Item 1. Business.
Background and History of Company
LCA-Vision Inc. (the Company or LCA-Vision) is a leading provider of fixed-site laser vision correction services at our LasikPlus vision centers. Our vision centers provide the staff, facilities, equipment and support services for performing laser vision correction that employ advanced laser technologies to help correct nearsightedness, farsightedness and astigmatism. We currently use three suppliers for fixed site excimer lasers: Bausch & Lomb, Advanced Medical Optics and Alcon. Our vision centers are supported mainly by independent, board-certified ophthalmologists and credentialed optometrists, as well as other health care professionals. The ophthalmologists perform the laser vision correction procedures in our vision centers, and either ophthalmologists or optometrists conduct pre-procedure evaluations and post-operative follow-ups in-center. We have performed over 740,000 laser vision correction procedures in our vision centers in the United States and Canada since 1991. Most of our patients receive a procedure called LASIK, which we began performing in the United States in 1997.
We currently own and operate 60 LasikPlus fixed-site laser vision correction centers generally located in larger metropolitan markets in the United States, and also have a joint venture in Canada.
The Company derives all of its operating revenues from laser refractive surgery, our only reported segment. Financial information concerning revenues, profit and loss and total assets are contained in “Item 8. Financial Statements and Supplementary Data” under “Consolidated Balance Sheets” and “Consolidated Statements of Operations.”
Laser Vision Correction Procedures
Laser vision correction procedures are designed to reshape the outer layers of the cornea to help correct refractive vision disorders by changing its curvature with an excimer laser, which may reduce the need for wearing corrective lenses such as glasses and contact lenses. Prior to the laser vision correction procedure, an assessment is made of the patient’s candidacy for the treatment and the correction required to program the excimer laser. The software of the excimer laser then calculates the number of pulses needed to achieve the intended correction using a specially developed algorithm. A speculum is inserted to prevent blinking and topical anesthetic eye drops are applied. The patient reclines in a chair, eyes focused on a fixed target, while the ophthalmologist positions the patient’s cornea for the procedure. The excimer laser emits energy in a series of pulses, with each pulse typically lasting only a fraction of a second. High-energy ultraviolet light produced by the excimer laser creates a ''non-thermal’’ ablation to remove corneal tissue and reshape the cornea. The amount of tissue removed depends upon the degree of the vision disorder being corrected. Following the procedure, the front surface of the eye is flatter when corrected for nearsightedness, and steeper when corrected for farsightedness. A series of patient follow-up visits is scheduled with an optometrist or ophthalmologist to monitor the corneal healing process, to check that there are no complications and to test the correction achieved by the procedure. The typical procedure takes 15 to 30 minutes from set-up to completion.
We provide primarily two types of procedures in our vision centers:
PRK and Surface Ablation. PRK has been approved by the U.S. Food and Drug Administration (FDA) for commercial use in the United States since 1995. In PRK procedures, the ophthalmologist removes the thin layer of cells covering the outer surface of the cornea (the epithelium) in order to apply the excimer laser pulses directly to the surface of the cornea. Following the PRK procedure, a contact lens bandage is placed on the eye to protect it. The patient may experience discomfort and blurred vision until the epithelium heals, which can take several days or longer. The doctor generally will prescribe certain topical pharmaceuticals for use by the patient post-procedure to assist in alleviating discomfort, minimizing infection and helping to promote corneal healing.
Although a patient generally experiences substantial improvement in clarity of vision within a few days following the procedure, it can take several months for the full benefits of the PRK procedure to be realized. Some patients elect to have one eye treated in one visit and the second eye treated at a later date. Some ophthalmologists also perform Epi-LASIK or LASEK, in which a portion of the surface tissue is lifted from the eye prior to laser treatment and then replaced.
LASIK. In 1997, we began performing LASIK, which now accounts for the majority of our laser vision procedures in the United States. In LASIK procedures, an automated microsurgical instrument called a microkeratome or a femtosecond laser is typically used to create a thin flap, which remains hinged to the eye. The corneal flap is then laid back and excimer laser pulses are applied to the exposed surface of the cornea to treat the eye according to the patient’s prescription. The corneal flap is then folded back to its original position and inspected to ensure that it remains secured in position by the natural suction of the cornea. Since the surface layer of the cornea remains intact with LASIK, a bandage contact lens is normally not required and the patient typically experiences little discomfort. LASIK often has the advantage of more rapid recovery than PRK, with most patients seeing well enough to drive a car the next day and enjoying shorter recovery periods. The LASIK procedure generally allows an ophthalmologist to treat both eyes of a patient during the same visit and produces prompt results, frequently enabling patients to see well postoperatively almost immediately.
The Laser Vision Correction Market
More than 150 million Americans, or approximately 50% of the U.S. population, require eyeglasses or contact lenses to correct common vision problems. Most people seeking vision correction suffer from one or more refractive vision disorders, which often result from improper curvature of the cornea as related to the size and shape of the eye. If the cornea’s curvature is not precisely correct, it cannot properly focus the light passing through it onto the retina, and the viewer will see a blurred image. Three common refractive vision disorders are:
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Myopia (nearsightedness)-images are focused in front of the retina, resulting in the blurred perception of distant objects
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Hyperopia (farsightedness)-images are focused behind the retina, resulting in the blurred perception of near objects
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Astigmatism-images are not focused on any point due to the varying curvature of the eye along different axes.
Since the FDA approved the first laser to perform laser vision correction procedures in the United States in 1995, industry sources estimate that approximately 5.5 million patients have been treated. Laser vision correction is currently one of the most widely performed elective surgical procedures in the United States, with an estimated 1.4 million laser vision correction procedures performed in 2006. It is estimated that the potential market for laser vision correction procedures in the United States is approximately 120 million procedures, according to some industry reports on the U.S. refractive market.
Laser vision correction is typically an elective, private pay procedure performed on an outpatient basis. The demand for laser vision correction procedures performed in the United States is widely believed to be attributable to many factors, including:
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Market acceptance - as the number of procedures performed increases, so does the number of patients able to attest to the perceived benefits of laser vision correction,
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Technology - compared to earlier laser vision correction procedures, the LASIK procedure typically results in less patient discomfort and a shorter recovery period, and
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Applications - FDA approval for the excimer laser used in LASIK laser vision correction procedures has been extended to the treatment of three of the most common types of refractive vision disorders: nearsightedness, farsightedness and astigmatism.
Estimated Number of Laser Vision Correction Procedures in North America per Year
Source: Market Scope, February, 2007
(e): 2007 data estimated
Our Business Strategy
Our business strategy is to provide quality laser vision correction services at an affordable price. We operate our vision centers as closed-access facilities, where we are responsible for marketing and patient acquisition and contract with independent ophthalmologists for their services.
We intend to grow our business through increased penetration in our current markets and expansion into new markets. Key elements of our business strategy include:
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Recruiting and retaining independent, board certified ophthalmologists and credentialed optometrists
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Providing patients with a “Continuum of Care”
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Opening and operating new laser vision correction centers
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Providing attractive patient financing alternatives
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Establishing and nurturing relationships with leading managed care providers in the United States to source additional patients
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Developing and implementing innovative marketing campaigns
Recruiting and retaining independent, board certified ophthalmologists and credentialed optometrists. We generally focus our recruiting efforts on leading independent ophthalmologists and optometrists with a reputation for providing quality eye care within their respective markets, and with experience in laser vision correction procedures. Our ophthalmologists generally have completed extensive FDA-mandated training and also have met our qualification criteria, which include a review of state licensure, board certification, malpractice insurance and surgical experience.
Providing patients with a “Continuum of Care.” We strive to achieve high patient satisfaction and have established a ''Continuum of Care’’ program, the goal of which is to achieve the level of visual correction agreed to by the patient and physician. This program begins with our initial contact with the prospective patient. Our call center personnel are trained to answer questions regarding procedures and generally have access to both a physician to address more difficult inquiries and to past patients to relate procedure experience. Once in the vision center, potential patients can receive a free eye evaluation with the local vision center independent ophthalmologist or optometrist to determine their candidacy for laser vision correction as well as a consultation focused on educating the patient on vision correction procedures, how the procedure may help correct the patient’s specific refractive vision disorder and what results the patient may expect after the procedure. Additionally, our vision centers are designed to create a patient-friendly environment and reduce any anxiety associated with getting laser vision correction. We schedule post-surgical follow-ups with patients who have received the procedure to monitor results and provide enhancements to those patients who do not receive the desired correction in the initial procedure. The vast majority of our treated patients who respond to our customer satisfaction surveys indicate that they are satisfied with the care they received in our vision centers.
Opening and operating new laser vision correction centers. We plan to continue to expand our business primarily through the development of new vision centers in attractive new markets and within existing markets. In evaluating new and current markets for
opening a laser vision correction center, we consider a number of factors, including population demographics and competition, among other variables. We also typically interview local ophthalmologists and optometrists. We target geographic markets which we believe have the potential to generate break-even procedure volume within the first six months of opening. We have developed what we believe to be relatively cost-efficient standardized vision center designs to be used in building each new vision center to effectively manage patient flow and physician and staff productivity.
Providing attractive patient financing alternatives. Because laser vision correction procedures are elective and generally not reimbursable by third party payors including governmental programs such as Medicare and Medicaid, we currently offer patients several financing alternatives. We work closely with an unaffiliated finance company that offers multiple payment plans to qualifying customers. These payment plans typically provide for payments over a 12-month to 60-month period. We bear no credit risk for loans made under this program. For patients not qualifying for these plans, we also currently offer our own direct financing to customers under which we charge an up-front fee, with the remaining balance paid by the customer in installments over a period of 12 to 36 months.
Establishing and nurturing relationships with leading managed care providers in the United States to source additional patients. With an increasing number of employers adding vision services to their employee benefit packages, we hope to further increase our U.S. footprint and market share by continuing to nurture, develop and grow relationships with managed care organizations, through which we offer discounted rates to plan participants. The plan participant, and not the managed care organization, is currently responsible for the payment of our fees under these arrangements.
Developing and implementing innovative direct marketing campaigns. Our marketing programs seek to reinforce the LasikPlus brand name in addition to raising awareness concerning laser vision correction and promoting our vision centers and the experience of our independent ophthalmologists. In each market, we target a specific demographic group of potential patients through the use of print media, radio, internet, television and direct mail campaigns, among other strategies. In most advertisements, prospective patients are provided a web site address and a toll-free number to contact us. Our call center representatives answer initial questions potential patients may have, and attempt to schedule eye evaluation appointments with the local vision center to determine whether the prospective patient is a candidate for laser vision correction.
Competition
Laser vision correction, whether performed at one of our vision centers or elsewhere, competes with several surgical and non-surgical treatments to correct refractive vision disorders, including eyeglasses, contact lenses, other types of refractive surgery, intraocular lenses and corneal implants. In addition, other technologies may ultimately prove to be more attractive and effective to consumers than current laser vision correction technology.
We also face competition from other providers of laser vision correction. Eye care services in the United States are delivered through a fragmented system of local providers, including individual or small groups of opticians, optometrists and ophthalmologists, and chains of retail optical stores and multi-site eye care vision centers. Industry sources estimate that such local providers represent over 50% of the laser vision correction market. Corporate laser vision correction providers, such as ourselves, are a specialized type of provider, operating multi-site eye care centers that primarily provide laser vision correction. Among the laser vision correction providers, we believe we are the largest provider in terms of number of procedures performed in fixed-site vision centers in the United States.
