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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
- --- Act of 1934 For the Year ended December 31, 1998.
- --- 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 and Telephone Number 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
Common Stock, par value $.01 per share Nasdaq National 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 Registrant's Common Stock, par value
$.01 per share (the "Common Stock") held by nonaffiliates of the Registrant as
of March 26, 1999, (based upon the closing price of $3.56 per share as quoted on
the Nasdaq National Market System) was approximately $14,726,000. For purposes
of this computation, the shares of Common Stock held by directors, executive
officers and principal shareholders owning more than 5% of the Registrant's
outstanding Common Stock and for which a Schedule 13G was filed, were deemed to
be stock held by affiliates. As of March 26, 1999, there were approximately
4,134,000 outstanding shares of Common Stock held by nonaffiliates.
As of March 26, 1999, there were 15,118,524 shares of the Registrant's
Common Stock outstanding.
Documents Incorporated by Reference
The Company's Proxy Statement for the 1999 Annual Meeting of Shareholders
is incorporated herein by reference in Part III of this Annual Report on Form
10-K.
Item 1. Business
The Company and its franchises develop and operate retail optical
stores principally under one of the trade names "Sterling Optical," "IPCO
Optical," "Site For Sore Eyes," "Benson Optical," "Southern Optical," "Superior
Optical," "Nevada Optical," "Duling Optical," "Monfried Optical," "Kindly
Optical" and "Singer Specs." The Company is presently formulating plans to
change the trade name of most Sterling Stores (other than its Site for Sore Eyes
stores located in Northern California) to "Sterling Optical." The Company also
operates Vision Care 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 affiliates with health care providers
(ophthalmologists) in offering Photorefractive Keratectomy ("PRK"), a procedure
performed with an excimer laser for the correction of certain degrees of myopia
(near-sightedness). The Company's wholly owned subsidiary. Insight Laser
Centers, Inc. ("Insight") and these ophthalmologists enter into agreements
whereby the ophthalmologists pay the Company a fee for each, PRK procedure
performed using an excimer laser installed in their offices by Insight. As of
December 31, 1998, the Company held leases for 6 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 its
additional 5 excimer lasers in ophthalmological offices located in New York,
California, Pennsylvania, Delaware and New Jersey.
The Company also operates a full service ambulatory surgery center
located in Garden City, New York, which contains 4 surgical operating rooms.
General
The Company is one of the largest chains of retail optical stores and
the second largest franchise optical chain in the United States, based upon
domestic sales and the number of locations of Company-owned and franchised
stores (collectively referred to herein as "Sterling Stores").
As of December 31, 1998, there were 292 Sterling Stores in operation,
consisting of 41 Company-owned stores (including 6 stores being managed by
Franchisees), 251 franchised stores including 12 stores being managed by the
Company on behalf of the Franchisee/owners thereof. The Company continually
seeks to expand both its Company-owned and franchised store operations. As of
December 31, 1998, Sterling was constructing 2 additional Company stores and an
additional 4 franchised stores, and had received commitments from existing
franchisees to develop an additional 17 franchised stores. Sterling Stores are
located in 26 states, the District of Columbia, Ontario, Canada, and the U.S.
Virgin Islands.
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, to provide 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, in many cases, allows
Sterling Stores to offer same-day service.
One of the Company's strategies is to treat certain of 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 trade
names "Sterling Optical," "IPCO Optical," "Site For Sore Eyes," "Benson
Optical," "Southern Optical," "Superior Optical," "Nevada Optical," "Duling
Optical," "Monfried Optical," "Kindly Optical," and "Singer Specs," the Company
is in the process of changing the trade name of most Sterling Stores (other than
those of its Site for Sore Eyes stores located in Northern California) to
"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 affiliates 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). The
Company's wholly owned subsidiary, Insight Laser Centers, Inc. ("Insight") and
these ophthalmologists enter into agreements whereby the ophthalmologists pay
the Company a fee for each PRK procedure performed using an excimer laser
installed in their offices by Insight. As of December 31, 1998, the Company held
leases for 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 its additional five excimer lasers in
ophthalmological offices located in New York, California, Pennsylvania, Delaware
and New Jersey.
On May 6, 1998, the Company, through its wholly-owned subsidiary,
Insight Laser Centers N.Y.I, Inc., purchased substantially all of the assets of
an ambulatory surgery center located in Garden City, New York (the "Center")
and, in connection therewith: (i) settled
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its legal action against the estate of the former owner of the Center; (ii)
entered into a long-term lease of the premises in which the Center is located;
and (iii) entered into an agreement whereby it will manage the operations of the
Center, on an interim basis, pending the approval from the New York State
Department of Health of the transfer of the license and certificate of need
therefor, to an affiliate of the Company, after which time it will continue to
manage such operations on behalf of such affiliate.
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, the Company also acquired VCC. In addition, the Company: (i) in
August 1994, purchased the assets of 8 additional retail optical stores located
in New York and New Jersey (the "Pembridge Transaction") from Pembridge Optical
Partners, Inc. ("Pembridge"); (ii) in November 1995, acquired, through one of
its wholly-owned subsidiaries, substantially all of the retail optical assets of
Benson Optical Co., Inc., OCA Acquisition Corp. and Superior Optical Company,
Inc. (the "Benson Transaction"), including the assets located in approximately
70 retail optical store locations, a substantial number of which were
subsequently closed by the Company; (iii) in May 1996, acquired, through one of
its wholly-owned subsidiaries (the "VCA Transaction"), 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"),
including the assets located in approximately 13 company operated stores and
franchise agreements, together with related agreements, with respect to
approximately 75 additional franchised stores; and (iv) in April 1997, acquired,
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 (the "Singer Transaction").
The following chart sets forth the breakdown of Sterling Stores as of
December 31, 1998 and December 31, 1997:
December 31
1998 1997
---- ----
I. COMPANY-OWNED STORES:
Company-Owned Stores in Operation..................................... 35 50
Company-Owned Stores Being Managed by Franchisees..................... 6 0
Leases Under Negotiation.............................................. 2 3
--- ---
Total.................................................... 43 53
=== ===
Existing store locations: California (10), Illinois (1), Kentucky
(2), Michigan (2), New Jersey (2), New York (20), North Dakota
(1), Pennsylvania (2) and West Virginia (1).
II. FRANCHISED STORES:
Stores in Operation................................................... 239 257
Franchise Owned Stores Being Managed by Company....................... 12 6
Stores Under Construction............................................. 4 2
--- ---
Total.................................................... 255 265
=== ===
Existing store locations: California (22), Colorado (1),
Connecticut (1), Delaware (5), Florida (2), Iowa (6), Illinois
(8), Indiana (1), Kentucky (5), Maryland (19), Massachusetts (1),
Michigan (4), Minnesota (20), Missouri (7), Montana (2), Nebraska
(3), Nevada (1), New Jersey (8), New York (44), North Carolina
(4), North Dakota (7), Pennsylvania (20), South Dakota (3),
Virginia (10), Washington, D.C. (1), West Virginia (4), Wisconsin
(31), Ontario, Canada (10) and the U.S. Virgin Islands (1).
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
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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 to maximize the benefit of advertising strategies and 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
Massachusetts) 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. If a
product test is successful, the Company attempts to negotiate a systemwide
preferred vendor discount for the product, and the discount is made available to
the Company's franchisees. In addition, a full line of eyeglass and contact lens
accessories is also available at most Sterling Stores. For the year ended
December 31, 1998, net sales at Company-owned stores were approximately
$23,163,000, and net sales at Company-managed stores were approximately
$4,503,000.
