UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER 001-15223
OPTICARE HEALTH SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 76-0453392
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
87 GRANDVIEW AVENUE, WATERBURY, CONNECTICUT 06708
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code:
(203) 596-2236
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
The number of shares outstanding of the registrant's Common Stock, par
value $.001 per share, at May 3, 2004 was 30,643,561 shares.
INDEX TO FORM 10-Q
Page No.
PART I. FINANCIAL INFORMATION --------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at March 31, 2004,
December 31, 2003 and March 31 2003 (unaudited) 3
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2004 and 2003 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 2004 and 2003 (unaudited) 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk 16
Item 4. Controls and Procedures 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURE 17
2
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
MARCH 31, DECEMBER 31, MARCH 31,
2004 2003 2003
---------------- ---------------- -----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $1,925 $ 1,695 $ 3,937
Accounts receivable, net 10,795 9,369 12,144
Inventories 6,292 5,918 9,231
Deferred income taxes, current - - 1,660
Other current assets 1,110 567 762
---------------- ---------------- -----------------
TOTAL CURRENT ASSETS 20,122 17,549 27,734
Property and equipment, net 4,312 4,683 5,572
Goodwill, net 19,195 19,195 20,516
Intangible assets, net 1,151 1,179 1,309
Deferred income taxes, non-current - - 3,140
Other assets 3,251 3,249 4,599
---------------- ---------------- -----------------
TOTAL ASSETS $48,031 $ 45,855 $ 62,870
================ ================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $9,620 $ 5,644 $ 12,090
Accrued expenses 5,720 5,507 5,940
Current portion of long-term debt 380 1,124 2,763
Other current liabilities 1,391 1,552 1,258
---------------- ---------------- -----------------
TOTAL CURRENT LIABILITIES 17,111 13,827 22,051
---------------- ---------------- -----------------
Long-term debt--related party - - 16,036
Other long-term debt, less current portion 10,174 11,469 7,799
Other liabilities 519 512 678
---------------- ---------------- -----------------
TOTAL NON-CURRENT LIABILITIES 10,693 11,981 24,513
---------------- ---------------- -----------------
Series B 12.5% mandatorily redeemable, convertible
preferred stock--related party 5,809 5,635 5,158
STOCKHOLDERS' EQUITY:
Series C preferred stock--related party 1 1 -
Common stock 31 30 30
Additional paid-in-capital 79,701 79,700 63,924
Accumulated deficit (65,315) (65,319) (52,806)
---------------- ---------------- -----------------
TOTAL STOCKHOLDERS' EQUITY 14,418 14,412 11,148
---------------- ---------------- -----------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 48,031 $ 45,855 $ 62,870
================ ================ =================
See notes to condensed consolidated financial statements.
3
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
------------------------------------
2004 2003
--------------- ----------------
NET REVENUES:
Managed vision $ 6,043 $ 7,408
Product sales 18,128 17,722
Other services 5,581 5,028
Other income 620 1,838
--------------- ----------------
Total net revenues 30,372 31,996
--------------- ----------------
OPERATING EXPENSES:
Medical claims expense 4,644 5,744
Cost of product sales 13,365 13,901
Cost of services 2,279 2,126
Selling, general and administrative 9,322 8,808
Depreciation 403 355
Amortization 28 44
Interest 321 751
--------------- ----------------
Total operating expenses 30,362 31,729
--------------- ----------------
Income before income taxes 10 267
Income tax expense 6 107
--------------- ----------------
Net income 4 160
Preferred stock dividends (174) (140)
--------------- ----------------
Net income (loss) available to
common stockholders $ (170) $ 20
=============== ================
EARNINGS (LOSS) PER SHARE:
Net income (loss) per common share:
Basic $ (0.01) $ 0.00
Diluted $ (0.01) $ 0.00
See notes to condensed consolidated financial statements.
4
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
----------------------------------
2004 2003
--------------- --------------
OPERATING ACTIVITIES:
Net income $ 4 $ 160
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 403 355
Amortization 28 44
Non-cash interest expense 38 558
Changes in operating assets and liabilities:
Accounts receivable (1,426) 55
Inventory (374) (1,499)
Other assets (602) (13)
Accounts payable and accrued expenses 4,364 905
Other liabilities (154) 30
--------------- --------------
Net cash provided by operating activities 2,281 595
--------------- --------------
INVESTING ACTIVITIES:
Cash received on notes receivable 46 265
Purchase of fixed assets (32) (174)
Purchase of assets from acquisition, excluding cash - (5,863)
Purchase of restricted certificates of deposit - (600)
--------------- --------------
Net cash provided by (used in) provided by investing activities 14 (6,372)
--------------- --------------
FINANCING ACTIVITIES:
Net increase (decrease) in revolving credit facility (1,920) 7,377
Principal payments on long-term debt (119) (684)
Principal payments on capital lease obligations (1) (14)
Payment of financing costs (25) (81)
Proceeds from issuance of common stock - 30
--------------- --------------
Net cash (used in) provided by financing activities (2,065) 6,628
--------------- --------------
Increase in cash and cash equivalents 230 851
Cash and cash equivalents at beginning of period 1,695 3,086
--------------- --------------
Cash and cash equivalents at end of period $ 1,925 $ 3,937
=============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 286 $ 165
Cash paid for income taxes $ 38 $ 76
See notes to condensed consolidated financial statements.
