Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission File Number: 0-26625
NOVAMED EYECARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 36-4116193
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
980 North Michigan Avenue, Suite 1620, Chicago, Illinois 60611
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (312) 664-4100
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Preferred Stock Purchase Rights
(Title of Class)
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. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |_| No |X|
The aggregate market value of the registrant's 19,339,400 shares of voting
stock held by non-affiliates of the registrant, based upon the last reported
sale price of the registrant's Common Stock on June 28, 2002 was $14,117,762.
The number of shares outstanding of the registrant's Common Stock, par value
$.01, as of April 4, 2003 was 21,439,553.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement in connection with
the registrant's 2003 Annual Meeting of Stockholders are incorporated by
reference into Part III of this Report on Form 10-K.
2
- --------------------------------------------------------------------------------
PART I
This Annual Report on Form 10-K (the "Form 10-K") contains, and
incorporates by reference, certain "forward-looking statements" (as such term is
defined in Section 21E of the Securities Exchange Act of 1934, as amended) that
reflect our current expectations regarding our future results of operations,
performance and achievements. These forward-looking statements are made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. We have tried, wherever possible, to identify these forward-looking
statements by using words such as "anticipates," "believes," "estimates,"
"expects," "plans," "intends" and similar expressions. These statements reflect
our current beliefs and are based on information currently available to us.
Accordingly, these statements are subject to certain risks, uncertainties and
contingencies that could cause our actual results, performance or achievements
in 2003 and beyond to differ materially from those expressed in, or implied by,
such statements. These risks and uncertainties include: our ability to acquire,
develop or manage a sufficient number of profitable surgical facilities; reduced
prices and reimbursement rates for surgical procedures; our ability to access
capital to pursue our growth strategy; our ability to maintain successful
relationships with the physicians who use our surgical facilities; our future
profitability could decrease because of existing agreements with physicians that
may require us to sell additional equity interests in our ASCs at varying future
intervals; the application of existing or proposed government regulations, or
the adoption of new laws and regulations, that could limit our business
operations and require us to incur significant expenditures; the continued
acceptance of laser vision correction and other refractive surgical procedures;
and demand for elective surgical procedures generally and in response to a
protracted economic downturn. These factors and others are more fully set forth
under "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations - Risk Factors." You should not place undue reliance on
any forward-looking statements. We undertake no obligation to update or revise
any such forward-looking statements that may be made to reflect events or
circumstances after the date of this Form 10-K or to reflect the occurrence of
unanticipated events.
Unless the context requires otherwise, you should understand all
references to "we," "us" and "our" to include NovaMed Eyecare, Inc. and its
consolidated subsidiaries.
Item 1. Business
General
We are an eye care services company and an owner and operator of
ambulatory surgery centers (ASCs). Our primary focus and strategy is to acquire,
develop and operate ambulatory surgery centers in joint ownership with
physicians throughout the United States. We own and operate sixteen ASCs.
Currently, all of our ASCs are single-specialty ophthalmic surgical facilities
where eye care professionals perform surgical procedures - primarily cataract
and refractive surgery (laser vision correction or LVC). Most of our ASCs are
also practice-based facilities - meaning that they are located adjacent to or
near a physician practice. We own a majority interest in eleven of our ASCs,
with physicians owning the remaining equity interests. We currently own all of
the equity interests in our other five ASCs; however, in the future we may
either elect, or be required pursuant to existing agreements, to sell to
physicians a minority interest in these facilities.
We are also a party to nine fixed-site laser agreements pursuant to which
we provide excimer lasers and other services to eye care professionals for their
use in performing laser vision correction surgery.
We also own and operate an optical products and services organization that
sells: corrective lenses and eyeglasses produced by our two wholesale optical
laboratories; eyeglass frames and contact lenses purchased from manufacturers by
our optical products purchasing organization; and marketing products and
services.
3
In addition to our surgical facilities and optical products businesses, we
also continue to provide management services to four eye care practices pursuant
to long-term service agreements. Under these service agreements, we provide
business, information technology, administrative and financial services to our
affiliated providers in exchange for a management fee.
We were originally organized as a Delaware limited liability company in
March 1995, under the name, NovaMed Eyecare Management, LLC. In connection with
a capital infusion from venture capital investors in November 1996, NovaMed
Holdings Inc., an Illinois corporation, was formed to serve as a holding
company, responsible for overall strategic planning, with NovaMed Eyecare
Management, LLC as our principal operating subsidiary. In May 1999, NovaMed
Holdings Inc. reincorporated as a Delaware corporation and changed its name to
NovaMed Eyecare, Inc. In June 1999, we changed the name of our principal
operating subsidiary to NovaMed Eyecare Services, LLC. In August 1999, we
consummated our initial public offering of common stock.
Information Available
Our corporate headquarters are located at 980 North Michigan Avenue, Suite
1620, Chicago, Illinois 60611, and our website is www.novamed.com. We file
annual, quarterly, and current reports, proxy statements, and other documents
with the Securities and Exchange Commission (the "SEC") under the Securities
Exchange Act of 1934 (the "Exchange Act"). The public may read and copy any
materials that we file with the SEC at the SEC's Public Reference Room at 450
Fifth Street, NW, Washington, D.C. 20549. The public may obtain information on
the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
Also, the SEC maintains an Internet website that contains reports, proxy and
information statements, and other information regarding issuers, including us,
that file electronically with the SEC. The public can obtain any documents that
we file with the SEC at http://www.sec.gov.
We also make available free of charge on or through our Internet website
(http://www.novamed.com) our Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K and, if applicable, amendments to those
reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon
as reasonably practicable after we electronically file such materials with, or
furnish them to, the SEC.
Discontinued Operations
In October 2001, we announced our intentions to discontinue our management
services business. In assessing our overall business, our Board of Directors
determined that we should focus our business strategy primarily on the
acquisition, growth and development of surgical facilities. Our surgical
facilities segment has historically been more efficient than our other business
segments, requiring relatively lower operating costs and producing our highest
operating margins. In reviewing our management services business, our Board
determined that, although the segment had been historically profitable, the
returns did not justify the high overhead and capital spending necessary to
operate the business. Beginning in the third quarter of 2001, we have reflected
the management services business as discontinued operations in our financial
statements.
As part of our discontinued operations plan, beginning in December 2001
and continuing through March 31, 2003, we have negotiated and closed seventeen
divestiture transactions in which we: (a) terminated or assigned the service
agreement with our affiliated practices; (b) terminated or transferred all
employees providing services at these practice locations; (c) closed or
relocated most of our regional business offices; (d) sold practice-based assets
including fixed assets, equipment and accounts receivable; and (e) terminated or
transferred certain corporate employees who provided services primarily to the
management services business. We are still in the process of negotiating
divestiture transactions with two affiliated practices. We will continue to
perform our obligations under our service agreements with these two entities
until they are either terminated through mutually agreed upon transactions or
otherwise transferred.
4
In the 2002 fourth quarter, we elected to not divest two physician
practices that had been previously included in our discontinued operations plan.
These practices are now included in our continuing operations. One practice is
an optometric practice with an optical retail store located in the Chicago
market. The other practice is primarily an ophthalmology practice with multiple
locations in the southeastern United States.
In early 2003, we substantially completed our discontinued operations
plan. As of March 31, 2003, we have consummated seventeen of our currently
planned nineteen divestiture transactions. From the seventeen transactions that
we have completed, we have received in the aggregate as of March 31, 2003
approximately $15.6 million in cash proceeds, promissory notes under which
approximately $2.3 million of principal remains payable to us in installments
over periods ranging from one to five years, and approximately 800,000 shares of
our common stock. In addition, the buyers assumed various liabilities, including
equipment and office leases. As part of these transactions, we required our
former affiliated physicians to enter into multi-year restrictive covenants
precluding them from owning and operating ASCs and other licensed surgical
facilities. In addition, depending on the particular characteristics of the
affiliated practice, we entered into multi-year optical products supply
agreements and multi-year refractive service agreements. Under these agreements,
we are continuing to provide services to these practices from our continuing
business segments. Under our refractive service agreements, we have contracted
with the practices to be their exclusive provider of current and future
refractive technology. With our optical products supply agreements, our group
purchasing organization and optical laboratories are the primary providers of
optical products and supplies to these entities.
In addition to our divestiture transactions, we also sold minority equity
interests in certain of our existing ASCs to various physician-owners of our
former affiliated practices. We sold minority interests in eight ASCs, and also
sold two ASCs entirely. In return, we received in the aggregate approximately
$4.0 million in cash proceeds and approximately 2.7 million shares of our common
stock.
Industry Overview
Ambulatory Surgery Center Industry
General
The term "ambulatory surgery" refers to procedures performed on a
nonhospitalized patient who is able to return home the same day. Since the
inception of outpatient surgery centers in the early 1970s, the ambulatory
surgery industry has grown consistently, with almost 3,400 ASCs in business as
of February 2002. Improved surgical techniques and technologies, including
improved anesthesia techniques, have contributed to the expansion of surgical
procedures that can be performed in an ASC. According to SMG Marketing Group
Inc.'s 2002 Outpatient Surgery Center Market Report, an estimated 7.2 million
surgeries were projected to be performed in ASCs in 2002, up an estimated 7.5%
from 2000. Ophthalmology is the largest single type of outpatient surgery,
representing approximately 27% of all outpatient surgeries performed in 2000.
We believe that the convenience and efficiencies offered by an ASC setting
have also contributed to the growth in ASC procedures. We believe that many
physicians prefer an ASC to a hospital because of greater scheduling
flexibility, faster turnaround time between cases and more efficient nurse
staffing. Patients prefer the experience of a surgical facility dedicated to
their specialized surgery that is free from disruptions or scheduling conflicts
that often arise in hospitals due to emergency procedures or more complex
surgical procedures that run longer than expected. Moreover, we believe third
party payors recognize the cost-effective benefits of outpatient rather than
inpatient surgery.
5
Eye Care
The eye care market consists of a large, diverse group of services and
products. The eye care services market includes routine eye examinations as well
as diagnostic and surgical procedures that address complex eye and vision
conditions. The most common conditions addressed by eye care professionals are
nearsightedness, farsightedness and astigmatism. Other frequently treated
conditions include cataracts, glaucoma, macular degeneration and diabetic
retinopathy. Eye and vision conditions are typically treated with surgery,
pharmaceuticals, prescription glasses, contact lenses or some combination of
these treatments. Additional services offered by eye care professionals include
research services for eye care devices or pharmaceuticals being developed or
tested in clinical trials. The optical products market consists of the
manufacture, distribution and sale of optical goods including corrective lenses,
eyeglasses, frames, contact lenses and other optical products and accessories.
