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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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(Mark One)
X Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
- ------ Act of 1934 For the Fiscal Year ended December 31, 1996
Transition Report pursuant to Section 13 or 15(d) of the Securities
- ------ Exchange Act of 1934
Commission File Number: 1-14128
STERLING VISION, INC.
(Exact name of Registrant as specified in its Charter)
New York 11-3096941
(State of Incorporation) (IRS Employer Identification Number)
1500 Hempstead Turnpike
East Meadow, NY 11554
Telephone Number: (516) 390-2100
(Address of Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
TITLE Exchange
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Common Stock, par value $.01 per share Nasdaq Market System
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the Common Stock held by nonaffiliates as of
March 20, 1997, (based upon the closing bid price of $7.75 per share as quoted
on the Nasdaq Market System) was approximately $43,000,000. For purposes of this
computation, the shares of Common Stock held by directors, executive officers
and principal shareholders owning more than 5% of the Company's outstanding
Common Stock and which a Schedule 13G were deemed to be stock held by
affiliates. As of March 20, 1997, there were 5,552,471 shares of Common Stock
outstanding held by nonaffiliates.
As of March 20, 1997, 12,387,535 shares of the Registrant's Common Stock
were outstanding.
The Company's Proxy Statement for the 1996 Annual Meeting of Shareholders
is incorporated by reference to Part III of this Annual Report on Form 10-K.
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Item 1. Business
All statements contained herein that are not historical facts including,
but not limited to, statements regarding the future development plans of
Sterling Vision, Inc. ("Sterling" or the "Company") and the Company's ability to
generate cash from its operations, are based upon current expectations. These
statements are forward looking in nature and involve a number of risks and
uncertainties. Actual results may differ materially. Among the factors that
could cause actual results to differ materially from the anticipated results or
other expectations expressed in the Company's forward-looking statements are the
following: competition in the retail optical industry; the ability of the
Company to enter into third party, managed care provider agreements on favorable
terms; the ability of the Company to acquire, at favorable prices, retail
optical chains; the uncertainty of the acceptance of Photorefractive Keratectomy
("PRK"); the availability of new and better ophthalmic laser technologies or
other technologies that serve the same purpose as PRK; the inability of the
Company to finalize favorable agreements with ophthalmologists to utilize the
Company's excimer lasers to perform PRK procedures; competition in the PRK
market; lack of experience in developing or managing PRK centers and
ophthalmological practices; the inability of the Company to enter into
amendments to the Credit Agreement (as hereinafter defined) and defaults related
therefrom; and general business and economic conditions.
General
The Company is one of the largest chains of retail optical stores and the
second largest franchised optical chain in the United States based upon domestic
sales and number of locations of Company-owned and franchised stores
(collectively, referred to herein as "Sterling Stores").
As of December 31, 1996, there were 319 Sterling Stores, consisting of 62
Company-owned stores and 257 franchised stores. The Company continually seeks to
expand both its Company-owned and franchised store operations. As of December
31, 1996, Sterling was constructing four additional stores, and had received
commitments from existing franchisees to develop an additional eight franchised
Sterling Stores. Sterling Stores are located in 27 states, the District of
Columbia and Ontario, Canada.
Most Sterling Stores offer eyecare products and services such as
prescription and non-prescription eyeglasses, eyeglass frames, ophthalmic
lenses, contact lenses, sunglasses and a broad range of ancillary items. To the
extent permitted by individual state regulations, an optometrist is employed by,
or affiliated with, most Sterling Stores, which optometrist provides
professional eye examinations to the public. The Company fills prescriptions
from these employed or affiliated optometrists, as well as from unaffiliated
optometrists and ophthalmologists. Most Sterling Stores have an inventory of
ophthalmic and contact lenses, as well as on-site lab equipment for cutting and
edging ophthalmic lenses to fit into eyeglass frames, which allows Sterling
Stores to offer same-day service in many cases.
Sterling views its Company-owned stores as "inventory" to be strategically
sold to qualified franchisees. By selling Company-owned Sterling Stores to
franchisees, the Company hopes to achieve two goals: to recognize a gain on the
conveyance of the assets of such stores, and to create a stream of royalty
payments based upon a percentage of the gross revenues of the franchised
locations. Sterling currently derives its revenues principally from: the sale of
eyecare products and services at Company-owned stores; ongoing royalties based
upon a percentage of gross revenues of franchised stores; and the conveyance of
Company-owned store assets to existing and new franchisees.
While most Sterling Stores presently operate under one of the tradenames
"Sterling Optical," "IPCO Optical," "Site For Sore Eyes," "Benson Optical",
"Southern Optical", "Superior Optical", "Nevada Optical", "Duling Optical",
Monfried Optical" or "Kindly Optical", the Company is presently formulating
plans to change the tradename of most Sterling Stores to "Sterling Optical". In
connection therewith, the Company intends to formulate and implement additional
advertising and marketing programs to create increased name recognition
throughout those areas of the United States where the Company is currently
operating under a tradename other than "Sterling Optical." The Company also
operates VisionCare of California ("VCC"), a specialized health care maintenance
organization licensed by the California Department of Corporations. VCC employs
licensed optometrists who render services in offices located immediately
adjacent to, or within, most Sterling Stores located in California.
The Company also plans to affiliate with health care providers
(ophthalmologists) in offering PRK, a procedure performed with an excimer laser
for the correction of certain degrees of myopia (near-sightedness). It is
anticipated that the Company and such ophthalmologists will enter into
agreements pursuant to which such ophthalmologists will pay to the Company a fee
for each PRK
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procedure performed using an excimer laser installed by Insight Laser Centers,
Inc. ("Insight"), a wholly-owned subsidiary of the Company, into such
ophthalmologists' offices. As of December 31, 1996, the Company had leased six
excimer lasers, each with a purchase option for nominal consideration. The
Company currently owns and operates one Insight Laser Center located in New York
City and has placed three excimer lasers into various ophthalmological offices
located in the New York metropolitan area and in San Francisco, California.
Background of the Company
Sterling was incorporated under the laws of the State of New York in
January 1992 and in February 1992, purchased substantially all of the
assets (the "IPCO Acquisition") of Sterling Optical Corp., f/k/a IPCO
Corporation ("IPCO"), a New York corporation then a
debtor-in-possession under Chapter 11 of the U.S. Bankruptcy Code.
Subsequent to the IPCO Acquisition, the Company, in October 1993,
acquired, through a merger, 26 retail optical stores (both Company
operated and franchised) operating under the name "Site For Sore Eyes"
("SFSE") and located in Northern California (the "SFSE Merger"). In
connection with the SFSE Merger, certain of the principal shareholders
of the Company also acquired VCC, a specialized health care maintenance
organization licensed by the California Department of Corporations
under the California Knox Keene Health Care Service Plan Act of 1975.
In addition, the Company: in August 1994, purchased the assets of eight
additional retail optical stores located in New York and New Jersey
from Pembridge Optical Partners, Inc. ("Pembridge"); in November 1995,
acquired, through one of its wholly-owned subsidiaries, substantially
all of the assets of Benson Optical Co., Inc., OCA Acquisition Corp.
and Superior Optical Company, Inc., (the "Benson Transaction")
including the assets contained in 32 retail optical store locations;
and, in May, 1996, acquired, through a private foreclosure sale,
substantially all of the retail optical assets of Vision Centers of
America, Ltd., D & K Optical, Inc., Monfried Corporation and Duling
Finance Corporation (collectively, "VCA") through a transaction that is
discussed more fully below. See "New Acquisitions". The Company has
also entered into an agreement to acquire, in exchange for shares of
its Common Stock, all of the issued and outstanding capital stock of
Singer Specs, Inc., a chain of approximately 30 franchised retail
optical stores located primarily in the States of Pennsylvania, New
Jersey, Delaware and Virginia. See Note 18 - Subsequent Events.
Company-Store Operations
The following chart sets forth the breakdown of the Company's Sterling
Stores as of December 31, 1996:
STERLING STORES
AS OF DECEMBER 31, 1996
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I. COMPANY-OWNED STORES:
Total Stores in Operation............................................ 62
--
Stores Under Construction............................................ 0
--
Leases Under Negotiation............................................. 0
--
Total..................................................... 62
==
Existing store locations: California (18), Illinois (3), Iowa (1),
Kentucky (7), Michigan (2), Nebraska (2), Nevada (1), New Jersey (2),
New York (18), North Dakota (2), Pennsylvania (4), and West Virginia (2)
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II. FRANCHISED STORES:
Total Stores in Operation............................................ 257
Stores Under Construction............................................ 4
---
Total................................... 261
===
Existing store locations: California (20), Colorado (2), Connecticut
(2), Florida (1), Illinois (13), Indiana (1), Kentucky (14), Maryland
(16), Massachusetts (1), Michigan (6), Minnesota (27), Missouri (8),
Montana (1), Nebraska (5), New Hampshire (1), New Jersey (7), New York
(45), North Carolina (5), North Dakota (7), Pennsylvania (5), South
Dakota (11), Virginia (7), Washington, D.C. (1), Washington (5), West
Virginia (3), Wisconsin (34), and Ontario, Canada (9)
Sterling Stores generally range in size from approximately 1,000 square
feet to 2,000 square feet, are substantially similar in appearance and are
operated under certain uniform standards and operating procedures. Many Sterling
Stores are located in enclosed regional shopping malls and smaller strip
centers. However, some Sterling Stores are located on the ground floor of office
buildings or other commercial structures. A limited number of Sterling Stores
are housed in freestanding buildings with adjacent parking facilities, and
certain Sterling Stores are situated in professional optometric offices (such as
facilities which also include sports therapy, physical therapy and other medical
services), clinics or hospitals. Sterling Stores are generally clustered within
geographic market areas so as to maximize the benefit of advertising strategies
and to minimize the cost of supervising operations. Sterling Stores which are
not clustered within geographic market areas (e.g. Sterling Stores located in
West Virginia and New Hampshire) have not produced results from which any
consistent performance standards can be drawn by the Company.
Most Sterling Stores offer a full line of prescription and
non-prescription eyeglasses, sunglasses and contact lenses, and, if permitted
under applicable law, professional eye examinations which are performed by
employed or affiliated optometrists. In response to the eyewear market becoming
increasingly fashion-oriented during the past decade, most Sterling Stores carry
a large selection of designer eyeglass frames. The Company continually
test-markets various brands of sunglasses, ophthalmic lenses, contact lenses and
designer frames in an attempt to maximize systemwide sales and profits from
these categories of merchandise. Small quantities of these items are usually
purchased for selected stores that test customer response and interest and, if a
product test is successful, the Company attempts to negotiate a systemwide
preferred vendor discount for such product, which discount is then made
available to the Company's franchisees. A full line of eyeglass and contact lens
accessories is also available at most Sterling Stores. For the period ended
December 31, 1996, net sales at Company-owned stores were $28,476,679.
Most Sterling Stores maintain a working inventory of the most often
prescribed contact and ophthalmic lenses and an on-site facility for cutting and
edging ophthalmic lenses to fit into eyeglass frames, which enables most
Sterling Stores to offer same-day or next-day service for a majority of
customers ordering prescription eyeglasses. At the end of the second quarter of
1995, the Company commenced operating a laboratory facility located in Roslyn,
New York which manufactured certain prescription ophthalmic lenses, which
laboratory was closed by the Company, at the end of 1996, primarily as a result
of the Company's ability to negotiate substantially lower pricing of such
products from independent laboratories and in an effort to reduce its general
and administrative expenses.
