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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
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 (I.R.S. Employer Identification No.)
jurisdiction of incorporation)
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 May 1, 2003, the number of shares of registrant's common stock, par value
$0.01 per share, outstanding was 5,697,962 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 MARCH 31, 2003
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 . . . . . . . . . . . . . . . . . . . . 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . 22
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . 22
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
CERTIFICATIONS BY CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER. . . 25
i
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2003 2002
----------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 4,061 $ 3,036
Investments available-for-sale, at fair value 10,066 9,668
Accounts receivable, net of allowances 2,228 2,554
Other current assets 675 853
----------- --------------
Total current assets 17,030 16,111
Property and equipment, net of accumulated depreciation and amortization 3,360 3,532
Restricted investments available-for-sale, at fair value 3,328 3,254
Notes receivable, net of allowances 447 457
Goodwill 9,289 8,590
Intangible assets, net of accumulated amortization 1,896 2,013
Other assets 147 157
----------- --------------
Total assets $ 35,497 $ 34,114
=========== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,675 $ 1,661
Accrued expenses 4,602 3,526
Current portion of long-term debt and capital lease obligations 2,259 2,430
Claims payable and claims incurred but not reported 4,856 4,690
Deferred premium revenue 2,126 1,786
----------- --------------
Total current liabilities 15,518 14,093
Long-term debt and capital lease obligations 2,545 2,997
Other long-term liabilities 971 1,013
Commitments and contingencies (Note 8)
Stockholders' equity:
Convertible preferred stock and additional paid-in capital 41,250 41,250
Common stock and additional paid-in capital 22,680 22,662
Retained earnings (accumulated deficit) (29,726) (30,170)
Accumulated other comprehensive income 85 95
Treasury stock, at cost (17,826) (17,826)
----------- --------------
Total stockholders' equity 16,463 16,011
----------- --------------
Total liabilities and stockholders' equity $ 35,497 $ 34,114
=========== ==============
See accompanying Notes to Condensed Consolidated Financial Statements.
1
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
2003 2002
-------- --------
Premium revenue, net $21,912 $20,688
Health care services expense 15,093 14,550
Selling, general and administrative expense 6,354 5,839
-------- --------
Operating income 465 299
Investment and other income 79 116
Interest expense (100) (7)
-------- --------
Income before income taxes 444 408
Income tax expense -- --
-------- --------
Net income $ 444 $ 408
======== ========
Basic net income per share $ 0.01 $ 0.01
Weighted-average basic shares outstanding 35,693 34,812
Diluted net income per share $ 0.01 $ 0.01
Weighted-average diluted shares outstanding 35,989 35,568
See accompanying Notes to Condensed Consolidated Financial Statements.
2
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(IN THOUSANDS)
(UNAUDITED)
2003 2002
------- -------
Cash flows from operating activities:
Net income $ 444 $ 408
Adjustments to reconcile net income to net cash
provided by operating activities:
Bad debt expense 39 64
Depreciation and amortization 420 293
Contribution to retirement plan in the form of common stock, at fair value 24 28
Changes in operating assets and liabilities, excluding effects of acquisition:
Accounts receivable 396 406
Other current assets 264 68
Other assets 10 20
Accounts payable (124) (75)
Accrued expenses (244) (225)
Claims payable and claims incurred but not reported 134 (776)
Deferred premium revenue 82 187
------- -------
Net cash provided by operating activities 1,445 398
Cash flows from investing activities:
Purchase of investments available-for-sale (777) (157)
Proceeds from sale/maturity of investments available-for-sale 760 1,600
Purchases of property and equipment (131) (191)
Cash acquired in acquisition of business 287 --
Payments received on notes receivable 10 --
------- -------
Net cash provided by investing activities 149 1,252
Cash flows from financing activities:
Increase (decrease) in bank overdrafts 96 (838)
Payments on debt (623) (63)
Exercise of stock options -- 7
Decrease in other long-term liabilities (42) (7)
------- -------
Net cash used in financing activities (569) (901)
------- -------
Net increase in cash and cash equivalents 1,025 749
Cash and cash equivalents at beginning of period 3,036 1,497
------- -------
Cash and cash equivalents at end of period $4,061 $2,246
======= =======
(Continued on next page)
3
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS -- CONTINUED
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(IN THOUSANDS)
(UNAUDITED)
2003 2002
-------- -----
Supplementary information:
Cash paid during the period for interest $ 102 $ 7
Supplementary disclosure of non-cash activities:
Liabilities assumed in acquisition of business:
Fair value of identifiable assets acquired $ 947 $ --
Goodwill related to transaction 699 --
Less - Liability for purchase price, which was paid in April 2003 (1,100) --
Less - Liability for contingent consideration (176) --
Less - Accrual for acquisition expenses (28) --
-------- -----
Liabilities assumed in acquisition of business $ 342 $ --
======== =====
See accompanying Notes to Condensed Consolidated Financial Statements.
