-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BfuW2H0r6NMYtSoPlqFhVvPeUbp2WRQNx1QRPFusrKKDcNiVnkkmwUtdWCZ7yiTC ElJPFHmeLmMDsD0gaS4S9w== 0000892569-99-001472.txt : 19990518 0000892569-99-001472.hdr.sgml : 19990518 ACCESSION NUMBER: 0000892569-99-001472 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SAFEGUARD HEALTH ENTERPRISES INC CENTRAL INDEX KEY: 0000727303 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 521528581 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-12050 FILM NUMBER: 99627200 BUSINESS ADDRESS: STREET 1: 95 ENTERPRISE T CITY: ALISO VIEJO STATE: CA ZIP: 92656-2601 BUSINESS PHONE: 9494254110 10-Q 1 FORM 10-Q 1 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, 1999 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 Identification No.) of incorporation) 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 outstanding of registrant's common stock, par value $.01 per share, at March 31, 1999, was 4,747,498 shares (not including 3,274,788 shares of common stock held in treasury). Page 1 of 17 2 SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1999 INFORMATION INCLUDED IN REPORT
Page ---- Part I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements 3 Consolidated Statements of Financial Position 3 Consolidated Statements of Income 4 Consolidated Statements of Cash Flows 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures about Market Risk 15 Part II. OTHER INFORMATION Item 1. Legal Proceedings 15 Item 3. Defaults on Senior Notes 15 Item 5. Other Information 15 Item 6. Exhibits and Reports on Form 8-K 16 SIGNATURES 17
Page 2 of 17 3 PART I. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (000'S OMITTED)
March 31, December 31, 1999 1998 --------- ------------ (Unaudited) ASSETS Current assets: Cash $ 1,602 $ 3,256 Investments available for sale, at estimated fair value 3,612 2,959 Accounts receivable, net of reserves of $2,687 in 1999 and $2,954 in 1998 6,344 4,641 Notes receivable, net of allowances of $17,305 in 1999 and 1998 10,878 10,892 Income taxes receivable 77 485 Prepaid expenses and other current assets 747 478 Deferred income taxes 6,447 6,672 Assets held for sale 3,562 3,562 -------- -------- Total current assets 33,269 32,945 -------- -------- Property and equipment, net 6,150 6,105 Investments available for sale, at estimated cost 5,071 4,225 Notes receivable - long term, net of allowances of $2,523 in 1999 and $2,601 in 1998 4,161 4,083 Other assets 240 240 Goodwill, net of accumulated amortization of $1,746 in 1999 and $1,563 in 1998 27,731 27,914 Intangibles and covenant not to compete, net of accumulated amortization of $2,288 in 1999 and $2,059 in 1998 3,639 3,893 Deferred income taxes - long term 539 539 -------- -------- Total assets $ 80,800 $ 79,944 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term debt $ 8,000 $ 8,000 Current portion of note payable 1,695 1,894 Accounts payable and accrued expenses 10,300 10,905 Income taxes payable 493 -- Reserves for incurred but not reported claims 3,858 3,558 Deferred revenue 739 1,022 -------- -------- Total current liabilities 25,085 25,379 Long-term debt 32,500 32,500 Accrued compensation agreement 302 311 Stockholders' equity Common stock $.01 par value; 30,000,000 shares authorized; 4,747,000 in 1999 and in 1998 shares outstanding, stated at 21,509 21,509 Preferred stock - $.01 par value; 1,000,000 shares authorized; no shares issued or outstanding -- -- Retained earnings 19,507 18,722 Net unrealized loss on investments available for sale, net of deferred taxes 20 (354) Treasury stock, at cost (18,123) (18,123) -------- -------- Total stockholders' equity 22,913 21,754 -------- -------- $ 80,800 $ 79,944 ======== ========
See accompanying Notes to Consolidated Financial Statements. Page 3 of 17 4 SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (000'S OMITTED, EXCEPT PER SHARE DATA)
Three months ended March 31, -------------------- 1999 1998 -------- -------- Revenues: $ 24,755 $ 24,396 Expenses: Health care services 16,442 16,431 Selling, general and administrative 7,712 7,300 -------- -------- Total expenses 24,154 23,731 -------- -------- Operating income 601 664 Other income 1,552 970 Interest expense (947) (922) -------- -------- Income from continuing operations before provision for income taxes and discontinued operations 1,207 712 Provision for income taxes 422 313 -------- -------- Net income $ 785 $ 399 ======== ======== Basic earnings per share from net income: $ 0.17 $ 0.08 Weighted average shares outstanding 4,747 4,747 Diluted earnings per share from net income: $ 0.17 $ 0.08 Weighted average shares outstanding 4,747 4,820
See accompanying Notes to Consolidated Financial Statements. Page 4 of 17 5 SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (000'S OMITTED)
