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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 SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 001-15223
OPTICARE HEALTH SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 76-0453392
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
87 GRANDVIEW AVENUE, WATERBURY, CONNECTICUT 06708
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code:
(203) 596-2236
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.
[X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
The number of shares outstanding of the registrant's Common Stock, par
value $.001 per share, at October 31, 2003 was 30,353,542 shares.
INDEX TO FORM 10-Q
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2003 and
December 31, 2002 (unaudited) 3
Condensed Consolidated Statements of Operations for the three and
nine months ended September 30, 2003 and 2002 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 2003 and 2002 (unaudited) 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 25
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURE 25
2
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2003 2002
---------------- -----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $2,233 $3,086
Accounts receivable, net of allowance for doubtful accounts of $1,305 and
$587, at September 30, 2003 and December 31, 2002, respectively. 11,445 5,273
Inventories 6,405 2,000
Deferred income taxes, current - 1,660
Other current assets 598 885
---------------- -----------------
TOTAL CURRENT ASSETS 20,681 12,904
Property and equipment, net 5,232 3,337
Intangible assets, net 1,222 1,353
Goodwill, net 19,534 20,516
Deferred income taxes, non-current - 3,140
Other assets 3,095 3,855
---------------- -----------------
TOTAL ASSETS $ 49,764 $ 45,105
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,820 $ 2,902
Accrued expenses 6,430 5,255
Current portion of long-term debt 426 1,266
Other current liabilities 1,379 1,245
---------------- -----------------
TOTAL CURRENT LIABILITIES 17,055 10,668
---------------- -----------------
Long-term debt--related party - 15,588
Other long-term debt, less current portion 10,284 2,564
Other liabilities 523 615
---------------- -----------------
TOTAL NON-CURRENT LIABILITIES 10,807 18,767
---------------- -----------------
Series B 12.5% voting, mandatorily redeemable, convertible preferred
stock--related party ($5,476 aggregate liquidation preference); 5,000,000
shares authorized (with Series C preferred stock); 3,204,959 shares issued
and outstanding. 5,476 5,018
---------------- -----------------
STOCKHOLDERS' EQUITY:
Series C preferred stock, $0.001 par value ($16,246 aggregate liquidation
preference); 406,158 shares issued and outstanding at September 30,
2003; No shares authorized, issued or outstanding at December 31, 2002. 1 -
Common stock, $0.001 par value; 150,000,000 shares authorized;
30,353,542 and 28,913,990 shares outstanding at September 30, 2003 and
December 31, 2002, respectively. 30 29
Additional paid-in-capital 79,853 63,589
Accumulated deficit (63,458) (52,966)
---------------- -----------------
TOTAL STOCKHOLDERS' EQUITY 16,426 10,652
---------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 49,764 $ 45,105
================ =================
See notes to condensed consolidated financial statements.
3
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- ----------------------------
2003 2002 2003 2002
------------ ----------- ------------ ------------
NET REVENUES:
Managed vision $ 7,118 $ 7,217 $ 22,006 $21,970
Product sales 20,038 9,920 56,961 31,675
Other services 5,438 5,182 16,222 15,486
Other income 352 671 2,720 1,317
------------ ----------- ------------ ------------
Total net revenues 32,946 22,990 97,909 70,448
------------ ----------- ------------ ------------
OPERATING EXPENSES:
Medical claims expense 5,993 5,009 17,250 16,807
Cost of product sales 15,698 7,992 44,251 25,244
Cost of services 2,233 1,855 6,685 6,137
Selling, general and administrative 10,195 6,571 28,925 19,093
Goodwill impairment loss 1,300 - 1,300 -
Depreciation 645 463 1,371 1,402
Amortization 44 45 132 134
Interest 333 769 1,729 2,300
------------ ----------- ------------ ------------
Total operating expenses 36,441 22,704 101,643 71,117
------------ ----------- ------------ ------------
Gain (loss) from early extinguishment of debt - - (1,847) 8,789
------------ ----------- ------------ ------------
Income (loss) from continuing operations before
income taxes (3,495) 286 (5,581) 8,120
Income tax expense 4,984 182 4,911 3,275
------------ ----------- ------------ ------------
Income (loss) from continuing operations (8,479) 104 (10,492) 4,845
Income (loss) from discontinued operations, net of tax - 130 - 313
Loss on disposal of discontinued operations - (153) - (4,092)
------------ ----------- ------------ ------------
Net income (loss) (8,479) 81 (10,492) 1,066
Preferred stock dividends (159) (143) (459) (388)
------------ ----------- ------------ ------------
Net income (loss) available to common stockholders $(8,638) $ (62) $(10,951) $ 678
============ =========== ============ ============
EARNINGS (LOSS) PER SHARE:
Income (loss) per common share from continuing
operations:
Basic $ (0.29) $ (0.01) $ (0.37) $ 0.35
Diluted $ (0.29) $ (0.01) $ (0.37) $ 0.10
Income (loss) per common share from discontinued operations:
Basic - $ (0.00) - $ (0.30)
Diluted - $ (0.00) - $ (0.08)
Net income (loss) per common share:
Basic $ (0.29) $ (0.01) $ (0.37) $ 0.05
Diluted $ (0.29) $ (0.01) $ (0.37) $ 0.02
See notes to condensed consolidated financial statements.
4
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
2003 2002
--------------- --------------
OPERATING ACTIVITIES:
Net income (loss) $ (10,492) $ 1,066
Plus loss from discontinued operations - 3,779
--------------- --------------
Income (loss) from continuing operations (10,492) 4,845
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation 1,371 1,402
Amortization 132 134
Non-cash interest expense 917 1,461
Non-cash settlement income (530) (446)
Non-cash (gain) loss on early extinguishment of debt 1,847 (8,789)
Non-cash goodwill impairment loss 1,300 -
Deferred income taxes 4,800 3,400
Changes in operating assets and liabilities:
Accounts receivable 299 (388)
Inventory 1,327 (341)
Other assets 178 64
Accounts payable and accrued expenses (1,356) (2,796)
Other liabilities 25 (468)
Cash provided by discontinued operations - 992
--------------- --------------
Net cash used in operating activities (182) (930)
INVESTING ACTIVITIES:
Cash received on notes receivable 72 -
Refunds of deposits 775 -
Purchase of assets from acquisition, excluding cash (6,192) -
Purchase of restricted certificates of deposit (600) -
Purchase of fixed assets (850) (507)
Purchase of notes receivable - (1,350)
Net proceeds from sale of discontinued operations - 3,862
--------------- --------------
Net cash (used in) provided by investing activities (6,795) 2,005
--------------- --------------
FINANCING ACTIVITIES:
Net increase (decrease) in revolving credit facility 7,153 (2,180)
Principal payments on long-term debt (912) (24,993)
Principal payments on capital lease obligations (43) (27)
Payment of financing costs (209) (1,445)
Proceeds from issuance of common stock 135 -
Proceeds from issuance of preferred stock - 4,000
Proceeds from long-term debt - 23,474
--------------- --------------
Net cash provided by (used in) financing activities 6,124 (1,171)
--------------- --------------
Decrease in cash and cash equivalents (853) (96)
Cash and cash equivalents at beginning of period 3,086 2,536
--------------- --------------
Cash and cash equivalents at end of period $ 2,233 $ 2,440
=============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 784 $ 1,406
Cash paid for income taxes 76 33
See notes to condensed consolidated financial statements.
5
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands except share data)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of OptiCare
Health Systems, Inc., a Delaware corporation, and its subsidiaries (collectively
the "Company") for the three and nine months ended September 30, 2003 and 2002
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information and the
instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities
Exchange Act of 1934 and are unaudited. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial statements. In
the opinion of management, all adjustments (consisting of only normal recurring
accruals) necessary for a fair presentation of the consolidated financial
statements have been included. The results of operations for the three and nine
months ended September 30, 2003 are not necessarily indicative of the results to
be expected for the full year. The condensed consolidated balance sheet as of
December 31, 2002 was derived from the Company's audited financial statements,
but does not include all disclosures required by accounting principles generally
accepted in the United States of America.
Certain prior period amounts have been reclassified to conform to the
current period presentation.
2. NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 143, "Accounting For Asset Retirement
Obligations". This statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The adoption of this statement did not have a
material impact on the Company's financial position or results of operations.
Effective January 1, 2003, the Company adopted SFAS No. 145, "Rescission of
FASB Statements 4, 44 and 64, Amendment of FASB Statement 13, and Technical
Corrections". SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires
companies to classify certain gains and losses from debt extinguishments as
extraordinary items, eliminates the provisions of SFAS No. 44 regarding
transition to the Motor Carrier Act of 1980 and amends the provisions of SFAS
No.13 to require that certain lease modifications be treated as sale leaseback
transactions. The provisions of SFAS No.145 related to classification of debt
extinguishment are effective for fiscal years beginning after May 15, 2002. As a
result of the Company's adoption of SFAS No. 145, the Company reclassified its
previously reported gain from extinguishment of debt of $8,789 and related
income tax expense of $3,475 in 2002 from an extraordinary item to continuing
operations.
Effective January 1, 2003, the Company adopted SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" and nullified EITF Issue No.