4
SAFEGUARD HEALTH ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 1. GENERAL
- -----------------
The accompanying unaudited condensed consolidated financial statements of
SafeGuard Health Enterprises, Inc. and subsidiaries (the "Company") as of March
31, 2003, and for the three months ended March 31, 2003 and 2002, 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
condensed consolidated financial statements should be read in conjunction with
the Company's Annual Report on Form 10-K for the year ended December 31, 2002,
which includes the Company's Consolidated Financial Statements and Notes thereto
for that period.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES ANDRECENTLY ADOPTED ACCOUNTING
- -----------------------------------------------------------------------------
PRINCIPLES
- ----------
GOODWILL
The Company's accounting for goodwill is in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets," which the Company adopted as of January 1, 2002. Goodwill as of March
31, 2003 consists of $4.7 million of goodwill related to the acquisition of
Paramount Dental Plan, Inc. ("Paramount") in August 2002, $3.9 million of
goodwill related to the acquisition of a Texas-based dental health maintenance
organization ("HMO") company in 1996, and $0.7 million of goodwill related to
the acquisition of Ameritas Managed Dental Plan, Inc. ("Ameritas") in March
2003. See Note 3 for more information on the Paramount and Ameritas
acquisitions. 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 an
adjustment in 1999 to reduce the carrying value of the goodwill to its estimated
realizable value. The Company has not yet completed its determination of whether
the assets acquired in the Ameritas acquisition in March 2003 include any
separately identifiable intangible assets apart from goodwill. Accordingly, the
entire excess of the purchase price over the net tangible assets acquired has
been classified as goodwill, pending completion of this determination.
SFAS No. 142 requires that goodwill be evaluated for possible impairment on an
annual basis and any time an event occurs that may have affected the value of
the goodwill. The Company has established October 1 as the date on which it
conducts its annual evaluation of goodwill for possible impairment. In
accordance with SFAS No. 142, the Company tested its goodwill for possible
impairment by estimating the fair value of each of its reporting units that
include goodwill, and comparing the fair value of each reporting unit to the
book value of the net assets of each reporting unit. The fair value of each
reporting unit was determined primarily by estimating the discounted future cash
flows of the reporting unit, and by estimating the amount for which the
reporting unit could be sold to a third party, based on a market multiple of
earnings. The Company had no impairment of its goodwill as of October 1, 2002,
based on the method of testing for possible impairment established by SFAS No.
142. The estimates to which the results of the Company's test are the most
sensitive are the amount of shared administrative expenses that are charged to
each reporting unit, and the market multiple of earnings that is used to
estimate the fair value of each reporting unit. The Company believes the
estimates used in its test are reasonable and appropriate, but a significant
change in either of these estimates could result in the indication of an
impairment of goodwill. The Company is not aware of any events that have
occurred since October 1, 2002, that represent an indication of a possible
impairment.
5
Changes in the carrying amount of goodwill during the three months ended March
31, 2003 were as follows (in thousands):
Balance at December 31, 2002 $8,590
Goodwill acquired (see Note 3) 699
------
Balance at March 31, 2003 $9,289
======
INTANGIBLE ASSETS
Intangible assets as of March 31, 2003 consist of customer relationships and
other intangible assets with an aggregate net book value of $1.9 million, all of
which were acquired in connection with the acquisition of Paramount in August
2002, as discussed in Note 3. The amount of the purchase price that was
allocated to each of the intangible assets was equal to the Company's estimate
of the fair value of each asset. Each intangible asset is being amortized over
its estimated useful life on a straight-line basis.
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, the recent trend
in payment rates, and the recent trend in 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.
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 condensed
consolidated balance sheet as deferred premium revenue.
STOCK-BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," provides a choice of
two different methods of accounting for stock options granted to employees. SFAS
No. 123 encourages, but does not require, entities to recognize compensation
expense equal to the fair value of employee stock options granted. Under this
method of accounting, the fair value of a stock option is measured at the grant
date, and compensation expense is recognized over the period during which the
stock option becomes exercisable. Alternatively, an entity may choose to use the
accounting method described in Accounting Principles Board Opinion ("APB") No.
25, "Accounting for Stock Issued to Employees." Under APB No. 25, no
compensation expense is generally recognized as long as the exercise price of
each stock option is at least equal to the market price of the underlying stock
at the time of the grant. If an entity chooses to use the accounting method
described in APB No. 25, SFAS No. 123 requires that the pro forma effect of
using the fair value method of accounting on its net income be disclosed in a
note to the financial statements.
The Company has chosen to use the accounting method described in APB No. 25. All
stock options granted by the Company have an exercise price equal to the market
value of the Company's common stock on the date of grant and accordingly, there
is no employee compensation expense related to stock options reflected in the
accompanying condensed consolidated statements of operations. Stock options
granted generally become exercisable in equal annual installments over a
three-year period after the date of grant.
6
The following table shows the pro forma effect of using the fair value method of
accounting for stock options, as described by SFAS No. 123, on the Company's net
income and net income per share (in thousands, except per share amounts):
THREE MONTHS ENDED
MARCH 31,
---------- ----------
2003 2002
---------- ----------
Net income, as reported $ 444 $ 408
Less - Employee compensation expense based on the fair value
method of accounting for stock options, net of
applicable tax effect (161) (214)
---------- ----------
Pro forma net income $ 283 $ 194
========== ==========
Basic net income per share, as reported $ 0.01 $ 0.01
Pro forma basic net income per share 0.01 0.01
Diluted net income per share, as reported $ 0.01 $ 0.01
Pro forma diluted net income per share 0.01 0.01
SFAS No. 123 requires a publicly traded entity to estimate the fair value of
stock-based compensation by using an option-pricing model that takes into
account certain facts and assumptions. The facts and assumptions that must be
taken into account are the exercise price, the expected life of the option, the
current stock price, the expected volatility of the stock price, the expected
dividends on the stock, and the risk-free interest rate. The option-pricing
models commonly used were developed to estimate the fair value of freely
tradable, fully transferable options without vesting restrictions, which
significantly differ from the stock options granted by the Company. The Company
estimates the fair value of stock options by using the Black-Scholes
option-pricing model.
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
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 ended March 31, 2003 and 2002, the potentially dilutive
securities outstanding consisted of stock options and convertible notes. Diluted
net income per share 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. Each
of these convertible notes would have an anti-dilutive effect on net income per
share for the three-months ended March 31, 2003. Accordingly, the convertible
notes are excluded from the calculation of diluted net income per share. As of
March 31, 2003, these two convertible notes were convertible into an aggregate
of 2,381,000 shares of common stock.