Cataract Surgery. Cataract surgery is currently the most widely performed
surgical procedure in the U.S., with an estimated 2.7 million cataract surgeries
in 2002. Cataract procedures are forecast to grow two to three percent annually
over the next five years. A cataract occurs when the normally transparent lens
of the eye becomes cloudy as part of the aging process. In cataract surgery, the
ophthalmologist removes the clouded natural lens and replaces it with a
synthetic intraocular lens. Cataract surgery is typically performed on an
outpatient basis using local anesthesia, and the procedure time is typically
less than 30 minutes. Cataract procedures are expected to continue to increase
for many years, driven primarily by the aging of the population and the
introduction of improved technologies and surgical techniques. With the vast
majority of cataract surgery patients being over the age of 65, the Medicare
program has been the primary source of reimbursement for cataract surgery
providers. In the U.S., approximately 35 million people are age 65 or older. The
over-65 age group's annual growth rate is projected to reach 2.4 percent by
2007, up from 1 percent in 2002. By 2010, this age group is expected to reach
approximately 40 million.
Vision Correction Surgery. Approximately 145 million people in the U.S.
require eyeglasses or contact lenses to correct refractive vision conditions
that result from the improper curvature of the cornea. If the cornea's curvature
is not correct, the cornea cannot properly focus the light passing through it
onto the retina, and the person will see a blurred image. The three most common
refractive conditions are:
o myopia, commonly referred to as nearsightedness, which is caused by
a steepening of the cornea, resulting in the blurring of distant
objects
o hyperopia, commonly referred to as farsightedness, which is caused
by a flattening of the cornea, resulting in the blurring of close
objects
o astigmatism, in which images are not focused on any point due to the
varying curvature of the eye along different axes, which results in
a distorted view of images
New surgical technologies and techniques have been developed over the
years to correct common vision conditions that result from the improper
curvature of the cornea. Laser In-Situ Keratomileusis, or LASIK, was introduced
in 1996, leading to a dramatic increase in the popularity of laser vision
correction surgery. The introduction of LASIK offered significant benefits to
ophthalmologists over preceding refractive surgical techniques such as Radial
Keratotomy, or RK, and the first vision correction surgery that used laser
technology, Photorefractive Keratectomy, or PRK. Relative to the earlier
refractive surgical techniques, the LASIK procedure provides significant
reductions in patient pain or discomfort, patient recovery times ranging from a
few hours after the procedure to two weeks, and reduced complication rates.
Although the number of vision correction procedures performed in the U.S.
grew rapidly between 1996 and 2000, the number of annual procedures has declined
over the past two years. In 2002, eye care professionals performed an estimated
1.2 million laser vision correction surgery procedures in the U.S., representing
a decrease of approximately twelve percent from 2001.
6
Optical Products and Services
While the number of patient options for vision correction has increased
with improved surgical vision correction technologies and techniques, the market
for basic optical goods including corrective lenses, eyeglass frames, contact
lenses and other optical products and accessories, remains a significant market.
We believe the increasing demand for premium products, along with the growing
number of people over the age of 40 (estimated to exceed 130 million people
within the next five years) will fuel the growth in this sector. Eyeglass frames
are typically sold through retail optical outlets located in optometrist and
ophthalmologist clinics, as well as through retail stores.
Our Business Model
Having substantially completed the divestiture of our management services
business, we are now focused primarily on acquiring, developing and operating
ASCs within new and existing markets. We believe that our experience in
operating single specialty ASCs, when coupled with our management services
experience in working with doctors, will provide our surgeon-partners with an
efficient operating environment to maximize quality patient care.
Surgical Facilities
We own and operate 16 single-specialty ASCs, each of which is a
state-licensed and Medicare-certified ASC focused primarily on eye care
procedures. Ophthalmologists perform cataract, laser vision correction and other
eye related surgical procedures in our ASCs. We plan to own and operate our
surgical facilities through joint ownership arrangements in which we will own a
majority interest in the facility and minority equity interests will be held by
physicians living in the ASC's local community. These arrangements will
principally be structured as limited liability companies with one of our
subsidiaries serving as the manager of the entity. In certain instances, we may
own the facility through a limited partnership with one of our subsidiaries
serving as the general partner. Currently, we own majority equity interests in
eleven of our ASCs. We wholly own the remaining five ASCs, but have entered into
option agreements with physicians involving two of the facilities pursuant to
which the doctors may acquire minority interests in these ASCs.
In addition to owning and operating ASCs, we also are parties to nine
fixed-site laser service agreements pursuant to which we provide excimer lasers
and various services to eye care providers for their use in performing laser
vision correction surgery. In response to the declining demand for laser vision
correction surgery, we closed several laser vision correction centers and
restructured the manner in which we provided this equipment and these services
to minimize our fixed costs. Our excimer lasers are principally now either
located in our ASCs or provided to physicians for use in their medical practices
through these fixed-site laser agreements. As of March 31, 2003, we have
eighteen excimer lasers in service.
We have a nonexclusive supply agreement with Alcon Laboratories, Inc.
pursuant to which we can procure and utilize excimer lasers and other equipment
manufactured by Alcon. The agreement sets forth pricing terms for our
APEX/Infinity lasers, as well as the procurement and pricing terms for Alcon's
most technologically advanced laser, the LADARVision System. During the term of
this agreement, which expires December 31, 2006, we will pay Alcon monthly based
on the number of procedures performed on each laser, with minimum annual
procedure requirements for each LADARVision System procured under the agreement.
As of March 31, 2003, we have eight LADARVision Systems covered by the
agreement. Alcon may terminate the agreement if we fail, after reasonable cure
periods, to comply with the material terms of the agreement. We may terminate
the agreement if the FDA withdraws or materially restricts its approval of the
use of any laser covered by the agreement or if patent issues or changes render
the lasers unusable. We recently amended this agreement to address a number of
items, most notably: (i) the terms upon which we can purchase from Alcon the
recent FDA-
7
approved LADARWave units for use with our existing LADARVision Systems; (ii)
extending the expiration date from February 28, 2006 to December 31, 2006; and
(iii) reducing our minimum annual procedure requirements.
Product Sales
We own and operate two full-service wholesale optical laboratories that
specialize in surfacing, finishing and distributing corrective lenses and
eyeglass lenses. Our laboratories have in excess of 500 active customers,
including ophthalmologists, optometrists, opticians and optical retail chains.
Our optical products purchasing organization allows eye care professionals to
purchase optical products through us from more than 100 suppliers. We process
consolidated monthly billing for over 1,000 customers that utilize our
purchasing organization. Customers of these businesses include our former
affiliated doctors who are a party to multi-year optical supply agreements with
us pursuant to which our group purchasing organization and optical laboratories
are the primary providers of optical products and supplies to these doctors.
Generally, these supply agreements will expire between March 2007 and May 2009,
and the product sales revenue generated from these customers in 2002 constituted
less than five percent of our total product sales revenue.
In addition, our marketing services and products business provides eye
care professionals with a range of products and services including brochures,
videos, advertising and website design, education and training programs, and
consulting services.
We also have a long-term service agreement with an optometric practice
located in Illinois. The optometric practice also has a retail optical outlet
that sells eyeglasses and other product to patients. We provide all of the
services, facilities and equipment necessary to operate this optometric practice
under a 25-year service agreement. The services include:
o billing, collection and cash management services
o procuring and maintaining all office space, equipment and supplies
o subject to federal and state law, recruiting, employing, supervising
and training all non-professional personnel
o assisting in recruiting additional doctors
o all administrative and support services
o information technology services
Other
We have a 40-year service agreement in place with an ophthalmology
practice with multiple locations in Georgia and Tennessee. We provide all of the
services, facilities and equipment necessary to operate this medical practice,
including services identical in nature to those described above with respect to
our Illinois affiliated optometric practice. We also have a five-year
administrative services agreement with a former affiliated practice under which
we provide limited administrative and financial services to the practice.
Our affiliated eye care professionals provide a wide range of eye care
services to patients including basic eye examinations, the diagnosis and
treatment of complex eye conditions and eye surgery, primarily cataract surgery.
Our affiliated eye care professionals currently practice in eye care clinics
that are leased and staffed by us. We also own all of the non-medical assets
used by the clinics, including all equipment and working capital.
8
Our Growth Strategy
Surgical Facilities
We are focused on acquiring, developing and operating ambulatory surgery
centers. Currently, all of our ASCs are single-specialty ophthalmic surgical
facilities. Although we intend to continue to pursue the acquisition and
development of eye care ASCs, we are also investigating opportunities in other
specialties. The key elements of our growth strategy are:
o Acquiring majority interests in ASCs with the existing physician-owners
retaining a minority ownership position;
o Developing newly constructed ASCs through joint ownership arrangements
with physicians; and
o Increasing the revenue and profitability of our existing ASCs.
Acquiring Majority Interests in ASCs
Having substantially completed our discontinued operations plan, our
development staff now has the time and resources to identify, evaluate and
negotiate the acquisition of majority interests in ASCs in new or existing
markets. In certain instances, we may also consider acquiring a minority, rather
than a majority, equity interest. The acquisition of a well-established,
single-specialty ASC is an attractive means of entry into a new market,
particularly in states that require a certificate of need, or CON, for
development. In analyzing potential transactions, the evaluation of our
prospective doctor-partners is a critical factor. We recognize that the success
of the targeted ASC is tied directly to the success of our doctor-partners and
their practices. We believe our management services experience greatly enhances
our doctor evaluation process.
We also assess the target's potential for future growth. We identify
opportunities to add new doctors or surgical procedures, or to improve managed
care participation. We also examine the opportunities to reduce expenses through
improved staff efficiency, better doctor scheduling and reduced supply costs.
Our development staff and operations personnel work closely to formulate a
growth strategy for each newly acquired facility to maximize our return on
investment.
We currently intend to finance our future acquisitions of equity interests
in ASCs using cash from our existing cash balance, cash generated from our
operations and amounts borrowed under our credit facility. Although we currently
have no borrowings under our credit facility, our existing credit facility
includes limitations on the amount of acquisitions we can complete in the event
our ratio of total debt to earnings exceeds certain thresholds. Our credit
facility expires on June 30, 2003. We are currently in discussions with lenders
regarding the terms of a new credit facility.
Developing Newly Constructed ASCs
Our development staff is also responsible for identifying potential
opportunities to build new ASCs with physician partners. These projects involve
the assembly of multiple physicians in a local community that is either
underserved from a facility standpoint, or involve physicians who don't have the
resources, productivity or expertise to construct a facility on their own and
need a corporate partner to help finance, structure and oversee the project.