Three months ended March 31, -------------------- 1999 1998 -------- --------- Cash flows from operating activities: Net income $ 785 $ 400 Adjustments to reconcile net income to net cash provided by (used in) continuing operations: Depreciation and amortization 709 671 Deferred income taxes (benefit) -- (850) Changes in operating assets and liabilities: Accounts receivable, net (1,688) (668) Income taxes receivable 407 (206) Prepaid expenses and other current assets (269) 8 Accounts payable and accrued expenses (605) (919) Income taxes payable 493 -- Deferred revenue (283) 21 Reserves for incurred but not reported claims 300 (600) -------- -------- Net cash provided by continuing operations (151) (2,143) Net cash used in discontinued operations -- (1,081) -------- -------- Net cash provided by (used in) operating activities (151) (3,224) -------- -------- Cash flows from investing activities: Purchase of investments available for sale (13,024) (589) Proceeds from sales/maturity of investments available for sale 12,123 1,259 Purchase of investments held to maturity -- (4,443) Proceeds from maturity of investments held to maturity -- 4,142 Purchases of property and equipment (394) (576) Additions to intangibles and other assets -- (63) -------- -------- Net cash provided by investing activities (1,295) (270) -------- -------- Cash flows from financing activities: Proceeds from bank loan -- 2,000 Payments on accrued compensation agreement (9) (9) Payments on notes payable (199) (298) -------- -------- Net cash (used in) provided by financing activities (208) 1,693 -------- -------- $ (2,143) Net increase (decrease) in cash (1,654) (1,801) Cash at beginning of period 3,256 3,652 -------- -------- Cash at end of period $ 1,602 $ 1,851 ======== ========
See accompanying Notes to Consolidated Financial Statements. Page 5 of 17 6 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 quarter ended March 31, 1999, have been prepared in accordance with generally accepted accounting principles applicable to interim periods, and reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of results for the interim periods. The statements have been prepared in accordance with the regulations of the Securities and Exchange Commission, but omit certain information and footnote disclosures necessary to present the statements in accordance with generally accepted accounting principles. This information should be read in conjunction with the Consolidated Financial Statements and Notes including Significant Accounting Policies, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. Management believes that the disclosures herein are adequate to make the information presented not misleading. As described in Note 6 herein, the operating results for the quarter ended March 31, 1998 has been reclassified to reflect the effect of the discontinued operation of the general dental practices and the orthodontic practices. NOTE 2: STOCKHOLDERS' EQUITY AND EARNINGS PER SHARE Since October 1986, the Company's Board of Directors has, at various times, authorized the repurchase of up to 4,510,888 shares of its common stock through open market or private transactions. As of March 31, 1999, a total of 3,819,088 shares had been acquired. All shares acquired prior to August 24, 1987, have been retired as required by California law. All shares acquired after the August 24, 1987 reincorporation in Delaware are being held as treasury stock at an average cost of $5.54 per share. Earnings per share have been restated to conform with the provisions of Statement of Financial Accounting Standards No. 128, "Earnings Per Share". Basic earnings per share excludes the effect of all potentially dilutive securities. Diluted earnings per share includes the effect of all potentially dilutive common securities. For the quarters ended March 31, 1999 and 1998 the current presentation of diluted earnings per share is identical to the Company's former presentation of primary earnings per share. NOTE 3: RECENT ACCOUNTING PRONOUNCEMENTS In February 1997, the FASB issued Statement of Financial Accounting Standards No. 128 ("FAS 128"), Earnings Per Share, which becomes effective for fiscal years ending after December 15, 1997. FAS 128 specifies the computation, presentation and disclosure requirements for earnings per share, and its objective is to simplify the computation of earnings per share, and to make the U.S. standard for computing earnings per share more compatible with the standards of other countries. The statement requires that all prior period earnings per share data presented shall be restated. The Company adopted FAS 128 in fiscal year 1997 as required, and for the quarters ended March 31, 1999 and 1998, the current presentation of diluted earnings per share is identical to the Company's former presentation of primary earnings per share. In June 1997, FASB issued Statement of Financial Accounting Standards No. 130 ("FAS 130"), Reporting Comprehensive Income, which becomes effective for fiscal years ending after December 15, 1997. FAS 130 requires that all components of comprehensive income be displayed with the same prominence as other financial statements. The Company adopted FAS 130 in fiscal year 1998 as required. The reconciliation of net income to comprehensive income is as follows:
Three months ended March 31, ------------------ 1999 1998 ------ ----- Net income $ 785 $ 400 Unrealized gain (loss) on investments, net 374 (228) ------ ----- Total comprehensive income $1,159 $ 172 ====== =====
Page 6 of 17 7 In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("FAS 131"), Disclosure About Segments of an Enterprises and Related Information, which becomes effective for fiscal years ending after December 15, 1997. FAS 131 requires that future financial statements contain disclosures about products and services, geographic areas and major customers related to its reportable operating segments. The Company anticipates the adoption of FAS 131 will not have a significant effect on the Company's financial position or results of operations. In June 1998, the FASB issued Statement of Financial Accounting Standard No. 133 (FAS 133), Accounting for Derivative Instruments and Hedging Activities, which becomes effective for fiscal years beginning after June 15, 1999. FAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company does not expect the adoption of FAS 133 to have a significant