UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
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)
949.425.4300
(Registrant's telephone number, including area code)
949.425.4586
(Registrant's fax telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE
NONE
(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 such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K/A or any amendment to
this Form 10-K/A. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 15, 2000, was $5,033,804.
The number of shares of the registrant's common stock outstanding as of March
31, 2000, was 4,747,498 (not including 3,247,788 shares held in treasury).
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SAFEGUARD HEALTH ENTERPRISES, INC.
1998 ANNUAL REPORT ON FORM 10-K/A
TABLE OF CONTENTS
Page
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PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
ITEM 3. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . . . . . . . . . . . . . . . . . . . 19
PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS . . . . . . . . . . . . 19
ITEM 6. SELECTED FINANCIAL DATA. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. . . . . . . . . . . . . . . . . . . 28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. . . . . . . . . . . . . . . . . . . . . . . . . . . 29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 29
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
ITEM 10. DIRECTORS AND/OR EXECUTIVE OFFICERS OF THE COMPANY. . . . . . . . . . . . . . . . . . . . . . . 29
ITEM 11. EXECUTIVE COMPENSATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. . . . . . . . . . . . . . . . . 33
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . . . . . . . . . . . . . . . . . . . . . . . 35
PART IV. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . . 35
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
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(i)
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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 (the "Company"), its
growth plans and business strategies, and its future operating results and
financial position, as well as those related to general 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.
RESTATEMENT OF FINANCIAL STATEMENTS
This Amendment on Form 10-K/A amends the Registrant's Annual Report on Form 10-K
for the period ended December 31, 1998, as filed by the Registrant on April 15,
1998, and is being filed to reflect the restatement of the Registrant's
consolidated financial statements (the "Restatement"). A summary and the impact
of the Restatement is presented below and in Note 15 of Notes to the
Consolidated Financial Statements.
BACKGROUND INFORMATION AND ORIGINAL ACCOUNTING
In September 1997, the Company sold several general dental practices to Pacific
Coast Dental, Inc., Associated Dental Services, Inc., and affiliated dentists
(the "Purchasers" or "PCD") in exchange for consideration consisting of $8.0
million of long-term promissory notes. In the Company's 1997 financial
statements, the Company recorded a gain on sale of discontinued dental practices
of $3.3 million (net of income taxes of $2.1 million) on this sale transaction.
In April 1998, the Company sold several orthodontic practices to the Purchasers
in exchange for consideration consisting of $15.0 million of long-term
promissory notes. In the Company's 1998 financial statements, the Company
recorded a gain of $2.1 million (net of income taxes of $1.3) on this sale
transaction.
The Company also sold four other general dental practices to other purchasers in
exchange for consideration consisting of long-term promissory notes. During 1997
and 1998, the purchasers of these practices conveyed the practices to the
Purchasers in exchange for the assumption of the promissory notes payable to the
Company. At the time of the conveyances of these practices to the Purchasers,
the related promissory notes had an aggregate carrying value of $1.9 million on
the Company's balance sheet, which exceeded the historical cost of the net
assets of the related dental practices by $1.4 million.
In connection with the sale of the general dental and orthodontic practices to
the Purchasers, the Company committed to lend the Purchasers certain amounts for
working capital. As of December 31, 1997 and 1998 the working capital loans to
the Purchasers amounted to $850,000 and $1.6 million, respectively. During 1997
and 1998, the Company originally recorded an aggregate of $192,000 (net of
income taxes of $124,000) and $1.0 million (net of income taxes of $670,000),
respectively, of interest income relating to all the various notes receivable
from the Purchasers.
The Company previously recorded various reserves against the promissory notes,
the working capital loans, and the accrued interest on these obligations, during
1997 and 1998, in an aggregate amount of $1.9 million and $14.4 million,
respectively. The Company also received during 1997 and 1998, $227,000 and
$38,000, respectively, of interest payments from the Purchasers. As a result,
the total carrying value of all the amounts receivable from the Purchasers as of
December 31, 1998 was $12.2 million in the previously reported consolidated
balance sheet. Of the $16.3 million of total reserves that were previously
recorded, $4.8 million were included in the calculation of the gains on sale
discussed above, and $7.0 million were charged to expense (net of income taxes
of $4.5 million) subsequent to the dates of the respective sale transactions.
RESTATEMENT
Subsequent to these transactions, the Purchasers defaulted on the amounts due to
the Company. In a subsequent review of the facts and circumstances related to
this matter, and based upon no new information that was not otherwise available
to the Company at the time when it entered into these transactions, the
Company's management has concluded that as of the dates of the initial sales,
the Purchasers did not have sufficient resources to repay the notes from sources
other than the operations of the purchased practices. As a result, the
accompanying 1998 and 1997 financial statements have been restated from amounts
previously reported to reverse the sales transactions to PCD discussed above,
and the related promissory notes and the working capital loans have not been
recognized in the restated financial statements. The historical cost of the net
assets of the related general dental and orthodontic practices have been
recorded on the Company's restated balance sheet under the caption "Assets of
discontinued operations transferred under contractual arrangements." The
restated financial statements do not reflect any gains on these sale
transactions, and do not reflect any interest income on the related promissory
notes. In addition, the carrying value of the promissory notes related to the
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four practices that were also transferred to the Purchasers was reduced to the
historical cost of the net assets of the related dental practices, at the time
of the transfers. The working capital loans are fully reserved at the time the
loans were made and the Company has no further obligation to provide such
working capital loans. Interest payments received have been applied to reduce
the historical cost of the net assets transferred. This accounting treatment
more appropriately reflects the economic substance of the transactions, as
distinct from the legal form of the transactions.
The effects of the restatement have been presented in Note 15 of the Notes to
the consolidated financial statements and have been reflected herein.
(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 from September 30, 1996 through
September 30, 1997.
Effective as of April 1, 1998, the Company sold all of the orthodontic practices
operated by Guards to the Purchasers. The total consideration received was a
$15 million, 8 1/2%, 30-year Promissory Note, secured by all current and future
assets of the Purchasers, including those assets transferred by Guards. Among
other provisions, the sale agreement details the sale of various assets of the
practices and a long term commitment to continue to provide orthodontic services
to the members of SafeGuard Health Plans, Inc., a subsidiary of the Company. In
addition to this transaction, the Purchasers had previously purchased certain of
the general dental practices from the Company in September 1997, in exchange for
an $8 million Promissory Note.
Due to the uncertainty of the Purchaser's ability to meet it obligations under
these Promissory Notes ("Notes"), the Company has not recognized these
transactions as sales for accounting purposes and accordingly has not recorded
the Notes in its financial statements. The historical cost of the underlying net
assets of the orthodontic and general dental practices have been segregated on
the Company's balance sheet as "Assets of discontinued operations transferred
under contractual arrangements" in order to appropriately convey the distinction
between the legal form of the transactions and their accounting treatment. The
Company is carrying the net assets of these businesses at their estimated net
realizable value, and accordingly, has not recognized any gain on these
transactions, including recognition of interest income on the Notes. The
discontinued assets have also been reduced by the amount of interest payments
received from the Purchasers.
As part of an ongoing review process, the Company ascertained that, in the
fourth quarter of 1998, the Notes granted to the Company by the Purchasers were
not performing pursuant to the terms and conditions thereof. 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. That agreement expired in July 1999, however the
Company, rather than electing to exercise its rights to foreclose on the notes
under the Agreement, is cooperating with the Purchasers to effect a sale of the
assets related to those practices.
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The Company's executive offices are located at 95 Enterprise, Aliso Viejo,
California 92656; its telephone number is 949.425.4300 and its 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 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.
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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 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 provider administration,
member and provider services, underwriting, financial analysis, quality
improvement and dental policy administration. The Company currently has two
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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 products, market research, product development and management, public
relations, information systems, claims administration, billing and collections,
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.
PRODUCTS
Dental HMO Plans. The Company offers a variety of Dental HMO plans under the
names SafeGuard Health Plans, SafeGuard Dental Plans and American Dental
Corporation. 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 on a discounted fee-for-service basis.
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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 by 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 transitional 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.
General Dental Services. On October 21, 1996, the Company implemented a
strategic plan to sell all of the general dental practices owned by the Company.
The assets sold consisted primarily of accounts receivable, supply inventories,
equipment and leasehold improvements. Each practice sold could enter into a
contract with the Company's practice management subsidiary, whereby the Company
would provide certain services to support the operation of their practice,
including administrative support. The Company discontinued its practice
management subsidiary and terminated these agreements in 1998. See "Restatement
of Financial Statements" and Note 15 of Notes to the Consolidated Financial
Statements.
Orthodontic Services. On February 26, 1998, the Company announced the
discontinuance of its orthodontic practices. The assets of the orthodontic
practices consisted primarily of accounts receivable, supply inventory and
dental equipment,which were sold on April 1, 1998, pursuant to the terms of the
definitive Master Asset Purchase Agreement (the "Agreement") dated and effective
as of April 1, 1998, by and among the Company and PCD. The orthodontic
practices were sold for $15 million, represented by an 8 1/2% 30-year
promissory note and secured by all current and future assets of the Purchasers,
including those assets transferred under the Agreement made by PCD. Among other
provisions, the Agreement includes a long term commitment to continue to provide
orthodontic services to the members of SafeGuard Health Plans, Inc. See
"Restatement of Financial Statements" and Note 15 of Notes to the Consolidated
Financial Statements.
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.
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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, 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.
See Part 1, Item 7, Management's Discussion and Analysis of Financial Condition
and Results of Operations regarding Year 2000 compliance.
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. The Company has also upgraded its current network server
systems to handle the increased activity within the network. 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
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.
The assets sold consisted primarily of accounts receivable, supply inventories,
equipment and leasehold improvements. Each practice sold could enter into a
contract with the Company's practice management subsidiary, whereby the Company
would provide certain services to support the operation of their practice,
including administrative support. The Company discontinued its practice
management subsidiary and terminated these agreements in 1998.
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Through June 1997, the Company sold fifteen general dental practices to
purchasers in exchange for consideration consisting of $9.5 million of long-term
promissory notes. In September 1997, the Company sold the remaining practices
to Pacific Coast Dental, Inc., Associated Dental Services, Inc., and affiliated
dentists (the "Purchasers" or "PCD") in exchange for consideration consisting of
$8.0 million of long-term promissory notes.
During 1997 and 1998, of the fifteen practices previously sold to parties other
than PCD, four of these practice were conveyed to PCD in exchange for the
assumption of the promissory notes payable to the Company. At the time of the
conveyances of these practices to PCD, the related promissory notes had an
aggregate carrying value of $1.9 million on the Company's balance sheet, which
exceeded the historical cost of the net assets of the related dental practices
by $1.4 million.
Orthodontic Practices. On February 26, 1998, the Company announced the
discontinuance of its orthodontic practices. The assets of the orthodontic
practices consisted primarily of accounts receivable, supply inventory and
dental equipment,which were sold on April 1, 1998, pursuant to the terms of the
definitive Master Asset Purchase Agreement (the "Agreement") dated and effective
as of April 1, 1998, by and among the Company and PCD. The orthodontic
practices were sold for $15 million, represented by an 8 1/2% 30-year
promissory note and secured by all current and future assets of the Purchasers,
including those assets transferred under the Agreement made by PCD. Among other
provisions, the Agreement includes a long term commitment to continue to provide
orthodontic services to the members of the Company's dental HMO plans.
In connection with the sale of the general dental and orthodontic practices to
PCD, the Company committed to lend PCD certain amounts for working capital. As
of December 31, 1997 and 1998 the working capital loans to PCD amounted to $.8
million and $1.6 million, respectively.
The Company concluded that PCD did not have sufficient resources to repay the
promissory notes from sources other than the operations of the purchased
practices. Accordingly, the related promissory notes and the working capital
loans have not been recorded in the financial statements. The historical cost
of the net assets of the practices sold to PCD are reflected on the Company's
balance sheet under the caption "Assets of discontinued operations transferred
under contractual arrangements." The financial statements do not reflect any
gains on these sale transactions, and do not reflect any interest income on the
related promissory notes. In addition, the carrying value of the promissory
notes related to the four practices that were ultimately transferred to PCD from
other purchasers, was reduced to the historical cost of the net assets of the
related practices. The working capital loans were fully reserved at the time the
loans were made and the Company has no further obligation to provide such
working capital loans. Interest payments received of $ .3 million have been
applied to reduce the historical cost of the net assets transferred.
At December 31, 1998, rather than the Company exercising its right to foreclose
on the Notes, the Company 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 audit 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
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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 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.
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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 $10 million 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.
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 paid an aggregate sum of $3.6 million over 3 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 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,
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Advantage Dental HealthPlans, Inc., a Missouri corporation, into its affiliate,
SafeGuard Health Plans, Inc., a Missouri corporation. 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 September 1999, the Company
completed 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 also
released surplus requirements of the no longer existing entity, SafeHealth, Inc.
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 in 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.
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.
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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 plans 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 completed the merger of
SafeHealth Inc. into and with SafeHealth Life during the third quarter of 1999.
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. At the end of 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, the volume of which is currently insignificant.
In late 1996, the Company purchased an indemnity dental claims processing system
capable of auto-adjudicating a 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 to 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.
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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 engages an actuary 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
increase the size of its PPO panel in the future.
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 geographic scope of service to existing
clients, by entering into contracts with new clients, or by establishing
marketing agreements with other organizations. Geographic expansion is also
expected to 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 may pursue
in the future.
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
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.
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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:
o SafeGuard used with a distinctive logo depicting a modified smile
used in connection with its Dental HMO plans;
o SafeGuard Health Plans used in descriptive material to describe the
products offered by the Company;
o SafeGuard Dental Plans used to describe the various Dental HMO plans
offered by the Company;
o SafeHealth Life 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 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.
