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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED FEBRUARY 1, 2003,
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO ______.
COMMISSION FILE NUMBER 1-12814
COLE NATIONAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 34-1453189
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
5915 LANDERBROOK DRIVE, MAYFIELD HEIGHTS, OHIO 44124
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (440) 449-4100
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL
REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER
PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS
BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS
YES |X| NO |_|.
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT
TO ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN AND WILL NOT BE
CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR
INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM
10-K OR ANY AMENDMENT TO THIS FORM 10-K. | |
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED
FILER (AS DEFINED IN RULE 12B-2 OF THE ACT). YES |X| NO |_|.
THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NONAFFILIATES
OF THE REGISTRANT AS OF AUGUST 3, 2002 WAS APPROXIMATELY $215,012,455,
BASED UPON THE LAST PRICE REPORTED FOR SUCH DATE BY THE NEW YORK STOCK
EXCHANGE.
AS OF MAY 12, 2003, 16,192,769 SHARES OF THE REGISTRANT'S COMMON
STOCK WERE OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE REGISTRANT'S PROXY STATEMENT FOR THE ANNUAL MEETING
OF STOCKHOLDERS TO BE HELD ON JUNE 25, 2003 ARE INCORPORATED HEREIN BY
REFERENCE INTO PART III.
TABLE OF CONTENTS
Part I Page
Item 1. Business ................................................................................. 1
2. Properties ............................................................................... 4
3. Legal Proceedings ....................................................................... 4
4. Submission of Matters to a Vote of Security Holders ...................................... 5
4a. Executive Officers of Cole National Corporation .......................................... 5
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .................... 6
6. Selected Financial Data .................................................................. 8
7. Management's Discussion and Analysis of Financial Condition and Results of Operations .... 10
7A. Quantitative and Qualitative Disclosures About Market Risk ............................... 24
8. Financial Statements and Supplementary Data .............................................. 25
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ..... 25
Part III
Item 10. Directors and Executive Officers of the Registrant ....................................... 25
11. Executive Compensation ................................................................... 26
12. Security Ownership of Certain Beneficial Owners and Management ........................... 26
13. Certain Relationships and Related Transactions ........................................... 26
14. Controls and Procedures .................................................................. 26
Part IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ......................... 27
Signatures ............................................................................... 28
Certifications ........................................................................... 29
Exhibit Index ............................................................................ X-1
FORWARD LOOKING STATEMENTS
The Company's expectations and beliefs concerning the future contained in
this document are forward looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
from those forecasted due to a variety of factors that can adversely affect the
Company's operating results, liquidity and financial condition such as risks
associated with potential adverse consequences of the restatement of the
Company's financial statements, including those resulting from litigation or
government investigations, restrictions or curtailment of the Company's credit
facility and other credit situations, costs and other effects associated with
the California litigation, the timing and achievement of improvements in the
operations of the optical business, the results of Things Remembered, which is
highly dependent on the fourth quarter holiday season, the nature and extent of
disruptions of the economy from terrorist activities or major health concerns
and from governmental and consumer responses to such situations, the actual
utilization of Cole Managed Vision funded eyewear programs, the success of new
store openings and the rate at which new stores achieve profitability, the
Company's ability to select, stock and price merchandise attractive to
customers, success of systems development and integration, competition in the
optical industry, integration of acquired businesses, economic and weather
factors affecting consumer spending, operating factors affecting customer
satisfaction, including manufacturing quality of optical and engraved goods, the
Company's relationships with host stores and franchisees, the mix of goods sold,
pricing and other competitive factors, and the seasonality of the Company's
business.
PART I
ITEM 1. BUSINESS
GENERAL
Cole National Corporation was incorporated as a Delaware corporation in
1984 as a successor to companies that began operations approximately 60 years
ago. Cole National Corporation, primarily through the subsidiaries owned by its
direct subsidiary, Cole National Group, Inc., is a leading provider of vision
care products and services, including managed vision care programs, and
personalized gifts with 2,944 retail locations in 50 states, Canada and the
Caribbean. References herein to the "Company" include Cole National Corporation,
its direct and indirect subsidiaries, and its predecessor companies. The
Company's retail vision locations do business primarily under the names "Pearle
Vision", "Sears Optical", "Target Optical" and "BJ's Optical" and its managed
vision care programs are offered primarily through Cole Managed Vision.
Collectively these businesses are referred to herein as "Cole Vision."
Personalized gifts are offered through retail locations, e-commerce and catalogs
by Things Remembered. The Company believes that, based on industry data, it is
the third largest retail optical company in the United States and operates the
only nationwide chain of personalized gift stores. The Company differentiates
itself from other specialty retailers by providing value-added services at the
point of sale at all of its retail locations. The Company also holds
approximately a 21% interest in Pearle Europe B.V., which operates 1,157 retail
optical locations in the Netherlands, Belgium, Germany, Austria, Italy, Poland,
Portugal, Estonia, Sweden, Finland and Russia.
The Company makes its annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and any amendments to those reports
available, free of charge, through its website, http://www.colenational.com, as
soon as reasonably practicable after such material is electronically filed with,
or furnished to, the Securities and Exchange Commission.
COLE VISION
Cole Vision contributed 76% of the Company's net revenue in fiscal 2002
with 2,174 company-owned and franchised retail locations throughout the United
States, Canada, and the Caribbean as of February 1, 2003. Cole Managed Vision
programs provide vision care benefits to participants through access to a
network of company-owned, franchised and third-party optical locations.
COLE LICENSED BRANDS
Cole Licensed Brands operates principally under the "Sears Optical",
"Target Optical" and "BJ's Optical" names. As of February 1, 2003, Cole Licensed
Brands operated 1,310 retail locations in 47 states and Canada, including 826
departments on the premises of Sears department stores, 117 freestanding Sears
Optical stores, 126 departments in BJ's Wholesale Club stores, and 241
departments in Target stores. Retail locations are generally operated under a
lease or license arrangement through which the host store collects the sales
receipts, retains an agreed upon percentage of sales and remits the remainder on
a weekly or monthly basis.
1
Locations are, in most cases, retail eyecare stores offering brand name
and private label prescription eyeglasses, contact lenses and accessories, which
make available services of a doctor of optometry who performs complete eye
examinations and prescribes eyeglasses and contact lenses. Most optical
departments, which are typically 1,000 square feet in size, operate with a
department manager and support staff of one to seven associates depending on
store sales volume. In a majority of the stores, eye examination services are
available from independent doctors of optometry, as is often required by state
law, and from doctors of optometry employed by Cole Licensed Brands.
Each of the United States retail locations is computer-linked to six
centralized laboratory facilities, which grind, cut and fit lenses to order and
ship them to the stores. The Canadian retail locations are served by a
centralized laboratory located near Toronto. Next-day delivery is provided on
most eyewear when requested by customers. All of the frames and most lenses used
in eyeglasses are purchased from outside suppliers, both in the United States
and several foreign countries.
A variety of marketing and promotional efforts, primarily host
advertising, newspaper, direct mail, magazine, television and yellow pages are
used to build and maintain the customer base for each of the Cole Licensed
Brands stores. Host advertising includes the placement of promotional material
within sales circulars or credit card billings sent out by the host store to its
customers.
The Company believes it has developed excellent relationships with the
host stores in which Cole Licensed Brands operates. The Company has maintained
its relationships in the optical business with Sears for over 40 years. Although
leases and licenses with major hosts are terminable upon relatively short
notice, Cole Licensed Brands has never had a lease terminated other than in
connection with a store closing, relocation or major remodeling.
PEARLE
Pearle Vision (Pearle) operates 400 company-owned and 464 franchised
stores located in 45 states, Canada, and the Caribbean. Most Pearle stores
operate in either an "Express" or "Mainline" store format. Express stores
contain a full surfacing lab that can produce most glasses in approximately one
hour. Mainline stores can produce over 50% of prescriptions on-site in
approximately one hour. Other prescriptions are sent to Pearle's central
laboratory in Dallas, Texas. At February 1, 2003, 274 of the company-owned
stores and 135 of the franchised stores were Express, with most of the balance
being Mainline.
The Express stores typically are located in high-traffic freestanding
strip centers or mall locations with most stores averaging 3,000 square feet.
The Express stores are usually staffed with a manager and a support staff of
four to eight associates. Mainline stores have an average size of 1,700 square
feet and are also located in freestanding buildings, or in smaller strip or
regional centers. Mainline stores are usually staffed with a manager and two or
three associates. Most Pearle stores make exams available by on-site doctors of
optometry with approximately 80% leasing space from Pearle on an independent
basis. Most of the remaining doctors are direct employees of Pearle. In
California, eye exams are provided by doctors of optometry, employed by Pearle
Vision Care, Inc., a licensed health care service plan.
Pearle's marketing strategy employs a wide range of media at both the
national and local levels. The franchised and company-owned stores each
contribute a percentage of revenues to Pearle's marketing budget with a
significant amount of Pearle's marketing expenditures devoted to television.
Pearle's brand positioning of high quality eyecare products and services has
been reinforced by an advertising and promotions program, which includes
Pearle's long-standing advertising slogan: "Nobody Cares for Eyes More Than
Pearle".
Pearle operates a central lab and distribution center in Dallas, Texas
that inventories and distributes a comprehensive product line, including frames,
eyeglass lenses, contact lenses, optical supplies and eyewear accessories, to
company-owned and franchised locations.
Pearle has maintained a franchise program since 1980. Most of the
franchised stores are single store franchise operations, with no franchisee
operating more than ten stores. Each franchisee must enter into a franchise
agreement requiring payment of an initial franchise fee. The term of the typical
franchise agreement is equal to the lesser of ten years or the term of the
underlying base lease. Royalty and advertising contributions typically have been
based on a percentage of the franchisee's gross revenues from the retail
operation, excluding nonsurgical professional fees. The total monthly
advertising contribution is distributed to Pearle's system-wide advertising fund
and the local co-op market advertising fund. Franchisees are generally eligible
to participate in Cole Vision's managed vision care programs. In fiscal 2002, 17
new franchise locations were opened, 13 company-operated locations were sold to
franchisees, 2 franchise locations were converted to corporate stores and 4
franchise locations closed.
2
COLE MANAGED VISION
Recognizing the role that managed health care would play in the coming
years, Cole Vision Corporation created Cole Managed Vision (CMV) to bring its
own unique capabilities to the vision benefit marketplace, and to provide an
additional source of customers for the Company's owned and franchised retail
locations. Since then, CMV has been developing, marketing, and administering
group vision benefit programs for employers, health plans and associations
nationwide. Today, CMV manages funded benefits for more than 13 million
participants, and discount benefits for more than 80 million participants.
Managed vision care participants comprise approximately one third of Cole
Vision's retail customers.