The market for providing laser vision correction service is highly competitive and fragmented. In most of our markets, we compete with other laser vision correction center chains. These include TLC Vision Corporation, which also is a public company, as well as with hospitals, surgical clinics, national and local operators of vision centers and ophthalmology practices, among others, that have purchased or rent their own lasers. TLC Vision Corporation has recently launched an aggressive new business model focusing on the value segment of the industry. We believe the market is likely to become progressively more competitive as it matures.
In the past, certain competitors have utilized deeply-discounted pricing in an effort to generate procedural volume. This practice has caused periods of intense price competition in our industry. As a result, we have lowered our prices in the past in order to remain competitive. We currently face competitors offering discounted prices, including large chains of laser vision correction centers, in some geographic markets where we conduct business. It is possible that our business could be materially adversely affected in the future by discounting practices of competitors, including from both a price and volume perspective.
Employees
As of February 6, 2007, we had approximately 700 employees, 614 of whom were full-time. None of our employees are subject to a collective bargaining agreement nor have we experienced any work stoppages. We believe our relations with our employees are good.
Trademarks
Not all of the names we use for our products and services have been registered with the United States Patent and Trademark Office. Where we use the “TM” (trademark) symbol, it is our intention to claim trademark rights on those names under common law. The duration of such trademarks under common law is the length of time we continue to use them.
Suppliers of Equipment and Financing Services
We are not directly involved in the research, development or manufacture of ophthalmic laser systems, diagnostic equipment, microkeratomes or microkeratome blades. There are several companies - including Bausch & Lomb, Advanced Medical Optics and Alcon, the three suppliers we currently use - whose excimer laser systems have been approved by the FDA for commercial sale in the United States. We currently rely primarily on Bausch & Lomb to provide us with microkeratomes, microkeratome blades and other disposable items required in LASIK procedures.
A significant percentage of our patients finance some or all of the cost of their procedure. As the role and mix of financing as a percentage of our revenues has expanded, our reliance on an unaffiliated finance company has grown. We currently rely exclusively on this finance company for third-party financing.
Government Regulation
Our operations are subject to extensive federal, state and local laws, rules and regulations affecting the healthcare industry and the delivery of healthcare. Some of these include laws and regulations, which vary significantly from state to state, prohibiting unlawful rebates and division of fees, and limiting the manner in which prospective patients may be solicited. Furthermore, contractual arrangements with hospitals, surgery centers, ophthalmologists and optometrists, among others, are extensively regulated by state and federal laws, some of which may be applicable to our business operations.
Failure to comply with applicable FDA requirements could subject excimer laser manufacturers and us to enforcement action, including product seizures, recalls, withdrawal of approvals and civil and criminal penalties, any one or more of which could have a material adverse effect on our business, financial condition and results of operations. In addition, clearance or approvals could be withdrawn in some circumstances. Failure by us or our principal suppliers to comply with regulatory requirements, or any adverse regulatory action, could result in us being named as a party in ensuing litigation or a limitation on or prohibition of our use of excimer lasers, financing programs, or other necessary services to our business, which in turn would have a material adverse effect on our business, financial condition or results of operations. Discovery of problems, violations of current laws or future legislative or administrative action in the United States or elsewhere may adversely affect the ability of our suppliers and partners to obtain or maintain appropriate regulatory approval. Furthermore, the failure of Advanced Medical Optics, Bausch & Lomb or Alcon or any other manufacturers or suppliers that supply or may supply excimer lasers, diagnostic or other equipment or necessary services to us to comply with applicable federal, state, or foreign regulatory requirements, or any adverse regulatory action against such business suppliers and partners, could limit the supply of lasers or limit our ability to use the lasers.
The following is a more detailed description of certain laws and regulations that affect our operations.
Restrictions on medical devices
In the United States, the FDA regulates the uses, manufacturing, labeling, distribution and marketing of medical devices, including excimer lasers, microkeratomes and certain equipment we use in laser vision correction surgery.
Once FDA approval is obtained, medical device manufacturers are subject to continuing FDA obligations. For example, the FDA requires that medical devices be manufactured in accordance with its Quality System Regulations. In essence, this means that medical devices must be manufactured and records must be maintained in a prescribed manner with respect to production, testing and control activities. In addition, the FDA sometimes imposes restrictions and requirements regarding the labeling and promotion of medical devices, with which users such as us, as well as manufacturers, must comply.
Non-compliance with FDA requirements could subject manufacturers to enforcement action, including:
Non-compliance by us could subject us to civil and criminal penalties. Any such enforcement action could have a material adverse effect on our business, financial condition and results of operations.
The use of an excimer laser to treat both eyes on the same day (bilateral treatment) has not been approved by the FDA. The FDA has stated that it considers the use of the excimer laser for bilateral treatment to be a practice of medicine decision, which the FDA is not authorized to regulate. Ophthalmologists, including those practicing in our vision centers, widely perform bilateral treatment in an exercise of professional judgment in connection with the practice of medicine. There can be no assurance that the FDA will not seek to challenge this practice in the future. Should the FDA choose to regulate this aspect of the use of excimer lasers in the future, any potential resulting inconvenience to patients could discourage potential patients from having laser vision correction, potentially having a material adverse effect on our business, financial condition and results of operations by decreasing the total number of procedures we perform.
To authorize new uses of medical devices, manufacturers are required to obtain a supplemental FDA authorization. Obtaining these authorizations is time consuming and expensive, and we cannot be sure that manufacturers of the devices we use will be able to obtain any such additional FDA authorizations. Further, later discovery of problems with the medical devices we use may result in restrictions on use of the devices or enforcement action against the manufacturers, including withdrawal of devices from the market. Changes in legislation or regulation could affect whether and how we can use the devices. These and other regulatory actions could limit the supply of devices we use or our ability to use them, which could have a material adverse effect on our business, financial condition and results of operations.
Federal and state laws on “kickbacks” and physician referrals
Because laser vision correction procedures currently are not reimbursable by Medicare, Medicaid or other governmental health programs, we do not believe numerous federal health care laws that frequently apply to health care providers’ business operations (such as the federal Anti-Kickback and “Stark” Physician Self-Referral statutes) are currently applicable to us. Any changes in the reimbursement and coverage rules for these governmental health programs may cause our services to be subject to such federal laws. Although we do not anticipate such changes in the near future, we cannot predict this with any degree of certainty. Some states have enacted statutes, similar to the federal Anti-Kickback and Stark statutes, that are applicable to our operations because they cover all referrals of patients regardless of the payer or type of health care service provided. These state laws vary significantly in their scope and penalties for violations. Although we have endeavored to structure our business operations to be in material compliance with such state laws, authorities in those states could determine that our business practices are in violation of such laws. This could have a material adverse effect on our business, financial condition and results of operations.
Advertising restrictions
Our business is heavily dependent on advertising, which is subject to regulation by the Federal Trade Commission (FTC). In 2002 the FTC conducted an extensive review of our advertising practices. Following this review, the FTC concluded that certain of our past advertisements contained claims that were not properly substantiated. We elected to voluntarily settle with the FTC. On July 18, 2003, the FTC formally entered a Complaint and an Agreement Containing Consent Order in which we agreed, among other things, that we would not represent in our advertising that our LASIK surgery services eliminate the need for glasses and contacts for life, pose significantly less risk to patients’ eye health than wearing glasses or contacts or eliminate the risk of glare and haloing, unless, at the time made, we possess and rely upon competent and reliable scientific evidence that substantiates the representation. No monetary penalties were imposed on us. Although we consented to this order in 2003, we cannot be certain that this order will not be perceived negatively, and thus restrict our ability to effectively generate demand for our laser vision correction services.
Fee-splitting
Many states prohibit professionals (including ophthalmologists and optometrists) from paying a portion of a professional fee to another individual unless that individual is an employee or partner in the same professional practice. Violation of a state’s fee-splitting prohibition may result in civil or criminal fines, as well as loss of licensing privileges of the physician participating in such arrangements. Many states do not offer clear guidance on what relationships constitute fee-splitting, particularly in the context of providing management services for doctors. Although we have endeavored to structure our business operations in material compliance with these laws, state authorities could find that fee-splitting prohibitions apply to our business practices in their states. If any aspect of our operations were found to violate fee-splitting laws or regulations, this could have a material adverse effect on our business, financial condition and results of operations.
Corporate practice of medicine and optometry
The laws of many states prohibit business corporations, such as us, from practicing medicine and employing or engaging physicians to practice medicine. Some states prohibit business corporations from practicing optometry or employing or engaging optometrists to practice optometry. Such laws preclude companies that are not owned entirely by eye care professionals from:
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Employing eye care professionals
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Controlling clinical decision making
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Engaging in other activities that are deemed to constitute the practice of optometry or ophthalmology
This prohibition is generally referred to as the prohibition against the corporate practice of medicine or optometry. Violation of this prohibition may result in civil or criminal fines, as well as sanctions imposed against the professional through licensing proceedings. Although we have endeavored to structure our contractual relationships to be in material compliance with these laws, if any aspect of our operations were found to violate state corporate practice of medicine or optometry prohibitions, this could have a material adverse effect on our business, financial condition and results of operations.
Facility licensure and certificates of need
State Departments of Health may require us to obtain licenses in the various states in which we have or acquire laser vision correction centers or other business operations. We believe that we have obtained the necessary material licensure in states where licensure is required and that we are not required to obtain licenses in other states. However, not all of the regulations governing the need for licensure are clear and there is little guidance available regarding certain interpretative issues. Therefore, it is possible that a state regulatory authority could determine that we are improperly conducting business operations without a license in that state. This could subject us to significant fines or penalties, result in our being required to cease operations in that state or otherwise have a material adverse effect on our business, financial condition and results of operations. While we currently have no reason to believe that we will be unable to obtain necessary licenses without unreasonable expense or delay, there can be no assurance that we will be able to obtain any required licensure.
Some states require permission by the State Department of Health in the form of a Certificate of Need (CON) prior to the construction or modification of an ambulatory care facility or the purchase of certain medical equipment in excess of a certain amount. We believe that we have obtained the necessary CONs in states where a CON is required. However, not all of the regulations governing the need for CONs are clear and there is little guidance regarding certain interpretive issues. Therefore, it is possible that a state regulatory authority could determine that we are improperly conducting business operations without a CON in that state. There can be no assurance that we will be able to acquire a CON in all states where it is required, or that our failure or inability to obtain a CON in markets into which we believe we could otherwise be successful expanding will not have a material adverse effect on our business, financial condition and results of operations.
Healthcare reform
Healthcare reform is considered by many in the United States to be a national priority. Several states are also currently considering healthcare proposals. We cannot predict what additional action, if any, the federal government or any state may ultimately take with respect to healthcare reform. Healthcare reform may bring significant changes in the financing and regulation of the healthcare industry. Depending on the nature of such changes, they could have a material adverse effect on our business, financial condition and results of operations.
