-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Si8UTIz9QwIicgHIFSDsw2JzjHNZXs43n3WXRniTd2R9n8no3ZPsaOvwdnG33+gP BwLj10mqh6wgkyurxQa5fg== 0000950147-99-000927.txt : 19990826 0000950147-99-000927.hdr.sgml : 19990826 ACCESSION NUMBER: 0000950147-99-000927 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990531 FILED AS OF DATE: 19990825 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AVESIS INC CENTRAL INDEX KEY: 0000795574 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 860349350 STATE OF INCORPORATION: DE FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-15304 FILM NUMBER: 99699041 BUSINESS ADDRESS: STREET 1: 3724 NORTH THIRD ST STREET 2: STE 300 CITY: PHOENIX STATE: AZ ZIP: 85012 BUSINESS PHONE: 6029567287 MAIL ADDRESS: STREET 1: 3724 NORTH THIRD STREET STREET 2: SUITE 300 CITY: PHOENIX STATE: AZ ZIP: 85012 FORMER COMPANY: FORMER CONFORMED NAME: NBS NATIONAL BENEFIT SERVICES INC DATE OF NAME CHANGE: 19910114 FORMER COMPANY: FORMER CONFORMED NAME: NATIONAL VISION SERVICES INC DATE OF NAME CHANGE: 19900117 10KSB 1 ANNUAL REPORT FOR FISCAL YEAR ENDING 5/31/99 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) [X] Annual Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended May 31, 1999 or [ ] Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _________________ to ____________________ Commission File Number: 0-15304 AVESIS INCORPORATED ---------------------------------------------- (Name of small business issuer in its charter) Delaware 86-0349350 - ------------------------------- --------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 3724 North Third Street, Suite 300 Phoenix, Arizona 85012 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Issuer's telephone number: (602) 241-3400 Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock, $.01 par value & $l0 Class A Nonvoting Cumulative Convertible Preferred Stock, Series 2, $.01 par value ------------------------------------------------------------- (Title of Class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 [ ] Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB. [ ] State issuer's revenues for its most recent fiscal year: $10,206,467. The aggregate market value of the voting common stock held by non-affiliates of the registrant, based upon the average of the last bid and asked prices of the registrant's Common Stock in the over-the-counter market reported by the Electronic Bulletin Board of the National Association of Securities Dealers, Inc. ("NASD") on August 2, 1999 was $966,700. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive. The number of outstanding shares of the registrant's Common Stock on August 2, 1999 was 7,356,297. Transitional Small Business Disclosure Format (check one): Yes [ ] No [X] AVESIS INCORPORATED FORM l0-KSB ANNUAL REPORT YEAR ENDED MAY 31, 1999 TABLE OF CONTENTS PART I Page ITEM l. Description of Business ....................................... 1 ITEM 2. Description of Properties ..................................... 6 ITEM 3. Legal Proceedings ............................................. 7 ITEM 4. Submission of Matters to a Vote of Security Holders ........... 7 PART II ITEM 5. Market for Common Equity and Related Stockholder Matters ...... 8 ITEM 6. Management's Discussion and Analysis or Plan of Operation...... 13 ITEM 7. Financial Statements .......................................... 17 ITEM 8. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure .................................... 18 PART III ITEM 9. Directors, Executive Officers, Promoters, and Control Persons; Compliance with Section 16(a) of the Exchange Act............ 18 ITEM 10. Executive Compensation ........................................ 22 ITEM 11. Security Ownership of Certain Beneficial Owners and Management .................................................. 24 ITEM 12. Certain Relationships and Related Transactions................. 26 ITEM 13. Exhibits and Reports on Form 8-K .............................. 28 SIGNATURES ................................................................ 29 PART I ITEM I. DESCRIPTION OF BUSINESS GENERAL Avesis Incorporated, a Delaware corporation (together with its subsidiary, Avesis of Washington, D.C., Inc., collectively the "Company"), incorporated in June 1978, markets and administers vision, dental, chiropractic and hearing managed care and discount programs ("Programs") nationally. The Programs are designed to enable participants ("Members"), who are enrolled through various sponsoring organizations such as insurance carriers, HMOs, Blue Cross and Blue Shield organizations, corporations, unions and various associations ("Sponsors"), to realize savings on purchases of products and services through networks of providers such as opticians, optometrists, ophthalmologists, dentists, chiropractors and hearing specialists ("Providers"). Administration fee and provider fee revenue has been derived from the product lines in the following proportions: Fiscal Years Ended May 31, -------------------------- 1999 1998 ---- ---- Vision and Hearing Program 87% 80% Dental Program 13% 20% VISION PROGRAM The Company offers provider networks and administrative services for group vision programs. Its Vision Program is designed to provide savings by reducing the cost of eye examinations and vision products (frames, eyeglass lenses and contact lenses). Under the Company's Vision Program, a Member is entitled to discounted pricing that Providers offer for eye examinations and the purchase of eyewear at network Provider locations. The Member may be fully responsible for paying the Provider unless the Sponsor (a self-funding employer or insurer) is obligated to pay the Provider, or reimburse the Member. In some cases, the Company may act as a third party administrator for the Sponsor and pay the Providers from funds provided by the Sponsor for that purpose. Under some Programs, each Member pays an annual enrollment fee to the Company for the right to utilize network Providers and receive discounts. In other cases, typically involving Sponsors who pay benefits, the Sponsors pay a periodic enrollment fee for each Member. 1 If the Program has insured or self-funded benefits, the Sponsor determines the products and services which will be covered, how frequently the benefit is available and, subject to local regulation, whether reimbursement for non-network Provider purchases will be made. The Company principally derives revenues from fees paid by or on behalf of Members for enrollment, plan administration and services, and claims administration, and in certain cases also derives revenues from fees paid by Providers when Members purchase eyewear and services. The table below sets forth the approximate numbers of Providers and Members enrolled in the Vision Program at the dates indicated: Date Number of Providers Number of States Number of Members ------------ ------------------- ---------------- ----------------- May 31, 1999 5,151 45 817,000 May 31, 1998 4,550 48 649,000 Substantially all of the Providers indicated above are optometrists. The numbers of Members indicated in the above table are as reported to the Company by Sponsors and generally do not include eligible spouses and children of Members. The Company administers a buying group for vision Providers so that they may take advantage of volume buying discounts for eyeglass frames. The Company has entered into arrangements with certain frame manufacturers that enable Providers to obtain frames at prices below wholesale. The Company is billed directly by the frame manufacturers and is responsible for the billing and collection of amounts due from the Providers. The Company receives a discount, above the amount given to the Providers, from the frame manufacturers to pay for the cost of administering the buying group program. Providers are not obligated to purchase from designated suppliers. HEARING PROGRAM The Company's hearing program (the "Hearing Program") has been marketed principally as an adjunct to the Vision Program. Revenues from the Hearing Program have not been significant. A Hearing Program Member may obtain a hearing evaluation by a Provider for a reduced fee. In addition, the Member may purchase a hearing aid from a Provider at wholesale cost plus a professional fee or at a discount from the Provider's usual charge, depending on the options selected by the Plan Sponsor. Such benefits are also available to the Member's spouse, children, parents and grandparents. 2 DENTAL PROGRAM The Company establishes and maintains dental Provider networks that it also makes available to Sponsors. Fees charged to Members by Providers are based upon panel fee schedules that the Providers have agreed to accept. Similar to the Vision Program, the Company's dental program (the "Dental Program") is offered both for Members who are themselves responsible for paying 100% of the costs of their care to their Providers, and for Programs under which the Sponsor assumes the obligation of paying Providers (or reimbursing Members) for the agreed-upon costs of specified care. Revenues from the Dental Program principally are derived in the same manner as the Vision Program. The table below sets forth the approximate number of Providers and Members enrolled in the Dental Program at the dates indicated, as reported to the Company by Sponsors: Date Number of Providers Number of States Number of Members ------------ ------------------- ---------------- ----------------- May 31, 1999 8,397 42 144,000 May 31, 1998 10,683 43 148,000 Included in the number of providers in the table above as of May 31, 1998 are 5,553 providers who participate in a third party's Provider network. The Company had a network rental agreement that allowed Members to utilize the services of the third party's Provider network that ended during fiscal 1999. As of August 13, 1999 the Company had 8,940 providers participating in its Dental Program. See also Item 6 - "Management's Discussion and Analysis or Plan of Operation." CHIROPRACTIC PROGRAM The Company has developed a program for the delivery of chiropractic services (the "Chiropractic Program"). Members pay reduced fees to the Provider for history and physical examinations, spinal manipulation, non-manual procedures, physiotherapy, acupuncture and additional care. The Company derived its first revenues from the Chiropractic Program in the first quarter of fiscal 1997. Although the Company has not generated significant revenues from the Chiropractic Program, Management believes the Program is important as it enables the Company to offer to Sponsors a complete line of ancillary benefits. 3 PROVIDER NETWORKS The Company usually contracts with Providers to provide services simultaneously with the plan Sponsor's development of a membership base in a geographic area; however, some Providers are enlisted in expansion areas where there currently is little or no membership base. The Programs supplement the practices of Providers by enabling them to obtain additional patients who are Members while allowing Providers to retain their existing practices. Although Members generally pay fees and charges less than those of non-Member patients, Member patients can be an important source of incremental revenue to Providers. There can be no assurance that Providers will continue to participate in the Programs even if their participation results in an increase in revenues since the portion of their practices derived from the Programs may be less profitable than other aspects of their practices. The Company periodically reviews a portion of the Providers. This review includes a patient survey form which is distributed on a random basis by the Company to Members, the investigation of any complaints received from Members and a desk or field audit by a Company auditor to confirm that Members were not charged more than the contracted prices for services and products. PROGRAM ADMINISTRATION AND ADMINISTRATION OF CLAIMS The Company receives fees from Sponsors for program administration services. These fees vary depending upon the type of program involved, the number of card-holding Members in a Sponsor's program, and the extent of claims administration and other administrative services involved. When the Company acts as a third party administrator for Programs under which the Sponsor pays for Provider services, Members obtaining services from Providers present their cards to the Providers, who in certain cases contact the Company to confirm eligibility and, upon performance of services, submit claim forms to the Company. The Company processes the claims, requests funds from the appropriate Sponsors, and forwards payments to the Providers and/or Members from the funds received from Sponsors. Monthly information about the use of the Programs by Members and cost savings is reported to certain Sponsors. Although the Company does not believe it would have any liability due to any malpractice on the part of any Provider, the usual form of Provider Agreement requires each Provider to indemnify the Company against any claim based on the negligence or other wrongdoing of the Provider in the performance of services for Members. In addition, Providers are required to carry malpractice insurance with limits equal to or greater than their state required minimums. 