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 March 31, 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 April 30, 2000, was 4,747,498 shares (not including 3,274,788
shares of common stock held in treasury).
<PAGE>
SAFEGUARD HEALTH ENTERPRISES, INC.
AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2000
INFORMATION INCLUDED IN REPORT
Page
----
Part I. Financial Information (unaudited)
- -------- -----------------------------------
Item 1. Consolidated Financial Statements 1
-------- -----------------------------------
Consolidated Balance Sheets 1
-----------------------------
Consolidated Statements of Operations 2
----------------------------------------
Consolidated Statements of Cash Flows 3
-----------------------------------------
Notes to Consolidated Financial Statements 4
----------------------------------------------
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 9
------- --------------------------------------------------
Item 3. Quantitative and Qualitative
Disclosures about Market Risk 11
------- -----------------------------
Part II. Other Information 12
- --------- ------------------
Item 1. Legal Proceedings 12
-------- ------------------
Item 2. Recent Sales of Unregistered Securities 12
-------- -------------------------------------------
Item 3. Defaults upon Senior Securities 12
-------- ----------------------------------
Item 5. Other Information 12
-------- ------------------
Item 6. Exhibits and Reports on Form 8-K 12
-------- -------------------------------------
SIGNATURES 13
- ----------
i
<PAGE>
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
------------ --------------
ASSETS (unaudited)
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 2,022 $ 1,639
Investments available-for-sale, at estimated fair value 9,585 3,361
Accounts receivable, net of allowances 2,872 2,978
Income taxes receivable -- 480
Prepaid expenses and other current assets 628 641
------------ --------------
Total current assets 15,107 9,099
Property and equipment, net of accumulated depreciation 4,168 4,816
Restricted cash and investments available for sale, at estimated fair value 3,483 3,454
Investments available-for-sale, at estimated fair value 547 515
Notes receivable, net of allowances 3,150 3,505
Assets of discontinued operations transferred under contractual arrangements 2,500 2,500
Intangible assets, net of accumulated amortization 4,689 4,437
Other assets 250 251
------------ --------------
Total assets $ 33,894 $ 28,577
============ ==============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 3,772 $ 5,771
Accrued expenses 4,089 3,691
Claims payable and claims incurred but not reported 6,792 6,437
Short-term debt 180 255
Deferred revenue 2,288 1,975
------------ --------------
Total current liabilities 17,121 18,129
Long-term debt 47,545 39,545
Other long-term liabilities 3,298 2,517
------------ --------------
Total liabilities 67,964 60,191
------------ --------------
Stockholders' equity (deficit):
Preferred stock -- --
Common stock 21,829 21,829
Retained earnings (accumulated deficit) (37,763) (35,302)
Accumulated other comprehensive income (loss) (13) (18)
Treasury stock, at cost (18,123) (18,123)
------------ --------------
Total stockholders' equity (deficit) (34,070) (31,614)
------------ --------------
Total liabilities and stockholders' equity (deficit) $ 33,894 $ 28,577
============ ==============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
1
<PAGE>
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
------------- -------------
(As restated)
(see Note 6)
<S> <C> <C>
Premium revenue $ 24,463 $ 23,863
Health care services expense 17,505 16,518
Selling, general and administrative expense 8,646 9,111
------------- -------------
Operating loss (1,688) (1,766)
Investment and other income 259 1,503
Interest expense (1,032) (947)
------------- -------------
Loss before income taxes (2,461) (1,210)
Income tax benefit -- (350)
------------- -------------
Net loss $ (2,461) $ (860)
============= =============
Basic and diluted loss per share $ (0.52) $ (0.18)
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 CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
(IN THOUSANDS)
(UNAUDITED)
2000 1999
-------- -------------
(As restated)
(see Note 6)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (2,461) $ (860)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 752 1,112
Deferred income taxes -- 226
Changes in operating assets and liabilities:
Accounts receivable 106 (994)
Income taxes receivable 480 130
Prepaid expenses and other assets 14 (245)
Accounts payable and accrued expenses (1,601) 214
Deferred revenue 313 (22)
Claims payable and claims incurred but not reported 355 546
Noncurrent assets and liabilities 425 90