Generally, development of a new ASC can be an attractive alternative in states
that do not require a CON to build a new center.
Increasing Revenue and Profitability of our Existing ASCs
The revenue generated by our existing eye-only ASCs is largely driven by
cataract and laser vision correction surgical procedures performed by a limited
number of ophthalmologists. Revenue growth will be
9
derived from an increase in surgical procedures performed at each facility,
whether this increase is from the existing surgeons or new surgeons utilizing
the facility. All of our ASCs currently have the capacity to handle additional
procedures. Given this capacity, we attempt to introduce the benefits of our
facilities to new doctors who may be using other less efficient and convenient
facilities. We believe the efficiency and convenience of an ASC, and the
opportunity to work in facilities affiliated with a national ASC operator with
significant management expertise, are appealing to physicians and their patients
and provides a more attractive setting than hospitals. We also work with our
physicians in identifying new procedures, technologies or equipment to integrate
into our facilities and expanding the scope of surgical services available in a
cost-effective manner. Moreover, with over ninety percent of our ASC revenue
derived from government and private third party payors, we are continuously
evaluating and attempting to increase the levels of our managed care panel
participation.
Twelve of our sixteen centers are currently accredited by the
Accreditation Association for Ambulatory Health Care, or AAAHC. We believe that
many managed care panels use AAAHC accreditation as a quality benchmark. Because
some managed care panels do not contract with a facility that is not accredited,
we believe our emphasis on having our facilities accredited in certain
competitive managed care markets will maximize our managed care panel
participation and also reflects our commitment to providing high quality patient
care.
Staffing and medical supply costs are generally an ASC's two largest
expense categories. We analyze staffing schedules and work with surgeons to
schedule surgeries in a manner that maximizes staff efficiency and optimizes
staffing costs. We also have negotiated purchasing contracts with many of our
largest vendors and we educate our doctors on lower cost supply alternatives
that still maintain high patient care standards.
Product Sales
We believe there are opportunities to grow our optical products and
services business by adding ophthalmologists and optometrists as customers, as
well as offering a broader range of products and services to our existing
customer base.
Competition
Surgical Facilities. In acquiring and developing ASCs, we compete with
both corporations and surgeons. There are several publicly held and private
companies actively engaged in the acquisition, development and operation of
ASCs. Some of these companies may acquire and develop multi-specialty ASCs,
practice-based ASCs focusing on varying specialties, or a combination of the
two. Moreover, some of these companies have the acquisition and development of
ASCs as their core business, while other competitors are larger, publicly held
companies that have subsidiaries or divisions engaged in this business. Many of
these competitors have greater resources than us. Our primary competitors in
acquiring, owning and operating ASCs are Amsurg Corp., United Surgical Partners
International, Inc., HealthSouth Corporation and Symbion, Inc.
Product Sales. Our two wholesale optical laboratories face a variety of
national, regional and local competitors. We compete in the optical laboratory
market on the bases of quality of service, breadth of services, reputation and
price.
In the market for providing optical group purchasing services, we
primarily compete with national and regional buying groups, as well as large
vendors. Competition in this market is based upon service, price, and the
strength of the purchasing organization, including the ability to negotiate
discounts.
Other. Our management services are provided to eye care professionals
through long-term affiliations. The market for these management services is
fragmented, and we do not face any single, dominant U.S. national competitor.
Eye care professionals may seek a corporate partner to assist them in the growth
and development of their practices, as well as with the day-to-day management
and administration of their businesses. Factors that
10
may influence an eye care professional's decision to retain a corporate partner
to provide management services are the corporate partner's experience and scope
and quality of services offered, the eye care professional's need for these
services, and the price for such services.
Employees
As of March 21, 2003, we had approximately 414 employees, 298 of whom are
full-time employees. We are not a party to any collective bargaining agreements
and we consider our relations with our employees to be good. As part of the
seventeen divestiture transactions closed as of March 21, 2003, we terminated
570 employees, the overwhelming majority of whom have been hired by our former
affiliated practices. Upon consummating all of our contemplated divestiture
transactions and completing our discontinued operations plan, we anticipate
employing approximately 360 employees in connection with our continuing
operations, approximately 260 of whom will be full-time employees. In addition,
approximately 240 of our 360 employees will be staffing our ASCs and affiliated
practices.
Governmental Regulation
As a participant in the health care industry, our operations are subject
to extensive and increasing regulation by governmental entities at the federal,
state and local levels. Many of these laws and regulations are subject to
varying interpretations, and we believe courts and regulatory authorities
generally have provided little clarification. Moreover, state and local laws and
interpretations vary from jurisdiction to jurisdiction. As a result, we may not
always be able to accurately predict interpretations of applicable law.
We believe our business practices comply in all material respects with
applicable federal, state and local laws and regulations. If the legal
compliance of any of our activities were challenged, however, we might have to
divert substantial time, attention and resources from running our business to
defend against these challenges regardless of their merit. If we do not
successfully defend these challenges, we might face a variety of adverse
consequences including losing our eligibility to participate in Medicare,
Medicaid or other federal or state health care programs, or losing other
contracting privileges and, in some instances, civil or criminal fines. Any of
these consequences could have a material adverse effect on our business,
financial condition and results of operations.
The regulatory environment in which we operate may change significantly in
the future. Numerous legislative proposals have been introduced in the U.S.
Congress and in various state legislatures over the past several years that
could cause major reforms of the U.S. health care system. In addition, several
sets of regulations have been recently adopted that may require substantial
changes in the way health care providers operate over the coming years. In
response to new or revised laws, regulations or interpretations, we could be
required to revise the structure of our legal arrangements, repurchase minority
equity interests in our ASCs that are owned by physicians, incur substantial
legal fees, fines or other costs, or curtail our business activities, reducing
the potential profit to us of some of our legal arrangements, any of which could
have a material adverse effect on our business, financial condition and results
of operations.
The following is a summary of some of the health care regulatory issues
affecting our operations and us.
Federal Law
Anti-Kickback Statute. The federal anti-kickback statute prohibits the
knowing and willful solicitation, receipt, offer or payment of any direct or
indirect remuneration in return for the referral of patients or the ordering or
purchasing of items or services payable under Medicare, Medicaid or other
federal health care programs. Violations of this statute may result in criminal
penalties, including imprisonment or criminal fines of up to $25,000 per
violation, civil penalties of up to $50,000 per violation plus up to three times
the amount of the underlying remuneration, and exclusion from federal or state
programs including Medicare or Medicaid.
11
The federal anti-kickback statute contains a number of exceptions. In
order to address the problems created by the broad language of the statute,
Congress directed the Department of Health and Human Services, or DHHS, to
develop regulatory exceptions, known as safe harbors, to the federal
anti-kickback statute's referral prohibitions. When possible, we have attempted
to structure our business operations within a safe harbor. However, some aspects
of our business either do not meet the prescribed safe harbor standards, or
relate to practices for which no safe harbor standards have been proposed.
Because there is no legal requirement that relationships fit within a safe
harbor, a business arrangement that does not comply with the relevant safe
harbor, or for which a safe harbor does not exist, does not necessarily violate
the anti-kickback statute.
Included among the safe harbors to the anti-kickback statute are certain
safe harbors for investment interests in general, and for investment interests
in ASCs, specifically. We currently co-own eleven of our ASCs with one or more
physicians, and we will likely co-own with physicians most of the ASCs that we
will acquire in the future. We will also likely be selling interests in our
existing wholly-owned ASCs to physicians in the near- to intermediate-term. It
is unlikely that our co-ownership will meet all of the parameters of the general
investment interest safe harbors or the ASC investment interest safe harbors. As
discussed above, however, an arrangement that does not fit squarely within a
safe harbor is not per se unlawful under the anti-kickback statute. It is our
intent to structure all such co-ownership arrangements in a manner that complies
with as many of the safe harbor components as possible, that meets the
objectives of the anti-kickback statute, and that follows the other available
regulatory guidance regarding ASC co-ownership arrangements to the greatest
extent possible.
The applicable regulatory authorities have provided little guidance
regarding ASC ownership arrangements that are permissible under the
anti-kickback statute. Based on the limited guidance that is available, we
believe that our joint ownership complies with the anti-kickback law based on,
among other things, the following factors: all of the jointly owned ASCs are
Medicare certified; patients referred to an ASC by an investor are informed of
the referring physician's investment interest in the ASC; the terms on which an
investment interest in the ASC is offered to an investor are not related to the
previous or expected volume of referrals or services by, or other business with,
the investor; neither any of the investors (including us) nor the ASC entity
will loan money to any investors or guarantee debt of any investors incurred to
purchase the investment interest; the return on investment in the ASC is
directly proportional to the investors' investment interests; the ASCs treat
federal health program beneficiaries in a non-discriminatory manner; and the
ASCs are an integral part of the investor-physicians' practices and account for
a significant portion of the investor-physicians' medical practice income.
Self-Referral Law. Subject to limited exceptions, the federal
self-referral law, known as the "Stark Law," prohibits physicians and
optometrists from referring their Medicare or Medicaid patients for the
provision of "designated health services" to any entity with which they or their
immediate family members have a financial relationship. "Financial
relationships" include both compensation and ownership relationships.
"Designated health services" include clinical laboratory services, radiology and
ultrasound services, durable medical equipment and supplies, and prosthetics,
orthotics and prosthetic devices, as well as seven other categories of services.
Physicians do not currently refer to our ASCs for the provision of "designated
health services" that do not otherwise meet an exception under the Stark Law.
The Stark law does not prohibit physician ownership or investment
interests in ASCs to which they refer patients. The Centers for Medicare and
Medicaid Services clarified this in the Phase I regulations interpreting the
Stark law by providing that services that would otherwise constitute a
"designated health service," but that are paid by Medicare as part of bundled
rate, will not be considered designated health services for purposes of the
Stark Law. Thus, when an intraocular lens, or IOL, used in cataract surgery is
included in an ASC bundled payment rate, the IOL will not be considered to be a
"designated health service."
Violating the Stark Law may result in denial of payment for the designated
health services performed,
12
civil fines of up to $15,000 for each service provided pursuant to a prohibited
referral, a fine of up to $100,000 for participation in a circumvention scheme,
and exclusion from the Medicare, Medicaid and other federal health care
programs. The Stark Law is a strict liability statute. Any referral made where a
financial relationship exists that fails to meet an exception constitutes a
violation of the law.
