UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 0-12050
SAFEGUARD HEALTH ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-1528581
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
95 ENTERPRISE
ALISO VIEJO, CALIFORNIA 92656
(Address of principal executive offices)
(Zip Code)
(949) 425-4300
(Registrant's telephone number, including area code)
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
--- ---
The number of shares of registrant's common stock, par value $.01 per share,
outstanding at October 31, 2000, was 4,747,498 shares (not including 3,274,788
shares of common stock held in treasury).
<PAGE>
<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
INFORMATION INCLUDED IN REPORT
Page
----
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Part I. Financial Information (unaudited) . . . . . . . . . . . . . . . 1
Item 1. Consolidated Financial Statements . . . . . . . . . . . . . . . 1
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . 1
Consolidated Statements of Operations . . . . . . . . . . . . . 2
Notes to Consolidated Financial Statements . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk . . 14
Part II. Other Information . . . . . . . . . . . . . . . . . . . . . . 14
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . 14
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . 15
Item 4. Submission of Matters to a Vote of Security Holders . . . . . 15
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . 16
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
</TABLE>
i
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PART I. FINANCIAL INFORMATION (UNAUDITED)
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2000 1999
--------------- --------------
<S> <C> <C>
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 1,089 $ 1,639
Investments available-for-sale, at fair value 13,337 4,642
Accounts receivable, net of allowances 2,473 2,978
Income taxes receivable -- 480
Prepaid expenses and other current assets 895 641
--------------- --------------
Total current assets 17,794 10,380
Property and equipment, net of accumulated depreciation 3,460 4,816
Restricted investments available-for-sale, at fair value 2,736 2,688
Notes receivable, net of allowances 2,650 3,505
Assets of discontinued operations transferred under contractual arrangements 750 2,500
Intangible assets, net of accumulated amortization 4,419 4,437
Other assets 250 251
--------------- --------------
Total assets $ 32,059 $ 28,577
=============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 5,684 $ 5,771
Accrued interest, subject to conversion to equity (Note 5) 4,038 --
Other accrued expenses 3,968 3,691
Short-term debt, subject to conversion to equity (Note 5) 47,545 --
Other short-term debt 30 255
Claims payable and claims incurred but not reported 6,415 6,437
Deferred revenue 1,742 1,975
--------------- --------------
Total current liabilities, including $51,583 of liabilities in 2000
that are subject to conversion to equity (Note 5) 69,422 18,129
Long-term debt, subject to conversion to equity (Note 5) -- 39,545
Other long-term liabilities 1,134 1,310
Accrued interest, subject to conversion to equity (Note 5) -- 1,207
Stockholders' equity (deficit):
Convertible preferred stock -- --
Common stock 21,829 21,829
Retained earnings (accumulated deficit) (42,242) (35,302)
Accumulated other comprehensive income (loss) 39 (18)
Treasury stock, at cost (18,123) (18,123)
--------------- --------------
Total stockholders' equity (deficit) (38,497) (31,614)
--------------- --------------
Total liabilities and stockholders' equity (deficit) $ 32,059 $ 28,577
=============== ==============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-1-
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<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
2000 1999
-------- ---------
<S> <C> <C>
Premium revenue, net $24,639 $ 24,065
Health care services expense 17,318 17,402
Selling, general and administrative expense 7,690 9,816
Loss on impairment of assets -- 24,576
-------- ---------
Operating loss (369) (27,729)
Investment and other income (losses) 478 (147)
Interest expense on debt that is subject to conversion to equity (Note 5) (1,287) (2,759)
Other interest expense (53) (42)
-------- ---------
Loss before income taxes and discontinued operations (1,231) (30,677)
Income tax expense -- 12,224
-------- ---------
Loss before discontinued operations (1,231) (42,901)
Discontinued operations:
Loss from assets transferred under contractual arrangements (1,750) (1,099)
-------- ---------
Net loss $(2,981) $(44,000)
======== =========
Basic and diluted loss per share:
Loss from continuing operations $ (0.26) $ (9.04)
Loss from discontinued operations (0.37) (0.23)
-------- ---------
Net loss $ (0.63) $ (9.27)
======== =========
Weighted average basic and diluted shares outstanding 4,747 4,747
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-2-
<PAGE>
<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
2000 1999
-------- ---------
<S> <C> <C>
Premium revenue, net $73,275 $ 71,917
Health care services expense 52,287 51,206
Selling, general and administrative expense 23,701 27,691
Loss on impairment of assets -- 24,576
-------- ---------
Operating loss (2,713) (31,556)
Investment and other income 1,115 1,793
Interest expense on debt that is subject to conversion to equity (Note 5) (3,504) (4,682)
Other interest expense (88) (168)
-------- ---------
Loss before income taxes and discontinued operations (5,190) (34,613)
Income tax expense -- 10,934
-------- ---------
Loss before discontinued operations (5,190) (45,547)
Discontinued operations:
Loss from assets transferred under contractual arrangements (1,750) (4,363)
-------- ---------
Net loss $(6,940) $(49,910)
======== =========
Basic and diluted loss per share:
Loss from continuing operations $ (1.09) $ (9.59)
Loss from discontinued operations (0.37) (0.92)
-------- ---------
Net loss $ (1.46) $ (10.51)
======== =========
Weighted average basic and diluted shares outstanding 4,747 4,747
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-3-
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<TABLE>
<CAPTION>
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(IN THOUSANDS)
(UNAUDITED)
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (6,940) $(49,910)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Loss from discontinued operations 1,750 4,363
Loss on impairment of assets -- 24,576
Amortization of deferred loan costs 198 1,953
