-----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, L5N7a/iWISJV0w9oXsJ6wdbhQ5vZkwAJI4iE0ost4vaNVPIbRvEszO3OrS2NgcpB o/CMcfzI4ElTQMYQGq289g== 0001015402-02-003759.txt : 20021114 0001015402-02-003759.hdr.sgml : 20021114 20021114124753 ACCESSION NUMBER: 0001015402-02-003759 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021114 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: 1934 Act SEC FILE NUMBER: 000-12050 FILM NUMBER: 02823350 BUSINESS ADDRESS: STREET 1: 95 ENTERPRISE T CITY: ALISO VIEJO STATE: CA ZIP: 92656-2601 BUSINESS PHONE: 9494254110 10-Q 1 doc1.txt SAFEGUARD HEALTH ENTERPRISES 10-Q 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, 2002 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, SUITE 100 ALISO VIEJO, CALIFORNIA 92656-2605 (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 --- --- As of November 1, 2002, the number of shares of registrant's common stock, par value $0.01 per share, outstanding was 5,666,203 shares (not including 3,216,978 shares of common stock held in treasury), and the number of shares of registrant's convertible preferred stock, par value $0.01 per share, outstanding was 30,000,000 shares.
SAFEGUARD HEALTH ENTERPRISES, INC. INDEX TO FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2002 PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . 1 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk. . . . . . . . . . . . . . 21 Item 4. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 PART II. OTHER INFORMATION Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . . . . . 22 SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 CERTIFICATIONS BY CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER . . . . . . . . . . . . . . . 24
i PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (UNAUDITED) SEPTEMBER 30, DECEMBER 31, 2002 2001 --------------- -------------- ASSETS Current assets: Cash and cash equivalents $ 2,338 $ 1,497 Investments available-for-sale, at fair value 9,752 13,956 Accounts receivable, net of allowances 2,616 2,839 Other current assets 637 903 --------------- -------------- Total current assets 15,343 19,195 Property and equipment, net of accumulated depreciation 3,664 2,348 Restricted investments available-for-sale, at fair value 3,299 2,831 Notes receivable, net of allowances 778 805 Goodwill 10,846 3,920 Other assets 152 226 --------------- -------------- Total assets $ 34,082 $ 29,325 =============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,560 $ 3,168 Accrued expenses 4,059 4,827 Current portion of long-term debt 2,596 265 Claims payable and claims incurred but not reported 5,162 5,905 Deferred premium revenue 1,449 823 --------------- -------------- Total current liabilities 14,826 14,988 Long-term debt 3,343 -- Other long-term liabilities 1,032 971 Commitments and contingencies (Note 9) Stockholders' equity: Convertible preferred stock and additional paid-in capital 41,250 41,250 Common stock and additional paid-in capital 22,641 21,552 Retained earnings (accumulated deficit) (31,285) (31,447) Accumulated other comprehensive income 101 63 Treasury stock, at cost (17,826) (18,052) --------------- -------------- Total stockholders' equity 14,881 13,366 --------------- -------------- Total liabilities and stockholders' equity $ 34,082 $ 29,325 =============== ============== See accompanying Notes to Condensed Consolidated Financial Statements.
1
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) 2002 2001 -------- -------- Premium revenue, net $20,682 $20,831 Health care services expense 14,546 14,456 Selling, general and administrative expense 6,040 6,062 -------- -------- Operating income 96 313 Investment and other income 92 213 Interest expense (84) (31) -------- -------- Income before income taxes 104 495 Income tax expense -- -- -------- -------- Net income $ 104 $ 495 ======== ======== Basic net income per share $ 0.00 $ 0.01 Weighted average basic shares outstanding 35,161 34,753 Diluted net income per share $ 0.00 $ 0.01 Weighted average diluted shares outstanding 35,526 35,542 See accompanying Notes to Condensed Consolidated Financial Statements.
2
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) 2002 2001 -------- -------- Premium revenue, net $61,544 $63,926 Health care services expense 43,772 44,557 Selling, general and administrative expense 17,656 19,049 -------- -------- Operating income 116 320 Investment and other income 311 903 Interest expense on debt that was converted to equity in 2001 -- (402) Other interest expense (115) (93) -------- -------- Income before income taxes and extraordinary item 312 728 Income tax expense -- -- -------- -------- Income before extraordinary item 312 728 Extraordinary item: Gain on conversion of debt to convertible preferred stock -- 11,251 -------- -------- Net income $ 312 $11,979 ======== ======== Basic net income per share: Income before extraordinary item $ 0.01 $ 0.02 Extraordinary item -- 0.36 -------- -------- Net income $ 0.01 $ 0.38 ======== ======== Weighted average basic shares outstanding 34,817 31,410 Diluted net income per share: Income before extraordinary item $ 0.01 $ 0.02 Extraordinary item -- 0.35 -------- -------- Net income $ 0.01 $ 0.37 ======== ======== Weighted average diluted shares outstanding 35,374 32,369 See accompanying Notes to Condensed Consolidated Financial Statements.
3
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (IN THOUSANDS) (UNAUDITED) 2002 2001 -------- --------- Cash flows from operating activities: Net income $ 312 $ 11,979 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Gain on conversion of debt to convertible preferred stock -- (11,251) Bad debt expense 160 225 Amortization of deferred loan costs -- 24 Depreciation and other amortization 908 1,523 Contribution to retirement plan in the form of common stock, at fair value 68 -- Gain on liquidation of notes receivable -- (175) Gain on sale of subsidiary (9) -- Gain on sale of investments (2) (98) Changes in operating assets and liabilities, excluding effects of acquisition: Accounts receivable 101 111 Other current assets 457 573 Accounts payable 96 (201) Accrued expenses (740) (1,691) Claims payable and claims incurred but not reported (968) (1,228) Deferred premium revenue 270 (467) Other assets 74 -- -------- --------- Net cash provided by (used in) operating activities 727 (676) Cash flows from investing activities: Purchase of investments available-for-sale (3,130) (14,324) Proceeds from sale/maturity of investments available-for-sale 6,893 15,693 Cash paid for acquisition of business, net of cash acquired (2,702) -- Purchases of property and equipment (311) (542) Payments received on notes receivable 27 1,320 Proceeds from sale of subsidiary 72 -- -------- --------- Net cash provided by investing activities 849 2,147 Cash flows from financing activities: Borrowings on long-term debt 2,000 -- Payments on debt (1,099) (174) Increase (decrease) in bank overdrafts (1,746) (1,203) Increase in accrued interest that was converted to equity in 2001 -- 321 Repurchase of common stock -- (10) Exercise of stock options 49 43 Increase (decrease) in other long-term liabilities 61 (247) -------- --------- Net cash used in financing activities (735) (1,270) -------- --------- Net increase in cash and cash equivalents 841 201 Cash and cash equivalents at beginning of period 1,497 1,381 -------- --------- Cash and cash equivalents at end of period $ 2,338 $ 1,582 ======== ========= (Continued on next page)
4
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS -- CONTINUED NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (IN THOUSANDS) (UNAUDITED) 2002 2001 -------- ------- Supplementary information: Cash paid during the period for interest $ 115 $ 306 Supplementary disclosure of non-cash activities: Debt converted into convertible preferred stock -- 41,250 Purchases of property and equipment through capital leases 1,784 -- Liabilities assumed in acquisition of business: Fair value of assets acquired $ 864 $ -- Goodwill related to transaction 6,926 -- Less - Secured convertible note issued in transaction (2,625) -- Less - Common stock issued in transaction (1,040) -- Less - Cash paid in transaction (3,158) -- -------- ------- Liabilities assumed in acquisition of business $ 967 $ -- ======== ======= See accompanying Notes to Condensed Consolidated Financial Statements.
5 SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2002 (UNAUDITED) NOTE 1. GENERAL - ----------------- The accompanying unaudited condensed consolidated financial statements of SafeGuard Health Enterprises, Inc. and subsidiaries (the "Company") as of September 30, 2002, and for the three months and nine months ended September 30, 2002 and 2001, 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 normal and recurring 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, accordingly, omit certain footnote disclosures and other information necessary to present the Company's financial position and results of operations for annual periods in accordance with accounting principles generally accepted in the United States of America. These consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2001, which includes the Company's Consolidated Financial Statements and Notes thereto for that period. NOTE 2. SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS - -------------------------------------------------------------------------------- GOODWILL Goodwill as of September 30, 2002 consists of $6.9 million of goodwill related to the acquisition of Paramount Dental Plan, Inc. ("Paramount") in August 2002, which is discussed in Note 3 to the accompanying condensed consolidated financial statements, and $3.9 million of goodwill related to the acquisition of a Texas-based dental health maintenance organization ("HMO") company in 1996. In the case of each acquisition, goodwill represents the excess of the purchase price of the acquired company over the fair value of the net assets acquired. In the case of the 1996 acquisition, the balance is net of accumulated amortization and an adjustment in 1999 to reduce the carrying value of the goodwill to its estimated realizable value. The Company estimated that the goodwill related to the 1996 acquisition had a useful life of 40 years from the date of acquisition of the related entity, and amortized the goodwill over that period during the nine months ended September 30, 2001. See Recently Adopted Accounting Principles below for a discussion of the impact of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." RECOGNITION OF PREMIUM REVENUE Premium revenue is recognized in the period during which dental coverage is provided to the covered individuals. Payments received from customers in advance of the related period of coverage are reflected on the accompanying consolidated balance sheet as deferred revenue. CLAIMS PAYABLE AND CLAIMS INCURRED BUT NOT REPORTED The estimated liability for claims payable and claims incurred but not reported is based primarily on the average historical lag time between the date of service and the date the related claim is paid by the Company, and the recent trend in payment rates and the average number of incurred claims per covered individual. Since the liability for claims payable and claims incurred but not reported is an actuarial estimate, the amount of claims eventually paid for services provided prior to the balance sheet date could differ from the estimated liability. Any such differences are included in the consolidated statement of operations for the period in which the differences are identified. NET INCOME PER SHARE Net income per share is presented in accordance with SFAS No. 128, "Earnings Per Share." Basic net income per share is based on the weighted-average common shares outstanding, including the common shares into which the convertible 6 preferred stock is convertible, but excluding the effect of other potentially dilutive securities. The number of basic common shares outstanding includes the common share equivalents of the convertible preferred stock, because the Company believes the convertible preferred stock is essentially equivalent to common stock, based on all the rights and preferences of both types of stock. Diluted net income per share is based on the weighted-average common shares outstanding, including the effect of all potentially dilutive securities. During the three months and nine months ended September 30, 2002 and 2001, the potentially dilutive securities of the Company that were outstanding consisted of stock options, convertible notes, and warrants. Diluted net income per share for all periods presented includes the effect of all outstanding stock options with an exercise price below the average market price of the Company's common stock during each applicable period. The Company issued two (2) convertible notes during the three months ended September 30, 2002, as discussed in Note 4. Both of these convertible notes would have an anti-dilutive effect on net income per share for both periods in 2002. Accordingly, they are excluded from the calculation of diluted net income per share for these periods. The only warrants issued by the Company were canceled without being exercised effective January 31, 2001, as discussed in Note 5. RECENTLY ADOPTED ACCOUNTING PRINCIPLES In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations." SFAS No. 141 requires the use of the purchase method of accounting for all business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method of accounting. The adoption of SFAS No. 141 had no significant effect on the Company's financial statements. See Note 3 for a business combination completed in August 2002. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill and other intangible assets with indefinite useful lives established after June 30, 2001 not be amortized, and that amortization of goodwill and other intangible assets with indefinite useful lives that existed as of June 30, 2001, be ceased effective January 1, 2002. As a result, the Company ceased amortizing its goodwill effective January 1, 2002. The Company recorded $28,000 and $85,000 of amortization expense related to goodwill, and $40,000 and $120,000 of amortization expense related to a non-competition agreement, during the three months and nine months ended September 30, 2001, respectively. The non-competition agreement became fully amortized in September 2001. The Company's adjusted results of operations for the three months and nine months ended September 30, 2001, which are adjusted to exclude goodwill amortization, are as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ------------------ 2002 2001 2002 2001 -------- -------- -------- -------- Income before extraordinary item, as reported $ 104 $ 495 $ 312 $ 728 Add back - Goodwill amortization -- 28 -- 85 -------- -------- -------- -------- Income before extraordinary item, as adjusted $ 104 $ 523 $ 312 $ 813 ======== ======== ======== ======== Net income, as reported $ 104 $ 495 $ 312 $ 11,979 Add back - Goodwill amortization -- 28 -- 85 -------- -------- -------- -------- Net income, as adjusted $ 104 $ 523 $ 312 $ 12,064 ======== ======== ======== ========
None of the Company's reported net income per share amounts for the three months or nine months ended September 30, 2001 would change as a result of the above adjustment for goodwill amortization expense, due to the relatively small amount of this adjustment. SFAS No. 142 also requires that all goodwill be evaluated for possible impairment as of January 1, 2002, and as of the end of each reporting period thereafter, and establishes a new method of testing for possible impairment. The Company had no impairment of its goodwill as of January 1, 2002, or as of September 30, 2002, based on the method of testing for possible impairment established by SFAS No. 142. The adoption of SFAS No. 142 had no other significant effect on the Company's financial statements. 7 In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring Events and Transactions." SFAS No. 144 establishes accounting and reporting standards for the impairment or disposal of long-lived assets and for reporting the results of discontinued operations. The Company adopted SFAS No. 144 effective on January 1, 2002. The adoption of SFAS No. 144 had no significant effect on the Company's financial statements. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In August 2001, the FASB issued SFAS No. 143, "Accounting for Obligations Associated with the Retirement of Long-Lived Assets." SFAS No. 143 establishes accounting and reporting standards for the recognition and measurement of an asset retirement obligation and the associated asset retirement cost. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The Company expects that SFAS No. 143 will not have a significant effect on its financial statements. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 updates, clarifies, and simplifies existing accounting pronouncements. This statement rescinds SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB No. 30 will now be used to classify those gains and losses. SFAS No. 64 amended SFAS No. 4 and is no longer necessary as SFAS No. 4 has been rescinded. SFAS No. 44 has been rescinded, as it is no longer necessary. SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions must be accounted for in the same manner as sale-lease transactions. This statement also makes certain technical corrections to existing pronouncements. While those corrections are not substantive in nature, in some instances, they may change accounting practice. The Company is currently evaluating whether SFAS No. 145 will have a significant effect on its financial statements. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires that a liability for the cost of an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 also requires that the liability be initially measured and recorded at fair value. SFAS No. 146 supersedes Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." Under EITF Issue No. 94-3, a liability for an exit cost, as defined in the EITF Issue, was recognized at the date of an entity's commitment to an exit plan. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. NOTE 3. ACQUISITION - --------------------- Effective August 30, 2002, the Company acquired all of the outstanding capital stock of Paramount Dental Plan, Inc. ("Paramount") for a purchase price of approximately $6.7 million, consisting of $3.0 million in cash, a secured convertible note for $2,625,000, and 769,231 shares of the Company's common stock. Paramount is a dental benefits company located in Florida, and was merged into the Company's dental HMO effective August 30, 2002. The secured convertible note bears interest at 7.0% annually, and is payable in 36 equal monthly installments of principal and interest, beginning in October 2002. The outstanding balance under the secured convertible note is convertible into common stock of the Company at a conversion price of $1.625 per share, at any time after August 30, 2003. The convertible note is secured by the stock of the Company's dental HMO subsidiary in Florida. The business purpose of the acquisition was to increase the Company's market penetration in Florida, which is one of the Company's primary geographic markets. The acquisition increased the number of members in Florida for which the Company provides dental benefits from approximately 50,000 members to approximately 275,000 members. 8 In connection with this transaction, the Company entered into a three-year employment agreement with the seller of Paramount, who is currently employed as president of the Company's operations in Florida. The Company also entered into a three-year office lease agreement with the seller of Paramount, related to the office space that will be used as the Company's administrative office in Florida beginning in late 2002. The cost of the acquisition was allocated among the assets acquired as follows (in thousands):
Cost of acquisition: Cash portion of purchase price $3,000 Secured convertible note issued to seller 2,625 Common stock issued to seller 1,040 Transaction expenses incurred by the Company 158 ------- Total cost $6,823 ======= Fair value of net assets acquired: Cash and cash equivalents $ 456 Restricted investment 50 Property and equipment 129 Other assets 229 Goodwill 6,926 Accounts payable and accrued liabilities (386) Claims payable and claims incurred but not reported (225) Deferred premium revenue (356) ------- Net assets acquired $6,823 =======
The value used for the Company's common stock issued in the acquisition is based on 769,231 shares of common stock issued, and a market value of $1.35 per share. The market value of $1.35 per share is the average closing price of the Company's common stock during the period from five (5) business days prior to execution of the Stock Purchase Agreement to five (5) business days after execution of the agreement. The Stock Purchase Agreement was executed on April 24, 2002. The Company made a preliminary determination of whether the assets acquired include any separately identifiable intangible assets apart from goodwill. The Company's preliminary conclusion is that there are no such intangible assets, and accordingly, the total excess of the purchase price over the net tangible assets acquired has been allocated to goodwill in the accompanying condensed consolidated financial statements. 9 The operations of Paramount are included in the accompanying condensed consolidated financial statements beginning on September 1, 2002. Following is certain pro forma statement of operations information, which reflects adjustments to the Company's historical financial statements as if the acquisition had been completed as of the beginning of each period presented (in thousands):
NINE MONTHS ENDED SEPTEMBER 30, ---------------- 2002 2001 ------- ------- Premium revenue, net $66,823 $68,359 Operating income 354 998 Income before extraordinary item 194 1,248 Net income 194 12,499 Basic net income per share before extraordinary item 0.01 0.04 Basic net income per share 0.01 0.39 Diluted net income per share before extraordinary item 0.01 0.04 Diluted net income per share 0.01 0.38
The above pro forma statement of operations information is not intended to indicate the results that would have occurred if the acquisition had actually been completed on the dates indicated, or the results that may occur in any future period. NOTE 4. LONG-TERM DEBT - ------------------------- Long-term debt consists of the following (in thousands):
SEPTEMBER 30, DECEMBER 31, 2002 2001 --------------- -------------- Secured convertible promissory note $ 2,559 $ -- Unsecured convertible promissory note 1,900 -- Capital lease obligations 1,411 -- Other 69 265 --------------- -------------- Total debt 5,939 265 Less - Current portion (2,596) (265) --------------- -------------- Long-term portion of debt $ 3,343 $ -- =============== ==============