94-3. SFAS No.146 requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred, whereas EITF
No 94-3 had recognized the liability at the commitment date of an exit plan.
There was no effect on the Company's financial statements as a result of such
adoption.
In November 2002, FASB Interpretation ("FIN") No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" was issued. The interpretation provides
guidance on the guarantor's accounting and disclosure requirements for
guarantees, including indirect guarantees of indebtedness of others. The Company
adopted the disclosure requirements of the interpretation as of December 31,
2002. Effective January 1, 2003, additional provisions of FIN No. 45 became
effective and were adopted by the Company. The accounting guidelines are
applicable to guarantees issued after December 31, 2002 and require that the
Company record a liability for the fair value of such guarantees in the balance
sheet. The adoption of FIN No. 45 did not have a material impact on its
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of Statement of Financial
Accounting Standard No. 123." This statement provides
6
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. This statement also
amends the disclosure requirements of SFAS No. 123 and Accounting Principles
Board Opinion ("APB") No. 28, "Interim Financial Reporting," to require
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. The Company elected to adopt the disclosure
only provisions of SFAS No. 123, as amended by SFAS No. 148, and will continue
to follow APB Opinion No. 25, "Accounting for Stock Issued to Employees", and
related interpretations in accounting for the stock options granted to its
employees and directors. Accordingly, employee and director compensation expense
is recognized only for those options whose price is less than fair market value
at the measurement date.
Had compensation cost for the Company's stock option plans been determined
in accordance with SFAS No. 123, the Company's reported net income (loss) and
earnings (loss) per share would have been adjusted to the pro forma amounts
indicated below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- -----------------------------
2003 2002 2003 2002
------------ ----------- ------------- -----------
Net income (loss), as reported $ (8,479) $ 81 $ (10,492) $ 1,066
Less: Total stock-based employee compensation
expense determined under Black-Scholes
option pricing model, net of related tax
effects (94) (129) (316) (389)
------------ ----------- ------------- -----------
Pro forma net income (loss) $ (8,573) $(48) $ (10,808) $ 677
============ =========== ============= ===========
Earnings (loss) per share - As reported (1):
Basic $ (0.29) $ (0.01) $ (0.37) $ 0.05
Diluted $ (0.29) $ (0.01) $ (0.37) $ 0.02
Earnings (loss) per share - Pro forma (1):
Basic $ (0.29) $ (0.02) $ (0.38) $ 0.02
Diluted $ (0.29) $ (0.02) $ (0.38) $ 0.01
(1) Includes effect of preferred stock dividends.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 requires an investor with
a majority of the variable interests in a variable interest entity to
consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A variable interest entity is
an entity in which the equity investors do not have a controlling interest or
the equity investment at risk is insufficient to finance the entity's activities
without receiving additional subordinated financial support from the other
parties. The consolidation provisions of this interpretation are required
immediately for all variable interest entities created after January 31, 2003,
and the Company's adoption of these provisions did not have a material effect on
its financial position or results of operations. For variable interest entities
in existence prior to January 31, 2003, the consolidation provisions of FIN 46
are effective December 31, 2003 and are not expected to have a material effect
on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments. This
statement is generally effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated after June 30, 2003. The
adoption of this statement did not have a material impact on the Company's
financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Most of the guidance in SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. Adoption of SFAS No. 150 did not have a
material impact on the Company's financial position or results of operations.
7
3. USE OF ESTIMATES
In preparing financial statements, management is required to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Significant
estimates and assumptions are used to determine the adequacy of the allowance
for doubtful accounts, insurance disallowances, managed care claims accrual,
valuation allowance for deferred tax assets and to evaluate goodwill and
intangibles for impairment.
4. ACQUISITION OF WISE OPTICAL VISION GROUP, INC.
On February 7, 2003, the Company acquired substantially all of the assets
and certain liabilities of the contact lens distribution business of Wise
Optical Vision Group, Inc. ("Wise Optical"), a New York corporation. The Company
acquired Wise Optical to become a leading optical product distributor. The
aggregate purchase price of $7,949 consisted of approximately $7,290 of cash,
750,000 shares of the Company's common stock with an estimated fair market value
of $330, and transaction costs of approximately $329. Funds for the acquisition
were obtained via the Company's revolving credit note with CapitalSource, which
was increased from $10 million to $15 million in connection with the acquisition
of Wise Optical.
The aggregate purchase price of $7,949 has been allocated to the estimated
fair value of the assets acquired and liabilities assumed with the excess
identified as goodwill. Fair values were based on valuations and other studies.
The goodwill resulting from this transaction, of $318, was assigned to the
Company's Distribution and Technology operating segment and is expected to be
deductible for tax purposes. See also Note 7 for discussion of goodwill
impairment.
The results of operations of Wise Optical are included in the consolidated
financial statements from February 1, 2003, the deemed effective date of the
acquisition for accounting purposes.
The following table sets forth the allocation of purchase price
consideration to the assets acquired and liabilities assumed at the date of
acquisition.
(Unaudited)
Assets:
Cash and cash equivalents $ 1,427
Accounts receivable 6,626
Inventory 5,732
Property and equipment, net 2,416
Other assets 148
Goodwill 318
--------------
Total assets $16,667
==============
Liabilities:
Accounts payable and accrued expenses $ 8,657
Other liabilities 61
--------------
Total liabilities $ 8,718
==============
Wise Optical has experienced substantial operating losses through September
30, 2003. These losses are largely attributable to significant expenses incurred
by Wise Optical, including integration costs (primarily severance and stay
bonuses, legal and professional fees), weakness in gross margins and an
operating structure built to support a higher sales volume. In September 2003,
the Company began implementing strategies and operational changes designed to
improve the operations of Wise Optical. These efforts include developing our
sales force, improving customer service, enhancing productivity, eliminating
positions and streamlining our warehouse and distribution processes. In
addition, effective September 3, 2003, Gordon Bishop, President of the Company's
Consumer Vision division, has replaced the former President of the Distribution
division. Gordon brings industry expertise and a strong optical background to
Wise Optical, along with a focus on operating expenses. The Company believes
these changes will lead to increased sales, improved gross margins and reduced
operating costs.
8
The following is a summary of the unaudited pro forma results of operations
of the Company as if the Wise Acquisition had closed effective January 1, of the
respective periods below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- -----------------------------
2003 2002 2003 2002
----------- ------------ ----------- --------------
Net Revenues $ 32,946 $40,297 $104,587 $121,024
Income (loss) from continuing operations (8,479) (116) (10,345) 4,342
Net income (loss) (8,479) (282) (10,345) 175
Income (loss) per common share from continuing
operations (1):
Basic $ (0.29) $ (0.02) $ (0.36) $ 0.29
Diluted $ (0.29) $ (0.02) $ (0.36) $ 0.08
Net income (loss) per common share available to
common stockholders (1):
Basic $ (0.29) $ (0.03) $ (0.36) $ (0.02)
Diluted $ (0.29) $ (0.03) $ (0.36) $ 0.00
(1) Includes effect of preferred stock dividends.
The unaudited pro forma information presented above is for informational
purposes only and is not necessarily indicative of the results that would have
been obtained had these events actually occurred at the beginning of the periods
presented, nor does it intend to be a projection of future results.
5. DISCONTINUED OPERATIONS
In May 2002, the Company's Board of Directors approved management's plan to
dispose of substantially all of the net assets relating to the retail optical
business and professional optometry practice locations it operated in North
Carolina and on August 12, 2002 the Company consummated the sale of those net
assets.
The sale was accounted for as a disposal group under SFAS No. 144.
Accordingly, amounts in the financial statements and related notes for all
periods presented have been reclassified to reflect SFAS No. 144 treatment.
Operating results of the discontinued operations for the three and nine
months ended September 30, 2002 are as follows:
Three Nine
Months Ended Months Ended
September 30, September 30,
2002 2002
---------------- -----------------
External revenue $ 2,366 $ 16,771
================ =================
Intercompany revenue $ 578 $ 4,875
================ =================
Income (loss) from discontinued operations before taxes $ 218 $ 523
Income tax expense (benefit) 88 210
---------------- -----------------
Income (loss) from discontinued operations, net of tax 130 313
Loss on disposal of discontinued operations, net of tax (153) (4,092)
-----------------
----------------
Total net loss from discontinued operations $ (23) $ (3,779)
================ =================
Loss per share from discontinued operations- basic and diluted $ 0.00 $(0.30)
9
6. SEGMENT INFORMATION
OptiCare Health Systems, Inc. is an integrated eye care services company
focused on providing managed vision and professional eye care products and
services. During the third quarter of 2002, the Company sold its retail
optometry division in North Carolina, modified the Company's strategic vision
and realigned its business into the following three reportable operating
segments: (1) Managed Vision, (2) Consumer Vision, and (3) Distribution and
Technology. These operating segments are managed separately, offer separate and
distinct products and services, and serve different customers and markets.
Discrete financial information is available for each of these segments and the
Company's President assesses performance and allocates resources among these
three operating segments.