Depreciation and other amortization 2,100 3,220
Gain on sale of investments and property and equipment (82) --
Deferred income taxes -- 10,569
Changes in operating assets and liabilities:
Accounts receivable 505 (348)
Income taxes receivable 480 5
Prepaid expenses and other current assets (254) 414
Accounts payable (86) 2,445
Accrued expenses 3,108 (401)
Claims payable and claims incurred but not reported (22) 1,725
Deferred revenue (233) 368
--------- ---------
Net cash provided by (used in) operating activities 524 (1,021)
Cash flows from investing activities:
Purchase of investments available-for-sale (24,350) (12,854)
Proceeds from sales/maturities of investments available-for-sale 15,678 13,830
Proceeds from sale of property and equipment 200 3,500
Purchases of property and equipment (661) (1,006)
Additions to intangible assets (395) (969)
Payments received on notes receivable 855 497
Issuance of notes receivable -- (500)
--------- ---------
Net cash provided by (used in) investing activities (8,673) 2,498
Cash flows from financing activities:
Proceeds from issuance of long-term debt 8,000 --
Payments on notes payable and long-term debt (225) (2,594)
Decreases in long-term liabilities, net (176) (28)
--------- ---------
Net cash provided by (used in) financing activities 7,599 (2,622)
--------- ---------
Net increase (decrease) in cash (550) (1,145)
Cash balance at beginning of period 1,639 3,256
--------- ---------
Cash balance at end of period $ 1,089 $ 2,111
========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-4-
<PAGE>
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. GENERAL
-----------------
The accompanying unaudited consolidated financial statements of SafeGuard Health
Enterprises, Inc. and subsidiaries (the "Company") for the three months and nine
months ended September 30, 2000 and 1999, have been prepared in accordance with
accounting principles generally accepted in the United States of America,
applicable to interim periods. The accompanying financial statements reflect all
adjustments that, in the opinion of management, are necessary for a fair
presentation of the Company's financial position and results of operations for
the interim periods. The financial statements have been prepared in accordance
with the regulations of the Securities and Exchange Commission, and omit certain
footnote disclosures and other information necessary to present the Company's
financial position and results of operations in accordance with accounting
principles generally accepted in the United States of America. These financial
statements should be read in conjunction with the Consolidated Financial
Statements and Notes thereto contained in the Company's Annual Report on Form
10-K for the year ended December 31, 1999. Management believes the disclosures
herein are adequate to prevent the accompanying financial statements from being
misleading.
Certain amounts in the prior year financial statements have been reclassified to
conform to the current year presentation.
NOTE 2. GOING CONCERN BASIS
-------------------------------
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 financial statements do not
include any adjustments related to the recoverability or classification of
assets, or to the amounts or classification of liabilities that might be
necessary in the event the Company is unable to continue as a going concern.
During the nine months ended September 30, 2000, and the years ended December
31, 1999 and 1998, the Company incurred net losses of $6.9 million, $52.0
million and $9.9 million, respectively. During the years ended December 31, 1999
and 1998, net cash used by operating activities was $574,000 and $2.0 million,
respectively. Net cash provided by operating activities was $524,000 during the
nine months ended September 30, 2000. As of September 30, 2000, the Company was
not in compliance with certain financial covenants contained in the credit
agreements related to its revolving credit facility and senior notes payable.
However, both lenders have agreed not to demand or accept any payment under
these credit agreements, and not to take any enforcement actions of any kind
under those agreements until April 30, 2001 (see Note 5).
As of September 30, 2000, and December 31, 1999, the Company's current
liabilities exceeded its current assets by $51.6 million (which is due to $51.6
million of debt and accrued interest that is expected to be converted into
equity securities, as discussed in Note 5) and $7.7 million, respectively. The
Company believes this lack of working capital will be mitigated by its plans to
return to profitability, as described below. The Company also sold certain
long-term assets during October 2000, as discussed in Note 8.
In March 2000 the Company entered into a Recapitalization Agreement with an
investor group and its primary lenders, under which the investor group and the
primary lenders agreed to convert substantially all of the Company's outstanding
debt to convertible preferred stock (see Note 5). This conversion is currently
pending regulatory approval of the change in control of the Company that would
result from the conversion. In connection with the Recapitalization Agreement,
the Company hired a new president and chief executive officer, and obtained
certain new directors.
The Company's results of operations have improved during the first three
quarters of 2000. Management believes this improvement is primarily the result
of actions taken during 2000 to increase premium rates, renegotiate certain
non-standard provider agreements, reduce the number of its employees by
consolidating administrative functions in one location, reduce the amount of
office space used, and reduce various other general and administrative expenses.
Management plans to further improve the profitability of the Company by
continuing its actions to increase premium rates, reduce certain types of health
care expenses, and reduce various general and administrative expenses, although
there can be no assurance it will be successful in doing so. 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 the results of its plans
will enable the Company to meets its ongoing obligations on a timely basis and
continue to improve the profitability of the Company, although there can be no
assurance it will be successful in doing so. The Company also believes it will
be able to obtain additional financing, if necessary, to support its operations.