5
OPTICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except share data)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of OptiCare
Health Systems, Inc., a Delaware corporation, and its subsidiaries (collectively
the "Company") for the three months ended March 31, 2004 and 2003 have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and the instructions
to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of
1934, as amended, and are unaudited. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. In the
opinion of management, all adjustments (consisting of only normal recurring
accruals) necessary for a fair presentation of the consolidated financial
statements have been included. The results of operations for the three months
ended March 31, 2004 are not necessarily indicative of the results to be
expected for the full year. The condensed consolidated balance sheet as of
December 31, 2003 was derived from the Company's audited financial statements,
but does not include all disclosures required by accounting principles generally
accepted in the United States of America.
2. STOCK BASED COMPENSATION
The Company accounts for its stock-based compensation plans under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and
related interpretations in accounting for the stock options granted to its
employees and directors. Accordingly, employee and director compensation expense
is recognized only for those options whose price is less than fair market value
at the measurement date.
Statement of Financial Standards ("SFAS") No. 123 "Accounting for
Stock-Based Compensation, as amended by SFAS No. 148 "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of Statement of Financial
Accounting Standard No. 123" requires that companies which do not elect to
account for stock-based compensation as prescribed by this statement, disclose
the pro forma effects on earnings and earnings per share as if SFAS No. 123 had
been adopted. If the Company applied the recognition provisions of SFAS No. 123,
the Company's reported net income (loss) and earnings (loss) per share available
to common stockholders, using the Black Scholes option pricing model, would have
been adjusted to the pro forma amounts indicated below.
THREE MONTHS ENDED
MARCH 31,
----------------------------
2004 2003
----------- -----------
Net income, as reported $ 4 $ 160
Less: Total stock-based employee compensation expense,
net of related tax effects (23) (108)
----------- -----------
Pro forma net income (loss) $ (19) $ 52
=========== ===========
Basic and diluted earnings (loss) per share:
As reported $ (0.01) $ 0.00
Pro forma $ (0.01) $ 0.00
3. ACQUISITION OF WISE OPTICAL VISION GROUP, INC.
On February 7, 2003, the Company acquired substantially all of the assets
and certain liabilities of the contact lens distribution business of Wise
Optical Vision Group, Inc. ("Wise Optical"), a New York corporation. The results
of operations of Wise Optical are included in the consolidated financial
statements from February 1, 2003, the deemed effective date of the acquisition
for accounting purposes.
6
Assuming the acquisition of Wise Optical had occurred on January 1, 2003,
pro forma net revenue and net income of the Company for the three months ended
March 31, 2003 would have been $38,615 and $248, respectively. On the same pro
forma basis, basic and diluted income per common share for the three months
ended March 31, 2003 would have been $0.00. This unaudited pro forma information
is for informational purposes only and is not necessarily indicative of the
results that would have been obtained had these events actually occurred at the
beginning of the periods presented, nor does it intend to be a projection of
future results.
4. INTANGIBLE ASSETS
Intangible assets subject to amortization are comprised of a service
agreement and non-compete agreements. The service agreement has a gross carrying
amount of $1,658 and accumulated amortization of $507, $479 and $396 at March
31, 2004, December 31, 2003 and March 31, 2003, respectively. The non-compete
agreements, which had a gross carrying amount of $265, were fully amortized at
March 31, 2004 and December 31, 2003 and had accumulated amortization of $218 at
March 31, 2003. Amortization expense for the three months ended March 31, 2004
and 2003 was $28 and $44, respectively. Estimated annual amortization expense is
expected to be $111 in each of the years 2004 through 2008.
5. SEGMENT INFORMATION
The Company is an integrated eye care services company focused on providing
managed vision and professional eye care products and services. The Company has
the following three reportable operating segments: (1) Managed Vision, (2)
Consumer Vision, and (3) Distribution and Technology. These operating segments
are managed separately, offer separate and distinct products and services, and
serve different customers and markets, although there is some cross-marketing
and selling between the segments. Discrete financial information is available
for each of these segments and the Company's President assesses performance and
allocates resources among these three operating segments.