The Managed Vision segment contracts with insurers, insurance fronting
companies, employer groups, managed care plans and other third party payors to
manage claims payment administration of eye health benefits for those
contracting parties. The Consumer Vision segment sells retail optical products
to consumers and operates integrated eye health centers and surgical facilities
where comprehensive eye care services are provided to patients. The Distribution
and Technology segment provides products and services to eye care professionals
(ophthalmologists, optometrists and opticians) through (i) Wise Optical, a
distributor of contact and ophthalmic lenses and other eye care accessories and
supplies; (ii) a Buying Group program, which provides group purchasing
arrangements for optical and ophthalmic goods and supplies and (iii) CC Systems,
which provides systems and software solutions to eye care professionals. In
addition to its reportable operating segments, the Company's "All Other"
category includes other non-core operations and transactions, including its
health service organization operation, which do not meet the quantitative
thresholds for a reportable segment.
Summarized financial information, by segment, for the three and nine months
ended September 30, 2003 and 2002 is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ----------- ------------ ------------
REVENUES:
Managed vision $ 7,118 $ 7,217 $ 22,006 $ 21,970
Consumer vision 7,887 7,155 22,989 21,635
Distribution and technology 19,107 9,132 53,953 28,922
------------ ----------- ------------ ------------
Reportable segment totals 34,112 23,504 98,948 72,527
All other 394 941 2,828 2,121
Elimination of inter-segment revenues (1,560) (1,455) (3,867) (4,200)
------------ ----------- ------------ ------------
Total net revenue $ 32,946 $ 22,990 $ 97,909 $ 70,448
============ =========== ============ ============
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE TAX:
Managed vision $ (32) $ 1,090 $ 1,037 $ 1,941
Consumer vision 772 424 2,134 1,167
Distribution and technology (1,185) 190 (2,186) 677
------------ ----------- ------------ ------------
Reportable segment totals (445) 1,704 985 3,785
All other 149 653 2,161 1,632
Gain (loss) from extinguishment of debt - - (1,847) 8,789
Goodwill impairment (1,300) - (1,300) -
Depreciation (645) (463) (1,371) (1,402)
Amortization (44) (45) (132) (134)
Interest expense (333) (769) (1,729) (2,300)
Corporate (877) (794) (2,348) (2,250)
------------ ----------- ------------ ------------
Income (loss) from continuing
operations before tax $ (3,495) $ 286 $ (5,581) $ 8,120
============ =========== ============ ============
Total assets by reportable operating segment as of September 30, 2003 were
as follows: Managed Vision $15,391, Consumer Vision $10,780 and Distribution and
Technology $18,941.
10
7. GOODWILL AND OTHER INTANGIBLE ASSETS
Intangible assets subject to amortization are comprised of the following:
SEPTEMBER 30, 2003 DECEMBER 31, 2002
---------------------------------- ---------------------------------
GROSS ACCUMULATED GROSS ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
---------------- ----------------- ---------------- ----------------
Service Agreement $ 1,658 $ (451) $ 1,658 $ (368)
Non-compete agreements 265 (250) 265 (202)
---------------- ----------------- ---------------- ----------------
Total $ 1,923 $ (701) $ 1,923 $ (570)
================ ================= ================ ================
Amortization expense for the three months ended September 30, 2003 and 2002
was $44 and $45, respectively and for the nine months ended September 30, 2003
and 2002 was $132 and $134, respectively. Estimated annual amortization expense
is expected to be $174 in 2003 and $111 for each of the years 2004 through 2007.
Changes in the carrying amount of goodwill for the nine months ended
September 30, 2003, by segment, are as follows:
Managed Consumer Distribution &
Vision Vision Technology Total
--------------- -------------- ----------------- --------------
Balance, December 31, 2002 $ 11,820 $ 4,746 $ 3,950 $ 20,516
Goodwill from Wise Acquisition - - 318 318
Impairment loss - - (1,300) (1,300)
--------------- -------------- ----------------- --------------
Balance, September 30, 2003 $ 11,820 $ 4,746 $ 2,968 $ 19,534
=============== ============== ================= ==============
During the quarter ended September 30, 2003, as a result of recent decreases
in Buying Group sales and significant operating losses at Wise Optical, the
Company performed an interim impairment test of goodwill. The first step of the
goodwill impairment test identifies potential impairment, and the second step of
the test is used to measure the amount of impairment loss, if any. The Company
utilized multiples of earnings to estimate fair value and completed the first
step of the impairment test, which resulted in carrying value exceeding fair
value, indicating impairment. The Company was unable to complete the second step
of the impairment test, however, since goodwill impairment is probable and can
be reasonably estimated, the Company recorded a goodwill impairment charge in
September 2003 of $1,300 in its Distribution and Technology segment, which
represents the Company's best estimate of the expected impairment The Company
plans to complete the second step of its interim impairment test during the
fourth quarter of 2003 and any adjustment to the estimated loss will be recorded
at that time. The Company will also perform its annual test for goodwill
impairment for all of its reporting units during the fourth quarter of 2003.
Adverse changes in the Company's business climate, revenues or profitability
could require further reductions to the carrying value of the Company's goodwill
in future periods.
8. LONG-TERM DEBT
On February 7, 2003, in connection with the Company's acquisition of Wise
Optical, the Company's credit facility with CapitalSource was amended. The
amendment resulted in an increase in the Company's revolving credit facility
from $10,000 to $15,000 and an increase in the required monthly principal
payments on the term loan from approximately $17 per month to $24 per month.
On May 12, 2003, Palisade Concentrated Equity Partnership L.P. ("Palisade"),
the Company's majority shareholder, and Linda Yimoyines, wife of Dean J.
Yimoyines, M.D., Chairman of the Board and Chief Executive Officer of the
Company, each exchanged the entire amount of principal and interest due to them
under the Company's senior subordinated secured notes payable totaling an
aggregate of $16,246 million, for a total of 406,158 shares of Series C
Preferred Stock, par value $0.001 per share (the "Series C Preferred Stock").
The aggregate principle and interest was exchanged at a rate equal to $.80 per
share, the agreed upon value of our common stock on May 12, 2003, divided by 50
(or $40.00 per share). Each share of Series C Preferred Stock is convertible
into 50 shares of common stock. The Series C Preferred Stock has the same
dividend rights, on an as converted basis, as the Company's common stock and an
aggregate liquidation preference of $16,246.
11
The Company did not meet its minimum fixed charge ratio financial covenant
for the three months ended September 30, 2003, however the Company received a
waiver for non-compliance with this covenant through March 31, 2004 from
CapitalSource.
On November 14, 2003 we entered into an amendment of the terms of our term
loan and credit facility with CapitalSource to, among other things, (i) increase
our term loan by $300 and extend the maturity date of our term loan from January
25, 2004 to January 25, 2006, (ii) extend the maturity date of our revolving
credit facility from January 25, 2005 to January 25, 2006, (iii) permanently
increase the advance rate on eligible receivables of Wise Optical from 80% to
85%, (iv) temporarily increase the advance rate on eligible inventory of Wise
Optical from 50% to 55% through March 31, 2004, and (v) provide access to a $700
temporary over-advance bearing interest at prime plus 5 1/2%, which is to be
repaid in full by March 31, 2004, and is guaranteed by Palisade, (vi) waive our
non-compliance with the minimum fixed charge ratio financial covenant through
March 31, 2004 and (vii) increase our minimum tangible net worth financial
covenant from (27,000) to (10,000). In connection with this amendment, the
Company agreed to pay CapitalSource $80 in financing fees. The amendment also
includes an additional $150 termination fee if the Company terminates the
revolving credit facility prior to December 31, 2004. Additionally, if the
Company terminates the revolving credit facility pursuant to a refinancing with
another commercial financial institution, it shall pay CapitalSource, in lieu of
a termination fee, a yield maintenance amount. The yield maintenance amount
shall mean an amount equal to the difference between (i) the all-in effective
yield which could be earned on the revolving balance through January 25, 2006,
and (ii) the total interest and fees actually paid to CapitalSource on the
revolving credit facility prior to the termination date or date of prepayment.
The Company has classified the current and long-term portion of its bank
debt on its consolidated balance sheet at September 30, 2003 based on the new
maturity date of the amended term loan and credit facility and the Company's
proven ability to refinance this debt (as described above).
The details of the Company's long-term debt at September 30, 2003 are as
follows:
Term loan payable to CapitalSource in principal amounts of $24 per month.
The final payment is due and payable on January 25, 2006. $1,833
Revolving credit facility to CapitalSource, due January 25, 2006. 8,710
Subordinated notes payable in 2004. Principal and interest payments are due
monthly. 167
----------------
Total 10,710
Less current portion 426
----------------
$10,284
================
9. GAIN (LOSS) ON EXTINGUISHMENT OF DEBT
On May 12, 2003, the Company recorded a $1,847 loss on the exchange of
$16,246 of debt for Series C Preferred Stock. The $1,847 loss represents the
write-off of the deferred financing fees and debt discount associated with the
extinguished debt.
On January 25, 2002, the Company recorded a gain on the extinguishment of
debt of $8,789 before income taxes as a result of the Company's restructuring of
its debt. The $8,789 gain was comprised principally of approximately $10,000 of
debt and interest forgiveness by Bank Austria, the Company's former senior
secured lender, which was partially offset by $1,200 of unamortized deferred
financing fees and debt discount.