-5-
<PAGE>
NOTE 3. RECENT ACCOUNTING PRONOUNCEMENTS
--------------------------------------------
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. SFAS 133 is
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000. SFAS 133 has had no significant effect on the Company's financial
statements, and the Company believes it will have no significant effect in the
future, as the Company has no derivative instruments or hedging activities.
In December 1999, the United States Securities and Exchange Commission issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition issues in financial statements. The Company
will be required to adopt SAB 101 no later than the fourth quarter of the year
ending December 31, 2001. The Company believes implementation of SAB 101will
have no significant effect on its financial statements.
In March 2000, the FASB issued FASB Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation." FIN 44 is
effective July 1, 2000 with respect to certain provisions applicable to new
awards, exchanges of awards in a business combination, modifications to
outstanding awards, and changes in grantee status that occur on or after that
date. FIN 44 addresses practice issues related to the application of Accounting
Practice Bulletin Opinion No. 25, "Accounting for Stock Issued to Employees."
The adoption of FIN 44 had no significant effect on the Company's financial
statements.
NOTE 4. ASSETS OF DISCONTINUED OPERATIONS TRANSFERRED UNDER CONTRACTUAL
-------------------------------------------------------------------------------
ARRANGEMENTS
------------
During the three months ended September 30, 1997, the Company sold a number of
general dental practices to a single purchaser (the "Purchaser") in exchange for
$8.0 million of long-term promissory notes. In April 1998 the Company also sold
a number of orthodontic practices to the Purchaser in exchange for $15.0 million
of long-term promissory notes. During 1997 and 1998, other entities that
purchased four other general dental practices from the Company conveyed those
practices to the Purchaser in exchange for the assumption of the related
promissory notes payable to the Company. At the time of the conveyances of these
practices to the Purchaser, the related promissory notes had an aggregate
outstanding principal balance of $1.9 million. During 1997 and 1998, the Company
loaned a total of $1.6 million to the Purchaser, which was used for working
capital purposes by the Purchaser.
Due to uncertainty about the Purchaser's ability to meet its commitments to the
Company under the promissory notes, the Company did not treat the transactions
with the Purchaser as sales for accounting purposes. Accordingly, the related
promissory notes and the working capital loans are not reflected in the
accompanying financial statements. Instead, the historical cost of the net
assets of the related general dental and orthodontic practices, less the
interest payments received from the Purchaser, is reflected on the Company's
balance sheet under the caption "Assets of discontinued operations transferred
under contractual arrangements," which is stated at estimated realizable value.
The Company's 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 transferred to the Purchaser, was reduced to the
historical cost of the net assets of the related dental practices. These assets
are also reflected on the Company's balance sheet under the caption "Assets of
discontinued operations transferred under contractual arrangements." The working
capital loans were treated as expenses at the time the loans were made. In the
opinion of management, this accounting treatment appropriately reflects the
economic substance of the transactions, as distinct from the legal form of the
transactions, which transactions were asset sales.
-6-
<PAGE>
During 1999, the Company reached an oral agreement with the Purchaser and
another third party (the "New Purchaser"), under which the long-term promissory
notes described above (the "Notes") would be liquidated. Under this agreement,
the Purchaser would convey the assets of the dental and orthodontic practices
that comprise the collateral for the Notes to the New Purchaser, in exchange for
proceeds that would be paid to the Company in satisfaction of the Notes. Based
on this agreement, the Company recorded a $4.4 million charge to earnings (net
of income tax benefit of $2.1 million) during the nine months ended September
30, 1999, to reduce the carrying value of "Assets of discontinued operations
transferred under contractual arrangements" to their estimated realizable value.
This charge is reflected on the Company's statement of operations under the
caption "Loss from operations to be disposed of."
In March 2000 the Company entered into a definitive agreement with respect to
this transaction. In September 2000, the Company entered into a restructured
agreement with respect to this transaction, which superseded the previous
agreement. Based on the terms of the restructured agreement, the Company
recorded a $1.8 million charge to earnings during the three months ended
September 30, 2000, to reduce the carrying value of "Assets of discontinued
operations transferred under contractual arrangements" to their new estimated
net realizable value. This charge is reflected on the Company's statement of
operations under the caption "Loss from assets transferred under contractual
arrangements." See Note 8 for discussion of a subsequent event with respect to
this transaction.
NOTE 5. SHORT-TERM AND LONG-TERM DEBT
------------------------------------------
Short-term and long-term debt consisted of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2000 1999
--------------- --------------
Investor senior loan $ 8,000 $ --
Revolving credit facility 7,045 7,045
Senior notes payable 32,500 32,500
Other notes payable 30 255
--------------- --------------
Total debt 47,575 39,800
Less - current portion (47,575) (255)
--------------- --------------
Long-term debt $ -- $ 39,545
=============== ==============
On March 1, 2000, the Company entered into a Recapitalization Agreement with an
investor group (the "Investors"), the holder of the senior notes payable (the
"Senior Note Holder"), and the revolving credit facility lender (the "Bank").
