<PAGE> 1
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
Form 10-K
ANNUAL REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998 Commission File Number 0-12050
---------------
SAFEGUARD HEALTH ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-1528581
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
95 Enterprise
Aliso Viejo, California 92656
(Address of principal offices) (Zip Code)
Registrant's telephone number, including area code: 949.425.4300
Fax telephone number, including area code: 949.425.4586
---------------
Securities registered to Section 12(b) of the Act:
None
Securities registered to Section 12(g) of the Act:
Common Stock, $0.01 par value
Listed on the NASDAQ Stock Market(R) - National Market System
(Name of exchange on which listed)
---------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to the filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filer pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of April 12, 1999, was $12,596,072.
The number of shares outstanding of the registrant's $0.01 par value common
stock as of April 12, 1999, was 4,747,498 (not including 3,247,788 shares held
in treasury).
- --------------------------------------------------------------------------------
<PAGE> 2
SAFEGUARD HEALTH ENTERPRISES, INC.
1998 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART 1
Item 1. Business..................................................................1
Item 2. Properties...............................................................20
Item 3. Legal Proceedings........................................................20
Item 4. Submission of Matters to a Vote of Security Holders......................20
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters................................................................21
Item 6. Selected Financial Data..................................................22
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..............................................23
Item 8. Financial Statements and Supplementary Data..............................32
Item 9. Changes in and Disagreements with Independent Accountants
on Accounting and Financial Disclosure.................................32
PART III
Item 10. Directors and Executive Officers of the Registrant.......................32
Item 11. Executive Compensation...................................................35
Item 12. Security Ownership of Certain Beneficial Owners and Management...........37
Item 13. Certain Relationships and Related Transactions...........................39
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K..........40
Signatures ........................................................................40
</TABLE>
-------------------------------------
(i)
<PAGE> 3
PART I
ITEM 1. BUSINESS
In addition to historical information, the description of business below
includes certain forward-looking statements, including those related to
SafeGuard Health Enterprises, Inc., a Delaware corporation's (the "Company")
growth and strategies, future operating results and financial position as well
as economic and market events and trends. The Company's actual results and
financial position could differ materially from those anticipated in the
forward-looking statements as a result of various factors, including
competition, changes in health care regulations, levels of utilization of dental
health care services, new technologies, rising dental care costs, risks of
acquisitions and sale of assets, ability to resell assets or notes of dental
offices, waivers and/or extensions from lenders, and other risks and
uncertainties as described below under "RISK FACTORS." The following should be
read in conjunction with the Consolidated Financial Statements of the Company
and Notes thereto.
(a) GENERAL DEVELOPMENT OF BUSINESS.
The Company owns and operates one of the largest publicly traded dental benefits
companies in the United States. The Company was founded in California in 1974
and is licensed to operate managed care dental plans in Arizona, California,
Colorado, Florida, Illinois, Kansas, Kentucky, Missouri, Nevada, Ohio, Oklahoma,
Oregon, Texas, Utah and Washington D.C., with significant operations in
California, Colorado, Florida, Missouri and Texas.
The Company's predecessor, SafeGuard Health Plans, Inc., a California
corporation (the "California Plan"), commenced operations in 1974 as a nonprofit
corporation. The California Plan converted from nonprofit status in December
1982 and is currently a wholly-owned subsidiary of the Company. The Company was
incorporated in California in November 1982 and acquired the California Plan in
December of that year. Wholly-owned subsidiaries conduct business in other
states. On August 24, 1987, the Company reincorporated in Delaware.
In September 1992, the Company acquired a California domiciled life insurance
company and renamed it SafeHealth Life Insurance Company ("SafeHealth Life"). In
August 1996, the Company acquired a Texas based managed dental care company,
named First American Dental Benefits, Inc. In May 1997, the Company acquired a
Florida based managed dental care company and renamed it SafeGuard Health Plans,
Inc., which company also operates in Georgia, Illinois, Kansas, Missouri, Ohio,
and Washington, D.C. In August 1997, the Company acquired a North Carolina
domiciled life and health indemnity insurance company, redomesticated it to the
State of Texas and renamed it SafeHealth Life Insurance Company, Inc. This
Company is licensed to operate in the states of Alabama, Arizona, Arkansas,
Delaware, Florida, Georgia, Indiana, Kentucky, Louisiana, Mississippi, North
Carolina, Oklahoma, South Carolina, Tennessee, Texas, and Virginia. Unless the
context otherwise requires, all references to the "Company" or "SafeGuard" mean
SafeGuard Health Enterprises, Inc., a Delaware corporation, its predecessor
California corporation, and its subsidiaries.
In September 1996, the Company initiated a strategic plan to sell the general
dental practices of the Company's dental office subsidiary, Guards Dental, Inc.
("Guards"). Guards dental offices were primarily formed for the purpose of
supplementing, in geographic areas where needed, plan coverage provided by
independent contracting dental offices. All of the general dental practices
owned by Guards were sold during the period of September 30, 1996 through
September 30, 1997. As of April 1, 1998, the Company sold the orthodontic
practices operated by Guards to Pacific Coast Dental, Inc., Associated Dental
Services, Inc., and their affiliated dentists.
Pursuant to the terms of the definitive Master Asset Purchase Agreement (the
"Agreement") dated and effective as of April 1, 1998, by and among Guards and
the Purchasers, the orthodontic practices were sold for total consideration of
$15,000,000, paid by an 8 1/2% 30-year Promissory Note, secured by all current
and future assets of the Purchasers, including those assets transferred under
the Agreement made by the Purchasers and payable to Guards. The principal
followed in determining the amount of consideration was the fair market value of
the assets. Among other provisions, the Agreement details the sale of associates
assets and liabilities of the practices and a long term commitment to continue
to provide orthodontic services to the members of SafeGuard Health Plans, Inc.
In the fourth quarter of 1998 and as part of an ongoing review process, the
Company ascertained that some of the Promissory Notes ("Notes") granted to the
Company by the Purchasers of these practices were not performing at currently
stated levels and therefore, unable to service such Notes pursuant to the terms
and conditions thereof. As a result, the Company reduced the value of the Notes
on its books so that they reflect management's current estimate of their market
value. Rather than the Company exercising its right to foreclose on the Notes,
Guards entered into a
-1-
<PAGE> 4
Default Forbearance Agreement and an Irrevocable Power of Attorney with the
Purchasers, which will enable the Company to either resell the assets or Notes
relating to the practices.
The Company's executive offices are located at 95 Enterprise, Aliso Viejo,
California 92656; its telephone number is 949.425.4300 and FAX number is
949.425.4586.
DENTAL CARE MARKETPLACE
According to the United States Office of National Health Statistics, the total
expenditures for dental care in the United States grew from approximately $14
billion in 1980 to an estimated $48 billion in 1996. The United States Health
Care Financing Administration reports that expenditures for dental services
account for approximately 5% of total national health care expenditures.
According to the United States Department of Labor ("DOL"), the cost of dental
services has been rising at a rate higher than that for consumer goods. The DOL
statistics reported that, from 1982 to 1998, the consumer price index for all
urban consumers for dental services increased 136%, whereas this index for all
items increased 63%. As a result, the Company believes that there has been an
increased interest by employers in managing dental care costs.
Employer-sponsored dental benefits are one of the most common employee welfare
benefits. The National Association of Dental Plans ("NADP") estimates that
approximately 147 million persons, representing approximately 55% of the total
United States population, are covered by some form of dental benefit coverage at
the end of 1997. The NADP estimates that managed care enrollment has grown from
18 million covered lives in 1994, to approximately 26 million covered lives by
the end of 1997. This compares to over 50 million Americans who were enrolled in
medical HMOs in 1997, according to the Group Health Association of America. The
Company believes that the relatively high growth rate for Dental HMO plans, is
attributable to (i) the greater acceptance of managed care by employers and
employees; (ii) the significant price advantage relative to traditional
fully-insured open panel fee-for-service or reimbursement plans; (iii) the cost
effectiveness to employers of Dental HMO plans as an employee benefit; and (iv)
the growing acceptance of dental health maintenance organization ("Dental HMO")
plans by dentists throughout the country, resulting in improved accessibility
and convenience for members. At the end of 1997, members of Dental HMO plans
represent approximately 18% of the population with dental care coverage, and
approximately 10% of the total United States population. As a result of these
factors, the Company believes that there will continue to be significant growth
opportunity in the Dental HMO benefits industry.
It has been the Company's experience that larger employers have been more likely
to offer dental benefit coverage to their employees. Additionally, according to
the 1995 Foster Higgins Survey of Employee Sponsored Health Plans, nationally,
approximately 89% of employers with more than 500 employees offer some type of
dental benefits to some or all employees, and approximately 79% of these
employers have a stand-alone dental plan, distinct and separate from other
health and welfare benefits offered to employees. By comparison, this survey
reported that approximately 54% of employers that had less than 500 employees,
offer dental benefits. About 62% of all employers who offer dental benefits have
distinct stand-alone plans. It has been the Company's experience that many
employers in the small to mid-size range, that do not offer dental benefits, are
willing to consider offering a plan, initially in which the employee pays the
full cost or substantially the full cost of such benefits through payroll
deductions collected by the employer. Consequently, it is the Company's current
intent to target its marketing efforts on the small to mid-size range of
employers to help increase growth.
The Dental HMO industry as a whole, is currently fragmented and characterized by
participation of several large, national insurance companies and numerous
independent organizations. As of December 31, 1996, the NADP estimated that
there were over 150 Dental HMO companies in the United States, with no dominant
market leader.
The increase in the number of dentists nationally during the last two decades,
has exceeded the rate of population growth. According to the American Dental
Association ("ADA"), the number of practicing dentists in the United States has
increased to approximately 151,000, while the rate per 100,000 population, has
increased from 53 in 1980 to 60 in 1991. In addition, the dental delivery
marketplace is highly fragmented with approximately 96% of all practicing
dentists, working in a one or two-dentist office, according to the ADA. Also,
according to a survey of dental practices published by Dental Economics in 1994,
the median of staff and other costs that are part of total overhead expenses for
practicing dentists were approximately 60% of the gross revenue of solo and
group dental practices. The significant increase in the number of dentists as a
proportion of the population, the fragmented dental delivery marketplace, the
high proportion of overhead costs for dentists and an improved level of overall
dental health in the country, has created a highly competitive environment among
dentists, particularly in major metropolitan areas where it is believed that
there is a greater than 25% vacancy rate in the average dentist's office. The
Company believes that these factors have contributed to the increased
willingness of qualified dentists to participate in Dental HMO and preferred
provider
-2-
<PAGE> 5
organization networks, such as those maintained by the Company, as dentists seek
alternative methods to increase practice revenues.
Under a traditional fee-for-service indemnity plan, coverage is provided based
on a reimbursement formula of the usual and customary charges submitted by the
dentist. Compared to medical coverage, the average cost of dental services is
lower and the utilization of services is more predictable. Unlike medical
coverage, dental coverage generally does not cover catastrophic risks. Dental
care is provided almost exclusively on an outpatient basis and, according to a
1990 ADA survey, over 81% of all dental services are performed by general
dentists. Also, dental plans generally do not include coverage for
hospitalization, typically the most expensive component of medical services.
Common features of dental indemnity plans include deductibles, maximum annual
benefits of less than $2,000 per person and significant patient cost-sharing.
Patient cost-sharing typically varies by type of dental procedure ranging from
no cost sharing for preventive procedures to 50% cost-sharing for dentures and
even greater cost-sharing for orthodontic care. This high patient cost-sharing
and the relatively predictable nature of dental expenditures substantially
limits the underwriting risk of a dental plan when compared to the underwriting
risk of a medical plan which covers catastrophic illness and injuries.
Furthermore, since most dental problems are neither life threatening nor
represents serious impairments to overall health, there is a higher degree of
patient cost sensitivity and discretion associated with obtaining dental
services. Many dental conditions also have a range of appropriate courses of
treatment, each of which has a different out-of-pocket cost for patients. For
example, a deteriorated amalgam filling may be replaced with another amalgam
filling (a low-cost alternative) a pin-retained crown build-up (a more costly
alternative) or a crown with associated periodontal treatment (the most costly
alternative). The level of coverage provided to the patient and the dental
plan's reimbursement methodology may influence the type of services selected by
the patient or rendered by the dentist.
Under a traditional indemnity insurance plan or fee-for-service arrangement, the
insurer and the patient each pays a percentage of the fee charged by the
dentist, subject to cost-sharing, maximum benefit allowances and usual and
customary limits. Under such an indemnity plan, dentists have little incentive
to reduce total charges because they are compensated on a fee-for-service basis.
By contrast, under a Dental HMO plan capitation payments are fixed and
co-payments for additional services are pre-negotiated by the Company. The
co-payments generally are designed to exceed the dentist's variable costs, but
are typically less than the dentist's usual and customary fee. Fixed capitation
payments that do not vary with the frequency of services provided create an
incentive for dentists to emphasize preventive care, control costs and maintain
a long-term patient relationship that generates consistent capitation revenue.
Fixed capitation payments also substantially reduce the underwriting risk to the
Company associated with the high utilization of dental services.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
The Company operates in a single industry segment providing Dental HMO and
indemnity dental benefits.
(c) NARRATIVE DESCRIPTION OF BUSINESS.
GENERAL DESCRIPTION OF THE COMPANY
The Company contracts with large and medium sized governmental or private sector
employers, and multiple employer trusts. In addition, over the last several
years the Company has focused its marketing efforts on mid-sized and small
employer groups, usually with less than 1,000 employees. At the end of 1998,
dental care under the Company's Dental HMO and preferred provider plans is
provided by a panel of approximately 5,600 independent dental offices consisting
of approximately 6,700 dentists.
As of December 31, 1998, the Company had contracts with approximately 6,300
employer clients providing benefits to approximately 1,018,000 members,
representing a 12.6% decrease in membership from 1,165,000 at December 31, 1997.
This decrease in membership resulted primarily from the anticipated loss of a
large private label HMO relationship in the first quarter of this year together
with a decline in the Company's indemnity dental insurance membership as a
result of the certain policy holders choosing not to renew their coverage when
renewal rates were offered.
The Company's Dental HMO contracts with its clients generally require the client
to pay a monthly per capita fee that is usually fixed for a period of one to two
years. The typical fee for a Dental HMO program for an employee and his or her
dependents varies depending on the level of dental benefits, dependent coverage
and member co-payment requirements stipulated in the contract. Each employee or
dependent member receives covered services from a dental
-3-
<PAGE> 6
office selected by the member or dependent which is on the Company's panel of
providers, whereas the individual is ordinarily free to select any dentist under
a traditional indemnity insurance program. The Company's Dental HMO plans do not
require the member to pay deductibles, file claim forms, or be subject to an
annual dollar limitation on the amount of dental care for which they are
eligible.
Under the Company's indemnity dental insurance programs, members are required to
pay small deductibles and copayments which are traditionally higher than that
which are required by the Company's Dental HMO products. However, members may
select any dentist of their choice for their dental care under these plans. The
typical fee for an indemnity dental program for an employee and his or her
dependents depends upon the level of dental benefits provided in the contract.
The Company utilizes a local market strategy which establishes local offices
responsible for sales, client services and provider relations, staffed by up to
twelve individuals who are responsible to the local office executive director.
Each local office is a separate profit center and has profitability
responsibility and decision-making process. Some larger metropolitan areas may
have more than one local office, depending upon the needs of the geographic
territory. The Company also uses regional offices as training and support for
the local office's sales, provider relations, client services and market
management activities. Regional offices also provide claims and provider
administration, member and provider services, underwriting, financial analysis,
quality improvement and dental policy administration. The Company has
established three regional offices which are responsible to provide support and
training to the local offices in those regions. The Company's corporate office
provides corporate governance, corporate finance, legal and regulatory services,
processing policy and compliance activities, obtaining regulatory approval of
new product market research, product development and management, public
relations, information systems, corporate quality improvement policy and
compliance activities, large case support, brokerage relationships, alternative
distribution programs and business planning. The Company's stated goal is to
move as much as possible of the decision-making process to the various
constituencies of the Company, to better serve the member, the client and the
producer by adopting the local office strategy.
It is the Company's primary goal to be the leading dental benefits company in
each of the markets in which it operates. Presently, the Company is licensed to
provide Dental HMO benefits in fifteen states and the District of Columbia and
indemnity benefits in twenty-seven states. It is the Company's belief that by
targeting a specific segment of each of the markets in which the Company
operates, it can attain and maintain market leadership by offering a full gamut
of Dental HMO and indemnity dental products more particularly described below.
To implement its strategy, the Company offers a comprehensive range of dental
benefit plans utilizing specific standard plan designs which are available in
each of the markets in which the Company operates. By standardizing the dental
plans the Company offers, it can attain market share and excellence in service
through the consistent application of policies and procedures, and
administrative functions. Such standardizing also allows employers to offer
substantially the same benefits in all states in which the Company is licensed
to operate.
The Company utilizes multiple distribution methods to sell its products. Its
sales force focusing on its target market, allows the Company to attain growth
in its core business areas, working with independent insurance brokers and
agents who market the Company's plans. The Company also works with large
national brokerage firms who provide consultative advice to large employers on
the selection of dental benefit plans. The Company also sells to third party
HMOs that offer its plans as an additional benefit to members of the medical
HMOs. The Company also utilizes a general agency relationship in several of the
markets in which it operates, targeting small employers and individuals.
The Company is committed to ensuring quality dental care through a panel of
accessible dentists. By providing multiple types of reimbursement programs, the
Company is able to contract with and maintain significant provider panels in the
markets in which it operates by providing a broad spectrum of patients to
dentists through various funding mechanisms. The Company's provider relations
representatives in each of its local market offices provide a valuable service
in assisting to maintain the provider relationships. Local knowledge and
expertise provided through these local representatives enable the Company to
develop highly accessible dental networks convenient for plan members which is
an important factor to employers in selecting a Dental HMO plan. Local efforts
are supported by the Company's regional and corporate activities.
An important factor in the Company's strategy is to provide an integrated
approach to member services. Regional member service representatives provide
support and assistance to local market offices by responding to member
inquiries, requests for change in provider facilities, claims questions and
payment information. Specific 800 telephone numbers accessible throughout the
country are maintained with the objective of providing consistent, reliable,
responsive and efficient member services.
-4-
<PAGE> 7
PRODUCTS
Dental HMO Plans. The Company offers a variety of Dental HMO plans under the
names SafeGuard Health Plans(R), SafeGuard Dental Plans(TM) and American Dental
Corporation(R). The Company's Dental HMO plans operate similarly in each state
in which business is conducted. Under the Company's Dental HMO plans, a premium
is paid to the Company on behalf of the subscriber by the employer from the date
the subscriber enrolls in the plan. A portion of this contribution is used by
the Company to "prepay" for dental care for members through regular monthly
capitation payments by the Company to a specific selected primary care dentist.
The capitation rate does not vary with the nature or the extent of services
utilized, but is variable based on plan design. In exchange for the capitation
payments, the selected provider is obligated to provide specific dental services
to plan members.
Members covered under the Company's Dental HMO plans obtain certain basic dental
procedures, such as examinations, x-rays, cleanings and fillings, at no
additional charge, other than, in some cases, a small per office visit
copayment. The plan's established copayments for more complicated procedures
provided by the selected primary care dentist, such as root canals and crowns,
vary in accordance with the complexity of the service and the level of benefits
provided. Most of the Company's Dental HMO plans also cover services provided by
specialists participating in the panel rather than the primary care dentists
selected by the subscriber, including oral surgery, endodontics, periodontics,
orthodontics, and pedodontics. The Company assumes responsibility under its
Dental HMO plans for such specialty care arrangements and is responsible for
such payments, usually at a discounted fee-for-service basis.
Dual Choice Plans. The Company's products also include dual choice dental plans
which allow subscribers to choose between a Dental HMO plan and an indemnity
dental insurance plan. The Company believes that its ability to offer dual
choice plans is an important element of its business success because it enables
the Company to offer prospective customers flexibility, particularly when there
are potential subscribers outside the area served by the Company's Dental HMO
panel. Certain states, such as Nevada and Oklahoma, require that Dental HMO
plans be offered only as part of a dual choice plan and other states may do so
in the future. Dual choice plans are particularly effective as part of the
Company's growth strategy in areas in which the Company's dental panel is less
well developed and members may value the ability to choose non-panel dentists.
The Company also believes that securing customers through dual choice
arrangements provides an opportunity to cross sell Dental HMO plans.
Preferred Provider Organizations. The Company's products also include a dental
plan which provides for an increased level of benefits in the event a member
utilizes a dentist participating on its Preferred Provider Organization ("PPO")
panel. The level of benefits provided to members who select a PPO dentist is
usually increased by at least 10% and usually provides for a waiver of annual
deductibles required to be paid by plan members. In exchange, the dentist has
contracted to provide dental benefits to plan members at a fee which is usually
discounted by at least 30% off of the dentist's usual and customary fee or the
Company's fee allowance, whichever is less. Additionally, the cost savings
through reduced fees charged by PPO dentists are shared equally between the
Company and the member. In the event the member utilizes a PPO dentist, the
member also receives the same level of discount off of the provider's usual and
customary fee, as applied to the member's coinsurance. The Company believes that
its PPO is an excellent way to enter into new markets or areas that have been
traditionally difficult areas to recruit dentists into a managed care plan,
since the PPO acts as a traditional step for dentists between the traditional
fee-for-service plans and the Dental HMO plans offered by the Company. The
indemnity insurance portion of the Company's Dual Choice and PPO dental plan is
underwritten by SafeHealth Life, a subsidiary of the Company. These plans
subject the Company to underwriting risks associated with over utilization and
pricing variances which are different from those pricing and reimbursement
mechanisms utilized by the Company's Dental HMO plans.
Other Dental Products. For self-insured employers, the Company provides claims
administration under an Administrative Services Organization ("ASO") arrangement
whereby the Company does not assume the underwriting risk for the indemnity
claims. The Company receives an administrative fee to process claims and the
underwriting risk is retained by the employer sponsoring the self-insured plan.
The Company also provides access to its PPO network for a fee to clients. Under
this program, the PPO network providers offer a reduced fee schedule for
services performed. Eligible participants pay reduced fees when they receive
dental services from a PPO network provider. The Company charges its PPO network
clients a monthly fee for each participant eligible to access the Company's PPO
fee arrangements. The Company does not make any payment to its PPO network
providers on behalf of the participant eligible to access the reduced fee
arrangement.
Orthodontic Services. On February 26, 1998, the Company announced the
discontinuance of its orthodontic practices. On April 1, 1998, the Company
completed the sale of its orthodontic practices to Pacific Coast Dental,
Inc./Associated Dental Services, Inc., and affiliated dentists. The practices
were sold for $15 million in 8.5% long-term notes,
-5-
<PAGE> 8
discounted for up to $2.5 million for early cash payment by December 31, 1998.
The transaction includes the sale of all assets and associated liabilities of
the orthodontic practices and a long-term commitment from the purchaser to
continue to provide orthodontic services to SafeGuard members. The assets of the
orthodontic practices sold consist of accounts receivable, supply inventory and
dental equipment.
The Company recorded a gain on the disposal of the discontinued orthodontic
practices of $3.7 million, net of taxes of $2.3 million. The Company also
recognized a loss of $620 on operations to be disposed of, net of taxes.
In the fourth quarter of 1998, and as part of an ongoing review process, the
Company ascertained that some of the Promissory Notes ("Notes") granted to the
Company by the Purchasers of these practices were not performing at currently
stated levels and therefore, unable to service such Notes pursuant to the terms
and conditions thereof. As a result, the Company reduced the value of the Notes
on its books so that they reflect management's current estimate of their market
value. Rather than the Company exercising its right to foreclose on the Notes,
Guards entered into a Default Forbearance Agreement and an Irrevocable Power of
Attorney with the Purchasers, which will enable the Company to either resell the
assets or Notes relating to the practices.
PROVIDER RELATIONS
The Company believes that the most essential element in its enrollment growth is
a stable panel of quality focused dentists in convenient locations. The Company
also requires that all Dental HMO and PPO providers meet all Quality Assessment
program standards. The program includes current professional license
verification, current liability insurance, and a risk management review of the
dental facility to ensure that all OSHA and regulatory requirements are met, an
inspection of the office's sterilization practices, and a review of the
facilities location, including parking availability and handicap access. See
"QUALITY MANAGEMENT AND IMPROVEMENT."
The Company believes that dental providers on the Company's Dental HMO and PPO
panels are willing to provide their services at a lower capitated (fixed) rate
per month in exchange for the relatively steady, extended stream of revenue
generated by panel participation. Furthermore, this contractual revenue source
for the provider is free from the collection problems and administrative costs
sometimes associated with other forms of dental coverage. Thus, qualified
dentists and/or dental groups have generally been available and willing to
participate on the Company's panels and supplement their fee-for-service
practice.
The Company compensates each panel dental office on its Dental HMO plans on a
monthly capitation rate for each member who selects that office, regardless of
the amount or character of service provided during the month. The capitation
rate does not vary with the nature or extent of services utilized, however it is
variable based upon plan design. The total amount paid to each dental office is
determined by the capitation rate per each client contract applicable thereto,
and the number of eligible members served by the participating dental office.
The Company provides additional compensation to its Dental HMO providers for
specified dental procedures. The Company believes that this compensation program
provides for a higher level of member and provider satisfaction through
increased compensation to the provider. For dentists who provide services to the
Company's insured members, compensation is based upon a percentage of the
provider's usual and customary fee based upon established tables of allowances
utilized by the Company in its claims paying processing systems. Benefits are
provided in accordance with percentages that are established for each member's
benefit program. Providers who participate in the Company's PPO program are
compensated at a fee which is less than the provider's usual and customary fee,
usually at a discount of up to 30 percent, or 30 percent off of the Company's
usual and customary fee for the area, whichever is less.
The Company currently employs provider relations representatives in each local
market. All have extensive dental office management backgrounds and act as
consultants to assist our panel providers with the administration of the plan in
the day-to-day operation of their offices.
Should a dental office terminate its contract with the Company, if necessary a
new provider will be recruited in a timely manner to meet the needs of the
members assigned to that office, and so there will be no delay in the member's
care. No individual dental office provided service to more than 10 percent of
the Company's members at December 31, 1998.
The Company's panel dental offices are free to contract with other dental plans
and both they and the Company can terminate the contract at any time upon 60
days prior written notice. In accordance with the contract, the Company may also
terminate the contract "for cause" upon 15 days prior written notice. The
Company may also, at anytime,
-6-
<PAGE> 9
change the terms, rates, benefits and conditions of the various plans serviced
by its providers with ten (10) days notice to the provider. The Company's
contracts with panel dental offices require them to maintain their own
professional liability insurance for a minimum of $200,000 per claim, and
$600,000 per annual aggregate and to indemnify the Company for claims arising
from the dentist's acts or omissions.
At December 31, 1998, approximately 5,000 primary care and specialty care dental
offices, consisting of approximately 6,000 dentists were participating panel
providers on the Company's Dental HMO plans. General dentists are required to
render all basic dental care and refer members to specialists only as required.
Under its policy, the Company offers nearly all specialty dental services,
including oral surgery, endodontics, periodontics, orthodontics, and pediatric
dentistry. If the specialty care falls within the Company's guidelines, all or a
substantial portion of the specialists fees are paid by the Company. Such
payments were 10.3 percent and 9.6 percent of the Company's dental health care
services expenses in 1998 and 1997, respectively. At December 31, 1998, the
Company contracted with approximately 11,790 primary care and specialty care
dentists on the Company's PPO panel.
MANAGEMENT INFORMATION SYSTEMS
During 1998, the Company continued to enhance its proprietary management
information system to better manage its operational resources and analysis of
data. These changes focused on reporting mechanisms to track regulatory
compliance and data interface with clients. The Company's goal is to continue to
enhance technologies to better equip the Company to compete while ultimately
reducing the Company's administrative expenses. The Company also continued its
development of various operating systems based upon software source code
purchased in 1996 for its business operations system, which are being adapted to
the specific needs of the Company. This software allows the Company to develop,
in-house, a system which is used to expand the Company's management information
system to all Company regional offices. This system takes advantage of the power
of personal computers in the workplace. The system provides a much easier and
more efficient interface using Windows-based screens. Individual users are able
to quickly customize data queries for their specific needs with results directed
to the screen, printer or downloaded into a word processor and/or spreadsheet.
The system also has integrated accounts receivable and accounts payable
components that allow the Company to more easily track, report and perform
analysis on revenue and expense.
The Company employs a personal computer network-based general ledger system
providing reporting and analysis tools which allows for the extraction and
download of data to word processors and spreadsheets for further analysis. The
Company also expanded the use of its electronic mail system to all its regional
and sales offices.
As the Company's client base continues to grow in all areas, the Company has
upgraded its current network server to handle the increased activity. The Dental
HMO plan, indemnity and PPO plans, and electronic mail environments are now
interconnected. With the implementation of these new and upgraded systems, the
entire network is tightly integrated. These systems demonstrate the Company's
proactive position in automating its computer operations and allowing it to
remain competitive in the marketplace.
COMPANY-OWNED DENTAL FACILITIES
In October 1996, the Company initiated a strategic plan to sell all of the
general dental practices owned by the Company. The assets of the general dental
practices sold pursuant to the Company's plan, consisted primarily of leasehold
improvements, equipment, accounts receivable and supply inventories. Four
general dental practices were sold during 1996 and the remaining twenty-seven
general dental practices were sold during the nine month period ended September
30, 1997. In August 1997, the Company sold all of the tangible assets of its
then remaining fifteen general dental practices to a non-affiliated entity. The
aggregate purchase price of all of the assets sold relating to the general
dental practices of the Company was $14.24 million in 1997 and $3.28 million in
1996. All transactions were wholly financed by the Company pursuant to various
promissory notes which have an effective interest rate of 8.5 percent and 30
year term, secured by the assets sold. The Company recorded the completion of
the sale of its remaining general dental practices in the third quarter of 1997.
The Company also recorded a loss from the general dental practices disposed of
net of income taxes in the fourth quarter, primarily relating to reserves for
under performing notes and receivables, litigation expenses and other related
transaction costs. On April 1, 1998, the Company sold all the orthodontic
practices operated by a subsidiary of the Company to Pacific Coast Dental, Inc.,
Associated Dental Services, Inc., and their affiliated dentists. The Company
recorded a gain on the disposal of the discounted orthodontic practices of $3.7
million, net of taxes of $2.3 million. The Company also recognized a loss of
$620 on operations to be disposed of, net of taxes.
Pursuant to the terms of the definitive Master Asset Purchase Agreement (the
"Agreement") dated and effective as of April 1, 1998, by and among Guards and
the Purchasers, the orthodontic practices were sold for total consideration of
$15,000,000, paid by an 8 1/2% 30-year Promissory Note, secured by all current
and future assets of the Purchasers, including those assets transferred under
the Agreement made by the Purchasers and payable to Guards. The principal
-7-
<PAGE> 10
followed in determining the amount of consideration was the fair market value of
the assets. Among other provisions, the Agreement details the sale of associates
assets and liabilities of the practices and a long term commitment to continue
to provide orthodontic services to the members of SafeGuard Health Plans, Inc.
In the fourth quarter of 1998 and as part of an ongoing review process, the
Company ascertained that some of the Promissory Notes ("Notes") granted to the
Company by the Purchasers of these practices were not performing at currently
stated levels and therefore, unable to service such Notes pursuant to the terms
and conditions thereof. As a result, the Company reduced the value of the Notes
on its books so that they reflect management's current estimate of their market
value. Rather than the Company exercising its right to foreclose on the Notes,
Guards entered into a Default Forbearance Agreement and an Irrevocable Power of
Attorney with the Purchasers, which will enable the Company to either resell the
assets or Notes relating to the practices.
QUALITY MANAGEMENT AND IMPROVEMENT
The Company's commitment to quality is supported throughout the entire
organization. The program is fully encompassing to include the quality of care
management process, provider selection, accreditation, maintenance assessment,
utilization management, provider network corrective action and counseling
management, grievance management functions, member satisfaction survey
functions, accessibility monitoring, and ongoing improvement studies. The
Company's quality management program objectives include quality assessment of
the credentials and qualifications of dentists to become and/or remain
affiliated providers, quality assessment of the affiliated network, dentist's
compliance with Company standards, analysis and measurement of network and
provider behavior, and continuous improvement of affiliated network dentist
performance through constructive and continuous feedback.
Under the direction of the Company, each affiliated dentist's office undergoes
regular assessments to determine appropriateness of care and treatment outcomes.
The Company outsources the onsite review process to several firms dedicated to
this process. This policy is similar to the concept of using independent
accountants to verify financial statements. By using an outside source, the
Company is able to maintain a significant level of independence not always found
when using employees to conduct the on-site assessments. The Company also
maintains a credentialing committee and credentialing verification process
through an outside source which is utilized to verify the provider's licensing
status, insurance, compliance with applicable federal and state regulations,
peer review society status, and other related processes with an objective
approach for consistency, effectiveness, and risk management review.
The Company's Member Satisfaction Assessment Program is designed to provide the
Company with valid and reliable information on members' perceptions of the value
of the dental services provided, as well as how expectations are being met. The
program is a fully integrated approach to monitoring and responding to customer
needs, and evaluating member satisfaction The specific functions of this program
are to establish an understanding of customer expectations, assess the
performance of the dentist's care relative to members' perceptions and levels of
satisfaction, link member complaints with satisfaction for appropriate
actionable network management, provide regular and accurate feedback to
providers on members' perceptions and levels of satisfaction, and provide
comparison levels for perception and levels of satisfaction measurements between
different dental products.
The Company maintains a comprehensive accessibility monitoring program which
tracks appointment availability with affiliated dentist offices through
standards including the availability of new patient appointments; the
availability of hygienist appointments; the availability of restorative
appointments; the availability of emergency appointments; the wait times upon
arrival at the dental offices; and arrival in the operatory room. The Company
conducts accessibility monitoring on a quarterly basis by mail, and results are
then compared to findings of the on-site quality review, member satisfaction
surveys, grievances, and Provider Relations visits.
The Company continues to improve its review system to assure members are
receiving quality care and providers are receiving training and guidance as
needed. The Company employs a team concept, combining its Quality Review, Member
Services and Provider Relations departments, to benefit both the member and
provider.
UTILIZATION REVIEW
The Company uses computerized analysis to monitor the dental treatment provided
to members. The analysis of provider utilization and cost data enable the
Company and its clients to determine the type of procedures performed by plan
contracted dental offices and ascertain the savings to both clients and members
compared to competitive dental indemnity insurance coverage. The analyses are
also used by the Company to identify unusual patterns of dental care utilization
or complaints which may trigger special or comprehensive dental reviews. The
computer system greatly
-8-
<PAGE> 11
enhances the Company's ability to monitor member utilization and appropriate
dental treatment and to provide essential statistical information.
The Company is also expanding its use of its indemnity claims paying processing
system to include utilization review and case management for its indemnity
insurance subsidiary. As part of the expansion of its PPO activities, the
Company has developed a sophisticated reporting system to demonstrate cost
savings for clients and members when PPO dentists are utilized. These reports
compare practice patterns that vary from established norms, identify patient
costs trends, provide detailed claims and group experience, and case and claims
management through a thorough preauthorization process. Repricing services are
also provided through the Company's PPO program. The Company compares
utilization patterns for dentists rendering dental services to the Company's
insureds to determine whether such dentists are over-utilizing the benefits
provided. In the event that an unusual practice pattern is ascertained, the
Company conducts a review of the dentist's facility to determine the basis for
such practice patterns and reviews its findings with the dentist on a regular
basis to eliminate any potential for abuse.
MEMBER SERVICES
The Company maintains a comprehensive Member Services and Grievance Resolution
System designed to assist members with simple inquiries and resolution of
dissatisfactions. The Company consistently monitors service statistics to ensure
continued ability to exceed the members' expectations. Eighty percent of all
dissatisfactions (grievances) received concerning eligibility or professional
services are resolved completely within 48 hours. The Company makes every
attempt to resolve more complex situations within 5 working days, but no longer
than 30 days following the receipt of the grievance.
The Company's Grievance Monitoring Committee, provides oversight of the
grievance process with particular attention paid to emerging patterns and
trends, nature and volume of complaints, financial implication for the
disposition of complaints, and quality of care issues. The monitoring process is
enhanced through the involvement of the Quality Management and Public Policy
Committees. The Quality Management Committee, at quarterly scheduled meetings,
reviews grievances at the provider level and has the responsibility to make
corrective action recommendations to the Company's Board of Directors based upon
grievance volume, trends and/or patterns. The Public Policy Committee, at
quarterly scheduled meetings, reviews grievances based on volume and type of
complaints, emergent patterns and trends, and has the responsibility to make
administrative, policy or plan change recommendations to the Company's Board of
Directors. Both committees also review specific complaints that have exhausted
the standard grievance resolution process.
All grievances receive a written disposition of the resolution within 30 days of
receipt of the grievance. The Company's arbitration policy is designed as a
final resort for members or providers that are dissatisfied with the results of
the appeals, Quality Management or Public Policy processes. Arbitration may not
be initiated until the grievance, Quality Management, or Public Policy processes
have been exhausted. The arbitration is conducted according to the American
Arbitration Association rules and regulations.
The Company utilizes an automated call distribution ("ACD") system for customer
call management. The Company provides toll-free customer telephone service with
automated 24-hours per day, 7 days per week access. Automated service features
are available for simple inquires such as provider selection, identification
card requests, and eligibility verification. The Company also provides customer
service telephone support during regularly scheduled business hours. The
Company's call volume averages 45,000 calls per month, with approximately 30
percent handled via automated selection features. The ACD system has the
capability to prioritize customer calls, and provide service update standards
per guidelines reports on a predetermined basis. The Company strives to maintain
a service standard of answering all customer calls within an average of 40
seconds, with an abandonment rate of approximately 2 percent to 4 percent
monthly.
RISK MANAGEMENT
The Company has sufficient general and professional liability insurance coverage
to manage the ordinary exposure of operating its Dental HMO plan business and
its indemnity dental plans. Generally, the Company is indemnified against
professional liability claims by its independently contracted providers. In
addition, each dentist is required to maintain professional liability insurance
with specified minimums of coverage. The Company also maintains arbitration
provisions in its contracts with providers.
Considering the Company's exposure to future claims for failure to provide
coverage in addition to the secondary risk to professional liability claims, the
Company carries its own professional liability insurance coverage in the amount
of
-9-
<PAGE> 12
$10,000,000, which it views as being adequate. However, no guarantee is made
that sufficient general and/or professional liability insurance coverage will be
available to the Company at an acceptable cost.