10. INCOME TAXES
The Company recorded an income tax benefit of $996 and $1,069 for the three
and nine months ended September 30, 2003, respectively, which represents the tax
benefit on the loss from continuing operations for the period. These tax
benefits were offset by $5,980 of tax expense recorded during the third quarter,
which represents the establishment of a full valuation allowance against the
Company's deferred tax assets. The liability method of accounting for deferred
income taxes requires a valuation allowance against deferred tax assets if,
based on the weight of historic available evidence, it is more likely than not
that some or all of the deferred tax assets will not be realized.
12
11. EARNINGS (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- ------------------------------
2003 2002 2003 2002
-------------- ------------- ------------- -------------
BASIC EARNINGS (LOSS) PER SHARE:
Income (loss) from continuing operations $ (8,479) $ 104 $ (10,492) $ 4,845
Preferred stock dividend (159) (143) (459) (388)
-------------- ------------- ------------- -------------
Income (loss) from continuing operations available
to common stockholders (8,638) (39) (10,951) 4,457
Discontinued operations - (23) - (3,779)
-------------- ------------- ------------- -------------
Net income (loss) available to common stockholders $ (8,638) $ (62) $ (10,951) $ 678
============== ============= ============= =============
Average common shares outstanding (basic) 30,304,541 12,065,252 29,956,664 12,539,200
Basic earnings (loss) per share:
Income (loss) from continuing operations available
to common stockholders $ (0.29) $ (0.01) $ (0.37) $ 0.35
Loss from discontinued operations, net - (0.00) - (0.30)
-------------- ------------- ------------- -------------
Net income (loss) per common share $ (0.29) $ (0.01) $ (0.37) $ 0.05
============== ============= ============= =============
DILUTED EARNINGS (LOSS) PER SHARE:
Income (loss) from continuing operations available
to common stockholders $ (8,638) $ (39) $ (10,951) $ 4,457
Assumed conversions of preferred stock dividends * * * 388
-------------- ------------- ------------- -------------
Income (loss) from continuing operations available
to common stockholders plus assumed conversions (8,638) (39) (10,951) 4,845
Discontinued operations - (23) - (3,779)
-------------- ------------- ------------- -------------
Net income (loss) available to common stockholders $ (8,638) $ (62) $ (10,951) $ 1,066
============== ============= ============= =============
Average common shares outstanding (basic) 30,304,541 12,065,252 29,956,664 12,539,200
Effect of dilutive securities:
Options * * * 767,525
Warrants * * * 7,811,802
Convertible Preferred stock * * * 29,232,053
-------------- ------------- ------------- -------------
Diluted shares 30,304,541 12,065,252 29,956,664 50,350,580
============== ============= ============= =============
Diluted earnings (loss) per share:
Income (loss) from continuing operations available
to common stockholders $ (0.29) $ (0.01) $ (0.37) $0.10
Discontinued operations - (0.00) - (0.08)
-------------- ------------- ------------- -------------
Net income (loss) per common share $ (0.29) $ (0.01) $ (0.37) $0.02
============== ============= ============= =============
* Anti-dilutive
13
The following table reflects the potential common shares of the Company at
September 30, 2003 and 2002 that have been excluded from the calculation of
diluted earnings per share because their effect would be anti-dilutive.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
--------------- -------------- -------------- ---------------
Options 5,922,066 4,908,545 5,922,066 1,426,045
Warrants 3,125,000 21,196,198 3,125,000 3,401,198
Convertible Preferred Stock 59,438,319 32,049,598 59,438,319 -
--------------- -------------- ---------------
--------------
68,485,385 58,154,341 68,485,385 4,827,243
=============== ============== ============== ===============
12. CONTINGENCIES
The Company is both a plaintiff and defendant in lawsuits incidental to its
current and former operations. Such matters are subject to many uncertainties
and outcomes are not predictable with assurance. Consequently, the ultimate
aggregate amount of monetary liability or financial impact with respect to these
matters at September 30, 2003 cannot be ascertained. Management is of the
opinion that, after taking into account the merits of defenses and established
reserves, the ultimate resolution of these matters will not have a material
adverse impact on the Company's consolidated financial position or results of
operations.
13. SUBSEQUENT EVENT
On November 14, 2003, the Company's credit facility was amended and
pursuant to that amendment, among other things, the maturity date of the term
loan and revolving credit facility were extended to January 25, 2006. See also
Note 8.
14
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion may be understood more fully by reference to our
consolidated financial statements, notes to the consolidated financial
statements, and management's discussion and analysis contained in our Annual
Report on Form 10-K for the year ended December 31, 2002, as filed with the
Securities and Exchange Commission.
OVERVIEW
We are an integrated eye care services company focused on vision benefits
management (managed vision), retail optical sales and eye care services to
patients and the distribution of products and software services to eye care
professionals.
Our business is comprised of three reportable operating segments: (1)
Managed Vision, (2) Consumer Vision, and (3) Distribution & Technology. Our
Managed Vision segment contracts with insurers, managed care plans and other
third party payers to manage claims payment administration of eye health
benefits for those contracting parties. Our Consumer Vision segment sells retail
optical products to consumers and operates integrated eye health centers and
surgical facilities in Connecticut where comprehensive eye care services are
provided to patients. The Distribution and Technology segment provides products
and services to eye care professionals (ophthalmologists, optometrists and
opticians) through (i) Wise Optical, a distributor of contact and ophthalmic
lenses and other eye care accessories and supplies; (ii) a Buying Group program,
which provides group purchasing arrangements for optical and ophthalmic goods
and supplies and (iii) CC Systems, which provides systems and software solutions
to eye care professionals.
In addition to these segments, we receive income from other non-core
operations and transactions, including our health service organization ("HSO")
operation, which receives fee income for providing certain support services to
individual ophthalmology and optometry practices. While we continue to provide
the services under existing contracts to these practices, we are in the process
of generally disengaging from a number of these operations.
On February 7, 2003, we acquired substantially all of the assets and certain
liabilities of the contact lens distribution business of Wise Optical Vision
Group, Inc. ("Wise Optical"), a New York corporation. The results of operations
of Wise Optical are included in the consolidated financial statements from
February 1, 2003, the deemed effective date of the acquisition for accounting
purposes. We have experienced substantial losses at Wise Optical through
September 30, 2003. These losses are largely attributable to significant
expenses incurred by Wise Optical, including integration costs (primarily
severance and stay bonuses, legal and professional fees), weakness in gross
margins and an operating structure built to support a higher sales volume. In
September 2003, we began implementing strategies and operational changes
designed to improve the operations of Wise Optical. These efforts include
developing our sales force, improving customer service, enhancing productivity,
eliminating positions and streamlining our warehouse and distribution processes.
In addition, effective September 3, 2003, Gordon Bishop, President of our
Consumer Vision division, has replaced the former President of the Distribution
division. Gordon brings industry expertise and a strong optical background to
Wise, along with a focus on operating expenses. We believe these changes will
lead to increased sales, improved gross margins and reduced operating costs.
On May 12, 2003, Palisade Concentrated Equity Partnership, L.P., our
majority shareholder, and Linda Yimoyines, wife of Dean J. Yimoyines, M.D., our
Chairman of the Board and Chief Executive Officer, each exchanged the entire
amount of principal and interest due to them under our senior subordinated
secured notes payable, totaling an aggregate of $16.2 million, for a total of
406,158 shares of Series C Preferred Stock.
On November 14, 2003, the Company's credit facility was amended and
pursuant to that amendment, among other things, the maturity date of the term
loan and revolving credit facility were extended to January 25, 2006.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2003 Compared to the Three Months Ended
September 30, 2002
Managed Vision revenue. Managed Vision revenue represents fees received
under our managed care contracts. Managed Vision revenue decreased to $7.1
million for the three months ended September 30, 2003, from $7.2 million for the
three months ended September 30, 2002, a decrease of $0.1 million or 1.4%. The
net decrease in managed vision revenue resulted from the loss of certain
contracts in Texas, as described below, which was partially offset by new
15
contracts and price increases. During the second quarter of 2003 the Texas state
legislature made changes to its Medicaid program and as a result HMO Blue, with
whom we maintained a Medicaid contract, withdrew from Texas' Medicaid program
effective September 1, 2003. Therefore, our contract with HMO Blue terminated on
September 1, 2003. This contract generated $0.4 million of revenue from July 1,
2003 through September 1, 2003. In addition and also effective September 1,
2003, the Texas state legislature will no longer fund a vision benefit in its
Children's Health Insurance Program. We maintained a number of contracts
covering routine exams and hardware benefits through this program that
terminated on September 1, 2003. Those contracts generated revenues of $0.5
million for the period July 1, 2003 through September 1, 2003.
Product sales revenue. Product sales include the retail sale of optical
products in our Consumer Vision segment, the sale of optical products through
our Buying Group and, effective February 2003, the sale of contact and
ophthalmic lenses through Wise Optical. Product sales revenue increased to $20.0
million for the three months ended September 30, 2003, from $9.9 million for the
three months ended September 30, 2002, an increase of $10.1 million or 101.2%.