Civil False Claims Act. The Federal Civil False Claims Act prohibits
knowingly presenting or causing to be presented any false or fraudulent claim
for payment by the government, or using any false or fraudulent record in order
to have a false or fraudulent claim paid. Violations of the law may result in
repayment of three times the damages suffered by the government and penalties
from $5,000 to $10,000 per false claim. Collateral consequences of a violation
of the False Claims Act include administrative penalties and possible exclusion
from participation in Medicare, Medicaid and other federal health care programs.
Health Insurance Portability and Accountability Act. In August of 1996,
Congress enacted the Health Insurance Portability and Accountability Act of 1996
(HIPAA). Included within HIPAA's health care reform provisions are its
"administrative simplification" provisions, which require that health care
transactions be conducted in a standardized format, and that the privacy and
security of certain individually identifiable health information be protected.
Proposed rules for many of the administrative simplification subject areas have
been published.
Final rules covering "Standards for Electronic Transactions and Code Sets"
were published on August 17, 2000, and set forth the standardized billing codes
and formats that we must use when conducting certain health care transactions
and activities. The effective date of these final rules was October 16, 2000.
Compliance with these rules was required by October 16, 2002, but by filing an
extension plan by October 16, 2002, we extended this compliance date to October
16, 2003 for our ASCs and affiliated practices.
On December 28, 2000, as modified on May 31, 2002 and August 14, 2002, the
DHHS published final rules addressing "Standards for Privacy of Individually
Identifiable Health Information" under HIPAA's administrative simplification
provisions. Compliance with these rules is required by April 14, 2003. These
rules create substantial new compliance issues for all "covered entities"--which
include health care providers, health plans, and health care
clearinghouses--that engage in regulated transactions and activities. Operations
of our ASCs and affiliated practices are covered by the final rules.
Final rules addressing the "Security Standards" under HIPAA's
administrative simplification provisions were published on February 20, 2003.
Our ASCs and affiliated practices must comply with these regulations by April
21, 2005. Because these rules have been released very recently, we are still in
the process of determining what impact these rules will have on our operations.
Violations of HIPAA's administrative simplification provisions can result
in civil penalties of up to $25,000 per person per year for each violation or
criminal penalties of up to $250,000 and/or up to 10 years in prison per
violation.
State Law
Facility Licensure and Certificate of Need. We are required to obtain
licenses from the state departments of health in states where we open or acquire
ASCs. We believe that we have obtained the necessary licenses in states where
licenses are required. With respect to future expansion, we cannot assure you
that we will be able to obtain the required licenses. However, we have no reason
to believe that, in states requiring facility licenses, we will not be able to
obtain these licenses without unreasonable expense or delay.
Some states require a Certificate of Need, or CON, prior to the
construction or modification of an ASC or the purchase of specified medical
equipment in excess of a dollar amount set by the state. We believe that we have
13
obtained the necessary CONs in states where a CON is required. However, we
believe courts and state regulatory authorities generally have provided little
clarification as to some of the regulations governing the need for CONs. It is
possible that a state regulatory authority could challenge our determination.
With respect to our future development of new ASCs or expansion of existing
ASCs, we cannot assure you that we will be able to acquire a CON in all states
where a CON is required.
Anti-Kickback Laws. In addition to the federal anti-kickback law, a number
of states have enacted laws that prohibit payment for referrals and other types
of kickback arrangements. Some of these state laws apply to all patients
regardless of their source of payment, while others limit their scope to
patients whose care is paid for by particular payors.
Self-Referral Laws. In addition to the Federal Stark Law, a number of
states have enacted laws that require disclosure of or prohibit referrals by
health care providers to entities in which the providers have an investment
interest or compensation relationship. In some states, these restrictions apply
regardless of the patient's source of payment.
State Privacy Laws. Numerous states have enacted privacy laws that have
similar objectives to the Federal HIPAA privacy regulations. These laws, which
vary from state to state, require that certain protective measures be taken in
connection with the disclosure of a patient's identifying information.
Corporate Practice of Medicine. A number of states have enacted laws that
prohibit, or have common law that prohibits, the corporate practice of medicine.
These laws are designed to prevent interference in the medical decision-making
process by anyone who is not a licensed physician. Application of the corporate
practice of medicine prohibition varies from state to state. Although we neither
employ physicians nor provide professional medical services, we continue to
provide services to physicians in connection with their performance of surgical
procedures through fixed-site laser agreements and through our remaining
management services agreements. To the extent any act or service to be performed
by us is construed by a court or enforcement agency to constitute the practice
of medicine, we cannot be sure that a particular state court or enforcement
agency may not construe our arrangements as violating that jurisdiction's
corporate practice of medicine doctrine. In such an event, we may be required to
redesign or reformulate our relationships with these eye care professionals and
there is a possibility that some provisions of our agreements may not be
enforceable.
Fee-Splitting Laws. The laws of some states prohibit providers from
dividing with anyone, other than providers who are part of the same group
practice, any fee, commission, rebate or other form of compensation for any
services not actually and personally rendered. Penalties for violating these
fee-splitting statutes or regulations may include revocation, suspension or
probation of a provider's license, or other disciplinary action. In addition,
courts have refused to enforce contracts found to violate state fee-splitting
prohibitions. The precise language and judicial interpretation of fee-splitting
prohibitions varies from state to state. Courts in some states have interpreted
fee-splitting statutes to prohibit all percentage of gross revenue and
percentage of net profit management fee arrangements. Other state statutes only
prohibit fee splitting in return for referrals. To the extent any of our
contractual arrangements are construed by a court or enforcement agency to
violate the jurisdiction's fee-splitting laws, we may be required to redesign or
reformulate our arrangements and there is a possibility that some provisions of
our agreements may not be enforceable.
Excimer Laser Regulation
Medical devices, including the excimer lasers used in our ASCs, are
subject to regulation by the U.S. Food and Drug Administration, or the FDA.
Medical devices may not be marketed for commercial sale in the U.S. until the
FDA grants pre-market approval for the device.
Failure to comply with applicable FDA requirements could subject us or
laser manufacturers to
14
enforcement action, product seizures, recalls, withdrawal of approvals and civil
and criminal penalties. Further, failure to comply with regulatory requirements,
or any adverse regulatory action, could result in a limitation on or prohibition
of our use of excimer lasers.
Government Regulation - Management Services
In addition, our management services business in both our continuing and
discontinued operations, and the operations of our affiliated providers, are
also subject to extensive and continuing regulation by governmental entities at
the federal, state and local levels. The following is a summary of the health
care regulatory issues affecting our management services business, both with
respect to our affiliated providers and us:
Federal Law
Anti-Kickback Statute. As discussed above, there are safe harbor
regulations to the federal anti-kickback statute. When possible, we have
attempted to structure our management services business and our relationships
with our affiliated providers within a safe harbor. Some aspects of our
management services business, the business of our affiliated providers, and our
relationships with our affiliated providers either do not meet the prescribed
safe harbor standards, or relate to practices for which no safe harbor standards
have been proposed. Because there is no legal requirement that relationships fit
within a safe harbor, a business arrangement that does not comply with the
relevant safe harbor, or for which a safe harbor does not exist, does not
necessarily violate the anti-kickback statute.
Self-Referral Law. Our affiliated providers provide limited categories of
designated health services, specifically, diagnostic radiology services,
including A-scans and B-scans, and prosthetic devices, including eyeglasses and
contact lenses furnished to patients following cataract surgery. Compensation
arrangements between our affiliated providers and their employers have
historically been structured to comply with the Stark Law.
Civil False Claims Act. The Federal Civil False Claims Act prohibits
knowingly presenting or causing to be presented any false or fraudulent claim
for payment by the government, or using any false or fraudulent record in order
to have a false or fraudulent claim paid.
Health Insurance Portability and Accountability Act. The operations of our
affiliated providers are covered by HIPAA. We have taken actions to assist our
remaining affiliated providers with their HIPAA compliance efforts.
15
State Law
State Privacy Laws. State health information privacy laws may also apply
to the activities of our affiliated providers. There is very little guidance
regarding the application of these state privacy laws. We cannot be sure that
the privacy measures taken by our affiliated providers will be construed as
complying with these laws. In the event the privacy measures taken by these
professionals are deemed not to comply with a particular state's health privacy
laws, we may need to incur significant time, effort and expense to establish
compliance.
Corporate Practice of Medicine Laws. Although we neither employ doctors
nor provide professional medical services, to the extent any portion of the
comprehensive management services that we provide under our service agreements
is construed by a court or enforcement agency to constitute the practice of
medicine, our service agreements provide that our obligations to perform the act
or service is waived. We cannot be sure that a particular state court or
enforcement agency may not construe our arrangements as violating that
jurisdiction's corporate practice of medicine doctrine. In such an event, we may
be required to redesign or reformulate our relationships with our affiliated
providers and there is a possibility that some provisions of our service
agreements may not be enforceable.
Fee-Splitting Laws. We believe our management fee arrangements differ from
those invalidated as unlawful fee splits because they establish a flat monthly
fee that is subject to adjustment based on the degree to which actual practice
revenues or expenses vary from budget. However, there is some risk that our
arrangements could be construed by a state court or enforcement agency to run
afoul of state fee-splitting prohibitions. Accordingly, all of our service
agreements contain either a reformation provision or a mechanism establishing an
alternative fee structure, or both.
Item 2. Properties
We do not own any real property. We lease space for our corporate offices
in Chicago, our ASCs and our optical services operations. As part of our
management services business, we also continue to lease the clinics of our
affiliated providers. In some cases, these facilities are leased from related
parties. See "Item 13 - Certain Relationships and Related Transactions." Our
corporate offices in the Chicago metropolitan area currently consist of 12,824
square feet in downtown Chicago, and 10,499 square feet in Des Plaines,
Illinois. We believe that our current corporate facilities are sufficient to
meet our needs for the foreseeable future. Because we have reduced our corporate
personnel as a result of the substantial completion of our discontinued
operations plan, we need less space for our corporate offices. Accordingly, we
are reducing our downtown Chicago office space by 4,674 square feet effective
July 31, 2003, and attempting to sublet approximately 4,500 square feet of our
Des Plaines location.
The terms and conditions of our real property leases vary. The forms of
lease range from "modified triple net" to "gross" leases, with terms generally
ranging from month-to-month to ten years, with certain leases having multiple
five-year renewal terms at our option. Generally, our ASCs and eye care clinics
are located in medical complexes, office buildings or free-standing buildings.