During 1998 as a result of its favorable claims history, the Company continued
to lower its risk management costs.
CLIENTS AND CONTRACTS
Substantially all of the Company's 1,018,000 members at December 31, 1998,
participate through over 6,300 group plans paid for by governmental and private
sector employers, multiple-employer trusts and educational institutions or, to a
minor extent, through individual plans.
The Company's 10 largest clients accounted for approximately 18 percent of the
Company's health care revenues for 1998 and 19 percent in 1997. Significant
clients served in 1998 by the Company include the City of Dallas, City of Los
Angeles, Southern California Edison, County of Los Angeles, Dallas Independent
School District, Health Net, Foundation, several contracts with McDonnell
Douglas Corporation, Southern California Gas Company, and the Joint Council #42
Welfare Trust. In the opinion of management, the loss of any single client would
not have a material adverse effect on the Company's financial condition or
results of operations.
The Company takes a proactive approach to better service its clients and
members. The Company maintains a multi-faceted plan to address the specific
needs of its clients by assigning a client services representative to all
clients. Each client services representative has dental care and field
experience. The Company's customer service complaint system also has been
enhanced by the Company's computer network which provides each representative
with full access to client, member and provider records. The Company's provider
network also benefits its multi-state clients.
Given the increasingly competitive nature of the dental care market, it is not
unusual for the Company to obtain a new client from competing indemnity insurers
or other dental HMO plans, or to lose an existing client to others. The Company
is also sensitive to the requirement that there be adequate levels of
compensation to its panel of participating providers so as to ensure that there
is an adequate panel of providers from which the client's members may select. As
a result, the Company has been obtaining price increases of up to 10 percent per
year. See "MARKETING" and "COMPETITION."
The Company's contracts generally provide for a defined dental benefit program
to be delivered to plan members for a period of one to two years at a fixed
monthly per-capita rate to the client. The contracts normally allow the client
the right to terminate on 60 days written notice of a deficiency in performance;
the Company has the right to extend the 60-day period to correct the deficiency.
ACQUISITIONS
In 1996, the Company completed the acquisition of all of the outstanding shares
of First American Dental Benefits, Inc., dba, American Dental Corporation
("First American"), a privately held Dental HMO company based in Dallas, Texas,
and an affiliated marketing entity, for a total consideration of approximately
$23.6 million. Of the purchase price, $20 million was paid at closing and the
Company is obligated to pay an aggregate sum of $3.6 million over 3 years to
satisfy certain payment obligations pursuant to non-competition agreements
entered into between the Company and the former owners of First American. The
Company financed the acquisition of First American through a credit agreement
with a bank. First American provides managed dental care services through a
network of approximately 1,100 dental care providers to approximately 175,000
members in Texas. The acquisition of First American was accounted for using the
purchase method of accounting with the results of operations of the businesses
acquired included from the effective date of the acquisition.
In May 1997, the Company completed the acquisition of all of the outstanding
shares of common stock of Advantage Dental HealthPlans, Inc. ("Advantage"), a
privately held Dental HMO company based in Fort Lauderdale, Florida, for a total
value of approximately $10.0 million consisting of cash and debt. As of December
31, 1998, Advantage provided benefits to approximately 125,000 members through
approximately 700 dental care providers in Florida. The acquisition of Advantage
was accounted for using the purchase method of accounting with the results of
operations of the business acquired included from the effective date of the
acquisition. In October 1997, the Company renamed Advantage to SafeGuard Health
Plans, Inc. In January 1998, the Company merged one of the Advantage affiliates,
Advantage Dental HealthPlans, Inc., a Missouri corporation, into its affiliate,
SafeGuard Health Plans, Inc., a Missouri corporation.
-10-
<PAGE> 13
In August 1997, the Company completed the acquisition of all of the outstanding
shares of common stock of Consumers Life Insurance Company of North Carolina
("Consumers"), a privately held dental indemnity insurance company with licenses
in sixteen states. The Company purchased the licenses and obtained all the
statutory deposits held on behalf of Consumers for a cash payment of $3.2
million and capitalized Consumers with total capital and surplus of $4.6
million. In connection with the acquisition of Consumers, it was redomesticated
from North Carolina to Texas and renamed SafeHealth Life Insurance Company,
Inc.("SafeHealth, Inc.") No active business was acquired in connection with the
acquisition of Consumers by the Company. In May 1998, the Company initiated the
merger of SafeHealth, Inc. into its affiliate, SafeHealth Life Insurance
Company, a California corporation ("SafeHealth"), as part of a strategic plan to
simplify business operations from an administrative, financial and legal
perspective. The merger of SafeHealth, Inc. into SafeHealth will also release
surplus requirements of the no longer existing entity, SafeHealth, Inc. The
Company has received regulatory approval for the merger from both the California
and Texas Departments of Insurance. It is anticipated that the merger will be
completed during the second quarter of 1999.
MARKETING
In the past, the Company's primary marketing strategy has been to contract with
large employer groups. While this strategy has served the Company well in the
past, several years ago the Company broadened its market strategy to seek out
and contract with employers with between 100 and 1,000 employees. While in the
past, the Company's Dental HMO plan had been offered as an alternative to the
primary dental insurance included in the employer's health care benefit program,
with the acquisition of the Company's indemnity insurance subsidiary, the
Company is now able to contract with the employer to provide both the Dental HMO
plan and the indemnity dental insurance program through one relationship. By
targeting the smaller and mid-sized employer groups described above, and by
offering both the Dental HMO and indemnity dental products to the employer, the
Company is able to obtain a higher per member per month rate than it could
previously by only offering its Dental HMO plan. Before submitting a proposal to
a prospective employer-client, the Company analyzes a demographic profile of the
potential new plan members, the current and desired dental benefit levels,
availability of adequate provider coverage and timely access, and other factors.
The Company markets its dental benefit plans through a network of over 1,500
independent insurance agents and brokers and an employee sales force. This
distribution system is designed to reach group purchasers of all sizes in an
efficient and cost effective manner. The Company believes that its marketing
strategy provides it with a competitive advantage by enabling it to market to a
wider range of potential groups more effectively than companies relying upon a
single distribution system.
The Company's sales force targets employers and groups, which are more likely to
contribute towards the cost of dental benefits for their employees. In marketing
to such groups, the Company's sales force focuses on selling both the Dental HMO
plan and an indemnity/PPO product. The Company pays its sales force through a
combination of salary and incentive compensation based upon the number of
members enrolled for new groups. As part of its growth strategy, the Company
intends to increase its sales staff during 1999.
The Company's independent insurance agent and broker network focuses on offering
Dental HMO and indemnity/PPO products to medium and smaller sized employers
which may or may not contribute towards or offer dental benefit plans to their
employees. The Company believes that there are significant opportunities for the
Company to expand Dental HMO and indemnity coverage to medium and smaller sized
employers by expanding its network of independent brokers who can effectively
sell dental benefit programs to the medium and smaller sized market. Brokers and
agents typically do not market the Company's dental plans on an exclusive basis.
Brokers and agents generally receive a flat percentage of premium collected as
commission for the initial sale and for each renewal thereafter. Brokerage
commissions paid by the Company were 6.3 percent and 5.7 percent of health care
revenues for 1998 and 1997, respectively.
Once plan participation is to be made available to employees, the Company's
marketing efforts shift to the potential plan members. During a designated
annual open enrollment period, participants may elect the Company's dental plans
or opt for the other form(s) of dental benefits being offered, generally dental
indemnity insurance, either offered by the Company or another insurance carrier.
Generally, participating employees can enroll into or drop out of the Company's
plans only during this enrollment period. Management believes that with most of
its group clients, an average of approximately 10 percent to 15 percent of
eligible employees select the Company's Dental HMO plan during the first open
enrollment period in which it is offered and that with smaller group clients, an
average of approximately 20 percent with voluntary plans select the Company's
Dental HMO plan, and an average of approximately 30 percent of eligible
employees with employer paid plans select the Company's Dental HMO plan during
the first open enrollment period in which it is offered.
-11-
<PAGE> 14
The Company believes that it has an opportunity to obtain new contracts from
employers with between 100 and 1,000 employees in the markets in which the
Company operates. The Company believes that this represents a significant under
penetrated market segment for the products offered by the Company. The Company
intends to build upon its current market position and increase its sales
activities by applying market segmentation and quality management principles to
identify the highest potential of customers and proactively anticipating their
needs in the marketing process. The Company intends to accomplish this by
identifying its core capabilities and competitive advantages that it has over
its competitors. By adding incremental service levels provided by the Company,
and applying technological advances to the marketing process, the Company's goal
is to lower per member acquisition costs, and eliminate unnecessary sales and
administrative expenses while increasing production capabilities of the
Company's marketing forces.
In the situation where the Company is successful in selling its multi-choice
products to the employer, all employees are enrolled in one of the plan's
offered by the Company. The Company believes that the ability to offer a
multi-choice option program increases the amount of revenue generated from each
sale by providing the employer with the entire insurance program which may be
available to its employees. This has the effect of increasing the overall per
member per month rate paid by the employer for each employee since the per
member per month premium for the Company's indemnity dental program is
significantly higher than that which the Company charges for its Dental HMO
plans. This has the overall effect of increasing the revenue generated from each
dollar of expense associated with the selling of the Company's products.
In 1998, approximately 60 percent of the Company's enrollment originated in the
State of California, while approximately 19 percent originated in the State of
Texas. No other state contributed more than 10% of the Company's enrollment
during 1998.
The Company provides a vision plan known as Premier Vision Care Plan (the
"Premier Plan"). The Company developed the Premier Plan with the intention of
enhancing the vision care component of its benefit programs. The Premier Plan
also features a convenient open provider option that allows members to select
any optometrist under contract with the Company at the time they seek care. This
open panel option is underwritten by the Company's indemnity insurance
subsidiary in California. The entire Premier Plan is underwritten by this
subsidiary in all other states in which it is provided. No provider preselection
is required. There are no cards to mail or forms to present before receiving
care so members can enjoy immediate access. The Premier Plan also allows members
to obtain services from any vision care professional and receive reimbursement
from the Company according to a set schedule of benefits. While the vision plan
did not generate significant revenues during 1998, it is anticipated that the
vision plans will continue to contribute to net income.
Smaller group employers find especially attractive the Company's ability to
offer one-stop shopping with its multi-choice dental package of indemnity dental
insurance and Dental HMO plans, its vision plans and its life insurance plans.
The Company continues to increase its efforts to expand its business through
strategic alliances. As a result, the Company maintains a relationship with
several Health Maintenance Organizations ("HMOs") to provide dual choice
indemnity and Dental HMO plans to segments of members enrolled in the HMO.
INDEMNITY INSURANCE PLANS - INDEMNITY INSURANCE BENEFITS
As a result of its desire to respond to the changing marketplace, the Company
expanded its business to include indemnity dental plans. In September 1992, the
Company acquired a California domiciled life and health insurance company and
renamed it SafeHealth Life Insurance Company ("SafeHealth Life"). SafeHealth
Life is regulated by the California Department of Insurance and currently holds
a Certificate of Authority as a life, health and disability insurer in the
states of Arizona, California, Colorado, Illinois, Kansas, Maryland, Missouri,
Nevada, New Mexico, Ohio, Oregon, Texas, Utah and Wisconsin. In August 1997, the
Company also acquired a North Carolina domiciled life and health insurance
company known as Consumers Life Insurance Company of North Carolina,
redomesticated it to the State of Texas and renamed it SafeHealth Life Insurance
Company, Inc. ("SafeHealth, Inc."). SafeHealth, Inc. is licensed to transact the
business of a life, health and disability insurance carrier in the states of
Alabama, Arizona, Arkansas, Delaware, Florida, Georgia, Indiana, Kentucky,
Louisiana, Mississippi, North Carolina, Oklahoma, South Carolina, Tennessee,
Texas, and Virginia. No active insurance business was acquired in connection
with the acquisition of SafeHealth Inc. The Company is in the process of merging
SafeHealth Inc. into and with SafeHealth Life, and has received all required
regulatory approvals to do so. The merger is anticipated to be completed during
the second quarter of 1999.
-12-
<PAGE> 15
SafeHealth Life has collaborated with other subsidiaries of the Company to
develop certain innovative marketing concepts with the intent of offering
consumers a multiple choice product consisting of a flexible indemnity plan, a
PPO plan, and a comprehensive Dental HMO plan in the states where it holds a
Certificate of Authority. The ability to offer fee-for-service dental plans
along with Dental HMO benefits, better serves new and existing clients. The
Company also offers a vision plan through SafeGuard in California, and
SafeHealth Life in Colorado, Illinois, Missouri, Nevada and Texas. SafeHealth
Life utilizes independent agents and brokers who specialize in the employee
benefits area and appreciate the ability of SafeHealth Life to custom design
plans as needed.
SafeHealth's client base includes small employer groups as well as governmental
agencies and political subdivisions. During 1998, the number of insured members
covered by SafeHealth stood at 114,000. SafeHealth anticipates increasing
production of its multiple choice dental programs in other states in which it is
admitted to do business. SafeHealth is also offering group term life insurance
as a participant in a reinsurance pool.
In late 1996, the Company purchased an indemnity dental claims processing system
capable of auto-adjudicating significant number of claims filed. In 1997, the
Company acquired the source code for its indemnity dental processing claim
system so as to allow the Company better utilize the features of this system so
as to maximize the technological advantages that are available with this system.
This system and its modifications will allow the Company to expand its indemnity
dental programs without necessarily incurring significant additional
administrative expense. In 1998, over 65 percent of claims filed were auto
adjudicated by this system.
The ownership of an indemnity insurance company exposes the Company to risk for
over utilization and claims costs in excess of premium revenue. To minimize its
risks, the Company conducts thorough claims review and develops lag studies
through the computer system purchased by the Company for its indemnity insurance
business. The Company also maintains a full-time actuary department which is
utilized to assist the Company in developing its benefit programs, rates and
payment schedules.
PREFERRED PROVIDER ORGANIZATION
Since 1993, SafeHealth Life has developed its PPO Network program in response to
the market demands to offer a more cost-effective alternative to traditional
indemnity insurance, and more freedom of choice than the Dental HMO
network/product alternatives. The PPO Network program was developed to
complement and also be used as a cost containment mechanism for current and
future indemnity dental plan clients. The negotiated fee arrangements enable the
Company to offer indemnity dental and SafeHealth PPO Network Plans that reduce
benefit costs for participating client groups and members. SafeHealth PPO
Network Plans are designed to encourage a greater level of participation from
participating network dentists due to lower levels of benefits for the
out-of-network option.
The Company also offers PPO Network Lease Services which offer the network as a
stand alone option for a per-member per-month fee. The Network Lease Service is
intended to be an option that is marketed to Health and Welfare Trusts,
Third-Party Administrators and Self-funded Employer Groups, again promoting the
cost containment features of the negotiated discounts. The Company assumes no
risk for clients that lease the PPO Network. At December 31, 1998, SafeHealth
had contracted with approximately 11,790 participating general and specialty
dentists in the markets in which it operates. The overall geographical
distribution of the dental network was developed to allow members easy access to
network dentists to take advantage of negotiated discounts. All participating
dentists have passed a strict qualification process and undergo annual quality
assessment reviews as part of ongoing compliance with network participation. The
Company continues to actively recruit dentists for its PPO plan, and intends to
add substantially more dentists to its PPO panel throughout 1999.
The PPO Network offers savings to the Company in the form of lower dollar levels
of claims costs, and savings to the insured in lower out-of-pocket costs due to
the PPO Network contracted fees. Administrative review protocol that utilizes a
sophisticated case management system insures that the individual needs of a
member are matched to treatment plans. The necessity and appropriateness of the
treatment plans are continually monitored to assure a professional and
appropriate treatment conclusion. The combination of the waiver of deductibles,
negotiated provider fees and case management review system can result in
significant member and claim costs savings.
GEOGRAPHIC EXPANSION
The Company's strategy regarding geographic expansion is presently undergoing a
strategic review to identify and capitalize upon opportunities that may exist in
states in which the Company is not presently operating. In the past, the
Company's strategy generally has been to enter new states only after obtaining a
major contract, either by expanding the
-13-
<PAGE> 16
geographic scope of service to existing clients, by entering into contracts with
new clients, or by establishing marketing agreements with other organizations.
Geographic expansion will also be accomplished through acquisition of other
Dental HMO or indemnity insurance organizations, such as the Advantage
acquisition that was completed in May 1997 which facilitated the establishment
of a regional office in Florida and allowed the Company to commence operations
in Florida, Georgia, and Washington, D.C. While the Company generally prefers
not to expand into new states until an adequate base of client business exists
to help defray the start-up costs of operations in those new states, the Company
is currently reviewing its strategic opportunities to provide Dental HMO and
dental indemnity benefits in other states and markets in which the Company does
not presently operate. A number of opportunities exist through strategic
affiliations which the Company is pursuing.
Once a decision to expand has been made, the Company usually establishes a local
market office to provide sales, marketing and provider services support in the
local market. Basic administrative services are provided by the Company at its
various regional offices. By using strategically located local market offices
and regional support offices, the Company has better controlled administrative
expenses associated with new plan start-ups, and can more efficiently and
effectively service a greater number of members in each market.
GOVERNMENT REGULATION
Many states have laws establishing the requirements for, and regulating the
conduct of, the Company and other Dental HMO plans. Such laws vary from state to
state and they generally require a state license, frequently prescribe
requirements for contracts, establish minimum benefit levels, impose financial
tests and maintain standards for management and other personnel. There is
currently no regulation of the Company's plans at the federal level.
Since some states will only license full service health plans, the Company
cannot enter those states except in conjunction with SafeHealth Life, its
indemnity insurance subsidiary, or with a full service HMO. Other states permit
only nonprofit corporations to become licensed as Dental HMO plans, again
limiting the Company's access. The heavily regulated nature of the Company's
industry imposes a variety of potential obstacles to management's plans for
further geographic expansion and could limit the Company's future growth. On the
other hand, this regulatory environment also governs the conduct and expansion
prospects of existing and new competitors, thereby providing a niche in the
marketplace for the Company.
The Company's Dental HMO plans are licensed and regulated by pertinent state
authorities. Among the areas regulated, although not necessarily by each state,
are the scope of benefits available to members, the content of all contracts
with clients, providers and others, tests of financial resources, including
maintenance of minimum stipulated financial reserves for the benefit of plan
members, procedures for review of quality assurance, enrollment requirements,
minimum loss ratios, "any willing provider" requirements which may limit the
Company's right to restrict the size of its provider network, the relationship
between the plan and its providers, procedures for resolving grievances, and the
manner in which premiums are determined or structured.
The Company's indemnity insurance operations through SafeHealth Life are
regulated by the California Department of Insurance, and the Department of
Insurance of the other states in which SafeHealth Life is licensed to transact
insurance business. The Company's indemnity insurance operations through
SafeHealth Life, Inc. are regulated by the Texas Department of Insurance and the
Department of Insurance in the other states in which SafeHealth Life, Inc. is
licensed to transact business. These regulations include specific requirements
with regard to minimum capital and surplus, permitted investments, advertising,
policy forms and claims processing requirements. The Company's insurance
operations are also licensed to transact business in other states which
traditionally follow the compliance requirements of the insurance company's
domiciled state, while sometimes imposing minimal specific policy and deposit
requirements for the Company's operations in those states. Insurance companies
are heavily regulated and require significant cash deposits for capital and
surplus. The Company's ability to expand its insurance operations into states in
which it is not currently licensed is dependent for the most part on the
regulatory review process which is conducted by the Department of Insurance in
each state in which the Company is applying. Such reviews may take anywhere
from six to twenty-four months.
TRADEMARKS, SERVICE MARKS AND TRADENAMES
The Company has filed, received approval and has obtained renewal protection
from the United States Patent and Trademark office for certain trademarks and
tradenames for names and products used by the Company in its ordinary course of
business. The Company has received a trademark, service mark or tradename for
the following words and phrases used with and without distinctive logos
maintained by the Company:
-14-
<PAGE> 17
o SafeGuard(R) used with a distinctive logo depicting a modified smile
used in connection with its Dental HMO plans;
o SafeGuard Health Plans(R) used in descriptive material to describe the
products offered by the Company;
o SafeGuard Dental Plans(TM) used to describe the various Dental HMO plans
offered by the Company;
o SafeHealth Life(R) used with a descriptive logo depicting a modified
smile used by the Company to describe its indemnity insurance and PPO
products; and
o American Dental Corporation(R) adjacent to a flag of the State of Texas
used in connection with its Dental HMO plans.
Collectively, these trademarks, service marks and tradenames were first used in
commerce in 1984 and have been continuously used thereafter. In addition, the
Company has nearly completed and is about to receive trademark/service mark
protection from the United States Assistant Commissioner for Trademarks of its
distinctive logo depicting a smile that the Company is currently utilizing in
interstate commerce.
COMPETITION
The Company operates in a highly competitive environment with numerous
competitors wherever the Company conducts business. The Company's competitors
include large insurance companies that offer both Dental HMO benefits and
traditional dental indemnity insurance, HMOs that offer dental benefits,
self-funded employer-sponsored dental programs, dental PPOs, discounted
fee-for-service dental plans and other local or regional companies which offer
dental benefit programs. Many of the Company's competitors are significantly
larger and have substantially greater financial and other resources, than the
Company.
The Company believes that key factors in selecting a particular dental benefits
company include the comprehensiveness and range of benefit plans offered, the
quality, accessibility and convenience of the plans' dental networks, the
responsiveness of customer service, and the premium rates charged. The Company's
competitors compete aggressively in all of the markets in which the Company
operates on all of these factors, including situations where the selection of a
dental plan is made through a competitive bidding process. Some markets in which
the Company operates also have intense price competition, which could occur in
all of the markets in which the Company operates in the future. The Company has
seen increasing competition from all competitive sectors and the Company
anticipates that this trend will continue in the future.
Larger, national indemnity insurance companies that offer both Dental HMO and
indemnity dental benefits may have a competitive advantage over independent
dental plans due to the availability of multiple product lines, established
business relationships, better name recognition and greater financial and
information system resources. The Company believes that it can effectively
compete with these insurance companies due to the comprehensiveness of its
management team and resources directed towards developing competitive dental
benefit plans at premium rates, which are generally lower than such large
national indemnity insurance companies. Some medical HMOs offer their own dental
benefit plans and others contract with independent Dental HMO plans for those
services. The Company believes that it can compete with HMOs that offer dental
benefit plans and the Company intends to continue to pursue opportunities to
form relationships with HMOs to offer dental benefit plans to HMO members.
Other than for technological expenses associated with the provision of Dental
HMO and indemnity dental benefit programs, the Company's business does not
require substantial amounts of capital. Other than government regulation and the
related operating costs of start-up, there are no significant barriers to new
companies entering into the market. There can be no assurance that the Company
will be able to compete successfully with new market entrants. Any such
additional competition could adversely impact the Company's revenues, net income
and growth prospects through fee reductions, loss of providers or clients,
and/or market share.
EMPLOYEES
At December 31, 1998, the Company had 269 employees, of whom 12 were executives
and 257 were administrative and clerical personnel. Regional administrative
services are provided in Aliso Viejo, California, Dallas, Texas and Fort
Lauderdale, Florida. Corporate administrative services are provided at the
Corporate office in Aliso Viejo, California. Approximately 45 clerical and
auxiliary employees are represented by a labor union. No other employees are
union members. The Company considers its relations with its employees to be
good.
-15-
<PAGE> 18
The Company maintains a 401(k) plan which allows for a pre-tax contribution from
an employee's earnings. Employees are eligible to participate in the 401(k) plan
upon completion of six months of service with the Company. Under the 401(k)
plan, an employee may defer up to 15 percent of his or her gross compensation
each pay period and the Company may, at its option, make an additional
discretionary contribution to be allocated among employees in the plan in
proportion to the compensation deferred. Employees are 100 percent vested in
their interest in the 401(k) plan at all times. The Company also maintains a
pre-tax medical insurance option within the meaning of Paragraph 106 of Section
125 of the Internal Revenue Code for its employees insuring dependents.
RISK FACTORS
The Company's business and competitive environment involve certain factors that
expose us to risk and uncertainty. Some risks relate to the managed dental care
industry in general and other risks relate to ourselves. As a result of the
risks and uncertainties described below as well as other risks presented
elsewhere in this report, there is no assurance that we will maintain our
current market position. Some of the below-referenced risk factors have affected
our operating results in the past, and all of these risk factors could affect
our future operating results.
Waivers and/or Extensions from Lender. Our financial position may be negatively
affected in the event we are unable to obtain waivers and/or extensions from our
senior note lender and line of credit lender concerning specific covenant
compliance requirements. Although there is an agreement in principal to
restructure the Company's debt to our senior note holder and line of credit
lender, no assurance can be given that the parties will execute definitive and
binding agreements with respect to such debt restructure by the agreed upon date
of April 28, 1999. See "RECENT DEVELOPMENTS" and "CREDIT FACILITIES."
Government Regulation. The health and dental care industry is subject to
extensive federal, state and local laws, rules and regulations. Due to
significant regulation of our business, a variety of potential obstacles to our
plans for further geographic expansion could limit our future growth.
Additionally, dental care practice standards and related federal and state
regulations may change. We cannot predict what changes may be enacted which may
affect our business and future growth.
Ability to Sell Dental Offices and/or Promissory Notes. Our financial position
may be negatively affected by our inability to consummate the proposed sale of
our dental practices represented by underperforming promissory notes. We
received promissory notes for all of the purchase price of some of the asset
sale transactions related to our discontinued operations. In the fourth quarter
of fiscal 1997, we established a reserve for underperformance of some of these
notes. The non-performance of such notes may have a negative effect on our
financial results if any charges exceed the reserves established. The sales may
also expose us to additional transition costs. The sales may expose us to the
time and costs of litigation. In the fourth quarter of 1998, and as part of an
ongoing review process, the Company ascertained that some of the Promissory
Notes ("Notes") granted to the Company by the Purchasers of these practices were
not performing at currently stated levels and therefore, unable to service such
Notes pursuant to the terms and conditions thereof. As a result, the Company
reduced the value of the Notes on its books so that they reflect management's
current estimate of their market value. Rather than the Company exercising its
right to foreclose on the Notes, Guards entered into a Default Forbearance
Agreement and an Irrevocable Power of Attorney with the Purchasers, which will
enable the Company to either resell the assets or Notes relating to the
practices.
Risk of Acquisitions. We completed three acquisitions in the past few years. The
acquisitions entail risks that we may be unable to successfully integrate the
acquired businesses into our existing operations. Also, the acquisitions may
fail to perform as expected. In addition, the acquisitions may require
significant amounts of our time to assimilate. As a result, occurrence of any of
the risks listed could have a material negative effect on our operating and
financial results.
Possible Volatility of Stock Price. Our stock price is subject to fluctuations.
The stock price volatility can be a response to actual or anticipated variations
in operating results, announcements of our new developments or our competitors,
developments in relationships with clients and other events or factors. Even our
modest underperformance against the expectations of the investment community can
lead to a significant decline in our stock price. Broad stock market
fluctuations, which may be unrelated to our operating performance may have a
negative affect on the price of our stock.
Competitive Market. We operate in a highly competitive environment. Our ability
to expand is affected by existing and increasing competition and dental product
choices and number of competitors in the areas that we offer products. There can
be no assurance that we will be able to compete successfully with new market
entrants. Any additional competition could have a negative impact on our
revenues, net income and growth prospects through premium reductions, loss of
providers or clients, or market share. We expect the level of competition to
remain high. In addition, we recognize that competitive pricing pressures may
have a negative effect on our operating margin.
-16-
<PAGE> 19
Ability to Continue Company Growth. We have grown in recent years through
expansion in new small and mid-size clients. We also had an increase in the
number of persons covered under indemnity insurance products offered by our
insurance subsidiary. Also, we experienced an increase in the number of members
covered as a result of strategic relationships with other health care providers
with our September 1996 acquisition of First American, the May 1997 acquisition
of Advantage, and the August 1997 acquisition of SafeHealth, Inc. Although we
desire and intend to continue to expand, we are not sure that we will be able to
maintain or continue to expand our market presence in our current locations or
successfully enter other markets. The ability to continue our growth will depend
on a number of factors, including existing and emerging competition. In
addition, our ability to maintain effective control over dental care costs,
secure cost effective contracts with additional dentists, introduce new
technologies, and availability of working capital to support our growth.
Levels of Utilization and Dental Care Services. Our dental indemnity and PPO
dental plans are underwritten by one of our subsidiaries. These plans subject us
to underwriting risks associated with over utilization and pricing variances in
excess of premium revenues. To minimize these risks, we conduct thorough claims
review and lag studies and maintain an actuary department. However, if
underwriting risks are not accurately assessed, rates charged to clients may not
cover costs. As a result, a material negative effect on our operating and
financial results may occur.
In addition, dental care provided by specialists is made available to members
under many of our Dental HMO plans. We assume responsibility under such plans
for such specialty care arrangements. We are responsible for payments to
specialists, usually at a discounted, fee-for-service basis and not on a
capitated basis. Accordingly, we retain the risk for the payment of specialty
dental care claims. If the utilization of specialty dental care increases under
our outstanding Dental HMO plans, operating and financial results could be
negatively impacted.
Effect of Adverse Economic Conditions. Our business may be negatively affected
by periods of economic slowdown or recession which, among other things, may be
accompanied by layoffs by client organizations reducing the number of members
served by us, and increased pricing pressure from our clients and competitors.
Relationships with Dental Providers. Our success is dependent upon our continued
maintenance of a large network of quality dentists in each of our markets.
Generally, we and network dentists enter into non-exclusive contracts that may
be terminated by either party with limited notice. Our operating results may be
negatively affected if we are unable to establish and maintain contracts with an
adequate number of quality dentists in any market in which we operate. See
"BUSINESS-PROVIDER RELATIONS."
Dependence on Key Personnel. We believe that our success is largely dependent
upon the abilities and experience of our senior management team. The loss of the
services of one or more of these senior executives could negatively affect our
operating and financial results. We have entered into employment agreements with
key senior executives, including the Chief Executive Officer and the Chief
Operating Officer.
-17-
<PAGE> 20
RECENT DEVELOPMENTS
The Company reached an agreement in principle with its Senior Note Holder to
restructure the debt owed by the Company. The senior notes due September 30,
2005 ("Note") will be modified to provide for an interest rate increase from
7.91% to 9.91% from the date that the Company and the Note holders execute
definitive documents. Thereafter, the interest rate will decrease to 8.91% and
then to 7.91% after the Company has satisfied certain conditions. The Company
will also be responsible for all reasonable out-of-pocket attorneys' fees and
costs and consultant's fee incurred by the Note holder after January 1, 1999, in
connection with this debt, to be paid on the closing date. In
-18-
<PAGE> 21
consideration of this agreement, the Note holder has waived all existing
defaults or events of defaults through April 28, 1999, or such mutually agreed
to extended date thereafter and extended to April 29, 1999, the payment of
interest due March 30, 1999. The sale of certain assets of the Company will also
not be considered an event of default under the agreement with the Notes holder
so long as the proceeds are used to repay the note holder in accordance with the
amendments to the agreement.
Various technical terms, covenants and provisions of the Note holder agreement
relating to consolidated net worth, interest expense coverage and limitation on
consolidated total debt will be amended.
New provisions will include a requirement for the Company to provide the Note
holder notice of any notice of intent to audit received by the Company from any
regulatory agency, copies of correspondence from any regulatory agency and the
Company's response thereto. In addition, the Company is not to declare dividends
or other distributions, and not incur any liens on the Company's subsidiary's
voting stock. The Company is also required to provide consolidated financial
reports and cash flows at regular intervals. The Company is also required to pay
from the proceeds of certain sales of assets owned by the Company specified
amounts to the Note holder on a prorata basis, including the sale of the
Company's former headquarters building, and certain promissory notes owned by
the Company.
The agreement in principal also provides that prior to December 31, 1999, the
Company may satisfy all of the financial obligations due to the Notes holder
without prepayment penalty. The Company's also responsible for issuing to
the Note holder non-transferable and cancelable Warrants representing the right
to acquire 382,000 shares of the Company's common stock, which are exercisable
at any time after January 1, 2000, and prior to December 31, 2003, at a price
per share equal to $1 above the twenty day weighted average of the NASDAQ
closing price for the Company's stock for such twenty days prior to and
including the closing date. However, the warrants will be automatically canceled
on the date the Company's debt to the senior note holders is satisfied in full
by December 31, 1999. Certain "piggyback" and demand registration rights with
respect to the Warrants have been granted to the Note holder.
Additional principal and collateral payments are required under the
restructuring agreement including payment of a portion of the proceeds from the
sale of the Company's former headquarters building in Anaheim, California, and
with all appropriate regulatory approval, the payment of funds derived from the
sale of certain promissory notes granted to the dental office subsidiary of the
Company in connection with the sale of the general dental and orthodontic
practices previously owned by the Company and a portion of the Company's 1998
federal tax refund. The Company also granted to the senior notes holder and the
line of credit lender a first priority deed of trust on the Anaheim, California
building, delivery of any promissory notes given to the Company in connection
with the sale of the building and certain other promissory notes owned by the
Company, to a collateral agent for the benefit of the senior notes holder.
Additionally, the senior note holder has agreed not to exercise any and all
rights or remedies under the original agreement through and including April 28,
1999, subject to certain events of default.
The Company has also reached an agreement, in principle, with its line of credit
lender to extend the maturity date of the existing obligation to January 29,
2000. The interest rate which shall be paid by the Company to the Lender from
and after the closing date will be equal to the prime interest rate plus 4%.
Thereafter, the rate shall be prime plus 3% and then the rate shall be prime
plus 1.5% thereafter until paid in full upon the Company satisfying certain
conditions. The Company is also required to make certain principal payment
reductions during specified periods and in specified amounts, consisting of the
payment of proceeds received from the sale of certain promissory notes owned by
the Company, and certain promissory notes, after appropriate regulatory approval
is received, owned by a subsidiary of the Company relating to previously sold
general dental and orthodontic dental practices, the payment of a portion of the
1998 federal tax refund, and a portion of the net cash proceeds of the sale of
the Anaheim, California building.
-19-
<PAGE> 22
The Agreement in Principal also provides that prior to the extended maturity
date, the Company may repay the line of credit lender in full without penalty.
Additionally, the line of credit lender has agreed not to exercise any and all
rights and remedies under the original loan agreement through and including
April 28, 1999, subject to certain events of default.
Additional collateral provided to both the senior note holder and line of credit
lender, shall be that as previously described. The Company is also obligated to
pay reasonable out-of-pocket attorneys' fees and costs by line of credit lender
through the closing date, and certain consulting fees for consultants required
to be hired by The Company. The Company is also obligated to comply with certain
operating covenants which are the same as previously described above.
In consideration of the agreement, the line of credit lender waives all existing
defaults and extends to April 29, 1999, the payment of outstanding principal and
interest due to the line of credit lender while definitive documents are
prepared. Additionally, the Company will provide credit lender with monthly
consolidated financial statements and covenants compliance certificates, all
Securities and Exchange Commissions filings, and other financial documents as
they may reasonably request, and the same notice requirements as described
above. Certain standard conditions are required as a condition of closing. The
Company has also agreed to modify the various loan documents in accordance with
Definitive Documents to be executed consistent with the Agreement in Principal.
Although there is an agreement in principal to restructure the Company's debt to
the Company's senior note holder and line of credit lender, no assurance can be
given that the parties will execute definitive and binding agreements with
respect to such debt restructure by the agreed upon date of April 28, 1999.
ITEM 2. PROPERTIES
During 1997, the Company entered into an agreement to lease office space
consisting of approximately 68,000 square feet in Aliso Viejo, California. The
Company moved its corporate headquarters and executive offices from its previous
location in Anaheim, California to Aliso Viejo, California during the third
quarter of 1998. The Company also owns a 60,000 square foot building in Anaheim,
California, which it previously utilized as its corporate headquarters and
executive offices. Currently, the Company is in the process of selling such
building and intends on completing that transaction during 1999. However, no
assurances can be given that such building will be sold during 1999 or that a
suitable buyer willing to purchase the building under terms and conditions which
are satisfactory to the Company will be found during 1999. In addition, the
Company leases offices in Phoenix, Arizona; Walnut Creek, California; Denver,
Colorado; Fort Lauderdale, Florida; St. Louis, Missouri; Austin, Dallas, and
Houston, Texas. The Company leased all of its previously owned Guards practices,
which leases have been assigned to the persons and/or entities who purchased the
dental practices, but for which the Company remains secondarily liable. Those
leases expire on dates ranging through July 2005. In the opinion of management,
the Company's facilities are adequate for its current needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various claims and legal actions in the ordinary
course of business. The Company believes all pending claims either are
adequately covered by insurance maintained by panel providers or the Company, or
will not have a material adverse effect on the Company's results of operations
or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 1998.
-20-
<PAGE> 23
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
(a) Market Information
The Company's common stock is traded on the NASDAQ National Market System under
the symbol SFGD. The following table sets forth the high and low prices at which
the Company's common stock traded as reported. The bid quotations represent
inter-dealer prices, without retail markups or commissions, and do not
necessarily represent actual transactions.
<TABLE>
<CAPTION>
High Low
-------- --------
<S> <C> <C>
Fiscal Year ended December 31, 1998
First Quarter...................................................$13.50 $ 8.25
Second Quarter..................................................$ 9.375 $ 6.00
Third Quarter...................................................$ 7.1875 $ 3.6875
Fourth Quarter..................................................$ 5.50 $ 3.3125
Fiscal Year ended December 31, 1997
First Quarter...................................................$18.375 $11.125
Second Quarter..................................................$12.75 $ 9.625
Third Quarter...................................................$14.00 $10.50
Fourth Quarter..................................................$14.875 $12.50
</TABLE>
Approximate Number of Equity Security Holders
<TABLE>
<CAPTION>
Approximate Number of
Record Holders
Title of Class (as of December 31, 1998)
-------------- ---------------------------
<S> <C>
Common Stock, $.01 Par Value 1,000
</TABLE>
Dividends
No cash dividends have been paid on the Company's common stock. It is the policy
of the Board of Directors to retain the Company's earnings for use in its
operations and expansion of its business, and the Company does not anticipate
paying cash dividends in the foreseeable future. The Company's credit
arrangements prohibit dividends.
Stockholder Rights Plan
In March 1996, the Company's Board of Directors declared a dividend of one right
to purchase fractions of the shares of its Series A Junior Participating
Preferred Stock, par value $.01 per share having rights, preferences, privileges
and restrictions under certain circumstances, other securities, for each
outstanding share of the Company's common stock, par value $.01 per share
distributed to stockholders of record at the close of business on April 12,
1996. The description and terms of the Rights are set forth in a Rights
Agreement, dated as of March 22, 1996, between the Company and American Stock
Transfer and Trust Company, as Rights Agent.
