ITEM 1. BUSINESS
THE FOLLOWING BUSINESS SECTION CONTAINS FORWARD-LOOKING STATEMENTS, WHICH INVOLVE RISKS AND UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS. (SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-FORWARD-LOOKING INFORMATION AND RISK FACTORS").
GENERAL
We are an integrated eye care services company focused on providing managed vision and professional eye care products and services. On September 10, 2004, we sold our Technology operation, CC Systems, Inc. and on January 12, 2005 we sold our Distribution division which was comprised of Wise Optical and the Buying Group. The effective date of the Distribution division sale was December 31, 2004. As a result of the sales, we now operate in two distinct segments of the eye care market which, together, cover a substantial portion of this market:
o Our Managed Vision Division contracts with insurers, employer groups, managed care plans, HMOs and other third-party payers to manage claims payment and other administrative services of eye health benefits for contracting parties in fourteen states and to provide insurance coverage relating to certain eye care products and services.
o Our Consumer Vision Division sells retail optical products to consumers and owns and/or operates integrated eye health centers, professional optometric practices and surgical facilities in Connecticut. We also own a manufacturing laboratory in Connecticut, in which prescription eyeglasses are fabricated and supplied to all of our Connecticut locations.
RECENT DEVELOPMENTS
New Capital Structure
On January 12, 2005, we (including certain of our subsidiaries) closed a series of transactions which resulted in a major restructuring of our debt, equity and voting capital stock. Taken together, these transactions lowered our long-term debt and accounts payable by approximately $6.1 million and $1.5 million, respectively and increased our equity by approximately $4.4 million.
The transactions included, among other things, the following:
o Palisade Concentrated Equity Partnership, L.P., our majority stockholder, purchased, for approximately $4.0 million in cash, 252,525 shares of our Series D Preferred Stock, par value $0.001 per share, which are convertible into 10,101,000 shares of our common stock and Linda Yimoyines, the spouse of our Chairman and former Chief Executive Officer, purchased for approximately $0.445 million in cash, 28,093 shares of our Series D Preferred Stock which are convertible into 1,123,720 shares of our common stock. Each holder of Series D Preferred Stock is entitled to vote, on an as converted basis, on all matters with the holders of common stock and receive dividends equally and ratably with the holders of common stock in an amount equal to the dividends such holder would receive if it had converted its Series D Preferred Stock into common stock on the date the dividends are declared.
o OptiCare Acquisition Corp., our wholly-owned subsidiary, entered into an Asset Purchase Agreement with Wise Optical, LLC and AECC/Pearlman Buying Group, LLC, both entities formed by Dean J. Yimoyines, M.D. our former Chief Executive Officer, current President and Chief Executive Officer of our medical affiliate, OptiCare P.C., and a current member of our Board of Directors, pursuant to which
we sold, effective as of December 31, 2004, substantially all of the assets and certain liabilities of our Distribution Division, which consisted of our contact lens distributor, Wise Optical, and our Optical Buying Group, for an aggregate purchase price of $4,150,000, less a working capital adjustment of $575,000 and closing costs and other direct costs of $349,000.
o We, together with certain of our subsidiaries, entered into the Third Amendment to the Second Amended and Restated Revolving Credit, Term Loan and Security Agreement with CapitalSource Finance LLC, our senior lender. The Loan Amendment amends the terms of the Second Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated as of March 29, 2004, as amended by the Waiver and First Amendment to Second Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated as of August 16, 2004, and the Second Amendment to Second Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated as of August 27, 2004, to reduce the tangible net worth covenant for December 2004 and January 2005 from ($3,000,000) to ($6,500,000). Without this Amendment, we would have been in violation of the tangible net worth covenant at December 31, 2004. Under the revolving credit, term loan and security agreement, as amended; we must maintain a tangible net worth of at least ($3,000,000) after February 1, 2005.
Capitalization Table
The following table sets forth our capitalization as of December 31, 2004 and the pro forma capitalization to reflect the transactions that closed on January 12, 2005, as if the transactions occurred on December 31, 2004.
Capitalization Table (Amounts in thousands) (Unaudited)
As of December 31, 2004 ----------------------- Actual Pro forma -------- --------- Long-term debt (including current portion): Term note payable $ 1,775 $ 1,725 Revolving credit note 8,388 2,293 Subordinated notes payable 193 193 -------- -------- Total long-term debt (including current portion) 10,356 4,211 Series B 12.5% Voting, Redeemable, Cumulative Convertible Participating Preferred Stock; $0.001 par value, 3,500,000 authorized, 3,204,959 shares issued and outstanding 6,344 6,344
Stockholders' equity: Series C Preferred Stock, $0.001 par value; ($16,251 aggregate liquidation preference); 406,158 shares issued and outstanding 1 1 Series D Preferred Stock, $0.001 par value; ($4,445 aggregate liquidation preference); no shares issued or outstanding (actual); 280,618 shares issued and outstanding (pro forma) -- -- Common Stock, $0.001 par value; 150,000,000 shares authorized; 30,638,283 shares issued and outstanding 31 31 Additional paid-in capital 79,192 83,637 Accumulated deficit (73,659) (73,659) -------- -------- Total stockholders' equity 5,565 10,010 -------- -------- Total Capitalization $ 22,265 $ 20,565 ======== ========
Our principal executive offices are located at 87 Grandview Avenue, Waterbury, Connecticut, 06708. Our telephone number is (203) 596-2236 and our web site address is www.opticare.com. We include our web site address in this Annual Report on Form 10-K only as an inactive textual reference and do not intend it to be an active link to our web site.
We make available free of charge through the Investor Relations section of our web site our Corporate Code of Conduct and Ethics and our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (the SEC). The public may read and copy any materials we file with the SEC at the SEC's Public Reference Room, 450 Fifth Street, NW, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Because we file reports and other information with the SEC electronically, the public may obtain access to those documents at the SEC's Internet web site: http://www.sec.gov.
THE EYE CARE INDUSTRY
Overview
The eye care market includes both eye care services (including the systems and equipment for delivering such services) and optical products.
In the eye care services sector, eye health professionals, including ophthalmologists and optometrists, provide diagnostic eye examinations and treatment interventions to address complex eye and vision conditions, including disease and/or lack of functionality of the eyes. The most common conditions addressed by eye care professionals are nearsightedness, farsightedness and astigmatism. These eye and vision conditions are treated with surgical intervention (notably, laser surgery), prescription glasses, contact lenses or some combination of these treatments.
The optical products sector of the eye care market consists of the manufacture, distribution and sale of corrective lenses, eyeglasses, frames, contact lenses and other related optical products.
In the U.S., ophthalmologists and optometrists have traditionally delivered eye care services. Optical products are typically dispensed by opticians. Ophthalmologists are specifically trained physicians who have completed four years of medical school, obtained a medical degree and have received specialty training in ophthalmology. Ophthalmologists are licensed to conduct diagnostic examinations and to perform ophthalmic surgery. Optometrists complete four years of optometry school and are generally licensed to perform routine eye examinations and prescribe corrective optical devices (principally eyeglasses and contact lenses). Optometrists do not perform surgery, but often provide pre- and post-operative care. Opticians measure, fabricate, fit and adjust glasses as requested by patients and as prescribed by doctors. They also perform routine repairs and dispense eyeglasses and contact lenses. There are approximately 17,100 practicing ophthalmologists and 32,000 practicing optometrists in the U.S.
The U.S. market for eye care services and optical products is large and growing. There are 187 million adults that wear corrective and non-corrective eyewear in the U.S., representing 86% of the total U.S. adult population. 135 million American adults wear prescription eyewear, or 62%. Of the 135 million adults that wear eyewear in the U.S., 48% have an eye exam every year or less and 22% have an eye exam every two years.
2004 proved to be a successful year for U.S. lens retailers. Both chain and independent stores showed 10.9% sales growth in 2004 compared to 2003.
The annual market for eye care services and optical products is expected to grow at rates of 2% to 5%, respectively, for the next several years. The single most compelling explanation for such growth is demographics, and, specifically the aging baby boom segment of the population. The need for corrective lenses is highly correlated with age. While 63% of 25-44 year-olds need such lenses, 95% of 45-64 year-olds require them. As the median age
of the population increases (the portion of the U.S. population age 45 and over is projected to grow 21% from 2001 to 2010), the number of Americans requiring vision correction is expected to grow. Further, the rise of third-party plan providers continues to fuel growth in the industry. Since 1989, the portion of the eye care population covered by third-party plan providers has grown from 40% to 54%.
Eye care in the U.S. is a $45 billion market. Of that, approximately $29 billion is spent annually on health care services related to eye care. In addition, consumers spend approximately $16 billion annually on retail optical products, of which approximately 84%--or $14 billion--is spent on lenses and frames, while approximately 12%--or $2 billion--is spent on contact lenses (with the balance, approximately 4% or $0.6 billion, being spent on sunglasses).
We do business in both sectors of this market (i.e., by providing eye care services and selling optical products). We also do business across both sectors of this market (i.e., by providing managed vision services with respect to both eye care services and optical products).
Eye Care Services and Products
We expect the demand for optical products and eye care services to show steady growth. We believe that the aging of the population, including the "baby boom" generation, will increase the demand for optical products and eye care services such as the medical and surgical treatment of such common disorders as glaucoma, macular degeneration, diabetic retinopathy and cataracts. For instance, Glaucoma affects approximately 3 million people in the U.S. and is projected by industry sources to double by 2030. 2.7 million cataract surgeries were performed in 2002, and that number is expected to increase to approximately 3.2 million by 2007. Since patients over the age of 65 are most affected by these eye disorders, the Medicare program is the primary payer for treatment, including surgical treatment, of these disorders.
Managed Vision Services
According to a Managed Care National Statistics publication, national managed care enrollment in 2004 in health maintenance organizations was 68.8 million and in preferred provider organizations was 109.0 million. Almost all health care insurance plans cover medical/surgical treatment of eye disorders and many also provide vision care benefits, including routine eye exams and optical products.
We believe that enrollment in health care insurance plans, which provide coverage of eye care services will continue to grow. We expect this trend will be supported by managed care plans offering enhanced vision and eye care benefits in order to more aggressively compete for potential membership.
Further, vision care coverage is the fastest growing employee benefit. Vision is a low-cost, high perceived value benefit, rated by employees as one of the three most important benefits. According to the Hay Group, a Philadelphia-based consulting firm, in their 2001 Hay Benefits Report, 65% of employers provided some form of vision care coverage, compared to 50% in 1997 and 58% in 1999.
DESCRIPTION OF BUSINESS DIVISIONS
Our business operations are managed through two divisions which, together, cover a substantial portion of the eye care market: Managed Vision and Consumer Vision.
Managed Vision Division
Description
Our Managed Vision Division contracts with insurers, insurance fronting companies, employer groups, managed care plans, HMOs and other third-party payers to manage claims payment and administration of eye health benefits for those contracting parties in Connecticut, Colorado, Florida, Georgia, Louisiana, Mississippi, Missouri, New Jersey, New York, North Carolina, Oklahoma, South Carolina, Tennessee and Texas. The typical range of benefits
administered includes well eye exams, prescription optical products and medical and surgical services related to eye care.
We have leveraged our leadership position in key markets to build a strong provider base of eye care professionals: ophthalmologists, optometrists and opticians. We verify and approve the credentials of these providers, ensuring they meet plan and regulatory standards. We educate these providers concerning the plan benefits which we administer and then streamline the authorization and claims payment process.
We believe that our managed vision services provide significant value to third-party payers by delivering high quality managed eye care benefits to plan members and comprehensive, cost-effective administrative services to the third-party payers. We believe that we are well positioned to compete for all types of eye care contracts because of our managed care expertise, sophisticated information systems, third party provider relationships and operating history.
Strategy
Recognizing the significant growth potential of this market segment, we are:
o Positioning ourselves to contract for business directly with employer groups and other associations, thereby reaching another sector of the third-party payer market and broadening the base of our revenue stream;
o Increasing our membership lives, which will enable us to offer cost advantages by directing volume to targeted markets, thereby increasing the value of our services to the practitioners who contract with us; and
o Offering non-insurance related products, including Administrative Services Only (ASO) and IRC Section 125 plans, with benefits that include the administration of well eye examinations and/or prescription optical products.
Market Position
As of December 31, 2004, we administered eye care benefit programs, delivered through networks of eye care professionals nationwide, for approximately 3.1 million benefit enrollees under capitation (i.e., payment by an insurer to a managed care entity or network of a fixed amount per member or per enrollee each month, quarter or year) and/or fee-for-service arrangements.
Customers
The customers of our Managed Care Vision Division include insurers, managed care plans, HMOs and other third-party payers. With the advent of our Direct-to-Employer suite of products, our customer base is being enlarged to include, among others, employers, employer groups, unions, trade organizations and municipalities. We have seven managed vision contracts with two insurers, CIGNA and United HealthCare, which account for 27% of our consolidated revenue in 2004. The consolidated revenues for 2004 exclude the revenues of both the Technology operation, CC Systems, Inc., which was sold in September 2004 and the Distribution business which was sold in January 2005. The operating results for these two businesses are reflected in discontinued operations in our consolidated financial statements. CIGNA experienced a decline in members receiving eye care benefits beginning in January 2004, which translated into a $2.0 million decline in our annual revenue; however, a new contract with a different payer became effective on March 1, 2004, which we expect will partially offset this decrease in revenue.
Most of our contracts have terms of one to three years and contain an automatic renewal provision for additional one-year periods and grant either party the right to terminate the contract upon 90-180 days' notice.
Products & Services
We are distinguished in the eye care insurance industry because we offer a number of different risk-bearing contractual relationships for our clients. In addition to traditional "Managed Care Vision Benefits," described in the first point below, we offer a suite of products, which we refer to as our "Direct-to-Employer" products, described in the second, third and fourth points below.
o Managed Care Vision Benefits - We administer vision benefits for health plans to over 3.1 million benefit lives under capitation and fee-for-service arrangements. Benefits administered under these programs are for well vision, preventive exams and optical hardware in addition to medical and surgical eye care benefits. We assume partial or full financial risk with respect to the majority of the lives for which we administer vision benefits. We have been administering benefits of this nature for more than ten years.
o Insured Vision Plan - We provide insurance coverage for well vision, preventive examinations and optical hardware through Fidelity Security Life Insurance Company and through our captive insurance company, OptiCare Vision Insurance Company, Inc.
o Section 125 Vision Plan - This vision benefit allows qualified groups and individuals to participate in vision programs for well vision, preventive examinations and optical hardware on a pretax basis.
o ASO Vision Plan - We administer benefits on a fee basis for well vision, preventive examinations and optical hardware for qualified groups which are self-funded.
Operations
The following are the principal components of our Managed Vision operations:
o Provider Contracting - Upon obtaining a managed care contract, we typically define and/or develop a network of ophthalmologists, optometrists and opticians, facilities and anesthesiologists to provide the eye care services required under the contract. Generally, we attempt to contract first with eye care professionals with whom we have an existing contractual relationship. Additionally, we seek to enter into contracts with independent eye care professionals as well as to work in conjunction with our partners to build networks that meet set access standards.
o Provider Credentialing - Under most contracts, we "credential" eye care professionals (i.e., establish to both our, and the third-party payer's, satisfaction the credentials of such professionals) who provide the eye care services specified under the contract to the third-party payer's members. In addition to our network enrollment process, we credential when requested by the health plan or as required by state law consistent with the standards established by those plans or applicable law. In those instances, we undertake a review process on each prospective eye care professional, which includes obtaining a copy of the state license and Drug Enforcement Agency number, verifying hospital privileges, liability insurance and board certification and reviewing work history.
In conducting our credentialing reviews, we apply the national standards--set by the National Committee for Quality Assurance--by which health plans are measured for compliance with quality assurance initiatives. OptiCare was re-audited for continued accreditation in late 2004 and subsequently re-awarded accreditation in January 2005 through December 2006 as a Credentialing Verification Organization by the National Committee for Quality Assurance for all of the eleven elements tested. Eye care professionals, who are credentialed for our panels, are currently re-credentialed every three years.
o Claims Payment - For most contracted payers, we pay claims to our network providers for services rendered in the fulfillment of vision benefits for members. We also have Internet capabilities for authorizations (if needed), direct claim submission and claim tracking. Additionally, we accept claims via electronic data interchange, enabling providers to send claims through their own practice management software. We believe these enhancements have continued to help lower our cost of operations, improve service and speed the payment cycle to our providers.
To enhance our claims payment administration, we utilize proprietary systems, which allow us to strictly follow Center for Medicare and Medicaid Services' rules for payment of eye care claims. In addition, we
have posted on-line our clinical criteria for treatment of every eye care condition for which we provide covered services. Our providers can use our secure web server to check these criteria and to inform themselves of new or modified criteria as changes occur.
o Utilization Management - Our Utilization Management staff ensures that established clinical criteria are followed in provision of services and benefits to members. Using proprietary clinical criteria for eye care procedures that are based on Center for Medicare and Medicaid Services' local carrier policy and the American Academy of Ophthalmology's guidelines; we work with eye care professionals to determine appropriate eye care treatments. While these practices are intended to reduce unnecessary procedures--and therefore costs--there can be no assurance that costs may not become excessive.
o Plan Member Relations - Service representatives answer plan members' questions relating to their benefits and the status of their claims and help resolve complaints relating to their eye care treatment. We believe that our issue-resolution structure is unique to the industry and increases plan members' satisfaction with their eye care benefits.
o Provider Relations - We continuously educate providers concerning the various plan benefits being administered. In addition, with the assistance of our staff, providers may obtain required authorizations prior to performing certain eye care procedures.
o Quality Management - Our Quality Management Department tracks complaints and concerns and conducts surveys for members, providers and payers to ensure that all parties are satisfied with the services and the service levels provided. Department personnel also recommend, or take, steps to address conditions from which valid complaints have arisen. In addition, we perform retrospective-outcome studies and other quality assessment studies on the care rendered by our network of providers.
o Claim Data Analysis - Our financial analysts review claim and other data to provide feedback to management and to the insurance companies and other payers with which we have claims payment contracts concerning our performance, enabling management to maintain profitability while providing excellent service.
Legal & Compliance
Our Managed Vision Division is subject to the following legal requirements and regulations:
Licensing Requirements. Most states impose strict licensure requirements on health insurance companies, HMOs and other companies that engage in the business of insurance, pre-paid health care or defined managed care activities. In some states, these laws do not apply to the discounted fee-for-service or capitation programs between insurers and provider networks contracting with those insurers.
Certain states, however, such as Texas, where we work on a capitated basis, require that the risk-bearing entity (e.g., the managed care company) be licensed for capitated arrangements unless that entity qualifies under certain exceptions (such as that it be a professional corporation which is owned by eye care providers). We do not qualify for such an exception. As a risk-bearing entity, we are currently licensed and operate our capitated arrangements through a wholly-owned, single-service HMO subsidiary, AECC Total Vision Health Plan of Texas, Inc. (See "--Regulation of Our HMO Subsidiary")
If we are required to become licensed under the laws of states other than Texas for our Managed Care Vision Benefits products, the licensure process can be lengthy and time consuming. In states where we already are conducting such business, unless the regulatory authority permits us to continue to operate while the licensure process is progressing, we could suffer losses of revenue that would result in material adverse changes in our business while the licensing process is pending. In addition, licensing requirements may mandate strict financial and other requirements we may not immediately be able to meet and which, if waivers or other exemptions are not available, might cause us to withdraw from those states or otherwise cause a material adverse change to our business, operations or financial position. (The same risks may not apply to the same degree for our Direct-to-Employer suite of products
due to our relationship with Fidelity Security Life Insurance Company, which is licensed to write life and health insurance in all 50 states (New York, reinsurance only). Once licensed, we would be subject to regulatory compliance and required to report to the licensing authority.
We also hold a license as a third-party administrator in Florida, North Carolina, South Carolina and Texas and are a licensed utilization review agent in South Carolina, Texas, Tennessee and New York. In addition, we have a preferred provider network license in Connecticut.
In New Jersey we have applications on file to become a Certified Organized Delivery System and a third-party administrator and were recommended for approval on February 22, 2005.
These same requirements, it should be noted, can also serve as a barrier to entry to competition in states where such licensure is required.
Regulation of Our Captive Insurance Subsidiary. Our Captive Insurance Company subsidiary, Opticare Vision Insurance Company (OVIC) is a licensed Captive Insurance Company domiciled in South Carolina. It is subject to regulation and supervision by the South Carolina Department of Insurance who requires us to maintain $500,000 of unencumbered capital and surplus via a letter of credit.
Regulation of Our HMO Subsidiary. Our Texas HMO subsidiary, AECC Total Vision Health Plan of Texas, Inc. is a licensed single service HMO. It is subject to regulation and supervision by the Texas Department of Insurance, which has broad administrative powers relating to standards of solvency, minimum capital and surplus requirements, maintenance of required reserves, payment of dividends, statutory accounting and reporting practices and other financial and operational matters. The Texas Department of Insurance requires that stipulated amounts of paid-in-capital and surplus be maintained at all times. Our Texas HMO subsidiary is required by terms of an Order of the Commissioner of Insurance, dated August 12, 1999, as modified in November 2003, to maintain a minimum net worth of $500,000. Dividends payable to us by our Texas HMO subsidiary are generally limited to the lesser of 10% of statutory-basis capital and surplus or net income of the preceding year excluding realized capital gains. In addition, the Company's agreement with the Texas Department of Insurance, required the Company to pledge investments of $250,000, at December 31, 2004 and December 31, 2003.
Third Party Administration Licensing. Some states require licensing for companies providing administrative services in connection with managed care business. We currently hold third party administrator licenses in Florida, North Carolina, South Carolina and Texas. We may seek licenses in the states where they are required for eye care networks, if needed. In the event such licensure is required and we are unable to obtain a license, we may be forced to withdraw from that state, which could have a material adverse effect on our business.
Direct-to-Employer Insurance Products. Fidelity Security Life Insurance Company, a carrier licensed to write life and health insurance in all 50 states (New York, reinsurance only), underwrites our insured product. Fidelity has been rated A- (Excellent), based on an analysis of financial position and operating performance by A.M. Best Company, an independent analyst of the insurance industry. Our insured product, offered through Fidelity, is reinsured through OptiCare Vision Insurance Company, Inc., our wholly-owned subsidiary, which is domiciled in South Carolina and has received approval to operate as a captive insurance company from the South Carolina Department of Insurance.
Preferred Provider Networks. We previously registered as a preferred provider network (PPN) with the Connecticut Office of Health Care Access. In 2003, this regulatory function was transferred to the Department of Insurance and the definition of a PPN was revised to focus on entities assuming financial risk. We have received approval from the Department of Insurance for a PPN in Connecticut. Many states have provider network licensure registration requirements and many of these mandate that an organization have specified financial reserves or insolvency protections and provide financial reporting and disclosures to state officials. Our activities over time in Connecticut and/or in various other states may subject us to regulation under such arrangements, and our ability to comply with these requirements or to secure the necessary regulatory approval, cannot be assured.
"Any Willing Provider" Laws. Some states have adopted, and others are considering, legislation that requires managed care networks to include any qualified and licensed provider who is willing to abide by the terms of the network's contracts. These laws could limit our ability to develop effective managed care networks in such states. However, we believe that if such legislation were adopted that the unique medical management and eye care claim data analysis services we offer would provide great value to our clients. There are currently no states in which we operate our managed care business that have "any willing provider" requirements, although Texas does impose certain anti-discrimination requirements for ophthalmologists and optometrists. Further, with the introduction of our Direct-to-Employer suite of products, we have added business lines which would not be directly affected by adoption of "any willing provider" requirements in the states in which we do such business.
Health Insurance Portability and Accountability Act - Administrative Simplification. The Health Insurance Portability and Accountability Act (referred to as HIPAA), passed in 1996 by Congress, requires the Department of Health and Human Services (referred to as HHS) to enact standards for information sharing, security and the use, disclosure and confidentiality of patients' protected health information. The HHS, in its administrative simplification provisions, has published three sets of final regulations implementing healthcare transactions and privacy standards under HIPAA. These regulations apply to what are termed "covered entities" (i.e., health plan, health care clearinghouse and healthcare provider) and, under terms of the regulations, in certain instances we may be a covered entity and in other instances we may be classified as a business associate of an independent covered entity. In addition, state laws may place additional limitations on the use or disclosure of patients' information.
The first set of final regulations requires covered entities to use uniform standards, including data reporting, formatting and coding, for common healthcare transactions. The Standards for Electronic Transactions Final Rule was published August 2000 and became effective in October 2003. We implemented the appropriate compliance initiatives, including systems enhancements, for the electronic transaction and code set requirements and we believe we are in compliance with this regulation.
The second set of final regulations imposes new standards relating to the privacy of individually identifiable health information. The Standards for Privacy and Individually Identifiable Health Information Final Rule was published December 2000 and became effective April 2001 with a compliance date of April 2003. These standards require covered entities to comply with rules governing the use and disclosure of protected health information. The standards also require covered entities to enter into certain contractual provisions with any business associate to whom individually identifiable information is disclosed. We implemented appropriate compliance initiatives, including systems enhancements, training and administrative efforts, required to be compliant with the HIPAA Privacy Regulations and we believe we are in compliance with this regulation.
A third set of regulations under HIPAA, the Final Rule for Security Standards, was published in February 2003 with a compliance date of April 2005. The Final Rule establishes minimum security requirements for covered entities to protect health information in electronic form. In some cases, we will also have to comply with applicable state regulations regarding privacy and medical information. We have created a security plan that includes administrative, technical and physical security safeguards to ensure our adherence to the regulations by the compliance date. While we will incur costs to become compliant with the HIPAA regulations, we believe this will not have a significant overall impact on our results of operations. We will continue to monitor new developments under HIPAA and the regulations and pronouncements issued there under to ensure compliance.
In addition to its administrative simplification provisions, HIPAA also imposes criminal penalties for fraud against any healthcare benefit program, for theft or embezzlement involving healthcare and for false statements in connection with the payment of any health benefits. These HIPAA fraud and abuse provisions apply not only to federal programs, but also to private health benefit programs. HIPAA also broadened the authority of the Department of Health and Human Services Office of Inspector General, or OIG, to exclude participants from federal healthcare programs. Although we do not know of any current violations of the fraud and abuse provisions of HIPAA, if we were found to be in violation of these provisions, the government could seek penalties against us including exclusion from participation in government payer programs. Significant fines could cause liquidity problems and adversely affect our results of operations.
Interpretation and Implications. Many of the laws described provide for civil and criminal penalties and have been subject to limited judicial and regulatory interpretation. They are enforced by regulatory agencies that are vested with broad discretion in interpreting their meaning. Our agreements and activities have not been examined by federal or state authorities under these laws and regulations. There can be no assurance that review of our business arrangements will not result in determinations that adversely affect our operations or that certain material agreements between us and eye care providers or third-party payers will not be held invalid and unenforceable.
In addition, some of these laws and their interpretation vary from state to state. The regulatory framework of certain jurisdictions may limit our expansion into, or ability to continue operations within, such jurisdictions if we are unable to modify our operational structure to conform to such regulatory framework. Any limitation on our ability to continue operating in the manner in which we have operated in the past could have an adverse effect on our business, financial condition and results of operations.
Competition
Our Managed Vision Division competes with several regional and national eye health companies, which provide services to health plans, associations, employer groups and various other payers. Our largest competitor is Vision Service Plan of America. We also compete for managed care contracts with HMOs, PPOs and private insurers, many of which have larger provider networks and greater financial and other resources than we do. Managed care organizations compete on the basis of administrative strength, size, quality and geographic coverage of their provider networks, marketing abilities, information systems, operating efficiencies and price.
Consumer Vision Division
Description
The Consumer Vision Division provides eye care services and products to consumers through a total of 18 integrated eye health centers and professional optometric practices, two surgery centers, one of which is a laser correction center we own and operate in Connecticut. In the integrated eye health centers, comprehensive eye care services are provided by ophthalmologists and optometrists. We also conduct all management, billing, systems and related procedures for the operation of these facilities.