The square footage of these offices range from less than 100 square feet to
approximately 15,000 square feet, and the terms of these leases have expiration
dates ranging from May 30, 2003 to March 31, 2012. Depending on state licensing
and Certificate of Need issues, addressing capacity constraints in any of our
ASCs in a similar manner may require state regulatory approval.
16
The following tables list the locations of our surgical facilities:
Medicare-Certified and Licensed ASCs
Number of
Location Operating Rooms
--------------------------------------
Colorado Springs, CO 2
Atlanta, GA 2
Columbus, GA 3
Chicago, IL 1
Maryville, IL 1
River Forest, IL 2
Merrillville, IN 2
New Albany, IN 2
Overland Park, KS 3
Thibodaux, LA 1
Florissant, MO 1
Kansas City, MO 2
St. Joseph, MO 1
Chattanooga, TN 1
Tyler, TX 2
Richmond, VA 1
Item 3. Legal Proceedings
We are not a party to any lawsuits or administrative actions pending, or
to our knowledge, threatened, which we would expect to have a material adverse
effect upon our business, financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
We did not submit any matter to a vote of our security holders during the
fourth quarter of 2002.
17
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Price Range of Common Stock
Since August 18, 1999, our common stock has been traded on the Nasdaq
National Market under the symbol NOVA. The following table sets forth, for the
periods indicated, the range of high and low sale prices for our common stock on
the Nasdaq National Market:
High Low
---- ---
Fiscal year ending December 31, 2002:
First Quarter .................................... $1.45 $0.52
Second Quarter ................................... $1.13 $0.67
Third Quarter .................................... $1.55 $0.65
Fourth Quarter ................................... $1.75 $1.11
Fiscal year ending December 31, 2001:
First Quarter .................................... $3.63 $1.06
Second Quarter ................................... $3.42 $1.06
Third Quarter .................................... $2.49 $1.35
Fourth Quarter ................................... $2.07 $1.01
On March 31, 2003, the last reported sale price of our common stock was
$1.24, and there were approximately 342 holders of record of our common stock.
This figure does not consider the number of individual holders of securities
that are held in the "street name" of a securities dealer.
Dividends
We have never paid a cash dividend on our common stock. We plan to retain
all future earnings to finance the development and growth of our business.
Therefore, we do not currently anticipate paying any cash dividends on our
common stock. Any future determination as to the payment of dividends will be at
our board of directors' discretion and will depend on our results of operations,
financial condition, capital requirements and other factors our board of
directors considers relevant. Moreover, our credit agreement prohibits the
payment of dividends on our common stock.
ITEM 6. SELECTED FINANCIAL DATA
The consolidated statement of operations data set forth below for the
years ended December 31, 2002, 2001 and 2000 and the balance sheet data at
December 31, 2002 and 2001, are derived from our respective audited consolidated
financial statements which are included elsewhere herein. The consolidated
statement of operations data set forth below with respect to the years ended
December 31, 1999 and 1998 and the consolidated balance sheet data at December
31, 2000, 1999 and 1998 are derived from our audited financial statements which
are not included in this Form 10-K.
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" included
elsewhere herein.
Year Ended December 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
(unaudited) (unaudited)
----------- ----------- ----------- ----------- -----------
(in thousands, except per share data)
Consolidated Statement of Operations Data:
Net revenue ........................................ $ 53,773 $ 53,440 $ 50,987 $ 36,541 $ 19,117
=========== =========== =========== =========== ===========
Net income (loss) from continuing operations (a) (b) $ 3,657 $ (7,093) $ 2,256 $ (831) $ (611)
=========== =========== =========== =========== ===========
Net income (loss) from continuing operations
per dilutive share (a) (b) ..................... $ 0.15 $ (0.29) $ 0.09 $ (0.27) $ (0.09)
=========== =========== =========== =========== ===========
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Other Data:
Number of surgical facilities operated
as of the end of period:
ASCs ......................................... 16 14 13 11 9
Fixed site laser agreements and LVC centers .. 9 13 19 7 --
Number of surgical procedures performed:
Cataracts .................................... 20,689 18,323 15,925 14,450 12,412
LVC .......................................... 8,385 15,199 20,045 12,586 4,640
Other eye surgery procedures ................. 10,070 9,609 7,275 7,308 8,675
----------- ----------- ----------- ----------- -----------
Total ..................................... 39,144 43,131 43,245 34,344 25,727
=========== =========== =========== =========== ===========
As of December 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
(unaudited) (unaudited)
----------- ----------- ----------- ----------- -----------
Consolidated Balance Sheet Data:
Working capital .................................... $ 7,226 $ 12,698 $ 23,725 $ 11,973 $ 9,186
Total assets ....................................... 64,128 92,252 120,913 88,251 62,679
Total debt, excluding current portion .............. 11 20,708 26,184 188 20,393
Redeemable convertible preferred stock ............. -- -- -- -- 16,430
Total stockholders' equity ......................... 48,648 50,579 82,864 74,781 16,954
Notes:
(a) In connection with our discontinued operations and restructuring plan
announced in October 2001, we recorded certain restructuring and other
charges related to the closure of certain facilities and the
reorganization and downsizing of our information technology function.
(b) In connection with our initial public offering consummated on August 18,
1999 (IPO), we recorded noncash, nonrecurring charges for compensation
expense related to stock options and a discount to the IPO offering price
upon the exchange of subordinated notes for common stock in 1999 and 1998.
In addition, we recorded accretion of Series C and Series D convertible
preferred stock to increase the carrying value of such stock to its
potentially redeemable value.
18
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion along with our consolidated
financial statements and related notes included elsewhere herein. Our actual
results, performance and achievements in 2003 and beyond may differ materially
from those expressed in or implied by forward-looking statements contained in
this discussion. Such forward-looking statements are made within the meaning of
the Private Securities Litigation Reform Act of 1995.
Critical Accounting Policies and Estimates
Management's discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the U.S.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosures. On an ongoing basis, we evaluate our estimates
and judgments based on historical experience and various other factors that are
believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions.
We annually review our financial reporting and disclosure practices and
accounting policies to ensure that our financial reporting and disclosures
provide accurate and transparent information relative to the current economic
and business environment. We believe that of our significant accounting policies
(see Note 2 in the Notes to the Consolidated Financial Statements beginning on
page F-6), the following policies involve a higher degree of judgment and/or
complexity.
Revenue Recognition and Accounts Receivable, Net of Allowances. Revenue from
surgical procedures performed at our surgical facilities, net of contractual
allowances, is recognized at the time the procedure is performed. The
contractual allowance is the difference between the fee we charge for a
procedure performed at our surgical facility and the amount we expect to be paid
by the patient or the applicable third-party payor, which includes Medicare and
private insurance. We base our estimates for the contractual allowance on the
Medicare reimbursement rates for the applicable procedure when Medicare is the
payor, our contracted rate with other third party payors or our historical
experience when we do not have a specific contracted rate. Our optical products
purchasing organization negotiates buying discounts with optical product
manufacturers. The buying discounts and any handling charges billed to the
members of the buying group represent the revenue recognized. Product sales
revenue from our wholesale optical laboratories and marketing services company,
net of an allowance for returns and discounts, is recognized when the product is
shipped to our customer. We base our estimates for sales returns and discounts
on historical experience and have not experienced significant fluctuations
between estimated and actual return activity and discounts given. Surgical
facilities and product sales revenue is further adjusted by a provision for
doubtful accounts. We base our estimate for doubtful accounts on the aging
category and our historical collection experience. If we fail to accurately file
for reimbursement on a timely basis with third party payors there may be an
adverse affect on our collection results.
19
Accounts receivable has been reduced by the reserves for estimated
contractual allowances and doubtful accounts noted above.
Property and equipment. Property and equipment are depreciated or
amortized over their useful lives based on management's estimates of the period
over which the assets will generate revenue. We periodically review these lives
relative to physical factors, economic factors and industry trends.
Asset impairment. In assessing the recoverability of our fixed assets,
goodwill and other noncurrent assets, we consider changes in economic conditions
and make assumptions regarding estimated future cash flows and other factors. If
these estimates or their related assumptions change in the future, we may be
required to record impairment charges.
Restructuring and discontinued operations reserves. In 2001, we recorded a
$10.9 million pretax charge related to our restructuring plan and a $27.2
million net loss to account for the contemplated disposal of our discontinued
operations. These estimated losses were based on the best information available
to management at the date the plan of discontinued operations and restructuring
was announced. The actual results could differ from our initial estimate and
those differences could be material to the financial statements. We evaluate the
estimates at least quarterly. If it is determined that the loss should be
adjusted based on changes in facts or circumstances, such adjustment will be
recorded at that time.
Income taxes. We record a valuation allowance to reduce our deferred tax
assets if it is more likely than not that some portion or all of the deferred
tax assets will not be realized. While we have considered future taxable income
and ongoing feasible tax strategies in assessing the need for the valuation
allowance, if these estimates and assumptions change in the future, we may be
required to adjust our valuation allowance. This could result in a charge to, or
an increase in, income in the period such determination is made.
Results of Operations
Year Ended December 31, 2002 Compared to the Year Ended December 31, 2001
Net Revenue. Net revenue increased 0.6% from $53.4 million to $53.8
million. Surgical facilities revenue decreased 0.4% from $33.8 million to $33.7
million, primarily due to a decrease in surgical procedures performed, offset by
an increase in net revenue per procedure. In 2001, net revenue per procedure was
reduced by the establishment of additional contractual allowance reserves of
$1.4 million. In 2002, total surgical procedures performed in our surgical
facilities decreased 9.2% from 43,131 to 39,144. LVC procedures decreased 44.8%,
cataract procedures increased 12.9% and other procedures increased 4.8%,
compared to 2001. The increase in procedures came from newly acquired ASCs.
Management believes that the demand for elective LVC surgery continues to be
negatively impacted by the general economic conditions. Due to the decrease in
demand, we have closed eight LVC centers since the announcement of our
discontinued operations and restructuring plan. Product sales and other revenue
increased 2.3% from $19.7 million to $20.1 million. Net revenues at our optical
products purchasing organization increased 18.0% over 2001. This increase was
offset by a 28.3% decrease in revenue at our marketing products business, which
has sold products primarily to the laser vision correction market. Management
believes the downturn in the LVC market was the cause of the decline in revenue
of this business.
20
Salaries, Wages and Benefits. Salaries, wages and benefits expense
decreased 5.6% from $21.4 million to $20.2 million. As a percentage of revenue,
salaries, wages and benefits expense decreased from 40.0% to 37.5%. The decrease
in salaries, wages and benefits expense is the result of certain corporate
salaries being charged to the discontinued operations reserves in accordance
with the discontinued operations and restructuring plan, staff reductions at
some surgical facilities in response to the reduction in LVC procedures and the
closure of several LVC centers in the fourth quarter of 2001 and during 2002.
