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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 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 Incorporation (I.R.S. Employer
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, 2004 was 30,671,800 shares.
INDEX TO FORM 10-Q
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2004,
December 31, 2003, and September 30, 2003, as restated
(unaudited) 3
Condensed Consolidated Statements of Operations for the three
and nine months ended September 30, 2004 and 2003
(unaudited) 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 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 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 3. Defaults Upon Senior Securities 24
Item 6. Exhibits 24
SIGNATURE 26
2
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
2004 2003 2003
------------- ------------ -------------
ASSETS As Restated
CURRENT ASSETS: See Note 3
Cash and cash equivalents $ 2,950 $ 1,695 $ 2,233
Accounts receivable, net 7,989 7,867 10,025
Inventories 5,160 5,770 6,296
Assets held for sale -- 1,652 1,535
Other current assets 1,174 565 592
-------- -------- --------
TOTAL CURRENT ASSETS 17,273 17,549 20,681
-------- -------- --------
Property and equipment, net 3,732 4,647 5,180
Goodwill, net 17,917 17,892 18,231
Intangible assets, net 1,096 1,179 1,207
Assets held for sale, non-current -- 1,339 1,475
Other assets 3,531 3,249 2,990
-------- -------- --------
$ 43,549 $ 45,855 $ 49,764
======== ======== ========
TOTAL ASSETS
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,739 $ 5,525 $ 8,705
Accrued expenses 7,050 5,379 6,284
Current portion of long-term debt 10,090 10,828 9,057
Liabilities of held for sale business -- 1,241 1,324
Other current liabilities 950 548 421
-------- -------- --------
TOTAL CURRENT LIABILITIES 26,829 23,521 25,791
-------- -------- --------
Long-term debt, less current portion 78 1,775 1,549
Other liabilities 513 512 522
-------- -------- --------
TOTAL NON-CURRENT LIABILITIES 591 2,287 2,071
-------- -------- --------
Series B 12.5% mandatorily redeemable, convertible
preferred stock--related party 6,163 5,635 5,476
STOCKHOLDERS' EQUITY:
Series C preferred stock--related party 1 1 1
Common stock 31 30 30
Additional paid-in-capital 79,347 79,700 79,853
Accumulated deficit (69,413) (65,319) (63,458)
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY 9,966 14,412 16,426
-------- -------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 43,549 $ 45,855 $ 49,764
======== ======== ========
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,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
NET REVENUES:
Managed vision $ 6,547 $ 7,118 $ 18,864 $ 22,006
Product sales 16,615 20,023 52,452 56,961
Other services 4,776 4,809 15,236 13,982
Other income -- 352 1,718 2,720
--------- --------- --------- ---------
Total net revenues 27,938 32,302 88,270 95,669
--------- --------- --------- ---------
OPERATING EXPENSES:
Medical claims expense 4,914 5,993 14,274 17,250
Cost of product sales 12,937 15,683 40,900 44,251
Cost of services 1,870 2,024 6,338 5,922
Selling, general and administrative 9,231 9,749 27,248 27,488
Goodwill impairment loss -- 1,300 -- 1,300
Loss from early extinguishment of debt -- -- -- 1,847
Depreciation 432 632 1,243 1,334
Amortization 27 29 83 87
Interest 300 330 896 1,719
--------- --------- --------- ---------
Total operating expenses 29,711 35,740 90,982 101,198
--------- --------- --------- ---------
Loss from continuing operations before taxes (1,773) (3,438) (2,712) (5,529)
Income tax expense (benefit) (20) 5,001 32 4,929
--------- --------- --------- ---------
Loss from continuing operations (1,753) (8,439) (2,744) (10,458)
Discontinued operations (Note 5)
Loss from discontinued operations (including
loss on disposal of $1,005 in 2004) (421) (57) (1,350) (52)
Income tax benefit -- 20 -- 18
--------- --------- --------- ---------
Loss on discontinued operations (421) (37) (1,350) (34)
Net loss (2,174) (8,476) (4,094) (10,492)
Preferred stock dividends (177) (159) (528) (459)
--------- --------- --------- ---------
Net loss to common stockholders $ (2,351) $ (8,635) $ (4,622) $ (10,951)
========= ========= ========= =========
LOSS PER SHARE - BASIC AND DILUTED:
Loss from continuing operations $ (0.06) $ (0.29) $ (0.11) $ (0.37)
Discontinued operations (0.02) 0.00 (0.04) 0.00
Net loss (0.08) (0.29) (0.15) (0.37)
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,
-------------------------
2004 2003
---- ----
OPERATING ACTIVITIES:
Net loss $ (4,094) $(10,492)
Loss on discontinued operations 1,350 34
-------- --------
Loss from continuing operations (2,744) $(10,458)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation 1,243 1,334
Amortization 83 87
Non-cash interest expense 115 917
Non-cash loss on early extinguishment of debt -- 1,847
Non-cash gain on contract settlements -- (530)
Non-cash goodwill impairment loss -- 1,300
Deferred taxes -- 4,800
Changes in operating assets and liabilities:
Accounts receivable (122) 36
Inventory 610 1,302
Other assets (771) 171
Accounts payable and accrued expenses 5,040 (1,402)
Other liabilities 403 216
Cash (used in) provided by discontinued operations (392) 62
-------- --------
Net cash provided by (used in) operating activities 3,465 (318)
-------- --------
INVESTING ACTIVITIES:
Cash received on notes receivable 111 177
Purchase of fixed assets, net of disposals (328) (813)
Refunds of deposits -- 775
Proceeds from the sale of discontinued operations 700 --
Investments in acquisitions, excluding cash (25) (6,192)
Purchase of restricted certificates of deposit (260) (600)
-------- --------
Net cash provided by (used in) investing activities 198 (6,653)
-------- --------
FINANCING ACTIVITIES:
Net increase (decrease) in revolving credit facility (2,184) 7,153
Principal payments on long-term debt (278) (918)
Principal payments on capital lease obligations (13) (43)
Payment of financing costs (5) (209)
Equipment financing 117 --
Payment of bank financing fees (65) --
Proceeds from issuance of common stock 20 135
-------- --------
Net cash (used in) provided by financing activities (2,408) 6,118
-------- --------
Increase (decrease) in cash and cash equivalents 1,255 (853)
Cash and cash equivalents at beginning of period 1,695 3,086
-------- --------
Cash and cash equivalents at end of period $ 2,950 $ 2,233
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 765 $ 784
Cash paid for income taxes, net of refunds $ 59 $ 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 nine months ended September 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 nine months ended September 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 and the nine months ended
September 30, 2004, due primarily to substantial operating losses at Wise
Optical which resulted in a significant use of cash from operations in both
periods. 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. 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
reduced ongoing costs to better match the operations and attempted to increase
sales and improve product margins at Wise Optical. As a result of the continued
losses at Wise Optical, the Company did not comply with the minimum fixed charge
ratio covenant under its term loan and revolving credit facility with
CapitalSource Finance, LLC ("CapitalSource") 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, on August 16, 2004, CapitalSource
amended the terms and covenants of the credit facility, waived all covenant
violations and provided additional credit, which has been guaranteed by Palisade
Concentrated Equity Partnership, L.P. ("Palisade Capital") the Company's
majority shareholder.
In 2004, Wise Optical engaged consultants who have recommended cost cutting
measures and the Company has implemented programs recommeded by such consultants
which have further reduced costs related to staffing and product shipments.
However, Wise Optical has been unable to increase sales or improve product
margins and operating income. While the Company has initiated programs designed
to enhance sales and has engaged additional consultants to assist in this
endeavor, there can be no assurance that these efforts can offset the decline in
sales and product margins.
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 has the sales force and infrastructure necessary to expand
its direct-to-employer business and as a result the Company has experienced an
increase in new direct-to-employer contracts in 2004. The Company experienced
improvements in revenue and profitability in the Consumer Vision segment from
2003 to 2004, from operating efficiencies, 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 through
October of 2004.
Although Wise operating losses have continued into 2004, the Company has
generated approximately $3.5
6
million of cash from operations in the nine months ended September 30, 2004,
which has resulted in reductions of debt of approximately $2.5 million. In
addition, in May 2004, management made the decision to dispose of the Technology
sector which was made up of CC Systems. The Company completed the sale of the
net assets of CC Systems on September 10, 2004. The sale of CC Systems generated
$0.7 million in cash proceeds and reduced demands on both working capital and
corporate personnel.
As noted above, if the Company is unable to offset the sales and product
margin declines at Wise Optical, it may continue to incur substantial operating
losses. As a result, these substantial operating losses at Wise Optical may
cause the Company to fail its debt covenants as early as the foruth quarter of
2004 and lead to cash shortfalls. Due to these conditions, the Company will
continue to classify its debt related to the revolving credit facility and term
note as current.
If we incur additional operating losses and we continue to fail to comply
with our financial covenants in the future 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 and there will be doubts that the entity will be able to continue
as a going concern and therefore may be unable to realize its assets and
discharge its liabilities in the normal course of business.
3. RESTATEMENT
The Company's 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
loan agreement also had contained 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, and as a result of the lock-box
arrangement and these subjective acceleration clauses, the Company's management
determined that the amounts outstanding under the credit facility with
CapitalSource 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. The December
31, 2003 financial statements were amended and restated on September 2, 2004.