-------- -------------
Net cash provided by (used in) operating activities (1,617) 197
Cash flows from investing activities:
Purchase of investments available-for-sale (8,850) (13,695)
Proceeds from sales/maturity of investments available for sale 2,570 12,497
Purchases of property and equipment -- (225)
Payments received on notes receivable 355 --
-------- --------------
Net cash provided by (used in) investing activities (5,925) (1,423)
Cash flows from financing activities:
Borrowings on long-term debt 8,000 --
Payments on notes payable and long-term debt (75) (199)
-------- --------------
Net cash provided by (used in) financing activities 7,925 (199)
-------- --------------
Net increase (decrease) in cash 383 (1,425)
Cash balance at beginning of period 1,639 2,978
-------- --------------
Cash balance at end of period $ 2,022 $ 1,553
======== ==============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE>
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF REPORTING
- ------------------------------
The accompanying unaudited consolidated financial statements of SafeGuard Health
Enterprises, Inc. and subsidiaries (the "Company") for the three months ended
March 31, 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
make the accompanying financial statements not misleading.
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 and classification of
assets, or to the amounts and classification of liabilities, that might be
necessary should the Company be unable to continue as a going concern. During
the quarter ended March 31, 2000, and the years ended December 31, 1999 and
1998, the Company incurred net losses of $2.5 million, $52.0 million and $9.9
million, respectively, and net cash used by operating activities was $1.6
million, $0.6 million and $2.0 million, respectively. As of March 31, 2000, the
Company was in violation of 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 4).
As of March 31, 2000, and December 31, 1999, the Company's current liabilities
exceeded its current assets by $2.0 million and $9.0 million, respectively. The
Company believes this negative working capital position will be mitigated by its
plans to return the Company to profitability, as described below. The Company
also intends to sell certain long-term assets during the next several months,
although there can be no assurance it will be successful in doing so.
In March 2000 the Company entered into an agreement with an investor group and
its primary lenders, under which the investor group and the primary lenders
agreed to convert all of the Company's outstanding debt to convertible preferred
stock (see Note 4). This conversion is currently pending regulatory approval of
the change in control of the Company that would result from the conversion. In
connection with this agreement, the Company obtained a new president and chief
executive officer, and certain new directors.
Management believes the Company's ability to continue as a going concern depends
on its return to profitable operations, its ability to generate sufficient cash
flow to meet its obligations on a timely basis, and its ability to obtain
additional financing as may be required. To return the Company to profitability,
management is taking action 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 the results of its plans will enable the Company to meets
its ongoing obligations on a timely basis and return to profitable operations.
The Company also believes it will be able to obtain additional financing, if
necessary, to support its operations.
4
<PAGE>
NOTE 2. INVESTMENTS
- ---------------------
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,
Accounting for Certain Investments in Debt and Equity Securities, and in
accordance with management's intent, the Company has classified its entire
investment portfolio as "available-for-sale." Investments classified as
available-for-sale are carried at fair value and unrealized gains and losses,
net of applicable income taxes, are reported in a separate caption of
stockholders' equity. At March 31, 2000, and December 31, 1999, the Company had
net unrealized losses of $13,000 and $18,000, respectively, which is reflected
in stockholders' equity under "Accumulated other comprehensive income (loss)."
NOTE 3. ASSETS OF DISCONTINUED OPERATIONS TRANSFERRED UNDER CONTRACTUAL
- -------------------------------------------------------------------------------
ARRANGEMENTS
- ------------
During the three months ended September 30, 1997, the Company sold several
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
several 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 sale
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." 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.