THINGS REMEMBERED
Things Remembered contributed 24% of the Company's net revenue in fiscal
2002. As of February 1, 2003, Things Remembered operated 770 stores and kiosks
located in large, enclosed shopping malls located in 48 states. Each location
carries a wide assortment of engraveable items and provides "while you shop"
personalization services for any occasion including holiday, wedding, business
recognition and other special occasion gift events. Engraving is offered for
items purchased at the store as well as for items purchased elsewhere. Customers
can purchase Things Remembered's broad gift assortment through its catalogs
(1-800-274-7367) and its e-commerce site, http://www.thingsremembered.com.
Merchandise sold at Things Remembered stores and through the catalog and
internet consists of a broad selection of moderately priced gift categories and
items at prices generally ranging from $15 to $150. The gift offerings include
writing instruments, desk accessories such as desk sets, recognition plaques and
awards; women's gifts which include sterling jewelry, jewelry boxes, and
keepsake boxes; men's gifts which include barware, valet boxes, and leather
goods; gifts for newborns and children including baby cups, rattles and jewelry
as well as apparel and quilts. Gifts for the home include glassware, clocks,
frames, albums, doorknockers and a special assortment of holiday gifts such as
ornaments and other collectible items. Things Remembered features brand name
merchandise as well as higher margin private label merchandise. At some
locations computer-controlled embroidery equipment is utilized for the
personalization of merchandise, such as throws, pillows, polo shirts, bathrobes,
jackets, canvas totes and baby blankets. These soft goods are also available in
most of Things Remembered's other locations with personalization services
provided from a central fulfillment facility.
At February 1, 2003, Things Remembered locations consisted of 472 stores
and 298 kiosks. The typical store consists of about 1,300 square feet, while
kiosks, which are units generally located in the center of the common mall area,
are typically 200 square feet.
Things Remembered locations are usually operated by one or two employees
during nonpeak periods and up to 15 employees during the peak fourth quarter
holiday season. Locations typically employ a store manager on a full-time basis,
an assistant store manager on a full-time or part-time basis, and the balance of
employees as part-time sales associates.
Nearly all locations are equipped with computerized engravers and key
duplicating machines. Most stores also have equipment for etching glassware
items. All locations are equipped with point-of-sale terminals.
Most of the Things Remembered's store merchandise is shipped through its
centralized warehouse and distribution facility located near Youngstown, Ohio.
The warehouse utilizes a computerized carousel system to automate the process of
locating merchandise needed to fulfill store orders. The warehouse also has
systems and support capabilities to fulfill e-commerce and catalog orders within
72 hours.
PURCHASING
The merchandise, supplies and component parts required for the various
products sold by the Company are purchased from a large number of suppliers and
manufacturers and are generally readily available. In most cases, such purchases
are not made under long-term contracts. The Company believes that the loss of
any one supplier or manufacturer would not have a material adverse effect on its
operations.
COMPETITION
The Company operates in highly competitive businesses. Cole Vision
competes with other optical companies, private ophthalmologists, optometrists
and opticians and HMOs and other managed vision care companies in a highly
fragmented marketplace on the basis of the services it provides, as well as
price and product quality. In addition, Pearle competes on the basis of its
highly recognized brand name, superior customer service and large merchandise
assortment. The Company believes that, based on industry data, Cole Vision is
the third largest optical retail company in the United States. Although Things
Remembered
3
operates the only nationwide chain of gift stores offering "while you shop" gift
engraving, key duplicating, glass etching and monogramming, as well as related
merchandise, it competes with many other retailers that sell gift items. Things
Remembered competes with such other retailers primarily on the basis of the
value-added point of sale services, as well as price and product quality. Some
competitors have greater financial resources than the Company.
EMPLOYEES
As of February 1, 2003, the Company and its subsidiaries had approximately
9,418 full-time employees. This full-time work force is supplemented by 6,098
part-time and seasonal employees. Approximately 134 Pearle employees are
represented by labor unions. The Company considers its present labor relations
to be satisfactory.
SEGMENT INFORMATION
Information for the Company's two reportable segments and geographical
information are contained in Note 11 of the Notes to Consolidated Financial
Statements.
ITEM 2. PROPERTIES
In June 2001, the Company completed a third party sale and leaseback of
its office headquarters located in Twinsburg, Ohio, which comprises
approximately 175,000 square feet of office space. The lease expires in 2019 and
includes two options to renew for ten-year terms. Cole Vision's home office
functions are located in this facility. The Company expects to fully relocate
its executive offices, which are currently located in leased space in Mayfield
Heights, Ohio, to the Twinsburg facility during 2003.
All Cole Licensed Brands retail locations are leased or operated under a
license with the host store, and none of the individual retail locations are
material to operations. Leases for departments operated in Sears and Target
stores are terminable upon relatively short notice. Freestanding stores operated
under the name "Sears Optical" are leased for terms which average five years.
The leases for departments operated in BJ's Wholesale Club stores expire in
April 2006.
Cole Licensed Brands leases six optical laboratory facilities, located in
Columbus, Ohio; Knoxville, Tennessee (two); Memphis, Tennessee; Salt Lake City,
Utah; and Richmond, Virginia, pursuant to leases expiring (including renewal
options) between 2005 and 2017.
Pearle leases most of its retail stores under noncancelable operating
leases with terms generally ranging from five to ten years and which generally
contain renewal options for additional periods. Pearle is the principal lessee
on a majority of stores operated by franchisees who sublease the facilities from
Pearle.
In January 2002, Pearle completed a sale and leaseback of its Dallas,
Texas Support Center, which comprises approximately 129,000 square feet of
laboratory and distribution facilities. The lease expires in 2017 and includes
four options to renew for five-year terms. An adjoining office facility, no
longer used for operations, was sold in April 2001. Pearle also owns a small
headquarters and a laboratory facility in Puerto Rico.
Cole Vision also leases a home office, an optical laboratory and a
distribution facility for its Canadian operations pursuant to leases expiring in
2004. The Company expects to close its Canadian optical laboratory and
distribution facility in June 2003, and move those operations to the United
States.
Leases for Things Remembered stores and kiosks are generally for terms of
ten and five years, respectively. Things Remembered's home office functions are
located in a 50,000 square foot leased facility in Highland Heights, Ohio. The
lease expires (including renewal options) in 2007. Things Remembered leases its
210,000 square foot warehouse and distribution facility located near Youngstown,
Ohio. The lease expires in 2013 and includes three options to renew for
five-year terms.
ITEM 3. LEGAL PROCEEDINGS
From time to time during the ordinary course of business, the Company may
be threatened with, or may become a party to, a variety of legal actions and
other proceedings incidental to its business.
A complaint was filed in the Superior Court of California, county of San
Diego against Cole National Corporation, its affiliates and certain of its
officers by the Attorney General of the State of California on February 14, 2002
and amended on February 22, 2002. The case, State of California v. Cole National
Corporation, et al., alleges claims for various statutory violations related to
the operation of 24 Pearle Vision Centers in California. The claims include
untrue or misleading
4
advertising, illegal dilation fees, unlawful advertising of eye exams,
maintaining an optometrist on or near the premises of a registered dispensing
optician, unlawful advertising of an optometrist, unlicensed practice of
optometry, and illegal relationships between dispensing opticians, optical
retailers and optometrists. The action seeks unspecified damages, restitution
and injunctive relief. Although the State of California obtained a preliminary
injunction to enjoin certain advertising practices and the charging of dilation
fees in July 2002, the terms of the injunction have not had and are not expected
to have a material effect on the Company's operations. In addition, both the
State and the Company have appealed the preliminary injunction. Although we
believe we are in compliance with California law and intend to continue to
defend the issues raised in the case vigorously, the case is in its early stages
and we cannot predict with certainty its outcome or costs.
A class action complaint was filed on August 14, 2002 in the Superior
Court of San Francisco, California, against Things Remembered by a purported
class of approximately 200 employees of Things Remembered alleging that the
members of the putative class were improperly denied overtime compensation in
violation of California law. The action sought unspecified damages, interest,
restitution, as well as declaratory and injunctive relief and attorneys' fees.
On February 3, 2003, Things Remembered and the plaintiffs reached an agreement
to resolve the lawsuit for $562,500. The settlement is subject to court
approval.
A class action complaint was filed on December 6, 2002 in the United
States District Court for the Northern District of Ohio against the Company and
certain present and former officers and directors by a purported class of
shareholders of the Company, alleging claims for various violations of federal
securities laws related to the Company's publicly reported revenues and
earnings. The action, which proposes a class period of March 23, 1999 through
November 26, 2002 and names the Company and certain present and former officers
and directors, seeks unspecified compensatory damages, punitive damages "where
appropriate", costs, expenses and attorneys fees. Following the announcement in
November 2002 of the restatement of the Company's financial statements, the
Securities and Exchange Commission began an inquiry into the Company's previous
accounting.
Cole National Group, Inc. has been named as a defendant, along with
numerous other retail companies, in patent infringement litigation in the United
States District Court for the District of Arizona, known as Lemelson Medical,
Education & Research Foundation, Limited Partnerships v. CompUSA, Inc. et. al.,
No. Civ. 00-0663, which challenges the defendants' use of bar code technology in
their retail operations. Cole National Group, Inc. is participating in a common
defense with a number of other defendants. A stay of the proceedings has been
sought and was granted, in deference to prior pending declaratory judgment suits
brought by the manufacturers and suppliers of the implicated technology seeking
to declare the patents in suit not infringed, invalid and unenforceable. Cole
National Group, Inc. likewise intends to oppose the allegations and claims
against it.
See Note 15 of Notes to Consolidated Financial Statements for further
discussion of these legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders through the
solicitation of proxies or otherwise during the fourth quarter of the fiscal
year ended February 1, 2003.
ITEM 4A. EXECUTIVE OFFICERS OF COLE NATIONAL CORPORATION
(a) The following persons are the executive officers of Cole National
Corporation who are not members of its Board of Directors, who have been
elected to their respective offices by the Board of Directors to serve
until the election and qualification of their respective successors:
Name Age Office
----------------- --- -------------------------------------------
Lawrence E. Hyatt 48 Executive Vice President and
Chief Financial Officer
Leslie D. Dunn 58 Senior Vice President -
Business Development,
General Counsel and Secretary
Joseph Gaglioti 57 Vice President and Treasurer
Ann M. Holt 46 Senior Vice President, Corporate Controller
and Principal Accounting Officer
5
(b) The following is a brief account of the positions held during the
past five years by each of the above named executive officers:
Mr. Hyatt has been Executive Vice President and Chief Financial
Officer since July 15, 2002. Prior to joining the Company, he was with
PSINet, Inc. as Chief Financial and Restructuring Officer since 2000; with
HMS Host Corporation as Chief Financial Officer since 1999; with Sodexho
Marriott Services, Inc. and its predecessor company as Chief Financial
Officer since 1989.