(b) Use of Proceeds
N/A
-21-
<PAGE> 24
ITEM 6. SELECTED FINANCIAL DATA
The financial data included in the table as of December 31, 1998 and 1997 and
for the three years ended December 31, 1998, have been derived from financial
statements audited by the Company's independent accountants, Deloitte & Touche,
LLP. This data was reclassified in prior years to reflect the discontinuation of
the Company's general dental and orthodontic practices (see Note 2 of the
Consolidated Financial Statements). This data should be read in conjunction with
such financial statements and notes thereto, and Item 7. "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS."
Selected Operating, Statistical and Balance Sheet Data
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996 1995 1994
- ----------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Operating Data (in $000's except income per share):
Health care revenues $ 97,449 $ 95,350 $ 72,709 $ 60,736 $ 53,921
--------- --------- --------- --------- ---------
Expenses:
Health care services 66,020 65,702 54,534 45,285 39,203
Selling, general and administrative 37,492 25,103 16,292 13,451 12,178
--------- --------- --------- --------- ---------
Total expenses 103,512 90,805 70,826 58,736 51,381
--------- --------- --------- --------- ---------
Operating income (6,063) 4,545 1,883 2,000 2,540
Other income 2,341 1,632 984 1,286 1,026
Loss on impairment of assets (11,165) -- -- -- --
Interest expense (4,311) (2,871) (485) -- (3)
--------- --------- --------- --------- ---------
Income (loss) from continuing operations before
(benefit) provision for income taxes and
discontinued operations (19,198) 3,306 2,382 3,286 3,563
Provision for income taxes (6,638) 1,495 980 1,251 1,390
--------- --------- --------- --------- ---------
Income (loss) before discontinued operations (12,560) 1,811 1,402 2,035 2,173
Income (loss) from discontinued operations
to be disposed of, net (620) (3,555) (852) 353 (881)
Income (loss) on disposal of dental practices, net 2,086 (605) 1,678 -- --
Cumulative effect of change in accounting
principle, net -- -- 824 -- --
--------- --------- --------- --------- ---------
Income (loss) from discontinued operations, net 1,466 (4,160) 1,650 353 (881)
--------- --------- --------- --------- ---------
Net income (loss) $ (11,094) $ (2,349) $ 3,052 $ 2,388 $ 1,292
========= ========= ========= ========= =========
Basic income per share:
Net income from continuing operations $ (2.66) $ 0.38 $ 0.30 $ 0.45 $ 0.47
Net income (loss) from discontinued
operations, net 0.31 (0.88) 0.34 0.08 (0.19)
--------- --------- --------- --------- ---------
Net income (loss) $ (2.35) $ (0.50) $ 0.65 $ 0.53 $ 0.28
========= ========= ========= ========= =========
Weighted average shares outstanding
(000's) -- Basic 4,747 4,723 4,711 4,523 4,613
========= ========= ========= ========= =========
Diluted income per share:
Net income from continuing operations $ (2.66) $ 0.37 $ 0.28 $ 0.43 $ 0.45
Net income (loss) from discontinued
operations, net 0.31 (0.85) 0.34 0.08 (0.18)
--------- --------- --------- --------- ---------
Net income (loss) $ (2.35) $ (0.48) $ 0.62 $ 0.51 $ 0.27
========= ========= ========= ========= =========
Weighted average shares outstanding
(000's) -- Diluted 4,747 4,899 4,940 4,725 4,852
========= ========= ========= ========= =========
Membership (000's): 1,018 1,165 983 761 721
Clients 6,306 5,550 4,922 2,661 2,086
Employees 269 249 461 458 432
Contracted managed care dental offices 5,600 5,000 4,200 3,291 2,902
PPO dental offices 11,800 9,100 9,600 9,706 5,765
Company owned dental offices -- -- 27 33 30
Balance Sheet Data (in $000's):
Cash and short-term investments $ 6,215 $ 12,906 $ 9,807 $ 14,746 $ 8,661
Current assets 32,945 26,403 27,622 23,576 12,378
Current liabilities 25,379 20,193 11,633 5,941 3,043
Long-term debt 32,500 33,894 19,086 -- --
Stockholders' equity 21,754 32,759 35,200 31,929 27,469
Total assets 79,944 88,518 68,116 38,343 30,792
</TABLE>
-22-
<PAGE> 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
The Private Securities Litigation Reform Act of 1995 (the "1995 Act") provides a
"safe harbor" for forward-looking statements, so long as those statements are
identified as forward-looking and are accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed in the statement. The Company desires to
take advantage of these safe harbor provisions. The statements contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations concerning growth and strategies, future operating results and
financial position, as well as economic and market events and trends, any future
premium pricing levels, future dental health care expense levels, the Company's
ability to control health care, selling, general and administrative expenses,
items discussed under heading "Year 2000" and all other statements that are not
historical facts, are forward looking statements. Words such as expects,
projects, anticipates, intends, plans, believes, seeks or estimates, or
variations of such words and similar expressions are also intended to identify
forward-looking statements. These forward-looking statements are subject to
significant uncertainties and contingencies, many of which are beyond the
control of the Company. Actual results may differ materially from those
projected in the forward-looking statements, if any, which statements involve
risks and uncertainties. The Company's ability to expand is affected by
competition not only in benefit program choices, but also the number of dental
plan competitors in the markets in which the Company operates. Certain large
employer groups and other purchasers of commercial dental health care services
continue to demand minimal premium rate increases, while limiting the number of
choices offered to employees. In addition, changes in dental health care
regulations, securing cost effective contracts with dentists may become more
difficult in part due to the increased competition among dental plans for
dentist contracts. The Company's ability to obtain waivers and/or extensions
from its lenders, whether or not the Company enters into any extraordinary
transaction, changes in the Company's operating or expansion strategy, or
failure to consummate proposed resale of dental offices and/or promissory notes.
The Company's profitability depends, in part, on its ability to maintain
effective control over health care costs, while providing members with quality
dental care. Factors such as levels of utilization of dental health care
services, new technologies, specialists costs, and numerous other external
influences may effect the Company's operating results. Any critical unresolved
Year 2000 issues at the Company or its vendors could have a material adverse
effect on the Company's results of operations, liquidity or financial condition.
In addition, the Company's expectations about the future costs and timely and
successful completion of its Year 2000 Program are subject to uncertainties that
could cause actual results to differ materially from what has been discussed
under the heading "Year 2000". Factors that could influence the amount of future
costs and the completion dates and effectiveness of remediation testing and
certification and contingency planning efforts include the Company's success in
identifying IT systems and embedded systems that contain two-digit year codes,
the nature and amount of required reprogramming, testing and certification, the
rate and magnitude of related labor and consulting costs, the availability of
qualified personnel and the success of the Company's external relationships in
addressing their own Year 2000 issues. The Company's expectations for the future
are based on current information and evaluation of external influences. Changes
in any one factor could materially impact the Company's expectations relating to
premium rates, benefits plans offered, membership growth, the percentage of
health care expenses, and as a result, profitability and therefore, effect the
forward-looking statements which may be included in these reports. In addition,
past financial performance is not necessarily a reliable indicator of future
performance. An investor should not use historical performance alone to
anticipate future results or future period trends.
The following should be read in conjunction with the Consolidated Financial
Statements of the Company and Notes thereto.
<TABLE>
<CAPTION>
Results of operations
(000's omitted except percentages) 1998 Versus 1997 1997 Versus 1996 1996 Versus 1995
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Membership enrollment (147) 182 222
Percentage change (12.6%) 18.5% 29.2%
- ----------------------------------------------------------------------------------------------------
Health care revenues $ 2,099 $ 22,641 $ 11,973
Percentage change 2.2% 31.1% 19.7%
- ----------------------------------------------------------------------------------------------------
Health care expenses $ 318 $ 11,168 $ 9,249
Percentage change 0.5% 20.5% 20.4%
Percent of revenues 67.7% 68.9% 75.0%
- ----------------------------------------------------------------------------------------------------
</TABLE>
-23-
<PAGE> 26
<TABLE>
<CAPTION>
Results of operations
(000's omitted except percentages) 1998 Versus 1997 1997 Versus 1996 1996 Versus 1995
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Selling, general and administrative
expenses $ 12,389 $ 8,811 $ 2,841
Percentage change 49.4% 54.1% 21.1%
Percent of revenues 38.5% 26.3% 22.4%
- ----------------------------------------------------------------------------------------------------
Other income, net $ 709 $ 648 $ (302)
Percentage change 43.5% 65.9% (23.5)%
Percent of revenues 2.4% 1.7% 1.4%
- ----------------------------------------------------------------------------------------------------
Interest expense $ 1,440 $ 2,386 $ 485
Percentage change 50.2% 492.0% N/A
Percent of revenues 4.4% 3.0% 0.7%
- ----------------------------------------------------------------------------------------------------
Income (loss) from continuing
operations before
Discontinued operations $ (14,371) $ 409 $ (633)
Percentage change (793.5)% 29.2% (31.1)%
- ----------------------------------------------------------------------------------------------------
Income (loss) from discontinued
operations, net $ 5,626 $ (5,810) $ 1,297
Percentage change 135.2% (352.1)% 367.4%
- ----------------------------------------------------------------------------------------------------
Net income (loss) $ (8,745) $ (5,401) $ 664
Percentage change (372.3)% (177.0)% 27.8%
- ----------------------------------------------------------------------------------------------------
</TABLE>
1998 Versus 1997
The Company's revenues for twelve months ended December 31, 1998 increased 2.2%
from $95,350 to $97,449 on a membership decrease of 12.6%. The 1997 basis of
comparison, however, includes the acquisition of Advantage in May 1997. On a pro
forma basis, including the effect of the Advantage acquisition for the entire
year, revenues for the same period increased $202 on a membership decrease of
12.6%. Notwithstanding the membership losses, largely in the first quarter of
1998, new business was acquired during the balance of the year that incorporated
improved pricing strategies that generated a recovery of revenues that would
have otherwise been lost. Additionally, cross selling of offerings to clients,
moderate price increases to the existing customer base and increases in sales to
small and mid-size clients contributed to the revenue stability.
Health care expenses increased 0.5% or $318 for the twelve months ended December
31, 1998. As a percent of revenues, health care expenses improved 1.2% from
68.9% of revenues for the twelve months ended December 31, 1997 to 67.7% for the
same period in 1998. Including the Advantage acquisition for twelve months of
1997, health care expenses for the period would have been $66,452 or 68.2% of
revenues. The comparison to 1998 then shows a decrease of $432 in health care
expenses and a decrease of 0.6% of revenues. The Company continues to improve
the health care cost ratios in its existing business, including the business
provided by its recent acquisitions, as well as improvements to cost control
measures.
Selling, general and administrative expenses increased $12,389 or 49.4%.
Including the Advantage acquisition for all of 1997, such increase is $11,819 on
an increase of 11.6% of revenues. The increase experienced in 1998 is
attributable to certain transitional costs the Company experienced during the
year, including a charge for uncollectible accounts receivable, the Company's
relocation of its corporate headquarters from Anaheim, CA to Aliso Viejo, CA,
and the associated operating leases, the costs associated with the elimination
of various job functions at year-end, and the continuing increases in costs
associated with telecommunications and computer networks.
Other income increased $709 for the twelve months ended December 31, 1998 from
$1,632 in 1997 to $2,341, an increase of 43.4%. This is primarily due to the
interest bearing notes receivable as a result of the sale of the discontinued
general dentist and orthodontic practices.
Loss on impairment of assets in the amount of $11,165 for the twelve months
ended December 31, 1998 primarily represents a pre-tax charge against
under-performing notes.
Interest expense increased $1,440 for the twelve months ended December 31, 1998
from $2,871 in 1997 to $4,311 in 1998, an increase of 50.2%. Such increase is a
result of the interest associated with the working capital credit facility which
was entered into in 1998 and the private placement long-term debt, which was
entered into during 1997.
-24-
<PAGE> 27
The operating results of the discontinued orthodontic and general dental
practices for the twelve months ended December 31, 1998 reflect a gain of $1,466
after a tax provision of $937 versus a loss of $4,160 for the same period in
the prior year, an increase of $5,626.
Net loss of $11,094 for the twelve months ended December 31, 1998 was an
increase of $8,745 over the loss of $2,349 reported for the same period a year
ago. This was primarily due to the year-end discontinued and transitional
charges discussed above.
1997 Versus 1996
As a result of the Company's discontinuation of its orthodontic practices in
1997, the financial statements have been reclassified for all comparative years
to reflect these changes (see Note 2 of the Consolidated Financial Statements).
The Company's revenues for the twelve months ended December 31, 1997, increased
31.1 percent, from $72,709 to $95,350, on a membership increase of 18.5 percent.
This includes the contribution from the acquisition of First American in
September 1996, as well as the acquisition of Advantage in May 1997. Excluding
the impact of the two acquisitions, revenues for the same period indicated above
increased 13.1 percent on a 5.9 percent increase in membership. These increases
were attributable to cross selling of product offerings to existing clients,
moderate price increases to renewing clients and increases in sales to small and
mid-size clients.
Health care expenses increased 20.5 percent, or $11,168 for the twelve months
ended December 31, 1997. As a percentage of revenues, health care expenses
improved by 6.1 percent, from 75.0 percent of revenues for the twelve months
ended December 31, 1996, to 68.9 percent for the same period in 1997. This was
primarily due to the acquisitions of both First American and Advantage, which
have a lower health care cost as a percent of revenues. The Company also
realized improvements in health care cost ratios for its existing business,
excluding the two acquisitions, from 76.2 percent for the twelve months ended
December 31, 1996, to 74.5 percent for the same period in 1997, an improvement
of 1.7 percentage points. This improvement is due to improved pricing as well as
continued improvement in control of costs.
Selling, general and administrative expenses increased $8,811, or 54.1 percent,
for the twelve months ended December 31, 1997. This was primarily due to the
acquisitions of First American and Advantage with the related selling, general
and administrative costs of those businesses. Goodwill and intangible
amortization expense related to the acquisitions was $1,525 for the twelve
months ending December 31, 1997 compared to $312 for same period in 1996.
Excluding the effect of the two acquisitions, the ratio of selling, general and
administrative expenses to revenues increased to 23.0 percent from 21.3 percent
for the twelve months ended December 31, 1997, compared to the same period of
1996. This was as a result of increases in telecommunications and computer
network systems costs, as well as increases in management staffing levels.
Other income increased by $648 for the twelve months ending December 31, 1997,
from $984 in 1996, to $1,632, an increase of 65.9 percent. This was due to an
increase in interest bearing notes receivable resulting from the sale of the
discontinued general dental practices. Interest expense of $2,871 for the twelve
months ending December 31, 1997, is primarily a result of the borrowings
obtained for the acquisition of both First American and Advantage. This
represents an increase of $2,386 from $485 in 1996.
The operating results, net of taxes, of the discontinued orthodontic and general
dental practices for the twelve months ended December 31, 1997, reflect a net
loss of $4,160 for the twelve months ending December 31, 1997, an increase in
losses of $5,810 over the same period in 1996. This includes a pre-tax charge of
$8,550 for under-performing notes and receivables ($5,600), litigation costs
($750), and other transition costs ($2,200).
Net loss of $2,349 for the twelve months ended December 31, 1997, was a decrease
of $5,401 in net income over the same period in the prior year. This was
primarily due to the impact of the discontinued charge discussed above, as well
as the other above factors.
1996 Versus 1995
After restating the Company's financial statements to reflect the
discontinuation of the Company's general dental practices, and for the adoption
of a change in accounting principle (see Notes 1 and 2 of the Consolidated
Financial
-25-
<PAGE> 28
Statement), the Company's revenues for the twelve months ended December 31,
1996, were $72,709, or a 19.7 percent increase on a 29.2 percent membership
increase over the corresponding period a year ago. These increases included the
impact on revenues and membership for the acquisition of First American,
completed September 27, 1996. Excluding the impact of the acquisition, revenues
for the same period indicated above increased 14.8 percent on a 6.0 percent
increase in membership. The increase in revenue was attributable to new small
and mid-size clients, cross-selling of product offerings to existing clients and
moderate price increases to renewing clients.
Health care expenses for the twelve months ended December 31, 1996 increased
$9,249 or 20.4 percent. Health care expense as a percentage of health care
revenues increased by 0.4 percent from 74.6 percent of revenues for the twelve
months ended December 31, 1995, to 75.0 percent for the same period in 1996.
This was primarily due to an increase in the estimated liability for claim costs
processed through the Company's indemnity dental system, as well as the selected
disenrollment of less profitable clients based on actuarial reviews of plan
designs and utilization.
General and administrative expenses for the twelve months ended December 31,
1996, increased $2,841 or 21.1 percent. This was due primarily to the
acquisition of First American. The acquisition had a slightly higher ratio of
general and administrative expenses to revenues than the Company had prior to
the acquisition. In addition, the goodwill expense of $312 attributable to the
acquisition, for the period following the purchase on September 27, 1996, is
included in general and administrative expenses. Excluding the impact of the
acquisition and the associated goodwill expense, the ratio of general and
administrative expenses to revenues improved slightly to 19.0 percent, from 20.1
percent for the twelve months ended December 31, 1996, compared to the same
period of 1995.
Other income declined to $984 from $1,286 due to lower balances of cash and
investments. The Company entered into a credit agreement during 1996 to
facilitate the acquisition of First American, resulting in interest expense of
$485.
Proforma operating results, net of taxes, of the discontinued general dental and
orthodontic practices for the twelve months ended December 31, 1996, reflect a
net income of $1,650 net of an after tax deferred loss of $621. This compares to
a net after tax income of $353 for the same period in 1995. The income amount
for 1996 included an after tax gain of $1,678 on the sale of four general dental
practices during 1996 as well as the cumulative effect, after taxes, of the
change in accounting principle which increased income by $824 and was adopted as
of January 1, 1996. Net income increased due to the above factors.
General
The Company's California dental plan contributes substantially to the Company's
operating revenues. Additionally, in 1998, the dental plans in each state all
contributed positively towards operating revenues. Management believes that each
state plan is capable of being profitable once targeted enrollment levels are
attained and stable provider panels are in place. The Company's indemnity
insurance subsidiary also contributed positively towards operating earnings.
The Company's ability to attract clients is affected by revisions in employee
benefit programs, fluctuations in employment levels, increasing market
competition and other factors. The Company's ability to increase revenues
depends on many factors, including existing and emerging competition. There can
be no assurance that the Company's revenues will continue to increase.
Liquidity and Capital Resources
The Company's capital and operational cash requirements have been met
principally from operating cash flows, and corporate borrowings, and this is
expected to continue.
At December 31, 1998 and December 31, 1997, the current ratio was 1.3 to 1.0 and
1.3 to 1.0, respectively. The Company's net worth was $21.8 million at December
31, 1998, compared to $32.8 million the previous year. The Company had $6.2
million and $12.9 million of cash and short-term investments as of December 31,
1998 and December 31, 1997, respectively. As a result of its regulated nature,
the Company is required to maintain various regulatory bank accounts in an
aggregate amount of approximately $9.0 million to satisfy depository
requirements imposed by state regulatory agencies. The Company believes that
cash flow from continuing operations, together with the existing cash and
short-term investments on hand and other available sources of financing, should
be adequate to meet operating capital and regulatory needs for the foreseeable
future. See discussion of credit facilities below.
-26-
<PAGE> 29
Credit Facilities
In September 1996, the Company established a $30 million bank loan which
provided for a $22 million reducing revolving acquisition sub-facility and an $8
million revolving working capital sub-facility. This agreement was terminated in
September 1997.
On September 30, 1997, the Company completed a private placement of $32.5
million in long-term debt consisting of eight-year notes through John Hancock
Mutual Life Insurance Company ("Hancock"). The Company used the proceeds to
repay all of its long-term indebtedness and for general corporate purposes. The
senior notes have a principal payment of $6.5 million due on September 30, of
each year starting in 2001. The interest rate for the loan is fixed at 7.91
percent. The notes are unsecured senior notes. In connection with the senior
notes, the Company is subject to certain financial and operational debt
covenants. As of December 31, 1998, the Company was in compliance, or has
obtained a waiver, with respect to these covenants.
On May 9, 1997, the Company completed the acquisition of Advantage Dental
HealthPlans, Inc. The Company financed part of the acquisition through an
unsecured $8.5 million promissory note with the seller, with an interest rate
which averaged 8.5 percent during 1998. The promissory note was paid in full in
April 1998.
On January 29, 1998, the Company entered into a $8,000,000 revolving working
capital credit facility with Silicon Valley Bank (the "Bank"), all of which is
currently being utilized by the Company. The loan had a maturity date of January
28, 1999, and is currently due and payable. The interest rate for the facility,
as amended, was established at the Bank's Prime rate, plus 1.5 percent or at the
Company's option, LIBOR plus 2.25 percent. The loan is secured by a first
priority security interest in all the personal property of the Company,
including accounts receivable, fixed assets and intangibles and a negative
pledge on the stock of the Company's subsidiaries and on the real property owned
by the Company. In connection with the Bank and Hancock loan, the Company is
subject to certain financial and operational debt covenants. As a result of
underperforming notes related to the sale of the dental offices that were
previously sold and discontinued, reduction in the value of the Company's former
headquarters building in Anaheim, California, which the Company is in the
process of selling, severance payments to a number of former employees who left
the Company in the fourth quarter as a result of the Company's continuing
efforts to streamline its operations, and expenses for a reduction in its
account receivable balances which may be uncollectable, as ascertained after the
Company completed its systems conversion in October 1998, as of the end of the
fourth quarter of 1998 the Company was not within compliance with such covenant
requirements.
See also the section entitled Recent Developments for a description of
restructuring of credit facilities in April 1999.
-27-
<PAGE> 30
Year 2000 Compliance
The Year 2000 issue results from computer programs using two digits rather than
four to define the applicable year. Any of the Company's computer programs that
have time-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruption of operations, including among other things,
a temporary inability to process transactions, send invoices, or engage in
similar normal business activities.
Company's State of Readiness
The Company relies heavily upon information technology ("IT") systems and other
systems and facilities such as telephones, building access control systems and
heating and ventilation equipment ("embedded systems") to conduct its business.
The Company also has business relationships with dental health care providers,
financial institutions and other third parties ("Vendors") as well as regulators
and customers who are themselves reliant upon IT and embedded systems to conduct
their business.
As part of the Company's proactive approach to automation, the Company began
planning an awareness activity as early as January 1996 and incorporated Year
2000 compliance into its business continuity plans. As a result, the Company
purchased and is in the final implementation process of upgrading any and all
information systems software and hardware. The implementation of such new and
upgraded computer information systems will recognize the Year 2000 and process
date data correctly, including the Company's manipulation of data when dates are
in the 20th or 21st century. The Company executed its initial steps in 1996 when
it continued to enhance its information systems, including all hardware and
software products, individually and in combination, to better manage operational
resources and analysis of data. A review was also performed to determine the
future needs of the Company and to enhance technology to better enable the
Company to provide its services. In addition, as a foundation for developing and
executing its Year 2000 compliance program, SafeGuard utilized and integrated
Year 2000 compliance programs developed by both Federal and State governments
and corporate industry leaders. Moreover, SafeGuard developed a comprehensive
five-phase approach for all of its Year 2000 program activities and management
processes. The five phases are included in the following table that indicates
the percentage completed as of November 1998.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
ANTICIPATED
PROGRAM GOALS START DATE DATE COMPLETED COMPLETION DATE
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Planning and Awareness 1 Jan 1996 1 Jun 1997 N/A
- ----------------------------------------------------------------------------------------------
Assessment 1 Jun 1996 1 Jan 1998 N/A
- ----------------------------------------------------------------------------------------------
Renovation 1 Dec 1996 1 Jan 1999 N/A
- ----------------------------------------------------------------------------------------------
Validation 1 Jan 1997 In Process 1 Jun 1999
- ----------------------------------------------------------------------------------------------
Implementation 1 Jun 1996 In Process 1 Jun 1999
- ----------------------------------------------------------------------------------------------
</TABLE>
The Company's five-phase comprehensive approach is as follows:
(1) Phase 1: Planning and Awareness - identify all IT and other systems and
facilities and risk rate each according to its potential business
impact;
-30-
<PAGE> 31
(2) Phase 2: Assessment - identify IT and other systems and facilities that
utilize date functions and assessing them for Year 2000 functionality;
(3) Phase 3: Renovation - reprogram or replace when necessary, inventoried
items to ensure that they are Year 2000 compliant;
(4) Phase 4: Validation - test the code modifications and new inventory of
other associated systems, including extensive date testing and
performing quality assurance testing to ensure successful operation in a
post-1999 environment; and
(5) Phase 5: Implementation of Year 2000 Compliant IT and other systems.
As indicated in the above-referenced chart, the Company completed Phase 1
Planning and Awareness on or about June 1, 1997, Phase 2 Assessment on or about
January 1, 1998 and Phase 3 Renovation of all of its IT and other systems and
related facilities on or about January 1, 1999. The Company anticipates
completing Phase 4 Validation and beginning Phase 5 Implementation of such Year
2000 Compliant IT and other systems and facilities by June 1999.
The Company has inventoried and risk rated substantially all of its embedded
systems. The results of these processes indicate that embedded systems should
not present a material Year 2000 risk to the Company. The Company's remaining
steps include testing selected embedded systems and remediating through
replacement and/or repair and certifying systems that exhibit Year 2000 issues.
The Company is focusing its testing and facilities such as data centers, service
centers and communication centers. The Company plans to complete the testing,
validation and implementation of these systems by June 1999.
The Company has also inventoried and risk rated its systems. Substantially all
of the tested systems have been found to be compliant.
As part of the Company's Year 2000 Compliance Program Planning/Awareness and
Assessment phases, the Company documented the state and condition of existing
systems and processes and conducted a thorough analysis of inventory and vendor
supplied systems and subsystems. The Company included information technology
systems and non-information technology systems.
The Company also faces the risk that one or more of its Vendors will not be able
to interact with the Company due to the Vendor's inability to resolve its own
Year 2000 issues, including those associated with its own external
relationships. The Company has completed its inventory of Vendors and risk rated
each external relationship based upon the potential business impact, available
alternatives and cost of substitution. Although the Company is diligently
working with its vendors regarding Year 2000 compliance, there can be no
guarantee that all of the Company's vendors will be Year 2000 compliant.
The Company has previously compiled a comprehensive list of any and all Vendors
and Vendor products, which was included in a Vendor identification matrix.
Although the Company does not currently rely upon external Vendors for
proprietary software or data services, all other Vendors have been identified
and have either stated their full compliance or partial compliance with
contingent solutions to Year 2000 issues. The Company believes that its Vendors
with which it has a material relationship are Year 2000 Compliant, based upon
such vendor's assurances. Nonmaterial Vendors of the Company currently have
provided either full and/or partial certification of compliance with the Year
2000 issue. The Company will continue to monitor such nonmaterial Vendor
compliance activity in order to determine the risk to overall company
operations.
As a result of the anticipated execution of the Renovation, Validation and
Implementation phases of the Company's Year 2000 Compliance Program, the Company
believes the Year 2000 issue will not have a material impact on the Company's
results or operations.
Cost to Address Company's Year 2000 Issues
The cost the Company incurred to address Year 2000 Compliance issues from a
historical perspective is approximately $2.5 million. Whereas, the estimated
cost of the Company's completion of the final phases of renovation, validation
and implementation is estimated to be approximately $0.5 million. A large
majority of these costs are expected to be incremental expenses that will not
recur in Year 2000 or thereafter. The Company's current estimates primarily
reflect increased remediation and testing efforts. The source of funds for the
Year 2000 Compliance Program costs, including the percentage of the information
technology budget utilized for the program was $3.0 million. Year 2000
Compliance
-31-
<PAGE> 32
is critical to the Company. Therefore, the Company has redeployed some resources
from non-critical system enhancements to address Year 2000 issues. Due to the
importance of IT systems to the Company's business, management has not deferred
the decision to make non-critical systems enhancements Year 2000 ready. The
Company does not expect these redeployments to have a material impact on the
Company's financial condition or result of operations.
Risk and Contingency/Recovery Planning
The Company reasonably believes that its Year 2000 Compliance Program, which
involves the phases of planning and awareness, assessment, renovation,
validation and implementation should prevent the Year 2000 from having a
material effect on the Company's business or financial condition. However, if
the Company's Year 2000 issues were unresolved, potential consequences would
include, among other possibilities, the inability to accurately and timely
process benefits claims, update client groups' accounts, process financial
transactions, bill client groups, report accurate data to management,
shareholders, customers, regulators and others as well as business interruptions
or shutdowns, financial losses, reputational harm, increased scrutiny by
regulators and litigation related to Year 2000 issues. The Company is attempting
to limit the potential impact of the Year 2000 by monitoring the progress of its
own Year 2000 project and those of its critical Vendors by developing
contingency/recovery plans.
The Company has begun to develop contingency/recovery plans aimed at ensuring
the continuity of critical business functions before and after December 31,
1999. As part of that process, the Company has begun to develop reasonably
likely failure scenarios for its critical IT systems and external relationships
and the embedded systems. Once these scenarios are identified, the Company will
develop plans that are designed to reduce the impact on the Company, and provide
methods of returning to normal operations, if one or more of those scenarios
occur. The Company expects contingency/recovery planning to be substantially
complete by June 1999.
To reduce the risk of the Company presented by the Year 2000, the Company has
also increased its on-hand supplies of inventory for printed documents and
materials that are provided to client groups, and has identified alternative
Vendors, whether such Vendors have previously provided assurances that they are
fully Year 2000 Compliant or are in the process of becoming Year 2000 Compliant.
Therefore, based upon the Company's proactive Year 2000 Compliance Program, the
Company anticipates that the Year 2000 issue will not have a material impact on
the Company's results or operations.
Impact of Inflation
Management believes that the Company's operations are not materially affected by
inflation. The Company believes that a majority of its costs are capitated or
fixed in nature and are directly related to membership levels, and therefore
related to premium levels.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements and the related Notes and Schedules
thereto filed as part of this 1998 Annual Report on Form 10-K are listed on the
accompanying Index to Financial Statements on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
During the two (2) most recent fiscal years, there have been no changes in the
Company's independent auditors or disagreements with such auditors on accounting
principles or practices or financial statement disclosures.
PART III
ITEM 10. DIRECTORS AND/OR EXECUTIVE OFFICERS OF THE COMPANY
The current directors and/or executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Steven J. Baileys, D.D.S. 45 Chairman of the Board of Directors and Chief Executive Officer(2)
John E. Cox 47 President, Chief Operating Officer and Director(2)
Ronald I. Brendzel, J.D. 49 Senior Vice President, General Counsel, Secretary and Director(2)
Herb J. Kaufman, D.D.S. 47 Senior Vice President and Chief Dental Officer
Kenneth E. Keating 35 Western Regional Vice President
</TABLE>
-32-
<PAGE> 33
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Ronald B. Bolden 33 Central Regional Vice President
Gordon W. Spiering 42 Eastern Regional Vice President
Judy M. Deal 47 Vice President-Provider Relations
Thomas J. Fluegel 32 Vice President-Regional Support
Carlos Ferrera 35 Vice President-Information Technologies
Robert J. Pommersheim 50 Interim Chief Financial Officer
Nancy Stokes 61 Vice President-Quality Improvement Programs
Michael M. Mann, Ph.D. 59 Director(1)(2)
William E. McKenna 79 Director(1)(2)
George H. Stevens 45 Director(1)(2)
Bradford M. Boyd, D.D.S. 47 Director(1)(2)
</TABLE>
- ----------
(1) Member, Compensation and Stock Option Committee, Audit Committee, and
Nominating Committee.
(2) Directors hold office from the Annual Meeting of Stockholders for
staggered terms of three years (until re-elected or until successors are
elected and qualified), as follows:
<TABLE>
<S> <C> <C>
Dr. Baileys and Mr. Stevens Class III May, 1999
Mr. McKenna and Mr. Cox Class I May, 2000
Mr. Brendzel, Dr. Mann and Dr. Boyd Class II May, 2001
</TABLE>
Officers are elected annually and serve at the pleasure of the Board of
Directors, subject to all rights, if any, under certain contracts of employment.
Dr. Baileys is Chairman of the Board of Directors and Chief Executive Officer.
He was President from 1981 until March 1997, Chief Executive Officer since May
1995, and Chairman of the Board of Directors since September 1995. He was Chief
Operating Officer from 1981 until May 1995. From 1975 until 1981, Dr. Baileys
served in a variety of executive and administrative capacities with the Company.
From September 30, 1996 through March 31, 1998, Dr. Baileys was an officer,
director and 50% shareholder in the Islas Professional Dental Corporation, which
operated a dental practice under contract to a subsidiary of the Company. Dr.
Baileys is also licensed to practice dentistry in the State of California. He is
also a member of the Southern California chapter of the Young Presidents'
Organization. Dr. Baileys is the brother-in-law of Mr. Brendzel.
Mr. Cox was appointed President and Chief Operating Officer, and was named as a
Director of the Company in March 1997. He was Executive Vice President and Chief
Operating Officer from May 1995 to March 1997. From 1985 to 1995, he served in
various executive capacities for CIGNA Dental Health, including Vice President,
National Sales and Account Services, Western Regional President, Chief Financial
Officer, and Controller. From 1981 to 1985, Mr. Cox served in various financial
capacities for Southeastern Health Services/Prucare-Prudential Insurance
Company's group model HMO in Atlanta, Georgia. He is the Company's
representative to the National Association of Dental Plans, and served on the
Board of Directors the California Association of Dental Plans.
Mr. Brendzel is Senior Vice President, General Counsel, Secretary and a Director
of the Company. He was Chief Financial Officer from April 1988 to May 1996, Vice
President-Corporate Development from August 1980 until April 1986, and held
various executive and administrative positions from 1978 until 1980. Mr.
Brendzel is a member of the California State Bar and is licensed to practice law
in the state of California. He is also a member of the Knox-Keene Health Care
Service Plan Advisory Committee, which assists the California Department of
Corporations in regulating managed care health plans. Mr. Brendzel is also a
former member of the Texas Health Maintenance Organization Solvency Surveillance
Committee which assists the Texas Department of Insurance in regulating health
maintenance organizations.
Dr. Kaufman was appointed Senior Vice President and Chief Dental Officer for the
Company in January 1997. From January 1995 to January 1997, he was National
Dental Director for CIGNA. From January 1996 to January 1997, Dr. Kaufman was
Chief Executive Officer of CIGNA Dental Health of Arizona, Inc. Preceding that,
he was Regional Dental Director for the western region for CIGNA from February
1990 to January 1995. Prior thereto, Dr. Kaufman was CIGNA's Dental Director for
the State of Arizona from April 1989 to February 1990. From September 1984 to
April 1989, he was Dental Director and Dental Department Chair for CIGNA
Healthcare of Arizona, Inc. Dr. Kaufman was in private dental practice from
August 1979 to August 1984. Prior thereto, Dr. Kaufman was a general dentist in
the United States Air Force from July 1976 to June 1979. Dr. Kaufman is licensed
to practice dentistry in the States of Arizona, California and Colorado. He is a
member of the American Dental Association, Arizona Dental Association, National
Association of Dental Professionals, and California Association of Dental Plans.
He serves on the advisory
-33-
<PAGE> 34
board for Procter and Gamble, Health Services Advisory Group, the Academy for
Managed Care Dentistry Counsel, and on the faculty at Northern Arizona
University.
Mr. Keating is the Western Regional Vice President responsible for all
administrative activities of the Company for its Western region. He was Vice
President-Imprimis and Guards Office Operations for the Company from October
1995 until October 1997. He was Vice President-SafeHealth Life Operations from
August 1995 until October 1995 when he was appointed to his present position.
From March 1987 to July 1995, Mr. Keating served in various executive capacities
for CIGNA Dental Health, including Director of Sales and Account Services,
Director of Network Development and Director of Staff Model Operations.
Mr. Bolden has been the Central Regional Vice President for the Company's
Central region operations since April 1996. Prior to that, he served as New
Business Manager for CIGNA Healthcare of California. From 1990 to 1994, Mr.
Bolden served in various operational capacities for CIGNA Dental Health-Western
Region, including Director, Provider Relations, Regional Sales Support Director
and Provider Relations Manager. He obtained a Bachelor of Science degree in
Biology from Morehouse College in 1987.
Mr. Spiering has been the Eastern Regional Vice President for the Company since
February 1998. Prior thereto, he was a Vice President for Lee Hecht Harrison
from 1994 until 1998. From 1993 to 1994, he was President of Gordon Spiering &
Associates. Preceding that, he was the Marketing/Contracting Manager for
National Consulting Group from 1990 until 1993. He served as a Case Manager for
Anon Anew of Boca Raton, Inc. from 1986 to 1989. From 1985 to 1986, he was Vice
President for Trial Consultant, Inc.
Ms. Deal was appointed Vice President-Provider Relations in October 1997. Prior
thereto, she was Vice President-Member and Provider Services for the Company
from January 1996 until October 1997. From January 1995 until January 1996, she
was Vice President-Provider Relations. Prior to joining the Company, Ms. Deal
was the Director of Provider Relations for CIGNA Dental Health from November
1988 to January 1995. Preceding that, Ms. Deal was the Dental Office Manager of
a large group dental practice from November 1974 to November 1988.
Mr. Fluegel was appointed Vice President-Regional Support in April 1998. He was
Director, Acquisition & Business Integration from September 1996 to April 1998.
From 1988 to 1996, he served in various managerial capacities for CIGNA Dental
Health, including Director- Sales and Account Services, Director- Group
Administration, Assistant Director-Administrative Development and
Manager-Quality Control.
Mr. Pommersheim was appointed Interim Chief Financial Officer in December 1998.
He joined the Company in February 1997 as Controller Eastern Region and also
served as Director Eastern Regional Operations until December 1998. From March
1995 until February 1997, he was the Controller for General Rental, Inc. Prior
thereto, he was self-employed from September 1989 to March 1995. From February
1980 until September 1989, he served as Regional Vice President and Vice
President, Finance for CIGNA Dental Health. Preceding that, he was the
Operations Manager for John Wanamaker Company from November 1974 to February
1980.
Mr. Ferrera was appointed Vice President-Information Technologies for the
Company in October 1997. Prior thereto, he was Vice President-SafeHealth Life
Operations for the Company. He joined the Company in October 1995. From March
1988 to October 1995, Mr. Ferrera served as Director of Provider Relations and
Product Consultant for CIGNA Dental Health. Preceding that, he was a Staff
Sergeant in the United States Air Force.