The Managed Vision segment contracts with insurers, insurance fronting
companies, employer groups, managed care plans and other third party payors to
manage claims payment administration of eye health benefits for those
contracting parties. The Consumer Vision segment sells retail optical products
to consumers and operates integrated eye health centers and surgical facilities
in Connecticut where comprehensive eye care services are provided to patients.
The Distribution and Technology segment provides products and services to eye
care professionals (ophthalmologists, optometrists and opticians) through (i)
Wise Optical, a distributor of contact and ophthalmic lenses and other eye care
accessories and supplies; (ii) a Buying Group program, which provides group
purchasing arrangements for optical and ophthalmic goods and supplies and (iii)
CC Systems, which provides systems and software solutions to eye care
professionals.
In addition to its reportable operating segments, the Company's "All Other"
category includes other non-core operations and transactions, which do not meet
the quantitative thresholds for a reportable segment. Included in the "All
Other" category is revenue earned under the Company's health service
organization ("HSO") operation, which receives fee income for providing certain
support services to individual ophthalmology and optometry practices. The
Company is in the process of disengaging from its HSO arrangements.
7
Management assesses the performance of its segments based on income before
income taxes, interest expense, depreciation and amortization, and other
corporate overhead. Summarized financial information, by segment, for the three
months ended March 31, 2004 and 2003 is as follows:
THREE MONTHS ENDED
MARCH 31,
----------------------------
2004 2003
------------ -----------
REVENUES:
Managed vision $6,051 $7,408
Consumer vision 8,143 7,306
Distribution and technology 17,191 16,420
------------ -----------
Reportable segment totals 31,385 31,134
All other 633 1,861
Elimination of inter-segment revenues (1,646) (999)
------------ -----------
Total net revenue $ 30,372 $ 31,996
============ ===========
SEGMENT INCOME (LOSS):
Managed vision $ 166 $426
Consumer vision 931 565
Distribution and technology 53 (270)
------------ -----------
Reportable segment totals 1,150 721
All other 424 1,677
Depreciation (403) (355)
Amortization (28) (44)
Interest expense (321) (751)
Corporate (812) (981)
------------ -----------
Income before income taxes $ 10 $ 267
============ ===========
6. EARNINGS (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
THREE MONTHS ENDED
MARCH 31,
---------------------------------
2004 2003
------------- --------------
BASIC EARNINGS (LOSS) PER SHARE:
Net income $ 4 $ 160
Preferred stock dividend (174) (140)
------------- --------------
Net income (loss) available to common $(170) $ 20
Stockholders ============= ==============
Average common shares outstanding (basic) 30,388,891 29,543,093
Basic earnings (loss) per share: $ (0.01) $ 0.00
============= ==============
8
THREE MONTHS ENDED
MARCH 31,
---------------------------------
2004 2003
------------- --------------
DILUTED EARNINGS (LOSS) PER SHARE:
Income (loss) available to common stockholders $ (170) $ 20
Assumed conversions of preferred stock dividends * 140
------------- --------------
Net income (loss) available to common
stockholders $ (170) $ 160
============= ==============
Average common shares outstanding (basic) 30,388,891 29,543,093
Effect of dilutive securities:
Options * 4,152,500
Warrants * 1,045,000
Convertible Preferred stock * 36,845,912
------------- --------------
Diluted shares 30,388,891 71,586,505
============= ==============
Diluted earnings (loss) per share: $ (0.01) $ 0.00
============= ==============
* Anti-dilutive
The following table reflects the potential common shares of the Company for
the three months ended March 31, 2004 and 2003 that have been excluded from the
calculation of diluted earnings per share due to anti-dilution.
THREE MONTHS ENDED
MARCH 31,
2004 2003
--------------- ---------------
Options 6,160,289 2,054,566
Warrants 3,125,000 2,080,000
Convertible Preferred Stock 61,801,304 -
--------------- ---------------
71,086,593 4,134,566
=============== ===============
7. CONTINGENCIES
The Company is both a plaintiff and defendant in lawsuits incidental to its
current and former operations. Such matters are subject to many uncertainties
and outcomes are not predictable with assurance. Consequently, the ultimate
aggregate amount of monetary liability or financial impact with respect to these
matters at March 31, 2004 cannot be ascertained. Management is of the opinion
that, after taking into account the merits of defenses and established reserves,
the ultimate resolution of these matters will not have a material adverse impact
on the Company's consolidated financial position or results of operations.
9
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion may be understood more fully by reference to our
consolidated financial statements, notes to the consolidated financial
statements, and management's discussion and analysis contained in our Annual
Report on Form 10-K for the year ended December 31, 2003, as filed with the
Securities and Exchange Commission.
OVERVIEW
We are an integrated eye care services company focused on vision benefits
management (managed vision), retail optical sales and eye care services to
patients and the distribution of products and software services to eye care
professionals.