See Note 3 for a description of the secured convertible promissory note, which was issued in the acquisition of Paramount in August 2002. In August 2002, the Company borrowed $2.0 million from one of its principal stockholders, which was used to increase the Company's working capital, to provide for the payments due under the two capital leases discussed below, and to provide for the payments due under the settlement of the stockholder litigation discussed in Note 9. The borrowing was made under an unsecured convertible note that bears interest at 7.0% annually, and is payable in 36 equal monthly installments of principal and interest, beginning in September 2002. The outstanding balance under the convertible note is convertible into common stock of the Company at a conversion price of $1.625 per share, at any time after one year from the date of the borrowing. In June 2002, the Company entered into two capital lease obligations with an aggregate value of approximately $1.8 million. The two leases are related to the purchase of a new computer software application and the purchase of formerly leased furniture for the Company's primary administrative office. The Company intends to use the new software as its primary business application, which will be used for eligibility file maintenance, billing and collections, payment of health care expenses, utilization review and other related activities. The new software application will replace the Company's two existing systems with a single system that can be used for all of the Company's existing product lines. The cost of both of the Company's two existing systems is fully depreciated as of September 30, 2002. The aggregate annual principal payments due under the two capital leases are $260,000 during the remainder of 2002, $963,000 during 2003 and $188,000 during 2004. Under each of the two capital leases, the Company has an option to purchase the leased assets for $1.00 at the expiration of the lease. 10 NOTE 5. CONVERSION OF DEBT TO CONVERTIBLE PREFERRED STOCK - ----------------------------------------------------------------- On March 1, 2000, the Company entered into a Recapitalization Agreement with an investor group (the "Investors"), the revolving credit facility lender (the "Bank"), and the holder of the senior notes payable (the "Senior Note Holder"). In this transaction, the Investors loaned $8.0 million to the Company in the form of an investor senior loan, due April 30, 2001. In addition, the Investors, the Bank, and the Senior Note Holder agreed to convert the investor senior loan, the outstanding balance under the revolving credit facility, and the senior notes payable into convertible preferred stock, subject to regulatory and stockholder approval. Effective as of January 31, 2001, the Company completed the conversion of the investor senior loan ($8.0 million), the outstanding balance under the revolving credit facility ($7.0 million), the senior notes payable ($32.5 million), and the accrued interest on the revolving credit facility and the senior notes payable ($5.3 million) into 30 million shares of convertible preferred stock. The estimated value of the convertible preferred stock was $1.375 per share as of January 31, 2001, which is based on the closing price of the Company's common stock on January 31, 2001, which was $1.375 per share, and the fact that each share of convertible preferred stock is convertible into one share of common stock. The number of shares of convertible preferred stock, the estimated value per share, and the conversion ratio indicated above have all been adjusted to reflect an exchange of the Company's outstanding shares of convertible preferred stock that was completed in May 2002. See Note 6 for more information on this exchange. Based on the estimated value of the convertible preferred stock as of January 31, 2001, the conversion transaction resulted in an extraordinary gain of $11.3 million, which is net of approximately $350,000 of transaction costs. There was no income tax effect related to this transaction, due to the Company's net operating loss carryforwards for tax purposes. The Company's deferred tax asset related to net operating loss carryforwards is fully reserved, due to uncertainty about whether the deferred tax assets will be realized in the future, as discussed in Note 7. In 1999, in connection with a restructuring of the senior notes payable, the Company issued warrants to purchase 382,000 shares of its common stock for $4.51 per share to the Senior Note Holder. These warrants were canceled without being exercised, in connection with the conversion of the senior notes payable into convertible preferred stock effective January 31, 2001. NOTE 6. EXCHANGE OF CONVERTIBLE PREFERRED STOCK - ----------------------------------------------------- Prior to May 2002, there were 300,000 shares of convertible preferred stock issued and outstanding. Each share had a par value of $100 and a liquidation preference of $100, and was convertible into 100 shares of the Company's common stock. In May 2002, each outstanding share of convertible preferred stock was exchanged for 100 new shares of convertible preferred stock. Each new share of convertible preferred stock has a par value of $1.00 and a liquidation preference of $1.00, and is convertible into one share of the Company's common stock. All other rights and preferences of the convertible preferred stock remained the same. NOTE 7. INCOME TAXES - ----------------------- The Company's accounting for income taxes is in accordance with SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that are recognized in the Company's financial statements in different periods than those in which the events are recognized in the Company's tax returns. The measurement of deferred tax liabilities and assets is based on current tax laws as of the balance sheet date. The Company records a valuation allowance related to deferred tax assets in the event that available evidence indicates that the future tax benefits related to the deferred tax assets may not be realized. A valuation allowance is required when it is more likely than not that the deferred tax assets will not be realized. The Company's net deferred tax assets have been fully reserved since September 30, 1999, due to uncertainty about whether those net assets will be realized in the future. The uncertainty is primarily due to cumulative operating losses incurred by the Company during the period from January 1, 1998 to September 30, 2002, and the existence of significant net operating loss carryforwards. 11 Due to the conversion of outstanding debt into convertible preferred stock, as described in Note 5, there was a "change of control" of the Company for purposes of Internal Revenue Code Section 382, effective January 31, 2001. As a result, effective January 31, 2001, the amount of preexisting net operating loss carryforwards that can be used to offset current taxable income on the Company's federal income tax return is limited to approximately $350,000 per year. As of December 31, 2001, the Company had net operating loss carryforwards for federal and state tax purposes of approximately $9.0 million and $8.1 million, respectively, which are net of the amounts that will expire unused due to the change of control limitation. The federal and state net operating loss carryforwards will begin to expire in 2018 and 2003, respectively. The Company had taxable income for the nine months ended September 30, 2002 and 2001, but its taxable income in both periods was completely offset by net operating loss carryforwards from previous years. NOTE 8. TOTAL COMPREHENSIVE INCOME - -------------------------------------- Total comprehensive income includes the change in stockholders' equity during the period from transactions and other events and circumstances from nonstockholder sources. Total comprehensive income of the Company for the nine months ended September 30, 2002 and 2001, includes net income and other comprehensive income or loss, which consists of unrealized gains and losses on marketable securities, net of realized gains and losses that occurred during the period. Other comprehensive income (loss) was $47,000 and $27,000 for the three months ended September 30, 2002 and 2001, respectively, and $38,000 and $(52,000) for the nine months ended September 30, 2002 and 2001, respectively. Total comprehensive income was $151,000 and $522,000 for the three months ended September 30, 2002 and 2001, respectively, and $350,000 and $11,927,000 for the nine months ended September 30, 2002 and 2001, respectively. NOTE 9. COMMITMENTS AND CONTINGENCIES - ----------------------------------------- LITIGATION The Company is subject to various claims and legal actions arising in the ordinary course of business. The Company believes all pending claims either are covered by liability insurance maintained by the Company or by dentists in the Company's provider network, or will not have a material adverse effect on the Company's consolidated financial position or results of operations. 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. In September 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 and its officers. In October 2000, the plaintiffs filed an appeal of the dismissal of the lawsuit, and the dismissal was overturned in February 2002. The case was remanded back to the District Court with instructions to allow the plaintiff to file a second amended complaint. Subsequently, the Company conducted mediation and reached an agreement with the plaintiffs to settle the lawsuit for a payment of $1.25 million to the plaintiffs, without an admission of liability by any party. The agreement between the Company and the plaintiffs was approved by the District Court in September 2002. The Company's insurer paid $1.0 million of the cost of the settlement. Accordingly, the Company recorded a $250,000 expense during the three months ended June 30, 2002, which is included in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations. CONTINGENT LEASE OBLIGATIONS The Company sold all of its general dental practices and orthodontic practices in 1996, 1997 and 1998. The Company also re-sold certain of these practices in October 2000, after the original purchaser of a number of the practices defaulted on its obligations to the Company. The office lease agreements related to those practices either have been assigned to the respective purchasers of the practices, or have expired. 12 In the case of the assigned leases, the Company is secondarily liable for the lease payments in the event the purchasers of those practices fail to make the payments. As of September 30, 2002, the total of the minimum annual payments under these leases was approximately $1.4 million, and the aggregate contingent liability of the Company related to these leases was approximately $3.5 million over the terms of the lease agreements, which expire at various dates through 2007. The aggregate contingent liability related to these leases was approximately $5.2 million as of September 30, 2001. Management has not been notified of any defaults under these leases that would materially affect the Company's consolidated financial position. The aggregate contingent lease obligation of $3.5 million excludes $120,000 of estimated lease obligations that have been accrued as of September 30, 2002, due to a failure by one of the entities to make the lease payments under a lease that was assigned to that entity by the Company. This estimated lease obligation is included in the accompanying condensed consolidated balance sheet under the caption "Accrued expenses." LIABILITY INSURANCE The Company's directors' and officers' liability insurance policy, which contained $5 million of coverage after a $250,000 deductible, expired on September 30, 2002. Due to a significant increase in the cost of such insurance, the Company has elected not to purchase this insurance coverage effective October 1, 2002. 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. In addition to the Risk Factors section of the Company's Annual Report on Form 10-K for the year ended December 31, 2001, the Current Reports on Form 8-K dated as of April 24, 2002, and August 30, 2002, and the Current Report on Form 8-K/A dated as of August 30, 2002, all of which have been filed with the Securities and Exchange Commission, the following risk factors should be considered in connection with this Quarterly Report on Form 10-Q for the period ended September 30, 2002. 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. RISK FACTORS The Company's business and competitive environment includes numerous factors that expose the Company to risk and uncertainty. Some risks are related to the dental benefits industry in general and other risks are related to the Company specifically. Due to the risks and uncertainties described below, there can be no assurance that the Company will be able to maintain its current market position. Some of the risk factors described below have adversely affected the Company's operating results in the past, and all of these risk factors could affect its future operating results. PARAMOUNT INTEGRATION The Company is in the process of integrating the business operations of Paramount into the Company's operations. Due to the complexities inherent in this process, there is a risk that the Company may not be able to complete such integration activities in a timely and cost effective manner. In such case, the general and administrative expenses of the Company may be higher than anticipated, which could have a negative impact on the Company's overall profitability. 13 GOVERNMENT REGULATION The dental benefits industry is subject to extensive state and local laws, rules and regulations. A number of the Company's subsidiaries, which generate substantially all of the Company's revenue, are subject to various requirements imposed by state laws and regulations related to the operation of a dental HMO plan or a dental insurance company, including the maintenance of a minimum amount of net worth by certain subsidiaries. In addition, regulations applicable to dental benefit plans could be changed in the future. There can be no assurance that the Company will be able to meet all applicable regulatory requirements in the future. HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 ("HIPAA") HIPAA imposes various responsibilities on the Company, and the Company is in the process of developing policies and procedures to comply with these requirements. The total cost of compliance with HIPAA is not known at this time. There is a risk that the Company will not be able to successfully implement all of the HIPAA requirements. There is also a risk that the cost of compliance with HIPAA could have a material adverse impact on the Company's financial position. CONTINGENT LEASE OBLIGATIONS The Company sold all of its general dental practices and orthodontic practices in 1996, 1997 and 1998. The Company also re-sold certain of these practices in October 2000, after the original purchaser of a number of the practices defaulted on its obligations to the Company. All of the office lease agreements related to those practices either have been assigned to the respective purchasers of the practices, or have expired. As of September 30, 2002, the Company is contingently liable for an aggregate of approximately $3.5 million of office lease obligations related to those practices for which the leases have been assigned. Although all the leases have been assigned to the purchasers of those practices, there can be no assurance that the persons and/or entities to which these office leases were assigned will make the lease payments, and that the Company will not become liable for those payments. LIABILITIES RELATED TO DENTAL AND ORTHODONTIC PRACTICES The Company has various liabilities in connection with the dental and orthodontic practices sold in October 2000, including, but not limited to, the obligation to pay for orthodontic treatments for certain dental HMO patients who previously paid for the treatments in full. The remaining amount of the liabilities is subject to uncertainties, and there can be no assurance that the ultimate amount of the remaining liabilities will not exceed the amounts accrued on the Company's balance sheet as of September 30, 2002. PAYMENTS DUE ON PROMISSORY NOTES In connection with the sale of certain dental practices, the dentists who purchased those practices issued long-term promissory notes to the Company, which are secured by the assets purchased. There can be no assurance that each of these dentists will make timely payments on the promissory notes in the future. POSSIBLE VOLATILITY OF STOCK PRICE The market price of the Company's common stock has fluctuated significantly during the past few years. Stock price volatility can be caused by actual or anticipated variations in operating results, announcements of new developments, actions of competitors, developments in relationships with clients, and other events or factors. Even a modest shortfall in the Company's operating results, compared to the expectations of the investment community, can cause a significant decline in the market price of the Company's common stock. In addition, the trading volume of the Company's common stock is relatively low, which can cause fluctuations in the market price and a lack of liquidity for holders of the Company's common stock. The fact that the Company's common stock is not listed on an exchange can have a negative influence on the trading volume of the stock. Broad stock market fluctuations, which may be unrelated to the Company's operating performance, could also have a negative effect on the Company's stock price. 14 COMPETITIVE MARKET The Company operates in a highly competitive industry. Its ability to operate on a profitable basis is affected by significant competition for employer groups and for contracting dental providers. Dental providers are becoming more sophisticated, their practices are busier, and they are less willing to join the Company's networks under capitation arrangements or discounted fees. There can be no assurance the Company will be able to compete successfully enough to be profitable. Existing or new competitors could have a negative impact on the Company's revenues, earnings and growth prospects. The Company expects the level of competition to remain high for the foreseeable future. ABILITY TO MAINTAIN REVENUE The Company's premium revenue decreased from $63.9 million for the nine months ended September 30, 2001 to $61.5 million for the first nine months of 2002, primarily due to the loss of a number of its customers, and a net decrease in its enrollment within existing customers. The Company intends to expand its business in the future and to increase its annual revenue, but there can be no assurance the Company will be able to maintain its current level of revenue or increase it in the future. The ability of the Company to maintain its existing business or to expand its business depends on a number of factors, including existing and emerging competition, its ability to renew its relationships with existing customers on an annual basis, its ability to maintain competitive networks of dental providers, its ability to maintain effective control over the cost of dental services, and its ability to obtain sufficient working capital to support an increase in revenue. UTILIZATION OF DENTAL CARE SERVICES Under the Company's preferred provider ("PPO")/indemnity dental plan designs, the Company assumes the underwriting risk related to the frequency and cost of dental care services. If the Company does not accurately assess these underwriting risks, the premium rates charged to its customers might not be sufficient to cover the cost of the dental services delivered. This could have a material adverse effect on the Company's operating results. Under the Company's dental HMO plan designs, the Company assumes underwriting risk related to the frequency and cost of specialist services, the cost of supplemental payments made to general dentists, and the frequency and cost of dental services provided by general dentists with whom the Company does not have standard capitation arrangements. If the Company does not accurately assess these underwriting risks, the premium rates charged to its customers might not be sufficient to cover the cost of the dental services delivered to subscribers and dependents. This could have a material adverse effect on the Company's operating results. EFFECT OF ADVERSE ECONOMIC CONDITIONS The Company's business could be negatively affected by periods of general economic slowdown, recession or terrorist activities which, among other things, may be accompanied by layoffs by the Company's customers, which could reduce the number of subscribers enrolled in the Company's benefit plans, and by an increase in the pricing pressure from customers and competitors. RELATIONSHIPS WITH DENTAL PROVIDERS The Company's success is dependent on maintaining competitive networks of dentists in each of the Company's geographic markets. Generally, the Company and the network dentists enter into nonexclusive contracts that may be terminated by either party with limited notice. The Company's operating results could be negatively affected if it is unable to establish and maintain contracts with a competitive number of dentists in locations that are convenient for the subscribers and dependents enrolled in the Company's benefit plans. 15 DEPENDENCE ON KEY PERSONNEL The Company believes its success is dependent to a significant degree upon the abilities and experience of its senior management team. The loss of the services of one or more of its senior executives could negatively affect the Company's operating results. 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 revenue, premium rates, benefit plans offered, membership enrollment, health care expenses, general and administrative expenses, 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 for the Company. SIGNIFICANT ACCOUNTING POLICIES The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. Application of those accounting principles includes the use of estimates and assumptions that have been made by management, and which the Company believes are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses in the accompanying consolidated financial statements. The Company believes the most significant accounting policies used to prepare the accompanying condensed consolidated financial statements are the following: RECOGNITION OF PREMIUM REVENUE Premium revenue is recognized in the period during which dental coverage is provided to the covered individuals. Payments received from customers in advance of the related period of coverage are reflected on the accompanying consolidated balance sheet as deferred revenue. GOODWILL Goodwill as of September 30, 2002 consists of $6.9 million of goodwill related to the acquisition of Paramount Dental Plan, Inc. ("Paramount") in August 2002, which is discussed in Note 3 to the accompanying condensed consolidated financial statements, and $3.9 million of goodwill related to the acquisition of a Texas-based dental HMO company in 1996. In the case of each acquisition, goodwill represents the excess of the purchase price of the acquired company over the fair value of the net assets acquired, and in the case of the 1996 acquisition, the balance is net of accumulated amortization and an adjustment in 1999 to reduce the carrying value of the goodwill to its estimated realizable value. The Company estimated that the goodwill related to the 1996 acquisition had a useful life of 40 years from the date of acquisition of the related entity, and amortized the goodwill over that period during the nine months ended September 30, 2001. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," the Company ceased amortizing its goodwill effective January 1, 2002. SFAS No. 142 requires that all goodwill be evaluated for possible impairment as of January 1, 2002, and as of the end of each reporting period thereafter, and establishes a new method of testing for possible impairment. The Company had no impairment of its goodwill as of January 1, 2002, or as of September 30, 2002, based on the method of testing for possible impairment established by SFAS No. 142. However, there can be no assurance that impairment will not occur in the future. CLAIMS PAYABLE AND CLAIMS INCURRED BUT NOT REPORTED The estimated liability for claims payable and claims incurred but not reported is based primarily on the average historical lag time between the date of service and the date the related claim is paid by the Company, and the recent trend in payment rates and the average number of incurred claims per covered individual. Since the liability for claims payable and claims incurred but not reported is an actuarial estimate, the amount of claims eventually paid for services provided prior to the balance sheet date could differ from the estimated liability. Any such differences are included in the consolidated statement of operations for the period in which the differences are identified. 16 INCOME TAXES The Company's accounting for income taxes is in accordance with SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that are recognized in the Company's financial statements in different periods than those in which the events are recognized in the Company's tax returns. The measurement of deferred tax liabilities and assets is based on current tax laws as of the balance sheet date. The Company records a valuation allowance related to deferred tax assets in the event that available evidence indicates that the future tax benefits related to the deferred tax assets may not be realized. A valuation allowance is required when it is more likely than not that the deferred tax assets will not be realized. The Company's net deferred tax assets have been fully reserved since September 30, 1999, due to uncertainty about whether those net assets will be realized in the future. The uncertainty is primarily due to cumulative operating losses incurred by the Company during the period from January 1, 1998, to September 30, 2002, and the existence of significant net operating loss carryforwards. RESULTS OF OPERATIONS The following table shows the Company's results of operations as a percentage of premium revenue, and is used in the period-to-period comparisons discussed below.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 2002 SEPTEMBER 30, ------------------ ----------------- 2002 2001 2002 2001 -------- -------- -------- -------- Premium revenue, net 100.0% 100.0% 100.0% 100.0% Health care services expense 70.3 69.4 71.1 69.7 Selling, general and administrative expense 29.2 29.1 28.7 29.8 -------- -------- -------- -------- Operating income 0.5 1.5 0.2 0.5 Investment and other income 0.4 1.0 0.5 1.4 Interest expense on debt that was converted to equity in 2001 (1) -- -- -- (0.6) Other interest expense (0.4) (0.1) (0.2) (0.2) -------- -------- -------- -------- Income before income taxes and extraordinary item 0.5 2.4 0.5 1.1 Income tax expense -- -- -- -- -------- -------- -------- -------- Income before extraordinary item 0.5 2.4 0.5 1.1 Extraordinary item -- -- -- 17.6 -------- -------- -------- -------- Net income 0.5% 2.4% 0.5% 18.7% ======== ======== ======== ======== (1) Substantially all of the Company's debt was converted into convertible preferred stock effective January 31, 2001. See Note 5 to the accompanying condensed consolidated financial statements.