Strategy
We are seeking to improve the profitability of our Consumer Vision Division by generating higher volume through existing locations. To do so, we are trading on our promise of "better doctors, better training and better care" and our wide selection of quality brand name and private label products which span a wide range of price points. Further, we are continuing test marketing programs to increase optical sales and implementing profit improvement plans throughout the Consumer Vision Division to better define our customer base and to improve target marketing.
Market Position
We are the second largest optical retailer in Connecticut.
Customers
Our customers and patients are individuals who come to us for eye exams, corrective lenses, surgery and non-prescription eyewear, such as sunglasses. We are not dependent upon customers or patients of any particular age, gender, ethnic origin or from any particular community or economic strata.
Products & Services
Integrated Eye Health Centers. Through our nine integrated eye health centers, comprehensive eye care services are provided to individual patients. Such services include medical and surgical treatment of eye diseases and
disorders by ophthalmologists, and vision measuring and non-surgical eye care correction and treatment services by optometrists.
Professional Optometric Practices. Our professional optometric practice locations provide vision correction services by optometrists, and/or sell eyeglasses and other optical products. These facilities are either free-standing or are located within our fully integrated eye health centers. Our professional optometric practices provide all customary optical goods and are supported by our billing, collection and information systems. We operate 18 retail optical locations in Connecticut (nine of those facilities also offer medical services and are referred to as the "integrated eye health centers" discussed above).
Surgical Centers. We own and operate two surgery centers in Connecticut, one of which is a laser correction center. In our ambulatory surgery center in Waterbury, Connecticut, ophthalmic surgeons perform a range of eye care surgical procedures, including cataract surgery and surgical treatment of glaucoma, macular degeneration and diabetic retinopathy. In our laser center in Danbury, Connecticut, we use a VISX excimer laser for the correction of nearsightedness, farsightedness and astigmatism. In these centers, we bill patients (or their insurers, HMOs, Medicare, Medicaid or other responsible third-party payers) for use of the surgery facility. Our surgeons bill the patients separately for their services. For laser correction, patients are billed directly and, generally, we are not reimbursed by third-party payers. Our ambulatory facility in Waterbury is state licensed and approved for the payment of facility fees by most health plans and is Medicare approved.
Manufacturing Laboratory. We also have a complete manufacturing facility in Connecticut, with state of the art equipment, in which lenses are fabricated, surfaced and ground to specifications and supplied to all of our Connecticut locations. Additionally, our lab manufacturing services are integrated into some of our Managed Vision programs that are administered in Connecticut.
Operations
For our integrated eye health centers, professional optometric practices and surgical centers, we contract with a professional corporation, OptiCare P.C., which employs ophthalmologists and optometrists, to provide surgical, medical, optometric and other professional services to patients. We provide management services to OptiCare P.C. under a renewable professional services and support agreement. We refer to OptiCare P.C. as our "professional affiliate."
We purchase most of our eyeglass frames, ophthalmic lenses and other optical goods and devices through our recently sold buying group operation. In addition, most of our contact lenses were and will continue to be provided by Wise Optical which was also sold as part of the Distribution business sale which took place on January 12, 2005. In connection with the sale of the Distribution business, we entered into a Supply Agreement with AECC/Pearlman Buying Group, LLC and Wise Optical LLC. The supply Agreement is a four year commitment to purchase, on a non-exclusive basis $4.2 million of optical products per year through AECC/Pearlman Buying Group, LLC from certain designated manufacturers and suppliers. This annual commitment includes the purchase of approximately $1.3 million of contact lenses a year from Wise Optical LLC. Under the Supply Agreement, we are also obligated to pay AECC/Pearlman Buying Group, LLC an annual fee based on the total of all purchases we make under the Supply Agreement. If the Supply Agreement is terminated because of our default, we must make a buyout payment of between $0.8 million and $0.2 million depending on when the Supply Agreement is terminated.
Legal & Compliance
Our Consumer Vision Division is subject to numerous federal and state laws and regulations, including the following:
Surgical Facility Regulations. Our licensed ophthalmic outpatient surgical facility in Waterbury, Connecticut is subject to the terms of Certificate of Need approvals from the Office of Health Care Access and licensure under the provisions of the Connecticut Public Health Code. The facility also is a participating provider under the federal Medicare and Connecticut Medicaid programs and has provider agreements with various commercial and governmental third-party payers. Violation of any of the terms and conditions of the Certificate of Need approvals
and the Connecticut Public Health Code license governing the facility's operation could result in fines or other sanctions against the facility and its operators, including OptiCare being enjoined or precluded from further operation of the facility. Failure to adhere to the terms of participation for the Medicare or Medicaid programs or a violation of billing or other requirements for the public and private third-party payment programs governing the facility could result in civil or criminal sanctions against the facility and its operators, refund obligations or claims denials and/or termination or exclusion from participation in Medicare, Medicaid or other payer programs. The structure of relationships involving the facility and clinicians providing services in conjunction with the facility also is subject to federal fraud and abuse statutes (including the anti-kickback statute) and related state and federal authorities.
Excimer Laser Regulation. Medical devices, including the excimer laser used in our Danbury, Connecticut laser surgery center, are subject to regulation by the U.S. Food and Drug Administration, referred to as the FDA. Failure to comply with applicable FDA requirements could subject us, our affiliated providers or laser manufacturers to enforcement action, product seizures, recalls, withdrawal of approvals and civil and criminal penalties. Further, failure to comply with regulatory requirements could result in a limitation on, or prohibition of, our use of excimer lasers. Currently, the FDA recognizes that physicians may, in their medical judgment, determine that a particular FDA approved laser is appropriate to use for a particular procedure, even if such use has not been evaluated by the FDA. The FDA's policy on such non-FDA approved use is that it falls under the practice of medicine and is not within the jurisdiction of the FDA. If the FDA was to adversely change its policy with regard to non-FDA approved uses, or take any other adverse regulatory action, it could have a detrimental effect on our use of excimer lasers.
Regulation of Laser Vision Marketing. The marketing and promotion of laser correction and other vision correction surgery procedures in the U.S. is subject to regulation by the FDA and the Federal Trade Commission, referred to as the FTC. The FDA and FTC have released a joint communique on the requirements for marketing these procedures in compliance with the laws administered by both agencies. The FTC staff also issued more detailed staff guidance on the marketing and promotion of these procedures. It has been monitoring marketing activities in this area through a non-public inquiry to identify activities that may require further FTC attention. The FDA has traditionally taken the position that the promotion and advertising of lasers by manufacturers and physicians should be limited to the uses approved by the FDA. Although the FDA does not prevent non-approved uses of excimer lasers, the FDA reserves the right to regulate advertising and promotion of non-FDA-approved uses.
Corporate Practice of Ophthalmology and Optometry. The laws of a number of states prohibit corporations that are not owned entirely by eye care professionals from:
o Employing eye care professionals;
o Receiving for their own account reimbursements from third-party payers for health care services rendered by licensed professionals;
o Controlling clinical decision-making; or
o Engaging in other activities that constitute the practice of ophthalmology or optometry.
To comply with these requirements, we:
o Perform only non-professional services;
o Contract with our professional affiliate (which is owned by a licensed ophthalmologist), which in turn employs or contracts with licensed ophthalmologists or optometrists to provide professional services to patients;
o Do not represent to the public or customers that we provide professional eye care services (which is done by the professional affiliate);
o Do not exercise influence or control over the professional practices or clinical judgments of eye care practitioners employed by the professional affiliate; and
o Only dispense prescription ophthalmic products under the sole supervision of the employees of the professional affiliate.
Our agreement with our professional affiliate specifically provides that all decisions required by law to be made by licensed ophthalmologists or optometrists shall be made only by such licensed persons, and that we shall not engage in any services or activities which would constitute the practice of ophthalmology or optometry. If health care regulations and their interpretations change in the future, we may have to revise the terms of such agreement to comply with regulatory changes.
Prohibitions of Certain Referrals. The Omnibus Budget Reconciliation Act of 1993 includes a provision that significantly expands the scope of the Ethics in Patient Referral Act, also known as the "Stark Law." The provisions of the Stark Law originally prohibited a physician from referring a Medicare or Medicaid patient to any entity for the provision of clinical laboratory services if the physician or a family member of the physician had an ownership interest in or compensation relationship with the entity. Revisions to the Stark Law since 1993 prohibit a referral to an entity in which the physician or a family member has a prohibited ownership interest or compensation relationship if the referral is for any of a list of "designated health services," which includes "prosthetic devices." Under federal authority and the standards imposed by various state Medicaid programs, eyeglasses and contact lenses for patients who have undergone certain ophthalmic procedures would be considered prosthetic devices covered by the Stark Law and regulations. The Stark regulations provide that the prohibition of referrals for these types of eyewear does not apply if the arrangement between the physician and the eyewear seller conforms to the Medicare and Medicaid anti-kickback statute (42 USC Section 1320a-7b), referred to as the Anti-Kickback Statute, and other regulatory requirements. There can be no assurance that future interpretations of such laws and future regulations promulgated thereunder will not affect our existing relationship with our professional affiliate.
State Fee-Splitting and Anti-Kickback Laws. Most states have laws which prohibit the paying or receiving of any remuneration, direct or indirect, that is intended to induce referrals for health care products or services and prohibit "fee-splitting" by health care professionals with any party except other health care professionals in the same professional corporation or practice association. In most cases, these laws apply to the paying of a fee to another person or entity for referring a patient or otherwise generating business, and do not prohibit payment of reasonable compensation for facilities and services other than the generation of business, even if the payment is based on a percentage of the revenues of the professional practice. In addition, to the extent we are engaged in the direct delivery of vision care services in a jurisdiction we have to comply with those statutes. There is no express statute on this specific subject in Connecticut.
Federal Anti-Kickback Statute. The federal Anti-Kickback Statute prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for the referral of "federal health care program" patients, or in return for the purchase, lease or order of any item or service that is covered by a "federal health care program." A "federal health care program" includes Medicare, Medicaid, TRICARE, and certain other state programs funded by the federal government, among others. Pursuant to this law, the federal government has pursued a policy of increased scrutiny of transactions among health care providers in an effort to reduce potential fraud and abuse relating to government health care costs. The Anti-Kickback Statute, provides criminal penalties for individuals or entities participating in federal health care programs who knowingly and willfully offer, pay, solicit or receive remuneration in order to induce referrals for items or services reimbursed under such programs. In addition to federal criminal penalties, the Anti-Kickback Statute provides for civil monetary penalties and exclusion of violators from participation in federal health care programs. A violation of the Anti-Kickback Statute requires the existence of all of these elements: (i) the offer, payment, solicitation or receipt of remuneration; (ii) the intent to induce referrals; (iii) the ability of the parties to make or influence referrals of patients; (iv) the provision of services that are reimbursable under any federal health care program; and (v) patient coverage under any federal health care program.
To our knowledge, there have been no case law decisions regarding service agreements similar to that which we have with our professional affiliate that would indicate that such agreements violate the Anti-Kickback Statute. Because of the breadth of the Anti-Kickback Statute and the government's active enforcement thereof, there can be no assurance, however, that future interpretations of such laws will not require modification of our existing relationship with our professional affiliate. If our services agreement is ever determined to be in violation of the Anti-
Kickback Statute, it is likely that there would be a material adverse impact on our business, financial condition and results of operation.
Advertising Restrictions. Many states have laws that prohibit licensed eye care professionals from using advertising that includes any name other than their own, or from advertising in any manner that is likely to mislead a person to believe that a non-licensed professional is eligible to be engaged in the delivery of eye care services. Advertising is prohibited if it is undertaken in a manner that is deemed inappropriate for a professional or likely to mislead. There are regulatory requirements in Connecticut delineating certain specific advertising requirements with which we must comply.
Additionally, the Federal Trade Commission Act prohibits false and deceptive advertising. The FTC and FDA prohibit advertising or promotion of non-FDA approved uses of laser systems. Although non-FDA approved uses of a device are deemed to be within the medical discretion of a physician, promotion of non-FDA approved uses is prohibited. Both the FTC and FDA require that advertising or promotional statements be limited to laser applications that have been reviewed by the FDA. Our services agreement with our professional affiliate provides that all advertising shall conform to these requirements, but there can be no assurance that the interpretation of the applicable laws or our advertising will not inhibit us or result in legal violations that could have a material adverse effect on our business, financial condition or results of operation.
Health Insurance Portability and Accountability Act - Administrative Simplification. This federal statute and its regulations, discussed above in "--Managed Vision Division" is applicable to the Consumer Vision Division as well.
Interpretation and Implications. The laws described above provide for civil and criminal penalties and have been subject to limited judicial and regulatory interpretation. They are enforced by regulatory agencies that are vested with broad discretion in interpreting their meaning. Our agreements and activities have not been examined by federal or state authorities under these laws and regulations. There can be no assurance that review of our business arrangements will not result in determinations that adversely affect our operations or that certain material agreements between us and eye care providers or third-party payers will not be held invalid and unenforceable. Any limitation on our ability to continue operating in the manner in which we have operated in the past could have an adverse effect on our business, financial condition and results of operations.
In addition, these types of laws and their interpretation vary from state to state. The regulatory framework of certain jurisdictions may limit our expansion into such jurisdictions if we are unable to modify our operational structure to conform to such regulatory framework.
Competition
The most direct competition for our Consumer Vision Division is with independent ophthalmologists and optometrists, as well as with regional operators of retail optical locations. On a national basis, companies that compete in this sector include retail optical chains, such as LensCrafters, Cole Vision, Pearle Vision, Wal-Mart, Eye Care Centers of America, Consolidated Vision Group, Costco Wholesale, U.S. Vision and D.O.C. Optics. Retail optical operators compete on price, service, product availability and location.
Several of our competitors have greater financial and other resources than we have or may charge less for certain services than we do. However, we believe the integrated nature of our business model provides significant competitive advantages in the marketplace.
Distribution & Technology Division
In 2004, the operations comprising our Distribution & Technology segment were sold. In September 2004, we sold our Technology operation, CC System, Inc. and in January 2005, we sold both our Buying Group operation and our contact lens distributor Wise Optical. The effective date of the January 2005 transaction was December 31, 2004.
TRADEMARKS, DOMAIN NAMES AND ASSUMED NAMES
We own the following U.S. trademark registrations: OPTICARE and the miscellaneous curve design, which is the OptiCare Health Systems, Inc. logo; EYE CARE FOR A LIFETIME; EYEWEAR AND EYE CARE FOR A LIFETIME; CONNECTICUT VISION CORRECTION; LOSE THE GLASSES, KEEP THE VISION; THE DIFFERENCE IS CLEAR; and KEEPING YOU AHEAD OF THE CURVE. Other trademarks for which applications for U.S. registration are pending are: THE VISION OF HEALTH and DOCTOR'S EXPRESS. We also maintain a common law trademark in CLAIM IT.
We own the following domain names: opticare.com; opticareeye.com; opticare.net; opticare-ehn.com; opticarevisionplans.com; myvisionplan.com; opticarenas.net; and opticareonline.com.
We consider these trademarks, domain names and assumed names important to our business. However, our business is not dependent on any individual trademark or trade name.
EMPLOYEES
As of December 31, 2004, we and our professional affiliate had approximately 440 employees, including 97 ophthalmologists, optometrists and opticians and 40 ophthalmic assistants. These numbers include an aggregate of approximately 47 part-time personnel who work fewer than 30 hours per week. Of the 440 total employees, approximately 104 are employees of the Distribution business that was sold on January 12, 2005. We believe that our relations with our employees are good. We are not a party to any collective bargaining agreement.
ITEM 2.
ITEM 2. PROPERTIES
We have executive offices in Waterbury, Connecticut and Rocky Mount, North Carolina.
The Waterbury facility, which contains corporate offices and an integrated eye health center, is leased under three separate leases with remaining terms of six, six and eight years, respectively. These leases have renewal options of 20, 20 and 10 years, respectively. The combined base rent is $807,364 per year for a total of 43,592 square feet.
The facility in Rocky Mount which contains our office for our Managed Vision Division is leased under one lease which began on August 1, 2002 and which has a remaining term of three years. The base rent for this facility is $145,626 per year for 15,316 square feet.
The facilities in Waterbury, Connecticut described above, are each leased from parties that are affiliated or associated with our former Chief Executive Officer.
We lease 17 additional offices in the state of Connecticut principally for our Consumer Vision operation. These leases have remaining terms of up to ten years. Many of these leases are also subject to renewal options. We believe our properties are adequate and suitable for our business as presently conducted.
In connection with the sale of the Distribution business, the lease obligation on the facility occupied by Wise Optical and located in Yonkers, New York will remain with OptiCare. The lease term on the facility expires in June 2011. We have estimated our potential exposure on the lease to be approximately $1.3 million and have recorded a provision for this amount which is included in the loss on disposal of discontinued operations on our consolidated financial statements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
HEALTH SERVICE ORGANIZATION LAWSUITS
In September and October 2001, the following actions were commenced: Charles Retina Institute, P.C. and Steven T. Charles, M.D. v. OptiCare Health Systems, Inc., filed in Chancery Court of Tennessee for the Thirtieth Judicial District at Memphis; Eye Associates of Southern Indiana, P.C. and Bradley C. Black, M.D. v. PrimeVision Health, Inc., filed in United States District Court, Southern District of Indiana; and Huntington & Distler, P.S.C., John A. Distler, M.D. and Anne C. Huntington, M.D. v. PrimeVision Health, Inc., filed in United States District Court, Western District of Kentucky. Plaintiffs (ophthalmology or optometry practices) in each of these actions alleged that our subsidiary, PrimeVision Health, Inc. (referred to as PrimeVision) defaulted under agreements effective as of April 1, 1999 entitled Services Agreement (HSO Model) (referred to as Services Agreements) by failing to provide the services allegedly required under those agreements in exchange for annual fees (referred to as HSO Fees) to be paid to PrimeVision. Plaintiffs also alleged that PrimeVision repudiated any duty to perform meaningful services under the Services Agreements and never intended to provide meaningful services. Plaintiffs seek declaratory relief that they are not required to make any payments of HSO Fees to PrimeVision under the Services Agreements for a variety of reasons, including that plaintiffs are discharged of any duty to make payments, there was no termination of the Services Agreements that would trigger an obligation by plaintiffs to pay PrimeVision the amounts designated in the agreements as being owed upon early termination (referred to as the Buy-out Price), the agreements contained an unenforceable penalty, there was lack of consideration and there was a mutual and material misunderstanding. Plaintiffs also seek damages for non-performance and breach of duty of good faith and fair dealing and seek to rescind the Services Agreements for fraud in the inducement, material misrepresentation and mistake. Finally, plaintiffs seek punitive damages and attorneys' fees, interest and costs. PrimeVision also filed denials of all of the material allegations of the complaints in the Huntington & Distler and Eye Associates of Southern Indiana cases, and asserted counterclaims to recover HSO Fees and the Buy-out Price.
In November 2001, PrimeVision commenced the following action: PrimeVision Health, Inc. v. Charles Retina Institute and Steven T. Charles, M.D. filed in United States District Court for the Eastern District of North Carolina, Western District. In this action, PrimeVision sued in North Carolina, which is its principal place of business, one of the practices which had, in an action cited above, sued it in Tennessee. PrimeVision alleged that the Services Agreement and a Transition Agreement, also entered into by Defendant and PrimeVision in April 1999, were part of an integrated transaction in which many practices (referred to as the Practices) that had previously entered into a physician practice management (referred to as PPM) arrangement with PrimeVision converted to a health service organization (referred to as HSO) model. As part of that integrated transaction, the Practices (including Defendant) repurchased assets that they had sold to PrimeVision in or about 1996 and were able to terminate agreements entered into with PrimeVision in 1996 and the obligations thereunder. PrimeVision sought a declaratory judgment that the Services Agreement is enforceable and that Defendant must pay to PrimeVision the annual HSO Fees required under the Services Agreement or, alternatively, the Buy-out Price.
The Multidistrict Litigation. On March 18, 2002, PrimeVision filed a motion with the Judicial Panel on Multidistrict Litigation in Washington, D.C. (referred to as the Judicial Panel) to transfer the foregoing matters to a single federal district court for consolidated or coordinated pretrial proceedings. Over the opposition of the plaintiffs, the Judicial Panel granted the motion and ordered that all of the cases be consolidated in the U.S. District Court for the Western District of Kentucky under the caption In re PrimeVision Health, Inc. Contract Litigation, MDL 1466 (MDL 1466).
In October and November 2002, PrimeVision commenced the following actions:
1. PrimeVision Health, Inc. v. The Brinkenhoff Medical Center, Inc., Michael Brinkenhoff, M.D., Tri-County Eye Institute, and Mark E. Schneider, M.D., filed in the United States District Court for the Central District of California;
2. PrimeVision Health, Inc. v. Robert M. Thomas, Jr., M.D., a medical corporation, Robert M. Thomas, Jr., M.D., Jeffrey P. Wasserstrom, M.D., a medical corporation, Jeffrey P. Wasserstrom, M.D., Lawrence S. Rice, a medical corporation and Lawrence S. Rice, M.D., filed in the United States District Court for the Southern District of California;
3. PrimeVision Health, Inc. v. The Milne Eye Medical Center, P.C. and Milton J. Milne, M.D., filed in the United States District Court for the District of Maryland;
4. PrimeVision Health, Inc. v. Eye Surgeons of Indiana, P.C., Michael G. Orr, M.D., Kevin L. Waltz, M.D. and Surgical Care, Inc., in the United States District Court for the Southern District of Indiana, Indianapolis Division;
5. PrimeVision Health, Inc. v. Downing-McPeak Vision Centers, P.S.C. and John E. Downing, M.D., in the United States District Court for the Western District of Kentucky, Bowling Green Division;
6. Prime Vision Health, Inc. v. HCS Eye Institute, P.C., Midwest Eye Institute of Kansas City, John C. Hagan, III, M.D. and Michael Somers, M.D., filed in the United States District Court for the Western District of Missouri; and
7. PrimeVision Health, Inc. v. Delaware Eye Care Center, P.A., a professional corporation; and Gary Markowitz, M.D., filed in the Superior Court of the State of Delaware, New Castle County.
PrimeVision requested the Judicial Panel to transfer all of the actions except No. 7 to Kentucky and consolidate them as part of MDL 1466. (Action 7 could not be transferred because it was filed in state court.) The Judicial Panel entered a conditional transfer order for such actions, and because there was no opposition to transfer and consolidation in Actions 4, 5 and 6, they are now part of MDL 1466. One practice defendant in Action 1, and the defendants in Actions 2 and 3 opposed transfer to MDL 1466. On April 11, 2003, the Judicial Panel denied those defendants' motions to vacate the Judicial Panel's order to conditionally transfer the actions to the Western District of Kentucky and ordered the remaining three actions transferred to the Western District of Kentucky for inclusion in the coordinated or consolidated pretrial proceedings occurring there.
The actions filed by PrimeVision contain similar allegations as the action PrimeVision filed against Charles Retina Institute in North Carolina District Court as described above. Instead of declaratory relief, however, PrimeVision seeks money damages for payment of the contractual Buy-Out Price.
All of the defendants have denied the material allegations of the complaints, and the defendants in Actions 3, 4, 5, 6 and 7, above, have asserted counterclaims and seek relief similar to the claims asserted and relief sought by the practices in the Charles Retina, Eye Associates of Southern Indiana and Huntington & Distler cases. PrimeVision has denied all of the material allegations of the counterclaims.
The parties have exchanged written discovery and have begun taking depositions. PrimeVision also has discussed settlement with all of the Practices. To date, we have reached settlement with ten HSO Practices with which we were in litigation and with twelve other Practices with which we were not in litigation but where there was a mutual desire to disengage from the Services Agreements. We also have an agreement in principal to settle with an additional Practice with which we were in litigation. The Company is continuing to discuss settlement with the three remaining Practices; however there can be no assurance that the parties will be able to reach mutually agreeable settlement terms. While we continue to meet our contractual obligations by providing the requisite services under our Services Agreements, we are in the process of disengaging from a number of these arrangements. At this stage of the actions, we are unable to form an opinion as to the likely outcome or the amount or range of potential loss, if any.
OTHER LITIGATION
OptiVest, LLC v. OptiCare Health Systems, Inc., OptiCare Eye Health Centers, Inc. and Dean Yimoyines, filed in the Superior Court, Judicial District of Waterbury, Connecticut on January 14, 2002. Plaintiff is a Connecticut limited liability corporation that entered into an Asset Purchase Agreement for certain of our assets. We believe we properly cancelled the Asset Purchase Agreement pursuant to its terms. Plaintiff maintains that it incurred expenses in investigating a potential purchase of certain assets that we misled it with respect to our financial condition, and, as a result, Plaintiff has suffered damages. Plaintiff seeks specific performance of the Asset Purchase Agreement and an injunction prohibiting us from interfering with concluding the transactions contemplated by the Asset Purchase Agreement. Further, Plaintiff alleges a breach of contract with regard to the Asset Purchase Agreement. Plaintiff further alleges we engaged in innocent misrepresentation, negligent misrepresentation, intentional and fraudulent misrepresentation and unfair trade practices with respect to the Asset Purchase Agreement.
The parties agreed to non-binding mediation, which began in April 2003. At the mediation, OptiVest, LLC agreed to withdraw its lawsuit and continue to attempt to resolve this matter through non-binding mediation. Optivest,LLC has withdrawn its lawsuit, however, non-binding mediation has not been successful and the parties have exchanged discovery information and will proceed with an arbitration hearing which was originally scheduled for March 2005 but was postponed and has not yet been rescheduled.
In the normal course of business, 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 December 31, 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 effect in relation to the Company's consolidated financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of security holders in the fourth quarter of 2004.
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth the name, age and position of each of our directors and executive officers as of March 1, 2005. Each director will hold office until the next annual meeting of stockholders or until his or her successor has been elected and qualified. Our executive officers are appointed by and serve at the discretion of the Board of Directors.
NAME AGE POSITION ---- --- -------- Christopher J. Walls, Esq. 41 Chief Executive Officer, President and General Counsel Dean J. Yimoyines, M.D. 57 Chairman of the Board of Directors Eric J. Bertrand 32 Director Gordon A. Bishop 56 President of Consumer Vision Division William A. Blaskiewicz 42 Vice President and Chief Financial Officer Norman S. Drubner, Esq. 65 Director Jason M. Harrold 35 President of Managed Vision Division Mark S. Hoffman 43 Director Richard L. Huber 68 Director Clark A. Johnson 73 Director Melvin Meskin 60 Director Mark S. Newman 55 Director
Mr. Walls was named Chief Executive Officer on January 12, 2005, in addition to his duties as President and General Counsel. Mr. Walls has served as our President and Chief Administrative Officer since October 2004. Additionally, he has served as our Vice President, General Counsel and Corporate Secretary since February 2002. Mr. Walls also served as the President of the Technology sector of the Distribution and Technology Division from January 2004 until its sale on September 10, 2004. Prior to joining us, from December 2000 to February 2002, Mr. Walls was Vice President, Corporate Counsel and Corporate Secretary for Cyberian Outpost, Inc., a technology company in Connecticut. Prior to that, from October 1999 to December 2000, he was Corporate Counsel, Vice President of Business Affairs and Assistant Corporate Secretary with Real Media Inc., an international technology start-up. From December 1995 to October 1999, Mr. Walls served as an in-house litigator with St. Paul Fire and Marine Insurance Company. His professional career also included private practice concentrating on litigation that
included medical malpractice defense and complex insurance administrative proceedings. Mr. Walls received his Bachelor of Arts degree from the University of Dayton and his Juris Doctor degree from Widener University School of Law.
Dr. Yimoyines has served as Chairman of the Board since August 13, 1999. Dr. Yimoyines also served as our Chief Executive Officer from August 13, 1999 to January 12, 2005 and as our President from August 13, 1999 to June 10, 2002. Dr. Yimoyines is a founder of OptiCare Eye Health Centers, Inc. and has served as the Chairman, President and Chief Executive Officer of OptiCare Eye Health Centers, Inc. since 1985. He graduated with distinction from the George Washington School of Medicine. He completed his ophthalmology residency at the Massachusetts Eye and Ear Infirmary, Harvard Medical School. Dr. Yimoyines completed fellowship training in vitreoretinal surgery at the Retina Associates in Boston. He is a graduate of the OPM (Owner / President Management) program at Harvard Business School and is a Fellow of the American Academy of Ophthalmology.