Under the Recapitalization Agreement, the Investors loaned $8.0 million to the
Company in the form of an investor senior loan, which is due April 30, 2001, and
bears interest at 10% annually. The Investors, the Senior Note Holder, and the
Bank agreed to convert the $8.0 million investor senior loan, the $32.5 million
of senior notes payable, and the outstanding balance of $7.0 million under the
revolving credit facility, to convertible preferred stock, subject to regulatory
and stockholder approval, as described below. See Note 8 for a subsequent event
related to the Recapitalization Agreement.
The convertible preferred stock would not accrue dividends of any kind, and
would be convertible into common stock at the option of the holder. The
convertible preferred stock would entitle the holder to one vote for each share
of common stock into which the preferred stock is convertible, with respect to
all matters voted on by the common stockholders of the Company. The conversion
of the Company's outstanding debt to convertible preferred stock is currently
pending regulatory approval of the change in control of the Company that would
result from this conversion.
After regulatory approval of the change in control is obtained, and the
conversion of the Company's outstanding debt to convertible preferred stock is
completed, the existing stockholders of the Company would own approximately 14%
of the common stock interests of the Company. Under the Recapitalization
Agreement, the Company agreed to place new directors on its board of directors,
who represent the Investors, the Senior Note Holder and the Bank, and who,
collectively, will constitute a majority of the board of directors.
-7-
<PAGE>
Under the Recapitalization Agreement, both the Senior Note Holder and the Bank
agreed not to demand or accept any payment of principal or interest under their
respective credit agreements, and not to take any enforcement actions of any
kind under those agreements until April 30, 2001. The Company is subject to
various financial covenant requirements under the credit agreements with the
Senior Note Holder and the Bank. The Company was not in compliance with those
requirements as of September 30, 2000. Therefore, in the event the conversion of
the Company's outstanding debt to convertible preferred stock is not completed
prior to April 30, 2001, the outstanding balances under the senior notes payable
and the revolving credit facility will be due and payable on April 30, 2001.
Accordingly, these outstanding balances are reflected as short-term debt on the
Company's balance sheet as of September 30, 2000.
In 1999, the Company issued warrants to purchase 382,000 shares of its common
stock for $4.51 per share to the Senior Note Holder. However, the Senior Note
Holder has agreed to cancel the warrants upon conversion of the Company's
outstanding debt into convertible preferred stock, as set forth in the
Recapitalization Agreement described above.
RECAPITALIZATION TABLE
The expected effect of the conversion of the Company's outstanding debt into
convertible preferred stock on the Company's capital structure is shown in the
recapitalization table below, as though the conversion had occurred on September
30, 2000 (in thousands).
<TABLE>
<CAPTION>
ACTUAL AS OF
SEPTEMBER 30, EFFECT OF AFTER
2000 TRANSACTION RECAPITALIZATION
--------------- ------------- ------------------
<S> <C> <C> <C>
Short-term debt, subject to conversion to equity $ 47,545 $ (47,545) $ --
Accrued interest, subject to conversion to equity 4,038 (4,038) --
Other current liabilities 17,839 -- 17,839
Long-term liabilities 1,134 -- 1,134
--------------- ------------- ------------------
Total liabilities 70,556 (51,583) 18,973
Preferred stock -- 16,500 16,500
Common stock 21,829 -- 21,829
Accumulated deficit (42,242) 35,083 (7,159)
Accumulated other comprehensive income (loss) 39 -- 39
Treasury stock (18,123) -- (18,123)
--------------- ------------- ------------------
Total stockholders' equity (deficit) (38,497) 51,583 13,086
--------------- ------------- ------------------
Total liabilities and stockholders' equity (deficit) $ 32,059 $ -- $ 32,059
=============== ============= ==================
</TABLE>
Pursuant to the Recapitalization Agreement described above, it is expected that
substantially all of the Company's short-term debt ($47.5 million at September
30, 2000) and the accrued interest on the senior notes payable and the revolving
credit facility ($4.0 million at September 30, 2000) will be converted into
convertible preferred stock. In exchange for the outstanding debt and accrued
interest, it is expected that the Company will issue 300,000 shares of
convertible preferred stock. The convertible preferred stock has been valued at
$55 per share for purposes of the above information, which is the Company's
estimate of its market value as of September 30, 2000. Each share of convertible
preferred stock would be convertible into 100 shares of common stock, and the
last closing price of the Company's common stock as of September 30, 2000 was
$0.55 per share.
The transaction illustrated in the above table is contingent upon regulatory
approval of the change in control of the Company that would result from this
transaction. See Note 8 for a subsequent event related to this transaction. The
purpose of the above recapitalization table is to show what the significant
effects of the above-described transaction on the Company's capital structure
might be if the transaction had been completed on September 30, 2000. The above
information is not necessarily indicative of the results of the transaction or
related effects on the Company's financial position that would result if the
above-described transaction is completed on a different date, with a different
valuation of the convertible preferred stock.
-8-
<PAGE>
NOTE 6. INCOME TAXES
-----------------------
The Company's deferred tax assets have been fully reserved since September 30,
1999, 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. Accordingly, the
Company recorded no income tax expense or benefit during the three months and
nine months ended September 30, 2000.
NOTE 7. LITIGATION
--------------------
In December 1999, a stockholder lawsuit against the Company was filed, which
alleged 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. On September 12, 2000, after the plaintiffs had filed a first amended
complaint, the Federal District Trial Court dismissed the lawsuit with
prejudice, stating that the plaintiffs had failed to state a claim against the
Company. On October 6, 2000, the plaintiffs filed an appeal of the dismissal of
the lawsuit. 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.