17 THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2001 Premium revenue decreased by $0.1 million, or 0.7%, from $20.8 million in 2001 to $20.7 million in 2002. The average membership for which the Company provided dental coverage increased by approximately 6,000 members, or 1.0%, from 601,000 members during 2001 to 607,000 during 2002. The small decrease in premium revenue was primarily due to the loss of a number of the Company's customers, and a net decrease in its enrollment within retained customers, which were offset by an increase in premium revenue due to the Paramount acquisition, which is included in the accompanying condensed consolidated financial statements beginning on September 1, 2002. Premium revenue decreased slightly even though average membership increased, which was due to the impact of the Paramount acquisition. The acquired Paramount business has lower premium revenue per member than the Company's preexisting business. This is due to the dental plan designs offered by Paramount, which include a significantly lower level of benefits than the benefit plans offered by the Company prior to the acquisition of Paramount. Substantially all of the Company's premium revenue was derived from dental benefit plans in 2002 and 2001. Premium revenue from vision benefit plans and other products was not material in 2002 or 2001. Health care services expense increased slightly from 2001 to 2002, but was approximately $14.5 million in both periods. Health care services expense as a percentage of premium revenue (the "loss ratio") increased from 69.4% in 2001 to 70.3% in 2002. The increase in the loss ratio was primarily due to a shift in the type of plan designs toward preferred provider ("PPO")/indemnity plan designs, which have a higher loss ratio than HMO plan designs. Selling, general and administrative ("SG&A") expense was approximately $6.0 million in both 2002 and 2001, and SG&A expense as a percentage of premium revenue increased slightly, from 29.1% in 2001 to 29.2% in 2002. Investment and other income decreased by $0.1 million, from $0.2 million in 2001 to $0.1 million in 2002. This decrease is primarily due to a decrease in interest rates on short-term fixed-income investments during the past year, a decrease in interest income from notes receivable, due to the liquidation of a portion of the Company's notes receivable during the past year, and a decrease in the amount of investments held by the Company, compared to the third quarter of 2001. The decrease in investments was primarily due to the Company's use of its cash to make significant reductions in accounts payable, accrued expenses, and claims payable and claims incurred but not reported ("IBNR") during the past year. By intentionally accelerating its payment of claims, the Company believes it will enhance its image among dental providers. Income before income taxes decreased by $0.4 million, from $0.5 million in 2001 to $0.1 million in 2002. Income before income taxes as a percentage of premium revenue decreased from 2.4% in 2001 to 0.5% in 2002. This decrease was primarily due to an increase in the loss ratio from 69.4% in 2001 to 70.3% in 2002, as well as a decrease in investment income and an increase in interest expense. NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2001 Premium revenue decreased by $2.4 million, or 3.7%, from $63.9 million in 2001 to $61.5 million in 2002. The average membership for which the Company provided dental coverage decreased by approximately 58,000 members, or 9.3%, from 626,000 members during 2001 to 568,000 during 2002. The decrease in membership was primarily due to the loss of a number of the Company's customers, and a net decrease in its enrollment within retained customers, which were partially offset by an increase in premium revenue due to the Paramount acquisition, which is included in the accompanying condensed consolidated financial statements beginning on September 1, 2002. Premium revenue decreased by only 3.7% even though average membership decreased by 9.3%. This was primarily due to increases in premium rates and a shift in the type of plan designs toward PPO/indemnity plan designs, which have higher premium rates than HMO plan designs. Substantially all of the Company's premium revenue was derived from dental benefit plans in 2002 and 2001. Premium revenue from vision benefit plans and other products was not material in 2002 or 2001. Health care services expense decreased by $0.8 million, or 1.8%, from $44.6 million in 2001 to $43.8 million in 2002. The loss ratio increased from 69.7% in 2001 to 71.1% in 2002. The increase in the loss ratio was primarily due to increases in supplemental payments and discounted fee-for-service payments to dental HMO providers, and a shift in the type of plan designs toward PPO/indemnity plan designs, which have a higher loss ratio than HMO plan designs. The increases in supplemental and discounted fee-for-service payments were partially due to high-cost arrangements with certain providers, which were 18 started early in 2002, and which have been terminated. These arrangements resulted in an unusually large amount of supplemental payments and discounted fee-for-service payments in 2002. The increase was also partially due to a general increase in supplemental payments, which the Company believes is due to more comprehensive submission of claims information by the dentists in its HMO network. SG&A expenses decreased by $1.4 million, or 7.3%, from $19.0 million in 2001 to $17.6 million in 2002. SG&A expenses as a percentage of premium revenue decreased from 29.8% in 2001 to 28.7% in 2002. The decrease in SG&A expenses is primarily due to decreases in depreciation and amortization, furniture rent, property rent, and a $350,000 refund of maintenance fees from one of the Company's vendors, which were partially offset by a $250,000 expense in 2002 related to the settlement of stockholder litigation, as described in Note 9 to the accompanying condensed consolidated financial statements. The decrease in depreciation and amortization expense is primarily due to the fact that a significant component of the Company's computer software became fully depreciated during the past year, and the fact that the Company had no amortization of goodwill or other intangible assets during 2002, as discussed in Note 2 to the accompanying condensed consolidated financial statements. There was $205,000 of amortization expense related to goodwill and another intangible asset during the first nine months of 2001. The decrease in furniture rent was due to the purchase of the office furniture used in the Company's primary administrative office through a new capital lease during the second quarter of 2002, as discussed in Note 4 to the accompanying condensed consolidated financial statements. The related furniture was formerly leased under an operating lease with relatively expensive terms, compared to the new capital lease. The new capital lease caused an increase in depreciation expense, but this was more than offset by other decreases in depreciation and amortization, as noted above. The decrease in property rent was primarily due to the fact that the Company recorded an expense of approximately $300,000 in the second quarter of 2001 to accrue all the future rent payments under a lease for office space previously occupied by the Company. The Company had been subleasing the space to an unrelated entity, and that entity ceased making rent payments in the second quarter of 2001, due to its insolvency. The refund of maintenance fees was primarily due to the settlement of a dispute over the amount of equipment maintenance fees paid by the Company in several prior years. Investment and other income decreased by $0.6 million, from $0.9 million in 2001 to $0.3 million in 2002. This decrease is primarily due to realized gains on the sale of investments in 2001, a decrease in interest rates on short-term fixed-income investments during the past year, a decrease in interest income from notes receivable, due to the liquidation of a portion of the Company's notes receivable during the past year, and a decrease in the amount of investments held by the Company, compared to the prior year. The decrease in the Company's investments was primarily due to significant reductions in accounts payable, accrued expenses, and claims payable and IBNR during the past year. By intentionally accelerating its payment of claims, the Company hopes to enhance its image among dental providers. Total interest expense decreased by $0.4 million, from $0.5 million in 2001 to $0.1 million in 2002, primarily due to the conversion of substantially all of the Company's debt into convertible preferred stock effective January 31, 2001, which eliminated nearly all of the Company's interest expense. Income before income taxes decreased by $0.4 million, from $0.7 million in 2001 to $0.3 million in 2002. Income before income taxes as a percentage of premium revenue decreased from 1.1% in 2001 to 0.5% in 2002. This decrease was primarily due to an increase in the loss ratio, which was partially offset by a decrease in SG&A expense as a percentage of premium revenue. LIQUIDITY AND CAPITAL RESOURCES The Company's net working capital decreased from $4.2 million as of December 31, 2001, to $0.5 million as of September 30, 2002, primarily due to the acquisition of Paramount in August 2002, as discussed in Note 3 to the accompanying condensed consolidated financial statements. The Paramount acquisition decreased working capital by a total of $3.5 million, including $2.7 million of net cash used in the acquisition and the current portion of the secured convertible note issued in the transaction, which is $0.8 million. The Company borrowed $2.0 million of working capital in August 2002, but this increase in working capital was offset by the current portion of the two capital lease obligations entered into in June 2002, as discussed in Note 4 to the accompanying condensed consolidated financial statements. 19 The Company's total debt increased from $265,000 as of December 31, 2001, to $5.9 million as of September 30, 2002, primarily due to the $2.6 million convertible note issued in the Paramount acquisition, the $2.0 million unsecured convertible note issued in August 2002, and the two capital leases discussed above, which added $1.8 million of debt during the second quarter of 2002. The aggregate principal payments due under all of the Company's debt, including its capital leases, are $563,000 during the remainder of 2002, $2,424,000 in 2003, $1,755,000 in 2004, and $1,197,000 in 2005. In August 2002, the Company borrowed $2.0 million from one of its principal stockholders, which was used to increase the Company's working capital, to provide for the payments due under the two new capital leases discussed above, and to provide for the payments due under the settlement of the stockholder litigation discussed in Note 9 to the accompanying condensed consolidated financial statements. The borrowing was made under an unsecured convertible note that bears interest at 7.0% annually, and is payable in 36 equal monthly installments of principal and interest, beginning in September 2002. The outstanding balance under the convertible note is convertible into common stock of the Company at a conversion price of $1.625 per share, at any time after one year from the date of the borrowing. Effective August 30, 2002, the Company acquired all of the outstanding capital stock of Paramount Dental Plan, Inc. ("Paramount") for a purchase price of approximately $6.7 million, consisting of $3.0 million in cash, a secured convertible note for $2,625,000, and 769,231 shares of the Company's common stock. The secured convertible note bears interest at 7.0% annually, and is payable in 36 equal monthly installments of principal and interest, beginning in October 2002. The outstanding balance under the secured convertible note is convertible into common stock of the Company at a conversion price of $1.625 per share, at any time after August 30, 2003. The convertible note is secured by the stock of the Company's dental HMO subsidiary in Florida. The operations of Paramount are included in the accompanying condensed consolidated financial statements beginning on September 1, 2002. The Company believes it has adequate financial resources to continue its current operations for the foreseeable future, and that it will be able to meet its various financial obligations from its existing financial resources and future cash flows from its operations. However, there can be no assurance that the Company's future earnings will be adequate to make all of the payments on the Company's various obligations as they become due. Net cash provided by operating activities was $0.7 million during the nine months ended September 30, 2002, compared to $0.7 million of net cash used by operating activities in the same period last year. The change is primarily due to the fact that net cash used to reduce accounts payable, accrued expenses and claims payable and claims incurred but not reported ("IBNR") decreased from $3.1 million in 2001 to $1.6 million in 2002. The most significant decreases in both periods were payments made to reduce the obligations assumed in connection with the re-sale of certain dental practices in October 2000, and reductions in claims payable and IBNR. The obligations assumed in connection with the re-sale of dental practices were reduced by $680,000 during 2001 and by $360,000 during 2002, due to payments made during both periods. Claims payable and IBNR decreased by $1.2 million in 2001 and $1.0 million in 2002, primarily due to intentional decreases in the processing time for payment of provider claims, and in the case of 2001, partially due to a decrease in the Company's volume of PPO/indemnity business during the period. Due in part to the recent decline in interest rates on investments, the Company has adopted the practice of paying all provider claims as rapidly as possible, in order to enhance its image among dental providers. Net cash provided by investing activities was $0.8 million in 2002, compared to $2.1 million in 2001. In 2002, the Company had a net liquidation of $3.8 million of investments, the proceeds of which were used primarily to finance the acquisition of Paramount and to finance the reduction in bank overdrafts, as discussed below. In 2001, the Company had a net liquidation of $1.4 million of investments and received $1.3 million from the liquidation of certain of its notes receivable, the proceeds of which were used primarily to finance the reduction in bank overdrafts, as discussed below, and to finance the reductions in accounts payable, accrued expenses and claims payable and IBNR, as discussed above. Net cash used in financing activities decreased from $1.3 million in 2001 to $0.7 million in 2002. The net cash used in both periods was primarily due to reductions in the amount of bank overdrafts, which are due to outstanding checks not yet presented for payment. 20 RECENT ACCOUNTING PRONOUNCEMENTS See Note 2 to the accompanying condensed consolidated financial statements for a discussion of recently adopted accounting principles and recently issued accounting pronouncements. 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 Company expects that its earnings will be negatively impacted by inflation in health care costs, because fees charged by dentists and other dental providers have been increasing due to inflation in recent years. The impact of inflation on the Company's health care expenses is partially mitigated in the short-term by the fact that approximately 30% of total health care services expense consists of capitation (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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is subject to risk related to changes in short-term interest rates, due to its investments in interest-bearing securities. As of September 30, 2002, the Company's total cash and investments were approximately $15.4 million. Therefore, a one percentage-point change in short-term interest rates would have a $154,000 impact on the Company's annual investment income. The Company is not subject to a material amount of risk related to changes in foreign currency exchange rates. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Within 90 days prior to the date of this report, the Company completed an evaluation, under the supervision and with the participation of the Company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in alerting them, on a timely basis, to material information related to the Company required to be included in the Company's periodic filings with the Securities and Exchange Commission. CHANGES IN INTERNAL CONTROLS No significant changes to the Company's internal controls were made during the periods covered by this report. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is subject to various claims and legal actions arising in the ordinary course of business. The Company believes all pending claims either are covered by liability insurance maintained by the Company or by dentists in the Company's provider network, or will not have a material adverse effect on the Company's consolidated financial position or results of operations. 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. In September 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 and its officers. In October 2000, the plaintiffs filed an appeal of the dismissal of the lawsuit, and the dismissal was overturned in February 2002. The 21 case was remanded back to the District Court with instructions to allow the plaintiff to file a second amended complaint. Subsequently, the Company conducted mediation and reached an agreement with the plaintiffs to settle the lawsuit for a payment of $1.25 million to the plaintiffs, without an admission of liability by any party. The agreement between the Company and the plaintiffs was approved by the District Court in September 2002. The Company's insurer paid $1.0 million of the cost of the settlement. Accordingly, the Company recorded a $250,000 expense during the three months ended June 30, 2002, which is included in selling, general and administrative expense in the accompanying condensed consolidated statement of operations. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS EXHIBIT DESCRIPTION ------- ----------- 10.30 Convertible Promissory Note dated August 8, 2002. 10.31 Registration Rights Agreement dated August 8, 2002. 10.32 Amended and Restated Stock Option Plan. 10.33 Amendment to Restated Certificate of Incorporation. (b) REPORTS ON FORM 8-K. The Company filed a Current Report on Form 8-K on September 13, 2002, related to the completion of the acquisition of Paramount Dental Plan, Inc. The Company also filed a Current Report on Form 8-K/A on November 12, 2002, which includes historical financial statements of Paramount and pro forma financial information for the Company related to this acquisition. See Note 3 to the accompanying condensed consolidated financial statements for more information on this transaction. The Company filed a Current Report on Form 8-K on October 1, 2002, related to the Company's settlement of the stockholder litigation filed against the Company. See Note 9 to the accompanying condensed consolidated financial statements for more information on the settlement. 22 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 2002. 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) 23 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002; QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2002 Each of the undersigned hereby certifies in his capacity as an officer of SafeGuard Health Enterprises, Inc. (the "Company"), that the Quarterly Report of the Company on Form 10-Q for the period ended September 30, 2002 (the "Report") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition of the Company at the end of such period and the results of operations of the Company for such period. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this certification has been signed by the undersigned in the City of Aliso Viejo, State of California, on the 13th day of November 2002. 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) 24 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002; QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2002 I, James E. Buncher, President and Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of SafeGuard Health Enterprises, Inc., (the "Report"). 2. Based on my knowledge, this Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this Report; 4. The registrant's other certifying officers and I, are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Report (the "Evaluation Date"); and c) presented in this Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this Report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this certification has been signed by the undersigned in the City of Aliso Viejo, State of California, on the 13th day of November 2002. SAFEGUARD HEALTH ENTERPRISES, INC. By: /s/ James E. Buncher ----------------------- James E. Buncher President and Chief Executive Officer (Principal Executive Officer) 25 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002; QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2002 I, Dennis L Gates, Senior Vice President and Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of SafeGuard Health Enterprises, Inc., (the "Report"). 2. Based on my knowledge, this Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this Report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Report (the "Evaluation Date"); and c) presented in this Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this Report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this certification has been signed by the undersigned in the City of Aliso Viejo, State of California, on the 13th day of November 2002. SAFEGUARD HEALTH ENTERPRISES, INC. By: /s/ Dennis L. Gates ---------------------- Dennis L. Gates Senior Vice President and Chief Financial Officer (Chief Accounting Officer) 26 EX-10.30 3 doc2.txt EXHIBIT 10.30 THIS NOTE AND THE COMMON STOCK ISSUABLE ON EXERCISE OF THE CONVERSION OPTION SET FORTH IN THIS NOTE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF (a) AN EFFECTIVE REGISTRATION STATEMENT FOR THIS NOTE AND/OR COMMON STOCK UNDER THE SECURITIES ACT OF 1933 OR (b) AN OPINION REASONABLY SATISFACTORY TO SAFEGUARD HEALTH ENTERPRISES, INC. FROM COUNSEL FOR SAFEGUARD HEALTH ENTERPRISES, INC. OR FROM COUNSEL FOR THE PROPOSED TRANSFEROR TO THE EFFECT THAT THE TRANSFER MAY BE EFFECTED WITHOUT REGISTRATION. TRANSFER OF THIS NOTE AND THE SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION OF THIS NOTE ARE SUBJECT TO THE TERMS AND PROVISIONS OF A REGISTRATION RIGHTS AGREEMENT DATED THE SAME DATE AS THIS NOTE, A COPY OF WHICH IS ON FILE AT THE PRINCIPAL OFFICE OF SAFEGUARD HEALTH ENTERPRISES, INC. THIS NOTE AND THE SHARES OF COMMON STOCK ISSUABLE ON CONVERSION OF THIS NOTE MAY NOT BE SOLD OR OTHERWISE DISPOSED, EXCEPT IN ACCORDANCE WITH THAT AGREEMENT. A COPY OF THE AGREEMENT WILL BE FURNISHED WITHOUT CHARGE TO THE HOLDER OF THIS NOTE ON RECEIPT BY SAFEGUARD HEALTH ENTERPRISES, INC. AT ITS PRINCIPAL PLACE OF BUSINESS OR REGISTERED OFFICE OF A WRITTEN REQUEST FROM THE HOLDER REQUESTING A COPY. CONVERTIBLE PROMISSORY NOTE Borrower: SAFEGUARD HEALTH ENTERPRISES, INC. Holder: JACK R. ANDERSON Initial Principal Amount: $2,000,000 Date of Note: August 8, 2002 1. PROMISE TO PAY, INTEREST RATE. For value received, SafeGuard Health Enterprises, Inc., a Delaware corporation ("BORROWER"), promises to pay to the order of Jack R. Anderson ("HOLDER"), in lawful money of the United States of America, the sum of Two Million and 00/100 Dollars ($2,000,000), together with interest assessed on a fixed-rate basis at a rate of seven percent (7%) per annum. 2. MATURITY. Borrower shall pay the outstanding principal amount of this Note, together with any accrued unpaid interest, on the earliest of (a) August 7, 2005, or (b) at the Holder's election, the occurrence of a Change in Control (as defined in the next sentence), all subject to the right of acceleration described below (the "MATURITY DATE"). A "CHANGE OF CONTROL" means (w) equity holders of Borrower approve a liquidation of all or substantially all of Borrower's assets; (x) a sale, lease, exchange, or other transfer of all or more than 50% in value of the assets of Borrower in one transaction or a series of transactions; (y) a merger, consolidation, reorganization, tender offer, exchange offer, or share exchange in which securities possessing more than fifty percent (50%) of the total combined voting power of Borrower's outstanding securities are transferred to a person or persons different from those persons holding those securities prior to such transaction; or (z) the occurrence of any event, transaction, or arrangement that results in any person or group other than the shareholders of Borrower prior to such event, transaction, or arrangement becoming the beneficial owner, either directly or indirectly, of a majority of the outstanding Common Stock. 