4 MARKETING The Company markets nationally to potential Sponsors that have or have access to a large number of potential Members. Marketing is done through the efforts of the Company's sales personnel and unaffiliated insurance brokers, general agents and employee benefit consultants compensated on a commission basis. Substantial marketing services are also provided through National Health Enterprises, Inc. ("NHE"), an affiliate. See Item 12 - "Certain Relationships and Related Transactions - Agreements with National Health Enterprises, Inc." See also Item 6 - "Management's Discussion and Analysis or Plan of Operations - Results of Operations." The Company's sales and marketing personnel market the full range of the Company's products and services. The Company believes that offering a range of products and services in multiple product lines differentiates it from its competitors and enables it to offer a more comprehensive solution to its customers' benefits needs. Two major Sponsors accounted for 48% and 14% of total service revenues in fiscal 1999 and three major Sponsors accounted for 28%, 15% and 10% in fiscal 1998. Two of the three major Sponsors accounted for separately during fiscal 1998 were combined during fiscal 1999 to be one major Sponsor. The Company is substantially dependent on a limited number of Sponsors and may be materially adversely affected by termination of its agreements with Sponsors. COMPETITION The Company competes for potential Sponsors, Members and Providers, depending on the geographic area or market, with various provider organizations, health maintenance organizations and health care membership programs. Most of these competitors have significantly greater financial, marketing and administrative resources than the Company. The Company believes it has a competitive advantage as it is able to offer a full line of ancillary benefits while substantially all of its competitors concentrate on one benefit line. 5 REGULATION Certain registration and licensing laws and regulations (including those applicable to third party administrators, preferred provider organizations, franchises and business opportunities) in many states in which the Company operates may have application to various aspects of the Company's programs. In addition, statutes and regulations applicable to insurers and providers, including those relating to fee splitting, referral fees, advertising, patient freedom of choice, provider rights to participate and antidiscrimination in reimbursement, may impact the Company. The Company believes that it is in compliance with applicable laws and regulations as they are currently interpreted. However, there can be no assurance that changes in interpretation will not occur in the future or that existing laws and regulations will not be broadened. In that event, the Company could be required to register in various additional states and/or post substantial fidelity or surety bonds. Alternatively, the Company may be required to alter its services, modify its contractual arrangements with Sponsors, Providers and Members, be precluded from providing some or all of its services in some states, or be subject to substantial fines or penalties. Any or all of the foregoing consequences could materially adversely affect the Company. EMPLOYEES As of August 2, 1999, the Company had 47 full-time and 2 part-time employees, compared to 42 full-time and 2 part-time employees as of August 10, 1998. The Company believes that its relationship with its employees is good. ITEM 2. DESCRIPTION OF PROPERTIES The Company maintains its executive offices at 3724 North Third Street, Suite 300, Phoenix, Arizona 85012, in space leased from an unaffiliated party. On December 16, 1998, the Company entered into a lease agreement to expand its current principal office location by approximately 3,200 square feet to 9,900 square feet. The term of the lease will run concurrently with the current lease on the principal office location and will expire on September 30, 2002. Until October 1997, the Company maintained its executive offices at 100 West Clarendon, Suite 2300, Phoenix, Arizona 85013. The lease agreement covered approximately 13,300 usable square feet of space and was scheduled to expire on September 30, 2000. On October 29, 1996 the Company entered into an agreement to sublease approximately 9,090 usable square feet of space through October 1, 1997, and all 13,300 usable square feet thereafter, until the expiration of the Company's lease agreement. On February 24, 1999, the Company was released by the landlord from the lease agreement and by the lessee from the sub-lease agreement covering the Company's former principal office. The write-off of unamortized broker's commissions and accrued rent that related to the lease for the Company's former principal office resulted in approximately $47,000 of miscellaneous income. For the years ended May 31, 1999 and 1998, rent expense related to the subleased premises was $169,426 and $159,623, respectively, and sublease rental income was $168,071 and $161,720, respectively. 6 The Company maintains sales and administrative offices at 11460 Cronridge Drive, Suite 118, Baltimore, Maryland 21117 and at 5321 First Place NE, Washington, D.C. 20011. The offices are used pursuant to verbal agreements with the lessees that are terminable at will and are at no cost to the Company. The Company owns and leases various computer, data processing and other office equipment. The Company believes that its facilities and equipment are maintained in good operating condition and are adequate for the present level of operations. ITEM 3. LEGAL PROCEEDINGS Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 7 PART II ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's Common Stock and its Class A Nonvoting Cumulative Convertible Preferred Stock, Series 2 ("Series 2 Shares") Shares are quoted in the over-the-counter market. Quotations are reported in the "pink sheets" published by the National Quotation Bureau, Inc. and via the National Association of Securities Dealers' Inc. Electronic Bulletin Board. The following table sets forth the high and low bid price for the Company's Series 2 Shares and Common Stock as reported by the National Quotation Bureau, Inc. for each quarterly period during fiscal 1998 and 1999. Such market quotations reflect inter-dealer prices, without retail markup, markdown or commission and may not represent actual transactions. The Company's Class A Senior Nonvoting Cumulative Convertible Preferred Stock, Series A ("Series A Shares") Shares were not quoted during fiscal 1998 or fiscal 1999 and quotes are currently not available pursuant to the National Quotation Bureau, Inc. and via the National Association of Securities Dealers' Inc. Electronic Bulletin Board. Series 2 Shares Common Stock --------------- ------------ Bid Quotation Range Bid Quotation Range ------------------- ------------------- Fiscal Year 1998 High Low High Low - ---------------- ---- --- ---- --- First Quarter ended Aug. 31, 1997 $1.25 $1.25 $0.25 $0.1875 Second Quarter ended Nov. 30, 1997 1.25 1.00 0.21875 0.15625 Third Quarter ended Feb. 28, 1998 1.125 1.0625 0.27 0.1875 Fourth Quarter ended May 31, 1998 1.125 1.125 0.27 0.1875 Fiscal Year 1999 - ---------------- First Quarter ended Aug. 31, 1998 $1.25 $1.00 $0.21875 $0.21875 Second Quarter ended Nov. 30, 1998 2.75 1.25 0.29 0.21875 Third Quarter ended Feb. 28, 1999 2.75 2.75 0.30 0.29 Fourth Quarter ended May 31, 1999 2.75 2.75 0.46875 0.30 8 1998 EXCHANGE OFFER During fiscal 1998 the Company completed an Exchange Offer which offered one share of its Class A Senior Nonvoting Cumulative Convertible Preferred Stock, Series A ("Series A Shares"), for each outstanding share of the Class A Nonvoting Cumulative Convertible Preferred Stock, Series 2 ("Series 2 Shares") of the Company. The purpose of this offer was to eliminate or significantly reduce the number of Series 2 Shares outstanding including the related dividend arrearage and to adjust the Company's capital structure. The Exchange Offer expired on May 27, 1998, and resulted in the tendering of 317,880 (approximately 82%) of the 388,180 then outstanding Series 2 Shares for the Series A Shares. Series 2 Shares are entitled to receive a cumulative dividend at an annual rate of 9% of the face value of $10.00 ($0.90 per share). Each share is currently convertible into 2.5 shares of the Company's Common Stock. Series A Shares are entitled to receive a cumulative dividend at an annual rate of $0.3375 per share paid semi-annually and each share is currently convertible into 10 shares of the Company's Common Stock. The exchange of the Series 2 Shares pursuant to the Exchange Offer and the Company's repurchase program, under which it repurchased and retired 64,300 Series 2 Shares at $3.00 per share during fiscal 1999, significantly reduced the number of the Series 2 Shares that trade publicly and the number of holders of the shares. These reductions may adversely affect the liquidity and the "pink sheet" market value of remaining Series 2 Shares. At the same time, there is no assurance that any market will develop for the Series A Shares issued pursuant to the Exchange Offer. As of August 2, 1999, there were 7,356,297 shares of the Common Stock outstanding held by approximately 165 stockholders of record. Trading activity with respect to the Common Stock has been limited and the volume of transactions may not of itself be deemed to constitute an "established public trading market." A public trading market having the characteristics of depth, liquidity and orderliness depends upon the existence of market makers as well as the presence of willing buyers and sellers, which are circumstances over which the Company does not have control. 9 DIVIDENDS The Company has not paid any dividends on its Common Stock since its inception and does not expect to pay dividends on its Common Stock at any time for the foreseeable future. The Series A Shares are senior in rights to annual dividends and redemptions to the Series 2 Shares. Under the Certificate of Designation for the Series A Shares, no dividends may be paid on the Series 2 Shares or the Common Stock until the Series A Shares have received all current and cumulative dividends and the earliest of any of the following events occur (i) every outstanding share of the Series A Shares has been either redeemed or converted, (ii) any time after May 31, 2005, or (iii) the first day of any fiscal year following two consecutive fiscal years in which the Company had net income and net cash flow in each year in excess of $1.5 million and the Company's tangible net equity at the end of the second fiscal year is at least $5 million. Moreover, the terms of the Series 2 Shares provide that as long as any of the Series 2 Shares remain outstanding, the Company may not declare or pay any dividend, whether in cash or property, on the Common Stock of the Company unless the full dividends on the Series 2 Shares for all past dividend periods and the then current dividend period shall have been paid or declared and a sum set aside for payment thereof. RECENT SALES OF UNREGISTERED SECURITIES On May 27, 1998, the Company's Offer to Exchange one share of Class A, Senior Nonvoting Cumulative Convertible Preferred Stock, Series A, par value $.01 for each outstanding share of Class A, Nonvoting Cumulative Convertible Preferred Stock, Series 2, par value $.01 expired. The Offer resulted in 317,880 of the 388,180 outstanding Series 2 Shares being exchanged for the Series A Shares. The Exchange Offer was made by the Company in reliance on the exemption from the registration requirements of the Securities Act of 1933, as amended (the "Securities Act"), afforded by Section 3(a)(9) thereof and under certain state law exemptions. The Company did not pay any commission or other remuneration to any broker, dealer, salesman or other person for soliciting tenders of the Series 2 Shares. Each Series A Share is currently convertible into 10 shares of Common Stock. This conversion ratio is subject to adjustment for any subdivisions, combinations or any other adjustments made to the Company's Common Stock. On July 30, 1998, the Company's Board of Directors approved a modification providing all outstanding stock option and warrant holders the opportunity to exercise any or all of their vested options and warrants at a discounted exercise price from their original grant, during the period from August 1, 1998, to August 31, 1998. The discounted price was calculated by discounting the stated exercise price of each stock option or warrant by 10% per annum from the expiration date back to August 1998, and rounding the calculated price to the 10 nearest whole cent. The discounted price in no case was allowed to be less than the prevailing market price of the Company's Common Stock at the time of exercise of the options, defined as the high bid price, and rounded to the nearest whole cent. The modification expired on August 31, 1998, and all terms returned to the original exercise terms for all unexercised stock options and warrants. Pursuant to the revised terms, the following individuals exercised their stock options or warrants during August 1998, in the following amounts at the following exercise prices per option or warrant: Number of Number of Common Stock Common Stock Modified Option/Warrant Holder Options Warrants Exercise Price - --------------------- ------- -------- -------------- Alan S. Cohn 1,054,750 $0.31 Alan S. Cohn 700,000 $0.26 Kenneth L. Blum, Jr 1,064,750 $0.31 Kenneth L. Blum, Jr 700,000 $0.26 William L. Richter 50,000 $0.31 William L. Richter 109,091 $0.31 William L. Richter 50,909 $0.26 Richter & Co., Inc. 72,500 $0.31 Richter & Co., Inc. 163,636 $0.31 Richter & Co., Inc. 76,364 $0.26 Gerald L. Cohen 100,000 $0.26 William R. Cohen 100,000 $0.26 The total cash received by the Company from the exercise of the above stock options and warrants was $1,228,657. Of the preceding amount, approximately $400,712 was used to repurchase all 931,888 shares of the Company's common stock held by the founder of the Company, at a price of $0.43 per share. The excess funds received from these transactions was used as working capital. RETIREMENT OF STOCK INFORMATION Subsequent to year-end the Company made the following stock repurchase: Total Purchase Price Date Series 2 Shares including Commissions ---- --------------- --------------------- June 29, 1999 1,000 $3,276 11 SELECTED FINANCIAL DATA The following table sets forth selected financial information regarding the Company. This information should be read in conjunction with the Company's Financial Statements and related notes and Management's Discussion and Analysis or Plan of Operation included elsewhere in this Form 10-KSB. The selected financial data for each of the five fiscal years ending May 31, 1995 through 1999, have been derived from the Company's audited financial statements. The selected financial data are included herein as additional information.