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 to the majority of
customers ordering prescription eyeglasses.
Company-Managed Stores
In the fourth quarter of 1998, the Company, as required, adopted the
provisions of Emerging Issues Task Force Issue 97-2 ("EITF 97-2"), "Application
of FASB Statement No. 94 and APB Opinion No. 16 to Physician Practice Management
Entities and Certain Other Entities with Contractual Management Arrangements."
In connection with the adoption of EITF 97-2, for the year ended December 31,
1998, the Company deconsolidated the results of operations of certain franchise
locations of certain franchise locations operated by the Company under
management agreements. In accordance with EITF 97-2, the results of operations
for the years ended December 31, 1997, and 1996 have been restated to conform to
the provisions of EITF 97-2 applied to the year ended December 31, 1998. Such
restatement had the effect of reducing net sales by approximately $2,047,000 and
$981,000 and total expenses by approximately $2,220,000 and $1,246,000 for the
years ended December 31, 1997 and 1996, respectively. Such restatement had no
impact on the net loss or net loss per share for either period.
During 1998, the Company managed a total of 12 locations for
franchisees under the terms of management agreements. Such agreements generally
provide for the operations of the location to be run by the Company, with
primarily all operating decisions made by Company employees. The Company owns
the inventory at the locations and is generally responsible for the collection
of all revenues, and the payment of expenses. For the year ended December 31,
1998, such stores generated revenue of approximately $4,503,000 and total
expenses of $5,295,000. The net result of such operations is classified as loss
from stores operated under management agreements in the accompanying
consolidated statement of operations.
Effective December 31, 1998, the Company acquired 6 stores previously
operated under management agreements from a franchisee.
Franchise Operations
As of December 31, 1998, the Company had 251 franchised stores in
operation, as compared to 263 franchised stores as of December 31, 1997. 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,
inventory selection and sources, 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; and (iii) provides initial
training, an operations manual and a comprehensive business review to aid the
franchisee in attempting to maximize its sales and profitability. In addition,
the Company generally restricts itself from operating or franchising other
Sterling Stores within a specified radius of existing franchised stores.
Further, on an ongoing basis the Company 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 the 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
generally are 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 for more than one location) must pay
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; and, for each franchisee entering into agreements
for more than one location, the Company charges a non-recurring, initial
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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, 1998 were approximately $238,000.
(c) Ongoing Royalties. Typically, all franchisees are obligated to pay 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. In addition, most of the Franchise
Agreements acquired by the Company in the Singer Transaction (the "Singer
Franchise Agreements") provide for ongoing royalties calculated at 7% of gross
revenues. Franchise Agreements entered into prior to January 1994 provide for
the payment of 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 royalty fees earned by the Company for the year ended
December 31, 1998 were approximately $9,135,000.
(d) Advertising Fund Contributions. Most franchisees must make ongoing
contributions to one of two advertising funds (the "Advertising Funds") equal to
a percentage of their store's gross revenues. Except for the Singer Franchise
Agreements, which generally provide for contributions equal to 7% of 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, 1998,
the Company received approximately $4,432,000 in Advertising Fund contributions
from franchisees.
(e) Financing. 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. The Company generally does not
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 1998, ranged from approximately $5,000 to $810,000.
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 an aggregate of 51% thereof) and is generally
secured by all of the assets of the store in question, including after acquired
assets and the proceeds thereof. From time to time, certain franchisees obtain
financing from third parties. In such cases, the Company generally subordinates
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 on its payment of monies due to the Company, or in its performance
of the other terms and conditions of the Franchise Agreement. During 1998, 18
franchised stores were closed, an additional 8 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 the
related Franchise Agreements, although the Company, in January, 1999, reinstated
4 of such agreements. The Company has, in many such instances, reconveyed the
assets of certain of such stores to a new franchisee, whereby the new franchisee
enters into Sterling's then current form of Franchise Agreement.
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 offering PRK, under the trade name "Insight Laser."
Published reports indicate 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 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 of excimer lasers manufactured by Summit Technology, Inc. ("Summit") and
VISX, Incorporated ("VISX"), for use in connection with the PRK procedure. Both
Summit and VISX charge a royalty fee for each procedure performed utilizing
their respective excimer lasers.
As of December 31, 1998, the Company held leases for six excimer lasers,
each with a purchase option for nominal consideration. The Company owns and
operates one Insight Laser Center located in New York City, and has placed its
additional five excimer lasers into ophthalmological offices located in New
York, California, Pennsylvania, Delaware and New Jersey.
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Singer Transaction
On April 1, 1997, the Company acquired all of the issued and outstanding
shares of the capital stock of Singer Specs, Inc., a Delaware corporation, and
certain of its wholly-owned subsidiaries (collectively, "Singer") pursuant to
the terms of a certain Agreement and Plan of Reorganization, dated February 19,
1997 (the "Singer Agreement"), between the Company and the owners (collectively,
the "Shareholders") of all of the capital stock of Singer; and, in April, 1998,
Singer Specs, Inc. was merged with and into the Registrant. As of the date of
such acquisition, Singer was the: (i) operator of 4 retail optical stores, each
of which were simultaneously franchised to corporations owned by the
Shareholders; (ii) franchisor of an additional 27 retail optical stores, all of
which were located in the States of Pennsylvania, Delaware, New Jersey, Virginia
and the U.S. Virgin Islands; and (iii) owner of a commercial building located in
Philadelphia, Pennsylvania, which was sold by the Company in December 1998.
The Singer Agreement provided for the Shareholders to convey all of their
capital stock to the Company in exchange for shares of the Company's Common
Stock. The Shareholders pledged all such shares of the Company's Common Stock to
secure their obligations under the Singer Agreement, with certain restrictions
as to when the Shareholders could sell certain portions of such Common Stock.
The Singer Agreement also provided that the Company, under certain
circumstances, pay the Shareholders the difference between the market price of
its Common Stock as of the closing, and the selling price (net of 50% of
commissions) of any such shares subsequently sold by the Shareholders (the
"Price Protection Guaranty"). In 1997, approximately $143,000 was paid to the
Shareholders pursuant to the Price Protection Guaranty related to their sale of
approximately 100,000 shares of the Company's Common Stock.
On July 31, 1998, the Company and the Shareholders entered into a
Settlement Agreement whereby: (i) the Company released to the Shareholders all
of the remaining shares originally pledged to the Company; (ii) the parties
agreed to reduce the Price Protection Guaranty, from $8.05 to $6.60; (iii) the
Shareholders agreed to pay the Company the first $300,000 of net proceeds
realized by them in connection with their future sale of the Company's Common
Stock above the Price Protection Guaranty; (iv) the Company agreed to accelerate
the time periods within which the Shareholders could sell such shares of Common
Stock; and (v) the Company waived certain claims it was then alleging against
the Shareholders.
During 1998, the Company paid the Shareholders approximately $285,000
pursuant to the Price Protection Guaranty related to their sale of approximately
80,000 shares of the Company's Common Stock (see Note 18).
Competition
The optical business is highly competitive and includes chains of retail
optical stores, superstores, individual retail outlets, the operators of
websites 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 to this, the Company has, from time to time, offered the same or
similar incentives to its customers, which competitive promotional incentives
adversely affect the Company's results of operations.