3. PAYMENTS. Except as otherwise provided in this Note, this Note shall be due and payable in equal monthly installments of principal and interest in the amount of Sixty-One Thousand Seven Hundred Fifty-Four and 19/100th Dollars ($61,754.19), and in a final payment of all outstanding principal and unpaid accrued interest on the Maturity Date. Each payment will be due and payable on the first Business Day of each month of each year during the term of this Note, commencing on the first Business Day of the first full month that commences more than fifteen days after this Note is executed and delivered. Borrower may not prepay this Note without Holder's prior consent. In the event a portion of this Note is converted into Common Stock of SafeGuard pursuant to Section 11 of this Note, the amount of the monthly installments of principal and interest specified above will be adjusted. The parties will recalculate the amount of the equal monthly installments of principal and interest based on the outstanding principal amount after the conversion and interest thereon over the remaining term of this Note. 4. OTHER TRANSACTION DOCUMENTS. Borrower shall be subject to the terms, conditions, and covenants of and shall comply with the provisions set forth in any agreements related to this Note. 5. BORROWER'S AFFIRMATIVE COVENANTS. Until full payment and performance of all obligations of Borrower under this Note, Borrower shall: (a) Compliance. Comply, and cause its subsidiaries to comply,in all ---------- material respects with all applicable laws, ordinances, rules, regulations and governmental requirements. (b) Conduct of Business: Maintenance of Corporate Status. Continue, ----------------------------------------------------- and cause each of its subsidiaries to continue, to engage in business of the same general type as now conducted by Borrower and its subsidiaries, and preserve, renew and keep in full force and effect, and cause each subsidiary to preserve, renew and keep in full force and effect, their respective corporate existence and their respective rights, privileges and franchises necessary or desirable in the normal conduct of business; provided, however, if Borrower in good faith determines the action to be -------- ------- in the best interest of the Borrower and not materially disadvantageous to Borrower, Borrower may terminate the corporate existence of any subsidiary, surrender any license or certificate of authority of any subsidiary or sell the capital stock of any subsidiary. (c) Deliver Stock Certificates. On conversion of all or part of this -------------------------- Note, promptly issue and deliver to Holder a certificate for the number of full shares of Common Stock issuable upon such conversion and, if applicable, a new Note evidencing any remaining principal amount not converted, in a form substantially identical to this Note. 2 (d) Reserve Common Stock. Reserve and keep available, free from ---------------------- preemptive rights, from its authorized shares of Common Stock, the maximum number of shares that are issuable upon conversion of this Note. (e) Taxes. Accurately prepare and timely file, and cause each ----- subsidiary to accurately prepare and timely file, all tax returns required by law to be filed on behalf of Borrower or subsidiary, as applicable. Borrower and each subsidiary shall promptly pay and discharge all taxes, assessments and governmental charges or levies imposed by applicable law upon them or upon their income or profit, or upon their properties, real, personal or mixed; provided, however, that neither Borrower nor any -------- ------- subsidiary shall be required to pay or cause to be paid any such tax, assessment, charge or levy if the same will not at the time be due and payable or if the validity thereof is contested in good faith by appropriate proceedings; provided further, however, that Borrower and -------- ------- ------- each subsidiary shall pay all such taxes, assessments, charges or levies forthwith whenever, as the result of proceedings to foreclose any lien which attached as security therefore, foreclosure on such lien appears imminent, or will obtain a surety bond or take such other steps as will prevent such foreclosure. 6. BORROWER'S NEGATIVE COVENANTS. Until it fully pays and performs all of its obligations under this Note, Borrower shall not: (a) Dividends and Redemptions. Declare any dividends on any shares --------------------------- of any class of its capital stock, or apply any of its property or assets to the purchase, redemption or other retirement of, or set apart any sum for the payment of any dividends on, or for the purchase, retirement of, or make any other distribution or reduction of capital or otherwise in respect of, any shares of its capital stock; provided, however, that Borrower shall -------- ------- be permitted to take any such actions so long as at the time of such action: (i) there is not an Event of Default under this Note or condition with the passage of time or notice will constitute an Event of Default; (ii) the total amount of the consideration paid does not exceed the cumulative net income of Borrower from and after February 28, 2002; and (iii) such action does not result in a disproportionate payment to Borrower's shareholders on an as-converted basis, unless all of Borrower's shareholders first had been given the same opportunity to participate in such action. (b) Restrict Performance. Enter into any agreements that restrict --------------------- its right or ability to perform under this Note. (c) Related Party Transactions. Enter into any transaction with a ---------------------------- Related Party, except for (i) transactions entered in good faith and on terms comparable to those that could be obtained from an unaffiliated third party, and (ii) the consulting agreement in effect on the date of this Note between Borrower and Steven J. Baileys. For purposes of the foregoing provision, the term "RELATED PARTY" means any person who directly or indirectly controls, is controlled by, or under common control with, Borrower or any subsidiary, including an officer, director, or holder of more than 10% of the Borrower's or any subsidiary's capital stock, a spouse or relative of any of the foregoing persons, and any entity of which any of the foregoing persons is a member, officer, director, employee, 3 partner, trustee, or a direct or indirect beneficial owner of any equity or beneficial interest of 5% or more. (d) Borrower Actions. Without the Holder's prior consent, cause or ----------------- permit Borrower to do any of the following: (i) create, assume, issue or incur debt in excess of $1,000,000 in the aggregate, excluding ordinary trade payables and that certain $2,625,000 Promissory Note to be issued to Nicholas M. Kavouklis, DMD (the "Kavouklis Note") pursuant to that certain Stock Purchase Agreement, dated April 24, 2002 relating to the purchase of the capital stock of Paramount Dental Plan, Inc. by Borrower (the "Paramount Stock Purchase Agreement"); (ii) redeem any of its outstanding stock; (iii) create financial obligations (other than traditional (and not synthetic) operating leases) that are not reported as liabilities or obligations to pay on the balance sheet of the financial statements of Borrower, whether the obligations are leases, lease-purchases, non-recourse financing, or other means or methods commonly referred to as "off-balance sheet financing"; (iv) extend, endorse, or guarantee, or become a surety, accommodation party, or responsible for, any indebtedness or other obligation of any other person, except for guarantees and endorsements made in connection with the deposit of items for collection; or (v) prepay, redeem, retire, or otherwise acquire for value any indebtedness in amounts greater or at times earlier than required, other than payment of accounts payable in the usual and ordinary course of business. 7. SECURITY. This Note is unsecured. 8. DEFAULT. Each of the following shall constitute an "Event of Default" under this Note: (a) Non-payment. Borrower fails to pay in full within five (5) days ----------- of the date when due any principal, interest, fee or other amount payable to the Holder under this Note or any other obligation of Borrower to the Holder, whether at maturity or otherwise and fails to cure such default within five (5) days after written notice of such default from Holder to Borrower, provided, however, if Holder previously provided Borrower with -------- ------- two (2) written notices of default pursuant to this Section 8(a) in any twelve-month period, Holder shall not be required to provide Borrower with a written notice of such default; (b) Breach of Representation or Warranty. A material breach of any -------------------------------------- representation or warranty made by Borrower in this Note or any related agreement and the failure to cure such breach or violation within twenty (20) days after written notice 4 thereof from Holder to Borrower (but only if the breach or violation is of a nature that it can be cured); (c) Breach of Covenant. A breach of or failure by Borrower to -------------------- perform any covenant or obligation of Borrower set out or contemplated in this Note or any related agreement and the failure to cure such breach or violation within twenty (20) days after written notice thereof from Holder to Borrower (but only if the breach or violation is of a nature that it can be cured); (d) Voluntary Bankruptcy and Insolvency Proceedings. Borrower files ------------------------------------------------ a petition in bankruptcy or for reorganization or for an arrangement or any composition, readjustment, liquidation, dissolution or similar relief pursuant to the Federal Bankruptcy Code or under any similar present or future federal law or the law of any other jurisdiction or shall be adjudicated a bankrupt or become insolvent, or consent to the appointment of or taking possession by a receiver, liquidator, assignee, trustee, custodian, sequester (or other similar official) of the Borrower or for all or any substantial part of the property of the Borrower, or shall make an assignment for the benefit of its creditors, or shall admit in writing its in ability to pay its debts generally as they become due, or shall take any corporate action, in furtherance or any of the foregoing; (e) Adjudication of Bankruptcy. A petition or answer is filed ---------------------------- proposing the adjudication of Borrower as a bankrupt or its reorganization or arrangement, or any composition, readjustment, liquidation, dissolution or similar relief with respect to it pursuant to the Federal Bankruptcy Code or under any similar present or future federal law or the law of any other jurisdiction applicable to Borrower and such petition is not dismissed within sixty (60) days after the date of service on Borrower; or (f) Other Defaults. There shall occur any default under any other --------------- indenture, agreement or instrument evidencing or securing indebtedness of Borrower or under any of Borrower's capital leases, which default shall not be cured within any applicable cure period for such default, if such indebtedness of Borrower is an amount greater than $1,000,000 in each case or in the aggregate, provided, however, Borrower shall not be deemed in -------- ------- default under any capital lease as a result of a good faith dispute between Borrower and the lessor regarding the exercise price of a fair market value purchase option of the equipment under such capital lease. 9. HOLDER'S RIGHTS ON DEFAULT. On the occurrence of an Event of Default, the Holder may (i) declare this Note to be immediately due and payable, in which case this Note shall become due and payable both as to principal and interest, and initiate legal action for collection of this Note, and (ii) pursue the other remedies under applicable law or any related agreement that Holder deems appropriate. 10. DEFAULT RATE OF INTEREST. From and after an Event of Default until the default is cured, interest shall accrue on this Note in an amount equal to twelve percent (12%) per annum. 5 11. CONVERSION. (a) The Holder of this Note has the right at the Holder's option, but only prior to payment in full of the principal balance of this Note, to convert this Note in whole or in part, into fully paid and non-assessable shares of Common Stock of Borrower, at any time after twelve (12) months after the date of this Note, in minimum installments of at least $500,000. The number of shares of Common Stock into which this Note may be converted (the "CONVERSION SHARES") shall be determined by dividing the outstanding principal balance hereof to be converted by the Conversion Price (defined below) in effect at the time of conversion. The "CONVERSION PRICE" initially will be $l.625, and will be adjusted as hereinafter provided (the "CONVERSION PRICE"). (b) To convert this Note, the Holder shall surrender this Note at the principal office of Borrower in Aliso Viejo, California together with written notice to Borrower of the election to convert this Note, and shall state the principal amount to be converted. Unless the shares of Common Stock issuable on conversion are to be issued in the same name as the name in which this Note is registered, this Note shall be accompanied by an instrument of transfer, in form satisfactory to Borrower, duly executed by the Holder or the Holder's authorized attorney, together with an amount sufficient to pay any transfer or similar tax. Borrower shall promptly issue, execute and deliver to the Holder a certificate or certificates for the number of shares of Common Stock to which the Holder shall be entitled upon the conversion. The conversion shall be deemed to have been effected immediately prior to the close of business on the date that the Holder surrenders the Note, and the person entitled to receive shares of Common Stock issuable upon conversion will be treated for all purposes as the record holder or holders of such shares of Common Stock as of that date. All shares of Common Stock delivered on conversion of this Note will upon delivery be duly and validly issued and fully paid and nonassessable, free of all Liens and charges and not subject to any preemptive rights. (c) Borrower shall pay all interest on the principal amount of the Note surrendered for conversion accrued to the date of conversion. Borrower shall pay any and all taxes, documentary, stamp or similar issue or transfer taxes that are payable with respect to the issuance or delivery of Common Stock on conversion of this Note; provided, that the Borrower shall not be required to pay any tax payable in respect of any transfer involved in the issue or delivery of shares of Common Stock in a name other than that of the Holder. 12. ADJUSTMENT ON CHANGES IN STOCK. (a) Generally. The Conversion Price and the number of shares of Common --------- Stock issuable upon the conversion of this Note shall be subject to adjustment for transactions entered into after the date hereof as follows: (i) Except as hereinafter provided in Section 12(c), if Borrower shall at any time after the execution date hereof issue or sell any shares of Common Stock (including shares held in Borrower's treasury) for a consideration per share less than the Conversion Price (or, if an adjusted Conversion Price shall be in 6 effect by reason of a previous adjustment under this Section 12 as provided below, then less than the adjusted Conversion Price), the Conversion Price shall be reduced to the price (calculated to the nearest cent, a half cent or more being considered a full cent) determined by multiplying the Conversion Price in effect immediately prior to the time of such issue or sale by a fraction, the numerator of which will be the sum of (A) the number of shares of Common Stock outstanding immediately prior to such issue or sale multiplied by the Conversion Price in effect immediately prior to such issue or sale plus (B) the consideration received by the Borrower upon such issue or sale, and the denominator of which shall be the product of (Y) the total number of shares of Common Stock outstanding immediately after such issue or sale, multiplied by (Z) the Conversion Price in effect immediately prior to such issue or sale. (ii) In case of the issuance or sale of shares of Common Stock for a consideration part or all of which shall be cash, the amount of cash consideration therefore shall be deemed to be the amount of cash received by Borrower for such shares (or, if shares of Common Stock are offered by Borrower for subscription, the subscription price, or, if shares of Common Stock shall be sold to underwriters or dealers for public offering without a subscription offering, the initial public offering price) without deducting therefrom any compensation paid or discount allowed in the sale, underwriting or purchase thereof by underwriters or dealers or others performing similar services or any expenses incurred in connection therewith. (iii) In case of the issuance or sale (otherwise than as a dividend or other distribution on or subdivision of any stock of Borrower or on conversion or exchange of other securities of Borrower) of shares of Common Stock for a consideration part or all of which shall be other than cash, the amount of the consideration therefore other than cash shall be deemed to be the value of such consideration, as determined in good faith by the Board of Directors of Borrower, at or about, but as of, the date of the adoption of the resolution authorizing such issuance for a consideration other than cash of such Common Stock immediately prior to the close of business on the date fixed for the determination of security holders entitled to receive such Common Stock. (iv) Shares of Common Stock issuable by way of dividend or other distribution on or subdivision of any stock of Borrower shall be deemed to have been issued immediately after the opening of business on the date following the date fixed for the determination of stockholders entitled to receive such dividend or other distribution or subdivision. (b) For purposes of subparagraph (a)(i), the following subparagraphs (b)(i) to (b)(viii) also apply to conversion of this Note to Common Stock: (i) Issuance of Rights or Options. In case the Borrower in any ------------------------------- manner issues (whether directly or by assumption in a merger or otherwise) warrants or other rights to subscribe for or purchase, or options to purchase, Common Stock 7 or stock or securities convertible into or exchangeable for Common Stock (the warrants, rights or options are "OPTIONS" and the convertible or exchangeable stock or securities are "CONVERTIBLE SECURITIES"), whether or not the Options or Convertible Securities are immediately exercisable, and the price per share (determined, for a formula price, based on current circumstances or, if dependent on future circumstances, facts that would result in the lowest price per share) for which Common Stock is issuable on the Options' exercise or on the conversion or exchange of the Convertible Securities (determined by dividing (1) the total amount, if any, payable to the Borrower as consideration for the Option grant, plus the aggregate amount of additional consideration payable to the Borrower on the Option exercise, plus, in the case of any Options that relate to Convertible Securities, any consideration payable on the issue or sale of the Convertible Securities and on their conversion or exchange, by (2) the total number of shares of Common Stock issuable upon the Options' exercise or on the conversion or exchange of Convertible Securities issuable on the Options' exercise) is less than the Conversion Price in effect immediately before the Option grant, the total number of shares of Common Stock issuable on the Options' exercise or on conversion or exchange of any Convertible Securities issuable on the Options' exercise will be deemed issued for such price per share on the date of the Options' grant and thereafter will be deemed outstanding. Except as otherwise provided in subparagraph (b)(iii), the Conversion Price will not be further adjusted when the Common Stock is actually issued on exercise of the Options or conversion or exchange of Convertible Securities. (ii) Issuance of Convertible Securities. In case the Borrower ------------------------------------ in any manner issues (whether directly or by assumption in a merger or otherwise) or sells Convertible Securities, whether or not the rights to exchange or convert the Convertible Securities are immediately exercisable, and the price per share (determined, in the case of a formula price, on the basis of current circumstances or, if dependent on future circumstances, the facts would result in the lowest price per share) for which Common Stock is issuable upon the conversion or exchange (determined by dividing (1) the total amount payable to the Borrower as consideration for the issue or sale of the Convertible Securities, plus the aggregate amount of additional consideration, if any, payable to the Borrower on the conversion or exchange; by (2) the total number of shares of Common Stock issuable on conversion or exchange of all such Convertible Securities) is less than the Conversion Price in effect immediately before the issue or sale, then the total number of shares of Common Stock issuable upon conversion or exchange of the Convertible Securities will be deemed to be issued for such price per share as of the date of the issue or sale of the Convertible Securities and thereafter will be deemed outstanding, provided that (a) except as provided in subparagraph (b)(iii), no further adjustment of the Conversion Price will be made otherwise when the Common Stock is actually issued on conversion or exchange of the Convertible Securities and (b) the Conversion Price will not be further adjusted pursuant to this subsection for the issue or sale of Convertible Securities on the exercise of Options to purchase the Convertible Securities if the Conversion Price has been or 8 will be adjusted for the transaction pursuant to other provisions of this paragraph (b). (iii) Change in Option Price or Conversion Rate. Upon the ----------------------------------------------- happening of any of the following events, namely, if the purchase price provided for in any Option referenced in subparagraph (b)(i), the additional consideration, if any, payable upon the conversion or exchange of any Convertible Securities referred to in subparagraph (b)(i) or (b)(ii), or the rate at which Convertible Securities referred to in subparagraph (b)(i) or (b)(ii) are convertible into or exchangeable for Common Stock changes at any time (including, but not limited to, changes under or by reason of provisions designed to protect against dilution), the Conversion Price in effect at the time of such event will be readjusted to the Conversion Price which would have been effective at that time had the Options or Convertible Securities still outstanding provided for such changed purchase price, additional consideration or conversion rate, as the case may be, when initially granted, issued or sold; and on the expiration of the Options or the termination of a right to convert or exchange any Convertible Securities, the Conversion Price then in effect will be increased to the Conversion Price that would have been in effect at the time of the expiration or termination had the Options or Convertible Securities never been issued. (iv) Stock Dividends and Subdivisions. In case the Borrower ----------------------------------- declares a dividend or makes any other distribution on stock of the Borrower payable in Common Stock, Options, or Convertible Securities, the Common Stock, Options, or Convertible Securities, as the case may be, issuable in payment of the dividend or distribution will be deemed to have been issued or sold (as of the record date) without consideration (except for the consideration payable to exercise any Options or convert any Convertible Securities). In case the Borrower subdivides its outstanding shares of Common Stock into a greater number of shares, the Conversion Price then in effect will be proportionately reduced to reflect the subdivision. In case the Borrower combines its outstanding shares of Common Stock into a fewer number of shares, the Conversion Price then in effect will be proportionately increased to reflect the combination. An adjustment made pursuant to this paragraph (b)(iv) will become effective retroactively (x) in the case of any such dividend or distribution, to a date immediately following the close of business on the record date for determination of the holders of Common Stock entitled to receive such dividend or distribution, or (y) in the case of any such subdivision or combination, to the close of business on the day upon which such corporate action becomes effective. (v) Consideration for Stock. In case any shares of Common ------------------------- Stock, Options, or Convertible Securities are issued or sold for cash, the consideration deemed to be received will be the amount actually received by the Borrower, without deduction of any expenses incurred or any underwriting commissions or concessions paid or allowed by the Borrower in connection with the issuance or sale. In case any shares of Common Stock, Options, or Convertible Securities are issued or sold for a consideration other than cash, the amount of the consideration 9 other than cash received by the Borrower will be the fair value of such consideration as determined in good faith by the Borrower's Board of Directors, without deduction of any expenses incurred or any underwriting commissions or concessions paid or allowed by the Borrower in connection with the issuance or sale. (vi) Record Date. If the Borrower does not set a record date to ----------- determine the holders of its Common Stock entitled (1) to receive a dividend or other distribution payable in Common Stock, Options, or Convertible Securities or (2) to subscribe for or purchase Common Stock, Options, or Convertible Securities, the record date will be deemed to be the date of the issue or sale of the shares of Common Stock deemed to have been issued or sold upon the declaration of a dividend or the making of another distribution or the date of the granting of such right of subscription or purchase, as the case may be. (vii) Treasury Shares. The number of shares of Common Stock ---------------- outstanding at any given time does not include shares owned or held by or for the account of Borrower, and its disposition of these shares will be considered an issue or sale of Common Stock for purposes of this Section 12. (viii) Reports as to Adjustments. Whenever the Conversion Price ------------------------- is adjusted as provided in this subsection, any adjustment shall be rounded to three decimal points and Borrower will promptly compute the adjustment and furnish to the Holder a certificate, signed by a principal financial officer of Borrower, setting forth the new Conversion Price and the number of shares of Common Stock into which the Note is convertible as a result of the adjustment, a brief