Our business is comprised of three reportable operating segments: (1)
Managed Vision, (2) Consumer Vision, and (3) Distribution & Technology. Our
Managed Vision segment contracts with insurers, managed care plans and other
third party payers to manage claims payment administration of eye health
benefits for those contracting parties. Our Consumer Vision segment sells retail
optical products to consumers and operates integrated eye health centers and
surgical facilities in Connecticut where comprehensive eye care services are
provided to patients. The Distribution and Technology segment provides products
and services to eye care professionals (ophthalmologists, optometrists and
opticians) through (i) Wise Optical, a distributor of contact and ophthalmic
lenses and other eye care accessories and supplies; (ii) a Buying Group program,
which provides group purchasing arrangements for optical and ophthalmic goods
and supplies and (iii) CC Systems, which provides systems and software solutions
to eye care professionals.
In addition to these segments, we receive income from other non-core
operations and transactions, including our health service organization (HSO)
operation, which receives fee income for providing certain support services to
individual ophthalmology and optometry practices. We are in the process of
disengaging from our HSO arrangements.
We experienced losses at Wise Optical throughout 2003. In September 2003, we
began implementing strategies and operational changes to turn around Wise
Optical. These strategies included growing sales through improved customer
service, improving gross margin through pricing discipline and active purchasing
strategies as well as reducing operating expenses through the elimination of
positions and tightening of expense policies. In the first quarter of 2004, as a
result of these strategies, Wise Optical achieved sales growth, increased gross
margins and reduced operating expenses. We expect continued improvement in the
operating results of Wise Optical in the future as we continue executing these
strategies.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2004 Compared to the Three Months Ended March 31,
2003
Managed Vision revenue. Managed Vision revenue represents fees received
under our managed care contracts. Managed Vision revenue decreased to
approximately $6.0 million for the three months ended March 31, 2004 compared to
approximately $7.4 million for the three months ended March 31, 2003, a decrease
of approximately $1.4 million or 18.9%. Of this decrease, approximately $1.3
million is due to terminated contracts, primarily as a result of changes made by
the Texas state legislature to its Medicaid and Children's Health Insurance
Programs, and $0.6 million is due to a decline in membership in existing
contracts with the insurer CIGNA. These decreases are partially offset by
increases in revenue of approximately $0.3 million from new contracts and
approximately $0.2 million from net growth in existing contracts. We expect the
decrease in revenue associated with the CIGNA contracts to be more than offset
by revenue under a new contract with a different payor, which became effective
March 1, 2004. We expect managed vision revenue to increase in the future as we
enter into new direct-to-employer contracts.
Product sales revenue. Product sales include the retail sale of optical
products in our Consumer Vision segment, the sale of optical products through
our Buying Group and the sale of contact and ophthalmic lenses through Wise
Optical. Product sales revenue increased to approximately $18.1 million for the
three months ended March 31, 2004 compared to approximately $17.7 million for
the three months ended March 31, 2003, an increase of approximately $0.4 million
or 2.3%. This increase represents an approximate $1.0 million increase in
revenue from Wise Optical and
10
an approximate $0.2 million increase in revenue from Consumer Vision, which were
partially offset by an approximate $0.8 million decrease in revenue from the
Buying Group. Revenue of Wise Optical was approximately $1.0 higher in the first
quarter of 2004 as compared to the first quarter of 2003, because 2004 revenue
included a full quarter of revenue, whereas 2003 revenue only included revenue
from February 1, 2003, the effective date of our acquisition of Wise Optical.
The increase in Wise Optical revenue due to the additional month of revenue in
2004 is partially offset by the overall decline in sales volume we experienced
immediately after we purchased Wise Optical. We began implementing strategies in
September 2003 to increase sales at Wise Optical and we have experienced
improved revenue since we began that initiative. We expect future sales at Wise
Optical to approximate current levels, adjusted for seasonal fluctuations. The
increase in Consumer Vision product sales is primarily due to an increase in
purchasing volume associated with improved sales efforts and increased sales of
higher value products through incentive programs and product promotions. We
expect Consumer Vision product sales to continue to increase throughout the
year, adjusted for seasonal fluctuations. The decrease in Buying Group revenue
is due to a decrease in purchasing volume primarily due to the loss of the
business of Optometric Eye Care Center, P.A., which occurred in the second
quarter of 2003. We expect product sales of the Buying Group to remain at
current levels for the remainder of the year, adjusted for seasonality.
Other services revenue. Other services revenue includes revenue earned from
providing eye care services in our Consumer Vision segment, software services in
our Distribution & Technology segment and HSO services. Other services revenue
increased to approximately $5.6 million for the three months ended March 31,
2004 compared to approximately $5.0 million for the three months ended March 31,
2003, an increase of approximately $0.6 million or 12.0%. This increase is
primarily due to increased services volume in the medical, optometry and
surgical areas attributable to increased doctor coverage and productivity. We
expect services revenue to remain at these levels or increase slightly in the
future, adjusted for seasonality.