NOTE 8. SUBSEQUENT EVENTS
----------------------------
In October 2000, the Company completed the sale of the assets described in Note
4. As a result of this transaction, the Company expects to realize an estimated
$750,000 of net proceeds, a portion of which is still subject to certain
contingencies. In connection with this transaction, the New Purchaser agreed to
make all of the remaining lease payments related to the dental offices discussed
in Note 4. However, the Company remains contingently liable for the lease
payments in the event the New Purchaser fails to make those payments. At
September 30, 2000, the aggregate contingent liability of the Company related to
these leases was approximately $4 million over the terms of the various lease
agreements, which expire at various dates through 2006. As of September 30,
2000, management has not been notified of any defaults under these lease
agreements that would materially affect the Company's financial position.
In October 2000, the stockholders of the Company elected six directors to serve
until the next annual stockholders meeting, approved an increase in the number
of authorized common shares from 30 million shares to 40 million shares,
approved an amendment to the Company's Restated Articles of Incorporation to
eliminate the classification of the board of directors so that all directors are
elected annually, and approved an amendment to the Stock Option Plan (the
"Plan") to increase the number of shares issuable under the Plan from 1.3
million to 3.0 million shares. The reason for the increase in the authorized
common shares was to support the issuance of 300,000 shares of convertible
preferred stock, which will be convertible into 30 million shares of common
stock, in connection with the transaction described in Note 5.
-9-
<PAGE>
ITEM 2. 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 provides a "safe harbor"
for forward-looking statements, as 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 statements. 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 expected growth, the
outcome of business strategies, future operating results and financial position,
economic and market events and trends, future premium revenue, future health
care expenses, the Company's ability to control health care, selling, general
and administrative expenses, 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 risks,
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, which statements involve risks and uncertainties.
The Company's ability to expand its business is affected by competition from a
large number of other entities, many of which are much larger and have greater
financial resources than the Company, that offer dental plans in the markets in
which the Company operates. There is a risk that the Company will not be able to
increase revenues in the future as employer groups and other purchasers of
dental coverage continue to resist premium rate increases, while demanding a
wide choice of dental care providers and a high level of customer service.
Securing cost-effective contracts with dentists may become more difficult due to
increased competition among dental plans for contracts with dental providers and
a possible decrease in the number of dentists in practice in the markets in
which the Company operates.
There is a risk that the Company will be unable to obtain waivers and/or
extensions from its lenders, in the event the expected conversion of its
outstanding debt to preferred stock does not occur. There are risks that the
Company will be unable to obtain regulatory approval for the Recapitalization
Agreement described elsewhere in this Report. There are risks associated with
changes in the Company's operating and expansion strategies, and the possible
inability to realize all of the proceeds from the recent resale of certain
dental office assets to a third party. There is a risk that the Company will be
unable to continue to improve its earnings before interest, taxes, depreciation
and amortization ("EBITDA"), as any such improvement is dependent upon a
multitude of factors including, but not limited to, the ability of the Company
to identify additional opportunities to reduce costs.
There is a risk that the purchaser of certain resold dental office assets will
not comply with its agreement to make rental payments on the related office
lease agreements, for which the Company remains contingently liable, and there
is a risk that other dentists who previously purchased dental practices from the
Company will not make payment on their assigned or sublet lease agreements, for
which the Company remains contingently liable.
There is a risk that the Company may incur additional expenses in connection
with the delivery of the dental office assets resold to the Purchaser, and there
are risks associated with additional health care expenses that may be incurred
by the Company for the cost of the completion of dental treatment that may be
required to be paid in connection with the transfer of the recently resold
dental office assets.
All of these risks and uncertainties could have a negative impact on the
estimated net realizable value of the dental office assets sold by the Company.
The Company's profitability depends, in part, on its ability to maintain
effective control over its health care costs, while providing members with
quality dental care. A variety of factors, such as utilization rates of dental
services, changes in the value of the Company's assets, new technologies, the
cost of dental services delivered by referral specialists, the amount of claims
incurred by patients insured by the Company, and numerous other external
influences could affect the Company's operating results.
-10-
<PAGE>
All of the risks set forth herein could negatively impact the earnings of the
Company in the future. The Company's expectations for the future are based on
current information and its evaluation of external influences. Changes in any
one factor could materially impact the Company's expectations related to premium
rates, benefits plans offered, membership enrollment, the amount of health care
expenses incurred, and profitability, and therefore, affect the forward-looking
statements which may be included in this report. 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.