The Company believes that the principal competitive factors in the retail
optical business are convenience of location, on-site availability of
professional eye examinations, quality and consistency of product and service,
price, product warranties, a broad selection of merchandise and the
participation in third party, managed care provider agreements. The Company
believes that it competes favorably in each of these respects.
As of December 31, 1998, the Company owned and operated one Insight Laser
Center and had five excimer lasers placed in ophthalmological offices. The
Company believes that its Insight Laser Center, as well as the lasers placed by
it in ophthalmological offices, experience competition from numerous other
companies 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. In addition, as of December 31,
1998, the Company owned substantially all of the assets of an ambulatory
surgery center which the Company believes experiences competition from hospitals
and other similar centers located in the area of the Center.
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, including
privately labeled contact lenses and lens cleaning solutions presently being
offered by the Company and certain of its franchisees. Optometric examinations
by licensed optometrists are generally available on the premises of, or directly
adjacent to, all Sterling Stores.
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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 and most franchised Sterling Stores
participate in advertising and in-store promotions, which include visual
merchandising techniques to draw attention to the products displayed in Sterling
Stores. The Company has also developed an inter-active website (which it
anticipates will be fully operational in May, 1999) on which its products are
offered, and, in many instances, also uses 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
advertising, promotions and public relations programs. In most cases, the
Company may expend approximately 50% of such funds as it deems necessary or
appropriate, to advertise and promote all Sterling Stores.
Management Information Systems
Over the past few years, management had conducted research as to the
availability and development of a point-of-sale computer system (the "POS
System" or the "System") for use in both Company operated and franchised
Sterling stores. The Company tested several 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, among other
features, inventory and patient database management. The Company has commenced
utilization of the A-P System and anticipates that it will take between one or
two additional years to install the A-P System in all existing Company-owned
stores. As of December 31, 1998, the Company had installed fourteen 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, maintain quality control, keep product testing and sales
records, incorporate certain design and operating features in lasers to
end-users and 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 (including those pertaining to the
operation of its ambulatory surgery center) 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 continuing
royalty fees based upon a percentage of the gross revenues of the fees collected
by its affiliated optometrists. 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 government 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 material compliance
with all such applicable laws and regulations.
As a franchisor, the Company is subject to various registration and
disclosure requirements imposed by the Federal Trade
7
Commission and by many states in which the Company conducts franchising
operations. The Company believes that it is in material 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
disposal 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.
Seasonality
The Company's retail optical and laser correction businesses, as well as
the operation of its ambulatory surgery center, 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". The
Company believes that these trademarks and servicemarks have acquired
significant commercial value and have helped to promote the Company's
reputation, even though the Company intends to change the trade name of most
Sterling Stores (other than the Site for Sore Eyes stores located in Northern
California) to "Sterling Optical." In connection with the Benson, VCA and Singer
Transactions, the Company also acquired several additional trademarks, some of
which the Company continues to utilize in connection with the operation of its
Sterling Stores.
Employees
As of December 31, 1998, the Company employed approximately 476
individuals, of which approximately 85% were employed on a full-time basis.
Except for those individuals employed at Company operated/managed Sterling
stores located in the New York metropolitan area, and except for those
individuals employed by the Registrant's wholly owned subsidiary, Insight IPA of
New York, Inc. (which solicits managed care provider agreements in the State of
New York), no employees are covered by any collective bargaining agreement. The
Company considers its labor relations with its employees to be good and has not
experienced any interruption of its operations due to disagreements.
Item 2. Properties.
The Company's headquarters, approximately 21,950 square feet in size
(approximately 60% of the entire building), are located in an office building
(owned by certain of the Company's principal shareholders) in East Meadow, New
York, under a sublease which expires in 2006. This facility houses the Company's
principal executive and administrative offices.
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
franchisees' Sterling Stores are held in the names of the individual
franchisees.
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, which houses the Company's Insight Laser Center.
Item 3. Legal Proceedings.
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. 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 properties are or may be subject,
which are likely to have a material adverse effect on the Company.
8
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 fourth quarter ended December 31, 1998.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Registrant's Common Stock has been listed on the Nasdaq National
Market System ("Nasdaq") under the trading symbol "ISEE" since December 25,
1995. The range of high and low sales prices for the Registrant's Common Stock
for the last two years are as follows:
1998 1997
------------------------- ------------------------
Quarter Ended: High Low High Low
- -------------- ---- --- ---- ---
March 31 $6.88 $4.63 $10.88 $4.50
June 30 $6.88 $4.50 $ 8.88 $6.25
September 30 $7.38 $2.50 $ 8.63 $5.63
December 31 $4.75 $2.13 $ 7.88 $5.50
The approximate number of Shareholders of record of the Registrant's
Common Stock at March 26, 1999, was 187.
The Company has no intention to pay dividends on its Common Stock in the
foreseeable future. It is the present policy of the Company's Board of Directors
to retain earnings to finance the Company's operations and expansion.
In February 1998, the Registrant issued $3,500,000 (stated value) of its
Senior Convertible Preferred Stock (the "Preferred Stock") (see Note 14 and Note
19), which requires the Company to pay quarterly dividends during the one year
period which commenced on such date, calculated at the rate of 10% per annum.
During 1998, the Company paid the aggregate sum of $87,500 in cash
($57,500 of interest on its Convertible Debentures Due August 1998 (the "1997
Debentures") and $30,000 of interest on the Preferred Stock) and issued an
aggregate sum of 47,494 registered shares of its Common Stock in payment of two
quarterly dividends on such Preferred Stock, as well as interest on its
Convertible Debentures (see Note 14 and Note 18).
9
Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
This Selected Financial Data should be read in conjunction with the Consolidated
Financial Statements of the Company and the related notes thereto included in
Item 8 of this Report, which consolidated financial statements have been
examined and reported on by Arthur Andersen LLP, independent public accountants,
with respect to the year ended December 31, 1998. The financial statements for
the years ended December 31, 1997, 1996 and 1995 were audited by Deloitte &
Touche LLP, independent public accountants; and the financial statements for the
year ended December 31, 1994 were audited by Janover Rubinroit, LLC, independent
public accountants.