Ms. Stokes joined the company in September 1997 as Vice President-Quality
Improvement Programs. From August 1996 until September 1997, she was employed as
a Health Planning Consultant, Quality Improvement Manager for the Arizona
Department of Health Services, Office of Oral Health, responsible for designing,
conducting, coordinating and documenting quality improvement reviews and program
evaluations for all licensed prepaid dental plans operating in Arizona. Program
oversight included conducting site visits, tracking, analyzing, monitoring and
reporting quality improvement efforts and outcomes. From September 1991 until
June 1996, Ms. Stokes was employed by CIGNA Dental Health where she was, at
various times, responsible for provider recruitment, specialty referral
processing, claim analysis and adjudication, and was director of member
services.
Dr. Mann has been a Director of the Company since May 1987. He is also Chairman
of Blue Marble Partners, and Chairman, President and Chief Executive Officer of
Blue Marble Development Group, Inc. international corporate development and
consulting firms, and an Adjunct Professor of Industrial and Systems Engineering
at the University of Southern California. He also serves as a member of the
Board of Examiners for the Malcolm Baldrige National Quality Award. During the
period from September 1987 to July 1988, Dr. Mann was a Senior Consultant of
Arthur D. Little, Inc. From August 1986 until September 1987, Dr. Mann was a
Partner of Mann, Kavanaugh, Chernove & Associates, a
-34-
<PAGE> 35
business development firm. He was President, Chief Executive Officer and a
Director of Helionetics, Inc., a defense, energy and signal information
processing company, from December 1984 to July 1986, and Executive Vice
President from April to December 1984. Dr. Mann is a Director of Datum, Inc. and
Management Technology, Inc.
Mr. McKenna has been a Director of the Company since September 1983. Since
December 1977, Mr. McKenna has been a general partner of MCK Investment Company,
a private investment company. Mr. McKenna was Chairman of the Board of
Technicolor, Inc. from 1970 to 1976 and was formerly Chairman of the Board and
Chief Executive Officer of Hunt Foods & Industries, Inc. and its successor,
Norton Simon, Inc. From 1960 to 1967, Mr. McKenna was associated with Litton
Industries, Inc. as a Director and in various executive capacities. He is
currently a Director of California Amplifier, Inc., Midway Games, Inc., Drexler
Technology Corporation, and WMS Industries, Inc.
Mr. Stevens has been a Director of the Company since May 1989. Since 1982, he
has been President of Belle Haven Marina, Inc., a privately held leisure and
recreational organization located in Virginia. He is also President of Kingfish
Corporation, a privately held corporation which is engaged in the business of
chartering pleasure yachts in the mid-Atlantic region. Mr. Stevens is also the
owner of Mariner Sailing School located in Virginia. Mr. Stevens' combined
organization is the largest operator of recreational vessels in the Washington
D.C. area.
Dr. Boyd has been a Director of the Company since May 1995. He has been licensed
to practice dentistry in the State of California since 1983, and has been the
sole proprietor of Bradford M. Boyd, D.D.S., located in Lancaster, California.
Dr. Boyd also is a private investor. He is a member of the American Dental
Association, California Dental Association, and San Fernando Valley Dental
Society. Dr. Boyd is also an officer of the Dental Foundation of California and
is also a member of the Board of Directors of High Desert Children's Dental, a
charity organization providing free dental services to underprivileged children
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF EXECUTIVE OFFICERS
The following table discloses compensation received by the Company's Chief
Executive Officer and the four (4) remaining most highly paid executive officers
who received total compensation in excess of $100,000 for the previous years
ended December 31, 1998, 1997 and 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long Term
Annual Compensation
Compensation Awards
-----------------------------------------------------
Other Stock
Name and Principal Position Year Salary($) Bonus($) ($)(2) Options
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Steven J. Baileys, D.D.S., 1998 400,000 * 1,260 70,000
Chairman of the Board of 1997 400,000 * 1,260 50,000
Directors and 1996 400,000 * 1,260 25,000
Chief Executive Officer
John E. Cox, President and Chief 1998 275,000 * * 25,000
Operating Officer 1997 258,221 * * 25,000
1996 200,000 * * 25,000
Ronald I. Brendzel, J.D., Senior 1998 185,000 * 900 5,000
Vice President, General Counsel 1997 185,000 * 900 5,000
and Secretary 1996 185,000 * 900 10,000
Herb J. Kaufman, D.D.S., Senior 1998 165,530 * 249 7,500
Vice President and Chief Dental 1997 153,907 * 249 25,000
Officer(1)
Kenneth E. Keating, Western 1998 150,000 * * 5,000
Regional Vice President 1997 150,000 * * 2,500
1996 170,823 * * 7,500
</TABLE>
- ----------
* None.
(1) Joined the Company on January 5, 1997.
-35-
<PAGE> 36
(2) Represents premiums paid for life insurance policies for the named
individuals.
- ----------
EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT ARRANGEMENTS
The Company has written employment agreements with Steven J. Baileys, D.D.S.,
John E. Cox, Ronald I. Brendzel, J.D., and Herb J. Kaufman, D.D.S. The
employment agreements for Dr. Baileys, Mr. Cox and Mr. Brendzel are for a term
through May 31, 2000, and provide for an annual salary of $400,000, $275,000,
and $185,000, respectively. The employment agreement for Dr. Kaufman is for a
term through January 5, 2002, and provides for an annual salary of $170,000. The
Company may terminate the agreements for cause. The employee may terminate his
agreement for any reason. Should there be a change in control of the Company in
that more than fifty percent (50%) of the Company's then outstanding common
stock is purchased by a then non-existing stockholder, and newly elected
Directors constitute a majority of the Company's Board of Directors, the
employee, at his option, may terminate his employment. In such event, the
Company would be obligated to pay Dr. Baileys, Mr. Cox and Mr. Brendzel an
amount equal to three (3) times, and in the case of Dr. Kaufman, one (1) times
the employee's then current salary and bonus, paid on or before the fifth (5th)
day following such change in control, along with the continuance of all employee
benefits for the length of the employment agreement.
STOCK OPTIONS
The following table contains information concerning the grant of stock options
pursuant to the Stock Option Plan (the "Plan") during the fiscal year ended
December 31, 1998, to the named executives:
STOCK OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
Potential Realizable
Value at
Assumed Annual
Rates of Stock
Price Appreciation
Individual Grants for Option Term(2)
- ----------------------------------------------------------------------------------------------------------------
Percent of
Number of Total
Securities Options/SARs Exercise or
Underlying Granted to Base
Options/SARs Employees Price Expiration
Name Granted(#)(1) In Fiscal Year ($/Share) Date 5%($) 10%($)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Steven J. Baileys, D.D.S 70,000 39.2 10.038 3/27/03 194,132 428,981
John E. Cox 25,000 13.1 9.125 3/27/08 143,467 363,572
Herb J. Kaufman, D.D.S 7,500 3.9 9.125 3/27/08 43,040 109,072
Ronald I. Brendzel, J.D 5,000 2.6 9.125 3/27/08 28,693 72,714
Kenneth E. Keating 5,000 2.6 9.125 3/27/08 28,693 72,714
</TABLE>
- ----------
(1) All options were granted under the Plan. The options described in this
column vest in equal one-third (1/3) amounts over a three (3) year
period following the date of grant. Unvested options terminate upon the
employee's termination from the Company, for any reason.
(2) Potential realizable value is based on an assumption that the market
price of the common stock of $3.3125 as of December 31, 1998,
appreciates at the stated rate, compounded annually, from the date of
grant to the expiration date. These values are calculated based on
requirements promulgated by the Securities and Exchange Commission and
do not reflect the Company's estimate of future stock price
appreciation. Actual gains, if any, are dependent on the future market
price of the Company's common stock.
STOCK OPTION EXERCISES AND HOLDINGS
The following information is with respect to the named executive officers and
indicated groups concerning the exercise of options during fiscal year December
31, 1998, and unexercised options held as of December 31, 1998.
-36-
<PAGE> 37
AGGREGATED STOCK OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
<TABLE>
<CAPTION>
Shares Number of Securities Value of Unexercised
Acquired Value Underlying Unexercised In-the-Money
Name on Exercise(#) Realized($) Options at FY-End(#) Options at FY-End($)(1)(2)
- -------------------------------------------------------------------------------------------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
<S> <C> <C> <C> <C> <C> <C>
Steven J. Baileys, D.D.S * * 183,333 111,667 0 0
John E. Cox * * 75,000 50,000 0 0
Ronald I. Brendzel, J.D * * 33,333 11,667 0 0
Herb J. Kaufman, D.D.S * * 8,333 24,167 0 0
Kenneth E. Keating * * 5,833 9,167 0 0
All executive officers as a group
(10) persons) * * 339,833 242,667 0 0
All directors who are not executive * * 81,333 26,667 0 0
Officers as a group (4 persons)
All employees who are not executive * * 15,067 35,733 0 0
Officers as a group (29 persons)
</TABLE>
- ----------
* None.
(1) Assumes a price per share of common stock of $3.3125 as of December 31,
1998. Gains are reported net of the option exercise price, but before
any taxes associated with exercise. Actual gains, if any, on stock
option exercises are dependent on future performance of the common
stock, as well as the optionee's continued employment throughout the
vesting period.
(2) No stock appreciation rights were outstanding at the end of the 1998
fiscal year or exercised during that year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth the beneficial ownership of the common stock of
as of April 1, 1999, by each director, each executive officer named in the
Summary Compensation Table below and all current directors and officers as a
group. All shares of common stock are subject to the named person's sole voting
and investment power, except where otherwise indicated.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY APPROXIMATE PERCENT
NAME OWNED(1) OF CLASS
- ---- ------------------- -------------------
<S> <C> <C>
Steven J. Baileys, D.D.S.(2) 1,982,099 41.8
Ronald I. Brendzel, J.D.(3) 136,573 2.9
John E. Cox(4) 85,000 1.8
William E. McKenna(5) 36,500 *
Michael M. Mann, Ph.D.(6) 29,000 *
George H. Stevens(7) 24,350 *
Herb J. Kaufman, D.D.S.(8) 16,768 *
Bradford M. Boyd, D.D.S.(9) 11,080 *
Kenneth E. Keating(10) 5,833 *
All current directors and officers as a group
(12 persons) 2,346,202 49.4
</TABLE>
- ----------
* Less than one percent (1%).
(1) Some of the stockholders included in this table reside in states having
community property laws under which the spouse of a stockholder in whose
name securities are registered may be entitled to share in the
management of their community property which may include the right to
vote or dispose of such shares, and includes options to purchase 334,834
shares of common stock exercisable as of April 1, 1999, or within sixty
(60) days thereafter.
(2) The shares indicated include options to purchase 183,333 shares of
common stock, 700,767 shares of common stock representing 14.8% owned by
the Baileys Family Trust, 303,000 shares of common stock representing
6.4% held in various trusts for relatives of Dr. Baileys, for both of
which Dr. Baileys is Trustee and for which Dr. Baileys has sole power to
vote the securities, but for both of which Dr. Baileys disclaims
beneficial ownership, and 150,000 shares of common stock representing
3.2% held by the Alvin and Geraldine Baileys
-37-
<PAGE> 38
Foundation, for which Dr. Baileys is an officer and director and for
which Dr. Baileys has shared power to vote the securities, but for which
Dr. Baileys disclaims beneficial ownership.
(3) Includes options to purchase 25,000 shares of common stock.
(4) Includes options to purchase 75,000 shares of common stock.
(5) Includes options to purchase 29,000 shares of common stock.
(6) Represents options to purchase 29,000 shares of common stock.
(7) Includes options to purchase 24,000 shares of common stock.
(8) Includes options to purchase 16,666 shares of common stock
(9) Includes options to purchase 10,000 shares of common stock.
(10) Represents options to purchase 5,833 shares of common stock.
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to those persons who, to
the Company's knowledge, beneficially owned five percent (5%) or more of common
stock as of April 1, 1999, except with respect to the Baileys Family Trust, FMR
Corp., Brinson Partners, Inc., Dimensional Fund Advisors, Inc., and T. Rowe
Price Associates, Inc., which are stated as of December 31, 1998, based on
filings made with the Securities and Exchange Commission. For purposes of this
Annual Report on Form 10-K, beneficial ownership of securities is defined in
accordance with the rules and regulations of the Securities and Exchange
Commission and generally means the power to vote or dispose of securities
regardless of any economic interest therein.
<TABLE>
<CAPTION>
APPROXIMATE AMOUNT AND NATURE
NAME OF BENEFICIAL OWNER OF BENEFICIAL OWNERSHIP(1) PERCENT OF CLASS
- ------------------------ -------------------------- ----------------
<S> <C> <C>
Steven J. Baileys, D.D.S.(2) 1,982,099 41.8
Baileys Family Trust(3) 700,767 14.8
FMR Corp.(4) 462,700 9.8
Brinson Partners, Inc.(5) 403,755 8.5
Dimensional Fund Advisors, Inc.(6) 288,100 6.1
T. Rowe Price Associates, Inc.(7) 264,100 5.6
All Principal Stockholders 4,101,521 86.4
</TABLE>
- ----------
(1) Except as otherwise stated herein, the persons and entities named in the
table have sole voting and investment power with respect to all shares
of common stock shown as beneficially owned by them, subject to
community property laws where applicable, and include all shares held of
record on April 1, 1999, and shares subject to options outstanding and
exercisable within sixty (60) days thereafter.
(2) Steven J. Baileys, D.D.S., an officer and director of the Company,
located at 95 Enterprise, Aliso Viejo, California 92656, has sole voting
and investment power with respect to the shares indicated. The shares
indicated include options to purchase 183,332 shares of common stock,
700,767 shares of common stock representing 14.8% owned by the Baileys
Family Trust, 303,000 shares of common stock representing 6.4% held in
various trusts for relatives of Dr. Baileys, for both of which Dr.
Baileys is Trustee and for which Dr. Baileys has sole power to vote the
securities, but for both of which Dr. Baileys disclaims beneficial
ownership, and 150,000 shares of common stock representing 3.2% held by
the Alvin and Geraldine Baileys Foundation, for which Dr. Baileys is an
officer and director, and for which Dr. Baileys has shared power to vote
the securities, but for which Dr. Baileys disclaims beneficial
ownership.
(3) The Baileys Family Trust of which Steven J. Baileys, D.D.S., is Trustee,
owns 700,767 shares of the Company's common stock and has sole voting
and investment power with respect to the shares indicated. The shares
indicated do not include 303,000 shares of common stock representing
6.4% held in various trusts for
-38-
<PAGE> 39
relatives of Dr. Baileys, for which Dr. Baileys is Trustee and for which
Dr. Baileys has sole power to vote the securities, but for which Dr.
Baileys disclaims beneficial ownership, and 150,000 shares of common
stock representing 3.2%, held by the Alvin and Geraldine Baileys
Foundation, for which Dr. Baileys is an officer and director, and for
which Dr. Baileys has shared power to vote the securities, but which Dr.
Baileys disclaims beneficial ownership. The address of the Baileys
Family Trust is P.O. Box 9109, Newport Beach, California 92658. A
Schedule 13G dated February 10, 1999, was filed with the Securities and
Exchange Commission with respect to such shares.
(4) These securities are owned by various individual and institutional
investors including Fidelity Low-Priced Stock Fund, which owns the
shares indicated, for which Fidelity Management and Research Company
("Fidelity") serves as investment advisor with power to direct
investments and/or sole has the power to vote the securities. For
purposes of the reporting requirements of the Securities Exchange Act of
1934, Fidelity is deemed to be a beneficial owner of such securities;
however, Fidelity expressly disclaims that it is, in fact, the
beneficial owner of such securities. The address of FMR Corp. is 82
Devonshire Street, Boston, Massachusetts 02109. A Schedule 13G dated
February 12, 1999, was filed with the Securities and Exchange Commission
with respect to such shares.
(5) Brinson Partners, Inc. ("BPI"), a wholly owned subsidiary of Brinson
Holdings, Inc. ("BHI") and Brinson Trust Company ("BTC"), a wholly owned
subsidiary of BPI, 209 South La Salle, Chicago, Illinois 60604-1295 have
the sole voting and dispositive power of the shares indicated. A
Schedule 13G dated February 3, 1999, was filed with the Securities and
Exchange Commission with respect to such shares.
(6) These securities are owned by four institutional investment companies
for which Dimensional Fund Advisors, Inc. ("Dimensional") serves as
investment advisor with power to direct investments and/or has the sole
power to vote the securities. For purposes of the reporting requirements
of the Securities Exchange Act of 1934, Dimensional is deemed to be a
beneficial owner of such securities; however Dimensional expressly
disclaims that it is, in fact, the beneficial owner of such securities.
The address of Dimensional Fund Advisors, Inc. is 1299 Ocean Avenue,
11th Floor, Santa Monica, California 90401. A Schedule 13G dated
February 11, 1999, was filed with the Securities and Exchange Commission
with respect to such shares.
(7) These securities are owned by various individual and institutional
investors including T. Rowe Price Small Cap Value Fund, Inc., and T.
Rowe Price Associates, Inc. which collectively own the shares indicated
for which T. Rowe Price Associates, Inc. ("Price Associates") serves as
investment advisor with power to direct investments and/or has the sole
power to vote the securities. For purposes of the reporting requirements
of the Securities Exchange Act of 1934, Price Associates is deemed to be
a beneficial owner of such securities; however, Price Associates
expressly disclaims that it is, in fact, the beneficial owner of such
securities. The address of T. Rowe Price Associates, Inc. is 100 E.
Pratt Street, Baltimore, Maryland 21202. A Schedule 13G dated February
11, 1999, was filed with the Securities and Exchange Commission with
respect to such shares.
- ------------------------------
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On September 30, 1996, the Company sold to Islas Professional Dental Corporation
("Islas"), a dental practice (the "Practice") owned by a subsidiary of the
Company in the aggregate amount of $1,131,000. Steven J. Baileys, D.D.S., the
Company's Chairman of the Board of Directors and Chief Executive Officer, owned
a fifty percent (50%) interest in Islas, which secured two (2) promissory notes
from a subsidiary of the Company in the amount of the purchase price. Said notes
are payable in equal monthly installments over a thirty (30) year period and a
five (5) year period, respectively, and bear interest at eight and one half
percent (8.5%). The Practice is also under contract to provide services to a
subsidiary of the Company. During fiscal year 1998, the Company paid Islas
$205,262.57 under said contract. The sale of the Practice was reviewed and
approved by the independent members of the Board of Directors on September 27,
1996, which took into consideration information provided to it by the Company's
independent accountants and outside counsel concerning the value of the Practice
as an ongoing business owned by the Company contrasted to being owned by an
independent dentist, the sale price of dental practices of similar size and
scope, and the sale of other dental practices owned by the Company to unrelated
parties. The action of the independent members of the Board of Directors in
approving the sale of the Practice was ratified by the full Board of Directors
of the Company on September 27, 1996. The Practice was sold to an unrelated
third party effective on March 31, 1998, for the assumption of the obligation
referred to above.
-39-
<PAGE> 40
PART IV
EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
ITEM 14(A) (1) - (2)
AND (D). FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
The consolidated financial statements and financial statement schedule of
SafeGuard Health Enterprises, Inc. filed as part of this 1998 Annual Report on
Form 10-K are listed in the accompanying Index to Financial Statements on Page
F-1.
ITEM 14(A) (3) AND (C). EXHIBITS
An "Exhibit Index" has been filed as part of this 1998 Annual Report on Form
10-K beginning on Page E-1. All Exhibits are either attached hereto or are on
file with the Securities and Exchange Commission.
ITEM 14(B). REPORTS ON FORM 8-K
Reports on Form 8-K concerning the Company's wholly-owned subsidiary completed
the sale of all of its thirty-four (34) orthodontic practices and related assets
and liabilities and the appointment of Robert J. Pommersheim as Interim Chief
Financial Officer, replacing Thomas C. Tekulve, C.P.A., who resigned to pursue
other interests, were filed with the Securities and Exchange Commission on or
about April 1, 1998 and December 14, 1998, respectively. The Reports on Form 8-K
mentioned in this Item 14(b), are hereby incorporated herein to this 1998 Annual
Report on Form 10-K for the period ended December 31, 1998, as is set forth in
full herein.
- --------------------------------------------------------------------------------
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Aliso
Viejo, State of California, on the 15th day of April, 1999.
SAFEGUARD HEALTH ENTERPRISES, INC.
/s/ STEVEN J. BAILEYS, D.D.S.
----------------------------------------
STEVEN J. BAILEYS, D.D.S.,
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
/s/ ROBERT J. POMMERSHEIM
----------------------------------------
ROBERT J. POMMERSHEIM
Interim Chief Financial Officer
(Principal Financial Officer)
-40-
<PAGE> 41
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
POWER OF ATTORNEY
We, the undersigned directors and officers of SafeGuard Health Enterprises,
Inc., and each of us, do hereby constitute and appoint Steven J. Baileys, D.D.S.
and/or Ronald I. Brendzel, as our true and lawful attorneys and/or agents, each
with power of substitution, to do any and all acts and things in our name and
behalf in our capacities as directors and officers and to execute any and all
instruments for us and in our names in the capacities indicated above, which
said attorneys and/or agents, or any one of them, may deem necessary or
advisable to enable said corporation to comply with the Securities Exchange Act
of 1934, as amended, and any rules, regulations, and requirements of the
Securities and Exchange Commission, in connection with this 1998 Annual Report
on Form 10-K, including specifically but without limitation, power and authority
to sign for us or any of us in our names in the capacities indicated below, any
and all amendments hereto; and we do hereby ratify and confirm all that the said
attorneys and/or agents, or their substitute or substitutes, or any one of them,
shall do or cause to be done by virtue hereof.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
STEVEN J. BAILEYS, D.D.S. Chairman of the Board and April 15, 1999
- ------------------------- Chief Executive Officer
STEVEN J. BAILEYS, D.D.S.
JOHN E. COX President, Chief Operating April 15, 1999
- ------------------------- Officer And Director
JOHN E. COX
RONALD I. BRENDZEL Senior Vice President, April 15, 1999
- ------------------ General Counsel,
RONALD I. BRENDZEL Secretary and Director
MICHAEL M. MANN Director April 15, 1999
- ---------------
MICHAEL M. MANN
WILLIAM E. MCKENNA Director April 15, 1999
- ------------------
WILLIAM E. MCKENNA
GEORGE H. STEVENS Director April 15, 1999
- -----------------
GEORGE H. STEVENS
BRADFORD M. BOYD, D.D.S. Director April 15, 1999
- ------------------------
BRADFORD M. BOYD, D.D.S.
</TABLE>
-41-
<PAGE> 42
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----------
<S> <C>
Independent Auditors' Report...................................................F-2
Financial Statements
Consolidated Statements of Financial Position..........................F-3
Consolidated Statements of Operations..................................F-4
Consolidated Statements of Stockholders' Equity........................F-5
Consolidated Statements of Cash Flows..................................F-6
Notes to Consolidated Financial Statements.........................F-7 to F-22
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts........................F-23
</TABLE>
All other schedules are omitted where they are not applicable or the required
information is shown in the consolidated financial statements or notes thereto.
F-1
<PAGE> 43
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
SafeGuard Health Enterprises, Inc.:
We have audited the accompanying consolidated statements of financial position
of SafeGuard Health Enterprises, Inc. and subsidiaries (the "Company") as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1998. Our audits also included the financial
statement schedule listed in the Index at Item 14. These financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of SafeGuard Health Enterprises, Inc.
and subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for recognizing revenue relating to providing
orthodontic health care services in 1996.
DELOITTE & TOUCHE LLP
Costa Mesa, California
April 15, 1999
F-2
<PAGE> 44
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
($000'S OMITTED, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
December 31, 1998 1997
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 3,256 $ 3,652
Investments available for sale, at estimated fair value 2,959 5,557
Investments held to maturity, at amortized cost -- 3,697
Accounts receivable, net of allowances of $2,954 in 1998 and
$1,061 in 1997 4,641 5,349
Notes receivable, net of allowances of $17,305 in 1998 and $0 in 1997 10,892 1,878
Income taxes receivable 485 132
Prepaid expenses and other current assets 478 1,029
Deferred income taxes 6,672 1,047
Assets held for sale 3,562 --
Net assets of discontinued operations -- 4,062
-------- --------
Total current assets 32,945 26,403
Property and equipment, net 6,105 9,351
Investments available for sale, at estimated fair value 4,225 --
Investments held to maturity, at amortized cost -- 5,656
Notes receivable - long-term, net of allowances of $2,601 in
1998 and $3,595 in 1997 4,083 12,327
Goodwill, net of accumulated amortization of $1,563 in 1998 and
$815 in 1997 27,914 29,556
Intangibles and covenant not to compete, net of accumulated
amortization of $2,059 in 1998 and $2,297 in 1997 3,893 4,978
Deferred income taxes - long-term 539 --
Other assets 240 247
-------- --------
$ 79,944 $ 88,518
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt $ 8,000 $ 8,500
Current portion of note payable 1,894 1,692
Accounts payable and accrued expenses 10,905 5,193
Reserves for dental claims 3,558 3,631
Deferred revenue 1,022 1,177
-------- --------
Total current liabilities 25,379 20,193
Long-term debt 32,500 32,500
Note payable -- 1,394
Deferred income taxes -- 1,289
Accrued compensation agreement 311 383
Commitments and contingencies (Notes 6 and 11)
Stockholders' equity:
Preferred stock - $.01 par value; 1,000,000 shares authorized,
no shares issued or outstanding -- --
Common stock - $.01 par value; 30,000,000 shares authorized; 4,747,000 in
1998 and in 1997 shares issued and outstanding,
Stated at 21,509 21,509
Retained earnings 18,722 29,816
Accumulated other comprehensive income (354) (443)
Treasury stock, at cost (18,123) (18,123)
-------- --------
Total stockholders' equity 21,754 32,759
-------- --------
$ 79,944 $ 88,518
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-3
<PAGE> 45
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
($000'S OMITTED, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Health care revenues $ 97,449 $ 95,350 $ 72,709
Expenses:
Health care services 66,020 65,702 54,534
Selling, general and administrative 37,492 25,103 16,292
--------- --------- ---------
Total expenses 103,512 90,805 70,826
--------- --------- ---------
(Loss) income from operations (6,063) 4,545 1,883
Other income 2,341 1,632 984
Loss on impairment of assets (11,165) -- --
Interest expense (4,311) (2,871) (485)
--------- --------- ---------
(Loss) income from continuing operations before
(benefit) provision for income taxes, discontinued
operations and cumulative effect (19,198) 3,306 2,382
(Benefit) provision for income taxes (6,638) 1,495 980
--------- --------- ---------
(Loss) income from continuing operations before
discontinued operations and cumulative effect (12,560) 1,811 1,402
--------- --------- ---------
Discontinued operations and cumulative effect:
Loss from operations to be disposed of (net of income
tax benefit of $396 in 1998, $2,267 in 1997 and
$616 in 1996 and net of after tax deferred loss
of $621 in 1996) (620) (3,555) (852)
Income (loss) on disposal of dental practices
(net of income tax expense of $1,333 in 1998,
income tax benefit of $367 in 1997 and income
tax expense of $1,088 in 1996) 2,086 (605) 1,678
Cumulative effect of change in accounting principle-
orthodontic operations, net of tax of $536 in 1996 -- -- 824
--------- --------- ---------
Gain (loss) from discontinued operations and
cumulative effect 1,466 (4,160) 1,650
--------- --------- ---------
Net (loss) income $ (11,094) $ (2,349) $ 3,052
========= ========= =========
Basic (loss) earnings per share:
(Loss) income from continuing operations before
discontinued operations $ (2.66) $ 0.38 $ 0.30
Income (loss) from discontinued operations 0.31 (0.88) 0.17
Cumulative effect of change in accounting principle -- -- 0.17
--------- --------- ---------
Net (loss) income $ (2.35) $ (0.50) $ 0.64
========= ========= =========
Diluted earnings per share:
Income from continuing operations before
discontinued operations $ (2.66) $ 0.37 $ 0.28
Income (loss) from discontinued operations 0.31 (0.85) 0.17
Cumulative effect of change in accounting principle -- -- 0.17
--------- --------- ---------
Net (loss) income $ (2.35) $ (0.48) $ 0.62
========= ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-4
<PAGE> 46
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
($000'S OMITTED)
<TABLE>
<CAPTION>
Accumulated
Number of Shares Other
----------------- Common Retained Comprehensive Treasury
Common Treasury Stock Earnings Income Stock Total
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
January 1, 1996 7,979 (3,275) $21,092 $29,113 $ (153) $(18,123) $ 31,929
Comprehensive income:
Net income 3,052
Net unrealized gain on
investment securities
available for sale, net
of tax of $36 56 56
--------
Total comprehensive income (3,108)
Exercise of stock options
(includes $33 tax benefits) 12 163 3,052
----- ------ ------- -------- ------- -------- --------
December 31, 1996 7,991 (3,275) 21,255 32,165 (97) (18,123) 35,200
Comprehensive income:
Net loss (2,349) (2,349)
Net unrealized loss on
investment securities
available for sale, net
of tax benefit of $221 (346) (346)
--------
Total comprehensive loss 2,695
Exercise of stock options
(includes $121 tax benefits) 31 254 254
----- ------ ------- -------- ------- -------- --------
December 31, 1997 8,022 (3,275) 21,509 29,816 (443) (18,123) 32,759
Comprehensive income:
Net loss (11,094) (11,094)
Net unrealized gain on
investment securities
available for sale, net
of tax of $57 89 89
--------
Total comprehensive loss (11,005)
----- ------ ------- -------- ------- -------- --------
December 31, 1998 8,022 (3,275) $21,509 $ 18,722 $ (354) $(18,123) $ 21,754
===== ====== ======= ======== ======= ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-5
<PAGE> 47
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
($000'S OMITTED)
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income $ (11,094) $ (2,349) $ 3,052
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
(Gain) Loss from discontinued operations (2,043) 6,794 4,719
Gain on disposal of discontinued dental practices (8,092) (2,577) (2,766)
Gain on sale of property and equipment -- -- (7)
Loss on valuation of assets 12,269 -- --
Depreciation and amortization 2,839 2,284 2,350
Deferred income taxes (7,453) (1,256) 1,408
Changes in operating assets and liabilities, net
of effects of acquisitions:
Accounts and current notes receivable, net 8,306 (351) (1,478)
Income taxes receivable (353) (88) 34
Prepaid expenses and other current assets 558 (299) (419)
Accounts payable and accrued expenses 5,676 234 (111)
Deferred revenue (155) 625 357
Reserves for incurred but not reported claims (73) 801 1,067
--------- -------- --------
Net cash provided by continuing operations 385 3,818 8,206
Net cash used in discontinued operations (2,778) (5,183) (7,336)
--------- -------- --------
Net cash (used in) provided by operating activities (2,393) (1,365) 870
--------- -------- --------
Cash flows from investing activities:
Purchase of investments available for sale (10,169) (9,386) (14,218)
Proceeds from sales/maturity of investments available
for sale 11,319 9,903 21,892
Purchase of investments held to maturity -- (8,104) (5,977)
Proceeds from maturity of investments held to maturity 4,906 5,063 3,940
Purchases of property and equipment (2,449) (2,118) (3,029)
Proceeds from sale of property and equipment -- -- 7
Payments received on notes receivable 54 38 --
Cash paid for business acquired, net of cash acquired -- (1,203) (20,320)
Additions to intangibles and other assets 64 (2,109) (127)
--------- -------- --------
Net cash used in investing activities -
continuing operations 3,725 (7,916) (17,832)
Net cash used in discontinued operations -- (684) (1,670)
--------- -------- --------
Net cash used in investing activities 3,725 (8,600) (19,502)
--------- -------- --------
Cash flows from financing activities:
Proceeds from long-term debt 8,000 40,500 19,000
Proceeds from exercise of stock options -- 133 130
Payments on accrued compensation agreement (36) (30)
Payments on bank debt -- (27,000)
Payments on notes payable (9,692) (692) (298)
--------- -------- --------
Net cash provided by financing activities (1,728) 12,911 18,832
--------- -------- --------
Net increase in cash (396) 2,946 200
Cash at beginning of year 3,652 706 506
--------- -------- --------
Cash at end of year $ 3,256 $ 3,652 $ 706
========= ======== ========
Supplemental disclosure of non-cash activities:
Tax benefit from exercise of stock options $ -- $ 121 $ 33
Supplementary information:
Cash paid during the year for:
Interest $ 4,008 $ 2,872 $ 485
Income taxes $ -- $ -- $ 619
Purchase of businesses acquired (Notes 1 and 3):
Fair value of assets acquired $ -- $ 17,342 $ 25,697
Less: cash acquired -- (5,455) (201)
Less: note payable issued -- (9,500) (3,576)
Less: liabilities assumed -- (1,184) (1,600)
--------- -------- --------
Cash paid for business acquired $ -- $ 1,203 $ 20,320
========= ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-6
<PAGE> 48
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
SafeGuard Health Enterprises, Inc., a Delaware corporation (the "Company"), is a
holding company that manages what is, collectively, one of the largest
publicly-traded Dental HMO plans in the United States. The Company provides
managed care and indemnity dental benefits for approximately 1,018,000 members,
through a panel of independent primary care dental offices and specialists, and
a preferred provider organization panel. Operations are conducted through
wholly-owned subsidiaries in twenty-seven states and the District of Columbia.
The Company was founded as a non-profit entity in California in 1974, and
converted to a for-profit entity at the end of 1982. In 1992, the Company
acquired a California-based indemnity insurance company licensed to transact
insurance business and currently holds a certificate of authority in 14 states.
In 1996, the Company acquired a Texas-based managed dental care company and in
1997 the company acquired a Florida based managed dental care company. In 1997,
the Company acquired Consumers Life Insurance Company of North Carolina, renamed
it SafeHealth Life Insurance Company, Inc., and redomesticated it to Texas. That
company is licensed in 16 states.
In January 1998, the Company merged one of the Advantage affiliates, Advantage
Dental HealthPlans, Inc., a Missouri corporation into SafeGuard Health Plans,
Inc. a Missouri corporation. In May 1998, the Company initiated the merger of
SafeHealth, Inc., into its affiliate, SafeHealth Life Insurance Company, a
California corporation ("SafeHealth"), as part of a strategic plan to simplify
business operations from an administrative, financial and legal perspective. The
merger of SafeHealth, Inc. into SafeHealth will also release surplus
requirements of the no longer existing entity, SafeHealth, Inc. The merger is
subject to regulatory approval from both the California and Texas Departments of
Insurance. In December 1998, the Company received approval from the California
Department of Insurance and in March 1999, regulatory approval from the Texas
Department of Insurance.
As indicated in the accompanying consolidated statements of operations, the
Company incurred a net loss of approximately $11 million during 1998. A
significant component of this loss was the loss on impairment of assets of
approximately $11.1 million, comprised primarily of reduction in value of notes
received upon the sale of various discontinued operations, and the reduction in
value of land and building held for sale to its estimated net realized value.
Management's plans to return to profitability and positive cash flow from
operations include restructuring of the Company's debt (see Note 14),
disposition of non-core assets, reduction of selected costs, and the
consideration of various strategic alternatives.
Basis of Consolidation
The consolidated financial statements include all the accounts of the Company
and its subsidiaries. Significant intercompany accounts and transactions have
been eliminated in consolidation.
Revenue and Cost Recognition
Premiums collected for health care revenues are recognized in the period for
which the member is entitled to service. Related costs for health care services
are expensed in the period the Company provides such service.
On January 1, 1996, the Company changed its method of recognizing revenues
relating to providing orthodontic health care services to the proportional
performance method. This change in method of revenue recognition resulted in
orthodontic practice revenues being recognized based on the ratio of costs
incurred to total estimated costs, which better matches revenues and expenses
over the life of an orthodontic contract. Previously, the Company recognized
revenue ratably over the life of the contract on a straight-line basis. The
Company believes the proportional performance method provides for a better
matching of expenses to revenues over the life of each individual orthodontic
contract. As a result, the Company recorded a total earned but unbilled
receivable of approximately $1.9 million in 1997 and $2.6 million in 1996. Of
the $2.6 million in 1996, $1.35 million represented cumulative effect, ($824,000
net of taxes, or $.17 per share) as of January 1, 1996. The orthodontic
practices were disposed of on April 1, 1998. (See Note 2).
Investments
In accordance with Statement of Financial Accounting Standards No. 115 ("FAS
115"), Accounting for Certain Investments in Debt and Equity Securities, the
Company has classified its investment portfolio into "available for sale" and
"held to maturity" categories. Investments classified as available-for-sale are
carried at fair value and unrealized gains or losses, net of applicable income
taxes, are reported in a separate caption of stockholders' equity. Investments
classified as held to maturity are carried at amortized cost. At December 31,
1998, the Company recorded net unrealized losses of $567,000 and decreased
stockholders' equity by $354,000 (net unrealized losses, less deferred income
taxes of $213,000).
Investments consist principally of variable rate interest-bearing tax-exempt
investments, taxable bonds, equity securities, treasury bills and notes, and
certificates of deposit with original maturities greater than three months. The
adjusted cost of specific securities sold is used to compute the gain or loss on
sale of investments.
F-7
<PAGE> 49
During 1998, the Company transferred approximately $4.2 million of securities
from the held to maturity category to the available for sale category. This
amount represented the amortized cost of the securities at the date of transfer.
The estimated fair value of those securities was approximately $4.4 million
resulting in a net after tax unrealized gain of $0.1 million, which was
reflected as a direct increase to equity. The change in classification was a
result of a change in management's intent with respect to these securities
related to a change in the Company's liquidity as discussed above, which could
not have been predicted when the held to maturity investments were purchased. In
order to have the flexibility to respond to changes in interest rates and to
take advantage of changes in the availability of and the yield on alternative
investments, management determined that the reclassification of these securities
as available for sale was appropriate.
Fair Value of Financial Instruments
The Company's balance sheet includes the following financial instruments: cash,
investments, accounts and notes receivable, accounts payable, short and
long-term debt. The Company considers the carrying amounts in the financial
statements to approximate the fair value for these financial instruments because
of the relatively short period of time between origination of the instruments
and their expected realization for current items. Due to current payment trends,
notes receivable have been written down to management's estimate of net
realizable value which approximates fair value (see Note 10). The fair value of
the Company's long-term debt approximated its carrying value.