SUMMARY OF RESULTS OF OPERATIONS
The following table shows the Company's results of operations as a percentage of
revenue, and is used in the period-to-period comparisons discussed below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------- ---------------
2000 1999 2000 1999
------- -------- ------ -------
<S> <C> <C> <C> <C>
Premium revenue, net 100.0% 100.0% 100.0% 100.0%
Health care services expense 70.3 72.3 71.4 71.2
Selling, general and administrative expense 31.2 40.8 32.3 38.5
Loss on impairment of assets -- 102.1 -- 34.2
------- -------- ------ -------
Operating loss (1.5) (115.2) (3.7) (43.9)
Investment and other income 1.9 (0.6) 1.5 2.5
Interest expense on debt that is subject
to conversion to equity (1) (5.2) (11.5) (4.8) (6.5)
Other interest expense (0.2) (0.2) (0.1) (0.2)
------- -------- ------ -------
Loss before income taxes and discontinued operations (5.0) (127.5) (7.1) (48.1)
Income tax expense -- 50.8 -- 15.2
------- -------- ------ -------
Loss before discontinued operations (5.0) (178.3) (7.1) (63.3)
Loss from assets transferred under contractual
arrangements (7.1) (4.5) (2.4) (6.1)
------- -------- ------ -------
Net loss (12.1)% (182.8)% (9.5)% (69.4)%
======= ======== ====== =======
<FN>
(1) See Note 5 to the accompanying financial statements for a discussion of a
transaction that is expected to convert substantially all of the Company's debt
and the related accrued interest into preferred stock.
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1999
Premium revenue increased by $574,000, or 2.4%, from $24.1 million in 1999 to
$24.6 million in 2000. The average membership for which the Company provided
dental coverage decreased by approximately 86,000 members, or 9.7%, from 883,000
members during 1999 to 797,000 during 2000. The decrease in the average number
of members is primarily due to the loss of several customers during the first
nine months of 2000. Premium revenue increased by 2.4% even though average
membership decreased by 9.7%. This was primarily due to a shift in the product
mix toward preferred provider ("PPO")/indemnity plans, which have higher premium
rates than managed care plans, increases in premium rates, and a shift in the
product mix toward managed care plans with higher benefit levels and higher
premium rates.
Health care services expense decreased by $84,000, or 0.5%, from $17.4 million
in 1999 to $17.3 million in 2000. Health care services expense as a percentage
of premium revenue (the "loss ratio") decreased from 72.3% in 1999 to 70.3% in
2000. This decrease is primarily due to a decrease in the loss ratio in the
managed care business. This decrease was primarily due to a decrease in health
care expenses incurred pursuant to non-standard provider payment arrangements,
such as minimum capitation arrangements and fee-for-service payments for dental
services that are covered by capitation arrangements in most cases. The Company
renegotiated several of these non-standard arrangements, or in some cases,
terminated the related provider contracts, during the first half of 2000.
-11-
<PAGE>
Selling, general and administrative ("SG&A") expenses decreased by $2.1 million,
or 21.7%, from $9.8 million in 1999 to $7.7 million in 2000. SG&A expenses as a
percentage of premium revenue decreased from 40.8% in 1999 to 31.2% in 2000.
The decrease in SG&A expenses is due to several reasons. Salaries and benefits
decreased due to a reduction in the number of employees during the first quarter
of 2000, in connection with a consolidation of the Company's administrative
services into a single location. The decrease is also partially due to an
accrual for a lease commitment for unused office space in the third quarter of
1999. Part of the decrease is due to a decrease in computer programming
expenses, as the Company has completed several enhancements to its proprietary
management information system that were in process during 1999.
Investment and other income increased by $625,000, from a loss of $147,000 in
1999 to income of $478,000 in 2000. This increase is primarily due to realized
losses on the sale of investments in the third quarter of 1999.
Total interest expense decreased by $1.5 million, or 52.2%, from $2.8 million in
1999 to $1.3 million in 2000. This decrease is primarily due to $1.9 million of
deferred loan costs that were charged to expense during the third quarter of
1999. This decrease was partially offset by interest expense and amortization of
deferred loan costs related to the $8.0 million borrowing on March 1, 2000,
which was completed in connection with the transaction described in Note 5 to
the accompanying financial statements.
The loss before income taxes and discontinued operations decreased by $29.4
million, from $30.7 million in 1999 to $1.2 million in 2000. The loss before
income taxes and discontinued operations as a percentage of premium revenue
decreased from 127.5% in 1999 to 5.0% in 2000. The decrease in the loss was
primarily due to a loss on impairment of assets of $24.6 million in 1999, a $2.4
million decrease in SG&A expenses, as discussed above, and a $1.5 million
decrease in interest income, as discussed above.
The income tax benefit decreased from $12.2 million in 1999 to zero in 2000. The
Company recorded no income tax expense or benefit in 2000 due to the valuation
reserve against its deferred tax assets. See Note 6 to the accompanying
financial statements.
The loss from assets transferred under contractual arrangements increased by
$651,000, from $1.1 million in 1999 to $1.8 million in 2000. The loss in both
periods represents a reduction in the carrying value of "Assets of discontinued
operations transferred under contractual arrangements" to their estimated
realizable value. See Note 8 to the accompanying financial statements for
discussion of a transaction in October 2000, in which the Company sold these
assets.
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1999
Premium revenue increased by $1.4 million, or 1.9%, from $71.9 million in 1999
to $73.3 million in 2000. The average membership for which the Company provided
dental coverage decreased by approximately 50,000 members, or 5.7%, from 878,000
members during 1999 to 828,000 during 2000. The decrease in the average number
of members is primarily due to the loss of several customers during the first
nine months of 2000. Premium revenue increased by 1.9% even though average
membership decreased by 5.7%. This was primarily due to a shift in the product
mix toward PPO/indemnity plans, which have higher premium rates than managed
care plans, increases in premium rates, and a shift in the product mix toward
managed care plans with higher benefit levels and higher premium rates.