Franchise Operations
As of December 31, 1996, the Company had 257 franchised stores, as
compared to 150 franchised stores as of December 31, 1995. An integral part of
the Company's franchising system includes providing what the Company believes to
be a high level of marketing, financial, training and administrative support to
its franchisees. The Company provides "grand opening" assistance for each new
franchised location by consulting with its franchisees with respect to store
design, fixture and equipment requirements and sources,
5
inventory selection and initial marketing and promotional programs.
Specifically, the Company's grand opening assistance (i) helps to establish
business plans and budgets; (ii) provides preliminary store designs and plan
approval prior to construction of a franchised store; (iii) provides initial
training, an operations manual and a comprehensive business review to aid the
franchisee in attempting to maximize its sales and profitability; and (iv) in
California, through VCC, operates Sterling VisionCare offices located adjacent
to, or within, most franchised stores, at which a licensed optometrist performs
eye examinations. Further, the Company generally restricts itself from operating
or franchising other Sterling Stores within a specified radius of each existing
franchised store. In addition, the Company, on an ongoing basis, provides
training through regional seminars and an annual convention, offers assistance
in marketing and advertising programs and promotions, and consults with its
franchisees as to their management and operational strategies and business
plans.
Preferred Vendor Network. With the collective buying power of
Company-owned and franchised stores, the Company has established a network (the
"Preferred Vendor Network") of preferred vendors (the "Preferred Vendors") whose
products may be purchased directly by franchisees at group discount prices,
thereby providing such franchisees with the opportunity for higher gross
margins. In addition, many Preferred Vendors pay promotional fees to the Company
to be used to defray a portion of the Company's costs in conducting certain
meetings, training seminars, conventions and other activities.
Franchising Agreements. Each franchisee enters into a franchise agreement
(the "Franchise Agreement") with the Company, the material terms of which are
generally as follows:
(a) Term. Generally, the term of each Franchise Agreement is ten years
and, subject to certain conditions, is renewable at the option of the
franchisee.
(b) Initial Fees. Generally, all franchisees (except for any franchisees
converting their existing retail optical store to a Sterling Store (a "Converted
Store") and those entering into agreements or for more than one location) , must
pay to the Company a non-recurring, initial franchise fee of $20,000. The
Company charges each franchisee of a Converted Store, a non-recurring, initial
franchise fee of $10,000 per location, for each franchisee entering into
agreements for more than one location, the Company charges a non-recurring
initial franchise fee of $15,000 for the second location, and $10,000 for each
location in excess of two. Initial fees collected by the Company for the year
ended December 31, 1996 were $353,555.
(c) Ongoing Royalties. Typically, all franchisees are obligated to pay to
the Company ongoing royalties in an amount equal to a percentage, generally 8%,
of the gross revenues of their Sterling Store. Franchisees of Converted Stores,
however, pay ongoing royalties on their store's historical average base sales at
reduced rates increasing, in most cases, from 2% to 6% for the first four years
of the term of the Franchise Agreement. Franchise Agreements entered into prior
to January 1994 provide for the payment of the ongoing royalties on a monthly
basis, while those entered into after January 1994 provide for their payment on
a weekly basis, in each case, based upon the gross revenues for the preceding
period. Gross revenues generally include all revenues generated from the
operation of the Sterling Store in question, except for refunds to customers,
sales taxes, a limited amount of bad debts, and, to the extent required by state
law, fees charged by independent optometrists. Ongoing royalties paid by
franchisees to the Company for the year ended December 31, 1996 were $7,616,360.
(d) Advertising Fund Contributions. Most franchisees must make ongoing
contributions to one of two advertising funds (the "Advertising Funds") equal to
a percentage of the store's gross revenues. For Franchise Agreements entered
into prior to August 1993, the rate of contribution is generally 4% of the
store's gross revenues, while Franchise Agreements entered into after August
1993 generally provide for contributions equal to 6% of the store's gross
revenues. For the year ended December 31, 1996, the Company received $2,907,875
in Advertising fund contributions from franchisees.
(e) Financing. Company-owned store assets are sold for cash although, in
most cases, the Company provides purchase money financing for all, or a portion
of, the purchase price thereof. The Company does not generally finance the
initial, non-recurring franchise fee or rent security deposits, which are
generally required under a franchisee's sublease. The purchase price is
generally based upon the historical and projected cash flow of the Sterling
Store in question and, in 1996, ranged from approximately $95,000 to $587,000.
The Company generally has financed up to 90% of the acquisition price, to be
repaid over a period of seven years, together with interest computed at the rate
of 12% per annum. However, the Company has, on occasion, financed, and may, in
the future, finance, up to 100% of the acquisition price of a franchised store.
Substantially all such financing is personally guaranteed by the franchisee (or,
if a corporation, by the principals owning in excess of 25% thereof) and is
generally secured by all assets conveyed, as well as all proceeds thereof. From
time to time, certain franchisees obtain financing from third parties. In such
event, the Company generally subordinates
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its security interest in the assets of the franchised location to the security
interests granted to the provider of such financing.
(f) Termination. Franchise Agreements may be terminated if the franchisee
has defaulted in its payment of monies due the Company or in its performance of
the other terms and conditions of the Franchise Agreement. During 1996, two
franchised stores were closed due to the expiration of the leases for each of
such store; and an additional seven franchised stores and substantially all of
the assets located therein were voluntarily surrendered and transferred back to
the Company in connection with the termination of Franchise Agreements related
thereto. The Company, in one such case, thereafter resold the assets of such
store to a new franchisee, which new franchisee thereupon entered into
Sterling's then current form of Franchise Agreement.
New Acquisitions
A key element of the Company's business strategy is to build its retail
optical business and increase its customer base by acquiring existing retail
optical chains, converting independently owned retail optical stores to Sterling
Stores and opening new stores.
On May 30, 1996, the Company, through its wholly-owned subsidiary,
Sterling Vision DKM, Inc. ("DKM"), acquired, from Norwest Investment Services,
Inc. ("Norwest") in a private, foreclosure sale, substantially all of the retail
optical assets (collectively, the "Assets"), other than leases, of Vision
Centers of America, Ltd., D & K Optical, Inc., Monfried Corporation and Duling
Finance Corporation (collectively, "VCA"), which Assets were subject to a lien
in favor of Norwest Investment Services, Inc. (the "VCA Transaction"). Norwest
was entitled to exercise its rights as a secured creditor of VCA as a result of
VCA's default with respect to its obligations to Norwest. The Assets acquired
include: (i) furniture, fixtures, machinery, equipment and inventory located in
21 company-owned and operated retail optical stores and in an ophthalmic lens
manufacturing facility and several warehouses; and (ii) all of VCA's general
intangibles (other than store leases), including franchise agreements,
promissory notes and accounts receivable related to approximately 75 franchised
retail optical stores. DKM purchased the Assets at a private foreclosure sale
subject to certain liens, claims and encumbrances; however, Norwest indemnified
DKM, in an amount up to $400,000, for certain of such liens, claims and
encumbrances. The purchase price for the Assets was $4,150,000, which was paid
by DKM's delivery to Norwest of a ninety (90) day, direct pay letter of credit
to Norwest.
In addition, DKM initially entered into three Assignment and Assumption
of Lease Agreements (two with respect to an aggregate of 13 company store leases
and one with respect to 45 stores subleased to franchisees), pursuant to which
VCA assigned to DKM all of its right, title and interest in and to each of the
leases, in exchange for DKM's payment to VCA of $50,000 and the assumption of
all of the obligations under the company store leases, only, subject to DKM's
right, in its sole discretion, to reject the lease for any such location on or
before September 30, 1996.
DKM also received an option, which expired on November 1, 1996, to
purchase the stock of VCA for $100. Additionally, DKM entered into an oral
consulting agreement with Dr. Larry Joel, the President of VCA, whereby DKM paid
to him the sum of $25,000 per month for consulting services provided to DKM,
which fee will be reduced to $12,500 per month from and after April 1997. Such
consulting arrangement is on a month-to-month basis and each party has the right
to terminate the agreement at any time. Dr. Joel was previously the President
and a shareholder of Fast Cast Corporation, an entity also owned, in part, by
certain of the Registrant's principal shareholders and from which the Company
purchases, from time to time, machinery, equipment and supplies. In addition, in
March 1997, two corporations of which Dr. Joel is a fifty percent owner: (i)
purchased the assets of the Company's laboratory facility located in Louisville,
Kentucky, (which was acquired by DKM and part of the DKM Transaction); and, (ii)
purchased the assets of four of the Company's retail optical stores and, in
connection therewith, entered into a Franchise Agreement.
DKM also subsequently purchased from Bank One Kentucky, N.A., for the
approximate sum of $111,000, all of its right, title and interest in and to
certain additional prior liens (held by such Bank) against VCA's inventory,
accounts receivable and franchise agreements.
On September 30, 1996, the Company entered into various agreements with
two Canadian corporations (collectively, the "Purchaser" or the "Master
Franchisor") and the principal owner thereof, pursuant to which the following
transactions were consummated; (i) the Company sold the assets of its four
retail optical stores located in Ontario, Canada to the Purchaser which,
simultaneously therewith, converted its five existing retail optical stores to
franchised Sterling Stores; (ii) the Company and the Master Franchisor entered
into a Master Franchise Agreement pursuant to which the aforesaid nine retail
optical stores were franchised to the Master Franchisor; and (iii) the Master
Franchisor was granted the exclusive right, in the Province of Ontario, Canada,
only, to open additional franchised Sterling Stores and/or grant sub-franchises
with respect thereto.
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In addition, the Master Franchise Agreement: (i) provides for the Master
Franchisor's payment to the Company of a portion of the initial non-recurring
franchise fees and continuing royalty fees paid by any of its sub-franchisees;
(ii) requires the Master Franchisor to open, within the Province of Ontario,
Canada, additional Sterling Stores in accordance with a specified time schedule;
and (iii) affords the Master Franchisor the right of first refusal with respect
to any other Master Franchise Agreements to be entered into by the Company in
any other Province of Canada.
Insight Laser Centers
An integral part of the Company's business strategy of becoming a
full-service eyecare company originally included developing and/or managing, a
chain of eyecare centers under the tradename "Insight Laser," offering PRK.
Published reports indicated that there are at least 50 million Americans who are
myopic (near-sighted). Management believes that some of these individuals would
prefer to correct their vision without a corrective appliance. PRK is an
outpatient procedure to be performed by ophthalmologists trained to perform the
procedure. During the PRK process, the shape of the cornea (the clear outermost
layer of the eye) is altered by a high-precision, computer controlled excimer
laser which ablates microscopic layers of corneal tissue in a predetermined
pattern to reshape the cornea in a manner that allows it to focus light
properly, thereby correcting, or treating, specific refractive conditions. In
1995 and 1996, the United States Food and Drug Administration ("FDA") approved
the use, in the United States, of an excimer laser manufactured by Summit
Technology, Inc. ("Summit") and VISX, Incorporated ("VISX"), respectively, for
use in connection with the PRK procedure to correct certain degrees of myopia.
Both Summit and VISX charge a royalty fee based on each procedure performed
utilizing their respective excimer lasers, which royalty fee is $250 per
procedure.