statement of the facts requiring the adjustment, the computation of the adjustment, and when the adjustment will become effective. (c) Certain Issues of Common Stock Excepted. Notwithstanding the -------------------------------------------- foregoing provisions, Borrower will not be required to adjust the Conversion Price as a result of the following transactions: (i) the issuance or sale of Common Stock upon the exercise of options or rights or upon the conversion or exchange of convertible or exchangeable securities in any case where the adjustment was made upon the issuance of such options, rights, or convertible or exchangeable securities by reason of the provisions of Section 12; (ii) the issuance to employees, directors, consultants or others with similar relationships with Borrower or its subsidiaries of options to purchase, at a price equal to or in excess of fair market value as determined by the Board of Directors of Borrower at the time of grant, shares of Common Stock and the issuance of shares of Common Stock upon the exercise of any such options; 10 (iii) the issuance or sale of shares of Common Stock to officers, directors or employees of, or consultants to, Borrower pursuant to a grant or plan approved by the Board of Directors of Borrower; (iv) the issuance of shares of Common Stock or any security or instrument exchangeable for or convertible into shares of Common Stock in connection with any acquisition of assets, securities, or a business or any exchange of securities to acquire all or part of any business, provided that such acquisition or exchange has been approved by the Board of Directors of Borrower; (v) the issuance of Common Stock for any contribution by Borrower to its 401(k) plan; (vi) the issuance of Common Stock upon the conversion of the preferred stock of Borrower and the stock options of Borrower that are outstanding on the date of this Note; (vii) the issuance of Common Stock or other securities upon conversion of this Note; and (viii) the issuance of Common Stock pursuant to the Paramount Stock Purchase Agreement and upon conversion of the Kavouklis Note. (d) Adjustments for Merger. Consolidation, etc. In the case of any --------------------------------------------- classification, reclassification, or other reorganization of the Borrower's capital stock, or in the case of the merger or consolidation of the Borrower with or into another corporation, or the conveyance to another corporation of all or any major portion of the Borrower's assets, then, as part of the classification, reclassification, merger, consolidation, or conveyance, adequate provision will be made for the Holder, on exercise of its conversion privilege, to receive on the same basis and conditions set forth in Section 11 (as modified by Section 12) with respect to the Common Stock, the stock, securities, or other property that the Holder would have been entitled to receive on such classification, reclassification, merger, consolidation, or conveyance, if the Holder had exercised the conversion privilege immediately before the classification, reclassification, merger, consolidation, or conveyance, and in any such case appropriate provision will be made with respect to the rights and interests of the Holder to the end that the provisions of Section 11 (including without limitation, provision for adjustment of the Conversion Price in this Section 12) will be applicable to the shares of stock, securities, or other property deliverable on the exercise of the conversion privilege; and, as a condition of any consolidation, merger, or conveyance, any corporation that succeeds to the Borrower by reason of the merger, consolidation or conveyance will assume the obligation to deliver, on exercise of the conversion privilege, the shares of stock, securities or other considerations that the Holder is entitled to receive pursuant to this Note. (e) Certain Notices. If at any time Borrower proposes to: ---------------- (i) declare a cash dividend on its Common Stock; 11 (ii) declare a dividend on its Common Stock payable in stock or make a special dividend or other distribution to the holders of its Common Stock; (iii) reorganize, or reclassify the capital stock of the Borrower, or consolidate, merge or otherwise combine with, or sell all or substantially all of its assets to, another corporation; (iv) voluntarily or involuntarily dissolve, liquidate or wind up the affairs of the Borrower; or (v) redeem or purchase any shares of its capital stock or securities convertible into its capital stock; then, Borrower shall give to the Holder, by certified or registered mail, (A) at least twenty (20) days' prior written notice of the date on which the books of Borrower shall close or a record shall be taken for the dividend, distribution or subscription rights or for determining rights to vote in respect of any such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up, and (B) in the case of such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up, at least twenty (20) days' prior written notice of the date when the event will take place. Any notice required by clause (A) shall also specify, in the case of any such dividend, distribution or subscription rights, the date on which the holders of Common Stock will be entitled thereto, and any notice required by clause (B) shall specify the date on which the holders of Common Stock shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up, as the case may be. (f) Distributions to Shareholders. If Borrower does any of the ------------------------------- following (a "DILUTIVE EVENT") after the execution date of the Stock Purchase Agreement (but before conversion of this Note): (i) makes any distribution of its assets to holders of its Common Stock as a liquidation or partial liquidation or return of capital; (ii) declares or distributes to the holders of Common Stock (A) a noncash dividend payable in any property or securities of Borrower, (B) any cash payable by dividend or otherwise out of the capital surplus (as distinguished from the earned surplus) of Borrower, or (C) cash, property, or securities in connection with a spin-off, split-up, or similar transaction; then upon the conversion of this Note after the record date for, or the occurrence of, each Dilutive Event, the Holder will be entitled to receive, in addition to the shares of Common Stock otherwise issuable upon conversion of this Note, the other securities and property (including cash) resulting from every Dilutive Event that the Holder would have been entitled to receive if the Holder had (1) converted this Note immediately before the Dilutive Event and had been the record owner of the number of shares of Common Stock issuable pursuant to the conversion since that time, and (2) had participated in every Dilutive Event as a holder of that number of shares of Common Stock and had retained all shares of Common Stock and other or additional securities and property (including cash) receivable during that period, after giving effect to all the Dilutive Events that occurred during that period. Whenever an adjustment occurs in the number or kind of 12 securities and other property (including cash) issuable or distributable upon conversion of this Note, the Borrower promptly shall deliver to the Holder a notice describing in reasonable detail the facts requiring the adjustment and the number and kind of securities and other property (including cash) issuable upon conversion of this Note after the adjustment. 13. WAIVERS. Except as expressly set forth herein, Borrower waives demand, presentment for payment, protest, notice of protest and notice of nonpayment. Any discharge or release of any party who is or may be liable to Holder for the indebtedness represented by this Note will not have the effect of releasing any other party or parties, which will remain liable to Holder. Holder's acceptance of payment other than in accordance with the terms of this Note, or Holder's subsequent agreement to extend or modify the repayment terms, or Holder's failure or delay in exercising any rights or remedies granted to Holder, will likewise not have the effect of releasing Borrower or any other party or parties from their respective obligations to Holder. In addition, any failure or delay on the part of Holder to exercise any of the rights and remedies granted to Holder shall not have the effect of waiving any of Holder's rights and remedies under this Note. Any partial exercise of any rights and/or remedies granted to Holder shall furthermore not be construed as a waiver of any other rights and remedies, it being Borrower's intent and agreement that Holder's rights and remedies shall be cumulative in nature. Should any default event occur or exist under this Note, any waiver or forbearance on the part of Holder to pursue the rights and remedies available to Holder will bind Holder only to the extent that Holder agrees in writing to the waiver or forbearance. 14. CAPTION HEADINGS. Caption headings of the sections of this Note are for convenience purposes only and are not to be used to interpret or to define their provisions. In this Note, whenever the context so requires, the singular includes the plural and the plural also includes the singular. 15. SEVERABILITY. If any provision of this Note is held to be invalid, illegal or unenforceable by any court, that provision shall be deleted from this Note and the balance of this Note shall be interpreted as if the deleted provision never existed. 16. SAVINGS CLAUSE. Borrower and Holder intend to comply strictly with applicable law regulating the maximum allowable rate or amount of interest that Holder may charge and collect on the loan by Holder to Borrower evidenced by this Note. Accordingly, and notwithstanding anything in this Note to the contrary, the maximum, aggregate amount of interest and other charges constituting interest under applicable law that are payable, chargeable, or receivable under the Note shall not exceed the maximum amount of interest now allowed by applicable law or any greater amount of interest allowed because of a future amendment to existing law. Borrower is not liable for any interest in excess of the maximum lawful amount, and any excess interest charged or collected by Holder will constitute an inadvertent mistake and, if charged but not paid, will be cancelled automatically, or if paid, will be either refunded to Borrower or credited against the outstanding principal balance of the Note, at the election of Borrower. 17. ATTORNEY'S FEES AND COSTS. In the event of an Event of Default, and in the event that thereafter this Note is placed in the hands of an attorney for collection, or in the 13 event this Note is collected in whole or in part through legal proceedings of any nature, then and in any such case Borrower promises to pay all reasonable costs of collection, including but not limited to reasonable attorneys' fees incurred by the Holder hereof on account of such collection, whether or not suit is filed. 18. WAIVER OF JURY TRIAL. BORROWER AND HOLDER KNOWINGLY, VOLUNTARILY, AND INTENTIONALLY WAIVE ALL RIGHTS TO A JURY TRIAL IN ANY LAWSUIT, PROCEEDING, COUNTERCLAIM, OR OTHER LITIGATION ARISING UNDER OR RELATING TO THIS NOTE, THE STOCK PURCHASE AGREEMENT AND ANY OF THE RELATED AGREEMENTS. BORROWER AND HOLDER HAVE FULLY DISCUSSED THIS PROVISION AND AGREE THAT THIS WAIVER IS SUBJECT TO NO EXCEPTIONS AND WAS A MATERIAL INDUCEMENT FOR HOLDER TO MAKE THE LOAN TO BORROWER EVIDENCED BY THIS NOTE. 19. GOVERNING LAW; VENUE. The laws of the State of Delaware and the federal laws of the United States of America, excluding the laws of those jurisdictions pertaining to the resolution of conflict with laws of other jurisdictions, govern the validity, construction, enforcement, and interpretation of this Note. 20. VOTING RIGHTS. The Holder of this Note shall have no right and power to vote the shares of Common Stock into which this Note is convertible as determined from time to time by the provisions hereof unless and until this Note is converted and such shares are issued to the Holder. 21. TRANSFERABILITY. This Note evidenced hereby may not be pledged, sold, assigned or transferred except upon satisfaction of the conditions specified in the legend on the face of this certificate. 22. SUCCESSORS AND ASSIGNS. All of the covenants, stipulations, promises, and agreements in this Note by or on behalf of Borrower shall bind its successors and assigns, whether so expressed or not; provided, however, that -------- ------- Borrower may not, without the prior written consent of the Holder hereof, assign any rights, duties, or obligations under this Note. Any assignment in violation of the foregoing shall be null and void. (REMAINDER OF PAGE INTENTIONALLY LEFT BLANK) 14 IN WITNESS WHEREOF, the Borrower has executed this Note as of the day and year first written above. BORROWER: SAFEGUARD HEALTH ENTERPRISES, INC., a Delaware corporation By: /s/ James E. Buncher ----------------------------------- James E. Buncher President and Chief Executive Officer By: /s/ Ronald I. Brendzel ----------------------------------- Ronald I. Brendzel Senior Vice President and Secretary 15 ELECTION TO CONVERT ------------------- To the Chief Financial Officer of SafeGuard Health Enterprises, Inc. The undersigned owner of the accompanying Convertible Promissory Note hereby irrevocably exercises the option to convert to shares of Common Stock in accordance with the terms of such Note, and directs that the shares issuable and deliverable upon such conversion be issued in the name of and delivered to the undersigned. Dated: __________________________________ COMPLETE FOR REGISTRATION OF SHARES OF COMMON STOCK ON THE STOCK TRANSFER RECORDS MAINTAINED BY THE COMPANY: ________________________________________________________________________________ Name of Note Holder Name(s) or Entities in which Common Stock Certificate(s) are to be registered: ________________________________________________________________________________ Address:_____________________________ _____________________________________ JACK R. ANDERSON _____________________________________ Taxpayer Identification Number Principal Portion to be converted (if less than all) $___________________ Shares of Common Stock to be Issued ___________________ shares 16 EX-10.31 4 doc3.txt EXHIBIT 10.31 REGISTRATION RIGHTS AGREEMENT This Registration Rights Agreement (this "AGREEMENT") is entered into as of August 8, 2002, by and between SafeGuard Health Enterprises, Inc., a Delaware corporation ("SAFEGUARD"), and Jack R. Anderson ("HOLDER"). BACKGROUND ---------- On the date of this Agreement, Holder acquired a Convertible Promissory Note of SafeGuard (the "NOTE") in the principal amount of $2,000,000, which is convertible into Common Stock of SafeGuard. SafeGuard agreed to grant registration rights with respect to the Common Stock of SafeGuard issuable upon conversion of the Note on and subject to the terms and conditions of this Agreement. OPERATIVE TERMS --------------- The parties agree as follows: ARTICLE 1. DEFINITIONS ----------- 1.1 CERTAIN DEFINED TERMS. --------------------- "Commission" means the Securities and Exchange Commission or any ---------- other federal agency at the time administering the Securities Act. "Common Stock" means the common stock, $.01 par value per share, of ------------ SafeGuard. "Conversion Shares" means any shares of Common Stock issuable or ----------------- issued upon conversion of the Note. "Exchange Act" means the Securities Exchange Act of 1934, as ------------ amended. "Holder" means Jack R. Anderson and each subsequent holder of the ------ Note (or portion of the Note) or shares of Common Stock issued on conversion of the Note. "RegistrableSecurities" means (i) any Conversion Shares that may be --------------------- issued pursuant to the conversion of the Note, and (ii) any Common Stock issued as a dividend or other distribution with respect to or in exchange for or in replacement of the Conversion Shares. "Securities Act" means the Securities Act of 1933, as amended, or -------------- any similar federal statute, and the rules and regulations of the Commission thereunder, in effect at the time. "Underwritten Public Offering" means a public offering of Common ---------------------------- Shares for cash that is offered and sold in a registered transaction on a firm commitment underwritten basis through one or more underwriters, all pursuant to an underwriting agreement between the Company and such the underwriters. "Underwriters" means a securities dealer that purchases any ------------ Registrable Securities as principal and not as part of such dealer's market-making activities. ARTICLE II. REGISTRATION RIGHTS ------------------- 2.1 DEMAND REGISTRATION. -------------------- (a) Rights to Registration. On notice (a "DEMAND NOTICE") from all ---------------------- Holders or Holders of at least fifty (50%) of the Registrable Securities (the "INITIATING HOLDERS"), SafeGuard shall effect one demand registration for those Holders. SafeGuard shall: (1) promptly give written notice to all other Holders of the proposed registration, qualification or compliance; and (2) use its best efforts to promptly effect the registrations, qualifications, and compliances (including, without limitation, the execution of an undertaking to file post-effective amendments, appropriate qualifications under the applicable blue sky or other state securities laws, and appropriate compliance with exemptive regulations issued under the Securities Act and any other governmental requirements or regulations) needed to permit or facilitate the public sale and distribution of the requesting Holders' Registrable Securities specified in the notice and the Registrable Securities of any other Holders that notify SafeGuard of their desire to join in the request within ten (10) business days after they receive SafeGuard's notice specified in part (1). SafeGuard shall use its best efforts to prepare and file with the Commission a registration statement covering the Registrable Securities subject to the registration request within 60 days after it receives the Demand Notice. (b) Underwriting. The Initiating Holders shall include in their ------------ request made pursuant to Section 2.1 the name of the managing underwriter ----------- or underwriters, if any, that the majority in interest of such Initiating Holders propose to underwrite the public offering pursuant to the requested registration. SafeGuard will include these underwriters' names in its written notice to the other Holders pursuant to Section 2.1. If the ----------- sale proposed by the requesting Holders is to be effected pursuant to an Underwritten Public Offering, each Holder's right to registration pursuant to Section 2.1 will be conditioned on its participation in the ----------- underwriting and inclusion of its Registrable Securities in the underwriting to the extent requested (unless otherwise mutually agreed by a majority in interest of the Initiating Holders and such Holders). SafeGuard shall (together with all Holders proposing to distribute their securities through such underwriting) use its best efforts to enter into an underwriting agreement in customary form with the underwriters selected for the underwriting in the manner set forth above. SafeGuard shall take the actions required for compliance with the terms and obligations of the underwriting agreement, and shall furnish the underwriters and their respective representatives reasonable and sufficient access to all information requested for their "due diligence" review of SafeGuard and its operations, subject to the terms of any letter of intent, confidentiality or other agreement between SafeGuard and the 2 underwriter(s). Notwithstanding any other provisions of Section 2.1, if, ----------- in connection with an Underwritten Public Offering, the managing underwriter advises SafeGuard or the Initiating Holders in writing that marketing factors require that the number of shares to be underwritten be limited, the Initiating Holders shall so advise SafeGuard (or vice versa) and Holders with shares that would otherwise be registered and underwritten pursuant to this Agreement, and the number of shares of Registrable Securities to be included in the registration and underwriting will be allocated among all Holders in proportion, as nearly as practicable, to the respective amounts of Registrable Securities that were proposed to be sold by Holders. The Registrable Securities excluded from the underwriting by reason of the underwriter's marketing limitation will not be included in the registration. Any Holder that disapproves of the terms of an Underwritten Public Offering may elect to withdraw therefrom by written notice to SafeGuard, the managing underwriter and the Initiating Holders. The Registrable Securities so withdrawn will also be withdrawn from registration; provided, however, if by the withdrawal of -------- ------- the Registrable Securities a greater number of Registrable Securities held by other Holders may be included in such Underwritten Public Offering (subject to any limitation imposed by the underwriters), the requesting Holders will offer to all Holders who have included Registrable Securities in the registration the right to include additional shares in the same proportion used in effecting the limitation referred to above in this Section 2(b). ------------ (c) Additional Shares to be Registered. SafeGuard may include in any ---------------------------------- registration statement described in this Section 2.1, for sale in ----------- accordance with the method of disposition specified by the Initiating Holders, Common Shares to be sold by SafeGuard for its own account or the other SafeGuard shareholders for their own account, except as and to the extent that, in the opinion of the managing underwriter (if such method of disposition is an Underwritten Public Offering), such inclusion would result in any of the Registrable Securities proposed to be sold being excluded from the offering or would materially adversely affect the marketing of such Registrable Securities to be sold. (d) Exceptions to Demand Registration Rights. Anything in this -------------------------------------------- Section 2.1 to the contrary notwithstanding: ----------- (1) SafeGuard will not be required to register Registrable Securities pursuant to this Section 2.1 unless the aggregate ------------ estimated public offering price of all shares of Registrable Securities, including, without limitation, any shares sold for the account of SafeGuard or any existing shareholder of SafeGuard (based, in the case of Common Shares, upon the highest closing price or bid price, as the case may be, during the 30-day period preceding such request for registration in the principal trading market for the Common Shares, or, if there is no active trading market for the Common Shares, based upon the proposed public offering price estimated in good faith by the requesting holders of Registrable Securities), is at least equal to the lesser of (i) $400,000 or (ii) The total value of all shares of Common Stock then owned by Holder; (2) SafeGuard will not be required to file a registration statement requested pursuant to this Section 2.1 during the time ----------- period between the last day of SafeGuard's fiscal year and the date on which SafeGuard's audited financial statements for the fiscal year are first available; 3 (3) SafeGuard will not be obligated to effect, or to take any action to effect, any registration pursuant to this Section 2.1 in ----------- any particular jurisdiction in which SafeGuard would be required to execute a general consent to service of process in effecting such registration, qualification, or compliance, unless SafeGuard is already subject to service in such jurisdiction and except as may be required by the Securities Act; (4) SafeGuard will not be obligated to effect, or to take any action to effect, any registration pursuant to this Section 2.1 ----------- during the period starting with the date 30 days prior to SafeGuard's good faith estimate of the date of filing of, and ending on a date 120 days after the effective date of, a SafeGuard-initiated registration; provided that SafeGuard is actively employing in good faith all reasonable efforts to cause the registration statement to become effective; and (5) SafeGuard will not be obligated to effect, or to take any action to effect, any registration pursuant to this Section 2.1 if ----------- the Initiating Holders propose to dispose of shares of Registrable Securities that may be immediately registered on Form S-3 in accordance with Section 2.3. ----------- (6) SafeGuard will be entitled to delay filing a registration statement for up to 90 days upon written notice to all Holders that it is engaged in discussions regarding a material transaction concerning SafeGuard and that it would be disadvantageous to disclose during such period. 2.2 SAFEGUARD REGISTRATION. ---------------------- (a) Rights to Registration. If SafeGuard registers any of its Common ---------------------- Shares in an Underwritten Public Offering for its own account (but not including: (i) an offering initiated at a Holder's request pursuant to Section 2.1, or (ii) an offering that is registered on Commission Forms ----------- S-4 and S-8 or another form not available for registering the Registrable Securities for sale by SafeGuard), SafeGuard shall: (1) Promptly notify each Holder, at least thirty (30) days before the anticipated filing date of the registration (including, to the extent available, the jurisdictions in which SafeGuard intends to qualify the offer and sale of securities under applicable blue sky or other state securities laws); and (2) Use its best efforts to include in the registration (and any related qualification under blue sky laws or other compliance) and in any related Underwritten Public Offering, all the Registrable Securities that the Holder specifies in a written request delivered to SafeGuard within 20 days after SafeGuard's notice. 