Health care services expense increased by $1.1 million, or 2.1%, from $51.2
million in 1999 to $52.3 million in 2000. Health care services expense as a
percentage of premium revenue (the "loss ratio") increased from 71.2% in 1999 to
71.4% in 2000. This increase is primarily due to a shift in the product mix
toward more PPO/indemnity business, which was largely offset by a decrease in
the loss ratio in the managed care business. The Company's PPO/indemnity
business has a significantly higher loss ratio than its managed care business.
However, the PPO/indemnity business has a higher amount of gross margin (premium
revenue less health care services expense) per insured individual. In addition,
the Company believes the PPO/indemnity business has significantly lower selling,
general and administrative expenses than the Company's managed care business, as
a percentage of premium revenue. The decrease in the loss ratio in the managed
care business was due to the reasons described above in the discussion of health
care services expense in the third quarter.
-12-
<PAGE>
Selling, general and administrative ("SG&A") expenses decreased by $4.0 million,
or 14.4%, from $27.7 million in 1999 to $23.7 million in 2000. SG&A expenses as
a percentage of premium revenue decreased from 38.5% in 1999 to 32.3% in 2000.
The decrease in SG&A expenses is due to several reasons. Salaries and benefits
decreased due to a reduction in the number of employees during the first quarter
of 2000, in connection with a consolidation of the Company's administrative
services into a single location. The decrease is also partially due to a
decrease in amortization expense related to intangible assets. During the third
quarter of 1999, the Company recorded a $24.9 million impairment loss to reduce
the carrying values of its intangible assets to their estimated realizable
values, which caused a decrease in amortization expense in 2000. Part of the
decrease is due to a decrease in computer programming expenses, as the Company
has completed several enhancements to its proprietary management information
system that were in process during 1999. An additional part of the decrease was
due to an accrual for a lease commitment for unused office space in 1999.
Investment and other income decreased by $678,000, or 37.8%, from $1.8 million
in 1999 to $1.1 million in 2000. This decrease is primarily due to $1.2 million
of realized gains on the sale of investments in 1999, compared to nearly zero in
2000. This was partially offset by an increase in interest income in 2000, due
to investment of the proceeds of the $8.0 million borrowing on March 1, 2000,
which was completed in connection with the transaction described in Note 5 to
the accompanying financial statements.
Total interest expense decreased by $1.3 million, or 25.9%, from $4.9 million in
1999 to $3.6 million in 2000. This decrease is primarily due to $1.9 million of
deferred loan costs that were charged to expense during the third quarter of
1999. This decrease was partially offset by interest expense and amortization of
deferred loan costs in 2000, related to the $8.0 million borrowing on March 1,
2000, which was completed in connection with the transaction described in Note 5
to the accompanying financial statements.
The loss before income taxes and discontinued operations decreased by $29.4
million, from $34.6 million in 1999 to $5.2 million in 2000. The loss before
income taxes and discontinued operations as a percentage of premium revenue
decreased slightly from 48.1% in 1999 to 7.1% in 2000. The decrease in the loss
was primarily due to a loss on impairment of assets of $24.6 million in 1999,
and a $4.9 million decrease in SG&A expenses.
The income tax benefit decreased from $10.9 million in 1999 to zero in 2000. The
Company recorded no income tax expense or benefit in 2000 due to the valuation
reserve against its deferred tax assets. See Note 6 to the accompanying
financial statements.
The loss from assets transferred under contractual arrangements decreased by
$2.6 million, from $4.4 million in 1999 to $1.8 million in 2000. The loss in
both periods represents a reduction in the carrying value of "Assets of
discontinued operations transferred under contractual arrangements" to their
estimated realizable value. See Note 8 to the accompanying financial statements
for discussion of a transaction in October 2000, in which the Company sold these
assets.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $524,000 during the nine months
ended September 30, 2000, compared to $1.0 million of net cash used by operating
activities during the same period in 1999. This improvement was due to several
reasons, the largest of which are described below. There was a $3.1 million
increase in accrued expenses in 2000, compared to a $401,000 decrease in 1999.
The increase in 2000 was primarily due to a $2.8 million increase in accrued
interest that is subject to conversion to equity, as described in Note 5 to the
accompanying financial statements. Net cash used by the net loss, including the
adjustments reflected in the accompanying statements of cash flows, decreased
from $5.2 million in 1999 to $3.0 million in 2000, primarily due to a decrease
in SG&A expenses, as discussed above. These factors were partially offset by a
$108,000 decrease in accounts payable and claims payable in 2000, compared to
$4.3 million of increases in those liabilities in 1999. The increases in these
liability accounts in 1999 were primarily due to an increase in the processing
time for both accounts payable and dental claim payments during 1999. The
processing time for claims payable has decreased significantly during 2000.
However, this decrease was offset by an increase in the amount of claims
payable, due to a shift in the product mix toward PPO/indemnity plans, for which
the health care expenses are reimbursed based on claims submitted, instead of
capitation payments.
-13-
<PAGE>
Net cash used by investing activities was $8.7 million during 2000, compared to
$2.5 million of net cash provided by investing activities in 1999. The net cash
used by investing activities in 2000 was primarily due to the purchase of
investments with the $8.0 million proceeds from the borrowing on March 1, 2000,
as described in Note 5 to the accompanying financial statements. The net cash
provided by investing activities in 1999 was primarily due to $3.5 million of
proceeds from the sale of the building formerly used as the Company's corporate
office. Net cash provided by financing activities was $7.6 million during 2000,
compared to net cash used by financing activities of $2.6 million during 1999.