NOTE 4. SHORT-TERM AND LONG-TERM DEBT
- ------------------------------------------
Short-term and long-term debt consisted of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
----------- --------------
<S> <C> <C>
Investor senior loan $ 8,000 $ --
Revolving credit facility 7,045 7,045
Senior notes payable 32,500 32,500
Other notes payable 180 255
----------- --------------
Total debt 47,725 39,800
Less - current portion (180) (255)
----------- --------------
Long-term debt $ 47,545 $ 39,545
=========== ==============
</TABLE>
On March 1, 2000, the Company entered into an agreement (the "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 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 shareholder
approval, as described below.
5
<PAGE>
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 Agreement, both the Senior Note Holder and the Bank agreed not to
demand or accept any payment under their respective credit agreements, and not
to take any enforcement actions of any kind under those agreements until April
30, 2001. 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.
In May 1999 the Company executed restructured credit agreements with respect to
both the revolving credit facility and the senior notes payable. The
restructured agreements include revisions of various terms and conditions,
including interest rates, financial covenants, reporting requirements, and
principal payments. Under the restructured agreements, the senior notes payable
are due in annual installments of $6.5 million each September 30, beginning in
2001, with a final maturity date of September 30, 2005. Also under the
restructured agreements, the outstanding balance under the revolving credit
facility is payable in full as of January 29, 2000. The Company is subject to
various financial covenant requirements under the restructured agreements. The
Company was not in compliance with those requirements as of March 31, 2000.
However, due to the transaction completed on March 1, 2000, as set forth in the
Agreement described above, the outstanding balances under the senior notes
payable and the revolving credit facility are classified as long-term as of
March 31, 2000.
In connection with the restructured credit agreements, 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 Agreement described above.
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 March 31,
2000 (in thousands).
<TABLE>
<CAPTION>
ACTUAL AS OF EFFECT OF AFTER
MARCH 31, 2000 TRANSACTION RECAPITALIZATION
---------------- ------------- ------------------
<S> <C> <C> <C>
Current liabilities $ 17,121 $ -- $ 17,121
Long-term debt 47,545 (47,545) --
Other long-term liabilities 3,298 (2,107) 1,191
---------------- ------------- ------------------
Total liabilities 67,964 49,652 18,312
---------------- ------------- ------------------
Preferred stock -- 51,000 51,000
Common stock 21,829 -- 21,829
Accumulated deficit (37,763) (1,348) (39,111)
Accumulated other comprehensive income (loss) (13) -- (13)
Treasury stock (18,123) -- (18,123)
---------------- ------------- ------------------
Total stockholders' equity (deficit) (34,070) 49,652 15,582
---------------- ------------- ------------------
Total liabilities and stockholders' equity (deficit) $ 33,894 $ -- $ 33,894
================ ============= ==================
</TABLE>
6
<PAGE>
Pursuant to the Agreement described above, it is expected that all of the
Company's long-term debt ($47.5 million at March 31, 2000) and the accrued
interest on the revolving credit facility and the senior notes payable ($2.1
million at March 31, 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 $170 per share for purposes of
the above information, which is the Company's estimate of its market value as of
March 31, 2000. Each share of convertible preferred stock would be convertible
into 100 shares of common stock, and the closing price of the Company's common
stock on March 31, 2000 was $1.70 per share. As a result of this conversion, and
based on the estimated preferred stock value of $170 per share, the Company
would record an extraordinary loss of $1.3 million from the conversion.
The transaction illustrated in the above table is contingent upon shareholder
approval of an increase in the number of authorized shares of common stock, and
regulatory approval of the change in control of the Company that would result
from 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
March 31, 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.
NOTE 5. 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 ended
March 31, 2000.