impact on the Company's financial position or results of operations. NOTE 4: DISCONTINUED OPERATIONS On February 26, 1998, the Company announced the discontinuance of its orthodontic practices. On April 1, 1998, the Company completed the sale of its orthodontic practices to Pacific Coast Dental, Inc./Associated Dental Services, Inc., and affiliated dentists. The practices were sold for $15 million in 8.5% long-term notes. The transaction included the sale of all assets and associated liabilities of the orthodontic practices and a long-term commitment from the purchaser to continue to provide orthodontic services to members of a subsidiary of the Company. The assets of the orthodontic practices sold consist of accounts receivable, supply inventory and dental equipment. The Company recorded a gain of $2,403,000 net of $937,000 in taxes on the sale of the discontinued orthodontic practices in the second quarter 1998. In the fourth quarter of 1998 and as part of an ongoing review process, the Company ascertained that some of the promissory notes granted to the Company by the purchasers of certain general and orthodontic practices were not performing at currently stated levels and such purchasers were unable to service such promissory notes pursuant to the terms and conditions thereof. As a result, the Company reduced the value of the promissory notes on its books so that they reflect management's current estimate of their market value. Rather than the Company exercising its right to foreclose on the promissory notes, the Company entered into a Default Forbearance Agreement and an Irrevocable Power of Attorney with the purchasers, which will enable the Company to either resell the assets or promissory notes relating to the practices. NOTE 5: CREDIT AGREEMENTS On September 30, 1997, the Company completed a private placement of $32.5 million in long-term debt consisting of eight-year notes through John Hancock Mutual Life Insurance Company ("Hancock"). The Company used the proceeds to repay all of its long-term indebtedness and for general corporate purposes. The senior notes (the "Notes") are unsecured and are due September 30, 2005, with a principal payment of $6.5 million due on September 30, of each year starting in 2001. The interest rate for the loan is fixed at 7.91 percent. On January 29, 1998, the Company entered into a $8,000,000 revolving working capital credit facility with Silicon Valley Bank (the "Bank"), all of which is currently being utilized by the Company. The loan had a maturity date of January 28, 1999, and is currently due and payable. The interest rate for the facility, as amended, was established at the Bank's Prime rate, plus 1.5 percent or at the Company's option, LIBOR plus 2.25 percent. The loan is secured by a first priority security interest in all the personal property of the Company, including accounts receivable, fixed assets and intangibles and a negative pledge on the stock of the Company's subsidiaries and on the real property owned by the Company. In connection with the Bank and Hancock loan, the Company is subject to certain financial and operational debt covenants. As a result of underperforming notes related to the sale of the dental offices that were previously sold and discontinued, a reduction in the value of the Company's former headquarters building in Anaheim, California, which the Company is in the process of selling, severance payments to a number of former employees who left the Company in the fourth quarter of 1998 as a result of the Company's continuing efforts to streamline its operations, and expenses for a reduction in its account receivable balances which may be uncollectible, as ascertained after the Company completed its systems conversion in October 1998. As of the end of the fourth quarter of 1998, the Company was not in compliance with such covenant requirements. Page 7 of 17 8 As a result of these conditions, the Company reached an agreement in principle with Hancock to restructure the debt owed by the Company. The Notes will be modified to provide for an interest rate increase from 7.91% to 9.91% from the date that the Company and Hancock execute definitive documents. Thereafter, the interest rate will decrease to 8.91% and then to 7.91% after the Company has satisfied certain conditions. The Company will also be responsible for all reasonable out-of-pocket attorneys' fees and costs, and consultant's fee incurred by Hancock after January 1, 1999. In consideration of this agreement, Hancock has waived all existing defaults or events of defaults through April 28, 1999, or such mutually agreed to extended date thereafter, and extended the due date for the payment of interest due on March 30, 1999. The sale of certain assets of the Company will also not be considered an event of default under the agreement with Hancock so long as the proceeds are used to repay Hancock in accordance with the amendments to the agreement. Various technical terms, covenants and provisions of the agreement relating to consolidated net worth, interest expense coverage and limitation on consolidated total debt will be amended. New provisions will include a requirement for the Company to provide Hancock of any notice of intent to audit received by the Company from any regulatory agency, copies of correspondence from any regulatory agency and the Company's response thereto. In addition, the Company is not to declare dividends or other distributions, and not incur any liens on the Company's subsidiary's stock. The Company is also required to provide consolidated financial reports and cash flows at regular