Mr. Bertrand has been a member of the Board of Directors since January 2002. From 1997 through January 2005, Mr. Bertrand held a series of positions of increasing responsibility at Palisade Capital Management, LLC, an affiliate of Palisade Concentrated Equity Partnership, L.P., most recently as a Director. From 1996 to 1997, Mr. Bertrand held a position with Townsend Frew & Company, a healthcare-focused investment banking boutique. From 1994 to 1996, he held positions with Aetna, Inc.'s private equity group, focusing on middle market leveraged buy-outs and larger private equity investments. Mr. Bertrand is a Director of U.S. Vision, Control and Versura, Inc. He holds a Bachelor of Science in Business Administration from Bryant College and a Master of Business Administration in Finance and Entrepreneurship with a certificate in the Digital Economy from New York University.
Mr. Bishop has served as President of our Consumer Vision Division since May 2001. In addition to these duties from September 2003 until its sale in January 2005, he served as President of the Distribution sector of the Distribution and Technology Division. From August 1999 to November 2002, he also was President of our Buying Group. From June 1998 to August 1999, Mr. Bishop directed the retail operations of OptiCare Eye Health Centers, Inc. Mr. Bishop has over 30 years of experience in the optical industry, having served in a variety of capacities with companies in the U.S. and Canada. From August 1997 to April 1998, he served as Vice President of Operations for Public Optical. From July 1994 to April 1997, he served as Operations Manager for Vogue Optical. From June 1990 to July 1994, he held positions of increasing responsibility with Standard Optical Ltd., ultimately holding the position of Vice President of Operations for that company. Mr. Bishop received his Business Administration Diploma from Confederation College of Applied Arts and Technology and subsequently obtained an Ophthalmic Dispensing Diploma from Ryerson Polytechnic University. He holds a variety of eye care professional certifications, including certification by the American Board of Opticianry. He holds a Fellowship in the National Academy of Opticianry.
Mr. Blaskiewicz has served as our Chief Financial Officer since September 2001. Prior to that, he was our Director of Finance, Corporate Controller, Vice President of Finance and, most recently, our Chief Accounting Officer from February 1998 to August 2001. Prior to joining us, Mr. Blaskiewicz held various positions, including Director of Budgeting, with Massachusetts Mutual Life Insurance Company (1993 to 1998), Manager with Ernst & Young (1989 to 1993) and Field Auditor with the Internal Revenue Service (1986 to 1989). He holds a Master of Business Administration from the University of Hartford and a Bachelor of Science in Accounting from Central Connecticut State University, and is a member of the American Institute of Certified Public Accountants, the Connecticut Society of Certified Public Accountants and the Institute of Management Accountants or IMA. Mr. Blaskiewicz is a certified public accountant in Connecticut and holds Certified Management Accountant and Certified Financial Manager designations from the IMA.
Mr. Drubner has been a member of the Board of Directors since November 2001; is senior partner in the law firm of Drubner, Hartley & O'Connor, which he founded in 1971; and is the owner of Drubner Industrials, a commercial real estate brokerage firm. Mr. Drubner has been practicing law in Connecticut since 1963, specializing in real estate, zoning and commercial transactions. He is a member of the Connecticut Bar and the Waterbury, Connecticut Bar Association. Mr. Drubner has been admitted to practice before the U.S. District Court, District of Connecticut. He is a former trustee of Teikyo Post University and was a Director of American Bank of Connecticut from 1985 to 2001. Mr. Drubner holds a Bachelor of Arts degree from Boston University and received his Juris Doctor degree from Columbia University in 1963.
Mr. Harrold has served as President of the Managed Vision Division since August 2000. Mr. Harrold served as Chief Operating Officer of the Managed Vision Division from January 2000 through July 2000, before being appointed its President. Mr. Harrold served as Vice President of Operations from July 1999 to December, 1999, and Vice President of Quality Management from July 1996 to June 1999 for the Managed Vision Division. From November 1993 to July 1996, Mr. Harrold was employed by Alcon Laboratories as a sales representative for its vision care division. Mr. Harrold graduated from the University of South Carolina in 1992 with a Bachelor of Science degree with dual majors in Business Administration for Management Science and Insurance and Economic Security. He earned a Masters degree in Business Administration from Appalachian State University in 1993.
Mr. Hoffman has been a member of the Board of Directors since January 2002 and is a Managing Director of Palisade Capital Management, LLC, an affiliate of Palisade Concentrated Equity Partnership, L.P., which he joined upon its formation in 1995. He is a Director of Refac and Neurologix, Inc., both publicly-traded companies, as well as several privately held companies. Mr. Hoffman is a graduate of the Wharton School at the University of Pennsylvania.
Mr. Huber has been a member of the Board of Directors since July 2002 and is Chief Executive Officer of Norte Sur, a private equity firm targeting Latin America. Mr. Huber is former Chairman, President and Chief Executive Officer of Aetna, Inc., the Hartford, Connecticut-based insurance company, which he joined in 1995. At Aetna, Mr. Huber was responsible for a number of strategic acquisitions, such as NYLCare, PruCare and USHealthcare, making Aetna the largest healthcare insurer in the world. Prior to Aetna, Mr. Huber had a 35-year career in banking, including four years as Vice Chairman and Director of Continental Bank and senior management positions at Chase Manhattan and Citibank. Mr. Huber serves as Director of Danielson Holding Company and was a member of the Congressional International Financial Institutions Advisory Commission. He is a former Coast Guard officer and holds a Bachelor of Arts degree from Harvard College.
Mr. Johnson has been a member of the Board of Directors since May 2002 and is Chairman of PSS World Medical, Inc., a national distributor of medical equipment and supplies to physicians, hospitals, nursing homes and diagnostic imaging facilities. He is a Director of MetroMedia International Group, Neurologix, Inc., World Factory, Inc. and Refac; is retired Chairman and Chief Executive Officer of Pier 1 Imports; and is former Executive Vice President and Director of the Wickes Companies, Inc. Mr. Johnson, who attended the University of Iowa, completed the Advanced Management Program at the Harvard Business School. He is former Chairman of the American Business Conference, former trustee of Texas Christian University and is a former Chief Executive Officer Participant in the National Conference on Ethics in America.
Mr. Meskin has been a member of the Board of Directors since January 2002 and is Chairman of Refac, a publicly held company on the American Stock Exchange. Mr. Meskin retired as Vice President-Finance-National Operations of Verizon, the combined Bell Atlantic/GTE telecommunications company. Mr. Meskin joined New York Telephone in 1970 and held a variety of line and staff assignments with the company over a 31-year career. In 1994, he was named Vice President-Finance and Treasurer for NYNEX Telecommunications. When Bell Atlantic and NYNEX merged, he was appointed Vice President-Finance and Comptroller of Bell Atlantic.
Mr. Newman has been a member of the Board of Directors since May 2002 and is Chairman of the Board, President and Chief Executive Officer of DRS Technologies, Inc., a leading supplier of defense electronics systems to government and commercial customers worldwide. Mr. Newman joined DRS Technologies in 1973, served many years as its Chief Financial Officer, was named a Director in 1988, became President and Chief Executive Officer in 1994, and was elected Chairman of the Board. Mr. Newman serves as Chairman of the American Electronics Association and as a Director of the New Jersey Technology Council, SSG Precision Optronics and the Congoleum Corporation where he chairs the Audit Committee. He is a member of the Board of Governors of the Aerospace Industries Association of America, and also serves as a member of the Navy League of the United States, the National Defense Industrial Association, the Association of the U.S. Army, and the American Institute of Certified Public Accountants, among other professional affiliations. Mr. Newman holds a Bachelor of Arts degree in Economics from the State University of New York at Binghamton and a Master of Business Administration from Pace University. He is also a C.P.A.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Trading in OptiCare Common Stock
Our common stock is traded on the American Stock Exchange under the symbol "OPT". The high and low trading prices for the periods presented are based on trades effected on the American Stock Exchange.
2004 HIGH LOW ---- ----- ----- 4th Quarter $0.36 $0.21 3rd Quarter 0.35 0.20 2nd Quarter 0.65 0.36 1st Quarter 0.85 0.60
2003 HIGH LOW ---- ----- ----- 4th Quarter $0.99 $0.55 3rd Quarter 0.74 0.53 2nd Quarter 0.90 0.52 1st Quarter 0.95 0.29
As of March 1, 2005, there were approximately 201 stockholders of record of our common stock. The number of record holders was determined from the records of our transfer agent, Mellon Investor Services, LLC, and does not include beneficial owners of our common stock whose shares are held in the names of various securities brokers, dealers and registered clearing agencies. We believe the number of beneficial holders of our common stock is approximately 1,100.
We have never paid any cash dividends on our common stock and do not intend to pay any cash dividends on our common stock for the foreseeable future. It is our present policy that any retained earnings will be used for repayment of indebtedness, working capital, capital expenditures and general corporate purposes. Furthermore, we are precluded from declaring or paying any cash dividends on our common stock, or making a distribution to our stockholders under the covenants of our revolving credit, term loan and security agreement with our senior lender, until the termination of such agreement and the repayment of all amounts due to such lender.
RECENT SALES OF UNREGISTERED SECURITIES.
None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical consolidated financial data has been derived from audited historical financial statements and should be read in conjunction with our consolidated financial statements and the notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations.
During 2004, we sold the net assets of our Technology operation in Florida and in 2005 we sold our Distribution operation in New York, which was effective as of December 31, 2004, and both sales were accounted for as discontinued operations. During 2002, we sold the net assets of our retail optometry operations in North Carolina and accounted for the sale as a discontinued operation. Accordingly, historical amounts presented below
have been restated to reflect discontinued operations treatment.
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------ (in thousands, except per share data) 2004 2003 2002 2001 2000 ------- ------- ------- ------- --------
STATEMENT OF OPERATIONS DATA: Total net revenues $58,903 $61,099 $60,855 $59,475 $ 68,409 Income (loss) from continuing operations (1) (2) $ 38 $(7,053) $ 4,842 $ 2,969 $(14,874) Weighted average shares outstanding: Basic 30,598 30,067 12,552 12,795 12,354 Diluted 30,598 30,067 51,172 13,214 12,354 Income (loss) from continuing operations per share available to common stockholders: Basic $ (0.02) $ (0.25) $ 0.35 $ 0.23 $ (1.20) Diluted $ (0.02) $ (0.25) $ 0.09 $ 0.22 $ (1.20)
BALANCE SHEET DATA: Net assets of discontinued operations $ 3,361 $ 9,493 $ 4,287 $13,892 $ 14,813 Total current assets 14,818 17,549 13,279 20,583 14,913 Goodwill and other intangibles, net 17,731 17,744 17,859 17,978 18,962 Total assets 39,814 45,855 45,105 59,742 55,513 Total current liabilities 16,386 23,628 10,558 17,139 49,454 Total debt (including current portion) (3) 10,356 12,593 19,321 34,286 34,312 Redeemable preferred stock 6,344 5,635 5,018 -- -- Total stockholders' equity (3) $ 5,565 $14,412 $10,652 $ 6,981 3,877
(1) Includes the effect of goodwill amortization of $943 in both 2001 and 2000. The amortization of goodwill was discontinued in 2002 pursuant to Statement of Financial Accounting Standards (SFAS) No. 142. Also includes preferred stock dividends of $709, $618 and $531 in 2004, 2003 and 2002, respectively, with respect to our Series B Preferred Stock.
(2) As a result of our adoption of SFAS No. 145, we reclassified our previously reported gain from extinguishment of debt of approximately $8.8 million and related income tax expense of approximately $3.5 million in 2002 from an extraordinary item to continuing operations.
(3) See the Capitalization Table included in the Subsequent Event footnote No. 21, which reflects the pro forma impact on our Debt and Stockholders' Equity resulting from the Distribution business sale on January 12, 2005 and the issuance of 280,618 shares of Series D Preferred Stock.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto which are included elsewhere in this Annual Report on Form 10-K. (See "Index to Financial Statements" beginning at page.)
Overview. We are an integrated eye care services company focused on vision benefits management (managed vision) and retail optical sales and eye care services to patients.
Throughout 2004, we implemented cost cutting measures and programs designed to increase sales and product margins at Wise Optical. However, we were unable to increase sales or improve product margins and operating income at Wise Optical, which negatively impacted our results of operations in 2004. As a result of the continued troubles at Wise Optical, on January 12, 2005, our wholly-owned subsidiary, OptiCare Acquisition Corp., entered into an Asset Purchase Agreement with Wise Optical, LLC and AECC/Pearlman Buying Group, LLC, both entities formed by Dean J. Yimoyines, M.D., our former Chief Executive Officer, current President and Chief Executive Officer of our medical affiliate, OptiCare P.C., and our current Chairman, pursuant to which we sold, effective as of December 31, 2004, substantially all of the assets and certain liabilities of our Distribution division, which consisted of our contact lens distributor, Wise Optical, and our Optical Buying Group, for an aggregate purchase price of approximately $4.2 million.
In addition, in May 2004, our Board of Directors approved management's plan to exit and dispose of our Technology business, CC Systems, Inc. We completed the sale of the net assets of CC Systems on September 10, 2004.
As a result of selling these businesses, we now have the following two reportable operating segments: (1) Managed Vision and (2) Consumer Vision. Our Managed Vision segment contracts with insurers, managed care plans and other third party payers and employer groups to manage claims payment administration of eye health benefits for those contracting parties and to provide insurance. 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.
In addition to these segments, we receive income from other non-core operations and transactions, including our health service organization (HSO) operation which receives fee income for providing certain support services to individual ophthalmology and optometry practices. While we continue to provide the required services to these practices, we are in the process of generally disengaging from a number of these operations. (See "Legal Proceedings --Health Services Organization Lawsuits")
In the first and second quarters of 2004, we failed our fixed charges ratio covenant under our revolving credit facility with CapitalSource Financial, LLC. As a result of our non-compliance with this covenant, 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. In addition, on August 27, 2004, we further amended the revolving credit facility with CapitalSource to eliminate a provision whereby a material adverse change with respect to OptiCare can constitute an event of default or prevent further advances under the facility. Palisade Concentrated Equity Partnership, L.P., our majority stockholder, guaranteed $1.0 million of the loan balance due to CapitalSource related to this amendment. In connection with the sale of certain assets of our Distribution division on January 12, 2005, we further amended the terms of our revolving credit facility with CapitalSource to reduce the tangible net worth covenant for December 2004 and January 2005 from ($3,000,000)
to ($6,500,000). Pursuant to the terms of the revolving credit facility, as amended, we must maintain a tangible net worth of at least ($3,000,000) after February 1, 2005. Management believes it will comply with its future financial covenants, however, if operating losses continue and we fail to comply with financial covenants in the future or otherwise default on our debt, our creditors could foreclose on our assets.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Estimates are adjusted as new information becomes available. Actual results may differ from these estimates under different assumptions or conditions.
For a detailed discussion on the application of these and other accounting policies, see Note 3 to the consolidated financial statements. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Services Revenue
Through our affiliated professional corporation, OptiCare P.C., our Consumer Vision Division provides to consumers comprehensive eye care services, including medical and surgical treatment of eye diseases and disorders by ophthalmologists, and vision measuring and non-surgical treatments and correction services by optometrists. We charge a fee for providing the use of our ambulatory surgery center by professionals for surgical procedures. Our ophthalmic, optometric and ambulatory surgery center services are recorded at established rates, reduced by an estimate for contractual allowances. Contractual allowances arise due to the terms of certain reimbursement contracts with third-party payers that provide for payments to us at amounts different from our established rates. The contractual allowance represents the difference between the charges at established rates and estimated recoverable amounts and is recognized in the period the services are rendered. The contractual allowance is estimated based on an analysis of historical collection experience in relation to amounts billed and other relevant information. Any differences between estimated contractual adjustments and actual final settlements under reimbursement contracts are recognized as adjustments to revenue in the period of final settlements. Historically, we have not had significant adjustments to these estimates.
Medical Claims Expense
Claims expense is recorded as provider services are rendered and includes an estimate for claims incurred but not reported. Reserves for estimated insurance losses are determined on a case by case basis for reported claims, and on estimates based on our experience for loss adjustment expenses and incurred but not reported claims. These liabilities give effect to trends in claims severity and other factors which may vary as the losses are ultimately settled. We believe that our estimates of the reserves for losses and loss adjustment expenses are reasonable; however, there is considerable variability inherent in the reserve estimates. These estimates are continually reviewed and, as adjustments to these liabilities become necessary, such adjustments are reflected in current operations in the period of the adjustment. Historically, we have not had significant adjustments to this estimate.
Goodwill
Goodwill, which arises from the purchase price exceeding the assigned value of net assets of acquired businesses, represents the value attributable to unidentifiable intangible elements being acquired. Of the total goodwill included on our consolidated balance sheet, approximately 72% is recorded in our Managed Vision segment and 28% in our Consumer Vision segment.
On an annual basis, or as circumstances dictate, management reviews goodwill and evaluates events or other developments that may indicate impairment in the carrying value. The evaluation methodology for potential
impairment is inherently complex, and involves significant management judgment in the use of estimates and assumptions. We use multiples of revenue and earnings before interest, taxes, depreciation and amortization of comparable entities to value the reporting unit being evaluated for goodwill impairment.
We evaluate impairment using a two-step process. First, we compare the aggregate fair value of the reporting unit to its carrying amount, including goodwill. If the fair value exceeds the carrying amount, no impairment exists. If the carrying amount of the reporting unit exceeds the fair value, then we compare the implied fair value of the reporting unit's goodwill with its carrying amount. The implied fair value is determined by allocating the fair value of the reporting unit to all the assets and liabilities of that unit, as if the unit had been acquired in a business combination and the fair value of the unit was the purchase price. If the carrying amount of the goodwill exceeds the implied fair value, then goodwill impairment is recognized by writing the goodwill down to the implied fair value. Adverse changes in our business climate, revenues or profitability could require further reductions to the carrying value of our goodwill in future periods.
Events that may indicate goodwill impairment include significant or adverse changes in business or economic climate, an adverse action or assessment by a regulator, unanticipated competition, loss of key personnel, and the sale or expected sale/disposal of a reporting unit. Due to uncertain market conditions it is possible the financial information used to support our goodwill may change in the future, which could result in non-cash charges that would adversely affect our results of operations and financial condition. See note 9 to consolidated financial statements.
Income Taxes
We account for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes" which requires an asset and liability method of accounting for deferred income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis using enacted tax rates expected to apply to taxable income in the years the temporary differences are expected to reverse. Our determination of the likelihood that deferred tax assets can be realized is based on our examination of available evidence, which involves estimates and assumptions. We consider future market growth, forecasted earnings, future taxable income and known future events in determining the need for a valuation allowance. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period such determination is made. In the third quarter of 2003, we recorded a valuation reserve against our entire deferred tax assets due to historical operating losses. As we experience future profitability, we expect to reduce or eliminate the valuation reserve. See note 18 to consolidated financial statements.
RESULTS OF CONTINUING OPERATIONS
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Managed Vision revenue. Managed Vision revenue represents fees received under our managed care contracts. Managed Vision revenue decreased to approximately $25.5 million for the year ended December 31, 2004, from approximately $28.1 million for the year ended December 31, 2003, a decrease of approximately $2.6 million or 9.3%. The decrease resulted from approximately $3.2 million of lost revenue from terminated and modified contracts that resulted from changes made by the Texas State Legislature to its Medicaid and Children's Health Insurance Programs, $2.3 million of lost revenue 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 $2.6 million from new contracts and approximately $0.3 million from net growth in existing contracts.
Product sales revenue. Product sales primarily include the sale of optical products through our Consumer Vision segment. Product sales revenue increased to approximately $11.6 million for the year ended December 31, 2004, from approximately $11.3 million for the year ended December 31, 2003, an increase of approximately $0.3 million or 2.7%. This increase is primarily due to an increase in consumer vision product sales, primarily from an increase in
purchasing volume as a result of sales incentives.
Other services revenue. Other services revenue includes revenue earned from providing eye care services in our Consumer Vision segment and HSO services. Services revenue increased to approximately $19.9 million for the year ended December 31, 2004, from approximately $19.0 million for the year ended December 31, 2003, an increase of approximately $0.9 million or 4.7%. This increase includes an approximate $1.1 million increase in Consumer Vision services revenue due to increased services volume in the optometry and surgical areas due to increased doctor coverage. These increases were offset by an approximate $0.2 million decrease in fees collected under our HSO agreements primarily due to disputes with certain physician practices, which are parties to these agreements, and due to HSO settlements which cancelled these agreements. We continue to be in litigation with several of these practices and intend to continue to pursue settlement of these matters in the future. We expect future revenue from HSO settlements to be minimal and that all remaining contract settlements will be finalized by the end of the second quarter 2005. While we expect future HSO revenue to decline, we believe this will be more than off set by growth in Consumer Vision.
Other income. Other income represents non-recurring settlements on health service organization contracts. Other income decreased to approximately $1.9 million for the year ended December 31, 2004 from approximately $2.7 million for the year ended December 31, 2003, as a result of fewer settlements.
Medical claims expense. Medical claims expense decreased to $19.2 million for the year ended December 31, 2004, from approximately $22.0 million for the year ended December 31, 2003, a decrease of approximately $2.8 million or 12.7%. The medical claims expense loss ratio (MLR) representing medical claims expense as a percentage of Managed Vision revenue decreased to 75.2% in 2004 from 78.3% in 2003. The year-over-year reduction in the MLR is primarily attributable to an unusually high claims experience in 2003 related to a utilization spike with Children's Health Insurance Programs and Medicaid Programs under our management immediately prior to the elimination of vision benefits announced and initiated by the Texas State Legislature beginning in the third quarter of 2003.
Cost of product sales. Cost of product sales increased to approximately $4.1 million for the year ended December 31, 2004, from approximately $3.8 million for the year ended December 31, 2003, an increase in product sales approximately $0.3 million or 7.9%. This increase relates to our Consumer Vision business primarily as a result of a shift in product mix to products with higher costs.
Cost of services. Cost of services increased to approximately $8.3 million for the year ended December 31, 2004, compared to approximately $8.0 million for the year ended December 31, 2003, an increase of approximately $0.3 million or 3.8%. The increase in cost of services is due to the increase in Consumer Vision services.
Selling, general and administrative expenses. Selling, general and administrative expenses increased to approximately $25.1 million for the year ended December 31, 2004, from approximately $24.2 million for the year ended December 31, 2003, an increase of approximately $0.9 million or 3.7%. Of this increase, approximately $0.5 million relates to increased Corporate compliance costs. The remaining increase is attributable to costs incurred as part of our direct-to-employer initiative in the Managed Vision segment and increased costs in Consumer Vision segment related to increased sales volume.
Interest expense. Interest expense decreased to approximately $1.2 million for the year ended December 31, 2004 from approximately $2.0 million for the year ended December 31, 2003, a decrease of $0.8 million or 40%. The 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 (benefit). Income tax expense of less than $0.1 million for the year ended December 31, 2004 primarily represents minimum state tax expense. For the year ended December 31, 2003, we recorded approximately $4.9 million of income tax expense from continuing operations, which includes approximately $7.1 million of tax expense to establish a full valuation allowance against our deferred tax assets and is partially offset by an approximate $2.2 million income tax benefit on our loss from continuing operations. The valuation allowance was
established based on the weight of historic available evidence, that it is more likely than not that the deferred tax assets will not be realized.
Discontinued operations. In May 2004, our Board of Directors approved management's plan to dispose of our Technology business, CC Systems, Inc. and in accordance with SFAS No. 144 this business is reported as a discontinued operation. We completed the sale of the net assets of CC Systems on September 10, 2004. The loss on discontinued operations of approximately $1.4 million 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. In December 2004, our Board of Directors approved management's plan to dispose of the Distribution business, which was comprised of our contact lens distributor, Wise Optical and our Buying Group operation. In accordance with SFAS No. 144 the Distribution business is reported as a discontinued operation. The loss on discontinued operations of approximately $8.4 million includes a loss on disposal of approximately $4.4 million, based on the fair value of the net assets held for sale, and the loss from operations of the Distribution business of approximately $4.0 million.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Managed Vision revenue. Managed Vision revenue represents fees received under our managed care contracts. Managed Vision revenue decreased to approximately $28.1 million for the year ended December 31, 2003, from approximately $29.4 million for the year ended December 31, 2002, a decrease of approximately $1.3 million or 4.5%. During the second quarter of 2003 the Texas state legislature made changes to its Medicaid program and as a result HMO Blue, with whom we maintained a Medicaid contract, withdrew from Texas' Medicaid program effective September 1, 2003. Therefore, our contract with HMO Blue terminated on September 1, 2003. This contract generated revenue of approximately $1.7 million in 2003 compared to approximately $2.5 million in 2002. In addition and also effective September 1, 2003, the Texas state legislature decided to no longer fund a vision benefit in its Children's Health Insurance Program or provide vision hardware benefits to those over the age of 21. We maintained a number of contracts through this program that reduced benefits and/or terminated on September 1, 2003 and these contracts generated revenues of approximately $2.0 million in 2003 and approximately $2.2 million in 2002. Other decreased revenue of approximately $2.0 million was primarily from contracts not renewed in 2003, and was partially offset by increased revenue of approximately $1.5 million from new contracts and growth in existing contracts.
Product sales revenue. Product sales primarily include the retail sale of optical products in our Consumer Vision segment. Product sales revenue increased to approximately $11.3 million for the year ended December 31, 2003, from approximately $10.8 million for the year ended December 31, 2002, an increase of approximately $0.5 million or 4.6%. The increase is primarily attributable to increases in the average prices of units sold.
Other services revenue. Other services revenue includes revenue earned from providing eye care services in our Consumer Vision segment and HSO services. Services revenue increased to approximately $19.0 million for the year ended December 31, 2003, from approximately $18.3 million for the year ended December 31, 2002, an increase of approximately $0.7 million or 3.8%. This increase includes an approximate $1.5 million increase in Consumer Vision services revenue due to increased services volume in the optometry and surgical areas due to increased doctor coverage. This increase was partially offset by an $0.8 million decrease in fees collected under our HSO agreements primarily due to disputes with certain physician practices, which are parties to these agreements, and due to HSO settlements which cancelled these agreements for the future.
Other income. Other income represents non-recurring settlements on health service organization contracts. Other income increased to approximately $2.7 million for the year ended December 31, 2003 from approximately $2.3 million for the year ended December 31, 2002.
Medical claims expense. Medical claims expense decreased to $22.0 million for the year ended December 31, 2003, from approximately $22.3 million for the year ended December 31, 2002, a decrease of approximately $0.3 million. The MLR increased to 78.3% in 2003 from 75.9% in 2002. The MLR was lower in 2002 primarily due to a favorable adjustment to the reserve of approximately $0.6 million in 2002 from a contract settlement. Excluding this
adjustment, MLR for 2002 would have been 77.9% compared to 78.3% in 2003. In addition, the MLR in 2003 was negatively impacted by the recent change in the Texas state legislature, which no longer funds a vision benefit in its Children's Health Insurance Program and vision hardware to Medicaid recipients over the age of 21. As a result, we experienced an increase in claims as utilization increased prior to the elimination of the benefit.
Cost of product sales. Cost of product sales decreased to approximately $3.8 million for the year ended December 31, 2003, from approximately $4.1 million for the year ended December 31, 2002, a decrease of approximately $0.3 million or 7.9%. This decrease in cost of sales is due to a decrease in product costs in our Consumer Vision business primarily resulting from a shift in product mix to higher margin products as a result of sales incentives.
Cost of services. Cost of services increased to approximately $8.0 million for the year ended December 31, 2003, compared to approximately $7.6 million for the year ended December 31, 2002, an increase of approximately $0.4 million or 5.3%. This increase is due to the increase in Consumer Vision services.
Selling, general and administrative expenses. Selling, general and administrative expenses increased to approximately $24.2 million for the year ended December 31, 2003, from approximately $23.4 million for the year ended December 31, 2002, an increase of $0.8 million or less than 1%. This increase is primarily attributable to costs we incurred as part of our direct-to-employer initiative in the Managed Vision segment, including legal, consulting, compensation costs for a new sales force and other professional fees.