Other income. Other income represents non-recurring settlements on HSO
contracts. Other income for the three months ended March 31, 2004 was
approximately $0.6 million compared to approximately $1.8 million for the three
months ended March 31, 2003, representing a decrease of approximately $1.2
million or 66.7%, as a result of a decrease in the number of settlements in the
current quarter.
Medical claims expense. Medical claims expense decreased to approximately
$4.6 million for the three months ended March 31, 2004, from approximately $5.7
million for the three months ended March 31, 2003, a decrease of approximately
$1.1 million or 19.3%. The medical claims expense loss ratio (MLR) representing
medical claims expense as a percentage of Managed Vision revenue decreased to
76.8% in 2004 from 77.5% in 2003. The favorable change in MLR is a result of
changes to existing contracts and increased revenue from certain contracts which
do not generate claims expense. We expect claims expense to increase in the
future as we enter into additional direct-to-employer contracts.
Cost of product sales. Cost of product sales decreased to approximately
$13.4 million for the three months ended March 31, 2004 compared to
approximately $13.9 million for the three months ended March 31, 2003, a
decrease of approximately $0.5 million or 3.6%. This decrease is primarily due
to an approximate $0.8 million decrease in product costs associated with the
decrease in Buying Group sales, which was partially offset by an approximate
$0.2 million increase in product costs associated with increased sales in our
Consumer Vision division and $0.1 million increase in Wise Optical product
costs. The increase in Wise Optical product costs is because 2004 product costs
included a full quarter of Wise Optical costs, whereas 2003 product costs only
included costs from February 1, 2003, the effective date of our acquisition of
Wise Optical. This increase in Wise Optical product costs in 2004 is partially
offset by a decrease in its product costs as a result of a decrease in sales
volume. Overall, we expect total product costs to increase slightly in the
future due to an expected increase in product sales.
Cost of services. Cost of services increased to approximately $2.3 million
for the three months ended March 31, 2004 compared to approximately $2.1 million
for the three months ended March 31, 2003, an increase of approximately $0.2
million or 9.5%. This increase is primarily due to the increased services volume
in the Consumer Vision area.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased to approximately $9.3 million for the three
months ended March 31, 2004 compared to approximately $8.8 million for the three
months ended March 31, 2003, an increase of approximately $0.5 million or 5.7%.
The increase in 2004 is primarily due to expenses associated with Wise Optical's
operations being included in our results for a full quarter, whereas 2003
expenses only included Wise Optical from February 1, 2003, the effective date of
our acquisition of Wise Optical.
11
Interest expense. Interest expense decreased to approximately $0.3 million
for the three months ended March 31, 2004 from approximately $0.8 million for
the three months ended March 31, 2003, a decrease of approximately $0.5 million
or 62.5%. This decrease in interest expense is primarily due to a decrease in
the average outstanding debt balance as a result of the conversion of
approximately $16.2 million of debt to preferred stock in May 2003.
Income tax expense. Income tax expense for the three months ended March 31,
2004 primarily represents minimum state tax expense. Income tax expense of
approximately $0.1 million for the three months ended March 31, 2003, represents
tax expense on income from operations of approximately $0.3 million, at an
effective rate of 40%.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities at the date of our financial statements. Management bases its
estimates and judgments on historical experience, current economic and industry
conditions and on various other facts that are believed to be reasonable under
the circumstances. Actual results may differ significantly from these estimates
under different assumptions, judgments or conditions.
Management believes critical accounting estimates are used in determining
the adequacy of the allowance for doubtful accounts, insurance disallowances,
managed care claims accrual, valuation allowance for deferred tax assets and in
evaluating goodwill and intangibles for impairment.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Our primary sources of liquidity have been cash flows generated from
operations in our Managed Vision and Consumer Vision segments and borrowings
under our term loan and revolving credit facility.
As of March 31, 2004, we had cash and cash equivalents of approximately $1.9
million and approximately $2.5 million of additional availability under our
revolving credit facility with CapitalSource.
The following table sets forth a quarter-over-quarter comparison of the
components of our liquidity and capital resources for the quarters ended March
31, 2004 and 2003:
(In millions)
$
2004 2003 CHANGE
---- ---- ------
Cash and cash equivalents $ 1.9 $ 3.9 $ (2.0)
Cash provided by (used in):
Operating activities 2.3 0.6 1.7
Investing activities - (6.4) 6.4
Financing activities (2.1) 6.6 (8.7)
Net cash provided by operating activities was approximately $2.3 million for
the three months ended March 31, 2004 compared to approximately $0.6 million for
the three months ended March 31, 2003, an increase of approximately $1.7
million. The increase in cash provided by operating activities was primarily due
to improved inventory management and an increase in accounts payable due to
higher product sales and the timing of purchases and payments on payables.
