. Risk Management Pacific Smiles is subject to various risk factors, both business specific and of a general nature. Pacific Smiles has not identified any specific, material exposure to its economic, social or environmental sustainability over the long term. Pacific Smiles has established policies and structures for oversight and management of material business risks. Further information regarding how Pacific Smiles recognises and manages risks can be sourced from our Corporate Governance Statement and related governance policies on our website. The risk areas and mitigating factors identified by Pacific Smiles are shown on page 15. Phil McKenzie Chief Executive Officer and Managing Director Dividends EBITDA (underlying) $m Interim Dividend Final Dividend Special Dividend 12.0 10.0 8.0 6.0 4.0 2.0 0.0 FY 23.5 22.8 21.5 20.9 19.7 18.4 15.1 13.3 13 10.2 8.0 6.8 5.0 4.4 2014 2015 2016 2017 2018 2019 2020 08 09 10 11 12 13 14 15 16 17 18 19 20 ANNUAL REPORT 2020 | PACIFIC SMILES “During the height of the COVID-19 pandemic in Australia there was so much uncertainty, yet we felt informed,cared for and supported by our dentist at Pacific Smiles as their only priority.” 14 ANNUAL REPORT 2020 | PACIFIC SMILES Table 1: Risk Management Risk Area Mitigating Factors General economic conditions Downturns in general economic conditions could adversely impact demand for dental services, given the discretionary nature of some of those services. Reduction in private health insurance coverage Changes to the nature or extent of private health insurance coverage could impact upon the attendance frequency of patients. Competition-induced fee pressure An increase in the number of practicing dentists could increase competition for patients and the degree to which dentists compete on the basis of fee levels. Termination of Service and Facility Agreements by dentists Under the Service and Facility Agreements between Pacific Smiles and dentists, the dentists may terminate without cause, on a few months’ notice. Reputational damage Actions by employees or dentists could give rise to reputational damage to Pacific Smiles and its brands. Supply of skilled dentists Should the availability of appropriately skilled and aligned dentists become restricted, then growth and expansion of Pacific Smiles could be slowed, and/or the cost of dentists could escalate. Pandemic Should a pandemic restrict the dental services able to be performed in specific locations, States or nationally due to the risk of infection to staff, dentists and patients. Cyber Security Actions whereby the Company’s IT systems are accessed and result in the failure of or interruption to key IT systems or a material patient privacy breach. Dentists at Pacific Smiles’ dental centres provide a range of treatments to patients in a number of different geographic zones throughout the eastern States of Australia. Patients at Pacific Smiles’ dental centres are a mix of privately insured and non-insured individuals and there are various payment plans and treatment payment options available. Pacific Smiles’ dental centres are usually differentiated from other local providers and compete on the basis of convenience, value, access and overall patient experience. Pacific Smiles views the dentists as a key customer group and focuses resources accordingly. There is a close focus on internal procedures and clinical governance by management and the Board. This has been further enhanced by the internal and external appointments to the Dental Advisory Committee. The focus on training and development of dentists, including a structured mentoring program for new graduate dentists, is building a platform of appropriately skilled and aligned dentists for the long term. Close monitoring and adherence to Government or professional body recommendations. Ensuring adequate stock of appropriate personal protective equipment (PPE), and close focus on internal procedures and clinical governance by management and the Board. Pacific Smiles Group has industry best practice controls in place to minimise technology related business interruptions and to manage the end-to-end cyber lifecycle. It also has cyber and technology roadmaps in place to continually uplift its maturity in both areas to meet compliance and operational expectations. 15 Key Supply Chain Should an event result in the closure, restriction or delay of key consumables or personal protective equipment (PPE) meaning our ability to meet the needs of patients or support dentists could be impacted. Long-term relationships with national suppliers and back-up suppliers identified. Close monitoring of inventory levels and ensuring adequate stock of appropriate personal protective equipment (PPE). Strategy for emergency store of critical PPE enacted. ANNUAL REPORT 2020 | PACIFIC SMILES Dental Centre Locations QLD 19 NSW 41 ACT 6 VIC 28 16 ANNUAL REPORT 2020 | PACIFIC SMILES VIC Bairnsdale Bendigo Caroline Springs Chirnside Park Cranbourne Park Drysdale Epping Glen Iris Glen Waverley Greensborough Keysborough Leopold Melbourne nib Melbourne Melton Mill Park Mulgrave Narre Warren Ocean Grove Point Cook Preston Ringwood Sale Torquay Traralgon Warragul Waurn Ponds Werribee QLD Aspley Birtinya Bribie Island Brisbane CBD Browns Plains Buddina Burleigh Heads Capalaba Deception Bay Helensvale Mitchelton Morayfield Mount Gravatt Mount Ommaney North Lakes Redbank Plains Robina Runaway Bay Strathpine ACT Belconnen Gungahlin Manuka Tuggeranong Woden nib Woden 17 NSW Balgowlah Bateau Bay Baulkham Hills Belmont Belrose Blacktown Brookvale Campbelltown Charlestown nib Chatswood Erina nib Erina Figtree Forster Gladesville nib Glendale Greenhills Jesmond Kotara Lake Haven Marrickville Morisset Mount Hutton Narellan nib Newcastle nib North Parramatta Nowra Parramatta Penrith Queanbeyan Rutherford Salamander Bay Shellharbour Singleton nib Sydney Toronto Town Hall Tuggerah Tweed Heads Wagga Wagga nib Wollongong ANNUAL REPORT 2020 | PACIFIC SMILES 18 ANNUAL REPORT 2020 | PACIFIC SMILES Directors’ Report and Financial Statements FOR THE FINANCIAL YEAR ENDED 30 JUNE 2020 20 Directors’ report 33 Auditor’s Independence Declaration 34 Consolidated Statement of Profit or Loss and Other Comprehensive Income 35 Consolidated Balance Sheet 36 Consolidated Statement of Changes in Equity 37 Consolidated Statement of Cash Flows 38 Notes to the Consolidated Financial Statements 68 Directors’ Declaration 69 Independent Auditor’s Report 77 Shareholder Information IBC Corporate Information 19 ANNUAL REPORT 2020 | PACIFIC SMILES Directors’ Report The Directors present their report, together with the financial statements, on the consolidated entity (referred to hereafter as the ‘consolidated entity’) consisting of Pacific Smiles Group Limited (referred to hereafter as the ‘company’ or ‘parent entity’) and the entities it controlled at the end of, or during, the year ended 30 June 2020. Directors The following persons were directors of Pacific Smiles Group Limited during the whole of the financial year and up to the date of this report, unless otherwise stated: Ms Zita Peach (appointed Chairperson 19 February 2020) Mr Robert Cameron AO (resigned 19 February 2020) Mr Phil McKenzie Dr Alex Abrahams (resigned 23 July 2020) Mr Mark Bloom (appointed 18 October 2019) Mr Hilton Brett Mr Ben Gisz Mr Simon Rutherford Principal activities The consolidated entity principally operates dental centres at which independent dentists practice and provide clinical treatments and services to patients. Revenues and profits are primarily derived from fees charged to dentists for the provision of these fully serviced dental facilities. Dividends Dividends paid during the financial year were as follows: Final dividend for the year ended 30 June 2019 of 3.50 cents (2018: 3.80 cents) per ordinary share, fully franked Interim dividend for the year ended 30 June 2020 of 2.40 cents (2019: 2.30 cents) per ordinary share, fully franked 2020 $’000 5,320 2019 $’000 5,776 3,648 3,496 8,968 9,272 Dividend reinvestment plan The consolidated entity’s dividend reinvestment plan (DRP) applied to the fully franked interim dividend of 2.40 cents per share announced on 20 February 2020. The DRP allowed eligible shareholders to reinvest all or part of their dividend payments into Pacific Smiles shares. The price at which shares are allocated under the DRP is the daily volume weighted average market price of the company’s shares sold in the ordinary course of trading on the ASX over a period of 5 days beginning on 20 April 2020. Shares allocated under the DRP rank equally with the company’s existing fully paid ordinary shares. The DRP resulted in shareholders electing to receive an additional 1,522,155 shares in total, priced at $1.716 million. There were no dividends declared but not recognised at the end of the financial year. Review of operations Information on the operations and financial position of the consolidated entity and its business strategies and prospects is set out in the Operating and Financial Review accompanying this report. 20 Significant changes in the state of affairs There were no significant changes in the state of affairs of the consolidated entity during the financial year. ANNUAL REPORT 2020 | PACIFIC SMILES Matters subsequent to the end of the financial year Coronavirus (COVID-19) pandemic The impact of the Coronavirus (COVID-19) pandemic is ongoing, and it is not practicable to estimate the potential impact after the reporting date. There has been no material impact to the consolidated entity’s financial performance or position arising from the pandemic from the end of the reporting period to the date of this report. The situation is ongoing and is dependent on measures imposed by the Australian Government and other countries, such as maintaining social distancing requirements, quarantine, travel restrictions and any economic stimulus that may be provided. Management services agreement with HBF Pacific Smiles has signed an initial 10-year base term Management Services Agreement (MSA) with Western Australian health fund HBF in early July 2020. Under the agreement HBF will build a minimum of five HBF Dental (HBFD) clinics across Western Australia over the next 18 months. Pacific Smiles will be the exclusive operator of these and any additional HBFD clinics rolled out in Western Australia for the term of the MSA. Pacific Smiles will receive a percentage of revenue from the operations in return for providing comprehensive operational support for the design, construction, and all aspects of the clinics’ day to day operations. HBF will be responsible for funding capital expenditure and in-clinic operating costs. Pacific Smiles does not expect the arrangement to be material to earnings within the first year of operation. Resignation of director Dr Alex Abrahams has resigned as Non-executive Director on 23 July 2020. Other events No other matter or circumstance has arisen since 30 June 2020 that has significantly affected, or may significantly affect, the consolidated entity’s operations, the results of those operations, or the consolidated entity’s state of affairs in future financial years. Likely developments and expected results of operations The consolidated entity will continue to pursue opportunities to enhance the growth and prosperity of its business. Refer to the Operating and Financial Review accompanying this report for further details. Environmental regulation The consolidated entity is not subject to any significant environmental regulation under Australian Commonwealth or State law. 21 ANNUAL REPORT 2020 | PACIFIC SMILES Information on Directors Ms Zita Peach Non-executive Chairperson, appointed February 2020 Non-executive Director, appointed August 2017 Member of the Nomination and Remuneration Committee BSc, FAICD, FAMI Zita has more than 25 years of commercial experience in the pharmaceutical, biotechnology, medical devices and health services industries. She has extensive sales and marketing experience across a broad range of sectors in healthcare, locally and internationally, as well as leading international expansions and conducting major business transactions. At leading global healthcare company Fresenius Kabi, Zita was Executive Vice President for South Asia Pacific, Managing Director for Australia and New Zealand and Chair of the Boards for Malaysia, Australia and New Zealand. Zita was Vice President of Business Development at CSL Limited and has an extensive track record in mergers and acquisitions deals, licensing and commercialising products and technologies on a global scale. Zita is a Non-executive Director of Monash IVF Group Limited, Starpharma Holdings Limited and Visioneering Technologies, Inc. Zita is also a member of the Hudson Institute of Medical Research Board. Zita is a Fellow of the Australian Institute of Company Directors and a Fellow of the Australian Marketing Institute. Other current directorships: Monash IVF Group Limited, Starpharma Holdings Limited, VIsioneering Technologies, Inc. 22 Former directorships (last 3 years): AirXpanders Inc. Interests in shares: 22,095 Mr Phil McKenzie Chief Executive Officer and Managing Director, appointed October 2018 B.Bus (Auckland Uni) Prior to joining Pacific Smiles, Phil was Chief Executive Officer for Audiology Management Group (AMG), a leading audiology services business with a network of more than 200 clinic locations across the USA. During his time at AMG, Phil balanced and transitioned the model from acquisition driven to greenfield expansion and delivered strong financial performance for the group. Prior to his role as CEO of AGM, Phil was CEO of Widex Australia, New Zealand, Singapore, Hong Kong and India retail where he successfully turned around and grew those operations. Phil has also held leadership positions at Apple Retail as Australian Market Director and was a driver of Apple’s retail entry into the Australian market from 2008 to 2011, and Luxottica as National Operations Manager from 2005 to 2007. Other current directorships: Nil Former directorships (last 3 years): Nil Interests in shares: Nil Dr Alex Abrahams Founder and Executive Director, appointed in 2002 until June 2017 Non-executive Director, appointed June 2017 until July 2020 Member of the Audit and Risk Management Committee BDS (Syd Uni), GAICD Alex has overseen the development of the company from a group of partnerships to an incorporated entity in January 2003. Alex is a dentist with a special interest in dental implants. Alex is a member of the Australian Dental Association (ADA) and is on both the ADA (NSW) Advocacy committee, and the Australian Dental Health Foundation Advisory Committee. He is a Director of Group Homes Australia Pty Limited and a Director of the Trustees of Canyon Property Trust and Key Health Unit Trust. Other current directorships: Microequities Asset Management Group Limited Former directorships (last 3 years): Nil Interests in shares: 30,827,361 ANNUAL REPORT 2020 | PACIFIC SMILES Directors’ Report Mr Ben Gisz Non-executive Director, appointed in 2012 Chairman of the Nomination and Remuneration Committee Mr Simon Rutherford Non-executive Director, appointed in 2003 Chairman of the Audit and Risk Management Committee Mr Mark Bloom Non-executive Director, appointed October 2019 Member of the Audit and Risk Management Committee Mr Hilton Brett Non-executive Director, appointed August 2018 Member of the Nomination and Remuneration Committee B.Comm, CA, FFin, CFA B.Comm, CA, FAICD B.Comm, B.Acc, CA ANZ B.Comm, PGDA Ben is a partner at TDM Growth Partners, a Sydney based global investment firm. Ben has extensive financial markets experience, including prior roles in private equity investing and investment banking. Other current directorships: Nil Former directorships (last 3 years): Nil Interests in shares: 35,705,996 Simon is a chartered accountant and partner with PKF in business advisory services. He has been with the firm for 35 years. He works with corporate and family owned groups as an advisory board member and lead adviser on strategy, governance, structuring, business sales, mergers and acquisitions. He is also a Director of PKF Wealth. In his role Simon has assisted various companies with capital raising and listing requirements. Simon is a Director of the Trustee of Canyon Property Trust and is involved with other syndicated investments. He has also served on a number of boards including National Brokers Group and Vow Financial Group. Other current directorships: Nil Former directorships (last 3 years): Nil Interests in shares: 1,744,863 Up until April 2019, Mark held the position of Chief Financial Officer at ASX 20 listed Scentre Group Limited (owner and operator of Westfield in Australia and NZ). Mark’s executive career as a Finance Executive has spanned 36 years as Chief Financial Officer and an Executive Director at 3 top 20 listed entities in Real Estate (Westfield and Scentre Group – 16 years) and Insurance and diversified Financial Services (Liberty Life, South Africa and Manulife Financial, Toronto – 20 years). He has had extensive experience in running global and local Finance and IT teams encompassing Treasury, Tax, Operations, Finance, Compliance, Risk Management, Financial Reporting, Legal and Information Technology. Mark has extensive experience in corporate transactions and restructuring. Mark is a Non- executive Director at AGL Energy Limited. Other current directorships: AGL Energy Limited Former directorships (last 3 years): Nil Interests in shares: 102,128 Hilton is an Operating Advisor at TDM Growth Partners, a private investment firm founded in 2004, which invests in fast growing companies run by passionate management teams. Up until March 2018, Hilton was co-Chief Executive Officer of Accent Group Limited (formerly RCG Corporation Ltd) which is the regional leader in the retail and distribution of performance and lifestyle footwear with over 420 stores across 10 retail banners and exclusive distribution rights for 10 international brands across Australia and New Zealand. Accent’s brands include The Athlete’s Foot, Hype DC, Platypus Shoes, Podium Sports, Skechers, Merrell, CAT, Vans, Dr. Martens, Saucony, Timberland, Sperry Top-Sider, Palladium and Stance. Hilton joined Accent in 2006 when the business had a market capitalisation of $8 million. Over the 12 years, the team grew the business to a $800 million market capitalisation and delivered total shareholder returns in excess of 25% CAGR. Hilton is a Non-Executive Director of Guzman Y Gomez Mexican Taqueria. Other current directorships: Nil Former directorships (last 3 years): Accent Group Limited Interests in shares: 655,290 23 ANNUAL REPORT 2020 | PACIFIC SMILES ‘Other current directorships’ quoted above are current directorships for listed entities only and excludes directorships of all other types of entities, unless otherwise stated. ‘Former directorships (last 3 years)’ quoted above are directorships held in the last 3 years for listed entities only and excludes directorships of all other types of entities, unless otherwise stated. Company secretaries Mark Licciardo and Belinda Cleminson of Mertons Corporate Services (Mertons) are joint company secretaries. Mark is the founder of Mertons and a Director of various Australian Stock Exchange (ASX) listed public and private companies. Belinda has extensive experience as a Company Secretary of Australian listed and unlisted companies including providing support to ASX 200 clients. Meetings of directors The number of meetings of the company’s Board of Directors (‘the Board’) and of each Board committee held during the year ended 30 June 2020, and the number of meetings attended by each director, were: Ms Zita Peach Mr Robert Cameron AO Mr Phil McKenzie* Dr Alex Abrahams Mr Mark Bloom Mr Hilton Brett Mr Ben Gisz Mr Simon Rutherford Full Meetings of Directors Nomination and Remuneration Committee Audit and Risk Committee Attended Held Attended Held Attended Held 16 9 16 17 11 17 17 17 17 9 16 17 11 17 17 17 4 1 – – – 2 4 – 4 2 – – – 2 4 – – – – 4 3 – 1 4 – – – 4 3 – 1 4 Held: represents the number of meetings held during the time the director held office or was a member of the relevant committee. * Management were not required to attend one Board meeting. 