7
The differences between weighted-average basic shares outstanding and
weighted-average diluted shares outstanding are as follows (in thousands):
THREE MONTHS ENDED
MARCH 31,
--------------------
2003 2002
--------- ---------
Weighted-average basic shares outstanding 35,693 34,812
Effect of dilutive stock options 296 756
--------- ---------
Weighted-average diluted shares outstanding 35,989 35,568
========= =========
RECENTLY ADOPTED ACCOUNTING PRINCIPLES
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement Nos.
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 any related income tax effect. As a result, the
criteria in APB No. 30 is now used to classify those gains and losses. SFAS No.
44 has been rescinded, as it is no longer necessary. SFAS No. 64 amended SFAS
No. 4 and is no longer necessary, as SFAS No. 4 has been rescinded. 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-leaseback transactions, and to require that the fair
value of a lease guarantee be recorded as a liability on the guarantor's balance
sheet for all guarantees issued after May 15, 2002. 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. SFAS No. 145 is generally effective for financial
statements issued after May 15, 2002. The adoption of SFAS No. 145 had no
significant effect on the Company's consolidated 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. The adoption of SFAS No.
146 had no significant effect on the Company's consolidated financial
statements.
In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 is an interpretation of
FASB Statement Nos. 5, 57, and 107, and a rescission of FIN No. 34, "Disclosure
of Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a
guarantor recognize a liability for the fair value of certain types of
guarantees, at the time the guarantee is initially made. It also elaborates on
the financial statement disclosures to be made by a guarantor about its
obligations under certain types of guarantees. The initial recognition and
measurement provisions of this interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements for periods ending after
December 15, 2002. The adoption of FIN 45 had no significant effect on the
Company's consolidated financial statements.
In December 2002, the FASB Issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which is an amendment of SFAS No.
123. SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. It also requires prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. SFAS No.
8
148 is effective for fiscal years ending after December 15, 2002. The adoption
of SFAS No. 148 had no significant effect on the Company's consolidated
financial statements.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities," an interpretation of Accounting Research Bulletin No. 51. FIN 46
requires that variable interest entities be consolidated by the investing
company if the investing company is obligated to absorb a majority of the losses
incurred by the variable interest entity, or is entitled to receive a majority
of the profits earned by the entity, or both. FIN 46 also requires disclosures
about significant variable interests in entities that don't meet the criteria
for consolidation. The consolidation requirements of FIN 46 are effective for
all periods with respect to variable interest entities created after January 31,
2003. The consolidation requirements with respect to variable interest entities
created prior to February 1, 2003 are effective for periods beginning after June
15, 2003. The disclosure requirements are effective for all financial
statements issued after January 31, 2003. The Company had no variable interest
entities as of March 31, 2003, and the adoption of FIN 46 had no significant
effect on its consolidated financial statements.
NOTE 3. ACQUISITIONS
- ----------------------
Effective August 30, 2002, the Company acquired all of the outstanding capital
stock of Paramount Dental Plan, Inc. ("Paramount") for an aggregate cost of
approximately $6.8 million, including acquisition expenses. Paramount was a
dental benefits company located in Florida and was merged into the Company's
Florida dental HMO subsidiary effective August 30, 2002. 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.
The operations of Paramount are included in the Company's 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 for the three months ended March 31, 2002, as if
the acquisition had been completed as of the beginning of that period (in
thousands):
Premium revenue, net $22,611
Operating income 397
Net income 364
Basic net income per share $ 0.01
Diluted net income per share 0.01
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 date indicated, or the results that may occur in any
future period.
Effective March 31, 2003, the Company acquired all of the outstanding capital
stock of Ameritas Managed Dental Plan, Inc. ("Ameritas") for a purchase price of
$1.1 million in cash, plus contingent quarterly payments during the five years
following the acquisition date. Each contingent quarterly payment is equal to
10% of the actual premium revenue during the quarter from customers of Ameritas
that existed as of March 31, 2003. The Company recorded a $176,000 liability as
of March 31, 2003, for the estimated contingent quarterly payments related to
the remaining portion of annual customer contracts that are in force as of April
1, 2003. The Company intends to accrue additional portions of the contingent
purchase price in the future, if and when the payment of such amounts becomes
probable, based on the renewal of existing customer contracts. Ameritas had
premium revenue of $3.7 million during the year ended December 31, 2002, and
accordingly, the maximum aggregate amount of the contingent quarterly payments
over the five-year period would be approximately $1.8 million, if the Company
retained all of the existing customers of Ameritas for five years after the
acquisition date at the premium rates in effect during 2002.
Ameritas is a dental benefits company located in California. The business
purpose of the acquisition was to increase the Company's market penetration in
California, which is one of the Company's primary geographic markets. The
acquisition increased the number of members in California for which the Company
provides dental benefits from approximately 300,000 members to approximately
330,000 members.
9
The aggregate purchase price recorded by the Company as of March 31, 2003,
including the amount paid at closing and the estimated liability for contingent
quarterly payments, is approximately $1.3 million. The cost of the acquisition
was allocated among the assets acquired as follows (in thousands):
Fair value of net assets acquired:
Cash and cash equivalents $ 287
Investments 465
Goodwill 699
Other assets 195
Accounts payable and accrued liabilities (84)
Deferred premium revenue (258)
-------
Total cost of acquisition $1,304
=======
The Company has not yet completed its determination of whether the assets
acquired include separately identifiable intangible assets apart from goodwill.