This increase is primarily due to our acquisition of Wise Optical on February 7,
2003, which generated product sales revenue of $12.3 million for the three
months ended September 30, 2003, and a $0.3 million increase in Consumer Vision
revenue due to increased sales. This increase in revenue was partially offset by
a $2.5 million decrease in Buying Group revenue, due to a decrease in sales
volume. The decrease in Buying Group sales volume is primarily due to the loss
of the business of Optometric Eye Care Centers, P.A. and its franchise
affiliates and, to a lesser extent, due to consolidation in the eye care
industry. We expect the decrease in Buying Group revenue to continue as
consolidation in this market continues, however, we do not expect this trend to
have a material impact on our overall profitability.
Other services revenue. Other services revenue includes revenue earned from
providing eye care services in our Consumer Vision segment, software services in
our Distribution & Technology segment and HSO services. Other services revenue
increased to $5.4 million for the three months ended September 30, 2003 from
$5.2 million for the three months ended September 30, 2002, an increase of $0.2
million or 4.9%. This increase is primarily due to a $0.4 million increase in
Consumer Vision services revenue due to increased services volume in the
optometry and surgical areas as a result of improved productivity. This increase
was partially offset by a $0.2 million decrease in HSO fees collected under our
HSO agreements, primarily due to disputes with certain physician practices,
which are parties to these agreements. We continue litigation with several of
these practices and intend to continue to pursue settlement of these matters in
the future.
Other income. Other income represents non-recurring settlements on HSO
contracts. Other income for the three months ended September 30, 2003 was $0.4
million compared to $0.7 million for the three months ended September 30, 2002,
representing a decrease of $0.3 million.
Medical claims expense. Medical claims expense increased to $6.0 million for
the three months ended September 30, 2003, from $5.0 million for the three
months ended September 30, 2002, an increase of $1.0 million. The medical claims
expense loss ratio (MLR) representing medical claims expense as a percentage of
Managed Vision revenue increased to 84.2% in 2003 from 69.4% in 2002. The MLR
was unusually low in 2002 primarily due to a favorable adjustment of $0.6
million to the reserve in the third quarter of 2002. The increase in MLR in 2003
is primarily the result of an increase in claims associated with the utilization
surge experienced on the Children's Health Insurance Program contracts prior to
the elimination of the vision benefit by the Texas state legislature effective
September 1, 2003.
Cost of product sales. Cost of product sales increased to $15.7 million for
the three months ended September 30, 2003, from $8.0 million for the three
months ended September 30, 2002, an increase of $7.7 million or 97.0%. This
increase includes a $10.2 million increase resulting from an increase in sales
volume attributed to our Wise Optical business, which we acquired in February
2003, and is partially offset by a $2.5 million decrease in cost of sales,
primarily due to a decrease in Buying Group sales.
Cost of services. Cost of services increased to $2.2 million for the three
months ended September 30, 2003 from $1.9 million for the three months ended
September 30, 2002, an increase of $0.3 million or 20.4%. This increase is
primarily due to the increase in consumer vision services during the period.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased to $10.2 million for the three months ended
September 30, 2003, from $6.6 million for the three months ended September 30,
2002, an increase of $3.6 million or 55.2%. This increase primarily represents
operating expenses of Wise Optical and includes $0.3 million of Wise integration
related expenses, which mainly consist of severance, stay bonuses and
professional fees
16
Goodwill impairment loss. During the quarter ended September 30, 2003, we
recorded a non-cash goodwill impairment loss of $1.3 million in our Distribution
and Technology segment, as a result of an interim impairment test of goodwill.
We performed an interim impairment test due to recent decreases in sales by the
Buying Group and significant operating losses at Wise Optical. As the first step
of our test, we utilized multiples of earnings of comparable companies to
estimate fair value, which resulted in carrying value in excess of estimated
fair value, indicating impairment. We were unable to complete the second step of
the impairment test, which is used to measure the amount of impairment loss, if
any. However, since goodwill impairment is probable and can be reasonably
estimated, we recorded a goodwill impairment charge of $1.3 million in September
2003, which represents our best estimate of impairment. We plan to complete the
second step of our interim impairment test during the fourth quarter of 2003 and
any adjustment to the estimated loss will be recorded at that time.
Interest expense. Interest expense decreased to $0.3 million for the three
months ended September 30, 2003 from $0.8 million for the three months ended
September 30, 2002, a decrease of $0.5 million. This decrease in interest
expense is primarily due to a decrease in the average outstanding debt balance.
Income tax expense (benefit). For the three months ended September 30, 2003,
we recorded $5.0 million of income tax expense, which includes a $1.0 million
income tax benefit on our loss from continuing operations and $6.0 million of
tax expense to establish a full valuation allowance against our deferred tax
assets. The valuation allowance was established based on the weight of historic
available evidence, that it is more likely than not that the deferred tax assets
will not be realized. We recorded an income tax benefit of $0.2 million for the
three months ended September 30, 2002, which represents the tax benefit on the
loss from continuing operations at the statutory rate after adjusting for
non-deductible expenses.
Discontinued operations. In May 2002, the company's Board of Directors
approved management's plan to dispose of the company's North Carolina retail
optometry division. During the quarter ended September 30, 2002 the company
recorded an additional loss on disposal of discontinued operations of $0.2
million, primarily due to changes in estimated closing costs and increases in
the carrying value of the net assets held for sale as a result of operations
from June 30, 2002 through the sale date. Income generated by the discontinued
operations, net of tax, for the three months ended September 30, 2002 was $0.1
million. On August 12, 2002 the company consummated the sale of its North
Carolina retail optometry operations.
Nine Months Ended September 30, 2003 Compared to the Nine Months Ended
September 30, 2002
Managed Vision revenue. Managed Vision revenue remained unchanged at $22.0
million for the nine months ended September 30, 2003 and 2002. During the second
quarter of 2003 the Texas state legislature made changes to its Medicaid program
and as a result HMO Blue, with whom we maintained a Medicaid contract, withdrew
from Texas' Medicaid program effective September 1, 2003. Therefore, our
contract with HMO Blue terminated on September 1, 2003. This contract generated
revenue of $1.7 million from January 1, 2003 through the termination date. In
addition and also effective September 1, 2003, the Texas state legislature no
longer funds a vision benefit in its Children's Health Insurance Program. We
maintained a number of contracts through this program that terminated on
September 1, 2003. Those contracts generated revenues of $2.0 million from
January 1, 2003 through the termination date. The decrease in revenue associated
with the loss of this business in Texas was offset by new contracts and price
increases.
Product sales revenue. Product sales revenue increased to $57.0 million for
the nine months ended September 30, 2003, from $31.7 million for the nine months
ended September 30, 2002, an increase of $25.3 million or 80.1%. This increase
is primarily due to our acquisition of Wise Optical on February 7, 2003, which
generated product sales revenue of $32.8 million for the nine months ended
September 30, 2003 and a $0.2 million increase in consumer vision product sales.
This increase in revenue is partially offset by a $ 7.7 million decrease in
Buying Group revenue, due to a decrease in sales volume. The decrease in Buying
Group sales volume is primarily due to the loss of the business of Optometric
Eye Care Centers, P.A. and its franchise affiliates and, to a lesser extent, due
to consolidation in the eye care industry whereby smaller independent eye care
businesses are being replaced by larger eye care chains that purchase directly
from vendors. We expect consolidation in this market to continue and potentially
further reduce the Buying Group's market share and revenue, however, we do not
expect this trend to have a material impact on our overall profitability.
Other services revenue. Other services revenue increased to $16.2 million
for the nine months ended September 30, 2003 from $15.5 million for the
comparable period in 2002, an increase of $0.7 million or 4.8%. This increase is
comprised of a $1.0 million increase in Consumer Vision services revenue due to
increased services volume in the
17
optometry and surgical areas and a $0.4 million increase in software services
revenue due to an increase in sales volume. These increases were offset by a
$0.7 million decrease in fees collected under our HSO agreements primarily due
to disputes with certain physician practices, which are parties to these
agreements. We continue to be in litigation with several of these practices and
intend to continue to pursue settlement of these matters in the future.
Other income. Other income for the nine months ended September 30, 2003 was
$2.7 million compared to $1.3 million for the nine months ended September 30,
2002, an increase of $1.4 million. This increase is due to an increase in
settlements on HSO contracts.
Medical claims expense. Medical claims expense increased to $17.3 million
for the nine months ended September 30, 2003, from $16.8 million for the nine
months ended September 30, 2002, an increase of $0.5 million. The medical claims
expense loss ratio (MLR) representing medical claims expense as a percentage of
Managed Vision revenue increased to 78.4% in 2003, from 76.5% in 2002. The MLR
was lower in 2002 primarily due to a favorable adjustment to the reserve of $0.6
million in 2002. In addition, the MLR in 2003 was negatively impacted by the
recent change in the Texas state legislature, which no longer funds a vision
benefit in its Children's Health Insurance Program, and which resulted in an
increase in claims as utilization increased prior to the elimination of the
benefit.
Cost of product sales. Cost of product sales increased to $44.3 million for
the nine months ended September 30, 2003, from $25.2 million for the nine months
ended September 30, 2002, an increase of $19.1 million or 75.3%. This increase
is primarily due to a $26.7 million increase in product costs from an increase
in sales volume due to the acquisition of Wise Optical in February 2003. This
increase is partially offset by a $7.2 million decrease in product costs related
to the decrease in sales volume generated by our Buying Group and a $0.4 million
decrease in product costs in our Consumer Vision business.