24 ANNUAL REPORT 2020 | PACIFIC SMILES Directors’ Report Remuneration report (audited) The remuneration report details the key management personnel remuneration arrangements for the consolidated entity, in accordance with the requirements of the Corporations Act 2001 and its Regulations. Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including all directors. The remuneration report is set out under the following main headings: • Principles used to determine the nature and amount of remuneration • Details of remuneration • Share-based compensation • Additional disclosures relating to key management personnel Principles used to determine the nature and amount of remuneration The objective of the consolidated entity’s executive reward framework is to ensure reward for performance is competitive and appropriate for the results delivered. The framework aligns executive reward with the achievement of strategic objectives and the creation of value for shareholders, and it is considered to conform to the market best practice for the delivery of reward. The Board of Directors (‘the Board’) ensures that executive reward satisfies the following key criteria for good reward governance practices: • competitiveness and reasonableness • acceptability to shareholders • performance linkage/alignment of executive compensation • transparency The Nomination and Remuneration Committee is responsible for determining and reviewing remuneration arrangements for its directors and executives. The performance of the consolidated entity depends on the quality of its directors and executives. The remuneration philosophy is to attract, motivate and retain high performance and high quality personnel. The reward framework is designed to align executive reward to shareholders’ interests. The Board have considered that it should seek to enhance shareholders’ interests by: • having economic profit as a core component of plan design • focusing on sustained growth in shareholder wealth, consisting of dividends and growth in share price, and delivering constant or increasing return on assets as well as focusing the executive on key non-financial drivers of value • attracting and retaining high calibre executives Additionally, the reward framework should seek to enhance executives’ interests by: • rewarding capability and experience • reflecting competitive reward for contribution to growth in shareholder wealth • providing a clear structure for earning rewards In accordance with best practice corporate governance, the structure of non-executive director and executive director remuneration is separate. Non-executive Directors remuneration Directors’ fees and payments are reviewed annually by the Nomination and Remuneration Committee. The Nomination and Remuneration Committee may, from time to time, receive advice from independent remuneration consultants to ensure non- executive Directors’ fees and payments are appropriate and in line with the market. The Chairperson’s fees are determined independently to the fees of other non-executive Directors based on comparative roles in the external market. The Chairperson is not present at any discussions relating to the determination of her own remuneration. Non-executive Directors do not receive share options or other incentives. 25 The non-executive Director fees are reviewed annually to ensure that the fees reflect market rates. There are no guaranteed annual increases in any Directors’ fees. ANNUAL REPORT 2020 | PACIFIC SMILES Non-executive Directors are entitled to be reimbursed for their reasonable expenses incurred in connection with the affairs of the consolidated entity. The consolidated entity’s constitution provides that Non-executive Directors are entitled to receive compensation for their services as determined by approval at a general meeting. As at 30 June 2020, the current Directors’ fees pool is an aggregate sum of $800,000. The base fee payable to the Chairperson is $120,000 per annum, and the base fee payable to other Non-executive Directors is $70,000 per annum. Any change to this aggregate annual amount is required to be approved by shareholders. The Board may approve additional remuneration for special exertions and additional services performed by a Director outside of the aggregated pool. Remuneration paid to Directors in their capacity as employees also falls outside of the aggregated pool. Executive remuneration The consolidated entity aims to reward executives based on their position and responsibility, with a level and mix of remuneration which has both fixed and variable components. In determining executive remuneration, the Board aims to ensure that remuneration practices are: • competitive and reasonable, enabling the consolidated entity to attract and retain key talent • aligned to the consolidated entity’s strategic and business objectives and the creation of shareholder value • transparent • acceptable to shareholders; and • rewarding for performance The executive remuneration and reward framework has four components: • base pay and non-monetary benefits • short-term performance incentive (STI) plan • long-term equity incentive (LTI) plan • other remuneration such as superannuation and long service leave The combination of these comprises the executive’s total remuneration. Fixed remuneration, consisting of base salary, superannuation and non-monetary benefits, is reviewed annually by the Nomination and Remuneration Committee based on individual and business unit performance, the overall performance of the consolidated entity and comparable market remunerations. Executives may receive their fixed remuneration in the form of cash or other fringe benefits (for example motor vehicle benefits) where it does not create any additional costs to the consolidated entity and provides additional value to the executive. The short-term incentives (STI) program is designed to provide executives the opportunity to earn an annual incentive linked to the achievement of performance hurdles. The actual level of STI paid to each executive is determined at the end of the financial year based on the consolidated entity’s financial performance and non-financial key performance indicators (KPIs). Financial performance is assessed based on consolidated underlying Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) meeting or exceeding Board approved targets. Non-financial KPIs are group KPIs, rather than individual KPIs and relate to Net Promoter Score (NPS) for patients, dentists and employees for the consolidated entity exceeding specific NPS targets. Targets are reviewed annually. 26 The executive STI plan performance criteria are summarised below: Underlying EBITDA targets Non-financial performance metrics Total maximum STI % of base salary Chief Executive Officer % of base salary Other Executive Officers Up to 35.0% Up to 15.0% Up to 50.0% Up to 24.5% Up to 10.5% Up to 35.0% ANNUAL REPORT 2020 | PACIFIC SMILES Directors’ Report Ongoing participation by executives in the STI plan is at the discretion of the Board. With reference to recommendations from the Nomination and Remuneration Committee, the Board will approve all executive STI payments, and may use its discretion to adjust STI remuneration up or down, to prevent any inappropriate reward outcomes. The STI amounts are paid in cash, and are those earned during the financial year and provided for in the annual financial statements. STI cash bonuses are generally payable in September following the end of the financial year, and once the financial results of the year have been subject to independent external audit. The consolidated entity has a LTI plan to assist in the motivation, retention and reward of executives. The LTI plan is designed to align the interests of senior management more closely with the interests of shareholders by providing an opportunity for senior management to receive an equity interest in the consolidated entity through the granting of performance rights. Performance rights have been issued to the Chief Executive Officer and selected senior managers, at the absolute discretion of the Board, pursuant to the LTI plan in financial years from 2016 to 2020. Vesting of the performance rights on issue for the years 2018, 2017 and 2016 is subject to: • satisfaction of earnings per share (EPS) performance hurdles for a four-year performance period. The number of performance rights vesting will be determined on a sliding scale from nil vesting for an EPS compound annual growth rate (CAGR) of 15% per annum or less and 100% vesting for an EPS CAGR of 25% per annum; and • the participant remaining employed by the Pacific Smiles Group (or its subsidiaries) over a four-year period through to the vesting date, subject to certain ‘good leaver’ exemptions. Vesting of the performance rights on issue for the years 2020 and 2019 is subject to: • satisfaction of EPS performance hurdles for a four-year period. The number of performance rights vesting will be determined on a sliding scale from nil vesting for an EPS CAGR of 10% per annum or less and 100% vesting for an EPS CAGR of 25% per annum; and • the participant remaining employed by Pacific Smiles Group (or its subsidiaries) over a four-year period through to the vesting date, subject to certain ‘good leaver’exemptions. Performance rights that do not vest on the relevant vesting date will lapse. Performance rights will also lapse if total shareholder return (TSR) does not reach a minimum threshold per annum over the relevant performance period. In the event of serious misconduct or a material misstatement in the consolidated entity’s financial statements, the Board may determine that certain performance-based remuneration (including STIs and/or LTIs) should not have been paid and may claw back performance-based remuneration paid in the preceding three financial years. Consolidated entity performance and link to remuneration The following table shows key performance indicators (KPIs) for the consolidated entity over the last five years. Revenue ($’000) EBITDA (statutory – $’000) Net profit after tax (statutory – $’000) Dividends per share – ordinary (cents) Earnings per share (cents) Increase/(decrease) in share price ($) 2020 2019 2018 120,055 122,156 104,528 32,859 6,383 2.4 4.2 0.40 22,300 8,573 5.8 5.6 18,439 6,604 6.1 4.3 2017 91,471 20,552 10,037 5.9 6.6 2016 83,337 19,306 9,903 5.5 6.5 (0.40) (0.24) (0.28) (0.26) 27 ANNUAL REPORT 2020 | PACIFIC SMILES Details of remuneration Amounts of remuneration Details of the remuneration of key management personnel of the consolidated entity are set out in the following tables. The key management personnel of the consolidated entity consisted of the following directors of Pacific Smiles Group Limited: • Ms Zita Peach • Mr Mark Bloom (appointed 18 October 2019) • Mr Robert Cameron AO (until 19 February 2020) • Mr Hilton Brett • Mr Phil McKenzie • Mr Ben Gisz • Dr Alex Abrahams (until 23 July 2020) • Mr Simon Rutherford And the following persons: • Mr Paul Robertson • Ms Allanna Ryan Short-term benefits Post- employment benefits Cash salary and fees Cash bonus Other Super- annuation Long-term benefits Long service leave Share- based payments Rights 2020 Non-Executive Directors: Ms Zita Peach (appointed Chairperson 19 February 2020) Mr Robert Cameron AO (resigned 19 February 2020) Dr Alex Abrahams Mr Mark Bloom (appointed 18 October 2019) Mr Hilton Brett Mr Ben Gisz Mr Simon Rutherford Executive Directors: $ 72,048 71,654 61,250 37,521 56,797 61,250 61,250 Mr Phil McKenzie 506,398 Other Key Management Personnel: Mr Paul Robertson Ms Allanna Ryan 261,318 260,599 1,450,085 28 $ – – – – – – – – – – – $ – – – – – – – – – – – $ 6,845 6,807 – 3,434 5,396 – – $ – – – – – – – $ – – 9,806 – – – – Total $ 78,893 78,461 71,056 40,955 62,193 61,250 61,250 21,003 8,750 204,581 740,732 21,716 21,003 86,204 4,719 4,498 73,563 66,322 361,316 352,422 17,967 354,272 1,908,528 ANNUAL REPORT 2020 | PACIFIC SMILES Directors’ Report Short-term benefits Post- employment benefits Cash salary and fees Cash bonus Other* Super- annuation Long-term benefits Long service leave 2019 Non-Executive Directors: Mr Robert Cameron Dr Alex Abrahams Mr Hilton Brett (appointed 24 August 2018) Mr Ben Gisz Ms Zita Peach Mr Simon Rutherford Executive Directors: Mr Phil McKenzie (appointed 29 October 2018) Mr John Gibbs (resigned 28 October 2018) $ 109,589 70,000 53,109 70,000 63,927 70,000 331,653 168,127 Other Key Management Personnel: Mr Paul Robertson Ms Allanna Ryan 251,772 236,718 1,424,895 $ – – – – – – – – – – – Share- based payments Rights $ – (14,521) – – – – Total $ 120,000 55,479 58,154 70,000 70,000 70,000 $ 10,411 – 5,045 – 6,073 – $ – – – – – – $ – – – – – – – 14,665 5,449 39,167 390,934 450,000 7,505 9,760 (67,164) 568,228 – – 450,000 23,845 20,540 88,084 4,581 4,115 (14,092) 3,498 266,106 264,871 23,905 (53,112) 1,933,772 * Other benefits include termination benefits paid to Mr John Gibbs in 2019. There were no termination benefits paid or payable to key management personnel during 2020. Termination benefits paid were in accordance with employment contracts. STI awarded For each STI bonus included in the 2020 remuneration table above, the percentage of the available bonus that was earned in the financial year and the percentage that was forfeited because the person did not meet the target performance criteria are set out below. Mr Phil McKenzie Mr Paul Robertson Ms Allanna Ryan % of maximum STI awarded % of STI forfeited – – – 100.0% 100.0% 100.0% Based on significant outperformance in 2021 an additional bonus will be available to Executive Managers. 29 ANNUAL REPORT 2020 | PACIFIC SMILES Employment contracts Remuneration and other terms of employment for the executives are formalised in employment contracts. The employment contracts specify the remuneration arrangements, benefits, notice periods and other terms and conditions. Participation in the STI and LTI plans are subject to the Board’s discretion. The current executive contracts do not have fixed terms. Contracts may be terminated by the executive with notice, or by the Company with notice or by payment in lieu of notice, or with immediate effect in circumstances involving serious or wilful misconduct. Executive key management personnel (EKMP) Mr Phil McKenzie Mr Paul Robertson Ms Allanna Ryan Share-based compensation Issue of shares Termination notice by EKMP Termination notice by Company 6 months 3 months 6 months 6 months 3 months 6 months There were no shares issued to directors and other key management personnel as part of compensation during the year ended 30 June 2020. Options There were no options over ordinary shares issued to directors and other key management personnel as part of compensation that were outstanding as at 30 June 2020. Performance rights The terms and conditions of each grant of performance rights over ordinary shares affecting remuneration of Directors and other key management personnel in this financial year or future reporting years are as follows: Grant date Number of rights granted Vesting date 30 November 2015 30 November 2016 1 December 2017 4 March 2019 13 February 2020 1,725,000* 2,200,000** 2,100,000*** 3,026,000 3,500,000 30 November 2019 30 November 2020 1 December 2021 4 March 2023 13 February 2024 * 500,000 rights were forfeited on 28 October 2018, the remaining 1,225,000 rights were forfeited on 30 November 2019. ** 500,000 rights were forfeited on 28 October 2018, 200,000 rights were forfeited on 30 November 2019. *** 500,000 rights were forfeited on 28 October 2018, 325,000 rights were forfeited on 30 November 2019. Performance rights granted carry no dividend or voting rights. Fair value per right at grant date $0.890 $0.760 $0.620 $0.470 $0.610 30 ANNUAL REPORT 2020 | PACIFIC SMILES Directors’ Report Additional disclosures relating to key management personnel Shareholding The number of shares in the company held during the financial year by each Director and other members of key management personnel of the consolidated entity, including their personally related parties, is set out below: Ordinary shares Ms Zita Peach Dr Alex Abrahams Mr Hilton Brett Mr Mark Bloom Mr Ben Gisz Mr Simon Rutherford Mr Paul Robertson Balance at the start of the year Received as part of remuneration Additions Disposals/ other Balance at the end of the year 12,340 36,327,361 – – 32,777,817 1,741,017 300,000 71,158,535 – – – – – – – – 9,755 – 22,095 – (5,500,000) 30,827,361 655,290 102,128 2,928,179 3,846 – – – – – – 655,290 102,128 35,705,996 1,744,863 300,000 3,699,198 (5,500,000) 69,357,733 Performance rights holding The number of performance rights over ordinary shares in the company held during the financial year by each Director and other members of key management personnel of the consolidated entity, including their personally related parties, is set out below: Performance rights over ordinary shares Mr Phil McKenzie Dr Alex Abrahams Mr Paul Robertson Ms Allanna Ryan Balance at the start of the year Granted Vested Expired/ forfeited/ other Balance at the end of the year 2,000,000 1,500,000 450,000 1,271,000 782,000 – 355,000 338,000 4,503,000 2,193,000 – – – – – – 3,500,000 (225,000) 225,000 (300,000) 1,326,000 – 1,120,000 (525,000) 6,171,000 Loans to key management personnel and their related parties There were no loans to key management personnel during the year. Other transactions with key management personnel and their related parties Transactions with key management personnel and/or related parties are detailed below. These transactions were conducted on terms no more favourable than those reasonably expected under arm’s length dealings with unrelated parties. Key management personnel or their related parties held shares in the consolidated entity during 2020 and 2019, and as such, participated in dividends. Bislab Pty Limited ATF the Canyon Property Trust, an entity related to Alex Abrahams and Simon Rutherford, leased business premises to the consolidated entity during 2019 and up until August 2019 on normal commercial terms and conditions. 