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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 and Dallas, Texas. 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. The Company considers its relations with its employees to be
good.
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.
RISK FACTORS
The Company's business and competitive environment involve certain factors that
expose it to risk and uncertainty. Some risks relate to the managed dental care
industry in general and other risks relate to the Company specifically. 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 the Company will
be able to maintain its current market position. Some of the below-referenced
risk factors have affected the Company's operating results in the past, and all
of these risk factors could affect its future operating results.
Waivers and/or Extensions from Lender. As of December 31, 1999, the Company was
not in compliance with certain financial covenants contained in its credit
agreements. As a result, the entire outstanding balance under these credit
agreements, which was $39.5 million at December 31, 1999, was due on January 28,
2000. The Company's financial position may be negatively affected in the event
it is unable to obtain regulatory approval for its agreement with certain
investors and its lenders dated March 1, 2000. See "RECENT DEVELOPMENTS" and
"CREDIT FACILITIES."
Recent Operating Losses. The Company incurred significant operating losses
during 1998 and 1999. The Company's ability to meet its financial obligations
and to continue its business depends upon a return of its operations to
profitability.
Government Regulation. The health and dental care industry is subject to
extensive federal, state and local laws, rules and regulations. Each of the
Company's operating subsidiaries is subject to various requirements imposed by
state laws and regulations related to the operation of a health plan or
insurance company, including the maintenance of a minimum amount of tangible net
worth by each subsidiary. Due to significant regulation of the Company's
business, a variety of potential obstacles to its plans for further geographic
expansion could limit future growth. Additionally, dental care practice
standards and related federal and state regulations may change. The Company
cannot predict what changes may be enacted which may affect its business and
future growth.
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Ability to Sell Dental Offices and/or Promissory Notes. 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. The assets sold
consisted primarily of accounts receivable, supply inventories, equipment and
leasehold improvements. Each practice sold could enter into a contract with the
Company's practice management subsidiary, whereby the Company would provide
certain services to support the operation of their practice, including
administrative support. The Company discontinued its practice management
subsidiary and terminated these agreements in 1998.
Through June 1997, the Company sold fifteen general dental practices to
purchasers in exchange for consideration consisting of $10.4 million of
long-term promissory notes. In September 1997, the Company sold the remaining
practices to Pacific Coast Dental, Inc., Associated Dental Services, Inc., and
affiliated dentists (the "Purchasers" or "PCD") in exchange for consideration
consisting of $8.0 million of long-term promissory notes.
During 1997 and 1998, of the fifteen practices previously sold to parties other
than PCD, four of these practice were conveyed to PCD in exchange for the
assumption of the promissory notes payable to the Company. At the time of the
conveyances of these practices to PCD, the related promissory notes had an
aggregate carrying value of $1.9 million on the Company's balance sheet, which
exceeded the historical cost of the net assets of the related dental practices
by $1.4 million.
Orthodontic Practices. On February 26, 1998, the Company announced the
discontinuance of its orthodontic practices. The assets of the orthodontic
practices consisted primarily of accounts receivable, supply inventory and
dental equipment,which were sold on April 1, 1998, pursuant to the terms of the
definitive Master Asset Purchase Agreement (the "Agreement") dated and effective
as of April 1, 1998, by and among the Company and PCD. The orthodontic
practices were sold for $15 million, represented by an 8 1/2% 30-year
promissory note and secured by all current and future assets of the Purchasers,
including those assets transferred under the Agreement made by PCD. Among other
provisions, the Agreement includes a long term commitment to continue to provide
orthodontic services to the members of the Company's dental HMO plans.
In connection with the sale of the general dental and orthodontic practices to
PCD, the Company committed to lend PCD certain amounts for working capital. As
of December 31, 1997 and 1998 the working capital loans to PCD amounted to $.8
million and $1.6 million, respectively.
The Company concluded that PCD did not have sufficient resources to repay the
promissory notes from sources other than the operations of the purchased
practices. Accordingly, the related promissory notes and the working capital
loans have not been recorded in the financial statements. The historical cost
of the net assets of the practices sold to PCD are reflected on the Company's
balance sheet under the caption "Assets of discontinued operations transferred
under contractual arrangements." The financial statements do not reflect any
gains on these sale transactions, and do not reflect any interest income on the
related promissory notes. In addition, the carrying value of the promissory
notes related to the four practices that were ultimately transferred to PCD from
other purchasers, was reduced to the historical cost of the net assets of the
related practices. The working capital loans were fully reserved at the time the
loans were made and the Company has no further obligation to provide such
working capital loans. Interest payments received of $ .3 million have been
applied to reduce the historical cost of the net assets transferred.
The Company's working capital and liquidity will be negatively impacted should
the Company be unable either resell the assets or Notes relating to the
practices.
Risk of Acquisitions. The Company completed three acquisitions in the past few
years. These acquisitions entail risks that the Company may be unable to
successfully integrate the acquired businesses into its existing operations.
Also, the acquisitions may fail to perform as expected. In addition, the
acquisitions may require significant amounts of management's time to assimilate.
As a result, occurrence of any of the risks listed could have a material
negative effect on the Company's operating and financial results.
Possible Volatility of Stock Price. The Company's stock price is subject to
fluctuations. The stock price volatility can be a response to actual or
anticipated variations in operating results, announcements of new developments,
actions of competitors, developments in relationships with clients, and other
events or factors. Even a modest underperformance against the expectations of
the investment community can lead to a significant decline in the Company's
stock price. Broad stock market fluctuations, which may be unrelated to the
Company's operating performance may have a negative affect on the price of its
stock.
Competitive Market. The Company operates in a highly competitive environment.
Its ability to expand is affected by existing and increasing competition and
dental product choices and number of competitors in the areas that it offers
products. There can be no assurance that the Company will be able to compete
successfully with new market entrants. Any additional competition could have a
negative impact on the Company's revenues, net income and growth prospects
through premium reductions, loss of providers or clients, or market share. The
Company expects the level of competition to remain high. In addition, the
Company recognizes that competitive pricing pressures may have a negative effect
on its operating margins.
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Ability to Continue Company Growth. The Company has grown in recent years
through expansion in new small and mid-size clients. There has also been an
increase in the number of persons covered under indemnity insurance products
offered by the Company's insurance subsidiary. Also, the Company experienced an
increase in the number of members covered as a result of strategic relationships
with other health care providers due to the September 1996 acquisition of First
American, the May 1997 acquisition of Advantage, and the August 1997 acquisition
of SafeHealth, Inc. Although the Company intends to continue to expand, there
can be no assurance that the Company will be able to maintain or continue to
expand its market presence in its current locations or to successfully enter
other markets. The ability to continue the Company's growth will depend on a
number of factors, including existing and emerging competition. In addition, it
will depend upon the Company's ability to maintain effective control over dental
care costs, secure cost-effective contracts with additional dentists, introduce
new technologies, and on the availability of working capital to support its
growth.
Levels of Utilization and Dental Care Services. The Company's dental indemnity
and PPO dental plans are underwritten by a subsidiary that is a licensed
insurer. These plans subject the Company to underwriting risks associated with
over utilization and pricing variances. To minimize these risks, the Company
conducts thorough claims review and lag studies and engages an actuary. However,
if underwriting risks are not accurately assessed, rates charged to clients may
not cover costs. As a result, a material negative effect on the Company's
operating and financial results may occur.
In addition, dental care provided by specialists is made available to members
under many of the dental HMO plans. The Company assumes responsibility under
such plans for such specialty care arrangements. The Company is responsible for
payments to specialists, usually on a discounted, fee-for-service basis and not
on a capitated basis. Accordingly, it retains the risk for the payment of
specialty dental care claims. If the utilization of specialty dental care
increases under outstanding dental HMO plans, operating and financial results
could be negatively impacted.
Effect of Adverse Economic Conditions. The Company's 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, and increased pricing pressure from clients and competitors.
Relationships with Dental Providers. The Company's success is dependent upon the
continued maintenance of a large network of quality dentists in each of the
Company's markets. Generally, the Company and the network dentists enter into
non-exclusive contracts that may be terminated by either party with limited
notice. The Company's operating results may be negatively affected if it is
unable to establish and maintain contracts with an adequate number of quality
dentists in any market in which it operates. See "BUSINESS-PROVIDER RELATIONS."
Dependence on Key Personnel. The Company believes that its success is largely
dependent upon the abilities and experience of its senior management team. The
loss of the services of one or more of these senior executives could negatively
affect our operating and financial results. The Company has entered into
employment agreements with key senior executives, including the Chief Executive
Officer and the Chief Operating Officer.
RECENT DEVELOPMENTS
On May 29, 1999, the Company restructured the credit agreement related to $32.5
million of outstanding debt under its unsecured senior notes. The senior notes,
which have a final maturity date of September 30, 2005, (the "Notes") were
modified to provide for an increase in the interest rate from 7.91% to 9.91%
effective on April 28, 1999. The interest rate decreased to 8.91% in June 1999,
due to the execution of a definitive agreement with an investor group regarding
a planned investment in the company (see more discussion of this below). Under
the restructured agreement, the interest rate would decrease to 7.91% upon the
occurrence of certain other events, which have not yet occurred. In connection
with the restructuring, the Company issued warrants to acquire 382,000 shares of
the Company's common stock to the holder of the Notes. The warrants are
exercisable any time between January 1, 2000, and December 31, 2003, at a price
of $4.51 per share.
On May 29, 1999, the Company also restructured the credit agreement related to
its $8 million bank line of credit, under which $8 million was outstanding at
December 31, 1998. The restructured agreement extended the maturity date from
January 31, 1999 to January 28, 2000. The interest rate on the outstanding
balance is equal to the bank's prime rate plus 4%, effective on April 28, 1999.
The interest rate decreased to prime plus 3% in June 1999, due to the execution
of a definitive agreement with an investor group regarding a planned investment
in the company (see more discussion of this below). Under the restructured
agreement, the interest rate would decrease to prime plus 1.5% upon the
occurrence of certain other events, which have not yet occurred.
Additional collateral was provided to both the senior note holder and line of
credit lender under the restructured agreements. The Company also paid the
out-of-pocket attorneys' fees and costs incurred by both lenders through the
closing date, and the cost of certain consultants the lenders required the
Company to hire. The Company agreed to provide both lenders with monthly
consolidated financial statements and covenant compliance certificates, all
Securities and Exchange Commissions filings, and other financial documents as
they may reasonably request.
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New provisions include a requirement for the Company to provide the lenders with
any notice of intent to audit from any regulatory agency, and copies of
correspondence from any regulatory agency and the Company's response thereto. In
addition, the Company is prohibited from declaring dividends or other
distributions, and may not incur any liens on the voting stock of any
subsidiaries of the Company. In the event the Company sells certain assets,
including the notes receivable related to the sale of dental offices, the
proceeds have to be paid to the holder of the Notes and the Company's line of
credit lender, in proportions specified in the restructured agreements. Various
other terms, covenants and provisions of the credit agreement, including various
financial covenants, were also revised. In consideration of the new agreement,
both lenders waived all existing defaults under the previous credit agreements.
As of September 30, 1999 and December 31, 1999 the Company was not in compliance
with these new restructured debt agreements.
On June 30, 1999, the Company entered into an agreement with an investor group
under which the investor group agreed to purchase $20 million of senior notes
and $20 million of convertible preferred stock from the Company. This
transaction was subject to regulatory approval, stockholder approval, and
various other conditions. In connection with this agreement, the Company filed
a Proxy Statement with the Securities and Exchange Commission on October 12,
1999. However, the agreement with the investor group was terminated in February
2000.
On March 1, 2000, the Company entered into an agreement with both of its lenders
and the same investor group, under which the investor group loaned $8 million to
the Company. Under this agreement, the investor group and the existing lenders
agreed to convert the $8 million loan, the outstanding balance of $7.0 million
under the bank line of credit, and the outstanding balance of $32.5 million
under the senior notes to convertible preferred stock, subject to regulatory
approval. Under this agreement, both lenders agreed not to demand or accept any
payment under the credit agreements, and not to take any enforcement actions of
any kind under the agreements until April 30, 2001.
During June 1999 the Company completed the sale of its former headquarters
office building for approximately $3.5 million, which was the carrying amount of
the building on the Company's balance sheet as of December 31, 1998. The
carrying amount of the building is reflected on the consolidated balance sheet
under the caption "Assets Held for Sale."
On September 1, 1999 trading in the Company's common stock was removed from the
NASDAQ National Market due to the Company's inability to meet the relevant
minimum net tangible worth requirement.
During the quarter ended September 30, 1999, the Company recorded a charge to
earnings to establish a valuation allowance against its deferred tax assets.
The amount of the allowance is equal to the total amount of its net deferred tax
assets, which was $8.5 million at December 31, 1998. The Company's deferred tax
assets have been fully reserved due to uncertainty about whether they will be
realized in the future, primarily due to operating losses incurred by the
Company in 1998 and 1999 and the existence of significant unused loss
carryforwards.