Cost of services. Cost of services increased to $6.7 million from $6.1
million for the nine months ended September 30, 2003 and 2002, respectively,
representing an increase of $0.6 million or 8.9%. Of this increase $0.4 million
is due to the increase in software sales volume and $0.2 million is due to an
increase in consumer vision services.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased to $28.9 million for the nine months ended
September 30, 2003, from $19.1 million for the nine months ended September 30,
2002, an increase of $9.8 million or 51.5%. Of this increase, approximately $8.5
million represents operating expenses of Wise Optical, including $1.0 million of
Wise integration related costs consisting primarily of severance, stay bonuses,
legal, consulting and other professional fees. The remaining $1.3 million
primarily represents increased compensation and professional fees of the
company.
Goodwill impairment loss. For the nine months ended September 30, 2003, we
recorded a non-cash goodwill impairment loss of $1.3 million in our Distribution
and Technology segment, as a result of an interim impairment test. We performed
an interim impairment test due to recent decreases in sales by the Buying Group
and significant operating losses at Wise Optical. As the first step of our test,
we utilized multiples of earnings of comparable companies to estimate fair
value, which resulted in carrying value in excess of estimated fair value,
indicating impairment. We were unable to complete the second step of the
impairment test, which is used to measure the amount of impairment loss, if any.
However, since goodwill impairment is probable and can be reasonably estimated,
we recorded a goodwill impairment charge of $1.3 million in September 2003,
which represents our best estimate of impairment.
Interest expense. Interest expense decreased to $1.7 million for the six
months ended September 30, 2003 from $2.3 million for the nine months ended
September 30, 2002, a decrease of $0.6 million. This decrease in interest
expense is primarily due to the decrease in the average outstanding debt
balance.
Gain (loss) on extinguishment of debt. The $1.8 million loss on
extinguishment of debt for the nine months ended September 30, 2003 represents
the write-off of deferred financing fees and debt discount associated with the
exchange of $16.2 million of debt for Series C Preferred Stock, which occurred
on May 12, 2003. The $8.8 million gain on extinguishment of debt for the nine
months ended September 30, 2002 was the result of our capital restructuring in
January 2002. The gain is comprised of approximately $10.0 million of
forgiveness of principal and interest by Bank Austria, our former senior secured
lender, and was partially offset by the write-off of $1.2 million of related
unamortized deferred financing fees and debt discount.
18
Income tax expense (benefit). For the nine months ended September 30, 2003,
we recorded $4.9 million of income tax expense, which includes $1.1 million of
an income tax benefit on our loss from continuing operations, offset by $6.0 of
tax expense to establish a full valuation allowance against our deferred tax
assets. The valuation allowance was established based on the weight of historic
available evidence, that it is more likely than not that the deferred tax assets
will not be realized. The tax expense for the nine months ended September 30,
2002 of $3.3 million was primarily due to $3.5 million of tax expense associated
with the $8.8 million gain on extinguishment of debt, partially offset by $0.2
million of tax benefit on other operating losses of $.7 million.
Discontinued operations. In May 2002, the company's Board of Directors
approved management's plan to dispose of the net assets used in the retail
optical and optometry practice locations we operated in North Carolina. On
August 12, 2002, we consummated the sale of those assets, which resulted in a
$4.1 million loss on disposal. Income from discontinued operations, net of tax,
for the nine months ended September 30, 2002 was $0.3 million, representing
income generated from this operation prior to its disposal on August 12, 2002.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities at the date of our financial statements. Management bases its
estimates and judgments on historical experience, current economic and industry
conditions and on various other facts that are believed to be reasonable under
the circumstances. Actual results may differ significantly from these estimates
under different assumptions, judgments or conditions.
Management believes critical accounting estimates are used in determining
the adequacy of the allowance for doubtful accounts, insurance disallowances,
managed care claims accrual, valuation allowance for deferred tax assets and in
evaluating goodwill and intangibles for impairment. During the three months
ended September 30, 2003, as further described above, we made significant
changes to our estimates surrounding the valuation of our deferred tax assets
and goodwill.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2003, we had cash and cash equivalents of approximately
$2.2 million, $1.8 million of borrowings outstanding under our term loan with
CapitalSource, $8.7 million of advances outstanding under our revolving credit
facility with CapitalSource and $1.6 million of additional availability under
our revolving credit facility. Although we may borrow up to $15 million under
the revolving credit facility, the maximum amount which may be advanced is
limited to the value derived from applying advance rates to eligible accounts
receivable and inventory. As of September 30, 2003 the advance rates were (i)
80% of accounts receivable of Wise Optical (ii) 85% of all other accounts
receivable, (iii) 50% of inventory of Wise Optical and (iv) 55% of all other
inventory.
Our primary sources of liquidity have been cash flows generated from
operations and borrowings under our credit facility. Our principal uses of
liquidity are to provide working capital, meet debt service requirements and
finance capital expenditures. Due to our non-compliance with the minimum fixed
charge ratio financial covenant contained in the CapitalSource Loan and Security
Agreement and anticipated cash shortfalls in December 2003 through February
2004, primarily as a result of losses incurred at Wise Optical, integration
expenses and, to a lesser extent the seasonality of our business (as further
described below), on November 14, 2003 we amended the terms of the term loan and
revolving credit facility with CapitalSource. This amendment provides for the
following: (i) an increase to our term loan of $0.3 million and an extension of
the maturity date of our term loan from January 25, 2004 to January 25, 2006,
(ii) an extension of the maturity of our revolving credit facility from January
25, 2005 to January 25, 2006, (iii) a permanent increase to the advance rate on
eligible receivables of Wise Optical from 80% to 85%, (iv) a temporarily
increase to the advance rate on Wise eligible inventory from 50 to 55% through
March 31, 2004, (v) access to a $0.7 million temporary over-advance bearing
interest at prime plus 5 1/2%, which is to be repaid in full by March 31, 2004,
and is guaranteed by Palisade (vi) a waiver of our non-compliance with the
minimum fixed charge ratio financial covenant through March 31, 2004 and (v) an
increase in our minimum tangible net worth financial covenant from $(27) million
to ($10) million. In connection with this amendment, we agreed to pay
CapitalSource $80,000 in financing fees and received a waiver from CapitalSource
for non-compliance with our fixed charges financial covenant (see also "The
CapitalSource Loan and Security Agreement"). The amendment also includes an
additional $150,000 termination fee if the Company terminates the revolving
credit facility prior to December 31, 2004. Additionally, if the Company
terminates the revolving credit facility pursuant to a refinancing with another
commercial financial institution, it shall pay CapitalSource, in lieu of a
termination fee, a yield maintenance amount. The yield maintenance amount shall
mean an amount equal to the difference between (i) the all-in effective yield
which could be earned on the revolving balance through January 25, 2006, and
(ii) the total interest and fees actually paid to CapitalSource on the revolving
credit facility prior to the termination date or date of prepayment.
19
We believe that our cash flow from operations, borrowings under our amended
credit facility and operating and capital lease financing will provide us with
sufficient funds to finance our operations for the next 12 months. If, however,
additional funds are needed, we may attempt to raise such funds through the
issuance of equity or convertible debt securities. If additional funds are
raised through the issuance of equity or convertible debt securities, the
percentage ownership of our stockholders will be reduced and our stockholders
may experience dilution of their interest in us. If additional funds are needed
and are not available or are not available on acceptable terms, our ability to
fund our operations, take advantage of unanticipated opportunities, develop or
enhance services or products or otherwise respond to competitive pressures may
be significantly limited.
On November 13, 2003, the Texas Commissioner of Insurance reduced the
required minimum net worth for our Texas HMO subsidiary from $1,000,000 to
$500,000, which will improve the Company's liquidity.
Seasonality
Our revenues are generally affected by seasonal fluctuations in the Consumer
Vision and Distribution and Technology segments. During the winter and summer
months, we generally experience a decrease in patient visits and product sales.
As a result, our cash, accounts receivable, and revenues decline during these
periods and, since we retain certain fixed costs related to staffing and
facilities, our cash flows can be negatively affected.
Cash Flows
Net cash used in operating activities was $0.2 million for the nine months
ended September 30, 2003 and primarily consisted of a $10.5 million net loss,
which was partially offset by net non-cash charges of $ 9.8 million and $0.5
million of changes in operating assets and liabilities. Net cash used in
operating activities for the nine months ended September 30, 2002 of $0.9
million was primarily driven by income from continuing operations of $4.8
million and cash provided by discontinued operations of $1.0 million, which were
partially offset by net non-cash expenses of $2.8 million, and $3.9 million of
net changes in operating assets and liabilities.