31 Exandal Investments, an entity related to Alex Abrahams and Alison Hughes, leased business premises to the consolidated entity during 2020 and 2019 on normal commercial terms and conditions. 88 Park Avenue Pty Limited ATF the Key Health Unit Trust, an entity related to Alex Abrahams, leased business premises to the consolidated entity during 2020 and 2019 on normal commercial terms and conditions. Refer to note 33 for further information on related party transactions. This concludes the remuneration report, which has been audited. ANNUAL REPORT 2020 | PACIFIC SMILES Indemnity and insurance of officers During the financial year, the company paid a premium in respect of a contract to insure the Directors and executives of the company against a liability to the extent permitted by the Corporations Act 2001. The contract of insurance prohibits disclosure of the nature of the liability and the amount of the premium. Indemnity and insurance of auditor The company has not, during or since the end of the financial year, indemnified or agreed to indemnify the auditor of the company or any related entity against a liability incurred by the auditor. Non-audit services During the financial year the following fees were paid or payable for services provided to KPMG, the auditor of the company: Audit services – audit or review of the financial statements Other services – tax compliance and advisory services 2020 2019 130,012 128,850 26,134 40,743 156,146 169,593 The Directors are satisfied that the provision of non-audit services during the financial year, by the auditor (or by another person or firm on the auditor’s behalf), is compatible with the general standard of independence for auditors imposed by the Corporations Act 2001. The Directors are of the opinion that the services as disclosed in note 30 to the financial statements do not compromise the external auditor’s independence requirements of the Corporations Act 2001 for the following reasons: • all non-audit services have been reviewed and approved to ensure that they do not impact the integrity and objectivity of the auditor; and • none of the services undermine the general principles relating to auditor independence as set out in APES 110 Code of Ethics for Professional Accountants issued by the Accounting Professional and Ethical Standards Board, including reviewing or auditing the auditor’s own work, acting in a management or decision-making capacity for the company, acting as advocate for the company or jointly sharing economic risks and rewards. Rounding of amounts The company is of a kind referred to in Corporations Instrument 2016/191, issued by the Australian Securities and Investments Commission, relating to ‘rounding-off’. Amounts in this report have been rounded off in accordance with that Corporations Instrument to the nearest thousand dollars, or in certain cases, the nearest dollar. Auditor’s independence declaration A copy of the auditor’s independence declaration as required under section 307C of the Corporations Act 2001 is set out immediately after this directors’ report. Auditor KPMG continues in office in accordance with section 327 of the Corporations Act 2001. Voting of shareholders at last year’s annual general meeting The Group received more than 99% of ‘yes’ votes on its remuneration report for the 2019 financial year. The Group did not receive any specific feedback at the annual general meeting or throughout the year on its remunerations practices. 32 This report is made in accordance with a resolution of Directors, pursuant to section 298(2)(a) of the Corporations Act 2001. On behalf of the Directors Zita Peach Chairperson 19 August 2020 ANNUAL REPORT 2020 | PACIFIC SMILES Directors’ Report Auditor’s Independence Declaration Lead Auditor’s Independence Declaration under Section 307C of the Corporations Act 2001 To the Directors of Pacific Smile Group Limited I declare that, to the best of my knowledge and belief, in relation to the audit of Pacific Smile Group Limited for the financial year ended 30 June 2020 there have been: i. ii. no contraventions of the auditor independence requirements as set out in the Corporations Act 2001 in relation to the audit; and no contraventions of any applicable code of professional conduct in relation to the audit. KPMG Sarah Cain Partner Melbourne 19 August 2020 33 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. Liability limited by a scheme approved under Professional Standards Legislation. ANNUAL REPORT 2020 | PACIFIC SMILES Consolidated Statement of Profit or Loss and Other Comprehensive Income For the year ended 30 June 2020 Revenue Other income Expenses Direct expenses Consumable supplies expenses Employee expenses Occupancy expenses Marketing expenses Administration and other expenses Depreciation and amortisation expense Net finance costs Profit before income tax expense Income tax expense Profit after income tax expense for the year Other comprehensive income for the year, net of tax Total comprehensive income for the year Basic earnings per share Diluted earnings per share Note 5 6 2020 $’000 2019 $’000 120,055 122,156 9,820 1,249 (10,639) (9,243) (58,078) (2,825) (1,948) (14,283) (20,033) (3,455) (11,833) (9,430) (52,013) (13,363) (1,954) (12,512) (9,399) (622) 9,371 12,239 (2,988) (3,666) 6,383 8,573 – – 6,383 8,573 Cents Cents 4.2 4.2 5.6 5.6 7 8 37 37 The above consolidated statement of profit or loss and other comprehensive income should be read in conjunction with the accompanying notes. 34 ANNUAL REPORT 2020 | PACIFIC SMILES ASSETS Current assets Cash and cash equivalents Receivables Inventories Other Assets of disposal groups classified as held for sale Total current assets Non-current assets Receivables Property, plant and equipment Right-of-use assets Intangibles Deferred tax Total non-current assets Total assets LIABILITIES Current liabilities Payables Lease liabilities Income tax Provisions Liabilities directly associated with assets classified as held for sale Total current liabilities Non-current liabilities Borrowings Lease liabilities Provisions Total non-current liabilities Total liabilities Net assets EQUITY Contributed equity Reserves Retained profits Total equity Note 2020 $’000 2019 $’000 9 10 11 12 13 14 15 16 17 8 18 19 8 20 21 22 23 24 25 26 15,279 4,261 4,051 462 6,951 1,087 3,672 554 24,053 12,264 630 – 24,683 12,264 227 51,199 51,805 10,608 9,101 122,940 147,623 – 54,642 – 10,939 6,008 71,589 83,853 16,168 12,485 9,959 1,654 4,354 – 1,385 3,771 32,135 17,641 122 – 32,257 17,641 22,000 53,240 3,233 78,473 110,730 36,893 36,769 3,934 (3,810) 36,893 17,000 – 8,130 25,130 42,771 41,082 35,053 180 5,849 41,082 35 The above consolidated balance sheet should be read in conjunction with the accompanying notes ANNUAL REPORT 2020 | PACIFIC SMILES Consolidated Balance SheetAs at 30 June 2020 Contributed equity $’000 Reserves $’000 Retained profits $’000 Balance at 1 July 2018 35,053 277 Profit after income tax expense for the year Other comprehensive income for the year, net of tax Total comprehensive income for the year Transactions with owners in their capacity as owners: Share-based payments – performance rights Dividends paid (note 27) Balance at 30 June 2019 Balance at 1 July 2019 Adjustment on initial application of AASB 16 Balance at 1 July 2019 – restated Profit after income tax expense for the year Other comprehensive income for the year, net of tax Total comprehensive income for the year Transfers between reserves Transactions with owners in their capacity as owners: Share-based payments – performance rights Dividends paid (note 27) Dividend reinvestment plan Balance at 30 June 2020 – – – – – 35,053 Issued capital $’000 35,053 – 35,053 – – – – – – 1,716 36,769 – – – (97) – 180 Reserves $’000 180 – 180 – – – 490 (8,968) – 3,934 6,548 8,573 – 8,573 – (9,272) 5,849 Retained profits $’000 5,849 2,039 6,383 – 6,383 – – – 12,232 (12,232) Total equity $’000 41,878 8,573 – 8,573 (97) (9,272) 41,082 Total equity $’000 41,082 37,272 6,383 – 6,383 – 490 (8,968) 1,716 (3,810) (3,810) (3,810) 36,893 The above consolidated statement of changes in equity should be read in conjunction with the accompanying notes 36 ANNUAL REPORT 2020 | PACIFIC SMILES Consolidated Statement of Changes in EquityFor the year ended 30 June 2020 Cash flows from operating activities Receipts from customers Payments to suppliers and employees Interest received Government grant received Interest and finance costs paid Income taxes paid Net cash from operating activities Cash flows from investing activities Payments for property, plant and equipment Proceeds from disposal of property, plant and equipment Lease payments received from finance leases Net cash used in investing activities Cash flows from financing activities Proceeds from borrowings Dividends paid Repayment of lease liabilities Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at the beginning of the financial year Cash and cash equivalents at the end of the financial year Note 2020 $’000 2019 $’000 133,390 133,744 (102,222) (109,501) 31,168 24,243 77 5,043 (3,532) (4,179) 28,577 35 – (697) (2,554) 21,027 (10,107) (16,649) 64 359 162 – (9,684) (16,487) 5,000 (7,252) (8,313) 5,000 (9,272) – (10,565) (4,272) 8,328 6,951 15,279 268 6,683 6,951 36 15 27 9 The above consolidated statement of cash flows should be read in conjunction with the accompanying notes 37 ANNUAL REPORT 2020 | PACIFIC SMILES Consolidated Statement of Cash FlowsFor the year ended 30 June 2020 Notes to the Consolidated Financial Statements For the year ended 30 June 2020 Note 1. Corporate information The financial statements cover Pacific Smiles Group Limited as a consolidated entity consisting of Pacific Smiles Group Limited and the entities it controlled at the end of, or during, the year. The financial statements are presented in Australian dollars, which is Pacific Smiles Group Limited’s functional and presentation currency. Pacific Smiles Group Limited is a listed public company limited by shares, incorporated and domiciled in Australia. On 21 November 2014 Pacific Smiles Group Limited was listed on the ASX. Its registered office and principal place of business is: 6 Molly Morgan Drive, Greenhills, New South Wales. A description of the nature of the consolidated entity’s operations and its principal activities are included in the directors’ report, which is not part of the financial statements. The financial statements were authorised for issue, in accordance with a resolution of directors, on 19 August 2020. The directors have the power to amend and reissue the financial statements. Note 2. Significant accounting policies The principal accounting policies adopted in the preparation of the financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated. Basis of preparation These general purpose financial statements have been prepared in accordance with Australian Accounting Standards and Interpretations issued by the Australian Accounting Standards Board (‘AASB’) and the Corporations Act 2001, as appropriate for for-profit oriented entities. These financial statements also comply with International Financial Reporting Standards as issued by the International Accounting Standards Board (‘IASB’). Historical cost convention The financial statements have been prepared on an accruals basis and are based on historical costs, modified where applicable, by the measurement at fair value of selected non-current assets, financial assets and financial liabilities, and assets and liabilities held for sale. Critical accounting estimates The preparation of financial statements requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the consolidated entity’s accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the financial statements include non-financial asset impairment testing. New or amended Accounting Standards and Interpretations adopted The consolidated entity has adopted all of the new or amended Accounting Standards and Interpretations issued by the Australian Accounting Standards Board (‘AASB’) that are mandatory for the current reporting period. Any new or amended Accounting Standards or Interpretations that are not yet mandatory have not been early adopted. The adoption of these Accounting Standards and Interpretations did not have any significant impact on the financial performance or position of the consolidated entity. 38 The following Accounting Standards and Interpretations are most relevant to the consolidated entity: AASB 16 Leases The consolidated entity has adopted AASB 16 from 1 July 2019. AASB 16 introduced a single, on-balance sheet lease accounting model for lessees. A lessee recognises a right of use asset representing the right to use the underlying asset and a lease liability representing the lease payment obligations. Leases that are short term and low value are exempt under the standard and continue to be accounted for as an operating lease. ANNUAL REPORT 2020 | PACIFIC SMILES On transition to AASB 16, the consolidated entity elected to apply the practical expedient to grandfather the assessment of which transactions are leases. The consolidated entity recognised new assets and liabilities for its leases of dental centres. The nature of expenses related to those leases has changed because the consolidated entity will recognise a depreciation charge for right of use assets and interest expense on lease liabilities. Previously, the consolidated entity recognised operating lease expense on a straight line basis over the term of the lease. At 1 July 2019, the consolidated entity recognised a net post tax reduction in retained earnings for $3,810,000 represented by the following: • A right of use asset for $54,187,000 for former operating leases; • A $64,794,000 lease liability related to the same operating leases; • De-recognition of $5,419,000 in lease provisions existing at 30 June 2019 due to the write back of straight-line lease liability; • De-recognition of $1,200,000 in assets existing at 30 June 2019 due to a reduction in existing make good assets; • A lease receivable of $942,000 relating to sub-leases which have been classified as finance leases; and • A net increase in deferred tax assets of $1,633,000 due to the above adjustments. As a result of initially applying AASB 16, both head-leases and sub-leases, that were previously classified as operating leases, the consolidated entity recognised $51,805,000 of right-of-use assets and $63,199,000 of lease liabilities as at 30 June 2020. Also in relation to those leases under AASB 16, the consolidated entity has recognised depreciation and interest costs, instead of operating lease expenses. During the financial year ending 30 June 2020, the consolidated entity recognised $9,183,000 of depreciation charges, $2,790,000 of interest costs from these leases payable, and $27,000 of interest income from leases receivable. Parent entity information In accordance with the Corporations Act 2001, these financial statements present the results of the consolidated entity only. Supplementary information about the parent entity is disclosed in note 34. Principles of consolidation The consolidated financial statements incorporate the assets and liabilities of all subsidiaries of Pacific Smiles Group Limited (‘company’ or ‘parent entity’) as at 30 June 2020 and the results of all subsidiaries for the year then ended. Pacific Smiles Group Limited and its subsidiaries together are referred to in these financial statements as the ‘consolidated entity’. Subsidiaries are all those entities over which the consolidated entity has control. The consolidated entity controls an entity when the consolidated entity is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power to direct the activities of the entity. Subsidiaries are fully consolidated from the date on which control is transferred to the consolidated entity. They are de-consolidated from the date that control ceases. Intercompany transactions, balances and unrealised gains on transactions between entities in the consolidated entity are eliminated. Unrealised losses are also eliminated unless the transaction provides evidence of the impairment of the asset transferred. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the consolidated entity. The acquisition of subsidiaries is accounted for using the acquisition method of accounting. A change in ownership interest, without the loss of control, is accounted for as an equity transaction, where the difference between the consideration transferred and the book value of the share of the non-controlling interest acquired is recognised directly in equity attributable to the parent. 