Accordingly, the accompanying September 30, 2003 balance sheet has been restated
to reflect the reclassification of the amounts outstanding pursuant to this
credit facility as current liabilities.
On August 27, 2004, the Company and CapitalSource amended the loan
agreement to eliminate the provision of the loan agreement whereby a material
adverse change with respect to the Company could constitute an event of default
or prevent further advances under the loan agreement.
A summary of the significant effects of the restatement is as follows:
SEPTEMBER 30, 2003
------------------
AS PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
Current Portion of Long Term Debt $ 322 $ 9,057
Long Term Debt Less Current Portion 10,284 1,549
Total Current Liabilities 17,056 25,791
7
Non-current Liabilities 10,806 2,071
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 Standard 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net loss, as reported $ (2,174) $ (8,476) $ (4,094) $(10,492)
Less: Total stock-based employee compensation
expense, net of related tax effects, determined
under the fair value method for all awards (45) (94) (104) (316)
-------- -------- -------- --------
Pro forma net loss $ (2,219) $ (8,570) $ (4,198) $(10,808)
======== ======== ======== ========
Basic and diluted net loss per share:
As reported $ (0.08) $ (0.29) $ (0.15) $ (0.37)
Pro forma (0.08) (0.29) (0.15) $ (0.38)
5. DISCONTINUED OPERATIONS - CC SYSTEMS
In May 2004, the Company's Board of Directors approved management's plan to
exit the technology business, CC Systems, (formerly reported in the Distribution
and Technology segment) and dispose of the Company's CC Systems division. The
Company completed the sale of the net assets of CC Systems on September 10,
2004. 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. The Company recorded a $1,005 loss on disposal of
discontinued operations based on the fair value of the net assets held for sale.
Amounts in the financial statements and related notes for the periods December
31, 2003 and September 30, 2003 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 December 31, 2003 and September 30, 2003 were as follows:
December 31, September 30,
2003 2003
------------ -------------
Assets:
Accounts receivable $ 1,502 $ 1,420
Inventory 148 109
Property and equipment, net 36 52
Intangible assets, net 1,303 1,318
Other assets 2 111
------- -------
Total assets $ 2,991 $ 3,010
======= =======
8
Liabilities:
Accounts Payable $ 119 $115
Accrued Expenses 129 146
Other liabilities 993 932
------- -------
Total liabilities $ 1,241 $ 1,193
======= =======
Operating results of the discontinued operations are as follows:
Three Months Ended Nine months Ended
September 30, September 30,
------------------ -----------------
2004 (1) 2003 2004 (1) 2003
-------- ---- -------- ----
Net revenues $ 427 $ 644 $ 1,504 $ 2,240
======= ======= ======= =======
Income (loss) from discontinued operations before taxes $ 4 $ (57) $ (345) $ (52)
Income tax benefit -- 20 -- 18
------- ------- ------- -------
Income (loss) from discontinued operations 4 (37) (345) (34)
Loss on disposal of discontinued operations (425) -- (1,005) --
------- ------- ------- -------
Total loss from discontinued operations $ (421) $ (37) $(1,350) $ (34)
======= ======= ======= =======
Loss per share from discontinued operations $ (0.02) $ 0.00 $ (0.04) $ 0.00
======= ======= ======= =======
(1) For 2004 periods presented, the operating results of the discontinued
operations include the operating activity through September 9, 2004.
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 SFAS 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 nine months ended September 30, 2003 would have been $102,347,
$10,311 and $10,345, respectively. On the same pro forma basis, basic and
diluted loss per common share for the nine months ended September 30, 2003 would
have been $0.36. This unaudited pro forma information
9
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 $562, $479 and
$450 at September 30, 2004, December 31, 2003 and September 30, 2003,
respectively. The non-compete agreements, which had a gross carrying amount of
$265, were fully amortized at September 30, 2004 and December 31, 2003 and had
accumulated amortization of $250 at September 30, 2003. Amortization expense for
the three months ended September 30, 2004 and 2003 was $27 and $29,
respectively, and for the nine months ended September 30, 2004 and 2003 was $83
and $87, respectively. Estimated annual amortization expense is expected to be
approximately $111 in each of the years 2004 through 2008.
9. DEBT
The Company has classified its debt with CapitalSource, its senior lender,
totaling $10,060 as of September 30, 2004, as a current liability. The Company
did not comply with the minimum fixed charge ratio covenant under its term loan
and revolving credit facility with CapitalSource Finance 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, on August 16, 2004,
CapitalSource amended the terms and covenants of the credit facility, waived all
covenant violations and provided additional credit, which has been guaranteed by
Palisade Capital.