Ms. Dunn has been Senior Vice President-Business Development,
General Counsel and Secretary since September 1997. Prior to joining the
Company, she had been a partner in the law firm of Jones Day Reavis &
Pogue since 1985.
Mr. Gaglioti has been Vice President since 1992 and Treasurer since
1991. Mr. Gaglioti joined the Company in 1981.
Ms. Holt has been Senior Vice President, Corporate Controller and
Principal Accounting Officer since December 2002. She joined Cole National
Corporation as the Vice President, Finance for Cole Licensed Brands in
June 2000. Prior to joining the Company, she was with ICI Paints as Vice
President, Finance in the U.S. stores division since September 1998, and
with OfficeMax, Inc. as Vice President, Controller and other financial
management positions between 1990 and May 1998.
Information concerning Jeffrey A. Cole and Larry Pollock, the
Company's executive officers who are also Directors, will be included in
Cole National Corporation's Proxy Statement for the 2003 Annual Meeting of
Stockholders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Cole National Corporation's common stock is traded on the New York Stock
Exchange (NYSE) under the symbol "CNJ". The following table sets forth, for the
fiscal periods indicated, the high and low sales prices per share.
Fiscal 2002 Fiscal 2001
------------------------ -------------------------
Quarter High Low High Low
- ------- ----- ------ ------ ------
First $19.65 $13.55 $10.40 $7.20
Second 19.03 12.45 15.22 9.65
Third 16.87 7.75 14.90 10.70
Fourth 13.99 9.54 16.55 12.78
The Company's dividend policy has been, and for the foreseeable future
will continue to be, to retain earnings to support its growth strategy. No
dividends were paid during the last two fiscal years.
As of March 31, 2003, there were 628 shareholders of record of Cole
National Corporation's common stock.
6
Securities authorized for issuance under equity compensation plans as of
February 1, 2003 follows:
Equity Compensation Plan Information Number of securities
remaining available
Plan category Number of securities Weighted-average for future issuance
to be issued upon exercise price of under equity
exercise of outstanding options, compensations plans
outstanding options warrants and rights (excluding securities
warrants and rights reflected in column (a))
(a) (b) (c)
-------------------- -------------------- ----------------------
Equity compensation plans approved by
security holders 1,231,606 $ 15.51 809,394
Equity compensation plans not approved by
security holders 1,520,928 12.09 62,191
--------- -------
Total 2,752,534 $ 13.61 871,585
========= =======
7
ITEM 6. SELECTED FINANCIAL DATA
Fiscal years end on the Saturday closest to January 31 and are identified
according to the calendar year in which they begin. For example, the fiscal year
ended February 1, 2003 is referred to as "fiscal 2002". Fiscal 2002, 2001, 1999
and 1998 each consisted of a 52-week period, and fiscal 2000 consisted of a
53-week period.
The selected financial data for the 2002, 2001 and 2000 fiscal years have
been derived from the Company's audited financial statements appearing in this
Form 10-K. The financial statements for the fiscal years 2001 and 2000 have been
restated. See Note 17 of the Notes to Consolidated Financial Statements for
further discussion of the restatement. The selected financial data for the 1999
and 1998 fiscal years have been derived from unaudited financial statements. The
unaudited financial statements for these years have been restated to be
consistent with the restatement adjustments made for the subsequent years.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
When you read this financial data, it is important that you also read the
consolidated financial statements and related notes included in this Form 10-K,
as well as the section of this report entitled Management's Discussion and
Analysis of Financial Condition and Results of Operations. Historical results
are not necessarily indicative of future results.
2002(1)(3) 2001(4) 2000(4) 1999(4) 1998(4)
----------- ----------- ----------- ----------- -----------
(Dollars in thousands, except per share amounts)
Net revenue $ 1,148,119 $ 1,109,123 $ 1,078,634 $ 1,041,188 $ 1,043,125
Operating income $ 26,997 $ 28,243 $ 16,400 $ 23,800 $ 24,956
Income (loss) before extraordinary loss $ 2,093 $ (2,387) $ (7,810) $ (2,110) $ (4,042)
Net income (loss) $ (5,149) $ (2,387) $ (7,810) $ (2,110) $ (4,042)
Basic earnings (loss) per common share:
Income (loss) before extraordinary loss $ 0.13 $ (0.15) $ (0.50) $ (0.14) $ (0.27)
Extraordinary loss (0.45) -- -- -- --
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (0.32) $ (0.15) $ (0.50) $ (0.14) $ (0.27)
=========== =========== =========== =========== ===========
Diluted earnings (loss) per common share:
Income (loss) before extraordinary loss $ 0.13 $ (0.15) $ (0.50) $ (0.14) $ (0.27)
Extraordinary loss (0.44) -- -- -- --
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (0.31) $ (0.15) $ (0.50) $ (0.14) $ (0.27)
=========== =========== =========== =========== ===========
Weighted average number of shares
outstanding (000's)
Basic 16,223 16,019 15,564 14,879 14,802
Diluted 16,500 16,019 15,564 14,879 14,802
Total assets $ 643,607 $ 635,594 $ 633,756 $ 626,054 $ 649,447
Working capital $ 66,509 $ 74,563 $ 50,887 $ 56,436 $ 79,246
Stockholders' equity $ 93,253 $ 108,316 $ 108,542 $ 117,443 $ 119,226
Current ratio 1.32 1.36 1.24 1.29 1.38
Long-term debt, including
capital leases $ 286,553 $ 284,574 $ 284,535 $ 284,754 $ 276,130
Number of stores at year end(2) 2,944 2,919 2,813 2,722 2,884
(1) Net income (loss) for fiscal 2002 includes an extraordinary loss of
$7,242, net of tax for early extinguishment of debt.
(2) Includes franchise locations.
(3) The Company ceased amortization of goodwill and tradenames in fiscal 2002
upon adoption of SFAS No. 142, "Goodwill and Other Intangible Assets".
(4) As restated.
8
The following selected financial data for the 1999 and 1998 fiscal years
is derived from unaudited financial statements, and compares originally reported
amounts with restated amounts for these two years.
1999 1998
---------------------------- ---------------------------
As reported Restated As reported Restated
----------- ----------- ----------- -----------
(Dollars in thousands, except per share)
Net revenue $1,040,426 $ 1,041,188 $1,049,441 $ 1,043,125
Operating income $ 29,113 $ 23,800 $ 42,346 $ 24,956
Net income (loss) $ 2,008 $ (2,110) $ 14,276 $ (4,042)
Basic earnings (loss) per common share:
Income (loss) before extraordinary loss $ 0.13 $ (0.14) $ 0.96 $ (0.27)
Extraordinary loss -- -- -- --
---------- ----------- ---------- -----------
Net income (loss) $ 0.13 $ (0.14) $ 0.96 $ (0.27)
========== =========== ========== ===========
Diluted earnings (loss) per common share:
Income (loss) before extraordinary loss $ 0.13 $ (0.14) $ 0.94 $ (0.27)
Extraordinary loss -- -- -- --
---------- ----------- ---------- -----------
Net income (loss) $ 0.13 $ (0.14) $ 0.94 $ (0.27)
========== =========== ========== ===========
Weighted average number of shares
outstanding (000's)
Basic 14,887 14,879 14,802 14,802
Diluted 14,941 14,879 15,176 14,802
Total assets $ 588,271 $ 626,054 $ 622,844 $ 649,447
Working capital $ 63,899 $ 56,436 $ 76,732 $ 79,246
Stockholders' equity $ 146,516 $ 117,443 $ 145,360 $ 119,226
Current ratio 1.45 1.29 1.44 1.38
Long-term debt, including
capital leases $ 284,584 $ 284,754 $ 276,013 $ 276,130
Number of stores at year end(1) 2,722 2,722 2,884 2,884
(1) Includes franchise locations.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
As discussed in Note 17 to the Notes to Consolidated Financial Statements,
the Company's fiscal year 2001 and fiscal 2000 financial statements have been
restated. See Note 17 for a summary of the significant effects of the
restatement. The following discussion of the Company's financial condition and
results of operations gives effect to the restatement and should be read in
conjunction with the Consolidated Financial Statements and related notes.
OVERVIEW
Cole National, primarily through the subsidiaries owned by its direct
subsidiary, Cole National Group, Inc., is a leading provider of optical products
and services and personalized gifts. The Company sells its products and services
through 2,480 company-owned retail locations and 464 franchised locations in 50
states, Canada and the Caribbean.
Fiscal years end on the Saturday closest to January 31 and are identified
according to the calendar year in which they begin. For example, the fiscal year
ended February 1, 2003 is referred to as "fiscal 2002". Fiscal 2002 and fiscal
2001 each consisted of a 52-week period, and fiscal 2000 consisted of a 53-week
period.
The Company has two reportable segments, Cole Vision and Things
Remembered. Most of Cole Vision's revenue represents sales of prescription
eyewear, accessories and services through its Cole Licensed Brands and Pearle
Vision retail locations. Cole Vision revenue also includes sales of merchandise
to franchisees, royalties based on franchise sales, initial franchise fees for
Pearle Vision and capitation revenue, administrative service fee revenue and
discount program service fees from its Cole Managed Vision business.
Things Remembered's revenue represents sales of engraveable gift
merchandise, personalization and other services primarily through retail in-line
stores and kiosks. Things Remembered revenue also includes direct sales through
its e-commerce site, http://www.ThingsRemembered.com, sales through Things
Remembered catalogs and through affiliate programs direct to businesses.
10
RESULTS OF OPERATIONS
The following schedule sets forth the results from continuing operations
for the fiscal years ended February 1, 2003, February 2, 2002 and February 3,
2001. This schedule and subsequent discussions should be read in conjunction
with the consolidated financial statements and notes thereto included in Item 8
of this Form 10-K.
Change
Fiscal Year ----------------------
------------------------------------ 2002 vs. 2001 vs.