intervals. The Company is also required to pay from the proceeds of certain sales of assets owned by the Company, specified amounts to Hancock on a prorata basis, including the sale of the Company's former headquarters building (the "Building"), and certain promissory notes owned by the Company. The agreement in principal also provides that prior to December 31, 1999, the Company may satisfy all of the financial obligations due to Hancock without prepayment penalty. The Company is also responsible for issuing to Hancock non-transferable and cancelable warrants representing the right to acquire 382,000 shares of the Company's common stock, which are exercisable at any time after January 1, 2000, and prior to December 31, 2003, at a price per share equal to $1 above the twenty day weighted average of the NASDAQ closing price for the Company's stock for such twenty days prior to and including the closing date. However, the warrants will be automatically canceled on the date the Company's debt to Hancock is satisfied in full by December 31, 1999. Certain "piggyback" and demand registration rights with respect to the warrants have been granted to Hancock. Additional principal and collateral payments are required under the agreement, including payment of a portion of the proceeds from the sale of the Building, and with all appropriate regulatory approval, the payment of funds derived from the sale of certain promissory notes granted to the dental office subsidiary of the Company in connection with the sale of the general dental and orthodontic practices previously owned by the Company, and a portion of the Company's 1998 federal tax refund. The Company has also reached an agreement in principle with the Bank to extend the maturity date of the existing obligation to January 29, 2000. The interest rate which shall be paid by the Company to the Bank from and after the closing date will be equal to the prime interest rate, plus 4%. Thereafter, the rate shall be prime plus 3% and then the rate shall be prime plus 1.5% thereafter until paid in full upon the Company satisfying certain conditions. The Company is also required to make certain principal payment reductions during specified periods and in specified amounts, consisting of the payment of proceeds received from the sale of certain promissory notes owned by the Company, and certain promissory notes, after appropriate regulatory approval is received, owned by a subsidiary of the Company relating to previously sold general dental and orthodontic dental practices, the payment of a portion of the 1998 federal tax refund, and a portion of the net cash proceeds of the sale of Building. The Company also granted to Hancock and the Bank a first priority deed of trust on the Building, delivery of any promissory notes given to the Company in connection with the sale of the Building, and certain other promissory notes owned by the Company, to a collateral agent for the benefit of Hancock and the Bank. The agreement in principal also provides that prior to the extended maturity date, the Company may repay the Bank in full without penalty. The Company is obligated to pay reasonable out-of-pocket attorneys' fees and costs incurred by the Bank through the closing date, and certain consulting fees for consultants required to be hired by the Company. Page 8 of 17 9 In consideration of the agreement, the Bank waives all existing defaults and has extended the payment obligation of outstanding principal and interest due to the Bank while definitive documents are prepared. Additionally, the Company will provide the Bank with monthly consolidated financial statements and covenants compliance certificates, all Securities and Exchange Commissions filings, and other financial documents as they may reasonably request, and the same notice requirements as described above. Certain standard conditions are required as a condition of closing. Although there is an agreement in principal to restructure the Company's debt to Hancock and the Bank, no assurance can be given that the parties will execute definitive and binding agreements with respect to such debt restructure. NOTE 6: RESTATEMENT OF QUARTERLY INFORMATION The results for the quarter ended March 31, 1998 were restated as follows (in 000's):
As Previously Recorded As Restated ------------- ----------- Current Assets: Cash $ 1,851 $ 1,851 Investments available for sale 4,860 4,860 Investments held to maturity 4,272 4,272 Accounts and notes receivable, net 7,894 7,894 Income tax receivable 132 132 Prepaid and other current assets 1,378 1,021 Net assets of discontinued operations 5,143 5,143 Deferred income taxes 1,608 1,608 -------- -------- Total current assets 27,138 26,781 Long-term assets: Property and equipment, net 9,729 9,684 Investments held to maturity, long-term 5,182 5,182 Notes receivable, long-term 12,389 12,389 Other assets 247 247 Intangibles and goodwill, net 34,111 34,111 -------- -------- Total long-term assets 61,658 61,613 -------- -------- Total Assets $ 88,796 $ 88,394 ======== ======== Liabilities and Stockholders' Equity Current liabilities: Short-term notes payable $ 10,500 $ 10,500 Current portion of note payable 1,692 1,692 Accounts payable and accrued expenses 3,484 3,552 Income taxes payable 427 221 Reserve for dental claims 3,331 3,331 Deferred revenues 1,198 1,198 -------- -------- Total current liabilities 20,632 20,494 Long-Term Liabilities: Long-term debt 32,500 32,500 Note payable 1,096 1,096 Deferred income taxes 1,000 1,000 Accrued compensation agreement 374 374 -------- -------- Total long-term liabilities 34,970 34,970 Stockholders' Equity: Common stock 21,509 21,509 Retained earnings 30,479 30,215 Accumulated other comprehensive income (671) (671) Treasury stock, at cost (18,123) (18,123) -------- -------- Total stockholders' equity 33,194 32,930 -------- -------- Total Liabilities and Stockholders' Equity $ 88,796 $ 88,394 ======== ========