There were no significant sources or uses of cash related to investing
activities for the three months ended March 31, 2004. Net cash used in investing
activities for the three months ended March 31, 2003 was approximately $6.4
million, which was primarily used to purchase the assets of Wise Optical in
February 2003.
12
Net cash used in financing activities was approximately $2.1 million for the
three months ended March 31, 2004 compared to approximately $6.6 million of net
cash provided by financing activities for the three months ended March 31, 2003.
Net cash used in financing activities in 2004 was primarily used for repayments
under our revolving credit facility. Net cash provided by financing activities
in 2003 was primarily from borrowings under our revolving credit facility used
to fund the purchase of Wise Optical in February 2003.
We believe that our cash flow from operations, borrowings under our term
loan and revolving credit facility with CapitalSource, operating and capital
lease financing, and other short-term financing arrangements will provide us
with sufficient funds to finance our operations for the next 12 months.
The CapitalSource Loan and Security Agreement
As of March 31, 2004, we had approximately $2.0 million of borrowings
outstanding under our term loan with CapitalSource, approximately $8.5 million
of advances outstanding under our revolving credit facility with CapitalSource
and approximately $2.5 million of additional availability under our revolving
credit facility.
The term loan and revolving credit facility with CapitalSource are subject
to a Loan and Security Agreement. The Loan and Security Agreement contains
certain restrictions on the conduct of our business, including, among other
things, restrictions on incurring debt, purchasing or investing in the
securities of, or acquiring any other interest in, all or substantially all of
the assets of any person or joint venture, declaring or paying any cash
dividends or making any other payment or distribution on our capital stock, and
creating or suffering liens on our assets. We are required to maintain certain
financial covenants, including a minimum fixed charge ratio and to maintain a
minimum net worth. Upon the occurrence of certain events or conditions described
in the Loan and Security Agreement (subject to grace periods in certain cases),
including our failure to meet the financial covenants, the entire outstanding
balance of principal and interest would become immediately due and payable. In
January and February 2004, we did not meet our fixed charge ratio covenant,
primarily due to operating losses incurred at Wise Optical, but received a
waiver on our non-compliance from CapitalSource. As of March 31, 2004, we were
in compliance with all of our debt covenants.
On March 29, 2004, we entered into the Second Amended and Restated Credit
Facility which, among other things, confirmed that our $0.7 million temporary
over-advance in November 2003 was fully repaid on February 29, 2004, changed the
expiration date of the waiver of our fixed ratio covenant from March 31, 2004 to
February 29, 2004 and reduced the tangible net worth covenant from $(10) million
to $(2) million. We paid CapitalSource a $25,000 financing fee in connection
with this amendment.
Our term loan and revolving credit facility with CapitalSource mature on
January 25, 2006. We are required to make monthly principal payments of $25,000
on the term loan with the balance due at maturity. Although we may borrow up to
$15 million under the revolving credit facility, the maximum amount that may be
advanced is limited to the value derived from applying advance rates to eligible
accounts receivable and inventory. The advance rate under our revolving credit
facility is 85% of all eligible accounts receivable and 50 to 55% of all
eligible inventory. The interest rate applicable to the term loan equals the
prime rate plus 3.5% (but not less than 9%) and the interest rate applicable to
the revolving credit facility is prime rate plus 1.5% (but not less than 5.75%).
If we terminate the revolving credit facility prior to December 31, 2004, we
must pay CapitalSource a termination fee of $300,000. If we terminate the
revolving credit facility after December 31, 2004 but prior to the expiration of
the revolving credit facility the termination fee is $150,000. Additionally, if
we terminate the revolving credit facility pursuant to a refinancing with
another commercial financial institution, we must pay CapitalSource, in lieu of
the termination fee, a yield maintenance amount equal to the difference between
(i) the all-in effective yield which could be earned on the revolving balance
through January 25, 2006, and (ii) the total interest and fees actually paid to
CapitalSource on the revolving credit facility prior to the termination date or
date of prepayment.
Our subsidiaries guarantee payments and other obligations under the
revolving credit facility and we (including certain subsidiaries) have granted a
first-priority security interest in substantially all our assets to
CapitalSource. We also pledged the capital stock of certain of our subsidiaries
to CapitalSource.