Internet
The Company’s websites are www.lasikplus.com and www.lca-vision.com. The Company makes available free of charge through a link provided at the websites its Forms 10-K, 10-Q and 8-K, as well as any amendments thereto. These reports are available as soon as reasonably practicable after they are filed with or furnished to the Securities and Exchange Commission. To obtain a copy of Form 10-K by mail, free of charge, please send a request to Investor Relations at LCA-Vision Inc., 7840 Montgomery Road, Cincinnati, Ohio 45236.
Item 1A.
Item 1A. Risk Factors
We have experienced operating losses in the past.
We commenced operations in 1991 and, other than in the year 1999, posted net losses in every year prior to 2003. Our ability to remain profitable depends on, among other factors:
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Continued market acceptance for laser vision correction services
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Our ability to execute our planned business strategy
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Our ability to manage equipment and operating costs
Our quarterly and annual operating results are subject to significant fluctuations.
Our revenue and operating results have fluctuated and may continue to fluctuate significantly from quarter to quarter and from year to year depending on many factors, including but not limited to:
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Market acceptance of laser vision correction services
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The number of laser vision correction procedures performed
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The timing of new advancements by our suppliers and the purchase of such advancements or upgrades of equipment by us or our competitors
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The impact of competitors, including those who compete by deeply discounting the price of laser vision correction services, in the geographic areas in which we operate
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Declining economic conditions in the geographic areas in which we operate, which can result in decreased demand for our laser vision correction services
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The opening, closing or expansion of vision centers
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Regulatory matters
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Litigation
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Acquisitions and other transactions
In addition, our revenue and operating results are subject to seasonal factors. In terms of number of procedures performed, our strongest quarter historically has been the first quarter of the year, and our business is generally weaker in the latter half of the year. We believe these fluctuations are due to several factors, including:
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The availability to potential patients of funds under typical corporate medical flexible spending plans
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Time constraints imposed by the holiday season and a desire by some individuals not to schedule procedures at that time of year
Reductions in revenues or net income between quarters or our failure to achieve expected quarterly earnings per share has in the past and could in the future result in a decrease in the market price of our common stock.
Changes in general economic conditions may cause fluctuations in our revenues and profitability.
The cost of laser vision correction procedures is typically not reimbursed by third-party payors such as health care insurance companies or government programs. Accordingly, as we have experienced in prior fiscal periods, our operating results may vary based upon the impact of changes in the disposable income of consumers interested in laser vision correction, among other economic factors. A significant decrease in consumer disposable income in a weakening economy may result in a decrease in the number of laser vision procedures performed and a decline in our revenues and profitability. In addition, weak economic conditions may cause some of our customers to experience financial distress or declare bankruptcy, which may negatively impact our accounts receivable collection experience. Weak economic conditions may also change the risk profile or volume of business our unaffiliated finance business partner is willing to underwrite, which could adversely affect our results of operations and cash flow.
Our industry is highly correlated with consumer confidence.
Following the events of September 11, 2001, we experienced a marked drop-off in business. Similarly, with the spike in oil prices in 2005, we also saw deterioration in volume, especially from patients at the lower-income levels. Deteriorating consumer confidence can negatively impact our financial performance.
We derive all of our revenue from laser vision correction services and a decrease in the provision of these services could result in a significant decrease in our revenues and profitability.
We derive substantially all of our revenues from laser vision correction services. If we are not able to provide those services or the number of laser vision correction procedures we perform significantly decreases, our revenues and profitability would decrease materially. We do not have other diversified revenue sources to offset a significant decrease in revenues from our provision of laser vision correction services.
If we are unable to attract and retain qualified independent ophthalmologists, our ability to open new vision centers, to maintain operations at existing vision centers, or to attract patients could be negatively affected.
Our revenues are generated by independent ophthalmologists who work with us to perform surgeries. In certain states where the corporate practice of medicine is prohibited, we may contract with professional corporations for ophthalmologists to perform surgeries at our vision centers. The hiring of independent qualified ophthalmologists is a critical factor in our ability to successfully launch a new vision center, and the retention of those ophthalmologists is a critical factor in the success of our existing vision centers. However, it is sometimes difficult for us to hire or retain qualified ophthalmologists. If we are unable to consistently attract, hire and retain qualified ophthalmologists, our ability to open new vision centers, to maintain operations at existing vision centers, or to attract patients could be negatively affected.
If technological changes occur which render our equipment or services obsolete, or increase our cost structure, we may need to make significant capital expenditures or modify our business model, which could cause our revenues or profitability to decline.
As a result of industry, competitive or clinical factors, among others, we may be required to introduce alternate ophthalmic laser technology or other surgical or non-surgical methods for correcting refractive vision disorders than those that we currently use in our laser vision correction centers. Such alternative technologies could include a technology in which a laser is used to cut a corneal flap instead of a microkeratome, various intraocular lens technologies, or an increased penetration in the percent of custom wavefront treatments we perform, among others. Introducing such technology or such changes could require significant capital investment or force us to modify our business model in such a way as to make our revenues or profits decline. Such changes could include higher costs to us or higher prices for our patients. An increase in costs could reduce our ability to maintain our profit margin. An increase in prices could adversely affect our ability to attract new patients.
If a better-financed or lower-cost provider of laser vision correction or a competing vision treatment forces us to lower our laser surgery prices in a particular geographic area, our revenues and profitability could decline.
Laser eye surgery competes with other surgical and non-surgical treatments for refractive vision disorders, including eyeglasses, contact lenses, other types of refractive surgery, corneal implants and other technologies currently under development. Among providers of laser vision correction, competition comes from firms similar to us and from hospitals, hospital-affiliated group entities, physician group practices and private ophthalmologists, among others, that, in order to offer laser vision correction to patients, purchase or rent excimer lasers. Suppliers of conventional eyeglasses and contact lenses, such as optometry chains, also may compete with us by purchasing laser systems and offering laser vision correction to their customers.
Some of our current competitors or companies that may choose to enter the industry in the future, including laser manufacturers themselves, may have substantially greater financial, technical, managerial, marketing or other resources and experience than we do and compete more effectively. Competition in the market for laser vision correction could increase as excimer laser surgery becomes more common and the number of ophthalmologists performing the procedure increases. Similarly, competition could increase if the market for laser vision correction does not experience growth, and existing providers compete for market share. TLC Vision Corporation recently launched a new business model focusing on the value segment of the industry. Additional competition may develop, particularly as the price to purchase or rent excimer laser systems decreases. Our management, operations, strategy and marketing plans may not be successful in meeting this competition.
If more competitors offer laser vision correction or other competitive types of vision treatments in a given geographic market, we might find it necessary to reduce the prices we charge, particularly if competitors offer the procedures at lower prices than we do. If that were to happen or we were not successful in cost effectively acquiring new patients for our procedures, we may not be able to make up for the reduced profit margin by increasing the number of procedures we perform, and our revenues and profitability could decrease, as we have experienced in prior fiscal periods.
Our business has been adversely affected in the past by deeply-discounted pricing by some competitors, and it is possible that such competitive practices may adversely affect our business in the future.
In the past, certain competitors have utilized deeply-discounted pricing in an effort to generate procedure volume. This practice has caused periods of intense price competition in our industry. As a result, we have lowered our prices in the past in order to remain competitive. We currently face competitors offering discounted prices, including several large chains of laser vision correction centers, in some geographic markets where we conduct business. It is possible that, in the future, our revenues and profitability could decrease as a result of the discounting practices of competitors.
We have expanded the role and mix of financing as a percentage of our revenues. As a result, our direct financing program has grown, increasing our credit risk.
A significant percentage of our patients finance some or all of the cost of their procedure. We provide certain of our patients, including patients who could not otherwise obtain third-party financing, with the ability to pay for our procedures with direct
financing. The terms of our direct financing typically require the customer to pay a set fee up-front, with the remaining balance paid by the customer in up to 36 monthly installments. As of December 31, 2006, we had $17,176,000 in accounts receivable, compared to $14,797,000 as of December 31, 2005. We are now exposed to significantly increased credit risk, particularly given that patients who participate in our direct financing program generally have not been deemed creditworthy by third-party financing companies with more experience in credit issues than we have. If the uncollectible amounts exceed the amounts we have reserved, we could be required to write down our accounts receivable, and our cash flow and results of operations would be adversely affected.
If laser vision correction does not gain broader market acceptance, our profitability and growth will be severely limited.
We derive all of our revenues from laser vision correction. As a result, we believe that our profitability and expansion depend to a large extent on the acceptance of laser vision correction as a safe and effective treatment. There can be no assurance that laser vision correction will be accepted more widely by ophthalmologists, optometrists or the general population as an alternative to existing or future methods of treating refractive vision disorders. The industry has been relatively flat to slightly down since 2005.
Wider acceptance of laser vision correction may be affected adversely by:
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Concerns about the safety and effectiveness of laser vision correction procedures, including procedures using new technologies
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General resistance to surgery of any type, and eye surgery in particular
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Cost, particularly since laser vision correction is not typically covered by government or private insurers
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The effectiveness of alternate methods of correcting refractive vision disorders, including but not limited to various intraocular lens technologies
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Possible unknown side effects not yet revealed by long-term follow-up data
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Regulatory developments
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Reported adverse events or other unfavorable publicity involving patient outcomes from laser vision correction
Concerns about potential side effects and long-term results may negatively impact market acceptance of laser vision correction, result in potential liability for us and prevent us from growing our business.
Concerns have been raised with respect to the predictability and stability of results and potential complications or side effects of laser vision correction. Laser vision correction has been provided in the U.S. only since 1995. Any long-term complications or side effects of laser vision correction may call into question its safety and effectiveness, which in turn may negatively affect market acceptance of laser vision correction. Complications or side effects of laser vision correction could lead to professional liability, malpractice, product liability or other claims against us. Several significant verdicts have been awarded against non-affiliated refractive surgeons in the past few years. Consequences of proceedings could include increased liability to us in connection with malpractice litigation, increased difficulty in hiring and retaining qualified independent ophthalmologists who may be wary of the increased liability of laser eye surgery, and decreased operational and financial yield from pre-operative examinations, among other effects that will be adverse to our results of operations and profitability.
Some of the possible side effects of laser vision correction may include:
•
Foreign body sensation
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Sensitivity to bright lights
•
Poor or reduced visual quality
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Overcorrection or under correction
•
Decreased corneal integrity
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Corneal flap or corneal healing complications
•
Loss of best corrected visual acuity
•
Inflammation or infection
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Need for corrective lenses or reading glasses post-operatively
•
Need for further treatment
Laser vision correction may also involve the removal of “Bowman’s membrane,’’ an intermediate layer between the outer corneal layer and the middle corneal layer of the eye. The effect of the removal of Bowman’s membrane on patients is currently not clear.
We depend on limited sources for the excimer lasers, diagnostic equipment, microkeratomes and disposable blades we use and for the third-party financing made available to our patients, and shortages of these items or services could hinder our ability to increase our procedure volume.
We currently use three suppliers - Bausch & Lomb, Advanced Medical Optics and Alcon - for our excimer lasers. If any or all three of these companies become unwilling or unable to supply us with excimer lasers and diagnostic equipment to repair or replace parts or to provide services, our ability to open new vision centers or increase our capacity to perform laser vision correction services at existing vision centers could be restricted.