Accordingly, the excess of the purchase price over the net tangible assets
acquired has been classified as goodwill, pending completion of this
determination. The operations of Ameritas will be included in the Company's
consolidated financial statements beginning on April 1, 2003.
NOTE 4. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
- -----------------------------------------------------------
Long-term debt and capital lease obligations consisted of the following (in
thousands):
MARCH 31, DECEMBER 31,
2003 2002
----------- --------------
Secured convertible promissory note $ 2,226 $ 2,427
Unsecured convertible promissory note 1,643 1,798
Capital lease obligations 935 1,202
----------- --------------
Total debt and capital lease obligations 4,804 5,427
Less - Current portion (2,259) (2,430)
----------- --------------
Long-term debt and capital lease obligations $ 2,545 $ 2,997
=========== ==============
Effective in August 2002, the Company issued a secured convertible promissory
note for $2,625,000 in connection with the acquisition of Paramount, which is
discussed in Note 3. The 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.
In August 2002, the Company borrowed $2.0 million from one of its principal
stockholders under an unsecured convertible promissory note. The note 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 unsecured 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.
The outstanding capital lease obligations consist primarily of two leases
entered into by the Company in June 2002. Those two leases are related to the
purchase of an updated version of the Company's primary 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 March 31, 2003. Under
each of these 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. 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. All references to the convertible preferred stock in the
accompanying condensed consolidated financial statements reflect the effects of
this exchange on a retroactive basis.
NOTE 6. 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 assets and liabilities 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 assets and liabilities 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 large losses incurred by the
Company during 1998, 1999 and 2000, relative to the amounts of income earned by
the Company during 2001, 2002 and the first quarter of 2003, as well as the
existence of significant net operating loss carryforwards.
Due to the conversion of outstanding debt into convertible preferred stock in
January 2001, 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 pre-existing 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, 2002, the Company had net operating loss carryforwards for federal
and California state tax purposes of approximately $9.8 million and $5.2
million, respectively, which are net of the amounts that will expire unused due
to the change of control limitation. The federal and California state net
operating loss carryforwards will begin to expire in 2018 and 2004,
respectively.
The Company had taxable income for federal income tax purposes for the three
months ended March 31, 2003 and 2002, but its taxable income in both periods was
completely offset by net operating loss carryforwards from previous years. The
State of California has suspended the use of net operating loss carryforwards to
offset current taxable income in 2003 for all corporations. The Company had a
net loss for California state tax purposes during the three months ended March
31, 2003.
NOTE 7. TOTAL COMPREHENSIVE INCOME
- --------------------------------------
Total comprehensive income includes the change in stockholders' equity during
the period from transactions and other events and circumstances from
non-stockholder sources. Total comprehensive income of the Company for the
three months ended March 31, 2003 and 2002, 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 $(10,000) and $(36,000) for the
three months ended March 31, 2003 and 2002, respectively. Total comprehensive
income was $434,000 and $372,000 for the three months ended March 31, 2003 and
2002, respectively.
11
NOTE 8. 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.
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 all of the practices sold by the Company either have been assigned to the
respective purchasers of the practices, or have expired.
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 March 31, 2003, the total of the minimum annual payments under
these leases was approximately $1.3 million, and the aggregate contingent
liability of the Company related to these leases was approximately $2.9 million
over the remaining terms of the lease agreements, which expire at various dates
through 2007. In the event that the parties to which these lease agreements have
been assigned defaulted on the leases, the aggregate contingent liability of
approximately $2.9 million could be mitigated by the Company by subleasing the
related office space to other parties, although there can be no assurance it
would be able to do so. The Company 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 $2.9 million excludes
$85,000 of estimated lease obligations that have been accrued as of March 31,
2003, 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."
GUARANTEES AND INDEMNITIES
As discussed above, the Company has contingent lease obligations under which it
is secondarily liable for the lease payments under dental office leases that
have been assigned to third parties. In the event those third parties fail to
make the lease payments, the Company could be obligated to make the lease
payments itself. The Company has also purchased a letter of credit for $250,000
in connection with a certain customer agreement. In the event the Company fails
to meet its financial obligations to the customer, the customer would be able to
use the letter of credit to satisfy the Company's obligations, in which case the
Company would be obligated to repay the issuer of the letter of credit. The
Company also indemnifies its directors and officers to the maximum extent
permitted by Delaware law. In addition, the Company makes indemnities to its
customers in connection with the sale of dental and vision benefit plans in the
ordinary course of business. The maximum amount of potential future payments
under all of the preceding guarantees and indemnities cannot be determined. The
Company has recorded no liabilities related to these guarantees and indemnities
in the accompanying consolidated balance sheets, except as described above under
"Contingent Lease Obligations." The Company issued no guarantees during the
three months ended March 31, 2003.
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.
GOVERNMENT REGULATION
As of March 31, 2003, one of the Company's subsidiaries, which had an
insignificant amount of revenue during the three months ended March 31, 2003 and
2002, was not in compliance with the applicable regulatory net worth
12
requirement. The Company has not invested the required funds in this subsidiary
because the Company is in the process of closing that subsidiary's business, and
the Company has received a waiver of compliance from the applicable regulatory
agency. During the three months ended March 31, 2003 and 2002, another of the
Company's subsidiaries was not in compliance with a regulatory requirement that
limits the amount of the subsidiary's administrative expenses as a percentage of
premium revenue. The Company has discussed this noncompliance with the
applicable regulatory agency, and that agency has taken no action with respect
to this noncompliance. The Company believes these two instances of noncompliance
with regulatory requirements will have no significant effect on its consolidated
financial statements.