4 (b) Underwriting. A Holder's right to registration pursuant to ------------ Section 2.2 will be conditioned on the Holder's inclusion of its ----------- Registrable Securities in any related Underwritten Public Offering. All Holders proposing to distribute their securities through an Underwritten Public Offering (together with SafeGuard and any other shareholder distributing its securities through the underwriting) shall enter into an underwriting agreement in customary form with the underwriter or underwriters selected for the Underwritten Public Offering. (c) Certain Underwriter Limitations. Notwithstanding any other ------------------------------- provisions of this Section 2.2, if the managing underwriter reasonably ----------- determines that marketing factors require a limitation of the number of shares to be underwritten, the underwriter may limit the Registrable Securities to be included in the registration and Underwritten Public Offering. In such event, the underwriter will so advise all shareholders whose shares would otherwise be registered and underwritten pursuant thereto, and the number of shares that may be included in the registration and Underwritten Public Offering will be allocated: (1) first to SafeGuard; then (2) to the extent that such securities do not exhaust the number of shares determined by such underwriter, among all remaining shareholders of SafeGuard (including the Holders) to whom SafeGuard extended registration rights, in proportion, as nearly as practicable, to the respective amounts of Common Shares that are proposed to be sold by such shareholders. (d) Certain Sales During an Underwritten Public Offering. In the ------------------------------------------------------- event that there is an Underwritten Public Offering and a selling holder of Registrable Securities does not elect to sell its Registrable Securities to the underwriters of SafeGuard's securities in connection with such offering, such holder, on request of SafeGuard or the principal underwriter managing that public offering, will not sell, make a short sale of, grant an option for the purchase of, or otherwise dispose of any Registrable Securities without the prior written consent of SafeGuard or such underwriter as the case may be, for up to 90 days or such other lesser time period that the underwriter specifies. SafeGuard may impose stop transfer instructions with respect to the Common Shares (or other securities) subject to this restriction until the end of these periods. Notwithstanding anything to the contrary, the obligations of the holder of Registrable Securities under this section are conditioned on the officers and directors of SafeGuard entering into similar "lock-up" arrangements. 2.3 REGISTRATION ON FORM S-3. At such time as SafeGuard has qualified ------------------------- for the use of Form S-3 (or any similar form or forms promulgated under the Securities Act), Holders will have the right to request up to two registrations (but no more than one registration each 12 months) on Form S-3 (which request or requests will be in writing, will specify the Registrable Securities intended to be sold or disposed of by the Holder thereof, will state the intended method of disposition of such Registrable Securities by the Holder requesting such registration, and will relate to Registrable Securities having a proposed aggregate gross offering price (before deduction of underwriting discounts and expenses of sale) of at least $100,000 based on the current market price), and SafeGuard will be obligated to use its best efforts to effect the registration or registrations on Form S-3. Any such registration shall satisfy the obligations of SafeGuard with respect to a demand registration underSection 2.1. 5 2.4 REGISTRATION EXPENSES. SafeGuard shall pay all expenses of any ---------------------- registrations permitted pursuant to this Agreement (including, but not limited to, the expenses of any interim audit required by any underwriters in the event of an offering requested pursuant toSection 2.1 hereof, any qualifications under the blue-sky or other state securities laws, compliance with governmental requirements of preparing and filing any post-effective amendments required for the lawful distribution of any securities to the public in connection with registration, of supplying prospectuses, offering circulars or other documents and the reasonable fees and disbursements of a single special counsel retained by a majority in interest of the Holders, but excluding underwriting discounts and selling commissions applicable to the sale of the Registrable Securities, which are payable by the Holders, pro rata on the basis of the number of shares registered). 2.5 REGISTRATION PROCEDURES. In the case of a registration, ------------------------ qualification or compliance effected by SafeGuard pursuant to this Article Il in which any Holder's Registrable Securities are included, SafeGuard shall, at its expense: (a) Prepare and file with the Commission a registration statement with respect to the Common Shares, and use its best efforts to cause such registration statement to become and remain effective for the period that is reasonably necessary to effect the sale of the Common Shares, not to exceed nine (9) months or, if sooner, upon completion by Holders of the contemplated distribution; (b) Prepare and file with the Commission such amendments to the registration statement and supplements to the prospectus contained therein as may be necessary to keep such registration statement effective for such period as may be reasonably necessary to effect the sale of such Common Shares, not to exceed nine (9) months or, if sooner, upon completion by Holders of the contemplated distribution; (c) Furnish to the Holders participating in such registration and to the underwriters of Common Shares being registered such reasonable number of copies of the registration statement, preliminary prospectus, final prospectus and such other documents as such underwriters may reasonably request in order to facilitate the public offering of the Common Shares; (d) Use its diligent good faith efforts to register or qualify the Common Shares covered by such registration statement under such state securities or blue sky laws of such jurisdictions as such participating Holders may reasonably request in writing within 20 days following the original filing of such registration statement; provided, however, in the -------- ------- case of an Underwritten Public Offering, the managing underwriter will (to the exclusion of the participation of the Holders) advise SafeGuard with respect to blue sky qualification and related matters; (e) Notify counsel for the Holders participating in such registration, promptly after it receives notice thereof, of the time when such registration statement has become effective or a supplement to any prospectus forming a part of such registration statement has been filed; 6 (f) Notify counsel for such Holders promptly of any request by the Commission for the amending or supplementing of the registration statement or prospectus or for additional information; (g) Prepare and file with the Commission, promptly upon the request of any Holders, any amendments or supplements to the registration statement or prospectus which, in the opinion of counsel for such Holders (and concurred in by counsel for SafeGuard), is required under the Securities Act or the rules and regulations thereunder in connection with the distribution of the Common Shares, other than an amendment or supplement required solely as a result of a change by such Holders in the method of distribution of the Common Shares; (i) Prepare and promptly file with the Commission and promptly notify counsel for the Holders of the filing of such amendment or supplement to the registration statement or prospectus as may be necessary to correct any statements or omissions if, at the time when a prospectus relating to such Common Shares is required to be delivered under the Securities Act, any event other than a change in the method of distribution of the Common Shares selected by a Holders has occurred as the result of which any such prospectus or any other prospectus as then in effect would include any untrue statement of a material fact or omit to ' state any material fact necessary to make the statements therein, in the light of the circumstances in which they were made, not misleading; and (j) Not file any amendment or supplement to the registration statement or prospectus if, in the opinion of counsel for such Holders, the amendment or supplement does not comply in all material respects with the requirements of the Securities Act or the rules and regulations thereunder, after having been furnished with a copy substantially in the form thereof at least two business days prior to the filing thereof, provided, however, if in the opinion of counsel for SafeGuard, the filing -------- ------- of the amendment or supplement is reasonably necessary to protect SafeGuard from any liabilities under any applicable federal or state law and the filing will not violate applicable law, SafeGuard may make such filing. 2.6 RELATED REGISTRATION MATTERS. SafeGuard shall use its best efforts ----------------------------- to enter into an underwriting agreement in connection with any registration subject to the provisions of thisArticle II in which any Holder's Common Shares is included, which agreement will contain such terms, provisions and agreements as are customary and appropriate for such registration. In connection with any Underwritten Public Offering in which any Holder's Common Shares are included, to the extent not provided in the underwriting, agreement related to such offering, SafeGuard will use its best efforts to: (a) List the shares of Common Shares included in such offering on any national securities exchange or stock market on which the Common Shares is approved for listing; (b) Engage a bank or other company to act as transfer agent and registrar for the Common Shares; 7 (c) Cause customary opinions of counsel, comfort letters of accountants, and other appropriate documents to be delivered by representatives of SafeGuard; and (d) As soon as practicable after "the effective date of the registration statement" (within the meaning of Rule 158 under the Securities Act), and, in any event, within 16 months thereafter, make "generally available to its securities holders" (within the meaning of Rule 158 under the Securities Act) an earnings statement (which need not be audited) complying with Section II(a) of the Securities Act and covering a period of at least 12 consecutive months beginning after the effective date of the registration statement. 2.7 INDEMNIFICATION AND CONTRIBUTION. --------------------------------- (a) In the case of each registration effected by SafeGuard pursuant to this Agreement in which any Holder's Common Shares is included, SafeGuard agrees to indemnify and hold harmless such Holder, including its Officers and partners, each underwriter of the shares of Common Shares so registered and each person who controls any such underwriter within the meaning of Section 15 of the Securities Act, against any and all losses, claims, damages or liabilities to which they or any of them may become subject under the Securities Act or any other statute or common law, including any amount paid in settlement of any litigation, commenced or threatened, and to reimburse them for any reasonable legal or other reasonable expenses incurred by them in connection with the investigation of any claims and defenses of any actions (subject to subsection (c) of this Section 2.7 , insofar as any such losses, claims, damages, ------------ liabilities or actions arise out of or are based upon: any untrue statement or alleged untrue statement of a material fact contained in the registration statement, any preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereto, or the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, notwithstanding the foregoing, SafeGuard may agree to -------- ------- indemnify each such underwriter and person who so controls such underwriter to such other extent as SafeGuard and such underwriter will agree; and provided further, however, that the indemnification agreement -------- ------- ------- contained in this subsection (a) will not (1) apply to such losses, claims, damages, liabilities or actions arising out of, or based upon, any such untrue statement or alleged untrue statement, or any such omission or alleged omission, if such statement or omission was made in reliance upon and in conformity with information furnished to SafeGuard in writing by a Holder or such underwriter claiming rights of indemnification pursuant to this Section 2.7 for use in connection the preparation of the registration ----------- statement or any preliminary prospectus or final prospectus contained in the registration statement or any such amendment thereof or supplement thereto; (2) inure to the benefit of any underwriter (or to the benefit of any person controlling such underwriter) from whom the person asserting any such losses, claims, damages, expenses or liabilities purchased the securities which are the subject thereof, if such underwriter failed to send or give a copy of the final prospectus, as then amended or supplemented, to such person and if the untrue statement or omission alleged had been corrected in such final prospectus; or (3) inure to the benefit of any person to the extent such person's. claim for indemnification hereunder arises out of or is based on any violation by such person of applicable law. 8 (b) In the case of each registration effected by SafeGuard pursuant to this Agreement in which any Holder's Common Shares is included, such Holder will be obligated, and will cause each underwriter of the shares of Common Shares to be registered on behalf of such person (each Holder and such underwriters being referred to severally in this subsection (b) as the "INDEMNIFYING PERSON") to be obligated, in the same manner and to the same extent as set forth in subsection (a) of this Section 2.7. to ----------- indemnify and hold harmless SafeGuard and each person, if any, who controls SafeGuard within the meaning of Section 15 of the Securities Act, its directors, officers, partners, accountants and legal counsel, with respect to any statement or alleged untrue statement in, or omission or alleged omission from, such registration statement or any post-effective amendment thereof or any preliminary prospectus or final prospectus (as amended or supplemented, if amended or supplemented as aforesaid) contained in such registration statement, if such statement or omission was made in reliance upon and in conformity with information furnished in writing to SafeGuard by such indemnifying person for use in connection with the preparation of such registration statement or any preliminary prospectus or final prospectus contained in such registration statement or any such amendment thereof or supplement thereto; provided, however, the -------- ------- liability of each Holder hereunder is limited to the gross proceeds received by each Holder from the sale of Common Shares covered by such registration statement, amendment, supplement or prospectus, as the case may be. (c) Each person to be indemnified pursuant to this Section 2.7 will, ----------- promptly after its receipt of written notice of the commencement of any action against such indemnified person in respect of which indemnity may be sought from an indemnifying person under this Section 2.7, notify the ----------- indemnifying person in writing of the commencement thereof. The indemnifying person will assume the defense thereof with counsel reasonably satisfactory to such indemnified person and assume the payment of all fees and expenses. In any such proceeding, the indemnified party may retain its own counsel, but the fees and expenses of the counsel will be at the indemnified party's expense, unless (1) the indemnified party has employed counsel in an action in which the indemnified party and indemnifying party are both defendants and there is a conflict of interest between such parties that would prevent counsel from adequately representing both parties, as determined by counsel to the indemnified person, (2) the indemnifying party has not employed counsel satisfactory within the exercise of reasonable judgment of the indemnified party to represent the indemnified party within a reasonable time after the notice of the commencement of the action, or (3) the indemnifying party has authorized the employment of counsel for the indemnified party at the expense of the indemnifying party. The undertaking contained in this Section 2.7 is in addition to any liabilities that the indemnifying person ----------- might have pursuant to law. No indemnifying party will, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened proceeding in respect of which any indemnified party is or could have been a party and indemnity could have been sought under this Agreement by the indemnified party, unless the settlement includes an unconditional release of the indemnified party from all liability arising from the proceeding. 9 (d) If the indemnification provided for in this Section 2.7 is held ----------- by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, liability, claim, damage, or expense referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, will contribute to the amount paid or payable by such indemnified party as a result of such loss, liability, claim, damage, or expense in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the statements or omissions that resulted in such loss, liability, claim, damage, or expense as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party will be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties' relative intent, knowledge, access to information, and opportunity to correct or prevent such statement or omission. (e) Notwithstanding the foregoing, to the extent that the provisions on indemnification and contribution contained in an underwriting agreement entered into in connection with the underwritten public offering are in conflict with the foregoing provisions, the provisions of the underwriting agreement will control. 2.8 INFORMATION BY HOLDERS. Each Holder requesting Registrable ----------------------- Securities to be included in any registration shall furnish to SafeGuard such information regarding such Holder and the distribution proposed by such Holder as SafeGuard may request and as is reasonably required in connection with any registration, qualification or compliance described in this Article II. 2.9 RULE 144 REPORTING. With a view to making available to the Holder the ------------------- benefits of certain rules and regulations of the Commission that may permit the sale of the Registrable Securities to the public without registration, SafeGuard will: (a) Commission Reports. File with the Commission in a timely manner ------------------ all reports and other documents thereafter required of SafeGuard if SafeGuard is or becomes subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act; and (b) Other Information. Furnish to each Holder promptly upon its ----------------- request the following information: (1) A written statement by SafeGuard as to SafeGuard's compliance with the public information requirements of Commission Rule 144 (at any time after 90 days after SafeGuard becomes subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act), (2) A copy of the most recent annual or quarterly report of SafeGuard, and 10 (3) Such other reports and documents filed by SafeGuard with the Commission as may be reasonably requested in availing any Holder of any rule or regulation of the Commission permitting the sale of any such securities without registration. 2.10 TRANSFER OF REGISTRATION RIGHTS. The rights to cause SafeGuard to -------------------------------- register securities under this Article II may be assigned following receipt by ---------- SafeGuard of notice of the proposed transfer by any Holder to any assignee or transferee of the Common Shares issued upon conversion of the Note who also qualifies as a Holder; provided that: (a) the transfer is otherwise be effected in accordance with registration requirements imposed by applicable securities laws, and (b) the transferee agrees to be bound by this Agreement. 2.11 NOTICE OF SALE INFORMATION.Any notice from a Holder of Registrable --------------------------- Securities requesting registration of some or all of such Registrable Securities pursuant to this Article II will: (a) Specify the number of shares of Registrable Securities intended to be included in such registration; (b) Describe the nature and method of the proposed offering and sale; (c) Include an undertaking to provide all information and materials concerning such Holder and the method of distribution and to take any other actions reasonably requested by SafeGuard to enable SafeGuard to comply with the Securities Act, any state securities law and/or the applicable requirements of the Commission or any state securities commissioner or similar agency or official; and (d) If such Holder is not a party to this Agreement, include such Holder's agreement to be bound by the provisions of this Agreement applicable to Holders of Registrable Securities. 2.12 SUSPENSION. SafeGuard may suspend the Holders' further ----------- disposition of Registrable Securities by notifying the Holders of a state of facts or the occurrence of any event (including pending negotiations regarding a transaction that might require SafeGuard's disclosure of additional material, non-public information in its registration statement, for which SafeGuard believes in good faith it has a bona fide business purpose for preserving confidentiality or circumstances which render SafeGuard unable to comply with the published rules and regulations of the Commission under the Securities Act or the Exchange Act) which might reasonably cause a legal deficiency in the registration statement or the prospectus issued under the registration statement. SafeGuard shall deliver amended disclosure materials to the Holders within 15 days following this notice. At its request, the Holders shall deliver to SafeGuard all copies in their possession of the prospectus covering such Registrable Securities that was current when they received the notice. SafeGuard may not, without the Holders' consent, suspend disposition of Registrable Securities for more than 90 calendar days in any rolling twelve (12) month period. 11 ARTICLE III. MISCELLANEOUS ------------- 3.1 REMEDIES. Each party hereto acknowledges that a remedy at law for --------- any breach or attempted breach of this Agreement will be inadequate, agrees that each other party hereto is entitled to specific performance and injunctive and other equitable relief in case of any such breach or attempted breach, and further agrees to waive any requirement for the securing or posting of any bond in connection with the obtaining of any such injunctive or any other equitable relief. 3.2 EFFECT OF SALE. Any Holder who sells all of his Note and ----------------- Registrable Securities pursuant to the terms of this Agreement will cease to be a party to this Agreement and will have no further rights or obligations hereunder. 3.3 AMENDMENT. This Agreement may be amended from time to time by an ---------- instrument in writing signed by SafeGuard and Holders of a majority of the then outstanding Registrable Securities. 3.4 NOTICES. Any notice, request, reply instruction or other -------- communication (herein severally and collectively called "NOTICE") in this Agreement provided or permitted to be given to SafeGuard or to any Holder must be given in writing and may be given or served by overnight delivery service, depositing the same in the United States mail, in certified or registered form postage fully prepaid, addressed to the party or parties to be notified, with return postage fully requested, or by delivering the same in person to such party or parties. Notice deposited in the United States mail, mailed in the manner hereinabove described, will be effective upon deposit. Notice given in any other manner will be effective only if and when received by the party to be notified. For purpose of notice hereunder, until notice is given of a change of address, the address of SafeGuard will be 95 Enterprise, Suite 100, Aliso Viejo, California 92656-2605, and the address of Holder will be the address hereinafter set forth on the signature page. 3.5 LEGAL MATTERS. -------------- (a) Jurisdiction; Venue. The laws of the State of Delaware and the ------------------- federal laws of the United States of America, excluding the laws of those jurisdictions pertaining to the resolution of conflict with laws of other jurisdictions, govern the validity, construction, enforcement, and interpretation of this Agreement. (b) Costs. In any legal proceeding between SafeGuard and Holder ----- arising out of this Agreement, the losing party shall reimburse the prevailing party, on demand, for all reasonable costs incurred by the prevailing party in enforcing, defending, or prosecuting this Agreement. 3.6 SUCCESSORS AND ASSIGNS. This Agreement is binding upon and inures ----------------------- to the parties contained in this Agreement and their respective heirs, executors, distributees, successors (including successors by merger) and permitted assigns. 3.7 INVALID PROVISIONS. Should any portion of this Agreement be ------------------- adjudged or held to be invalid, unenforceable or void, such holding will not have the effect of invalidating or voiding the remainder of this Agreement and the parties hereby agree that the portion so held invalid, unenforceable or void will, if possible, be deemed amended or reduced in scope, or to otherwise be stricken from this Agreement to the extent required for the purposes of validity and enforcement thereof. 12 3.8 SECTION HEADINGS. The section and paragraph headings contained ----------------- herein are for reference purposes only and will not in any way affect the meaning and interpretation of this Agreement. 