We currently rely primarily on Bausch & Lomb to provide us with microkeratomes, the devices used to create the corneal flap in the LASIK procedure, as well as with microkeratome blades and other disposable items required for LASIK. There are a limited number of manufacturers of microkeratomes and microkeratome blades, and, if alternate or additional suppliers were needed, there can be no assurance that microkeratomes and microkeratome blades would be available in the quantities or within the time frames we require. Any shortages in our supplies of this equipment could limit our ability to maintain or increase the volume of procedures that we perform, which could result in a decrease in our revenues and profitability.
We currently rely exclusively on one unaffiliated finance company for third-party financing made available to our patients. As the percentage of our patients who choose to obtain financing from such unaffiliated finance company grows, so too does our reliance on such finance company. There can be no assurance that financing services will be available in such structure or at such interest rates or costs as we or our patients may require. Any shortage in this area could limit our ability to maintain or increase the volume of procedures that we perform, which could result in a decrease in our revenues and profitability.
Our business may be impaired due to government regulations which could restrict our equipment, services and relationships with ophthalmologists, optometrists and other healthcare providers.
As described under “Government Regulation” and below, we, excimer laser manufacturers and our other business partners, including managed care companies and third-party patient financing companies, among others, are subject to extensive federal, state and foreign laws, rules and regulations, including all or some of the following:
•
Federal restrictions on the approval, distribution and use of medical devices
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Anti-kickback statutes in some states
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Fee-splitting laws in some states
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Corporate practice of medicine restrictions in some states
•
Physician self-referral laws in some states
•
Anti-fraud provisions in some states
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Facility license requirements and certificates of need in some states
•
Conflict of interest regulations in some states
•
Rules and regulations regarding advertising and marketing practices in some states
Some of these laws and regulations are vague or ambiguous, and courts and regulatory authorities have not always provided clarification. Moreover, state and local laws, including but not limited to those on sales and use taxes, vary from jurisdiction to jurisdiction. As a result, some of our activities could be challenged, the success of which cannot be predicted.
The failure of our suppliers to obtain regulatory approvals for any additional uses of excimer lasers or otherwise comply with regulatory requirements could limit the number of excimer lasers we have available for use and, therefore, limit the number of procedures we can perform.
Failure of the laser manufacturers to comply with applicable FDA requirements could subject us, the independent ophthalmologists who practice in our vision centers or those manufacturers to enforcement actions, including product seizure, recalls, withdrawal of approvals and civil and criminal penalties. Further, failure to comply with regulatory requirements, or any adverse regulatory action, could result in limitations or prohibitions on our use of excimer lasers. Any such actions or proceedings could result in negative publicity, which in turn could result in decreased demand for our services and in a decrease in our capacity to perform laser vision correction services.
Our business is heavily dependent on advertising, which is subject to regulation by the Federal Trade Commission. We are subject to a 2003 FTC Consent Order in which we agreed, among other things, that we would not represent in our advertising that our LASIK surgery services eliminate the need for glasses and contacts for life, pose significantly less risk to patients’ eye health than wearing glasses or contacts, or eliminate the risk of glare and haloing, unless, at the time made, we possess and rely upon competent and reliable scientific evidence that substantiates the representation. We cannot be certain that this order to which we agreed, or any future action by the Federal Trade Commission, will not restrict our laser vision correction services, or otherwise result in negative publicity and damage our reputation.
We are subject to lawsuits for patient injuries, which could subject us to significant judgments and damage our reputation.
The laser vision correction procedures performed in our vision centers involve the risk of injury to patients. Such risk could result in professional liability, malpractice, product liability, or other claims brought against us or our independent ophthalmologists and optometrists based upon injuries or alleged injuries associated with a defect in a product’s performance or malpractice by an ophthalmologist, optometrist, technician or other health care professional. Some injuries or defects may not become evident for a number of years. The operation of any excimer laser, diagnostic equipment, microkeratome or other equipment may result in substantial claims against us by patients who allege they were injured as a result of vision correction procedures. Significant lawsuits against us could subject us to significant judgments and damage our reputation. In addition, a partially or completely uninsured claim against us could have a material adverse effect on our business, financial condition and results of operations. We primarily rely and intend to continue to primarily rely on the independent ophthalmologists’ professional liability insurance policies and manufacturers’ insurance policies for product liability coverage, although we have limited umbrella product and professional liability insurance. We generally require the independent ophthalmologists who use our vision centers to maintain certain levels of professional liability insurance, although there can be no guarantee that the ophthalmologists will be successful in obtaining or maintaining such insurance coverage, particularly in the current insurance market.
The availability of professional liability insurance has decreased and its cost has increased significantly for a variety of reasons, including reasons outside our control, particularly in certain states. A future increase in cost could result in the reduced profitability of our business, and a future lack of availability of coverage for us or our independent ophthalmologists and optometrists could result in increased exposure to liability and potentially limit our ability to expand in certain markets.
We established a captive insurance company, and if significant claims are paid, it could affect our profitability and our financial condition.
Effective as of December 18, 2002, we established a captive insurance company to provide professional liability insurance coverage for claims brought against us after December 17, 2002. In addition, our captive insurance company’s charter allows it to provide professional liability insurance for our doctors, some of whom are currently insured by the captive. Our captive insurance company is managed by an independent insurance consulting and management firm and is capitalized and funded by us based on actuarial studies performed by an affiliate of the consulting and management firm. Beginning December 18, 2003, the Company elected to use the captive insurance company for both the primary insurance and the excess liability coverage. A number of claims are now pending with our captive insurance company. The payment of significant claims by our captive insurance company could negatively affect our profitability and our financial condition.
Disputes with respect to intellectual property could result in a decrease in revenues and profitability.
Not all of the names we use for our products and services have been registered with the United States Patent and Trademark Office. Some of our internal processes and systems do not have intellectual property protection. If a competitor were to attempt to use our names, processes or systems, we may not be able to prevent such use. The unauthorized use of our name could cause confusion among our customers, and the misappropriation of internal processes or systems could reduce our competitive advantages, either of which could negatively affect our profitability or financial condition.
Our business is very reliant upon direct-to-consumer marketing.
The effectiveness of our marketing programs and messages to consumers can have a significant impact on our financial performance. During the third quarter of 2006, the effectiveness was less than previous quarters, resulting in an increased cost of marketing per procedure, a decline in our revenue and earnings growth, and an erosion in our margins. Less effective marketing programs could negatively affect our profitability or financial condition.
Recent changes in management and dependence on a small number of senior managers.
Our success depends, to a significant extent, upon the efforts and abilities of a small number of senior executives. On November 2, 2006, Steven Straus became our Chief Executive Officer. Stephen Joffe, the previous Chief Executive Officer, stepped down effective March 1, 2006. On March 3, 2006, Stephen Joffe disclosed in a public filing that he and a non-profit foundation with which he is affiliated purchased a significant interest in TLC Vision Corporation, a competitor of ours. Effective October 6, 2006, Kevin Hassey resigned as President. These recent changes could cause further management instability, which could have a material adverse effect on our business.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
Our corporate headquarters and one of our laser vision correction centers are located in a 32,547 sq. ft. office building that we own in Cincinnati, Ohio. Our other laser vision correction centers are in leased locations. The typical location is in a professional office building or retail site and includes a laser surgery room, private examination rooms and patient waiting areas. The leased space ranges in size from approximately 2,646 to 6,931 square feet with lease expiration dates ranging from June 30, 2007 to February 28, 2016.
Item 3.
Item 3. Legal Proceedings.
Our business results in a number of medical malpractice lawsuits. Claims reported to us prior to December 18, 2002 were generally covered by external insurance policies and to date have not had a material financial impact on our business other than the cost of insurance and our deductibles under those policies. Due to substantial increases in insurance premiums, effective as of December 18, 2002, we established a captive insurance company to provide coverage for claims brought against us after December 17, 2002. Our captive insurance company is managed by an independent insurance consulting and management firm and is capitalized by us based on actuarial studies performed by an affiliate of the consulting and management firm.
Since December 18, 2003, the Company has used the captive insurance company for both primary insurance and excess liability coverage. A number of claims are now pending with our captive insurance company. Over the first four years of operation, the losses paid by the captive insurance company have not been material.
In addition, we are periodically subject to various claims and lawsuits. We believe that none of the legal proceedings to which we are currently subject will have a material adverse effect on our business, financial position or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is traded on the Nasdaq Global Select Market under the symbol “LCAV.” There were approximately 20,000 beneficial owners of our Common Stock as of February 20, 2007.
The following table sets forth the range of high and low sales prices of the common stock as reported on the Nasdaq Global Select Market for the specific periods.
The Company initiated a quarterly cash dividend in the third quarter of 2004 which it has paid since that time. While the Company intends to pay regular quarterly dividends for the foreseeable future, each dividend is reviewed quarterly and requires declaration by the Board of Directors. The following table sets forth the quarterly cash dividends paid for 2006 and 2005.
The Company has not sold any unregistered securities within the past three years.
The following table provides information regarding the Company’s purchase of its common stock during the quarter ended December 31, 2006.
On May 17, 2005, the Board of Directors authorized the Company to repurchase up to one million shares of its common stock. This repurchase program was completed in November 2006. On November 22, 2006, the Company announced that the Board of Directors authorized a new share repurchase plan under which the Company is authorized to purchase up to $50 million of its common stock. Through December 31, 2006, the Company had repurchased 442,400 shares of its common stock under this second program at an average price of $35.06 per share for a total cost of approximately $15.5 million.
Item 6.
Item 6. Selected Financial Data.
The data set forth below should be read in conjunction with the Consolidated Financial Statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis in conjunction with ''Item 6. Selected Financial Data’’ above and with the financial statements and related notes included in “Item 8. Financial Statements and Supplemental Data” of this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed here. Factors that could contribute to such differences include, but are not limited to, those discussed in “Item 1A. Risk Factors.”
Overview
We are a leading developer and operator of fixed-site laser vision correction centers at our LasikPlus vision centers. Our vision centers provide the staff, facilities, equipment and support services for performing laser vision correction that employ advanced laser technologies to help correct nearsightedness, farsightedness and astigmatism. We currently use fixed-site excimer lasers manufactured by Bausch & Lomb, Advanced Medical Optics and Alcon. Our vision centers are supported mainly by independent, board-certified ophthalmologists and credentialed optometrists, as well as other health care professionals. The ophthalmologists perform the laser vision correction procedures in our vision centers, and either ophthalmologists or optometrists conduct pre-procedure evaluations and post-procedure follow-ups in our vision centers.
The majority of our revenues currently are derived from LASIK laser vision correction procedures performed in our U.S. vision centers.
Our operating costs and expenses include:
•
Medical professional and license fees, including per procedure fees for the ophthalmologists performing laser vision correction and the license fees per procedure paid to equipment suppliers Advanced Medical Optics, Bausch & Lomb and Alcon
•
Direct costs of services, including vision center rent and utilities, equipment lease and maintenance costs, surgical supplies, center staff expense, financing charges and costs related to other revenues
•
General and administrative costs, including headquarters staff expense and other overhead costs
•
Marketing and advertising costs
•
Depreciation of equipment
Results of Operations
Revenues
We derived all of our revenues for the last three years from the delivery of laser vision correction services performed in our U.S. vision centers. Our revenues are primarily a function of the number of laser vision correction procedures performed and the pricing for these services. Our vision centers have a relatively high degree of operating leverage due to the fact that many of our costs are fixed in nature. As a result, our level of procedure volume can have a significant impact on our level of profitability.