During 1995, the Company leased five excimer lasers manufactured by
Summit, which were delivered to the Company during the third quarter of 1995,
and in 1996, the Company leased one additional laser manufactured by VISX and
entered into two purchase orders to acquire one additional laser from both VISX
and Summit. All of such leases contain a purchase option for nominal
consideration. During 1996, the Company opened four Insight Laser Centers in the
Metropolitan New York and San Francisco markets, one of which is Company-
owned. In March, 1996, the Company entered into an agreement with an
ophthalmologist pursuant to which he agreed to pay to the Company a fee for each
PRK procedure performed with the excimer lasers installed by Insight in his two
offices located in Long Island, New York; and, in October, 1996, the Company and
such ophthalmologist entered into various agreements, which were due to be
released from escrow no later than November 30, 1996, and which provided for,
among other things: (i) the contribution, by the ophthalmologist, of
substantially all of the assets of his existing two medical practices and
ambulatory surgery center to a new entity established by the Company; (ii) an
agreement to engage the ophthalmologist, on an exclusive basis, in connection
with the ownership and/or operation of ophthalmological practices and/or laser
surgery centers located in the New York Metropolitan area; and (iii) the new
entity's management of the ophthalmologist's medical practices and ambulatory
surgery center, in exchange for a fee based upon the cost of operating such
practices and center. On November 30, 1996, the escrow agreement expired and the
documents (deposited thereunder) were terminated, by such ophthalmologist.
The Company believed that it was well positioned to successfully develop
its Insight Laser Centers by reason of, among other things: (i) Sterling's and
its franchisees' combined customer base of over one million people, some of
which may be candidates for the PRK procedure; (ii) Sterling's access to excimer
lasers for performing the PRK procedure; and (iii) Sterling's extensive
experience in marketing eyecare products and services. Accordingly, the Company
created an internal organization and staff to develop, operate and expand its
Insight Laser Center business.
Furthermore, the Company developed an advertising campaign to attract
additional customers to its Insight Laser Centers. Additionally, the Company,
from time to time, offered educational programs to the optometrists employed by,
or affiliated with, Sterling Stores and stores operated and franchised by Cohen
Fashion Optical, Inc. ("CFO"), a retail optical chain owned by certain of the
Company's shareholders, as well as to unaffiliated ophthalmologists, on the
benefits of PRK.
Because of the collective customer base of the Company and its
franchisees, the Company believed that its Insight Laser Centers would have a
competitive advantage as compared with other companies formed specifically for
this purpose. The Company was aware that the following companies operate or plan
to operate laser surgery centers in the United States: American Laser Vision,
Beacon Eye Institute, Eye Shaper Laser Centers, Global Vision, Inc., Laser
Focus, Inc., Refractive Laser Centers, Inc., The Laser Center, Inc., Vision
Correction Group, Inc., Vision Sculpting, 20/20 Laser Centers, Inc., Laser
Vision Centers, Inc., Lasersight Centers, Inc., New Vision Technology, Inc.,
LCA-Vision Inc., Summit and VISX. In addition, the Company was also aware that
numerous medical offices and hospitals located throughout the United States had
already installed, and/or were in the process of installing, excimer lasers for
performing
8
the PRK procedure. Based upon the Company's growth strategy, it was anticipated
that the Company would derive a substantial portion of its revenues from the
following two businesses: (i) the management and administration of its Insight
Laser Centers; and, (ii) the management of ophthalmological practices. However,
revenues at such centers grew modestly and were predominately in the form of
laser access fees. Such fees were paid by ophthalmologists who utilized the
Company's excimer lasers to perform PRK procedure. During the latter part of
1996, published reports concluded that consumer acceptance of PRK as a vision
correction alternative was below industry expectations despite aggressive
marketing and advertising programs conducted by the Company and other such laser
surgery companies.
Competition
The optical business is highly competitive and includes chains of retail
optical stores, superstores, individual retail outlets, and a large number of
individual opticians, optometrists and ophthalmologists who provide professional
services or may, in connection therewith, dispense prescription eyewear. As
retailers of prescription eyewear generally service local markets, competition
varies substantially from one location or geographic area to another. Since
1994, certain major competitors of the Company have been offering promotional
incentives to their customers and, in response thereto, the Company has, from
time to time, offered to its customers the same or similar incentives. As such,
there can be no assurance that these competitive promotional incentives would
not adversely affect the Company's results of operations.
The Company believes that the principal competitive factors in its retail
optical business are convenience of location, the on-site availability of
professional eye examinations, quality and consistency of product and service,
price, product warranties, and a broad selection of merchandise, and it believes
that it competes favorably in each of these respects.
As of December 31, 1996, the Company owned and operated one Insight Laser
Center and had three excimer lasers placed in affiliated ophthalmological
offices. The Company believes that such Center and ophthalmological offices
experience competition from the various other companies noted above (see
"Insight Laser Centers") that have entered the business, in addition to many
existing ophthalmological offices and hospitals that are equipped with excimer
lasers that are adapted to perform the PRK procedure.
Marketing and Advertising
The Company's marketing strategy emphasizes professional eye
examinations, value pricing (primarily through product promotions), convenient
locations, excellent customer service, customer-oriented store design and
product displays, knowledgeable sales associates and a broad range of quality
products in each of its Sterling Stores. Optometric examinations by licensed
optometrists are generally available on the premises of, or directly adjacent
to, all Sterling Stores, although future markets may call for some variation due
to regulatory constraints.
The Company continually prepares and revises in-store point of purchase
displays, which provide various promotional messages to customers upon arrival
at Sterling Stores. Both Company-owned Sterling Stores and most franchised
stores participate in such advertising and in-store promotions, which include
visual merchandising techniques to draw attention to products displayed in
Sterling Stores. The Company also employs direct mail advertising to reach
prospective, as well as existing consumers.
The Company annually budgets approximately 4% to 6% of systemwide sales
for advertising and promotional expenditures. Franchisees are obligated to
contribute a percentage of their stores' gross revenues to the Company's
segregated advertising fund accounts, which the Company maintains for such
advertising, promotions or public relations programs, fifty percent of which, in
most cases, the Company may, as it directly deems necessary or appropriate to
advertise and promote all Sterling Stores.
Management Information Systems
Over the past few years, management had conducted research into the
availability and development of a point-of-sale computer system (the "POS
System" or the "System"). The Company tested several existing systems available
in the marketplace, as well as developed and installed on a trial basis, its own
Windows-based POS System. During 1995, as a result of this research, the Company
undertook the installation of ADD-POWER, a UNIX-based POS System (the "A-P
System"), that is presently utilized by various retail optical chains in
approximately 600 retail optical stores nationwide, to provide, amongst other
features, inventory and patient database
9
management. The Company has commenced utilization of the system and anticipates
that it will take between one and two years to install the A-P System in all
existing Company-owned stores. As of December 31, 1996, the Company had
installed twenty such A-P Systems in existing Company-owned stores.
Government Regulation
Ophthalmic excimer lasers are considered medical devices and are subject
to regulation by the FDA. The Company understands that Summit and VISX, the
manufacturers of the excimer laser systems that the Company currently uses in
its Company-owned Insight Laser Center or makes available to its affiliated
ophthalmologists, have received approval from the FDA for their use to treat
certain degrees of near-sightedness. This approval contains restrictions on the
use, labeling, promotion and advertising of the excimer laser. In addition, as
part of the FDA approval process, Summit and VISX have agreed to conduct
post-marketing studies on the long term safety of the excimer laser, including
continuing to follow patients treated in existing studies, for at least four
years after FDA approval, to assure that those parties' vision remains stable
over long periods of time.
Manufacturers of lasers are also subject to regulation under the
Electronic Product Radiation Control Provisions of the Federal Food, Drug and
Cosmetic Act. This law requires laser manufacturers to file new product and
annual reports, to maintain quality control, product testing and sales records,
to incorporate certain design and operating features in lasers to end-users and
to certify and label each laser sold as belonging to one of four classes, based
on the level of radiation from the laser that is accessible to users. Certain
maintenance levels at the user level are also required. Various warning labels
must be affixed and certain protective devices installed, depending on the class
of the product. The Federal Food, Drug and Cosmetic Act applicable to all
medical devices, imposes fines and other remedies for violations of the
regulatory requirements.
The Company and its operations are subject to extensive federal, state
and local laws, rules and regulations affecting the health care industry and the
delivery of health care, including laws and regulations prohibiting the practice
of medicine and optometry by persons not licensed to practice medicine or
optometry, prohibiting the unlawful rebate or unlawful division of fees, and
limiting the manner in which prospective patients may be solicited. The
regulatory requirements that the Company must satisfy to conduct its business
will vary from state to state. In particular, some states have enacted laws
governing the ability of ophthalmologists and optometrists to enter into
contracts to provide professional services with business corporations or lay
persons. and some states prohibit the Company from computing its fee for its
management services based upon a percentage of the gross revenues of the
ophthalmological practice being managed. It is possible that, in certain other
states, the proposed activities of the Company will not be permissible on terms
acceptable to the Company, in which case the Company would not do business in
such states. Various federal and state regulations limit the financial and
non-financial terms of agreements with these health care providers; and the
revenues potentially generated by the Company differ among its various health
care provider affiliations.
The FDA and other United States, state or local governmental agencies may
amend current, or adopt new rules and regulations that could affect the use of
ophthalmic excimer lasers for PRK and thereby adversely affect the business of
the Company.
The Company is also subject to certain regulations adopted under the
Federal Occupational Safety and Health Act with respect to its in-store
laboratory operations. The Company believes that it is in compliance with all
such applicable laws and regulations.
As a franchisor, the Company is subject to various registrations and
disclosure requirements imposed by the Federal Trade Commission and by many
states in which the Company conducts franchising operations. The Company
believes that it is in compliance with all such applicable laws and regulations.
Environmental Regulation
The Company's business activities are not significantly affected by
environmental regulations, and no material expenditures are anticipated in order
for the Company to comply with environmental regulations. However, the Company
is subject to certain regulations promulgated under the Federal Environmental
Protection Act ("EPA") with respect to the grinding, tinting, edging and
disposing of ophthalmic lenses and solutions. In addition, the Company is
subject to additional EPA regulations as a result of its use of the excimer
laser approved by the FDA, the impact of which regulations have not been
determined at this time.
10
Seasonality
The Company's retail optical and laser correction businesses are not
seasonal.
Patents and Trademarks
The Company has registered the following trademarks and/or servicemarks
with the United States Patent and Trademark Office and the Canadian Registrar of
Trademarks: "Sterling Optical," "IPCO Optical," and "Site For Sore Eyes". In
connection with the Benson and VCA Transactions, the Company acquired several
additional trademarks, certain of which the Company continues to utilize in
connection with the operation of its Sterling Stores. The Company believes that
these trademarks and servicemarks have acquired significant commercial value and
have helped to promote the Company's reputation, although the Company intends to
change the tradename of most Sterling Stores to "Sterling Optical".
Employees
As of December 31, 1996, the Company employed approximately 620
individuals, of which approximately 85% were employed on a full-time basis. No
employees are covered by any collective bargaining agreement. The Company
considers labor relations with its employees to be good and has not experienced
any interruption of its operations due to labor disagreements.
Item 2. Properties.
The Company's headquarters comprised of approximately 21,950 square feet
(approximately 60%) located in an office building situated in East Meadow, New
York, which building is owned by certain of the Company's principal
shareholders, under a sublease which expires in 2006. This facility houses the
Company's principal executive and administrative offices.
The Company's former headquarters comprised approximately 7,500 square
feet of space in a building located in Lynbrook, New York occupied under a lease
which will expire on April 30, 1997.