Effective December 31, 1998, rather than the Company exercising its right to
foreclose on certain promissory notes (the "Notes"), the Company entered into a
Default Forbearance Agreement and an Irrevocable Power of Attorney with the
issuer of those notes (the "Issuer"), which will enable the Company to either
resell the assets or Notes relating to the practices. During 1999, the Company
reached an oral agreement with the Issuer and another third party (the
"Purchaser"), under which the Notes would be liquidated. Under this agreement,
the Issuer would convey the dental practices that comprise the collateral for
the Notes to the Purchaser, in exchange for proceeds that would be paid to the
Company in satisfaction of the Notes. Due to uncertainty of the ability of the
Issuer of these Notes to meet its contractual obligations to the Company (See
RISK FACTORS and Restatement) the Company did not recognize the transactions
that gave rise to these Notes as sales for accounting purposes and accordingly
these Notes have not been recorded in the Company's financial statements. Based
on this oral agreement with the Issuer, and other factors, the Company has
determined that the value of the discontinued net assets being transferred
underlying the Notes has been impaired. Accordingly, the Company recorded an
additional loss of $6.4 million included in loss from operations of discontinued
operations during the nine months ended September 30, 1999 to reduce the
carrying value of these assets being transferred to their estimated net proceeds
that would be realized from a sale of these assets. During March 2000, the
Company entered into a definitive agreement with respect to this transaction,
which is currently pending regulatory approval.
The Company incurred a significant operating loss during 1999, in addition to
interest expense on outstanding debt, the write-down of notes receivable,
impairment of discontinued net assets transferred under contractual arrangements
and the valuation allowance against deferred tax assets. The Company borrowed an
additional $8 million in March 2000, and executed an agreement under which all
of its debt will be converted to equity upon regulatory approval. However,
there can be no assurance that the Company will be successful in returning to
profitability.
In December 1999, a shareholder lawsuit against the Company was filed, which
alleges that the Company and certain of its officers violated certain securities
laws by issuing a series of alleged false and misleading statements concerning
the Company's publicly reported revenues and earnings during a specified class
period. The Company has directors and officers liability insurance and intends
to vigorously defend this litigation. In the opinion of the Company's
management, the ultimate outcome of this matter will not have a material adverse
effect on the Company's financial position or results of operations.
-18-
<PAGE>
At December 31, 1999 the Company determined that its wholly-owned subsidiary,
SafeHealth, was below its required regulatory minimum capital and surplus by
approximately $4.5 million. A significant portion of the proceeds from the
Company's new loan entered into on March 1, 2000, described above, was used to
resolve this regulatory capital deficiency.
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 previously owned a 60,000 square foot building in
Anaheim, California, which it previously utilized as its corporate headquarters
and executive offices. This building was sold by the Company during the second
quarter of 1999. In addition, the Company leases offices in Phoenix, Arizona;
Walnut Creek, California; Denver, Colorado; Fort Lauderdale, Florida; St. Louis,
Missouri; and Austin, Dallas, and Houston, Texas. The Company leased all of the
office space used by 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. In December 1999, a shareholder lawsuit against the
Company was filed, which alleges that the Company and certain of its officers
violated certain securities laws by issuing a series of alleged false and
misleading statements concerning the Company's publicly reported revenues and
earnings during a specified class period. The Company has directors and officers
liability insurance and intends to vigorously defend this litigation. In the
opinion of the Company's management, the ultimate outcome of this matter will
not have a material adverse effect on the Company's financial position or
results of operations.
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.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
(a) Market Information
The Company's common stock is currently traded on the National Quotation Bureau
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>
-19-
<PAGE>
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 certain rights, preferences,
privileges and restrictions, and 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
-20-
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data in the following table has been derived from the
audited Consolidated Financial Statements of the Company. The financial data as
of December 31, 1998 and 1997, and for the two years then ended have been
restated (see Note 15 of Consolidated Financial Statements). The financial data
as of December 31, 1998 and 1997 and for each of the five years in the period
ended December 31, 1998, have also been 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."
<TABLE>
<CAPTION>
Selected Operating, Statistical and Balance Sheet Data
Year Ended December 31, 1998 1997 1996 1995 1994
----------- ----------- -------- ------- --------
Operating Data (in $000's except income per share): (Restated) (Restated)
<S> <C> <C> <C> <C> <C>
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 . . . . . . . . . . . . 36,259 25,103 16,292 13,451 12,178
Loss on impairment of assets. . . . . . . . . . . . . . . . 2,397 -- -- -- --
----------- ----------- -------- ------- --------
Total expenses. . . . . . . . . . . . . . . . . . . . . . . 104,676 90,805 70,826 58,736 51,381
----------- ----------- -------- ------- --------
(Loss) income from operations . . . . . . . . . . . . . . . (7,227) 4,545 1,883 2,000 2,540
Other income. . . . . . . . . . . . . . . . . . . . . . . . 624 1,316 984 1,286 1,026
Interest expense. . . . . . . . . . . . . . . . . . . . . . (4,311) (2,871) (485) -- (3)
----------- ----------- -------- ------- --------
Income (loss) before (benefit) provision for income taxes,
discontinued operations and cumulative effect of
accounting change . . . . . . . . . . . . . . . . . . . . . (10,914) 2,990 2,382 3,286 3,563
Provision (benefit) for income taxes. . . . . . . . . . . . (3,406) 1,371 980 1,251 1,390
----------- ----------- -------- ------- --------
Income (loss) before discontinued operations and
cumulative effect of accounting change. . . . . . . . . . . (7,508) 1,619 1,402 2,035 2,173
Income (loss) from operations to be disposed of, net. . . . (2,430) (7,408) (852) 353 (881)
Gain on disposal of orthodontic and
dental practices, net . . . . . . . . . . . . . . . . . . . -- 296 1,678 -- --
Cumulative effect of change in accounting
principle, net. . . . . . . . . . . . . . . . . . . . . . . -- -- 824 -- --
----------- ----------- -------- ------- --------
Income (loss) from discontinued operations, net and
cumulative effect of accounting change. . . . . . . . . . . (2,430) (7,112) 1,650 353 (881)
----------- ----------- -------- ------- --------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . $ (9,938) $ (5,493) $ 3,052 $ 2,388 $ 1,292
=========== =========== ======== ======= ========
Basic net income (loss) per share:
Net income (loss) from continuing operations. . . . . . . . $ (1.58) $ 0.34 $ 0.30 $ 0.45 $ 0.47
Net income (loss) from discontinued
operations, net . . . . . . . . . . . . . . . . . . . . . . (0.51) (1.50) 0.17 0.08 (0.19)
Cumulative effect of change in accounting principle . . . . -- -- 0.17 -- --
----------- ----------- -------- ------- --------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . $ (2.09) $ (1.16) $ 0.64 $ 0.53 $ 0.28
=========== =========== ======== ======= ========
Weighted average shares outstanding
(000's) -- Basic. . . . . . . . . . . . . . . . . . . . . . 4,747 4,723 4,711 4,523 4,613
=========== =========== ======== ======= ========
Diluted net income (loss) per share:
Net income (loss) from continuing operations. . . . . . . . $ (1.58) $ 0.33 $ 0.28 $ 0.43 $ 0.45
Net income (loss) from discontinued
operations, net . . . . . . . . . . . . . . . . . . . . . . (0.51) (1.45) 0.17 0.08 (0.18)
Cumulative effect of change in accounting principle . . . . -- -- 0.17 -- --
----------- ----------- -------- ------- --------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . $ (2.09) $ (1.12) $ 0.62 $ 0.51 $ 0.27
=========== =========== ======== ======= ========
Weighted average shares outstanding
(000's) -- Diluted. . . . . . . . . . . . . . . . . . . . . 4,747 4,899 4,940 4,725 4,852
=========== =========== ======== ======= ========
Balance Sheet Data (in $000's):
Cash and short-term investments . . . . . . . . . . . . . . $ 6,215 $ 12,906 $ 9,807 $14,746 $ 8,661
Current assets. . . . . . . . . . . . . . . . . . . . . . . 14,691 21,738 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. . . . . . . . . . . . . . . . . . . . 19,766 29,615 35,200 31,929 27,469
Total assets. . . . . . . . . . . . . . . . . . . . . . . . 77,956 84,085 68,116 38,343 30,792
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
Contracted PPO dental offices . . . . . . . . . . . . . . . 11,800 9,100 9,600 9,706 5,765
Company owned dental offices. . . . . . . . . . . . . . . . -- -- 27 33 30
</TABLE>
-21-
<PAGE>
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 the 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, securing cost effective contracts
with dentists may become more difficult in part due to the increased competition
among dental plans for dentist contracts. Other risks include the Company's
potential inability 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 the
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. 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, health care expenses, and as a result, profitability and
therefore, affect 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. Where applicable, amounts for 1999
and 1998 have been revised to give effect to the restatement of the financial
statements. (See Note 15 of Notes to the Consolidated Financial Statements).
-22-
<PAGE>
<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%
---------------- ---------------- ------------------
Selling, general and administrative
expenses . . . . . . . . . . . . . . $ 11,156 $ 8,811 $ 2,841
Percentage change. . . . . . . . . . 44.4% 54.1% 21.1%
Percent of revenues. . . . . . . . . 37.2% 26.3% 22.4%
---------------- ---------------- ------------------
Other income, net. . . . . . . . . . $ (692) $ 332 $ (302)
Percentage change. . . . . . . . . . (52.6)% 33.7% (23.5)%
Percent of revenues. . . . . . . . . 0.6% 1.4% 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 cumulative
effect of accounting change. . . . . $ (9,127) $ 217 $ (633)
Percentage change. . . . . . . . . . (563.7)% 15.5% (31.1)%
---------------- ---------------- ------------------
Income (loss) from discontinued
operations, net. . . . . . . . . . . $ 4,682 $ (7,938) $ 1,297
Percentage change. . . . . . . . . . 65.8% (961.0)% 367.4%
---------------- ---------------- ------------------
Net income (loss). . . . . . . . . . $ (4,445) $ (8,545) $ 664
Percentage change. . . . . . . . . . (80.9)% (280.0)% 27.8%
---------------- ---------------- ------------------
</TABLE>
1998 Versus 1997
The Company's revenues for the 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, the average revenue per member increased due to price increases
implemented by the Company and an increase in the volume of indemnity business,
which has significantly higher revenue per member than the dental HMO business.
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 68.3% of
revenues. The comparison to 1998 then shows a decrease of $432 in health care
expenses and a decrease of 0.6% in health care expenses as a percentage of
revenues. The Company continues to improve the health care cost ratios in its
existing business, including the business provided by its recent acquisitions.
Selling, general and administrative expenses increased $11,156 or 44.4%.
Including the Advantage acquisition for all of 1997, such increase would be
$10,586. The increase experienced in 1998 is attributable to various factors,
including a charge for uncollectible accounts receivable, increases in the sales
and management staff and other infrastructure components to support anticipated
growth of the Company in the future, the cost of the Company's relocation of its
corporate headquarters from Anaheim, California to Aliso Viejo, California, 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.
-23-
<PAGE>
Other income decreased by 52.6%, or $692, for the twelve months ended December
31, 1998 from $1,316 in 1997 to $624. This is primarily due to capital losses on
the sale of investments in 1998.
Loss on impairment of assets in the amount of $2,397 for the twelve months ended
December 31, 1998 primarily represents a reduction in the carrying value of
certain promissory notes related to the sale of discontinued operations, and a
charge to reduce the book value of the old corporate headquarters building to
estimated net realizable value.
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 of long-term debt, which was
entered into during 1997.
The net loss related to the discontinued orthodontic and general dental
practices for the twelve months ended December 31, 1998 was $2,430 versus a loss
of $7,112 for the same period in the prior year, a decrease of $4,682.
Net loss of $9,938 for the twelve months ended December 31, 1998 was an increase
of $4,445 over the loss of $5,493 reported for the same period a year ago. This
was primarily due to the increase in selling, general and administrative
expenses discussed above, which was partially offset by the decrease in the loss
from discontinued operations.
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 $332 for the twelve months ending December 31, 1997,
from $984 in 1996, to $1,316, an increase of 33.7 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 $7,112 for the twelve months ending December 31, 1997, an increase in
losses of $7,938 over the same period in 1996. The net loss in 1997 includes a
pre-tax charge of $7.2 million for under-performing notes and receivables ($4.3
million), litigation costs ($750), and other transition costs ($2.2 million).
The net loss in 1997 also includes a substantial increase in operating losses
incurred by the discontinued operations in 1997, compared to 1996.
Net loss of $5,493 for the twelve months ended December 31, 1997, was a decrease
of $8,545 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.
-24-
<PAGE>
Liquidity and Capital Resources
During 1998 and 1997, the Company met its cash requirements primarily through
borrowings on long-term debt and liquidations of investments. At December 31,
1998 and December 31, 1997, the current ratio was 0.6 to 1.0 and 1.1 to 1.0,
respectively. The Company's net worth was $19.8 million at December 31, 1998,
compared to $29.6 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 $6.0 million to satisfy depository requirements imposed
by state regulatory agencies.
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 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 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 8.91
percent as of December 31, 1999. 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 January 29, 1998, the Company entered into a $8 million revolving working
capital credit facility with Silicon Valley Bank (the "Bank"), all of which was
outstanding at December 31, 1998. 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.
Recent Developments
On May 28, 1999, the Company restructured the credit agreement related to $32.5
million of outstanding debt under its unsecured senior notes. The senior notes,
which have a final maturity date of September 30, 2005, (the "Notes") were
modified to provide for an increase in the interest rate from 7.91% to 9.91%
effective on April 28, 1999. The interest rate decreased to 8.91% in June 1999,
due to the execution of a definitive agreement with an investor group regarding
a planned investment in the company (see more discussion of this below). Under
the restructured agreement, the interest rate would decrease to 7.91% upon the
occurrence of certain other events, which have not yet occurred. In connection
with the restructuring, the Company issued warrants to acquire 382,000 shares of
the Company's common stock to the holder of the Notes. The warrants are
exercisable any time between January 1, 2000, and December 31, 2003, at a price
of $4.51 per share.