Years Ended May 31, ------------------------------------------------------------------- Selected Operating Data: 1999 1998 1997 1996 1995 ----------- ---------- ----------- ----------- ---------- Operating revenues $10,206,467 $8,336,631 $ 5,645,276 $ 6,019,896 $6,351,106 Operating expenses 9,300,195 8,010,021 5,739,503 6,106,694 5,986,897 Net income (loss) 1,006,265 313,875 (190,265) (124,859) 505,411 Net income (loss) per share of Common Stock - Basic (1) .13 .06 (.13) (.12) .02 As of May 31, ------------------------------------------------------------------- Selected Balance Sheet Data: 1999 1998 1997 1996 1995 ----------- ---------- ----------- ----------- ---------- Working capital $ 1,651,410 $ 350,418 $ 293,595 $ 422,922 $ 747,566 Current assets 3,197,248 1,588,969 1,271,505 864,566 1,242,534 Total assets 3,897,255 2,241,705 1,639,389 1,650,527 1,839,377 Current liabilities 1,545,838 1,238,551 977,910 441,644 494,968 Long term obligations 20,368 90,475 92,044 449,183 484,850 Total liabilities 1,566,206 1,329,026 1,069,954 890,827 979,818 Total stockholders' equity 2,331,049 912,679 569,435 759,700 859,559
(1) After provision for preferred stock dividends as follows: $107,936 in 1999; $63,270 in 1998 (70,300 Series 2 Shares outstanding as of May 31, 1998 times $0.90 per share); and $349,162 in 1997, 1996 and 1995. 12 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS FOR THE FISCAL YEARS ENDED MAY 31, 1999 AND 1998: The statements contained in this discussion and analysis regarding management's anticipation of adequacy of cash reserves for operations, adequacy of reserves for claims, anticipated level of operating expenses related to new cardholders, viability of the Company, cash flows and marketability of the Company constitute "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve risks and uncertainties, which could cause actual results to differ materially from the forward-looking statements. Management's anticipation is based upon assumptions regarding the market in which the Company operates, the level of competition, the level of demand for services, the stability of costs, the retention of Sponsors and Members enrolled in the Company's benefit programs, the relevance of the Company's historical performance, Year 2000 issues and the stability of the regulatory environment. Any of these assumptions could prove inaccurate, and therefore there can be no assurance that the forward-looking information will prove to be accurate. The Company derives its administration fee revenue from Plan Sponsors who customarily pay a set fee per Member per month. Administration fee revenue is recognized on the accrual basis during the month that the Member is entitled to use the benefit. Certain Sponsors pay for services rendered by the Company on a fee for service basis. Based upon the type of program (e.g., managed care, discount, third party administration) the Provider's claim for service provided to Members is paid either by the Company, Sponsor, Member or combination thereof. Buying Group revenues are recorded at the total amount billed to participating Providers and recognized in the month the product is shipped. Vision Provider fee revenue is based upon a percentage of materials sold by certain participating Providers under certain plans. 13 RESULTS OF OPERATIONS The following table details the Company's major revenue and expense categories for the years ended May 31, 1999 and 1998:
Year Ended Year Ended May 31, 1999 May 31, 1998 Increase/(Decrease) -------------------------- ------------------------ --------------------- % of % of Total Service Total Service Revenue: Revenue Revenue % Change - -------- ------- ------- -------- Total Service Revenue $10,206,467 100% $8,336,631 100% $1,869,836 22% Vision & Hearing Program 7,386,670 72% 5,258,750 63% 2,127,920 40% Vision Provider Fee 142,863 1% 124,397 1% 18,466 15% Dental Program 1,054,660 10% 1,266,548 15% (211,888) (17%) Buying Group Program 1,607,000 16% 1,655,298 20% (48,298) (3%) Expenses: Cost of Services 7,131,269 70% 6,120,416 73% 1,010,853 17% General & Administrative 1,066,390 10% 1,121,099 14% (54,709) (5%) Selling & Marketing 1,102,536 11% 768,506 9% 334,030 43% Income from Operations 906,272 9% 326,610 4% 579,662 177% Net Income 1,006,265 10% 313,875 4% 692,390 221%
Past and future revenues in all lines of business are directly related to the number of Members enrolled in the Company's benefit programs. However, there may be significant pricing differences to Sponsors depending on whether the benefit offered is funded in part or whole by the plan Sponsor. A substantial portion of the Company's Member base is derived from a limited number of Sponsors. The increase in the Company's total service revenues was principally due to the growth of the Company's managed care vision products. The Company was able to decrease operating expenses as a percentage of total service revenues in fiscal 1999 by 5% compared to fiscal 1998 results. The Company anticipates that the trend of decreased operating expenses as a percentage of total service revenues will continue during fiscal 2000, due to the operational efficiencies achieved during fiscal 1999 and the expected efficiencies to be achieved related to the new systems currently under development. The increase in vision and hearing revenues primarily resulted from the addition of a significant Sponsor, with approximately 86,000 managed care vision Members, and the increase in the level of benefits provided to a portion of the membership of a significant Sponsor, with approximately 100,000 affected vision cardholders. Revenues derived from the Company's managed care programs have a significantly higher cost of service than the revenues derived from the Company's discount programs. There were approximately 817,000 vision and 6,000 hearing Members as of May 31, 1999, compared to approximately 649,000 vision and 6,000 hearing Members as of May 31, 1998. 14 Vision provider fee revenue remained constant as a percentage of total service revenues from fiscal 1998 to fiscal 1999. The decrease in Dental Program revenues resulted from a Sponsor's loss of approximately 18,000 Members. This loss of Members was partially offset by increases of Members from various other current Sponsors. The revenue derived from the new Members was less than the lost revenue due to the differences in the level of benefits provided. There were approximately 144,000 dental Members as of May 31, 1999, compared to approximately 148,000 as of May 31, 1998. The Company makes available to its vision Providers a buying group program that enables the Provider to purchase eyeglass frames from the manufacturers at discounts from wholesale costs. These discounted prices are generally lower than a Provider could negotiate individually, due to the large volume of purchases of the buying group. Cost of Services primarily relates to servicing Members, Providers and Sponsors under the Company's vision, hearing, dental and chiropractic benefit programs as well as the cost of frames that are sold through the Company's buying group program as discussed above. Cost of Services and General and Administrative Expenses continued to decrease as a percentage of total service revenues in the current fiscal year as compared to the two prior fiscal years. This is due to the efficiencies of scale that the Company is experiencing as its Total Service Revenues and Member base continue to grow. Included in 1998 General and Administrative Expense is $142,000 of legal and professional fees directly related to the Company's Offer to Exchange Series 2 Preferred shares for Series A Preferred shares. Selling and marketing expenses include marketing fees, broker commissions, employee sales and marketing salaries and related expenses, travel related to the Company's sales activities and an allocation of other overhead expenses relating to the Company's sales and marketing functions. The increase in expenses in the current fiscal year resulted from the increase of commissions directly related to the increase in administration fee revenue, the addition of an experienced salesperson during September 1998 and the increase of travel and related expenses to expand the Company's markets. A significant amount of the Company's marketing activities has been outsourced to management consultants, National Health Enterprises. See Item 12 - "Certain Relationships and Related Transactions - Agreements with National Health Enterprises, Inc.." Non-operating income/(expense) was $112,993 and ($12,735) in fiscal 1999 and 1998, respectively. Included in non-operating income was $85,875 and $30,982 of interest income for the years ended May 31, 1999 and 1998, respectively. Also included in current year non-operating income was approximately $47,000 related to the write-off of unamortized broker's commissions and accrued rent that related to the lease for the Company's former principal office. Prior year 15 non-operating expense includes $25,373 for the write-off of virtually all of the unamortized moving expenses related to the Company's previous relocation of the principal office. LIQUIDITY AND CAPITAL RESOURCES On May 31, 1999, the Company's cash and cash equivalents were $2,599,342, compared to $993,610 as of May 31, 1998. The increase of $1,605,732 was primarily due to the Company's profitability, coupled with the timely collections of accounts receivable and the favorable timing of vendor and claim payments. The Company also received cash of $1,228,657 from the exercise of stock options by members of the Board of Directors, which was offset by $714,016 for repurchases of capital stock throughout the year. Current cash on hand and cash provided from operations are expected to allow the Company to sustain operations for the foreseeable future. The Company is party to a revolving credit facility for an amount not to exceed $100,000. The credit facility allows the Company flexibility to better manage its cash liquidity. To date, the Company has never drawn funds on the credit facility. As of May 31, 1999, the Company had $1,364,586 of Accounts Payable, compared to $1,106,165 in the prior fiscal year. The increase is predominately due to claims reserves of $1,082,072 in the current year compared with $786,052 in the prior year, included in Accounts Payable. The reserves are for incurred but not reported claim reimbursements to Providers who participate in certain managed care programs. The Company has continued to realize significant growth during the current year of managed vision care revenues and the associated claims. The Company believes this reserve is adequate. During fiscal 1998 the Company retired the final $189,000 of Convertible Subordinated Debentures, due December 1, 1997, and all $160,000 of subordinated notes payable to certain affiliates due March 18, 1998, with funds provided by operations. The Company expects to pay dividends of approximately $50,821 on the Series A Shares to holders of record on November 30, 1999. YEAR 2000 COMPLIANCE The Year 2000 issue is the result of computer systems that were written using two digits rather than four to define the applicable year. This programming decision may prevent such systems from accurately processing dates occurring in the Year 2000 and thereafter. This could result in system failures or in miscalculations causing a disruption of operations, including, but not limited to, a temporary inability to process Member eligibility information, to process claims payments, or to engage in routine business activities and operations. 