2002 2001 2000 2001 2000
-------- -------- -------- -------- --------
(Dollars in millions)
Net revenue:
Cole Vision $ 877.5 $ 836.8 $ 802.5 4.9% 4.3%
Things Remembered 270.6 272.3 276.1 (0.6) (1.4)
-------- -------- --------
Total net revenue $1,148.1 $1,109.1 $1,078.6 3.5% 2.8%
Gross margin:
Cole Vision $ 576.8 $ 550.9 $ 525.2 4.7% 4.9%
Things Remembered 192.6 193.8 193.8 (0.6) --
-------- -------- --------
Total gross margin $ 769.4 $ 744.7 $ 719.0 3.3% 3.6%
Operating expenses:
Cole Vision $ 546.2 $ 531.7 $ 513.0 2.7% 3.6%
Things Remembered 177.5 168.8 170.3 5.2 (0.9)
Unallocated corporate expense 18.7 11.0 14.1 70.0 (22.0)
-------- -------- --------
Total operating expenses $ 742.4 $ 711.5 $ 697.4 4.3% 2.0%
Goodwill and tradename amortization:
Cole Vision $ -- $ 4.1 $ 4.2 (100.0)% (2.4)%
Things Remembered -- 0.9 1.0 (100.0) (10.0)
-------- -------- --------
Total goodwill and tradename amortization $ -- $ 5.0 $ 5.2 (100.0)% (3.8)%
Operating income:
Cole Vision $ 30.6 $ 15.1 $ 8.0 102.6% 88.7%
Things Remembered 15.1 24.1 22.5 (37.3) 7.1
Unallocated corporate expense (18.7) (11.0) (14.1) 70.0 (22.0)
-------- -------- --------
Total operating income $ 27.0 $ 28.2 $ 16.4 (4.3)% 72.0%
======== ======== ========
Percentage of net revenue:
Gross margin 67.0% 67.1% 66.7% (0.1) 0.5
Operating expenses 64.7 64.2 64.7 0.5 (0.5)
Goodwill and tradename amortization -- 0.5 0.5 (0.5) --
Operating income 2.4% 2.5% 1.5% (0.2) 1.0
Number of retail locations at the end
of the period:
Cole Licensed Brands 1,310 1,282 1,164
Pearle company-owned 400 423 439
Pearle franchised 464 440 426
-------- -------- --------
Total Cole Vision 2,174 2,145 2,029
Things Remembered 770 774 784
-------- -------- --------
Total Cole National 2,944 2,919 2,813
======== ======== ========
Same-Store Sales Growth:
Cole Licensed Brands (U.S.) 3.7% 3.8% 3.7%
Pearle company-owned (U.S.) 4.0 2.6 2.0
Total Cole Vision 3.3 2.6 3.1
Things Remembered (2.5) (1.8) 5.4
Total Cole National 1.8% 1.4% 3.7%
Pearle US franchise stores 1.1% --% 3.3%
As used in Item 7 of this Form 10-K, same-store sales growth is a non-GAAP
financial measure, which includes deferred warranty sales on a cash basis and
does not reflect provisions for returns and remakes and certain other items. The
Company's current systems do not gather data on these items on an individual
store basis. Adjustments to the cash basis sales information accumulated at the
store level are made for these items on an aggregate basis. As a retailer, the
11
Company believes that a measure of same-store sales performance is important for
understanding its operations. The Company calculates same-store sales for stores
opened for at least twelve months. A reconciliation of same-store sales to net
revenue is presented below in the section "Reconciliation of Same-Store Sales
Growth".
Same-store sales for Pearle U.S. franchise stores is a non-GAAP financial
measure that is provided for comparative purposes only. The Company believes
that its franchisees' method of reporting sales is consistent on a year-to-year
basis.
FISCAL 2002 COMPARED TO FISCAL 2001
CONSOLIDATED OPERATIONS
Total revenues were $1,148.1 million in fiscal 2002, compared with
$1,109.1 million in fiscal 2001. Total revenues increased 3.5% in fiscal 2002,
primarily attributable to a 1.8% increase in same-store sales, an increase in
the number of stores open at year-end from 2,919 to 2,944 and an increase in
revenues from managed vision care programs.
Gross margin was $769.4 million in fiscal 2002, compared with $744.7
million in fiscal 2001, an increase of 3.3%. Gross margin dollars increased
primarily due to higher revenues at Cole Vision. Gross margin percent declined
to 67.0% in fiscal 2002, compared with 67.1% in fiscal 2001. The decline was
attributable to lower gross margin percent at Cole Vision. A shift in sales mix
to products with lower gross margin rates occurred at both Pearle Vision and
Cole Licensed Brands (further discussion is included in the Cole Vision
Segment). The gross margin rate at Things Remembered was the same as the prior
year.
Operating expenses were $742.4 million in fiscal 2002, compared with
$711.5 million in fiscal 2001, an increase of 4.3%. Increased costs of store
payroll, benefits, store occupancy and other store costs to support the increase
in revenues at Cole Vision comprised most of the increase. Operating expenses at
Cole Vision as a percent of sales declined from the prior year by 1.3%. At
Things Remembered, operating expenses increased 5.2% on declining sales,
primarily in occupancy, nonstore overhead and store wages. Store rent and
occupancy expenses increased in fiscal 2002 primarily due to increases in
insurance, taxes and other common area charges. These charges are generally
variable and can increase as mall ownership or tenant occupancy rates change.
Things Remembered nonstore expense increased in fiscal 2002 due primarily to
costs associated with the anticipated settlement of a class action complaint in
California involving overtime compensation (See Note 15 of the Notes to
Consolidated Financial Statements). Legal and settlement costs for this matter
totaled $1.1 million. Nonstore overhead also included costs of $0.5 million for
a new store point of sales system, the implementation of which has subsequently
been indefinitely delayed. Severance costs related to a senior Things Remembered
executive totaled $0.3 million. Store wage costs at Things Remembered increased
due to higher average hourly wage rates and increases in benefits and workers
compensation.
Also included in operating expenses, the Company incurred charges of
approximately $3.4 million in fiscal 2002 for outside audit fees related to the
reaudit of its restated financial statements for the previous two years. The
Company and its optical subsidiaries have been sued by the State of California,
which alleges claims for various statutory violations related to the operation
of 24 Pearle Vision Centers in California (see Note 15 of the Notes to
Consolidated Financial Statements). Legal costs associated with the defense of
this matter totaled $3.5 million in fiscal 2002 and were charged to the Cole
Vision segment. During the fourth quarter of fiscal 2002, the Company recorded a
restructuring charge against operating expense of $1.1 million. Of this amount,
$0.6 million was paid and $0.5 million was accrued to accrued liabilities for
ongoing benefits, salary continuation and out placement costs. Charges to the
liability are expected to total $0.4 million through the end of the first
quarter of fiscal 2003, with the remaining costs continuing through the fourth
quarter of fiscal 2003. The restructuring charge was related to a reduction in
workforce of 60 individuals in the corporate office and field management. The
Company expects the functions performed by these individuals to be absorbed by
others. The Company recorded a charge of $0.3 million related to the closing of
the corporate office and relocating it to the Company's facility in Twinsburg,
Ohio. The Company recorded incremental costs of $1.2 million for continuing
group medical and basic life insurance coverage for a group of employees covered
under a postemployment benefits plan. Coverage of these benefits continue until
death. In January 2002, the Company approved a plan freeze of its
noncontributory defined benefit pension plan. As a result, the Company recorded
no pension expense in fiscal 2002, compared to a $1.2 million charge in fiscal
2001, primarily in the Cole Vision segment. See Note 10 of Notes to the
Consolidated Financial Statements for more information. In conjunction with
Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for
Impairment or Disposal of Long-Lived Assets," (SFAS 144), which addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets, the Company evaluated the operating performance of each of its
locations. The Company recorded impairment charges of $0.9 million in fiscal
2002, compared with impairment charges of $3.7 million in fiscal 2001. The
reduction of the impairment charge was primarily attributable to improvements at
Pearle Vision. In November 2002, the Company changed its paid-time-off (PTO)
policy for its employees, and discontinued the practice of permitting most of
its employees to carryover three leave days from one year
12
to the next. As a result of this change in policy, the Company reversed $0.5
million of accrued leave into income, as an offset to operating expense.
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets"
(SFAS142), in the first quarter of fiscal 2002. SFAS 142 requires that goodwill
and certain intangible assets deemed to have indefinite useful lives no longer
be amortized, but instead, be subject to at least an annual review for
impairment. With the adoption of this statement, the Company ceased amortization
of goodwill and tradenames as of February 3, 2002. The Company recorded a $5.0
million goodwill and tradename amortization charge in fiscal 2001.
Operating income in fiscal 2002 was $27.0 million compared with $28.2
million in fiscal 2001, a decrease of 4.3%. A decline in operating income at
Things Remembered and the costs associated with the reaudit, restructuring and
legal costs associated with the California Attorney General's action, as well as
the increased costs of post-employment benefits offset improvements at Cole
Vision.
Interest and other (income) expense, consists of interest expense on the
Company's indebtedness, transaction gains and losses related to its holdings in
notes and interest receivable from Pearle Europe, which are denominated in a
foreign currency, interest income on franchise notes at Pearle Vision, interest
income from temporary investments, and gains and losses from the sale of assets.
Interest and other (income) expense, net, decreased to $20.0 million in fiscal
2002, compared to $25.5 million in fiscal 2001. The Company recorded a
transaction gain of $3.8 million related to its investment in notes and interest
receivable from Pearle Europe in fiscal 2002. This compared to a transaction
loss of $1.2 million in fiscal 2001. In addition, the Company recorded lower
interest expense in fiscal 2002 due to replacement of the $150.0 million 9-7/8%
Senior Subordinated Notes with the issuance of 8-7/8% Senior Subordinated Notes
in May 2002. See Note 5 of the Notes to Consolidated Financial Statements for
further information regarding this transaction. The Company recognized a gain of
$0.7 million from the sale of a Dallas, Texas facility in the first quarter of
fiscal 2001.
The effective income tax rate was 70.0% in fiscal 2002 compared with
187.8% in fiscal 2001. The lower effective tax rate in 2002 was primarily due to
the elimination of goodwill amortization pursuant to the new accounting standard
and a reduction in the provision for valuation allowances related to deferred
tax assets for charitable contribution carryforwards. See Note 9 of Notes to
Consolidated Financial Statements for further discussion.
The results for fiscal 2002 include an extraordinary loss on early
extinguishment of debt of $7.2 million, which is net of an income tax benefit of
$3.9 million. The extraordinary charge represents payment of premiums and other
costs of retiring Cole National Group's 9-7/8% Senior Subordinated Notes due
2006 and the write-offs of unamortized discount and deferred financing fees. See
the section below entitled "Liquidity and Capital Resources" and Note 5 of the
Notes to Consolidated Financial Statements for more information regarding this
transaction.
COLE VISION SEGMENT
Cole Vision revenues were $877.5 million in fiscal 2002, compared with
$836.8 million in fiscal 2001, an increase of 4.9%. Same store sales increased
4.0% at Pearle Vision company-owned stores, primarily reflecting an increase in
average spectacle selling price. Improved merchandise assortment and selling
skills at the store level have resulted in a higher rate of multi-pair purchases
and increased sales of additional features. At Cole Licensed Brands, same-store
sales increased 3.7%, driven by both average spectacle selling price and
increased sales of accessories. New premium product introductions at both Sears
Optical and Target Optical, offset slightly by increased sales of contact
lenses, was a key factor in the average selling price increase. Cole Managed
Vision sales also increased from the prior year, due to increases in claims
revenue and administrative service only (ASO) fees and the addition of laser
procedure revenue.