Page 9 of 17 10 NOTE 6: RESTATEMENT OF QUARTERLY INFORMATION (CONTINUED) The income statement for the period January 1, 1998 to March 31, 1998, was restated as follows (in 000's except per share data):
As Previously Recorded As Restated ------------- ----------- Health care revenues $24,395 $24,396 Health care expenses 16,431 16,431 Selling, general and administrative 6,830 7,300 ------- ------- Total expenses 23,261 23,731 Other expense 970 970 Interest expense (922) (922) ------- ------- Income from continuing operations 1,182 713 Provision for income taxes 519 313 ------- ------- Net Income $ 663 $ 400 ======= ======= Basic earnings per share: Net income (loss) per share $ 0.14 $ 0.08 Weighted average shares 4,747 4,747 Diluted earnings per share: Net income(loss) per share $ 0.14 $ 0.08 4,820 4,820
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the attached consolidated financial statements and notes thereto.
1999 versus 1998 Three months ended March 31, ----------------------- Increase/ Percent Results of operations (000's omitted) (Decrease) Change - ------------------------------------- ---------- ------- Health care revenues $ 359 1.5 Health care expenses $ 11 0.1 Selling, general and administrative expenses $ 412 5.6 Other income, net $ 582 60.0 Interest expense $ 25 2.7 Net income $ 385 96.3
1999 Versus 1998 Health care revenues for the quarter ended March 31, 1999 were $24,755, or a 1.5% increase on a decrease of 1.7% in membership over the corresponding period a year ago. Notwithstanding the loss of two private label HMO relationships, which provided lower than average revenues per member per month, the Company was successful in replacing these accounts with business that counteracted the effect of the business lost. Page 10 of 17 11 Health care expenses for the three months ended March 31, 1999 increased $11, or 0.1%. Health care expense as a percentage of health care revenues improved by 1.0% from 67.4% of revenues for the three months ended March 31, 1998, to 66.4% for the same period in 1999. This improvement was primarily as a result of the effect of the continued improvements in the Company's health care cost ratios in its existing business as well as cost control measures implemented in recent quarters. Selling, general and administrative expenses for the three months ended March 31, 1999, increased $412, or 31.2% of revenue compared to 29.9% of revenue for the same period a year ago. This was impacted by the Company's relocation of its Corporate and Western Region operations from Anaheim, California to Aliso Viejo, California and the associated costs which were offset to some extent by savings realized in other operating areas. Other income for the three months ended March 31, 1999 was $1,552, which increased from $970 for the same period a year ago. This was largely due to gains on the sale of certain securities coupled with interest recorded on notes receivable resulting from the sale of certain dental practices. Interest expense of $947 for the three months ended March 31, 1999 is the result of the interest associated with the Notes and the $8 million revolving working capital credit facility. This represents an increase of $25 from $922 for the same period in 1998. Net income for the three months ended March 31, 1999, was $785, which changed from the same period in 1998 due to the above discussed factors. Net income for the same period in 1998 was $399. Business Segment Information The Company is engaged in a single business segment: the provision of dental benefits to employer groups, associations and individuals. Liquidity and Capital Resources The Company's capital and operational cash requirements have been met principally from operating cash flows, and corporate borrowings, and this is expected to continue. At March 31, 1999, the current ratio was 1.4 to 1.0. The Company's net worth was $22.9 million compared to $33.2 million a year earlier. The Company had $10.3 million of cash and investments as of March 31, 1999 compared to $10.4 million a year earlier. As a result of its regulated nature, the Company is required to maintain various regulatory bank accounts in an aggregate amount of approximately $9.0 million to satisfy depository requirements imposed by state regulatory agencies. Due to the significant cash and investments maintained by the Company, these requirements do not pose a significant liquidity burden on the Company. The Company believes that cash flow from continuing operations, together with the existing cash and investments on hand and other available sources of financing, should be adequate to meet operating capital and regulatory needs for the foreseeable future. Credit Facilities Please see information set forth in Note 5 of Notes to Consolidated Financial Statements herein. Impact of Inflation Management believes that the Company's operations are not materially affected by inflation. The Company believes that a majority of its costs are capitated or fixed in nature and are directly related to membership levels, and therefore related to premium levels. Page 11 of 17 12 Risk Factors In addition to the Risk Factors set forth in the Company's 1998 Annual Report on Form 10-K, we have received a letter from NASDAQ indicating that the Company no longer