Property and Equipment
Property and equipment are recorded at cost. Depreciation and amortization are
calculated using the straight-line method over the estimated useful lives of the
respective property and equipment as follows: leasehold and building
improvements - 5 to 25 years; furniture, fixtures and other equipment - 3 to 10
years. Expenditures for maintenance and repairs are expensed as incurred, while
major improvements which extend the estimated useful life of an asset are
capitalized. Upon the sale or other retirement of assets, the accounts are
relieved of the cost and related accumulated depreciation and amortization, and
any resultant gain or loss is recognized.
In March 1995, the FASB issued Statement of Financial Accounting Standards No.
121 ("FAS 121"), Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, which became effective for fiscal years
beginning after December 15, 1995. FAS 121 requires impairment losses to be
recognized for long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows are not sufficient to
recover the assets' carrying amount. The impairment loss is measured by
comparing the fair value of the assets to their carrying amount. The statement
also requires that assets to be disposed of be written down to fair value, less
selling costs. The Company adopted this statement in fiscal year 1996 as
required, and its adoption did not have a significant effect on the Company's
financial position or results of operations.
Intangibles
License acquisition costs associated with the purchase of an indemnity insurance
company in October 1992 and another in August 1997 are amortized over a 20 year
period. Goodwill related to the acquisition of First American Dental Benefits,
Inc. ("First American") in September 1996 and Advantage Dental HealthPlans
("Advantage") in May 1997 is being amortized over a period of 40 years. The
covenants not to compete related to the acquisition of First American and
Advantage are being amortized over a 5 year period. The Company periodically
evaluates whether events and circumstances have occurred which may affect the
estimated useful lives or the recoverability of the remaining balance of its
intangibles. At December 31, 1998, the Company's management believed that no
material impairment of goodwill or other intangible assets existed.
Income Taxes
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109 ("FAS 109"), Accounting for Income Taxes.
This statement requires the recognition of deferred tax assets and liabilities
for the future consequences of events that have been recognized in the Company's
financial statements or tax returns. The measurement of the deferred items is
based on enacted tax laws. In the event the future consequences of differences
between financial reporting basis and the tax basis of the Company's assets and
liabilities result in a deferred tax asset, FAS 109 requires an evaluation of
the probability of being able to realize the future benefits indicated by such
asset. A valuation allowance related to a deferred tax asset is recorded when it
is more likely than not that some portion or all of the deferred tax asset will
not be realized.
F-8
<PAGE> 50
401(k) Plan
The Company maintains a 401(k) plan which allows for a pre-tax contribution from
an employee's earnings. Employees are eligible to participate in the 401(k) plan
upon completion of six months of service with the Company. Under the 401(k)
plan, an employee may defer up to 15 percent of his or her gross compensation
each pay period and the Company may, at its option, make an additional
discretionary contribution to be allocated among employees in the plan in
proportion to the compensation deferred. Employees are 100 percent vested in
their interest in the 401(k) plan at all times. The Company did not make
contributions in 1998 or 1997. The Company also maintains a pre-tax medical
insurance option within the meaning of Section 125 of the Internal Revenue Code
for its employees insuring dependents.
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted
accounting principles, requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Net (Loss) Income Per Share
(Loss) earnings per share have been restated to conform with the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share". Basic
earnings per share excludes the effect of all potentially dilutive securities.
Diluted earnings per share includes the effect of all potentially dilutive
common securities (see Note 9). The potentially dilutive securities were
excluded from the calculation of diluted loss per share for 1998 because they
were anti-dilutive.
The weighted average number of basic and dilutive shares outstanding and the
related earnings per share for the years ended December 31, were as follows:
<TABLE>
<CAPTION>
For the year ended December 31, 1998 1997 1996
- ------------------------------- ------------------------------ ----------------------------- -----------------------------
Number Per-share Number Per-share Number Per-share
Amount of shares amount Amount of shares amount Amount of shares amount
-------- --------- --------- ------- --------- --------- ------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic earnings per share
Net (loss) income available
to common stockholders $(11,094) 4,747 $(2.35) $(2,349) 4,723 $(0.50) $(3,052) 4,711 $(0.65)
Effect of Dilutive Securities
Options -- -- -- 176 -- 229
Diluted earnings per share
Income available to
common stockholders and
assumed conversions $(11,094) 4,747 $(2.35) $(2,349) 4,899 $(0.48) $(3,052) 4,940 $(0.62)
</TABLE>
Regulatory Requirements and Restricted Deposits
Pursuant to various state regulations, certain of the Company's subsidiaries are
required to hold restricted deposits. As of December 31, 1998 and December 31,
1997, the Company held restricted deposits of $6.0 million and $9.0 million,
respectively. Additionally, the Company is required to maintain minimum capital
and surplus balances. As of December 31, 1998 and December 31, 1997, these
subsidiaries were in compliance with all regulatory requirements.
Reclassifications
Certain amounts have been reclassified in prior years to conform with the
financial statement presentation for the year ended December 31, 1998.
Stock Options
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
Accounting for Stock-Based Compensation, which requires adoption of the
disclosure provisions no later than years beginning after December 15, 1995, and
adoption of the recognition and measurement provisions for non-employee
transactions no later than after December 15, 1995. The new standard defines a
fair value method of accounting for stock options and other equity instruments.
Under the fair value method, compensation cost is measured at the grant date
based on the fair value of the award and is recognized over the service period
which is usually the vesting period.
F-9
<PAGE> 51
Pursuant to the new accounting standard, companies are encouraged, but are not
required, to adopt the fair value method of accounting for employee stock-based
transactions. Companies are also permitted to continue to account for such
transactions under Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, but are required to disclose in a note to the
financial statements pro forma net income and earnings per share as if the
company had applied the new method of accounting. The Company has determined
that it will not change to the fair value method and will continue to use
Accounting Principles Board Opinion No. 25 for measurement and recognition of
employee stock-based transaction. (See Note 9).
Recent Accounting Pronouncements
In June 1997, FASB issued Statement of Financial Accounting Standards No. 130
("FAS 130"), Reporting Comprehensive Income, which becomes effective for fiscal
years ending after December 15, 1997. FAS 130 requires that all components of
comprehensive income be displayed with the same prominence as other financial
statements.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131 ("FAS 131"), Disclosure About Segments of an Enterprise and Related
Information, which becomes effective for fiscal years ending after December 15,
1997. FAS 131 requires that future financial statements contain disclosures
about products and services, geographic areas and major customers related to
its reportable operating segments.
The adoption of FAS 130 and 131 did not have a significant effect on the
Company's financial position or results of operations.
In June 1998, the Financial Accounting Standards Board (FASB) issued statement
of Financial Accounting Standard No. 133 (FAS 133), Accounting for Derivative
Instruments and Hedging Activities, which becomes effective for fiscal years
beginning after June 15, 1999. FAS 133 requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The Company does not
expect the adoption of FAS 133 to have a significant impact on the Company's
financial position or results of operations.
NOTE 2: DISCONTINUED OPERATIONS
General Dental Practices
On October 21, 1996, the Company implemented a strategic plan to sell all of the
general dental practices owned by the Company. Four of the general dental
practices were sold during 1996, the remaining were sold during 1997.
The assets of the general dental practices sold pursuant to the Company's plan,
consisted primarily of accounts receivable, supply inventories, equipment and
leasehold improvements. Each general dental practice sold could enter into a
contract with the Company's practice management subsidiary, at the time of sale,
whereby the Company would provide certain services to support the dentists in
the operation of their practices, including administrative support. The Company
discontinued operating its practice management subsidiary and terminated these
agreements in 1998.
The Company projected a gain on the disposal of the discontinued operations that
offset the operating losses of the dental practices during the phase-out period
ended September 30, 1997. In the fourth quarter 1997, the Company recorded a
pretax charge of $8.5 million related to discontinued operations for both dental
and orthodontic practices. This charge included reserves for under-performing
notes and receivables ($5.6 million), litigation costs ($0.7 million) and other
transition costs ($2.2 million).
In 1996, year to date operating losses for discontinued dental operations prior
to the measurement date of October 21, 1996, were $2.3 million net of a tax
benefit of $1.5 million. The operating losses subsequent to the measurement date
in 1996 were recognized in the consolidated statements of income up to the
amount of the net gain on disposal of the discontinued dental practices which
was $550 net of taxes as of December 31, 1996. The remaining losses of $621 net
of taxes for December 31, 1996, were deferred as an asset until the completion
of the sale of all the dental practices as of September 30, 1997. The income
statement for prior years has been restated and operating results of the dental
and orthodontic practices are also shown as discontinued operations.
Net revenue generated by the discontinued dental practices for the twelve months
ended December 31, 1997 and 1996, were $4.6 million and $18.6 million,
respectively. These amounts are not included in revenue in the accompanying
statements of operations.
Orthodontic Practices
On February 26, 1998, the Company announced the discontinuance of its
orthodontic practices. The assets of the orthodontic practices which were sold
on April 1, 1998, pursuant to the Company's plan, consisted primarily of
accounts receivable, supply inventory and dental equipment.
F-10
<PAGE> 52
Pursuant to the terms of the definitive Master Asset Purchase Agreement (the
"Agreement") dated and effective as of April 1, 1998, by and among Guards and
the Purchasers, the orthodontic practices were sold for total gross
consideration of $15 million, paid by an 8 1/2% 30-year promissory note, secured
by all current and future assets of the Purchasers, including those assets
transferred under the Agreement made by the Purchasers and payable to Guards.
Among other provisions, the Agreement details the sale of associated assets and
liabilities of the practices and a long term commitment to continue to provide
orthodontic services to the members of SafeGuard Health Plans, Inc. The Company
recorded a gain on disposal of the orthodontic practices of $3.7 million, net
of taxes of $2.3 million.
The operating results of the orthodontic practices for the three months ended
March 31, 1998, and twelve months ended December 31, 1997 and 1996, are included
in the accompanying consolidated statement of operations under the term
"Discontinued Operations".
Net revenue generated by the discontinued orthodontic practices for the three
months ended March 31, 1998, and the years ended December 31, 1997 and 1996,
were $1.9 million, $8.16 million and $8.28 million, respectively. These amounts
are not included in revenue in the accompanying statements of operations.
Assets of the discontinued general dental and orthodontic practices to be
disposed of, shown at their net book value (in $000's), consisted of the
following:
<TABLE>
<CAPTION>
April 1, 1998 December 31, 1997 December 31, 1996
------------- ----------------- -----------------
<S> <C> <C> <C>
Accounts receivable, net $ 1,896 $ 1,896 $ 3,462
Supplies inventory 265 270 639
Leasehold improvements and equipment, net 2,413 2,478 7,571
Intangible assets 1,000 -- --
Deferred operating loss of discontinued operations, net 1,246 -- 1,036
Other 171 168 439
Legal reserves -- (750) --
------- -------- -------
$ 6,991 $ 4,062 $13,147
======= ======== =======
</TABLE>
Net assets to be disposed of, at their book values, have been separately
classified in the accompanying consolidated balance sheet at December 31, 1997
and 1996.
NOTE 3: BUSINESS ACQUISITIONS
Effective September 27, 1996, the Company completed the acquisition of all of
the outstanding shares of First American, a privately-held managed dental care
company based in Dallas, Texas, and a related marketing entity, for a total
consideration of $23.6 million, plus assumed liabilities of $1.6 million,
acquisition costs of $0.3 million and acquired cash of $0.2 million. Of the
purchase price, $20 million was paid at closing (which included a $1 million
holdback account) and an aggregate sum of $3.6 million over three years pursuant
to non-competition agreements entered into between the Company and the former
owners of First American. The Company financed the acquisition of First American
through a credit agreement with Bank of America. First American provides managed
dental care services through a network of approximately 1,100 dental care
providers to approximately 175,000 members in Texas. The acquisition of First
American was accounted for using the purchase method of accounting with the
results of operations of the businesses acquired included from the effective
date of the acquisition. The acquisition resulted in excess cost over fair
market value of net assets acquired of $21.5 million. The acquisition is
included as part of the Company's consolidated financial statements, subsequent
to September 27, 1996.
Effective May 9, 1997 the Company completed the acquisition of all of the
outstanding shares of Advantage, a privately held managed dental care company
based in Fort Lauderdale, Florida for a total consideration of $10 million plus
assumed liabilities of $2.3 million, and acquired cash of $0.8 million. Of the
purchase price, cash was paid at closing consisting of a $0.5 million holdback
account and the Company is obligated to pay an aggregate sum of $1 million over
two years pursuant to a non-competition agreement entered into between the
Company and the former owner of Advantage. The Company financed the acquisition
of Advantage through a note from the seller for $8.5 million which had a due
date, with extensions, of April 2, 1998. Advantage provides managed dental care
services through a network of approximately 800 dental care providers to
approximately 125,000 members in Florida, Missouri and several other
southeastern states. The acquisition of Advantage was accounted for using the
purchase method of accounting with the results of operations of the businesses
acquired included from the effective date of the acquisition. The acquisition
resulted in excess cost over fair market value of net assets acquired of $9.2
million. The acquisition is included as part of the Company's consolidated
financial statements, subsequent to May 9, 1997.
F-11
<PAGE> 53
Effective August 1997, the Company completed the acquisition of all of the
outstanding shares of Consumers Life Insurance Company of North Carolina
("Consumers"), a privately held dental indemnity insurance company with licenses
in sixteen states. The Company purchased the licenses and obtained all the
statutory deposits held on behalf of Consumers for a cash payment of $3.2
million and capitalized Consumers with total capital and surplus of $5 million.
The acquisition of Consumers was accounted for using the purchase method of
accounting with the results of operations of the businesses acquired included
from the effective date of the acquisition.
Unaudited pro forma results (in $000's) of operations of the Company for the
twelve months ended December 31, 1997 and December 31, 1996, are included below.
Such pro forma presentation has been prepared assuming that the acquisitions had
occurred as of January 1, of each period.
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Revenues $ 97,808 $ 77,990
Net income (loss) (1,879) 1,705
Net (loss) income diluted common share $ (0.38) $ 0.35
Net (loss) income per diluted common share $ (0.47) $ 0.68
</TABLE>
The pro forma results include, (1) the historical accounts of the Company and of
the acquired businesses; (2) and pro forma adjustments, including the
amortization of the excess purchase price over the fair value of the net assets
acquired, the amortization for the non-compete agreements entered into between
the Company and the former owners of First American and Advantage, interest on
related debt, and the applicable income tax effects of these adjustments. The
pro forma results for the year ended December 31, 1997, include the effect of
adjustments recorded subsequent to the purchase of First American by the
Company. Substantially all of the adjustments were one-time in nature. Such
adjustments will be applied to the applicable holdback funds maintained by the
Company in connection with this acquisition. The pro forma results of operations
are not necessarily indicative of actual results which may have occurred had the
operations of the acquired companies been combined in prior years.
NOTE 4: COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS
Investments
The following table summarizes the Company's investments as of December 31, 1998
(in $000's). The estimated fair value of investments is based on quoted market
prices.
<TABLE>
<CAPTION>
Gross Gross Estimated
Cost/Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Classified as available for sale:
U.S. government and its agencies $3,538 $101 $ -- $3,638
State obligations 674 32 -- 706
Corporate bonds 376 -- (57) 319
Equity securities 2,715 -- (665) 2,050
Funds and other short-term
Municipal obligations 448 23 -- 471
------ ---- ----- ------
Total available for sale $7,751 $155 $(722) $7,184
====== ==== ===== ======
</TABLE>
The contractual maturities of investments as of December 31, 1998, are shown
below (in $000's). Expected maturities may differ from contractual maturities:
<TABLE>
<CAPTION>
Cost/Amortized Cost Estimated Fair Value
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Classified as available for sale:
Due in one year or less $ 904 $ 909
Due after one year through five years 2,642 2,731
Due after five years through ten years 873 833
Due after ten years 616 661
Equity securities 2,715 2,049
------ ------
Total available for sale $7,751 $7,184
====== ======
</TABLE>
F-12
<PAGE> 54
The following table summarizes the Company's investments as of December 31, 1997
(in $000's). The estimated fair value of investments is based on quoted market
prices.
<TABLE>
<CAPTION>
Cost/ Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Classified as available for sale:
U.S. government and its agencies $ 553 $ 8 $ -- $ 561
State obligations 1,000 -- 1,000
Corporate bonds 184 -- (60) 124
Equity securities 3,885 132 (806) 3,211
Funds and other short-term
Municipal obligations 661 -- -- 661
------- ---- ------- -------
Total available for sale 6,283 140 (866) 5,557
------- ---- ------- -------
Classified as held to maturity:
U.S. Government and its agencies 7,847 39 (2) 7,884
State obligations 702 24 -- 726
Municipal obligations 449 20 -- 469
Corporate bonds 353 -- -- 353
Funds and other short-term obligations 2 -- -- 2
------- ---- ------- -------
Total held to maturity 9,353 83 (2) 9,434
------- ---- ------- -------
Total $15,636 $223 $ (868) $14,991
======= ==== ======= =======
</TABLE>
The Company computes its realized gains and losses from sales of investments
based on a specific identification.
Property and Equipment
The Company's property and equipment consist of the following:
<TABLE>
<CAPTION>
December 31, 1998 1997
- ---------------------------------------------------------------------------------
<S> <C> <C>
Land $ -- $ 644
Buildings and improvements 165 5,579
Leasehold improvements 520 402
Furniture, fixtures and other equipment 9,203 10,050
Construction in progress -- 265
-------- --------
$ 9,888 16,940
Less - accumulated depreciation and amortization (3,783) (7,589)
-------- --------
$ 6,105 $ 9,351
======== ========
</TABLE>
Accounts Payable and Accrued Expenses
The Company's accounts payable and accrued expenses consist of the following (in
$000's):
<TABLE>
<CAPTION>
December 31, 1998 1997
- ---------------------------------------------------
<S> <C> <C>
Accounts payable $ 4,918 $1,457
Accrued compensation 296 71
Accrued interest 984 681
Other accrued expenses 4,707 2,984
------- ------
$10,905 $5,193
======= ======
</TABLE>
F-13
<PAGE> 55
NOTE 5: NOTES PAYABLE AND LONG-TERM DEBT
Notes payable and long-term debt consisted of the following (in $000's):
<TABLE>
<CAPTION>
December 31, 1998 1997
- ---------------------------------------------------------------
<S> <C> <C>
Bank line of credit $ 8,000 $ --
Note payable -- 8,500
Senior notes payable 32,500 32,500
Less: current portion (8,000) (8,500)
-------- --------
ng-term debt $ 32,500 $ 32,500
======== ========
</TABLE>
On May 13, 1997, under the terms of the Company's acquisition of Advantage (see
Note 3), the Company issued an unsecured $8.5 million promissory note to the
seller. This note was repaid during April 1998.
On September 30, 1997, the Company completed a private placement of $32.5
million in long-term debt consisting of eight-year unsecured senior notes. The
Company used the proceeds to repay all of its long-term indebtedness and for
general corporate purposes. The senior notes have a principal payment of $6.5
million due each year starting on September 30, 2001. The interest rate for the
loan was fixed at 7.91% at December 31, 1998. In connection with the senior
notes, the Company is subject to certain financial and operational debt
covenants (see Note 15).
On January 29, 1998, the Company entered into an $8 million revolving working
capital credit facility with Silicon Valley Bank (the "Bank"). The interest rate
for the facility, as amended, was established at the bank's prime rate plus 1.5
percent (7.75% at December 31, 1998). The loan is secured by a first priority
security interest in all of the personal property of the Company, including
accounts receivable, fixed assets and intangibles and a negative pledge on the
stock of the Company's subsidiaries and on the real property owned by the
Company. In connection with the bank loan, the Company is subject to certain
financial and operational debt covenants. (See Note 15)
NOTE 6: LEASE OBLIGATIONS
The Company leases administrative offices under various non-cancelable operating
leases. Rental expense (in 000's) for these offices was $1,501, $1,217 and
$2,201 in 1998, 1997 and 1996, respectively. Additionally, the Company also
leases various computer equipment and furniture under other operating leases.
Future minimum rental payments required under operating leases that have the
initial or remaining lease terms in excess of one year as of December 31, 1998,
are as follows (in 000's):
Year ending December 31, 1998:
<TABLE>
<S> <C>
1999 $ 3,682
2000 3,624
2001 3,351
2002 2,522
2003 1,993
Thereafter 8,436
</TABLE>
F-14
<PAGE> 56
NOTE 7: INCOME TAXES
The Company's (benefit from) provision for federal and state income taxes is as
follows (in $000's):
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(Benefit) provision for income taxes due to continuing operations:
Taxes currently payable:
Federal $ (22) $ 1,585 $ 936
State 11 407 343
Tax effect of timing differences:
Difference in depreciation and amortization methods 92 22 75
Difference in accounting method for revenue adjustments (4,834) (282) (116)
Difference in accounting method for specialist cost 258 (343) (275)
Deferred state taxes (986) 36 (11)
Net operating loss (1,929) -- --
Other (242) 70 28
------- ------- -------
$(7,652) $ 1,495 $ 980
======= ======= =======
(Benefit) provision due to:
Continuing operations $(6,638) $ 1,495 $ 980
Discontinued operations 936 (2,634) 1,008
------- ------- -------
$(5,700) $(1,139) $ 1,988
======= ======= =======
</TABLE>
A reconciliation of the federal income tax (benefit) provision at the expected
statutory rate compared to the actual income tax provision is as follows (in
$000's):
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
- -------------------------------------------------- ------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Expected $(7,628) (35.0%) $ 1,157 35.0% $ 834 35.0%
State taxes, net of
Federal effect (1,011) (4.6) 175 5.3 181 7.6
Tax-free income (19) (0.1) (35) (1.1) (99) (4.2)
Non-deductible 254 1.2 186 5.6 47 2.0
amortization
Transaction lost 531 2.4
Other 221 1.0 12 0.4 (17) 0.7
------- ----- ------- ---- ----- ----
$(7,652) (35.1%) $ 1,495 45.2% $ 980 41.1%
======= ===== ======= ==== ===== ====
</TABLE>
The major components of the Company's deferred taxes are as follows (in $000's):
<TABLE>
<CAPTION>
December 31, 1998 1997
- ------------------------------------------------------------------------------------
<S> <C> <C>
Current deferred tax assets (liabilities):
Accrued specialist costs and policy reserves $ 459 $ 784
Reserve for revenue adjustments 6,605 515
Amortization of prepaid expenses (23) (87)
State income taxes (501) (100)
Other 132 (65)
------- -------
Net current deferred tax asset 6,672 1,047
------- -------
Non-current deferred tax assets (liabilities):
Book versus tax basis in property, including
Depreciation and amortization (875) (748)
Deferred gain on sale of dental offices (979) (979)
Unrealized loss on investments 97 283
Amortization of intangibles 43 30
Net operating loss carry forward 2,253 --
Other -- 125
------- -------
Net non-current deferred tax asset/liability 539 (1,289)
------- -------
Net deferred tax asset/liability $ 7,211 $ (242)
======= =======
</TABLE>
F-15
<PAGE> 57
As of December 31, 1998, the Company has not recorded a valuation allowance
against deferred tax assets. The Company has net operating loss carry forwards
for federal and state purposes of $5,674 and $3,667 which begin to expire in
2018 and 2003, respectively.
NOTE 8: OTHER INCOME
Other income consists principally of interest income and dividends earned on
investments, as follows (in $000's):
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
- ----------------------------------------------------------------
<S> <C> <C> <C>
Interest income $1,985 $ 1,642 $809
Dividend income -- 12 61
Other 356 (22) 114
------ ------- ----
$2,341 $ 1,632 $984
====== ======= ====
</TABLE>
NOTE 9: CAPITAL STOCK
Stock Information
Thirty million shares of common stock, $.01 par value, have been authorized
since the Company's reincorporation in Delaware in August 1987. One million
shares of Preferred Stock, $.01 par value, are authorized but no preferred stock
has been issued. The Board of Directors may, without stockholder approval,
establish rights, terms, preferences and privileges for these preferred shares.
Stock Transactions
Since October 1986, the Company has, at various times, announced plans to
repurchase up to a total of 4,510,888 shares of its common stock through open
market or private transactions. As of December 31, 1998, a total of 3,819,088
shares had been acquired. A total of 544,300 shares acquired prior to August 24,
1987, have been retired as required by California law. Shares acquired after the
August 24, 1987 reincorporation in Delaware are being held as treasury stock, at
an average cost of $5.54 per share. The Company has a current authorization for
the repurchase of up to an additional 691,800 shares of the Company's common
stock which may be made from time to time in either open market or private
transactions.
Stock Plans
The Company's Stock Option Plan (the "Plan") authorizes both incentive and
non-qualified stock options to be granted in an aggregate amount up to 1,700,000
shares of common stock. Options may be granted to executive officers or other
key employees of the Company; non-employee directors of the Company are also
eligible but only for nonqualified options. The option price must, at least,
equal fair market value on the date the option is granted. The Plan is divided
into a discretionary program for key employees and an automatic program for
non-employee directors. The Plan is administered by the Compensation and Stock
Option Committee of the Board of Directors.
All stock options granted by the Company to employees through December 31, 1998
were incentive stock options. The following is a summary of stock option
transactions:
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding at beginning of year 638,017 510,817 397,500
Granted 184,000 168,000 132,300
Canceled (52,217) (10,134) (6,987)
Exercised -- (30,666) (11,996)
------------ ------------- -------------
Outstanding at end of year 769,800 638,017 510,817
============ ============= =============
Exercisable at end of year 455,066 363,228 303,389
============ ============= =============
Price range of options granted $5.00-$10.04 $10.81-$18.00 $15.75-$20.75
Price range of options canceled $9.00-$15.75 $ 9.00-$15.75 $ 9.00-$15.75
Price range of options exercised -- $ 4.25-$ 9.00 $ 9.00-$11.88
Price range of options outstanding $4.25-$20.75 $ 4.67-$20.75 $ 4.25-$20.75
</TABLE>
F-16
<PAGE> 58
The following table summarizes information concerning stock options at December
31, 1998:
<TABLE>
<CAPTION>
Number Weighted Average Number
Range of Outstanding Remaining Weighted Average Exercisable Weighted Average
Exercise Price 12/31/98 Contractual Life Exercise Price 12/31/98 Exercise Price
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 4.25-$ 7.25 150,000 2.74 $ 4.80 134,000 $ 4.77
9.00- 10.38 228,500 8.14 9.57 73,000 9.66
10.25- 13.06 251,400 7.05 11.25 163,133 11.01
15.75- 15.75 61,400 7.23 15.75 40,933 15.75
17.33- 20.75 78,500 7.65 18.35 44,000 18.24
------- -------
769,800 6.90 $ 10.58 455,066 $ 10.10
======= =======
</TABLE>
The estimated fair value of options granted during 1998, 1997, and 1996, was
$5.93, $4.56, and $4.84 per share, respectively. The Company applies Accounting
Principles Board Opinion No. 25 and related Interpretations in accounting for
the Plan. No compensation cost has been recognized for the Plan. Had
compensation cost for the Plan been determined based on the fair value at the
grant dates for awards under the Plan consistent with the method of FAS 123, the
Company's net income (loss) and earnings (loss) per share for the years ended
December 31, 1998, 1997 and 1996, would have been reduced to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
---------- --------- ---------
<S> <C> <C> <C>
Net income (loss) (in $000's)
As reported $ (11,094) $ (2,349) $ 3,052
Pro forma (11,481) (2,702) 2,855
Net income (loss) per common and common equivalent share
As reported $ (2.35) $ (.48) $ .62
Pro forma $ (2.42) $ (.55) $ .58
</TABLE>
Under FAS 123, the fair value of stock-based awards to employees is calculated
through the use of option pricing models, even though such models were developed
to estimate the fair value of freely tradable, fully transferable options
without vesting restrictions, which significantly differ from the Company's
stock option awards. These models also require subjective assumptions, including
future stock volatility and expected time to exercise, which greatly affect the
calculated values. The fair value of options granted under the Plan was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions used: no dividend yield, expected
volatility of 50% in 1998, 38% in 1997, and 25% in 1996, risk free interest rate
of approximately 6%, and an average expected life of four (4) years.
NOTE 10: IMPAIRMENT OF ASSETS
During the fourth quarter of 1998, the Company was notified by a major debtor
that their obligation to the Company would not be able to be fully met as of
December 31, 1998, and thereafter. As a result, the Company determined that
notes and interest receivable from the sale of the orthodontic practices and
general dental offices were impaired and not fully collectible. Therefore, the
Company increased the allowances relates to these Notes and interest receivable
related to these notes by $10,596, which was charged to continuing operations.
As of the date of impairment, the Company ceased all recognition of interest
revenue on all nonperforming Notes.
During the third quarter of 1998, the Company moved its corporate and western
region operations from its fully-owned building in Anaheim, CA to a leased
facility in Aliso Viejo, CA. As a result of this relocation, the Company has
been actively marketing the building and its related assets in Anaheim. Those
assets include the land, building, and various building improvements. During the
first quarter of 1999, the Company received a written offer for these assets.
Based on this offer and as required by FAS 121, the Company wrote down the value
of the building by $570 and accrued closing costs of $188. The book value of
these assets was $3,562 at December 31, 1998. The sale of these assets is
expected to be completed by the third quarter of 1999.
NOTE 11: COMMITMENTS AND CONTINGENCIES
The Company is a defendant in various litigation arising in the normal course of
business. In the opinion of Management, the ultimate outcome of such litigation
or any other contingencies would not have a material effect on the Company's
consolidated financial position or results of operations.
F-17
<PAGE> 59
The Company has employment agreements with various executive officers requiring
an annual payment of the following (in $000's):
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C>
1999 $1,140
2000 551
2001 155
2002 39
2003 --
</TABLE>
NOTE 12: RESERVES FOR INCURRED BUT NOT REPORTED CLAIMS
Activity in the liability for dental indemnity insurance policy reserves and
specialists claims expense is summarized as follows (in $000's):
<TABLE>
<CAPTION>
Policy Reserves Specialist Total
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at January 1, 1997 $ 2,120 $ 1,010 $ 3,130
Incurred related to:
Current year -- 1997 18,100 8,126 26,225
Prior years (13) (22) (34)
-------- ------- --------
Total incurred 18,087 8,104 26,191
Paid related to:
Current year -- 1997 15,950 6,645 22,595
Prior years 2,107 988 3,095
-------- ------- --------
Total paid 18,057 7,633 25,690
-------- ------- --------
Balance at December 31, 1997 $ 2,150 $ 1,481 $ 3,631
======== ======= ========
Incurred related to:
Current year -- 1998 $ 16,909 $ 7,251 $ 24,160
Prior years 794 (338) 456
-------- ------- --------
Total incurred 17,703 6,913 $ 24,616
Paid related to:
Current year -- 1998 14,636 5,966 20,601
Prior years 2,944 1,143 4,088
-------- ------- --------
Total paid 17,580 7,109 24,689
-------- ------- --------
Balance at December 31, 1998 $ 2,273 $ 1,285 $ 3,558
======== ======= ========
</TABLE>
NOTE 13: BUSINESS SEGMENT INFORMATION
The Company is engaged in the operation of Dental HMO and indemnity/PPO dental
plans. The operation of the Dental Practices and the Orthodontic Practices have
both been discontinued. The last of the discontinued operations were sold
effective April 1, 1998. The identifiable assets for the discontinued operations
have been segregated on the Consolidated Statements of Financial Position. (See
Note 2: Discontinued Operations). Following the April 1, 1998 sale, the
Company's sole line of business is providing dental benefits to employer groups,
associations and individuals.
NOTE 14: UNAUDITED SELECTED QUARTERLY INFORMATION
Unaudited quarterly results of operations for the years ended December 31, 1998
and 1997 are set forth in the table below ($000's omitted, except per share
data). The quarterly results should be read in conjunction with the audited
Consolidated Financial Statements of the Company.
Restatement:
Subsequent to the issuance of the Company's 1998 quarterly results of
operations for each of the three quarters ended September 30, 1998, the
Company's management determined that certain prepaid expenses, fixed assets,
accrued liabilities and deferred revenue balances were not properly stated. As
a result, these balances have been restated from the amounts previously
reported and income (loss) from continuing operations has been reduced by
$469,000, $390,000, and $1,423,000. The tax affect of these adjustments on
income (loss) from continuing operations were $206,000, $168,000, and $463,000
for the three months ended March 31, 1998, June 30, 1998 and September 30,
1998, respectively. These adjustments also resulted in a decrease in basic
earnings per common share from continuing operations of .06 and .05 for the
three months ended March 31, 1998 and June 30, 1998, respectively and an
increase in the basic loss per common share from continuing operations of .20
for the three months ended September 30, 1998.
In addition, management also determined that the gain on sale of discontinued
operations for the three months ended June 30, 1998 was not properly stated. As
a result, this gain has been reduced by $1,895,000 (tax affect of $739,000).
The basic earnings per common share from discontinued operations was also
reduced by .27 for the three months ended June 30, 1998.
Fourth Quarter Adjustment:
During its year end evaluation, the Company determined that the notes and
interest receivable from the sale of the orthodontic practices and general
dental offices were impaired and not fully collectible. As a result, the
Company increased its allowances related to these notes and interest receivable
by approximately $10,516,000 (tax affect of $3,709,000) which was charged to
continuing operations during the quarter ended December 31, 1998. In addition,
the Company determined that certain aged accounts receivable balances were
uncollectible and accordingly recorded an increase to its reserves for doubtful
accounts in the amount of $3,500,000 (tax affect of $1,225,000) during the
fourth quarter of 1998.
F-18
<PAGE> 60
The results for 1998 were restated for changes to the results previously
recorded:
<TABLE>
<CAPTION>
First Second Third
Year ended December 31, 1998 Quarter First Quarter Second Quarter Third
As Quarter As Quarter As Quarter
previously As previously As previously As Fourth
reported restated reported restated reported restated Quarter
- ------------------------------------------------------ -------- ---------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Current assets:
Cash $ 1,851 $ 1,851 $ 3,884 $ 3,884 $ 2,187 $ 2,187 $ 3,256
Investments available for sale 4,860 4,860 3,205 3,205 3,716 3,716 2,959
Investments held to maturity 4,272 4,272 1,249 1,249 -- -- --
Accounts and notes receivable, net 7,894 7,894 9,477 9,477 11,235 11,235 15,533
Income tax receivable 132 132 133 133 475 475 485
Prepaids and other current assets 1,378 1,021 1,361 923 1,003 565 478
Net assets of discontinued operations 5,143 5,143 -- -- -- -- --
Deferred income taxes 1,608 1,608 1,829 1,829 705 705 6,672
Assets available for sale -- -- -- 3,562
------- ------- ------- ------- ------- ------- -------
Total current assets 27,138 26,781 21,138 20,700 19,321 18,883 32,945
Long-term assets:
Property & equipment, net $ 9,729 $ 9,684 $10,184 $9,998 $10,598 $ 9,557 $ 6,105
Investments available for sale-long-term -- -- -- 4,225
Investments held to maturity-long-term 5,182 5,182 5,600 5,600 3,363 3,363 --
Notes receivable - long-term 12,389 12,389 21,753 21,753 22,778 22,778 4,083
Other assets 247 247 245 245 246 246 240
Intangibles and Goodwill, net 34,111 34,111 32,710 32,710 32,264 32,264 31,807
-- -- -- 539
------- ------- ------- ------- ------- ------- -------
Total long-term assets 61,658 61,613 70,492 70,306 69,249 68,208 46,999
======= ======= ======= ======= ======= ======= =======
Total Assets 88,796 88,394 91,630 91,006 88,570 87,091 79,944
======= ======= ======= ======= ======= ======= =======
Liabilities and Stockholders' Equity
Current liabilities:
Short-term notes payable 10,500 10,500 8,000 8,000 8,000 8,000 8,000
Current portion of note payable 1,692 1,692 1,692 1,692 1,692 1,692 1,894
Accounts payable and accrued expenses 3,484 3,552 5,907 6,043 3,751 4,455 10,905
Income taxes payable 427 221 -- (374) -- (837) --
Reserve for dental claims 3,331 3,331 3,306 3,306 3,561 3,561 3,558
Deferred Revenues 1,198 1,198 1,341 1,441 949 1,049 1,022
------- ------- ------- ------- ------- ------- -------
Total current liabilities 20,632 20,494 20,246 20,108 17,953 17,920 25,379
Long-Term Liabilities:
Long-term debt 32,500 32,500 32,500 32,500 33,000 33,000 32,500
Note payable 1,096 1,096 798 798 -- -- --
Deferred income taxes 1,000 1,000 2,789 2,789 2,837 2,837 --
Accrued compensation agreement 374 374 365 365 356 356 311
------- ------- ------- ------- ------- ------- -------
Total long-term liabilities 34,970 34,970 36,452 36,452 36,193 36,193 32,811
Stockholders' Equity:
Common stock 21,509 21,509 21,509 21,509 21,509 21,509 21,509
Retained Earnings 30,479 30,215 32,401 31,915 31,778 30,332 18,722
Accumulated other comprehensive income (671) (671) (855) (855) (740) (740) (354)
Treasury stock, at cost (18,123) (18,123) (18,123) (18,123) (18,123) (18,123) (18,123)
------- ------- ------- ------- ------- ------- -------
Total stockholders' equity 33,194 32,930 34,932 34,446 34,424 32,978 21,754
------- ------- ------- ------- ------- ------- -------
Total Liabilities and Stockholders' Equity 88,796 88,394 91,630 91,006 88,570 87,091 79,944
======= ======= ======= ======= ======= ======= =======
</TABLE>
F-19
<PAGE> 61
<TABLE>
<CAPTION>
First Second Third
Year ended December 31, 1998 Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
As previously reported
Health care revenues $24,395 $24,540 $24,004
Health care expense 16,431 16,288 16,539
Selling, general and administrative 6,830 6,567 7,567
------- ------- -------
Total expenses 23,261 22,855 24,106
Other income 970 534 199
Interest expense (922) (973) (1,020)
------- ------- -------
Income (loss) from continuing operations
before tax 1,182 1,246 (923)
Provision (benefit) for income taxes 519 538 (300)
------- ------- -------
Income (loss) from operations before
discontinued operations 663 708 (623)
Income from discontinued operations -- 1,214 --
------- ------- -------
Net income $ 663 $ 1,922 $ (623)
======= ======= =======
Basic Earnings (Loss) Per Share
Income from continuing operations per share $ 0.14 $ 0.15 $ (0.13)
Income from discontinued operations per share -- 0.26 --
------- ------- -------
Net income (loss) per share 0.14 0.40 (0.13)
------- ------- -------
Weighted average shares 4,747 4,747 4,747
Diluted Earnings Per Share
Income from continuing operations per share $ 0.14 $ 0.15 $ (0.13)
Income from discontinued operations per share -- 0.26 --
------- ------- -------
Net income (loss) per share 0.14 0.40 (0.13)
------- ------- -------
Weighted average shares 4,747 4,747 4,747
</TABLE>
F-21
<PAGE> 62
<TABLE>
<CAPTION>
First Second Third Fourth
Year ended December 31, 1998 Quarter Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
As restated
Health care revenues 24,396 24,440 23,504 25,109
Health care expense 16,431 16,288 16,539 16,762
Selling, general and administrative 7,300 6,857 7,920 15,415
Other income 970 534 (371) 1,208
Loss on impaired assets -- -- -- (11,165)
Interest expense (922) (973) (1,020) (1,396)
------- ------- ------- -------
Income (loss) from continuing
operations before tax 713 856 (2,346) (18,421)
Provision for income taxes 313 370 (763) (6,558)
------- ------- ------- -------
Income (loss) from continuing operations
before discontinued operations 400 486 (1,583) (11,863)
Income from discontinued operations -- (58) -- 1,524
------- ------- ------- -------
Net income $ 400 $ 428 $(1,583) $(10,339)
======= ======= ======= =======
Basic Earnings (Loss) Per Share
Income from continuing operations per share $ 0.08 $ 0.10 $ (0.33) $ (2.51)
Income from discontinued operations per share -- (0.01) -- 0.32
------- ------- ------- -------
Net income (loss) per share $ 0.08 $ 0.09 $ (0.33) $ (2.19)
Weighted average shares 4,747 4,747 4,747 4,747
Diluted Earnings Per Share
Income from continued operations per share $ 0.08 $ 0.10 $ (0.33) $ (2.51)
Income from discontinued operations per share -- (0.01) -- $ .32
------- ------- ------- -------
Net income (loss) per share $ 0.08 $ 0.09 $ (0.33) $ 2.19
Weighted average shares 4,747 4,747 4,747 4,747
</TABLE>
NOTE 15. SUBSEQUENT EVENTS
On April 14, 1999, the Company and its primary lenders (Silicon Valley Bank and
John Hancock Mutual Life Insurance Company) agreed to modifications with respect
to the working capital credit facility and the eight-year notes, respectively.