On May 28, 1999, the Company also restructured the credit agreement related to
its $8 million bank line of credit, under which $8 million was outstanding at
December 31, 1998. The restructured agreement extended the maturity date from
January 29, 1999 to January 28, 2000. The interest rate on the outstanding
balance is equal to the bank's prime rate plus 4%, effective on April 28, 1999.
The interest rate decreased to prime plus 3% in June 1999, due to the execution
of a definitive agreement with an investor group regarding a planned investment
in the company (see more discussion of this below). Under the restructured
agreement, the interest rate would decrease to prime plus 1.5% upon the
occurrence of certain other events, which have not yet occurred.
Additional collateral was provided to both the senior note holder and line of
credit lender under the restructured agreements. The Company also paid the
out-of-pocket attorneys' fees and costs incurred by both lenders through the
closing date, and the cost of certain consultants the lenders required the
Company to hire. The Company agreed to provide both lenders with monthly
consolidated financial statements and covenant compliance certificates, all
Securities and Exchange Commissions filings, and other financial documents as
they may reasonably request.
New provisions include a requirement for the Company to provide the lenders with
any notice of intent to audit from any regulatory agency, and copies of
correspondence from any regulatory agency and the Company's response thereto. In
addition, the Company is prohibited from declaring dividends or other
distributions, and may not incur any liens on the voting stock of any
subsidiaries of the Company. In the event the Company sells certain assets,
including the notes receivable related to the sale of dental offices, the
proceeds have to be paid to the holder of the Notes and the Company's line of
credit lender, in proportions specified in the restructured agreements. Various
other terms, covenants and provisions of the credit agreement, including various
financial covenants were also revised. In consideration of the new agreement,
both lenders waived all existing defaults under the previous credit agreements.
As of September 30, 1999 and December 31, 1999 the Company was not in compliance
with these new restructed debt agreements.
-25-
<PAGE>
On June 30, 1999, the Company entered into an agreement with an investor group
under which the investor group agreed to purchase $20 million of senior notes
and $20 million of convertible preferred stock from the Company. This
transaction was subject to regulatory approval, stockholder approval, and
various other conditions. In connection with this agreement, the Company filed
a Proxy Statement with the Securities and Exchange Commission on October 12,
1999. However, the agreement with the investor group was terminated in February
2000.
On March 1, 2000, the Company entered into an agreement with both of its lenders
and the same investor group, under which the investor group loaned $8 million to
the Company. Under this agreement, the investor group and the existing lenders
agreed to convert the $8 million loan, the outstanding balance of $7.0 million
under the bank line of credit, and the outstanding balance of $32.5 million
under the senior notes to convertible preferred stock, subject to regulatory
approval. Under this agreement, both lenders agreed not to demand or accept any
payment under the credit agreements, and not to take any enforcement actions of
any kind under the agreements until April 30, 2001. The $8 million loan from
the investor group will be converted to $6.4 million of Series A Preferred Stock
and $1.6 million of Series A Convertible Notes with the Series A Convertible
Notes converting into shares of Series A Preferred Stock upon shareholder
approval of an amendment to the Company's certificate of incorporation
increasing the number of authorized shares. The amounts due under the bank line
of credit and the senior unsecured notes, which was approximately $40.7 million
including accrued interest as of March 1, 2000, will be converted to Series B,C
and D Preferred Stock and Series B, C and D Convertible Notes in an aggregate
amount of $22 million with the remaining portion of the debt and accrued
interest forgiven by the lenders. The issuance and conversion of these shares
and notes is binding and scheduled to occur on the first day of the month
following regulatory approval, performance of the parties under the agreement,
forbearance on the part of the lenders, and as long as the Company has not been
placed in bankruptcy or receivership.
During June 1999 the Company completed the sale of its former headquarters
office building for approximately $3.5 million, which was the carrying amount of
the building on the Company's balance sheet as of December 31, 1998. The
carrying amount of the building is reflected on the consolidated balance sheet
under the caption "Assets Held for Sale."
Effective December 31, 1998, rather than the Company exercising its right to
foreclose on certain promissory notes (the "Notes"), the Company entered into a
Default Forbearance Agreement and an Irrevocable Power of Attorney with the
issuer of those notes (the "Issuer"), which will enable the Company to either
resell the assets or Notes relating to the practices. During 1999, the Company
reached an oral agreement with the Issuer and another third party (the
"Purchaser"), under which the Notes would be liquidated. Under this agreement,
the Issuer would convey the dental practices that comprise the collateral for
the Notes to the Purchaser, in exchange for proceeds that would be paid to the
Company in satisfaction of the Notes. Due to uncertainty of the Issuer of these
Notes to meet its contractual obligations to the Company (See RISK FACTORS and
Restatement) the Company did not recognize the transactions that gave rise to
these Notes as sales for accounting purposes and accordingly these Notes have
not been recorded in the Company's financial statements. Based on this oral
agreement with the Issuer, and other factors, the Company has determined that
the value of the discontinued net assets being transferred underlying the Notes
has been impaired. Accordingly, the Company recorded an additional loss of $6.4
million included in loss from operations of discontinued operations during the
nine months ended September 30, 1999 to reduce the carrying value of these
assets being transferred to their estimated net proceeds that would be realized
from a sale of these assets. During March 2000, the Company entered into a
definitive agreement with respect to this transaction, which is currently
pending regulatory approval.
The Company incurred a significant operating loss during 1999, in addition to
interest expense on outstanding debt, a reduction in the carrying value of notes
receivable, impairment of discontinued net assets transferred under contractual
arrangements and the valuation allowance against deferred tax assets. The
Company borrowed an additional $8 million in March 2000, and executed an
agreement under which all of its debt will be converted to equity upon
applicable state regulatory approval. However, there can be no assurance that
the Company will be successful in returning to profitability.
In December 1999, a shareholder lawsuit against the Company was filed, which
alleges that the Company and certain of its officers violated certain securities
laws by issuing a series of alleged false and misleading statements concerning
the Company's publicly reported revenues and earnings during a specified class
period. The Company has directors and officers liability insurance and intends
to vigorously defend this litigation. In the opinion of the Company's
management, the ultimate outcome of this matter will not have a material adverse
effect on the Company's financial position or results of operations.
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.
-26-
<PAGE>
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;
(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.
-27-
<PAGE>
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 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.
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.
-28-
<PAGE>
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.
The Company believes it has adequately modified its information systems so that
dates in the year 2000 are properly recognized by all of its significant
applications. As of January 31, 2000, the Company has experienced no
significant impact on its business related to the year 2000 issue, from either
its own information systems or those of its customers or vendors.
Impact of Inflation
Management believes that the Company's operations are not materially affected by
inflation. The Company believes that a significant portion of its costs are
capitated or fixed in nature and are directly related to membership levels, and
therefore related to premium levels.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is not subject to material risk from interest rate or foreign
currency exchange rate fluctuations.
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/A 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
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
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)
<FN>
-29-
<PAGE>
(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>
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
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 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.
-30-
<PAGE>
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. 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 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
-31-
<PAGE>
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 $100,000 for the previous years
ended December 31, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Annual Long Term
Compensation Compensation Awards
------------ -------------------
Other Stock
Name and Principal Position Year Salary($) 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
<FN>
* None.
(1) Joined the Company on January 5, 1997.
(2) Represents premiums paid for life insurance policies for the named
individuals.
</TABLE>
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 $170,000. The
Company may terminate the agreements for cause. The employee may terminate his
agreement for any reason. Should there be a change in control of the Company in
that more than fifty percent (50%) of the Company's then outstanding common
stock is purchased by a then non-existing stockholder, and newly elected
Directors constitute a majority of the Company's Board of Directors, the
employee, at his option, may terminate his employment. In such event, the
Company would be obligated to pay Dr. Baileys, Mr. Cox and Mr. Brendzel an
amount equal to three (3) times, and in the case of Dr. Kaufman, one (1) times
the employee's then current salary and bonus, paid on or before the fifth (5th)
day following such change in control, along with the continuance of all employee
benefits for the length of the employment agreement.
STOCK OPTIONS
The following table contains information concerning the grant of stock options
pursuant to the Stock Option Plan (the "Plan") during the fiscal year ended
December 31, 1998, to the named executives:
-32-
<PAGE>
<TABLE>
<CAPTION>
STOCK OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants Potential Realizable
----------------------------- Value at
Percent of Assumed Annual
Number of Total Rates of Stock
Securities Options/SARs Exercise or Price Appreciation
Underlying Granted to Base for Option Term(2)
Options/SARs Employees Price Expiration ------------------
Name Granted(#)(1) In Fiscal Year ($/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
<FN>
(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 $3.3125 as of December 31, 1998, appreciates at the stated rate, compounded annually,
from the date of grant to the expiration date. These values are calculated based on requirements
promulgated by the Securities and Exchange Commission and do not reflect the Company's estimate of
future stock price appreciation. Actual gains, if any, are dependent on the future market price of
the Company's common stock.
</TABLE>
STOCK OPTION EXERCISES AND HOLDINGS
The following information is with respect to the named executive officers and
indicated groups concerning the exercise of options during fiscal year December
31, 1998, and unexercised options held as of December 31, 1998.
<TABLE>
<CAPTION>
AGGREGATED STOCK OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
Shares Number of Securities Value of Unexercised
Acquired Value Underlying Unexercised In-the-Money
Name on Exercise(#) Realized($) 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
officers as a group (4 persons). . * * 81,333 26,667 0 0
All employees who are not executive
officers as a group (29 persons) . * * 15,067 35,733 0 0
<FN>
* 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.
</TABLE>
-33-
<PAGE>
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 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
<FN>
* 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 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.
</TABLE>
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/A, 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.
-34-
<PAGE>
<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
<FN>
(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
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.
</TABLE>
-35-
<PAGE>
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
to 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
$205,263 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 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.
PART IV
ITEM 14. 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/A 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/A 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's 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. Reports on Form 8-K
concerning the Company's restructuring of its debt to its lenders, the execution
of an definitive agreement with an investor group to invest $40 million into the
Company, the notification from NASDAQ that the Company's shares of common stock
were to be delisted from the NASDAQ as of the close of business on September 1,
1999, the execution of several amendments to the definitive agreement with an
investor group to invest $40 million into the Company, and the announcement that
the Company believes its revenue and its earnings for the quarter and nine
months ended September 30, 1999, which were announced on October 21, 1999, were
overstated by a material amount and that the Company expects to restate its
financial statements for the years ended December 31, 1998 and 1997 and such
financial statements and independent auditors' report should not be relied upon,
were filed with the Securities and Exchange Commission on or about June 4, 1999,
July 2, 1999, September 16, 1999, October 6, 1999, and November 16, 1999,
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/A for the period
ended December 31, 1998, as is set forth in full herein.
-36-
<PAGE>
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.
SAFEGUARD HEALTH ENTERPRISES, INC.
By: /s/ James E. Buncher Date: April 14, 2000
-------------------------- -------------------------
James E. Buncher
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Dennis L. Gates Date: April 14, 2000
-------------------------- -------------------------
Dennis L. Gates
Senior Vice President, Chief Financial
Officer and Director
(Principal Accounting Officer)
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.
By: /s/ James E. Buncher Date: April 14, 2000
-------------------------- -------------------------
James E. Buncher
President, Chief Executive Officer
and Director
By: /s/ Steven J. Baileys Date: April 14, 2000
-------------------------- -------------------------
Steven J. Baileys, D.D.S.
Chairman of the Board f Directors
By: /s/ Ronald I. Brendzel Date: April 14, 2000
-------------------------- -------------------------
Ronald I. Brendzel, J.D.
Senior Vice President, General Counsel,
Secretary and Director
By: /s/ Dennis L. Gates Date: April 14, 2000
-------------------------- -------------------------
Dennis L. ates
Senior Vice President, Chief Financial
Officer and Director
By: Date:
-------------------------- -------------------------
Jack R. Anderson
Director
By: Date:
-------------------------- -------------------------
Leslie B. Daniels
Director
-37-
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT INDEX
NUMBER
EXHIBIT OF
NUMBER COLUMNS DESCRIPTION
- ------- ------- --------------------------------------------------------------------------------
<C> <S> <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 Auditors' Consent
27.1 One Financial Data Schedule
<FN>
_________________________________________
(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 the Company's
Annual Report on Form 10-K for the period ended December 31, 1998.
(14) Incorporated by reference and disclosed and filed as an exhibit to the Company's Annual
Report on Form 10-K for the period ended December 31, 1998.
(15) Incorporated by reference 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.
</TABLE>
E-1
<PAGE>
<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
Page
-----------
<S> <C>
Independent Auditors' Report.. . . . . . . . . . . F-2
Financial Statements (As Restated)
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-23
Financial Statement Schedule (As Restated)
Schedule II - Valuation and Qualifying Accounts. S-1
<FN>
All other schedules are omitted where they are not applicable or the required
information is shown in the consolidated financial statements or notes thereto.
</TABLE>
F-1
<PAGE>
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. Also, as discussed in Note 15 to the
consoldidated financial statements, the accompanying 1998 and 1997 consolidated
financial statements and financial statement schedule have been restated for the
effects of certain transactions related to the sale of the Company's
discontinued dental operations.