39 Where the consolidated entity loses control over a subsidiary, it derecognises the assets including goodwill, liabilities and non-controlling interest in the subsidiary together with any cumulative translation differences recognised in equity. The consolidated entity recognises the fair value of the consideration received and the fair value of any investment retained together with any gain or loss in profit or loss. ANNUAL REPORT 2020 | PACIFIC SMILES Operating segments Operating segments are reported in a manner consistent with the internal reporting provided to the consolidated entity’s Chief Executive Officer (the chief operating decision maker). The chief operating decision maker is responsible for allocating resources and assessing performance of the operating segments. Revenue recognition The consolidated entity recognises revenue as follows: Service and facility fees The consolidated entity provides services and facilities to dentists practicing out of consolidated entity owned dental centres. Services and facilities include the use of fully equipped surgeries, staff, marketing and other support infrastructure. The monthly fee the consolidated entity invoices the dentists is a percentage of patient receipts net of direct costs, which are costs directly incurred by the dentists. The percentage is determined based on monthly patient receipts and the hours worked in accordance with a Services and Facilities Agreement. Revenue is recognised over time as the service is provided to the dentists. The Services and Facilities Agreement with the dentists allows the dentists the right to cancel the arrangement with one to three months of notice without penalty. Professional dental fees Employed and contracted dentists provide a range of dental services to patients. Revenue is recognised once the service is provided for the amount charged to the patient, based on standard list price. Prosthetist fees Prosthetist fees include the manufacture and fitting of custom made dental prosthesis such as dentures. Upon completion and receipt of the product, control is passed to the customer and invoicing occurs. Revenue is recognised when the prosthesis is provided to the customer as although a denture is produced to a customer’s specification, if the contract is terminated by the customer the consolidated entity is not entitled to payment for services performed to date. Sale of dental products The consolidated entity sells a range of dental products. Revenue is recognised when the product is provided to and paid for by the customer as this is when control transfers. Other revenue Other revenue is recognised when it is received or when the right to receive payment is established. Income tax The income tax expense or benefit for the period is the tax payable on that period’s taxable income based on the applicable income tax rate for each jurisdiction, adjusted by the changes in deferred tax assets and liabilities attributable to temporary differences, unused tax losses and the adjustment recognised for prior periods, where applicable. Deferred tax assets and liabilities are recognised for temporary differences at the tax rates expected to be applied when the assets are recovered or liabilities are settled, based on those tax rates that are enacted or substantively enacted, except for: • When the deferred income tax asset or liability arises from the initial recognition of goodwill or an asset or liability in a transaction that is not a business combination and that, at the time of the transaction, affects neither the accounting nor taxable profits; or • When the taxable temporary difference is associated with interests in subsidiaries, associates or joint ventures, and the timing of the reversal can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future. 40 Deferred tax assets are recognised for deductible temporary differences and unused tax losses only if it is probable that future taxable amounts will be available to utilise those temporary differences and losses. The carrying amount of recognised and unrecognised deferred tax assets are reviewed at each reporting date. Deferred tax assets recognised are reduced to the extent that it is no longer probable that future taxable profits will be available for the carrying amount to be recovered. Previously unrecognised deferred tax assets are recognised to the extent that it is probable that there are future taxable profits available to recover the asset. ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Deferred tax assets and liabilities are offset only where there is a legally enforceable right to offset current tax assets against current tax liabilities and deferred tax assets against deferred tax liabilities; and they relate to the same taxable authority on either the same taxable entity or different taxable entities which intend to settle simultaneously. Pacific Smiles Group Limited (the ‘head entity’) and its wholly-owned Australian subsidiaries have formed an income tax consolidated group under the tax consolidation regime. The head entity and each subsidiary in the tax consolidated group continue to account for their own current and deferred tax amounts. The tax consolidated group has applied the ‘separate taxpayer within group’ approach in determining the appropriate amount of taxes to allocate to members of the tax consolidated group. In addition to its own current and deferred tax amounts, the head entity also recognises the current tax liabilities (or assets) and the deferred tax assets arising from unused tax losses and unused tax credits assumed from each subsidiary in the tax consolidated group. Assets or liabilities arising under tax funding agreements with the tax consolidated entities are recognised as amounts receivable from or payable to other entities in the tax consolidated group. The tax funding arrangement ensures that the intercompany charge equals the current tax liability or benefit of each tax consolidated group member, resulting in neither a contribution by the head entity to the subsidiaries nor a distribution by the subsidiaries to the head entity. Current and non-current classification Assets and liabilities are presented in the balance sheet based on current and non-current classification. An asset is classified as current when: it is either expected to be realised or intended to be sold or consumed in the consolidated entity’s normal operating cycle; it is held primarily for the purpose of trading; it is expected to be realised within 12 months after the reporting period; or the asset is cash or cash equivalent unless restricted from being exchanged or used to settle a liability for at least 12 months after the reporting period. All other assets are classified as non-current. A liability is classified as current when: it is either expected to be settled in the consolidated entity’s normal operating cycle; it is held primarily for the purpose of trading; it is due to be settled within 12 months after the reporting period; or there is no unconditional right to defer the settlement of the liability for at least 12 months after the reporting period. All other liabilities are classified as non-current. Deferred tax assets and liabilities are always classified as non-current. Cash and cash equivalents Cash and cash equivalents includes cash on hand, deposits held at call with financial institutions, other short-term, highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Trade and other receivables Trade receivables are initially recognised at fair value and subsequently measured at amortised cost using the effective interest method, less any allowance for expected credit losses. Trade receivables are generally due for settlement within 30 days. The consolidated entity has applied the simplified approach to measuring expected credit losses, which uses a lifetime expected loss allowance. To measure the expected credit losses, trade receivables have been grouped based on days overdue. Other receivables are recognised at amortised cost, less any allowance for expected credit losses. Inventories 41 Finished goods are stated at the lower of cost and net realisable value on a ‘first in first out’ basis. Cost comprises of purchase and delivery costs, net of rebates and discounts received or receivable. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. ANNUAL REPORT 2020 | PACIFIC SMILES Non-current assets or disposal groups classified as held for sale Non-current assets and assets of disposal groups are classified as held for sale if their carrying amount will be recovered principally through a sale transaction rather than through continued use. They are measured at the lower of their carrying amount and fair value less costs of disposal. For non-current assets or assets of disposal groups to be classified as held for sale, they must be available for immediate sale in their present condition and their sale must be highly probable. An impairment loss is recognised for any initial or subsequent write down of the non-current assets and assets of disposal groups to fair value less costs of disposal. Any impairment loss on a disposal group is allocated first to goodwill, and then to the remaining assets and liabilities on a pro rata basis, except that no loss is allocated to inventories, financial assets, deferred tax assets, employee benefit assets, which continue to be measured in accordance with the consolidated entity’s other accounting policies. A gain is recognised for any subsequent increases in fair value less costs of disposal of a non-current assets and assets of disposal groups, but not in excess of any cumulative impairment loss previously recognised. Non-current assets are not depreciated or amortised while they are classified as held for sale. Interest and other expenses attributable to the liabilities of assets held for sale continue to be recognised. Non-current assets classified as held for sale and the assets of disposal groups classified as held for sale are presented separately on the face of the balance sheet, in current assets. The liabilities of disposal groups classified as held for sale are presented separately on the face of the balance sheet, in current liabilities. Property, plant and equipment Plant and equipment is stated at historical cost less accumulated depreciation and impairment. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Depreciation is calculated on a straight-line basis to write off the net cost of each item of property, plant and equipment (excluding land) over their expected useful lives as follows: Leasehold improvements Plant and equipment 10-20 years 3-10 years The residual values, useful lives and depreciation methods are reviewed, and adjusted if appropriate, at each reporting date. Leasehold improvements are depreciated over the unexpired period of the lease or the estimated useful life of the assets, whichever is shorter. An item of property, plant and equipment is derecognised upon disposal or when there is no future economic benefit to the consolidated entity. Gains and losses between the carrying amount and the disposal proceeds are taken to profit or loss. Right-of-use assets A right-of-use asset is recognised at the commencement date of a lease. The right-of-use asset is measured at cost, which comprises the initial amount of the lease liability, adjusted for, as applicable, any lease payments made at or before the commencement date net of any lease incentives received, any initial direct costs incurred, and, except where included in the cost of inventories, an estimate of costs expected to be incurred for dismantling and removing the underlying asset, and restoring the site or asset. Right-of-use assets are depreciated on a straight-line basis over the unexpired period of the lease or the estimated useful life of the asset, whichever is the shorter. Where the consolidated entity expects to obtain ownership of the leased asset at the end of the lease term, the depreciation is over its estimated useful life. Right-of use assets are subject to impairment or adjusted for any remeasurement of lease liabilities. 42 The consolidated entity has elected not to recognise a right-of-use asset and corresponding lease liability for short-term leases with terms of 12 months or less and leases of low-value assets. Lease payments on these assets are expensed to profit or loss as incurred. ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Intangible assets Intangible assets acquired as part of a business combination, other than goodwill, are initially measured at their fair value at the date of the acquisition. Intangible assets acquired separately are initially recognised at cost. Indefinite life intangible assets are not amortised and are subsequently measured at cost less any impairment. Finite life intangible assets are subsequently measured at cost less amortisation and any impairment. The gains or losses recognised in profit or loss arising from the derecognition of intangible assets are measured as the difference between net disposal proceeds and the carrying amount of the intangible asset. The method and useful lives of finite life intangible assets are reviewed annually. Changes in the expected pattern of consumption or useful life are accounted for prospectively by changing the amortisation method or period. Goodwill Goodwill arises on the acquisition of a business. Goodwill is not amortised. Instead, goodwill is tested annually for impairment, or more frequently if events or changes in circumstances indicate that it might be impaired, and is carried at cost less accumulated impairment losses. Impairment losses on goodwill are taken to profit or loss and are not subsequently reversed. Goodwill is allocated to relevant cash-generating units (CGU) for the purpose of impairment testing. Rights and licences Contractual rights and licences have a finite useful life and are carried at cost less accumulated amortisation and impairment losses. Amortisation is calculated using the straight line method to allocate the cost of the rights and licences over their estimated useful lives, being 15 years. Impairment of non-financial assets Goodwill and other intangible assets that have an indefinite useful life are not subject to amortisation and are tested annually for impairment, or more frequently if events or changes in circumstances indicate that they might be impaired. Other non-financial assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the asset’s carrying amount exceeds its recoverable amount. Recoverable amount is the higher of an asset’s fair value less costs of disposal and value-in-use. The value-in-use is the present value of the estimated future cash flows relating to the asset using a pre-tax discount rate specific to the asset or cash- generating unit to which the asset belongs. Assets that do not have independent cash flows are grouped together to form a cash-generating unit. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash inflows which are largely independent of the cash inflows from other assets or groups of assets (cash generating units). Non-financial assets other than goodwill that suffered an impairment are reviewed for possible reversal of the impairment at each reporting date. Cash inflows considered for the purposes of impairment testing are discounted to present value. Significant judgement has been used in testing assets for impairment and in determining the amounts recognised as impairment losses at reporting date. Further details of the key judgements and estimates along with any impairment loss recognised in the financial statements are provided in the notes dealing with the relevant asset category. Trade and other payables These amounts represent liabilities for goods and services provided to the consolidated entity prior to the end of the financial year and which are unpaid. Borrowings 43 Borrowings are measured at amortised cost. Borrowing costs are expensed as incurred. Borrowings are classified as current liabilities unless the consolidated entity has an unconditional right to defer settlement of the liabilities for at least twelve months after the reporting period. ANNUAL REPORT 2020 | PACIFIC SMILES Lease liabilities As a lessee: Lease liabilities are measured at amortised cost using the effective interest method. The carrying amounts are remeasured if there is a change in the following: future lease payments arising from a change in an index or a rate used; residual guarantee; lease term; certainty of a purchase option and termination penalties. When a lease liability is remeasured, an adjustment is made to the corresponding right-of use asset, or to profit or loss if the carrying amount of the right-of-use asset is fully written down. Rent concessions: The consolidated entity has applied the practical expedient to not assess rent concessions affecting payments due before the 30 June 2021 and has occurred as a direct consequence of the COVID-19 pandemic as a lease modification. The consolidated entity has recognised the amount as “other income” in profit or loss for the reporting period to reflect changes in lease payments that arise from rent concessions to which the lessee has applied the practical expedient. When the consolidated entity acts as a lessor, it determines at lease inception whether each lease is a finance lease or an operating lease. To classify each lease, the consolidated entity makes an overall assessment of whether the lease transfers substantially all of the risks and rewards incidental to ownership of the underlying asset. If this is the case, then the lease is a finance lease; if not, then it is an operating lease. As part of this assessment, the consolidated entity considers certain indicators such as whether the lease is for the major part of the economic life of the asset. As a lessor: When the consolidated entity acts as a lessor, it determines at lease inception whether each lease is a finance lease or an operating lease. To classify each lease, the consolidated entity makes an overall assessment of whether the lease transfers substantially all of the risks and rewards incidental to ownership of the underlying asset. If this is the case, then the lease is a finance lease; if not, then it is an operating lease. As part of this assessment, the consolidated entity considers certain indicators such as whether the lease is for the major part of the economic life of the asset. When the consolidated entity is an intermediate lessor, it accounts for its interests in the head lease and the sub-lease separately. It assesses the lease classification of a sub-lease with reference to the right-of-use asset arising from the head lease, not with reference to the underlying asset. If a head lease is a short-term lease to which the consolidated entity applies the exemption described above, then it classifies the sub-lease as an operating lease. If an arrangement contains lease and non- lease components, then the consolidated entity applies AASB 15 to allocate the consideration in the contract. The consolidated entity applies the derecognition and impairment requirements in AASB 9 to the net investment in the lease. The consolidated entity further regularly reviews estimated unguaranteed residual values used in calculating the gross investment in the lease. The consolidated entity recognises lease payments received under operating leases as income on a straight-line basis over the lease term as part of ‘other revenue’. Generally, the accounting policies applicable to the consolidated entity as a lessor in the comparative period were not different from AASB 16 except for the classification of the sub-lease entered into during current reporting period that resulted in a finance lease classification. Finance costs Finance costs attributable to qualifying assets are capitalised as part of the asset. All other finance costs are expensed in the period in which they are incurred. 