Gain (loss) from early extinguishment of debt. The approximate $1.9 million loss from early extinguishment of debt for the year ended December 31, 2003, primarily 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 and the amendment of our term loan with CapitalSource on November 13, 2003. The approximate $8.8 million gain on extinguishment of debt for the year ended December 31, 2002 was the result of our capital restructuring in January 2002. The 2002 gain is comprised of approximately $10.0 million of forgiveness of principal and interest by Bank Austria, our former senior secured lender, and was partially offset by the write-off of $1.2 million of related unamortized deferred financing fees and debt discount.
Interest expense. Interest expense decreased to approximately $2.1 million for the year ended December 31, 2003 from approximately $3.0 million for the year ended December 31, 2002, a decrease of $0.9 million. This decrease in interest expense is primarily due to the decrease in the average outstanding debt balance, primarily due to the conversion of debt to preferred stock in May 2003.
Income tax expense (benefit). For the year ended December 31, 2003, we recorded approximately $4.9 million of income tax expense from continuing operations, which includes approximately $7.1 million of tax expense to establish a full valuation allowance against our deferred tax assets and is partially offset by an approximate $2.2 million income tax benefit on our loss from continuing operations. The valuation allowance was established based on the weight of historic available evidence, that it is more likely than not that the deferred tax assets will not be realized. The tax expense for the year ended December 31, 2002 of approximately $2.5 million was primarily due to approximately $3.5 million of tax expense associated with the approximate $8.8 million gain on extinguishment of debt, partially offset by an approximate $1.0 million of tax benefit on other operating losses.
Discontinued operations. In May 2002, our Board of Directors approved our plan to dispose of the net assets used in the retail optical and optometry practice locations we operated in North Carolina. On August 12, 2002, we consummated the sale of those assets, which resulted in an approximate $4.4 million loss on disposal in 2002, including income tax expense of approximately $0.3 million. We reported approximately $0.3 million of income from discontinued operations, net of tax, for the year ended December 31, 2002, representing income from this operation prior to disposal.
LIQUIDITY AND CAPITAL RESOURCES
Uses of Liquidity.
The following table summarizes our significant contractual obligations (in thousands) at December 31, 2004 that impact our liquidity.
CONTRACTUAL THERE- OBLIGATIONS 2005 2006 2007 2008 2009 AFTER TOTAL ---------------- ------ ------ ------- ------ ------ ------ -------
Debt $ 332 $1,475 $ 8,549 $ -- $ -- $ -- $10,356 Operating leases 2,572 2,486 2,275 1,885 1,504 10,062 20,784 Capital leases 11 13 6 -- -- -- 30 ------ ------ ------- ------ ------ ------- ------- Total $2,915 $3,974 $10,830 $1,885 $1,504 $10,062 $31,170 ====== ====== ======= ====== ====== ======= =======
Our long-term debt is explained in detail in Note 10 to the consolidated financial statements. Operating leases and capital leases are explained in detail in Note 12 to the consolidated financial statements.
In connection with the sale of the Distribution division on January 12, 2005, we entered into a Supply Agreement with AECC/Pearlman Buying Group, LLC and Wise Optical LLC. The supply Agreement is a four year commitment to purchase, on a non-exclusive basis $4.2 million of optical products per year through AECC/Pearlman Buying Group, LLC from certain designated manufacturers and suppliers. This annual commitment includes the purchase of approximately $1.3 million of contact lenses a year from Wise Optical LLC. Under the Supply Agreement, we are also obligated to pay AECC/Pearlman Buying Group, LLC an annual fee based on the total of all purchases we make under the Supply Agreement. If the Supply Agreement is terminated because of our default, we must make a buyout payment of between $0.8 million and $0.2 million depending on when the Supply Agreement is terminated.
Throughout 2005, we plan to continue making substantial investments in our business. In that regard, we foresee the following as significant uses of liquidity in 2005: interest and principal payments of approximately $1.3 million to be made to our principal lender, CapitalSource, and capital expenditures of approximately $0.4 million. We also may make investments in future acquisitions of complementary businesses or technologies.
The amounts and timing of our actual expenditures will depend upon numerous factors, including our investments in technology, the amount of cash generated by our operations and the amount and extent of our acquisitions. Actual expenditures may vary substantially from our estimates.
Sources of Liquidity.
Our primary sources of liquidity have been cash flows generated from operations in our Managed Vision and Consumer Vision segments and borrowings under our term loan and revolving credit facility with CapitalSource. We believe the combination of the above and management's initiatives, as discussed in Note 2 to the consolidated financial statements, will provide sufficient liquidity to meet our capital needs.
As discussed below, we have failed to comply with the minimum fixed charge ratio covenant under our term loan and revolving credit facility with CapitalSource the first and second quarters of 2004, for which we have received waivers from CapitalSource. We are currently in compliance with all of our financial covenants under our term loan and revolving credit facility, but if we fail to comply with these financial covenants, we may not be able to obtain additional funds from CapitalSource and the term loan and revolving credit facility could become immediately due and payable, which could have a material adverse effect on our financial position. As a result of the January 12, 2005 amendment to the Loan and Security Agreement with CapitalSource, we were in compliance with our covenants. The amendment reduced the tangible net worth covenant from ($3,000,000) to ($6,500,000) for December 2004 and January 2005. Without this amendment, we would have been in violation of the tangible net worth covenant at December 31, 2004.
The following table sets forth a year-over-year comparison of the components of our liquidity and capital resources for the years ended December 31, 2004 and 2003:
(In millions) ------------- 2004 2003 $ CHANGE ----- ----- -------- Cash and cash equivalents $ 2.2 $ 1.7 $ 0.5 Cash (used in) provided by: Operating activities 2.9 (2.7) 5.6 Investing activities (0.2) (6.7) 6.5 Financing activities (2.2) 8.0 (10.2)
Net cash provided by operating activities in 2004 was $2.9 million and is primarily attributable to a net reduction in working capital of $1.6 million and approximately $1.3 million in non-cash charges. The net reduction in working capital is primarily the result of increases in both accounts payable and other liabilities offset in part by cash used by discontinued operations. Net cash used in operating activities in 2003 included a loss from continuing operations of approximately $7.1 million, which was offset by approximately $8.7 million of non-cash charges. The remaining $4.5 million of cash used in operating activities was a net decrease in working capital, primarily due to cash used by the discontinued operations.
Net cash used in investing activities was approximately $0.2 million for the year ended December 31, 2004 and included $0.7 million used to purchase fixed assets and approximately $0.3 million used for managed care deposits offset by approximately $0.7 million in proceeds related to the sale of CC Systems and $0.2 million of payments received on notes receivable. Net cash used in investing activities was approximately $6.7 million for the year ended December 31, 2003 and included approximately $6.2 million of cash used to purchase the assets of Wise Optical in February 2003 and approximately $0.7 million of cash used for capital expenditures. Wise Optical was sold as part of our sale of the Distribution business on January 12, 2005.
Net cash used by financing activities was approximately $2.2 million for the year ended December 31, 2004 and resulted primarily from repayments made under our term loan and revolving credit facility with CapitalSource. Net cash provided by financing activities was approximately $8.0 million for the year ended December 31, 2003 and was primarily the result of an approximate $8.8 million net increase in borrowings under our revolving credit facility, which was primarily used to fund the purchase of Wise Optical and offset Wise Optical's operating losses during the year.
We incurred operating losses in 2003 that continued into 2004, due primarily to substantial operating losses at Wise Optical. In January 2005, we sold our Distribution business including the Wise Optical operation. In September 2004, we also sold our Technology business, CC Systems, Inc. The sale of these operations generated cash proceeds and reduced demands on working capital and corporate personnel. In addition, in January 2005, we sold 280,618 shares of newly created Series D Preferred Stock, which is convertible into our common stock, for an aggregate price of approximately $4.4 million.
In addition, in 2003 the Managed Vision segment began shifting away from the lower margin and long sales cycle of our third party administrator, or 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 that has led to new contracts. We 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 we expect to continue. We have also continued to settle outstanding HSO litigation with positive results through March of 2005.
We believe the combination of the above initiatives executed in the operating segments will continue to improve our liquidity and should ensure compliance with CapitalSource covenants in the future. We believe that our cash flow from operations, borrowings under our amended term loan and revolving credit facility with CapitalSource and operating and capital lease financing will provide us with sufficient funds to finance our operations for the next 12 months including the purchase of certain operating equipment.
The CapitalSource Loan and Security Agreement
As of December 31, 2004, we had borrowings of $1.8 million outstanding under our term loan with CapitalSource Finance, $8.4 million of advances outstanding under our revolving credit facility (including a $1.7 million temporary over-advance) with CapitalSource and $1.2 million of additional availability under our revolving credit facility. As of February 28, 2005, we had borrowings of $1.7 million under the term loan and $1.9 million of advances outstanding under our revolving credit facility with CapitalSource including $1.5 million of temporary advances and $1.8 million of additional availability.
In January 2002, as part of a debt and equity restructuring, we entered into a credit facility with CapitalSource consisting of a $3.0 million term loan and a $10.0 million revolving credit facility. In February 2003, in connection with our acquisition of Wise Optical, the revolving credit facility was amended to $15.0 million. Although we may borrow up to $15.0 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.
We did not meet our minimum fixed charge ratio covenant in the third and fourth quarter of 2003, primarily due to operating losses incurred at Wise Optical. However, on November 14, 2003 we entered into an amendment of the terms of our term loan and credit facility with CapitalSource which, among other things,
(i) increased our term loan by $0.3 million and extend the maturity date of the term loan from January 25, 2004 to January 25, 2006,
(ii) extended the maturity date of our revolving credit facility from January 25, 2005 to January 25, 2006,
(iii) permanently increased the advance rate on eligible receivables of Wise Optical from 80% to 85%,
(iv) temporarily increased the advance rate on eligible inventory of Wise Optical from 50% to 55% through March 31, 2004,
(v) provided access to a $0.7 million temporary over-advance bearing interest at prime plus 5 1/2%, which was repaid by March 1, 2004, and was guaranteed by Palisade Concentrated Equity Partnership, L.P.,
(vi) through March 31, 2004, waived our non-compliance with the minimum fixed charge ratio covenant, and
(vii) changed our net worth covenant from ($27) million to tangible net worth of ($10) million.
In connection with the foregoing amendment, we paid CapitalSource $80,000 in financing fees. The amendment also included an additional $150,000 termination fee if we terminate the revolving credit facility prior to December 31, 2004. 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, 2006, and (ii) the total interest and fees actually paid to CapitalSource on the revolving credit facility prior to the termination date or date of prepayment.
We did not meet our fixed charge ratio covenant in January and February 2004, however, we expected to meet all covenants in March 2004. Accordingly, on March 29, 2004 we entered into the Second Amended and Restated Revolving Credit, Term Loan and Security Agreement which incorporated all of the changes embodied in the above amendments and: (i) confirmed that the temporary over-advance was repaid as of February 29, 2004
(ii) changed the expiration date of the waiver of our fixed ratio covenant from March 31, 2004 to February 29, 2004 and (iii) reduced the tangible net worth covenant from $(10) million to $(2) million. In connection with the third amendment, we agreed to pay $25,000 to CapitalSource in financing fees.
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, 2004 or May 31, 2004. We 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.
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, which is guaranteed by our largest stockholder, Palisade Concentrated Equity Partnership, L.P., (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 for the period October 31, 2004 to February 28, 2005. 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. On August 17, 2004, we paid CapitalSource $25,000 in financing fees in connection with this waiver and amendment.
In addition, on August 27, 2004, we amended our 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 $1.0 million guarantee against the loan balance due to CapitalSource related to this amendment. We paid CapitalSource $15,000 in financing fees in connection with this amendment.
On January 12, 2005, we amended the term loan and revolving credit facility with CapitalSource to reduce the tangible net worth covenant for December 2004 and January 2005 from ($3,000,000) to ($6,500,000). Without this Amendment, we would have been in violation of the tangible net worth covenant at December 31, 2004. Under the term loan and revolving credit facility, as amended, we must maintain a tangible net worth of at least ($3,000,000) after February 1, 2005. We paid CapitalSource $12,500 in financing fees in connection with this amendment.
The term loan and revolving credit facility with CapitalSource are subject to the second amended and restated revolving credit, term loan and security agreement, as amended on August 16, 2004, August 27, 2004 and January 12, 2005. 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 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.
Pursuant to the revolving credit, term loan and security agreement, as amended on August 16, 2004, August 27, 2004 and January 12, 2005, 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. The $0.9 million reduction in our inventory value as a result of the mathematical and fundamental errors in accounting and reconciliation for inventory reduced our borrowing availability under this formula from $2.5 million to $1.9 million at March 31, 2004. 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 revolving credit, term loan and security agreement with CapitalSource required us to maintain a lock-box arrangement with our banks whereby amounts received into the lock-boxes are applied to reduce the revolving credit note outstanding. The agreement also contains certain subjective acceleration clauses. Emerging Issues Task Force 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 current liabilities. In accordance with this pronouncement, we classified our revolving credit facility as a current liability in the amount of $9,694,000 and $1,557,000 at December 31, 2003 and December 31, 2002, respectively.
We believe that we will be able to comply with our financial covenants under our amended credit facility with CapitalSource. 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 the business and operations.
Working Capital Constraint and Contingencies
Our Managed Vision segment maintains approximately $1.4 million of restricted investments in the form of certificates of deposit, primarily related to the operation of our South Carolina Captive Insurance Company and our Texas HMO, thereby resulting in a restriction upon working capital. Of this amount, $1.1 million is held as collateral for letters of credit.
In November 2003, the Texas Commissioner of Insurance reduced the required minimum net worth for our Texas
HMO subsidiary from $1.0 million to $0.5 million, which had a positive impact on our liquidity.
Seasonality
Our revenues are generally affected by seasonal fluctuations in the Consumer Vision segment. 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 during these periods, our cash flows can be negatively affected.
Impact of Inflation and Changing Prices
Our revenue is subject to pre-determined Medicare reimbursement rates that, for certain products and services, have decreased over the past three years. Decreases in Medicare reimbursement rates could have an adverse effect on our results of operations if we cannot offset these reductions through increases in revenues or decreases in operating costs. To some degree, prices for health care services and products are set based upon Medicare reimbursement rates, so that our non-Medicare business is also affected by changes in Medicare reimbursement rates.
We believe that inflation has not had a material effect on our revenues during 2004, 2003 or 2002.
The Series B Preferred Stock
As of December 31, 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 and the Series D Preferred Stock, 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 rights. Each share of Series B Preferred Stock is, at the holder's option, immediately 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 increases at a rate of 12.5% per year compounded annually.
Each share of Series B Preferred Stock must be redeemed in full by the Company on December 31, 2008, at a price equal to the greater of (i) the aggregate adjusted redemption value of the Series B Preferred Stock ($1.40 per share) plus accrued but unpaid dividends or (ii) the amount the preferred stockholders would be entitled to receive if the Series B Preferred Stock plus accrued dividends were converted at that time into common stock and the Company were to liquidate and distribute all of its assets to its common stockholders. The Series B Preferred Stock accrues dividends at an annual rate of 12.5%. As of December 31, 2004, cumulative accrued and unpaid dividends on the Series B Preferred Stock totaled $1.9 million.
If our assets are insufficient to pay the full amount payable to the holders of the Series B Preferred Stock with respect to dividends, redemption rights or liquidation preferences, then such holders will share ratably in the distribution of assets.
The Conversion of Our Senior Subordinated Secured Loans Into Series C Preferred Stock
In January 2002, Palisade Concentrated Equity Partnership, L.P. and Linda Yimoyines, wife of Dean Yimoyines, our former Chief Executive Officer and current Chairman made subordinated secured loans to us in the amount of $13.9 million and $0.1 million, respectively. On May 12, 2003, Palisade and Ms. Yimoyines exchanged the entire amount of principal and interest due to them under the senior secured loans, totaling an aggregate of approximately $16.2 million, for a total of 406,158 shares of Series C Preferred Stock, of which 403,256 shares were issued to Palisade and 2,902 shares were issued to Linda Yimoyines. The aggregate principle and interest was exchanged at a rate equal to $.80 per share, the agreed upon value of our common stock on May 12, 2003, divided by 50 (or $40.00 per share). The Series C Preferred Stock has an aggregate liquidation
preference of approximately $16.2 million and ranks senior to our issued and outstanding Series B Preferred Stock and Common Stock with respect to liquidation rights. Each share of Series C Preferred Stock is, at the holder's option, convertible into 50 shares of common stock and has the same dividend rights, on an as converted basis, as our common stock.
The SeriesD Preferred Stock
In January 2005, we issued and sold an aggregate of 280,618 shares of our newly created Series D Preferred Stock, which are initially convertible into an aggregate of 11,224,720 shares of our common stock, to Palisade and Ms. Yimoyines for an aggregate purchase price of approximately $4.4 million. Each share of Series D Preferred Stock has a senior liquidation preference over all other series and classes of our currently outstanding capital stock equal to (a) $15.84 and (b) an amount in cash equal to all accrued but unpaid dividends thereon. Each share of Series D Preferred Stock is initially convertible, at the option of the holder, into 40 shares of our common stock based on an initial conversion price of $0.396. The conversion price is subject to adjustment for dividends on our common stock and subdivisions and/or reclassifications of our common stock. Each holder of Series D Preferred Stock is entitled to vote, on an as converted basis, on all matters with the holders of our common stock and receive dividends equally and ratably with the holders of our common stock in an amount equal to the dividends such holder would receive if it had converted its Series D Preferred Stock into common stock on the date the dividends are declared.
The following table sets forth our capitalization as of December 31, 2004 and the pro forma capitalization to reflect the transactions that closed on January 12, 2005, as if the transactions occurred on December 31, 2004.
Capitalization Table (Amounts in thousands) (Unaudited)
As of December 31, 2004 ----------------------- Actual Pro forma -------- ---------
Long-term debt (including current portion): Term note payable $ 1,775 $ 1,725 Revolving credit note 8,388 2,293 Subordinated notes payable 193 193 -------- -------- Total long-term debt (including current portion) 10,356 4,211 Series B 12.5% Voting, Redeemable, Cumulative Convertible Participating Preferred Stock; $0.001 par value, 3,500,000 authorized, 3,204,959 shares issued and outstanding 6,344 6,344
Stockholders' equity: Series C Preferred Stock, $0.001 par value ($16,251 aggregate liquidation preference); 406,158 shares issued and outstanding 1 1 Series D Preferred Stock, $0.001 par value; ($4,445 aggregate liquidation preference); no shares issued or outstanding (actual); 280,618 shares issued and outstanding (pro forma) -- -- Common Stock, $0.001 par value; 150,000,000 shares authorized; 30,638,283 shares issued and outstanding 31 31 Additional paid-in capital 79,192 83,637 Accumulated deficit (73,659) (73,659) -------- -------- Total stockholders' equity 5,565 10,010 -------- -------- Total Capitalization $ 22,265 $ 20,565 ======== ========
SIGNIFICANT RELATED PARTY TRANSACTIONS
We maintain a substantial number of real estate leases with various terms with related parties for properties located in Connecticut. The leases are for property that is used for executive offices and for the practice of ophthalmology, optometry, sale of eyeglasses or other operating and administrative functions. We believe that these leases reflect the fair market value and contain customary terms for leased commercial real estate in the geographic area where they are located.
In January 2002, we entered into a $14 million loan agreement with Palisade and Ms. Yimoyines and issued 3.2 million shares of Series B Preferred Stock and warrants to purchase 17.5 million shares of our common stock to them as part of our debt restructure. (See "--Liquidity and Capital Resources -- The Conversion of our Senior Subordinated Secured Loans into Series C Preferred Stock")
On May 12, 2003, Palisade and Ms. Yimoyines exchanged the entire amount of principal and interest due to them under the aforementioned loan agreement, totaling an aggregate of approximately $16.2 million, for a total of 406,158 shares of Series C Preferred Stock. (See "--Liquidity and Capital Resources -- The Conversion of our Senior Subordinated Secured Loans into Series C Preferred Stock")
We had an unsecured promissory note payable to a former officer of the Company related to an amount owed in connection with our purchase of Cohen Systems (now "CC Systems") in 1999. On September 10, 2004, CC Systems was sold back to the former officer and the unpaid balance on the promissory note at the time of the sale of approximately $71 was settled in the form of consideration from the sale.
On January 12, 2005, Palisade and Ms. Yimoyines purchased 280,618 shares of our newly created Series D Preferred Stock for an aggregate purchase price of approximately $4.4 million. (See "--Liquidity and Capital Resources -- The Series D Preferred Stock")
On January 12, 2005, our wholly-owned subsidiary, OptiCare Acquisition Corp., entered into an Asset Purchase Agreement with Wise Optical, LLC and AECC/Pearlman Buying Group, LLC, both entities formed by Dean J. Yimoyines, M.D., our former Chief Executive Officer, current President and Chief Executive Officer of our medical affiliate, OptiCare P.C., and our current Chairman, pursuant to which we sold, effective as of December 31, 2004, substantially all of the assets and certain liabilities of our Distribution division, which consisted of our contact lens distributor, Wise Optical, and our Optical Buying Group, for an aggregate purchase price of approximately $4.2 million.
Our subsidiary, OptiCare Eye Health Centers, Inc., is party to a Professional Services and Support Agreement with OptiCare, P.C., a Connecticut professional corporation. Dr. Yimoyines, our Chairman, and former Chief Executive Officer, and beneficial holder of approximately 18% of our outstanding voting stock, is the sole nominee stockholder of OptiCare, P.C. Pursuant to our agreement, OptiCare, P.C. employs medical personnel and performs all ophthalmology and optometry services at our facilities in Connecticut. We select and provide the facilities at which the services are performed and provide all administrative and support services for the facilities for which OptiCare, P.C. provides medical personnel and performs its ophthalmology and optometry services. We bill and receive payments for services rendered by the medical personnel of OptiCare, P.C. and OptiCare P.C. pays its physicians compensation for such medical services rendered.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, Financial Accounting Standards Board ("FASB') Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" was issued. The interpretation provides guidance on the guarantor's accounting and
disclosure requirements for guarantees, including indirect guarantees of indebtedness of others. The Company adopted the disclosure requirements of the interpretation as of December 31, 2002. Effective January 1, 2003, additional provisions of FIN No. 45 became effective and were adopted by the Company. The accounting guidelines are applicable to guarantees issued after December 31, 2002 and require that the Company record a liability for the fair value of such guarantees in the balance sheet. The adoption of FIN No. 45 did not have a material impact on the Company's financial position or results of operations.
Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting For Asset Retirement Obligations". This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The adoption of this statement did not have a material impact on the Company's financial position or results of operations.
Effective January 1, 2003, the Company adopted SFAS No. 145, "Rescission of FASB Statements 4, 44 and 64, Amendment of FASB Statement 13, and Technical Corrections". SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires companies to classify certain gains and losses from debt extinguishments as extraordinary items, eliminates the provisions of SFAS No. 44 regarding transition to the Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require that certain lease modifications be treated as sale leaseback transactions. The provisions of SFAS No. 145 related to classification of debt extinguishment are effective for fiscal years beginning after May 15, 2002. As a result of the Company's adoption of SFAS No. 145, the Company reclassified its previously reported gain from extinguishment of debt of approximately $8.8 million and related income tax expense of approximately $3.5 million in 2002 from an extraordinary item to continuing operations.
Effective January 1, 2003, the Company adopted SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" and nullified EITF Issue No. 94-3. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF No 94-3 had recognized the liability at the commitment date of an exit plan. There was no effect on the Company's financial statements as a result of such adoption.
Effective January 1, 2003, the Company adopted SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an amendment of FASB Statement No. 123." This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This statement also amends the disclosure requirements of SFAS No. 123 and Accounting Principles Board Opinion ("APB") No. 28, "Interim Financial Reporting," to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company elected to adopt the disclosure only provisions of SFAS No. 148 and will continue to follow APB Opinion No. 25 and related interpretations in accounting for the stock options granted to its employees and directors. Accordingly, employee and director compensation expense is recognized only for those options whose price is less than fair market value at the measurement date. For disclosure regarding stock options had compensation cost been determined in accordance with SFAS No. 123. In December 2004, the FASB issued SFAS No. 123, Share-Based Payments (revised 2004). (SFAS No. 123R). See below.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities." FIN 46 requires an investor with a majority of the variable interests in a variable interest entity to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A variable interest entity is an entity in which the equity investors do not have a controlling interest or the equity investment at risk is insufficient to finance the entity's activities without receiving additional subordinated financial support from the other parties. The consolidation provisions of this interpretation are required immediately for all variable interest entities created after January 31, 2003, and the Company's adoption of these provisions did not have a material effect on its financial position or results of operations. For variable interest entities in existence prior to January 31, 2003, the consolidation provisions of FIN 46 are effective December 31, 2003 and did not have a material effect on the Company's financial position or results of operations.
In December 2003, the FASB issued a revised version of FIN 46 ("FIN 46R"), which incorporated a number of modifications and changes to the original version. FIN 46R replaced FIN 46 and, subject to certain special provisions, was effective no later than the end of the first reporting period that ended after December 15, 2003 for entities considered to be special-purpose entities and no later than the end of the first reporting period that ended after March, 15, 2004 for all other variable interest entities. The Company adopted FIN 46R in the fourth quarter of 2003 and did not have a material effect on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments. This statement is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of this statement did not have a material impact on the Company's financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Most of the guidance in SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of SFAS No. 150 did not have a material impact on the Company's financial position or results of operations.
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 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, 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 No. 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 is not expected to have a material impact on the Company's consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123, Share-Based Payments (revised 2004). (SFAS No. 123R). This statement eliminates the option to apply the intrinsic value measurement provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees to stock compensation awards issued to employees. Rather the Statement requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, the requisite period (usually the vesting period). SFAS No. 123R will also require companies to measure the cost of employee services received in exchange for Employee Stock Purchase Plan (ESPP) awards and we will be required to expense the grant date fair value of the Company's ESPP awards. SFAS No. 123R will be effective for the Company's fiscal quarter beginning July, 1 2005. Based on the number of stock options outstanding as of December 31, 2004, the effect of the adoption of SFAS No. 123R would be to increase compensation expense by approximately $0.2 million in the Company's fiscal quarter beginning July 1, 2005.
FORWARD-LOOKING INFORMATION AND RISK FACTORS
The statements in this Annual Report on Form 10-K 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 27A of the Securities Exchange Act of 1934. When used in this document and elsewhere, words such as "anticipate," "believe," "expect," "plan," "intend," "estimate," "project," "could," "may," "predict" and similar expressions are intended to identify forward-looking statements. Such forward-looking statements include those relating to:
o Our opinion that with respect to lawsuits incidental to our current and former operations, after taking into account the merits of defenses and established reserves, the ultimate resolution of these matters may not have a material adverse impact on our financial position or results of operations;
o Our belief that our new direct-to-employer product will lead to increased revenue and gross margins in our Managed Vision segment.
o Our expectation of future revenue, profitability and expense levels;
o Our expectation of increased demand for optical products and eye care services;
o Our belief that enrollment in health care plans may grow;
o Our belief that we are well positioned to compete for all types of eye care contracts;
o Our expectation that interest rates may not have a material adverse effect on income or cash flows in 2005;
o Our belief that our initiatives may continue to improve liquidity and should ensure compliance with covenants in our amended term loan and revolving credit facility with CapitalSource; and
o Our belief that cash from operations, borrowings under our amended term loan and revolving credit facility, and operating and capital lease financings will provide sufficient funds to finance operations for the next 12 months.
In addition, such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause 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:
WE HAVE FAILED AND MAY FAIL FINANCIAL COVENANTS IN THE FUTURE
In the third and fourth quarters of 2003 and the first and second quarters of 2004, we failed our fixed charges ratio covenant under our revolving credit facility with CapitalSource, but received waivers from CapitalSource for any non-compliance with the minimum fixed charge ratio covenant through June 30, 2004. Effective December 31, 2004, we would have been in violation of our tangible net worth covenant, however; on January 12, 2005, we amended our Revolving Credit, Term Loan and Security Agreement to reduce the tangible net worth covenant from ($3,000,000) to ($6,500,000). If we fail a financial covenant in the future or otherwise default on our debt, our creditors could foreclose on our assets.