Net cash used in investing activities was $6.8 million for the nine months
ended September 30, 2003 compared to net cash provided by investing activities
of $2.0 million for the same period in 2002. Net cash used in investing
activities for the nine months ended September 30, 2003 included $6.2 million to
purchase the net assets (excluding cash) of Wise Optical, a deposit of $0.6
million into restricted certificates of deposit to secure standby letters of
credit to establish and collateralize a new wholly owned subsidiary, OptiCare
Vision Insurance Company, Inc., to operate as a captive insurance company
domiciled in South Carolina, as part of our Managed Vision division's entrance
into the "direct-to-employer" market and $0.9 million used to purchase fixed
assets. These uses of cash were offset by $0.8 million of cash resulting from
refunds of escrow deposits and payments on our notes receivable. Net cash
provided by investing activities in 2002 consisted principally of $3.9 million
in net cash received from the sale of discontinued operations, which was
partially offset by a $1.4 million payment we made to reacquire certain notes
receivable and contractual rights as part of our capital restructuring in
January 2002 and $0.5 million paid for the purchase of fixed assets.
Net cash provided by financing activities was $6.1 million for the nine
months ended September 30, 2003 compared to net cash used in financing
activities of $1.2 million for the nine months ended September 30, 2002. Net
cash provided by financing activities in 2003 included a $7.2 million net
increase in borrowings under our revolving credit facility, which was primarily
used to finance our purchase of the net assets of Wise Optical. This $7.2
million increase was partially offset by $0.9 million in principal payments on
debt and $0.2 million in financing fees related to the increase in our credit
facility in February 2002 and the conversion of debt to equity in May 2003. Net
cash provided by financing activities in 2002 consisted of approximately $27.5
million from the issuance of debt and preferred stock which was offset by a $2.2
million net decrease in our revolving credit facility, $25.0 million of
principal payments on long-term debt (primarily related to our capital
restructuring in January 2002) and $1.5 million in financing costs.
The CapitalSource Loan and Security Agreement
In January 2002, we entered into a credit facility with CapitalSource
Finance, LLC consisting of a $3.0 million term loan and a $10.0 million
revolving credit facility. In February 2003, in connection with our acquisition
of Wise
20
Optical, the revolving credit facility was amended to $15.0 million. Although we
may borrow up to $15 million under the revolving credit facility, the maximum
amount which may be advanced is limited to the value derived from applying
advance rates to eligible accounts receivable and inventory. As of September 30,
2003 the advance rates under our revolving credit facility were (i) 80% of
accounts receivable of Wise Optical (ii) 85% of all other accounts receivable,
(iii) 50% of inventory of Wise Optical and (iv) 55% of all other inventory. We
are required to make monthly principal payments of approximately $24,000 on the
term loan with the balance due at maturity. The interest rate applicable to the
term loan equals the prime rate plus 3.5% (but not less than 9%) and the
interest rate applicable to the revolving credit facility is prime rate plus
1.5% (but not less than 5.75%).
On November 14, 2003 we entered into an amendment of the terms of our term
loan and credit facility with CapitalSource to, among other things, (i) increase
our term loan by $0.3 million and extend the maturity date of the term loan from
January 25, 2004 to January 25, 2006, (ii) extend the maturity date of our
revolving credit facility from January 25, 2005 to January 25, 2006, (iii)
permanently increase the advance rate on eligible receivables of Wise Optical
from 80% to 85%, (iv) temporarily increase the advance rate on eligible
inventory of Wise Optical from 50% to 55% through March 31, 2004, and (v)
provide access to a $0.7 million temporary over-advance bearing interest at
prime plus 5 1/2%, which is to be repaid in full by March 31, 2004, and is
guaranteed by Palisade (vi) waive our non-compliance with the minimum fixed
charge ratio financial covenant through March 31, 2004 and (vii) increase our
minimum tangible net worth financial covenant from ($27) million to ($10)
million. Accordingly, we have classified the current and long-term portions of
our bank debt on our consolidated balance sheet at September 30, 2003 based on
the new maturity dates of the amended term loan and revolving credit facility.
In connection with the foregoing amendment, we agreed to pay CapitalSource
$80,000 in financing fees. The amendment also includes an additional $150,000
termination fee if the Company terminates the revolving credit facility prior to
December 31, 2004. Additionally, if the Company terminates the revolving credit
facility pursuant to a refinancing with another commercial financial
institution, it shall pay CapitalSource, in lieu of a termination fee, a yield
maintenance amount. The yield maintenance amount shall mean an amount equal to
the difference between (i) the all-in effective yield which could be earned on
the revolving balance through January 25, 2006, and (ii) the total interest and
fees actually paid to CapitalSource on the revolving credit facility prior to
the termination date or date of prepayment.
The term loan and revolving credit facility with CapitalSource are subject
to a Loan and Security Agreement. The Loan and Security Agreement contains
certain restrictions on the conduct of our business, including, among other
things, restrictions on incurring debt, purchasing or investing in the
securities of, or acquiring any other interest in, all or substantially all of
the assets of any person or joint venture, declaring or paying any cash
dividends or making any other payment or distribution on our capital stock, and
creating or suffering liens on our assets. We are required to maintain certain
financial covenants, including a minimum fixed charge ratio and to maintain a
minimum net worth. Upon the occurrence of certain events or conditions described
in the Loan and Security Agreement (subject to grace periods in certain cases),
including our failure to meet the financial covenants, the entire outstanding
balance of principal and interest would become immediately due and payable. Due
to losses incurred by Wise Optical, we did not meet our minimum fixed charge
ratio financial covenant for the three months ended September 30, 2003. However,
in connection with the amendment to the terms of our term loan and credit
facility with CapitalSource as noted above, we have received a waiver for
non-compliance of this covenant through March 31, 2004 from CapitalSource and
the minimum net worth covenant has been increased from ($27) million to $(10)
million.
Our subsidiaries guarantee payments and other obligations under the credit
facility and we (including certain subsidiaries) have granted a first-priority
security interest in substantially all our assets to CapitalSource. We also
pledged the capital stock of certain of our subsidiaries to CapitalSource.
The Series B Preferred Stock
As of September 30, 2003, we had 3,204,959 shares of Series B Preferred
Stock issued and outstanding. Subject to the senior liquidation preference of
the Series C Preferred Stock described below, the Series B Preferred Stock ranks
senior to all other currently issued and outstanding classes or series of our
stock with respect to dividends, redemption rights and rights on liquidation,
winding up, corporate reorganization and dissolution. Each share of Series B
Preferred Stock is convertible into a number of shares of common stock equal to
such share's current liquidation value, divided by a conversion price of $0.14,
subject to adjustment for dilutive issuances. The number of shares of common
stock into which each share of Series B Preferred Stock is convertible will
increase over time because the liquidation value of the Series B Preferred
Stock, which was $1.71 per share as of September 30, 2003, increases at a rate
of 12.5% per year, compounded annually.
The Conversion of Our Senior Subordinated Secured Loans Into Series C Preferred
Stock
In January 2002, Palisade Concentrated Equity Partnership, L.P. and Linda
Yimoyines, wife of Dean Yimoyines, our Chairman and Chief Executive Officer made
subordinated secured loans to us in the amount of $13.9 million and
21
$0.1 million, respectively. The subordinated secured loans were evidenced by
senior subordinated secured notes that ranked pari passu with each other. The
notes were subordinated to our indebtedness to CapitalSource and were secured by
second-priority security interests in substantially all of our assets. Principal
was due on January 25, 2012 and interest was payable quarterly at the rate of
11.5%. In the first and second years, we had the right to defer 100% and 50%
respectively, of interest to maturity by increasing the principal amount of the
note by the amount of interest so deferred.
On May 12, 2003, Palisade and Ms. Yimoyines exchanged the entire amount of
principal and interest due to them under the senior secured loans, totaling an
aggregate of $16.2 million, for a total of 406,158 shares of Series C Preferred
Stock, of which 403,256 shares were issued to Palisade Concentrated Equity
Partnership, L.P. and 2,902 shares were issued to Linda Yimoyines. The aggregate
principle and interest was exchanged at a rate equal to $.80 per share, the
agreed upon value of our common stock on May 12, 2003, divided by 50 (or $40.00
per share). The Series C Preferred Stock has an aggregate liquidation preference
of $16.2 million and ranks senior to all other currently issued and outstanding
classes or series of our stock with respect to liquidation rights. Each share of
Series C Preferred Stock is convertible into 50 shares of common stock and has
the same dividend rights, on an as converted basis, as our common stock.
Contractual Obligations
As discussed above, in May 2003, the senior secured loans to Palisade and
Ms. Yimoyines were exchanged for Series C Preferred Stock and in November 2003
we amended our credit facility with CapitalSource, which extended its maturity
date to 2006. As a result, the remaining principal payments on our long-term
debt, as of September 30, 2003, are payable as follows: 2003- $114; 2004 - $410;
2005 - $286; 2006 - $9,900.
RECENT ACCOUNTING CHANGES
Effective January 1, 2003, we adopted Statement of Financial Accounting
Standards ("SFAS") No. 143, "Accounting For Asset Retirement Obligations". This
statement addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. The adoption of this statement did not have a material
impact on our financial position or results of operations.
Effective January 1, 2003, we adopted SFAS No. 145, "Rescission of FASB
Statements 4, 44 and 64, Amendment of FASB Statement 13, and Technical
Corrections". SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires
companies to classify certain gains and losses from debt extinguishments as
extraordinary items, eliminates the provisions of SFAS No. 44 regarding
transition to the Motor Carrier Act of 1980 and amends the provisions of SFAS
No.13 to require that certain lease modifications be treated as sale leaseback
transactions. The provisions of SFAS No.145 related to classification of debt
extinguishment are effective for fiscal years beginning after May 15, 2002. As a
result of our adoption of SFAS No. 145, we reclassified our previously reported
gain from extinguishment of debt of $8.8 million and related income tax expense
of $3.5 million in 2002 from an extraordinary item to continuing operations.