Our revenues are impacted by a number of factors, including the following:
•
Our ability to generate customers through our arrangements with managed care companies, direct to consumer advertising and word of mouth referrals
•
Our mix of procedures among the different types of laser technology
•
New vision center openings and our ability to increase procedure volume at existing vision centers
•
The availability of patient financing
•
General economic conditions and consumer confidence levels
•
The continued growth and increased acceptance of laser vision correction
•
The effect of competition and discounting practices in our industry
Certain states prohibit us from practicing medicine, employing ophthalmologists to practice medicine on our behalf or employing optometrists to render optometry services on our behalf. In those states, we may contract with professional corporations to provide these services.
We currently own a non-controlling interest in Lasik M.D. Toronto. Prior to the third quarter of 2005, financial results for our Canadian joint venture were consolidated into our financial statements. During the third quarter of 2005, we transferred financial and operational control of the joint venture to our partners in Toronto. Therefore, effective July 1, 2005, we began to account for the results of the Canadian venture using the equity method.
The following table details the number of laser vision correction procedures performed at our consolidated vision centers during the last three fiscal years.
In 2006, revenues increased by $64,530,000, or 33.5%, to $256,927,000 from $192,397,000 in 2005. Approximately $58,624,000 of this increase in revenues in 2006 was a result of higher procedure volumes and approximately $5,906,000 was a result of improved pricing. For vision centers open at least 12 months, revenues increased by 17.7% in 2006 compared to 2005. Procedure volume of 185,268 increased 30.5% from 142,000 in 2005. Revenue per procedure of $1,387 increased about 2% from $1,355 in 2005. Increased marketing expenditures coupled with new centers drove market share increases in 2006.
In 2005, revenues increased by $65,235,000 or 51.3%, to $192,397,000 from $127,122,000 in 2004. Approximately $61,237,000 of this increase in revenues in 2005 was a result of higher procedure volumes and approximately $4,038,000 was a result of improved pricing. Continued improvement in marketing and advertising effectiveness and continued growth and increased patient acceptance of laser vision correction, together with third-party financing and our own patient financing plan, among other factors, helped to grow procedure volume in 2005 over 2004.
Our strongest quarter in terms of number of procedures performed historically has been the first quarter of the year. We believe this is related to a number of factors, including the availability of funds under typical employer medical flexible spending programs and the general effect of the New Year season. The historic seasonality of our business was in part offset in 2005 by opening vision centers throughout the year.
Operating Costs and Expenses
2006 Compared to 2005
The following table shows the increase in components of operating expenses from 2005 to 2006 in dollars and as a percent of revenues for each period (dollars in thousands):
Medical professional expenses increased by approximately $5,869,000, or 27%, in 2006 from 2005 as a result of increased revenues from higher procedure volumes. License fees increased by $3,834,000, or 18%, primarily as a result of higher procedure volume.
Direct costs of services include the salary component of physician compensation for certain physicians employed by us, staffing, equipment, medical supplies, finance charges and facility costs of operating laser vision correction centers. These direct costs increased in 2006 by $22,660,000, or 41%, compared to 2005. Of this amount, $19,669,000 was primarily a result of increased salaries, fringe benefits, rent and utilities, financing fees, insurance, laser rent and surgical supplies in connection with an increase in the number of vision centers and our higher procedure volumes. The recording of stock-based compensation expense (SFAS 123(R)) resulted in expense of $2,991,000 in 2006.
General and administrative expenses increased by $7,135,000, or 51%, in 2006 as compared to 2005. Of this amount, $4,461,000 was primarily due to increase in salaries, fringe benefits, contractual professional services and director fees. The recording of stock-based compensation expense (SFAS 123(R)) resulted in $2,674,000 expense in 2006.
Marketing and advertising expenses increased by $16,158,000, or 51%, in 2006 from 2005, primarily as a result of our efforts to support new markets and existing markets. The marketing and advertising expense increased more than the increase in revenue in 2006. The company is adjusting its marketing strategies with the goal of improving the marketing effectiveness.
Depreciation expense increased by $817,000 in 2006 from 2005, primarily as a result of depreciation of capitalized expenditures at new vision centers in 2006.
Net investment income increased by $2,253,000, or 57%, in 2006 from 2005, due to income on patient financing, higher levels of investments and higher interest rates.
2005 Compared to 2004
The following table shows the increase in components of operating expenses from 2004 to 2005 in dollars and as a percent of revenues for each period (dollars in thousands):
Medical professional expenses increased by approximately $6,700,000 in 2005 from 2004 as a result of increased revenues from higher procedure volumes. License fees increased by $4,076,000, primarily as a result of higher procedure volume.
Direct costs of services include the salary component of physician compensation for certain physicians employed by us, staffing, equipment, medical supplies, finance charges and facility costs of operating laser vision correction centers. These direct costs increased in 2005 by $14,110,000 compared to 2004. This increase was largely due to salaries and benefits, financing fees related to third-party patient financing, surgical supplies, laser rent and maintenance contracts, and rent and utilities.
General and administrative expenses increased by $3,729,000 in 2005 as compared to 2004, primarily as a result of increased salaries and benefits, professional services, telecommunications and travel.
Marketing and advertising expenses increased by $11,345,000 in 2005 from 2004, primarily as a result of our efforts to support new markets and help to grow volume in existing markets.
Depreciation expense increased by $591,000 in 2005 from 2004, primarily as a result of opening 10 new vision centers in 2005.
Interest and dividend income increased by $1,872,000 in 2005 from 2004, due to income on long-term receivables, higher levels of invested cash and higher interest rates.
Income Taxes
The following table summarizes the components of income tax provision for 2006, 2005 and 2004 (in thousands of dollars):
See Note 4 to the consolidated financial statements for further details regarding income taxes.
Liquidity and Capital Resources
Cash and cash equivalents and short-term investments totaled $98,052,000 as of December 31, 2006, down from $110,531,000 at December 31, 2005. Net cash provided by operating activities in 2006 was $53,532,000. Proceeds from the exercise of stock options totaled $5,528,000. Net investment in securities was made in the amount of $70,930,000. Repurchase of shares for treasury stock amounted to $51,816,000.
During the second quarter of 2006, the Company, with guidance from the Board of Directors, adopted a new investment policy for the company’s liquid assets. The objectives of the policy are to maintain adequate liquidity, to provide safety of principal, to
maximize the after-tax rate of return, and to maintain a well-diversified portfolio. This policy places limitations on maturity, acceptable credit ratings, authorized securities, and credit concentration.
Our contractual obligations for future cash payments as of December 31, 2006 are summarized in the following table.
As of December 31, 2006 and 2005, we had net operating loss carryforwards for federal income tax purposes of $1,954,000 and $5,200,000, respectively. These expire in varying amounts from 2017 until 2022.
Our costs associated with the opening of a new vision center generally consist of capital expenditures such as the purchase or lease of lasers, diagnostic equipment, office equipment and leasehold improvements. In addition, we typically incur other startup expenses and pre-opening advertising expenses. Generally, we estimate the costs associated with opening a new vision center to be between $1,200,000 and $1,500,000. Actual costs vary from vision center to vision center based upon the location of the market, the number of lasers purchased or leased for the vision center, the site of the vision center, the cost of grand opening marketing and the level of leasehold improvements required. Our capital expenditures consist primarily of investments incurred in connection with the opening of new vision centers and equipment purchases or upgrades at existing facilities.
The following is a list of the new vision centers we opened in the last two fiscal years:
Paramus, NJ
Sacramento, CA
Grand Rapids, MI
Norfolk, VA
Seattle, WA
Hartford, CT
Sugar Land, TX
Milwaukee, WI
Denver, CO
Phoenix, AZ
New Haven, CT
Austin, TX
Dallas, TX
Portland, OR
Oakdale, MN
Pittsburgh, PA
Lexington, KY
Albuquerque, NM
Lincoln Park, IL
Birmingham, AL
Laser and equipment upgrades and vision center expansions resulted in capital expenditures of $9,656,000 in 2006 and $10,748,000 in 2005, which were funded by cash flow from operations in both years.
We continue to offer our own sponsored patient financing. As of December 31, 2006, we had $14,300,000 in accounts receivable, net of allowance for doubtful accounts, which is an increase of $2,700,000, or 23.0%, since December 31, 2005, compared to growth in revenue of 33.5%.
Other assets include $500,000 of cash maintained by our consolidated captive insurance company pursuant to statutory requirements as of December 31, 2006. These funds are not available for general corporate purposes.
We believe that cash flow from operations, available cash and short-term investments provide sufficient cash reserves and liquidity to fund our working capital needs, capital expenditures and capital lease obligations.
Critical Accounting Estimates
Accounts Receivable
We provide patient financing to some of our customers, including those who could not otherwise obtain third-party financing. The terms of the financing require the patient to pay an up-front fee and the remainder is deducted over a period of 12 to 36 months. Accounts receivable for patients that we finance for a period of 12 months or less are recorded at the undiscounted total expected payments less an estimated allowance for doubtful accounts. For patients we finance with an initial term over 12 months, we record the present value of expected payments. The discount rate assumption is based upon current market rates charged by other providers of unsecured credit to similar customers. Interest income is recorded over the term of the payment program. As of December 31, 2006, the discount in receivables with an initial term over 12 months was $117,000.
Allowance for Doubtful Accounts
As a result of an expansion of the amount of patient financing provided in 2006, we are exposed to more credit risk than we have experienced in the past. Based upon our own experience with patient financing and based upon the credit experience of lenders that provide financing to customers similar to ours, we have established allowance for doubtful accounts as of December 31, 2006 of $2,842,000 against accounts receivable of $17,176,000, compared to an allowance of $3,145,000 against accounts receivable of $14,797,000 at December 31, 2005. Our policy is to reserve for all receivables that remain open past financial maturity date and to provide reserves for receivables prior to the maturity date to bring receivables net of reserves down to the estimated net realizable value based on historical collectibility rates. To the extent that our actual allowance for doubtful account writeoffs are greater than our estimated bad debt reserve, it would adversely impact our results of operations and cash flows. To the extent that our actual allowance for doubtful accounts write-offs are less than our estimated bad debt reserve, it would favorably impact our results of operations and cash flows.
Captive Insurance Company Reserves
Effective December 18, 2002, we established a captive insurance company to provide professional liability insurance coverage for claims brought against us after December 17, 2002. In addition, our captive insurance company’s charter allows it to provide professional liability insurance for our doctors, some of whom are currently insured by the captive. Our captive insurance company is managed by an independent insurance consulting and management firm, and it is capitalized and funded by us based on actuarial studies performed by an affiliate of the consulting and management firm. Beginning December 18, 2003, the Company elected to use the captive insurance company for both the primary insurance and the excess liability coverage. A number of claims are now pending with our captive insurance company. The financial statements of the captive insurance company are consolidated with our financial statements since it is a wholly-owned enterprise. As of December 31, 2006, we recorded an insurance reserve amount of $6,163,000, which primarily represents an actuarially determined estimate of claims incurred but not yet reported. This represents an increase in the reserve of $2,323,000 from $3,840,000 at December 31, 2005. To the extent that our actual claim experience is greater than our estimated insurance reserve, it would adversely impact our results of operations and cash flows. To the extent that our actual claim experience is less than our estimated insurance reserve, it would favorably impact our results of operations and cash flows.