These decreases were offset, in part, by the increase in salaries, wages and
benefits expense from the acquisitions we made in 2002.
Cost of Sales and Medical Supplies. Cost of sales and medical supplies
expense increased 1.7% from $13.9 million to $14.1 million. As a percentage of
revenue, cost of sales and medical supplies expense increased from 26.0% to
26.3%. The absolute increase in cost of sales and medical supplies expense is
primarily a result of 2002 acquisitions offset in part by the closure of
under-performing LVC centers. The increase in cost of sales and medical supplies
as a percentage of revenue is due to our lower profit margin product sales and
other revenue increasing to 37.4% of total revenue in 2002, up from 36.8% in
2001.
Selling, General and Administrative. Selling, general and administrative
expense decreased 2.9% from $11.9 million to $11.5 million. As a percentage of
revenue, selling, general and administrative expense decreased from 22.2% to
21.4%. The decrease was the result of a $1.3 million reduction in corporate
administrative expenses and bad debt expense, offset by expenses from our 2002
acquisitions.
Restructuring and Other Charges. We reevaluated our restructuring plan at
the end of 2002 and determined we had excess reserves of $1.0 million. The
excess reserves were primarily due to better than expected results resolving
outstanding lease obligations and the decision to retain one ASC slated for
closure.
Depreciation and Amortization. Depreciation and amortization expense
decreased 43.9% from $4.4 million to $2.5 million. The required cessation of
goodwill amortization as of January 1, 2002 contributed $1.1 million of this
decrease. The remainder of the decrease is due to the write-off of assets at the
end of our 2001 third quarter related to our discontinued operations and
restructuring plan.
Other (Income) Expense. We recognized $0.9 million of other income during
2002 versus $1.0 million of other expense during 2001. The current year income
includes an aggregate gain of $1.6 million from the sales of minority interests
in our ASCs and $0.4 million of income from proceeds received from a class
action lawsuit settlement. There is $0.9 million of minority interest in the
earnings of our ASCs reported in 2002. Interest expense decreased by $0.5
million, the result of lower average interest rates during 2002 (5.1%) as
compared to 2001 (6.5%) as well as lower average borrowing of $10.2 million
during 2002 as compared to $25.7 million during 2001.
Provision for Income Taxes. Our effective tax rate increased to 40.0% from
39.3%. Our effective tax rate is affected by expenses that are deducted from
operations in arriving at pre-tax income that are not allowed as a deduction on
our federal income tax return.
21
Year Ended December 31, 2001 Compared to the Year Ended December 31, 2000
Net Revenue. Net revenue increased 4.8% from $51.0 million to $53.4
million. Surgical facilities revenue decreased 10.8% from $37.9 million to $33.8
million due to the establishment of additional contractual allowance reserves of
$1.4 million as well as a slight decrease in overall surgical procedures. Total
surgical procedures performed in our surgical facilities decreased from 43,245
to 43,131. LVC procedures decreased 24.2%, cataract procedures increased 15.1%
and other procedures increased 32.1%, compared to 2000. Management believes that
the demand for elective LVC surgery was negatively impacted by the general
economic conditions in 2001. Due to the decrease in demand, we closed four LVC
centers in 2001. Product sales and other revenue increased 49.9% from $13.1
million to $19.7 million. This increase was due to the full year contribution to
other revenue from management fees received from a physician practice with which
we affiliated in November 2000 offset by a 4.7% decrease in product sales
revenue.
Salaries, Wages and Benefits. Salaries, wages and benefits expense
increased 17.9% from $18.1 million to $21.4 million. As a percentage of revenue,
salaries, wages and benefits expense increased from 35.5% to 40.0%. The increase
in salaries, wages and benefits expense is due to acquisitions made in 2000
offset, in part, by staff reductions at some surgical facilities in response to
the reduction in LVC procedures as well as corporate staff reductions. In
addition, corporate salaries were further reduced in the fourth quarter as a
result of our discontinued operations and restructuring plan.
Cost of Sales and Medical Supplies. Cost of sales and medical supplies
expense increased 0.6% from $13.8 million to $13.9 million. As a percentage of
revenue, cost of sales and medical supplies expense decreased from 27.1% to
26.0%. The absolute increase in cost of sales and medical supplies expense is
primarily due to acquisitions made in 2000 which was only partially offset by
the closure of under-performing LVC centers. The decrease in cost of sales and
medical supplies as a percentage of revenue is also due to the acquisition of
surgical facilities and affiliation with a physician practice which have lower
cost of sales than our product sales businesses.
Selling, General and Administrative. Selling, general and administrative
expense increased 11.4% from $10.6 million to $11.9 million. As a percentage of
revenue, selling, general and administrative expense decreased from 20.9% to
22.2%. The increase in selling, general and administrative expense was the
result of a $2.0 million increase for expenses at facilities acquired or
developed late in 2000 or during 2001 and a $0.5 million increase in bad debt
reserves at our product sales segment. These increases were offset, in part, by
a $1.3 million reduction in administrative expenses related to the corporate
staff reductions as well as a decrease in marketing expense.
Restructuring and Other Charges. We recorded $10.9 million of charges in
connection with our announcement to restructure our corporate support functions,
including information technology, and to close under-performing facilities. An
additional $1.7 million of other related charges were recorded which included
professional fees incurred in the development of our discontinued operations and
restructuring plan and severance and other employee costs incurred prior to
approval of this plan.
Depreciation and Amortization. Depreciation and amortization expense
increased 15.3% from $3.8 million to $4.4 million due to the full year impact of
significant capital expenditures in 2000 in the surgical facilities and product
sales segments as well as the impact of surgical facilities acquisitions and
openings in 2000.
22
Other Expense. Other expense increased to $1.0 million from $0.9 million
in 2000. Interest expense remained even at $1.0 million, as average lower
interest rates in 2001 offset a higher average debt balance.
Provision for Income Taxes. Our effective tax rate increased to 39.3% from
39.2%. Our effective tax rate is affected by expenses that are deducted from
operations in arriving at pre-tax income that are not allowed as a deduction on
our federal income tax return, primarily goodwill amortization.
Liquidity and Capital Resources
We generated cash from continuing operating activities for the year ended
December 31, 2002 of $12.4 million. We used $8.0 million in our investing
activities in 2002, which included the purchases of a 60% interest in an ASC in
Tyler, TX and a 51% interest in an ASC in Colorado Springs, CO as well as the
purchase of property and equipment. This was offset, in part, by our receipt of
$2.8 million in proceeds from the sale of minority equity interests in our ASCs
for a net use of $5.2 million in investing activities. We received $14.9 million
from our discontinued operations which included proceeds from divestitures. We
used this cash provided by both continuing and discontinued operations to
decrease net bank borrowings by $20.7 million and at December 31, 2002 we had no
outstanding borrowings under our credit facility. As of December 31, 2002 and
2001, we had cash and cash equivalents of approximately $2.0 million and $1.0
million, respectively, and working capital of approximately $7.2 million and
$12.7 million, respectively.
We amended our revolving credit facility on June 13, 2002. The primary
purpose of this amendment was to obtain the consent of our lenders to our sale
of optical dispensary assets and one of our ambulatory surgery centers and to
increase our ability to sell minority interests in our existing ambulatory
surgery centers. The amendment included a reduction of the maximum commitment
available under the facility from $40 million to $35 million on June 13, 2002
and a further reduction to $30 million on October 1, 2002. The credit agreement
expires on June 30, 2003 and we are currently in discussions with lenders
regarding the terms of a new or extended credit facility.
Under the amended facility, interest on borrowings under the credit
agreement is payable at an annual rate equal to our lender's published base rate
plus the applicable borrowing margin ranging from 0% to 1.0% or LIBOR plus a
range from 1.5% to 3.0%, varying upon our ability to meet financial covenants.
The weighted average interest rate on credit line borrowings was 5.1% for the
twelve months ended December 31, 2002. The credit agreement contains covenants
that include limitations on indebtedness, liens, capital expenditures,
acquisitions and affiliations and ratios that define borrowing availability and
restrictions on the payment of dividends. The credit agreement requires that we
use 100% of the proceeds from our divestiture transactions to pay down our
outstanding debt. As of December 31, 2002, we were in compliance with all our
credit agreement covenants.
We expect our cash flow from operations and funds available under our
existing and new credit facility will be sufficient to fund our operations for
at least 12 months. Our future capital requirements and the adequacy of our
available funds will depend on many factors, including the timing of our
acquisition and expansion activities, capital requirements associated with our
surgical facilities, the future cost of surgical equipment and the cost of
completing our
23
discontinued operations plan. We also expect the cash proceeds from our two
remaining divestiture transactions to supplement our cash flow.
During 2002, we received 2.5 million shares of common stock as a result of
two physician practice divestiture transactions, the sale of an ASC and the sale
of a minority interest in an ASC.
We are a party to option agreements with various physicians pursuant to
which the physicians have the right to purchase or sell equity interests in nine
of our sixteen ASCs. These are summarized as follows:
o One of our former affiliated physicians has the option to
acquire up to a 30% interest in one of our wholly owned ASCs,
exercisable beginning January 1, 2004 through January 1, 2006;
o One of our former affiliated physicians who owns a 5% interest
in one of our ASCs has the option to acquire an additional 5%
interest, exercisable beginning July 1, 2003 through July 1,
2005;
o Two of our former affiliated physicians who own a 49% interest
in one of our ASCs have an option to purchase our remaining
51% interest, exercisable on April 15, 2005;
o One of our former affiliated physicians who owns a 49%
interest in one of our ASCs has an option to purchase our
remaining 51% interest, exercisable at periodic intervals
beginning March 1, 2005 through March 1, 2008;
o One of our existing physician-partners who owns a 40% interest
in one of our ASCs has the right to sell us up to a 10%
interest in the ASC in November 2004 and up to an additional
10% interest in November 2006;
o One of our former affiliated physicians who owns a 10%
interest in one of our ASCs has an option to purchase an
additional 10% interest, exercisable on or before July 1,
2003;
o A physician has an option to purchase a 10% interest in one of
our wholly owned ASCs, exercisable on or before November 12,
2003;
o One of our former affiliated physicians has an option to
purchase a 10% interest in one of our wholly owned ASCs,
exercisable on or before July 31, 2004; and
o One of our former affiliated physicians who owns a 10%
interest in one of our ASCs has an option to purchase an
additional 10% interest, exercisable on or before July 31,
2003.