The Company leases the space occupied by all of its Company-owed stores
and the majority of its franchised stores. The balance of the leases for the
Sterling Stores are held in the name of the individual franchisee.
Sterling Stores are generally located in commercial areas, including
major shopping malls, strip centers, free-standing buildings and other areas
conducive to retail trade. Certain Sterling Stores not located in commercial
areas are located in professional optometric offices, clinics and hospitals.
The Company leases approximately 4,500 square feet of space in an office
building located in Trump Tower, New York, New York under a sublease which
expires on May 30, 2000. The facility houses the Company's Insight Laser Center.
Pursuant to the terms of a revolving credit and term loan agreement
between The Chase Manhattan Bank, f/k/a Chemical Bank, (the "Bank") and the
Company, dated as of April 5, 1994, as amended (the "Credit Agreement"),
substantially all of the Company's assets and properties are subject to a first
priority perfected lien and security interest in favor of the Bank.
Item 3. Legal Proceedings.
As part of the IPCO Acquisition, Sterling acquired all of IPCO's
franchise notes receivable, some of which were subject to a pledge in favor of
Sanwa Business Credit Corporation ("Sanwa"). The Company is of the opinion that,
after payment of the indebtedness owed to Sanwa, it is entitled to a return of
such franchise notes, the residual value of which the Company estimated to be
approximately $1,325,000 as of December 31, 1996. Sanwa has contested such claim
by the Company and contends that it is not obligated to return to Sterling the
franchise notes remaining after Sanwa has been paid in full. On January 9, 1995,
Sterling filed a complaint in the United States Bankruptcy Court, Southern
District of New York (Case No. 91 B15944 (JLG)) seeking a judgment of the Court
directing Sanwa to render an accounting of all monies paid to Sanwa under such
franchise notes and to declare its rights in such franchise notes receivable.
Although, management believes that it will be successful in this action, no
assurance can be given as to the outcome thereof, and in the
11
event such claim is denied by the Court, such denial will result in a decrease
of the Company's assets (as set forth in the Company's Consolidated Financial
Statements) for the full amount of such estimated residual value of such
franchise notes receivable pledged to Sanwa.
The Company is a defendant in certain lawsuits alleging various claims
incurred in the ordinary course of business. These claims are generally covered
by various insurance policies, subject to certain deductible amounts and maximum
policy limits, and, in the opinion of management, the resolution of existing
lawsuits should not have a material adverse effect, individually or in the
aggregate, upon the Company's business or financial condition. Management
believes that there are no other legal proceedings pending or threatened to
which the Company is, or may be, a party or to which any of its property is or
may be subject which are likely to have a material adverse effect on the
Company.
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote by the Company's shareholders
during the quarter ended December 31, 1996.
Executive Officers of the Registrant
The executive officers, directors and key employees of the Registrant are
as follows:
Name Age Position
---- --- --------
Robert Cohen, O.D. 53 Chairman of the Board of Directors
Alan Cohen, O.D. 46 Vice-Chairman of the Board of Directors
Robert B. Greenberg 52 Chief Executive Officer, President and Director
Sebastian Giordano 39 Executive Vice President - Finance, Chief Financial Officer and Treasurer
Joseph Silver 50 Executive Vice President, Secretary and General Counsel
Jerry R. Darnell 46 Executive Vice President - Franchising
Kevin Cambra 33 Executive Vice President - Company Store Operations
Edward Cohen, O.D. 57 Director
Joel L. Gold 55 Director
Francis A. L'Esperance, Jr., M.D. 64 Director
Jay Fabrikant 40 Director
Martin J. Shoman, O.D. 57 President - VisionCare of California
Charles Raab 48 Chief Financial Officer - Insight Laser Centers, Inc.
Al Akbar 44 Vice President - Managed Care
Dr. Robert Cohen has served as Chairman of the Board of Directors of the
Registrant since its inception. He also served as Chief Executive Officer of
Sterling from inception until October, 1995. His principal office is located at
the Company's executive offices in East Meadow, New York. Dr. Robert Cohen and
his brothers, Drs. Edward Cohen and Alan Cohen, together with certain members of
their immediate families, are the principal shareholders of Sterling. From 1968
to the present, Dr. Robert Cohen has been engaged in the retail and wholesale
optical business. For more than 10 years, Dr. Cohen has also served as President
and a director of CFO, which currently maintains its principal office in the
Company's executive offices in East Meadow, New York. Dr. Cohen and his
brothers, Drs. Edward Cohen and Alan Cohen, together with certain members of
their immediate families, also are the sole shareholders of CFO. CFO engages in
the operation and franchising of retail optical stores similar to those operated
and franchised by the Company. Dr. Cohen is a director of, and, together with
Dr. Alan Cohen and certain members of their respective immediate families, is a
shareholder of Fast Cast Corporation, f/k/a Rapid Cast ("Rapid Cast") which
offers for sale equipment and supplies to produce ophthalmic lenses.
Additionally, he is a shareholder, officer and director of Lensco Consulting
Inc. ("Lensco"), which acts as a consultant to Neolens, Inc. ("Neolens"), an
entity engaged primarily in the manufacturing and marketing of polycarbonate
ophthalmic lenses. Dr. Cohen, together with certain members of his immediate
family, also owns a portion of Neolens' outstanding common stock, as well as
warrants to purchase additional shares. Dr. Cohen is also an officer and a
director of several management and real estate companies and numerous other
businesses.
12
Dr. Alan Cohen has served as a Director of Sterling since its inception.
He also served as Chief Operating Officer of Sterling from 1992 until October,
1995 when he became Vice-Chairman of the Board of Directors of Sterling. His
principal office is located at the Company's executive offices in East Meadow,
New York. Dr. Alan Cohen and his brothers, Drs. Edward Cohen and Robert Cohen,
together with certain members of their immediate families, are the principal
shareholders of Sterling. From 1974 to the present, Dr. Alan Cohen has been
engaged in the retail and wholesale optical business. For more than 10 years,
Dr. Cohen has also been a director, principal shareholder and officer of CFO.
Dr. Cohen is a director of, and, together with Dr. Robert Cohen and certain
members of their respective immediate families, is a shareholder of Rapid Cast
and a shareholder, director and officer of Lensco. Dr. Cohen, together with
certain members of his immediate family, also owns a portion of Neolens'
outstanding common stock, as well as warrants to purchase additional shares. He
is also an officer and a director of several management and real estate
companies and numerous other businesses.
Robert B. Greenberg has served as a Director of Sterling since July,
1992, became President in August, 1994 and became Chief Executive Officer in
October, 1995. From 1984 through 1994, Mr. Greenberg served as President of
Natural Cosmetic Licensing, Inc. and its predecessor companies, which was, until
September, 1994, the owner and licensor of "i natural" skin care and cosmetic
products. Mr. Greenberg previously served as a Director of I Natural, Inc., the
general partner of I Natural Cosmetics, L.P., the current owner and licensor of
the name and the products offered under the name "i natural cosmetics". Mr.
Greenberg is a member of the Board of Directors of Benihana, Inc., a company
operating company-owned and franchised Japanese-style restaurants, which
position he has held since 1983. In addition, since 1983, Mr. Greenberg has been
a member of the International Council of Shopping Centers, and the International
Franchise Association. In addition, from time to time, Mr. Greenberg renders
real estate and financial consulting advisory services to various companies,
including CFO.
Sebastian Giordano has served as Chief Financial Officer, Executive Vice
President - Finance and Treasurer of Sterling since the IPCO Acquisition. From
March 1990 to July 15, 1992, Mr. Giordano was Vice President and Treasurer of
IPCO, which was located in Hackensack, New Jersey. Accordingly, Mr. Giordano was
Vice President and Treasurer of IPCO at the time it filed for protection under
Chapter 11 of the United States Bankruptcy Code. In June, 1992, he was appointed
Responsible Officer by the Bankruptcy Court overseeing the liquidation of IPCO,
to be the person in charge of the liquidation of the remaining assets of IPCO.
Mr. Giordano resigned from that position on or about July 26, 1992. Mr. Giordano
and his wife are shareholders of Dani-Marc Optical, Inc., the former franchisee
of the Sterling Store located in Nanuet, New York.
Joseph Silver has served as Executive Vice President and Secretary of,
and General Counsel to, the Company since March, 1992. From May 1985 to December
1991, Mr. Silver served as General Counsel to The Trump Organization, located in
New York, New York. Mr. Silver is a member of the New York State Bar, and
received a Juris Doctorate degree from Brooklyn Law School in 1969. In addition
to the services which Mr. Silver provides to the Company, he also provided legal
services to other persons or entities, including persons and entities which are
affiliates of the Company, although such legal services (except with respect to
two wholly-owned subsidiaries of the Company and except for legal services
rendered for no consideration) ceased upon consummation of the Company's initial
public offering. Mr. Silver, together with his wife, are the principal
stockholders of RJL Optical, Inc., the franchisee of the Sterling Store located
in Great Neck, New York, which is presently being managed by the Company.
Jerry Darnell has served as Sterling's Executive Vice President -
Franchising since July, 1992. From February 1990 through December 1991, Mr.
Darnell served as Director of Franchise Development for Physicians Weight Loss
Centers, Inc., located in Akron, Ohio. From July 1989 to February 1990, he was
Senior Vice President of Formu-3 International, Inc., a company operating
company owned and franchised weight loss centers, located in Canton, Ohio. From
August 1988 to July 1989, Mr. Darnell was Vice President of Franchise
Development of Medicine Shoppe International, Inc., a company in the business of
franchising retail pharmaceutical stores, located in St. Louis, Missouri, having
first been associated with that company, as a consultant, in November 1987. Mr.
Darnell is a member of the International Franchise Association, served as
Chairman of its trade show exhibit committee and has served as a franchise
consultant to many franchise organizations where he has been a seminar leader.
He has also been a keynote speaker for national sales and business
organizations.
Kevin Cambra has been employed by Sterling in various capacities since
October, 1993. He has been responsible for Company store operations, first as
Director of Store Operations, and most recently as Executive Vice President -
Company Store Operations. From 1987 to 1993, Mr. Cambra was employed by SFSE in
various capacities, including Vice President of Company Store Operations, a
position to which he was appointed in 1990. Accordingly, Mr. Cambra was an
officer of SFSE at the time it filed a petition in bankruptcy and prior to the
SFSE Merger.
13
Dr. Edward Cohen has served as a Director of Sterling since July, 1992.
He also served as Vice President of Sterling from July, 1992 until October,
1995. Dr. Edward Cohen and his brothers, Drs. Robert Cohen and Alan Cohen,
together with certain members of their immediate families, are principal
shareholders of Sterling. For more than 16 years, Dr. Edward Cohen has also been
a director, shareholder and officer of CFO. Dr. Cohen is also an officer and a
director of several management and real estate companies and numerous other
businesses.
Joel L. Gold has served as a Director of Sterling since December, 1995.
He is currently an Executive Vice President of LT Lawrence & Co., and was
formerly a Managing Director of Fechtor, Detwiler & Co., Inc., a representative
of the underwriters for the Company's initial public offering. Mr. Gold was a
Managing Director of Furman Selz Incorporated from January, 1992 until March,
1995. From April, 1990 until January, 1992, Mr. Gold was a Managing Director of
Bear Stearns and Co., Inc. ("Bear Stearns"). For approximately 20 years before
he became affiliated with Bear Stearns, he held various positions with Drexel
Burnham Lambert, Inc. He is currently a director of Action Industries, a
marketer of houseware products ("Action"); Concord Camera Corp., a manufacturer
and distributor of cameras ("Concord"); Life Medical Sciences, a
biotechnological company ("Life"); BCAM Corporation, a provider of ergonometric
services ("BCAM"); and William Greenberg, Jr. Desserts and Cafes, Inc., a
specialty bakery. He currently serves on the Compensation Committee of each of
Action, Concord, Life and BCAM.
