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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 JUNE 30, 2004
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 aggregate market value of the registrant's Common Stock held by
non-affiliates of the registrant (without admitting that any person whose shares
are not included in such calculation is an affiliate) computed by reference to
the closing market price as reported on the American Stock Exchange on June 30,
2004, the last business day of the registrant's most recently completed second
fiscal quarter, was $4,116,126.
The number of shares outstanding of the registrant's Common Stock, par
value $.001 per share, at July 31, 2004 was 30,686,800 shares.
INDEX TO FORM 10-Q
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at June 30, 2004,
December 31, 2003, and June 30, 2003, as restated (unaudited) 3
Condensed Consolidated Statements of Operations for the three and
six months ended June 30, 2004 and 2003 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 2004 and 2003 (unaudited) 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matter to a Vote of Security Holders 23
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURE 24
2
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
JUNE 30, DECEMBER 31, JUNE 30,
2004 2003 2003
---------------- ----------------- -----------------
AS RESTATED
See Note 3
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,362 $ 1,695 $ 3,881
Accounts receivable, net 9,031 7,867 9,600
Inventories 5,243 5,770 6,463
Deferred income taxes, current - - 1,660
Assets held for sale 1,115 1,652 1,656
Other current assets 1,090 565 841
---------------- ----------------- -----------------
TOTAL CURRENT ASSETS 18,841 17,549 24,101
---------------- ----------------- -----------------
Property and equipment, net 4,037 4,647 5,551
Goodwill, net 17,892 17,892 19,531
Intangible assets, net 1,124 1,179 1,235
Deferred income taxes, non-current - - 3,320
Assets held for sale, non-current 792 1,339 1,496
Other assets 3,139 3,249 3,028
---------------- ----------------- -----------------
TOTAL ASSETS $ 45,825 $ 45,855 $ 58,262
================ ================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,936 $ 5,525 $8,114
Accrued expenses 6,590 5,379 4,990
Current portion of long-term debt 9,306 10,828 12,395
Liabilities of held for sale business 1,057 1,241 1,389
Other current liabilities 1,022 548 435
---------------- ----------------- -----------------
TOTAL CURRENT LIABILITIES 26,911 23,521 27,323
---------------- ----------------- -----------------
Long-term debt, less current portion 63 1,775 54
Other liabilities 539 512 550
---------------- ----------------- -----------------
TOTAL NON-CURRENT LIABILITIES 602 2,287 604
---------------- ----------------- -----------------
Series B 12.5% mandatorily redeemable, convertible
preferred stock--related party 5,986 5,635 5,317
STOCKHOLDERS' EQUITY:
Series C preferred stock--related party 1 1 1
Common stock 31 30 30
Additional paid-in-capital 79,534 79,700 79,966
Accumulated deficit (67,240) (65,319) (54,979)
--------------- ----------------- -----------------
TOTAL STOCKHOLDERS' EQUITY 12,326 14,412 25,018
--------------- ----------------- -----------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 45,825 $ 45,855 $58,262
=============== ================= =================
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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------------- ----------------------------
2004 2003 2004 2003
------------ ----------- ------------ ------------
NET REVENUES:
Managed vision $ 6,267 $ 7,480 $12,317 $ 14,888
Product sales 17,880 19,174 35,837 36,938
Other services 5,517 4,819 10,460 9,173
Other income 1,098 530 1,718 2,368
------------ ----------- ------------ ------------
Total net revenues $30,762 32,004 60,332 63,367
------------ ----------- ------------ ------------
OPERATING EXPENSES:
Medical claims expense 4,717 5,514 9,360 11,257
Cost of product sales 13,761 14,626 27,963 28,568
Cost of services 2,427 2,043 4,468 3,898
Selling, general and administrative 9,234 9,318 18,017 17,739
Loss from early extinguishment of debt - 1,847 - 1,847
Depreciation 420 359 811 702
Amortization 27 29 56 58
Interest 277 630 596 1,389
------------ ----------- ------------ ------------
Total operating expenses 30,863 34,366 61,271 65,458
------------ ----------- ------------ ------------
Loss from continuing operations before taxes (101) (2,362) (939) (2,091)
Income tax expense (benefit) 46 (183) 52 (72)
------------ ----------- ------------ ------------
Loss from continuing operations (147) (2,179) (991) (2,019)
Discontinued operations (Note 5)
Income (loss) from discontinued operations (including
loss on disposal of $580) in 2004 (810) 9 (929) 5
Income tax expense (benefit) - (3) - (2)
------------ ----------- ------------ ------------
Income (loss) on discontinued operations (810) 6 (929) 3
Net loss (957) (2,173) (1,920) (2,016)
Preferred stock dividends (177) (160) (351) (300)
------------ ----------- ------------ ------------
Net loss to common stockholders $ (1,134) $ (2,333) $(2,271) $ (2,316)
============ =========== ============ ============
LOSS PER SHARE- BASIC AND DILUTED:
Loss from continuing operations $ (0.01) $ (0.08) $ (0.04) $ (0.08)
Discontinued operations (0.03) 0.00 (0.03) 0.00
Net loss (0.04) (0.08) (0.07) (0.08)
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 SIX MONTHS ENDED
JUNE 30,
----------------------------------
2004 2003
--------------- --------------
OPERATING ACTIVITIES:
Net (loss) $ (1,920) $ (2,016)
(Income) loss on discontinued operations 929 (3)
--------------- --------------
Loss from continuing operations (991) $ (2,019)
Adjustments to reconcile net (loss) to net cash provided by (used in)
operating activities:
Depreciation 811 701
Amortization 56 58
Non-cash interest expense 79 855
Non-cash loss on early extinguishment of debt - 1,847
Non-cash gain on contract settlements (530)
Deferred taxes - (180)
Changes in operating assets and liabilities:
Accounts receivable (963) 633
Inventory 528 1,135
Other assets (749) (57)
Accounts payable and accrued expenses 4,802 (3,064)
Other liabilities 466 (59)
Cash provided by discontinued operations 3 39
--------------- --------------
Net cash provided by (used in) operating activities 4,042 (641)
--------------- --------------
INVESTING ACTIVITIES:
Cash received on notes receivable 91 180
Purchase of fixed assets (207) (552)
Refunds of deposits 775
Acquisition of business, net of cash acquired (6,192)
Purchase of restricted certificates of deposit (600)
--------------- --------------
Net cash used in investing activities (116) (6,389)
--------------- --------------
FINANCING ACTIVITIES:
Net increase (decrease) in revolving credit facility (3,097) 8,777
Principal payments on long-term debt (220) (801)
Principal payments on capital lease obligations (11) (28)
Payment of financing costs (25) (209)
Equipment financing 81 -
Proceeds from issuance of common stock 13 86
--------------- --------------
Net cash (used in) provided by financing activities (3,259) 7,825
--------------- --------------
Increase in cash and cash equivalents 667 795
Cash and cash equivalents at beginning of period 1,695 3,086
--------------- --------------
Cash and cash equivalents at end of period $ 2,362 $ 3,881
=============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 528 $ 508
Cash paid for income taxes $ 76 $ 76
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 six months ended June 30, 2004 and 2003 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, as amended, 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 condensed consolidated
financial statements have been included. The results of operations for the three
and six months ended June 30, 2004 are not necessarily indicative of the results
to be expected for the full year. The condensed consolidated balance sheet as of
December 31, 2003 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. MANAGEMENT'S PLAN
The Company incurred net operating losses in 2003 that have continued into 2004,
due primarily to substantial operating losses at Wise Optical which in 2003
resulted in a significant use of cash from operations. The losses at Wise
Optical were initially attributable to significant expenses incurred for
integration, but have continued due to weakness in gross margins and higher
operating expenses resulting from an operating structure built to support higher
sales volume. As a result of the losses at Wise Optical, the Company did not
comply with the minimum fixed charge ratio covenant under the term loan and
revolving credit facility with CapitalSource Finance, LLC as of March 31, 2004
April 30, 2004 or May 31, 2004, which could have allowed CapitalSource to demand
payment in full of the credit facility. However, Capital Source has amended the
terms and covenants of the credit facility, waived current covenant violations
and provided additional credit, which has been guaranteed by Palisades Capital.