Income Taxes
At December 31, 2006 and 2005, we had approximately $1,954,000 and $5,200,000, respectively, of net operating loss carryforwards that can be used to reduce future taxable income.
The Company decreased the valuation allowance on deferred tax assets in 2004 by $16,399,000. The reversal of the valuation allowance on deferred tax assets was made because of continued profitability of the Company in 2004 and expected future profitability. We currently believe it is more likely than not that our deferred tax assets will be realized to the extent of the tax benefit recorded.
Consolidation
We use the consolidation method to report our investment in majority-owned subsidiaries and other companies that are not considered variable interest entities (VIEs) and in all VIEs for which we are considered the primary beneficiary. In addition, we consolidate the results of operations of professional corporations with which we contract to provide the services of ophthalmologists or optometrists at our vision centers in accordance with EITF 97-2, Application of FASB Statement 94 and APB Opinion No. 16 to Physician Management Entities and Certain Other Entities with Contractual Management Agreements. Investments in joint ventures and 20% to 50% owned affiliates where we have the ability to exert significant influence are accounted for by the equity method.
Recent Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), Share-Based Payment, which is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant and to be expensed over the applicable vesting period. SFAS No. 123(R) became effective for all stock-based awards granted on or after January 1, 2006. In addition, companies must recognize compensation expense related to any awards that were not fully vested as of the effective date. Compensation expense for the unvested awards is measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS No. 123. The impact of adopting SFAS 123(R) decreased net income by $4,511,000 in 2006.
In June 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes. This Interpretation is effective for fiscal years beginning after December 15, 2006 and prescribes a framework for recognizing and measuring income tax benefits for inclusion in the consolidated financial statements. This interpretation also provides guidance on derecognition, classification, interest and penalties. FIN 48 provides that an income tax benefit is recognized in the financial statements when it is more likely than not that the benefit claimed or to be claimed on an income tax return will be sustained upon examination. The amount of income tax benefit recognized is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. We adopted FIN 48 as of January 1, 2007 and are in the process of finalizing our assessment of uncertain tax positions based on current FASB guidance. We do not anticipate the cumulative effect of adopting FIN 48 will be material to our consolidate financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements since the FASB has previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. SFAS 157 becomes effective for us on January 1, 2008. We are currently in the process of determining the effect, if any, the adoption of SFAS 157 will have on the consolidated financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The carrying values of financial instruments including cash and cash equivalents, accounts receivable, and accounts payable approximate fair value because of the short maturity of these instruments.
Short-term investments are recorded at market value. Due to the short-term nature of the investment in corporate bonds and the significant portion of the investments in government bonds, there is little risk to the valuation.
We have a low exposure to changes in foreign currency exchange rates and, as such, have not used derivative financial instruments to manage foreign currency fluctuation risk.
Item 8.
Item 8. Financial Statements and Supplementary Data.
REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
We, the management of LCA-Vision Inc., are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Securities Exchange Act Rules 13a-15(f) and 15d-15(f), and for the preparation and integrity of the consolidated financial statements and the information contained in this Annual Report. We prepared the accompanying consolidated financial statements in accordance with U. S. generally accepted accounting principles. In addition to selecting appropriate accounting principles, we are responsible for the way information is presented and its reliability. To report financial results we must often make estimates based on currently available information and judgments of current conditions and circumstances.
We assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. As a result of this assessment, management believes that, as of December 31, 2006, the Company’s internal control over financial reporting is effective based on the criteria described above. No matter how well designed, all internal control systems have inherent limitations and even those systems determined to be effective provide only reasonable assurance with respect to financial statement preparation and presentation.
Our assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their attestation report which is included herein.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of LCA-Vision Inc.
We have audited the accompanying consolidated balance sheets of LCA-Vision Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ investment, and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the index at Item 15(a)(2).These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of LCA-Vision Inc. at December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As described in Note 1 to the consolidated financial statements, in 2006 the Company changed its method of accounting for stock-based compensation.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of LCA-Vision Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Cincinnati, Ohio
February 27, 2007
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of LCA-Vision Inc.
We have audited management’s assessment, included in the accompanying Report of Management on Internal Control Over Financial Reporting, that LCA-Vision Inc. maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). LCA-Vision Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that LCA-Vision Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, LCA-Vision Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of LCA-Vision Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ investment, and cash flows for each of the three years in the period ended December 31, 2006 of LCA-Vision Inc. and our report dated February 27, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Cincinnati, Ohio
February 27, 2007
LCA-VISION INC.
CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements
LCA-VISION INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See Notes to Consolidated Financial Statements
LCA-VISION INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to Consolidated Financial Statements
LCA-VISION INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ INVESTMENT
See Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description Of Business And Summary Of Significant Accounting Policies
Business
We are a leading developer and operator of fixed-site laser vision correction centers at our LasikPlus vision centers. Our vision centers provide the staff, facilities, equipment and support services for performing laser vision correction that employ advanced laser technologies to help correct nearsightedness, farsightedness and astigmatism. We currently use fixed-site excimer lasers manufactured by Bausch & Lomb, Advanced Medical Optics and Alcon. Our vision centers are supported mainly by independent board-certified ophthalmologists and credentialed optometrists as well as other health care professionals. The ophthalmologists perform the laser vision correction procedures in our vision centers, and either ophthalmologists or optometrists conduct pre-procedure evaluations and post-operative follow-ups in-center. We have performed over 740,000 laser vision correction procedures in our vision centers in the United States and Canada since 1991. Most of our patients receive a procedure called LASIK, which we began performing in the United States in 1997.
We currently own and operate 60 LasikPlus fixed-site laser vision correction centers generally located in larger metropolitan markets in the United States, and are part of a joint venture in Canada. Due to the nature of our operations and organization, we operate in only one business segment.
Consolidation and Basis of Presentation
We use the consolidation method to report our investment in majority-owned subsidiaries and other companies that are not considered variable interest entities (VIEs) and in all VIEs for which we are considered the primary beneficiary. In addition, we consolidate the results of operations of professional corporations with which we contract to provide the services of ophthalmologists or optometrists at our vision centers in accordance with EITF 97-2, Application of FASB Statement 94 and APB Opinion No. 16 to Physician Management Entities and Certain Other Entities with Contractual Management Agreements. Investments in joint ventures and 20% to 50% owned affiliates where we have the ability to exert significant influence are accounted for by the equity method. Intercompany transactions and balances have been eliminated upon consolidation.
Use of Estimates
The preparation of our consolidated financial statements in conforming with U.S. generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Significant items that are subject to such estimates and assumptions include patient financing receivables and reserves, insurance reserves, income taxes and long-lived assets. Although management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, actual results could differ significantly from the estimates under different assumptions or conditions.
Reclassification
Certain prior period amounts have been reclassified in the consolidated financial statements and accompanying notes to conform to current period presentation.
Cash and Cash Equivalents
We consider highly liquid investments with an original maturity of 90 days or less when purchased to be cash equivalents. Other assets include $500,000 of cash maintained by our consolidated captive insurance company pursuant to statutory requirements as of December 31, 2006. These funds are not available for general corporate purposes.
Short-term Investments
Management determines the appropriate classification of securities at the time of purchase and reevaluates such designation as of each balance sheet date. Currently all securities are classified as available-for-sale. Available-for-sale securities are carried at fair market value, with unrealized gains and losses, net of tax, reported in accumulated other comprehensive income. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity computed under the effective interest method. Such amortization is included in net investment income. Realized gains and losses and declines in value judged to be other-than-temporary are also included in net investment income. The cost of securities sold is based upon the specific identification method. Interest and dividends on securities classified as available-for-sale are included in net investment income.
The following table is a summary of available-for-sale securities at December 31, 2006:
The gross realized gains and losses on sales of available-for-sale securities for the twelve months ended December 31, 2006 totaled $18,000 and $7,000, respectively.
The net carrying value and estimated fair value of debt securities available for sale at December 31, 2006, by contractual maturity, is shown below. Expected maturities may differ from contractual maturities because the issuers of the securities may have the right or obligation to prepay obligations without prepayment penalties.
All securities are classified as short-term investments since the Company intends that such investments are available for operating purposes.
Accounts Receivable
Accounts receivable are comprised primarily of amounts owed to the Company from patients and from professional corporations. Accounts receivables are presented net of allowances for doubtful accounts of $2,842,000 and $3,145,000 at December 31, 2006 and 2005, respectively. For patients that we finance with an initial term over 12 months, we recognize revenues based upon the present values of the expected payments. Finance charges on patient receivables were $1,094,000 in 2006, $857,000 in 2005 and $860,000 in 2004. These amounts are included in Net Investment Income on the Consolidated Statements of Operation. At December 31, 2006 and 2005, the discount in receivables with an initial term over 12 months was $117,000 and $284,000, respectively.
Allowance for Doubtful Accounts
We provide patient financing to some of our customers, including those who could not otherwise obtain third-party financing. The terms of the financing require the patient to pay an up-front fee which is intended to cover some or all of our variable costs, and the remainder is generally deducted automatically from the patient’s checking account over a period of 12 to 36 months. We began our patient financing program in May 2002. We have recorded an allowance for doubtful accounts as a best estimate of the amount of probable credit losses from our patient financing program. Each month, we review the allowance and adjust the allowance based upon our own experience with patient financing and the credit experience of other centers that provide financing to customers similar to ours. Receivables are charged off against the allowance for doubtful accounts when it is probable a receivable will not be recovered.
Property and Equipment, and Depreciation and Amortization
Property and Equipment
We record our property and equipment at its original cost, net of accumulated depreciation. At the time property or equipment is retired, sold, or otherwise disposed of, the related cost and accumulated depreciation or amortization are deducted from the amounts reported in the Consolidated Balance Sheets and any gains or losses on disposition are recognized in the Consolidated Statements of Operations. We expense repair and maintenance costs as incurred. Assets recorded under capitalized leases are amortized to expense which is included in the Depreciation and Amortization expense.
Depreciation and Amortization
We compute depreciation using the straight-line method which recognizes the cost of the asset over its estimated useful life. We use the following estimated useful lives for computing the annual depreciation expense: building and building improvements, 5 to 39 years; furniture and fixtures, 3 to 7 years; medical equipment, 3 to 5 years; other equipment, 3 to 5 years. Amortization of leasehold improvements is recorded in the Consolidated Statements of Operations using the straight-line method based on the lesser of the useful life of the improvement or the lease term, which is typically five years or less.
We assess the impairment of property and equipment whenever events or circumstances indicate that the carrying value might not be recoverable. Recorded values of property and equipment that are not expected to be recovered through undiscounted future net cash flows are written down to fair value, which is generally determined from estimated discounted cash flows for assets held for use.
Deferred Compensation Plan Assets
The deferred compensation plan assets are invested in a variety of mutual funds including a money market fund, a bond fund and several equity funds. Assets are reported at fair market value.