Jay Fabrikant has been actively engaged in the healthcare field for over
15 years. Mr. Fabrikant , since 1983, has been the President of Medical
Development Systems, Inc., a health care consulting firm, since 1983. Mr.
Fabrikant has been the Chairman and Chief Executive Officer of Total Health
Systems, a NASDAQ( NMS) traded firm, Chairman and Chief Executive Officer of
Advanced Healthcare Systems, Inc., a New Jersey State Certified Managed Care
Organization, President of The New York Health Plan, Inc. and the founder and
initial Chairman and Chief Executive Officer of National Health Plan Plus, Inc.,
a multi-state health, life, disability, and managed care company. Mr. Fabrikant
has also been on several governmental panels for healthcare regulation.
Dr. Francis A. L'Esperance, Jr. has served as a Director of Sterling
since December, 1995 and was appointed as the Chairman of the Insight's Board of
Directors in March, 1996. Dr. L'Esperance has been a Professor of Clinical
Ophthalmology at the Columbia University College of Physicians and Surgeons and
an Attending Ophthalmologist at the Edward S. Harkness Eye Institute and the
Manhattan Eye, Ear and Throat Hospital since 1985. Throughout his career, Dr.
L'Esperance has written eight textbooks and 104 articles and multiple chapters
particularly on the subject of ophthalmic laser applications. He has been
researching ophthalmic lasers since 1963 and has performed various ophthalmic
procedures using various types of lasers since 1968. He co-founded Taunton
Technologies, Inc. (which acquired, by merger, and later changed its name to
VISX). Taunton Technologies, Inc. was the first excimer laser company to gain
approval by the FDA for evaluation of the excimer laser to remove corneal scars
and to correct certain refractive errors. He was awarded the William B. Mark
Award for Research Excellence by the American Society for Laser Medicine and
Surgery in 1986 and the Arthur L. Schawlow Award by the Laser Institute of
America in 1988. In addition, Dr. L'Esperance has been an Overseers Member at
Dartmouth Medical School and C. Everett Koop Institute in Hanover, New
Hampshire.
Dr. Martin Shoman has served as President and Chief Operating Officer of
VCC since June, 1994. From April, 1994 until June, 1994 he was Vice President of
VCC. From May, 1993 through June, 1994 he was President of M.J. Shoman &
Associates, an eyecare consultant business that offered services to the Company
and other retail optical stores. From January, 1977 until May, 1993 he was
President and Chief Executive Officer of a subsidiary of Pearle Vision Centers,
operating a California specialized health maintenance organization.
Charles Raab has been employed by Insight since February, 1996 and, in
March, 1996, was elected as its Chief Financial Officer. Prior to joining
Insight, Mr. Raab served as President of Empire Fiscal Management, Inc., since
1986. Prior to Empire he held CFO positions over a twelve year period with the
Osteopathic Hospital and Clinic in Queens, New York and the New York Medical
College/Flower Fifth Avenue Hospital in New York City. Mr. Raab holds a Masters
Degree in Accounting, a Graduate Degree in Public Health Administration, and an
Undergraduate Degree in International Business and Finance.
Al Akbar has been Vice President - Managed Care of Sterling since March,
1996. For the 11 years prior to joining the Company, Mr. Akbar served in various
capacities at Pearle, Inc., including Director of Managed Care. In 1980, Mr.
Akbar received his degree in business from the University of Dallas Graduate
School of Business.
14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock has been listed on the Nasdaq Market System
under the trading symbol "ISEE" since December 20, 1995. For the year ended
December 31, 1996, the high and low sales prices for the Company's Common Stock
as reported on the Nasdaq Stock Market were $9.06 and $5.00, respectively.
The approximate number of recordholders of the Company's Common Stock at
March 20, 1997 was 169.
Prior to its initial public offering (the "Offering"), the Company was a
Subchapter S corporation. In 1992, 1993, 1994, and 1995, the Company paid cash
dividends to its shareholders in the aggregate amounts of $124,000, $3,943,000,
$6,187,000, and $1,800,000, respectively, and immediately prior to the
consummation of its Offering, the Company authorized and declared the payment of
a dividend,in the aggregate amount of $1,450,000, to the individuals who were
shareholders of the Company immediately prior to the Company's Offering.
The following table sets forth the high and low stock prices for 1996:
Stock Prices
High Low
---- ---
Year ended December 31, 1996:
-----------------------------
Quarter ended March 31, 1996 $7.25 $6.50
Quarter ended June 30, 1996 $8.75 $7.88
Quarter ended September 30, 1996 $8.00 $7.63
Quarter ended December 31, 1996 $8.81 $8.00
Pursuant to the Credit Agreement, the Company is restricted from paying
dividends on its Common Stock without the Bank's consent, although it has no
intention to pay dividends in the foreseeable future.
15
Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The selected consolidated financial data set forth below for the period
from February 19, 1992 through December 31, 1992 and for the years ended
December 31, 1993, 1994, 1995 and 1996 were derived from the audited
consolidated financial statements of the Company. Systemwide sales and Sterling
Store data is derived from the Company's records and is unaudited. The data set
forth below should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements and related Notes appearing elsewhere.
Period From
February 19 1992
Year Ended Through
December 31, December 31,
1996 1995 1994 1993 1992 (1)
------ ----- ------ ----- --------
(In thousands except per share data and number of stores)
Statement of Operations Data: (2)
Systemwide sales (3) $ 131,593 $ 112,258 $ 104,168 $ 84,272 $ 34,402
========= ========= ========= ======== ========
Net sales - Company-owned stores $ 28,477 $ 25,773 $ 27,684 $22,820 $12,583
Franchise royalties 7,616 6,891 5,921 4,659 1,459
Net gains and fees from the conveyance of
Company- owned store assets to
Franchisees that are:
Unrelated parties 1,963 2,197 2,832 3,044 3,943
Related parties - - 519 - -
Other income (4) 2,287 2,017 1,768 1,468 163
--------- --------- --------- -------- --------
Total revenues 40,343 36,878 38,724 31,991 18,148
--------- --------- --------- -------- --------
Cost of sales 8,851 6,495 7,590 5,870 3,698
Selling expenses 19,943 16,127 16,414 12,975 7,833
General and administrative expenses 16,743 10,529 11,321 6,155 3,714
Interest expense 1,297 831 647 786 373
--------- --------- --------- -------- --------
Total costs and expenses 46,834 33,982 35,972 25,786 15,618
--------- --------- --------- -------- --------
Income (loss) before provision for income taxes
and extraordinary item (6,491) 2,896 2,752 6,205 2,530
Provision (benefit) for income taxes (5) (2,001) 2,129 127 259 76
--------- --------- --------- -------- --------
Income (loss) before extraordinary item $ (4,490) $ 767 $ 2,625 $ 5,946 $ 2,454
--------- --------- --------- -------- --------
Income (loss) per share of common
stock and common stock equivalents
before extraordinary item $( .36) $ .08 $ .26 $ .60 $ .25
Weighted average common shares and
common share equivalents
outstanding (7) 12,341 10,031 9,963 9,963 9,963
--------- --------- --------- -------- --------
Pro forma statement of operations data
(unaudited):(2)(6)
Income before provision for income
taxes and extraordinary item $ 2,896 $ 2,752 $ 6,205 $ 2,530
Pro forma provision for income taxes 1,158 1,101 2,482 1,012
--------- --------- -------- --------
Pro forma net income before extraordinary item 1,738 1,651 3,723 1,518
Pro forma income per share of common stock and
common stock equivalents before
extraordinary item
before extraordinary item $.17 $.16 $.37 $.15
Weighted average common shares and
common share equivalents
outstanding (7) 10,031 10,031 10,031 10,031
16
Period From
February 19, 1992
Year Ended Through
December 31, December 31,
1996 1995 1994 1993 1992 (1)
------- ------- --------- -------- ------------
(In thousands except per share data and number of stores)
Statement Store Data:
Company-owned stores bought, opened
or reacquired 24 39 14 18 58
Company-owned stores sold or closed (33) (8) (19) (16) (15)
Company-owned stores owned at end of period 62 71 40 45 43
Franchised stores at end of period 257 150 141 126 97
Same store sales:(8)
Company-owned stores - $15,513 $16,050 - - N/A
- $19,626 $19,411 - N/A
- - $15,903 $15,520 N/A
Franchised stores - $73,664 $74,453 - - N/A
- 71,450 $69,818 - N/A
- - $52,284 $50,378 N/A
Average sales per store: (9) (10)
Company-owned stores $ 395 $ 659 $ 637 $ 594 $ 488
Franchised stores $ 392 $ 600 $ 586 $ 545 $ 501
Average franchise royalties per franchised
store (9) $ 43 $ 48 $ 45 $ 41 $ 33
December 31,
Balance Sheet Data :(2) 1996 1995 1994 1993 1992 (1)
------- ------- --------- -------- ----------
Working capital (deficit) $(3,803) $16,312 $ 1,750 $ 2,653 $ 2,525
Total assets 46,269 46,455 24,186 25,998 19,812
Total debt 15,184 13,900 8,121 7,335 6,825
Shareholders' Equity 19,557 22,825 10,517 13,326 8,353
- --------------------------------
(1) The Registrant was formed on January 15, 1992. On February 19, 1992, The
Registrant was capitalized in order to provide debtor-in-possession
financing to, and bid for the assets then comprising the retail optical
business of, IPCO. On February 28, 1992, The Registrant, as the successful
bidder, and with the approval of the United States Bankruptcy Court for the
Southern District of New York, entered into a contract to purchase
substantially all of the assets then comprising such retail optical
business of IPCO. On July 15, 1992, Sterling consummated the transactions
set forth in such contract and commenced operations.
(2) The financial data contained herein does not include information regarding
stores previously licensed by IPCO (until such stores were acquired by the
Company) since the Company believes that the information pertaining to such
stores was not, and is not, material to the Company's results of
operations.
(3) Systemwide sales are unaudited and represent the combined retail sales of
Company-owned and franchised stores, as well as revenues generated by VCA.
(4) Other income consists primarily of interest income on franchise notes
receivable and funds provided by certain Preferred Vendors for convention
and seminars.
17
(5) From May 1, 1992, until the consummation of the Company's Offering, the
Company operated as an S Corporation for federal and state income tax
purposes. As a result, the Company's 1992, 1993, 1994 and 1995 earnings
through December 19, 1995, the day prior to the completion of the Company's
Offering, at which date the Company'S Corporation status terminated, have
been taxed, with certain exceptions, for federal and certain state income
tax purposes, directly to the individuals who were shareholders of the
Company immediately prior to the consummation of the Offering. The Company
authorized and declared the payment of a dividend of $1,450,000, based upon
the net income of the Company for the period January 1, 1995 to December
19, 1995, to such individuals immediately prior to the Offering.
(6) Pro Forma Income Statement Data reflect adjustments to the historical
income statement data assuming the Company had not elected S Corporation
status for income tax purposes. The provision for federal and state income
taxes assumes an effective tax rate of 40% for each of the following years:
1992, 1993, 1994 and 1995.