Gross margin percent declined 0.1% at Cole Vision in fiscal 2002 compared
to fiscal 2001. The decline in gross margin rate was attributable to a change in
sales mix at both Pearle Vision and Cole Licensed Brands. At Pearle, the decline
in margin rate was attributable to increased sales of product to franchisees,
which are sold at lower gross margin rates than retail sales at company-owned
locations. Sales to franchisees offer benefits for the Company, including
producing a more uniform merchandise assortment and consistent brand look across
all stores. Additionally, Pearle's mix of contact lens sales increased, which
also contributed to a decline of the gross margin rate.
At Cole Licensed Brands, the decline in gross margin rate was attributable
to the increased sales of premium product and saleable accessories. Accessories,
which include lens cleaner, lens cloth, clips and other products designed to
care for optical purchases, and premium products, generally are sold at lower
gross margin rates. In addition, Cole Licensed Brands made a strategic decision
to lower retail prices of contact lenses in fiscal 2002 to become more
competitive. The price decrease was a key factor in the gross margin rate
decline.
13
Operating expenses as a percent of sales declined at Cole Vision by 1.3%
in fiscal 2002, compared to fiscal 2001. In conjunction with SFAS 144, the
Company evaluated the operating performance of each of its locations. Cole
Vision recorded impairment charges of $0.4 million in fiscal 2002, compared with
impairment charges of $2.8 million in fiscal 2001. The reduction of the
impairment charge was primarily attributable to improvements at Pearle Vision.
At Pearle Vision, store payroll declined as a percent of sales compared to the
prior year due to higher same-store sales combined with reduced hours. The
average hours worked per store per week was reduced 3.3 hours. In addition,
overtime pay declined as a percent to sales compared to last year. Operating
expenses at Cole Licensed Brands declined as a percent to sales compared to last
year due primarily to improvements at Target Optical. Results at Target Optical
improved as the focus changed from aggressive growth to measured growth and
improved operations. Operating expenses at Cole Managed Vision declined as a
percent to sales compared to last year primarily due to the reduction of
processing fees paid to MetLife as claims processing was converted to the
Company's internal systems at a lower cost per claim. Pension expense was $1.0
million lower than the prior year at Cole Vision due to the Company's decision
to freeze the defined benefit pension plan. Operating expenses in fiscal 2002
included legal costs of $3.5 million associated with the California Attorney
General's action mentioned previously.
Operating income at Cole Vision improved to $30.6 million in fiscal 2002,
compared to $15.1 million in fiscal 2001. The revenue increase of $40.7 million
and improved expense leverage were the primary drivers of the increase in
operating income. Results at Target Optical improved as the focus changed from
aggressive growth to measured growth and improved operations. The cessation of
goodwill and tradename amortization resulted in $4.1 million lower expense in
fiscal 2002, compared to fiscal 2001. In addition, the growth in revenue and
improved claims management efficiencies resulted in higher operating income at
Cole Managed Vision. These improvements were offset by the $3.5 million in legal
costs associated with the California Attorney General's action.
THINGS REMEMBERED SEGMENT
Things Remembered sales were $270.6 million in fiscal 2002, compared with
$272.3 million in fiscal 2001, a decrease of 0.6%. The decrease in sales was
primarily due to a same-store sales decrease of 2.5% and a lower number of
stores operating than the prior year. Store count at fiscal year end dropped
from 774 to 770. The same-store sales decline was primarily attributable to a
slowdown in mall traffic during fiscal 2002. Demand for business award and
recognition gifts also declined during the year due to changes in general
economic conditions. Declines in customer count were partially offset by
increases in average transaction value and a 40% growth in the still relatively
small direct channel business.
The gross margin rate at Things Remembered was the same as the prior year.
At Things Remembered, operating expenses grew 5.2% on declining sales,
primarily in occupancy, nonstore overhead and store wages. Store rent and
occupancy charges increased in fiscal 2002 primarily due to increases in
insurance, taxes and other common area charges. These charges are generally
variable and can increase as mall ownership or tenant occupancy rates change.
Things Remembered nonstore expense increased in fiscal 2002 due primarily to
costs associated with the pending settlement of a class action complaint in
California involving overtime compensation (See Note 15 of the Notes to
Consolidated Financial Statements). Legal and settlement cost for this matter
totaled $1.1 million. Nonstore overhead also included costs of $0.5 million for
a new store point of sales system, the implementation of which has subsequently
been indefinitely delayed. Severance costs related to a senior Things Remembered
executive totaled $0.3 million. Store wage costs at Things Remembered increased
due to higher average hourly wage rates and increases in benefits and workers
compensation. Things Remembered recorded impairment charges of $0.5 million in
fiscal 2002, compared with impairment charges of $0.9 million in fiscal 2001.
Operating income decreased to $15.1 million in fiscal 2002 from $24.1
million in fiscal 2001. Reductions in revenue, higher mall occupancy costs,
higher payroll and overhead costs were the primary causes of the reduction in
operating income.
FISCAL 2001 COMPARED TO FISCAL 2000
CONSOLIDATED OPERATIONS
Total revenue was $1,109.1 million in fiscal 2001, compared with $1,078.6
million in fiscal 2000. Total revenue increased 2.8% in fiscal 2001, primarily
attributable to a 1.4% increase in same-store sales, an increase in the number
of stores opened at year-end from 2,813 to 2,919 and an increase in claims
revenue from managed vision care programs. These increases were partially offset
by one less week of revenue in fiscal 2001. Fiscal 2000 included 53 weeks of
operations, compared to 52 weeks in fiscal 2001. The 53rd week in fiscal 2000
provided approximately $17.6 million in revenue.
14
Gross margin was $744.7 million in fiscal 2001, compared with $719.0
million in fiscal 2000, an increase of 3.6%. Gross margin dollars increased
primarily due to higher revenues at Cole Vision and improvements in gross margin
rate at Things Remembered. Gross margin percent increased to 67.1% in fiscal
2001, compared to 66.7% in fiscal 2000. The increase was attributable to gross
margin rate improvements at both Cole Vision and Things Remembered. The gross
margin rate at Cole Vision was higher than the prior year, although it declined
in the second half of fiscal 2001, as more customers selected merchandise from
Cole Licensed Brands' new, higher cost frame assortment at Sears. Higher revenue
from managed vision care programs partially offset the impact of a decline in
frame margins in fiscal 2001. At Things Remembered, the gross margin rate
improved 1.0% compared to the prior year, reflecting the improvement in average
selling price, lower merchandise acquisition costs, and less inventory
shrinkage.
Operating expenses were $711.5 million in fiscal 2001, compared with
$697.4 million in fiscal 2000, an increase of 2.0%. Increased costs of store
payroll, store occupancy and other store costs to support the increase in
revenue at Cole Vision and the Target Optical expansion comprised most of the
increase. Operating expenses at Cole Vision declined as a percent of sales
compared to last year by 0.4%. Productivity gains at Pearle and reduced managed
care claims processing costs contributed to the improvement. Further discussion
is included in the Cole Vision segment. In conjunction with SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" (SFAS 121), which establishes accounting standards for the
impairment of long-lived assets, certain identifiable intangibles and goodwill
related to those assets, the Company evaluated the operating performance of each
of its locations. In fiscal 2000, Pearle Vision recorded $3.5 million of
impairment charges related to the performance of 39 store locations. This
compared to impairment charges of $2.6 million for 28 locations in fiscal 2001,
a reduction of $0.9 million. At Things Remembered, operating expenses decreased
by $1.5 million. Lower costs of store payroll together with reduced bonus
expenses were partially offset by higher costs of store rent and occupancy.
Things Remembered recorded impairment charges in accordance with SFAS 121 of
$0.9 million in fiscal 2001 compared to $0.3 million the prior year.
Goodwill and tradename amortization was $5.0 million in fiscal
2001 compared to $5.2 million in fiscal 2000.
In fiscal 2001, the Company's operating income improved 72.0% from $16.4
million in fiscal 2000 to $28.2 million in fiscal 2001. Improvements were made
at both segments. At Cole Vision, operating income improved 88.7% from the prior
year due primarily to the reduced impairment charge and to productivity
improvements. Things Remembered operating income improved 7.1% despite a decline
in sales. Lower costs of store payroll and an increase in gross margin rate
mitigated the reduction in revenues. During fiscal 2000, the Company recorded a
restructuring charge against operating expense of $1.8 million. Of this amount,
$1.6 million was paid and $0.2 million was recorded to accrued liabilities for
salary continuation. Charges to the liability were $0.2 million in fiscal 2001.
The restructuring charge was related to a reduction in workforce of 44
individuals in the corporate office. In addition, a reduction in corporate bonus
expense of $0.8 million contributed to the improvement in operating income. The
improvement in operating income occurred despite one less week of sales, and the
absorption of increased losses from the continued expansion of Target Optical.
Interest and other (income) expense, net, increased $0.2 million in fiscal
2001.
The effective tax rate was 187.8% in fiscal 2001 compared to 10.6% in
fiscal 2000. The higher effective tax rate in 2001 was primarily due to
increased provision for state income taxes and an increase in the valuation
allowances related to deferred tax assets for contribution carryforwards. See
Note 9 of Notes to Consolidated Financial Statements for further discussion.
COLE VISION SEGMENT
Cole Vision revenues were $836.8 million in fiscal 2001, compared with
$802.5 million in fiscal 2000, an increase of 4.3%. Same-store sales increased
2.6% at Pearle Vision company-owned stores, reflecting an increase in average
selling price for the first nine months and an increase in the number of
transactions for the fourth quarter. The increase in average selling price was
due, in part, to not repeating a "50% off frames" promotion that ran during the
entire first quarter of fiscal 2000. At Cole Licensed Brands, same-store sales
increased 3.8%, primarily reflecting an increase in the average spectacle
selling price. The 53rd week in fiscal 2000 provided approximately $14.4 million
in revenue.
The gross margin rate at Cole Vision was higher compared to the prior
year, although it declined in the second half of 2001, as more customers
selected merchandise from Cole Licensed Brands' new, higher cost frame
assortment at Sears. Higher revenue from Cole Managed Vision partially offset
the impact of decline in frame margins in fiscal 2001.
Operating expenses increased 3.6%, but declined 0.4% as a percent of sales
compared to last year at Cole Vision. Increased store payroll, occupancy and
other store costs to support the increase in revenues at Cole Vision comprised
most of the increase. Operating expenses at Pearle decreased from the prior
year. Pearle Vision recorded $2.6 million of impairment
15
charges in accordance with SFAS 121 in fiscal 2001 compared to an impairment
charge of $3.5 million in fiscal 2000. In addition, payroll costs were favorable
due to productivity improvements. A reduction of the average weekly hours worked
per store relative to fiscal 2000 was achieved. Other store costs at Pearle were
lower than fiscal 2000, primarily due to write-offs of $0.8 million in third
party receivables in fiscal 2000. Expenses declined as a percent of sales
compared to last year at Cole Managed Vision due to a reduction in the
processing cost per claim and increased volume and leverage gains in capitated
business.