/S/ DELOITTE & TOUCHE LLP
Costa Mesa, California
April 15, 1999 (Except for Note 15 for which the date is March__, 2000)
F-2
<PAGE>
<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
($000'S OMITTED, EXCEPT PER SHARE DATA)
December 31, 1998 1997
----------- ---------
(As Restated, see Note 15)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 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 $1,942 in 1998 and
$1,061 in 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,345 5,260
Notes receivable, current portion. . . . . . . . . . . . . . . . . . . . . . . . . -- 1,878
Income taxes receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485 132
Prepaid expenses and other current assets. . . . . . . . . . . . . . . . . . . . . 1,017 1,029
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 533
Assets held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,562 --
----------- ---------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,691 21,738
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 $3,561 in
1998 and $2,205 in 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,523 4,783
Assets of discontinued operations transferred under contractual arrangements, net. 8,950 2,478
Net assets of discontinued operations. . . . . . . . . . . . . . . . . . . . . . . -- 4,062
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. . . . . . . . . . . . . . . . . . . . . . . . . 8,415 1,236
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 247
----------- ---------
$ 77,956 $ 84,085
=========== =========
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
Accrued compensation agreement . . . . . . . . . . . . . . . . . . . . . . . . . . 311 383
Commitments and contingencies (Notes 6, 11 and 16)
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
shares issued and outstanding in 1998 and 1997, at stated value. . . . . . . . . 21,509 21,509
Retained earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,734 26,672
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . (354) (443)
Treasury stock, at cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (18,123) (18,123)
----------- ---------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,766 29,615
----------- ---------
$ 77,956 $ 84,085
=========== =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-3
<PAGE>
<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
($000'S OMITTED, EXCEPT PER SHARE DATA)
Years ended December 31, 1998 1997 1996
--------- -------- --------
(As Restated, see Note 15)
<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. . . . . . . . . . 36,259 25,103 16,292
Loss on impairment of assets. . . . . . . . . . . . . . 2,397 -- --
--------- -------- --------
Total expenses. . . . . . . . . . . . . . . . . . . . 104,676 90,805 70,826
--------- -------- --------
(Loss) income from operations . . . . . . . . . . . . . (7,227) 4,545 1,883
Other income. . . . . . . . . . . . . . . . . . . . . . 624 1,316 984
Interest expense. . . . . . . . . . . . . . . . . . . . (4,311) (2,871) (485)
--------- -------- --------
(Loss) income before (benefit) provision for income
taxes, discontinued operations and cumulative effect
of accounting change. . . . . . . . . . . . . . . . . (10,914) 2,990 2,382
(Benefit) provision for income taxes. . . . . . . . . . (3,406) 1,371 980
--------- -------- --------
(Loss) income from continuing operations
before cumulative effect of accounting change . . . . (7,508) 1,619 1,402
--------- -------- --------
Discontinued operations and cumulative effect
of accounting change:
Loss from operations to be disposed of (net of income
tax benefit of $1,554 in 1998, $4,736 in 1997 and
$616 in 1996 and net of after tax deferred loss
of $621 in 1996). . . . . . . . . . . . . . . . . . . (2,430) (7,408) (852)
Gain on disposal of orthodontic and
dental practices (net of income tax expense of
$189 in 1997 and $1,088 in 1996). . . . . . . . . . . -- 296 1,678
Cumulative effect of change in accounting principle-
orthodontic operations, net of tax of $536 in 1996. . -- -- 824
--------- -------- --------
(Loss) income from discontinued operations and
cumulative effect of accounting change. . . . . . . . (2,430) (7,112) 1,650
--------- -------- --------
Net (loss) income . . . . . . . . . . . . . . . . . . $ (9,938) $(5,493) $ 3,052
========= ======== ========
Basic (loss) earnings per share:
(Loss) income from continuing operations. . . . . . . $ (1.58) $ 0.34 $ 0.30
(Loss) income from discontinued operations. . . . . . (0.51) (1.50) 0.17
Cumulative effect of change in accounting principle . -- -- 0.17
--------- -------- --------
Net (loss) income . . . . . . . . . . . . . . . . . . $ (2.09) $ (1.16) $ 0.64
========= ======== ========
Diluted (loss) earnings per share:
(Loss) income from continuing operations. . . . . . . $ (1.58) $ 0.33 $ 0.28
(Loss) income from discontinued operations. . . . . . (0.51) (1.45) 0.17
Cumulative effect of change in accounting principle . -- -- 0.17
--------- -------- --------
Net (loss) income . . . . . . . . . . . . . . . . . . $ (2.09) $ (1.12) $ 0.62
========= ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-4
<PAGE>
<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
($000'S OMITTED)
Accumulated
Other
Number of Shares Comprehensive
Common Retained (Loss) 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 3,052
Unrealized holding gains
arising during the year. . . . . . 124
Less: reclassification adjustment
for gains included in net income . (68)
---------
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). . . . 12 163 163
------- --------- ------- --------- -------- --------- -------
December 31, 1996. . . . . . . . . . 7,991 (3,275) 21,255 32,165 (97) (18,123) 35,200
Comprehensive (loss) income:
Net loss (as restated, see Note 15). (5,493) (5,493)
Unrealized holding losses
arising during the year. . . . . . (357)
Less: reclassification adjustment
for losses included in net income. 11
--------
Net unrealized loss on
investment securities
available-for-sale, net
of tax benefit of $221 . . . . . . (346) (346)
---------
Total comprehensive loss (as
restated, see Note 15) . . . . . . (5,839)
Exercise of stock options
(includes $121 tax benefits) . . . 31 254 254
------- --------- ------- --------- -------- --------- -------
December 31, 1997 (as restated,
see Note 15) . . . . . . . . . . . 8,022 (3,275) 21,509 26,672 (443) (18,123) 29,615
Comprehensive (loss) income:
Net loss (as restated, see Note 15). (9,938) (9,938)
Unrealized holding losses
arising during the year. . . . . . (161)
Less: reclassification adjustment
for losses included in net income. 250
--------
Net unrealized gain on
investment securities
available-for-sale, net
of tax of $57. . . . . . . . . . . 89 89
-------
Total comprehensive loss (as
restated, see Note 15) . . . . . . (9,849)
------- --------- ------- --------- -------- --------- -------
December 31, 1998 (as
restated, see Note 15) . . . . . . 8,022 (3,275) $21,509 $ 16,734 $ (354) $(18,123) $19,766
======= ========= ======= ========= ======== ========= =======
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
F-5
<PAGE>
<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
($000'S OMITTED)
(As Restated, see Note 15)
Year ended December 31, 1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income. . . . . . . . . . . . . . . . . . . . . . . . . $ (9,938) $ (5,493) $ 3,052
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
Loss from discontinued operations. . . . . . . . . . . . . . . . . 2,430 7,408 852
Gain on disposal of discontinued orthodontic and dental practices. -- (296) (1,678)
Gain on sale of property and equipment . . . . . . . . . . . . . . -- -- (7)
Loss on impairment of assets . . . . . . . . . . . . . . . . . . . 2,397 -- --
Depreciation and amortization. . . . . . . . . . . . . . . . . . . 3,505 2,284 2,350
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . (2,349) (1,380) 1,408
Changes in operating assets and liabilities, net
of effects of acquisitions:
Accounts and current notes receivable, net . . . . . . . . . . . 912 (105) (1,478)
Income taxes receivable. . . . . . . . . . . . . . . . . . . . . (353) (88) 34
Prepaid expenses and other current assets. . . . . . . . . . . . 449 (299) (419)
Accounts payable and accrued expenses. . . . . . . . . . . . . . 4,281 134 (111)
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . (155) 625 357
Reserves for dental claims . . . . . . . . . . . . . . . . . . . (73) 801 1,067
--------- --------- ---------
Net cash provided by continuing operations . . . . . . . . . . . 1,106 3,591 5,427
Net cash used in discontinued operations . . . . . . . . . . . . (2,779) (5,183) (6,297)
--------- --------- ---------
Net cash (used in) provided by operating activities. . . . . . . (1,673) (1,592) 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. . . . . . . . . . . . . . . . (2,357) (2,118) (3,029)
Proceeds from sale of property and equipment . . . . . . . . . . . -- -- 7
Payments received on notes receivable. . . . . . . . . . . . . . . 92 265 --
Issuance of notes receivable . . . . . . . . . . . . . . . . . . . (750) -- --
Cash paid for businesses acquired, net of cash acquired. . . . . . -- (1,203) (20,320)
Additions to intangibles and other assets. . . . . . . . . . . . . -- (2,109) (127)
--------- --------- ---------
Net cash provided by (used in) investing activities -
continuing operations. . . . . . . . . . . . . . . . . . . . . . 3,041 (7,689) (17,832)
Net cash used in discontinued operations . . . . . . . . . . . . -- (684) (1,670)
--------- --------- ---------
Net cash provided by (used in) investing activities. . . . . . . 3,041 (8,373) (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 . . . . . . . . . . . . (72) (30) --
Payments on bank debt. . . . . . . . . . . . . . . . . . . . . . . -- (27,000) --
Payments on notes payable and long-term debt . . . . . . . . . . . (9,692) (692) (298)
--------- --------- ---------
Net cash (used in) provided by financing activities. . . . . . . (1,764) 12,911 18,832
--------- --------- ---------
Net (decrease) increase in cash. . . . . . . . . . . . . . . . . . (396) 2,946 200
Cash and cash equivalents at beginning of year . . . . . . . . . . 3,652 706 506
--------- --------- ---------
Cash and cash equivalents 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>
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 1,000,000 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 27 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. ("SafeHealth, 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.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company's financial statements
do not include any adjustments relating to the recoverability and classification
of recorded asset amounts or the amounts and classification of liabilities that
might be necessary should the Company be unable to continue as a going concern.
As shown in the financial statements, during the year ended December 31, 1998
and 1997, the Company incurred net losses of $9.9 million and $5.5 million,
respectively, and net cash used by operating activities was $1.7 million and
$1.6 million, respectively. As of December 31, 1998, the Company's current
liabilities exceeded its current assets by $10.7 million. As of December 31,
1999, the Company was in violation of certain financial covenants relating to
its two major lenders and was $4.5 million below the minimum capital
requirements for one of its regulated subsidiaries.
Management believes that the Company's continuation as a going concern is
dependent upon its ability to generate sufficient cash flow to meet its
obligations on a timely basis, to comply with the terms and covenants of its
financing agreements, to obtain additional financing as may be required, and
ultimately to attain profitable operations. As further discussed in Note 16, on
March 1, 2000 the Company entered into an agreement with its primary lenders and
an investor group. Under this agreement all the Company's debt will be
converted to equity, and the Company was able to cure its minimum capital
deficiency. Also, in connection with this agreement the Company obtained a new
chief executive officer and certain new directors. Management's plans to
continue as a going concern and to return the Company to profitability include
plans to increase premium rates, reduce certain types of non-standard provider
payments, reduce the number of its employees by consolidating certain
administrative functions in one location, reduce the amount of office space
used, and reduce various other selling, general and administrative expenses.
Management's plans also include enhanced programs for customer retention,
increasing the efficiency of its provider network and streamlining operations
with a focus toward strengthening customer service. Management believes that
the results of its plans, and with the agreement reached on March 1, 2000
discussed above, that the Company will be able to meets its ongoing obligations
on a timely basis and return to profitable operations.
Basis of Consolidation
The consolidated financial statements include 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.
F-7
<PAGE>
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 (SFAS) No. 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 accumulated other comprehensive income, 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 gains of $146,000 and increased stockholders' equity by $89,000 (net
unrealized gains, less deferred income taxes of $57,000). At December 31, 1997,
the Company recorded net unrealized losses of $567,000 and decreased
stockholders' equity by $346,000 (net unrealized losses, less deferred income
taxes of $221,000). At December 31, 1996, the Company recorded net unrealized
gains of $92,000 and increased stockholders' equity by $56,000 (net unrealized
gains, less deferred income taxes of $36,000).
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.
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 unrealized gain of $0.1 million (net of tax of $0.1 million),
which was reported in other comprehensive income. The change in classification
was a result of a change in management's ability to hold these securities to
maturity date 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. 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: buildings - 30 years; 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 Financial Accounting Standards Board (FASB) issued SFAS No.
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. SFAS No. 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.
F-8
<PAGE>
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 SFAS No. 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 the financial reporting basis and the tax
basis of the Company's assets and liabilities result in a deferred tax asset,
SFAS No. 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.
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, and 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.
The Company is responsible for paying claims submitted by dentists for certain
types of dental services provided to patients who have purchased dental coverage
from the Company. Estimates of the liability for reported claims are determined
primarily by evaluation of individual reported claims. Estimates of the
liability for claims incurred but not reported are based on actuarial
projections of historical developments with respect to the probable number and
nature of such claims. Although the Company considers its actual experience to
date and industry data in determining such reserves, assumptions and projections
as to future events are necessary, and ultimate losses may differ significantly
from the amounts provided. Methods for making such estimates and for
establishing the resulting liabilities are continually reviewed and updated, and
any resulting adjustments are reflected in the results of current operations.
Management believes that, in the aggregate, the reserves for dental claims are
adequate.
Net (Loss) Income Per Share
(Loss) earnings per share are stated in accordance with the provisions of SFAS
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). At December 31,
1998, options to purchase 769,800 shares of common stock at a weighted average
exercise price of $10.58 were outstanding but were not included in the
computation of diluted loss per share as their effect on loss per share was
antidilutive. At December 31, 1997 and 1996, options to purchase 150,350 and
23,500 shares, respectively, of common stock at a weighted average exercise
price of $11.13 and $10.29, respectively, were outstanding but were not included
in the computation of diluted EPS because the options' exercise price was
greater than the average market price of the common shares. (See Note 9).
F-9
<PAGE>
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
(000's omitted, except per share data):
<TABLE>
<CAPTION>
1998 1997 1996
----------- --------- -------
Net Number Per-share Net Number Per-share Net Number Per-share
loss of shares amount loss of shares amount income of shares amount
- --------------------------------- ----------- --------- ------- ----------- --------- -------- ---------- --------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic (loss) earnings per share . $ (9,938) 4,747 $(2.09) $ (5,493) 4,723 $ (1.16) $ 3,052 4,711 $0.64
Effect of Dilutive Securities
Options . . . . . . . . . . . . . -- -- -- 176 -- 229
Diluted (loss) earnings per share $ (9,938) 4,747 $(2.09) $ (5,493) 4,899 $ (1.12) $ 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, which are included in investments. 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. (See Note 16).