meets the tangible net asset requirement for continued listing on the NASDAQ National Market under Maintenance Standard Number 1. We have provided NASDAQ our proposal for achieving compliance, which we believe may result in our meeting all NASDAQ National Market listing requirements under Maintenance Standard Number 2, although no assurance can be made that after the applicable hearing and appeal periods, we will be able to maintain our NASDAQ National Market listing. In such event, the trading ability of our stock may be impaired. Year 2000 Compliance Company's State of Readiness The Company relies heavily upon information technology ("IT") systems and other systems and facilities such as telephones, building access control systems and heating and ventilation equipment ("embedded systems") to conduct its business. The Company also has business relationships with dental health care providers, financial institutions and other third parties ("Vendors") as well as regulators and customers who are themselves reliant upon IT and embedded systems to conduct their business. As part of the Company's proactive approach to automation, the Company began planning an awareness activity as early as January 1996 and incorporated Year 2000 compliance into its business continuity plans. As a result, the Company purchased and is in the final implementation process of upgrading any and all information systems software and hardware. The implementation of such new and upgraded computer information systems will recognize the Year 2000 and process date data correctly, including the Company's manipulation of data when dates are in the 20th or 21st century. The Company executed its initial steps in 1996 when it continued to enhance its information systems, including all hardware and software products, individually and in combination, to better manage operational resources and analysis of data. A review was also performed to determine the future needs of the Company and to enhance technology to better enable the Company to provide its services. In addition, as a foundation for developing and executing its Year 2000 compliance program, SafeGuard utilized and integrated Year 2000 compliance programs developed by both Federal and State governments and corporate industry leaders. Moreover, SafeGuard developed a comprehensive five-phase approach for all of its Year 2000 program activities and management processes. The five phases are included in the following table and indicates the percentage completed as of March 31, 1999.
Anticipated Program Goals Start Date Date Completed Completion Date - ------------- ---------- -------------- --------------- Planning and Awareness 1 Jan 1996 1 Jun 1997 N/A Assessment 1 Jun 1996 1 Jan 1998 N/A Renovation 1 Dec 1996 1 Jan 1999 N/A Validation 1 Jan 1997 In Process 1 Jun 1999 Implementation 1 Jun 1996 In Process 1 Jun 1999
The Company's five-phase comprehensive approach is as follows: (1) Phase 1: Planning and Awareness - identify all IT and other systems and facilities and risk rate each according to its potential business impact; Page 12 of 17 13 (2) Phase 2: Assessment - identify IT and other systems and facilities that utilize date functions and assessing them for Year 2000 functionality; (3) Phase 3: Renovation - reprogram or replace when necessary, inventoried items to ensure that they are Year 2000 compliant; (4) Phase 4: Validation - test the code modifications and new inventory of other associated systems, including extensive date testing and performing quality assurance testing to ensure successful operation in a post-1999 environment; and (5) Phase 5: Implementation of Year 2000 Compliant IT and other systems. As indicated in the above-referenced chart, the Company completed Phase 1 Planning and Awareness on or about June 1, 1997, Phase 2 Assessment on or about January 1, 1998, and Phase 3 Renovation of all of its IT and other systems and related facilities on or about January 1, 1999. In addition, the Company anticipates completing Phase 4 Validation and beginning Phase 5 Implementation of such Year 2000 Compliant IT and other systems and facilities by June 1, 1999. The Company has inventoried and risk rated substantially all of its embedded systems. The results of these processes indicate that embedded systems should not present a material Year 2000 risk to the Company. The Company's remaining steps include testing selected embedded systems and remediating through replacement and/or repair and certifying systems that exhibit Year 2000 issues. The Company is focusing its testing and facilities such as data centers, service centers and communication centers. The Company plans to complete the testing, validation and implementation of these systems by June 1999. The Company has also inventoried and risk rated its systems. Substantially all of the tested systems have been found to be compliant. As part of the Company's Year 2000 Compliance Program Planning/Awareness and Assessment phases, the Company documented the state and condition of existing systems and processes and conducted a thorough analysis of inventory and vendor supplied systems and subsystems. The Company included information technology systems and non-information technology systems. The Company also faces the risk that one or more of its Vendors will not be able to interact with the Company due to the Vendor's inability to resolve its own Year 2000 issues, including those associated with its own external relationships. The Company has completed its inventory of Vendors and risk rated each external relationship based upon the potential business