In late 2003, the Company began implementing strategies and operational changes
designed to improve the operations of Wise Optical. Those efforts included
developing the Company's sales force, improving customer service, enhancing
productivity, eliminating positions and streamlining the warehouse and
distribution processes. The Company has reduced ongoing costs to better match
the operations and has engaged consultants, who the Company believes will assist
in increasing sales and improving product margins at Wise Optical.
In addition, in 2003 the Managed Vision segment began shifting away from the
lower margin and long sales cycle of the Company's third party administrator
("TPA") style business to the higher margin and shortened sales cycle of a
direct-to-employer business. This new direct-to-employer business also removes
some of the volatility that is often experienced in the Company's TPA-based
revenues. The Company now has the sales force and infrastructure necessary to
expand the direct-to-employer business and expect increased profitability as a
result of this product shift that has lead to new contracts and improved gross
margins. The Company experienced significant improvements in revenue and
profitability in the Consumer Vision segment from 2003 to 2004, largely from
growth in existing store sales and enhanced margins as a result of sales
incentives that the Company expects to continue. OptiCare has also continued to
settle outstanding litigation with positive results through June of 2004.
Although Wise operating losses have continued into 2004, the Company has
generated approximately $4.0 million of cash from operations in the six months
ended June 30, 2004, which has resulted in reductions of senior debt of
approximately $3.3 million and increased borrowing availability to the Company.
In addition, in May 2004, management made the decision to dispose of the
Technology operation, CC Systems. The Company anticipates the sale of that
operation will generate cash proceeds while reducing demands on working capital
and corporate personnel. The Company believes the combination of the above
initiatives executed in the operating segments will continue to improve the
Company's liquidity and should ensure compliance with the CapitalSource
covenants going forward.
6
3. RESTATEMENT
The loan agreement with CapitalSource requires the Company to maintain a
lock-box arrangement with banks whereby amounts received into the lock-boxes are
applied to reduce the revolving credit facility outstanding. The agreement also
contains certain subjective acceleration clauses in the event of a material
adverse event.
Subsequent to the issuance of the Company's consolidated financial
statements for the year ended December 31, 2003, the Company's management
determined that the amounts outstanding pursuant to certain provisions contained
in the credit facility should have been classified as current liabilities rather
than long-term debt, pursuant to the provisions of consensus 95-22 issued by the
Financial Accounting Standards Board Emerging Issues Task Force. Accordingly,
the accompanying balance sheets have been restated to reflect the
reclassification of the amounts outstanding pursuant to this credit facility as
current liabilities.
A summary of the significant effects of the restatement is as follows:
AS OF JUNE 30, 2003
----------------------------
AS PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
Current Portion of Long Term Debt 2,061 12,395
Long Term Debt Less Current Portion 10,388 54
Current Liabilities 16,989 27,323
Non-current Liabilities 10,938 604
4. STOCK BASED COMPENSATION
The Company accounts for its stock-based compensation plans under Accounting
Principles Board 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.
Statement of Financial Standards ("SFAS") No. 123 "Accounting for
Stock-Based Compensation, as amended by SFAS No. 148 "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of Statement of Financial
Accounting Standards No. 123" requires that companies which do not elect to
account for stock-based compensation as prescribed by this statement, disclose
the pro forma effects on earnings and earnings per share as if SFAS No. 123 had
been adopted. If the Company applied the recognition provisions of SFAS No. 123,
the Company's reported net loss and loss per share, using the Black Scholes
option pricing model, would have been adjusted to the pro forma amounts
indicated below.
THREE MONTHS ENDED JUNE SIX MONTHS ENDED
30, JUNE 30,
--------------------------- --------------------------
2004 2003 2004 2003
----------- ------------ ----------- -----------
Net loss, as reported $ (957) $ (2,173) $ (1,920) $ (2,016)
Less: Total stock-based employee compensation
expense, net of related tax effects, determined (37) (114) (59) (222)
under the fair value method for all awards
----------- ------------ ----------- -----------
Pro forma net loss $ (994) $(2,287) $ (1,979) $ (2,238)
=========== ============ =========== ===========
Basic and diluted net loss per share:
As reported $ (0.03) $ (0.08) $ (0.07) $ (0.08)
Pro forma (0.03) (0.08) (0.08) $ (0.09)
7
5. DISCONTINUED OPERATIONS - CC SYSTEMS
In May 2004, the Company's Board of Directors approved management's plan
to exit the technology business (formerly reported in the Distribution and
Technology segment) and dispose of the Company's CC Systems division. The
Company expects to complete the sale of the net assets of CC Systems within
the next six months. In accordance with SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets," the disposal of CC Systems is
accounted for as a discontinued operation. During the quarter ended June 30,
2004, the Company recorded a $580 loss on disposal of discontinued
operations based on the estimated fair value of the net assets held for
sale. Amounts in the financial statements and related notes for all periods
presented have been reclassified to reflect treatment as held for sale.