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,
had necessitated the revolving credit facility be classified as 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"). On August 27, 2004, the
Company amended its loan agreement with CapitalSource to eliminate the provision
of the loan agreement whereby a material adverse change with respect to the
Company could constitute an event of default or 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
Capital, provided a $1,000 guarantee against the loan balance due to
CapitalSource related to this amendment.
As discussed in Note 2, if the Company is unable to offset the sales and
product margin declines at Wise Optical, it may continue to incur substantial
operating losses. As a result, these substantial operating losses at Wise
Optical may cause the Company to fail its debt covenants as early as the fourth
quarter of 2004. Due to these conditions, the Company will continue to classify
its debt related to the revolving credit facility and term note as current.
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.
10
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 nine months ended September 30, 2004 and 2003 is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
REVENUES:
Managed vision $ 6,547 $ 7,118 $ 18,864 $ 22,006
Consumer vision 7,850 7,887 24,761 22,989
Distribution 15,387 18,461 48,478 51,696
-------- -------- -------- --------
Reportable segment totals 29,784 33,466 92,103 96,691
All other 16 394 1,540 2,828
Elimination of inter-segment revenues (1,862) (1,558) (5,373) (3,850)
-------- -------- -------- --------
Total net revenue $ 27,938 $ 32,302 $ 88,270 $ 95,669
======== ======== ======== ========
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE TAX:
Managed vision $ 251 $ (32) $ 657 $ 1,037
Consumer vision 679 702 2,740 2,134
Distribution (704) (1,158) (1,891) (2,225)
-------- -------- -------- --------
Reportable segment totals 226 (488) 1,506 946
All other (171) 149 1,009 2,161
Loss from early extinguishment of debt -- -- -- (1,847)
Goodwill impairment loss -- (1,300) -- (1,300)
Depreciation (432) (632) (1,243) (1,334)
Amortization (27) (29) (83) (87)
Interest expense (300) (330) (896) (1,719)
Corporate (1,069) (808) (3,005) (2,349)
-------- -------- -------- --------
Loss from continuing operations
before tax $ (1,773) $ (3,438) $ (2,712) $ (5,529)
======== ======== ======== ========
11
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
12. LOSS PER COMMON SHARE
The following table sets forth the computation of basic and diluted
loss per share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
LOSS PER SHARE:
Loss from continuing operations $ (1,753) $ (8,439) $ (2,744) $ (10,458)
Preferred stock dividend (177) (159) (528) (459)
------------ ------------ ------------ ------------
Loss from continuing operations to common
Stockholders (1,930) (8,598) (3,272) (10,917)
Discontinued operations (421) (37) (1,350) (34)
------------ ------------ ------------ ------------
Net loss to common stockholders $ (2,351) $ (8,635) $ (4,622) $ (10,951)
============ ============ ============ ============
Weighted average common shares outstanding--
Basic and diluted 30,685,060 30,304,541 30,579,558 29,956,664
Loss per share--basic and diluted:
Loss from continuing operations to common
Stockholders $ (0.06) $ (0.29) $ (0.11) $ (0.37)
Discontinued operations $ (0.02) $ 0.00 $ (0.04) $ 0.00
Net loss to common stockholders $ (0.08) $ (0.29) $ (0.15) $ (0.37)
The following table reflects the potential common shares of the Company at
September 30, 2004 and 2003 that have been excluded from the calculation of
diluted earnings per share for the three and nine month periods due to
anti-dilution.
2004 2003
---- ----
Options 6,195,943 5,922,066
Warrants 3,275,000 3,125,000
Convertible Preferred Stock 64,343,513 59,438,319
---------- ----------
73,814,456 68,485,385
========== ==========
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 September 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.
13
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 optical products and services to eye care
professionals.
In September 2003, we began implementing strategies and operational changes
designed to improve the operations of Wise Optical. These efforts included
developing our sales force, improving customer service, enhancing productivity
and streamlining the warehouse and distribution processes. In the nine months
ended September 30, 2004, we reduced ongoing costs to better match the operations and
attempted to increase sales and improve product margins at Wise Optical.
In 2004, Wise Optical engaged consultants who have recommended cost cutting
measures and we have implemented programs recommended by such consultants which
have further reduced costs related to staffing and product shipments. However,
Wise Optical has been unable to increase sales or improve product margins and
operating income. While the Company has initiated programs designed to enhance
sales and has engaged consultants to assist in this endeavor, there can be no
assurance that these efforts can offset the decline in sales and product
margins.