NOTE 9. SUBSEQUENT EVENTS
- ----------------------------
On April 7, 2003, the Company entered into a definitive agreement to purchase
all of the outstanding capital stock of Health Net Dental, Inc. ("HN Dental")
and certain group dental insurance business underwritten by Health Net Life
Insurance Company ("HN Life"), which is an affiliate of HN Dental, for $9.0
million in cash, subject to regulatory approval. HN Dental is a California
dental HMO, which had premium revenue of approximately $46 million during the
year ended December 31, 2002. In addition, the group dental insurance business
being acquired generated premium revenue of approximately $14 million during the
year ended December 31, 2002. The transaction is currently pending regulatory
approval.
On April 7, 2003, the Company also entered into a binding letter of intent to
purchase all of the outstanding capital stock of Health Net Vision, Inc. ("HN
Vision"), which is an affiliate of HN Dental, and certain group vision insurance
business underwritten by HN Life, for $3.0 million in cash, subject to
regulatory approval. A substantial portion of the business of HN Vision will be
transferred to a third party prior to the Company's acquisition of HN Vision,
and the remainder of the business of HN Vision will be transferred to the
Company. HN Vision is a California vision HMO, and the portion of its business
that is being acquired by the Company generated premium revenue of approximately
$5 million during the year ended December 31, 2002. In addition, the group
vision insurance business being acquired generated premium revenue of
approximately $1 million during the year ended December 31, 2002. The
transaction is currently pending negotiation of definitive agreements and
regulatory approval.
The Company plans to finance the two transactions described above through the
issuance of up to approximately $18 million of unsecured convertible promissory
notes to certain of its principal stockholders. The proceeds from the
convertible notes will be used to finance the two pending transactions described
above, to increase the net worth of the Company's insurance subsidiary to
support the group dental and vision insurance business to be acquired, and to
provide working capital that may be required in connection with the integration
of the acquired businesses into the Company's existing operations.
The Company has reached an oral agreement with the principal stockholders
referred to above, regarding the expected terms of the convertible notes. In
accordance with this agreement, the convertible notes will bear interest at 6.0%
annually, and will be convertible into the Company's common stock at the rate of
$1.75 per share, at the option of the holder. There will be no principal
payments due under the convertible notes during the first six years after
issuance, principal payments will be due during the succeeding four years
pursuant to a ten-year amortization schedule, and the remaining balance will be
payable in full ten years after the date of issuance. The convertible notes will
be payable in full upon a change in control of the Company, at the holder's
option. Provided that the Company redeems all of the outstanding convertible
notes at the same time, it will have the option of redeeming the convertible
notes for 229% of the face value of the notes during the first seven years after
the date of issuance, for 257% of the face value during the eighth year after
issuance, for 286% of the face value during the ninth year after issuance, and
for 323% of the face value during the tenth year after issuance. The issuance of
the convertible notes is currently pending negotiation of definitive agreements
and the completion of the acquisitions described above.
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
13
identifying important factors that could cause actual results to differ
materially from those discussed in the statements. The Company desires to take
advantage of these safe harbor provisions. The following risk factors, as well
as the risk factors identified in the Company's Annual Report on Form 10-K for
the year ended December 31, 2002, and the Company's Current Reports on Form 8-K
filed on February 14, 2003, April 3, 2003, April 25, 2003, and May 5, 2003, all
of which have been filed with the Securities and Exchange Commission, should be
read in conjunction with this Management's Discussion and Analysis of Financial
Condition and Results of Operations ("MD&A").
The statements contained in this MD&A 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.
All of the risks set forth below 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, the amount
of health care expenses incurred, and profitability, and therefore, affect the
forward-looking statements which may be included in this report. In addition,
past financial performance is not necessarily a reliable indicator of future
performance. An investor should not use historical performance alone to
anticipate future results or future period trends for the Company.
RISK FACTORS
The Company's business and competitive environment include 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.
INTEGRATION OF ACQUIRED COMPANIES
The Company completed the acquisition of Paramount Dental Plan, Inc.
("Paramount") effective on August 30, 2002, and the acquisition of Ameritas
Managed Dental Plan, Inc. ("Ameritas") effective on March 31, 2003. The Company
is in the process of integrating the business operations of both Paramount and
Ameritas into the Company's pre-existing 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 effective manner. In such
case, the Company may not be able to retain all of the customers of the acquired
companies, resulting in a loss of revenue, and the Company's general and
administrative expenses could be higher than expected, which could have a
negative impact on the Company's overall profitability.
GOVERNMENT REGULATION
The dental benefits industry is subject to extensive state and local laws, rules
and regulations. Several of the Company's operating subsidiaries 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, and these requirements 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.
14
HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 ("HIPAA")
HIPAA imposes various responsibilities on the Company, which are primarily
related to protecting confidential information related to its subscribers and
their dependents. 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 March 31, 2003, the Company
is contingently liable for an aggregate of approximately $2.9 million of office
lease obligations related to those practices for which the leases have been
assigned. Although 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.
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.
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 combined premium revenue of the Company and Paramount decreased from $22.6
million on a pro forma basis during the three months ended March 31, 2002, to
$21.9 million during the comparable period in 2003, primarily due to the loss of
a number of customers, and a net decrease in the 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
15
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 maintain its relationships with existing customers
and brokers, 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 dental PPO/indemnity plan designs, the Company assumes the
underwriting risk related to the frequency and cost of dental services provided
to the covered individuals. 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.
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.