Year Ended December 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Statement of Operations Data: (In thousands except for per share data and number of stores)
Systemwide sales $149,947 $146,333 $131,593 $112,258 $104,168
======== ======== ======== ======== ========
Net sales - Company-owned stores $ 23,163 $ 22,402 $27,496 $25,773 $27,684
Franchise royalties 9,135 9,550 7,616 6,891 5,921
Net gains and fees from the conveyance of
Company-owned store assets to Franchisees that are:
Unrelated parties 564 1,462 1,963 2,197 2,832
Related parties - - - - 519
Other income (1) 2,265 2,578 2,287 2,017 1,768
-------- -------- -------- -------- --------
Total revenues 35,127 35,992 39,362 36,878 38,724
-------- -------- -------- -------- --------
Cost of sales 8,087 6,973 8,587 6,495 7,590
Selling expenses 15,981 16,296 18,961 16,127 16,414
General and administrative expenses 21,758 17,859 16,743 10,529 11,321
Loss from Company-managed stores (2) 792 173 265 - -
Provision for store closings (3) 2,800 1,336 - - -
Amortization of debt discount 1,110 5,916 - - -
Interest expense 1,571 1,601 1,297 831 647
-------- -------- -------- -------- --------
Total costs and expenses 52,099 50,154 45,853 33,982 35,972
-------- -------- -------- -------- --------
(Loss) Income before provision for
income taxes and extraordinary item (16,972) (14,162) (6,491) 2,896 2,752
Provision for (benefit from) income taxes (4) - - (2,001) 2,129 127
-------- -------- -------- -------- --------
(Loss) income before extraordinary item (16,972) (14,162) (4,490) 767 2,625
-------- -------- -------- -------- --------
Extraordinary charge for early retirement of debt (805) - - - -
Net (loss) income $(17,777) $(14,162) $(4,490) 767 $ 2,625
-------- -------- -------- -------- --------
(Loss) income per share of common stock - basic and
diluted $ (1.22) $ (1.02) $ (.36) $ .08 $ .26
-------- -------- -------- -------- --------
Weighted average common shares - basic and
diluted (6) 14,627 13,883 12,341 10,031 9,963
-------- -------- -------- -------- --------
Pro Forma Statement of Operations Data (Unaudited):(5)
Income before provision for income taxes and
extraordinary item $ 2,896 $ 2,752
Pro forma provision for income taxes 1,158 1,101
-------- --------
Pro forma net income before extraordinary item $ 1,738 $ 1,651
Pro forma income per share of common stock - basic
and diluted $ .17 $ .16
Weighted average common shares - basic and
diluted (6) 10,031 10,031
10
Year Ended December 31,
-------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Sterling Store Data: (In thousands except number of stores)
Company-owned stores bought, opened or reacquired 6 7 24 39 14
Company-owned stores sold or closed (17) (19) (33) (8) (19)
Company-owned at end of period 35 50 62 71 40
Company-owned stores being managed by Franchisees at
end of period 6 0 0 0 0
Franchised stores being managed by Company at end of
period 12 6 6 1 0
Franchise-owned/managed stores at end of period 239 263 257 150 141
Average sales per store: (7)
Company-owned stores $ 478 $ 424 $ 395 $ 659 $ 637
Franchised stores $ 475 $ 478 $ 392 $ 600 $ 586
Average franchise royalties per
franchised store (7) $ 35 $ 37 $ 43 $ 48 $ 45
Balance Sheet Data:
Working capital (deficit) $(3,351) $ 3,472 $(3,803) $16,312 $ 1,750
Total assets 34,494 45,843 46,269 46,455 24,186
Total debt 11,552 15,378 15,184 13,900 8,121
Shareholders' equity 12,547 21,271 19,557 22,825 10,517
- --------------------------------
(1) Other income consists primarily of interest income on franchise notes
receivable and funds provided by certain Preferred Vendors for use in
connection with the Company's annual convention and regional seminars.
(2) Loss from Company-managed stores represents the loss from those Sterling
stores which the Company manages on behalf of the Franchisees/owners
thereof.
(3) A provision of approximately $2,800,000 and $1,336,000 was established for
the closing of certain Company stores in 1998 and 1997, respectively.
(4) From May 1, 1992, until the consummation of the Company's initial public
offering (the "Offering"), the Company operated as an S Corporation for
federal and state income tax purposes. As a result, the Company's 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 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.
(5) Pro Forma Statement of Operations 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 a combined, effective tax rate of 40% for each
of the following years: 1994 and 1995.
(6) Assumes as outstanding during the year ended December 31, 1994, 9,963,495
shares of Common Stock reflecting the 4,506.31-to-1 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. In accordance with SFAS No. 128, as a result
of losses from operations for the years ended December 31, 1998, 1997 and
1996, the inclusion of employee stock options and Warrants were
anti-dilutive and, therefore, were not utilized in the computation of
diluted earnings per share.
(7) 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.
11
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
For the Year Ended December 31, 1998 compared to December 31, 1997
Systemwide sales, which represent combined retail sales generated by
Company-owned and franchised stores, as well as revenues generated by VCC and
Insight Laser, increased by approximately $3,614,000, or 2.5%, to approximately
$149,947,000 for the year ended December 31, 1998, as compared to approximately
$146,333,000 for the same period in 1997. On a same store basis (for stores that
operated as either a Company-owned or franchised store during the entirety of
both of the years ended December 31, 1998 and 1997), systemwide sales increased
by approximately $2,066,000, or 1.7%, to approximately $122,378,000 for the year
ended December 31, 1998, as compared to approximately $120,312,000 for the
comparable period in 1997. There were 230 stores that operated as either a
Company-owned, a Company-managed or a franchised store during the entirety of
both of the years ended December 31, 1998 and 1997.
Aggregate sales generated from the operation of Company-owned stores
increased by approximately $761,000, or 3.4%, to approximately $23,163,000 for
the year ended December 31, 1998, as compared to approximately $22,402,000 for
the same period in 1997. This increase was principally due to an increase of
2.7% in comparable store sales, offset in part by the closing of certain
Company-owned stores. 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 stores 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 the franchised stores. On a
same store basis, aggregate sales generated by Company-owned stores in operation
during the entirety of both of the years ended December 31, 1998 and 1997,
increased by approximately $333,000, or 2.7%, to $12,910,000 for the year ended
December 31, 1998, as compared to approximately $12,577,000 for the same period
in 1997.
Aggregate sales generated from the operation of Company-managed stores
increased by approximately $2,456,000, or 120%, to approximately $4,503,000 for
the year ended December 31, 1998, as compared to approximately $2,047,000 for
the comparable period in 1997. This increase was principally due to an increase
in the number of Company-managed stores to 12 stores for the year ended December
31, 1998, as compared to 6 stores for the comparable period in 1997.
Aggregate sales generated from the operation of franchised stores
increased by approximately $397,000, or .3%, to approximately $122,281,000 for
the year ended December 31, 1998, as compared to approximately $121,884,000 for
the same period in 1997. On a same store basis, aggregate sales generated by
franchised stores in operation during the entirety of both of the years ended
December 31, 1998 and 1997, increased by approximately $1,733,000, or 1.6%, to
approximately $109,468,000 for the year ended December 31, 1998, as compared to
approximately $107,735,000 for the same period in 1997.
Aggregate ongoing franchise royalties decreased by approximately $415,000,
or 4.4%, to approximately $9,135,000 for the year ended December 31, 1998, as
compared to approximately $9,550,000 for the same period in 1997. This decrease
was principally due to a lower number of franchised units in operation during
the year ended December 31, 1998, as compared to the same period in 1997.
Net gains and fees on the conveyance of Company-owned store assets to
franchisees decreased by approximately $898,000, or 61.4%, to approximately
$564,000 for the year ended December 31, 1998, as compared to approximately
$1,462,000 for the same period in 1997. This decrease was principally due to net
gains on the conveyance of the assets of 4 Company-owned stores to franchisees
for the year ended December 31, 1998, as compared to net gains on the conveyance
of the assets of 20 Company-owned stores to franchisees for the comparable
period in 1997.
The Company's gross profit margin decreased by 3.8%, to 65.1% for
the year ended December 31, 1998, as compared to 68.9% for the same
period in 1997. 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 approximately $315,000, or 1.9%, to
approximately $15,981,000 or 69% of net sales for the year ended December 31,
1998, from approximately $16,296,000 or 72.7% for the same period in 1997.
This decrease was principally due to lower operating costs related to stores in
operation for the year ended December 31, 1998, as compared to the comparable
period in 1997, offset, in part, by an increase in payroll related expenses.
General and administrative expenses (including depreciation and provision
for doubtful accounts) increased by approximately $3,899,000, or 21.8%, to
approximately $21,758,000 or 61.9% of net sales for the year ended December
31, 1998, as compared to approximately $17,859,000 or 79.7% for the comparable
period in 1997. The increase was principally due to an increase of approximately
$5,200,000 in the Company's provision for doubtful accounts, reflecting the
Company's assessment that certain receivables have become
12
uncollectible, offset, in part, by a reduction in payroll costs as a result of
the Company's reduction in certain administrative overhead expenses.