The carrying amount of the assets and liabilities of the disposal group
held for sale at June 30, 2004, December 31, 2003 and June 30, 2003 were as
follows:
June 30, December 31, June 30,
2004 2003 2003
---------- ------------ ----------
Assets:
Accounts receivable $ 1,019 $ 1,502 $ 1,577
Inventory 84 148 72
Property and equipment, net 19 36 58
Intangible assets, net 773 1,303 1,333
Other assets 12 2 112
---------- ------------ ----------
Total assets $ 1,907 $ 2,991 $ 3,152
========== ============ ==========
Liabilities:
Accounts payable $ 91 $ 119 $ 45
Accrued expenses 116 129 188
Other liabilities 850 993 1,156
---------- ------------ ----------
Total liabilities $1,057 $ 1,241 $ 1,389
========== ============ ==========
Operating results of the discontinued operations are as follows:
Three Months Ended Six months Ended
June 30, June 30,
-------------------------- ----------------------------
2004 2003 2004 2003
----------- ----------- ------------ ------------
Net revenues $ 455 $ 921 $ 1,077 $ 1,596
=========== =========== ============ ============
Income (loss) from discontinued operations before income
taxes $ (230) $ 9 $ (349) $ 5
Income tax expense - 3 - 2
----------- ----------- ------------ ------------
Income (loss) from discontinued operations (230) 6 (349) 3
Loss on disposal of discontinued operations (580) - (580) -
----------- ----------- ------------ ------------
Total income (loss) from discontinued operations $ (810) $ 6 $ (929) $ 3
=========== =========== ============ ============
Income (loss) per share from discontinued operations $ (0.03) $ 0.00 $ (0.03) $ 0.00
=========== =========== ============ ============
8
6. RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the Financial Accounting Standards Board ratified the
consensus reached in Emerging Issues Task Force ("EITF") Issue 03-6
"Participating Securities and the Two-Class Method under FAS 128." EITF 03-6
supersedes the guidance in Topic No, D-95, Effect of Participating Convertible
Securities on the Computation of Basic Earnings per Share, and requires the use
of the two-class method for participating securities. The two-class method is an
earnings allocation formula that determines earnings per share for each class of
common stock and participating security according to dividends declared (or
accumulated) and participation rights in undistributed earnings. In addition,
EITF Issue 03-6 addresses other forms of participating securities, including
options, warrants, forwards and other contracts to issue an entity's common
stock, with the exception of stock-based compensation (unvested options and
restricted stock) subject to the provisions of Opinion 25 and FAS 123, EITF
Issue 03-6 is effective for reporting periods beginning after March 31, 2004 and
should be applied by restating previously reported earnings per share. The
adoption of EITF Issue 03-6 did not have a material impact on the Company's
condensed consolidated financial statements.
7. 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 results
of operations of Wise Optical are included in the consolidated financial
statements from February 1, 2003, the effective date of the acquisition for
accounting purposes.
Assuming the acquisition of Wise Optical had occurred on January 1, 2003,
pro forma net revenue, net loss from continuing operations and net loss of the
Company for the six months ended June 30, 2003 would have been $70,045, $1,869
and $1,866, respectively. On the same pro forma basis, basic and diluted loss
per common share for the six months ended June 30, 2003 would have been $0.07.
This unaudited pro forma information 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.
8. INTANGIBLE ASSETS
Intangible assets subject to amortization are comprised of a service
agreement and non-compete agreements. The fifteen year service agreement has a
gross carrying amount of $1,658 and accumulated amortization of $534, $479 and
$424 at June 30, 2004, December 31, 2003 and June 30, 2003, respectively. The
non-compete agreements, which had a gross carrying amount of $265, were fully
amortized at June 30, 2004 and December 31, 2003 and had accumulated
amortization of $234 at June 30, 2003. Amortization expense for the three months
ended June 30, 2004 and 2003 was $28 and $44, respectively, and for the six
months ended June 30, 2004 and 2003 was $55 and $88, respectively. Estimated
annual amortization expense is expected to be $111 in each of the years 2004
through 2008.
9. DEBT
The Company's revolving credit facility requires a lockbox arrangement,
which provides for all receipts to be swept daily to reduce borrowings
outstanding under the credit facility. This arrangement, combined with the
existence of a subjective acceleration clause in the revolving credit facility,
necessitates the revolving credit facility be classified a current liability on
the balance sheet in accordance with FASB's Emerging Issues Task Force Issue
No. 95-22, "Balance Sheet Classification of Borrowings Outstanding under
Revolving Credit Agreements that Include Both a Subjective Acceleration Clause
and a Lock-Box Arrangement" ("EITF 95-22").
The Company has classified its revolving debt with CapitalSouce, its senior
lender, totaling $9,222 as of June 30, 2004, as a current liability. On August
16, 2004, however, the Company and CapitalSource amended the loan
9
agreement and in connection with this amendment, the Company received a waiver
from CapitalSource for any non-compliance of this covenant as of March 31, 2004,
April 30, 2004, May 31, 2004 and June 30, 2004 (see Note 14 for a discussion of
the amendment and waiver).
In addition, on August 27, 2004, the Company amended its loan agreement with
CapitalSource to eliminate a material adverse change as an event of default or
to prevent further advances under the loan agreement. This amendment eliminates
the lender's ability to declare a default based upon subjective criteria as
described in consensus 95-22 issued by the Financial Accounting Standards Board
Emerging Issues Task Force. Palisade Concentrated Equity Partnership, L.P.,
provided a $1,000 guarantee against the loan balance due to CapitalSource
related to this amendement.
10. SEGMENT INFORMATION
The Company is an integrated eye care services company focused on providing
managed vision and professional eye care products and services. The Company has
the following three reportable operating segments: (1) Managed Vision, (2)
Consumer Vision, and (3) Distribution. The Distribution segment, formerly known
as Distribution and Technology, was renamed in May 2004 in connection with the
Company's decision to dispose of its Technology business (see Note 5). These
operating segments are managed separately, offer separate and distinct products
and services, and serve different customers and markets, although there is some
cross-marketing and selling between the segments. 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
in Connecticut where comprehensive eye care services are provided to patients.
The Distribution 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, and (ii) a Buying Group program, which provides group
purchasing arrangements for optical and ophthalmic goods and supplies.
In addition to its reportable operating segments, the Company's "All Other"
category includes other non-core operations and transactions, which do not meet
the quantitative thresholds for a reportable segment. Included in the "All
Other" category is revenue earned under the Company's health service
organization ("HSO") operation, which receives fee income for providing certain
support services to individual ophthalmology and optometry practices. The
Company is in the process of disengaging from its HSO arrangements.
Management assesses the performance of its segments based on income before
income taxes, interest expense, depreciation and amortization, and other
corporate overhead. Summarized financial information, by segment, for the three
and six months ended June 30, 2004 and 2003 is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------ -------------
REVENUES:
Managed vision $ 6,267 $ 7,480 $12,317 $ 14,888
Consumer vision 8,768 7,796 16,911 15,102
Distribution 16,705 17,448 33,091 33,235
------------ ------------ ------------ -------------
Reportable segment totals 31,740 32,724 62,319 63,225
All other 891 573 1,524 2,434
Elimination of inter-segment revenues (1,869) (1,293) (3,511) (2,292)
------------ ------------ ------------ -------------
Total net revenue $ 30,762 $ 32,004 $ 60,332 $ 63,367
============ ============ ============ =============
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE TAX:
Managed vision $239 $ 643 $ 406 $1,069
Consumer vision 1,130 836 2,061 1,432
Distribution (376) (779) (1,187) (1,067)
------------ ------------ ------------ -------------
Reportable segment totals 993 700 1,280 1,434
All other 756 334 1,180 2,012
Loss from extinguishment of debt - (1,847) - (1,847)
Depreciation (420) (359) (811) (702)
Amortization (27) (29) (56) (58)
Interest expense (277) (630) (596) (1,389)
Corporate (1,126) (531) (1,938) (1,541)
------------ ------------ ------------ -------------
Loss from continuing operations
before tax $ (101) $ (2,362) $ (939) $ (2,091)
============ ============ ============ =============
10
11. LOSS ON EXTINGUISHMENT OF DEBT
On May 12, 2003, the Company recorded a $1.8 million loss on the exchange of
$16.2 million of debt for Series C Preferred Stock. The $1.8 million loss
represents the write-off of the deferred financing fees and debt discount
associated with the extinguished debt.