This agreement provides for changes in interest rates, modifications to the
financial covenants and reporting requirements, as well as specific principal
repayments.
In connection with the agreement, the Company, has obtained waivers for all
prior and existing defaults and events of default under the related credit
agreements through the date that definitive documents incorporating the
agreed-upon terms are executed.
F-22
<PAGE> 63
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 1998, 1997 AND 1996
(in $000's)
<TABLE>
<CAPTION>
Balance at Charged to Charged to Balance at
Beginning Cost and Beginning Cost and Other End
Classification of Year Expenses Accounts(1) Write Offs Of Year
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1996:
Allowance for doubtful accounts:
Accounts $ 260 $ 615 $ 62 $ (406) $ 531
1997:
Allowance for doubtful accounts:
Accounts $ 531 $ 1,058 $ -- $ (528) $ 1,061
Long-term notes receivable $ -- $ 3,595 $ -- $ -- $ 3,595
1998:
Allowance for doubtful accounts:
Accounts receivable $1,061 $ 2,745 $ -- $(851) $ 2,954
Current notes receivable $ -- $14,910 $ 2,395 $ -- $17,305
Long-term notes receivable $3,595 $ 1,401 $(2,395) $ -- $ 2,601
</TABLE>
(1) Represents balance forward from First American, which was charged to the
opening goodwill balance and reclasses between long-term and short-term.
S-1
<PAGE> 64
EXHIBIT INDEX
<TABLE>
<CAPTION>
NUMBER
EXHIBIT OF
NUMBER COLUMNS DESCRIPTION
- ------ ------- -----------
<S> <C> <C>
2.1 One Plans of Acquisition(8)
3.1 One Articles of Incorporation(4)
3.2 One Bylaws(4)
10.1 One 1984 Stock Option Plan(3)
10.2 One Stock Option Plan Amendment(1)
10.3 One Stock Option Plan Amendment(5)
10.4 One Stock Option Plan Amendment(6)
10.5 One Amended Stock Option Plan(10)
10.6 One Corporation Grant Deed, dated December 21, 1984,
relating to a property located at 505 North Euclid
Avenue, Anaheim, California(2)
10.7 One Employment Agreement, as Amended, dated May 25, 1995,
between Steven J. Baileys, D.D.S. and the Company.(7)
10.8 One Employment Agreement, as Amended, dated May 25, 1995,
between Ronald I. Brendzel and the Company.(7)
10.9 One Employment Agreement dated May 25, 1995, between John E.
Cox and the Company.(7)
10.10 One Form of Rights Agreement, dated as of March 22, 1996,
between the Company and American Stock Transfer and
Trust Company, as Rights Agent.(7)
10.11 One Employment Agreement dated January 5, 1997, between Herb J.
Kaufman, D.D.S. and the Company.(10)
10.12 One Credit Agreement dated September 25, 1996, between Bank
of America National Trust and Savings Association and
the Company.(9)
10.13 One Stock Purchase Agreement between Consumers Life
Insurance Company and SafeGuard Health Enterprises, Inc.
dated March 6, 1997(11)
10.14 One Purchase Agreement between Associated Dental Services,
Inc. and Guards Dental, Inc. dated August 1, 1997(11)
10.15 One Purchase agreement between Pacific Coast Dental, Inc.
and Guards Dental, Inc. dated August 1, 1997(11)
10.16 One Form of Note Purchase Agreement dated as of September
30, 1997, and form of Promissory Note(12)
10.17 One Form of Master Asset Purchase Agreement effective as of
April 1, 1998, and Form of Promissory Note without
exhibits.(13)
10.18 One Default Forbearance Agreement and Irrevocable Power of
Attorney(14)
10.19 One Credit Agreement dated January 29, 1998, between Silicon
Valley Bank and the Company.(15)
21.1 One Subsidiaries of the Company
23.1 One Independent Auditor's Consent
24.1 One Power of Attorney (Reference is made to Page 41 of the Report)
27.1 One Financial Data Schedule
</TABLE>
- ----------
(1) Incorporated by reference herein to the exhibit of the same number filed
as an exhibit to the Company's Registration Statement on Form S- filed
on September 12, 1983 (File No. 2-86472).
(2) Incorporated by reference herein to the exhibit of the same number filed
as an exhibit to the Company's Registration Statement on Form S-1 filed
on August 22, 1985 (File No. 2-99663).
(3) Incorporated by reference herein to the exhibit of the same number filed
as an exhibit to the Company's Registration Statement on Form S-1 filed
on July 3, 1984 (File No. 2-92013).
(4) Incorporated by reference herein to the exhibit of the same number filed
as an exhibit to the Company's Annual Report of Form 10-K for the period
ended December 31, 1987.
(5) Incorporated by reference herein to the exhibit of the same number filed
as an exhibit to the Company's Annual Report of Form 10-K for the period
ended December 31, 1989.
(6) Incorporated by reference herein to the exhibit of the same number filed
as an exhibit to the Company's Annual Report of Form 10-K for the period
ended December 31, 1992.
(7) Incorporated by reference herein to the exhibit of the same number filed
as an exhibit to the Company's Annual Report of Form 10-K for the period
ended December 31, 1995.
(8) Incorporated by reference herein to Exhibit D filed as an exhibit to the
Company's Report on Form 8-K dated September 27, 1996.
(9) Incorporated by reference herein to Exhibit E filed as an exhibit to the
Company's Report on Form 8-K dated September 27, 1996.
(10) Incorporated by reference herein to the exhibit of the same number filed
as an exhibit to the Company's Annual Report on Form 10-K for the period
ended December 31, 1996.
(11) Incorporated by reference to the exhibit of the same number filed as an
exhibit to the Company's quarterly statement on Form 10-Q for the period
ended June 30, 1997.
(12) Incorporated by reference herein to Exhibit 99.1 filed as an exhibit to
the Company's Report on Form 8-K dated October 7, 1997.
(13) Incorporated by reference herein to Exhibit F filed as an exhibit to the
Company's Report on Form 8-K dated April 1, 1998. 14 Referenced,
disclosed and filed as an exhibit to Company's Annual Report on Form
10-K for the period ended December 31, 1998.
(14) Referenced, disclosed and filed as an exhibit to Company's Annual
Report on Form 10-K for the period ended December 31, 1998.
(15) Referenced and disclosed in the Company's Quarterly Report on Form 10-Q
for the period ended September 30, 1998 and filed as an exhibit to the
Company's Annual Report on Form 10-K for the period ended December 31,
1998.
E-1
<PAGE> 1
EXHIBIT 10.18
DEFAULT FORBEARANCE AGREEMENT
This Default Forbearance Agreement (this "AGREEMENT") is dated as of
February 12, 1999, and is executed and delivered by and among Associated Dental
Services, Inc., a California corporation ("ADS"), Pacific Coast Dental, Inc., a
California corporation and a wholly-owned subsidiary of ADS, ("PCD") (ADS and
PCD together, "BORROWERS"), The Pellkofer Family Trust (40% owner of ADS), Eric
F. Pellkofer (10% owner of ADS), Frank G. Pellkofer (president of ADS), The
Stalcup Family Trust (40% owner of ADS), and Robert W. Stalcup, D.D.S. (10%
owner of ADS) ( the "SHAREHOLDERS") and Guards Dental, Inc., a California
corporation ("LENDER"), with respect to the following facts:
R E C I T A L S
A. Lender is the holder of (i) a Promissory Note and Security Interest
dated August 1, 1997, executed by ADS and payable to Lender, in the original
principal amount of Four Million, Five Hundred Thousand Dollars ($4,500,000)
(the "ADS NOTE"); (ii) a Promissory Note and Security Interest dated August 1,
1997, executed by PCD and payable to Lender, in the original principal amount of
Three Million, Five Hundred Thousand Dollars ($3,500,000) (the "PCD NOTE");
(iii) a Promissory Note and Security Interest dated April 1, 1998, executed by
ADS and PCD and payable to Lender, in the original principal amount of Fifteen
Million Dollars ($15,000,000) (the "ADS/PCD NOTE"); (iv) a Promissory Note and
Security Interest dated September 30, 1996, and assumed by ADS and PCD pursuant
to an Assignment and Assumption of Note Agreement dated April 1, 1998 and
payable to Lender, in the original principal amount of One Million Dollars
($1,000,000) (the "GLENDALE NOTE"); (v) a Promissory Note and Security Interest
dated March 31, 1997, and assumed by ADS and PCD pursuant to an Assignment and
Assumption of Note Agreement dated April 1, 1998 and payable to Lender, in the
original principal amount of One Hundred Thirty One Thousand Dollars ($131,000)
(the "EQUIPMENT NOTE"); (vi) a Promissory Note and Security Interest dated
December 30, 1996, and assumed by ADS and PCD pursuant to an Assignment and
Assumption of Note Agreement dated April 1, 1998 and payable to Lender, in the
original principal amount of Six Hundred Thousand Dollars ($600,000) (the
"RANCHO CUCAMONGA NOTE"); (vii) a Promissory Note and Security Interest dated
June 23, 1997, and assumed by ADS and PCD pursuant to an Assignment and
Assumption of Note Agreement dated April 1, 1998 and payable to Lender, in the
original principal amount of Six Hundred Twenty Five Thousand Dollars ($625,000)
(the "KEARNY MESA NOTE"); each as modified by that certain Master Asset Purchase
Agreement dated April 1, 1998 among Lender, ADS and PCD; and (viii) a Promissory
Note and Security Interest dated December 1, 1998 and assumed by ADS and PCD
pursuant to an Assignment and Assumption of Note Agreement dated January 1,
1999, in the original principal amount of Three Hundred Thirty Five Thousand
Dollars ($335,000) (the "MORENO VALLEY NOTE"). The ADS Note, PCD Note, ADS/PCD
Note, Glendale Note, Equipment Note, Rancho Cucamonga Note, Kearny Mesa Note and
Moreno Valley Note shall be referred to herein collectively as the "NOTES".
<PAGE> 2
B. ADS's obligations under the ADS Note are secured pursuant to the
terms of the ADS Note by all tangible, nonorthodontics-related assets of ADS
existing on the date of the ADS Note or thereafter acquired and/or accrued,
including any proceeds or replacements relating to the same. PCD's obligations
under the PCD Note are secured pursuant to the terms of the PCD Note by all
assets of PCD existing on the date of the PCD Note or thereafter acquired and/or
accrued, including any proceeds or replacements relating to the same. Borrowers'
obligations under the ADS/PCD Note are secured pursuant to the terms of the
ADS/PCD Note by all of ADS's assets and PCD's assets related to or associated
with the dental practices located on Schedule 3 attached thereto, or any other
dental practices owned by PCD and ADS existing on the date of the PCD/ADS Note
or thereafter acquired and/or accrued, including any proceeds or replacements
relating to the same. Borrowers' obligations under the Glendale Note are secured
pursuant to the terms of the Glendale Note by all of Borrowers' assets existing
on the date of the Glendale Note or thereafter acquired and/or accrued,
including any proceeds or replacements relating to the same. Borrowers'
obligations under the Equipment Note are secured pursuant to the terms of the
Equipment Note by all of Borrowers' assets existing on the date of the Equipment
Note or thereafter acquired and/or accrued, including any proceeds or
replacements relating to the same. Borrowers' obligations under the Rancho
Cucamonga Note are secured pursuant to the terms of the Rancho Cucamonga Note by
all of Borrowers' assets existing on the date of the Rancho Cucamonga Note or
thereafter acquired and/or accrued, including any proceeds or replacements
relating to the same. Borrowers' obligations under the Kearny Mesa Note are
secured pursuant to the terms of the Kearny Mesa Note by all of Borrowers'
assets existing on the date of the Kearny Mesa Note or thereafter acquired
and/or accrued, including any proceeds or replacements relating to the same.
Borrowers' obligations under the Moreno Valley Note are secured pursuant to the
terms of the Moreno Valley Note by all of Borrowers' assets existing on the date
of the Moreno Valley Note or thereafter acquired and/or accrued, including any
proceeds or replacements relating to the same.
C. Borrowers acknowledge that Borrowers have failed to pay and will not
pay the full amount owing on the Notes for the months of January 1999 through
the date of termination of this Agreement, such monthly deficit equaling
$41,716.41 for the ADS Note, $32,446.09 for the PCD Note, $115,037.02 for the
ADS/PCD Note, $9,309.08 for the Glendale Note, $3,874.46 for the Equipment Note,
$5,570.64 for the Rancho Cucamonga Note, $5,988.87 for the Kearny Mesa Note, and
$2,575.86 for the Moreno Valley Note, for a total deficit per month of
$207,073.33 ("PAYMENT DEFICIT"), and as a result, Borrowers have accrued late
fees in the amounts specified in the Notes ("LATE FEES"). Such failure to pay
the Payment Deficit is referred to herein as the "SPECIFIED DEFICIT."
2
<PAGE> 3
D. Borrowers have asked Lender, and Lender is willing to agree, to
forbear temporarily from exercising its rights and remedies with respect to the
Specified Deficit, on the terms and conditions set forth in this Agreement.
E. The Dental Practice Asset Purchase Agreement dated August 1, 1997
between ADS and Lender, the Dental Practices Purchase Agreement dated August 1,
1997 between PCD and Lender, the Master Asset Purchase Agreement dated April 1,
1998 among ADS, PCD and Lender, the Assumption of Note Agreements described
above for the Glendale Note, the Equipment Note, The Rancho Cucamonga Note, the
Kearny Mesa Note, and the Moreno Valley Note, this Agreement, and the Notes,
together with all modifications and amendments thereto and any documents
required thereunder, are referred to herein collectively as the "LOAN DOCUMENTS"
and each individually is referred to as a "LOAN DOCUMENT." Capitalized terms not
otherwise defined herein shall have the respective meanings set forth in the
Notes.
F. All of the parties agree that it is in their best interest to market
and sell the businesses operated by ADS and PCD (the "BUSINESSES") by causing
ADS, PCD and the Shareholders to sign an irrevocable power of attorney in favor
of Lender in the form attached hereto as Exhibit A.
NOW, THEREFORE, FOR VALUABLE CONSIDERATION, the receipt and sufficiency
of which are hereby acknowledged, Borrowers, Shareholders and Lender agree as
follows:
A G R E E M E N T
1. Forbearance. Subject to strict compliance by Borrowers with every
covenant, condition and obligation set forth in this Agreement and in each and
all of the other Loan Documents, Lender hereby agrees, until the earliest to
occur of (i) August 12, 1999; (ii) the occurrence of any default (other than the
Specified Deficit), following the expiration of applicable notice and grace
periods, if any, under any of the Loan Documents, or (iii) any other event
allowing Lender to declare the Notes immediately due and payable; to forbear
from exercising Lender's rights and remedies under the Loan Documents arising
out of or with respect to the Specified Deficit. Borrowers hereby agree and
acknowledge that this forbearance by Lender does not constitute a waiver of the
Specified Deficit or a waiver of Lender's right to assert and enforce its rights
and remedies with respect to any default under the Loan Documents which may
already have occurred (other than the Specified Deficit) or which may occur in
the future. Borrowers further agree that, upon the occurrence of a default under
any of the Loan Documents (other than the Specified Deficit), Lender may
exercise any of its rights and remedies with respect to such default as well as
with respect to the Specified Deficit.
2. Representations and Warranties. ADS, PCD, The Pellkofer Family
Trust, Eric F. Pellkofer, Frank G. Pellkofer, The Stalcup Family Trust and
Robert W. Stalcup, D.D.S., jointly and severally, represent and warrant to
Lender, and agree with Lender, as follows:
3
<PAGE> 4
(a) Defaults. Except for the Specified Deficit and the
"Specified Deficit" as defined in the Forbearance Agreement entered
into on the date hereof by and among SafeGuard Enterprises, Inc., ADS
and the Shareholders, no event, omission, breach or failure of
condition has occurred that is a default or, with the giving of notice
or the passage of time or both, would constitute a default under any
Loan Document.
(b) Authority and Enforceability. Borrowers have all requisite
power and authority to execute, deliver and perform their obligations
under this Agreement, and this Agreement is a valid and binding
obligation of Borrowers. The Pellkofer Family Trust, Eric F. Pellkofer,
The Stalcup Family Trust and Robert W. Stalcup, D.D.S. are the sole
shareholders of ADS. ADS is the sole shareholder of PCD. Frank G.
Pellkofer represents and warrants that he has been duly authorized to
enter into this Agreement on behalf of ADS, The Pellkofer Family Trust
and Eric F. Pellkofer and has full and complete authority to do so.
Robert W. Stalcup, D.D.S. represents and warrants that he has been duly
authorized to enter into this Agreement on behalf of PCD and The
Stalcup Family Trust, and has full and complete authority to do so.
(c) Power of Sale. Borrowers have all requisite power and
authority to execute, deliver and perform their obligations under
agreements to sell the Businesses.
(d) Obligations. As of January 1, 1999, (i) the amounts of the
unpaid principal plus accrued interest balances are $4,500,000 for the
ADS Note (plus accrued interest), $3,500,000 for the PCD Note (plus
accrued interest), $15,000,000 for the ADS/PCD Note (plus accrued
interest), $1,060,324.50 for the Glendale Note, $134,558.40 for the
Equipment Note, $636,750.25 for the Rancho Cucamonga Note, $674,997.06
for the Kearny Mesa Note, and $335,000 for the Moreno Valley Note,
and the total unpaid principal balance on the Notes is $25,841,630.21;
and (iii) each and all of such amounts are payable to Lender.
(e) No Conflicts. The execution and delivery of, and the
performance of Borrowers' obligations under, this Agreement do not (i)
require the consent of, or filing of any document with, any individual,
entity, court, governmental agency or other person in order to be
binding on Borrowers; (ii) violate any law, regulation, order or decree
applicable to ADS or PCD; or (iii) conflict with the terms of any deed
of trust, lease, loan, credit agreement, articles of incorporation,
bylaws or other agreement or instrument to which ADS, PCD or any
Affiliate of ADS or PCD is a party or by which they, any of their
Affiliates or the collateral described in the Notes (the "PROPERTY")
may be bound or affected. The term "AFFILIATE" means any person or
entity which controls, is controlled by, or is under common control
with, a specified person or entity.
4
<PAGE> 5
3. Sale of Businesses. In consideration of Lender's agreement to
forbear temporarily from exercising its rights and remedies with respect to the
Specified Deficit on the terms and conditions set forth in this Agreement, ADS,
PCD, the Shareholders and Lender agree to cooperate with each other in an effort
to market and sell the Businesses as follows:
(a) Trenwith Securities, Inc., as agent for and acting under
authority granted by Lender ("AGENT"), shall control the marketing of
the Businesses for sale to one or more third parties. Borrowers shall
cooperate with Lender in the marketing and sale of the Businesses by,
among other things, (i) sharing financial and other information
pertaining to the Businesses (ii) providing access to facilities of the
Businesses, and (iii) referring all interested parties to Agent rather
than showing the Businesses for sale independently. Lender shall
cooperate with Borrowers by, among other things, sharing information
about the progress of any sale efforts and the terms of any offers that
are submitted.
(b) Lender shall have sole authority to negotiate and
determine the terms of the transaction in which the Businesses are
sold, including, but not limited to, the sales price and the structure
of the sales transaction. Lender may accept or reject any offer and
Lender may or may not agree to sell the Businesses during the term of
this Agreement. Borrowers shall not enter into any transaction for the
sale of the Businesses which has not been approved by Lender and any
attempt to do so shall constitute a default under this Agreement. As a
condition to Lender entering into this Agreement, ADS, PCD and the
Shareholders shall execute an irrevocable power of attorney in favor of
Lender in the form attached hereto as Exhibit A.
(c) Notwithstanding subsection (b) above, any final sales
transaction must (i) provide for the sale of either all the issued and
outstanding stock of ADS and PCD or the sale of all or substantially
all of the assets of ADS and PCD, and (ii) provide for the payment or
assumption of all of the outstanding trade payables, payroll and
payroll taxes of the Businesses.
(d) The current management teams of ADS and PCD shall retain
control over the day to day operations and management of the
Businesses. However, failure to operate the Businesses in the ordinary
course shall constitute a default under this Agreement. In particular
but without limitation, any increases in salaries, distributions to the
Shareholders or transactions between ADS or PCD and the Shareholders or
their Affiliates shall constitute a default under this Agreement.
(e) The Shareholders acknowledge and agree that they will make
commercially reasonable representations and warranties to the
purchaser(s) of the Businesses in their individual capacities.
5
<PAGE> 6
(f) Proceeds from any sale of the Businesses pursuant to this
Agreement shall be divided as follows:
(i) The Shareholders shall receive a minimum of
$500,000 in cash at the time of closing, regardless of the
final sales price for the Businesses. Allocation among the
Shareholders of funds payable to the Shareholders under this
Agreement shall be pursuant to their respective shareholdings.
(ii) Additional proceeds shall be payable to the
Shareholders in cash at the time of closing based upon the
average of the following two formulas: (A) 7.5% of the Net
Sales Proceeds (as defined below) under $10 million plus 15%
of the Net Sales Proceeds over $10 million; and (B) a minimum
payment of $500,000 for any Net Sales Proceeds under $10
million plus 12.5% of any Net Sales Proceeds over $10 million.
Amounts payable to the Shareholders at various assumed amounts
of Net Sales Proceeds under the foregoing formula are
illustrated in the chart below.
<TABLE>
<CAPTION>
AMOUNT PAYABLE
NET SALES PROCEEDS TO SHAREHOLDER
------------------ --------------
\<S> <C>
$15,000,000 $1,312,500
14,000,000 1,175,000
13,000,000 1,037,500
12,000,000 900,000
11,000,000 762,500
10,000,000 625,000
9,000,000 587,500
8,000,000 550,000
7,000,000 512,500
6,000,000 500,000
5,000,000 500,000
</TABLE>
6
<PAGE> 7
(iii) All Net Sales Proceeds not payable to the
Shareholders pursuant to this Agreement shall be payable to
Lender. The term "NET SALES PROCEEDS" means the gross sale
price of the Businesses, less the direct costs of the sale
(commissions to Agent, escrow fees, attorneys' fees... etc.),
less any of the Businesses' gross liabilities (other than
liabilities owing to Lender or its Affiliates), paid either
(i) by Lender or (ii) by the purchaser of the Businesses where
payment or assumption of such liabilities by the purchaser
reduces the amount of the gross sale price available for
distribution to Lender, less all costs and expenses incurred
by Lender in connection with: (1) the preparation of this
Agreement and any and all other sales agreements contemplated
hereby; (2) the administration of this Agreement and the other
sales agreements; and (3) the enforcement or satisfaction by
Lender of any of Borrowers' obligations under this Agreement
or any sales agreement. For all purposes of this Agreement,
Lender's costs and expenses shall include, without limitation,
all appraisal fees, legal fees, accounting fees and auditor
fees.
(iv) On the closing date of the sale of the
Businesses, an amount equal to the lesser of (i) 25% of the
total proceeds payable to the Shareholders or (ii) $250,000
shall be held back from distribution to the Shareholders and
placed into an interest bearing escrow account for a period of
six months to cover any claims made under the representations,
warranties or guaranties of Borrowers or Shareholders which
Lender or its Affiliates pays within six months of the closing
date. The amount of escrowed funds needed to cover any claim
of Lender will be released to the Lender upon proof of payment
of the liability. If Lender has made no claims by the date
three months from the closing date of the sale, one half of
the escrowed amount will be distributed to the Shareholders.
Any remaining escrowed funds will be distributed to the
Shareholders on the date six months from the closing date of
the sale.
(v) Commissions payable to Agent for the sale of the
Businesses are (i) $250,000 of the Transaction Value, as
defined in the Agreement between SafeGuard Health Enterprises,
Inc. and Agent, up to $10 million, plus (ii) two and one half
percent (2.5%) per million thereafter.
4. Mutual Release.
(a) In consideration of Lender's agreements set forth herein,
Borrowers and Shareholders, for themselves, their Affiliates, and the
respective successors, heirs and assigns of each of the foregoing
(collectively, some or all of such persons and entities shall be
referred to herein as the "BORROWER RELEASORS" and each reference to a
"BORROWER RELEASOR" herein shall refer to each such person or entity
individually), do hereby fully, forever
7
<PAGE> 8
and irrevocably release, discharge and acquit Lender, and its
respective past and present Affiliates, and the respective past and
present officers, directors, shareholders, agents, and employees of
each and all of the foregoing entities, and its and their respective
successors, heirs, and assigns, and any other person or entity now,
previously, or hereafter affiliated with any or all of the foregoing
entities (Lender, together with each and all said Affiliates, officers,
directors, shareholders, agents and employees shall be referred to
collectively hereinbelow as the "BORROWER RELEASED PARTIES" and each
such reference shall refer jointly and severally to each and all of
Lender and such other persons and entities) of and from any and all
rights, claims, demands, obligations, liabilities, indebtedness,
breaches of contract, breaches of duty or any relationship, acts,
omissions, misfeasance, malfeasance, cause or causes of action, debts,
sums of money, accounts, compensations, contracts, controversies,
promises, damages, costs, losses and expenses of every type, kind,
nature, description or character, and irrespective of how, why, or by
reason of what facts, whether heretofore or now existing, or that
could, might, or may be claimed to exist, of whatever kind or name,
whether known or unknown, suspected or unsuspected, liquidated or
unliquidated, claimed or unclaimed, whether based on contract, tort,
breach of any duty, or other legal or equitable theory of recovery,
each as though fully set forth herein at length (collectively, a
"CLAIM" or the "CLAIMS") arising from or out of, connected with, or
relating to this Agreement, the transactions contemplated hereby, or
the administration hereof.
(b) In consideration of Borrowers' and Shareholders'
agreements set forth herein, Lender, for itself, its Affiliates, and
the respective successors, heirs and assigns of each of the foregoing
(collectively, some or all of such persons and entities shall be
referred to herein as the "LENDER RELEASORS" and each reference to a
"LENDER RELEASOR" herein shall refer to each such person or entity
individually), does hereby fully, forever and irrevocably release,
discharge and acquit Borrowers and Shareholders, and their respective
past and present Affiliates, and the respective past and present
officers, directors, shareholders, agents, and employees of each and
all of the foregoing entities, and their respective successors, heirs,
and assigns, and any other person or entity now, previously, or
hereafter affiliated with any or all of the foregoing entities
(Borrowers and Shareholders, together with each and all said
Affiliates, officers, directors, shareholders, agents and employees
shall be referred to collectively hereinbelow as the "LENDER RELEASED
PARTIES" and each such reference shall refer jointly and severally to
each and all of Borrowers, Shareholders and such other persons and
entities) of and from any and all Claims arising from or out of,
connected with, or relating to this Agreement, the transactions
contemplated hereby, or the administration hereof.
8
<PAGE> 9
(c) Borrower Releasors and Lender Releasors (together, the
"RELEASORS"), and each of them, irrevocably covenant and agree that
each of them shall forever refrain from initiating, filing,
instituting, maintaining, or proceeding upon, or encouraging, advising
or voluntarily assisting any other person or entity to initiate,
institute, maintain or proceed upon any Claim of any nature whatsoever
released in paragraphs 4(a) and 4(b) above.
(d) Releasors, and each of them, represent and warrant that
each of them is the owner of and has not assigned, sold, transferred,
or otherwise disposed of any of the Claims released in paragraphs 4(a)
and 4(b) above.
(e) Releasors, and each of them, represent and warrant that
each of them has the authority and capacity to execute this Agreement.
(f) Releasors, and each of them, for themselves, their
successors and their assigns, hereby agree, represent, and warrant that
the matters released herein are not limited to matters that are known
or disclosed, and Releasors, and each of them, hereby waive any and all
rights and benefits that they now have, or in the future may have,
conferred upon them by virtue of the provisions of Section 1542 of the
Civil Code of the State of California (or any other statute or common
law principles of similar effect), which Section provides as follows:
A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT
KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE
RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS
SETTLEMENT WITH THE DEBTOR.
In this connection,
(i) Borrower Releasors, and each of them, hereby
agree, represent, and warrant that they realize and
acknowledge that factual matters now unknown to them may have
given or may hereafter give rise to causes of action, claims,
demands, debts, controversies, damages, costs, losses, and
expenses that are presently unknown, unanticipated, and
unsuspected, and they further agree, represent, and warrant
that paragraphs 4(a)-(f) have been negotiated and agreed upon
in light of that realization and that they nevertheless hereby
intend to release, discharge and acquit the Borrower Released
Parties from any such unknown causes of action, claims,
demands, debts, controversies, damages, costs, losses, and
expenses that are in any way related to this Agreement, the
transactions contemplated hereby, or the administration
hereof; and
9
<PAGE> 10
(ii) Lender Releasors, and each of them, hereby
agree, represent, and warrant that they realize and
acknowledge that factual matters now unknown to them may have
given or may hereafter give rise to causes of action, claims,
demands, debts, controversies, damages, costs, losses, and
expenses that are presently unknown, unanticipated, and
unsuspected, and they further agree, represent, and warrant
that paragraphs 4(a)-(f) have been negotiated and agreed upon
in light of that realization and that they nevertheless hereby
intend to release, discharge and acquit the Lender Released
Parties from any such unknown causes of action, claims,
demands, debts, controversies, damages, costs, losses, and
expenses that are in any way related to this Agreement, the
transactions contemplated hereby, or the administration
hereof.
(g) The provisions of paragraphs 4(a)-(f) shall survive
payment in full of the Notes, termination of this Agreement, and full
performance of this Agreement and the other Loan Documents.
INITIAL:
------------------------ ----------------------
------------------------ ----------------------
-----------------------
5. Waiver of Anti-Deficiency Protection. Borrowers hereby expressly and
irrevocably disclaim and renounce any right and hereby irrevocably waive any
defense, protection or right under: (a) California Code of Civil Procedure
("CCP") Section 580d concerning the bar against rendition of a deficiency
judgment after foreclosure under a power of sale; (b) CCP Section 580a
purporting to limit the amount of a deficiency judgment which may be obtained
following exercise of a power of sale under a deed of trust; (c) CCP Section 726
concerning exhaustion of collateral, the form of foreclosure proceedings with
respect to real property security located in California and otherwise limiting
the amount of a deficiency judgment which may be recovered following completion
of a judicial foreclosure by reference to the "fair value" of the foreclosure
collateral; and (d) any duty on the part of Lender to conduct a commercially
reasonable sale under California Uniform Commercial Code ("CUCC") Section
9504(3) to the extent any portion of the collateral for the obligations of
Borrowers to Lender consists of personal property or fixtures, including,
without limitation, the making of any election under CUCC Section 9501(4) in
respect of any such personal property or fixtures.
INITIAL:
-------------------- --------------------
6. Non-Impairment. Except as expressly provided herein, nothing in this
Agreement shall alter or affect any provision, condition or covenant contained
in the Notes or in any other Loan Documents or affect and impair any rights,
powers or remedies of Lender, it being the intent of the parties hereto that the
provisions of the Notes and the other Loan Documents shall continue in full
force and effect except as expressly modified hereby. The breach of any
representation or warranty hereunder shall constitute a "DEFAULT" under the Loan
Documents.
10
<PAGE> 11
7. Miscellaneous. This Agreement and the other Loan Documents shall be
governed by and interpreted in accordance with the laws of the State of
California, unless and to the extent preempted by Federal law, in which case
this Agreement and the other Loan Documents shall be governed by and interpreted
in accordance with Federal law to such extent. In any action brought or arising
out of this Agreement or the Loan Documents, Borrowers, and the Affiliates of
Borrowers, hereby consent to the jurisdiction of any Federal or State Court
having proper venue within the State of California and also consent to the
service of process by any means authorized by California or Federal law. The
headings used in this Agreement are for convenience only and shall be
disregarded in interpreting the substantive provisions of this Agreement. Except
as expressly provided otherwise herein, all capitalized terms used herein shall
have the respective meanings given to them in the other Loan Documents. Time is
of the essence of each term of the Loan Documents, including this Agreement. The
parties and their attorneys have cooperated in drafting and preparing this
Agreement; consequently, the presumption that ambiguities are resolved against
the drafting party shall be inapplicable, and any such ambiguities shall not be
construed against any party. If any provision of this Agreement or any of the
other Loan Documents shall be determined by a court of competent jurisdiction to
be invalid, illegal or unenforceable, that portion shall be deemed severed from
this Agreement and the remaining parts shall remain in full force as though the
invalid, illegal, or unenforceable portion had never been a part thereof.
8. Knowing, Free, Voluntary Execution. The parties represent that they
have carefully read and understand each of the provisions in this Agreement,
know its contents, and have freely and voluntarily signed it.
9. Advice of Counsel. Each of the parties, by the execution of this
Agreement, represents that it has reviewed each term of this Agreement with its
legal counsel, and that hereafter it shall not deny the validity of the
Agreement on the grounds that it did not have advice of counsel.
10. Integration; Interpretation. This Agreement contains or expressly
incorporates by reference the entire agreement of the parties with respect to
the matters contemplated herein and supersedes all prior negotiations. Clerical
errors, if any, in computing dollar amounts relating to the Notes shall be
corrected as soon as practicable by a written addendum to this Agreement
executed by all the parties. This Agreement shall not be modified except by
written instrument executed by all parties. Any reference in this Agreement to
the Property shall include all or any part of the Property.
11. Authorization. Borrowers expressly waive any defense to this
Agreement based on any lack of authority to enter into and be bound by the terms
of this Agreement.
12. Execution in Counterpart. This Agreement may be executed in any
number of counterparts, each of which when executed and delivered will be deemed
to be an original and all of which, taken together, will be deemed to be one and
the same instrument.
11
<PAGE> 12
IN WITNESS WHEREOF, Borrowers, Shareholders and Lender have caused this
Agreement to be duly executed as of the date first above written.
"LENDER"
GUARDS DENTAL, INC.,
a California corporation
By:_________________________________
Its:________________________________
By:_________________________________
Its:________________________________
"BORROWERS"
ASSOCIATED DENTAL SERVICES, INC.
a California corporation
By: /s/ FRANK G. PELLKOFER
---------------------------------
Frank G. Pellkofer,
President
PACIFIC COAST DENTAL, INC.
a California corporation
By: /s/ ROBERT W. STALCUP, D.D.S.
---------------------------------
Robert W. Stalcup, D.D.S.,
President
"SHAREHOLDERS"
THE PELLKOFER FAMILY TRUST
By: /s/ FRANK G. PELLKOFER
---------------------------------
Frank G. Pellkofer,
Trustee
ERIC F. PELLKOFER
By: /s/ FRANK G. PELLKOFER
---------------------------------
Frank G. Pellkofer,
Attorney-in-fact
/s/ FRANK G. PELLKOFER
---------------------------------
Frank G. Pellkofer
THE STALCUP FAMILY TRUST
By: /s/ ROBERT W. STALCUP, D.D.S.
---------------------------------
Robert W. Stalcup, D.D.S.,
Trustee
/s/ ROBERT W. STALCUP, D.D.S.
---------------------------------
Robert W. Stalcup, D.D.S.
12
<PAGE> 13
IRREVOCABLE POWER OF ATTORNEY
KNOW ALL BY THESE PRESENTS that in consideration of Guards Dental, Inc.
entering into that certain Default Forbearance Agreement dated as of February
12, 1999 by and among Guards Dental, Inc., Pacific Coast Dental, Inc.,
Associated Dental Services, Inc., The Pellkofer Family Trust, Eric F. Pellkofer,
Frank G. Pellkofer, The Stalcup Family Trust, and Robert W. Stalcup, D.D.S. (the
"Forbearance Agreement") each of the undersigned hereby irrevocably constitutes
and appoints GUARDS DENTAL, INC. as the undersigned's true and lawful
attorney-in-fact and agent, with full power of substitution, for and in the
undersigned's name, place and stead, in any and all capacities, to execute and
deliver any and all agreements, notices, certificates and other documents
arising from and/or relating to the undersigneds' purpose of allowing Guards
Dental, Inc. to control a sale of the businesses of Pacific Coast Dental, Inc.
and Associated Dental Services, Inc. (the "Businesses"), including but not
limited to, the selling of the Businesses, setting of terms, hiring of agents,
marketing the Businesses, establishing a price and any and all other items
contemplated by the Forbearance Agreement to which this Irrevocable Power of
Attorney is attached as such attorney-in-fact, in its sole discretion, deems
advisable.