The Company has identified certain long-lived assets, principally those
contained in certain of its Company-owned stores, where there has been, or there
is expected to be, a change in circumstances which would affect the
recoverability of all or a portion of the depreciated cost of such long-lived
assets. The Company anticipates the future closure of certain of its
Company-owned stores and/or the sale, to franchisees, of the assets contained
therein; and, as such, the Company has recorded a provision for store closings
of approximately $2,800,000 for the year ended December 31, 1998, as compared to
approximately $1,336,000 for the comparable period in 1997.
Loss from the operation of franchised stores managed by the Company
increased by approximately $619,000, or 358%, to approximately $(792,000) for
the year ended December 31, 1998, as compared to approximately $(173,000) for
the comparable period in 1997. This increase was principally due to an increase
in the number of franchised stores managed by the Company to 12, as of December
31, 1998, as compared to 6 for the comparable period in 1997.
The Company's net loss increased by approximately $3,615,000, or 25.5%, to
a loss of approximately $(17,777,000) for the year ended December 31, 1998, as
compared to a loss of approximately $(14,162,000) for the comparable period in
1997. The increase in the net loss was principally due to an increase of
approximately $5,200,000 in the Company's provision for doubtful accounts,
reflecting the Company's assessment that certain receivables had become
uncollectible; an increase of approximately $1,464,000 in the Company's
provision for store closings; a non-cash charge of approximately $1,915,000
(approximately $1,110,000 of amortization of debt discount and an extraordinary
loss of approximately $805,000) related to the extinguishment of debt upon the
issuance of the Preferred Stock on April 14, 1998; approximately $421,000 of
costs related to the inducement of Warrant conversions (see Note 14), a
reduction of $898,000 in the net gains on the conveyance of Company-owned store
assets to franchisees; and a $619,000 increase in the losses attributable to
Company-managed, franchised stores; all of which were offset, in part, by a
decrease in the amortization of debt discount of approximately $4,806,000.
For the Calendar-Year Ended December 31, 1997 compared to December 31, 1996
Systemwide sales, which represent combined retail sales generated by
Company-owned and franchised stores, as well as revenues generated by VCC,
increased by $14,740,000, or 11.2%, to $146,333,000 for the calendar year ended
December 31, 1997, as compared to $131,593,000 for the same period in 1996. 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, 1997 and 1996), systemwide sales decreased by $2,773,000, or 2.5%,
to $108,094,000 for the calendar year ended December 31, 1997, as compared to
$110,867,000 for the same period in 1996. There were 193 stores that operated as
either a Company-owned or franchised store during the entirety of both of the
calendar years ended December 31, 1997 and 1996.
Aggregate sales generated from the operation of Company-owned stores
decreased by $5,094,000, or 18.5%, to $22,402,000 for the calendar year ended
December 31, 1997, as compared to $27,496,000 for the same period in 1996. Such
decrease was primarily due to the conveyance of the assets of Company-owned
stores to franchisees, as well as the closing of certain Company-owned stores.
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 ended December 31, 1997 and 1996,
decreased by $640,000, or 3.7%, to $16,801,000 for the calendar year ended
December 31, 1997, as compared to $17,441,000 for the same period in 1996.
Aggregate sales generated from the operation of Company-managed stores
increased $1,066,000 or 109% to $2,047,000 for the year
13
ended December 31, 1997, as compared to $981,000 for the comparable period in
1996. This increase was principally due to an increase in the number of
Company-managed stores for the year ended December 31, 1997, as compared to the
comparable period in 1996.
Aggregate sales generated from the operation of franchised stores
increased by $18,768,000, or 18.2% to $121,884,000 for the calendar year ended
December 31, 1997, as compared to $103,116,000 for the same period in 1996, due
primarily to the acquisition of certain franchised stores on: (i) May 30, 1996,
from VCA and (ii) April 1, 1997, in connection with the Singer Transaction. On a
same store basis, aggregate sales generated by franchised stores in operation
during the entirety of both of the calendar years ended December 31, 1997 and
1996, decreased by $1,482,000, or 1.8%, to $78,734,000 for the calendar year
ended December 31, 1997, as compared to $80,216,000 for the same period in 1996.
Aggregate ongoing franchise royalties increased by $1,934,000, or 25.4%,
to $9,550,000 for the calendar year ended December 31, 1997, as compared to
$7,616,000 for the same period in 1996, due primarily to an increase in the
number of Company-owned stores conveyed to franchisees and certain franchised
stores acquired in the VCA and Singer Transactions.
Net gains on the conveyance of the assets of 9 Company-owned stores to
franchisees decreased by $501,000, or 25.5%, to $1,462,000 for the year
ended December 31, 1997, as compared to net gains on the conveyance of the
assets of 20 Company-owned stores to franchisees, in the aggregate amount of
$1,963,000 for the same period in 1996. 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 such
stores and the Company's basis (net book value) in the assets of the stores
conveyed.
The Company's gross profit margin increased by .1 percentage points, to
68.9%, for the year ended December 31, 1997, as compared to 68.8% for the same
period in 1996. 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 $2,665,000, or 14.1%, to $16,296,000
for the year ended December 31, 1997, as compared to $18,961,000 for the
same period in 1996, due primarily from the conveyance of the assets of
Company-owned stores to franchisees, as well as the closure of certain
Company-owned stores.
General and administrative expenses (including depreciation and provision
for doubtful accounts) increased by $1,116,000 or 6.7%, to $17,859,000 for the
year ended December 31, 1997, as compared to $16,743,000 for the same period in
1996. This increase was primarily due to the following seven factors: (i)
approximately $160,000 in higher occupancy expenses in connection with the
Company's relocation, in the second quarter of 1996, of its administrative
offices; (ii) approximately $380,000 in costs related to stock options granted
to certain consultants to the Company; (iii) approximately $188,000 in costs
related to compensation paid to the Company's new President and Chief Operating
Officer; (iv) approximately $188,000 in consulting fees paid to a company owned
by two of the Company's principal shareholders; (v) approximately $200,000 in
costs related to severance compensation paid to three former executives of the
Company; (vi) approximately $400,000 in amortization costs related to the Singer
Transaction and the shares of Common Stock issued to franchisees during 1996 and
1997; and (vii) an increase in the Company's provision for doubtful accounts, as
discussed below. This increase was partially offset by a decrease in
administrative costs of approximately $1,300,000 related to the business of
Insight. The Company's provision for doubtful accounts, which is included in
general and administrative expenses, increased by approximately $270,000, or
29.1%, to $1,198,000 for the year ended December 31, 1997, as compared to
$928,000 for the same period in 1996, was due primarily to the reduction of the
residual value of franchisee notes pledged to Sanwa.
Interest expense increased by approximately $304,000, or 23.4%,
to $1,601,000 for the calendar year ended December 31, 1997, as compared
to $1,297,000 for the same period in 1996, substantially due to the
costs related to stock options granted as consideration of certain loans
made to the Company by certain of its principal shareholders.
Loss from the operation of franchised stores managed by the Company
decreased by $92,000, or 34.7%, to $(173,000) for the year ended December 31,
1997, as compared to a loss of $(265,000) for the comparable period in 1996.