CRITICAL 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 condensed consolidated financial statements. The
Company believes the most critical accounting policies used to prepare the
accompanying condensed consolidated financial statements are the following:
ACCOUNTS RECEIVABLE
Accounts receivable represent uncollected premiums related to coverage periods
prior to the balance sheet date, and are stated at the estimated collectible
amounts, net of an allowance for bad debts. The Company continuously monitors
the timing and amount of its premium collections, and maintains a reserve for
estimated bad debt losses. The amount of the reserve is based primarily on the
Company's historical experience and any customer-specific collection issues that
are identified. The Company believes its reserve for bad debt losses is adequate
as of March 31, 2003. However, there can be no assurance that the bad debt
losses ultimately incurred will not exceed the reserve for bad debts established
by the Company.
16
NOTES RECEIVABLE
Notes receivable are stated at their estimated realizable values, net of an
allowance for bad debts. The Company continuously monitors its collection of
payments on the notes receivable, and maintains a reserve for estimated bad debt
losses. The amount of the reserve is based primarily on the Company's historical
experience in collecting similar notes receivable that are no longer
outstanding, and any available information about the financial condition of the
note issuers, although the Company has access to very little such information.
The Company believes its reserve for bad debt losses is adequate as of March 31,
2003. However, there can be no assurance that the Company will realize the
carrying amount of its notes receivable.
GOODWILL
The Company's accounting for goodwill is in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets," which the Company adopted as of January 1, 2002. Goodwill as of March
31, 2003 consists of $4.7 million of goodwill related to the acquisition of
Paramount Dental Plan, Inc. ("Paramount") in August 2002, $3.9 million of
goodwill related to the acquisition of a Texas-based dental health maintenance
organization ("HMO") company in 1996, and $0.7 million of goodwill related to
the acquisition of Ameritas Managed Dental Plan, Inc. ("Ameritas") in March
2003. See Note 3 to the accompanying condensed consolidated financial statements
for more information on the Paramount and Ameritas acquisitions. 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 an adjustment in 1999 to reduce the
carrying value of the goodwill to its estimated realizable value. The Company
has not yet completed its determination of whether the assets acquired in the
Ameritas acquisition in March 2003 include any separately identifiable
intangible assets apart from goodwill. Accordingly, the entire excess of the
purchase price over the net tangible assets acquired has been classified as
goodwill, pending completion of this determination.
SFAS No. 142 requires that goodwill be evaluated for possible impairment on an
annual basis and any time an event occurs that may have affected the value of
the goodwill. The Company has established October 1 as the date on which it
conducts its annual evaluation of goodwill for possible impairment. In
accordance with SFAS No. 142, the Company tested its goodwill for possible
impairment by estimating the fair value of each of its reporting units that
include goodwill, and comparing the fair value of each reporting unit to the
book value of the net assets of each reporting unit. The fair value of each
reporting unit was determined primarily by estimating the discounted future cash
flows of the reporting unit, and by estimating the amount for which the
reporting unit could be sold to a third party, based on a market multiple of
earnings. The Company had no impairment of its goodwill as of October 1, 2002,
based on the method of testing for possible impairment established by SFAS No.
142. The estimates to which the results of the Company's test are the most
sensitive are the amounts of shared administrative expenses that are charged to
each reporting unit, and the market multiple of earnings that is used to
estimate the fair value of each reporting unit. The Company believes the
estimates used in its test are reasonable and appropriate, but a significant
change in either of these estimates could result in the indication of an
impairment of goodwill. The Company is not aware of any events that have
occurred since October 1, 2002, that represent an indication of a possible
impairment. However, there can be no assurance that impairment will not occur in
the future.
INTANGIBLE ASSETS
Intangible assets as of March 31, 2003 consist of customer relationships and
other intangible assets with an aggregate net book value of $1.9 million, all of
which were acquired in connection with the acquisition of Paramount in August
2002, as discussed in Note 3 to the accompanying condensed consolidated
financial statements. The amount of the purchase price that was allocated to
each of the intangible assets was equal to the Company's estimate of the fair
value of each asset. Each intangible asset is being amortized over its estimated
useful life on a straight-line basis.
CLAIMS PAYABLE AND CLAIMS INCURRED BUT NOT REPORTED
The estimated liability for claims payable and claims incurred but not reported
("IBNR") 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
17
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.
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 condensed
consolidated balance sheet as deferred premium revenue.
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 assets and liabilities 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 assets and liabilities 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 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 March 31,
2003, 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
MARCH 31,
----------------------
2003 2002
---------- ----------
Premium revenue, net 100.0% 100.0%
Health care services expense 68.9 70.3
Selling, general and administrative expense 29.0 28.2
---------- ----------
Operating income 2.1 1.5
Investment and other income 0.4 0.5
Interest expense (0.5) --
---------- ----------
Income before income taxes 2.0 2.0
Income tax expense -- --
---------- ----------
Net income 2.0% 2.0%
========== ==========
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Premium revenue increased by $1.2 million, or 5.9%, from $20.7 million in 2002
to $21.9 million in 2003. The average membership for which the Company provided
dental coverage increased by approximately 185,000 members, or 33.5%, from
552,000 members during 2002 to 737,000 members during 2003. The operations of
Paramount are included in the Company's financial statements beginning on
September 1, 2002. Average membership increased in 2003 by approximately 220,000
members due to the Paramount acquisition, but this increase was partially offset
18
by the loss of a number of the Company's customers, and a net decrease in its
enrollment within retained customers. The Company believes the net decrease in
its enrollment within retained customers is primarily due to reduced employment
levels within its customers due to general economic conditions, and to reduced
enrollment in the Company's dental benefit plans due to significant increases in
the cost of medical coverage, which may cause employers and employees to
allocate less spending for the purchase of dental coverage, which is usually
viewed as being more discretionary than medical coverage. Premium revenue
increased by only 5.9% even though average membership increased 33.5%. This was
primarily due to the Paramount acquisition, as the business acquired from
Paramount consists largely of products that have significantly lower premium
rates than the Company's pre-existing business. This is because the dental plan
designs offered by Paramount 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 2003 and 2002. Premium revenue from vision benefit plans
and other products was not material in 2003 or 2002.