Each of the undersigned hereby grants to such attorney-in-fact full
power and authority to do and perform any and every act and thing whatsoever
requisite, necessary or proper to be done in the exercise of any of the rights
and powers herein granted, as fully to all intents and purposes as the
undersigned might or could do if personally present, hereby ratifying and
confirming all that such attorney-in-fact, or his substitute or substitutes,
shall lawfully do or cause to be done by virtue of this Irrevocable Power of
Attorney and the rights and powers herein granted; provided, however, that this
Irrevocable Power of Attorney does not grant to the attorney-in-fact authority
to agree to any individual or trust representations or warranties made by The
Pellkofer Family Trust, Eric F. Pellkofer, Frank G. Pellkofer, The Stalcup
Family Trust, or Robert W. Stalcup, D.D.S. in their individual or trust
capacities.
The rights, powers and authority of said attorney-in-fact to exercise
any and all of the rights and powers herein shall commence and be in full effect
on the date hereof and shall continue thereafter and shall only terminate and be
of no further force and effect as of the date of termination of the Forbearance
Agreement.
<PAGE> 14
IN WITNESS WHEREOF, the undersigned have executed this Irrevocable
Power of Attorney as of this 12th day of February 1999.
PACIFIC COAST DENTAL, INC.
/s/ ROBERT W. STALCUP, D.D.S.
---------------------------
Robert W. Stalcup, D.D.S.,
President
ASSOCIATED DENTAL SERVICES, INC.
/s/ FRANK G. PELLKOFER
----------------------------
Frank G. Pellkofer, President
THE PELLKOFER FAMILY TRUST
/s/ FRANK G. PELLKOFER
----------------------------
Frank G. Pellkofer, Trustee
ERIC F. PELLKOFER
/s/ FRANK G. PELLKOFER
----------------------------
Frank G. Pellkofer,
Attorney-in-fact
/s/ FRANK G. PELLKOFER
----------------------------
Frank G. Pellkofer
THE STALCUP FAMILY TRUST
/s/ ROBERT W. STALCUP, D.D.S
----------------------------
Robert W. Stalcup, D.D.S.,
Trustee
/s/ ROBERT W. STALCUP, D.D.S
----------------------------
Robert W. Stalcup
2
<PAGE> 1
EXHIBIT 10.19
SILICON VALLEY BANK
AMENDMENT TO LOAN AND SECURITY
AGREEMENT AND CONSENT AGREEMENT
BORROWER: SAFEGUARD HEALTH ENTERPRISES, INC
DATE: JUNE 22, 1998
THIS AMENDMENT TO LOAN AGREEMENT is entered into between SILICON VALLEY
BANK ("Bank") and the borrower named above (the "Borrower"). The Parties agree
to amend, effective as of the date hereof, the Loan and Security Agreement
between them, dated January 29, 1998, as amended by that Amendment to Loan and
Security Agreement dated March 23, 1998, and as otherwise amended or modified
from time to time (the "Loan Agreement"), as follows. (Capitalized terms used
but not defined in this Amendment, shall have the meanings set forth in the Loan
Agreement.) Reference is also to the Interest Rate Supplement to Agreement of
even date with the Loan Agreement between Bank and Borrower (the "Supplement").
1. REVISED DEFINITION. The definition of the term "Interest Rate" as set
forth in the Supplement and as referred to in the Loan Agreement, is hereby
amended, effective as of July 1, 1998, to read as follows:
"Interest Rate" shall mean (I) if the Borrower attains a Current Ratio
of less than 1.25 to 1 with respect to the period ending June 30, 1998,
then as to: (a) Prime Rate Advances, the Interest Rate shall be equal to
the Prime Rate plus .50%; and (b) LIBOR Rate Advances, the Interest Rate
shall be equal to a rate of 2.50% per annum in excess of the LIBOR Rate
(based on the LIBOR Rate applicable for the Interest Period selected by
the Borrower) and (II) otherwise if the Borrower attains a Current Ratio
of 1.25 to 1 or greater with respect to the period ending June 30, 1998,
as to: (a) Prime Rate Advances, the Interest Rate shall be equal to a
rate equal to the Prime Rate plus .25%; and (b) LIBOR Rate Advances, the
Interest Rate shall be equal to a rate of 2.25% per annum in excess of
the LIBOR Rate (based on the LIBOR Rate applicable for the Interest
Period selected by the Borrower)."
2. REVISED SECTION 6.8. Section 6.8 of the Loan Agreement is hereby
amended to read as follows:
"6.8 Current Ratio. Borrower shall, on a consolidated basis, maintain,
as of the last day of each fiscal quarter, a ratio of Current Assets to
Current Liabilities of at least 1.00 to 1.0 for the period ending June
30, 1998. Thereafter, Borrower shall maintain, as of the last day of
each calendar quarter, a ratio of Current Assets to Current Liabilities
of at least 1.25 to 1.0."
3. CONSENT. Borrower owns real property commonly known as 505 North
Euclid Street, Anaheim, California 92801, and is entering into a sale thereof
(such Sale being the "Sale"). As such property is subject to a negative pledge
agreement, as more fully set forth in the Loan Agreement, the Borrower has
requested that the Bank consent to the Sale and waive any and all provisions in
the Loan Agreement that restrict the Sale (such provisions being the
-1-
<PAGE> 2
"Sale Restriction Provisions"). The Bank is agreeable to such request and hereby
consents to the Sale and waives the Sale Restriction Provisions, for the sole
and specific purpose of effectuating the Sale. Such waiver does not waive,
diminish or otherwise affect any other term or provision of the Loan Agreement,
all of which shall remain in full force and effect.
4. REPRESENTATIONS TRUE. Borrower represents and warrants to Bank that
all representations and warranties set forth in the Loan Agreement, as amended
hereby, are true and correct.
5. GENERAL PROVISIONS. This Amendment and Consent, the Loan Agreement,
any prior written amendments to the Loan Agreement signed by Bank and the
Borrower, and the other written documents and agreements between Bank and the
Borrower set forth in full all of the representations and agreements of the
parties with respect to the subject matter hereof and supersede all prior
discussions, representations, agreements and understandings between the parties
with respect to the subject hereof. Except as herein expressly amended, all of
the terms and provisions of the Loan Agreement, and all other documents and
agreements between Bank and the Borrower shall continue in full force and effect
and the same are hereby ratified and confirmed. This Agreement and Consent may
be executed in any number of counterparts, which when taken together shall
constitute one and the same agreement.
BORROWER: BANK:
SAFEGUARD HEALTH ENTERPRISES, INC. SILICON VALLEY BANK
BY /s/ THOMAS C. TEKULVE, CPA BY
-------------------------------- ---------------------------------
TITLE: Vice President, TITLE
Chief Financial Officer ------------------------------
BY /s/ STEVEN J. BAILEYS, DDS
--------------------------------
TITLE: Chairman and CEO
APPROVED AS TO FORM AND CONTENT
BY /s/ RONALD I. BRENDZEL, JD
--------------------------------
TITLE: Senior Vice President
and Secretary
-2-
<PAGE> 3
- --------------------------------------------------------------------------------
SILICON VALLEY BANK
AMENDMENT TO LOAN AND SECURITY
AGREEMENT AND CONSENT AGREEMENT
BORROWER: SAFEGUARD HEALTH ENTERPRISES, INC.
DATE: NOVEMBER 19, 1998
THIS AMENDMENT TO LOAN AGREEMENT is entered into between SILICON VALLEY
BANK ("Bank") and the borrower named above (the "Borrower"). The Parties agree
to amend, effective as of the date hereof, the Loan and Security Agreement
between them, dated January 29, 1998, as amended by that Amendment to Loan and
Security Agreement dated March 23, 1998, that Amendment to Loan and Security
Agreement dated June 22, 1998, and as otherwise amended or modified from time to
time (the "Loan Agreement"), as follows. (Capitalized terms used but not defined
in this Amendment, shall have the meanings set forth in the Loan Agreement.)
Reference is also made to the Interest Rate Supplement to Agreement of even date
with the Loan Agreement between Bank and Borrower (the "Supplement").
1. REVISED DEFINITION. The definition of the term "Interest Rate" as set
forth in the Supplement and as referred to in the Loan Agreement, is hereby
amended to read as follows:
""Interest Rate" shall mean the Prime Rate plus 1.5%."
2. REVISED SECTION 6.3. Section 6.3 of the Loan Agreement is hereby
amended to read as follows:
"6.3 Financial Statements, Reports, Certificates. Borrower shall deliver to
Bank: (a) within five (5) days of filing, copies of all statements, reports
and notices sent or made available generally by Borrower to its security
holders or to any holders of Subordinated Debt and all reports on Form
10-K, 10-Q and 8-K filed with the Securities and Exchange Commission
(collectively, the "SEC Reports"); (b) on or before the last day of each
month, the consolidated balance sheet and income statement for the
immediately preceding month; (c) promptly upon receipt of notice thereof, a
report of any legal actions pending or threatened against Borrower or any
Subsidiary that could result in damages or costs to Borrower or any
Subsidiary of One Hundred Thousand Dollars ($100,000) or
<PAGE> 4
more; and (d) such budgets, sales projections, operating plans or other
financial information as Bank may reasonably request from time to time.
On or before the last day of each month, for the immediately preceding
month, Borrower shall deliver to Bank a Compliance Certificate signed by a
Responsible Officer in substantially the form of Exhibit D to the Loan
Agreement.
Bank shall have a right from time to time hereafter to audit Borrower's
Accounts at Borrower's expense, provided that such audits will be conducted
no more often than every six (6) months unless an Event of Default has
occurred and is continuing."
3. AMENDMENT FEE. In consideration of Bank's execution of this Amendment
and that certain Waiver of Default dated November 19, 1998, Borrower shall pay
to Bank an amendment fee in the amount of $20,000.00 on or before November 19,
1998.
4. INFORMATION REQUEST. Borrower shall provide to Bank the information
and documents set forth on Exhibit A hereto on or before November 23, 1998.
5. REPRESENTATIONS TRUE. Borrower represents and warrants to Bank that
all representations and warranties set forth in the Loan Agreement, as amended
hereby, are true and correct.
6. GENERAL PROVISIONS. This Amendment, the Loan Agreement, any prior
written amendments to the Loan Agreement signed by Bank and the Borrower, and
the other written documents and agreements between Bank and the Borrower set
forth in full all of the representations and agreements of the parties with
respect to the subject matter hereof and supersede all prior discussions,
representations, agreements and understandings between the parties with respect
to the subject hereof. Except as herein expressly amended, all of the terms and
provisions of the Loan Agreement, and all other documents and agreements
between Bank and the Borrower shall continue in full force and effect and the
same are hereby ratified and confirmed. This Agreement and Consent may be
executed in any number of counterparts, which when taken together shall
constitute one and the same agreement.
BORROWER: BANK:
SAFEGUARD HEALTH ENTERPRISES, INC. SILICON VALLEY BANK
BY /s/ STEVEN J. BAILEYS, DDS BY /s/ KITTRIDGE CHAMBERLIN
------------------------------------ -----------------------------
TITLE: Chairman & Chief Executive Officer TITLE SVP
---------------------------------- ---------------------------
BY /s/ THOMAS C. TEKULVE, CPA
------------------------------------
TITLE: Vice Pres, Chief Financial Officer
----------------------------------
-2-
<PAGE> 5
[LOGO] SILICON VALLEY BANK
LOAN AND SECURITY AGREEMENT
by and between
SILICON VALLEY BANK
as Lender
and
SAFEGUARD HEALTH ENTERPRISES, INC.
as Borrower
Dated: January 29, 1998
<PAGE> 6
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C> <C>
1. DEFINITIONS AND CONSTRUCTION.................................................. 1
1.1 Definitions........................................................ 1
1.2 Accounting and Other Terms......................................... 6
2. LOAN AND TERMS OF PAYMENT..................................................... 6
2.1 Credit Extensions.................................................. 6
2.2 Overadvances....................................................... 7
2.3 Interest Rates, Payments, and Calculations......................... 7
2.4 Crediting Payments................................................. 8
2.5 Fees............................................................... 8
2.6 Additional Costs................................................... 8
2.7 Term............................................................... 9
3. CONDITIONS OF LOANS........................................................... 9
3.1 Conditions Precedent to Initial Credit Extension................... 9
3.2 Conditions Precedent to all Credit Extensions...................... 9
4. CREATION OF SECURITY INTEREST................................................. 10
4.1 Grant of Security Interest......................................... 10
4.2 Delivery of Additional Documentation Required...................... 10
4.3 Right to Inspect................................................... 10
5. REPRESENTATIONS AND WARRANTIES................................................ 10
5.1 Due Organization and Qualification................................. 10
5.2 Due Authorization.................................................. 10
5.3 No Prior Encumbrances.............................................. 11
5.4 [Reserved]......................................................... 11
5.5 Merchantable Inventory............................................. 11
5.6 [Reserved]......................................................... 11
5.7 Name............................................................... 11
5.8 Litigation......................................................... 11
5.9 No Material Adverse Change in Financial Statements................. 11
5.10 Solvency........................................................... 11
5.11 Regulatory Compliance.............................................. 11
5.12 Environmental Condition............................................ 11
5.13 Taxes.............................................................. 12
5.14 Subsidiaries....................................................... 12
5.15 Government Consents................................................ 12
5.16 Full Disclosure.................................................... 12
6. AFFIRMATIVE COVENANTS......................................................... 12
6.1 Good Standing...................................................... 12
6.2 Government Compliance.............................................. 12
6.3 Financial Statements, Reports, Certificates........................ 12
6.4 Inventory.......................................................... 13
6.5 Taxes.............................................................. 13
6.6 Insurance.......................................................... 13
6.7 Principal Depository............................................... 13
6.8 Current Ratio...................................................... 14
6.9 Debt-Net Worth Ratio............................................... 14
6.10 Stated Net Worth................................................... 14
6.11 EBITA/Interest Expense Ratio....................................... 14
6.12 Clean Up Period.................................................... 14
6.13 Further Assurances................................................. 14
7. NEGATIVE COVENANTS............................................................ 14
</TABLE>
-i-
<PAGE> 7
TABLE OF CONTENTS (CONTD)
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C> <C>
7.1 Dispositions....................................................... 14
7.2 Changes in Business, Ownership, or Management,
Business Locations................................................. 14
7.3 Mergers or Acquisitions............................................ 14
7.4 Indebtedness....................................................... 15
7.5 Encumbrances....................................................... 15
7.6 Distributions...................................................... 15
7.7 Investments........................................................ 15
7.8 Transactions with Affiliates....................................... 15
7.9 [Reserved]......................................................... 15
7.10 Subordinated Debt.................................................. 15
7.11 Inventory.......................................................... 15
7.12 Compliance......................................................... 15
8. EVENTS OF DEFAULT............................................................. 16
8.1 Payment Default ................................................... 16
8.2 Covenant Default................................................... 16
8.3 Material Adverse Change............................................ 16
8.4 Attachment ........................................................ 16
8.5 Insolvency......................................................... 16
8.6 Other Agreements................................................... 16
8.7 Subordinated Debt.................................................. 17
8.8 Judgments.......................................................... 17
8.9 Misrepresentations................................................. 17
8.10 Guaranty........................................................... 17
9. BANK'S RIGHTS AND REMEDIES.................................................... 17
9.1 Rights and Remedies................................................ 17
9.2 Power of Attorney.................................................. 18
9.3 Accounts Collection................................................ 18
9.4 Bank Expenses...................................................... 19
9.5 Bank's Liability for Collateral.................................... 19
9.6 Remedies Cumulative................................................ 19
9.7 Demand............................................................. 19
10. NOTICES ................................................................... 19
11. CHOICE OF LAW AND VENUE....................................................... 20
12. GENERAL PROVISIONS............................................................ 20
12.1 Successors and Assigns............................................. 20
12.2 Indemnification.................................................... 20
12.3 Time of Essence.................................................... 20
12.4 Severability of Provisions......................................... 20
12.5 Amendments in Writing, Integration................................. 20
12.6 Counterparts....................................................... 21
12.7 Survival........................................................... 21
</TABLE>
-ii-
<PAGE> 8
LOAN AND SECURITY AGREEMENT
This LOAN AND SECURITY AGREEMENT is entered into as of January 29, 1998 by and
between SILICON VALLEY BANK ("Bank") and SAFEGUARD HEALTH ENTERPRISES, INC., a
Delaware corporation ("Borrower").
RECITALS
Borrower wishes to obtain credit from time to time from Bank, and Bank desires
to extend credit to Borrower. This Agreement sets forth the terms on which Bank
will advance credit to Borrower, and Borrower will repay the amounts owing to
Bank.
AGREEMENT
The parties agree as follows:
1. DEFINITIONS AND CONSTRUCTION
1.1 Definitions. As used in this Agreement, the following terms shall
have the following definitions:
"Accounts" means all presently existing and hereafter arising
accounts, contract rights, and all other forms of obligations owing to Borrower
arising out of the sale or lease of goods (including, without limitation, the
licensing of software and other technology) or the rendering of services by
Borrower, whether or not earned by performance, and any and all credit
insurance, guaranties, and other security therefor, as well as all merchandise
returned to or reclaimed by Borrower and Borrower's Books relating to any of the
foregoing.
"Advance" or "Advances" means a loan advance under the Committed
Revolving Line.
"Affiliate" means, with respect to any Person, any Person that
owns or controls directly or indirectly such Person, any Person that controls or
is controlled by or is under common control with such Person, and each of such
Person's senior executive officers, directors, partners and, for any Person that
is a limited liability company, such Persons, managers and members.
"Bank Expenses" means all reasonable costs or expenses (including
reasonable attorneys' fees and expenses) incurred in connection with the
preparation, negotiation, administration, and enforcement of the Loan Documents;
and Bank's reasonable attorneys' fees and expenses incurred in amending,
enforcing or defending the Loan Documents, (including fees and expenses of
appeal or review, or those incurred in any Insolvency Proceeding) whether or not
suit is brought.
"Borrower's Books" means all of Borrower's books and records
including, without limitation: ledgers; records concerning Borrower's assets or
liabilities, the Collateral, business operations or financial condition; and all
computer programs, or tape files, and the equipment, containing such
information.
"Business Day" means any day that is not a Saturday, Sunday, or
other day on which banks in the State of California are authorized or required
to close, provided that with respect to all transactions involving LIBOR Rate
Advances (as defined in the Supplement), "Business Day" shall have the meaning
set forth in the Supplement.
"Closing Date" means the date of this Agreement.
-1-
<PAGE> 9
"Code" means the California Uniform Commercial Code.
"Collateral" means the property described on Exhibit A attached
hereto.
"Committed Revolving Line" means a credit extension of up to
$8,000,000.
"Consolidated EBITA" means for any period the amount of which is
to be determined, Consolidated Net Income for such period plus (but only to the
extent such amounts were deducted in the computation of Consolidated Net Income)
(i) Consolidated Interest Expense, (ii) income tax expense (including deferred
income tax expense) and (iii) amortization expense of the Consolidated Group for
such period, determined on a consolidated basis in accordance with GAAP,
consistently applied.
"Consolidated Group" means the Borrower and each of its
Subsidiaries and if the context so requires, the Borrower and its Subsidiaries,
taken as a whole.
"Consolidated Interest Expense" means for any period the amount
of which is to be determined, the aggregate interest charges of the Consolidated
Group (including without limitation that portion of any obligation under
capitalized leases allocable to interest expense) on any Obligations for such
period (without regard to any limitation on the payment thereof) as determined
in accordance with GAAP, consistently applied.
"Consolidated Net Income" means for any period the amount of
which is to be determined, the net income of the Consolidated Group determined
on a consolidated basis in accordance with GAAP, consistently applied.
"Contingent Obligation" means, as applied to any Person, any
direct or indirect liability, contingent or otherwise, of that Person with
respect to (i) any indebtedness, lease, dividend, letter of credit or other
obligation of another, including, without limitation, any such obligation
directly or indirectly guaranteed, endorsed, co-made or discounted or sold with
recourse by that Person, or in respect of which that Person is otherwise
directly or indirectly liable; (ii) any obligations with respect to undrawn
letters of credit issued for the account of that Person; and (iii) all
obligations arising under any interest rate, currency or commodity swap
agreement, interest rate cap agreement, interest rate collar agreement, or other
agreement or arrangement designated to protect a Person against fluctuation in
interest rates, currency exchange rates or commodity prices; provided, however,
that the term "Contingent Obligation" shall not include endorsements for
collection or deposit in the ordinary course of business. The amount of any
Contingent Obligation shall be deemed to be an amount equal to the stated or
determined amount of the primary obligation in respect of which such Contingent
Obligation is made or, if not stated or determinable, the maximum reasonably
anticipated liability in respect thereof as determined by such Person in good
faith; provided, however, that such amount shall not in any event exceed the
maximum amount of the obligations under the guarantee or other support
arrangement.
"Credit Extension" means each Advance, Letter of Credit or any
other extension of credit by Bank for the benefit of Borrower hereunder.
"Current Assets" means, as of any applicable date, all amounts
that should, in accordance with GAAP, be included as current assets on the
consolidated balance sheet of Borrower and its Subsidiaries as at such date.
"Current Liabilities" means, as of any applicable date, all
amounts that should, in accordance with GAAP, be included as current liabilities
on the consolidated balance sheet of Borrower and its Subsidiaries, as at such
date, plus, to the extent not already included therein, all outstanding Credit
Extensions made under this Agreement, including all Indebtedness that is
-2-
<PAGE> 10
payable upon demand or within one year from the date of determination thereof
unless such Indebtedness is renewable or extendable at the option of Borrower or
any Subsidiary to a date more than one year from the date of determination, but
excluding Subordinated Debt.
"Equipment" means all present and future machinery, equipment,
tenant improvements, furniture, fixtures, vehicles, tools, parts and attachments
in which Borrower has any interest.
"ERISA" means the Employment Retirement Income Security Act of
1974, as amended, and the regulations thereunder.
"GAAP" means generally accepted accounting principles as in
effect in the United States from time to time.
"Indebtedness" means (a) all indebtedness for borrowed money or
the deferred purchase price of property or services, including without
limitation reimbursement and other obligations with respect to surety bonds and
letters of credit, (b) all obligations evidenced by notes, bonds, debentures or
similar instruments, (c) all capital lease obligations and (d) all Contingent
Obligations.
"Insolvency Proceeding" means any proceeding commenced by or
against any person or entity under any provision of the United States Bankruptcy
Code, as amended, or under any other bankruptcy or insolvency law, including
assignments for the benefit of creditors, formal or informal moratoria,
compositions, extension generally with its creditors, or proceedings seeking
reorganization, arrangement, or other relief.
"Interest Rate" shall have the meaning set forth in the
Supplement.
"Inventory" means all present and future inventory in which
Borrower has any interest, including merchandise, raw materials, parts,
supplies, packing and shipping materials, work in process and finished products
intended for sale or lease or to be furnished under a contract of service, of
every kind and description now or at any time hereafter owned by or in the
custody or possession, actual or constructive, of Borrower, including such
inventory as is temporarily out of its custody or possession or in transit and
including any returns upon any accounts or other proceeds, including insurance
proceeds, resulting from the sale or disposition of any of the foregoing and any
documents of title representing any of the above.
"Investment" means any beneficial ownership of (including stock,
partnership interest or other securities) any Person, or any loan, advance or
capital contribution to any Person.
"IRC" means the Internal Revenue Code of 1986, as amended, and
the regulations thereunder.
"Letter of Credit" means a letter of credit or similar
undertaking issued by Bank pursuant to Section 2.1.2.
"Letter of Credit Reserve" has the meaning set forth in Section
2.1.2.
"Lien" means any mortgage, lien, deed of trust, charge, pledge,
security interest or other encumbrance.
"Loan Documents" means, collectively, this Agreement, any note or
notes executed by Borrower, and any other present or future agreement entered
into between Borrower and/or for
-3-
<PAGE> 11
the benefit of Bank in connection with this Agreement, all as amended, extended
or restated from time to time.
Material Adverse Effect" means a material adverse effect on (i)
the business operations or condition (financial or otherwise) of Borrower and
its Subsidiaries taken as a whole or (ii) the ability of Borrower to repay the
Obligations or otherwise perform its obligations under the Loan Documents.
"Maturity Date" means the Revolving Maturity Date.
"Negotiable Collateral" means all of Borrower's present and
future letters of credit of which it is a beneficiary, notes, drafts,
instruments, securities, documents of title, and chattel paper.
"Obligations" means all debt, principal, interest, Bank Expenses
and other amounts owed to Bank by Borrower pursuant to this Agreement or any
other agreement, whether absolute or contingent, due or to become due, now
existing or hereafter arising, including any interest that accrues after the
commencement of an Insolvency Proceeding and including any debt, liability, or
obligation owing from Borrower to others that Bank may have obtained by
assignment or otherwise.
"Payment Date" means the first calendar day of each month
commencing on the first such date after the Closing Date and ending on the
Revolving Maturity Date.
"Permitted Indebtedness" means:
(a) Indebtedness of Borrower in favor of Bank arising
under this Agreement or any other Loan Document;
(b) Indebtedness existing on the Closing Date and
disclosed in the Schedule;
(c) Subordinated Debt;
(d) Indebtedness to trade creditors incurred in the
ordinary course of business; and
(e) Indebtedness secured by Permitted Liens.
"Permitted Investment" means:
(a) Investments existing on the Closing Date disclosed
in the Schedule;
(b) (i) marketable direct obligations issued or
unconditionally guaranteed by the United States of America or any agency
or any State thereof maturing within one (1) year from the date of
acquisition thereof, (ii) commercial paper maturing no more than one (1)
year from the date of creation thereof and currently having the highest
rating obtainable from either Standard & Poor's Corporation or Moody's
Investors Service, Inc., and (iii) certificates of deposit maturing no
more than one (1) year from the date of investment therein issued by
Bank; and
(c) those Investments set forth on Exhibit C attached
hereto.
"Permitted Liens" means the following:
-4-
<PAGE> 12
(a) Any Liens existing on the Closing Date and disclosed
in the Schedule or arising under this Agreement or the other Loan
Documents;
(b) Liens for taxes, fees, assessments or other
governmental charges or levies, either not delinquent or being contested
in good faith by appropriate proceedings and as to which adequate
reserves are maintained on Borrower's Books in accordance with GAAP,
provided the same have no priority over any of Bank's security
interests;
(c) Liens (i) upon or in any Equipment acquired or held by
Borrower or any of its Subsidiaries to secure the purchase price of such
Equipment or indebtedness incurred solely for the purpose of financing
the acquisition of such Equipment, or existing on such equipment at the
time of its acquisition, provided that the Lien is confined solely to
the property so acquired and improvements thereon, and the proceeds of
such equipment; and
(d) Liens incurred in connection with the extension,
renewal or refinancing of the indebtedness secured by Liens of the type
described in clauses (a) through (c) above, provided that any extension,
renewal or replacement Lien shall be limited to the property encumbered
by the existing Lien and the principal amount of the indebtedness being
extended, renewed or refinanced does not increase.
"Person" means any individual, sole proprietorship, partnership,
limited liability company, joint venture, trust, unincorporated organization,
association, corporation, institution, public benefit corporation, firm, joint
stock company, estate, entity or governmental agency.
"Prime Rate" means the variable rate of interest, per annum, most
recently announced by Bank, as its "prime rate," whether or not such announced
rate is the lowest rate available from Bank.
"Responsible Officer" means each of the Chief Executive Officer,
the President and the Chief Financial Officer.
"Revolving Maturity Date" means one day prior to the first
anniversary of the date of this Agreement.
"Schedule" means the schedule of exceptions attached hereto, if
any.
"SEC Reports" shall have the meaning set forth in Section 6.3(a)
hereof.
"Stated Net Worth" means as of any applicable date, the stated
net worth of the Borrower determined in accordance with GAAP, consistently
applied.
"Subordinated Debt" means any debt incurred by Borrower that is
subordinated to the debt owing by Borrower to Bank on terms acceptable to Bank
(and identified as being such by Borrower and Bank).
"Subsidiary" means with respect to any Person, corporation,
partnership, company association, joint venture, or any other business entity of
which more than fifty percent (50%) of the voting stock or other equity
interests is owned or controlled, directly or indirectly, by such Person or one
or more Affiliates of such Person.
"Supplement" shall mean the Interest Rate Supplement to Agreement
of even date herewith between Bank and Borrower attached hereto and forming a
part of this Agreement.
-5-
<PAGE> 13
"Total Liabilities" means as of any applicable date, any date as
of which the amount thereof shall be determined, all obligations that should, in
accordance with GAAP be classified as liabilities on the consolidated balance
sheet of Borrower, including in any event all Indebtedness, but specifically
excluding Subordinated Debt.
1.2 Accounting and Other Terms. All accounting terms not specifically
defined herein shall be construed in accordance with GAAP and all calculations
and determinations made hereunder shall be made in accordance with GAAP. When
used herein, the term "financial statements" shall include the notes and
schedules thereto. The terms "including"/ "includes" shall always be read as
meaning "including (or includes) without limitation", when used herein or in any
other Loan Document.
2. LOAN AND TERMS OF PAYMENT
2.1 Credit Extensions. Borrower promises to pay to the order of Bank, in
lawful money of the United States of America, the aggregate unpaid principal
amount of all Credit Extensions made by Bank to Borrower hereunder. Borrower
shall also pay interest on the unpaid principal amount of all Credit Extensions
at rates in accordance with the terms hereof.
2.1.1 Advances.
(a) Subject to and upon the terms and conditions of this
Agreement, Bank agrees to make Advances to Borrower in an aggregate
outstanding amount not to exceed (i) the Committed Revolving Line minus
(ii) the face amount of all outstanding Letters of Credit (including
drawn but unreimbursed Letters of Credit). Subject to the terms and
conditions of this Agreement, amounts borrowed pursuant to this Section
2.1 may be repaid and reborrowed at any time during the term of this
Agreement.
(b) Whenever Borrower desires an Advance, Borrower will
notify Bank by facsimile transmission or telephone no later than 3:00
p.m. Pacific time, on the Business Day that the Advance is to be made,
provided that a LIBOR Rate Advances (as defined in the Supplement) shall
be subject to the Advance request provisions set forth in the
Supplement. Each such notification shall be promptly confirmed by a
Payment/Advance Form in substantially the form of Exhibit B hereto. Bank
is authorized to make Advances under this Agreement, based upon
instructions received from a Responsible Officer, or without
instructions if in Bank's discretion such Advances are necessary to meet
Obligations which have become due and remain unpaid. Bank shall be
entitled to rely on any telephonic notice given by a person who Bank
reasonably believes to be a Responsible Officer or a designee thereof,
and Borrower shall indemnify and hold Bank harmless for any damages or
loss suffered by Bank as a result of such reliance. Bank will credit the
amount of Advances made under this Section 2.1 to Borrower's deposit
account.
(c) The Committed Revolving Line shall terminate on the
Revolving Maturity Date, at which time all Advances under this Section
2.1 and other amounts due under this Agreement (except as otherwise
expressly specified herein) shall be immediately due and payable.
2.1.2 Letters of Credit.
(a) Subject to the terms and conditions of this Agreement,
Bank agrees to issue or cause to be issued Letters of Credit for the
account of Borrower in an aggregate
-6-
<PAGE> 14
outstanding face amount not to exceed (i) the Committed Revolving Line
minus (ii) the then outstanding principal balance of the Advances;
provided that the face amount of outstanding Letters of Credit
(including drawn but unreimbursed Letters of Credit and any Letter of
Credit Reserve) shall not in any case exceed $1,000,000. Each Letter of
Credit shall have an expiry date no later than the Revolving Maturity
Date. All Letters of Credit shall be, in form and substance, acceptable
to Bank in its sole discretion and shall be subject to the terms and
conditions of Bank's form of standard Application and Letter of Credit
Agreement.
(b) The obligation of Borrower to immediately reimburse
Bank for drawings made under Letters of Credit shall be absolute,
unconditional and irrevocable, and shall be performed strictly in
accordance with the terms of this Agreement and such Letters of Credit,
under all circumstances whatsoever. Borrower shall indemnify, defend,
protect, and hold Bank harmless from any loss, cost, expense or
liability, including,. without limitation, reasonable attorneys' fees,
arising out of or in connection with any Letters of Credit.
(c) Borrower may request that Bank issue a Letter of
Credit payable in a currency other than United States Dollars. If a
demand for payment is made under any such Letter of Credit, Bank shall
treat such demand as an Advance to Borrower of the equivalent of the
amount thereof (plus cable charges) in United States currency at the
then prevailing rate of exchange in San Francisco, California, for
sales of that other currency for cable transfer to the country of which
it is the currency.
(d) Upon the issuance of any letter of credit payable in
a currency other than United States Dollars, Bank shall create a
reserve under the Committed Revolving Line for letters of credit
against fluctuations in currency exchange rates, in an amount equal to
ten percent (10%) of the face amount of such letter of credit. The
amount of such reserve may be amended by Bank from time to time to
account for fluctuations in the exchange rate. The availability of
funds under the Committed Revolving Line shall be reduced by the amount
of such reserve for so long as such letter of credit remains
outstanding.
2.2 Overadvances. If, at any time or for any reason, the amount of
Obligations owed by Borrower to Bank pursuant to Section 2.1.1 or 2.1.2 of this
Agreement is greater than the Committed Revolving Line, Borrower shall
immediately pay to Bank, in cash, the amount of such excess.
2.3 Interest Rates, Payments, and Calculations.
(a) Interest Rate. Except as set forth in Section 2.3(b), any
Advances shall bear interest, on the average daily balance thereof, at a per
annum rate equal to the applicable Interest Rate.
(b) Default Rate. All Obligations shall bear interest, from and
after the occurrence of an Event of Default, at a rate equal to five (5)
percentage points above the interest rate applicable immediately prior to the
occurrence of the Event of Default, provided that LIBOR Rate Advances (as
defined in the Supplement) shall first be subject to conversion to Prime Rate
Advances (as defined in the Supplement) as more fully set forth in the
Supplement.
(c) Payments. Interest hereunder shall be due and payable on each
Payment Date. Borrower hereby authorizes Bank to debit any accounts with Bank,
including, without limitation, Account Number ____________________ for payments
of principal and interest due on the Obligations and any other amounts owing by
Borrower to Bank. Bank will notify
-7-
<PAGE> 15
Borrower of all debits which Bank has made against Borrower's accounts within
the next customary bank statement reporting period. Any such debits against
Borrower's accounts in no way shall be deemed a set-off. Any interest not paid
when due shall be compounded by becoming a part of the Obligations, and such
interest shall thereafter accrue interest at the rate then applicable hereunder.
(d) Computation. In the event the Prime Rate is changed from time
to time hereafter, the applicable rate of interest with respect to Prime Rate
Advances (as defined in the Supplement) shall be increased or decreased
effective as of 12:01 a.m. on the day the Prime Rate is changed, by an amount
equal to such change in the Prime Rate. All interest chargeable under the Loan
Documents shall be computed on the basis of a three hundred sixty (360) day year
for the actual number of days elapsed.
2.4 Crediting Payments. Prior to the occurrence of an Event of Default,
Bank shall credit a wire transfer of funds, check or other item of payment to
such deposit account or Obligation as Borrower specifies. After the occurrence
of an Event of Default, the receipt by Bank of any wire transfer of funds,
check, or other item of payment, whether directed to Borrower's deposit account
with Bank or to the Obligations or otherwise, shall be immediately applied to
conditionally reduce Obligations, but shall not be considered a payment in
respect of the Obligations unless such payment is of immediately available
federal funds or unless and until such check or other item of payment is honored
when presented for payment. Notwithstanding anything to the contrary contained
herein, any wire transfer or payment received by Bank after 12:00 noon Pacific
time shall be deemed to have been received by Bank as of the opening of business
on the immediately following Business Day. Whenever any payment to Bank under
the Loan Documents would otherwise be due (except by reason of acceleration) on
a date that is not a Business Day, such payment shall instead be due on the next
Business Day, and additional fees or interest, as the case may be, shall accrue
and be payable for the period of such extension.
2.5 Fees. Borrower shall pay to Bank the following:
(a) Facility Fee. A Facility Fee equal to $40,000, which fee
shall be due on the Closing Date and shall be fully earned and non-refundable;
(b) Financial Examination and Appraisal Fees. Bank's customary
fees and reasonable out-of-pocket expenses for Bank's audits and appraisals of
Collateral and financial analysis and examination of Borrower performed from
time to time by Bank or its agents; and
(c) Bank Expenses. Upon demand from Bank, including, without
limitation, upon the date hereof, all reasonable Bank Expenses incurred through
the date hereof, including reasonable attorneys' fees and expenses, and, after
the date hereof, all reasonable Bank Expenses, including reasonable attorneys'
fees and expenses, as and when they become due.
2.6 Additional Costs. In case any law, regulation, treaty or official
directive or the interpretation or application thereof by any court or any
governmental authority charged with the administration thereof or the compliance
with any guideline or request of any central bank or other governmental
authority (whether or not having the force of law):
(a) subjects Bank to any tax with respect to payments of
principal or interest or any other amounts payable hereunder by Borrower or
otherwise with respect to the transactions contemplated hereby (except for taxes
on the overall net income of Bank imposed by the United States of America or any
political subdivision thereof);
-8-
<PAGE> 16
(b) imposes, modifies or deems applicable any deposit insurance,
reserve, special deposit or similar requirement against assets held by, or
deposits in or for the account of, or loans by, Bank; or
(c) imposes upon Bank any other condition with respect to its
performance under this Agreement,
and the result of any of the foregoing is to increase the cost to Bank, reduce
the income receivable by Bank or impose any expense upon Bank with respect to
any loans, Bank shall notify Borrower thereof. Borrower agrees to pay to Bank
the amount of such increase in cost, reduction in income or additional expense
as and when such cost, reduction or expense is incurred or determined, upon
presentation by Bank of a statement of the amount and setting forth Bank's
calculation thereof, all in reasonable detail, which statement shall be deemed
true and correct absent manifest error.
2.7 Term. Except as otherwise set forth herein, this Agreement shall
become effective on the Closing Date and, subject to Section 12.7, shall
continue in full force and effect for a term ending on the Maturity Date.
Notwithstanding the foregoing, Bank shall have the right to terminate its
obligation to make Credit Extensions under this Agreement immediately and
without notice upon the occurrence and during the continuance of an Event of
Default. Notwithstanding termination of this Agreement, Bank's lien on the
Collateral shall remain in effect for so long as any Obligations are
outstanding.
3. CONDITIONS OF LOANS
3.1 Conditions Precedent to Initial Credit Extension. The obligation of
Bank to make the initial Credit Extension is subject to the condition precedent
that Bank shall have received, in form and substance satisfactory to Bank, the
following:
(a) this Agreement;
(b) a certificate of the Secretary of Borrower with respect to
its certificate of incorporation, bylaws, incumbency and resolutions authorizing
the execution and delivery of this Agreement;
(c) financing statements (Forms UCC-1);
(d) insurance certificate;
(e) payment of the fees and Bank Expenses then due specified in
Section 2.5 hereof;
(f) Certificate of Foreign Qualification (if applicable);
(g) review and approval by the Bank of the Note Purchase
Agreement dated as of September 30, 1997 regarding the issuance of certain
senior notes by the Borrower and all exhibits and all other documents relating
thereto; and
(h) such other documents, and completion of such other matters,
as Bank may reasonably deem necessary or appropriate.