12. EARNINGS (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- ------------------------------
2004 2003 2004 2003
-------------- ------------- ------------- -------------
EARNINGS (LOSS) PER SHARE:
Loss from continuing operations $ (147) $ (2,179) (991) $ (2,019)
Preferred stock dividend (177) (160) (351) (300)
-------------- ------------- ------------- -------------
Loss from continuing operations to common (324) (2,339) (1,342) (2,319)
stockholders
Discontinued operations (810) 6 (929) 3
-------------- ------------- ------------- -------------
Net loss to common stockholders $ (1,134) $ (2,333) $ (2,271) $ (2,316)
============== ============= ============= =============
Weighted average common shares outstanding--
Basic and diluted 30,663,562 30,013,991 30,526,227 29,779,834
Earnings (loss) per share--basic and diluted:
Loss from continuing operations to common
stockholders $ (0.01) $ (0.08) $ (0.04) $ (0.08)
Discontinued operations $ (0.02) $ 0.00 $ (0.03) $ 0.00
Net loss to common stockholders $ (0.03) $ (0.08) $(0.07) $ (0.08)
The following table reflects the potential common shares of the Company at
June 30, 2004 and 2003 that have been excluded from the calculation of diluted
earnings per share for the three and six month periods due to anti-dilution.
2004 2003
--------------- --------------
Options 6,076,685 6,132,066
Warrants 3,125,000 3,125,000
Convertible Preferred Stock 63,065,507 58,302,314
--------------- --------------
72,267,192 67,559,380
=============== ==============
13. 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 June 30, 2004 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.
11
14. SUBSEQUENT EVENTS
As a result of operating losses of Wise Optical, the Company did not meet
its minimum fixed charge ratio covenant under its loan agreement with
CapitalSource as of March 31, 2004, April 30, 2004 or May 31, 2004. On August
16, 2004, the Company received a waiver from CapitalSource for any
non-compliance with this covenant as of March 31, 2004, April 30, 2004, May 31,
2004 and June 30, 2004. The Company and CapitalSource also amended the term
loan and revolving credit facility with CapitalSource to, among other things,
extend the maturity date of the revolving credit facility from January 25, 2006
to January 25, 2007, (ii) provide access to a $2,000 temporary over-advance
bearing interest at prime plus 5 1/2%, and in no event less than 6%, which is to
be repaid in eleven monthly installments of $100 (principal and interest)
commencing on October 1, 2004 with the remaining balance to be repaid in full by
August 31, 2005, which is guaranteed by the Company's largest stockholder,
Palisade Concentrated Equity Partnership, L.P., (iii) change the fixed charge
ratio covenant from 1.5 to 1 to not less than 1 and to extend the next test
period for this covenant to March 31, 2005, (iv) decrease the minimum tangible
net worth financial covenant from $(2,000) to $(3,000) and (v) add a debt
service coverage ratio covenant of between 0.7 to 1.0. In addition, the waiver
and amendment increased the termination fee payable if the Company terminates
the revolving credit facility by 2% and increased the yield maintenance amount
payable, in lieu of the termination fee, if the Company terminates the revolving
credit facility pursuant to a refinancing with another commercial financial
institution, by 2%. The yield maintenance amount was also changed to 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, 2007 and (ii) the
total interest and fees actually paid to CapitalSource on the revolving credit
facility prior to the termination or repayment date. The Company agreed to pay
CapitalSource $25 in financing fees in connection with this waiver and
amendment.
In addition, on August 27, 2004, the Company amended its loan agreement with
CapitalSource to eliminate a material adverse change as an event of default or
to prevent further advances under the loan agreement. This amendment eliminates
the lender's ability to declare a default based upon subjective criteria as
described in consensus 95-22 issued by the Financial Accounting Standards Board
Emerging Issues Task Force. Palisade Concentrated Equity Partnership, L.P.,
provided a $1,000 guarantee against the loan balance due to CapitalSource
related to this amendment.
12
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/A for the year ended December 31, 2003, 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.
In September 2003, we began implementing strategies and operational changes
to improve operating results at Wise Optical. These strategies included growing
sales through improved customer service, improving gross margin through pricing
discipline and active purchasing strategies as well as reducing operating
expenses through the elimination of positions and tightening of expense
policies. In the first quarter of 2004, as a result of these strategies, Wise
Optical reduced operating expenses. We expect modest improvement in the
operating results of Wise Optical in the future as we continue executing these
strategies.
In May 2004, our Board of Directors approved management's plan to exit and
dispose of our Technology business, CC Systems. We expect to complete the sale
of the net assets of CC Systems within the next six months. In accordance with
Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for the
impairment or Disposal of Long-Lived Assets," the disposal of CC Systems is
accounted for as a discontinued operation.
Our business is comprised of three reportable operating segments: (1)
Managed Vision, (2) Consumer Vision, and (3) Distribution. The Distribution
segment, formerly known as Distribution and Technology, was renamed in May 2004
in connection with our decision to dispose of our Technology business. 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 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 and (ii) a Buying Group program, which provides
group purchasing arrangements for optical and ophthalmic goods and supplies.
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. We are in the process of
disengaging from our HSO arrangements.
As a result of our non-compliance with the fixed charge ratio covenant under
our term loan and revolving credit facility with CapitalSource Finance, LLC, on
August 16, 2004, our term loan and revolving credit facility with CapitalSource
was amended to, among other things, waive our non-compliance with this covenant,
extend the maturity date of the revolving credit facility to January 25, 2007
and provide us a $2.0 million temporary over-advance.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2004 Compared to the Three Months Ended June 30,
2003
Managed Vision revenue. Managed Vision revenue represents fees received
under our managed care contracts. Managed Vision revenue decreased to
approximately $6.3 million for the three months ended June 30, 2004 compared to
approximately $7.5 million for the three months ended June 30, 2003, a decrease
of approximately $1.2 million or 16.4%. This decrease resulted from
approximately $1.2 million in lost revenue from terminated contracts, primarily
as a result of changes made by the Texas state legislature to its Medicaid and
Children's Health Insurance Programs, and $0.8 million of lost revenues
resulting from a decline in membership in existing contracts with one of our
large health plan customers, which were partially offset by increases in revenue
of approximately $0.7 million from new contracts
13
and approximately $0.1 million from net growth in existing contracts. We expect
the decrease in revenue associated with our large health plan customer contracts
to be more than offset by revenue under new contracts with different payors,
which became effective in 2004. We expect managed vision revenue to increase in
the future as we enter into new direct-to-employer contracts.
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 the sale of contact and ophthalmic lenses through Wise
Optical. Product sales revenue decreased to approximately $17.9 million for the
three months ended June 30, 2004 compared to approximately $19.2 million for the
three months ended June 30, 2003, a decrease of approximately $1.3 million or
6.6%. This represents a decrease in revenue from Wise Optical of approximately
$1.0 million and a decrease in revenue from the Buying Group of approximately
$0.5 million, which were partially offset by an increase in revenue from
Consumer Vision of approximately $0.2 million. The decrease in Wise Optical
revenue was primarily due to a decrease in sales volume that we experience after
we purchased Wise Optical. In September 2003, we began implementing strategies
to increase sales at Wise Optical and we have experienced improved revenue since
we began that initiative. We expect future sales at Wise Optical to approximate
current levels, adjusted for seasonal fluctuations. The decrease in Buying Group
revenue is due to a decrease in purchasing volume primarily due to the loss of
the business of Optometric Eye Care Center, P.A., which occurred during the
second quarter of 2003. We expect product sales of the Buying Group to
approximate current levels for the remainder of the year, adjusted for
seasonality. The increase in Consumer Vision product sales is primarily due to
an increase in purchasing volume associated with an improved sales force and
increased sales of higher value products through incentive programs and product
promotions. We expect Consumer Vision product sales to continue to increase
throughout the year, adjusted for seasonal fluctuations.