44 Provisions Provisions are recognised when the consolidated entity has a present (legal or constructive) obligation as a result of a past event, it is probable the consolidated entity will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. The amount recognised as a provision is the best estimate of the consideration required to settle the present obligation at the reporting date, taking into account the risks and uncertainties surrounding the obligation. If the time value of money is material, provisions are discounted using a current pre-tax rate specific to the liability. The increase in the provision resulting from the passage of time is recognised as a finance cost. ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Make good provision The consolidated entity is required to restore most leased premises to their original condition at the end of their respective lease terms. A provision has been recognised for the present value of the estimated expenditure required to remove any leasehold improvements and repair any associated damage. These costs have been capitalised as part of the cost of leasehold improvements and are amortised over the shorter of the term of the lease or the useful life of the assets. Onerous contracts A provision for onerous contracts is recognised when the expected benefits to be derived by the consolidated entity from a contract are lower than the unavoidable cost of meeting its obligations under the contract. The provision is measured at the present value of the lower of the expected cost of terminating the contract and the expected net cost of continuing with the contract. Before a provision is established, the consolidated entity recognises any impairment loss on the assets associated with that contract. Restructuring A provision for restructuring is recognised when the consolidated entity has approved a detailed and formal restructuring plan, and the restructuring has either commenced or has been announced. Future operating losses are not provided for. Employee benefits Short-term employee benefits Short-term employee benefit obligations are measured on an undiscounted basis and are expensed as the related service is provided. The liabilities are measured at the amounts expected to be paid when the liabilities are settled. The liability for annual leave is recognised in the provision for employee benefits. All other short-term employee benefit obligations are presented as payables. Other long-term employee benefits The consolidated entity’s net obligation in respect of long-term employee benefits is the amount of future benefit that employees have earned in return for their service in the current and prior periods. Consideration is given to expected future wage and salary levels, experience of employee departures and periods of service. The benefit is discounted to determine its present value. Re-measurements are recognised in profit or loss in the period in which they arise. The obligations are presented as a current liability in the balance sheet if the Group does not have an unconditional right to defer settlement for at least twelve months after the reporting date, regardless of when the actual settlement is expected to occur. Defined contribution superannuation expense Contributions to defined contribution superannuation plans are expensed in the period in which they are incurred. Share-based payments Share-based compensation benefits are provided to selected employees via a long term incentive plan (LTI plan). The fair value of performance rights granted under the LTI plan is recognised as an employee benefits expense with a corresponding increase in equity. The total amount to be expensed is determined by reference to the fair value of the performance rights granted, which includes any market performance conditions and the impact of any non-vesting conditions but excludes the impact of any service and non-market performance vesting conditions. Non-market vesting conditions are included in assumptions about the number of performance rights that are expected to vest. The total expense is recognised over the vesting period, which is the period over which all of the specified vesting conditions are satisfied. At the end of each period, the consolidated entity revises its estimates of the number of performance rights that are expected to vest based on the non-market vesting conditions. It recognises the impact of the revision to original estimates, if any, in profit or loss, with a corresponding adjustment to equity. 45 ANNUAL REPORT 2020 | PACIFIC SMILES Fair value measurement When an asset or liability, financial or non-financial, is measured at fair value for recognition or disclosure purposes, the fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date; and assumes that the transaction will take place either: in the principal market; or in the absence of a principal market, in the most advantageous market. Fair value is measured using the assumptions that market participants would use when pricing the asset or liability, assuming they act in their economic best interests. For non-financial assets, the fair value measurement is based on its highest and best use. Valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair value, are used, maximising the use of relevant observable inputs and minimising the use of unobservable inputs. Issued capital Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds. Dividends Provision is made for the amount of any dividend declared, being appropriately authorised and no longer at the discretion of the company, on or before the end of the financial year but not distributed at the reporting date. Business combinations The acquisition method of accounting is used to account for business combinations regardless of whether equity instruments or other assets are acquired. The consideration transferred is the sum of the acquisition-date fair values of the assets transferred, equity instruments issued or liabilities incurred by the acquirer to former owners of the acquiree and the amount of any non-controlling interest in the acquiree. For each business combination, the non-controlling interest in the acquiree is measured at either fair value or at the proportionate share of the acquiree’s identifiable net assets. All acquisition costs are expensed as incurred to profit or loss. On the acquisition of a business, the consolidated entity assesses the financial assets acquired and liabilities assumed for appropriate classification and designation in accordance with the contractual terms, economic conditions, the consolidated entity’s operating or accounting policies and other pertinent conditions in existence at the acquisition-date. Where the business combination is achieved in stages, the consolidated entity remeasures its previously held equity interest in the acquiree at the acquisition-date fair value and the difference between the fair value and the previous carrying amount is recognised in profit or loss. Contingent consideration to be transferred by the acquirer is recognised at the acquisition-date fair value. Subsequent changes in the fair value of the contingent consideration classified as an asset or liability is recognised in profit or loss. Contingent consideration classified as equity is not remeasured and its subsequent settlement is accounted for within equity. The difference between the acquisition-date fair value of assets acquired, liabilities assumed and any non-controlling interest in the acquiree and the fair value of the consideration transferred and the fair value of any pre-existing investment in the acquiree is recognised as goodwill. If the consideration transferred and the pre-existing fair value is less than the fair value of the identifiable net assets acquired, being a bargain purchase to the acquirer, the difference is recognised as a gain directly in profit or loss by the acquirer on the acquisition-date, but only after a reassessment of the identification and measurement of the net assets acquired, the non-controlling interest in the acquiree, if any, the consideration transferred and the acquirer’s previously held equity interest in the acquirer. 46 Business combinations are initially accounted for on a provisional basis. The acquirer retrospectively adjusts the provisional amounts recognised and also recognises additional assets or liabilities during the measurement period, based on new information obtained about the facts and circumstances that existed at the acquisition-date. The measurement period ends on either the earlier of (i) 12 months from the date of the acquisition or (ii) when the acquirer receives all the information possible to determine fair value. ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Earnings per share Basic earnings per share Basic earnings per share is calculated by dividing the profit attributable to the owners of Pacific Smiles Group Limited, excluding any costs of servicing equity other than ordinary shares, by the weighted average number of ordinary shares outstanding during the financial year, adjusted for bonus elements in ordinary shares issued during the financial year. Diluted earnings per share Diluted earnings per share adjusts the figures used in the determination of basic earnings per share to take into account the after income tax effect of interest and other financing costs associated with dilutive potential ordinary shares and the weighted average number of shares assumed to have been issued for no consideration in relation to dilutive potential ordinary shares. Goods and Services Tax (‘GST’) and other similar taxes Revenues, expenses and assets are recognised net of the amount of associated GST, unless the GST incurred is not recoverable from the tax authority. In this case it is recognised as part of the cost of the acquisition of the asset or as part of the expense. Receivables and payables are stated inclusive of the amount of GST receivable or payable. The net amount of GST recoverable from, or payable to, the tax authority is included in other receivables or other payables in the balance sheet. Cash flows are presented on a gross basis. The GST components of cash flows arising from investing or financing activities which are recoverable from, or payable to the tax authority, are presented as operating cash flows. Commitments and contingencies are disclosed net of the amount of GST recoverable from, or payable to, the tax authority. Government grants Government grants shall be recognised in profit or loss on a systematic basis over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate. The consolidated entity recognises a government grant relating to JobKeeper payment as other income when the grant becomes receivable and when the consolidated entity has complied with the conditions associated with the grant. Rounding of amounts The company is of a kind referred to in Corporations Instrument 2016/191, issued by the Australian Securities and Investments Commission, relating to ‘rounding-off’. Amounts in this report have been rounded off in accordance with that Corporations Instrument to the nearest thousand dollars, or in certain cases, the nearest dollar. New Accounting Standards and Interpretations not yet mandatory or early adopted Australian Accounting Standards and Interpretations that have recently been issued or amended but are not yet mandatory, have not been early adopted by the consolidated entity for the annual reporting period ended 30 June 2020. The consolidated entity has not yet assessed the impact of these new or amended Accounting Standards and Interpretations. 47 ANNUAL REPORT 2020 | PACIFIC SMILES Note 3. Critical accounting judgements, estimates and assumptions The preparation of the financial statements requires management to make judgements, estimates and assumptions that affect the reported amounts in the financial statements. Management continually evaluates its judgements and estimates in relation to assets, liabilities, contingent liabilities, revenue and expenses. Management bases its judgements, estimates and assumptions on historical experience and on other various factors, including expectations of future events, management believes to be reasonable under the circumstances. The resulting accounting judgements and estimates will seldom equal the related actual results. The judgements, estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities (refer to the respective notes) within the next financial year are discussed below. Coronavirus (COVID-19) pandemic Judgement has been exercised in considering the impacts that the Coronavirus (COVID-19) pandemic has had, or may have, on the consolidated entity based on known information. This consideration extends to the nature of the products and services offered, customers, supply chain, staffing and geographic regions in which the consolidated entity operates. Other than as addressed in specific notes, there does not currently appear to be either any significant impact upon the financial statements or any significant uncertainties with respect to events or conditions which may impact the consolidated entity unfavourably as at the reporting date as a result of the Coronavirus (COVID-19) pandemic. Share-based payment transactions The consolidated entity measures the cost of equity-settled transactions with employees by reference to the fair value of the equity instruments at the date at which they are granted. The fair value is determined by using either the Binomial or Black- Scholes model taking into account the terms and conditions upon which the instruments were granted. The accounting estimates and assumptions relating to equity-settled share-based payments would have no impact on the carrying amounts of assets and liabilities within the next annual reporting period but may impact profit or loss and equity. Estimation of useful lives of assets The consolidated entity determines the estimated useful lives and related depreciation and amortisation charges for its property, plant and equipment and finite life intangible assets. The useful lives could change significantly as a result of technical innovations or some other event. The depreciation and amortisation charge will increase where the useful lives are less than previously estimated lives, or technically obsolete or non-strategic assets that have been abandoned or sold will be written off or written down. Goodwill and other indefinite life intangible assets The consolidated entity tests annually, or more frequently if events or changes in circumstances indicate impairment, whether goodwill and other indefinite life intangible assets have suffered any impairment, in accordance with the accounting policy stated in note 2. The recoverable amounts of cash-generating units have been determined based on value-in-use calculations. These calculations require the use of assumptions, including estimated discount rates based on the current cost of capital and growth rates of the estimated future cash flows. Impairment of non-financial assets other than goodwill and other indefinite life intangible assets The consolidated entity assesses impairment of non-financial assets other than goodwill and other indefinite life intangible assets at each reporting date by evaluating conditions specific to the consolidated entity and to the particular asset that may lead to impairment. If an impairment trigger exists, the recoverable amount of the asset is determined. This involves fair value less costs of disposal or value-in-use calculations, which incorporate a number of key estimates and assumptions. Income tax 48 The consolidated entity is subject to income taxes in the jurisdictions in which it operates. Significant judgement is required in determining the provision for income tax. There are many transactions and calculations undertaken during the ordinary course of business for which the ultimate tax determination is uncertain. The consolidated entity recognises liabilities for anticipated tax audit issues based on the consolidated entity’s current understanding of the tax law. Where the final tax outcome of these matters is different from the carrying amounts, such differences will impact the current and deferred tax provisions in the period in which such determination is made. ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Recovery of deferred tax assets Deferred tax assets are recognised for deductible temporary differences only if the consolidated entity considers it is probable that future taxable amounts will be available to utilise those temporary differences and losses. Employee benefits provision As discussed in note 2, the liability for employee benefits expected to be settled more than 12 months from the reporting date are recognised and measured at the present value of the estimated future cash flows to be made in respect of all employees at the reporting date. In determining the present value of the liability, estimates of attrition rates and pay increases through promotion and inflation have been taken into account. Lease make good provision A provision has been made for the present value of anticipated costs for future restoration of leased premises. The provision includes future cost estimates associated with closure of the premises. The calculation of this provision requires assumptions such as application of closure dates and cost estimates. The provision recognised for each site is periodically reviewed and updated based on the facts and circumstances available at the time. Changes to the estimated future costs for sites are recognised in the balance sheet by adjusting the asset and the provision. Reductions in the provision that exceed the carrying amount of the asset will be recognised in profit or loss. Note 4. Operating segments The consolidated entity is organised into one operating segment, being activities within the dental sector throughout Eastern Australia. This operating segment is based on the internal reports that are reviewed and used by the consolidated entity’s Chief Executive Officer, who is identified as the chief operating decision maker, in assessing performance and in determining the allocation of resources. The consolidated entity’s operation inherently has one profile and performance assessment criteria. The financial results from this segment are consistent with the financial statements for the consolidated entity as a whole. Note 5. Revenue Dental service fees Dental product sales Revenue Note 6. Other income Government grant Rents Sundry income Other income Government grants 2020 $’000 2019 $’000 119,584 121,656 471 500 120,055 122,156 2020 $’000 8,373 747 700 9,820 2019 $’000 – 1,207 42 1,249 Government grant income relates to JobKeeper payments received or receivable from the federal government. 