Reclassifications
Certain prior year amounts have been reclassified to conform with the financial
statement presentation for the year ended December 31, 1998.
Stock Options
In October 1995, the FASB 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.
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 transactions. (See Note 9).
Recent Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income,
which becomes effective for fiscal years ending after December 15, 1997. SFAS
No. 130 requires that all components of comprehensive income be displayed with
the same prominence as other financial statements.
In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information, which becomes effective for fiscal years
ending after December 15, 1997. SFAS No. 131 requires that future financial
statements contain disclosures about products and services, geographic areas and
major customers related to its reportable operating segments.
The Company adopted SFAS Nos. 130 and 131 in 1998.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which becomes effective for fiscal years
beginning after June 15, 2000, as amended. SFAS No. 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 SFAS No. 133 to have a significant impact on the
Company's financial position or results of operations.
F-10
<PAGE>
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. The assets sold consisted
primarily of accounts receivable, supply inventories, equipment and leasehold
improvements. Each practice sold could enter into a contract with the Company's
practice management subsidiary, whereby the Company would provide certain
services to support the operation of their practice, including administrative
support. The Company discontinued its practice management subsidiary and
terminated these agreements in 1998.
Through June 1997, the Company sold fifteen general dental practices to
purchasers in exchange for consideration consisting of $10.4 million of
long-term promissory notes. In September 1997, the Company sold the remaining
practices to Pacific Coast Dental, Inc., Associated Dental Services, Inc., and
affiliated dentists (the "Purchasers" or "PCD") in exchange for consideration
consisting of $8.0 million of long-term promissory notes.
During 1997 and 1998, of the fifteen practices previously sold to parties other
than PCD, four of these practice were conveyed to PCD in exchange for the
assumption of the promissory notes payable to the Company. At the time of the
conveyances of these practices to PCD, the related promissory notes had an
aggregate carrying value of $1.9 million on the Company's balance sheet, which
exceeded the historical cost of the net assets of the related dental practices
by $1.4 million.
Orthodontic Practices
On February 26, 1998, the Company announced the discontinuance of its
orthodontic practices. The assets of the orthodontic practices consisted
primarily of accounts receivable, supply inventory and dental equipment,which
were sold on April 1, 1998, pursuant to the terms of the definitive Master Asset
Purchase Agreement (the "Agreement") dated and effective as of April 1, 1998, by
and among the Company and PCD. The orthodontic practices were sold for $15
million, represented by an 8 1/2% 30-year promissory note and secured by all
current and future assets of the Purchasers, including those assets transferred
under the Agreement made by PCD. Among other provisions, the Agreement includes
a long term commitment to continue to provide orthodontic services to the
members of SafeGuard Health Plans, Inc.
In connection with the sale of the general dental and orthodontic practices to
PCD, the Company committed to lend PCD certain amounts for working capital. As
of December 31, 1997 and 1998 the working capital loans to PCD amounted to $.8
million and $1.6 million, respectively.
In a subsequent review of the facts and circumstances related to this matter,
and based upon no new information that was not otherwise available to the
Company at the time when it entered into these transactions, the Company's
management concluded that PCD did not have sufficient resources to repay the
promissory notes from sources other than the operations of the purchased
practices. Accordingly, the related promissory notes and the working capital
loans have not been recorded in the financial statements. The historical cost
of the net assets of the practices sold to PCD are reflected on the Company's
balance sheet under the caption "Assets of discontinued operations transferred
under contractual arrangements." The financial statements do not reflect any
gains on these sale transactions, and do not reflect any interest income on the
related promissory notes. In addition, the carrying value of the promissory
notes related to the four practices that were also transferred to PCD from other
purchasers, was reduced to the historical cost of the net assets of the related
practices. The working capital loans were fully reserved at the time the loans
were made and the Company has no further obligation to provide such working
capital loans. Interest payments received of $ .3 million have been applied to
reduce the historical cost of the net assets transferred.
Net assets of discontinued operations at December 31, 1997, which represent
orthodontic practices subsequently transferred to PCD, are shown at their net
book value (in 000's), and consisted of the following:
Accounts receivable, net $1,896
Supplies inventory 270
Leasehold improvements and equipment, net 2,478
Other 168
Legal reserves (750)
-----
$4,062
======
F-11
<PAGE>
Operating and transactional results of discontinued general dental and
orthodontic practices
In 1996, operating losses of the discontinued general dental practices, prior to
the measurement date of October 21, 1996, were $1.6 million, net of a tax
benefit of $1.0 million. This amount is included in the accompanying
consolidated statements of operations under the caption "Loss from operations to
be disposed of." The operating losses subsequent to the measurement date in
1996 were recognized in the consolidated statements of operations up to the
amount of the net gain on disposal of the dental practices, which was $1.3
million, net of tax expense of $0.8 million, for 1996. The remaining losses of $
.6 million, net of tax expense of $ .4 million for the year ended December 31,
1996, were deferred as an asset until the completion of the sale of all the
dental practices as of September 30, 1997.
Operating income for the years ended December 31, 1996 and 1997 of the
orthodontic practices were $2.0 million and $1.1 million, respectively, net of
tax expense of $1.2 million and $.7 million, respectively. Operating losses for
the year ended December 31, 1998 were $.6 million, net of tax benefits of $.4
million. These amounts are included in the accompanying consolidated statements
of operations under the caption "Loss from operations to be disposed of."
In 1996 and 1997, the Company recognized gain on the disposal of general dental
practices of $1.7 million and $0.3 million, respectively, net of tax expense of
$1.1 million and $0.2 million, respectively.
Net assets of discontinued operations transferred to PCD, which are reflected on
the Company's balance sheet under the caption "Assets of discontinued operations
transferred under contractual arrangements" yielded losses during the years
ended December 31, 1997 and 1998 and are included under the caption "Loss from
operations to be disposed of" in the amount of $8.5 million and $1.8 million,
respectively, net of income tax benefit of $5.4 million and $1.1 million,
respectively.
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 which is being amortized
over its useful life which is estimated to be 40 years. 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 $1.2 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 which is being amortized over its useful life which is estimated to be
40 years. The acquisition is included as part of the Company's consolidated
financial statements, subsequent to May 9, 1997.
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.
F-12
<PAGE>
1997 1996
-------- -------
Revenues $97,808 $77,990
Net income (loss) (5,023) 1,705
Net (loss) income per diluted common share $(1.03) $0.35
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>
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. $ 3,538 $ 100 $ -- $ 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. . . . . . . . . . . 2,716 2,050
-------------------- ---------------------
Total available-for-sale . . . . . . . $ 7,751 $ 7,184
==================== =====================
</TABLE>
F-13
<PAGE>
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 specific identification.
Gross realized gains on sales of investment securities were $815,000 and gross
realized losses were $1,225,000 for the year ended December 31, 1998. Gross
realized gains on sales of investment securities were $155,000 and gross
realized losses were $173,000 for the year ended December 31, 1997. Gross
realized gains on sales of investment securities were $149,000 and gross
realized losses were $38,000 for the year ended December 31, 1996.
Property and Equipment
<TABLE>
<CAPTION>
The Company's property and equipment consist of the following (in 000's):
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>
F-14
<PAGE>
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>
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
Other notes . . . . . 1,894 3,086
-------- ---------
Less: current portion (9,894) (10,192)
-------- ---------
Long-term debt. . . . $32,500 $ 33,894
======== =========
</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 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.
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 both the senior notes and the bank loan, the Company is
subject to certain financial and operational debt covenants. The Company
obtained waivers for lack of compliance with such covenants through the date of
the restructure of these obligations. See Note 16 for more discussion of notes
payable and long-term debt.
NOTE 6: LEASE OBLIGATIONS
The Company leases administrative offices, computer equipment and furniture
under various non-cancelable operating leases. Rental expense (in 000's) was
$1,501, $1,217 and $2,201 in 1998, 1997 and 1996, respectively. 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:
1999 . . . . $3,682
2000 . . . . 3,624
2001 . . . . 3,351
2002 . . . . 2,522
2003 . . . . 1,993
Thereafter 8,436
F-15
<PAGE>
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. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (31) $ 1,585 $ 936
State. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 407 343
Deferred income taxes:
Federal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,667) (483) (233)
State. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (719) (138) (66)
-------- -------- -------
$(3,406) $ 1,371 $ 980
======== ======== =======
(Benefit) provision due to:
Continuing operations. . . . . . . . . . . . . . . . . . . . . . . $(3,406) $ 1,371 $ 980
Discontinued operations. . . . . . . . . . . . . . . . . . . . . . (1,554) (4,547) 1,008
-------- -------- -------
$(4,960) $(3,176) $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. . . . . . . . $(3,820) (35.0%) $1,047 35.0% $834 35.0%
State taxes, net of
Federal effect. . . . . (497) (4.5) 158 5.3 181 7.6
Tax-free income . . . . (19) (0.2) (35) (1.2) (99) (4.2)
Non-deductible
amortization. . . . . 254 2.3 186 6.2 47 2.0
Dental office transfer. 670 6.1
Other . . . . . . . . . 6 .1 15 0.5 17 0.7
-------- ------- ------- ----- ----- -----
$(3,406) (31.2%) $1,371 45.8% $980 41.1%
======== ======= ======= ===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
The major components of the Company's deferred taxes are as follows (in $000's):
December 31, . . . . . . . . . . . . . . . . . . 1998 1997
<S> <C> <C>
------- -------
Current deferred tax assets (liabilities):
Policy reserves. . . . . . . . . . . . . . . . . $ 459 $ 784
Amortization of prepaid expenses . . . . . . . . (23) (87)
State income taxes . . . . . . . . . . . . . . . (501) (100)
Other. . . . . . . . . . . . . . . . . . . . . . 132 (64)
------- -------
Net current deferred tax asset . . . . . . . . 67 533
------- -------
Non-current deferred tax assets (liabilities):
Reserve for revenue adjustments. . . . . . . . . 1,697 607
Depreciation and amortization. . . . . . . . . . (875) (748)
Gain on sale of dental offices . . . . . . . . . 5,200 939
Unrealized loss on investments . . . . . . . . . 97 283
Amortization of intangibles. . . . . . . . . . . 43 30
Net operating loss . . . . . . . . . . . . . . . 2,253 --
Other. . . . . . . . . . . . . . . . . . . . . . -- 125
------- -------
Net non-current deferred tax asset (liability) 8,415 1,236
------- -------
Net deferred tax asset (liability) . . . . . . $8,482 $1,769
======= =======
</TABLE>
As of December 31, 1998, the Company has not recorded a valuation allowance
against deferred tax assets as management believed it was more likely than not
that such assets will be realized. The Company has net operating loss carry
forwards for federal and state purposes of $5,674,000 and $3,667,000 which begin
to expire in 2018 and 2003, respectively.
F-16
<PAGE>
NOTE 8: OTHER INCOME
Other income consists principally of interest income and dividends earned on
investments, as follows (in $000's):
Year ended December 31, 1998 1997 1996
----- ------- -----
Interest income . . . . $ 268 $1,326 $ 809
Dividend income . . . . -- 12 61
Other . . . . . . . . . 356 (22) 114
----- ------- -----
$ 624 $1,316 $ 984
===== ======= =====
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. . . . . . 643,517 510,817 397,500
Granted . . . . . . . . . . . . . . . . . . 178,000 169,500 132,300
Canceled. . . . . . . . . . . . . . . . . . (51,717) (6,134) (6,987)
Exercised . . . . . . . . . . . . . . . . . -- (30,666) (11,996)
--------- --------- ---------
Outstanding at end of year. . . . . . . . . 769,800 643,517 510,817
========= ========= =========
Exercisable at end of year. . . . . . . . . 455,066 349,895 296,056
========= ========= =========
Weighted average exercise price of options:
Granted . . . . . . . . . . . . . . . . . . $ 8.78 $ 12.59 $ 16.67
Canceled. . . . . . . . . . . . . . . . . . $ 12.45 $ 14.83 $ 11.27
Exercised . . . . . . . . . . . . . . . . . -- $ 4.35 $ 11.66
Outstanding . . . . . . . . . . . . . . . . $ 10.58 $ 11.13 $ 10.29
Excercisable. . . . . . . . . . . . . . . . $ 10.10 $ 9.17 $ 7.46
</TABLE>
F-17
<PAGE>
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- 10.04 228,500 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 SFAS No.
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 revised to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
--------- -------- ------
<S> <C> <C> <C>
Net income (loss) (in $000's)
As reported. . . . . . . . . . . . $ (9,938) $(5,493) $3,052
Pro forma. . . . . . . . . . . . . (10,325) (5,846) 2,855
Diluted net income (loss) per share
As reported. . . . . . . . . . . . $ (2.09) $ (1.17) $ .62
Pro forma. . . . . . . . . . . . . $ (2.17) $ (1.19) $ .58
</TABLE>
Under SFAS No. 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 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
marketed 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 SFAS No. 121, the Company wrote down the value of the
building by $569,000 and accrued closing costs of $188,000, as of December 31,
1998. The book value of these assets was $3,562,000 at December 31, 1998 and is
recorded as "Assets held for sale" on the balance sheet.
During the fourth quarter of 1998, the Company, in an effort to liquidate
assets, offered to reduce the principal amount of the notes due from certain
parties to whom it had sold dental practices (other than PCD, as discussed in
Note 2) in exchange for current cash payment in satisfaction of the notes.