Other services revenue. Other services revenue primarily represents revenue
earned from providing eye care services in our Consumer Vision segment. Other
services revenue increased to approximately $5.5 million for the three months
ended June 30, 2004 compared to approximately $4.8 million for the three months
ended June 30, 2003, an increase of approximately $0.7 million or 14.6%. This
increase is primarily due to increased services volume in the Consumer Vision
segment, primarily in the medical services area, and is attributable to
increased doctor coverage and productivity. We expect services revenue to remain
at these levels or increase slightly in the future, adjusted for seasonality.
Other income. Other income represents non-recurring settlements on
contracts. Other income increased to approximately $1.1 million for the three
months ended June 30, 2004 compared to approximately $0.5 million for the three
months ended June 30, 2003, an increase of approximately $0.6 million or 120%.
This increase is due to an increase in HSO contract settlements of approximately
$0.3 million and the settlement of a buying group contract of approximately $0.2
million in 2004.
Medical claims expense. Medical claims expense decreased to approximately
$4.7 million for the three months ended June 30, 2004, from approximately $5.5
million for the three months ended June 30, 2003, a decrease of approximately
$0.8 million or 14.5%. The medical claims expense loss ratio (MLR) representing
medical claims expense as a percentage of Managed Vision revenue increased to
75.4% for the quarter ended June 30, 2004 from 73.7% for the quarter ended June
30, 2003. The change in MLR is a result of changes to existing contracts along
with the claims expense associated with new contracts. We expect claims expense
to increase in the future as we enter into additional direct-to-employer
contracts.
Cost of product sales. Cost of product sales decreased to approximately
$13.8 million for the three months ended June 30, 2004 compared to approximately
$14.6 million for the three months ended June 30, 2003, a decrease of
approximately $0.8 million or 5.5%. This decrease is primarily due to a decrease
in Wise Optical product costs of approximately $0.5 million and a decrease in
Buying Group product costs of approximately $0.5 million, which were partially
offset by an increase in product costs in Consumer Vision of approximately $0.2
million. The decrease in Wise Optical and Buying Group product costs is due to
the decrease in sales volume, while the increase in Consumer Vision product
costs is due to an increase in sales volume.
Cost of services. Cost of services increased to approximately $2.4 million
for the three months ended June 30, 2004 compared to approximately $2.0 million
for the three months ended June 30, 2003, an increase of approximately $0.4
million or 20%. This increase in cost is primarily due to the increased medical
services volume in the Consumer Vision area.
14
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased to approximately $9.2 million for the three
months ended June 30, 2004 compared to approximately $9.3 million for the three
months ended June 30, 2003, a decrease of approximately $0.1 million or 1.1%.
The decrease in 2004 is primarily due to a decrease in compensation expense
associated with the staff reductions which occurred at Wise Optical during the
integration of that business.
Loss from early extinguishment of debt. The approximate $1.8 million loss
from early extinguishment of debt for the three months ended June 30, 2003,
represents the write-off of deferred debt issuance costs and debt discount
associated with the exchange of approximately $16.2 million of debt for Series C
Preferred Stock, which occurred on May 12, 2003.
Interest expense. Interest expense decreased to approximately $0.3 million
for the three months ended June 30, 2004 from approximately $0.6 million for the
three months ended June 30, 2003, a decrease of approximately $0.3 million or
50%. This decrease in interest expense is primarily due to a decrease in the
average outstanding debt balance mainly as a result of the conversion of
approximately $16.2 million of debt to preferred stock in May 2003.
Income tax expense. Income tax expense recorded for the three months ended
June 30, 2004 of less than $0.1 million primarily represents minimum state tax
expense. We recorded an income tax benefit of approximately $0.2 million for the
three months ended June 30, 2003, representing a tax benefit on the loss from
continuing operations at the statutory rate after adjusting for non-deductible
expenses.
Discontinued operations. In May 2004, our Board of Directors approved
management's plan to dispose of our Technology business, CC Systems, and in
accordance with SFAS No. 144 this business is reported as a discontinued
operation. The loss on discontinued operations of approximately $0.9 million for
the three months ended June 30, 2004 includes an estimated loss on disposal of
approximately $0.6 million, based on the estimated fair value of the net assets
held for sale, and the loss from operations of CC Systems during the quarter of
approximately $0.2 million.
Six Months Ended June 30, 2004 Compared to the Six Months Ended June 30, 2003
Managed Vision revenue. Managed Vision revenue represents fees received
under our managed care contracts. Managed Vision revenue decreased to
approximately $12.3 million for the six months ended June 30, 2004 compared to
approximately $14.9 million for the six months ended June 30, 2003, a decrease
of approximately $2.6 million or 17.4%. This decrease resulted from
approximately $2.5 million of lost revenue from terminated contracts, primarily
as a result of changes made by the Texas state legislature to its Medicaid and
Children's Health Insurance Programs, and $1.4 million of lost revenues
resulting from a decline in membership in existing contracts with one of our
large health plan customers, which were partially offset by increases in revenue
of approximately $1.0 million from new contracts and approximately $0.3 million
from net growth in existing contracts.
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 the sale of contact and ophthalmic lenses through Wise
Optical. Product sales revenue decreased to approximately $35.8 million for the
six months ended June 30, 2004 compared to approximately $36.9 million for the
six months ended June 30, 2003, a decrease of approximately $1.1 million or
3.0%. This decrease primarily represents a decrease in Buying Group revenue of
$1.3 million, which was partially offset by a decrease in Consumer Vision
revenue of $0.4 million. The decrease in Buying Group revenue is due to a
decrease in purchasing volume primarily due to the loss of the business of
Optometric Eye Care Center, P.A., which occurred in the second quarter of 2003.
The increase in Consumer Vision product sales is primarily due to an increase in
purchasing volume associated with an improved sales force and increased sales of
higher value products through incentive programs and product promotions.
Other services revenue. Other services revenue primarily represents revenue
earned from providing eye care services in our Consumer Vision segment. Other
services revenue increased to approximately $10.5 million for the six months
ended June 30, 2004 compared to approximately $9.2 million for the six months
ended June 30, 2003, an increase of approximately $1.3 million or 14.1%. This
increase is primarily due to increased services volume in the medical, optometry
and surgical areas attributable to increased doctor coverage and productivity.
Other income. Other income represents non-recurring settlements on
contracts. Other income for the six months ended June 30, 2004 was approximately
$1.7 million compared to approximately $2.4 million for the six months ended
June 30, 2003, representing a decrease of approximately $0.7 million or 29.3%.
This decrease is primarily due to a
15
decrease in HSO contract settlements of approximately $0.9 million, which was
partially offset by the settlement of a buying group contract of approximately
$0.2 million.