3.9 EXECUTION IN COUNTERPARTS. This Agreement may be executed in any -------------------------- number of counterparts, each of which when so executed and delivered will be deemed an original, and such counterparts together will constitute only one instrument. 3.10 ADJUSTMENTS. In the event SafeGuard declares a stock split, stock ------------ dividend or other distribution of capital stock in respect of, or issues capital stock in replacement of or exchange for, shares of Common Shares, such shares will be subject to this Agreement, and the provisions of this Agreement providing for calculations based on the number of shares of Common Shares will include the shares issued in respect of the Common Shares and the shares converted into Common Shares from the Note. (REMAINDER OF PAGE INTENTIONALLY LEFT BLANK) 13 REGISTRATION RIGHTS AGREEMENT SIGNATURE PAGE The undersigned execute the Registration Rights Agreement and authorize this signature page to be attached to a counterpart of the Registration Rights Agreement executed by the other parties to the Registration Rights Agreement. Executed as of the day and year first above written. "SAFEGUARD" SAFEGUARD HEALTH ENTERPRISES, INC., a Delaware corporation By: /s/ James E. Buncher -------------------- James E. Buncher President and Chief Executive Officer By: /s/ Ronald I. Brendzel ---------------------- Ronald I. Brendzel Senior Vice President and Secretary 14 REGISTRATION RIGHTS AGREEMENT SIGNATURE PAGE The undersigned executes the Registration Rights Agreement and authorize this signature page to be attached to a counterpart of the Registration Rights Agreement executed by the other parties to the Registration Rights Agreement. Executed as of the day and year first above written. "HOLDER" /s/ Jack R. Anderson ------------------------------------------------ Jack R. Anderson 16495 Dallas Parkway Suite 735 Addison, TX 75001 15 EX-10.32 5 doc4.txt EXHIBIT 10.32 AMENDED AND RESTATED STOCK OPTION PLAN OF SAFEGUARD HEALTH ENTERPRISES, INC. SAFEGUARD HEALTH ENTERPRISES, INC., a corporation organized under the laws of the State of Delaware, hereby adopts this Amended and Restated Stock Option Plan of Safeguard Health Enterprises, Inc., as of January 15, 2002. The purposes of this Plan are as follows: (1) To further the growth, development and financial success of the Company by providing additional incentives to certain of its Directors and executive and other key Employees who have been or will be given responsibility for the management or administration of the Company's business affairs, by assisting them to become owners of capital stock of the Company and thus to benefit directly from its growth, development and financial success. (2) To enable the Company to obtain and retain the services of the type of Directors and professional, technical and managerial Employees considered essential to the long range success of the Company by providing and offering them an opportunity to become owners of capital stock of the Company under options, some of which are intended to qualify as "incentive stock options" under Section 422 of the Internal Revenue Code. The Plan shall be divided into two separate components: the Discretionary Option Grant Program described in Articles III through VI and the Automatic Option Grant Program described in Article VII. Under the Discretionary Option Grant Program, eligible individuals may, at the discretion of the Plan Administrator, be granted stock options to purchase shares of Common Stock in accordance with the provisions of Articles III through VI. Under the Automatic Option Grant Program, each eligible member of the Board will automatically receive periodic option grants to purchase shares of Common Stock in accordance with the provisions of Article VII. Unless the context clearly indicates otherwise, the provisions of Articles I, II and VIII of the Plan shall apply to both the Discretionary Option Grant Program and the Automatic Option Grant Program and shall accordingly govern the interests of all individuals under the Plan. ARTICLE I DEFINITION ---------- Section 1.1 - General - ------------ ------- Whenever the following terms are used in this Plan, they shall have the meaning specified below unless the context clearly indicates to the contrary. Section 1.2 - Board - ------------ ----- "Board" shall mean the Board of Directors of the Company. Section 1.3 - Code - ------------ ---- "Code" shall mean the Internal Revenue Code of 1986, as amended from time to time. Section 1.4 - Committee - ------------ --------- "Committee" shall mean the committee appointed by the Board pursuant to Section 6.1(a) to administer the provisions of the Discretionary Stock Option Grant Program. Section 1.5 - Company - ------------ ------- "Company" shall mean Safeguard Health Enterprises, Inc. Section 1.6 - Director - ------------ -------- "Director" shall mean a member of the Board. Section 1.7 - Employee - ------------ -------- "Employee" shall mean any employee (as defined in accordance with the Regulations and Revenue Rulings then applicable under Section 3401(c) of the Code) of the Company or of any corporation which is then a Parent or Subsidiary, whether such employee is so employed at the time this Plan is adopted or becomes so employed subsequent to the adoption of this Plan. Section 1.8 - Incentive Stock Option - ------------ ------------------------ "Incentive Stock Option" shall mean an Option qualifying under Section 422 of the Code and designated as such by the Plan Administrator. - 2 - Section 1.9 - Non-Employee Director - ------------ ---------------------- "Non-Employee Director" shall mean any Director who qualifies as a "non-employee director" within the meaning of Rule 16b-3 promulgated by the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Section 1.10- Non-Qualified Stock Option - ------------- ---------------------------- "Non-Qualified Stock Option" shall mean an Option which is not an Incentive Stock Option and which is designated as a Non-Qualified Stock Option by the Plan Administrator. Section 1.11 - Officer - ------------- ------- "Officer" shall mean an officer of the Company or of any Parent or Subsidiary. Section 1.12 - Option - ------------- ------ "Option" shall mean an option to purchase capital stock of the Company, granted under the Plan. "Options" includes both Incentive Stock Options and Non-Qualified Stock Options, except that for purposes of Article VII, such term shall refer solely to Non-Qualified Stock Options. Section 1.13 - Optionee - ------------- -------- "Optionee" shall mean an Employee or non-Employee member of the Board to whom an Option is granted under the Plan. Section 1.14 - Parent Corporation - ------------- ------------------- "Parent" shall mean any corporation in an unbroken chain of corporations ending with the Company if each of the corporations in the unbroken chain (other than the Company) owns at the time of determination stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. Section 1.15 - Plan - ------------- ---- The "Plan" shall mean this Stock Option Plan of Safeguard Health Enterprises, Inc. Section 1.16 - Plan Administrator - ------------- ------------------- "Plan Administrator" shall mean the Board or the Committee appointed to administer the Discretionary Option Grant provisions of the Plan, to the extent such entity is carrying out its administrative functions under the Plan in accordance with the provisions of Article VI. - 3 - Section 1.17 - Pronouns - ------------- -------- The masculine pronoun shall include the feminine and neuter and the singular shall include the plural, where the context so indicates. Section 1.18 - Secretary - ------------- --------- "Secretary" shall mean the Secretary of the Company. Section 1.19 - Subsidiary - ------------- ---------- "Subsidiary" shall mean any corporation in an unbroken chain of corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain owns at the time of determination stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. Section 1.20 - Termination of Employment - ------------- --------------------------- "Termination of Employment" shall mean the time when the employee-employer relationship between the Optionee and the Company or any Parent or Subsidiary corporation, is terminated for any reason, with or without cause, at any time, including, but not by way of limitation, a termination by resignation, discharge, death or retirement, but excluding terminations where there is a simultaneous reemployment by the Company or any Parent or Subsidiary corporation. The Plan Administrator, in its absolute discretion, shall determine the effect of all other matters and questions relating to the Optionee's Termination of Employment, including, but not by way of limitation, the question of whether a Termination of Employment resulted from a discharge for good cause, and all questions of whether particular leaves of absence constitute Terminations of Employment; provided, however, that, with respect to Incentive Stock Options, a leave of absence shall constitute a Termination of Employment if, and to the extent that, such leave of absence interrupts employment for the purposes of Section 422(a)(2) of the Code and then applicable Treasury Regulations and other administrative authority under said Section. ARTICLE II SHARES SUBJECT TO PLAN ---------------------- Section 2.1 - Shares Subject to the Plan - ------------ ------------------------------ The shares of stock subject to Options shall be shares of the Company's authorized common stock ("Common Stock"). The aggregate number of - 4 - such shares, which may be issued over the term of the Plan, shall not exceed 3,600,000. The total number of shares issuable from time to time under the Plan shall be subject to periodic adjustment in accordance with the provisions of Section 2.3 below. Should an Option expire or terminate for any reason prior to exercise or surrender in full, the shares subject to the portion of the Option not so exercised or surrendered shall be available for subsequent Option grants under the Plan. Shares subject to any Option or portion thereof surrendered in accordance with Section 7.10 of the Plan and all share issuances under the Plan, whether or not such shares are subsequently repurchased by the Company pursuant to its repurchase rights under the Plan, shall reduce on a share-for-share basis the number of shares of Common Stock available for subsequent Option grants under this Plan. In addition, should the option price of an outstanding Option under the Plan be paid with shares of Common Stock, then the number of shares of Common Stock subsequently available for issuance under the Plan shall be reduced by the gross number of shares for which the Option is exercised, and not by the net number of shares of Common Stock actually issued to the Optionee. Section 2.2 - Limitation on Incentive Stock Option Grants - ------------ ------------------------------------------------ The aggregate fair market value (determined as of the respective date or dates of grant) of the shares of Common Stock for which one or more Incentive Stock Options granted to any Employee under the Plan (or any other stock option plan of the Company or its Parent or Subsidiary corporations) may for the first time become exercisable as Incentive Stock Options under the Federal tax laws during any one (1) calendar year shall not exceed the sum of One Hundred Thousand Dollars ($100,000) or such greater amount as may be permitted under subsequent amendments to Section 422 of the Internal Revenue Code. To the extent the Employee holds two (2) or more such Options which become exercisable for the first time in the same calendar year, the foregoing limitation on the exercisability thereof as Incentive Stock Options under the Federal tax laws shall be applied on the basis of the order in which such Options are granted. In the event the applicable $100,000 limitation is in fact exceeded in any calendar year, the Option may nevertheless be exercised for those excess shares as a Non-Qualified Stock Option. Section 2.3 - Changes in Company's Shares - ------------ ------------------------------ In the event that the outstanding shares of Common Stock of the Company are hereafter changed into or exchanged for a different number or kind of shares or other securities of the Company, or of another corporation, by reason of reorganization, merger, consolidation, recapitalization, reclassification, stock split-up, stock dividend or combination of shares, appropriate adjustments shall be made by the Stock Option Committee in the number and kind of shares for the purchase of which Options may be granted, including adjustments of the limitations in Sections 2.1 and 2.2 on the maximum number and kind of shares which may be issued on exercise of Options. - 5 - ARTICLE III GRANTING OF DISCRETIONARY OPTIONS --------------------------------- Section 3.1 - Eligibility for Option Grants - ------------ -------------------------------- (a) The persons eligible to receive Option grants pursuant to the Discretionary Option Grant Program shall be limited to the following individuals: (i) such Employee-members of the Board as the Committee shall select from time to time; and (ii) such other key Employees (including officers who are not Directors) as the Plan Administrator shall select from time to time. (b) The Plan Administrator shall have the sole and exclusive authority, within the scope of its administrative functions under the Plan, to select the eligible individuals who are to receive Option grants under the Discretionary Option Grant Program and to determine the number of shares to be covered by each such Option grant, the status of the granted Option as either an Incentive Stock Option or a Non-Qualified Stock Option, the time or times at which such Option is to become exercisable and the maximum term for which the Option is to remain outstanding. (c) Non-Employee members of the Board (including members of the Committee) shall not be eligible to participate in the Discretionary Option Grant Program. However, non-Employee members of the Board shall be eligible to receive periodic Option grants pursuant to the Automatic Option Grant provisions of Article VII. (d) Upon the selection of an eligible individual to receive an Option grant under the Discretionary Option Grant Program, the Plan Administrator shall instruct the Secretary to issue such Option and may impose such conditions on the grant of such Option as it deems appropriate. Without limiting the generality of the preceding sentence, the Plan Administrator may, in its discretion and on such terms as it deems appropriate, require as a condition to the grant of the Option that the Optionee surrender for cancellation some or all of the unexercised Options which have been previously granted to him. Any Option the grant of which is unconditioned upon such surrender may have an option price lower (or higher) than the option price of the surrendered Option, may cover the same (or a lesser or greater) number of shares as the surrendered Option, may contain such other terms as the Plan Administrator deems appropriate and shall be exercisable in accordance with its terms, without regard to the number of shares, price, option period or any other term or condition of the surrendered Option. - 6 - ARTICLE IV TERMS OF DISCRETIONARY OPTION GRANTS ------------------------------------ Section 4.1 - Option Agreement - ------------ ----------------- Each Option issued under the Discretionary Option Grant Program shall be evidenced by a written Stock Option Agreement, which shall be executed by the Optionee and authorized Officers of the Company and which shall contain such terms and conditions as the Plan Administrator shall determine, consistent with the Plan. Stock Option Agreements evidencing Incentive Stock Options shall contain such terms and conditions as may be necessary to qualify such Options as "incentive stock options" under Section 422 of the Code. Section 4.2 - Option Price - ------------ ------------- (a) The price of the shares subject to each Option shall be set by the Plan Administrator; provided, however, that the price per share shall be not less than one hundred percent (100%) of the fair market value of such shares on the date such Option is granted; provided, further, that, in the case of an Incentive Stock Option granted to an individual then owning (within the meaning of Section 424(d) of the Code) more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Subsidiary or any Parent corporation (a "10% Stockholder"), the price per share shall not be less than one hundred ten percent (110%) of the fair market value of such shares on the date such Option is granted. (b) For the purpose of Section 4.2(a) and all other valuation purposes under the Plan, the fair market value of a share of the Company's stock on the date the Option is granted shall be: (i) the closing price of a share of the Company's Stock on the principal exchange on which shares of the Company's stock are then trading, if any, on such date, or, if shares were not traded on such date, then on the next preceding trading day during which a sale occurred; or (ii) if such stock is not traded on an exchange but quoted on NASDAQ or a successor quotation system, (1) the last sale price (if the stock is then listed as a National Market Issue) or (2) the mean between the closing representative bid and asked prices (in all other cases) for the stock on such date as reported by NASDAQ or such successor quotation system; or (iii) if such stock is not publicly traded on an exchange and not quoted on NASDAQ or a successor quotation system, the mean between the closing bid and asked prices for the stock on such date as determined in good faith by the Committee effecting the Option grant; or (iv) if the Company's stock is not publicly traded, the fair market value established by such Plan Administrator acting in good faith. Section 4.3 - Commencement of Exercisability - ------------ -------------------------------- (a) No Option may be exercised in whole or in part during the first year after such Option is granted. Thereafter the Optionee may, within the specified term of the Option and pursuant to the provisions of this Agreement, purchase the Optioned Shares in accordance with the following schedule: - 7 - (i) One-third of the Optioned Shares at any time after the expiration of twelve (12) months measured from the date of grant. (ii) An additional one-third of the Optioned Shares at any time after the expiration of twenty-four (24) months measured from the date of grant. (iii) The final one-third of the Optioned Shares at any time after the expiration of thirty-six (36) months measured from the date of grant. Within the limitations provided in this Section 4.3 but subject to the other provisions of this Agreement, an Optionee may, on any two (2) occasions in each fiscal year during the term of the Option, purchase any or all of the Optioned Shares for which the Option is at the time exercisable; provided however, that each exercise shall be for not less than twenty-five (25) shares or the minimum installment set forth in this Section 4.3, if a smaller number of shares. In no event, however, shall an Option be exercisable for any fractional shares. (b) Subject to the provisions of Sections 4.3(a) and 4.3(c), Options shall become exercisable at such times and in such installments (which may be cumulative) as the Plan Administrator shall provide in the terms of the individual Option; provided, however, that by a resolution adopted after an Option is granted, the Plan Administrator may, on such terms and conditions as it may determine to be appropriate and subject to Sections 4.3(a) and 4.3(c), accelerate the time at which such Option or any portion thereof may be exercised. (c) No portion of an Option which is unexercisable at Termination of Employment shall thereafter become exercisable. Section 4.4 - Expiration of Options - ------------ ----------------------- (a) No Incentive Stock Option may be exercised to any extent by anyone after the first to occur of the following events: (i) The expiration of ten (10) years from the date the Option as granted; (ii) In the case of a 10% Stockholder, the expiration of five (5) years from the date that the Option was granted; (iii) Except in the case of any Optionee who is disabled (within the meaning of Section 22(e)(3) of the Code) at the time Employee status terminates, the expiration of ninety (90) days from the date of the Optionee's Termination of Employment for any reason, other than such Optionee's death unless the Optionee dies within said thirty (30) days; (iv) In the case of an Optionee who is disabled (within the mean of Section 22(e)(3) of the Code) at the time Employee status - 8 - terminates, the expiration of six (6) months from the date of the Optionee's Termination of Employment for any reason other than such Optionee's death unless the Optionee dies within said six (6) month period; (v) The expiration of six (6) months from the date of the Optionee's death. No Non-Qualified Stock Option may be exercised to any extent by anyone after the expiration of ten (10) years and one (1) day from the date the Option was granted. (b) Subject to the provisions of Section 4.4(a), the Plan Administrator shall provide, as part of the terms of the Option, when such Option expires and becomes unexercisable; and (without limiting the generality of the foregoing) the Plan Administrator may provide as part of the terms of the Option that such Option is to expire immediately upon a Termination of Employment for any reason. Section 4.5 - Consideration - ------------ ------------- In consideration of the granting of the Option, the Optionee shall agree, in the written Stock Option Agreement, to remain in the employ of the Company or a Parent or Subsidiary corporation for a period of at least one (1) year after the Option is granted. Nothing in this Plan or in any Stock Option Agreement hereunder shall confer upon any Optionee any right to continue in the employ of the Company or any Parent or Subsidiary corporation or shall interfere with or restrict in any way the rights of the Company and any such Parent or Subsidiary corporation, which are hereby expressly reserved, to discharge any Optionee at any time for any reason whatsoever, with or without good cause. Section 4.6 - Adjustments in Outstanding Options - ------------ ------------------------------------- In the event that the outstanding shares of the stock subject to Options are changed into or exchanged for a different number or kind of shares of the Company or other securities of the Company by reason of merger, consolidation, recapitalization, reclassification, stock split-up, stock dividend or combination of shares, the Plan Administrator shall make an appropriate and equitable adjustment in the number and kind of shares as to which all outstanding Options, or portions thereof then unexercised, shall be exercisable, to the end that after such event the Optionee's proportionate interest (vis-a-vis the other stockholders of the Company) shall be maintained as before the occurrence of such event. Such adjustment in an outstanding Option shall be made without change in the total price applicable to the Option or the unexercised portion of the Option (except for any change in the aggregate price resulting from rounding-off of share quantities or prices) and with any necessary corresponding adjustment in option price per share; provided, however, that, in the case of Incentive Stock Options, each such adjustment shall be made in such manner as not to constitute a "modification" within the meaning of Section 424(h) (3) of the Code. Any such adjustment made by the Primary Committee (or the Board) shall be final and binding upon all Optionees, the Company and all other interested persons. - 9 - Section 4.7 - Merger, Consolidation, Exchange, Acquisition, Liquidation or - ------------ --------------------------------------------------------------- Dissolution - ----------- In its absolute discretion, and on such terms and conditions as it deems appropriate, the Plan Administrator may provide as part of the terms of the Option that such Option cannot be exercised after the merger or consolidation of the Company into another corporation, the acquisition by another corporation of all or substantially all of the Company's assets or eighty percent (80%) or more of the Company's then outstanding voting stock or the liquidation or dissolution of the Company; and if the Plan Administrator so provides, it may, in its absolute discretion and on such terms and conditions as it deems appropriate, also provide either by the terms of such Option or by a resolution adopted prior to the occurrence of such merger, consolidation, exchange, acquisition, liquidation or dissolution, that, for some period of time prior to such event, such Option shall be exercisable as to all shares covered thereby, notwithstanding anything to the contrary in Section 4.3(a), Section 4.3(b) and/or in any installment provisions of such Option. ARTICLE V EXERCISE OF DISCRETIONARY OPTIONS --------------------------------- Section 5.1 - Persons Eligible to Exercise - ------------ ------------------------------- During the lifetime of the Optionee, only he may exercise an Option granted to him, or any portion thereof. After the death of the Optionee, any exercisable portion of an Option may, prior to the time when such portion becomes unexercisable under Section 4.4 or Section 4.7, be exercised by his personal representative or by any person empowered to do so under the deceased Optionee's Will or under the then applicable laws of descent and distribution. Section 5.2 - Partial Exercise - ------------ ----------------- At any time and from time to time prior to the time when any exercisable Option or exercisable portion thereof becomes unexercisable under Section 4.4 or Section 4.7, such Option or portion thereof may be exercised in whole or in part; provided, however, that the Company shall not be required to issue fractional shares and the Plan Administrator may, as part of the terms of the Option, require any partial exercise to