16 During July 1997 the Company contracted with a third party vendor to develop new systems to support the Company's claims payment, customer and provider service, quality assurance and network development functions. As of August 1999, the new system was in the implementation phase and is expected to be fully implemented as of September 1, 1999. As of May 31, 1999, the Company had paid approximately $384,000 for software development and related hardware, which was properly capitalized. The Company expects to incur approximately $100,000 of additional software development and related hardware expenses during fiscal 2000. The Company has reviewed all internally used software and believes that its systems that have recently been developed and are currently under testing and all other critical applications are Year 2000 compliant. Based upon its current computer operations and systems development, the Company believes that its risks related to Year 2000 compliance are minimal. The Company does not presently anticipate that any additional costs to address the Year 2000 issue will have a material adverse effect on the Company's financial condition, results of operations or liquidity. The Company is in the process of contacting all vendors and clients who forward data electronically to determine the extent of their compliance and to plan accordingly. Based upon information received from third parties, the Company believes that all significant vendors and clients have Year 2000 remediation efforts underway. The Company's five largest Sponsors that collectively account for greater than 90% of the total administration fee revenue, either electronically transmit data using a four digit year or forward data in a hard copy format. To the extent that the Company's vendors and clients data are not Year 2000 compliant, the Company's new systems have been written with the flexibility to translate the data accordingly into a Year 2000 compliant format. While the Company believes that its risks related to disruption arising from Year 2000 compliance by vendors and its clients are minimal, it does not have any control over these third parties and cannot determine to what extent future operating results may be adversely affected by the failure of third parties to successfully address Year 2000 issues. ITEM 7. FINANCIAL STATEMENTS Financial Statements appear commencing at page F-1 immediately hereafter. 17 AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 (With Independent Auditors' Report Thereon) INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Avesis Incorporated: We have audited the accompanying consolidated balance sheet of Avesis Incorporated and subsidiary as of May 31, 1999, and the related consolidated statements of earnings, stockholders' equity, and cash flows for the years ended May 31, 1999 and 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Avesis Incorporated and subsidiary as of May 31, 1999, and the results of their operations and their cash flows for each of the years in the two-year period ended May 31, 1999, in conformity with generally accepted accounting principles. /s/ KPMG LLP Phoenix, Arizona July 16, 1999 F-1 AVESIS INCORPORATED AND SUBSIDIARY Consolidated Balance Sheet May 31, 1999 ASSETS Current assets: Cash and cash equivalents $ 2,599,342 Receivables, net 341,005 Prepaid expenses and other 256,901 ----------- Total current assets 3,197,248 Property and equipment, net 466,088 Deposits 233,919 ----------- $ 3,897,255 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,364,586 Current installments of obligations under capital lease 10,288 Accrued expenses: Compensation 75,232 Other 32,709 Dividends payable 50,821 Deferred income 12,202 ----------- Total current liabilities 1,545,838 Obligations under capital lease, excluding current installments 20,368 ----------- Total liabilities 1,566,206 ----------- Stockholders' equity: Preferred stock, $.01 par value, authorized 12,000,000 shares: $3.75 Class A, senior nonvoting cumulative convertible preferred stock, Series A, $0.01 par value; authorized 1,000,000 shares; 301,160 and outstanding (liquidation preference of $3.75 per share) 3,012 $10 Class A, nonvoting cumulative convertible preferred stock, Series 2, $.01 par value; authorized 1,000,000 shares; 6,000 shares issued and outstanding (liquidation preference of $10 per share) and $35,100 of dividends in arrears at $5.85 per share; dividends accrue at $.225 per share each calendar quarter 60 Common stock of $.01 par value, authorized 20,000,000 shares; 7,356,297 shares issued and outstanding 73,563 Additional paid-in capital 10,461,420 Accumulated deficit (8,207,006) ----------- Total stockholders' equity 2,331,049 Commitments and contingencies (notes 4, 10, 11, 12 and 13) ----------- $ 3,897,255 =========== See accompanying notes to consolidated financial statements. F-2 AVESIS INCORPORATED AND SUBSIDIARY Consolidated Statements of Earnings Years ended May 31, 1999 and 1998 1999 1998 ------------ ------------ Service revenues: Administration fees $ 8,447,735 6,550,966 Buying group 1,607,000 1,655,298 Provider fees 142,863 124,397 Other 8,869 5,970 ------------ ------------ Total service revenues 10,206,467 8,336,631 Cost of services 7,131,269 6,120,416 ------------ ------------ Income from services 3,075,198 2,216,215 General and administrative expenses 1,066,390 1,121,099 Selling and marketing expenses 1,102,536 768,506 ------------ ------------ Income from operations 906,272 326,610 ------------ ------------ Non-operating income (expense): Interest income 85,875 30,982 Interest expense (3,960) (19,305) Other 31,078 (24,412) ------------ ------------ Total non-operating expense 112,993 (12,735) ------------ ------------ Income before income taxes 1,019,265 313,875 Income taxes (13,000) -- ------------ ------------ Net income 1,006,265 313,875 Preferred stock dividends (107,936) (63,270) ------------ ------------ Net income available to common stockholders $ 898,329 250,605 ============ ============ Earnings per share - basic $ 0.13 0.06 ============ ============ Earnings per share - diluted $ 0.10 0.06 ============ ============ Weighted average common and equivalent shares outstanding - basic 6,788,944 4,073,918 ============ ============ Weighted average common and equivalent shares outstanding - diluted 9,902,713 5,089,657 ============ ============ See accompanying notes to consolidated financial statements. F-3 AVESIS INCORPORATED AND SUBSIDIARY Consolidated Statements of Stockholders' Equity Years ended May 31, 1999 and 1998
PREFERRED STOCK TOTAL -------------------------- COMMON ADDITIONAL ACCUMULATED STOCKHOLDERS' SERIES A SERIES 2 STOCK PAID-IN CAPITAL DEFICIT EQUITY ----------- ----------- ----------- ----------- ----------- ----------- Balance, May 31, 1997 $ -- 3,882 41,004 9,949,159 (9,424,610) 569,435 Repurchase of 79,294 shares of common stock -- -- (793) (19,838) -- (20,631) Exchange offer (Series 2 for Series A preferred) 3,179 (3,179) -- -- -- -- Issuance of 250,000 shares of common stock in connection with the Supplemental Investment Banking Agreement -- -- 2,500 47,500 -- 50,000 Net income -- -- -- -- 313,875 313,875 ----------- ----------- ----------- ----------- ----------- ----------- Balance, May 31, 1998 3,179 703 42,711 9,976,821 (9,110,735) 912,679 Repurchase of shares (167) (643) (11,568) (701,638) -- (714,016) Exercise of stock options -- -- 38,420 1,072,601 -- 1,111,021 Exercise of warrants -- -- 4,000 113,636 -- 117,636 Dividends declared, $.3375 per Class A, senior nonvoting cumulative convertible preferred stock, Series A -- -- -- -- (102,536) (102,536) Net income -- -- -- -- 1,006,265 1,006,265 ----------- ----------- ----------- ----------- ----------- ----------- Balance, May 31, 1999 $ 3,012 60 73,563 10,461,420 (8,207,006) 2,331,049 =========== =========== =========== =========== =========== ===========
See accompanying notes to consolidated financial statements. F-4 AVESIS INCORPORATED AND SUBSIDIARY Consolidated Statements of Cash Flows Years ended May 31, 1999 and 1998 1999 1998 ----------- ----------- Cash flows from operating activities: Net income $ 1,006,265 313,875 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 124,538 112,071 Provision for losses of accounts receivable 11,283 9,898 Loss on disposal of fixed assets 18,245 2,124 Common stock issued for professional services -- 50,000 Increase (decrease) in cash resulting from changes in: Receivables 127,620 (149,450) Prepaid expenses and other (141,450) (1,837) Deposits 9,590 (60,626) Accounts payable 258,421 641,788 Deferred income (4,746) (6,284) Accrued rent (92,827) (16,842) Accrued expenses 36,278 (53,125) Dividend payable 50,821 -- ----------- ----------- Net cash provided by operating activities 1,404,038 841,592 ----------- ----------- Cash flows from investing activities: Purchases of property and equipment (209,389) (294,307) Proceeds from dispositions of property and equipment 9,745 5,000 ----------- ----------- Net cash used in investing activities (199,644) (289,307) ----------- ----------- Cash flows from financing activities: Payment of dividend on preferred stock (102,536) -- Repayment of convertible subordinated debentures -- (189,000) Payments for repurchase of common stock (714,016) (20,631) Proceeds from exercise of stock options and warrants 1,228,657 -- Repayment of shareholder notes payable -- (160,000) Principal payments under capital lease obligations (10,767) (6,579) ----------- ----------- Net cash provided by/(used in) financing activities 401,338 (376,210) ----------- ----------- Net increase in cash and cash equivalents 1,605,732 176,075 Cash and cash equivalents, beginning of year 993,610 817,535 ----------- ----------- Cash and cash equivalents, end of year $ 2,599,342 993,610 =========== =========== Supplemental information: Cash paid for interest $ 3,960 20,118 =========== =========== Equipment acquired under capital lease $ -- 48,002 =========== =========== See accompanying notes to consolidated financial statements. F-5 AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) NATURE OF BUSINESS AND CONSOLIDATION POLICY Avesis Incorporated, a Delaware Corporation, and its wholly-owned subsidiary, Avesis of Washington, D.C., a District of Columbia Corporation (collectively, the Company), markets and administers vision, hearing, dental and chiropractic programs which are designed to enable participants (members), who are enrolled through various sponsoring organizations such as insurance carriers, Blue Cross and Blue Shield organizations, corporations, unions, and various associations (sponsors) to realize savings on purchases of products and services through Company-organized networks of providers, such as opticians, optometrists, ophthalmologists, hearing specialists, dentists and chiropractors (providers). The Company also makes available to its vision providers a buying group program that enables the provider to purchase frames from the manufacturers at discounts from wholesale costs. These discounted prices are generally lower than a provider could negotiate individually, due to the large volume of purchases of the buying group. The Company receives a fee for its services which varies according to the volume of activity. The consolidated financial statements include the accounts of Avesis Incorporated and its wholly-owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation. (b) CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, money market funds, and short-term investments with original maturities of 90 days or less. (c) PROPERTY AND EQUIPMENT Property and equipment are stated at cost and are depreciated using the straight-line method over estimated useful lives which range from five to ten years. Software is amortized over the estimated useful life of five years. (d) REVENUE RECOGNITION Administrative fee revenue is recognized on the accrual basis, in accordance with generally accepted accounting principles, during the month that the member is entitled to use the benefit. Substantially all administrative fee revenue is received in the month the member is entitled to use the benefit. Any amounts received in advance are recorded as deferred income and recognized ratably over the membership period. Buying group revenue is recognized in the month the merchandise is shipped to the provider. Provider fee revenue, based on member utilization, is recognized when the service is performed. (e) EARNINGS PER SHARE In accordance with SFAS 128, basic EPS is computed by dividing net income, after deducting the preferred stock dividends requirement, by the weighted average number of shares of common stock outstanding. Diluted EPS reflects the maximum dilution that would result after giving effect to dilutive stock options and warrants and to the assumed conversion of all dilutive convertible securities and stock. F-6 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 (f) INCOME TAXES The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect during the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (g) STOCK OPTION PLAN AND WARRANTS All stock options and warrants are granted at the fair market value or greater of the underlying securities on the date of grant. Prior to June 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations. As such, compensation expense was recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On June 1, 1996, the Company implemented SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1996 and subsequent years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. (h) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF The Company reviews long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. (i) USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the financial statement date and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. F-7 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 (j) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash and cash equivalents approximated fair value because their maturity is generally less than three months. The fair value of accounts receivable, accounts payable, and accrued expenses approximates the carrying value due to the short-term nature of these instruments. (k) COMPREHENSIVE INCOME On June 1, 1998, the Company adopted SFAS No. 130, REPORTING COMPREHENSIVE INCOME. SFAS 130 establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income consists of net income and net unrealized gains (losses) on securities and does not affect the Company's consolidated financial statements for the year ended May 31, 1999. (l) SEGMENT REPORTING The Company has one operating business segment which markets and administers vision, hearing, dental and chiropractic programs. (2) RECEIVABLES As of May 31, 1999 receivables consists of: Trade accounts receivable $ 382,038 Less allowance for doubtful accounts (41,033) ---------- $ 341,005 ========== (3) PROPERTY AND EQUIPMENT As of May 31, 1999 property and equipment consists of: Furniture and fixtures $ 267,946 Equipment 805,197 Software 370,486 ---------- 1,443,629 Less accumulated depreciation and amortization 977,541 ---------- $ 466,088 ========== (4) LEASES The Company leases office space under an agreement which expires September 30, 2002. Until October 1997, the Company maintained its executive offices at a different location. The lease agreement was set to expire on September 30, 2000. On October 29, 1996, the Company entered into an agreement to sublease the space until the expiration of the Company's lease agreement. On February 24, 1999, the Company was released by the landlord from the lease agreement and by the lessee from the sub-lease agreement covering the Company's former principal office. The Company also leases equipment under long-term operating lease agreements. For the years ended May 31, 1999 and 1998, rent expense for all operating leases was $185,785 and $159,224, F-8 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 respectively. For the years ended May 31, 1999 and 1998, sublease rent expense was $169,426 and $159,623, respectively, and sublease rental income was $168,071 and $161,720, respectively. The Company is obligated under one capital lease for telephone equipment that expires in October 2001. As of May 31, 1999 the gross amount of equipment and accumulated depreciation recorded under this capital lease was $48,002 and $16,000, respectively. The Company records rent expense using the straight-line method. For the lease that expires September 30, 2002, there is no difference between rent expense and actual rent paid. Future minimum lease payments for capital lease payments and operating leases are as follows: CAPITAL OPERATING LEASE LEASES ---------- ---------- Years ending May 31: 2000 $ 14,731 $ 208,625 2001 14,731 178,128 2002 4,911 179,899 2003 -- 86,007 2004 -- 26,569 Thereafter -- 12,394 ---------- ---------- Total future minimum lease payments 34,373 $ 691,622 ========== Less amount representing interest (at 10.4%) 3,717 ---------- Present value of net minimum lease payments 30,656 Less current installments of obligations under capital lease 10,288 ---------- Obligations under capital lease, excluding current installments $ 20,368 ========== (5) INCOME TAXES For the year ended May 31, 1999, income tax expense amounted to $13,000. No income tax benefit was recorded for the year ended May 31, 1998. This was due to the establishment of a 100% valuation allowance against the Company's deferred tax assets because of the uncertainty surrounding the Company's ability to realize its net operating loss carryforwards. F-9 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before taxes. The sources and tax effects of the differences for the years ended May 31, 1999 and 1998 are as follows: 1999 1998 ----------- ----------- Computed "expected" federal income tax expense $ 346,550 80,325 Change in valuation allowance (350,117) (129,660) Other 16,567 49,335 ----------- ----------- $ 13,000 -- =========== =========== The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows: Deferred tax assets: Net operating loss carryforwards (NOL) $ 2,075,667 Accrued expenses and other 37,819 Property and equipment (14,199) Valuation allowance (2,099,287) ----------- Net deferred tax assets $ -- =========== Management estimates that it is more likely than not that it will not realize a substantial portion of the benefits of its deferred tax assets. Accordingly, it has established a valuation allowance to reflect this uncertainty. The net change in the valuation allowance for the year ended May 31, 1999 and 1998 was a decrease of $290,868 and $361,945, respectively. The Company's federal NOLs of approximately $6,100,000 expire between 2004 and 2013. (6) COMMON STOCK During the year ended May 31, 1999, the Company repurchased 1,156,829 shares of common stock for prices ranging from $0.23 to $0.43 per share, 64,300 shares of Class A, nonvoting cumulative convertible preferred stock, Series 2, for a price of $3 per share and 16,720 shares of Class A, senior nonvoting cumulative convertible preferred stock, Series A, for prices ranging from $2.63 to $3.81 per share. Subsequent to the repurchase, the Company retired these shares. During the year ended May 31, 1998, the Company repurchased 79,294 shares of common stock for prices ranging from $0.25 to $0.27 per share. Subsequent to the repurchase, the Company retired these shares. F-10 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 (7) EARNINGS PER SHARE A summary of the reconciliation from basic earnings per share to diluted earnings per share for the years ended May 31, 1999 and 1998 follows: 1999 1998 ----------- ----------- Net earnings $ 1,006,265 313,875 Less: preferred stock dividends (107,936) (63,270) ----------- ----------- Income available to common stockholders $ 898,329 250,605 =========== =========== Basic EPS - weighted average shares outstanding 6,788,944 4,073,918 =========== =========== Basic earnings per share $ 0.13 0.06 =========== =========== Basic EPS - weighted average shares outstanding 6,788,944 4,073,918 Effect of diluted securities: Convertible debentures -- 19,162 Convertible preferred stock 3,113,769 996,577 ----------- ----------- Dilutive EPS - weighted average shares outstanding 9,902,713 5,089,657 Net earnings 1,006,265 313,875 Interest expense on non-CSE debt -- 8,978 ----------- ----------- 1,006,265 322,853 Diluted earnings per share $ 0.10 0.06 =========== =========== (8) STOCK OPTION PLANS AND WARRANTS In 1993 the Company adopted a stock option plan (the "Plan"). The stock option plan sets aside 600,000 shares of common stock (including incentive qualified and non-qualified stock options) to be granted to employees at a price not less than the fair market value of the stock at the date of grant. The vesting provisions are determined by the Board of Directors at the dates of grant. At May 31, 1999, there were 170,000 incentive options outstanding under this plan (of which 113,333 were exercisable at $0.48) and 310,000 nonqualified options exercisable at prices ranging from $.40 -$1.00 per share. In connection with the Long-Term Management Agreement, National Health Enterprises, Inc. of Owing Mills, Maryland (NHE) received ten-year options to purchase up to 4,400,000 shares of the Company's common stock. Options to purchase 1,400,000 shares at an exercise price of $.40 per share were vested at inception, and the remaining options to purchase shares at an exercise price of $.48 per share vested on December 5, 1994, in connection with a Board of Directors resolution. NHE transferred all of the options in March 1993 to certain individuals affiliated with NHE. Effective December 5, 1994, these individuals collectively transferred an aggregate of 125,000 of the options exercisable at $.48 per share to Richter & Co., Inc. F-11 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 On July 30, 1998, the Company's Board of Directors approved a modification providing all outstanding stock option and warrant holders the opportunity to exercise any or all of their vested options and warrants at a discounted exercise price from their original grant, during the period from August 1, 1998 to August 31, 1998. The discounted price was calculated by discounting the stated exercise price of each stock option or warrant by 10% per annum from the expiration date back to August 1998, and rounding the calculated price to the nearest whole cent. The discounted price in no case was allowed to be less than the prevailing market price of the Company's common stock at the time of exercise of the options, defined as the high bid price, and rounded to the nearest whole cent. During August 1998, 3,842,000 options were exercised at prices ranging between $0.26 and $0.31. The modification expired on August 31, 1998 and all terms returned to the original exercise terms for all unexercised stock options and warrants. A summary of stock option activity for the years ended May 31, 1999 and 1998 follows: PRICE PER OPTIONS OPTION ----------- ----------- Balance outstanding, May 31, 1997 4,710,000 Options granted 180,000 $ .48 Options exercised -- Options canceled -- ----------- Balance outstanding, May 31, 1998 4,890,000 Options granted -- Options exercised 3,842,000 $ .26 - .31 Options canceled 10,000 $ .48 ----------- Balance outstanding, May 31, 1999 1,038,000 =========== As of May 31, 1999 and 1998, options to purchase 981,333 and 4,770,000 shares, respectively, at prices ranging from $.40 to $1.00 were exercisable. A summary of stock options for common stock granted at May 31, 1999 follows: OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------- ----------------------- WEIGHTED NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE EXERCISE AT MAY 31, CONTRACTUAL EXERCISE AT MAY 31, EXERCISE PRICE 1999 LIFE PRICE 1999 PRICE --------- ----------- ----------- --------- ----------- --------- .40-$1.00 858,000 4 years $ .47 858,000 $ .47 1.00 10,000 8 years 1.00 10,000 1.00 .48 170,000 9 years .48 113,333 .48 ----------- --------- ----------- --------- 1,038,000 .48 981,333 .48 =========== ========= =========== ========= F-12 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 No stock options were granted in 1999. The per share weighted-average fair value of stock options granted during 1998 was $0.30 on the date of the grant using the Black-Scholes option pricing model with the following weighted-average assumptions: 1999 expected dividend yield rate of 0.0%, risk-free interest rate of 8.0%, volatility of 54.92%, and an expected life of six years; 1998 expected dividend yield rate of 0.0%, risk-free interest rate of 8.0%, volatility of 57.98% and an expected life of six years. The Company applies APB Opinion No. 25 and related interpretations in accounting for its plan. Accordingly, no compensation cost has been recognized for the Plan. Had compensation cost for the Company's stock-based compensation plan been determined consistent with FASB Statement No. 123, the Company's net income would have been reduced to the pro forma amounts indicated below: 1999 1998 ----------- ----------- Net income/(loss): As reported $ 1,006,265 313,875 Pro forma 1,003,622 305,633 Earnings per share: Basic: As reported .13 .06 Pro forma .13 .06 Diluted: As reported .10 .06 Pro forma .10 .06 The management agreement discussed above and related transactions with NHE and certain other substantial transactions were structured and negotiated for the Company by Richter & Co., Inc. (RCI), a New York investment banking firm, whose principal, William L. Richter, is a member of the Company's Board of Directors. RCI received cash consideration of $50,000 and ten-year warrants to purchase 400,000 shares of common stock. 