In the event these options are exercised, we will receive cash proceeds from
these sales. Moreover, in many of these instances, we have corresponding rights
to sell the stated equity interests to the physicians at the same timing
intervals.
We have a nonexclusive supply agreement with Alcon Laboratories, Inc. pursuant
to which we can procure and utilize excimer lasers and other equipment
manufactured by Alcon. We recently amended this agreement to address a number of
factors, most notably: (i) the terms upon which we can purchase from Alcon the
recent FDA-approved LADARWave units for use with our existing LADARVision
Systems; (ii) extending the expiration date from February 28, 2006 to December
31, 2006; and (iii) reducing our minimum annual procedure requirements.
Commencing January 1, 2003 and through the termination date of December 31,
2006, we will pay Alcon monthly based on the number of procedures performed on
each of our APEX/Infinity lasers and LADARVision Systems. We are required to pay
for a minimum number of annual procedures on each LADARVision System during the
remaining term, whether or not these procedures are performed. Assuming we don't
procure additional LADARVision Systems under
24
the agreement, the annual minimum commitment for each of the next four years
commencing with 2003 would be approximately $0.9 million, $1.0 million, $1.2
million and $0.9 million, respectively.
25
New Accounting Pronouncements
Effective January 1, 2002 we adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 142
addresses the financial accounting and reporting for acquired goodwill and other
intangible assets. Under the new rules, we are no longer required to amortize
goodwill and other intangible assets with indefinite lives, but will be subject
to periodic testing for impairment. Under the new pronouncement, goodwill
related to acquisitions after July 1, 2001 has not been amortized. Upon initial
adoption we evaluated the carrying value of our existing goodwill and determined
that the goodwill associated with our marketing products business was impaired
and recorded a net of tax charge of $1.8 million as a change in accounting
principle. Later, as the demand for laser vision correction continued to
decline, we recorded an additional impairment charge of $1.3 million, fully
impairing all goodwill associated with our marketing products business.
Effective January 1, 2002 we adopted Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS 144). This pronouncement establishes a single accounting model of
the impairment of disposal of long-lived assets, including discontinued
operations. Although SFAS 144 supercedes SFAS 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of and Accounting
Principles Board (APB) Opinion 30, Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions, the accounting
treatment related to our decision in September 2001 to discontinue our
management services segment under APB Opinion 30 is not impacted. During 2002 we
sold two ambulatory surgery centers and three optical dispensaries and made the
decision to sell our remaining optical dispensaries. These 2002 transactions are
reported as discontinued operations under the provisions of SFAS 144, and all
prior periods have been revised accordingly.
Under SFAS 144, we are required to revise prior period financial
statements, including our financial statements for the years ended December 31,
2000 and 2001, to reflect these disposed businesses as discontinued operations.
Arthur Andersen LLP was our independent auditor for our 2000 and 2001 financial
statements. Because Arthur Andersen LLP has ceased its audit services and is no
longer in a position to certify the restatement of our 2000 and 2001 financial
statements, our current auditor, PricewaterhouseCoopers LLP ("PwC) re-audited
our 2000 and 2001 financial statements after they were revised in accordance
with SFAS 144. Consequently, the financial statements for the years ended
December 31, 2000 and 2001 contained in this Form 10-K, as revised in accordance
with SFAS 144, have been re-audited by PwC .
In June 2002, the Financial Accounting Standards Board (FASB) Issued
Statement of Financial Accounting Standards No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146). SFAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. SFAS 146 requires that the initial measurement
of a liability be at fair value. SFAS 146 will be effective for exit or disposal
activities that are initiated after December 31, 2002 with early adoption
encouraged. We do not expect that the adoption will have a material impact on
our consolidated results of operations or financial position.
In December 2002, the FASB Issued Statement of Financial Accounting
Standards No. 148, Accounting for Stock-Based Compensation -- Transition and
Disclosure, an amendment of FASB Statement No. 123. This pronouncement provides
alternative methods of transition for an
26
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
SFAS 123 to require prominent disclosure of the effects on reported net income
of an entity's accounting policy decisions with respect to stock-based employee
compensation. We have elected to continue to apply APB Opinion 25 and account
for stock-based compensation under the intrinsic value method. We have amended
our disclosures to those required by SFAS 148.
27
Risk Factors
The following factors should be considered in evaluating our company and
our business. These factors may have a significant impact on our business,
operating results and financial condition.
Risks Relating to Our Business
Our failure to operate, acquire or develop a sufficient number of
profitable surgical facilities could limit our profitability and revenue
growth
Our growth strategy is focused on growing our existing ASCs and acquiring
or developing new ASCs in a cost-effective manner. We may not experience an
increase in surgical procedures at our existing or future ASCs. We may not be
able to achieve the economies of scale and patient base, or provide the
business, administrative and financial services, required to sustain
profitability in our existing and future ASCs. Newly acquired or developed
facilities may generate losses or suffer lower operating margins than our more
established facilities, or they may not generate returns that justify our
investment. In addition, if vision correction technology becomes available to
ophthalmologists that is less expensive than the medical equipment currently
required for laser vision correction, eye care professionals might have less
interest in using our ASCs or refractive surgical equipment for vision
correction procedures.
We may not be able to identify suitable acquisition or development
targets, successfully negotiate the acquisition or development of these
facilities on satisfactory terms, or have the access to capital to finance these
endeavors. We anticipate that we will fund the acquisition and development of
future ASCs from borrowings under our credit facility. The maximum commitment
available under our credit facility is currently $30 million. Our current credit
facility expires on June 30, 2003. We are currently in discussions with lenders
regarding the terms of a new credit facility. We may have difficulty negotiating
a new facility with more favorable or even comparable terms, which could limit
our ability to acquire and/or develop ASCs.
In addition, we continue to wholly own five of our sixteen ASCs. The terms
of our credit facility permit us to sell minority interests in our existing ASCs
only to the extent such a sale, when combined with other minority interest sales
during the preceding twelve-month period, does not reduce by more than $3
million our earnings before interest, taxes, depreciation and amortization. This
limitation could affect the manner and timing in which we may want to pursue
initial or incremental minority interest sales in our existing ASCs (whether
wholly owned or otherwise) to physicians in our existing local markets.
If we are unable to successfully implement our growth strategy or manage
our growth effectively, our business, financial condition and results of
operations, including our ability to achieve and sustain profitability, could be
adversely affected.
We may not compete effectively with other companies that have more
resources and experience than us
Competitors with substantially greater financial, technical, managerial,
marketing and other resources and experience may compete more effectively than
us. We compete with other businesses, including ASC companies, hospitals,
individual ophthalmologists, other ASCs, laser vision correction centers, eye
care clinics and providers of retail optical products. Competitors with
substantially greater resources may be more successful in acquiring and
developing surgical facilities. Our wholesale optical laboratories and optical
products purchasing organization also face competition on national, regional and
local levels. Companies in other health care industry segments, including
managers of hospital-based medical specialties or large group medical practices,
may become competitors in providing ASCs and surgical equipment as well as
competitive eye care related services.
28
Competition for retaining the services of highly qualified medical, technical
and managerial personnel is significant.
Reduced prices and reimbursement rates for surgical procedures as a result
of competition or Medicare and private third party payor cost containment
efforts could reduce our revenue, profitability and cash flow.
Government sponsored health care programs, directly or indirectly,
accounted for approximately 34% of our consolidated revenue for the year ended
December 31, 2002. This includes facility fees we receive directly for the
surgeons' use of our ASCs, but does not include amounts derived from laser
vision correction, which is an elective procedure that patient-consumers pay for
out-of-pocket.
The health care industry is continuing to experience a trend toward cost
containment as government and private third-party payors seek to impose lower
reimbursement and utilization rates and to negotiate reduced payment schedules
with health care providers. These trends may result in a reduction from
historical levels in per patient revenue received by our ASCs. Changes in
Medicare payment rates have, in the past, resulted in reduced payments to ASCs.
Private insurance payments also could be affected to the extent that these
insurance companies use payment methodologies based on Medicare rates. Medicare
payment rates for ASCs are currently based on cost surveys completed by DHHS.
The current payment system is based on cost surveys from 1986. In 1998, the DHHS
proposed a new payment methodology for ASCs that could have adversely affected
our revenue. The DHHS never implemented this new payment methodology and on May
13, 2002 listed this proposal as a "discontinued action."
The Medicare Payment Advisory Commission, or MedPac, and the Office of
Inspector General, or OIG, have both recently recommended changes to the
Medicare payment methodology for ASCs. MedPac is a congressional advisory body
whose sole role is to advise Congress on Medicare payment issues, while the OIG
is a governmental agency responsible for investigating and monitoring Medicare,
Medicaid and other DHHS programs. Generally, MedPac has recommended that
reimbursement levels for ASC procedures not exceed reimbursement levels paid to
hospital outpatient departments, while the OIG has recommended that whichever
reimbursement level is lowest for a particular procedure be the governing rate
for both ASCs and hospital outpatient departments. In addition, MedPac
recommended that ASCs not receive any inflation increases in 2004, essentially
freezing ASC payments at 2003 levels. These are recommendations only and it is
uncertain if Congress will act on either or both recommendations. If these
recommendations become effective, our revenue and profitability could be
adversely affected. While most of our existing ASC surgical procedures are
generally reimbursed at levels lower than hospital outpatient departments, some
of our existing surgical procedures are reimbursed at higher levels. One example
of such a procedure is a post-cataract laser procedure, commonly referred to as
a YAG procedure. Although it is uncertain whether Congress will adopt these
recommendations, a reduction in the Medicare-reimbursed fee for YAG procedures
performed in our ASCs to levels paid to hospital outpatient departments would
have reduced our 2002 revenue by two percent if this reduction had been
effective January 1, 2002.
Revenue from laser vision correction procedures comprised approximately
eleven percent of our consolidated revenue for the year ended December 31, 2002.
The market for providing laser vision correction and other refractive surgery
procedures continues to be highly competitive. This competitiveness has resulted
in many of our competitors offering laser vision correction or other refractive
surgery services at lower prices than the prices we charge. If price competition
continues, however, we may choose or be forced to lower the facility fees we
charge in our surgical facilities. If we lower our fees, we could experience
reductions in our revenue, profitability and cash flow.
Reductions in payments to our ASCs, and through our fixed-site laser
service arrangements, or other changes in reimbursement for eye care services
could reduce our revenue, profitability and cash flow.