NOTE 6. RESTATEMENT
- ---------------------
Subsequent to the issuance of the Company's financial statements for the three
months ended March 31, 1999, the Company determined that it would be necessary
to restate its revenue and earnings for that period. The Company also determined
that various other amounts in its balance sheet and statement of operations
related to that period, including accounts receivable, deferred income taxes and
deferred revenue, required modification. This information was disclosed in the
Company's 1999 Annual Report on Form 10-K. The statement of operations for the
three months ended March 31, 1999, has been restated from the amounts previously
reported, as shown below (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1999
=====================
AS
PREVIOUSLY AS
REPORTED RESTATED
========== ========
<S> <C> <C>
Premium revenue $ 24,755 $23,863
Health care services expense 16,442 16,518
Selling, general and administrative expense 7,712 9,111
--------- --------
Operating income (loss) 601 (1,766)
Investment and other income 1,552 1,503
Interest expense (947) (947)
--------- --------
Income (loss) before income taxes 1,207 (1,210)
Income tax expense (benefit) 422 (350)
--------- --------
Net income (loss) $ 785 $ (860)
========= ========
Basic and diluted earnings (loss) per share $ 0.17 $ (0.18)
Weighted average basic and diluted shares outstanding 4,747 4,747
</TABLE>
7
<PAGE>
NOTE 7. LITIGATION
- --------------------
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.
8
<PAGE>
ITEM 1. 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 dental health care expenses, 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, which statements involve risks and
uncertainties. The Company's ability to expand its business 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 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. There is a risk that the Company will
be unable to obtain waivers and/or extensions from its lenders, in the event the
conversion of its outstanding debt to preferred stock does not occur. There are
also risks associated with changes in the Company's operating or expansion
strategy, and the possible inability to complete the proposed resale of dental
office assets and/or promissory notes. 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. Factors such as levels of
utilization of dental health care services, possible increases in reserves, new
technologies, the cost of services delivered by referral specialists, claims
expenses, and numerous other external influences may affect 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 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.
9
<PAGE>
Summary of Results of Operations
<TABLE>
<CAPTION>
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.
THREE MONTHS ENDED
MARCH 31,
====================
2000 1999 (1)
========= =========
<S> <C> <C>
Premium revenue 100.0% 100.0%
Health care services expense 71.6 69.2
Selling, general and administrative expense 35.3 38.2
--------- ---------
Operating loss (6.9) (7.4)
Investment and other income 1.0 6.3
Interest expense (4.2) (4.0)
--------- ---------
Loss before income taxes (10.1) (5.1)
Income tax benefit -- (1.5)
--------- ---------
Net loss (10.1)% (3.6)%
========= =========
<FN>
(1) As restated. See Note 6 to the accompanying financial statements.
</TABLE>
Three Months Ended March 31, 2000 Compared to Three Months Ended March 31, 1999
Premium revenue increased by $600,000, or 2.5%, from $23.9 million in 1999 to
$24.5 million in 2000. The average membership for which the Company provided
dental coverage decreased by approximately 13,000 members, or 1.5%, from 872,000
members during 1999 to 859,000 during 2000. The decrease in the average number
of members is primarily due to the loss of a single customer, which accounted
for approximately 8,000 members, effective January 1, 2000. Premium revenue
increased by 2.5% even though average membership decreased by 1.5%. This was
primarily due to a shift in the product mix toward 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 $987,000, or 6.0%, from $16.5 million
in 1998 to $17.5 million in 1999. Health care services expense as a percentage
of premium revenue (the "loss ratio") increased from 69.2% in 1999 to 71.6% in
2000. This increase is primarily due to an increase in premium revenue from
indemnity dental plans, as a percentage of total premium revenue. The Company's
indemnity dental business has a significantly higher loss ratio than its managed
care dental business, but the indemnity business has a higher amount of margin
per insured individual, and the Company believes it has significantly lower
selling, general and administrative expenses than its managed care business, as
a percentage of premium revenue.
Selling, general and administrative ("SG&A") expenses decreased by $465,000, or
5.1%, from $9.1 million in 1999 to $8.6 million in 2000. SG&A expenses as a
percentage of premium revenue decreased from 38.2% in 1999 to 35.3% in 2000.