Operating income at Cole Vision improved to $15.1 million in fiscal 2001,
compared to $8.0 million in fiscal 2000. The reduction of the impairment charge
at Pearle Vision and other operating improvements at both Pearle and Cole
Managed Vision were the primary reasons for the increase. Gains in retail
operations were tempered by the loss of revenues associated with the 53rd week
in fiscal 2000 as well as the expansion of Target Optical. The Company opened
107 Target Optical stores during fiscal 2001. The losses associated with the
Target Optical expansion are expected to decline as older stores ramp up to
profitability, as a result of the new focus on opening only in Super Target
stores and with a switch from fixed to percentage rent. The average time to
store level profitability is also expected to become shorter.
THINGS REMEMBERED SEGMENT
Things Remembered revenues were $272.3 million in fiscal 2001, compared
with $276.1 million in fiscal 2000, a decrease of 1.4%. The largest contributor
to this year over year decrease was the 53rd week in fiscal 2000, which provided
approximately $3.2 million in revenue. The decrease in revenues was due to a
same-store sales decrease of 1.8%, attributable to the general slowdown in mall
traffic which worsened following the events of September 11 and from not
repeating a merchandise clearance promotion that was held in fiscal 2000.
However, the average transaction selling price increased as a result of sales of
new merchandise at higher average unit retails, more personalization and fewer
promotions.
At Things Remembered, the gross margin rate improved 1.0 percentage points
compared to the prior year, reflecting the improvement in average selling price,
lower merchandise acquisition costs and less inventory shrinkage.
Operating expenses decreased $1.5 million in fiscal 2001 compared to the
prior year due to lower costs of store payroll and bonus expense. These
improvements were partially offset by higher costs of rent and occupancy. Things
Remembered recorded impairment charges in accordance with SFAS 121 of $0.9
million in fiscal 2001 compared to $0.3 million in the prior year.
Operating income increased to $24.1 million in fiscal 2001 from $22.5
million in fiscal 2000, primarily due to lower operating expenses and
improvements in gross margin rate.
RECONCILIATION OF SAME-STORE SALES GROWTH
Same store sales growth is a non-GAAP financial measure, which includes
deferred warranty sales on a cash basis and does not reflect provisions for
returns and remakes and certain other items. The Company's current systems do
not gather data on these items on an individual store basis. Adjustments to the
cash basis sales information accumulated at the store level are made for these
items on an aggregate basis. As a retailer, the Company believes that a measure
of same store performance is important for understanding its operations. The
Company calculates same-store sales for stores opened for at least twelve
months. A reconciliation of same store sales to revenue reported on a GAAP basis
follows:
16
2002 2001 2000
----------- ----------- -----------
(Dollars in thousands)
Current year same-store sales $ 993,776 $ 961,240 $ 949,023
Prior year same-store sales(1) 976,291 948,060 915,286
Percent change 1.8% 1.4% 3.7%
Current year same-store sales $ 993,776 $ 961,240 $ 949,023
Adjustment for:
Sales at new and closed stores 30,185 25,510 26,504
Extended warranties (2,701) (1,846) (102)
Order vs. customer receipt (478) 4,341 (3,148)
Returns, remakes and refunds (1,183) (751) (707)
Other (37) 188 (968)
----------- ----------- -----------
Store sales 1,019,562 988,682 970,602
Nonstore revenues 157,042 146,631 129,072
Intercompany eliminations (28,485) (26,190) (21,040)
----------- ----------- -----------
GAAP Basis Net Revenue $ 1,148,119 $ 1,109,123 $ 1,078,634
=========== =========== ===========
(1) Prior year same-store sales differ from current year same-store sales in
the prior year due to store openings and closings.
LIQUIDITY AND CAPITAL RESOURCES
Cole National Corporation's primary source of liquidity is funds provided
from operations of its operating subsidiaries. In addition, its wholly owned
subsidiary, Cole National Group, Inc., and its operating subsidiaries have a
working capital line of credit. As of fiscal year end 2002, the total commitment
was $75.0 million and availability under the credit facility totaled $62.7
million after reduction for commitments under outstanding letters of credit.
There are no working capital borrowings outstanding as of February 1, 2003. The
maximum amount outstanding during fiscal 2002 was $2.3 million and the daily
average borrowing during fiscal 2002 was approximately $31,000.
The credit facility, which is guaranteed by Cole National Corporation and
Cole National Group, requires Cole National Group and its principal operating
subsidiaries to comply with various operating covenants that restrict corporate
activities, including covenants restricting the ability of the subsidiaries to
incur additional indebtedness, pay dividends, prepay subordinated indebtedness,
dispose of certain investments or make acquisitions. The credit facility also
requires Cole National Group to comply with certain financial covenants,
including covenants regarding minimum interest coverage and maximum leverage. On
November 25, 2002, the Company received a waiver from the lenders under the
credit facility, which expired on December 31, 2002, of certain covenants to
accommodate anticipated changes in the accounting treatment for the sale of
certain optical warranties and the costs associated with auditing the Company's
restated consolidated financial statements. On December 19, 2002, the credit
agreement was amended to accommodate the anticipated changes due to the
restatement. The Company received a waiver dated May 9, 2003 of the maximum
leverage coverage test for the fiscal year end 2002 and the first quarter of
fiscal 2003. During that waiver period the maximum leverage test was adjusted to
accommodate the effect of the restatement on the Company's financial statements.
This waiver will expire on the earlier of May 17, 2003 if the Lenders do not
receive the Form 10-K and 10-Q's for the first through third fiscal quarters of
2002; on May 23, 2003 if certain additional financial information is not
received by the Lenders; or June 30, 2003. The Company is currently in
compliance with the covenants in the credit agreement and currently expects to
meet the waiver conditions. The Company currently expects to complete a
permanent amendment to the credit agreement on or before June 30, 2003. However,
there is no assurance that the Company will be successful in its effort to
complete such an amendment by that time if at all. The Company believes that,
even if it is unsuccessful in its effort to complete such an amendment, it will
have sufficient liquidity from internal and other external sources.
On May 22, 2002, the Company issued $150.0 million of 8-7/8% senior
subordinated notes due 2012. The notes are unsecured and mature on May 15, 2012.
Net proceeds from the notes offering, together with cash on hand, were used to
retire $150.0 million of 9-7/8% senior subordinated notes due 2006 and pay
premium and other costs associated with retiring those notes. An extraordinary
loss on early extinguishment of debt of $7.2 million, which is net of an income
tax benefit of $3.9 million, representing the payment of premiums and other
costs of retiring the notes and write-offs of unamortized discount and deferred
financing fees, was recorded in the second quarter of fiscal 2002.
17
The indentures pursuant to which the 8-5/8% notes and the 8-7/8% notes
were issued contain certain optional and mandatory redemption features and other
financial covenants, including restrictions on the ability of Cole National
Group to incur additional indebtedness, pay dividends or make other restricted
payments to Cole National Corporation. The indentures also permit payments to
Cole National Corporation for certain tax obligations and for administrative
expenses not to exceed 0.25% of net sales. See Note 5 of the Notes to
Consolidated Financial Statements. The Company may from time to time purchase
its outstanding notes in the open market or refinance them depending on capital
market conditions.
No significant principal payment obligations are due under the Company's
outstanding indebtedness until April 2004, when a $5.0 million principal payment
is due under a 5.0% promissory note and until 2007, when the $125.0 million
Senior Subordinated debt is due. The ability of Cole National Corporation and
its subsidiaries to satisfy their obligations will be primarily dependent upon
the future financial and operating performance of the subsidiaries and upon Cole
National Corporation's ability to renew or refinance borrowings or raise
additional capital through equity financing or sales of assets.
The Company maintains a noncontributory defined benefit pension plan that
covers employees who have met eligibility service requirements and are not
members of certain collective bargaining units. The pension plan calls for
benefits to be paid to eligible employees at retirement, based primarily upon
years of service and their compensation levels near retirement. In January 2002,
the Company approved a plan freeze for all participants except for participants
who are at least age 50 or older with 10 years of benefit service as of March
31, 2002. These participants had their average pay frozen as of March 31, 2002,
and covered compensation frozen as of December 31, 2001, but their benefit
service will continue to grow. The Company's policy is to fund amounts necessary
to keep the pension plan in full force and effect, in accordance with the
Internal Revenue Code and the Employee Retirement Income Security Act of 1974.
During fiscal 2002, the Company changed the discount rate used to
calculate its projected benefit obligation from 7.5% to 6.5%. The change in the
discount rate reflects the overall decline in market interest rates and has led
to an increase in the projected benefit obligation at February 1, 2003. In
addition, the stock market declines have reduced the fair value of the pension
plan's assets. As a result of these factors, the pension plan was underfunded by
$16.0 million as of February 1, 2003. The Company has written off a prepaid
pension asset of $4.6 million and recorded the minimum pension liability by
charging $20.6 million to accumulated other comprehensive income (loss) in
stockholders' equity. This charge will not impact the actual funding
requirements of the plan or the Company's compliance with debt covenants.
In November 1998, the Board of Directors authorized the repurchase from
time to time of up to 1.0 million shares of common stock, through open market or
block transactions. It is expected that any purchases will be made from
internally generated funds and that the shares purchased will be used, in part,
to offset dilution from stock options and in connection with other benefit
plans. As of February 1, 2003, Cole National Corporation had purchased a total
of 318,000 shares of common stock and has authority to purchase up to 682,000
additional shares of common stock in the open market or through block purchases.
No shares were purchased during fiscal 2002, 2001 or 2000.
Cash and cash equivalents at year end were $42.0 million at February 1,
2003 compared to $63.4 million at February 2, 2002. Operations generated net
cash of $35.9 million in fiscal 2002, compared with $54.7 million in fiscal 2001
and $32.7 million in fiscal 2000. The primary reason for the $18.8 million
decrease in cash provided from operations in fiscal 2002 compared to fiscal 2001
was changes in working capital. Changes in working capital resulted in a use of
funds totaling $3.8 million in fiscal 2002 compared to a source of funds
totaling $8.3 million in fiscal 2001. During fiscal 2001, the Company undertook
an extensive re-merchandising program at Pearle Vision, which contributed to an
inventory reduction of $9.8 million. Changes in receivables and other assets
resulted in a use of $11.2 million in cash in fiscal 2002, compared to a source
of $0.7 million in fiscal 2001. The increase in receivables was primarily due to
increased sales and corresponding receivables at Cole Vision. Changes in
accounts payable and other liabilities resulted in a source of cash of $8.8
million in fiscal 2002 compared to a use of cash of $4.2 million in fiscal 2001.
The increase in other liabilities was due to accrued audit fees, deferred
revenues, accrued retirement plans, benefit obligations and bonus accruals.
Changes in accrued taxes resulted in a use of cash of $4.1 million in fiscal
2002, primarily due to a decrease in current year accruals for federal and state
income taxes.