160,000 of these warrants had been assigned to William L. Richter. In August 1998, RCI and William L. Richter exercised their warrants at exercise prices of $.26 and $.31. (9) PREFERRED STOCK The Company has authorized 1,000,000 shares of $10 Class A, Nonvoting Cumulative Convertible Preferred Stock, Series 2 (the "Series 2 Shares") with a par value of $.01 per share and quarterly dividends at the fixed annual rate of $.90 per share. The Series 2 Shares are convertible at the option of the holder into common stock of the Company at $4.00 per share, subject to adjustment under certain conditions. There is a liquidation preference which entitles holders to receive, out of the assets of the Company, $10.00 per share plus all accrued and unpaid dividends, before any amounts are distributed to the holders of common stock. F-13 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 During fiscal 1998 the Company completed an Exchange Offer which offered one share of its Class A, Senior Nonvoting Cumulative Convertible Preferred Stock, Series A, par value $.01 ("Series A Shares"), for each outstanding share of the Class A, Nonvoting Cumulative Convertible Preferred Stock, Series 2, par value $.01, of the Company. The purpose of this offer was to eliminate or significantly reduce the number of Series 2 Shares outstanding including the related dividend arrearage and to adjust the Company's capital structure. The Exchange Offer expired on May 27, 1998, and resulted in the tendering of 317,880 (approximately 82%) of the 388,180 outstanding Series 2 Shares for the Series A Shares. As of May 31, 1999, there were 6,000 Series 2 Shares outstanding, with each share entitled to receive a cumulative dividend at an annual rate of 9% of the face value of $10.00 ($0.90 per share). As of May 31, 1999, there were 301,160 Series A Shares outstanding, with each share entitled to receive a cumulative dividend at an annual rate of $0.3375 per share paid semi-annually. The Series A Share dividends shall accrue through the last day of each semi-annual period and shall be payable to holders of record on the last day of such semi-annual period. The Company has not paid any dividends on its common stock since its inception and does not expect to pay dividends on its common stock at any time for the foreseeable future. The Series A Shares are senior in rights to annual dividends and redemptions to the Series 2 Shares. Under the Certificate of Designation for the Series A Shares, no dividends may be paid on the Series 2 Shares or the common stock until the Series A shares have received all current and cumulative dividends and the earliest of any of the following events occur (i) every outstanding Series A Share has been either redeemed or converted, (ii) any time after May 31, 2005, or (iii) the first day of any fiscal year following two consecutive fiscal years in which the Company had net income and net cash flow in each year in excess of $1.5 million and the Company's tangible net equity at the end of the second fiscal year is at least $5 million. Moreover, the terms of the Series 2 Shares provide that as long as any of the Series 2 Shares remain outstanding, the Company may not declare or pay any dividend, whether in cash or property, on the common stock of the Company unless the full dividends on the Series 2 Shares for all past dividend periods and the then current dividend period shall have been paid or declared and a sum set aside for payment thereof. (10) CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS The Company's programs and services are offered throughout the United States. Most of the Company's customers are located in the Midwest, Texas, the Southwest and the D.C. metropolitan area. Two major customers provided 48% and 14% of total service revenues in 1999 and three major customers provided 28%, 15% and 10% of total service revenues in 1998. (11) LONG-TERM MANAGEMENT AND MARKETING AGREEMENT In March 1993, the Company entered into a Long-Term Management Agreement with NHE, which provides for NHE to manage all aspects of the Company's business. The initial term of the agreement was five years and was renewable. NHE also received options to purchase up to 4,400,000 shares of the Company's common stock. In December 1997, the Company renewed this agreement for a term of five years with payments of $250,000 per year due to NHE. In May 1999, the Company increased the payments, effective June 1999, to $300,000 per year. F-14 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 Additionally, the Company entered into a Marketing Representation Agreement with NHE, whereby NHE is entitled to receive a commission of 7.5% of enrollment fees from sponsor contracts generated by NHE, or 2.5% of enrollment fees where marketing assistance is rendered. The Company paid approximately $310,000 and $211,000 to NHE under the terms of this agreement in fiscal 1999 and 1998, respectively. (12) RELATED PARTY TRANSACTIONS During fiscal 1995, the Company contracted with National Computer Services, Inc. ("NCS"), a company owned by a member of the Company's board of directors, to develop software related to the Company's vision, dental and hearing programs. The Company did not pay any development fees related to the software during fiscal 1999 and 1998. Additionally, the Company has contracted with NCS to lease its computer system for approximately $1,000 per month. The Company paid $12,000 of computer lease charges in fiscal 1999 and 1998. The Company entered into a Registration Rights Agreement (the "Registration Rights Agreement") effective March 18, 1993 with NHE, and two shareholders. The Registration Rights Agreement provides two demand registrations with respect to 100,000 shares previously purchased and the shares issuable pursuant to the ten-year options discussed in note 9 ("Registrable Securities"). The first demand registration is exercisable at the request of holders of at least 900,000 Registrable Securities after the exercise by NHE and/or its transferees of at least 900,000 options. The second demand registration is exercisable at the request of holders of at least 1,000,000 options after completion of a fiscal year in which the Company has profits of at least $1,000,000. The Registration Rights Agreement also provides piggyback registration rights with respect to registrations in which other selling stockholders are participating. The Company is obligated to pay the offering expenses of each such registration, except for the selling stockholders' pro rata portion of underwriting discounts and commissions. No precise prediction can be made of the effect, if any, that the availability of shares pursuant to registrations under the Registration Rights Agreement will have on the market price prevailing from time to time. Nevertheless, sales of substantial amounts of the common stock pursuant to such registrations could adversely affect prevailing market prices. Effective January 18, 1995, the Company retained RCI as exclusive financial advisor and placement agent. RCI's fees under this arrangement are payable only upon completion of defined transactions and, in such event, are calculated upon the basis of a percentage of the transaction value. The agreement is terminable by the Company upon 90 days notice, provided that RCI is entitled to receive certain fees for two years following termination in the event a transaction is concluded with an entity introduced to the Company by RCI. On April 23, 1998, the Company entered into a Supplemental Investment Banking Agreement with RCI for investment banking services related to the Exchange Offer for the Company's Series 2 Shares. RCI received cash consideration of $50,000 and 250,000 shares of the Company's common stock valued at $0.20 per share. RCI provided substantial ongoing financial management and other services to the Company at no charge through May 1999. In May 1999, the Company's Board of Directors approved a cash payment to RCI at an annual rate of $30,000 to commence in June 1999. In the opinion of management, the terms of the Company's arrangements with RCI, NHE and NCS taken as a whole are at least as favorable to the Company as could be obtained from third parties. F-15 (Continued) AVESIS INCORPORATED AND SUBSIDIARY Consolidated Financial Statements May 31, 1999 and 1998 (13) EMPLOYEE BENEFIT PLAN The Company has a qualified 401(k) Plan (defined contribution plan). The plan covers substantially all employees who have completed three months of service and attained age twenty-one. Subject to limits imposed by Internal Revenue Service regulations and other options retained by the Company affecting participant contribution, participants may voluntarily contribute a percentage of their annual wages not to exceed limits established by the Tax Reform Act of 1986. Participants are immediately vested in the amount of their direct contribution. For the years ended May 31, 1999 and 1998, the Company did not contribute to the plan. F-16 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT The following table sets forth the names of the directors and executive officers of the Company and certain biographical information relating to them. Name Age Position(s) with Company - ---- --- ------------------------ William R. Cohen 68 Co-Chairman and Director William L. Richter 56 Co-Chairman and Director Kenneth L. Blum, Sr. 72 Director, Former Acting President and CEO as of May 31, 1998 Gerald L. Cohen 55 Director Sam Oolie 63 Director Alan S. Cohn 43 President, CEO and Director Kenneth L. Blum, Jr. 36 Director Neal A. Kempler 31 Corporate Secretary, Vice President of Operations Shannon R. Barnett 31 Controller Joel H. Alperstein 31 Treasurer, Director of Finance 18 On July 30, 1998, the Company's Board of Directors expanded the Board of Directors from 5 to 7 members. Consequently, Alan S. Cohn and Kenneth L. Blum, Jr. were named to the Board of Directors to fill the two vacant seats until the next stockholder meeting at which time they were re-elected as directors. The election to the Board of Messrs. Cohn and Blum, Jr. was conditioned upon the early exercise of their stock options. William R. Cohen, 68, Co-Chairman of the Board, has served as a Director of the Company since April 1986. Mr. Cohen is the Chairman of Go Lightly Candy Company. Mr. Cohen has served as Chairman of American Mobile Communications, a cellular communications company, and has also held various positions with CFC Associates, a venture capital partnership, and its predecessor organizations. Mr. Cohen serves as a lifetime trustee of the Hospital Center, Orange, New Jersey. Mr. Cohen is not related to Gerald L. Cohen. William L. Richter, 56, Co-Chairman of the Board, has been a director of the Company since August 1993. Mr. Richter has been President of Richter Investment Corp. and its wholly-owned subsidiary, Richter & Co., Inc., a registered broker-dealer and investment banking firm (or its predecessor organization) for the past ten years and has been a Senior Managing Director of Cerberus Capital Management, L.P. (or its predecessor organizations) since their founding in late 1992. Mr. Richter was Co-Chairman of Rent-A-Wreck of America, Inc., a franchiser of automobile rental agencies, from November 1989 to June 1993 and has been Vice Chairman of that Company since June 1993. Kenneth L. Blum, Sr., 72, has served as a Director of the Company since August 1993. Mr. Blum was acting President and Chief Executive Officer of the Company from September 1996 to May 1998. Mr. Blum has been Chairman of the Board of Rent-A-Wreck of America, Inc., an automobile rental franchiser, since June 1993, President from June 1993 to October 1994, and Chief Executive Officer since January 1994. Mr. Blum has been the President of KAB Leasing, Inc., an automobile wholesaler, since its inception during 1998. Mr. Blum has been the President of KAB, Inc., a management company, since 1990. Mr. Blum co-founded United HealthCare, Inc., a Baltimore, Maryland-based healthcare company, in 1974 and served as its President and Chief Executive Officer until 1990. Since 1990, Mr. Blum has been a management consultant to a variety of companies, including National Computer Services, Inc., a computer service bureau; American Business Information Systems, Inc., a high-volume laser printing company; and Mail-Rx, a mail-order prescription drug company. Mr. Blum is the father of Kenneth L. Blum, Jr. and the father-in-law of Alan S. Cohn. See "Management Services Agreement." 