In May 2004, our Board of Directors approved management's plan to exit and
dispose of our Technology business, CC Systems. We completed the sale of the net
assets of CC Systems on September 10, 2004. In accordance with Statement of
Financial Accounting Standard (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. However,
continued operating losses at Wise Optical may cause us to fail our debt
covenants with CapitalSource as early as the fourth quarter of 2004.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2004 Compared to the Three Months Ended
September 30, 2003
Managed Vision revenue. Managed Vision revenue represents fees received
under our managed care contracts. Managed Vision revenue decreased to
approximately $6.5 million for the three months ended September 30, 2004
14
compared to approximately $7.1 million for the three months ended September 30,
2003, a decrease of approximately $0.6 million or 8.5%. This decrease resulted
from approximately $0.9 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 $0.3 million of lost
revenues resulting from a decline in membership in existing contracts with one
of our large health plan customers and net decreases of $0.3 million from the
balance of existing contracts, which were partially offset by increases in
revenue of approximately $0.9 million from new 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.
Product sales revenue. Product sales include the sale of contact and
ophthalmic lenses through Wise Optical, the sale of optical products through our
Buying Group and the retail sale of optical products in our Consumer Vision
segment. Product sales revenue decreased to approximately $16.6 million for the
three months ended September 30, 2004 compared to approximately $20.0 million
for the three months ended September 30, 2003, a decrease of approximately $3.4
million or 17.0%. This represents a decrease in revenue from Wise Optical of
approximately $2.7 million and a decrease in revenue from the Buying Group of
approximately $0.7 million. The decrease in Wise Optical revenue was primarily
due to a decrease in sales volume that we have continued to experience after we
purchased Wise Optical. While the Company has initiated programs designed to
enhance sales and has engaged consultants to assist in this endeavor, there can
be no assurance that these efforts can offset the decline in sales. The decrease
in Buying Group revenue is primarily due to lost business and overall weakness
in the optical market. We expect product sales of the Buying Group to
approximate current levels for the remainder of 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 remained relatively constant at $4.8 million for the three
months ended September 30, 2004 compared to the three months ended September 30,
2003.
Other income. Other income represents non-recurring settlements on
contracts. We did not have other income for the three months ended September 30,
2004. This compared to other income of approximately $0.4 million for the three
months ended September 30, 2003, a decrease of approximately $0.4 million. This
decrease is due to a lack of HSO contract settlements for the three months ended
September 30, 2004.
Medical claims expense. Medical claims expense decreased to approximately
$4.9 million for the three months ended September 30, 2004, from approximately
$6.0 million for the three months ended September 30, 2003, a decrease of
approximately $1.1 million or 18.3%. The medical claims expense loss ratio (MLR)
representing medical claims expense as a percentage of Managed Vision revenue
decreased to 75.1% for the quarter ended September 30, 2004 from 84.2% for the
quarter ended September 30, 2003. The reduction in the MLR is primarily
attributable to the unusually high claims experience in the three months ended
September 30, 2003. The high claims experience resulted from the utilization
surge experienced on the Children's Health Insurance Program and Medicaid
Program prior to the elimination of vision benefits announced and initiated by
the Texas state legislature beginning in the third quarter of 2003. 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
$12.9 million for the three months ended September 30, 2004 compared to
approximately $15.7 million for the three months ended September 30, 2003, a
decrease of approximately $2.8 million or 17.8%. This decrease is primarily due
to a decrease in Wise Optical product costs of approximately $2.2 million and a
decrease in Buying Group product costs of approximately $0.6 million. The
decrease in Wise Optical and Buying Group product costs is due to the decrease
in product revenue.
Cost of services. Cost of services decreased to approximately $1.9 million
for the three months ended September 30, 2004 compared to approximately $2.0
million for the three months ended September 30, 2003, a decrease of
approximately $0.1 million or 5.0%. This decrease in cost is primarily due to
the decrease in medical services revenue in the Consumer Vision area.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased to approximately $9.2 million for the three
months ended September 30, 2004 compared to approximately $9.7 million for the
three months ended September 30, 2003, a decrease of approximately $0.5 million
or 5.2%. The decrease in 2004 is primarily due to a decrease in compensation
expense associated with the staff reductions which occurred at Wise Optical.
15
Interest expense. Interest expense remained relatively constant at
approximately $0.3 million for the three months ended September 30, 2004
compared to the three months ended September 30, 2003.
Income tax expense. Income tax recorded for the three months ended
September 30, 2004 of less than $0.1 million primarily represents minimum state
tax expense. For the three months ended September 30, 2003 we recorded $5.0
million of income tax expense, which included a $1.0 million income tax benefit
on our loss from continuing operations and $6.0 million of tax expense which
resulted from the establishment of a full valuation allowance against our
deferred tax assets.