49 ANNUAL REPORT 2020 | PACIFIC SMILES Note 7. Expenses Profit before income tax includes the following specific expenses: Depreciation Leasehold improvements Plant and equipment Right-of-use assets Total depreciation Amortisation Rights and licences Total depreciation and amortisation Impairment Receivables Software development asset Total impairment Finance costs Interest and finance charges paid/payable on borrowings Interest and finance charges paid/payable on lease liabilities Interest received/receivable Finance costs expensed Superannuation expense 2020 $’000 2019 $’000 5,236 5,548 9,183 4,685 4,649 – 19,967 9,334 66 20,033 65 9,399 71 836 907 742 2,790 (77) 3,455 64 – 64 697 – (35) 662 Defined contribution superannuation expense 4,342 4,151 Share-based payments expense Share-based payments expense Direct expenses Direct expenses 490 (97) 10,639 11,833 Direct expenses relate to the cost of the sale of dental products and dental practitioner employment costs 50 ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Note 8. Income tax Income tax expense Current tax Deferred tax Adjustment recognised for prior periods Adjustment on initial application of AASB 16 Aggregate income tax expense Deferred tax included in income tax expense comprises: Increase in deferred tax assets Numerical reconciliation of income tax expense and tax at the statutory rate Profit before income tax expense Tax at the statutory tax rate of 30% Tax effect amounts which are not deductible/(taxable) in calculating taxable income: Entertainment expenses Share-based payments Building write-off deduction Sundry items Adjustment recognised for prior periods Income tax expense 2020 $’000 4,455 (3,093) (7) 1,633 2,988 2019 $’000 4,710 (1,044) – – 3,666 (3,093) (1,044) 9,371 12,239 2,811 3,672 39 147 (2) – 2,995 (7) 2,988 – (29) – 23 3,666 – 3,666 51 ANNUAL REPORT 2020 | PACIFIC SMILES Deferred tax asset Deferred tax asset comprises temporary differences attributable to: Amounts recognised in profit or loss: Allowance for expected credit losses Property, plant and equipment Employee benefits Lease liabilities Accrued expenses Borrowing costs Intangibles Lease receivables Right of use assets Prepayments Deferred tax asset Movements: Opening balance Credited to profit or loss Closing balance Provision for income tax Provision for income tax Note 9. Current assets – cash and cash equivalents Cash at bank and in hand Note 10. Current assets – receivables Trade receivables Less: Allowance for expected credit losses Finance lease receivables 52 Other receivables 2020 $’000 2019 $’000 53 3,314 2,276 18,959 349 – (176) (177) (15,541) 44 9,101 6,008 3,093 9,101 2020 $’000 32 2,648 3,211 – 285 3 (196) – – 25 6,008 4,964 1,044 6,008 2019 $’000 1,654 1,385 2020 $’000 15,279 2020 $’000 567 (176) 391 362 3,508 4,261 2019 $’000 6,951 2019 $’000 908 (107) 801 – 286 1,087 ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Note 11. Current assets – inventories Inventories – at cost Note 12. Current assets – other Prepayments Other 2020 $’000 4,051 2020 $’000 315 147 462 Note 13. Current assets – assets of disposal groups classified as held for sale Assets held for sale 2020 $’000 630 2019 $’000 3,672 2019 $’000 340 214 554 2019 $’000 – Management have committed to a plan to sell part of the laboratory business of Everything Dentures Pty Limited. Accordingly, the laboratory part of the business is presented as a disposal group held for sale. Efforts to sell the disposal group have started and a sale is expected during the next financial year. Assets of disposal group held for sale Property, plant and equipment Goodwill Inventory Assets held for sale Refer to note 21 for further information on liabilities of the disposal group classified as held for sale. Note 14. Non-current assets – receivables Finance lease receivables Note 15. Non-current assets – property, plant and equipment Leasehold improvements – at cost Less: Accumulated depreciation and impairment Plant and equipment – at cost Less: Accumulated depreciation and impairment 2020 $’000 293 265 72 630 2020 $’000 227 2019 $’000 – 2020 $’000 57,045 (25,168) 31,877 50,496 (31,174) 19,322 51,199 2019 $’000 56,439 (21,208) 35,231 46,852 (27,441) 19,411 54,642 53 ANNUAL REPORT 2020 | PACIFIC SMILES Reconciliations Reconciliations of the written down values at the beginning and end of the current and previous financial year are set out below: Balance at 1 July 2018 Additions Disposals Depreciation expense Balance at 30 June 2019 Additions Classified as held for sale Disposals Impairment of assets Reversal of make good assets on initial application of AASB 16 Depreciation expense Balance at 30 June 2020 Note 16. Non-current assets – right-of-use assets Leaseholds – right-of-use Less: Accumulated depreciation Reconciliations Leasehold improve- ments $’000 Plant and equipment $’000 31,537 8,497 (118) (4,685) 35,231 3,215 (40) (93) – (1,200) (5,236) 31,877 15,787 8,302 (29) (4,649) 19,411 6,882 (253) (1,169) (836) – (5,548) 19,322 2020 $’000 60,956 (9,151) 51,805 Total $’000 47,324 16,799 (147) (9,334) 54,642 10,096 (293) (1,262) (836) (1,200) (10,784) 51,199 2019 $’000 – – – Reconciliations of the written down values at the beginning and end of the current and previous financial year are set out below: Balance at 1 July 2018 Balance at 30 June 2019 Adjustment on initial application of AASB 16 Disposals Additions Depreciation expense Balance at 30 June 2020 54 $’000 – – Total $’000 – – 54,187 54,187 (32) 6,833 (9,183) 51,805 (32) 6,833 (9,183) 51,805 ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Note 17. Non-current assets – intangibles Goodwill Less: Impairment Rights and licences Less: Accumulated amortisation Reconciliations 2020 $’000 12,915 (2,894) 10,021 985 (398) 587 2019 $’000 13,180 (2,894) 10,286 985 (332) 653 10,608 10,939 Reconciliations of the written down values at the beginning and end of the current and previous financial year are set out below: Balance at 1 July 2018 Amortisation expense Balance at 30 June 2019 Classified as held for sale Amortisation expense Balance at 30 June 2020 Goodwill $’000 10,286 – 10,286 (265) – 10,021 Rights and licences $’000 718 (65) 653 – (66) 587 Total $’000 11,004 (65) 10,939 (265) (66) 10,608 Impairment testing for cash-generating units (CGUs) The impairment assessments for each CGU are made on the basis of the assets’ expected value in use and involve the use of key assumptions. Recoverable amounts of the CGUs exceeded their carrying values, therefore no impairment losses were recorded in the financial year. For the purpose of impairment testing, the carrying amount of goodwill has been allocated to groups of CGUs as below: New South Wales Victoria Queensland Total goodwill 2020 $’000 2019 $’000 4,944 2,631 2,446 5,209 2,631 2,446 10,021 10,286 The calculations use discounted cash flow projections covering a ten-year period, which is consistent with the typical lease term entered into for the consolidated entity’s dental centre locations, and matches the average growth profile of our dental centres. The cash flows for years one to five are based on detailed management projections, which consider historical financial results and trends, the Board-approved financial budget for the next financial year and reasonable expectations regarding future business and market circumstances. Cash flows beyond the first five year period are extrapolated to year ten using an estimated growth rate of 3%. The cash flow projections for years 1 to 5 are based on key assumptions including dentist numbers, number of operating chairs, practitioner hours, patient demand and associated costs. 55 A long term growth rate of 2.5% is used beyond year ten in determining the terminal values, which is considered reasonable in the context of the long term growth rates for the markets in which each CGU operates. Future cash flows are discounted using the consolidated entity’s weighted average cost of capital of 9.6% (2019: 9.3%). ANNUAL REPORT 2020 | PACIFIC SMILES Rights and licences As part of the consolidated entity’s acquisition of the three former ahm dental centres, the consolidated entity received preferential provider support from ahm. These rights and licenses relate to ahm marketing rights at each Pacific Smiles dental centre with 9 amortisation periods remaining as at balance date. Note 18. Current liabilities – payables Trade payables Contingent consideration payable Note 19. Current liabilities – lease liabilities Lease liability Refer to note 28 for further information on financial instruments. Note 20. Current liabilities – provisions Employee benefits Deferred lease incentives Onerous contracts Refer to note 24 for further information on movements in provisions. Note 21. Current liabilities – liabilities directly associated with assets classified as held for sale Liabilities held for sale Liabilities of disposal group held for sale Employee benefits – annual leave Employee benefits – other 56 Liabilities held for sale 2020 $’000 2019 $’000 16,168 12,187 – 298 16,168 12,485 2020 $’000 9,959 2019 $’000 – 2020 $’000 4,354 – – 2019 $’000 3,504 234 33 4,354 3,771 2020 $’000 122 2020 $’000 77 45 122 2019 $’000 – 2019 $’000 – – – ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Note 22. Non-current liabilities – borrowings Bank loans Total secured liabilities The total secured liabilities (current and non-current) are as follows: Bank loans Assets pledged as security 2020 $’000 2019 $’000 22,000 17,000 2020 $’000 2019 $’000 22,000 17,000 The bank loans are secured by registered equitable mortgage over the whole of the assets and undertakings of the consolidated entity, including uncalled capital and inter-entity guarantees. Financing arrangements Unrestricted access was available at the reporting date to the following lines of credit: Total facilities Bank overdraft Bank loans Bank guarantees Used at the reporting date Bank overdraft Bank loans Bank guarantees Unused at the reporting date Bank overdraft Bank loans Bank guarantees Covenants attached to bank borrowings were complied with during the financial year. Note 23. Non-current liabilities – lease liabilities Lease liability Refer to note 28 for further information on financial instruments. 2020 $’000 2019 $’000 500 30,000 4,000 34,500 – 22,000 3,025 25,025 500 8,000 975 9,475 500 20,000 4,000 24,500 – 17,000 2,962 19,962 500 3,000 1,038 4,538 2020 $’000 53,240 2019 $’000 – 57 ANNUAL REPORT 2020 | PACIFIC SMILES Note 24. Non-current liabilities – provisions Employee benefits Deferred lease incentives Lease make good Movements in provisions 2020 $’000 1,016 – 2,217 3,233 2019 $’000 814 5,186 2,130 8,130 Movements in each class of provision (current and non-current) during the current financial year, other than employee benefits, are set out below: 2020 Carrying amount at the start of the year Change in accounting policy Additional provisions recognised Carrying amount at the end of the year Note 25. Equity – contributed equity Straight-line lease adjustment $’000 Make good provision $’000 Onerous contracts $’000 5,420 (5,420) – – 2,130 – 87 2,217 33 (33) – – Ordinary shares – fully paid 153,515,550 151,993,395 36,769 35,053 2020 Shares 2019 Shares 2020 $’000 2019 $’000 Movements in ordinary share capital Details Balance Balance Date Shares Issue price 1 July 2018 151,993,395 30 June 2019 151,993,395 Dividend reinvestment plan 20 April 2020 1,522,155 $1.13 Balance Ordinary shares 30 June 2020 153,515,550 $’000 35,053 35,053 1,716 36,769 Ordinary shares entitle the holder to participate in dividends and the proceeds on the winding up of the company in proportion to the number of shares held. At shareholders’ meetings, each ordinary share is entitled to one vote when a poll is called, otherwise each shareholder has one vote on a show of hands. Capital risk management 58 The consolidated entity’s objectives when managing capital are to safeguard its ability to continue as a going concern, so that it can continue to provide returns for shareholders and benefits for other stakeholders, maintain sufficient financial flexibility to pursue its growth objectives, and maintain an optimum capital structure to reduce the cost of capital. The consolidated entity monitors its working capital continually and manages it within a Board approved finance facility. Debt covenants are consistently achieved and monitored monthly. Capital is regarded as total equity, as recognised in the balance sheet, plus net debt. Net debt is calculated as total borrowings less cash and cash equivalents. ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Note 26. Equity – reserves Profits reserve Share-based payments reserve Profits reserve 2020 $’000 3,264 670 3,934 2019 $’000 – 180 180 The profits reserve represents current year profits transferred to a reserve to preserve the characteristic as a profit so as to quarantine from being appropriated against accumulated losses arising from the adoption of AASB 16. Such profits are available to enable payment of franked dividends in the future should the Directors declare so by resolution. Note 27. Equity – dividends Dividends Dividends paid during the financial year were as follows: Final dividend for the year ended 30 June 2019 of 3.50 cents (2018: 3.80 cents) per ordinary share, fully franked Interim dividend for the year ended 30 June 2020 of 2.40 cents (2019: 2.30 cents) per ordinary share, fully franked 2020 $’000 5,320 2019 $’000 5,776 3,648 3,496 8,968 9,272 Dividend reinvestment plan The consolidated entity’s dividend reinvestment plan (DRP) applied to the fully franked interim dividend of 2.40 cents per share announced on 20 February 2020. The DRP allowed eligible shareholders to reinvest all or part of their dividend payments into Pacific Smiles shares. The price at which shares are allocated under the DRP is the daily volume weighted average market price of the company’s shares sold in the ordinary course of trading on the ASX over a period of 5 days beginning on 20 April 2020. Shares allocated under the DRP rank equally with the company’s existing fully paid ordinary shares. The DRP resulted in shareholders electing to receive an additional 1,522,155 shares in total, priced at $1.716 million. There were no dividends declared but not recognised at the of the financial year. [TBC] Franking credits Franking credits available for subsequent financial years based on a tax rate of 30% 2020 $’000 10,296 2019 $’000 11,848 The above amounts represent the balance of the franking account as at the end of the financial year, adjusted for franking credits that will arise from the payment of the amount of income tax payable or collection of income tax receivable. The consolidated amount includes franking credits that would be available to the parent entity if distributed profits of subsidiaries were paid as dividends. 59 ANNUAL REPORT 2020 | PACIFIC SMILES Note 28. Financial instruments Financial risk management objectives The consolidated entity’s activities expose it to a variety of financial risks: market risk (interest rate risk), credit risk and liquidity risk. The Board has overall responsibility for the establishment and oversight of the risk management framework, and is supported by the Board Audit and Risk Management Committee. Senior management develops and monitors risk management policy, and reports regularly to the Directors on issues and compliance matters. Risk management principles and systems are reviewed regularly to reflect changes in market conditions and the consolidated entity’s activities. The consolidated entity’s principal financial instruments during the 2020 and 2019 financials years comprised bank and other loans, and cash. The main purpose of these instruments has been to raise finance for the consolidated entity’s operations and investments. The consolidated entity has various other financial instruments such as trade and other debtors and creditors, which arise directly from its operations. The consolidated entity does not trade in financial instruments. Market risk Interest rate risk The consolidated entity’s exposure to market risk for changes in interest rates at the end of the year was minimal, with bank debt partially offset by cash balances at 30 June. Cash balances are held in a combination of short term fixed interest deposit accounts and other cheque and on-call accounts which attract variable interest rates. The weighted average interest rate on cash balances at the end of the year was 0.25% (2019: 0.67%). Variable rate bank loans totalling $22,000,000 form part of an ongoing loan facility which was updated during the 2020 financial year. The overall facility term expires on 30 September 2022. The loans are subject to interest charged at the prevailing variable rate payable on each reset date. The weighted average interest rate on borrowings at the end of the year was 4.11% (2019: 3.82%). Basis points increase Basis points decrease Basis points change 100 Effect on profit before tax Effect on equity (138) (138) Basis points change 100 Effect on profit before tax Effect on equity 138 138 Basis points increase Basis points decrease Basis points change 100 Effect on profit before tax Effect on equity (114) (114) Basis points change 100 Effect on profit before tax Effect on equity 114 114 2020 Variable rate bank loans 2019 Variable rate bank loans Credit risk The consolidated entity has no significant concentrations of credit risk. The consolidated entity does not have significant credit exposure to any one financial institution or customer. The consolidated entity only transacts with reputable Australian banks and its credit risk on trade receivables is not considered significant. 60 ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Liquidity risk The consolidated entity’s objective is to maintain a balance between continuity of funding and flexibility through the use of working capital and bank borrowings. The consolidated entity aims to achieve this flexibility by keeping committed credit lines available. Opportunities to raise additional capital from shareholders are also considered where appropriate. The Group manages liquidity risk by continuously monitoring forecast and actual cash flows to ensure sufficient liquidity is always available to meet liability obligations as they fall due. The Group’s balance sheet shows an excess of current liabilities over current assets at balance date of $8.021 million. Liabilities have been classified as current where it is probable that they will be settled within twelve months or if there is a contractual obligation that may require settlement within twelve months, regardless of how likely settlement under contractual arrangements is judged to be. The Group’s current assets, available financing facilities, and ongoing positive operating cash flows continue to be sufficient to satisfy all payment obligations within the time-frames required. Remaining contractual maturities The following tables detail the consolidated entity’s remaining contractual maturity for its financial instrument liabilities. The tables have been drawn up based on the undiscounted cash flows of financial liabilities based on the earliest date on which the financial liabilities are required to be paid. The tables include both interest and principal cash flows disclosed as remaining contractual maturities and therefore these totals may differ from their carrying amount in the balance sheet. 