Medical claims expense. Medical claims expense decreased to approximately
$9.4 million for the six months ended June 30, 2004, from approximately $11.3
million for the six months ended June 30, 2003, a decrease of approximately $1.9
million or 16.9%. The MLR increased to 76.1% in 2004 from 75.6% in 2003. The
change in MLR is a result of changes to existing contracts along with the claims
expense associated with new contracts.
Cost of product sales. Cost of product sales decreased to approximately
$28.0 million for the six months ended June 30, 2004 compared to approximately
$28.6 million for the six months ended June 30, 2003, a decrease of
approximately $0.6 million or 2.1%. This decrease is primarily due to a decrease
in product costs of the Buying Group of approximately $1.3 million, which was
partially offset by an increase in product costs of Wise Optical of
approximately $0.4 million and an increase in product costs in Consumer Vision
of approximately $0.3 million. The decrease in Buying Group costs is driven by
the decrease in Buying Group sales. The increase in product costs of Consumer
Vision is due to the related increase in sales in this division. During 2003,
product cost at Wise Optical included a write-up of inventory to fair value due
to a purchase accounting adjustment related to the acquisition of Wise Optical.
Cost of services. Cost of services increased to approximately $4.5 million
for the six months ended June 30, 2004 compared to approximately $3.9 million
for the six months ended June 30, 2003, an increase of approximately $0.6
million or 15.1%. This increase is primarily due to the increased services
volume in the Consumer Vision area.
Selling, general and administrative expenses. Selling, general and
administrative expenses remained relatively unchanged at $18.0 million for the
six months ended June 30, 2004 compared to approximately $17.8 million for the
six months ended June 30, 2003, an increase of approximately $0.2 million or
1.1%.
Loss from early extinguishment of debt. The approximate $1.8 million loss
from early extinguishment of debt for the six months ended June 30, 2003,
represents the write-off of deferred debt issuance costs and debt discount
associated with the exchange of approximately $16.2 million of debt for Series C
Preferred Stock, which occurred on May 12, 2003.
Interest expense. Interest expense decreased to approximately $0.6 million
for the six months ended June 30, 2004 from approximately $1.4 million for the
six months ended June 30, 2003, a decrease of approximately $0.8 million or
57.1%. This decrease in interest expense is primarily due to a decrease in the
average outstanding debt balance mainly as a result of the conversion of
approximately $16.2 million of debt to preferred stock in May 2003.
Income tax expense. Income tax expense of less than $0.1 million recorded
for the six months ended June 30, 2004 primarily represents minimum state tax
expense. The income tax benefit of less than $0.1 million for the six months
ended June 30, 2003, represented a tax benefit on the loss from continuing
operations at the statutory rate after adjusting for non-deductible expenses.
Discontinued operations. In May 2004, our Board of Directors approved
management's plan to dispose of our Technology business, CC Systems, and in
accordance with SFAS No. 144 this business is reported as a discontinued
operation. The loss on discontinued operations of approximately $0.9 million for
the six months ended June 30, 2004 includes an estimated loss on disposal of
approximately $0.6 million, based on the estimated fair value of the net assets
held for sale, and the loss from operations of CC Systems during the period of
approximately $0.3 million.
CRITICAL ACCOUNTING POLICIES
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. . The accounting policies
and judgments, estimates and assumptions are described in greater detail in the
Company's Annual Report on Form 10-K/A in the "Critical Accounting Policies and
Estimates" of Managements Discussion and Analysis and in Note 4 to the
Consolidated Financial Statements for the year ended December 31, 2003.
16
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.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Our primary sources of liquidity have been cash flows generated from
operations in our Managed Vision and Consumer Vision segments, other income from
litigation settlements and borrowings under our term loan and revolving credit
facility with CapitalSource Finance LLC. We have continued to settle
outstanding litigation with positive results through June 2004.
As of June 30, 2004, we had cash and cash equivalents of approximately $2.4
million and additional availability under our revolving credit facility with
CapitalSource of approximately $2.6 million.
As a result of operating losses at Wise Optical, we were not in compliance
with the minimum fixed charge ratio covenant under our term loan and revolving
credit facility with CapitalSource as of March 31, 2004. In addition, we were
not in compliance with this covenant as of April 30 or May 31 2004. As discussed
below, we amended our term loan and revolving credit facility with CapitalSource
on August 16, 2004 and received a waiver from CapitalSource for any
non-compliance with this covenant as of March 31, 2004, April 30, 2004, May 31,
2004 and June 30, 2004.
The following table sets forth a year-over-year comparison of the
components of our liquidity and capital resources for the quarters ended June
30, 2004 and 2003:
(In millions)
$
2004 2003 CHANGE
---- ---- ------
Cash and cash equivalents $ 2.4 $3.9 $ (1.5)
Cash provided by (used in):
Operating activities $4.0 $(0.6) $4.6
Investing activities $(0.1) $(6.4) $(6.3)
Financing activities $(3.3) $7.8 $(11.1)
Net cash provided by operating activities was approximately $4.0 million for
the six months ended June 30, 2004 compared to approximately $0.6 million of net
cash used in operating activities for the six months ended June 2003. Net cash
provided by operating activities in 2004 included a net loss from continuing
operations of approximately $1.0 million, which was offset by $0.9 million of
non-cash charges for depreciation, amortization and interest. The remaining $4.0
million of net cash provided by operating activities was primarily due to
increases in accounts payable and accrued expenses. Net cash provided by
operating activities in 2003 included a loss from continuing operations of
approximately $2.0 million, which was offset by $3.5 million of non-cash charges
for depreciation, amortization, interest and early extinguishment of debt. The
remaining $0.9 million of net cash used in operating activities was primarily
due to a decrease in accounts payable and accrued expenses of $3.0 million
offset by increases in accounts receivable and inventory of $1.1 million and
$0.6 million respectively.
Net cash used in investing activities was approximately $0.1 million for
the six months ended June 30, 2004 compared to approximately $6.4 million for
the six months ended June 30, 2003. Net cash used in investing activities in
2004 included $0.2 million of fixed asset purchases, partially offset by $0.1
million of payments received on notes receivable. Net cash used in investing
activities in 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 in connection with establishing our
captive insurance company and $0.6 million used to purchase fixed assets.
17
These uses of cash were offset by $0.9 million of cash resulting from refunds of
escrow deposits and payments on our notes receivable.
Net cash used in financing activities was approximately $3.3 million for the
six months ended June 30, 2004 compared to approximately $7.8 million of net
cash provided by financing activities for the six months ended June 30, 2003.
Net cash used in financing activities in 2004 was primarily used for repayments
under our revolving credit facility and term loan with our senior lender. Net
cash provided by financing activities in 2003 was primarily from borrowings
under our revolving credit facility to fund the purchase of Wise Optical in
February 2003.
We believe that our cash flow from operations, borrowings under our amended
credit facility with CapitalSource, operating and capital lease financing, and
other short-term financing arrangements will provide us with sufficient funds to
finance our operations for the next 12 months. In late 2003, we began
implementing strategies and operational changes designed to improve the
operations of Wise Optical. Those efforts included developing our sales force,
improving customer service, enhancing productivity, eliminating positions and
streamlining our warehouse and distribution processes. We have reduced ongoing
costs to better match the operations and have engaged consultants, who we
believe will assist us in increasing sales and improving product margins at Wise
Optical.