Thus, the Company provided a reserve of $1.9 million at December 31, 1998 to
reflect the impact of its decision to actively pursue liquidation of the notes
receivable.
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. See also Note 16.
F-18
<PAGE>
The Company has employment agreements with various executive officers requiring
an annual payment of the following (in $000's):
Year ending December 31,
1999 $1,140
2000 551
2001 155
2002 39
2003 --
NOTE 12: RESERVES FOR DENTAL CLAIMS
Activity in the liability for dental indemnity insurance policy reserves and
specialists claims expense is summarized as follows (in $000's):
<TABLE>
<CAPTION>
Specialist
Policy Reserves Claims Expense 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 26,226
Prior years (13) (22) (35)
----------------- ---------------- --------
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 20,602
Prior years 2,944 1,143 4,087
----------------- ---------------- --------
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 General Dental Practices and the Orthodontic
Practices have both been discontinued. The last of the discontinued operations
were divested effective April 1, 1998. The identifiable assets for the
discontinued operations have been segregated on the Consolidated Statements of
Financial Position as "Net assets of discontinued operations." (See Note 2:
Discontinued Operations). Following the April 1, 1998 divestiture, 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 tables 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.
Restatements:
F-19
<PAGE>
Subsequent to the issuance of the Company's financial statements for each of the
quarters ended March 31, 1998, June 30, 1998, and September 30, 1998, and for
the six months ended June 30, 1998 and the nine months 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, the quarterly financial statements for each of the quarters ended
March 31, 1998, June 30, 1998, and September 30, 1998, and for the six months
ended June 30, 1998 and the nine months ended September 30, 1998 have been
restated from the amounts previously reported.
As discussed in Note 15, subsequent to the issuance of the Company's financial
statements for the year ended December 31, 1998, the Company's management
determined that the accounting treatment applied to certain sale transactions of
discontinued orthodontic and general dental practices that occurred during 1998
and 1997 required modification. As a result, the quarterly financial statements
for each of the quarters ended September 30, 1997, March 31, 1998, June 30,
1998, and September 30, 1998, and the financial statements for the nine months
ended September 30, 1997 and the six months ended June 30, 1998 and nine months
ended September 30, 1998 have been restated from the amounts previously
reported.
Each line item in the Company's balance sheet or income statement that is
affected by the restatements discussed above is shown in the table below.
Fourth Quarter Adjustments:
During its year end evaluation in 1998, 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
(before a tax effect of $1,225,000) during the quarter ended December 31, 1998.
As a result of its year end evaluation in 1997, the Company increased its claim
reserves by $1.5 million, which resulted in a $1.5 million charge to pretax
earnings in the fourth quarter of 1997. In addition, the Company recorded a
pre-tax charge of $7.2 million related to discontinued operations in the fourth
quarter of 1997.
Reclassifications:
Revenues and expenses related to the Company's orthodontic operations for each
of the quarters ended March 31, 1997, June 30, 1997, and September 30, 1997 have
been reclassified to reflect them as discontinued operations. Each line item in
the Company's income statement that is affected by these reclassifications is
shown in the table below.
The effects of the restatements, adjustments, and reclassifications on
previously filed interim financial statements are as follows (in thousands,
except per share data):
<TABLE>
<CAPTION>
At March 31, 1998 At June 30, 1998 At September 30, 1998
As As As
previously As previously As previously As
reported restated reported restated reported restated
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Assets
Accounts and notes receivable. . . . . . . . $ 7,894 $ 7,614 $ 9,477 $ 9,288 $ 11,235 $ 10,469
Prepaids and other current assets. . . . . . 1,378 1,021 1,361 923 1,003 565
Net assets of discontinued operations. . . . 5,143 4,523 -- -- -- --
Assets of discontinued operations
transferred under contractual arrangements -- 2,465 -- 8,950 -- 8,950
Property & equipment, net. . . . . . . . . . 9,729 9,684 10,184 9,998 10,598 9,557
Notes receivable-long term . . . . . . . . . 12,389 4,645 21,753 -- 22,778 825
Deferred income taxes. . . . . . . . . . . . -- 1,094 -- 1,315 -- 191
Deferred income taxes - long term. . . . . . 1,608 1,683 -- 4,738 -- 5,041
Total assets . . . . . . . . . . . . . . . . $ 88,796 $ 83,384 $ 91,630 $ 82,238 $ 88,570 $ 77,849
F-20
<PAGE>
Liabilities and stockholders' equity
Accounts payable and accrued expenses. . . . $ 3,484 $ 3,552 $ 5,907 $ 6,043 $ 3,751 $ 4,454
Income taxes payable . . . . . . . . . . . . 427 221 -- -- -- --
Deferred revenues. . . . . . . . . . . . . . 1,198 1,198 1,341 1,441 949 1,049
Deferred income taxes. . . . . . . . . . . . 1,000 -- 2,789 976 2,837 561
Retained Earnings. . . . . . . . . . . . . . 30,479 26,205 32,401 24,586 31,778 22,530
Total Liabilities and Stockholders' Equity . $ 88,796 $ 83,384 $ 91,630 $ 82,238 $ 88,570 $ 77,849
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended Three Months Ended Three Months Ended
March 31, 1998 June 30, 1998 September 30, 1998 December 31, 1998
As As As As
previously As previously As previously As previously As
Statements of operations reported restated reported restated reported restated reported restated
-------- -------- -------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue $24,395 $24,396 $24,540 $24,440 $24,004 $23,504 $ 24,510 $25,109
Health care expenses 16,431 16,431 16,288 16,288 16,539 16,539 16,762 16,762
Selling, general and administrative 6,830 7,300 6,567 7,172 7,567 7,920 16,528 13,867
Other income (loss) 970 766 534 (35) 199 (948) 638 841
Loss on impairment of assets -- -- -- -- -- -- (11,165) (2,397)
Interest expense (922) (922) (973) (973) (1,020) (1,020) (1,396) (1,396)
-------- -------- -------- -------- -------- -------- --------- --------
Income (loss) from continuing
operations before tax 1,182 509 1,246 (28) (923) (2,923) (20,703) (8,472)
Provision (benefit) for income taxes 519 233 538 25 (300) (988) (7,395) (2,676)
-------- -------- -------- -------- -------- -------- --------- --------
Income (loss) from continuing
operations 663 276 708 (53) (623) (1,935) (13,308) (5,796)
Income (loss) from discontinued
operations -- (742) (620) (1,566) -- (122) -- --
Gain on disposal of discontinued
operations -- -- 1,834 -- -- -- 252 --
-------- -------- -------- -------- -------- -------- --------- --------
Net income (loss) $ 663 $ (466) $ 1,922 $(1,619) $ (623) $(2,057) $(13,056) $(5,796)
======== ======== ======== ======== ======== ======== ========= =======
Basic Earnings (Loss) Per Share
Income (loss) from continuing operations
per share $ 0.14 $ 0.06 $ 0.15 $ (0.01) $ (0.13) $ (0.41) $ (2.80) $ (1.22)
Income (loss) from discontinued operations
per share -- (0.16) 0.26 (0.46) -- (.02) .05 --
-------- -------- -------- -------- -------- -------- --------- -------
Net income (loss) per share $ 0.14 $ (0.10) $ 0.41 $ (0.47) $ (0.13) $ (0.43) $ (2.75) $ (1.22)
======== ======== ======== ======== ======== ======== ========= ========
Weighted average shares 4,747 4,747 4,747 4,747 4,747 4,747 4,747 4,747
Diluted Earnings (Loss) Per Share
Income (loss) from continued
operations per share $ 0.14 $ 0.06 $ 0.15 $ (0.01) $ (0.13) $ (0.41) $ (2.80) $ (1.22)
Income (loss) from discontinued
operations per share -- (0.15) 0.25 (0.46) -- (.02) .05 --
-------- -------- -------- -------- -------- -------- --------- --------
Net income (loss) per share $ 0.14 $ (0.09) $ 0.40 $ (0.47) $ (0.13) $ (0.43) $ (2.75) $ (1.22)
======== ======== ======== ======== ======== ======== ========= ========
Weighted average shares 4,820 4,820 4,802 4,747 4,747 4,747 4,747 4,747
</TABLE>
F-21
<PAGE>
<TABLE>
<CAPTION>
At September 30, 1997
As
previously As
reported restated
--------- ---------
<S> <C> <C>
Balance Sheet
Accounts and notes receivable . . . $ 11,398 $ 11,309
Notes receivable-long term. . . . . 15,423 6,599
Assets of discontinued operations
transferred under contractual
arrangements, net . . . . . . . . . -- 2,478
Deferred income taxes - long-term . -- 2,510
Total assets. . . . . . . . . . . . 94,780 90,855
Retained earnings . . . . . . . . . 35,958 32,033
Total liabilities and stockholders'
equity. . . . . . . . . . . . . . 94,780 90,855
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended Three Months Ended Three Months Ended
March 31, 1998 June 30, 1998 September 30, 1998 December 31, 1998
As As As As
previously As previously As previously As previously As
Statements of operations reported restated reported restated reported restated reported restated
-------- -------- -------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $25,053 $22,942 $25,610 $23,488 $26,843 $24,491 $17,844 $24,429
Health care expenses 16,998 15,671 17,132 15,546 17,961 16,255 13,611 18,230
Selling, general and administrative 5,749 5,749 6,104 6,104 6,597 6,597 6,653 6,653
Other income 298 281 395 335 795 190 144 510
Interest expense (497) (497) (627) (627) (836) (836) (911) (911)
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations before tax 2,107 1,306 2,142 1,546 2,244 993 (3,187) (855)
Provision for income taxes 877 561 906 654 917 438 (1,205) (282)
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations 1,230 745 1,236 892 1,327 555 (1,982) (573)
Income (loss) from discontinued
operations (754) (269) (566) (222) (3,291) (3,153) 1,056 (3,764)
Gain on disposal of discontinued
operations 754 754 566 566 3,291 -- (5,216) (1,024)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) $ 1,230 $ 1,230 $ 1,236 $ 1,236 $ 1,327 $(2,598) $(6,142) $(5,361)
======== ======== ======== ======== ======== ======== ======== ========
Basic income per share:
Net income (loss) from continuing
operations per share $ 0.26 $ 0.16 $ 0.26 $ 0.19 $ 0.28 $ 0.12 $ (0.42) $ (0.15)
Net income (loss) from discontinued
operations per share -- 0.10 -- 0.07 -- (0.67) (0.89) (1.01)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) per share $ 0.26 $ 0.26 $ 0.26 $ 0.26 $ 0.28 $ (0.55) $ (1.31) $ (1.16)
======== ======== ======== ======== ======== ======== ======== ========
Weighted average shares 4,717 4,717 4,717 4,717 4,717 4,717 4,693 4,693
Diluted income per share:
Net income (loss) per continuing
operations per share $ 0.25 $ 0.15 $ 0.25 $ 0.18 $ 0.27 $ 0.11 $ (0.42) $ (0.15)
Net income (loss) from discontinued
operations per share -- 0.10 -- 0.07 -- (0.64) (0.89) (1.01)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) per share $ 0.25 $ 0.25 $ 0.25 $ 0.25 $ 0.27 $ (0.53) $ (1.31) $ (1.16)
======== ======== ======== ======== ======== ======== ======== ========
Weighted average shares 4,928 4,928 4,882 4,882 4,888 4,888 4,693 4,693
</TABLE>
F-22
<PAGE>
NOTE 15. RESTATEMENT
BACKGROUND INFORMATION AND ORIGINAL ACCOUNTING
In September 1997, the Company sold several general dental practices to Pacific
Coast Dental, Inc., Associated Dental Services, Inc., and affiliated dentists
(the "Purchasers" or "PCD") in exchange for consideration consisting of $8.0
million of long-term promissory notes. In the Company's 1997 financial
statements, the Company recorded a gain on sale of discontinued dental practices
of $3.3 million (net of income taxes of $2.1 million) on this sale transaction.
In April 1998, the Company sold several orthodontic practices to the Purchasers
in exchange for consideration consisting of $15.0 million of long-term
promissory notes. In the Company's 1998 financial statements, the Company
recorded a gain of $2.1 million (net of income taxes of $1.3) on this sale
transaction.
The Company also sold four other general dental practices to other purchasers in
exchange for consideration consisting of long-term promissory notes. During 1997
and 1998, the purchasers of these practices conveyed the practices to the
Purchasers in exchange for the assumption of the promissory notes payable to the
Company. At the time of the conveyances of these practices to the Purchasers,
the related promissory notes had an aggregate carrying value of $1.9 million on
the Company's balance sheet, which exceeded the historical cost of the net
assets of the related dental practices by $1.4 million.
In connection with the sale of the general dental and orthodontic practices to
the Purchasers the Company committed to lend the Purchasers certain amounts for
working capital. As of December 31, 1997 and 1998 the working capital loans to
the Purchasers amounted to $850,000 and $1.6 million, respectively. During 1997
and 1998, the Company originally recorded an aggregate of $192,000 (net of
income taxes of $123,000) and $1 million (net of income taxes of $670,000),
respectively, of interest income relating to all the various notes receivable
from the Purchasers.
The Company previously recorded various reserves against the promissory notes,
the working capital loans, and the accrued interest on these obligations, during
1997 and 1998, in an aggregate amount of $1.9 million and $14.4 million,
respectively. The Company also received during 1997 and 1998, $227,000 and
$38,000, respectively, of interest payments from the Purchasers. As a result,
the total carrying value of all the amounts receivable from the Purchasers as of
December 31, 1998 was $12.2 million in the previously reported consolidated
balance sheet. Of the $16.3 million of total reserves that were previously
recorded, $4.8 million were included in the calculation of the gains on sale
discussed above, and $7 million were charged to expense (net of income taxes of
$4.5 million) subsequent to the dates of the respective sale transactions.