(7) Assumes, as outstanding during the period ended December 31, 1992 and the
years ended 1993 and 1994, 9,963,495 shares of Common Stock reflecting the
4,506.31-to-one stock split of the Company's outstanding Common Stock as of
the date of the Offering; and 12,207,495 shares of Common Stock, reflecting
the stock split, for the year ended December 31, 1995. Under the treasury
stock method of accounting, the dilutive effect of options granted under
the Company's 1995 Stock Incentive Plan is not material and therefore is
not reflected in weighted average common shares and common share
equivalents outstanding.
(8) Same store sales represent sales generated by VCC and Company-owned or
franchised stores which were open during the entirety of the one-year
periods compared and are not necessarily comparable as between one-year
periods.
(9) Average sales per store and average franchise royalties per franchised
store are computed based upon the weighted average number of Company-owned
and franchised stores, respectively, for each of the specified periods. For
periods less than a year, the averages have been annualized.
(10) The decline in average sales per store for Company-owned and franchised
stores was due primarily from the impact of the Benson and DKM stores which
have sales volumes substantially lower than the typical Sterling store.
Excluding Benson and DKM stores, averages sales per store for Sterling
Company-owned and franchised stores were $620,000, and $613,000,
respectively, for the calendar year ended December 31, 1996.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
All statements contained herein (other than historical facts) including,
but not limited to, statements regarding the Company's future development plans,
the Company's ability to generate cash from its operations, including the
operations of the Registrant's subsidiary, Insight, and any losses related
thereto, are based upon current expectations. These statements are forward
looking in nature and involve a number of risks and uncertainties. Actual
results may differ materially from the anticipated results or other expectations
expressed in the Company's forward looking statements. Generally, the words
"anticipate", "believe", "estimate", "expects" and similar expressions, as they
relate to the Company and/or its management, are intended to identify forward
looking statements. Among the factors that could cause actual results to differ
materially are the following: the inability of the Company to obtain waivers of
its failure to comply with certain covenants under its Credit Agreement and the
possible defaults related therefrom; the inability of the Company to enter into
third party, managed care provider agreements on favorable terms; the inability
of the Company to obtain additional financing to meet its capital needs;
competition in the retail optical industry; the ability of the Company to
acquire, at favorable prices, retail optical chains; the uncertainty of the
acceptance of PRK, a procedure being offered by Insight to correct the vision of
individuals experiencing certain degrees of myopia; the availability of new
and/or better ophthalmic laser technologies or other technologies that serve the
same purpose as PRK; the inability of the Company to finalize favorable
agreements with ophthalmologists to utilize the Company's excimer lasers to
perform PRK procedures; competition in the PRK market; lack of experience in
developing or managing PRK centers and ophthalmological practices; and general
business and economic conditions.
General Overview
In July, 1992, the Company acquired substantially all of the assets
pertaining to 58 company-owned stores and 80 franchised locations then utilized
by IPCO in connection with the operation of its retail optical business.
18
The expansion of the Company's franchise system was primarily
attributable to the conveyance to franchisees, by the end of 1993, of the assets
of 31 of the 58 initially acquired Company-owned stores. In October 1993, August
1994, November 1995, and May 1996, respectively, the Company replenished its
inventory of Company-owned stores with the acquisition of 16 Company-owned
stores as part of the SFSE Merger (which 16 stores were in addition to ten
stores then franchised by SFSE), the acquisition of eight of the stores
previously licensed by IPCO to Pembridge, the acquisition of 32 Company-owned
stores in connection with the Benson Transaction, and the acquisition of 13
Company-owned stores (which 13 stores were in addition to the 75 stores
franchised by VCA) in connection with the VCA Transaction.
The Company currently derives its revenues primarily from: (i) the sale
of eye care products (of which the sale of eyeglasses represented in excess of
70% of total sales for each period since inception) and by providing eye care
services at Company-owned stores and in those franchised locations in which
certain of the Company's VCC operations are located; (ii) ongoing franchise
royalties based upon the gross revenue of franchised stores; (iii) the
conveyance of Company-owned store assets to franchisees; (iv) initial franchise
fees; (v) interest income derived primarily from purchase money financing
provided by the Company on its conveyance of Company-owned store assets to
franchisees and on the proceeds of the Offering, until such time that the
proceeds were expended; and, (vi) laser access fees paid by ophthalmologists
utilizing the Company's excimer lasers to perform PRK procedures.
Management's growth strategy is to transform the Company from a retailer
of optical products into a full-service eye care company, including the
management of its existing Insight Laser Center and by developing affiliations
with ophthalmologists to utilize the Company's excimer lasers, while at the same
time expanding the Company's existing core business and customer base. A key
element of such strategy is to acquire existing retail optical chains, convert
independently owned retail optical stores to franchised stores and open new
stores.
Average retail store sales and average ongoing franchise royalty
information described below is computed based upon the weighted average of
existing stores in each category. Since the Benson Transaction occurred in
November 1995, the number of Benson stores and the retail store sales generated
by such stores are not utilized in calculating the weighted average of existing
stores and average retail store sales for the calendar year ended December 31,
1995.
Same store sales represent sales generated by Company-owned or franchised
stores which were Sterling Stores in operation during the entirety of the
one-year periods.
Net gains on the conveyance of the assets of Company-owned stores to
franchisees vary depending upon the number of stores conveyed to franchisees,
the consideration paid for the assets of each such store and the Company's basis
(net book value) in the assets of the stores conveyed.
19
Results of Operations
For the Calendar-Year Ended December 31, 1996 compared to December 31, 1995
Systemwide sales, which represent combined retail sales generated by
Company-owned and franchised stores, as well as revenues generated by VCA,
increased by $19,335,000, or 17.2%, to $131,593,000 for the calendar year ended
December 31, 1996, as compared to $112,258,000 for the same period in 1995. On a
same store basis (for stores that operated as either a Company-owned or
franchised store during the entirety of both of the calendar years ended
December 31, 1996 and 1995), systemwide sales decreased by $2,459,000, or 2.3%,
to $105,630,000 for the calendar year ended December 31, 1996, as compared to
$108,089,000 for the same period in 1995. There were 171 stores that operated as
either a Company-owned or franchised store during the entirety of both of the
calendar years ended December 31, 1996 and 1995.
Aggregate sales generated from the operation of Company-owned stores
increased by $2,704,000, or 10.5%, to $28,477,000 for the calendar year ended
December 31, 1996, as compared to $25,773,000 for the same period in 1995. Such
increase was primarily due to the VCA Transaction in the second quarter of
1996), which resulted in the Company's acquisition, among other assets, of the
assets and leases for 13 company-owned stores, which was partially offset by the
decrease in aggregate sales resulting from the conveyance of the assets of
Company-owned stores to franchisees. Historical comparisons of aggregate sales
generated by Company-owned stores can become distorted due to the conveyance of
Company-owned store assets to franchisees. When Company-owned store assets are
conveyed to franchisees, sales generated by such franchised store are no longer
reflected in Company-owned store sales; however, the Company receives on-going
royalties based upon a percentage of the sales generated by such franchised
stores. On a same store basis, aggregate sales generated by Company-owned stores
in operation during the entirety of both of the calendar years 1996 and 1995,
decreased by $537,000, or 3.4%, to $15,513,000 for the calendar year ended
December 31, 1996, as compared to $16,050,000 for the same period in 1995. The
Company believes that such decrease resulted, in part, from general business
conditions and from the Company's change in its employment arrangements with
certain of its optometrists from that of a salaried employee to an independent
optometrist subleasing the professional office located within the Sterling Store
in question. This change resulted in the loss of eye examination fee income for
the Company of approximately $290,000, since such doctors now collect such fees
as part of their income, although this contributed to the reduction in selling
expenses as described below.
Aggregate sales generated from the operation of franchised stores
increased by $16,631,000, or 19.2%, to $103,116,000 for the calendar year ended
December 31, 1996, as compared to $86,485,000 for the same period in 1995, due
primarily to an increase in the number of Company-owned stores conveyed to
franchisees and certain franchised stores acquired in the VCA Transaction. On a
same store basis, aggregate sales generated by franchised stores in operation
during the entirety of both of the calendar years 1996 and 1995, decreased by
$789,000, or 1.1%, to $73,664,000 for the calendar year ended December 31, 1996,
as compared to $74,453,000 for the same period in 1995.
Aggregate ongoing franchise royalties increased by $725,000, or 10.5%, to
$7,616,000 for the calendar year ended December 31, 1996, as compared to
$6,891,000 for the same period in 1995, due primarily to an increase in the
number of Company-owned stores conveyed to franchisees and certain franchised
stores acquired in the VCA Transaction.
Net gains on the conveyance of the assets of twenty Company-owned stores
to franchisees decreased by $234,000, or 10.7%, to $1,963,000 for the calendar
year ended December 31, 1996, as compared to net gains on the conveyance of the
assets of eight Company-owned stores to franchisees in the aggregate amount of
$2,197,000 for the same period in 1995 (which included the gain on the
conveyance of the assets of one store, in the amount of $1,173,000).
The Company's gross profit margin decreased by 6.2 percentage points, to
68.9%, for the year ended December 31, 1996, as compared to 75.1% for the same
period in 1995. This decrease resulted primarily from the Company having
instituted, in the Fall of 1996, a promotional program in response to certain
promotional incentives offered by certain major competitors of the Company. To
match such incentives, the Company offered similar types of promotional programs
to its customers, which resulted in lower gross profit margins. In the future,
the Company's gross profit margin may fluctuate depending upon the extent and
timing of changes in the product mix in Company-owned stores, competition and
promotional incentives.
Selling expenses increased by $3,816,000, or 23.7%, to $19,943,000 for
the calendar year ended December 31, 1996, as compared to $16,127,000 for the
same period in 1995, due to the inclusion of selling expenses of approximately
$5,488,000 incurred by the stores
20
acquired in connection with the Benson and VCA Transactions, and the operations
of Insight, which were partially offset by a decrease in selling expenses of
approximately $1,332,000, due primarily from the conveyance of the assets of
Company-owned stores to franchisees, as well as a decrease in selling expenses
of approximately $330,000 in connection with the change in the Company's
employment arrangements (as described above) with certain of its optometrists.
General and administrative expenses (including interest expense,
depreciation and bad debt expense) increased by $6,680,000, or 58.8%, to
$18,040,000 for the calendar year ended December 31, 1996, as compared to
$11,360,000 for the same period in 1995. This increase was due primarily to the
following five factors: (i) an increase in administrative costs of approximately
$3,400,000 related to the business of Insight, which incurred expenses of
approximately $600,000 in 1995; (ii) approximately $535,000 in administrative
costs related to the Benson Transaction; (iii) approximately $439,000 in
administrative costs related to the VCA Transaction; (iv) approximately $400,000
in occupancy and moving expenses related to the Company's relocation, in the
second quarter of 1996, of its administrative offices; and (v) approximately
$475,000 in costs related to operating as a publicly held company. Interest
expense, which is included in general and administrative expenses, increased by
$466,000, or 56.1%, to $1,297,000 for the calendar year ended December 31, 1996,
as compared to $831,000 for the same period in 1995. This increase was due to
increased indebtedness incurred by the Company in connection with the leasing,
in 1995, of five excimer lasers and, in 1996, one additional excimer laser
(which are capital leases and, accordingly, such payments include interest
expense), and an additional loan, at the end of the fourth quarter of 1995, of
$1,670,000 to fund the Benson Transaction. The Company's provision for doubtful
accounts, which is included in general and administrative expenses, increased by
$727,000, or 361.7%, to $928,000 for the calendar year ended December 31, 1996,
as compared to $201,000 for the same period in 1995. This increase was due
primarily to the reduction in the residual value of the cash collateral and
franchise notes held by the CIT Group / Equipment Financing, Inc. ("CIT"). See
Liquidity and Capital Resources.