We believe that we will be able to comply with our financial covenants under
our amended credit facility with CapitalSource, including our minimum fixed
charge ratio covenant, the waiver with respect to which expired on
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February 29, 2004. However, if we incur operating losses and we fail to comply
with our financial covenants in the future or otherwise default on our debt, our
creditors could foreclose on our assets, in which case we would be obligated to
seek alternate sources of financing. There can be no assurance that alternate
sources of financing will be available to us on terms acceptable to us, if at
all. If additional funds are needed, we may attempt to raise such funds through
the issuance of equity or convertible debt securities. If additional funds are
raised through the issuance of equity or convertible debt securities, the
percentage ownership of our stockholders will be reduced and our stockholders
may experience dilution of their interest in us. If additional funds are needed
and are not available or are not available on acceptable terms, our ability to
fund our operations, take advantage of unanticipated opportunities, develop or
enhance services or products or otherwise respond to competitive pressures may
be significantly limited and may have a material adverse impact on our business
and operations.
The Series B Preferred Stock
As of March 31, 2004, we had 3,204,959 shares of Series B Preferred Stock
issued and outstanding. Subject to the senior liquidation preference of the
Series C Preferred Stock described below, the Series B Preferred Stock ranks
senior to all other currently issued and outstanding classes or series of our
stock with respect to dividends, redemption rights and rights on liquidation,
winding up, corporate reorganization and dissolution. Each share of Series B
Preferred Stock is convertible into a number of shares of common stock equal to
such share's current liquidation value, divided by a conversion price of $0.14,
subject to adjustment for dilutive issuances. The number of shares of common
stock into which each share of Series B Preferred Stock is convertible will
increase over time because the liquidation value of the Series B Preferred
Stock, which was $1.81 per share as of March 31, 2004, increases at a rate of
12.5% per year, compounded annually.
The Series C Preferred Stock
As of March 31, 2004, we had 406,158 shares of Series C Preferred Stock
issued and outstanding. The Series C Preferred Stock has an aggregate
liquidation preference of approximately $16.2 million and ranks senior to all
other currently issued and outstanding classes or series of our stock with
respect to liquidation rights. Each share of Series C Preferred Stock is
convertible into 50 shares of common stock and has the same dividend rights, on
an as converted basis, as our common stock.
Seasonality
Our revenues are generally affected by seasonal fluctuations in the Consumer
Vision and Distribution and Technology segments. During the winter and summer
months, we generally experience a decrease in patient visits and product sales.
As a result, our cash, accounts receivable, and revenues decline during these
periods and, because we retain certain fixed costs related to staffing and
facilities, our cash flows can be negatively affected.
Impact of Reimbursement Rates
Our revenue is subject to pre-determined Medicare reimbursement rates which,
for certain products and services, have decreased over the past three years. A
decrease in Medicare reimbursement rates could have an adverse effect on our
results of operations if we cannot manage these reductions through increases in
revenues or decreases in operating costs. To some degree, prices for health care
are driven by Medicare reimbursement rates, so that our non-Medicare business is
also affected by changes in Medicare reimbursement rates.
FORWARD-LOOKING INFORMATION AND RISK FACTORS
The statements in this Form 10-Q and elsewhere (such as in other filings by
the Company with the Securities and Exchange Commission, press releases,
presentations by the company or its management and oral statements) that relate
to matters that are not historical facts are "forward-looking statements" within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
When used in this document and elsewhere, words such as "anticipate," "believe,"
"expect," "plan," "intend," "estimate," "project," "will," "could," "may,"
"predict" and similar expressions are intended to identify forward-looking
statements. Such forward-looking statements include, but are not limited to,
those relating to:
o Our expectation of future revenue and expense levels;
14
o Our belief that we will be able to comply with our financial
covenants under our amended credit facility with CapitalSource;
o Our opinion that the outcome of lawsuits will not have a material
adverse impact on our consolidated financial position or results of
operations;
o Our expectation of continued improvement in operating results of
Wise Optical in the future;
o Our expected future sales levels;
o Our expected impact of future interest rates on income and cash
flows; and
o Our belief that cash from operations, borrowings under our term
loan and revolving credit facility, and operating and capital lease
financings will provide sufficient funds to finance operations for
the next 12 months.