19 Gerald L. Cohen, 55, has served as a Director of the Company since March 1985. Mr. Cohen is a managing director of Greenley Capital Company, a limited partnership which is a New York-based investment banking firm. Mr. Cohen is the sole shareholder of the general partner (Greenley Corp.) of Greenley Capital Company. From August 1982 through April 1989, Mr. Cohen was a managing director of Richter, Cohen & Co., a New York-based investment banking firm. Mr. Cohen also serves as a Director of Marketing Systems of America. Mr. Cohen is not related to William R. Cohen. Sam Oolie, 63, has served as a Director of the Company since March 1985. Mr. Oolie has been Chairman of NoFire Technologies, Inc., a manufacturer of fire retardant coatings and textiles, since August 1995 and has been Chairman of Oolie Enterprises, an investment company, since July 1985. Mr. Oolie has held various positions with CFC Associates, a venture capital partnership, and its predecessor companies since January 1984. He was Vice Chairman of American Mobile Communications, Inc. a cellular telephone company, from February 1986 until July 1989 and Chairman of the Nostalgia Network, a 24-hour cable television program service, from April 1987 until January 1990. Mr. Oolie also serves as a Director of NCT Group, Inc. (formerly Noise Cancellation Technologies, Inc.) and Comverse Technology, Inc. Alan S. Cohn, 43, became the President and CEO of the Company as of June 1998 and a Director of the Company as of August 1998. Mr. Cohn is providing management services on behalf of the Company through an arrangement with NHE. Mr. Cohn has been a management consultant for NHE and KAB, Inc. since 1993 and 1990, respectively. Since 1990, Mr. Cohn has been a principal or management consultant to a variety of companies, including National Computer Services, Inc., a computer service bureau; American Business Information Systems, Inc., a high-volume laser printing company; Rent-A-Wreck of America, Inc., an automobile franchiser; Allscripts, Inc., formerly Physician Dispensing Systems, Inc., a pharmaceutical dispensing company; Lawphone, Inc., a prepaid legal fee company; and Mail-Rx, a mail-order prescription drug company. Mr. Cohn is the son-in-law of Kenneth L. Blum, Sr., the Company's former acting President and CEO, and a member of the Board of Directors. Kenneth L. Blum, Jr., 36, became a Director of the Company as of August 1998. Mr. Blum is the President, Chief Executive Officer and the sole stockholder of NHE. Mr. Blum is also President and Secretary of Rent-A-Wreck of America, Inc., an automobile rental franchiser, President of National Computer Services, Inc., a computer service bureau, and President of American Business Information Systems, Inc., a high-volume laser printing company. Kenneth L. Blum, Sr., the Company's former acting President and CEO, and a member of the Board of Directors, is the father of Kenneth L. Blum, Jr. See "Management Services Agreement." 20 Neal Kempler, 31, has been the Corporate Secretary of the Company since June 1996, the Vice President of Marketing & Operations of the Company since August 1996 and the Assistant to the President/Director of Marketing from January 1993 until August 1996. Mr. Kempler served as Account Executive of National Health Enterprises, Inc., a management company, from June 1990 until January 1993. Shannon R. Barnett, 31, has been the Controller of the Company (Principal Accounting Officer) since August 1996 and was a Senior Accountant of the Company from November 1995 until August 1996. Ms. Barnett was Assistant Controller of Quality Hotel and Marlyn Nutraceuticals, a vitamin manufacturer, from September 1994 until November 1995 and Staff Accountant of General Atlantic Resources, Inc., an oil and gas company, from November 1992 until June 1994. Joel H. Alperstein, 31, has been the Treasurer of the Company since December 1997 and the Director of Finance of the Company (Principal Financial Officer) since January 1997. Since March 1999, Mr. Alperstein has been a management consultant to American Business Information Systems, Inc., a high-volume laser printing company. Mr. Alperstein was a self-employed financial consultant from September 1996 until December 1996. Mr. Alperstein was a Manager at Stout, Causey & Horning, P.A., a full service public accounting firm, from September 1992 until August 1996, and a Senior Accountant at Arthur Andersen, LLP, from July 1990 until September 1992. Mr. Alperstein has a Masters of Business Administration from Loyola College of Maryland and is a Certified Public Accountant. All directors will hold office until the next annual meeting of stockholders and the election and qualification of their successors. Officers are appointed annually and serve at the pleasure of the Board of Directors. MANAGEMENT SERVICES AGREEMENT Effective March 18, 1993, the Company entered into a Management Agreement (the "Management Agreement") with National Health Enterprises, Inc., a Maryland corporation ("NHE") pursuant to which NHE agreed to manage substantially all aspects of the Company's business, subject to certain limitations and the direction of the Company's Board of Directors. See Item 12 - "Certain Relationships and Related Transactions." 21 SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Under the securities laws of the United States, the Company's directors, its executive officers, and any persons holding more than ten percent of the Company's Common and Preferred Stock are required to report their initial ownership of the Company's Common and Preferred Stock and any subsequent changes in that ownership to the Securities and Exchange Commission. Specific due dates for these reports have been established and the Company is required to disclose any failure to file by these dates. The Company believes that all of these filing requirements were satisfied during the year ended May 31, 1999, except that no Form 4 was received from a more than 10% shareholder in connection with the Company's August 1998 repurchase of his shares. In making these disclosures, the Company has relied solely on representations obtained from certain of its former and current directors, executive officers and ten percent holders and/or copies of the reports that they have filed with the Commission. ITEM 10. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table and related notes set forth information regarding the compensation awarded to, earned by or paid to the Company's Chief Executive Officer during the year ended May 31, 1999. No executive officer who was serving as an executive officer during fiscal 1999 received salary and bonus which aggregated at least $100,000 for services rendered to the Company during the year ended May 31, 1999.
Annual Compensation Long Term Compensation ------------------- -------------------------------------- Awards -------------------------------------- Name and Principal Position Year Salary ($) Securities Underlying Options/SARs (#) - --------------------------- ---- ---------- -------------------------------------- Alan S. Cohn, CEO (1) 1999 $0 -- Kenneth L. Blum, Sr., Acting CEO 1998 $0 -- 1997 $0 --
- ---------- (1) Mr. Cohn became CEO of the Company as of June 1, 1998. Mr. Cohn is compensated through the Management Agreement with National Health Enterprises, Inc. See also Item 12 -- "Certain Relationships and Related Transactions - Agreements with National Health Enterprises, Inc. -- Stock Option Grant." 22 EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT, AND CHANGE-IN-CONTROL ARRANGEMENTS No employment contracts, termination of employment, or change-in-control arrangements currently exist except for the National Health Enterprises, Inc. arrangement described below. DIRECTOR COMPENSATION Directors are reimbursed for out-of-pocket expenses incurred in connection with each Board of Directors or committee meeting attended. Directors who also are employees of the Company are eligible to participate in the Company's Incentive Stock Option Plan and the Company's 401(k) Plan, and all directors are eligible to participate in the Company's 1993 Stock Option Plan (the "1993 Plan"). Pursuant to the 1993 Plan, options for 100,000 shares of the Company's Common Stock were granted on April 8, 1993 to each of directors William R. Cohen, Gerald L. Cohen, and Sam Oolie. The exercise price of such options is $.40 per share, which was at least the fair market value of the Company's Common Stock on the date of grant. (See Item 5 - "Market for Common Stock and Related Stockholder Matters - Recent Sales of Unregistered Securities") Options for 25,000 shares of Common Stock were exercisable by each of the optionees as of the date of grant, with the balance vesting in equal parts at the end of each of the 10 three-month periods following the date of grant. During August 1998, William R. Cohen and Gerald L. Cohen each exercised their 100,000 stock options pursuant to the reduced pricing as approved by the Board of Directors. See Item 5 - "Market for Common Stock and Related Stockholder Matters - Recent Sales of Unregistered Securities." 23 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT As of August 13, 1999 there were 7,356,297 shares of Common Stock, 5,000 Series 2 Shares and 301,160 Series A Shares outstanding. The table below sets forth as of August 13, 1999, certain information regarding the shares of Common Stock and Series A Preferred Stock beneficially owned by each director of the Company and each named executive officer in the Summary Compensation table set forth in Item 10, by all of the Company's executive officers and directors as a group, and by those persons known by the Company to have owned beneficially 5% or more of the outstanding shares of Common Stock, which information as to beneficial ownership is based upon statements furnished to the Company by such persons. None of the directors or executive officers owns any Series 2 Shares.
Common issuable upon conversion or exercise of: (1) ----------------------------------- Series A Total Common Common % of Preferred Stock % of Options Beneficially Percent of Name and Address Stock Common (actual shares) Pref. or Warrants Owned (1) Common (2) - ---------------- ----- ------ ---------------- ----- ----------- ------------ ---------- Gerald L. Cohen* 253,359 3.4 22,274(7) 7.4 -- 476,099 6.3 William R. Cohen* 161,117(4) 2.2 10,552 3.5 -- 266,637 3.6 William L. Richter 1,194,620(3) 16.2 50,099(3) 16.6 -- 1,695,610(3) 21.6 C/o Richter & Co., Inc. 450 Park Ave., 28th Floor New York, NY 10022 Sam Oolie* 220,021(5) 3.0 24,023 8.0 100,000 560,251 7.3 Kenneth L. Blum, Sr. 140,000(6) 1.9 2,000 0.7 -- 160,000 2.2 17133 Ericarose Street W. Boca Raton, FL 33496 Kenneth L. Blum, Jr. 1,814,750 24.7 -- -- -- 1,814,750 24.7 11460 Cronridge Drive Suite 120 Owings Mills, MD 21117 Alan S. Cohn 1,804,750 24.5 -- -- -- 1,804,750 24.5 11460 Cronridge Drive Suite 120 Owings Mills, MD 21117 All directors and 5,588,617(4)(5) 76.0 108,948 36.2 505,000 7,183,097 80.3 Executive officers as A group (9 persons)
- ---------- * Business Address: 3724 North Third Street, Suite 300, Phoenix, Arizona 85012. 24 (1) Includes shares of Common Stock with respect to which the identified person had the right to acquire beneficial ownership on or within 60 days of the date of the above table pursuant to the Series A Preferred or options or warrants, as indicated. Each share of Series A Preferred Stock indicated in the table is convertible into 10 shares of Common Stock and such shares of Common Stock are included in the total Common Stock beneficially owned. (2) The percentages shown include Common Stock actually owned as of the date of the above table and Common Stock as to which the person had the right to acquire beneficial ownership within 60 days of such date pursuant to the Series A Preferred, options or warrants, as indicated. In calculating the percentage of ownership, all shares of Common Stock which the identified person had the right to acquire within 60 days of the date of the above table are deemed to be outstanding when computing the percentage of Common Stock owned by such person but are not deemed to be outstanding when computing the percentage of Common Stock owned by any other person. (3) Includes 462,500 shares of Common Stock and shares of Common Stock issuable upon conversion of 22,300 shares of Series A indirectly owned via an affiliated corporation, Richter & Co., Inc. ("RCI"), which thereby beneficially owns in its own name 685,500 shares or 9.0% of the Company's Common Stock. Also includes shares of Common Stock issuable upon conversion of 3,883 and 4,530 shares of Series A Preferred held via two other corporations. Also includes shares of Common Stock issuable upon conversion of 2,500 shares of Series A Preferred and 15,169 shares of Common Stock held by family members, as to which Mr. Richter disclaims beneficial ownership. (4) Includes 6.67% of the 6,337 shares of common stock and 19,412 shares of Series A Preferred stock held by an affiliated corporation, with respect to which William R. Cohen owns 6.67% of the outstanding stock. (5) Includes 20% of the 6,337 shares of common stock and 19,412 shares of Series A Preferred stock held by an affiliated corporation, with respect to which Mr. Oolie owns 20% of the outstanding stock. Also includes 8,679 shares owned by Mr. Oolie's wife, as to which Mr. Oolie disclaims beneficial ownership. (6) The indicated shares are held by Mr. Blum's spouse. (7) Includes 43.75% of the 4,530 shares of Series A Preferred held by an affiliated corporation. 