Restatement
Subsequent to these transactions, the Purchasers defaulted on the amounts due to
the Company. In a subsequent review of the facts and circumstances related to
this matter, and based upon no new information that was not otherwise available
to the Company at the time when it entered into these transactions, the
Company's management has concluded that as of the date of the initial sale the
Purchasers did not have sufficient resources to repay these notes from sources
other than the operations of the purchased practices. As a result, the
accompanying 1998 and 1997 financial statements have been restated from amounts
previously reported to reverse the sales transactions to PCD discussed above,
and the related promissory notes and the working capital loans have not been
recognized in the restated financial statements. The historical cost of the net
assets sold in all of the sale transactions discussed above, less the interest
payments received from the Purchasers, have been recorded on the consolidated
balance sheets under the caption "Assets of discontinued operations transferred
under contractual arrangements." As of December 31, 1998, the balance in this
caption was $9.0 million, compared to a carrying value of $12.2 million for the
promissory notes and working capital loans in the previously issued financial
statements. As of December 31, 1997, the balance in this caption was $2.5
million, compared to a carrying value of $7.6 million for the promissory notes
and working capital loans in the previously issued financial statements. The
restated financial statements do not reflect any gains on these sale
transactions, and do not reflect any interest income on the related promissory
notes. In addition, the carrying value of the promissory notes related to the
four practices that were also transferred to the Purchasers was reduced to the
historical cost of the net assets of the related dental practices, at the time
of the transfers. The working capital loans are fully reserved at the time the
loans were made and the Company has no further obligation to provide such
working capital loans. Interest payments received have been applied to reduce
the historical cost of the net assets transferred. This accounting treatment
more appropriately reflects the economic substance of the transactions, as
distinct from the legal form of the transactions.
F-23
<PAGE>
The effects of the restatement are as follows (in thousands, except for share
data):
<TABLE>
<CAPTION>
1998 1997
As As
previously As previously As
As of December 31, reported restated reported restated
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Accounts receivable, net of allowance . . . . $ 4,641 $ 3,345 $ 5,349 $ 5,260
Notes receivable - current. . . . . . . . . . 10,892 -- 1,878 1,878
Prepaid expenses and other current assets . . 478 1,017 1,029 1,029
Deferred income taxes - current . . . . . . . 6,672 67 1,047 533
Notes receivable - long term. . . . . . . . . 4,083 3,523 12,327 4,783
Assets of discontinued operations transferred
under contractual arrangements. . . . . . -- 8,950 -- 2,478
Deferred income taxes - long term . . . . . . 539 8,415 -- 1,236
Total assets. . . . . . . . . . . . . . . . . $ 79,944 $ 77,956 $ 88,518 $ 84,085
Deferred income taxes . . . . . . . . . . . . $ -- $ -- $ 1,289 $ --
Retained earnings . . . . . . . . . . . . . . 18,722 16,734 29,816 26,672
Total liabilities and
stockholder equity . . . . . . . . . . . . $ 79,944 $ 79,956 $ 88,518 $ 84,085
</TABLE>
F-24
<PAGE>
<TABLE>
<CAPTION>
1998 1997
As As
previously As previously As
Year ended December 31, reported restated reported restated
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues . . . . . . . . . . . . . . $ 97,449 $ 97,449 $ 95,350 $ 95,350
Health care expenses . . . . . . . . 66,020 66,020 65,702 65,702
Selling, general and administrative. 37,492 36,259 25,103 25,103
Loss on impairment of assets . . . . (11,165) (2,397) -- --
Other income . . . . . . . . . . . . 2,341 624 1,632 1,316
Interest expense . . . . . . . . . . (4,311) (4,311) (2,871) (2,871)
Income (loss) from continuing
operations before tax . . . . . . (19,198) (10,914) 3,306 2,990
Provision for income taxes . . . . . (6,638) (3,406) 1,495 1,371
Income (loss) from continuing
operations. . . . . . . . . . . . (12,560) (7,508) 1,811 1,619
Income (loss) from discontinued
operations. . . . . . . . . . . . (620) (2,430) (3,555) (7,408)
Gain (loss) on disposal of
discontinued operations . . . . . 2,086 -- (605) 296
------------ ----------- ----------- -----------
Net income (loss). . . . . . . . . $ (11,094) $ (9,938) $ (2,349) $ (5,493)
============ =========== =========== ===========
Basic earnings (loss) per share
Income (loss) from continuing
operations per share. . . . . . . $ (2.66) $ (1.58) $ 0.38 $ 0.34
Income (loss) from discontinued
operations per share. . . . . . . 0.31 (0.51) (0.88) (1.50)
------------ ----------- ----------- -----------
Net loss per share . . . . . . . . $ (2.35) $ (2.09) $ (0.50) $ (1.16)
============ =========== =========== ===========
Weighted average shares. . . . . . . 4,747 4,747 4,723 4,723
Diluted earnings (loss) per share
Income (loss) from continuing
operations per share. . . . . . . $ (2.66) $ (1.58) $ 0.37 $ 0.33
Income (loss) from discontinued
operations per share. . . . . . . 0.31 (0.51) (0.85) (1.45)
------------ ----------- ----------- -----------
Net loss per share . . . . . . . . $ (2.35) $ (2.09) $ (0.48) $ (1.12)
============ =========== =========== ===========
Weighted average shares. . . . . . . 4,747 4,747 4,899 4,899
</TABLE>
NOTE 16. SUBSEQUENT EVENTS (UNAUDITED)
The consolidated financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company's financial statements
do not include any adjustments relating to the recoverability and classification
of recorded asset amounts or the amounts and classification of liabilities that
might be necessary should the Company be unable to continue as a going concern.
As shown in the financial statements, during the years ended December 31, 1998
and 1997, the Company incurred net losses of $9.9 million and $5.5 million,
respectively, and net cash used by operating activities was $1.7 million and
$1.6 million, respectively. As of December 31, 1998, the Company's current
liabilities exceeded its current assets by $10.7 million. As of December 31,
1999 the Company was in violation of certain financial covenants relating to its
two major lenders. As of December 31, 1999, the net worth of one of the
Company's subsidiaries, SafeHealth Life Insurance Company ("SafeHealth Life"),
was below the required regulatory minimum capital and surplus by $4.5 million. A
significant portion of the proceeds from the Company's new loan entered into on
F-25
<PAGE>
March 1, 2000, as described below, was used to resolve this regulatory capital
deficiency.
Management believes that the Company's continuation as a going concern is
dependent upon its ability to generate sufficient cash flow to meet its
obligations on a timely basis, to comply with the terms and covenants of its
financing agreements, to obtain additional financing as may be required, and
ultimately to attain profitable operations. As further discussed below, on March
1, 2000 the Company entered into an agreement with its primary lenders and an
investor group. Under this agreement all the Company's debt will be converted
to equity, and the Company was able to cure its minimum capital deficiency.
Also, in connection with this agreement the Company obtained a new chief
executive officer and certain new directors. Management's plans to continue as
a going concern and to return the Company to profitability include plans to
increase premium rates, reduce certain types of non-standard provider payments,
reduce the number of its employees by consolidating certain administrative
functions in one location, reduce the amount of office space used, and reduce
various other selling, general and administrative expenses. Management's plans
also include enhanced programs for customer retention, increasing the efficiency
of its provider network and streamlining operations with a focus toward
strengthening customer service. Management believes that the results of its
plans, and with the agreement reached on March 1, 2000 discussed above, that the
Company will be able to meets its ongoing obligations on a timely basis and
return to profitable operations.
On May 28, 1999, the Company and its primary lenders, Silicon Valley Bank and
John Hancock Mutual Life Insurance Company ("John Hancock"), executed
restructured credit agreements with respect to the revolving credit facility and
the senior notes, respectively. The restructured agreements provide for changes
in interest rates and modifications to the financial covenants and reporting
requirements, as well as specific principal repayments. In connection with the
execution of the restructured agreements, the Company obtained waivers for all
prior and existing defaults and events of default under the previous credit
agreements through May 28, 1999. In connection with the restructured agreements,
the Company issued warrants to purchase 382,000 shares of common stock for $4.51
per share to John Hancock. The warrants were exercisable at any time from
January 1, 2000 to December 31, 2003.
As of June 29, 1999, the Company entered into a definitive agreement with an
investor group, subject to regulatory and stockholder approvals, under which the
investor group would purchase $20 million of convertible preferred stock and $20
million of convertible subordinated debentures from the Company. However, the
agreement with the investor group was terminated in February 2000. On March 1,
2000, the Company entered into an agreement with both of its lenders and the
same investor group, under which the investor group loaned $8.0 million to the
Company. Under this agreement, the investor group and the existing lenders
agreed to convert the $8.0 million loan, the outstanding balance of $7.0 million
under the revolving credit facility, and the outstanding balance of $32.5
million under the senior notes to convertible preferred stock, subject to
regulatory approval. In addition, the warrants to purchase 382,000 shares of the
Company's common stock that were issued to the holder of the senior notes were
cancelled. Under this agreement, both lenders agreed not to demand or accept any
payment under the credit agreements, and not to take any enforcement actions of
any kind under the agreements until April 30, 2001.
During 1999, the Company reached an oral agreement with the issuer (the
"Issuer") of certain promissory notes held by the Company (the "Notes"), and
another third party (the "Purchaser"), under which the Notes would be
liquidated. Under this agreement, the Issuer would convey the dental practices
that comprise the collateral for the Notes to the Purchaser, in exchange for
proceeds that would be paid to the Company in satisfaction of the Notes. Due to
uncertainty of the Issuer's ability to meet its obligations under the Notes, the
Company did not recognize these transactions as sales for accounting purposes
and accordingly has not recorded the related promissory notes in its financial
statements (see Note 15). Based on this oral agreement with the Issuer and the
Purchaser and other factors, the Company has determined that the carrying value
of the discontinued net assets related to the Notes has been impaired.
Accordingly, the Company recorded an additional loss from disposal of
discontinued operations of $6.5 million before income taxes during the nine
months ended September 30, 1999 to reduce the carrying value of these assets to
their estimated net realizable value. During March 2000, the Company entered
into a definitive agreement with respect to this transaction, which is currently
pending regulatory approval.
During June 1999 the Company completed the sale of its former headquarters
office building for approximately $3.5 million, which was the carrying amount of
the building on the Company's balance sheet as of December 31, 1998. The
carrying amount of the building is reflected on the consolidated balance sheet
under the caption "Assets Held for Sale."
In September 1999 the Company's common stock was removed from the NASDAQ
National Market due to the Company's inability to meet the relevant minimum net
tangible worth requirement.
During the quarter ended September 30, 1999, the Company recorded a charge to
earnings to establish a valuation allowance against its deferred tax assets.
The amount of the allowance is equal to the total amount of its net deferred tax
assets, which was $8.5 million at December 31, 1998. The Company's deferred tax
assets have been fully reserved due to uncertainty about whether they will be
realized in the future, primarily due to operating losses incurred by the
Company in 1998 and 1999, and the existence of significant net operating loss
carry-forwards for tax purposes.
F-26
<PAGE>
In December 1999, a shareholder lawsuit against the Company was filed, which
alleges that the Company and certain of its officers violated certain securities
laws by issuing a series of alleged false and misleading statements concerning
the Company's publicly reported revenues and earnings during a specified class
period. The Company has directors and officers liability insurance and intends
to vigorously defend this litigation. In the opinion of the Company's
management, the ultimate outcome of this matter will not have a material adverse
effect on the Company's financial position or results of operations.
F-27
<PAGE>
<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 1998, 1997 AND 1996
(in $000's)
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 receivable. . . . . . . . . $ 260 $ 615 $ 62 $ (406) $ 531
1997:
Allowance for doubtful accounts:
Accounts receivable. . . . . . . . . $ 531 $ 1,058 $ -- $ (528) $ 1,061
Long-term notes receivable (as
restated, see Note 15 to the
consolidated financial statements) $ -- $ 2,205 $ -- $ -- $ 2,205
1998:
Allowance for doubtful accounts:
Accounts receivable. . . . . . . . . $ 1,061 $ 1,733 $ -- $ (851) $ 1,942
Long-term notes receivable (as
restated, see Note 15 to the
consolidated financial statements) $ 2,205 $ 2,020 $ -- $ (664) $ 3,561
<FN>
(1) Represents balance forward from First American, which was charged to the opening goodwill
balance.
</TABLE>
F-28
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1000
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 3256
<SECURITIES> 2959
<RECEIVABLES> 5287
<ALLOWANCES> 1942
<INVENTORY> 0
<CURRENT-ASSETS> 14691
<PP&E> 9888
<DEPRECIATION> 3783
<TOTAL-ASSETS> 77956
<CURRENT-LIABILITIES> 25379
<BONDS> 32500
0
0
<COMMON> 21509
<OTHER-SE> (1743)
<TOTAL-LIABILITY-AND-EQUITY> 77956
<SALES> 0
<TOTAL-REVENUES> 97449
<CGS> 0
<TOTAL-COSTS> 66020
<OTHER-EXPENSES> 34903
<LOSS-PROVISION> 3753
<INTEREST-EXPENSE> 4311
<INCOME-PRETAX> (10914)
<INCOME-TAX> (3406)
<INCOME-CONTINUING> (7508)
<DISCONTINUED> (2430)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9938)
<EPS-BASIC> (2.09)
<EPS-DILUTED> (2.09)
</TABLE>