In addition, such forward-looking statements involve known and unknown
risks, uncertainties, and other factors which may cause the actual results,
performance or achievements of the company to be materially different from any
future results expressed or implied by such forward-looking statements. Also,
our business could be materially adversely affected and the trading price of our
common stock could decline if any of the following risks and uncertainties
develop into actual events. Such risk factors, uncertainties and the other
factors include:
o Changes in the regulatory environment applicable to our business,
including health-care cost containment efforts by Medicare,
Medicaid and other third-party payers;
o Risks related to the eye care industry, including the cost and
availability of medical malpractice insurance, and adverse
long-term experience with laser and other surgical vision
correction;
o The fact that managed care companies face increasing threats of
private-party litigation, including class actions, over the scope
of care that the managed care companies must pay for;
o Loss of the services of key management personnel could adversely
effect our business;
o Our ability to execute our growth strategy, without which we may
not become profitable or sustain our profitability;
o Our ability to obtain additional capital, without which our growth
could be limited;
o The fact that we have a history of losses and may incur further
losses in the future;
o Our ability to maintain the listing of our common stock on the
American Stock Exchange;
o The fact that if we default on our debt to CapitalSource, it could
foreclose on our assets;
o The possibility that we may not compete effectively with other eye
care services companies which have more resources and
experience than us;
o Failure to negotiate profitable capitated fee arrangements could
have a material adverse effect on our results of operations and
financial condition;
o The possibility that we may have potential conflicts of interests
with respect to related party transactions which could result in
certain of our officers, directors and key employees having
interests that differ from us and our stockholders;
o Health care regulations or health care reform initiatives, could
materially adversely affect our business, financial condition and
results of operations;
o The fact that the company is dependent upon letters of credit or
other forms of third party security in connection with certain of
its contractual arrangements and, thus, would be adversely
affected in the event it was unable to obtain such credit as
needed;
o The fact that we may not realize the expected benefits from our
acquisition of Wise Optical;
o The fact that our largest stockholder, Palisade Concentrated
Equity Partnership, L.P., owns sufficient shares of our common
stock and voting equivalents to significantly affect the results
of any stockholder vote and control our board of directors;
o The fact that conflicts of interest may arise between Palisade and
OptiCare;
o The fact that we may fail financial covenants in the future; and
o Other risks and uncertainties discussed elsewhere in this Form
10-Q and detailed from time to time in our periodic earnings
releases and reports filed with the Securities and Exchange
Commission.
15
Except as required by law, we undertake no obligation to publicly update or
revise forward-looking statements to reflect events or circumstances after the
date of this Form 10-Q or to reflect the occurrence of unanticipated events.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to market risk from exposure to changes in interest rates
based on our financing activities under our credit facility with CapitalSource,
due to its variable interest rate. The nature and amount of our indebtedness may
vary as a result of future business requirements, market conditions and other
factors. The extent of our interest rate risk is not quantifiable or predictable
due to the variability of future interest rates and financing needs.
We do not expect changes in interest rates to have a material effect on
income or cash flows in the year 2004, although there can be no assurances that
interest rates will not significantly change. A 10% change in the interest rate
payable by us on our variable rate debt would have increased or decreased the
three-month interest expense by approximately $22,000 assuming that our
borrowing level is unchanged. We did not use derivative instruments to adjust
our interest rate risk profile during the three months ended March 31, 2004.
ITEM 4: CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our principal
executive officer and principal financial officer, after evaluating the
effectiveness of our disclosure controls and procedures (as defined in Exchange
Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this
Quarterly Report on Form 10-Q, have concluded that, based on such evaluation,
our disclosure controls and procedures were adequate and effective to ensure
that material information relating to us, including our consolidated
subsidiaries, was made known to them by others within those entities,
particularly during the period in which this Quarterly Report on Form 10-Q was
being prepared.
In designing and evaluating our disclosure controls and procedures, our
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and our management necessarily was required to apply
its judgment in evaluating the cost-benefit relationship of possible controls
and procedures.
(b) Changes in Internal Controls. There were no changes in our internal
control over financial reporting, identified in connection with the evaluation
of such internal control that occurred during our last fiscal quarter that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
HEALTH SERVICE ORGANIZATION LAWSUITS
In January 2004 and March 2004, we reached settlement with Downing-McPeak
Vision Centers, P.S.C. and John E. Downing, M.D., and Milne Eye Medical Center,
P.C. and Milton J. Milne, M.D., respectively, two HSO practices with which we
were in litigation in the matter of In re Prime Vision Health, Inc. Contract
Litigation, MDL 1466, which was previously reported in our Annual Report on Form
10-K for the year ended December 31, 2003. These settlements resulted in cash
payments to us and mutual termination of the HSO service agreements.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. Exhibits
The following Exhibits are filed as part of this Quarterly Report on
Form 10-Q:
EXHIBIT DESCRIPTION
------- -----------
31.1 Certification of Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
b. Reports on Form 8-K
On March 31, 2004 we furnished information regarding results of our
quarter and year ended December 31, 2003 under Item 12 (Results of
Operation and Financial Condition) on a Current Report on Form 8-K.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be filed on its behalf by the
undersigned, hereunto duly authorized.
Date: May 14, 2004 OPTICARE HEALTH SYSTEMS, INC.
By: /s/ William A. Blaskiewicz
-------------------------------------------
William A. Blaskiewicz
Vice President and Chief Financial Officer
(Principal Financial and Accounting
Officer and duly authorized officer)
17
EXHIBIT INDEX
EXHIBIT DESCRIPTION
------- -----------
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of
2002.
32 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.