2020 Non-derivatives Non-interest bearing Trade payables Interest-bearing – variable Bank loans Total non-derivatives 2019 Non-derivatives Non-interest bearing Trade payables Interest-bearing – variable Bank loans Total non-derivatives Less than 6 months $’000 Between 6 and 12 months $’000 Between 1 and 5 years $’000 Remaining contractual maturities $’000 16,168 – – 16,168 236 16,404 236 236 22,591 22,591 23,063 39,231 Less than 6 months $’000 Between 6 and 12 months $’000 Between 1 and 5 years $’000 Remaining contractual maturities $’000 12,485 – – 12,485 136 12,621 136 136 17,067 17,067 17,339 29,824 The cash flows in the maturity analysis above are not expected to occur significantly earlier than contractually disclosed above. Fair value 61 Unless otherwise stated, the carrying amounts of financial instruments reflect their fair value. ANNUAL REPORT 2020 | PACIFIC SMILES Note 29. Key management personnel disclosures Compensation The aggregate compensation made to Directors and other members of key management personnel of the consolidated entity is set out below: Short-term employee benefits Post-employment benefits Long-term benefits Termination benefits Share-based payments 2020 $ 2019 $ 1,450,085 1,424,895 86,204 17,967 88,084 23,905 – 450,000 354,272 (53,112) 1,908,528 1,933,772 Note 30. Remuneration of auditors During the financial year the following fees were paid or payable for services provided by KPMG, the auditor of the company: Audit services Audit or review of the financial statements Other services Tax compliance and advisory services Note 31. Contingent liabilities Bank guarantees 2020 $ 2019 $ 130,012 128,850 26,134 40,743 156,146 169,593 2020 $’000 3,025 2019 $’000 2,962 The consolidated entity has given bank guarantees as at 30 June 2020 of $3,025,000 (2019: $2,962,000) to various landlords as security for leased premises. 62 ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Note 32. Commitments Capital commitments Committed at the reporting date but not recognised as liabilities, payable: Property, plant and equipment Lease commitments – operating Committed at the reporting date but not recognised as liabilities, payable: Within one year One to five years More than five years Lease commitments – finance Committed at the reporting date and recognised as liabilities, payable: Within one year One to five years More than five years Total commitment Less: Future finance charges Net commitment recognised as liabilities Note 33. Related party transactions Parent entity Pacific Smiles Group Limited is the parent entity. Key management personnel 2020 $’000 2019 $’000 952 2,611 111 40 – 151 11,589 39,685 23,232 74,506 12,522 41,742 19,041 73,305 (10,106) 63,199 – – – – – – Disclosures relating to key management personnel are set out in note 29 and the remuneration report included in the Directors’ report. Transactions with related parties Other than remuneration for their positions as Directors and executives of the consolidated entity, key management personnel or entities related to them entered into a number of transactions with the consolidated entity. Information on these transactions is set out below. Key management personnel or their related parties held shares in the consolidated entity during 2020 and 2019, and as such, participated in dividends. Bislab Pty Limited ATF the Canyon Property Trust, an entity related to Alex Abrahams and Simon Rutherford, leased business premises to the consolidated entity during 2019 and up until August 2019 on normal commercial terms and conditions. Exandal Investments, an entity related to Alex Abrahams and Alison Hughes, leased business premises to the consolidated entity during 2020 and 2019 on normal commercial terms and conditions. 63 88 Park Avenue Pty Limited ATF the Key Health Unit Trust, an entity related to Alex Abrahams, leased business premises to the consolidated entity during 2020 and 2019 on normal commercial terms and conditions. ANNUAL REPORT 2020 | PACIFIC SMILES The following transactions occurred with related parties: Revenues from rendering services Dividends paid Rental expenses Consulting fees paid 2020 $ – 2019 $ 2,535 3,408,498 3,945,582 313,315 710,611 30,000 80,861 The following balances are outstanding at the reporting date in relation to transactions with related parties: Current payables: Trade payables to other related party Note 34. Parent entity information Set out below is the supplementary information about the parent entity. Statement of profit or loss and other comprehensive income Profit after income tax Total comprehensive income Balance sheet Total current assets Total assets Total current liabilities Total liabilities Equity Contributed equity Profits reserve Share-based payments reserve Retained profits/(accumulated losses) Total equity Contingent liabilities 2020 $ 2019 $ 17,416 – 2020 $’000 6,362 6,362 2020 $’000 23,811 146,009 30,238 108,643 2019 $’000 8,555 8,555 2019 $’000 11,915 82,171 15,472 40,602 36,769 35,053 3,264 670 (3,337) – 180 6,336 37,366 41,569 The parent entity had no contingent liabilities, other than bank guarantees as at 30 June 2020 totaling $3,025k (30 June 2019: $2,962k). 64 ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Note 35. Events after the reporting period Coronavirus (COVID-19) pandemic The impact of the Coronavirus (COVID-19) pandemic is ongoing, and it is not practicable to estimate the potential impact after the reporting date. There has been no material impact to the consolidated entity’s financial performance or position arising from the pandemic from the end of the reporting period to the date of this report. The situation is ongoing and is dependent on measures imposed by the Australian Government and other countries, such as maintaining social distancing requirements, quarantine, travel restrictions and any economic stimulus that may be provided. Management services agreement with HBF Pacific Smiles has signed an initial 10-year base term Management Services Agreement (MSA) with Western Australian health fund HBF in early July 2020. Under the agreement HBF will build a minimum of 5 HBF Dental (HBFD) clinics across Western Australia over the next 18 months. Pacific Smiles will be the exclusive operator of these and any additional HBFD clinics rolled out in Western Australia for the term of the MSA. Pacific Smiles will receive a percentage of revenue from the operations in return for providing comprehensive operational support for the design, construction, and all aspects of the clinics’ day to day operations. HBF will be responsible for funding capital expenditure and in-clinic operating costs. Pacific Smiles does not expect the arrangement to be material to earnings within the first year of operation. Resignation of director Dr Alex Abrahams has resigned as Non-executive Director on 23 July 2020. Other events No other matter or circumstance has arisen since 30 June 2020 that has significantly affected, or may significantly affect the consolidated entity’s operations, the results of those operations, or the consolidated entity’s state of affairs in future financial years. Note 36. Cash flow information Reconciliation of profit after income tax to net cash from operating activities Profit after income tax expense for the year Adjustments for: Depreciation and amortisation Net profit on disposal of non-current assets Net loss on disposal of property, plant and equipment Share-based payments Change in operating assets and liabilities: Increase in receivables Increase in inventories Increase in deferred tax assets Decrease/(increase) in other operating assets Increase in payables Increase in other provisions Increase/(Decrease) in income tax Net cash from operating activities 2020 $’000 6,383 2019 $’000 8,573 20,033 9,399 – 1,209 490 (2,815) (450) (1,459) 90 3,810 1,018 268 (15) – (97) (218) (412) (1,044) (89) 1,294 1,480 2,156 28,577 21,027 65 ANNUAL REPORT 2020 | PACIFIC SMILES Note 37. Earnings per share Profit after income tax Basic earnings per share Diluted earnings per share 2020 $’000 6,383 2019 $’000 8,573 Cents Cents 4.2 4.2 5.6 5.6 Number Number Weighted average number of ordinary shares used in calculating basic earnings per share 152,214,420 151,993,395 Weighted average number of ordinary shares used in calculating diluted earnings per share 152,214,420 151,993,395 Performance rights Performance rights granted to employees under the consolidated entity’s long term incentive plan are considered to be potential ordinary shares and are only included in the determination of diluted earnings per share to the extent to which they are dilutive. The total 9,301,000 performance rights on issue are not included in the calculation of diluted earnings per share because they are contingently issuable ordinary shares and conditions were not satisfied at 30 June 2020. These performance rights could potentially dilute basic earnings per share in the future. Note 38. Share-based payments Long term incentive plan overview The consolidated entity has established a long term incentive plan (LTI) to assist in the motivation, retention and reward of senior management. The LTI plan is designed to align the interests of senior management more closely with the interests of shareholders by providing an opportunity for senior management to receive an equity interest in the consolidated entity through the granting of performance rights. Performance rights have been issued to the Chief Executive Officer and selected senior managers, at the absolute discretion of the Board, pursuant to the LTI plan in financial years 2020, 2019, 2018, 2017 and 2016. The performance rights will vest after a set term (the performance period), and are conditional on the achievement of relevant performance and service conditions. Vesting of the performance rights for the years 2018, 2017, and 2016 will be subject to: • satisfaction of earnings per share (EPS) performance hurdles for a four year performance period. The number of performance rights vesting will be determined on a sliding scale from nil vesting for an EPS compound annual growth rate (CAGR) of 15.0% per annum or less and 100% vesting for an EPS CAGR of 25.0% per annum; and • the participant remaining employed by Pacific Smiles Group, or its subsidiaries over a four year period through to the vesting date, subject to certain ‘good leaver’ exemptions. Vesting of the performance rights for the years 2020 and 2019 will be subject to: • satisfaction of EPS performance hurdles for a four year performance period. The number of performance rights vesting will be determined on a sliding scale from nil vesting for an EPS CAGR of 10.0% per annum or less and 100% vesting for an EPS CAGR of 25.0% per annum; and 66 • the participant remaining employed by Pacific Smiles Group, or its subsidiaries over a four year period through to the vesting period, subject to certain ‘good leaver’ exemptions. Performance rights that do not vest on the relevant vesting date will lapse. Performance rights will also lapse if total shareholder return does not reach a minimum threshold over the relevant performance period. ANNUAL REPORT 2020 | PACIFIC SMILES Notes to the Consolidated Financial StatementsFor the year ended 30 June 2020 Set out below are summaries of options granted under the plan: 2020 Grant date 30/11/2015 30/11/2016 01/12/2017 04/03/2019 13/02/2020 Expiry date 30/11/2019 30/11/2020 01/12/2021 04/03/2023 13/02/2024 Balance at the start of the year 1,225,000 1,700,000 1,600,000 3,026,000 – 7,551,000 Granted – – – – 3,500,000 3,500,000 Expired/ forfeited/ other (1,225,000) (200,000) (325,000) – – (1,750,000) Balance at the end of the year – 1,500,000 1,275,000 3,026,000 3,500,000 9,301,000 The weighted average remaining contractual life of options outstanding at the end of the financial year was 2.48 years (2019: 2.37 years). The fair values at grant dates have been determined via pricing models which use a Monte Carlo simulation, and take into account the following inputs: Grant date Fair value of right Share price at grant date Exercise price Term Expected price volatility Expected dividend yield Risk free interest rate 2020 2019 13 February 2020 4 March 2019 $0.61 $1.82 Nil 4 years 30.0% 4.0% 1.2% $0.47 $1.33 Nil 4 years 30.0% 4.0% 2.0% 67 ANNUAL REPORT 2020 | PACIFIC SMILES Directors’ Declaration In the directors’ opinion: • the attached financial statements and notes comply with the Corporations Act 2001, the Accounting Standards, the Corporations Regulations 2001 and other mandatory professional reporting requirements; • the attached financial statements and notes comply with International Financial Reporting Standards as issued by the International Accounting Standards Board as described in note 2 to the financial statements; • the attached financial statements and notes give a true and fair view of the consolidated entity’s financial position as at 30 June 2020 and of its performance for the financial year ended on that date; and • there are reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable. The Directors have been given the declarations required by section 295A of the Corporations Act 2001. Signed in accordance with a resolution of Directors made pursuant to section 295(5)(a) of the Corporations Act 2001. On behalf of the Directors Zita Peach Chairperson 19 August 2020 68 ANNUAL REPORT 2020 | PACIFIC SMILES Independent Auditor’s Report Independent Auditor’s Report To the shareholders of Pacific Smiles Group Limited Report on the audit of the Financial Report Opinion We have audited the Financial Report of Pacific Smiles Group Limited (the Company). In our opinion, the accompanying Financial Report of the Company is in accordance with the Corporations Act 2001, including: • • giving a true and fair view of the Group’s financial position as at 30 June 2020 and of its financial performance for the year ended on that date; and complying with Australian Accounting Standards and the Corporations Regulations 2001. Basis for opinion The Financial Report comprises: • Consolidated balance sheet as at 30 June 2020; • Consolidated statement of profit or loss and other comprehensive income, consolidated statement of changes in equity, and consolidated statement of cash flows for the year then ended; • Notes including a summary of significant accounting policies; and • Directors’ Declaration. The Group consists of the Company and the entities it controlled at the year-end or from time to time during the financial year. We conducted our audit in accordance with Australian Auditing Standards. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the Financial Report section of our report. We are independent of the Group in accordance with the Corporations Act 2001 and the ethical requirements of the Accounting Professional and Ethical Standards Board’s APES 110 Code of Ethics for Professional Accountants (the Code) that are relevant to our audit of the Financial Report in Australia. We have fulfilled our other ethical responsibilities in accordance with the Code. 69 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. Liability limited by a scheme approved under Professional Standards Legislation. ANNUAL REPORT 2020 | PACIFIC SMILES Key Audit Matters The Key Audit Matters we identified are: • Carrying value of intangible assets • Revenue recognition • Accounting for leases in accordance with AASB 16 Leases Key Audit Matters are those matters that, in our professional judgement, were of most significance in our audit of the Financial Report of the current period. These matters were addressed in the context of our audit of the Financial Report as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. Carrying value of intangible assets ($10,608,000) Refer to Note 17 to the Financial Report The key audit matter How the matter was addressed in our audit The carrying value of intangible assets, including the Group’s annual testing of goodwill for impairment was identified as a key audit matter due to the: • • Size of the balance; and Significant level of judgement required to assess the Group’s forecasts and discounted future cashflows, including higher estimation uncertainty arising from the impact of the COVID-19 global pandemic. We focussed on the significant forward-looking assumptions the Group applied in its value in use model, including: • Forecast operating cash flows, growth rates and terminal growth rates – the Group has experienced business disruption in the current year as a result of COVID-19, including the shutdown of 76 dental centres during April 2020. These conditions and continued uncertainty increase the possibility of goodwill and intangible assets being impaired, and the risk of inaccurate forecasts or a wider range of possible impacts such as government imposed restrictions for us to consider. We focused on the expected period for return to normal operations for the Group when assessing the feasibility of the Group’s forecast cashflows. • Discount rates - these are complicated in nature and vary according to the conditions and environment the Cash Generating Units Our procedures included: • We considered the appropriateness of the value-in-use method applied by the Group to perform its annual impairment testing of intangible assets against the requirements of the relevant accounting standards. We: - - - - Assessed the Group’s underlying methodology and documentation for the allocation of corporate costs to the forecast cash flows in the value in use model for consistency with our understanding of the business and the criteria in the accounting standards; Assessed the Group’s determination of its CGUs based on our understanding of the operations of the Group’s business including the impact of the 5 new centres opened during the financial year and how independent cash inflows were generated, against the requirements of the relevant accounting standards; Assessed the Group’s allocation of corporate assets to CGUs for reasonableness and consistency based on the requirements of the accounting standards; Assessed the Group’s determination of CGU assets for consistency with the assumptions used in the forecast cash flows and the requirements of the accounting standards; 70 ANNUAL REPORT 2020 | PACIFIC SMILES Independent Auditor’s Report (CGUs) are subject to from time to time, and the models approach to incorporating risks into the cash flows or discount rates. The Group’s modelling is sensitive to changes in the discount rate. Complex modelling, particularly those containing highly judgemental allocations of corporate assets and costs to CGUs, using forward-looking assumptions, tend to be prone to greater risk for potential bias, error and inconsistent application. These conditions necessitate additional scrutiny by us. The Group has a large number of individual dental centre locations, which includes 5 new centres opened during the financial year, necessitating our consideration of the Group’s determination of Cash Generating Units (CGUs), based on the smallest group of assets to generate largely independent cash inflows. - - - Compared forecast cash flows in the model to Board approved forecasts; Checked the consistency of the growth rates to the Group's forecasts and our experience regarding the COVID-19 economic environment in which it operates; and Assessed the accuracy of previous Group forecasts to inform our evaluation of forecasts incorporated in the model. • We considered the sensitivity of the model by varying key assumptions, such as forecast growth rates, terminal growth rates and discount rates, within a reasonably possible range, to identify those CGUs at higher risk of impairment and to focus our further procedures; • Working with our valuation specialists we: - - - Developed a discount rate range using publicly available market data for comparable entities, adjusted by risk factors based on the size and location of the Group’s CGUs; Assessed the integrity of the model used, including the accuracy of the underlying calculation formulas; and Challenged the Group's significant forecast cash flows and growth assumptions in light of the uncertainty of impacts of the COVID-19 pandemic. We compared forecast growth rates and terminal growth rates to published studies of industry trends and expectations, and considered differences for the Group's operations. We used our knowledge of the Group, its past performance, business and customers, and our industry experience. • We assessed the disclosures in the financial report using our understanding obtained from our testing and against the requirements of the relevant accounting standards. 