Health care services expense increased by $0.5 million, or 3.7%, from $14.6
million in 2002 to $15.1 million in 2003. Health care services expense as a
percentage of premium revenue (the "loss ratio") decreased from 70.3% in 2002 to
68.9% in 2003, primarily due to the Paramount acquisition. The business acquired
from Paramount has a significantly lower loss ratio than the Company's
pre-existing business, which is primarily due to the type of benefit plan
designs sold by Paramount. The loss ratios in the Company's pre-existing
business were substantially the same in 2003 and 2002.
Selling, general and administrative ("SG&A") expense increased by $0.5 million,
or 8.8%, from $5.8 million in 2002 to $6.3 million in 2003. SG&A expense as a
percentage of premium revenue increased from 28.2% in 2002 to 29.0% in 2003.
The increase in SG&A expense is primarily due to increases in selling expenses
and amortization expense. The increase in selling expenses includes modest
increases in salaries, internal commissions, sales consultant costs, and broker
commissions, which are primarily related to the Company's efforts to increase
its new sales activity. The increase in amortization expense is primarily due to
$117,000 of amortization expense related to the intangible assets acquired in
connection with the Paramount acquisition in August 2002.
Investment and other income decreased from $116,000 in 2002 to $79,000 in 2003,
which was primarily due to a decrease in the amount of investments held by the
Company, compared to the first quarter of 2002, a decrease in interest rates on
short-term fixed-income investments, and a decrease in interest income from
notes receivable.
Income before income taxes was $0.4 million, and 2.0% of premium revenue, in
both 2003 and 2002. The decrease in the loss ratio from 70.3% in 2002 to 68.9%
in 2003 was offset by an increase in SG&A expense as a percentage of premium
revenue from 28.2% in 2002 to 29.0% in 2003, as discussed above.
LIQUIDITY AND CAPITAL RESOURCES
The Company's net working capital decreased from $2.0 million as of December 31,
2002, to $1.5 million as of March 31, 2003, primarily due to the acquisition of
Ameritas in March 2003, as discussed in Note 3 to the accompanying condensed
consolidated financial statements. The Ameritas acquisition decreased working
capital by a net amount of $0.7 million, which represents the goodwill acquired
in the transaction. The Company made $0.6 million of payments on debt during the
quarter ended March 31, 2003, but this was offset by the total of net income
plus depreciation and amortization, which was $0.8 million during the quarter.
The Company's total debt decreased from $5.4 million as of December 31, 2002, to
$4.8 million as of March 31, 2003, primarily due to payments made during the
first quarter of 2003, as noted above. The aggregate principal payments due
under all of the Company's debt, including its capital leases, are $1.8 million
during the remainder of 2003, $1.8 million in 2004, and $1.2 million 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 capital lease obligations entered
into in June 2002, as discussed in Note 4 to the accompanying condensed
consolidated financial statements, and to provide for the payments due under the
settlement of the stockholder litigation. 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
19
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 for a total cost of approximately $6.8 million, consisting of
$3.0 million in cash, a secured convertible note for $2,625,000, 769,231 shares
of the Company's common stock, and $164,000 of transaction expenses. 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 Company's consolidated financial statements beginning on
September 1, 2002.
Effective March 31, 2003, the Company acquired all of the outstanding capital
stock of Ameritas for a purchase price of $1.1 million in cash, plus contingent
quarterly payments during the five years following the acquisition date. Each
contingent quarterly payment is equal to 10% of the actual premium revenue
during the quarter from customers of Ameritas that existed as of March 31, 2003.
Ameritas had premium revenue of $3.7 million during the year ended December 31,
2002, and accordingly, the maximum aggregate amount of the contingent quarterly
payments would be approximately $1.8 million, if the Company retained all of the
existing customers of Ameritas for five years after the acquisition date at the
premium rates in effect during 2002. See Note 3 to the accompanying condensed
consolidated financial statements for more information on this acquisition. The
operations of Ameritas will be included in the Company's consolidated financial
statements beginning on April 1, 2003.
On April 7, 2003, the Company entered into a definitive agreement to purchase
all of the outstanding capital stock of Health Net Dental, Inc. ("HN Dental")
and certain group dental insurance business underwritten by Health Net Life
Insurance Company ("HN Life"), which is an affiliate of HN Dental, for $9.0
million in cash, subject to regulatory approval. HN Dental is a California
dental HMO, which had premium revenue of approximately $46 million during the
year ended December 31, 2002. In addition, the group dental insurance business
being acquired generated premium revenue of approximately $14 million during the
year ended December 31, 2002. The transaction is currently pending regulatory
approval.
On April 7, 2003, the Company also entered into a binding letter of intent to
purchase all of the outstanding capital stock of Health Net Vision, Inc. ("HN
Vision"), which is an affiliate of HN Dental, and certain group vision insurance
business underwritten by HN Life, for $3.0 million in cash, subject to
regulatory approval. A substantial portion of the business of HN Vision will be
transferred to a third party prior to the Company's acquisition of HN Vision,
and the remainder of the business of HN Vision will be transferred to the
Company. HN Vision is a California vision HMO, and the portion of its business
that is being acquired by the Company generated premium revenue of approximately
$5 million during the year ended December 31, 2002. In addition, the group
vision insurance business being acquired generated premium revenue of
approximately $1 million during the year ended December 31, 2002. The
transaction is currently pending negotiation of definitive agreements and
regulatory approval.