3.2 Conditions Precedent to all Credit Extensions. The obligation of
Bank to make each Credit Extension, including the initial Credit Extension, is
further subject to the following conditions:
-9-
<PAGE> 17
(a) timely receipt by Bank of the Payment/Advance Form as
provided in Section 2.1; and
(b) the representations and warranties contained in Section 5
shall be true and correct in all material respects on and as of the date of such
Payment/Advance Form and on the effective date of each Credit Extension as
though made at and as of each such date, and no Event of Default shall have
occurred and be continuing, or would result from such Credit Extension. The
making of each Credit Extension shall be deemed to be a representation and
warranty by Borrower on the date of such Credit Extension as to the accuracy of
the facts referred to in this Section 3.2(b).
4. CREATION OF SECURITY INTEREST
4.1 Grant of Security Interest. Borrower grants and pledges to Bank a
continuing security interest in all presently existing and hereafter acquired or
arising Collateral in order to secure prompt payment of any and all Obligations
and in order to secure prompt performance by Borrower of each of its covenants
and duties under the Loan Documents. Except as set forth in the Schedule, such
security interest constitutes a valid, first priority security interest in the
presently existing Collateral, and will constitute a valid, first priority
security interest in Collateral acquired after the date hereof. Borrower
acknowledges that Bank may place a "hold" on any Deposit Account pledged as
Collateral to secure the Obligations. Notwithstanding termination of this
Agreement, Bank's Lien on the Collateral shall remain in effect for so long as
any Obligations are outstanding.
4.2 Delivery of Additional Documentation Required. Borrower shall from
time to time execute and deliver to Bank, at the request of Bank, all Negotiable
Collateral, all financing statements and other documents that Bank may
reasonably request, in form satisfactory to Bank, to perfect and continue
perfected Bank's security interests in the Collateral and in order to fully
consummate all of the transactions contemplated under the Loan Documents.
4.3 Right to Inspect. Bank (through any of its officers, employees, or
agents) shall have the right, upon reasonable prior notice, from time to time
during Borrower's usual business hours, to inspect Borrower's Books and to make
copies thereof and to check, test, and appraise the Collateral in order to
verify Borrower's financial condition or the amount, condition of, or any other
matter relating to, the Collateral.
5. REPRESENTATIONS AND WARRANTIES
Borrower represents and warrants as follows:
5.1 Due Organization and Qualification. Borrower and each Subsidiary is a
corporation duly existing and in good standing under the laws of its state of
incorporation and qualified and licensed to do business in, and is in good
standing in, any state in which the conduct of its business or its ownership of
property requires that it be so qualified.
5.2 Due Authorization; No Conflict. The execution, delivery, and
performance of the Loan Documents are within Borrower's powers, have been duly
authorized, and are not in conflict with nor constitute a breach of any
provision contained in Borrower's Articles/Certificate of Incorporation or
Bylaws, nor will they constitute an event of default under any material
agreement to which Borrower is a party or by which Borrower is bound. Borrower
is not in default under any agreement to which it is a party or by which it is
bound, which default could have a Material Adverse Effect.
-l0-
<PAGE> 18
5.3 No Prior Encumbrances. Borrower has good and indefeasible title to
the Collateral, free and clear of Liens, except for Permitted Liens.
5.4 [Reserved]
5.5 Merchantable Inventory. All Inventory is in all material respects of
good and marketable quality, free from all material defects.
5.6 [Reserved]
5.7 Name; Location of Chief Executive Office. Except as disclosed in the
Schedule, Borrower has not done business and will not without at least thirty
(30) days prior written notice to Bank do business under any name other than
that specified on the signature page hereof. The chief executive office of
Borrower is located at the address indicated in Section 10 hereof.
5.8 Litigation. Except as set forth in the Schedule, there are no
actions or proceedings pending, or, to Borrower's knowledge, threatened by or
against Borrower or any Subsidiary before any court or administrative agency in
which an adverse decision could have a Material Adverse Effect or a material
adverse effect on Borrower's interest or Bank's security interest in the
Collateral.
5.9 No Material Adverse Change in Financial Statements. All consolidated
financial statements related to Borrower and any Subsidiary that have been
delivered by Borrower to Bank fairly present in all material respects Borrower's
consolidated financial condition as of the date thereof and Borrower's
consolidated results of operations for the period then ended. There has not been
a material adverse change in the consolidated financial condition of Borrower
since the date of the most recent of such financial statements submitted to Bank
on or about the Closing Date.
5.10 Solvency. The fair saleable value of Borrower's assets (including
goodwill minus disposition costs) exceeds the fair value of its liabilities; the
Borrower is not left with unreasonably small capital after the transactions
contemplated by this Agreement; and Borrower is able to pay its debts (including
trade debts) as they mature.
5.11 Regulatory Compliance. Borrower and each Subsidiary has met the
minimum funding requirements of ERISA with respect to any employee benefit plans
subject to ERISA. No event has occurred resulting from Borrower's failure to
comply with ERISA that is reasonably likely to result in Borrower's incurring
any liability that could have a Material Adverse Effect. Borrower is not an
"investment company" or a company "controlled" by an "investment company" within
the meaning of the Investment Company Act of 1940. Borrower is not engaged
principally, or as one of its important activities, in the business of extending
credit for the purpose of purchasing or carrying margin stock (within the
meaning of Regulations G, T and U of the Board of Governors of the Federal
Reserve System). Borrower has complied with all the provisions of the Federal
Fair Labor Standards Act. Borrower has not violated any statutes, laws,
ordinances or rules applicable to it, violation of which could have a Material
Adverse Effect.
5.12 Environmental Condition. None of Borrower's or any Subsidiary's
properties or assets has ever been used by Borrower or any Subsidiary or, to the
best of Borrower's knowledge, by previous owners or operators, in the disposal
of, or to produce, store, handle, treat, release, or transport, any hazardous
waste or hazardous substance other than in accordance with applicable law; to
the best of Borrower's knowledge, none of Borrower's properties or assets has
ever been designated or identified in any manner pursuant to any environmental
protection statute as a hazardous waste or hazardous substance disposal site, or
a candidate for closure pursuant to any environmental protection statute; no
lien arising under any environmental protection statute has attached to any
revenues or to any real or personal property owned by
-11-
<PAGE> 19
Borrower or any Subsidiary; and neither Borrower nor any Subsidiary has received
a summons, citation, notice, or directive from the Environmental Protection
Agency or any other federal, state or other governmental agency concerning any
action or omission by Borrower or any Subsidiary resulting in the release, or
other disposition of hazardous waste or hazardous substances into the
environment.
5.13 Taxes. Borrower and each Subsidiary has filed or caused to be filed
all tax returns required to be filed on a timely basis, and has paid, or has
made adequate provision for the payment of, all taxes reflected therein.
5.14 Subsidiaries. Borrower does not own any stock, partnership interest
or other equity securities of any Person, except for Permitted Investments.
5.15 Government Consents. Borrower and each Subsidiary has obtained all
consents, approvals and authorizations of, made all declarations or filings
with, and given all notices to, all governmental authorities that are necessary
for the continued operation of Borrower's business as currently conducted.
5.16 Full Disclosure. No representation, warranty or other statement made
by Borrower in any certificate or written statement furnished to Bank contains
any untrue statement of a material fact or omits to state a material fact
necessary in order to make the statements contained in such certificates or
statements not misleading.
6. AFFIRMATIVE COVENANTS
Borrower covenants and agrees that, until payment in full of all
outstanding Obligations, and for so long as Bank may have any commitment to make
a Credit Extension hereunder, Borrower shall do all of the following:
6.1 Good Standing. Borrower shall maintain its and each of its
Subsidiaries' corporate existence and good standing in its jurisdiction of
incorporation and maintain qualification in each jurisdiction in which the
failure to so qualify could have a Material Adverse Effect. Borrower shall
maintain, and shall cause each of its Subsidiaries to maintain, to the extent
consistent with prudent management of Borrower's business, in force all
licenses, approvals and agreements, the loss of which could have a Material
Adverse Effect.
6.2 Government Compliance. Borrower shall meet, and shall cause each
Subsidiary to meet, the minimum funding requirements of ERISA with respect to
any employee benefit plans subject to ERISA. Borrower shall comply, and shall
cause each Subsidiary to comply, with all statutes, laws, ordinances and
government rules and regulations to which it is subject, noncompliance with
which could have a Material Adverse Effect or a material adverse effect on the
Collateral or the priority of Bank's Lien on the Collateral.
6.3 Financial Statements, Reports, Certificates. Borrower shall deliver to
Bank: (a) within five (5) days of filing, copies of all statements, reports and
notices sent or made available generally by Borrower to its security holders or
to any holders of Subordinated Debt and all reports on Form 10-K, 10-Q and 8-K
filed with the Securities and Exchange Commission (collectively, the "SEC
Reports"); (b) promptly upon receipt of notice thereof, a report of any legal
actions pending or threatened against Borrower or any Subsidiary that could
result in damages or costs to Borrower or any Subsidiary of One Hundred Thousand
Dollars ($100,000) or more; and (c) such budgets, sales projections, operating
plans or other financial information as Bank may reasonably request from time to
time.
-12-
<PAGE> 20
Within FIVE (5) days after the filing of the SEC Reports, Borrower shall
deliver to Bank with a Compliance Certificate signed by a Responsible Officer
substantially the form of Exhibit D hereto for the period then ended.
Bank shall have a right from time to time hereafter to audit Borrower's
Accounts at Borrower's expense, provided that such audits will be conducted no
more often than every six (6) months unless an Event of Default has occurred and
is continuing.
6.4 Inventory; Returns. Borrower shall keep all Inventory in good and
marketable condition, free from all material defects. Returns and allowances, if
any, as between Borrower and its account debtors shall be on the same basis and
in accordance with the usual customary practices of Borrower, as they exist at
the time of the execution and delivery of this Agreement. Borrower shall
promptly notify Bank of all returns and recoveries and of all disputes and
claims, where the return, recovery, dispute or claim involves more than Fifty
Thousand Dollars ($50,000).
6.5 Taxes. Borrower shall make, and shall cause each Subsidiary to make,
due and timely payment or deposit of all material federal, state, and local
taxes, assessments, or contributions required of it by law, and will execute and
deliver to Bank, on demand, appropriate certificates attesting to the payment or
deposit thereof; and Borrower will make, and will cause each Subsidiary to make,
timely payment or deposit of all material tax payments and withholding taxes
required of it by applicable laws, including, but not limited to, those laws
concerning F.I.C.A., F.U.T.A., state disability, and local, state, and federal
income taxes, and will, upon request, furnish Bank with proof satisfactory to
Bank indicating that Borrower or a Subsidiary has made such payments or
deposits; provided that Borrower or a Subsidiary need not make any payment if
the amount or validity of such payment is (i) contested in good faith by
appropriate proceedings, (ii) is reserved against (to the extent required by
GAAP) by Borrower and (iii) no lien other than a Permitted Lien results.
6.6 Insurance.
(a) Borrower, at its expense, shall keep the Collateral insured
against loss or damage by fire, theft, explosion, sprinklers, and all other
hazards and risks, and in such amounts, as ordinarily insured against by other
owners in similar businesses conducted in the locations where Borrower's
business is conducted on the date hereof. Borrower shall also maintain insurance
relating to Borrower's ownership and use of the Collateral in amounts and of a
type that are customary to businesses similar to Borrower's.
(b) All such policies of insurance shall be in such form, with
such companies rated A-1, and in such amounts as are reasonably satisfactory to
Bank, and that the current insurance amount of $5,000,000 regarding personal
property is acceptable as of the date hereof, with the understanding that future
events affecting the Borrower may cause the Bank to reevaluate such amount from
time to time. All such policies of property insurance shall contain a lender's
loss payable endorsement, in a form satisfactory to Bank, showing Bank as an
additional loss payee thereof and all liability insurance policies shall show
the Bank as an additional insured, and shall specify that the insurer must give
at least twenty (20) days notice to Bank before canceling its policy for any
reason. At Bank's request, Borrower shall deliver to Bank certified copies of
such policies of insurance and evidence of the payments of all premiums
therefor. All proceeds payable under any such policy shall, at the option of
Bank, be payable to Bank to be applied on account of the Obligations.
6.7 Principal Depository. Borrower shall maintain its principal
depository and operating accounts with Bank, no later than June 1, 1998.
-13-
<PAGE> 21
6.8 Current Ratio. Borrower shall, on a consolidated basis, maintain, as
of the last day of each fiscal quarter, a ratio of Current Assets to Current
Liabilities of at least 1.25 to 1.0 for the period ending December 31, 1997.
Thereafter, Borrower shall maintain, as of the last day of each calendar
quarter, a ratio of Current Assets to Current Liabilities of at least 1.50 to
1.0.
6.9 Debt-Net Worth Ratio. Borrower shall, on a consolidated basis,
maintain, as of the last day of each fiscal quarter, a ratio of Total
Liabilities less Subordinated Debt to Stated Net Worth plus Subordinated Debt of
not more than 1.75 to 1.0.
6.10 Stated Net Worth. Borrower shall, on a consolidated basis,
maintain, as of the last day of each fiscal quarter, a Stated Net Worth of not
less than $30,000,000 plus 50% of the Borrower's positive, quarterly
consolidated net income starting with the period ending December 31, 1996.
6.11 EBITA/Interest Expense Ratio. Borrower shall, on a consolidated
basis, maintain, as of the last day of each fiscal quarter, a ratio of
Consolidated EBITA to Consolidated Interest Expense, with respect to the most
recent four fiscal quarter period, of not less than 2.00 to 1.0.
6.12 Clean Up Period. During each fiscal year of the Borrower, Borrower
shall maintain a period of no less than 30 consecutive calendar days during
which no Advances shall be outstanding.
6.13 Further Assurances. At any time and from time to time Borrower and
Bank shall execute and deliver such further instruments and take such further
action as may reasonably be requested by Bank and the Borrower, respectively, to
effect the purposes of this Agreement.
7. NEGATIVE COVENANTS
Borrower covenants and agrees that, so long as any Credit Extension
hereunder shall be available and until payment in full of the outstanding
Obligations or for so long as Bank may have any commitment to make any Advances,
Borrower will not do any of the following, without the written consent of the
Bank (and in connection therewith the Bank agrees to use reasonable efforts to
respond to any such consent request by the Borrower within a reasonable time
period with the understanding that such agreement does not mean or imply that
such consent will be granted).
7.1 Dispositions. Convey, sell, lease, transfer or otherwise dispose of
(collectively, a "Transfer"), or permit any of its Subsidiaries to Transfer, all
or any part of its business or property, other than Transfers: (i) of inventory
in the ordinary course of business, (ii) of non-exclusive licenses and similar
arrangements for the use of the property of Borrower or its Subsidiaries in the
ordinary course of business; (iii) that constitute payment of normal and usual
operating expenses in the ordinary course of business; or (iii) of worn-out or
obsolete Equipment.
7.2 Changes in Business, Ownership, or Management, Business Locations.
Engage in any business, or permit any of its Subsidiaries to engage in any
business, other than the businesses currently engaged in by Borrower and any
business substantially similar or related thereto (or incidental thereto), or
suffer a change in Borrower's ownership of greater than 40% or the Chairman of
the Board and the President and Chief Executive Officer of the Borrower change
after the date hereof. Borrower will not, without at least thirty (30) days
prior written notification to Bank, relocate its chief executive office or add
any new offices or business locations.
7.3 Mergers or Acquisitions. Merge or consolidate, or permit any of its
Subsidiaries to merge or consolidate, with or into any other business
organization, or acquire, or permit any of its Subsidiaries to acquire, all or
substantially all of the capital stock or property of another Person, except
that the Borrower or any of its Subsidiaries may merge or consolidate with
another
-14-
<PAGE> 22
corporation if the Borrower or the Borrower's Subsidiary is the surviving
corporation in the merger and the aggregate value of the assets acquired in the
merger does not exceed 25% of Borrower's tangible net worth or the Subsidiary's
tangible net worth, as applicable, as of the end of the month prior to the
effective date of the merger, and the assets of the corporation acquired in the
merger are not subject to any liens or encumbrances, except Permitted Liens.
Tangible net worth shall be determined in accordance with GAAP, consistently
applied.
7.4 Indebtedness. Create, incur, assume or be or remain liable with
respect to any Indebtedness, or permit any Subsidiary so to do, other than
Permitted Indebtedness.
7.5 Encumbrances. Create, incur, assume or suffer to exist any Lien with
respect to any of its property, including, without limitation, (A) the real
property of the Borrower commonly known as at 505 North Euclid Street, Anaheim,
California 92801 or (B) any stock or other equity interest of any of the
Subsidiaries of the Borrower; or assign or otherwise convey any right to receive
income, including the sale of any Accounts, or permit any of its Subsidiaries to
do so, except for Permitted Liens.
7.6 Distributions. Pay any dividends or make any other distribution or
payment on account of or in redemption, retirement or purchase of any capital
stock.
7.7 Investments; Loans; Guarantees. Directly or indirectly acquire or own,
or make any Investment in or to any Person, or permit any of its Subsidiaries so
to do, other than Permitted Investments, or make any loans of any money or any
other assets to any Person, or guarantee or otherwise become liable with respect
to the obligations of any other Person.
7.8 Transactions with Affiliates. Directly or indirectly enter into or
permit to exist any material transaction with any Affiliate of Borrower except
for transactions that are in the ordinary course of Borrower's business, upon
fair and reasonable terms that are no less favorable to Borrower than would be
obtained in an arm's length transaction with a non affiliated Person.
7.9 [Reserved]
7.10 Subordinated Debt. Make any payment in respect of any Subordinated
Debt, or permit any of its Subsidiaries to make any such payment, except in
compliance with the terms of such Subordinated Debt, or amend any provision
contained in any documentation relating to the Subordinated Debt without Bank's
prior written consent.
7.11 Inventory. Store the Inventory with a bailee, warehouseman, or
similar party unless Bank has received a pledge of any warehouse receipt
covering such Inventory. Except for Inventory sold in the ordinary course of
business and except for such other locations as Bank may approve in writing,
Borrower shall keep the Inventory only at the location set forth in Section 10
hereof and such other locations of which Borrower gives Bank prior written
notice and as to which Borrower signs and files a financing statement where
needed to perfect Bank's security interest.
7.12 Compliance. Become an "investment company" or a company controlled
by an "investment company," within the meaning of the Investment Company Act of
1940, or become principally engaged in, or undertake as one of its important
activities, the business of extending credit for the purpose of purchasing or
carrying margin stock, or use the proceeds of any Advance for such purpose; fail
to meet the minimum funding requirements of ERISA; permit a Reportable Event or
Prohibited Transaction, as defined in ERISA, to occur; fail to comply with the
Federal Fair Labor Standards Act or violate any other law or regulation, which
violation could have a Material Adverse Effect or a material adverse effect on
the Collateral or the priority of Bank's Lien on the Collateral; or permit any
of its Subsidiaries to do any of the foregoing.
-15-
<PAGE> 23
8. EVENTS OF DEFAULT
Any one or more of the following events shall constitute an Event of
Default by Borrower under this Agreement:
8.1 Payment Default. If Borrower fails to pay, when due, any of the
Obligations.
8.2 Covenant Default.
(a) If Borrower fails to perform any obligation under Sections
6.3, 6.6, 6.7, 6.8, 6.9, 6.10, 6.11, 6.12 or 6.13 or violates any of the
covenants contained in Article 7 of this Agreement, or
(b) If Borrower fails or neglects to perform, keep, or observe
any other material term, provision, condition, covenant, or agreement contained
in this Agreement, in any of the Loan Documents, or in any other present or
future agreement between Borrower and Bank and as to any default under such
other term, provision, condition, covenant or agreement that can be cured, has
failed to cure such default within ten (10) days after the occurrence thereof;
provided, however, that if the default cannot by its nature be cured within the
ten (10) day period or cannot after diligent attempts by Borrower be cured
within such ten (10) day period, and such default is likely to be cured within a
reasonable time, then Borrower shall have an additional reasonable period (which
shall not in any case exceed thirty (30) days) to attempt to cure such default,
and within such reasonable time period the failure to have cured such default
shall not be deemed an Event of Default (provided that no Advances will be
required to be made during such cure period);
8.3 Material Adverse Change. If there (i) occurs a material adverse
change in the business, operations, or condition (financial or otherwise) of the
Borrower, or (ii) is a material impairment of the prospect of repayment of any
portion of the Obligations or (iii) is a material impairment of the value or
priority of Bank's security interests in the Collateral;
8.4 Attachment. If any material portion of Borrower's assets is
attached, seized, subjected to a writ or distress warrant, or is levied upon, or
comes into the possession of any trustee, receiver or person acting in a similar
capacity and such attachment, seizure, writ or distress warrant or levy has not
been removed, discharged or rescinded within ten (10) days, or if Borrower is
enjoined, restrained, or in any way prevented by court order from continuing to
conduct all or any material part of its business affairs, or if a judgment or
other claim becomes a lien or encumbrance upon any material portion of
Borrower's assets, or if a notice of lien, levy, or assessment is filed of
record with respect to any of Borrower's assets by the United States Government,
or any department, agency, or instrumentality thereof, or by any state, county,
municipal, or governmental agency, and the same is not paid within ten (10) days
after Borrower receives notice thereof, provided that none of the foregoing
shall constitute an Event of Default where such action or event is stayed or an
adequate bond has been posted pending a good faith contest by Borrower (provided
that no Credit Extensions will be required to be made during such cure period);
8.5 Insolvency. If Borrower becomes insolvent, or if an Insolvency
Proceeding is commenced by Borrower, or if an Insolvency Proceeding is commenced
against Borrower and is not dismissed or stayed within 30 days (provided that no
Advances will be made prior to the dismissal of such Insolvency Proceeding);
8.6 Other Agreements. If there is a default in any agreement to which
Borrower is a party with a third party or parties resulting in a right by such
third party or parties, whether or not exercised, to accelerate the maturity of
any Indebtedness in an amount in excess of Five Hundred Thousand Dollars
($500,000) or that could have a Material Adverse Effect;
-16-
<PAGE> 24
8.7 Subordinated Debt, If Borrower makes any payment on account of
Subordinated Debt, except to the extent such payment is allowed under any
subordination agreement entered into with Bank;
8.8 Judgments. If a judgment or judgments for the payment of money in an
amount, individually or in the aggregate, of at least Two Hundred Fifty Thousand
Dollars ($250,000) shall be rendered against Borrower and shall remain
unsatisfied and unstayed for a period of ten (10) days (provided that no Credit
Extensions will be made prior to the satisfaction or stay of such judgment);
8.9 Misrepresentations. If any material misrepresentation or material
misstatement exists now or hereafter in any warranty or representation set forth
herein or in any certificate or writing delivered to Bank by Borrower or any
Person acting on Borrower's behalf pursuant to this Agreement or to induce Bank
to enter into this Agreement or any other Loan Document; or
8.10 Guaranty. Any guaranty of all or a portion of the Obligations
ceases for any reason to be in full force and effect, or any Guarantor fails to
perform any obligation under any guaranty of all or a portion of the
Obligations, or any material misrepresentation or material misstatement exists
now or hereafter in any warranty or representation set forth in any guaranty of
all or a portion of the Obligations or in any certificate delivered to Bank in
connection with such guaranty, or any of the circumstances described in Sections
8.4, 8.5 or 8.8 occur with respect to any Guarantor.
9. BANKS RIGHTS AND REMEDIES
9.1 Rights and Remedies. Upon the occurrence and during the continuance
of an Event of Default, Bank may, at its election, without notice of its
election and without demand, do any one or more of the following, all of which
are authorized by Borrower:
(a) Declare all Obligations, whether evidenced by this Agreement,
by any of the other Loan Documents, or otherwise, immediately due and payable
(provided that upon the occurrence of an Event of Default described in Section
8.5 all Obligations shall become immediately due and payable without any action
by Bank);
(b) Cease advancing money or extending credit to or for the
benefit of Borrower under this Agreement or under any other agreement between
Borrower and Bank;
(c) Demand that Borrower (i) deposit cash with Bank in an amount
equal to the amount of any Letters of Credit remaining undrawn, as collateral
security for the repayment of any future drawings under such Letters of Credit,
and Borrower shall forthwith deposit and pay such amounts, and (ii) pay in
advance all Letters of Credit fees scheduled to be paid or payable over the
remaining term of the Letters of Credit;
(d) [Reserved];
(e) Settle or adjust disputes and claims directly with account
debtors for amounts, upon terms and in whatever order that Bank reasonably
considers advisable;
(f) Without notice to or demand upon Borrower, make such payments
and do such acts as Bank considers necessary or reasonable to protect its
security interest in the Collateral. Borrower agrees to assemble the Collateral
if Bank so requires, and to make the Collateral available to Bank as Bank may
designate. Borrower authorizes Bank to enter the premises where the Collateral
is located, to take and maintain possession of the Collateral, or any part of
it, and to pay, purchase, contest, or compromise any encumbrance, charge, or
lien which in Bank's determination
-17-
<PAGE> 25
appears to be prior or superior to its security interest and to pay all expenses
incurred in connection therewith. With respect to any of Borrower's premises,
Borrower hereby grants Bank a license to enter such premises and to occupy the
same, without charge in order to exercise any of Bank's rights or remedies
provided herein, at law, in equity, or otherwise;
(g) Without notice to Borrower set off and apply to the
Obligations any and all (i) balances and deposits of Borrower held by Bank, or
(ii) indebtedness at any time owing to or for the credit or the account of
Borrower held by Bank;
(h) Ship, reclaim, recover, store, finish, maintain, repair,
prepare for sale, advertise for sale, and sell (in the manner provided for
herein) the Collateral. Bank is hereby granted a non-exclusive, royalty-free
license or other right, solely pursuant to the provisions of this Section 9.1,
to use, without charge, Borrower's labels, patents, copyrights, mask works,
rights of use of any name, trade secrets, trade names, trademarks, service
marks, and advertising matter, or any property of a similar nature, as it
pertains to the Collateral, in completing production of, advertising for sale,
and selling any Collateral and, in connection with Bank's exercise of its rights
under this Section 9.1, Borrower's rights under all licenses and all franchise
agreements shall inure to Bank's benefit;
(i) Sell the Collateral at either a public or private sale, or
both, by way of one or more contracts or transactions, for cash or on terms, in
such manner and at such places (including Borrower's premises) as Bank
determines is commercially reasonable, and apply the proceeds thereof to the
Obligations in whatever manner or order it deems appropriate;
(j) Bank may credit bid and purchase at any public sale, or at
any private sale as permitted by law; and
(k) Any deficiency that exists after disposition of the
Collateral as provided above will be paid immediately by Borrower.
9.2 Power of Attorney. Effective only upon the occurrence and during the
continuance of an Event of Default, Borrower hereby irrevocably appoints Bank
(and any of Bank's designated officers, or employees) as Borrower's true and
lawful attorney to: (a) send requests for verification of Accounts or notify
account debtors of Bank's security interest in the Accounts; (b) endorse
Borrower's name on any checks or other forms of payment or security that may
come into Bank's possession; (c) sign Borrower's name on any invoice or bill of
lading relating to any Account, drafts against account debtors, schedules and
assignments of Accounts, verifications of Accounts, and notices to account
debtors; (d) make, settle, and adjust all claims under and decisions with
respect to Borrower's policies of insurance; and (e) settle and adjust disputes
and claims respecting the accounts directly with account debtors, for amounts
and upon terms which Bank determines to be reasonable; provided Bank may
exercise such power of attorney to sign the name of Borrower on any of the
documents described in Section 4.2 regardless of whether an Event of Default has
occurred. The appointment of Bank as Borrower's attorney in fact, and each and
every one of Bank's rights and powers, being coupled with an interest, is
irrevocable until all of the Obligations have been fully repaid and performed
and Bank's obligation to provide advances hereunder is terminated.
9.3 Accounts Collection. Upon the occurrence and during the continuance of
an Event of Default, Bank may notify any Person owing funds to Borrower of
Bank's security interest in such funds and verify the amount of such Account.
Borrower shall collect all amounts owing to Borrower for Bank, receive in trust
all payments as Bank's trustee, and if requested or required by Bank,
immediately deliver such payments to Bank in their original form as received
from the account debtor, with proper endorsements for deposit.
-18-
<PAGE> 26
9.4 Bank Expenses. If Borrower fails to pay any amounts or furnish any
required proof of payment due to third persons or entities, as required under
the terms of this Agreement, then Bank may do any or all of the following: (a)
make payment of the same or any part thereof; (b) set up such reserves under the
Committed Revolving Line as Bank deems necessary to protect Bank from the
exposure created by such failure; or (c) obtain and maintain insurance policies
of the type discussed in Section 6.6 of this Agreement, and take any action with
respect to such policies as Bank deems prudent. Any amounts so paid or deposited
by Bank shall constitute Bank Expenses, shall be immediately due and payable,
and shall bear interest at the then applicable rate hereinabove provided, and
shall be secured by the Collateral. Any payments made by Bank shall not
constitute an agreement by Bank to make similar payments in the future or a
waiver by Bank of any Event of Default under this Agreement.
9.5 Bank's Liability for Collateral. So long as Bank complies with
reasonable banking practices, Bank shall not in any way or manner be liable or
responsible for: (a) the safekeeping of the Collateral; (b) any loss or damage
thereto occurring or arising in any manner or fashion from any cause; (c) any
diminution in the value thereof; or (d) any act or default of any carrier,
warehouseman, bailee, forwarding agency, or other person whomsoever. All risk of
loss, damage or destruction of the Collateral shall be borne by Borrower.
9.6 Remedies Cumulative. Bank's rights and remedies under this
Agreement, the Loan Documents, and all other agreements shall be cumulative.
Bank shall have all other rights and remedies not expressly set forth herein as
provided under the Code, by law, or in equity. No exercise by Bank of one right
or remedy shall be deemed an election, and no waiver by Bank of any Event of
Default on Borrower's part shall be deemed a continuing waiver. No delay by Bank
shall constitute a waiver, election, or acquiescence by it. No waiver by Bank
shall be effective unless made in a written document signed on behalf of Bank
and then shall be effective only in the specific instance and for the specific
purpose for which it was given.
9.7 Demand; Protest. Borrower waives demand, protest, notice of protest,
notice of default or dishonor, notice of payment and nonpayment, notice of any
default, nonpayment at maturity, release, compromise, settlement, extension, or
renewal of accounts, documents, instruments, chattel paper, and guarantees at
any time held by Bank on which Borrower may in any way be liable.
10. NOTICES
Unless otherwise provided in this Agreement, all notices or demands by
any party relating to this Agreement or any other agreement entered into in
connection herewith shall be in writing and (except for financial statements and
other informational documents which may be sent by first-class mail, postage
prepaid) shall be personally delivered or sent by a recognized overnight
delivery service, by certified mail, postage prepaid, return receipt requested,
or by telefacsimile to Borrower or to Bank, as the case may be, at its addresses
set forth below:
If to Borrower SafeGuard Health Enterprises, Inc.
505 North Euclid Street
Anaheim, California 92803
Attn: Ronald I. Brendzel, Esq.
FAX: 714-758-4383
If to Bank Silicon Valley Bank
18872 MacArthur Boulevard, Suite 100
Irvine, CA 92715
Attn: Manager
FAX: 714-474-7892
-19-
<PAGE> 27
The parties hereto may change the address at which they are to receive notices
hereunder, by notice in writing in the foregoing manner given to the other.
11. CHOICE OF LAW AND VENUE; JURY WAIVER
The Loan Documents shall be governed by, and construed in accordance
with, the internal laws of the State of California, without regard to principles
of conflicts of law. Each of Borrower and Bank hereby submits to the exclusive
jurisdiction of the state and Federal courts located in the County of Orange,
State of California. BORROWER AND BANK EACH HEREBY WAIVE THEIR RESPECTIVE RIGHTS
TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF ANY
OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED THEREIN, INCLUDING
CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW OR
STATUTORY CLAIMS. EACH PARTY RECOGNIZES AND AGREES THAT THE FOREGOING WAIVER
CONSTITUTES A MATERIAL INDUCEMENT FOR IT TO ENTER INTO THIS AGREEMENT. EACH
PARTY REPRESENTS AND WARRANTS THAT IT HAS REVIEWED THIS WAIVER WITH ITS LEGAL
COUNSEL AND THAT IT KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS
FOLLOWING CONSULTATION WITH LEGAL COUNSEL.
12. GENERAL PROVISIONS
12.1 Successors and Assigns. This Agreement shall bind and inure to the
benefit of the respective successors and permitted assigns of each of the
parties; provided, however, that neither this Agreement nor any rights hereunder
may be assigned by Borrower without Bank's prior written consent, which consent
may be granted or withheld in Bank's sole discretion. Bank shall have the right
without the consent of or notice to Borrower to sell, transfer, negotiate, or
grant participation in all or any part of, or any interest in, Bank's
obligations, rights and benefits hereunder.
12.2 Indemnification. Borrower shall, indemnify, defend, protect and
hold harmless Bank and its officers, employees, and agents against: (a) all
obligations, demands, claims, and liabilities claimed or asserted by any other
party in connection with the transactions contemplated by the Loan Documents;
and (b) all losses or Bank Expenses in any way suffered, incurred, or paid by
Bank as a result of or in any way arising out of, following, or consequential to
transactions between Bank and Borrower whether under the Loan Documents, or
otherwise (including without limitation reasonable attorneys fees and expenses),
except for losses caused by Bank's gross negligence or willful misconduct.
12.3 Time of Essence. Time is of the essence for the performance of all
obligations set forth in this Agreement.
12.4 Severability of Provisions. Each provision of this Agreement shall
be severable from every other provision of this Agreement for the purpose of
determining the legal enforceability of any specific provision.
12.5 Amendments in Writing, Integration. This Agreement cannot be
amended or terminated except by a writing signed by Borrower and Bank. All prior
agreements, understandings, representations, warranties, and negotiations
between the parties hereto with respect to the subject matter of this Agreement,
if any, are merged into this Agreement and the Loan Documents.
-20-
<PAGE> 28
12.6 Counterparts. This Agreement may be executed in any number of
counterparts and by different parties on separate counterparts, each of which,
when executed and delivered, shall be deemed to be an original, and all of
which, when taken together, shall constitute but one and the same Agreement.
12.7 Survival. All covenants, representations and warranties made in
this Agreement shall continue in full force and effect so long as any
Obligations remain outstanding. The obligations of Borrower to indemnify Bank
with respect to the expenses, damages, losses, costs and liabilities described
in Section 12.2 shall survive until all applicable statute of limitations
periods with respect to actions that may be brought against Bank have run.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed
as of the date first above written.
SAFEGUARD HEALTH ENTERPRISES, INC.
By: /s/ THOMAS C. TEKULVE, CPA
---------------------------------------
Title: Vice President and CFO
------------------------------------
By: /s/ JOHN E. COX
---------------------------------------
Title: President and COO
------------------------------------
SILICON VALLEY BANK
By: /s/ KITTRIDGE CHAMBERLIN
---------------------------------------
Title: Vice President
------------------------------------
-21-
<PAGE> 1
Exhibit 21.1
SAFEGUARD HEALTH ENTERPRISES, INC.
SUBSIDIARIES OF THE COMPANY
The wholly owned subsidiaries of SafeGuard Health Enterprises, Inc., a Delaware
corporation, are as follows:
1. SafeGuard Health Plans, Inc., an Arizona corporation
2. SafeGuard Health Plans, Inc., a California corporation
3. SafeGuard Health Plans, Inc., a Colorado corporation
4. SafeGuard Health Plans, Inc., a Florida corporation
5. SafeGuard Health Plans, Inc., an Illinois corporation
6. SafeGuard Health Plans, Inc., a Kansas corporation
7. SafeGuard Health Plans, Inc., a Kentucky corporation
8. SafeGuard Health Plans, Inc., a Missouri corporation
9. SafeGuard Health Plans, Inc., a Nevada corporation
10. SafeGuard Health Plans, Inc., an Ohio corporation
11. SafeGuard Health Plans, Inc., an Oklahoma corporation
12. SafeGuard Health Plans, Inc., an Oregon corporation
13. SafeGuard Health Plans, Inc., a Texas corporation
14. SafeGuard Health Plans, Inc., a Utah corporation
15. SafeHealth Life Insurance Company, Inc., a Texas corporation
16. Advantage Dental HealthPlans, Inc., a Delaware corporation
17. ADH Marketing, Inc., a Florida Corporation
18. ADH Plans, Inc., a Delaware corporation
19. Advantage Dental Plans, Inc., a Delaware corporation
20. Guards Dental, Inc., a California corporation (A wholly owned subsidiary
of SafeGuard Health Plans, Inc., a California corporation)
21. SafeHealth Life Insurance Company, a California corporation
22. First American Dental Benefits, Inc., a Texas corporation
23. Imprimis Practice Management Company, Inc., a Delaware corporation
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-2226 of SafeGuard Health Enterprises, Inc. on form S-8 of our report dated
April 15, 1999, appearing in this Annual Report on Form 10-K of SafeGuard
Health Enterprises, Inc. for the year ended December 31, 1998.
Deloitte & Touche LLP
Costa Mesa, California
April 15, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM BALANCE
SHEET AND INCOME STATEMENT AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH 1998 10-K FILING.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 3,256
<SECURITIES> 2,959
<RECEIVABLES> 32,804
<ALLOWANCES> (17,721)
<INVENTORY> 0
<CURRENT-ASSETS> 32,945
<PP&E> 13,450
<DEPRECIATION> (3,782)
<TOTAL-ASSETS> 79,944
<CURRENT-LIABILITIES> 25,379
<BONDS> 0
0
0
<COMMON> 21,509
<OTHER-SE> 245
<TOTAL-LIABILITY-AND-EQUITY> 79,944
<SALES> 97,449
<TOTAL-REVENUES> 99,790
<CGS> 66,020
<TOTAL-COSTS> 103,512
<OTHER-EXPENSES> 0
<LOSS-PROVISION> (13,764)
<INTEREST-EXPENSE> (4,311)
<INCOME-PRETAX> (21,796)
<INCOME-TAX> (7,652)
<INCOME-CONTINUING> (14,144)
<DISCONTINUED> 3,050
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,094)
<EPS-PRIMARY> (2.35)
<EPS-DILUTED> (2.35)
</TABLE>