71 ANNUAL REPORT 2020 | PACIFIC SMILES Revenue recognition ($120,055,000) Refer to Note 5 to the Financial Report. The key audit matter How the matter was addressed in our audit A substantial amount of the Group’s revenue relates to revenue from the rendering of services, being service fees charged to dentists who practice using the Group’s dental surgeries. Service fees represent the net amount the Group is entitled to after paying the dentists a share of total patient billings (dentist payments). Dentist payments are based on percentages agreed with each dentist per underlying Service Facility Agreements (agreed dentist percentages) which are variable based on the following drivers: • Monthly total patient billings; and • Actual time spent by the dentists at the Group’s dental surgeries for the month per timesheet reports. We focused on revenue recognition of service fees as a key audit matter due to the significant audit effort to test the: • • High volume of transactions recorded as revenue and significant value of revenue recognised; • • Largely manual nature of the Group’s calculation of dentist payments and therefore service fee revenue. This increases the risk of potential error and inconsistent application due to the number of different agreed dentist percentages and drivers, in particular around the last month of the year; and The opening of 5 new dental centres during the current year, which necessitated us to assess the new Service Facility Agreements and increased our audit effort in this key area. 72 Our procedures included: • We evaluated the appropriateness of the Group’s revenue recognition policies against the requirements of the accounting standard; • We tested key controls in the services fee revenue recognition process, including: - Management review and approval of monthly bank account reconciliations; - Management’s check of the monthly total patient billings, monthly timesheet reports, and agreed dentist percentages used by the Group in the monthly dentist payment calculations; and - Management’s dual authorisation of dentist payments and the monthly dentist payment calculations. For a sample of service fees recognised throughout the financial year, we agreed the underlying inputs from the dentist fee calculation to the monthly total patient billings derived from the Group’s bank statements, and the Group’s dentists’ monthly timesheet reports to check the consistency of the agreed dentist percentages to the underlying Service Facility Agreements; • We assessed service fees recognised in the last month of the financial year by multiplying the weighted average agreed dentist percentages based on the relevant underlying Service Facility Agreements and total patient billings from the Group’s bank statements for the month; and • We checked total patient billings and dentist payments throughout the year to the Group’s bank statements. We compared service fees recognised during the year, to the total patient billings received less dentist payments made by the Group. ANNUAL REPORT 2020 | PACIFIC SMILES Independent Auditor’s Report Accounting for leases in accordance with AASB 16 Leases (Right-of-use asset – $51,805,000, lease liability – $63,199,000, deferred tax asset – $3,418,000, depreciation and interest expense – $11,973,000, and adjustment to opening retained earnings – $3,810,000) Refer to Note 7, 16, 19 and 23 to the Financial Report. The key audit matter How the matter was addressed in our audit Accounting for leases using AASB 16 Leases (“AASB 16”) is a key audit matter as it is inherently complex and specific and individualised lease-features drive different accounting outcomes, increasing the need for interpretation, judgement and audit effort. We focused on: • First time adoption – the Group was required to determine interpretations for AASB 16 new and complex accounting requirements for the first time in the year, including new accounting policies. Interpreting an accounting standard is more challenging in its first year of existence. The Group also had to build new processes to apply the requirements, which we had not tested before; • High volume of leases – the Group has a high volume of individualised lease agreements used to estimate the lease liability, right-of-use asset, deferred tax asset balances and adjustment to opening retained earnings. A focus for us was the completeness of the lease population and the accuracy of multiple and varied inputs which may drive different accounting outcomes, including key terms of the lease agreements, such as key dates, fixed and variable rent payments, incentives, renewal options, and make good obligations; • Complex modelling process - the Group developed an AASB 16 lease calculation model, which is complex, and therefore prone to greater risk for potential bias, error and inconsistent application; and • Relative magnitude – the size of balances has a significant financial impact on the Group’s financial position and performance. The most significant areas of judgement we focused on was in assessing the Group’s: • Incremental borrowing rates used – these are meant to reflect the Group's entity Our procedures included: • We considered the appropriateness of the Group’s new accounting policies against the requirements of the accounting standard and our understanding of the business; • We obtained an understanding of the Group’s new processes and IT systems used to calculate the lease liability, right-of-use asset, deferred tax asset, depreciation and interest expense and retained earnings adjustment; • We assessed the completeness of the Group’s leases taking into consideration the selected transition approach and practical expedients upon adoption by the Group by: - - - - - Inquiring with the Group to understand its process to compile the Group’s listing of leases; Inspecting a sample of lease agreements entered into by the Group and comparing these to the Group’s listing of leases; Checking the Group’s listing of leases to the items included in the operating lease commitments disclosure in the prior year’s financial report; Inspecting non-lease agreements including Service Facility Agreements for the existence of embedded leases; and Inspecting relevant expense accounts for routine payments during the year to identify the existence of leases not included in the Group’s listing of leases. • We compared the Group’s inputs in the AASB 16 lease calculation model, such as, key dates, fixed and variable rent payments, incentives, renewal options, and make good obligations, for consistency to the relevant terms of a sample of underlying source documents including signed lease agreements and lessor’s invoices. We also compared the index used by the Group in computing the variable 73 ANNUAL REPORT 2020 | PACIFIC SMILES specific credit risk and vary based on each lease term. The Group’s AASB 16 lease calculation model is sensitive to changes in the incremental borrowing rates; and • Lease terms where leases have renewal options – assessing the probability of exercising the renewal options to determine each lease term impacts the measurement of the lease, therefore is critical to the accuracy of the accounting; We involved our senior audit team members in assessing this key audit matter along with our debt advisory specialists. rent payments to the Australian consumer price index; • We assessed the Group’s determination of lease terms based on the probability of the Group exercising the lease renewal options. We compared key management decisions for consistency to board approved plans, strategies and past practices; • We considered the sensitivity of the Group’s AASB 16 lease calculation model by varying the incremental borrowing rate, within a reasonably possible range. We did this to identify the risk of bias or inconsistency in application and to focus our further procedures; • Working together with our debt advisory specialists, we independently developed a series of point estimates for the incremental borrowing rates applied to the leases using the S&P Healthcare indicative credit rating and corporate yield curve, adjusted by risk factors specific to the Group, the industry it operates in, and each lease term. We compared it to the incremental borrowing rates applied by the Group; • We assessed the integrity of the Group’s AASB 16 lease calculation model used, including the accuracy of the underlying calculation formulas. For a sample of leases, we recalculated the amount of lease liability, right-of-use asset, deferred tax asset, depreciation, interest expense and retained earnings adjustment relevant to this financial year and compared our recalculated amounts against the amounts recorded by the Group; and • We assessed the disclosures in the financial report using our understanding obtained from our testing and against the requirements of the accounting standard. 74 ANNUAL REPORT 2020 | PACIFIC SMILES Independent Auditor’s Report Other Information Other Information is financial and non-financial information in Pacific Smiles Group Limited’s annual reporting which is provided in addition to the Financial Report and the Auditor’s Report. The Directors are responsible for the Other Information. The Other Information we obtained prior to the date of this Auditor’s Report was the Operational overview and insights, Directors’ Report, the Remuneration Report, the Shareholder Information, and the Corporate Directory. Our opinion on the Financial Report does not cover the Other Information and, accordingly, we do not and will not express an audit opinion or any form of assurance conclusion thereon, with the exception of the Remuneration Report and our related assurance opinion. In connection with our audit of the Financial Report, our responsibility is to read the Other Information. In doing so, we consider whether the Other Information is materially inconsistent with the Financial Report or our knowledge obtained in the audit, or otherwise appears to be materially misstated. We are required to report if we conclude that there is a material misstatement of this Other Information, and based on the work we have performed on the Other Information that we obtained prior to the date of this Auditor’s Report we have nothing to report. Responsibilities of the Directors for the Financial Report The Directors are responsible for: • preparing the Financial Report that gives a true and fair view in accordance with Australian Accounting Standards and the Corporations Act 2001; • • implementing necessary internal control to enable the preparation of a Financial Report that gives a true and fair view and is free from material misstatement, whether due to fraud or error; and assessing Group and Company’s ability to continue as a going concern and whether the use of the going concern basis of accounting is appropriate. This includes disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless they either intend to liquidate the Group or to cease operations, or have no realistic alternative but to do so. 75 ANNUAL REPORT 2020 | PACIFIC SMILES Auditor’s responsibilities for the audit of the Financial Report Our objective is: • • to obtain reasonable assurance about whether the Financial Report as a whole is free from material misstatement, whether due to fraud or error; and to issue an Auditor’s Report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Australian Auditing Standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error. They are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the Financial Report. A further description of our responsibilities for the audit of the Financial Report is located at the Auditing and Assurance Standards Board website at: http://www.auasb.gov.au/auditors_responsibilities/ar1_2020.pdf. This description forms part of our Auditor’s Report. Report on the Remuneration Report Opinion Directors’ responsibilities In our opinion, the Remuneration Report of Pacific Smiles Group Limited for the year ended 30 June 2020, complies with Section 300A of the Corporations Act 2001. The Directors of the Company are responsible for the preparation and presentation of the Remuneration Report in accordance with Section 300A of the Corporations Act 2001. Our responsibilities We have audited the Remuneration Report included in pages 11 to 18 of the Directors’ report for the year ended 30 June 2020. Our responsibility is to express an opinion on the Remuneration Report, based on our audit conducted in accordance with Australian Auditing Standards. PAR_SIG_01 PAR_NAM_01 PAR_POS_01 PAR_DAT_01 PAR_CIT_01 KPMG 76 Sarah Cain Partner Melbourne 19 August 2020 ANNUAL REPORT 2020 | PACIFIC SMILES Independent Auditor’s Report Shareholder Information The shareholder information set out below was applicable as at 1 August 2020. Distribution of equitable securities Analysis of number of equitable security holders by size of holding: 1 to 1,000 1,001 to 5,000 5,001 to 10,000 10,001 to 100,000 100,001 and over Holding less than a marketable parcel Equity security holders Twenty largest quoted equity security holders The names of the twenty largest security holders of quoted equity securities are listed below: HSBC Custody Nominees (Australia) Limited Alexander John Abrahams Alison Jane Hughes J P Morgan Nominees Australia Pty Ltd National Nominees Limited Susan Louise Abrahams Just Paddling Pty Ltd Robert G Cameron & Paula S Cameron Channings Holdings Pty Ltd Citicorp Nominees Pty Ltd Karen Wright Sudemo Pty Ltd Lodka Pty Ltd Sterling Surgical Pty Ltd BNP Paribas Nominees Pty Ltd Trevor Collins & Dianne Elizabeth Collins William McIllwraith Pty Ltd Amanda Taylor Newtown Dyers & Bleachers Pty Ltd UBS Nominees Pty Ltd Number of equity security holders 252 291 143 206 68 960 127 Ordinary shares % of total shares issued 25.39 13.38 10.55 8.58 6.70 3.87 2.67 2.35 2.01 1.60 1.32 1.14 1.13 0.99 0.92 0.74 0.68 0.65 0.61 0.52 85.80 77 Number held 38,983,200 20,544,779 16,197,850 13,175,879 10,289,069 5,939,269 4,104,646 3,608,480 3,090,150 2,449,540 2,022,000 1,744,863 1,737,329 1,515,000 1,411,173 1,128,480 1,046,000 1,000,000 929,256 796,576 13,713,539 ANNUAL REPORT 2020 | PACIFIC SMILES Unquoted equity securities Performance rights issued under the consolidated entity’s LTI plan Substantial holders Substantial holders in the company are set out below: TDM Growth Partners Dr Alex Abrahams Dr Alison Hughes QVG Capital Voting rights Number on issue Number of holders 9,301,000 8 Number held 35,705,996 30,827,361 16,197,850 8,330,824 Ordinary shares % of total shares issued 23.26 20.08 10.55 5.43 Each ordinary share carries the right to one vote. No voting rights are attached to performance rights. There are no other classes of equity securities. 78 ANNUAL REPORT 2020 | PACIFIC SMILES Shareholder Information Corporate Information Directors Ms Zita Peach Non-executive Chairperson Mr Phil McKenzie Managing Director and Chief Executive Officer Dr Alex Abrahams Non-executive Director Mr Mark Bloom Non-executive Director Mr Hilton Brett Non-executive Director Mr Ben Gisz Non-executive Director Mr Simon Rutherford Non-executive Director Company secretaries Mark Licciardo and Belinda Cleminson Registered office Level 1, 6 Molly Morgan Drive Greenhills NSW 2323 T: 02 4930 2000 F: 02 4930 2099 W: www.pacificsmiles.com.au Share register Link Market Services Limited Level 12, 680 George Street Sydney NSW 2000 T: 1300 554 474 F: 02 9287 0303 E: registrars@linkmarketservices.com.au Auditor KPMG Tower Three, 300 Barangaroo Avenue Sydney NSW 2000 Stock exchange listing Pacific Smiles Group Limited shares are listed on the Australian Securities Exchange (ASX code: PSQ) Corporate Governance Statement The 2020 corporate governance statement is dated 30 June 2020 and reflects the corporate governance practices in place for the 2020 financial year. The 2020 corporate governance statement was approved by the Board on 19 August 2020, a copy can be found on the Pacific Smiles website. ANNUAL REPORT 2020 | PACIFIC SMILES