This decrease is 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. The decrease in SG&A expenses is also partially
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 decreased by $1.2 million, or 82.8%, from $1.5
million in 1999 to $259,000 in 2000. This decrease is primarily due to $1.2
million of realized gains on the sale of investments in 1999, compared to none
in 2000.
10
<PAGE>
Interest expense increased by $85,000, or 9.0%, from $947,000 in 1999 to
$1,032,000 in 2000. This increase is primarily due to interest expense on the
$8.0 million borrowing on March 1, 2000, which was done in connection with the
transaction described in Note 4 to the accompanying financial statements.
The loss before income taxes increased by $1.3 million, from $1.2 million in
1999 to $2.5 million in 2000. The loss before income taxes as a percentage of
premium revenue increased from 5.1% in 1999 to 10.1% in 2000. The increase in
the loss was primarily due to $1.2 million of realized gains on the sale of
investments in 1999, and an $85,000 increase in interest expense, as discussed
above.
Income tax expense decreased from $350,000 in 1999 to zero in 2000. The Company
recorded no income tax expense or benefit in 2000 due to the valuation allowance
against its deferred tax assets (see Note 5 to the accompanying financial
statements).
Liquidity and Capital Resources
Net cash used by operating activities was $1.6 million during the three months
ended March 31, 2000, compared to net cash provided by operating activities of
$197,000 during the same period in 1999. This change of $1.8 million was
primarily due to a $1.6 million reduction in accounts payable in 2000, which was
financed through the sale of investments. Net cash used in investing activities
was $6.0 million during 2000, compared to $1.4 million during 1999. The increase
in cash used by investing activities is primarily due to the purchase of
investments with the $8.0 million proceeds of the investor senior loan obtained
in connection with the transaction completed on March 1, 2000 (see Note 4 to the
accompanying financial statements). This was partially offset by the proceeds
from the sale of investments that were used to reduce accounts payable in 2000,
as noted above. Net cash provided by financing activities was $7.9 million
during 2000, compared to net cash used by financing activities of $199,000
during 1999. This change of $8.1 million was primarily due to $8.0 million of
proceeds from the investor senior loan obtained on March 1, 2000.
The Company's total short-term and long-term debt increased from $39.8 million
at December 31, 1999, to $47.7 million at March 31, 2000, due to an $8.0 million
borrowing on March 1, 2000, in connection with the Agreement described in Note 4
to the accompanying financial statements.
Year 2000 Compliance
The Year 2000 issue results from computer programs that use two digits rather
than four to define the applicable year. 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 April 30, 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 third
parties with which it does business.
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 expenses. 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 Company expects that its earnings will be negatively impacted by
inflation in health care costs, because fees charged by other dental providers
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. In addition, most of the Company's selling, general
and administrative expenses are impacted by general inflation in the economy.
ITEM 2. 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.
11
<PAGE>
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 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 2. RECENT SALES OF UNREGISTERED SECURITIES
On March 1, 2000, the Company entered into an agreement with the Investors, the
Senior Note Holder, and the Bank. Under the 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 approval. See Note 4 to the accompanying financial
statements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See Note 4 to the accompanying consolidated financial statements herein.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT DESCRIPTION
- ------------------- -----------------------------------------------------------
10.26 Term Sheet Agreement dated as of March 1, 2000 (1)
27.1 Financial Data Schedule
(1) Incorporated by reference herein to the Exhibit of the same number filed
as an Exhibit to the Company's 1999 Annual Report on Form 10-K.
(b) REPORTS ON FORM 8-K.
A Report on Form 8-K was filed with the Securities and Exchange Commission on
March 17, 2000, to report that the Company had entered into an agreement (the
"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 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 approval. This Report on Form 8-K is hereby incorporated by reference
in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2000.
12
<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 15th day of May, 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)
13
<PAGE>
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