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 Company completed the sale of the net assets of CC Systems on
September 10, 2004. The loss from discontinued operations of approximately $0.4
million for the three months ended September 30, 2004 reflects the adjusted loss
on disposal, based on the fair value of the net assets held for sale.
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended September
30, 2003
Managed Vision revenue. Managed Vision revenue decreased to approximately
$18.9 million for the nine months ended September 30, 2004 compared to
approximately $22.0 million for the nine months ended September 30, 2003, a
decrease of approximately $3.1 million or 14.1%. This decrease resulted from
approximately $3.2 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 $1.7 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 $1.7 million from new contracts and approximately $0.1 million
from net growth in existing contracts.
Product sales revenue. Product sales revenue decreased to approximately
$52.5 million for the nine months ended September 30, 2004 compared to
approximately $57.0 million for the nine months ended September 30, 2003, a
decrease of approximately $4.5 million or 7.9%. This represents a decrease in
revenue from Wise Optical of approximately $2.9 million and a decrease in
revenue from the Buying Group of approximately $2.0 million, which was partially
offset by an increase in Consumer Vision revenue of $0.4 million. The decrease
in Wise Optical revenue was primarily due to a decrease in sales volume that we
experienced after we purchased Wise Optical. While the Company has initiated
programs designed to enhance sales and has engaged consultants to assist in this
endeavor, there can be no assurance that these efforts can offset the decline in
sales. 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 increased to approximately
$15.2 million for the nine months ended September 30, 2004 compared to
approximately $14.0 million for the nine months ended September 30, 2003, an
increase of approximately $1.2 million or 8.6%. 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 for the nine months ended September 30, 2004 was
approximately $1.7 million compared to approximately $2.7 million for the nine
months ended September 30, 2003, representing a decrease of approximately $1.0
million or 37.0%. This decrease is primarily due to a decrease in HSO contract
settlements of approximately $1.2 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
$14.3 million for the nine months ended September 30, 2004, from approximately
$17.3 million for the nine months ended September 30, 2003, a decrease of
approximately $3.0 million or 17.3%. The MLR decreased to 75.7% in 2004 from
78.4% in 2003. The reduction in the MLR is primarily attributable to the
unusually high claims experience in the nine months ended September 30, 2003.
The high claims experience resulted from the utilization surge experienced on
the Children's Health Insurance Program and Medicaid Program prior to the
elimination of vision benefits announced and initiated by the Texas state
legislature beginning in the third quarter of 2003.
16
Cost of product sales. Cost of product sales decreased to approximately
$40.9 million for the nine months ended September 30, 2004 compared to
approximately $44.3 million for the nine months ended September 30, 2003, a
decrease of approximately $3.4 million or 7.7%. This decrease is primarily due
to a decrease in Wise Optical product costs of $1.9 million and a decrease in
Buying Group product costs of approximately $1.9 million, both of which were
partially offset by an increase in product costs in Consumer Vision of
approximately $0.4 million. The decrease in Wise Optical and Buying Group
product costs is due to the decrease in product revenue. The increase in product
costs of Consumer Vision is due to the related increase in sales in this
division.
Cost of services. Cost of services increased to approximately $6.3 million
for the nine months ended September 30, 2004 compared to approximately $5.9
million for the nine months ended September 30, 2003, an increase of
approximately $0.4 million or 6.8%. This increase in cost is primarily due to
the increase in medical services revenue in the Consumer Vision area.
Selling, general and administrative expenses. Selling, general and
administrative expenses remained relatively unchanged at $27.2 million for the
nine months ended September 30, 2004 compared to approximately $27.5 million for
the nine months ended September 30, 2003, a decrease of approximately $0.3
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.
Loss from early extinguishment of debt. The approximate $1.8 million loss
from early extinguishment of debt for the nine months ended September 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 $0.9 million
for the nine months ended September 30, 2004 from approximately $1.7 million for
the nine months ended September 30, 2003, a decrease of approximately $0.8
million or 47.1%. 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 nine months ended September 30, 2004 primarily represents minimum state
tax expense. For the nine months ended September 30, 2003 we recorded $4.9
million of income tax expense, which included a $1.1 million income tax benefit
on our loss from continuing operations, offset by $6.0 million of tax expense
which resulted from the establishment of a full valuation allowance against our
deferred tax assets.
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 Company completed the sale of the net assets of CC Systems on
September 10, 2004. The loss on discontinued operations of approximately $1.4
million for the nine months ended September 30, 2004 includes a loss on disposal
of approximately $1.0 million, based on the fair value of the net assets held
for sale, and the loss from operations of CC Systems during the period of
approximately $0.4 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.
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.
17
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 October 2004.