Net cash from investing activities resulted in a use of funds of $51.0
million in fiscal 2002, compared to $36.9 million in fiscal 2001. Capital
expenditures, which accounted for most of the cash used for investing, were
$39.4 million, $33.8 million and $28.9 million in fiscal 2002, 2001 and 2000,
respectively. The majority of capital expenditures were for store fixtures,
equipment and leasehold improvements for new stores, including the Target
Optical expansion, and remodeling of existing stores. A payment was made to
Target Corporation in fiscal 2002 in consideration of prior years' capital
expenditures, which had been accrued. The Company paid approximately $5.6
million, $6.9 million and $8.4 million for systems development costs in fiscal
2002, 2001 and 2000, respectively. Such costs have been capitalized and are
being
18
amortized over the systems' estimated useful lives. In fiscal 2002, the Company
provided a $4.0 million loan to U.S. Vision, Inc., as part of that company's
management-led buyout. U.S. Vision is a large provider in Cole Managed Vision's
Preferred Provider Network. Interest on the note accrues at 8.75% per annum
(11.75% per annum in the event of default per the agreement) and is due
quarterly starting on December 31, 2002 and on the last day of each March, June
and September. The note matures December 1, 2003. The Company used $1.6 million
and $0.8 million in fiscal 2002 and fiscal 2001, respectively, for contingent
payments in connection with the prior acquisition of MetLife's managed vision
business. In fiscal 2001, net proceeds of $12.5 million were received from the
sale of two facilities no longer required for operations and from the sale and
leaseback of Pearle Vision's former headquarters office building in Dallas,
Texas and a portion of the land. In fiscal 2001, the Company used $6.4 million
for additional net investment in Pearle Europe, primarily in connection with its
acquisition of an optical retailer in Portugal.
For fiscal 2003, the Company plans to expand the number of stores,
including opening approximately 23 Target Optical stores, and to remodel and
relocate other stores. The Company expects to open in new Super Target stores
that will offer Target Optical excellent, highly visible and high traffic
locations. As a result, the Company's emphasis on Target Optical has moved from
opening stores to improving their operations. The Company currently estimates
that capital expenditures in fiscal 2003 will be approximately $35.5 million,
excluding acquisition and systems development costs. Approximately $3.9 million
is estimated to be incurred for systems development costs in 2003, which will be
capitalized and subsequently amortized.
Net cash used for financing activities totaled $6.4 million in fiscal
2002. Net cash provided by financing totaled $8.4 million and $8.3 million in
fiscal 2001 and fiscal 2000, respectively. In May 2002, Cole National Group,
Inc., issued $150.0 million of 8-7/8% Senior Subordinated Notes due May 2012.
The net proceeds of the issuance and cash on hand were used to retire all of
Cole National Group's $150.0 million 9-7/8% Senior Subordinated Notes due 2006.
Finance fees and early repayment of the 9-7/8% notes resulted in a net cash
usage of $14.2 million. In fiscal 2000, the Company entered into a sale and
leaseback transaction from the sale of its office facility in Twinsburg, Ohio.
The transaction was accounted for under the finance method of accounting. At the
time of the transaction, the Company had a continuing involvement. In July 2001,
the continuing involvement ended and the transaction was reflected as a sale and
leaseback. The Company received approximately $13.5 million in fiscal 2000, net
of related costs.
The Company believes that funds provided from operations, including cash
on hand, along with funds available under the credit facility, will provide
adequate sources of liquidity to allow its operating subsidiaries to continue to
expand the number of stores and to fund capital expenditures and systems
development costs.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Company leases a substantial portion of its equipment and facilities
including laboratories, office and warehouse space, and retail locations. In
addition, Cole Vision operates departments in various host stores and pays
occupancy costs solely as a percentage of sales. A more complete discussion of
the Company's lease and license commitments is included in Note 12 of the Notes
to Consolidated Financial Statements.
The Company guarantees future minimum lease payments for certain store
locations leased directly by Pearle franchisees. The term of these guarantees
range from one to ten years of which many are limited to periods that are less
than the full term of the leases involved. A more complete discussion of the
Company's guarantees is included in Note 12 of the Notes to Consolidated
Financial Statements.
The following table summarizes certain payments due by period for
contractual obligations including operating leases:
Payments Due by Period (Dollars in thousands)
----------------------------------------------------------------------
Less Than After
Contractual Obligations Total 1 Year 1-3 Years 4-5 Years 5 Years
- ----------------------- -------- -------- -------- -------- --------
Long-term debt $285,000 $ -- $ 6,000 $127,000 $152,000
Capital lease obligations, including interest 1,210 328 576 306 -
Operating leases 419,079 82,904 133,282 88,217 114,676
Sublease agreements (43,223) (10,765) (15,825) (9,793) (6,840)
-------- -------- -------- -------- --------
Total contractual obligations $662,066 $ 72,467 $124,033 $205,730 $259,836
======== ======== ======== ======== ========
19
INVESTMENT IN PEARLE EUROPE
Included in other assets is the Company's minority investment in Pearle
Europe B.V. ("Pearle Europe"). HAL Holding N.V. ("HAL") owns a 68% interest, the
Company owns a 21% interest, and Pearle Europe's management owns the remaining
11% interest in Pearle Europe. The Company believes that it no longer has the
ability to exercise significant influence over the operating and financial
policies of Pearle Europe as a result of a change in the shareholders agreement
in June 2000. Accordingly, as discussed in Notes 2 and 17 of Notes to
Consolidated Financial Statements, the Company's common equity investment in
Pearle Europe of $9.1 million at February 1, 2003 is accounted for using the
cost method. At February 1, 2003 the Company also holds $19.6 million of loans
and interest receivable from Pearle Europe.
Pearle Europe is one of Europe's largest optical retailers, and owns a
number of optical retail chains with a total of more than 1,100 stores in eleven
European countries. Pearle Europe's revenues for its fiscal year ended December
31, 2002 increased 22% to EUR 470 million or $490.0 million. In November 2002
Pearle Europe acquired the optical retail activities of Instrumentarium Oy
("Instrumentarium"), a Finnish company. These activities include optical retail
chains in Finland, where it is the market leader with 132 stores; Sweden, where
it has 31 stores, including 8 operated by franchisees; Estonia, where it has 15
stores; and Russia, where it has 1 store. Instrumentarium's revenue for 2002 was
EUR 106 million or $111.0 million.
The Company's equity interest in Pearle Europe includes 2 Class A Common
Shares and 22,887 Class B Common Shares. Pearle Europe is closely held, and
there is no market for these shares. The 2 Class A Common Shares have preferred
share characteristics.
On occasion, HAL, the Company or Pearle Europe sell shares to, or offer
liquidity to and purchase shares from members of Pearle Europe management.
Pearle Europe has developed a methodology to set a fair price for such purchase
and sale transactions that is based upon the performance of its operating
subsidiaries, the prices paid by Pearle Europe for recent acquisitions, and
other factors. The most recent sale transaction of Class B Common Shares was
completed by Pearle Europe at a price of EUR 4,190 per share. Applying this
price to the Company's holdings of Pearle Europe Class B shares would indicate a
value for the Company's holdings of EUR 96.0 million, which is equal to $103.0
million, using the exchange rate on February 1, 2003. A limited scope appraisal
by Valuation Research, the Company's independent valuation advisors, indicates
that this figure is within a range of reasonable values for the Company's equity
interest in Pearle Europe, without taking into account discounts for minority
interest or lack of marketability. Given the illiquid nature of this investment,
there is no assurance that the Company would be able to sell its interest in
Pearle Europe for that amount or at all. Moreover, the Company currently has no
plans to sell its interest in Pearle Europe.
Agreements between HAL, the Company and members of Pearle Europe
management require HAL and the Company to periodically offer to purchase Pearle
Europe shares held by the members of Pearle Europe Management. The offer price
is to be set by HAL and the Company by agreement, and is required to be "fair in
the opinion of" HAL and the Company. These offers are required to be made (1)
not later than September 3, 2003, (2) in May 2005, and (3) biannually in May
commencing in 2007. The obligations to fund the purchase of any shares as to
which the offer to purchase is accepted are pro rata to HAL and to the Company
based on their respective ownership interests on the date of the offer.
HAL and the Company have not yet agreed on the price to offer this year or
on the process to agree to the price or on the source of funding for any
purchases. Funds could be derived from payments by Pearle Europe, from the
separate resources of HAL and the Company, or from financings. In the event that
all of Pearle Europe's managers who are entitled to receive an offer to purchase
their shares were to accept that offer, the resulting obligation to the Company
could be material. The Company believes that it will have sufficient liquidity
to meet the obligation, if any, that may result from their commitment in fiscal
2003.
RECENTLY ISSUED ACCOUNTING STANDARDS
The Company adopted SFAS 142, "Goodwill and Other Intangible Assets" (SFAS
142) in the first quarter of fiscal 2002. This statement requires that goodwill
and certain intangible assets deemed to have indefinite useful lives no longer
be amortized, but instead be subject to at least an annual review for
impairment. Other intangible assets with finite lives are amortized over their
useful lives. With the adoption of this statement, the Company ceased
amortization of goodwill and tradenames as of February 3, 2002. Amortization of
goodwill and tradenames totaled $5.0 million and $5.2 million in fiscal 2001 and
fiscal 2000, respectively.
During the second quarter of fiscal 2002, the Company completed the
transitional impairment testing of goodwill as required by SFAS 142. Based on
the findings of its outside valuation advisor, the Company has concluded that
there was no impairment of either its goodwill or tradenames at the adoption
date of the new accounting standard, effective February 3, 2002. The Company has
elected to perform its annual tests for potential impairment as of the first day
of the Company's
20
fourth quarter. Based on its annual tests performed in the fourth quarter of
fiscal 2002, the Company has concluded that there was no impairment of its
goodwill or tradenames. As part of the restatement, the Company and its outside
valuation advisor reviewed the previously completed impairment testing and
confirmed that there was no impairment of either goodwill or tradenames.
The Financial Accounting Standards Board (FASB) has issued SFAS No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of SFAS Statement
No. 13, and Technical Corrections" (SFAS 145). SFAS 145 states that the
rescission of SFAS No. 4 shall be applied in fiscal years beginning after May
15, 2002. Any gain or loss on extinguishment of debt that was classified as an
extraordinary item in prior periods presented that does not meet the criteria in
Accounting Principles Board (APB) Opinion 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for
classification as an extraordinary item shall be reclassified as operating
expenses. The Company will adopt SFAS 145 as of the beginning of fiscal 2003. As
a result, the loss on early extinguishment of debt reported as an extraordinary
item for the year ended February 1, 2003 will be reclassified at that time. The
pretax loss from the early extinguishment of debt will be presented as a
separate line within interest and other (income) expenses and the related income
tax benefit will reduce the reported income tax provision. Other portions of the
statement are not applicable to the Company.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS 146). This statement requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002. The Company adopted SFAS 146 on January 1, 2003. The adoption had no
effect on the Company's financial position or operations.
The FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosures" (SFAS 148) which amends SFAS No. 123, "Accounting
for Stock-Based Compensation" (SFAS 123). SFAS 148 provides alternate methods of
transition for a voluntary change to the fair value method of accounting for
stock-based employee compensation. In addition, SFAS 148 amends the disclosure
requirements of SFAS 123 to require more prominent and more frequent disclosures
in the financial statements about the effects of stock-based compensation. The
Company has adopted the disclosure provisions of SFAS 148 as of fiscal 2002.
The FASB has also issued SFAS No. 143, "Accounting for Asset Retirement
Obligations" (SFAS 143), and SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets" (SFAS 144). SFAS 143 provides guidance for legal
obligations arising from the retirement of long-lived assets. SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. SFAS 144 was adopted during fiscal 2002 and had no effect on the
Company's financial position or operations. SFAS 143 will be adopted during
fiscal 2003 and is not expected to have a material effect on the Company's
financial position or operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). This interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The Company adopted the fair value recognition provision
of this interpretation for guarantees issued or modified after December 31,
2002, which did not have a material effect on the Company's financial position
or operations. The disclosure provisions of the interpretation have been adopted
for the year ended February 1, 2003.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN 46). The Interpretation
requires certain variable interest entities, including certain special purpose
entities, to be consolidated by the primary beneficiary if the equity investors
in the entity do not have all the essential characteristics of a controlling
financial interest or do not have sufficient equity at risk. The Interpretation
immediately applies to entities created after January 31, 2003, and at the
beginning of the Company's 2003 third quarter for existing variable interest
entities. Management is still assessing the impacts of this Interpretation on
its consolidated financial statements. However, it is reasonably possible that
the synthetic operating lease for the Highland Heights, Ohio facility will
require consolidation under this Interpretation. The consolidation will require
an additional $2.4 million in assets and liabilities on the consolidated balance
sheet.
In November 2002, the Emerging Issues Task Force of the FASB ("EITF")
reached a consensus on Issue 02-16, "Accounting by a Reseller for Cash
Consideration Received from a Vendor" (Issue 02-16). Certain aspects of the
issue were effective immediately, which were adopted and did not have a
significant impact on operations. The remaining portion of Issue 02-16 will be
adopted during fiscal 2003 and is not expected to have a material effect on the
Company's financial position or operations.
21
CONTINGENCIES
The Company and its optical subsidiaries have been sued by the State of
California, which alleges claims for various statutory violations related to the
operation of 24 Pearle Vision Centers in California. The claims include untrue
or misleading advertising, illegal dilation fees, unlawful advertising of eye
exams, maintaining an optometrist on or near the premises of a registered
dispensing optician, unlawful advertising of an optometrist, unlicensed practice
of optometry, and illegal relationships between dispensing opticians, optical
retailers and optometrists. The action seeks unspecified damages, restitution
and injunctive relief. Although the State of California obtained a preliminary
injunction to enjoin certain advertising practices and from charging dilation
fees in July 2002, the terms of the injunction have not had and are not expected
to have any material effect on the Company's operations. In addition, both the
State and the Company have appealed the preliminary injunction. The injunction
is not expected to have a material effect on the Company's operations. Although
the Company believes it is in compliance with California law and intends to
continue to defend the issues raised in the case vigorously, it may be required
to further modify its activities or might be required to pay damages and or
restitution in currently undeterminable amount if it is not successful, the cost
of which, as well as continuing defense costs, might have a material adverse
effect of the Company's operating results and cash flow in one or more periods.
Things Remembered, Inc. is in the process of settling a class action
complaint in California alleging that the putative class (alleged to include 200
members) were improperly denied overtime compensation in violation of a
California law. The action sought unspecified damages, interest, restitution, as
well as declaratory and injunctive relief and attorneys' fees. On February 3,
2003, Things Remembered and the plaintiffs reached an agreement to resolve the
lawsuit for $562,500. The settlement is subject to court approval. A liability
of $562,500 was recorded in the fourth quarter of 2002.
Cole National Corporation is defending a purported class action lawsuit
alleging claims for various violations of federal securities laws related to the
Company's publicly reported revenues and earnings. The action, which proposes a
class period of March 23, 1999 through November 26, 2002 and names the Company
and certain present and former officers and directors as defendants, seeks
unspecified compensatory damages, punitive damages "where appropriate", costs,
expenses and attorneys fees. Following the Company's announcement in November
2002 of the restatement of the Company's financial statements, (see Note 17 of
the Notes to Consolidated Financial Statements), the Securities and Exchange
Commission began an inquiry into the Company's previous accounting. The course
of this or further litigation or investigations arising out of the restatement
of the Company's financial statements cannot be predicted. In addition, under
certain circumstances the Company would be obliged to indemnify the individual
current and former directors and officers of the Company who are named as
defendants in litigation or who are or become involved in an investigation. The
Company believes it has insurance that should be available with respect to
litigation and any indemnification obligations. However, if the Company is
unsuccessful in defending against any such litigation, and if its insurance
coverage is not available or is insufficient to cover its expenses, indemnity
obligations and liability, if any, the litigation and/or investigation may have
a material adverse effect on the Company's financial condition, cash flow and
results of operations.
As described in Part I, Item 3, "Legal Proceedings", Cole National Group,
Inc. has been named as a defendant along with numerous other retailers, in
patent infringement litigation challenging the defendants' use of bar code
technology. The Company believes it has available defenses and does not expect
any liability. However, if Cole National Group, Inc. were to be found liable for
an infringement, it might have a material adverse effect on our operating
results and cash flow in the period incurred.
In the ordinary course of business, the Company is involved in various
other legal proceedings. The Company is of the opinion that the ultimate
resolution of these matters will not have a material adverse effect on the
results of operations, liquidity or financial position of the Company.
SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements requires the Company to estimate
the effect of various matters that are inherently uncertain as of the date of
the financial statements. Each of these required estimates varies in regard to
the level of judgment involved and its potential impact on the Company's
reported financial results. Estimates are deemed significant when a different
estimate could have reasonably been used or where changes in the estimate are
reasonably likely to occur from period to period, and would materially impact
the Company's financial condition, changes in financial condition or results of
operations. The Company's significant accounting policies are discussed in Note
1 of the Notes to Consolidated Financial Statements. Critical estimates inherent
in these accounting policies are discussed in the following paragraphs.
ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
The Company records an allowance for uncollectible accounts to reflect
management's best estimate of losses inherent in its portfolio of receivables
from Cole Licensed Brands' host stores, Pearle Vision franchisees and managed
vision care accounts. The allowance is established through a charge to the
provision and represents amounts of current and past due receivable balances
which management estimates will not be collectible. The Company calculates the
allowance for uncollectible
22
accounts using historical experience, current trends, credit policy and aging
reports. An analysis, including historical performance, break-even analysis and
payment arrangements is performed on delinquent accounts. The Company's
calculation is reviewed by management to assess whether additional consideration
is required to appropriately estimate losses in the receivable portfolio.
Management believes its receivables are adequately reserved under current
conditions. Any significant deterioration in the economic environment could
materially affect these expectations.
VALUATION OF INVENTORIES
Inventories are recorded at the lower of cost or market based on the
first-in, first-out (FIFO) method for the optical inventories and based on the
weighted average cost method for the gift inventories. The Company records a
reserve for future inventory cost markdowns to be taken for inventory not
expected to be part of its ongoing merchandise offering. The reserve is
estimated based on historical information regarding sell through for similar
products. The Company records a reserve for estimated shrinkage based on various
factors including sales volume, historical shrink results and current trends.
Management believes its inventories are appropriately valued.
VALUATION OF LONG-LIVED ASSETS
Property and equipment, systems development, and other finite intangibles
are amortized over their estimated useful lives. Useful lives are based on
management's estimates of the period that the assets will generate revenue.
These assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. An
initial screening is performed on all long-lived assets. Store locations less
than three years old and stores relocated within three years of fiscal year-end
are excluded from testing. If the undiscounted future cash flows from the
long-lived asset are less than the carrying value, the Company recognizes a loss
equal to the difference between the discounted future cash flow and the carrying
value. Management's estimate of future cash flow is based on our experience,
knowledge and market data. However, these estimates can be affected by factors
such as future store profitability, real estate demand and economic conditions
that can be difficult to predict.
Goodwill, noncompete agreements and tradename assets were amortized over
their estimated useful economic life using the straight-line method and are
carried at cost less accumulated amortization. Beginning with fiscal year 2002,
all goodwill and tradename amortization ceased in accordance with Statement of
Financial Accounting Standard (SFAS) No. 142, "Goodwill and Other Intangible
Assets" (SFAS 142); and both goodwill and tradenames are tested at least
annually for impairment. The Company adopted the first day of the fourth fiscal
quarter for the annual impairment review.
VALUATION OF DEFERRED INCOME TAXES
Deferred tax assets and liabilities are recognized based on the
differences between the financial statement carrying amounts and the tax bases
of assets and liabilities. Management regularly reviews its deferred tax assets
for recoverability and establishes a valuation allowance for tax assets based on
historical taxable income, projected future taxable income and the expected
timing of the reversals of existing temporary differences. In determining the
valuation allowance related to deferred tax assets, management estimates taxable
income into the future. The assessment of whether or not a valuation allowance
is required often requires significant judgment including the forecast of future
taxable income and the evaluation of tax planning initiatives. Adjustments to
the deferred tax valuation allowance are made to earnings in the period when
such assessment is made.
ALLOWANCE FOR REMAKES AND RETURNS
Sales are recorded in accordance with the Company's policy for revenue
recognition and deferred revenue discussed in the summary of Significant
Accounting Policies. Revenues have been reduced by allowances for remakes of
product and returns. The estimated allowances are calculated as a percentage of
sales and based upon historical return percentages.
MANAGED VISION UNDERWRITING RESULTS
The Company sells capitated managed vision care plans which generally have
a duration of one year. Based upon its experience, the Company believes that it
can predict utilization and claims experience under these plans with a high
level of confidence. Underwriting results are recognized using an estimated
percentage of claims revenue. Each quarter, a portion of the resulting gain is
reserved for potential variances between predicted and actual results. The
reserves are reconciled following the end of each plan year.
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SELF-INSURANCE RESERVES
Due to the significant deductible under its insurance policies, the
Company is primarily self-insured for property loss, workers' compensation,
automobile and general liability costs. The liabilities are determined
actuarially based on claims filed and estimates for claims incurred but not
reported. These liabilities are not discounted. In estimating the obligation
associated with incurred losses, the Company utilizes loss development factors
prepared by independent third party actuaries. These development factors utilize
historical data to project the future development of incurred losses. Loss
estimates are adjusted based upon actual claims settlements and reported claims.
DEFINED BENEFIT RETIREMENT PLANS
The plan obligations and related assets of defined ben