impact, available alternatives and cost of substitution. Although the Company is diligently working with its vendors regarding Year 2000 compliance, there can be no guarantee that all of the Company's vendors will be Year 2000 compliant. The Company has previously compiled a comprehensive list of any and all Vendors and Vendor products, which was included in a Vendor identification matrix. Although the Company does not currently rely upon external Vendors for proprietary software or data services, all other Vendors have been identified and have either stated their full compliance or partial compliance with contingent solutions to Year 2000 issues. The Company believes that its Vendors with which it has a material relationship are Year 2000 Compliant, based upon such vendor's assurances. Nonmaterial Vendors of the Company currently have provided either full and/or partial certification of compliance with the Year 2000 issue. The Company will continue to monitor such nonmaterial Vendor compliance activity in order to determine the risk to overall company operations. As a result of the anticipated execution of the Renovation, Validation and Implementation phases of the Company's Year 2000 Compliance Program, the Company believes the Year 2000 issue will not have a material impact on the Company's results or operations. Page 13 of 17 14 Cost to Address Company's Year 2000 Issues The cost the Company incurred to address Year 2000 Compliance issues from a historical perspective is approximately $2.5 million. Whereas, the estimated cost of the Company's completion of the final phases of renovation, validation and implementation is estimated to be approximately $0.5 million. A large majority of these costs are expected to be incremental expenses that will not recur in Year 2000 or thereafter. The Company's current estimates primarily reflect increased remediation and testing efforts. The source of funds for the Year 2000 Compliance Program costs, including the percentage of the information technology budget utilized for the program was $3.0 million. Year 2000 Compliance is critical to the Company. Therefore, the Company has redeployed some resources from non-critical system enhancements to address Year 2000 issues. Due to the importance of IT systems to the Company's business, management has not deferred the decision to make non-critical systems enhancements Year 2000 ready. The Company does not expect these redeployments to have a material impact on the Company's financial condition or result of operations. Risk and Contingency/Recovery Planning The Company reasonably believes that its Year 2000 Compliance Program, which involves the phases of planning and awareness, assessment, renovation, validation and implementation should prevent the Year 2000 from having a material effect on the Company's business or financial condition. However, if the Company's Year 2000 issues were unresolved, potential consequences would include, among other possibilities, the inability to accurately and timely process benefits claims, update client groups' accounts, process financial transactions, bill client groups, report accurate data to management, shareholders, customers, regulators and others as well as business interruptions or shutdowns, financial losses, reputational harm, increased scrutiny by regulators and litigation related to Year 2000 issues. The Company is attempting to limit the potential impact of the Year 2000 by monitoring the progress of its own Year 2000 project and those of its critical Vendors by developing contingency/recovery plans. The Company has begun to develop contingency/recovery plans aimed at ensuring the continuity of critical business functions before and after December 31, 1999. As part of that process, the Company has begun to develop reasonably likely failure scenarios for its critical IT systems and external relationships and the embedded systems. Once these scenarios are identified, the Company will develop plans that are designed to reduce the impact on the Company, and provide methods of returning to normal operations, if one or more of those scenarios occur. The Company expects contingency/recovery planning to be substantially complete by June 1, 1999. To reduce the risk of the Company presented by the Year 2000, the Company has also increased its on-hand supplies of inventory for printed documents and materials that are provided to client groups, and has identified alternative Vendors, whether such Vendors have previously provided assurances that they are fully Year 2000 Compliant or are in the process of becoming Year 2000 Compliant. Therefore, based upon the Company's proactive Year 2000 Compliance Program, the Company anticipates that the Year 2000 issue will not have a material impact on the Company's results or operations. See "Safe Harbor Statement" heading for factors that could cause actual Year 2000 results to differ from the Company's expectations. Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995 The Private Securities Litigation Reform Act of 1995 (the "1995 Act") provides a "safe harbor" for forward-looking statements, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statement. The Company desires to take advantage of these safe harbor provisions Page 14 of 17 15 The statements contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations concerning any future premium pricing levels, future dental health care expense levels, the Company's ability to continue to comply with the NASDAQ National Market listing standards, the Company's ability to control health care, selling, general and administrative expenses, items discussed under heading "Year 2000" and all other statements that are not historical facts, are forward looking statements. Words such as expects, projects, anticipates, intends, plans, believes, seeks or estimates, or variations of such words and similar expressions are also intended to identify forward-looking statements. These forward-looking statements are subject to significant uncertainties and contingencies, many of which are beyond the control of the Company. Actual results may differ materially from those projected in the forward looking statements, if any, which statements involve risks and uncertainties. The Company's ability to expand is affected by competition not only in benefit program choices, but also the number of dental plan competitors in the markets in which the Company operates. Certain large employer groups and other purchasers of commercial dental health care services continue to demand minimal premium rate increases, while limiting the number of choices offered to employees. In addition, securing cost effective contracts with dentists may become more difficult in part due to the increased competition among dental plans for dentist contracts. The Company's profitability depends, in part, on its ability to maintain effective control over health care costs, while providing members with quality dental care. Factors such as levels of utilization of dental health care services, new technologies, specialists costs, and numerous other external influences may effect the Company's operating results. Any critical unresolved Year 2000 issues at the Company or its Vendors could have a material adverse effect on the Company's results of operations, liquidity or financial condition. In addition, the Company's expectations about the future costs and timely and successful completion of its Year 2000 Program are subject to uncertainties that could cause actual results to differ materially from what has been discussed above under the heading "Year 2000." Factors that could influence the amount of future costs and the completion dates and effectiveness of remediation, testing and certification and contingency planning efforts include the Company's success in identifying IT systems and embedded systems that contain two-digit year codes, the nature and amount of required reprogramming, testing and certification, the rate and magnitude of related labor and consulting costs, the availability of qualified personnel and the success of the Company's external relationships in addressing their own Year 2000 issues. The Company's expectations for the future are based on current information and evaluation of external influences. Changes in any one factor could materially impact the Company's expectations relating to premium rates, benefit plans offered, membership growth, the percentage of health care expenses, and as a result, profitability and therefore, effect the forward looking statements which may be included in these reports. In addition, past financial performance is not necessarily a reliable indicator of future performance. An investor should not use historical performance alone to anticipate future results or future period trends. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is not subject to material risk from interest rate or foreign currency exchange rate fluctuations. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is a defendant in litigation arising in the normal course of business. In the opinion of management, the defense costs and/or ultimate outcome of such litigation is covered by insurance or will not have material effect on the Company's financial position or results of operations. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Please see information set forth in Note 5 of Notes to Consolidated Financial Statements herein. ITEM 5. OTHER INFORMATION Please see information set forth in Notes 4 and 5 of Notes to Consolidated Financial Statements herein, and the section on Risk Factors in Part I., Item 2. Page 15 of 17 16 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.18 Default Forbearance Agreement and Irrevocable Power of Attorney, dated as of February 12, 1999(1) 27.1 Financial Data Schedule - -------------- (1) Referenced, disclosed and filed as an exhibit to Company's Annual Report on Form 10-K for the period ended December 31, 1998. (b) Reports on Form 8-K. There were no reports on Form 8-K filed by the Company with the Securities and Exchange Commission during the quarter ended March 31, 1999. Page 16 of 17 17 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 14th of May, 1999. SAFEGUARD HEALTH ENTERPRISES, INC. By: /s/ STEVEN J. BAILEYS, D.D.S. ------------------------------------ Steven J. Baileys, D.D.S., Chairman and Chief Executive Officer By: /s/ ROBERT J. POMMERSHEIM ------------------------------------ Robert J. Pommersheim, Interim Chief Financial Officer (Chief Accounting Officer) Page 17 of 17 18 EXHIBIT LIST EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.18 Default Forbearance Agreement and Irrevocable Power of Attorney, dated as of February 12, 1999(1) 27.1 Financial Data Schedule - -------------- (1) Referenced, disclosed and filed as an exhibit to Company's Annual Report on Form 10-K for the period ended December 31, 1998. EX-27.1 2 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-1998 JAN-01-1999 MAR-31-1999 1,602 3,612 37,214 (19,992) 0 32,945 10,141 (3,991) 80,800 25,085 0 0 0 21,509 1,404 80,800 24,755 26,307 16,442 24,154 0 0 947 1,207 422 785 0 0 0 785 .17 .17
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