29
Lack of adequate financing could limit our growth
Successful implementation of our growth strategy will require continued
access to capital to acquire and develop new ASCs. If we do not have sufficient
cash resources, our growth could be limited unless we are able to obtain capital
through additional equity or debt financings. To the extent we use our equity as
acquisition currency to acquire new ASCs or in financing transactions to raise
money, our shareholders could be diluted. To the extent we incur debt, we may
have significant interest expense and our activities could be limited by our
loan agreement covenants. We currently intend to finance future acquisitions and
development of ASCs, as well as our other strategic initiatives, with our
existing cash balance, cash generated from our operations and amounts borrowed
under our credit facility. Capital raised through other means may not be
available to us. Further, if financing is available, it may not be on terms that
are favorable to us or sufficient for our needs.
Our credit facility expires on June 30, 2003. Our existing facility
includes limitations on the amount of acquisitions we can complete in the event
our ratio of total debt to earnings exceeds certain thresholds. We are currently
in discussions with lenders regarding the terms of a new credit facility. Given
the current commercial lending environment, we may have difficulty negotiating a
new facility with more favorable or even comparable terms to our existing
facility. Our ability to acquire and/or develop new ASCs, will be limited by the
amount of our existing cash balance, the cash generated from our operations and
the amount of borrowing availability under our credit facility.
Regulation of the construction, acquisition or expansion of ASCs could
prevent us from developing, acquiring or expanding facilities
All states require licenses to own and operate ASCs, and some states
require a certificate of need, or CON, to construct or modify an ASC. If we are
unable to procure the appropriate state licensure approvals, or if we are unable
to obtain a CON in states with CON laws, then we may not be able to acquire or
construct a sufficient number of ASCs, or to expand the scope of services
offered in our existing ASCs, to achieve our growth strategy. See "Government
Regulation - State Law."
Our revenue and profitability could decrease if we are unable to maintain
positive relationships with the surgeons who perform surgical procedures
at our ASCs
The success of our business depends on our relationship with, and the
success and efforts of, the surgeons who perform surgical procedures at our
ASCs. Our revenue and profitability would decline if our relationship with key
surgeons deteriorated or those surgeons reduced or eliminated their use of our
ASCs.
For example, since late 2001, we have been negotiating and consummating
divestiture transactions with our former affiliated providers, many of whom were
also customers using our ASCs and excimer lasers, and/or purchasing products
from our optical products division. Physicians affiliated with us for some or
all of 2002 performed 88% of the surgical procedures performed in our ASCs.
Given the nature of the doctor services industry, particularly with
respect to the physician practice management model that we used to form the
structure of our relationships, some of our affiliated providers viewed
favorably the prospects of terminating our services agreements and regaining the
day-to-day control over their business operations. Despite their desire to
terminate our relationship, many negotiations to reach agreement on divestiture
terms acceptable to our lenders and us were long and difficult. As a result, our
future relationships with these doctors could be strained. These strained
relationships could deter a doctor from purchasing our optical products and
services or using our ASCs even in situations where they own minority equity
interests in the ASC.
30
As part of the terms of each applicable divestiture transaction, we
negotiated multi-year supply and refractive services agreements where we
continue to be the primary supplier of optical products and refractive
technology to our former affiliated providers. In future years as these
agreements expire or otherwise terminate, or if the other parties were to
successfully challenge the enforceability of the agreements, our former
affiliated providers may elect to purchase or use optical products and/or
refractive technology from sources other than us, thereby reducing our
profitability and revenue growth. Generally, these supply agreements will expire
between March 2007 and May 2009, and the product sales revenue generated from
these customers in 2002 constituted less than five percent of our total product
sales revenue. Our refractive services agreements will expire between April 2006
and November 2007, and the laser vision correction revenue generated from these
customers in 2002 constituted eleven percent of our total surgical facilities
revenue.
Since January 1, 2002, as part of our divestiture transactions, we have
sold minority interests in eight of our ASCs to former affiliated providers.
Selling minority interests in these previously wholly owned ASCs reduces the
percentage of the profits we are entitled to receive from these facilities.
Because these minority interest sales occurred throughout 2002 and in early
2003, the profits we received from these facilities in 2002 will likely decline
in 2003 unless there is an offsetting increase in surgical volume at these
facilities.
For the year ended December 31, 2002, surgical procedures performed by one
of our former affiliated practices accounted for 23% of our surgical facilities
revenue, and 14% of our total consolidated net revenue. We consummated our
divestiture transaction with this practice in October 2002. If some or all of
the physicians from this affiliated practice elect to reduce their use of our
surgical facilities, we could experience reductions in our profitability and
revenue growth.
In addition, co-owning ASCs with physicians may create additional
regulatory risk. See "Government Regulation - Federal Law - Anti-Kickback
Statute."
Although we have substantially completed our discontinued operations plan,
we may continue to have liabilities and expenses relating to our
management services business.
Having negotiated and consummated most of our divestiture transactions, we
have assigned or been released from many of the ongoing liabilities relating to
the operation of our management services business, such as real property and
equipment leases relating to the operations of our former affiliated practices.
In some instances, however, lessors and other third parties have required us to
remain liable under these agreements. In these cases, we are indemnified by our
former affiliated providers against any costs and obligations that we may have
to incur under these agreements. If we do incur such liability, our
indemnification rights may prove worthless if our former affiliated providers
cannot satisfy their liabilities to us. In addition, under the terms of our
divestiture agreements, we have also agreed to share with our former affiliated
providers certain potential liabilities, principally relating to any refunds
that may ultimately be due and owing to third party payors for cash received by
us during the period we managed our former affiliated practices. Consequently,
our payment of residual liabilities and expenses relating to our management
services business could limit or reduce our revenue and profitability.
We are also still negotiating two more divestiture transactions. Although
these transactions involve relatively small practices, we may incur unforeseen
cost and expense relating to these transactions to the extent negotiations
become long and protracted.
Our future profitability could decrease because of existing agreements
with physicians that may require us to sell them additional equity
interests in our ASCs
We are a party to option agreements with various physicians pursuant to
which the physicians have the right to purchase equity interests in nine of our
sixteen ASCs. Although these agreements are consistent with our
31
joint ownership model, the sale of these equity interests will reduce the
percentage of the profits we are entitled to receive from these facilities.
Unless there is an offsetting increase in surgical volume at these facilities,
our dilution from these equity interest sales will likely cause our profits from
these facilities to decline. Although these agreements in most instances
contemplate the doctors' purchase of minority interests in these facilities,
doctors have the right to purchase our remaining majority interest in two of our
existing ASCs. In all instances we will receive cash proceeds from these sales
that we believe are fair and adequate.
Changes in the interpretation of existing laws and regulations, or
adoption of new laws or regulations, governing our business operations,
including physician use and/or ownership of ambulatory surgery centers,
could result in penalties to us, require us to incur significant
expenditures, or force us to make changes to our business operations.
We are subject to extensive government regulation and supervision under
federal, state and local laws and regulations. Many of these laws and
regulations are subject to varying interpretations, and courts and regulatory
authorities generally have provided little clarification. Moreover, state and
local laws and interpretations vary from jurisdiction to jurisdiction. As a
result, we may not always be able to accurately predict interpretations of
applicable law, and federal and state authorities could challenge some of our
activities, including our co-ownership of ASCs with physicians and other
investors. If any of our activities are challenged, we may have to divert
substantial time, attention and resources from running our business to defend
our activities against these challenges, regardless of their merit. If we do not
successfully defend these challenges, we may face a variety of adverse
consequences, including:
o loss of use of our ASCs
o losing our eligibility to participate in Medicare or Medicaid or losing
other contracting privileges
o in some instances, civil or criminal fines or penalties
Any of these results could impair our sources of revenue and our profitability
and limit our ability to grow our business.
For example, the federal anti-kickback statute prohibits the knowing and
willful solicitation, receipt, offer or payment of any direct or indirect
remuneration in return for the referral of patients or the ordering or
purchasing of items or services payable under Medicare, Medicaid or other
federal health care programs. This statute is very broad and Congress directed
DHHS to develop regulatory exceptions, known as safe harbors, to the statute's
referral prohibitions. While we have attempted to structure the ownership and
operation of our ASCs within a safe harbor, we do not satisfy all of the
requirements. Because there is no legal requirement that relationships fit
within a safe harbor, a business arrangement that doesn't comply with the safe
harbor, or for which a safe harbor does not exist, does not necessarily violate
the anti-kickback statute.
Presently, despite the fact that we do not fit within a safe harbor, we
believe that our ownership and operation of ASCs complies with the anti-kickback
statute. However, existing interpretations or enforcement of the federal
anti-kickback statute or other applicable federal or state laws and regulations
could change. If so, violations of the anti-kickback statute or other laws may
result in substantial civil and criminal penalties and exclusion from
participation in Medicare, Medicaid and other federally funded programs.
In addition, our limited liability company agreements and limited
partnership agreements provide that if certain laws and regulations change, or
the interpretation and/or enforcement of such laws and regulations change, we
may have to purchase some or all of the minority equity interests in our ASCs
owned by physicians. The regulatory changes that could trigger this repurchase
include it becoming: (i) illegal for a physician to own an equity interest in
one of our ASCs; (ii) illegal for physician-owners in our ASCs to refer Medicare
or other patients to the facility; or (iii) substantially likely that the
receipt by physician-owners of cash distributions from the limited liability
company or partnership will be illegal. The cost of repurchasing these equity
interests would
32
be substantial. We may not have sufficient capital resources to fund these
obligations, and it may trigger the need to procure additional equity financing.
To the extent any such financing was available to us, it would likely be
dilutive to our current equity holders. While we attempt to structure these
purchase obligations as favorable as possible to us, the triggering of these
obligations could have a significantly negative effect on our financial
condition and business prospects.
If eye care professionals and the general population do not continue to
accept laser vision correction and other refractive surgical procedures as
alternatives to eyeglasses and contact lenses, an important source of our
historical and future revenue and earnings growth will be limited
Our profitability and growth will depend, in part, upon continued
acceptance by eye care professionals and the general population of laser vision
correction and other refractive surgical procedures in the U.S. Eye care
professionals and the general population might not continue to accept laser
vision correction surgery because of the cost of the procedure that, to date,
has primarily been paid directly by patients, and concerns about the safety and
effectiveness of laser vision correction. If eye care professionals and the
general population do not continue to accept laser vision correction and other
refractive surgical procedures, an important source of our historical and future
revenue and earnings growth will be limited.
We have a long-term, non-exclusive supply agreement with Alcon
Laboratories Inc. under which we have procured excimer lasers. We pay Alcon
monthly based on the number of procedures performed on each laser, but are
required to pa