Effective January 1, 2003, we adopted SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" and nullified EITF Issue No. 94-3.
SFAS No.146 requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred, whereas EITF No
94-3 had recognized the liability at the commitment date of an exit plan. There
was no effect on our financial statements as a result of such adoption.
In November 2002, FASB Interpretation ("FIN") No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" was issued. The interpretation provides
guidance on the guarantor's accounting and disclosure requirements for
guarantees, including indirect guarantees of indebtedness of others. We adopted
the disclosure requirements of the interpretation as of December 31, 2002.
Effective January 1, 2003, additional provisions of FIN No. 45 became effective
and were adopted by us. The accounting guidelines are applicable to guarantees
issued after December 31, 2002 and require that we record a liability for the
fair value of such guarantees in the balance sheet. The adoption of FIN No. 45
did not have a material impact on its financial position or results of
operations.
22
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of Statement of Financial
Accounting Standard No. 123." This statement provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. This statement also amends the disclosure
requirements of SFAS No. 123 and Accounting Principles Board Opinion ("APB") No.
28, "Interim Financial Reporting," to require 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. We elected to adopt the disclosure only provisions of SFAS No. 148 and
will continue to follow APB Opinion No. 25 and related interpretations in
accounting for the stock options granted to its employees and directors.
Accordingly, employee and director compensation expense is recognized only for
those options whose price is less than fair market value at the measurement
date. For disclosure regarding stock options had compensation cost been
determined in accordance with SFAS No. 123, see Note 2 to the condensed
consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 requires an investor with
a majority of the variable interests in a variable interest entity to
consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A variable interest entity is
an entity in which the equity investors do not have a controlling interest or
the equity investment at risk is insufficient to finance the entity's activities
without receiving additional subordinated financial support from the other
parties. The consolidation provisions of this interpretation are required
immediately for all variable interest entities created after January 31, 2003,
and our adoption of these provisions did not have a material effect on our
financial position or results of operations. For variable interest entities in
existence prior to January 31, 2003, the consolidation provisions of FIN 46 are
effective December 31, 2003 and are not expected to have a material effect on
our financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments. This
statement is generally effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated after June 30, 2003. The
adoption of this statement did not have a material impact on our financial
position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Most of the guidance in SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. Adoption of SFAS No. 150 did not have a
material impact on our financial position or results of operations.
IMPACT OF REIMBURSEMENT RATES
Our revenue is subject to pre-determined Medicare reimbursement rates
which, for certain products and services, have decreased over the past three
years. A decrease in Medicare reimbursement rates could have an adverse effect
on our results of operations if we cannot manage these reductions through
increases in revenues or decreases in operating costs. To some degree, prices
for health care are driven by Medicare reimbursement rates, so that our
non-Medicare business is also affected by changes in Medicare reimbursement
rates.
FORWARD-LOOKING INFORMATION AND RISK FACTORS
The statements in this Form 10-Q and elsewhere (such as in other filings by
the company with the Securities and Exchange Commission, press releases,
presentations by the company or its management and oral statements) that relate
to matters that are not historical facts are "forward-looking statements" within
the meaning of Section 27A of the Securities Exchange Act of 1934. When used in
this document and elsewhere, words such as "anticipate," "believe," "expect,"
"plan," "intend," "estimate," "project," "will," "could," "may," "predict" and
similar expressions are intended to identify forward-looking statements. Such
forward-looking statements include those relating to:
23
o Our opinion that with respect to lawsuits incidental to our
current and former operations, after taking into account the
merits of defenses and established reserves, the ultimate
resolution of these matters will not have a material adverse
impact on our financial position or results of operations;
o The expectation that the consolidation in the eye care industry
will continue and could further reduce our Buying Group's market
share and revenue, and that we do not expect this trend to have a
material impact on our overall profitability; and
o Our belief that cash from operations, borrowings under our credit
facility, and operating and capital lease financings will provide
sufficient funds to finance operations for the next 12 months.
In addition, such forward-looking statements involve known and unknown
risks, uncertainties, and other factors which may cause the actual results,
performance or achievements of the company to be materially different from any
future results expressed or implied by such forward-looking statements. Also,
our business could be materially adversely affected and the trading price of our
common stock could decline if any of the following risks and uncertainties
develop into actual events. Such risk factors, uncertainties and the other
factors include:
o Changes in the regulatory environment applicable to our business,
including health-care cost containment efforts by Medicare,
Medicaid and other third-party payers;
o Reduction in demand and increased competition for our products and
services; o General economic conditions;
o Risks related to the eye care industry, including the cost and
availability of medical malpractice insurance, and adverse
long-term experience with laser and other surgical vision
correction;
o Risks related to the managed care and insurance industries,
including risks relating to class action litigation seeking to
broaden the scope of covered services;
o Our ability to successfully integrate and profitably manage our
operations;
o Loss of the services of key management personnel;
o Our ability to execute our growth strategy, without which we may
not become profitable or sustain our profitability;
o Our ability to obtain additional capital, without which our growth
could be limited;
o The fact that we have a history of losses and may incur further
losses in the future;
o The fact that if we fail a financial covenant in the future
(beyond the date of our current waiver) or otherwise default on
our debt, our creditors could foreclose on our assets;
o The possibility that we may not compete effectively with other eye
care services companies which have more resources and experience
than us;
o Failure to negotiate profitable capitated fee arrangements;
o The possibility that we may have potential conflicts of interests
with respect to related party transactions which could result in
certain of our officers, directors and key employees having
interests that differ from us and our stockholders;
o Health care regulations or health care reform initiatives, which
could materially adversely affect our business, financial
condition and results of operations;
o The fact that the nature of our business could subject us to
potential malpractice, product liability and other claims;
o The fact that managed care companies face increasing threats of
private-party litigation, including class actions, over the scope
of care that the managed care companies must pay for;
o The fact that the company is dependent upon letters of credit or
other forms of third party security in connection with certain of
its contractual arrangements and, thus, would be adversely
affected in the event it was unable to obtain such credit as
needed;
24
o The fact that certain parties are challenging the validity of
and/or our compliance with HSO contracts and have ceased or may
cease making payments under such contracts;
o Failure to timely and effectively integrate our acquisition of
Wise Optical, decrease its operating losses and profitably manage
its operations in the future ;
o Failure to effectively compete in the marketplace with other
distributors, including an entity created by the former owner of
Wise Optical; and
o Other risks and uncertainties discussed elsewhere in this Form
10-Q and detailed from time to time in our periodic earnings
releases and reports filed with the Securities and Exchange
Commission.
Except as required by law, we undertake no obligation to publicly update or
revise forward-looking statements to reflect events or circumstances after the
date of this Form 10-Q or to reflect the occurrence of unanticipated events.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to market risk from exposure to changes in interest rates
based on our financing activities under our credit facility with CapitalSource,
due to its variable interest rate. The nature and amount of our indebtedness may
vary as a result of future business requirements, market conditions and other
factors. The extent of our interest rate risk is not quantifiable or predictable
due to the variability of future interest rates and financing needs.
We do not expect changes in interest rates to have a material effect on
income or cash flows in the year 2003, although there can be no assurances that
interest rates will not significantly change. A 10% change in the interest rate
payable by us on our variable rate debt would have increased or decreased the
nine-month interest expense by approximately $65,000 assuming that our borrowing
level is unchanged. We did not use derivative instruments to adjust our interest
rate risk profile during the nine months ended September 30, 2003.
ITEM 4: CONTROLS AND PROCEDURES
Our chief executive officer and chief financial officer, after evaluating
the effectiveness of our disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered
by this Quarterly Report on Form 10-Q, have concluded that, based on such
evaluation, our disclosure controls and procedures were adequate and effective
to ensure that material information relating to us, including our consolidated
subsidiaries, was made known to them by others within those entities,
particularly during the period in which this Quarterly Report on Form 10-Q was
being prepared.
There were no changes in our internal control over financial reporting,
identified in connection with the evaluation of such internal control that
occurred during our last fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. Exhibits
The following Exhibits are filed as part of this Quarterly Report
on Form 10-Q:
EXHIBIT DESCRIPTION
------- -----------
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934, as
amended.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934, as
amended.
32 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
25
b. Reports on Form 8-K filed in the period covered by this report:
On August 12, 2003 we filed a Current Report on Form 8-K pursuant to
Item 9 (Regulation FD Disclosures) to furnish a press release reporting
results of our second quarter of fiscal 2003.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be filed on its behalf by the
undersigned, hereunto duly authorized.
Date: November 14, 2003 OPTICARE HEALTH SYSTEMS, INC.
By: /s/ William A. Blaskiewicz
-------------------------------------------
William A. Blaskiewicz
Vice President and Chief Financial Officer
(Principal Financial and Accounting
Officer and duly authorized officer)
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934, as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934, as amended.
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.