The Company plans to finance the two transactions described above through the
issuance of up to approximately $18 million of unsecured convertible promissory
notes to certain of its principal stockholders. The proceeds from the
convertible notes will be used to finance the two pending transactions described
above, to increase the net worth of the Company's insurance subsidiary to
support the group dental and vision insurance business to be acquired, and to
provide working capital that may be required in connection with the integration
of the acquired businesses into the Company's existing operations.
The Company has reached an oral agreement with the principal stockholders
referred to above, regarding the expected terms of the convertible notes. In
accordance with this agreement, the convertible notes will bear interest at 6.0%
annually, and will be convertible into the Company's common stock at the rate of
$1.75 per share, at the option of the holder. There will be no principal
payments due under the convertible notes during the first six years after
issuance, principal payments will be due during the succeeding four years
pursuant to a ten-year amortization schedule, and the remaining balance will be
payable in full ten years after the date of issuance. The convertible notes will
be payable in full upon a change in control of the Company, at the holder's
option. Provided that the Company redeems all of the outstanding convertible
notes at the same time, it will have the option of redeeming the convertible
20
notes for 229% of the face value of the notes during the first seven years after
the date of issuance, for 257% of the face value during the eighth year after
issuance, for 286% of the face value during the ninth year after issuance, and
for 323% of the face value during the tenth year after issuance. The issuance of
the convertible notes is currently pending negotiation of definitive agreements
and the completion of the acquisitions described above.
The Company believes it has adequate financial resources to continue its current
operations for the foreseeable future. The Company also believes it will be able
to meet all of its financial obligations from its existing financial resources
and future cash flows from its operations, except for the obligation to complete
the pending acquisitions of HN Dental, HN Vision, and the related dental
insurance and vision insurance businesses. As discussed above, the Company plans
to finance these acquisitions through the issuance of convertible notes to
certain of its principal stockholders. Although the Company believes it can meet
its other financial obligations from its internal resources, 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 increased from $0.4 million during the
three months ended March 31, 2002, to $1.4 million during the first quarter of
2003. The increase is primarily due to $0.1 million of net cash provided by an
increase in claims incurred but not reported ("IBNR") during 2003, compared to
$0.8 million of net cash used by a decrease in claims payable and IBNR in 2002.
The decrease in claims payable and IBNR in 2002 was primarily due to an
intentional decrease in the processing time for payment of provider claims. 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. The reduced processing times
for payment of provider claims have been substantially maintained through the
first quarter of 2003.
Net cash provided by investing activities decreased from $1.3 million in 2002 to
$0.1 million in 2003. The decrease is primarily due to a decrease in the
proceeds from liquidation of investments from $1.6 million in 2002 to $0.8
million in 2003. The liquidation of investments in 2002 was related to the net
cash used to reduce claims payable and IBNR by $0.8 million in 2002, as
discussed above.
Net cash used in financing activities decreased from $0.9 million in 2002 to
$0.6 million in 2003. The Company made $0.6 million of debt payments in 2003,
compared to $0.8 million of net cash used in 2002 to decrease the amount of bank
overdrafts, which are due to outstanding checks not yet presented for payment.
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 March 31, 2003, the
Company's total cash and investments were approximately $13.4 million.
Therefore, a one percentage-point change in short-term interest rates would have
a $134,000 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.
21
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 then in office violated
certain securities laws by issuing alleged false and misleading statements
concerning the Company's publicly reported revenues and earnings during a
specified class period. During 2002 the Company settled the lawsuit for a
payment of $1.25 million to the plaintiffs, without any admission of liability.
The agreement between the Company and the plaintiffs was approved by the
District Court in September 2002, and the matter has been dismissed with
prejudice. 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 was included in selling, general and
administrative expenses.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
None.
(b) REPORTS ON FORM 8-K.
The Company filed a Current Report on Form 8-K on April 3, 2003, to report the
completion of the acquisition of Ameritas Managed Dental Plan, Inc. effective
March 31, 2003. 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 April 25, 2003, to report the
execution of a definitive agreement to purchase all of the outstanding stock of
Health Net Dental, Inc. ("HN Dental") and certain group dental insurance
business underwritten by Health Net Life Insurance Company ("HN Life"), which is
an affiliate of HN Dental, for $9.0 million in cash, subject to regulatory
approval, and to report the execution of a binding letter of intent to purchase
all of the outstanding capital stock of Health Net Vision, Inc. ("HN Vision"),
which is an affiliate of HN Dental, and certain group vision insurance business
underwritten by HN Life, for $3.0 million in cash, subject to regulatory
approval. These transactions are currently pending regulatory approval, and in
the case of the HN Vision transaction, pending negotiation of definitive
agreements. See Note 9 to the accompanying condensed consolidated financial
statements for more information on these transactions.
22
The Company filed a Current Report on Form 8-K on May 5, 2003, to report the
issuance of a news release containing information on the Company's results of
operations for the quarter ended March 31, 2003.
23
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 May 2003.
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 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 MARCH 31, 2003
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 March 31, 2003 (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 May 2003.
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)
25
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 MARCH 31, 2003
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 officer and I am 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 May 2003.
SAFEGUARD HEALTH ENTERPRISES, INC.
By: /s/ James E. Buncher
-----------------------
James E. Buncher
President and Chief Executive Officer
(Principal Executive Officer)
26
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 MARCH 31, 2003
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 am 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 May 2003.
SAFEGUARD HEALTH ENTERPRISES, INC.
By: /s/ Dennis L. Gates
----------------------
Dennis L. Gates
Senior Vice President and Chief Financial Officer
(Chief Accounting Officer)
27