Financial Instruments
Concentration of Credit Risk
Financial instruments that subject us to concentrations of credit risk consist primarily of temporary cash investments and short-term investments. Our policy is to place our temporary cash investments in short-term investment-grade, interest-bearing corporate securities or obligations of, or guaranteed by, the US government or state and municipal related entities. Our short-term investment portfolio is comprised of investment-grade securities, obligations of the US government and obligations of various states and municipalities.
Fair Values of Financial Instruments
The cost basis of our cash and cash equivalents, trade receivables with an initial term within 12 months and accounts payable approximate their fair values due to their short term maturities. For trade receivables with an initial term in excess of 12 months, we record the present value of the expected payments discounted at a rate of 17.5 percent per year. The fair values of available-for-sale securities are based on quoted market prices.
Accrued Enhancement Expense
We offer our patients the option to purchase a one-year or lifetime acuity plan which will cover the cost of post-surgical enhancements should the patient not achieve the desired visual correction during the initial procedure. We record an enhancement accrual based on our best estimate of the number and associated cost of procedures to be performed. Each month, we review the enhancement accrual and consider factors such as procedure costs and historical procedure volume when determining the appropriateness of the recorded balance.
Captive Insurance Company Reserves
Effective December 18, 2002, we established a captive insurance company to provide professional liability insurance coverage for claims brought against us after December 17, 2002. In addition, our captive insurance company’s charter allows it to provide professional liability insurance for our doctors, some of whom are currently insured by the captive. Our captive insurance company is managed by an independent insurance consulting and management firm, and it is capitalized and funded by us based on actuarial studies performed by an affiliate of the consulting and management firm. Beginning December 18, 2003, the Company elected to use the captive insurance company for both the primary insurance and the excess liability coverage. A number of claims are now pending with our captive insurance company. The financial statements of the captive insurance company are consolidated with our financial statements since it is a wholly-owned enterprise. As of December 31, 2006 and 2005, we recorded an insurance reserve amount of $6,163,000 and $3,840,000, respectively, which primarily represents an actuarially determined estimate of claims incurred but not yet reported.
Income Taxes
We are subject to income taxes in the United States and Canada. Significant judgment is required in determining our provision for income taxes and the related assets and liabilities. Income taxes are accounted for under FASB Statement No. 109 (FAS 109), Accounting for Income Taxes. The provision for income taxes includes income taxes paid, currently payable or receivable, and those deferred. Under FAS 109, deferred tax assets and liabilities are determined based on the temporary differences between amounts reported for financial reporting and tax basis of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Deferred tax assets are also recognized for the estimated future effects of tax loss carryforwards. The effect on deferred taxes of changes in tax rates is recognized in the period in which the enactment date changes. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts expected to be realized.
In the ordinary course of business, there are transactions and calculations where the ultimate tax determination is uncertain. We are periodically under audit by tax authorities. Accruals for tax contingencies are provided for in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies. The Financial Accounting Standards Board (FASB) has recently issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes. This Interpretation is effective for fiscal years beginning after December 15, 2006 and prescribes a framework for recognizing and measuring income tax benefits for inclusion in the consolidated financial statements. FIN 48 also provides guidance on derecognition, classification, interest and penalties. FIN 48 provides that an income tax benefit is recognized in the financial statements when it is more likely than not that the benefit claimed or to be claimed on an income tax return will be sustained upon examination. The amount of income tax benefit recognized is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement.
We adopted FIN 48 as of January 1, 2007 and are in the process of finalizing our assessment of uncertain tax positions based on current FASB guidance. We do not anticipate the cumulative effect of adopting FIN 48 will be material to our financial statements.
Per Share Data
Basic per share data is income applicable to common shares divided by the weighted average common shares outstanding. Diluted per share data is income applicable to common shares divided by the weighted average common shares outstanding plus shares issuable upon the vesting of outstanding restricted stock units and the exercise of in-the-money stock options.
The total number of unexercised options and outstanding restricted stock units as of December 31 was:
Following is a reconciliation of basic and diluted earnings per share for the twelve-month periods ended December 31, 2006, 2005 and 2004 (dollars in thousands, except per share data).
Revenue Recognition
We recognize revenues as services are performed and pervasive evidence of an arrangement for payment exists. Additionally, revenue is recognized when the price is fixed and determinable and collectibility is reasonably assured.
Marketing and Advertising Expenditures
Marketing and advertising costs are expensed as incurred, except for the costs associated with direct mail. Direct mail costs include printing mailers for future use, purchasing mailing lists of potential customers and postage cost. The printing and postage costs are expensed as the items are mailed. The mailing lists are amortized over a twelve-month period consistent with their use. Prepaid advertising expense (principally direct mail cost) was $3,702,000 at December 31, 2006 and $1,897,000 at December 31, 2005.
Stock-Based Compensation
Effective January 1, 2006, on a modified prospective basis, the Company began using the fair value method under SFAS No. 123(R), Share Based Payment, to recognize equity compensation expense in our results of operations. Prior to January 1, 2006, the Company accounted for stock options using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (Opinion 25), Accounting for Stock Issued to Employees. SFAS 123(R) requires the cost of all stock-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values at grant date, or the date of later modification, over the requisite service period. In addition, SFAS 123(R) requires unrecognized cost (based on the amounts previously disclosed in our pro forma footnote disclosure) related to options vesting after the date of initial adoption to be recognized in the financial statements over the remaining requisite service period.
Under the modified prospective approach, the amount of compensation cost recognized includes: (i) compensation cost for all share-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimate in accordance with the provisions of SFAS 123(R) and (ii) compensation cost for all stock-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimate in accordance with the provisions of SFAS 123(R). We recognize the cost of stock-based awards on a straight-line basis over the requisite service period. The stock-based compensation expense recognized due to the adoption of SFAS 123(R) for 2006 was $5,665,000 with associated tax benefits of $1,154,000 respectively. The amount of stock-based compensation capitalized was not material to our consolidated financial statements. Results for prior periods were not restated.
SFAS 123(R) requires the cash flows resulting from income tax deductions in excess of compensation costs to be classified as financing cash flows. This requirement resulted in reduced net operating cash flows and increased net financing cash flows of $5,409,000 for 2006. Prior to the adoption of SFAS 123(R), we presented all income tax benefits from deductions resulting from stock-based compensation costs as operating cash flows in the Consolidated Statements of Cash Flows.
Prior to the adoption of SFAS 123(R), the Company granted primarily stock options to employees. Since the adoption of SFAS 123(R), the Company has not granted any stock options, but instead has issued restricted stock units. Restricted stock unit awards to executive officers have performance conditions and cliff vesting. Restricted stock units awarded to other employees and non-employee directors to date do not have performance conditions and vest over specified time periods subject to continued employment or service.
As a result of adopting SFAS 123(R) on January 1, 2006, and our resulting decision to begin issuing restricted shares after January 1, 2006, the Company’s income before income taxes and net income for 2006 are lower than if we had continued to account for share-based compensation under Opinion 25 in the following amounts (in thousands of dollars except per share amounts):
Because we adopted SFAS 123(R) using the modified prospective approach, the prior years have not been restated. The following table sets forth the effect on net income and basic and diluted earnings per share as if we had applied the fair value recognition provisions for our stock-based compensation arrangements for 2005 and 2004 (dollars in thousands except per share amounts).
Other Recent Accounting Pronouncements
In September 2006, FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements since the FASB has previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. SFAS 157 becomes effective for us on January 1, 2008. We are currently in the process of determining the effect, if any, the adoption of SFAS 157 will have on the consolidated financial statements.
2. Stockholders’ Investment
We are authorized to issue up to 55 million shares of common stock with a par value of $.001 per share. On May 17, 2005, the Board of Directors authorized the Company to repurchase up to one million shares of its common stock. This repurchase was completed in November 2006. On November 22, 2006 the Company announced that the Board of Directors authorized a new share repurchase plan under which the Company is authorized to purchase up to $50,000,000 of its common stock. Through December 31, 2006, the Company had repurchased 442,400 shares of its common stock under this second program at an average price of $35.06 per share for a total cost of approximately $15,500,000.
At December 31, 2006, there were 4,993,194 shares of common stock held in treasury.
3. Investment in Unconsolidated Businesses
Our investments in unconsolidated businesses were $904,000 and $158,000 at December 31, 2006 and 2005, respectively. These balances represent our equity investments in Eyemed/LCA-Vision, LLC (50% ownership at December 31, 2006) and Lasik M.D. Toronto Inc. (40% ownership at December 31, 2006).
On July 1, 2005, we transferred financial and operational control of Lasik M.D. Toronto Inc. to our joint venture partners in Toronto, Canada. Therefore, effective July 1, 2005 we began to account for the results of Lasik M.D. Toronto Inc. using the equity method. Prior to July 1, 2005, the financial results and balance sheet of Lasik M.D. Toronto Inc. were consolidated into our financial statements. While there was no material difference in the net income or earnings per share as a result of this change, our revenues and reported procedural volume no longer include the procedures performed in Canada.
Combined summary financial information for these entities is as follows (dollars in thousands):
4. Income Taxes
The components of income tax expense (benefit) for the three years ended December 31, 2006 are presented in the following table (dollars in thousands):
The Company decreased the valuation allowance on deferred tax assets in 2004 by $16,399,000. The reversal of the valuation allowance on deferred tax assets was made because of continued profitability of the Company in 2004 and expected future profitability. We currently believe it is more likely than not that our deferred tax assets will be realized to the extent of the tax benefit recorded.
The foreign tax provisions consist primarily of Canadian income taxes. We have made no provision for U.S. income taxes on undistributed earnings of approximately $898,000 from our international businesses because it is our intention to reinvest those earnings in those operations. If those earnings are distributed in the form of dividends, we may be subject to both foreign withholding taxes and U.S. income taxes net of allowable foreign tax credits. The amount of additional tax that might be payable upon reparation of these foreign earnings is approximately $200,000.
Income before income taxes for the last three years is presented in the following table (dollars in thousands):
Deferred taxes arise because of temporary differences in the book and tax bases of certain assets and liabilities. Significant components of our deferred taxes are shown in the following table (dollars in thousands):
The following table reconciles the statutory federal income tax rate of 35% for 2006, 35% for 2005 and 34% for 2004, and the tax provision (benefit) shown in our Consolidated Statements of Operations (dollars in thousands):
At December 31, 2006 and 2005 we had federal net operating loss carryforwards for income tax purposes of approximately $1,954,000 and $5,200,000, respectively, that can be used to reduce future taxable income. These expire in varying amounts from 2017 until 2022.
5. Leasing Arrangements
We lease office space for our vision centers under lease arrangements that qualify as operating leases. Capitalized leases are being used to finance the lasers used in the laser vision correction procedures.
The following table displays our aggregate minimal rental commitments under noncancellable leases for the periods shown (dollars in thousands):
The net book value of assets under capitalized leases at December 31, 2006 was $5,763,000 and $4,154,000 at December 31, 2005.
Total rent expense under operating leases amounted to $8,661,000 in 2006, $6,385,000 in 2005, and $5,538,000 in 2004.
6. Employee Benefits
Savings Plan
We sponsor a savings plan under Internal Revenue Code Section 401(k) to provide an opportunity for eligible employees to save for retirement on a tax-deferred basis. Under this plan, we may make discretionary contributions to the participants’ accounts. We made contributions of $68,000 in 2006; $52,000 in 2005; and $41,000 in 2004.