This change of $10.4 million was primarily due to $8.0 million of proceeds from
the investor senior loan obtained on March 1, 2000, and $2.6 million of debt
payments in 1999.
The Company's total short-term and long-term debt increased from $39.8 million
at December 31, 1999, to $47.6 million at September 30, 2000, due to the $8.0
million borrowing on March 1, 2000, as described in Note 5 to the accompanying
financial statements. The Company believes it has adequate financial resources
to continue its current operations for the foreseeable future.
IMPACT OF INFLATION
The Company's operations are potentially impacted by inflation, which can affect
premium rates, health care services expense, and selling, general and
administrative expense. The Company expects that its earnings will be positively
impacted by inflation in premium rates, because premium rates for dental benefit
plans in general have been increasing due to inflation in recent years. The
impact of inflation on the Company's health care expenses is mitigated to some
extent by the fact that 45-50% of total health care services expense is
comprised of capitation or fixed payments to providers. However, the Company
expects that its earnings will be negatively impacted by inflation in health
care costs to some extent, because fees charged by other dental providers have
been increasing due to inflation in recent years. In addition, most of the
Company's selling, general and administrative expenses are impacted by general
inflation in the economy.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is not subject to a material amount of risk related to changes in
interest rates or foreign currency exchange rates.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to various claims and legal actions in the ordinary
course of business. The Company believes that all pending claims either are
adequately covered by insurance maintained by its contracted dental providers or
by the Company, or will not have a material adverse effect on the Company's
results of operations or financial position. In December 1999, a stockholder
lawsuit against the Company was filed, which alleged 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. On September 12,
2000, after the plaintiffs had filed a first amended complaint, the Federal
District Trial Court dismissed the lawsuit with prejudice, stating that the
plaintiffs had failed to state a claim against the Company. On October 6, 2000,
the plaintiffs filed an appeal of the dismissal of the lawsuit. 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.
-14-
<PAGE>
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See Note 5 to the accompanying consolidated financial statements herein.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A Special Meeting of the Stockholders (the "Meeting") of the Company was held at
the executive offices of the Company in Aliso Viejo, California on October 25,
2000, 4:00 p.m. The following matters were addressed at the Meeting:
ELECTION OF DIRECTORS
It was proposed that Steven J. Baileys, James E. Buncher, Ronald I. Brendzel,
Dennis L. Gates, Jack R. Anderson, and Leslie B. Daniels be elected to serve as
Directors of the Company until the Company's next annual meeting of
stockholders. The proposal received an affirmative vote of 4,429,826 shares of
Common Stock present at the Meeting in person or by proxy, or 94.5% of the
4,687,727 shares entitled to vote, or 93.3% of the 4,747,498 shares outstanding,
and was approved.
PROPOSAL TO INCREASE AUTHORIZED SHARES OF COMMON STOCK
It was proposed that the number of authorized shares of the Company's Common
Stock be increased from 30 million to 40 million. The proposal received an
affirmative vote of 4,427,976 shares of Common Stock, or 93.3% of the 4,747,498
shares outstanding, and was approved.
PROPOSAL TO AMEND THE RESTATED CERTIFICATE OF INCORPORATION TO ELIMINATE
CLASSIFICATION OF THE BOARD OF DIRECTORS
It was proposed that the Company's Restated Certificate of Incorporation be
amended to eliminate the classification of the Board of Directors such that all
members of the Board of Directors will constitute a single class and be elected
annually. The proposal received an affirmative vote of 3,560,187 shares of
Common Stock, or 75.0% of the 4,747,498 shares outstanding, which exceeded the
66 and 2/3% of the outstanding shares of the Company's Common Stock required by
the Company's by-laws to amend the applicable section of the by-laws, and was
approved.
PROPOSAL TO AMEND THE COMPANY'S STOCK OPTION PLAN
It was proposed that the Company's Employee Stock Option Plan (the "Plan") be
amended to increase the number of shares of Common Stock issuable under the Plan
from 1.7 million to 3 million shares. The proposal received an affirmative vote
of 3,011,436 shares of Common Stock, or 64.2% of the 4,687,727 shares entitled
to vote, or 63.4% of the 4,747,498 shares outstanding, and was approved.
-15-
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT DESCRIPTION
------- -----------------
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K.
None.
-16-
<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, in the City of Aliso
Viejo, State of California, on the 13th day of November 2000.
SAFEGUARD HEALTH ENTERPRISES, INC.
By: /s/ James E. Buncher
-----------------------
James E. Buncher
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Dennis L. Gates
----------------------
Dennis L. Gates
Senior Vice President and Chief Financial Officer
(Chief Accounting Officer)
-17-
<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, in the City of Aliso
Viejo, State of California, on the 13th day of November 2000.
SAFEGUARD HEALTH ENTERPRISES, INC.
By:
-----------------------
James E. Buncher
President and Chief Executive Officer
(Principal Executive Officer)
By:
-----------------------
Dennis L. Gates
Senior Vice President and Chief Financial Officer
(Chief Accounting Officer)
-18-
<PAGE>