IF WE DEFAULT ON OUR DEBT TO CAPITALSOURCE FINANCE, LLC, IT COULD FORECLOSE ON OUR ASSETS
Our outstanding indebtedness to CapitalSource under its term loan and revolving credit facility as of December 31, 2004 was approximately $10.2 million. Substantially all of our assets are pledged to secure this indebtedness. If we default on the financial covenants in this loan and credit facility, CapitalSource could foreclose on its security interest in our assets, which would have a material adverse effect on our business, financial condition and results of operations.
CHANGES IN THE REGULATORY ENVIRONMENT APPLICABLE TO OUR BUSINESS, INCLUDING HEALTH-CARE COST CONTAINMENT EFFORTS BY MEDICARE, MEDICAID AND OTHER THIRD-PARTY PAYERS MAY ADVERSELY AFFECT OUR PROFITS.
The health care industry has experienced a trend toward cost containment as government and private third-party payors seek to impose lower reimbursement and utilization rates and negotiate reduced payment schedules with service providers. Our revenue is subject to pre-determined Medicare reimbursement rates for certain products and services, and decreases in Medicare reimbursement rates could have an adverse effect on our results of operations if we cannot offset these reductions through increases in revenues or decreases in operating costs. To some degree, prices for health care services and products are driven by Medicare reimbursement rates, so that
our non-Medicare business is also affected by changes in Medicare reimbursement rates. In addition, federal and state governments are currently considering various types of health care initiatives and comprehensive revisions to the health care and health insurance systems. Some of the proposals under consideration, or others that may be introduced, could, if adopted, have a material adverse effect on our business, financial condition and results of operations.
RISKS RELATED TO THE EYE CARE INDUSTRY, INCLUDING THE COST AND AVAILABILITY OF MEDICAL MALPRACTICE INSURANCE, AND POSSIBLE ADVERSE LONG-TERM EXPERIENCE WITH LASER AND OTHER SURGICAL VISION CORRECTION COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The provision of eye care services entails the potentially significant risk of physical injury to patients and an inherent risk of potential malpractice, product liability and other similar claims. Our insurance may not be adequate to satisfy claims or protect us and our affiliated eye care providers, and this coverage may not continue to be available at acceptable costs. A partially or completely uninsured claim against us could have a material adverse effect on our business, financial condition and results of operations.
MANAGED CARE COMPANIES FACE INCREASING THREATS OF PRIVATE-PARTY LITIGATION, INCLUDING CLASS ACTIONS, OVER THE SCOPE OF CARE FOR WHICH MANAGED CARE COMPANIES MUST PAY.
Several large national managed care companies have been the target of class action lawsuits alleging fraudulent practices in the determination of health care coverage policies for their beneficiaries. Such lawsuits have, thus far, been aimed solely at full service managed care plans and not companies that specialize in specific segments, such as eye care. We cannot assure you that private party litigation, including class action suits, will not target it in the future, or that we will not otherwise be affected by such litigation.
LOSS OF THE SERVICES OF KEY MANAGEMENT PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS.
Our success, in part, depends upon the continued services of our executive officers. We believe that the loss of any of our executive officers could have a material adverse effect on our business, financial condition and results of operations. In addition, we have employment agreements with certain executive officers that require lump sum payments to be made upon the event of a change in control. These changes in control payments could deter takeover bids even if those bids are in our stockholders' best interests.
IF WE FAIL TO EXECUTE OUR GROWTH STRATEGY, WE MAY NOT BECOME PROFITABLE.
Our growth strategy depends in part on its ability to expand and successfully implement our integrated business model. Our growth strategy also requires successful sales results and operational execution in our managed care business. Our growth strategy has resulted in, and will continue to result in, new and increased responsibilities for management and additional demands on management, operating and financial systems and resources. Our ability to continue to expand will also depend upon our ability to hire and train new staff and managerial personnel, and adapt our structure to comply with present or future legal requirements affecting our arrangements with ophthalmologists and optometrists. If we are unable to implement these and other requirements, our business, financial condition, results of operations and ability to achieve and sustain profitability could be materially adversely affected.
IF WE ARE UNABLE TO OBTAIN ADDITIONAL CAPITAL, OUR GROWTH COULD BE LIMITED.
If we do not generate sufficient cash from its operations, we may need to obtain additional capital in order to successfully implement our growth strategy and to finance our continued operations. We believe that our cash flow from operations, borrowings under our amended term loan and revolving credit facility, and operating and capital lease financing will provide us with sufficient funds to finance our operations for the next 12 months. If however, additional funds are needed, we may attempt to raise such funds through the issuance of equity or convertible debt securities. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and our stockholders may experience dilution of their interest in us. If additional funds are needed and are not available or are not available on
acceptable terms, our ability to fund our operations, take advantage of unanticipated opportunities, develop or enhance services or products or otherwise respond to competitive pressures may be significantly limited.
WE HAVE A HISTORY OF LOSSES AND MAY INCUR FURTHER LOSSES IN THE FUTURE.
We have historically incurred substantial operating losses due to our sizeable outstanding indebtedness and costs relating to the integration of newly acquired businesses. We cannot assure that it will not incur further losses in the future.
WE MAY NOT BE ABLE TO MAINTAIN THE LISTING OF ITS COMMON STOCK ON THE AMERICAN STOCK EXCHANGE, WHICH MAY MAKE IT MORE DIFFICULT FOR STOCKHOLDERS TO DISPOSE OF OUR COMMON STOCK.
Our common stock is listed on the American Stock Exchange. The exchange's rules for continued listing include stockholders' equity requirements, which we may not meet if we experience further losses; and market value requirements, which we may not meet if the price of our common stock does not increase. If our common stock is delisted from the American Stock Exchange, trading in our common stock would be conducted, if at all, in the over-the-counter market. This would make it more difficult for stockholders to dispose of their common stock and more difficult to obtain accurate quotations on our common stock. This could have an adverse effect on the price of the common stock.
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY WITH OTHER EYE CARE SERVICES COMPANIES WHICH HAVE MORE RESOURCES AND EXPERIENCE THAN US, AND WITH OTHER EYE CARE DISTRIBUTORS.
Some of our competitors have substantially greater financial, technical, managerial, marketing and other resources and experience than we do and, as a result, may compete more effectively than we can. We compete with other businesses, including other eye care services companies, hospitals, individual ophthalmology and optometry practices, other ambulatory surgery and laser vision correction centers, managed care companies, eye care clinics and providers of retail optical products. Companies in other health care industry segments, including managers of hospital-based medical specialties or large group medical practices, may become competitors in providing surgery and laser centers as well as competitive eye care-related services. Our failure to compete effectively with these and other competitors, could have a material adverse effect on our business, financial condition and results of operations.
IF WE FAIL TO NEGOTIATE PROFITABLE CAPITATED FEE ARRANGEMENTS, IT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
Under some managed care contracts, known as "capitation" contracts, health care providers accept a fixed payment per member per month, whether or not a person covered by a managed care plan receives any services, and the health care provider is obligated to provide all necessary covered services to the patients covered under the agreement. Many of these contracts pass part of the financial risk of providing care from the payor, i.e., an HMO, health insurer, employee welfare plan or self-insured employer, to the provider. The growth of capitation contracts in markets which we serve could result in less certainty with respect to profitability and require a higher level of actuarial acumen in evaluating such contracts. We do not know whether we will be able to continue to negotiate arrangements on a capitated or other risk-sharing basis that proves to be profitable, or to pass the financial risks of providing care to other parties, or to accurately predict utilization or the costs of rendering services. In addition, changes in federal or state regulations of these contracts may limit our ability to transfer financial risks away from us. Any such developments could have a material adverse effect on our business, financial condition and results of operations.
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 OUR STOCKHOLDERS AND US.
We have contractual agreements with entities owned or controlled by our officers, our former Chief Executive Officer and Chairman and key employees, which agreements could create the potential for possible conflicts of
interests for such individuals. Through our subsidiaries, we lease property owned by certain of our officers and their family members.
Our subsidiary, OptiCare Eye Health Centers, Inc., is party to a Professional Services and Support Agreement with OptiCare, P.C., a Connecticut professional corporation. Dr. Yimoyines, our Chairman, and former Chief Executive Officer, and beneficial holder of approximately 18% of our outstanding voting stock, is the sole nominee stockholder of OptiCare, P.C. Pursuant to our agreement, OptiCare, P.C. employs medical personnel and performs all ophthalmology and optometry services at our facilities in Connecticut. We select and provide the facilities at which the services are performed and provide all administrative and support services for the facilities for which OptiCare, P.C. provides medical personnel and performs its ophthalmology and optometry services. We bill and receive payments for services rendered by the medical personnel of OptiCare, P.C. and OptiCare P.C. pays its physicians compensation for such medical services rendered.
HEALTH CARE REGULATIONS OR HEALTH CARE REFORM INITIATIVES COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
We are subject to extensive federal and state governmental regulation and supervision, including, but not limited to:
o anti-kickback statutes;
o self-referral laws;
o insurance and licensor requirements associated with our managed care business;
o civil false claims acts;
o corporate practice of medicine restrictions;
o fee-splitting laws;
o facility license requirements and certificates of need;
o regulation of medical devices, including laser vision correction and other refractive surgery procedures;
o FDA and FTC guidelines for marketing laser vision correction; and
o regulation of personally identifiable health information.
We cannot assure you that these laws and regulations will not change or be interpreted in the future either to restrict or adversely affect its business activities or relationships with other eye care providers.
These laws and regulations have been subject to limited judicial and regulatory interpretation. They are enforced by regulatory agencies that are vested with broad discretion in interpreting their meaning. Neither federal nor state authorities have examined our agreements and activities with respect to these laws and regulations. We cannot assure you that review of our business arrangements will not result in determinations that adversely affect our operations or that certain material agreements between us and eye care providers or third-party payers will not be held invalid and unenforceable. Any limitation on our ability to continue operating in the manner in which we have operated in the past could have an adverse effect on our business, financial condition and results of operations. In addition, these laws and their interpretation vary from state to state. The regulatory framework of certain jurisdictions may limit our expansion into such jurisdictions if we are unable to modify our operational structure to conform to such regulatory framework.
WE ARE DEPENDENT UPON LETTERS OF CREDIT OR OTHER FORMS OF THIRD PARTY SECURITY IN CONNECTION WITH CERTAIN OF OUR CONTRACTUAL ARRANGEMENTS AND, THUS, WOULD BE ADVERSELY AFFECTED IN THE EVENT WE ARE UNABLE TO OBTAIN SUCH CREDIT AS NEEDED.
We have obtained letters of credit to secure its contractual commitments to certain managed care companies. If we are unable to maintain these letters of credit or secure replacement letters of credit, we may not be able to retain our existing contracts or obtain new contracts with certain managed care companies. The inability to do business with these managed care companies could have an adverse effect on our business, financial condition and results of operations.
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 CONTROLS OUR BOARD OF DIRECTORS.
Palisade owns approximately 84% of our voting power and therefore will determine the outcome of all corporate matters requiring stockholder approval, including the election of all of our directors and transactions such as mergers. In addition, in connection with the restructuring, we agreed that so long as Palisade owns more than 50% of the voting power of our capital stock, Palisade shall have the right to designate a majority of our board of directors.
CONFLICTS OF INTEREST MAY ARISE BETWEEN PALISADE AND OPTICARE.
Conflicts of interest may arise between us and Palisade and its affiliates in areas relating to past, ongoing and future relationships and other matters. These potential conflicts of interest include corporate opportunities, indemnity arrangements, potential acquisitions or financing transactions; sales or other dispositions by Palisade of our shares held by it; and the exercise by Palisade of its ability to control our management and affairs. In addition, one of our directors is an officer of Palisade Capital Management, LLC, an affiliate of Palisade. There can be no assurance that any conflicts that may arise between Palisade and us will not have a material adverse effect on our business, financial condition and results of operations or our other stockholders.
CONFLICTS OF INTEREST MAY ARISE BETWEEN DEAN J. YIMOYINES AND OPTICARE.
Conflicts of interest may arise between us and Dean J. Yimoyines and his affiliates in areas relating to past, ongoing and future relationships and other matters. These potential conflicts of interest include indemnity arrangements and sales or other dispositions by Dean J. Yimoyines of our shares held by him. In addition, conflicts may arise regarding Dean J. Yimoyines designation as sole nominee shareholder, President and Chief Executive Officer of OptiCare, P.C..
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-K or to reflect the occurrence of unanticipated events.
ITEM 7A.
ITEM 7A. 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 term loan and revolving 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 2005, 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 annual interest expense by $0.1 million, assuming our borrowing level is unchanged. We did not use derivative instruments to adjust our interest rate risk profile during the year ended December 31, 2004.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and the reports of independent certified public accountants thereon are set forth herein beginning on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. 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 the Exchange Act Rules 13a-15(e) and 15(d)-15(e)) as of the end of the period covered by this Annual Report on Form 10-K, 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 Annual Report on Form 10-K 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 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. This material weakness occurred at an operation that has been subsequently sold as part of the Distribution business sale which took place on January 12, 2005. Upon identifying the areas of weakness, management implemented measures to rectify the past errors and to prevent them in the future. The measures included the enhancement of the inventory reconciliation process to provide more detailed, mathematical checks and 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.
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 other changes in our internal control over financial reporting, identified in connection with the evaluation of such internal control that occurred during the fourth quarter of our last fiscal year, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The information regarding directors and executive officers required by Item 10, appearing under the captions "Election of Directors," "Section 16(A) Beneficial Ownership Reporting Compliance" and "Code of Conduct and Ethics" of our Proxy Statement for the 2005 Annual Meeting of Stockholders, is incorporated herein by reference.
Information regarding our directors and executive officers is included in Part I of this Form 10-K as permitted by General Instruction G (3).
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 appearing under the caption "Executive Compensation" of our Proxy Statement for the 2005 Annual Meeting of Stockholders is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 appearing under the caption "Security Ownership of Certain Beneficial Owners and Management" and "Equity Compensation Plan Information" of our Proxy Statement for the 2005 Annual Meeting of Stockholders is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by Item 13 appearing under the captions "Employment Contracts and Change of Control Agreements" and "Certain Relationships and Related Transactions" of our Proxy Statement for the 2005 Annual Meeting of the Stockholders is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 appearing under the caption "Audit and Non-Audit Fees" of our Proxy Statement for the 2005 Annual Meeting of Stockholders is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES
The following documents are filed as part of this Annual Report on Form 10-K:
1. FINANCIAL STATEMENTS:
See the "Index to Financial Statements" beginning on page.
2. FINANCIAL STATEMENT SCHEDULES:
Required schedules have been omitted because they are either not applicable or the required information has been disclosed in the consolidated financial statements or notes thereto.
3. EXHIBITS:
EXHIBIT DESCRIPTION ------- -----------
3.1 Certificate of Incorporation of Registrant, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed January 19, 2005, Exhibit 3.1.
3.2 Certificate of Amendment of the Certificate of Incorporation, dated as of August 13, 1999, as filed with the Delaware Secretary of State on August 13, 1999, incorporated herein by reference to Registrant's Current Report on Form 8-K filed on January 19,
EXHIBIT DESCRIPTION ------- -----------
2005, Exhibit 3.2.
3.3 Certificate of Designation with respect to the Registrant's Series A Convertible Preferred Stock, as filed with the Delaware Secretary of State on August 13, 1999, incorporated herein by reference to Registrant's Current Report on Form 8-K filed on January 19, 2005, Exhibit 3.3.
3.4 Certificate of Amendment of the Certificate of Incorporation, as filed with the Delaware Secretary on January 21, 2002, increasing the authorized common stock of the Registrant from 50,000,000 to 75,000,000 shares, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on January 19, 2005, Exhibit 3.4.
3.5 Certificate of Designation, Rights and Preferences of the Series B 12.5% Voting Cumulative Convertible Participating Preferred Stock of the Registrant, as filed with the Delaware Secretary of State on January 23, 2002, incorporated herein by reference to the Registrant's Current Report on Form 8-K dated filed on February 11, 2002, Exhibit 3.2.
3.6 Certificate of Designation, Rights and Preferences of the Series C Preferred Stock of the Registrant, as filed with the Delaware Secretary of State on May 12, 2003, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on January 19, 2005, Exhibit 3.6.
3.7 Certificate of Amendment of the Certificate of Incorporation, as filed with the Delaware Secretary of State on May 29, 2003, increasing the authorized common stock of the Registrant from 75,000,000 to 150,000,000 shares, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on January 19, 2005, Exhibit 3.7.
3.8 Certificate of Designation, Rights and Preferences of the Series D Preferred Stock of the Registrant, as filed with the Delaware Secretary of State on January 12, 2005, incorporated by reference to the Registrant's Current Report on Form 8-K filed on January 19, 2005, Exhibit 3.8.
3.9 Amended and Restated By-laws of Registrant adopted March 27, 2000, incorporated herein by reference to Registrant's Annual Report on Form 10-K filed on March 30, 2000, Exhibit 3.3.
3.10 Amendment No. 1 to the Amended and Restated Bylaws of Registrant incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 3.3.
4.1 Form of Warrant to purchase 2,250,000 shares of common stock issued in connection with the Secured Promissory Note issued as of October 10, 2000, by OptiCare Eye Health Centers, Inc., PrimeVision Health, Inc. and OptiCare Eye Health Network, Inc. to Medici Investment Corp., incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on November 29, 2001, Exhibit 10.54.
4.2 Form of Warrant to purchase 300,000 shares and 2,000,000 shares of common stock issued in connection with the Amended and Restated Secured Promissory Note issued as of October 10, 2000, by OptiCare Eye Health Centers, Inc., PrimeVision Health, Inc. and OptiCare Eye Health Network, Inc. to Medici Investment Corp., incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on November 29, 2001, Exhibit 10.55.
4.3 Form of Warrant to purchase 50,000 shares of common stock issued in connection with the Amended and Restated Secured Promissory Note issued as of October 10, 2000, by OptiCare Eye Health Centers, Inc., PrimeVision Health, Inc. and OptiCare Eye Health
EXHIBIT DESCRIPTION ------- -----------
Network, Inc. to Dean J. Yimoyines, M.D., incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on November 29, 2001, Exhibit 10.56.
4.4 Form of Warrant to purchase 400,000 shares of common stock issued in connection with the Amended and Restated Secured Promissory Note issued as of October 10, 2000, by OptiCare Eye Health Centers, Inc., PrimeVision Health, Inc. and OptiCare Eye Health Network, Inc. to Palisade Concentrated Equity Partnership, L.P., incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on November 29, 2001, Exhibit 10.57.
4.5 Form of Warrant dated January 25, 2002, issued to CapitalSource Finance, LLC, for the purchase of up to 250,000 shares of common stock, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 3.6.
10.1 1999 Performance Stock Program, incorporated herein by reference to the Registrant's Registration Statement on Form S-4, registration no. 333-78501, first filed on May 14, 1999, as amended (the "Registration Statement 333-78501"), Exhibit 4.1. +
10.2 Amended and Restated 1999 Employee Stock Purchase Plan, incorporated herein by reference to Registrant's Annual Report on Form 10-K filed on March 30, 2000, Exhibit 4.2. +
10.3 2000 Professional Employee Stock Purchase Plan incorporated herein by reference to Registrant's Annual Report on Form 10-K filed on March 30, 2000, Exhibit 4.3. +
10.4 Amended and Restated 2002 Stock Incentive Plan incorporated herein by reference to Registrant's Quarterly Report on Form 10-Q filed August 14, 2002, Exhibit 4.4. +
10.5 Vision Care Capitation Agreement between OptiCare Eye Health Centers, Inc. and Blue Cross & Blue Shield of Connecticut, Inc. (and its affiliates) dated October 23, 1999, incorporated herein by reference to the Registration Statement 333-78501, Exhibit 10.9.
10.6 Eye Care Services Agreement between OptiCare Eye Health Centers, Inc. and Anthem Health Plans, Inc. (d/b/a Anthem Blue Cross and Blue Shield of Connecticut), effective November 1, 1998, incorporated herein by reference to the Registration Statement 333-78501, Exhibit 10.10.
10.7 Contracting Provider Services Agreement dated April 26, 1996 and amendment thereto dated as of January 1, 1999, between Blue Cross and Blue Shield of Connecticut, Inc., and OptiCare Eye Health Centers, Inc., incorporated herein by reference to the Registration Statement 333-78501, Exhibit 10.11.
10.8 Form of Employment Agreement between the Registrant and Dean J. Yimoyines, M.D., effective August 13, 1999, incorporated herein by reference to the Registration Statement 333-78501, Exhibit 10.11. +
10.9 Lease Agreement dated September 1, 1995, by and between French's Mill Associates, as landlord, and OptiCare Eye Health Centers, Inc. as tenant, for premises located at 87 Grandview Avenue, Waterbury, Connecticut incorporated herein by reference to the Registration Statement 333-78501, Exhibit 10.17.
10.10 Lease Agreement dated September 30, 1997, by and between French's Mill Associates II, LLP, as landlord, and OptiCare Eye Health Center, P.C., as tenant, for premises located at 160 Robbins Street, Waterbury, Connecticut (upper level), incorporated herein by reference to the Registration Statement 333-78501, Exhibit 10.18.
EXHIBIT DESCRIPTION ------- -----------
10.11 Lease Agreement dated September 1, 1995 and Amendment to lease dated September 30, 1997, by and between French's Mill Associates II, LLP, as landlord, and OptiCare Eye Health Center, P.C., as tenant, for premises located at 160 Robbins Street, Waterbury, Connecticut (lower level), incorporated herein by reference to the Registration Statement 333-78501, Exhibit 10.19.
10.12 Second Amendment to Lease Agreement dated September 30, 1997, by and between French's Mill Associates II, LLP, as landlord, and OptiCare Eye Health Center, Inc., as tenant, for premises located at 160 Robbins Street, Waterbury, Connecticut, incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q filed on August 12, 2003, Exhibit 10.4.
10.13 Lease Agreement dated August 1, 2002, by and between Harrold-Barker Investment Company, as landlord, and OptiCare Health Systems, Inc., as tenant, for premises located at 110 and 112 Zebulon Court, Rocky Mount, North Carolina incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on March 18, 2003, Exhibit 10.12.
10.14 Form of Health Services Organization Agreement between PrimeVision Health, Inc. and eye care providers, incorporated herein by reference to the Registration Statement 333-78501, Exhibit 10.21.
10.15 Professional Services and Support Agreement dated December 1, 1995, between OptiCare Eye Health Centers, Inc. and OptiCare P.C., a Connecticut professional corporation, incorporated herein by reference to the Registration Statement 333-78501, Exhibit 10.22.
10.16 Amendment No. 1 dated January 12, 2005, to the Professional Services and Support Agreement dated December 1, 1995.*
10.17 Stock Purchase Agreement dated October 1, 1999, among the Registrant, Stephen Cohen, Robert Airola, Gerald Mandel and Reginald Westbrook (excluding schedules and other attachments thereto), incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q filed on November 15, 1999, Exhibit 10.10.
10.18 Employment Agreement between the Registrant as employer and Gordon A. Bishop, dated August, 13, 1999, incorporated herein by reference to the Registration Statement 333-93043, Exhbit 10.41. +
10.19 Employment Agreement between the Registrant and Jason M. Harrold effective July 1, 2000, incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q filed on August 14, 2000, Exhibit 10.10. +
10.20 OptiCare Directors' and Officers' Trust Agreement dated November 7, 2001, between the Registrant and Norman S. Drubner, Esq., as Trustee, incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on November 29, 2001, Exhibit 10.52. +
10.21 Agreement for Consulting Services between Morris Anderson and Associates, Ltd. and the Registrant dated April 16, 2001, incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on November 19, 2001, Exhibit 10.53.
10.22 Restructure Agreement dated December 17, 2001, among Palisade Concentrated Equity Partnership, L.P., Dean J. Yimoyines, M.D. and the Registrant incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 10.1.
10.23 Amendment No. 1 dated January 5, 2002, to the Restructure Agreement dated
EXHIBIT DESCRIPTION ------- -----------
December 17, 2001, among Palisade Concentrated Equity Partnership, L.P., Dean J. Yimoyines, M.D. and the Registrant incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 10.2.
10.24 Amendment No. 2 dated January 22, 2002, to the Restructure Agreement dated December 17, 2001, among Palisade Concentrated Equity Partnership, L.P., Dean J. Yimoyines, M.D. and the Registrant incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 10.3.
10.25 Amendment No. 3 dated May 12, 2003, to the Restructure Agreement dated December 17, 2001, among Palisade Concentrated Equity Partnership, L.P., Dean J. Yimoyines, M.D. and the Registrant, incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q filed on August 12, 2003, Exhibit 10.3.
10.26 Subordinated Pledge and Security Agreement dated as of January 25, 2002, by the Registrant (including certain of its subsidiaries) as grantor, and Palisade Concentrated Equity Partnership, L.P., as secured party and agent for the other secured party (Linda Yimoyines), securing the senior secured subordinated notes made by the Registrant to the secured parties dated January 25, 2002, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 10.6.
10.27 Registration Rights Agreement dated January 25, 2002, covering common stock held by Palisade, common stock issuable on conversion of the Series B Preferred Stock and exercise of the warrants issued to Palisade, Linda Yimoyines and CapitalSource Finance, L.L.C., incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 10.7.
10.28 Amendment No. 1 dated May 12, 2003, to the Registration Rights Agreement dated January 25, 2002, incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q filed on August 12, 2003, Exhibit 10.2.
10.29 Amendment No. 2 dated January 12, 2005, to the Registration Rights Agreement dated January 25, 2002.*
10.30 Subordination Agreement dated January 25, 2002, among Palisade Concentrated Equity Partnership, L.P., Linda Yimoyines, CapitalSource Finance, L.L.C. and the Registrant, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 10.8.
10.31 Amended and Restated Revolving Credit, Term Loan and Security Agreement dated as of January 25, 2002, between CapitalSource Finance, L.L.C. and the Registrant, including Annex I, Financial Covenants, and Appendix I, Definitions, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 10.9.
10.32 Waiver and Second Amendment, dated as of November 14, 2003, to the Amended and Restated Revolving Credit, Term Loan and Security Agreement, originally dated as of January 25, 2003, by and between the Registrant, OptiCare Eye Health Centers, Inc., PrimeVision Health, Inc. and CapitalSource Finance, L.L.C., incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on November 19, 2003, Exhibit 10.1.
10.33 Term Note B dated November 14, 2003, by and between the Registrant, OptiCare Eye Health Centers, Inc., PrimeVision Health, Inc. (individually and collectively as borrower) and CapitalSource Finance, L.L.C. (as lender), incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on November 19, 2003, Exhibit 10.2.
EXHIBIT DESCRIPTION ------- -----------
10.34 Guaranty Agreement dated November 14, 2003 by and between Palisade Concentrated Equity Partnership, L.P., the Registrant, PrimeVision Health, Inc., OptiCare Eye Health Centers, Inc., OptiCare Acquisition Corp., and CapitalSource Finance, L.L.C., incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on November 19, 2003, Exhibit 10.3.
10.35 Reassignment of Rights to Payments under Services Agreements, Physician Notes and Physician Security Agreements, between Bank Austria Creditanstalt Corporate Finance, Inc., and the Registrant, dated January 25, 2002, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 10.10.
10.36 Assignment and Assumption Agreement dated January 25, 2002, between Bank Austria Creditanstalt Corporate Finance, Inc., and CapitalSource Finance, L.L.C., incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 11, 2002, Exhibit 10.11.
10.37 OptiCare Directors' & Officers' Tail Policy Trust dated January 10, 2002, between the Registrant and Norman S. Drubner, Esq. as trustee incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on April 1, 2002, Exhibit 10.74. +
10.38 Employment Agreement dated as of September 1, 2001, between the Registrant and William Blaskiewicz, incorporated herein by reference of the Registrant's Quarterly Report on Form 10-Q filed on December 3, 2002, Exhibit 10.21. +
10.39 Amended and Restated Employment Agreement dated October 6, 2004, between the Registrant and Christopher J. Walls, incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on October 10, 2004, Exhibit 10.1. +
10.40 Employment Letter Agreement dated as of May 21, 2002, between the Registrant and Lance A. Wilkes, incorporated herein by reference of the Registrant's Quarterly Report on Form 10-Q filed on August 14, 2002, Exhibit 10.77. +
10.41 Asset Purchase Agreement dated as of August 1, 2002, by and among the Registrant, PrimeVision Health, Inc. and Optometric Eye Care Center, P.A., incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on August 27, 2002, Exhibit 2.