The Company's loss before income taxes increased by $7,671,000, or 118.2%,
to a loss of $14,162,000 for the year ended December 31, 1997, as compared to a
loss of $6,491,000 for the same period in 1996. This increase was primarily due
to the following five factors: (i) a charge against earnings, in the approximate
amount of $5,916,000, the non-cash portion which was $5,436,000, as a result of
the Company's issuance and sale, in February, 1997, of its Convertible
Debentures due August 23, 1998, which charge is being credited to the Company's
paid-in-capital (See Note 14) over the period of time that the holders thereof
actually convert the Debentures into shares of the Company's Common Stock (See
Note 14); (ii) approximately $772,000 in lease termination costs related to the
closure of eleven Company-owned stores; (iii) the reduction in the net gains on
the conveyance of Company-owned store assets to franchisees; (iv) the increase
in general and administrative costs as discussed above; and (v) approximately
$564,000 in asset impairment costs. This increase was partially offset by the
decrease in selling expenses and the decrease in administrative costs related to
the business of Insight.
14
Liquidity and Capital Resources
The Company has incurred losses before income taxes and
extraordinary items aggregating approximately $37,625,000 over the three
year period ended December 31, 1998, and has a working capital
deficiency of $3,351,000 as of December 31, 1998.
For the year ended December 31, 1998, cash flows used in operating
activities were $4,120,000, as compared to cash flows used in operating
activities of $7,629,000 for the year ended December 31, 1997. Cash flows from
operating activities were relatively flat, as compared to the net loss of
$17,777,000 for the year ended December 31, 1998, as significant components of
the loss for the year represented non-cash charges.
For the year ended December 31, 1998, cash flows used in investing
activities were $3,138,000 comprised primarily of cash used in acquisitions and
purchases of property and equipment.
For the year ended December 31, 1998, cash flows provided by financing
activities were $3,868,000, comprised primarily of the proceeds from the
issuance of convertible debentures. The net impact of other financing activities
(proceeds from net of payments made under various debt arrangements) was not
significant.
The Company believes that, in the furtherance of its business strategies,
the Company's future capital requirements will include i) renovating and/or
remodeling of Company-owned stores, ii) acquiring retail optical stores, subject
to the availability of qualified opportunities and iii) continued upgrading of
management information systems within the retail chain. Additionally, the
Company is likely to continue to provide financing of sales of Company-owned
stores to franchisees, which is likely to defer the inflow of cash relating to
the sales of such assets.
The Company believes that it will improve cash flows during 1999 based on
the following factors, among others: i) closing certain under-performing
Company-owned stores, ii) improvement in store profitability through increased
monitoring of store by store operations and actual results as compared to
expected results, iii) expected increases in operations and cash flows of the
Company's Insight Laser and ambulatory center businesses, and iv) a reduction of
administrative overhead expenses, if necessary.
As of December 31, 1998, the Company was not in compliance with the
financial covenants of its loan agreement with STI although STI, on
April 13, 1999, (i) waived all such defaults through December 31, 1999; (ii)
agreed to the elimination of all prepayment penalties contained in the Loan
Agreement; and (iii) agreed to apply the balance of the Additional Funds
($500,000 plus accrued interest) to the balance of the loan, all in exchange for
the Company's payment, to STI, of a fee of $150,000, which fee was charged
against the Additional Funds to be credited to the balance of the loan. However,
there can be no assurance that the Company would be able to obtain such a waiver
in future periods, should such financial or other covenants not be met by the
Company.
The Company believes that, based on its current position and the
implementation of the plans described above, sufficient resources will be
available for the Company to continue in operations through the end of 1999.
However, there can be no assurance that the Company will be able to generate
positive cash flows and, if it does, that such cash flows will be sufficient to
adequately fund its ongoing operations and future plans. If the Company cannot
generate sufficient cash flows from operations, it may be required to seek
alternative debt and/or equity financing. However, there can be no assurance
that such debt and/or equity financing will be available to the Company when
necessary, or at terms that are attractive to the Company.
Year 2000
The Year 2000 issue is the result of potential problems with computer
systems and/or any equipment with computer chips that use dates, where the date
has been stored as just two digits (e.g., 98 for 1998). On January 1, 2000, any
clock or date recording mechanism (including date sensitive software) which uses
only two digits to represent the year, may recognize the year 1900 (when using
00 as the year) rather than the year 2000. This could result in a system failure
or miscalculations, causing disruption of operations, as such systems may be
unable to accurately process certain date-based information.
The Company has reviewed the Year 2000 issue with its management
information system's providers and consultants. The Company believes that the
Year 2000 issue will not have a material, adverse impact on the operations of
the Company, since its computer programs were written utilizing four digits to
define the applicable year. The Company, however, cannot determine, as of the
date hereof, the impact of the Year 2000 issue on any of its vendors and/or
franchisees, which might materially impact the operations of the Company.
Impact of Inflation and Changing Prices
Although the Company cannot accurately determine the precise effect of
inflation on its operations, it does not believe that inflation has had a
material effect on sales or results of operations.
Forward Looking Statements
All statements contained herein (other than historical facts) 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 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.
15
Item 8. Financial Statements and Supplementary Data
STERLING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED
DECEMBER 31, 1998 TOGETHER WITH
INDEPENDENT AUDITORS' REPORTS
TABLE OF CONTENTS
PAGE
----
INDEPENDENT AUDITORS' REPORTS 17, 18
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets as of December 31, 1998 and 1997 19
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996 20
Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1998, 1997 and 1996 21
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 22, 23
Notes to Consolidated Financial Statements 24
16
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Sterling Vision, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Sterling Vision,
Inc. (a New York corporation) and subsidiaries as of December 31, 1998, and the
related consolidataed statements of operations, shareholders' equity and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Sterling Vision, Inc. and
subsidiaries as of December 31, 1998, and the results of their operations and
their cash flows for the year then ended in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Melville, New York
April 13, 1999
17
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Sterling Vision, Inc. and Subsidiaries
East Meadow, New York
We have audited the accompanying consolidated balance sheets of Sterling Vision,
Inc. and Subsidiaries (the "Company") as of December 31, 1997 and the related
statements of operations, shareholders' equity, and cash flows for the two years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Sterling Vision, Inc. and
Subsidiaries as of December 31,1997 and the results of its operations and its
cash flows for the two years ended December 31, 1997, in conformity with
generally accepted accounting principles.