In addition, in 2003 our Managed Vision segment began shifting away from the
lower margin and long sales cycle of our third party administrator (TPA) style
business to the higher margin and shortened sales cycle of a direct-to-employer
business. This new direct-to-employer business also removes some of the
volatility that is often experienced in our TPA-based revenues. We now have the
sales force and infrastructure necessary to expand our direct-to-employer
business and expect increased profitability as a result of this product shift,
which has lead to new contracts and improved gross margins. We experienced
significant improvements in revenue and profitability in our Consumer Vision
segment from 2003 to 2004, largely from growth in existing store sales and
enhanced margins as a result of sales incentives, which we expect to continue.
We have continued to settle outstanding litigation with positive results through
June of 2004. In May 2004, management made the decision to dispose of our
Technology operations, CC Systems. We anticipate the sale of that operation will
generate cash proceeds while reducing demands on working capital and corporate
personnel. We believe the combination of the above initiatives executed in our
operating segments will lead to improved liquidity.
However, if we incur additional operating losses and we continue to fail to
comply with our financial covenants or otherwise default on our debt, our
creditors could foreclose on our assets, in which case we would be obligated to
seek alternate sources of financing. There can be no assurance that alternate
sources of financing will be available to us on terms acceptable to us, if at
all. If 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 and may have a material adverse impact on our business
and operations.
The CapitalSource Loan and Security Agreement
As of June 30, 2004, we had approximately $1.9 million of borrowings
outstanding under our term loan with CapitalSource, approximately $7.3 million
of advances outstanding under our revolving credit facility with CapitalSource
and approximately $2.6 million of additional availability under our revolving
credit facility.
As a result of continued operating losses incurred at Wise Optical, we were
not in compliance with the minimum fixed charge ratio covenant as of March 31,
2004 under our term loan and revolving credit facility with CapitalSource. In
addition, we were not in compliance with this covenant as of April 30, 2004 or
May 31, 2004, but were in compliance with the covenant as of June 30, 2004. In
connection with a waiver and amendment to the term loan and revolving credit
facility with CapitalSource entered into on August 16, 2004, we received a
waiver from CapitalSource for any non-compliance with this covenant as of March
31, 2004, April 30, 2004, May 31, 2004 and June 30, 2004.
18
The August 16, 2004 waiver and amendment also amended the term loan and
revolving credit facility to, among other things, extend the maturity date of
the revolving credit facility from January 25, 2006 to January 25, 2007, (ii)
provide access to a $2.0 million temporary over-advance bearing interest at
prime plus 5 1/2%, and in no event less than 6%, which is to be repaid in eleven
monthly installments of $100,000 commencing on October 1, 2004 with the
remaining balance to be repaid in full by August 31, 2005, (iii) change the
fixed charge ratio covenant from between 1.5 to 1 to not less than 1 and to
extend the next test period for this covenant to March 31, 2005, (iv) decrease
the minimum tangible net worth financial covenant from $(2.0) million to $(3.0)
million and (v) add a debt service coverage ratio covenant of between 0.7 to
1.0. In addition, the waiver and amendment increased the termination fee payable
if we terminate the revolving credit facility by 2% and increased the yield
maintenance amount payable, in lieu of the termination fee, if we terminate the
revolving credit facility pursuant to a refinancing with another commercial
financial institution, by 2%. The yield maintenance amount was also changed to
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, 2007 and (ii)
the total interest and fees actually paid to CapitalSource on the revolving
credit facility prior to the termination or repayment date. We agreed to pay
CapitalSource $25,000 in financing fees in connection with this waiver and
amendment.
In addition, on August 27, 2004, the Company amended its loan agreement
with CapitalSource to eliminate a material adverse change as an event of default
or to prevent further advances under the loan agreement. This amendment
eliminates the lender's ability to declare a default based upon subjective
criteria as described in consensus 95-22 issued by the Financial Accounting
Standards Board Emerging Issues Task Force. Palisade Concentrated Equity
Partnership, L.P., provided a $1,000 guarantee against the loan balance due to
CapitalSource related to this amendment.
The term loan and revolving credit facility with CapitalSource are
subject to a second amended and restated revolving credit, term loan and
security agreement, as amended August 16, 2004. The revolving cedit, term 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, as discussed above 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. As discussed
above, we have not complied with our fixed charge ratio covenant in the past.
Pursuant to the revolving credit, term loan and security agreement, as
amended on August 16, 2004, our term loan with CapitalSource matures on January
25, 2006 and our revolving credit facility matures on January 25, 2007. We are
required to make monthly principal payments of $25,000 on the term loan with the
balance due at maturity. Although we may borrow up to $15 million under the
revolving credit facility, the maximum amount that may be advanced is limited to
the value derived from applying advance rates to eligible accounts receivable
and inventory. The advance rate under our revolving credit facility is 85% of
all eligible accounts receivable and 50 to 55% of all eligible inventory. As of
June 30, 2004, the net advances to the Company were $7,297,000. 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 6.0%).
If we terminate the revolving credit facility prior to December 31, 2005, we
must pay CapitalSource a termination fee of $600,000. If we terminate the
revolving credit facility after December 31, 2005 but prior to the expiration of
the revolving credit facility the termination fee is $450,000. Additionally, if
we terminate the revolving credit facility pursuant to a refinancing with
another commercial financial institution, we must pay CapitalSource, in lieu of
the termination fee, a yield maintenance amount equal to the difference between
(i) the all-in effective yield which could be earned on the revolving balance
through January 25, 2007, 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.
Our subsidiaries guarantee payments and other obligations under the
revolving 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.
In addition, the loan agreement with CapitalSource requires us to maintain a
lock-box arrangement with our banks whereby amounts received into the lock-boxes
are applied to reduce the revolving credit facility outstanding. The agreement
also contains certain subjective acceleration clauses in the event of a material
adverse event. EITF Issue 95-22, "Balance Sheet Classification of Borrowings
Outstanding under Revolving Credit Agreements That Include both a Subjective
Acceleration Clause and a Lock-Box Arrangement" requires us to classify
outstanding borrowings under the revolving credit note as short-term obligations
due to the existence of both a lock-box arrangement and subjective acceleration
clauses. In conjunction with this pronouncement, we classify our revolving
credit facility as a current liability in the amount of $7,297,000, $9,694,000
and $10,334,000 at June 30, 2004, December 31, 2003 and June 30, 2003,
respectively.
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The Series B Preferred Stock
As of June 30, 2004, 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 $1.87 per share as of June 30, 2004, increases at a rate of
12.5% per year, compounded annually.
The Series C Preferred Stock
As of June 30, 2004, we had 406,158 shares of Series C Preferred Stock
issued and outstanding. The Series C Preferred Stock has an aggregate
liquidation preference of approximately $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.
Recent Accounting Pronouncements
In March 2004, the Financial Accounting Standards Board approved Emerging
Issues Task Force Issue 03-6 "Participating Securities and the Two-Class Method
under FAS 128." The EITF supersedes the guidance in Topic No. D-95, Effect of
Participating Convertible Securities on the Computation of Basic Earnings per
Share, and requires the use of the two-class method of participating securities.