10.42 Asset Purchase Agreement dated as of February 7, 2003, by and among the Wise Optical Vision Group, Inc. and OptiCare Acquisition Corp., incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on February 10, 2003, Exhibit 2.
10.43 Joinder Agreement and First Amendment dated as of February 7, 2003, to the Amended and Restated Revolving Credit, Term Loan and Security Agreement, originally dated as of January 25, 2003, by and between the Registrant, OptiCare Eye Health Centers, Inc., PrimeVision Health, Inc. and CapitalSource Finance, L.L.C., incorporated herein by reference to the Registrant's Current Report on Form 8-K filed February 10, 2003, Exhibit 99.2.
10.44 Lease Agreement dated August 7, 2000 and Amendment to Lease dated August 1, 2001, by and between Mack-Cali So. West Realty Associates L.L.C., as landlord, and Wise/Contact US Optical Corporation, as tenant, for premises located at 4 Executive Plaza, Yonkers, New York incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on March 18, 2003, Exhibit 10.39.
10.45 Letter Agreement dated May 12, 2003, by and among Palisade Concentrated Equity Partnership, L.P., the Registrant and Linda Yimoyines, incorporated herein by
EXHIBIT DESCRIPTION ------- -----------
reference to the Registrant's Quarterly Report on Form 10-Q filed on August 12, 2003, Exhibit 10.1.
10.46 Second Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated as of March 29, 2004, by and between the Registrant, OptiCare Eye Health Centers, Inc., PrimeVision Health, Inc. OptiCare Acquisition Corporation and CapitalSource Finance, L.L.C., incorporated herein by reference to the Registrant's Annual Report on Form 10-K filed on March 30, 2004, Exhibit 10.44.
10.47 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., incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q filed on November 15, 2004, Exhibit 10.1.
10.48 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., incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on September 1, 2004, Exhibit 10.1.
10.49 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., incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on September 1, 2004, Exhibit 10.2.
10.50 Third Amendment to Second Amended and Restated Revolving Credit, Term Loan and Security Agreement dated as of January 12, 2005, by and between the Registrant, OptiCare eye Health Centers, Inc., PrimeVision Health, Inc., OptiCare Acquisition Corporation and CapitalSource Finance LLC.*
10.51 Series D Preferred Stock Purchase Agreement dated as of January 12, 2005, by and among the Registrant, Palisade Concentrated Equity Partnership, L.P. and Linda Yimoyines.*
10.52 Asset Purchase Agreement dated as of January 12, 2005, between OptiCare Acquisition Corp., Wise Optical, LLC and AECC/Pearlman Buying Group, LLC.*
10.53 Transition Agreement dated as of January 12, 2005 between Dr. Dean J. Yimoyines and the Registrant.*
10.54 Supply Agreement dated as of January 12, 2005, by and among OptiCare Eye Health Centers, Inc., Wise Optical, LLC and AECC/Pearlman Buying Group, LLC.*
10.55 Employment Agreement dated as of January 12, 2005, by and between OptiCare P.C. and Dr. Dean J. Yimoyines.+*
21 List of Subsidiaries of the Registrant*.
23 Consent of Deloitte & Touche LLP regarding its report on our financial statements as of December 31, 2004 and 2003, and for each of the three years in the period ended December 31, 2004. *
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
EXHIBIT DESCRIPTION ------- -----------
Act of 2002.*
32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
* Filed herewith.
+ Management or compensatory plan.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
March 30, 2005 OPTICARE HEALTH SYSTEMS, INC.
By: /s/ Christopher J. Walls ------------------------------------ Christopher J. Walls Chief Executive Officer, President and General Counsel
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ----
/s/ Christopher J. Walls Chief Executive Officer, President and General Counsel March 30, 2005 -------------------------- (Principal Executive Officer) Christopher J. Walls
/s/ William A. Blaskiewicz Vice President and Chief Financial Officer March 30, 2005 -------------------------- (Principal Financial and Accounting Officer) William A. Blaskiewicz
/s/ Dean J. Yimoyines Director and Chairman of the Board March 30, 2005 -------------------------- Dean J. Yimoyines, M.D.
/s/ Eric J. Bertrand Director March 30, 2005 -------------------------- Eric J. Bertrand
/s/ Norman S. Drubner Director March 30, 2005 -------------------------- Norman S. Drubner
/s/ Mark S. Hoffman Director March 30, 2005 -------------------------- Mark S. Hoffman
/s/ Richard L. Huber Director March 30, 2005 -------------------------- Richard L. Huber
/s/ Clark A. Johnson Director March 30, 2005 -------------------------- Clark A. Johnson
/s/ Melvin Meskin Director March 30, 2005 -------------------------- Melvin Meskin
/s/ Mark S. Newman Director March 30, 2005 -------------------------- Mark S. Newman
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders OptiCare Health Systems, Inc. Waterbury, Connecticut
We have audited the accompanying consolidated balance sheets of OptiCare Health Systems, Inc. and subsidiaries (the "Company") as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of OptiCare Health Systems, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 3 to the consolidated financial statements, on January 1, 2002, the Company changed its method of accounting for goodwill and other intangible assets to conform to Statement of Financial Accounting Standard No. 142.
/s/ Deloitte & Touche LLP
Stamford, Connecticut March 29, 2005
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31, -------------------- 2004 2003 -------- --------
ASSETS CURRENT ASSETS: Cash and cash equivalents $ 2,228 $ 1,695 Accounts receivable, net 2,164 2,044 Inventories 1,851 1,773 Assets held for sale 7,894 11,578 Notes receivable 82 105 Other current assets 599 354 -------- -------- Total Current Assets 14,818 17,549 -------- -------- Property and equipment, net 2,628 2,761 Goodwill 16,663 16,565 Intangible assets, net 1,068 1,179 Assets held for sale, non-current 1,150 4,670 Deferred debt issuance costs, net 342 398 Notes receivable, less current portion 734 791 Restricted cash 1,413 1,158 Other assets 998 784 -------- -------- TOTAL ASSETS $ 39,814 $ 45,855 ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES: Accounts payable $ 2,727 $ 734 Claims payable and claims incurred but not reported 1,897 1,534 Accrued salaries and related expenses 2,743 2,186 Accrued expenses 1,874 1,184 Current portion of long-term debt 332 10,818 Current portion of capital lease obligations 11 10 Liabilities of held for sale business 5,683 6,755 Other current liabilities 1,119 407 -------- -------- Total Current Liabilities 16,386 23,628
NON-CURRENT LIABILITIES: Long-term debt, less current portion 10,024 1,775 Capital lease obligations, less current portion 19 -- Other liabilities 1,476 405 -------- -------- Total Non-Current Liabilities 11,519 2,180 -------- --------
COMMITMENTS AND CONTINGENCIES (Notes 10, 12, and 19)
SERIES B 12.5% REDEEMABLE, CONVERTIBLE PREFERRED STOCK AT AGGREGATE LIQUIDATION PREFERENCE-RELATED PARTY 6,344 5,635
STOCKHOLDERS' EQUITY: Series C Preferred Stock, $.001 par value ($16,251 aggregate liquidation preference); 406,158 shares issued and outstanding at December 31, 2004 and December 31, 2003, respectively 1 1 Common Stock, $0.001 par value; 150,000,000 shares authorized; 30,638,283 and 30,386,061 shares issued and outstanding at December 31, 2004 and 2003, respectively 31 30 Additional paid-in-capital 79,192 79,700 Accumulated deficit (73,659) (65,319) -------- -------- TOTAL STOCKHOLDERS' EQUITY 5,565 14,412 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 39,814 $ 45,855 ======== ========
See notes to consolidated financial statements.
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
YEAR ENDED DECEMBER 31, ----------------------------- 2004 2003 2002 -------- -------- -------
NET REVENUES: Managed vision $ 25,495 $ 28,111 $29,426 Product sales 11,580 11,295 10,826 Other services 19,907 18,971 18,257 Other income 1,921 2,722 2,346 -------- -------- ------- Total net revenues 58,903 61,099 60,855 -------- -------- ------- OPERATING EXPENSES: Medical claims expense 19,156 22,000 22,311 Cost of product sales 4,128 3,837 4,098 Cost of services 8,322 8,001 7,616 Selling, general and administrative 25,053 24,165 23,411 (Gain) loss from early extinguishment of debt -- 1,896 (8,789) Depreciation 848 1,168 1,721 Amortization 117 114 119 Interest 1,190 2,044 3,010 -------- -------- ------- Total operating expenses 58,814 63,225 53,497 -------- -------- ------- Income (loss) from continuing operations before income tax 89 (2,126) 7,358 Income tax expense 51 4,927 2,516 -------- -------- ------- Income (loss) from continuing operations 38 (7,053) 4,842
Discontinued Operations: Income (loss) from discontinued operations, net of income tax (3,973) (5,300) 337 Loss on disposal of discontinued operations, net of income tax expense of $342 in 2002 (4,405) -- (4,434) -------- -------- -------
Loss from discontinued operations (8,378) (5,300) (4,097) -------- -------- ------- Net income (loss) (8,340) (12,353) 745
Preferred stock dividends (709) (618) (531) -------- -------- ------- Net income (loss) available to common stockholders $ (9,049) $(12,971) $ 214 ======== ======== =======
EARNINGS (LOSS) PER SHARE: Income (loss) from continuing operations: Basic $ (0.02) $ (0.25) $ 0.35 Diluted $ (0.02) $ (0.25) $ 0.09 Loss from discontinued operations: Basic $ (0.28) $ (0.18) $ (0.33) Diluted $ (0.28) $ (0.18) $ (0.08) Net income (loss): Basic $ (0.30) $ (0.43) $ 0.02 Diluted $ (0.30) $ (0.43) $ 0.01
See notes to consolidated financial statements.
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ----------------------------- 2004 2003 2002 ------- -------- --------
OPERATING ACTIVITIES: Net income (loss) $(8,340) $(12,353) $ 745 Loss on discontinued operations 8,378 5,300 4,097 ------- -------- -------- Income (loss) from continuing operations 38 (7,053) 4,842 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation 848 1,168 1,721 Amortization 117 114 119 Deferred income taxes -- 4,800 3,000 Bad debt (income) expense (46) 162 173 Non-cash interest expense 149 958 258 Non-cash (gain) loss on early extinguishment of debt -- 1,867 (8,789) Non-cash gain on contract settlements (12) (529) -- Non-cash compensation charges 181 178 -- Loss on disposal of fixed assets -- 62 -- Changes in operating assets and liabilities Accounts receivable (74) (219) 436 Inventories (78) 23 29 Other assets (563) 9 (160) Accounts payable and accrued expenses 3,575 (236) (2,501) Other liabilities 1,783 (111) (45) Cash (used in) provided by discontinued operations (3,038) (3,964) 686 ------- -------- -------- Net cash provided by (used in) operating activities 2,880 (2,771) (231) ------- -------- --------
INVESTING ACTIVITIES: Purchases of property and equipment, net of disposals (715) (749) (750) Purchase of notes receivable -- -- (1,350) Payments received on notes receivable 183 458 658 Refund of security deposits -- 775 -- Purchase of restricted investments (260) (900) -- Investments in acquisitions, excluding cash (65) (6,192) -- Net proceeds from sale of discontinued operations 700 -- 3,862 ------- -------- -------- Net cash (used in) provided by investing activities (157) (6,608) 2,420 ------- -------- --------
FINANCING ACTIVITIES: Proceeds from long-term debt -- 314 23,474 Net increase (decrease) in revolving credit facility (2,004) 8,837 (4,917) Proceeds from exercise of warrants -- -- 2,450 Proceeds from issuance of stock 20 144 4,000 Principal payments on long-term debt (300) (988) (25,143) Equipment financing 238 -- Payment of financing costs (128) (261) (1,445) Principal payments on capital lease obligations (16) (58) (58) ------- -------- -------- Net cash (used in) provided by financing activities (2,190) 7,988 (1,639) ------- -------- -------- Increase (decrease) in cash and cash equivalents 533 (1,391) 550 Cash and cash equivalents at beginning of year 1,695 3,086 2,536 ------- -------- -------- Cash and cash equivalents at end of year $ 2,228 $ 1,695 $ 3,086 ======= ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest $ 1,016 $ 1,061 $ 1,359 Cash paid (received) for income taxes 46 76 45 Reduction of debt in exchange for reduction of receivables -- 86 1,011 Conversion of senior subordinated debt to Series C Preferred Stock -- 16,251 --
See notes to consolidated financial statements.
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
Series A Series C Preferred Stock Preferred Stock Common Stock Additional ----------------- ----------------- ------------------- Paid-in Accumulated Shares Amount Shares Amount Shares Amount Capital Deficit Total -------- ------ ------- ------- ---------- ------ ---------- ----------- --------
Balance at December 31, 2001 418,803 $ 1 -- -- 12,815,092 $13 $60,679 $(53,711) $ 6,982 Issuance of common stock -- -- -- -- 17,525,000 17 2,433 -- 2,450 Cancellation of shares (418,803) (1) -- -- (1,426,102) (1) (375) -- (377) Issuance of warrants -- -- -- -- -- -- 1,383 -- 1,383 Dividends on redeemable preferred stock -- -- -- -- -- -- (531) -- (531) Net income for 2002 -- -- -- -- -- -- -- 745 745 -------- --- ------- --- ---------- --- ------- -------- -------- Balance at December 31, 2002 -- $-- -- -- 28,913,990 $29 $63,589 $(52,966) $ 10,652 Issuance of preferred stock -- -- 406,158 $ 1 -- -- 16,113 -- 16,114 Issuance of common stock -- -- -- 1,555,000 1 651 -- 652 Cancellation of shares -- -- -- -- (82,929) -- (35) -- (35) Dividends on redeemable preferred stock -- -- -- -- -- -- (618) -- (618) Net loss for 2003 -- -- -- -- -- -- -- (12,353) (12,353) -------- --- ------- --- ---------- --- ------- -------- -------- Balance at December 31, 2003 -- $-- 406,158 $ 1 30,386,061 $30 $79,700 $(65,319) $ 14,412 Issuance of common stock -- -- -- -- 375,000 1 199 -- 200 Issuance of warrants -- -- -- -- -- -- 33 -- 33 Cancellation of shares -- -- -- -- (122,778) -- (31) -- (31) Dividends on redeemable preferred stock -- -- -- -- -- -- (709) -- (709) Net loss for 2004 -- -- -- -- -- -- -- (8,340) (8,340) -------- --- ------- --- ---------- --- ------- -------- -------- Balance at December 31, 2004 -- $-- 406,158 $ 1 30,638,283 $31 $79,192 $(73,659) $ 5,565 ======== === ======= === ========== === ======= ======== ========
See notes to consolidated financial statements.
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except share and per share data)
1. ORGANIZATION AND BASIS OF PRESENTATION
OptiCare Health Systems, Inc. and subsidiaries (the "Company") is an integrated eye care services company focused on vision benefits management (managed vision) and consumer vision services, including medical, surgical and optometric services and optical retail. The Company contracts with OptiCare, P.C., a professional corporation, which employs ophthalmologists and optometrists to provide the surgical, medical, optometric and other professional services to patients.
In September 2004, the Company sold its Technology business, CC Systems, Inc. and in January 2005, sold its Distribution business which was comprised of Wise Optical and the Buying Group. The effective date of the distribution transaction was December 31, 2004. In accordance with Statement of Financial Accounting Standards ("SFAS") 144 "Accounting for the Impairment or Disposal of Long-Lived Assets," both sales were accounted for as discontinued operations. Amounts in the financial statements and related notes for the periods December 31, 2003 and December 31, 2002 have been reclassified to reflect treatment as held for sale.
2. MANAGEMENT'S PLAN
The Company incurred net operating losses in 2003 that continued into 2004, due primarily to substantial operating losses at Wise Optical. In January 2005, the Company sold its Distribution business including the Wise Optical operation. In September 2004, the Company also sold its Technology business, CC Systems, Inc. The sale of these operations generated cash proceeds and reduced demands on working capital and corporate personnel. In addition, in January 2005, the Company sold 280,618 shares of newly created Series D Preferred Stock ("Series D Preferred Stock") for an aggregate price of $4,445,000.
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 our direct-to-employer business and expects increased profitability as a result of this product shift that has led to new contracts. 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 HSO litigation with positive results through March of 2005.
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 covenants in the loan agreement with CapitalSource Finance LLC ("CapitalSource") in the future.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its affiliate OptiCare P.C. All significant intercompany accounts and transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
The Company considers investments purchased with an original maturity of three months or less when purchased to be cash equivalents.
RECEIVABLES
Receivables are stated net of allowances for doubtful accounts. The allowance for doubtful accounts reflects the Company's best estimate of probable losses inherent in the accounts receivable balance from bad debts. We determine the allowance based on historical experience and other currently available evidence. Adjustments to the allowance are recorded to bad debt expense, which is included in operating expenses. Gross receivables are stated net of contractual allowances and insurance disallowances. (See also "Services Revenue" below)
INVENTORIES
Inventories primarily consist of eyeglass frames, lenses, sunglasses, contact lenses and surgical supplies. Inventories are valued at the lower of cost or market, determined on the first-in, first-out "FIFO" basis.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost net of accumulated depreciation. Leasehold improvements are being amortized over the term of the lease or the life of the improvement, whichever is shorter. Depreciation and amortization are provided primarily using the straight-line method over the estimated useful lives of the respective assets as follows:
CLASSIFICATION ESTIMATED USEFUL LIFE -------------- --------------------- Furniture, fixtures and equipment 5 - 7 years Leasehold improvements 7 - 10 years Computer hardware and software 3 - 5 years
DEFERRED DEBT ISSUANCE COSTS
Deferred debt issuance costs are being amortized on the straight-line method, which approximates the interest method, over the term of the related debt and such amortization is included in interest expense. Amortization expense of deferred debt issuance costs totaled $121 and $248 for the years ended December 31, 2004 and 2003, respectively.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired in a business combination accounted for as a purchase. Intangible assets, which represent purchased service and non-compete agreements, are amortized over their contract life and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.
The Company accounts for goodwill and intangible assets in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets" (see "New Accounting Pronouncements" below), which was adopted by the Company on January 1, 2002. In accordance with this standard, goodwill and other intangible assets with indefinite useful lives are no longer subject to amortization, but are reviewed by the Company for impairment on an annual basis, or more frequently if events or circumstances indicate potential impairment. The evaluation methodology for potential impairment is inherently complex, and involves significant management judgment in the use of estimates and assumptions. The Company uses multiples of earnings before interest, taxes, depreciation and amortization of comparable entities to value the reporting unit being evaluated for goodwill impairment.
The Company evaluates impairment using a two-step process. First, the aggregate fair value of the reporting unit is compared to its carrying amount, including goodwill. If the fair value exceeds the carrying amount, no impairment exists. If the carrying amount of the reporting unit exceeds the fair value, then we compare the implied fair value of the reporting unit's goodwill with its carrying amount. The implied fair value is determined by allocating the fair
value of the reporting unit to all the assets and liabilities of that unit, as if the unit had been acquired in a business combination and the fair value of the unit was the purchase price. If the carrying amount of the goodwill exceeds the implied fair value, then goodwill impairment is recognized by writing the goodwill down to the implied fair value.
MANAGED VISION REVENUE
The Company provides vision care services, through its managed vision care business, as a preferred provider to HMOs, PPOs, third party administrators and insurance indemnity programs. The contractual arrangements with these entities operate primarily under capitated programs. Capitation payments are accrued when they are due under the related contracts at the agreed-upon per-member, per-month rates. Revenue from non-capitated services, such as fee-for-service and other preferred provider arrangements, is recognized when the services are provided and the Company's customers are obligated to pay for such services. Unearned premiums represent the portion of premiums written applicable to the unexpired terms of policies.
PRODUCT SALES REVENUE
The Company recognizes revenue on product sales at the time of delivery to the customer. Product sales revenue include sales of optical products to customers through the retail optometry centers that the Company manages.
SERVICES REVENUE
The Company (through its affiliated professional corporation) provides comprehensive eye care services to consumers, including medical and surgical treatment of eye diseases and disorders by ophthalmologists, and vision measuring and non-surgical correction services by optometrists. The Company also charges a fee for providing the use of its ambulatory surgery center to professionals for surgical procedures. The Company's ophthalmic, optometric and ambulatory surgery center services are recorded at established rates reduced by an estimate for contractual allowances. Contractual allowances arise due to the terms of certain reimbursement contracts with third-party payors that provide for payments to the Company at amounts different from its established rates. The contractual allowance represents the difference between the charges at established rates and estimated recoverable amounts and is recognized in the period the services are rendered. The contractual allowance recorded is estimated based on an analysis of collection experience in relation to amounts billed and other relevant information. Any differences between estimated contractual adjustments and actual final settlements under reimbursement contracts are recognized as adjustments to revenue in the period of final settlements.
The Company's Health Services Organization ("HSO") provides marketing, managed care and other administrative services to individual ophthalmology and optometry practices under agreements between the Company and each practice. HSO revenue is recognized monthly at a contractually agreed upon fee, based on a percentage of cash collections by the HSO practices.
OTHER INCOME
Revenue from HSO settlements are recognized in other income when received. The Company expects future revenue from HSO settlements to be minimal and that all remaining contract settlements will be finalized by the end of the second quarter 2005.
MEDICAL CLAIMS EXPENSE
Claims expense is recorded as provider services are rendered and includes an estimate for claims incurred but not reported.
Reserves for estimated insurance losses are determined on a case by case basis for reported claims, and on estimates based on Company experience for loss adjustment expenses and incurred but not reported claims. These liabilities give effect to trends in claims severity and other factors which may vary as the losses are ultimately settled. The Company's management believes that the estimates of the reserves for losses and loss adjustment expenses are reasonable; however,
there is considerable variability inherent in the reserve estimates. These estimates are continually reviewed and, as adjustments to these liabilities become necessary, such adjustments are reflected in current operations in the period of the adjustment.
COST OF PRODUCT SALES
Cost of product sales is comprised of optical products including eyeglasses, contact lenses and other optical goods.
COST OF SERVICES
Cost of services represents the direct costs associated with services revenue. These costs are primarily comprised of medical and other service provider wages, as well as medical and other supplies and costs incidental to other services revenue.
MALPRACTICE CLAIMS
The Company purchases insurance to cover medical malpractice claims. The current insurance contract for medical malpractice is written on a claims made basis. There are known claims and incidents as well as potential claims from unknown incidents that may be asserted from past services provided. Management believes that these claims, if asserted, would be settled within the limits of insurance coverage.
INSURANCE OPERATIONS
THE COMPANY'S MANAGED VISION CARE BUSINESS INCLUDES A WHOLLY-OWNED SUBSIDIARY WHICH IS A LICENSED SINGLE SERVICE HMO IN TEXAS (THE "TEXAS HMO") AND A LICENSED CAPTIVE INSURANCE COMPANY DOMICILED IN SOUTH CAROLINA, OPTICARE VISION INSURANCE COMPANY ("OVIC"). OVIC IS SUBJECT TO THE REGULATION AND SUPERVISION BY THE SOUTH CAROLINA DEPARTMENT OF INSURANCE that requires us to maintain $500 of unencumbered capital and surplus via a letter of credit. The Texas HMO is subject to regulation and supervision by the Texas Department of Insurance, which has broad administrative powers relating to standards of solvency, minimum capital and surplus requirements, maintenance of required reserves, payments of dividends, statutory accounting and reporting practices, and other financial and operational matters. The Texas Department of Insurance requires that stipulated amounts of paid-in-capital and surplus be maintained at all times. Our Texas HMO subsidiary is required by terms of an Order of the Commissioner of Insurance, dated August 12, 1999, as modified in November 2003, to maintain a minimum net worth of $500. DIVIDENDS PAYABLE BY THE TEXAS HMO TO THE COMPANY ARE GENERALLY LIMITED TO THE LESSER OF 10% OF STATUTORY-BASIS CAPITAL AND SURPLUS OR NET INCOME OF THE PRECEDING YEAR EXCLUDING REALIZED CAPITAL GAINS. In addition, the Company's agreement with the Texas Department of Insurance, required the Company to pledge investments of $250, at December 31, 2004 and December 31, 2003.
INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes" which requires an asset and liability method of accounting for deferred income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis using enacted tax rates expected to apply to taxable income in the years the temporary differences are expected to reverse. A valuation allowance against deferred tax assets is recorded if, based on the weight of historic available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
REDEEMABLE CONVERTIBLE PREFERRED STOCK
In January 2002 the Company issued 3,204,959 shares of Series B 12.5% Voting Cumulative Convertible Participating Preferred Stock ("Series B Preferred Stock"). Each share of Series B Preferred Stock is, at the holder's option, immediately convertible into a number of shares of common stock based on such share's current liquidation value. Each share of Series B Preferred Stock must be redeemed in full by the Company on December 31, 2008. (See also Note 16)
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" requires an issuer to classify a mandatorily redeemable instrument as a liability if it represents an unconditional obligation requiring the Company to redeem the instrument by transferring its assets at a specified or determinable date or upon an event that is certain to occur. The Company's convertible redeemable preferred stock is not classified as a liability due to its conversion feature.
STOCK-BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. As permitted under SFAS No. 123 and as amended by SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an Amendment of Financial Accounting Standards Board ("FASB") Statement No. 123", the Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board ("APB") Opinion No. 25 "Accounting for Stock Issued to Employees" and related interpretations, and provides the pro forma disclosure. Accordingly, compensation cost for the stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the measurement date over the amount an employee must pay to acquire the stock.
Pro forma information regarding net income (loss) and income (loss) per share is required by SFAS No. 123, and has been determined as if the Company accounted for its employee stock options granted subsequent to December 31, 1995, under the fair value method of SFAS No. 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2004, 2003 and 2002:
2004 2003 2002 ------- ------- ------- Risk free interest rate 3.3% 3.0% 3.0% Dividends -- -- -- Volatility factor .675 .60 .60 Expected Life 5 years 5 years 5 years
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
YEAR ENDED DECEMBER 31, --------------------------- 2004 2003 2002 ------- -------- ------
Net income (loss) as reported $(8,340) $(12,353) $ 745 Less: Total stock-based employee compensation expense determined under Black-Scholes option pricing model, net of related tax effects (152) (357) (519) ------- -------- ------ Pro forma net income (loss) $(8,492) $(12,710) $ 226 ======= ======== ====== Earnings (loss) per share - As reported: Basic $ (0.30) $ (0.43) $ 0.02 Diluted $ (0.30) $ (0.43) $ 0.01 Earnings (loss) per share - Pro forma: Basic $ (0.30) $ (0.44) $(0.02)
Diluted $(0.30) $(0.44) $0.00
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, as amended, "Disclosures about Fair Value of Financial Instruments," requires the disclosure of fair value information for certain assets and liabilities for which it is practicable to estimate that value. The Company's financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, long-term debt and redeemable preferred stock.
The Company considers the carrying amount of cash and cash equivalents, accounts receivable, notes receivable, accounts payable and accrued liabilities to approximate their fair values because of the short period of time between the origination of such instruments and their expected realization or their current market rate of interest. The carrying amount of long term debt approximates fair value due to the variable interest rate. Using available market information, the Company determined that the fair value at December 31, 2004 of the redeemable preferred stock was $16,313 compared to a carrying value of $6,344.
CONCENTRATIONS
The Company's principal financial instrument subject to potential concentration of credit risk is accounts receivable which is unsecured. The Company records receivables from patients and third party payors related to eye health services rendered. The Company does not believe that there are any substantial credit risks associated with receivables due from governmental agencies and any concentration of credit risk from other third party payors is limited by the number of patients and payors. The Company does not believe that there is any substantial credit risks associated with other receivables due from any of its other customers.