The Company's income before income taxes decreased by $9,387,000, or
324.1%, to a loss of $6,491,000 for the calendar year ended December 31, 1996,
as compared to income of $2,896,000 for the same period in 1995. This decrease
was primarily due to the following three factors which were not comparable to
the Company's operations for the same period in 1995: (i) the Company
consummated the Benson Transaction during the fourth quarter of 1995 and thereby
acquired substantially all of the assets and certain continuing expenses of the
debtors. The Company incurred a loss of $2,312,000, for the calendar year ended
December 31, 1996, as compared to a loss of $520,000 for the same period in
1995, from the operation of the stores acquired in the Benson Transaction; (ii)
the Company incurred a loss of $3,330,000, for the calendar year ended December
31, 1996, as compared to a loss of $193,000 for the same period in 1995, in
establishing the operations of Insight, although Insight began generating
minimal revenues during the second quarter of 1996; and (iii) an increase in
general and administrative expenses as discussed above. This decrease was
partially offset by income of $1,112,000 generated from the operations of the
stores acquired (during the second quarter of 1996), in the VCA Transaction.
Income from the Company's operations (excluding the losses applicable to the
operations of the stores acquired in the Benson Transaction, Insight, and the
income applicable to the operation of the stores acquired in the VCA
Transaction) decreased by $5,583,000, or 285.4%, to a loss of $1,975,000 for the
calendar year ended December 31, 1996, as compared to income of $3,608,000 for
the same period in 1995. This decrease was primarily due to the increase in
general and administrative expenses (including interest expense, depreciation
and bad debt expense), as explained above, (excluding such expenses applicable
to the operation of Insight and the stores acquired in the Benson and VCA
Transactions. This increase in general and administrative expenses was partially
offset by an increase in net gains from the conveyance of the assets of
Company-owned stores to franchisees, (excluding such gains applicable to the
conveyance of the assets of two Company-owned store acquired in the VCA
Transaction).
Calendar Year Ended December 31, 1995 Compared to Calendar Year Ended
December 31, 1994
Systemwide sales, increased by $8,090,000, or 7.8%, to $112,258,000 for
calendar year 1995, as compared to $104,168,000 for same period in 1994. There
were 221 and 181 Sterling Stores in operation as of December 31, 1995 and
December 31, 1994, respectively, of which 150 and 141 stores, respectively, were
franchised.
Aggregate sales generated from the operation of Company-owned stores
decreased by $1,911,000, or 6.9%, to $25,773,000, for calendar year 1995, as
compared to aggregate sales of $27,684,000 at Company-owned stores for the same
period in 1994, due to the conveyance of the assets of eight Company-owned
stores to Franchisees. In addition, the Company changed its employment
arrangements with certain of its optometrists from that of a salaried employee
to an independent optometrist subleasing the professional office located within
the Sterling Store in question. This change in status resulted in the loss of
eye examination fee income for the Company, since the independent doctors now
collect such fees as part of their income, although this contributed to the
decrease in selling expenses described below.
21
On a same store basis, aggregate sales generated from the operation of
Company-owned stores in operation during the entirety of both of the calendar
years 1995 and 1994 increased by $215,000, or 1.1%, to $19,626,000 for calendar
year ended December 31, 1995, as compared to $19,411,000 for the same period in
1994.
Aggregate sales generated by franchised stores increased by $10,001,000,
or 13.1%, to $86,485,000 for calendar year ended December 31, 1995, as compared
to $76,484,000 for the same period in 1994, due to an increase of the number of
franchised stores, as well as higher sales volume per store. On a same store
basis, aggregate sales generated by franchised stores increased by $1,722,000,
or 2.5%, to $71,540,000 for calendar year ended December 31, 1995, as compared
to $69,818,000 for the same period in 1994.
Average sales generated by Company-owned stores, other than the Benson
stores acquired during the fourth quarter of 1995, increased by $22,000, or
3.5%, to $659,000 for calendar year ended December 31, 1995, as compared to
$637,000 for the same period in 1994. Average sales generated by franchised
stores increased by $14,000, or 2.3%, to $600,000 for calendar year ended
December 31, 1995, as compared to $586,000 for the same period in 1994.
Aggregate ongoing franchise royalties increased by $970,000, or 16.4%, to
$6,891,000 for calendar year ended December 31, 1995, as compared to $5,921,000
for the same period in 1994, due to an increase in the number of franchised
stores, as well as an increase in the sales volume per franchised stores.
Average ongoing franchise royalties per franchised store increased by $3,000, or
6.7%, to $48,000 for calendar year ended December 31, 1995, as compared to
$45,000 for the same period in 1994.
Net gains on the conveyance of the assets of eight Company-owned stores
to franchisees decreased by $1,154,000, or 34.4%, from $2,197,000 for calendar
year ended December 31, 1995 (including the gain on the conveyance of one store,
in the amount of $1,173,000), as compared to the net gains on the conveyance of
assets of 17 Company-owned stores to franchisees, in the aggregate amount of
$3,351,000, for the same period in 1994.
The Company's gross profit margin increased by 2.3 percentage points, to
74.8%, for calendar year ended December 31, 1995, as compared to 72.5% for the
same period in 1994. This increase resulted primarily from the Company having
discontinued, in the Fall of 1995, two marketing programs: (i) a test program
which had changed the product mix in Company-owned stores by increasing the
quantities of higher priced/lower margin designer frames and specialty
ophthalmic lenses; and (ii) a promotional program in response to certain major
competitors of the Company which had offered promotional incentives to their
customers. To match such incentives, the Company had offered similar types of
promotional programs to its customers, which resulted previously in lower gross
profit margins. In the future, the Company's gross profit margin may fluctuate
depending upon the extent and timing of changes in the product mix in
Company-owned stores, competition and promotional incentives.
Selling expenses decreased by $287,000, or 1.8%, to $16,127,000 for
calendar year ended December 31, 1995, as compared to $16,414,000 for the same
period in 1994. Although the Company , in connection with the Benson
Transaction, acquired an additional 32 stores during the fourth quarter of 1995,
this decrease was primarily due to the change in the Company's employment
arrangement (as described above) with certain of its optometrists from that of a
salaried employee to an independent optometrist subleasing the professional
office located within the Sterling Store in question, and the conveyance of the
assets of eight Company-owned stores to franchisees during the calendar year
ended December 31, 1995.
General and administrative expenses (including interest expense,
depreciation and bad debt expense) decreased by $608,000, or 5.1%, to
$11,360,000 for calendar year ended December 31, 1995, as compared to
$11,968,000 for the same period in 1994. This decrease was primarily due to a
reduction in the Company's provision for doubtful accounts of $1,597,000 (see
explanation below) which was partially offset by an increase in administrative
costs of approximately $600,000 relating to Insight, the Company's investment
(by its wholly owned subsidiary, Sterling Vision of Metro N.Y., Inc.) in
National Optical Services, Inc. ("NOS"), an entity engaged in the business of
developing and administering third party provider agreements, and the Company's
construction and opening of an ophthalmic lens manufacturing facility, each of
which had not incurred expenses until 1995, as well as approximately $300,000 in
administrative costs related to the Benson Transaction.
Interest expense, which is included in general and administrative
expenses, increased by $184,000, or 28.4%, to $831,000 for calendar year ended
December 31, 1995, as compared to $647,000 for the same period in 1994. This
increase was due to increased indebtedness incurred by the Company in connection
with its acquisition of eight retail optical stores from Pembridge, in 1994, and
the leasing, in 1995, of five excimer lasers (which are capital leases and,
accordingly, the payments under which are treated as interest expense), as
partially offset by lower interest rates resulting from the refinancing, during
1994, of the Company's debt at more favorable
22
interest rates.
The Company's provision for doubtful accounts, which is included in
general and administrative expenses, decreased by $1,597,000, or 89%, to
$201,000 as of December 31, 1995, as compared to $1,798,000 for December 31,
1994. This decrease resulted primarily from several factors: (i) the Company's
election, in 1994, to reserve an additional $194,000 and $132,000 against the
residual value of the corresponding franchise notes held by Sanwa and CIT,
respectively; (ii) the Company's election to reserve $391,000 against the cash
collateral held by CIT (see "Liquidity and Capital Resources"); (iii) as part of
the franchise system restructuring commenced by the Company in the latter part
of 1992, the Company wrote off, in 1994, $280,000 against certain franchise
notes receivable which were subject to forgiveness upon a franchisee's
compliance with certain financial covenants; and (iv) based upon historical
performance, the Company reduced its reserve against accounts and notes
receivable by approximately $600,000.
The Company's income before extraordinary item and income taxes increased
by $144,000, or 5.2%, to $2,896,000 for calendar year ended December 31, 1995,
as compared to $2,752,000 for the same period in 1994. During 1995, the Company
consummated the Benson Transaction and thereby acquired substantially all of the
assets and certain continuing expenses of the Sellers; began incurring costs in
anticipation of establishing its Insight Laser Center business; invested capital
in NOS; and opened an ophthalmic lens manufacturing facility. The Company
believes that the costs associated with acquiring and establishing these
businesses are nonrecurring. As a result, certain aspects of the Company's
operations during 1995 were not comparable to its operation during 1994. Income
from the Company's comparable operations increased by $1,156,000, or 42%, to
$3,908,000 for calendar year ended December 31, 1995, as compared to $2,752,000
for the same period in 1994, primarily due to the $895,000 decrease in selling,
general and administrative expenses, as described above, and the net profit
generated from the operations of VCC, in the amount of $212,000. This increase
was offset primarily by the following four factors: (i) the Company incurred a
$520,000 loss from the operation of the Benson stores during the fourth quarter
of 1995, primarily due to losses generated by the 66 stores the Company
ultimately closed and the costs incurred in maintaining Benson's administrative
office and warehouse facilities, which were eventually closed in the first
quarter of 1996; (ii) the Company incurred a $193,000 loss in establishing the
operations of Insight, which has yet to generate revenues, although it incurred
payroll costs and interest expense with respect to its leasing of five (5)
excimer lasers; (iii) the Company incurred a $192,000 loss from the operation of
NOS, including the Company's election to write-off the $50,000 balance of its
investment in such entity; and (iv) the Company incurred expenses in the amount
of $107,000 in connection with the initial operations of its lens manufacturing
facility.
Liquidity and Capital Resources
The Company is a party to a Term Loan and Revolving Credit Agreement (the
"Credit Agreement") with the Bank which, as of December 31, 1996, provided for
term loans totaling an aggregate principal amount of $4,640,448 and a $2,375,000
revolving line of credit.
The term loans are divided into two separate classes or tranches
(collectively, the "Tranches"). Tranche A was in the original principal amount
of $5,000,000 and is being amortized over five years with equal monthly payments
of principal. Interest is fixed at 8.07% per annum on the outstanding balance
and is payable monthly. Tranche B was in the original principal amount of
$2,500,000 and is being amortized over five years with equal monthly payments of
principal. Interest is calculated on the outstanding balance at 3/4% over the
prime rate in effect from time to time and is payable monthly. As of December
31, 1996, the outstanding principal balance of Tranche A was $2,333,344, and the
outstanding principal balance of Tranche B was $1,166,656. In addition, on
November 30, 1995, the Bank converted an existing demand loan into a term loan
to be repaid over the remaining term of the Tranches, with interest payable
monthly at a fixed rate of 7.9% per annum. Such loan, in the original amount of
$1,670,000, was incurred by the Company to fund the Benson Transaction. As of
December 31, 1996, the outstanding principal balance of such loan was
$1,140,484.