Deloitte and Touche LLP
New York, New York
March 27, 1998
18
STERLING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
December 31,
---------------------------
1998 1997
---------- ----------
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 828 $ 334
Franchise receivables, net of allowance for doubtful accounts of $2,060 and
$514, respectively 2,257 5,956
Other receivables 1,121 2,490
Current portion of notes receivable from franchisees 3,077 3,301
Inventories 2,268 3,310
Due from related parties 125 110
Prepaid expenses and other current assets 395 516
------- --------
Total current assets 10,071 16,017
Property and equipment, net 8,104 9,903
Franchise and other notes receivable - net of allowance for doubtful accounts
of $450 for 1998 and $562 for 1997 11,359 14,884
Goodwill/net 3,735 2,957
Restricted cash 624 550
Other assets 601 1,532
------- --------
34,494 45,843
======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current portion of long-term debt $ 4,130 $ 3,477
Accounts payable and accrued liabilities 7,099 6,126
Accrual for store closings 1,254 453
Convertible debentures - 1,652
Franchise deposits and other current liabilities 939 837
------- --------
Total current liabilities 13,422 12,545
Long-term debt 7,422 10,249
Deferred franchise income 90 96
Excess of fair value of assets acquired over cost 1,013 1,362
Lease termination costs - 320
Commitments and contingencies (Note 10)
Shareholders' equity:
Preferred stock, $.01 par value per share; authorized 5,000,000 shares;
35 shares issued and outstanding 4,025 -
Common stock, $.01 par value per share; authorized 28,000,000 shares;
14,920,351 and 13,927,227 issued and outstanding in 1998 and 1997, respectively 149 139
Additional paid-in capital 46,036 40,843
(Accumulated deficit) (37,663) (19,711)
------- --------
12,547 21,271
------- --------
$ 34,494 $ 45,843
======== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
19
STERLING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Data)
For the Year Ended December 31,
---------------------------------------------
1998 1997 1996
--------- -------- ---------
Revenues:
Net sales $ 23,163 $ 22,402 $ 27,496
Franchise royalties 9,135 9,550 7,616
Net gains and fees from the conveyance of Company-owned
assets to franchisees 564 1,462 1,963
Interest and other income 2,265 2,578 2,287
---------- ---------- ----------
Total revenues 35,127 35,992 39,362
---------- ---------- ----------
Costs and expenses:
Cost of sales 8,087 6,973 8,587
Selling expenses 15,981 16,296 18,961
General and administrative expenses 21,758 17,859 16,743
Loss from stores operated under management agreements 792 173 265
Provision for store closings 2,800 1,336 -
Amortization of debt discount 1,110 5,916 -
Interest expense 1,571 1,601 1,297
---------- ---------- ----------
Total costs and expenses 52,099 50,154 45,853
---------- ---------- ----------
Loss before benefit from income taxes and extraordinary item (16,972) (14,162) (6,491)
Benefit from income taxes - - (2,001)
---------- ---------- ----------
Loss before extraordinary item (16,972) (14,162) (4,490)
Extraordinary item - loss from early retirement of debt (805) - -
---------- ---------- ----------
Net loss $(17,777) $(14,162) $ (4,490)
========= ========= ==========
Net loss per common share - basic and diluted:
Loss from continuing operations $ (1.16) $ (1.02) $ (0.36)
Extraordinary item - loss from early retirement of debt (0.06) - -
---------- ---------- ----------
Net loss $ (1.22) $ (1.02) $ (0.36)
========= ========= ==========
Weighted average number of common shares outstanding - basic
and diluted 14,627 13,883 12,341
========= ========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
20
STERLING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Dollars in Thousands, Except Number of Shares)
Additional Total
Preferred Stock Common Stock Paid-In Shareholders'
Shares Amount Shares Amount Capital Deficit Equity
---------- ------ ------ -------- -------- -------- --------
Balance - December 31, 1995 -- $ -- 12,207,495 $ 122 $ 23,762 $ (1,059) $ 22,825
Issuance of 100,000 common
shares in an over-allotment
from the public offering
and 80,040 shares to
franchisees -- -- 180,040 2 1,220 -- 1,222
Net loss -- -- -- -- --
---------- ------ ---------- -------- -------- -------- --------
Balance - December 31, 1996 -- -- 12,387,535 124 24,982 (5,549) 19,557
Issuance of common
shares in exchange for debt -- -- 144,916 1 973 -- 974
Issuance of common shares
related to an acquisition -- -- 305,747 3 2,293 -- 2,296
Issuance of common shares
to franchisees -- -- 4,002 -- 30 -- 30
Issuance of shares upon
conversion of debentures -- -- 1,085,027 11 6,348 -- 6,359
Debt discount -- -- -- -- 5,436 -- 5,436
Non-employee stock options -- -- -- -- 781 -- 781
Net loss -- -- -- -- -- (14,162) (14,162)
---------- ------ ------ -------- -------- --------- --------
Balance - December 31, 1997 -- -- 13,927,227 139 40,843 (19,711) 21,271
Issuance of shares upon
conversion of 1997
Debentures -- -- 395,630 4 1,648 -- 1,652
Debt discount for the intrinsic
value of the 1998
Debentures and the fair
value of the 1998 Warrants -- -- -- -- 1,915 -- 1,915
Issuance of shares upon
conversion of Warrants -- -- 550,000 6 2,038 -- 2,044
Issuance of Senior
Convertible Preferred Stock 35 4,025 -- -- (525) -- 3,500
Reduction related to stock
price guarantees -- -- -- -- (285) -- (285)
Stock dividend on Senior
Convertible Preferred Stock -- -- 47,494 -- 175 (175) 0
Non-employee stock options 227 227
Net loss -- -- -- (17,777) (17,777)
---------- ------ ---------- -------- -------- -------- --------
Balance - December 31, 1998 35 $ 4,025 14,920,351 $ 149 $ 46,036 $(37,663) $ 12,547
========== ======== ========= ======== ======== ========= ========
The accompanying notes are an integral part of these
consolidated financial statements.
21
STERLING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
For the Year Ended
December 31,
1998 1997 1996
-------- -------- --------
Cash flows from operating activities:
Net loss $(17,777) $(14,162) $ (4,490)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 3,000 2,310 1,481
Allowance for doubtful accounts 6,500 1,198 928
Provision for store closings 2,800 772
Net gain from the conveyance
of Company-owned assets
to franchisees (564) (1,131) (1,610)
Deferred income taxes payable -- -- (2,082)
Accrued interest 72 84 121
Amortization of fair value of assets acquired over cost (349) (347) (231)
Stock options charged to expense 227 781 --
Amortization of debt discount 1,915 5,436 --
Changes in operating assets and liabilities:
Accounts receivable (549) (477) (4,541)
Inventories 1,042 368 1,168
Prepaid expenses and other current assets 127 375 (478)
Other assets 1,122 223 50
Accounts payable and accrued liabilities 536 (2,760) 778
Franchise deposits and other current liabilities 102 (387) 400
Deferred franchise income (6) (232) 328
Accrual for store closings and lease termination
costs (2,318) 320 --
-------- -------- --------
Net cash used in operating activities (4,120) (7,629) (8,178)
-------- -------- --------
Cash flows from investing activities:
Acquisition, net of cash acquired (1,598) -- (4,150)
Franchise notes receivable issued (2,001) (2,658) (3,901)
Reduction of franchise and other notes receivable 4,968 2,756 1,887
Purchases of property and equipment (791) (1,992) (5,607)
Conveyance of property and equipment 1,023 2,517 3,536
-------- -------- --------
Net cash provided by (used in) investing activities $ 1,601 $ 623 $ (8,235)
-------- -------- --------
(Continued on next page)
The accompanying notes are an integral part of these
consolidated financial statements.