The Company has seven managed vision contracts with two insurers, CIGNA and United HealthCare, which account for approximately 27% of the Company's consolidated revenue in 2004. The consolidated revenues for 2004 exclude the revenues of both the Technology operation, CC Systems, Inc., which was sold in September 2004, and the Distribution business, which was sold in January 2005. The operating results for these two businesses are reflected in Discontinued Operations. (See Note 6)
ESTIMATES
In preparing financial statements, management is required to make estimates and assumptions, particularly in determining the adequacy of the allowance for doubtful accounts, insurance disallowances, managed care claims accrual, deferred taxes and in evaluating goodwill and intangibles for impairment, that affect the reported amounts of assets and liabilities as of the balance sheet date and results of operations for the year. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified in order to conform to the current year presentation.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, FASB Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" was issued. The interpretation provides guidance on the guarantor's accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others. The Company adopted the disclosure requirements of the interpretation as of December 31, 2002. Effective January 1, 2003, additional provisions of FIN No. 45 became effective and were adopted by the Company. The accounting guidelines are applicable to guarantees issued after December 31, 2002 and require that the Company record a liability for the fair value of such guarantees in the balance sheet. The adoption of FIN No. 45
did not have a material impact on the Company's financial position or results of operations.
Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting For Asset Retirement Obligations". This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The adoption of this statement did not have a material impact on the Company's financial position or results of operations.
Effective January 1, 2003, the Company adopted SFAS No. 145, "Rescission of FASB Statements 4, 44 and 64, Amendment of FASB Statement 13, and Technical Corrections". SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires companies to classify certain gains and losses from debt extinguishments as extraordinary items, eliminates the provisions of SFAS No. 44 regarding transition to the Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require that certain lease modifications be treated as sale leaseback transactions. The provisions of SFAS No. 145 related to classification of debt extinguishment are effective for fiscal years beginning after May 15, 2002. As a result of the Company's adoption of SFAS No. 145, the Company reclassified its previously reported gain from extinguishment of debt of approximately $8.8 million and related income tax expense of approximately $3.5 million in 2002 from an extraordinary item to continuing operations.
Effective January 1, 2003, the Company adopted SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" and nullified EITF Issue No. 94-3. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF No 94-3 had recognized the liability at the commitment date of an exit plan. There was no effect on the Company's financial statements as a result of such adoption.
Effective January 1, 2003, the Company adopted SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an amendment of FASB Statement No. 123." This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This statement also amends the disclosure requirements of SFAS No. 123 and APB No. 28, "Interim Financial Reporting," to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company elected to adopt the disclosure only provisions of SFAS No. 148 and will continue to follow APB Opinion No. 25 and related interpretations in accounting for the stock options granted to its employees and directors. Accordingly, employee and director compensation expense is recognized only for those options whose price is less than fair market value at the measurement date. For disclosure regarding stock options had compensation cost been determined in accordance with SFAS No. 123, see Pro forma Disclosure for Stock Based Compensation above. In December 2004, the FASB issued SFAS No. 123, Share-Based Payments (revised 2004). (SFAS No. 123R). See below.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities." FIN No. 46 requires an investor with a majority of the variable interests in a variable interest entity to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A variable interest entity is an entity in which the equity investors do not have a controlling interest or the equity investment at risk is insufficient to finance the entity's activities without receiving additional subordinated financial support from the other parties. The consolidation provisions of this interpretation are required immediately for all variable interest entities created after January 31, 2003, and the Company's adoption of these provisions did not have a material effect on its financial position or results of operations. For variable interest entities in existence prior to January 31, 2003, the consolidation provisions of FIN No. 46 are effective December 31, 2003 and did not have a material effect on the Company's financial position or results of operations.
In December 2003, the FASB issued a revised version of FIN 46 ("FIN 46R"), which incorporated a number of modifications and changes to the original version. FIN 46R replaced FIN 46 and, subject to certain special provisions, was effective no later than the end of the first reporting period that ended after December 15, 2003 for entities considered to be special-purpose entities and no later than the end of the first reporting period that ended after March, 15, 2004 for all other variable interest entities. The Company adopted FIN 46R in the fourth quarter of 2003 and did not have a material effect on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments. This statement is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of this statement did not have a material impact
on the Company's financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Most of the guidance in SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of SFAS No. 150 did not have a material impact on the Company's financial position or results of operations.
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 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, 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 No. 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 consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123, Share-Based Payments (revised 2004) ("SFAS No. 123R"). This statement eliminates the option to apply the intrinsic value measurement provisions of APB Opinion No. 25. Rather the Statement requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, the requisite period (usually the vesting period). SFAS No. 123R will also require companies to measure the cost of employee services received in exchange for Employee Stock Purchase Plan (ESPP) awards and the Company will be required to expense the grant date fair value of the Company's ESPP awards. SFAS No. 123R will be effective for the Company's fiscal quarter beginning July 1, 2005. Based on the number of stock options outstanding as of December 31, 2004, the effect of the adoption of SFAS No. 123R would be to increase compensation expense by approximately $0.2 million in the Company's fiscal quarter beginning July 1, 2005.
4. DISCONTINUED OPERATIONS
In May 2004, the Company's Board of Directors approved management's plan to exit the technology business, which as comprised of CC Systems, Inc. (formerly reported in the Company's Distribution and Technology segment) and to dispose of the Company's CC System Division. The Company completed the sale of the net assets of CC Systems, Inc. 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, Inc. is accounted for as a discontinued operation. In connection with the sale, the Company received $700 in cash. Additional consideration provided by the buyer included the surrender of 82,500 shares of the Company's common stock which had a fair market value of approximately $21 and the forgiveness of an unsecured promissory note payable owed by the Company which had an outstanding balance of $71 at the time of the sale. The Company recorded a $1,005 loss on the 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 December 31, 2002 have been reclassified to reflect treatment as held for sale.
On February 7, 2003, the Company acquired substantially all of the assets and certain liabilities of the contact lens distribution business of Wise Optical Vision Group, Inc. ("Wise Optical"), a New York corporation. The Company acquired Wise Optical to become a leading optical product distributor. The aggregate purchase price of Wise Optical was $7,949 and consisted of approximately $7,290 of cash, 750,000 shares of the Company's common stock that had an estimated fair market value of $330 at the time of acquisition, and transaction costs of approximately $329. Funding for the acquisition was obtained via the Company's revolving credit note with CapitalSource.
Wise Optical experienced substantial operating losses in 2003 and 2004. These losses were largely attributable to significant expenses incurred by Wise Optical, including integration costs (primarily severance and stay bonuses and legal and professional fees), weakness in gross margins and an operating structure built to support a higher sales
volume. In September 2003, the Company began implementing strategies and operational changes designed to improve the operations of Wise Optical. These efforts included developing the sales force, improving customer service, enhancing productivity, eliminating positions and streamlining our warehouse and distribution processes. The Company believed these changes would lead to increased sales, improved gross margins and reduced operating costs. Wise Optical continued to experience substantial operating losses in 2004 in spite of the strategies and operating changes that were implemented.
The results of operations of Wise Optical are included in the consolidated financial statements as part of discontinued operations from February 1, 2003, which was the effective date of the acquisition for accounting purposes. The net loss on a pro forma basis for the years ended December 31, 2003 and 2002 including the operations of Wise Optical as if the acquisition had closed effective January 1, of both years is $12,026 and $10,762, respectively.
In December 2004, the Company's Board of Directors approved management's plan to exit the Distribution business, which was comprised of Wise Optical and the Buying Group, (formerly reported in the Company's Distribution segment) and to dispose of the Company's Distribution sector. The Company completed the sale of the net assets of the Distribution sector on January 12, 2005 to the Company's Chairman and former Chief Executive Officer. The effective date of the transaction was December 31, 2004. In accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets," the disposal of Distribution sector is accounted for as a discontinued operation. The aggregate gross consideration from the sale was $4,150, less a working capital adjustment of $575 and estimated closing costs and other direct costs of $349. The Company recorded a $3,400 loss on the 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 December 31, 2002 have been reclassified to reflect treatment as held for sale.
In connection with the sale of the Distribution business, the Company entered into a Supply Agreement with the Buying Group operation and Wise Optical. The Supply Agreement is a four year commitment to purchase, on a non-exclusive basis, $4,200 of optical products per year through the Buying Group from certain designated manufacturers and suppliers. This annual commitment includes the purchase of $1,275 of contact lenses a year from Wise Optical. In addition, the Company is also obligated to pay the Buying Group an annual fee based on the total of all purchases it makes under the Supply Agreement. The Supply Agreement also contains certain buyout provisions depending on when the Supply Agreement is terminated.
Also in connection with the sale of the Distribution business, the lease obligation on the facility occupied by Wise Optical and located in Yonkers, New York will remain with the Company. The lease term on the facility expires in June 2011. The Company has estimated its potential exposure on the lease to be $1,300 and has recorded a provision for this amount which is included in the loss on disposal of discontinued operations.
In May 2002, the Company's Board of Directors approved management's plan to dispose of substantially all of the net assets relating to the retail optical business and professional optometry practice locations it operated in North Carolina ("NCOP"). Accordingly, during the quarter ended June 30, 2002 the Company recorded a $3,940 loss on disposal of discontinued operations based on the estimated fair value of the net assets held for sale. On August 12, 2002 the Company consummated the sale of the NCOP net assets to Optometric Eye Care Center, P.A. ("OECC"), an independent professional association owned by two former officers of the Company and recorded an additional loss on disposal of $494, including income tax expense of $342. In connection with the sale, the Company received $4,200 in cash and a $1,000 promissory note. Additional consideration included OECC's surrender of 1,321,010 shares of the Company's common stock (for retirement) with an estimated fair market value of $357 and OECC's assumption of $135 of certain other liabilities. The aggregate gross consideration from the sale of approximately $5,692 was offset by approximately $477 of closing and other direct costs associated with the sale. The Company paid $3,074 to its bank from the proceeds it received from the sale, of which $500 was applied as a payment on the term loan and $2,574 was applied as a payment on the outstanding credit facility. This sale was accounted for as a disposal group under SFAS No. 144. Accordingly, amounts in the financial statements and related notes for all periods presented have been reclassified to reflect SFAS No. 144 treatment.
Operating results of the discontinued operations are as follows:
2004 2003 2002 (1) ------- ------- --------
External revenue $57,254 $64,603 $47,455 ======= ======= =======
Intercompany revenue $ 5,663 $ 4,436 $ 9,221 ======= ======= =======
Income (loss) from discontinued operations before tax $(3,973) $(5,300) $ 559 Income tax expense (benefit) -- -- 222 ------- ------- ------- Income (loss) from discontinued operations (3,973) (5,300) 337 Loss on disposal of discontinued operations, net of income tax of $342 in 2002 (4,405) -- (4,434) ------- ------- ------- Total loss from discontinued operations $(8,378) $(5,300) $(4,097) ======= ======= =======
Loss per share from discontinued operations $ (0.28) $ (0.18) $ (0.33) ======= ======= =======
(1) The 2002 operating results of the discontinued operations exclude Wise Optical, which was acquired by the Company in February 2003.
5. SEGMENT INFORMATION
During the third quarter of 2004, the Company sold its Technology business, CC Systems, Inc. and on January 12, 2005 sold its Distribution business which was comprised of Wise Optical and the Buying Group with an effective date of December 31, 2004. As a result of selling these businesses, the Company has the following two reportable operating segments: (1) Managed Vision and (2) Consumer Vision. 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 two operating segments.
The Managed Vision segment contracts with insurers, insurance fronting companies, employer groups, managed care plans and other third party payers to manage claims payment administration of eye health benefits for those contracting parties. The Consumer Vision segment sells retail optical products to consumers and operates integrated eye health centers and surgical facilities where comprehensive eye care services are provided to patients.
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 HSO operation, which receives fee income for providing certain support services to individual ophthalmology and optometry practices. While the Company continues to meet its contractual obligations by providing the requisite services under its HSO agreements, the Company is in the process of disengaging from a number of these 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 years ended December 31, 2004, 2003 and 2002 is as follows:
YEAR ENDED DECEMBER 31, --------------------------- 2004 2003 2002 ------- ------- -------
REVENUES: Managed vision $25,495 $28,111 $29,426 Consumer vision 32,455 30,871 28,842 ------- ------- ------- Reportable segment totals 57,950 58,982 58,268 All other 1,849 2,869 3,282 Elimination of inter-segment revenues (896) (752) (695) ------- ------- -------
Total net revenue $58,903 $61,099 $60,855 ======= ======= =======
SEGMENT INCOME (LOSS): Managed vision $ 1,183 $ 1,271 $ 2,631(1) Consumer vision 3,406 2,973 1,463 ------- ------- ------- Total reportable segment income 4,589 4,244 4,094 All other 1,341 2,053 2,335 Depreciation (848) (1,168) (1,721) Amortization expense (117) (114) (119) Interest expense (1,190) (2,044) (3,010) Corporate (3,686) (3,201) (3,010) Gain (loss) on early extinguishment of debt -- (1,896) 8,789 ------- ------- ------- Income (loss) from continuing operations before income taxes $ 89 $(2,126) $ 7,358 ======= ======= =======
(1) Includes a $600 reduction in claims expense due to a favorable adjustment to the reserve.
YEAR ENDED DECEMBER 31, --------------------------- 2004 2003 2002 ------- ------- ------- ASSETS: Managed vision $15,766 $15,567 $15,133 Consumer vision 10,716 10,229 10,200 ------- ------- ------- Segment totals 26,482 25,796 25,333 Discontinued operations 9,044 16,248 7,456 Corporate and other 4,288 3,811 12,316 ------- ------- ------- Total $39,814 $45,855 $45,105 ======= ======= =======
CAPITAL EXPENDITURES: Managed vision $ 10 $ 135 $ 51 Consumer vision 716 591 518 ------- ------- ------- Segment totals 726 726 569 Discontinued operations 73 142 391 Corporate and other 7 22 184 ------- ------- ------- Total $ 806 $ 890 $ 1,144 ======= ======= =======
6. RESTRUCTURING AND OTHER ONE-TIME CHARGES
OPERATIONS RESTRUCTURING
In the fourth quarter of 2000, the Company recorded $2,306 of restructuring charges related to the canceled sale of the Connecticut operations. The Company's restructuring plans included closing and consolidating facilities, reducing overhead and streamlining operations and was completed in 2001.
During the years ended December 31, 2004, 2003 and 2002, $59, $206 and $119, respectively, was charged against the restructuring accrual, representing primarily severance and lease related payments on vacant facilities that were closed as part of the Company's restructuring activities. In 2004, the Company increased its restructuring reserve by $22 due to a change in estimated future rent payments. The remaining restructuring liability at December 31, 2004 of $434 principally relates to lease obligations on excess office space that are not expected to be utilized over the terms of the remaining leases.
7. RECEIVABLES
Activity in the allowance for doubtful accounts consisted of the following for the years ended December 31:
2004 2003 2002 ---- ----- ----- Balance at beginning of period $285 $ 256 $ 268 Additions charged (reductions credited) to expense (46) 162 173 Deductions (74) (133) (185) ---- ----- ----- Balance at end of period $165 $ 285 $ 256 ==== ===== =====
8. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
DECEMBER 31, ----------------- 2004 2003 ------- ------- Leasehold improvements $ 3,758 $ 3,567 Furniture and equipment 4,922 4,495 Computer hardware and software 3,501 3,852 ------- ------- Total 12,181 11,914 Accumulated depreciation and amortization (9,553) (9,153) ------- ------- Property and equipment, net $ 2,628 $ 2,761 ======= =======
9. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets". The standard changed the accounting for goodwill and intangible assets with an indefinite life whereby such assets are no longer amortized; however the standard does require at least annually a test for impairment, and a corresponding write-down, if appropriate. The first step of the goodwill impairment test identifies potential impairment and the second step of the test is used to measure the amount of impairment loss, if any. The Company completed its transitional test for impairment in the second quarter of 2002 and its annual test for impairment during the fourth quarter of 2002. No impairment charges were required in connection with these tests and there were no changes to the carrying value of goodwill during 2002.
The Company performed its annual test for goodwill impairment for its Managed Vision and Consumer Vision reporting units as of December 31, 2004 and no impairment charge was required. The increase in goodwill of $98 relates to an immaterial acquisition of a managed care company made in the third quarter of 2004. The purchase agreement related to this acquisition includes a provision whereby the previous owners may be entitled to receive
additional proceeds, if certain future profitability thresholds are achieved. Future contingent payments related to this acquisition could increase goodwill in the future.
In 2003, the Company recorded a $1,639 goodwill impairment charge that was due to a decline in Buying Group sales and significant operating losses at Wise Optical. Both operations comprised the Company's Distribution business which was sold on January 12, 2005. As a result of the sale, the 2003 goodwill impairment charge was reclassified on the Company's 2003 consolidated statement of operations from operating expenses to loss from discontinued operations, net of income tax. In addition, the remaining Buying Group goodwill of $1,327 was charged to expense in December 2004 and is included in loss from discontinued operations in the Company's consolidated statement of operations.
Changes in the carrying amount of goodwill for the year ended December 31, 2004, by segment, are as follows:
MANAGED CONSUMER VISION VISION TOTAL ------- -------- ------- Balance, December 31, 2003 $11,819 $4,746 $16,565 Goodwill from acquisition 98 -- 98 ------- ------ ------- Balance, December 31, 2004 $11,917 $4,746 $16,663 ======= ====== =======
Intangible assets subject to amortization are as follows as of December 31:
2004 2003 ------------------------------- ------------------------------- Gross Accumulated Net Gross Accumulated Net Amount Amortization Balance Amount Amortization Balance ------ ------------ ------- ------ ------------ -------
Service Agreement $1,658 $(590) $1,068 $1,658 $(479) $1,179 Non-compete agreements 265 (265) -- 265 (265) -- ------ ----- ------ ------ ----- ------ Total $1,923 $(855) $1,068 $1,923 $(744) $1,179 ====== ===== ====== ====== ===== ======
The weighted average amortization period for the service agreements and non-compete agreements are 15 years and 3.5 years, respectively.
Amortization expense for the years ended December 31, 2004, 2003 and 2002 was $111, $114 and $119, respectively. Annual amortization expense is expected to be $111 for each of the years 2005 through 2008.
10. LONG-TERM DEBT
The details of the Company's long-term debt at December 31, 2004 and 2003 are as follows:
2004 2003 ------- -------
Term note payable to CapitalSource, due January 25, 2006. Monthly principal payments of $25 with balance due at maturity. $ 1,775 $ 2,075
Revolving credit note to CapitalSource, due January 25, 2007. 8,388 10,394
Subordinated notes payable due at various dates through 2004. Principal and interest payments are due monthly or annually. Interest is payable at rates ranging from 7% to 11.4%. 193 124
------- ------- Total 10,356 12,593 Less current portion 332 10,818 ------- ------- Total Long-Term Debt $10,024 $ 1,775 ======= =======
Aggregate maturities of long-term debt by year are $332 in 2005, $1,475 in 2006 and $8,549 in 2007.
The loan agreement with CapitalSource requires the Company to maintain a lock-box arrangement with its banks whereby amounts received into the lock-boxes are applied to reduce the revolving credit note outstanding. The agreement also contained certain subjective acceleration clauses in the event of a material adverse event. Emerging Issues Task Force Issue ("EITF") 95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements That Include both a Subjective Acceleration Clause and a Lock-Box Arrangement" required the Company to classify outstanding borrowings under the revolving credit note as current liabilities. In accordance with this pronouncement, the Company classified its revolving credit facility as a current liability in the amount of $9,694 at December 31, 2003. In addition, $700 of an over advance from CapitalSource was included in current liabilities for 2003.
On August 27, 2004, the Company amended its loan agreement with CapitalSource to eliminate the lenders ability to declare a default based upon subjective criteria as described in the EITF. Palisade Concentrated Equity Partnership, L.P. ("Palisade"), provided a $1,000 guarantee against the loan balance due to CapitalSource related to this amendment. As a result of this amendment, the Company has classified the loan balance related to the revolving credit facility as long-term at December 31, 2004.
The Company had standby letters of credit outstanding at December 31, 2004 and 2003 for $1,160 and $900, respectively. There were no draw downs against these standby letters of credit in 2004 and 2003. The letters of credit outstanding at December 31, 2004 and 2003 were secured by restricted certificates of deposit and security deposits, respectively.
THE CAPITALSOURCE LOAN AND SECURITY AGREEMENT
Prior to January 2002, the Company was a party to a loan agreement (the "Credit Facility") with Bank Austria. The Credit Facility made available to the Company a $21,500 term loan and up to a $12,700 revolving loan facility secured by a security interest in substantially all of the assets of the Company. On January 25, 2002 Bank Austria forgave approximately $10,000 of principal and interest and sold this loan to CapitalSource. CapitalSource, as lender, and the Company, as borrower, amended and restated the terms of the indebtedness as described below.
In January 2002 the Company entered into an Amended and Restated Revolving Credit, Term Loan and Security Agreement (the "Amended Credit Facility") with CapitalSource. CapitalSource acquired this agreement from the Company's previous senior secured lender, Bank Austria, discussed below. The Amended Credit Facility made available to the Company a $3,000 term loan and up to a $10,000 revolving loan facility (the "Revolver") secured by a security interest in substantially all of the assets of the Company. The revolver agreement, prior to its amendment in 2004 required the Company to maintain a lock-box arrangement whereby amounts received into the lock-box is applied to reduce the revolver debt outstanding.
On February 7, 2003, in connection with the Company's acquisition of Wise Optical, the Company's credit facility with CapitalSource was amended. The amendment primarily resulted in an increase in the Company's Revolver from $10,000 to $15,000.
On November 14, 2003 the Company amended the terms of the Amended Credit Facility which, among other things, (i) increased the term loan by $314 and extended the maturity date of the term loan from January 25, 2004 to January 25, 2006, (ii) extended the maturity date of the revolver from January 25, 2005 to January 25, 2006, (iii) permanently increased the advance rate on eligible receivables of Wise Optical from 80% to 85%, (iv) temporarily increased the advance rate on eligible inventory of Wise Optical from 50% to 55% through March 31, 2004, (v) provided access to a $700 temporary over-advance bearing interest at prime plus 5.5 % due March 31, 2004 (which was prepaid in full by March 1, 2004) and was guaranteed by Palisade Concentrated Equity Partnership, L.P. ("Palisade"), (vi) waived the Company's non-compliance with the minimum fixed charge ratio financial covenant through March 31, 2004 and (vii) changed the net worth covenant from ($27,000) to tangible net worth of ($10,000). In connection with this amendment, the Company agreed to pay CapitalSource $80 in financing fees. The amendment also included an additional $150 termination fee if the Company terminates the Revolver prior to December 31, 2004. Additionally, if the Company terminates the Revolver pursuant to a refinancing with another commercial financial institution, it shall pay CapitalSource, in lieu of a termination fee, a yield maintenance amount which shall mean an amount equal to the difference between (i) the all-in effective yield which could be earned on the revolving balance through January 25, 2006 and (ii) the total interest and fees actually paid to CapitalSource on the Revolver prior to the termination date or date of prepayment.
On March 29, 2004 we entered into the Second Amended Credit Facility with CapitalSource which incorporates all of the changes embodied in the above amendments and: (i) confirmed that the temporary over-advance was repaid as of February 29, 2004 (ii) changed the expiration date of the waiver of our fixed ratio covenant from March 31, 2004 to February 29, 2004 (iii) reduced the tangible net worth covenant from $(10) million to $(2) million.
As a result of continued operating losses incurred 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, 2004 or May 31, 2004. We 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.
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 $2,000 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 commencing on October 1, 2004 with the remaining balance to be repaid in full by August 31, 2005, which is guaranteed by our largest stockholder, Palisade Concentrated Equity Partnership, L.P., (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 for the period October 31, 2004 to February 28, 2005. 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. On August 17, 2004, we paid 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.
On January 12, 2005, the Company, and certain of its wholly-owned subsidiaries, entered into the Third Amendment to the Second Amended and Restated Revolving Credit, Term Loan and Security Agreement with CapitalSource LLC. The Loan Amendment amends the terms of the Second Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated as of March 29, 2004, as amended by the Waiver and First Amendment to Second Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated as of August 16, 2004, and the Second Amendment to Second Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated as of August 27, 2004, to reduce the tangible net worth covenant for December 2004 and January 2005 from ($3,000,000) to ($6,500,000). Without this Amendment, the Company would have been in violation of the tangible net worth covenant at December 31, 2004. Under the Loan Agreement as amended by the Loan Amendment, the Company, as borrower, must maintain a tangible net worth of at least ($3,000,000) after February 1, 2005.
The term loan and revolving credit facility with CapitalSource are subject to a second amended and restated revolving credit, term loan and security agreement. 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 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, August 27, 2004 and January 12, 2005, 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 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 55% of all eligible inventory. 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.
SENIOR SUBORDINATED SECURED NOTES
In January 2002, Palisade made a subordinated loan to the Company of $13,900 and Ms. Yimoyines made a subordinated loan to the Company of $100 (collectively, the "Senior Secured Loans"), which were evidenced by senior subordinated secured notes. These notes were subordinated to the Company's senior indebtedness with CapitalSource, and were secured second priority security interests in substantially all of the Company's assets. Principal was due on January 25, 2012 and interest was payable quarterly at a rate of 11.5% per annum. In the first and second years of the notes, the Company had the right to defer 100% and 50%, respectively, of interest to maturity by increasing the principal amount of the note by the amount of interest so deferred.
On May 12, 2003, Palisade and Ms. Yimoyines exchanged the entire amount of principal and interest due to them under the Senior Secured Loans, totaling an aggregate of $16,246, for a total of 406,158 shares of Series C Preferred Stock, of which 403,256 shares were issued to Palisade and 2,902 shares were issued to Ms. Yimoyines. The aggregate principle and interest was exchanged at a rate equal to $.80 per share, the agreed upon value of our common stock on May 12, 2003, divided by 50 (or $40.00 per share).
11. GAIN (LOSS) ON EARLY EXTINGUISHMENT OF DEBT
On January 25, 2002, the Company recorded a gain on the early extinguishment of debt of $8,789 before income tax as a result of the Company's debt restructuring. The $8,789 gain was comprised principally of approximately $10,000 of debt and interest forgiveness by Bank Austria, the Company's former senior secured lender, which was partially offset by $1,200 of unamortized deferred financing fees and debt discount. (See Note 10)
On May 12, 2003, the Company recorded a $1,847 loss on the exchange of $16,246 of debt for Series C Preferred Stock. The $1,847 loss represents the write-off of the unamortized deferred debt issuance costs and debt discount associated with the extinguished debt. (See Notes 10 and 15)
On November 14, 2003, the Company amended the Amended Credit Facility with CapitalSource and recorded a $49 loss on the extinguishment of debt, representing financing fees and the write-off of unamortized deferred debt issuance costs associated with the original loans under the Amended Credit facility. (See Note 10)
12. LEASES
The Company leases certain furniture, machinery and equipment under capital lease agreements that expire through 2007. The Company primarily leases its facilities under cancelable and non-cancelable operating leases expiring in various years through 2014; including leases with related parties (see Note 16). Several facility leases have annual rental terms comprised of base rent at the inception of the lease adjusted by an amount based, in part, upon the increase in the consumer price index. Lease expense charged to continuing operations during the years ended December 31, 2004, 2003 and 2002 was $2,557, $2,344 and $3,929, respectively.
Property and equipment includes the following amounts for capital leases at December 31:
2004 2003 ----- ----- Furniture, machinery and equipment $ 233 $ 197 Less accumulated amortization (203) (189) ----- ----- $ 30 $ 8 ===== =====
Future minimum lease payments, by year and in the aggregate, under capital leases and operating leases with remaining terms of one year or more consisted of the following at December 31, 2004:
CAPITAL OPERATING LEASES LEASES ------- --------- 2005 $11 $ 2,572 2006 13 2,486 2007 6 2,275 2008 -- 1,885 2009 1,504 Thereafter -- 10,062 --- ------- Total minimum lease payments $30 $20,784 === =======
13. 401(K) SAVINGS PLAN
The Company provides a defined contribution 401(k) savings plan to substantially all employees who meet certain age and employment criteria. Eligible employees are allowed to contribute a portion of their income in accordance with specified guidelines. The Company matches a percentage of employee contributions up to certain limits. Employer contributions are made on a discretionary basis as authorized by the Board of Directors. Employer contributions for the years ended December 31, 2004, 2003, and 2002 were $259, $243 and $288, respectively.