be with respect to a specified minimum number of shares. Section 5.3 - Manner of Exercise - ------------ -------------------- An exercisable Option, or any exercisable portion thereof, may be exercised solely by delivery to the Secretary or his office of all of the following prior to the time when such Option or such portion becomes unexercisable under Section 4.4 or Section 4.7: (a) Notice in writing signed by the Optionee or other person then entitled to exercise such Option or portion, stating that such Option or portion is exercised, such notice complying with all applicable rules established by the Plan Administrator; and - 10 - (b) Payment of the option price for the purchased shares in any of the following forms: (i) full payment in a cashiers' check or wire transfer payable to the Company's order; or (ii) full payment in shares of Common Stock held for the requisite period necessary to avoid a charge to the Company's reported earnings and valued at fair market value on the Exercise Date (as such term is defined below); or (iii) payment effected through a broker-dealer sale and remittance procedure pursuant to which the Optionee shall provide irrevocable written instruction (I) to the designated brokerage firm to effect the immediate sale of the purchased shares and to remit to the Company, out of the sale proceeds available on the settlement date, an amount equal to the aggregate option price payable for the purchased shares plus all applicable federal and state income and employment taxes required to be withheld by the Company in connection with such purchase and sale and (II) to the Company to deliver the certificates for the purchased shares directly to such brokerage firm in order to complete the sale transaction; or (iv) any combination of the consideration provided in the foregoing subsections (i), (ii) and (iii). For purposes of this subsection 5.3(b), the Exercise Date shall be the date on which written notice of the Option exercise is received by the Company. Except to the extent the sale and remittance procedure is utilized in connection with the Option exercise, payment of the option price for the purchased shares must accompany such exercise notice; and (c) Such representations and documents as the Plan Administrator may, in its absolute discretion, deem necessary or advisable to effect compliance with all applicable provisions of the Securities Act of 1933, as amended, and any other federal or state securities laws or regulations. The Plan Administrator may, in its absolute discretion, also take whatever additional actions it deems appropriate to effect such compliance including, without limitation, placing legends on share certificates and issuing stop-transfer orders to transfer agents and registrars; and (d) In the event that the Option or portion thereof shall be exercised pursuant to Section 5.1 by any person or persons other than the Optionee, appropriate proof of the right of such person or persons to exercise the Option or portion thereof. - 11 - Section 5.4 - Conditions to Issuance of Stock Certificates - ------------ ------------------------------------------------- The shares of stock issuable and deliverable upon the exercise of an Option, or any portion thereof, may be either previously authorized but unissued shares or issued shares which have then been reacquired by the Company. The Company shall not be required to issue or deliver any certificate or certificates for shares of stock purchased upon the exercise of any Option or portion thereof prior to fulfillment of all of the following conditions: (a) The admission of such shares to listing on all stock exchanges on which such class of stock is then listed; and (b) The completion of any registration or other qualification of such shares under any state or federal law or under the rulings or regulations of the Securities and Exchange Commission or any other governmental regulatory body, which the Plan Administrator shall, in its absolute discretion, deem necessary or advisable; and (c) The obtaining of any approval or other clearance from any state or federal governmental agency which the Plan Administrator shall, in its absolute discretion, determine to be necessary or advisable; and (d) The payment to the Company of all amounts which it is required to withhold under federal, state or local law in connection with the exercise of the Option; and (e) The lapse of such reasonable period of time following the exercise of the Option as the Plan Administrator may establish from time to time for reasons of administrative convenience. Section 5.5 - Rights as Stockholders - ------------ ------------------------ The holders of Options shall not be, nor have any of the rights or privileges of, stockholders of the Company in respect of any shares purchasable upon the exercise of any part of an Option unless and until certificates representing such shares have been issued by the Company to such holders. Section 5.6 - Transfer Restrictions - ------------ ---------------------- The Plan Administrator, in its absolute discretion, may impose such restrictions on the transferability of the shares purchasable upon the exercise of the Option as it deems appropriate, and any such restriction shall be set forth in the respective Stock Option Agreement and may be referred to on the certificates evidencing such shares. The Plan Administrator may require an Optionee to give the Company prompt notice of any disposition of shares of stock, acquired by exercise of an Incentive Stock Option, within two (2) years from the date of granting such Option or one (1) year after the transfer of such shares to such Optionee. The Plan Administrator may direct that the certificates evidencing shares acquired by exercise of an Option refer to such requirement to give prompt notice of disposition. - 12 - ARTICLE VI ADMINISTRATION -------------- Section 6.1 - Administration of Plan - ------------ ------------------------ The Plan shall be administered in accordance with the following standards: (a) The Discretionary Option Grant Program shall be administered by the Plan Administrator, which shall be the Board or, in the discretion of the Board, a Committee appointed by the Board and composed solely of two (2) or more Non-Employee Directors. Members of the Committee shall serve for such term as the Board may determine and shall be subject to removal by the Board at any time. Subject to the provisions of the Plan, the Plan Administrator shall have the sole and exclusive authority to grant Options under the Discretionary Option Grant Program, to accelerate the exercisability of such Options, and to make all determinations necessary or advisable for the administration of the Discretionary Option Grant Program. (b) The Plan Administrator shall have full power and authority (subject to the express provisions of the Plan) to establish such rules and regulations as it may deem appropriate for the proper administration of the Plan functions within the scope of its administrative authority and to make any and all determinations with respect to those functions which it may deem necessary or advisable. All decisions of the Plan Administrator taken in good faith and within the scope of its administrative authority under the Plan shall be final and binding on the Optionee, the Company and all other parties who have an interest in any outstanding Option granted pursuant to such authority. (c) Administration of the Automatic Option Grant provisions of Article VII shall be self-executing in accordance with the express terms and conditions of such Article VII, and the Plan Administrator shall exercise no discretionary functions with respect to the Option grants made pursuant to such Article VII. Section 6.2 - Compensation; Professional Assistance; Good Faith Actions - ------------ -------------------------------------------------------------- Individuals serving as Plan Administrator shall not receive compensation for their services as such, but all expenses and liabilities they incur in connection with the administration of the Plan shall be borne by the Company. The Plan Administrator may, with the approval of the Board, employ attorneys, consultants, accountants, appraisers, brokers or other persons. The Plan Administrator, together with the Company and its Officers and Directors, shall be entitled to rely upon the advice, opinions or valuations of any such persons. No individual serving as Plan Administrator shall be personally liable for any action, determination or interpretation made in good faith with respect to the Plan or the Options, and such individuals shall be fully protected by the Company with respect to any such action, determination or interpretation. - 13 - ARTICLE VII AUTOMATIC OPTION GRANT PROGRAM ------------------------------ Section 7.1 - Eligible Optionees - ------------ ------------------- (a) Each individual serving as a non-Employee member of the Board at any time on or after November 9, 1992, shall be eligible to receive periodic automatic Option grants pursuant to the provisions of this Article VII. However, in no event will any non-Employee Board member be eligible to receive Option grants under this Article VII program, if such individual has previously served as an Employee of the Company or any Parent or Subsidiary corporation. (b) Except for the Option grants to be made pursuant to the provisions of this Article VII, non-Employee Board members shall not be eligible to receive any additional Option grants under this Plan. Section 7.2 - Grant Dates - ------------ ------------ Option grants will be made under this Article VII on the dates specified below: (i) On November 9, 1992, each individual who is at the time serving as a non-Employee member of the Board shall automatically be granted on that date a Non-Qualified Stock Option to purchase two thousand (2,000) shares of Common Stock upon the terms and conditions of this Article VII. (ii) On the second Monday of November of each subsequent year, commencing with the 1993 calendar year, each member of the Board shall automatically be granted on that date a Non-Qualified Stock Option to purchase two thousand (2,000) shares of Common Stock upon the terms and conditions of this Article VII, or such other number of shares of Common Stock as may be fixed by the Board from time to time. There shall be no limit on the number of such share Option grants any one non-Employee Board member may receive over his period of service on the Board. The number of shares subject to each automatic Option grant (including grants to be made in the future) shall be subject to periodic adjustment pursuant to the applicable provisions of Section 4.7. Section 7.3 - Option Price - ------------ ------------- The option price per share shall be equal to one hundred percent (100%) of the fair market value per share of Common Stock on the automatic grant date. - 14 - Section 7.4 - Payment - ------------ ------- The option price shall be payable in one of the alternative forms specified below: (i) full payment in a cashiers check or wire transfer payable to the Company's order; or (ii) full payment in shares of Common Stock held for the requisite period necessary to avoid a charge to the Company's reported earnings and valued at fair market value on the Exercise Date (as such term is defined below); or (iii) payment effected through a broker-dealer sale and remittance procedure pursuant to which the Optionee shall provide irrevocable written instructions (I) to the designated brokerage firm to effect the immediate sale of the purchased shares and to remit to the Company, out of the sale proceeds available on the settlement date, an amount equal to the aggregate option price payable for the purchased shares and (II) to the Company to deliver the certificates for the purchased shares directly to such brokerage firm in order to complete the sale transaction; or (iv) any combination of the consideration provided in the foregoing subsections (i), (ii), and (iii). For purposes of this subsection 7.4, the Exercise Date shall be the date on which written notice of the Option exercise is received by the Company. Except to the extent the sale and remittance procedure is utilized in connection with the Option exercise, payment of the option price for the purchased shares must accompany such exercise notice. Section 7.5 - Option Term - ------------ ------------ Each automatic grant under this Article VII shall have a maximum term of ten (10) years measured from the automatic grant date. Section 7.6 - Exercisability - ------------ -------------- Each automatic Option shall become exercisable for the Option shares one (1) year after the grant date. Section 7.7 - Termination of Board Service - ------------ ------------------------------- (a) Should the Optionee cease service as a Board member for any reason while holding one or more automatic Option grants under this Article VII, then such options granted hereunder not exercised by the Board member at the time of termination of Board membership, shall terminate and cease to be exercisable as of such date. - 15 - (b) In no event shall any automatic grant under this Article VII remain exercisable after the specified expiration date of the ten (10) year Option term. Upon the expiration of the applicable exercise period in accordance with subparagraph (a) above or (if earlier) upon the expiration of the ten (10) year Option term, the automatic Option grant shall terminate and cease to be exercisable. Section 7.8 - Stockholder Rights - ------------ ------------------- The holder of an automatic Option grant under this Article VII shall have no stockholder rights with respect to any shares covered by such Option until such individual shall have exercised the Option, paid the option price for the purchased shares and been issued a stock certificate for such shares. Section 7.9 - Corporate Transaction - ------------ ---------------------- In the event of any of the following stockholder-approved transactions to which the Company is a party (a "Corporate Transaction"): any merger or consolidation of the Company into another corporation, the acquisition by another corporation of all or substantially all of the Company's assets or the liquidation or dissolution of the Company, the exercisability of each automatic Option grant at the time outstanding under this Article VII shall automatically accelerate so that each such option shall, immediately prior to the specified effective date for the Corporate Transaction, become fully exercisable with respect to the total number of shares of Common Stock at the time subject to such Option and may be exercised for all or any portion of such shares. Upon the consummation of the Corporate Transaction, all automatic Option grants under this Article VII shall terminate and cease to be outstanding. Section 7.10 - Change in Control - ------------- ------------------- In connection with any Change in Control of the Company, the exercisability of each automatic Option grant at the time outstanding under this Article VII shall automatically accelerate so that each such Option shall, immediately prior to the specified effective date for the Change in Control, become fully exercisable with respect to the total number of shares of Common Stock at the time subject to such Option and may be exercised for all or any portion of such shares. For purposes of this Article VII, a Change in Control shall be deemed to occur when any person or related group or persons (other than the Company or a person that directly or indirectly controls, is controlled by, or is under common control with, the Company) directly or indirectly acquires beneficial ownership [within the meaning of Rule 13d-3 of the Securities Exchange Act of 1934, as amended (the "1934 Act")] of securities possessing more than eighty percent (80%) of the total combined voting power of the Company's outstanding securities pursuant to a tender or exchange offer made directly to the Company's stockholders which the Board does not recommend such stockholders to accept. The shares of Common Stock subject to each Option surrendered in connection with the Change in Control shall not be available for subsequent issuance under this Plan. - 16 - The automatic Option grants outstanding under this Article VII shall in no way affect the right of the Company to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets. Section 7.11 - Remaining Terms - ------------- ---------------- The remaining terms and conditions of each automatic Option grant shall be as set forth in the prototype Directors Automatic Option Grant Agreement. Section 7.12 - Amendment of the Automatic Grant Provisions - ------------- ------------------------------------------------ The provisions of this Automatic Option Grant Program, including any automatic Option grants outstanding under this Article VII, may not be amended at intervals more frequently than once every six (6) months, other than to the extent necessary to comply with applicable federal income tax laws and regulations. ARTICLE VIII MISCELLANEOUS PROVISIONS ------------------------ Section 8.1 - Options Not Transferable - ------------ -------------------------- During the lifetime of the Optionee, Options granted under either the Discretionary Option Grant Program or the Automatic Option Grant Program (and any stock appreciation rights attaching thereto) shall be exercisable only by the Optionee and shall not be assignable or transferable by the Optionee other than by a transfer of the Option effected by the Optionee's will or by the laws of descent and distribution following the Optionee's death. Accordingly, except for such permitted transfer, the Option (or any interest or right therein or part thereof) shall not be subject to disposition by transfer, alienation, anticipation, pledge, encumbrance, assignment or any other means whether such disposition be voluntary or involuntary or by operation of law by judgment, levy, attachment, garnishment or any other legal or equitable proceedings (including bankruptcy), and any such attempted disposition thereof shall be null and void and of no effect. Section 8.2 - Amendment, Suspension or Termination of the Plan - ------------ ------------------------------------------------------ (a) The Plan may be wholly or partially amended or otherwise modified, suspended or terminated at any time or from time to time by the Board; provided, however, that (I) no such amendment or modification shall, without the consent of the Option holders, adversely affect their rights and obligations under their Options and (II) any amendment to the Automatic Option Grant program shall be effected in compliance with the limitations of Section 7.12. In addition, the Board shall not, without the approval of the Company's stockholders, (i) materially increase the maximum number of shares issuable under the Plan, except for permissible adjustments under Section 2.3, (ii) materially modify the eligibility requirements for the grant of Options under the Plan, (iii) materially increase the benefits accruing to participants under the Plan or (iv) increase the maximum number of shares for which Automatic Option Grants may be periodically made pursuant to the provisions of Article VII. - 17 - (b) No Option may be granted during any period of suspension nor after termination of the Plan, and in no event may any Option be granted under this Plan after the earlier of the following events: (i) December 31, 2006; or (ii) the date on which all shares available for issuance under the Plan shall have been issued or canceled pursuant to the exercise or surrender of the Options granted hereunder. If the date of termination is determined under clauses (i) above, then options outstanding on such date shall thereafter continue to have force and effect in accordance with the provisions of the instruments evidencing such options. Section 8.3 - Effective Date of Plan - ------------ ------------------------- (a) The Plan was initially adopted by the Board on April 25, 1984, and approved by the Company's stockholders on May 22, 1984. On November 9, 1992, the Board approved a restatement of the Plan, effective as of such date, to (i) increase the number of shares of Common Stock reserved for issuance under the Plan by an additional 450,000 shares, (ii) bring the Plan in compliance with the applicable requirements of SEC Rule 16b-3, as amended May 1, 1991, under the 1934 Act, (iii) revise the Incentive Stock Option provisions of the Plan to conform to applicable changes in the federal tax laws, (iv) establish the Automatic Option Grant Program for non-Employee Board members and (v) extend the term of the Plan to December 31, 2002. The November 1992 restatement was approved by the Company's stockholders on May 26, 1993. On February 7, 1997, the Board approved an Amendment to the Plan, effective as of such date, to (i) increase the number of shares of Common Stock reserved for issuance under the Plan by an additional 500,000 shares, and (ii) extend the term of the Plan to December 31, 2006. The February 1997 Amendment will be submitted to stockholder approval at the 1997 Annual Meeting and no options granted on the basis of the 500,000 share increase shall become exercisable in whole or in part unless and until such stockholder approval shall have been obtained at the 1997 Annual Meeting. The November 1992 restatement shall apply only to options granted under the Plan from and after the November 9, 1992, effective date. Each option issued and outstanding under the Plan immediately prior to such effective date shall continue to be governed by the terms and conditions of the Plan (and the instrument evidencing such option) as in effect on the date such option was previously granted, and nothing in the November 1992 restatement shall be deemed to affect or otherwise modify the rights or obligations of the holders of such options with respect to the acquisition of shares of Common Stock thereunder. - 18 - (b) The sale and remittance procedure for the exercise of outstanding options shall be available for all options granted under the Plan after November 9, 1992, and for all Non-Qualified Stock Options outstanding under the Plan on such date. The Plan Administrator may also allow such procedure to be utilized in connection with one or more disqualifying dispositions of Incentive Stock Option shares effected after such date. (c) Options may be granted under this Plan to purchase shares of Common Stock in excess of the number of shares then available for issuance under the Plan, provided (i) an amendment to increase the maximum number of shares issuable under the Plan is adopted by the Board prior to the initial grant of any such option and is thereafter submitted to the Company's stockholders for approval and (ii) each option so granted is not to become exercisable, in whole or in part, at any time prior to the obtaining of such stockholder approval. Section 8.4 - Effect of Plan Upon Other Options and Compensation Plans - ------------ --------------------------------------------------------------- The adoption of this Plan shall not affect any other compensation or incentive plans in effect for the Company or any Parent or Subsidiary corporation. Nothing in this Plan shall be construed to limit the right of the Company or any Parent or Subsidiary corporation (a) to establish any other forms of incentives or compensation for employees of the Company or any Parent or Subsidiary corporation or (b) to grant or assume options otherwise than under this Plan in connection with any proper corporate purpose, including, but not by way of limitation, the grant or assumption of options in connection with the acquisition by purchase, lease, merger, consolidation or otherwise, of the business, stock or assets of any corporation, firm or association. Section 8.5 - Titles - ------------ ------ Titles are provided herein for convenience only and are not to serve as a basis for interpretation or construction of the Plan. We hereby certify that the above Amended and Restated Stock Option Plan of the Company, was duly adopted by the Board of Directors and the Stockholders of the Company as of January 15, 2002, and May 30, 2002, respectively. Executed at Aliso Viejo, California on May 30, 2002. /s/James E. Buncher /s/ Ronald I. Brendzel - ---------------------------------------- ------------------------------- JAMES E. BUNCHER RONALD I. BRENDZEL President and Chief Executive Officer Senior Vice President and Secretary - 19 - EX-10.33 6 doc5.txt EXHIBIT 10.33 AMENDMENT TO RESTATED CERTIFICATE OF INCORPORATION OF SAFEGUARD HEALTH ENTERPRISES, INC. The Corporation was originally incorporated in Delaware under the name "SFGD Reincorporation Company" on April 27, 1987, and the Restated Certificate of Incorporation was duly adopted in accordance with Section 245 and 242 of the General Corporation Law of Delaware on October 25, 2000. The Corporation hereby amends the first paragraph of Article Fourth of the Restated Certificate of Incorporation so that the first paragraph of Article Fourth reads as follow: "FOURTH. The total number of shares of stock that the corporation shall have authority to issue is Seventy-Three Million Five Hundred Thousand (73,500,000), of which Forty-Two Million Five Hundred Thousand (42,500,000) shares are Common Stock, one cent ($.01) par value per share, and Thirty-One Million (31,000,000) shares are Preferred Stock, one cent ($.01) par value per share." All other terms of the Company's Restated Certificate of Incorporation dated as of October 25, 2000, shall remain the same. We the undersigned do hereby certify that the forgoing is a true and correct Amendment to the Restated Certificate of Incorporation of SafeGuard Health Enterprises, Inc. a Delaware Corporation. Executed as of the 30th day of May 2002 at Aliso Viejo, California. SafeGuard Health Enterprises, Inc. /s/ James E. Buncher - -------------------------------------- By: JAMES E. BUNCHER President and Chief Executive Officer /s/Ronald I. Brendzel - --------------------------------------- By: RONALD I. BRENDZEL Senior Vice President and Secretary -----END PRIVACY-ENHANCED MESSAGE-----