22
STERLING VISION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Dollars in Thousands)
For the Year Ended
December 31,
1998 1997 1996
-------- -------- --------
Cash flows from financing activities:
Sale of common stock and other
capital contributions 1,759 -- 625
Borrowings under STI Loan Agreement -- 9,500 --
Repayment of borrowings under STI Loan Agreement (2,587) (1,380) --
Borrowings under Chase Credit Agreement -- 1,000 225
Borrowings under additional Loan Agreement 1,610
Repayment of borrowings under Chase Credit Agreement (1,000) (7,015) --
Repayments of other debt (269) (3,173) (2,984)
Issuance of convertible debentures 3,500 7,540 --
Other borrowings -- -- 3,922
-------- -------- --------
Net cash provided by financing activities 3,013 6,472 1,788
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 494 (534) (14,625)
Cash and cash equivalents - beginning of year 334 868 15,493
-------- -------- --------
Cash and cash equivalents - end of year 828 334 868
======== ======== ========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 1,351 $ 1,226 $ 1,232
======== ======== ========
Taxes $ 88 $ 57 $ 579
======== ======== ========
Non-cash investing and financing activities:
Franchise stores reacquired $ 1,480 $ -- $ --
Exchange of convertible debentures for Preferred Stock 4,025 -- --
Preferred Stock dividend paid in common shares 175 -- --
Acquisitions, net of cash acquired:
Working capital, other than cash $ (314) $ (231) $ 807
Property, plant and equipment 160 200 600
Excess of cost over net assets acquired 1,722 2,541 --
Excess of fair value of assets acquired over cost -- -- (1,940)
Other assets 30 -- --
Franchise notes -- -- 4,683
Common stock issued -- (2,510) --
-------- -------- --------
Acquisitions, net of cash acquired $ 1,598 $ -- $ 4,150
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
23
STERLING VISION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF BUSINESS RESULTS OF OPERATIONS AND MANAGEMENT'S PLANS
Business
The Company and its franchisees develop and operate retail optical stores
principally under one of the trade names "Sterling Optical," "IPCO Optical,"
"Site For Sore Eyes," "Benson Optical," "Southern Optical," "Superior Optical,"
"Nevada Optical," "Duling Optical," "Monfried Optical," "Kindly Optical" and
"Singer Specs." The Company is presently formulating plans to change the trade
name of most Sterling Stores (other than its Site for Sore Eyes stores located
in Northern California) to "Sterling Optical." The Company also operates Vision
Care 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 affiliates with health care providers (ophthalmologists)
in offering Photorefractive Keratectomy ("PRK"), a procedure performed with an
excimer laser for the correction of certain degrees of myopia
(near-sightedness). The Company's wholly-owned subsidiary, Insight Laser
Centers, Inc. ("Insight") and these ophthalmologists enter into agreements
whereby the ophthalmologists pay the Company a fee for each PRK procedure
performed using an excimer laser installed in their offices by Insight. As of
December 31, 1998, the Company held leases for 6 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 its
additional 5 excimer lasers in ophthalmological offices located in New York,
California, Pennsylvania, Delaware and New Jersey.
The Company also operates a full service ambulatory surgery center located
in Garden City, New York, which contains 4 surgical operating rooms.
Results of Operations and Management's Plans
The Company has incurred losses before income taxes aggregating $37,625
over the three year period ended December 31, 1998, and has a working capital
deficiency of $3,801 as of December 31, 1998.
The Company believes that, in the furtherance of its business strategies,
the Company's future capital requirements will include: i) renovating and/or
remodeling of Company-owned stores, ii) acquiring retail optical stores,
subject to the availability of qualified opportunities and iii) continued
upgrading of management information systems within the retail chain.
Additionally, the Company is likely to continue to provide financing of sales
of Company-owned stores to franchisees, which is likely to defer the inflow
of cash relating to the sale of such assets.
The Company believes that it will improve cash flows during 1999 based
on the following factors, among others: i) closing certain under-performing
Company-owned stores, ii) improvement in store profitability through increased
monitoring of store by store operations and actual results as compared to
expected results, iii) expected increases in operations and cash flows of the
Company's Insight Laser and ambulatory center businesses, and iv) a reduction
of administrative overhead expenses, if necessary.
The Company believes that, based on its current position and the
implementation of the plans described above, that sufficient resources will be
available for the Company to continue in operations through the end of 1999.
However, there can be no assurance that the Company will be able to generate
positive cash flows and, if it does, that such cash flows will be sufficient
to adequately fund its ongoing operations and future plans. If the Company
cannot generate sufficient cash flows from operations, it may be required to
seek alternative debt and/or equity financing. However, there can be no
assurance that such debt and/or equity financing will be available to the
Company when necessary, or at terms that are attractive to the Company.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of Sterling
Vision, Inc. and its Subsidiaries (collectively, the "Company"), all of which
are wholly-owned. All significant intercompany balances and transactions have
been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
24
Franchised Locations Operated by the Company under Management Agreements
In the fourth quarter of 1998, the Company, as required, adopted the
provisions of Emerging Issues Task Force Issue 97-2 ("EITF 97- 2"), "Application
of FASB Statement No. 94 and APB Opinion No. 16 to Physician Practice Management
Entities and Certain Other Entities with Contractual Management Arrangements."
In connection with the adoption of EITF 97-2, for the year ended December 31,
1998, the Company deconsolidated the results of operations of certain franchise
locations operated by the Company under management agreements. In accordance
with EITF 97-2, the results of operations for the years ended December 31, 1997,
and 1996 have been restated to conform to the provisions of EITF 97-2 applied to
the year ended December 31, 1998. Such restatement had the effect of reducing
net sales by approximately $2,047,000 and $981,000 and total expenses by
approximately $2,220,000 and $1,246,000 for the years ended December 31, 1997
and 1996, respectively. Such restatement had no impact on the net loss or net
loss per share for either period.
During 1998, the Company managed a total of 12 locations for franchisees
under the terms of management agreements. Such agreements generally provide for
the operations of the location to be run by the Company, with primarily all
operating decisions made by Company employees. The Company owns the inventory at
the locations and is generally responsible for the collection of all revenues,
and the payment of expenses. For the year ended December 31, 1998, such stores
generated revenue of approximately $4,503 and total expenses of $5,295.
The net result of such operations is classified as loss from stores operated
under management agreements in the accompanying consolidated statement of
operations.
Effective December 31, 1998, the Company acquired 6 stores previously
operated under management agreements from a franchisee for approximately
$1,480,000.
Revenue Recognition
Except in limited circumstances, the Company charges each franchisee a
nonrefundable initial franchise fee. This fee is used, in part, to defray
certain costs and expenses incurred by the Company in connection with its
franchising activities. Initial franchise fees are recognized at the time all
material services required to be provided by the Company have been substantially
performed. Continuing franchise royalty fees are based upon the gross revenues
of each location and are recorded as earned.
Interest earned on franchise notes receivable is recorded as earned and is
included in other income. Gains or losses from the conveyance of Company-owned
store assets to franchisees are recognized upon closing, net of applicable
reserves for collectibility.
Cash and Cash Equivalents
Cash and cash equivalents includes cash and any investments with
maturities of 90 days or less.
Fair Value of Financial Instruments
At December 31, 1998 and 1997, the carrying value of financial
instruments, such as cash and cash equivalents, accounts and notes receivable
and credit facilities, approximated their fair value, based on the short-term
maturities of these instruments.
Inventories
Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market value, and consist primarily of contact lenses,
ophthalmic lenses, eyeglass frames and sunglasses.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is provided on a
straight-line basis over the estimated useful lives of the respective classes of
assets.
Intangible Assets
Intangible assets is comprised of the goodwill resulting from the
acquisitions of Singer Specs and Insight, which are being amortized on a
straight line basis over their estimated useful lives of 10 and 20 years,
respectively. Accumulated amortization on goodwill was approximately $527 and
$585 at December 31, 1998 and 1997 respectively.
25
Summary of Significant Accounting Policies (continued)
Impairment of Long-Lived Assets
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting
for the Impairment of Long Lived Assets and for Long-Lived Assets to be Disposed
of", requires that long-lived assets and certain identifiable intangibles to be
held and used by an entity be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of the asset may not be
r