Stock Incentive Plans
We have four stock incentive plans, the 1995 Long-Term Stock Incentive Plan (“1995 Plan”), the 1998 Long-Term Stock Incentive Plan (“1998 Plan”), the 2001 Long-Term Stock Incentive Plan (“2001 Plan”), and the 2006 Stock Incentive Plan (“2006 Plan”). With the adoption of the 2006 Plan, all prior plans were frozen and no new grants will be made from the 1995 Plan, the 1998 Plan or the 2001 Plan. Under the stock incentive plans, at December 31, 2006 approximately 1,076,000 shares of our common stock were reserved for issuance upon the exercise of outstanding stock options and the vesting of outstanding restricted stock units, including 171,000 shares under the 1995 Plan, 459,000 shares under the 1998 Plan, 433,000 shares under the 2001 Plan, and 13,000 shares under the 2006 Plan. At December 31, 2006 a total of 1,731,922 shares were available for future awards under the 2006 Plan. The Compensation Committee of the Board of Directors administers all of our stock incentive plans.
The 2006 Plan permits us to issue incentive or non-qualified stock options to purchase shares of common stock, stock appreciation rights, restricted and unrestricted stock awards, performance awards, and cash awards to employees and non-employee directors.
As disclosed in Note 1, we adopted SFAS No. 123(R) on January 1, 2006 under the modified prospective method. The components of our pre-tax stock-based compensation expense (net of forfeitures) and associated income tax benefits are as follows (in thousands of dollars):
Stock Options
Our stock incentive plans permit certain employees to receive grants of fixed-price stock options. The option price is not less than the fair value of a share of the underlying stock at the date of grant. Option terms are generally 10 years, with options generally becoming exercisable between one and five years from the date of grant.
The fair value of each stock option is estimated on the date of the grant using a Black-Scholes option pricing model that uses assumptions noted in the following table. Expected volatility is based on a blend of implied and historical volatility of our common stock. We use historical data on exercises of stock options and other factors to estimate the expected term of the share-based payments granted. The risk free rate is based on the U.S. Treasury yield curve in effect at the date of grant. The expected life of the options is based on historical data and is not necessarily indicative of exercise patterns that may occur.
No stock options were granted in 2006. The fair value of each common stock option granted during 2005 and 2004 was estimated using the following weighted-average assumptions:
The total intrinsic value (market value on date of exercise less exercise price) of options exercised during 2006, 2005 and 2004 was approximately $16,389,000, $19,780,000 and $2,944,000 respectively.
Intrinsic Value of Options at December 31, 2006
The preceding aggregate intrinsic values represent the total pretax intrinsic value (the difference between the closing stock price of our stock on the last trading day of 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the holders of those options specified in the table above had all option holders exercised their options on December 31, 2006. These amounts will change based on the fair market value of our stock.
Cash received from option exercises under all share-based payment arrangements for 2006 was approximately $5,528,000 for 2006, $4,884,000 for 2005 and $2,202,000 for 2004. The actual tax benefit recognized for the tax deductions from option exercises under all share-based payment arrangements for 2006 was approximately $5,409,000. SFAS 123(R) requires the cash flows resulting from income tax deductions in excess of compensation costs to be classified as financing cash flows. Prior to the adoption of SFAS 123(R), we presented all income tax benefits from deductions resulting from stock-based compensation costs as operating cash flows in the consolidated statements of cash flows.
At December 31, 2006, there was $4,127,000 of total unrecognized, pre-tax compensation cost related to non-vested stock options. This cost is expected to be recognized over a weighted-average period of approximately 1.52 years.
The Company did not make any modifications to outstanding share options prior to the adoption of SFAS 123(R). There were no changes in valuation methodology after the adoption of SFAS 123(R). The only change of assumptions was in the recognition of forfeitures. Prior to the adoption of SFAS 123(R), forfeitures were recognized on a proforma basis in the period in which they occurred. With the adoption of SFAS 123(R), the Company now estimates forfeitures based on a number of factors, including historical forfeiture rates, trends and expected forfeitures (estimated at 4%).
The following table summarizes the status of options granted under our 1995, 1998, 2001 and 2006 Plans:
The following table summarizes information about the stock options granted under the 1995, 1998, 2001 and 2006 Plans that were outstanding at December 31, 2006:
The weighted-average fair value of options granted was $28.99 per option during 2005 and $16.57 per option during 2004.
Restricted Stock
Our stock incentive plans permit certain employees and non-employee directors to be granted restricted share unit awards in common stock. Awards of restricted share units are valued by reference to shares of common stock and entitle a participant to receive, upon the settlement of the unit, one share of common stock for each unit. The awards vest annually, over either a two or three year period from the date of the award, and do not have voting rights.
Restricted stock awards granted to employees and non-employee directors during 2006 totaled 142,895 shares. There were no restricted stock awards prior to January 1, 2006. The fair value of the awards at the grant date is expensed over the applicable vesting periods.
As of December 31, 2006, there was $4,278,000 of total unrecognized pre-tax compensation cost related to non-vested restricted stock. This cost is expected to be recognized over a weighted-average period of approximately 2.15 years.
The following table summarizes the restricted stock activity for 2006:
7. Commitments and Contingencies
Our business results in a number of medical malpractice lawsuits. Claims reported to us prior to December 18, 2002 were generally covered by external insurance policies and to-date have not had a material financial impact on our business other than the cost of insurance and our deductibles under those policies. Due to substantial increases in insurance premiums, effective as of December 18, 2002, we established a captive insurance company to provide coverage for claims brought against us after December 17, 2002. Our captive insurance company is managed by an independent insurance consulting and management firm and is capitalized by us based on actuarial studies performed by an affiliate of the consulting and management firm.
Since December 18, 2003, the Company has used the captive insurance company for both primary insurance and excess liability coverage. A number of claims are now pending with our captive insurance company. The losses paid by the captive insurance company have not been material. As of December 31, 2006 and 2005, we recorded an insurance reserve amount of $6,163,000 and $3,840,000 respectively, which primarily represents an actuarially determined estimate of claims incurred but not reported.
In addition, we are periodically subject to various claims and lawsuits. We believe that none of the legal proceedings to which we are currently subject, individually or in the aggregate, will have a material adverse effect on our business, financial position or results of operations.
8. Additional Financial Information
The tables below provide additional financial information related to our consolidated financial statements (dollars in thousands):
Balance Sheet Information
Other accrued liabilities include expenses incurred for which the invoices have not been received.
Cash Flow Information
9. Quarterly Financial Data (unaudited)
Financial results for interim periods do not necessarily indicate trends for any twelve-month period. Quarterly results can be affected by the number of procedures performed and the timing of certain expense items (dollars in thousands, except per share amounts):
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Disclosure controls and procedures
Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), an evaluation of the effectiveness of the Company’s disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and 15d -15(e) was performed. Based on this evaluation, the CEO and CFO have concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2006.
Changes in Internal Control Over Financial Reporting
In addition, the CEO and CFO concluded that there was no change in the Company’s internal control over financial reporting during the fourth quarter of our fiscal year ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, LCA-Vision Inc.’s internal control over financial reporting.
Management’s report on internal control over financial reporting
Information on the Company’s internal control over financial reporting is contained in “Item 8. Financial Statements and Supplementary Data - Report of Management on Internal Control over Financial Reporting” and “Report of Independent Registered Public Accounting Firm”, and is incorporated herein by reference.
Item 9B.
Item 9B. Other Information.
Not applicable.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this Item 10 is incorporated by reference from “Section 16(a) Beneficial Ownership Reporting Compliance,” “Election of Directors,” “Executive Officers” and “Information About the Board of Directors and Its Committees” to be included in our definitive Proxy Statement which will be filed with the Securities and Exchange Commission (SEC) in connection with the 2007 Annual Meeting of Stockholders.
Item 11.
Item 11. Executive Compensation.
The information required by this Item 11 is incorporated by reference from “Compensation Committee Report on Executive Compensation,” “Compensation Discussion and Analysis” and “Executive Compensation” to be included in our definitive Proxy Statement which will be filed with the SEC in connection with the 2007 Annual Meeting of Stockholders.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information called for by Item 403 of Regulation S-K and required by this Item 12 is incorporated by reference from “Security Ownership of Certain Beneficial Owners and Management” to be included in our definitive Proxy Statement to be filed with the SEC in connection with the 2007 Annual Meeting of Stockholders.
The information called for by Item 201(d) of Regulation S-K is presented below.
Equity Compensation Plan Information
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item 13 is incorporated by reference from “Information About the Board of Directors and Its Committees” and “Certain Transactions” to be included in our definitive Proxy Statement which will be filed with the SEC in connection with the 2007 Annual Meeting of Stockholders.
Item 14.
Item 14. Principal Accountant Fees and Services.
The information required by this Item 14 is incorporated from “Ratification of Appointment of Independent Auditors” to be included in our definitive Proxy Statement which will be filed with the SEC in connection with our 2007 Annual Meeting of Stockholders.
PART IV
Item 15.
Item 15. Exhibits and Financial Statements Schedules.
(a)(1) List of Financial Statements
The following are the consolidated financial statements of LCA-Vision Inc. and its subsidiaries appearing elsewhere herein:
Report of Independent Registered Public Accounting Firm on Financial Statements
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
Consolidated Balance Sheets as of December 31, 2006 and 2005
Consolidated Statements of Operations for the years ended December 31, 2006, 2005, and 2004
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005, and 2004
Consolidated Statements of Stockholders’ Investment for years ended December 31, 2006, 2005, and 2004
Notes to Consolidated Financial Statements
(a)(2) List of Schedules
Schedule II Valuation and Qualifying Accounts and Reserves
All other financial statement schedules have been omitted because the required information is either inapplicable or presented in the consolidated financial statements.
Schedule II Valuation and Qualifying Accounts and Reserves
LCA-Vision Inc.
For the years ended December 31, 2006, 2005, and 2004
(in thousands)
(a)(3)List of Exhibits
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.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints each of Alan H. Buckey and Craig P. R. Joffe, his true and lawful attorney-in-fact and agent, with full power of substitution, and with power to act alone, to sign and execute on behalf of the undersigned any amendment or amendments to this annual report on Form 10-K for the fiscal year ended December 31, 2006, and to perform any acts necessary to be done in order to file such amendment or amendments, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission and each of the undersigned does hereby ratify and confirm all that said attorney-in-fact and agent, or his substitutes, shall do or cause to be done by virtue hereof.
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 indicated below as of the 27th day of February, 2007.
/s/ Steven C. Straus
Steven C. Straus
Chief Executive Officer (Principal Executive Officer)
/s/ Alan H. Buckey
Alan H. Buckey
Executive Vice President/Finance and Chief Financial Officer (Principal Financial and Accounting Officer)
/s/ E. Anthony Woods
E. Anthony Woods
Chairman of the Board
/s/ William F. Bahl
William F. Bahl
Director
/s/ Thomas G. Cody
Thomas G. Cody
Director
/s/ John H. Gutfreund
John H. Gutfreund
Director
/s/ John C. Hassan
John C. Hassan
Director
/s/ Craig P. R. Joffe
Craig P. R. Joffe
Director
/s/ David W. Whiting
David W. Whiting
Director