25 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AGREEMENTS WITH NATIONAL HEALTH ENTERPRISES, INC. MANAGEMENT AGREEMENT. On December 12, 1997 the Company's Board of Directors agreed to extend the term of the Company's Management Agreement with NHE to March 18, 2003. Also, effective March 18, 1998, the Company's Board of Directors agreed to increase the cash compensation paid to NHE under the Management Agreement by $50,000 per year to $250,000 per year. On May 3, 1999, the Company's Board of Directors agreed to increase the cash compensation paid to NHE under the Management Agreement by an additional $50,000 per year to $300,000 per year. Messrs. Blum Sr., Blum Jr. and Cohn abstained from voting due to their relationship to National Health Enterprises. The increase became effective as of June 1, 1999. STOCK OPTION GRANT. Pursuant to the Management Agreement, on March 18, 1993, the Company issued options (the "Options") to NHE for the purchase of up to 4,400,000 shares of the Company's Common Stock. Also pursuant to the Management Agreement, the Company entered into a Registration Rights Agreement effective March 18, 1993 with NHE, Mr. Blum, Jr. and Mr. Cohn. During August 1998, Messrs. Blum, Jr., Cohn and Richter exercised all of their outstanding options from the March 18, 1993 Stock Option Grant. See Item 5 - - "Market for Common Stock and Related Stockholder Matters - Recent Sales of Unregistered Securities." SUBORDINATED PROMISSORY NOTES. On March 18, 1993, the Company obtained loans in the amount of $80,000 from each of Mr. Blum, Jr. and Mr. Cohn. The notes were due March 18, 1998 and accrued interest at the rate of 6% per annum, provided that the holders could accelerate the notes if the Company terminated the Management Agreement without cause. Interest was payable semiannually in arrears, commencing September 18, 1993. The notes were unsecured and subordinated to the Company's outstanding 9 1/2% Debentures and future indebtedness of the Company for borrowed money. The Company paid $8,416 in interest under the terms of these notes in fiscal 1998. On March 18, 1998 the Company paid Mr. Blum, Jr. and Mr. Cohn the outstanding principal and accrued interest amounts on the subordinated promissory notes. MARKETING AGREEMENT. Effective March 18, 1993, the Company and NHE entered into a Marketing Representation Agreement (the "Marketing Agreement") pursuant to which NHE is entitled to receive a commission equal to 7 1/2% of the enrollment fees (as defined) from Sponsor contracts generated by NHE. The Company also agreed to pay NHE commissions equal to 2 1/2% of the enrollment fees from Sponsor contracts with respect to which NHE provides marketing assistance in procuring the contract, but does not itself generate the initial Sponsor contact. The term of the Marketing Agreement is coextensive with that of 26 the Management Agreement. In fiscal 1999 and 1998, the Company paid approximately $310,000 and $211,000, respectively, to NHE under the Marketing Agreement. In fiscal 1999 and 1998, the Company paid approximately $13,446 and $8,000, respectively, in reimbursable marketing expenses to NHE under the Marketing Agreement. INVESTMENT BANKING SERVICES On April 23, 1998, the Company entered into a Supplemental Agreement with Richter & Co., Inc. ("RCI") for Investment Banking services related to the Exchange Offer for the Company's Series 2 Preferred shares. RCI received cash consideration of $50,000 and 250,000 shares of the Company's Common Stock. RCI assigned 100,000 shares of the Company's Common Stock received under this agreement to William L. Richter. On May 3, 1999, the Company's Board of Directors approved a cash payment to Richter & Co., Inc. at an annual rate of $30,000 under the Investment Advisor Agreement. Mr. Richter abstained from voting due to his relationship to Richter & Co., Inc. The payment commenced as of June 1, 1999. SOFTWARE DEVELOPMENT SERVICES During fiscal 1995, the Company contracted with National Computer Services, Inc. ("NCS") to develop software related to the Company's vision, dental and hearing programs. The Company did not pay any development fees related to the software during fiscal 1999 and 1998. Additionally, the Company has contracted with NCS to lease its computer system for approximately $1,000 per month. The Company paid $12,000 of computer lease charges in fiscal 1999 and 1998. Kenneth L. Blum, Jr., a Director, is President and a stockholder of NCS and the son of Kenneth L. Blum, Sr., the former Acting President and CEO, and a Director of the Company. 27 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) See Exhibit Index following the Signatures page which Index is incorporated herein by reference. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of the period covered by this report. 28 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AVESIS INCORPORATED Date August 24, 1999 By: /s/ Alan S. Cohn ------------------------ ------------------------------------- Alan S. Cohn President and Principal Executive Officer In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date - --------- ----- ---- /s/ Alan S. Cohn President, Principal August 24, 1999 - ------------------------ Executive Officer and Director Alan S. Cohn /s/ Neal A. Kempler Corporate Secretary and August 24, 1999 - ------------------------ Vice President of Operations Neal A. Kempler /s/ Joel H. Alperstein Treasurer and Director August 24, 1999 - ------------------------ of Finance Joel H. Alperstein (Principal Financial Officer) /s/ Shannon R. Barnett Controller August 24, 1999 - ----------------------- (Principal Accounting Officer) Shannon R. Barnett /s/ William R. Cohen Co-Chairman of the August 24, 1999 - ---------------------- Board of Directors William R. Cohen /s/ William L. Richter Co-Chairman of the August 24, 1999 - ------------------------ Board of Directors William L. Richter /s/ Kenneth L. Blum, Sr. Director August 24, 1999 - ------------------------ Kenneth L. Blum, Sr. /s/ Kenneth L. Blum, Jr. Director August 24, 1999 - ------------------------ Kenneth L. Blum, Jr. /s/ Gerald L. Cohen Director August 24, 1999 - ------------------------ Gerald L. Cohen /s/ Sam Oolie Director August 24, 1999 - ------------------------ Sam Oolie 29 AVESIS INCORPORATED EXHIBIT INDEX FORM 10-KSB FOR THE FISCAL YEAR ENDED MAY 31, 1999
EXHIBIT NO. EXHIBIT INCORPORATED BY REFERENCE FROM THE: - ----------- ------- ----------------------------------- 3.1 Amended and Restated Certificate of Company's Registration Statement on Form S-1 Incorporation of the Company, as amended (File No. 33-17217) filed January 12, 1988, and declared effective January 12, 1988. 3.2 Bylaws of the Company Company's Registration Statement on Form S-18 (File No. 33-6366-LA) filed July 11, 1986 and declared effective July 14, 1986. 3.3 Amendments to Bylaws adopted December 6, 1991 Company's Annual Report on Form 10-K for the year ended May 31, 1992 (File No. 1-9758). 4.1 Statement of Designations, Preferences, Company's Registration Statement on Form S-l Privileges, Voting Powers, Restrictions, filed May 17, 1989 (File No. 33-28756). Qualifications and Rights of the Series 2 Preferred 4.2 Specimen Certificate representing $.0l par value Company's Registration Statement on Form S-18 Common Stock (File No. 33-6366-LA) filed July 11, 1986 and declared effective July 14, 1986. 4.3 Specimen Certificate representing $10 Class A Amendment No. l to the Company's Registration Nonvoting Cumulative Convertible Preferred Statement on Form S-l filed June 29, 1989 Stock, Series 2 (File No. 33-28756). 4.4 Statement of Designations, Preferences, Company's Schedule 13E-4 filed April 27, 1998 Privileges, Voting Powers, Restrictions and (Annex A). Qualifications of the Series A Preferred 10.1 Incentive Stock Option Plan of the Company, as Company's Registration Statement on Form S-1 amended (File No. 33-17217) filed January 12, 1988, and declared effective January 12, 1988. 10.2 401(k) Plan of the Company Company's annual report on Form 10-K for the year ended May 31, 1989 (File No. 1-9758).
EXHIBIT NO. EXHIBIT INCORPORATED BY REFERENCE FROM THE: - ----------- ------- ----------------------------------- 10.3 Management Agreement dated March 18, 1993 Company's report on Form 8-K dated March 18, between the Company and NHE 1993 (File No. 1-9758). 10.4 Stock Option Grant to NHE dated March 18, Company's report on Form 8-K dated 1993 relating to options for the purchase of March 18, 1993 (File No. 1-9758). 4,400,000 shares of the Company's Common Stock 10.5 Subordinated Promissory Note dated March 18, Company's report on Form 8-K dated 1993 in the amount of $80,000 payable by the March 18, 1993 (File No. 1-9758). Company to Mr. and Ms. Blum 10.6 Subordinated Promissory Note dated March 18, Company's report on Form 8-K dated 1993 in the amount of $80,000 payable by the March 18, 1993 (File No. 1-9758). Company to Mr. and Mrs. Cohn 10.7 Registration Rights Agreement dated March 18, Company's report on Form 8-K dated 1993 among NHE, Mr. Blum, and Alan S. Cohn March 18, 1993 (File No. 1-9758). 10.8 Marketing Agreement dated March 18, 1993 between Company's report on Form 8-K dated the Company and NHE March 18, 1993 (File No. 1-9758). 10.9 Option Transfer Documents dated March 31, 1993 Company's report on Form 8-K dated March 18, 1993 (File No. 1-9758). 10.10 Stock Purchase Warrant issued to Richter & Co., Company's report on Form 8-K dated Inc. dated March 18, 1993 for the purchase of March 18, 1993 (File No. 1-9758). 240,000 shares of the Issuer's Common Stock 10.11 Stock Purchase Warrant issued to William L. Company's report on Form 8-K dated Richter dated March 18, 1993 for the purchase of March 18, 1993 (File No. 1-9758). 160,000 shares of the Issuer's Common Stock 10.12 1993 Stock Option Plan Company's annual report on Form 10-KSB for the year ended May 31, 1993 (File No. 1-9758). 10.13 Lease Agreement between the Company and Company's Report on Form 10-QSB for the three Phoenix City Square months ended February 28, 1995 (File No. 1-9758). 10.14 Fee Agreement between the Company and Richter Company's Report on Form 10-QSB for the three & Co., Inc. months ended February 28, 1995 (File No. 1-9758). 10.15 Software Development Agreement between the Company's Report on Form 10-QSB for the three Company and National Computer Services, Inc. months ended August 31, 1995 (File No. 1-9758). 10.16 Litigation Agreement between the Company and Company's Report on Form 10-KSB for the year Ken Blum, Sr., Ken Blum, Jr., and Alan Cohn ended May 31, 1997 (File No. 0-15304).
EXHIBIT NO. EXHIBIT INCORPORATED BY REFERENCE FROM THE: - ----------- ------- ----------------------------------- 10.17 Sublease Agreement between the Company and Company's Report on Form 10-KSB for the year InfoImage, Inc. ended May 31, 1997 (File No. 0-15304). 10.18 Lease Agreement between the Company and Company's Report on Form 10-KSB for the year Principal Mutual Life Insurance Company ended May 31, 1997 (File No. 0-15304). 10.19 Supplemental Agreement to the December 5, 1994 Company's Report on Form 10-KSB for the year Investment Banking Agreement ended May 31, 1998 (File No. 0-15304). 11 Statement recomputation of per-share earnings Earnings (Loss) per Share Computation, see Note 7 to the Notes to Consolidated Financial Statements. 21 Subsidiary of Registrant filed herewith 27 Financial Data Schedule filed herewith
EX-21 2 SUBSIDIARY OF REGISTRANT Exhibit 21 Subsidiary of Registrant Avesis of Washington, D.C., Inc. State of Incorporation: District of Columbia Name under which business is done: Avesis of Washington, D.C., Inc. EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S FORM 10-KSB FOR THE YEAR ENDED MAY 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-KSB. 1 U.S. DOLLARS 12-MOS MAY-31-1999 JUN-01-1998 MAY-31-1999 1 2,599,342 0 382,038 (41,033) 0 3,197,248 1,443,629 (977,541) 3,897,255 1,545,838 0 0 3,072 73,563 0 3,897,255 0 10,206,467 7,131,269 2,168,926 (116,953) 0 (3,960) 1,019,265 13,000 1,006,265 0 0 0 1,006,265 0.13 0.10
-----END PRIVACY-ENHANCED MESSAGE-----