As of September 30, 2004, we had cash and cash equivalents of approximately
$3.0 million and additional availability under our revolving credit facility
with CapitalSource of approximately $2.9 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, April 30, 2004 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. As discussed below, continued
operating losses at Wise Optical may cause us to fail the debt covenants in our
term loan and revolving credit agreement in future periods.
The following table sets forth a year-over year comparison of the
components of our liquidity and capital resources for the nine months ended
September 30, 2004 and 2003:
(In millions)
2004 2003 $ CHANGE
---- ---- --------
Cash and cash equivalents $ 3.0 $ 2.2 $ 0.8
Cash provided by (used in):
Operating activities $ 3.5 $ (0.3) $ 3.8
Investing activities $ 0.2 $ (6.7) $ 6.9
Financing activities $ (2.4) $ 6.1 $ (8.5)
Net cash provided by operating activities was approximately $3.5 million
for the nine months ended September 30, 2004 compared to approximately $0.3
million of net cash used in operating activities for the nine months ended
September 2003. Net cash provided by operating activities in 2004 included a net
loss from continuing operations of approximately $2.7 million, which was offset
by $1.4 million of non-cash charges for depreciation, amortization and interest.
The remaining $4.8 million of net cash provided by operating activities was
primarily due to increases in accounts payable and accrued expenses. Net cash
used in operating activities in 2003 included a loss from continuing operations
of approximately $10.5 million, which was offset by $9.8 million of non-cash
charges for depreciation, amortization, interest, goodwill impairment, deferred
taxes and early extinguishment of debt. The remaining $0.7 million of net cash
used in operating activities was primarily due to a decrease in accounts payable
and accrued expenses of $1.4 million offset in part by an increase in other
liabilities of $0.2 million and by decreases in inventory and other assets of
$1.3 million and $0.2 million respectively.
Net cash provided by investing activities was approximately $0.2 million
for the nine months ended September 30, 2004 compared to approximately $6.7
million of net cash used in investing activities for the nine months ended
September 30, 2003. Net cash provided by investing activities in 2004 included
$0.7 million in proceeds related to the sale of CC Systems, $0.1 million of
payments received on notes receivable offset by $0.3 million used to purchase
fixed assets and $0.3 million used for managed care deposits. Net cash used in
investing activities in 2003 included
18
$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 $0.8 million used to purchase fixed assets. 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 $2.4 million for
the nine months ended September 30, 2004 compared to approximately $6.1 million
of net cash provided by financing activities for the nine months ended September
30, 2003. Net cash used in financing activities in 2004 was primarily used for
repayments under our revolving credit facility and term loan with CapitalSource.
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.
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 the warehouse and distribution processes.
We have reduced ongoing costs to better match the operations and attempted
to increase sales and product margins at Wise Optical.
In 2004, Wise Optical engaged consultants who have recommended cost cutting
measures and we have implemented programs recommended by such consultants which
have further reduced costs related to staffing and product shipments. However,
Wise Optical has been unable to increase sales or improve product margins and
operating income. While we have initiated programs designed to enhance sales and
has engaged consultants to assist in this endeavor, there can be no assurance
that these efforts can offset the decline in sales and product margins.
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
have the sales force and infrastructure necessary to expand our
direct-to-employer business and as a result, we have experienced an increase in
new direct-to-employer contracts in 2004. We are experiencing 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 completed the sale of the assets of CC Systems on September 10,
2004. This sale generated $0.7 million in cash proceeds and reduced demands on
both working capital and corporate personnel.
If we are unable to offset the sales and product margin declines at Wise
Optical, it may continue to incur substantial operating losses. As a result,
these substantial operating losses at Wise Optical may cause us to fail the debt
covenants as early as the fourth quarter of 2004 and lead to cash shortfalls.
Due to these conditions, we will continue to classify the debt related to the
revolving credit facility and term note as current.
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.
19
The CapitalSource Loan and Security Agreement
As of September 30, 2004, we had approximately $1.9 million of borrowings
outstanding under our term loan with CapitalSource, approximately $8.2 million
of advances outstanding under our revolving credit facility with CapitalSource
and approximately $2.9 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 second amended and restated
revolving credit, term loan and security agreement 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.
The August 16, 2004 waiver and amendment also amended the term loan and
revolving credit facility to, among other things, (i) 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 5.5%, 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 further amended the second
amended and restated revolving credit, term loan and security agreement with
CapitalSource to eliminate a provision whereby a material adverse change with
respect to the Company can constitute an event of default or 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
$1.0 million guarantee against the loan balance due to CapitalSource related to
this amendment. We agreed to pay CapitalSource $15,000 in financing fees in
connection with this amendment.
As noted above, if we are unable to offset the sales and product margin
declines at Wise Optical, it may continue to incur substantial operating losses.