The two-class method is an earnings allocation formula that determines earnings
per share for each class of common stock and participating security according to
dividends declared (or accumulated) and participation rights in undistributed
earnings. In addition, the EITF addresses other forms of participating
securities, including options, warrants, forwards and other contracts to issue
an entity's common stock, with the exception of stock-based compensation. The
EITF is effective for the reporting periods beginning after March 31, 2004 and
should be applied by restating previously reported earnings per share. The
adoption of the EITF is not expected to have a material impact on our condensed
consolidated financial statements.
Seasonality
Our revenues are generally affected by seasonal fluctuations in the Consumer
Vision and Distribution 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, because we retain certain fixed costs related to staffing and facilities,
our cash flows can be negatively affected.
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
us with the Securities and Exchange Commission, press releases, presentations by
us or our management and oral statements) that relate to matters that are not
historical facts are "forward-looking statements" within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended. 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, but are not limited to, those relating to:
o Our expectation of future revenue, sales and expense levels;
o Our opinion that the outcome of lawsuits will not have a material
adverse impact on our consolidated financial position or results of
operations;
o Our expectation of improvement in operating results of Wise Optical
in the future;
o Our expectation of increased profitability in our Managed Vision
segment;
o Our expectation of continued improvements in our Consumer Vision
segment;
o Our expectation that we will dispose of our Technology operations,
CC Systems, and that such sale will generate cash proceeds while
reducing demands on working capital and corporate personnel;
20
o Our expected impact of future interest rates and cash flows; and
o Our belief that cash from operations, borrowings under our term loan
and revolving credit facility, and operating and capital lease
financings will provide sufficient funds to finance operations for
the next 12 months and our expectation that initiatives implemented
recently or to be implemented by management will lead to improved
liquidity.
In addition, such forward-looking statements involve known and unknown
risks, uncertainties, and other factors which may cause our actual results,
performance or achievements 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 The fact that we have failed financial covenants and may fail them
in the future;
o If we default on our debt to CapitalSource, it could foreclose on
our assets;
o Our ability to execute our strategy to improve our operations and
our liquidity;
o Our ability to obtain additional capital, without which our growth
could be limited;
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 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 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 Loss of the services of key management personnel could adversely
effect our business;
o The fact that we have a history of losses and may incur further
losses in the future;
o Our ability to maintain the listing of our common stock on the
American Stock Exchange;
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 could
have a material adverse effect on our results of operations and
financial condition;
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, could
materially adversely affect our business, financial condition and
results of operations;
o The fact that we are 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;
o The fact that we may continue to not realize the expected benefits
from our acquisition of Wise Optical;
o The fact that our largest stockholder, Palisade Concentrated Equity
Partnership, L.P., owns sufficient shares of our common stock and
voting equivalents to significantly affect the results of any
stockholder vote and control our board of directors;
o The fact that conflicts of interest may arise between Palisade and
OptiCare; 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.
21
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 2004, 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
six-month interest expense by approximately $42,000 assuming that our borrowing
level is unchanged. We did not use derivative instruments to adjust our interest
rate risk profile during the six months ended June 30, 2004.
ITEM 4: CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. In designing and
evaluating our disclosure controls and procedures, our management recognized
that any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and our management necessarily was required to apply its judgment in evaluating
the cost-benefit relationship of possible controls and procedures.
Our principal executive officer and principal 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, that deficiencies caused our disclosure controls and
procedures not to be effective at a reasonable assurance level. Our principal
executive officer and principal financial officer, along with our Audit
Committee, determined that there was a "material weakness," or a reportable
condition in which the design or operation of one or more of the specific
internal control components does not reduce to a relatively low level the risk
that errors or fraud in amounts that would be material in relation to the
consolidated financial statements may occur and not be detected within a timely
period by employees in the normal course of performing their assigned functions,
in our internal controls relating to our accounting for inventory that did not
prevent the erroneous reporting of actual inventory levels primarily due to
mathematical and fundamental errors in the reconciliation process.
Our management discussed the areas of weakness described above with our
Audit Committee and agreed to implement remedial measures to identify and
rectify past accounting errors and to prevent the situation that resulted in the
need to restate prior period financial statements from reoccurring. To this end,
we have initially enhanced the inventory reconciliation process to provide more
detail, mathematical checks and a detailed comparison to prior periods. We are
continuing to monitor these processes to further enhance our procedures as may
be necessary. This reconciliation process is also supported by additional levels
of management and senior management review.
Management believes the new controls and procedures address the conditions
identified by its review. We are continuing to monitor the effectiveness of our
internal controls and procedures on an ongoing basis and will take further
action, as appropriate.
(b) Changes in Internal Controls. There were no changes in our internal
control over financial reporting, except as noted above 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. However, we
believe the measures we have implemented and currently are implementing to
improve our internal controls are reasonably likely to have a material impact on
our internal controls over financial reporting in future periods.
22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
HEALTH SERVICE ORGANIZATION LAWSUITS
In June 2004, we reached settlement with Eye Surgeons of Indiana and Eye
Associates of Southern Indiana respectively, two HSO practices which we were in
litigation in the matter of In re Prime Vision Health, Inc. Contract Litigation,
MDL 1466, which was previously reported in our Annual Report on Form 10-K for
the year ended December 31, 2003. These settlements resulted in cash payments to
us and mutual termination of the HSO service agreements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
We were not in compliance with the minimum fixed charge ratio covenant under
our term loan and revolving credit facility with CapitalSource as of March 31,
2004, April 30, 2004 and May 31, 2004. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Liquidity and Capital
Resources" above for a complete discussion of our term loan and revolving credit
facility with CapitalSource and our compliance with the terms thereof.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of Stockholders of OptiCare Health Systems, Inc. was held
on May 7, 2004. There were represented, in person or by proxy, 27,264,328
shares of common stock entitled to vote at the meeting, constituting a
quorum. The only matter voted upon and approved by our stockholders at the
meeting was the election of directors by the following votes:
NUMBER OF SHARES NUMBER OF SHARES
VOTED FOR: WITHHELD:
-------------------- --------------------
Dean J. Yimoyines, M.D 27,227,018 37,310
Eric J. Bertrand 27,232,018 32,310
Norman S. Drubner 27,231,018 33,310
Mark S. Hoffman 27,232,018 32,310
Richard L. Huber 27,234,018 30,310
Clark A. Johnson 27,234,118 30,210
Melvin Meskin 27,232,018 32,310
Mark S. Newman 27,234,018 30,310
There were no [broker non-votes, votes cast against or abstentions] in
connection with this matter.
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 Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
23
b. Reports on Form 8-K
On May 14, 2004, we furnished information regarding results of our
quarter ended March 31, 2004 under Item 12 (Results of Operations and
Financial Condition) on a Current Report on Form 8-K.
On July 1, 2004, we filed information regarding the review of our
inventory and the expected restatement of our financial statements for
the quarter ended March 31, 2004 under Item 5 (Other Events and
Regulation FD Disclosure) and Item 12 (Results of Operations and
Financial Condition) on a Current Report on Form 8-K.
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: September 2, 2004 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)
24
EXHIBIT INDEX
EXHIBIT DESCRIPTION
------- -----------
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
25