14. REDEEMABLE CONVERTIBLE PREFERRED STOCK
On January 25, 2002 the Company designated and issued 3,204,959 shares of Series B Preferred Stock having a liquidation preference of $1.40 per share. Subject to a senior liquidation preference of the Series C Preferred Stock (see Note 15) and Series D Preferred Stock (see Note 2), the Series B Preferred Stock ranks senior to all other currently issued and outstanding classes or series of the Company's 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, at the holder's option, immediately 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 increases at a rate of 12.5% per year compounded annually.
Each share of Series B Preferred Stock must be redeemed in full by the Company on December 31, 2008, at a price equal to the greater of (i) the aggregate adjusted redemption value of the Series B Preferred Stock ($1.40 per share) plus accrued but unpaid dividends or (ii) the amount the preferred stockholders would be entitled to receive if the Series B Preferred Stock plus accrued dividends were converted at that time into common stock and the Company were to liquidate and distribute all of its assets to its common stockholders. As of December 31, 2004, cumulative accrued and unpaid dividends on the Series B Preferred Stock totaled $1,857 or $0.58 per preferred share. As of December 31, 2004 there were 3,204,959 shares of Series B Preferred Stock outstanding with a liquidation value of $1.98 per share.
15. STOCKHOLDERS' EQUITY
SERIES C PREFERRED STOCK
On May 12, 2003, the Company issued 406,158 shares of Series C preferred stock to Palisade and Ms. Yimoyines, collectively, in exchange for amounts due to them by the Company under Senior Secured Loans (See Note 10). Subject to the rights of the Series D Preferred Stock, the Series C Preferred Stock 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, at the holder's option, convertible into 50 shares of common stock and has the same dividend rights, on an as converted basis, as the Company's common stock.
WARRANTS
As of December 31, 2004, the following warrants to purchase common stock of the Company were outstanding and exercisable with expiration dates ranging from 2005 to 2014:
OUTSTANDING EXERCISE WARRANTS PRICE ----------- -------- 275,000 $0.14 20,000 $0.16 150,000 $0.29 750,000 $0.40 2,000,000 $1.00 50,000 $3.50 30,000 $4.50 --------- 3,275,000 =========
In December 2002 warrants to purchase 17,500,000 common shares of the Company were exercised at a price of $0.14 per share. These warrants were scheduled to expire in 2012. In connection with the immaterial acquisition of a managed care company made in the third quarter of 2004, the Company issued 150,000 warrants at $0.29.
EMPLOYEE STOCK PURCHASE PLAN
The Company provides an Employee Stock Purchase Plan (the "ESPP") to substantially all eligible employees who meet certain employment criteria. Under the terms of the ESPP, eligible employees may have up to 20% of eligible compensation deducted from their pay to purchase common stock. The per share purchase price is 85% of the average high and low per share trading price of common stock on the American Stock Exchange on the last trading date prior to the investment date, as defined in the ESPP. The amount that may be offered pursuant to this plan is 450,000 shares. Effective July 2001, the Company suspended the purchase of shares by employees under the ESPP. As of December 31, 2004, the purchase of shares under the ESSP remained suspended and, therefore, no shares were purchased by employees during 2004, 2003 and 2002.
STOCK PLANS
The Company's stock plans provide for the grant of incentive stock options and non-qualified stock options as well as restricted stock. Stock options generally are granted with an exercise price equal to 100% of the market value of a share of common stock on the date of grant, have a 10-year term and vest within four years from the date of grant. The weighted average fair value of stock options, calculated using the Black-Scholes option pricing model, granted during 2004, 2003 and 2002 was $0.26, $0.37 and $0.11 per share, respectively. There were 282,500, 225,000 and 25,000 shares of restricted common stock issued in 2004, 2003 and 2002, respectively, with a weighted average fair value at the date of grant of $0.64, $0.65 and $0.16, respectively. As of December 31, 2004, 8,734,791 shares were reserved for issuance under the stock plans, including 1,721,348 shares available for future grant.
Presented below is a summary of the status of the Company's stock options and the related transactions for the years ended December 31, 2004, 2003 and 2002.
WEIGHTED AVERAGE OPTIONS EXERCISE OUTSTANDING PRICE ----------- -------- December 31, 2001 920,458 $5.62 Granted 4,732,500 $0.33 Canceled (68,892) $5.71 --------- ----- December 31, 2002 5,584,066 $1.14 Granted 888,000 $0.66 Exercised (580,000) $0.25 Canceled (368,604) $0.66 --------- ----- December 31, 2003 5,523,462 $1.19 Granted 1,567,000 $0.50 Exercised (92,500) $0.21 Canceled (359,519) $3.62 --------- ----- December 31, 2004 6,638,443 $0.90 ========= =====
The following table summarizes in more detail information regarding the Company's stock options outstanding at December 31, 2004.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------- ---------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE Exercise Price OPTIONS LIFE (YEARS) PRICE OPTIONS PRICE --------------- ----------- ------------ -------- ----------- -------- $ 0.15 - $ 0.16 1,300,000 7.0 $ 0.15 975,000 $ 0.15 $ 0.20 - $ 0.30 2,207,500 8.2 $ 0.25 1,005,000 $ 0.23 $ 0.31 - $ 0.36 540,000 7.9 $ 0.36 535,000 $ 0.36 $ 0.45 220,000 9.3 $ 0.45 220,000 $ 0.45 $ 0.65 - $ 0.77 1,145,000 8.8 $ 0.67 270,750 $ 0.65 $ 1.00 - $ 1.78 245,000 7.2 $ 1.14 145,000 $ 1.24 $ 2.00 - $ 2.56 545,131 5.7 $ 2.35 445,131 $ 2.43 $ 5.85 428,750 4.6 $ 5.85 428,750 $ 5.85 $ 6.37 - $19.12 7,062 4.6 $12.74 7,062 $12.74 --------- --- ------ --------- ------ Total 6,638,443 7.6 $ 0.90 4,031,693 $ 1.17 ========= === ====== ========= ======
16. RELATED PARTY TRANSACTIONS
The Company incurred rent expense of $106 in 2002,which was paid to certain doctors for the use of equipment.
The Company incurred rent expense of $1,153, $1,086 and $1,780 in 2004, 2003 and 2002, respectively, which was paid to entities in which the former Chief Executive Officer of the Company had an interest, for the lease of facilities. (See Note 21)
At December 31, 2004, the Company owed Palisade Concentrated Equity Partnership, L.P. $216 for expenses that Palisade incurred on behalf of the Company. This liability was subsequently paid in the first quarter of 2005.
In the normal course of business, the Company contracts with OptiCare P.C. to provide medical, surgical and optometric services to patients. The Company's former Chief Executive Officer is the sole nominee stockholder of OptiCare P.C. (See Note 21)
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.
A subsidiary of the Company remains a guarantor with respect to two leases where the lessee is an entity owned by two former officers of the Company. Aggregate annual rent under the leases is $194,392. Each of the guarantees and its underlying lease involved the professional optometry practice locations and retail optical business the Company operated in the State of North Carolina, which was sold to Optometric Eye Care Center, P.A. ("OECC") in August 2002. Although, in connection with that sale, OECC assumed from the Company any obligations the Company or its subsidiaries or affiliates may have had as lessee under those leases, OECC and the Company were unable to obtain landlord consent to the assignment of the Company's guarantees with respect to the leases, which expire in 2005. As a guarantor, performance by the Company would be required if the borrowing entity defaulted, however the Company had deemed that its performance as a guarantor is not likely to occur. In addition, if the Company were called upon to perform in the event of default by OECC, the Company would have recourse against OECC.
In January 2002, the Company issued senior subordinated secured notes payable to Palisade, a significant shareholder, for $13,900 and to Ms. Yimoyines, wife of the Company's Chief Executive Officer, for $100. For the years ended December 31, 2002, interest expense on the notes to Palisade and Ms. Yimoyines was $1,577 and $11, respectively, which was paid in kind. In May 2003, Palisade and Ms. Yimoyines exchanged the entire amount of principal and interest due to them under these notes for shares of Series C Preferred Stock, of which 403,256 shares were issued to Palisade and 2,902 shares were issued to Ms. Yimoyines. Interest expense on the notes payable to Palisade and Ms. Yimoyines in 2003, prior to the exchange for Series C Preferred Stock, was $658 and $5, respectively.
In January 2002, in connection with providing the Senior Secured Loans to the Company, Palisade and Ms. Yimoyines received warrants to purchase 17,375,000 and 125,000 shares, respectively, of the Company's common stock at an exercise price of $0.14. These warrants were exercised in December 2002.
In January 2002, Palisade purchased 2,571,429 shares of the Company's Series B Preferred Stock for $3,600 in cash and Ms. Yimoyines purchased 285,714 shares of Series B Preferred Stock for $400 in cash. Also in January 2002, the Company issued an additional 309,170.5 shares of Series B Preferred Stock to Palisade to satisfy an outstanding loan of $400 of principal and $33 of accrued interest and issued an additional 38,646.3 shares of Series B Preferred Stock to Ms. Yimoyines to satisfy an outstanding loan of $50 of principal and $4 of accrued interest due to Ms. Yimoyines. As of December 31, 2004, accrued and unpaid dividends on these shares owned by Palisade and Ms. Yimoyines totaled $1,669 and $188, respectively.
We had an unsecured promissory note payable to a former officer of the Company related to an amount owed in connection with our purchase of Cohen Systems (now "CC Systems") in 1999. On September 10, 2004, CC Systems was sold back to the former officer and the unpaid balance on the promissory note at the time of the sale of approximately $71 was settled in the form of consideration from the sale.
17. EARNINGS (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings (loss) per share:
YEAR ENDED DECEMBER 31, --------------------------------------- 2004 2003 2002 ----------- ----------- -----------
Income (loss) from continuing operations $ 38 $ (7,053) $ 4,842 Preferred stock dividends (709) (618) (531) ----------- ----------- ----------- Income (loss) from continuing operations applicable to Common stockholders (671) (7,671) 4, 311 Discontinued operations (8,378) (5,300) (4,097) ----------- ----------- ----------- Net income (loss) applicable to common shareholders $ (9,049) $ (12,971) $ 214 =========== =========== ===========
Weighted average common shares - basic 30,598,203 30,066,835 12,552,185
Effect of dilutive securities: Options * * 790,102 Warrants * * 7,887,094 Preferred Stock * * 29,942,229 ----------- ----------- ----------- Weighted average common shares - dilutive 30,598,203 30,066,835 51,171,610 =========== =========== ===========
Basic Earnings Per Share: Income (loss) from continuing operations $ (0.02) $ (0.25) $ 0.35 Discontinued operations (0.28) (0.18) (0.33) ----------- ----------- ----------- Net income (loss) per common share $ (0.30) $ (0.43) $ 0.02 =========== =========== ===========
Diluted Earnings Per Share: Income (loss) from continuing operations $ (0.02) $ (0.25) $ 0.09 Discontinued operations (0.28) (0.18) $ (0.08) ----------- ----------- ----------- Net income (loss) per common share $ (0.30) $ (0.43) $ 0.01 =========== =========== ===========
* Anti-dilutive
The following table reflects the potential common shares of the Company at December 31, 2004, 2003 and 2002 that have been excluded from the calculation of diluted earnings per share due to anti-dilution.
2004 2003 2002 ---------- ---------- --------- Options 6,638,443 5,523,462 2,111,566 Warrants 3,275,000 3,125,000 2,830,000 Convertible preferred stock 65,621,514 60,574,323 -- ---------- ---------- --------- Total 75,534,957 69,222,785 4,941,566 ========== ========== =========
18. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The liability method of accounting for deferred income taxes requires a valuation allowance against deferred tax assets if, based on the weight of historic available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Company recorded income tax expense of $51 for the year ended December 31, 2004. The 2004 valuation allowance is required due to the substantial operating losses that the Company has historically recognized.
Significant components of the Company's deferred tax assets and liabilities consisted of the following at December 31, 2004 and 2003:
2004 2003 ------- ------- Deferred tax assets (liabilities): Net operating loss carryforwards $ 4,976 $ 2,956 Accruals 1,687 1,336 Allowance for bad debts -- 138 Depreciation and amortization 1,974 2,279 Other 366 420 ------- ------- Total deferred tax assets 9,003 7,129 Valuation allowance (9,003) (7,129) ------- ------- Total deferred tax assets, net $ -- $ -- ======= =======
As of December 31, 2004, the Company has net operating loss carryforwards available of approximately $12,900 for federal tax purposes. These NOL carryforwards expire in the years 2021 through 2024.
The components of income tax expense for the years ended December 31, 2004, 2003 and 2002 are as follows:
2004 2003 2002 ---- ------ ------ Current: Federal $ 3 $ -- $ -- State 48 127 80 --- ------ ------ Total current 51 127 80 --- ------ ------
Deferred: Federal -- 3,980 2,020 State -- 820 416 --- ------ ------ Total deferred -- 4,800 2,436 --- ------ ------ Total income tax expense $51 $4,927 $2,516 === ====== ======
A reconciliation of the tax provision (benefit) at the U.S. Statutory Rate to the effective income tax rate as reported is as follows:
2004 2003 2002 ---- ----- ---- Tax provision at U.S. Statutory Rate 34% (34)% 34% State income taxes, net of federal benefit 36% 29% 5% Non-deductible expenses and other (355)% (37)% (5)% Change in valuation allowance 342% 274% -- ---- ---- --- Effective income tax rate 57% 232% 34% ==== ==== ===
19. COMMITMENTS AND CONTINGENCIES
HEALTH SERVICE ORGANIZATION LAWSUITS
In September and October 2001, the following actions were commenced: Charles Retina Institute, P.C. and Steven T. Charles, M.D. v. OptiCare Health Systems, Inc., filed in Chancery Court of Tennessee for the Thirtieth Judicial District at Memphis; Eye Associates of Southern Indiana, P.C. and Bradley C. Black, M.D. v. PrimeVision Health, Inc., filed in United States District Court, Southern District of Indiana; and Huntington & Distler, P.S.C., John A. Distler, M.D. and Anne C. Huntington, M.D. v. PrimeVision Health, Inc., filed in United States District Court, Western District of Kentucky. Plaintiffs (ophthalmology or optometry practices) in each of these actions alleged that our subsidiary, PrimeVision Health, Inc. (referred to as "PrimeVision") defaulted under agreements effective as of April 1, 1999 entitled Services Agreement (HSO Model) (referred to as "Services Agreements") by failing to provide the services allegedly required under those agreements in exchange for annual fees (referred to as "HSO Fees") to be paid to PrimeVision. Plaintiffs also alleged that PrimeVision repudiated any duty to perform meaningful services under the Services Agreements and never intended to provide meaningful services. Plaintiffs seek declaratory relief that they are not required to make any payments of HSO Fees to PrimeVision under the Services Agreements for a variety of reasons, including that plaintiffs are discharged of any duty to make payments, there was no termination of the Services Agreements that would trigger an obligation by plaintiffs to pay PrimeVision the amounts designated in the agreements as being owed upon early termination (referred to as the "Buy-out Price"), the agreements contained an unenforceable penalty, there was lack of consideration, and there was a mutual and material misunderstanding. Plaintiffs also seek damages for non-performance and breach of duty of good faith and fair dealing, and seek to rescind the Services Agreements for fraud in the inducement, material misrepresentation, and mistake. Finally, plaintiffs seek punitive damages and attorneys' fees, interest and costs. PrimeVision also filed denials of all of the material allegations of the complaints in the Huntington & Distler and Eye Associates of Southern Indiana cases, and asserted counterclaims to recover HSO Fees and the Buy-out Price.
In November 2001, PrimeVision commenced the following action: PrimeVision Health, Inc. v. Charles Retina Institute and Steven T. Charles, M.D. filed in United States District Court for the Eastern District of North Carolina, Western District. In this action, PrimeVision sued in North Carolina, which is its principal place of business, one of the practices which had, in an action cited above, sued it in Tennessee. PrimeVision alleged that the Services Agreement and a Transition Agreement, also entered into by Defendant and PrimeVision in April 1999, were part of an integrated transaction in which many practices (referred to as the "Practices") that had previously entered into a physician practice management (referred to as "PPM") arrangement with PrimeVision converted to a health service organization (referred to as "HSO") model. As part of that integrated transaction, the Practices (including Defendant) repurchased assets that they had sold to PrimeVision in or about 1996 and were able to terminate agreements entered into with PrimeVision in 1996 and the obligations there under. PrimeVision sought a declaratory judgment that the Services Agreement is enforceable and that Defendant must pay to PrimeVision the annual HSO Fees required under the Services Agreement or, alternatively, the Buy-out Price.
The Multidistrict Litigation. On March 18, 2002, PrimeVision filed a motion with the Judicial Panel on Multidistrict Litigation in Washington, D.C. (referred to as the "Judicial Panel") to transfer the foregoing matters to a single federal district court for consolidated or coordinated pretrial proceedings. Over the opposition of the plaintiffs, the Judicial Panel granted the motion and ordered that all of the cases be consolidated in the U.S. District Court for the Western District of Kentucky under the caption In re PrimeVision Health, Inc. Contract Litigation, MDL 1466 ("MDL 1466").
In October and November 2002, PrimeVision commenced the following actions:
8. PrimeVision Health, Inc. v. The Brinkenhoff Medical Center, Inc., Michael Brinkenhoff, M.D., Tri-County Eye Institute, and Mark E. Schneider, M.D., filed in the United States District Court for the Central District of California;
9. PrimeVision Health, Inc. v. Robert M. Thomas, Jr., M.D., a medical corporation, Robert M. Thomas, Jr., M.D., Jeffrey P. Wasserstrom, M.D., a medical corporation, Jeffrey P. Wasserstrom, M.D., Lawrence S. Rice, a medical corporation and Lawrence S. Rice, M.D., filed in the United States District Court for the Southern District of California;
10. PrimeVision Health, Inc. v. The Milne Eye Medical Center, P.C. and Milton J. Milne, M.D., filed in the United States District Court for the District of Maryland;
11. PrimeVision Health, Inc. v. Eye Surgeons of Indiana, P.C., Michael G. Orr, M.D., Kevin L. Waltz, M.D. and Surgical Care, Inc., in the United States District Court for the Southern District of Indiana, Indianapolis Division;
12. PrimeVision Health, Inc. v. Downing-McPeak Vision Centers, P.S.C. and John E. Downing, M.D., in the United States District Court for the Western District of Kentucky, Bowling Green Division;
13. Prime Vision Health, Inc. v. HCS Eye Institute, P.C., Midwest Eye Institute of Kansas City, John C. Hagan, III, M.D. and Michael Somers, M.D., filed in the United States District Court for the Western District of Missouri; and
14. PrimeVision Health, Inc. v. Delaware Eye Care Center, P.A., a professional corporation; and Gary Markowitz, M.D., filed in the Superior Court of the State of Delaware, New Castle County.
PrimeVision requested the Judicial Panel to transfer all of the actions except No. 7 to Kentucky and consolidate them as part of MDL 1466. (Action 7 could not be transferred because it was filed in state court.) The Judicial Panel entered a conditional transfer order for such actions, and because there was no opposition to transfer and consolidation in Actions 4, 5 and 6, they are now part of MDL 1466. One practice defendant in Action 1, and the defendants in Actions 2 and 3 opposed transfer to MDL 1466. On April 11, 2003, the Judicial Panel denied those defendants' motions to vacate the Judicial Panel's order to conditionally transfer the actions to the Western District of Kentucky and ordered the remaining three actions transferred to the Western District of Kentucky for inclusion in the coordinated or consolidated pretrial proceedings occurring there.
The actions filed by PrimeVision contain similar allegations as the action PrimeVision filed against Charles Retina Institute in North Carolina District Court as described above. Instead of declaratory relief, however, PrimeVision seeks money damages for payment of the contractual Buy-Out Price.
All of the defendants have denied the material allegations of the complaints, and the defendants in Actions 3, 4, 5, 6 and 7 above have asserted counterclaims and seek relief similar to the claims asserted and relief sought by the
practices in the Charles Retina, Eye Associates of Southern Indiana and Huntington & Distler cases. PrimeVision has denied all of the material allegations of the counterclaims.
The parties have exchanged written discovery and have begun taking depositions. PrimeVision also has discussed settlement with all of the Practices. To date, we have reached settlement with ten HSO Practices with which we were in litigation and with twelve other Practices with which we were not in litigation but where there was a mutual desire to disengage from the Services Agreements. We also have an agreement in principal to settle with an additional Practice with which we were in litigation. The Company is continuing to discuss settlement with the three remaining Practices; however there can be no assurance that the parties will be able to reach mutually agreeable settlement terms. While we continue to meet our contractual obligations by providing the requisite services under our Services Agreements, we are in the process of disengaging from a number of these arrangements. At this stage of the actions, we are unable to form an opinion as to the likely outcome or the amount or range of potential loss, if any.
OTHER LITIGATION
OptiVest, LLC v. OptiCare Health Systems, Inc., OptiCare Eye Health Centers, Inc. and Dean Yimoyines, filed in the Superior Court, Judicial District of Waterbury, Connecticut on January 14, 2002. Plaintiff is a Connecticut limited liability corporation that entered into an Asset Purchase Agreement for certain of our assets. We believe we properly cancelled the Asset Purchase Agreement pursuant to its terms. Plaintiff maintains that it incurred expenses in investigating a potential purchase of certain assets, and that we misled it with respect to our financial condition, and, as a result, Plaintiff has suffered damages. Plaintiff seeks specific performance of the Asset Purchase Agreement and an injunction prohibiting us from interfering with concluding the transactions contemplated by the Asset Purchase Agreement. Further, Plaintiff alleges a breach of contract with regard to the Asset Purchase Agreement. Plaintiff further alleges we engaged in innocent misrepresentation, negligent misrepresentation, intentional and fraudulent misrepresentation and unfair trade practices with respect to the Asset Purchase Agreement.
The parties agreed to non-binding mediation, which began in April 2003. At the mediation, OptiVest, LLC agreed to withdraw its lawsuit and continue to attempt to resolve this matter through non-binding mediation. Optivest, LLC has withdrawn its lawsuit, however, non-binding mediation has not been successful and the parties have exchanged discovery information and will proceed with an arbitration hearing which was originally scheduled for March 2005 but was postponed and has not yet been rescheduled.
In the normal course of business, 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 December 31, 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 effect in relation to the Company's consolidated financial position or results of operations.
20. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Historical quarterly results for 2003 have been restated, as presented below, to reflect the Distribution Division as Discontinued Operations.
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- -------
Net revenue $14,642 $15,704 $14,179 $14,378 Gross profit 6,859 7,509 6,307 6,622 Income (loss) from continuing operations 149 453 (850) 286 Discontinued operations (1,113) (1,409) (1,324) (4,532) Net loss (964) (956) (2,174) (4,246) Preferred stock dividend (174) (177) (177) (181) Basic and diluted earnings (loss) per share: Income (loss) from continuing operations 0.00 0.01 (0.03) 0.00 Net loss (0.04) (0.04) (0.08) (0.14)
Net revenue $16,383 $15,661 $15,213 $13,842 Gross profit 7,891 7,233 6,191 5,956 Income (loss) from continuing operations 510 (1,318) (5,605) (640) Discontinued operations (350) (856) (2,874) (1,220) Net income (loss) 160 (2,173) (8,479) (1,860) Preferred stock dividend (140) (160) (159) (159) Basic earnings (loss) per share : Income (loss) from continuing operations 0.01 (0.05) (0.19) (0.03) Net income (loss) 0.00 (0.08) (0.29) (0.07) Diluted earnings (loss) per share : Income (loss) from continuing operations 0.01 (0.05) (0.19) (0.03) Net income (loss) 0.00 (0.08) (0.29) (0.07)
Quarterly and year-to-date computations of earnings per share amounts are made independently. Therefore, the sum of earnings per share amounts for the quarters may not agree with the per share amounts for the year.
21. SUBSEQUENT EVENTS
New Capital Structure
On January 12, 2005, we (including certain of our subsidiaries) closed a series of transactions which resulted in a major restructuring of our debt, equity and voting capital stock. Taken together, these transactions lowered our long-term debt and accounts payable by approximately $6.1 million and $1.5 million, respectively and increased our equity by approximately $4.4 million.
The transactions included, among other things, the following:
o Palisade Concentrated Equity Partnership, L.P., our majority stockholder, purchased, for approximately $4.0 million in cash, 252,525 shares of our Series D Preferred Stock, par value $0.001 per share, which are convertible into 10,101,000 shares of our common stock and Linda Yimoyines, the spouse of our Chairman and former Chief Executive Officer, purchased for approximately $0.445 million in cash, 28,093 shares of our Series D Preferred Stock which are convertible into 1,123,720 shares of our common stock. Each holder of Series D Preferred Stock is entitled to vote, on an as converted basis, on all matters with the holders of common stock and receive dividends equally and ratably with the holders of common stock in an amount equal to the dividends such holder would receive if it had converted its Series D Preferred Stock into Common Stock on the date the dividends are declared.
o OptiCare Acquisition Corp., our wholly-owned subsidiary entered into an Asset Purchase Agreement with Wise Optical, LLC and AECC/Pearlman Buying Group, LLC, both entities formed by Dean J. Yimoyines, M.D. our former Chief Executive Officer, current President and Chief Executive Officer of our medical affiliate, OptiCare P.C., and a current member of our Board of Directors, pursuant to which we sold, effective as of December 31,2004, substantially all of the assets and certain liabilities of our Distribution Division, which consisted of our contact lens distributor, Wise Optical, and our Optical Buying Group, for an aggregate purchase price of $4,150,000, less a working capital adjustment of $575,000 and closing costs and other direct costs of $349,000.
o We, together with certain of our subsidiaries, entered into the Third Amendment to the Second Amended and Restated Revolving Credit, Term Loan and Security Agreement with CapitalSource Finance LLC, our senior lender. The Loan Amendment amends the terms of the Second Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated as of March 29, 2004, as amended by the Waiver and First Amendment to Second Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated as of August 16, 2004, and the Second Amendment to Second Amended and Restated Revolving
Credit, Term Loan and Security Agreement, dated as of August 27, 2004, to reduce the tangible net worth covenant for December 2004 and January 2005 from ($3,000,000) to ($6,500,000). Without this Amendment, the Company would have been in violation of the tangible net worth covenant at December 31, 2004. Under the revolving credit, term loan and security agreement, as amended, we must maintain a tangible net worth of at least ($3,000,000) after February 1, 2005.
The following table sets forth our capitalization as of December 31, 2004 and the pro forma capitalization to reflect the transactions that closed on January 12, 2005, as if the transactions occurred on December 31, 2004.
Capitalization Table (Amounts in thousands) (Unaudited)
As of December 31, 2004 ----------------------- Actual Pro forma -------- ---------
Long-term debt (including current portion): Term note payable $ 1,775 $ 1,725 Revolving credit note 8,388 2,293 Subordinated notes payable 193 193 -------- -------- Total long-term debt (including current portion) 10,356 4,211
Series B 12.5% Voting, Redeemable, Cumulative Convertible Participating Preferred Stock; $0.001 Par value, 3,500,000 authorized, 3,204,959 shares issued and outstanding 6,344 6,344
Stockholders' equity: Series C Preferred Stock, $0.001 par value; ($16,251 aggregate liquidation preference); 406,158 shares issued and outstanding 1 1 Series D Preferred Stock, $0.001 par value; ($4,445 aggregate liquidation preference); no shares issued or outstanding (actual); 280,618 shares issued and outstanding (pro forma) -- -- Common Stock, $0.001 par value; 150,000,000 shares authorized; 30,638,283 shares issued and outstanding 31 31 Additional paid-in capital 79,192 83,637 Accumulated deficit (73,659) (73,659) -------- -------- Total stockholders' equity 5,565 10,010 -------- -------- Total Capitalization $ 22,265 $ 20,565 ======== ========