As a result, these substantial operating losses at Wise Optical may cause us to
fail our debt covenants as early as the fourth quarter of 2004 and lead to cash
shortfalls. Due to these conditions, we will continue to classify our debt
related to the revolving credit facility and term note as current.
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 and August 27, 2004. The revolving credit,
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
second amended and restated revolving credit, term 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.
20
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
September 30, 2004, the net advances to the Company were $8.2 million. 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.
The Series B Preferred Stock
As of September 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 $1.92 per share as of September 30, 2004, increases at a rate
of 12.5% per year, compounded annually.
The Series C Preferred Stock
As of September 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.
21
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, profitability 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 increased profitability in our Managed Vision
segment;
o Our expectation of continued improvements in our Consumer Vision
segment; and
o Our expected impact of future interest rates and cash flows.
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;
22
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, including those set
forth under "Forward Looking Information and Risk Factors" in the Form
10-K/A we filed with the Commission on September 2, 2004.
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
nine-month interest expense by approximately $62,000 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, 2004.
ITEM 4: CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure 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,
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.
As noted in our Quarterly Report on Form 10-Q for the period ended June 30,
2004, as filed with the Securities and Exchange Commission, our principal
executive officer and principal financial officer, along with our
23
Audit Committee, determined that there was a "material weakness," or a
reportable condition related 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. Upon
identifying the areas of weakness, management has implemented measures to
rectify the past errors and to prevent them in the future. These measures
include an enhanced inventory reconciliation process to provide more detailed,
mathematical checks and a detailed comparison to prior periods, daily analysis
of product margin and cost of goods sold, random inventory cycle counts and
improved tracking of customer deposits related to inventory lens banks. We are
continuing to monitor these processes to further enhance our procedures as may
be necessary.
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.
(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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
HEALTH SERVICE ORGANIZATION LAWSUITS
In October 2004, we reached settlement with Tri-County Eye Institute {and
in November 2004 we settled with Thomas Wassestrom, and Rice}, the 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/A 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 6. EXHIBITS
The following Exhibits are filed as part of this Quarterly Report on Form
10-Q:
EXHIBIT DESCRIPTION
- ------- -----------
10.1 Waiver and First Amendment to Second Amended and Restated Revolving
Credit, Term Loan and Security Agreement, dated as of August 16, 2004,
by and between the Registrant, OptiCare Eye Health Centers, Inc.,
PrimeVision Health, Inc., OptiCare Acquisition Corporation and
CapitalSource Finance LLC.
10.2 Second Amendment to Second Amended and Restated Revolving Credit, Term
Loan and Security Agreement, dated as of August 27, 2004, by and
between the Registrant, OptiCare Eye Health Centers, Inc., PrimeVision
Health, Inc., OptiCare Acquisition Corporation and
24
CapitalSource Finance LLC. (Filed as Exhibit 10.1 to the Registrant's
Current Report on Form 8-K filed with the Commission on September 1,
2004 (File No. 001-15223))
10.3 Letter Agreement, dated as of August 27, 2004, by and between the
Registrant, OptiCare Eye Health Centers, Inc., PrimeVision Health,
Inc., OptiCare Acquisition Corporation, CapitalSource Finance LLC and
Palisade Concentrated Equity Partnership, L.P. (Filed as Exhibit 10.2
to the Registrant's Current Report on Form 8-K filed with the
Commission on September 1, 2004 (File No. 001-15223))
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
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 15, 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)
26
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
10.1 Waiver and First Amendment to Second Amended and Restated Revolving
Credit, Term Loan and Security Agreement, dated as of August 16, 2004,
by and between the Registrant, OptiCare Eye Health Centers, Inc.,
PrimeVision Health, Inc., OptiCare Acquisition Corporation and
CapitalSource Finance LLC.
10.2 Second Amendment to Second Amended and Restated Revolving Credit, Term
Loan and Security Agreement, dated as of August 27, 2004, by and
between the Registrant, OptiCare Eye Health Centers, Inc., PrimeVision
Health, Inc., OptiCare Acquisition Corporation and CapitalSource
Finance LLC. (Filed as Exhibit 10.1 to the Registrant's Current Report
on Form 8-K filed with the Commission on September 1, 2004 (File No.
001-15223))
10.3 Letter Agreement, dated as of August 27, 2004, by and between the
Registrant, OptiCare Eye Health Centers, Inc., PrimeVision Health,
Inc., OptiCare Acquisition Corporation, CapitalSource Finance LLC and
Palisade Concentrated Equity Partnership, L.P. (Filed as Exhibit 10.2
to the Registrant's Current Report on Form 8-K filed with the
Commission on September 1, 2004 (File No. 001-15223))
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.