In addition to the term loans mentioned above, the Bank initially also
provided a $1,000,000 revolving line of credit. The Company is required to pay
1/4% per annum on the unused portion of this line of credit, regardless of
whether any actual borrowings occur. On November 30, 1995, the Bank: (i)
converted an existing bridge loan, in the principal amount of $1,670,000, into
the term loan mentioned above, which will be amortized over the remaining term
of the Tranches; (ii) increased the Company's line of credit by an additional
$1,500,000, of which $2,375,000 was outstanding as of December 31, 1996; and
(iii) extended the maturity date of the line of credit to April 5, 1997. On
February 26, 1997, the Bank amended the Credit Agreement (as explained below)
which included, in part, a $1,000,000 payment and permanent reduction in the
amount of the line of credit and an extension of the maturity date of such line
of credit until May 30, 1997. Loans outstanding under the line of credit bear
interest at the prime rate in effect from time to time.
Pursuant to the terms of the Credit Agreement, the Company must comply
with certain financial covenants relating to: (i) the ratio
23
of total assets to total revenues; (ii) minimum net worth plus subordinated
indebtedness; (iii) the ratio of total unsubordinated liabilities to net worth;
(iv) its current ratio; (v) its debt service coverage ratio; (vi) maximum net
loss; and (vii) the ratio of funded debt to net operating cash flow, all as such
terms are defined in the Credit Agreement. Except for the quarter ended March
31, 1996, the Company was not in compliance with certain of these financial
covenants for the quarters ended June 30, 1996, September 30, 1996 and December
31, 1996, although, in each instance, the Company was able to secure a waiver of
such non-compliance from the Bank. At June 30, 1996, the Company was not in
compliance with the covenants described in (v) and (vii) above, primarily due to
the decrease in net income before taxes for the six months ended June 30, 1996
as compared to the same period in 1995, and an increase in the Company's then
short-term debt incurred as a result of the Banks issuance of a $4,150,000
letter of credit in connection with the VCA Transaction, which was completed
during the quarter ended June 30, 1996; at September 30, 1996, the Company was
not in compliance with the covenants described in (v) and (vii) above, primarily
due to the decrease in net income before taxes for the nine months ended
September 30, 1996 as compared to the same period in 1995; and, at December 31,
1996, the Company was not in compliance with any of the financial covenants
described above primarily due to the net loss before tax provision incurred for
the calendar year ended December 31, 1996. Unless waived, such defaults would
give the Bank the right to accelerate the payment of the then outstanding
balance under the Company's term loans and line of credit.
On November 29, 1996, the Company borrowed from each of Drs. Robert
Cohen, Alan Cohen and Edward Cohen (collectively, the "Cohen Brothers") the sum
of $666,666.66 each of which loans was for a term of ninety (90) days and bears
interest at a rate of 1.0% above the Banks prime rate, in effect, from time to
time. As a condition to the Company borrowings such funds, the Bank amended the
Credit Agreement which: (i) permitted the Company to borrow such funds from the
Cohen Brothers; (ii) placed additional restrictions on the Company's ability to
acquire other retail optical chains without the Bank's approval; (iii) expanded
the default provisions contained in the Credit Agreement; and (iv) placed
additional restrictions on the Company's ability to sell its excess franchisee
promissory notes. As of December 31, 1996, the aggregate outstanding principal
balance of such loans was $2,000,000. On February 26, 1997, the Company repaid
$1,000 of such loams together with the interest accrued to date thereof, and the
Cohen Brothers orally agreed to extend the maturity date of the balance of such
loans to May 30, 1997.
On February 26, 1997, the Company entered into Convertible Debenture and
Warrants Subscription Agreements (see Note 18 - Subsequent Events) with certain
investors in connection with the private placement of units consisting of an
aggregate of $8,000,000 principal amount of convertible debentures
(collectively, the "Debentures") and an aggregate of 800,000 warrants
(collectively, the "Warrants"), which Warrants entitle the holders thereof to
purchase a maximum number of 1.2 million shares of the Company's Common Stock").
The Company intends to use the net proceeds (approximately $7,500,000) of the
private placement: (i) to repay a $1,000,000 portion of the loans made to it by
the Cohen Brothers as discussed above, together with thereon, in the approximate
amount of $50,000; (ii) to pay down the Company's revolving line of credit with
the Bank ($1,000,000): (iii) The balance of such proceeds is intended to be used
by the Company for general corporate purposes. The Debentures bear no interest
and mature on August 25, 1998.
In connection with the Company's acquisition, which occurred in May 1996,
of substantially all of the assets of VCA, the Company delivered to Norwest, the
Seller, a ninety (90) day direct pay letter of credit, in the amount of
$4,150,000, representing the purchase price for such assets, which letter of
credit was drawn upon by Norwest in the ordinary course of business.
In connection with the IPCO Acquisition, the Company acquired IPCO's
right to cash collateral and certain franchise promissory notes pledged to, and
securing loans made to, IPCO and CIT. The residual value of such franchise notes
receivable (i.e., the sums remaining payable on such franchise notes after
payment, in full, of the indebtedness owed to CIT and Sanwa, which obligations
were not assumed by the Company) represent notes acquired from IPCO and are
currently being held by Sanwa and CIT as collateral against obligations incurred
by IPCO. The indebtedness payable to CIT is scheduled to be repaid on or about
July 2000, at which time it is anticipated that the cash collateral and
franchise notes pledged to CIT will be returned to the Company. However, the
Company's residual value of the cash collateral underlying the franchise notes
pledged to CIT has been reduced as a result of the application, by CIT, of such
collateral to offset certain franchisee note forgiveness. The Company's right to
the return of the notes pledged to Sanwa (after payment of the indebtedness
incurred by IPCO and subject to which the Company acquired such notes) is the
subject of litigation between Sanwa and the Company. The Company maintains that
it is entitled to a return of the franchise notes held by Sanwa upon the
repayment of the indebtedness owed to Sanwa, based upon the advice given to it
by its outside counsel. The residual value of the franchise notes, net of
reserves of $562,000, held by Sanwa and CIT as of December 31, 1996 was
$1,325,000 and $325,000, respectively.
Franchise and other accounts receivable increased by $4,541,000, or
134.8%, to $7,911,000 as of December 31, 1996, as compared to $3,370,000 as of
December 31, 1995, due primarily to slower collections of certain amounts owed
to the Company by a number of its franchisees, as well as an increase in
royalties generated by an increase in the number of franchised stores acquired
in the VCA Transaction
24
The Company is working with these franchisees in an attempt to obtain collection
of outstanding receivables through the following means: (i) restructuring of the
repayment of such obligations; or (ii) if necessary, exercising its rights under
the various documents pursuant to which each such franchisee occupies its
Sterling Store, including the possible termination of the applicable Franchise
Agreement.
Franchise and other notes receivable as of December 31, 1996 were
$19,588,000, which includes approximately $5,400,000 of franchise notes acquired
in connection with the VCA Transaction. In addition, such amount consists of
approximately $3,900,000 of new franchise notes generated from the conveyance of
Company-owned assets to franchisees, and is partially offset by approximately
$2,000,000 of principal payments collected during the calendar year ended
December 31, 1996. The Company believes that the underlying value of the
collateral securing its franchise accounts and notes receivable together, in
most cases, with the personal guarantees of the principal owners of each of the
Company's franchised stores, will be sufficient to support the collectibility of
these receivables.
Inventories at Company-owned stores decreased by $424,000, or 10.4%, to
$3,678,000 as of December 31, 1996, as compared to $4,102,000 as of December 31,
1995. This decrease was due primarily to the conveyance, during the calendar
year ended December 31, 1996, of the assets of 20 Company-owned stores to
franchisees.
As of December 31, 1996, Insight had leased, with $1.00 purchase options,
six excimer lasers. Aggregate lease payments pursuant to such leases will
approximate $1,029,000, $1,029,000, $1,015,000, $767,000 and $218,700 for the
years ended December 31, 1997, 1998, 1999, 2000 and 2001, respectively.
In December, 1995, the Company completed the Offering and raised
approximately $14,791,000, net of commissions and expenses, from the sale of
2,200,000 shares of its Common Stock at a price of $7.50 per share. In January,
1996, the Company raised approximately $625,000, net of commissions and
expenses, from the sale of an additional 100,000 shares of its Common Stock at
$7.50 per share pursuant to an over-allotment option granted the Underwriters in
connection with the Offering. As of December 31, 1996 and December 31, 1995, the
Company had $(3,803,000) and $16,312,000, respectively, in working capital, and
$868,000 and $15,493,000, respectively, of cash and cash equivalents. As of the
date hereof, the Company has ceased the construction of any new Insight Laser
Centers, including the one in San Francisco, California (which was anticipated
to open during the first quarter of 1997). During the twelve months ending
December 31, 1997, the Company anticipates having the following capital
requirements: renovating of six existing Company-owned stores, and the
continuing upgrade of the Company's management information system in conjunction
with the POS systems being installed in its Company-owned stores, in the
aggregate, approximate amount of $750,000; acquiring retail optical stores,
subject to the availability of qualified opportunities and which would require
the approval of the Bank, in furtherance of the Company's business strategy, in
amounts that cannot be projected by the Company at this time, (except for a
$300,000 loan to be made by Sterling in connection with a proposed acquisition
(see Note 18 - Subsequent Events); and opening new retail optical stores in
furtherance of the Company's business strategy, also in amounts that cannot be
projected by the Company at this time.
The Company experienced negative cash flow during the calendar year ended
December 31, 1996 resulting, primarily, from losses attributable to the stores
acquired in the Benson Transaction (the "Benson Stores") and the operations of
Insight. By the end of 1996, the following measures were taken by the Company
which management believes will reduce the magnitude of the losses it sustained
during 1996 and improve the Company's operations and cash flow in 1997: (i)
closing nine Benson Stores, some of which were unprofitable or where leases for
which were not renewed: (ii) franchising eleven Benson Stores which are
currently producing royalty income; (iii) eliminating virtually all
administrative overhead in connection with Insight; (iv) reducing overhead at
the Company's Insight Laser Center; and (v) reduced general and administrative
expenses, exclusive of those incurred by Insight, by approximately $1,000,000.
Although the Company also anticipates a positive cash flow from its retail
optical store operations, it nevertheless anticipates that Insight will
continue to operate at a loss for the twelve months ended December 31, 1997,
therefore the Company believes that such operating cash flow will be
insufficient to result in a positive cash flow for the Company for the twelve
months ended December 31, 1997. However, in February 1997, the Company entered
into a Convertible Debentures and Warrants Subscription Agreement (see Note 18
- - Subsequent Events) which provided net proceeds of approximately $7,500,000 to
the Company. Except for approximately $2,050,000 of such amount, which was
utilized to repay a portion of the Company's debt, approximately
$5,400,000 will be available to the Company for general corporate purposes.
Although the Company believes that its financial condition will improve for the
twelve months ended December 31, 1997, the Company also anticipates that it may
not be in compliance with certain of its existing financial covenants as
contained in its Credit Agreement with the Bank. Consequently, the Company is
required for the calendar year ended December 31, 1997, to recla